ea_2013_1-2 notes from the editor-in-chief the economic analysis (ea) seeks the input of top quality scientific papers with contributions from multiple disciplines. in line with this, we invite you to send us scientifically based research papers, case studies and book reviews in business economics, entrepreneurship, education, finance, employment, marketing and other scientific disciplines. i thank all our members of the editorial board and advisory board and reviewers for their continued support and encouragement. the journal is currently indexed with the following databases: directory of open access journals (doaj) ebsco gesis ullbe university databases cabell's directories of publishing opportunities google scholar. more information about the journal can be found on our website http://www.ien.bg.ac.rs/index.php/sr/asopis-ekon-analiza. we encourage potential authors to contact us if they have any questions about the relevance of their papers for submission. questions may be directed to the editorial office at eaoffice@ien.bg.ac.rs. may, 2013. yours, editor-in-chief prof. dr. mirjana radović-marković, fea, frsa, fwaas, femaas, skanu microsoft word 2011_1-2 review    reviewing form for trilogy of national center for european and global studies of slovak republic        objectives  of  all  three  monographies,  issued  by  national  centres  for  european  and  global studies of the slovak republic – university of economics in bratislava, are very clear  and precise. the first one „creativity, invention, inovation – incentives for growth, prosperity and  sustainability of the slovak republic“ covered different aspects in area of managing inovations.  in order to achieve lisbon goals eu must invest in inovations and knowledge. authors tried  to put attention on varios questions how to improve level of innovation in slovak republic  in  order  to  achieve  eu  level  in  that  field.  there  are  a lot  of  good  contributions  such  as  innovative  incentives  to  accelerate  the  development  of  slovak  economy,  synergy  of  creativity, invention and innovation, economic funds and their potential for a socio‐economic  development in slovakia, etc. some authors tried to analyze foreign experience, such as in  nordic  countries,  denmark,  visegrad  countries  and  the  others.  the  analysis  was  done  correctly,  the  results  of  analysis  were  correctly  interpreted  and/conclusions  were  sound.  writing style was mostly clear and concise. in my opinion some chapters could be avoided,  but overall impression is very positive.  monograph  no.  2  „overcoming  crisis  –  creation  of  the  new  model  for  socio‐economic  development of slovakia“ tried to give some new and fresh view on global crisis and slovak  economic development after that. authors discuses need for new post‐crisis model of socio‐ economic  development  in  slovakia,  as  well  as  other  questions,  like  –  social  justice  and  development, seeking a new civilization paradigm, the economic knowledge creation in the  global knowledge‐based society,  trends  in  territorial development  in slovakia,  intellectual  security on slovakia, culture and a regional develpment factor and so many other questions.  i am  pretty  sure  that  this  monograph  will  offer  a fresh  and  very  original  view  on  some  contemporary economic and social problems and be source of solution for decision makers  in  slovak  government.  thera  are  a lot  of  good  ideas  which  could  help  fast  recovery  of  slovak economy after crises.  book no. 3 „economic aspect of social justice and human rights“ round up this trilogy.  putting attention on value system of social justice, problems and tasks of the community of  science, national and regional development in the globalized context, social responsibility,  creative  economy,  and  so  many  other  questions  this  unique  monograph  offer  variety  of  different  opinions  and  ideas.  economic  crisis  always  has  some  social  implication.  global  economic  and  financial  crisis  changed  the  world  for  ever.  analysing  economic  aspect  of  social  justice  and  human  right  is  brave  and  wise  decison.  i congratulate  to  the  authors,  editors and center for this kind of courrage.       erić, d., reviewing form for trilogy, ea (2011, vol. 44, no. 1‐2, 98‐99)     99 in these monographies highly reputable slovak as well as foreign authors have presented  their opinions on present development of global economy, in europe as well as in the slovak  republic.  the implications derived from this triology can be succesfully applied also on the  serbian economic environment which makes these publications even more recommendable  for academic and broader audience.       erić dejan  institute of economic sciences, belgrade            microsoft word 2010_1_2.doc review book review inflation and unemployment by bojan dimitrijević there’s no book or a study guide in contemporary macroeconomic literature which don’t deal with a phillips curve as analytical instrument that explains relation between unemployment rate and a rate of wage changes. the phillips curve became obligatory part of macroeconomic theory, subject of numerous empirical examinations, theoretical discussions and controversies, conclusions and recommendations for concrete application in shaping economic policy. a modern version of phillips curve in combination with is lm and as – ad model indicates how inflation, unemployment, and gdp can be affected through monetary and fiscal policy, as well as managing aggregate demand and supply. the author’s objective is to show theoretical fundamentals of phillips curve and phillipsokun’s model; to point out the place of this concept in leading theoretical schools – it’s genesis and numerous research related to it. the book consists of six chapters. in the first chapter, author deals with theoretical fundamentals and genesis of phillips curve, as well as development phases of this concept. intellectual influences and predecessors of phillips concept are displayed. furthermore, the original phillips curve, lipsey model and modification of this concept, friedman – phelps’ hypothesis of natural rate of unemployment (nru) and vertical phillips curve in rational expectations theory. the second chapter displays phillips-okun’s model originated by synthesis of phillips curve and okun’s curve. phillips-okun’s model could be simply articulated as a relation between gross domestic product and rate of inflation. in this chapter author presents okun’s law, associating okun’s and phillips curve and comparing economic policies and macroeconomic aggregates in the phillips-okun’s model and is – lm model. at the end of chapter, author deals with theoretical aspects of inflation, it’s quantification and economic policies concerning this economic phenomenon. the third chapter presents comparative analysis of relevant schools of economic thought: neoclassical, keynesianism, monetarism and rational expectations school (ratex); their basic postulates and relationship to labor market. furthermore, it explains concept and characteristics of natural rate of unemployment (nru) and non accelerating inflation rate of unemployment (nairu). the fourth chapter is heterogeneous and presents numerous researches related to phillips curve: labor market models and analysis of institutional factors on labor market, role and significance of syndicate, empirical research on behavior of phillips curve in oecd countries, etc. economic analysis (2009, vol. 42, no. 3-4, 91-94) 24 in the fifth chapter author examines economic system of yugoslavia, assessing empirical and theoretical research of inflation, unemployment and gdp in the period between 1956 and 1990. moreover, this chapter provides a review of economic literature which is dealing with phillips and okunʹs curve and an attempt of creating empirical foundations of these two theoretical concepts in yugoslavian economic system. in the sixth chapter author is analyzing contemporary research of phillips curve and its implementation in modern concepts of macroeconomics and economic policies. in this chapter following issues are elaborated: hysteresis as an answer of new keynesianism, alternative hysteresis theories, relation between adaptive and rational expectations, lucas supply function and lucas critiques, implementation of phillips curve in welfare economics and game theory, analysis of phillips curve in developing and transition countries; with special interest in behavior of phillips curve during stagflation period from 1980 to 2000. as a supplement to this book, author presents his empirical research about possibility of existence of phillips curve in yugoslavian economy in the period between 1982 to 1990. the book contains numerous contemporary methods, a number of charts and spreadsheets, and portrayal of basic relations of phillips curve and macroeconomic models. author used voluminous literature and a great number of empirical researches related to this topic. a vast number of statistical and econometrical methods, as well as comparative analyses of myriad scientific papers, theories and economic schools are employed. the author is trying to find an answer for the following basic question: could phillips curve be used as an economic tool in macroeconomic policy? by using relatively modest econometric methodology, he gets to the right conclusion that phillips curve is not applicable in yugoslavian economy and couldn’t be used as useful theoretical instrument in macroeconomic policy. the book is logically structured with valid conclusions. on the basis of presented analysis of phillips curve, its reflection on contemporary economic schools, comparative analysis of leading theoretical schools – as well as analysis of labour market – it presents useful and current macroeconomic study guide for economists, academics, researchers, business people and students. lovre ivan, perić mladen university educons, faculty for business economics, sremska kamenica microsoft word 2010_1_2.doc note from the editor-in-chief i am pleased to be able to present this special issue of economic analysis which is devoted to scientific conference “economic prospect in the second decade of the 21st century” (14. – 15. april 2010), organized by belgrade banking academy and institute of economic science in belgrade. furthermore, i am glad to announce that almost articles for this issue have been collected by dr jozef glova from faculty of economics, technical university in košice, slovakia whom i invited to be our guest editor and help me in selecting articles for the first issue of economic analysis in 2010. it is another step forward in strengthening cooperation between our partner institutions. at the same time, work on this issue is more closely connected us with colleagues from other faculties of economics within v4 and countries of south eastern europe who provided special contributions to our peer journal with their high quality papers. thanks to everyone for their cooperation with the hope that it will continue in the future. prof. dr mirjana radović marković editor-in-chief economic analysis microsoft word 2010_1_2.doc original scientific paper social aspects in buyer-supplier relationships of smes in hungary gubik andrea, university of miskolc, institute of economic theory, hungary udc: 658.11(439) jel: p43; p31; n84 abstarct – cooperation among companies was brought to the focus of attention by the fast changes of economic circumstances and the role it can play in coping with risk, appreciating all those characteristics which can help fast reactions and adaptability, like faith among business partners and long run relationships. the entrepreneur him/herself has a great influence on the characteristics of cooperation as well, besides these processes pushing them to the direction of cooperation, whose intention to get involved depends on his/her skills, abilities, but such characteristics of the company like scale, fields of activities affect it too. economic, social and cultural circumstances are of major importance too, among which the above mentioned factors pursues their effects. cooperation among companies can happen on any fields of the firms’ activities, for example research and development, marketing, purchase, or trading. this present paper intends to introduce the reader to the characteristics of supplier-purchaser relationships of smalland medium sized enterprises, based on an empirical research’s experiences. according to our opinion, we can draw conclusions on the intention to cooperate concerning the nature of the buyer-supplier relationships of companies, so a wide range of information can be concluded on smalland medium sized enterprises’ partnerships. key words: supplier-purchaser relationships, smes, hungary introduction smalland medium sized enterprises receive more and more attention these days all over the world considering their economic, and their social importance. economic processes and their fluctuations caused an increase in the uncertainty of economic decisions and appreciated flexibility on all fields of companies’ management. the ever stronger competition and permanent change in circumstances forces the actors of the economy to renew themselves from time to time, to search for new methods and new solutions to their problems. networking and the evolution of a broad scale of international relations among companies can be regarded as one of these innovative solutions. partnerships have always been playing an important role in the lives of the majority of the smalland medium sized enterprises, mainly because of the limited nature of their resources. but uncertainty accompanying changes and the requirement of enhanced flexibility brought about major changes both in the quality of company cooperation and in the circle of the participants. the evolution and development of hungarian smalland medium sized enterprises shows major differences from the international trends. this specialty is explained by several factors by the authors (for example by historical traditions, and by socialisation inheritance gubik, a., social aspects in buyers-supplier relationships, ea (2010, vol. 43, no. 1-2, 108-116) 109 of loose business faith, by the lack of in heritage effect, by the valuable nature of political relationships and their economic effects, etc.) (see for example: róbert 1999, román 2007, kuczi 1998, czakó et al. 1995, gábor 1997.). hungary’s small-and medium sized enterprises show resemblance to neither the development process based on economic logic characteristic for the western part of europe, nor with the sme sector of asian countries which is based on social traditions. its evolution and development can be regarded as an organic process as its major fragment had evolved based on obligations after the changing of the regime. on the other hand social traditions had not played major role in its development. all these factors determine the operation, attitudes and practice of the actors of the hungarian sme sector. all these specialities are of major importance even if hungarian sme sector does not show major differences concerning statistical data from other european countries. this is the reason why we will have to be careful in using the results of international researches (for example observatory of european smes, 2003). this is even more important in case of the data of the north-hungarian region. our research intends to fill in this gap, searching the answer for the question what type of work distribution specialties can be observed in the chosen circle of the small-and medium sized enterprises on the one hand, while on the other hand what kind of characteristic differences can be found compared to international surveys. based on these researches we intend to answer the important question of whether the analysed circle of hungarian entrepreneur had already managed to form real cooperation or not. methodology in my empirical work i used the questionnaire accomplished in the framework of the fkfp 0015/2002. education and research project. the data basis constructed based on the results of the survey contains representative data according to employee number and field of activity of 217 smalland medium sized enterprises of borsod-abaúj-zemplén county (10249 employees). furthermore, 16 micro enterprises’ (1-9 employees) answers were also used, but only case of the questions concerning the subjective opinions of entrepreneurs about tendencies. in case of these questions i always guided the attention to treat these results with precaution. the county’s structure of smes concerning the scale of enterprises shows major differences from neither national nor european statistics. if analysing only enterprises employing more than 10 people the distribution of small-and medium sized enterprises is 8020 percent. for the analyses of the data i used spss 14.0 software package. i analysed the sample by descriptive statistics, multi-variable analyses, cluster-, factor analyses and by correlation showing the strength of stochastic relationship among variables. in order to able to draw general conclusions based my sample i paid special attention to the structure of my sample. i used the layered sample technique belonging to the group of random samples. the reliability of the sample was 95 percent, the sampling error ± 6,16 percent. during the analysis i used pair wise method when treating missing values, i only used the full answers in case any questions. in my research i considered 0,05 significance level to be relevant and gave the probability values by the distinct questions if they differed. economic analysis (2010, vol. 43, no. 1-2, 108-116) 110 the situation of borsod-abaúj zemplén county in this paper we would like to demonstrate the county’s situation only by laying some data, given the limited framework of this paper. the per capita gdp is 1355 thousands huf, which is 67 per cent of the national average (ksh, 2006a). the same fallback is perceptible in investments, where the county’s per capita performance is 70.3 per cent of the national average (ksh, 2006a). the county shows underdevelopment in terms of the economic organisation’s statistics as well. low enterprising willingness implies unfavourable economic situation as well. 4.8 per cent of the country’s registered organisation can be found in the county, about 63 thousands, which are enterprises in almost 90 per cent of the cases. this statistic proves that enterprising here is far below the national average. the number of enterprises vested for a thousand inhabitant is 77 while the national average is 120 (ksh, 2006a). it partly contradicts the gem’s subsequent survey, as according to it the northernhungarian region is the 4-5th in the region’s hierarchy in terms of enterprising activity. according to the authors the better data can be the sign of convergence, in which motorwaybuilding can act as a catalyser. (szerb, varga, 2004). in terms of research-expansion, performance is below the national average again. (ksh, 2005a, 2005b). unfavourable economic situation reflects in the social indices as well. the unemployment rate was 11.7 per cent in the first quarter of 2006, whilst the national average is 7.7 per cent. we can find further unfavourable social tendencies while analysing emigration and polarization. results of the empirical research in the course of the research the cooperation declared by companies (when the company filling in the questionnaire declared involvement in cooperation) and latent cooperation were treated separately. in this paper we focus on this latter. (the question was the following: are you involved in any types of cooperation beyond buyer-supplier relationships (cooperation: long run partnership among independent smalland medium sized enterprises which aims to achieve some kind of common goal going beyond a distinct action, a one-time transaction.) latent cooperation was analyzed by the characteristics of buyer-supplier relationships, their share, geographical distance and the time-horizon of the relationship. companies had to give the characteristics of their three most important buyer and supplier. literature emphasizes the advantages of long run cooperation, because of the routines and the evolution of mutual faith, by which companies can realize economic benefits. a possible benefit of this kind can be the ever decreasing cost of processes. according to our work hypothesis rational companies will form permanent partnerships as strategic decisions within a relatively narrow geographical area. in order to be able to test this hypothesis we asked the companies about their three most important partners. the average share of the most important purchaser is higher than 50 percent, but we face a high level of standard deviation (st dev=27,9). the most important supplier’s share is slightly beyond this, it is 48,3 percent (st dev=25,2). a weak but significant relationship can be found between the shares of purchasers and suppliers (p=0,01, pearson correlation=0,302) gubik, a., social aspects in buyers-supplier relationships, ea (2010, vol. 43, no. 1-2, 108-116) 111 which mean that the concentrated nature of purchaser and supplier relationships are interrelated, companies with a concentrated circle of purchasers tend to have more concentrated supplier relationships. after analysing the share of the most important partners, the length of the surveyed companies’ buyer-subcontractor relationships was analyzed. table 1. the average length of buyer relationships according to type of the buyer and size of the company size type of the buyer average (year) n standard deviation consumer 10,10 31 5,31 small and medium sized enterprise 10,33 12 6,41 large enterprise 7,95 19 4,74 local government 7,50 2 3,54 10-19 total 9,42 64 5,33 consumer 13,58 12 4,38 small and medium sized enterprise 8,13 23 3,92 large enterprise 9,14 21 5,15 local government 12,67 3 2,52 20-49 total 9,83 59 4,85 consumer 23,25 8 19,73 small and medium sized enterprise 9,71 7 4,64 large enterprise 10,64 14 5,56 local government 9,00 2 1,41 50-249 total 13,58 31 11,94 when analysing the length of partnerships it can be concluded that the average length of relationship with the most important buyer is over 10 years (st.dev=7,059). partnerships among companies and their suppliers also last for almost 10 years on average (st.dev=6,04). the analysis of buyer-supplier relationships of companies is made more difficult by the fact that companies’ chances to survive differ according to their size, so the average age of the groups of companies also differ. so the average age of partnerships increases with the increase of the scale of companies. that’s’ why we introduced a new variable by filtering the age of companies to decide the permanent nature of these relationships by measuring the length of the relationships as a share (%) of the companies’ age. the variable expresses the faith of buyers to the company and the company’s loyalty to its suppliers. time period of the partnership (year) length of the partnership as a share of the companies’ age = age of the company (year) economic analysis (2010, vol. 43, no. 1-2, 108-116) 112 the average value of the permanency index is 0.783 in case of the most important buyers, while 0.72 in case of suppliers which shows that companies’ relationships can be regarded to be stable. it can be concluded based on these tests that there is a connection between the permanent natures of the surveyed companies’ relationships: if a company decides to be involved in a permanent relationship, it is more likely to act so in all of its partnerships (p=0,000, the most important and second important buyer’s pearson correlations 0,721; the most important and second important supplier’s pearson correlations 0,657). this means companies tend to harvest the additional gains of cooperation as strategic decisions. after this the buyer-supplier relationships were analysed according to their geographical concentration. according to our working hypothesis there is a connection between the size of companies and the geographical concentration of their relationships and the geographical concentration and the permanent nature of cooperation. local markets are generally very important for the surveyed companies. the smaller the size of a company is, the more likely it is to be connected to the local environment, to the local market, because of its limited resources and the characteristics of its purchasers. it was cleared that personal contacts and human factors generally are decisive in respect of the cooperation’s success. that is why they play a major role in forming permanent cooperation. when analyzing the partnerships from the geographic point of view it can be concluded that there is a statistically significant relationship between the geographical distance and the size of the company involved in cooperation (p=0,01, eta 0,341). that means, that the smaller the company is, the more like its partnerships are concentrated. these are demonstrated by the following figures. figure 1. geographical concentration of suppliers according to the size of the company 0% 20% 40% 60% 80% 100% 10-19 20-49 50-249 same region other hungarian region foreign gubik, a., social aspects in buyers-supplier relationships, ea (2010, vol. 43, no. 1-2, 108-116) 113 figure 2.geographical concentration of buyers according to the size of the company 0% 20% 40% 60% 80% 100% 10-19 20-49 50-249 same region other hungarian region foreign the further extent of cooperation proved to be matched with the more permanent nature of relationships. on the other hand, both the characteristics of activities and their types are decisive in the aspect of geographical situation of the partners (p=0,000, cramer’s v=0,259). buyers of companies in the fields of merchandise and services are more concentrated geographically; more distant partnerships and international activity are rather characteristic for industrial companies. the main connections are shown on figure 3. about 90 percent of the partners of companies supplying directly consumers or local governments can be found in the same region the firm is situated in. buyers of those who sell to smalland medium sized or large enterprises are less concentrated, but even in their case, partners pursuing their activities in the same region play a major role (63,7 and 49,3 percent). figure 3. geographical concentrations of buyers according to the affiliation and field of activities of the buyers suppliers’ geographical positions differ both according to the type of supplier and the field of activity. suppliers of small enterprises can usually be found in the same region where 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% indu stry tra de ser vice s same region other hungarian region foreign 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% con sum er sm e larg e en terp rise loc al g ove rnm ent same region other hungarian region foreign economic analysis (2010, vol. 43, no. 1-2, 108-116) 114 the company is situated in. with the increase of the supplier company’s size the probability of having more distant partners increases too (p= 0,000, cramer’s v= 0,304). this context is shown on figure 4. inter-regional relationships of both industrial and service sector firms are over-average important (56,5 and 59 percent). in case of services major differences can be found according to branches of services pursued (transportation and financial activities are less concentrated). figure 4. geographical concentrations of suppliers according to the affiliation and field of activities of the companies the time-horizon of the surveyed companies’ buyer-supplier relationships and the geographical concentration was analysed separately. the stochastic relationship between the permanent nature of relationships (the length of the partnership as a share of the companies’ age) and the geographical location of the buyer-subcontractor was tested. based on the edification of the sample the more close partners are situated to each-other (the buyer and its supplier), the more lengthy their relationship will be. we can conclude that personal relationships favour the length of partnerships and human factors of cooperation can be decisive for its success. table 2. the average length of buyer relationships according to the geographical location of buyers geographical location of buyers average (year) n standard deviation same seat as the company 12,41 32 4,655 in 50 km round of the company 9,93 41 8,878 same region 9,46 37 4,959 other hungarian region 9,24 33 3,873 eu member state 9,29 14 5,797 other country 3,00 3 1,732 total 9,99 160 6,144 high values of deviation warn us that the sample is not homogenous, so the context was analysed distributing buyers to types as well. according to the type of purchaser smalland medium sized enterprises show a significant, while large enterprises show no significant relationship between the geographical position and the length of the partnership, which 0% 20% 40% 60% 80% 100% indu stry tra de ser vice s same region other hungarian region foreign 0% 20% 40% 60% 80% 100% sm all e nter ptis e med ium siz ed e nter pris e larg e en terp rise same region other hungarian region foreign gubik, a., social aspects in buyers-supplier relationships, ea (2010, vol. 43, no. 1-2, 108-116) 115 means that in case of large companies, purchaser partners’ geographical distance does not play an important role in the permanent nature of the relationship. the permanency of the partnership (percentage form) and the geographical position of the purchaser also show the same context, geographical closeness of the purchaser increases with the permanency of the partnership (p=0,02, éta2=0,117). the above mentioned observations concerning the cooperation among companies shed light on the contradiction of the time-horizon and geographical aspects of partnerships. the geographical concentration of partnerships is beneficial for the companies involved as it contributes to the permanent nature of relationships on the one hand, giving additional economic advantages for the companies, but on the other hand, concentration denies the requirement of economic rationality as it causes the company to be dependent on the economic fluctuations of its close environment. summary interrelation can be found between the permanent nature of the surveyed companies most important partnerships: if a company forms permanent relationship on any fields of its activity, it will try do act so in all of its partnerships. companies tend to harvest the additional advantages of cooperation by making strategic decisions. permanent partnerships are usually made within a relatively narrow geographic region and as the concentration of partnerships increases so will increase the time-horizon of the relationships as well. permanent and geographically concentrated partnerships of smalland medium sized enterprises contribute to harvesting the additional advantages of cooperation while on the other hand make them more dependent on their economic environment. economic rationality appears in a paradox way in this case. this is why rationally behaving companies have to find the balance between forming economically beneficial permanent partnerships and bearing additional risk of geographical concentration. the survey of the county was a one time, cross section research, but we see the opportunity to broaden it to the north-hungarian region, with some adaptation of the questionnaire. this would enable us to make a regional comparison and moreover, to compare our results with the observatory of european smes results on smalland medium sized enterprises. in the framework of the laky teréz foundation’s grant an experts’ questionnaire will be accomplished in the course of which we would like to get to know the opinions of other parties (supporting institutions, authorities) too. the results of empirical researches will be controlled by this expert questionnaire and interviews will be made for the situation of smalland medium sized enterprises too, asking the representatives of institutions which influence smalland medium sized enterprises directly, or indirectly. further qualitative research should be made, as the barriers of our research showed, which evolved from the complex nature of relationships among companies. this complexity of the system of relationships and the analysis of embeddedness requires qualitative methods to be used. data standing at our disposal did not enable us to fully map all the economic analysis (2010, vol. 43, no. 1-2, 108-116) 116 relationships between factors of partnerships, mainly in case of reasoning, so further efforts should be made to answer all questions. references róbert, p. (1999): kikből lettek vállalkozók? a vállalkozóvá válás meghatározó tényezői magyarországon a kommunizmus előtt, alatt és után. közgazdasági szemle xlvi. évf. 403-427. oldal román, z. (2007): a vállalkozás a magyar gazdaságban – nemzetközi tükörben. köz-gazdaság 2007. ii. évf. 2. pp. 67-84. kuczi, t. (1998): vállalkozói kultúra – az életutak finalitása. replika 29. szám 1998. czakó, á., kuczi, t., lengyel, gy. vajda, á. (1995): a kisvállalkozások néhány jellemzője a 90-es évek elején. közgazdasági szemle, xlii. évf. 1995. 4. sz. gábor, r. i. (1997): belső versus foglalkozási munkaerőpiac – a posztszocialista átalakulás elhanyagolt dimenziója. közgazdasági szemle xliv. évf. 457-473. oldal ksh (2006a): a gazdasági fejlődés regionális különbségei magyarországon 2005-ben. országos statisztika, központi statisztikai hivatal debreceni igazgatósága ksh (2005a): kutatás és fejlesztés 2004 központi statisztikai hivatal ksh (2005b): innováció 2003. központi statisztikai hivatal szerb, l., varga, a. (2004): a vállalkozói aktivitás regionális és lakóhely szerinti különbségei magyarországon 2004-ben. megjelent: vállalkozásindítás, vállalkozói hajlandóság és a vállalkozási környezeti tényezők alakulása magyarországon a 2000-es évek első felében. global entrepreneurship monitor, 2004 pécs observatory of european smes (2003/5): smes and cooperation. kpmg special services and eim business & policy research in the netherlands, european network for sme research, intomart luxembourg. received: 8 january 2010 article history: accepted: 1 march 2010 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp84-93 scientific review the determinants of capital structure and optimization: evidence from the power sector almir alihodžić1* | ajla muratović ‐ dedić1 1 faculty of economics university of zenica bosnia and herzegovina, department for finance and accounting abstract the optimal capital structure differs between companies and depends on the nature of the business, the characteristics of the business, etc. usually when business income is higher, there is a reduction in business risk, while, on the other hand, higher profits and accumulated profits lead to an increase in investments and debt. in the research 10 companies of the power sector, representing the stock exchange index ers 10 were examined. the following dependent variable was used: short term debt to total liabilities (stdtl). the following independent variables were used: current ratio (cr), return on capital employed (roce), earnings before interest taxes depreciation (ebitda), return on assets (roa), return on equity (roe), the tangibility of assets (toa), firm size (fs) and gross domestic product growth (gdp growth). the research period covered the years from 2008-2018 on a semi-annual basis. the total number of observations was 220. the main objective of the paper is to determine explanatory factors that influence the changes in short-term indebtedness and profitability. key words: capital structure, tangibility of assets, power sector, profitability, regression analysis jel classification: g3, g31, g32, m400 introduction optimal theories of capital structure depend first and foremost on which economic and business enterprises the research is based on. for example, the trade-off theory is tax based, free cash flow theory is based on agency costs, while pecking order theory is based on differences in information. the theory of financial distress states that if a company has a higher share of tangible assets, it will use more loans and debts than a company with a high proportion of intangible assets, because businesses with more tangible assets may have lower costs of financial distress in the event of bankruptcy. in emerging central and eastern european region some theories cannot be used in explaining the capital structure. delcoure (2007) demonstrates influential factors that determine capital structure are characteristics of banking systems, legal systems, sophistication of financial markets and corporate governance. also, results of this study can be used as argument for the market timing theory. the market timing theory does suggest that current conditions in financial markets have some influence on managers' capital structure decisions (frank & goyal, 2009). the power industry of republika srpska deals with the production of electricity, the exploitation of raw materials required for electricity production, the sale of electricity, project * corresponding author, e-mail: almir.dr2@gmail.com almir alihodžić, ajla muratović dedić 85 management and other activities within its jurisdiction. the capital structure of the power sector of republika srpska consists of 65% participation of parent company, 20% vouchers, 10% pension and disability insurance and 5% restitution (the power sector of republika srpska, 2019). in the post-crisis period, the power companies of republika srpska, with increased yield potential, created the basis for an increase in borrowing capacity, primarily short-term loans to banks due to the high share of current assets, and smaller amounts of cash and cash equivalents. the power sector of republika srpska is the leader in electricity exports in the region, which is evidenced by the fact that in 2018, 15% of total exports were related to foreign electricity sales, which certainly increases the yield potential (the power sector of republika srpska, 2019). this paper will test whether a partial decline in revenue potential leads to an increase in short-term debt in the first place and how is it further reflected in profitability indicators. therefore, the main objective of this paper is to investigate how firms compose their capital structure, that is, how selected independent variables influence firms to borrow short-term loans to a greater or lesser extent. the zero hypothesis supports the random effects model. on the other hand, alternative hypotheses support the fixed effects model. the following hypotheses will be tested:  h0: zero hypothesis: random-effect model is appropriate.  h1: first hypothesis: fixed effect model is appropriate. the small chi square value together with the associated small p value leads to the conclusion that the null hypothesis is true, i.e., that all variations are equal. this paper consists of four parts and a conclusion. the first part refers to the introductory considerations and defining the aim of the research. the second part is a broad literature review. the third part refers to the empirical methodology and data. the fourth part refers to the obtained results. finally, concluding considerations and specific recommendations are given. literature review traditional theories of capital structure should be tested in the transitional central and eastern european region. according to the pecking order theory, companies will first use retained earnings as their investment assets, and then move to debt and new equity only if necessary (myers, 1984). petersen and rajan (1994) point out that leverage decreases with the years of business of the enterprise and, on the other hand, increases with size. they also claim that larger companies are better diversified, have better access to the capital market and borrow at more favorable interest rates. rajan and zingles (1995) find that large firms are less susceptible to asymmetric information, more capable of acquiring equity and reducing debt capital, suggesting a negative association between leverage and size. according to titman and wessels (1988), smaller firms are less associated with financial institutions due to the impact of costs and leverage risks, and are less desirable for clients and banks charging high interest rates to smaller firms, while larger firms are offering competitive interest rates. according to ozkan (2001), i.e., according to his evidence, companies have a long-term leverage ratio and adapt to the target ratio relatively quickly, suggesting that target ratio and cost of adjustment are very important for businesses. the results also indicate that there is an inverse correlation between profitability, liquidity, growth opportunities, non-debt tax shields and the borrowing ratio of firms. furthermore, giner and reverte (2001) claim that debt represents positive signal for firms with good prospect and investors negatively perceive differences between debt-to-equity ratio and its target level. empirical contributions on association between ownership structure and capital structure provided brailsford, oliver and pua (2002). specifically, significant positive linear relation 86 economic analysis (2020, vol. 53, no. 1, 84-93) between external blockholders and leverage is suggested. at the same time, the authors find non-linear relation between managerial ownership and leverage. in their research, korajczyk and levy (2003) came to the conclusion that macroeconomic parameters change over time, which in turn changes the decision on the capital structure of an enterprise. the value of a business will depend on changes in managerial decisions based on macroeconomic changes. in order to maintain the level of debt, managers should monitor and adapt to macroeconomic changes. pittman and fortin (2004) investigated the relationship between auditor selection and debt pricing for public companies. they have come to the conclusion that riskier debtors must provide security for loans taken as interest rates rise, which is in line with business in the banking industry. delcoure (2007) points out that companies in emerging central and eastern european region follow the modified pecking order theory. furthermore, aggarwal & kyaw (2009) report the higher importance of transparency factors regarding corporate capital structure for large firms. also, using sample of 26.896 firm-years observation in the 14 european countries these authors documented that higher levels of audit intensity and financial reporting disclosures have positive association with debt ratio. empirical methodology the traditional ols regression model represents an important method of identifying and testing certain theories of the capital structure and factors influencing the structure of capital (rajan & zingales, 1995). based on the results of breusch-pagan lm test, the paper employs the pooled ols regression model (fe model) and the random-effects gls regression model to test the influence, significance and impact of selected independent variables on the determination and anticipation of the dependent variable. therefore, fixed effects regression is a common model that can be used to control for omitted variables. also, it allows us to evaluate the effects of independent variables on our dependent variable, where it is the main technique used to analyse panel data. panel data are called cross – sectional time data that include multiple cases (such as businesses, countries, etc.). there are usually two types of information in terms of time series data, namely: the cross sectional information that reflects differences between subjects and time series information within subjects. in order to decide which method we should use we applied the breusch-pagan test which is proposed by trevor breusch and adrian pagan (1979). the breusch‐pagan test tests the heteroscedasticity of regression errors. the test explains that error deviations are due to the linear function of one or more explanatory variables in the model. in order to achieve a better return on the observed variables, the following regression model has been set up: 𝑆𝐻𝑇𝐷𝑇𝐿 , 𝛼 𝛼 𝐶𝑅 , 𝛼 𝑅𝑂𝐶𝐸 , 𝛼 𝐸𝐵𝐼𝑇𝐷𝐴 , 𝛼 𝑅𝑂𝐴 , 𝛼 𝑅𝑂𝐸 , 𝛼 𝑇𝑂𝐴 , 𝛼 𝐹𝑆 , 𝛼 𝐺𝐷𝑃𝑔𝑟𝑜𝑤𝑡ℎ 𝜀 , 1 where is: 𝐶𝑅 , – current assets to total assets of the 𝑖 company in period 𝑡. 𝑅𝑂𝐶𝐸 , – return on capital employed of the 𝑖 company in period 𝑡. 𝐸𝐵𝐼𝑇𝐷𝐴i,t earnings before interest, taxes and depreciation of the 𝑖 company in period 𝑡. 𝑅𝑂𝐴 , – return on assets of the 𝑖 company in period 𝑡. 𝑅𝑂𝐸 , – return on equity of the 𝑖 company in period 𝑡. 𝑇𝑂𝐴 , – tangibility of assets of the 𝑖 company in period 𝑡. 𝐹𝑆 , – firm size of the 𝑖 company in period 𝑡. 𝐺𝐷𝑃𝑔𝑟𝑜𝑤𝑡ℎ of the 𝑖 company in period 𝑡. almir alihodžić, ajla muratović dedić 87 data data have been collected from the stock exchange index created in the power sector at the banja luka stock exchange (ers10 stock exchange index). this empirical study uses semiannual data for 10 companies. the research period covers 11 years, i.e., from 2008 to 2018. the dependent variable the ratio of short-term debt to total liabilities (stdtl) was used. eight independent variables as current ratio (cr), return on capital employed (roce), earnings before interest, taxes and depreciation (ebitda), return on assets (roa), return on equity (roe), the tangibility of assets (toa), firm size (fs) and gdp growth were used. in table 1 the explanatory variables, formulas, and expected effects of dependent and independent variables are given: table 1. a brief description of the dependent and independent variables in the model explanatory variables formula expected signs supported theories debt short term debt to total liabilities liquidity current ratio (current assets/short-term liabilities) negative (-) trade-off theory profitability return on capital employed (roce) positive (+) trade-off theory profitability earnings before interest, taxes and depreciation (ebitda) negative (-) profitability net profit/average assets (roa) positive (+) trade-off theory profitability net profit/average equity (roe) negative (-) trade-off theory tangibility of assets fixed assets/total assets negative (-) collateral view firm size ln (sales) positive (+) trade-off theory gdp growth gdp growth over the previous period positive (+) trade-off theory source: authors own study return on assets (roa) ‐ it represents the ability of management to convert assets into earnings. net profit represents the volume of earnings, but not how well the bank operates viewed relative, or in terms of their size. this is assessed by a comparison of roa banks of different sizes (đukić, 2011). return on equity (roe) ‐ measure of banks` profitability. it is decided to choose roe due to the observed increase in the equity capital of banks in the global market and higher capital requirements for banks. it is the fact that many of the bank's operations are off-balance sheet but not on-balance sheet (drozdowska & witkowski, 2016). earnings before interest, taxes and depreciation (ebitda) – is calculated by taking the net income of the business and adding interest, taxes, depreciation and amortization. so basically it takes sales revenue, and subtracts all expenses except interest, taxes, depreciation and depreciation. therefore, ebitda is a measure of the performance of a business, that is, of evaluating the performance of a business without affecting financial, tax and other decisions (marr, 2012). the tangibility of assets – represents an important balance sheet category that may cause an increase in indebtedness in the enterprise. certain theories believe there is a positive correlation between the assets tangibility and leverage. higher amounts of tangible assets can lead to increased indebtedness as tangible assets can be used as collateral for loan approval, which reduces bankruptcy costs. also, tangible assets can be used to reduce agency costs incurred due to debt monitoring costs as well as an insufficient investment due to the presence of asymmetric information. the assumption is that companies that have higher amounts of fixed assets with a 88 economic analysis (2020, vol. 53, no. 1, 84-93) larger amount of collaterals should consequently have a higher level of leverage in their capital structure (jensen & mekling, 1976). firm size (fs) ‐ smaller companies generally use less credit from banks in comparison with larger enterprises. that is for a few reasons. the core reason is that smaller companies can face the problems of asymmetric information, and banks with negative selection and moral hazard. this situation is particularly pronounced in bosnia & herzegovina. also, smaller companies tend to be less diversified in terms of debt capital, compared to larger companies, which increases the chances of financial failure. on the other hand, larger enterprises have relatively lower direct costs of bankruptcy (mc connell & pettit, 1984). in this regard, smaller companies have access to less capital, or they are offered a charge at substantially higher costs than large companies, which refuses them to use debt financing. firm size is calculated by the natural logarithm of sales. therefore, firm size is expected to be positively correlated with larger companies that use higher amounts of indebtedness. current ratio (cr) – measures the ability of the company to settle its mature short-term liabilities with the total available working capital. the current ratio is expressed as a numerical value, and as its value increases, the enterprise operates more liquid, so that is able to repay short-term liabilities to creditors on time (alihodžić, 2018). return on capital employed (roce) – the main elements of the roce indicator are operating profit as well as capital employed. therefore, roce compares earnings with the capital employed in the company. the roce indicator can be measured for several years in a row in order to find a trend of growth or decline in profitability. in other words, roce how much a business is gaining for its assets or how much it is losing from its liabilities (marr, 2012). gdp growth – gdp is a widely used indicator that best describes the difference in wealth between countries. also, gdp growth encourages businesses to make new investments. according to smith and watts (1992), gdp growth encourages companies to make new investments, which has an impact on the optimal choice of financing sources. gdp growth is measured as a percentage change in the growth rate of real gross domestic product. we assume that gdp growth will be positively correlated to leverage. results descriptive statistics of the power sector of the republika srpska are shown in the table 2. this shows that the gdp growth has a high value at 102.65% average. the tangibility of assets represents 85.25%, earnings before interest and taxes represent 26.28% and firm size represents 17.85%. in terms of standard deviation, the following independent variables recorded the highest volatility: earnings before interest, taxes, depreciation and amortization (15.08%), gdp growth (14.58%), then the current ratio (8.12%) and tangibility of assets (6.91%). table 2. descriptive statistics of dependent and independent variables of the power sector in the republic of srpska for the period: 2008-2018 variables observations mean std. dev. min max stdtl 220 8.102 7.575 0.02 29.44 cr 220 5.752 8.126 0.47 42.48 roce 220 0.509 1.726 -7.15 11.89 ebitda 220 26.279 15.081 -17.22 65.37 roa 220 0.164 1.098 -3.75 2.53 roe 220 0.170 1.283 -4.62 3.06 toa 220 85.254 6.915 66.98 97.72 fs 220 17.848 0.790 16.07 19.23 gdp growth 220 102.65 14.587 66.50 128.87 source: calculated by the authors (stata 13.0) almir alihodžić, ajla muratović dedić 89 the gross domestic product (gdp) in bosnia and herzegovina had a volatile character during the survey period, both due to the impact of the global economic crisis, the post-crisis period, and because of weakened export potential. economic growth in bosnia and herzegovina in 2008 amounted to 5.5%, which was a slight decrease compared to previous years, because the effects of the crisis did not fully reflect by the end of the observed period. just three years later, that is, in 2011, real gdp growth was only 1.9%, suggesting that the countries of southeast europe showed a vulnerability to distortions in the euro area during the recession period. in the postcrisis period, there was a certain stabilization of economic trends, where the real growth rate increased by about 2.6% as a result of the reduction of the external deficit and favourable external conditions. the real growth rate in 2017 was about 3%, which is the result of favourable economic developments in eu countries and to a lesser extent in the countries of the region. the energy sector of bosnia and herzegovina accounts for about 1/3 of total industrial production and is an important factor in its stability (directorate for economic planning, 2017). gdp growth encourages businesses to expand their businesses. korajczyk and levy (2003) conclude that macroeconomic conditions change over time, where the structure of capital also changes over time in certain sectors of activity. the average value of the fixed assets of the power sector of republika srpska for the period 2008 to 2018 was approximately 85% of total assets, which is a consequence of the nature of the activities of the selected companies. on the other hand, the average value of short-term debt to total liabilities for the period 2008 2018 was about 8%, which is a small amount of bank debt, which also leads to the conclusion that it is a healthy revenue potential that needs to be maintained. changing macroeconomic conditions will affect the change in the value of the enterprise. the table 3 shows the correlation between the dependent and independent variables of the power sector in the republic of srpska for the period: 2008-2018. table 3: correlation matrix between dependent and independent variables of the power sector in the republic of srpska for the period: 2008-2018 variables stdtl cr roce ebitda roa roe toa fs gdp growth stdtl 1.000 cr -0.528 1.000 roce 0.048 0.046 1.000 ebitda -0.567 0.620 0.237 1.000 roa 0.221 0.211 0.642 0.517 1.000 roe -0.213 0.192 0.636 0.472 0.994 1.000 toa -0.561 0.014 0.100 0.302 -0.062 -0.064 1.000 fs 0.425 0.452 0.105 0.405 0.012 0.007 0.202 1.000 gdpgrowth 0.001 0.035 0.073 0.045 0.091 0.090 0.058 0.037 1.000 source: calculated by the authors (stata 13.0) the strongest negative correlation of the dependent variable short-term debt to total liabilities (stdtl) was recorded with the following independent variables: earnings before interest taxes depreciation and amortization (-0.567), then tangibility of assets (-0.561) and the current ratio (-0.528). therefore, with the decrease in the balance sheet item of current assets (primarily referred to cash and cash equivalents), a number of companies within the power sector of republika srpska raise short-term loans with commercial banks to maintain their current liquidity. on the other hand, the following independent variables were recorded the same direction of movement with the dependent variable: firm size (0.425) and return on assets (0.221). relatively larger companies (in terms of income, assets and possibly employees) will 90 economic analysis (2020, vol. 53, no. 1, 84-93) borrow more loans from banks to finance their business than smaller companies that will finance their business mainly with equity and reduce the indebtedness due to certain restrictions imposed by commercial banks. it is also important to point out that larger companies can also use their assets as collateral, and that because of the length of their business, they have a greater reputation for granting loans from banks. rajan and zingales (1995), as well as chittendan et al. (1996) also confirm in their research a positive relationship between company size and debt ratio. the table 4 shows the results of the fixed effects regression (fe) between the selected variables in the model. the total number of observations is 220 which makes the models representative. the empirical value of the f test for 8 degrees of freedom in the numeration and 212 in the denomination was 42.84. the independent variables that showed the most significant correlation with the dependent variable in the model, that had a p-value of less than 5% were the following: tangibility of assets (0.000), current ratio (0.000) and firm size (0.032). table 4. fixed effects regression between dependent and independent variables of the power sector of republic srpska for the period: 2008 – 2018 fixed‐effects (within) regression number of obs = 220 r‐sq: within =0.6200 number of groups = 2 between =0.000 overall = 0.6200 obs per group: min = 110 avg =110 max = 110 f(8,212) = 42.84 prob > f =0.0000 stdtl (dependent) coef. std. err. t p>[t] [95% conf . interval] cr -0.390 0.056 -6.90 0.000 -0.502 -0.279 roce 0.056 0.247 0.23 0.822 -0.433 0.544 ebitda -0.019 0.042 -0.45 0.653 -0.103 0.064 roa 0.859 3.317 0.26 0.796 -5.678 7.398 roe -1.668 2.690 -0.62 0.536 -6.971 3.634 toa -0.583 0.055 -10.63 0.000 -0.691 -0.475 fs 1.046 0.485 2.16 0.032 0.089 2.003 gdpgrowth 0.016 0.023 0.71 0.480 -0.029 0.062 _cons 40.326 10.397 3.88 0.000 19.829 60.823 sigma_u 0.096 sigma_e 4.768 rho 0.0004 source: calculated by the author (stata 13.0) there is also an inverse relationship between tangibility of assets and short-term debt to total liabilities (-0.583). the average value of fixed assets of a company within the power industry for the period: 2008-2018 was about 85% of total assets, given the nature of the business they are engaged in. therefore, with the amortization of fixed assets due to the impact of depreciation, there is a need to modernize fixed assets from internal sources or external sources of financing. given that, a large number of companies had a stable yield potential, then in the upcoming period they can base their financing needs on internal (accumulated) sources of financing. almir alihodžić, ajla muratović dedić 91 table 5. random effects (gls) regression between dependent and independent variables of the power sector of republika srpska for the period: 2008 – 2018 random‐effects gls regression number of obs = 220 r-sq: within =0.000 number of groups = 2 between = 0.000 overall = 0.6200 obs per group: min = 110 avg = 110.0 max = 110.0 wald chi2 (8)=344.23 prob > chi2 = 0.000 stdtl (dependent) coef. std. err. z p>[z] [95% conf . interval] cr -0.390 0.056 -6.92 0.000 -0.501 -0.280 roce 0.056 0.247 0.23 0.820 -0.428 0.541 ebitda -0.019 0.042 -0.45 0.653 -0.101 0.064 roa 0.859 3.309 0.26 0.795 -5.626 7.345 roe -1.667 2.684 -0.62 0.535 -6.927 3.593 toa -0.583 0.055 -10.65 0.000 -0.690 -0.475 fs 1.047 0.484 2.16 0.031 0.0981 1.996 gdpgrowth 0.015 0.022 0.68 0.497 -0.028 0.058 sigma_u 0.000 sigma_e 4.768 rho 0.000 source: calculated by the author (stata 13.0) based on the results of the gls regression model, the following independent variables, with respect to p-values, had the strongest influence on the dependent variable, i.e., short-term debt to total liabilities: current ratio (0.000), tangibility of assets (0.000) and firm size (0.031). in terms of coefficient movements, the return on equity (roe) had a negative correlation with short-term debt to total liabilities. the average value of the indicator return on assets of the power sector of republika srpska for the period 2008-2018 was about 0.17%, while the average value of the indicator return on equity was about 0.16%, which is at an extremely low level. table 6. results obtained by application breusch and pagan lagrangian multiplier test variables var sd=sqrt(var) stdtl 57.393 7.575 e 22.741 4.768 u 0.00 0.00 source: calculated by the author (stata 13.0) given that the chi square value equal to zero, as p value of certain independent variables is slightly higher than zero but less than 0.05 (such as: current ratio, the tangibility of assets and firm size), then it can be concluded that independent variables had an effect on the dependent variable, and confirm the hull hypothesis, and the alternative hypothesis for slightly higher significance. 92 economic analysis (2020, vol. 53, no. 1, 84-93) conclusion a number of companies within the power industry of republika srpska entity have a stable and growing yield potential which creates the basis for higher debt capacity through corporate bond issuance and investments in new fixed asset infrastructure. the potential growth of companies within the republika srpska power industry can also have significant fiscal consequences given the contribution of the power industry to local and state budget revenues, etc. the effect of the independent variables on the dependent variable using the pooled ols regression model (fe) model and the random-effects gls regression model by using the breusch-pagan test was used. the most significant impact through the ols regression model and gls regression model had the following variables: current ratio, the tangibility of assets and firm size. therefore, these three independent variables play a decisive role in composing the capital structure of the power sector of republika srpska, with particular emphasis on tangibility of assets due to the nature of the business and the great need to invest and replace dilapidated fixed assets. also, this paper confirms both the null and alternative hypothesis with greater emphasis on the gls regression model. a number of companies in the power industry of republika srpska are increasing their shortterm indebtedness due to small amounts of cash and cash equivalents in the structure of total assets, and due to a fall in sales revenues in certain years of operation. in the upcoming period, the strategy of the power sector of 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(1992). the investment opportunity set and corporate financing, dividend, and compensation policies”, journal of financial economics, pp 263-292. the power sector of republika srpska (2019). ers internal information journal, no. 31, april – june. retrieved from: https://ers.ba/wp-content/uploads/2019/08/list-ers-31-web.pdf titman, s. and r. wessels (1988). the determinants of capital structure choice, journal of finance 43(1), 1–19. article history: received: october 10, 2019 accepted: november 19, 2019 ea_2013_3-4 finalna ver original scientific paper how structural changes affect enterprises’ expectations about employment in serbia?1 ognjenović kosovka∗∗, institute of economic sciences, belgrade, serbia udc: 330.341.4:331.5(497.11)"2011" ; 331.526 jel: c13, c35, d21, j23 id: 203730444 abstract – this article examines enterprises’ responses to structural changes in the economy of serbia caused by both transitional changes and the global economic crisis, as well as by influences of other accompanying factors. an assessment of the enterprises’ expectations in terms of short-term dynamics of employment needs is provided. enterprises use different coping strategies, but their potentials for growth and development are particularly tight. the multinomial logit econometric models are employed in order to estimate outcomes in the enterprises’ expectations with respect to changes in job flows. the coefficient estimate of the variable that measures the amount of engaged labour at the level of an average enterprise in serbia shows a statistically significant influence that this variable has on the enterprises’ decisions about the fluctuations of workers. taking the decision that would not result in changes in the number of employees as a baseline alternative, the first rational choice of the employers would be to dismiss old or to employ new workers if they expect unfavourable, i.e. favourable, trends, respectively. the estimated multinomial logit model can be used for predictions of employers’ decisions about expected in(out)flows of workers. however, a parsimonious multinomial model was estimated, implying that more accurate predictions would be obtained by using the model with more explanatory variables. for the purpose of the analysis presented in this article, a micro set of the survey data provided by the public employment service of serbia is used. the survey, with enterprises as primary sample units, was carried out in 2011. key words: enterprises’ expectations, employment, serbia, structural changes introduction transitional changes are the main driver of structural changes in the economy of serbia, but the national economy is influenced by global shifts as well. this article examines how enterprises in serbia respond to structural changes, to influences of the recent global economic crisis, as well as to other accompanying factors, when they make decisions about their future employment needs. the firm-level data, taken from the employer survey that is provided by the public employment service of serbia, are used for the analysis presented in ∗ this paper is part of research projects: 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education, science and technological development of the republic of serbia. ∗∗ research associate, institute of economic sciences, 12 zmaj jovina, 3rd floor, #308, 11000 belgrade, serbia; e-mail: kosovka.ognjenovic@ien.bg.ac.rs. economic analysis (2013, vol. 46, no. 3-4, 141-151) 142 this article. the multinomial logit (mnl) econometric model is employed in order to estimate the most predictable outcomes in the enterprises’ expectations regarding the changes in job flows. the estimated model can be used for prediction of the enterprises’ expectations, and, therefore, for expected movements in the labour demand, depending on the main characteristics of enterprises. the global trends show that, in many cases, shifts in the demand for labour are results of the increasing diversity in the supply of labour. some early studies for the developed european countries pointed out to the persistent decrease in the demand for unskilled labour (goux and maurin, 2000). technological advancement, as a driver of structural changes at the global level, significantly contributed to the appearance of these movements. the countries of the european union pay a lot of attention to the changes in occupation and skill needs that will occur in the future (cedefop, 2012). transition countries like serbia also have requests for collecting accurate information about the most demanded occupations and skills (vasić et al., 2011). the more advanced countries have more sophisticated demand for labour. ognjenović and branković (2010) found that skills and education of the labour supply in serbia are not the main obstacle for the creation of better and more productive new jobs. the useful reviews of the literature for the transition countries, regarding the influence of structural changes on shifts in the labour demand, are provided by domadenik et al. (2008) (for slovenia), micevska (2008) (for macedonia), and vehovec and domadenik (2003) (for croatia and slovenia). all studies provide results for the early period of economic transition that was characterized by significant fluctuations of workers and by decreasing rates of net employment. in general, all the counters follow the pattern of slow restructuring. that is the case of serbia as well (stošić et al., 2012). the main research hypotheses that will be explored in this article are as follows: (i) it will be investigated whether structural changes (approximated by the successive relative changes in the number of employees) are associated with the enterprises’ decision processes about in(out)flows of workers. (ii) the other factors that are associated with the enterprises’ expectations on the fluctuations of workers will be identified and tested by conventional statistical tests. (iii) from the point of view of the mnl model estimation, it is important to check for the independence of the decision made between two alternatives, relative to the decision that may result from additional alternatives, in order to confirm the assumption about identically and independently distributed error terms across all existing alternatives. the problems related to this issue are: (i) this assumption is usually violated in empirical studies, and (ii) there is a limited number of tools for the models with qualitative dependent variables that can be used when the distributional assumptions are violated. the article includes three main sections. after the introductory part, section two provides the descriptions of the theoretical and empirical models that will be examined in this article, as well as the estimation methods that will be used for obtaining the estimated coefficients. in the second and third parts of this section, the data sources and the results of estimation will be discussed. the final section of the article contains concluding remarks. ognjenović, k., how structural changrs, ea (2013, vol. 46, no, 3-4, 141-151) 143 empirical model estimation theoretical model and estimation methods according to the economic theory of firm, the labour demand model can be expressed by the following function: ),,( zlgqf = (1) where fq measures the current level of firms’ capacities, while l represents workers’ labour, and z includes all other factors that may influence the level of capacity of firms. in addition, due to the fact that firms are represented by employers, then, according to the theory of rational expectations of economic subjects, one may conclude that firms will behave in a way that will ensure maximisation of firms’ profits alongside with minimisation of firms’ costs. taking into account that the data sources that are usually used for creation of variables of the economic model are often deficient, in this article the following econometric model will be specified and estimated: .,..,1,exp nizl iiii =+++= εγβα (2) in the equation (2), the variable iexp , on the left side, approximates the level of firms’ capacities by representing enterprises’ expectations on the fluctuations of workers related to the future developments of their businesses, i.e. the expected increase (decrease) in the business activity due to favourable (unfavourable) business environment. these expectations, as we assumed, are based on their rational business decisions, having in mind that they are aware of potential market risks and other uncertainties. il and iz are labour and other explanatory variables related to the characteristics of the i-th firm (i=1,…,n), while α , β and γ represent an intercept term and a set of unknown regression coefficients, respectively, that will be estimated by appropriate methods; iε is an error term. the equation (2) can be expressed in the general form of a multinomial logit (mnl) model for unordered outcomes following greene (2000): jjxy jjj ,...,1, ' =+= ηβ (3) where x is a (1+k)x1 vector of explanatory variables, including a vector of units as a first element, which are individual-specific variables and are identical across alternatives. on the other side, a (kx1) vector of unknown regression coefficients jβ differs across alternatives, while the error terms jη are independently and identically distributed across alternatives. (the notation for individual firm i is exempt from the formulas.) based on the mnl model (3), the response probabilities across alternatives are given as: economic analysis (2013, vol. 46, no. 3-4, 141-151) 144 jjxxxjyp j l lj ,...,1],)exp(1/[)exp()|( 1 '' =+== ∑ = ββ (4a) ],)exp(1/[1)|0( 1 ' ∑ = +== j l lxxyp β (4b) where the equation (4a) represents the probability that the i-th firm made a decision j, while the equation (4b) results from the condition that the response probabilities across the alternatives must sum to one, i.e. 1)|( 1 ==∑ = j l xjyp . the log-odds, across alternatives, can be calculated as: jljlj xxpp βββ '' )()/log( =−= , assuming l is the baseline alternative, which implies the normalization at 0=lβ (the results can be normalized by the probability of any alternative from j=1,...,j). this implies that the log-odds ratio of the alternative j relative to the baseline alternative l in x is given as: jlj xpp β=∂∂ /)/log( . this is a useful result that allows for direct interpretation of the coefficient estimates. in addition, one may be interested in reporting the marginal effects after the estimation of the mnl model. the marginal effects of x on the response probabilities are calculated by using the formula: )()/( ββµ −=∂∂= jjj pxp , where β is the average of the β s for all alternatives. if the marginal effects are obtained for each case and then averaged for all cases, we deal with the average marginal effects. the marginal effects for the mnl model will not be reported in this article in order to simplify yielded results interpretation. standard errors of the estimated coefficients are provided by using the delta method. as in the case of the binary logit model, the mnl model is consistently estimated by the maximum likelihood estimator. the details are provided in greene (2000). data the data that will be used in this article come from the employer survey that was carried out by the public employment service of serbia in 2011 (public employment service of serbia, 2011). the main characteristics of the population of enterprises selected in the sample were recorded in the statistics business register provided by the national bureau of statistics. the sample units, i.e. enterprises, were selected according to the following stratification criteria: districts, economic activity, size (only enterprises with 10 and more employees were chosen), and ownership structure. the realized sample consists of the total of 4,083 sample units. the region of kosovo and metohija is excluded from the data set, because only 14 enterprises from the kosovsko-mitrovački district responded to the survey. full description of the methodology and of the sample selection process is provided by vasić et al. (2011). a set of variables that will be used in the estimation of the mnl model is defined as follows. the dependent variable is created as a qualitative response variable that takes on three values: 0 if no change in terms of increase or decrease in the number of employees is expected, 1 if enterprises expect increase in the number of employees and 2 if they expect decrease in the number of employees. a set of independent variables includes: the total ognjenović, k., how structural changrs, ea (2013, vol. 46, no, 3-4, 141-151) 145 number of employed in the year that precedes enterprises’ expectations (this variable represents the amount of engaged labour) (lnemp), a dummy variable for the size of enterprises, which are classified according to the three criteria (the number of employees, total annual turnover and average annual balance sheet) prescribed by the accounting and auditing law (large-sized enterprises are the reference category), a dummy variable for the region (the southern and eastern serbia region is the reference category), a dummy variable for sectors of economic activity (the economic activity of agriculture, forestry and fishing is the reference category) and a dummy variable for ownership structure (other forms of ownerships are the reference category). an additional variable that measures relative changes in the number of employees in two successive years is included in the mnl model. this variable is a proxy for the effects that the recent economic crisis and structural changes may have had on the expected job flows (proxy_re). results of estimation and discussion as it was already stated in the previous section, the dependent variable expresses three possible outcomes (alternatives), regarding the employers’ decisions about expected in(out)flows of workers. these outcomes are: no change that represents steady-state (expectation=0), to employ new (expectation=1) and to dismiss old (expectation=2) workers, so that the net employment is positive for the former and negative for the latter. following the logic of the binary logit model, it is suitable to assume that the first alternative (expectation=0) is the baseline alternative. in the sample, the distribution among the alternatives is as follows: 55, 31, and 14 percent for no expected changes, increase and decrease in employment, respectively. the results of the estimated mnl model are reported in table 1. we built the model in order to investigate potential influences of long-term structural changes, the recent global economic crisis, and the characteristics of enterprises on the employers’ decisions about expected job flows. the results of the research studies for transition countries show that structural changes that are mainly driven by the transitional changes caused significant fluctuations of workers (see for instance domadenik et al. (2008) for slovenia, micevska (2008) for macedonia, vehovec and domadenik (2003) for croatia and slovenia). using the expanded data set ognjenović and branković (2012) found that the economy of serbia creates and destroys almost the same percent of jobs on average, which results in the excess job reallocation rate of above 14 percent and in no significant changes in the net employment rate. the intercept terms are found to be both negative and statistically significant in the estimated mnl model. a negative sign of the estimates underlines the skewness of the enterprises’ expectations towards the alternative that will not result in the significant fluctuations of workers in the incoming period. this result is in accordance with the findings of some previous analyses of job flows (ognjenović and branković, 2012) and the assessment of the implementation of structural reforms in the economy of serbia (stošić et al., 2012). stošić et al. (2012) concluded that enterprises need to be determined to create more effective strategies that will improve their performances in the long-run under the conditions of significantly improved business climate. economic analysis (2013, vol. 46, no. 3-4, 141-151) 146 table 1. multinomial logit estimates and odds ratio for the econometric model explanatory variable estimated coeff. signif. exp (beta) estimated coeff. signif. exp (beta) expectation=1 expectation=2 lnemp 0.240 0.000 1.271 0.325 0.000 1.389 proxy_re 0.335 0.067 1.398 -1.626 0.000 0.197 size of firm d_small 0.832 0.001 2.297 0.311 0.336 1.365 d_medium 0.721 0.000 2.056 0.151 0.520 1.163 d_large f region d_belgrade -0.417 0.003 0.659 -0.499 0.009 0.607 d_vojvodina -0.311 0.002 0.732 -0.364 0.005 0.695 d_sumadija_west -0.044 0.641 0.957 0.061 0.624 1.062 d_south_east f economic activity d_agriculture f d_industry 0.261 0.100 1.298 -0.262 0.151 0.769 d_construction 0.139 0.435 1.149 -0.109 0.603 0.897 d_business_services 0.169 0.279 1.185 -0.326 0.072 0.721 d_other_services 0.125 0.489 1.133 -0.100 0.643 0.905 ownership d_private 0.224 0.068 1.251 0.012 0.936 1.012 d_public -0.215 0.225 0.806 -0.429 0.063 0.651 d_other f intercept -2.367 0.000 -2.463 0.000 log-likelihood: -3868.7655 χ2 (26)=198.477, p=0.000 percent correctly predicted (p≥0.50): 55.14% test for the independence of irrelevant alternatives assumption: omitted alternative (expectation=1): χ2(14)=5.975, p=0.967 omitted alternative (expectation=2): χ2(14)=23.561, p=0.052 notes: expectation=0 is the reference alternative. f denotes the reference category for dummy explanatory variables. source: author’s calculation. the coefficient estimate of the variable that measures the amount of engaged labour at the level of an average firm in serbia shows the statistically significant influence that this variable has on the enterprises’ decisions about the fluctuations of workers. greater amount ognjenović, k., how structural changrs, ea (2013, vol. 46, no, 3-4, 141-151) 147 of unproductive labour, alongside with the low level of enterprises’ capacities engagement, would probably result in the decisions about dismissals of workers. the odds ratio associated with this variable would increase the probability of choosing the third, instead of the baseline alternative, by about 1.4 times, holding all other variables in the mnl model fixed. the second choice, according to the estimated model, would be that the enterprises, which expect some favourable developments, will opt for new employment over the alternative that will not cause any change in the number of employees. in this case, the odds ratio would be expected to increase by about 1.3 times, holding all other factors constant. information about the positive successive relative increases in the number of employees from the past, taken by employers when they make decisions about the new employment, would more likely make them decide to increase the number of employed rather than not to change it. this implies that the effects of the recent global economic crisis on the performance of successful enterprises were only transitory and that they benefited from structural changes (for instance, positive cases include transformed old enterprises, new enterprises established in growing economic sectors, enterprises that produce tradable goods or services that can be sold in the international markets, etc.). the odds ratio would be expected to increase by about 1.4 times, holding all other variables in the model fixed. the estimate is statistically significant at the 10 percent level. on the other hand, those enterprises that have experienced unfavourable trends recently, or expect them in the near future, are more likely to report that no changes are expected to occur in the number of employees in the incoming period. small and medium-sized enterprises are more likely to expect inflows of new workers than the large-sized ones, compared to the baseline alternative. those small and mediumsized enterprises that would opt to decrease the number of employees cannot expect statistically significant changes, relative to the baseline alternative. the sector of small and medium-sized enterprises employs about 65.3 percent of the total number of employees in the non-financial sector in serbia (ministry of finance and economy of serbia et al., 2012). the potentials of this sector are of great importance for the economic development of serbia, but, unfortunately, the indicators of their business performance are still unfavourable (oecd et al., 2012). enterprises whose business activity is mainly concentrated in the regions of belgrade and vojvodina are less likely to expect inflows of new workers, so that they are more likely to keep the current level of employment unchanged. the answers of enterprises from the šumadija and western serbia region report statistically not significant expectations on outflows of workers. comparing the enterprises’ expectations in the rest of serbia with the southern and eastern serbia region, we can conclude that no concentrations are expected to occur, which would result in the statistically significant fluctuations of workers. this is probably due to the fact that the majority of large commercial privatisations have been already finished. additionally, the global economic crisis has slowed-down the inflow of foreign direct investments in the european transition countries (ślusarczyk, 2010). the estimated mnl model shows that there are no statistically significant changes in the enterprises’ expectations on the fluctuations of workers across the main sectors of economic activity. regarding the ownership structure of the enterprises, the privately owned ones are more likely to expect some inflows of new workers than to decide not to make changes in the economic analysis (2013, vol. 46, no. 3-4, 141-151) 148 current number of employees. on the other hand, those enterprises that are owned by the central and local governments are more likely to expect outflows of workers, instead of expecting no changes in the number of employees. the overall success rate of the estimated model is 55.14 percent, meaning that the estimated model correctly predicts more than a half of outcomes with the probability that is equal to or exceeds 0.5. this implies that the estimated model can be used for predictions of employers’ decisions about expected in(out)flows of workers. however, it should be stressed that the modal expectation of firms occurs in the alternative no expected changes that is used as a baseline alternative. the obtained results seem credible, having in mind that the decisions of enterprises, which may result in the fluctuations of workers, are influenced by the longterm structural changes (slow but persistent influence) and global economic crisis (transitory influence). testing for the independence of irrelevant alternatives assumption confirms that we cannot reject the null hypothesis that the observed alternatives are independent (small and hsiao, 1984). the null hypothesis is tested at the 5 percent level. this implies that the results of the estimated mnl model can be interpreted within the conventional confidence intervals. in addition, it can be confirmed that the estimates of the mnl model do not change significantly by omitting irrelevant alternatives. in addition, the wald test for testing the joint significance of the explanatory variables across alternatives is conducted too. the results of the test are given in table 2a in the annex. the estimated mnl model is based upon a parsimonious specification, because a limited set of variables was at disposal. among the explanatory variables, the vast majority are related to the characteristics of interviewed enterprises. analysing the results of the test leads us to the conclusion that the sets of dummy variables for sectors of economic activity and ownership structure are not statistically significant at the 5 percent level across alternatives, but some of the estimated coefficients for dummies, representing a particular industry or the type of ownership, were statistically significant for one of the alternatives in the mnl model. that was the reason why these explanatory variables are not excluded from the estimated model. neglecting the potential influence of these variables does not significantly change the predicting power of the mnl model, but still it can be informative for the policy making. all other estimated coefficients are statistically significant at the 5 percent level. concluding remarks in this article, an empirical specification of the mnl econometric model for the enterprises’ expectations on the fluctuations of workers in serbia is developed and estimated. the estimated model is built upon the research hypotheses that are specified in order to investigate potential influences of the factors, such as long-term structural changes, the recent global economic crisis, and the characteristics of enterprises, on the employers’ decisions about expected job flows. enterprises have opted for three alternatives: the first alternative means that enterprises prefer not to change the current level of employment, rather than to increase or decrease the total number of employees, which are the second and third alternatives, respectively. it is assumed that all decisions depend on their business ognjenović, k., how structural changrs, ea (2013, vol. 46, no, 3-4, 141-151) 149 prospects. the first alternative is taken as the baseline alternative. the overall success rate of the estimated mnl model is 55.14 percent, so that the model can be used for the prediction purposes. however, more accurate predictions of the enterprises’ expectations should be based on the model with more explanatory variables included. that would confirm the robustness of the estimation results reported in this article. the results of the estimated mnl model show that enterprises respond slowly to potentially needed adjustments in the demand for labour. the estimated intercept terms are found to be both negative and statistically significant, which points to the skewness of the enterprises’ expectations towards the alternative that will not result in the significant fluctuations of workers in the incoming period. enterprises with favourable business performances would more likely opt for new employment over the alternative that will not cause any change in the number of employees. both explanatory variables, the amount of engaged labour in the year that precedes enterprises’ expectations, as well as a proxy variable for structural changes, affected the employers’ decisions. the estimates of both coefficients are positive and statistically significant at the conventional levels. regarding the characteristics of interviewed enterprises, smalland medium-sized ones would be the main drivers of new employment. the size does not significantly determine the enterprises’ decisions when they opt for dismissals of workers instead of expecting no changes in the number of employees. variations of enterprises’ expectations throughout the sectors of economic activity are not statistically significant across the alternatives. privately owned enterprises would more likely expect inflows of workers, while the public enterprises would expect outflows of workers over the alternative that would not make changes in the number of employees. the distribution of answers of enterprises across the regions points to the fact that enterprises would not behave differently regarding the expected changes in the number of employees, regardless in which region they are pursuing their business activities. only in the šumadija and western serbia region some outflows of workers would be expected. these results can be used for the policy making process. references accounting and auditing law. official gazette of serbia, 46/2006, 111/2009, 99/2011. available at: http://www.paragraf.rs. cedefop. 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financial theory and practice 27(4): 609–623. kako strukturne promene utiču na očekivanja preduzeća o zapošljavanju u srbiji? rezime – u ovom članku se razmatraju odgovori preduzeća na strukturne promene u ekonomiji srbije koje su uzrkovane kako tranzicionim promenama i globalnom ekonomskom krizom tako i uticajima drugih pratećih faktora. ocenjena su očekivanja preduzeća o kratkoročnoj dinamici potreba za zapošljavanjem. preduzeća koriste različite strategije preživljavanja, međutim, njihovi potencijali za dalji rast i razvoj su prilično suženi. korišćeni su multinominalni logit ekonometrijski modeli kako bi se ocenili verovatni ishodi u očekivanjima preduzeća vezano za promene u kretanju broja radnika u preduzeću. ocena koeficijenta uz promenljivu koja meri količinu angažovanog rada na nivou prosečnog preduzeća u srbiji ukazuje na njen statistički značajan uticaj na odluke preduzeća o fluktuacijama zaposlenih. uzimajući odluku koja ne bi dovela do promene broja zaposlenih kao baznu, prvi racionalan izbor poslodavaca bi bio da otpuste postojeće i zatim da zaposle nove radnike, ako ognjenović, k., how structural changrs, ea (2013, vol. 46, no, 3-4, 141-151) 151 očekuju nepovoljna ili povoljna kretanja, respektivno. ocenjeni multinominalni logit model može da se koristi za predviđanja poslodavčevih odluka o očekivanim tokovima radnika. međutim, ocenjen je štedljiv multinominalni model, tako da bi za dobijanje tačnijih predviđanja trebalo koristiti model sa više objašnjavajućih promenljivih. za potrebe analize prikazane u ovom radu, korišćeni su podaci nacionalne službe za zapošljavanje srbije iz ankete u kojoj su preduzeća učestvovala kao jedinice istraživanja. anketa je sprovedena 2011. godine. ključne reči: multinominalni logit model, očekivanja preduzeća, srbija, strukturne promene, zaposlenost. annex table 2a. wald test for the joint significance of explanatory variables across alternatives explanatory variable χ2 df signif. lnemp 26.731 2 0.000 proxy_re 68.884 2 0.000 size of firm d_small 11.546 2 0.003 d_medium 14.963 2 0.001 d_large f region d_belgrade 12.912 2 0.002 d_vojvodina 14.195 2 0.001 d_sumadija_west 0.644 2 0.725 d_south_east f economic activity d_agriculture f d_industry 6.410 2 0.041 d_construction 1.185 2 0.553 d_business_services 5.682 2 0.058 d_other_services 0.936 2 0.626 ownership d_private 3.448 2 0.178 d_public 4.129 2 0.127 d_other f source: author’s calculation. article history: received: 12 july 2013 accepted: 15 november 2013 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp156-167 scientific review impact of the covid‐19 outbreak on macedonian trade flows iskra stanceva gigov1* 1 ss. cyril and methodius university in skopje, institute of economics – skopje, skopje, republic of north macedonia abstract reduced demand and the disruptions in value chains, as a result of the covid-19, are expected to have a significant impact on the external sector, especially in economies such as macedonian, whose manufacturing sectors are more integrated into global supply chains. hence, the main purpose of the paper is to see to what extent and in which segments the new conditions have reflected on exports and imports in the macedonian economy, and to review the measures and activities taken in order to mitigate short-term challenges and facilitate cross-border trade. the paper analyzes the trend and the changes that occur both on the import and export side, in general, by selected products and by countries. the data generally refer to a last 5 years. for more particular and specific analyzes, they cover the period from january 2019 until june 2020, on a quarterly basis. the main used research methods are: analysis and synthesis, statistical, historical and inductive-deductive method. the results have shown that the decline in economic activity and demand globally, including in the european union, and thus in the most important macedonian export partners, directly affects export sector in the country. economy also faces serious import problems, especially due to its heavy dependence on materials needed for industrial production processes that are usually imported from the hardest-hit markets in europe. the trade measures are mainly designed to avoid unnecessary barriers to trade and disruption of global supply chains. key words: export, import, covid‐19 outbreak, macedonian economy jel classification: f13, f14, f15, e61 introduction in addition to health risks, covid-19 has brought great challenges to the world economy. it suffers significant negative consequences. in such conditions, there is a shock on both the demand side and the supply side. the first one occurs as a result of people not spending money, either because they do not have it or because they have nowhere to spend it. the second one occurs because some sectors are almost dead, partly due to social distance policies (restaurants and cafes, hotels, beauty salons and hairdressers, theaters and cinemas, sports facilities, etc.), partly due to the nature of the business (travel agencies, fashion industry etc.) and partly due to the cessation of world trade (exports and imports are almost non-existent, and supply chains are interrupted). the macedonian economy is also not immune to the consequences of the coronavirus. the reduced demand, as well as disruptions in the value chains, especially in economy such as macedonian, whose manufacturing sectors are relatively more integrated into global supply chains are expected to have a significant impact on the external sector. in recent years, an * e-mail: iskra@ek-inst.ukim.edu.mk iskra stanceva gigov 157 average of 40% of exports and 60% of imports in the country have taken place through the small and medium-sized companies, which means that their survival is very important, but they are significantly vulnerable in such situations (gjorgjioska, 2020). thereby, there are increased layoffs of employees from the companies, which reduces the consumption capacity, and thus again affects the demand. its reduction may also mean a reduction in exports. an additional problem facing the economy is the slower transport of goods, with delays at borders, despite the fact that the transport of goods is to some extent free from the usual travel bans imposed by european countries and the balkan region. having in mind the above as a necessity arises the need for a detailed analysis of the foreign trade sector and to assess the extent to which the new conditions have affected the export and import sector in the country. on the other hand, the importance of this sector for the growth of the economy, necessarily imposes the timely introduction of appropriate measures and policies for easier management and exit from this situation. in this regard, the paper is structured as follows: in the first section attention is paid to the impact of the corona crisis on the export and import sector, by different aspects (in general, by sict and by trading partners), while in the second section are presented all measures taken so far in order to support the operation of export companies and strengthen trade in goods and services in the country. impact of the coronia crisis on the export and import sector export and import in general the covid-19 pandemic and related restraint measures are doing enormous damage on the global economy and certainly affect the western balkan economies. economies with higher levels of trade integration, such as the macedonian economy, confirmed mainly by data on: trade balance, openness of the economy and export coverage by imports (shown in chart 1 and chart 2), are particularly exposed to reduced global demand and distortions in global supply chains and they feel the immediate effects of the coronavirus crisis. chart 1. exports, imports, trade balance, coverage of imports by exports and trade openness in north macedonia, yearly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia 65.7 71.1 73.4 76.5 76.1 113.7 116.2 124.1 133.7 137.3 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 105 110 115 120 125 130 135 140 145 -4000000 -2000000 0 2000000 4000000 6000000 8000000 10000000 2015 2016 2017 2018 2019 exports imports trade balance coverage of imports by exports (%) trade openness 158 economic analysis (2020, vol. 53, no. 2, 155-167) the spread of covid-19 across the european continent provoked a series of strict measures among eu member states, which contributed to many shocks of supply and demand, that disrupted economic activity in the eu, especially in the first half of 2020. after the decline in gdp of 3.3 recorded in the first quarter of 2020, further contraction in the second quarter was very large with an average decline in gdp of 11.4% (eurostat, ec data browser, 2020). the decline of eu real gdp in the first half of 2020 is a result of the declines in private consumption, investment and the negative contribution of net exports. annual real gdp in the eu is expected to shrink in 2020 by 7.4% (european commission, 2020). a decline was also registered in the industrial production, especially in the months of march and april 2020 with a cumulative drop of 27.5%. in the next two months of may and june 2020, with the gradual lifting of restraint measures, industrial production increased by 23%, but is still lower than in february (european commission, 2020). the production of motor vehicles, trailers and semi-trailers is most affected, and the production of textiles and furniture is less affected. as a result of the decline on the supply and demand side, along with downward price pressures, inflation in the eu is also projected to fall to 0.3% in 2020 (european commission, 2020). data on international trade movements in the eu in the past two quarters of 2020 also show a slowdown in the exchange of goods and services. namely, international trade in the first quarter of 2020 decreased by 3% compared to the same quarter of 2019, while the decline in the second quarter was much higher, 22.4% compared to the same quarter last year. the overall negative growth of international trade for the eu for the first half of 2020 is -12.7%. (macedonia2025, 2020) these conditions of economic downturns in the eu and the restrictions imposed by eu member states, especially with the closure of borders for non-eu citizens, negatively affect supply, industry (especially the export-oriented processing industry) and trade in goods, and services in economies such as the macedonian economy. this is due to its high dependence on eu markets, where trade with the eu accounts for over 60% of imports and 80% of the country's exports. chart 2. exports, imports, trade balance, coverage of imports by exports and trade openness, in north macedonia, quarterly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 105 110 115 120 125 130 135 140 145 150 -1000000 -500000 0 500000 1000000 1500000 2000000 2500000 q1-2019 q2 2019 q3 2019 q4 2019 q1 2020 q2 2020 exports imports trade balance coverage of imports by exports (%) trade openness iskra stanceva gigov 159 the situation is further complicated by the fact that the western balkans economies, including the macedonian one, have also introduced some restrictive and often uncoordinated measures for the movement of people and goods. these measures combined with that taken by the eu increase the congestion at some border crossings which further slows down the trade flow, especially in the second quarter which is best seen in chart 2. exports in the second quarter decreased by 36% both annually and compared to the previous quarter, and the decline in imports was about 32%, which is a serious decrease in these categories for the macedonian economy. the previous means that the crisis also threatens the trade deficit, which is mainly covered by exports, as an important category in the balance of payments. export and import by sitc dominant macedonian export products in the last 5 years are: chemical products, machinery and transport equipment as a result of higher export activity of new facilities in the economy in industrial zones, while from traditional export sectors only exports of clothing and iron and steel recorded slightly higher positive contribution (as shown in chart 3). in the new conditions part of the export capacities have already temporarily stopped the production which reflects on the total export activity. it has led to a reduction in exports of machinery, transport equipment, and chemical products, which are products that create export capacity, especially in industrial zones. this happened mainly in the second quarter, especially in april and may in 2020 (with a decline of about 50% annually), and consequently, there is a decrease in industrial production of these product categories. chart 3. most exported products from north macedonia by sitc, yearly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia also, a significant part of the traditional export sectors was affected in the second quarter in 2020 as a result of the reduced foreign demand, as well as the logistical problems in the realization of global trade and uncertainty in general. 0.0 200.0 400.0 600.0 800.0 1,000.0 1,200.0 1,400.0 1,600.0 2015 2016 2017 2018 2019 chemicals and chemical products electrical machines and spare parts iron and steel clothing road vehicles 160 economic analysis (2020, vol. 53, no. 2, 155-167) chart 4. most exported products from north macedonia by sitc, quarterly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia exceptions to such conditions were the categories of textile yarns and medical and pharmaceutical products (see chart 4). as in the world trends also in the macedonian economy, the pharmaceutical industry is actually identified as one of the few "winners", while the automotive industry is one of the biggest "losers". chart 5. most imported products in north macedonia by sitc, yearly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia the movements of the macedonian import to a large extent reflect the export achievements. most of it comes from the raw material import of the new foreign export facilities, which is -80.0 -60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0 2019 q1 2019 q2 2019 q3 2019 q4 2020 q1 2020 q2 chemicals and chemical products road vehicles medical and pharmaceutical products textile yarns electrical machines and spare parts clothing 0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 2015 2016 2017 2018 2019 petroleum and petroleum products iron and steel textile yarns electrical machines and spare parts non-metallic mineral products road vehicles iskra stanceva gigov 161 reflected in the higher import of non-ferrous metals, machinery and transport equipment, as well as chemical products. the energy component also contributes to the growth of imports (as shown in chart 5). having in mind the import dependence of the macedonian export and the decreased domestic demand, the reduced level of import is quite expected, especially in the second quarter of the year (as shown in chart 6), and during the whole year in general. the new conditions reduce the import of all dominant categories, and there is a positive change in the import of products that do not fall into the dominant categories such as food and live animals, namely fruits and vegetables, meat and processed meats and cereals and processed cereals. chart 6. most imported products in north macedonia by sitc, quarterly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia the effects of such disorders are visible in the third quarter with a gradual decrease in intensity and are expected to be present in the last quarter of the year, but the intensity is still unpredictable. export and import by trading partners the european union is the most important foreign trade partner of the macedonian economy with a share of about 70% in the total foreign trade. germany, belgium and bulgaria stand out as the most dominant eu export partner countries in the last five years. in addition, serbia and kosovo have a significant contribution to macedonian exports. as can be seen, biggest export markets are countries in which the virus is rapidly spreading and which have imposed high restrictions, meaning that demand in their markets shrink, so the decline in exports from our country is quite expected. hence, the decline in economic activity globally, including in the european union, and thus in the german economy, where a large part -70.0 -60.0 -50.0 -40.0 -30.0 -20.0 -10.0 0.0 10.0 20.0 30.0 40.0 2019 q1 2019 q2 2019 q3 2019 q4 2020 q1 2020 q2 cereals and cereal preparations fruit and vegetables non-metallic mineral products meat and meat preparations electrical machines and spare parts road vehicles textile yarns iron and steel petroleum and petroleum products 162 economic analysis (2020, vol. 53, no. 2, 155-167) of macedonian exports is concentrated (chart 7), has a direct impact on the country's exports to dominant partner countries. chart 7. exports to the five major trading partners of north macedonia, yearly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia this is quite obvious in the second quarter of the 2020 (chart 8) when there was a significant decrease in exports to germany by 50%, belgium by 43%, bulgaria and kosovo by about 30% and serbia by 20%. these are relatively high percentages of export reduction for the macedonian economy, especially if we keep in mind that higher exports and deeper integration are very important for creating greater economic growth and higher income in the country. chart 8. exports to the five major trading partners of north macedonia, quarterly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia the analysis of imports by trading partners indicates that the largest contribution is made by imports from germany, followed by imports of precious metals from the uk, as well as slightly higher imports from greece on a combination of energy and non-energy imports. they are 0 500 1000 1500 2000 2500 3000 3500 2015 2016 2017 2018 2019 germany bulgaria serbia kosovo belgium 0 100 200 300 400 500 600 700 800 900 q1-2019 q2-2019 q3-2019 q4-2019 q1-2020 q2-2020 germany bulgaria kosovo serbia belgium iskra stanceva gigov 163 followed by the import of equipment and machinery from serbia, and no less important is the import from china. chart 9. imports from the five major trading partners of north macedonia, yearly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia trade through global value chains is highly dependent on the timely delivery of critical import components, making it particularly vulnerable when deliveries are disrupted by quarantine, production disruptions and border controls. the macedonian economy is mainly integrated into the global value chains through purchases of raw materials from the world economy. chart 10. imports from the five major trading partners of north macedonia, quarterly source: prepared by the author based on data from the state statistical office and the ministry of finance of the republic of north macedonia the disruption of supply chains from the slowdown in production in china, europe and the united states is another channel for transmitting the crisis in north macedonia, contributing to reduced imports from major trading partners. namely, its exports, such as automotive parts or 0 200 400 600 800 1000 1200 2015 2016 2017 2018 2019 germany great britain greece serbia china 0 50 100 150 200 250 300 350 q1-2019 q2-2019 q3-2019 q4-2019 q1-2020 q2-2020 germany great britain greece china serbia 164 economic analysis (2020, vol. 53, no. 2, 155-167) electronics require imports of a significant part of foreign parts, especially from european countries and china. the eu is the region most affected by the pandemic and production facilities in these countries are closed, which certainly has an impact on the macedonian import of industrial parts and components, which is confirmed by the data shown in chart 10. the chart shows that the country registered a significant decline in import from all five dominant trading partners especially in the second quarter of the 2020. that annual decline is around 50% among the eu's largest import partners, followed by 22% in serbia and 7% in china (chart 10). this is very unfavorable for the macedonian economy, especially in the direction of eu import partners, because the eu is the country's largest trading partner. covid‐19 measures and policy priorities to strengthen the trade of goods and services having in mind the great importance of the export sector in the macedonian economy, in this period, the introduction of measures to support the operation of export companies and to strengthen trade in goods and services is of particular significance. some of the involved measures are the following:  trade measures which mostly have been designed to ban macedonian exports of medical equipment temporary export quotas on masks, which is still in use, or food products temporary export quotas of wheat and flour, which was terminated on 30 april (international trade centre, 2020). these bans aimed to ensure sufficient quantities of these products in the country amid growing market demand for them and set maximum prices for certain products of first necessity in the wholesale and retail trade.  the government of north macedonia together with the customs administration has adopted various specific measures facilitating customs procedures and cross-border trade including authorisations for a delay in the payment of the amount of duties or simplified procedures for the import of certain products. in order to lower prices, the government also abolished import duties on certain goods (wb6 cif, 2020).  country also has introduced measures to overcome tariff restrictions – or associated measures such as tariff reciprocity – that are not economically justified. in particular, those imposed on basic supplies whose shortage could lead to a runaway price.  next involved measures are aimed at the realization of an un-impeded transport at border key points which is crucial to maintain availability of goods, in particular of essential goods that the country largely imports from the eu during the time of the crisis but also goods embedded into gvcs and necessary for the local industries’ production.  in this context, the country, together with some other western balkans economies, introduced priority "green lanes" to facilitate the free flow of goods through the "green" priority border/customs crossings points (oecd, 2020).  measures have also been introduced by the national bank which refer to both companies that are oriented only to the domestic market and companies from the export sector, as one of the first sectors affected by the crisis. some of these measures are: reduced interest rate to a historic low of 1.5%, reduced supply of treasury bills etc., in order to provide additional liquidity to the banking sector which can be directed to lending to the private sector.  another non-standard measure by the national bank of north macedonia is reduction of the basis for mandatory reserve of banks for the amount of newly approved loans to companies that are from the most affected sectors, including net iskra stanceva gigov 165 exporters. this measure aims to provide a reduction in the cost of loans and increase the volume of credit support for these companies.  in general, all previous measures were adopted by the national bank in order to alleviate the consequences of the crisis, to improve the liquidity of companies, i.e. to facilitate the conditions of financing and support as a whole (izvoz.mk export news portal, 2020).  the development bank of north macedonia in addition to the series of measures for interest-free loans for micro, small and medium enterprises, also offer a 30% grant (non-refundable) for those companies that are run or founded by women or employ young people, are export-oriented or introduce innovation and digitalization in their operations. all these measures lead to trade facilitation which is confirmed with the data from the third quarter which are better than the previous one. it is interesting to note that the rest of the western balkan countries are also taking a combination of a series of short-term measures to alleviate the crisis in the export sector and boost trade in goods and services. as in the macedonian economy, so in other countries in the western balkans, trade measures are designed mostly to ban the export of medical equipment or food products. thus, in albania, as a measure on the export side, a ban on the export of medicines and medical devices has been introduced. that export is allowed only upon the authorization of the minister of health. this measure is still in place and has a limiting effect on trade. (international trade centre, 2020). furthermore, the second set of measures taken by the albanian government includes a sovereign guarantee of all 15 billion (0.9% of gdp) to provide loans for working capital for active processing exporting companies (and for the tourism sector), with the government taking charge of the interest costs (groupe société générale, importexport solutions, 2020). in bosnia and herzegovina, measures have been introduced on the import side, which refer to the reduction and exemption from calculation and payment of customs duties on the import of medical products. they have a liberalizing effect on trade (international trade centre, 2020). likewise, the government of the federation of bosnia and herzegovina established a special fund to support export companies that are facing difficulties due to the effects of the pandemic on their export markets (groupe société générale, importexport solutions, 2020). all customs offices in bosnia and herzegovina are operating full time, and import and export customs procedures are completed in shorter possible period with due regard for legal regulations (world customs organization, 2020). in montenegro in the area of customs there is extending of the limit of the exposure of customs guarantee for payment of customs debt (government of montenegro, 2020). serbia introduced an export ban on medicaments, as well as a ban for certain basic life products (wheat flour, sugar, oil, hygiene products, etc.). as measure on import ethyl alcohol was exempted from customs duties (international trade centre, 2020). further, the export insurance and financing agency (aofi) granted a moratorium on all claims in order to overcome the negative effects on serbia's exportoriented businesses due to the covid-19 pandemic (groupe société générale, import-export solutions, 2020). while some trade measures may ease the impact of the crisis, obligations to keep markets open for essential products could help avoid major price changes. export restrictions should be carefully considered to avoid unnecessary barriers to trade, i.e. unnecessary disruption of supply chains. conclusion the effects of the covid-19 are strongly felt in the country's export and import sectors. the crisis has led to a decline in exports of products that create export capacity, especially in industrial zones and also in some traditional export sectors. exceptions to such conditions are 166 economic analysis (2020, vol. 53, no. 2, 155-167) the categories of textile yarns and medical and pharmaceutical products as a result of the increased need for those products in times of crisis. the new conditions also reduce the import of all dominant categories, but they conduct a positive change in the import of products that do not fall into the dominant categories. the country also registers a significant percent of decrease in export and import by the main trading partners especially in germany where the major part of the export and import is realized. this happened mainly in the second quarter of the year, especially in april and may 2020. such effects are visible in the third quarter 2020, and are expected to be present in the last quarter of the year, but the intensity depends on the spread of the coronavirus. although some trade measures may ameliorate the impact of the crisis, commitments to keep markets open for essential products could help avoid large price swings. hence, export restrictions should be carefully designed to avoid unnecessary barriers to trade and disruption of global supply chains. macedonian economy should also scale up trade flows of certain products, as companies worldwide will reevaluate their dependence to highly concentrated supply chains, which will open new markets for the country. the limitations of this paper are seen in the short period of time for analysis, as well as the simplified analysis without more specific correlation with other key variables, which remains a challenge to be achieved in future papers. another potential for future research is the measurement of the effects of the implemented trade measures in the country. references eurostat, ec data browser (2020). retrieved from: https://ec.europa.eu/eurostat/databrowser/view/namq_10_gdp__custom_77309/bookmar k/table?lang=en&bookmarkid=b74febcd-e664-4f22-9c93-2ef510fe371f european commission (2020). european economic forecast. autumn 2020. institutional paper 136. november 2020 gjorgjioska, a. 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http://www.wcoomd.org//media/wco/public/global/pdf/topics/facilitation/activities-and-programmes/naturaldisaster/covid_19/bosnia-andherzegovina_en.pdf?la=en#:~:text=all%20customs%20offices%20in%20bosnia,against%20t he%20covid%2d19%20pandemic. world trade organization (2020). trade statistics and outlook. trade set to plunge as covid-19 pandemic upends global economy. press/855. retrieved from: https://www.wto.org/english/news_e/pres20_e/pr855_e.htm article history: received: november 5, 2020 accepted: december 8, 2020 editor’s note hello, and welcome to volume 3-4 of the economic analysis. the year 2010 starts with a small change for the journal. namely, for the first time we engaged a foreign guest editor prof. dr. jozef glova from technical faculty, kosice , slovak republic. due to his excellent contribution to volume 1-2, the journal’s editorial staff will continue to call periodically foreign guest editors. in order to meet the standards, set forward by the ministry of science and technology, republic of serbia, we have increased year-byyear quality content. in that context, the editorial board promise to all our readers and other contributors that our team will do the best to maintain a high standard of the journal and add more improvements in coming volumes. we expect that mentioned changes and high quality of the journal would also improve our already not small citation rankings. it has been a pleasure and an honor to create with a patient staff the economic analysis this year. i hope you enjoy and learn from the results, as we have. once again, thank you. prof. dr. mirjana radović marković editor-in-chief economic analysis microsoft word 2009_1_2.doc administrative practice in nigeria: implications for national development m. a. omolaja, president, international college of management and technology, ayetoro-yewa, nigeria jel: h83,n47 abstract – administration cannot be practiced in isolation of the culture of the society. this assertion implies that the knowledge, attitude, societal norms and orientation which people hold epitomize their administrative philosophy and the way it is practiced. administration in nigeria is practiced in ways and manners which will benefit the administrator and in most cases not in the best interest of the common man. whether in the private sector or in the public sector, the nigerian administrators would normally use their positions and every other resource at their disposal to amass pecuniary interests for themselves. hence, for a turn around and development of the economy, there should be a reorientation of the society apparently through proper education and training for the professional administrators as well as general attitudinal change to the way administrative functions are performed; that is, a new administrative philosophy which will inculcate in the society the true and genuine spirit of administration should be institutionalized in the country. anatomy of adminsitration the simple dictionary definition of the word ʺadministrationʺ is the management of organizational affairs: that is, the day to day administration of an organization. in another sense, administration implies ʺthe part of the government that manages public affairs during the period of office of a president of a country, say, the united states of america or nigeria. also administration may be used to mean the period of office of the leader of a country, especially of the president of a country. for instance, during the babangida administration in nigeria. administration may also be explained in terms of providing, giving or application of something. for illustration, judges are responsible for administration of justice while nurses are responsible for administration of drugs in hospitals after the doctorsʹ prescription. august adebayo (1995) defined administration as ʺthe organization and direction of persons in order to accomplish a specified end.ʺ from the above anatomy of administration. it would be crystal clear that there are two main concepts of administration: one, as a process and two as personale at law; that is, as a legal entity. however, it is self evident that administration must take place in any social setting; be it as small as a family unit or as large as the universe. whether you think of the private sector organizations or their counterparts in the public sector, administration is administration. the only difference is the way it is practiced. this also is dependent upon the culture and norms of the organization in question. whatever the nature and scope of organizations, administration has to exist as every organization deals with human, material and other resources which have to be harmonized, integrated or unified for the common goal of corporate performance. economic analysis 1-2 (2009) 53-64 54 consequently, the general in the army, the vice chancellor or president in the university, the president of a business empire; all have under them a hierarchy of subordinate officers with differentiated duties and responsibilities assigned to them. even the almighty creator himself is a good administrator and that is why there is a place for everything and everything for a place in the universe. hence, when considered as a process, administration would consist of planning, organizing, commanding, directing, leading, coordinating and controlling functions to be performed in a predestined order towards predetermined goals. every organization in the contemporary society whether in canada, japan, united states of america or nigeria, consists of several individuals and groups connected together in a network of roles, duties or responsibilities in a manner to accomplish the corporate objectives of the organization. in industrial enterprises like the p.z nigeria plc., first bank of nigeria plc., as in the case of the public sector organizations like the ministry of labor and productivity, ministry of external affairs, etc., the corporate productivity of the organization is dependent upon the culture of administration. this claim becomes highly imperative because a large number of employees have to be controlled, supervised, monitored, coordinated, etc. if administration is considered as personale at law, then, it will be regarded as a legal entity; that is, the symbol of unity within the organization. this perspective is evident in the case of governmental organizations as is usually the case when a governor of a state, a military head of state or an executive president makes a declaration that ʺ.....our administration has provided free education at all levels . and free medical services.in the past .years for the enjoyment of the massesʺ. however, whether administration is considered as an executive function, a process or a person, a group of persons performing administrative functions symbolizes the administrator. from experience, the roles of administration within an organization or a society are strategic, institutional, central and pivotal. it has now been widely acknowledged that the position of an administrator is fundamentally significant in every establishment being the pillar of success or otherwise as s/he needs to be central to decision making process. it is because of the supremacy of administration and administrators, especially in the complex contemporary organizations and because of the turbulent or dynamic nature of the modern society, that discussions on them have become commonplace in the organization theory and practice literature. philosophy of administration ordinarily, philosophy stands for the search for knowledge and understanding of the universe and of human life or existence. when applied to the concept of administration, it becomes philosophy of administration. in essence, philosophy of administration implies the search for the body of knowledge including the origin, evolution and practice of administration as well as the study of administrative culture. the origin of administration can be traced to the beginning of the universe when the earth and heaven were created. however, in management literature, the major work on administrative management may be traced to the era of the classical school, and the major contributors then were henri fayol, f.w taylor, frank and lillian giberath, etc. each of these theorists used m.a. omolaja / ea 1-2 (2009) 53-64 55 different approaches to study administration. for instance, marx webber, a sociologist born in germany in 1864, was the first theorist who was interested in knowing why individuals obey command in organizations. this led him to the concept of authority which represented the core of his study of administration. he classified administrative authorities into charismatic, traditional and bureaucratic types. the next theorist in the parlance of administration was henri fayo (1949), a french man, who was probably the first classical theorist. he came up with his ʺgeneral principles of managementʺ which formed the title of his first book. he provided a list of what he considered the six major activities of an industrial undertaking. these are technical, production, commercial, financial, security and accounting activities. later he listed his fourteen principles of management. these include division of labor, authority, discipline, unity of command, unity of direction and subordination of individual interest to general interest. others are remuneration, centralization, scalar chain, order, equality, stability of tenure of office, span of control and espirit de corps. these principles are relevant to the study of administration today as when they were first propounded. it was his quest for sound knowledge of administration that made him write his ʺindustrial and general administrationʺ in 1916 and also led him to establish the center of administration in paris to make sound administrative practice available to the french civil and military agencies. this evolution continues through the human relations school, neo-human relations school, system approach and contingency approach to the study of administration and management. from this analysis, it can be observed that the ideal administrative culture and philosophy should follow realism, objectivity, rationalism and orderliness. in practice, however, especially in developing countries, administration is at variance with these requirements. administration culture in nigeria the administrative culture of a society cannot be fully discussed without a thorough understanding of the culture of the society. culture implies a complete way of life of people in a society. that is, culture is tantamount to the code of value by which a group or society lives. according to edward j. lurie (1979), culture ʺis a collection of people who had been bounded together to achieve some common ends usually economic and definitiveʺ. the economic ends include provision of basic things of life such as food, cloth and shelter. on the other hand, the definitive ends aim to provide members of a society with identities. such identities will be in the form of ʹ i am a member of ayetoro club 80ʺ, ʺi am a member of the institute of management consultantsʺ, ʺi am a complete gentlemanʺ or ʺ i am one of the elites in this countryʺ etc. in the ʺnigerian life and cultureʺ edited by oyeneye and shoremi, culture has been defined as ʺ that complex whole which includes knowledge, belief, art, law , moral, custom and all other capabilities and habits acquired by man as a member of a societyʺ. clyde cluckhohn and willains kelly (1979) defined culture as ʺa historically derived economic analysis 1-2 (2009) 53-64 56 system of explicit and inplicit design for living which tends to be shared by all or specially designated members of a society. andah (1979) perceived culture as ʺall the material and non-material expressions of a people and the process by which the expressions are communicatedʺ. consequently, culture is comprised of all the social, ethical, intellectual, scientific, artistic and technological expressions and processes of a people usually related and live together in a geographical contiguous location. it also includes what the people pass on to their successors and how these are passed as well as the way they think. from the aforementioned facts, it is crystal clear that every society has its own culture and that this culture serves to dictate their attitudinal dispositions, inclinations, orientations and behavior. having said as much, what then are the features or characteristics of the nigerian culture which have actual or potential influence on the administrative practice of the nigerians? since there are many tribes or ethnic groups in nigeria, the coverage of this article shall be limited to the three major ethnic groups the country; that is, the yorubas, hausas and the igbos as samples of the ʺuniverseʺ. observing the general way of life of most nigerians, one would observe that the nigerian culture is multifarious and multidimensional. however, the following are the specific aspects of the culture which are of paramount significance to this paper: a. extravagant spending; most nigerians have imbibed the culture of wasteful spending and ostentatious life styles which jeopardize their ability to grab investment opportunities as they come. a yoruba man, for instance, prefers to spend his last kobo on funeral ceremony of his father, uncle or even in-laws. this can be observed from the weekend rush along lagos-ijebu roads, abeokuta-lagos expressway and evenwithin most popular yoruba cities. such monies being wasted should have been gainfully applied for profitable ventures. b. outrageous taste and fashion; closely related to the extravagant spending is the love which most nigerians have for the use of unnecessary and nonsensically valued luxurious materials. it is not only here in nigeria, but even in the cities abroad like japan and the united state of america, one would normally find nigerians in ʺbig carsʺ highly sophisticated gadgets, etc. some would even park about 6 to 7 or more cars in front of their houses for reasons best known to them alone! such excess funds should have been extended to other members of the society or else invested in an economic activity probably in agriculture, manufacturing or service industry. as a result, one would be directly or indirectly contributing to the foreign exchange and employment opportunities capacity of the country which would normally lead to the much needed economic advancement. c. extended family system; if only one person is affluent in a family, he would be regarded as the bread winner to cater for the whole extended family. this is not done in the advanced countries. once one has taken care of this direct biological children and wife, he is at liberty to invest his extra billions of dollars on trade and commerce at will. however, this extended family system is being curtailed by the present economic hardship in the country. m.a. omolaja / ea 1-2 (2009) 53-64 57 d. low education; in the language of alexander pope, ʺa little learning is a dangerous thing, so drink deep or taste not the pierian springʺ. it was just of recent that many nigerians started to give their wards sound and befitting education especially in the northern part of the country. it is possible to meet a typical able-bodied hausa man along the streets of cities like lagos, ibadan, kaduna or kano selling about a dozen of kolanuts, one or two packets of cigarettes and perhaps some biscuits! as for the eastern part, the igbos hardly cater for their wards beyond school certificate level. this people are usually found in small scale businesses in the cities although many of them develop into giant businesses as time goes on. initially, instead of thinking in terms of some millions of naira, the business owner would be manipulating some five thousand naira or a little more. birds of these feathers cannot be expected to be much concerned with the national development. they will rather be interested in their own selfish interests. although, there have been more efforts in this part of the country towards higher education, the trend is expected to be better. e. polygamous culture; the holy quran provides that a muslim should marry two, three or four wives. if he fears that he cannot do justice among them, he should marry only one. this provision of the islamic ʺconstitutionʺ has however been misinterpreted. a man is expected to many two if he has power for four; three if he can cater for six; and four if only he can maintain eight wives. nowadays, there are many muslims having seven, eight or more wives despite the limitation of maximum of four. the contribution of the christian counterparts is dicephalous. first, the christians would normal boast of ʺone man, one wifeʺ in the public. but there are many christians with ʺone man, one wifeʺ at home with several concubines outside usually unknown to the wife at home, until when the man dies and a chain of children is dumped for him as his. shall we call this posthumous children adoption? on the other hand, those that do not deal with concubines would practice what i can call ʺserial monogamyʺ. here, one will normally have one wife at home at a time. however, after two or three children and having found another ʺnew bloodʺ and more beautiful one outside, the one at home would be ejected this process continues until his death when several children would be dumped for him perhaps half educated including some ruffians. there was even a pastor and founder of a church who died leaving not less than seven wives. yet he was a devoted christians. f. power tussle; the question of power tussle is not less gloomy. nigerians have witnessed more than enough changes of government during the last forty years of post independence era. there have been many coups and countercoups de tat; many abortive, some successful. majority of the coup plotters had always claimed protection of public interests as their ultimate aims. yet ʺthere are several figures behind 6 other than 7ʺ. there is no doubt that most coup executed were for the simple reasons of struggling for power; be it economic or political. economic analysis 1-2 (2009) 53-64 58 successive governments have always been having their own tailor-made development plans. whenever there is a sudden change of government, such a plan, however, laudable, would have to be shelved or truncated, and hence the journey starts all over again! when then are we going to reach the ʺpromised landʺ of economic advancement and self-reliance? also there is the question of power balance, power distribution or power rationalization among the various ethnic groups in the country which also serves as the killer of our national development. g. others; there are styles of administrative management, dressing and so on which we employ in our daily activities especially to boost our egos! can you imagine an agricultural officer visiting a farmyard probably for inspection in suit? a german engineer would always be found with shorts and shirts together with his tools in his hands. every nigerian, if given the chance, would want to be a ʺtie-manʺ. it is true that practice makes perfect. however, if one practices wrongly, the result comes out perfectly wrongly. other facilitators of the backwardness of the nationʹs economy and which has become the culture of the society include tribalism, nepotism, favoritism and ʺcrown-the-prince complexʺ. knowledge knowing what to do but wisdom lies in knowing when and how to do it. we have to change our styles as it appears that the sea is becoming more fogy than when we set sail. from this exposition, one can now imagine the impact of the nigerian culture on the way administration, is practiced, for instance, how would you expect a man with many wives, children and extended family members to cater for not to look for money at all cost to satisfy all these interests? put such a man at the head of affairs of an organization whether private or public, his major objectives would be how to amass wealth for the use of his family. again, a man haring six or more cars together with many houses has to maintain them. also, he has to build houses for his children, wives and for use as motor parks. he needs a substantial amount of money to do all these. finally, the culture of extravagancy and ostentatious lifestyle requires a large amount of money to maintain and sustain. this requirement would not allow administration to be practiced objectively and rationally for any national development. finally, the case of power tussle and general indiscipline as well as poor accountability and control which have become institutionalized in the country would not allow a typical nigerian to be successful if put in positions of authority. all these are the influences of culture on the way administration is practiced in most developing countries administrative practice in nigeria it has become widely acknowledged that there is the universality of administration. the implication of this claim is that administrative duties and responsibilities tend to remain constant irrespective of the location and time where and when they are performed ceteris paribus. however, from experience, nothing remains the same except the change itself. m.a. omolaja / ea 1-2 (2009) 53-64 59 consequently, since culture differs across national boundaries and over time, administrative responsibilities also differ in mode of performance. hence, administrative practice in nigeria is dependent on the nigerian culture while administrative practice in europe or in asia is also dependent on the culture of the respective continents. this assertion implies that the practice of administration is a function of cultural pattern of behavior of the administrator; which implies non-homogeneity of administration. consider the major differences between the performance of administrative duties in developing countries and the system in europe, what do you think is the main differences which you observe? it is nothing but cultural differences. culture, generally would influence, and be influenced by, what we do, how and when we do it, what we wear, what we say, how we develop, our mode of dressing, our thinking faculty and practically every aspect of our life. the way a person is brought up, his family background, his class in the society, etc, would definitely affect the way he thinks, behaves, his orientation and general attitudinal disposition to his work, place of work and the society at large consequently, because of the cultural background of the nigerians as discussed in the previous sections, administrative practice in the country may be said to be at variance from the ideal practice especially when compared to the european model. for instance, administrative duties and responsibilities in nigeria are not sufficiently organized, coordinated, controlled, disciplined and sometimes lacks proper planning; reflecting the culture of the society. a typical illustration of the culture of administrative practice in nigeria is the hypothetical case of a managing director called mr. nigerman. mr. nigerman arrived at the office in the morning about 9.50 a.m. looking tired and depressed. he had decided to go through the report submitted by the re-engineering committee the previous day before any other thing that day to enable him to digest the main contents before his formal presentation to the board of directors by 10.00 a.m. the office opened at 8.00 a.m. and now he arrived in the office at 9.50 a.m. with only 10 minutes to glance through the report before the board meeting. his subordinates who saw him getting out of his car and had been waiting for him for one assistance or the other described his lateness as one of the benefits of being at the top, and look at him in high esteem. what the subordinates with the erroneous belief got to know later was that mr. nigerman had been up busy at home on one thing or the other since 5.00 a.m. he had allowed himself some minutes to have his bath, have his breakfast and dressed up for the office. just as he was about to leave home for the office, two elderly members of his extended family walked in. mr. nigerman had greeted them and to comply with his native custom or culture, he had to invite them to join him for the breakfast while the august visitors declined telling him that they here okay already. due to the status of the visitors in his family, mr. nigerman was unable to advise them to go as it was believed they had come because of the recognition of his own position and roles in the family. he therefore lost his senses of self-control and had done his best to be polite and friendly to them as a man with cultural etiquette. by the time the visitors left, mr. nigerman was left with no option than to come late to the office. economic analysis 1-2 (2009) 53-64 60 already, some of the board members had started arriving at the venue of the meeting and messages had been pouring into mr. nigermanʹs office inviting him to bring the report for presentation. despite this problematic situation, another important personality in the immediate community had come sitting down at the reception waiting for his attention although uninvited. he had based his notion of visit on the basis that that was the best time to ʺcatchʺ him before he is engrossed with office responsibilities. on noticing the prevailing situations, the visitor had quietly left leaving a note in annoyance that he was not duly recognized, and that he would show him how to show respect to important personalities like him in the society. presently mr. nigerman had no more time to glance through the report and to contact some divisional heads to ask for up-to-date information on certain issues pertaining to their operations. he also needed to quickly dictate a minute concerning his comments on an urgent strategic decision. it was then mr. nigerman rushed to the venue of the board meeting as he was a few minute late already. after the meeting the next two hours, he returned to his office panting. his table had become disorganized and covered with heaps of files and papers some of which were labeled ʺurgentʺ and the others ʺfor immediate actionʺ. as he was trying to settle down and tidy up his table, his secretary rushed in to tell him that the commissioner had telephoned thrice and left a message inviting him to his office concerning a negotiated contract which needed further consideration before decision is made on its approval. mr. nigerman quickly rushed to the commissioner’s office where papers and documents were referred to on several occasions. he was there for about an hour before he returned again to his office. the time had come for another meeting and he had to be there as there was nobody to deputize for him. this was due to the fact that there was a little misunderstanding between him and his second-in-command. his deputy, wanted autonomy on certain issues which mr. nigerman was not prepared to grant in order that he would not loose his esteemed recognition as the alpha and omega in the company. the meeting went on until the closing time which was also behind the schedule. meanwhile some of the divisional heads had been waiting to brief. mr. nigerman on certain pressing issues in the company. in the meantime, the august visitor who left in annoyance in the morning came back having been pacified by a colleague who understood better mr. nigermanʹs condition. some others also were their to see him. consequently, for over two hours after the close of the office, the officer was still busy. finally tired, hungry and angry with himself and every other person around, he prepared to go home without forgetting two or three other reports to be studied over the night for action the next day! although the above case epitomizes a typical case of administrative process, the process is more refined in the western administrative mechanism. from the case, it is apparently clear that such a process is unorganized, lacks orderliness, unstructured, and control process is very poor; reflecting the administrative culture in nigeria. the british administrative culture is orderly, controlled and very structured. a briton, for instance, would not because of pecuniary interest waste a-day holiday; not even a rest period. on the contrary, a nigerian, apart from preparing to work overtime, is also prepared to wok in two or thee palaces within 24 hours to earn what m.a. omolaja / ea 1-2 (2009) 53-64 61 is called abnormal profits in order to show off as an important person in the society. what he has forgetter is that whatever he gains in form of pecuniary interest, he has lost in quality of life! in the european administrative practice, division of labor, specialization of labor and the principles propounded by early management and administrative philosophers including elton mayo, henri fayol, f. w. taylor, marx webber, etc, are respected and practiced to the letter. management and administrative practice demands that work should be delegated to subordinates with full responsibility assigned and with absolute confidence in performance. in the british system of administration, so be it; in the developing nigeria, however, the reverse is usually the case. as a further comparison, the rule of privacy is normally respected in europe. you cannot pay an european an unscheduled visit. the game is so played in such of way that even the closest friend has to book an appointment before a visit to an office not to talk of a private home. again, in the british model, there is nothing like power tussle. consequently, there is no dignity in arrogating power to oneself. responsibilities, resources and benefits are shared on the basis of an agreed upon formula. this is due to the fact the british administrative culture allows for the practice of administrative functions of planning organizing, etc, according to intended design. impact of organizational politics organizational politics has become the permanent culture of every modern organization or society. whether in europe or in africa, the impact of organizational politics is being felt significantly. however, in nigeria undue attention is being paid to organizational politics and other subjective variables giving room for mediocrity against meritocracy. this is affecting the corporate performance of the nigerian organizations both in the private sector and in the public sector. because of the federalism and its concomitant societal systems of federal character; quota and representative mechanism, people who would not normally qualify to be in positions are being put in positions of authority. this has affected and still affecting their administrative performance, and consequently causing backwardness to the economy. also affected is the morale and confidence on the part of highly qualified professional administrators and career officers who are relegated to the back on political grounds. arising from this phenomenon is the fact that hard-work has no more place in the society the concept of hard-work is apparently respondent on the way the authority in question denies it. if a hardworking subordinate is adjudged by his supervisor or manager as being slow, inexperience and lazy worker, then he is taken to be so and consequently he is not qualified for promotion or advancement. on the other hand, if an unqualified employee is favored for promotion by his superior, he enjoyed the fruit of organizational polities which apparently he is very good at playing. economic analysis 1-2 (2009) 53-64 62 impact on national development national development implies development in all sectors of the economy. it covers development in gross national product, development in agriculture, in industry, in culture, in education, and so on. consequently, national development comes from all the facets of the economy. by implication, all the sectors, including administrative functions and office holders, must develop for accelerated national development. for meaningful national development to take place, administrations in the private and public organizations must be practiced the way it is done in the western society with little modifications in line with the situations on ground. for instance, the culture of polygamy, power tussle, extravagance and ostentatious spending have all contributed to the downward trend in the economv. hence, these should all be discontinued. again, seasoned and dedicated administrators with required exposure and experience should be encouraged by giving them appropriate recognition and status instead of promoting mediocrity. the ideal use of management principles of authority, delegation, subordination of individual interest to common objectives, etc. should be practiced. however, administration in nigeria can be cured of the negative culture at several levels using several criteria. the levels include the governmental, social groups like schools, among peers, among friends, and changes originated from within the individual members of the society. in fact, no decree or constitution can force a nigerian to behave entirely contrary to his will. for instance, despite the gravity of punishment meted for drug trafficking offences, nigerians are still prominent in dealings involving cocaine, heroine and similar hard drugs due to absence of commensurate employment. because of the fact that it is possible to force a horse to a river, it is not possible to force it to drink water from the river. most of the negative ethos of the nigerian administrative culture can be made more liberal for meaningful national development through the use of organizational or administrative psychology to appeal to the senses of the participants individually and collectively. also, a kind of economic development awareness programs via effective administrative performance throughout the nooks and crannies of the economy may also be relevant. this can be organized by some special machinery of government like the ministry of information and culture, family support program, centre for management development, centre for strategic and policy studies, etc. granted that the aforementioned administrative cultural reforms can be refined to effect the demands of modern administration, though nigeria is economically down today, a more prosperous future is ahead. in terms of availability of manpower resources for effective administration, it is inappropriate to think that this country does not possess enough people in the administrative cadre whether generalists or specialists. the fact still remains that the country lacks the appropriate ideology with the required substances to tap and utilize the nation’s abundant human resources effectively and efficiently. i am convinced that this country has enough manpower machinery but our problem is decisions on the use they are put individually and collectively. in actual fact, what we need at this stage of our national development is an agricultural analogy in growing or developing administrative talents rather than the m.a. omolaja / ea 1-2 (2009) 53-64 63 industrial one to man facture them. if we have a correct administrative theory, idea or culture but merely prate about it, pigeonhole it, and do not put it into practice, then that theory, philosophy or culture, however laudable, beautiful or practical, is of no significance. summary and conclusion this paper started with the anatomy or etymological basis of ʺadministrationʺ: this was followed by the scope and nature of administration, administrative functions and administrators. in the second section of the article, the philosophy of administration was presented with particular reference to administration in the nigerian context. next is a brief discussion of the nigerian culture especially the aspect that are contrary to the norm of the western culture and the ideal practice of administration. also, administrative practice in nigeria was explicitly analysed, discussed and necessary illustrations were made. this would definitely allow the reader to understand the nature and significance of administrative culture in the nigerian society. one would also be able to understand the reason while an officer in nigeria behaves the way he does. consequently, administration in nigeria was compared with the european model at one time or the other in this exposition drawing references particularly from the british mechanism. the nigerian administrative culture was said to be unorganized, lacks planning, unstructured and practiced in a disorderly society or environment. this was said to be part of the variables that are contributing to the backwardness of the national development in the country. the contribution of organizational politics was also discussed. here, politics was said to have eaten deep into the administrative system in nigeria. as a result, the system was said to allow for mediocrity to the detriment of meritocracy in the scheme of things discouraging the practice of administration in an ideal sense, and the participation of qualified, experienced, seasoned and professional administrators. consequently, it was claimed that the only authority that can define handwork is the superior officer which may be based on his own subjective personal judgment of what is normal. in this case, if a hardworking employee is adjudged to be lazy, so be it! the last point that was presented is the implication of the culture of administrative practice in the country on national development. here, national development was explained to include development in all the ramifications of an economy. hence, if the economy is to develop, all the facets of it must not be left out in the scheme of things. administration, administrative duties and administrators are said to have roles to play in any developmental process. conclusively, it has been made clear from this article that the administrative practice in nigeria is taking place within the boundaries of two extremists: that is, the administrative culture or the ethos of the mechanism on the one hand and the national development on the other. if the national development is, therefore, our target, then some kinds of tradeoffs should be maintained between the two. that is, our wasteful attitudes and behavior should be reconciled with the national objective which is the ʺpromised landʺ of national development via economic, social, cultural, technological and political emancipation. economic analysis 1-2 (2009) 53-64 64 also, there should be a proper re-orientation of the administrative culture and philosophy in the country for a turn-around and development of the economy. references omolaja, m. a. (2002): the impact of europeansʹ ethos on their administrative mehchanisms: a critical analysis of the british and french models in ogun journal of foreign studies, department of foreign studies, olabisi onabanjo university, ago-iwoye simon, h smithbury and thompson v (1950): public administration, new york, donham, w.b. (1936): the theory and practice of administration, harvard business review vol. 14, summer. wilson w, (1941): the study of public administration, political science quarterly, vol. 2 june 1887; reprinted in the quarterly, vol. 56, december, 1941. keeling d, (1972): management in government, george alien and unwin, london self peter (1972): administrative theories and politics, george alien and unwin, london gulick l (1937): notes on the theory of organisation, in papers on the science of administration,, institute of public administration fayol h. (1996): industrial and general administration translated by j. a. conbrough for the international management institute. marshall demock (1956): the executive in action, harper & sons, new york. gorson j. and harris (1963): public administration in modern society, mcgraw hill, new york. samson a. (1965):77/e anatomy of british today, mcdonnell & evans london. merian l. (1936):p«w/ʹc service and special training, university of chicago press, chicago. swith d. t. (1945): education for administration, harvard business review, vol. 23, spring. simion h. a. (1976): administration behaviour, the free press 3rd editor new york augustus adebayo (1995): principles and practice of administration in nigeria revised editor, spectrum books limited, ibadan. microsoft word 2010_3_4.doc scientific report comparative analysis of var models aplicability in the evaluation of exchange rate risk in the b&h banking sector kozarević emina, university of tuzla, faculty of economics, b&h udc: 336.02; 339.74 jel: g21; g29; c15; c19 abstarct – in this paper the author tests a variety of market var models for evaluation of exposure to exchange rate risk, in order to illuminate the advantages and disadvantages of their implementation in the b&h banking sector. as known, b&h monetary policy operates on the basis of currency board arrangement. the selection of a particular var model is determined with the fact that income generated from taking the risk should always exceed the cost of keeping capital reserves needed to cover taken risks. in the concrete bank three var models are applied and comparation of the results is done. key words: exchange rate risk, evaluation, bootstrapping, riskmetricstm, monte carlo simulation for var introduction generally speaking, var model involves a combination of financial theory, mathematics and logic to ʺmotivateʺ var measure as an algorithm by which portfolio’s var is calculated. market var models in practice are usually classified as: • historical model (historical simulation for var), • riskmetricstm model and • monte carlo simulation for var. although it would be more representative to test historical model through the example of the evaluation of market risk related to price movements of securities that banks hold in their assets, considering the fact that banks in b&h mostly have no portfolio of securities (i.e. trading book), there is an objective determination to implement the historical model in evaluation of market risk resulting from fluctuations in exchange rates of specific b&h bankʹs long position (the bank). the historical model the practical procedure of calculating var according to historical model passes through 5 successive phases. these are:1 • conversion, or calculation of bam equivalents; • calculate the deviation, or delta position (δ); • calculation of individual and total daily risks; 1 see: (šverko, 2001). economic analysis (2010, vol. 43, no. 3-4, 29-41) 30 • the ranking of overall daily risks; • determining the confidence level and finding var. this process will hereinafter be implemented in order to evaluate the risk of long foreign currency positions of the bank on 28th of december, 2007, pursuant to the known long foreign currency positions on 25th of december, 2007, and the movements of corresponding foreign exchange rates in the last 253 (working) days.2 in other words, on 25th of december, 2007, the bank had long positions in currencies and in the amounts shown in table 1. table 1. review of long foreign exchange positions currency the nominal amount of positions swiss franc chf 621,000 british pound gbp 75,000 croatian kuna hrk 254,000 danish krone dkk 145,000 swedish krona sek 146,000 first stage: calculation of bam equivalents on the basis of foreign exchange rates to bam on 25th of december, 2007, is presented in table 2. table 2. calculation of bam equivalents of long foreign exchange positions on 25th of december, 2007 currencythe nominal amount of positions the course of foreign currencies to bam original bam equivalent chf 621,000.00 1.265254 785,722.73 gbp 75,000.00 2.780933 208,569.98 hrk 254,000.00 0.258537 65,668.40 dkk 145,000.00 0.262859 38,114.56 sek 146,000.00 0.216473 31,605.06 sum 1,129,680.72 accordingly, 621,000 chf worthed on 25th of december 785,722.73 bam, £ 75,000 on the same day worthed 208,569.98 bam, etc. total of bam equivalent of long foreign currency position of the bank was 1,129,680.72 bam on 25th december. phase two: in order to calculate the δ position or variations in bam, the trends of exchange rates of observed foreign currencies to bam in the last 100-500 working days, for example, 253 days,3 should be taken into account, and then assume for 28th of december: • for chf appreciation of 0.002881%; • for gbp appreciation of 0.000285%; • for dkk appreciation of 0.000233% and 2 please note: as each monday applies exchange rate list from the last saturday, mondays are excluded from consideration. 3 www.cbbh.gov.ba kozarević e., comparative analysis of var models, ea (2010, vol. 43, no, 3-4, 29-41) 31 • for sek appreciation of 0.001674%. these are actually the average daily changes of appropriate exchange rates in the last 253 (working) days. δ position is obtained as the difference between the expected (assumed) and the original bam equivalents. calculation of the δ position on 25th of december, 2007, is given in table 3. table 3. the calculation of δ position currency bam exchange rate to foreign currency expected exchange rate of bam to foreign currency (%) bam corrected exchange rate to foreign currency expected equivalent of bam the difference between the expected and the original bam equivalent (δ) chf 0,790355 -0,002881 0,790332 785.745,37 22,64 gbp 0,359592 -0,000115 0,359591 208.570,22 0,24 hrk 3,867925 -0,004231 3,867761 65.671,06 2,78 dkk 3,804321 -0,000233 3,804312 38.114,64 0,09 sek 4,619514 -0,001674 4,619436 31.605,59 0,53 phase three: it is the most complex considering calculation. first, it requires that number of observed (working) days is precised. in the specific example the sample of 253 last days was taken, i.e. the period between 25th of december, 2007, and 1st of january, 2007, speaking backwards, in which the daily movements of the relevant foreign currency exchange rates by bam, are observed. basic calculation part of the third phase refers to the determination of actual and expected daily changes of exchange rates and the multiplication of the relative relation of these changes with δ, which are calculated in the second phase. based on the bam exchange rates to the appropriate foreign currencies for the last 253 days, actual daily changes of these rates were determined, which divided with the expected changes, and then multiplied with the corresponding δ, give daily risks of individual long foreign currency positions of the bank. by adding them together, the total of daily exchange rate risks of the specific bankʹs position for the last 252 days, are obtained. if, therefore, on 25th of december, bam exchange rate compared to chf appreciated to 0.097135%, compared to gbp appreciated to 0.285192%, compared to hrk appreciated to 0.144080%, compared to dkk appreciated to 0.040326% and also appreciated against sek for the 0.082689% and if position of δ chf is 22.64 bam, gbp of position 0,24 bam, the position of hrk 2.78 bam, 0.09 bam dkk positions and, finally, the position of sek 0.53 bam, daily exchange rate risk of these positions is -763.30 bam, -592.82 bam, -94.67 bam, -15.57 bam and -26.18 bam, respectively. the sum of the daily risks of all long positions provides overall risk of the exchange rate of the bankʹs position, which was -1,492.53 bam on 25th of december. phase four: in the observed sample, the ranking of overall daily risks according to the largest potential losses, or from the largest losses to the largest gain, needs to be done. this phase of the process of calculating var is presented in table 4. economic analysis (2010, vol. 43, no. 3-4, 29-41) 32 table 4. risk ranking order date total risk 1 12/23 -4,125.83 2 6/30 -4,013.93 3 4/16 -3,992.06 4 7/21 -3.919,71 5 5/1 -3,808.39 6 6/23 -3,458.74 7 6/29 -3,288.95 8 1/7 -3,009.03 9 12/3 -2,926.96 10 7/15 -2,857.15 11 12/2 -2,845.24 12 1/20 -2,776.29 13 2/3 -2,769.18 14 8/4 -2,744.62 15 12/22 -2,710.78 . . . . . . . . . 252 6/12 5,381.57 the fifth phase: after ranking has been made, and then the desired confidence level is specified, var of long foreign exchange positions for the next working day, i.e. 28th of december, 2007, can be determined. if the confidence level is 95%, then this is the amount of 14-th biggest risk because this is a sample of 252 days (for example, in a sample of 100 or 200 days, the amount of 6-th or 11-th largest risk would be taken etc.). therefore, the data from the past have shown that long foreign currency positions of the bank on 28th of december, 2007, in 95% of cases will not lose more than 2,744.62 bam. if, however, that analysis is tried to be applied with 99% of confidence, then the var is equal to the amount of the fourth greatest risk (for example, in a sample of 100 or 200 days, the amount of the second or the third largest risk would be taken etc.). furthermore, one may conclude that, according to data from the past, long currency bank’s positions on 28th of december in 99% of cases will not lose more than 3,919.71 bam.4 according to that, the amounts of 2,744.62 bam and 3,919.71 bam represent var95% and var99% of portfolio of long foreign exchange bank’s positions on 28th of december. that is the amount of reserves (capital), that the bank needs to form to be able, in 95% or 99% of cases, to cover the total loss next day, arised from exchange rate movements, according to its long foreign currency positions. 4 some banks in b&h base their var calculations on the 99% level of confidence that the bank portfolio in foreign currencies can suffer changes during the portfolio holding period of 10 days due to changes in exchange rates and based on daily changes in the last 250 days of trading. also, var are presented separately for the usd, chf, gbp, sec, etc. kozarević e., comparative analysis of var models, ea (2010, vol. 43, no, 3-4, 29-41) 33 finally, by ex post analysis, the evaluation of the efficiency of the historical model impementation in evaluation of the risk of long foreign currency bankʹs positions, was made. calculation of bam equivalents for nominal amounts on 25th of december, 2007,5 on the basis of foreign exchange rates to bam on 28th of december, 2007, is presented in table 5. table 5. calculating of bam equivalents at 28th of december, 2007 currency the nominal amount of positions the course of foreign currencies to bam original bam equivalent chf 621,000.00 1.263130 784,403.73 gbp 75,000.00 2.779747 208,481.03 hrk 254,000.00 0.258181 65,577.97 dkk 145,000.00 0.262842 38,112,09 sek 146,000.00 0.216612 31,625.35 ukupno 1,128,200.17 according to that, on 28th of december, the bank did not realize a loss larger than the var (which is equal to 2,744.62 bam at 95% of confidence level and 3,919.71 bam at 99% of confidence level), which has confirmed the usefulness of this approach in evaluating the risk of exchange rate or, wider, market risk. the actual loss of the bank was 1,480.55 bam (1,128,200.17 bam 1,129,680.72 bam). in conclusion, another important explanation could be added: the reason for such a small daily var compared to the total bam equivalent of long foreign currency bank’s positions results from the currency board arrangement under which monetary policy of b&h operates (mainly from the fixed bam exchange rate against eur, 1 bam = 0.51 eur), followed by a very weak fluctuations of exchange rates in which the bank has long positions (chf, gbp, hrk, dkk and sek) against eur, and thus the bam. we should accent the fact that the bank at observing day had a short position in usd, which, as is well known, are subject to much wider range of changes in relation to the eur than the previous currencies, by which the bank is actually protected from the excessive foreign exchange exposure. moreover, the bank may be concluded as the one that is exposed to very low level of risk of exchange rate, or, wider, the market risk.6 riskmetricstm riskmetricstm model has two characteristics. first, riskmetricstm assumes that changes in market factors (i.e. exchange rates) are distributed normally. second, it is the only var model which during the calculation of var takes into account the effects of portfolio diversification, 5 a propos, the mere assumption about constant structure of the portfolio has its stronghold in the basel ii because the basel committee, in addition to 99% confidence level, it is recommended portfolio holding period of 10 days. 6 however, including in international business and financial markets, banks in b&h in the future, no doubt, have to be more exposed to market risks. economic analysis (2010, vol. 43, no. 3-4, 29-41) 34 by introducing a correlation matrix or variance-covariance matrix, which is directly related to modern portfolio theory (mpt). by introducing of variance-covariance matrix, the correlation or interdependence between the individual parts (ʺparticlesʺ) of portfolio are taken into account (not only the risk of individual positions), which are in this example, with the bank’s portfolio of long foreign currency positions, n(n-1)/2 = 5(5-1)/2 = 10 (see table 6). it is known that the lower risk of portfolio can be achieved through low correlation and/or by investing in a large number of instruments of portfolio. table 6. correlation matrix of exchange rates (period 1/1-12/25/2007) chf/bam gbp/bam hrk/bam dkk/bam sek/bam chf/bam 1.000000 0.005536 0.607637 0.921060 0.392015 gbp/bam 0.005536 1.000000 0.573704 -0.142484 -0.687682 hrk/bam 0.607637 0.573704 1.000000 0.528907 -0.244216 dkk/bam 0.921060 -0.142484 0.528907 1.000000 0.541801 sek/bam 0.392015 -0.687682 -0.244216 0.541801 1.000000 when calculating the var according to riskmetricstm model we should start from the basic definition by which var is the product of volatility (standard deviation) and the loss of multiple volatility, where you can use algebraic and/or matrix notation. however, before that, in addition to correlation, it is also necessary to calculate the standard deviation of individual exchange rates (table 7). table 7. the standard deviation of exchange rate (period 1/1-12/25/2007) chf/bam gbp/bam hrk/bam dkk/bam sek/bam σ 0.014910 0.053199 0.003786 0.000235 0.001943 in algebraic form the volatility of bank’s portfolio of long foreign currency positions7 (σport) will have to be equal: kmsekkmdkkkmsekkmdkksekdkkkmsekkmhrkkmsekkmhrksekhrk kmdkkkmhrkkmdkkkmhrkdkkhrkkmsekkmgbpkmsekkmgbpsekgbp kmdkkkmgbpkmdkkkmgbpdkkgbpkmhrkkmgbpkmhrkkmgbphrkgbp kmsekkmchfkmsekkmchfsekchfkmdkkkmchfkmdkkkmchfdkkchf kmhrkkmchfkmhrkkmchfhrkchfkmgbpkmchfkmgbpkmchfgbpchf kmseksekkmdkkdkkkmhrkhrkkmgbpgbpkmchfchf ///,////,/ ///,////,/ ///,////,/ ///,////,/ ///,////,/ 2 / 22 / 22 / 22 / 22 / 2 22 22 22 22 22 σσρωωσσρωω σσρωωσσρωω σσρωωσσρωω σσρωωσσρωω σσρωωσσρωω σωσωσωσωσω ++ +++ +++ +++ +++ +++++ 7 the market values of the positions (ωchf, ωgbp, ωhrk, ωdkk, ωsek) are actually what is in the historical simulation model for var nominated as ʺoriginal bam equivalentʺ of individual positions on the date 12/25/2007. kozarević e., comparative analysis of var models, ea (2010, vol. 43, no, 3-4, 29-41) 35 when we include the appropriate values, we get that σport = 42.566,087,267 = 16,342.81. therefore, the var estimated using riskmetricstm model for the next day (28th of december), with the 95% of confidence level is var = 1.65 × 16,342.81 = 26,965.64 bam, or with confidence level of 99% var = 2.33 × 16,342.81 = 38,078.75 bam. this practically means that, based on past data, the conclusion can be drawn, that the portfolio of the bankʹs foreign exchange long positions in 95% or 99% cases of the next day will not lose more than 26,965.64 bam or 38,078.75 bam. the question is how the correlation coefficients, and thus the effects of diversification, influenced the var of the total portfolio compared to the var, which would be obtained simply by adding together the var of individual positions? var of particular position, at 99% of confidence level, is: varchf = 785,722.73 × 2.33 × 0.014910 = 27,296.24; vargbp = 208,569.98 × 2.33 × 0.053199 = 25,853.01; varhrk = 65,668.40 × 2.33 × 0.003786 = 579.29; vardkk = 38,114.56 × 2.33 × 0.000235 = 20.87 i varsek = 31,605.06 × 2.33 × 0.001943 = 143.08, and their sum is 53,892.49 bam. in other words, because of the introduction of correlation coefficient (-0.687682 ≤ ρij ≤ 0.921060, i≠j) var of the total portfolio is less for 15.813,74 bam than what would be gained by adding the var of portfolio of individual positions. in matrix form, for example, 99% of confidence level, will have the following expression: var = 2.33 × ( ) 2 1 5 4 3 2 1 4,53,52,51,5 5,43,42,41,4 5,34,32,31,3 5,24,23,21,2 5,14,13,12,1 54321 1 1 1 1 1                                   ×                   × v v v v v vvvvv ρρρρ ρρρρ ρρρρ ρρρρ ρρρρ , where are: v1 = ωchfσchf/bame = 11,715.13; v2 = ωgbpσgbp/bam = 11,095.71; v3 = ωhrkσhrk/bam = 248.62; v4 = ωdkkσdkk/bam = 8.96; v5 = ωsekσsek/bam = 61.41. by including of the appropriate values in the upper matrix, the amount of 38,078.75 bam, which is var99%, is obtained. economic analysis (2010, vol. 43, no. 3-4, 29-41) 36 monte carlo simulation for var in monte carlo simulation for var also went from a sample of 253 days (from 12/25 to 1/1/2007, speaking backwards) and the corresponding value in foreign exchange rates in the bank’s portfolio (chf, gbp, hrk, dkk and sek) to bam, in those days. historical courses for some foreign currency to bam are divided into 30 intervals, or classes, going from the smallest to the largest, and after determining the frequency of their occurrence in each interval, the probability distribution had been formed. after that, using microsoft office excel 2007, by 253 random numbers for each course were generated. this number was taken for comparison possibility with the historical model. then the intervals were determined for random numbers and the corresponding class of middle courses, for assignment of the same, previously generated random numbers (table 8). table 8. the initial table (distributions of probability for individual courses, intervals for random numbers and the corresponding classes of middle courses) intervals for exchange rates frequencies probabilities intervals for random numbers class middle courses 1,234897 1,236952 2 0,007905 0,000000 0,007905 1,235924 1,236952 1,239007 5 0,019763 0,007905 0,027668 1,237979 1,239007 1,241061 5 0,019763 0,027668 0,047431 1,240034 1,241061 1,243116 8 0,031621 0,047431 0,079051 1,242089 1,243116 1,245171 1 0,003953 0,079051 0,083004 1,244143 1,245171 1,247226 12 0,047431 0,083004 0,130435 1,246198 1,247226 1,249280 12 0,047431 0,130435 0,177866 1,248253 1,249280 1,251335 4 0,015810 0,177866 0,193676 1,250308 1,251335 1,253390 5 0,019763 0,193676 0,213439 1,252363 1,253390 1,255445 10 0,039526 0,213439 0,252964 1,254417 1,255445 1,257499 3 0,011858 0,252964 0,264822 1,256472 1,257499 1,259554 9 0,035573 0,264822 0,300395 1,258527 1,259554 1,261609 12 0,047431 0,300395 0,347826 1,260582 1,261609 1,263664 12 0,047431 0,347826 0,395257 1,262636 1,263664 1,265719 8 0,031621 0,395257 0,426877 1,264691 1,265719 1,267773 7 0,027668 0,426877 0,454545 1,266746 1,267773 1,269828 14 0,055336 0,454545 0,509881 1,268801 1,269828 1,271883 23 0,090909 0,509881 0,600791 1,270855 1,271883 1,273938 12 0,047431 0,600791 0,648221 1,272910 1,273938 1,275992 17 0,067194 0,648221 0,715415 1,274965 1,275992 1,278047 13 0,051383 0,715415 0,766798 1,277020 1,278047 1,280102 6 0,023715 0,766798 0,790514 1,279074 1,280102 1,282157 11 0,043478 0,790514 0,833992 1,281129 1,282157 1,284211 7 0,027668 0,833992 0,861660 1,283184 1,284211 1,286266 5 0,019763 0,861660 0,881423 1,285239 1,286266 1,288321 12 0,047431 0,881423 0,928854 1,287294 1,288321 1,290376 5 0,019763 0,928854 0,948617 1,289348 1,290376 1,292430 8 0,031621 0,948617 0,980237 1,291403 1,292430 1,294485 3 0,011858 0,980237 0,992095 1,293458 chf/bam 1,294485 1,296540 2 0,007905 0,992095 1,000000 1,295513 2,775014 2,781956 2 0,007905 0,000000 0,007905 2,778485 gbp/bam 2,781956 2,788898 5 0,019763 0,007905 0,027668 2,785427 kozarević e., comparative analysis of var models, ea (2010, vol. 43, no, 3-4, 29-41) 37 2,788898 2,795839 7 0,027668 0,027668 0,055336 2,792368 2,795839 2,802781 5 0,019763 0,055336 0,075099 2,799310 2,802781 2,809723 7 0,027668 0,075099 0,102767 2,806252 2,809723 2,816665 8 0,031621 0,102767 0,134387 2,813194 2,816665 2,823606 2 0,007905 0,134387 0,142292 2,820135 2,823606 2,830548 15 0,059289 0,142292 0,201581 2,827077 2,830548 2,837490 14 0,055336 0,201581 0,256917 2,834019 2,837490 2,844432 9 0,035573 0,256917 0,292490 2,840961 2,844432 2,851373 5 0,019763 0,292490 0,312253 2,847903 2,851373 2,858315 5 0,019763 0,312253 0,332016 2,854844 2,858315 2,865257 10 0,039526 0,332016 0,371542 2,861786 2,865257 2,872199 7 0,027668 0,371542 0,399209 2,868728 2,872199 2,879141 7 0,027668 0,399209 0,426877 2,875670 2,879141 2,886082 9 0,035573 0,426877 0,462451 2,882611 2,886082 2,893024 4 0,015810 0,462451 0,478261 2,889553 2,893024 2,899966 9 0,035573 0,478261 0,513834 2,896495 2,899966 2,906908 10 0,039526 0,513834 0,553360 2,903437 2,906908 2,913849 13 0,051383 0,553360 0,604743 2,910378 2,913849 2,920791 14 0,055336 0,604743 0,660079 2,917320 2,920791 2,927733 17 0,067194 0,660079 0,727273 2,924262 2,927733 2,934675 16 0,063241 0,727273 0,790514 2,931204 2,934675 2,941616 15 0,059289 0,790514 0,849802 2,938146 2,941616 2,948558 14 0,055336 0,849802 0,905138 2,945087 2,948558 2,955500 6 0,023715 0,905138 0,928854 2,952029 2,955500 2,962442 6 0,023715 0,928854 0,952569 2,958971 2,962442 2,969383 7 0,027668 0,952569 0,980237 2,965913 2,969383 2,976325 2 0,007905 0,980237 0,988142 2,972854 2,976325 2,983267 3 0,011858 0,988142 1,000000 2,979796 0,253422 0,253861 10 0,039526 0,000000 0,039526 0,253641 0,253861 0,254299 2 0,007905 0,039526 0,047431 0,254080 0,254299 0,254738 4 0,015810 0,047431 0,063241 0,254518 0,254738 0,255176 5 0,019763 0,063241 0,083004 0,254957 0,255176 0,255615 9 0,035573 0,083004 0,118577 0,255395 0,255615 0,256053 8 0,031621 0,118577 0,150198 0,255834 0,256053 0,256492 2 0,007905 0,150198 0,158103 0,256272 0,256492 0,256930 0 0,000000 0,158103 0,158103 0,256711 0,256930 0,257369 3 0,011858 0,158103 0,169960 0,257149 0,257369 0,257807 4 0,015810 0,169960 0,185771 0,257588 0,257807 0,258246 10 0,039526 0,185771 0,225296 0,258026 0,258246 0,258684 18 0,071146 0,225296 0,296443 0,258465 0,258684 0,259123 10 0,039526 0,296443 0,335968 0,258903 0,259123 0,259561 6 0,023715 0,335968 0,359684 0,259342 0,259561 0,260000 9 0,035573 0,359684 0,395257 0,259780 0,260000 0,260438 7 0,027668 0,395257 0,422925 0,260219 0,260438 0,260877 15 0,059289 0,422925 0,482213 0,260657 0,260877 0,261315 12 0,047431 0,482213 0,529644 0,261096 0,261315 0,261754 6 0,023715 0,529644 0,553360 0,261535 0,261754 0,262192 1 0,003953 0,553360 0,557312 0,261973 0,262192 0,262631 8 0,031621 0,557312 0,588933 0,262412 0,262631 0,263069 2 0,007905 0,588933 0,596838 0,262850 0,263069 0,263508 4 0,015810 0,596838 0,612648 0,263289 0,263508 0,263946 6 0,023715 0,612648 0,636364 0,263727 0,263946 0,264385 9 0,035573 0,636364 0,671937 0,264166 0,264385 0,264823 19 0,075099 0,671937 0,747036 0,264604 hrk/bam 0,264823 0,265262 23 0,090909 0,747036 0,837945 0,265043 economic analysis (2010, vol. 43, no. 3-4, 29-41) 38 0,265262 0,265700 25 0,098814 0,837945 0,936759 0,265481 0,265700 0,266139 10 0,039526 0,936759 0,976285 0,265920 0,266139 0,266577 6 0,023715 0,976285 1,000000 0,266358 0,262443 0,262471 11 0,043478 0,000000 0,043478 0,262457 0,262471 0,262499 16 0,063241 0,043478 0,106719 0,262485 0,262499 0,262527 2 0,007905 0,106719 0,114625 0,262513 0,262527 0,262555 3 0,011858 0,114625 0,126482 0,262541 0,262555 0,262583 8 0,031621 0,126482 0,158103 0,262569 0,262583 0,262610 8 0,031621 0,158103 0,189723 0,262596 0,262610 0,262638 9 0,035573 0,189723 0,225296 0,262624 0,262638 0,262666 7 0,027668 0,225296 0,252964 0,262652 0,262666 0,262694 4 0,015810 0,252964 0,268775 0,262680 0,262694 0,262722 4 0,015810 0,268775 0,284585 0,262708 0,262722 0,262750 5 0,019763 0,284585 0,304348 0,262736 0,262750 0,262778 0 0,000000 0,304348 0,304348 0,262764 0,262778 0,262806 3 0,011858 0,304348 0,316206 0,262792 0,262806 0,262834 7 0,027668 0,316206 0,343874 0,262820 0,262834 0,262862 14 0,055336 0,343874 0,399209 0,262848 0,262862 0,262889 11 0,043478 0,399209 0,442688 0,262875 0,262889 0,262917 6 0,023715 0,442688 0,466403 0,262903 0,262917 0,262945 11 0,043478 0,466403 0,509881 0,262931 0,262945 0,262973 16 0,063241 0,509881 0,573123 0,262959 0,262973 0,263001 12 0,047431 0,573123 0,620553 0,262987 0,263001 0,263029 16 0,063241 0,620553 0,683794 0,263015 0,263029 0,263057 12 0,047431 0,683794 0,731225 0,263043 0,263057 0,263085 16 0,063241 0,731225 0,794466 0,263071 0,263085 0,263113 6 0,023715 0,794466 0,818182 0,263099 0,263113 0,263141 11 0,043478 0,818182 0,861660 0,263127 0,263141 0,263168 11 0,043478 0,861660 0,905138 0,263154 0,263168 0,263196 9 0,035573 0,905138 0,940711 0,263182 0,263196 0,263224 8 0,031621 0,940711 0,972332 0,263210 0,263224 0,263252 2 0,007905 0,972332 0,980237 0,263238 dkk/bam 0,263252 0,263280 5 0,019763 0,980237 1,000000 0,263266 0,210735 0,211036 2 0,007905 0,000000 0,007905 0,210886 0,211036 0,211338 6 0,023715 0,007905 0,031621 0,211187 0,211338 0,211639 4 0,015810 0,031621 0,047431 0,211488 0,211639 0,211940 8 0,031621 0,047431 0,079051 0,211790 0,211940 0,212242 10 0,039526 0,079051 0,118577 0,212091 0,212242 0,212543 11 0,043478 0,118577 0,162055 0,212393 0,212543 0,212845 21 0,083004 0,162055 0,245059 0,212694 0,212845 0,213146 17 0,067194 0,245059 0,312253 0,212995 0,213146 0,213447 21 0,083004 0,312253 0,395257 0,213297 0,213447 0,213749 11 0,043478 0,395257 0,438735 0,213598 0,213749 0,214050 19 0,075099 0,438735 0,513834 0,213899 0,214050 0,214351 16 0,063241 0,513834 0,577075 0,214201 0,214351 0,214653 14 0,055336 0,577075 0,632411 0,214502 0,214653 0,214954 16 0,063241 0,632411 0,695652 0,214803 0,214954 0,215256 12 0,047431 0,695652 0,743083 0,215105 0,215256 0,215557 8 0,031621 0,743083 0,774704 0,215406 0,215557 0,215858 5 0,019763 0,774704 0,794466 0,215708 0,215858 0,216160 11 0,043478 0,794466 0,837945 0,216009 0,216160 0,216461 7 0,027668 0,837945 0,865613 0,216310 0,216461 0,216762 7 0,027668 0,865613 0,893281 0,216612 0,216762 0,217064 1 0,003953 0,893281 0,897233 0,216913 sek/bam 0,217064 0,217365 1 0,003953 0,897233 0,901186 0,217214 kozarević e., comparative analysis of var models, ea (2010, vol. 43, no, 3-4, 29-41) 39 0,217365 0,217666 2 0,007905 0,901186 0,909091 0,217516 0,217666 0,217968 1 0,003953 0,909091 0,913043 0,217817 0,217968 0,218269 11 0,043478 0,913043 0,956522 0,218118 0,218269 0,218571 3 0,011858 0,956522 0,968379 0,218420 0,218571 0,218872 2 0,007905 0,968379 0,976285 0,218721 0,218872 0,219173 2 0,007905 0,976285 0,984190 0,219023 0,219173 0,219475 2 0,007905 0,984190 0,992095 0,219324 0,219475 0,219776 2 0,007905 0,992095 1,000000 0,219625 random numbers were then given the appropriate classʹs middle courses and so the simulated future courses of certain foreign currencies to bam are determined. multiplying them with their nominal amounts of the positions, simulated bam equivalent of portfolio is calculated. from the obtained values, the current value of the portfolio is taken and, as results, simulated or hypothetical gains and/or losses of portfolio in 253 scenarios, are obtained. simulated total profits and/or losses of the portfolio are ranked from the largest loss to the largest profit and after that var is determined (see table 9). table 9. ranking of the total of simulated profit/loss order total of simulated profit/loss 1 -13,971.75 2 -10,919.03 3 -10,766.48 4 -9,126.25 5 -8,464.59 6 -8,464.51 7 -7,742.29 8 -7,272.61 9 -7,222.57 10 -7,215.78 11 -6,182.50 12 -6,070.88 13 -5,915.04 14 -5,881.06 15 -5,737.31 . . . . . . 253 31,674.11 since it is about the sample of 253 days, var portfolio of the bank for the next day, i.e. 28th of december, estimated by monte carlo simulation procedure, with confidence level of 95%, is 5,881.06 bam, or, with confidence level of 99%, it is equal to 9,126.25 bam. economic analysis (2010, vol. 43, no. 3-4, 29-41) 40 comparation and valorization of the models as it can be noted and summarized, var estimates are different in all market var models (table 10). by riskmetricstm model the largest var amount is obtained and by historical model, the smallest is obtained. the differences, of course, derive from different assumptions on which these models are based. historical model assumes that the past quite accurately reflects what will happen in the future. in this particular example, with a sample of 252 daily changes of exchange rate, where their oscillations are in accordance with the assumption of ʺnormal market movements,ʺ as well as the exchange rate on the forecast day (12/28), historical model is fully acceptable and useful model. however, the historical model, like other var models, is unable to predict extreme loss. for example, if we, on the date of 22nd of december, do the var forecast for 12/23, when the biggest loss is made in the observed sample (249 of daily changes in exchange rates were taken into account) in the amount of 4,147.93 bam (bam 1,132,447.89 1,136,595.82 bam), ceteris paribus, we will get that var95% is 2,756.90 bam or var99% is 3,949.38 bam. this is one of the biggest weaknesses of the historical model. table 10. the evaluation of the var for 28th of december, 2007, obtained by different models model historical model riskmetricstm monte carlo simulation for var var99% 3,919.71 bam 38,078.76 bam 9,126.25 bam note: the actual daily loss was 1,480.55 bam. in monte carlo simulation for var, although in this case it is based on data from the historical volatility of the basic risk factors (i.e. exchange rates), and a statistical distribution derived from them, rather than the assumption of their theoretical distribution, the mentioned weakness of the historical model is overcomed. using generator of the pseudorandom numbers the 252 (random) scenario movements are simulated for each exchange rate so that the var estimated by this model is much larger than the historical var. commitment of the bank for one or another model depends on whether the bank prefers higher ʺsafety marginʺ in order to avoid impending insolvency, at the expense of profitability, or vice versa. finally, the question is why var estimated by riskmetricstm model overestimated the amount of actual loss so much. the answer should be sought in limits of normal distribution and coefficients of correlation from which riskmetricstm starts. first, since it takes into account only the first two moments (µ and σ), but not more moments around the middle (a measure of asymmetry and flattening), the normal distribution represents well only the central part of the area under the curve of distribution, but not its end (boundary) parts. because of that, the normal distribution, and therefore riskmetricstm, can often underestimate/ overestimate the risk that the portfolio is exposed to at the uttermost parts of the distribution (cases where high confidence level is required). second, the problem of the normal distribution is represented by a fact that gains/losses on the portfolio can take any value (∞, + ∞), which means that, theoretically, a bank (or any other financial institution) may lose more than they invested. this is not possible in reality kozarević e., comparative analysis of var models, ea (2010, vol. 43, no, 3-4, 29-41) 41 for a portfolio consisting of stocks and bonds because of the limited liability of holders of financial instruments, it is only possible in a portfolio containing financial derivative instruments, such as short positions in options, swaps or futures. since the normal distribution is not limited to the maximum possible loss, var calculated by riskmetricstm model can highly overestimate potential losses. third, coefficients of correlation in crisis situations, but sometimes in situations that are not crisis as is the case with countries in transition, change significantly, i.e. converge to 1, which makes var forecasts using riskmetricstm incorrect.8 conclusion the basic principle of optimizing a risk-return profile of the bank implies that the income on the risk exceeds the cost of capital for its coverage, and it should be considered while choosing an appropriate var model. under normal market conditions, the historical model is a very useful model for evaluating market risk and calculating the appropriate level of economic capital adjusted for risk (i.e. risk capital). however, if the risk manager believes that the prediction based on historical data is not sufficiently realistic, one can apply monte carlo simulation, which has a task to statistically generate random scenarios which can be used to determine var. riskmetricstm model, due to the underdevelopment of the b&h financial market, is obviously not an approach that could adequately evaluate market risk and required capital, since it highly overestimates the risk and makes holding (keeping) of required economic capital too expensive. references kozarević e., (2009), analiza i upravljanje finansijskim rizicima (analysis and management of financial risks), cpa plc., tuzla kozarević e., (2008), konceptualizacija i operacionalizacija evaluacije rizika finansijskih institucija (the conceptualization and operationalization of risk evaluation of financial institutions), doctoral dissertation, faculty of economics, university of tuzla, tuzla šverko i., (2001), moguća primjena povijesne metode rizične vrijednosti pri upravljanju rizicima financijskih institucija u republici hrvatskoj (possible application of historical value-at-risk method in risk management of financial institutions in the republic of croatia), financial theory and practice, 4/2001, institute of public finance, zagreb (www.ijf.hr/financijska_praksa/pdf%202001/sverko.pdf, the may of 2004) www.cbbh.gov.ba žiković s., (2005), formiranje optimalnog portfolija hrvatskih dionica i mjerenje tržišnog rizika primjenom var metode (forming the optimal portfolio of croatian stocks and measurement of market risk using var method), master thesis, faculty of economics, university of ljubljana, ljubljana (http://www.cek.ef.uni-lj.si/magister/zikovic513.pdf, the september of 2005) received: 20 september 2010 article history: accepted: 2 november 2010 8 for more details, see: (žiković, 2005). microsoft word 2009_3_4-korigovano.doc research report analysis and planning of apple production as factor of rural development support* ivanović lana**, institute of agricultural eeconomics, belgrade jeločnik marko, institute of agricultural eeconomics, belgrade udc: 338.492 jel: q1, q18 abstarct – apple production has great importance for agriculture of republic of serbia, as for processing industry and other followed industries. for this kind of production excellent conditions exist, but also specific problems in production organization, products selling and financing of plantation establishment are presented. regardless to insufficient use of available natural resources in apple production, it has great potential for export and development of small processing capacities, so it might be relevant factor in stimulation of rural development. analysis showed that areas under apple are growing in serbia, as total quantum of apple production. that is caused by increment of apple trees number and with increment of yield per one tree. by using of trend method is estimated that in next period can be expected further growth of apple production in serbia, what is confirming importance of this fruit species for rural development. in manuscript, group of measures that can notably stimulate and improve this kind of production, are also mentioned. key words: apple, production, planning, rural development introduction apple is the most important fruit species in the world and besides plum one of the most significant fruit species which is grown on the territory of republic of serbia. it could be said that in serbia basically are predominate dessert sorts of apple. the most spread, in other words leading sorts are jonagold, gold delicious, melrose and idared. they are also economically the most valuable sorts. because of its precious characteristics, apple is widely used in food industry. among numerous products, as most important could be labeled juice, marmalade, jam, cider, etc. development of fruit production in whole, as apple production too, has great influence on development of input industry, like they are productions of preparation for herbal protection, mineral fertilizers, agricultural mechanization, packing materials, building of storage facilities, etc. parallel with modernization and intensification of apple production, it is necessary to improve and develop all following industries (input industries and * paper work is part of researching on project mntr -159004 “accession of serbian economy into eu – planning and financing of regional and rural development, as companies development policy“, financed by ministry of science and environmental protection of republic of serbia. ** address: volgina 15 street, 11060 belgrade, serbia, e-mail: lana_i@mail.iep.bg.ac.rs ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 79 processing industry), how will on that way affects on increment of serbian fruit competitiveness level on international market. good climate and soil conditions in serbia are excellent precondition for development of this production. however, disregarding those conditions, apple production is not developed in adequate measure. areas under apple plantations are small sized (atomized), great number of tree trunks still are grown in farmsteads where are achieved low yields. also significant part of plantations is old and already amortized. during production process, the biggest problems are high input prices, lack of labor, obsolete mechanization, old plantations, old-fashioned (inadequate) sorts, etc. during the sale producers are faced of with next significant problems: low prices and impossibility of total produced volume selling at once. because of introduction of new breeding technologies and new, more productive sorts, it comes to gradual development of apple production, what enables, as higher production of more qualitative fruits per area unit, as increment of total apple production in serbia. apple represents one of the agricultural products which have great export perspective for serbian agriculturalists and on that way possible significant role in rural development encouragement. because of that it is necessary to analyze previous production volume and present state in serbian apple production, as to forecast production quantum in closer future. for getting of better picture about situation in domestic apple production and chance that improvement of this agricultural branch induces rural development, it has to be parallel introspected all characteristics of european and world apple production, as to predict trends of its further development. objective and aim of reseraching researching objective in paper work is previous and in next period expected apple production in the world, europe and serbia. objective is also an analysis of factors which affect on production volume of apple in observed territories. starting from researching objective and importance of apple as fruit species, next researching goals are defined: • analysis of present condition in apple production in the world and serbia, • determination and comparison of apple production trends, • analysis of influence of natural and socio-economic conditions on apple production, • introspection of possibilities that apple production become a carrier of rural development in serbia. data resources and working method in paper work are used two basic resources for areas under apple, average yields, achieved production, etc. first resource is available statistical data of republic of serbia, while as second resource is used fao’s statistical documentation for observed years. focusing on methods which are used in analysis of statistical data, next can be separated: • tables, economic analysis (2009, vol. 42, no. 3-4, 78-85) 80 • graphs, • trend, • index and • comparative analysis. researching results general data about apple production and selling apple is produced in many countries, almost on all continents, at most spread on north hemisphere. in 2007., in the world is produced 64.255.520 t of apple. the biggest planetary producers are china, usa, iran and turkey. italy is european leader in apple production. serbia is one of the minor european and world producers, with participation of 0,36% in total world production and 1,55% in total european production. yearly consumption of apple per capita, on the world level in 2003., was around 8 kg. consumption on european level was higher, about 20 kg per capita, while in serbia and montenegro, during the same year, was achieved consumption per capita of 22 kg. during 2007., in the world were under the apple plantations 4.921.767 hectares, what is little more than 10% of total world areas under fruits (without cantaloupes and water melons). total import of apples in 2006. on the world level was 6.967.882 t (http://faostat.fao.org). the biggest importer is russian federation, which participates in total world import with 11,66%, then, deutschland with participation of 10,02% (the biggest importer within eu). significant importers are united kingdom (7,63%) and holland (5,24%) too. apple export on the world level in 2006. was 7.166.752 t. china is the largest world exporter, with participation of 11,22% in total world export, then comes chile with 10,12%. italy is most important european exporter (ranked as third exporter in the world), with participation of 9,95%. france, also, takes significant place as exporter. it participates with 9,54% in total world apple export. serbia is at once apple importer and exporter. last years the biggest importer of serbian apples was russian federation. according vlahović (2003.), regionally observed the largest production is achieving in north-bačka region (in municipalities of bačka topola, mali iđoš, subotica), which gives 12% of total domestic production. also, significant are belgrade city, south-banat, podunavski and sremski regions, which commonly give up to 50% of national apple production. absolutely, the highest production has subotica municipality. the most concentrated production is in central part of republic, almost 66%. large number of sorts is grown, from autochthonous (each year less and less) to the economically most effective sorts“. apple production trend in average, for the period of 1998-2007., surfaces under apple were 5,1 million of ha (table 1.). areas under apple plantations in the world, besides variation per analyzed years, were decreased during observed period, from 5,8 million ha in starting year to 4,9 million ha in 2007., in other words reduction amounted 14,66%. similar tendency is noticed in europe ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 81 too, with comment that decreasing trend of areas is little more expressed (index 83,23). surfaces under apple in serbia were increased for 37,04%. table 1. areas under apple plantations in period 1998 2007. world europe serbia* year area (ha) base index (1998=100) area (ha) base index (1998=100) area (ha) base index (1998=100) 1998. 5.767.416 100,00 1.584.995 100,00 27.000 100,00 1999. 5.587.710 96,88 1.578.036 99,56 27.000 100,00 2000. 5.386.836 93,40 1.581.532 99,78 27.000 100,00 2001. 5.138.881 89,10 1.526.357 96,30 27.000 100,00 2002. 4.878.245 84,58 1.421.804 89,70 20.000 74,07 2003. 4.781.818 82,91 1.358.743 85,73 32.000 118,52 2004. 4.761.005 82,55 1.356.021 85,55 27.000 100,00 2005. 4.802.133 83,26 1.323.931 83,53 27.000 100,00 2006. 4.786.350 82,99 1.257.517 79,34 35.000 129,63 2007. 4.921.767 85,34 1.319.129 83,23 37.000 137,04 average 1998-2007. 5.081.216 / 1.430.807 / 28.600 / notice: * in period 1998-2005. are shown data for serbia and montenegro, and for 2006. and 2007. only for serbia. resource: http://faostat.fao.org europe, with average surfaces under apple from 1,4 million ha, participates with 28,16% in total world surfaces under apple plantations. serbia with average areas from 28.600 ha has participation from 1,99% in total european areas under apple. table 2.. total apple production in period 1998-2007. world* europe* serbia** year production (in t) base index (1998=100) production (in t) base index (1998=100) production (in t) base index (1998=100) 1998. 56.651.712 100,00 15.832.629 100,00 177.446 100,00 1999. 57.904.585 102,21 15.366.265 97,05 196.474 110,72 2000. 59.054.808 104,24 17.733.553 112,01 197.490 100,52 2001. 57.584.159 101,65 16.441.403 103,85 135.374 68,55 2002. 55.952.172 98,77 16.265.946 102,74 95.584 53,87 2003. 58.377.086 103,05 15.798.745 99,79 246.138 138,71 2004. 62.775.656 110,81 16.968.620 107,17 183.571 103,45 2005. 62.123.069 109,66 15.112.921 95,45 198.030 100,79 2006. 63.875.324 112,75 15.087.118 95,29 240.320 135,43 2007. 64.255.520 113,42 13.950.045 88,11 245.228 138,20 average 1998-2007. 59.855.409 / 15.855.725 / 191.566 / resource: * http://faostat.fao.org, ** municipalities in serbia 1998-2008., republic of serbia, republic statistical institute, belgrade. economic analysis (2009, vol. 42, no. 3-4, 78-85) 82 average volume of apple production in world in period 1998-2007. was 59,9 million t, and production showed in observed period increment for 13,42% (table 2). apple production in europe in same period was decreased for 11,89%, while in republic of serbia was significantly increased (index 138,20). with average apple production of around 15,9 million t europe has participation from 26,49% in total world apple production. serbia with average production of 191.566 t participates in total european apple production with 1,21%. for more detailed insight of apple production flow in the world, europe and serbia, on graphs are, besides of apple production presentation in ten analyzed years, created trend lines for the period of five years, finally with 2012. during the trend line creation, the best adjusted trend lines are used. apple production in the world has growing tendency. if apple production in next five years would in accordance with previous flow, in 2012. it could be expected world apple production from 68,1 million t (graph 1). graph 1. apple production volume trend for the world in period 1998-2012. (in 000 t) y = 870,15x + 55070 r2 = 0,7223 0 10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 year p ro d u ct io n v o lu m e (t ) production (t) linear (production (t)) according the apple production trend line, in europe in 2012., it could be expected production from 14,1 million t. in distinction to total world and serbian production, where is, based on existing data, expected production increment, in europe according trend line is evident reduction of apple production (graph 2). production volume in serbia in 2012., in accordance to the best adjusted trend line, which determination is based on previous data, will be 262.000 t. this means, that in next 5 years apple production in serbia, if it continues previous trend, will be increased for around 17.000 t in compare to production in 2007. (graph 3). ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 83 graph 2. apple production volume trend for the europe in period 1998-2012. (in 000 t) y = 16915e-0,0121x r2 = 0,2945 0 2.000 4.000 6.000 8.000 10.000 12.000 14.000 16.000 18.000 20.000 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 year p ro d uc tio n vo lu m e (t ) production (t) expon. (production (t)) graph 3. apple production volume trend for the serbia in period 1998-2012. (in 000 t) y = 7,4061x + 150,67 r2 = 0,217 0 50 100 150 200 250 300 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 year p ro du ct io n vo lu m e (t ) production (t) linear (production (t)) total apple production in serbia, as is mentioned, records permanent growth. production increment is based on higher number of fruitful tree trunks and increasing of average yield per one apple trunk. in average, in period 1998-2007. total number of apple tree trunks in serbia was 16,5 million, from that, number of fruitful trunks was around 14,6 million. economic analysis (2009, vol. 42, no. 3-4, 78-85) 84 average yield in observed period in serbia was 13,1 kg/trunk. comparing starting and last year of mentioned period, yield per one trunk is increased for 32,52%, before all, as result of apple production intensifying. so, increment of yield per trunk is achieved by higher investment in production (higher usage of plant protection preparations, mineral fertilizers, irrigation, etc.). also, individual producers in last ten years, in difference with previous period, more and more are dealt with fruit growing and apple production as professionals, looking on that not only as on additional income source. conclusion apple should have great role in development of serbian agriculture, in same time for supporting of rural development. it comes from fact that apple is second fruit species in serbia by its importance (behind plum), and that it has great export potentials (before all on market of russian federation). beside apple could be attractive export product, it could be pulled development of processing and input industry too. on that way in rural areas development it would not be focused only on agriculture, than it would be included establishing of small family processing factories, in other words employment of significant number of population. analysis showed that momentarily within world and european frame, serbia is relatively small apple producer, but at same time exist some positive tendencies which have to be maximally used in upcoming period. for example, areas under apple in world and europe are decreasing, while in serbia they are presenting increasing trend. while total apple production is mildly growing in world, or it is decreasing in europe, then total production volume of this fruit species in serbia showed significant growth in observed period. that is influenced by increment of apple trunks number, as by higher yield achieved per one trunk. also, by using of trend method is determined that in following period it could be expected further growth of apple production in serbia. for additional encouraging of apple production in serbia (rural development is included), it is necessary to introduce certain changes into the production practice, as they are new sorts, irrigation, establishing of anti-hail nets, better selling through the new established cooperative organizations, building of coolers, etc. as one of the most important factors, which could be contributed to the advancement of serbian apple production is improvement of financing conditions, at first place for long term credit arrangements. references milić, d., radojević, v. (2003): proizvodno-ekonomska i upotrebna vrednost voća i grožđa, novi sad; milić, d., kalanović bulatović branka, trmčić snežana (2009): menadžment proizvodnje voća i grožđa, univerzitet u novom sadu, poljoprivredni fakultet, novi sad; opštine u srbiji (1999 2008), republički zavod za statistiku, beograd; stanković, d., jovanović, m. (1990): opšte voćarstvo, naučna knjiga, beograd; veličković, m. (2002): voćarstvo, poljoprivredni fakultet beograd – zemun; vlahović, b. (2003): tržište poljoprivredno-prehrambenih proizvoda, specijalni deo, knjiga ii, univerzitet u novom sadu, poljoprivredni fakultet, novi sad; vlahović, b., stevanović, s., tomašević, d., zelenjak, m. (2006): agrarna proizvodnja u republici srbiji, monografija, društvo agrarnih ekonomista republike srbije, beograd; ivanović, l. et al., analysis and planning of apple production, ea (2009, vol. 42, no. 3-4, 78-85) 85 www.agromreza.org.yu; www.poljoberza.net; www.poljoprivreda.info; http://faostat.fao.org; apstrakt – proizvodnja jabuke ima izuzetan značaj za poljoprivredu republike srbije, ali i za prehrambenu industriju i ostale prateće industrije. za ovu proizvodnju postoje odlični prirodni uslovi, ali su prisutni i određeni problemi u organizaciji proizvodnje, plasmanu i finansiranju podizanja zasada. bez obzira što se u proizvodnji jabuke još uvijek dovoljno ne koriste raspoloživi prirodni uslovi, ova proizvodnja ima odličan potencijal za izvoz i razvoj malih prerađivačkih kapaciteta, pa može biti veoma značajan faktor podsticanja ruralnog razvoja. analiza je pokazala da površine pod jabukom u srbiji rastu, kao i ukupan obim proizvodnje jabuke. to je uzrokovano povećanjem broja stabala jabuke, kao i rastom prinosa po stablu. primjenom metode trenda utvrđeno je da se u narednom periodu može očekivati dalji rast proizvodnje jabuke u srbiji, što potvrđuje značaj ove vrste voća za ruralni razvoj. u radu je takođe naveden i skup mjera kojima se može značajno podstaći i unaprediti ova proizvodnja. ključne reči: jabuka, proizvodnja, planiranje, ruralni razvoj received: 24 july 2009 article history: accepted: 15 august 2009 microsoft word 2009_1_2.doc specificities of online concept in comparision with a classic concept of marketing research hasan hanić, belgrade banking academy, serbia beriz čivić, faculty of economics of the university of tuzla, b&h key words: marketing, researching, decision making, information technology, online research jel: l22,m3,l86 abstarct – generation of quality marketing decisions necessarily anticipates existence of a developed system of marketing research. the paper assesses limits of a classic concept of marketing research and stresses specificities of online concepts. the accent is put to a role of information and communications technology and a process and organization of online concepts of marketing research. the paper also analyzes the comparison of these concepts of marketing research and underlines their complementarities and a possibility to eliminate individual limitations of each of the concepts in order to establish an effective process of marketing research with a function to support the process of generation of marketing decisions. introduction contemporary business practice requires a faster process of making business decisions from managers. it is very important for managers to have business information of good quality. companies have an imposed need to establish a quality system of collection and its management. a special accent should be put on market activities of companies and complexity of marketing decisions making. the question is: ″how marketing managers can realize facts in regard to changeable desires of consumers, new initiatives of competitors, changes in distribution channels, etc.?″ the answer is that management has to develop an adequate system of collection and management of marketing data. the marketing research process enables management to collect data of good quality and it is a basis of generation of quality management decisions. significance of marketing research is especially visible in a possibility to diagnose a specific market position of a company. a diagnosis of the existing situation enables management to structure a management instrument that would enable improvement and strengthening of a market position of a company. many companies lack a sophisticated collecting and management of data and information. experience from local and international business practice show that many companies do not have established market research systems or the systems are reduced only to routine predictions based on empirical cognitions or to analyzing of historical data. in the best cases they are reduced to a partial survey as a way of primary data collection. in regard to an increase of effectiveness of a business process, it is very important to establish a system of collection and management of marketing (and other) data and information of a good quality in order to improve the process of marketing decision making and support improvement and strengthening of a marketing position of a company. economic analysis 1-2 (2009) 43-52 44 we can differ two concepts of marketing research, depending on how much application of marketing research is based on the internet and depending on information technology solutions based on the internet. those are: • classic concept of marketing research, • online concept of marketing research. limitations of classic concept of marketing research the classic concept of marketing research anticipates application of a scientifically approved methodology in realization of marketing research, which was a characteristic of the period until the end of the xx century – before a development of modern information and communications solutions based on the internet. when we talk about the classic concept of marketing research, we need to underline the fact that the internet and data bases available via the internet (but only as a source of secondary data) and various software applications for data processing are used for these marketing researches. however, that is a far lower level of application of information technology in marketing research in comparison with the online concept. the classic concept of marketing research can ensure a valid and reliable information basis for making marketing decisions. however, this concept often requires more time and assets to ensure a continuous maintenance of up to date information basis based on what marketing decisions are made. this is a significant limiting factor in contemporary conditions of business operations, which is characterized with an increasing complexity and a need for a quick decision making. the mentioned imposes a need to establish a system of marketing researches that would be based on the application of contemporary information and communications technologies in order to enable a quick collection of valid and reliable data. these data should be available in time, at a proper place in the decision making system and in a form that enables a decision maker to generate a decision quickly. starting from contemporary conditions of a business activity, managers are generally, and particularly those from the field of marketing decision making, faced with a very dynamic market movements which generate a need to make business decisions quickly so they need a continuous provision of quality information in order to retain and improve their market position. ensuring an up to date information basis can be achieved only if a process of generation of data is established as a continuous and organized process. this process can not in wholeness be based on a support provided by the classic concept of marketing research. hence, there is a need to solve this problem in a systemic way. identified weaknesses of this concept in the process of generation of the information basis in the business practice contributed to it and they are manifested through the following: • information necessary to solve various aspects of marketing problematic are counted. however, due to a lack of time and one system that would continuously ensure collecting and managing of information, decision makers are forced to undertake an non systemic ʺhunt for information when making every decisionʺ; h. hanić, b. čivić / ea 1-2 (2009) 43-52 45 • a consequence of the non systemic approach is that not all relevant information are collected or many information that are collected are late or incomplete; • as a consequence of the fact that there is not any organized process of collecting and managing of information, it often happens that important information are not recorded in an adequate way and form in order to be available at all relevant destinations in a company. often they are jealously kept by individuals who want to use them in certain situations as instruments to improve their positions in the company; • since the process of generation of the information basis is not systematic, questioning of a level of quality of an information is often justified (validity and reliability of the information), and that is a prerequisite for a decision of a good quality. the rest of the paper will focus on specificity of the contemporary approach to the process of marketing research that is named as the online concept of marketing research. this concept enables application of solutions of contemporary information and communications technology in the process of marketing research, which enables researchers to improve a process of collecting, processing and storing of data ensuring anticipation of improvement of the process of generation of business decisions in a company. the online concept of marketing research is based on the implementation of these solutions specificity of online concept of marketing research as previously stressed, one of the key prerequisites of making quality marketing decisions is availability of quality information. application of solutions of the contemporary information and communications technology in the process of marketing research enables researchers to improve the process of collecting, processing and storing of data, also ensuring the prerequisite to improve the process of generation of business decisions in a company. the online concept of marketing research is developed on a basis of the application of these solutions. the online concept of marketing researches means application of a scientifically approved methodology in realization of marketing research using solutions of the contemporary information and communications technology based on the internet in all phases of realization of the research process. in this way certain limitations faced by the researchers in the classic concept of marketing research are eliminated. it is important to be aware of the fact that these two concepts of marketing research do not exclude each other but they are complimentary. it is very important to ensure a continuous updating of information background, which serves as a basis for business decisions making. this can be achieved only if the process of data/information generation is established as a continuous and organized process. this process can not in wholeness be based only on a support provided by the classic concept of marketing research. a role of information and communications technology in the process of marketing research wanting to stress a widely spread use of information and communications technology in contemporary business, many authors use the term digital economics in their works. the economic analysis 1-2 (2009) 43-52 46 potential of the contemporary information and communications technology will be assessed in this paper in regard to a possibility of its application and effects of the application to the process of marketing research. hence, the rest of the text focuses on the online concept of marketing research as a frame that enables the application of the solutions of the contemporary information and communications technology in the process of marketing research (in the process of collecting and analyzing data and presenting obtained results). this concept ensures a possibility to use the internet and solutions of the information and communications technology based on the internet in order to realize a standardized systemic process of collecting, processing and presenting the marketing data. however, we need to be aware of the fact that the application of the online concept in a combination with the classic concept can have far better effects than an isolated application of any of these two concepts of market research. but first of all, we need to take care about information needs of users and of market decisions makers. within the marketing information system, we can realize a combination of the classic and the online concept of marketing research, depending on the nature of the information needs, and in order to realize an effective functioning of the system of collecting, managing and application of the data in order to improve business performances of a company. the previously mentioned is more than enough to motivate management to ensure application of the information and communications technology in order to provide a continuous quality process of generation of marketing data and create necessary prerequisites for improvement of business performances of a company. in regard to the mentioned, a need to connect the information and communications technology with the process of marketing researches in order to make the process effective in finding out needs and requests and enable creating of a better system of their satisfaction is clear. the online marketing research represents a standardized systematic procedure of providing marketing data through the internet and the information and communications technology based on the internet. what is characteristic for the marketing research methodology that is realized in a classic way is also valid for the online marketing research. a difference is in resources and a technique used for collection of primary and secondary data. the internet has been (since its appearance) representing a very important source of secondary data, even within the classic concept of the marketing research. in this case we want to focus on ways of realization of primary data collection using the internet resources and other information and communications solutions. it is important to underline that within the frame of the online concept of marketing research we can realize data collection, both internally and externally, because a working methodology of this concept is the same on the internet and on the intranet. however, if we want to realize an internal primary data collection, it is not essential to realize it only within a frame of the intranet because each employee that should be questioned can use resources from the internet. it is the same with usage of secondary internal data sources. one of important advantages of the realization of marketing research by the concept of the online research is that data can be processed as soon as they are obtained. data from the internet do not require any extra steps of data entry because they already are in electronic form. using appropriate software those data (replies of examinees) can be imported into the h. hanić, b. čivić / ea 1-2 (2009) 43-52 47 software which will do further processing of the data and send them to a working position within the business process where they will be used as an information basis for making business decisions. the internet (or web as its most commonly used form) can be used to access collected data of a company from distanced locations (distanced branches), to process the data and present them on the internet and make them available to all those who are interested. besides data collecting, a very important issue is management of collected data and ensuring their adequate storage and timely availability at all places in an organizational structure where they will be used for certain purposes. a process of online marketing research a process of marketing research based on the internet and information and communications solutions do not differ from the process of the classic marketing research. it means that all elements and their inter-relations that characterize the process of the classic marketing research are valid in the case of the online marketing research. what differs the online marketing research from the classic marketing research are techniques and a form of primary data collection. the reason for application of the online marketing research supervenes, among other, from the fact that application of the internet and the information and communication technologies based on it in the process of primary data collection enable this process to be performed: • with less time consumption, • with less assets consumption, • with less possibility of an error. a possibility to decrease sources of errors in the process of primary data collection within the online concept lies in a part of the process connected to editing and coding of data. namely, this process is automatic with marketing research based on the contemporary information and communication technologies. different from the online concept, in the classic concept of marketing researches these activities directly depend on the researcher who has to edit and code the data manually. if we want to analyze collected data with certain software, it is necessary to enter prepared data manually in the software and to analyze the collected data afterwards. these manual operations are time-consuming and a possibility of error occurrence is significant. in the online concept of marketing research this process is automatic and data entry into the software is supported by an examinee (in a method of questioning an examinee gives answers to questions directly in a certain software environment; in a method of observing an observed situation is directly processed by an appropriate software solution), and then the data are transferred from the examinee to a researcher due to a certain information and communications solution. then the data are automatically imported in the appropriate software and an analysis can start immediately. this eliminates editing and coding phases from the whole process and increases a speed of obtaining desired data but eliminates a possibility of occurrence an error that is connected to the two mentioned activities. since marketing research is often realized using a combination of primary and secondary sources, this approach can successfully be realized with the online concepts of marketing research. economic analysis 1-2 (2009) 43-52 48 the process of the online marketing research, as well as the classic concept of marketing research, is realized through basic phases: planning of a research, data collection, analyzing collected data and presentation of results. however, the online concept puts a stress to the application of the software support wherever the nature of marketing research allows and wherever activities of a researcher can be substituted by solutions of the contemporary information and communications technology. in this way one wants to shorten duration of certain phases in the marketing research process or to eliminate the whole process and release a research from manual activities and minimize possibilities of error occurrence. organization of the online marketing research an issue of organization of marketing research deserves a special attention in the classic and in the online concept of marketing research. namely, a quality of marketing research is, among other, determined by a possibility of ensuring a representative sample. to conduct the online marketing research, one needs to establish and maintain a basis of e-mail addresses of potential examinees in order to invite them to participate in a research, if necessary. experience of professional researchers from agencies [gfk croatia, 2006, page 3] state that it is better to do generation of bases of e-mail addresses of potential examinees with an offline method (a survey via phone or personal questioning) than via the online method (via links, banners or pop-up windows from selected web pages). for example, the basis of the internet addresses possessed by gfk is created offline and it contains several thousands potential examinees. gfk croatia – center for market research conducts its online research on a basis of email addresses that has been created since 2002. persons who have [gfk croatia, 2006, page 6] e-mail addresses and the internet access are registered with classic representative surveys (a telephone survey or personal questioning). one can extract a sample for certain target groups of examinees from the base, according to needs of a certain research. then, from gfk’s online pool, one e-mails a user name and a password to every examinee and the examinee registers on a certain web page and fills in a previously prepared questionnaire (picture 1). picture 1. a way of conducting a research with the gfk’s online pool source: gfk croatia, 2006, page 6 users themselves can be conductors of the online marketing research or they can do it through a certain model of cooperation with specialized organizations that deal in the marketing research process. recruitment internet pool address data base examines www questionnaire server e-mail id-nr. offline recruit users of internet (personal surveys, telephone’s surveys, etc.) h. hanić, b. čivić / ea 1-2 (2009) 43-52 49 a recommendation to users is to engage a specialized organization for these services for the online marketing research. namely, a realization of the online marketing research requires a certain infrastructure of technological nature. a construction of this infrastructure can be ensured through a construction of a marketing information system in a company. however, very often creation of infrastructure settings for realization of the online concept of the market research represents a very huge effort for individual users. the online marketing researches can be organized as: • (one time) ad hoc online research, • occasional (repetitive) online research, • continuous (longitudinal) online research. also, the concept of the online marketing research enables an organization have a researching process in a form of: • online panel research, • online omnibus research, • online focus groups. all mentioned forms of organizing the online marketing research can be implemented within the process of establishing the marketing information system, but it is necessary to assess information needs and, according to them, decide about a form and contents of the organization of the online marketing research and a need to combine them with the classic concept of marketing research. comparision of classic and online concept, of marketing research it is the best to make a comparison of performances of the classic and the online concept of marketing research on some examples from research practice. we will use experience of gfk croatia – centre for market research for this paper. namely, for a successful realization of the online concept one needs to pay attention to a level of usage of the internet by potential target groups. the higher the level of the internet usage by a selected target group is, the more representative a certain type of the online samples is. for example, in cases where a target group consists of older people, or with groups of lower income, application of the online concept of marketing research can give worse results than in case when data are collected in this way from students. in regard to an aspect of consumption of time and assets, the online research (questioning techniques) can be realized in a shorter time period and with less consumption of assets than techniques of questioning in the classic concept. the online researches are especially appropriate in case when information is needed urgently and when a wide geographic coverage is necessary in data collecting. it is especially a case with, for example, testing reactions on promotional solutions, etc. the centre for market research gfk croatia has an interesting experience in regard to duration of the process of data collection. according to their experience [gfk croatia, 2006, page 3], the online survey usually do not last longer than 15 to 20 minutes, but the practice proved that interesting topics and questionnaires designed in a interesting way can last longer. it also turned out that the online methodology actually is the best way to conduct in economic analysis 1-2 (2009) 43-52 50 depth conversations with experts from the field of health care. for example, with pediatricians, gynecologists, surgeons and similar professions who have a lack of time and do not accept the in-depth survey eagerly. in regard to complexness of questions the online concept of market research can also give better results. complex questions can be presented in a better way with an adequate usage of software solutions than via telephone or in a survey via post. advantages of the online concept are stressed in regard to a need to use certain presentation material (samples, pictures, promotional solutions, etc.) in the process of data collection in order to entice reactions of examinees. using a multimedia support within the online concept, all types of audio and video recordings and pictures can be presented. for example, web surveys are the most favorable to represent promotional solutions, design solutions, projection solutions, etc. on the other hand, with personal questioning we can have printed, audio or video material, but they require additional expenses because reproduction of a huger number of quality color prints is expensive. with telephone questioning it is possible to present only audio recordings and it limits a possibility to apply the classic approach to this type of researching. previously we stressed significant advantages of the online concept in regard to the classic concept of marketing researches and in regard to processing of collected data and a possibility to eliminate errors that occur in these phases of the research process. according to previous practice of the gfk group, we can define that examinees answer questions more thoroughly in online surveys than via telephone or similar questioning. a short comparison of the classic and the online concepts is given in table 1. table 1. a comparison of the classic and the online concept of the marketing research criteria of comparison online face to face telephone post target group many, even specific almost all almost all majority duration of survey 10 – 20 min – 60 min 15 – 20 min – 90 min possibility of complex questions medium high low medium presentation material multimedia simple possible, but difficult impossible possible, but with influence of survey conductor none medium low none time of realization short long relatively short relatively long expenses low to medium relatively high medium low to medium source: gfk croatia, 2006, page 7 table 2 can be consulted for possibilities of application and advantages of the online concept of marketing research for researchers h. hanić, b. čivić / ea 1-2 (2009) 43-52 51 table 2. some of characteristics of the online concept of the marketing research assessed requirements possibility of satisfying requirements fast implementation yes favorable price yes multimedia presentation yes without influence of survey conductor yes ʺdifficult ʺ topics are possible yes representativeness of sample yes (with exceptions) target groups many, and very specific regional causing yes topics most topics are possible preliminary results yes, unweighted very difficult questions better not without survey d source: gfk croatia, 2006, page 7 according to the previously mentioned, we can conclude that one necessarily needs to take the online concept of marketing research into consideration in planning a realization of the process of marketing research. this is because of an extraordinary spectrum of possibilities offered by this concept. conclusion ensuring a quality information basis is one of the key prerequisites for generation of quality business decisions. this prerequisite is realized through the marketing research process that can be established in a company in several ways. establishing the marketing research process on a basis of application of the internet and solutions of the contemporary information and communicatory solutions based on the internet can ensure adequate results. it is especially a case if it is assessed from an aspect of fulfillment of requirements of modern business practice in regard to a need for availability of up to date data and information and a need to deliver data at a proper place of an organizational structure and in time in order to be used for improvement of business performances of the company. an organizational platform that enables an effective fulfillment of these requirements is the marketing information system. establishment of the system in a company creates an adequate frame for an effective organization of the marketing research process and the process of generation of marketing decisions. it is important to underline that the two concepts of marketing research that are treated in the paper (the classic and the online concept) do not exclude each other. on the contrary, they are complementary and enable establishment of the market research process on a basis of a combination of these two concepts, which eliminates limitations of each of them. economic analysis 1-2 (2009) 43-52 52 references chinsnall m. p., (2001), marketing research, the mcgraw-hill companies, london cooper d. r., schindler p. s., (2006), business research methods, mcgraw hill international edition čivić b., (2007), modeliranje savremenog sistema marketinških istraživanja, magistarski rad, ekonomski fakultet univerziteta tuzla, tuzla fletcher k., (1995), marketing management and information technology, prentice hall europe, london gfk croatia – centar za istraživanje tržišta, (septembar, 2006), gfk e-solutions – online istraživanja (www.gfk.hr) hanić h., (2004), istraživanje tržišta i marketing informacini sistem, ekonomski fakultet beograd, beograd saskcan pulse trading, (2006), prosoft xp, istraživački projekat, the computerworld honors program, regina, canada ea_2019_2 doi: 10.28934/ea.19.52.2.pp104-112 scientific review characteristics of marketing communication strategy of a small enterprise marija lazarević-moravčević1* 1 belgrade banking academy – faculty of banking, insurance and finance, business economics and management, belgrade, serbia abstract the subject of this paper is the analysis of the characteristics of the market communication strategy used by small businesses, with special focus on serbia and western balkan region. the aim of the paper is to highlight the importance of modern information technology in market communication, that is, to emphasize its role in creating effective solutions for promotional activity of small organizations. the study assumes that, due to certain resource constraints, small businesses are forced to create unique approaches to communicating with the market and, in the process, rely primarily on the resources they have in abundance creativity and innovation. desk-research method was used in the paper, primarily analyzing papers and publications from scientific journals and other professional literature in the field of marketing, as well as official data, databases and reports of relevant institutions. pointing to the basic advantages achieved by applying modern forms of market communication, the paper could contribute to the improvement of the market communication practice of smaller business systems. key words: marketing, market communication, small business, information technology, internet jel classification: m31, m37 introduction market communication can most easily be described as the process of exchanging information, ideas, opinions and experiences between businesses and the environment. considering the goals which should be achieved, as well as the approach to the analysis, market communication should not be equated with promotion. unlike promotion, which mainly has the task of informing, persuading, reminding and connecting the company with the target audience, the goal of market communication is to establish and maintain quality relationships, not only with consumers, but with all key stakeholders. observed from the consumer's perspective, marketing communication can be explained as a “process where a customer perceives an offering, product, service, company or person. it can be deliberated or embedded in context, visible or merely in the head of the customer. it can include experience, processes, activities triggering value-in-use for the customer, and can consist of several simultaneous senders” (finne, gronroos, 2017). market communication plays an important role in business strategy of any company, especially due to the fact that it contributes to creating and enhancing competitive advantage. large and globally oriented corporations (coca-cola, nike, ikea, google, etc.) have understood * e-mail: marija.lazarevic@bba.edu.rs marija lazaević-moravčević 105 the role of marketing communication in market positioning and are providing significant funding for promotion. similar to large systems, small businesses need to promote their products/services, inform the prospective consumers about important events, remind them, listen to their demands and take into consideration their opinions. as open and highly flexible systems, these companies enter into collaborative relationships with the environment, sharing resources/products and information with key stakeholders. however, due to certain resource constraints, small businesses are unable to use all available market communication options, especially if they involve high financial investment. both small and large businesses have the same goal to make a profit. they achieve this goal in different ways and by applying different market communication strategies (levinson, 2009). taking into consideration the mentioned limitations of small business, but also the role of promotional activities in modern business conditions, the paper emphasizes the fact that intensive use of modern information technology, as well as the solutions it offers in the domain of communications, can significantly improve the visibility of small businesses in the market. market communication in contemporary business conditions there is no filed in marketing that is more susceptible to change and development than promotion or market communication. it is an extremely flexible marketing mix instrument, whose application and development are determined by many factors. the most significant changes in this segment of marketing are driven by the development of modern information technology. influenced by technology, approaches to market communication are constantly changing, modifying and improving. modern technologies are also introducing new forms, that is, channels of marketing communication, which primarily refers to forms of direct marketing and internet marketing. thanks to them, communication becomes interactive, targeted at target groups (individuals) and the results of communication are measurable (domazet, đokić, milovanov, 2017). modern information technology is a factor that significantly influences the development and implementation of a new concept in market communication integrated marketing communication (imk). it is a strategic approach to communication that gained importance in the late twentieth century. the concept involves the integration and coordination of different communication channels to convey a clear, consistent and acceptable message about an organization and its products (kotler, 2006). “in fact, imk is a strategic combination of all messages and the media used by an organization to influence the perception of brand value in consumers” (low, 2000). when it comes to the concept of imk, integration of forms of promotion is the first association. another dimension of integration is the coordination of the promotion form with the other elements of the marketing mix and the third stage is creative integration, which involves harmonizing topics, messages and concepts. in addition to modern technology, the development of the imk concept has been influenced by certain market factors: intense competition, increased investment in promotional activities, redistribution of the promotional budget at the expense of advertising in favor of other forms of promotional activity and changes in consumer behavior (domazet, stošić, lazić, 2018). under the influence of modern technology, consumer behavior is changing as well as its role in the communication process. modern consumers are extremely well informed and “more cautious when purchasing, while after-sales services are gaining in importance in the competition between different manufacturers” (stošić, 2014). consumers become immune to traditional forms of advertising and focus on the internet and other interactive media. the fact that the number of users of its services globally is constantly increasing confirms that the internet is becoming an extremely important channel of communication. various forms of communication are enabled through the internet such as follows: e-mail, e-presentation (web 106 economic analysis (2019, vol. 52, no. 2, 104-112) site), launching messages (banners, micro-sites), blogs, forums, communication via social networks, etc. (domazet, neogradi, 2018). table 1. world internet usage world regions internet users 30 june 2019 penetration rate (%pop.) growth 2000-2019 africa 522,809,480 39.6 11.48% asia 2,300,469,859 54.2 1.91% europe 727,559,682 87.7 592% latin america / caribbean 453,702,292 68.9 2.41% middle east 175,502,589 67.9 5.24% north america 327,568,628 89.4 203% oceania / australia 28,636,278 68.4 276% world total 4,536,248,808 58.8 1.16% source: internet world stats, 2019 based on the above, it can be concluded that modern market communication is characterized by the transition from mass communication to targeted communication. business-to-consumer communication becomes interactive and intense. in the communication process, the position of consumers has been significantly improved. the communication role of all marketing mix instruments is emphasized. modern marketing communication is also characterized by the application of information technology. the new solutions that technology offers make the communication process more efficient and effective (domazet, 2018). creating market communication strategy in small enterprises the characteristics of small businesses affect every segment of business, and in particular the planning and implementation of marketing activities. small businesses are characterized by exceptional flexibility, a propensity for entrepreneurial ventures, smaller production volumes, simple organizational structure, and informal internal communication. these are the business systems “that most survive in labor-intensive activities, that is, in activities where development rather than growth is the main determinant of business success” (milisavljević, 2017). these companies are mainly gaining competitive advantage by applying a strategy of focus a strategy of focusing on a market segment whose needs can be successfully met (coulter, 2010). also, small businesses face many weaknesses: lack of financial and often human resources, inability to exploit the effects of economies of scale, lack of business planning and strategic thinking (domazet, stošić, 2013). the constraints faced by small businesses make it difficult to carry out individual marketing activities and force these businesses to find new, unconventional ways to implement them. regardless of the limited resources, marketing orientation is necessary for small businesses, especially due to the fact that the relationship between it and profitability is linear (jobber, 2006). the absence of a marketing orientation in small businesses leads to lower performance and higher risks of business failure (alpkan, yilmaz, kaya, 2007). small businesses adapt marketing to their needs and capabilities without relying too much on theory. the business owner plays a key role in planning and implementing marketing activities. small business owners do not define the marketing mix in terms of product, price, distribution and promotion, but are focused on interactive marketing. they do not conduct formal market research, but collect information through informal methods based on contact networks (collinson, shaw, 2001). “in fact, owners conduct marketing through natural and intrinsic marija lazaević-moravčević 107 networking activity, through normal and common communication activity, such as interaction and involvement in social, business and commercial activities” (butigan, mahnić, 2011). based on the above, it can be concluded that the traditional marketing concept is not an acceptable solution for small businesses (gilmore, carson, grant, 2001). the traditional approach to marketing is more oriented towards large organizations (levinson, 2009). “a small business is more flexible, closer to customers, and more capable of adapting and implementing creative solutions than traditional marketing frameworks” (hill, 2001). for smaller companies, the more appropriate solution is the concept of marketing relationships. the concept is explained as the process of identifying and establishing, maintaining and strengthening relationships with customers and other stakeholders regarding profit, so that the goals of all parties involved are met (gronroos, 2002). in the new approach, the focus is on gaining customer loyalty and retention over the long term, customer value, quality of service provided, as well as care of all employees for clients (hanić, domazet, drašković, 2011). small organizations face certain problems that limit their ability in market communications domain. due to the constant lack of financial resources and a deeply rooted opinion that promotion is a necessary evil, these companies do not have a planned approach in creating a market communication strategy. similar to large organizations, small businesses can use different forms of promotion: economic propaganda (advertising), sales promotion, events, public relations, personal selling and direct marketing. the choice of form of promotion is determined by the goals that the company wants to achieve, but also by the amount of investment that these forms entail. economic propaganda (advertising) is a paid form of mass communication (hanić, 2007), that is, a way of promotion in which the company sends messages to the market through various means of communication (the media). approaches to advertising have changed dramatically in recent years. once wide spread advertising in newspapers and other mass media (radio, television) today is increasingly giving way to digital advertising, that is, advertising via e-mail, websites, social networks. this type of advertising is becoming more and more prevalent in the promotion of small businesses. sales promotion techniques are mainly used as a tactical tool to stimulate sales growth in the short term. they vary depending on whether they are aimed at 1) the consumer samples, coupons, discounts, sweepstakes, free trials, 2) the merchant network free goods, rebates, advertising and exposure bonuses, higher margins, or 3) sales operations fairs, conventions, competitions of sales representatives, etc. (jobber, lancaster, 2006). despite some similarities that can be observed between the various sales promotion techniques and economic propaganda, the two forms of promotion differ substantially. the basic difference can be realized in the goal that is to be achieved. “advertising offers a reason and sales promotion is an incentive to buying” (kotler, 2006). in the broadest sense, public relations are defined as any activity aimed at developing a positive attitude in the public about the organization and its activities. the goals of public relations are: 1) creating consumer loyalty; 2) attracting investors or partners for association; 3) attracting quality workers; 4) opening new markets; 5) new product launches (jobber, lancaster, 2006). it is a form of market communication that enjoys credibility and public confidence. events and experiences are company-sponsored activities and can take many forms, such as sporting events, company visits, parties, festivals, street activities, etc. with this form of promotion, the company seeks to strengthen the image it enjoys in public, based on activities that confirm its commitment to the community and issues of social importance. personal selling is a form of market communication that involves establishing personal contact between the company and the customer. “it is based on interpersonal communication where all aspects of communication are emphasized: bidirectionality, symmetry, verbal and 108 economic analysis (2019, vol. 52, no. 2, 104-112) non-verbal speech” (ognjanov, 2013). it is a communication characterized by flexibility, the ability to receive feedback and sell something in a short period of time. on the other hand, it is also characterized by high costs. direct marketing is the communication with key stakeholders based on the use of direct channels (direct mail, telemarketing, catalogs, interactive television, mobile devices, internet, etc.). three basic features of direct marketing are: interactivity, response and measurability (hanić, 2007). in today's business environment, internet is becoming the most effective means of direct marketing. in addition to the goal which should be achieved, the choice of the form of promotion is determined by other factors as follows: market characteristics, product type (consumables/production goods), distribution strategy (pull/push strategy). in the business market, the dominant form of market communication is personal selling. in the consumer goods market, marketers generally rely on advertising followed by sales promotion and personal selling. the implementation of push strategy involves focusing on personal selling and sales promotion in order to push the product through distribution channels. on the other hand, the pull strategy relies heavily on advertising, with the idea that the product being advertised will attract consumers' attention, which will make them look for a particular product in the store (jobber, lancaster, 2006). the company generally does not rely on one form of promotional activity but uses a combination of these. creating a promotional mix is also influenced by available resources, market size, competition intensity and customer needs for information (jobber, 2006). it is necessary to carefully and creatively design the process of market communication. the strategic approach involves the following steps: 1) identifying the target audience, 2) defining goals; 3) communication design, 4) channel selection; 5) budgeting; 6) deciding on the media mix; 7) measurement of results; 8) managing integrated marketing communications (kotler, 2006). creating an effective marketing communication strategy begins by identifying the target audience and defining the goals that the promotional activity wants to achieve. this is followed by creating a message and selecting a channel. even the best promotional activity plan will not work well if wrong media is chosen. due to the costs involved, some communication channels are inaccessible to small businesses. it primarily refers to television, that is, the media that is considered to be the primary source of information, according to some studies conducted in serbia and the region macedonia, bosnia and herzegovina, montenegro (ognjanov, nojković, 2007). on the other hand, modern communication technology offers small businesses more efficient solutions, i.e. options that result in relatively low investment over traditional media, as well as other benefits two-way communication, interaction, personalization, etc. table 2. basic media characteristics television: reaches a large number of people excellent technical capabilities combines image and sound lower selectivity of the audience high costs radio: high interactivity and flexibility limited creativity relatively low cost lower level of attention than television transient exposure newspapers: high flexibility and low interactivity short life span good local market coverage wide acceptance magazines: high level of selectivity longevity better technical options than newspapers information obsolescence marija lazaević-moravčević 109 internet: extremely high flexibility and interactivity high selectivity excellent technical capabilities unlimited creativity long lasting effects the ability to be exposed to the message repeatedly relatively low cost source: author review based on hanić, 2007 and ognjanov, 2013 an effective market communication strategy requires certain resources, which must be foreseen and booked in advance. different methods can be used for budget planning: arbitrary method, percentage of sales method, competition method, as well as goal and task method (kotler, 2006). in today's business environment, the best solution for any business, regardless of its size, is the goal and task method. “the idea is to break down a budget based on well-defined goals, specific tasks to accomplish these goals and estimate the cost of all activities” (lončar, 2011). after the promotional campaign has been conducted, it is necessary to analyze the results, i.e. the profitability of the investment in the promotion. the effects of promotional activity can be analyzed on the basis of different quantitative and qualitative indicators. most businesses, while neglecting the fact that all promotional activities do not directly influence consumer behavior and produce no effects in the short term, rely on quantitative indicators and evaluate the effects of promotional activity on the basis of sales or profits achieved. market communication the practice of small enterprises in serbia the analysis of the existing practice in the field of market communication of small businesses in serbia has not been researched much. such research was mostly conducted by marketing agencies. the results of a survey conducted by smart plus research indicate that small businesses in serbia lack certain elements of marketing orientation. the prevailing view is that marketing is of great importance for business development, but there is also a phenomenon that in small companies there is no organizational unit in charge of marketing activities, neither is there an individual specialized in this field. there is no practice of using the services of marketing agencies. the research also concluded that advertising, that is, printing and distribution of promotional material, is the dominant form of promotional activity. few businesses use business gatherings and events to promote themselves. relatively few companies systematically monitor and measure the effects of marketing investments. the results of the research also point to the fact that even advertising on social networks is not sufficiently used. as expected, facebook is the dominant advertising platform, and an extremely small number of businesses in serbia advertise on linkedin. a positive trend of advertising on social networks is expected in the forthcoming period, since a significant number of respondents plan this form of promotional activity (smart plus research, 2019). a positive trend in the use of modern technologies for promotional purposes is confirmed by the fact that digital marketing agencies have been achieving intense growth in revenue and net profit in recent years. revenue growth of digital marketing agencies is a proof that businesses in serbia are increasingly investing in digital communications (marketing mreže, 2018). similar conclusions were drawn from a survey conducted in 2018 by the statistical office of the republic of serbia. the research aimed to evaluate the use of modern information technology in business operations in serbia. it was conducted by using a questionnaire on a sample of 1,781 businesses. about 45% of the companies in the sample were small businesses, that is, systems employing 10 to 50 employees. the basic observation in the research is that the largest number of companies in serbia uses the internet in their business, but that the 110 economic analysis (2019, vol. 52, no. 2, 104-112) opportunities offered by the internet are not used enough. it is commendable that a large number of small businesses have a website to promote their products/services. it is mainly used for product description and pricing. other aspects of e-business, such as e-commerce, are underrepresented. research also indicates that the use of social networks for the purpose of promotion by small businesses is increasingly intense (statistical office of the republic of serbia, 2018). the market communication strategy of small businesses in serbia must be adapted to the situation in which these systems operate. it is determined by internal factors, primarily the resource capabilities of the company, but also by a number of factors of an external nature consumer habits in the use of particular media, as well as competitors' actions. when designing a marketing communication strategy, it should be taken into account that television is still considered by the consumers to be the most important media in serbia, but also the view that recommendations from friends (word-of mouth advertising) are considered to be an extremely important source of information. also, attitudes towards personal selling are more positive than towards advertising (ognjanov, nojković, 2007). taking into account the results of the aforementioned research as well as the characteristics of small businesses, it is concluded that there are effective solutions for small businesses regarding their promotional activities. one of the possible solutions is the recommendations of a satisfied client. this form of promotion should be encouraged on the basis of certain incentives for each new consumer or service user. also, an extremely convenient form of promotion for a small business is business gatherings and the organization of certain events of social importance. this form of market communication demonstrates concern and commitment to the local community, which can have a positive effect on the image of business in public. small business promotional activities should also target the existing customers. in order to improve relationships and create loyalty with this category of customers, it is necessary to communicate intensively. for this purpose, the following can be used: e-mail notifications or sms messages, discounts for large quantities of purchased goods, gifts, establishing loyalty programs, etc. the visibility of small businesses, that is, products and services, can be enhanced by applying certain solutions offered by modern information technology. one of these solutions is internet advertising. every small business should have a functional website where all the useful information (business description, location, opening hours, contacts) is required. modern websites are dynamic, provide the ability to download and post content, as well as the opportunity for interactive communication. unlike traditional ways of advertising (local magazines, informants, brochures), promotion through the internet allows for a high level of selectivity and interactivity. considering the mentioned advantages, as well as the fact that the number of internet users in serbia and its surrounding environment is growing consistently, the key recommendation addressed to small business owners / managers is to rely more on the internet in the process of market communication. table 3. internet stats and facebook usage in serbia and surrounding countries selected economies population 2019 est. internet users 30 june 2019 penetration (% population) facebook 31 dec. 2018 bosnia-herzegovina 3,501,774 2,828,846 80.8 % 1,500,000 montenegro 629,355 448,541 71.3 % 320,000 north macedonia 2,086,720 1,592,376 76.3 % 1,000,000 serbia 8,733,407 6,325,816 72.4 % 3,400,000 slovenia 2,081,900 1,663,795 79.9 % 910,000 croatia 4,140,148 3,787,838 91.5 % 1,800,000 source: internet world stats, 2019 marija lazaević-moravčević 111 for small businesses that plan to use social networks for promotional purposes, it may be useful to know that the population in serbia is most focused on facebook 89, 66%, then on pinterest 3,88%, instagram 2,34%, twitter 2,28, youtube 1,36%, tumblr 0,3% (statcounter global stats, 2019). finally, it should be pointed out that contemporary marketing theory is increasingly emphasizing the communicative role of not only promotion but also of other marketing mix instruments (product, price, distribution). all elements of the marketing mix send a specific message about the company and its business. the product communicates with its physical characteristics color, shape, packaging, etc. price is usually linked to quality. different messages are transmitted exclusively in relation to intensive distribution. conclusion due to the persistent lack of financial resources, small organizations are unable to allocate significant funds for promotion. unlike large organizations, these companies do not plan promotional activities. due to the costs they may include, certain channels (media) are almost inaccessible to these businesses. research conducted by marketing agencies indicated that small businesses in serbia lack certain elements of market orientation, as well as a planned approach to creating promotional activities. marketing activities, which promotion is a part of, are the responsibility of owners and employees who generally lack expertise in these areas. the practice of using agency services is not common in small organizations. the benefits of certain forms of market communication which are suitable solutions for small businesses are not used sufficiently. it primarily refers to the organization of business events and the use of the internet and social networks for promotional purposes. advertising, as the dominant form of promotional activity, is mainly limited to printing and distribution of promotional material. taking into account characteristics of small business, as well as the role of market communication in modern business conditions, a conclusion can be drawn that small businesses, with the use of modern information technology, can eliminate many weaknesses identified in the marketing domain. the internet and other interactive tools can play a key role in promoting these businesses and making communication with the market more effective and efficient. references alpkan l, yilmaz, c., kaya, n (2007). marketing orientation and planning flexibility in smes. international small business journal 25(2), pp. 152–172. butigan, r., mahnić, i. 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(2014). uloga marketinga u restrukturiranju preduzeća u uslovima krize, marketing, 45(1), pp. 41-49 statistical office of the republic of serbia (2018). usage of information and communication technologies in republic of serbia, available at: http://publikacije.stat.gov.rs/g2018/pdf/g201816013.pdf, accessed 1st september 2019. smart plus research, available at: https://www.smart-plus.rs, accessed 10th september 2019. article history: received: october 9, 2019 accepted: november 3, 2018 ea_2012_1_2 original scientific paper foreign direct investment and political risk in pacific rim behname mehdi*, department of economics of ferdowsi university of mashhad (fum), mashhad, iran udc: 339.727.22 jel: f21; f23; c31; c33 abstract – the main purpose of this article is to study the effect of political risk on foreign direct investment in the pacific rim. the considered time period is from 1984 to 2008. in this study, 12 indexes of political risk offered by political risk services group have been used. after studying the stationarity of variables by im-pesaran shin test, the benchmark model is estimated for 12 political risks and we come to the conclusion that the risks of corruption, external conflict, internal conflict, investment profile, and military in politics have significant effect on fdi. key words: pacific rim, foreign direct investment, political risk introduction nowadays, besides the phenomenon of globalization, foreign investment attraction has become one of the main concerns of developed and developing countries. fate of national economies is increasingly getting connected with economies of other nations. the phenomenon of globalization has been the main cause of this fact and nowadays, the condition is so that the politicians have the less control over this matter (lizentiatsarbeit). foreign investment not only increases national product and employment, it also affects gnp (gross national product) indirectly by overflow of knowledge and technology. it is why the developing countries are trying like the developed countries to attract such capitals in the recent years. dani rodrik (1997) considers it impossible to study the miraculous development of the east asia without taking into account their governments' policies in private investment. he proves that there is a strong correlation between good institutions and economic growth in eastern asia. it is worth mentioning that before 1980's, developing countries have not had a positive attitude towards foreign investment, but during the past thirty years, foreign investment have been increased significantly among the developing countries. many factors are involved in foreign investment attraction. from among these factors are gdp, technology gap, wage level, agglomeration of other firms, economic infrastructures, tax, subside, unemployment rate, economic stability, political risk, etc.. determinants of foreign investment for fdi attraction have been studied enough in different studies. in 1990's, studies on effect of risk variables on fdi included cross-country studies (brunetti and * e-mail: mehdi_behname@yahoo.com behname, m., fdi and pilitical risk, ea (2012, vol. 45, no, 1-2, 74-80) 75 weder, 1998). but in the recent year, studies on fdi determinants have focused mostly on political issues. political risk is such a risk in which a host government suddenly changes the rules of the game (butler and joaquin, 1998). existence of disorders and irregularities in a society makes the political leaders of the society think about controlling these tensions; therefore, they are sometimes forced to change laws and regulations which itself leads to unreliability on future and the investors can not forecast well the future conditions. factors such as legitimacy, difference in cultural and governmental rules and custom, fund remittance control, etc. are among the factors which increase political risk. studies indicate that in countries with weak economic systems, poor enforcement mechanisms, ambiguous rules and regulations, corruption is observed more (treisman, 2000). political risk makes a distance between activity and aim. since the aim of foreign firms is to achieve maximum profit, there is no guarantee in unreliable conditions that their activity leads them towards their goal. although all investors are encountered with non-financial risks in their foreign investments, direction and value of investment shows high response to the investor's aim and political risk. political risk is in relation with international trade and foreign investment. to simmonds and robock (1971), political risk is effective on national and international investment only when discontinuity occur in the trade environment and this discontinuity is not predictable and follows political changes. although most of economists agree that political factors are effective on the level and value of fdi, they are less sue about the relationship between the nature of fdi and political risk and some of them are not even sure enough about direction. therefore, this article tries to study the relationship between foreign investments and political risk in the pacific rim. methodology heterogeneous unit root test to conduct co-integration test for the panel data like time series data it is necessary to perform stationarity test. of course, it should be taken into consideration that panel unit root test has higher power than time series unit root test. in order to consider unit root in panel data, the following autoregressive model can be used: yit = ρ i yit-1 + δi xit + ε it where i = 1, 2, …, n indicates the countries and t = 1, 2, …, t stands for time. xit indicate the exogenous variables, ρ i indicates autoregressive coefficient, and ε i is the error term. if ││pi ≤ 1, ∀ i, the considered series is stationary , and if ││pi = 1, yi has unit root. llc, brt and hardi unit root tests suppose that ρ i = ρ , ∀ i. in this scenario, yit-1 coefficient is used for all homogeneous cross -section. but ips and fisher tests are conducted with supposition of heterogeneous coefficient meaning ρ i (costantini, martini, 2010). economic analysis (2012, vol. 45, no. 1-2, 74-80) 76 since the economic structures of the greater middle east countries are independent from each other, we use ips test. im, pesaran test for every sample of crosssection data is as follow: it p j jitijitiiit i yyy ερβα +∆++=∆ ∑ = −− 1 1 wher ρ i is the number of lags in adf regression. the zeo and alternative hypotheses are as follow: data and variables the analysis we have made to study the effect of political risk on foreign direct investment is limited to 17* countries member of the pacific rim in the time period 19842008. the data related to political risk has been collected from the international country risk guide, heritage and other data has been gathered from imf, undata, unctad, and the world bank. from 1984 on, the political risk services group presented 12 indexes for political risk: these indexes have been degreed from 0 to 12, and higher values shows less risks (busse and hefeker 2007). • government stability, called govst in the empirical analysis, measures the government's ability to carry out its policies and to stay in office • socio quantifies socio-economic pressures at work in society that might restrain government action or elevate social dissatisfaction and thus destabilise the political regime • invest assesses the investment profile, that is, factors related to the risk of investment that are not covered by other (financial and economic) risk components, such as contract viability (expropriation), profits repatriation or payment delays • iconfl stands for internal conflict, measuring political violence within the country and its actual or potential impact on governance by focusing on, for instance, civil war, terrorism, political violence or civil disorder • econfl weighs external conflict, namely the risk to the incumbent government from foreign action, ranging from non-violent external pressure, such as diplomatic pressures, withholding aid or trade sanctions, to violent external pressures, ranging from cross-border conflicts to allout war • corr assesses the level of corruption    = ∀= ioneleastatfor sisomefor h h i i ii 0 '0 : ,0: 1 0 pβ β β behname, m., fdi and pilitical risk, ea (2012, vol. 45, no, 1-2, 74-80) 77 • milit represents the influence of the military in politics, which could signal that the government is unable to function effectively and that, therefore, the country might have an unfavourable environment for business • relig measures religious tensions, stemming from the domination of society and/or governance by a single religious group seeking, for instance, to replace civil by religious law or to exclude other religions from the political and social process • law quantifies law and order, that is, the strength and impartiality of the legal system • ethnic assesses the degree of tensions among ethnic groups attributable to racial, nationality or language divisions • democ relates to the democratic accountability of the government, that is, the responsiveness of the government to its citizens, but also to fundamental civil liberties and political rights • bur stands for the institutional strength and quality of the bureaucracy, which might act as a shock absorber tending to reduce policy revisions if governments change. indexes themselves are correlated but each of them alone has a direct relationship with fdi. fdi inflow has been considered as the dependant variable. gdp per capita and population have been used for market measurement. the larger is the market's size, the easier the foreign firm sells its products. from among other variables we can mention trade openness, openness = x+m/gdp, infrastructure (number of telephone lines), inflation and tax. inflation and tax are expected to have negative effect on fdi and infrastructure to have positive effect. but effect of openness can be negative or positive. to study the effect of political risk on fdi, the following model is used: itititititititit taxinfrpolinfopepopfdi εβββββββ +++++++= lnlnlnlnlnln 7654321 where ln gdp is the logarithm of gross domestic product, ln pop is the logarithm of population, ln ope is the logarithm of trade openness, ln inf is the logarithm of gdp deflator, and ln tax is logarithm of tax. since the hausman test statistic is x2 = 26.3 (p = 0.00), we apply fixed –effects model instead of random-effects. before estimating the model, we study the variables' stationarity by im-pesaran-shin test to avoid spurious regression. table 1. unit root test of panel data (1984-2008) gdp fdi pop inf infr tax ope 2.13* -7.14* -5.10* -4.71* -3.12* 5.12* 6.02* the variables are stationary at the 5% confidence level economic analysis (2012, vol. 45, no. 1-2, 74-80) 78 results indicate that the variables are stationary at the 5% confidence level. in the benchmark equation, pol variable indicates the 12 political risk indexes. in table 2, 12 indexes of political risk have entered the equation one by one to control regression. in column 1, the equation has been estimated without political risk. in this model, variables which have effect on fdi are gdp, pop, infrastructure and tax. we have entered each of the 12 risks in the next columns. in column 2, government stability risk which has no effect on fid has been entered; but in this model, openness has become significant. in column 3, risk of social-economic conditions has been entered which again has no effect on fdi, and tax is also ineffective on fdi. table 2. panel analysis, country fixed-effects, 1984-2008 dependent variable: lnfdi govst soci inve icon econ corr mil reli law eth dem bur indep (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) variables lngnp 2.01* 3.2* 1.32** 2.21* 2.55* 2.31* 1.18* 2.21* 1.2* 2.12* 2.51* 2.73 2.17* (3.1) (4.2) (2.25) (3.13) (5.15) (4.12) (3.17) (4.1) (3.33) (4.11) (3.17) (2.59) (4.11) lnpop 1.12* 1.08* 1.3 0.8 0.93** 0.85* 1.1** 0.93** 0.94** 0.99** 1.02** 1.01** 0.93* (2.81 (2.1) (2.25) (0.91) (1.89) (2.51) (2.27) (2.1) (2.1) (2.22) (2.01) (1.89) (3.1) lnope 0.15 0.17* 0.27 0.31** 0.35 0.27 0.31 0.41* 0.35 0.42 0.39 0.21 0.22 (1.22) (3.1) (2.22 (1.99) (0.95) (1.1) (1.31) (2.1) (0.91) (1.12) (1.1) (0.73) (1.1) lninf -0.12 -0.08 -0.13** -0.09* -0.14 -0.12** -0.15* -0.13** -0.10** -0.12** -0.14 -0.16* -1.1 (-1.2) (-1.1) (-2.1) (-2.51) (-1.31) (-2.22) (-2.91) (-1.93) (-2.1) (-2.2) (-1.4) (-2.1) (-1.1) lninfr 0.03** 0.09** 0.04* 0.09 0.08** 0.1 0.07 0.11** 0.06** 0.07** 0.05 0.09 0.07** (1.19) (2.1) (2.56) (1.21) (2.2) (1.31 (1.22) (1.98) (2.1) (1.81) (1.31) (1.1) (1.99) lntax -0.18** -0.17 -0.18 -0.16 -0.09* -0.15 -0.18 -0.19 -0.1 -0.09** -1.1 -0.9 -0.1 (-1.99) (-1.21) (-1.01) (-1.51) (-1.89) (-1.31) (-1.21) (-1.2) (-1.25) (-2.1) (-0.9) (-0.8) (-0.9) pol 0.13 0.02 0.17** 0.08** 0.15** 0.07** 0.05** 0.09 0.15 0.09 0.04 0.14 (1.3) (1.21) (1.99 (2.1 (2.11) (1.89) (2.1) (1.12) (0.9) (0.95) (1.13) (1.34) notes: t-values reported in parentheses; * significant at 1% level; ** significant at 5% level;*** significant at 10% level in the next columns, investment profile, internal conflict, external conflict, corruption, and military in politics are the risks which have effect on fdi; it means that by increase of such risks, the tendency towards foreign investment would be decreased. from among the model variables, gdp and pop have the maximum effect on fdi since the investors become sure that they can sell out their product if these two variables are increased. the results show that gdp has effect on fdi, behname (2008, 2011a, 2011b) shows the same results. behname, m., fdi and pilitical risk, ea (2012, vol. 45, no, 1-2, 74-80) 79 conclusion this article aims at studying the effect of political risk on fdi attraction. after conducting unit root test of im-pesaran and shin, we came to the conclusion that all the variables were stationary and spurious regression was avoided. afterwards, 12 indexes of political risk were regressed in the base equation and we concluded that the risks of investment profile, internal conflict, external conflict, corruption, and military in politics have effect on fdi and their increase leads to decrease of tendency towards investment. on one hand, variables such as gdp, pop and infrastructure lead to fdi attraction. according to the above-mentioned results, countries member of pacific rim have to take necessary decisions to decrease political risks. these countries should control their internal and external conflicts and involvements and corruption in order to be able to increase the value of foreign investments in their countries. on the other hand, by increasing tax, these countries may increase their government's income without decreasing the value of fdi very much. another recommendation to these countries is that they should control economic risk or inflation. such countries can control inflation and facilitate inflow of capital to their country by adopting appropriate monetary and financial policies. *the pacific rim countries in this research are: australia, brunei, cambodia, canada, chile, china, colombia, ecuador, el salvador, japan, mexico, new zealand, russia, taiwan, thailand, united states references behname, mehdi. 2008. les stratégies de la localisation d'entreprise et la réactualisation de la politique industrielle: étude appliquée a la france, thèse de doctorant a l'université de la sorbonne nouvelle. behname. 2011a. „studying the effect of foreign direct investment on economic growth in greater and traditional middle east countries”. journal of economic analysis, 45(3-4): 35-43. behname. 2011b. “determinants of foreign direct investment in iran”, management and economics conference, iran, miane. brunetti, a. and b. weder. 1998. “investment and institutional uncertainty: a comparative study of different uncertainty measures.” weltwirtschaftliches archiv 134, 513–533. busse, matthias and carsten hefeker. 2007. “political risk, institutions and foreign direct investment.” european journal of political economy, 23: 397–415. butler, k., and d. joaquin. 1998. “a note on political risk and the required return on foreign direct investment.” journal of international business studies, 29: 599–608. costantini, valeria & chiara martini. 2010. "the causality between energy consumption and economic growth: a multi-sectoral analysis using non-stationary cointegrated panel data." energy economics, elsevier, 32(3): 591-603. hausmann, r., and e. ferna´ndez-arias. 2000. “foreign direct investment: good cholesterol?”. working paper 417. imf. 2012, http://www.imf.org/external/data.htm. robock, s. h. 1971. “political risk: identification and assessment”. columbia journal of world business, 6:4(6-20). economic analysis (2012, vol. 45, no. 1-2, 74-80) 80 rodrik, dani. 1997. has globalization gone too far?. washington, dc: institute for international economics. the world bank group. 2012. http://www.worldbank.org/. treisman, d. 2000. “the causes of corruption: a cross-national study”. journal of public economics, 76(3): 399-457. unctad. 2012. http://archive.unctad.org/templates/page.asp?intitemid=3594&lang=1. strane direktne investicije i politički rizik u pacifičkom obruču rezime – glavni cilj rada je analiza efekta političkog rizika na strane direktne investicije u pacifičkom obruču. analiza obuhvata period od 1984 do 2008. godine. u istraživanju korišćeno je 12 indeksa political risk services group-e. nakon proučavanja stacionarnosti varijabli pomoću impesaran shin testa, izabrani model 12 političkih rizika je pokazao da rizici poput korupcije, unutrašnjih i spoljnih sukoba, investicionog profila i vojske u politici imaju značajan uticaj na strane direktne investicije. ključne reči: pacifički obruč, strane direktne investicije, politički rizik article history: received: 7 march 2012 accepted: 21 july 2012 doi: 10.28934/ea.22.55.1.pp90-104 original scientific paper forecast of belex15 and belexline movement using arima model aleksandra živković121f* 1 university of novi sad, faculty of economics, department for finance and banking, subotica, republic of serbia abstract financial markets are known to be volatile and often unpredictable. movement of stock indices and stock prices over time can be labelled with big oscillations during time, so financial institutions and other investors are constantly working on forecasting these movements, in order to adjust their business decisions and increase their profit. aim of this research is to determine whether the arima model, which is often used for short-term forecast, is suitable for forecasting of movement of belgrade stock exchange indices. subject of this research is forecast of belex15 and belexline indices based on historical daily data from 5th january 2009 until 31st march 2022. arima model was used to forecast index values for the following 11 trading days from 1st april until 15th april 2022. methodology of this research consists of presenting and analysing empirical data of belex15 and belexline movements, choosing suitable arima models for forecast and forecasting index values, which were then compared with real index values. obtained results point to high accuracy of forecasted values and lead to the conclusion that arima model is corresponding econometric method for short-term forecast of belgrade stock exchange indices. key words: belex15, belexline, belgrade stock exchange, forecast, arima jel classification: g17 introduction financial markets are known for great uncertainty and volatility of stock indices and stock prices. financial institutions and other participants in financial markets, which act as investors, are constantly trying to predict movements on financial markets, as well as values of stock indices and stock prices, in order to adapt their decisions which would lead to profit. even though it is difficult to predict movement on financial markets because of their volatility, certain econometrics methods are used for forecasting, among which the arima model stands out for short-term forecasts. so far, the arima model was often used for forecasting in economics practice, but also for testing accuracy of this model when forecasting certain stock indices and stock prices movements. however, this type of empirical research has not been empirically researched in detail in serbia and on belgrade stock exchange indices (bse). subject of this research are stock indices of belgrade stock exchange – belex15 and belexline, which are analysed from 5th january 2009 until 31st march 2022 (in total number of observations is 3,336 trading days per index). empirical data has been taken from belgrade stock exchange. aim of this research is to determine whether arima model is suitable for short-term forecasting of movement of stock indices belex15 and belexline. arima model was used to * phd student, e-mail: zivkovicc.aleksandra@gmail.com aleksandra živković 91 forecast values of belex15 and belexline for 11 trading days – from 1st april 2022 until 15th april 2022. after these values have been forecasted, they were compared with real values to determine if it is possible to make an accurate forecast of belex15 and belexline using the arima model, which is based on historical data. methodology of this research contains of presenting empirical data of belex15 and belexline, basic descriptive statistics, checking of stationarity, choosing potential arima models and selecting the corresponding one, based on which forecast of indices values has been conducted and forecasted values were compared to real values. in this paper two hypotheses are defined: hypothesis h1: arima model is suitable for accurate forecast of movement of stock index belex15 in period 1st april 2022 15th april 2022. hypothesis h2: arima model is suitable for accurate forecast of movement of stock index belexline in period 1st april 2022 15th april 2022. this paper is divided into 6 parts: the first part is introduction, where subject, methodology and aim of this research are expressed and hypotheses are defined. the second part is literature review, which contains so far empirical research which has used the arima model to forecast stock prices and indices movements, in both serbian capital market and foreign markets. third part is the methodology of this research, which presents the theoretical background of the arima model, which was used as guideline for the arima model analysis and forecast. in the fourth part is presented empirical data of belex15 and belexline values, which is followed by selection of corresponding arima models for both indices, as well as forecast of belex15 and belexline indices respectively. in the fifth part of this paper are presented results of forecasts which are then compared to real values, in order to determine if it is accurate to use the arima model for precise forecast of movement of analysed indices. conclusion is the last part of this paper, where findings are expressed and recommendation for future research is given. literature review financial institutions and individuals participating in financial markets are encouraged to continuously work on and promote econometrics methods for forecasting, due to their need to make decisions about investing, as well as to plan daily and future steps on financial markets. due to the nature of financial markets, forecasting stock indices movement or stock prices is a difficult task. among techniques that stand out for forecasting is the arima model (autoregressive integrated moving average), which is known for its efficient forecast of financial time series, especially for short-term forecasts. in 1970 box and jenkins introduced the arima model, which consists of 3 steps – identification, estimation and diagnosis of the arima model (adebiyi, adewumi & ayo, 2014). among so far research, which aimed to forecast values of stock indices or stock prices movements, arima model was often used, especially for short-term forecasts. mondal, shit & goswami (2014) analysed the efficiency of the arima model to predict movement of values of 56 companies from 7 sectors from national stock exchange india (nse india). used historical data was from april 2012 until february 2014 and obtained results point to over 85% of correctly predicted values for all sectors. khan & alghulaiakh (2020) used the arima model to predict stock values of netflix, using empirical data for 5 years (from 7th april 2015 until 7th april 2020). rotela, salomon & de oliveira pamplona (2014) confirmed the efficiency of arima model for short-term forecast of bovespa stock index (index of sao paulo stock exchange), by using monthly historical data of closing price from january 2000 until december 2012. wadi, almasarweh & alsaraireh (2018) conducted a short-term forecast of closing prices of index amman stock exchange (ase) using daily historical data from january 2010 until january 2018 and they empirically confirmed efficiency of arima model for short-term forecast. li, yang & li (2017) used shanghai composite index monthly closing price from january 2005 until october 2016 to 92 economic analysis (2022, vol. 55, no. 1, 90-104) forecast the index movement for the period july 2016 until october 2016. average error of predicted values is 2,4% which confirmed efficiency of arima model for short-term forecast. meher, hawaldar, spulbar & birau (2021) used arima model to predict stock prices of selected pharmaceutical companies in india (quoted on nifty100). analysis contained historical data from 1st january 2017 until 31st december 2019 and it has confirmed that there are no significant deviations between predicted and real values. arima model has been used to predict future values of stock indices in our region and domestic indices as well. among authors which have researched forecast of index values of belgrade stock exchange, stanković, marković & radović (2015) stand out, which have conducted a research in order to determine precision of forecast of belex15 index values and its most important components (at the time of writing their paper, the most important components were: “alfa plam” a.d. vranje, “energoprojekt holding” a.d. beograd, “metalac” a.d. gornji milanovac, “sojaprotein” a.d. bečej, aik banka a.d. niš, komercijalna banka a.d. beograd). method used for the forecast was the least square support vector machine – ls-svms). obtained results point to higher precision in the forecast of values of belex15 index components than the forecast of the index itself. marković et al. (2014) have confirmed accuracy of belex15 index prediction using method ls-svm – subject of the analysis has been data of belex15 movement from 4th april 2005 until 30th march 2013. petrović (2020) used arima model to predict belex15 values for coming 10 trading days and it has been empirically confirmed that arima model was corresponding model for short-term forecast of index values. used historical data contained from index opening price from 10th january 2014 until 21st december 2018. jakšić, milanović & stojković (2020) conducted a shortterm forecast of belex15 and belexline movement (used methods were winter’s additive and winter’s multiplicative method). analysis was based on monthly data from january 2009 until february 2019. methodology in the arima model, future values of variables are predicted based on the linear combination of historical values and residuals (pai & lin, 2005). arima model is defined as arima (p,d,q), where p represents autoregressive parameter of analysed data set (number of lags of ar model), d refers to integrated parts of data set, and q represents number of moving averages (number of lags of ma model) (mondal, shit & goswami, 2014). arima model is an upgrade of arma model (autoregressive moving average), which expresses the conditional mean of yt as a function of previous values yt-1, yt-2...yt-p and previous residuals εt-1, εt-2...εt-p. number of previous values (observations) on which yt depends (p) is ar degree, whereas number of previous residuals (q) is ma degree. to determine the range of ar and ma degree, significant deviations are examined and compared on the correlogram acf and pacf (meher, hawaldar, spulbar & birau, 2021). arma (p, q) model can be presented as: 𝑌𝑌𝑡𝑡 = ∅1𝑌𝑌𝑡𝑡−1 +… + ∅𝑝𝑝𝑌𝑌𝑡𝑡−𝑝𝑝 + 𝜀𝜀𝑡𝑡 − 𝜃𝜃1𝜖𝜖𝑡𝑡−1 − ⋯ − 𝜃𝜃𝑞𝑞𝜖𝜖𝑡𝑡−𝑞𝑞 (1) where yt is observed variable, εt is random error in time t, ∅i i 𝜃𝜃i are ar and ma coefficients, p and q are number of lags in ar and ma model. arima model has an additional letter “i” in acronym of this model, which represents integrated. arma (p,q) model which is differentiated d times is arima (p, d, q) model (mustapa, hayati & mohd, 2019). to determine an appropriate model for forecasting, the first step is to define the degree of differentiation d, which is required in order to make the data stationary. method which is frequently used for this is augmented dickey-fuller test (adf test). after parameter d is defined, parameters p (autoregressive parameters defined by partial autocorrelation function (pacf)) aleksandra živković 93 and q (moving-average parameters defined by autocorrelation function (acf)) need to be determined (jarrett & kyper, 2011). acf provides information about the potential number of lags of ma model, whereas pacf provides information about the potential number of lags of ar model (prorok & paunović, 2015). in order to begin with defining the arima model, it is necessary to define is analysed data stationary – a graphic overview of the variable movement can point to this conclusion. stationary data implies that mean and variance are constant over time. beside from the graphic overview, autocorrelation function, acf plot and augmented dickey-fuller test are used to check stationarity. acf plots autocorrelation of time series among lags, which point to differences between one observation and observation which precedes. if data is not stationary, it should be differentiated and in most of the cases it is enough to differentiate the data set only once (d=1) (mustapa, hayati & mohd, 2019). belex15 and belexline – empirical data and forecast of index values by using arima model serbian stock market is considered to be new and not very developed. period after 2000 was defined with numerous privatizations of public companies, and this has led to stimulation of trading on the secondary market. until the financial crisis in 2008, the number of listed companies on market and trading volume was increasing, but after the financial crisis outburst, market liquidity has significantly decreased (petronijević, 2018). capital market in serbia is still underdeveloped, with small trading volume and turnover. it is not fully regulated and transparent and the number of domestic and foreign investors is low (kršikapa-rašajski & rankov, 2016). small number of securities and government bonds are traded, transactions are expensive and slow, market capitalization is low – these are all labels of serbian stock market today (prorok & radović, 2014). belgrade stock exchange indices belex15 and belexline are subject of this research. belex15 is a leading index of bse, which contains the most liquid serbian shares and it is calculated in real time. belexline is a general, benchmark index, which is calculated at the end of a trading day. both indices are free-float market capitalization weighted indices, which are not adjusted for paid dividends and are not protected from dilution effect resulting from dividends payout. belex15 is composed of shares traded on the regulated market, which have satisfied criteria for inclusion into the index basket. each component is limited to a maximum of 20% of the total market capitalization of the index. purpose of the belex15 index is to improve the investment process, by measuring performance and stock prices of most liquid serbian shares. it is calculated and published every working day in real time. minimum number of index components is 7, whereas maximum is 15 and this decision is made by the index committee. belexline is weighted only by free-float market capitalization. it consists of shares traded on the belex markets, which have satisfied criteria for inclusion in the index basket. components limitation is up to 10% of index capitalization. its purpose is to measure and keep track of price changes of shares which are traded on the bse (which had fulfilled criteria for index basket) and to give insight into serbian market movements. the index committee decides on composition of the index basket, which can have minimum 70 components and upper limit is not defined, since the purpose is to give good representation of total market movements (source: belgrade stock exchange; https://www.belex.rs/proizvodi_i_usluge/indeksi_opste). values of belex15 and belexline have been taken from belgrade stock exchange and they are analysed on a daily basis from 5th january 2009 until 31st march 2022. total number of observations is 3,336 for each index. in figure 1 are presented movements of belex15 and belexline during the analysed period. https://www.belex.rs/proizvodi_i_usluge/indeksi_opste 94 economic analysis (2022, vol. 55, no. 1, 90-104) figure 1. movement of belex15 (left figure) and belexline (right figure) from 5th january 2009 until 31st march 2022 source: belgrade stock exchange graphic overviews point to high volatility of both indices, but also to uniform trend of movement: significant decrease of values of both indices at the beginning of 2009 after the financial crisis outbreak, which was followed by increase of index values until the end of the same year. until 2011 both indices were fluctuating within certain frameworks (for belex15 value was fluctuating between 600 and 800 stock exchange points, whereas for belexline it was fluctuating between 1,200 and 1,600 points). until the beginning of 2013, values of both indices were significantly decreasing, after which stable growth followed, until the coronavirus pandemic outbreak, when at the beginning of 2020 values of both indices suddenly decreased. after the financial market stabilized, not only in serbia, but in the whole world, values of stock indices started increasing again. in table 1 are presented basic descriptive statistics for indices belex15 and belexline. this table presents data about the mean, standard deviation, minimum and maximum for both indices. total number of observations is 3,336 for both indices, which points to balanced data. table 1. basic descriptive statistics variable obs mean std. dev. min max belex15 3,336 659.125 103.340 354.39 865.06 belexline 3,336 1,359.479 239.507 841.99 1,789.15 source: author’s calculation first bse index for which forecast has been performed is belex15 index. precondition for using arima model for forecasting is stationarity of analysed data. if data is not stationary, it must be differentiated and afterwards checked does differentiated data satisfy the criteria of stationarity. graphic overview of index belex15 historical movement (figure 1 – left figure) points to non-stationary data because of significant oscillations. in figure 2 is presented differentiated data for belex15 which is stationary. aleksandra živković 95 figure 2. differentiated belex15 data source: author’s calculation stationarity of differentiated data can be confirmed with dickey-fuller test and these results are presented in table 2. table 2. dickey-fuller test – differentiated data of belex15 dickey-fuller test for unit root number of obs = 3,334 z (t) has t-distribution test statistic 1% critical value 5% critical value 10% critical value z (t) -48. 847 -2.327 -1.645 -1.282 p-value for z(t) = 0.0000 d2.belex15 coef. std. err. t p>|t| [95% conf. interval] belex15 ld. -.834389 .0170816 -48.85 0.000 -.8678806 -.8008975 _cons .0756504 .1012637 0.75 0.455 -.1228949 .2741957 source: author’s calculation in order to determine potential arima models, it is necessary to define values of p,d,q. value of d is 1, since data is differentiated only once, while for defining values of p and q partial autocorrelation function (pac) and autocorrelation function (ac) have been performed respectively. in figure 3 are presented models for autocorrelation and partial autocorrelation for differentiated data in order to define potential p and q values for the arima model. 96 economic analysis (2022, vol. 55, no. 1, 90-104) figure 3. autocorrelation (left figure) and partial autocorrelation (right figure) of differentiated data for belex15 source: author’s calculation by using the autocorrelation function, in the graph overview the following lags stand out: p=1,2,4,8, whereas for partial autocorrelation these lags are q=1,2,4,8. by combining potential values of p and q, following arima models have been tested to determine the most appropriate one: (1,1,1), (1,1,2), (1,1,4), (1,1,8), (2,1,1), (2,1,2), (2,1,4), (2,1,8), (4,1,1), (4,1,2), (4,1,4), (4,1,8), (8,1,1), (8,1,2), (8,1,4), (8,1,8). in table 3 is presented data about the number of p-values which are statistically significant (p<0.05), sigma sq value, log likelihood, aic and bic. model arima (8,1,8) is not presented, since statistical processing indicates that results of this model cannot be defined. table 3. analysed arima models for belex15 arima model p-value sigma loglikelihood aic bic arima (1,1,1) 1/2 5.846 -10,621.56 21,249.12 21,267.45 arima (1,1,2) 3/3 5.836 -10,616.11 21,238.22 21,256.55 arima (1,1,4) 2/5 5.839 -10,618.13 21,246.26 21,276.82 arima (1,1,8) 1/9 5.814 -10,603.40 21,226.79 21,287.91 arima (2,1,1) 2/3 5.840 -10,618.17 21,244.34 21,268.79 arima (2,1,2) 2/4 5.835 -10,615.21 21,240.42 21,270.98 arima (2,1,4) 1/6 5.818 -10,605.64 21,223.29 21,259.96 arima (2,1,8) 2/10 5.790 -10,589.65 21,201.30 21,268.53 arima (4,1,1) 3/5 5.818 -10,605.63 21,223.27 21,259.94 arima (4,1,2) 2/6 5.818 -10,605.62 21,223.25 21,259.92 arima (4,1,4) 8/8 5.811 -10,601.58 21,219.15 21,268.05 arima (4,1,8) 3/12 3.773 -10,597.31 21,218.63 21,291.97 arima (8,1,1) 4/9 5.797 -10,593.70 21,207.40 21,268.52 arima (8,1,2) 3/10 5.797 -10,593.46 21,206.91 21,268.03 arima (8,1,4) 5/12 5.785 -10,586.68 21,199.37 21,278.82 source: author’s calculation following criteria has been used to define the most appropriate arima model: 1. significance of arma parameters – choosing the model which has the most parameters that are statistically significant (p<0.05) 2. sigma sq – measure of volatility, choosing the model that has the lowest indicator 3. log likelihood – choosing the model which has the highest indicator aleksandra živković 97 4. aic – choosing the model with lowest indicator 5. bic – choosing the model with lowest indicator regarding the first criteria (significance of arma parameters) – models arima (1,1,2) and arima (4,1,4) are most appropriate, since for both models all arma parameters are statistically significant: 3/3 and 8/8 respectively. sigma sq is lowest within arima (4,1,8), loglikelihood is highest within arima (8,1,4), aic is lowest within arima (8,1,4) and bic is lowest within arima (1,1,2). this leads to the conclusion that both arima (1,1,2) and arima (8,1,4) have 2/5 fulfilled criteria. neither of these two models is unequivocally chosen, since only 2/5 criteria are met, but since model arima (8,1,4) has only 5/12 parameters which are statistically significant, chosen arima model for forecast is arima (1,1,2). in table 4 are presented its results, whereas in table 5 are presented results of aic and bic tests. table 4. arima (1,1,2) – corresponding model for belex15 sample: 09jan2009-31mar2022 number of obs = 3,334 wald chi2 (3) = 56,916.60 log likelihood = -10,616.11 prob > chi2 = 0.000 d2.belex15 coef. opg std. err. z p > |z| [95% conf. interval] arma .595 .038 15.54 0.000 .520 .671 ar l1. ma -1.452 .047 -31.07 0.000 -1.544 -1.361 l1. l2. .452 .045 10.02 0.000 .364 .541 /sigma 5.836 source: author’s calculation table 5. akaike & bayesian information criteria (aic & bic) for arima (1,1,2) – belex15 model obs 11(null) 11 (model) df aic bic 3,334 -10,616.11 3 21,238.22 21,256.55 source: author’s calculation after the appropriate arima model has been chosen, a forecast of movement of belex15 has been conducted for the coming 11 trading days (until 15th april 2022.). in table 6 are presented results of forecast from 1st april 2022 until 15th april 2022, as well as the real index value during this period (data of real values of belex15 has been taken from belgrade stock exchange). table 6. forecasted and real values of belex15 date forecasted value real value 01.04.2022. 844.468 836.00 04.04.2022. 844.878 835.78 05.04.2022. 845.159 834.80 06.04.2022. 845.361 837.87 07.04.2022. 845.518 843.55 08.04.2022. 845.647 847.95 11.04.2022. 845.759 851.15 12.04.2022. 845.862 857.23 13.04.2022. 845.959 854.22 14.04.2022. 846.052 853.27 15.04.2022. 846.144 855.73 source: author’s calculation 98 economic analysis (2022, vol. 55, no. 1, 90-104) real value of belex15 index has been lower compared to forecasted values until 7th of april, as from when the real value started to grow faster compared to forecasted value. the biggest absolute deviation between forecasted and real value has been on 12th of april and this deviation was 1.33%. as for the belex15 forecast, the same steps were taken for the belexline index, and results are presented below. same as for historical data of belex15, which is not stationary, values of belexline had similar movement, so belexline data is not stationary either. differentiation has been performed and differentiated data is presented in figure 4 – it meets the condition of stationarity. figure 4. differentiated belexline data source: author’s calculation table 7 presents results of dickey-fuller test, which confirms stationarity of differentiated data for belexline. table 7. dickey-fuller test – differentiated data for belexline dickey-fuller test for unit root number of obs = 3,334 z (t) has t-distribution test statistic 1% critical value 5% critical value 10% critical value z (t) -46.900 -2.327 -1.645 -1.282 p-value for z(t) = 0.000 d2.belexline coef. std. err. t p>|t| [95% conf. interval] belexline ld. -.795 .017 -46.90 0.000 -.829 -.762 _cons .133 .154 0.86 0.388 -.169 .435 source: author’s calculation in figure 5 are presented models for autocorrelation and partial autocorrelation for differentiated data of belexline. aleksandra živković 99 figure 5. autocorrelation (left figure) and partial autocorrelation (right figure) for differentiated data of belexline source: author’s calculation p-values for potential arima models are p=1,2,4,8 and q-values q=1,2,4,8,13. for belexline, following arima models have been analysed: (1,1,1), (1,1,2), (1,1,4), (1,1,8), (1,1,13), (2,1,1), (2,1,2), (2,1,4), (2,1,8), (2,1,13), (4,1,1), (4,1,2), (4,1,4), (4,1,8), (4,1,13), (8,1,1), (8,1,2), (8,1,4), (8,1,8), (8,1,13). in table 8 are presented results of all analysed arima models. model arima (2,1,2) is not presented, since results of this model couldn’t be defined by statistical processing. table 8. analysed arima models for belexline arima model p-value sigma loglikelihood aic bic arima (1,1,1) 2/2 8.883 -12,016.68 24,037.36 24,049.59 arima (1,1,2) 3/3 8.867 -12,010.30 24,026.60 24,044.94 arima (1,1,4) 4/5 8.870 -12,011.81 24,033.63 24,064.19 arima (1,1,8) 1/9 8.824 -11,994.06 24,008.12 24,069.24 arima (1,1,13) 1/14 8.795 -11,984.11 23,996.23 24,081.79 arima (2,1,1) 2/3 8.874 -12,013.03 24,034.05 24,058.50 arima (2,1,4) 5/6 8.829 -11,995.82 24,003.63 24,040.31 arima (2,1,8) 2/10 8.793 -11,982.50 23,987.00 24,054.23 arima (2,1,13) 1/14 8.787 -11,979.86 23,991.71 24,089.50 arima (4,1,1) 4/5 8.831 -11,996.62 24,003.24 24,033.80 arima (4,1,2) 3/6 8.830 -11,996.41 24,004.82 24,041.49 arima (4,1,4) 4/8 8.794 -11,982.51 23,979.02 24,021.81 arima (4,1,8) 4/12 8.788 -11,981.40 23,988.81 24,068.26 arima (4,1,13) 4/17 8.772 -11,974.77 23,985.54 24,095.56 arima (8,1,1) 5/9 8.800 -11,985.04 23,988.08 24,043.09 arima (8,1,2) 6/10 8.797 -11,983.82 23,987.63 24,048.75 arima (8,1,4) 5/12 8.787 -11,980.35 23,986.69 24,066.15 arima (8,1,8) 2/16 8.759 -11,969.49 23,972.98 24,076.89 arima (8,1,13) 4/21 8.737 -11,963.52 23,969.04 24,097.39 source: author’s calculation models arima (1,1,1) and arima (1,1,2) fulfil the criteria of significance of arma parameters, since all parameters are statistically significant – 2/2 and 3/3 respectively. sigma is lowest within arima (8,1,13), loglikelihood is highest within arima (8,1,13), aic is lowest within arima (8,1,13) and bic is lowest within arima (4,1,4). model arima (8,1,13) fulfills 3/5 criteria, but 100 economic analysis (2022, vol. 55, no. 1, 90-104) only 4/21 arma parameters are statistically significant which is a lack for this model. since the appropriate model is chosen by the majority of fulfilled criteria, arima (8,1,13) will be used to forecast belexline movement. results of this model are presented in table 9 and results of aic and bic tests are presented in table 10. table 9. arima (8,1,13) – corresponding model for belexline sample: 09jan2009-31mar2022 number of obs = 3,334 wald chi2 (20) = 585,157.78 log likelihood = -11,963.52 prob > chi2 = 0.000 d2.belexline coef. opg std. err. z p > |z| [95% conf. interval] arma -.242 .148 -1.64 0.101 -.531 .047 ar l1. l2. -.796 .163 -4.89 0.000 -1.115 -.476 l3. .850 .207 4.11 0.000 .445 1.256 l4. .230 .157 1.46 0.143 -.078 .538 l5. 1.077 .136 7.94 0.000 .811 1.343 l6. -.075 .179 -0.42 0.675 -.427 .276 l7. .071 .133 .54 0.592 -.189 .331 l8. -.573 .133 -4.30 0.000 -.845 -.312 ma -.567 l1. l2. .494 30.043 0.02 0.987 -58.388 59.376 l3. -1.577 154.913 -0.01 0.992 -305.200 302.046 l4. .426 58.020 0.01 0.994 -113.290 114.142 l5. -.902 44.175 -0.02 0.984 -87.484 85.680 l6. 1.024 63.969 0.02 0.987 -124.353 126.402 l7. -.137 7.966 -0.02 0.986 -15.750 15.477 l8. .784 101.609 0.01 0.994 -198.366 199.935 l9. -.500 64.981 -0.01 0.994 -127.860 126.861 l10. .086 .611 0.14 0.888 -1.111 1.283 l11. -.104 12.785 -0.01 0.993 -25.163 24.954 l12. .047 6.840 0.01 0.994 -13.358 13.453 l13. -.075 10.779 -0.01 0.994 -21.201 21.051 /sigma 8.737 629.689 0.01 0.494 0 1,242.905 source: author’s calculation table 10. akaike & bayesian information criteria (aic & bic) for arima (8,1,13) belexline model obs 11 (null) 11 (model) df aic bic 3,334 -11,963.52 21 23,969.04 24,097.39 source: author’s calculation in table 11 are presented results of forecast for the following 11 trading days, as well as real values of belexline. aleksandra živković 101 table 11. forecasted and real values of belexline index date forecasted value real value 01.04.2022. 1,743.467 1,732.07 04.04.2022. 1,745.202 1,734.43 05.04.2022. 1,745.102 1,730.73 06.04.2022. 1,745.760 1,735.43 07.04.2022. 1,747.383 1,740.18 08.04.2022. 1,749.036 1,745.12 11.04.2022. 1,749.572 1,750.03 12.04.2022. 1,750.431 1,756.38 13.04.2022. 1,751.277 1,749.34 14.04.2022. 1,752.575 1,746.44 15.04.2022. 1,754.675 1,748.98 source: author’s calculation forecasted values of belexline have been higher compared to real values of this index for a few points, with the exception of 11th, 12th and 13th of april, when real index values overcame forecasted values. the highest percentage difference has been noted on 5th of april and it was around 0.8%. discussion of results after appropriate arima models have been chosen for indices belex15 and belexline and their movement has been forecasted, in graphical overview are presented movements of real and forecasted values of these indices, in order to determine accuracy of arima model for short-term forecast. figure 6. movement of real and forecasted values of belex15 source: author’s calculation movement of belex15 is presented from the beginning of 2022 until 15th of april, which is the last day of the forecast (figure 6). forecasted values have more stable growth of index value, without significant oscillations, whereas in reality there have been some oscillations. even though there are some deviations between forecasted and real values, highest deviation was around 102 economic analysis (2022, vol. 55, no. 1, 90-104) 1.33%, which points to the conclusion that arima model is suitable for short-term forecast of belex15 index. in figure 7 are presented real and forecasted values of belexline. figure 7. movement of real and forecasted values of belexline source: author’s calculation as presented for belex15, forecasted values have a more stable ascending path compared to real index values. first half of the forecasted period had higher oscillations, which was followed by more accurate forecast during the second half of the analysed period. highest deviation was less than 1%, so the conclusion is that the arima model is suitable for forecasting the belexline index as well. even though there have been some differences with both indices, since they are not significant, the arima model is appropriate for short-term forecasts for both belgrade stock exchange indices. observed deviations are lower with belexline, so arima model is more suitable for forecasting of this index compared to belex15. the arima model has proven to be appropriate for short-term forecast in stock exchanges around the world, which leads to the conclusion that historical data can be used as a good starting point for a short-term forecast. obtained results in this research are in accordance with rotela, salomon & de oliveira pamplona (2014) who have confirmed accuracy of short-term forecast of bovespa stock index; wadi, almasarweh & alsaraireh (2018) came to the same conclusion for forecast of index amman stock exchange; li, yang & li (2017) have forecasted shanghai composite index movement by using arima model. when it comes to using arima model for short-term forecast of belgrade stock exchange indices, results by petrović (2020) are in accordance with this paper’s results and they confirm accuracy of arima model for short-term forecast of belex15. the disadvantage of both arima models chosen for forecast is that none of them have fulfilled all criteria for choosing the most appropriate arima model. when it comes to belex15, two models (arima (1,1,2) and arima (8,1,4)) have fulfilled 2/5 criteria, so a decision about using arima (1,1,2) has been made based on statistical significance of arma models. with the belexline index, arima (8,1,13) fulfilled 3/5 criteria, but the small number of arma parameters is statistically significant. aleksandra živković 103 conclusion in this paper a short-term forecast of stock indices belex15 and belexline has been conducted (from 1st until 15th of april 2022) by using arima model, in order to determine whether this model is suitable for forecast of movement of these indices. indices values have been forecasted for the following 11 trading days based on historical data from 5th january 2009 until 31st march 2022. arima (1,1,2) was a suitable model to forecast belex15 values. forecasted values of this index have more stable growth compared to real values, which recorded some oscillations. since there have not been significant differences between forecasted and real values of index belex15, conclusion is that arima model is suitable for short-term forecast and that hypothesis h1 cannot be rejected. arima (8,1,13) is the corresponding model for belexline index forecast and same as for forecasted values for belex15, forecasted values have more stable movement compared to real values of this index. oscillations between forecasted and real values of belexline are smaller compared to ones for belex15, which points to the conclusion that arima model is suitable for short-term forecast and that hypothesis h2 cannot be rejected. obtained results prove high potential of arima model for short-term forecast when it comes to belgrade stock exchange indices. executed analysis should be observed as a starting point for researching possibilities of forecasting domestic indices and expanded additionally with other econometric methods for forecasting, in order to conclude if it is possible to use other methods for financial forecast besides arima model. references adebiyi, ayodele ariyo, aderemi adewumi, and charles ayo. 2014. “stock price prediction using the arima model.” uksim-amss 16th international conference on computer modelling and simulation, 105-111. jakšić, milena, marina milanović, and dragan stojković. 2020. “short-term forecasting of belexline and belex15 movements.” facta universitatis, economics 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110-122. petrović, marijana. 2020. “estimating the movement of belex15 index values using the arima model.” journal of process management – new technologies, international, 8 (2): 1-11. prorok, vesna, and slađana paunović. 2015. “predviđanje kretanja tržišnog indeksa belexline na bazi arima modela.” synthesis 2015 – finance and banking, 432436. prorok, vesna, and dajana radović. 2014. “testiranje slabe hipoteze efikasnosti na tržištu kapitala srbije.” socioeconomica – the scientific journal for theory and practice of socioeconomic development, 3 (5): 51-64. rotela junior, paulo, fernando luiz riera salomon, and edson de oliveira pamplona. 2014. “arima: an applied time series forecasting model for the bovespa stock index.” applied mathematics, 5 (21): 3383-3391. stanković, jelena, ivana marković, and ognjen radović. 2015. “predviđanje trenda belex15 indeksa i njegovih konstituenata pomoću ls-svm metoda.” anali ekonomskog fakulteta u subotici, 52 (34/2015): 251-264. wadi al s., mohammad almasarweh, and ahmed atallah alsaraireh. 2018. “predicting closed price time series data using arima model.” modern applied science, 12 (11): 181-185. belgrade stock exchange. 2022. historical data of belex15 and belexline values. https://www.belex.rs/trgovanje/indeksi/svi/indeksi (accessed 03/04/2022) article history: received: may 20, 2022 revised: july 3, 2022 accepted: july 7, 2022 doi: 10.28934/ea.20.53.1.pp94-104 scientific review the necessity of using social networks in contemporary tourism industry and the tourist organization of serbia olja munitlak ivanović1* | lukrecija đeri1 | predrag stamenković2 | aleksandra ilić3 1 university of novi sad, faculty of sciences, department of geography, tourism and hotel management, novi sad, serbia 2 higher business school of vocational studies in leskovac, leskovac, serbia 3 national tourism organisation of serbia, beograd, serbia abstract the practice so far has shown that the tourist destination is managed through the public sector, private companies or according to the model of public-private partnership. modern business and everyday life is unthinkable without the use of social networks and e-marketing. there is an unbroken link between the products of the information sector, social networks and everyday business and private communications. tourism as a service activity is particularly dependent on social networks. potential buyers of tourism products with just “one click” can book, pay for the service, view the pictures and read comments about the desired destination. using concrete data and business on national tourism organisation of serbia, the authors point to a growing trend of using social networks in presenting serbia as a desirable destination. tourist organization of serbia (tos) uses integrated on-line marketing for promotive activities and targeting marketing campaigns. this paper discusses the importance and role of the public sector as a way of managing a tourist destination through tos, but with synergetic effects with the use of social networks. key words: tourism industry, social networks, tourist organisation of serbia (tos), digital promotion jel classification: z30, l83, l86 introduction the end of the xx and the beginning of the xxi century is characterized by a significant development of information technologies, which can even be called a revolutionary turn, that has affected all segments of life. business in all areas have significantly accelerated, facilitated, shortened in time, also the needs for some new professions have emerged, and largely have become internationalized as geographical distance has become a relative category. development of information technologies has all also influenced the changes in everyday life. the average person life, who has access to this technology has also changed dramatically and accelerated. on the one hand, business activities can be completed more quickly, and on the other hand, there is enough free time to do other activities, thanks to advanced technology. life without the internet has virtually become unthinkable. it can even be said that people have become “addicted” to monitoring current “just-in-time”. they usually carry a mobile phone, tablet or computer with * corresponding author, e-mail: olja.mi@dgt.uns.ac.rs olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 95 them, so they can follow events on social networks in a timely manner, respond to messages, take pictures of different events and simultaneously post them on social networks. the younger generation can say that "if an event was not recorded with a cellphone camera and if it was not immediately posted on one of the social networks, the event did not even happen." an ordinary day cannot be imagined without browsing through email, instagram, facebook and other social networks. this has certainly made life easier and more interesting, but it has in some ways led to alienation, as deals that took place tet-a-tet are now done via skype and other mobile applications using the possibility of simultaneous visual contact with the interviewee. this issue is the subject of serious analysis of sociological, psychological and ethical research. as all activities are covered by this process, neither the tourism industry nor the dominant tertiary (labor-intensive, service-oriented) has remained immune to new ways of communication and advertising. following the business trends and the new concept of life of the potential consumer, tourism companies have embraced information technology as the dominant way of conducting all business activities. this particularly applies to the field of marketing. to facilitate and accelerate the communication process with business partners and customers, e-commerce has become a conditio sine qua non. although there are many forms of digital marketing, the subject of this paper is to analyze the impact of social networks on promotion (ilić, 2018). as the tourist organization of serbia (tos) is the main carrier of the formation of a national brand and the promotion of tourism, the focus in analyzing the impact of social networks on marketing will be viewed from the point of view of the impact on this irreplaceable institution for serbian tourism. literature review fahy and jobber (2006) consider that marketing with the use of information technology could be defined as internet marketing, or marketing that fulfills its goals by using the internet and technologies based on it. tošić (2013) believes that internet marketing is part of the promotional mix. of course, the author obtains that in addition to this form of promotional mix, classic forms such as advertising, public relations, sales promotion, personal selling and direct marketing are still being used. nicić (2011) calls this form of marketing as electronic or e-marketing. the author points out that e-marketing encompasses all online and electronically based business activities that make it easier for manufacturers of goods and services to satisfy as many consumer desires and needs as possible in a faster and more efficient manner. almost three decades buhalis (1998) highlighted the fact that consumers are aware of and familiar with increasing use of information technology. consequently, potential consumers have more intensively started using different information tools for the purpose of organizing travel (buhalis & law, 2008). the use of social media has enabled the joint creation of tourism products, based on the experiences of other users of tourism services and their impressions (sigala, 2008). bakić (2005) pointed out that the most significant changes in marketing, in addition to economic, demographic, natural, socio-cultural and political, in the future development of tourism will be felt most in the technological environment, precisely because of the intense reason of information technology. he states that advancements in the reservation systems (crs) of airlines, reservation and management systems at hotel and travel agencies, rapid development of the data transmission network, electronic money, implementation of satellite links are leading to a new quality of marketing mix instruments. along with these processes, there is a disintermediation, which can be seen through the disappearance of classical intermediaries in the market (classic tourist agencies), due to the increasing possibilities of direct sale through the use of information technologies (spasić & rabotić, 2008). 96 economic analysis (2020, vol. 53, no. 1, 94-104) digital promotional mix instruments effectively combining the four marketing mix instruments produces an effective marketing program that, above all, should provide value to consumers. promotion, or marketing communication, is one of the elements of the marketing mix, which in order to be effective, must be coordinated with other marketing activities. increasingly, the more comprehensive term integrated marketing communication (imc) is being used. the overall effect of coordinating different communication activities is greater when they are performed independently and in some cases in conflict with each other (milojević & mikić, 2017). the importance of online promotion is steadily growing and gaining importance in budgeting and marketing efforts whether it is a text message that can change consumer behavior in the moment or keywords that can increase the number of queries or a contextual banner that changes attitudes or viral marketing that encourages people to talk about the product. online channels can do what offline channels simply cannot, e.g. some websites can promote, communicate, and create a unique experience that is unique to online users. although websites, by themselves, cannot be considered as a propaganda tool, they are an integral part of all ten elements shown in table 1. table 1. on-line equivalent promotional assets promotional mix online equivalents advertising interactive ads, pay per click, search engine advertising sale viral sales, affiliate marketing sales improvement incentives, rewards, online loyalty public relations social networks, links, newsletters, online editorials direct mail opt-in email when using e-newsletter, e-blast exhibitions virtual exhibitions product display promotional ads at trade shows, personalized recommendations packaging virtual tours, really packed online oral propaganda viral marketing, referrals to friends via email and links source: chaffey, smith, 2008. four marketing mix instruments, first of all, should answer seven important questions: 1. defining the audience, 2. defining the goal of promotion, 3. determining the topic of addressing the market, 4. developing a clear message to be conveyed, 5. choosing the medium for conveying messages, 6. defining the budget for promotion and 7. determination of mechanisms of continuous control. social networks social networks are free, interactive internet services that allow users to create public or semi-public pages with basic information about themselves, provide a list of users with whom they have a connection, and view and interact with their contact list (boyd & ellison, 2007). there are various types of social networks and they may be of a general type or may be specific to a particular geographical area, as well as to the occupations, interests and needs of users. the most popular social networks are facebook, youtube, whatsapp, wechat and instagram (figure 1). olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 97 figure 1. the world's leading social networks by number of active users source: survey conducted, 2018. pew research center the three main arguments for using social networks in tourism are: 1. high targeting easy to reach, and the promotion is tailored to market segmentation; 2. measurability any effort can be measured, and the result of the activity can be seen. statistics can provide "tons of information", it's up to the company to analyze and use them regularly; 3. accessibility and low prices the use of social networks is generally completely free. in order to increase the effects of its business appearance, the company can also use various methods of paid promotion, which, in comparison with other media, is far cheaper and accessible to everyone (stojković, 2013). many travelers ''consult'' social networks when planning a trip to find destinations, benefits, tips, and reviews from other travelers, but to what extent do social networks have the power to shape travel? not only do social networks have an impact on travel planning, they are also very present and influential during the tourists' stay in a particular destination, but also upon their return from destination to the place of residence. promotional activities of the tourist organization of serbia on the internet tourism law of 1994 established the tourist organization of serbia (tos), as the official carrier of the institutional promotion of tourism of the republic. the activity of tos is aimed at positioning the tourist product of serbia in the domestic and foreign markets and tourist valorization of serbia's comparative advantages, such as its geo-strategic position, historical, cultural and natural identity. in order to uniquely implement tourism information and propaganda activities, integrate serbia's tourism space into european tourism itineraries and strengthen bilateral cooperation in the field of tourism development, tos is present at all major tourism fairs worldwide, cooperates with other national tourism organizations and other international, regional and professional tourist associations. in addition to the above activities, tos is engaged in monitoring and placing the latest news in the field of tourism. new promotional activities can be noticed on the website: • projects from china and 17 countries in central and eastern europe (china cee 17+1), where applications for the prestigious marco polo award are encouraged. this is a 73% 68% 35% 29% 27% 25% 24% 22% 0% 10% 20% 30% 40% 50% 60% 70% 80% youtube facebook instagram pinterest snapchat linkedin twitter whatsapp 98 economic analysis (2020, vol. 53, no. 1, 94-104) logical sequence of activities, because in 2019, serbia was declared one of the most promising destinations in china. • tos promotes specific destinations that it considers extremely attractive: lepenski vir, gamzigrad, studenica, resava cave and palić lake. • tos launches internal competitions for awards in the field of tourism in serbia: exceptional destinations in serbia eden2019; tourist flower, the best photo of serbia and the like. use of the website for the purpose of promoting tourism in serbia the website is an 'id card' of every organization. primarily, because it is the first meeting of a potential user of goods and/or services, in this case tourists, with the organization through the internet. it can be said that a quality website is the equivalent of a smiling and kind person at the hotel reception, in terms of getting a first impression of the seriousness and quality of the organization/destination. second, because any additional efforts made by the organization through the internet are closely linked to the functioning of the website. this should practically mean that without a quality website there is no successful web marketing. as for the history of using websites to promote serbia as a tourist destination, it is also quite long. the first website of the tourist organization of serbia was published in 1997 and functions as a subpage of the website of the faculty of economics in belgrade. it has been modified and modernized several times since 1997. it now operates under the domain http://www.serbia.travel. the current website of the tourist organization of serbia is just over two years old. it was first presented at the tourism fair in belgrade in 2016. it has since been used as the official website of this national tourism organization. at the bottom of the homepage are links to social networks: facebook, twitter, youtube, instagram, pinterest and tripadvisor. the introductory (home) page of a website is the page where the most important things are. if viewed from this side, it can be said that this web site fulfilled this role of tos because everything that is most important for the tourists themselves is on the homepage, starting with the information about serbia itself, through all the major events to various information related to tourism in serbia. the presentation of tourism on the website is mostly dominated by pictures, which attracts tourists because the pictures best describe a particular destination. use of social networks in promotion of serbian tourism if we look at tos activities on social networks, they can be divided into three groups: 1. daily publishing of multimedia content in the form of photos, infographics, news, videos. compared to last year, the novelty in this field was the development of special creative platforms (regular sections dedicated to specific topics that they publish in a specific term). 2. organizing periodic campaigns: paid advertising campaigns and prize competitions. 3. direct communication with interested citizens through responses to comments and private messages. tos profiles on social networks publish information, news, photos and other promotional materials, answer questions of users interested in serbia's tourism offer, organize sweepstakes and publish competitions related to building an image and positioning serbia's tourist offer on the domestic and world markets. the number of tos followers on social networks has increased dramatically as a result of the excellent results that tos sites achieve, which is the result of a long-term strategic appearance on social networks that results in a large interaction of users with published content. this is also the basic criterion that facebook's algorithm takes into account when placing content as well as conducting an advertising campaign on tos pages in olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 99 serbian and english, their quality designing, which includes: target group selection, ad placement method, conceptual design, etc. the rating of a tourist destination on social networks makes a great contribution to creating a pleasant image of a tourist destination. thanks to the rating, a larger number of people participate in the exchange of opinions and experiences about a tourist destination, using social networks. good publicity contributes to the development of the reputation of duristic destinations. terms such as liking, sharing, blogging, tweeting, and the like have become part of an individual’s everyday speech in this area as well. analysis of the tourist organization of serbia facebook page the tourist organization of serbia is present on the social network facebook through facebook pages. the organization owns pages that are being updated in different world languages for different markets. the tourism organization of serbia is also responsible for the site dedicated to tos souvenir shops. tos manages two souvenir shops in belgrade. this tos activity is promoted through the instagram and facebook page of serbia travel souvenirs (@ serbiatourism.souvenirs). the site has existed since 2017 and was opened in parallel with the opening of the tos gift shop near the avala tower. the facebook page has 1740 likes, while its instagram profile is followed by 452 people. the most interesting facebook pages are the tourist organization of serbia, the site that tos has best developed and through which the largest number of advertising campaigns have been conducted and serbia travel, which tos uses as a means of communication at the international level and through which all advertising campaigns are conducted globally. content that is published daily on the site is planned two months in advance and depends on: marketing campaigns run by tos at a given moment, tourist season, significant events, markets for which it is planned and availability of materials for creating posts. most of the audience is in the following two age groups: 25-35 and 35-44. the demographic structure of tos's followers on facebook shows that the women are in the majority (figure 2 and figure 3). as for the posts themselves, tos uses a variety of formats to properly convey the message to followers of the site, such as: status with a photo, video, event, note, poll, live stream, and facebook story. figure 2. the demographic characteristics of the tos facebook page followers by gender source: https://www.facebook.com 62% 38% female followers male followers 100 economic analysis (2020, vol. 53, no. 1, 94-104) figure 3. the demographic characteristics of the tos facebook page followers by age source: https://www.facebook.com analysis of the tourist organization of serbia twitter account tos's twitter account is currently followed by 27,800 twitter users, including 129 followers with verified accounts. interestingly, even though this is a tos account that has the lowest number of followers compared to other social networks, and the only one has a verified profile tag. the account is updated daily with at least one tweet created by tos and several retweets. the tweets mostly consist of a photo, branded with a logo, hashtag and slogan, and accompanying text. in addition, there are blogs about serbia, as well as occasional surveys on serbia's tourism offer. organizations such as the european tourism commission, the world tourism organization, the national museum and other institutions on which serbia's tourist offer depends, are most commonly retweeted; famous world media that broadcast a positive image on tourism in serbia; local tourism organizations; influencers; but also smaller users who conceptualize their tweets to create a positive image of serbia as a tourist destination, in a creative and receptive way for twitter audiences. tweets are written in english. at the top of the page is a tweet, related to the campaign tos is currently running. the tos account belongs to two lists, one is a list of all accounts of tourist organizations in serbia and the other is a list of all twitter accounts of national tourist organizations. figure 4. the demographic structure of tos followers on twitter by gender source: tourist organization of serbia 0.66% 7% 18% 17% 11% 6% 2% 0.43% 5% 11% 10% 6% 3% 2% 0.00% 10.00% 20.00% 13-17 18-24 25-34 35-44 45-54 55-64 65+ male followers female followers 61% 39% male followers female followers olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 101 figure 5. the demographic structure of tos followers on twitter by age source: tourist organization of serbia unlike other female-dominated tos accounts, on twitter, these are men with 61%. the most dominant audience is 25-34. (figure 4 and figure 5). when it comes to the most successful tweets, in the period from 2015 to the present, it is a tweet with the video serbia: “the place to be”, with which, in 2017, tos presented the beauties of serbia on bbc world television and eurosport. analysis of instagram profile of tourist organization of serbia the instagram profile of the tourist organization of serbia has more than 51 thousand followers. the most dominant audience is 25-34. the demographic structure of tos's followers on instagram shows that the women are in the majority (figure 6 and figure 7). the page name is serbia travel and the username is @serbiatourism. the profile description states that this is the official profile of the serbian tourism organization, as well as a sentence stating that if you use #seeserbia or #videoserbia you give tos permission to share your content on your own page. both in english. the website included in the page description is http://serbia-the-place-tobe.serbia.travel/. the profile is in business form. the account title bar above the gallery contains shortcuts to phone number, email address, and location. the account is in the category government organization and is updated daily. there are two methods of updating: user generated content (ugc); and content from the tourist organization of serbia database. as a way of collecting content from users, the above mentioned hashtags are used to the greatest extent, as well as tags, geolocations and also online tools. photos are posted without any delusions. the descriptions are bilingual with text in serbian and english. the descriptions are enriched with hashtags, but not so much to stifle the main message. each photo contains geolocation. tos takes full advantage of this social network. instagram stories are occasionally created, some of which are featured on the profile. tos has on several occasions on this network conducted live broadcasts from different destinations in serbia, such as vrnjacka banja, cacak, nis, belgrade. igtv is also active, with two videos so far. 2.50% 8.20% 34.40% 32.10% 13.90% 6.90% 2% 0.00% 10.00% 20.00% 30.00% 40.00% 18-20 21-24 25-34 35-44 45-54 55-64 65+ followers by age 102 economic analysis (2020, vol. 53, no. 1, 94-104) figure 6. the demographic structure of tos's followers on instagram by gender source: tourist organization of serbia figure 7. the demographic structure of tos's followers on instagram by age source: tourist organization of serbia analysis of youtube channel of tourist organization of serbia youtube channel of the serbian tourism organization has been subscribed by 6,596 users. the total number of videos posted on this channel is 168, with a total of 7,183,797 views. there is no certain dynamic for video publishing, since it depends on the production. all videos on this youtube channel are the property of tos, which means that on this social network the tourist organization of serbia relies only on its own content, no user-generated content. the channel is organized into 9 playlists, but not all videos are included. videos can be divided into different series. in addition to the video series, there are also individual videos from different campaigns. the videos with the most views on this channel are: the danube in serbia: 588 impressions with 1.8 million views; serbia one journey, million impressions with 625,538 views; serbia – the land of new beginnings with 486,197 views. the tourist organization of serbia also advertises itself on this social network. the most dominant format used is the skippable and non-skippable video ad. 41% 59% male followers female followers 1% 16% 44% 25% 9% 3% 2% 0% 10% 20% 30% 40% 50% 13-17 18-24 25-34 35-44 45-54 55-64 65+ followers by age olja munitlak ivanović, lukrecija đeri, predrag stamenković, aleksandra ilić 103 analysis of tos account on weibo the china market is one of the most significant markets covered by the serbian tourism organization. according to tos statistics, the number of chinese tourists in serbia increased by as much as 181% in 2017, while during the first 6 months of 2018, the number of chinese tourists increased by 97%. the tourism organization of serbia, taking into account the results that serbia's tourism has achieved when it comes to the influx of tourists from china, as well as the fact that china has banned the use of the world's most dominant social networks, has found through weibo a way to bring chinese tourists closer to serbia's tourist offer online. this site is administered from china, that is, by a partner pr agency in charge of promoting serbia in the chinese market. the site is updated daily. the most dominant formats are photos and videos. what is particularly interesting is the fact that this site also makes extensive use of usergenerated content. this fact also indicates the great interest of chinese tourists in european destinations, and therefore serbia. also, this site uses celebrities from serbia known to the chinese public in order to bring serbia closer to chinese tourists, so the site can find posts related to trophies that novak djokovic wins, music by goran bregovic, bata zivojinovic, etc. conclusion the use of social networks in tourism is increasingly justified because of high targeting easy to reach, and the promotion is tailored to market segmentation; measurability any effort can be measured, and the result of the activity can be seen. statistics can provide "tons of information", it's up to the company to analyze and use them regularly; accessibility and low prices the use of social networks is generally completely free. in order to increase the effects of its business appearance, the company can also use various methods of paid promotion, which, in comparison with other media, is far cheaper and accessible to everyone. many travelers ''consult'' social networks when planning a trip to find destinations, benefits, tips, and reviews from other travelers, they are also very present and influential during the tourists' stay in a particular destination. in order to uniquely implement tourism information and propaganda activities, integrate serbia's tourism space into european tourism itineraries and strengthen bilateral cooperation in the field of tourism development, tos is present on all major social networks (facebook, twitter, instagram, youtube, weibo). tos profiles on social networks publish information, news, photos and other promotional materials, answer questions of users interested in serbia's tourism offer, organize sweepstakes and publish competitions related to building an image and positioning serbia's tourist offer on the domestic and world markets. the number of tos followers on social networks has increased dramatically as a result of the excellent results that tos sites achieve, which is the result of a long-term strategic appearance on social networks that results in a large interaction of users with published content. acknowledgements this paper is a part of research project number 01037 176020 (transformacija geoprostora srbijeprošlost, savremeni problemi i predlozi rešenja) financed by the ministry of education, science and technological development of the republic of serbia. this paper is a part of research project number iii47009 (european integrations and social and economic changes in serbian economy on the way to the eu) financed by the ministry of education, science and technological development of the republic of serbia. 104 economic analysis (2020, vol. 53, no. 1, 94-104) references bakić, o. (2005). turizam. sremska kamenica: fakultet poslovne ekonomije-educons univerzitet boyd, d., ellison, n. (2007). social network sites: definition, history, and scholarship. journal of computer-mediated communication, 13: 210–230. https://doi.org/10.1111/j.10836101.2007.00393.x buhalis, d. (1998). strategic use of information technologies in the tourism. tourism management. 19(5): 409-421. https://doi.org/10.1016/s0261-5177(98)00038-7 buhalis, d., law, r. (2008). progress in information technology and tourism management: 20 years on and 10 years after the internet the state of etourism research. tourism management. 29(4): 609-623. https://doi.org/10.1016/j.tourman.2008.01.005 chaffey, d., smith, p.r. (2008). e-marketing excellence. london: routledge. facebook. (2019). https://www.facebook.com (accessed july 1, 2019) fahy, j., jobber, d. (2006). osnovi marketinga. beograd: data status. ilić, a. (2018). analiza promotivne strategije turističke organizacije srbije na internetu. novi sad: univerzitet u novom sadu – prirodno-matematički fakultet. milojević, s., mikić, a.. (2017). promocija. beograd: beogradska poslovna škola – visoka škola strukovnih studija. nicić, m. (2011). elektronski marketing/elektronsko poslovanje u turizmu. beograd: visoka turistička škola strukovnih studija. pew research center. (2018). https://www.pewresearch.org/ (accessed july 1, 2019) sigala, m. (2008). “developing and implementing an e-crm 2.0 strategy: usage and readiness of greek tourism firms”. in p. o'connor, w. höpken & u. gretzel (eds.), information and communication technologies in tourism 2008: proceedings of the international conference in innsbruck, austria 2008 (463-474). wien; new york: springer. spasić, v., rabotić, b. (2013). poslovanje turističkih agencija. beograd: visoka turistička škola strukovnih studija. stojković, m. (2013). “primena društvenih mreža u turizmu i ugostiteljstvu.” http://www.turizamiputovanja.com/primenadrustvenihmrezauturizmuiugost iteljstvu.pdf . tošić, v. (2013). marketing u turizmu. beograd: visoka turistička škola strukovnih studija. tourist organization of serbia. (2019). http://www.serbia.travel/home.779.html (accessed june 15, 2019) article history: received: october 29, 2019 accepted: november 20, 2019 https://doi.org/10.1111/j.1083-6101.2007.00393.x https://doi.org/10.1111/j.1083-6101.2007.00393.x https://doi.org/10.1016/s0261-5177(98)00038-7 https://doi.org/10.1016/j.tourman.2008.01.005 https://www.facebook.com/ http://www.turizamiputovanja.com/primenadrustvenihmrezauturizmuiugostiteljstvu.pdf http://www.turizamiputovanja.com/primenadrustvenihmrezauturizmuiugostiteljstvu.pdf http://www.serbia.travel/home.779.html the necessity of using social networks in contemporary tourism industry and the tourist organization of serbia olja munitlak ivanović114f* | lukrecija đeri1 | predrag stamenković2 | aleksandra ilić3 introduction literature review digital promotional mix instruments social networks promotional activities of the tourist organization of serbia on the internet use of the website for the purpose of promoting tourism in serbia use of social networks in promotion of serbian tourism analysis of the tourist organization of serbia facebook page analysis of the tourist organization of serbia twitter account analysis of instagram profile of tourist organization of serbia analysis of youtube channel of tourist organization of serbia analysis of tos account on weibo conclusion acknowledgements references microsoft word 2010_1_2.doc original scientific paper method of banks valuation horvátová eva*, university of economics in bratislava, faculty of national economy, department of banking and international finance, bratislava, slovakia udc: 336.717 jel: g21 abstract – since there is not a special common framework for valuation banks and it gives possibilities to create establishment, improvement and adaptation of various approaches to measuring the value of banks and financial institutions. most approaches banks valuation note the strong dependence of financial institutions value from market interest rates (mishkin, f., miller, wd, copeland, t., koller, t., damodaran, a., and others). each approache reflects greater or lesser degree of accuracy depending on the method of determining resources for owners, the discount factor, approaches to defining the rate of growth and methods of measurement. key words: banks valuation methods, free cash flow equity, discounting factor, cost on equity, beta factor introduction the issue of banks and financial institutions valuation have been written relatively few comprehensive theoretical and methodological work. the valuation is carried out by experts and expertise for different purposes and with varying degrees of methodological accuracy of the estimate of input factors. a significant shift in valuation theory and practice came when r. c. merton (1973) [1], introduced the risk-neutral valuation model for financial assets. bank valuation under this model can be interpreted as determining the value of a call option on the value of bank assets.1 currently, (august 2009), r. c. merton (2009) in the context of the financial crisis makes the promotion of a market valuation of banks and their components. it states that banks and entities that oppose the use of market valuation, are trying to hide the fall in prices. equally critically views on issues of aid, saying that the government is trying to solve complex problems easily. he also expressed the desire to stimulate trading in securities market in order to restore the natural function of the market in setting prices. about using of derivatives, the lack of market information for investors blames frozen market.2 * address: dolnozemská cesta 1, 85235 bratislava, slovakia., e-mail: eva.horvatova@euba.sk 1 merton, r. c. an intertemporal capital assets pricing model. econometrica. vol. 41, 1973. http://ideas.repec.org/a/ecm/emetrp/v41y1973i5p867-87.html 2 merton, r. c.: mark it to market. august, 19, 2009. http://www.swampreport.com/investments/scholes-and-merton-mark-it-to-market/ horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 51 a. damodaran (2002) says, that „the fundamental valuation rules may be applied equally to companies such as to financial services institutions“3, should be pointed here. some approaches to the bank valuation note the strong dependence of financial institutions value from market interest rates (mishkin, f., miller, wd, copeland, t., koller, t., damodaran, a., and others). each approache reflects greater or lesser degree of accuracy depending on the method of determining resources for owners, the discount factor, approaches to defining the rate of growth and methods of measurement. t. copeland highlights that the interest rate risk should focus attention on 4 factors: 1 interest margin between the market rate and bank rate, as well as their flexibility to market developments, 2 dynamics of tidal funds, 3 degree of substitution of banking products and services as an alternative to interest-rate changes, 4 need to cover risks arising from maturity mismatch of assets and liabilities part of the profit. koch, t. w. (2005), samuelson, klein and monti formulate a conclusion on the positive relationship between net income and the relative market power of banks. these theoretical ideas support empirical research work such as damodaran, a., as well as other authors. a significant shift in valuation theory and practice came when r. c. merton (1973) [2] introduced the risk-neutral valuation model for financial assets. bank valuation under this model can be interpreted as determining the value of a call option on the value of bank assets.4 valuation of banks and financial institutions by the yield method business valuation models are largely based on discounted cash flow approach (dcf model) and assume some growth stages, which is typical for different growth rate of cash flow or resources for owners. expression of fcfe (free cash flow equity) in financial institutions the annual effect on the owner may be defined differently. this may be as free cash flow to shareholders (fcfe free cash flow equity) generated as operating profit by reducing the costs that are not spending in the current period and the investment needed work and investment property for the operation. according w.d. miller, the desire is to move closer to the category income of owners net proceeds, which could be as bank potencial of dividends. sometimes, in this case refers to the free cash flow to shareholders (free cash flow equity). using cash flow as a basis for calculating income of owners as dividend income potential for the owners of the bank is inappropriate for two reasons: 3 damodaran, a.: investment valuation. 2-nd edition. john wiley & sons, 2002, 2002. isbn 978-0-47175121-2, page 603. 4 merton, r. c. an intertemporal capital assets pricing model. econometrica. vol. 41, 1973. http://ideas.repec.org/a/ecm/emetrp/v41y1973i5p867-87.html economic analysis (2010, vol. 43, no. 1-2, 50-60) 52 • statement of cash flows in the banking business is not suitable for determining sources for owners, such as dividends as source for owners can be paid only from real net income after tax and not from the movement of cash (cash flow); • bank and company profits are not equally attainable by shareholders, in the bank there is no problem with the availability of cash to shareholders because of the nature of the vast majority of assets and liabilities, although other types of businesses can generate significant differences between cash flow and profits in the sense that the business generates profits, but not sufficient cash flow; • the main source of income in banking is the differences between interest income and expense, as well as fees for services. the valuation of financial institutions can not be made without respect of interest income and expense as the most significant component of their income and capital growth, or its renewal. the calculation of fcfe in banks and financial institutions can be implemented in two basic ways: 1-st method of expressing fcfe: fcfe = net income growth of capital + other income it should be noted that net income is not equal to cash flow. with the growth of financial institutions should also increase its capital. growth fcfe lowers the capital, because it means that the bank is inserted into the banking business of profits that would otherwise be paid to owners as dividends. otherwise, if the bankʹs growth has not been accompanied by an adequate increase in the capital, it could happen to failure of financial institutions due to lack of solvency. 2-nd method of calculating fcfe: fcfe = resources from issue of shares preference shares + dividends capital increase (+ decrease in capital) changes in bank capital are resulting from the relationship between balance, profit and loss statements, cash flow and value of financial institutions. changes in assets and liabilities are reflected in changes in equity. equally polemical recommendation is adding into the value of cash flows the initial cash balance. the problem is the fact that they were a combination of yield method valuation and substance valuation method. since the yield valuation takes into account the future potential of banks, it leads to the discussions on the question of the length of the period under review (planning period). for example, w. d. miller (1995) [1] 5 advised to examine 10 years, others, such as m. tucek 6 recommend 2-3 years. this follows from the specifics of the environment, for example, in u.s. valuation concerns small, local banks are not investment activities and 5 miller, w. d.: commercial bank valuation. john villey and sons, inc., 1995, isbn13 9780471128205, page 28. 6 hrdý, m.: oceňování finančních institucí. praha: grada publishing, 2005, isbn 80-247-0938-4, page 35. horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 53 planning for 10 years it may be relatively simply. banks in slovakia perform mixed operations, and planning the future results for longer than 5 years could cause problems. net income as a basis for potential dividend or resource for owners by koller, t., goedhard, m. and wessels, d. (2005) [1] can establish two basic ways: 7 1. on net interest income, or 2. model based on interest margins (spread model). determination of the discount factor a particular problem is the correct determination of the discount factor to be within the individual models recommended. it is necessary to respect the logical links between the numerators and denominators and formulas used to discount the recommended indicators. there are different approaches for determining the interest rate for discounting, such as the determination of weighted average cost of capital. this method provides, in particular disposable cash flow for businesses, called the principle of free cash flow of firms (fcff). the bank is not appropriate given the high gearing ratio (leverage). for the purposes of the valuation of banks need to set the cost of equity. estimate the required rate of return on equity re in terms of banking, there are significant differences in the proportion of own and foreign sources of funding compared to other businesses. in the banking sector given the nature of the business of banking must accept a higher gearing ratio. cost of capital represents the expected rate of income investors given the risk level of the investment. since any form of business is associated with a higher risk than when depositing money in the bank, then the expected return is higher than interest rates in the bank. the role of the so-called risk-free rate rf (free of risk) may be selected interest rates on government bonds or yield to maturity of these types of bonds. yield to maturity is recommended to use as a discount factor such as for example m. marik (2007) [1]: ʺas a source for safe return to the czech capital market, we recommend using such proceeds to maturity of government bonds with maturities equal to ten or more years by source patria finance.“ 8 the cost of capital must be re invariably higher than rf in connection with the tax shield. required rate of return on equity can provide a number of ways to serve its particular setting: • gordon growth model, • capm (capital assets pricing model) or a model of capital assets • the average profitability • the cost of foreign funds 7 koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition, mc kinsey & company john willey & sons, inc., 2005, isbn: 978-0-471-70218-4, pages 670 671. 8 mařík, m.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ecopress, 2007, isbn 978-80-86929-32-3, page 218. economic analysis (2010, vol. 43, no. 1-2, 50-60) 54 • apt model (arbitrage pricing theory). 1. gordon growth model is based on a calculation of the growth rate of dividends: g sharesofprice dividends r t t e += +1 where: re = rate of return required by shareholders (return on equity) g = growth rate of dividends 2. capm is used frequently, although it also has some shortcomings. this model assumes that the risk premium is proportional in relation to systematic risk β. the capm can be re established as follows: ( )[ ]fmfe rrerr −+= .β where: rf = risk-free interest rate re = rate of return required by shareholders (return on equity) β = systematic risk e (rm) = expected return on market portfolio 3. the derivation of the discount rate based on average profitability. data on the average profitability of the industry are relatively accessible, and therefore in practice often used to determine the cost of equity. the disadvantage of this method is the impact on accounting practices can distort the indicator roe. the downside is mainly the lack of data on market value of capital of financial institutions, as the book value of capital is not suitable for these purposes. the basic conditions of dcf models include a requirement that the discount rate used to be in session with the risk profile of cash flow (for example: fcff ↔ wacc or fcfe ↔ re).9 for the valuation of banks is appropriate to use a model based on fcfe. fcfe is generally recommended to enjoy when financial leverage is stable and this is relatively high. using the fcfe model is preferred and recommended if it can generate a large difference between the dividends and fcfe. an alternative model is the dividend fcfe model. in practice, it could happen that the dividends could be higher than fcfe, the likely addition to the problems in the management of financial institutions and causing uncertainty in their valuations. it is recommended and preferred by hrdý, m. (2005) [1] model for the dividend fcfe model.10 9 kislingerová, e.: oceňování podniku. 2. přepracované a doplnené vydání. praha: c. h. beck, 2001, isbn 80-7179-529-1, page 160. 10 hrdý, m.: oceňování finančních institucí. praha: grada publishing, 2005, isbn 80-247-0938-4, page 23., and koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition, mc kinsey & company john willey & sons, inc., 2005, isbn: 978-0-471risk premium horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 55 using the fcfe valuation model, banks are avoiding the use of wacc. the average weighted cost of capital wacc is always lower than the cost of equity – re, which corresponds with the result that they are reduced by the so-called tax shield resulting from the use of foreign funds and netting interest expenses to the bank. determination of the beta coefficient another problem is the calculation of the beta coefficient. for example m. hrdý (2005) [2] 11 recommends using a simplified assumption that β is equal to one, because it assumes that changes in the profitability of financial institutions are equal to changes in market portfolio returns. another argument in favor of simplifying the calculation of the beta coefficient is that fairly significant change of beta affects the overall change in the risk premium in the relatively small scale, and also a rather complex calculation of the coefficient beta. above mentioned (the relatively low impact on the valuation premium) is shown on a graph. if the valuation is performed in less stable conditions, or if there are other reasons to choose a more accurate calculation of β, we use these basic approaches: 1. coefficient estimate based on historical data. 2. by analogy. 3. an analysis of factors. beta coefficient expresses sensitivity to market risk. actions that have beta between 0 and 1.0 tend to move in the same direction as the market, but not to an extent. rapidly growing company has beta over 5 years at level 1.11. the market growth of 1 % will increase the companyʹs stock price by 1.11 % or decrease by 2 % of the market reduces price of shares by 2.22 %. 12 70218-4, page 668., and mařík, m. and all.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ekopress, 2007, isbn 978-80-869929-3, page 206. 11 hrdý , m.: oceňování finančních institucí. grada publishing, praha 2005, isbn 80-247-0938-4, page 10. 12 brealey, r. a., myers, s. c.: teorie a praxe firemních financí. praha: east publishing, 1992, isbn 8085605-24-4, page 153. cost on equity (required return) by different degrees of risk (4 risk degrees) for maximum re 0 10 20 30 40 50 1 2 3 4 max. re is 20% max. re is 30% max. re iis 40 % economic analysis (2010, vol. 43, no. 1-2, 50-60) 56 beta coefficient may be measured on the basis of historical data and hence the change in performance of individual shares in the bank, depending on changes in market portfolio as follows: ∑ ∑ ∑ ∑ ∑ −× ×−×× = 22 ))(()( )()()()( mprmprn mprsrmprsrn β where: β a quantitative measure of the volatility of portfolio r (s) return on shares of a particular bank r (mp) return on market portfolio, n number of years of evolution. the disadvantage of this method is that it is not possible to reliably use knowledge about the development of beta from past to the future. the beta factor derives also by analogy from the following relationship by marik, m. (2007) [2]13 ( ) ( ) e d t e d t dul ⋅−⋅−      ⋅−+⋅= 111 βββ where: βu = beta at zero debt (unlevered beta)14 βl = beta entity debt (levered beta) βd = beta for debt = 0 t = tax rate this method of determining the beta is an appropriate indicator in the valuation of banks. βeta coefficients are published for each industry and country. as the beta for foreign capital is 0, the resulting relationship is: ( )       ⋅−+⋅= e d tul 11ββ this relationship expresses the dependence of beta on the degree of indebtedness of the entity. with this option you can use data on individual sectors of beta. coefficients are published for debted and indebted companies. the objective determination of β is the worldʹs best practice accepted valuation model capm. it is recommended that indicators of the environment of the u.s. market have been adjusted to current country risk. capital costs are then expressed by: 13 mařík, m.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ecopress, 2007, isbn 978-80-86929-32-3, page 225. 14 data on the average values of β coefficients for each industry states are published on website of aswath damodaran (www.damodaran.com , section updated data). the average value of β in 2009 for european countries indicated 1.04 and the average βu is at 0.80. horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 57 rpcrpmrr fe +⋅+= β where: rpm = market risk premium rpc = country risk premium is recommended to calculate than 1.5 times the risk of failure in the country (0,7.1,5) + 0.6 difference between inflation in the u.s. and for example in slovakia. determination of the cost of equity based on capm (on the example of slovakia) current risk-free return is 3.5 %; the risk premium for the capital market in slovakia 7.21 % 15 country risk premium 2.21 % unlevered beta for specialized banking services 0.23 %, the ratio of debt and equity 0.95 %. ( ) ( )( ) 41,095,019,01123,011 =⋅−+⋅=      ⋅−+⋅= e d dul ββ 67,821,221,741,05,3 =+⋅+=+⋅+= rpcrpmrr fe β the cost on equity methods based on capm model, are assuming the input data set to 8.67 % in slovakia. practical problems and procedures of bank valuation a key practical problem when evaluating the bank will determine the future anticipated net effect on the owner, plans for future net earnings. future development of profit can be detected in two ways: • regression analysis; • a financial plan based on data compiled from balance sheet and profit and loss account. the method of regression analysis is appropriate for the valuation of banksʹ long-term stable conditions, and operating in developed economies. regression analysis is more suitable for banks than for companies, because regulatory frameworks for business banking ensure continuous development without major fluctuations. nevertheless, the most accurate and most reliable way to estimate deemed dividend potential is derived from the financial plan for the bank. the expert must be able to assess future development of bank finances and key items of bank profits. the aim should be to approximate the planned balance sheet and profit and loss account over the next 5 years. important indicators are known profit generators such as loans and other earning assets, recently banks have a large proportion of income from fees for services, which should also be included in the calculations. 15 http://pages.stern.nyu.edu./adamodar/ economic analysis (2010, vol. 43, no. 1-2, 50-60) 58 the task of valuing the bank by the yield method is ultimately provided by continuing value to the bank. the formula for calculating the discounted value of continuing is as follows: ( ) ( ) ( )5 5 1 1 . 1. igi gdiv cv +− + = where: cv continuing value of bank div5 expected dividend paid in the 5-th year i interest rate used to discount g expected dividend growth rate per year with a similar approach is also encountered in determining the value of ongoing (continuing value) in the work by t. koller, m. goedharda and d. wessels (2005) [2]: 16 ( )gk rone g ni сv e −       −⋅ = 1 where: ni expected net revenue in 1-st year after the end the projected period g expected dividend growth rate per year ke cost of equity (required return) rone increasing the return on new capital conclusions – why is bank valuation important at present, confidence in the banking and financial sector is simulated by states and their guarantees. experience of banking sector restructuring in sr gives an example of how many banks are able to operate with inadequate or even having a negative value of capital. if it is well known that a major bank failure is undesirable because it would cause serious economic problems, then a function of confidence in the bank does not perform as bank capital, as some fiction or a social agreement, which may have different real form. the question arises whether the trust bank can reliably operate on this basis. it is undisputed and confirmed that the practice in the short term is possible. in the medium and long term, it is only a matter of time before such a basis for confidence in a banking institution is exhausted and positive incentives will be more costly than alternative problems for radical action against the bank. such confidence is not inexhaustible; its boundaries are identical with states and capabilities of countries. there is a risk of such an approach, on the other hand, if the banks do not use this second chance, the financial crisis could be even greater. 16 koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition, mc kinsey & company john willey & sons, inc., 2005, isbn: 978-0-471-70218-4, page 669. horvátová, e., method of banks valuation, ea (2010, vol. 43, no, 1-2, 50-60) 59 at present, the consequences of the financial crisis occurred requirements (for example, merton r.c.) to value banks by the market valuing approach, which uncovered a genuine reality and lead to more real situation on the financial and banking market. such an approach would certainly be very appropriate. valuation of banksʹ issues are important because the focus has to be not on profit growth, but on growth of stability and hence the value of the bank. banks managers also should not have rewards based on profit but on the basis of value growth of institution, which they manage. therefore, the states and supervisory institutions to carefully analyze the effectiveness of its intervention measures to support banking and financial market and take such measures that would prevent the repeat similar problems. access to regulate the banking sector varies depending on the distance of negative experiences. this area will be clearly show degree of risk in dealing with its negative consequences. addressing the negative consequences of the risks of using public funds is a sign that many economic entities, in principle, are not able to cover all the risks that they may occur, and therefore in my view, essential is that such entities to regulate the rate of risk-taking potential exist. it is necessary to believe that negative experiences will serve as a warning against gambling of people and countries, as in the historical experience translated it into a collective sacrifice of wealth necessary to prevent fatal consequences of similar threats. references adams, m., markus, r.: a new approach to the valuation of banks. http://www.campusforfinance.com/fileadmin/content/cffrc/documents/2007/banking_i_adams.pdf allen, f., galle, d.: comparing financial systems. cambridge: mit press 2000. isbn 0-262-01177-8. benninga, s.: bank valuation. new york instirute of finance course in singapore, www.wharton.upenn.edu, february 13, 2001. benninga, s. , sarig, o.: bank valuation. february 13, 2001. http://senverb.boun.edu.tr/pdf/bank%20valuation.pdf brealey, r. a., myers, s. c.: teorie a praxe firemních financí. praha: east publishing 1992, isbn 8085605-24-4. calomiris, ch. w., doron nissim: activity based valuation of bank holding companies. working paper 12918. http://www.nber.org/papers/w12918. davis, s. i.: bank mergers. lessons for the future. london: macmillan 2000. isbn 0-333-91260-8. damodaran, a.: investment valuation. 2-nd edition. john wiley & sons 2002. isbn 978-0-471-75121-2. www.damodaran.com (sekcia updated data). http://pages.stern.nyu.edu./adamodar/ freixas, x., rochet, j. ch.: microeconomics of banking. cambridge: mit press 1998. isbn 0-262-06193-7. horvátová, e.: bankovníctvo. žilina: georg 2009. isbn 978-80-89401-03-1. hrdý, m.: oceňování finančních institucí. praha: grada publishing, 2005. isbn 80-247-0938-4, kidwll, d. s., peterson, r. p., blacwell, d.w.: financial institutions, markets and money. forth worth: the dryden press 1993. koller, t., goedhard, m., wessels, d.: valuation, measuring and managing the value of companies. fourth edition. mc kinsey & company john willey & sons, isbn 0471702188, isbn: 978-0-47170218-4. levy, h., sarnat, m.: kapitálové investice a finanční rozhodování. praha: grada publishing 1999. isbn 807169-504-1. economic analysis (2010, vol. 43, no. 1-2, 50-60) 60 kislingerová, e.: oceňování podniku. praha: c. h. beck, 2001. isbn 80-7179-529-1. mařík, m.: metody oceňování podniku. druhé upravené a rozšířené vydání. praha: ecopress 2007, isbn 978-80-86929-32-3. merton, r. c.: an intertemporal capital assets pricing model. econometrica. vol. 41, 1973. http://ideas.repec.org/a/ecm/emetrp/v41y1973i5p867-87.html merton, r. c.: mark it to market. august, 19, 2009. http://www.swampreport.com/investments/scholesand-merton-mark-it-to-market/ miller, w.d.: commercial bank valuation. john wiley and sons, inc., usa 1995, isbn13 9780471128205. mishkin, f.: economics of money, banking and financial markets. reading: addison-wesley 2003. isbn 0-321-20049-7. rose, p. s., hudgins, s. c.: bank management and financial services. boston: mcgraw hill 2005. isbn 007-286163-0. sharpe, w.f., alexander, g.j.: investice. praha: victoria publishing 1993. isbn 80-85605-47-3. sinkey, j. f.: commercial bank financial management. london: prentice hall 1998. isbn 0-13-521048-8. received: 7 january 2010 article history: accepted: 7 march 2010 microsoft word 2010_1_2.doc original scientific paper the analysis of long run growth oriented fiscal policy erős adrienn*, university of miskolc, institute of economic theory, miskolc, hungary udc: 336.02(439);(415) jel: h3; n14 abstract one of the most debated questions of growth theory is whether or not government policies can be used to influence the long run growth rate of the economy. neoclassical theory states economic policy actions can only have short run effects on the growth rate of the economy, but it can’t change the long run perspectives for growth. endogenous growth theory integrated (among several other factors) fiscal policy to the growth models, enabling it to influence long run growth performance. according to these theories some elements of the government budget have positive effects on the long run growth rate of the economy (productive expenditures, and budget balance), while others are neutral (non-distortionary taxation and unproductive expenditures), or have negative consequences for growth (distortionary taxation). in my paper i summarize the theoretical and empirical literature of the relationship between fiscal policy and long run economic growth shortly. then i continue my work with using the parameter estimates of a third generation study of developed countries (which considers the budget constraint as well) to evaluate the fiscal policy actions taken in hungary and in ireland, concentrating on the overall long run trends in the last one and a half decade. i will try to give explanation for the differences in the two countries’ reactions to some of the similar fiscal policy changes mapped during my research. key words: fiscal policy, economic growth, hungary, ireland review of the research topic the most important aim of economic policy is to ensure the highest level and most general welfare possible to the citizens of a country. there can be no other way to improve welfare over the long run but stimulating intense and sustainable economic growth. that is why the analysis of economic growth is a central question in the theory of economic policy, macroand international economics. „even small differences in long-term growth rates when cumulated over a generation or more, have much greater consequences for standards of living than the kinds of short-term business fluctuations that have typically occupied most of the attention of macroeconomists. to put it another way, if we can learn about government policy options that have even small effects on the long-term growth rate, then we can contribute much more to improvements in standards of living than has been provided by the entire history of macroeconomic analysis of countercyclical policy and fine-tuning. economic growth is the part of macroeconomics that really matters.” [barro – sala-i-martin (1995) 4-5 pp.] * tel: +36 / 46 / 565-111 / 18-71, mob: +36 / 20 / 34-27-486, fax: +36 / 46 / 565-194, e-mail: geteros@unimiskolc.hu economic analysis (2010, vol. 43, no. 1-2, 25-33) 26 the above cited words perplexed me, when i first read them. i found their message a bit exaggerated, showing the self-consciousness of the researcher, his preference of his own interest. still they made me think about the question. the more i thought about their veracity, the more i had to admit they are right. i think the matter of long run economic growth is of major importance. it is a stressful and timely problem from hungary’s point of view, as after our accession to the european union, convergence got into the focus of attention. hungary’s per capita gdp, based on purchasing power parities did not reach even half of that of 25 member european union’s average a decade ago (in 1997 it was only 49,5% of that, eurostat), and even in this year, in 2007 it reaches only 64,5% of the eu average. we are facing a long period of convergence, based on these data. it is a highly logical question to ask what we can do to improve the pace of economic growth. this question belongs to the field of economic policy (among others) as well. i chose to study the fiscal instruments’ possible effects on long run economic growth in my research. i had three reasons to make this choice. on the one hand, the literature of economic growth theory focuses on fiscal policy’s growth effects, while on the other hand monetary policy (as we hope) will be lost as a national policy instrument after accessing the euro-zone. this means the only policy left at our disposal to influence economic activities (among them economic growth) will be fiscal policy. my third reason was that before this research i was concerned with taxation matters and international tax harmonization so fiscal policy was familiar to me. i chose ireland as a reference country, because she proved in the last two decades with her outstanding economic performance that convergence is not just a dream, and that economic policy (if properly done) can contribute to the pace of economic growth. research background and methodology during the empirical work (arising from the macroeconomic characteristics of the theme) i made my calculations based on data taken from different international statistical databases. the main (but not the only) source of the data i used was the sourceoecd on-line statistical database. in order to ensure comparability, i endeavoured to minimize the types of databases used. because of the methodological differences sustained by hungary till 1997 distinct data are not published for hungary in international databases. so in the case of those variables i had to rely on the data of the ksh (central statistics office of hungary), and pm ápmso áhir (hungarian finance ministry’s database). in my empirical work i analysed the relevant fiscal variables by using spss 14.0 and eviews 4.1. software. empirical analysis the question dealt with in the paper is whether there is correlation, and if yes, how strong it is, between the long run growth rate of the economy and fiscal policy. arguments can often be heard that economic policy is almighty, and the state can do anything. other experts tend to stress that the state should not involve in economic affairs and its influence on economy ought to be minimized. others add that the major aim should be (if economy evolved in such a way that state’s involvement in the economy, and mixed economy can be erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 27 considered as natural) the maintenance of budget balance and the confine of state’s debt as a share of gdp. according to neoclassical growth theory, long run economic growth can be contributed to two exogenous factors, technological progress and the growth rate of economically active population. this attitude leaves only limited, short run, temporary effect for fiscal policy on the growth rate of the economy even though it is capable of changing the achieved level of welfare permanently. endogenous growth theory on the other hand states that fiscal policy can influence the long run growth rate of the economy as well. the most recent, third generation empirical studies based on the endogenous theory of growth use several groups of variables which can either contribute to the growth rate (like productive expenditure, budget balance), or be neutral to growth (like non-distortionary taxation and unproductive expenditure), or harm growth (like distortionary taxation). those revenue sources and expenditure types, which have ambiguous growth effect, are called other revenues and other expenditure. according to our hypothesis there is correlation among these fiscal variables and the long run growth rate of the economy, and these correlations meet the expectations concluded by surveying the relevant theoretical and empirical literature both in their strength and in their directions. based on the correlation and regression calculations made it can be concluded that the calculated results meet our expectations based on the survey of the theoretical and empirical literature in the case of most fiscal variables, even though there are some exceptions. both the indicators used to measure the extent of the state as a share of gdp (the ratio of income centralisation and the ratio of redistribution) are negatively correlated with long run growth rate of the economy in both countries. this relationship is known as scale-effect in the literature of endogenous growth theory, and its existence can be confirmed in case of the analysed countries. the ratio to gdp of distortionary taxation is negatively related with the growth rate of the economy in both countries, which tendency meets our expectations formed when surveying the theoretical and empirical literature of growth. the share of non-distortionary taxation to gdp is not significantly correlated with growth based on irish data, which trend coincides with our theoretical cognition. at the same time, hungarian data show a reverse relationship, showing significant positive correlation between the two variables. the most probable reason for this is the increase in the share of non-distortionary taxation within the generally shrinking tax wedge, while decrease in the share of distortionary taxation is positively related with growth. the increase of the ratio of non-distortionary taxation to revenue enhances growth based on both countries’ data, which result meets our expectations. productive expenditure as a share of gdp is not significantly related with the growth rate of the economy based on irish data (this results meets our expectations), while according to hungarian data the two variables correlate negatively. this contradicts the finding of theoretical and empirical literature, and the reason for it must lay in the parallel changes occurred in the structure and extension of the budget as a share of gdp. the ratio of public expenditure to gdp decreased by 8 percentage points during the period in question, while productive expenditure as a share of gdp fall back only by 2 percentage points, so their economic analysis (2010, vol. 43, no. 1-2, 25-33) 28 share of all expenses rose by 2 percentage points. the decrease of productive expenditure’s ratio to gdp must rather have been parallel in time to the rise of the growth rate than being the reason for it. the share of unproductive expenditure in gdp is not significantly correlated with the long run growth rate of the economy in ireland, in accordance with the predictions of the third generation studies. in hungary significant negative relation can be found between the two variables. this suits the findings of certain second generation studies, showing negative relation between the extension of transfer programmes and the long run growth rate of the economy. the ratio of budget balance to gdp relates positively with the long run growth rate of the economy according to all types of empirical studies. this statement can be confirmed both in the case of hungary and ireland, showing significant positive correlation between the two variables. two measures were used to characterise the relationship between long run economic growth and state debt. three and five year averages of state debt’s share in gdp relate significantly negatively with growth in both countries. three and five year average change in state debt is in significant negative correlation with the long run growth rate of the economy. these results meet our expectations formed when surveying the theoretical and empirical literature. our conjuncture is that ireland forewent the previous leaded states. what can the enviable success of ireland be attributed to? several possible reasons, like aptitudes (geographical position, english mother tongue, a young population unmatched in developed countries) economic history (doubling of the eu funds, single european market), and economic development (globalisation, foreign direct investment, change in the importance of distance, revolution of the it systems) are mentioned in literature. many of the experts stress the importance of economic policy actions (tax system and industrial policy aiming to attract fdi, activities of enterprise agencies, reform of the system of education, partnership agreements securing a low wage level for a long period of time). we think additionally to what has been mentioned the role of certain political and cultural factors, economic and social sacrifices made for success are worth attention as well. fast convergence is due to several factors. according to our analysis a possible explanation of the “irish economic miracle” can be conditional convergence. the two known forms of transition paths (delayed convergence, which occurs due to the elimination of barriers to growth and imitation based on adaptation of more developed, more productive technology) strengthened each-other, and three beneficial external factors’ synergic effect (doubling of the eu funds, european single market and a long boom of the us economy) made the convergence so fast and dynamic. we can conclude convergence has happened in ireland. further strengthening of her economic position (foregoing the present leader states) requires her to take part in developing new technologies. the country is committed to this and r&d expenses have been increased seriously even in real terms. irish enterprise agencies have noticed that their strategy needs to be reformed, as competition for international capital escalated and ireland’s traditional competitive advantages, low wages and low taxes are not unique in the eu anymore, and after the new member states in eastern europe accessed the union. new strategic directions were appointed in 2004; the aim is to form new clusters in high value erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 29 added sectors and internationally tradable services. most of the selected industries have antecedents in the country and the necessary regulations are being formed now. based on these facts we can conclude that ireland does not rest in her laurels but takes any steps she can in order to maintain her dynamic growth. according to economic data ireland’s convergence is so successful that she has already foregone almost all her competitors with respect to per capita real gdp based on purchasing power parity (she has foregone most of her eu-member concurrent during 1997-1998, since 2001 only the performance of norway, luxembourg and the usa is higher than ireland’s). convergence has been finished in ireland, moreover, she has even foregone the previous leaders (those member states of the european union whose economic performance was better than hers), and we have witnessed the rare phenomena of leapfrogging in ireland’s case. as we have seen, the direction of the correlation between fiscal variables and the growth rate are the same in each variable’s case in both countries. at the same time, according to our hypothesis the decrease of government sector as a share of gdp (and any other budgetary variables) can not be unrestricted; the pace of growth can not be dynamized by this endlessly. this conjecture of us is strengthened by the fact that underlying processes in the two analysed countries differ. during the analyses of the correlation between most of the fiscal variables and the long run growth rate of the economy we discovered an important statutory. we found a negative relation between the certain fiscal factors and the long run growth rate of the economy in both countries’ case during correlation calculations, but when estimating regression equations we experienced that negative correlation is unambiguous based on hungarian data, but to irish data parabolic regression functions can be fitted in most cases (there are some exemptions like social security contributions, health and productive expenditure). in the case of all the other variables we can conclude that the right hand leg of the irish parabolic function can be regarded as the continuation of the negative regression fitted to hungarian data. this finding can be originated in two reasons. on the one hand, hungarian government’s extension as a share of gdp is higher, than the irish one. for example, the ratio of government expenses to gdp shrunken from 45,3% to 31,5% in ireland during the period in question, while in hungary it fall back from 63,44% to 47,4%, so it is still much higher, than the original level of ireland used to be in 1990. similar tendencies show in the other possible measure of government’s extension, government revenues’ share in gdp. on the other hand, another possible explanation for the divergence in the behaviour of the two countries can be the different situation the two countries are in on their transition paths. ireland stepped on a transition path around 1987. during the twenty years passed, convergence finished and even more, we witness the rare case of leapfrogging. hungary is in quite a different situation after the changing of the regime [erdős (2003) 294 p.], she is on a transition path as well, but her path is very different from that of ireland’s and her lag from the leaders is still very large. the gap is closing from year to year, still, even in 2007 we only achieve 64,5% of the 25 member eu member states’ average per capita gdp based on purchasing power parity. hungary still has a long convergence period to go through. that is why we do not have to expect the tendencies to turn for a long period of time, which means economic analysis (2010, vol. 43, no. 1-2, 25-33) 30 that the advices given by growth theory are worth considering in hungary’s case, based on irelands recent past. in our opinion irish fiscal policy contributes to the slow pace of the necessary fallback in the growth rate at the end of the transition path. the existence of conditional convergence is strengthened by the fact that the pace of economic growth has been slowing in ireland in the recent past. at the same time, we must consider that the present, relatively slower growth is still enviable to most developed countries. it can only be called slow after the outstandingly high growth rate experienced from 1987 to 2001. convergence (as we have already discussed above) has been enhanced by several fiscal and non-fiscal measures in ireland. based on the above analysis we can unequivocally conclude that the radical reform of fiscal policy contributed to the evolution of “irish economic miracle”, or the “celtic tiger” phenomena. figure 1. long run growth rate of the economy as a function of the share of government revenue to gdp in hungary and in ireland government revenue as a share of gdp (moving average) source: own representation source of data used: sourceoecd consistent shrinking of the government’s extension as a share of gdp, maintenance of the budget balance and the decrease of the ratio of state debt to gdp (which the fast growth of gdp used as benchmark also contributed to, of course) eventuated the result anticipated by growth theory, and even contributes to the evolution of the still very favourable (even though slowing) pace of economic growth. we endeavoured to strengthen this result by using the parameter estimates of a third generation empirical study as well. the analysis performed by the model confirmed recent year’s fiscal policy’s beneficial effects on the growth rate of the economy. our findings show that after the millennium, as the growth rate erös, a., the analysis of long run growth, ea (2010, vol. 43, no, 1-2, 25-33) 31 started falling back in ireland, fiscal policy contributed to the relatively slower decrease of the growth rate which is statutory at the end of the transition path. hungary is under pressure in forming her fiscal policy today, the most important task is (beyond growth aspects we are required to meet the maastricht criteria as well) to restore the balance of the budget. fiscal consolidation in hungary started only about a year ago, so it would be quite early to evaluate the long run effects of these policy actions now. hungarian tax wedge can be considered as averagely high compared to other eu member states (hungarian tax wedge is 39,2% of our gdp, while the average of the 25 eu member states is 40,7%). even though compared to other recently accessed member states (their average is 35,2%) and to the irish tax wedge (31,7%) it is quite high. [eurostat, issn 4020-4298] this means we have enough space to shrink the share of tax revenue to gdp, which would be beneficial to growth according to our analysis. according to these findings, from a growth oriented point of view we should rather decrease government expenses in order to restore budget balance, than increase government revenues. opposite to the expansive trends of irish fiscal policy in the 1970’s, the change in fiscal policy’s direction, a gradual shrinking of the budget’s extension as a share of gdp, which started at the end of the 1980’s contributed to the evolution of the „celtic tiger” phenomena. according to our hypothesis it is not enough to concentrate generally on the decrease of government activity’s level as a share of gdp. structure of the budget plays at least as an important role in forming growth performance. to prove our assumption we used the parameter estimates of the already mentioned third generation endogenous bleaney-gemmel-kneller model. the two countries we analyse represent too small a sample to calculate our own parameter-estimates based on them. but as both are developed countries (oecd member states) we found the study’s results (based on oecd member states’ sample) relevant for the countries in question. authors of the study (out of the seven fiscal variables they included in their research) found significant effects of three fiscal variables on long run economic growth: • the ratio of distortionary taxation to gdp, which they attributed negative growth effects to based on the original model of barro’s (1988); • the ratio of productive expenditure to gdp, which turns up with positive growth effects (again, in accordance with the model of barro), and • the ratio of budget balance to gdp (which, again meeting our expectations formed when surveying theoretical and empirical literature) has a positive coefficient the regression equation. these three relevant factors influence the complex effect of fiscal policy actions on the pace of economic growth with different weights, calculated in the third generation empirical study. when evaluating the long run growth effects of irish and hungarian fiscal policies by using the parameter-estimates of the bleaney-gemmel-kneller model we concluded that productive expenditure plays a major role in shaping the overall growth effect of fiscal policy. this was the most obtrusive in the case of ireland, where the decrease in the ratio of productive expenditure to gdp meant the main growth impulse since 2000 (since the pace of economic growth started slowing). in hungary, the dominant element in shaping the favourable long run growth effect of fiscal policy changes was the gradual decrease of the ratio of distortionary taxation to gdp. economic analysis (2010, vol. 43, no. 1-2, 25-33) 32 at the same time we have to consider the increase in the ratio of productive expenditure to gdp in the second part of the time-period, after the years of the bokros-package, which enhanced growth significantly. we calculated a neutral growth effect for the bokros-package by using parameter estimates of the third generation study. this can be attributed to the fact that the positive effect evolving from the improvement of budget balance and the decrease in the share of distortionary taxation to gdp was fully outweighed by the negative effect of the decrease in productive expenditure’s share in gdp. the dominant element again (we have to stress, just like in the case of ireland) was the decrease in the ratio of productive expenditure to gdp. altogether, we wished to demonstrate and strengthen with our analysis that adequately adopted fiscal policy actions are capable of enhancing the long run growth rate of the economy. restoration of the budget balance and gradual (but not unlimited) shrinking of government’s extension as a share of gdp are needed in order to achieve the aimed effect at the same time we must not forget the importance of the structure of revenues and expenditure. reduction of the government expenditure should be done by decreasing unproductive expenditure (as those are neutral to growth). productive expenditure (which enhances growth as we have stated above) should be maintained. references barro, r. j. 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(2005) közpénzügyeink. kjk kerszöv. isbn 963 224 863 5 received: 7 january 2010 article history: accepted: 16 march 2010 ea_2019_2 doi: 10.28934/ea.19.52.2.pp93-103 scientific review comparative analysis of high technology exports and selected innovation indicators for serbia and cee countries darko marjanović1* | deniz ahmetagić2 | isidora beraha1 1 institute of economic sciences, belgrade, serbia 2 faculty of economics in subotica, serbia abstract the article reports on comparative analysis of high technology exports and selected innovation indicators for serbia and three cee countries – hungary, romania and bulgaria for the 2011-2015 period, with an aim to provide an insight on the innovation potential of serbia. the analysis is based on data publicly available at eurostat and the global innovation index rankings. the selection of countries for country comparison is based on many similarities such as historical circumstances and geographical position. htp exports are exports of high technology products as a share of total exports. as for innovation indicators, the article considers the global innovation index (gii) which provides metrics about innovation performance of countries and economies, as well as values of selected inputs contained in the innovation pillar of the gii such as costs, r&d investment (total by sector) and number of researchers (in total and by sector). the analysis shows that there are considerable differences between serbia and the three cee countries. the analysis results are divided into three groups according to impact on the htp export. the first group refers to innovation indicators with significant impact on htp exports such as gdp, number of researchers, the gii rank and r&d costs in the business enterprise sector. the second group are innovation indicators with significant impact on htp export such as total r&d costs, and finally the third group are innovation indicators with little impact on htp export. key words: high technology products, export, global innovation index, serbia, cee countries jel classification: o32, q55 introduction many scientific studies discuss enterprise innovation potential, and thereby reveal that while some struggle to introduce new products through radical innovations, others tend to use the existing knowledge through cooperation as an effective tool for knowledge transfer, thus developing incremental innovations to improve performances of existing products. the innovation process and its results have characteristics of complexity, primarily referring to nonlinearity and multi-level phenomena. (hurmelinna-laukkanen & olander, 2014; martinez-ros & orfila-sintes, 2009; fernandes pacheco dias et al., 2014). as a result of social interactions, technological progress brings changes in technological processes (eisenman, 2013; domazet, 2018), new innovative production technologies are created from which certain categories of products are obtained, thus brining such innovations to new markets innovative products market. this kind of radical innovations enable new * corresponding author, e-mail: darko.marjanovic@ien.bg.ac.rs 94 economic analysis (2019, vol. 52, no. 2, 93-103) products, and as such are difficult and expensive processes leading to break with obsolete knowledge and requiring new, more complex knowledge (stošić et al., 2019). it is important to emphasize that risk associated with radical innovations is greater than risk associated with growth and promotion, but the problem refers to return on investment as early as possible (kennedy et al., 2017). these trade risks come as a result of rapid development of technological innovations and decrease in high-tech products (htp) sales prices, as well as increased competition and short life expectancy of new products, primarily htp, for example, computers recorded a decline in sales prices by around 1% per week (yang et al., 2011). investments in research and development (r&d) are key factor in creating new knowledge, as well as creativity and ideas for design, production and commercialization of htp. it is clear that the level of gdp determines the level of state allocation in r&d activities, but often countries that have the same or similar gdp realize different innovation results and capacities, and they achieve more significant growth, than expected, with regard to resources and potentials (ahlstrom, 2010). by analyzing the data related to serbia and the countries of the region, the question is also raised about the degree to which the cee countries depend on foreign investors to increase their innovation potentials (allen & aldred, 2011). much of the literature gives a pessimistic picture of the ability of the cee countries to emerge from the dependence of being able to achieve economic growth and development with their own radical innovations. the main research objective of the paper is to provide a comparative analysis of htp exports and selected innovation indicators for serbia and the cee countries with an aim to provide an insight on the innovation potential of serbia. the analysis is based on data publicly available at eurostat. literature review most authors point out that in new products development (npds) process, the strategy and the effect of duration of new products implementation depend on the company’s absorption capacity (kiss & barr, 2014). this means that the high-tech cee countries will need to have a far higher level of knowledge and skills in their companies for which an adequate absorption capacity is required between companies in the region (allen & aldred, 2011; domazet & marjanović, 2017). a country’s innovation growth depends to a large extent on how innovation activity is realized and on effectiveness of national innovation system (nis.). a national innovation system (nis) refers to a set of organizations, institutions and their relationships directed towards generation, diffusion and application of scientific and technological knowledge in a country. more precisely, nis is a complex network of enterprises, universities, research and development (ir) institutes, professional societies, financial institutions, educational and information infrastructure, government agencies and public resources aimed at producing, distributing and applying different types of knowledge (kutlača & semenčenko, 2015). lundvall (1992) defines a national system of innovation as the elements and relationships which interact in the production, diffusion and use of new, and economically useful, knowledge ... and are either located within or rooted inside the borders of a nation state. nis largely determines the innovation potential of a country and its economy. for innovative technologies, special knowledge flow is needed between different actors in networks. in these networks, for example, the newly created knowledge is supplemented between two potential partners (firms) (caminati, 2016; chiou et al., 2016) and their knowledge bases serve as an incentive factor for cooperation intensity in realizing innovation activities and radical r&d projects. individual competence of partners in the complex r&d cooperation process determine the level, scope and scenarios of their specialized activities in developing several products (bondarev, 2016). darko marjanović, deniz ahmetagić, isidora beraha 95 there are several concepts and measurements of national innovation capacity through various indicators. "innovation score board" and "global innovation index gii" are among the world's most renowned innovation bases of innovation performance (babić et al., 2015). in this article, we can use gii as a measure of national innovation capacity of the country, that is, its innovation level. this indicator (gii) consists of 7 pillars of various activities, the first five are dedicated to innovative inputs (institutions, human resources, infrastructure, market sophistication, and sophistication of business processes), and the next two relate to innovation autopsies (scientific outputs and creative outputs). competitiveness of an economy or national competitiveness is a complex concept which depends on several factors on both micro and macro levels. in addition to several methodologies for measuring competitiveness of enterprises and economy, the global competitiveness index (gci), defined by the world economic forum, is based on company surveys (cvetanović & sredojević, 2012; tošović-stevanović, 2011). the gci index has many pillars of competitiveness including institutions, infrastructure, education, enterprise sophistication, market efficiency, etc. interpretation of gci has to consider a county’s development level. by analyzing 7 pillars of innovation (gii) and 12 pillars of competitiveness (gci), we found structural similarities. innovation is a prerequisite for increased competitiveness. according to the world economic forum methodology, there is a direct correlation between quality of national innovation system and competitiveness of economy (cvetanović & sredojević 2012). the basic issues of theoretical discussions on competitiveness are between the theory of comparative advantage and the framework of competitive advantage with the first paragraph relating to ricardo and the other to porter (croes & kubickova, 2013; marjanović, 2018; paraušić et al., 2017). the manifestation of national competitiveness is reflected in capability to supply customers with competitive products (igor gurkov, 2005), as competition is pushing for continuous search for new products, and that requires new knowledge growth coming from different sides in the communications between companies in the global world market. (golebiovski & lewandovska, 2015; domazet & marjanović, 2018). creativity should be encouraged within companies. also, countries have different innovation potentials (marjanović & domazet 2018). as a result of creativity, knowledge is transformed into new products, services or processes. however, creativity is necessary but not a sufficient condition. to be complete it must be achieved through innovations that use new or existing ideas transforming them into actions (stošić et al., 2013). unlike creativity which is often defined as an individual cognitive process, innovations arise from complex inter-individual and social processes that occur within a company (anderson et al., 2014). creativity is a complex process and phenomenon which involves not only new ideas generation, but different ways of thinking at different organizational level in a company. however, innovation is achieved by studying, processing and applying an idea for a product or service (adam & clelland, 2002). there is no creativity without new knowledge, and new knowledge is gained through research, individual and team activities. new knowledge creation occurs from interactions in various fields of activities, and most obviously in new products development (de massis et al., 2016). new knowledge that is created from different activities must be adequately managed and targeted. this is particularly important in terms of new products development (npds). considering npds, if various functional knowledge is inadequately used and combined within a company, then the acquired experience and resources which could be useful for further new products creation, will be inadequately stored, and will reduce the possibility of knowledge acquisition, accumulation and transfer and that is critical for npd as it is dynamic and rapidly repeating process (ordanina et al., 2008). a company must be capable to acquire new knowledge from recombining and applying the existing one to new products development along with new knowledge (enkel & heil, 2014), and its reaction to the perception of a competitive company with high absorption capacity can be withdrawal from further innovation in the area where a competitive company of higher absorption capacity is located or, more importantly, to increase its own research and 96 economic analysis (2019, vol. 52, no. 2, 93-103) innovation efforts and activities by continuously acquiring new knowledge in order to find themselves in front of a market competitor (cuerro-cazurra et al., 2018). in terms of innovation performance, serbia is lagging behind the new eu member states i.e. hungary, romania and bulgaria, and it is even more emphasized in comparison with more developed eu countries. abandoning planned economy, not being followed by qualitative shifts in organization, management, entrepreneurship, innovation culture, politics, legislation, etc., has not and will not introduce the cee countries directly into the market economy as predicted by the neoclassical transitional theory (mikl-horke, 2004). consequently, many problems have arisen in these countries’ economies and societies. the cee countries, and particularly the private sector, have experienced a strong influence of principles and practices from the west. however, the question arises as to the extent to which the individual cee countries are in capitalism, how innovative the absorption capacities of knowledge and skills firms are necessary for the htp production (allen & aldred, 2011). without an adequate absorption capacity of the cee countries, and serbia, they will not be able to produce and export high-end products, regardless of their access to a relatively cheap labor force. competitiveness is the key factor driving faster economic growth and higher living standards. the question is how companies can practically increase their innovations through major investments in r&d activities. research findings show (anderson et al., 2014) that high level of innovation is provided by companies that carry out innovative employee trainings, apply salary system based on performance, foster employee independence and creativity, have flexible working hours and fluctuations, etc. data and methodology in order to achieve the stated objective of the paper, a comparative analysis of htp exports and selected innovation indicators for serbia and the cee countries is conducted. the analysis is based on data publicly available at eurostat and the global innovation index rankings. htp exports are exports of high technology products as a share of total exports. as for innovation indicators, we considered the global innovation index (gii) which provides metrics about the innovation performance of countries and economies, as well as values of the following inputs contained in the innovation pillar of the gii: costs, r&d investment (total by sector) and number of researchers (in total and by sector). a comparative analysis is conducted to provide an insight and better understanding of innovation potentials and particularly of serbia based on the value of htp exports, the global innovation index, r&d investments and number of researchers. research results based on the eurostat database, the fair value of htp export, the values of global innovation index (gii) and values of inputs such as costs, r&d investments and number of researchers are presented. the data presented in graph 1 shows the share of exports of high-tech products (htp) for serbia and the selected cee countries. in the observed period 2011-2015, the average value of htp exports for serbia was 2.3%, while the same indicator for bulgaria, romania and hungary was 4.1%, 6.9% and 16.8% respectively. darko marjanović, deniz ahmetagić, isidora beraha 97 graph 1. share of exports of high-tech products (htp) source: eurostat considering the value of export of htp as a share of country’s total export, serbia significantly legs behind the cee countries. in 2015, the export of htp in bulgaria accounted for 4.6% of country’s total exports, in romania it accounted for 7.3%, while in hungary it accounted for 15.2% of country’s total export which is more than six times larger than the value for serbia. gaining competitiveness of htp on the world market is more significant than competitiveness of products of middle or lower level of technology. considering the value of gdp per capita as a potential source of funding for r&d, there is a notable oscillation in the figures for serbia. serbia’s gdp for 2015 was 5,237 usd and for 2011 was 6,423 usd, the last being the highest recorded level in the observed period. when comparing the gdp figures of serbia and the cee countries, the findings show that hungary recorded the highest average gdp per capita in the observed period. hungary recorded the average gdp per capita of 13,396.1 usd, romania of 9,264.6 usd, bulgaria of 7,542.7 usd, and serbia of 5,874.8 usd. the data shows that serbia is falling behind the cee countries whereas its gdp per capita was twice as lower than in hungary. graph 2. gdp per capita (us$) source: eurostat also, the findings indicate a significant lagging of serbia in terms of r&d expenditure. in 20112015 period, serbia’s average r&d expenditure as a percentage of gdp was 1.34%. additionally, 98 economic analysis (2019, vol. 52, no. 2, 93-103) the innovation activity of the serbia’s non-profit sector is rather insufficient. the serbia’s lowest recorded value of gdp per capita in comparison with other analyzed countries is a limiting factor for r&d activity. these allocations also determine the number of actors in innovation process and their allocation by sector. when analyzing high-tech products, their specific characteristics must be considered (yang et al., 2011), such as: shorter product life, need for rapid response as prices fall, demand for global co-operation and ability of firms to adapt to new market demands in a flexible or rapid manner. the global innovation index (gii) for serbia, bulgaria, romania and hungary is presented in graph 3. the gii ranking for the surveyed countries show that hungary recorded the highest values during the five-year period, while serbia holds the worst position. also, when looking at the average value of gii as an indicator of a country’s innovation capabilities, serbia is ranked the lowest (37.31), while hungary, bulgaria and romania recorded higher values (45.83, 40.67, 38.25 respectively). graph 3. global innovation index rankings source: gii report the average recorded r&d investment as a percentage of gdp in the observed period was 1.32 for hungary, 0.78 for serbia, 0.70 for bulgaria and 0.45 for romania. the findings show significant oscillations in terms of r&d investments of the business enterprise sector by countries and by years. the highest average value was recorded for hungary (0.91%), while bulgaria recorded 0.45%, romania 0.17% and serbia 0.16%. the sector’s costs in serbia are three times lower than in bulgaria, and five times lower than in hungary. the r&d spending of the public sector ranges between 0.16% and 0.24%, as shown in graph 4. serbia recorded the average r&d investment as a percentage of gdp of approximately 0.23%, while the other three countries recorded an average of 0.19%. the data indicates the public sector records higher investments in serbia comparing to other observed countries. higher education expenditure on r&d varies greatly across concerned countries. serbia recorded the most considerable spending (0.39%), while bulgaria, romania and hungary recorded significantly lower expenditures (0.05%, 0.09%, and 0.20% respectively). the sector’s costs are two times higher in serbia in comparison with hungary, and notably higher than in romania and bulgaria. the r&d costs of the private non-profit sector are negligible, and the data are incomplete. darko marjanović, deniz ahmetagić, isidora beraha 99 graph 4. r & d costs source: eurostat graph 5 shows the total number of researchers in 2011-2015 period for all four considered countries. the average number of researchers in hungary was 37,739, in romania 26,865, in bulgaria 15,976, and in serbia 14,166. the figures show that serbia has approximately the same number of researchers as bulgaria, but that number is significantly higher in romania, and especially notably higher in hungary. graph 5. total number of researchers source: eurostat the number of researchers engaged in the business enterprise sector in serbia increased greatly over the observed period (165 in 2011 and 1,467 in 2014). however, this number is still significantly lower for serbia comparing to three other observed cee countries. an increase in the number of researchers engaged in the business enterprise sector in serbia is still insufficient, particularly considering the figures for bulgaria (3.969), romania (5.848), and hungary 100 economic analysis (2019, vol. 52, no. 2, 93-103) (17.008) recorded in 2014). the number of researchers in this sector in serbia accounts for less than 10% of the number of researchers in hungary. conclusion the analysis shows that there are considerable differences between serbia and the three cee countries. serbia recorded almost two times lower export of htp comparing to bulgaria, and notably lower export comparing to romania. hungary’s export of htp is larger than those of serbia, romania and bulgaria all together. because all three cee countries recorded significantly higher exports of htp in comparison with serbia, an analysis of innovation indicators having considerable positive impact on the increase in htp export was conducted. the analysis results are divided into three groups according to the impact on htp export. the first group refers to innovation indicators with significant impact on htp exports such as gdp, number of researchers, the gii rank and r&d costs in the business enterprise sector. the second group are innovation indicators with significant impact on htp export such as total r&d cost, and finally the third group are innovation indicators with little impact on export of htp. the analysis indicates that the impact of gdp on htp export is the largest. this particularly provides valuable insight for serbia since it records significantly lower figures of gdp comparing to the cee countries. also, the gii ranks as a measure of innovation capabilities are higher for hungary, bulgaria and romania comparing to serbia. considering that gdp is a basis for r&d expenditures of a country, major improvements are necessary for serbia to provide financial and general conditions for increased investments in r&d. also, the structure of r&d investments within the existing level of r&d cost allocation is rather challenging issue for the serbian policy makers. the data show that serbia recorded an average r&d investment in the business enterprise sectors of 0.16%, romania 0.17%, bulgaria 0.45% and hungary 0.91%. accordingly, the figure for bulgaria is more than two times higher and the figure for hungary is more than five times higher comparing to serbia. also, the data analysis of the number of researchers point out that serbia recorded the highest number of researchers in the higher education sector (70%) but with no positive impact on htp exports. serbia recorded the least number of researches in the business enterprise sector (10%) which significantly negatively affected the export of htp. the analysis of the gii ranking considering a very complex set of indicators on innovation capabilities showed that serbia holds the worst position among surveyed countries. based on the conducted data analysis, significant changes in the serbian innovation policy are necessary particularly concerning the expanding role of human resources at universities and research institutes, more rational management of existing r&d capacities and infrastructure, as well as increased co-operation and coordination of institutions and different actors in the innovation ecosystem. increasing public and private r&d investments would positively influence scientific and creative outputs contained in the htp exports. the serbia’s share of r&d investment indicates that there is potential for improvements since the figures are not the lowest in comparison with other surveyed countries. serbia recorded two times larger r&d investment than romania, almost the same as bulgaria, and significantly lower than hungary. the gdp as an indicator of economic strength and the basis for r&d activity is a limiting factor for serbia. according to the world bank data for 2015, serbia’s gdp was 37.16 billion usd, bulgaria’s 50.20 billion usd, romania’s 177.50 billion usd, and hungary’s 121.70 billion usd. the size and strength of an economy measured by its gdp indicates that serbia is behind the observed cee countries. serbia’s gdp is 35% lower than that of bulgaria, more than four times than of romania and more than three times than gdp of hungary. darko marjanović, deniz ahmetagić, isidora 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(2019) https://www.wipo.int/publications/en/details.jsp?id=4434 (1.8.2019). article history: received: september 29, 2019 accepted: november 8, 2019 microsoft word 2010_3_4.doc scientific report cognitive microfoundations for the economics of nonrival goods * simandan dragos**, brock university, canada udc: 330.341 jel: o31 abstract this paper shows that the economics of nonrival goods cannot be fully comprehended without taking into account the role of intelligence differences among economic agents. the analysis focuses on paul romer’s contributions and explains that the study of the economics of ideas (memes) through an institutional lens alone misses the crucial economic implications of the interplay between genes and memes. ideas appear to be nonrival if and only to the extent that we neglect wide individual differences in the capacity to appropriate ideas. differences in intelligence among humans make the theoretically and politically appealing non-rivalry of ideas a practical falsehood key words: paul romer, innovation, imitation, nonrival goods, intelligence, creativity, knowledge spillovers, positive feedback loops introduction this paper assumes a readership fully familiar with recent developments in new growth theory (helpman, 2004) in general, and with paul romer’s path-breaking “endogenous technological change” (henceforth etc; 1990; see also romer, 2007) in particular. instead of joining the chorus of those who praise his contribution, i want to begin to outline the reasons that led me to believe that his theory fails to explain the totality of available evidence. i do not use “explanatory failure” loosely, but in the very precise sense deployed in epistemology (lipton, 2004). other things being equal, when assessing a number of competing explanations for a given set of phenomena, we have to rank higher that theory that best accounts for the whole set of phenomena to be explained. if a theory explains only part of the explanandum, we can say that it fails to explain, i.e. the explanans is incomplete. very often, explanatory failure becomes apparent over time, as new scientific facts are uncovered. the addition of new facts to an old set of facts can dramatically change the kinds of inferences that can be drawn, a phenomenon known in meta-logic and the philosophy of reasoning as the non-monotonicity of induction. as it will become apparent from the references that i cite to support my argument, many of the facts that romer’s theory fails to explain have been uncovered since the publication of etc. this means that my analysis should be read not so * acknowledgments: thanks to jeff boggs for reading an earlier draft of this paper and pointing out sections that needed a clearer phrasing. ** e-mail: simandan@brocku.ca economic analysis (2010, vol. 43, no. 3-4, 87-96) 88 much as a critique, but as a challenge to romer to adjust his theory to account for the new facts adduced against his hypothesis. factors of production instead of the old division of factors of production into labour, land, and capital, romer prefers the trichotomy people-ideas-things. the advantage of this new classification is twofold: on the one hand, it singles out ideas as crucial to productivity; on the other hand, it alerts us to beware of conflating people with ideas by means of some vague phrase such as “human capital”. i think he could have gone farther than this, by appropriating keith stanovich’s (2004) conceptual dissection of the human subject into genes, memes (i.e. ideas; see heylighen & chielens, 2008), and the vehicle. each and every human being is best conceptualized as a vehicle, a carrier that both genes and memes use to spread themselves. the obvious advantage of this framework consists in the insight that what makes us human is the result of the interplay of genes and memes, i.e. of biology and culture. its much less obvious advantage derives from the insight that ideas cannot be analysed separately from genes, that their impact depends crucially on their match or mismatch with the genes. romer missed this latter insight in a way that profoundly undermines the quality and completeness of his account of economic growth. intelligence differences, social class, and education part of the reason why humans differ from one another is genetic. if we think of an infant’s sex, eye colour, or hair colour, that much is unproblematic. things become more political and more unpleasant when we add the mounting body of evidence (conveniently ignored by heckman, 2008) from both behavioral genetics and molecular genetics that shows differences in iq (rushton & jensen, 2005, deary et al, 2006, pol et al, 2006, shaw, 2007, manning, 2007, miller & penke, 2007, plomin et al, 2007, friedman et al, 2008) and creativity (reuter et al, 2006, simonton, 2007, 2008) among humans to be largely the result of different genetic endowments. to make things worse, iq is significantly correlated with creativity (kuncel et al, 2004, preckel et al, 2006, lubinski et al, 2006, park et al, 2007, simandan, 2008, silvia, 2008), a correlation most probably explained by shared genetic factors (chiappe & mcdonald, 2005, plomin et al, 2007, cochran et al, 2007, lynn & kanazawa, 2008). contrary to common prejudice among the social scientists, iq is not a proxy for one’s parents’ social class (gottfredson, 2009, in press; simandan, 2009a). the correlation between a child’s iq and parent’s social class found in most studies is less than 0.35, which means that 87.75% of variance in iq cannot be explained by parent’s social class (a most recent study by gale et al (2009) found the correlation between iq and parent’s social class for two different british cohorts to be 0.25 and 0.29 only!). in other words, explanations of human inequality cannot simply ignore intelligence differentials by assuming that they are an epiphenomenon of the real cause – social class differentials. it is wishful thinking to assume that iq can be boosted through education or special training both reliably and substantively. the reason is four-fold. first, scholars in the field have begun to make the distinction between iq and rationality (stanovich, 2009). the first term refers to the common source of inter-individual differences simandan, d., cognitive microfoundations, ea (2010, vol. 43, no. 3-4, 87-96) 89 in the capacity to acquire capacity. it is a complex biological property of the brain having to do with total brain size (miller & penke, 2007; r = .40-.45), volume of gray matter (colom et al, 2009), properties of the white matter (fields, 2008, ullen, 2008), the balance between neural inhibition and neural excitation (fernandez & garner, 2007), the relative proportion of the types of oligodendrocytes and neurons available (mercado, 2008), the architecture of the cholinergic and dopaminergic pathways, etc. the second term, rationality, refers to what lay people usually mean by intelligence – common sense, sound judgment, maturity, knowledge. although an average iq is a necessary condition for the acquisition of rationality (i.e. a behavioral repertoire of far-sighted, mature, and efficient “if-then” situation-action pairs), iq alone is not a sufficient cause for rational behavior to occur (sternberg, 2002). the other ingredients include personality factors and good education. whereas rationality (including knowledge) can be boosted through education (stanovich, 2009), iq (more technically the g factor) is a matter of genes, epigenetic perinatal and neonatal injuries, nutrition, and health (lynn, 2009). in short, rationality is social, iq is mainly biological. second, there is now convincing evidence from both third world and first world countries that clearly shows that: a) children’s fluid intelligence (i.e. by and large, the g factor) grows at the same rate regardless of whether they go to school or not (the key reference is brouwers et al, 2006), and b) verbal intelligence does not increase at all with the increase in the number of years of education (the key references are nie et al, 2007, and nie & golde, 2008 for the data, and jensen, 2001, for understanding why). one’s knowledge base is the result of the interaction between one’s iq and one’s opportunity to learn. because increased schooling means increased opportunity to learn, the common misconception that schooling boosts iq can be explained as the result of 1. the conflation of iq with knowledge/rationality, and 2. the deliberate forgetting that schooling can increase knowledge not via the increased iq causal pathway, but via the more prosaic increased-opportunity-to-learn causal pathway (see also watkins et al, 2007, simandan, 2009a). third, there is now a well-documented sad history of the failure of programs of early intervention for the low iq children to generate sustained significant increases in iq. they succeed in boosting iq immediately after the end of the program, but when iq is measured again several years later almost all the apparent gain is lost (the most recent serious analysis of these early interventions is in murray, 2008; to be contrasted with heckman, 2008 and his topic-related papers). fourth, after the recent media hype about the ability of working-memory training to improve iq, a number of respected scholars have begun to publish new research as well as re-analyses of the data from the very studies that prompted that media hype. this new, more rigorous wave of scholarship, casts serious doubts on the hypothesis that working-memory training could improve iq scores (see moody, 2009; colom et al, 2010; lövdén et al, 2010). the tradeoff between innovation and imitation why is this evidence damaging to paul romer’s theory? it is damaging because he completely neglects the gene*meme interplay and chooses to study the economics of ideas through an institutional lens alone. for him, the problem of economic growth is reducible to the problem of how to best manage an inherent tension in the dynamics of ideas. on one economic analysis (2010, vol. 43, no. 3-4, 87-96) 90 hand, governments should encourage invention, innovation, and creativity, and the best way to do this is to provide institutional incentives to the innovators (patents, copyrights, etc). on the other hand, governments should encourage the wide propagation of good ideas, in order to maximise the economic returns from them and to spur further waves of innovation. but the second desideratum (henceforth referred to as the imitation problem) is undermined by the first desideratum (henceforth referred to as the innovation problem). how can one encourage innovation without damaging the rate and scope of imitation is romer’s central research puzzle and so far he has attacked it by a careful analysis of the divergent logic of two key institutions: the market and science. he does not have yet an answer, but he does have a meta-answer, i.e. an answer about how the answer should be like. more precisely, he insists on the role of meta-ideas, i.e. generating good ideas about how best to manage the innovationimitation conundrum. and i emphasised in the text “how best to manage” to bring out the fact that romer sees government intervention as fundamental to economic growth. he also sees that the quality of the human stock is crucial, because he mentions the need for the government to invest in education and to give portable scholarships to talented youngsters interested in science and engineering. what he fails to see is that the quality of the (local) human stock is not a variable that governments can control via the right incentives. i adduced evidence showing that both creativity and iq are largely under genetic control, and that they are positively correlated. creativity is the key concept that maps into romer’s innovation problem, and iq is the key concept that maps into romer’s imitation problem. since both share common genetic variance, both of romer’s problems drive us to conclude that economic prosperity at the individual level critically depends on genes (for a dramatic demonstration see murray’s 2002 comparison of the incomes of siblings differing in iq). the cognitive microfoundation of innovation here is how romer stumbles. within the innovation problem, one cannot assume that more scholarships to science-inclined individuals will linearly increase the number and quality of innovations. the probability of significant discoveries increases with higher iqs, but higher iqs are very improbable. the work of wai et al (2005), benbow et al (2006), lubinski et al (2006), and park et al (2007) clearly shows that very high iq individuals are more likely to generate patents, but very high iqs are very rare (e.g. for iq 160, 1 in 10,000 individuals). it is very likely that they would easily obtain some of the scholarships already available anyways. by generating more opportunities for scientific research (more doctoral fellowships, etc) the government does nothing but move the bar of selection for scholarships from the far-right end of the normal distribution of intelligence toward its middle. as the quality of the researchers decline, so does the return on investment in scientific innovation (as an aside, this is also the reason why scientific progress cannot naively be measured by number of researchers or number of publications; see also rescher, 2006). this is not to say that there is nothing that governments can do to increase the number of high iq individuals available. clever schemes of immigration policy (for canada, see simandan & boggs, 2007) can and do silently select for intelligence, fact which begins to explain both the continuing growth of developed countries and the increasing gap between the rich and the poor countries. given that a) the key constraint on innovation is high iq (via the correlated high simandan, d., cognitive microfoundations, ea (2010, vol. 43, no. 3-4, 87-96) 91 creativity), b) iq is under genetic control (we have no idea whatsoever on how to increase one’s iq from 115 to 160), and c) high iq individuals are very rare, it follows that the innovation problem at the international level is a zero-sum game. more to the point, those countries that have or will acquire the largest number of very smart individuals will lead in technological innovation, and those countries that don’t have or lose their smart individuals will lag well behind. this is not a prophecy. it is what the actual data show (dickerson, 2006, jones & schneider, 2006, lynn & vanhanen, 2006, whetzel & mcdaniel, 2006, ram, 2007, hunt & wittmann, 2008, rindermann, 2008, gelade, 2008). the cognitive microfoundation of imitation but romer stumbles when analysing the imitation problem as well. iq is the single most important predictor of the ability to learn quickly (duncan et al, 2008) and thoroughly (kuncel et al, 2004, deary et al, 2007). this is the same thing with the ability of a human vehicle (stanovich, 2004) to download memes to her brain, or with the ability to profit from someone else’s ideas by appropriating them. romer gets it wrong because he focuses on the misleading presumption that ideas are non-rival goods. but the abstract theoretical point that nothing in principle can prevent one and the same idea/meme/theory to be lodged and used by different brains becomes a falsehood when seen in the context of the actual cast of characters that make and remake the economic world. ideas are non-rival if and only if we neglect wide individual differences in the capacity to appropriate ideas. even if anybody is free to read a statistics textbook at the local public library, not everybody will understand its contents. the good is free, but just as you can’t load furniture on a bike, you can’t load certain ideas on low intelligence brains. differences in intelligence among humans make the theoretically appealing non-rivalry of ideas a practical falsehood. but the inability of low intelligence brains to appropriate difficult ideas is theoretically and politically significant not because it falsifies romer’s account but because it may well turn out to be the best explanation of human inequality we have. the crux of the matter is that the difficulty of a set of ideas is often correlated with its usefulness. learning statistics is not only more difficult but also more socially and personally useful than learning the names of soccer players in the local team. the former might earn one a job, whereas the latter will at best earn one some cheers from onesʹ buddies. difficult-to-master ideas/memes are more useful to those who master them either because a) they can be used to solve difficult real-life problems (e.g. statistics, see simandan, 2010) or because b) their mastery is a difficult-to-fake indicator that their possessor is a smart individual (e.g. poststructuralist theory), or, more commonly because of a combination of the two factors (arrow, 1973, spence 1973, gottfredson, 1985). smart brains master difficult ideas, which means that by detecting such brains and hiring them one can acquire not only actual capacity (their knowledge of a set of difficult and useful ideas) but also potential capacity (their ability to quickly grasp and recombine other difficult and useful ideas). intelligence-driven geographical differentiation of economic wellbeing significantly, one of the best ways to gravitate towards complex ideas is to gravitate towards those who host those ideas, i.e. other great minds. birds of a feather flock together economic analysis (2010, vol. 43, no. 3-4, 87-96) 92 (simandan, 2006, 2008, 2009a). here we get into the geographical-economic problem of positive externalities of human capital, neighbourhood effects, the contagion of genius, knowledge spillovers – theorised by economists ever since marshall, but in complete disregard of the literature on individual differences in intelligence and, even more relevant, of the literature of interaction effects between people of different iqs (gordon, 1997, day et al 2005, simandan, 2006, 2008, jeong & chi, 2007). conversely, dull brains are unappealing, and therefore poorly paid, both because the kinds of things they know are not particularly difficult (and hence supply is abundant) and because they signal that one cannot rely on their acquiring of difficult ideas in a reasonable time (let alone on their creative recombination of these ideas). this is the gene*meme interplay problem i mentioned earlier: the best minds gravitate towards the complex ideas and the encounter generates further great ideas, whereas the average and below-average minds gravitate towards trivial ideas and the encounter generates further trivialities (e.g. belief in god in general and religious dogmatism in particular are negatively correlated with iq across countries and within countries; see lynn et al, 2009). the economic inequality that ensues is the dark side of these gravitational pulls (or, more exactly, of these positive feedback loops). of relevance, this inequality becomes magnified across generations via geographical effects, in a path-dependent manner: the smart neighbourhoods or countries enter a virtuous spiral of high quality knowledge spillover and economic growth; the less smart neighbourhoods or countries become trapped in a vicious spiral of low quality knowledge spillover and economic stagnation. so much for gerschenkron’s convergence debate. romer’s solution to economic development is to encourage innovation in developed countries and imitation of these innovations in third world countries. developed countries can increase their innovation rate by stealing the bright brains of third world countries. what is left behind in the third world countries is low intelligence. the question is whether successful imitation can occur in these conditions (clark, 2007, simandan, 2009b). the majority of third world countries seem to have their average intelligence well below the western mean (iq 100; rindermann, 2007). not surprisingly, the severity of their economic situation is negatively correlated with their iq (rindermann, 2008) and gelade’s (2008) analysis strongly suggests that iq is a cause and not an effect of economic development. conclusion i hope i have begun to sketch why romer’s etc is an explanatory failure and why economists cannot explain much about economic growth if they don’t engage with the scholarship on individual and national differences in intelligence. both innovation and imitation are partly determined by iq differentials both among individuals and among countries. romer is to be praised for having analysed those factors other than iq that matter; but he overlooked the single most important constraint to economic growth: human intelligence and its wide dispersion. the economics of nonrival goods must dwell on these cognitive microfoundations or else it will fail to deliver on its promises. simandan, d., cognitive microfoundations, ea (2010, vol. 43, 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yale university press. ullen et al (2008) intelligence and variability in a simple timing task share neural substrates in the prefrontal white matter, the journal of neuroscience 28(16):4238-4243. wai, j., lubinski, d. and benbow, c. p (2005) vocational achievement and creativity among intellectually precocious youth: an age 13 to age 33 longitudinal study. journal of educational psychology, 97: 484-492. whetzel d l, and mcdaniel m a (2006) prediction of national wealth intelligence 34 (5): 449-458. watkins, m. w., lei, p. and canivez, g. l (2007) psychometric intelligence and achievement: a crosslagged panel analysis. intelligence. 35(1): 59-68. received: 12 may 2010 article history: accepted: 30 august 2010 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp95-108 original scientific paper impact of economic freedom on total factor productivity in former socialist countries zoran borović1* | dragan gligorić1 | jelena trivić1 1 university of banja luka, faculty of economics abstract total factor productivity (tfp) is the portion of the country's output not explained by the amount of inputs used in production. the main goal of the present paper is to estimate the total factor productivity levels and then determine the long-term impact of economic freedom on the tfp in ten former socialistic countries, which are full eu members since 2000. to estimate the tfp we have applied the fixed effect panel on standard cobb-douglas production function in per capita terms. in the second iteration we have used pmg ardl model to estimate the long-term impact of economic freedom on the tfp. this research has proven that higher level of economic freedom, which is used as a proxy of the quality of the institutions and institutional framework, caused higher level of total factor productivity in the period 2000-2018 in the case of ten former socialistic countries which are full eu members since 2000. the obtained results enable us an insight in policies which are important for efficiency increase and economic performance. our finding could be very useful for policymakers, stressing which policies are contributing to efficiency, and which are not. so that policymakers could intervene in the way to increase the quality of institutional framework and economic institutions. many other studies investigate the tfp and growth, or growth and institutional framework for the countries of central and east europe. our survey is among the first to investigate the long-term impact of the institutional framework and economic institutions on the countries efficiency for this countries. our survey enables us an insight into the mechanism through which the institutions can positively impact the tfp through increasing the predictability and reducing the uncertainty for ce countries. key words: growth, total factor productivity, economic freedom, institutional framework, cobb‐ douglas production function jel classification: o30, o38, f20 introduction intense and ruthless competition is the main characteristic of modern capitalism. the technological development, which leads to increased efficiency, represents the concrete foundation of sustainable growth in the environment which is characterized by fierce competition. the neo-classical model of economic growth specifies that technological progress is exogenous. on the other hand, the endogenous growth theory suggests that technological development is created within the economic system, and it is affected by economic decisions. the quality of institutions and institutional framework, and their impact on efficiency has been in the focus of recent growth literature. one of the main questions in economic literature regards * corresponding author, e-mail: zoran.borovic@ef.unibl.org 96 economic analysis (2020, vol. 53, no. 2, 95-108) the differences in life quality between rich and poor countries. many authors, like hall and jones (1999) and acemoglu, johnson and robinson (2008), claims that these differences in wellbeing can be explained by differences in quality of institutions and institutional framework. this study relies on the so-called today “new institutional economics and development literature”. the incentives of the key economic actors are shaped and influenced by economic institutions. the production organization, investment in human and physical capital, decisions between investments and savings, technological progress, are all shaped by economic institutions. in our survey, we use the economic freedom as a proxy of the quality of the institutions and institutional framework. there are two economic freedom indexes which have been used in economic literature to measure the quality of institutions and institutional framework. the economic freedom index (efi) represents the first attempt to quantify the quality level of institutions and institutional framework., and it is reported annually by the fraiser institute in the report called economic freedom of the world. the fraiser institute started the freedom of the world project with milton rose and friedman in 1986. the index of economic freedom (here and after ief) is published by the heritage foundation in cooperation with the wall street journal. as berggren states, ``economic freedom is a composite that attempts to characterize the degree to which an economy is a market economy—that is, the degree to which it entails the possibility of entering into voluntary contracts within the framework of a stable and predictable rule of law that upholds contracts and protects private property, with a limited degree of interventionism in the form of government ownership, regulations, and taxes`` (berggren, 2003. p 194). total factor productivity (here and after tfp) is the portion of output not explained by the amount of inputs used in production (comin, 2008). regarding the tfp, our position is close to the "conventional view", in according which, changes in tfp measure the rate of technical change (law, krugman, young). in our paper, we use the tfp as the best expression of the efficiency of economic production. many studies conducted by solow (1957), hall and jones (1999), and more recently, caselli (2005) and jorgenson and vu (2010), have proven the hypothesis that the tfp represents an important channel, through which economic freedom impacts the gdp per employee. in this survey we investigate tfp determinants by focusing on economic freedom. we conduct our analysis on ten former socialist countries which are a full european union members since 2004 (bulgaria, czech republic, estonia, hungary, latvia, lithuania, poland, romania, slovak republic and slovenia). they were all a part of socialist economic system with central planning. these countries have changed their economic system and shifted from socialism to capitalism. our survey cover the time period between 2000 and 2018. this study is organized as follows. after this introduction, in the second section, we present a critical review of the existing literature regarding economic freedom and tfp. in the third section, we provide the model specification and used methodology. empirical results and discussion are presented in the fourth section, while the fifth section concludes the paper. literature review there are numerous studies which focus on the impact of economic freedom on the economic growth (ayal and karras, 1998; gwartney et al., 1999; heckelman, 2000; de haan and sturm, 2000; dawson, 1998). in all these studies, the researchers came to the same conclusion, that economic freedom does have a positive and statistically significant impact on the economic growth. economic freedom is guaranteed by an institutional structure. this means that liberal market economy creates an environment that is both augmenting growth and accelerating development (ulosoy and tas, 2017). even though there is a consensus regarding positive impact of economic freedom on the economic growth, many researchers have find that subcomponents of both economic freedom indexes can have positive or negative impact on economic growth. zoran borović, dragan gligorić, jelena trivić 97 acemoglu (acemoglu et al., 2004) states that quality institutions are of great importance for the productivity and economic growth. according to henry (henry, 2003) economic freedom have a positive impact on the physical capital. the mechanism is very simple, the higher the economic freedom is, the more will economic actors save and invest, thus, increasing the physical capital. high level of economic freedom means free international trade. according to cagetti and denardi (2006), removing the restrictions on capital movements between countries will increases the supply of venture capital, which may lead huge increase in innovation. impact of the fdi on the tfp, both in the host and in the home country has been investigated by a number of authors. there are two channels through which the fdi inflow can positively affect the tfp in the host country (griffith, et al. 2003). on one hand, the fdi inflow can lead to the increase in the competition, which might result in speeding up domestic innovative outcomes. on the other hand, as the result of the fdi inflow, the host country is expected to benefit from the technology transfer (keller, 2004). these positive effects of the fdi inflow are much more important for less developed economies, because of their larger distance to the international technological frontier. according to aitken and harrison (aitken and harrison, 1999), the developing countries might be unable to utilize the benefits of fdi inflow due to their weak absorptive capacity. analogously, if the knowledge-base synergies are strong enough to flow from the host to the source country, the home country will benefit from productivity increase. the positive effect on tfp growth rate can be achieved through the openness in international trade (alcalá and ciccone 2004; coe and helpman 1995; greenaway and kneller 2007; wagner 2007). trade flows of goods and services, similarly as in the case of fdi, might lead to an increased competition of domestic sectors. bjørnskov and foss (2010) have stressed that high level of regulation, sound money, judicial system, security of property rights, openness to international trade and investments, all have a positive impact on tfp. on the other hand, high taxes and large government can have both, positive and negative impact on the tfp. the institutions with high level of economic freedom can positively impact the tfp through reduction of transaction costs, increasing the predictability and reducing the uncertainty. this positive impact is direct result of the favorable environment for the entrepreneurial experimentation that lead to productivity-enhancing innovations in products, processes and ways of organizing productive activities (bjørnskov and foss, 2010). model specification and methodology our analysis is split in two iterations. in the first iteration, we will estimate the tfp levels over time and across countries. in the second iteration, we will investigate the impact of economic freedom on the tfp. to estimate the tfp, we will apply the cobb-douglas production function. our analysis is based on the assumption that all analyzed countries are very homogenous in relation to structural and institutional factors affecting productivity. the standard cobb-douglas production function can be written as: 𝑌 𝐴𝐾 𝐿 (1) , where y represents output or real gdp, the k stands for the economy-wide capital stock, l represents employment and α is the elasticity of output to capital. the a is interpreted as the tfp. with some rearrangement, the standard cobb-douglas production function is transformed into a log-log model: ∆ log 𝑌 ∆ log 𝐴 𝛼∆ log 𝐾 1 𝛼 ∆ log 𝐿 (2) 98 economic analysis (2020, vol. 53, no. 2, 95-108) the modern economic literature is rich with empirical approaches for tfp evaluation (see. welfe (ed.) 2007; severgnini and burda, 2010, pp. 447–466; gehringer et al., 2014). the tfp estimation is also split into two iterations. our analysis is based on the approach proposed by tokarski (tokarski, 2008) and later, used by balcerzak and pietrzak (balcerzak and pietrzak 2015a; 2015b, 2016). firstly, the cobb-douglas production function is estimated in per capita terms: log 𝑦 𝑐 𝑔𝑡 𝛼𝑙𝑜𝑔𝑘 (3) , where y is gdp per employee, k stands for capital per employee, g is the rate of technological progress in the sense of hicks, α is the elasticity of labor productivity to the capital to labor ratio, and it is time trend. the classification of technical progress was presented by sir john hicks in his theory of wages (1932). the technical progress, in per employee production function, is said to be hicks-neutral if, at any constant value of the capital-labour ratio (k/l), the ratio of the marginal product of capital to the marginal product of labour remains constant. hicks-neutral progres implies that the ratio of rental rate of capital to the wage rate is constant. and thus, the ratio of relative shares of labour and capital income in national income is constant. in other words, the hicks-neutral technical progress indicates the economy’s growth rate, assuming that capital investments and the employment are kept constant. the fixed parameter α has been applied in the tfp calculation for all countries, with different output per employee, and with different capital per employee. after estimation of parameter α from equation (3), we can estimate the tfp in the second iteration, by applying parameter α in the following equation (tokarski, 2008, pp. 38–53): 𝑇𝐹𝑃 (4) with some rearrangements, we can rewrite equation (4) in log terms (balcerzak and pietrzak, 2016): log 𝑇𝐹𝑃 log 𝑦 𝛼 log 𝑘 (5) the data on the capital volume is very often published by the official statistics offices. the problem is that the data on the capital volume published by official statistical offices from different countries are very likely obtained by applying different methods. therefore, the additional calculation is necessary in order to obtain the tfp. the researchers have used the perpetual inventory method in many studies for assessment of the capital stock. the perpetual inventory method can be described with the following equation: 𝐾 𝐼 1 𝛿 𝐾 (6) where δ represents the depreciation rate and i stands for investments. the subscript t stands for the beginning of the time period t and t-1 represent the previous time period. the assessment of capital stock requires the calculation of the anchor capital volume. in many studies, the researchers have used the first year in the sample as an anchor year. in the steadystate, the anchor capital volume is characterized by constant growth rate g. assuming the steady-state of the economy, we can calculate the anchor capital volume with the following equation: 𝐾 (7) where k0 is the initial capital stock, i0 are investments in the anchor period. the steady-state assumes that output and capital grew at the same rate (harberger, 1988). therefore, we can use zoran borović, dragan gligorić, jelena trivić 99 the growth rate of output smoothed using an hp filter with λ = 100, to evaluate the steady-state growth rate. the last piece of a puzzle needed for evaluation of the capital stock in the initial period, and for estimation capital volume from time to time, is the depreciation rate. in our survey, we will set the depreciation rate at 0.05, with the assumption that the depreciation rate is constant over the period and across countries. many authors and researchers set the depreciation rate between 0.04 and 0.1 (vanags and bems 2005; griliches, 1980; nehru and dhareshwar, 1993; romer, 1988; kamps, 2006; rapacki and prochniak, 2009; berlemann and wesselhöft, 2014; harberger, 1988; nadiri and prucha, 1996). there are many surveys where the depreciation rate is set at 0.05 (de la fuente and doménech, 2006; hernandez and mauleon, 2003; cororaton, 2002; and felipe, 1997). once we estimate the tfp levels over time and across countries, we will investigate the existence of co-integration relationship between tfp and economic freedom. here, we will estimate the models which is described with following equatuion: log 𝑡𝑓𝑝 𝑐 log 𝑒𝑓𝑖 log 𝑀 𝜀 (8) , where efi represents the composite index of economic freedom, and vector m holds the control variables: openness, fdi and human capital, and ɛ represents the error term. a similar vector of control variables was used by borovic, rebic & tomas (2020) in order to capture the tfp drivers for the fourteen eu countries. data and results we will conduct our analysis on ten former socialist countries which are a full european union members since 2004. for the period 2000-2018 (bulgaria-bul, czech republic-cze, estonia-est, hungary-hun, latvia-lat, lithuania-lit, poland-pol, romania-rom, slovak republic-slv and slovenia-slo). variables, their definition and sources are presented in table (1). table 1. variables description variable description source y gdp (constant 2010 us$) world bank national accounts data, and oecd national accounts data files. i gross fixed capital formation (constant 2010 us$) world bank national accounts data, and oecd national accounts data files. k capital stock authors calculation l number of persons engaged (in millions) penn world table y gdp per employee authors calculation k capital per employee authors calculation tfp total factor productivity authors calculation efi index of economic freedom heritage foundation open calculated as a sum of export and import as a percentage of gdp world bank national accounts data, and oecd national accounts data files. fdi foreign direct investment, net inflows (% of gdp) world bank national accounts data, and oecd national accounts data files. h human capital investment rate -as proxied by secondary enrolment rate world bank national accounts data, and oecd national accounts data files. source: authors some observation for the fdi were negative, se we had to transform them using the following procedure (busse and hefeker, 2007; ren, et al, 2012). 100 economic analysis (2020, vol. 53, no. 2, 95-108) 𝑌 log 𝑥 √𝑥 1 (9) the data on gdp per employee are presented on graph (1). 3.8 4.0 4.2 4.4 4.6 4.8 00 02 04 06 08 10 12 14 16 y_bul y_cze y_est y_hun y_lat y_lit y_pol y_rom y_slo y_slv graph 1. gdp per employee (in logs) source: authors most of the countries converge around the same level of average productivity over the time period, and with similar growth rates of average productivity. three countries have an average productivity below the general level, but with tendency to catch up with the rest of the sample. the data on capital per worker are presented on graph (2). 4.0 4.4 4.8 5.2 5.6 00 02 04 06 08 10 12 14 16 k_bul k_cze k_est k_hun k_lat k_lit k_pol k_rom k_slo k_slv graph 2. capital per worker (in logs) source: authors most of the countries converge between 4.4 and 5.0. the countries below the average level tend to catch up, because of higher growth rates of the capital per worker, relative to the countries above average. we start econometrics estimation by estimating cobb-douglas production function in per capita terms (equation (3). the authors which have used the equation (3) to estimate the parameter α, they did not test the series for stationarity, instead, they used a panel with fixed zoran borović, dragan gligorić, jelena trivić 101 effects, i.e. classic ols (tokarski, 2008, balcerzak and pietrzak 2016а, 2016b). the estimation of parameter α was carried out by applying the classic ols on panel data with fixed effects. in addition to the classic ols estimation, we have checked for robustness. the estimation of parameters for equation (3) is presented in table (2). the parameters α and g are statistically significant at 5% level of significance. the results of estimation are presented in table (2). table 2. estimation of elasticity of labor productivity to the capital to labor ratio (α) parameter estimate robust std. err. p value α 0.392412 0.000 0.000 g 0.011323 0.011 0.011 constant 1.959962 0.006 0.006 r-sq 0.44 source: authors calculation the technological progress in the sense of hicks (parameter g) is estimated at 0.011323, which means, that under assumption of constant level of capital and labor, the selected countries are characterized with rate 1.1323% of production growth. once we have estimated the parameter α, we will calculate the tfp by applying the α on equation (5). the descriptive statistics for tfp, efi, h, fdi, and openness are presented in table (3). table 3. descriptive statistics for tfp, efi, h, fdi, and openness tfp efi fdi h open mean 2.54 65.98 11.47 98.99 119.36 median 2.56 66.10 7.80 98.17 122.96 maximum 2.75 79.10 109.75 117.52 190.68 minimum 2.32 47.30 0.032 79.78 48.52 std. dev. 0.10 6.13 14.66 7.65 33.68 observations 178 178 178 178 178 source: authors calculation the tfp on a country level is presented in graph (3). 2.3 2.4 2.5 2.6 2.7 2.8 00 02 04 06 08 10 12 14 16 tfp_bul tfp_cze tfp_est tfp_hun tfp_lat tfp_lit tfp_pol tfp_rom tfp_slo tfp_slv graph 2: evolution of the tfp on country level (in logs) source: authors calculation 102 economic analysis (2020, vol. 53, no. 2, 95-108) regarding the tfp, we have three groups of countries. the first group of countries converges around the same level of the tfp (2.5): poland, czech republic, estonia, hungary, and slovakia. also, they have almost the same growth rate of the tfp. the second group of countries is characterized by the lowest tfp rate: bulgaria, latvia, and romania. since 2010. their growth rates of the tfp accelerates and tend to catch up with the first group. the third group has the highest tfp level, and the growth rates of the tfp are much higher than the rest of the sample. members of this group are slovenia and lithuania. our data are not affected by the problem of multicollinearity. the correlation matrix is presented in table (4). table 4. correlation matrix tfp efi fdi h open tfp 1 efi 0.4682 1 fdi -0.1236 -0.0160 1 h 0.2796 0.5365 -0.1975 1 open 0.5767 0.5960 -0.0829 0.3796 1 source: authors calculation in the present paper, we have used a cross-section dependence test (pesaran cd test) to test the null hypothesis that there is no cross-section dependence (correlation) in the time-series, cd ~ n(0,1). ignoring a cross-section dependency in panel analysis will result in substantial bias in estimations. the results of a cross-section dependence test are presented in table (5). table 5. cross-section dependance test variable cd test p value tfp 22.717 0.000 fdi 10.308 0.000 efi 12.999 0.000 h 14.663 0.000 opp 25.764 0.000 source: authors calculation the results of cross-section dependence test showed that change in tfp, fdi, h, and opp that occurred in any of the observed countries affected other countries as well. we have used the second generation of unit root test (cips cross-section im, pesaran, and shin) in order to test our series for stationarity. the results are presented in table (6). table 6. unit root test series stationarity tfp i (1) efi i (1) h i (0) open i (0) fdi i (0) source: authors calculation our main goal is to determine the long-term impact of economic freedom on the tfp. we have used human capital, fdi, and country openness to capture their impact on the tfp. our series do zoran borović, dragan gligorić, jelena trivić 103 not have the same level of integration, in which case standard co-integration tests such as pedroni, kao and fisher johansen test are not allowed. instead, we will use relatively new pmg ardl (autoregressive distributed lag) model proposed by pesaran (1997) and pesaran and shin (1999) which will enable us an effective estimation of both long and short-term effects, on the basis of panel data series with a different level of integration, but lower than i(2). we have fixed the number of lags of both dependent and independent variables to 1. the form of the dynamic ardl (p, q) model was defined by paseran and shin (1997): y ∑ λ y , ∑ δ x , μ ε 10 , where i represents the number of observation units i 1,2,....,n; t represents the number of time instances t 1,2,....,t; xit is vector of independent variables of dimension k 1; ij is coefficient of lagged dependent variable; i is parameter that determines the specific effects of the group or observation unit. a similar cointegration technique was carried out by gligoric, borovic & vujanic (2017) for the commonwealth of the independent states, which are also former socialist countries. we have estimated five different models, and the best model is chosen based on loglikelihood, akaike, and bayesian information criterion. the results of our analisys for the pmg estimator are presented in table (7). table 7. results of the pmg ardl estimation variable model 1 model 2 model 3 model 4 model 5 short-run coeff. ect -0.174*** -0.142* -0.104*** -0.153*** -0.125*** (0.056) (0.085) (0.029) (0.051) (0.043) δ efi 0.016 -0.054* 0.125*** 0.023 0.015 (0.035) (0.030) (0.045) (0.029) (0.026) δ fdi -0.001 0.004 0.001 0.002 (0.001) (0.003) (0.001) (0.002) δ h 0.009 0.019 0.029 (0.069) (0.051) (0.088) δ opp 0.044** 0.045** 0.063*** (0.017) (0.020) (0.015) long-run coeff. efi 0.244*** 0.627*** -0.765*** 0.307*** 0.392*** (0.060) (0.079) (0.255) (0.079) (0.075) fdi 0.054*** 0.006 0.060*** 0.063*** (0.007) (0.004) (0.008) (0.008) h -0.027 0.449** 0.087 (0.093) (0.186) (0.074) opp 0.091*** 0.074*** 0.018 (0.031) (0.015) (0.047) constant 0.196*** -0.058* 0.374*** 0.114*** 0.102*** (0.059) (0.035) (0.106) (0.033) (0.029) obs. 168 170 168 168 170 log lik 601.5 584.3 584.2 567.8 566.7 aic -1183 -1153 -1152 -1120 -1121 bic -1152 -1127 -1127 -1095 -1103 standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 source: authors calculation 104 economic analysis (2020, vol. 53, no. 2, 95-108) according to log-likelihood, akaike, and bayesian information criterion, the best pmg ardl estimator is model 1, therefore, our conclusion will be based on the pmg estimation of model 1. the existence of a long-run relationship among the variables of interest requires that the coefficient on the error–correction term (ect) has to be negative and not lower than -2. in our model, error correction term is statistically significant at 1% level and negative, which means that variables in our model have long rung equilibrium. except human capital, all variables are statistically significant at 1% level. our variable of particulas interest, economic freedom index (efi) is statistically significant a 1% level and positive, which is expected. we can conclude that high economic freedom led to the higher total factor productivity in the selected former socialistic countries. other two variables which have statistically significant impact on total factor productivity also have expected positive impact on total factor productivity. higher openness to foreign trade and foreign direct investment growth cause higher total factor productivity growth. in assessing the effects of economic freedom on total factor productivity growth, one important concern is the possibility of reverse causality, namely that countries with higher total factor productivity have higher degree of economic freedom. we test directly for reverse causality by conducting pairwise dumitrescu-hurlin test. table 8. dumitrescu-hurlin causality test null hypothesis zbar‐stat p value efi does not homogeneously cause tfp 0.0912 0.0365 tfp does not homogeneously cause efi 1.2919 0.3160 source: authors calculation the results of dumitrescu-hurlin test indicate that we can accept hypothesis that total factor productivity does not granger-cause economic freedom, i.e. we have no problem with reverse causality. also, we cannot accept the hypothesis that economic freedom does not granger cause total factor productivity. conclusion this research has proven that higher level of economic freedom, which is used as a proxy of the quality of the institutions and institutional framework, caused higher level of total factor productivity in the period 2000-2018 in the case of ten former socialistic countries which are full eu members since 2000. the presence of cointegration between the total factor productivity and composite index of economic freedom are observed using pmg ardl model while dumitrescu-hurlin test has indicated that reverse causality between this two variables does not exist. also, foreign direct investment and openness rate have positive and significant impact on economic growth in observed countries. half of our sample converge around the same level of tfp (2.5), and their growth rate of tfp tends to decelerate after the crisis. two countries with the highest level and highest growth rate of the tfp are slovenia and lithuania. the lowest tfp is a characteristic of bulgaria, latvia, and romania. but, since 2010. their growth rates of the tfp are accelerating and they tend to catch up with the rest of the sample. the results of our research are in line with those of ulosoy and tas, acemoglu, henry, and bjørnskov and foss. the conclusion is same, the economic actors will invest more and produce more in environment which characterize higher level of economic freedom. quality institutions and institutional framework are of great importance for the productivity and economic growth in former socialistic countries. the obtained results enable us an insight in policies which are important for efficiency increase and economic performance. our finding could be very useful for policymakers, stressing which policies are contributing to efficiency, and zoran borović, dragan gligorić, jelena trivić 105 which are not. to boost productivity and economic growth, policymakers should intervene to increase the quality of institutional framework and economic institutions. many other studies investigate the tfp and growth, or growth and institutional framework for the countries of central and east europe. 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(2007). gospodarka oparta na wiedzy [knowledge-based economy]. warszawa: pwe 108 economic analysis (2020, vol. 53, no. 2, 95-108) appendix table 5. unit root tets results variable exogenous variables second generation of unit root test cips test statistics number of opservations tfp individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -2.326 170 efi individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -2.064 170 h individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -1.576** 158 fdi individual-specific intercepts; incidental linear trends cips cross-section im, pesaran, and shin -3.597*** 170 openenes no constant nor trend cips cross-section im, pesaran, and shin -1.862** 170 *** p<0.01, ** p<0.05, * p<0.1 source: authors calculation article history: received: october 31, 2020 accepted: december 3, 2020 ea_2012_3-4 professional paper small and medium-sized enterprises as a factor of serbian economy ivković dragan*, čukanović karavidić marija, vujičić slađana, faculty of business economics and entrepreneurship, belgrade, serbia udc: 330.341(497.11) ; 005.52:334.012.63/.64(497.11) ; 334.71(497.11) jel: d02; l26; o12 id: 19585281 abstract – in contemporary conditions of economy, small and medium enterprises are one of the key development factors of economy of every country. these companies make 99% of the total number of registered companies in most countries. in addition to the impact that these companies have on strengthening of employment, they also affect improvement of the economic situation of a country as well as the development of competition. in republic of serbia, small and mediumsized enterprises are the most profitable segment of economy. this sector realizes about 46% of exports and 60% of imports and employs over 67% of total number of employees. also, balanced regional development of serbia largely depends on the success of small and medium-sized enterprises and their equitable distribution. key words: small and medium-sized enterprises, development, economic crisis, business operations introduction small and medium-sized enterprises sector (smes) is the most important economy segment of every country. this sector has an impact on the initiation of economic development and employment increase, as well as on reduces of regional disparities. as a driving force of economic growth in developed market economies, these companies encourage innovation, stimulate initiative and help development of the entrepreneurial spirit. thanks to the features of adaptation to changes taking place on the market, there is a large number of small and medium enterprises in developed market economies. it is necessary to develop a competitive economy based on knowledge, innovation and new technologies for serbia to achieve economic growth and development. the special significance of all this is in the willingness of smes to quickly conquer the market of the european union, the adoption of standards and reducing differences in levels of development (official gazette of rs, no. 59/2008). * dragan.ict@gmail.com economic analysis (2012, vol. 45, no. 3-4, 31-45) 32 sme sector in republic of serbia in 2011 in republic of serbia, commercial activity was performed by 106,537 companies (apr,2011). if we analyze the statistical data on the economic importance of this sector, they clearly indicate that it is a key economic segment that is necessary to develop (birovljev et al. 2011, p. 295). if we analyze the number of enterprises in 2010 which were registered in serbia, and their classification according to international recommendations 0-9 employees (micro), 10-49 employees (small), 50-249 employees (medium-sized), 250 or more employees (large) and realize: the number of enterprises, number of employees, turnover and gross value added, we can see that from a total of 90,364 enterprises in republic of serbia in 2010, there were: 77,989 micro (86.3%), 9614 small (10.6%), 2257 medium-sized enterprises (2.5%) and 504 large enterprises (0.6%). table 1. key indicators of enterprises by size in serbia for 2010 total micro enterprises (1-9) small enterprises (10-49) medium-sized enterprises (50-249) large enterprises (>250) number of enterprises in serbia 90364 77989 9614 2257 504 number of employees in serbia 995375 153264 194450 234695 412966 turnover in serbia (in mil. of dinars) 6355195 1074186 1396636 1401972 2482401 gross value added in serbia (in mil. of dinars) 1277427 136832 234073 261213 645309 source: working document, “enterprises in republic of serbia by size 2010”, no.77, statistical office these data show that the presence of micro, small and medium enterprises is very high, and that there is the fewest number of large companies which shows how great is the importance of smes for the development of serbian economy. report on the development of serbia in 2010 indicates the fact that the reduction of external and domestic demand, investment, and increased risk of investments had a negative impact on business operations of enterprises in serbia. in addition to the unfavorable business climate, the application of the provisions on the automatic deletion of business entities due to insolvency for more than three years out of law on bankruptcy has significantly influenced acceleration of the pace of closing businesses. ratio of the number of established and closed enterprises (net effect) is 1:1, and it is much less favorable than in 2009 (1:2.8) (izvestaj o razvoju srbije, 2010). number of established enterprises in serbia in the period from 2006 to 2010 is decreasing, as well as the number of newly established stores. in 2011, the establishment of companies has slowed down as in the previous year, so the number of newly established companies as compared to the previous year decreased by 13.1%. according to the data from financial reports, 7130 of companies were established in 2011 that is 7.8% of the total number of companies. also, the number of employees in the newly established companies is reduced compared to the previous year by 14.8%, so these ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 33 companies employed 15,547 workers which is 1.5% of employees in the economy of republic of serbia. table 2. number of newly established and closed smes number of enterprises number of stores established closed established closed 2006 11.536 1.528 45.693 27.010 2007 11.902 2.027 47.951 31.619 2008 11.248 3.068 43.375 34.572 2009 10.014 3.597 39.365 36.445 2010 9.469 9.340 35.036 37.168 source: nationl agency for regional development, izveštaj o msp u 2010 if we compare the rates of formation and closing rates of companies for the period from 2006 to 2010, lower formation rate and greater closing rate of enterprises and stores is noticeable. table 3. growth and closing rates of enterprises and stores in % enterprises stores total formation rate closing rate formation rate closing rate formation rate closing rate 2006 18,9 1,9 23,7 14,0 22,3 10,6 2007 16,2 5,0 22,6 14,9 20,7 12,1 2008 12,8 6,4 20,2 16,1 18,0 13,2 2009 11,3 4,1 17,4 16,1 15,7 12,7 2010 10,7 10,5 15,6 16,6 14,2 14,9 source: ministry of finance and economy companies in the republic of serbia in 2011 expressed, at a total level, a positive net financial result amounted to 84,838 million dinars. besides, the net income is reported by 53,496 companies, and a net loss by 31,338 companies. table 4. results of business operations and companies description 2011 2010 amount number of companies amount number of companies net profit 458.565 53.496 322.217 53.746 net loss 373.727 31.338 423.692 33.269 net financial result 84.838 -101.475 source: statement on economy operations in the republic of serbia in 2011, business register agency, belgrade economic analysis (2012, vol. 45, no. 3-4, 31-45) 34 according to the data from financial reports for the year 2011, total income of companies in serbia had the amount of 8,065,283 dinars, which, compared to 2010, represents an increase of 11, 1%. expenses of companies for the year 2011, also show an increase of 8.3% compared to the year 2010, and they had the amount of 7,945,082 dinars. table 5. structure of business income in the republic of serbia, according to the elements of income and quarters, 2011 business income total income from sales of goods, products and services income from activating the output and goods income from premiums, subsidies, grants etc. other business income i quarter 100.0 97.5 0.6 0.6 1.3 ii quarter 100.0 97.7 0.6 0.6 1.1 iii quarter 100.0 97.5 0.7 0.6 1.1 iv quarter 100.0 97.1 0.9 0.6 1.2 source: working document, “quarterly business operations of companies 2011”, results of the research of sbs03, statistical office if we look at the structure of operating income by elements and quarters we can see that revenues from sales of goods, products and services have the largest shareapproximately 97.5% (this share ranges from 97.1% in the fourth quarter to 97.7% in second quarter). other operating income (those generated from rents, membership and license fees, etc.) participate in total income approximately 1.2% (this share ranges from 1.1% in the second and third quarter to 1.3% in the first quarter), while the share of premium income, subsidies and grants is the same as the share of income from activating the outcome of goods approximately 0.8%. graph 1. structure of operating income in the republic of serbia, by sectors and quarters, 2011. source: working document, “quarterly business operations of companies 2011”, results of the research of sbs03, statistical office ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 35 table 6. structure of total income and expenses of companies (in millions of dinars) description 2011 2010 amount share (%) amount share(%) total income 8.065.283 100% 7.260.114 100% total expenses 7.945.082 100% 7.339.319 100% 1.business income 7.444.882 92.3 6.773.627 93.3 2. business expenses 7.148.380 90.0 6.491.454 88.4 i business profit 296.502 282.173 financial income 278.933 3.5 241.661 3.3 financial expenses 420.169 5.3 533.349 7.3 ii financial loss 141.236 291.688 other income 341.468 4.2 244.826 3.,4 other expenses 376.533 4.7 314.516 4.3 iii other losses 35.065 69.690 source: statement of economy operations in the republic of serbia in 2011 limiting factors of development of small and medium-sized enterprises in serbia national agency for regional development conducted a survey on the status, needs and problems of small and medium-sized enterprises in 2010 on the sample of 3000 reporting units, which showed that outside environment has an influence on a good businesses operation of companies, and the most important influence comes from the state. table 7. layout of surveyed smes by size type of enterprise/store according to its size number % micro 382 12,0 small 1.353 42.4 mediumsized 457 14.3 stores 1.000 31.3 total 3.192 100.0 source: national agency for regional development, belgrade, 2011, status, needs and problems of small and mediumsized enterprises in serbia 2010, http://narr.gov.rs/ index.php the survey results showed that there is a dependence of business on the environment conditions, i.e. influences which act outside of a business subject. the fact is that in times of crisis there are increased expectations from the state. greater support from banks, as a condition of business improvement, absorbed 18% of responses. economic analysis (2012, vol. 45, no. 3-4, 31-45) 36 graph 2. conditions for business improvement in serbia source: status, needs and problems of small and mediumsized enterprises in serbia 2010, national agency for regional development, belgrade, 2010 surveyed companies stated lack of favorable sources of funding and unfavorable legal environment as obstacles to business development. if you look at average grades of intensity of limitations, ranging from 1 to 7, lack of funds has the highest intensity of limitations, and it is followed by legislation. lack of workers with required qualifications, business mismatch with the requirements of quality, lack of information, difficult collection of receivables, unfair competition are just some of the barriers for the development of small and medium sized enterprises. the conducted survey showed that the biggest limitations for smes are lack of resources and regulations. graph 3. intensity of problems in business operation source: status, needs and problems of small and mediumsized enterprises in serbia 2010, national agency for regional development, belgrade, 2010 the economic crisis has led to a deterioration of the environment for development of entrepreneurship, because it caused the reduction in consumer demand, loss of business confidence, which had a negative impact on the availability of financial support and all together limited the creation of new and development of existing enterprises. ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 37 graph 4. impact of economic crises on business operations in serbia source: status, needs and problems of small and mediumsized enterprises and entrepreneurship in serbia 2010, national agency for regional development, belgrade, 2010 national agency for regional development (nard) conducted a survey on status, needs and problems of entrepreneurs in serbia on a sample of 3,500 reporting units (realization of the sample 88.5%, that is 3096 smes), and in its report on the survey of small and medium sized enterprises and entrepreneurs in serbia in 2011 made a conclusion that the respondents expect support from the state as a prerequisite for the improvement of business operations. bigger support from banks would also be effective. respondents rated that the external factors, i.e. factors that act outside the business entity, have great influence on the success of their business. graph 5. how to improve business operations (in%) source:” status, needs and problems of, entrepreneurs in serbia”, the report on the survey of small and mediumsized enterprises and entrepreneurs in serbia in 2011, national agency for regional development, belgrade, 2011 in order to develop small and medium-sized enterprises, it is necessary to improve competitiveness, which is currently very low. according to the report of the world economic forum (the global competitiveness report 2011-2012) on the competitiveness of 142 countries in the world, serbia took 95th place with an overall score of 3.9 through 12 indicators. in the "report on operations 2013" (doing business 2013), the world bank and the international finance corporation (ifc) economic analysis (2012, vol. 45, no. 3-4, 31-45) 38 aligned serbia on 86th place among 185 countries of the world. serbia has made a jump from last year's 95th to 86th place. the statement said that in the above mentioned report, serbia was among the top ten economies that implemented most of the reforms, and the position of our country was improved thanks to the progress in the areas of starting a business, enforcing contracts and resolving insolvency (apr, 2012). table 8. report on business conditions for the year 2013 topic rankings db 2013 rank db 2012 rank change in rank starting a business 42 91 49 dealing with construction permits 179 178 -1 getting electricity 76 77 1 registering property 41 40 -1 getting credit 40 38 -2 protecting investors 82 79 -3 paying taxes 149 145 -4 trading across borders 94 92 -2 enforcing contracts 103 102 -1 resolving insolvency 103 120 17 source: world bank,ease of doing business in serbia,2013. one of the ways to increase effectiveness of business and efficiency of small and medium enterprises, and thus their competitiveness and the competitiveness of the overall economy, is stimulating the development of business incubators. a business incubator is a type of business association whose purpose is to support the process of starting new successful businesses through the provision of specific services, which might include: incubator space, shared services (office equipment, accounting, entrepreneurial counseling, financial advice, etc.), marketing and networking (brosura biznis incubator, 2012). today, the number of business incubators in the world is estimated at about 5,000, of whom over 1,000 are in asia, about 1,000 in north america, a bit fewer (about 900) in europe and the rest on other continents (infodev, 2008). business incubators are gathered in 60 national and regional associations of which the most important is national business incubation association, which brings together over 1,900 members from 60 countries around the world, mostly from the usa. depending on these specific objectives, the founders or initiators of starting business incubators are: organizations for economic development, local government universities, forprofit organizations or consortia (some or all) of these organizations. the main profit of a community from business incubators are healthy companies. ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 39 support measures for the development of small and mediumsized enterprises in serbia the european union gives a great importance to the development of small and mediumsized enterprises. the european commission has positioned smes in the center of industrial development policy of the eu. european charter, as a document developed under the lisbon agenda of the european union, has established guidelines for the promotion of policies to support the development of entrepreneurship and smes in the following 10 areas: education and training for entrepreneurship, less expensive and faster starting businesses, improvement of legislation and regulations, availability of professional development, promotion of on-line access, better use of the possibilities of the common market, taxation and financial issues, strengthening technological capacities of small enterprises, successful e-business models and business support to enterprises and development of a stronger and more effective representation of small enterprises interests. as a new policy framework for smes in the eu, which replaced the european charter, with a view for giving further support to the sustainable development and competitiveness of smes, in june 2008, the european commission accepted the small business act, which was confirmed by the european council in december 2008 (boskovic & kostadinovic, 2011:57). since june 2008, the small business act, as a new policy framework for smes development, is being applied in european union. this document is similar to the european charter and contains principles or areas that are important for the development of smes, but it also has the guidelines for concrete application of these policies in the scope of these principles at the level of the european union and its member states. since june 2009, after the regional ministerial conference on the european charter for small enterprises in the western balkans, serbia, as well as other countries in the region, began implementing the small business act, which highlights the key role of smes in the european economy, in the form of 10 principles which define key areas for operating of this sector (boskovic & kostadinovic, 2011:57). in 2003, serbia accepted the european charter for small enterprises, by which it committed itself to achieving its objectives by measures of economic policy. priorities and directions of development of small and mediumsized enterprises in the republic of serbia are defined by the strategy for development of competitive and innovative small and medium-sized enterprises for the period from 2008 to 2013. this strategy includes 5 basic principles: the promotion and support to entrepreneurship and the creation of new enterprises, human resources for competitive sme sector, finance and taxation of smes, sme competitive advantage in export markets, legal, institutional and business environment for smes. institutions implementing measures aimed at direct support to smes are the national agency for regional development, the development fund of the republic of serbia, the serbian investment and export promotion agency, the national employment service and others. through these institutions, smes in serbia have the possibility to obtain information that may have an impact on their business, find business partners, and participate in eu programs. economic analysis (2012, vol. 45, no. 3-4, 31-45) 40 owners of small and mediumsized enterprises point out getting financial means for investment, expansion of production, employment of new workers, the introduction of quality standards as the main problems in business operations. in 2009, the ministry of economy and regional development, through the development fund of the republic of serbia, realized the assets intended for start-up loans in the amount of 3855 million dinars (2630 credit applications), for loan and development of entrepreneurship in underdeveloped communities, while 2988 million dinars were approved through the development fund. (annual report for 2009 on the implementation of the development strategy for competitive and innovative small and mediumsized enterprises for the period from 2008 to 2013, with a five-year operational plan, the ministry of economy and regional development, belgrade, 2010.). in 2009, 37.7 million dinars were approved for the project for encouraging companies to invest in innovation. agency for export insurance has approved 28.3 million euro for financing exports of small and medium-sized enterprises, while the export promotion agency realized the program of the internationalization of companies. ministry of economy and regional development has also realized a program on the distribution and use of funds for encouraging the development of clusters in 2009 and realized 22.3 million dinars for the clusters. in 2009, national employment service gave subsidies for self-employment in the total amount of 300.00 million dinars and subsidies for opening new work positions in the amount of 396.00 million dinars (annual report for 2009 on the implementation of the development strategy for competitive and innovative small and mediumsized enterprises for the period from 2008 to 2013, with a five-year operational plan, the ministry of economy and regional development, belgrade, 2010). in 2010, the ministry of economy and regional development, through the development fund of the republic of serbia, realized the assets intended for start-up loans in the amount of 2.261,9 million dinars, for loan and development of entrepreneurship in underdeveloped communities 3.300 million dinars, while 1137 million dinars were allocated in the scope of program for stimulating production and employment in the devastated areas. also, 800 million dinars were spent through the program for investment in labor-intensive manufacturing industries in underdeveloped municipalities. agency for export insurance realized the purchase of demands with small and medium-sized enterprises in the amount of 19.2 million euro, while 30.1 million euro were realized for export financing of small and mediumsized enterprises. (annual report for 2010 on the implementation of the development strategy for competitive and innovative small and mediumsized enterprises for the period from 2008 to 2013, with a five-year operational plan, the ministry of economy and regional development, belgrade, 2011). nea has awarded subsidies for self-employment in the amount of 353.7 million dinars, and subsidies for opening new work positions in the amount of 547.6 million dinars. ministry of economy and regional development (merr) also with the help of the national agency for regional development realized 17 million dinars to encourage the development of clusters. in 2010, agency for foreign investment (siepa) realized the assets in the amount of nearly 56 million dinars through the program of internationalization of companies. (annual report for 2010 on the implementation of the development strategy for competitive and innovative small and mediumsized enterprises for the period from 2008 to 2013, with a ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 41 five-year operational plan, the ministry of economy and regional development, belgrade, 2011). graph 6. financial support for economic and regional development in serbia, 2010 source: reports from the institutions, 2010. in 2011 in serbia, small and medium-sized enterprises were enabled to apply for getting financial means for the development, enhancing innovation, hiring new workers through various national programs. ministry of economy and regional development issued a tender for the allocation of funds to support smes which tend to develop fastgazelles, in the amount from 100.000 to 1.500.000 dinars and from 100.000 to 800.000 dinars, depending on which group of activities a company applies for. also, the ministry of economy and regional development issued a tender for the allocation of funds for sme support for enhancing innovation in the amount from 100.000 to 1.500.000 dinars as well as a tender for the development of innovative clusters from 200.000 to 2.000.000 dinars for the newly formed clusters and from 2.000.000 dinars to 14.000.000 dinars for existing innovative clusters in the development phase. serbian investment and export promotion agency (siepa), by a program of financial support to investors, provided funds for investments in the manufacturing sector in the amount from 2.000 to 5.000 euro and from 4,000 to 10,000 euro for devastated areas and areas of special interest per each new workplace, for investments in the automotive, electronics and information technology industry in the areas of special interest: (publication “support for success”, sme support measures, ministry of economy and regional development, national agency for regional development). development fund of the republic of serbia allowed business entities that are registered in the territory of the republic of serbia to apply for the means intended for starting businesses through the start-up loans. in 2011, agency for export credit and insurance allowed companies which have good programs and quality customers and do not have enough working capital to finance long collection period, to use factoring service through its program. by its programs, national economic analysis (2012, vol. 45, no. 3-4, 31-45) 42 employment service (nes) allowed smes to apply for financial means for opening new work positions and self-employment. development prospects of small and medium-sized enterprises in serbia after 2000, during the implementation process of privatization of public enterprises, there was a significant growth in the sme sector in serbia, so that in 2010, about 92% of all companies, which employ about 55% of the total number of employees and which create about 43% of value added, belonged to smes group (moguca srbija, 2012). small and medium-sized enterprises significantly affect the improvement of competitiveness of the national economy. for the sector of small and mediumsized enterprises and entrepreneurs, we can say that it has become the most effective segment of the serbian economy, the holder of growth and employment, and, in 2009, it provided 66.7% of turnover and 57.4 of gross value added of non-financial sector of the serbian economy. one of the reasons for the small number of new companies is the fact that at the very start of the business enterprises are faced with the problem of lack of seed capital, lack of knowledge of the market as well as business operations on it. one of the solutions for overcoming these problems is the establishment of business incubators in the terms of supporting start-up businesses. when starting a new company, an incubator reduces cost and risk, and provides potential entrepreneurs and their companies the best chance to survive. incubators are designed for enterprises to survive and grow during first years of business operations. establishment of business incubators in serbia should become one of the priority programs of economic development of serbia, which should enable the strengthening of economic capacities, promotion of international cooperation, as well as one of the key components of the national innovation system (arsenijević & vemić, 2011). the development of business incubators in serbia started through entrance program for the entrepreneurship development funded by the norwegian government. entrance program has worked on the development project of incubators in serbia closely with the state institutions, primarily with the national agency for smes development and the ministry of economy and privatization of republic of serbia.in late 2004 in niš, the first business incubator was founded. in 2006 most of the incubators were established in subotica, zrenjanin, belgrade, prokuplje and vranje. there are different models of business incubators: from the ones that just provide a space or service to virtual ones (graph 7). ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 43 graph 7. model of bi development source: stikic d., “business incubators as a support for the development of innovative enterprises,, festival of quality, 36th conference on quality, kragujevac, 2009. functioning of business incubation centers can be described in terms of considering the required inputs, processes and performances. business incubation process consists of three phases (krstić & vučić, 2005) : preincubation, incubation and a phase after incubation. graph 8. three phases of business incubation source: krstić b., vučić s. 2005., business incubator centre – instrument for support for the development of small and mediumsized enterprises, economy topics, p. 121–130 no. 4. in business incubators, tenants can expect a range of services depending on the capabilities and objectives. the most important segment of the help that business incubators provide, is the access to initial capital needed to start and develop new businesses. companies in business incubators have a more opened way to potential investors, because belonging to a business incubator itself means that members of the business incubator have already passed the test on capability of business ideas when entering the incubator. economic analysis (2012, vol. 45, no. 3-4, 31-45) 44 conclusion the importance of small and mediumsized enterprises in serbia is illustrated by the basic indicators these companies make 99.8% of total non-financial sector companies. it is clear that the sector of small and mediumsized enterprises is very important for the economic development of serbia. number of employees, turnover, and gross value added are just some of the facts that show how important is the role of smes in the country. however, small and mediumsized enterprises face a number of limitations in their business operations: lack of capital, high business risk, bad tax policy, a shortage of workers with needed qualifications, business mismatch with the requirements of quality standard, lack of information, difficult collection of receivables, unfair competition, etc. in order to develop this sector in the right way, it is necessary to ensure a favorable environment for its growth and development. sme development strategy should be based on the development of innovative business approach, linking education and economy, introduction of tax incentives, easier access to finance resources, creating an environment for companies to connect for more efficient operations, etc, which should lead to the creation of healthy, strong and stable enterprises. references arsenijević o.,vemić m. 2011. business incubator as a factor of economic and technology development – the study of the case of the business incubator in zrenjanin. novi sad: faculty of management. birovljev, davidovic, petrovic. 2011 „credit support to small and medium enterprises in serbia.“ economics of the company, 59 (5-6): 288-296. boskovic g., kostadinovic i. 2011. ,,clusters of small and medium enterpises– a key to economic development.,, school of business, (4/2011). http://narr.gov.rs/index.php/dokumenta/istrazhivanja-i-analize/izvestaj o malim i srednjim preduzecima i preduzetnistvu u 2010. http://www.apr.gov.rs/portals/0/gfi/makrosaopstenja/2011/saopstenje.pdf http://www.doingbusiness.org/data/exploreeconomies/serbia/( accessed september 28 ,2012). http://www.mogucasrbija.rs/oblast/100/ekonomska%20politika/48/re%c5%a1avanje%20ekono mskih%20problema,%20prioritet%20u%20budu%c4%87em%20radu%20vlade%20srbije.html (accessed october 16 ,2012). http://www.skgo.org/bz/data/8%20ler%20koncept%20brosure/ser/business%20incubators.pdf (accessed september 5 ,2012). krstić b., vučić s. 2005. „business incubator centre – instrument for support for the development of small and mediumsized enterprises.“ economy topics, (4): 121-130. national agency for regional development. 2010. status, needs and problems of small and mediumsized enterprises in serbia 2010, belgrade. national agency for regional development. 2011. „status, needs and problems of, entrepreneurs in serbia”, the report on the survey of small and medium-sized enterprises and entrepreneurs in serbia in 2011, belgrade. official gazette of rs, no. 59/2008 publication “support for success”, sme support measures, ministry of economy and regional development, national agency for regional development). statement of economy operations in the republic of serbia in 2011. ivković, d., et al., sme's as a factor of serbian economy, ea (2012, vol. 45, no, 3-4, 31-45) 45 statement on economy operations in the republic of serbia in 2011. business register agency, belgrade. stikic d. 2009. „business incubators as a support for the development of innovative enterprises,, festival of quality, 36th conference on quality, kragujevac. strategy for development of competitive and innovative smes for the period from 2008 to 2013, official gazette of rs, no. 59/2008. the ministry of economy and regional development, belgrade. 2010. annual report for 2009 on the implementation of the development strategy for competitive and innovative small and mediumsized enterprises for the period from 2008 to 2013, with a five-year operational plan. the ministry of economy and regional development, belgrade. 2011. annual report for 2010 on the implementation of the development strategy for competitive and innovative small and mediumsized enterprises for the period from 2008 to 2013, with a five-year operational plan. working document. “enterprises in republic of serbia by size 2010”, no. 77, statistical office working document. “quarterly business operations of companies 2011”, results of the research of sbs-03, statistical office www.mfp.gov.rs/userfiles/file/dokumenti/izvestaj%20o%20razvoju%20srbije%202010. pdf (accessed june 5, 2012). www.nbia.org. (accessed october 12, 2012). mala i srednja preduzeća kao faktor razvoja privrede srbije rezime – u savremenim uslovima privređivanja mala i srednja preduzeća predstavljaju jedan od ključnih razvojnih faktora privrede svake zemlje. ova preduzeća čine 99% ukupnog broja registrovanih preduzeća u većini zemalja. pored uticaja koji ova preduzeča imaju na jačanje zaposlenosti ona utiču i na poboljšavaju privrednu situaciju zemlje kao i na razvoj konkurentnosti. u republici srbiji mala i srednja preduzeća predstavljaju najprofitabilniji segment privrede. ovaj sektor ostvaruje oko 46% izvoza i 60% uvoza i zapošljava preko 67% ukupnog broja zaposlenih. od uspešnosti malih i srednjih preduzeća i njihovog ravnomernog rasporeda u velikoj meri zavisi i ravnomerni regionalni razvoj srbije ključne reći: mala i srednja preduzeća, razvoj, ekonomska kriza, poslovanje article history: received: 29 september 2012 accepted: 19 october 2012 doi: 10.28934/ea.21.54.2.pp128-138 preliminary report monitoring fiscal risks in the national economy mladenka balaban1* | zoran grubišić1 1 belgrade banking academy, faculty for banking, insurance and finance, belgrade, serbia abstract due to the materialization of various types of fiscal risks over the past years, serbia has begun institutionalizing and developing fiscal risk monitoring. the lack of systematic monitoring of fiscal risks in previous years has led to difficulties in resource planning and poses a risk of unexpected budget expenditures, which distorts resource use and leads to suboptimal spending and compromised results and targets. fiscal risks are shortand medium-term budget, financial or other reports or projections of public finances. the paper systematically presents the fiscal risks of each national economy with an emphasis on the world bank project aimed at improving the monitoring of fiscal risks in serbia. the paper presents four methodologies for monitoring different types of fiscal risks as well as the structure of some of these risks in serbia. the paper presents a quantitative monitoring of fiscal risks, which is still developing in serbia, in the context of the crisis and government borrowing. the paper points out the various fiscal risks that affect the budget of the national economy, as well as ways to monitor and reduce fiscal risks. key words: fiscal risk, budget, public finance, economy, government, monitoring jel classification: e69 introduction any fiscal risk that materializes becomes a burden on the state budget and fiscal position, which is why a functional monitoring system is a key to maintaining the stability of public finances. in the republic of serbia in 2019, a (new) advisory project was launched by the world bank, to support serbia in further strengthening its resilience to fiscal risks and reducing its sensitivity to fiscal and economic shocks. with the increasing increase in the free movement of capital on the world market, countries have come to the position of competing with each other for the favor of economic entities, in order to attract as much investment as possible to their territory. (marjanović d. 2018). the project also aims to help the ministry of finance to strengthen the regulatory framework, institutional capacity and coordination with other relevant actors to better manage fiscal risks. internal risks, ie their materialization are a consequence of activities in the public sector, and the probability of their realization can be influenced by decisions and policies of the government. identifying the biggest fiscal risks that may affect public finances in the medium term is a starting point in better fiscal risk management. there are detailed data on certain fiscal risks and it is possible to identify whether and with what probability they will affect fiscal aggregates in the medium term. for others, however, there are not enough detailed data, but only their identification raises awareness of the possibility of deviations from the planned fiscal framework in the coming period. fiscal policy should be kept in the hands of national *corresponding author, e-mail: mladenka.balaban@bba.edu.rs mladenka balaban, zoran grubišić 129 governments and that rules to avoid excessive deficits should be put in place. those rules were considered necessary because governments’ temptation to create budget deficits to absorb negative shocks in an emu could lead to problems of sustainability of those deficits and to growing government debts. (castro, vitor. 2011). the ministry of finance has a leading role in managing fiscal risks. as a key institution for medium-term macroeconomic and fiscal planning, budget formulation and management, it is important that the ministry of finance also takes an active part in establishing the institutional structure, in the context of normative activities and capacity building for fiscal risk management. therefore, an organizational unit for fiscal risk management has been established within the ministry of finance, which includes strengthening the regulatory and methodological framework, capacity building, and developing technical tools and models necessary for monitoring and assessing fiscal risks. finally, the result of these activities should be the identification and assessment of risks and proposing exit strategies, as an aid to the government in maintaining the stability of public finances, which is a key goal of fiscal policy and one of the basic preconditions for more dynamic economic growth. the unique methodology for monitoring fiscal risks includes four methodologies, namely: • methodology for monitoring fiscal risks arising from the operations of public enterprises; • methodology for monitoring fiscal risks arising from the activities of local selfgovernment units; • methodology for monitoring fiscal risks based on litigation. • methodology for monitoring fiscal risks that occur as a result of natural disasters. sources of fiscal risk in republic of serbia the fiscal system and fiscal policy are a key factor in initiating the process of improving the competitiveness of the serbian economy. that is why it is necessary to lay the institutional foundations of the fiscal system, while increasing the efficiency of the tax administration and creating transparent control of public finances (marjanović d. and domazet i. 2018). financial support to state-owned enterprises through subsidies, activation of state guarantees and other funds was a significant burden on the state budget. a large number of state-owned enterprises (soes) in the past decade have needed financial assistance from the state due to losses and liquidity problems due to e.g. shrinking markets for their business or a large number of employees inherited from the socialist period. at the same time, the reduction in the number of employees brings with it social implications, regulated prices, low pay from other public sector entities, etc. although in the last few years there has been a decrease in the level of state financial support through subsidies, in the period 2014-2018. subsidies continued to average around € 200 million, taking into account only public enterprises. similarly, servicing the debt of state-owned enterprises from the state budget based on the activation of loans covered by the state guarantee amounts to approximately 300 million euros per year. in contrast, the total amount of stateguaranteed debt is about 1.4 billion euros. there are other ways of ad-hoc financial as well as indirect support to state-owned enterprises, such as tolerating tax deferrals and other contributions, which allows for the growth of arrears between state-owned enterprises as well as between state-owned enterprises and the public sector. state own enterprises (soes) are a major source of fiscal risk in serbia. according to the imf analysis, in the last 10 years, state-owned companies have cost the budget about 1.9% of gdp annually. to help state-owned enterprises, the government relied on various mechanisms such as direct budget subsidies, state guarantees and debt collection, as well as various types of indirect support, such as enabling arrears among state-owned enterprises, tax delays and other contributions. in recent years, serbia has made significant progress in implementing state-owned enterprise reforms to improve their operational sustainability and limit fiscal risks, while 130 economic analysis (21, vol. 54, no. 2, 128-138) significantly reducing state aid. however, state-owned enterprises continue to create significant direct and potential liabilities for the state. table 1. historical damages from disasters in serbia by type of danger according to the desinventar database (2000–2020) type of hazard no. of events total damages (rsd) drought 47 90,084,246 flood 513 413,675,282,758 earthquake 1 10,900,000 landslide 65 35,743,523 storm 26 77,785,082 snowstorm 128 462,124,886 fire 271 1,755,752 forest fire 535 248,759,257 hailstorm 224 5,514,847,334 othera 159 1,734,878,303 total 1.969 421,852,161,140 source: desinventar database, http://www.desinventar.net/index_www.html. therefore, serbia is exposed to various types of natural disasters, including floods, droughts, earthquakes and landslides. in recent years, the country has been severely affected by disasters and suffered extensive earthquake damage, especially in 1999 and 2010. it is estimated that 30 % of the country is in danger of landslides. the total drought damage is estimated at $ 500 million a year (1.4 % of current gdp), and floods are recurring across the country. according to data from the desinventory database, almost 2,000 catastrophic disasters were registered in serbia from 2000 to 2020 (table 1). the total recorded losses in this period amount to about 421 billion dinars. according to estimates, the biggest economic losses in the period 2000-2020. years were the result of floods (responsible for 98 % of losses). the next fiscal risk is connected with local self-government (lsgs). sub-national governments are a crucial element for achieving inclusive and sustainable development in serbia and play an important role in providing public services. the new public administration reform strategy aims to increase the share of funds spent through lsgs (from 14.8 % in 2021 to 16.5 % by 2026) and to invest significantly in the capacity of public sector staff at sub-national levels. a new lsg development strategy is under development. lsgs manage and oversee local public enterprises as well as private contractors to discharge these and other functions. however, so far, many lsgs struggle with insufficient resources and capacities to provide the services under their jurisdiction and therefore may represent a fiscal risk for the central government. there are 174 local selfgovernments in serbia. local self-government units are municipalities, cities and the city of belgrade. despite significant differences in size and level of development, all local selfgovernment units are organized in the same way and have the same competencies. the risks associated with legal claims have been identified as one of the key fiscal risks in the serbian context. in particular, in past periods, legal cases have been a significant source of fiscal risk for claims related to, among others, military pensions and old foreign currency savings. in this type of case, the claims seer government compensations, for which having timely information about their results and costs is crucial. compared to other european countries, serbia does not have favourable results when analyzing claims against public institutions. as shown in graph 1, administrative cases take more than 3 times the number of days to be solved in serbia (745) the european median (241). this leaves serbia as the fourth country with a higher number of days to solve an administrative case, behind malta (1,056), portugal (927) and italy (888). mladenka balaban, zoran grubišić 131 figure 1. administrative cases – first instance source: cepej (2020). european judicial systems: cepej evaluation reporthttps://public.tableau.com/app/profile/cepej/viz/cepejquestionexplorerv2020_1_0en/questionexplorer serbia faces challenges related to the judicial performance in administrative cases when compared to other european countries: a higher number of days to solve a case, fewer solved cases per year, a high number of pending cases, increasing number of new cases. in general, those challenges can be summarized in two main aspects. on one side, the cases are taking longer to be solved (which reduces the number of cases that can be solved each year and therefore increases the backlog). on the other, there is an increasing number of new claims being filed before courts. serbia has been experiencing a rise in the payments related to legal cases. methodology for monitoring fiscal risks monitoring fiscal risk in public enterprises the methodology for monitoring fiscal risk in soes, have two aims. first, it suggests a monitoring process from the collection of soes data and identification of fiscal risks to the frmd reporting on soes., international practices often recommend elaborating a matrix showing the list of pes and the source of fiscal risks to government finances associated with each company, as shown in the table below. again, the review and update of this matrix, usually performed annually, implies receiving regular information from other institutions, although the department in the ministry of finance for monitoring fiscal risk would be the only entity responsible for completing the matrix. 0.50 1.00 1.50 2.00 2.50 disposition time (years) incoming/ 100 resolved/ 100 pending/ 100 serbia european median 132 economic analysis (21, vol. 54, no. 2, 128-138) table 2. the matrix of identification of pes fiscal risks sources list of pes g u ar an te ed d eb t su bs id ie s an d ot h er tr an sf er s r es tr u ct u ri n g an d ca p it al in je ct io n s d iv id en d s co rp or at e t ax es an d fe es p ri va ti za ti on p ro ce ed s p oo r bu si n es s p er fo rm an ce q u as ifi sc al a ct iv it ie s m ac ro a n d m ar k et ri sk s (v ar ia ti on o f th e ex ch an ge r at e, ec on om ic g ro w th , et c. ) pe 1 * * * pe 2 * * * * * * pe 3 * * * * * * pe 4 * * * * * source: https://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=gov/pgc/sbo(2014)4/fi fiscal risk analysis performed by the department for monitoring fiscal risk could be further developed by assessing the likelihood of risk realization. the department is currently computing the financial ratios of companies and monitoring their evolution. by benchmarking these financial ratios to pre-defined thresholds, the analyst can compute a risk rating for each company. this rating can, then, be used to determine which companies represent a higher risk for the national budget, or even to set a probability of default for the company which could be associated with the amount exposed to risk to calculate an expected loss for the government. both quantitative and qualitative indicators could be rated on the same scale to calculate more easily the overall risk rating of the company. each indicator could receive a grade from a+ to d, a+ indicating the lower risk and d the highest. the methodology should be used backwards-looking and forward-looking by computing planned figures from the abp or the quarterly reports of the companies or forecasts of other departments/institutions. there are multiple approaches when it comes to risk assessment. three main credit risk modelling approaches are altman z-score, credit score and scenario analysis. all of them centre on the use of the financial ratios of the companies that could be used to calculate a composite index such as the altman z-score or a credit score, frequently used for rating purposes. this report will use the altman z-score as an example to the evaluations of credit risk modelling that relies on corporate ratio analysis based on three dimensions: the company profitability, liquidity and solvency. the rating obtained with this simple quantitative method could represent part of the overall risk rating of the companies (for example 60%), the remaining part being found by computing a set of qualitative indicators. qualitative indicators could take the form of an index and represent a certain percentage (e.g., 40%) of the overall risk rating attributed internally to each public enterprise. the index would consist of a number of categories of indicators with their respective weight. for example it can be used five categories: managerial independence (8%), quasi-fiscal activities (15%), operating and regulatory environment (5%), corporate governance (10%), other factors (e.g., competitive position, environment) (2%). the results of the z-score rating and the analysis of the qualitative indicators would determine an overall risk index for each pe. the public enterprises with a high-risk rating must receive greater attention from the ministry of finance and they should be highlighted in the quarterly fiscal risk report. monitoring fiscal risks arising from the activities of local self-government units (lsg) the criteria to determine which local self-governments should be monitored by the department for monitoring fiscal risk in the ministry of finance are essentially the size of the municipalities, https://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=gov/pgc/sbo(2014)4/fi mladenka balaban, zoran grubišić 133 the total outstanding liabilities, the total amount of transfers received from central government, as well as the size of arrears of public utility companies. the methodology could be extended to all the other local self-governments in a later stage if the ministry of finance considers it necessary. the department for monitoring fiscal risk in the ministry of finance, will classify the lsgs according to these criteria and monitor the ones for which the execution of government transfers to the lsg, including the additional transfers from government reserves, deviated substantially from budgeted transfers. to monitor fiscal risks arising from local self-governments, the frmd will use a set of fiscal risk indicators. many indicators can measure the liquidity, solvency, profitability, and investment capacity of local self-governments. the ones proposed in this methodology, and summarized in the table below, are frequently used by local self-governments in other countries. in addition, few indicators of the general economic situation in the region or in the municipalities could be added to further expand the comparison between local self-governments. most of these indicators can be calculated from lsgs financial accounts and national economic statistics, but one requires information on the cash balance available in the bank account of the local treasury. an early warning system tries to flag local self-governments when they show first signs of fiscal difficulties which could lead further to a crisis. this methodology suggests the frmd should examine the ten fiscal risk indicators described in the previous sub-section to determine which local selfgovernments are heading towards financial troubles which could have an impact on the national budget. the gross operating balance is the difference between lsgs current revenues and operating expenditures. the ratio is obtained by dividing this difference by current revenues. the ownsource revenues ratio indicates the level of the local self-government’s dependency on intergovernmental transfers. this ratio is obtained by dividing the municipality’s own-source revenues by its current revenues. own-source revenues are all the revenues that are not coming from transfers from other government levels. the cash balance ratio is an indicator of the local self-government’s liquidity position and the potential stress to meet payments obligations in the short-term. this ratio is obtained by dividing the cash balance on the municipality’s account by the debt service amount of the year. the short-term debt ratio measures how much the local selfgovernment has to borrow for liquidity purposes. it is obtained by dividing the total stock of shortterm debt (less than one year maturity) of the municipality by its total revenues. the public debt law set a ceiling of 5% on this indicator of local self-government short-term borrowing. the longterm debt ratio measures how much the local self-government must borrow for investment purposes. it is obtained by dividing the total stock of medium/long-term debt (more than one year maturity) of the municipality by its total revenues. debt service coverage reveals local selfgovernments capacity to service its debt and its solvency in the medium-term. it is obtained by dividing municipality’s debt service expenses by its current revenues. it indicates the part of revenues absorbed by the overall debt service, that is to say by the payment of interest and principal. it is, therefore, a measure of the constraint exercised by the existence of a debt on the financial leeway of a municipality. the interest burden indicator measures the cost of borrowing of the local self-government and the burden of interest payments for the budget. it is obtained by dividing municipality’s interest expenses by its current revenues. the investment intensity ratio is an indicator of local self-government investment effort and its capacity to meet the needed local service priorities. gdp per capita level is a measure which allow the comparison between local self-governments gdp per capita. the number of local self-government employees per thousand inhabitants is a measure of administrative efficiency. this indicator tells if the local selfgovernment is overstaffed and, thereby, is dedicating too much of its revenues to recurrent administrative expenses. 134 economic analysis (21, vol. 54, no. 2, 128-138) table 3. proposed fiscal risk indicators to monitor local self-governments number indicators type of indicators source formula possible benchmark threshold 1 gross operating balance ratio profitability financial accounts gross operating balance / current revenues above 5% 2 own-source revenues ratio profitability financial accounts own-source revenues / current revenues above 50% 3 cash balance ratio liquidity consolidated account of lsg treasury cash balance / debt service for the year above 1 4 short-term debt ratio liquidity financial accounts short-term debt stock / total revenues below 5% 5 long-term debt ratio solvency financial accounts medium to longterm debt stock / total revenues below 50% 6 debt service burden solvency financial accounts debt service expenses / current revenues below 10% 7 interest burden solvency financial accounts interest expenses / current revenues below 5% 8 investment intensity investment capacity financial accounts capital expenditures / total expenditures above 15% 9 gdp per capita level macroeconomic national statistics local gdp per capita / average national gdp per capita 100% 10 municipal employees per 1000 inhabitants macroeconomic national statistics municipal employees / adult population 10 source:https://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=gov/pgc/sbo(2014)4/f the system is based on two composite indexes to evaluate local self-governments self-financing capacity and payment burden. the value of these indexes is calculated according to the results of fiscal risk indicators. for each index, the local self-government will be categorized (i) “at risk”, (ii) “under scrutiny” or (iii) “normal”. of course, local self-government with a low self-financing capacity and a high payment burden will be flagged in the quarterly fiscal risk report as necessitating immediate assistance. taking into account the results of the calculation of indicators and historical levels of financial support to lsgs (through all means of transfers), the department for monitoring fiscal risk should provide a quantitative amount or range of estimated outflows towards the lsgs in the coming period. less favorable level of indicators signals potentially higher financial outflows towards lsgs in the coming period. mladenka balaban, zoran grubišić 135 table 4. benchmarks of fiscal risk indicators and associated level of risk risk level index 1. self-financing capacity index 2. payment burden gross operating balance ratio own-source revenues ratio investmen t intensity gdp per capita level (in % of national average) cash balanc e ratio shortterm debt ratio longterm debt ratio debt service coverage interest burden municipal employees per 1000 inhabitants low >10% >60% >20% > 120% > 100% < 2% < 20% < 5% < 2% < 5 medium 5 10% 50 60% 10 20% 90 120% 50%– 100% 3 5% 40 50% 5-10% 2-5% 5 -10 high 0 5% 25 50% 3 10% 75 90% 25%50% 5 7% 60 70% 10-15% 5-8% 10 -25 excessive < 0% < 25% < 3% < 75% < 25% > 7% > 70% > 15% > 8% > 25 source:https://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=gov/pgc/sbo(2014)4/ inal&doclanguage=en taking into account the results of the calculation of indicators and historical levels of financial support to lsgs (through all means of transfers), the department for monitoring fiscal risk should provide a quantitative amount or range of estimated outflows towards the lsgs in the coming period. less favourable level of indicators signals potentially higher financial outflows towards lsgs in the coming periods. process of monitoring fiscal risks from natural disasters minimizing the fiscal risk from a natural disaster requires that i) adequate investments in risk reduction are undertaken and that such investments are maintained by providing necessary finance on recurring bas, and ii) that there is enough fiscal space/contingent financing to be able to respond to the materialization of residual risk in a timely and effective manner. disaster insurance penetration in serbia is low. the public sector has a budget that covers insurance. however, public asset insurance against disasters in serbia is very low. similarly, insurance coverage against natural disasters by the private sector in serbia is low. according to the data of the insurers association of serbia, only two or three percent of households in serbia are insured against floods, and fewer than 10 percent of households have property insurance. only about 25 30% of property insurance policies in serbia have additional flood insurance. regarding agricultural insurance, there is a state subsidy of 40% except in five districts with high exposure to severe weather events, where the subsidy is 75%. in view of these facts, it is very important to establish a methodology for monitoring fiscal risks. the methodology for monitoring fiscal risks from natural disasters has the following steps: • collection of and monitoring of disaster-related expenditure data. depending on data availability, the department for monitoring fiscal risk should annually collect data on budgeted and actual annual investment and associated recurrent expenditure on risk reduction at all levels of government. such data should be collected from the treasury. if such data is currently not being adequately tracked, the department could work with the treasury to introduce budget tags/classifiers which would enable to better track disaster-related expenditure. such tagging could result in across-cutting disaster-related expenditure subprogram. • information on disaster-related fiscal risk can inform two key policy areas: investments in risk reduction and adoption of risk financing instruments to deal with residual risk. first, the benefit of further investing in risk reduction is intrinsically linked to the risk of foregoing such investments. thus, a better understanding of the potential fiscal cost of disaster impacts with the current state of infrastructure will allow a better analysis of the potential returns on risk reduction investments. department for monitoring fiscal risk should work with other government agencies to ensure that adequate funds are made 136 economic analysis (21, vol. 54, no. 2, 128-138) available for risk reduction. secondly, the department can use estimates of the potential fiscal impact of disasters to assess the potential financing gap after major events and to inform decisions on the adoption of financial instruments to close that gap, such as reserve funds, contingent credit lines, or insurance. table 5. key data on natural disasters data capital and current expenditure for risk reduction at central government level capital and current expenditure for risk reduction at local government level investments and expenditures for risk reduction of soes post-disaster expenditures for emergency response, recovery and reconstruction technical assessments on probability and magnitude of natural disasters risk macroeconomic parameters fiscal data to assess impact on fiscal balance the information in this report should be based on the data and analysis outlined in the previous section taking into account the analysis produced with the fiscal risk model. it should also identify key steps to be taken in order to reduce natural disaster risk and the associated fiscal risk in the future. process of methodology for monitoring risks from legal contingencies there are several aspects for the monitor to be aware of potential impacts of the amounts that will need to be paid related to court cases. international experience shows that the highest amount paid corresponds to interest, rather than the original claims. the main aspects related to the accumulation of interests are the time that a regular case takes to be solved in court and the time that the public institution takes to pay. serbia faces challenges related to the judicial performance in administrative cases when compared to other european countries: a higher number of days to solve a case, fewer solved cases per year, a high number of pending cases, an increasing number of new cases. in general, those challenges can be summarized in two main aspects. on one side, the cases are taking longer to be solved. on the other, there is an increasing number of new claims being filed before courts. serbia has been experiencing a rise in payments related to legal cases. most countries do not have detailed data on the time that takes to solve a judicial case. most of the estimates are based on the experiences of lawyers or other informed opinions. however, when empirical studies have been carried out with samples, there is a big mismatch between those perceptions and the real-time a case takes to be solved. for this reason, the european commission for the efficiency of justice (cepej) has created a formula to estimate the time (in days) to solve a case. the suggested formula is the following: time to disposition= (pending cases (inventory))/(solved cases)×365 as mentioned before, this indicator is relevant to monitor the payments related to legal claims given that the longer a case takes, the higher the amount to be paid. it is important to note that this is an estimate of the time taken to solve a judicial case. however, that formula does not fully reflect the time taken to solve the controversy, which is only closed when the institution effectively pays the total amount of the decision. the proposed methodology assumes that all institutions make their payments within a reasonable and similar time among them. the third aspect to consider monitoring is the effective payments made. similarly, to the other aspects, it is suggested to compare the perceptual variation between specific periods. the variation of this indicator can be a consequence of a variation of the previous indicators. however, unlike the other mladenka balaban, zoran grubišić 137 two indicators, this comparison is useful to identify a potential change in the behavior either of courts or of the payment schedules of the public institutions. conclusion any fiscal risk that materializes becomes a burden on the state budget and fiscal position, which is why a functional monitoring system is a key to maintaining the stability of public finances. recognizing and proactively managing fiscal risks, using risk mitigation measures, insurance and other mechanisms, helps states save public funds and better protect their citizens. the government will maintain a reserve, provision or “fiscal space” in their fiscal plans in case certain risks materialize. the level of the reserve will depend on the estimates of the potential impact of certain risks and their likelihood of occurring in the fiscal risk reports. the ministry of finance should establish strict criteria for accessing these funds and separate reserves can be established for new policies to be decided over the course of the budget execution vs. funding for unexpected events. the budget beneficiaries are also responsible for monitoring and preventing their fiscal risks, allocating funding in their budget if their materialization becomes probable and funding from their own budget if a risk unexpectedly materializes before they can claim additional funds from the general budget. the government may decide in the situations of excessive fiscal risks which are assessed to have a potentially significant impact on the budget and probability of materializing, to introduce specific measures to address individual fiscal risks. these measures include limits on state guarantees, risk-based fees for state guarantees, subsidies linked to performance. as needed, the government may decide to form separate funds which would serve as a liquidity response in cases of certain risks materializing. references castro, v. (2011). “the impact of the european union fiscal rules on economic growth.” journal of macroeconomics, 33: 313–326 cooper, d.j., ezzamel, m. (2013). “globalization discourses and performance measurement systems in a multinational firm.” accounting, organizations and society, 38: 288–313. marjanović, d. (2018). “competitiveness of the serbian economy through the prism of tax incentives for foreign investors”, vol 51 no 3-4, economic analysis, institute of economic sciences, belgrade, serbia: 95-104 marjanović, d., domazet, i. (2018). “unapređenje makro konkurentnosti–fiskalni aspekti”. beograd: institut ekonomskih nauka. imf (2018). “managing public wealth”, fiscal monitor reports, https://www.imf.org/~/media/files/publications/fiscalmonitor/2018/octobe/pdf/fm1802.as hx?la=en. imf (2016). analyzing and managing fiscal risks best practices https://www.imf.org/external/np/pp/eng/2016/050416.pdf imf (2008). fiscal risks sources, disclosure, and management, https://www.imf.org/external/np/pp/eng/2008/052108.pdf imf (2015). fiscal transparency evaluation of finland, http://www.imf.org/external/pubs/ft/scr/2015/cr1560.pdf. oecd (2020). best practices for managing fiscal risks, lessons from case studies of selected oecd countries and next steps post covid-19, establishing a fiscal risk management department in the ministry of finance of serbia, https://openknowledge.worldbank.org/bitstream/handle/10986/26421/113855-wp establishing-a-fiscal-risk-management-department-in-the-ministry-of-finance-of-serbiapublic.pdf?sequence=1&amp;isallowed=y https://www.imf.org/%7e/media/files/publications/fiscalmonitor/2018/octobe/pdf/fm1802.ashx?la=en https://www.imf.org/%7e/media/files/publications/fiscalmonitor/2018/octobe/pdf/fm1802.ashx?la=en https://www.imf.org/external/np/pp/eng/2016/050416.pdf https://www.imf.org/external/np/pp/eng/2008/052108.pdf http://www.imf.org/external/pubs/ft/scr/2015/cr1560.pdf https://openknowledge.worldbank.org/bitstream/handle/10986/26421/113855-wp 138 economic analysis (21, vol. 54, no. 2, 128-138) article history: received: december 16, 2021 accepted: december 29, 2021 monitoring fiscal risks in the national economy mladenka balaban10f* | zoran grubišić1 introduction monitoring fiscal risks arising from the activities of local self-government units (lsg) process of monitoring fiscal risks from natural disasters conclusion references microsoft word 2011_1-2 original scientific paper    currency options in function of currency risk hedging  and speculating   barjaktarović miljana*, karić dušica, zečević radoje,   alfta university, belgrade, serbia   udc: 339.743(497.1)   jel: g18         abstract – due to current monetary policy of national bank of serbia which is focused on  targeting the inflation rate, and therefore the introduction of a flexible foreign exchange rate policy  which includes foreign exchange rate fluctuations, there is need for transactions performed in foreign  currencies to be ensured from unpredictability of foreign exchange rate movements. this is related not  only to transactions but also to property that is denominated in foreign currency. serbia is a country  in the advanced transition becoming more open to other markets, which requires the use of all more  sophisticated financial instruments in business to reduce the risk due to the unpredictability of market.  mechanism that is used in the function of reducing the risk of foreign exchange rate in the financial  markets of developed countries is currency hedging. a currency derivative is the contract whose price  is partially derived from the value of the underlying currency that is represents. some individuals,  corporations and financial institutions take position in currency derivatives to hedge or speculate on  future  foreign  exchange  rate  movements.  currency  options  provide  the  right  to  purchase  or  sell  currencies at specified prices. the specific objective of  this  text  is  to explain how currency option  contracts are used to speculate or hedge based on anticipated foreign exchange rate movement.  introduction  currency options provide the right to purchase or sell currencies at specified prices. they  are available for many currencies,  including  the u.s. dollar, british pound, brazilian real,  canadian dollar, euro, japanese yen, mexican peso, etc.  in  late,  exchanges  in  amsterdam,  montreal  and  philadelphia  first  allowed  trading  in  standardized  foreign  currency  options.  since  that  time,  option  have  been  offered  on  the  chicago mercantile  exchange and the chicago board options exchange. in addition to the  exchange where currency options are available, there is an over‐the‐counter market where  currency options are offered by commercial banks and brokerage firms. unlike the currency  options traded on an exchange, the over‐the‐counter market offers currency options that are  tailored to the specific needs of the firm. since these options are not standradized, all the  terms  must  be  specified  in  the  contracts.  the  number  of  units,  desired  strike  price,  and  expiration date can be tailored to the specific needs of the client. when currency options are  not standardized, there is less liquidity and wider and a bid/ask spread. currency options  are classified as either calls or puts, as discussed in the next section.                                                         * e‐mail: miljana.barjaktarovic@ftb.rs      barjaktarović, m., et al., currency options, ea (2011, vol. 44, no, 1‐2, 38‐46)     39 currency call options  a currency call options grants the right to buy a specific currency at a designed price  within a specific period of time. the price at which the owner is allowed to by that currency  is known as the exercise price (strike price), and there are monthly expiration dates for each  option.   call option are desirable when one wishes to lock in a maximum price to be paid for a  currency in the future. if the spot rate of the currency rises above the strike price, owners of  call options can “exercise” their options by purchasing the currency at the strike price, which  will be cheaper than the prevailing spot rate. the owner can choose to let the option expire  on the expiration date without ever exercising it. owners of expired call options will have  lost the premium they initialy paid, but that is the most they can lose. the premium on a call  option represents the cost of having the right to buy underlying currency at a specified price.  for multinational companies that use currency call options to hedge, the premium reflects a  cost of insurance or protection to the multinational companies. the call option premium is  primariliy  influenced  by  three  factors:  the  diference  between  the  spot  exchange  rate,  the  strike or exercise price, the time to maturity, and the volatility of the currency.  hedging with currency call options  corporations with open positions in foreign currencies can sometimes use currency call  options to cover next positions: hedge payables, project and target bidding and speculating.  multinational companies can purchase call options on a currency to hedge future payables.  example: when serbian importer orders european union goods, it makes a payment in  euros (eur) to the exporter upon delivery. an euro call option locks in a maximum rate at  which importer can exchange serbian dinar (rsd) for euros. this exchange of currencies at  the specified strike price on the call option contract can be executed at any time before the  expiration  date.  in  essence,  the  call  option  contract  specifies  the  maximum  price  that  importer must pay to obtain these eu imports. if the euros value remains below the strike  price, importer can purchase euros at the prevailing spot rate when it needs to pay for its  imports and simply let its call option expire. used – based multinational companies that bid  for  foreign  projects  may  purchase  call  options  to  lock  in  the  dinar  cost  of  the  potential  expenses.  example: serbian company  that  is bid on a project sponsored by  the eu.  if  the bid  is  accepted,  company  will  need  approximately  eur  500,000  to  purchase  eu  materials  and  services. however, company will not know whether the bid is accepted until 3 months from  now. in this case, it can purchase call options with a 3‐month expiration date. ten call option  contracts will cover the entire amount of potential exposure. if the bid is accepted, company  will likely let the options expire.  assume  that  the  exercise  price  on  eur  is  rsd100    and  the  call  option  premium  is  rsd0.02 per unit. company will pay rsd1000 per option (50,000 units per euro option), or  rsd10,000 for the 10 option contracts. with the options, the maximum amount necessary.  the amount of dinars needed would be less if the euros spot rate were below the exercise  price at the time the euro were purchased.     economic analysis (2011, vol. 44, no. 1‐2, 38‐46)   40 even if company s bid is rejected, it will exercise the currency call option if the euro spot  rate exceeds the exercise price before the option expires and would then sell the euro in the  spot market. any gain from exercising may partialy or even fully offset the premium paid  for the options.  firms can also use call options to hedge a possible acquisition.  example: u.s. multinational company is attempting to acquire a serbian company and has  submitted its bid in euros. u.s. company has purchased call options on the euro because it  will need euros to purchase the serbian company s stock. the call options hedge the u.s.  company against the potential appreciation of the euro by the time the acquisition occurs. if  the acquisition does not occur and the spot rate of the euro remains below the strike price.  u.s. company can let the call options expire. if the acquisition does not occur and the spot  rate of the euro exceeds the strike price, u.s. company can exercise the options and sell the  euros in the spot market. alternatively, u.s. company can sell the call options it is holding.  either of these actions may offset part or all of the premium paid for this options.  speculating with currency call options  individuals may speculate in the currency options market based on their expectation on  the  future  movements  in  a  particular  currency.  speculators  who  expect  that  a  foreign  currency will appreciate can purchase call options on that currency. once the spot rate of the  currency appreciates, the speculators can exercise their options by purchasing that currency  at the strike price and then sell the currency at the prevailing spot rate.  a seller (writer) of a call option is obligated to sell a specified currency at a specified price  (the strike price) up to a specified expiration date. speculators may sometimes want to sell a  currency call option on a currency that they expect will depreciate in the future. the only  way a currency call option will be exercised is if the spot rate is higher than the strike price.  thus, a seller of a currency call option will receive th premium when the option is purchased  and can keep the entire amount if the option is not exercised. when it appears that an option  will be exercised at some point. the net profit to a speculator who trades call options on a  currency is based on a comparison of the selling price of the currency and the premium paid  for the call option.  example: henkel ad is a speculator who buys a british pound call option with a strike  price of rsd116.52 at a decembar settlement date. the current spot price as out of that date  is about rsd116.10. henkel pays a premium of rsd0.01 per unit for the call option. assume  there are no brokerage fees. just before the expiration date, the spot rate of the british pound  reaches rsd116.55. at this time, henkel ad exercise the call option and the  immidiatelly  sells the pounds at the spot rate to bank. to determine his profit or loss, first compute hiss  revenues from selling the currency. then, subtract from this amount the purchase price of  pounds when exercise the option, and also subtract the purchase price of the option.       per unit (rsd) per contract (rsd)  selling price of £  116.59  1,165,590 (116.59 x 1000 units  ‐ purchase price of £  ‐116.52  ‐1,165,520 (116.52 x 1000 unit)  ‐ premium  ‐0.10  ‐100  (‐0.10  x 1000 units)  = net profit  ‐0.03  ‐ 30 (‐0.03 x 1000 units)       barjaktarović, m., et al., currency options, ea (2011, vol. 44, no, 1‐2, 38‐46)     41 assume that aikbanka ad was the seller of the call option purchased by henkel ad.  also assume that aikbanka would purchase british pound only if and when the option was  exercised, at which time she must provide the pounds at the exercise price of rsd116.50.  using the information in this example, aikbanka´s net profit from selling the call option is  derived here:      per unit rsd per contract (rsd)  selling price of £  116.59  116,559 (116.59 x 1000 units)  ‐ purchase price of £ ‐116.52  ‐116,552 (116.52 x 1000 units)  ‐ premium  +0.10  +100    (‐0.10 x 1000 units)  = net profit  +0.03  + 30     (‐0.03 x 1000 units)    when brocerage fees are ignored, the currency call purchaser´s gain will be the seller´s  loss.  the  currency  call  purchaser´s  expenses  represent  the  seller´s  revenues,  and  the  purchaser s revenues represent the seller s expenses. yet, because it possible for puchasers  and sellers of options to close out their positions, the relationship described here will not  hold unless both parties begin and close out their positions at the same time. the purchaser  of a call option will break even if the revenue from selling the currency equals the payments  for the currency (at the strike price) and the option premium.  if other words, regradeless of the number of units in a contract, a purchaser will break  even if the spot rate at which the currency is sold is equal to the strike price plus the option  premium. based on the information in the previus example, the strike price is rsd116.52 and  the option premium is rsd0.10. thus, for the purchaser to break even, the spot rate existing  at  the  time  the  call  is  exercised  must  be  rsd116.62  (116.52+0.10).  speculators  will  not  purchase a call option if they think the spot rate will only reach the break‐even point and not  go higher before the expiration date.  currency put options  the owner of a currency put option receives the right to sell a currency at a specified  price (the strike price) within a specified period of time. as with currency call options the  owner of a put option  is not obligated  to exercise  the option. therephore,  the maximum  potential loss to the owner of the put option is the price (or premium) paid for the option  contract.  the  put  option  premium    is  primarily  influenced  by  three  factors:  difference  between the spot exchange rate, strike or exercise price, time to maturity and volatility of the  currency, as measured by the standard deviation of the movements in the currency.  hedging with currency put options  corporations with open positins  in foreign currencies can use currency put options  in  some cases to cover these positions.  example: the company exports from serbia to germany in the value of the million that  will be charged within three months. current spot rate eur/rsd is 77.56, while the forward  rates at three months is 78.89. value contract rates at the spot exchange rate is rsd 77.56  million.     economic analysis (2011, vol. 44, no. 1‐2, 38‐46)   42 if the exporter believes that the eur will continue to strenghten, that is that the rates rsd  continue to decline, most  likely by 79.15, and  if his expecations realized, the value of the  contract will amount to 79.15 million rsd. to a profit of 1.59 million rsd than expected  growth  rate,  should  not  undertake  anything,  but  to  wait  than  to  happen.  however,  this  problem may occur if you happen to weaken the eur and rsd to strenghten the potential  77.00. he buys three – month put option to one million eur to 78.50 price execution, or the  right to one million eur sold at a price of 78.50. price of these options is 10%, ie. 0.1 point of  the course.  for three months, rsd was the highest historical level against the eur from 77.10, while  the  exporter  automatically  receives  payment  rates  from  78.50  (one  million  eur  at  the  exchange rate 78.50) and thus achieves a bonus of 1.40 million rsd, or 1.4 dinars per eur).  effective exchange rate for this option is 78.40, or total earnings relative to the current spot  exchange rate for exporters in the bussines of 1.3 million rsd (78.50‐0.1‐77.1 =1.30 dinar per  eur)  speculating with currency put options  individuals may speculate with currency put options based  on their expectatins of the  future movements  in a particular currency. for example, speculators who expect that the  british  pound  will  depreciate can  purchase british  pound  put options, which  will  entitle  them to sell british pounds at a specified strike price. if the pound s spot rate depreciates as  expected, the speculators can then purchase pounds at the spot rate and exercise their put  options by selling  these pounds at  the strike price. speculators can also attempt  to profit  from selling currency put options. the seller of such options  is obligated to purchase the  specified  currency  at  the  strike  price  from  the  owner  who  exercise  the  put  option.  speculators who believe the currency will apreciate (or at least will not depreciate) may sell a  currency put option. if the currency appreciates over the entire period, the option will not be  exercised.  this  is  an  ideal  situation  for  put  option  sellers  since  they  keep  the  premiums  received when selling the options and bear no cost.  speculating with combined put and call options  for volatile currencies, one possible speculative strategy  is to create a straddle, which  uses both a put option and a call option at the same exercise price. this may seem unusual  because  owning  a  put  option  is  appropriate  for  expectations  that  the  currency  will  appreciate. however, it is possible that the currency will depreciate (at which time the put is  exercised) and then reverse direction and appreciate (allowing for profits when exercising  the call). also, a speculator might anticipate that a currency will be substantially affected by  current economic events yet be uncertain of the exact way it will be affected. by purchasing a  put option and a call option, the speculator will gain if the currency moves substantially in  either direction. although  two options are purchased and only one  is execised,  the gains  could more than offset the costs.       barjaktarović, m., et al., currency options, ea (2011, vol. 44, no, 1‐2, 38‐46)     43 contigency graph for currency options  a contigency graph for currency illustrates the potential gain or loss for various exchange  rate scenarios  a contigency graph for a purchaser of a call option compares the price paid for the call  option to potential payoffs to be received with varius exchange rate scenarios.  example: a british pound cal option is available, with a strike price of rsd116,00 and a  call premium of rsd0,02. the speculator plans to exercise the option on the expiration date  and then immediately sell the pounds received in the spot market. under this conditions, a  contigency graph can be created to measure the profit or loss per unit (graph 1.). notice that  if the future spot rate is rsd116,00 or less, the net gain per unit is ‐$.02 (ignoring transaction  costs). this represents the loss of the premium per unit paid for the option, as the option  would not be exercised. at rsd117,00,  rsd.01 per unit would be earned by exercising the  option,  but  considering  the  rsd.02  premium  paid,  the  net  gain  would  be  ‐rsd.01.  at  rsd118,00, rsd.02 per unit would be earned by exercising the option, which would offset  the rsd.02 premium per unit. this is the break‐even point.     graph no 1. for purchasers of bp call options -0.03 -0.02 -0.01 0 0.01 0.02 0.03 0.04 14.00 15.00 16.00 17.00 18.00 19.00 20.00 21.00 future spot rate ne t p ro fit p er u ni t     at any rate above this point, the gain from exrcising the option would more than offset  the premium, resulting in a positive net gain. the maximum loss to the speculator in this  example is the premium paid for the option.  a contigency graph for the seller of a call option compares the premium received from  selling a call option to the potential payoffs made to the buyer of the call option for varius  exchange rate scenarios.  example: the graph 2. provides a contigency graph  for a speculator who sold  the call  option   described in the previous example. it assumes that this seller would purchase the  pounds in the spot market just as the option was exercised (ignoring transaction costs). at  future spot rates of less than rsd116,00, the net gain to the seller would be the premium of  rsd.02 per unit, as the option would not have exercised. in the future spot rate is rsd117,00  the  seller  would  lose  rsd.01  per  unit  on  the  option  transaction  (paying  rsd117,00  for  pounds in the spot market and selling pounds for rsd116,00 to fulfill the exercise request).  yet,  this  loss  would  be  more  than  offset  by  the  premium  of  rsd.02  per  unit  received,  resulting in a net gain rsd.01 per unit. the break‐even point is at rsd118,00, and the net  gain to the seller of a call option becomes negative at all future spot rates higher than that     economic analysis (2011, vol. 44, no. 1‐2, 38‐46)   44 point. notice that the contigncy graph for the buyer and seller of this call option becames  negative at all future spot rates higher than that point. notice that the contigency graphs for  the buyer and seller of this call option are mirror images of one another.    graph no 2 for sellers of bp call options -0.04 -0.03 -0.02 -0.01 0 0.01 0.02 0.03 14.00 15.00 16.00 17.00 18.00 19.00 20.00 21.00 future spot rate ne t p ro fit p er u ni t     a contingency graph for a buyer of a put option compares the premium paid for the put  option to potential payoffs received for various exchange rate scenarios.  example: the graph 3. shows the net gains to a buyer of a british pound put option with  an exercise price of rsd 116.00 and a premium of rsd 0.03 per unit. if the future spot rate is  above rsd 116.00, the option will not be exercised. at a future spot rate of rsd 115,00, the  put option will be exercised.  however, considering the premium of rsd.033 per unit, there  will be a net  loss of rsd.01 per unit. the break‐even point  in this example  is rsd114.00,  since  this  is  the  future spot rate  that will generate rsd 0.03 per unit  from exercising  the  option to offset the rsd0.03 premium. at any future spot rates of less than rsd114.00 the  buyer of the put option will earn a positive net gain.    graph no.3 for purchasers of bp put options -0.04 -0.03 -0.02 -0.01 0 0.01 0.02 0.03 0.04 0.05 111.00 112.00 113.00 114.00 115.00 116.00 117.00 118.00 future spot rate ne t p ro fit p er u ni t     a contigency graph for the seller of this put option compares th premium received from  selling the option to the possible payoffs made to the buyer of the put option for various  exchange rate scenarios. the graph 4. is like the mirror image of the contigency graph for the  buyer of a put option.  for various reasons, an option buyer s net gain will not always represent an option seller  s net loss. the buyer may be using call options to hedge a foreign currency, rather than to       barjaktarović, m., et al., currency options, ea (2011, vol. 44, no, 1‐2, 38‐46)     45 speculate. in this case, the buyer does not evaluate the option position taken by measuring a  net gain or loss; the option is used simply for protection. in adition, sellers of call options on  a  currency  in  which  they  currently  maintain  a  position  will  not  need  to  purchase  the  currency at the time an option is execised.     graph no.4. for sellers of bp put options -0.05 -0.04 -0.03 -0.02 -0.01 0 0.01 0.02 0.03 0.04 111.00 112.00 113.00 114.00 115.00 116.00 117.00 118.00 future spot rate n et p ro fit p er u ni t   conclusion  instruments of protection against exchange rate risk in our market are already available.  are simpler  than  it  first appears and  there  is no need  to wait passively until  the date of  payment  or  charges  that  would  then  also  face  the  effects  of  market  changes  already  implemented. for commercial banks and monetary regulators to continue in the direction of  creating a good climate for further development of financial derivatives market. for potential  customers,  on  the  other  hand,  to  recognize  their  interest  in  these  instruments  and  their  knowledge of the essence. financial derivatives, in the case of currency options, through its  internal mechanisms, the uncertainty of the future are reduced to a flat torque current and  the  known.  this  adventage,  however,  implies  the  responsibility  of  both  parties  to  the  contract of financial derivative that is a contracted until the end of respect, regardless of the  actual outcome of maturity. it is at this point of financial derivatives to fully perform their  function  of  ʺhedgingʺ  instruments  and  fully  diverge  with  ʺcrystal  ballʺ,  which  provides  unpredictable and because of that in our country, there is still resistance and doubt about the  usefulness  of  financial  derivatives  contracts.  but  once  they  removed  the  idea  of  extraordinary profit in the name of the price change that has occurred, and did not have to  happen,  and  adopted  the  principle  of  ʺsafety  and  responsibility  towards  themselves,  shareholders, employees,  financial derivatives market will become an  instrument without  which the and still can not.       economic analysis (2011, vol. 44, no. 1‐2, 38‐46)   46 references  apte. 2006. international financial management, tata mcgraw/hill education   geert bekaert, robert j. hodrick. 2008. international financial management. new york: pearson prentice  hall  madura, jeff.2010. international financial management. abridged edition.  suk h.kim and kim seung h.2006. global corporate finance. oxford: blackwell publishing  thummuluri, siddaiah.2010. international financial management. new york: pearason education  vyuptakesh,  sharan.2009.  international  financial  management.  new  delhi:  phi  leraning  private  limited.  bourse de montreal.2009.“currency options.” www.m‐ x.ca/f_publications_en/currency  options.pdf   finance‐mapsofworld.com ʺcurrency option trading.  ”www.mapsofworld.com/option/trading/currency/html  investopedia “currency option.” www.investopedia.com  wikipedia ”foreig exchange option.” www.en.wikipedia.org/wiki/foreign_exchange_option          article history:  received:  12 march 2011 accepted:  13 april 2011            microsoft word 2009_3_4-korigovano.doc original scienfitic paper inflation in serbia and in the european union* vukotić-cotič gordana, institute of economic sciences, belgrade stošić ivan, institute of economic sciences, belgrade udc: 339.745(497.11:4) jel: e31, f31 abstract – administration cannot be practiced in isolation of the culture of the society. this assertion implies that the knowledge, attitude, societal norms and orientation which people hold epitomize their administrative philosophy and the way it is practiced. key words: serbia, eu, emu, inflation, real exchange rate of the serbian dinar introduction in this paper we shall compare the rate of inflation in serbia with the rate of inflation in the european union (eu), to find out how much serbia – as a potential candidate country to the eu – diverges from general price tendencies exhibited by eu member states. we shall also examine the real exchange rate of the serbian dinar to the euro, the single currency within the european economic and monetary union (emu), bearing in mind the role it plays in serbia’s trade policy. finally, we shall observe the structure of inflation by main items of household consumption in both serbia and the eu – to contrast the standard of living in serbia with the standard of living in the eu. the rates of inflation will be derived from the index of consumer prices in serbia and the harmonized index of consumer prices in the eu1. the index of consumer prices in serbia is methodologically compatible with the harmonized index of consumer prices in the eu. the statistical office of the republic of serbia has been releasing data on this index since january 2007. this is the reason why our analysis will cover the period from january 2007 to april 2009, the latter being the last month for which we have collected final data on the harmonized index of consumer prices in the eu from the website of the statistical office of the european communities (eurostat)2. * this paper is a part of research project 159004 “the integration of the serbian economy into the european union – the planning and financing of the regional and rural development, and the enterprises development policy”, financed by the ministry of science and technological development of the republic of serbia. 1 the rate of inflation – as the rate of growth of the general level of consumer prices in a country, or region – is obtained by subtracting one hundred from the index of consumer prices in serbia, or the harmonized index of consumer prices in the eu. consumer prices are retail prices of goods and services purchased by households. 2 for the month for which the eurostat has posted its most recent data on the harmonized index of consumer prices at its website, data for some countries may have been provisional or unavailable. economic analysis (2009, vol. 42, no. 3-4, 29-37) 30 the eu will comprise the twenty-seven countries of which it has been actually constituted throughout the period under observation. these countries, listed in alphabetical order, are: austria, belgium, bulgaria, cyprus, the czech republic, denmark, estonia, finland, france, germany, greece, hungary, ireland, italy, latvia, lithuania, luxembourg, malta, the netherlands, poland, portugal, romania, slovakia, slovenia, spain, sweden and the united kingdom. the emu is actually composed of thirteen countries from january to december 2007, fifteen countries from january to december 2008, and sixteen countries from january 2009. the emu13 included: austria, belgium, finland, france, germany, greece, ireland, italy, luxembourg, the netherlands, portugal, slovenia and spain. the eu15 contained the emu13 plus cyprus and malta. the emu16 encloses the emu15 and slovakia. to accomplish analytical comparability, however, we shall deal with the emu16 over the entire period from january 2007 to april 2009. inflation and the real exchange rate of the serbian dinar chart 1 shows the annual rates of inflation in both serbia and the eu3. annual inflation was higher in serbia than in the eu throughout the period under observation. as a rule, the discrepancy between annual inflation in serbia and annual inflation in the eu was large. this suggests that a reference interest rate of the central bank should not be regarded as an almighty means of combating inflation in serbia. it is the growth of factor productivity, along with a rational public spending, that strengthens the ability of a nation to stabilize prices and to increase its share in world trade. but, the fact is that serbia is significantly lagging in this respect. prominent institutions often exclude serbia from their analyses of national competitiveness. in its most recent annual report on the competitiveness of nations, the institute for management development, located in lausanne (switzerland), included only slovenia and croatia of the ex-yugoslav republics. among the fifty-seven countries observed by three hundred and twenty-nine criteria, slovenia was ranked thirty-second, whereas croatia was ranked fifty-third4. on the other hand, the course of annual inflation in serbia was similar to the course of annual inflation in the eu. yet, the acceleration of annual inflation started earlier and lasted longer in serbia than in the eu: annual inflation was speeding up from may 2007 to june 2008 in serbia, and from august 2007 to july 2008 in the eu. 3 the annual rate measures the growth of a given variable between the current month and the same month of the previous year. thus, the annual rate of inflation – or, annual inflation – measures the growth of the general level of consumer prices over a twelve-month period. 4 institute for management development (2009), word competitiveness yearbook 2009 vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 31 chart 1. inflation in serbia and in the eu, january 2007 – april 2009: annual rates (%) 0 2 4 6 8 10 12 14 16 01 ,0 7 02 ,0 7 03 ,0 7 04 ,0 7 05 ,0 7 06 ,0 7 07 ,0 7 08 ,0 7 09 ,0 7 10 ,0 7 11 ,0 7 12 ,0 7 01 ,0 8 02 ,0 8 03 ,0 8 04 ,0 8 05 ,0 8 06 ,0 8 07 ,0 8 08 ,0 8 09 ,0 8 10 ,0 8 11 ,0 8 12 ,0 8 01 ,0 9 02 ,0 9 03 ,0 9 04 ,0 9 inflation in serbia inflation in the eu27 sources: eurostat, statistical office of the republic of serbia chart 2. inflation in serbia and in the eu member states, april 2009: annual rates (%) -0.7 -0.6 -0.3 -0.2 0.1 0.5 0.6 0.6 0.7 0.8 0.9 1.1 1.1 1.1 1.2 1.3 1.3 1.4 1.8 1.8 2.1 2.3 3.2 3.8 4.0 4.3 5.9 5.9 6.5 8.8 -2 0 2 4 6 8 10 ireland portugal luxembourg spain france austria cyprus emu16 belgium germany estonia denmark greece slovenia italy czech rep. eu27 slovakia netherlands sweden finland uk hungary bulgaria malta poland lithuania latvia romania serbia sources: eurostat, statistical office of the republic of serbia economic analysis (2009, vol. 42, no. 3-4, 29-37) 32 chart 2 depicts the annual rates of inflation in serbia and in the eu member states for april 2009. in this month, annual inflation accounted for 1.3% in the eu, and only 0.6% in the emu. four countries of the euro zone recorded annual deflation, ranging from 0.2% (spain) to 0.7% (ireland). in contrast, serbia registered an annual inflation rate of 8.8%, thus failing to keep up even with top-ranking romania (6.5%). while the reference interest rates of central banks in the eu were particularly low in april 2009, as a response to the current economic crisis, the reference interest rate of the national bank of serbia was 16.5% per year at the beginning, and 14% per year at the end of that month5. but, in spite of such a high reference rate, serbia’s annual inflation rate remained high. this clearly shows that monetary policy alone cannot suppress inflation in a country with a low level of productivity and a high level of budget deficit. chart 3 displays inflation in the emu per unit of inflation in serbia and its determinants – inflation in the emu, and inflation in serbia – as annual rates. the course of annual inflation in the emu per unit of annual inflation in serbia was influenced, as it might have been expected, by the course of annual inflation in serbia rather than by the course of annual inflation in the emu. at the same time, the course of annual inflation in the emu did not differ from the course of annual inflation in the eu: annual inflation in the emu was stagnant from january to august 2007, increasing from august 2007 to july 2008, and decreasing from july 2008 to april 2009. in all the months, however, the emu recorded a lower annual rate of inflation than the eu. the difference between annual inflation in the eu and that in the emu was especially large in march and april 2009, when four countries of the euro zone had an annual deflation (ireland, portugal, luxembourg and spain), while three countries outside the euro zone had a high annual inflation (romania, latvia and lithuania). chart 3. inflation in the emu per unit of inflation in serbia and its determinants, january 2007 – april 2009: annual rates (%) -10 -5 0 5 10 15 20 25 01 ,0 7 02 ,0 7 03 ,0 7 04 ,0 7 05 ,0 7 06 ,0 7 07 ,0 7 08 ,0 7 09 ,0 7 10 ,0 7 11 ,0 7 12 ,0 7 01 ,0 8 02 ,0 8 03 ,0 8 04 ,0 8 05 ,0 8 06 ,0 8 07 ,0 8 08 ,0 8 09 ,0 8 10 .0 8 11 .0 8 12 .0 8 01 ,0 9 02 ,0 9 03 ,0 9 04 ,0 9 inflation in the emu16 inflation in serbia inflation in the emu16 per unit of inflation in serbia sources: eurostat, statistical office of the republic of serbia 5 the reference interest rate of serbia’s central bank was lowered from 16.5% to 15% per year on the 6th of april 2009, and from 15% to 14% per year on the 22nd of april 2009. vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 33 chart 4. real exchange rate of the serbian dinar to the euro and its determinants, january 2007 – april 2009: annual rates (%) -15 -10 -5 0 5 10 15 20 01 ,0 7 02 ,0 7 03 ,0 7 04 ,0 7 05 ,0 7 06 ,0 7 07 ,0 7 08 ,0 7 09 ,0 7 10 ,0 7 11 ,0 7 12 ,0 7 01 ,0 8 02 ,0 8 03 ,0 8 04 ,0 8 05 ,0 8 06 ,0 8 07 ,0 8 08 ,0 8 09 ,0 8 10 .0 8 11 .0 8 12 .0 8 01 ,0 9 02 ,0 9 03 ,0 9 04 ,0 9 nominal exchange rate of the serbian dinar to the euro inflation in the emu16 per unit of inflation in serbia real exchange rate of the serbian dinar to the euro sources: eurostat, statistical office of the republic of serbia, national bank of serbia chart 4 presents the real exchange rate of the serbian dinar to the euro and its determinants – the nominal exchange rate of the serbian dinar to the euro, and inflation in the emu per unit of inflation in serbia – in the form of annual rates6. the annual growth of the nominal exchange rate of the serbian dinar to the euro exhibited a clear downward tendency only from february to august 2008. only in this interval were fewer units of the serbian currency being exchanged, from month to month, for one unit of the emu currency than a year earlier. this means that the serbian dinar was experiencing an accelerated annual appreciation to the euro in nominal terms only from february to august 2008. on the other hand, the annual growth of the real exchange rate of the serbian dinar to the euro was decelerating not only from february to august 2008, but also from july to october 2007. in these intervals fewer units of commodities produced in serbia were being exchanged, from month to month, for one unit of commodities produced in the emu than a year earlier. this means that the serbian dinar was undergoing an accelerated annual appreciation to the euro in real terms not only from february to august 2008, but also from july to october 2007. in these intervals, therefore, the real exchange rate of the serbian dinar, as a relative price of home-produced and foreign-produced goods and services, was demonstrating annual changes that were not in favour of the serbian net exports to the emu. 6 the index of the real exchange rate of the serbian dinar to the euro, rer, is computed as: rer = ner x p*/p where ner is the index of the nominal exchange rate of the serbian dinar to the euro, p* the harmonized index of consumer prices in the emu, and p the index of consumer prices in serbia. (let us recall that the rate of growth is obtained by subtracting one hundred from a given index.) the nominal exchange rate of the serbian dinar to the euro refers to the monthly average of daily midpoint exchange rates released by the national bank of serbia. it is directly quoted, for instance: 1 euro = 93.0588 serbian dinars. economic analysis (2009, vol. 42, no. 3-4, 29-37) 34 chart 5. real bilateral exchange rates of the serbian dinar to the euro, april 2009: annual rates (%) 6.1 6.2 6.5 6.7 7.0 7.4 7.5 7.5 7.6 7.7 8.0 8.0 8.2 8.4 8.8 9.1 11.1 0 2 4 6 8 10 12 ireland portugal luxembourg spain france austria cyprus emu16 belgium germany greece slovenia italy slovakia netherlands finland malta sources: eurostat, statistical office of the republic of serbia, national bank of serbia chart 5 shows real bilateral exchange rates of the serbian dinar to the euro as annual rates for april 2009. in this month, serbia registered annual changes of its currency in real terms that favoured its net exports to each country of the euro zone, ranging from 6.1% (in bilateral trade with ireland) to 11.1% (in bilateral trade with malta). on average, the serbian dinar depreciated to the euro in real terms by 7.5% in april 2009 over april 2008. the structure of inflation in april 2009, as in many other months of the period under observation, two categories – among the twelve main categories of goods and services of household consumption7 – stood out by their contributions to the overall annual growth of consumer prices, in serbia as in the eu. these categories were food and non-alcoholic beverages, on the one hand, and goods and services required for housing (actual rentals; the maintenance and repair of the dwelling; water supply and other services relating to the dwelling; electricity, gas and other fuels), on the other. the first category was more important than the second one in serbia, whereas the second category was more important than the first one in the eu. 7 the classification of goods and services of household consumption, being used for the computation of consumer price indices, has the following main categories: 1) food and non-alcoholic beverages; 2) alcoholic beverages and tobacco; 3) clothing and footwear; 4) goods and services required for housing; 5) furnishings, household equipment and the routine maintenance of the house; 6) medical products, out-patient and hospital services; 7) transportation equipment and services; 8) postal services, telephone equipment and services; 9) goods and services required for recreation and culture; 10) education services; 11) catering and accommodation services; 12) miscellaneous goods and services. vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 35 in april 2009, the annual growth of consumer prices of food and non-alcoholic beverages was predominantly due to the annual growth of consumer prices of food in both serbia and the eu. the annual growth of consumer prices of food – which accounted for 6.4% in serbia, and 2.2% in the eu – was lower than the overall annual growth of consumer prices in serbia (by nearly 30%), and higher than that in the eu (by nearly 70%)8. yet, the proportion in which it contributed to the overall annual growth of consumer prices was almost the same in serbia and in the eu (25%). such a result stemmed from a remarkably high share of food in the consumption of households in serbia (35%), in comparison with that in the eu (14.5%). chart 6. indices of consumer prices of food in serbia and in the eu member states, 2009: weights (%) 9.7 10.4 10.8 11.7 11.7 12.3 12.7 14.2 14.3 14.5 14.8 14.9 15.0 15.5 16.1 16.2 16.2 16.5 16.7 16.8 17.1 17.4 17.6 19.8 20.3 21.6 21.9 23.1 34.8 35.0 0 5 10 15 20 25 30 35 40 luxembourg uk germany denmark austria netherlands ireland sweden emu16 eu27 czech rep. france finland slovenia belgium slovakia cyprus italy malta greece spain hungary portugal estonia poland latvia bulgaria lithuania romania serbia sources: eurostat, statistical office of the republic of serbia chart 6 depicts the weights for the indices of consumer prices of food in serbia and in the eu member states for the year 2009. the chart reminds us of engel’s law: as income rises, the proportion of income spent on food falls (and the other way round). the share of food in total household expenditure is much the same in serbia (35%) as in top-ranking romania (34.8%). at the opposite end stands luxembourg, with only 9.7% of household income being spent on food. we may conclude that the living standard in serbia is low. 8 let us recall that the overall annual rate of growth of consumer prices accounted for 8.8% in serbia, and 1.3% in the eu in april 2009. economic analysis (2009, vol. 42, no. 3-4, 29-37) 36 conclusion the annual rate of inflation was persistently higher in serbia than in the eu from january 2007 to april 2009. this suggests that a reference interest rate of the central bank should not be regarded as an almighty means of combating inflation in serbia. it is the growth of factor productivity, along with a rational public spending, that strengthens the ability of a nation to stabilize prices and to increase its share in world trade. but, the fact is that serbia is significantly lagging in this respect. the annual growth of the real exchange rate of the serbian dinar to the euro was decelerating from july to october 2007, and from february to august 2008. in these intervals fewer units of commodities produced in serbia were being exchanged, from month to month, for one unit of commodities produced in the emu than a year earlier. this means that the serbian dinar was experiencing an accelerated annual appreciation to the euro in real terms from july to october 2007, and from february to august 2008. in these intervals, therefore, the real exchange rate of the serbian dinar, as a relative price of home-produced and foreign-produced goods and services, was undergoing annual changes that were not in favour of the serbian net exports to the emu. in april 2009, annual inflation accounted for 1.3% in the eu, and 8.8% in serbia. in that month, as in many other months of the period under observation, two categories of goods and services of household consumption stood out by their contributions to the overall annual growth of consumer prices, in serbia as in the eu. these categories were food and nonalcoholic beverages, on the one hand, and goods and services required for housing, on the other. the first category was more important than the second one in serbia, while the second category was more important than the first one in the eu. in april 2009, the annual growth of consumer prices of food and non-alcoholic beverages was predominantly due to the annual growth of consumer prices of food in both serbia and the eu. the annual growth of consumer prices of food – which accounted for 6.4% in serbia, and 2.2% in the eu – was lower than the overall annual growth of consumer prices in serbia (by nearly 30%), and higher than that in the eu (by nearly 70%). yet, the proportion in which it contributed to the overall annual growth of consumer prices was almost the same in serbia and in the eu (25%). such a result stemmed from a remarkably large share of food in the consumption of households in serbia (35%), in comparison with that in the eu (14.5%). this fact completes the picture of a low living standard in serbia. references bulíř a., hurník j. (2006), “the maastricht inflation criterion: how unpleasant is purgatory?”, economic systems, vol. 30, no. 4, pp. 385-404 coricelli f., jazbec b. (2004), “real exchange rate dynamics in transition economies”, structural change and economic dynamics, vol. 15, no. 1, pp. 83-100 de broeck m., sløk t. (2006), “interpreting real exchange rate movements in transition economies”, journal of international economics, vol. 68, no. 2, pp. 368-383 kim j., ruge-murcia f. j. (2009), “how much inflation is necessary to grease the wheels”, journal of monetary economy, vol. 56, no. 3, pp. 365-377 vukotić-cotič, g. et al., inflation in serbia and in the eu, ea (2009, vol. 42, no, 3-4, 29-37) 37 krause s., méndez f. (2008), “institutions, arrangements and preferences for inflation stability: evidence and lessons from a panel data analysis”, journal of macroeconomics, vol. 30, no. 1, pp. 282-307 leitemo k. (2004), “a game between the fiscal and the monetary authorities under inflation targeting”, european journal of political economy, vol. 20, no. 3, pp. 709-724 mishkin f. s. (2007), monetary policy strategy, mit press, 549 p. reynard s. (2007), “maintaining low inflation: money, interest rates, and policy stance”, journal of monetary economy, vol. 54, no. 5, pp. 1441-1471 vukotić-cotič g., stefanović s. (2008), “inflacija u srbiji u svetlu koncentrisanog tržišta 2008” (pp. 295-303): drašković b., vuković v. (eds.), tržišne strukture i zaštita konkurencije: iskustva zemalja u tranziciji, institute of economic sciences, belgrade banking academy, 303 p. živković b., stamenković s., vučković v. (2007), “novi model monetarne regulacije”, ekonomika preduzeća, vol. 55, no. 1-2, pp. 46-56 received: 24 july, 2009 article history: accepted: 15 august, 2009 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp42-58 original scientific paper housing, inequality and economic growth: evidence from a sample of brazilian states vittoria manzoli1 | antónio portugal duarte2 | marta simões2* 1 faculty of economics, university of coimbra, coimbra, portugal 2 ceber and faculty of economics, university of coimbra, coimbra, portugal abstract this paper investigates the inequality-growth nexus using state-level data for brazil from 2005 to 2013 and considers that the housing deficit better reflects inequality in the brazilian economy, a highly unequal country. we estimate a growth regression where the housing deficit is the main explanatory variable taken alongside other control variables. the findings point to the existence of a negative linear association between the housing deficit and the growth rate of real gpd per capita across the 27 brazilian states, with a higher explanatory power relative to the regressions that use the gini index. the association is also stronger for the sample of richer states. other statistically significant regressors include initial income and human capital/education. our findings endorse investing in housing as a potential important means for fighting inequality and promoting faster economic growth in brazil. attention should also be given to broadening access to higher quality utilities such as electricity and sanitation. the promotion of universal access to education as a means to increase the human capital stock is also a path to achieve faster growth in brazil. key words: housing inequality, economic growth, brazilian states, panel data jel classification: c23, o18, o40 introduction brazil is a country with high contrasts in terms of income distribution, as evidenced in the united nations human development report (hdr), which identified the country as the ninth most unequal country in the world in 2017, a position based on the gini index that recorded a value of 0.549 in 2017. on the other hand, over the period 2000-2015, brazil's real gdp per capita recorded an average annual growth rate of 1.7%, according to oecd statistics. in this study we investigate whether brazil could have grown faster if not for the high level of inequality. according to the literature, the relationship between inequality and economic growth can be either negative or positive. neves and silva (2014) argue that there is no universal sign that applies to all countries at all times for the relationship between inequality and economic growth and so researchers and policymakers must take into account the specificities of each country or region. in any case, the sign of the effect of inequality on growth in less developed countries is in general negative and more intense and so policies aimed at reducing inequality in developing countries such as brazil will likely have a positive impact on economic growth. * corresponding author, e-mail: mcsimoes@fe.uc.pt vittoria manzoli, antónio portugal duarte, marta simões 43 one of the clearest expressions of inequality in the brazilian case is access to housing, and so this study will focus on the relationship between the housing deficit and economic growth to gain a better understanding of the role of inequality on economic growth in this particular situation. access to housing of adequate quality is essential to guaranteee the well-being of inidividuals. lack of or inadequate housing can thus have repercussions in terms of labour force reproduction or the supply of goods and services, mainly because housing represents shelter, protection, and security. the debate on housing access in brazil is necessary to understand and deal with inequalities that affect a large proportion of the population. a significant proportion of the brazilian population sets as a main goal to own a house, because housing is seen as performing a social function, as a means to provide shelter for the family and assist in its development, besides being associated with success and social position. this paper investigates the inequality-growth nexus using state-level data for brazil from 2005 to 2013, retrieved from different sources, such as the institute for applied economic research (ipea) and the brazilian institute of geography and statistics (ibge) that make available census and national accounts data for the different states. we consider that the housing deficit, computed by fundação joão pinheiro (fpj), better reflects inequality in the brazilian economy, a highly unequal country. albeit over the past decade targeted income and social inclusion policies managed to achieve a reduction in inequality, it remains high and so it is important to assess the potential growth benefits from inequality reduction using indicators that enable the design of more precise and effective policies. the empirical formulation adopted corresponds to a growth regression where the housing deficit is the main explanatory variable taken alongside other control variables. this indicator measures housing shortages at the state level relative to the total population of a state. in its calculation, the housing deficit considers any housing in which one of the following occurs: precarious housing; different families’ cohabitation; excessive rent burden; or excessive number of dwellers in rented housing. the remainder of the paper is organized as follows. in the next section we carry out a brief review of the literature on the relationship between income inequality and economic growth. section 3 presents the empirical model and the estimation methodology. the variables selected and a brief descriptive analysis of the data are presented in section 4. section 5 presents and discusses the results and policy implications. section 6 concludes. literature overview how does inequality affect a country's economic growth performance? the relationship between inequality and economic growth can be either positive or negative and the results from the vast empirical literature on the subject to date, such as barro (2000), also show considerable ambiguity. several researchers have analysed the relationship between inequality and economic growth taking into account different transmission channels in order to gain a better understanding on the sign, as reviewed by neves and silva (2014) and neves, afonso and silva (2016). while the aggregate savings and the r&d channels predict a positive impact of inequality on growth, other transmission channels point to a negative relationship, including: (i) credit constraints and associated barriers to the accumulation of human and physical capital; (ii) socio-political instability; (iii) redistribution and associated high tax burdens; and (iv) joint education and fertility decisions. some of the possible explanations for the negative effects are: (a) in the presence of strong credit constraints, the poorest population will not be able to invest in physical and human capital, mainly because they have few (if any) guarantees to give as collateral for obtaining credit (barro, 2000); (b) inequality may increase the risk of political instability, with negative investment outcomes. for instance, when inequality is accompanied by low rates of social mobility, people may be attracted to criminal practices rather than formal work or education, and high crime rates may lead to lower investment as the enforcement of 44 economic analysis (2020, vol. 53, no. 1, 42-58) property rights is weakened and since they create uncertainty (gründler and scheuermeyer, 2018); (c) income redistribution policies, if common in more unequal countries, may lead to the need to increase the tax burden and the transfer of resources from the richest to the poorest, possibly discouraging labour supply and effort and investment by firms; and (d) finally, gründler and scheuermeyer (2018) suggest that the most unequal societies tend to have high fertility rates and low levels of education because the poorest cannot afford to invest in their children's education and they regard children as a chance to increase family income. by contrast, richer families are willing to have fewer children and invest more in their education. as for the possible positive effect of inequality on economic growth through aggregate savings, according to gründler and scheuermeyer (2018), kaldor (1955) argued that inequality stimulates growth as the marginal propensity to save increases with the income level and so the richest save a higher fraction of their income, increasing investment and in this way growth. the positive effect of inequality on economic growth is also revealed through the demand side. more unequal income distributions increase the demand for high quality products such as luxury goods and high-tech products, and not just for basic needs, for a given price increase. when the price effects outweigh market size effects, innovative companies are favoured by the presence of those that are willing to pay higher prices for new products, and thus inequality can stimulate r&d, a main driver of economic growth (halter et al., 2014). identifying the impact of inequality on economic growth is thus an empirical issue, which has been the subject of extensive research. at the empirical level it is possible to find studies that obtain a negative effect of inequality on growth, results that are in turn contradicted by a significant number of other studies that arrive at a positive effect. neves and silva (2014) suggested, based on a comprehensive survey of this literature, that differences in estimation methods, the quality of the data collected and sample coverage may influence the relationship between inequality and growth obtained by different empirical studies. neves, afonso and silva (2016) conducted a meta-analysis of the empirical literature that estimates the relationship between inequality and growth based on a reduced form regression, i.e. studies that seek to identify the direct impact of inequality on growth. the main results and conclusions drawn support different impacts of inequality on growth, highlighting that: (i) the impact is negative and stronger in developing countries relative to richer countries; (ii) inequality in wealth distribution has a stronger negative impact on growth than inequality in income distribution, possibly due to the fact that the relevant transmission channels in action in the two types of distribution are not the same, and therefore policies focusing on reducing inequality in developing countries will be more likely to have a positive impact on growth. income inequality refers to the discrepancy in income distribution among holders of productive factors or between individuals and is mainly due to unemployment, low paid jobs or a high wage pay gap, common in developing countries. inequality in the distribution of wealth is measured based on the distribution of productive factors, human capital, physical capital, or on the distribution of real and financial assets (castelló and doménech, 2008). in the presence of wealth inequality, the less favoured will be less likely to make investments in productive factors, such as human and physical capital, and will prefer direct income transfers over investment. this scenario possibly leads the government to increase taxation so that infrastructure and other productive public investments can be carried out, for example. for the brazilian case, two recent empirical studies on the relationship between inequality and growth are cruz et al. (2015) and bessaria et al. (2018). cruz et al. (2015) investigate the link based on data for the 27 brazilian states over the period 1995-2009. by focusing on brazil at the state level it is possible to overcome some of the data comparability issues involved in crosscountry studies, especially as far as inequality is concerned. the growth regression estimated by the authors considers a non-linear relationship between inequality and growth by including both a linear and a quadratic term of the gini index of income distribution, alongside other control variables such as initial income per capita, the crime rate, schooling, fertility, life expectancy, openness and state intervention. the results using the system-gmm estimator point to a positive relationship between inequality and growth in the richer states and the opposite vittoria manzoli, antónio portugal duarte, marta simões 45 applies in the poorer states. another important growth determinant in the case of the brazilian states according to the authors is educational attainment. in bessaria et al. (2018) the main explanatory factors of output growth rate differences across brazilian states are income inequality and education. using state level data for the period 1990-2014 to estimate a growth regression, the authors conclude that additional years of education positively affect economic growth and, by contrast, income inequality, measured by the gini index, has a negative growth impact. the data used, besides real gdp per capita and the gini index, included investment (capital expenditure), political instability (homicides rate), openness and regional dummies. bessaria et al. (2018) also show that, during this period, there was a reduction in income inequality at the national level and, following the trend of the brazilian economy, all of its macroregions (recorded a reduction in income inequality, higher in the southern regions. the authors additionally carried out cointegration tests in a panel data context and concluded that there is a long run relationship between real gdp per capita growth, the gini index and educational attainment at the state level. for the specific case of brazil, what the study by bessaria et al. (2018) suggests is that inequality is likely to have a negative impact on economic growth, even though the empirical literature has not reached a consensus on this issue. brazil is characterized by strong social contrasts, high income inequality and a poorly educated population. their paper investigates the inequality-growth nexus at the state level for brazil considering as a proxy for inequality the housing deficit. brazil is frequently in the spotlight for the lack of domestic security and the large number of “favelas” where violent episodes frequently occur. the choice of the housing deficit as a proxy for inequality in brazil is due to the importance of housing in terms of providing individuals with better living conditions, thus improving other important factors for the wellbeing of people, such as health and educational outcomes. the big inequality levels in the country resulted in the exclusion of the poor, who are deprived of some basic rights, such as access to decent quality housing and consequently greater security. access to decent housing is a right of every citizen inscribed in the brazilian constitution and, in addition, housing investment is able to deliver benefits not only to the low-income population but also to the country as a whole, if it is able to promote economic growth. empirical strategy and data to investigate the link between inequality and economic growth in brazil we use data for the 27 states that compose this country. limited time coverage for our explanatory variable of interest, the housing deficit, for some states implied that the analysis concentrates on the period 2005-2013. in this way we have data for the 27 states observed over two 4-years sub-periods (2005-2009 and 2009-2013) in order to overcome to some extent business cycle effects, as is usual in empirical studies of economic growth. the panel is balanced with 2 observations for each of the 27 states, which gives a total of 54 observations. the baseline empirical model is given by equation (1): 𝐺𝑟𝐺𝐷𝑃 𝑝𝑐 𝛼 𝛽 𝑙𝑛𝐺𝐷𝑃𝑝𝑐 ; 𝛽 _ ; ; + 𝛽 𝑆𝑐ℎ𝑜𝑜𝑙 ; 𝛽 𝐼𝑛𝑣 +𝛽 𝐺𝑟𝑃𝑜𝑝 𝜀 (1) according to equation (1), economic growth depends on initial output, the accumulation of factors of production, physical and human capital, the population growth rate and inequality. the control variables included in the empirical model were selected taking into account the predictions of the augmented solow model (mankiw, romer and weil, 1992) and previous empirical studies on the relationship between inequality and growth (forbes, 2000). the dependent variable, grgdppc, is the annual average growth rate of real gdp per capita, our measure of economic growth. initial income, lngdppc measured at the beginning of each subperiod, intends to capture the possibility of convergence among the brazilian states due to the 46 economic analysis (2020, vol. 53, no. 1, 42-58) diminishing marginal returns assumption of exogenous growth models, according to which initially poorer states will grow faster and converge to the income levels of the richer states. the estimated coefficient on initial income per capita is thus expected to be negative. also according the augmented solow model, higher rates of accumulation of physical and human capital, measured respectively as the investment rate (inv) and as the average years of schooling of the population aged 25 and above (school) are expected to lead to faster growth and so the respective estimated coefficients are expected to be positive. finally, as far as control variables are concerned, faster population growth (grpop) saps growth since the same amount of inputs has to be distributed across a higher number of workers and so the respective estimated coefficient is expected to be negative. our explanatory variable of interest is inequality, proxied by the initial housing deficit per capita, _ . although the literature has not reached a consensus on the sign of the link between inequality and growth, the prevailing evidence for developing countries is that the relationship is negative and so we expect that the respective estimated coefficient is negative for brazil, classified by the world bank as an upper middle income country. 𝑎 is the constant terms and 𝜀 the error term. table 1 contains a description of the variables used and respective sources. table 1. variables and sources notation description source grgdppc annual average growth rate of real gdp per capita for each 4-years sub-period ipea lngdppc log of real gdp per capita at the beginning of each 4years sub-period. ipea hous_def pop shortage or inadequate housing per capita at the beginning of each 4-years sub-period. fundação joão pinheiro and ibge school average years of schooling of the population aged 25 and above at the beginning of each 4-years subperiod ipea inv annual average investment rate for each 4-years subperiod. due to limited data availability at the state level the proxy used corresponds to public capital expenditure as a percentage of gdp. brazilian ministry of finance (ministério da fazenda) grpop annual average growth rate of the population for each 4-years sub-period. ibge gini gini index of the distribution of personal income at the beginning of each 4-years sub-period. ipea concerning the data used, it is important to look in some detail at the indicator chosen to measure inequality in brazil, the housing deficit, calculated annually by foundation joão pinheiro (fjp), in a partnership with the ministry of cities, the inter-american bank for development bank (idb) and the united nations development program (undp). the protocol signed between the fjp and the federal government is relatively recent, 1995, and the main objective is to calculate the brazilian housing deficit and improving its calculation methodology. but it was from 2003 onwards, with the creation of the ministry of cities, that the computation and analysis of such indicator gained more importance. based on the calculations of the housing deficit, the central government makes decisions on housing policies, housing subsidies, sanitation and urban transport (fjp, 2014). indeed, the main objective of the housing deficit indicator is to guide those responsible for the implementation of public policies and programs reduce this deficit. this indicator can measure and track the development and progress of vittoria manzoli, antónio portugal duarte, marta simões 47 housing policies adopted by the government, and inform policy makers on the need for government action. the indicator of the housing deficit that will be used in this work is directly related to housing shortages. the housing deficit can be understood in two ways: the deficit due to the need for an increase in the stock of housing and the deficit due to the need to replace the depreciation of the existing stock. the first component is due to lack of housing and the second component is due to the need to replace existing decaying housing. the calculation of the housing deficit is the result of the sum of four elements: precarious housing, family cohabitation, excessive rent burden and excessive density. these elements are presented in table 2 below. the calculation methodology used by the fjp ensures that double counting does not occur. table 2. components of the housing deficit 1. precarious housing 1.1. improvised housing usually located in a building that was not built exclusively for housing, as well as places considered unsuitable for housing which are occupied for this purpose. 1.2. rustic housing housing not made of masonry or paired wood. the dominant material is usually uncoated mud, reused wood, etc. 2. family cohabitation 2.1. rooms according to the ibge “rooms are private housing consisting of one or more rooms located in a casa de cômodo, cortiço, cabeça-de-porco, etc.” 2.2. cohabiting families families living in the same house, with the intention of constituting their own / separate home. 3. excessive rental burden rent is considered excessive when the household spends 30% or more of its income to pay for the rental of housing. (households with incomes above three minimum wages are not included in this indicator). 4. excessive density in rented households excessive density occurs when permanent private rented housing has more than three inhabitants per room. source: based on information from ibge and fundação joão pinheiro. table a.1 in the appendix contains descriptive statistics for real gdp per capita for the 27 brazilian states between 2005 and 2013. the highest real per capita gdp recorded was that of the federal district in 2013, corresponding to a value of 63.05 thousand reais (the brazilian currency). in contrast, the lowest real gdp per capita recorded during this period was in the state of piauí in 2005 (5.63 thousand reais), located in the northeast region of brazil. for the total sample (27 states) the average real gdp per capita was 17 thousand reais. table a.2 in the appendix contains descriptive statistics for the annual average growth rate of real gdp per capita for the two sub-periods under analysis, 2005-2009 and 2009-2013. the state of pará, located in the north part of brazil, recorded the lowest growth rate, 0.86% in 20052009. the state of paraná, located in the south part of brazil, recorded the highest growth rate, 12.81%, 2009-2013. as far as the explanatory variable of interest is concerned, figures 1 and 2 in the appendix show that over the period 2000-2015, for five brazilian regions and for brazil as a whole, respectively, although the housing deficit is still considerable it recorded a slight improvement 48 economic analysis (2020, vol. 53, no. 1, 42-58) during this period. the total brazilian housing deficit went from 7,222,644 in 2000 to 6,355,743 in 2015, a reduction of about 12%. as shown in table a.3 in the appendix, the state with the largest housing deficit in this period was são paulo (1510463 units in 2005). the fact that this number is so high for são paulo is associated with the fact that são paulo is the most populous state over the period. são paulo was the only state that in 2015 recorded a housing deficit that exceeds one million houses (1.337 million), and of the total housing deficit for this specific year, 48% (639 thousand houses) is located in the metropolitan region of são paulo. also for the year 2015, minas gerais recorded the second largest housing deficit, 575 thousand units, followed by bahia, with a deficit of 461 thousand units. throughout the sample period, the state with the lowest total housing deficit was roraima, with 13799 units in 2008. results we first applied three diagnostics tests, the f-test, the breusch-pagan test and the hausman test, to choose between pooled ols, fixed effects or random effects estimation methodologies. pooled ols assumes that the units under analysis behave in exactly the same way and so the constant term and the estimated coefficients in equation (1) are common to all the 27 states over the 2 sub-periods for which they are observed. if this assumption is not correct and the model suffers from ommitted variable bias then the results are not robust. fixed effects considers that the behaviour of real gdp per capita can differ across the 27 states due to specific features that remain constant over time, which is translated in a different intercept for each cross section unit. with random effects these specific characteristics of each cross-section unit are also taken into account, but are not considered constant over time (they are random), so heterogeneity is included in the error term. table 3 presents the results of the three diagnostic tests based on the estimation of equation (1). the f-test considers as the null hypothesis that pooled ols is the adequate estimation procedure against fixed effects. the breusch-pagan test considers as the null hypothesis that pooled ols is the adequate estimation procedure against random effects. finally, the hausman test considers as the null hypothesis that fixed effects is the adequate estimation procedure against random effects. according to the results presented in table 3, the p-value for the f-test does not allow us to reject pooled ols as the adequate estimation procedure at the usual significance levels since it is higher than 10%. on the other hand, the hausman test tell us that we cannot reject fixed effects as the most adequate estimation procedure relative to random effects. in this case, it is thus not necessary to perform the breusch-pagan test since transitivity of results from the former two tests implies that pooled ols is the most adequate estimation procedure relative to fixed effects and random effects. we thus proceeded with the estimation of our empirical model using pooled ols. table 3. results of the diagnostics tests to select the appropriate panel estimation procedure test statistic p‐value f f(26, 22) = 1.5925 0.1355 breusch-pagan ---- hausman h = 73.4513 1.95744e-014 source: authors’ computations using the econometric package gretl. table 4 contains the results of the estimation of the baseline regression given by equation (1) using pooled ols. as can be seen in column (1), the housing deficit adjusted for population size presents a negative and statistically significant coefficient at the 1% significance level. this result confirms, at least in qualitative terms, the results observed in neves, afonso and silva (2016), which concluded that the effect of inequality on output growth is negative in developing countries. the signs of the estimated coefficients for most of the control variables also confirm the theoretical predictions. initial real per capita gdp presents a negative contribution to real vittoria manzoli, antónio portugal duarte, marta simões 49 per capita gdp growth, which suggests conditional convergence between the brazilian states. the estimated coefficient for the level of education is positive and statistically significant as expected. in the case of the population growth rate, the estimated coefficient is negative as expected, but not statistically significant. in the case of the investment rate, the estimated coefficient is negative, contrary to theoretical predictions, but it is not statistically significant, suggesting that the accumulation of physical capital is not a relevant source of growth for the brazilian states, contrary to what happens with the accumulation of human capital. next we carried out a sensitivity analysis of the results to the consideration of the standard measure of inequality, the gini index of income distribution. again the diagnostic tests results point to pooled ols as the most adequate estimation procedure (results available from the authors). table (4), column (2), contains the results using the gini index. as can be seen, the estimated coefficient for the gini index is also negative, although not statistically significant. it is also important to note that the explanatory power of the model is now smaller: the adjusted r2 decrease to around 22% and the value of the akaike information criterion is higher, when the best model is the one that minimizes this value. in summary, the results using the housing deficit are more robust than the results using the gini index. these results are in accordance with those reported in neves, afonso and silva (2016), according to which the negative growth impact of an unequal distribution of wealth is stronger than the negative growth impact of an unequal income distribution. we can think of the housing deficit as closer to a measure of inequality in the distribution of wealth, while the gini index used is a measure of inequality in the distribution of income. table 4, columns (3) and (4), presents the results of accommodating the possibility of a nonlinear relationship between inequality and economic growth in the form of an inverted u so that an increase in inequality may increase the pace of economic growth up to a certain level beyond which additional increases in inequality become detrimental to growth. to capture this effect, a quadratic term of the inequality measure was introduced, in addition to the linear term. table 4, columns (3) and (4), contain the estimation results by alternatively considering the housing deficit or the gini index as measures of inequality and again using the pooled ols method. as can be seen, the estimated coefficients of both linear and quadratic inequality terms are not statistically significant, regardless of the inequality measure considered, thus not confirming the existence of a nonlinear relationship. note that the explanatory power of the models also seems to decrease based on the lower adjusted r2 value, while the information criteria values are higher than for the linear models. to overcome, to some extent, the possibility of omitted variable bias we further estimated our empirical model with the inclusion of regional dummies. the dummies correspond to the five brazilian macro-regions: north, northeast, midwest, southeast and south. the dummies allow us to capture specific regional effects, which may have been ignored before, such as effects of differences in violence, culture, regional institutions, among others. the regression includes only four of the dummies (regions), north, northeast, southeast, and midwest, due to the obvious linear dependency problems that the inclusion of a fifth dummy would cause. the results show that only the dummy for the north region presents a negative estimated coefficient, as can be seen in table 4, columns (5) and (6). moreover, none of the dummies revealed a statistically significant coefficient. 50 economic analysis (2020, vol. 53, no. 1, 42-58) table 4. results for the whole sample (pooled ols) (1) (2) (3) (4) (5) (6) const 0.0987*** (0.0306) 0.1205 (0.0798) 0.0983*** (0.0334) −0.2852 (0.8873) 0.1018 (0.0477) 0.1655 (0.0813) lngdppc -0.095*** (0.0223) -0.093*** (0.0244) −0.0951*** (0.0225) −0.0912*** (0.0251) -0.1149*** (0.0275) -0.1063*** (0.0313) school 0.0379*** (0.0102) 0.0408*** (0.0112) 0.0379*** (0.0104) 0.0407*** (0.0113) 0.0449 (0.0105)*** 0.0472 (0.0115)*** inv -0.0283 (0.0364) -0.0442 (0.0395) −0.0284 (0.0372) −0.0470 (0.0403) -0.0152 (0.0363) -0.0320 (0.0396) grpop 0.1449 (0.4966) -0.1109 (0.5382) 0.1442 (0.5023) −0.071 (0.5497) 0.3262 (0.5319) 0.0412 (0.5926) def_house -0.993*** (0.2959) −0.9643 (0.9375) -1.0389 (0.2974) def_house2 −0.3407 (10.394) gini -0.1476 (0.1271) 1.325 (3.209) -0.2626 (0.1600) gini2 −1.3463 (2.9322) dum_north -0.0169 (0.0185) -0.0116 (0.0228) dum_northeast 0.0059 (0.0204) 0.0178 (0.0276) dum_southeast 0.0075 (0.0153) 0.0111 (0.0176) dum_centre-west 0.0149 (0.0163) 0.0178 (0.0196) r2 0.4092 0.2905 0.4093 0.2937 0.4879 0.3835 adjusted r2 0.3477 0.2166 0.3339 0.2036 0.3830 0.2574 fstats (p-value) 0.000089 0.0045 0.00025 0.0092 0.000233 0.0065 akaike -223.6166 -213.729 −221.618 −211.971 -223.3215 -213.3138 bic -211.6827 -201.796 −207.7 −198.05 -203.432 -193.424 hannan-quinn -219.0142 -209.127 −216.248 −206.602 -215.6508 -205.6430 notes: standard errors in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. source: authors’ computations using the econometric package gretl. we also analysed the sensitivity of the results obtained to the division of the sample according to the value of real gdp per capita in the year 2005, in accordance with the study by brueckner and lederman (2018), who concluded that the relationship between inequality and growth depends on initial income. the results of brueckner and lederman (2018) provide support for the assumption that income inequality is conducive to faster growth in poor countries, but is detrimental to growth in high to middle income economies. regression with panel data was thus performed for two distinct samples: high and low income states. the sample was split based on the average real gdp per capita in 2005, equivalent to 12037 reais. the first sub-sample, which comprises the high income states, those with values of income per capita in 2005 above the average, contains 13 states (amazonas, federal district, espírito santo, goiás, mato grosso, mato grosso do sul, minas gerais, paraná, rio de janeiro , rio grande do sul, roraima, sao paulo, santa catarina); the second sub-sample comprises the low-income states, those with below vittoria manzoli, antónio portugal duarte, marta simões 51 average intial income per capita, and contains 14 states (acre, alagoas, amapá, bahia, ceara, maranhão, para, paraiba, pernambuco, piaui, rio grande do norte, rondonia, sergipe, tocantins). the results obtained with the splitting of the sample are shown in table 5. the three diagnostics tests were also applied and pointed to pooled ols as the most adequate estimation procedure when using the housing deficit, columns (1) and (2), also for the high-income states of column (4) when using the gini index, while for the low-income states when using the gini index, column (3), the adequate estimation procedure is fixed effects. these results are available from the authors. the main take away from these results is that the housing deficit has a stronger negative association with growth in the initially richer states. of course this result could be the consequence of reverse causality since richer states attract more people, which in turn results probably in a higher housing deficit. the other results remain basically unchanged. table 5. results with the two sub-samples, 14 richest states and 13 poorest states (pooled ols/fixed effects) (1) 14 richest states (2) 13 poorest states (3) 14 richest states (4) 13 poorest states const 0.1266 (0.0501) 0.1534 (0.0898) -0.3607 (0.7096) -0.0157 (0.1605) lngdppc -0.1086*** (0.0346) -0.1210** (0.0501) 0.0142 (0.2552) -0.0741 (0.0742) school 0.0433*** (0.0146) 0.0370** (0.0141) 0.0846* (0.0369) 0.0372** (0.0155) inv -0.0313 (0.0595) -0.0110 (0.0519) 0.7487* (0.3254) -0.0383 (0.0543) grpop 1.4364 (0.7185) -0.0051 (0.7469) 1.0334 1.0869 -0.3079 (0.7885) def_house -2.1733*** (0.5218) -0.8629* (0.4475) gini -0.5439 (0.5125) 0.0637 (0.2363) r2 0.6519 0.3593 0.4256 0.2535 adjusted r2 0.5649 0.2137 0.2820 0.0838 f-stat. (p-value) 0.00042 0.0641 0.0367 0.2321 akaike -112.7503 -110.8854 -99.7273 -106.6045 bic -105.2017 -102.8921 -92.1787 -98.6112 hannan-quinn -110.5765 -108.4417 -97.5536 -104.1608 notes: standard errors in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. source: authors’ computations using the econometric package gretl. overall our results point to the housing deficit as an important policy instrument for public decision makers. since public resources are scarce, it is very important to define priorities and accurate indicators are of paramount importance in order to avoid waisting scarce resources. in such an unequal context as is the case of brazil, it is probably not efficient nor effective to 52 economic analysis (2020, vol. 53, no. 1, 42-58) implement the same public housing policies across the states, with different income levels, as shown by the results presented in table 5. the construction of new residential units seems of utmost importance to foster growth. a possible measure in this regard would be the financing of housing investments in a longer time horizon, thereby promoting access by low income households. financing is essential for building new houses and also for maintaining the existing ones, as highlighted by maricato (2017), p. 57, "production because it is the immobilization of significant capital over a long period of time, and consumption because housing is a special, high-priced commodity that requires credit for its purchase." improving brazil's housing situation should not only be concerned with building new housing units, but also with helping the poorest people maintaining the existing ones. stimulus packages for taking advantage of empty houses could also be used by the government, given the large number of empty houses because owners cannot find people who can pay the rent demanded or simply do not want to rent their houses. policies that facilitate and encourage the renting market may also help to reduce brazil's housing deficit and in this way promote growth. conclusion in this paper we investigated the relationship between inequality and economic growth for brazil using state-level data for the period 2005-2013 and focusing on the housing deficit as an indicator of inequality of opportunities, instead of the most often used gini index of income distribution. according to the literature, inequality can have a negative growth effect through three main channles: it generates socio-political instability that reduces investment, increases the demand for redistribution which hurts incentives and in a context of credit market imperfections prevents the poor from investing. but a positive impact can also emerge if higher inequality creates incentives to work harder and with higher effort, innovate and if the rich have a higher propensity to save and there are investment indivisilities. for developing countries such as brazil previous evidence points predominantly to a negative impact. the housing deficit can be seen as an indicator of wealth inequality, which previous literature as argued can be more important for the explanation of economic growth than income inequality since, quoting islam & mcgillivray (2019), pp.1-2 “(…) a negative growth effect of wealth inequality may be more noticeable than that of income inequality as wealth accumulates over time by generating its own income in terms of interests, dividends, rents, and capital gain and passing on between generations.” it could also be the case that when national wealth is highly concentrated in a few elites there will be an increase in political rent-seeking, resulting in less productive investment decisions and barriers to the entry of new investors which will also slow down growth (morck et al. (2000)). for instance, deininger & olinto (2000) find evidence that land inequality, a proxy for wealth inequality, has a relatively large significant negative effect on growth in a sample of 60 countries over the period 1960-1990, while income inequality reveals to have only a tenuous growth effect and in some cases with a positive sign. also, the authors findings indicate that a highly unequal distribution of assets reduces the effectiveness of educational interventions. our findings also revealed that the housing deficit is more strongly associated with the dynamics of real gdp per capita for the sample of brazilian states over the period under analysis than the gini index. the evidence found of a growth-reducing impact of the housing deficit is of policy relevance in a number of aspects, supporting housing policy as a means to promote social inclusion, provide more equal chances to every citizen and stimulate economic growth. housing policies should be designed to ensure adequate housing for all citizens and promote growth so that improving people's access to quality housing should become a priority. in brazil, recent efforts in this direction have been made, for instance with the minha casa minha vida (my house my life) program, which introduced financial subsidies through public banks for the purchase of the first house. however, little has been done by the government to subsidize the maintenance and depreciation of housing, which directly impacts the quality of the flow of services derived from vittoria manzoli, antónio portugal duarte, marta simões 53 existing housing. in addition to facilitating people's access to funds to maintain their capital stock (housing), the government could set as a priority, whithin an economic growth agenda, the extension to the whole country of basic services, such as sanitation and electricity. additionally, these policies can have spillover effects on human capital, another important determinant of the growth of real gdp per capita in our sample of brazilian states according to our findings. access to housing and of better quality can be an important determinant of the quality of the education received (learning outcomes) and the health status of the population. especially at early stages of economic development, quality housing is highly correlated with the population's health conditions and even the quality of education. therefore, policies aimed at expanding access to and the quality of housing should be a priority, not withstanding the need for other more direct measures aimed at reducing inequality in the wealth and income distributions, such as increasing the minimum wage, encourage higher savings rates among the poorer (e.g. through compulsory retirement plans), provide access to low-cost financial services (that can also facilitate home ownership) or investments in education. the evidence presented in this paper should in any case be interpreted with some caution since it is based on a rather short period of time, which additionally did not allow us to control in a more precise way for the possibility of reverse causality. as more data on the housing deficit becomes available, in particular covering a longer time period, it will be possible to deal with these limitations. references barro, r. (2000). “inequality and growth in a panel of countries.” journal of economic growth, 5(1), 5-32. bessaria, c. n., araujo, j. m., silva, a. f. d., sobral, e. f. m., & pereira, t. g. (2018). “effects of income inequality on the economic growth of brazilian states: an analysis using the cointegrated panel model.” international journal of social economics, 45(3), 548-563. brueckner, m., & lederman, d. (2018). “inequality and economic growth: the role of initial income.” journal of economic growth, 23, 341-366. castelló ‐ climent, a. and doménech, r. 2008. “human capital inequality, life expectancy and economic growth.” the economic journal,118(528), 653-677. cruz, p. b. d., teixeira, a., & monte‐mor, d. s. (2015). “o efeito da desigualdade da distribuição de renda no crescimento econômico.” revista brasileira de economia, 69(2), 163186. deininger, k. & olinto, p. (2000). “asset distribution, inequality, and growth”. world bank policy research working paper series no 2375. forbes, k. j. (2000). “a reassessment of the relationship between inequality and growth.” american economic review, 90(4), 869-887. fundação joão pinheiro, centro de estatísticas e informações. (2014). “estatísticas & informações déficit habitacional no brasil – 2015.” gründler, k., & scheuermeyer, p. (2018). “growth effects of inequality and redistribution: what are the transmission channels?” journal of macroeconomics, 55, 293-313. halter, d., oechslin, m., & zweimüller, j. (2014). “inequality and growth: the neglected time dimension.” journal of economic growth, 19(1), 81-104. islam, md rabiul & mark mcgillivray. (2019). “wealth inequality, governance and economic growth.” economic modelling (forthcoming). kaldor, n. (1955). “alternative theories of distribution.” the review of economic studies, 23(2), 83-100. maricato, e. (2017). “o impasse da política urbana no brasil.” editora vozes limitada. mankiw, n. g. d., romer, and d. weil. (1992). “a contribution to the empirics of economic growth.” quarterly journal of economics, 107(2), 407-437. 54 economic analysis (2020, vol. 53, no. 1, 42-58) morck, r., d. stangeland & b. yeung. (2000). "inherited wealth, corporate control, and economic growth the canadian disease?" nber working paper no. 6814. neves, p. c., afonso, ó., & silva, s. t. (2016). “a meta-analytic reassessment of the effects of inequality on growth.” world development, 78, 386-400. neves, p. c., & silva, s. m. t. (2014). “inequality and growth: uncovering the main conclusions from the empirics.” journal of development studies, 50(1), 1-21. pnud. (2018). tendências do idh do brasil com base em dados de séries consistentes.” organização das nações unidas. silva, m. e. a. (2017). “does inequality benefit growth? new evidence using a panel var approach.” universidade federal do pernambuco. vittoria manzoli, antónio portugal duarte, marta simões 55 appendix table a.1. summary statistics for real gdp per capita, thousands of reais, 27 states, 2005-2013, constant 2002 prices states average std. dev. min. max. acre 11,41 1,70 9,40 14,78 alagoas 8,18 1,76 6,61 11,29 amapá 12,91 2,22 10,82 17,37 amazonas 17,33 2,20 15,33 21,81 bahia 10,73 1,54 9,27 13,62 ceará 9,20 1,67 7,35 12,42 distrito federal 56,64 4,16 51,12 63,05 espírito santo 23,80 4,98 18,13 32,66 goiás 16,83 3,71 13,47 23,52 maranhão 7,21 1,39 5,81 9,96 mato grosso 20,54 3,91 16,26 28,04 mato grosso do sul 18,52 4,32 14,41 26,75 minas gerais 18,05 3,00 15,13 23,70 pará 10,98 2,03 9,30 15,15 paraíba 8,57 1,76 6,89 11,85 paraná 21,11 4,57 17,18 30,32 pernambuco 10,98 2,31 8,76 15,33 piauí 7,11 1,44 5,63 9,82 rio de janeiro 27,02 5,81 22,15 38,38 rio grande do norte 10,87 2,30 8,98 15,27 rio grande do sul 23,04 3,34 19,12 29,76 rondônia 14,59 2,74 11,31 18,94 roraima 14,18 2,04 12,04 18,46 santa catarina 25,29 3,52 22,04 32,33 são paulo 30,04 5,10 24,36 39,28 sergipe 11,97 2,29 9,75 16,09 tocantins 12,09 2,09 9,73 16,10 total 17,01 10,43 5,63 63,05 source: authors based on data from ipea. 56 economic analysis (2020, vol. 53, no. 1, 42-58) table a.2. annual average growth rate of real gdp per capita, 2005-09 and 2009-13 states period annual average growth rate rondônia 2005-2009 4,60% 2009-2013 5,88% acre 2005-2009 3,54% 2009-2013 6,72% amazonas 2005-2009 0,90% 2009-2013 7,23% roraima 2005-2009 2,80% 2009-2013 6,91% pará 2005-2009 0,86% 2009-2013 11,25% amapá 2005-2009 2,59% 2009-2013 8,43% tocantins 2005-2009 4,03% 2009-2013 7,56% maranhão 2005-2009 2,52% 2009-2013 10,48% piauí 2005-2009 3,90% 2009-2013 9,19% ceará 2005-2009 2,95% 2009-2013 9,44% rio grande do norte 2005-2009 1,85% 2009-2013 11,13% paraíba 2005-2009 2,31% 2009-2013 10,83% pernambuco 2005-2009 2,90% 2009-2013 10,56% alagoas 2005-2009 2,07% 2009-2013 10,97% sergipe 2005-2009 3,09% 2009-2013 8,61% bahia 2005-2009 1,33% 2009-2013 7,54% minas gerais 2005-2009 1,28% 2009-2013 9,43% espírito santo 2005-2009 2,82% 2009-2013 9,53% rio de janeiro 2005-2009 1,98% 2009-2013 11,53% são paulo 2005-2009 2,93% 2009-2013 8,13% paraná 2005-2009 1,52% 2009-2013 12,81% santa catarina 2005-2009 1,45% 2009-2013 7,35% rio grande do sul 2005-2009 2,69% 2009-2013 7,45% mato grosso do sul 2005-2009 3,05% 2009-2013 12,21% goiás 2005-2009 2,48% 2009-2013 11,07% mato grosso 2005-2009 2,07% 2009-2013 9,26% distrito federal 2005-2009 1,57% 2009-2013 2,87% source: authors based on data from ipea. vittoria manzoli, antónio portugal duarte, marta simões 57 table a.3: summary statistics for the housing deficit, units, 2005-2013 states average std. dev. min. max. acre 25641.78 5011.24 18804.00 34054.00 alagoas 104768.67 17064.99 84377.00 131963.00 amapá 23451.78 6625.82 15546.00 35419.00 amazonas 166549.89 26223.29 131574.00 212487.00 bahia 477590.67 78827.16 379160.00 657555.00 ceará 292796.33 55367.58 245951.00 424321.00 distrito federal 114963.33 10039.00 98269.00 126169.00 espírito santo 99232.89 15100.09 77033.00 125412.00 goiás 184292.11 27276.73 145678.00 229488.00 maranhão 430812.78 70407.48 274930.00 539571.00 mato grosso 90276.89 19653.12 66866.00 118889.00 mato grosso do sul 78738.67 6855.49 65024.00 87182.00 minas gerais 528256.00 85922.57 431049.00 682432.00 pará 316086.56 60371.95 256212.00 427327.00 paraíba 121643.00 15083.21 101315.00 153320.00 paraná 253781.67 43691.66 199633.00 325681.00 pernambuco 286144.89 60138.47 236658.00 427923.00 piauí 120979.78 21460.24 93316.00 165177.00 rio de janeiro 454335.89 87469.45 368098.00 596207.00 rio grande do norte 116039.33 13126.68 97647.00 143319.00 rio grande do sul 257215.11 57141.10 191189.00 368233.00 rondônia 49683.22 12380.29 30579.00 71281.00 roraima 19504.44 4309.01 13799.00 25237.00 santa catarina 156419.78 24458.30 128464.00 195947.00 são paulo 1254420.11 181327.02 1032999.00 1510463.00 sergipe 76520.33 10209.60 66445.00 99998.00 tocantins 59464.00 11305.17 42706.00 82111.00 total 228133.70 253411.64 13799.00 1510463.00 source: authors based on data from foudation joão pinheiro. 58 economic analysis (2020, vol. 53, no. 1, 42-58) figure 1. housing deficit in 5 brazilian regions, units, 2000-2015 source: authors based on data from foundation joão pinheiro figure 2. housing deficit in brazil, units, 2000-2015 source: authors based on data from foundation joão pinheiro article history: received: november 13, 2019 accepted: december 22, 2019 microsoft word 2010_1_2.doc original scientific paper competition in banking market in slovakia střelecká zdenka*, ekonomická univerzita v bratislave, národohospodárska fakulta, bratislava, slovakia udc: 336.7 (437.6) jel: g21; n24 abstarct – the process of fundamental changes of slovak banking sector has had essential influence on the concentration and on the character of banking products. the article is oriented on analysing the competition level using herfindahl index and cr3 and cr5 indexes. indeces are used to compare the level of competition using following balance items: total assets, bank loans and deposits to corporate and retail sector. this approach brings us different conclusions. key words: competition, banking sector in slovakia, herfindahl index, cr3, cr5, balance sheet introduction competition is a basic component of a well-functioning market mechanism. it is a rivalry between individuals or economic groups with their differentiated interests and goals. in general, we recognize competition on the supply or demand side, price or non-price and perfect or imperfect competition. imperfect competition is further characterized as monopolistic competition, oligopoly and monopoly. information about the level of concentration is important not just for the evaluation of market structure, but they help in the process of creating recommendation for concrete measures of monetary policy. because of its special position it is important to determine the level of the competition in the banking market. firstly, it is because banking market belongs to the markets with high and strict regulation. supervision on the banking sector is carried out by specialized departments of the ministries of finance, separate offices or central banks. in slovakia, the supervision is operated by national bank of slovakia (nbs). secondly, entry in the market is a subject to several restrictions. for example the management has to be qualified enough; it has to obtain a banking license from the supervisor and has to own a sufficient level of capital. furthermore, during their activity commercial banks have to meet the requirements of domestic supervisor and the minimum capital requirements known as basel ii. on the other hand it is known that banks undertake high risk and their actions affect the overall development of the economy. that is the main reason why the banking sector is a subject to a higher degree of regulation than other sectors are. in the past the importance of healthy functioning of the banking sector forced the governments in many countries to undergo restructuring process of banking sectors to avoid the negative impact on the entire sector and on the whole economy. * e-mail: zdenka.strelecka@gmail.com economic analysis (2010, vol. 43, no. 1-2, 117-125) 118 the bank is exposed to risks on both sides of its balance sheet. on the asset side it runs the market and credit risk (counterparty default risk). on the liabilities side there is a risk of availability of the bank´s funds and their time restriction. measures of competition frequently and easily used way how to determine the concentration in a particular sector are concentration ratios, the herfindahl index and hirshman index. with these indices it is possible to determine the level of market concentration; the higher the concentration is the weaker market competition will be. recent studies dealing with the competition in the banking market use a boone indicator, which is based on the opposite approach the more efficient bank is the greater market share of competitive market it gains. in some cases, especially when comparing banking markets with various sizes, the boone indicator appears as a more appropriate and flexible variable. concentration ratio is designed as a sum of variable rk which represents market share of the ith largest firm. herfindahl index (some sources refer to herfindahl-hirschman index, hhi index) is based on the theory of industrial organization of harvard school. this theory deals with the relationship between the industry structure – conducting the business and its performance (so-called scp paradigm “structure conduct – performance”). highly concentrated structure is associated with monopolistic behaviour (tokárová mária, rievajová eva (2007)). it is defined as the sum of the squares of market shares of all firms. index takes into account the number of firms in the industry and their market share. analytical transcript of herfindahl index (kočišová kristína (2008, p. 20)) is as follows: h real function of n variables n number of firms in the industry qk the value of the variable for the ith firm, k = 1, ..., n q – the value of the variable for the industry rk – the market share of the company in the industry converted in the percentage by definition of the u.s. department of justice, the market is considered as highly concentrated if the hhi exceeds 18001. if the value is below 1000 the market is considered as not concentrated. when the value of the index is close to zero it is a symbol of a competitive environment without a dominant player. if all firms in the market have equal market share, then inverse value of the index represents the number of firms performing on the market. 1 [cit. 2009/12/31] http://www.justice.gov/atr/public/testimony/hhi.htm střelecká, z., competition in banking market in slovakia, ea (2010, vol. 43, no. 1-2, 117-125) 119 modified version of hhi index is a hirschman index, the analytical entry is defined as follows: the index can take values [0.1]. low value of hirschman index shows highly competitive environment, by contrast, value close or equal to 1 indicates maximal concentration (kočišová (2008, p. 21)). these indicators have one disadvantage. they do not distinguish between large and small countries. the fact that the concentration may occur as a result of a natural competition when the effective company eliminates its market rivals is also ignored. competition in the slovak banking market as a measure of the competition in the slovak banking market national bank of slovakia uses three indices: cr3, cr5 indeces and the hhi index. for comparison, czech national bank uses different measure and that is a lerner index. • cr3 index is defined as the share of the three banks with the highest volume of the variable on total volume of the variable in the banking sector; only institutions with the positive value of the variable are included in calculation • analogically cr5 presents the share of five banks with the highest volume of the variable on the total volume of the variable in the banking sector; only institutions with the positive value of the variable are included in calculation • herfindahl index (hhi) is defined as the sum of the squares of individual banksʹ share on the total volume of the variable, expressed in percentage; only institutions with the positive value of the variable are included in calculation. the following chart shows the evolution of all three indices since the year 2005 till the second quarter of 2009 using the total assets as a variable. looking at the development of the hhi index it is best to see that level of competition does not stagnate and during the period 2005 2q 2009 several changes in various indicators occurred. increase in the value of the hhi index means an increase in market concentration (and vice versa the reduction of competition). in the year 2005 hhi index reached the value 1084 and in the second quarter of 2009 the value of the 1220. although the values are within the zone of moderate market concentration, it should be noted that since the year 2005 there has been a substantial increase of the concentration ratios in the banking market. during the years 2006, 2008 and during the second half of 2009 cr3 indicator and the hhi index reached the highest values. the share of five largest banks (cr5) on total assets more or less copied the development. the exception is the year 2006 when there was a decline in the share of the five largest banks and increase in the share of three largest banks. we could say that during this year three largest banks reinforced their leading market position. looking on the decrease of cr3 and hhi parameters between 2005 and 2007 thus caused an increase in competition. in the same time variable cr5 had an opposite development. the share of five largest banks on total assets increased at the expense of the economic analysis (2010, vol. 43, no. 1-2, 117-125) 120 share of three largest banks, which can be defined as a positive development. the highest degree of concentration was observed at the end of 2008, which was due to the big amount of cash deposits from population. the reason for cash deposits was a euro adoption and conversion of slovak crowns to euro currency. later on commercial banks imposed these funds through the deposit facility in the nbs. in comparison with the study of european central bank the average value of cr5 indicator for 25 european countries is 72% (european central bank (2005)). chart 1. development of the hhi index, cr3 and cr5 indeces on the total assets market2 analyzing the values of indices for different sectors (retail and corporate) and for each balance sheet item (client´s credits and client´s deposits) it allows us to observe in which sector the concentration reaches the highest level. the values of individual variables are shown in the following two tables. the first table is an analysis of market concentration for credits to corporate and retail sector. the second table monitors developments on the deposit market. (cr3 r – cr3 indicator for retail sector, cr3 c – cr3 indicator for corporate sector, cr 5 r – cr5 indicator for retail sector, cr5 c – cr5 indicator for corporate sector, hhi r – hhi index for retail sector, hhi c – hhi index for corporate sector) table 1. cr3, cr5 a hhi index values on the loan market1 credits cr3 r cr3 c cr5 r cr5 c hhi r hhi c 2005 64% 40% 81% 58% 1610 907 2006 63% 43% 81% 63% 1588 981 2007 61% 48% 82% 68% 1587 1088 2008 63% 47% 82% 67% 1607 1096 2009q1 64% 47% 82% 67% 1618 1096 2009q2 64% 47% 83% 67% 1639 1088 2 [cit. 2009/12/1] http://www.nbs.sk střelecká, z., competition in banking market in slovakia, ea (2010, vol. 43, no. 1-2, 117-125) 121 table 2. cr3, cr5 a hhi index values on the deposit market3 deposits cr3 r cr3 c cr5 r cr5 c hhi r hhi c 2005 61% 52% 75% 68% 1612 1314 2006 62% 53% 76% 69% 1636 1344 2007 63% 55% 75% 74% 1625 1480 2008 64% 58% 76% 75% 1614 1485 2009q1 63% 56% 75% 74% 1580 1459 2009q2 63% 56% 75% 74% 1567 1503 using individual balance sheet items instead of total assets demonstrate us higher values of concentration indices. values for deposit market differ at most. in comparison with the value of the hhi index for total assets they vary approximately from 300 to 500 points. competition in the credit market developed in different way. compared with the analysis of total assets, the values of the hhi index in the retail sector are higher by 400 to 500 points and in the corporate sector are even below around 200 points. the concentration on the credit market for the retail sector is substantially higher than the concentration for the corporate sector. similar development can also be seen on the deposit market even though there is not so high disparity. chart 2. hhi index for loans and deposits to retail and corporate sector2 the values of the hhi index for retail sector on both markets reached the value around 1600 (see chart 2). this level of concentration indicates that a low level of competition dominated in this sector. it should be noted that the market with the hhi index value of 1800 is considered as a highly concentrated. in the corporate sector, the situation on the market with deposits and loans is different. a high level of competition dominates on the credit market. the values of the hhi index in deposit market for corporate sector are catching up with the index values in deposit market for retail sector. this is a sign of lower competition than on the credit market. 3 [cit. 2009/12/1] http://www.nbs.sk economic analysis (2010, vol. 43, no. 1-2, 117-125) 122 chart 3. cr3 and cr5 indeces on credit market4 the development of the cr3 and cr5 indeces for credit market gives us interesting conclusions. while the share of five largest banks for the retail sector changed over the period very slightly, in 2007 the proportion of three and five largest banks in the credit market for the corporate sector reached the highest level. an important and surprising fact is that the difference between the share of three largest banks in the retail sector and the share of five largest banks in the corporate sector is minimal. what once again is a demonstration of the low level of competition in the services for retail sector and the dominant position of the three largest banks. until 2007 deposit market for retail sector had substantially higher concentration than the corporate sector. but since 2007 the share of five largest banks in both sectors is almost equal (the difference is 1 percentage point.). although the share of three largest banks in the corporate sector is lower than in the retail sector, around 10%, there is a similar trend with the share of three largest banks in the retail sector. it should be noted that during the watched period in the retail sector minimal changes took place. chart 4. cr3 and cr5 indeces for deposit market3 4 [cit. 2009/12/1] http://www.nbs.sk střelecká, z., competition in banking market in slovakia, ea (2010, vol. 43, no. 1-2, 117-125) 123 an alternative method of determining the competition an alternative way how to determine the competitive environment is to compare the difference between the individual market shares of market players. total assets are considered as an appropriate indicator for determining the market share. in the following section the share of assets of the ith bank on assets of total banking sector (ms i) is compared with the share of assets of jth bank on total assets of banking sector (ms j). chart 5. development of market shares (variable – total assets)5 the difference between the market share of bank with the strongest position (leding bank, ms 1) and bank with the second largest share (ms 2) reaches the highest value in 2006. comparing the difference between the market shares of leading bank and bank with the third largest share (ms 3) a similar trend can be seen. the development of these indicators gives us interesting results. while during years 2004 2006 leading bank affirmed its position (see chart 5), between years 2007 and 2008 lost this favourable position and what is interesting the difference between the leading bank and position of the second and the third bank decreased. in the future we can expect the exchange of the positions between bank with the second and third largest market share. if in the calculation of market shares is variable “total assets” replaced by balance sheet items: client´s credits or clientsʹ deposits, it would bring us interesting conclusions, too. the development on the deposit market is slightly different. till 2006 there is a widening gap between the market shares of leading bank and the bank with the second highest market share. during the years 2006 and 2008 there is a reduction of this difference. on the contrary, the difference between leading bank and the bank with the third largest market share (ms 1 ms 3) during years 2004 and 2008 decreased (chart 7). leadership on the market with deposits and with total assets belongs to the same bank. 5 author´s calculations. [cit. 2009/12/1] http://www.nbs.sk/sk/statisticke-udaje/menova-abankovastatistika /menova-statistika-penaznych-financnych-institucii#am1-12pf economic analysis (2010, vol. 43, no. 1-2, 117-125) 124 chart 6. market shares (credits)4 chart 7. market shares (deposits)4 the situation on credit market during the years 2004 and 2008 changed significantly. the bank with leading role in 2004 dropped to second place in 2005 and since 2006 it declined to third rung. the bank which won the leadership in 2005 remained at first place until 2007. in the following year the difference between ms 1 and ms 2 was minimal and the leading position was overtaken by the bank with the second largest market share of loans. these findings correspond with the development of the recent years. due to the high economic growth we could observe easening of credit conditions and competitive fights between commercial banks. analyzing the level of competition by using the market shares of 3 major banks brought us, especially for the credit market, opposed conclusions as the analysis of market concentration using the hhi index. while the hhi index (and also partly cr3 and cr5 index) informed us about the stagnation or increase of market concentration, market share analysis demonstrated a highly competitive fight between commercial banks. conclusion a general rule about countries with a small market is that they have a high degree of concentration. in slovakia, more than 50% of banking sector assets is held by the three largest banks and approximately 70% is held by the five largest market players. such a situation refers to a higher concentration, but compared with other ʺnewʺ eu countries we belong among the moderate above-average. analysis of the market share of three largest banks has shown us competition and a decreasing position of the leading bank. on one hand, the situation in retail sector, where there is a permanently higher level of concentration than in the corporate sector, is caused by unconcerned consumers. on the other hand, the fact is that the three largest players on the banking market are banks with the longest history. two of them operate on the slovak market for more than 50 years and they inherited a number of clients from the previous socialist era, when bank did not need to fight for a client. střelecká, z., competition in banking market in slovakia, ea (2010, vol. 43, no. 1-2, 117-125) 125 recently, the situation has changed dramatically. except for the entry of few new players (most recently in november 2007), the slovak banking sector was marked by the adoption of the euro and economic crisis. these two factors caused the decrease of profitability of the banking sector and both sides of the balance sheet were affected. one of the potential benefits of euro adoption should be an increase of competition but so far the development did not show such benefit. it will be questionable whether the future development will bring strengthening or weakening of the position of three biggest players. references european central bank. 2005. eu banking structures. frankfurt am main: european central bank. kočišová, kristína. 2008. “konkurencia na slovenskom bankovom trhu”. biatec, 16/2008 (10): 20-25 tokárová, mária, and rievajová, eva. 2007. “inovácie vo vývoji prístupov k teóriám konkurencie, súťaživosti, resp. protimonopolnej politiky.” http://semafor.euke.sk/zbornik2007/pdf/tokarova _rievajova2.pdf received: 13 january 2010 article history: accepted: 14 march 2010 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp92-103 scientific paper panel cointegration analysis of total environmental taxes and economic growth in eu countries vera mirović1 | branimir kalaš1* | nada milenković1 1 university of novi sad, faculty of economics in subotica, department for finance and accounting, subotica, serbia abstract the paper investigates the nexus between total environmental taxes and economic growth for twenty-eight eu countries from 1994 to 2018. the objective of this research is to evaluate the longrun relationship between these variables based on panel data analysis. the analysis includes panel cointegration test as well as panel ordinary least squares such as dols and fmols models. the results identify long-run relationship between total environmental taxes and economic growth in selected countries. likewise, there is a significant relation running from total environmental taxes to economic growth measured by gross domestic product rate. empirical findings confirm that revenue of environmental taxes have positive impact on economic growth measured by gross domestic product rate. key words: environment taxation, economic growth, panel cointegration, eu countries jel classification: e60, h23, q5 introduction – theoretical background economic growth has become the basic aim of developing countries without adequate consideration of environmental issues (mitić et al. 2019). however, as environmental issues become more relevant, governments have realized the significance of balanced economic and environmental development (gao et al. 2019). pautrel (2009) argue that effect of the environmental policy can have positive implications to the economy when impacts of pollution on health are reduced. zhou et al. (2020) detected that an increase in environmental tax rate can reduce the use of polluting consumer goods by households as well as investment in polluting factors by companies. likewise, their growth can negatively impact employment, income and economic growth and include both effects: substitution effect and income effect on household consumption. likewise, wesseh et al. (2017) highlight that tax policy is often more efficient or less distorted than direct regulation. accordingly, taxes are effective tools to modify consumers' behaviour in terms of sustainability (kosonen and nicodème, 2009). for most environmental problems, adequately determined fiscal policy is the most natural tools for including environmental detriment into the products price and non-market actions (heine et al. 2012). stram (2014) determined that tax revenues enables stability and support for research focused on energy sources and emissions reduction in the long-run. according that, many economists and international institutions determine environmental taxes as the most efficient market-based * coressponding author, e-mail: branimir.kalas@ef.uns.ac.rs vera mitrović, branimir kalaš, nada milenković 93 tools (lin and li, 2011). mirović et al. (2019) highlight that tax forms should take an important place in the economic policy of each country. the findings of castiglione et al. (2014) suggest that countries should take advantage of the relationship between economic growth and institutional enforcement ie, the nexus between economic development and environmental awareness in order to provide an adequate environmental tax policy. environmental taxes enhance the costs and price products for the environment and decrease the pressure on it. (piciu and trică, 2012) where davidović et al. (2019) determined environmental taxes as crucial for more effective environmental protection. andrei et al. (2016) emphasized that environmental taxes have significant impact on economic sustainability in post-transition countries. environmental taxes are increasingly considered as essential part of the economic policy where their proper design can enable economic incentives, dynamic innovation. it implies that these taxes help achieving economic, social and environmental benefits (withana et al. 2014). accordingly, environmental taxes have a more relevant role in europe and especially in the scandinavian economies compared to the rest of the world at the beginning of the 2000 (radulescu et al. 2017). also, bachus et al. (2019) determined that taxes are robust tool for reducing complex environmental problems in the world. labeaga and labandeira (2020) defined environmental taxes such as cost-effective corrective approach which contributes development and uses clean technologies. liobikiene et al. (2019) argue that environmental taxes are imposed with the aim to decrease negative effects to environment. on the other hand, borozan (2018) argue that energy taxes are not efficient policy tool for directly effecting electricity consumption due to various subventions and exemptions through european union. vukadinović and ješić (2019) cite that ecological modernization that includes carbon tax, a decline of labour costs and subsidies for research and development. tantau et al. (2018) determined significant impact of environmental tax revenues in european union to recycling rate of municipal waste for the period 2010-2014. further, aubert et al. (2019) point out regressive effect of indirect taxes where environmental taxation decreases consumers’ purchasing power and has regressive implications to poor consumers compared to rich. the nexus between the environment and economic growth is one of the most essential relation for policy makers (mitić et al. 2017). the standard way to evaluate economic success is by measuring economic growth (petrov and trivić, 2018). analyzing causality between environmental taxes and economic growth, in oecd countries from 1995 to 2006, morley and abdullah (2010) identified long-run causality between economic growth and environmental taxation. likewise, this analysis manifested short-run causality between these variables in the reverse direction. liang et al. (2007) and highlight that effect of carbon tax may depend on the economic conditions of an economy. hájek et al. (2019) indicate that it’s more environmentally efficient if taxes have been collected for a longer time. dökmen (2012) researched the relationship between environmental taxes and economic growth in twenty-nine eu countries for the period 1996-2010. the results of panel vector autoregressive models identified positive and statistically significant effect of environmental taxes on economic growth in these countries for the observed period. abdullah and morley (2014) investigated causality between environmental taxes and economic growth in eu countries and oecd countries for the period 1995-2006. empirical results showed long-run causality running from economic growth to increased environmental tax revenues, as well as, short-run causality in the reverse direction. loganathan et al. (2014) analysed the relationship between carbon taxation and economic growth in malaysia from 1974 to 2010. their findings suggest that there is bidirectional causality between these components for the analysed period. li and masui (2018) found that the environmental tax and carbon tax would lead to a gdp loss of 0.1% to 0.67% and highlighted that energyintensive sectors will have bigger damage compared to service sector and agriculture that will have a small growth. he et al. (2019) confirmed that environmental taxes are cointegrated with energy consumption, economic growth, and co2 emissions in china, finland and malaysia. 94 economic analysis (2021, vol. 54, no. 1, 92-103) similarly, busu and trica (2019) revealed significant and positive effect of environmental taxes on economic growth in eu countries for the observed period 2010-2017. the need for research is manifested in providing information support and giving guidance to economic policymakers in eu about the long-run relationship between total environmental taxation and economic growth in these countries. it implies that fundamental goal of this research is to reveal are environmental taxes significant for economic growth in eu countries. the structure of this paper is as follows. after the introduction and definition of necessity of environmental tax approach, there is an analysis of environmental taxes and gross domestic product in eu countries from 1994-2018. the greatest part of this research includes empirical analysis and results which consist panel cointegration tests and different panel models such as pols, dols and fmols. the last segment includes summarizes and conclusion about cointegration between total environmental taxes and economic growth in eu countries from 1994 to 2018. the necessity of environmental tax approach and double dividend hypothesis over the last three decades, ecological modernisation has emerged as a strong political discourse in which economic growth, environmental protection as well as energy security are jointly intensifying (machin, 2019). the government should implement stricter and more comprehensive system of environmental policy in order to provide future sustainable development. it implies reasonable tax system and design of ecological policy system based on neutrality (yang et al. 2019). according to european environmental agency green taxes are classified into three categories: cost-covering charges, incentive taxes and fiscal environmental tax forms (european environmental agency, 1996). the main purpose of cost-covering charges is covering the costs of regulation and control and implies that users pay for consumption of environmental resources. further, incentive taxes are created in line with pigouvian tax where core idea is to change the behaviour of the polluter in the long-term. fiscal environmental taxes are main driving force of green tax reforms where highlight the tax for use of resources without significant change to the budgetary balance (maxim and zander, 2019). environmental taxation has been increasingly seen as an effective economic tool to make incentives in terms of cleaner production and consumption habits (freire-gonzález, 2018). own resources based on taxes for the european union can be a powerful tool to the current lack of sustainability because they have the potential to cover existing sustainability gaps in tax systems in the eu (krenek and schratzenstaller, 2017). there is a growing consensus that environmental taxes are not only a promising instrument to reducing environmental effects, but also a way to increase public revenues and decrease fiscal pressure (freire-gonzález and ho, 2019). alexeev et al. (2016) argue that an emissions taxes are used as an environmental policy instrument to decline environmental damages. bachus et al. (2019) highlight an importance of recycling the revenues from an environmental tax reform and defined a “ladder of acceptability of revenue recycling options” based on: a) financing special environmental programmes; b) reducing taxes on labour, consumption, corporate income, property or other distortionary taxes; c) returning the additional tax forms from one sector to that same sector in a way that is not proportional to the emissions, pollution or resource use; d) eliminating regressive effects of the environmental taxes; e) reducing public debt or adding to the general budget. kirchner et al. (2019) provided that carefully designed tax policy about co2 can potentially enable an equitable double dividend, where the double dividend hypothesis implies the possibility of realizing economic and environmental benefits as a result of implementing an environmental tax policy and recycling revenues (wesseh et al. 2019). this theoretical approach is a widely examined topic that considers the possibility of producing additional economic benefits using environmentally beneficial tax measures (maxim and zander, 2019). the early version of the double dividend hypothesis can also be determined as the efficiency double vera mitrović, branimir kalaš, nada milenković 95 dividend in which the essence was that green tax reform can decrease pollution and increase economic efficiency (maxim et al. 2019). double dividend hypothesis arises from progress of the environmental conditions as a result of environmental tax incentives as well as improvement of economic conditions due of the shift from high distorting taxes to less distorting taxes (freiregonzález, 2018). sasmaz (2016) examined the effect of environmental tax reforms on environment and employment in fifteen countries in eu (austria, belgium, denmark, finland, france, germany, greece, ireland, italy, luxembourg, the netherlands, portugal, spain, sweden, united kingdom) for the period 1995-2012. using panel cointegration and fully modified ordinary least square tests, this analysis showed the validity of double dividend hypothesis in these countries. methods and materials in this research twenty-eight eu countries are analysed for the period 1994-2018. the research used eurostat for environmental taxation and imf for gross domestic product. in order to stationary, panel unit root tests are applied for selected variables. after we determined that variable are stationary at first difference and integrated of order one process or i(1), we have applied cointegration analysis. after identifying long-run relation between variables, an analysis has included different panel models such as pols, dols and fmols. before presenting panel cointegration estimation it is necessary to develop research hypothesis which is defined as follows: h1: environmental taxes have significant and positive impact on economic growth in eu countries. panel cointegration test is often used to identify a potential long-run relation between two or more variables. the long-run relationship implies the variables move together over time. the panel cointegration test allows for cross-sectional interdependence with both different individual effects and deterministic trends can be determined as follows: lnyit = αit δit  βilneit εit (1) εit=ρitεit-1 + uit (2) where i = 1,…n reflects the panel member, t = 1,…t refers to the time period, y reflects the gdp, tet reflects the total environmental taxes and βi reflects the slope coefficient. the parameters αit and δi allow for possibility of country-specific effects and deterministic trend effects, where εit manifests the evaluated residual deviations from the long-run relation (adhikari, chen, 2012). empirical analysis and results this segment includes analysis trend of gross domestic product rate and total environmental taxes from aspect of their share and collected revenue from 1994 to 2018. after that, empirical study implies panel cointegration tests and three models such as pols, dols and fmols. 96 economic analysis (2021, vol. 54, no. 1, 92-103) -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 austriaaustria -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 belgiumbelgium -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 bulgariabulgaria -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 croatiacroatia -8, 000 -4, 000 0 4, 000 8, 000 12, 000 1995 2000 2005 2010 2015 cypruscyprus -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 czech rczech r -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 denmarkdenmark -20, 000 -10, 000 0 10, 000 20, 000 1995 2000 2005 2010 2015 estoniaestonia -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 finlandfinland -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 franc efranc e -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 germanygermany -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 greecegreece -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 hungaryhungary -10, 000 0 10, 000 20, 000 30, 000 1995 2000 2005 2010 2015 i relandi reland -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 1995 2000 2005 2010 2015 i talyi taly -20, 000 -10, 000 0 10, 000 20, 000 1995 2000 2005 2010 2015 latvialatvia -20, 000 -10, 000 0 10, 000 20, 000 1995 2000 2005 2010 2015 l ithuanial ithuania -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 l uxembourgl uxembourg -4, 000 0 4, 000 8, 000 12, 000 1995 2000 2005 2010 2015 maltamalta -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 netherlandsnetherlands 0 2, 000 4, 000 6, 000 8, 000 1995 2000 2005 2010 2015 polandpoland -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 portugalportugal -10, 000 -5, 000 0 5, 000 10, 000 1995 2000 2005 2010 2015 romaniaromania -8, 000 -4, 000 0 4, 000 8, 000 12, 000 1995 2000 2005 2010 2015 slovakiaslovakia -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 sloveniaslovenia -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 spainspain -8, 000 -4, 000 0 4, 000 8, 000 1995 2000 2005 2010 2015 swedensweden -6, 000 -4, 000 -2, 000 0 2, 000 4, 000 6, 000 1995 2000 2005 2010 2015 united kingdomunited kingdom figure 1. gdp rate in eu countries source: authors calculation based on imf although gross domestic product is being criticized for not adequately representing social welfare in terms of development, the gdp is a dominant and widely used indicator for measuring economic activity (sanyé-mengual et al. 2019). the gross domestic product in the european union was around 13.94 trillion euros which reflects the total value of all goods and services produced in eu countries. figure 1 shows trend of gdp rate in eu countries for the period 19942018. the average gdp rate was 2.68%, where ireland had the highest average gdp rate of 6.05% during observed period. on the other hand, italy had the smallest average gdp rate of 0.69%. analyzing by countries, estonia, lithuania and slovakia had average gdp rate above 4%, while other countries had smaller growth rate of gross domestic product. the level of average gdp rate of 2% was recorded in latvia, luxembourg, malta and romania, while most of countries had mean gdp rate around 2%. twelve of twenty-eight economies had mean gdp rate below eu average, while greece and italy recorded average gdp rate below 1%. vera mitrović, branimir kalaš, nada milenković 97 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 aus tri aaus tri a 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 bel gi u mbel gi u m 0. 5 1. 0 1. 5 2. 0 2. 5 3. 0 3. 5 1995 2000 2005 2010 2015 bu l gari abu l gari a 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 c ro ati ac ro ati a 2. 0 2. 4 2. 8 3. 2 3. 6 4. 0 1995 2000 2005 2010 2015 c yp ru sc yp ru s 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 cz ech rcz ech r 3. 5 4. 0 4. 5 5. 0 5. 5 1995 2000 2005 2010 2015 den m arkden m ark 0. 5 1. 0 1. 5 2. 0 2. 5 3. 0 1995 2000 2005 2010 2015 es to n i aes to n i a 2. 4 2. 6 2. 8 3. 0 3. 2 3. 4 1995 2000 2005 2010 2015 fi n l an dfi n l an d 1. 8 2. 0 2. 2 2. 4 2. 6 1995 2000 2005 2010 2015 fran cefran ce 1. 6 1. 8 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 germ anygerm any 2. 0 2. 5 3. 0 3. 5 4. 0 1995 2000 2005 2010 2015 greecegreece 2. 0 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 hu ngaryhu ngary 1. 5 2. 0 2. 5 3. 0 3. 5 1995 2000 2005 2010 2015 irel an direl an d 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 ital yital y 0 1 2 3 4 1995 2000 2005 2010 2015 latvi alatvi a 1. 6 2. 0 2. 4 2. 8 3. 2 1995 2000 2005 2010 2015 li thu an i ali thu an i a 1. 6 2. 0 2. 4 2. 8 3. 2 1995 2000 2005 2010 2015 luxem b o urgluxem b o urg 2. 4 2. 8 3. 2 3. 6 4. 0 1995 2000 2005 2010 2015 mal tamal ta 3. 2 3. 3 3. 4 3. 5 3. 6 1995 2000 2005 2010 2015 n eth erl an d sn eth erl an d s 1. 6 2. 0 2. 4 2. 8 1995 2000 2005 2010 2015 p o l an dp o l an d 2. 0 2. 4 2. 8 3. 2 3. 6 1995 2000 2005 2010 2015 p ortu galp ortu gal 1. 5 2. 0 2. 5 3. 0 3. 5 4. 0 1995 2000 2005 2010 2015 r om an i ar om an i a 1. 8 2. 0 2. 2 2. 4 2. 6 1995 2000 2005 2010 2015 sl o vaki asl o vaki a 2. 5 3. 0 3. 5 4. 0 4. 5 5. 0 1995 2000 2005 2010 2015 sl o ven i asl o ven i a 1. 4 1. 6 1. 8 2. 0 2. 2 2. 4 1995 2000 2005 2010 2015 sp ai nsp ai n 2. 0 2. 2 2. 4 2. 6 2. 8 3. 0 1995 2000 2005 2010 2015 swedensweden 2. 0 2. 2 2. 4 2. 6 2. 8 1995 2000 2005 2010 2015 uni ted k i ngdo muni ted k i ngdo m figure 2. total environmental taxes in eu countries source: authors calculation based on eurostat after presenting gdp rate in eu countries, next figure manifests share of total environmental taxes in the gross domestic product from 1994 to 2018. environmental tax revenues in the european union totalled 324.6 billion euro which is 3% increase in nominal terms compared to previous year and 49% higher than in 2002 (https://ec.europa.eu/eurostat/web/productseurostat-news/-/ddn-20200219-1). european union has growth of the environmental tax revenues in the period 2005-2008, but since 2008 the revenue based on environmental taxes decreased in these countries (munitlak ivanović and golušin, 2012). total environmental taxes had average share 2.66% of gdp during observed period, where denmark had the highest mean share 4.43% of gdp. on the other hand, spain is a country with the smallest average share 1.9% of gdp for the analyzed period. economies such as croatia, italy, malta, netherlands and slovenia had average share above 3% of gdp, while most of analyzed countries had mean share around 2%. seventeen of twenty-eight countries recorded mean share of total environmental taxes below eu average during observed period. in most cases, environmental taxes refer to exploitation of natural resources such as energy and water as well as waste generation. the highest part of the revenue is raised through taxes on energy products where significant level of revenues is also collected via taxes on motor vehicles (golušin et al. 2013). an increase of environmental taxes in the european union resulted in a growth of revenues based on environmental taxes where fifteen countries increased environmental taxes including excise duties on energy products and electricity (hodžić and bratić, 2015). table 1. descriptive statistics of total environment tax revenue country mean std. dev min max austria 6532.03 1485.61 3974.84 8855.83 belgium 8231.15 2125.01 5303.99 12407.2 bulgaria 826.56 485.71 84.2 1648.09 croatia 1289.79 210.53 1001.29 1853.35 cyprus 430.93 143.06 188.62 589.4 czech r 2726.52 1046.46 1205.44 4507.93 denmark 9567.33 1404.39 6099.74 11065.4 98 economic analysis (2021, vol. 54, no. 1, 92-103) country mean std. dev min max estonia 325.14 214.89 25.61 708.95 finland 4993.47 1095.01 2930.92 6848 france 38132.77 7260.88 30139 55949 germany 53626.48 6113.61 41524.55 59737 greece 4933.84 1371.79 3190.58 7162 hungary 2263.69 706.98 905.53 3142.61 ireland 3754.73 1089.64 1565.12 5186.03 italy 45331.86 8566.98 31015.51 58735 latvia 453.99 296.92 40.74 982.72 lithuania 477.46 202.47 95.99 899.78 luxembourg 812.43 204.56 468.77 1039.61 malta 186.48 62.04 87.6 321.75 netherlands 19100.53 4280.41 11190.14 25832 poland 7352.46 3546.65 1939.76 13500.41 portugal 4146.89 587.75 3047.89 5270.52 romania 2154.67 1167.89 499.25 4239.84 slovakia 1155.87 642.48 374.32 2232.7 slovenia 1099.30 323.05 632.25 1609.66 spain 16594.21 3486.29 9976.01 22066 sweden 8582.46 1472.35 5292.38 10341.43 united kingdom 46627.26 8772.09 25538.44 63763.36 total 10418.23 15691.72 25.61 63763.36 source: authors calculation results of descriptive analysis show that france, germany, italy and united kingdom have the highest mean level of total environment tax revenue in the analyzed period. in these countries, environment revenue are above thirty-five billion euro which is far more than other economies. the mean total environment tax revenue are 10418.23 billion euro, where only six countries recorded higher revenue level compared to average value in observed period. it implies that there is a greater difference between selected countries, where for example germany has more than fifty billion euro which is far more than baltic countries (estonia, latvia and lithuania). the smallest standard deviation is identified in malta (62.04), while united kingdom and france had the highest value of standard deviation. it implies that these economies had no stability in environment revenue level in observed period. table 2. stationary tests variable levin-lin-chu test im, pesaran shin test augmented dickey-fuller test phillipsperron test gdp intercept -11.83 -9.99 201.483 192.91 gdp intercept & trend -10.81 -7.59 152.-55 149.92 δ gdp intercept -23.68*** -22.77*** 479.524*** 1073.35*** δ gdp intercept & trend -18.69*** -18.81*** 362.08*** 1255.52*** tet intercept -2.18 -6.47 25.35 32.25 tet intercept & trend -2.07 -0.04 64.32 50.18 δtet intercept -16.67*** -14.27*** 293.24*** 347.92*** δtet intercept & trend -15.29*** -13.21*** 250.35*** 310.03*** source: authors calculation the results of these tests show that selected variables are not stationary at level, but variables are stationary at first difference. it implies that null hypothesis can be rejected at the 1% when applying each variable at first difference. it can notice that these variables are stationary at first difference and integrated of order one process. after we confirm that variables are the first vera mitrović, branimir kalaš, nada milenković 99 difference, the next step is to estimate the long-run nexus between selected variables (nguyen and kakinaka, 2018). table 3. cointegration tests cointegration gdp tet tet – gdp intecept intercept & trend intercept intercept & trend within-dimension panel v-statistic -2.27** -6.56*** -0.32** -4.78*** panel rho-statistic -12.59*** -6.80*** -15.98*** -17.74*** panel pp-statistic -26.72*** -31.69** -16.17*** -18.06*** panel adf-statistic -19.48*** -23.18** -15.51*** -17.98*** between-dimension group rho-statistic -10.45*** -14.92*** -9.52*** -15.16*** group pp-statistic -40.21** -50.89*** -16.89*** -17.49*** group adf-statistic -20.84*** -24.26*** -15.03*** -18.46*** source: authors calculation table 3 presents panel cointegration test statistics between gdp and tet for analyzed period 1994-2018. the analysis manifests a cointegration between gdp and tet and can reject the null-hypothesis of no cointegration. presence of a cointegration between gdp and tet implies that these variables move together in the long-run and we can conclude there is a long-run relation between gdp and tet in eu countries from 1994 to 2018. after identifying the cointegration relationship, the next step is to examine the cointegration coefficients of independent variables by using panel fully modified ordinary least squares (fmols) and panel dynamic ordinary least squares (dols) models (bilgili et al. 2016). the long-run cointegration vector is analyzed by these panel models. table 4. results of different panel models variable gdp model ols dols fmols tet 0.18 (0.03) 0.21 (0.01) 0.23 (0.02) r-squared 0.41 0.72 0.68 source: authors calculation table 4 reflects the results of the panel ols, dols and fmols estimators for eu countries. the empirical results show that tet have positive and significant effect on gdp. first, ols shows that a 1% increase in revenue of total environmental taxes enhances gdp by 0.18% with 41% explanation of variations in this model. second, dols reflects that a 1% increase in revenue of total environment taxes raises gdp by 0.21% with 72% explanation of variations in this model. finally, fmols manifests that a 1% increase in revenue of total environmental taxes rises gdp by 0.23%. conclusion environmental policy is a necessary for sustainable economic development although some economists cite that society have to choose between environmental policy and economic growth. environment taxes can be a very powerful tool to increase public revenues and contribute to the environment protection. namely, these taxes can be more considered by eu countries to improve green economic activity and discourage”dirty” industries. this paper should reveal are environmental taxes statistically significant for economic growth in eu countries and the research examines the relationship between total environmental taxes and economic growth for 100 economic analysis (2021, vol. 54, no. 1, 92-103) twenty-eight eu countries for the period 1994-2018. the objective of this paper is to evaluate the long-run relationship between these variables based on panel data analysis that includes panel cointegration test, and three models such as pols, dols and fmols. the results show long-run relationship between total environmental taxes and economic growth in eu countries for the observed period. empirical findings reflect that environmental taxes have a positive and significant impact on economic growth which implies that hypothesis h1 can be accepted. precisely, results of different panel models manifest that a 1% increase in total environmental taxes enhances gdp, where fmols model has shown a greatest change of gdp by 0.23%. these empirical findings confirm previous research studies (morley and abdullah, 2010; dökmen (2012; abdullah and morley, 2014; he et al. 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(2020). “environmental tax reform and the “double dividend” hypothesis in a small open economy”. international journal of environmental research and public health, 17(1): 1-21. doi: 10.3390/ijerph17010217 article history: received: april 24, 2020 accepted: april 29, 2021 microsoft word 2009_3_4-korigovano.doc professional paper assumptions and requirements for entrepreneurship determining role in the development of the national economy đogić rifet, university of zenica, faculty of economics, zenica, b&h kulović dženan, university of zenica, faculty of economics, zenica, b&h čolaković đenana, secretary of business service centre government of zenica-doboj canton, b&h udc: 005.961:005.914.3 jel: l26 abstract – we live in a time of brutal globalism, order in which developed national economies are establishing standards and rules of conduct. domestic enterprises had to replace the national business environment with international (global) environment in order to survive, because businesses outside the national borders become the backbone of their growth and development. in an order of globalism, small-scale economies are dependent on those very big national economies which had just entered in a phase of recession, a span of time which is very hard to predict, but it is certain that their recession will have far reaching consequences for small-scale economies such as bosnian. that gives us the right to say that it is the time for an alert! by which means can the economy of bosnia and herzegovina confront with the global economic (financial) crisis? this work should draw attention to that path, and that is the development of entrepreneurship. we are witnesses that entrepreneurship in the world is in a constant rise, and that entrepreneurship greatly contributes to the economic development of societies in which it operates. however, for the development of entrepreneurship it is necessary to be familiar with the market economic system. unfortunately, economy of bosnia and herzegovina is still in the transition process that takes place very slowly and inefficiently, which will result with a greater burden in overcoming the consequences of the global economic crisis. key words: market economy, entrepreneurship development, development of national economy, transition of economy, company restructure introduction we are living in a time of changes. those changes are very broad, deep and occur very fast. they occur in almost all spheres of human life and affection. no matter what the causes are all those changes, as well as their consequences, are structural and economic in nature. entrepreneurship, as a special activity and the entrepreneur as the advocator of that activity are elaborate, dynamic and economic socio-culture categories which today, in addition to classical, receive various new features and meanings in theory and practice. the changes we are encountering include abstract, willing, creative and innovative business and development activities, pervading all enterprise and management functions: planning, organizing, staff recruitment, operating (leading), controlling, and improving due to achieving predetermined goals. đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 51 the phenomenon of entrepreneurship and small-scale economy presents some of the main political, economic, media and social topics and the interest for entrepreneurship derives from the perception that the history of mankind is an a certain way a product of an entrepreneurship effect as well as from expectations that this century will represent a period of further expansion or even explosion of entrepreneurship. the social and economic context of contemporary entrepreneurship has been significantly alteredby abandoning the concept of scope economy as the primary driving force of the economy of development, by the occurrence of periods of global uncertainty, by an entry of a huge number of countries in the processes of social and economic transition, entrepreneurship, especially the one realized via lots of small scale enterprise, is again perceived as a booster of development. todayʹs entrepreneurship renews, transforms and encourages the development of economies worldwide it generates the occurrence of new business ventures, founding of new, usually small-scale enterprises, new employments, and renewing the national economies with ʺfresh bloodʺ, providing them with vitality, innovative products and services and increasing their chances for general, societal, cultural and social improvement. in a world where ideas set forward economy, it is not peculiar that entrepreneurship and small-scale economy are often perceived as an inseparable unity by decreasing the significance of comparative advantages of material resources, the role of knowledge in achieving advantages of rivals and generating economic growth is increased. according to the previously mentioned, contemporary entrepreneurship based on knowledge, information, human and social capital, and intellectual technology, is frequently alleged as a further, fourth factor of production, in addition to labour force, natural resources and capital. human creativity and entrepreneurship are a necessity for combining inputs in a profitable manner and the institutional environment which will encourage entrepreneurs becomes a critical determinant of economic growth. by this approach the entrepreneurs and the entrepreneurship grab the spotlight in acquiring a long-term economic and social development, especially of those economies which tend to be an enterprise and a man, as a social and economic being, gradually becomes an enterprising beinghomo entreprenaurus too. however, creativity, manliness, and courage will not be the generators of the new entrepreneurship entrepreneurship does not only affect our lives by providing us with new products and services, but also represents, for many of us, the future perceived through employment, through our workplaces. namely the fashion in which big corporations continue with firing results in the fact that more people enter into creating their own business ventures they establish and manage small-scale enterprising corporations which provide high-quality services for their consumers. in a business environment where big corporations tend to maintain slimmer structures with little hierarchical levels, and without the burden of bureaucracy, an eruption of ʺmicro-enterprisesʺenterprises with less then ten employees occurs. some of these enterprises are founded by workers who were fired. some of these entrepreneurship based enterprises will be established by individuals who will try to avoid the next wave of resignations. contemporary entrepreneurship is a call for struggle, a struggle in which one has to have great courage in order to succeed. todayʹs and future enterpriser is an explorer, an unsettled spirit asking questions about everything and questioning various paradigms. he is aware of the unpredictability, uncertainty, risk, the chaotic state and sometimes even the pain which goes along with the entrepreneurship process. however, he tries to think things over, economic analysis (2009, vol. 42, no. 3-4, 50-68) 52 upgrade the exiting things, or invent new ones for the common good, and the social process in which he is a protagonist never stops. from this point of view entrepreneurship becomes one of the deadliest weapons which and individual can own and activate in a struggle to survive in the turbulent and uncertain world and an in an environment disposed to firing workers. entrepreneurship is connected with uncertainty, risk, and responsibilities for business and development ventures, but it is also linked with the pleasure of the achieved and the satisfaction due to participating in such a creative process. a modern and prosperous enterpriser is gifted with creativity and innovativeness. unsatisfied with moderate and filled with a desire for change and success. capable of making an enterprise enterprising, flexible, and adaptive to environment changes, market shaped with buyers and suppliers as a locus of interest. he has to choose partners, assign appropriate tasks to them, must be able to communicate and cooperate with people, to listen and consider their positions, motivate them to work, give them appropriate rewards, and ensure their constant advanced study and timely progress. an enterpriser has to make quality timely decisions and be capable of choosing, obtaining, combining, and activating resources. he has to poses sufficient knowledge about jobs and people and he must be a visionary, a strategist, frank, honest, courageous but also reasonable, cautious but not fearful, enterprising but not rash. he needs to know how to set the right aims, comprehend the meaning of science, knowledge, information, time, place, as well as new resources. a contemporary enterpriser has got to grasp the change of role and position of a man in manufacturing and social processes. he has to be a master of modern electronic communication devices, know at least to world languages, undertake measures which will strengthen the competitiveness and the position of his enterprise on the market, providing permanent income, development and dynamic stability.science and knowledge are developing into a fundamental producing force of the society. the manner of production, relationships among people, positions toward labour, labour means, as well as relationships of people towards nature in an exchange of matter with it are being changed. the old electromechanic, technology-technological basis, and its bureaucracy structures are giving up their place to new electronic-biotic-genetic and robotic-technology-technological basis and its organic structure. in order to survive bosnia and herzegovina enterprises have to replace their national business environment with a global one which is governed by multinational corporations from developed economies. it also has got to ,as soon as possible, acquire the ʹalphabet of market economyʹ i.e. reconstruct itself in order to ʹplay a game at the global marketʹ. unfortunately the process of domestic enterprise transition is developing very slow and inefficient which amplifies the difficulties when coping with the consequences of the global economic crisis. the quality of the economy of domestic enterprises which are still in transition has a constant down lane which is logical since the managing of those enterprises is left to non-professional managers which are not required to successfully manage an enterprise. instead of taking responsibility for the results, they ere only required to be obedient and to execute the parties goals, so domestic enterprises, due to low efficiency and effectiveness, constantly create damages which have to be covered from the exiting state capital. hence the capital of government enterprises constantly derogates and ends up in the đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 53 pockets of individuals. the consequence of all that is a low quality of economy and a low level of competition on the global market, as well as reducing the quality of economy of overall state business. the effect of entrepreneurship on the accelerated growth of national economy entrepreneurship is defined as a process and activity (equal protagonists and society as a whole) which, with the aid of innovativeness in the presence of new combinations with limited producing factors, creates and realizes an venture which results in profit (and other social benefits). enterpriser is a person who risks: money, health, time, social status, and sometimes family to create and realize a profit-based innovative product i.e. service by offering his creativity and innovativeness in most cases. many of todayʹs established and worldwide famous enterprises such as wal-mart, ford motor, bmw, fiat, procter&gamble, dell computers, microsoft, michelin, ikea, qualcomm, benetton begun their business life as small enterprises with a enterprising vision of their founders as their main generator of development. despite the risks involved, world entrepreneurship is in a constant growth and greatly contributes to the economic development of the society in which it operates. we can rightfully state that todayʹs entrepreneurship is the bearer of the permanent innovation (entrepreneurial innovatiori) which renews, transforms and encourages the development of economy worldwide. it generates: (a) the appearance of new business ventures, (b) the occurrence of many new work places, (c) renews the national economy with ¨fresh blood¨ offering: vitality, innovative products and services, and increasing its chances for a general social and societal advance. in 2002, it is estimated that around 460 million people around the globe were involved either in the activities of starting new business ventures or representing owners-managers of new enterprises. [bygrave, zacharakis, 2003] the dynamics of entrepreneurship is illustrated by the fact that only in the usa more than one thousand new business ventures are created every hour in every work day. for the sake of a better comprehension of the correlation link between entrepreneurship and the growth of national economy we shall create a concept model of economic growth in which we can see the relationships between its basic parts (see picture 1). this picture demonstrates that the economic growth of certain national economies is strongly influenced by social, cultural, and political factors expressed through: social norms and conduct, the level of democracy, educational degree, political stability, attitude towards entrepreneurship, perception of enterprisers, etc. the factors which determine two significant mechanisms which encourage the economic growth are: • general national terms which generate the most significant, defined and established, enterprises no matter whether big (primary economy) or micro, small or moderate scale enterprises (secondary economy) are at stake. in addition to national scenes, big enterprises also develop on the global scene, making a significant contribution to the prosperity and development of their national economies. the enhance of growth of these enterprises and the expand of their operating will increase the demand for products and services of national economies, including increased market chances for a variety of micro, small and moderate enterprises. in addition to general terms of dealings on the global scene, economic analysis (2009, vol. 42, no. 3-4, 50-68) 54 the success of overall observed categories of national enterprises is determined by national context in which they operate (general national terms). • entrepreneurship terms which generate the entrepreneurship process, emphasize and strengthen the role of entrepreneurship in founding and developing new enterprises and other forms of enterprising processes. in this part of the model it is also possible to see that, in addition to general national terms, special i.e. entrepreneurship terms affect the entrepreneurship process and the expand of new enterprises. furthermore, the prosperity of the entrepreneurship process is subordinate to the following critic contents: • entrepreneurship opportunities (which are related to the existence of market conveniences and the perception of market opportunities) and b) entrepreneurship capacity (which enables people to establish a new business to fulfil the needs of market opportunities which is primarily related to the motivation for entering the world of entrepreneurship and possessing knowledge and skills necessary for the realization of market opportunities. picture 1. the concept model of entrepreneurship and the economic growth of national economy if the entrepreneurship opportunities and privileges allow for, and the capacity of the economy permits it, an entrepreneurship business creativity and activity is developed. on a national level this activity is represented by a number of processes of births, struggles to đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 55 survive, developments, but also the ends of enterprises or business ventures. the result of the entrepreneurship business creativity and activity is a national economic growth expressed via an increased gross of domestic products, higher employment, and by generating job creations. both previously mentioned mechanisms (general national terms and entrepreneurship terms) are in mutual correlation and in clear complexity: through acquiring new technology, expanding technological proficiency and developing new products, the established enterprises can encourage and increase business opportunities for a number of entrepreneurship initiatives. the same goes for enterprises with an accelerated technological development and by cutting down the business expenses they can allow established enterprises to achieve extra advances over competition. in that way entrepreneurship makes another contribution to the growth of national economies. seeing the importance of entrepreneurship for national companies and their development, the largest number of countries accepted entrepreneurship as a vital component in the process of economic growth and development. in the process of globalization the world economy is gradually losing its local regional state features and those damages are significantly accelerated by new technologies, new innovative processes and by a number of integrations of a variety of local, regional, and international institutions. the contribution of entrepreneurship is undisputable in the process since enterprisers, as one of the factors of success, develop and implement new technologies, generate new products and services and facilitate the development of educational processes, the growth of common welfare of the society in which they operate. entrepreneurship and contemporary tendencies entrepreneurship always had an important role in the development and reconstructing of market economy and it was decisive in the so called trans periods when civilization changes were occurring, e.g. the transfer from agrarian to industrial civilization in the 15th and 16th century or the current transfer from industrial to information civilization which in terms of time coincides with the transfer from command economy to social-market economy in the so called countries in transition, while the worldʹs most developed countries have more-less entered that world a long time ago. the processes of development are expressed in decentralization, and flexible organizational structure of the economy and society, among other. new regulations on the position and role of a man in economic and social processes, comparing to the ratio of workers and administrators and the overall human relationships, are being established. regarding that, t. peters, in his book thriving on chaos, gave attention to ten trends of development which are vital in understanding the meaning which entrepreneurship receives in the modern age. those are the following trends: 1) a great deal of uncertainty concerning contemporary economic changes (prices, production, design, distribution, organization). huge economy dynamic, innovativeness and constant adaptation is required 2) time becomes the main factor and the battlefield for rival fights since uncertainty requires speed and flexibility, huge ability to react, and adaptability base on economic analysis (2009, vol. 42, no. 3-4, 50-68) 56 informational technological changes (the so called zero responds time company, just in time, stock management) 3) all markets become patchy, and the merchandize is produced for a noted buyer (customized goods) which requires computer design and a flexible factory system, electronic data processing and distribution. that means that there are no more so called usual ¨market niches which the traditional manager used to build up strategies. 4) quality, design and service become the most important comparative advantages of manufacturers of new products which are made by modern technology and by a new comprehension of quality in new organizational shapes of activities and design as an assembly of technological and esthetic features on a business basis. 5) reconstruction of big enterprises corporations on the basis of competition among quality, design and services, organizational-technological flexibility, and market adaptability. that means that that big enterprises, due to business irreversibility can become flexible themselves with the creation of new lines of autonomous enterprises. 6) new organizational configuration of enterprises denies traditional enterprise bureaucratic hierarchy which is no longer competent to compete with time, quality, design, and services. that is the reason why organizations are being decentralized, converted in to networks of inner and outer autonomous organizational units. 7) old economic ideas about big size economy are changes under the influence of market structure and conglomeration; it strengthens the trend of small and moderate enterprises which are more and more merging into networks which include enterprises and/or their organizational units. the big corporation becomes a system of small enterprises and their organizational combinations in which the informational technology is one of the key prerequisites of a network of business correlation. 8) individual organization becomes a part of corporation networks of an enterprise and market partners are more considered as business associates (partnership). 9) internationalization of all economic processes means that all economic subjects are mutually connected and dependant on the global market. production, distribution, exchange and consumption actually become international and the competition and informational flows make the enterprises an integral part of the world production and turnover. 10) significant changes occur in the process of labor and in the status of employees in an enterprise. repetition labor is transformed into innovative sophisticated labor which produces quality instead of quantity, usually provokes higher interest form the employees and decreases absence from work and increases the economy of manufacturing and dealing. [peters, waterman 1982] the stated changes are both the result and the backbone of new changes in entrepreneurship and management. the key question for enterprisers and managers is: how to transfer from one state to another, which is usually linked with dynamic events in the enterprise (collapse or success) or with changes of enterpriserʹs leadership or new changes in đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 57 the form of decentralization of enterprise ownership (management buy out, spin offis, split offis, split up,...etc.). on the other side, for a macro-economic approach, the type of institutional changes is very important to enable a fast and efficient restructuring of the whole economy. the determinateness of entrepereurship development assumptions and conditions the development of entrepreneurship requires freedom: it has to be free entrepreneurship in a free market economy. that includes the right to found an enterprise, the right to choose the subject of dealing (with the exception of areas reserved for some common social interests defense, ecology, etc.), free convention concluding, free selection of organizational shape, an provided system of acquiring assets and the freedom of investing. it also requires institutional postulates of existence and national functioning of free, integrated and opened marked, free competition. for the development of entrepreneurship it is also important that there is a social, economic and political environment as well as general perception, philosophy, and atmosphere which are not hostile towards entrepreneurship and the righteous profit-gaining of individuals and the community including the protection of economic subjects from unreasonable tax and similar duties which could jeopardize the necessary accumulation and development of an enterprise. in addition to that it is also necessary that the government advocates a suitable economy-development policy and establishes appropriate stabilizers and stimulators of economic life. accordingly, it is necessary to provide the following terms necessary for the development of contemporary entrepreneurship: (a) economic, (b) societal and (c) political terms. (a) economic terms of the development of entrepreneurship. free market is one of the main economic prerequisites for the development of entrepreneurship. it provides enterprisers with the necessary information to make the right calls. free market generates apportioning and distributional function accepting economic criteria and the rules of the game defined by the conjoint of offer and demands. the prosperous functioning of a market implies free movement, turnover of goods, money and labor force, and creating prices in accordance with specific conditions. enterprisers acquire the necessary resources under the same conditions and equally participate in the market exchange of goods. the innovative rules of the game which make them to take account of competition, prizes, the selection of manufacturing factors, means of its combining and the possibility of accessing products and their realization on certain markets in organizing their own business are exercised on them. the basis of market position is formed by its efficiency, lower producing expenses, lucrative work etc. for a better positioning it is necessary to select a product (service) and constantly work on the development of its quality. also, before making a decision on entering into a production, it is necessary to evaluate the technological needs and to choose a strategy which maximizes the advances in disposal of the enterpriser. (b) societal terms of entrepreneurship development. according to p. drucker entrepreneurship is a socio-cultural phenomenon which is essentially dependant economic analysis (2009, vol. 42, no. 3-4, 50-68) 58 on societal structure, and a valuableness (ethic) system. from the societal point of view the crucial factor is also the societal mobility of people and their education as one of the most important criterion of their societal promotion and successfulness in economy. [drucker 3/84] namely, entrepreneurship requires a dynamic restructuring of the society on the basis of constant new criteria in societal structure. the system of values, i.e. its broader conception «economic culture» is an important string in the development of entrepreneurship. economic behavior of individuals on the basis of private property, market competition or, for example the christian ethics of rationalism philosophy, individualism, innovativeness, self-discipline, and selfinitiation were very encouraging elements in the development of entrepreneurship civilization of the west. when it comes to societal terms of entrepreneurship development, a special place is occupied by innovative and climate culture as a very significant societal condition for the development of entrepreneurship. creating an innovative culture depends on several factors, primarily on tradition and encouraging actions for creating new ideas, products and services. in the development of entrepreneurship tradition has a significant role, since experience is acquired and passed on, and the reputation is inherited and increases from generation to generation. a captured product and the market form the basis for advancing the scope, the assortment and better positioning of the company. successors add positive things to the company and attempt to modernize its work with knowledge and experience. creating an innovative culture, as a dominant value in the business of a company is conditioned by the skills of the employees, their abilities and predispositions to explore and innovate. the creation of innovative culture and climate is also affected by healthy competition, imitating and the cooperative work of all participants. a special color to innovative pace is added by prosperous explorers and managers with a vision, willing invest and risk. (c) political terms of entrepreneurship development. the development of entrepreneurship depends on basic political-economic values such as democracy, liberalism, pluralism, freedom...etc. those very values represent the surface framework field of development of entrepreneurship-economic values. since the policy freedom determines the economic freedom, it furthermore determines the development of entrepreneurship. so political pluralism is the precondition for economic pluralism which enables the development of a variety of entrepreneurship forms. worldwide experience points out that the government behavior and its special regulative part in economy are vital for the development of entrepreneurship, but not if it is the substitution for objective economic legitimacy, but rather in the function of creating conditions for their market operating. unreasonable state legal regulative for economic processes and shapes can be very harmful creating an ambient which prevents or slows down initiatives and entrepreneurship, increases uncertainty and risk, restricts foreseeing and prosperity of finishing entrepreneurship actions. the state, with the aid of itʹs law regulation and economy-development policy has to encourage and support positive conducts, and prevent negative such as monopoly, autonomy, law insecurity, tax overwork, đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 59 credit discourage, etc. in that sense, anti-bureaucracy and anti-regulation belong to the same type of institutional innovativeness, but under the condition that the government really removes barriers to the undisturbed functioning of market economy and free entrepreneurship and promotes positive movements. that includes stimulating small and medium entrepreneurship, reasonable taxes, suitable monetary and credit policy, the support of science, education...etc. hence the state deregulation in economy is a very important determining factor of the entrepreneurship development. it is necessary to provide free functioning of market institutes by deregulation. the government, by means of its laws, actions and agencies, cannot limit the autonomy of enterprises, nor assign them with the role and manner of participating in the exchange of assets with other market subjects. if the government determines prizes, payrolls in an administrative manner, and conditions the distribution of merchandize (products and services) by its actions, then the market does not have its role and itʹs economic laws do not force the producers to deal rationally. in addition to that, the government cannot prevent entrepreneurship initiatives by means of administration and to subject them to a special regime of control, taxation, and tariff payment. moreover, it can have a extremely positive effect in the entrepreneurship development of countries if it, by its regulations, stimulates creating of new organizations, introduces tax relieves, and enables enterprisers to successfully start and develop their business. enterprisers who isolate assets for new investments should be tax relieved for that part of assets, and should be enabled to import the necessary equipment under favorable terminal conditions. the state should create a framework for creating new enterprises by various actions, since they are sometimes complementary with other companies and can discover a part of new market demands and make the offer more various and attractive for the market. ideological prejudices on entrepreneurship should make room for the economic cause of rational organization of market structure in which different forms of ownership and companies of different proportions have their place under the sun. the transition of economy of bosnia and herzegovina in the function of entrepreneurship development the transition of economy of a country includes itʹs promotion to the tracks of propulsive market economizing which means the confrontation of an enterprise with picky, organized, and sophisticated consumers and aggressive (domestic and foreign) competition. since the 1980s, the economy of bosnia and herzegovina, as well as the economy of other former socialistic countries, is an a process of transformation from non-market, earlier selfgoverning, to contemporary market economy. the transitional package implemented in bosnia and herzegovina is based on the «rules of the game» defined by the washington consensus. on the international level, the transition, so far, has been lead by the international monetary fund, the world bank and the usaid. there is a historic difference concerning the process of transition occurring in a mature market economy and the one in the former socialistic economy. we in bosnia and herzegovina are transforming the entire political, social and economic system. this is economic analysis (2009, vol. 42, no. 3-4, 50-68) 60 actually a revolutionary step and to realize it, we need the following: capital, better management, construction of institutions, time, market, and an adequate macro-economical management. the constitutionalism of the market economy system and creation of a marketoriented enterprise represent two axioms of the transition process. on a macro-economic level that includes the establishment of a business ambient appropriate for the developed market economies. on a micro-economic level that includes a series of structural changes of an enterprise directed towards the improvement of business efficiency and adaptation to the market demands. so, for a company to efficiently realize the transition of its economy, it is inevitable to start from enterprise transition. the transition of enterprises has to be realized fully, in an appropriate way and according to appropriate methodology and not by demands and desires of a political party or group, or an international factor. transitions (restructuring) of enterprises represents an activity of finding the most efficient and effective way to achieve the goals of an enterprise, from the aspect of all of itʹs internal and external stakeholders, and that activity results in an accelerated economic development and an increased life standard. transition is permanently exercised in developed market economy countries and it is not our feature or our very own characteristic process in economy. in almost all market economy countries there are continuously different transformational processes in the scope of ownership, organization, managing, as well as market and financial restructuring in order to increase efficiency and competitiveness of their enterprises on the domestic and foreign market. those processes include: (1) the selling of enterprises and or their parts, (2) selling of the check action package, (3) enterprise linking in various forms such as holding or concern, (4) decomposing of enterprises on more dependant (subsidiaries) enterprises, (5) integration and merging of enterprises, (6) decentralization of enterprises and forming various types of business units in it such as a strategy business unit, financial, profit, and investment centers, (7) business pre-orientation of an enterprise, (8) financial recovery of an enterprise, (9) liquidation of an enterprise...etc. in addition to these transformational ventures undertaken by the enterprises themselves there are also some interesting transformational ventures which are undertaken by the government via its specialized agencies to encourage enterprise capital investment in prosperous activities. so restructuring is a common process in market economies today. it is the prerequisite and the basis of efficient and effective business of its enterprises. since every enterprise in the market economy has itʹs development stages, growth, stabilization, stagnation, and healing (or liquidation) it sooner or later finds a way out of the crisis in some of the mentioned transformational ventures. [milisavljević, todorović 1991] bosnia and herzegovina enterprises took a huge step toward business on market criteria. for them, restructuring is not only a necessary move, but something vital for itʹs survival on the market economy based on personal risk and fierce competition struggle on the global market. they have to reform from the ground which means systematizing in the sense of ownership, organization, management, and market, similarly to enterprises of developed market economy countries. in additon to ownership, organization and management transformation, the restructuring of domestic enterprises requires a revision of producing programmes and aimed markets, as đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 61 well as a change of market approach strategy. isolation from international surrounding, as well as certain clumsiness and indecisiveness in the adaptation of the economic system created the existence of gaps in the field of management and marketing, technology, organization, and motivation. those gaps must be removed by including our enterprises in the international distribution of labor on the basis of the international marketing standard. the survival of enterprises is conditioned by their ability to refine their offer via relocation of their resources and by establishing new attitudes towards the challenges and limitations of the global business surrounding. the enterprise on the market is worth as much as it makes profit in the given market ambient. home enterprises, in order to redefine the market orientation, have to redefine their business portfolio. all efforts on managing, organizational, or financial restructuring will very soon vanish unless they are not followed by market and whereby programme restructuring. for a better grasp of the «transition» phenomenon and the need to restructurate domestic enterprises in the function of entrepreneurship development it is necessary to point out to the fundamental features of the market economy system as an postualte of entrepreneurship development. market system of economizing as a postulate for entrepreneurship development market economy implies a clearly defined role of the state and itʹs relationship towards enterprises. the government effects the terms of economy on the market by itʹs monetary and fiscal policy, but it cannot affect the business calls of private enterprises. it is important that the government makes regulations within itʹs authority which provide maximal financial discipline and other conditions necessary for a safe performance of enterprises and banks on the market of goods and capital, especially regulations concerning: financial dealing, accountancy reports and supervision, financial recovery and bankruptcy...etc. on the other side of this process there is a enterprise whose main goal is survival i.e. development in the constant struggle with competition, which is achieved, among other, by constant restructuring, i.e. providing substantial capital structure, reducing debts and risk, creating conditions for a more favourable getting onto debts, securing better cash management, stabilizing money flows...etc. market economy is a system in which people have the freedom to choose their occupation (activities, business) depending on the offer and demands of the market, and on the basis of their own possibilities. that is substantial difference compared to the earlier systems of non-market economy where a different force (e.g. in centralistic-planning economy that force is the state) determined the choice of activities. almost all systems of economizing have three basic questions: (a) what to produce, (b) how to produce, i.e. which technology and organization to implement, (c) how to distribute the achieved results. in a market economy system the answer to the previous questions is looked fo on the market and depends on the offer and demands. in this system everyone has a chance to display their skills and knowledge and to valorise on the market, that way providing existence for themselves and their family. this is an important market economy system feature which was not present in any of the previous social-economy systems. the economic analysis (2009, vol. 42, no. 3-4, 50-68) 62 relationships between offer and demands in the market economy are regulated by means of price mechanism, without the need of anyone else to interfere. famous american economists heilborner and thurow reached a conclusion that the market system of economizing has four foundation posts, which helped it to prove itself as the best solution for a number of modern world countries. those four posts are: (1) dominant role of private property in business, (2) profit as the only objective norm of success in all activities requiring market valorisation, (3) freedom of choice of every individual to decide in which way to secure existence in accordance with his knowledge and skills, (4) competition in areas where that is achievable, since competition motivate all people to do a better job and to contribute to a higher fulfilment of many human needs. (1) private property as the dominant form of ownership in society is the first post of market economy. market economy cannot function without the private property of most manufacturing tools. former communist countries, even the former yugoslavia, had failed trying to create some kind of market economy without the dominating private property. since it is in the human nature to first think about personal interests then about others, the economy could not grow. only in the presence of private property people can primarily fulfil their own interests, but contribute to the development of the overall society at the same time. rich individuals through tax systems help to solve the social problems of the poor and to meet many common society needs, whether the want it or not. adam smith called that nice self-regulating system mechanism the invincible hand. (2) profit is the only objective norm of success in all activities demanding market valorisation. it is the motor fuel of every market participant. owners of capital are not admirers of one or the other kind of business, except the one which increases their fortune. so the main goal of capital owners is to draw out as many profits as possible from it, no matter which business they are into. the ratio of achieved profit and invested capital is the basic criterion for the manager work control by the owner. profit is also the main motif for resource allocation .i.e. the removal of capital from one business to another or from one region to another. (3) the freedom of choice of every individual to, in accordance with his skills and knowledge, decide in which way to secure existence is the third post of the market system of economizing. this possibility is a very important feature of the market economy, and it is closely connected with democracy, as the main aim of all civilized societies. market economy and democracy are interrelated and fail to exist without the other. every individual in the market economy has a wide spectrum of activities to choose from, but the final decision depends on his intellectual and psychological features, as well as financial possibilities. so, for example, there are people predisposed to be enterprisers. enterprisers are all people who establish and develop new enterprises, accepting the risk alongside with the desire to achieve their goals concerning profit. unlike them there are other people who do not have tendency towards entrepreneurship. those people entrust their money to enterprisers and in that way they make profit. they call themselves investors. a lot of people are very prominent managers but do not share the entrepreneurship spirit. they sell their knowledge to enterprise owners đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 63 and in that way secure their own existence. hence, in the market economy system there is complete freedom of choice of every individual who can change his decision anytime he wants during his entire lifetime. (4) competition is a very important post of market economy due to the fact that it continuously contributes to the increase of product and service quality, pricelowering, and better fulfilment of the consumer’s needs and wishes. that is why it is necessary to provide competition in all suitable areas, since it motivates everyone to do a better job and contributes to a better fulfilment of all human desires. it is well-known that an individual who has a monopoly position on the market will not bother trying to do something more for his buyers, because nobody is forcing him to, there is not anyone who can take over his customers. only an appearance of loyal competition can force him to adapt to the needs of customers, in order to keep them. comprehension of competence and its further monitoring is the key element of an enterprise strategy and the element helping it to grasp the relationship between itʹs buyers and the internal possibilities of providing better services to them than the competition. hence, it is necessary that the management of an enterprise, in the process of formulation and implementation of its strategy, provides answers on the following questions: (a) what consumers buy, (b) what are the needs of the buyers and how to meet those needs, (c) who is the best at fulfilling those identified needs, (d) what is the status of my company, comparing to the best, (e) can i change my position, and be equal with the competition on the market. [heilbroner, thurow 1987.] the need to restructure domestic enterprises to develop entrepreneurship enterprise restructuring presents an activity which speeds up the economic development. this activity has been exercised for years in the developed market economies, and it shows itʹs abilities in various transformational ventures concerning capital ownership, management organisation, as well as market and financial restructuring. the aim of theses transformational processes is placing efficiency and competition on a higher level. these processes are particularly needed in our enterprises in bosnia and herzegovina, considering bad habits from the previous system, as well as war consequences which multiplied the inherited past. restructuring of bosnia and herzegovina enterprises is inevitable and a prerequisite of effective and efficient business, primarily since our every enterprise aspiring towards market economy undergoes itʹs developing stages: growth, stabilization, stagnation, and healing (or liquidation). accordingly, domestic enterprises in a current state of stagnation have two possible paths healing throughout the mentioned transformational ventures or liquidation. domestic enterprises have to reform from the grounds to be able to successfully take part in the global market game based on ownership risk and fierce competition struggle on the market. prosperous enterprises in countries with years of experience in the market system of economizing are being carefully analysed and can be distinguished by some relevant features. that kind of analysis was performed by two prominent experts of the famous consulting agency mckinsey. after a minute research they created a model which is known as the seven economic analysis (2009, vol. 42, no. 3-4, 50-68) 64 s and its scheme is represented on picture 2. [peters, waterman, 1982] the authors believe that prosperous enterprises in the market economy have a clearly defined strategy which is used as a foundation to form adequate organizational structure supported by systems such as informational, technological...etc. in addition to these three elements, which we call hardware, there are four other software elements. a prosperous company has prominent staff with specific skills and knowledge, recognizable corporation culture and shared values. picture 2. the mckinsey 7s model source: peters t. j., r.h. waterman: in search exellence, harper and row, new york, 1982. following the mentioned elements it is necessary to identify the critical points in domestic enterprises, i.e. the largest weaknesses which will need devotion in the process of transition. strategy is the modern managerʹs tool which can bring the crucial competitive advance on the market. we in bosnia and herzegovina have not paid attention to that issue nether in theory nor in practice. the previous system and the current inertia of state enterprises are the reason why strategy is one of the weakest chains. in our environment there is a lot of talk about the lack of strategy in the economic development of bosnia and herzegovina as a unit, but there are almost no actions to improve strategic managing of every enterprise. it should be also reminded that more attention is paid to the strategy of enterprises in the market system, and the strategy of the government is reduced to creating an ambient which is favourable for prosperous enterprises. considering the elements of the previous model which is used by prosperous enterprises in the market economy and the fact that they are prosperous due to that usage, we can state that domestic enterprises in the process of transition are absolutely necessary to undergo the following restructures: (a) ownership,(b) organizational, (c) managing and (d) market restructuring. (a) the necessity of ownership transition. we mentioned that the dominant private property is the cornerstone of market economy due to the fact that it produces higher efficiency than other ownership systems because of the following reasons: (1) private property establishes the market of managersby producing more quality managing, (2) capital market does a better job at disciplining private đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 65 companies than companies of public ownership which operate under soft budget restrictions do; (3) private company are more likely to exit the market, i.e. they are more often the subject of bankruptcy, liquidation, and hostile takeovers; (4) the influence of politicians on private companies is less than in companies with public ownership; (5) private companies are the subject of supervision of shareholders and members of managing bodies and, on the basis of that, they use the capital and other factors of production more efficiently. due to producing better efficiency in economizing it is necessary to start transforming the government ownership of funds in to private property in bosnia and herzegovina. that process has begun by the enactment of law on privatization of enterprises and banks and the process is still ongoing with different intensity in different state entities. by changing the structure of ownership it is necessary to eliminate the fatal influence of the political parties’ governs over business, which was the main cause of the collapse of the previous commanding system of economizing. privatization in bosnia and herzegovina will not solve the economic problems of existing state enterprises by itself. on the contrary, it will increase them. however, that is the prize we have to pay to enter the system of market economy. why is it necessary to approach to the amendment of capital ownership structure in enterprises? the answer is very simple considering the former capital owner (social property everyoneʹs and nobodyʹs, and later on it is a country without sense of sight, touch or brain...etc.) who cannot or is not able to effectively manage that capital, has got to give away that property to those who will make an efficient use of it to increase the economic prosperity in our country. the current social and later on state capital has been swiped and transferred into private pockets by various illegal actions, constantly decreasing the economic ground of enterprises. no one demanded responsibility from managers of social i.e. state enterprises for a higher achievement. such managers were usually appointed according to a political, kinship or grandpa background, without any economic criteria which make a successful manager. all the above contributed to the inefficiency of enterprises on the market and the fact that they could not contribute to the improvement of life standard on the macro level. (b) the necessity of organisational transition. if we want to include the existing enterprises in bosnia and herzegovina in to the global market game and to increase the quality of domestic economy economics at the same time, it is necessary to exercise organizational changes (restructuring), in addition to changing the titular of ownership of producing assets. that presupposes performing a lot of important changes and innovations in the system of enterprise business organization. the following innovations are highlighted as the most important ones: (1) abandoning social (later on state) enterprise as the institutional form of organizing enterprises in our economy, (2) transforming social (later on state) enterprises into suitable, market economy immanent, forms of institutional organizations, (3) decomposing, i.e. profit decentralizing of social (state) enterprises into suitable entities which are more less autonomous and business organizational and billing entities. [babić, 1997] in order to successfully come up with itʹs strategy and implement it on the market, domestic enterprises economic analysis (2009, vol. 42, no. 3-4, 50-68) 66 will have to drastically change their organizational structure, i.e. the manner of organizing their activities. the development of informational and communication technology will enable far more knowledge to everyone involved in the process of business decision making. the established organizational structure, with lots of hierarchical levels and barriers between various functions and an enterprise is no longer able to support flexibility and fast changes in strategy. as a result, the future is in the so called shallow organization, with little staff on the top and a bigger number of independent interdisciplinary teams, created on the basis of project tasks. in such teams there will be planning and executing of all actions needed to achieve global goals set by the top of the management. (c) the necessity of managing transition. in addition to ownership and organizational transition, management restructuring of domestic enterprises presents a very important transitional venture. in the current process of transition our enterprises will have more sovereignty in decision making, but they will also have to take responsibility for bad decisions, profit loss and even liquidation. private owners will not tolerate bad managers, and the quality of their work will only be valued by the market value of stocks and the size of dividends. the essence of this restructuring is made by introducing an modern, professional management system, like the one present in the enterprises of developed countries on the economy market. professional management system is based on: separating management and ownership, manager staff professionalization, standard establishing, ratio of managerʹs norms and efficiency, monitoring and grading the managerʹs work, rewarding the success and punishing the failure of managers, signing professional manager contracts, development of market by the manager. domestic enterprises virtually have none of the previously mentioned in their managing systems. to have a good, superior management is the main prerequisite of participating in a market game. hence it is necessary to establish this kind of management system in the period of ownership or other transitions as soon as possible. (d) the necessity of market transition. the market economy of a country presents itʹs transfer to the path of propulsive market economizing. that means the confrontation of the enterprise with picky, organized and sophisticated consumers and fierce competition. domestic enterprises will have to do a revision of their producing programmes and aimed markets, as well as their strategy of outbreak on the market. this will have to be done as soon as possible, because these enterprises, due to the collapse of former yugoslavia and the consequences of the ugly war, suffered a devastation of the market of sales and supplies. market transition of domestic enterprises, after privatization, will have to start searching for answers on difficult questions such as: (1) which business do we want to belong to, i.e. what are the essential needs of our potential buyers that we want to emphasize? (2) what is our current status? (3) where do we want to be? (4) do we know which road is going to take us there? (5) how many human and material resources do we need for that? (6) how to select our aimed markets, and position ourselves in relation to the competition? (7) what kind of products and đogić, r. et al., assumption and requirements, ea (2009, vol. 42, no. 3-4, 50-68) 67 services to offer on the market, under which terms, how to promote and distribute them? these questions are strategic concerning every enterprise on the market system of economizing, and its faith, i.e. survival and development depends on the success of the given answers and on entrepreneurship actions. conclusion contemporary entrepreneurship renews, transforms and encourages the development of economy worldwide it generates the emerging of new business ventures, the opening of new, usually small enterprises, new jobs, and renewing the national economies by ʹʹfresh bloodʹʹ offering vitality, innovative products and services and increasing their chances for a general, social, cultural, and societal improvement. the development of entrepreneurship is determined by social, economic and cultural context of previously national and today global economy. social, economic and political context of modern entrepreneurship is significantly altered. by abandoning the concept of scope economy as the main driving force of economic development, by occurrence of higher uncertainty on the global bulk, by the entry of a number of countries in the process of social and economical transition, by decreasing business activities and restructuring big-scale world companies, entrepreneurship is again perceived as an accelerator of development, especially the one realized by a number of smallscale enterprises. through the development of entrepreneurship every national economy, especially the undeveloped economies such as the one in bosnia and herzegovina, finds it easier to confront with the consequences of the global economic crisis. in order for the domestic enterprises to function as the generator of development they must undergo restructuring in a ownership, managing, organizational, financial and market sense, and that is the way to prepare them for the global market game. the process of economy transition in bosnia and herzegovina is, unfortunately, happening very slowly and inefficiently, which is a result of three things: (a) the complexity of organization of bosnia and herzegovina after the dayton treaty, where the authority representatives cannot reach an agreement on important transition ventures, (b) our balkan primitivism led us to be a ʹʹguinea pigʹʹ to the international community in transitional processes, which has sent some low-quality missionaries, so called «experts» as councillors for our government to lead the process of transition, disregarding qualified domestic staff of higher quality, (c) the consequences of the ugly war which left our home enterprises destroyed, devastated, robbed, with severed market and reproduction connections, expired technology...etc. all that results in the fact that the fall of economy quality in most enterprises in transition has not been stopped. considering the previously mentioned, we can conclude that the entrepreneurship development in bosnia and herzegovina requires the ending of the transition process and whereby the qualification of domestic enterprises to confront with the global market challenges. ending of the domestic enterprise transition process will initiate entrepreneurship as the main lever in the economic development. along with domestic enterprise restructuring, the basis of the entrepreneurship development in the following period, as a good therapy for the consequences of global economic crisis, will be formed by new entrepreneurship ventures mainly expresses via small and moderate enterprises. small and moderate business will be the main outline of the development of the morbid bosnia and herzegovina economy. economic analysis (2009, vol. 42, no. 3-4, 50-68) 68 references babić m, i dr. 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(1991), strategijsko upravljanje, ekonomski fakultet, beograd peters t. j., r.h. waterman (1982): in search exellence, harper and row, new york received: 2 may, 2009 article history: accepted: 1 september, 2009 doi: 10.28934/ea.22.55.2.pp91-106 first online: december 23, 2022 original scientific paper influence of green transformational leadership on the workplace pro-environment behavior: a case study of a large energy company in thailand patarawadee tongsoongnern1 | wing shing lee29f* 1 imba program, college of management, i-shou university, kaohsiung, taiwan 2 department of international business administration, international college, i-shou university, kaohsiung, taiwan abstract today, environmental problems are worsening, greenhouse gas emissions are increasing, and natural resources are depleting. solving these problems requires the efforts of everyone in the organization. this study aims to analyze the impact of green transformational leadership on proenvironmental behavior in the workplace. specifically, the main hypothesis is that green transformational leadership positively influences workplace pro-environment behavior. two other pathways are also proposed. the relationship can be mediated through green mindfulness and green self-efficacy. the method used in this study is a questionnaire, and data were collected from 163 respondents who work for the electricity generation authority of thailand. an integrated model containing the hypothesized structure was then tested with structural equation modeling. the results showed that green transformational leadership positively impacted workplace proenvironment behaviors and that this relationship was mediated by green mindfulness. however, green self-efficacy did not mediate between green transformational leadership and workplace proenvironment behavior as there was no relationship between self-efficacy and workplace proenvironment behavior. rather, green self-efficacy influences workplace pro-environment behavior through green mindfulness. the revised model provides some practical implications for corporations that intend to promote workplace pro-environment behavior. first, green transformational leadership serves as an important factor as it has both direct and indirect impacts on workplace proenvironment behavior. second, green mindfulness is an important mediator for two indirect effects upon workplace pro-environment behavior. these two factors are key in motivating staff members to work environmentally keywords: green transformational leadership, workplace pro-environment behavior, green selfefficacy, green mindfulness jel classification: m10, m14 introduction today, environmental protection has become a major concern of many societies in both developing and developed countries. according to the emissions gap report 2022 (unep, 2022), little progress has been made towards meeting the temperature goal of the paris agreement since the 26th united nations conference of the parties to climate change (cop26) in 2021. to achieve this goal in 2030, annual global greenhouse gas emissions must be reduced * corresponding author, e-mail: joelee@isu.edu.tw 92 economic analysis (2022, vol. 55, no. 2, 91-106) by 45% compared to emissions projected under current policies. thailand was among the top 10 countries that were most affected by climate change from 2000 to 2019, according to germanwatch, an environmental ngo. the prime minister of thailand attended cop26 and emphasized that thailand attaches great importance to solving the problem of climate change. thus, “going green” becomes inevitable for both individuals and organizations. the term "going green” involves people making conscious and sustainable choices. frequently referred to as the three r's (reduce, reuse, and recycle) for the workplace, going green not only helps an organization conserve resources, but also helps create a socially responsible image. in some parts of the world, customers are concerned about how businesses have an impact on the environment, such as their contribution to sustainable production and green consumption (lin & niu, 2018; souri, sajjadian, sheikh, & sana, 2018). in organizations, green innovation has become a powerful and positive tool due to the increasing preference of customers for environmentally friendly products in the market (chen & chang, 2013; sheu, 2014). this phenomenon arises because the world has experienced issues such as climate change and global warming that are harming human beings. therefore, in this era, enterprises should strive to promote knowledge and innovations in the green domain. green transformation leadership becomes a key element of this process. still, most companies in thailand fall behind the global trend of going green. according to a report issued by the bank of thailand (bot, 2022), in 2021, only 16 companies announced their intention to achieve net zero emissions. however, this is about to change, as the same report states that if companies fail to commit to net zero emissions, they may find it harder to raise capital internationally. due to the importance of going green and the lack of research in thailand on how to transition companies to green outcomes, this study aims to fill the gap. specifically, this study aims to investigate how green transformational leadership, directly and indirectly, influences proenvironmental behavior in the workplace as the latter affects greenhouse gas emissions. currently, little research on green transformational leadership has been conducted in thailand, although some studies have been published on transformational leadership and human resource issues (phungsoonthorn & charoensukmongkol, 2018; promchart & potipiroon, 2020). green transformational leadership stems from transformational leadership. ackoff (1999) defines transformational leadership as a leader who guides, encourages, and facilitates followers to change. similarly, green transformational leadership provides employees with a clear vision, inspiration and motivation and supports their developmental needs to achieve their goals in a green organizational environment (chen & chang, 2013; mittal & dhar, 2016). this paper proposes that green transformational leadership can enhance followers' workplace proenvironment behavior in two ways. the first is through green mindfulness, and the second is through green self-efficacy. the results may boost the organization's green profile and help it capture business opportunities (mittal & dhar, 2016). the research questions of this paper are then specified as follows: (1) does green transformational leadership have a direct effect on workplace proenvironment behavior and an indirect effect through green mindfulness? (2) does green transformational leadership have a direct effect on workplace proenvironment behavior and an indirect effect through green self-efficacy? the structure of the rest of the paper is as follows. the second part, a literature review, will discuss recent literature on green transformational leadership, workplace pro-environmental behaviors, green self-efficacy, and green mindfulness. hypotheses are then developed. the third part is data and methodology. here, the samples, measures, data analysis, and results of the structural equation modeling are presented. the fourth part includes the discussion of results and follows the conclusion. patarawadee tongsoongnern, wing shing lee 93 literature review green transformational leadership transformational leaders inspire their followers to strive for performance that exceeds expectations. they instill confidence in their subordinates, improving their inner motivation and outer performance. transformational leadership has four elements: idealized influence, inspirational motivation, intellectual stimulation, and individual consideration (commonly referred to as the "four is"). idealized influence enables a leader to build respect and trust among team members, to become their role model, and to make followers feel proud to be part of the team. leaders must have very high standards of ethical conduct. inspirational motivation is when a leader sees a vision and inspires others by executing and challenging the work of followers. intellectual stimulation describes how leaders work with followers to find innovative ways to deal with organizational problems. individualized consideration allows leaders to focus on the needs of their followers and act as a coach or an advisor for their personal achievement and growth. green transformational leadership stems from transformational leadership. it motivates employees to acquire new knowledge (han, seo, yoon, & yoon, 2016; le & lei, 2018) and engages them in activities related to green products and process innovation. this will help companies to introduce green products and/or market services (andriopoulos & lewis, 2010) and improve their environmental performance (martinez-conesa, soto-acosta, & carayannis, 2017). through inspiration from the leaders, followers work toward environmental goals, strive to generate fresh ideas for the environment (mittal & dhar, 2016), and try to attain performance that exceeds expectations. previous research has found that green transformational leadership is associated with many green outcomes. several studies have shown a positive relationship between green transformational leadership and green performance (chen & lai, 2014; gustiah & nurhayati, 2022; zafar, nisar, shoukat, & ikram, 2017). other studies have found that transformational leadership has a positive impact on green creativity or innovation (li et al., 2020; singh, del giudice, chierici, & graziano, 2020; zhang, xu, & wang, 2020). huang, ting, and li (2021) have shown that green transformational leadership of ceos positively impacted green work engagement and environmentally proactive strategies. çop, olorunsola, and alola (2021) also have reported similar results. green work engagement and green team resilience are also positively related to green transformational leadership. workplace pro-environmental behavior one of the three types of environmental behavior proposed by stern (2000) is environmentalism in the private sphere, which is the focus of this paper. of particular interest to us is behavioral choice (clayton & myers, 2015), which involves decisions that are less harmful to nature, such as the three rs (reduce, reuse, and recycle), buying organic, and taking public transportation. such behaviors are important because they are performed voluntarily and privately by employees. in general, however, environmental behavior in the workplace helps organizations protect natural resources and the environment (anderson & bateman, 2000), as well as promote corporate social responsibility (jones, 1996). recent research has identified some determinants of work pro-environmental behavior. they include the status and power of a leader (arsanti, sugiarto, pasharibu, & wijayanto, 2021), coworkers’ relationships (videras, owen, conover, & wu, 2012), social norms (banwo & du, 2019; czajkowski, hanley, & nyborg, 2017), moral motivation, private costs or efforts (czajkowski et al., 2017), perceived behavior control, intention to act, and environmental attitude (banwo and du 2019). 94 economic analysis (2022, vol. 55, no. 2, 91-106) green mindfulness kabat-zinn and hanh (2009) and bishop et al. (2004) define mindfulness as the awareness of experiences in a non-identifying, unbiased, open, and accepting manner. this definition includes two aspects: awareness and acceptance (rau & williams, 2016). sometimes it also refers to one's ability to respond to change one's focus, or one's willingness to consider alternatives (chandwani, agrawal, & kedia, 2016). green mindfulness is considered a condition for an individual's awareness of environmental context, knowledge, and information (blok, 2018). green mindfulness activities depend on the shared vision of the organization. without a shared vision, mistrust and doubt can breed, and promoting mindfulness activities can become challenging (uchihira, 2019). therefore, leaders who can instill a shared vision among members of an organization are key to building green mindfulness among them. geiger, otto, and schrader (2018) found that increased mindful awareness of momentary experiences had a positive impact on healthy lifestyles, which in turn had positive effects on ecological behaviour. amel, manning, and scott (2009) also showed that mindfulness is positively associated with sustainable behavior. on the other hand, arslan et al. (2022) considered green mindfulness as a moderator variable. they have found that green mindfulness moderated the relationship between energy efficiency and green creativity. green self-efficacy according to schwoerer, may, hollensbe, and mencl (2005), general self-efficacy refers to an individual's belief in one's ability to complete different tasks successfully. similarly, bandura (1994) believes that self-efficacy is a person's judgment of one's ability to organize and perform certain actions to achieve a certain level of performance. people who are high in self-efficacy tend to be more engaged and persistent (bandura, freeman, & lightsey, 1999; schunk, 1995). they perform better and are more committed to their goals (bandura, 1994). they are also confident in their ability to generate new ideas (hmieleski & baron, 2008). green self-efficacy is a specific mechanism related to environmental motivation. it can be referred to as one's belief in organizing and working towards environmental goals. green self-efficacy was found to have a positive impact on green buying intentions (sharma & dayal, 2016) and pro-environmental behaviour (abraham, pane, & chairiyani, 2015). it also served as a moderator in the relationship between green servant leadership and proenvironment behavior (faraz, ahmed, ying, & mehmood, 2021). farooq, zhang, talwar, and dhir (2022) have found that green self-efficacy mediated the relationship between green human resource management and green creativity. hypotheses development the first hypothesis concerns the relationship between green transformational leadership and workplace pro-environment behaviour. the idealized influence, one of the components of transformational leadership, is likely to be the driving force in this relationship. idealized influence means the leaders can build trust with followers and make followers become valued team members. leaders themselves are role models for followers. previous studies have found that green transformational leadership has a positive impact on social aspects such as green work engagement (gustiah & nurhayati, 2022) and green team resilience (çop et al., 2021). social norms and relationships are key determinants of workplace pro-environment behaviour (banwo & du, 2019; czajkowski et al., 2017). in addition, by using a focus group, arsanti et al. (2021) have found that the position, status, and power of a leader positively influence subordinates’ pro-environment bheavior. therefore, the first hypothesis is: h1: a positive relationship exists between green transformational leadership and workplace pro-environment behavior. patarawadee tongsoongnern, wing shing lee 95 on the other hand, green transformational leadership can also have a positive impact on green mindfulness. mindfulness is considered to be a condition for an individual's awareness of environmental context and information (blok, 2018). furthermore, green mindfulness activities depend on the shared vision of the organization. here, it is proposed that green transformational leadership can increase followers' environmental awareness through a shared vision initiated by the leader. the inspirational motivation factor of transformational leadership helps to introduce new ideas by conveying inspiration, rational motivation and image (mumford, 2000). an inspiring vision presents an impressive picture of future goal achievement and motivates followers to achieve the goal (arendt, 2009). followers will then be able to view their work in a mindful context (gioia & chittipeddi, 1991; vogus & sutcliffe, 2012), and contextual awareness is a major component of green mindfulness. therefore, transformational leadership is likely to have a positive influence on mindfulness (madsen, desai, roberts, & wong, 2006). previous studies (chen & lai, 2014; zafar et al., 2017) did find a positive correlation between green transformational leadership and green mindfulness through questionnaire surveys. accordingly, the following hypothesis is proposed: h2: a positive relationship exists between green transformational leadership and green mindfulness. mindfulness includes five elements: openness to novelty, sensitivity to different contexts, alertness to distinction, orientation to the present moment, and awareness of multiple perspectives (langer, 2016). these five elements can significantly promote workplace proenvironment behaviors (langer, 2016). for example, openness to novelty may help employees to adopt new procedures to reduce waste. other elements, such as attention to new stimuli, sensitive interpretation of different contexts, appreciation for a different perspective, and extended scanning (fiol and o'connor, 2003) may be associated with pro-environment behaviors in the workplace. once followers understand their work in a more important context through different perspectives, they become fully committed to their work, and this engagement benefits environmental behavior in the workplace (friedman & förster, 2001). moreover, mindfulness may enhance employees’ problem-solving and communication skills, as well as maintain their concentration. all of these qualities may also contribute to enhancing environmental behavior (davis, 1993). therefore, green mindfulness can positively contribute to workplace pro-environment behavior (friedman & förster, 2001). empirical evidence provides support that mindfulness can lead to certain green outcomes. geiger et al. (2018) have found an indirect relationship between mindful awareness and ecological behavior. amel et al. (2009) reported a positive relationship between mindfulness and sustainable behaviour. thus, the third hypothesis is: h3: a positive relationship exists between green mindfulness and workplace pro-environment behavior. workplace pro-environment behavior depends on employees' ability to take responsibility and support decision-making (fiol & o'connor, 2003). green mindfulness can help reduce the complexity of the decision-making process by focusing on the present moment and awareness of multiple perspectives. previous research has shown that mindfulness can positively impact creative thinking and learning (langer, 2016), as it can help build open-mindedness, commitment, and resilience in workplace pro-environment behaviors (kirkpatrick & locke, 1996). therefore, green mindfulness may mediate between green transformational leadership and workplace pro-environment behaviors. in other words, workplace pro-environment behavior is not only directly influenced by green transformational leadership, but also indirectly through green mindfulness as the mediator. the fourth hypothesis is proposed as follows: h4: green transformational leadership has an indirect effect on workplace pro-environment behavior through green mindfulness as the mediator. 96 economic analysis (2022, vol. 55, no. 2, 91-106) next, a positive relationship between green transformational leadership and green selfefficacy is proposed. in general, self-efficacy is referred to as the effectiveness of performing specific behaviors and actions to achieve goals (chen, chang, yeh, & cheng, 2015). transformational leaders are good at inspiring others to pursue the vision (ackoff, 1999). they actively communicate with their followers, trust them, and guide them to achieve their goals. furthermore, transformational leaders can bring out ideas and trust so followers can successfully overcome challenges (bass, 1998). transformational leadership, through positive perceptions and communications, influences followers' self-efficacy (kirkpatrick and locke, 1996; bandura et al., 1999), making them believe in their ability to achieve their goals. previous studies (chen & lai, 2014; zafar et al., 2017) did find a positive correlation between green transformational leadership and green self-efficacy through questionnaire survey methods. the fifth hypothesis is thus formed as follows: h5: a positive relationship exists between green transformational leadership and green selfefficacy. self-efficacy refers to people’s beliefs about their ability to achieve a specified level of performance (bandura et al., 1999). individuals who are high in self-efficacy are more engaged, persistent, and committed to achieving their goals (bandura, 1994; bandura et al., 1999; schunk, 1995). they tend to think positively, set effective goals, and regulate themselves skillfully (bandura et al., 1999; zimmerman & bandura, 1994). they are also confident in their ability to create new ideas. past research has reported a positive relationship between self-efficacy and workplace behavior (hsiao, tu, chang, & chen, 2011; kumar & uzkurt, 2011; mumford, 2000). sharma and dayal (2016) found through a survey method that green self-efficacy is positively correlated with green purchase intentions, which in turn are related to workplace proenvironment behavior. therefore, the sixth hypothesis is: h6: a positive relationship exists between green self-efficacy and workplace pro-environment behavior. by combining h5 and h6, green self-efficacy mediates between green transformational leadership and workplace pro-environment behavior. by sharing vision, inspiring confidence, and building trust with followers, green transformational leadership increases followers' selfefficacy. as followers increase their self-efficacy, they will become more engaged and committed to environmental behaviors in the workplace. a study has found that self-efficacy is positively associated with ethical behavior, such as responsible purchases and dispositions (song & kim, 2018). therefore, the final hypothesis is: h7: green transformational leadership has an indirect effect on workplace pro-environment behavior through green self-efficacy as the mediator all hypotheses are now summarized in figure 1. data and methodology sample collection the questionnaire was distributed to the employees of the electricity authority of thailand. respondents evaluated the statements from the questionnaire using the 5-point likert scale (1 strongly disagree; 5 – strongly agree). the total sample consists of 163 respondents. an overview of the demographic structure of the respondents is presented in table 1. patarawadee tongsoongnern, wing shing lee 97 figure 1: framework of the hypotheses source: authors table 1. demographic structure of respondents number of respondents percentage of respondents gender male 81 49.7 female 82 50.3 total 163 100.0 age less than 20 6 3.7 21-30 57 35.0 31-40 37 22.7 41-50 27 16.6 above 50 36 22.0 total 163 100.0 education high school/diploma 7 4.3 bachelor 99 60.7 postgraduate 57 35.0 total 163 100.0 working experience less than 2 years 35 21.5 more than 2 years 128 78.5 total 163 100.0 position officer 100 61.3 senior manager 47 28.9 director 16 9.8 total 163 100.0 source: authors participants in this study included 163 employees (82 women; 81 men) from the electricity authority of thailand. their positions ranged from junior officers (100) to senior managers (47) and directors (16). their education backgrounds include 35% postgraduates, 60% graduates, and the rest own a diploma or high-school qualifications. about 80% of them worked for more than two years, and the rest for less than two years. measures green transformational leadership the six-items scale developed by chen and chang (2013) was adopted here. a sample question included “the leader of the green innovation project provides a clear environmental green self-efficacy h5 h6 workplace proenvironment behavior h1 h3 green transformational leadership green mindfulness h2 h4 h7 98 economic analysis (2022, vol. 55, no. 2, 91-106) vision for the project members to follow”. the measurement for the latent variable of green transformational leadership is: 𝐺𝐺𝑇𝑇𝐺𝐺𝑚𝑚 = 𝜆𝜆𝑚𝑚1𝐺𝐺𝑇𝑇𝐺𝐺 + 𝛿𝛿𝑚𝑚1 (1) where 𝐺𝐺𝑇𝑇𝐺𝐺𝑚𝑚 are the six items of measurement (i = 1,…,6) of the latent variable green transformational leadership (𝐺𝐺𝑇𝑇𝐺𝐺), 𝜆𝜆𝑚𝑚1 are the factor loadings and 𝛿𝛿𝑚𝑚1 are the errors of measurement. workplace pro-environment behavior three items of the daily task-related pro-environment behavior from bissing-olson, iyer, fielding, and zacher (2013) were used. an example is, “today, i fulfilled responsibilities specified in my job description in environmental protection at work.” the measurement for the latent variable of workplace pro-environment behavior is: 𝑊𝑊𝑊𝑊𝑊𝑊𝑚𝑚 = 𝜆𝜆𝑚𝑚4𝑊𝑊𝑊𝑊𝑊𝑊 + 𝜀𝜀𝑚𝑚4 (2) where 𝑊𝑊𝑊𝑊𝑊𝑊𝑚𝑚 are the three items of measurement (i = 1,…,3) of the latent variable workplace pro-environment behavior (𝑊𝑊𝑊𝑊𝑊𝑊), 𝜆𝜆𝑚𝑚4 are the factor loadings, and 𝜀𝜀𝑚𝑚4 are the errors of measurement. green mindfulness green mindfulness is referred to the scale used by chen et al. (2015). the scale has five items. a sample question included “the members of the green innovation project feel free to discuss environmental issues and problems”. the measurement for the latent variable of green mindfulness is: 𝐺𝐺𝐺𝐺𝑚𝑚 = 𝜆𝜆𝑚𝑚3𝐺𝐺𝐺𝐺 + 𝜀𝜀𝑚𝑚3 (3) where 𝐺𝐺𝐺𝐺𝑚𝑚 are the five items of measurement (i = 1,…,5) of the latent variable green mindfulness (𝐺𝐺𝐺𝐺), 𝜆𝜆𝑚𝑚3 are the factor loadings, and 𝜀𝜀𝑚𝑚3 are the errors of measurement. green self-efficacy this measure is also adopted from chen et al. (2015). there are six items. a sample item states: “we feel competent to deal effectively with environmental tasks”. the measurement for the latent variable of green self-efficacy is: 𝐺𝐺𝑆𝑆𝑚𝑚 = 𝜆𝜆𝑚𝑚2𝐺𝐺𝑆𝑆 + 𝜀𝜀𝑚𝑚2 (4) where 𝐺𝐺𝑆𝑆𝑚𝑚 are the six items of measurement (i = 1,…,6) of the latent variable green self-efficacy (𝐺𝐺𝑆𝑆), 𝜆𝜆𝑚𝑚2 are the factor loadings, and 𝜀𝜀𝑚𝑚2 are the errors of measurement. data analysis empirical research was conducted by survey method. reliability analysis was applied to measure the internal consistency between the items of measurement and cronbach’s alpha patarawadee tongsoongnern, wing shing lee 99 coefficient was used. the measurement model combines the four equations (1) – (4) above. the structural model includes the following regressions: 𝑊𝑊𝑊𝑊𝑊𝑊 = 𝛽𝛽43𝐺𝐺𝐺𝐺 + 𝛽𝛽42𝐺𝐺𝑆𝑆 + 𝛾𝛾41𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁1 𝐺𝐺𝑆𝑆 = 𝛾𝛾21𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁2 𝐺𝐺𝐺𝐺 = 𝛾𝛾31𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁3 where 𝛾𝛾𝑠𝑠 and 𝛽𝛽𝑠𝑠are regression paths, and 𝜁𝜁𝑠𝑠 are residual errors. structural equation modeling (using lavaan package in rstudio v.1.2.1335) was used to analyze both the measurement model and the structure model. measurement model was evaluated by reliability, discriminant validity and convergent validity. structural model was evaluated by multiple fitness indicators. results and discussion the measurement model the correlations between the four latent variables and their means and standard deviations are shown in table 2. positive correlations were found between all four latent variables. table 2. means, standard deviations and correlations of the latent variables. latent variables mean s.d. a. b. c. a green transformational leadership (gtl) 1.626 0.439 b workplace pro-environment behaviour (wpb) 1.888 0.584 0.53** c green mindfulness (gm) 1.724 0.443 0.54** 0.54** d green self-efficacy (gs) 1.687 0.485 0.53** 0.45** 0.66** note: ** p < 0.01 source: authors table 3 describes the results of the measurement model. all factor loadings of the latent variables are significant. cronbach's alpha coefficients are all above the minimum requirement of 0.7, which indicates the reliability of the measurements is acceptable. discriminant and convergent validity are then tested. discriminant validity was satisfied by comparing the correlations between the latent variables and the square roots of average variance extracted (ave). the former should be smaller than the latter. table 2 shows that the aves for the constructs ranged from 0.728 to 0.733, greater than all correlations shown in table 1 (ranging from 0.45 to 0.66). therefore, discriminant validity is acceptable. second, the convergent validity was also satisfactory, as the aves for all four constructs were higher than 0.5. 100 economic analysis (2022, vol. 55, no. 2, 91-106) table 3. the items’ factor loadings (λ), the reliability, and the average variance extracted (ave) latent variables items factor loading (λ) reliability (cronbach’s αlpha) ave √𝑨𝑨𝑨𝑨𝑨𝑨 green transformational leadership (gtl) gtl1 0.641 0.87 0.535 0.731 gtl2 0.712 ** gtl3 0.747 ** gtl4 0.758 ** gtl5 0.763 ** gtl6 0.738 ** workplace pro-environment behavior (wpb) wpb1 0.650 0.78 0.537 0.733 wpb2 0.777 ** wpb3 0.780 ** green mindfulness (gm) gm1 0.724 0.87 0.533 0.730 gm2 0.808 ** gm3 0.762 ** gm4 0.688 ** gm5 0.675 ** gm6 0.719 ** green self-efficacy (gs) gs1 0.701 0.87 0.530 0.728 gs2 0.753 ** gs3 0.667 ** gs4 0.762 ** gs5 0.744 ** gs6 0.740 ** source: authors the structural model the structural model was then tested. table 4 shows the results and figure 2 shows the path diagram. the overall fitness of the model is acceptable (χ2 (184) = 324.38, p < .01; cfi = 0.917; rmsea = 0.068; srmr = 0.085). the only path that is not significant is the one between green self-efficacy and workplace pro-environment behavior. it means all the hypotheses are supported except the two related to green self-efficacy, namely h6 and h7. nonetheless, it is found that the fitness of the model could be improved by making some alterations to the framework. a path to connecting green self-efficacy to green mindfulness was added and the improvement in fitness is significant. (χ2 (183) = 283.27, p < .01; cfi = 0.941; rmsea = 0.058; srmr = 0.051). the revised structural model includes the following regressions: 𝑊𝑊𝑊𝑊𝑊𝑊 = 𝛽𝛽43𝐺𝐺𝐺𝐺 + 𝛾𝛾41𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁1 𝐺𝐺𝑆𝑆 = 𝛾𝛾21𝐺𝐺𝑇𝑇𝐺𝐺 + 𝜁𝜁2 𝐺𝐺𝐺𝐺 = 𝛾𝛾31𝐺𝐺𝑇𝑇𝐺𝐺 + 𝛽𝛽32𝐺𝐺𝑆𝑆 + 𝜁𝜁3 where 𝛾𝛾𝑠𝑠 and 𝛽𝛽𝑠𝑠are regression paths, and 𝜁𝜁𝑠𝑠 are residual errors. table 5 shows the results and figure 3 shows the path diagram of the revised framework. overall, the revised framework shows that green transformational leadership directly influenced workplace pro-environment behavior. moreover, it also indirectly influenced the latter through green mindfulness. in addition, green transformational leadership has a direct impact on both green mindfulness and green efficacy. patarawadee tongsoongnern, wing shing lee 101 table 4. the results of structural equation modeling for the proposed framework regression path coefficient z-value sig value standardized path estimate wpb -> gm 0.483 3.242 0.001 0.389 ** gs 0.059 0.484 0.628 0.053 gtl 0.550 2.473 0.013 0.368* gm -> gtl 0.813 6.145 0.000 0.676** gs -> gtl 0.897 5.990 0.000 0.666** goodness of fit statistics chi-square χ2 (184) = 324.38, p < .01 comparative fit index (cfi) 0.917 rmsea 0.068 srmr 0.085 note: ** level of significance 0.01; * level of significance 0.05 source: authors figure 2. path diagram for the proposed framework source: authors table 5. the results of structural equation modeling for the revised framework regression path coefficient z-value sig value standardized path estimate wpb -> gm 0.550 3.874 0.000 0.444 ** gtl 0.547 3.244 0.001 0.367** gm -> gs 0.543 5.531 0.000 0.605** gtl 0.305 2.750 0.006 0.254** gs -> gtl 0.821 5.683 0.000 0.614** goodness of fit statistics chi-square χ2 (184) = 283.27, p < .01 comparative fit index (cfi) 0.941 rmsea 0.058 srmr 0.051 note: ** level of significance 0.01; source: authors 0.368* 0.676** 0.389** 0.053 0.666** workplace proenvironment behavior green mindfulness green transformational leadership green self-efficacy 102 economic analysis (2022, vol. 55, no. 2, 91-106) figure 3. path diagram for the revised framework source: authors discussion regarding the first research question on whether transformational leadership has a direct effect on workplace pro-environment behavior and an indirect effect through green mindfulness, the results are affirmative. for the second question, the results did not support the indirect effect of self-efficacy. rather, their relationship is more complex. there is no direct relationship between green self-efficacy and workplace pro-environment behavior. the only effect on green self-efficacy is that it is positively related to green mindfulness. according to the results, green transformational leadership is a pivotal factor in influencing workplace pro-environment behavior. green transformation leadership not only had a direct impact on the latter but also indirectly through green mindfulness. it is a surprise that green self-efficacy is not significantly related to workplace pro-environment behavior. conversely, green self-efficacy directly affected green mindfulness, which in turn affected workplace proenvironment behavior positively. in other words, green self-efficacy has an indirect relationship with workplace pro-environment through green mindfulness as the mediator. in fact, this finding is quite plausible. without mindfulness, even individuals with high green self-efficacy may not be aware of whether their actions are pro-environment or not. nonetheless, this relationship suggests that awareness and acceptance of the environment also depend on beliefs about one's own ability to deal with green-related issues in summary, the findings suggest that green transformational leaders can influence followers’ workplace pro-environment behavior through different pathways. first, green transformational leadership has a direct and positive impact on workplace pro-environment behavior. this is probably due to the idealizing influence of transformational leadership. leaders serve as role models for others to follow. second, green transformational leaders can also indirectly influence work pro-environment behavior by raising employees' green awareness. green mindfulness may be enhanced due to the inspiring motivation and intellectual stimulation of transformational leaders. here, leaders constantly challenge followers and constantly work with them. third, green transformational leaders act as advisors to help followers grow, thereby increasing their green self-efficacy, which further strengthens their green mindfulness. practical implications first, the findings suggest that green transformational leadership does have a direct and indirect impact on individuals' workplace pro-environment behavior. this means that green transformational leaders are able to motivate followers to adopt green behaviors at work, including actions to reduce, reuse and recycle. as noted in the revised framework, green mindfulness is also another key factor in green behavior at work. if the individual is more aware 0.254** 0.444** green mindfulness workplace proenvironment behavior green transformational leadership green self-efficacy 0.614** 0.605** 0.367** patarawadee tongsoongnern, wing shing lee 103 of the issue or embraces environmental protection, then the individual's work will be more proenvironment. since green mindfulness is also related to the shared vision of the organization, an approach that clearly communicates the vision is recommended. therefore, if organizations want to motivate their employees to work green, they should first consider the feasibility of green transformational leadership. second, they should also contemplate the enhancement of green mindfulness among staff. conclusion this study supports the argument that green transformational leadership directly and indirectly affects workplace pro-environment behavior, whereas the indirect effect comes from green mindfulness. on the other hand, contrary to the initial predictions, green self-efficacy did not serve such a mediating role. in fact, green self-efficacy and workplace pro-environment behavior have no direct relationship. rather, the relationship is mediated through green mindfulness. this highlights the importance of green mindfulness in workplace proenvironment behavior. in other words, an individual's behavior will be pro-environment only when the individual is mindful of the environment. overall, this study shows that green transformational leadership and green mindfulness are two critical forces in contributing to workplace pro-environment behavior. a limitation of this study is that the sample was limited to one organization in thailand. nonetheless, it contributes to the literature as research on green transformational leadership in thailand is rare. in addition, companies in thailand are under pressure to engage in environmental activities to secure overseas capital. this study could serve as a starting point for future research. 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(2000). the term structure of very short-term rates: new evidence for the expectations hypothesis. journal of financial economics, 58(3), 397-415. covid-19 and serbian stock market response: a panel data approach bojan đorđević1 | sunčica stanković14f* introduction literature review research methodology research methods results of econometric tests conclusion references the quest towards obtaining a competitive advantage in organizations through managing the human capital nikaela wilson1* | iva vuksanović herceg25f* introduction the concept of human capital, elements and approaches for achieving competitive advantage in organizations human capital elements for achieving competitive advantage in organizations employees’ natural and personal skills employees’ commitment employees’ knowledge employees’ innovative skills intellectual capital and competitive advantage the two common types of competitive advantage the resource base perspective to achieve competitive advantage approaches based on the theory of human capital competitive advantage and managing human capital industry 4.0 and human capital in achieving competitive advantage concluding comments does the increase in the number of registered patents affect economic growth? evidence from romania and bulgaria ivana domazet16f* | darko marjanović1 | deniz ahmetagić2 | marija antonijević1 introduction literature review data analysis and findings conclusion acknowledgements references business process innovation of serbian entrepreneurial firms mihailo paunović1 | marija lazarević-moravčević1 | marija mosurović ružičić17f* introduction theoretical background data and methodology results and discussion conclusion acknowledgements references key features and challenges of the china-western balkan countries merchandise trade development elena jovičić18f* | danijela stojanović1 introduction theoretical background results and discussions trade intensity index development main challenges hampering the trade relations enhancement recommendations for the overwhelming of key obstacles conclusion acknowledgements references influence of green transformational leadership on the workplace pro-environment behavior: a case study of a large energy company in thailand patarawadee tongsoongnern1 | wing shing lee29f* introduction literature review green transformational leadership workplace pro-environmental behavior green mindfulness green self-efficacy hypotheses development data and methodology sample collection measures green transformational leadership workplace pro-environment behavior green mindfulness green self-efficacy data analysis results and discussion the measurement model the structural model discussion practical implications conclusion references ea_2014_3-4 note oft he editor-in-chief the concept of the journal is such that it gives the advantage to multidisciplinary approach to various subjects. it also emphasizes publishing of the scientific papers, which have an empirical and a research character. however, there is also the place in the journal for quality theoretical papers as well, reviews of the latest publications of national and international significance and scientific critiques and discussions. all papers are subjected to anonymous review, and the authors are notified of its outcome within one month. papers are sent in via e-mail to the address of the redaction. the potential authors are advised not to send the papers which are not laid out according to the technical instructions for writing the papers. such papers will not be taken into consideration for publishing. besides this, we insist on language correctness and a professional translation to english language. any manuscript submitted to the journals must not already have been published in another journal or be under consideration by any other journal. the journal does not have page charges or submission fees. prof. dr. mirjana radović-marković, european academy of sciences and arts (easa), salzburg,austria academia europea (ea), london, united kingdom world academy of art and science (waas), united states royal society of arts (rsa), london, united kingdom bulgarian academy of science and arts (basa), sofia, bulgaria editor in chief doi: 10.28934/ea.23.56.1.pp43-56 first online: may 12, 2023 original scientific paper exploring the economy – environment interactions in the western balkans: a panel data analysis petar mitić13f* | aleksandra fedajev2 | milena kojić1 1 institute of economic sciences, department for environmental economics, belgrade, serbia 2 the university of belgrade, technical faculty in bor, bor, serbia abstract in order to balance economic growth with environmental preservation, the implementation of sustainable policies is necessary. as such, it is imperative to have a comprehensive understanding of the intricate relationship between the economy and the environment. this study examines the relationship between co2 emissions and gdp per capita in five wb countries during 1960-2018, using a methodological framework that includes panel unit root testing, cointegration testing, and a vector error correction model. the study provides robust evidence of a long-term cointegration between co2 emissions and gdp per capita. furthermore, the study also reveals a short-run bidirectional causal relationship between co2 emissions and gdp per capita. in the long run, no statistically significant causality exists from gdp per capita to co2 emissions, but it is statistically significant from co2 emissions to gdp per capita. these findings offer valuable insights for policymakers to develop comprehensive policies that promote economic growth and environmental sustainability, such as investing in clean energy, implementing stronger environmental regulations, and encouraging environmentally sound management practices. keywords: economic growth, co2 emissions, wbs, panel causality, sustainability jel classification: c33, o13, q56 introduction threats of global warming have steadily grown in recent years. the european union (eu) has emphasized the need for climate change mitigation measures and has set ambitious targets for reducing greenhouse gas (ghg) emissions (skjærseth, 2021; dolge & blumberga, 2021). including the western balkan (wb) countries in the european green deal strategy and guiding the area toward 2030 and 2050 climate neutrality goals with eu money and support could expedite the region’s transformation. as a strategy that the eu and the wb will jointly implement, the green agenda can increase chances for successfully implementing climate-neutral policies and create more economically feasible scenarios for fast reductions in ghg emissions only in the short term. for long-term success, it is critical that neighboring countries also take significant environmental action. only in this way will the green deal agenda be entirely successful (ćetković et al., 2021). as “going green” becomes inevitable for both individuals and organizations (tongsoongnern & lee, 2022), transitioning to a “green” growth path remains challenging, particularly in the short * corresponding author, e-mail: petar.mitic@ien.bg.ac.rs 44 economic analysis (2023, vol. 56, no. 1, 43-56) term, due to the reluctance of wbs to abandon traditional “brown” sectors, skills, employment, market infrastructure, and established value chains. accelerated structural reforms must be carried out alongside a rational economic policy to attain sustainable economic growth (marjanović et al., 2021). although the carbon intensity of economic growth has decreased in recent years, it is still many times higher than in the eu (world bank, 2022). in 2018, the wb produced about 100 mt of co2 emissions from combustion and fossil fuel operations, accounting for nearly 3% of eu co2 emissions that year. although there were many changes during those years, and energy consumption altered due to political changes in the wb nations, this value is similar to 1990. co2 emissions in the region were 8.7% lower in 2018 than in 1990 (banja et al., 2020). however, the actions aimed at reducing pollution affect economic growth rates, which are already very low or even negative during the past few years (matić et al., 2022). after a severe economic downturn caused by the covid-19 pandemic (kisin et al., 2021), the wb countries are reconsidering their long-term growth and development strategies. they are at the crossroads of their future development path where they should decide if their development should be based on a “brown” recovery (which means employing existing manufacturing methods and benefiting from low costs of coal and labor and foreign direct investments inflow) or fundamentally change their economy to a “green” growth model. although the traditional “brown” industries require minor adjustments to crisis conditions, they are accompanied by high economic and environmental costs. on the other hand, “green” growth is not easy to achieve, and its benefits are not so apparent in the short term, especially as fiscal space has narrowed and the higher debt burden imposed by the crisis has limited the actions and funds available to governments when it comes to significant investments. nevertheless, continuing with the traditional “brown” growth will make long-term economic growth and development unsustainable (world bank, 2021). given the doubts about future development strategies, there is significant relevance to researching the interdependencies between environmental degradation and economic growth for the wb countries. such research can assist the wbs in achieving long-term economic recovery while also satisfying environmental goals, thereby promoting economic growth and development. in particular, investigating these interdependencies in the wb region is significant as it has not been extensively studied in previous research. as these goals are typically viewed as opposing in wb countries, understanding the link between them may also have relevance for the eu when these countries join the union. the research examines how co2 emissions and gdp per capita are related in five countries of the world bank. the study uses panel data analysis, which involves conducting tests for crosssectional dependence, unit root, cointegration, and granger causality and constructing a vector error correction model. this approach allows for investigating the link between economic growth and environmental degradation. the paper is organized as follows. section 2 presents a literature review of the relationships between economic and environmental indicators and their implications for developing countries, including the critical economic and environmental prerequisites for the balanced growth of wbs. section 3 describes the methodology for analyzing the relationship between economic growth and environmental degradation using panel data. section 4 presents the main research results. section 5 discusses obtained results in the wbs, including policy implications of derived findings. finally, section 6 concludes the paper while contributing to the ongoing debate about the relationship between economic growth and environmental quality in the wb region. literature review it is crucial to understand the relationship between economic growth and environmental deterioration to ensure the long-term sustainability of economic development. although economic growth can improve living standards and expand access to resources, it frequently petar mitić, aleksandra fedajev, milena kojić 45 harms the environment, leading to deforestation, air and water pollution, and climate change. researchers from many fields, including economics, environmental science, and ecology, have thoroughly examined this relationship using statistical analyses, case studies, and modeling approaches. their findings have highlighted the complexity of this relationship and helped shape policies and strategies for fostering sustainable economic growth and reducing environmental damage. this literature review section provides a brief overview of the extensive scientific research on this topic and the insights gained from it. the environmental kuznets curve (ekc) is possibly the most prominent theory when analyzing economic growth and environmental degradation at country, regional, and group of countries levels. ekc theory suggests that environmental degradation initially increases as a country experiences economic growth and industrialization but eventually declines once a certain level of economic development is reached. this theory assumes that as a country gains additional wealth, it has the resources to invest in environmental protection measures and shift towards cleaner technologies. the validity of the ekc hypothesis has been extensively examined in various studies using panel data and time series methods. panel data studies conducted by apergis & ozturk (2015), ummalla & goyari (2020), and pata et al. (2022) support the presence of the ekc, while time series studies for individual countries by sarkodie & ozturk (2020), suki et al. (2020), jiang et al. (2021), jahanger et al. (2022), and voumik et al. (2022) also confirm its existence. however, some research suggests that environmental degradation continues to persist even at higher levels of economic growth, as shown in panel studies by özokcu & özdemir (2017) and hussain & dogan (2021) and individual countries studies by ozturk & acaravci (2010), yilanci & pata (2020), and villanthenkodath et al. (2021). additionally, some studies provide conflicting evidence depending on the variable selection, such as those conducted by aung et al. (2017), mrabet & alsamara (2017), and ansari (2022). overall, the ekc remains contested, and further research is valuable to clarify its existence and validity. achieving both goals – increasing economic growth and pollution mitigation is especially challenging for developing and transition countries like wbs. adedoyin et al. (2020) analyzed the relationship between energy production and co2 emissions in three groups of countries from 1992 to 2014: central and eastern europe (cee), the commonwealth of independent states (cis), and new member states (nms). according to the empirical findings, a 1% increase in renewable energy production causes co2 emissions to rise by 0.04% and 0.02% in cis and cee countries but fall by 0.02% in nms countries. mitić et al. (2023) researched the situation in eight south-eastern european countries and found a short-run bidirectional causality between co2 emissions and employment and between available energy and employment. the long-run causal relationship results suggest that co2 emissions, gdp, and employment could significantly affect the system’s adjustment process as it departs from long-run equilibrium. mitić et al. (2017) used cointegration analysis to investigate a link between gdp and co2 emissions in transition economies. according to the recommendations given in this study, transition economies should follow global initiatives and adopt new processes and tools to control and restrict co2 emissions if they want to minimize co2 emissions while maintaining sufficient gdp growth. furthermore, arndt et al. (2017) emphasized that including developing countries in any successful global mitigation program is justified, given the level of existing emissions from developing countries and their high growth rates. the wb countries are still establishing and enhancing the appropriate legislative framework and strategies for climate change mitigation. furthermore, the implementation of these frameworks and strategies is still insufficient. the adoption strategy must involve transitioning to power plants using cleaner energy sources and identifying concrete economic policy goals and government support measures (knez et al., 2022). it should be noted that the application of the eu acquis on environment and climate in wb countries varies. it ranges from the basic stages of implementation to more advanced ones (banja et al., 2020). 46 economic analysis (2023, vol. 56, no. 1, 43-56) considering the significant challenges to long-term development prospects, it will be necessary for wb economies to undertake fundamental reforms and boost economic transformation. the financial sector can help to ease this transformation. unfortunately, green finance has fallen short of the needed size and scope internationally and notably in the wbs (world bank, 2022). besides financial sector weaknesses, the institutional environment is still not sufficiently developed to enable a smooth transition to green growth. the wbs have been through a difficult economic and political upheaval during the previous 30 years. following the chaotic and conflict-ridden 1990s, which had many adverse political and economic effects, the wbs region had an economic recovery at the beginning of the new century. economic growth trends and transition processes in economies of this region have resulted in a need for additional energy, requiring upgrades to the entire energy supply system. one of the fundamental characteristics of all the countries in the region is their reliance on solid fossil fuels, primarily coal, as an energy source while simultaneously being heavily reliant on oil, coal, and natural gas imports (dunjic et al., 2016). the energy sector, particularly coal, produces the most pollution. on the other side, there is a scarcity of mechanisms for monitoring, reporting, and verifying greenhouse gas emissions (berishaj, 2021). recent decades’ political and economic changes significantly impacted the energy supply of individual wb countries. except for albania, all countries were part of a single energy system before gaining independence. most wb countries inherited their energy infrastructure (for example, for oil, gas, and electricity) from the socialist federal republic of yugoslavia (sfry), where most of the production units were outdated, requiring rebuilding and efficiency improvements (lalic, 2011). consequently, one of the key characteristics of the wbs’ energy systems is their low energy efficiency, primarily reflected in power distribution energy losses (sanfey et al., 2016). the inadequately maintained and outdated energy infrastructure resulted in significantly greater energy intensity than the eu average. the primary underlying reasons for excessive air pollution in the region are capacity limits and governance challenges in implementing comprehensive, cross-sectoral air quality control initiatives. common issues include unsuitable regulations, insufficient enforcement of laws, and technological capacity shortages, such as incomplete emissions inventories and a lack of adequate air quality monitoring. furthermore, a country’s low institutional capability, mainly vertical and horizontal institutional coordination, poses a challenge to responding adequately when air pollution affects many sectors (kikoni & schiffbauer, 2020). typically, air pollutants generated mainly through human activities such as industry (including energy production), domestic heating, and transportation exceed the country’s standards. meanwhile, the wb countries’ primary sources of ghg are energy and transportation (banja et al., 2020). the mitigation of air pollution resulting from increased economic growth, especially industrial activities, will not be possible without switching to renewable energy sources (res) in producing energy. countries in the wbs have considerable renewable energy potential. in their long-term policies, many of them have set ambitious sectorial res targets. nevertheless, there is a huge disparity between these goals and the actual outcomes. although renewables provide numerous benefits acknowledged globally, the penetration of res into global and local energy markets remains limited (đurašković et al., 2021). due to numerous economic, environmental, political, and institutional challenges faced by wbs, it is necessary to intensify research in this area. it is crucial to consider the similarities of wbs but also the specificities of each country within the region to respond adequately to inherited problems and prospects. in this regard, this research is one of the necessary steps in this direction and should motivate more authors to focus their research on this region. petar mitić, aleksandra fedajev, milena kojić 47 data and methodology the study uses gdp and co2 emissions data for five wb countries: albania, bosnia and herzegovina, montenegro, north macedonia, and serbia. the data span a period from 1960 to 2018. the real gdp per capita data was obtained from the maddison project database 2020 and used as a measure of economic growth (jutta & van zanden, 2020). the data for co2 emissions per capita were obtained from the global carbon atlas, a widely recognized source for co2 emissions data (global carbon atlas, 2022; friedlingstein et al., 2022; andrew & peters, 2021; un, 2019). it is important to note that the data for the time frame between 1960 and 1995 are approximations for all countries except albania. this is because, during this period, all countries except albania were a part of the socialist federative republic of yugoslavia (sfry), and reliable data for each country is unavailable. therefore, the data estimates were done ex-post using available information. both data sets were collected for the same countries and periods, allowing for an analysis of the relationship between economic growth and environmental quality in the wbs. the econometric analysis in this research is based on the methodology framework presented in figure 1. figure 1. methodology framework source: authors. the first methodology framework step is to conduct cross-sectional dependence tests. these tests are vital diagnostics before estimating any panel data models. the presence or lack of crosssectional dependency dictates the next methodological step. if cross-sectional dependence is detected in the data, additional analysis processes must be conducted to account for it. only a few cross-sectional reliance tests are available to identify the cross-sectional dependency issue (see table 1 for a summary). 48 economic analysis (2023, vol. 56, no. 1, 43-56) table 1. residual cross-section dependence test test test application breusch and pagan (1980) lm test panels with a small number of cross-section units. pesaran (2004) scaled lm panels with a large number of cross-sectional units and large time dimensions. pesaran (2004) cd test panels with a small number of cross-sectional units and small-time dimensions. baltagi et al. (2012) bias-corrected scaled lm test panels with a large number of cross-sections and small-time dimensions. source: authors. if the panel dataset consists of a small number of cross-section units, then the breusch and pagan (1980) lm test is the most reliable choice. if the panel dataset consists of many crosssection units, then the better choice is the pesaran (2004) scaled lm test, a standardized version of the lm test. pesaran’s (2004) cd test is the most appropriate if the panel dataset consists of small cross-sections and time dimensions. finally, for panel datasets with panels with large crosssections and small-time dimensions, the best choice is bias correction for the scaled lm test proposed by baltagi et al. (2012). the null hypothesis in these tests is “there is no cross-sectional dependence in the data.” we used all four tests to look for any cross-sectional dependence between the time series in the research to confirm the accuracy of the findings. since the results demonstrated the absence of cross-sectional dependence (see results section), panel unit root tests of the first generation have been applied. the order of cointegration is determined through five-panel unit root tests: levin, lin & chu (levin et al., 2002), breitung (breitung, 2001), im, pesaran, and shin (im et al., 2003), fisher-adf (maddala & wu, 1999) and fisher-pp (choi, 2001) tests. the existence of a unit root is the null hypothesis for each of the five tests, as opposed to the alternative hypothesis that there is not one. each test is applied to logarithm transformations of the time series at the level and then at first difference. once the panel unit root tests have been applied, the next methodological step is to apply the johansen-fisher panel cointegration maximum likelihood-based test (johansen, 1988; johansen, 1995). the proof that the time series are all not stationary at level is sufficient for examining the cointegration and the long-run relationship between the variables. the johansen-fisher panel cointegration test is based on johansen’s methodology and maximum eigenvalue. the initial point is a vector autoregression (var) of the order of 𝑝𝑝 𝑦𝑦𝑡𝑡 = 𝜇𝜇 + �𝐴𝐴𝑖𝑖𝑦𝑦𝑖𝑖−1 + 𝜖𝜖𝑡𝑡, 𝑝𝑝 𝑖𝑖=1 (1) where 𝑦𝑦𝑡𝑡 is an 𝑛𝑛 × 1 vector of variables integrated of order one 𝐼𝐼(1) variables, 𝐴𝐴 is an autoregressive matrix, 𝜇𝜇 is intercept and 𝜖𝜖𝑡𝑡 is an 𝑛𝑛 × 1 vector of innovations. the model can be rewritten as δ𝑦𝑦𝑡𝑡 = 𝜇𝜇 + πyt−1 + �γ𝑖𝑖δ𝑦𝑦𝑖𝑖−1 + 𝜖𝜖𝑡𝑡 , 𝑝𝑝−1 𝑖𝑖=1 (2) where π = ∑ 𝐴𝐴𝑖𝑖 − i 𝑝𝑝 𝑖𝑖=1 and γ𝑖𝑖 = −∑ 𝐴𝐴𝑗𝑗 𝑝𝑝 𝑗𝑗=𝑖𝑖+1 for 𝑖𝑖 = 1, … , 𝑝𝑝. if the matrix π does not have full rank but rather reduced 𝑟𝑟 < 𝑛𝑛, then there exist two 𝑛𝑛 × 𝑟𝑟 matrices 𝛼𝛼 and 𝛽𝛽 with rank 𝑟𝑟 such that π = 𝛼𝛼𝛽𝛽′, where the elements of 𝛼𝛼 are the analogous adjustment of coefficient in the vecm and 𝛽𝛽 is the matrix of parameters of the cointegrating vector. we apply the maximum eigenvalue test, which can be expressed as petar mitić, aleksandra fedajev, milena kojić 49 𝜆𝜆𝑚𝑚𝑚𝑚𝑚𝑚 = 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁(1 − 𝜆𝜆𝑟𝑟+1) (3) where 𝑁𝑁 is the length of the time series and 𝜆𝜆 denotes characteristic roots obtained from the projected matrix. the null hypothesis is that there are 𝑟𝑟 cointegration (𝑟𝑟 = 0) vectors, and the alternative hypothesis is that there are 𝑟𝑟 + 1 cointegration vectors. that is null hypothesis is that there is no cointegration among variables. the above test statistic does not follow the chi-square distribution and is based on pure unit-root assumption. if there is cointegration among variables, it means a long-run interrelationship exists among them. the following methodology step evaluates the short-run relationship of cointegrated series by estimating vector error correction model (vecm). the existence of cointegration suggests a causality relation among variables, at least in one direction. we estimate the vecm and use granger causality. dynamic panel causality test established on vecm is developed in the equations δ𝐶𝐶𝑂𝑂2,𝑡𝑡 = 𝛼𝛼𝑐𝑐 + �𝛾𝛾𝑖𝑖 𝑐𝑐 𝑚𝑚 𝑖𝑖=1 δ𝐶𝐶𝑂𝑂2,𝑡𝑡−1 + �𝛿𝛿𝑠𝑠𝑐𝑐 𝑞𝑞 𝑠𝑠=1 δ𝐺𝐺𝐺𝐺𝑃𝑃𝑖𝑖,𝑡𝑡−𝑠𝑠 + 𝜆𝜆 𝑐𝑐𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑐𝑐 + 𝑢𝑢𝑖𝑖 (4) δ𝐺𝐺𝐺𝐺𝑃𝑃𝑡𝑡 = 𝛼𝛼𝑔𝑔 + �𝛾𝛾𝑖𝑖 𝑔𝑔 𝑚𝑚 𝑖𝑖=1 δ𝐺𝐺𝐺𝐺𝑃𝑃2,𝑡𝑡−𝑖𝑖 + �𝛿𝛿𝑠𝑠 𝑔𝑔 𝑞𝑞 𝑠𝑠=1 δ𝐶𝐶𝑂𝑂2,𝑡𝑡−𝑠𝑠 + 𝜆𝜆 𝑔𝑔𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑔𝑔 + 𝑣𝑣𝑖𝑖, (5) where 𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑐𝑐,𝑔𝑔 denotes lagged residuals estimated from the long-run cointegration, 𝛾𝛾𝑖𝑖 𝑐𝑐 and 𝛿𝛿𝑠𝑠 𝑔𝑔 denote short-run adjustment coefficients, and 𝑢𝑢𝑖𝑖 and 𝑣𝑣𝑖𝑖 denote uncorrelated zero mean disturbance terms. the akaike or the schwarz information determines the optimal lag lengths 𝑚𝑚 and 𝑞𝑞. firstly, the existence of long-run causality can be reviewed by checking the significance of the speed of adjustment of the coefficients of 𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 𝑐𝑐,𝑔𝑔 that is 𝜆𝜆 𝑐𝑐,𝑔𝑔. the coefficients indicate the speed at which adjustments to deviations from the long-term equilibrium occur in response to alterations in individual variables. the statistical significance of coefficients 𝜆𝜆 𝑐𝑐,𝑔𝑔, determines the long-run relationship in the cointegrating process, and movements along this path can be deemed permanent. secondly, the statistical significance of the coefficients 𝛾𝛾𝑖𝑖 𝑐𝑐 and 𝛿𝛿𝑠𝑠 𝑔𝑔 can be interpreted as a short-run causality because the dependent variable responds only to short-term shocks to the stochastic environment. results and discussion results the breusch-pagan lm, pesaran scaled lm, bias-corrected scaled lm, and pesaran cd tests are principally conducted to detect any cross-sectional dependence among the time series. based on the results presented in table 2, the null hypothesis of no cross-sectional dependence (correlation) in weighted residuals is accepted, suggesting an absence of correlation or crosssectional dependency among the time series. 50 economic analysis (2023, vol. 56, no. 1, 43-56) table 2. residual cross-section dependence test test statistics breusch-pagan lm 2.013904 pesaran scaled lm -1.785745 bias-corrected scaled lm -1.828849 pesaran cd -0.395904 source: authors’ calculation. note: statistical significance levels are indicated as follows: *** represents significance at p < 0.001; ** represents significance between p = 0.001 and p = 0.01; * represents significance between p = 0.01 and p = 0.05. cross-section effects were removed during computation. the first generation of tests assumes that cross-sectional units are independent of each other, while the second generation tests relaxes this assumption and permits cross-sectional dependence. before conducting cointegration testing, it is crucial to establish the order of cointegration using five panel unit root tests: levin, lin & chu, breitung, im, pesaran, and shin, as well as adf-fisher and pp-fisher tests. in all five tests, the null hypothesis is that a unit root exists, with the alternative hypothesis being the absence of a unit root. the outcomes of these tests are presented in table 3. table 3. panel unit root test results variable levin, lin & chu t* level first difference co2 -0.67385 -21.8346*** gdp -0.25069 -6.65684*** breitung t-stat level first difference co2 1.05322 -15.7657*** gdp -1.48945 -8.51767*** im, pesaran and shin w-stat level first difference co2 0.47319 -18.9006*** gdp 0.23179 -7.11565*** adf fisher chi-square level first difference co2 6.19320 187.563*** gdp 8.76358 63.2753*** pp fisher chi-square level first difference co2 7.16849 189.432*** gdp 4.52145 71.9744*** source: author’s calculation. note: statistical significance levels are indicated using the following notation: *** denotes significance at p < 0.001, ** denotes significance between p = 0.001 and p = 0.01, and * denotes significance between p = 0.01 and p = 0.05. the unit root tests employed schwarz automatic selection to determine the lag length. fisher tests used an asymptotic chi-square distribution for computing probabilities, while all other tests assume asymptotic normality. the results from the five tests demonstrate that all variables are non-stationary at level but stationary when converted to first differences. at the 0.01 significance level, we fail to reject the null hypothesis of a unit root at level, but we can reject the null hypothesis of a unit root for the first difference. as such, the variables are integrated of order 1 – i(1). all tests indicate nonstationarity at level and stationarity at the first difference, prompting us to proceed with cointegration testing. petar mitić, aleksandra fedajev, milena kojić 51 therefore, table 4 displays the outcomes of the johansen fisher panel cointegration test, which reveals that there is at least one cointegrated equation, signifying that the variables are cointegrated in the long-run. according to pao & tsai (2011), confirming cointegration eliminates the possibility of spurious relationships. these results suggest that there is granger causality, at least in one direction. table 4. johansen fisher panel cointegration test results null hypothesis: variables are not cointegrated hypothesized no. of ce(s) trace maximum eigenvalue r = 0 22.02* 20.03* r ≤ 1 14.05 14.05 source: author’s calculation. note: statistical significance levels are indicated using the following notation: *** denotes significance at p < 0.001, ** denotes significance between p = 0.001 and p = 0.01, and * denotes significance between p = 0.01 and p = 0.05. the symbol r represents the number of cointegrating equations. the interval for lags is set to 1 1 (in first differences). the probabilities are computed using an asymptotic chi-square distribution. given that the johansen fisher cointegration tests confirm the existence of a long-run relationship between the variables in our model, the vector error correction approach is a viable method for estimating the cointegrating coefficients. table 5. panel causality analysis results short-run granger causality error correction δco2 δgdp ect (-1) coeff. δco2 54.25702*** -1.250434 -0.013515 δgdp 61.16536*** -3.051348** -0.016419 source: authors’ calculation. note: statistical significance levels are indicated using the following notation: *** denotes significance at p < 0.001, ** denotes significance between p = 0.001 and p = 0.01, and * denotes significance between p = 0.01 and p = 0.05. δ denotes the first difference operator, while ect (-1) represents the error correction term lagged one year. the results of a granger causality test and a vecm for the relationship between co2 emissions (δco2) and gdp per capita (δgdp) are presented in table 5. the variables are expressed as first differences (δ), implying that the analysis is performed on the changes in the variables over time. the results of the short-run granger causality test reveal a short-run causal relationship between the changes in co2 emissions and gdp per capita, as the significance level of the test (p < 0.001) indicates statistical significance. this implies that over the short run, changes in co2 emissions significantly impact changes in gdp per capita and vice versa, establishing a short-run bidirectional panel causality between co2 emissions and gdp per capita. the findings, however, imply no statistically significant long-term causality from gdp per capita to co2 emissions. the lack of a long-term causality from gdp to co2 implies there is a lack of evidence that aberrations from this relationship are corrected over time, as the error correction term (ect) for δco2 (-1.250434) is statistically non-significant. nevertheless, the non-significant ect for δco2 emissions does not necessarily suggest no long-run relationship between the two variables; therefore, this conclusion should be cautiously approached. other factors, such as the sample size, the presence of omitted variables, or measurement error, could also affect the significance of the ect. this claim is further supported by the fact that, as mentioned above, the results of the short-run granger causality test still suggest a causal relationship between δco2 and δgdp over the short run. 52 economic analysis (2023, vol. 56, no. 1, 43-56) this assertion is further strengthened by the statistically significant ect(-1) for δgdp, which points to a long-term causality from co2 emissions to gdp per capita. a decrease in co2 emissions is associated with a rise in gdp. the long-run equilibrium between the two variables is represented by the ect (-3.051348**), with the negative and statistically significant ect showing a negative adjustment mechanism to correct deviations from the long-run relationship. therefore, it might be concluded that the findings imply a long-term relationship between co2 emissions and gdp with a negative adjustment mechanism to remedy aberrations from this relationship. the scale of the ect can be used to estimate the speed of adjustment. discussion and policy implications long-term economic disruption may result from the detrimental effects of co2 emissions on the environment (such as climate change and air pollution). for instance, extreme weather events, like hurricanes, floods, and droughts, brought on by climate change can harm infrastructure, sabotage supply chains, and lower agricultural productivity. air pollution can also have health impacts on individuals, leading to more considerable healthcare costs and diminished workforce productivity. the findings of this paper have significant policy ramifications for the wb countries. initially, the cointegration results show that co2 emissions and gdp per capita have a long-term relationship, suggesting that a long-run relationship exists between the variables. this finding is significant because it emphasizes the link between environmental sustainability and economic growth in the wbs. furthermore, the granger causality test results and the vecm suggest a shortrun bidirectional causality between co2 emissions and gdp per capita. the importance of simultaneously addressing economic growth and environmental sustainability in wb countries’ policies and plans is highlighted by this finding. furthermore, the statistically significant error correction term for δgdp suggests that a longterm causal relationship exists and runs from co2 emissions gdp per capita, with a negative adjustment mechanism to correct deviations from the long-run relationship. this suggests that a decline in co2 emissions results in a rise in gdp per capita, underscoring that policies and actions to cut co2 emissions, such as improving energy efficiency, encouraging the use of green energy sources, and implementing carbon taxes, can have positive spillover effects on the economy. as shown in a recent study (đurašković et al., 2021), investing in renewable energy can have positive impacts on both employment and innovation. furthermore, improving energy efficiency can decrease production costs and increase competitiveness. these benefits can be achieved by developing and implementing energy-efficient technologies, such as smart grids and energyefficient buildings, as well as using renewable energy sources like solar and wind power. by adopting such measures, economies in the wb region can reduce their dependence on fossil fuels and mitigate the potential impact of global energy market fluctuations. in order to encourage businesses to cut their co2 emissions and embrace environmentally friendly practices, policymakers in the wbs ought to consider the complex interplay between economic growth and environmental sustainability to formulate policies that balance both objectives. investing in clean energy and green technologies through green finance (world bank, 2022), enacting stronger environmental regulations and taxes, following global initiatives in this area (mitić et al., 2017; arndt et al., 2017), and encouraging environmentally sound management techniques can help reduce pollution and protect natural resources while stimulating economic growth. by adopting a comprehensive approach to policy-making, wb countries can achieve sustainable development and contribute to a greener future for the region and beyond. conclusion the wbs have undergone significant economic and political transitions in recent decades, resulting in increased industrialization and urbanization with significant environmental impacts, petar mitić, aleksandra fedajev, milena kojić 53 leading to growing concerns about the region’s environmental sustainability and its potential effects on economic growth. the sofia declaration on the green agenda for the wbs and other international policies have highlighted the importance of balancing economic and environmental sustainability in the region. this paper’s findings add to the research on the intricate link between economic growth and the environment in the wbs. the cointegration results suggest a long-term relationship between co2 emissions and gdp per capita, emphasizing the need to address economic growth and environmental sustainability in policies and plans. furthermore, the vecm has identified a negative adjustment mechanism suggesting a rise in co2 emissions will cause a decline in gdp per capita, highlighting the need for sustainable economic growth to lower co2 emissions and protect the environment. the short-term bidirectional causality between co2 emissions and gdp per capita further underscores the need for policymakers to adopt a comprehensive approach to policy-making. investing in clean energy and green technologies, enacting stronger environmental regulations and taxes, and encouraging environmentally sound management techniques can help reduce pollution and protect natural resources while stimulating economic growth. policymakers can use these findings to formulate policies that balance economic growth and environmental sustainability. however, more research is needed to fully understand the complex relationship between economic growth and the environment in the wbs. future studies can build on these findings to further inform policies and plans that promote sustainable development in the region. additionally, it is important to consider other environmental, social, and economic variables, such as population growth, income inequality, and access to education and healthcare, to develop a comprehensive understanding of the challenges and opportunities for sustainable development in the region. acknowledgments this research has been financed by the ministry of science, technological development and innovations of the republic of serbia. references adedoyin, f., abubakar, i., bekun, f. v., & sarkodie, s. a. 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(2020). investigating the ekc hypothesis for china: the role of economic complexity on ecological footprint. environmental science and pollution research, 27(26), 32683–32694. https://doi.org/10.1007/s11356-020-09434-4 article history: received: 16.3.2023 revised: 4.5.2023 accepted: 8.5.2023 https://doi.org/10.1016/j.rser.2019.109481 https://doi.org/10.1007/s10784-021-09529-4 https://doi.org/10.1016/j.jclepro.2020.121669 https://doi.org/10.28934/ea.22.55.2.pp91-106 https://doi.org/10.1002/pa.2126 https://esa.un.org/unpd/wpp/ https://doi.org/10.1186/s40008-021-00259-z https://doi.org/10.1016/j.heliyon.2022.e10357 https://elibrary.worldbank.org/doi/epdf/10.1596/36402 https://openknowledge.worldbank.org/handle/10986/38189 https://doi.org/10.1007/s11356-020-09434-4 microsoft word 2009_1_2.doc opportunities for the development of partnerships through cross-border cooperation merdža handalić, governance acountability project (gap) bih, gap office tuzla, tuzla key words: cross-border cooperation, regionalization, partnership jel: f15, 052 abstract – successful implementation of cross-border cooperation not only depends on the capacity of state institutions to successfully lead and coordinate activities in the course of realization of the program but also the ability of potential users to make as many good project proposals, crossborder related, which could be financed from funds cross-border cooperation. intensive cross-border cooperation among development actors on the principles of partnership may have influence on the development of cross-border regions and increase the absorptive capacity of these regions. introduction international cooperation of the regions or other decentralized areas is not an alternative to the current process of accession of new countries to the european union and its institutions. from the viewpoint of countries that are outside the european union, this is an opportunity for the newly established boundaries in the neighborhood not to represent the limit for those international initiatives that are available and which require an additional effort towards internal institutional modernization with a flexible and layered structure of decision-making that will not depend on strictly confronted relation between the center and neglected periphery. for most countries in the south-east of europe the process of regional cooperation and gradual strong integration into the european union is, in many ways, the issue of survival because it contains within itself not only democratic but also the development potential. regionalization and cross-border cooperation until the 80ʹs, the main actors of european integration flows were national-states on the political plan, and large business systems in the field of economy. however, as usual throughout history, not by accident but because of real reasons, i.e. the recession during those years caused by the energy crisis, the new factors of cooperation appear, as well as the regions as the political-administrative framework, on the one hand, and small and medium enterprises (sme), on the other hand. market liberalization within the european union imposed the need of association and linking the smaller business units that initiated the establishment of a transnational partner networks in the area of technology transfer and access to new markets. regional communities, especially the most developed among them, have felt the need and opened their doors to economic initiatives by establishing international regional cooperation. positive reactions of the competent authorities of the eu followed quickly, which, insight m. handalić / ea 1-2 (2009) 32-42 33 integrative capacity of regional cooperation and its importance for overall economic development, established special funds for financial support to these programs of which the known is interreg program. in the document, which the european commission produced in 20031 before of accepting ten new member states, called wider europe or a new framework of cooperation with the eastern and southern neighbors, it has been stated that the expansion of the eu brings to the need of approaching countries that remains in the boundary area of the new union. although such a demand imposed from the interests of the eu and the need to guarantee their own security, stability and development, it is also proposed to develop new instruments that will focus, above all, to the cross-border cooperation, using the experiences from the implementation of phare, interreg, tacis and the cards program, which have been used in relation to particular groups of countries that are not members. thus, in addition to logical and expected cooperation in the areas that are of importance, above all, to the safety of the union, such as ensuring a stable border regimes and cooperation in order to prevent the activities of organized crime, human trafficking and illegal migration, the goal of the people from these areas is, in the long run, the integration of the neighboring countries, the gradual adjustment of their legal and economic systems to eu standards. such a goal has been recognized in the part of the document which states that closer cooperation with neighbors can help accelerate economic and social development and reduce poverty in the boundary areas. that would be achieved by the intensification of trade exchange, increasing investment and expanding cross-border cooperation on social and economic projects, which achieves a better integration of the neighboring countries in the wider european cooperation. as a rule, proximity of the eu market directly encourages the attractively of the areas near the eu border to the neighboring countries and opens new opportunities for them. these expectations are realistic because of the fact that in the neighborhood the work force and transportation costs are cheaper. in addition to such cooperation, which conceals the mainly national arrangements, the above mentioned document specifically points to the need of strengthening direct cooperation on sub national, regional or local level, pointing out the importance that such cooperation had in the relations between the eu member states. it has also been highlighted that the intention of the new eu borders could not be an obstacle for the development and strengthening of economic, social, cultural and educational cooperation between local communities on both sides of the new border. in this way and undoubtedly the regional dimension of european foreign policy is underlined and it is given an additional importance to the previously established cross-border communication created through the enlargement of the european union. in the framework of an integrated europe, these processes of direct cooperation are given a completely new dimension, especially within the european union itself where the classical limits have disappeared. different interests that motivated the creation of regional integration are influenced on its form. the usual and simplest form of international regional cooperation takes place through the conclusion of bilateral agreements between countries or regions partner. since this cooperation over time develops into a complex structure of mutual relations, its application 1 commission of the european communities, communication from the commission paving the way for new neighborhood instrument, brussels 2003, com economic analysis 1-2 (2009) 32-42 34 often, except for the region, requires the participation of other institutions of specific countries, which are involved in different phases of the performance of obligations under the basic agreement. although we have unified regional cooperation, it still connects the two vertical structure of decision-making level, since it starts with the local community, but is linked to the intermediary and the central institutions of government. specifically speaking on the countries in transition and the southeast europe countries,2 the analysts of regional cooperation in this area suggest some specific problems, which are important to reflect their ability to develop such ways of cooperation. most often mentioned problems directly burden the local community such as unemployment, low wages, insufficient expertise and lack of experience in the approach to european institutions, massive and inefficient administration, corruption, weak civil society, etc. however, of a state point of view, the main obstacle is the presence of centralization and distrust towards any form of international sub-national units. experience shows that a number of regional connections are not given the results of what would be in normal situations expected. negotiation between the two countries, based on bilateral agreements, is only the first step in regional cooperation, which, essentially, will not happen if there are no indigenous partners such as local and regional communities on both sides of the border. regionalization was undoubtedly a process that has gradually changed an internal structure of european countries over the last several years and that was also in function of their intensive connection. strong economic incentive of the program for regional cooperation of the european union represented a crucial commitment to internal regionalization or strengthening of the already established regional autonomy in many countries. in addition, regional cooperation has the tendencies of the international grouping of countries on regional basis. countries in transition are more and more directed to different types of regional integration, which are, ultimately, part of preparations for a wider integration frameworks thought process of testing their maturity and gradually adapting to the principles of the european union. although the interest for utilization of the eu funds is growing on local and regional levels, significant obstacles in this respect are insufficient information and qualifications. experience in previous years shows an urgent need for running different informative programs for citizens, as well as business structures, with special emphasis on training of professional staff in the cities and municipalities in order to competently work with all relevant issues of eu integration. regional and cross-border cooperation through the component ii of the instrument for pre-accession assistance mechanism for utilization of the assistance in the framework of the second component of the instrument for pre-accession assistance (ipa), which refers to cross-border cooperation is different in comparison to other components, and currently provides much greater opportunities for local government projects in cross-border regions. this is important for local governments in bosnia and herzegovina because since through the ipa from 2007 to 2 european commission, regional cooperation in the western balkans, a policy priorities for the european union, office for official publications of the european communities, 2006, pg. 17-21 m. handalić / ea 1-2 (2009) 32-42 35 2013, it will be continued with funding of the cross-border programs with croatia, serbia and montenegro commenced under the regional cards and interreg iii in the previous budget period of the union. bearing in mind the amount of funds selected for cross-border programs for bih (around five million euros per year)3, as well as the number of crossborder program (three in total), we come to the conclude that local actors in bosnia and herzegovina can count on the significant funding for projects of cross-border cooperation, with respect that they, in the framework of this component, can directly apply to published calls. this provides an opportunity for local administrations to improve their capacity for absorption of eu funds, which will, in future years, be much more and actually implemented on regional and local level. the objectives of cross-border cooperation are defined on the basis of the specific needs of cross-border regions of countries participating in cross-border cooperation. the objectives of cross-border cooperation are: • promoting cross-border initiatives in the field of social development, economy and environmental protection in cross-border areas; • encouraging resolution of common problems in the field of environmental protection, public health, the prevention and fight against organized crime; • borders – strengthening the efficiency and security of borders; • promoting legal and administrative cooperation; • encouraging “people to people” local activities. through conducting the cross-border programs at the local and regional level, we are creating a long-term personal contacts and connections between people from the communities on both sides of the border, which is the basis for further cooperation and development. also, through the process of identifying projects, sign up for the funds, as well as during the implementation of projects, partners in bosnia-herzegovina arrived, therefore, valuable experience in using the funds of the eu, since all the calls for project proposals conducted in accordance with the rules of eu external assistance. regions that are eligible or regions to which those programs relate are regions of the nuts 3 level, or if there is no adopted nuts classification, as is the case in bosniaherzegovina, then it is equivalent areas along the borders of countries and potential candidates. the list of eligible regions has been included in the relevant cross-border program documents, which are prepared jointly and approved by the european commission. in addition, these documents contain the analysis of the situation of eligible areas for cooperation, the strengths and weaknesses, as well as medium-term needs and goals based on that analysis. also, these documents contain the cooperation strategy, priorities and measures for the realization of goals. each individual cross-border document is done on the basis of strategic documents of the european union, especially the multy-year indicative financial framework (miff) and the multy-year indicative planning document (mipd), as well as on the basis of relevant national and regional strategic documents. at the same time, to make a programming document has a major role and the process of consultations with potential participants in the cross-border cooperation. the co-financing arrangement of the 3 multi-annual indicative financial framework for bih miff for period of 2008 – 2011, sarajevo, 2007, pg. 22-26 economic analysis 1-2 (2009) 32-42 36 eu cannot be greater than 85% of the eligible project costs, which means that 15% should be secured by the project partners. the cross-border cooperation is being implemented on both sides of the border of the participant countries; the program requires the participation of partners from both sides under a single policy for all participants of the program. for each program, each participating country has to establish the appropriate operational authority for the implementation of these programs that are related to the given country. the task of these bodies is to cooperate in the process of drafting and implementation of cross-border cooperation. state institutions responsible for preparation and coordination of the implementation of cross-border and transnational cooperation in bosnia and herzegovina is the directorate for european integration. in addition, it is necessary to establish a common management structure to participate in the implementation of the program: the joint monitoring committee (jmc) and joint technical secretariat (jts). both of these bodies consist of representatives of countries participating in cross-border cooperation. joint monitoring committee is responsible to oversee the implementation of cross-border cooperation, approves annual reports and made the choice of projects, while the joint technical secretariat assists the joint committee for monitoring and operating structures, organizes calls for submission of proposals, offers support to applicants and over see the implementation of selected projects. the process of establishing joint bodies for three of bilateral programs of the cross-border cooperation in bosnia and herzegovina, whose implementation began the first time in 2008, has been completed, and the first calls for submission of proposals are expected very soon. since the cross-border cooperation programs, at least in its initial phase, are going to be implemented through centralized management, the ec delegation in bosnia and herzegovina will be responsible for approving the list of approved projects, contracting the approved projects and payments of the contracted amounts. programming documents for the three bilateral neighbors’ agreements have officially been approved on 18th december 2007. financial agreements between the european commission and the participating countries were signed during the 2008th and the implementation of the program will be able to start after that4. a) serbia bosnia and herzegovina the strategic goal of cross-border cooperation of bosnia-herzegovina with serbia will be connecting people, communities, and economies of the cross-border areas to the mutual activities in the area of communication development, using the advantages of this area in human, natural and economic resources.5 based on the swot analysis and determination of this strategic goal, the priorities and activities for this program have been set: • priority i the realization of socio-economic cohesion through joint action to improve the natural, business, social and institutional capacity and infrastructure; 4 available on http://ec.europa.eu/enlargement/potential-candidate-countries/ bosnia_and_herzegovina /financial _en 5 cbc programme bosnia and herzegovina and serbia, sarajevo, 2007, pg. 27-29 m. handalić / ea 1-2 (2009) 32-42 37 • measure i.1 improving productivity and economic competitiveness, rural and natural resource areas; • measure i.2 cross border initiative aimed at the exchange of people and ideas for the purpose of enhancing cooperation in the professional level and among civil society. • priority ii technical assistance. b) croatia bosnia and herzegovina the strategic goal is to create incentive to cross-border networks and partnerships and the development of unique cross-border activities with the aim of revitalization economy, protection of nature and enhance social cohesion in the area.6 determined three priorities with appropriate measures to enforcement: • priority i creating a single economic space • measure i.1 joint development of the tourism offer; • measure i.2 promoting entrepreneurship. • priority ii improving quality of life and social cohesion • measure ii.1 protection of nature and environment; • measure ii.2 improving the services available to communities in the border area. • priority iii – technical assistance c) montenegro and bosnia i herzegovina the strategic goal is to enhance sustainable development of joint cross-border areas, their economic, cultural, natural and human resources and potentials so as to strengthen the capacity of human resources and institutional network shared among local communities, private and public actors.7 two priorities are related to this program: • priority i support the creation of a unique socio-economic environment to people, • communities and the economy of border regions • measure i.1 cross border initiatives for regional development with emphasis on • tourism and rural development; • measure i.2 advocacy for the development of the environment mainly for the protection, promotion and management of natural resources; • measure i.3 social cohesion and cultural exchange through institutional and interpersonal interactions. • priority ii technical assistance to improve the administrative capacity for the management and implementation of cross-border cooperation. in addition to these programs bosnia and herzegovina has the right to participation in transnational programs. transnational program see (transnational cooperation program south east europe) aims to strengthen the territorial balanced development and territorial 6 cbc programme bosnia and herzegovina and croatia, sarajevo, 2007, pg. 30-41 7 cbc programme bosnia and herzegovina and montenegro, programme summary, sarajevo, 2007, pg. 8-11 economic analysis 1-2 (2009) 32-42 38 integration in the areas of cooperation. this program is not only a part of the eu cohesion policy which includes only the member states, but it is also a component of pre-accession assistance, and as such it is a program in which majority of the eu non-members countries are allowed to participate (candidate and potential candidate countries). this transnational program includes 17 countries: albania, austria, bosnia and herzegovina, bulgaria, romania, croatia, macedonia, greece, hungary, italy, serbia, montenegro, slovakia, slovenia, turkey, moldova and ukraine. financial resources are significantly greater than the funds that were allocated to the previous program interreg iiib cadses 2000 -2006. the main goal of this program is the development of transnational partnerships based on strategic issues for improving the process of territorial, economic and social integration and contribution to cohesion, stability and competitiveness. transnational program med (mediterranean space) is a program funded from the european regional development fund (erdf) and aims to strengthen cross-border cooperation through local and regional initiatives, strengthening transnational cooperation activities leading integrated territorial development, and strengthening interregional cooperation and exchange experiences. this program, in fact, represents the continuation of medocc and archimede that were implemented within the interreg iiib initiatives, and focuses on cooperation among regions of the eu member states in the entire mediterranean area. bosnia and herzegovina has received an invitation to participate in this program, which includes some regions of the following countries: cyprus, france, greece, italy, malta, portugal, slovenia, spain and united kingdom. the main goal of this program is to make the entire area of the mediterranean a territory that is competitive at the international level with the aim of ensuring growth and employment for future generations, support territorial cohesion and active participation in the field of environmental protection in terms of sustainable development. partnership fundamental framework of cross-border cooperation successful implementation of cross-border cooperation not only depends on the capacity of state institutions to successfully lead and coordinate activities in the course of realization of the program, but it also depends on the ability of potential users to make as many good project proposals, cross-border-related, which could be financed from funds cross-border cooperation. cross-border cooperation is therefore reflected in the joint activities and harmonized coordination of the state institutions’ program participants on both sides, as well as the program users. what is common to all projects of cooperation? first of all, it requires at least minimum documentation, such as a memorandum, an agreement or declaration of partnership. this document establishes who are participants of cooperation, their readiness to cooperate, and the planned framework of that cooperation in a specific or indefinite period of time. this agreement is recommended, even when it tales the exchange of experts solely. depending on the extent of cooperation, the partners can agree on the funds that will put at disposal for the purpose of realization of joint projects (financial resources, people, and infrastructure). and finally, when it comes to intensive cooperation, the partners can establish, for example: forums, assemblies, and agree on practical implementation aspects of m. handalić / ea 1-2 (2009) 32-42 39 cooperation. the document can be in the form of unofficial document, if a single project, or may have a legal basis of the contract or legal document, when the financial resources are involved, especially when the instruments of cooperation are being established (institutions). good partnership is not absolute guarantee that the project will be good. in fact, it is difficult to imagine a good project without a good partnership. partners should be aware that quality partnership includes the time, finances, and activities. all project partners are the ultimate beneficiaries of european funds. this means that the partners should be considered only those participants who play an active role in the preparation and implementation of the project and as such they should be put on the list of ipa agreement on co-financing. also, the partner is not only a promoter and coordinator of activities. partner, in fact, spends money for the purpose of the project and contributes to the achievement of the results of crossborder program, and concrete results of the project. it is important to note that none of the partners should come into conflict of interest with other bodies or contractors. this means that they will need to buy products and services without prejudice to the free market competition. eligible are only those costs paid directly by users (expenses paid “in the name of” or in his capacity as agents, which are not predicted by the ipa agreement on co-financing should not be allowed). it needs to clearly indicate that it cannot approve any discounts or any other benefits. furthermore, the partner must be different from suppliers and associates. namely, a partner cannot act as a supplier (i.e. can not be a contractor or subcontractor that provides services and products for a fee). generally, partners cannot enter into contracts with each other and the bodies that operate within the framework of free market competition for the activities for which bids may be submitted by other partners to be treated as suppliers. partners can select associates for the project. their role is to promote good project results, having in mind that they are not participating in the financial part; neither have any financial interest in the project. associates do not have to meet the criteria for acceptability established for partners and cannot perform as suppliers. in the event that these associate, however, become financially interested in the project, then they should be treated, taking account of their activities, as suppliers (respecting the rules of market competition) or as partners, with an update of the partnership statement. partners must be placed within the program acceptable area. if the project partnership includes partners located outside the program areas, than it should be explained why the contribution of those partners is necessary for the achievement of the project objectives, and why these activities cannot be performed a partner located within the program area. to be eligible, partners who come from outside the acceptable area must be the legal entity established in a member state, then in the country that is user of the regulation of ipa, the country that is the user of the instrument of the european neighborhood and partnership, or in a member state of european economic region. all partners must have legal, financial and operational capability to participate in the program. partners between themselves name the leading partners for each project, and they become the main user once a contract on the ipa co-financing has been signed. it will also appoint a project or functional partner, who works at the level of the project and is responsible for the functioning of the activities on the implementation of the project. economic analysis 1-2 (2009) 32-42 40 for partnership to be acceptable for cross-border cooperation, or to have the project acceptable for financing in this context, at least one condition has to be met: a) joint development. in fact, all partners should contribute to the development of the project. jointly define how the project will be carried out, participate in the development goals, immediate results and performance, and budget, determining the time, the division of responsibilities and tasks in order to achieve goals. b) joint implementation. functional partner is responsible for the overall implementation of the project, but also all the partners responsible for different parts of the process. each partner is responsible for the assigned tasks to achieve the objectives and should ensure that the necessary activities and those they found a critical point and resolved unexpected implementation challenges. c) the joint staff. all partners, participants have a role and allocate staff to fulfill this role. personnel coordinate their activities in cooperation with others involved, and regularly exchanges information. should not be unnecessary repetition of functions in different partner organizations. d) joint funding. the project has a separate budget with funds allocated to the leading partners in accordance with the activities they carry out. the budget includes annual spending targets. the programs that are mentioned in this paper have been based on the international and european level. however, not all the projects of cooperation between local administrations are of the international character. similar links are often created within the national borders since the local government in the former communist countries rather quickly realize the importance of horizontal cooperation with neighboring local communities, when it comes to the specific needs of organizations such as utilities (management of water resources, waste management, and construction of infrastructure), or with similar regional or national bodies, when it comes to lobbying at the higher levels of government. these forms of cooperation in bosnia and herzegovina are existing in the form of permanent alliance of towns and municipalities or other forms, such as associations. states have learned that they were easier to deal with alliance but loosely connected with the local administrations, where everyone is trying to promote local interests, and that on the international stage the local unit may prove as important allies. european policy in encouraging local initiatives and lobbying bodies such as the congress of local and regional authorities of europe (council of europe), the committee of the regions (european union), the assembly of european regions and the other in the post-communist countries, promoting a better understanding of the importance of cooperation between the local or regional body to the national and at international level. in the process of transition, bosnia and herzegovina is going through several important socio-historical processes. the most important is, of course, the process of integration into the european union. in trying to realize this goal it is necessary to create conditions in order to apply european standards. one of these standards is the establishment of regional structures within the country but also in the process of cooperation with neighbors. at the regional and local level in the b&h, it is necessary to review the existing partnership structure. the existing partnerships in the framework of realization of business m. handalić / ea 1-2 (2009) 32-42 41 regions’ development strategies have been focused on economic development. in addition, there are partnerships for employment and social inclusion. partnerships are mainly related to the projects and often dismiss at the end of the project. although the projects require these kinds of partnership, it is necessary to establish permanent control through the strategic partnerships. this model of partnership should include participants of wide range of areas from the level of municipalities, cantons and entities, (economic development, employment, social inclusion, education, etc.). such a partnership should mitigate any organizational or political disagreements between the different levels of government and different areas of activity. it is recommended to have a regular and relevant communication within the established, efficient organizational structure through the official agreement among the partners. partnerships may be formed on a voluntary basis with the steering board, the executive body and a broad participation of all partners. conclusion the role and importance of regionalization in the economic and political development in europe had the need for the establishment of appropriate institutions. based on the synthesis of experiences during the decades, the european union has established several important institutions dealing with different aspects of regionalization and regional development, the statistical institutions, through committees of regions to other institutions needed in the process. in addition in our country, government at the state level as a whole should do much to establish the conditions for the application of the regulations of the eu regional policy, the actors at lower levels should also be involved in the process immediately. currently in bosnia and herzegovina, we should take advantage of public administration and regional and local agencies as the leading organizations. namely, for the partnership to worked well we need professional support structure that would provide assistance with the procedures of project preparation, organization and financial management, and this would be an agency or public administration took over administrative duties while the partners, then, could focus on strategic issues. in most eu countries the international network and cooperation through the exchange of professional, non-governmental, university and entrepreneurial organizations, has been accepted as a condition for the successful management of partnerships. in addition, public administration and development agencies, in our case, organization of small and medium-sized enterprises (smes), located in the established entrepreneurial centers and industrial zones or outside them, can contribute to faster job creation, and also be very useful partner. a role of enterprises (especially smes) in partnerships is becoming more and more important, as well as the need for the provision of services by launching new businesses for what entrepreneurial centers have or should have the capacity. eu experience directs us to the potential leading role of large enterprises as sponsors of local organizations for employment and creating business links between smes and large enterprises. organization for employment, in cooperation with educational organizations can contribute to large companies get the appropriate staff. acceptance and application of the euro regions concept based on partnership relations of local and regional actors, including entrepreneurs, smes, development agencies and economic analysis 1-2 (2009) 32-42 42 associations, educational institutions and public administration in bosnia and herzegovina, but also with neighbors, in addition to opening opportunities of access to eu funds for regional development , would contribute to the internal and external economic integration of bosnia and herzegovina and the fulfillment of the conditions for the reception of our countryʹs membership in the european union. a clear political willingness of local representatives from both sides of the border is a precondition of any cooperation. such willingness of local representatives should be accompanied by a professional team, which would be responsible for managing cross-border arrangements, from the establishment of common objectives to implementation of concrete projects. successful implementation of these joint projects should be the basis for the establishment of long-term, strategic relationship with the explicit objective of improving cross-border regions and better living conditions in them. references commission of the european communities, communication from the commission paving the way for new neighborhood instrument, brussels, 2003, com. directorate for european integration of b&h, cbc programme bosnia and herzegovina and serbia, sarajevo, 2007. directorate for european integration of b&h, cbc programme bosnia and herzegovina and croatia, sarajevo, 2007. directorate for eu enlargement, cbc programme bosnia and herzegovina and montenegro, programme summary, sarajevo, 2007. commission of the european communities, multi-annual indicative financial framework to bosnia and herzegovina–miff for the period of 2008-2011, brussels, 2007. european commission, regional cooperation in the western balkans, a policy priorities for the european union, office for official publications of the european communities, brussels, 2006 ricq, c.: handbook on transfrontier cooperation for local and regional authorities in europe, council of europe, strasbourg, 2006 www.ec.europa.eu/enlargement www.cadses.net www.programmemed.eu www.dei.gov.ba www.cbib-eu.org ea_2012_1_2 conference paper green growth as a generator for overcoming the crisis jovanović gavrilović biljana *, university of belgrade, faculty of economics, belgrade, serbia minić natalija, master's degree student, university of belgrade faculty of geography, belgrade, serbia udc: 502.12; 502.131.1 jel: q01; q56 abstract – faced with the severest economic crisis after world war two, the global economy is turning to new sources of growth, which should guide it on the road to economic recovery. in such circumstances, the idea of green growth, based on the belief that economic growth and care for the environment go "hand in hand," is being reaffirmed. in a way, green growth represents a step backward, i.e., going back to the un conference on environment and development held in rio in 1992, when environmental sustainability of economic growth was the focus of attention. on the other hand, green growth also represents a step forward, as it is a practical and flexible approach that should contribute to the implementation of the concept of sustainable development in all its dimensions: economic, environmental and also social. a large number of countries, including the european union, follow the green growth model, respecting national idiosyncrasies, which is demonstrated in this paper. in order to communicate with europe and the world successfully, serbia needs to share their fundamental values and commitments, but also preserve its national economic identity. green growth (in the context of sustainable development) is a good option for serbia and is its strong link to the rest of the world. key words: green growth, sustainable development, environment, economic crisis, investment, employment, natural capital, renewable energy sources, public policies introduction two decades after the conference on environment and development held in rio de janeiro, the world is once again on the road to rio, both literally and figuratively: a conference on sustainable development is scheduled to be held in this city in june 2012 and one of the main topics at the conference will be a green economy (and green growth), which means that the environmental dimension of sustainability has returned as the focus of attention. this is by all means a result of the global financial and economic crisis, which has exposed the unsustainability of the existing model of economic growth and given rise to debates on new sources of increasing production and employment. * faculty of economics, university of belgrade, belgrade, kamenicka 6, bgavrilo@ekof.bg.ac.rs this paper is a result of research within projects nos. 149047 and iii 46001, financed by the ministry of education and science of the republic of serbia economic analysis (2012, vol. 45, no. 1-2, 19-31) 20 expansive fiscal policy is the usual response by governments to a decrease in aggregate demand in recession-stricken economies. what was characteristic of a large number of countries during the 2008-09 recession was a comparatively high share of incentives intended for green investment, which contributes to achieving environmental goals. this is in line with the "global green new deal," which, launched as part of unep's green economy initiative, echoes the original new deal of u.s. president franklin d. roosevelt from the 1930s. data indicate that from september 2008 to december 2009 around 16% of stimulus funds on the global level were intended for green projects. the european union allocated 59% of total fiscal incentives for this purpose, whereas individual member states and the u.s. allocated around 11% on average. by the amount allocated (79% of total fiscal incentives, or 5% of gdp), south korea is the world leader. (carolyn fischer, 2011) green expenditures comprised support to renewable energy sources, energy efficiency and other measures aimed at protecting the environment. the bulk of the funds was channeled to energy efficiency projects in the belief that these activities could create new jobs fastest. green growth has been emphasized during the crisis, even though the debate about the compatibility of economic growth and environment protection has been going on for a long time now. according to current views, a government's basic concern should not be economic growth per se, but people's wellbeing, which requires certain trade-offs between growth and the quality of the environment. however, a well designed environmental policy could contribute to a significant reduction in the trade-offs. notion and significance of green growth the concept of green growth appeared in response to the multifold crises that have been shaking the world lately: unfavorable climate change, threatened streams of water, loss of biodiversity, food and energy crises, and, of course, the global financial and economic crisis. there is growing awareness that the current model of growth is unsustainable and that, sooner or later, it will lead to the depletion of natural resources and erosion of environmental services. the environmental future of the world, according to the latest oecd projections, is rather bleak. without new policies in the energy sector, the global energy mix will remain unchanged until 2050, which will lead to a 50% increase in green house gas (ghg) emissions, mostly due to increased carbon dioxide emissions related to the use of fossil fuels. (oecd, 2012, p. 72) the demand for water in the same period will grow by 55%; therefore another 2.3 billion people will be faced with water supply problems. biodiversity will decrease by another 10% on the global level. (oecd, 2012, p. 156) a stronger focus on environmental sustainability today would help avoid such a scenario and at the same time open up new sources of economic growth, which would induce global recovery. with the right policies, which would encourage investment and stimulate new markets, green growth might increase productivity, boost employment and change the current model of consumption. the concept of green growth is consistent with the broader and older concept of sustainable growth. a special thing about this broader concept is its holistic character (it encompasses three pillars of development – economic, social and environmental) and its particular emphasis on inter-generational justice. accordingly, even though it stresses the relationship between economy and ecology, the concept of green growth should not lose jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 19-31) 21 sight of the justice dimension, especially the needs of the poorest people worldwide, the particular needs of developing countries, and, of course, future generations. this is reflected in unep's definition of green economy, focused on achieving green growth, as an economy resulting in improved human well-being and social justice, with a substantial reduction in environmental risks and depletion of natural resources. (unep, 2011, p. 16) green growth is not a novel paradigm that should replace sustainable development. it is a concept expected to contribute to a more successful application of sustainable development, through concrete political moves by governments and interested stakeholders. it is a practical and flexible approach whose aim is to ensure progress in the economic and environmental dimensions of sustainable development, taking into account the social effects of greening growth. (oecd, 2011, p. 11) the justification for introducing the concept of green growth lies in the fact that modernday economies tend to deplete natural capital in order to achieve economic growth, which then jeopardizes the possibility of achieving sustainable development. most interpretations of sustainable development start from the world commission for environment and development's 1987 definition, which states that it is "development that meets the needs of the present without compromising the ability of future generations to meet their own needs" (wced, 1987, p. 43). the potential to meet the needs of the present and future generations depends primarily on the availability of total supplies of capital: natural (natural resources and environmental resources, such as clean air or water), produced (physical capital and financial resources) and human (health and education). the prerequisite for sustainability is that per capita wellbeing should not be reduced over time, i.e., that there should be adequate total supplies of capital that can sustain it. what is essential, however, is not only aggregate supplies, but their composition. excessive depletion and degradation of natural capital on account of a fast accumulation of produced and human capital are not acceptable. it is feared that, due to an irreversible reduction of the global supplies of natural wealth, the existing model of development will jeopardize the future generations' possibility of attaining wellbeing. a green economy and green growth as its product are necessary in this respect to overcome market-related, economic-political and institutional errors, which encourage irrational attitudes towards natural capital and render sustainable development impossible. there are, however, certain, not at all negligible, dangers of misapplication of the concept of green growth. firstly, the concept may be defined and operationalized in a onedimensional way as a mere environmental concept, which is a step backward in relation to the multidimensional concept of sustainable development. secondly, green growth may be understood in a uniform manner ("one size fits all") and applied using the same pattern in all countries. thirdly, there may be confusion about what is sustainable development and what is green growth, and this at a time when the idea of sustainable development has finally been widely supported by politicians. also added to this should be a set of risks in the field of foreign trade, which primarily applies to developing countries – from using the environment for protectionist purposes to developing countries' encounter with products that are subsidized in the industrial world without being able to use their own corrective measures, to narrowing the space for implementing policies that may contribute to promoting the green sector in less developed economies, and to imposing technical standards which exporters in these countries are unable to meet. finally, the concept of green growth could be used as an economic analysis (2012, vol. 45, no. 1-2, 19-31) 22 alibi for imposing new requirements on developing countries in the areas of aid, loans, and rescheduling or writing off debts. (report by a panel of experts, 2011, p. 5) all these fears need to be dispelled, not only verbally, but during the process of implementation of green growth. it is of great importance for developing countries that the principles harmonized at the united nations conference on environment and development in 1992 be respected, especially the principle of common but differentiated responsibilities, which implies that developed countries should lead the way in changing production and consumption models, and developing countries, while upholding their proclaimed development goals, should change the manner of attaining them, i.e., adopt sustainable practices. it is, of course, important for developing countries that developed countries support their sustainable development financially, through technology transfers, and also through a reform of the global economic and financial architecture. (report by a panel of experts, 2011, p. 4-5) there are views in the developed world that green growth is favorable exactly to developing countries where potentially adverse effects of environmental degradation are especially obvious. developing countries are more vulnerable to climate change and more dependent on the exploitation of natural resources for the needs of economic growth. through green growth they are offered a possibility of avoiding unsustainable, profligate production and consumption patterns and of directly embarking on building an adequate infrastructure and network for the support of sustainable development. greening growth of a national economy depends on its institutional and economicpolitical idiosyncrasies, development level, availability of natural resources and environmental pressures to which it is exposed. both industrialized and developing countries will be faced with diverse challenges and opportunities in the process of green growth implementation, but with similar problems and dilemmas. according to the oecd, two types of policy are required for greening growth in any country: first, macroeconomic management that can effectively secure allocation of resources, with preservation of the natural capital; and, second, specific policies that induce greater efficiency in using natural resources or impose penalties for pollution. the green approach to economic growth promotes four key concepts: • productivity, i.e., increased efficiency in the use of energy and other resources, primarily owing to human knowledge and skill; • natural capital, which (like other forms of capital) needs to be valued fully as a factor of production and human wellbeing; • innovation, i.e., the creation, accessing, absorption and application of knowledge and/or technology that leads to new or significantly improved products, services or processes (it can include so-called green or clean technologies); and • green growth indicators, i.e. new measures "beyond gdp" to measure green growth progress. (report of the green growth advisory group, 2011, p. 12-13) as an economic and political approach, compatible with sustainable development, green growth is attracting a lot of attention in scientific and scholarly circles, but research in this field is still limited and knowledge is fragmented. progress is expected on the theoretical and practical planes, as well as on the plane of measuring a green economy. jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 19-31) 23 application of the green growth concept in finding the way out of the crisis global economies are slowly, but at different speeds, overcoming the severest crisis after world war ii. the return to "business as usual," as it has turned out, is not a good solution and involves risks, which in the long run threaten to jeopardize the very process of economic growth and development. the world is turning to a green economy and green growth in seeking new, sustainable models of production and consumption. the "green race" has already started. the winners will be rewarded innovation and investment in technologies for producing clean energy will stimulate green growth, which will create new jobs and provide greater energy independence and national security. business people around the world have recognized green products and technologies as markets of the future worth investing in. investors are turning to green infrastructure, which is regarded as an attractive field for investing available capital. the state, on its part, should provide a relevant economic-political framework and encourage private investment in this field. the efforts of world governments to support the greening of economic growth have intensified in the past several years. many countries have adopted policies and programs that can be characterized as broadly defined green growth. in june 2009, 34 world countries and the european union signed the oecd declaration on green growth. the declaration states that economic recovery and environmentally and socially sustainable economic growth are the key challenges of the modern world. a number of well targeted policy instruments need to be used in order to simultaneously contribute to economic recovery in the short-term and help to build the environmentally friendly infrastructure required for a green economy in the long-term. in order to advance the move towards sustainable lowcarbon economies, international cooperation is crucial in areas such as the development and diffusion of clean technologies, application of green ict for raising energy efficiency, and the development of an international market for environmental goods and services. the countries that signed the declaration agreed to encourage green investment and sustainable management of natural resources; to encourage domestic policy reform with the aim of avoiding or abandoning environmentally harmful policies that might thwart green growth, such as subsidies to fossil fuel consumption or production that increases greenhouse gas emissions, subsidies that encourage unsustainable use of other scarce natural resources or contribute to negative environmental outcomes; to work towards establishing appropriate regulations and policies to ensure clear and long-term price signals encouraging efficient environmental outcomes; to ensure close coordination of green growth measures with labor market and human capital formation policies in order to support the development of green jobs and the skills needed for them. (oecd, 2009). in line with the above declaration and in response to the economic and financial crisis and climate change challenges, the european union adopted in 2010 the strategy "europe 2020", focused on a new sustainable market economy, a smarter, greener economy in which prosperity comes from innovation and more efficient utilization of resources, whose key input is knowledge. (european commission, 2010). in comparison with the previous, lisbon strategy, there is an evident shift from quantitative to qualitative green growth that takes into account the interdependence between the economy and environment. among the key targets of the new eu strategy is to reduce greenhouse gas emissions by 20% compared to the 1990 levels (perhaps even by 30% if other developed countries commit economic analysis (2012, vol. 45, no. 1-2, 19-31) 24 themselves to comparable emission reductions and if developing countries contribute adequately according to their capabilities), to increase the share of renewable energy sources in the final energy consumption to 20%, and to increase energy efficiency also by 20%. (european commission, 2010, p. 11). meeting the energy goals by 2020, it is estimated, could result in € 60 billion less in oil and gas imports. in this case it is not only about financial savings, but about maintaining energy security. further progress with the integration of the european energy market can add an extra 0.6% to 0.8% gdp. meeting the objective of 20% of renewable energy sources has the potential to create more than 600,000 jobs in the eu. adding the 20% target on energy efficiency, the number of new jobs could well exceed one million. (european commission, 2010, p. 15) the said strategy identifies three priorities that the eu will pursue in its internal and external policies:: (1) creating value by basing economic growth on knowledge (promoting knowledge and innovation as the main incentives to sustainable growth); (2) empowering people in inclusive society (through the acquisition of new skills, fostering creativity, development of entrepreneurship); and (3) creating a more competitive, coherent and greener economy. (european commission, 2010, p. 10) to green the eu economy, according to eu 2020, the following instruments and measures are required: enhancing resource utilization by adequate regulations, emissions trading, tax reform, grants, subsidies, public investment, public procurement policy; creating new industries and accelerating the modernization of existing ones, with emphasis on sustainability, innovation and education of human resources, aimed at enhancing the competitiveness of the eu economy in the global market; and developing a smart, modern transport and energy infrastructure, which will contribute to attaining multiple goals, including lower carbon emissions, transport safety and energy security. (european commission, 2009, p. 7-8) the starting point for a revitalization of the european economy is a substantial increase of investment. ambitious energy and climate policies, it is estimated, should become the fulcrum of eu's overall economic policy (carlo. c. jaaeger et al, 2011, p. 5). building wind turbines, implementing cogeneration of heat and electricity, insulating houses, modernizing the power grid, etc. – all require substantial investment. however, the green investment should not simply displace investment in other sectors, as in this case growth would not speed up and employment would only be re-allocated between sectors, without reducing the number of unemployed. in the coming years green investment can be part of a broader surge of investment induced by the perspective of achieving sustainable growth. (after the global crises of 1929, such a surge of investment in europe was initiated, but with different, less acceptable motives – investment in military armament). additional investment will enable economies to grow faster, and faster growth, for its part, will generate positive expectations for the future, which will induce further investment. this is a virtuous circle that should take european economies to a new growth path. south korea is a good example of a country that is strongly committed to the promotion of green growth during the crisis. among other things, it chaired the oecd ministerial council meeting that adopted the "green growth declaration." in august 2008, "low carbon/green growth" was proclaimed as the new national vision to guide the development jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 19-31) 25 of the republic of korea in the next fifty years. in order to implement this vision, the "national strategy for green growth" (2009-2050) was adopted, as was the five-year plan for green growth (2009-2013), which provides a comprehensive policy framework for implementing green growth in mediumand long-term. instead of the "brown economy," where growth is achieved regardless of costs, a "green economy," focused on long-term prosperity and sustainability, is advocated. the national strategy contains three objectives, three strategies and ten policy agendas for their implementation. the basic objectives of the national strategy are: to promote a synergetic relationship between economic growth and environmental protection; to improve people's quality of life and promote a green revolution in their lifestyle; and to contribute to international efforts to fight climate change and other environmental threats. the three strategies include: mitigating climate change and promoting energy independence; creating new engines for economic growth; and improving the quality of life and enhancing korea's international standing. the ten policy agendas include: effective mitigation of greenhouse gas emissions (the government will pursue mitigation strategies for buildings, transport and industry, and will also insist on reporting on emissions and promote forestation); reduction in the use of fossil fuels and the enhancement of energy independence (korea will reduce energy intensity to the oecd average, increase the use of renewable energy and expand nuclear power capacity); strengthening the capacity to adapt to climate change. (in this context, korea will launch the restoration of its four major rivers and increase the share of environmentally friendly agricultural products to 18% by 2020); development of green technologies (this should boost the share of relevant sectors in the world market to 8% within five years); the greening of existing industries and promotion of green industries (exports of green goods will rise from 10% in 2009 to 22% in 2020, and the government will help small and medium-sized enterprises green their business); advancement of the industrial structure to increase the role of services (health care, education, finance, and high value-added services); engineering a structural basis for the green economy (the government will gradually introduce an emission trading system, make the tax system greener and extend public credit guarantees to green industry); greening land and water and building the green transport infrastructure (the share of passenger travel by rail will rise from 18% in 2009 to 26% in 2020); bringing the green revolution into people's daily lives (education on green growth will be expanded, the government will increase mandatory procurement of green goods); and becoming a role-model for the international community as a green growth leader (korea will actively engage in international climate-change negotiations and increase the share of green oda from 11% to 30% in 2020. (randal. s. jones and byungseo, 2011p. 6). the five-year plan lays out the government's activities towards implementing the strategy and the specific tasks of the ministries and local government bodies. also earmarked is the funding for the implementation of green growth programs and projects in the amount of 2% of gdp. (unep, 2010, p. 6) at first, investment will predominantly be streamlined into infrastructure in order to get the economy going. korea has the ambition to gradually become a leading exporter in the field of green research and green technology. it is worth noting that korea was one of the first countries to prepare in 2012 a report on the results achieved in the field of green growth in the past ten years, following the indicators proposed by the oecd. it was demonstrated in it that the set of policies adopted economic analysis (2012, vol. 45, no. 1-2, 19-31) 26 in 2009 is yielding results and that, generally, this country is moving towards a greener economy. further implementation of the green growth strategy will enable korea to transform its energy-intensive economy and create new sustainable resources for long-term growth. (korea’s green growth – based on oecd green growth indicators, 2012) china, as the world's largest emitter of greenhouse gases, faces severe problems from air and water pollution. to further reduce poverty, china's economy must continue growing. at current emissions per unit of gdp, chinese economic growth implies that by 2030 they would account for the entire global emission allowance of carbon dioxide that is consistent with the target of keeping earth's temperature from rising. (gill and raiser, 2012, p. 429) aware of the seriousness of environmental challenges, china incorporated green growth in its 12th five-year plan 2011-2015. the plan, among other things, envisages reduction in energy consumption by 16% per unit of gdp and carbon dioxide emission by 17% per unit of gdp by 2015. all seven strategic industries, as defined in the plan, lead china towards a less resource-intensive economy. four industries are explicitly green: new energy sources, new materials, new energy cars, and energy conservation and environmental protection. (china’s twelfth five year plan 2011-2015) even though the transition to green growth is a long-term process, it is estimated that the next 20 years are a crucial period for china to seize the opportunity, gain competitive advantages, and show global leadership in green goods and services. china enjoys substantial advantages over other countries when it comes to pursuing green growth (government ability to mobilize collective action on high-priority issues; lower level of development, which facilitates its transition to new growth and development; large domestic market and the possibility of achieving economies of scale in the development of green industries; abundant capital including human capital – to invest in green sectors; natural endowment of resources for clean energy, etc.), but it is also faced with not so small challenges (distorted prices of resource commodities, over-reliance on administrative measures for reducing carbon emissions, weak incentives for environmental protection, lack of a competitive market environment for green sectors, etc.). (the world bank, 2012, p. 257) if it succeeds in meeting these and other challenges and remains committed to achieving sound growth, the results will certainly be good. there are many more examples that illustrate the importance of green growth in paving the way out of the crisis. various governments are committing to invest substantial funds in specific green growth-related programs or industries. the united kingdom, for example, intends to launch a green investment bank in 2012 to provide funding for "low carbon projects" with returns that are too long term, or too risky, for capital market investment. (report of the green growth advisory group, 2011, p. 11) also remarkable is the example of germany, which announced in may 2011 that it will strive to become the first industrialized country to completely shift to clean energy by increasing investment and research and development for renewable energy and energy efficiency. germany intends to close all its nuclear power plants by 2022 and fill the gap in its energy supply it has proposed vigorous development of wind, solar and biomass, new standards for thermal efficiency of buildings, and creation of a continent-wide super smart grid, which would include the import of power from sun-rich north africa. also, the united states has issued a 10-year clean energy strategy, brazil has aggressively merged its policies for growth, climate change, and jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 19-31) 27 environmental management, while japan, even though it is already one of the most energy efficient countries in the world, is pushing for an additional 30% in energy efficiency gains by 2020 relative to 2006. (the world bank, 2012, p. 234) serbia ahead of the challenge for green growth in the last several years, serbia has been openly faced with a twofold economic crisis – internal and external. the effects of belated transition, burdened with blunders in the sphere of current economic policy and strategic shaping of the future, are interwoven with the impact of the global economic crisis that has "spilled over" to our region and uncovered internal weaknesses in the implementation of reforms, which would have come to light sooner or later anyway. even before the outbreak of the global crisis, all serious analyses indicated that economic growth in our country is not of high quality, that it fails to create conditions for self-sustainability, for continuation in the coming years, but rather directly jeopardizes the prospects for economic progress in the coming period. it was growth now at the expense of the future, based on excessive consumption and enormous foreign debts. there is much debating in the scholarly circles in serbia about the "new model of economic growth." one gets the impression that designed after the year 2000 was a model of economic growth which successfully operated until the crisis, but its potential was exhausted in the altered circumstances, so other solutions should be sought. however, the fact is that our growth and development in the past period has been largely haphazard, heedless of "paper strategies," which were too late and numerous anyway to represent a true support and signpost when development-related decisions were being made. this, of course, does not mean denying the need to define the key directions of our country's development in the future. in its attempt to pave the way out of the crisis, serbia needs to concentrate not only on reviving economic growth, but on raising its quality as well. any continuation of economic growth on the earlier foundations is not only undesirable but impossible. the time of economic growth that feeds on "fruit from the lower branches" is behind us – foreign capital inflows have been reduced, privatization proceeds are drying up, and the country's foreign debt has risen substantially. as has already been said, the european union has issued a new economic strategy for europe in order to overcome the crisis and strengthen the foundations of european social market economy in the coming decade. among the priorities is the necessity to achieve sustainable growth, which involves promoting a more resource efficient, "greener" and more competitive economy. following the example of the european union, our country drafted a relevant document, "serbia 2020", which is declaratory in character and, essentially, copies european objectives. (serbia 2020: a concept of serbia's development to 2020, 2010) even though green growth is not explicitly mentioned in this document, the energy sector and increased energy efficiency are recognized as important generators of serbia's economic growth in the next decade. in line with eu objectives, a 40% increase in energy efficiency is envisaged (which, it is estimated, would save a total of € 3 billion by 2020 due to reduced energy imports), with the share of renewable energy sources in serbia's total energy consumption increased to 18% by the end of the decade. in order to achieve these goals, it is economic analysis (2012, vol. 45, no. 1-2, 19-31) 28 necessary to provide adequate legal and economic-political conditions, including tax relief and other benefits for companies implementing energy efficiency promoting projects. (serbia 2020, 2010, p. 16) another strategic view of serbia's future economic growth and development is found in the study "a post-crisis model of serbia's economic growth and development 2011-2020". the study also advocates a change to the model of economic growth that, among other things, would imply diversification of energy sources and an extensive use of renewable energy sources, with promoting energy efficiency in all sectors of energy production and consumption. the measures and actions that need to be taken in order to achieve these priorities include: removing price disparities among energy-generating products, passing relevant regulations, removing administrative obstacles, and earmarking incentives at the systemic level to stimulate investment in energy projects, especially those relating to renewable energy sources. (group of authors, 2010, p. 41, 292) it should also be mentioned that a little earlier, in may 2008, serbia adopted the "national strategy for sustainable growth" to 2017, where the issues of environmental protection and promotion and rational utilization of natural resources feature prominently. sustainable growth has been a topic of discussion in our country since late 1980s, but the authorities are late in putting the concept into practice. the concept, as we said above, is compatible with the more recent idea of green growth. in its quest for a way out of the economic and social crises rooted in sound and lasting foundations, serbia, like european and other countries in the world, should to a much greater extent turn to a green economy and green growth, which can contribute to creating new jobs and boosting standards of living, and to rational utilization of natural resources and environmental protection. for this purpose our country has access to relevant eu funds and credit lines with european banks. in december 2009 the green for growth fund for south-east europe was set up by the european investment bank and the kfw entwicklungsbank (germany's development bank), with financial assistance from the european commission and the european bank for reconstruction and development. mostly through local financial institutions, the fund invests in the sector of renewable energy sources and energy efficiency. funding is intended for the countries in this region (including turkey) which are in the eu pre-accession phase. a green economy and green growth need to be viewed within the broader context of sustainable development of serbia's economy, so that, while taking care of the environmental and economic aspects of development, its social dimension may not be neglected. a comprehensive concept of sustainable development represents the best framework for the coordination of the various policies – economic, social and environmental – and their joint activities towards promoting people's wellbeing. conclusion the global crisis has made many countries aware of the fact that a different kind of economic growth from the one they pursued before its outbreak is required. accordingly, governments around the world have taken steps towards achieving green recovery. the crisis has created an opportunity and also served as a catalyst for increased efficiency of jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 19-31) 29 energy and materials utilization, for the development of new green industries and jobs, which is desirable from the standpoint of both the economy and the environment. nevertheless, the transition to a green economy and green growth is accompanied by incomprehension and suspicions. the most widespread is the belief that there is an inevitable trade-off between environmental sustainability and economic progress. the fact is, however, that greening the economy does not jeopardize the creation of wealth or job opportunities. on the contrary, many green industries provide good opportunities for investment and growth and for increasing employment in the long run. in order to make full use of the opportunities, it is necessary to create favorable conditions for investment during the transition to a green economy, which implies relevant actions on the part of policymakers. another myth is that a green economy is a luxury that only rich countries can afford, or, worse still, that this type of economy jeopardizes development and upholds poverty in underdeveloped countries. the example of many developing countries today controverts these views. the experience of developed countries also demonstrates that a number of environmental problems are the result of errors. less developed economies have the opportunity of avoiding their mistakes and achieving better quality economic growth. of course, this does not mean that all countries, regardless of the degree of their economic development, should carry the same burden of responsibility for environmental damage, nor that the environment in underdeveloped economies should have the same priority as in developed ones. also, of necessity, the manner of building green growth varies from country to country depending on a number of factors: availability of labor, capital and natural resources; institutional and management capacities; political stability; demographic profile; strength of private sector and social groups; rural-urban and regional differences; culture and tradition, etc. the world resource institute has recently published a survey of green policies, programs and initiatives around the world. the survey comprises 52 countries that have seen positive green economy results of the implementation of public policies. (world resources institute, 2011) even this incomplete survey reveals two key points: first, the idea of green growth is being implemented worldwide; and, second, the modalities of achieving this growth are rather diverse and adapted to country-specific conditions. references china’s twelfth five year plan (2011-2015) – the full english version. http://cbi.typepad.com/china_direct/2011/05/chinas-twelfth-five-new-plan-the-full-englishversion.html. (accessed april 10, 2012). european commission. 2010. "europe 2020 – a strategy for smart, sustainable and inclusive growth". communication from the commission, brussels. com(2010) 2020 final. european commission. 2009. consultation on the “eu 2020” strategy, commission working document, com(2009)647 final. fischer, carolin. 2011. 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"a compilation of green economy policies, programs and initiatives from around the world", green economy in practice: interactive workshop 1. http://www.uncsd2012.org/rio20/content/documents/compendium_green_economy.pdf (accessed may 2, 2012). zeleni rast kao generator za prevazilaženje krize rezime suočena sa najtežom ekonomskom krizom posle drugog svetskog rata, globalna ekonomija se okreće ka novim izvorima rasta, koji treba da je izvedu na put ekonomskog oporavka. u takvim okolnostima, afirmiše se ideja zelenog rasta, koji počiva na uverenju da ekonomski rast i briga za okruženje mogu da idu «ruku pod ruku». zeleni rast, u izvesnom smislu, znači korak nazad, tj. vraćanje na konferenciju un o životnoj sredini i razvoju koja je održana u riju 1992. godine, kada je ekološka održivost privrednog rasta i razvoja bila u centru pažnje. s druge strane, zeleni rast predstavlja korak napred, jer je to praktičan i fleksibilan pristup koji treba da doprinese implementaciji koncepta održivog razvoja u svim njegovim dimenzijama: ekonomskoj, ekološkoj, ali i socijalnoj. veliki broj zemalja sveta, uključujući evropsku uniju, sledi model zelenog rasta, uz uvažavanje nacionalnih jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 19-31) 31 specifičnosti, što je u radu i pokazano. da bi uspešno komunicirala sa evropom i svetom srbija treba da deli njihove osnovne vrednosti i opredeljenja, ali i da čuva svoj nacionalni ekonomski identitet. zeleni rast (u kontekstu održivog razvoja) je dobar izbor za srbiju i čvrsta spona koja je veže za ostatak svet. klju:ne reči: zeleni rast, održivi razvoj, okruženje, ekonomska kriza, investicije, zaposlenost, prirodni kapital, obnovljivi izvori energije, javne politike article history: received: 12 may 2012 accepted: 3 june 2012 doi: 10.28934/ea.22.55.1.pp1-11 original scientific paper crowdfunding response to the covid-19 pandemic: evidence from kickstarter isidora ljumović10f* | aida hanić1 | slavica stevanović1 1 institute of economic sciences, belgrade, serbia abstract the aim of this paper was to explore the impact of covid-19 on crowdfunding using data from the kickstarter platform. the study period covers the covid years from march 2020 through 2021 and three years before the pandemic. we crawled data from kickstarter.com with custom-made software, a scraper robot. the research was based on a sample of a total of 43.977 campaigns, of which 29.5% were started during the covid era and 70.5% were launched previously. to test our expectation that the characteristics of the campaigns during covid-19 have changed, we applied a t-test. the results show that crowdfunding created an early response to the covid crisis, manifested as differences between campaigns initiated during and before the pandemic period. campaigns initiated during the covid-19 pandemic had lower goals, much higher amounts of funds pledged, a higher number of backers, higher chances for success, and a shorter blurb description, while they were more frequently chosen as favorites by the kickstarter staff. the coronavirus is a huge economic burden, particularly for start-ups, entrepreneurs, and small and medium-sized businesses (smes). as a result, the findings of this study suggest that crowdfunding, as an online option, might help fill in the finance gap during times of crisis. key words: crowdfunding, covid-19, kickstarter jel classification: o16, g23, d26 introduction the pandemic of covid-19 had a huge impact on different aspects of people’s life and behavior, causing health and economic problems worldwide leading to the conclusion that existing economic and societal patterns are insufficient in times of crisis (petkovska mirchevska et al., 2021; hanić, 2020). it resulted in the greatest recession since world war ii (world bank, 2020), with 114 million people losing their jobs because of temporary and permanent company closures (ilo, 2020). at the same time, mckinsey estimates that the banking sector will suffer a loss of cumulative revenue of $1.5 trillion to $4.7 trillion between 2020 and 2024 (mckinsey's global banking annual review, 2020). in practice, the pandemic has resulted in an economic contagion that is spreading at the same rate as the disease (carlsson-szlezak et al., 2020). a tool that can be critical in minimizing the harmful consequences of crises like covid-19 is social enterprises because it can address the financial needs of individuals and communities (farhoud et al., 2021). in that aspect, our focus is on crowdfunding. mollick (2014) defines * corresponding author, e-mail: isidora.ljumovic@ien.bg.ac.rs 2 economic analysis (2022, vol. 55 no. 1, 1-11) crowdfunding as "the efforts by entrepreneurial individuals and groups—cultural, social, and forprofit-to fund their ventures by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries". in practice, crowdfunding is an initiative proposed by someone to raise financial sources from the capital providers or the "crowd" to fund innovative new ventures (ordanini et al., 2011; moritz & block, 2016; moysidou & hausberg, 2020). although there are other different online techniques for raising funds, crowdfunding has become an "umbrella" term for all forms of social entrepreneurship. there are four different types of crowdfunding: donation-based, reward-based, equity-based, and lending-based (wang et al., 2018). the major difference is in the desired outcome (mollick, 2014). for instance, vismara (2019) notes that in a reward-based model, proponents seek financial contributions from backers in exchange for rewards or products. donation-based crowdfunding refers to charitable giving with no return, while in the lendingbased model, there are fixed interest rates for lenders. on the other hand, in an equity-based model, entrepreneurs make an open call to sell a specific amount of equity in their company. no matter the type, every crowdfunding process includes four basic elements. the project creator is an individual that launches the crowdfunding campaign, the second element is the campaign itself, to be funded, the supporters are investors that back the project with a small amount of funds and finally, there is a crowdfunding platform as an intermediary between the project creator and its supporters (jovanovic, 2019). one of the major advantages in the context of crowdfunding is reducing the obstacles related to the lack of financing. according to moysidou and hausberg (2020), crowdfunding gave a chance to startups that had no access to traditional capital markets, considering not just the financial aspect but the feedback from potential customers (bernardino & freitas santos, 2020) as a signal of approval or disapproval (vasileiadou et al., 2016). crowdfunding can be effective for both immediate and long-term responses in times of crisis. for instance, berliner and kenworthy (2017) note an increase in the use of crowdfunding to cover extra costs of health care in the us after the financial crisis in 2008, while nagui saleh et al. (2021) state that crowdfunding created the early response to the covid-19 pandemic. this is consistent with saleh et al. (2021), who found a significant spike in overall crowdfunding efforts in march 2020, owing in part to the covid-19 pandemic. in this regard, the aim of this paper was to explore the impact of covid-19 on crowdfunding since it can be considered as a tool that can help the community in an emergency (farhoud et al., 2021) because “if many people contribute small amounts, even costly projects can happen” (bone and baeck, 2016). to explore how the advent of covid-19 impacted the character of crowdfunding, authors used data from the kickstarter platform with custom-made software, a scraper robot, covering the covid years from march 2020 through 2021 and three years before the pandemic. this paper is structured as follows. section 1 reviews the relationship between entrepreneurship and crises in terms of understanding how crisis can lead to better understanding of how the crisis can lead to the creation of alternative ways to solve the financial problems of individuals and societies, since covid-19 has shown certain shortcomings in the social systems of some countries. section 2 presents the empirical model and data used while section 3 contains the discussion of the results obtained. finally, the section 4 concludes. literature review the relationship between entrepreneurship and crises is influenced by the way we define crisis or threat. in general, it is a process that develops over time, or in phases, and it leads to disjunction in normal functioning (williams et al., 2017). in that aspect, doern et al. (2018) emphasize that crisis management and resilience are the two concepts important to understand. considering this, herbane (2010) stands four reasons why should entrepreneurs be interested in crisis management: isidora ljumović1, aida hanić, slavica stevanović 3 • the use of technology brought new forms of threats; • losses from the crisis, particularly revenue, are not the only ones that should be observed but mostly damage to customer service, reputation and availability; • local and national public authorities are concerned with business resilience and • entrepreneurs should ensure the continuity of their operations. regarding the way people (entrepreneurs) deal with the crisis, muñoz et al. (2019) conducted a two-stage exploratory study before and after calbuco volcano eruptions in 2015 and 2016 in chile and found four resilience strategies: anchored reflectiveness, situated experience, breaking through, and reaching out. in the case of covid-19, farhoud et al. (2021) analyzed crowdfunding for social entrepreneurship in crisis based on the uk's social enterprise crowdfunding platform, upeffect. when considering the intersection of social entrepreneurship and crowdfunding, the authors suggested three perspectives: social enterprise, funding crowd, and institutional perspective. this is presented in figure 1. figure 1. strategies of how can crowdfunding contribute to serving social issues in times of crisis source: farhoud et al. (2021) these methods mean that crowdfunding platforms must support social entrepreneurs as clients, engage the community as a source of funding, and ensure consistency in funding social enterprises, particularly when emphasizing the "togetherness" aspect of crowdfunding campaigns. according to bernardino et al. (2016), using crowdfunding in social entrepreneurship is based on “common social causes” or the “collective cooperation of people”. in that aspect, social fundraising has become important, especially for the young or y generation that is more socially and environmentally oriented (ming-li et al., 2020; calic & mosakowski, 2016) and because of the accessibility and outreach that crowdfunding provides. building on this research, crowdfunding models perform particularly effectively in situations when funding decisions are influenced by a mix of social motives and local ties, and money is required quickly. in the aspect of the use of crowdfunding during covid-19, igra et al. (2021) use the term coronavirus-related crowdfunding (ccf). according to the authors, there were more than 175,000 gofundme campaigns in the us for covid-19 between january 1 and july 31, 2020. in this period, more than $416 million from over 4,750,000 individual donations were raised. 4 economic analysis (2022, vol. 55 no. 1, 1-11) in similar research, elmer et al. (2021) analyzed launched campaigns on gofundme (between 27 march and 27 april 2020). on a sample of 500 campaigns, results show that matters of business, family, health, and community constituted 72% of all campaigns, which can be considered as a “call for help” or call for community fundraising on issues related to individuals. this is consistent with wang et al. (2021), who found that categories related to individuals were more funded after than before the outbreak of covid-19. on the other hand, in a research done by raywa et al. (2020), on a sample of 1579 campaigns that were created on gofundme.com between march 3 and 20, 2020, almost 83% of non-u.s. campaigns, directed at italy, focused on hospitals and healthcare workers (54.6%), which emphasizes the differences between the u.s. and europe in terms of healthcare but also financial stability. in general, the crowdfunding market is predicted to grow by $ 196.36 bn during 2021-2025, progressing at a cagr of 15% (global crowdfunding market 2021-2025, 2021). regarding countries that are considered the largest, us and canada are top performers since they generated $74 billion in p2p lending in 2020 while the uk generated $12.6 billion followed by asia pacific (apac) at almost $9 billion with the notice that china was not included in this data (cambridge centre for alternative finance report, 2021). when we exclude the best performers, the top 20 include both developed and emerging economies but also small economies and countries that just started to practice crowdfunding as presented in the following table. table 1. top crowdfunding national markets in 2017 rank country total volume in us 4 australia $1,148,515,565.00 5 south korea $1,129,918,098.00 6 canada $867,577,549.42 7 france $747,274,513.52 8 germany $672,751,878.90 9 japan $348,650,302.00 10 netherlands $316,287,611.90 11 israel $295,455,044.29 12 italy $271,919,936.14 13 india $268,579,820.00 14 new zealand $261,621,933.00 15 finland $222,314,696.19 16 sweden $221,890,190.29 17 brazil $216,357,244.21 18 georgia $195,784,289.95 19 singapore $190,821,714.00 20 spain $181,620,894.27 source: ziegler t., shneor r., zhang b.z. (2020). the global status of the crowdfunding industry. in: shneor r., zhao l., flåten bt. (eds) advances in crowdfunding. methods in may 2021, we used custom-made software, a scraper robot, to collect data on projects and funders from kickstarter.com for our empirical analysis. it crawled projects from the kickstarter homepage (kickstarter.com, last entry 6 may 2021) and collected data for each campaign. kickstarter is one of the most popular reward-based platforms. crowdfunding platforms like kickstarter are becoming more popular for analysis because they can provide documentation and isidora ljumović1, aida hanić, slavica stevanović 5 analysis of new financing mechanisms while also offering substantial information on entrepreneurs, investors, funding attempts, and other related elements that are typically not disclosed to outsiders in other financing mechanisms like banks and venture capitalists. we were able to collect data on 43,977 campaigns between march 2017 and may 2021, with a focus on the period of the covid-19 pandemic; hence, the study period covers covid years from march 2020 through 2021, and three years before the pandemic. we found 12,970 (29.5%) campaigns that were started during the covid era and 31,007 (70.5%) campaigns that were launched previously. variables we have collected several variables from kickstarter's campaigns: campaign id, the id of the creator, a short, concise, effective introduction and description of the campaign, so-called blurb, goal of the campaign ($), blurb length, currency, time of launching the campaign, duration of the campaign, number of backers, the status of the campaign (active, succeeded, suspended, cancelled, or failed), pledged funds ($), category and subcategory, and country of the creator. we tested how selected factors of crowdfunding campaigns altered during the covid-19 pandemic, following mainstream academic literature. the variables related to the crowdfunding campaign include goal, pledged funds, and duration of the campaign, blurb length, and the creator's country of origin. we define the campaign goal as the amount of money the creator of the campaign wants to raise. there are no upper or lower limitations on the goal on the kickstarter. the amount of money received from investors is referred to as pledged funds. due to the high skewness of the distribution data related to the target and pledged value, we used the logarithm of the target capital (log_goal). we excluded all campaigns from the sample with a goal of below $5,000 and over $5,000,000. campaigns with minimal aims are easy to achieve, and it has been confirmed that they are not serious fundraising efforts (mollick, 2014). they also frequently target family and friends (cumming et al., 2017). campaigns with high amounts set as a goal have different characteristics from the majority of campaigns in the sample. the duration of the project campaign is the period in which the campaign is active, and it can last from 1 to 60 days. blurb is a project's brief description, and we calculated its length by counting the number of letters in it. it is one of the metrics used to assess the complexity of a project campaign. individuals from 25 countries can create projects, including the united states, the united kingdom, canada, australia, 16 european nations, new zealand, hong kong, singapore, mexico, and japan. in that aspect, for this research, we categorized countries into 6 categories: the us, uk, canada, australia, european countries, and others. the stage of the campaign and the number of backers are variables that show the campaign's outcome. the campaign's status can be successful, failed, active, cancelled, or suspended. the campaign is successful if the project creator has raised the amount of money specified in the objective; otherwise, the campaign fails if he has not met the goal. at the time of this research, active projects were underway, and we had no way of knowing how they would turn out. cancelled projects were terminated by the creator before the end of the duration, for an unknown reason. if a campaign violates platform rules, it will be suspended. all active, suspended, and cancelled projects were left out of the sample. the variable state is a dummy variable that takes the value of 1 if the campaign goal was successful, or zero elsewise, meaning that the campaign is treated as failed. backers are people (the crowd) who support an idea in the crowdfunding world. they invest a particular amount of money in someone's idea. to distinguish projects that are designated by kickstarter team members as "favourite" while active, we used the staff-pick variable. the variable is a dummy, taking the value of 1 if the kickstarter team marked it as a favourite, after an endorsement process in which platform staff assesses a campaign's quality (wessel et al., 2016), zero elsewise. to test our expectation that the characteristics of the campaigns during covid-19 have changed, we applied a t-test. the analysis was performed using spss v.25. table 2 shows descriptive statistics. the sample consists of 6 economic analysis (2022, vol. 55 no. 1, 1-11) 43,977 projects, with a success rate of 51.9%. the average amount of money a campaign creator may raise is about $37,000 with the sample's minimum and maximum set at $5,000 and $5,000,000. the average pledge amount is $31,455 which is lower than the average goal amount. the greatest sum collected was $11,386,449. however, only 164 of the projects in the sample received more than $1 million. the typical project lasts 35.51 days, with an average of 301.13 backers per project and a blurb length of 104.80 words. table 2. descriptive statistics of the sample characteristic sample no. of projects 43,977 successful projects (%) 22,844 (51.9) minimum maximum mean std. deviation goal for collecting ($) 5,000.00 5,000,000.00 37,069.97 148,253.70 amount pledged ($) 0 11,386,449.10 31,455.46 177,746.39 duration (days) 1 60 35.51 12.09 backers (no.) 0 88,887 301.13 1394.69 blurb length (no. of words) 4 140 104.80 31.61 country number of campaigns (% of campaigns) us (%) 28,563 (64.9) uk (%) 4,266 (9.7) ca (%) 1,848 (4.2) european countries (%) 5,871 (13.4) au (%) 919 (2.1) other (%) 2,509 (5.7) source: authors results using t-test statistics, table 3 reveals statistical differences between campaigns launched during the covid-19 phase and those launched prior to that period. the results show significant differences among all analyzed characteristics. the campaigns initiated during the covid-19 pandemic have lower goals ($33,974 against $38,365, p-value < 0.05), much higher amounts of funds pledged ($54,714 opposed to $21,726, p-value < 0.05) and number of backers (517.40 compared to 211.02, p-value < 0.05) and, most importantly, higher chances for success (0.62 against 0.48, p-value < 0.05). the wide range of standard deviations for specified goals, pledged funds, and number of backers indicates that the most and least successful campaigns have vastly different outcomes. the campaigns during the covid-19 period have a somewhat longer duration (35.69 to 35.42, p-value 0.015), while the blurb description, as a measure of project complexity, is shorter (95.29 to 108.78, p-value 0.05). finally, during the covid-19 epidemic, campaigns were more frequently chosen as favourites by the kickstarter staff (0.22 against 0.16, p-value 0.05). crowdfunding is primarily a us phenomenon, and the vast majority of campaigns, not only on kickstarter but also on other platforms, originate in the united states. to see how the covid-19 pandemic period changed the origins of campaign creators across countries, we transformed a variable pointing out the country or origin of the campaign creator. the new variable has a value of 1 if the creator is from the united states, 2 if from the united kingdom, 3 if from canada, 4 if, from a european country, 5 if from australia, and 6 if from any other country in the sample, zero elsewise. for all countries except australia, the t-statistic reveals statistically significant differences. we interpret these results as a fact that the number of campaigns from the us area decreased during the pandemic caused by covid-19. in parallel, the number of campaigns coming from other countries increased during the pandemic. european countries have seen the greatest increase in the number of campaign creators. specifically, during the pandemic, the number of campaign creators from isidora ljumović1, aida hanić, slavica stevanović 7 european countries increased by 3%, followed by a 2% growth in the group of other countries. during the covid-19 period, the number of campaign creators from the united kingdom and canada increased by 1% each. table 3. differences between campaigns initiated during and before the covid-19 pandemic covid-19 period 12,970 obs pre-covid period 31,007 obs 95% ci for mean difference t df m sd m sd goal for collecting 33,974* 140,945 38,365* 151,190 -7,429 -1,352 -2.83 43,975 pledged funds 54,714* 259,065 21,726* 128,126 29,358-36,618 17.81 43,975 duration 35.69* 12.45 35.42* 11.93 0.02-0.51 2.08 43,975 backers 517.39* 2050.27 211.02* 987.55 277.92-334.83 21.10 43,975 blurb length 95.29* 34.03 108.78* 29.64 -14.12--12.85 -41.61 43,975 staff pick 0.22* 0.41 0.16* 0.37 0.05-0.06 13.71 43,975 failed or succeed 0.62* 0.49 0.48* 0.50 0.14-0.15 28.01 43,975 us 0.60* 0.49 0.67* 0.47 -0.07--0.05 -13.00 43,975 uk 0.10* 0.31 0.09* 0.29 0-0.02 3.18 43,975 ca 0.05* 0.21 0.04* 0.19 0-0.01 4.12 43,975 european countries 0.15* 0.36 0.13* 0.33 0.02-0.03 7.73 43,975 au 0.02 0.15 0.02 0.14 0-0 0.73 43,975 other countries 0.07* 0.25 0.05* 0.22 0.01-0.02 7.31 43,975 * significance level: 0.05. source: authors discussion the problem of financial constraints for start-ups and small and medium-sized enterprises (smes) is well known in contemporary literature. this issue is even more pronounced in the external disruptions and extreme uncertainty caused by crisis events. the negative consequences of the covid-19 crisis have been demonstrated in the financial industry, where the stock market has experienced crashes and high volatility, and the banking system is under pressure to maintain liquidity (zhang et al., 2020). in such circumstances, it is debatable whether new technologies, such as online video pitches used in equity crowdfunding, might mitigate the effect of the crisis (brown & rocha, 2020). in this paper, we provide an empirical analysis of how the advent of covid-19 impacted the character of crowdfunding by using data from the kickstarter platform. we discovered statistical disparities between campaigns launched during the covid-19 period and those before, as those who start campaigns (i.e., entrepreneurs) and those who finance them (i.e., the crowd) have changed dramatically (chandler et al., 2021) following the covid-19 pandemic. campaigns started during the covid-19 pandemic have lower targets, considerably higher quantities of funds contributed (as in saleh et al., 2021), a significantly higher number of backers, and most importantly, an increased probability of success. we argue that such an increase is related to several reasons. it is commonly recognized that social media allows for rapid dissemination of information in emergency situations such as natural disasters and large-scale crises. given that crowdfunding is a type of social investing platform, embracing new technological trends by using the online sphere to connect people with entrepreneurs, growth in 8 economic analysis (2022, vol. 55 no. 1, 1-11) the number of people willing to invest on the platform is reasonable. during the pandemic, communities were shut down, financial systems were only available online, government assistance programs were halted or delayed, and a large number of people turned to crowdsourcing to satisfy their needs. campaign creators were looking to get funding for their project and investors to find opportunities in the scarce market. increased interest in the platform has resulted in an increase in the number of investors and campaign creators, as well as an increase in the amount of money pledged. crowdfunding reflects the community’s response, and the novelty of action likely influenced a larger number of campaigns and their success. moreover, the increased rate of success proves that natural disasters and large-scale crises unite people. campaigns ran for a little longer during the covid-19 period; the blurb description, as a measure of project complexity, was a bit shorter; campaigns were more frequently chosen as favorites by the kickstarter staff. during the epidemic triggered by covid-19, the european countries have seen the greatest increase in the number of campaign creators, whereas the percentage of us crowding campaigns has decreased. our results on the sample of campaigns from kickstarter in the period between march 2017 and may 2021 coincide with the general finding from popper and lorenz (2020), who claim that there was an unexpected boom of activity in the midst of the global pandemic with the number of campaigns increasing by over 60% and with rajwa et al. (2020), who found that the number of active campaigns rapidly increased with the spread of covid-19 on the gofundme crowdfunding platform. the findings from the research correspond to those of saleh et al. (2021), arguing that crowdfunding created an early response, where covid-19–related campaigns were created more frequently, raised more money than other campaigns and had longer narrative descriptions. the results are in line with moine and papiasse (2020), who found that the covid-19 crisis led to an upsurge in crowdfunding activity across france, with a proactive attitude towards accompanying emergency demands. we can argue that even though the crowd’s disposable income may be reduced, considering the economic recession, we have witnessed an extraordinary growth of crowdfunding in a relatively short time, mainly due to the harsh economic realities of the pandemic caused by covid-19 and massive delays in government relief (fairlie, 2020). for many existing and successful entrepreneurs, crowdfunding provided financial relief for their businesses (farhoud et al., 2020; saleh et al., 2021), while in contrast, many entrepreneurs have leveraged crowdfunding as an exit strategy (chandler et al., 2021). this research adds to the existing body of knowledge about crowdfunding because it is one of the first to look at how covid-19 altered the nature of crowdsourcing. the consequences of covid-19 on the nature of crowdfunding will demand a more detailed consideration in future research and policy. to do this additional research with data from other platforms such as gofundme, indiegogo, patreon and similar is needed. conclusion the covid-19 pandemic has drastically altered human civilization, causing a disturbance in the functioning of the current socio-economic norms. during the crisis (comparably with the financial crisis of 2008), the spread of the coronavirus represents a significant economic burden, particularly for start-ups, entrepreneurs, and smes. it is critical to keep them alive and prevent them from going bankrupt on a massive scale during this time of crisis. in the economic crisis, financial resources are scarce and expensive, investors postpone their investments and access to finance becomes particularly limited for innovative smes. to address those needs, many turned to the use of crowdfunding. crowdfunding, as an online solution, can provide support and fill in the financing gap in a time of crisis. one of the main advantages of crowdfunding is that it can be effective for immediate and long-term responses in terms of helping the community in a time of crisis. in that aspect, this paper aimed to explore the impact of covid-19 on crowdfunding using the kickstarter platform. isidora ljumović1, aida hanić, slavica stevanović 9 research results suggest that crowdfunding created an early response regarding the covid crisis since we discovered major differences between campaigns initiated during and before the pandemic. in other words, campaigns initiated during the covid-19 pandemic had lower goals, much higher amounts of funds pledged, including the higher number of backers and higher chances for success. at the same time, results show that the pandemic influenced the use of crowdfunding regarding the country of origin, where there was a great increase in the number of campaign creators in europe, contrary to the us. the present covid-19 crisis is likely to have offered much-needed assistance to local communities by promptly responding to local needs and mobilizing financial resources. european citizens are not as accustomed to using crowdfunding to respond to social issues in the way americans are, particularly in the case of health care (berliner & kenworthy, 2017), since the european institutions pay more attention to social issues than in ones in the united states. in the first month of the pandemic, most european countries did not provide for an adequate policy response to the crisis, pushing for the individuals to turn to crowdfunding for requiring financial support. as crowdfunding showed to be effective in situations influenced by a mix of social motives and local ties, where money is required quickly, local government support mechanisms should be more flexible and better-suited for financing for innovative projects. even though crowdfunding does not have geographic barriers, the local solutions must be custom-made and adjusted to the local economic and social entrepreneurial environment. future research will require a more in-depth examination of crowdfunding patterns. although the covid-19 pandemic boosted the appeal of all internet technologies, including social lending networks, crowdfunding systems evolved organically over time as well. it's possible that the findings are related in part to this expansion and in part to the covid-19 pandemic. acknowledgments this paper is a result of the research financed by the ministry of education, science and technological development of the republic of serbia. references berliner ls, kenworthy nj. 2017. “producing a worthy illness: personal crowdfunding amidst financial crisis”. soc sci med. bernardino, s., freitas santos, j. 2020. “crowdfunding: 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101528. ziegler t., shneor r., zhang b.z. 2020. the global status of the crowdfunding industry. in: shneor r., zhao l., flåten bt. (eds) “advances in crowdfunding”. palgrave macmillan, cham. https://doi.org/10.1007/978-3-030-46309-0_3 article history: received: july 27, 2021 revised: march 25, 2022 accepted: april 1, 2022 microsoft word 2011_1-2 review  book review serbia and the european union: economic lessons from the new member states    edited by  mirjana radović‐marković, srdjan redžepagić, et al.      the “serbia and the european union: economics lessons from  the  new  member  states“  proceedings    is  a  result  of  the  cooperation between the institute of economic sciences and the  belgrade banking academy and  the faculty of economics of  the university of coimbra. the editors of these proceedings are  the honoured professors of the institute of economic sciences:  prof. dr mirjana radović‐marković and dr srdjan redžepagić,  as well as the honoured professors of the faculty of economics,  coimbra: professor joao sausa andrade and professor paulino  teixeira.  the  reviewers  of  these  proceedings  containing  25  papers were the professors of the coimbra university: prof. dr  anonio portugal duarte, prof. dr marta c.n. simoes and prof.  dr carlos carriera.    the major goal of the book „serbia and european union: economic lessons from the new  member  states“  is  to  provide  an  accessible  presentation  of  the  facts,  theories  and  controversies that are necessary to understand this process. this book covers the essential  aspects  of  integration,  institution,  laws,  politics  and  policies.  the  book  does  not  only  contribute to our understanding of the explanations of the enlargement through community  rules  and  norms,  but  also  provides  a  strong  theoretical  contribution  to  the  analysis  of  international institutions as well as tries to extract some  general lessons that can be learned  from  the history of eu admission of  the member countries.   the different aspects of  the  integration process are presented in different chapters of the book.   the book consists of  three parts:  • the first section examines the modern european economy and integration.   • the second section examines the regional policy, agriculture and the eu accession  • the third section examines the role of policy  in sme development and the eu  accession.   one  of  the  basic  problems  of  the  transition  countries,  among  them  serbia,  in  their  endeavours to integrate into the eu are mirrored   in the lack of foreign capital, in serious  indebtedness, in the budget deficit, as well as  in the adjustment of financial systems. it is  these  issues  that  the  authors  of  the  publication  dealt  with,  offering  proposals  and     jaško, a., book review, ea (2011, vol. 44, no. 1‐2, 100‐103)     101 recommendations  for  improving  the  critical  points  in  the  economic,  social  and  political  sphere in the integration processes domain.  the first section consists of 10 chapters the aim of which is to get the answers to some  economic,  financing,  monetary  and  cultural  issues  as  the  major  curcumastances    for  the  process of integration. the integrataion is connected to the poltical and normative conditions  and thus considers the  establishmant of the system of functioning market economy. due to  the  integration  process  in  europe  and  the  european  union,  the  authors  of  the  papers  concentrate  in  a  special  way  on  the  economic  integration   proccess  and  describe  the  atratctivness  of  some  balkan  countries  for  foreign  direct  investments  as  esential  to  the  dynamic economic and social development of the countries. special attention is paid to the  financial system in serbia and other countries because it has been subject to major structural  changes in the past decade.   some authors stress the importance of the cultural dimension in the process of individual  countries’ accession   to the eu, because europe  is often seen as economically prosperous,  with  high  standards  of  living  and  monetary  investments  that  could  stimulate  economic  development, and the fact is that to join europe requires many written and unwritten rules  and laws as mental adjustments to the new value system and behaviouroul models that are  different from the old habits. in case of serbia, joining the european union means not only  the  access  to  the  funds  and  a  higher  standard  of  living  but  also  changing  the  „mental  models“ under the influence of the requests that would be made when serbia has joined.   a group of authors point out that one problem of the transition countries, among them  serbia, is the credibility problem, since prominent risks of the transition countries reduce the  credit  worthiness  of  these  countries,  thus  directly  increasing  the  prce  of  capital  and  consequently  reducing  the  national  and  international  competitiveness  of  their  entire  economies.  also,  the  performance  of  the  current  monetry  regime  in  serbia  and  other  countries is not satisfactory. in serbia, like in most developing countries, the predictions for  adopting  inflation  targeting are not present yet. the credibility problem  is still unsolved.  this problem is emphasized by the lack of trusting in the national currency and its exchange  rate.   the  experiences  of  other  countries,  such  as  greece  and  portugal,  in  constituting  the  consumption model can serve as a good example to serbia in its efforts to solve the problems  of debts and high interest rates. the experiences of slovakia in resolving the monetary policy  problems  certainly  serve  as  a  good  example  for  a  further  analysis  and  benchmarking  of  similar problems in serbia.   the second part of the proceedings explores the issues regarding the regional policy and  agriculture in view of the accessionto the eu. the selection of regional policies of a country is  largely conditioned by the regional differences in its development and the specific features of  its  economic  structure.  the  inequalities  in  economic  growth  certainly  is  an  important  problem of the developing countries, among them portugal, the authors dealing with this  phenomenon stress. the financial policy of development and of the  assets from the republic  and institutions’ funds cannot ensure the results that are necessary to accomplish in a short‐ term and the medium‐term periods. it is for these reasons that one solution to an acellerated  development of serbia  is  to make use of  the european  funds earmarked  for  the regional  development. the importance and potential support of these funds for serbia is visiable in     economic analysis (2011, vol. 44, no. 1‐2, 100‐103)   102 the fact that the european union’s financial capacity for the purpose of the equal regional  development is more than ten times higher than the serbian annual gdp. one of the basic  preresquisities for a stable and continuous social and economic development   is the equal  regional growth of all the regions of the country and as one of the basic european values this  should contribute  to planning and application of  the development policy.   as a potential  candidate, the republic of serbia  has made great efforts in conducting legal and technical  preparations  for  an  access  to  these  funds.  in  that  sense,  regionalization  may  be  a  good  preparatory activity. by the time it attains the status of a candidate country, serbia could do  more on the cooperation play with nehgbouring countries and by doing so it would receive  more resources from the eu funds.   since  agriculture  is  the  prevailing  activity  ina  majority  of  the  most  underdeveloped  regions  of  the  eu,  as  well  as  of  serbia,  it  is  evident  that  a  large  number  of  the  serbian  regional development policies  may be related to the eu policy.  a large number of authors  highlight the importance of agriculture as a key factor of a country’s  economic growth. the  authors that deal with the agriculture problems in this section of the proceedings point out  that agriculture is an important determinant of a country’s economic growth. the agriculture  sector  in  serbia  has  a  highly  important  role  in  the  employment  of  the  population.  the  development of agriculture should become a corner stone of a general policy of development  in serbia and should be allocated far larger financial assets from the budget compared to the  previous period. in order that the competitivness of agriculture sector should be improved it  is necessarry that a system solution to  its financing be worked out. this requires that the  agricultural budget and policy be known for the period of at least five years, as well as that a  transparent mechanism of cost control and the control of the efficiency of measures financed  from the agricultural budget be established.   the third section of the proceedings deals with the area of policies in the context of the  small and the medium‐size enterprise development   as well as creating conditions for the  accession to the eu. the authirs stress that small and medium‐size enterprises make a key  issue in the economic development of any country, and the basic source of economic growth  and flexibility.  it is for this reason that they stress the importance of formulating adequate  policies  and  legislature  in  this  area.  the  policymakers  are  conclusive  in  their  attempt  to  promote  a  more  dynamic  development  of  the  sme  sector  by  creating  policies  and  consistently implementing the basic principles contained in the european charter for small  enterprises.  the  further  course  of  the  serbian  integration  to  european  union  will  be  a  primary determinant of  the sme  sector.  the realization of smes growth  potential  in  the  future requires an advanced approach orientied towards promoting enterpreneurship and  creating a friendlier environment for small businesses.   it should be noted that an important point in bringing together the small and medium‐ size businessas and entrepreneurship is the company’s socially responsible business doing  that is one way of achieving sustainable growth.  the countries such as serbia, which strive  to become the eu members, should base their socio‐economic development on the good eu  practices. the role of the academia, the civil sector and the business associations is crucial for  the achievement of this goal. the state has a partcular role in stimulating the csr through  rewarding  the  socially  responsible  behaviour  and  through  public‐private  partnerships  in  addressing the needs of the society.      jaško, a., book review, ea (2011, vol. 44, no. 1‐2, 100‐103)     103 having in mind the importance of the above‐mentioned areas in the process of serbia’s  accession to the european union, this proceedings addresses the key issues and problems  the  transition  countries  are  faced  with.  sharing  the  experiences  of  the  countries  such  as  portugal, greece, slovakia,  we gain the economic, financial and monetary knoeldege which  may be of use to serbia in the process of its accession to the eu. this is where the importance  of this proceedings lies – in the efforts of each of its authors to contribute with their works to  the european integrations.   ana jaško  institute of economic sciences, belgrade    notes from the editor-in-chief the economic analysis publishes original articles in all fields of economic theory and practice. in other words, it connects economics to real-world experiences. the potential spectrum of topics is broad including economic development, green economics, employment and education policy, labor issues, business governance and ethics, management of human resources, marketing, microeconomics, monetary and financial economics and other topics. we invite academicians, professors, researchers, phd and master students which are connected to the topics of the journal, to publish their work. i hope that 2013 will bring you professional advancement and a lot of quality research to share with our readers. yours! editor-in-chief prof. dr. mirjana radović-marković, fea, frsa, fwaas, femaas, skanu microsoft word 2011_1-2         letter from the editor‐in‐chief        the economic analysis (ea) has published its first issue in 2011  and has made this edition available online. we would like to remind you  that ea is one of the oldest journals in economics in serbia, with many of  the  worldʹs  leading  economists  on  its  editorial  board.  despite  we  permanently  attempt  to  wide  editorial  board  and  cooperation  with  eminent  economists,  how  we  would  maintain  and  improve  quality  of  journal.    we will continue to publish scientific articles by well‐known foreign and domestic economists  different  profiles,  how  we  will  introduce  our  readers  with  contemporary  world  economic  ideas,  opinions, themes and tendencies. namely,  it  is committed to publishing cutting‐edge research that  makes theoretical advances to the discipline.  ea is published by the institute of economic sciences twice a year, in april and october.    sincerely,     prof. dr. mirjana radović marković  fellow of world academy of art and science         ea_2019_2 doi: 10.28934/ea.19.52.2.pp12-27 original scientific paper gauging the effects of modern payment technologies adoption on the demand for money in nigeria tersoo iorngurum1* 1 veritas university abuja, faculty of social sciences, department of economics, federal capital territory (fct), nigeria, west africa abstract in contrast to the global intermediate goals of monetary policy, “financial exclusion” remains prevalent. therefore, using the nigerian economy as a point of reference, this paper attempts to shed more light on the role played by modern payment technologies in promoting financial inclusion, especially as it relates to the provision of currency in the hands of the nigerian public for liquidity services during the period 2009:q1 to 2017:q4. in actualizing this objective, the johansen cointegration method is employed to test for cointegration alongside vector error correction modeling (vecm) techniques, while the gregory-hansen cointegration method is employed to test for structural breaks and regime shifts. subsequently, empirical results from the johansen cointegration test and the normalized cointegrating coefficients of the estimated vector error correction model (vecm) reveal that real currency in the hands of the nigerian public is positively cointegrated with real modern payment technologies transactions as well as real gross domestic product (gdp), but negatively cointegrated with real savings interest rates, real quarterly time deposits interest rates, and inflation rate. on the other hand, empirical results from the gregoryhansen cointegration method indicate further that there are no structural breaks or regime shifts in the cointegrating coefficients during the period 2009:q1 to 2017:q4. in conclusion, the existence of a positive relationship between real modern payment technologies transactions and real currency in the hands of the nigerian public implies that the former are partly responsible for the growth of the latter, thereby indicating that modern payment technologies are effective in promoting financial inclusion by providing access to liquidity services. based on this finding the study recommends that the adoption of modern payment technologies should be promoted in order to further extend liquidity services to financially excluded nigerians. key words: modern payment technologies, money demand jel classification: e42, e41 introduction apart from the core mandate which primarily aims at achieving economic growth and curtailing inflation, monetary authorities all over the world aim at facilitating adequate access to financial services and financial products, otherwise known as “financial inclusion”, in their respective economies. in the nigerian context, several policies and initiatives have been formulated and enacted in this regard, such as the financial stability strategy (fss2020), the microfinance policy, non-interest banking, and until recently, the cashless policy initiative * e-mai: tersoodavid@gmail.com tersoo iorngurum 13 which aims at extending digital financial services through modern electronic payment technologies (kama & adigun, 2013; cbn, 2014). in spite of these however, it is pertinent to note that inadequate access to financial services and financial products, otherwise known as “financial exclusion”, remains prevalent. with regards to the nigerian economy, this problem prominently manifests itself with the majority of households (60.3%) lacking access to basic financial services and products such as liquidity services, savings accounts, deposit accounts, and credit services (world bank, 2018). if this problem is allowed to persist, then the ultimate goal of achieving economic development may be unattainable in the short-term. this paper therefore attempts to shed more light on the possible solutions to this problem by examining the role played by modern payment technologies in promoting financial inclusion with reference to the nigerian economy, especially as it relates to the provision of currency in the hands of the nigerian public for liquidity services during the period 2009:q1 to 2017:q4. the empirical methods adopted in this study include the johansen cointegration method, the gregory-hansen cointegration method, as well as theoretical considerations from milton friedman’s money demand theory. further, in structuring the paper we adopt the following pattern: section 2 deals with the literature review. section 3 deals with the empirical methodology. section 4 deals with the empirical results. and section 5 deals with the conclusions. literature review in reviewing the empirical literature, a distinction is made between those early studies which focused on money demand and its conventional theoretical determinants such as income, inflation, interest rates, and exchange rates, and those contemporary studies which focused on money demand and modern payment technologies. money demand, income, interest rates, and ininflation in nigeria pertaining to those early contemporary studies that laid empirical foundations for money demand investigations in nigeria, nwaobi (2002) examined the stability of money demand and the robustness of gdp as a scalar determinant of money demand in nigeria during the period 1960 to 1995. with a relatively simple model-specifying vector valued autoregressive process, the hypothesis of the existence of cointegration vectors was tested and it was found that the demand for money was cointegrated with real income, interest rate and price level. furthermore, adopting general to specific approach, an over parameterized dynamic money demand function was estimated. thereafter, evidence gathered from the non-nested tests, suggested that income was the more appropriate scale variable in the estimation of the demand for money in nigeria. these results sharply contradict most findings based on developed countries but are in tune with the majority of studies that used income as the appropriate scale variable in demand for money functions estimated through techniques of cointegration and error correction mechanism. akinlo (2006) examined the determinants of broad money demand in nigeria and its functional stability during the period 1970q1 to 2002q4. in so doing, the study employed the bounds cointegration method and the cusum stability test. the bounds cointegration results showed that broad money was positively cointegrated with income, but negatively cointegrated with interest rate and exchange rate, while the cusum test reported a weakly stable money demand function. omotor and omotor (2011) studied the functional stability of the demand for money in nigeria during the period 1960 to 2008. the method employed was the gregory-hansen cointegration method. the empirical results revealed an endogenous break in nigeria’s money 14 economic analysis (2019, vol. 52, no. 2, 12-27) demand function in 1994. however after estimation, money demand was found to be functionally stable, thereby confirming the findings of previous studies which found money demand to be functionally stable and also established the fact that the central bank of nigeria can effectively use money supply as a monetary policy instrument. aiyedogbon, ibeh, edafe, and ohwofasa (2013) investigated the stability of money demand in nigeria during the period 1986 to 2010. the study employed the johansen cointegration test and the cusum/cusumsq stability tests to test for cointegration and parametric stability respectively. the results showed that interest rate, inflation rate and openness had negative impacts on real money demand, while gross capital formation, exchange rate and government expenditure had positive impacts. further, the results showed that the money demand was functionally stable during the study period. doguwa, olowofeso, uyaebo, adamu, and bada (2014) studied nigeria’s broad money demand function during the period 1991:q1 to 2013:q4. the procedures employed included the gregory-hansen cointegration method and the cusumsq stability test. the gregory-hansen cointegration results revealed both intercept and regime shifts in 2007:q1, thereby indicating that structural breaks existed in the long run relationship between real broad money demand, real income, real monetary policy rate, exchange rate spread and exchange rate movements in nigeria. further, the cusumsq test provided evidence of a stable money demand function before and after the 2008/2009 global financial crisis. in conclusion, the study recommended that since the relationship among the aforementioned variables held over a fairly long period of time, the estimated money demand model can provide important foundations for monetary policy setting in nigeria. folarin and asongu (2017) studied the long-run demand for money and its stability in nigeria during the period 1992:q1 to 2015:q4. in this study, the bounds cointegration method was employed alongside the cusum/cusumsq stability tests to determine the existence of a cointegrated and stable relationship between money demand and its determinants. on this note, the empirical results showed that a stable and cointegrated relationship existed between money demand, income, interest rate, and inflation. also, inflation rate was found to be a better opportunity cost variable in explaining money demand when compared to interest rate. tule, okpanachi, ogiji, and usman (2018) investigated the determinants of broad money demand in nigeria and its stability during the period 1985:q1 to 2016:q4. the procedures employed were the bounds cointegration method and the cusumsq stability test. the empirical results of this study revealed that a stable long-run relationship existed between broad money (m2) and its determinants namely gdp, stock prices, foreign interest rates and real exchange rate. particularly, stock prices showed a significant and positive effect on long-run broad money demand, which in some ways reflected increased “financialization” and integration of the nigerian economy into the global economic system. overall, the findings of this study gave credence to the continued relevance of broad money (m2) as a benchmark for monetary policy implementation in nigeria. nwude, offor, and udeh (2018) examined the determinants of broad money demand in nigeria during the period 1991:q1 to 2014q4. the procedures employed included the bounds cointegration method and the cusum stability test. the empirical results showed that a cointegrated and stable relationship existed between real broad money, real income, domestic interest rate, inflation rate, exchange rate and foreign interest rate. to be precise, real income and exchange rate were found to be positively related to the demand for real broad money while domestic interest rate, inflation rate and foreign interest rate were found to be negatively related to the demand for real broad money. tersoo iorngurum 15 money demand, modern payment technologies, and financial innovation in nigeria pertaining to those contemporary studies that attempted to investigate the impact of modern payment technologies and financial innovations on money demand in nigeria, odularu and okunrinboye (2009) studied the impact of the financial innovations on the demand for real currency in nigeria during the period 1970 to 2004. the procedure employed was the engle and granger two step cointegration method. the empirical findings revealed that financial innovations did not significantly affect the demand for real currency in nigeria. however, the empirical findings revealed that income was positively related to the demand for real currency whereas interest rate was inversely related to the demand for real currency. oyelami and yinusa (2013) examined the impact of modern payment technologies on money demand during the period 2008:m01 to 2010:m12. the procedures employed included vector error correction modeling (vecm) and impulse response function analysis. the findings revealed that money demand was cointegrated atms usage, pos usage, web usage, and mobile money usage. further, impulse response functions showed that money demand responded positively to innovations from automated teller machines (atm) and point-of-sales (pos), but responded negatively to innovations from internet payment and mobile money. sowunmi, amoo, olaleye, and salako (2014) investigated the effects of automated teller machine (atm) on demand for money in isolo local government area of lagos state. the procedure employed included probit analyses. the results revealed that automated teller machines (atms) has significantly increased the frequency of demand for money when compared with non-users of atm. however, the average volume of money withdrawn through atm was found to be significantly less than the amount withdrawn though cheque. the study also found that the ability of customers to meet their precautionary cash needs was enhanced by the use of atms because customers have access to cash during weekends and national strikes. further, atms did not only reduce long queues in the banking halls but also reduced the average time spent in withdrawing cash. among the problems encountered, most of the atm users (45.5%) complained of inadequate service due to technical fault or power outages. therefore, it was recommended that the quality of atms should be improved through adequate investment. egbetunde, ayinde, and adeyemo (2015) investigated the impact of modern payment technologies on broad money demand in order to determine the impact of nigeria’s cash policy on money demand during the period 2010:m1 to 2013:m8. the procedures employed included the johansen cointegration method and vector error correction modeling (vecm). the empirical results revealed that a negative cointegrated relationship existed between money demand, atms usage, pos usage, monetary policy rate, and exchange rate, while a positive cointegrated relationship existed between money demand, inflation, government expenditure, real gdp, and web transfer. apere (2017) studied the implications of financial innovations in modern payment technologies on money demand in nigeria during the period 1981 to 2016. the procedures employed included impulse-response analysis and var granger causality testing. the empirical results revealed that innovation in modern payment technologies is an important variable that affects money demand negatively. the results of the study also revealed that the long-run demand for money balances in nigeria positively depends on income level but negatively depends on interest rate. theoretical framework this study adopts friedman’s (1956) money demand theory. according to this theory, the demand for real (money) balances is determined by the real yields of other assets (bonds, equities, and physical assets), the rate of inflation, real wealth, the ratio of human to non-human 16 economic analysis (2019, vol. 52, no. 2, 12-27) wealth, and individuals’ tastes and preferences. this is captured in the following money demand function: �� = ��� = �� �, … … , #, $, %, &, '( )'(� (1) here, md denotes demand for money balances in real terms, md denotes demand for money balances in nominal terms, p denotes price level, ri denotes returns in real terms of the ith asset, π denotes rate of inflation, w denotes wealth in real terms, u denotes individuals’ tastes and preferences, and hw/nhw denotes the ratio of human to non-human wealth. given that data on the ratio of human to non human wealth was not available at the time of friedman’s (1956) postulation, the empirical version of the money demand function was and/or is often expressed as: �� = ��� = �� �, … … , #, $, %� (2) based on this equation, friedman (1956) empirically argued that real wealth w, is positively related to the demand for real balances md, whereas the returns on other assets ri and inflation π are inversely related to the demand for real balances md. therefore, on the basis of this theory, it is expected that: *+� *, > 0 (3) *+� */0 < 0 (4) *+� *2 < 0 (5) in order to introduce modern payment technologies, we assume that the liquidity services of money or currency in the hands of the public can be substituted (or complemented) by utilizing modern payment technologies like automated teller machines (atms), point of sales (pos) terminals, web payment systems, and mobile payment systems for transactionary and precautionary purposes. under this assumption, individuals’ decisions to use modern payment technologies in lieu of currency in the hands of the public for liquidity services at any given point in time reflects their tastes and preferences at that point in time. therefore, assuming that the degree of individual’s tastes and preferences for money (u) in friedman’s (1956) theory is proxied by the volume of modern payment technologies transactions (mpt) in the economy, it can be assumed that: *+� *3 ≈ *+� *��5 (6) where mpt denotes modern payment technologies transactions, and all other variables remain as previously denoted. further, it is intuitively inferable that: *+� *��5 = *+� *65� + *+� *�78 + *+� *,9: + *+� *+;:�<9 (7) and: *+� *65� > 0 (8) *+� *�78 > 0 (9) tersoo iorngurum 17 *+� *,9: < 0 (10) *+� *+;: < 0 (11) such that the direction and magnitude of (6) depends on the predominance of (8) and (9) over (10) and (11). in other words, if atms and other cash-dispensing payment technologies are found to be predominant in the economy, it is expected that: *+� *��5 > 0 (12) but if mobile payment systems and other cashless payment technologies such as internet payment systems are found to be predominant in the economy, it is expected that: =>? =@ab < c (13) empirical methods and results data the data used in carrying out this study is quarterly time series data covering the period 2009q1 to 2017q4. the data is obtainable from the statistical bulletin of the central bank of nigeria (2019). model specification in accordance with friedman’s (1956) money demand theory, the demand for real balances is specified as a function real wealth proxied by real gross domestic product (y), real savings interest rate (r1), real quarterly time deposits interest rates (r2), inflation rate (π), and individuals’ tastes and preferences proxied by real modern payment technologies transactions (mpt) as seen in (14): �� = ��d� , �� , �� , $� , �e�� � (14) in var form we have: ��� = f + ∑ f�� d�h�i�j − ∑ f�� ��h�i�j − ∑ f�� ��h�i�j − ∑ f�� $�h�i�j + ∑ f�� �e��h�i�j + ∑ fl� ��h��i�j� + ��� (15) d� = m + ∑ m�� d�h�i�j� − ∑ m�� ��h�i�j − ∑ m�� ��h�i�j − ∑ m�� $�h�i�j + ∑ m�� �e��h�i�j + ∑ ml� ��h��i�j + ��� (16) �� = n + ∑ n�� d�h�i�j − ∑ n�� ��h�i�j� − ∑ n�� ��h�i�j − ∑ n�� $�h�i�j + ∑ n�� �e��h�i�j + ∑ nl� ��h��i�j + ��� (17) �� = o + ∑ o�� d�h�i�j − ∑ o�� ��h�i�j − ∑ o�� ��h�i�j� − ∑ o�� $�h�i�j + ∑ o�� �e��h�i�j + ∑ ol� ��h��i�j + ��� (18) $� = p + ∑ p�� d�h�i�j − ∑ p�� ��h�i�j − ∑ p�� ��h�i�j − ∑ p�� $�h�i�j� + ∑ p�� �e��h�i�j + ∑ pl� ��h��i�j + ��� (19) 18 economic analysis (2019, vol. 52, no. 2, 12-27) �e�� = q + ∑ q�� d�h�i�j − ∑ q�� ��h�i�j − ∑ q�� ��h�i�j − ∑ q�� $�h�i�j + ∑ q�� �e��h�i�j� + ∑ ql� ��h��i�j + �l� (20) estimation procedures unit root testing with break points the order of integration of the given time series, yt, may be examined by a unit root test which accounts for structural breaks. for this purpose we adhere to peron (1989) by utilizing a parametric approach to evaluate a null of non-stationarity (φ = 0) against an alternative of broken trend-stationarity (φ < 0) with the following equations: d� = � + rst� �u:� + os� �u: � + fd�h� + ∑ v� wd�h�x�j� + &� (21) d� = � + m� + rst� �u: � + os� �u: � + fd�h� + ∑ v� wd�h�x�j� + &� (22) d� = � + m� + ysu� �u: � + fd�h� + ∑ v� wd�h�x�j� + &� (23) d� = � + m� + rst� �u: � + ysu� �u:� + os� �u: � + fd�h� + ∑ v� wd�h�x�j� + &� (24) here, (21) represents a non-trending level-break model which allows for a change in level; (22) represents a trending level-break model which also allows for a change in level with a trend specification; (23) represents a trending trend-break model in which allows for a change in trend; and (24) represents a trending level/trend-break model which allows for a change in both level and trend. further, in (21) to (24) the three dummy variables characterize the break points. the first is a level-break dummy defined by: st� �u: � = z0, [� � ≤ u:1, [� � > u: (25) the second is a trend-break dummy defined by: su� �u: � = z 0, [� � ≤ u:1�� − u: + 1�, [� � > u: (26) and the third is a one-time break dummy defined by: s� �u: � = z0, [� � ≠ u:1, [� � = u: (27) lag length selection in determining the optimal lag length of the var, it is pertinent to adopt appropriate information criteria. on this note, we adopted the akaike information criterion (aic) and the schwarz information criterion (sic) which involves the following computations: �_` = u ∗ abc│e│ + 2g (28) h_` = u ∗ abc│e│ + g ∗ abc�u� (29) here, aic denotes akaike information criterion statistic, sic denotes schwarz information criterion statistic, t denotes number of usable observations, log│σ│ denotes natural log of tersoo iorngurum 19 covariance matrix, and n denotes total number of parameters to be estimated in the var (lutkepohl, 2005). cointegration testing in testing for cointegration, johansen’s (1995) method utilizes two tests: the maximum eigenvalue test and the trace test. the maximum eigenvalue test evaluates a null of r cointegrating relations against an alternative of r+1 cointegrating relations. the test statistic is computed as: ij+kl � | + 1� = −u abc�1 − n/o�� = ij�/ � |p� − ij�/ � + 1|p� (30) for r = 0,1, …, k-1. on the other hand, the trace test evaluates a null of r cointegrating relations against an alternative of k cointegrating relations, where k is the number of endogenous variables, for r = 0, 1, …, k-1. the alternative of k cointegrating relations corresponds to the case where none of the series has a unit root such that a stationary var may be specified in terms of the levels of all the series. the trace test statistic for the null of r cointegrating relations is computed as: ij�/ � |p� = −u ∑ abc�1 − n� �x�j/o� (31) where λi denotes the i-th largest eigenvalue of the π matrix (johansen, 1995). vector error correction modeling (vecm) when evidence of cointegration abounds, granger’s representation theorem allows one to estimate a vector error correction model which takes the following form: wd� = ∑ q�xh��j� wd�h� + r� d�hx + � + ɛ� (32) here, yt is a px1 vector of endogenous i(1) variables; μ is a px1 vector of intercepts; ɛt is a px1 vector of stationary random processes with zero mean and constant variance; γ is a pxp matrix of short-run coefficients; and π is a matrix decomposed into m’f, where m’ is an pxr matrix of cointegrating vectors and f is a pxr matrix of error correction coefficients (johansen, 1995). statistical and econometric evaluation the t-test and the f-test may be utilized to impose restrictions on the estimated coefficients of the vector error correction model (vecm) and the cointegrating vectors in order to test for statistical significance. further, a plethora of econometric tests may be employed to ensure that the estimated models possess the necessary second order econometric properties. to be precise, reference will be made to the breusch-godfrey test, the breusch-pagan-godfrey test, and the jarque-bera test in order to test for serial correlation, heteroskedasticity, and normality respectively. the alternative of cointegration testing with structural breaks in johansen’s (1995) method, the cointegrating coefficients may be biased if structural breaks actually exist in the cointegrating coefficients. a more suitable approach which allows for cointegration testing with structural breaks is gregory and hansen’s (1992b) method. in this method, the null of hypothesis of “no cointegration” is evaluated against four distinct alternative 20 economic analysis (2019, vol. 52, no. 2, 12-27) hypotheses of cointegration with structural breaks. the first alternative hypothesis (gh 1) assumes that there is a level-break in the cointegrating relationship: d�� = �� + ��p�/ + f5 d�� + t� (33) the second alternative hypothesis (gh 2) assumes that there is a level break with a trend specification: d�� = �� + ��p�/ + m� + f5 d�� + t� (34) the third alternative hypothesis (gh 3) assumes that there is a regime-shift: d�� = �� + ��p�/ + f�5 d�� + f�5 d�� p�/ + t� (35) the fourth alternative hypothesis (gh 4) assumes that there is a regime shift and a trend break: d�� = �� + ��p�/ + m�� + m��p�/ + f�5 d�� + f�5 d�� p�/ + t� (36) in order to evaluate the null of “no cointegration” against the aforementioned alternative hypotheses, gregory and hansen’s (1992b) method employs the philips tests (zt and zα) and the augmented dickey-fuller (adf) test. however, the non-parametric phillips tests are preferable because they are robust against misspecification and structural breaks which might encountered in parametric estimations. empirical results unit root test results the results of the unit root tests are presented in table 1. table 1. unit root test results variable s lags included trend specification break date adf test statistic 5% critical value remarks mtd 1 trend 2011q4 -5.1573 -5.1757 i(1) δmtd 2 no trend 2011q4 -5.9083 -4.4437 i(0) mptt 1 trend 2015q3 -3.9637 -5.1757 i(1) δmptt 0 no trend 2011q1 -6.1528 -4.4436 i(0) yt 4 trend 2011q1 -3.6790 -5.1757 i(1) δyt 0 no trend 2017q2 -6.8611 -4.4437 i(0) r1t 0 trend 2013q2 -4.0692 -5.1757 i(1) δr1t 0 no trend 2016q1 -7.8116 -4.4436 i(0) r2t 1 trend 2015q3 -3.2078 -5.1757 i(1) δr2t 0 no trend 2011q1 -5.0090 -4.4436 i(0) πt 3 trend 2016q1 -3.7669 -5.1757 i(1) δπt 2 no trend 2015q4 -8.3801 -4.4436 i(0) lag selection based on schwarz information criterion (sic) source: result processed using eviews 9. for each variable, the null of non-stationarity is evaluated against the alternative of stationarity with a break point. in the level form, the null of non-stationarity is accepted at the 5% level of significance. but in the first difference, the null hypothesis of non-stationarity is tersoo iorngurum 21 rejected at the 5% level of significance. therefore, in compliance with the johansen cointegration method, the unit root test results shows that each variable is difference-stationary. lag length selection results the results of the aic and the sic are presented in table 2. the aic and the sic both suggest that 4 lags should be utilized. therefore in testing for cointegration with the johansen method, 4 lags will be incorporated in estimating the var model. table 2. lag length selection results lag length aic sic 0 25.5078 25.7827 1 19.8126 21.7364 2 19.9453 23.5180 3 19.0485 24.2701 4 13.8920* 20.7626* note: * indicates lag order selected by criterion source: result processed using eviews 9. cointegration test results table 3 presents the trace test results while table 4 presents the maximum eigenvalue test results. table 3. unrestricted cointegration test results trace test null hypothesis eigen-value trace statistic 5% critical value p-value none* 0.8731 124.5164 95.7537 0.0001 at most 1 0.5804 60.5175 69.8189 0.2198 at most 2 0.4707 33.5922 47.8561 0.5242 at most 3 0.2462 13.8672 29.7971 0.8480 at most 4 0.1314 5.1039 15.4947 0.7977 at most 5 0.0235 0.7371 3.8415 0.3906 notes: trace test indicates 1 cointegrating equation * denotes rejection at 5% level source: result processed using eviews 9. table 4. unrestricted cointegration test results maximum eigenvalue test null hypothesis eigen-value trace statistic 5% critical value p-value none* 0.8731 63.9989 40.0776 0.0000 at most 1 0.5804 26.9253 33.8769 0.2674 at most 2 0.4707 19.7250 27.5843 0.3605 at most 3 0.2462 8.7634 21.1316 0.8510 at most 4 0.1314 4.3668 14.2646 0.8187 at most 5 0.0235 0.7371 3.8415 0.3906 notes: maximum eigenvalue test indicates 1 cointegrating equation * denotes rejection at 5% level source: result processed using eviews 9. 22 economic analysis (2019, vol. 52, no. 2, 12-27) the decision rule is to reject the null of “no cointegrating vectors” if the trace and maximum eigenvalue statistics are greater than their corresponding 5% critical values. therefore, from tables 3 and 4, the null hypotheses of no cointegrating vectors are rejected at the 5% level of significance, thereby indicating that 1 cointegrating vector exists for the relationship between money demand and the other endogenous variables of the var. vector error correction modeling (vecm) results the evidence of cointegration in table 3 and table 4 allows us to estimate a vector error correction model based on granger’s representation theorem. the estimates of the vector error correction model are presented in table 5, while the corresponding normalized cointegrating coefficients are presented in table 7. in tables 5 and 7, and the subsequent equations, md still denotes real currency in the hands of the public, y still denotes gross domestic product which serves as a proxy for wealth, r1 still denotes real savings interest rate, r2 still denotes real quarterly time deposits interest rate, π still denotes inflation rate, and mpt still denotes real modern payment technologies transactions. table 5.: estimates of the vector error correction model (vecm) eqn. δmdt δmptt δyt δr1t δr2t δπt δ mdt-3 0.0814 (0.1563) [ 0.5209] 0.1422* (0.0673) [ 2.1115] 2.8012 (1.3838) [ 2.0241] 0.0779 (0.0872) [ 0.8929] 0.1554 (0.1584) [ 0.9811] -0.6301* (0.2628) [-2.3970] δmptt-3 -1.1109* (0.4511) [-2.4625] -0.2500 (0.1943) [-1.2877] 1.0590 (3.9936) [ 0.2651] 0.2452 (0.2518) [ 0.9739] 0.8453 (0.4571) [ 1.8491] 0.2581 (0.7586) [ 0.3403] δyt-3 -0.04007 (0.0207) [-1.9318] -0.0174* (0.0089) [-1.9517] 0.3530 (0.1836) [ 1.9225] 0.0144 (0.0115) [ 1.2450] 0.0145 (0.0210) [ 0.6930] -0.0176 (0.0348) [-0.5059] δr1t-3 0.1448 (0.6912) [ 0.2095] 0.0826 (0.2977) [ 0.2774] -15.4736* (6.1187) [-2.5288] -0.2020 (0.3858) [-0.5236] -0.2419 (0.7004) [-0.3453] -0.4603* (1.1623) [-0.3960] δr2t-3 -0.4504 (0.2424) [-1.8579] -0.2233* (0.1044) [-2.1392] 4.4526* (2.1459) [ 2.0749] -0.0229 (0.1353) [-0.1692] -0.0399 (0.2456) [-0.1625] 0.4736 (0.4076) [ 1.1620] δπt-3 0.17808 (0.1725) [ 1.0327] 0.0197 (0.0742) [ 0.2664] -2.2950 (1.5266) [-1.5033] 0.0629 (0.0962) [ 0.6543] 0.0965 (0.1747) [ 0.5524] -0.4812 (0.2900) [-1.6596] c 0.01431 (0.2584) [ 0.0554] 0.3345* (0.1113) [ 3.0053] 3.3837 (2.2875) [ 1.4791] -0.0184 (0.1442) [-0.1278] -0.3041 (0.2618) [-1.1616] 0.1274 (0.4345) [ 0.2933] ectt-1 -0.0202* (0.0089) [-2.2592] -0.0046 (0.0038) [-1.2021] 0.3932* (0.0789) [ 4.9796] 0.0007 (0.0049) [ 0.1530] -0.0306* (0.0090) [-3.3884] -0.0150 (0.0150) [-1.0045] notes: * indicates significance at 5% level of significance standard errors in parenthesis ( ), t-statistics in square brackets [ ] source: result processed using eviews 9. tersoo iorngurum 23 table 6. summary statistics of the vector error correction model (vecm) δmdt δmptt δyt δr1t δr2t δπt r-squared 0.5814 0.4640 0.6479 0.2056 0.4624 0.3451 adj. r-sq 0.4593 0.3077 0.5452 -0.0259 0.3057 0.1541 f-statistic 4.7628 2.9688 6.3101 0.8877 2.9501 1.8070 bg(4) 36.2591 {0.4565} bpg(294) 309.5488 {0.2553} jb(12) 3.8144 {0.9865} notes: p-values in brackets { } f-test 5% critical value equals 2.49, at v1=6 and v2=26 degrees of freedom bg(4) denotes breusch-godfrey lm test for 4th order serial correlation bpg(294) denotes breusch-pagan-godfrey heteroskedasticity test at 294 degrees of freedom jb(12) denotes jarque-bera joint normality test at 12 degrees of freedom, 2 for each of 6 components source: result processed using eviews 9. table 7. normalized cointegrating coefficients mdt c mptt yt r1t r2t πt 1 -9.6496 -10.0091* (1.8327) [-5.4614] -0.5762* (0.2046) [-2.8163] 11.8729* (4.9138) [ 2.4163] 7.7256* (1.9776) [ 3.9066] 5.3337* (1.3068) [ 4.0814] notes: * indicates significance at 5% level of significance standard errors in parenthesis ( ), t-statistics in square brackets [ ] source: result processed using eviews 9. for ease of interpretation, the estimates in table 5 are also presented linearly in (37) to (42), while the coefficients in table 7 are also presented linearly in (43). w��� = 0.0143 + 0.0814w��h�� − 1.1109w�e��h� − 0.0401wd�h� + 0.1448w ��h� − 0.4504w ��h� + 0.1781w$�h� − 0.0202�`u�h� + &�� (37) w�e�� = 0.3345 + 0.1422w��h�� − 0.250w�e��h� − 0.0174wd�h� + 0.0826w ��h� − 0.2233w ��h� + 0.0197w$�h� − 0.0046�`u�h� + &�� (38) wd� = 3.3837 + 2.8012w��h�� + 1.0590w�e��h� + 0.3530wd�h� − 15.4736w ��h� + 4.4526w ��h� − 2.2950w$�h� + 0.3932�`u�h� + &�� (39) w �� = −0.0184 + 0.0779w��h�� + 0.2452w�e��h� + 0.0144wd�h� − 0.2020w ��h� − 0.0229w ��h� + 0.0629w$�h� + 0.0007�`u�h� + &�� (40) w �� = −0.3041 + 1554w��h�� + 0.8453w�e��h� + 0.0145wd�h� − 0.2419w ��h� − 0.0399w ��h� + 0.0965w$�h� − 0.0306�`u�h� + &�� (41) w$� = 0.1274 − 0.6301w��h�� + 0.2581w�e��h� − 0.0176wd�h� − 0.4603w ��h� + 0.4736w ��h� − 0.4812w$�h� − 0.0150�`u�h� + &l� (42) among the numerous coefficients, interest lies in the error correction coefficient (ectt-1) which shows the rate of adjustment to the long-run cointegrated relationship between mdt and the other endogenous variables. in (37), the error correction coefficient is expectedly negative and statistically significant, thereby signifying equilibrium and indicating that 2.02 percent of 24 economic analysis (2019, vol. 52, no. 2, 12-27) any discrepancies in long-run mdt will be corrected in each period. in (38), the error correction coefficient is negative but statistically insignificant, thereby implying that (38) is out of equilibrium. in (39), the error correction coefficient is positive and statistically significant, thereby implying that (39) is too high to be in equilibrium. in (40), the error correction coefficient is positive, but statistically insignificant, thereby implying that (40) is out of equilibrium. in (41), the error correction coefficient is negative and statistically significant, thereby implying that (41) reverts to equilibrium with respect to discrepancies in long-run mdt. in (42), the error correction coefficient is negative but statistically insignificant, thereby implying that (42) is out of equilibrium. further, based on the adjusted r2s in table 6, (39) seems to be the only component with a good fit (54.52%). on the other hand, based on the f-statistics, (37), (38), (39), and (41) seem to be statistically significant at the 5% level, while (40) and (42) seem to be statistically insignificant at the 5% level. pertaining to the second order econometric criteria, the p-values (0.4564 and 0.2553) for the breusch-godfrey (bg) test and the breusch-pagan-godfrey (bpg) test lead to the rejection of the null hypothesis of 4th order serial correlation and the null hypothesis of heteroskedasticity respectively, while the p-value (0.9865) for the jarque-bera (jb) test leads to the rejection of the null hypothesis of abnormally distributed residuals. therefore, the vecm does not violate any of the second order econometric criteria. for the long-run analysis, the normalized cointegrating coefficients in (41) will be interpreted accordingly. ��� = 9.6496 + 10.0091�e�� + 0.5762d� − 11.8729 �� − 7.7255 �� − 5.3337$� + t� (43) the coefficient of mptt is positive and statistically significant at the 5% level, thereby implying that a unit increase (decrease) in real modern payment technologies transactions causes real currency in the hands of the public to increase (decrease) by 10.0091 units. the coefficient of yt is expectedly positive and statistically significant at the 5% level, thereby implying that a unit increase (decrease) in the level of real gdp causes real currency in the hands of the public to increase (decrease) by 0.5762 units. the coefficients of r1t and r2t are expectedly negative and statistically significant at the % level, thereby implying that a unit increase (decrease) in real savings interest rates and real quarterly time deposits interest rates cause real currency in the hands of the public to decrease (increase) by 11.8729 units and 7.7255 units respectively. the coefficient of inflation rate is expectedly negative and statistically significant, thereby implying that a unit increase (decrease) in inflation rate causes real currency in the hands of the public to decrease (increase) by 5.3337 units. finally, the intercept of the cointegrating equation is positive and it implies that the real currency demand function has a positive autonomous magnitude of 9.6496 units. alternative evidence from cointegration testing with structural breaks unlike the johansen cointegration method, the gregory-hansen cointegration method is employed as an alternative cointegration method which accounts for structural breaks. the gregory-hansen test results are presented in table 8. table 8. gregory-hansen test results specification break date zt statistic 5% critical value accept h0 gh 1 2014q4 -5.27 -5.56 yes gh 2 2010q1 -5.38 -5.83 yes gh 3 2015q2 -5.61 -6.41 yes specification break date zα statistic 5% critical value accept h0 gh 1 2014q4 -31.30 -59.40 yes tersoo iorngurum 25 gh 2 2010q1 -32.99 -65.44 yes gh 3 2015q2 -33.19 -78.52 yes specification break date adf statistic 5% critical value accept h0 gh 1 2014q3 -5.29 -5.56 yes gh 2 2010q1 -6.90 -5.83 no gh 3 2014q4 -5.61 -6.41 yes note: r2 was excluded in order to obtain 4 regressors gh 4 was not computed due to limited observations source: result processed using stata 13. in interpreting results, we adopt the non-parametric zt and zα statistics instead of the parametric adf statistic because the former are robust against misspecification and structural breaks which might be encountered in parametric estimation. on this note, table 8 shows that the zt statistics are less than their 5% critical values, thereby leading to the acceptance of the null hypotheses of “no cointegration” in lieu of the alternative hypotheses of cointegration with level-break, level-break with trend, and regime shift. similarly, table 8 also shows that the zα statistics are less than their 5% critical values, thereby leading to the acceptance of the null hypotheses of “no cointegration” in lieu of the alternative hypotheses of cointegration with level-break, level-break with trend, and regime shift. therefore, based on the zt and zα statistics we accept the null of “no cointegration” but reject the alternative hypotheses of cointegration with structural breaks. conclusion in order to evaluate the role of modern payment technologies in promoting financial inclusion in the nigerian economy, this study mainly attempted to examine the effects of modern payment technologies adoption on the availability of currency in the hands of the nigerian public during the period 2009:q1 to 2017:q4. on this note, the johansen cointegration method was employed to test for cointegration alongside vector error correction modeling (vecm) techniques, while the gregory-hansen cointegration method was employed to test for structural breaks and regime shifts. thereafter, empirical results from the johansen cointegration test and the normalized cointegrating coefficients of the vector error correction model (vecm) revealed that real currency in the hands of the nigerian public was positively cointegrated with real modern payment technologies transactions as well as real gross domestic product (gdp), but negatively cointegrated with real savings interest rates, real quarterly time deposits interest rates, and inflation rate. on the other, empirical results from the gregory-hansen cointegration method indicated further that there were no structural breaks or regime shifts in the cointegrating coefficients during the period 2009:q1 to 2017:q4. in conclusion, the existence of a positive relationship between real modern payment technologies transactions and real currency in the hands of the nigerian public indicated that the former were partly responsible for the growth of the latter during the period under investigation, thereby implying that modern payment technologies were effective in promoting financial inclusion by providing more access to liquidity services. therefore, it was recommended that wide-spread adoption of modern payment technologies should be promoted in order to further extend liquidity services to financially excluded nigerians. acknowledgements i humbly wish to acknowledge my dissertation supervisor who also doubles as chairman of economics department and visiting professor of the african union, distinguished professor g.c. nwaobi for his indispensible guidance during the preparation of this manuscript. 26 economic analysis (2019, vol. 52, no. 2, 12-27) references aiyedogbon, j.o., ibeh, s.e., edafe, m., & ohwofasa, b.o. 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(2018). “a reassessment of money demand in nigeria.” cbn journal of applied statistics, 9(1): 47-75. world bank (2018). the little data book on financial inclusion. washington dc: world bank group. tersoo iorngurum 27 appendix table a.1: data obs. quarter md y r1 r2 π mpt 1 2009q1 27.0800 60.1500 0.8629 11.3629 1.5500 1.6000 2 2009q2 24.9400 62.7400 -0.4864 9.8736 2.8200 1.6400 3 2009q3 23.4800 67.3000 -2.3838 7.6329 4.5800 1.8500 4 2009q4 25.4700 68.1800 0.6174 10.8641 2.3100 1.6400 5 2010q1 23.6300 120.5800 -0.6108 6.7925 3.8600 0.6700 6 2010q2 22.9000 121.2000 0.3386 3.9153 2.3600 0.8300 7 2010q3 22.5200 128.4100 -2.8753 0.2114 4.6800 1.1600 8 2010q4 25.1600 130.6100 -0.1617 3.0250 1.8400 1.3800 9 2011q1 27.1300 115.1000 -1.7568 1.8032 3.6300 3.1400 10 2011q2 27.0500 115.8400 -0.2459 3.7408 1.9000 3.3400 11 2011q3 25.4800 121.2900 -1.4598 2.4969 3.4200 3.3400 12 2011q4 26.8000 123.7900 -0.9654 4.6613 2.8900 4.0000 13 2012q1 25.3000 106.1300 -3.3073 3.1027 6.0500 3.5400 14 2012q2 24.7900 106.9000 -0.4012 5.9955 2.8600 3.7600 15 2012q3 23.6100 114.4300 -0.2625 6.5142 2.7500 3.8700 16 2012q4 25.6700 114.5500 -0.7601 6.4866 3.3500 4.2700 17 2013q1 24.9100 101.6600 -0.3474 6.3093 2.9100 4.7000 18 2013q2 23.8300 103.5800 0.1098 5.7931 2.7700 5.1100 19 2013q3 23.3900 111.1400 0.8520 6.1720 2.3000 5.5300 20 2013q4 26.4300 113.3600 0.3996 5.8396 3.0800 6.2600 21 2014q1 25.1400 100.1400 1.2885 7.4018 3.0400 6.0600 22 2014q2 23.8200 102.1900 1.3249 7.2716 3.2300 6.4200 23 2014q3 23.9100 108.9300 1.4159 7.1226 3.0600 7.5500 24 2014q4 24.6300 111.2100 1.7262 7.7895 2.7500 7.6900 25 2015q1 24.9600 96.1000 1.2356 7.0656 3.8100 6.8800 26 2015q2 21.5100 96.0100 0.9297 6.6130 4.4600 6.9100 27 2015q3 20.2400 102.4700 1.3624 8.0991 3.9400 7.1600 28 2015q4 21.9500 103.7900 1.7043 5.7176 3.1500 7.6400 29 2016q1 22.5800 85.7900 -0.7968 2.7332 7.2700 7.4300 30 2016q2 21.3300 82.0500 -2.7846 0.5487 11.8200 7.5500 31 2016q3 20.4700 85.1500 -0.3403 3.4064 8.5000 8.2000 32 2016q4 23.3000 86.1100 1.5801 5.9601 5.3600 9.7900 33 2017q1 22.3800 72.1000 0.6222 5.4422 7.6000 9.5600 34 2017q2 19.9900 70.8000 -0.9766 4.1867 11.2000 9.5500 35 2017q3 18.4000 123.1400 0.2332 6.1899 8.8500 9.2300 36 2017q4 19.6100 127.5000 1.7387 7.5054 5.6000 10.7400 notes: md denotes real currency in the hands of the nigerian public, y denotes real gross domestic product, r1 denotes real savings interest rate, r2 denotes real quarterly time deposits rate, π denotes inflation rate, and mpt denotes real modern payment technologies transactions. md, y, and mpt are in billions of naira. π is calculated as change in consumer price indices; r1 and r2 are expressed in percentages. source: central bank of nigeria (2019). article history: received: october 9, 2019 accepted: november 3, 2019 2013_1_2 professional paper analysis of the serbian capital market1 minović jelena2, vuković vlastimir, institute of economic sciences, belgrade, serbia udc: 336.76(497.11) jel: o16, g01, g10, g12 id: 198572044 abstract – this paper analyses the serbian capital market. its main characteristic is that it is a very narrow and depth lacking market. for analysis we used data from the belgrade stock exchange (bse), republic of serbia securities commission (sec), and national bank of serbia (nbs). the crisis has negatively influenced on the capital market in serbia. due to this fact, the analysis was done by dividing into two sub-periods: before the crisis (2006 – 2008), and during the crisis (2009 – 2011). results showed that turnover decreased for over 70% for both belex indices, while the whole capital market has notably recovered thanks to an extensive borrowing of the state. stock market capitalization has fallen. results of analysis showed that government debt securities dominate after the crisis on the capital market (93% in 2011), while other shares from privatization make a negligible part of the market (equity market dropped for over 10 times from 2006 to 2010). we concluded that the privatization in serbia significantly influenced on the features and volatility of the capital market in serbia. key words: capital market, frontier market, turnover, gdp, belex indices, liquidity introduction serbian capital market is by its characteristics categorized into the group of frontier markets (spiedell, 2011), which is specially investigated. the privatization in serbia significantly influenced on the features and volatility of the capital market in serbia. the same effects of the privatization were also noticed in other transition economies (megginson & boutchova, 2000). “frontier market” is an economic term first used in 1992 by the international finance corporation to describe a subset of very small and illiquid emerging stock markets. twenty years later there is no strict definition of frontier markets, though, by default, they are commonly viewed as those markets which are neither developed nor emerging. highlighting both their opportunity and their challenge, frontier markets represent one-fifth of the world’s population, yet less than 10% of global gdp, and only about 2% of global market 1 this paper is part of the research projects number 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and number 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. the part of the results from this paper were presented at the conference economic changes in a time of crisis: challenges and opportunities in coimbra, portugal (6-7 september, 2012). 2 institute of economic sciences, zmaj jovina 12, belgrade, serbia, e-mail : jelena.minovic@ien.bg.ac.rs economic analysis (2013, vol. 46, no. 1-2, 1-11) 2 capitalization.3 examples include the frontier markets of serbia, croatia, bulgaria, kazakhstan, nigeria, sri lanka, vietnam4, venezuela, jordan, pakistan, and argentina (speidell, 2011), (vuković & minović, 2012). some of the first authors who research and analyse the frontier and emerging markets are chuhan (1994), rouwenhorst (1999), bekaert & harvey (2002, 2003), cajueiroa & tabak (2004), bekaert, harvey & lundblad (2007), clark (2008), yeyati, schmukler & van horen (2008), hearn, piesse & strange (2009), živković & minović (2010), minović & živković (2010), speidell (2011), minović (2012a), minović (2012b), and others. sometimes progress from frontier market status to a more developed status is agonizingly slow, if it occurs at all. the upside potential of frontier equity markets has motivated many investors to consider taking positions in them, but to date, relatively few have done so. the reason stated most often for this reluctance to invest is risk (speidell, 2011), (vuković & minović, 2012). in this paper we analysed the serbian frontier capital market. we used data for total turnover on the serbian capital market, as well as turnover for both belex indices. for analysis we used data from the belgrade stock exchange (bse), republic of serbia securities commission (sec), and national bank of serbia (nbs). the crisis has also negatively influenced on the capital market in serbia. due to this fact, the analysis was done by dividing into two sub-periods: before the crisis (2006 – 2008), and during the crisis (2009 – 2011). the capital market in this analysis is segmented on bond market and equity market, as often done in the reports (ecb, 2012). we showed that government debt securities (66,7%) are the dominant segment on the capital market in serbia. shares make the rest of this market (33,3%), because there weren’t any corporate debt securities. the privatization in serbia significantly influenced on the features and volatility of the capital market in serbia. without the analysis of the privatization it would not be possible to explain the behaviour of investors and shareholders in these countries (vuković & minović, 2012). the structure of this paper is as follows: section 1 presents introduction, section 2 describes frontier capital market in serbia, in section 3 is given analysis of the turnover on the capital market in serbia, section 4 analysis turnover of belex indices on the bse, and in section 5 conclusion is given. frontier capital market in serbia gross domestic product (gdp) in the republic of serbia declined by 3.5% in 2009, due to the impact of the global economic crisis, and the resulting slowdown in economic activity (see table 1). gdp decline mainly due to the domestic demand. the largest negative contribution of gdp growth has given investment spending of private and public sector. private consumption is contributed to decline in final demand, due to rising unemployment and falling purchasing power (nbs, 2009). 3 http://blogs.cfainstitute.org/investor/2012/05/03/frontier-market-investing-inefficiency-equals-opportunity/ 4 http://www.doughroller.net/investing/frontier-markets-to-boldly-go-where-few-investors-have-gone-before/ minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 3 table 1. growth rate of gdp in republic of serbia gdp 2005 2006 2007 2008 2009 2010 2011 growth rate (in %) 5.4 3.6 5.4 3.8 -3.5 1.0 1.6 source: nbs (http://www.nbs.rs/internet/cirilica/80/index.html) gdp growth (after 2009) was dominant due to increase in foreign demand. exports grew faster than imports, leading to a significant reduction in the trade deficit. such a trend has resulted in a positive contribution of net exports to gdp growth, which was higher than the negative contribution of domestic demand (nbs, 2010). speidell (2011) pointed out that today, frontier countries account for 21.6% of the world’s population, 6% of its nominal gdp, and only 3.1% of world market capitalization. even with this imbalance, a naive investor using cap weights as his or her guideline would still want to have 3.1% of a global portfolio in frontier markets. speidell (2011) showed that serbia has a 20% weight in the msci frontier market index, and 10% weight in the russell frontier market index (see table 2). table 2. serbia in the msci, and russell frontier market indices population (millions) gdp per capita (ppp, 2008) gni per capita, atlas method (2008 us$) world bank market cap (2008 $ millions) msci frontier market index russell frontier serbia 7.4 11,456 5,700 12,165 0.2 0.1 source: speidell (2011), page 10. precisely, the serbian capital market is the belgrade stock exchange (bse), as the only organized market of this kind in the country (see figure 1). serbian capital market, as under developed market, faces many problems: small capitalization, small number of shares on the liquid segments of the market, appearance of some unsynchronized trading, irregular frequency of transactions, lack of transparency in the reports, lack of government regulations and so-called the invisible signs of risk (latković & barac, 1999), (živković & minović, 2010). from its beginning, the serbian market was not a share market but corporate market. also, this is a one-way market, considering the supply and demand. this means that the major share sellers are individual share owners who got the shares, usually free, in the process of mass privatization. major share buyers come from the corporate sector. the basic aim of investing was not the share yield, but taking over the companies. the usual chain of events was as the following: turnover volume and share liquidity rise when the firm is in a threat of being taken over. when taking over happens, the liquidity and volume drop, while the share price becomes inert. trading in these transactions is in a great measure based on informer information (živković et al., 2005), (živković & minović, 2010). economic analysis (2013, vol. 46, no. 1-2, 1-11) 4 figure 1. share trading on bse and otc5 market (in million eur) source: sec (2006) & (2010). šoškić & živković (2007) stated that in the serbian market, there are no exact rules regarding available information about company, and consequently insider information has a huge influence on investor’s decisions. better regulation in this area, with increased amount of publicly available information, can reduce the information asymmetry risk. on the other side, this will lead to decreasing transactional costs and also to reduced illiquidity risk, which could bring up the level of foreign investments. we would like to point out that there is not much papers in the capital market of the republic of serbia. some of them are papers by živković et al. (2005), erić, nikolić & zdravković (2009), živković & minović (2010), erić (2010), minović (2012b), and vuković & minović (2012). erić, nikolić & zdravković (2009) studied the movement of the belgrade stock exchange index, and compared it with the stock exchange indices in the region in order to analyze the impact of the global economic crisis. živković & minović (2010) explored causes for illiquidity of the serbian capital market for the period of 2005-2009. these authors described phenomenology of emerging and frontier financial markets in detail. their results showed that level of market liquidity was low and persistent in serbia. additionally, živković & minović (2010) showed that time-varying illiquidity and its volatility was highly unstable in this market. they identified different periods and showed that, in most cases, ups and 5 over the counter market (otc) minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 5 downs in foreign investors’ participation leads to dramatic falls and rises in market illiquidity and its volatility. minović (2012b) analysed equilibrium of the serbian stock market using the standard capital asset pricing model (capm, by sharpe, 1964, and lintner, 1965). she tested this model empirically using regression analysis on the serbian stock market. minović’s (2012b) results showed that the classic capm was good for developed and liquid markets, but it was not able to describe the equilibrium of the serbian frontier market, or the process of discovering prices on this market. minović (2012a) analysed liquidity of the croatian frontier stock market. for her analysis she used prices of all stocks listed at the the zagreb stock exchange in the period: 2005 2009. she showed that the level of liquidity for the croatian market was very low. at the same time, minović’s (2012a) results suggested that the croatian market was less illiquid than the serbian market. she concluded that low level of liquidity was one of the key problem areas facing this small, undeveloped and frontier market. minović’s (2012a) results suggested that illiquidity was persistent in the croatian stock market. turnover on the serbian capital market in the analysis, we used data for total turnover from annual reports of securities commission republic of serbia (sec, www.sec.gov.rs). however, the turnover on the serbian market was 10% less than the gdp. figure 2 presents total turnover in billion eur, on the capital market of republic of serbia. figure 2. total turnover (in billion eur), on the bse and the otc market in the republic of serbia note: rsd values of turnover trading securities are translated into euro by average exchange rate of nbs on the date of the transaction. source: sec (2006) & (2010). economic analysis (2013, vol. 46, no. 1-2, 1-11) 6 thus, the annual turnover of securities increased from 7.4 billion eur (in 2005) to 16.6 billion eur (in 2006), then reached 51.3 billion eur (in 2007), and 66.1 billion eur (in 2008). in the post crisis years total annual turnover of the securities declined to 36.2 billion eur (in 2009), and 27.4 billion eur (in 2010). the average volume, in 2009 and in 2010, on the serbian capital market has decreased by more than 55% than the average volume in the period: 2005-2008. figure 3 shows the movement of the turnover on the serbian market. alongside the total turnover, there is also the turnover on equity and bond markets. looking at this, one can notice not only the dynamics in change, but also some structural changes (vuković & minović, 2012). vuković & minović (2012) showed that turnover movement by years was very unusual: before the crisis it dropped very fast, then it was almost faster recovery during the crisis, so the record level was achieved last year (4.42 billion eur) (see figure 3). figure 3. securities trading (in million eur) without nbs securities on the serbian capital market source: sec (2006) & (2010); vuković & minović (2012). vuković & minović (2012) pointed out that the total turnover covers up a key structural change: market dynamics was determined by the equity market before the crisis, and after it minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 7 by the bond market. consequently, the share of debt securities market was increased from 20% in 2008 to predominant 93% in 2011. they said that this dramatic fall of equity market was also illustrated by the data that the total turnover over the last three years was only 1.04 billion eur. bond market was entirely consisted of government debt securities. state borrowing on the capital market explosively rose – the turnover of government bonds from 2008 to 2011 was increased for 12 times. thanks to this, the capital market not only recovered, but also significantly rose (for 1/3 compared to 2006 and 3.2 times compared to 2008). by this, there was no squeezing of corporate bonds, because they were not issued, despite the projections (jefferson institute, 2005) (vuković & minović, 2012). equity market dropped for almost 10 times from 2006 to 2010. the primary cause of market fall was not the global financial crisis6, but the nature of the shares issued with the purpose of privatization. privatizations have dramatically increased the number of shareholders; large numbers of shareholder are not a stable ownership structure (megginson & boutchova, 2000). it is not surprising why it came to the withdrawal of the attractive (liquid) shares from the turnover after the end of the taking over process7 of the privatized companies, i.e. concentration (živković, 2008). at the end, it could be seen that the expected rapid growth of equity markets (lieberman & kirkness, 1998) was not sustainable for a longterm period after the privatization (vuković & minović, 2012). underdevelopment of the domestic capital market is also shown by the information that the total turnover was below 10% gdp (nbs, 2012a). a predominant share trading was done in the bse, while the rest was in the otc (sec, 2012). a small equity market could not significantly encourage the economic growth in serbia, which is still facing the transition problems. namely, gdp has been noticeably lower during the previous years than in 1989 (ebrd, 2011), (vuković & minović, 2012). vuković & minović (2012) showed that despite a small volume turnover there was no significant reduce in market capitalization. by the bse data, stock market capitalization was 8.67 billion eur in 2008, and 7.43 billion eur in 2011. these authors said that fall in capitalization for 14% could be explained only by reserved shareholders, where many of them were waiting for the market recovery to issue the sale orders. from 2006 to 2010, there was reducing of foreign investors’ participation in trading with all the securities in the bse (from 48% to 33%, respectively). turnover of belex8 indices the belgrade stock exchange was the first re-established stock exchange after the second world war in east europe (1989). nevertheless, up until early 2002, it existed as an organization without normal rules of the game. only during that year the market began to operate in a more or less standard manner. the main classes of assets traded on serbian 6 most of other european frontier emerging stock markets showed a great resilience to the adverse effects of the financial crisis (nikkenen et al., 2011). 7 therefore, the turnover on equity market was the largest in the period 2002 – 2004 (privatization agency, 2005). 8 the belgrade stock exchange, serbia economic analysis (2013, vol. 46, no. 1-2, 1-11) 8 market are shares issued as a result of a process of insider privatization model (živković et al. 2005), (živković & minović, 2010). the belgrade stock exchange has calculated and published the index belexline since april 2, 2007, as a benchmark for monitoring broad market movements (http://www.belex.rs). belexline index is descriptive, in the statistical sense, and not investible. the index weighting is based on market capitalization. belex15 is a free-float market capitalization weighted price index, which follows the movements of the 15 most liquid shares traded by the continuous method and fulfilling criteria for inclusion in the index basket (http://www.belex.rs) (minović & živković, 2010). we use data for the turnover of both belex indices from the belgrade stock exchange (bse) for the period: october, 2005 – january, 2010. in the table 3 is the change of turnover for both belex indices that ensued by the world economic crisis. this table shows that the turnover of the both belex indices fell for more than 70% from the other half of 2008 to the end of 2009. table 3. the average value of the daily turnover expressed in rsd for belex indices, before and during the crisis, and its relative change turnover average 3.10.200512.9.2008 15.9.2008-31.12.2009. relative change belexline 1,949,045 2,508,482 702,108 -72.0% belex15 8,777,022 11,221,731 3,327,972 -70.3% source: bse & author’s calculation; vuković & minović (2012). despite the economic crisis, the reason for the decrease in total turnover, and in turnover of belex indices is reduction in the number of shares due to the withdrawal of attractive (liquid) stocks from the market, after the completion of the takeover process, or concentration (živković, 2008). in the crisis conditions, it is obvious that the lack of trust in the mechanism of publishing the fair value of the financial assets, caused a fall in the turnover and at the same time a fall in market liquidity and massive withdrawal of foreign investors (see živković & minović, 2010). the investors, especially retail investors, have the expectation that they can be expropriated by the management or more informed investors. they also have relatively low disposable income to invest in the stock market and limited resource to obtain information (zhang, 2010). he pointed out that all these factors result in the on average low trading activity in the emerging markets (minović, 2011). erić (2010) told that revenues from privatization, grants and foreign direct investments have declined, some even dried up with the increase of crisis. therefore, there is a slowdown in serbian economic growth. this author pointed out that the development of the serbian capital market is an extremely important issue and involves a very serious and responsible approach. there are no new legal regulations, the development of institutions is slow, there are no new instruments and the turnover of the existing instruments has been reduced. all these facts must be understood as an important warning (erić, 2010), (minović, 2011). minović, j., et al., analysis of the serbian capital market, ea (2013, vol. 46, no, 1-2, 1-11) 9 redžepagić & richet (2008) pointed out that the transformation of the western balkan countries economies into market economies could not have taken place without the assistance of the foreign capital. these authors told that the western balkan region has been transformed into a marketplace with dynamic growth, attracting a significant amount of foreign direct investments (fdi). fdi in the western balkans are mostly concentrated in the service sector (banks, telecommunications, insurance) in non-tradable inward oriented sectors (constructions, real-estate) (redžepagić & richet, 2008), (minović, 2011). conclusion the capital market of the republic of serbia lacks depth, it is small illiquid market in transition. there is not much papers in analyses of the serbian capital market. this paper contributes to this field of research. the paper analysed the serbian frontier capital market. we used data from the belgrade stock exchange (bse), republic of serbia securities commission (sec), and national bank of serbia (nbs). in analysis, we showed that government debt securities (67%) were the dominant segment on this capital market in the observed period (2006-2011). our results showed that shares made the rest of this market (33%), because there weren’t any corporate debt securities. in crises period (2011) government debt securities dominate on the capital market with 93%. other shares from privatization process make a negligible part of the serbian market. so, the privatization process in serbia significantly influenced on the features and volatility of this market. our results showed that the turnover decreased for over 70% for both belex indices, in this period (crises). however, market capitalization was not significantly reduced and it was approximately 33% of the gdp. thus, the serbian equity market dropped for over 10 times from 2006 to 2010. references bekaert, g., harvey c. r. 2002. research in emerging markets finance: looking to the future. emerging markets review. 3: 429–448. bekaert, g., harvey c. r. 2003. emerging markets finance, journal of empirical finance, 10: 3–55. bekaert, g., harvey c.r., lundblad c. 2007. liquidity and expected returns: lessons from emerging markets, review of financial studies, 20(6): 1783 1831. http://www.kelley.iu.edu/clundbla/liquidity_bhl.pdf cajueiro, d. o., tabak b. m. 2004. “the hurst exponent over time: testing the assertion that emerging markets are becoming more effcient”, physica a, 336: 521 – 537. chuhan, p. 1994. are institutional investors an important source of portfolio investment in emerging markets? washington, d.c.: international economics department, world bank. clark, a. 2008. „liquidity risk in frontier markets history, measurement and a new approach“. thomson reuters. http://thomsonreuters.com/content/financial/pdf/i_and_a/liquidity_risk.pdf european bank for reconstruction and development (ebrd). 2011. transition report 2011 – crisis and transition: the people’s perspective. european central bank (ecb). 2012. financial integration in europe, april 2012. erić, d. 2010. “what is actually capital market in serbia?”, economic growth and development of serbia new model, pp. 243-261. erić d., zdravković a. & nikolić d. 2009. 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economics, university of belgrade, the second edition. vuković, v. & minović, j. 2012. “needs and possibilities for enhancement of serbian financial markets”. chapter 7 in managing structural changes trends and requirements, publisher: portugal: faculty of economics (feuc), university of coimbra, portugal, pp. 129-147. yeyati, e. l., schmukler s. l., van horen n. 2008. “emerging market liquidity and crises”, journal of the european economic association, mit press, 6 (2-3): 668-682. živković, b., minović j. 2010. illiquidity of frontier financial market: case of serbia. panoeconomicus. 57(3): 349-367. (http://www.panoeconomicus.rs/casopis/2010_3/07.pdf). živković, b. 2008. “finansijski sektor”, reforme u srbiji: dostignuća i izazovi, beograd: clds. živković, b., urošević, b., cvijanović, d., drenovak, m. 2005. “serbia's financial market: 20002005”. quarterly monitor, 1: 65-72 official the belgrade stock exchange (bse) web site, http://www.belex.rs official the national bank of serbia (nbs) web site, http://www.nbs.rs official the securities commission (sec) republic of serbia web site, http://www.sec.gov.rs analiza srpskog tržišta kapitala rezime – ovaj rad analizira srpsko tržište kapitala. glavna karakteristika ovog tržišta je da je ono malo i izrazito plitko tržište. za analizu smo koristili podatke sa beogradske berze (bb), komisije za hartije od vrednosti republike srbije (khvrs) i narodne banke srbije (nbs). zapazili smo da je kriza negativno uticala na tržište kapitala u srbiji. zbog ove činjenice, našu analizu smo podelili u dva pod-perioda: pre krize (2006 – 2008), i za vreme krize (2009 – 2011). naši rezultati su pokazali da je promet opao za preko 70% za oba belex indeksa, dok je na celom tržištu kapitala zabeležen oporavak zahvaljujući ekstenzivnom zaduživanju države. tržišna kapitalizacija akcija je opala. rezultati analize su pokazali da državne dužničke hartije od vrednosti dominiraju posle krize na tržištu kapitala (93% u 2011), dok druge akcije iz privatizacije čine neznatan deo tržišta (tržište akcija je opalo 10 puta od 2006 do 2010). mi smo zaključili da je privatizacija u srbiji značajno uticala na osobine i volatilnost srpskog tržišta kapitala. ključne reči: tržište kapitala, granično tržište, promet, bdp, belex indeksi, likvidnost. article history: received: 14 february 2013 accepted: 12 march 2013 ea_2013_3-4 finalna ver scientific review global financial crisis and its effects on european financial system balaban mladenka1, institute of economic science, belgrade, serbia župljanin slobodan, independent university banja luka, faculty of economic, bih andrejević irena, economic school, zemun, serbia udc: 336.012.23(4-672eu) ; 339.747(100) jel: e22, e4, g 21 id: 203723788 abstract – the effects of the global financial crisis are widespread. looking at the global level, consequences of the crisis: the decline in economic activity, productivity, employment, foreign direct investment exports, liquidity, weakening the banking sector, the deterioration of the fiscal position due to measures to stimulate consumption, laded to the rapid growth of the debt of many countries, which reached unsustainable levels. the consequences can be seen depending on the degree of development of the country. this work analyzes effects of the crisis in financial sector. in developed countries, the crisis led to the fall of liquidity due to the weakening of the banking sector, which results in lower consumption and investment, and hence the reduction in gdp growth and employment. in the case of developing countries the crisis has affected the reduction in foreign direct investment by developed countries, the decline in exports due to lower demand from developed countries and weakening of the banking sector. in poor countries, the crisis has resulted in a lack of credit and grants by developed countries, reduced exports and foreign direct investment. key words: crises, investment, financial sector, banking sector, productivity introduction the causes of the financial crisis, which outgrew and became a global economic crisis, rooted from the period of expansive growth in the 2003-2007 period. during this period, the developing countries have recorded a surplus of the current account deficit, obtaining higher savings rate of investment, which created the possibility of placing excess of domestic savings in the developed countries. china, as one of the fastest growing developing countries, most of the savings is invested in the u.s., and the same thing happened with oilproducing countries that have surpluses from oil exports placed through investment funds. in addition, in developing countries there was a low level of financial intermediation. depositors of developing countries have had an aversion to risk and were willing to invest in safer jobs with lower yields. as a result, these countries have opted for investments primarily in the united states that perceived to be less risky. on the other hand, developed countries have recorded the development of financial innovation. 1 mladenka.balaban@ien.bg.ac.rs balaban, m., et al., gčobal financial crisis, ea (2013, vol. 46, no, 3-4, 14-25) 15 the financial sector before the financial crisis in the period before the crisis, in almost all industrialized economies was present relative sustainability of economic growth and inflation. key issues that have attracted the attention of economists in this period were: the improvement of macroeconomic policies, structural change and security less destructive distribution of shocks. reduced macroeconomic instability was associated with significant improvement in economic performance. potential growth in many developed countries has increased, allowing citizens benefits extended period of economic expansion that are occasionally interrupted by a moderate recessions. central banks long before the crisis kept interest rates at very low levels. in fact, as the growth of the economy at that time was satisfactory and low inflation, the central bank felt that there is no reason to raise interest rates. sustainable economic growth, accompanied by low and stable interest rates, contributed to the improvement of expectations about asset prices, particularly in the area of real estate prices. with the progress of globalization of financial market, increasing deregulation and liberalization of the banking and financial sectors, as well as due to the introduction of new financial instruments, the optimistic expectations of house prices at that time led to their rapid growth. the process is in some countries has been accompanied massive borrowing households. it is important to point out the failure of rating agencies whose inadequate assessment led to the crisis spilling over to the real estate market in the financial sector. these agencies are high valuation of risky securities, encourage further investment. profitability of banks and other financial institutions significantly increased due to overall favorable economic and financial conditions. financial institutions, due to low interest rates and in search of greater profits, began to invest in a much riskier instruments, new instruments in the financial market. at the same time, bank supervision was focused on standard financial instruments. rise to a number of shortcomings of the regulatory and institutional framework financial sector in the u.s. solvency of the system is drastically reduced, which led to the fall of consumption and therefore reduce gdp. so, the three key problems in the period before the crisis were: 1) the problem of the monetary policy (interest rates), 2) the problem is on supervision, and 3) a problem with the rating agencies and conflicts interest.2 the mortgage market in the u.s. is considered to be one of the most advanced and safest market that is characterized by almost certain earnings with little risk. with low interest rates, the real estate market and the u.s. experienced great expansion. due to the high influx of cheap money from abroad, banks placed free funds in order for higher profits. when comparing the present crisis with large and deep crises that shook the developed countries over the past three decades, one aspect of their essence has remained the same. it's unlimited greed for higher profit, desire to earn millions in commissions, the tendency to take any more risky and more profitable investment to the measures that go beyond the legal and regulatory framework. in terms of macroeconomic stability with very low interest rates, high degree of liquidity and very low fluctuations, the u.s. non-bank financial institutions have begun to underestimate risk. this has led to the degradation of the system of credit and 2 source: ecb's gonzález-páramo, j. m, speech, the banking sector towards the "new normal": some considerations'' pwc and ie business school, madrid, 2011. economic analysis (2013, vol. 46, no. 3-4, 14-25) 16 portfolio risk management, and the emergence of a number of deficiencies in the definition and implementation of measures regulating financial sector and supervision of financial institutions. the growth in demand for real estate on a limited offer has led to the growth of real estate prices in the u.s. in conditions of poor regulation was growing world demand for safe investments. however, the problem was created the moment a large number of creditors was not able to repay the loan. with an increasing number of mortgages on the supply and excess demand, there was a decline in real estate prices. in terms of macroeconomic stability with very low interest rates, high degree of liquidity and very low fluctuations, the u.s. non-bank financial institutions have begun to underestimate risk. this has led to the degradation of the system of credit and portfolio risk management, and the emergence of a number of deficiencies in the definition and implementation of measures regulating financial sector and supervision of financial institutions. to get the more resources and increase revenues, financial institutions are weak criteria for granting mortgage loans. in this way they have accepted more risk. during most of the real estate, was granted the highest number of subprime loans. bank and specialized agencies, in order to obtain higher wages, reduced the risk premium for this type of lending which led to the expansion of the market subprime loans. banks are subprime loans transformed into securities with coverage of mortgage loans and further resold to investors who were eager for speculative reader. financial market in usa was not regulated sufficiently; the distribution of the primary risk experienced a wide scale. the volume of business with financial derivatives in 2002 amounted to 106 thousand billion, but during the 2008 reached 531 thousand billion dollars3. subprime felt the first tremors middle 2007, when investors realized that hold riskier securities than they initially thought, resulting in a massive sale of these securities. one of the biggest losses have commercial and investment banks. write-off assets in 2007 year for citigroup was 46.4 billion for merrill lynch 36.8 billion and the swiss ubs 36.7 billion dollars4. the mortgage market crisis already early 2008 has shifted to the stock and bond markets. in september 2008 was the escalation financial crisis and the decline of real american giants. the first is declared bankrupt lehman brothers and wachowia. the state has nationalized fannie mae and freddie mac, which controlled about 50% of all mortgage loans usa. merrill lynch was rescued takeover by bank of found in approximately half of the actual value, and jpmorgan took over washington. beginning of the financial crisis and its expansion globalization has led to huge transfers of capital between countries, multinational companies and financial institutions, which aided the spread of the crisis to the rest of the world. the financial crisis is a domino effect first transferred to countries that have a similar mechanism of mortgage lending (uk and some asian countries), but soon afterwards flooded world market and led to a decline in the value and liquidity of the securities of the 3 http://www.wsjprimerate.us/fedfundsrate/federal_funds_rate_history.htm 4 http://www.wsjprimerate.us/fedfundsrate/federal_funds_rate_history.htm balaban, m., et al., gčobal financial crisis, ea (2013, vol. 46, no, 3-4, 14-25) 17 base value. 5 stock exchange panic replaced the bank panic with an accelerated withdrawal of deposits and rising interest rates. financial system of national borders has a major role and the present crisis has not remained isolated within the united states but has spread to other parts of the world. in financial market in usa besides domestic investors participate companies, banks and funds from other countries and large financial centers such as the european union. overseas, such as u.s. investors, investors from other country believing in the evaluation of relevant rating agencies, and their assets are placed in harry's debt securities high rating such as mortgage-backed securities (rating from aaa to b) to the u.s. market. also, its assets put of the stocks of large funds and investment banks believing they were at low risk. imf study6, indicating that the current crisis is the result the weaknesses that exist in the institutional and regulatory in financial sector in the usa. the imf suggests that the crisis is manifested in next stages:7 • credit concerns (2006 summer 2007) : increase default subprime loans and alt a credit in the usa, reducing the prices of certain securitized loans , the expectation of falling prices of real estate. • the initial collapse of confidence and liquidity collapse (summer fall 2007): collapse of two big hedge fund, a sudden increase in spread between the interbank and other loan financing the products. • accumulation of losses and liquidity constraints continue (fall 2007 the beginning of summer 2008): serious loss of market value in the trading book, the collapse of the commercial paper markets, concerns about the liquidity of major institutions, government assistance in the rescue bear stearns. • intensification of losses and lack of liquidity (summer 2008): loss of market value and the lack of liquidity continue to escalate, revealed widespread problems in the housing market in the uk, the usa and other countries, as housing prices began to fall and the supply of credit to dry up; ''fannie mae and freddie mac'' increasingly rely on the support of the usa government, intensifying the problem of financing mortgage banks in the uk. • severe loss of confidence (september 2008) : bankruptcy, lehman brothers '' and eroded the confidence that large institutions too big to fail could; credit downgrading aig initiated increase in requests for collateral by demanding help from the government; mixture credit problems and withdrawal of deposits led to the collapse, washington mutual „'s „ bradford & bingley'' and the icelandic banks; big banks rely heavily on the assistance of the central bank. 5 swint, b. (2009), bank of england cuts main rate a half point to 1%, bloomberg.com: http:// www.bloomberg.com/apps/news?pid=20601102&sid=ak38at3528zc&refer=uk 05.09.2103. 6 source: strauss-kahn d: speech ,,lessons from the financial market crisis: priorities for the world and for the imf’’ to the indian council for research on international economic research (icrier), new delhi, india, 2008. 7 financial services authority, “the turner review: a regulatory response to the global banking crises”, 2009. economic analysis (2013, vol. 46, no. 3-4, 14-25) 18 • recapitalization and government guarantees, support from central banks (october 2008): significant government measures to prevent the collapse of major banks: an explicit commitment not to allow the failure of systemically important banks. • the feedback between the banking system and the economy (november 2008 → ) : decreased ability of banks to grant loans to the real economy, leading to economic decline, recession threatens to further loan losses, which could further reduce banks' capital, the support schemes assets. crises in europe union european economies have entered a period of recession, what is recorded by world war ii. the european debt crisis has followed a financial crisis in the united states with a delay of a year and a half ago. the collapse of the „lehman brothers“ in september 2008 signaling the transfer of the global financial crisis on the european market. basic factor of financial crises: • a strong appreciation of the euro: the euro has appreciated against the dollar, still the world's leading currency, from 1.20 usd to 1.60 usd, which is about 33% higher in the period in 2006 until summer 2008 year. simultaneously there was a parallel rise against the yen. the nominal interest rate is 6 euros developing countries have recorded high rates of economic growth and savings, and developed a high development of financial innovation. • the high prices of raw materials: oil prices have raised more than doubled between early 2007 until summer 2008 (from 40 euros / barrel at 90 euros / barrel). a similar increase has been practiced with a large number of other materials. prices of nonenergy raw materials have risen by about 10% during the 2008th compared to the previous year. the rise in prices of raw materials has affected the cost private sector and the decline in real wages of workers, reducing aggregate demand and inflation by raising short at around 4%. • the effect of high interest rates through the transmission mechanism: the ecb has started raising interest rates since 200. eight times the rates were increasing in the range of 2.0 to 4.0% by mid2007, bearing in mind that the inflation was mainly driven by higher import price. 8 the first drivers of the crisis, are primarily greece and ireland, as before crises had the best indicators of growth and economic activity in the european union. greece has misrepresented its fiscal position. greece's credibility has dropped, which led to foreign investors. after such knowledge, greece was forced to carry out issuing new bonds and to double the interest rate. prescribed by her strict fiscal constraints that weaken the tax base, increase taxes and cut public spending by 10 percentage points gdp in 2010, and requested the „internal devaluation“ (wage and tariff reduction) in the long term, in order to regain lost competitiveness of the greek economy. ireland has been called mini-crisis 2002 prices of houses in ireland to 2007 growing faster than in other developed countries fell by 50%, which has led many people into a situation that they owe more than their property is worth. in addition to uncontrolled lending by irish banks, high levels of foreign borrowing in the 8 glassner v., galgóczi b.: “plant – level responses to the crisis: can jobs be saved by working less”, etui policy brief,1/2009. balaban, m., et al., gčobal financial crisis, ea (2013, vol. 46, no, 3-4, 14-25) 19 credit boom has contributed to the creation of bubbles in the housing market that is filled with new loans. even greater deterioration of the irish public finances have suffered as a result, according to many bad policy decisions, to approve blanket guarantees to all, even doubtful accounts anglo-irish banks. it turns out that banking commitments by the irish government has guaranteed more than double the irish gdp. in an attempt to heal, the irish government has greatly reduced public spending. as the economies of the european countries mutually complementary crisis has also affected european countries that are not members of the european union. correlation of the financial systems of countries outside the european union with financial system within the european union is particularly pronounced. limited domestic demand, italian, french, austrian, greek and scandinavian banks are expanding their operations in the markets of eastern europe: • scandinavian banks have turned to the baltic countries; • greek and austrian banks have focused on the balkan market; • italian and french banks have turned to the russian market. in periods when the economy is in the expansion phase, capital is moving in the direction of center (central bank) to the periphery, while the phases of recession and major crises, capital changes direction and moves from the periphery to the center. economies of european countries which are not members of the european union is largely dependent on capital inflows from the european union. the countries in which foreign capital has a dominant share in the ownership structure of the banking sector are exposed to greater risk from the effects of the crisis on the financial markets of most developed countries.9 the situation has forced the european countries on joint measures to prevent the spread of the crisis. the leaders of the fifteen european countries and the uk government have met 12 october 2008 to agree on a common strategy that will take to go from financial crisis. however, unlike the usa, which represents single state, the eu consists of 27 countries, which further complicates and makes it difficult to find common solutions. leaders of the most developed countries had to react immediately. the european central bank (ecb), the central bank of sweden, britain, and switzerland lowered their benchmark interest rate. on august 2008, the short interest rate is increased to 4.25% and after september of the same year he appeared sharp downward trend that lasted until march 2009. from october 2008 until march 2009, european central bank is five times reduced its benchmark interest rate. during the 2008 interest rate reduced in october, from 4.25% to 3.75% in november to 3.25% and 2.5% at december, in january 2009. the key policy rate was reduced to 2% and then in march of this year to 1.5%.10 9 stratfor (2008.), the financial crisis in europe, stockanalyst: http://www.istockanalyst. com/article/viewarticlepaged/articleid/2702034/pageid/2 10.09.2013. 10 www.tradingeconomics.com, 12.09.2013. economic analysis (2013, vol. 46, no. 3-4, 14-25) 20 figure 1. trends in key ecb interest rates in the period from 01.01.2000. to 01.02.2009. source: www.tradingeconomics.com in addition to lowering the benchmark interest rate due to lack of capital and lack of trust that existed on the financial market, loans are becoming more and more expensive in availability. it was decided to allocate for this purpose the sum of 1.700 billion euros. measures were related to • capital-injection to increase the liquidity and solvency of the financial institutions; • guarantees for interbank loans; • guarantees of private savings to 50,000 euros per year. the governments of the benelux decided to help with 11.2 billion euros survival of fortis group in exchange for 49% ownership of one of the largest banks and insurance companies in this part of europe. before the intervention of the bank stocks have fallen to their lowest level in 15 years. belgium and luxembourg, with the help of france, rescue dexia bank with 6.4 billion euros. the german government saves the hypo real estate group, providing them with assistance of 50 billion euros. germany's 13 october set aside 70 billion euros to increase liquidity banks and 400 billion euros for the provision of interbank loans. france has earmarked 40 billion financial injections for banks and 300 billion euros for the provision of interbank credit. great britain gave aid of 20 billion pounds of royal bank of scotland and lloyds and hbos were helped by 17 billion pounds. the british government took control of mortgage lender bradford and bingley. spain has prepared a package of measures amounting to 30 billion euros to bought bad assets from the banks and at the same time increase their liquidity.11 11 stratfor (2008.), the financial crisis in europe, stockanalyst: http://www.istockanalyst. com/article/viewarticlepaged/articleid/2702034/pageid/12.09.2013. balaban, m., et al., gčobal financial crisis, ea (2013, vol. 46, no, 3-4, 14-25) 21 steps to eliminate the effects of the crisis in europe the eu and imf have responded to the crisis by providing amount of 750 billion euros. as part of the rescue package, the european union was created by two mechanisms: 1. european financial stability mechanism (efsm) and the 2. european financial stability facility (efsf) european mechanism of financial support to the stability originally was intended for eurozone member states. however, the funding mechanism can be used by all eu member states. funding for this mechanism (60 billion euros) allows the european commission of its funds. the formation of the european financial stability enabled lending within the eurozone members amounting to 440 billion euros at favorable interest rates. formed with the aim of covering financial difficulties recapitalize banks or buy government bonds. the mechanism is based in luxembourg, has a rating, aaa by all the rating agencies, which have the same and the european commission to borrow. table 1. basic characteristic of efsm, efsf and esm efsm efsf esm the value of assets 60 bilions euro 440 bilion euro 500 bilion euro instruments credit credit +purchase on the primary market credit +purchase on the primary market rating aaa rating users member of eu member of eurozone member of eurozone source: official journal of the european union c 314/1:2008 total fund assets of both mechanisms were 500 billion euros. mechanisms are organized for period of three years, in order to allow access to affected countries cheaper source of finance. simultaneously with the formation mechanisms of reactions by the ecb, this is started buying of bonds of vulnerable states and the imf, which provided a loan of 250 billion euros. on december 2010, the european council made a decision to establish a mechanism the european stabilization mechanism. this mechanism would effectively dispose of the assets of 500 billion euros and is expected to replace the previous two mechanisms after their expiry 2013. esm will buy bonds of member states in financial difficulties, provided that the countries adopt a program of revitalization of their finances and that it is fully implemented. therefore, financial assistance would be provided only with strict conditions. unlike the previous mechanism, the esm will involve the private sector in line with imf policies. economic analysis (2013, vol. 46, no. 3-4, 14-25) 22 europe after the crisis, which has left unpredictable consequences, faces a number of challenges, the most significant regulatory reform and its corresponding institutional development. from european central bank as some further recommendations sustainability of macroeconomic stability cited the following: • the implementation of fiscal consolidation and ensure the sustainability of public finances, • promoting sustainable growth and job creation, • improving the concept of crisis management • improving economic management, • strengthening the financial sector. effect of financial crisis in serbia effect of financial crisis in serbian financial sector can see in stock market and banking system. serbia's first hit of the crisis experienced in its most sensitive part financial market the stock market. stock market indices in belgrade were losing value faster than indices in developed markets. early 2008, driven by developments in the domestic and large international financial markets, it is evident that there was a significant withdrawal of foreign investors from the market of serbia. due to the poor credit rating of serbia and the increased risk of investing in the country, the entry of foreign capital through a portfolio of investments is unlikely. domestic investors in fear of future developments in the stock market and an insufficient stock of products to choose for savings banks. the downward trend of the index belex line and belex15 continued in the first quarter of 2008. the cause of the rapid decline of the index caused by the withdrawal of foreign portfolio investors from the market due to serbia expectations of further fall in share prices and widening of the current crisis. at the beginning of the third quarter, when financial crisis has spread to all the world financial markets, stock indices in serbia sector experienced steady decline, which continued in the quarter of 2009. from the regional stock exchanges bse indices have lost most of their values and belexline 68.72% and 75.62% belex15.12 followed stock index in skopje (72.92%), stock exchange index, podgorica (71.25%) and the sarajevo stock exchange index (67.34% and 66.52%) .127 the smallest decline in the index in the region has made in the banja luka stock exchange whose index lost 59.91% in terms of traffic vrednosti.128 biggest drop in 2008th compared to 2007. was achieved on the banja luka stock exchange (82.46%) and the smallest decline in turnover was recorded at the exchange ljubljana (42.26%) .129 regarding the market capitalization of the stock market, the biggest drop was registered on the stock exchange in vienna (67.23%), while the smallest drop was observed at the belgrade stock exchange (36.37%).13 neither the banking sector has not been immune to the global financial crisis. one of the first indicators that pointed to any serious extent of the crisis is the rise in interest rates of banks. the difference between the interest rate at which banks placed their funds and the benchmark interest rate of the european central bank has become more pronounced. 12 (2008), financial report september 2008 nbs, beograd; 13 http://www.euribor-rates.eu/11.09.2013. balaban, m., et al., gčobal financial crisis, ea (2013, vol. 46, no, 3-4, 14-25) 23 the banking sector is the most important sector in financial system in serbia. structure of sources of funds in the banking sector is very stable and resistant to external influences, as in the balance sheets of banks, domestic deposits make up about 70%, and capital around 24% of total liabilities of banks. table 2. the capital adequacy 2005-2010. 2005 2006 2007 2008 2009 2010 albania 18,6 18,1 17,1 17,2 16,2 15,4 bosnia-herzegovina 17,8 17,7 17,1 16,3 16,1 16,2 croatia 15,2 14,4 16,9 15,4 16,6 18,8 fyr macedonia 21,3 18,3 17 16,2 16,4 16,1 montenegro 27,9 21,3 17,1 15 15,8 15,9 serbia 26 24,7 27,9 21,9 21,3 19,9 source: cocozza e, colabella a., and spadafor s., the imapct of global crisis of south –estern europe“, imf working paper wp/11/300 given the underdevelopment financial market in serbia, banks have additional financial resources lending mainly received from their headquarters. trend of credit depending serbia abroad has decreased compared to the previous year, but in times of global lack of confidence in the banking system every business ties with the european banks have suffered losses in the market while putting in securities that are self-contained subprime mortgages, may contribute to the overflow financial crisis. the liquidity crisis in the banking system would have a negative impact on the stability of the sector and increase the level of country risk. thanks to the high rates of reserve requirements on foreign borrowing to domestic and foreign currency deposits, the banking sector in serbia is in advanced stages expressed financial crisis coverage deposits of foreign exchange reserves in the amount of 86%, which is well above the indicator other countries in the region, where this ratio was 35%. commercial banks in serbia guaranteed by their parent banks settlement of obligations arising from cross-border loans. it is the parent bank or central banks in serbia are one of the catalysts overflow financial instability in emerging market countries, including serbia. when the crisis hit european financial system, have been hit financial institutions that have borrowed funds in emerging. shortage of capital, which has produced a crisis of liquidity of these institutions, as reported on its institutions in serbia or directly to the users of its services. the consequences of the crisis spilling over with financial to real sector of serbia, reflected the unavailability of financial sources, increasing the outflow of capital from the economy and the lack of needed foreign investment. due to lack of capital, its price will expensive, finance from the loan will be limited and conditions of the loan will be tougher. lack of capital significantly hampers production and slow economic growth. conclusion the global financial crisis that has engulfed the whole world is the still ongoing. is uncertain duration and are not yet aware of all the consequences of the crisis. key economic economic analysis (2013, vol. 46, no. 3-4, 14-25) 24 and financial paradigms that prevailed before the crisis are reduced volatility of the macroeconomic system, sustainable economic growth, the dynamics of real estate prices, increase profitability of the financial sector as the main causes of the crisis highlight the poor quality regulation and supervision of financial institutions, which contributed to the increase in the number of participants and the growth of speculative confidence in the financial markets. poor quality regulation is generated and the risks of uncontrolled collapse of the financial system, which is further make recession economy. in addition, the rating agencies are unrealistically valorised issued securities, which contributed to creating conditions for the emergence of the financial crisis. it is the regulation of rating agencies and their control is one of the priority recommendations for overcoming the crisis. the european central bank has responded to the crisis reduction in key interest rates and the introduction of nonstandard package of measures all programs are adopted, or those that were announced in addition to calling for a coordinated and synchronized measures of relevant institutions, aim to: achieve harmony between monetary and fiscal policy, improve the coordination of measures adopted, to provide the necessary level of liquidity to support economic growth, and reduce the impact of the crisis on the most vulnerable sections of the population. references cocozza e, colabella a., and spadafor s., 2010. “the imapct of global crisis of south – estern europe.“ imf working paper 11/300. ecb's gonzález-páramo, j. m, (2011). the banking sector towards the „new normal“: some considerations. madrid: pwc and ie business school. european commission. 2011. “2011 report on public finances in emu.” european economy, 3. european commission. 2011. ,,european economic forecast spring 2011.” european economy, 1/2011. european commission. 2011. economic and financial affairs, ,,interim forecast, september. financial services authority. 2009. ,,the turner review: a regulatory response to the global banking crises’’. glassner v., and galgóczi b. 2009. “plant – level responses to the crisis: can jobs be saved by working less.’’ etui policy brief, 1/2009. nbs. (2008). financial report, september. official journal of the european union c 314/1:2008. stratfor. 2008. the financial crisis in europe, stockanalyst. http://www.istockanalyst. com/article/viewarticlepaged/articleid/2702034/pageid/. strauss-kahn d. 2008. lessons from the financial market crisis: priorities for the world and for the imf’’ to the indian council for research on international economic research (icrier). india: new delhi. swint, b. 2009. bank of england cuts main rate a half point to 1%. bloomberg.com: http:// www.bloomberg.com/apps/news?pid=20601102&sid=ak38at3528zc&refer=uk. http://www.istockanalyst. com http://www.euribor-rates.eu/ http://www.tradingeconomics.com, balaban, m., et al., gčobal financial crisis, ea (2013, vol. 46, no, 3-4, 14-25) 25 http://www.wsjprimerate.us/fedfundsrate/federal_funds_rate_history.htm globalna finansijska kriza i njeni efekti na evropski finansijski sistem rezime – efekti svetske finansijske krize su imali dalekosežne posledice. ako posmatramo na globalnom nivou posledice krize su: pad privredne aktivnosti, produktivnost, zaposlenost, izvoz stranih direktnih investicija, likvidnosti, slabljenje bankarskog sektora, pogoršanje fiskalne pozicije zbog mjera za stimulisanje potrošnje, preveliki rast duga mnogih zemalja, koji je dostigao neodrživ nivo. koliki je efekat krize može se videti u zavisnosti od stepena razvoja zemlje. ovaj rad analizira efekte krize u finansijskom sektoru. u razvijenim zemljama, kriza je dovela do pada likvidnosti usled slabljenja bankarskog sektora, što se odražava na smanjenje potrošnje i investicija, a time i smanjenja rasta bdp-a i zaposlenosti. u zemaljama u razvoju kriza je efekat globalne krize se može videti kroz smanjenje stranih direktnih investicija razvijenim zemljama, pad izvoza zbog smanjenja tražnje iz razvijenih zemalja i slabljenje bankarskog sektora. u siromašnim zemljama, kriza dovela je do nedostatka kredita i donacija od strane razvijenih zemalja, smanjenjem izvoza i stranih direktnih investicija. ključne reči: kriza, investicija, finansijski sektor, bankarski sektor, produktivnost article history: received: 13 september 2013 accepted: 22 november 2013 ea_2014_1-2 udc: 336.774.3 ; 336.76 jel: g24 id: 207707148 scientific review credit rating as a factor of stability in the global capital market musabegović ismail1, raičević ivana, union university, belgrade banking academy faculty for banking, insurance and finance, belgrade, serbia majstorović andrea, university of belgrade, faculty of organizational sciences, belgrade, serbia abstract – credit rating has an outstanding importance on the capital market. opinions and assessments of rating agencies help us to improve growth, stability and efficiency of international and domestic markets, which now include over 80 trillion dollars of rated bonds and other securities with the fixed income. the contribution of the credit agencies to the market stability and efficiency is reflected in their ability to provide accurate, clear and reliable assessments of the solvency of participants on the financial markets. an adequate and proper risk assessment of securities contributes to stability. in order to achieve a given goal and to satisfy its purpose, the assessments should be based on a fundamental understanding of the key components of the credit risk. also, in order to ensure a reliable framework for making investment decisions, the rating agencies are obliged to offer and to provide a wide range of securities, which are based on a global comparability of rating symbols and on the support given by the credit rating assignment committee and by the other relevant decision making bodies. markets for structured products could not have developed without the quality assurance provided by cras. when analyzing a securitization program cras examine legal and structural protections provided to investors. since the globalization is an inevitable phenomenon in today’s world the importance of the credit rating becomes more noticeable. on the other hand, the rating agencies have an obligation to reanalyze their decision making models in order to contribute to the reliability of the evaluation. key words: rating agencies, financial crisis, conflict of interest, credit rating, rating symbols introduction it is very unusual to initiate a discussion of some of the companies at the meeting of the general assembly of the united nations. in 2013 this kind of the initiative was launched at a global level. the influence of the rating agencies on the economic movements has been recognized as one of the important factors. it raises significant question which is whether rating agencies reports have become the generators of the financial crisis and ceased to be a safety factor of issuers and investors. credit rating is a result of analysis of the general creditworthiness of a particular financial subject or debit instrument securities or other financial obligations, based on the relevant 1 corresponding author: ismail.musabegovic@bba.edu.rs economic analysis (2014, vol. 47, no. 1-2, 19-31) 20 risk factors. as defined by moody’s rating agency “ratings represent the opinion of moody's investors service as to the relative creditworthiness of securities”2. according to international organization of securities commissions (iosco) and european securities committee (esc), the credit rating is a professional opinion regarding the creditworthiness of the entity, its credit obligations, a debt, measured by the previously defined and published ranking system (langohr, 2008). rating is usually marked by certain symbols in the form of one-dimensional rating scale, which represents a summarized product of the credit analysis. credit rating can be compared with a number of other types of opinions and assessments. some of them have been made to provide future estimates and to encourage users in making good business decisions. others are "historical" and do not have wide application and importance in practice. the influence of the world's leading agencies for determining credit ratings and their responsibility for the development of the current financial crisis, has been the subject of numerous analyzes from the moment when the crisis has started. in the last few years, the estimations of the rating agencies and of the other international agencies involved in assessment and in rating of the countries, their banks and the companies, have a significant impact on the global financial flows. according to a joint estimation of the professional public and relevant institutions, rating agencies are responsible for the emergence of the financial crisis. the basic determinants of credit rating credit rating (based on related risk factors) is the result of analysis of the general creditworthiness of a borrower or of the debit instruments securities or other financial liabilities. credit rating given by the rating agencies, as specialized institutions that are dealing with this field, can be seen as the most complete, because it has far-reaching features, it uses a number of factors in assessing creditworthiness and credit rating is expressed through a standardized rating scale (adelson, 2012). credit rating is focused on one aspect of investment decision the ability and the quality of given resources return – which in some cases (for example bankruptcy or restructuring of the company) may be perspective of something what investors can expect. credit ratings data are generally widely distributed and available in public in order to overcome the information gap between lenders and borrowers. this way none of the participants in the market would be able to surpass the others. 2 http://www.moodys.com/pages/amr002002.aspx musabegović, i., et al., crediti rating, ea (2014, vol. 47, no, 1-2, 19-31) 21 table 1. what the ratings mean what the ratings mean rating service fitch moody’s standard & poor’s highest quality “gilt edged” aaa aaa aaa high quality aa aa aa upper medium grade a a a medium grade bbb baa bbb predominantly speculative bb ba bb speculative low grade b b b poor to default ccc caa ccc highest speculation cc ca cc lowest quality, no interest c c c in default, in arrears questionable value ddd dd d ddd dd d source: http://www.latimes.com/ just as private companies, individuals, regulators and some government institutions also use the credit rating reports or they approve their usage. for example, in accordance with the basel ii passed by the basel committee on banking supervision, the institutions responsible for the regulatory framework may allow banks to use credit ratings of certain authorized credit agencies such as the export credit agencies (eca), especially in the calculating net reserve capital requirements. according to the guidelines of basel ii some criteria are defined. those criteria must be followed by the institution competent for the banking system regulatory framework when accepting the credit rating agencies reports, primarily in the sense of impartiality, independence, transparency, etc. (gaćeša, 2009.) the influence of the leading rating agencies on the financial market movements in the period before and after the financial crisis there are several rating agencies and other smaller organizations in the world involved in this area, but the most famous are moody's, standard & poor's and fitch rating known as the big three. rating agencies are often under suspicion of being too exposed to a conflict of interest. the proof is the fact that the issuer of debt securities pays for his credit rating, rather than an investor who uses the same rating when making his investment decisions. therefore, there is a possibility that the agency awards a better rating if the issuer offers to pay a higher fee for the service. this way the issuer actually "buys" the rating, which certainly opens the way for a possible abuse. another good example of the rating agencies involvement in a conflict of interest arises in the provision of additional advisory services that the rating agencies offer to their clients. economic analysis (2014, vol. 47, no. 1-2, 19-31) 22 figure 1: stowell, d. p. (2010). an introduction to investment banks, hedge funds, and private equity. elsevier, p. 126. the financial crisis of 2007, caused by the so-called "subprime" loans, confirms the previously mentioned problem. conflicts of interest may also be reflected in too close relation of rating agencies with the management companies, due to the fact that an excessive openness can lead to various abuses. at that time, monetary policy allowed an easy access to loans and instead of taking a 20% deposit, banks would only take 3% of the amount of the loan. in recent years, agencies have come under attack from numerous critics. the most complains about the standard and poor’s operations were directed in the midst of the enormous losses arisen during the financial crisis in 2007 and in 2008, due to the operations with the collateralized debt obligation (cdo) and synthetic financial products, which had a top ("aaa") rating. many critics consider that the standard & poor's, one of the most respected rating agencies in the world, failed not only in warning the investors about the risks that derivative mortgage securities carry, but that the agency was directly involved in creating them as well. today, standard & poor's is a leader in providing financial information and services around the world. its head office is located in new york city. the representatives and the offices of the company are located in over 20 countries worldwide. according to the financial statements, annual income is around 2.61 billion dollars.3 the company employs nearly ten thousand people, of which the largest number of financial analysts. at any time, the company has the financial data from 70 countries, more than 3 500 international companies and more than 2 600 american companies. some serious objections were sent to the standard & poor’s by many eu countries, especially germany and france, because of too harsh assessment and lowering the credit rating of many countries in the eurozone in 2011 and in 2012. 3 http://www.standardandpoors.com/about-sp/key-statistics/en/us credit rating musabegović, i., et al., crediti rating, ea (2014, vol. 47, no, 1-2, 19-31) 23 in august 2011, the s & p unexpectedly downgraded the united states' credit rating from aaa to aa+ for the first time since 1917, due to the amount of the budget deficit and rising debt burden. the news automatically reflected the movements on the financial markets (the major united states' stock indices fell by 4-6% on the first day after the announcement), while the united states’ officials had fierce reactions to the fact that funding sources become more expensive for the u.s. government. despite the turmoil in the beginning, people came to the conclusion that besides american public disapproval, this move will not have a drastic and long-term impact on the global economy of the us. experts and officials of the most developed countries in the world considered that the downgraded credit rating reflected the real picture of the us economy and would affect some changes in the fiscal policy of the us which was known as one of the most expansive in the world. after the announcement of information about the u.s. rating cut, the question, raised by the professionals, was if the credit rating was downgraded to the world's largest economy why it was done in that moment, regarding the fact that the amount of the u.s. debt was increasing for decades. also, the credit rating enigma was why none of the big three had taken any downgrade action except s&p. however, this decision, at the moment when the confidence in the global financial system has already been significantly weakened, contributed to the creation of even more pessimistic assessment. many countries, due to the problems with a large state debt and a budget deficit, were targeted by the standard & poor's. decisions made by the s & p caused significant disturbances on the financial markets. european stock markets reacted instantly, and the indices were in decline for days. on the other hand, the interest rate, actually the cost of borrowing money, further increased. european officials have strongly reacted and have expressed a great dissatisfaction with this decision. because of that, some countries, members of the eurozone, led by germany, demanded stricter control of private rating agencies. they also suggested creating a european rating agency, which would only evaluate european countries, members and non-members of the european union. this agency, in contrast to the u.s. agencies, would not be in private hands and the decision of such an agency would not have the political dimension. moody's investors service was involved in operations with the financial derivatives and mortgage-backed bonds. when it comes to the quality assessment of rating agencies it is interesting to mention the fact that during the period from 1950 to 2007 the average income on bonds that were rated aaa by moody’s was almost 1% lower than the income on the bonds that were rated baa. in the middle of 2008 this difference was increased to 3%. unlike its competitors, moody's was far more involved in the assessment of the government debt instruments of the eurozone countries, especially after the outbreak of the european debt crisis. many analysts and those familiar with the circumstances claim that moody's, although he had already been criticized because of the housing bubble, the crisis in the u.s., and the icelandic financial crisis (2008-2012), played a key and a very controversial role. the rating system is created the way that it does not change often. this is the reason why it does not represent a good tool in the analysis of investments in securities when there is a sudden and unexpected change in the fundamental factors of a company or a country. (božović, urošević, živković, 2011.) economic analysis (2014, vol. 47, no. 1-2, 19-31) 24 according to financial data from 2010, the company earned nearly two billion dollars, of which net income was 407.1 million dollars. according to the business segments, most of the companies' revenues were generated by the operations of the credit rating assignment, as well as numerous research and analysis, comprising 71.3% of total revenue. it is important to emphasize that moody's charges for each security that evaluates and rates. this is followed by the risk management activities, which are 25% of total income. and at the end, there are other services related to counselling and trainings organized by the company for its customers and these form 3.7% of revenue.4 the company employs approximately 6 500 people in over 28 countries where they have representatives and offices. moody's regularly monitors and evaluates the debt securities from over 110 countries, around 11 000 corporate bonds and more than 94,000 of derivatives and other structural financial products. numerous analyzes showed that the agency under the new, and much stricter rules, rated countries such as greece, italy, portugal, ireland, and that way made the situation even more complicated and forced the country to seek international assistance. for example, in a day moody's downgraded portugal's credit rating and the rating of its national companies (airport and electric utility) to a speculative level ba2 which caused severe turbulences on the stock markets across europe. it was later discovered that the mentioned companies had very solid financial statements and that the decision to cut their rating was too strict. great dissatisfaction and negative reactions caused the decision of the agency to cut italy’s credit rating from a3 to baa2, (two levels above junk status) and only one day before it was supposed that italy came out on the financial markets in order to assemble about 5, 25 billion euros at the auction for the medium and long-term government bonds. the italian government, the european parliament and the european commission reacted immediately. they accused moody's of making that decision on purpose, protecting american interests that way, and directly led italy in a danger of bankruptcy. moody's rating agency made a wrong assessment on june 14, 2012. just a day after the agency downgraded rating to some provinces and to 16 spanish banks, including the two largest santander and bbva, something unexpected happened. the value of shares of most spanish banks increased suddenly. the same year when the credit rating of the world's largest economy was lowered for the first time in the last hundred years, many expected that the economy of the other countries will get downgraded credit rating. germany, as the leading european country, was certainly at the centre of attention. after the start of the crisis and the bankruptcy of greece, it was clear to germany that it will bear an accumulated debt of spain and of greece. however, at that time the rating of germany remained unchanged, despite the significant amount of credit that should provide for recovery of the damage. germany's credit rating was reduced a year later than in the u.s. it is interesting that germany’s credit rating was downgraded by moody's only, which is the same as in the case of the u.s. the scenario that followed the information about the reduced rating of germany was very similar to the one that happened in august 2011. fitch ratings represents the youngest rating agency and a member of the big three. according to financial indicators from 2011, the annual income is over 732.5 million dollars.5 4 http://www.wikinvest.com/stock/moody%27s_%28mco%29/filing/10-k/2010/f46734536 5 http://www.fimalac.com/regulated-information.html musabegović, i., et al., crediti rating, ea (2014, vol. 47, no, 1-2, 19-31) 25 fitch currently monitors and gives its opinion, through the rating symbols, for about 2300 banks and other financial institutions, over 1000 companies, 70 countries and almost 26000 municipal bonds. the agency covers more than 7000 different types of issuer of derivatives and of the complex financial products, particularly on the mortgage market. the rating agency fitch, as well as two other rating agencies, has been heavily criticized by the investment professionals. the creation of a financial bubble, huge losses and the crisis, whose consequences can still be seen, are some of the reasons that have led many to see the main responsible for this situation in the rating agencies. in contrast to standard & poor’s and moody’s, fitch was warning of the danger that lied behind the whole industry of the financial engineering, which led to the creation of new and complex financial products. collateralized debt obligation (cdo), collateralized mortgage obligation (cmo), constant proportion debt obligation (cpdo) are just some of the products that are the results of the financial engineering, and behind are hidden different types of risk that are difficult to verify and to assess. fitch tried to warn of this as well as of some contradictory indicators on real estate market in the united states. however, because of fear of loss of market share and because of pressure of major "players" on the market, the agency had to ease up and, although the agency was aware of the dangers, it had to assign an investment rating to earlier mentioned products. and the consequences of this decision feel the whole world today. the basic methodological principle of analysis and assessment of creditworthiness each rating agency applies its own methodology for measuring creditworthiness and it uses special rating scales to announce its observations and opinions. typically, ratings are expressed through certain letter symbols, such as "aaa", "bb", "d", depending on the level of risk assessed by the agency. in 1924, the company fitch published and put into the use this rating scale, which was later accepted by the standard & poor's rating agency. moody's scale is almost identical, with a few minor differences. the moody's is different from the other two agencies because it has a superior approach to rating assignment process that does not only considers the probability of failing to fulfil the obligation, but also the severity of loss in the case of delay. it is also important to note that the rating agencies can improve or worsen the rating of a debtor or of the debt instrument without changing the symbols. these "fine adjustments" can be performed by adding certain numbers "1,2,3 ..." (moody’s does this way) , or symbols such as "+" or "-", the standard & poor's applies. the procedure of credit rating assignment is quite standardized and almost identical in all rating agencies. most frequently it consists of 6 to 8 steps, actually the procedures that must be followed in order to complete the whole process in the best possible way. during the rating process, each analyst involved in the work is required to: 6 • collect enough accurate, reliable and information of high-quality based on which he'll evaluate the risk for investors who might possess or acquire the security, • present and explain his opinion about the appropriate rating at the meeting of team members, 6 http://www.moodys.com/ratings-process/how-to-get-rated economic analysis (2014, vol. 47, no. 1-2, 19-31) 26 • constantly monitors over the given financial instrument in order to determine whether there are indications that the rating can be changed and • inform all interested market participants about his actions. table 2. rating symbols of ranking investment agencies interpretation moody’s standard & poor’s fitch the highest credit quality aaa aaa aaa aaa rating indicates a very high security level of the issuer, the high stability of the economy for investment and the issuer without credit risk / the highest rank of issued debt instruments. the ability of an issuer to fulfil its obligation regarding the payments of interest and principal is estimated to be very high. in general, this ranking includes a little risk from unperformed obligations. high credit quality, riskier than the previous one aa (1,2,3) aa (+/-) aa (+/-) aa rating indicates strong reliability of the issuer, the economy is stable and secure for investments with a low risk for investors / high ability to pay interest and principal. the instruments of this range do not follow the high level of protection, as in the case of the previous level. strong ability to pay, the economic situation partly affects on payment a (1,2,3) a (+/-) a (+/-) a rating indicates a good security of the issuer. the economy is safe for investments, except in the case of unexpected disorders that would have a harmful impact on the entire economy, or particular industries / high ability to pay interest and principal. generally, there are some doubts regarding the reactions to the change in circumstances and economic conditions, and it gives a higher risk to these instruments than to the instruments of the highest rank. adequate ability to pay, the medium size category the last rating in investment grade baa (1,2,3) bbb (+/-) bbb (+/-) bbb rating means sufficient security. issuers with this assessment have medium safety level for investment, with the potential problems of the worsening economic situation. issuers of this range have a satisfactory level of ability to pay interest and principal. under normal circumstances, they provide a sufficient level of protection for investors. due to the negative changes in the economy and unexpected circumstances, the ability of the issuer to properly fulfil the obligations will be significantly reduced. source: compilation of (http://www.standardandpoors.com/home/en/eu, http://www.fitchratings.com/web/en/dynamic/fitch-home.jsp, https://www.moodys.com/) musabegović, i., et al., crediti rating, ea (2014, vol. 47, no, 1-2, 19-31) 27 rating process involves active and constant dialogue between issuers and analysts who are in charge of it. once published, assessment, actually rating is constantly monitored, controlled and updated through regular meetings and discussions, during which the issuer is encouraged to express and to present all relevant facts that may be of importance for the analysis. credit rating of independent rating agencies such as moody's investor services, standard & poor's (s & p) and fitch ratings represent the cornerstone of investment strategies. popularity of credit rating is not derived only from its simplicity, where only one symbol presents the wealth of data and analysis, but also from the fact that it provides an independent and absolute evaluation of the subject's capacity to repay the debt. before 1975 rating agencies were using information about the company available for public in order to reduce the gap, or "information asymmetry" between the debtor (the issuer) and the lender (investor). in order to prevent conflicts of interest, rating agencies faithfully served investors and the marketplace by providing the information necessary for investment decisions and strategies. despite the fact that the rating agencies should be regulated by the u.s. securities and exchange commission (under the provisions of the credit rating agency reform act of 2006, local regulatory authorities and state regulators are not competent to control the rating agency) oversight was often sporadic and anaemic at best. this fact could represent outdated trace of the early history of independence and reliability of the rating agencies, or it could simply be the result of inadequate monitoring of the rating agencies activities by the federal government. rating agencies performance, as necessary participants in this market, was significant. in september 2011 , moody's announced that a new "damage", or non-payment of principal and interest claimed by investors through structured financial products, increased from 109 in 2006 to 2 153 in 2007 and to 12 719 in 2008, until it reached a peak of 14 242 in 2009. at the same time, 37 000 "of discrete" investment products were written off due to inability to pay. analysts calculated that, in spite of the fact that financial instruments with the highest credit rating (aaa) were irrecoverable in less than 1% of cases, more than 90% of subprime instruments (rmbs), which appeared in 2006 and in 2007, were downgraded to a low credit rating (junk) soon after they entered the market. advantages and disadvantages of the rating agencies more than half a century, rating agencies represented the main source of high-quality and objective information on creditworthiness of the participants on the global financial market. accurate and objective information affected the quality planning of investment activities, financial flows and risk control. the existence of rating agencies was necessary in order to avoid information asymmetry. in the business of the rating agencies, there are variety of financial, ethical and other difficulties and limitations. the main function of the rating agencies (to provide independent, objective, high-quality grades based on many examples) has been called into doubt. as previously mentioned the issuer of the security pays for its credit rating, not an investor who uses the same rating while making his investment decisions. it seems that this economic analysis (2014, vol. 47, no. 1-2, 19-31) 28 fact was never a problem until the collapse of lehman brothers. then, they quickly came to the conclusion that the basic assistance to banks in marketing activities and in increasing the credibility of the newly created financial products provided the world's leading credit rating agencies. the same case was with debt instruments that the companies emitted. the results of analysis of the impact of the rating agencies in development of the financial crisis, also suggested that the rating agencies often neglected important information in establishing rating and that in determining the credit rating a high degree of bias was presented by the agency. conclusion before the economic crisis shook the world, the credit agencies were support to all stakeholders on the global financial market. their assessments and opinions were extremely important. the future of the companies depended on them, and the national economy recorded fall and rise depending on the rating given by the rating agencies. however, nowadays the rating agencies have insufficient evaluation and their estimations have little influence on business decisions of participants on the financial market. the big three have rated mortgage-backed securities, providing much more securities with their highest ratings until 2007, when a portion of the mortgages backing these securities defaulted. finally, those credit rating agencies felt compelled to downgrade across the board many securities in this asset class, so many investors and insurers were facing with losses. during the crisis monetary policy allowed an easy access to loans, banks did not analyze the occurrence of reducing participation in obtaining credit. that was one of the factors that initiated crisis, since the potential risk has been ignored by rating agencies. by the end of 2009, over half of the cdos by value issued at the end of the housing bubble (from 2005-2007) that rating agencies gave their highest "triple-a" rating to, were "impaired"—that is either written-down to "junk" or suffered a "principal loss" (i.e. not only had they not paid interest but investors would not get back some of the principal they invested). financial crisis inquiry commission estimates that by april 2010, of all mortgagebacked securities moody's had rated aaa in 2006, 73% were downgraded to junk.7 in the process of securitization credit derivatives are made, and they are used to create synthetics for corporate and sovereign debt securities. the main goal is to create tradable securities from the cash flow of pools of non-liquid assets. securities backed by assets in the pool usually have several levels of credit enhancement to mitigate the potential loss arising from the credit risk of the underlying assets. in 2007and 2008 when credit crisis has happened it led to very significant drops in the price of many mortgage backed securities, especially those backed by subprime mortgages in the last few years there was a strong impact of the public on the rating agencies. especially european rating companies were criticized. there is a belief, that once their objective forecasts and estimates are put at the service of american capital and tendentious decrease in the european economy. thus, in a relatively short time rating agencies passed from extremely powerful, highly skilled professional institutions to institutions that are now accused of monopoly position, lack of professionalism and high level of corruption. the 7 http://en.wikipedia.org/wiki/credit_rating_agencies_and_the_subprime_crisis musabegović, i., et al., crediti rating, ea (2014, vol. 47, no, 1-2, 19-31) 29 rating agencies defend the reputation with the messages of this type: "do not kill the messenger", but there are too many mistakes behind them and it seems impossible that they will make disappointed investors around the world, especially the european union, believe them again. obviously, it is necessary to reform the entire system of the rating agencies, which should (dušanić , 2013): allow agencies to charge their services from investors, rather than from the issuer, • prohibit the provision of consultancy services • abolish an exclusive status to the rating agencies, which they have in many official documents • destroy existing monopoly • provide conditions for the creation of healthy competition through the elimination of many registration barriers when people want to open a new agency. many years and scores will pass until the return of the trust, but it is already apparent that they need to take some urgent measures. therefore, it is essential that the proposed measures should be immediately adopted and implemented in practice. this is the only way to establish the order among the rating agencies in order to recapture its original position on the market. if that happens, it will certainly lead to the return of the lost confidence among market participants, which undoubtedly would strengthen and lead to stability and prosperity of the financial markets. in serbia, the new securities act provides the establishment of the rating agencies, but so far none has been registered. although serbia has introduced a new act about credit rating agencies and defined policies under which they can be established, it is very unlikely to expect credit rating agencies on a "local" level in the near future. this is because of the fact that foreign investors, who are considering serbia as a new investment destination, usually base their decisions on information provided by well known, global credit rating agencies. references adelson, m. (2012). the role of credit ratings in the financial system. new york: standard&poor's. atkinson, r. (2006). dpwn: the initial credit rating of a major corporation. global capital markets, 1 – 20, morgan stanley. božović, m., urošević, b., & živković, b. (2011). credit rating agencies and moral hazard. panoeconomicus, beograd. cecchetti. s. g. (2007). money, banking and financial markets. new york: mc graw-hill. dušanić ,j. (2013) .u zagrljaju neoliberalne hobotnice ,nauka i društvo,beograd. na internetu :http://dusanic.rs/nht.pdf gaćeša, r. (2009). osvrt na međunarodni kreditni rejting. udruženje banaka srbije, beograd. katz, j., salinas e., & stephanou, c. (2009). credit rating agencies: no easy regulatory solutions. the world bank group, financial and private sector, washington. kisgen, d.j., & strahan, p.e. (2010). do regulations based on credit ratings affect a firm’s cost of capital?. the review of financial studies. boston: boston college. economic analysis (2014, vol. 47, no. 1-2, 19-31) 30 klein, e. (2011). standard & poor’s has been wrong before. but they’re right now. the washington post, washington d.c. kundid, a., & ercegovac, r. (2011). credit rationing in financial distress: croatia smes' finance approach. international journal of law and management. liaw, t. (2012). the business of investment banking. john wiley & sons, inc. odders-white, e. r., & ready, m. j. (2005). credit ratings and stock liquidity. the review of financial studies. oxford university press. porket, j. l. (1998). modern economic systems and their transformation. st. antony`s college, oxford. reilly, f. k. & brown, k. c. (2006). investment analysis and portfolio management. thomson higher education. rose, p. s. & milton, m. (2008). money and capital markets. new york: mc graw-hill sinclair, t. j. (2010). credit rating agencies and the global financial crisis. economic sociology the european electronic newsletter, vol. 12, number 1. stinberg, m. (2000). new york institute of finance guide to investing. new york: institute of finance. stowell, d. p. (2010). an introduction to investment banks, hedge funds, and private equity. elsevier. thompson, i. (2011). standard & poor's ratings definitions. global credit portal. new york: standard&poor's. internet sources: http://www.standardandpoors.com/home/en/eu (accessed april 12 , 2013) www.washingtonpost.com (accessed april 25, 2013) http://www.fitchratings.com/web/en/dynamic/fitch-home.jsp (accessed april 30, 2013) http://www.moodys.com/ (accessed may 2, 2013) www.ft.com (accessed may 10, 2013) http://uk.wsj.com/home-page (accessed may 15, 2013) http://en.wikipedia.org/wiki/credit_rating_agency (acccessed june 8, 2013) http://www.latimes.com/ (accessed june 8, 2013) kreditni rejting kao faktor stabilnosti na globalnom tržištu kapitala rezime – kreditni rejting ima izuzetno važnu ulogu na tržištu kapitala. mišljenja i ocene rejting agencija pomažu da se podstakne rast, ali i stabilnost i efikasnost međunarodnih i domaćih tržišta, koja sada obuhvataju preko 80 hiljada milijardi dolara ocenjenih obveznica i drugih hartija od vrednosti sa fiksnim prihodom. doprinos rejting agencija tržišnoj stabilnosti i efikasnosti se najbolje ogleda u sposobnosti da pruže tačne, jasne i verodostojne procene boniteta učesnika na finansijskim tržištima. realna, adekvatna i ispravna ocena rizika hov doprinosi stabilnosti. da bi postigle zadati cilj i ispunile svrhu postojanja, te procene bi trebalo da se baziraju na fundamentalnom razumevanju ključnih komponenti kreditnog rizika. takođe, da bi obezbedile pouzdan okvir za donošenje musabegović, i., et al., crediti rating, ea (2014, vol. 47, no, 1-2, 19-31) 31 investicionih odluka, rejting agencije su dužne da ponude i obezbede široku pokrivenost hartija od vrednosti, koja se zasniva na globalnoj uporedivosti rejting simbola i podršci koju pruzaju strane odbora za dodeljivanje kreditnog rejtinga i drugih relevantnih organa odlučivanja. u procesu sekjruzitizacije, značajnu ulogu imaju kreditne agencije prilikom ispitivanja pravne i druge zaštite koje su propisane za investitore. uz uvažavanje globalizacije kao neizbežnog fenomena današnjice, kreditni rejting sve više dobija na značaju, uz neophodnost i obavezu rejting agencija da preispitaju svoje modele odlučivanja, te da na taj način doprinesu većoj pouzdanosti samih ocena. ključne reči: rejting agencije, finansijska kriza, sukob interesa, kreditni rejting, rejting simboli article history: received: 20 february 2014 accepted: 1 april 2014 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp51-67 original scientific paper gender based analysis of the access to public procurement in western balkan by smes sanja popović‐pantić1* | dušica semenčenko1 | nikola vasilić1 1 university of belgrade, institute mihajlo pupin, science and technology policy research center, belgrade, serbia abstract the subject of the research is the access to public procurement in western balkan region by smes including a gender equality perspective. the research has three key objectives: to identify key barriers that hinder the engagement in public procurement; to determine whether there are differences in the perception of the importance of barriers to access to public procurement between male and female-owned companies; and to check whether there are differences in the perception of the importance of barriers to participate in public procurement between different-sized companies. main statistical methods used in the research are descriptive statistics and nonparametric techniques for comparing differences between groups. as the most significant barrier in the domain of discriminatory barriers sorted out is limitations related to the financial capacity of the company. at the second place is limitations related to the number of employees and their qualifications. the importance of restrictions on production volume or quantity required and meeting quality standards is somewhat weaker compared to the aforementioned barriers. generally speaking, discriminatory barriers are of moderate importance for inclusion in the public procurement. similar results were obtained when non-discriminatory barriers were observed, with the greatest significance in order: complicated bidding process, short deadline for preparation of documentation, insufficient and incomplete information in the public procurement invitation. the results of the applied nonparametric techniques show that there are no significant differences in the perception of the importance of barriers to participate in public procurement between male and female-owned companies, as well as between different-sized companies. key words: public procurement, gender, smes, barriers, western balkan jel classification: m10, l26 introduction the public procurement costs represent an average 12% of gdp and account for almost onethird of government expenditure in oecd countries. in the european union (eu) these costs go to around 14% of gdp. every year, over 250 000 public authorities in the eu spend around 2 trillion euros per year on the purchase of services, works and supplies. small and medium-sized enterprises (smes) make up the largest percentage of enterprises in economies around the world. they are often the main backbones of economic development policies. comprehensive public procurement strategies implemented by some governments highlight the mutual benefits which can be achieved by closer and greater engagement of small businesses. although smes access to the public procurement market is one of the many demand* corresponding author, e-mail: sanjap.pantic@pupin.rs 52 economic analysis (2020, vol. 53, no. 2, 51-67) driven elements necessary for policy implementation, the wide range of efforts that some countries have developed through public procurement reforms can have a beneficial impact on the overall business environment of smes as well as other policy areas. it is estimated that between 2006 and 2008, the proportion of smes amongst companies who won public contracts over the european union thresholds for the whole period was 60%. in the terms of estimated total contract value of the public procurement secured, smes accounted for three years was 34%. the relative weight of all three sme categories is smaller here due to their tendency to win contracts with lower values unlike large enterprises (eu, 2010). according to the analysis of the sample notification of ted contracts, about 61% of public contracts were awarded to smes from the eu28 in the period 2011-2017. out of that, 19% of contracts were awarded to micro-sized enterprises, 22% to small ones and 20% of contracts were awarded to medium-sized enterprises. when looking at the total value of the contract, smes participated with 33% in the observed seven-year period, which implies that the ratio between the value of the contract and the probability of smes winning the contract was inversely proportional. analyzes show that only 5% of the value is assigned to micro-sized enterprises, 13% to small and 14% to medium-sized enterprises. as expected, the largest gap between the share in obtained contracts and the share in the value of contracts was the largest for micro-sized enterprises. this gap gradually narrowed as the size of the company increased (ec, 2019). the participation of more suppliers often encourages greater competition in the market, which reduces procurement costs. smes have lower administrative overheads and management costs compared to larger firms, so depending on the nature of the procurement may result in lower prices. on the other hand, smes can provide better quality of service because they have short management chains so they can quickly respond to changing customer requirements. smes can also be highly focused on specific markets, which is a benefit to them in relation to changes in those markets. smes are often able to more easily tailor products and services to specific customer requirements and thus develop long-term relationships with their customers. smes are more flexible and can respond to limited demand and focus on niche markets and retail. when it comes to innovation, smes have some advantages in terms of early exploitation of new technologies and rapid introduction of products or services into new or undeveloped markets, or using innovations to differentiate themselves from existing market players. public authorities are the big main buyers in many sectors, such as: energy, transport, waste management, social protection and health provision or education services. having this in mind public procurement is seen as source of economy growth, investment, jobs and incentive for more innovative economies, resource and energy efficient, and socially inclusive. although public procurement has a potential to support the fight against discrimination and promote gender equality and social inclusion of various marginalized social groups, femaleowned companies seem to be in even less favourable position than the male-owned ones in accessing public procurements. although, women-owned businesses make up more than 40% of the world’s micro, small and medium-sized enterprises, only 1% of government procurement tenders are won by women (unwomen;2017). incorporating gender equality into public procurement contracts is an effective tool that governments can use to promote social change and promote equality, but that is not a case in the vast majority of legislation all around the world. lack of equal opportunities in procurement and contracts can be caused by a number of factors, including lack of equality in procurement practices and contracting authorities' behaviour (i.e. direct or indirect discrimination on multiple grounds, including gender), as well as neglect to ensure that parties are awarded contracts, loans or other benefits, promote and respect non-discrimination policies. in addition, the lack of gender equality in procurement and public contracts may result from the lack of the equality in society in general. women-owned enterprises are mostly micro and small, which often puts them in an outsider position when they compete in public procurement tenders. in addition, a larger number of sanja popović-pantić, dušica semenčenko, nikola vasilić 53 these companies have less capacity when it is necessary to certify their technical competencies, financial resources, equipment and other physical guarantees. in the case of younger companies, one of the obstacles could be the management skills, business experience and staff which are not certified by the competent state agencies. practice in some countries has shown that for all these reasons, women-owned enterprises are losing out on the potential provided by the public procurement contracts: business expansion, volume building and innovation, and entry into new value chains. the paper consists of five parts. the first part deals with the main characteristics of smes in the western balkans as well as public procurement assessment of our sample countries. the second part discusses the characteristics of policies and legal regulations related to gender equality in public procurement in the european union and serbia. the third part is an overview of good practices in the eu and other developed countries when it comes to access of women entrepreneurs to public procurement. the fourth part of the paper describes the sample, research questions and statistical methods used to analyse the collected data and the fifth part presents the results of the research. smes sector performance and public procurement in western balkans regarding monitoring and assessment of the performance of the countries in public procurement, the eu small business act (sba) is relevant source for many aspects of entrepreneurship including this issue as well. it aims to improve the approach to entrepreneurship in europe, simplify the regulatory and policy environment for smes, and remove the remaining barriers to their development (ec, 2008). sba includes a set of 10 principles to guide the conception and implementation of policies both at eu and member state level. these principles are essential to bring added value at eu level, create a level playing field for smes and improve the legal and administrative environment throughout the eu. among them, the fifth principle – “adapt public policy tools to sme needs: facilitate smes’ participation in public procurement and better use state aid possibilities for smes” is in the scope of this paper. since june 2009, after the regional ministerial conference on the european charter for small enterprises in the western balkans, serbia, as well as other countries in the region, has begun implementing the small business act (ivković et al., 2012). implementation and advancements of sba are of interest not only in countries of implementation, and eu but in other international economic institutions, such as oecd. regarding that fact, there is evidence about sme sector performance, particularly in the field of public procurement as a dimension of 5b of sba (oecd/etf/eu/ebrd, 2019). according to the report, serbia and montenegro are performing the best regarding the number of smes in 2017. in relation to the number of inhabitants. table 1 presents the main statistical data regarding sample countries in this paper (except croatia). table 1. sme sector statistics (2017 or latest year available) bosnia and herzegovina montenegro serbia smes per 1 000 inhabitants in % 8.5 48.8 50.9 percentage of enterprises 99.12 99.84 99.85 value added in % 59.81 70.48 56.66 share of exports 54 economic analysis (2020, vol. 53, no. 2, 51-67) bosnia and herzegovina montenegro serbia 61.24 75.33 39.25 employment in % 63.92 80.09 66.0 source: oecd/etf/eu/ebrd (2019). western balkan economies also implemented some of the rules which are practiced in the eu regarding the public procurement, such as: division of procurement contracts into smaller lots in order to make it more accessible to smes, maximum time periods for payments in public procurement, penalties for late payments; minimum time periods for submitting complaints that are in accordance with the relevant eu remedies directives. smes in all the wbt countries have the access to some sort of the support offered by public procurement offices, like training in pp issues. all the assessed economies allow or require the use of electronic tools in public procurement. there is evidence on sme participation in public procurement and information on delayed payments for the few wbt economies (oecd/etf/eu/ebrd, 2019). table 2. dimension 5b – public procurement assessment bosnia and herzegovina montenegro serbia policy and regulatory framework 2.89 4.53 3.59 implementation 4.28 3.39 3.57 monitoring and evaluation 2.85 4.16 3.39 weighted average score 3.57 3.87 3.52 source: oecd/etf/eu/ebrd (2019). table 2 shows main statistical data regarding sba dimension 5a – public procurement assessment of our sample countries with exception of croatia which, is considered among the group of eu members, according to other kind of indicators and apparently, is scored very high ranked among eu-28 countries. (https://ec.europa.eu/internal_market/scoreboard/performance_per_policy_area/public_procu rement/index_en.htm). the average weighted score for serbia is 3.52 regarding dimension of pp, which is the lowest score among the western balkan countries. however, it should be taken into account that the assessment methodology applied in 2019 is not totally comparable with those in 2016. also, the new public procurement law (ppl), has been adopted in 2020 and came into force on 1st july 2020 ppo is still the key provider of support to smes, enabling access to free of charge advices. smes can obtain advice via telephone calls, e-mails or by post. so far, the reports published on the regular basis by ppo contain very limited statistical data about economic operators (in particular smes) who were awarded contracts. new ppl launched a full electronic procurement system and electronic functions. the re-launched pp portal includes gender identification of the bidder at the stage of registration, enabling further monitoring of the gender structure of the awarded tenderer. in 2016, the ppo published its guidelines for increasing participation of smes in public procurement procedures (ppos, 2016). the guidelines present the analysis of the obstacles faced by smes in accessing public procurement contracts, while proposing a number of actions and solutions to improve the current situation. these obstacles are as follows: 1. contracts of great value and the inability to meet additional conditions relating to the necessary capacity (financial, business, technical and personnel), temporary closure of the market through "framework agreements"; sanja popović-pantić, dušica semenčenko, nikola vasilić 55 2. lack of information and insufficient communication with clients; 3. short deadline for preparation of bids for particularly complex procurements; 4. lack of necessary knowledge about procedures and experience in participating in public procurement procedures; 5. giving priority to the lowest offered price in relation to the criterion of the most economically favourable offer; 6. unnecessary administrative burdens and 7. late payment or non-payment for work performed. policies and legal regulations related to gender equality in public procurement european union policies and legal regulations related to gender equality of the european union are recorded in many official documents as well as projects funded by the european commission (ec), starting with the basic principles and values of the eu that proclaim equality and nondiscrimination. the basic principles are enshrined in the treaty on the functioning of the european union (ec, 2012) and apply to the public procurement contracts and include the following: non-discrimination, equal treatment, transparency, mutual recognition, proportionality, freedom to provide services and freedom of business. the attitude towards companies owned and managed by women in public procurement processes is generally not highlighted; it is visible mainly in the aspects of socially responsible public procurement where female-owned companies are classified among other social categories. another type of recommendations that women have in mind refers to socially responsible public procurement from bidders who employ a larger number of employees from socially vulnerable categories (ethnic minorities, persons with disabilities, women) (ec, 2010). in recent years, when it comes to socially responsible business, the focus has increasingly shifted from environmental issues to social issues as a significant factor in sustainable development; social standards are increasingly identified as one of the factors of the growing corporate social responsibility movement (csr). among them, the perspective of gender equality (gender mainstreaming) becomes integrated into all phases of institutional policies, processes and practices from creation, monitoring to evaluation. the guidelines for public procurement for experts (ec, 2018) emphasize the strategic role of public procurement in the cost-effectiveness of public funds and in guaranteeing the best value for public funds. they also confirm its strategic role in achieving policy objectives, especially in terms of innovation, environmental and social inclusion. gender equality is not emphasized directly but indirectly through recommendations to contracting authorities that they can consider environmental protection and/or other social factors as criteria for awarding contracts or conditions for contract performance. socially responsible public procurement (srpp) can be achieved by the contracting parties considering various social aspects, such as social inclusion, working conditions, gender equality and ethical trade. it is also recommended to emphasize the standards or labels used in procurement procedures, which usually relate to quality assurance, environmental certification, as well as social requirements such as accessibility for people with disabilities or gender equality. european charter on equality between women and men (charter) at the local level (cemr, 2006) is the eu document that explicitly deals with gender equality in public procurement. the lack of gender equality in procurement and public contracts can result from the lack of equality in society in general. public procurement has the potential to support the fight against 56 economic analysis (2020, vol. 53, no. 2, 51-67) discrimination and promote gender equality and social inclusion. the role of public authorities, especially local authorities, in promoting equal opportunities and gender equality in relation to public procurement is recognized by the charter in article 12, which recommends the insertion of a gender equality clause in contracts or financial agreements. the insertion of this clause was confirmed by 24% of the signatories of the charter. limited progress has been made in the areas of public procurement and contracts (in eu countries), both in terms of obligations towards gender equality policy and in terms of concrete actions to introduce gender into this area of work. specific gender equality obligations in public procurement and contracts have only been partially adopted and only a few signatories have inserted gender equality clauses in contracts or financial agreements. articles requiring local authorities to take formal policies are more likely to apply than those requiring specific measures involving the redistribution of resources between women and men or significant changes in the policy cycle process (for example, the introduction of gender analysis at all stages of the process) (european charter, 2015). serbia similar to the eu legislation regarding public procurement, in the draft of the new law on public procurement (grs, 2019), the principles of transparency and equality of bidders are encountered. in the case of non-discrimination, the contracting authority may not determine the conditions that would mean national, territorial, substantive or personal discrimination among bidders, nor discrimination that would arise from the classification of activities performed by the bidder. in the mentioned draft of law to be adopted in 2020, among the criteria for the selection of the bid, there are also social criteria, but they are not stated individually. in the draft of the public procurement strategy 2020-24 (grs, 2019a), it is recommended that social criteria that take into account issues such as: employment opportunities for certain categories, compliance with labor and social rights, social inclusion and equal opportunities, respect for accessibility standards should be increasingly integrated into the implementation of the public procurement procedures for all users. the national strategy for gender equality for the period from 2016 to 2020(grs, 2016) defines possible measures that would refer to the promotion of gender equality in public procurement. realization of the special goal 2.3., which refers to the improvement of the economic position and status of women in the labor market, lists measures in the field of creating conditions for maximum use of economic potential, creativity and entrepreneurship of women who may have points of contact with the introduction of gender equality in public procurement. these measures are as follows: introduction of the principle "think small first" in the work of the legislative and executive branches when planning, drafting, adopting and implementing laws and mechanisms related to the economy and business. conditions for equal access of women entrepreneurs, including members of vulnerable groups, as well as profitable and capital development programs and projects, sources of financing and the market are created. in serbia, based on the law on budget system, gender responsive budgeting is adopted in 2015 (grs, 2019c). the connection between public procurement and gender responsive budgeting is unbreakable, and thus the gender-sensitive public procurement should correspond to gender responsive budgeting, which will be organized programmatically. the new provisions of this law were introduced as an obligation during the planning and execution of the budget which announced its gradual introduction from 2016 to 2021. we can find very similar practice regarding public procurement legislation in the rest of western balkan countries from the sample of this research, including croatia which is the only country in this region that is a full member of the eu. sanja popović-pantić, dušica semenčenko, nikola vasilić 57 the access of women entrepreneurs to public procurement – good practices in eu and beyond the examples of good practice regarding gender equality in public procurement in the countries of the european union are sporadic, more related to regional, local and / or sectoral experiences. we find such examples in sweden, norway and spain and in the united states of america. the examples of good practice that can be found in these few countries are mainly in form of guides, pilot projects and case studies. topics to which the guides are dedicated or the activities that the projects deal with refer to the general topic of gender equality in public procurement through: various types of promotions and instructions intended for municipal authorities as contracting authorities, but also for the general public, i.e. recipients and users of public services. the methods are different: organizing training to raise awareness, organizing a moderated dialogue with public procurement actors to learn policy, action plans defining steps to achieve goals, defining questionnaires to be applied in municipalities to collect gender disaggregated statistics, defining indicators and rules for monitoring and evaluation, websites for informing and collecting examples of good practice in municipalities. the case of sweden the swedish public procurement act does not go beyond the general declaration of antidiscrimination and equality. the first useful example of good practice for purposes of our research is the guide informing about the legal possibilities of imposing gender equality requirements published by swedish municipalities and counties skl. the guide relies on the charter on equality between women and men at the local level (cemr, 2006). it provides concrete examples of how public procurement requirements can be implemented and aims to encourage local authorities to start using this as an instrument to promote gender equality. the guidelines suggest that indicators and specific evaluation criteria must be included in the study to better assess public procurement from a gender perspective. the guidelines of the guide have been applied in practice on the example of the requirements for equality in the procurement of health care by the stockholm county council (scc). a prerequisite for concluding an agreement with the scc is that the caregiver must follow the scc equality policy, which includes, among other things, participation in ongoing quality work and focusing on providing equal treatment for women and men in health care. furthermore, all relevant key data and statistics disaggregated by sex and age should be reported in the evaluation of activities. the third example is the north of sweden where in one of the municipalities, within the project of health protection at work, the inclusion of the integration of gender equality policy in public procurement in that sector was one of the goals of the project. it has been shown that the general problem is the integration of gender into procurement because it is often considered a qualitative requirement, which is more difficult to address in the procurement process. the results show that since public procurement is a “difficult” management mechanism, it can be used to implement or encourage adaptive or innovative learning among suppliers by aligning them with a particular set of regulations. it has also been shown that innovative learning requires first a willing supplier and second an active client and open access. it is clear that the different types of relationships that a procuring entity may have with a supplier depend on the type of procurement and the extent to which it is perceived as experimental. when gender requirements are qualitative and when the supplier needs to be involved in innovative processes, because solutions do not yet exist, then close contact between the contracting authority and the supplier is inevitable. 58 economic analysis (2020, vol. 53, no. 2, 51-67) the case of norway although norway is not a member of the eu, norwegian public procurement legislation is largely based on the implementation of eu directives in line with norway's obligations under the agreement on the european economic area (eea). the basic principles of tender procedures are applied: equal treatment, transparency and competition. however, although there is no gender perspective here either, in norway we find examples of good practice at the local level. in 2012, the norwegian government launched a three-year program to promote gender equality in municipalities. a pilot project aimed at improving gender equality at the local level has been implemented in 20 municipalities in norway. the pilot project was preceded by an analysis to show whether gender-disaggregated statistics are applied in municipalities, whether the forms used for planning, service delivery are gender-disaggregated, whether there is a gender-disaggregated analysis of services and whether they are the same for women and men. however, the topics of the pilot projects were different. one of the main purposes of the program is to encourage municipalities to further include gender equality in the work of service providers, on the one hand, and the executive authorities as procuring entities, on the other. the program underscores the importance of gender mainstreaming in all areas, at all levels and by all municipal employees, both in decision-making processes regarding resource allocation and as part of the day-to-day work of municipal services. a website has been set up to collect examples of good practice from the municipalities involved in the pilot project. the case of spain gender equality requirements are imposed in the public procurement contracts. the women's institute in baskia, in cooperation with the community of municipalities, has developed a guide on setting conditions that favor gender equality in public contracts and grants. this guide highlights the specific tasks that municipalities can have in this regard and emphasizes the necessity of equality promotion all their activities and policies. gender mainstreaming as a precondition in public procurement contracts, is an effective instrument that public authorities can use to promote social change and promote equality. this can practically be achieved either by promoting positive actions or by including gender integration. positive actions include the establishment of temporary measures to compensate for previous inequalities or discrimination against vulnerable groups. the guide also identifies possible barriers and difficulties in implementing equality goals, such as an insufficient political will at the local level or fears that private companies could object to. the case of us the united states has used public procurement for a long time to promote the increased participation of small businesses and women entrepreneurs in the federal supply chain. the u.s. small business act (sba) stipulates, among other things, “that, to the greatest extent possible, procurement strategies implemented by a federal department or agency with contracting authority will allow for the maximum participation of small businesses as major contractors, subcontractors, and suppliers." in this regard, the law sets level targets for each fiscal year for smes participation of no less than 23 percent of the total value of major contracts awarded by the federal government. the law also sets a target for the participation of small enterprises “owned and managed by women” of at least 5% of the value of all major contracts (including subcontracts) to be awarded for each fiscal year. the federal government and all its departments and agencies make progress each year in achieving these goals. these goals are part of a much broader range of programs managed by the sba that help women and small businesses. sanja popović-pantić, dušica semenčenko, nikola vasilić 59 with the main purpose to support the women-owned enterprises in sectors in which they are underrepresented, such as hardware manufacturing, in 2000 the united states congress passed the fairness in women contract act, authorizing federal contracting authorities to set aside or reserve procurement for competition between women-owned small businesses (wosbs). methodology sample and data collection the study included smes from four western balkan countries: serbia, bosnia and herzegovina, montenegro and croatia. empirical research was conducted using a questionnaire that was electronically forwarded to the chambers of commerce of the countries involved in the analysis, which then distributed the questionnaire to smes in their countries. a total of 130 questionnaires were collected. of the total number of smes, 51% are male-owned, while 49% are female-owned companies. regarding the distribution of companies by size, 76 are microsized companies, 37 are small, and 17 are medium-sized companies. 31% of companies operate between 11 and 20 years, and 32% for more than 20 years, while a total of 37% operate for less than 10 years. the main part of the questionnaire consists of 7 items related to the barriers to the participation of smes in the public procurement. four items refer to discriminatory barriers, and three items to non-discriminatory barriers. these items were created according to the guidelines for increasing participation of smes in the public procurement procedures (ppos, 2016). respondents were given the task to rate the importance of each of the barriers to involvement in public procurement on a scale of 1 to 5, with a score of 1 indicating a low importance of the barrier and a score of 5 indicating a high importance of the barrier. also, the questionnaire contains items related to the demographic characteristics of companies, as described in the previous paragraph. research questions the subject of research is access by smes to public procurement in western balkan region including a gender equality perspective. research has three key objectives: to identify key barriers that hinder the engagement in the public procurement; to determine whether there are differences in the perception of the importance of barriers to inclusion in public procurement between male and female-owned companies; and check whether there are differences in the perception of the importance of barriers to inclusion in public procurement between differentsized companies. based on the determined subject and goals of the research, the main task of this paper is to answer the following research questions: rq1: what are the key barriers to involvement in public procurement in the western balkan? rq2: are there differences between male and female-owned companies according to the perception of the importance of barriers to participation in public procurement? rq3: are there differences between different-sized companies in terms of perception of the importance of barriers to participation in public procurement? statistical methods to provide answers to the defined research questions, the appropriate methods of statistical analysis were applied. for the needs of rq1, the descriptive statistics were applied, i.e. the arithmetic means (λ) of the estimates of discriminatory and non-discriminatory barriers were calculated. before we 60 economic analysis (2020, vol. 53, no. 2, 51-67) decided on certain tests that would help us answer the questions rq2 and rq3, appropriate normality tests were conducted. as the results showed that the available data were not characterized by a normal distribution (appendix i), a decision was made to apply nonparametric tests to compare groups. in the case of rq2, mann-whitney u test, suitable for comparing two groups, would be applied, and for the needs of rq3, kruskal-wallis h test, because it was suitable for comparing three or more groups. results assessment of the importance of barriers to access the public procurement as the most significant barrier in the domain of discriminatory barriers (figure 1), the respondents single out limitations related to the financial capacity of the company (λ=3.2) and limitations related to the number of employees and their qualifications (λ=3.09). the importance of restrictions on production volume or quantity required (λ=2.79) and meeting quality standards (λ=2.54) is somewhat weaker compared to the aforementioned barriers. generally, discriminatory barriers are of moderate importance for inclusion in the public procurement. 1 2 3 4 5 restrictions on production volume or quantity required meeting quality standards limitations related to the financial capacity of the company limitations related to the number of employees and their qualifications figure 1. importance of discriminatory barriers source: authors regarding the non-discriminatory barriers (figure 2), it can be said that their importance for participation in public procurement is slightly above moderate. all three types of the nondiscriminatory barriers have approximately the same significance for the respondents, with the greatest significance in order: complicated bidding process (λ=3.41), short deadline for preparation of documentation (λ=3.3), insufficient and incomplete information in the public procurement invitation (λ=3.26). sanja popović-pantić, dušica semenčenko, nikola vasilić 61 figure 2. importance of non-discriminatory barriers source: authors when discriminatory and non-discriminatory barriers are compared, respondents seem to perceive the latter as somewhat more important for participation in public procurement (discriminatory=2.91 < non‐discriminatory=3.32). gender analysis of barriers to access to public procurement it can be clearly seen from the table 3a that there are no significant differences between maleowned and female-owned companies in terms of perceptions of the importance of discriminatory barriers to inclusion in public procurement. in all cases asymptotic sig > 0.05 indicates the absence of significant differences between male-owned and female-owned companies. also, the effect size indicator is less than 0.3, which implies that the gender difference of the company owner explains a rather small part of the perception of importance of discriminatory barriers to participation in public procurement. in the case of limitations related to the number of employees and their qualifications there is a 7% probability that the differences between men-owned and women-owned companies are the result of random variations. however, even with this barrier the effect size is just below 0.3, which also indicates a small difference. precisely, only 6% of the variance in differences in the perception of the strength of barriers to participation in public procurement is explained by differences in company size. similar results were obtained when non-discriminatory barriers were observed (table 3b). asymptotic sig is greater than 0.05 in all cases and effect size is lesser than 0.3, which implies that an extremely small part of the perception of importance of non-discriminatory barriers is explained by differences in gender of the company main owner. 62 economic analysis (2020, vol. 53, no. 2, 51-67) table 3. barriers for participation in public procurement – gender perspective a. discriminatory barriers type of barrier gender mean rank z asymptotic sig (%) r r2 (%) restrictions on production volume or quantity required male 25.77 -1.451 15 0.19 4 female 31.88 meeting quality standards male 27.11 -0.217 83 0.03 0.1 female 28.02 limitations related to the financial capacity of the company male 25.84 -1.176 24 0.16 3 female 30.79 limitations related to the number of employees and their qualifications male 25.13 -1.836 7 0.25 6 female 33.00 b. non‐discriminatory barriers type of barrier gender mean rank z asymptotic sig (%) r r2 (%) insufficient and incomplete information in the public procurement invitation male 27.61 -0.740 46 0.1 1 female 30.78 short deadline for preparation of documentation male 27.59 -0.493 62 0.07 0.5 female 29.71 complicated bidding process male 28.34 -0.085 93 0.01 0. 01 female 28.70 note: r is a biased measure of effect size and according to cohen (1988) criterion it can have the following values: 0.1 – small; 0.3 – medium; 0.5 – large. t test of independent samples is also applied, because it is a pretty robust to non-normal variables. the results obtained using the t tests are almost identical to the results of the mann-whitney u test. source: authors barriers to access to public procurement – company size perspective considering the perceptions of discriminatory barriers by different-sized companies the situation is similar to the results of gender analysis. there is a 92% chance that the perceptions of importance of limitations related to the financial capacity of the company given by differentsized companies really are different. effect size is equal to 0.1 indicating moderate difference between micro companies, on the one side, and small and medium-sized companies, on the other side. in all other cases, different-sized companies have the similar perceptions of importance of discriminatory barriers for participation in public procurement (table 4a). different-sized companies similarly perceive the importance of non-discriminatory barriers to participation in public procurement (table 4b). asymptotic sig is larger than 5%, and ε2 is lesser than 0.08, which excludes the possibility of at least moderate differences in the perception of non-discriminatory barriers between different-sized companies. sanja popović-pantić, dušica semenčenko, nikola vasilić 63 table 4. barriers for participation in public procurement – company size perspective a. discriminatory barriers type of barrier size mean rank χ2 asymptotic sig (%) ε2 restrictions on production volume or quantity required micro 29.59 1.508 47 0.03 small 27.53 medium 21.79 meeting quality standards micro 28.66 1.084 58 0.02 small 25.53 medium 22.79 limitations related to the financial capacity of the company micro 31.31 5.079 8 0.1 small 22.77 medium 20.21 limitations related to the number of employees and their qualifications micro 31.39 3.359 19 0.06 small 23.82 medium 23.14 b. non‐discriminatory barriers type of barrier size mean rank χ2 asymptotic sig (%) ε2 insufficient and incomplete information in the public procurement invitation micro 28.70 0.013 99 2.36e-4 small 28.18 medium 28.36 short deadline for preparation of documentation micro 28.82 0.263 88 0.01 small 26.41 medium 28.21 complicated bidding process micro 27.77 0.056 97 0.001 small 28.71 medium 27.25 note: epsilon squared (ε2) is unbiased measure of effect size and it can have the following values: 0.01 – small; 0.08 – medium; 0.26 – large (mangiafico, n.d.). source: authors conclusion the literature highlights several of barriers that may have an impact on smes bidding for public procurement contracts. these include a lack of knowledge or awareness of procurement opportunities, lack of the capacity to deliver requested amount of the products or to produce products/services in the requested range of quality standards. however, female companies are facing even higher barriers to access public procurements which are the reasons why stakeholders in some countries are launching gender sensitive (responsive) public procurement programs, initiatives and measures. the role of public authorities, especially local authorities, in promoting equal opportunities and gender equality in relation to public procurement is 64 economic analysis (2020, vol. 53, no. 2, 51-67) recognized by the european charter on equality between women and men in article 12, which recommends the insertion of a gender equality clause in contracts or financial agreements. still, gender sensitive public procurements are not the mainstream, there is a lack of genderdisaggregated data and it is limited to a few good examples worldwide. as to the western balkan countries, gender-responsive public procurements are also limited to certain initiatives which promote better positioning of female companies in the public procurement. the research indicates that there are not significant differences in the perception of the importance of barriers to participation in public procurement between male-owned and female-owned firms. however, it does not mean that the access to public procurement is equal to men and women but only that their perceptions on the importance of barriers are almost the same. also, differentsized companies have a similar perception of the importance of barriers to participation in public procurement. therefore, it is recommended to continue research on access to the public procurement for smes including gender aspect in greater depth and in the bigger sample. acknowledgements the research presented in this paper was funded by the ministry of education, science and technological development of serbia. references ancarani, a., di mauro, c., hartley, t., tátrai, t. 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(2011). on the contribution of public procurement to entrepreneurship and small business policy. entrepreneurship & regional development, 23(9-10), 787–814. retrieved from: http://dx.doi.org/10.1080/08985626.2010.546433 66 economic analysis (2020, vol. 53, no. 2, 51-67) public procurement office serbia (2016). guidelines for increasing the participation of small and medium enterprises in public procurement procedures. retrieved from: http://www.ujn.gov.rs/dokumenti/analiticka-dokumenta/ un women (2017a). manual the power of procurement: how to source from women-owned businesses corporate guide to gender-responsive procurement. un women (2017b). gender responsible budgeting (grb) a new practice and legal obligation in the public financial management system in the republic of serbia. un women (2019). gender responsible budgeting introduction of gender responsible budgeting in the republic of serbia. retrieved from: https://www.undp.org/content/dam/unct/serbia/docs/publications/unw_grb_%202019_s rb%20_layout%20digital.pdf sanja popović-pantić, dušica semenčenko, nikola vasilić 67 appendix i normality tests variables kolmogorov‐smirnov shapiro‐wilk statistic sig. statistic sig. restrictions on production volume or quantity required .200 .000 .887 .000 meeting quality standards .188 .000 .878 .000 limitations related to the financial capacity of the company .206 .000 .880 .000 limitations related to the number of employees and their qualifications .159 .003 .910 .001 insufficient and incomplete information in the public procurement invitation .189 .000 .901 .001 short deadline for preparation of documentation .151 .006 .894 .000 complicated bidding process .184 .000 .884 .000 article history: received: june 7, 2020 accepted: november 27, 2020 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp1-13 original scientific paper the economic impact of the covid‐19 on the serbia’s labor market: statistics and facts dejana pavlović1* | duško bodroža1 | valentina vukmirović1 1 institute of economic sciences, belgrade, serbia abstract the global pandemic caused by the covid-19 public health crisis has affected the global economy, not sparing any single country. in order to identify weaknesses and threats posed to the republic of serbia’s labor force, this paper analyzes the impact of the crisis through the analysis of key macroeconomic indicators and key labor-market indicators. serbia’s labor market has shown a positive trend over the last five years. the latest statistics show that the labor market itself has not yet felt the effects of the emergency caused by the global pandemic. therefore, due to the implementation of emergency economic measures of the republic of serbia, the labor market has been buttressed; however, to what extent it would be able to weather another wave of severe economic interruption is unclear. the total impact the crisis has had on the labor market at the moment cannot be determined precisely as it is primarily determined by the inactivity within the economy as well as the second round of the pandemic which health experts largely predict to come by this year’s end. the sectors that will be most exposed to the impact of the crisis are expected to be manufacturing, wholesale and retail trade, the repair of motor vehicles and motorcycles, accommodation and food service activities as well as real estate activities. the results of research are significant for future studies centering on economic development as affected by global pandemics, as well as for analyzing the impact of the current crisis on the labor market and macroeconomic indicators in the republic of serbia. key words: labor market, covid‐19 crisis, employment, republic of serbia jel classification: e24, j21, e22, e61 introduction at the beginning of the covid-19 pandemic, the largest international financial institutions (imf, world bank, ecb, ebrd) had not been led to believe that the coronavirus would have a major impact on the economy. however, as the virus spread globally, economic predictions became increasingly pessimistic. the early optimistic outcomes foreseen may be attributable to the fact that economists are not universally experts in public health, thereby not fully taking into account the extent to which the virus would affect every day economic life. unlike other economic crises faced within the recent past whose main driving forces have been a steep decline in demand (marjanović, 2010), the current crisis stems from supply, primarily because production in most industries has been suspended due to massive government isolation orders as well as slow-down from knock on effects. as a consequence, there has been a decrease in overall household income, eventually causing a decline in aggregate demand (world bank, * corresponding author, e-mail: dejana.pavlovic@ien.bg.ac.rs 2 economic analysis (2020, vol. 53, no. 1, 1-13) 2020). due to the interdependence of the global economy that emerged and grew since the late 1980s, the negative economic consequences of the crisis are also worsened as one nation’s economy is shut down, thereby affecting another (ilo monitor, 2020). the inability to access international supply and production chains has led to challenges economies have not been faced since the end of world war two. absence of any significant economic growth had an impact on increase of unemployment, maintenance of trade deficit and growing foreign debt, which generally indicates a growing country risk and therefore this does not represent a business environment which would be attractive for investors (brkić, pijalović, 2016). experience has shown that a public-health crisis differs in the extreme from a natural disaster or a war. in the latter, rapid economic recovery may be anticipated in developed economies due to massive infrastructure renewal and public investment that generally ensues after their culmination (jordà et al. 2020). more to the point, natural disasters or war are externally effective on an economy. in a pandemic, however, labor crises as well as reduced supply and demand affect markets internally, resulting in the recovery to be hindered as the pillars of the economy weaken. within this work, the authors use empirical analysis to determine what long-term consequences covid-19 will have on the labor market in the republic of serbia (rs). sections two and three analyze the extent to which the serbian economy had been ready for the covid19 crisis, analyzing the rs’ macroeconomic and labor market indicators. the paper analyzes the movement of basic labor market indicators from 2015 to 2019, using annual data provided from the labor force survey of the statistical office of rs. in addition to basic global indicators, such as trends in activity rates, employment and unemployment, detailed trends in the key structural characteristics are shown, including employee activity by type, gender, age, regional structure and employment modalities, additional indicators of labor market stability were taken into account as well such as data from the rs’ national employment agency (i.e. data on registered unemployment). section four presents projections of labor market indicators made by international organizations, focusing on business sectors (economic sectors) that will be affected until the crisis has ceased, both in serbia and globally. section five presents economic measures to counteract the impact of covid-19, while section six presents the paper’s conclusions. macroeconomic trends in the republic of serbia the republic of serbia entered the covid-19 crisis with a stronger economy than it had even ten years ago. the implementation of economic reforms since 2014 has led to greater macroeconomic stability, increased production and reduced unemployment. from 2015 to 2019, the average annual gdp growth rate was 3.2% and inflation stabilized, ranging from 1.5 3.0%. the share of public debt in relation to national gdp fell from 70% of gdp in 2015 to 52% in 2019. the rsd has remained stable and even strengthened against the euro (the middle rate 120.95 rsd to one euro on 01/01/2015 as opposed to 117.63 for 31/12/2019) which has helped to normalize trade. although its liquidity has not significantly changed, non-performing loans within banks have been shed and have thereby strengthened the banking sector. indicators of the country's external position show that serbia is highly dependent on foreign capital inflows. the following table provides an overview of key macroeconomic indicators (national bank of serbia, ministry of finance, statistical office of rs, 2019). dejana pavlović, duško bodroža, valentina vukmirović 3 table 1. key macroeconomic indicators of the republic of serbia indicator 2015 2016 2017 2018 2019 economic activity, inflation and exchange rate real gdp growth (in %) 1.8 3.3 2.0 4.4 4.2 individual consumption expenditure household sector (in % of gdp) 70.8 69.7 69.6 68.1 67.0 gross fixed capital formation ((in % of gdp) 16.8 16.9 17.7 20.1 22.4 consumer prices (in %, relative to the same month a year earlier) 1.5 1.6 3.0 2.0 1.9 rsd/eur exchange rate (end of period) 121.6 123.5 118.5 118.2 117.6 fiscal policy rs public debt, (central government, in % of gdp) 70.0 67.8 57.9 53.7 52.0 consolidated fiscal result (in % of gdp) -3.5 -1.2 1.1 0.6 -0.2 consolidated public revenues (in % of gdp) 39.3 40.8 41.5 41.5 42.1 external debt/gdp (in %) 73.5 72.1 65.1 62.2 61.9 fx reserves /gdp (in %) 11.1 12.3 10.9 11.3 10.0 banking sector regulatory capital to risk-weighted assets 20.9 21.8 22.6 22.3 23.4 nonperforming loans to total gross loans 21.6 17.0 9.8 5.7 4.1 average monthly liquidity ratio 2.1 2.1 2.0 2.0 2.2 average monthly narrow liquidity ratio 1.7 1.7 1.7 1.7 1.8 foreign-currency-denominated liabilities to total liabilities 72.7 71.1 69.7 69.3 66.6 external vulnerability current account balance (in % of gdp) -3.5 -2.9 -5.2 -4.8 -6.9 export of goods (in % of gdp) 32.3 35.9 38.3 38.6 38.3 export of services (in % of gdp) 12.0 12.8 14.3 15.5 16.3 travel (% of export) 6.0 6.0 6.1 6.2 6.1 transport (% of export) 6.4 6.0 6.1 5.8 5.7 remittances (% of gdp) 6.1 5.5 5.9 7.0 6.3 fx reserves/imports of goods and services (in months) 6.7 6.2 5.4 5.4 5.7 foreign direct investment (in % of gdp) 5.1 5.2 6.2 7.4 7.8 openness of economy (exports + imports)/gdp (%) 96.2 100.7 106.3 108.3 111.9 source: national bank of serbia, ministry of finance, statistical office, authors’ calculation due to the fact that the covid-19 crisis is still ongoing, it is difficult to predict the total extent to which the economy has been affected. the interruption of the global supply chain and a reduction in the inflow of foreign capital will certainly bear the most negative effect on serbia’s economy. it may also be assumed that the crisis will further fragment the world's leading economies, even threatening to worsen the trade war between china and the united states. in order for national economies to be better insulated from global disruption, it is possible that protectionist measures may be introduced over the coming decade, thereby worsening interruptions in global supply. a drop in consumer consumption abroad and foreign investments into serbia from key foreign trade partners (primarily germany and italy) will certainly result in a decline of exports and a lower gdp (world bank, 2020). according to data, exports decreased by 10.8% in march 2020 compared to march of 2019 (statistical office of the republic of serbia, 2020). bearing in mind that domestic demand had been one of the main generators of serbia’s growth over the last decade, which is largely determined by the inflow of foreign capital in the form of remittances, cross-border interbank and intercompany loans, direct and portfolio investments, the slowing inflow of foreign liquid capital shall have a knock-effect in which gdp shall shrink, tax revenues shall fall and budget deficits widened. remittances represent a significant source of income for a large share of serbia’s population, as well as budget revenues from value added taxes on goods and services. according to the estimates of the world bank, in 4 economic analysis (2020, vol. 53, no. 1, 1-13) 2020, remittances are expected to fall in serbia by approximately 20%. as a consequence, depreciation effects on the dinar exchange rate will occur. from a macroeconomic point of view, depreciation is a mixed bag: a more favorable conversion rate to the serbian dinar may increase the competitiveness of goods and services originating in serbia, but growth in a post covid-19 world in national economies will largely be determined by their capacity to produce of which serbia is still limited (arandarenko, 2011). due to the high uncertainty, estimates of economic activity and gdp of serbia in the near future are difficult to provide. there is also little consensus among international and national bodies as to the extent of serbia’s decline in gdp: while the most pessimistic forecast of the european commission is -4.1%, the imf is projecting a 3% decline, while the government of the republic of serbia expects it to be limited to 1.5% and the world bank foresees a 2.5% fall in gdp. figure 1. projected gdp growth for 2020, republic of serbia source: imf, world bank, the government of republic serbia, authors’ calculation the slowdown in economic activity will also reduce budget revenues, which, along with the proposed measures of the government of serbia, will worsen budget deficits. the first estimate of the fiscal council of the rs is that the budget deficit will be 9% of gdp at the end of 2020. such a high deficit leads to a sharp increase in public debt, wherein the first estimate of the fiscal council is that the share of public debt in gdp at the end of 2020 will be slightly more than 60% of gdp. widening deficits to make up for budgetary shortfalls may be made up for by favorable borrowing conditions within the international financial market due to the long-term expansionary monetary policies of the key central banks. dejana pavlović, duško bodroža, valentina vukmirović 5 table 2. economic resilience to the covid-19 shock in republic of serbia criteria indicator impact financial sector liquidity low interest rates moderate loans moderate external shocks commodity prices high global value chains moderate tourism high foreign direct investment high remittances high policy space fiscal policy space moderate external resilience high exchange rate moderate source: adapted from the ebrd by the authors the duration of the crisis will largely determine the exposure of the banking sector. according to the nbs, more than 90% of serbian borrowers have participated in the national three-month moratorium on loan repayment introduced by the national bank of serbia. this measure will certainly affect the profitability of the banking sector, which will likely force banks to increase interest rates and raise fees. the serbian banking sector itself is highly exposed to the risk of capital withdrawals by parent branches abroad (19 banks out of 26 are foreign-owned) who may liquidate part of their controlling shares should a need arise in home countries for liquid capital injections. serbia’s labor market characteristics leading to and during the covid‐19 crisis it must be noted that there is an issue regarding the source of economic data as productivity does not generally match employment growth. a comparative analysis shows that the alleged phenomenon of high employment growth without gdp growth, as in serbia, has not occurred in any other country in central and eastern europe. in all other comparable countries, employment from 2012 to 2017 grew (in line with theoretical expectations) slower than gdp growth. the sharp decline of the unemployment rate and rise in employment since 2012 may be attributable to unreliable data (sors labor force survey) describing the labor market, as strong employment growth would have to leave a clearer mark on serbia's economy. stagnation was noticeable as private consumption was already in decline and payroll taxes were completely inconsistent with the formal employment figures from the labor force survey (nikolic, 2016). numerous analyses do point to the same conclusion that there are problems in the official statistical monitoring of employment trends; i.e., that the labor force survey is still not reliable. high employment growth coupled by low productivity growth run counter to established and proven economic theories that define a strict relationship between employment and productivity (nikolic, 2016; petrovic, brcerevic & minic, 2018). however, based on the data as given, the rs labor market has recorded positive trends over the past few years. by analyzing statistical data, labor-market indicators in the rs (rates of activity, employment and unemployment) from 2015 to 2019, it is important to note that the unemployment rate in 2019 reached 10.4% (those aged 15+), the lowest rate in the last five years. the unemployment rate for men in 2019 was 9.8%, while for women it was around 11%. data on registered unemployment of the national employment agency (2019), in the past five years (from 2015-2019) recorded a decrease in the number of unemployed by about 30%. from 2015 to 2019, the number of unemployed women fell from 380,274 to 286,872 (about 24%). unfavorable demographic trends have contributed to the decline of key labor market indicators in serbia. as a consequence of the negative natural population growth, the working 6 economic analysis (2020, vol. 53, no. 1, 1-13) age population from 2015 to 2019 has reduced, which also affected a reduction in the unemployment rate, especially among young people (15 to 24 years of age). according to census data (2011), the population of the republic of serbia for 2011 totaled 7,186,862. according to the same data, those aged 15 to 24 accounted for 841,735 of the overall population, while those aged 25 to 29 composed 480,286. slightly less than half of all those 15 to 24 years of age (approximately 413,765) lived in northern serbia, while about 183,848 lived in southern serbia (census, statistical office of the republic of serbia, 2011). however, estimates from 2018 indicate that the number of the total population in serbia decreased to 6,963,764, while the number of young people dropped to 661,250 (projections, statistical office of the republic of serbia, 2018), which has caused a marginal decline in the unemployment rate, especially among youth. from 2015 to 2019, the activity rate of the population did not change significantly. since 2017, the activity rate for the total population has averaged around 54%, whereas the activity for those aged 15 -24 has been roughly 30%. whereas there was a slight increase in the activity rate recorded from 2015-2016, at 1.7 pp for the total population, there was an increase in the activity rate for those 15 to 24 years of age by 0.9 pp (statistical office of the republic of serbia, 2019). the employment rate of the total working population was about 49% in 2019, which is 1.3 pp more than 2018. based on the total of those active in the labor force, as according to the total of those registered employed and unemployed, the region of šumadija and western serbia had the highest concentration of employment whereas the lowest was in the regions of southern and eastern serbia (table 3) (statistical office of the republic of serbia, 2019). table 3. employment at regional level in serbia, 2015-2019 year belgrade region region vojvodina region šumadija and west serbia region south and east serbia 2015 611,400 682,300 752,000 528,500 2016 656,600 709,900 789,500 563,400 2017 694,000 737,800 799,800 563,000 2018 720,000 753,900 799,000 560,000 2019 740,500 768,100 812,400 580,000 source: statistical office of the republic of serbia, 2019. young people are still at a disadvantage in the labor market compared to the general population, despite the fact that the youth unemployment rate has decreased significantly in recent years (declining from 2015 to 2019 by 15,7 pp). from 2015-2019, there was a noticeable decline of about 18 pp in the unemployment rate of young women (15 to 24). statistics show that the highest unemployment rate is to be found among young people (15 to 24) in the regions of southern and eastern serbia; in contrast, the youth unemployment rate in vojvodina is the lowest in relation to all four regions (republic statistical office, 2019). the decline in the youth unemployment rate is due to the migration of those aged 20-35, from serbia. according to eurostat data, there were approximately 300,000 registered employees from serbia in the eu in 2013, which was a consequence of the financial crisis and the inability to find employment in serbia proper (bobic, andjelkovic & kanazir, 2015). dejana pavlović, duško bodroža, valentina vukmirović 7 table 4. key labor market indicators of the rs, 2015-2019 2015. 15 year and more young (15‐24) rates of activity [%] 51.6 29.2 rates of employment [%] 42.5 16.6 rates of inactivity [%] 48.4 70.8 rates of unemployment [%] 17.7 43.2 2016. rates of activity [%] 53.3 30.3 rates of employment [%] 45.2 19.7 rates of inactivity [%] 46.7 69.7 rates of unemployment [%] 15.3 34.9 2017. rates of activity [%] 54.0 30.6 rates of employment [%] 46.7 20.9 rates of inactivity [%] 46.0 69.4 rates of unemployment [%] 13.5 31.9 2018. rates of activity [%] 54.5 30.0 rates of employment [%] 47.6 21.1 rates of inactivity [%] 45.5 70.0 rates of unemployment [%] 12.7 29.7 2019. rates of activity [%] 54.6 29.6 rates of employment [%] 49.0 21.5 rates of inactivity [%] 45.4 70.4 rates of unemployment [%] 10.4 27.5 source: labor force survey, statistical office of the republic of serbia, 2020, according to data from the national employment agency, compared to the first quarter of 2019 and 2020, registered employment increased by 1,8% (38,886 employees) in which the total number of registered employees was 2,186,834 for the same quarter. the largest number of employees was recorded in the belgrade region and vojvodina. the sectors of activity in which the largest increase in the number of employees occurred were in manufacturing (16,086), construction (10,249), education (5,833), information and communication (4,945) and traffic and storage (3,247). compared to q1 of 2019, there was an increase of 2,2% in overall employment numbers (44,068) in q1 of 2020 (statistical office of the republic of serbia, 2020). based on this economic background, it may be concluded that the pre-covid-19 economy of serbia was stabilized. however, it has been predicted that the covid-19 crisis will have a defined negative impact on the unemployment rate. according to the european commission, unemployment in serbia is projected to rise from 10,9 to 13,4% by the end of 2020. when analyzing the labor market, it is important to take into account that it does not include rs citizens working abroad who have returned to the country due to the virus. according to statements released from serbia’s foreign ministry, more than 400,000 serbian citizens who had permanent or temporary jobs abroad have returned to the republic of serbia since the declaration of the covid-19 virus pandemic. due to the uncertain nature of the coronavirus and the collapse of certain industries, it is not entirely anticipated that all these citizens who have returned may again go abroad to find work within the same positions or sectors of the economy. the crisis will also significantly affect seasonal workers who are generally employed abroad in the hospitality or service industry during peak times of tourism. the unemployment rate could therefore rise even further. 8 economic analysis (2020, vol. 53, no. 1, 1-13) analyzing formal employment trends prior to and following the onset of the crisis may help determine a more accurate picture of the extent to which the covid-19 crisis has affected labor market trends. in the rs, the beginning of the crisis was officially announced on march 15, 2020, when the government of serbia declared a state of emergency for the entire country. the rs’ decree on measures during the state of emergency prohibits the use of public places, parks and public areas intended for recreation and sports, as well as international traffic as well as road, rail and water traffic. due to these measures, most businesses have not been able to carry out the essential activities to conduct business. according to the data of the statistical office, the total number of those active in the labor market in q1 of 2020 fell by 15,200 compared to q4 of 2020. table 5. legal status of employees within serbia, q1 2020 category number of employees changes relative to the previous quarter all employees in "long-term employment" and in "temporary and occasional employment" 2,117,949 -15,200 employees in "long-term employment" 2,048,851 -11 754 employees at legal entities 1,678,923 -1,671 entrepreneurs and their employees as well as selfemployed business owners 369,927 -10,084 employees in "temporary and occasional employment" 69,098 3,446 employees working within legal entities 64,720 3,315 entrepreneurs and their employees as well as selfemployed business owners 4,378 -131 source: statistical office of the republic of serbia, 2020 by sector, out of a total of 19 activities (nace rev, 2), a decrease in employment was recorded in 8 in q1. the largest decrease in the number of employees occurred in administrative and support service activities (-5,7%), professional, scientific and technical activities (-3,9%), as well as agriculture, forestry and fishing (-3,2%). the highest employment growth was registered in mining and quarrying (8,8%) and education (2,8%). based on the presented data on the number of employees in q1 of 2020, the impact of the crisis caused by the covid-19 virus at the very beginning of the crisis does not readily appear to have had a significant impact on the labor market. the drop in unemployment of 0,7% compared to the previous quarter is primarily due to seasonal factors, taking into account the sectors in which the number of employees decreased. table 6. the number of employees in serbia by sector, q1 2020 sector changes relative to the previous quarter changes % to the previous quarter agriculture, forestry and fishing -1,004 -3.2% mining and quarrying 2,323 8.8% manufacturing 832 0.2% electricity, gas, steam and air conditioning supply -1,615 -6.2% water supply, sewerage, waste management and remediation activities 259 0.7% construction 158 0.1% wholesale and retail trade and repair of motor vehicles and motorcycles -3,959 -1.1% transportation and storage 635 0.5% accommodation and food service activities -840 -1.0% information and communication 121 0.2% dejana pavlović, duško bodroža, valentina vukmirović 9 sector changes relative to the previous quarter changes % to the previous quarter financial and insurance activities -143 -0.3% real estate activities 33 0.5% professional, scientific and technical activities -4,397 -3.9% administrative and support service activities -6,217 -5.7% public administration and defense; compulsory social security -288 -0.2% education 4,100 2.8% human health and social work activities -4,934 -3.1% arts, entertainment and recreation 265 0.7% other service activities -530 -1.2% total -15,200 -0.7% source: statistical office of the republic of serbia, 2020 in the second quarter, a significant decline in employees is not expected, primarily due to economic measures taken by the rs in order to prevent the impact of the crisis caused by the covid-19. however, the slowdown in economic activity for all of europe is anticipated to worsen the labor market in q3 and q4 of 2020. according to the international labor organization, the sectors most affected by the covid-19 virus are accommodation and food services, manufacturing, wholesale and retail trade, as well as real estate and business activities. table 7. impact of the covid-19 crisis in serbia sector gross value in % distribution of employment impact of crisis on economic output manufacturing 17.5 459,647 high wholesale and retail trade and repair of motor vehicles and motorcycles 13.8 342,569 high accommodation and food service activities 1.7 82,459 high real estate activities 8.5 6,747 high mining and quarrying 2.4 25,989 medium high construction 5.4 105,671 medium high transportation and storage 4.7 119,006 medium high financial and insurance activities 3.6 43,849 medium high arts, entertainment and recreation 1.4 36,595 medium high agriculture, forestry and fishing 7.7 30,875 lowmedium electricity, gas, steam and air conditioning supply 4.1 26,015 low water supply, sewerage, waste management and remediation activities 1.3 35,602 low information and communication 5.8 67,481 low professional, scientific and technical activities 4.7 108,935 low administrative and support service activities 2.7 106,631 low public administration and defense; compulsory social security 4.1 157,403 low education 4.1 146,247 low human health and social work activities 4.7 156,920 low other service activities 1.7 42,626 low source: statistical office of the republic of serbia, 2020. authors adapted from international labor organization 10 economic analysis (2020, vol. 53, no. 1, 1-13) the sectors most affected by the crisis contribute 41,5% to the total gross value added and have a total of 891,422 employees, which is 42,4% of all employees. unfortunately, it is not feasible at this time to assess the true extent of the impact of the crisis on employment in these sectors. it will primarily depend on the duration of the crisis itself and then on the speed of recovery of serbia’s largest foreign trade partners. if the crisis lasts longer or returns, a sharp decline in economic activity in these sectors may be expected, along with declining incomes and rising unemployment. when companies do start operating, activities shall need a significantly long time to recover to the pre-crisis state, if this is even possible. some companies will be forced to reduce production and some shut down due to reduced turnover. as a result, a number of jobs will simply vanish, which will significantly increase unemployment. economic measures to counteract the impact of covid‐19 in serbia, the financial crisis is a consequence of a significant drop in domestic and foreign demand as well as a result of physical distancing measures. the latter has particularly affected the service sector, which employs almost 50% of the serbian workforce. likewise, the tourism sector has suffered severe damage, as the financial loss between march and the first half of april amounted to 2,7 million euros (world bank, oecd). falling demand as well as supply disruptions have had a negative impact on production sectors, with liquidity constraints and economic instability also having a negative impact on potential investments. based on the number of individuals who applied for unemployment benefits at the national employment service of serbia, 9.200 people have so far lost their job since march (national employment agency, 2020). such data are not encouraging for serbia, which faced an unemployment rate of 10,4% before the onset of the latest world economic crisis (statistical office of the republic of serbia, 2020). the situation is further aggravated by the fact that 22,6% of employees are temporarily employed and 19,8% are informally employed. these individuals are considered to be particularly exposed to the crisis and more difficult to help through conventional measures (world bank, 2020). the key weaknesses of the labor market in serbia, which include but are not limited to its high unemployment rates, insufficient alignment between employee competencies and education with labor market needs, as well as insufficient social protection, have also come to the fore during the current crisis (european commission, 2020). due to the risk of a further increase in unemployment rates in serbia, authorities have made the decision to introduce financial measures to help the population and the economy. these measures are in line with the recommendations of the ebrd, which put forward providing liquidity to the economy, especially for small and medium enterprises, and financial support to vulnerable workers and other individuals as key priorities in combating the effects of covid 19 on the serbian economy (ebrd, 2020). these measures include the compensation of three minimum monthly salaries to employees in micro, small and medium enterprises, for which 237,000 employers with more than 1,1 million employees applied. over 834 million euros will be allocated for these purposes (ministry of finance, 2020). the financial aid program includes independent artists as well, who will also be paid three minimum salaries, for which an additional 1,7 million euros will be allocated. support to large companies was provided through the provision of funds for the payment of 50% of a minimum salary for all employees over a period of three months. moreover, the measures include assistance to employers in the form of a deferment of tax obligations and social security contributions until 2021, as well as deferment of payment of income tax for q2 of 2020. table 8 provides an overview of the short-terms measures introduced to mitigate the economic and social impacts of covid-19 in serbia and neighboring countries. dejana pavlović, duško bodroža, valentina vukmirović 11 table 8. short-term measures to mitigate the economic and social impacts of covid-19 in the western balkans policy measure fiscal and trade measures monetary and financial measures social measures r es ch ed u le d ta x p ay m en t an d t ax d ef er ra ls r es ch ed u le d so ci al co n tr ib u ti on s p ay m en t an d w ag e su b si d ie s m o ra to ri u m o n lo an re p ay m en t fo r n at u ra l a n d le ga l p er so n s r ed u ct io n o f th e c en tr al b an k in te re st ra te s l oa n g u ar an te e sc h em e d ev el op m en t b an ks c re d it li n es d ir ec t fi n an ci al su p p or t fo r ec o n o m ic en ti ti es o n eti m e ca sh tr an sf er a n d fi n an ci al h el p to so ci al ly vu ln er ab le albania bih montenegro north macedonia serbia source: world bank group, 2020 assistance is also provided for heavy-hit sectors, such as tourism, transport and logistics. in order to compensate for the loss that will occur due to the absence of guests coming from abroad, the government of serbia will distribute 560 thousand vouchers. through the development fund of serbia, the implementation of a program extending financial support to economic entities to maintain liquidity and procurement of working capital in challenging economic conditions caused by the covid-19 pandemic will also be carried out. the goal of this program, whose total value is roughly 205,9 million euros, is to provide financial support to economic entities so that they can regularly meet payroll, continue to work with business partners and repay the state. the funds are intended for entrepreneurs, as well as cooperatives, micro, small and medium-sized companies that are in majority private or cooperative ownership and which perform production, service, trade and agricultural activities (fond za razvoj, 2020). as part of the measures of financial assistance to the population, all the adult citizens who apply will be provided with the amount of 100 euros. the goal of this initiative is to provide additional financial assistance to the most vulnerable individuals as well as to encourage consumption. the world bank estimates that the government of serbia has responded in a timely and adequate manner to the economic challenges caused by the covid pandemic 19, with the opinion that adequate implementation of the fiscal stimulus plan totaling 5,2 billion euros and continued structural reforms will stabilize the serbian economy (world bank, 2020). according to the report of the national bank of serbia, despite the impact of global recession, macroeconomic stability in serbia is sustained (macroeconomic developments in serbia, 2020). it is reported that macroeconomic stability is the result of solid pre-crisis fundamentals, substantial monetary and financial stimulus, as well as favorable structure of the economy. government borrowing to raise missing funds, and injecting liquidity through banks and government guarantee funds, are certainly suitable initiatives for accelerating economic recovery (ies, 2020). however, it is advised that these funds should be used prudently, given that the effects of the global financial crisis in serbia will be felt in the second quarter as well. conclusion the presented data has demonstrated that the economy of the republic of serbia is stable. as the government had taken steps long before the crisis to reduce the share of public debt in gdp and the deficit, a space has been created in public finances for the state to adequately address the negative effects of the crisis. that being stated, exposure of serbia’s economy to the impact of the covid-19 crisis will depend primarily on the crisis’ duration. indeed, due to the slowdown 12 economic analysis (2020, vol. 53, no. 1, 1-13) in foreign capital inflows, the biggest challenge for economic-policy makers will be to find a way to reduce the deficit caused by measures taken to address the crisis. according to the data for q1 of 2020, the labor market was not affected by the crisis at first. in q3 and q4 of 2020, we can expect a decrease in the number of employees, primarily in the sectors most affected by the crisis (accommodation and food services, manufacturing, wholesale and retail trade, as well as real estate and business activities). in addition, the decline in the number of employed will occur due to a slowdown in economic activity internationally. it may be expected that severe pressure will be put onto serbia’s labor market due to the significant number of serbians who returned to serbia proper during the pandemic and who, taking into account the decline in economic activity globally, will remain in the country after the crisis. the package of proposed measures of the government of serbia to assist businesses in mitigating the economic consequences of covid-19 target key areas needed to combat the harmful effects of the crisis itself and the economic slowdown it has generated (fiscal council, 2020). temporary tax deferment, direct wage assistance and liquidity loans should have a positive impact on production and employment, especially in small and medium-sized enterprises. acknowledgements this paper is a result of the project financed by the ministry of education, science and technological development of the republic of serbia. references 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https://www,worldbank,org/en/news/pressrelease/2020/04/29/serbian-economy-shrinks-as-country-responds-to-covid-19 accessed: 10.05.2020. article history: received: may 18, 2020 accepted: may 25, 2020 doi: 10.28934/ea.22.55.1.pp105-127 original scientific paper economic activity and employment in the non-financial sector of bulgaria under conditions of covid-19 crisis. sectoral vulnerability assessment stoyan shalamanov122f* 1 sofia university “st. kliment ohridski”, faculty of economics and business administration, department of economics, sofia, bulgaria abstract this article examines the economic consequences in the non-financial sector of bulgaria as a result of the covid-19 pandemic. the development of the pandemic in bulgaria is analyzed from a medical point of view and it is concluded that the country will need periodic lockdowns (restrictions by the government and health authorities) of some economic sectors for at least a few more years. the analysis of the data from bulgaria and around the world shows that the lockdowns have general economic consequences, but mainly affect certain sectors. the main goal of the article is to identify the most vulnerable to social distancing industries in the bulgarian economy. to this end, the article develops a methodology based on a set of criteria for assessing sectoral vulnerability to lockdowns. the methodology includes an assessment of sectoral vulnerability to automation, percentage of selfemployed in the sectors, lockdown index, home-office index, teamwork, and customer-facing. we have found that the most vulnerable sectors in bulgaria is the hotel and restaurant business sector, and air transport. key words: covid-19, pandemic, non-financial sector, sectoral vulnerability, lockdown jel classification: e24, e32, j21, j23 introduction what is specific about the covid-19 pandemic is that it is an exogenous factor of economic growth. the specificity of addressing the health consequences of the virus requires imposing restrictions mainly on the mobility and social life of people. on the one hand, there are no purely economic and financial factors for the crisis. on the other hand, addressing the health aspect of the crisis concerns some sectors differently if compared to others. some sectors, such as health, land transport and construction, even turn out to be favored, their growth is stimulated both by the created situation with covid-19 and the support that is not precisely targeted according to the needs of the sectors. if the covid-19 crisis lasts longer, it would be useful for economic policy to identify the most vulnerable sectors in order to make support more targeted, rather than supporting sectors and businesses that do not need support, which only creates inflation. this is the purpose of the present study. the object is non-financial enterprises in bulgaria by sectors. the subject of research is the economic consequences of the pandemic on non-financial enterprises. * e-mail: shalamanov@feb.uni-sofia.bg 106 economic analysis (22, vol. 55, no. 1, 105-127) methodologically, a literary, comparative, and descriptive graphical analysis at sectoral level will be used to achieve the purpose. chapter one collects and analyzes data on the development of the pandemic. by analogy with the world trends in the spread of the virus and the introduced restrictions on social contacts, a forecast is made for the development of the pandemic in bulgaria. chapter two applies to the classification and comparison of the consequences of the pandemic in bulgaria and around the world. the third chapter summarizes data from various international studies on the effects of the pandemic on the non-financial sector of economies. the fourth chapter with the help of graphical, descriptive analysis presents the effects of the pandemic on the nonfinancial sector of the economy in bulgaria. we create a tabular model for assessing the vulnerability of the non-financial sectors in bulgaria in the fifth chapter, compare and classify the results. the methodology includes an assessment of sectoral vulnerability to automation, percentage of self-employed in the sectors, lockdown index, home-office index, teamwork, and customer-facing. the article will first describe the development of the pandemic from a medical point of view. this is an important component of the analysis because, as mentioned above, it is an exogenous crisis, which in this case is directly dependent on the development of the health factor, including: the rate and fluctuations in the spread of the infection, the approaches to dealing with it that have economic consequences, i.e. those that directly restrict certain economic sectors. second, the general economic consequences for the world, as well as for individual countries and regions, including bulgaria, will be discussed. third, the impact of the pandemic in the non-financial sectors of some countries will be analyzed as an introduction to getting acquainted with the consequences in the non-financial sector of bulgaria until the first quarter of 2021. in the last section of the analysis, based on various indicators and indices developed in scientific literature, a cumulative method for assessing sectoral vulnerability in bulgaria will be developed. this method will be used to analyze the sensitivity of the various non-financial sectors of the bulgarian economy to the consequences and restrictions associated with the pandemic and draw conclusions on the future support policy. general health consequences in the world and in bulgaria for 2020 and early 2021. the covid-19 virus occurred in wuhan city of central china at the end of 2019. it was identified when in december people developed pneumonia of unknown cause that did not respond to the known methods of treatment. it has rapidly widespread and on march 11, 2020, the world health organization (who) has declared the novel coronavirus (covid-19) outbreak a global pandemic. by the end of july 2021, there were already more than 198 million confirmed cases of people infected with the virus worldwide, of which over 4 million deaths, and nearly 15 million active cases (worldometer, 2021). figure 1. shows the dynamics of spread of the virus around the world from the beginning of the pandemic in the spring of 2020 to july 2021. both charts show a trend of increasing the cases in recent weeks; the world is on the verge of a fourth wave of covid-19. stoyan shalamanov 107 figure 1. daily new cases around the world source: worldometer. 2021. bulgaria reported the first confirmed case of coronavirus disease (covid-19) on march 8, 2020. since then, the statistics of prevalence and mortality has been following the global trends with a slight delay of several weeks, which can be seen in figure 2. as of the end of july 2021 bulgaria has already reported over 424 thousand officially registered cases of infected, of which over 18 thousand death cases, nearly 400 thousand recovered cases and over 8 thousand active cases (unified information portal, 2021). figure 2. daily new cases in bulgaria source: worldometer. 2021. towards the end of july, the origination of the fourth wave in bulgaria is not clearly visible graphically, but the cases are increasing and the logic of the first two waves suggests that we will probably continue to follow the negative trends in global statistics. this conclusion is also supported by the low vaccination rate in bulgaria compared to the rest of the world. as of september 2021, the fully vaccinated population in bulgaria is 15% compared to 30% on average for the world. on the one hand, the positive aspect in the fight against the pandemic are vaccines that reduce mortality; on the other hand, the negative aspect are new mutations of the virus such as delta variant, which so far do not allow a permanent reduction in the number of infected. these covid108 economic analysis (22, vol. 55, no. 1, 105-127) 19 mutations either multiply and spread more rapidly or are more resistant to vaccines. this means that the need for restrictions in social life and some economic activities will remain. social distancing measures are different types with different scope and stringency and can be categorized as partial and full. in the case of full measures, a quarantine blockade of entire regions or countries is required. in the strictest form, the entire population is forbidden to leave their homes, unless it is absolutely necessary. physical contact is allowed only between members of the same household. only basic essential organizations, such as grocery stores, pharmacies, and hospitals, operate. the full restrictive measures are imposed for a more limited period of time (fiscal council of bulgaria, 2020). the partial measures restrict activities related to mass events and crowing of people, and can be (covid 19 healthdata, 2021.): • closure of schools and educational institutions at all levels of education (primary, secondary and higher education), introduction of distance learning; • suspension of insignificant activities, closure stadiums, cinemas, shopping malls, museums and playgrounds, bars and restaurants (they can offer home deliveries), closure of retail stores and services such as beauty salons and hairdressing salons. only suppliers of basic goods and services work. fines are imposed on offenders. • restrictions on travel. movement between settlements is prohibited. only those who provide basic services and returning residents isolated in foreign territories are admitted. travel in private cars is limited only for the purposes of access to work and basic services. public transport is stopped. • gatherings are limited. restrictions can be applied both to public and private gatherings (a definite of people in one place). • businesses are temporarily closed. these restrictions do not apply to all companies but may include a particular group such as bars and restaurants. • contact persons are tracked and quarantined. • remote forms of employment are encouraged. • a mask is used, and distance is observed in contact with people outside the household. • information campaigns for prevention and vaccination. • mass testing policy. • promoting vaccination against covid-19 by different approaches – incentive and prohibitive. the measures applied by the health authorities differ not only in their type and stringency, but also in the timeliness and speed of their application. in general, they cause, in addition to the negative economic consequences, resistance and boycott by a part of the society. the gradual combination of different partial measures allows a large part of the economy to continue to operate. another approach is to alternate full measures with partial measures (in the form of ‘dance’). in any case, there is a risk of early or excessive loosening of the measures. figure 3 shows how the measures to restrict social contacts, applied by the government since the start of the pandemic, affect the mobility of people compared to the usual levels for bulgaria. stoyan shalamanov 109 figure 3. social distancing source: covid 19 healthdata. 2021. mobility should change with the application or easing of the measures for social distancing, so data should give us an idea of the extent to which the restrictive measures of the government have actually led to an increase in social distancing. individual decisions for mobility restriction, despite the government restrictions, also have an impact on the model because ‘mobility’ in the model is based on anonymous mobile phone tracking data provided by technology companies to combat covid-19. all other conditions being equal, it is accepted that mobility is an indicator of greater potential for personal contact that can contribute to the spread of the disease. when mobility is high, the risk of spreading covid-19 is also considered to be high. however, taking precautions, such as keeping distance between individuals during gatherings, wearing face masks in public areas and washing hands regularly, can significantly reduce the risk of transmitting the disease. the model also provides three forecast scenarios for the development of the situation (covid 19 healthdata, 2021.): • continuation of the trend (average reference scenario) under equal other conditions. • worsening of the situation (unfavourable scenario), in which new coronavirus mutations begin to spread more rapidly and/ or the use of masks among vaccinated persons begins to decrease exponentially one month after the end of the vaccination course. • the ‘mask’ scenario (favourable scenario) is based on the same assumptions as the reference scenario, but also assumes that 95% of the people wear masks in public areas. it is stated that the use of masks at this level can reduce the transmission of the virus by more than 30%. in the unfavourable scenario and the average reference scenario, the forecast from the model is that mobility in bulgaria will have to be significantly limited by october. only in case of over 95% wearing masks we can rely on maintaining the current mobility, but such a percentage in bulgaria is unattainable. currently, such a level of wearing masks is found only in singapore. based on this chart, it can be concluded that social distancing must also be maintained in the coming months in order to limit the spread of covid-19. at the same time, the measures for social distancing have a detrimental effect on the economy, but there is no alternative at this stage, because there is still not enough clarity about the effectiveness of vaccines against new mutations of covid-19. the conclusions from the above analysis at the time of writing this article are that the pandemic has not subsided at all, either in the world or in bulgaria. in connection with the emergence of newer mutations of the virus, which are more resistant to vaccines, precise forecasts cannot be 110 economic analysis (22, vol. 55, no. 1, 105-127) made for the development of the situation and the recovery of social and economic life. economies must be prepared for a long regime of opening and closing, and people for a long regime of social distancing. some studies have found that the application of strict protocols to several sectors is generally preferable to the application of softer protocols to a larger number of sectors both in terms of health and economic benefits. (janiak, machado & turén, 2021.) it would be useful for the economic management of the crisis to get to know in more detail the economic consequences of the pandemic both in the world and in bulgaria, as well as to identify the most vulnerable (most affected by closures) economic sectors in order to refine the economic support policy in bulgaria. general economic consequences of the pandemic for the world and bulgaria the onset of the covid-19 pandemic and the restrictive measures imposed to address its health consequences have led to a sharp contraction of economic activity in all major economies. the covid-19 pandemic has raised the global index of uncertainty to historic levels – fig. 4. uncertainty was declining relatively rapidly as early as the end of march 2020 (altig & others, 2020.), with the peak of the negative economic effects of the restrictive measures observed around may 2020. data from international trade confirm that the negative effects of covid-19 in exporting countries persist until august 2020, but their scale decreases over time. (hayakawa & mukunoki, 2021). the relatively rapid recovery of confidence and economic activity, especially in some large economies such as china, has allowed the overall global economic decline for 2020 to be limited to just 3.3%. the chinese economy even managed to report growth of 2.3% for the year, the decline for the united states was 3.5%, great britain – 9.9%, germany – 4.9%, france – 8.2%, russia – 3.1%. (world economic outlook, 2021.) figure 4. global index of uncertainty source: international monetary fund, through murginski, 2021. the global economy is expected to expand by about 6% in 2021, the fastest pace in 80 years, mainly due to the strong recovery of several major economies. however, many emerging markets and developing economies continue to struggle with the covid-19 pandemic and its aftermath. the world production will be about 2% below pre-pandemic forecasts at the end of 2021. among low-income economies, where vaccination is lagging behind, the effects of the pandemic are stoyan shalamanov 111 reducing the achievements in poverty reduction. these forecasts are included in the june issue of the world bank’s report on global economic prospects (global economic prospects, 2021). it should be noted, however, that these economic forecasts do not reflect the purely medical aspect of the problem that we have already addressed in chapter 1. uncertainty about the emergence of new mutations in the virus that are resistant to vaccines and new waves of the pandemic remains high. in the pre-pandemic year of 2019, the gross domestic product of bulgaria increased in real terms by 3.4%, exceeding 3% for five consecutive years. the leading factor of growth is final consumption, which increased by 5.7% compared to 2018. since mid-2019, there has been a slight slowdown in the real growth of gdp to 3.2% and 3.1%, due to the slowdown in the global economy that has already begun. the crisis caused by the global pandemic dramatically changed the dynamics of economic activity in the bulgarian economy. (institute for market economics, 2020). with the introduction of the state of emergency in bulgaria on march 13, 2020, strong restrictions on social and economic activities were imposed. hotels, restaurants, bars, beauty salons, tourist offices, cinemas, theatres, malls, retail stores, etc. completely closed. some manufacturing companies ceased their operations due to disruptions in the international supply chains. travelling was restricted, checkpoints were established at the exits of the regional centres, the mandatory fourteen-day quarantine of bulgarian and foreign citizens arriving in bulgaria was introduced. (petranov, zlatinov, velushev & karaivanov, 2020). the shock on transport is evident from the following statistics: • the number of trucks passing through the main border checkpoints of the country reduced by 30% 40%; • the bulgarian airlines association announced that the expected losses only in the months of march, april and may would amount to eur 34 million (customs agency, 2020); • only in march, the revenues of the sofia-based companies ‘metropolitan’, ‘stolichen avtotransport’ and ‘stolichen elektrotransport’ shrank by eur 3.3 million. the gross domestic product decreased by 8,5% in real terms compared to the second quarter of 2019 and by 10% compared to the first quarter of 2020. according to data of the employment agency, in the six weeks after the introduction of the state of emergency in the country, more than 105 thousand new unemployed people have been registered in the employment offices and only 16 thousand have started working for the same period. the number of registered unemployed reached the highest value of 295,5 thousand people in may or by over 112 thousand more compared to same month of 2019. (institute for market economics, 2020). the easing of restrictive measures and the opening of businesses in may – june 2020 have led to a resumption of the activity in july. the confidence of the business and consumers was increasing; the industrial production was beginning to recover. however, activity in the services and retail trade sectors has been hampered by the loss of consumer incomes, the increase in savings and the continued restrictions on some activities. (oecd economic reviews – bulgaria, 2021). in the end, the bulgarian economy contracted by 4.2% in the crisis year of 2020 to bgn 118.6 billion at current prices, according to preliminary data of the national statistical institute (nsi), as the decline was below the eu and euro area average. according to eurostat, the decline in the eu economy is 6.2% and the gross domestic product of the euro area countries is minus 6.6% in 2020. despite the severity of the pandemic and economic crisis, in 2020 the unemployment rate increased by only 0.9 percentage points, compared to 2019, and reached 5,1%, respectively 5,4% for men and 4,8% for women. the number of unemployed reached 168,6 thousand by the end of 2020, according to nsi data from march this year. the reported increase in unemployment is much less negative that during the previous global economic crisis of 2008-2010. (bulletin for macroeconomic development, 2021). 112 economic analysis (22, vol. 55, no. 1, 105-127) dynamics in the non-financial sectors of different countries at the moment of completion on this article, there is no available data regarding other countries that are more similar (in terms of size and economic development) to bulgaria. initially, with the introduction of the restrictive measures, the production and sale of vehicles and spare parts, as well as their service maintenance, were among the most affected economic activities because some manufacturers were forced to close their factories in a number of countries. transport was also strongly affected due to the closure of borders, introduction of quarantine blockades and decline in tourism. in air transport, already requested and paid reservations were cancelled. in the first week of april alone, there was a drop of over 90% in the scheduled flights to countries such as the united kingdom and germany (fiscal council of bulgaria, 2020). the introduction of quarantine blockades, the restrictions on mass events, the distance working of employees, etc. significantly reduced the passenger flow in the public urban transport. in retail trade, a number of companies faced difficulties and delayed the payment of their rents, the large shopping centres closed due to the ban on crowding of people. some of the catering establishments restaurants and cafes temporarily relied only on home deliveries of food, thus compensating at least a small part of the decline in their income. (fiscal council of bulgaria, 2020). some researchers have found that countries with a better virus control strategy, healthcare opportunities and relatively higher share of employment in the primary sector have suffered lower losses (goswami &, 2021). it can be argued that labour-intensive industries are more vulnerable, with the footwear industry suffering a decline until august 2020, the production of transport equipment showing a decline especially in april and may 2020. in other industries, such as those offering medical products or digital consumer services, software and computer services, electronic entertainment, positive effects of covid-19 have been observed. (hayakawa & mukunoki, 2021). another research claims that the sectors with high contact and higher vulnerability to infection are the wholesale and retail, hotels and restaurants, entertainment and personal services, transport, education, healthcare, and construction. all other sectors can be determined as sectors with low-contact and lower risk of infection (world economic outlook, 2021). in general, most sectors have been affected in some way the primary and secondary industries are suffering due to poor logistics and supply chain problems, the wholesale and retail due to the need to speed up their online services, and the tourism sector is the most affected sector. (lu & others, 2021). the greater vulnerability of some industries may depend on the share of self-employed in a given sector; such persons in a given economy are very often not insured or are insured on a minimum income and therefore cannot benefit from business and employment preservation programs. statistics on the sectoral distribution of this vulnerable employment in pakistan shows that the lowest percentage of self-employed is observed in the financial sector, supply of utilities (water, electricity and gas), mining and education, while in the agricultural sector, wholesale, retail and real estate they are at most over 60 % for each. (sohail, 2019). if such microenterprises and self-employed are left without state support, they could not survive for a long time. data from a study in pakistan show that most small and micro-enterprises would not survive for more than 5 weeks, if restrictive measures are introduced in a new wave of covid-19. tourism and entertainment industry are the economic sectors that have most been affected by covid-19 in the world. they report a decline of usd 2,86 trillion for 2020 or more than 50% loss of revenue. (abbas, & others, 2021) in fig. 5, the percentage change in the number of international tourist trips by geographical regions can be seen for january may 2019, compared to the same period of 2018, and for january may 2020, compared to the same period of 2019. for example, australia’s inbound tourism industry is expected to reach a decline of usd 39 to 42 billion in the gross domestic product for 2020. the results show direct losses of 152 000 jobs in tourism, which together with indirect losses, including related industries in the production chain, reach a total of stoyan shalamanov 113 about 450 000 jobs. (pham, 2021). the negative effects of covid-19 extend beyond the direct impacts on tourism-related industries. figure 5. change in the number of international tourist trips by geographical regions source: world tourism organisation, through: abbas, j., and others. 2021 the long-term economic consequences for the tourism industry will affect any household, directly or indirectly related to the sector. the pandemic has literally stopped tourism in some periods of 2020 and 2021. usually, when crises such as natural disasters, epidemics, wars, civil unrest, etc. affect a region, travellers are flexible and move from the destination affected by the crisis to another. tourism has the ability to attract consumers (visitors) from around the world. in this global pandemic of covid-19, however, all these alternative plans lose their meaning because the pandemic affects any type of tourism, whether summer, winter, cultural, pilgrimage, health and rehabilitation or otherwise. in addition, the covid-19 pandemic will have a lasting impact on the tourism industry, as tourists are not expected to regain their previous level of mobility even after its end (singh & others, 2021). covid-19 has made life very difficult for the poorer people of society working in tourism. these people have no other choice but turn to new professions, which will also have lasting consequences for the sector. apart from tourism, employment in developed economies is declining most sharply in the wholesale and retail, transport, catering, and arts and entertainment sectors. the difference with previous recessions in the last 50 years is that during such recessions the manufacturing and construction sectors were usually most affected. it is also interesting that covid-19 accelerates the existing structural trends to reduce employment in sectors that are more vulnerable to automation (fig. 6). sectors are classified as more vulnerable to automation, if more than half of their employment is in professions classified as routine (carrillo-tudela & others, 2016). in these sectors there is a gradual decrease in the share of employees with lower qualifications. most employees working remotely are in sectors that are classified as less vulnerable to automation, which means that covid-19 also creates a tendency to switch to teleworking. however, there are some exceptions, for example – sectors that are less vulnerable to automation, but cannot work remotely, including utilities, culture and entertainment, as well as sectors that can work remotely, but are more vulnerable to automation, including administrative services. there are indications that the shock of covid-19 is accelerating the existing trends, with employment declining in sectors and occupations that are more vulnerable to automation. this is also observed in the movement of labour flows during past recessions, although now the specific sectors most affected are different – wholesale and retail, accommodation and catering. (world economic outlook, 2021). 114 economic analysis (22, vol. 55, no. 1, 105-127) figure 6. sectors vulnerable to automation source: choi and others (2018), through: world economic outlook. 2021. in general, the effects of covid-19 on global employment affect young people, low-skilled and women to a greater extent. (world economic outlook, 2021). the shock of covid-19 is likely to have some lasting effects, accelerating the reduction of employment that is more vulnerable to automation and that cannot switch to teleworking. changes in economic activity and employment in bulgaria by main economic sectors. the growth by economic sectors of the bulgarian economy in pre-pandemic 2019 is defined as sustainable, because the industry sector has the highest contribution. at the same time, fundamental sectors such as trade, transport, hotel business, it and telecommunications are reducing their contribution to the overall growth (yotsov, zlatinov, & others, 2020). with the advent of covid-19, the government’s anti-crisis measures, including physical distancing, have had different effects on different sectors of the economy. when applying partial restrictions, the negative effects are focused on some sectors, but are subsequently extended to the related ones and ultimately to the whole economy. in the second quarter of 2020, when the crisis was most pronounced, compared to the same quarter of the previous year, the largest decline was reported – by 17,7% in the sectors of trade, repair of motor vehicles and motorcycles; transport, warehousing and post offices; hotel and restaurant business and by 4,7% in the sectors of culture, sports and entertainment. the number of persons employed in the second quarter of 2020 was lower by about 123 thousand than in the same quarter of 2019. the contraction is almost entirely due to the reduced employment in the sectors of trade, hotel and restaurant business (by over 72 thousand) and industry (by over 36 thousand), whereas, regardless of the crisis, in the sector of creation and distribution of it and creative products and telecommunications, employment increased by over 7 thousand people on an annual basis. growth is also reported in healthcare and social activities (institute for market economics, 2020). stoyan shalamanov 115 the pandemic has had an extremely negative impact on international tourism. in pre-pandemic year of 2019 the ‘hotel and restaurant business’ and ‘travel agency and operator activity’ sectors formed directly about 4.7% of the employment in the country; in 2019 the revenues from export of tourist services amounted to about 6.3% of the gdp (chobanov & others, 2020). with the onset of the pandemic, in june 2020 the total number of foreigners visiting bulgaria decreased by 75,2%, compared to their number in june of 2019, and the number of those coming for a vacation or excursion was lower by 94,6%. the university of oxford has developed a stringency index of government measures. it varies in the range from 0 to 100 points, as the higher value corresponds to tightening of restrictions. for bulgaria, the index registered a peak of 73.15 points at the end of march 2020 and from may a gradual easing of restrictive measures began as a result of the control of the first wave of the pandemic. bulgaria was among the eu states with the least restrictions at the end of the second and the beginning of the third quarter of 2020 (institute for market economics, 2020). this explains the relatively low rate of decline in economic activity and employment (fig. 7.1, 7.2. and 7.3) in most sectors during this period, compared to the other member states. figure 7.1. industry and services* figure 7.2. construction and transport* figure 7.3. hotel and restaurant business* sources: infostat, 2021, and own calculations (appendix table) * on the left scale, employment in the given sector is measured, and on the right scale – the value of stringency index. 0 10 20 30 40 50 60 70 460000 480000 500000 520000 540000 560000 580000 q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 stringency index industry services 0 10 20 30 40 50 60 70 115000 120000 125000 130000 135000 140000 145000 q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 stringency index construction transport 0 10 20 30 40 50 60 70 0 20000 40000 60000 80000 100000 120000 q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 stringency index hotel and restaurant business 116 economic analysis (22, vol. 55, no. 1, 105-127) the stringency index is calculated using policy indicators c1 c8 and h1. the value of the index for each day is the mean value of these nine indicators relating to individual policies, each with a value between 0 and 100. the indicators c1 to c7 and h1 have an additional coefficient corresponding to whether the policy is applied locally (in specific areas/cases) or as a whole throughout the country (covid-19 government response tracker, 2021). с – containment and closure policies: с1 – school and university closing; с2 – workplace closing; с3 – cancellation of public events; с4 – restrictions on gatherings; с5 – closure of public transport; с6 – stay-at-home requirements; с7 – restrictions on the internal movements between cities/ regions. н – health system policies: н1 – public information campaigns. in figure 7.3 we see, albeit in the opposite direction, the symmetrical development of stringency index, which is measured on the right scale, and employment, which is measured on the left scale, in the hotel and restaurant business sector for the first, third and fourth quarter of 2020, as well as employment in the services and industry sectors for the whole of 2020. interestingly, in all observed sectors there is growth in the first quarter of 2021, despite the increased stringency index. this can be explained by the adaptation of the business to some extent to the conditions of the pandemic and the restrictions associated with it. the results and analyses of 2020 presented above show that the government’s restrictive measures have a different impact on the non-financial sectors of the economy and the policies to support them need to be refined. the unnecessary support of some sectors has shown that it can put inflationary pressures on the economy, while the insufficient support of others can lead to lasting negative effects in some sectors, restructuring employment and thus increasing poverty and inequality, the latter being particularly strong in 2020. it would be useful to try to analyse the vulnerability of the main non-financial sectors of the economy with regard to the pandemicrelated closure. this knowledge can be used not only for the current crisis, but also for subsequent similar trials that bulgaria and humanity as a whole may face in the future. in pre-pandemic year of 2019, the industry sector was the basis of economic growth. subsequently, it was affected by the first wave of the pandemic and reported a strong decline in the months of march, april and may 2020, after which it began to recover in june 2020. both in the world and in bulgaria, the industry is coping relatively well with the crisis, is recovering quickly, and by june 2021 in bulgaria it is moving around the norm for the season with an index of 108,3 for 2019, the index for 2021 is 109,6 (fig. 8)(infostat, 2021). stoyan shalamanov 117 figure 8. industrial production indices, calendar adjusted data. source: infostat. 2021. clothing production has been permanently affected, for example with an index of 88,3 in june 2019 it fell to 75 in june 2020 and 73,5 in june 2021. this negative trend can easily be explained by the reduced demand for clothing in the conditions of severely limited mobility and social activity of the population both in bulgaria and around the world under pandemic conditions. the production of medicinal products and substances is at the other pole, with the production index reporting high values of over 130 in march, april and november 2020, and march 2021 (infostat, 2021). these values correspond to the three waves of covid-19 in bulgaria, which have been observed so far. despite the strong economic performance in 2019, employment in the industry sector has shown a trend of gradual decline since the beginning of the pre-pandemic year. from 574 477 persons employed in the first quarter of 2019, they reached 557 697 in the fourth quarter, with a sharp decline at the start of the pandemic in the second quarter of 2020, when 535 856 persons employed were reported. we can talk about recovery only in 2021, when for the first quarter the first for the period growth of 544 255 persons employed was reported (infostat, 2021). the trade sector, although more moderately than industry, also contributed to the economic growth prior to the crisis. after the initial lockdown in march and april 2020, similarly to international trade, the sector began to recover in the third quarter of 2020. it is noteworthy that companies and consumers were adapting relatively quickly to the new conditions and were largely switching to online forms of trading, which helped the rapid recovery of the sector as a whole. until the end of 2020 the tendency of wholesale in non-food consumer goods to move around and above pre-pandemic levels remained. employment in the sector was stable in 2019, showing over 390 thousand persons employed every quarter. however, the decline began already in the first quarter of 2020, when the number of persons employed was 389 thousand, compared to 396 thousand in the last quarter of 2019. in the next second quarter, which generally affected the economy most strongly, there was a smaller decrease by less than 3 thousand persons employed. employment remained below 390 thousand in the next quarters until the first quarter of 2021 inclusive (infostat, 2021). the construction sector, like the trade sector, is rapidly recovering after the initial shock. construction is one of the sectors with a smaller contribution to growth in 2019. fluctuations in housing construction and civil/ engineering construction are symmetrical, as all three more serious declines coincide with the three waves of coronavirus in 2020 and the spring of 2021 (fig. 9). it is noteworthy that the levels of housing construction, despite the growth of housing prices, are still below those of 2019, in contrast to civil/ engineering construction, which has a tendency to growth even above the levels of 2019. employment in the construction sector, similar to the trade sector, also began to decline in the first quarter of 2020, when nearly 124 thousand persons 118 economic analysis (22, vol. 55, no. 1, 105-127) employed were reported, compared to over 128 thousand persons employed in the first and last quarter of 2019. employment in the sector has recovered to the pre-pandemic levels of 128 thousand persons employed only in the first quarter of 2021 (infostat, 2021). figure 9. construction production. calendar adjusted data. source: infostat, 2021. the transport sector also contributed moderately to the economic growth in pre-pandemic year of 2019. all modes of transport were affected in the first months of the pandemic, falling in the second quarter of 2020. land transport can be said to have recovered, as its index for the first quarter of 2021 is even slightly higher than that for the first quarter of 2019 122.7 compared to 121.2. air transport is, however, still severely affected, including at an international level. the collapse is most noticeable in the third quarter of 2020, when the index is 56,5 compared to 229,2 for the third quarter of 2019. the first quarter of 2021 has an index of 37.1 compared to 49.4 for the first quarter of 2019; the decline seems less pronounced, but this is not a vacation period of the year. employment in the transport sector decreased by about 3000 people in the second quarter of 2020, recovering to the pre-pandemic levels of over 140 thousand persons employed in the first quarter of 2021 (infostat, 2021). sector services, excluding transport, hotels and restaurants: at the start of the pandemic not a small part of the activities for service provision were limited. however, some activities remained unaffected and others even managed to increase their production. postal and courier activities have been showing almost a continuous growth since the beginning of the pandemic, including in the second quarter of 2020 until the first quarter of 2021, when the index reached 174.8, with an index of 128.0 for the first quarter of 2019. the same can also be said for telecommunications, which reported a decline in the index only in the first quarter of 2021. information technologies can also be said not to have been affected by the pandemic; for information technologies, even no conclusion can be drawn for a significant impact of the pandemic in any direction. security activities are marking a slight increase, which is typical for the sector during crises. catastrophic is the situation with travel agency activity; it is indicative that the index is 7,8 for the second quarter of 2020, which will probably remain in history as the historically lowest value of a production index in bulgaria. for the same quarter of 2019 the index is 141.9. employment in sector services has been developing dynamically since 2019. in the second quarter it reached its highest value of 561 162 persons employed; since then it has started to fall steadily, reaching 506 954 during the highly crisis second quarter of 2020. in the following months, the fluctuations are stoyan shalamanov 119 various, as we can talk about signs of the beginning of recovery only in the first quarter of 2021, when the persons employed exceed 510 thousand (infostat, 2021). sector hotel and restaurant business: in general, tourism is the most affected sector by the pandemic. only for january may 2020, compared to the same period of 2019, tourist travel in eastern europe marked a decline by 54%. immediately after the introduction of the state of emergency in bulgaria, the sector collapsed and is still very far from its normal levels (fig. 10). figure 10. turnover indices in sector hotel and restaurant business at current prices. calendar adjusted data. source: infostat, 2021. in the hotel business, the negative dynamics is more pronounced. for the strongest third quarter of 2020 the index is 143.4, compared to 279.4 for the same quarter of 2019. for restaurants, restrictions were lifted several times and reintroduced, which put the sector in great uncertainty, as some of the restaurants closed permanently. it is noteworthy that for the strongest third quarter of 2020 the index of the restaurant business reached 170.5, almost equal to that for the same quarter of 2019 (177.4). for the other periods, however, the decline is significantly larger; it reached 79.7 for the first quarter of 2021, compared to 128.1 for the first quarter of 2019. employment in the sector is characterized by high seasonal dependence, which is also observed from the data for 2019, which range from 107 thousand in the winter months from the beginning of the year to over 137 thousand in the summer season; the trend of crisis decline can already be seen in the last quarter of 2019, when employment fell to 103 thousand, and in the first quarter of 2020 to 82 thousand. surprisingly, the second quarter of 2020 reported an increase to nearly 89 thousand persons employed, which can probably be explained by the beginning of the summer season in june, when the covid-19 cases decreased. however, the negative trends in the severely affected sector continued to be observed until the end of 2020 – there were 77 thousand persons employed in the last quarter, and 2021 began its first quarter with only 80 thousand, compared to 107 thousand for the first quarter of 2019 (infostat, 2021). sector it and telecommunications is traditionally among the strongly performing ones in bulgaria. in 2018, it had a strong contribution to the economic growth of the country. the whole year of 2019 also elapsed in growth of the sector from an index of 138.6 in the first quarter it reached 187.0 in the fourth quarter. in 2020, the sector started with an index of 151,2 in the first quarter and 150.5 in the second quarter, after which the index increased to 187.8 in the last 120 economic analysis (22, vol. 55, no. 1, 105-127) quarter. the new year of 2021 started with an index of 175.1 in the first quarter, compared to 138.6 and 151.2 for the same quarter of 2019 and 2020, respectively. as a whole, the sector has not been affected by the pandemic; even it can be said that it has been promoted by the fact that the increase in remote forms of work have lead to an increase in the demand for it products. this is also confirmed by the dynamics of employment in the sector, in which the trend of growth of the persons employed in 2019 continued in 2020, except for the second quarter, in which there was a slight decline by about a thousand people. the year of 2021 started strongly, with 105 917 persons employed in the first quarter, compared to 98 821 and 90343 for the same quarter of 2020 and 2019, respectively. vulnerability assessment of non-financial sectors in bulgaria under pandemic conditions in general, it can be argued that from the beginning of 2021 economic recovery is under way, but uncertainty remains high. from chapter 1 in the present study and on the basis of fig. 3 (social distancing), we concluded that social distancing should be maintained in the coming months in order to limit the spread of constantly mutating covid-19. the unique thing in this situation is that the human factor vulnerability is at the basis of economic difficulties. sectors in the economy, where living workforce is dominant and direct contact between a serving party and a served party is required, are more affected (national and international tourism, transport, healthcare, culture, sports). other sectors manage to readjust quickly and do not experience significant problems (part of the services, administration, education). some activities and productions will benefit (pharmacy, it sector, trade in goods of first necessity, production of protective clothing and protective equipment) (yotsov, zlatinov & others, 2020). for the management of the economy, it is important not only to assess the most affected sectors in bulgaria, but also to identify the most vulnerable sectors to lockdowns (restrictions related to social distancing) in general. if the support policies are not precisely targeted by sectors, we take the risk of creating inflation instead of supporting those that are in real need. to this end, we have developed a compilation method for assessing sectors. in it, each sector is assessed according to 8 criteria: • decline in production indices – number of quarters compared to the previous one, starting from the first quarter of 2020 and reaching to the first quarter of 2021. this indicator will show us how many quarters of the crisis period the companies in the sector have been vulnerable to closure. • decline in employment – number of quarters compared to the previous one, from the first quarter of 2020 to the first quarter of 2021 inclusive. this indicator will show us how many quarters of the crisis period the persons employed in the sector have been vulnerable to closure. • sectoral vulnerability to automation. we explained above (fig. 6) that the shock of covid19 accelerates the reduction of employment in sectors and occupations that are more vulnerable to automation. these sectors will, therefore, need stronger employment protection during the pandemic in order to limit the employment rate. • percentage of self-employed in the sectors. we explained above that the greater vulnerability of some sectors can be characterized by the percentage of self-employed in the sector. self-employed in an economy are very often not insured at all or are insured at a minimum income and, accordingly, cannot benefit from business and employment preservation programs. • lockdown index. • home-office index. • teamwork. stoyan shalamanov 121 • customer-facing. the last four indices will be discussed in the text below. we have already discussed in chapter 1 that, in order to respond to the spread of the covid19 pandemic, governments are implementing lockdown policies aimed at creating physical distance between people. these policies largely affect the workplace. many activities are closed or their capacity is seriously limited during the peaks of the pandemic. some jobs are more affected than others, in part because, by their nature, they cannot avoid physical closeness between people in the work process. in addition, some major activities are excluded from lockdown policy due to their crucial importance, such as healthcare, social care and public administration, and they remain unrestricted. there is a strong heterogeneity in the lockdown of different industries. these differences are captured in an indicator called lockdown index. according to a study conducted in switzerland, large industries, such as the hotel business, construction and education, are most affected by the lockdown. more than 56% of their workers and employees are limited by the lockdowns. in contrast, agriculture, financial services, it sector and communications are relatively unaffected, with less than 23% of the workers having to work close to other people (faber & others, 2020). the home-office index (work-from-home index) accounts for the proportion of workers and employees in a profession who can work from home. the calculation is based on a number of characteristics from the area of work, through the socio-demographic characteristics and whether a profession requires daily outdoor work, use of vehicles, mechanical devices or equipment. if so, such professions are classified as unsuitable for home office (work from home). the resulting indicator is defined as a home-office index, varying between 0 and 1, with 1 meaning that all workers in this group can work from home (dingel & neiman, 2020). in social distancing interventions, the businesses that rely heavily on face-to-face communication where everyone is in direct contact with each other are particularly vulnerable. data on the dependence of the american business on human interaction show that before the advent of the pandemic 43 million employees worked in professions that relied heavily on faceto-face communication or required physical closeness. many of these employees lost their jobs in the conditions of covid-19. indices measuring how intense the communication is in a job can help quantify the economic costs of social distancing. such indices are teamwork for measuring internal communication with colleagues and customer-facing for measuring external communication with customers. in order to be accounted for in the indices, face-to-face communication is required to occur at least several times a week, because face-to-face meetings can often be replaced by remote communication. the professions that work intensively in a team or with customers, where both e-mails and other electronic forms of communication are rarer, are included. (koren & pető, 2020). the teamwork index takes into account: • face-to-face discussions at least several times a week and predominantly before the use of emails and other remote forms. • teamwork. • provision of consultations and advice to colleagues. • coordinating the work and activity of employees. • management, guidance and motivation of subordinates. • team development and building. the customer-facing index takes into account: • face-to-face discussions at least several times a week and predominantly before the use of emails and other remote forms. 122 economic analysis (22, vol. 55, no. 1, 105-127) • working with external customers. • performing for or working directly with the public. • helping and servicing customers (patients). • providing consultations and advice to customers. • establishing and maintaining interpersonal relations. usually, the retail and accommodation and catering services, the arts, entertainment and recreation have the highest share of employees with intensive communication, exceeding 35%. the it, transport, scientific and technical services, as well as the agricultural industry are less dependent on face-to-face communication (koren & pető, 2020). table 1 shows the results of the assessment of the main non-financial sectors according to the above 8 criteria. the it and telecommunications sector is the least vulnerable sector by the pandemic, with the least (totally four) quarters of decline in production and employment. the sector is not assessed with a risk of automation and has the lowest percentage of self-employed. relatively low is also the lockdown index, which in turn means a low sensitivity to the permanent restrictions on economic life imposed by governments. finally, the sector is characterized by the highest home-office index, which means that it is highly adaptable to the conditions of social isolation. table 1. sectoral vulnerability assessment sources: *1faber & others. 2020; *2 dingel & neiman, 2020; *3 world economic outlook, 2021; *4koren & pető, 2020; infostat, 2021, and own calculations. the hotel and restaurant business sector is at the other pole. in the sector, there are totally six quarters of decline in production and employment. there is no risk of automation, but there is a relatively high percentage of self-employed. this sector is traditionally characterized by the lowest average income in the economy, which a consequence of the large-scale formal conclusion of part-time and minimum wage employment contracts with workers. in this regard, the sector is particularly vulnerable. it is also rated with the highest lockdown index and the lowest homeoffice index. 8% of those working in the sector are exposed to intensive communication with se ct or s\ in d ic at or s d ec li n e in p ro d u ct io n , n u m be r of q u ar te rs d ec li n e in e m p lo ym en t, n u m be r of q u ar te rs v u ln er ab il it y to au to m at io n *3 se lf -e m p lo ye d ( % ) lo ck d ow n in d ex *1 h om eof fi ce in d ex *2 t ea m w or k (% ) *4 cu st om er – fa ci n g (% ) *4 industry 3 4 1 7,37 0,27-0,47 0,17-0,45 7 5 trade 3 4 1 22,19 0,08-0,37 0,24-0,60 08-13 12-66 construction 4 2 1 19,73 0,56 0,16 transport 3 2 0 22,19 0,36 0,40 8 8 services 2 3 0 29,89 0,35-0,53 0,18-0,46 5-12 10-30 hotel and restaurant business 4 2 0 22,19 0,60 0,11 8 50 it and telecommunic. 3 1 0 5,92 0,23 0,77 stoyan shalamanov 123 colleagues and as much as 50% to intensive communication with customers, the latter being one of the highest values among the industries. the services and transport sectors have similar vulnerability characteristics a moderate total number of quarters of decline in production and employment – five quarters each, not a small percentage of self-employed – between 20-30%, average lockdown index and home-office index – between 0.35 and 0.53 and between 0.18 and 0.40, respectively. the teamwork index and customer-facing index also have average values – between 5 and 12% and between 8 and 30%, respectively. for the services sector, these variations in the indicators are accounted for due to the heterogeneity of the sector. in general, both sectors can be classified as moderately vulnerable. this assessment is also valid for the trade sector. what is special about it is that there are relatively more quarters of decline in production and employment as many as seven. there is also a risk of automation and a relatively high percentage of self-employed 22.19. on the other hand, some types of trade are characterized by a low lockdown index (0.08) and a high homeoffice index (0.60). online trading is characterized by such signs, which has intensified especially since the beginning of the pandemic. there are also serious differences between wholesale and retail. for example, in wholesale the intensive communication with customers is rated at 12%, while in retail it is as high as 66%. the industry and construction sectors each also have seven quarters of decline in production and employment. the sectors are also characterized by a risk of automation. in the construction sector, there is a large percentage of self-employed (19.73), a high lockdown index (0.56) and a very poor opportunity to work from home. it can be concluded that all data point to a high vulnerability of the sector to the pandemic-related restrictions, but such vulnerability does not seem to be socially significant; it is probably compensated to some extent by the strong rise in prices and demand for housing since the beginning of 2021, as well as by the traditional workforce deficit in the sector. in the industry sector, the percentage of self-employed is the lowest after that in the it and telecommunications sector only 7.37%. heterogeneity in the sector determines the variations in the lockdown index (0.27-0.47) and home-office index (0.17-0.45), as within these limits no conclusion of particularly high vulnerability can be drawn. the indicators for the intensity of communication in a team and with customers are also not very high 7% and 5%, respectively. conclusion the analysis of the development of the pandemic in bulgaria from a medical point of view leads to the conclusion that the health factor for the crisis will not be overcome soon. the mutations of the virus and the fluctuating rates of vaccination in bulgaria are likely to put the country in need of periodic lockdowns (restrictions) of some economic sectors for at least a few more years. a typical situation for pandemics is for governments and society as a whole to face the dilemma of choosing between the health and well-being of the population. in order to mitigate the effects of restrictions on social contacts, mobility and part of the economic activity, the government of bulgaria has introduced fiscal stimulus measures amounting to about 6% of the gross domestic product. these measures mitigate the shock effect of the pandemic by limiting the loss of jobs, easing the financial conditions for the most affected companies and households, and strengthening healthcare. the measure 60/40 for employment support is specifically targeted at the effects of the crisis. the state pays 60% of the costs for salaries and social security of workers in enterprises with reduced activity. according to data of the national social security institute (nssi), from the beginning of the pandemic until august 2020 more than 170 thousand, and by january 2021 more than 265 thousand employees to nearly 12,000 employers, were included in it. most of the supported enterprises are in the manufacturing and hotels and restaurants business sectors. 124 economic analysis (22, vol. 55, no. 1, 105-127) it is particularly important to identify the most vulnerable to the pandemic sectors to provide more targeted and regular support, commensurate with the available relief budgets and antiinflationary policies. based on the net government debt for 2020 (difference between gross debt and fiscal reserve), the cost of the crisis for public finance can be assessed. from the beginning to the end of 2020, the net debt increased by over bgn 5.5 billion (chobanov & others, 2020). all these funds would be in vain, if they lead to an acceleration of the inflation (for now forecasts for 2021 are for an inflation of over 3%), without supporting the most affected and vulnerable sectors of the economy. in the present study, we have found that the most vulnerable sector in bulgaria is the hotel and restaurant business sector. the negative consequences in it are expected to persist in long term. this sector is traditionally characterized by a relatively high share of selfemployment and seasonality, as well the lowest average income in the economy, which is a consequence of the large-scale grey sector practices such as: formal conclusion of part-time and minimum wage employment contracts with workers. for these reasons, government support in this sector is difficult. the fact that under the 60/40 program the state pays 60% of the costs for salaries and social security of employees in enterprises with reduced activity will not help much in the hotel and restaurant business sector. at the same time, this sector is fundamental for employment and sustainable economic growth of bulgaria. in these hard times, it needs specifically targeted strengthening. air transport remains directly related to tourism and seriously affected. the possible range of specifically designed government supported measures for strengthening of sectors hotel and restaurant business and air transport can be explored in a further study. it is most certain that they can only be saved by gradually easing the international travel restrictions. the right step in this direction are vaccination passports (certificates), but in order to validate their use and for people to start returning to the pre-pandemic levels of mobility, more decisive action will be needed at european union level. it is necessary to adopt the same (unified) requirements for issuing certificates and rules for mobility between countries. in this way, certificate holders will be able to return to a more normal life and mobility. acknowledgements this paper is a result of a research project under the code 80-10-107/25.03.2021 (the bulgarian economy in the first year of the covid-19 pandemic – sectoral analyses and macroeconomic impact) financed by the sofia university „st. kliment ohridski“. references abbas, j., and others. 2021. exploring the impact of covid-19 on tourism: transformational potential and implications for a sustainable recovery of the travel and leisure industry, current research in behavioral sciences, 2. altig, d., and others. 2020. economic uncertainty before and during the covid-19 pandemic, journal of public economics, 191. bulletin for macroeconomic development, 2021, bulgarian development bank, https://bbr.bg/en/ (accessed september 10, 2021). chobanov, p., and others. 2020. the economics of 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journal 2, issn :0205-3292. stoyan shalamanov 127 appendix table. dynamics of employment in non-financial sectors and stringency index for bulgaria quarters q4 2019 q1 2020 q2 2020 q3 2020 q4 2020 q1 2021 industry 557697 553860 535856 535485 534606 544255 construction 128096 123772 125336 125272 124985 128443 trade 396317 389231 386459 385707 387187 383564 services 520018 509842 506954 509850 494949 510436 transport 138911 140073 136979 137076 136108 140387 hotel and restaurant business 102684 81864 88891 89664 76904 80355 it and telecommunications 93480 98821 97386 99031 99765 105917 stringency index 0 18,98 57,69 37,91 46,78 54,34 article history: received: november 2, 2021 revised: july 7, 2022 accepted: july 11, 2022 crowdfunding response to the covid-19 pandemic: evidence from kickstarter isidora ljumović10f* | aida hanić1 | slavica stevanović1 introduction literature review methods variables results discussion conclusion references state and perspectives of agricultural land acquisitions ana budak11f* introduction data and methodology data methodology the general trends and causes of agricultural land acquisitions the crucial causes of agricultural land acquisitions and their relation to the growing world population the dynamics of agricultural land acquisitions conclusion references just-in-time strategy implementation challenges and the organizational structure dimensions jelena erić nielsen1 | vesna stojanović aleksić1 | ana todorović spasenić16f* introduction literature review challenges of jit strategy implementation organizational structure as a factor of the successful implementation of the jit strategy research design and results methodology and sample discussion of research results theoretical/practical implications and further directions of research conclusion references effects of consumer ethnocentrism, cosmopolitanism and cultural intelligence on the acceptance of foreign brands stefan zdravković17f* | dragana gašević2 introduction literature review research methodology research results conclusion references stock markets integration between western europe and central and south-eastern europe: latest trends jelena minović18f* | irena janković2 | vlado kovačević3 introduction literature review methodology and data data multivariate garch model: the bekk model results and discussion acknowledgements references appendix an evaluation of the short-term skills trainings targeting the roma ethnic minority lara lebedinski110f* introduction literature review sample overview and descriptive statistics sample overview descriptive statistics impact analysis assessment of matching quality impact estimates conclusion acknowledgements references forecast of belex15 and belexline movement using arima model aleksandra živković121f* introduction literature review methodology belex15 and belexline – empirical data and forecast of index values by using arima model discussion of results conclusion references economic activity and employment in the non-financial sector of bulgaria under conditions of covid-19 crisis. sectoral vulnerability assessment stoyan shalamanov122f* introduction general health consequences in the world and in bulgaria for 2020 and early 2021. general economic consequences of the pandemic for the world and bulgaria dynamics in the non-financial sectors of different countries changes in economic activity and employment in bulgaria by main economic sectors. vulnerability assessment of non-financial sectors in bulgaria under pandemic conditions conclusion acknowledgements references microsoft word 2011_3_4_finalna ver.doc professional paper    general characteristics, role and importance of international  marketing information system  stanetić vedran*, institute of economics ad banja luka  bosnia and herzegovina   udc:  339.138   jel: m31; l22; f23  osnovne karakteristike, uloga i značaj međunarodnog  marketinga informacionih sistema abstract –  information  flow  from  the company  to  the market, and contrary also, enables  effective communication of the subject with the environment. formalizing and directing that kind of  flows emanates information systems. the task of such systems is constantly refreshing the content of  the information flow. this ensures that company`s decisions, which would be undertaken, are adequate  and in the right time. information systems find their application in almost all areas of business. maybe  the most  interesting of them are marketing  information systems. however, such systems are often  considered a substitute for marketing (market) research, or if there are undertook marketing (market)  research,  then  there  is no need  for marketing  information  system. this  paper  seeks  to prove  the  opposite, that these two concepts are not identical, and therefore not mutually exclusive but rather  complementary and compatible. since the operations of business entities are  increasingly becoming  regional  or  global,  that  makes  sense  to  talk  primarily  about  international  marketing  information  systems. local business levels should be regarded only as a fragment of the total portfolio of markets.  the  last statement  is valid especially  if  the domicile market  is not sufficiently  large  for profitable  production or if it is under‐developed    key  words:  information  systems,  market,  marketing,  information,  marketing  research,  international environment  characteristics of international marketing information system  definition of international marketing information system  it is not an easy task to give a comprehensive and complete definition of international  marketing information system (imis), which would be easily understood at the same time.  defining difficulties arise  from  the complexity of  the aforementioned system,  interwoven  elements  that  make  up  the  imis,  their  entanglement  and  complementarity  with  other  activities in the enterprise, as well as understanding the role and importance of the imis. in  order to understand properly the meaning of the imis it is recommended to start with the  etymological  analysis  of  the  imis  concept.  the  compound  ʺinternational  marketing  information  systemʺ  will  be  briefly  analyzed  word  by  word  ʺsystemʺ,  ʺinformational,ʺ                                                         * address: krfska 94, 78000 banja luka, republika srpska, bih; e‐mail: vedranstanetic@ekinst.org,  staneticv@yahoo.com     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   70 ʺmarketing,ʺ  while  the  adjective  ʺinternationalʺ  is  in  brief  content  analyzed  through  the  entire text.   it is important to understand correctly the meaning of the word ʺsystemʺ because it is the  basis  for  not  only  a  imis,  but  also  any  other  form  of  organization.  according  to  efraim  turban, ephraim mclean, and james wetherbe (1999, pg. 40, 41) a system is a collection of  elements,  such  as:  people,  resources,  concepts  and  procedures,  intended  to  perform  an  identifiable  function  or  serve  a  goal.  a  system  is  separate  from  its  environment  by  a  boundary.  the  system  is  inside  the  boundary,  whereas  the  environment  lies  outside.  in  short, the system is determined by elements, its tasks and purpose, as well as the limits that  can be very abstract. especially interesting are the systems that collect and process various  kind of information. information system (is) of enterprise is defined as a set of human and  technical means that, with a certain organization and methodology, perform the collection,  storage, processing and disseminating to the use of data and information (lazo roljić, 1997,  pg. 23). is can be represented graphically by the diagram as follows:    figure 1. schematic view of the information system    inputs    processing outputs  business  problems:  data  information  instructions  opportunities  programs  people  equipment  storage    solutions:  reports  graphics  calculations  voices  tactics                control     feedback decision makers  auto‐control                     source: turban, mclean, and wetherbe (1999, pg. 18)  in  the  previous  figure  is  shown  that  the  tasks  of  the  is  are  to  collect  and  process  information,  which  goal  is  to  create  information  reports  for  different  purposes.  the  information system is a system that is oriented to decision making information.  classification of is in companies can be done in various ways. is can be classified taking  into account four main aspects: the organizational level, functional area, provided support,  system architecture, etc. however, regardless of classification, the structure of is is the same  and  consists  of  the  previously  mentioned  elements.  for  this  paper,  the  most  interesting  classification of is is based on the division of functional areas in the companies. besides to  marketing is, there are also: accounting is, financial is, manufacturing is, human recourses  is and the like. also, for purpose of this paper it is important only formal is, as opposed to  informal whose study is more in the field of operating management, or sociology.  in order to understand properly the marketing information system, it is needed to start  with  the  concept  of  the  marketing  system.  the  essence  of  the  marketing  system  is  the     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   71 information flow between producers and consumers. the flow of these data is twofold. data  from consumers go  to  the manufacturer. the content of  this data  include: needs, desires,  preferences and problems, and it is defined as the purchasing power demand. on the other  hand, information circulate from the manufacturer to the consumers and the content of this  data is about its mission, goals and tasks, in other words information about marketing plan  and program  ‐ defined as an offer. the process of communication between company and  customers  is  needed  to  ensure  that  market  exchange  would  be  performed  without  complications and to mutual satisfaction. this means that the consumers will satisfy their  needs, meet  their desires, solve  their problems and remove  the  tension; and, at  the same  time, the company will make a profit with lasting affection by consumers. as could be seen,  the marketing system is very complex, and when it is added to the information system leads  to more complex systems.  to generate a continuous flow of appropriate information is an essential task of imis. the  environment of the company is subject of constant change. these changes are particularly  evident  in  the  international environment. imis goal  is  to create an optimal database as a  basis for effective marketing management. there are two basic tips to keep in mind when  observing the imis that are continuous flow of data collection and international environment  as inevitable element in a globalized business world.   the  main  task  of  imis  is  an  ”intelligenceʺ.  intelligence  refers  to  the  gathering  of  information from decision‐making system`s environment and exploring that information in  an  effort  to  recognize  the  existence  of  problems  (gilbert  a.  churchill,  1991,  pg.  28).  therefore, the tasks of the imis are to continually survey the widest surrounding, to collect  general data that is even few suspected that might be of importance for the system, further  processing of these data, then thoroughly explore, and try to determine whether these data  represent or suggest changes in the environment that could be a threat or an opportunity for  the reference system. when it is concluded on the basis of such ʺgeneral informationʺ and  using ʺinsightʺ that there are threats or chances in environment, such information is further  transferred to a higher level of decision making.   when it comes to comparison between marketing information system (mis ‐ referring to  the information system oriented toward the domestic market only) and imis, the conclusion  is  the  same  as  the  comparison  between  domestic  and  international  marketing  research.  looking evolution through time first have came mis. however, the issue of performance is  not a matter of chronology rather than rationality. the broad framework of observation, or  more  statistical  populations,  theoretically  creates  a  greater  chance  of  optimal  choice.  the  practical significance of imis, in a liberalized and the changing business world, is increasing.  the need for a systematic approach to information collection and dissemination in the field  of  international  marketing  is  conditioned  by  the  weaknesses  that  are  typical  for  most  companies. according to boris tihi (2003, pg. 320) those weaknesses can be summarized as  follows:  • there are many information, concerning various aspects of market problems, but  the lack of a system that would select and direct that information force decision‐ makers  to  take  unsystematic  “information  hunt”  in  making  any  specific  marketing decisions;     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   72 • above mentioned “hunting” takes place in the business environment and within  an  entity,  and  a  result  of  unsystematic  work  is  the  fact  that  many  valuable  information are losing within the organizational structure of a subject;  • what  makes  situation  more  difficult  is  that  a  lot  of  information  are  often  not  formally recorded, information are kept in minds of individuals who sometimes  jealously keep information for themselves believing that it could ‘’increase their  authority’’ in some situations;  • late arrived information at the decision making place are practically worthless;  • due to unsystematic data collection and use of different sources of information, it  is difficult to assess the degree of reliability, which is an essential precondition for  the quality of decisions.  the only applicable way to solve the mentioned to solve the mentioned problems is a  systematic approach. one of the possible systematic approaches to the problem mentioned is  by  imis. the emphasis  in  these systems must be on determining  the precise  information  needs  of  each  marketing  decision  makers.  this  ensures  that  they  have  exactly  the  information they need, when they need them, to make the decisions that they have to. it is  not  easy,  but  it  is  possible  knowing  what  characterize  quality  and  developed  imis.  for  indicators of the quality and development of information activities miodrag jovićević (2001,  pg. 161) takes the following:  • the  time  between  the  moment  of  emerging  and  the  moment  of  noticing  a  problem;  • sources of data and information – to be known in advance and to provide data  and information of current, future and historical character;  • quality of data and information – reliability, accuracy and authenticity;  • procedures and programs of data and information processing – to be known and  provided  in  advance,  that  we  know  what  the  relationships  and  the  degree  of  abstraction of the past and the future projection;  • knowledge – a  fundamental prerequisite  for solving problems and conducting  informational activities.  content of an international marketing information system  within  a  imis  comes  to  generating  information  necessary  for  strategic  and  tactical  decision‐making in an international environment. for a better insight into complex structure,  and for the completeness and clarity, content of imis will be shown as a picture. this ensures  a complete overview of the elements and relationships between elements of a imis.  on  the  next  figure  is  shown  the  content  and  structure  of  elements,  and  a  connection  between  them  in  imis.  the  system  consists  of  three  essential  parts:  the  information  component,  processing  of  collected  data  and  the  application  of  the  imis.  information  components are included in the imis in the form of internal, external and other data. based  on the data collected, it is necessary to apply the methods of sorting, processing, analysis and  synthesis.  the  resulting  information  are  input  in  the  subsystemʹs  tasks  of  imis.  what  is  important to emphasize and what is not shown in the previous figure, is a feedback. data  and  information  regarding  the  purpose  and  quality  of  the  imis  application,  or  decisions     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   73 made  on  the  basis  of  information  obtained  through  imis,  have  to  become  one  of  the  components of information or re‐entry to miss.    figure 2. international marketing information system    information  components    issues in the data  aggregation process  applying the  international  information system    external data              macroenvironmental  information      data      scaning the global  environment                comparability        infrastructure  data               allocating resources                         synthesizing and      market size and  structure                            data input               interpreting data    monitoring company  performance    internal data        updating and  maintaining        company sales and  market performance    system      transfer of ideas and  experience           source: samule c. craig, and susan p. douglas (2005, pg.423)     the functioning of the international marketing information system  for successful operation of a imis is necessary to exist three sub‐systems shown in the  second  figure.  in  the  following  text  will  be  briefly  analyzed  each  of  the  subsystems  and  connections between them.  information components – source of the required data is the basis of the work of any of  information system. all data sources, from the point of origin can be divided into external,  internal and other sources.  external data are: macroeconomic indicators, data on infrastructure, as well as data on  market  size.  data  about  macro‐economic  situation  in  individual  countries,  regions  or  globally, could be only the secondary. the most complete such information can be found in  the database of: un, world bank, oecd economic indicators, eurostat and the like, as well  as  on  the  websites  of  other  institutions  that  monitor  such  indicators.  data  on  market  infrastructure  can  also  be  geographically  structured,  for  example:  globally,  regionally,  nationally, and locally in the cities, depending on which the target market is. these are data  about  the  media  infrastructure,  for  example:  electronic  media,  print  media,  outdoor  advertising  media  (billboards,  posters,  etc.),  and  retail  infrastructure,  e.g.:  type  of  organization and structure of retail organizations and wholesale  legislation,  the nature of  competition  and  the  like.  data  about  company`s  products,  about  market  size  and  it`s  structure, as well as alternative and complementary products can be found in databases. it is     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   74 important that the product`s market would not be too narrowly defined. therefore there is  the need to collect and analyze data on complementary and substitute products.  internal data are contained within the company itself. these data are relating to: financial  indicators (for example roa, roe, etc.); market indicators (for example market share, sales  costs,  increased  sales  by  individual  product  lines  and  the  like);  data  about  employees  (example fluctuations, the emergence of new professions of interest to the company, etc.);  data obtained through the marketing research studies (for example research centralized or  organized for particular target markets and the like).   other  data  sources  can  be  divided  into  two  groups:  people  as  a  source  of  data  and  observation  of  physical  stimuli  as  another  data  source.  people  could  create  and  transfer  ideas,  experiences  and  knowledge  within  the  organization,  or  between  world  or  region  markets. they create and transmit information to each other. such communication occurs in  the  oral  and  written  form,  staff  meetings,  teleconferencing  and  so  on.  also,  this  communication can be separated to the internal, within the same enterprise, and external,  communication  with  sales  representatives,  managers  from  other  countries,  promotion  agencies, distributors and so on. a complete picture about same market could be obtained  only by visiting that market, observing it and talking with customers and business partners,  looking  at  shopping  habits  and  the  type  of  retail  outlets,  monitoring  advertisements  on  electronic and print media,  looking at weather conditions, geographical terrain, quality of  transport infrastructure and the like.   issues in the data aggregation process – imis could not function  ideally  just on the  basis of data collected. there are also some technical problems, for example: quality of data  collected, data entry, constantly update the content of the data collected and the like. the  quality of data collected depends on the possibility to make comparisons with data collected  in other countries. this problem is usually related to the existence of different data collection  procedures, as well as different accounting practices between countries and regions of the  world.  data  are  presented  in  units  of  measure  that  can  be  quantitative,  qualitative  and  monetary  indicators  (e.g.  goodwill).  quantitative  measures  generally  are  not  a  problem.  however, monetary measures are subject to strong and rapid changes due to: changes  in  exchange  rates,  price  fluctuation  on  stock  exchanges  or  other  markets,  changes  in  fiscal  policy of the observed countries, or due to changes in the ways of their calculation. entering  data procedures define the degree of similarity and type of data to be collected to be useful  for  the  system.  there  have  to  be  defined  by  whom  and  how  to  enter  data  within  the  enterprise,  in  order  to  make  collection  procedures  more  successful.  also,  it  have  to  be  defined  how  to  change  data  presentation  to  make  them  comparable.  this  is  particularly  important  for data coming  from external sources. data  issued by  the un or world bank  generally  do  not  have  mentioned  problems  because  those  data  usually  cover  the  entire  world, and their parameters are either global or highly standardized for certain regions or  countries. the problem is with a regional or national data. these problems are reflected in  different ways of: collecting, sampling, systematization, generalization of data and the like,  to  the  language  of  presentation.  it  is  necessary  to  ensure  that  the  system  continuously  collects new data and to processes them. the processed data are synthesized, in other words  those  processed  data  are  the  basis  for  drawing  conclusions.  new  information  should  be     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   75 compared with previous ones and, in the case of difference, investigate the difference and  inform management. the system should be constantly maintained and serviced.  application (tasks) of imis – by roche (as cited in craig and douglas, 2005, pg. 434),  imis  is used  in performing  the  following  four  tasks: scanning  the global environment  to  monitor trends and pinpoint those with specific implications for the geographical areas and  product markets  in which the company  is  involved, assessing how to reallocate resources  and efforts across different countries, products markets and target segments so as to achieve  desired rates of growth and profitability, monitoring performance in different countries and  product markets through  the world, and transferring  ideas and experience from different  countries and areas of the world throughout the organization.  feedback – even  if  it  is not shown  in the previous figure, the  importance of feedback  should be particularly emphasized. through the previous analysis of imis it is mentioned  the  importance  of  re‐entry  of  data  into  the  system.  the  information  flow  in  imis  is  continuous. this is a fundamental feature of the marketing information system that ensures  the  quality  of  marketing  decisions  (momčilo  milisavljević,  1999,  pg.  62).  based  on  the  information collected and create through the imis, the company affects its environment. the  environment  reaction  creates  a  new  situation.  new  data  from  changed  environment  represents a new entrance into the system. in that way a company gets a feeling about the  success of implemented decisions, and the effectiveness of an imis, which in turn should be  constantly creating new, more favorable business conditions for the company.  the process of international marketing research in the absence of an international  marketing information system  the  relationship  between  international  marketing  research  and  imis  has  to  be  understood  as  a  relationship  of  complementarity  rather  than  equality  or  competition.  although  they have  the same goals and similar  tasks, ways of achieving  these goals and  tasks  are  based  on  different  grounds.  this  reflects  theirs  complementarity.  international  marketing  research  project  usually  occurs  when  a  company  finds  the  problem  that  often  needs to be urgently solved. that leads to an emphasis on data collection and analysis rather  than on the development of the formal and regular collection of information. therefore, the  main  difference  between  the  research  project  and  the  system  is  in  time  and  speed  of  execution. the research project appears in times of crisis, so from time to time and as rarely  as possible. on the other hand, the data collection process is ongoing, or the keyword in the  definition  of  marketing  information  system  is  ʺregularʺ,  since  the  emphasis  in  marketing  information system  is  the establishment of systems  that produces  information needed  for  decision making on a recurring basis (churchill, 1991, pg. 24). however, the project must be  completed as soon as possible due to the fact that the duration of the crisis only exacerbates  the situation of the entity which drives the research project. the system of data collection,  since it is a continuous process, has enough time to conduct quality research and make the  necessary analysis.  another important difference relates to the scope of research. considering that the study  (project) of research is conducted in a relatively short period of time, it is very often that so  called preliminary (investigative or orientation) research is neglected. according to the tihi     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   76 (2003,  pg.  83)  preliminary  research  is  a  way  to  get  an  information  that  is  not  strictly  formalized, as is the case with detailed research based on the plan drawn up in advance, and  therefore this type of study is called investigative. the ultimate goal of investigative research  is obtaining the necessary prior knowledge of the specific problem in a rational manner. it is  a  preceding  surveys  and  it  is  based  only  on  secondary  data.  in  preliminary  studies  are  commonly used four methods shown in the following figures:    figure 3. the four methods of preliminary research        research of existing literature            studies of previous experience  preliminary research          analysis of selected cases            pilot studies          sources: tihi (2003, pg. 84)    the figure shows a structured review of methods of preliminary research. the first and  basic  method  of  search  is  to  use  available  literature:  books,  magazines,  newspapers,  databases  accessible  through  the  internet,  libraries,  statistical  publications,  regular  information services for marketing research and the like. also, the use of othersʹ experiences  much  simplifies  and  cheapens  investigation.  therefore,  it  is  necessary  to  collect  other  experiences: field vendors, consultants, engineers and specialists, consumers and customers,  competitors and so on. the third method is based on learning through case studies. it is a  realistic analysis of some past or current problems and opportunities facing a company. the  last  method  of  preliminary  research  is  a  pilot  studies.  these  are  informal  methods  of  communication with customers through which could be know the motives and opinions of  consumers. preliminary research is especially important to a large international marketing  research projects. many of the facts, opinions and attitudes, which are already well known in  the domestic market, we have to find out when we come to another market. therefore, the  phase of preliminary research is almost obligatory in these cases and requires the collection  and analysis of numerous and diverse data (tihi, 2003, pg. 397).  the  third  difference  between  the  market  research  in  general,  and  therefore  the  international marketing research and imis is contained in the following assertion: the task of  marketing  research  is  to  provide  information,  while  the  marketing  information  system  focuses on the routing of information flow  in the direction to those who make marketing  decisions.  this  distinction  is  important  because  the  information  is  completely  worthless  unless  it  is  relevant  and  is  effectively  communicated  (geoff  lancaster  and  lester  massingham, 1997, pg. 333). previous  thesis  is based on  the kotler`s model of marketing  information  system,  where  marketing  research  is  treated  as  a  subsystem  of  marketing  information system (philip kotler, 1999). in this system, marketing research is conducted on  behalf  of  marketing  information  system.  all  obtained  information  are  analyzed  and  compared  with  information  gathered  from  internal  sources  of  the  company,  as  well  as     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   77 scanning the environment. thus the final information has high value and reliability because  it has been checked and confirmed many times. from the prior discussion could be seen how  the international marketing research methodology would be quite poor and the less reliable  if it is not combined with imis. their combination is a superior way of gathering reliable  information.  this  is  a  sure  path  to  successful  decision‐making  and  management  in  international marketing.  compatibility of international marketing information system with international  marketing research  compatibility analysis  according to jovićević (2001, pg. 129)29 compatibility could be determined as a situation  in which two or more objects (procedures, methods, goals, programs, ideas, etc.) can coexist  within one, as a part of the same system, so that the existence of one does not preclude the  other. some studies have shown that managers do not know what information to request for  researchers  and  analysts.  they  know  only  what  is  available.  experience  from  local  and  international business practice show that many companies do not have established market  research systems or the systems are reduced only to routine predictions based on empirical  cognitions or to analyzing of historical data (hasan hanić and čivić beriz, 2009, pg. 43). this  problem could be overcome by efficient functioning of imis. it provides, among other things,  the survey of the international environment and general information in form of intelligence.  on  the  basis  of  such  general  information,  managers  can  identify  important  threats  and  opportunities  in the environment, and how it fits  into the strategy and other plans of the  company. thus they are able to know exactly what information they need, and such, in this  case, detailed  information should be required of analysts and researchers of  international  marketing.  such  detailed  information  could  be  provided  by  comprehensive  international  marketing research. above mentioned is most easily represented graphically as follows:    figure 4. relationship between marketing research and marketing information system                                      sources: tull, hawkins, 1987, (as cited in tihi, 2003, pg. 325)                                                           29 similar milan vujaklija. (2002).; grupa autora, (1994, pg. 638)   environment    internal data  external data     marketing  research      decisions                       requests      information     instruction      marketing  managers    periodic information  monitoring  information  requested  information    mis        feedback         economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   78 figure 4 shows the relationship between marketing information system and marketing  research,  as  well  as  their  relationship  with  marketing  managers  and  the  environment.  previous  paragraph  depicted  an  explanation  of  such  relations  in  the  international  environment.  a slightly different relationship between marketing information system and marketing  research  is  shown  in  the  third  kotler`s  model  (philip  kotler,  1999).  in  that  model,  a  marketing research system, as a subsystem of marketing information system, is integrated  into the whole system together with the other three subsystems. according to the mentioned  model,  a  system  of  marketing  research,  in  union  with  the  system  of  internal  reports,  marketing information system and system‐analytical marketing, is working on collecting and  converting  data  from  the  internal  and  external  environment  into  information  useful  in  making decisions.  according  to  that model,  international marketing  research  is  part  of  a  larger system – marketing information system. this is clear evidence that those two systems  do not overlap. if it is provided that they are integrated into a higher system and the system  is properly organized, than there is no overlapping goals and responsibilities in their mutual  existence, as well as excessive spending organizational resources.  all of these on the relationship between imis and international marketing research could  be circled by the following heinzelbercker`s (1977) statement (as cited in hasan hanić, 2003,  pg.  599):  in  the  last  two  or  three  decades  market  research  is  developed  in  three  complementary  directions  which  represent  paths  from  traditional  marketing  research  till  marketing information system. they are characterized by:  • orientation to the method,  • orientation to the decision‐making,  • orientation to the system.  it  is  expected  that  the  integration  gap  between  marketing  research  and  marketing  management will soon be eliminated thanks to the system orientation of marketing research.  affirmation of systematic approach in marketing has led that a trends in marketing research,  method and decision making oriented, connect with each other, simultaneously providing  the missing link ‐ organization of the whole range of marketing information in relation to the  needs of marketing managers for information. this attitude becomes clear by following bellʹs  (as cited in hanić, 2003) stating: although the market research continually modernize and  make it more relevant for management problems solving, because of the narrowness of its  functions it is, unfortunately, inadequate to fully satisfy the information needs of marketing  staff. due to concerns about implementation of marketing research techniques, researchers  were unable to resolve a number of information problems in a company. as marketing has  become more complex, there was a need to expand its functions in order to provide greater  quantity and higher quality of information. application of marketing approach has led to the  development of marketing information systems. systematic orientation in marketing has led,  therefore,  to  the  knowledge  that  traditional  market  research  should  be  seen  as  part  of  a  larger marketing  information system. according  to hanić  (2003, pg. 602) development of  marketing research toward marketing information systems enabled:  • marketing  research  orientation  to  the  needs  for  information  of  marketing  management.     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   79 • continuously collecting of external information – marketing information system  contributes to the elimination of the situation in which are the most continuously  collected only internal information, while the collection of external information is  made by ad‐hoc marketing research with a defined beginning and end, concerning  a particular project. marketing managers need a marketing  intelligence system,  which would be ʺtailoredʺ to suit their needs.  • to organize total it activities in the marketing – marketing information system  should be structured so that decision‐making processes is supported by organized  flow of relevant information from sources that are in the company and outside it.  based on the presented analysis, it can be said that international marketing research and  imis  not  only  compatible  but  also  complementary,  i.e.  they  complement  each  other  to  achieve the common goals at a higher level.  identified savings due to the compatibility  from  the  analysis  above  it  is  clear  that  by  combining  and  complementing  imis  and  international marketing research are generating a new quality, which in itself contributes to  the  efficiency  and  savings  for  business  enterprises.  effective,  i.e.  well  structured  and  rationally organized international marketing information system, according to hanić (2003,  pg. 598), provides multiple benefits:  • provide more information in the time unit.  • allows to achieve the same  level of satisfaction for  information needs at  lower  cost.  • helps to large and decentralized companies to integrate information scattered in  smaller organizational units into a meaningful whole.  • provide a basis for effective application of the marketing concept – contributes to  enlargement of the overall marketing productivity of companies.  • enables faster identification of trends in the marketing environment.  • it enriches the analysis.  • provides  optimal  decision‐making  –  developed  and  cultivated  marketing  information system contains a bank of models which help marketing managers in  making optimal decisions.  • provides better control of marketing plans and actions implementation.  • provides data protection.  to the previous list it could be added the removal of redundancy as one more benefit.  avoid redundancy means saving time and unnecessary costs in obtaining information. in the  case of international marketing research, the imis should be considered a benefit gained by  its existence and costs arising from its organization and operation. although there are some  general  indication  about  usefulness  of  the  existence  and  functioning  of  the  imis  and  international  marketing  research,  in  each  case  it  should  be  re‐checked  their  opportunity.  only in a case of their synergetic effect their combination justifies their purpose. therefore,  to determine  the exact savings  in  the coexistence of  international marketing research and  imis depend upon the situation, or a planned project.     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   80 conclusion  international  marketing  information  system  is  a  complex  system,  within  the  organizational  structure,  focused  on  information  flow  from  a  company  towards  the  environment and vice versa. imis should integrate, lead and organize all communications  between company and the environment. this communication should not be limited to data  and information on supply of enterprise and demand from customers, but it should include  all  forms  of  information  that  could  be  used  in  company  decision  making,  and  better  informing  consumers  before  the  act  of  buying.  in  that  case,  the  company`s  environment  should  be  widely  seen,  that  takes  information  from  all  or  most  of  the  world  market  by  various market segments, other industries, various centers of decision‐making and the like.  collecting and processing data and information, and submission of processed information in  decision‐making must be timely. this provides rationality in business decisions making. the  tasks  of  the  imis,  in  addition  to  the  above,  are  monitoring  of  business  performance  of  organizational units of enterprises in various markets, as well as the transmission of ideas  and  experiences  from  other  countries  and  regions  of  the  world  to  the  organization.  relationship  between  marketing  research  and  imis  are  characterized  by  mutual  complementarity  and  compatibility.  their  complementarity  is  reflected  in  the  fact  that  marketing research is detailed and targeted at solving specific problems. unlike marketing  research, which takes place periodically and with limited duration, the information flow in  the imis is permanent and without a defined time period. from the mutual complementarity  and compatibility between imis and international marketing research, derives cost savings  for a company that strives to constantly observe its environment, thoroughly research and  identify  potential  problems,  timely  decisions  making  and  monitor  the  results  of  those  decisions. timely response to identified and explored, existing and potential problems, that  the company meets, creates a greater benefit than the cost of implementation and operation  of a imis. on the other hand, the elimination of consequences of bad or overdue decisions of  the  company,  in  terms  where  do  not  exist  a  imis,  creates  more  costs  than  the  costs  of  implementation and operation of a imis. because of all this it could be concluded that the  imis should take a more important position in the organizational structure of companies that  are proactive and market‐oriented.  references   cateora,  philip  r.,  and  graham,  john  l.  (2007).  international marketing.  13th  edition,  mcgraw‐hill  irwing, new york  churchill, gilbert a. (1991). marketing research – metodological foundations. fifth edition, the dryden  press  craig, samule c., and douglas, susan p. (2005). international marketing research. john wiley & sons  ltd. england  galogaža, milan. (1998). principi marketinga, knjiga prva i druga. copyright by milan galogaža, novi  sad  grupa autora. (1994). ekonomska i poslovna enciklopedija. savremena administracija, beograd  hanić,  hasan.  (2003).  istraživanje  tržišta  i  marketing  informacioni  sistem.  ekonomski  fakultet  beograd, beograd     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   81 hanić, hasan and beriz, čivić. (2009). “specificities of online concept in comparision with a classic  concept of marketing research.“ economic analysis, vol. 42, no. 2009/1‐2s: 43‐52.  harvard business review. (1991). “marketing research – the right way”, harvard business review  paperback no. 90061  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vujaklija, milan. (2002). leksikon stranih reči i izraza. izdavačko preduzeće prosveta, beograd        apstrakt – protok informacija od kompanije prema tržištu, i obrnuto, omogućava efektivnu  komunikaciju  subjekata  sa  okuženjem.  formalizaciju  i  usmeravanje  informacija  omogućava  informacijoni  sistem. suština  funkionisanja  sistema  se odnosi na neprekidno osvežavanje  sadržaja  informacionog  toka,  što  pruža  mogućnost  preduzećima  za  pravovremeno  donošenje  odluka.  informacioni sistemi nalaze primenu u gotovo svim oblastima poslovanja. između ostalih,  jedan od  najinteresantnijih je marketinški informacioni sistem, koji se često smatra substitutom marketinškog  istraživanja (tržišta). njegova upotreba se često percipira nepotrebnom ukoliko se aktivno učestvuje u  istraživanju  tržišta.  cilj  rada  je  da  dokaže  suprotno,  tj.  da  ova  dva  koncepta  nisu  identična  i  međusobno  isključiva,  već  komplementarna  i  kompatibilna.  kako  poslovanje  sve  više  teži  regionalizaciji  i  globalizaciji,  aktuelnost  međunarodnih  informacionih  sistema  dobija  na  značaju.  poslovanje na lokalnom nivou treba posmatrati isključivo kao fragment ukupnog tržišnog portfolia,  naročito  ako  domaće  tržište  nema  potrebne  kapacitete  za  profitabilnu  proizvodnju  ili  ako  je  nerazvijeno.     ključne reči: informacioni sistemi, tržište, marketing, informacije, marketinško istraživanje,  međunarodno okruženje        article history:  received:  27 july 2011 accepted: 25 october 2011        microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp60-70 original scientific paper change in consumers’ behavior during the covid 19 pandemic as an opportunity to foster digital entrepreneurship in the republic of north macedonia tatjana petkovska mirchevska1 | natasha daniloska1 | diana boshkovska1 | vladimir petkovski1* 1 university of “ss. cyril and methodius”, institute of economics skopje, skopje, republic of north macedonia abstract the covid 19 pandemic has a huge impact in different aspects of people’s life and behaviour. it causes both health and economic problems worldwide by reducing companies’ economic activity, increasing unemployment and reducing consumption. also demand is depended on consumer’s behaviour, which undoubtedly underwent changes caused with covid -19 pandemic. consumers are responding to the crisis in different ways; some of them feel anxious, others are worried and buying in panic, mainly the necessary products and some of them remain indifferent or suspicious despite the government and health professionals’ recommendations. to this date, due to the short period from the beginning of covid 19 pandemic, a limited number of studies are available that focus on the consumer behaviour caused by the new virus. this paper attempts to notify changes of the consumer behaviour because of covid -19 pandemic in republic of north macedonia. being that the aim is more to get an overview, rather than explore in-depth this phenomenon, the survey method is used. primary data is collected with administration of specially designed questioner. the relationship between multiple answers is quantitatively analysed with cross tabulation of the obtained data. the findings could contribute in predicting future consumer behavior, which is significant for many businesses affected by the pandemic. while at the first blush covid 19 pandemics imposed negative impact from the changed consumer behavior, in the concluding remarks of this paper there are clear indications for some possibilities and new business opportunities in fostering digital entrepreneurship for the present and future. key words: consumer’s behaviour, digital entrepreneurship, covid-19 pandemic, republic of north macedonia jel classification: d12 introduction the covid 19 pandemic has caused not only a risk for the global human health, but also for the social and economic balance in each affected country. consequently, declining travel, forced closure at home, and social distancing have caused supply and demand shocks (muellbauer, 2020). * corresponding author, e-mail: vladimir@ek-inst.ukim.edu.mk tatjana petkovska mirchevska, natasha daniloska, diana boshkovska, vladimir petkovski 61 it is indisputable that covid 19 pandemic causes wide-range effect in changing people’s behavior in general, but also in their behavior as consumers. namely, as one of the greatest crisis for the humanity in the past 100 years, the pandemic with covid 19 induced changes in consumer behavior. with prolonged presence of the pandemic, many countries experience that traditional shopping behavior is significantly disrupted and transformed. in addition, it is evident that the uncertainty is high, many businesses are closed, and there is a real concern about possible global recession. with these concerns, consumers are focusing rather on essential goods than other discretionary categories and leisure products. at the same time, with lockdown measures in place around the world, there has been a surge in the use of online baying channels (capgemini, 2020). it has been noted that in a period of economic instability, consumers are demonstrating transformation in their buying behavior, though how much of transformation experienced during the crisis will sustain is a question (seema, tanjul, & neetu, 2020). the findings from a study on the impact of the current crisis generated by the covid 19 pandemic on consumer behavior, show that in the period since the launch of the covid-19 pandemic, consumers in the us, uk and germany mostly buy health and hygiene products, due to personal and family fears (oana, 2020). according to one research study, consumers adopt new habits and behaviours that many expect to continue in the long run. their priorities are focused on the demand for hygiene, cleaning and other basic products. in times of crisis, the basic needs, personal and family health, food safety, financial security and safety become top priorities. digital commerce is also boosting as consumers increasingly buy groceries and other products online, and this trend is projected to continue after the pandemic (accenture, 2020). in order to find out how and when consumers started showing behavioural changes, nielsen conducted shopper behaviour research that started in the beginning of the pandemic in china and extended to other countries that have also been affected. they found that consumers are going through six stages of behaviour based on their awareness of the spread of covid-19 in their environment: proactive health-minded buying (increased interest in the acquisition of products that maintain well-being or health), reactive health management (prioritization of products for infection containment), higher product purchases and increased store visits, preparation for quarantine living (increased online shopping, reduced store visits), limited living (possible price increase due to limited stocks), living at a new normal level (increased health awareness even when people return to their typical daily activities. this behaviour makes it possible to understand and anticipate consumer actions, which can help companies to manage supply chains. from the beginning of covid19 pandemic, companies are also trying to counteract the current situation with new sales and service solutions, in order to secure at least the minimum level of business by changing their business models (deloitte, 2020).the growing consumer demand for some products, together with social distancing and increased hygiene protocols, have put pressure on the traditional distribution networks, but in same time reliable and affordable broadband services have become crucial, since demand for online services and access to communication services has soared. governments and businesses have taken actions to ensure affordable access to quality broadband services, yet the crisis has deepened the digital divide between consumers who have access to the internet and digital literacy, and those who do not. this division is particularly evident between developed and developing countries, urban and rural areas, the rich and poor, and among the elderly and people with disabilities, for whom purchasing products online may not be an option. if not addressed, these issues will result in increased inequality (oecd, 2020). in the period of covid 19 pandemic, consumers are learning to improvise and learn new habits. across the globe, they have responded to the crisis and its associated disruption to normal consumer behaviours by trying different shopping behaviours. because of the pandemic, 62 economic analysis (2021, vol. 54, no. 1, 60-70) they cannot go to the store, so the store “comes to home”. while consumers go back to old habits, it is likely that they will be modified by new regulations and procedures in the way consumers shop and buy products and services. one of the key questions is whether this behaviour will be return to normal after the period of covid-19 pandemic. as consumers adapt to limited mobility over a longer period, they are likely to embrace new technologies that facilitate work, study, and consumption. adoption of digital technology is likely to change existing habits; also, the public policy will impose new consumer habits. the findings also open the possibility for further research of consumer behaviour across cultural diversity (jagdish, 2020). consumers are the drivers of market competitiveness, growth and economic integration. businesses are facing a significant shift in consumer priorities, along with the subsequent emergence of a new competitive landscape (one space, 2017). in times of crisis such as the covid-19 pandemic, companies will need to identify changes in the way of running their businesses and developing digital entrepreneurship. survey on the consumer behaviour during the covid-19 pandemic in the republic of north macedonia research design and methodology methodological approach for this paper is based upon quantitative methodology, using a research survey to collect information from a sample of individuals through their responses to question, supplemented by cross tabulations of data tables in order to examine relationships within the data. a survey of consumer behaviour was conducted in april 2020 after the announcement of the covid-19 pandemic in republic of north macedonia. the questionnaire is composed of 11 questions, divided in two groups. the first group of questions is about the demographic profile and the employment status of the respondents. the second group of questions in the survey is about consumer behaviour and the awareness of their changing behaviour influenced by the pandemic crisis. the questionnaire was distributed online through google forms platform, thereby reaching 427 respondents (random sample). in order to obtain information that were not readily apparent when analysing total survey responses, cross tabulation was applied to the survey data. this research method enabled to explore relationships between various aspects of changes in consumer behaviour that businesses can use to step up their digital transformation efforts, foster e-commerce and promote an effective and widespread transition of many digital platform activities as a step forward in development of digital entrepreneurship. cross tabulation was used in order to analyse the relation between the change of consumer behavior in covid-19 pandemic and respondents concern about the covid-19 pandemic, their expectations for the length of the covid-19 crisis, employee status and the monthly income their household. survey analysis in order to identify changes in consumer behaviour as an opportunity for fostering digital entrepreneurship in the republic of north macedonia, an online survey was conducted in april 2020, when the covid-19 pandemic started. the findings based on the analysis of data obtained by the survey are given below. as mentioned above, the first group of questions is about the demographic characteristics of the respondent such as employment status, the number of the members of the family and monthly income of the households. the data shows that half of the respondents are employed in the private sector, 30% are employed in the public sector and only 8% of them are unemployed. tatjana petkovska mirchevska, natasha daniloska, diana boshkovska, vladimir petkovski 63 at the same time, the larger percent of the respondents (25%) lives in the households with 3 members and 37% are families with four members. only 8% of them live alone as singles. monthly income for the largest part of the respondents (34%) is between 30.000,00 and 60.000,00 mkd. the second largest percent of the respondents or 26% of them have monthly income between 14.500,00 and 30.000,00 mkd. only 7% have less than 14.000,00 mkd, while nearly 14% of the respondents declared of having monthly income above 100.000,00 mkd. the second group of questions is related to the consumer behavior and the awareness about the changing behaviour influenced by the pandemic. analysis of respondents’ answers to the question: “how would you express your concern about the covid-19 pandemic”, shows that more than a half of the respondents (59%) are seriously worried about the covid-19 pandemic. in addition, only 3% are not worried and 38% consider themselves little worried (see figure 1). figure 1. how would you express your concern about the covid-19 pandemic? source: own research based on primary data collection in correlation with the question about the respondent’s opinion of the duration period of pandemic, most of the respondents (60%) are optimistic and believe that the duration of the pandemic will bethree months. despite the fact that this survey was conducted in april 2020 when the pandemic has started, it become obvious that most of the respondents were not aware about the severity of the crisis and the period of its completion. only a small percentage of respondents believe that the crisis will last more than 6 months (8%) (see figure 2). figure 2. when do you expect the covid-19 crisis in the republic of north macedonia to end? (starting from the moment you fill in this questionnaire)? source: own research based on primary data collection 38% 59% 3% little worried seriously worried not worried 20% 53% 19% 8% up to a month from one to three months from three to six months more than six months 64 economic analysis (2021, vol. 54, no. 1, 60-70) figure 3 presents the respondents’ answers to the question: “do you have the impression that the crisis due to the covid-19 pandemic is changing your consumer habits?” it can be seen that 80% of the respondents have the impression that covid-19 pandemic has influence on consumer habits and behavior. given that the research was conducted at the beginning of the pandemic, changes in consumer behaviour are observed immediately after the onset of the pandemic, which is a significant indicator of behavioural changes that will be observed over a long period. figure 3. do you have the impression that the crisis due to the covid-19 pandemic is changing your consumer habits? source: own research based on primary data collection the data presented in figure 4 refer to the ways on how this pandemic changed the consumer habits of the respondents. it can be seen that 56% of the respondents choose the option “buying stocks of products that otherwise you would not buy them in such quantities”. the changes in the consumer’s behavior presented in the other three different possible choices are almost equally divided. therefore, overbuying and creation of stocks are the most common changes in the consumers’ behavior in the period when the survey was conducted, which is almost an instinctive human behavior. what is especially interesting, as can also be noted in figure 4, that covid-19 pandemic caused 16% of the respondent to start online shopping, which gives clear indication that this change in consumer behavior can accelerate the process of digital transformation across almost all sectors. figure 4. how did the situation with the covid-19 pandemic change your consumer habits? source: own research based on primary data collection 78% 17% 5% yes no i don't know 56% 17% 16% 11% buying stocks of products that otherwise you would not buy them in such quantities buying products you would not bought normally shopping online and order by phone, not in-store tatjana petkovska mirchevska, natasha daniloska, diana boshkovska, vladimir petkovski 65 the analysis of the obtained data about the products that consumers most often buy during the pandemics presented in figure5 and figure 6. figure 5. choose up to 5 (five) categories of products and services that you usually buy during covid 19 pandemic? source: own research based on primary data collection the four main categories of products and services that consumers usually buy in the time of the pandemic are: food and soft drinks, personal hygiene products, home hygiene products and health and beauty products. alcoholic beverages and tobacco and pet products are on the fifth and sixth place on the buying preference list. the highest percent (97.60%) is about the option that consumers mostly buy food and soft drinks, and products for personal and home hygiene products (90% and 81, 40% resp.). such a distribution of responses was expected given that respondents are committed to respecting government measures to combat the spread of the virus and they refer to personal hygiene and household hygiene as one of the measures for protection against the pandemic. figure 6. choose up to 5 (five) categories of products and services that you won’t consider buying during the crisis with the covid-19 pandemic? source: own research based on primary data collection 0,00% 20,00% 40,00% 60,00% 80,00% 100,00% 97,60% 25,70% 2,40% 12,90% 2,40% 90,00% 81,40% 60,00% 2,00% 11,40% 8,60% 6,70%2,40% 0% 24,30% 0,00% 10,00% 20,00% 30,00% 40,00% 50,00% 60,00% 70,00% 80,00% 1,50% 22,10% 61,80% 18,60% 73,00% 2,00% 2,00% 10,30% 49,00% 7,80% 24,50% 31,90% 67,20% 77,00% 26,50% 66 economic analysis (2021, vol. 54, no. 1, 60-70) the quarantine period in the country, the closure of restaurants and other fast food services have increased the amount of food and soft drinks that respondents buy for domestic needs. restaurants and bars, travel, hotel services and transport are the least chosen options for purchasing among the respondents. this can also be seen from the figure6 where the same categories were chosen as having the least chance to be bought during the pandemic. cross tabulation analysis survey analysis presented above is in aggregate form and give a summary of the results, one question at a time. cross tabulation takes this analysis one-step further and enables to see how one or more questions correlate to each other. this qualitative analysis helps to reveal a relationship between the change of consumer behavior in covid-19 pandemic and respondents concern about the covid-19 pandemic, their expectations for the length of the covid-19 crisis, employee status and the monthly income their household. cross tabulation analysis of selected answers is provided below. the first cross tabulation is shown in table 1. it represents the perception of changed consumer habits among the respondents, regarding to their level of concern for the covid 19 pandemic. table 1. cross tabulation analysis of the question about the respondents concern with covid-19 pandemic, and question about how the situation with the covid-19 pandemic changed their consumer habits buying stocks of products that otherwise you would not buy them in such quantities buying products you would not bought normally shopping online and order by phone, not in-store buying in a store or market where otherwise i don't buy little worried 42% 33% 52% 14% seriously worried 58% 63% 48% 79% not worried 0% 3% 0% 7% source: own research based on primary data collection it shows that level of concern regarding the covid-19 pandemic has accelerated the process of digital transformation of consumers’ habits. namely, the group of respondents that are little worried and the group of respondents that are seriously worried have significantly changed their consumer behavior. as seen on table 1, respondents who are little worried about covid19 are mostly using online shopping method (52 %) and buying products and services to create stocks (42%). the respondents who are seriously worried about the crisis (79%) are buying products in stores or markets where they would not otherwise buy, while only 48% of them use online or other non-physical forms of purchasing products and services. the group of respondents who are “not worried” are not interested in shopping online. tatjana petkovska mirchevska, natasha daniloska, diana boshkovska, vladimir petkovski 67 table 2. cross tabulation analysis of the question about expected length of the covid-19 crisis in the republic of north macedonia, and the question about how did the situation with the covid-19 pandemic change their consumer habits? buying stocks of products that otherwise you would not buy them in such quantities buying products you would not bought normally shopping online and order by phone, not in-store buying in a store or market where otherwise i don't buy up to a month 42% 13% 19% 21% from one to three months 42% 62% 38% 29% from three to six months 8% 16% 29% 43% more than six months 8% 8% 14% 7% source: own research based on primary data collection data in table 2 show that respondents who think that the crisis will last up to one or three months, are more oriented towards buying stocks of products that they would not otherwise buy in those quantities, i.e. buying products that are not usually bought (42% and 62%, respectively). in contrast, respondents who think that the crisis will last more than three or six months are using online shopping (29% and 14%, respectively). given that the crisis is still ongoing, and its end cannot be predicted with certainty, it is expected that the need for online sales will increase even more, which implies opportunities to foster digital entrepreneurship. the following cross-tabulation analysis shows the change in consumer behaviour in relation to employment status during the analysis period (table 3). in terms of online sales, the data show that it is most preferred by employees in the private sector, butis not used at all by craftsmen and retirees. table 3. cross tabulation analysis of the question about the employee status and the question about how did the situation with the covid-19 pandemic change their consumer habits? buying stocks of products that otherwise you would not buy them in such quantities buying products you would not bought normally shopping online and order by phone, not instore buying in a store or market where otherwise i don't buy less than 14.500 mkd 33 % 7 % 14 % 7 % from 14.500 to 30.000 mkd 33% 23% 24% 43% from 30.000 to 60.000 mkd 8% 35% 33% 21% from 60.000 to 100.000 mkd 25% 20% 10% 7% more than 100.000 mkd 0% 15 % 19 % 21 % source: own research based on primary data collection in table 4, data presents that respondents with lower amount of income are more prone to buy stocks of products that they would not otherwise buy in those quantities. this behavior could be explained with psychological factors i.e. the people that have lower income in the observational period stock as much products as they can because they are afraid of the uncertainty of their income in the future. survey data suggests that online shopping helped respondents with lower income to overcome their worries about security. as seen on table 3, these groups of respondents’ prefer more online shopping in comparison to people with monthly income more than 60,000 mkd. 68 economic analysis (2021, vol. 54, no. 1, 60-70) the findings from the cross-tabulations provide various aspects of consumer behaviour changes that businesses can use to step up in their digital transformation efforts. namely, this analysis provides possibility to identify appropriate target groups for digital entrepreneurshipdevelopment. conclusion the covid-19pandemic has caused many social and economic changes on the global level. from its beginning, in order to prevent the spread of the pandemic, in almost all countries affected by covid-19, a number of protective measures are undertaken for physical and social distance among population. the measures have caused changes in individual behaviour, most of which are psychological in nature, such as: anxiety, fear, and uncertainty. thesealso affected consumers' shopping behavior. the republic of north macedonia is still heavily affected by the covid-19 pandemic. selfimposed social distancing to avoid contagion, together with the strict confinement measures implemented in the country, have put a large share of traditional retail and many other businesses virtually on hold, at least temporarily. namely, during self-isolation, most of the macedonian consumers create stocks of food and other essential. this changes are result of the current situation when people (i.e. consumers) are in the risk of infections, have a feeling of fear, nervous and panic, loss of control and insufficient security. public health demands forced many people to be most of the time at home, leading to more internet use, as a neutral and most suitable platform for development of digital entrepreneurship. the survey about the impact of the crisis on consumer behaviour is conducted in order to examine whether the external shock (covid-19 pandemic) can foster the adoption of digital entrepreneurship in the republic of north macedonia. in this paper, in addition to the descriptive analysis of the survey data, the cross-tabulation provides information on the possible identification of target consumer groups as well as the possibilities for the current and future wider application of digital tools in business. the main findings from the survey data indicate that most respondents (78%) are aware of the changes in their shopping behaviour. more than half (56%) have changed their behaviour habits by buying bigger stocks of products compared to the period before the pandemic. although pandemic has accelerated the process of digital transformation across almost all sectors, it is evident that macedonian consumers intend to continue shifting their spending to essentials, while cutting back on most discretionary categories. consumer sentiment varies greatly across their expectations for the length of the pandemic, employment status and the level of their monthly income. in terms of shopping behaviour changes, during the analysed period, 16% of the respondents from the survey have started shopping online and/or ordering by phone, but not in the store. this indicates that digital entrepreneurship, creation of digital businesses and the adoption of digital technologies by existing macedonian businesses may hold potential for helping many of them to survive the ongoing crisis. the comparison between the survey data and the previous studies on consumer behaviour in covid 19 pandemic (capgemini, 2020) shows that consumers in republic of north macedonia are also focusing rather on essential goods than other discretionary categories and leisure products. their priorities are focused on the basic needs, which increases the demand for hygiene, cleaning and other basic products. also, in comparing the survey results and the findings of the nielsen study about the level of consumer awareness of the spread of covid-19 pandemic, it can be observed that consumers in the republic of north macedonia are aware of the danger from pandemic and the changes of their behaviour. regarding on the stages of their tatjana petkovska mirchevska, natasha daniloska, diana boshkovska, vladimir petkovski 69 awareness on the spread of covid-19 in the environment, they also show a tendency for increased online shopping and reduced store visits in the pandemic period. the cross-tabulation of the level of concerns and the changing consumer habits in the covid 19 pandemic period shows that respondents which are more concerned for the current situation are also more oriented towards changing their habits. it is noticeable that in comparing the survey data and the findings from previous studies (jagdish, 2020) macedonian consumers are also buying larger quantities of products they have not previously bought mainly from outlets including e-commerce. this could be very useful for companies to understand and anticipate consumer activities, which can help in the development and fostering of digital entrepreneurship in the present and the future. the findings in this paper could be used to give the business leverage to overcome the crisis. general conclusions are rather encouraging and show that undoubtedly, during the pandemic period, in the republic of north macedonia changes occurred in terms of greater application of e-commerce and e-business. businesses and companies will need to understand how their customers react and seriously consider using digital tools to survive the current crisis. noted changes in consumer behaviour indicate the need for all stakeholders to undertake a series of activities and measures to mitigate the short-term challenges of the crisis and provide sustainable solutions for survival and business development in the republic of north macedonia, during and after the crisis. the government needs to support and to step up digital transformation efforts, foster e-commerce and promote the effective and widespread transition of many digital platform activities, as a step forward in the development of digital entrepreneurship. macedonian entrepreneurs must intensify the utilisation of novel digital technologies (particularly social, big data, mobile and cloud solutions) to improve their business operations, invent new business models, sharpen business intelligence, and engage with customers for the long-term, rather than just for the length of the crisis. given that this research was conducted at the very beginning of the covid 19 pandemic, opportunities to deepen the results should be sought in further research on consumer behaviour in the republic of north macedonia during the pandemic, with an emphasis on the tendency to change ways of supplying a wider application of electronic commerce. also, as a result of changing consumer behaviour, further research should focus on the companies and their wider application to e-commerce and the development of e-entrepreneurship. references acecenture. april 28, 2020. https://www.accenture.com/us-en/insights/consumer-goodsservices/coronavirus-consumer-behavior-research, (accessed march 15, 2020). duralia, oana. 2020. "тhe impact of the current crisis generated by the covid-19 pandemic on consumer behavior." sciendo studies in business and economics, 15(2): 85-99. capgemini. april 2020. https://www.capgemini.com/research/the-consumer-and-covid-19/, (accessed march 21, 2020). muellbauer, john. 11 april 2020. "the corona virus pandemic and us consumption", vox cepr policy portal, june, 15, 2020. http://the%20coronavirus%20pandemic%20and%20us%20consumption%20_%20vox, %20cepr%20policy%20portal.html. mehta, seema, tanjul saxena and neetu purohit. 2020. "the new consumer behaviour paradigm amid covid-19: permanent or transient?" journal of health management, 22(2):291-301. oecd. 2020. http://www.oecd.org/coronavirus/policy-responses/protecting-onlineconsumers-during-the-covid-19crisis-2ce7353c, (accessed may 22, 2020). one space. 23th of may 2017. https://www.slideshare.net/onespacecom/consumerism-in-themillennial-age-white-paper, (accessed may 15, 2020). 70 economic analysis (2021, vol. 54, no. 1, 60-70) sheth, jagdish. 2020. "impact of covid-19 on consumer behaviour: will the old habits return or die?" journal of business research, 117:280-283. article history: received: november 11, 2020 accepted: april 2, 2021 microsoft word 2011_3_4_finalna ver.doc original research paper    an empirical study on the international competitiveness   of chinese commercial banks1   hong chen*, school of wuhan university, china  yuan yuan, wuhan economy research institution of wuhan government  udc:  336.7(510)   jel: g21; n25    empirijska studija međunarodne konkurentnosti kineskih  komercijalnih banki      abstract – according to the chinese government’ commitments while entering  the wto,  now china has  cancelled many  restrictions  for  foreign banks  including  the  restriction of  foreign  exchange business, the geographic restriction of rmb business and the restriction of the establishment  form of foreign banks. foreign banks are now permitted to offer services to all chinese clients and to  set up the same city services points to make cross‐region business. it means that nowadays foreign  commercial banks and chinese commercial banks are standing at the same start line to compete with  each other.  the innovation of this paper is mainly reflected in the following three aspects. first, we made a  complete and systematic summary about the latest achievements on the competitiveness of commercial  banks,  including  the  foreign and domestic authoritative method of  the  evaluation of  international  competitiveness of commercial banks, in order to build a solid theoretical foundation for the empirical  analysis. the second is the multilevel empirical method. in addition to the innovation on the selected  indicators of the traditional factor analysis, we also made a cointegration analysis on the macro‐level  variables which further strengthened the content of the international competitiveness of commercial  banks. thirdly,  the data used  in  the  empirical analysis are  the  latest ones  released by  the official  website of the commercial banks, statistical agencies, regulatory bodies and related database by 2010,  in order to ensure the validity and the timeliness of the empirical results.    key words: chinese commercial banks, factor analysis, competitiveness   literature review  foreign  scholars’  study  on  national  competitiveness,  corporate  competitiveness  and  commercial  banks’  competitiveness  started  as  early  as  the  1970s.  the  international  competitiveness  theory  can  be  traced  back  to  some  of  the  classical  school  theory.  adam  smith’s (1776) absolute advantage theory said that a country export the goods which have an  absolute advantage by international trade in exchange for their necessary goods which have                                                         1 sponsored by chinese national social science funds:《08cjl013》  *  contact  address:  ems  of  wuhan  university,  luojiashan,  wuhan  city,  china.  430077,  e‐mail:  chanhans@126.com        hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   13 a  high  production  cost  and  international  competitiveness  is  reflected  through  the  international trade and the absolute cost advantage. ricardo (1817) proposed the theory of  comparative advantage. heckscher ohlin’s (1919, 1933) factor endowment theory proposed  that the differences in comparative advantage between countries is based on differences of  resource  conditions  and  differences  of  production  inputs,  and  the  international  competitiveness  comes  from  a  country’s  resources  which  are  relatively  rich.  then  some  scholars  tried  to  explain  the  sources  of  international  competitiveness  from  other  perspectives. for example，schultz (1961) emphasis the role of human capital played in the  international competitive advantage and posner (1961) said that science and technology are  the main source of international competitiveness. these theories are mainly used to explain  the practices in international trade.  the  achievements  of  research  on  corporate  competitiveness  are  rich  as  well.  harvard  university  professor  spence  (1998)  proposed  that  the  corporate  international  competitiveness  is a enterprise’s ability  to  trade  in  the  international market. trade  flows,  r&d management, industrial policy, domestic economic policy, monopolistic competition all  have a  profound  effect on  the corporate competitiveness. feurer and chaharbaghi  (1999)  thought that the corporate international competitiveness is a relative concept which can be  reflected  by  the  products  and  services  of  enterprise,  the  ability  of  enterprises  and  the  development potential of enterprise. they established the three‐dimensional competitiveness  model  and  the  corresponding  qualitative  evaluation  matrix  which  are  constituted  by  customer value, shareholders, corporate human resources, technical potential and financial  strength.  m.  oral  (2001)  defined  the  corporate  competitiveness  from  the  dynamic  perspective:  he  believed  that  the  corporate  competitiveness  is  ary  result  of  the  internal  decision‐making process, and he emphasized the impact of competitive environment so his  study  combined  enterpriseʹs  internal  conditions  and  external  environment  to  analyze  the  corporate competitiveness. he pointed out that the corporate competitiveness is a function of  industry advantage, cost advantage and strategic advantage. lall (1999) said that the most  effective  way  to  enhance  the  international  competitiveness  of  enterprises  in  developed  countries  is  technological  innovation.the  researches  on  international  competitiveness  of  commercial banks are also very rich. emesto and federico (2000) proved that competition  can increase commercial banks’ ability to defend against risks and crises for the banks can  improve  their  viability  and  development  potential  more  quickly  and  targeted.  rajdeep  sengupta (2007) said that the international competitiveness of foreign banks primarily comes  from its selection of high‐quality customers. bang nam jeon (2010) made his study on asia  and latin america banking market and it is proved that the entry of foreign banks into local  market  that  is  conducive  to  the  improvement  of  the  competitiveness  of  local  banking  industry  for  the  resources  will  be  more  optimally  allocated.  tomas  jt  balino  and  angel  ubide  (2009)  analyzed  the  post‐crisis  banking  industry  and  they  found  that  the  major  challenges facing the banking  industry are the trade‐off between risk and benefit and the  expansion  of  business.  emesto  sehargrodsky  (2000)  considered  from  the  perspective  of  banking  supervision  that  the  raise  of  the  regulatory  requirements  is  not  good  for  the  differential operation of banks but the dynamic of competition will be increased. biker ja  (2000) proposed that through mergers and acquisitions, commercial banks can get easier to  form the economy of scale therefore enhance their international competitiveness.     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   14 empirical research on the international competitiveness of chinese commercial  banks  after years’ development in the market economy, chinese banking industry turns from a  state‐owned  monopoly  industry  into  a  competitive  industry  which  is  composed  of  state‐ owned  commercial  banks,  large  stock‐joined  commercial  banks,  regional  stock‐joined  commercial banks( city commercial banks) and foreign commercial banks. although the four  kinds  of  banks  are  different  in  scale,  target  client  and  main  business,  the  competition  of  market  shares  among  banks  is  becoming  increasingly  fierce.  the  four  major  state‐owned  banks are china’s earliest commercial banks, including industrial and commercial bank of  china  (icbc),  agricultural  bank  of  china  (abc),  bank  of  china  (boc)  and  china  construction bank (ccb). at the beginning of reform and opening, each bank had its own  specialization of business: industrial and commercial bank of china was responsible for the  industrial  and  commercial  credit  and  individual  saving;  agricultural  bank  of  china  specialized in rural finance; bank of china was in charge of foreign exchange business and  the management of country’s exchange reserves; china construction bank’s main business  was  long  term  credit  for  infrastructure  construction.  with  the  continuous  deepening  of  financial  reform，four  major  banks  are  gradually  turning  in  to  full‐service  banks.  in  addition,  as  china’s  first  national  joint‐stock  commercial  bank,  the  growing  bank  of  communication is integrated into the category of large state‐owned commercial banks.   the selection of indicators used in the evaluation system   based on the principles of comprehensiveness, operability and multilevel, the indicators  we use to construct the evaluation system of international competitiveness are mostly the  financial  index that banks released. the framework that jiao pujin proposed  in his book  study on international competitiveness of china’s banking industry has some reference value to  the  construction  of  our  evaluation  system.  considering  the  principles  and  the  data’s  accessibility, we have chosen the following indicators to construct the evaluation system of  commercial banks’ international competitiveness. our evaluation system excludes the impact  of  institutional  factors  on  commercial  banks’  international  competitiveness.  in  fact,  in  developing  countries,  impact  of  institutional  factors  is  significant.  however  in  order  to  comply with  the quantitative principle and  the operational principle, we  temporarily put  aside institutional factors.      table 1. index system of evaluation    1st level index  2nd level index  3rd level index  code  unit  actual  competitiveness  security index  asset scale  x1  10 billion yuan  capital scale  x2  10 billion yuan  capital ‐asset ratio  x3  %  capital adequacy ratio  x4  %  non‐performing loan  ratio  x5  %       hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   15 1st level index  2nd level index  3rd level index  code  unit  liquidity index  loan‐to‐deposit ratio  x6  %  excess reserves ratio  x7  %  liquidity ratio  x8  %  profitability  index  return on assets (roa)  x9  %  return on equity (roe)  x10  %  profits per capita  x11  10000 yuan  net profit growth rate  x12  %  efficiency index  operating expense ratio  x13  %  cost‐to‐income ratio  x14  %  deposit growth rate  x15  %  loan growth rate  x16  %  potential  competitiveness  human capital  proportion of staff highly  educated  x17  %  technological  progress  proportion of r&d  expenditure  x18  %  financial  innovation  proportion of non‐interest  income  x19  %  globalization  level  number of oversea  branches  x20  office  principle of factor analysis  model of factor analysis   factor  analysis  is originally used  to process  the  issues about  the  correlation of  multi‐ dimensional  random  variables  under  the  linear  transformation.  by  calculating  the  eigenvalues or eigenvectors of  the correlation coefficient  matrix, variables are aggregated  into  factors which contain main original  information  and are mutually  independent. the  model is as below:  suppose there are n samples, each sample has p observations denoted as x1，x2，…，xp.  1 11 1 12 2 1 1 2 21 1 22 2 2 2 1 1 2 2 m m m m p p p pm m p x a f a f a f x a f a f a f x a f a f a f ε ε ε = + + +⎧ ⎪ = + + +⎪ ⎨ ⎪ ⎪ = + + +⎩ k k m k + + +   in matrix it is like:  1 11 1 11 2 21 2 22 1 m m p p pm pm x a a f x a a f x x a a f ε ε ε ⎛ ⎞ ⎛ ⎞ ⎛ ⎞⎛ ⎞ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟⎜ ⎟= = × + ⎜ ⎟ ⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟⎜ ⎟⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎝ ⎠⎝ ⎠ ⎝ ⎠ ⎝ ⎠ k m m m mm      economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   16 in the model, all variables consist of two parts: one is the few factors shared by all the  variables, namely f1，f2，…，fm（m<p）, called common factors, which can be seen as m  mutually perpendicular axis in multi‐dimensional space; another part is the specific factors  iε   that  variables  respectively  have,  called  unique  factors  which  represent  the  parts  of  original  variables  that  can  not  be  explained  by  common  factors.  ij a   is  called  the  factor  loading, it is load of the i‐th variable in the j‐th common factor, namely the weight, which  reflects the relative importance of the i‐th variable to the j‐th factor. matrix a is called factor  loading matrix.  in  addition,  variables  need  to  satisfy  the  following  conditions:  i)  fi  and  fj  are  not  independent, and their variance both equal 1; ii) f and  ε  not related; iii)  iε  and j ε  are not  relevant and their variance are different too.  operation steps of factor analysis  common factor analysis steps are as follows:  (1) standardize original data processing to eliminate dimension impact  the  ultimate  goal  of  factor  analysis  is  to  integrate  a  small  number  of  representative  factors from a number of original variables in, so the precondition of using this method is  that original variables need  to have strong correlations. however, different  indicators are  often different in their economic significance and their representing form. in order to make  these  indicators comparable,  they must be standardized.  standardization,  that  is,  th non‐ dimensional  treatment  of  evaluation  index.  through  some  mathematical  transformation  method, we transform indictors with different natures and dimensions into relative value or  quantitative value, and their directions keep consistent. currently, the most commonly used  approach is z‐sore law.  the transformation formula is:   ' /ij ij j jx x x s= − ,  in which   1 / n j ij i x x n = = ∑ ,  ( ) 2 2 1 / 1 n j ij j i s x x n = = − −∑ , (i=1,2,…,n ,j=1,2,…,p)  after standardization, the variable  'ijx  satisfies that  ( ') 0ije x = ,  ( ') 1ijvar x = .  (2) calculate the correlation coefficient matrix r of sample  11 12 1 21 22 2 1 2 p p n n np r r r r r r r r r r ⎛ ⎞ ⎜ ⎟ ⎜ ⎟= ⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎝ ⎠ l l l l l l l   the correlation coefficient  ijr  is calculated by:  1 1 n ij ai aj a r x x n = = ∑        hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   17 (3) calculate the eigenvalues and eigenvectors of the correlation coefficient matrix r  eigenvalue  is  the  sum  of  squares  of  factor  loadings  in  a  certain  common  factor,  also  known as characteristic root. in the process of extraction of common factors, common factors  with  the  largest eigenvalue will be  first extracted, and common  factors with  the smallest  eigenvalues  are  the  last  ones.  the  purpose  of  factor  analysis  is  to  simplify  the  factor  dimensions, hoping to be able to make the largest amount of total variance explained by the  smallest number of common factors. therefore the less the extracted factors are the better,  and the more information that the extracted factors can explain the better.   suppose  the  eigenvalue  and  eigenvector  of  r  are  1 2 0pλ λ λ≥ ≥ ≥ >l   and  u1，u2，…，up..according  to  the  requirement  that  the  cumulative  contribution  of  factors  shall be more  than 85%  ,  take  the  first m eigenvalues and corresponding eigenvectors  to  build the factor loading matrix:  11 1 111 1 21 2 21 1 2 1 1 1 m mm m m m p pm p pm m u ua a a a u u a a a u u λ λ λ λ λ λ ⎛ ⎞⎛ ⎞ ⎜ ⎟⎜ ⎟ ⎜ ⎟⎜ ⎟= = ⎜ ⎟⎜ ⎟ ⎜ ⎟⎜ ⎟⎜ ⎟ ⎜ ⎟⎝ ⎠ ⎝ ⎠ k k m m m m   (4) calculate the cumulative contribution of m factors  the ability of each common factor to explain the original data can be measured by the  total variance it explains, that is the proportion of variance it explains to the total variance of  all  variables,  often  referred  to  as  contribution  of  factor.  according  to  the  standard  that  ( )k∂ > 85% we can determine the value of k.  1 1 ( ) ( ) / ( ) pk m m m m k λ λ = = ∂ = ∑ ∑   (5) calculate the comprehensive score  the common factors expressed as the linear combination of the original variables is like:  1 ' p mi m ij j f u x = = ⋅∑ , i=1,2�…�n� m=1,2�…�p.  take the contribution of each common factor as weight, the weighted sum is the  comprehensive evaluation score:  1 p i m mi m f fβ = = ⋅∑ , in which  1 / p m m m m β λ λ = = ∑ .  data sources  based  on  the  comparability  and  availability  of  data,  the  research  objects  of  empirical  analysis  we  chose  are  four  large  state‐owned  banks  (industrial  and  commercial  bank  of  china,  bank  of  china,  agricultural  bank  of  china  and  china  construction  bank),  ten  national  joint‐stock  commercial  banks  (bank  of  communication,  china  merchants  bank,  citic bank, shanghai pudong development bank, china minsheng bank, fujian industrial     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   18 bank, china everbright bank, huaxia bank, shenzhen development bank and guangdong  development  bank)  and  three  foreign  banks  with  relatively  larger  market  shares  in  the  chinese banking market (hsbc, standard chartered bank and bank of east asia).  because some of these banks above have not yet released their 2010 annual report, most  of the  indicators selected  in this paper are based on banks’ 2009 annual report. values of  specific indicators see appendix 1..  in the index system, for operating expense ratio (x13) and r & d expenditure (x18) are not  available, they are temporarily removed from the factor analysis. in addition, based on the  general level of education is higher in foreign banks than in state‐owned banks, as to foreign  banks’ utilization of  human resources, we assign  the highest value of  the  index value of  chinese commercial banks.  empirical results  extract the eigenvalue and the eigenvector  the data in the next table shows, the five largest eigenvalues are 40.187,19.927, 12.721,  9.456 and 7.236 respectively. their cumulative contribution rate is close to 90%, so that the  first five factors sufficiently have contained nearly all the information and they are sufficient  to reflect the international competitiveness of commercial banks.    table 2. total variance explained    component  initial eigenvalues  total  % of variance  cumulative %  1  7.234  40.187  40.187  2  3.587  19.927  60.114  3  2.290  12.721  72.835  4  1.702  9.456  82.291  5  1.303  7.236  89.528  6  0.927  5.153  94.680  7  0.411  2.281  96.961  8  0.296  1.642  98.603  9  0.146  0.812  99.414  10  0.074  0.414  99.828  11  0.031  0.172  100.000  12  0.000  0.000  100.000  13  0.000  0.000  100.000  14  0.000  0.000  100.000  15  0.000  0.000  100.000  16  0.000  0.000  100.000  17  0.000  0.000  100.000  18  0.000  0.000  100.000         hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   19        obtain the factor loading matrix and name the common factors  in  order  to  clarify  the  specific  meaning  of  each  common  factor,  we  used  maximum  variance orthogonal rotation method to rotate the factor loading matrix and the matrix after  rotation is shown in table 3.    table 3. rotated component matrix      component  1  2  3  4  5  x2  0.977  ‐0.157  ‐0.070  0.028  0.021  x11  0.949  ‐0.188  ‐0.138  0.105  ‐0.005  x20  0.921  ‐0.039  0.148  ‐0.129  ‐0.022  x1  0.921  ‐0.336  ‐0.090  0.026  0.028  x19  0.791  0.050  0.177  0.121  0.117  x4  0.719  ‐0.088  0.104  0.187  ‐0.527  x6  ‐0.641  0.640  0.324  0.056  ‐0.132  x3  0.466  0.815  0.031  ‐0.160  0.082  x7  0.442  ‐0.778  0.116  0.076  ‐0.322  x17  ‐0.406  0.754  0.284  ‐0.006  0.055  x5  0.199  ‐0.686  ‐0.173  ‐0.535  0.366  x16  0.188  0.220  0.909  0.115  ‐0.027  x12  ‐0.086  0.082  ‐0.804  0.505  0.056  x15  ‐0.420  0.193  0.717  0.282  0.322  x10  ‐0.039  ‐0.142  ‐0.138  0.847  ‐0.043  x9  0.616  0.158  0.206  0.718  ‐0.056  x14  ‐0.529  ‐0.019  ‐0.362  ‐0.555  0.241  x8  0.119  0.065  0.079  ‐0.087  0.959    from  table  3,  18  variables  are  compressed  into  five  separate  comprehensive  factors  through mathematical treatment. from factor f1 to f5, the amount of information contained  in each factor is descending in order.  the  coefficients  of  the  first  factor  f1  on  x1、x2、x4、x6、x11、x19、x20  are  0.921,0.977,0.719, ‐0.641,0.949,0.791 and 0.921, greater than the index’ weight on other factors,  including seven indicators: total assets, total capital, capital adequacy ratio, loan‐to‐deposit  ratio,  profit  per  capita,  non‐interest  income  and  the  number  of  overseas  branches.  total  assets,  total capital, capital adequacy ratio, oversea branches reflect banks’ scale strength.  and loan to deposit ratio, per capita profit, non‐interest income can be seen as banks’ ability  to  innovate. so  factor  f1 can be summarized as  the  banks scale strength and  innovation  capacity.  the coefficients of the second factor f2  on x3、x5、x7、x17  are 0.815,  ‐0.686,  ‐0.778 and  0.754,  greater  than  the  index’  weight  on  other  factors,  including  capital‐asset  ratio,  non‐ performing  loan  ratio,  excess  reserve  ratio  and  the  proportion  of  staff  highly  educated.  capital‐asset ratio, non‐performing loan ratio and excess reserve ratio are closely related to  security of commercial banks’ assets, while the proportion of staff highly educated can also     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   20 be seen as security of banks’ human capital. generally employees with higher educational  levels  are  less  possible  to  cause  the  operational  risks.  therefore,  the  factor  f2  is  a  measurement of banks’ risk management capability.  the  coefficient  of  the  third  factor  f3  on  x12、x15、x16  are  higher  than  on  the  three  indicators’  weights  on  other  factors,  so  this  factor  contains  the  information  of  net  profit  growth rate, deposit growth rate and loan growth rate. these three indicators can measure  commercial banks’ ability  in  its main  business. thus  the  factor f3 can  be  summed up as  commercial banks’ marketing capacity.  the  fourth  factor  f4  is  mainly  determined  by  x9、x10、x14  three  indicators:  return  on  assets, return on equity and cost‐income ratio, reflecting the banks efficiency  in using the  invested assets, which can be seen as banks profitability.  the information of the fifth factor f5 comes from x8, the  liquidity ratio. therefore, the  factor f5 measured bankʹs assets liquidity.  calculate banks’ score on each factor  according to the score coefficient of each factor on indicators, in each factor combined  with the standardized indicators’ value, we can calculate banks’ ranking position on various  factors.  calculate banks’ comprehensive score  according to banks’ scores in individual factor, take variance contribution rate of each  factor  (see  table  2)  as  weight,  the  formula  of  banks’  international  competitiveness  comprehensive evaluation score is as follows:  54 321 f36.27f56.49 f21.712f27.919f87.140 onscoreonscore onscoreonscoreonscorescoreivecomprehens ×+×+ ×+×+×=   the banks’ comprehensive scores and ranking see table 10.    table 4. banks’ score on each factor      f1  f2  f3  f4  f5  icbc  2.16162  ‐0.60621  ‐0.41259  0.81079  ‐0.80804  abc  0.45313  ‐0.48859  ‐2.33405  ‐0.41703  0.0145  boc  1.97887  0.82165  0.52487  ‐1.63455  0.71855  ccb  1.70885  ‐0.20116  ‐0.08205  1.15658  0.88894  bocom  0.04498  0.44298  ‐0.30695  0.31603  ‐1.40349  cmb  ‐0.11358  0.66874  0.5608  ‐0.03142  ‐0.42051  citic  ‐0.45848  1.15433  0.79548  ‐0.71757  1.49124  spdb  ‐0.75724  0.64966  ‐0.30012  ‐0.04561  1.02911  cmsb  ‐0.18216  0.93827  0.71587  0.90252  ‐0.82409  fib  ‐0.54211  1.68534  0.09486  ‐0.05637  ‐1.24795  ceb  ‐0.63033  0.53065  ‐0.39989  ‐0.80709  ‐0.66258  hxb  ‐1.06538  ‐0.87525  ‐1.20116  0.49552  ‐0.47629       hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   21     f1  f2  f3  f4  f5  gdb  ‐0.8757  ‐0.45849  ‐1.28072  0.28015  1.91349  sdb  ‐0.69823  0.31548  0.1737  1.3403  0.22656  hsbc  ‐0.33254  ‐1.3935  0.44346  ‐2.42974  ‐0.32569  scb  ‐0.45506  ‐1.90151  1.02919  ‐0.17183  ‐1.02721  bea  ‐0.23663  ‐1.2824  1.97932  1.00932  0.91348    table 5. banks’ comprehensive score and ranking      f1  f2  f3  f4  f5  comprehensive  score  ranking  icbc  1  13  14  5  13  0.713601   3  abc  4  12  17  13  8  ‐0.250564   12  boc  2  4  6  16  6  0.923191   1  ccb  3  10  10  2  5  0.809907   2  bocom  5  8  12  7  17  0.097184   7  cmb  6  5  5  9  10  0.125554   6  citic  10  2  3  14  2  0.187029   5  spdb  15  6  11  10  3  ‐0.142876   11  cmsb  7  3  4  4  14  0.230535   4  fib  12  1  9  11  16  0.034407   9  ceb  13  7  13  15  12  ‐0.322704   13  hxb  17  14  15  6  11  ‐0.742971   17  gdb  16  11  16  8  1  ‐0.441245   14  sdb  14  9  8  1  7  ‐0.052507   10  hsbc  9  16  7  17  9  ‐0.608225   16  scb  10  17  2  12  15  ‐0.521445   15  bea  8  15  1  3  4  0.062697   8  analysis on empirical results  a) analysis on scale strength and innovation capacity  the scale of commercial bank could influence not only its operational costs but also its  development  spaces  and  development  potential.  commercial  bank  always  takes  much  account of assets and accumulation of capital. because of this precondition bank could keep  on sustainable development. for scale strength 4 major state‐owned bank are the leaders. it  is  inseparable  with  history  evolution  and  national  policy.  although  bank’s  management  benefit doesn’t have an absolute relationship with  its scale strength, powerful assets size  could provide good conditions for sustainable development undoubtedly.  factor  f1  contains  innovation  capacity  which  is  embodied  by  profit  per  capita,  non‐ interest income and other indicators. it is remarkable that 3 foreign bank exceed many other     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   22 joint‐stock commercial banks on  this  factor. a reasonable explanation  is although  foreign  bank  is  smaller  than  state‐owned  banks  in  scale  strength,  the  long‐term  experience  of  operation in developed marketing make foreign bank focusing on innovations in finance and  operational efficiency. at present most banks in developed countries provide self‐service by  using video terminal internet and phone. unmanned operations in hsbc exceed 60% of its  total operations. thus many high‐end clients are interest in foreign banks.  b) analysis on risk management ability  risk management ability is an ability of avoiding various kinds of manage risk to ensure  the safety of capital. the operational status of commercial banks is decided by the quality of  credit to a great degree. only if the debtor have ability and are willing to repay capital with  interest on schedule and then benefits of depositor & creditor and bank shareholder could be  guaranteed. thus to prevent non‐performing loans banks should provision some capital as  value‐cash and central bank deposit to fulfill demand of withdrawal. npl ratio and excess  reserve ratio embody risk management ability of commercial banks from two points of view.  the better the capital‐asset ratio is, the better the ability of replying liquidity shortage using  owned capital is, that is the expression of elevation of risk management ability.  for risk management equity commercial banks are better than state‐owned banks. it is  related  to  institutional employment mode. besides unknown rights and responsibility  the  lack of professional skill result in the big value of npl ratio. in the end of 2001 npl ratio of 4  major banks is 25.37%. now it is not exceed 10%. but it is still worse than banks in western  developed countries. in raw data npl ratio in 3 foreign banks is lower than it in nationalized  banks. it explains that foreign banks are focusing not only at business in chinese market but  also at the security and liquidity of assets. however excess reserve ratio in foreign capital  banks is always lower it makes them scoring lower in this factor.  factor  f5  is  representative  factors  of  liquidity  ratios.  it  embody  in  risk  management  ability  to  a  certain  degree.  lack  of  short‐term  liquidity  is  an  ordinary  event  to  other  enterprise but  to commercial bank  it  is  really  a  big  operational risk. lack of paroxysmal  liquidity  may  result  in  difficulty  in  operation  and  even  many  small  banks  might  be  bankrupt. thus liquidity ratio in banking is higher than it is in other industries. the ratio is  30% normally.  c) analysis on marketing ability  the third factor in evaluate system contains net profits growth rate, deposit growth rate  and loan growth rate. these 3 indexes embody in the development ability in main business  of commercial bank. from the ranking we could find out clearly that marketing ability of  foreign bank  is greater. foreign bank catch up with and surpass state‐owned  in deposits  &loan  transaction  by  their  humanized  and  scientific  service.  it  make  us  realize  that  to  compete with  foreign bank,  the only way  is expanding source of  income and developing  intermediary business. the proportion of intermediary business in developed country banks  is  exceeding  40%  of  the  total  operating  income.  some  are  65%.  thus  marketing  ability  includes competition not only in traditional business but also in development and marketing  in intermediary business.           hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   23 d) analysis on profitability  profitability is a factor which could embody competitiveness mostly. the contribution  rate to the overall evaluation is 9.5%. for any enterprise profit maximization is the  fundamental goal in operation. from the ranking list we could find out that banks that are on  top in scale strength may not be on top in profitability. profitability is not only related to the  current resource quantity but also to the integration and the use of resource. organization  chart, human resources, business process and other factors are all important to the  profitability of banks. profitability of bea exceeds most chinese banks. but the other two  foreign banks are not impressive in profitability. compare with chinese commercial banks,  familiarity of foreign banks in china remains to be improved. unlike chinese banks which  have branches throughout the country, foreign banks tend to have higher cost of expansion.  besides, foreign banks are still in their initial stage of business development in china, it will  take some time to absorb their initial cost of inputs.  conclusion for factor analysis  according to the size of variance contribution rate table 2, the factors that influence the  international competitiveness of chinese commercial banks most are followed by the scale  strength, innovation capability, risk management capacity, marketing capacity and  profitability. from the ranking list, the factors are mutually independent and they impact  banks’ international competitiveness together. different banks may have different emphasis  on factors, and this unbalanced development trend also shows the development spaces and  development potential of chinese commercial banks are enormous.  cointegration analysis on chinese commercial banks’ international  competitiveness  through  the  integration  of  micro‐level  financial  data  and  related  indicators  in  the  previous chapter, we use factor analysis to derive the competitiveness ranking of chinese  main commercial banks and gap between them and three foreign banks. in order to further  understand the overall strength of china’s banking industry from a macro point of view, we  need to refer to porterʹs ʺdiamond modelʺ and the empirical results of factor analysis to do  cointegration analysis. cointegration analysis can determine the various factors that affect  the international competitiveness of chinaʹs banking industry and provide a basis to enhance  its overall competitiveness.  the selection of variables  different  from  the  preceding  factor  analysis,  the  selected  variables  of  cointegration  analysis  are  time  series  data  (2001‐2010)  related  to  the  overall  development  of  chinaʹs  banking industry. therefore, cointegration analysis on the one hand provides an empirical  basis  understand  the  content  of  commercial  banks’  competitiveness  from  a  macro  perspective,  on  the  other  hand,  the  longitudinal  empirical  method  and  the  previous  horizontal method are complementary.  according  to  porterʹs  ʺdiamond  modelʺ  and  the  empirical  results  of  factor  analysis,  considering data’s representative and accessibility, cointegration analysis will be carried out     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   24 mainly from five aspects: the bankʹs asset scale, profitability, risk management, innovation  and development capacity and macroeconomic situation.  for  banks’  asset  scale,  we  chose  each  year’s  total  assets  of  china’s  banking  industry  (excluding  non‐banking  financial  institutions  and  foreign  banks),  denoted  as  as.  measurement  of  banks’  profitability  in  chinaʹs  banking  sector  is  the  profits  per  capita,  denoted  by  pp.  for  risk  management  capabilities,  we  select  non‐performing  loan  ratio,  denoted by npl. innovation and development capability is based on the fact that innovation  can only  be driven by employees,  and  the  level of human capital determine  the average  innovative capability of enterprises, so we select the proportion of employees with bachelor  degree or above, denoted hr. macroeconomic conditions, is on one hand the measure of the  level  of  financial  development,  and  it  also  reflects  the  market  demand  conditions  of  the  banking industry. thus we chose the indicator gdp, denoted by pgdp.  finally, as to the selection of the explanatory variable—commercial banks’ international  competitiveness, we use the number of chinese banks in the top 1000 world banks released by  the british magazine ʺbankerʺ since the 1970s, denoted by bc.  sample and data  this time span of cointegration analysis is from 2001 to 2010. the data of the international  competitiveness of commercial banks come from the british ʺbankerʺ magazineʹs top 1000  world banks results. total assets come from the total assets of banking institutions released in  china  banking  regulatory  commission’s  annual  report.  profit  per  capita  is  the  banking  sector’s after‐tax profits divided by the number of employees of banking institutions released  in china banking regulatory commission’s annual report. non‐performing loan ratio refers  to  the  world  bank  web  site  statistics.  education  level  of  employee  data  comes  from  the  china financial yearbook. gdp per capita are taken from china statistical yearbook over  years. regression and test of the model are completed by eviews 6.0 software.    table 6. the data of china’s banking industry    year  international  competitiveness  total  assets  profits  per capita  npl ratio  employees  highly  educated  gdp per  capita  2001  14  144146  10452   29.8  14.51  8622  2002  15  188717  17521   26  17.91  9398  2003  16  254511  41928   20.4  20.11  10542  2004  19  290179  42239   13.2  20.69  12336  2005  19  342414  105198   8.6  24.1  14185  2006  25  399150  129279   7.1  26.97  16500  2007  31  481449  160539   6.2  32.96  20169  2008  45  572094  212703   2.4  33.88  23708  2009  52  726239  237816   1.6  38.3  25575  2010  84  862099  306269   1.1  42.31  29748       hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   25 modeling  to avoid the problem of heteroscedasticity, variables above are taken logarithm  processing and marked as lnbc�lnas�lnpp�lnnpl�lnhr�lnpgdp separately.  to avoid the problem of spurious regression resulted from non‐stationary of time series  when modeling, a test for quiet running property of time series should be taken firstly. in  this document adf test methods are used for unit root test. every adf statistics are exceed  5% level of significance. this explains that null hypothesis could not be refused (i.e. time  series is not stationary). after root of unity test of first‐order difference& second difference in  time series, the adf statistics of second difference are not exceed 5% level of significance.  this means level variables including lnbc�lnas�lnpp�lnnpl�lnhr�lnpgdp are the second  order single obeyed process i(2).    table 7. quiet running property test result of variables    variable  adf  statistic  5% critical  value  prob.  conclusion  lnbc  3.499878  ‐3.320969  0.9999  non  stationary  d(lnbc,2)  ‐8.179769  ‐3.403313  0.0005  stationary  lnas  ‐1.317273  ‐3.259808  0.5717  non  stationary  d(lnas,2)  ‐3.783777  ‐3.403313  0.0018  stationary  lnpp  2.211535  ‐3.320969  0.9991  non  stationary  d(lnpp,2)  ‐4.250265  ‐3.519595  0.0003  stationary  lnnpl  0.736219  ‐3.259808  0.9844  non  stationary  d(lnnpl,2)  ‐3.348504  ‐2.021193  0.0006  stationary  lnhr  ‐1.046156  ‐3.259808  0.6854  non  stationary  d(lnhr,2)  ‐4.599999  ‐3.403313  0.0012  stationary  lnpgdp  0.497042  ‐3.259808  0.9744  non  stationary  d(lnpgdp,2)  ‐4.189294  ‐3.519595  0.0248  stationary    in accordance with the result above every variable is with order single whole, this means  requirement of cointegration analysis is made. if some kind of linear combination between  variables  is  stationary  long‐term  stationary  relationship  between  variables  is  existed  (i.e.  cointegration  relationship).  here  is  common  e‐g  step  approach  to  test  cointegration  relationship between explanatory variables and explained variables.       economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   26 relationship between international competitiveness and banking assets scale  first take static regression test by traditional ols methods. regression results are below  ln 9.5178 0.9987 lnbc as= − +   t test (‐6.348)     (8.547)   f test 73.043  after adjusting  r =0.9013�dw=0.8698   second take unit root test residual in the regression model. the result is in table 8.  residual series is stationary. thus there is cointegration relationship between commercial  bank  assets  scale  and  international  competitiveness  (i.e.  long‐term  positive  equilibrium  relationship)  table 8.    variable  adf statistic  10% critical  value  prob.  conclusion  residual u1  ‐1.821336  ‐1.60014  0.0676  stationary    table 9. granger causality test between lnbc and lnas    null hypothesis  object  f statistic  prob.  lnas is not granger causality of lnbc  8  1.84748  0.2996  lnbc is not granger causality of lnas      5.38395  0.10171    then take granger causality test between two variables. the lag is 2. the result shows  that there is no obvious causality between lnbc and lnas.  relationship between international competitiveness and profit per capita.   first take ols regression test:  -1.8792 0.457l 3n lnbc pp= +   t test (‐1.829)    (5.049)    f test 25.491  after adjusting  r =0.7611�dw=0.7472  second take unit root test residual in the regression model. the result is in table 10.  residual series is stationary. thus there is cointegration relationship between profitability  and international competitiveness (i.e. long‐term positive equilibrium relationship)         hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   27 table 10.    variable  adf statistic  10% critical  value  prob.  conclusion  residual u1  ‐1.60014  ‐1.31285  0.162  stationary    table 11. granger causality test between lnbc and lnpp    null hypothesis  object  f statistic  prob.  lnpp is not granger causality of lnbc  8  0.94451  0.00067  lnbc is not granger causality of lnpp      0.50029  0.64938    then take granger causality test between two variables. the lags is 2. the result shows  that the suppose of lnpp is not granger causality of lnbc could be refused under 5% level of  significance. that means the change of profit per capita is the granger causality of the change  of international competitiveness.  relationship between international competitiveness and npl ratio.  first take ols regression test:  4.2861-0.5101ln lnbc npl=   t test (51.467)  (‐13.790)  f test 190.177  after adjusting  r =0.9596�dw=1.5449  second take unit root test residual in the regression model. the result is in table 12.  residual series is stationary under 10%level of significance. thus there is cointegration  relationship between risk management ability and international competitiveness (i.e. long‐ term positive equilibrium relationship)    table 12.    variable  adf  statistic  5% critical  value  prob.  conclusion  residual u1  ‐2.264887  ‐1.988198  0.030  stationary    table 13. granger causality test between lnbc and lnnpl    null hypothesis  object  f statistic  prob.  lnnpl is not granger causality of lnbc  8  3.0274  0.19071  lnbc is not granger causality of lnnpl      0.99778  0.46538    then take granger causality test between two variables. the lags is 2. the result shows  that there is no obvious causality between lnbc and lnnpl.     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   28 relationship between international competitiveness and hr.  first take ols regression test:  -1.9904+1.6244ln lnbc hr=   t test (‐3.066)  (8.168)  f test 66.716  after adjusting  r =0.8929�dw=1.1298  second take unit root test residual in the regression model. the result is in table 14.  residual series is stationary. thus there is cointegration relationship between education  level  of  staff  and  international  competitiveness  (i.e.  long‐term  positive  equilibrium  relationship)    table 14.    variable  adf  statistic  5% critical  value  prob.  conclusion  residual u1  ‐2.078769  ‐1.988198  0.042  stationary    table 15. granger causality test between lnbc and lnhr    null hypothesis  object  f statistic  prob.  lnhr is not granger causality of lnbc  8  7.96917  0.04305  lnbc is not granger causality of lnhr      0.13972  0.87495    then take granger causality test between two variables. the lags is 2. the result shows  that the suppose of lnhr is not granger causality of lnbc could be refused under 5% level of  significance. that means the change of education level is the granger causality of the change  of international competitiveness.  relationship between international competitiveness and gdp p.c..  first take ols regression test:  -9.6066+1.3345ln lnbc pgdp=   t test (‐7.941)  (10.667)   f test 113.778  after adjusting r =0.9343�dw=0.7286  second take unit root test residual in the regression model. the result is in table 16.  residual series is stationary under 10%level of significance. thus there is cointegration  relationship between income level ability and international competitiveness (i.e. long‐term  positive equilibrium relationship).       hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   29 table 16.    variable  adf  statistic  5% critical  value  prob.  conclusion  residual u1  ‐1.988198  ‐1.000873  0.026   stationary    table 17. granger causality test between lnbc and lngdp    null hypothesis  object  f statistic  prob.  lngdp is not granger causality of lnbc  8  1.04096  0.45357  lnbc is not granger causality of lngdp      1.11882  0.43349    then take granger causality test between two variables. the lag is 2. the result shows  that there is no obvious causality between lnbc and lngdp.  from  research  results  above  here  is  the  conclusion:  asset  size&  profitability&  risk  management& performance&  innovations and macro environment are always embodying  on  international  competitiveness.  although  only  profit  per  capita  and  hr  level  are  the  significant  causality  of  international  competitiveness,  the  result  of  cointegration  analysis  shows that  improvement on other factors can also  improve  international competitiveness.  asset  size&  profitability&  hr  and  macro  environment  are  positive  influence  on  competitiveness (especially the hr, its value increase 1 percentage point, the international  competitiveness level increase 1.62 percentage points). npl ratio is the only variable which  is  negative  influence  on  competitiveness.  npl  ratio  increased  1  percentage  point,  the  he  international competitiveness  level decrease 0.5 percentage points. note that npl ratio of  nationalized bank improves a lot in recent years. the npl ratio of 4 big nationalized bank  change from 25% into 5% or lower. however the veracity of this value is not conclusive.  empirical and final conclusion  the initial role of commercial banks is only playing as a platform for financing, but after  several  centuries  of  evolution  and  development,  commercial  banking  has  become  a  modernization  service  sector  collecting  various  types  of  financial  services.  because  of  its  special nature of business, it is not only highly relevant with economic lives, but also affects a  country’s  financial  and  economic  development.  through  qualitative  and  quantitative  analysis above, the main conclusions of this paper are the following:   through years of reform and development, the operating system of china’s commercial  bank has been continuously optimized, the management level has risen and the international  competitiveness has also enjoyed tremendous improvement. china’s commercial banks have  already got the strength to catch up with some of the great international banks in terms of  scale power. however, the advantage should not only lie in total size but in quality as well.  in  the  core  competitiveness,  such  as  intermediate  business  level,  the  level  of  human  resources, capital and other indicators of quality there still exists a certain gap with foreign  banks.     economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   30 according  factor  analysis,  there  are  five  main  micro  indicators  among  all  which  can  reflect the actual and potential competitiveness of commercial banks, scale, innovation and  development ability, risk management ability, market expansion ability, profitability ability  as well as asset mobility. among these five indicators, scale, innovation and development  ability contributes the most to overall strength. on the basis of scoring results in this five  indicators, we draw the following conclusions: state‐owned commercial banks have obvious  advantages in scale strength; innovation capacity of foreign banks is higher than nearly half  of  the  joint‐stock commercial banks;  in  terms of risk management capabilities,  joint‐stock  banks  such  as  the  industrial  bank,  minsheng  bank,  citic  bank  show  outstanding  performances; as to market expansion ability, the three foreign banks are ranked top, which  is closely related to their excellent intermediate business indicator; considering profitability  ability, foreign banks and joint‐stock commercial banks are ranked better than state‐owned  commercial banks. but for overall ranking, commercial banks which got higher scores are  mostly  those  with  great  scale  strength,  showing  that  domestic  banking  sector  in  china  should  change  from  total  amount  expansion  growth  mode  to  content  growth‐oriented  expansion mode gradually, that is through input‐output ratio and raising labor productivity,  with less costs and taking more output and efficiency, domestic commercial banks should  focus  on  the  development  of  financial  innovation,  improve  business  performance  and  enhance the risk management.   by co‐integration analysis on macroeconomic data of the sector, the conclusion is: from  2001  to  2010,  the  most  critical  factors  contributing  to  enhance  the  overall  international  competitiveness are  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međuregionalno  poslovanje.  to  znači  da  danas  strane komercijalne banke i kineske komercijalne banke imaju istu startnu poziciju da se takmiče jedni  sa drugima.  originalnost ovog rada se uglavnom ogleda u sledeća tri aspekta. prvo, napravili smo kompletan i  sistematski  pregled  najnovijih  dostignuća  na  polju  konkurentnosti  poslovnih  banaka,  uključujući  strane  i domaće merodavne metode procene međunarodne konkurentnosti komercijalnih banaka, u  cilju  kreiranja  čvrste  teorijske  osnove  za  empirijsku  analizu.  drugi  aspect  predstavlja  multilevel  empirijski  metod.  pored  inovacija  vezanih  za  odabrane  indikatore  tradicionalne  faktorske  analize,  takođe smo uradili kointegracijsku analizu promenljivih na makro nivou koja dodatno pojačava sadržaj  međunarodne  konkurentnosti  komercijalnih  banaka.  treće,  podaci  koji  su  korišćeni  u  empirijskoj  analizi  su  najnoviji  podaci  objavljeni  na  zvaničnim  sajtovima  komercijalnih  banaka,  statističke  agencije, regulatornih tela i srodnih baza podataka do 2010. godine, kako bi se osigurala validnost i  pravovremenost empirijskih rezultata.  klju:ne reči: kineske komercijalne banke, faktorke analize, konkurencija    article history:  received:  11 september 2011  accepted:  4 december 2011       economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   32 annex a  table 18. factor analysis of raw data        general  assets  x1  capitalization  x2  capital  assets  ratio  x3  capital  adequacy  ratio x4  npl ratio  x5  loan‐to‐deposit  ratios  x6  icbc  117851  6789  5.76   12.36  1.54  58.63  abc  88826  3429  3.86  10.07  2.91  55.19  bc  87519  5750  6.57  11.14  1.52  70.3  ccb  96234  5590  5.81  11.7  1.5  60.24  boco m  33091  1638  4.95  12  1.36  71.97  cmbc  20679  1214  5.87  10.45  0.82  73.74  citic  17750  1028  5.79  10.14  0.95  79.43  spdb  16227  681  4.2  10.34  0.8  70.29  cmbc  14264  889  6.23  10.83  0.84  78.28  cib  13321  596  4.47  10.75  0.54  76.8  ceb  11977  705  5.89  10.39  1.25  79  hxb  8455  440  5.2  10.2  1.5  74.01  cgd  6664  343  5.15  8.98  2.4  70.04  sdb  5878  319  5.43  8.88  0.68  79.07  hsbc  1621  123  7.59  15.7  0.8  55.42  sbc  1311  109  8.31  14.1  0.5  94.87  bea  1210  112  9.26  15  0.35  100.92  note: units of general assets and capitalization are hundred million and others are percent.      table 19. factor analysis of raw data（continued 1）        cash reserve  ratio   x7  liquidity ratio  x8  roa x9  roc x10  profit per capita  x11  nim x12  icbc  20.48  30.7  1.10   19.05  1672  2.26  abc  20.24  40.99  0.73  18.96  739  2.04  bc  16.25  45.3  1.09  16.44  1111  1.82  ccb  18.24  49.63  1.24  20.87  1387  2.41  bocom  18.34  28.02  1.01  19.26  382  2.29  cmbc  13.44  34.47  1  21.17  224  2.23  citic  13.34  48.12  0.94  12.91  193  2.03  spdb  15.63  48.71  0.81  19.41  173  2.07       hong, c., et al., an empirical study, ea (2011, vol. 45, no, 3‐4, 12‐34)   33     cash reserve  ratio   x7  liquidity ratio  x8  roa x9  roc x10  profit per capita  x11  nim x12  cmbc  17.69  34.56  0.98  20.19  172  2.59  cib  19.11  32.07  1.13  24.54  172  2.06  ceb  17.15  35.38  0.64  19.43  105  1.92  hxb  15.66  28.68  0.48  12.44  48  2.12  cgd  15.19  54.28  0.56  16.21  50  2.23  sdb  11.87  38.59  0.86  24.58  62  2.47  hsbc  12.38  35.6  na  na  7  1.69  sbc  15.24  28.7  0.32  3.86  4  2.15  bea  13.05  40.1  0.74  8.04  12  2.11  note: unit of profit per capita is ten thousand and others are percent.    table 20. factor analysis of raw data（continued 2）        cost  income  rate  x14  deposit  growth  rate  x15  loan  growt h rate  x16  undergraduate  rate  x17  non‐interest  income rate  x19  numbers of  embranchmen t overseas  x20  icbc  38.78  18.83  25.33  66  20.47  22  abc  43.11  22.96  33.05  60  18.28  10  bc  37.15  29.23  50.38  70  27.21  58  ccb  39.04  25.49  27.04  65  20.62  9  bocom  38.87  27.13  38.44  72  17.11  6  cmbc  44.86  28.59  35.62  82  21.54  3  citic  39.95  42.33  45.9  92  11.81  1  spdb  44.13  36.74  33.16  80  7.96  0  cmbc  42.17  43.51  34.19  78  22.22  0  cib  36.69  42.56  41.22  72  13.73  0  ceb  46.82  32.23  38.5  71  19.09  0  hxb  44.88  19.79  21.13  73  7.69  0  cgd  48  34.4  22  72  13.22  0  sdb  41.76  26.04  26.24  75  14.09  0  hsbc  84.72  18  20.37  95  26.52  0  sbc  85.14  13.04  13.85  95  23.16  0  bea  56.01  25.37  3.66  95  22.13  0  note: unit of numbers of embranchment overseas is number and others are percent       economic analysis (2011, vol. 45, no. 3‐4, 12‐34)   34 annex b  figure b‐1. scree plot of factor analysis    scree plot component number 181716151413121110987654321 ei ge nv al ue 8 6 4 2 0 -2     figure b‐2. cointegration analysis of residual sequence                                         u1                                   u2        u3                 u4          u5        microsoft word 2010_1_2.doc original scientific paper differences between harmonized indices of consumer prices and consumer price indices in selected countries milecová zuzana*, technical university of košice, faculty of economics, slovakia udc: 338.51 jel: c12, e31, e58 abstract – the aim of the paper is to analyse the differences between the harmonized indices of consumer prices and the national consumer price indices on the theoretical as well as on the practical levels. we are dealing with defining the differences between the indices not only in the euro area and in v4-countries, but also in serbia. the main differences are geographic and population coverage and owner-occupied housing. for statistical testing we have used a paired two sample t-test, which allows us to test the null hypothesis that the difference between the indices has a mean value of zero. out of all 21 realised tests we reject null-hypothesis in 14 cases. key words: harmonized index of consumer prices, consumer price index introduction the consumer price indices (cpis) constitute one of the key macroeconomic indicators, play an important role in monetary policy and economic analysis, are typically referred to in wage negotiations and often used for indexing prices in contracts. however, the underlying concepts and methods differ across countries. that is the reason why the harmonized indices of consumer prices (hicps) were constructed, they facilitate the carrying out of international comparisons. in addition, the hicp serves as one of the convergence criteria to assess whether a member state is ready to join the euro area. by means of hicp the european central bank (ecb) defines price stability as a year-on-year increase in the hicp for the euro area of below but close to 2% over the medium term. the hicp has found an important place in the economy and has replaced the cpis in several areas. on the other hand, the measurement of inflation in two different ways is after all confusing for consumers. that is one of the reasons why the significant differences between indices were not desirable. an example is the price progress in the slovak republic in august 2008. inflation measurement by the cpi rises from 2.2 to 2.4 per cent and the hicp showed the decrease from 1.1 to 0.7 per cent year on year. we can not clearly say which index is correct. simplest would be to have only one price index, but both have their justification in the economy. that is the reason why it is important to discuss the differences between the hicps and cpis. in each country the differences between these two indices were analysed. according to the results we can say that the most important differences are consumption expenditure coverage and treatment of owner-occupied housing (ooh). * e-mail: zuzana.milecova@tuke.sk milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 71 this paper deals with the differences between the hicps and cpis on both theoretical and practical levels. the aim is to analyse the differences between the used indices in the euro area and in v4-countries and also in serbia. for statistical testing a paired two sample ttest was used. we tested the null hypothesis that the difference between the indices has a mean value of zero. differences between indices in euro area both hicps and cpis measure the changes in the prices over time of buying goods and services. the used calculation method is the same, laspeyres chain index. the hicps and cpis are based on the same data sources, but they measure inflation with different concepts or methods. [9] in each member state analyses were realised to identify the differences between the national indices and the hicps. for example in netherlands the indices were compared by leendert (2001), in belgium by druant (2001). the differences between the indices in austria were analysed by fluch and rumler (2005). ray barrell, simon kirby and rebecca riley analysed the differences in uk and the results were published in the national institute economic review in 2003. in the slovak republic kosseyova and doliak (2005) published the analysis of the differences. ahnert and branchi (2005) analysed the main differences in all european union countries. some information about the differences is available on the websides of individual statistical offices. with respect to these studies, the most important difference is the geographic and population coverage. the cpis applying the residence concept reflect price changes in all goods and services purchased by consumers living in the country concerned, including their purchases abroad. by contrast, the domestic concept covers all consumption expenditure in the country concerned, regardless of who (residents or non-residents) purchased the goods and services. the hicps apply the domestic concept. [7], [9] decision about including the domestic concept is not random. ecb needs an index to monitor price changes in the territory of an individual member state, not in individual households. [8] on the other hand the choice of concept may have important impact on the differences between the indices in small countries like luxemburg. we could find the differences between the indices in coverage of institutional household’s spending too. most national indices follow only spending of private households. as an example we can mention estonia, latvia, slovenia, sweden, belgium, luxemburg and portugal. [1] the differences are also in the number and coverage of items in goods and services basket, especially in subsidized areas, such as in health, social protection, education and insurance services. [8], [9] for example in france are healthy services excluded from the cpi. the netherlands’s national price index follows some costs paid within healthy care and includes membership fees in sport and social clubs. the national index in sweden includes some items of social protection. games of chance are excluded from the cpi index for example in italy and in germany. the national index in germany includes lottery tax and motor vehicle tax. [1] but the most important factor affecting the international comparability between the cpis is the treatment of ooh. sixteen of twenty seven european union countries exclude ooh economic analysis (2010, vol. 43, no. 1-2, 70-82) 72 by calculating the cpis. [7] ooh is included in the cpi for example in denmark, sweden, germany, ireland, netherlands, austria and finland, but this countries use different approaches to cover ooh. in the hicp is ooh still excluded, because it has not yet been decided how owner-occupied housing should be covered. [1] the differences are formed by rounding the indices on individual aggregation levels too. [9] some national statistical institutes use different aggregation formulas in their national cpi and hicp for aggregation at the lowest levels of the index. [7] the consumption basket and the expenditure shares of the items covered in the national cpis and the hicps may be updated at different intervals. [7] france, italy, luxemburg, portugal, estonia, latvia, lithuania, slovenia, sweden and uk update weights in consumer basket for calculating the national cpis annually. the other member states review basket weights mostly every five years. updates interval in greece is as late as six years. [1] different update interval leads to the fact that there are many new goods and services which are in basket of the hicp, but the cpi does not cover them yet. for example organic food, air tickets, mobile phones and computers, were covered in the hicp sooner than in the cpi in belgium. [6] the methods used to estimate prices for goods when their quality is changing over time are differ across countries. the differences are in coverage of price reductions during winter and summer sales periods. there may be also differences between the national classifications used for the cpi and the harmonized classification of the hicp. [8] the progress of the hicps and the cpis is shown in picture 1 in the annex. table 1 differences between indices in euro area mean variance p-value hicp 1.97 1.53 belgium cpi 1.97 1.52 1.000000 hicp 1.49 0.70 germany cpi 1.46 0.57 0.168871 hicp 2.91 2.80 ireland cpi 3.10 6.35 0.069507 hicp 3.26 0.95 greece cpi 3.25 0.94 0.844333 hicp 2.84 1.51 spain cpi 2.89 1.52 0.041505 hicp 1.68 0.83 france cpi 1.55 0.70 7.38e-23 hicp 2.26 0.47 italy cpi 2.21 0.46 0.022933 hicp 2.48 2.19 luxembourg cpi 2.09 1.08 1.83e-11 hicp 2.64 1.56 malta cpi 2.44 1.67 0.003881 hicp 2.24 1.40 netherlands cpi 2.14 0.83 0.00124 hicp 1.70 0.77 austria cpi 1.80 0.85 9.75e-06 milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 73 hicp 2.58 1.69 portugal cpi 2.64 1.55 0.001239 hicp 5.34 7.20 slovenia cpi 5.31 7.15 0.008323 hicp 5.90 13.76 slovakia cpi 6.11 12.51 9.46e-10 hicp 2.51 2.42 cyprus cpi 2.65 2.01 0.000706 hicp 1.75 1.12 finland cpi 1.72 1.62 0.513191 sources: eurostat, national data, own calculations for statistical testing of the differences between the indices we used a paired two sample t-test. we have assumed normal distribution, which was verified by visual methods. we tested the null hypothesis that the difference between the indices has a mean value of zero on significance level 5%. if the p-value is less than 0.05, we reject the null hypothesis and if the p-value is more than 0.05, we cannot reject the null hypothesis. the results of this analysis are in table 1. we tested data from january 1998 to october 2009 for all sixteen countries, which gradually accessed the euro area (142 observations). in just five cases we could not reject the null hypothesis (belgium, germany, ireland, greece and finland). according to this analysis, we could not clearly say that there are no significant differences between the national cpis and the hicps in the euro area. ahnert and branchi (2005) analysed the differences between the hicps and the individual cpis. the aim of their research was to prove that the differences are not significant and there is a decreasing trend. to confirm this hypothesis, authors draw up an index as simple weighted average of the cpis of the euro area member states. the country weights are equal to the countries share of household final monetary consumption expenditure (hfmce) in total. this index was compared with the official monetary union index of consumer prices (muicp), which is configured by eurostat of the hicps of the member states participating in the emu. [1] this analysis inspired us to repeat calculations of current information and review present situation. von der lippe (2001) states the compiation method of the muicp index as follows [17]:       ⋅⋅      ⋅      = ∑∑∑ === mt k m mt k m mm k m mmt hchchcm 11 22 1 110 ... . (1), where m stands for the muicp, h for the individual hicps, cm represents the country weights, k the individual member states (m = 1, ..., k) and t is for the time. hmt is then the link (from t-1 to t) for country m. formula (1) represents time series of the muicp, which could by written as follows: tt mmmm ⋅⋅⋅= ...210 . (2), greece accessed the euro area in the year 2001 and the muicp index has been extended, as shown in formula (3): economic analysis (2010, vol. 43, no. 1-2, 70-82) 74       +⋅= +++++ = ++ ∑ 1,11,11, 1 * 1,01,0 tktktm k m tmtt hchcmm . (3), 1211,0 ... ++ ⋅⋅⋅= tt mmmm . (4), where t+1 states for the year 2001. star marks out the new country weights system after access of a new member state. the muicp has been extended progressively with access of individual member states to the euro area. the index includes sixteen countries till today. necessary data are published by individual national statistical offices, oecd and eurostat. we found the differences of up to 1.3 percentage points between data published by oecd and individual statistical offices. the same data are published only for germany, france and italy. for our model we used data published by statistical offices of member states, because they are revised. the country weights used in individual years are published on the web-side of eurostat. figure 2. muicp versus aggregated cpis sources: eurostat, national data, own calculations the result of calculations is shown in figure 2. we can confirm that the differences between the muicp and the index composed from the cpis have been diminishing over time. on the other hand, we tried to use the statistical test, to identify if the difference between the indices is significant or not. table 2. differences between muicp and aggregated cpis mean variance p-value muicp 1.96 0.67 euro area aggregated cpis 1.92 0.63 0.000184 sources: [1], eurostat, national data, own calculations milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 75 for statistical testing we used a paired sample t-test as in the previous case. we analysed data from january 1998 to october 2009. considering the fact that the p-value of analysed data is less than 0.05, we decided to reject null-hypothesis that the difference between the indices has a mean value of zero. differences between indices in v4-countries the differences between the hicps and the national cpis in v4-countries are collected by eurostat and the statistical offices of the individual countries. the hungarian national cpi includes approximately 900 items, which are observed in 35150 outlets depending on their character. altogether more than seventy-five thousand prices are collected monthly. [11] the main differences between the indices in hungary concern the coverage of owner-occupied housing and games of chance which are excluded from the hicp and the expenditure of foreign visitors which are excluded from the national cpi. the national cpi does not monitor development of expenditure of institutional households. the weights are updated in hungary every year, but weights for the hicp are updated every 5 years, only if required, review is made annually. [10], [11] the number of price representatives in consumer basket for the cpi calculation in the czech republic (cr) is 729. consumer prices are surveyed in 35 selected districts in the cr and in the capital of prague. consumer basket represents approximately 55,000 prices to be surveyed monthly. [4], [13] regarding the differences between the hicp and the national cpi in the czech republic, consumption expenditure of non-residents in the economic territory of the country is included in the hicp, but excluded from the national cpi. institutional households are excluded from the cpi, unlike from the hicp. expenditure of investments in the owner-occupied houses (major repairs) is included in the national cpi, but excluded from the hicp. the purchase of the house itself is excluded from both indices. [10] in poland there were about 1,800 representative consumer goods and services chosen for completing the cpi in 2009. on average, there are about 292 thousand prices collected each month in 209 price survey regions. [3] regarding the differences between the hicp and the national consumer price index in poland, institutional households and consumption expenditure of non-residents in the economic territory of the country are included in the hicp, but excluded from the national cpi. games of chance are included in the national cpi, but excluded from the hicp. another contributory factor to the differences between the hicp and the national consumer price index concerns the use of different weights. the cpi is calculated with the use of weights from the household budget survey for the previous year, while the hicp utilizes weights from the national accounts. owner-occupied housing is excluded from the hicp and from the cpi, too. weights for the cpi are reviewed annually. [10] the slovak cpi covers approximately 90 % of all households and the calculation is based on consumer basket with 709 representative items. prices of goods and services are collected in about 13,400 outlets and business premises. number of price quotations is about 90,000. [16] the main difference between the hicp and the national cpi in the slovak republic concerns the coverage of owner-occupied housing, in particular imputed rents and economic analysis (2010, vol. 43, no. 1-2, 70-82) 76 expenditure on major maintenance and repair which are excluded from the hicp. the weights for the cpi are reviewed annually. [10] the progress of the hicps and the national cpis in v4-countries is shown in figure 3. figure 3. progress of cpis and hicps in v4 countries hungary 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 18,0 20,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp czech republic -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp poland 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp slovakia -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 18,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp sources: eurostat and individual statistical offices the introduction of the hicp is an advantage in terms of convergence criteria and monetary policy, especially in the slovak republic. the inflation measured by method of the hicp is less than inflation measured by method of the cpi. the reason for this progress is that the cpi includes the ooh, which significantly increased in last months. the ooh was recently monitored only as monthly payments for repairs and maintenance of owner occupied apartments calculated per an apartment’s square meter floor (regular payments to so-called repairs fund). the government decided to support insulating homes by interest-free loans within anti-crisis measures. residents began to use them massively. this has led to the increase of payments to repair fund. significant increase of the cpi and its deviation in the hicp is not due to inflation, but due to numerous projects of insulating homes. this progress forced statistical office to change the method to calculate the ooh. the repair fund is only 60% of the ooh today, the other 40% are other items related to housing. data of the cpi were revised retroactively from january 2009. [12] for statistical testing we used also a paired two sample t-test, as in the previous cases. milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 77 table 3. differences between indices in v4-countries mean variance p-value hicp 7.16 11.13 hungary cpi 7.17 10.89 0.844968 hicp 4.59 12.49 poland cpi 4.54 12.74 0.030217 hicp 3.16 7.97 czech republic cpi 3.44 8.61 8.38e-21 sources: eurostat, national data, own calculations we tested data from january 1998 to october 2009 for v4-countries (the analysis of slovakia is in table 1). in just one case we could not reject the null hypothesis (hungary). in the other three cases we reject the null hypothesis, that the difference between the indices has a mean value of zero. according to this analysis, we could not clearly say that there are no significant differences between the national cpis and the hicps in v4-countries. consumer price indices in the republic of serbia in the republic of serbia two retail price indices were used on national level until january 2003. the first, the retail price index (rpi) is used as national inflation measure and deflator of output and assets. retail prices are the prices that retail outlets, individual agricultural producers and service providers apply in selling their products and services to end users, including the turnover tax. the second, the consumer price index, is a type of cost of living index and is used for wages, pensions and other social benefits revaluation. the weights for the rpi are based on structure of retail turnover of goods and services. the weights for the cpi were calculated from structure of household consumption. [5] the national cpi in serbia has different classification from coicop and follows seven sub-categories of goods and services. food; tobacco and beverages; clothes and footwear; housing and household operations; hygiene and health care; education, culture and entertainment; vehicles and services. [7] serbian national statistical office started to calculate the cpi by coicop in january 2007. [5] this index presents a special retail prices index that is being calculated according to the methodology that is harmonized with recommendations for retail prices index calculation in the european union. cpi-coicop is comparable with the hicp of the european union. [15] statistical office of the republic of serbia has published monthly series of indices on the web-side from january 2000 till now. for better demonstrations of the differences between the mentioned indices, we decided to construct figure 4 from shorter time series (from january 2003 to october 2009). economic analysis (2010, vol. 43, no. 1-2, 70-82) 78 figure 4. progresses of cpi, cpi-coicop and rpi in the republic of serbia (y-o-y) 0 2 4 6 8 10 12 14 16 18 20 01 03 06 03 11 03 04 04 09 04 02 05 07 05 12 05 05 06 10 06 03 07 08 07 01 08 06 08 11 08 04 09 09 09 cpi-coicop cpi rpi sources: statistical office of the republic of serbia the main difference between the cpi-coicop and the index of retail prices is coverage, because the list of products and services also includes rent, financial services, educational services as well as catering trade services. the indices use different weight systems and classification by calculating. also the formula for the index calculation at the lowest level of aggregating is different for the cpi-coicop and for the rpi too. [15] table 4. differences between rpi and cpi-coicop mean variance p-value rpi 8.89 5.19 the republic of serbia cpi-coicop 8.93 11.97 0.894883 sources: statistical office of the republic of serbia, own calculations for statistical testing we have used a paired sample t-test as in the previous cases. we tested data from january 2007, when the cpi-coicop was introduced in to the practice to the present (october 2009). considering that the p-value of analysed data is more than 0.05, we cannot reject null-hypothesis that the difference between the indices has a mean value of zero. we could test only the 35 observations this time. the rpi was the official measure of inflation in serbia for a long time, but from the start of 2009 the cpi became the main inflation indicator, which is targeted by the national bank of serbia. their aim is to have measurements for inflation comparable with eu. [14] time series of the hicp for serbia are not available so far. conclusion the harmonized index of consumer prices replaced the national consumer price index in several areas. the harmonized index is used as one of the convergence criteria, which milecová, z., differences between harmonized indices, ea (2010, vol. 43, no, 1-2, 70-82) 79 assesses the readiness of a member state to join the euro area. european central bank defines price stability through the harmonized index of consumer prices. but in economy there are differences between the indices. the main differences are geographic and population coverage and owner-occupied housing. for statistical testing we used a paired sample t-test, which allows testing if the difference between the indices has a mean value of zero. we tested data from january 1998 to october 2009 from all euro area member states and v4-countries. from 19 realised tests in the countries of the european union, we cannot reject the null-hypothesis in only six cases (belgium, germany, greece, ireland, finland and hungary). in the other cases we had nullhypothesis rejected on a significance level of 5 per cent. considering the realised analysis we could not clearly say that the differences between the indices are not significant. in the next step we have drawn up an aggregated cpi index. this analysis confirmed that the differences between the indices have been diminishing over time. on the other hand, the statistical test did not confirm the null-hypothesis. in the republic of serbia three retail price indices are followed; the retail price index, the consumer price index by national structure and the consumer price index by coicop. while the national bank of serbia used the retail price index as the main indicator until december 2008, from the start of 2009 it is targeting the cpi-coicop. considering the statistical analysis we cannot reject the null-hypothesis that the difference between the indices has a mean value of zero. references [1] ahnert, h., branchi, m. the hicp as an anchor for european consumer price statistics [online]. 2005 [cit. 2009-12-21] available on the internet: <http://www.oecd.org/dataoecd/14/45/34996095.pdf>. [2] astin, j. the european union harmonized indices of consumer prices (hicp) [online]. 1999 [cit. 2010-01-16] available on the internet: <http://www.ottawagroup.org/ottawa/ottawagroup.nsf/home/meeting+5/$file/1999%205th%20 meeting%20-%20astin%20john%20%20the%20european%20union%20harmonized%20indices%20of%20consumer%20prices%20% 28hicp%29.pdf>. [3] central statistical office of poland consumer price index [online] 2009 [cit. 2010-01-15] available on the internet: <http://stats.oecd.org/mei/default.asp?lang=e&subject=8&country=pol>. [4] czech statistical office consumer price indices user’s methodological manual [online]. 2010 [cit. 2010-01-06] available on the internet: <http://www.czso.cz/csu/2009edicniplan.nsf/p/710109>. [5] jankovic, m. price collection in unstable market conditions [online]. 2006 [cit. 2010-01-17] available on the internet: <http://www.unece.org/stats/documents/ece/ces/ge.22/2006/mtg2/11.e.ppt>. [6] druant, m. belgian hicp: a major step forward in the accurate measurement of inflation [online]. 2002 [cit. 2010-01-16] available on the internet: <http://www.pedz.unimannheim.de/daten/edz-ma/eus/02/ks-pb-02-003-en.pdf>. issn 1725-1338. [7] ecb understanding price developments and consumer price indices in south-eastern europe [online]. 2007 [cit. 2010-01-16] available on the internet: <http://www.ecb.int/pub/pdf/scpops/ecbocp57.pdf>. issn 1725-6534. economic analysis (2010, vol. 43, no. 1-2, 70-82) 80 [8] eurostat hicp-cpi differences [online]. [cit. 2009-12-21] available on the internet: <http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/documents/tab/tab/hicpcpi%20differences>. [9] eurostat harmonized indices of consumer prices (hicps): a short guide for users [online]. 2004 [cit. 2009-12-21] available on the internet: <http://epp.eurostat.ec.europa.eu/cache/ity_offpub/ks-be-04-001/en/ks-be-04-001en.pdf>. [10] eurostat information note on the harmonized indices of consumer prices, compliance monitoring [online]. 2008, 2009 [cit. 2010-01-12] available on the internet: <http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/methodology/compliance_monitoring [11] hungarian central statistical office consumer price index booklets october – december 2006 [online]. 2002 [cit. 2010-01-14] available on the internet: <http://www.eszt.hu/images/inflacio.pdf>. issn 0864-8409. [12] kovalčík, j. inflácia je po oprave výrazne nižšia [online]. 2009 [cit. 2009-10-01] available on the internet: <http://ekonomika.etrend.sk/ekonomika-slovensko/inflacia-po-oprave-vyraznenizsia.html>. [13] kudlák, k. k výpočtu indexů spotrěbitelských cen v čsú [online]. 2002 [cit. 2010-01-09] available on the internet: <http://www.cepin.cz/cze/prednaska.php?id=187>. [14] raiffeisen banka a.d. serbia economic report no. 18 [online]. 2009 [cit. 2010-01-17] available on the internet: <http://www.raiffeisen.at/ebusiness/services/resources/media/10232967115041025308884300_1025311539513_1025311893931-496114812233705012-1-na-de.pdf>. [15] statistical office of the republic of serbia communication nr. 345 price statistics [online]. 2009 [cit. 2010-01-17] available on the internet: <http://webrzs.statserb.sr.gov.yu/axd/en/dokumenti/saopstenja/cn11/cn11112009.pdf>. issn 0353-9555. [16] statistical office of the slovak republic metodika spotrebiteľské ceny (inflácia) [online]. 2010 [cit. 2010-01-14] available on the internet: <http://portal.statistics.sk/showdoc.do?docid=1670>. [17] von der lippe, p.: inflation in europe – different measures and their users [online]. 2001 [cit. 2010-01-09] available on the internet: <http://von-der-lippe.org/dokumente/ceies_english.pdf>. received: 6 january 2010 article history: accepted: 22 march 2010 anex 1 picture 1. progress of harmonized indices of consumer prices and national consumer price indices in euro zone member states belgium -4 -2 0 2 4 6 8 19 98 m 01 19 98 m 10 19 99 m 07 20 00 m 04 20 01 m 01 20 01 m 10 20 02 m 07 20 03 m 04 20 04 m 01 20 04 m 10 20 05 m 07 20 06 m 04 20 07 m 01 20 07 m 10 20 08 m 07 20 09 m 04 cpi hicp germany -1,0 0,0 1,0 2,0 3,0 4,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp ireland -8,0 -6,0 -4,0 -2,0 0,0 2,0 4,0 6,0 8,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp greece 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp spain -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp france -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp italy -1,0 0,0 1,0 2,0 3,0 4,0 5,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp cyprus -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 7,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp luxemburg -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 7,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp malta -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 7,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp netherlands -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp austria -1,0 0,0 1,0 2,0 3,0 4,0 5,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp portugal -3,0 -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp slovenia -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp slovakia -2,0 0,0 2,0 4,0 6,0 8,0 10,0 12,0 14,0 16,0 18,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp finland -2,0 -1,0 0,0 1,0 2,0 3,0 4,0 5,0 6,0 19 98 m0 1 19 98 m1 2 19 99 m1 1 20 00 m1 0 20 01 m0 9 20 02 m0 8 20 03 m0 7 20 04 m0 6 20 05 m0 5 20 06 m0 4 20 07 m0 3 20 08 m0 2 20 09 m0 1 cpi hicp source: eurostat and individual statistical offices ea_2013_3-4 finalna ver scientific review well-being – resorces, happiness and capabilities:theoretical discussions and the evidence from the western balkans1 radovanović bojana, institute of economic sciences, belgrade, serbia udc: 17.023.35:338.1(497-15)"2012" jel: o15 id: 203731212 abstract – the aim of this paper is two-fold. on the one hand, it aims at presenting discussion on advantages and disadvantages of different approaches to well-being, its indicators and measures. on the other, it aims at presenting empirical evidence on the level of well-being of the peoples in the western balkan region. although resources are necessary for the good-quality life, personal well-being cannot be fully assessed by looking only at the resources people have command of. the alternatives are to focus on people’s subjective well-being, then to create certain objective measure of well-being, as the one within human development approach, or the combination of the two, as within gross national happiness concept or happy planet approach. according to the available data on well-being in the countries of the western balkan region for 2012, croatia is the only country in the region that belongs to a group of upper middle income countries, and which also records high human development. the others are middle income countries with medium level of human development. it is interesting noticing that albania, which is with bosnia and herzegovina at the bottom of the list based on the gross national income (gni) per capita and human development index (hdi), is region’s leader in the happy planet index (hpi), and among top 20 countries in the world based on this indicator, particularly due to low level of ecological footprint. according the data on the subjective well-being, we can notice that the greatest satisfaction with one’s life is experienced by the people in croatia. it is also noticeable that reportedly more people in the western balkans experience positive feelings than they feel the negative. key words: well-being, subjective well-being, happiness, capabilities, western balkans introduction among many other definitions, development is also defined as „a multi-dimensional and multi-sectoral process, involving social, economic and political change aimed at improving people’s life” (alkire and deneulin, 2009, p.4). in order to achieve the goal of development – improvement in people’s life, it is necessary to define what a good-quality life entails, and also to create an indicator or a measure of improvement. 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education, science and technological development of the republic of serbia. radovanović, b., well-being – resources, happiness, ea (2013, vol. 46, no, 3-4, 152-163) 153 what does it mean to improve people’s life? how do we express the improvement? how can we measure it? in defining what a good-quality life requires we could look at the resources people have a command of. for example, we could look at their income or a commodity bundle they possess. an alternative approach is to express the quality of one’s life in terms of happiness. finally, we could examine capabilities – person’s substantive freedoms to choose a life one has reason to value. the aim of this paper is two-fold. on the one hand, it aims at presenting discussion on advantages and disadvantages of different approaches to well-being, its indicators and measures. on the other, it aims at presenting empirical evidence on the level of well-being of the peoples in the western balkans region. different approaches to well-being2 development has been equated with the economic growth for decades, where the increase in the gross national product (gnp) per capita has been an indicator of the increase in the quality of people’s life. although economic growth is certainly a necessary condition for increase in personal well-being, it however does not necessarily correspond with the improvement of people’s life conditions. for example, it is noticed that, in some countries, relatively high level of gross national product gnp per capita is not followed by the high quality of life as expressed in terms of life expectancy, adult literacy, and infant mortality (sen, 1999, ul haq, 1995). for instance, while saudi arabia had fifteen times higher gnp per capita than sri lanka, people from the latter country on average lived longer, were in greater number literate, and the infant mortality in this country was on the lower level (hdr 1990). in addition, gnp per capita does not tell anything about distribution of growth (ul haq, 1995). chile is often mentioned in the literature as an example of a country that, after the introduction of neo-liberal policies, has experienced a period of high economic growth, which is however obtained with high level of inequalities (spence, 2009). moreover, economic growth does not correspond with the high level of happiness people report. for example, „the world’s economic superpower, the united states, has achieved striking economic and technological progress over the past half century without gains in the selfreported happiness of the citizenry” (sachs, 2012, p. 3). therefore, focusing only on the county’s gross national product per capita we cannot have a full picture of how its citizens live. we have seen that gnp per capita is not an adequate measure of personal well-being. but, would we have a more precise picture of the quality of one’s life if we knew his income? it seems that the more financial sources one has the higher personal well-being she achieves. even if we agree that, in general this is true, it is so because financial sources allow people to obtain something that they consider as valuable rather than because of its intrinsic value. in other words, the resources are not valuable in themselves they are just means to more valuable ends (sen, 1999). therefore, resources cannot be an expression of personal wellbeing. moreover, someone can achieve higher personal well-being with less resources then the other person with more. also, as sen rightly points out, a person who for example suffers 2 this section draws on my paper “human development index as a measure of human development”, published in the journal philosophy and society (3/2011), pp. 193-208. economic analysis (2013, vol. 46, no. 3-4, 152-163) 154 from certain illness would need more resources to reach the same level of well-being as a healthy person (sen, 1999). therefore, the level of income or commodity bundle one has a command of cannot be an expression of the quality of his life. in short, although people cannot live, let alone live a good-quality life, without goods and services, the resources they have a command of do not tell us much about the level of personal well-being they achieve. therefore, we need more precise indicator of the quality of one’s life. what could be better indicator of well-being than the happiness a person experiences? a long philosophical tradition views happiness as a driving force and a final goal of one’s life. however, philosophers do not agree on the definition of happiness. the happiness is seen as the final goal both within eudemonism and utilitarianism, but what happiness entails is perceived differently. the greek word eudemonia, translated into english as happiness, means „a life that is rich and fulfilling for the one living it” (russell, 2012, p. 7). the greek moral philosophers, particularly the founders of the school within the moral philosophy known as virtue ethics, were concern with the question: what is the best way to live? they were preoccupied to define a final end – an end we pursue for its own sake, and for the sake of which we pursue all other goals. such an end, as they believe, is eudemonia – giving ourselves a good life, where a good life involves both human fulfilment and individual fulfilment (russell, 2012). eudemonia is seen as the happiness of a creature with its „characteristic mode of life” (russell, 2012, p.9). since our characteristic human way of living is a rational way, acting with wisdom and sound emotion is what aristotle means by virtuous activity (russell, 2012). thus, a virtuous activity is the most important thing for happiness, though not a sufficient. in other words, happiness, as seen within virtue ethics is not an affective state, but rather a fulfilled life of a human being, which can be objectively examined. this approach is known as eudemonism. quite a different approach to happiness can be found in the utilitarian tradition. in this approach, happiness is equated with utility and defined as a pleasure and absence of pain (bentham, 1982, mill, 2001). according to the founding fathers of utilitarianism, „nature has placed mankind under the governance of two sovereign masters, pain and pleasure” (bentham, 1982, p.1). in other words, people by nature seek to reach as much pleasure as possible, and to avoid painful actions. within this school, happiness is seen as an affective state and a person as the best judge of the level of well-being she achieves. as such, it is a hedonistic approach to happiness. though both schools define happiness as the final goal in one’s life, and personal well-being equate with the level of happiness a person achieves, there is a difference in the way they define happiness. thus, depending on the philosophical foundations, the indicators of happiness differ. how can the level of happiness be measured and expressed? in general, there are three possibilities. one way is to ask people to judge the level of well-being they achieve. this approach is known as subjective well-being (swb), which falls within hedonistic perspective of happiness. the other is to construct certain objective criteria, for example to look at the capabilities – person’s substantive freedoms to choose a life one has reason to value. finally, there is a possibility to combine objective and subjective indicators of well-being. such approach can be found, for example, within the concepts of gross national happiness or world happiness index. subjective well-being is defined as ‘a person’s cognitive and affective evaluations of his or her life’ (diener, lucas, and oshi, 2002, p. 63). cognitive element refers to what one thinks radovanović, b., well-being – resources, happiness, ea (2013, vol. 46, no, 3-4, 152-163) 155 about his or her life satisfaction in global and also in certain domains such as work, relationships, etc. the affective element refers to emotions, moods and feelings. affect could be positive or negative. it is considered positive when the emotions, moods and feelings experienced are pleasant (e.g. joy, laughter, etc.), while it is negative, when the emotions, moods and feelings experienced are unpleasant (e.g. stress, anger, sadness, etc.). the level of well-being is estimated based on the reports in the surveys. a person who reports a high level of satisfaction with her life, and who experiences a greater positive affect and little or less negative affect, has a high level of swb. the greatest advantage of this approach is that people and their experiences are put in the centre of attention. unlike the approaches that focus on resources, the subjective well-being is concerned with people and their views and feelings. however, the main advantage of this approach is at the same time its main challenges. research within psychology indicates that the level of experienced well-being is to a great extant influenced by the personality. in other words, if someone is by nature an optimistic person, she would score high on the subjective well-being scale, although it might be that she has an aliment which makes her life difficult (sen, 1999). people adapt to changes in their lives and return to their baseline levels of happiness. moreover, people adjust to the circumstances and try to make the best out of it. in other words, someone may score high on the subjective well-being scale, although it might be that she lives in extreme poverty. such life, seen from the viewpoint of an impartial spectator would not be considered as valuable. therefore, it is necessary to define some objective measure of well-being. as an attempt to overcome the imperfections of the two approaches to well-being, at the same time taking their good sides, a new concept of development emerged in the late 1980s and early 1990s titled human development. as amartia sen and mahbub ul haq pointed out, human development is about people realizing their potentials, increasing their choices and enjoying the freedom to lead lives they value (sen, 1999, haq, 1995). philosophical foundations of the human development approach could be traced back to eudemonism. in this approach, resources are seen as necessary for a good-quality life, but they are just means for more valuable ends – substantive freedoms. people should be in the centre of attention of the policies aiming at country’s development. however, due to above mentioned challenges related to subjective well-being, personal well-being should be defined in more objective terms. as it is already mentioned, within human development approach, development is seen as „a process of expanding the real freedoms that people enjoy” (sen, 1999, p. 3). under the substantive freedoms sen means the capabilities „to choose a life one has reason to value” (sen, 1999, p. 74). a person may value a number of different doings and beings which sen calls functionings. for example, one may value to be adequately nourished, while the selfrealisation is the valuable functioning for someone else. however, an individual is not always capable of enjoying the functionings she values, and then she faces unfreedom. for instance, someone who values adequate nourishment may not be capable of achieving this being because she is lacking financial resources. there is a need for conversion factors to translate a doing/being that one values to her capability to enjoy it. capability therefore „refers to the alternative combinations of functionings that are feasible for her to achieve” (ibid: 75). moreover, in reaching the substantive freedom, a person has to be an agent of her own life – has to have an „ability to pursue and realize goals she values and has reason to economic analysis (2013, vol. 46, no. 3-4, 152-163) 156 value” (alkire and deneulin, 2009, p. 22). what are the capabilities that one has reason to value? sen refuses to make a list of valuable capabilities. he believes that each society should, through democratic process, decide the list of basic capabilities (sen, 1999)). the main advantage of this approach is that, in sen’s version, it presupposes the engagement of the whole community in defining the capabilities that need to be in focus of public policies. however, such approach involves the problems with the implementation of deliberative democracy. it seems necessary to develop certain list of basic capabilities. nussbaum frames these basic principles in terms of ten capabilities: life, bodily health, bodily integrity, senses, imagination, and thought, emotions, practical reason, affiliation, other species, play, and control over one’s environment (for more details see nussbaum, 2000). however, any list of capabilities, even the one that nussbaum proposes is on the one hand limited – it may lack some of the capabilities certain community values, and on the other hand, it is too comprehensive for the operationalization – creation of a measure. as a measure of human development, the human development index (hdi) emerged. the hdi indicates a country’s average achievements in three dimensions of human development: health, as measured by life expectancy at birth; knowledge, as measured by the adult literacy rate (with two-thirds weight) and the measured by combining the expected years of schooling for a school-age child in a country today with the mean years of prior schooling for adults aged 25 and older (with one-third weight), income, as measured by purchasing-power-adjusted per capita gross national income (gni). the hdi is calculated as the geometric mean of the three dimension indices3. this indicator is an objective measure of personal well-being. however, since it is based only on three components it certainly does not fully capture all capabilities that people have reason to value. now, we will turn to the concepts that combine subjective and objective well-being – the gross national happiness (gnh) index and the happy planet index (hpi). the gross national happiness concept, developed in bhutan, is the first serious attempt in the world with an aim to measure happiness (helliwell, layard and sachs, 2012). since 1970s, bhutan pursues a holistic approach towards development basing it on the concept of gross national happiness. this approach relies on four pillars: good governance, sustainable socio-economic development, cultural preservation, and environmental conservation. the four pillars have been further classified into nine domains: psychological wellbeing, health, education, time use, cultural diversity and resilience, good governance, community vitality, ecological diversity and resilience, and living standards. all those components of the gnh concept are the means for reaching the happiness of the people which is the end of the country’s policies. what makes it similar to the subjective well-being concept is that the bhutanese’s satisfaction with life and state policies are directly assessed through a survey. concentrating on the nine indicators of the gnh concepts, where subjective well-being is only one of the components, decision-makers in bhutan are expanding people’s opportunities which make this concept 3 the maximum value of hdi is 1 and the minimum is 0. countries are divided into four groups according to the level of the hdi. the counties with the hdi that exceeds 0.900 are consider to have a very high human development, while those with the hdi between 0.800 and 0.899 are of the high human development. a country belongs to a group of medium level of human development if its hdi is between 0.500 and 0.799, while human development is on a low level in the countries with the hdi below 0.500. radovanović, b., well-being – resources, happiness, ea (2013, vol. 46, no, 3-4, 152-163) 157 similar to the capabilities approach. the gross national happiness concept is based on the premise that adequate standard of living, health and education of population, then vitality and diversity of ecosystem, as well as cultural vitality and diversity, use and balance of time, good governance, community vitality and emotional well-being are necessary for a good quality life. as an indicator of the level of personal well-being and country’s development a gross national happiness index is created. gnh index provides an overview of performance across 9 domains of gnh. this approach is limited to the territory of bhutan, but it however served as inspiration for the development of the indicators of happiness. another indicator that combines subjective and objective measures of personal wellbeing is happy planet index (hpi). it has three components: life expectancy, experienced well-being and ecological footprint. the experienced well-being is assessed using a question called the ‘ladder of life’ when respondents are asked to imagine a ladder where 0 represents the worst possible life and 10 the best possible life, and to report the step of the ladder they feel they currently stand on. the ecological footprint is a measure of resource consumption. it is a per capita measure of the amount of land required to sustain a country’s consumption patterns, measured in terms of global hectares (g ha) which represent a hectare of land with average productive bio-capacity. the hpi is then calculated as following: life expectancy is multiplied by experienced well-being, and it is then divided by ecological footprint. the index value is between 0 and 100, where the bigger value indicates the better score.4 this indicator is calculated for countries around the globe and it offers a possibility for international comparisons. since it is based both on subjective and objective measures it shares advantages and challenges of the two approaches. moreover, since it includes only three components it is certainly limited. to sum up, in this section i have briefly discussed different approaches to well-being. we have seen that although resources are necessary for the good-quality life, personal well-being cannot be fully assessed by looking only at the resources people have command of. the alternatives are to focus on people’s subjective, experiences well-being, to create certain objective measure of well-being, or the combination of the two. each of the approaches has its advantages and happiness. therefore, best picture about the well-being one gets by analyses of several indicators. evidence from the western balkans in this section, we will focus on the well-being of the peoples in the western balkan region. i will present the data on gross national income (gni) per capita, human development index (hdi), happy planet index (hpi) and data on subjective well-being. the presented data are for the year 2013. 4 each component of the hpi is evaluated separately. the life expectancy is evaluated as good if it is more than 75, middling if between 60 and 75, and poor if less than 60. experienced well-being is good if it is more than 6.2, middling between 4.8 and 6.2, and poor if less than 4.8. finally, the ecological footprint is good if it is less than 1.78, middling between 1.78 and 3.56, poor between 3.56 and 7.12, and very poor more than 7.12. economic analysis (2013, vol. 46, no. 3-4, 152-163) 158 according to the gni per capita in 2012, most of the western balkan countries are in the group of upper middle income countries5, while croatia is in the group of upper income countries. the lowest level of the gni per capita is recorded in bosnia and herzegovina (7.713), followed by albania (7.822). macedonia records the gni per capita of 9.377, serbia 9.533 and montenegro 10.471, while croatia is the region’s leader with the gni per capita of 15.419 $ ppp. croatia also records the highest level of human development, with the hdi of 0.80 which place it in the group of countries of high human development. all other countries of the western balkan region belong to the group of the countries with medium level of human development. with the hdi of 0.735, bosnia and herzegovina is a country with the lowest human development in the region, followed by macedonia (0.740), albania (0.749), serbia (0.769) and montenegro (0.791). the data on gni per capita and hdi for 2012 are presented in the table 1. table 1. gni per capita and hdi in the western balkans in 2012 country gni per capita ppp terms (constant 2005 international $) hdi albania 7.822 0.749 bosnia and herzegovina 7.713 0.735 croatia 15.419 0.805 macedonia 9.377 0.740 montenegro 10.471 0.791 serbia 9.533 0.769 source: undp quite a different picture about the well-being of the peoples in the western balkan countries one gets by looking at the data on happy planet index. albania, with hpi of 54.1, scores the best in the region, particularly due to the fact that none of the components of the hpi is poor and also due to the good ecological footprint. the region worst score of hpi of 28.3 records macedonia, with two components evaluated as poor (ecological foot-print and experienced well-being). croatia records hpi of 40.6, with ecological footprint evaluated as poor, while the experienced well-being is poor in serbia and bosnia and herzegovina, which have hpi of 41.3 and 42.4, respectively. it is interesting noticing that serbia is the only country in the region that does not score as good in any of the components. the data on hpi are presented in the table 2. 5 the world bank groups economies based on the gni per capita as following: low income, $1,035 or less; lower middle income, $1,036 $4,085; upper middle income, $4,086 $12,615; and high income,$12,616 or more. radovanović, b., well-being – resources, happiness, ea (2013, vol. 46, no, 3-4, 152-163) 159 table 2. hpi in the western balkans in 2012 country lifeexpectancy experienced well-being ecological footprint hpi albania 76.9 5.3 1.8 54.1 bosnia and herzegovina 75.7 4.7 2.7 42.4 croatia 76.6 5.6 4.2 40.6 macedonia 74.8 4.2 5.4 28.3 serbia 74.5 4.5 2.6 41.3 source: happy planet index now we will turn to the question of how people in the western balkan countries perceive their well-being. as it can be noticed from the hpi, the highest well-being is experienced by the people in croatia. croatians, when asked to imagine a ladder where 0 represents the worst possible life and 10 the best possible life, on average report 5.6 as the step of the ladder they feel they currently stand on. they are followed by albanians (5.3), then by the people in bosnia and herzegovina (4.7), serbia (4.5) and macedonia (4.2). graph 1. subjective well-being – positive affect in the western balkans in 2012 source: gallup, balkan monitor the data on positive and negative feelings of the people in the western balkans are collected by the gallup within the balkan monitor. here, i will present some of the data for 2012. the participants in the survey are asked whether they experienced the feelings such as happiness, enjoyment, worry, sadness, stress, anger, whether they smiled or laughed, were treated with respect during a lot of the previous day. relatively the greatest number of respondents in montenegro (65.20%) reported that they felt happy most of the previous day, economic analysis (2013, vol. 46, no. 3-4, 152-163) 160 followed by participants in macedonia (65.10%), croatia (58.40%), bosnia and herzegovina (58.30), serbia (57.30%) and albania (53.40%). relatively the greatest number of respondents in albania (62.70%) said they felt enjoyment the previous day, followed by people in macedonia (59.30%), bosnia and herzegovina (54.60%), montenegro (52.90%), serbia (50.90%), and croatia (48.60%). on average, the greatest number of people in albania (87.20%) feels they are treated with respect, while relatively the least number of respondents in montenegro feels the same (74.90%). in serbia 80.30% respondents stated that they were treated with respect during the previous day, while 77.10% in macedonia, 76.80% in croatia and 75.20% in bosnia and herzegovina reported the same. relatively the greatest number of citizens of croatia (63.60%) smiled/laughed during the previous day, followed by albanians (60%), macedonians (52.90%), bosnians (52%), montenegrins (48.60%) and serbians (43.10%). the data on positive feelings are presented in the graph 1. it is noticeable that reportedly more people in the western balkans experienced positive feeling than negative. according to the collected data, among the western balkan countries, the greatest number of citizens of serbia (55.70%) is worried, while albanians (38.70%) worry the least in the region, followed by people in bosnia and herzegovina (47.10%), macedonia (51.10%), croatia (51.20%) and montenegro (52%). the sadness is felt by the relatively smallest number of croatians (17.10%), while this negative affect is felt by the relatively greatest number of people in macedonia (28.50%). in montenegro 17.60% of the respondents reported they felt sadness during the previous day, followed by bosnia and herzegovina (21.60%), albania (22.80%) and serbia (26.40%). the greatest number of respondents in macedonia (43.60%) reported they felt stress, followed by albania (42.50%), croatia (33.80%), serbia (31.50%), bosnia and herzegovina (27.90%) and montenegro (24.50%). the anger is felt by the greatest number of people in montenegro (42.40%) followed by people in macedonia (40.50%), serbia (28.80%), bosnia and herzegovina (27.40%), albania (19.40%) and croatia (13.20%). the data on negative feelings are presented in the graph 2. graph 2. subjective well-being – negative affect in the western balkans in 2012 source: gallup, balkan monitor radovanović, b., well-being – resources, happiness, ea (2013, vol. 46, no, 3-4, 152-163) 161 conclusion in this paper i have briefly discussed different approaches to well-being and i have presented the data on well-being in the countries of the western balkan region. although resources are necessary for the good-quality life, personal well-being cannot be fully assessed by looking only at the resources people have command of. the alternatives are to focus on people’s subjective, experiences well-being, to create an objective measure of wellbeing, or the combination of the two. while the greatest advantage of subjective well-being approach is that the quality of life is directly assessed by the people who are experiencing it, there are some challenges that this approach faces. for example it is argued that personality influences the perception of one’s own situation and the feelings one experiences, and also that people adjust to the life circumstances no matter how bad they may seem to the impartial spectator. in order to overcome the imperfections of the two approaches to wellbeing, at the same time taking their good sides, a new concept of development emerged in the late 1980s and early 1990s titled human development, which is about people realizing their potentials, increasing their choices and enjoying the freedom to lead lives they value. an objective indicator of personal well-being is sought within human development approach. the main challenge of this concept is the choice of core capabilities. finally, there are some attempts that combine objective and subjective approach to well-being such as gross national happiness and happy planet. the main challenge of each approach is creation of an adequate measure of the wellbeing. the gross national product (gnp) and gross national income (gni) per capita are the most often used measures that indicate resources that individuals on average have command of in a certain country. the human development index (hdi) indicates a country’s average achievements in three dimensions of human development: health, knowledge and income, while the happy planet index hpi combines subjective and objective measures of personal well-being and it has three components: life expectancy, experienced well-being and ecological footprint. finally, subjective well-being is evaluated through surveys on life satisfaction and experienced affect. according to the available data on well-being in the countries of the western balkan region for 2012, croatia is the only country of the region that belongs to a group of upper middle income countries, which also scores high human development. the other countries of the region are middle income countries with medium level of human development. it is interesting noticing that albania, which is with bosnia and herzegovina at the bottom of the list based on the gni per capita and hdi, is region’s leader in the hpi, and among top 20 countries in the world, particularly due to low level of ecological footprint. the greatest satisfaction with one’s life is experienced by the people in croatia. it is noticeable that reportedly more people in the western balkans experience positive feeling than negative. references alkire, s. and deneulin, s. 2009. „a normative framework for development”. in an introduction to the human development and capability approach: freedom and agency, ed. deneulin, severine and shahani, lila, 3-22. london: human development and capability association. bentham, j. 1982. an introduction to the principles of morals and legislation, methuen. economic analysis (2013, vol. 46, no. 3-4, 152-163) 162 deneulin, s. and shahani, l. 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46, no, 3-4, 152-163) 163 blagostanje – resursi, sreća i sposobnosti: teorijska analiza i stanje na zapadnom balkanu rezime – cilj ovog rada je dvostruk. sa jedne strane, on ima za cilj analizu prednosti i nedostataka različitih pristupa blagostanju, a sa druge da predstavi empirijske podatke o stepenu blagostanja u zemljama zapadnog balkana. iako su finansijska sredstva neophodna za kvalitetan život, ona ne mogu biti adekvatan indikator blagostanja. alternative su formiranje subjektivnog pokazatelja blagostanja, potraga za objektivnim merilima, kakav je koncept ljudskog razvoja, ili kombinacija ova dva pristupa, kao u slučaju bruto društvene sreće ili pristupa srećne planete. prema raspoloživim podacima o blagostanja u zemljama zapadnog balkana za 2012. godinu, hrvatska je jedina zemlja u regionu koja pripada grupi zemalja sa gornjim srednjim dohotkom po glavi stanovnika, koja takođe beleži i visok nivo ljudskog razvoja. ostale zemlje su u grupi zemalja sa srednjim dohotkom po glavi stanovnika i srednjim nivoom ljudskog razvoja. zanimljivo je primetiti i to da albanija, koja je sa bosnom i hercegovinom na dnu liste na osnovu bruto nacionalnog dohotka (bnd) po glavi stanovnika i indeksa ljudskog razvoja (hdi), regionalni lider prema indeksu srećne planete (hpi) i među prvih 20 zemalja u svetu prema ovom pokazatelju, prenstveno zbog niskog nivoa ekološkog otiska. što se tiče subjektivnih pokazatelja blagostanja, najveće zadovoljstvo svojim životom doživljavaju stanovnici hrvatske. primetno je i da veći broj ispitanika u zemljama zapadnog balkana svedoči da doživljavaju pozitivna osećanja nego što je to broj onih koji svedoče o negativnim. ključne reči: blagostanje, subjektivno blagostanje, sreća, sposobnosti, zapadni balkan article history: received: 3 september 2013 accepted: 9 december 2013 ea_2013_3-4 finalna ver professional paper application of batch and automated (stp) processes in banking – case study aseba bi1 bradić-martinović aleksandra, institute of economic sciences, belgrade, serbia ranković marko, sas institute, belgrade, serbia krsmanović svetlana, asseco-see, belgrade, serbia udc: 336.717:004 ; 007:005]:004 jel: o31, o33, g21 id: 203726604 abstract – strong competition in banking market has led to a significant reliance of banks on information technology. in the last decade, main progress has been made in introducing straightthrough processing (stp) and batch processing in banking information systems. in this paper we analyse the impact of application of these processes in banks. we choose four parameters to follow: system quality information quality, service quality and user satisfaction. as a sample of case study we select aseba bi integrated banking information system, produced by asseco-see. through the analysis of several examples: batch processing in core banking system, batch processing in credit module, stp in national payment processes, stp in international payment processes, automation of treasury back office (tbo) and treasury (trading) and securities trading we conclude that batch processing and stp have great impact on selected parameters. key words: banking, information systems, automated processes, straight-through processing, stp, batch processing introduction fast development of financial markets has caused changes in bank services. bank is no longer perceived as a micro institution, but as a social and financial institution. furthermore, it can be seen as a social and financial institution whose business capabilities and operational efficiency significantly effect rationality of usage of funds at global level. as a result of these processes, the modern banking is perceived as a business with dynamically changes which is described through a frequently used expression „banking revolution”. it reflects in the manner in which banks and other financial institutions are reorganized and restructured, in the processes of their mutual merges and takeovers, as well as in the appearance of new functions, increasing speed of money transactions and deregulation of financial market. besides, information systems available to banks provide almost instantaneous speed of processing. 1 this research is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 73 modern banking is based on four aspects of analysis in the term of development tendencies: institutional or structural, functional, instrumental, and regulatory. the institutional transformation regulates the manner of founding and managing a bank, distribution of bank’s income and expenses, maintenance of liquidity and termination of bank’s operations. functional and intrinsic transformation is seen through establishment of new methods and mechanisms of mobilisation, concentration and circulation of free financial funds by usage of adequate banking channels. the essence of functional transformation manifests through the speed of economy’s potential increase or through the quality of change of economy’s financial position and other non-banking sectors within the bank’s balance structure. the instrumental aspect of transformation of banking system includes introduction of adequate structure of instruments and mechanisms which shall contribute to optimum financial transactions execution. introduction of new instruments for money transfer and payment into the payment system has aim to achieve faster circulation of funds. government control or control of some other regulatory body prevents banks from becoming monopolists and therefore prevents financial catastrophe with devastating economic consequences, having in mind that banks hold great funds in form of various types of deposits, along with their additional power of money and loan creation. in this paper we first present trends in banking information systems and then conduct an analysis of some major information systems parameters. we choose case study method as basis for analysis, and quality of information, quality of service and user satisfaction as basic banking information system parameters. also, we select aseba bi integral banking information system, product of asseco-see company as a sample for the case study. though the several examples we present impact of automated and batch processes on selected parameters. at the last part of paper we present our conclusions. trends in banking information systems the information system has become the lifeblood of a business (clemons, 1986; clemons&weber, 1990). it has been used successfully by many companies to increase their competitive advantages. in the modern economic environment it is assumed that banking operations greatly depend on information technology resources. the changes which occurred in economic, legal, technical and technological terms, along with constantly present process of globalization in world economy, have considerably influenced sharp competition, high price fluctuation, change of roles and nature of financial agents, together with appearance of new banking and financial products and change of customers’ behaviour. comparison of modern and traditional banking has resulted with the appearance of considerable differences. there is a new banking philosophy, which is the result of the new strategy, and it is characterized by orientation towards customer, which was not the case with traditional banking (khare, 2010; coltman, 2012). in the conditions of increasing competition and fight for survival on the market, customers and their requirements take the central place in banks which are striving to find easier ways of meeting these requirements. the changes in banking business philosophy were inevitable, as they appeared as an answer to the changed business conditions and they led to the great investing into techniques and technologies of information systems (han-yuh, 2007). banks introduce new technological solutions which provide access to computers by connecting hardware, software and economic analysis (2013, vol. 46, no. 3-4, 72-86) 74 telecommunication technologies for payment transfer, cashless payment of goods and services purchasing bills (pos systems), sending of cheques and execution of other transactions with no need of going to the bank. at the beginning this caused creation of a new group of products, and afterwards also a global phenomenon – electronic banking (ebanking). imperative for every bank which wants to survive in the twenty first century is to follow the market trends and to be fast in introducing and developing new information technologies, which is all due to the innovations which are adopted very quickly. foss&stone (2008, p. 302) argue that the need has become so pronounced that now many more companies that provide financial services start to determine the minimum rate of return on investment in information systems which explains the rationale income from investments, while ives&learmonth (1984) stressed the strategic importance of information systems in banks, twenty years ago. automation of banking operations started in nineteen sixties. the goal of introducing first computers was increase of banking efficiency, taking into account that banks are centralized institutions and that they have to be constantly informed about the funds they have available. application of automatic processes in banking has been postponed for a long time, regardless the revolutionary discoveries in the field of informatics, due to the low value of an average transaction. the reason was the price of information technologies and necessary technological infrastructure for retail payment systems which was too high, exceeding the costs of one transaction processing. research show (pikkarainen, 2004)) that many factor influence the quality and acceptance of e-banking and on-line banking: information about opportunities, security and privacy, etc. but the quality of back office is measured by the speed of the operations. according to the analysis of modern banking information systems there are two key innovations which stand out, batch and stp processes. batch processing is a type of processes where serial of programmes execute automatically, without any manual intervention. this type of processing involves setting of operational task queues, and the processing starts at or after a predefined time. demand for batch processing appeared at the very beginning of software development in the nineteen fifties, and the first examples are related with accounting calculations. usage of these processes helped in overcoming of problems caused by slow operational work, as at that time there was not available multitasking. based on morrison & wilhelm (2004) firstly, the advent in the 1960s of powerful transistor-based computers which facilitated batchprocessing of transactions data; and secondly, the development of the microcomputer which facilitated the real-time implementation of new techniques in financial engineering. batch processes are widely applicable today, and they also became important in banking. it has been noted that these transactions have an advantage compared with real time transactions as they are almost identical, but batch processes have an option of rollback. real time transactions do not have the rollback option. besides, transactions in real time are always executed immediately, and batch transactions include collection, and then mass processing which frequently takes place at night while the other banking operations are not performed. two common applications of batch processes in banks are serial cheque clearing and update of insurance companies’ policies. both processes include transfer of great quantity of information and they require high attention level so that any potential errors could be bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 75 avoided. leinonen & soramaki (1999) emphasize that the use of information technology in batch processing has enabled a reduction in payment processing time from several days in the forgone manual era to typically one day. figure 1. manual account opening process straight through processing (stp) represents a step further comparing to batch processing. stp paradigm is set of business processes and technologies that can be used to create an infrastructure for automated real-time transaction processing (khanna, 2008). the best way of showing a stp processing is the example provided in figure 1 where process of account opening with manual processing is shown, and in figure 2 where the same process is shown but instead of manual processing stp is applied. figure 2. automatized opening account process it is important to emphasize that these processes are suitable for banking operations because of two important features: a) they reduce transaction processing risk (operational risks), which is very high in case of manual operations and b) they reduce transactional costs providing at the same time better service quality (operational costs). economic analysis (2013, vol. 46, no. 3-4, 72-86) 76 both innovations have brought improvement to the routing banking operations execution, and in the next part of paper we will analyse the areas of benefit as well as the ways in which these positive effects are generated. methodology and hypotheses it was relatively long ago when darke, shanks and broadben (1998) acknowledged that interest of scientists for researches dealing with evaluation of successful application of information systems in various areas of business is growing. moreover, they emphasize the importance of usage of better quality researching methods such as action research and case study. analysis of these researches however shows that the case study method is most frequently used. in this research we also use a case study method for analysis of batch processes and automated processes implementation effects in banking operations. arguments regarding the selection of this method can be found in the study of flyvbjerg (2006) who shows that it is justified to accept the generalization of conclusions based on a case study research. he notes that one can often generalize on the basis of a single case, and the case study may be central to scientific development via generalization as supplement or alternative to other methods. however, it is important that the case study is strategically selected, i.e. that an example with most relevant researching properties is selected, which does not have to be the case with random selection method. apart from general methodology, other issue in this research is selection of appropriate parameters for measuring of successful information systems application in various business fields. beside traditional financial measures, such as roi, researchers also use balanced scorecards and benchmarking, emphasizing the need for better and more constant success matters, having in mind that information systems have complex, independent and multidimensional nature. in order to overcome the shortcomings of existing measures the authors suggested a model (dm model) which includes the following success dimensions: system quality, information quality, service quality, system use, user satisfaction and net benefits (petter, delone, mclean; 2008). figure 3. delone and mclean information system success model source: petter, delone, mclean; 2008 bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 77 starting from the conclusions set forth in this study, there has not been created a comprehensive and precise measure, so we have selected three dimensions which we assume could considerably improve the quality which is achieved with application of batch and stp processes in banking operations. therefore in this research we will test the following hypothesis: a) application of batch and automated processes in banking improves system quality, information quality and service quality; b) the result of improvements in system, information and service quality improves users’ satisfaction. we will test the hypothesis by using case study methodology. unit of analysis aseba bi is a banking information system which represents upgrade of bapo system. development of bapo system started in 1992 within the system of karić banka. the development was initiated at request of karić banka management team who requested automation of a part of operations in fx sector and a part of teller activities dealing with fx. it started with production at headquarters of karic banka in belgrade and in its branch office in kragujevac in 1993. its technology platform is oracle database, windows servers and unix operating system, which provided sufficient computing power for real time transaction. then in 1994 first major software revision took place. the major novelty was the feature enabling communication among branches. all the branches have a local server, so that the headquarters could have the real information on the situation. however, the system could not operate in real time regime. within the same year company started to develop loans subsystem, and in 1996 communication with swift system was developed, and in 1997 the technology transferred to 2000, forms ver. 4.5. that was the first time the usage of computer mouse was enabled and that graphical user interface (gui) was supported. four years later, in 2001, the payment system of bosnia and herzegovina was reformed, i.e. decentralized. local servers were abandoned, and it was required to provide a central server at the whole bank level. this year had another feature developed a robust card module (visa, master card) and in the following two to three years there was the greatest growth of the system. besides, e-banking was developed and data exchange via telephone lines was provided (until that time modems were used). this year was marked by a strong development of module for the payment cards (visa, master card, e-banking) and in two or three years it recorded the highest growth in the system. when in 2003 new payment system was implemented in serbia, it changed the focus of banking information system, so that it was no longer primarily used for posting, but it was required for various analyses, such as analysis of data based on basel standard which defines customer’s history. the system was now more oriented to the analysis of collected data, in contrast with the previous times when the collected data remained unused. this year system changed its name into banking intranet (bi), and after the acquisition of company asseco-see its today’s name aseba bi was created. economic analysis (2013, vol. 46, no. 3-4, 72-86) 78 today aseba bi has been implemented in sixteen banks in serbia, bosnia and herzegovina and montenegro. in this paper we also used the internal evaluation material of those banks, to provide statistical data, in order to illustrate improvement after implementation of new information system. 6 banaka smo obuhvatili u istraživanju case analysis summary analysis of the selected case was performed at two levels. the central part of the system (core) supported with batch processes was analysed first, and then modules with implemented straight-through processing: national payment transactions, international payment transactions, treasury back office (tbo) and treasury (trading) and securities. every system module was analysed from the perspective of its effecting on info quality, service quality and user satisfaction, after implementation of batch processing and stp. banking information system aseba bi is an integral information system which consists of modules with one central part core system. every module covers individual banking function, as it is presented in figure 4. figure 4. structure of aseba bi information system source: asseco-see internal material the database platform of aseba bi runs on newer versions of oracle database. on its applicative level aseba bi system uses oracle internet application server 9i enterprise edition. the middleware runs on oracle http server (oracle’s modification of apache server) and forms and reports server. all business processes in aseba bi system are performed in the real time. many of these processes are automated, and some of them also meet the stp criteria. transactions which are performed, and whose life cycle process in bank allows that, can be realized in aseba bi system from beginning to end automatically (without manual intervention at any of the stages). by system parameterization (setting of performances) bank can stop and check certain phases of a business process. the following part of the study shall analyse the effects bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 79 of automated business processes and stp processes throughout examples of transaction realization in various system modules. example 1 batch processes in core banking system. batch processes are introduced into core system in order to optimize utilization of resources and realization of operations processing great quantities of data in day periods when system is less occupied with transactional processing. batch enables avoiding of unnecessary system stress during the operational period, and 24 hours functioning of bank system is fully supported. batch controllers are in charge of execution of batch processing jobs and they need to be configured so that they perform groups of tasks in a desired sequence. the controllers are activated once or several times a day and they execute individual tasks, and the tasks can be configured to be executed every day, on a specified week day, on a specified date in month, or on a specified date. while a batch process is in progress, the operations go through various statuses, and information and possible processing errors are entered into log files. the system provides automatic control of batch processes based on provided parameters. it provides introduction of custom processes defined by system user, i.e. by bank. there are two types of batch processes, one which runs by using controllers and the other by using aqs (advanced queue) which can start unlimited number of processes and which speeds up the processing. scheme of using batch process in core system is presented in figure 5. with the growth of functions and operational domains of aseba bi application, batch processes became one of key points regarding efficiency and programme operability. the increase of processing procedures and quantity of data which are processed made it necessary that these processes are centrally administered and adapted to new requirements. in contrast with the sequential functioning which has been used so far, it is required to introduce a higher level of parallel processing so that user’s hardware resources are exploited in the best possible manner, and that higher system and service quality is provided, and as a result of that higher user satisfaction is enabled. figure 5. batch processing in core of aseba bi source: asseco-see internal material economic analysis (2013, vol. 46, no. 3-4, 72-86) 80 in contrast to the previous system version, introduction of batch processing, as shown in figure 5, has introduced automation into majority of processes referring to transactions which could be done without manual influence. that has directly improved quality of information as processing based on batch processes is considerably faster and error free, as in the case of manual operations. the information quality improvement indirectly effects improvement of service quality and therefore on user satisfaction. example 2 batch processes in loans module. loans module is one of the most ambitiously created module of aseba bi integrated information system, aiming to provide general support for all types of loans appearing in banking practice. within this module automated calculations are started from the batch processes triggered by the operating system, based on a defined sequence, at night and/or in morning. the following processes are automated: accounting and posting processes of due receivables and due liabilities, distribution of payments, collection from current account, successive release of deposits which secure a loan, creation of fixed interest rates, and creation of printed notifications. in this module, as well as in the previous one, batch processes directly affected improvement of information quality, which improves the quality of services and users’ satisfaction. example 3 – stp in national payment processes. subsystem for support of domestic payment system fully automates data exchange with clearing house, national (central) bank, agency for enforced collection and bank association (clearing of cheques) which is provided by this module integration with other modules of aseba bi system. every incoming message mt102, mt103, mt202 also generated in the payment operations system a posting order by which funds are paid to customer’s current account or to undistributed income when instructions are not complete. the system includes option of setting the stress level of batch processes which process the messages of giro clearing. besides, when an aseba bi system operator enters a transfer order, the system batch processes send an authorization order (control of current account’s balance of ordering party). if there are not funds, the processes stop the order in the order status „waiting for inflow to account“. after the inflow to account is realized, and when the ordering party’s balance on account is increased so that the order can be realized, the processes send the order to further processing. the system generates swift message, e.g. mt103 as well as the posting order. as well, system recognizes answer to this message. the answer is processed so that a posting order is generated, and then payment system order gets status realized, which means that its life cycle has ended. bank’s system parameterization can stop and check the order at two points of this process: a) immediately after the order is entered (when order is verified, i.e. when order data are checked), b) in assets management department, before a swift message is generated. finally, upon the receipt of message announcing account blocking, system attempts to collect the required amount from accounts of the customer whose accounts are to be blocked. if there are not enough funds no actions are taken, and at bank’s decision, a responding message is sent notifying that there are not enough funds so that request based on announced blocking message could be realized. when a blockade message is received, the system enters the customer to the black list (that is a log of customers by their id numbers where history of all blockade requests is recorded). if the customer has accounts which are subject to enforced collection, the system blocks them and a message on these accounts’ bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 81 balances is sent to the collection agency. the following phase is receipt of requests for payment based on blockade. banks can stop this request or they can allow its automatic processing depending on the system parameterization. upon the realization of payment order, the message on realization is automatically sent to the agency. upon the receipt of an unblock message the customer is removed from the black list and all its accounts are released, so that there are no other active blockades. in the previous version of this programme, all the specified steps were performed manually, most frequently by using excel spread sheets. that caused frequent errors and relatively slows processing. after the automation was introduced, the processes became faster, error free and this effected improvement of quality of all analysed parameters (system, information and service quality), which however improves user satisfaction, too. example 4 stp in international payment processes. international payment processes are supported by stp as much as it is allowed by regulations of the country where the programme is implemented to automatically cross book the inflow from a foreign country to a customer’s account. starting from february 2005, all f/x accounts have the structure of international bank account number (iban) which enables higher automation both of inflow and of outflow. when a message mt103 is received from the swift network, it triggers the automated processing of inflow (mt103) throughout batch processes along with the posting of inflow to the customer’s account. figure 6 shows a scheme of inflow message automation. figure 6. automatized loading of incoming mt103 from swift (straight-through processing) source: asseco-see internal material automatic file processing from swift service rma (relationship management application), by which banks exchange data on direction and type of messages which can be economic analysis (2013, vol. 46, no. 3-4, 72-86) 82 exchanged, is also supported. method of payment (serial or with coverage) is determined based on uploaded data, through the mechanisms of rules and priority definition of f/x payments from nostro accounts. the connection with swift is established at three levels. swift alliance entry is a software solution authorized by swift for access to swift network. it is usually installed on a separate machine which is kept in special conditions. swift client is asseco software solution which serves as interface between aseba bi f/x payment system and swift alliance entry package. it imports generated swift messages from aseba bi tables and delivers them to the other side in form of files. swift client can also run vice versa: it can take files with messages coming from swift and stores them into aseba bi tables. aseba bi subsystem for f/x payment operations stores generated swift telecommunication messages into special tables wherefrom, soon afterwards, swift client collects them and sends them into the world. these tables also contain all received swift messages. modules of aseba bi module for f/x payment system search for and process these messages. the automation applied in this segment of information system considerably improves information quality and service quality. example 5 – automation of treasury back office (tbo) and treasury (trading) f/x positions. the automation encompasses processes which are identified in operational work as bottle necks, and these are automatic posting of products, recording of review of f/x position and generation of swift messages. deals are not entered manually into aseba bi system but they are automatically imported from reuters application. import and generation of swift messages by products (mt300, mt399, mt202, mt320 and mt299) are automated, too. earlier operators used to match swift messages with appropriate reuters deals, but now this matching is automated. processes of loans and deposits (e.g. for money market product) had to be executed from loans and deposits module. after the automation and integration, loans and deposits can be directly processed from tbo module. the term treasury (trading) position means a total current balance of local and foreign currencies with bank. there are two types: f/x position (recorded in foreign currencies) and position in local currency. the application supports automatic recording and creation of f/x position which is required for management with funds and making of tactical and strategic decisions regarding trading with currencies. basic product characteristics of f/x trading position are as follows: • balances by items which enter into the treasury f/x position are read automatically in batch processes; • during the day, announcements are used for position definition (disbursements and loan and deposit repayments, f/x trading operations, etc.), and after the cut-off time real postings are used for accounting of the position (where „real“ position can be accounted several times before the end of day); • it enables manual entry of amounts which are not included by automatic balance accounting; • the position is kept in currencies which bank parameterizes and • initiation of the position items accounting is enabled for a date in the past. bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 83 the previous generation of banking software did not have this module, but it was developed due to the business requirements. the application of automation in this module appeared as an imperative for this particular process, as manual execution of operations relating tbo and trading would not be possible in modern business conditions. example 6 – securities. stock exchange is connected with aseba bi system through the client application and therefore automatic sending, withdrawal and modification of entered orders are enabled. the responding message from the stock exchange on complete or partial realization of a broker order is processed into the aseba bi system and then the order receives its final status (completely or partially realized). figure 7. exchange of swift messages between participants in securities trading source: asseco-see internal material upon the receipt of a message mt295 from the central register, the bills of sale on trading with securities are generated by aseba bi system and stored into the bills of sale records. in addition, bills of sale are grouped based on the security type, and it is controlled whether the customer’s accounts exist, and their balances are checked. simultaneously with placing of a bill of sale into unique bills of sales record its initial status in its life cycle is defined, as well as its status regarding its meeting of trading requirements. for verified bills of sale bank notifies the central register on conformity or inconformity regarding continuance of trading with securities by sending messages mt296 (for trading through money account of seller, security account of buyer and security account of seller) and mt202 (for trading through money account of buyer). in addition statuses of confirmed or rejected bills of sale are automatically updated. message mt900 from central register bears a piece of information on provided approval for money accounts of members and it is sent for bills of sale which refer to money accounts of buyer customers. message mt910 from central register bears information on provided approval for money accounts of members and it is sent for bills of sale which refer to money economic analysis (2013, vol. 46, no. 3-4, 72-86) 84 accounts of seller customers. upon the receipt of these messages within trading of bonds, provisions of funds reserved on date of trading are automatically executed, reservations are made of market values and bank, beokliring and broker fees, and appropriate postings are performed. when shares are traded, along with the receipt of these messages, grouping of share bills of sale is allowed, and posting is performed automatically upon the receipt of messages. when these messages are received, for trading with bonds and shares, the posted bills of sale are automatically transferred to the final status. after the message mt292 is received from the central register, bills of sale which were withdrawn, i.e. rejected on the starting date of trading, are automatically transferred to the final status. stock exchange and stock exchange operations have to provide accuracy and timely performing of transactions, which are their key success parameters. however, stock exchange transactions are closely related with financial flows whose transfer is in charge of bank custody. the development level of this operational segment is not very high in serbia, but in spite of that banks recognized the need to improve this information system segment, so that creation of a link between internal and external stock exchange segments was to be expected in the development of the new generation software. some empirical evidence when the banks decide to introduce a new version of the banking information system they expect to improve working processes. in order to measure performances banks use several indicators. also, asseco-see has its own, internal evidence for all banks with the system. in this paper we used empirical evidence for six banks with aseba bi based environment. figures that will be displayed are the average values of selected indicators for six banks. in loan module we chose a) accounting position of interest maturity and b) loan collection as typical transactions. before implementation of aseba bi system 4,856 calculations and entry of interest could be finished in 120 minutes, and that job needed 2 employees. after the introduction the new system, with active batch processes, the same number of transactions can be finish in 25 minutes, without the involvement of banks employees. the evidence for transaction of loans repayment entry shows even better results. before, banks needed 90 minutes and 3 employees for 5068 transactions and now the some process can be finished within 8 minutes, without the involvement of banks employees. in module for international payment processes the chosen transaction is execution of payment order and bank expense invoiced upon incoming mt103, type our. in old system 1 employee could execute 9 orders per hour, and for one order it needed 6 minutes and today 1 employee can execute 18 orders per hour. the time for one order is reduced to 3 minutes and 30 seconds. in the case of order 191 in old system banks needed 3 employees for 41 orders within 240 minutes and today 1 person can finish the same number of transactions within 1.04 minutes. finally, we chose order execution as a typical transaction in the securities module. before introducing new system banks needed 1.30 minutes for 1 order execution and 1 employee. with the support of aseba bi information system banks can execute 136 orders within 3 bradić-martinović, a., et al., case study aseba bi, ea (2013, vol. 46, no, 3-4, 72-86) 85 minutes and that process can be handled by 1 employee. the same process needed 60 minutes and 2 employees in old system. presented evidence showing a drastic increase in efficiency in the execution of transactions, reducing execution time and reducing the number of employees engaged in the work. conclusions analysis conducted in this paper shows that implementation of automated processes, i.e. batch processes and stp have substantial impact on successful application of information systems and results in banking business. based on aseba bi integral information system, product of asseco-see company we can conclude that all three parameters that we observed information quality, service quality and users’ satisfaction are improved in all automated module: core banking system, loans module, national payment processes, international payment processes and securities module. evidence provided at the last part of the paper support the hypothesis. the analysis based on case study methodology is often subjective, but the cross study analysis or benchmarking can improve results. regarding that we propose further research of this subject. references asseco-see, reports and internal material. clemons, e., and weber, b. 1990. “strategic information technology investments: guidelines for decision making.” journal of management information systems, 7(2): 9-28. clemons, e. 1986. “information systems for sustainable competitive advantage.” information & management, 11(3): 131-136. darke, p., shanks, g., and broadbent, m. 1998. “successfully completing case study research: combining rigour, relevance and pragmatism.” info systems j, 8: 273-289. flyvberg, b. 2006. “five misunderstandings about case-study research.” qualitative inquiry, vol. 12(2): 219-245. khanna, a. 2008. straigh through processing for financial services.london, new york: elsevier. leinonen, h., and soramäki, k. 1999. “optimizing liquidity usage and settlement speed in payment systems.” bank of finland discussion paper, financial market department. morrison, a, and, william, w. jr. 2008. “the demise of investment-banking partnerships: theory and evidence.” the journal of finance, 63(1): 311-350. petter, s., delone, w., and mclean, e. 2008. “measuring information systems success: models, dimensions, measures and interrelationship.” european journal of information systems, 17: 236263. foss, b, stone, m. 2008. crm in financial services – a practical guide to making customer relationship management work. beograd: dmd. ives, b., learmonth, g. 1984. “the information system as a competitive weapon.” communicaton on the acm, 27(12): 1193-1201. pikkarainen, t., pikkarainen, k., karjaluoto, h., and pahnila, s. 2004. “customer acceptance of online banking: an extension of the technology acceptance model.” internet research, 14(3): 224-235. economic analysis (2013, vol. 46, no. 3-4, 72-86) 86 khare, a. 2010. “online banking in india: an approach to establish crm.” journal of financial services marketing, 15(2): 176-188. coltman, t. 2007. “can superior crm capabilities improve performance in banking.” journal of financial services marketing, 12(2): 102-114. han-yuh, l. 2007. “development of a framework for customer relationship management (crm) in the banking industry.” international journal of management, 24(1): 15-32. primena batch i automatizovanih (stp) procesa u bankarstvu – studija slučaja aseba bi rezime – jaka konkurencija na tržištu bankarskih usluga dovela je do velikog oslanjanja banaka na informacionu tehnologiju. u poslednjoj dekadi glavni progres učinjen je na polju uvođenja straight-through procesiranja (stp) i batch procesiranja u banke. odabrali smo četiri parametra za analizu: kvalitet sistema, kvalitet informacija, kvalitet usluge i zadovoljstvo potrošača. integralni informacioni sistem kompanije asseco-see, aseba bi predstavlja slučaja na kojoj je izvršeno istraživanje. kroz analizu nekoliko primera: primena batch procesa u core bankarskom sistemu i kreditnom modulu, primene stp procesa u domaćem platnom prometu, međunarodnom platnom prometu, trgovini devizama i hartijama od vrednosti zaključili smo da batch i stp procesiranje imaju veliki uticaj na odabrane parametre. ključne reči: bankarstvo, informacioni sistemi, automatizovani procesi, straight-through procesiranje, stp, batch procesiranje article history: received: 21 july 2013 accepted: 21 november 2013 2013_1_2 original scientific paper absorption capacity of european union pre-accession programs in croatia ivandić vladimira1, ministry of finance, zagreb, croatia kandžija vinko, faculty of economics, university of rijeka, rijeka, croatia kandžija jelena, attorney at law, zagreb, croatia udc 339.96(4-672eu:497.5) jel: f36 id: 198578444 abstract – the utilization of european union (eu) financial assistance is one of the central issues for member states, as well as candidate countries like croatia. in order to fully gain from the allocated resources of the eu budget, each country needs an adequate absorption capacity (ac). this article is about the absorption capacity of eu pre-accession programs in croatia. the absorption capacity of eu pre-accession assistance is seen from two theoretical standpoints: the first originates from development economics, while the second developed from the theory of multilevel governance (mlg). the purpose of this article is to analyse the factors / determinants of absorption capacity, and the implementation of pre-accession programs in croatian municipalities. in order to test the relation of ac and implementation (usage) of the eu funds, an empirical multivariable regression model of ac was established. the empirical estimation confirmed the expected positive correlation between the ac and eu funds. another key issue that was discovered is that ac is very much a dynamic concept in the sense that ability to use eu funds changes over time, in response to a variety of endogenous and exogenous factors. as such, it calls for broader analysis and presents a challenge for further work on the subject. keywords: absorption capacity of financial assistance, eu pre-accession programs, municipalities, multilevel governance introduction the absorption capacity (ac) of european union (eu) financial assistance is a pertinent topic, particularly in light of croatia’s imminent membership in the eu. the eu financial assistance provides quantifiable benefits for croatia today in the form of pre-accession programs and, in the near future, as an eu member state, in the form of structural funds and cohesion fund. the ac depends on several key factors that are the focus of this research. although relevant, the issue of the absorption capacity of eu financial assistance has not been analysed in a comprehensive way, although the matter is a subject of heavy debate mostly within the national political arena. the academic literature on eu financial assistance is more oriented to the issue of the effectiveness of funds and less to the analysis of the ac. moreover, there is no systematic approach to the concept of the absorption capacity 1 address: lopašićeva 13, 10000 zagreb, e-mail: vladimira.ivandić@mfin.hr economic analysis (2013, vol. 46, no. 1-2, 53-71) 54 of eu financial assistance. therefore, this article presents an attempt to contribute to the literature on ac; for that purpose it will analyse the implementation of pre-accession programs in croatia with particular focus on the municipalities. this article begins with a review of the academic literature on ac from the two theoretical perspectives. the second part covers the ac of eu financial assistance, while the third part presents the analysis of the ac of pre-accession programs in croatia. finally, the fourth part contains the empirical model along with the results of the regression analysis, followed by the conclusion. theoretical considerations and literature review there is an absence of a theoretical framework of absorption capacity problems related to eu financial assistance. this is rather strange as interest in the topic is relatively high; one of the reasons often stated is because of its novelty and “changing nature”. horvat (2004) concluded that the absorption capacity of eu funds is still considered a “work in progress”. the issue of the absorption capacity in this article is considered from two theoretical standpoints. the first originates from the field of development economics and is based upon a consideration of the absorption capacity in the context of the effectiveness of the foreign assistance (aid). the second approach developed from the theory of multilevel governance (mlg) that was introduced to explain the nature of the european union (eu) cohesion policy and the implementation of the structural funds. development economics on absorption capacity one of the first works within development economics that captured the concept of absorption capacity of foreign aid was written by rosenstein-rodan (1961). his analysis of capital flows to less developed countries (ldcs) revealed their need to boost their investments and expedite the process of economic development. capital transfer from the wealthy and developed countries could trigger the sustainable growth in the ldcs and influence the catch-up process only if the ldcs possessed an adequate absorption capacity. the concept of absorption capacity was developed to account for and to measure the amount of foreign financial assistance that less developed countries (ldcs) can productively utilize during a set period of time. within academic literature, absorption capacity is seen as one of the constraints that influence the growth in ldcs; however, it also serves as a tool to measure the scale of the development assistance provided to them (clemens, radelet, 2003). following the decision taken by the international development community in 2005 to increase aid volume, the discussion about the ‘aid effectiveness’ was initiated, subsequently highlighting the concept of ‘absorptive capacity’. on one side were advocates of a general expansion of aid, while on the other side were opponents who cautioned against too much aid being delivered beyond the actual absorptive capacity of a country. the term absorptive capacity is used for an ability to implement additional aid without pronounced inefficiency of public spending and without induced adverse effects, such as ‘dutch disease’, or crowding-out of domestic saving (de renzio, 2005). bourguignon and sundberg (2006) state that, to date, there has been very little systematic effort to either define ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 55 the key drivers of absorptive capacity, or to measure a country’s ability to absorb foreign assistance. literature on development economics considers that a country has reached its absorptive capacity limit for foreign aid when the rate of return on further increments of aid falls to some minimum acceptable level (radelet, 2003). beneficiary countries could benefit from foreign assistance if there was an institutional and administrative capacity to effectively utilize the provided financial resources. collier and dollar (2002) concluded that many ldcs suffer from capacity constraints and, as a result, the potential benefits from additional aid may be constrained by weak capacity. several empirical international studies (hansen and tarp, 2001; dalgaard et al., 2004) revealed that, after a certain level, additional aid to gdp has little effect to growth. this ‘saturation point’ is a function of different proxies for absorptive capacity arising from macroeconomic, institutional, infrastructure, human resources, or socio-cultural constrains (collier and dollar, 2004). the world bank (2004) states that most ldcs suffer from an inadequate capability to absorb additionally-allocated financial assistance. absorption capacity is considered a constraint to the further allocation of aid and is one of the primary reasons of aid inefficiency; the additional financial aid simply does not generate economic development and growth in ldcs. several economists argued that, for many ldcs, there were severe limits on how much financial assistance could be utilised productively, or “absorbed”, as a consequence of low skill levels, lack of managerial talent, and poor governmental administrative facilities (adler, 1965). an extensive literature on policy environment linked ac to ‘good policies and institutions’ – countries that can absorb larger amounts of aid before diminishing returns set in (heller and gupta, 2002; dollar, pritchett, 1988). in countries with low capacity, the saturation point arrives much sooner and additional amounts of aid are unlikely to be very productive. bourguignon and sundberg (2006) commented that this conclusion is intuitive and appealing, even though it is derived from an international analysis, which is of little help when examining the case of a particular country. moreover, the literature is not overly clear on the causes of the complex phenomenon of declining returns. bourguignon and sundberg (2006) also state that the return to aid has many dimensions. in figure 1, return to aid is associated with the rate of growth of gdp. this return will vary depending on several initial conditions – institutions, endowments, policy environment, etc. – working in isolation or together. it is an increasing function of the amount of aid that is made available. the distinction between aid effectiveness and absorption capacity is depicted in the following figure. aid effectiveness can be characterized as the difference between the top and bottom curves, representing the return to aid in two different countries. country 2 is able to utilize aid more effectively than country 1 at any given level of aid (relative to the size of its economy) due to a combination of endowments, institutions and policies. economic analysis (2013, vol. 46, no. 1-2, 53-71) 56 figure 1. aid effectiveness and absorption capacity source: bourguignon, sundberg, 2006 the limit of absorption capacity is reached when the marginal rate of return falls below some minimal acceptable level. the absorption capacity (marginal return for a given aid / gdp ration as depicted by the slope of the curve) may be higher or lower than in the country with higher aid effectiveness. this underscores the fact that aid effectiveness and absorption capacity are dynamic processes linked to the underlying forces of economic development and change over time. absorption capacity refers to the marginal rate of return to aid, which declines as the amount of aid increases. hansen and tarp (2001) assume that increasing aid beyond some limit may even be detrimental to the recipient economy at some stage. bourguignon and sundberg (2006) state that the literature is not very clear on the causes of the complex phenomenon of declining returns and they conclude that there is little insight in the literature provided from country-specific examples of absorption capacity constrains. in order to clarify concepts they suggest a distinction between the broad factors that influence aid effectiveness over time, and absorptive capacity at a given point in time. they also define several broad categories as overall absorption capacity constrains: quantitative, macroeconomic and institutional. finally, they also conclude that ac needs to be country specific. theory of multilevel governance (mlg) and eu financial assistance the theory of multilevel governance rests on methodological assumptions that – rather than consider the state as a unitary actor – examine the decision-making of specific other actors, such as municipalities, etc. it assumes that the various actors have multiple, potentially incompatible goals and it finds that the influence of actors varies widely across different levels of government. in cohesion policy the influence of the european commission (ec) is shaped by the formal rules governing decision-making by the resources it can bring into play (marks, 1996). the fact that decisions concerning financial redistribution are made before decisions return to aid (e.g. gdp growth rate) relative volume of aid (e.g. aid/gdp) ∆ aid effectiveness ∆ absorptive capacity country 1 country 2 ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 57 concerning broad policy goals, or decisions concerning institutional design, is a distinctive feature of eu structural funds (and cohesion policy in general). marks (1996) commented that in a case of cohesion policy it is “funding looking for a set of institutions” while many policy areas can be described as a set of institutions seeking funding. the implementation of structural funds – determined by procedures among ec, member state, central, regional, local governments (sub-national governments) and other actors after the radical reform of the structural funds in late 1988 – gave the ec an impressive degree of financial and bureaucratic influence (hooghe, marks, 2001). several aspects of the conflict – including the way in which local actors were mobilised, their alliance with the commission, their effectiveness in shifting the government’s position – support the claim that structural policy has provided sub-national government with new political resources and opportunities in an emerging multilevel policy arena. the creation of regional partnerships to administer the structural funds (in 1988) was an attempt by the commission to empower sub-national actors at the expense of national government domination over the implementation process. marks (1993) cited the partnership principle as part of this argument that structural policy appeared to be a twosided process, “involving decentralisation to sub-national levels as well as centralisation of new powers at the supranational level”. as such, structural policy was seen to be “the leading edge of multilevel governance in which supranational, national, regional, and local governments are enmeshed in territorially overarching policy networks.” mlg breathed new life into the debate about the eu structural policy process and drew attention to the increased role played by the commission at the eu level as well as the emerging role of sub-national players at the implementation stage (bache, 2004). mlg dealt with the main actors as well as different levels and instruments of the cohesion policy. in spite of the fact that it was initially developed as a concept to explain the decision-making process within the european union, mlg represents a process of the implementation of eu funds. therefore, as such mlg provides an adequate background for the analysis of the absorption capacity of eu funds. through analysing the eu structural policy and the role of the ec, marks (1993) pointed out several crucial principles upon which the structural funds operate; these principles present the main framework under which the structural funds operate. absorption capacity of eu financial assistance literature on the absorption capacity of eu funds does not offer a unique definition for the term. herve and holzmann (1998) define the absorption capacity as a lack of institutional and administrative capacity. for šumpikova et. al. (2004) absorption capacity meant the extent to which a country is able to fully utilize all allocated financial resources from the eu funds/programs in an effective and efficient way. most definitions state that it represents the capacity of country to absorb an allocated eu fund/program, with more emphasis on quantitative aspects. others, such as mrak and tilev (2008) state that the absorption capacity denotes the degree to which a country is able to effectively and efficiently spend the financial resources from the eu so as to make a significant contribution toward economic and social cohesion. for the european commission, absorption capacity means the capability of the economic analysis (2013, vol. 46, no. 1-2, 53-71) 58 state (or region, unit) to use allocated funds in an efficient way. horvat (2003) concludes that the definitions of structural funds’ absorption capacity are usually based on different evaluation studies and reports prepared for and published by the european commission. for the purpose of this article, the absorption capacity stands for the degree upon which the country is capable of utilizing financial resources from the eu pre-accession programs. in order to use all the resources allocated from eu funds, it is necessary to have a statecreated institutional system to ensure an absorption capacity capable of managing the given resources (begg, 1999). conversely, it is also required to have absorption capacity from the beneficiaries to design and program projects. two distinct characteristics most frequently referred to as absorption capacity relate to supply and demand (šumpikova et. al., 2004). the first is usually connected with the programming and managing of eu funds, and it essentially falls within the responsibilities of the national/government level. the demand side of the absorption capacity relates to recipients; in the case of pre-accession programs, the final beneficiary and recipients are bodies at the government level. however, in the case of structural funds, recipients are more broadly defined (mostly at the local level, but also from the business community, ngos etc.). one could also speak about two distinct characteristics of the absorption capacity for the eu funds horvat (2005). a review of academic literature indicates the absence of a conceptual framework to comprehensively assess the issue of absorption problems related eu financial assistance. milio (2007) pointed out that existing literature on eu financial assistance lacks in-depth analysis of the implementation process. she stated that the vast majority of authors have been more concerned with the policy-making process, or with the economic impact of the resources to the economic and social structure of the country. in line with the most accepted definition of absorption capacity – stating that it represents the capability to absorb an allocated amount of eu financial resources – absorption capacity is usually measured by the absorption rates. in the european union’s evaluation practice even the effectiveness of structural funds’ interventions is measured through absorption rates. the absorption rate measures the ex-post investment output of structural funds’ spending in relation to ex-ante targets. the absorption rate therefore illustrates the absorption capacity and is defined as ‘the level of spending as a percentage of the total amount of structural funds available’ (horvat, 2004). achieving an absorption rate of 100% means that all funds allocated to a country have been fully utilized. on the contrary, if a region is unable to achieve 100% of the targeted values (allocated amounts) it is considered to have an absorption problem. herve and holzmann (1998) provide an output-oriented explanation of the absorption problem; namely, that any deviation from the potentially highest growth path can be conceived as an effect of the absorption problem. however, the absorption problem is usually defined as the case when the recipient country (or region) fails to achieve 100% of its target value programmed a priori, which means that the absorption capacity to deliver and implement the given operational program is inadequate. this approach is input-oriented. in both approaches the gap between the targeted optimal values and the measured real values (in investment of marginal outputs) is reflected in the so-called absorption rate. the european commission uses absorption rates to assess the progress of financial management and the implementation of funds and programs. ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 59 it is worth mentioning that the precise measurement of the effectiveness of pre-accession programs, as well as of the absorption capacity, is often hampered by the unavailability of data. in order to measure the absorption of eu funds spending, the contracting rate could be just one of several other indicators. the european commission often uses absorption rates during the formal process of evaluation to assess the progress of fund management. the effectiveness of absorbing eu funding on a national level is frequently presented in various ways in the form of rates, such as commitment rates, contracting rate (the share of signed funds), payment rates, etc. besides, eu financial assistance is difficult to assess, because structural changes take longer to generate and often suffer from the lack of systematic evidence. absorption capacity of the pre-accession programs in croatia research into the absorption capacity of eu financial assistance in croatia is based on quantitative analysis of the implementation of the pre-accession programs (mainly the phare and ipa programs). these pre-accession programs are still currently in use; they present an important source of investments following the areas of co-operation and negotiation with the eu. as a candidate country for membership in the european union, croatia is a beneficiary of the european union’s pre-accession programs. when it becomes a fully-ratified eu member state, croatia will be eligible for the resources of a cohesion policy, as well as common agricultural and fisheries policies. as such, croatia will be the beneficiary of structural funds, cohesion fund, agricultural fund and fisheries fund. overall, the financial assistance provided to croatia under the pre-accession programs is more than eur 1.255 billion (ministry of finance, 2012). only the phare and ipa programs include several hundred projects, worth in excess of eur 1.1 billion. some of the preaccession programs have already been completed (for instance phare 2005 and phare 2006, ipa 2007) while some are still currently under implementation (mainly ipa 2008-2010) – part of them are still in the preparatory phase. the scope of the research on ac of pre-accession assistance primarily focuses on the phare and ipa national programs, while other forms of eu pre-accession assistance (such as phare horizontal programs, regional programs, ispa and sapard/ipard) are not covered. there are several reasons for this. the first reason is that the phare objectives could be best characterized as the areas of intervention that have explicit connections with the accession process. the taib strategic objectives are even more closely linked with the eu accession, as they basically coincide with the fulfilment of the copenhagen criteria. phare and especially ipa have institutional set up and financial management alike the one similar to that of the structural funds. the second reason is more of a technical nature as it is related to the type of implementation of the program. it was chosen because they are implemented under the so-called decentralized implementation system (dis) in which national authorities are responsible for the system of financial management and the implementation of preaccession programs under the system of ex-ante control (performed by the eu delegation). economic analysis (2013, vol. 46, no. 1-2, 53-71) 60 figure 1. scope of analysis of eu pre-accession assistance cards phare national program s phare cross -border cooperation phare other horizontal/regional program s ipa national progra ms ipa multi -beneficiary comp onent i (taib) comp onent ii (cbc) comp onents iii, iv & v 2004 2005 2006 2007 2008 2011 scope source: author research into the absorption capacity takes place at both the national level and local (regional) levels. special emphasis is devoted to the absorption capacity of financial assistance of municipalities in croatia because their roles need to be strengthened through the use of the structural funds. moreover, regional and local government levels will become important actors in the whole process of the implementation of the eu funds. several recent analyses in the new eu member states reconfirm that the local governments in the system of usage of structural funds are one of the most important instruments in their socio-economic development, while the capacity to absorb the funds is primarily limited due to the low absorption capacity at the local government level (tatar, 2010). the data relevant to the study of absorption capacity is limited with regard to both structural funds and economic variables (hagen and mohl, 2009). it is the case with eu preaccession programs. for this research, data was collected from a survey conducted from the beginning of 2012 until april 2012. the survey was sent to all municipalities along with relevant questions to assess the absorption capacity of eu financial assistance in croatia. some of the questions were devoted to obtaining opinion on the overall functioning of the financial management system of the pre-accession programs. in addition, a few questions were included in the survey to provide feedback on the capability and managerial skills of the staff working on the eu project implementation (covering all phases of the project cycle – from programming to implementation and evaluation). furthermore, the questionnaire covered the different aspects needed to determine the factors of the absorption capacity of eu financial assistance, in accordance with the main goals of the research. besides the first question, which related to identification, the questionnaire covered five main sets of questions, namely: 1. assessment of the participation of the municipalities during the implementation of the pre-accession programs. this topic covered several important issues, starting with their participation in the programming process through to their ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 61 experiences during the implementation of projects within the allocated preaccession programs. 2. success factors combine with judgement about limitations in the implementation within the whole national system of financial management of pre-accession programs. for the purpose of this analysis, eight areas were covered; specifically, those relating to the availability of information, the decision-making processes, financial management, formal rules and eu procedures, readiness of the other actors within the system, interests of the beneficiaries, cooperation between different non-governmental actors, and the availability of financial support required for the implementation of eu projects. 3. success factors in line with the activities connected to the implementation of eu projects, which are within the scope of municipal responsibility. this topic also covered specific problems characterized for the implementation of actual projects. these factors were then summarized in seven categories, starting with institutional strengthening and adequate human resources, readiness (mature) project proposals, as well as questions related to sustainability upon project completion. the other set of questions was devoted to analysing the motivation of the staff involved in the process of eu projects, their observations on internal organizational issues in connection with the implementation of eu projects, details on activities covered by the job description, and division of labour within the staff responsible for the eu projects. success factors also include overview of the necessary conditions for the implementation of eu structural funds that are in place (such as, those that relate to the execution of partnership principle, etc.). 4. assessment on co-operation with other actors in the implementation of eu projects including relations with the state (national) level, other actors within the municipal level (town representatives, etc.) as well as with public companies and business community. 5. information on realized (contracted) eu pre-accession projects, as well as the one that is still currently in the preparatory phase. this topic included all relevant data about the nature of the project, modalities, categories, timing, etc. this set of questions was divided into a few subcategories, starting with the type of preaccession program and programming year, then the type of project (works, technical assistance, grants, twinning, etc.), followed by basic information in relation to size, project duration, components, etc. using statistical analysis, the main factors of the absorption capacity of eu pre-accession programs in croatia were identified. lastly, correlation between the absorption capacity and the utilization of the pre-accession programs was tested in order to reconfirm the projected positive connection. the assessment revealed that the absorption capacity of the eu pre-accession programs is adequate. the efficiency of the utilization of pre-accession programs rated higher than average (table 1.) – the arithmetic mean is 3.5, while the mode is 4.0. economic analysis (2013, vol. 46, no. 1-2, 53-71) 62 table 1. eu pre-accession programs’ effectiveness and importance arithmetic mean standard deviation variation coefficient mode asymmetry coefficient effectiveness 3.5 1.0 29.6 4.0 -0.5 participation in the planning process 2.3 0.7 31.3 2.0 0.2 program importance 4.1 0.8 18.8 4.0 -0.2 readiness for implementation 3.6 0.7 20.9 4.0 0.1 * for each activity, the rating is from 1 to 5 (where 1 is the lowest score). source: author the results of the quantitative analysis conducted at the municipal level reveal the key factors of the absorption capacity of the pre-accession programs in croatia. the following table (table 2.) presents the relevant factors of the absorption capacity of the eu preaccession programs. table 2: factors of the absorption capacity arithmetic mean standard deviation variation coefficient mode asymmetry coefficient information 4.1 0.7 15.8 4.0 -0.1 management 3.8 0.9 24.4 4.0 -0.8 organisation 3.9 0.8 21.3 4.0 -0.4 institutional support 3.9 1.0 26.3 4.0 -0.6 staff experience 3.7 0.7 19.3 4.0 -0.4 motivation of staff 4.0 0.9 22.4 4.0 -0.5 responsibility of staff 4.2 0.7 16.5 4.0 -0.4 rewards policy 2.7 1.3 47.9 2.0 0.4 * for each activity, the rating is from 1 to 5 (where 1 is the lowest score). source: author the results show that the main influence on the absorption of the eu pre-accession programs is the administrative issue (71.4%). in second place, equally important is harmonization with the national development strategy. it is interesting to note that almost a quarter (23.4%) of all municipalities think that political support is also crucial for the effective utilization of the eu pre-accession programs. in regard to the more technical issues, the preparation of project documents and the readiness of projects are also important. the majority of municipalities think that this has extreme influence on the absorption capacity. specifically, more than 61% of municipalities are of the opinion that mature projects are more able to absorb, as they have all the prerequisite project documentations and licences ready for their implementation. as a result, there is no delay and the contracting deadline is usually achieved within the given ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 63 timeframe. also crucial in the case for the efficient usage of eu pre-accession programs are well-defined projects with clear objectives that are easily implementable and straightforward. municipalities are considered institutional building and availability of skilled staff as the second most important factors for the absorption of eu funds. conversely, it is rather surprising that only 19% of municipalities recognize the exercise of the partnership principle to be one of the main elements that influence the absorption of funds. this is in line with the fact that the partnership principle was not often exercised in the case of pre-accession assistance, as it was not formally required. it is further worth mentioning that the partnership principle is of extreme importance for the usage of structural funds; therefore, in the near future, much work would need to be devoted to its proper introduction within the system of implementation. if we compare the results of the analysis and actual data on the contracting of projects, interesting observations could be made in regard to the absorption capacity. from the data on contracting and disbursements of eu projects, it is evident that most developed municipalities contracted more funds from pre-accession programs. they additionally claim that their absorption capacity for the implementation is quite high. the structure of the municipalities in the contracting of eu projects (from pre-accession programs2) is presented in the following figure (figure 2). figure 2. municipalities by contracted amounts (cards 2003-2004, phare 2005-2006, ipa i3, iib 2007-2009) 0 2 4 6 8 10 12 14 16 18 20 bjelovarsko-bilogorska brodsko-posavska county dubrovačko-ner etvanska city of zagreb istar ska county karlovačka county koprivničko-križevačka krapinsko-zagorska ličko-senjska međimurska county osječ ko-baranjska požeško-slavonska primorsko-gor anska sisačko-moslavačka splitsko-dalmatinska šibensko-kninska varaždinska county virovitičko-podr avska vukovarsko-srijemska zadar ska county zagrebačka county percentage of total contracted amount source: author 2 programs are: cards 2003-2004, phare 2005-2006, ipa 2007-2009. 3 in the case of two municipalities eligible for cross-border cooperation, projects from ipa ii were also included. total contracted amount: 59,4 mio ura economic analysis (2013, vol. 46, no. 1-2, 53-71) 64 it is obvious from the figure that the capability to contract (and absorb) the eu resources differ between the various municipalities. one of the reasons could be because of the strong influence of the factors characterized from the demand side of the absorption capacity. in regard to the supply factors of the absorption capacity, the administrative dimension is positioned as dominant. it is evident that where administrative capacity in municipalities is higher, they are better able to disburse more eu assistance, meaning that they developed an adequate absorption capacity to efficiently utilize allocated eu resources. however, it is also necessary to emphasize that in the case of the croatian municipalities, the differences between the contracting rates are not entirely the result of the absorption capacity. in the case of pre-accession programs, a couple of municipalities were in the position to fully utilize other possibilities and programs (for instance, cross-border cooperation) while the rest were not eligible. alternatively, economic constraints (co-financing elements) were not emphasized as expected because finances were mainly secured by the state budget or other financing sources, including loans from international financial institutions such as the european bank for reconstruction and development, (ebrd). in order to test the correlation between the absorption capacity and the implementation of the eu pre-accession programs, statistical analysis was conducted. first, the relation between the elements of the absorption capacity and efficiency of the eu pre-accession programs was tested. the correlation was estimated by using statistical analysis (sas statistical program package) in order to calculate the pearson coefficient and the spearman coefficient. however, the pearson coefficient was not appropriate for testing the correlation between the absorption capacity and the implementation of the pre-accession programs because it is adequate for the estimation of linear correlation. therefore, the spearman coefficient was calculated and the results are presented in the following table (table 3) which confirms that the correlation exists, though it is rather weak. table 3. spearman coefficient of the selected factors of the absorption capacity factors of the absorption capacity of eu pre-accession programs spearman coefficient success in the implementation of eu pre-accession programs 0.23538 co-operation in the decision-making process about development priorities -0.23447 importance of the eu programs -0.03753 readiness for the implementation of eu programs 0.03677 availability of information -0.31582 management and governance -0.22297 organisation -0.31175 institutional support 0.15245 staff experience 0.13946 motivation of staff 0.00755 staff responsibilities 0.08666 reward options -0.15509 source: author ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 65 empirical model and results of the regression analysis based on the conclusion from examining the correlation between the utilization of financial resources and the factors/determinants of ac, the model on the implementation of the eu pre-accession programs at the municipal level was empirically estimated. a multivariable regression model was used, in which the independent variables and functional types of model were determined in the first place by the extent of the research. the availability of set indicators of ac presented the second limitation. the model was based on the assumptions derived from the theoretical concepts behind the determinants of ac, and its influence on the use of the resources from the pre-accession programs in croatia. kpfi=f(aki) i (number of observations)= 1, …, n (1.1.) in which kpfi means the usage of pre-accession programs in each of the croatian municipalities (i), aki the absorption capacity of the municipality (i), and f an increasing function ( >0). the linear function form assumed in 1.1. allows the set up of an econometric model that allows testing the hypothesis if there exists a dependence between the use of pre-accession financial resources and the absorption capacity. the linear regression model, including an error term that is multiplied by the deterministic dependent variable: i = 1, …, n (1.2.) with • kpfi– the usage of pre-accession programs in each of the croatian municipality (i), assumed as the dependent variable in the model; • aki – the absorption capacity of the municipality (i), assumed as the independent variable in the model; • conti – a set of control variables that ensures that the model does not include a specification error leading to an omitted variable bias (kmenta, 1997), the control variables concern indicators that define the demand side of the absorption capacity; • εi~ n(0, σ2) –a normal distributed random term assumed to have a mean at zero and a variance of σ2 for every i=1, …,n. the parameters of the model can be estimated with cross-section data for each municipality (n=21, including zagreb city). the log linear transformation of the model implies: (1.3.) which a logarithmic transformation becomes a linear function: (1.4.) economic analysis (2013, vol. 46, no. 1-2, 53-71) 66 the crucial assumption of using a non-linear function form is a result of a preceding analysis that did not show a corresponding linear function between the variables. in the nonlinear log model, the estimated parameters can be interpreted as the coefficients of partial elasticity that show the amount of the relative change in the dependent variable as a result of an incremental increase in one of the independent variables (bahovec i erjavec, 2009). data gathered in the “primary research” and collected from the cfca (central finance and contracting agency) allows us the use of the following variables: • the usage of pre-accession programs in each municipality (kpf) – the use of preaccession programs in each municipality is measured as the amount of contracted projects that each municipality acquired from the eu pre-accession programs ; • the absorption capacity of municipality (ak) – the variables is defined as an aggregate indicator of the absorption capacity, and is presented a weighted arithmetic mean of selected determinants of absorption capacity; • the size of the municipality (bdp) – the size of the gross national product within a municipality is used as a control variable in the model. the data on the gross national product of each municipality is acquired from the data set of on municipalities bdp from state statistics office (publication on bdp no. 12./ “priopćenje bruto domaći proizvod za republiku hrvatsku, prostorne jedinice za statistiku 2. razine i županije u 2009., broj 12.) dated april 14, 2012.; table 1”). coefficients on the correlation between the variables show a weak relation within the variables and a very low relation within the independent variables (table 4) which is viewed upon favourably as it ensures the absence of multicollinearity in the model. table 4. the matrix of correlation coefficients within the variables in the model logkpf logak logbdp logkpf 1,0000 logak -0,0863 1,0000 logbdp 0,3404 -0,1026 1,0000 source: author’s calculations using stata 9.1. parameters in the model are estimated with the ordinary least squares (ols) method that estimates the model parameters as to minimize the squared sum of the model’s residuals. the necessary assumption for ols estimated parameters to be consistent and unbiased in any sample is the assumption of homoscedasticity. autocorrelation cannot cause inconsistent estimators in this model since the use of cross-section data is time-constant. ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 67 table 5. the estimated model of the use of eu pre-accession programs in croatia, on the municipality level method ordinary least squares (general method of moments) data cross-section data on 20 counties in croatia and the city of zagreb (n=21) dependent variable logkpf the log of the variable of the use of eu pre-accession programs independent variable coefficient t-statistic p-value logak (log of the absorption capacity, municipality level) 4,78459 3,63 0 logbdp (log of gross national product, municipality level) 1,073876 4,29 2 constant r2 (coefficient of determination) 0,9937 2(the adjusted coefficient of determination) 0,9930 breusch-pagan/cook-weisberg test of heteroscedasticity (1)=0,10 prob =0,753 ramsey reset test f(3,15)=0,67 prob>f=0,581 source: author’s calculation, stata 9.1. the estimated coefficient on the absorption capacity is positive and equal to 4,78 which can be interpreted that when the absorption capacity increases by 1% the use of preaccession programs will increase by 4,78%. the following table (6.) shows the estimated parameters of five different models where the variable logk is replaced by one or more variables: • the evaluation of the experienced of employees (variable logiskus), • the evaluation of the responsibility of employees (variable logodg), • the evaluation of the efficiency of organization of the municipality administration (variable logorg), • the evaluation of the management of the municipality administration (variable logup). economic analysis (2013, vol. 46, no. 1-2, 53-71) 68 table 6. the estimated five different models of the use of eu pre-accession programs in croatia, on the level of municipalities method ordinary least squares data cross-section data on 20 counties in croatia and the city of zagreb (n=21) dependent variable logkpf the log of the variable of the use of eu pre-accession programs independent variable model i model ii model iii model iv model v c o ef fi ci en t p -v al u e co ef fi ci en t p -v al u e co ef fi ci en t p -v al u e co ef fi ci en t p -v al u e c o ef fi ci en t p v al u e logiskus (the evaluation of the experienced of employees) 2,92 17 1,47 280 logodg (the evaluation of the responsibility of employees) 2,76 86 3,79 6 5,52 5 5,24 11 logorg (the evaluation of the efficiency of organization of the municipality administration) -2,12 0,18 -2,72 177 logup (the evaluation of the management of the municipality administration) 0,76 609 logbdp (the size of the municipality bdp) 1,46 0 1,18 0 1,24 0 1,28 0 1,32 0 constant r2 (coefficient of determination) 0,9929 0,9933 0,9929 0,9936 0,9937 2(the adjusted coefficient of determination) 0,9917 0,9922 9,9921 0,9925 0,9922 source: author’s calculation, stata 9.1. in the models in which besides the control variable (logbdp) only one variable of the each of elements of absorption capacity is used (model i and model iii) the statistically significant variables are estimated variable on experienced of employees (logiskus) and responsibility of employees (logodg). it is evident that these two variables are crucial for the assessment on the ac and the implementation of the eu pre-accession programs in croatia and consequently the further analysis on ac should be concentrated exactly on these elements. conclusion the article is about the analysis of the absorption capacity of eu financial assistance. the aim of this article had been to highlight the matter of absorption capacity of eu financial assistance and examined relevant factors of absorption capacity of pre-accession programs in croatia. ivandić, v., et al., absorption capacity of eu, ea (2013, vol. 46, no, 1-2, 53-71) 69 the issue of the absorption capacity in this article is considered from two theoretical standpoints. the first originates from the field of development economics and is based upon a consideration of the absorption capacity in the context of the effectiveness of the foreign assistance. the second approach developed from the theory of multilevel governance. research into the absorption capacity of eu financial assistance in croatia is based on quantitative analysis of the implementation of the phare and ipa pre-accession programs. special emphasis is devoted to the absorption capacity of financial assistance of municipalities in croatia because their roles need to be strengthened through the use of the structural funds. moreover, regional and local government levels will become important actors in the whole process of the implementation of the eu funds. using statistical analysis, the main factors of the absorption capacity of eu pre-accession programs in croatia were identified. the results show that the main influence on the absorption of the eu pre-accession programs is the administrative issue. based on the conclusion from examining the correlation between the utilization of financial resources and the factors/determinants of absorption capacity, the model on the implementation of the eu pre-accession programs at the municipal level was empirically estimated. a multivariable regression model was used, in which the independent variables and functional types of model were determined in the first place by the extent of the research. the model was based on the assumptions derived from the theoretical concepts behind the determinants of absorption capacity, and its influence on the use of the resources from the pre-accession programs in croatia. the results of the model showed that the estimated coefficient on the absorption capacity is positive and equal to 4,78 which can be interpreted that when the absorption capacity increases by one percent the use of pre-accession programs will increase by 4,78 percent. 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halduskultuur – administrative culture, 11(2): 202-226. world bank. 2004. “aid effectiveness and financing modalities”, paper prepared for development committee meeting, washington. apsorbcioni kapacitet pretpristupnih fondova evropske unije u hrvatskoj rezime – korišćenje finansijske pomoći evropske unije (eu) je jedno od centralnih pitanja za države članice, kao i za zemlje kandidate kao što je hrvatska. da bi se u potpunosti iskoristila dodeljena sredstava iz budžeta eu, svakoj zemlji treba odgovarajući apsorpcioni kapacitet (ac). ovaj članak je o apsorpcionom kapacitetu pretpristupnih programa u hrvatskoj. apsorpcioni kapacitet pretpristupne pomoći eu može se videti sa dva teorijska gledišta: prvo potiče od ekonomije razvoja, dok drugi razvio iz teorije više nivoa upravljanja (vnu). svrha ovog članka je da se analiziraju faktori / determinante apsorpcionog kapaciteta, i sprovođenje predpristupnih programa hrvatskih opština. da bi testirali odnos ac i implementacije (upotrebe) sredstava eu, uspostavljen je empirijski multivarijabilni model regresije ac. empirijska procena potvrdila je očekivanu pozitivnu korelaciju između ac i fondova eu. druga ključna stvar do koje se došlo je da je ac veoma dinamičan koncept u smislu da su mogućnosti korišćenja fondova eu promenljive tokom vremena, kao odgovor na različite endogene i egzogene faktore. kao takva, ona zahteva širu analizu i predstavlja izazov za dalji rad na tu temu. ključne reči: apsorpcioni kapacitet, eu pretpristupni programi, opštine, više nivoa upravljanja article history: received: 21 march 2013 accepted: 29 april 2013 doi: 10.28934/ea.21.54.2.pp55-67 preliminary report intercultural competences in the french financial services companies miloš petković*1 1 singidunum university, faculty of business, belgrade, serbia abstract the aim of this paper is to explore public corporate news related to the topic of intercultural competence (icc) in 4 french companies in the year of 2018. in order to answer the research question, a computerized lexical content analyses were done of 424 separate news (texts), with 243,146 words. the research model generated a bottom up clustering on keywords, titles and abstracts. the examination of the data concentrates on 4 main clusters of news that focus on (1) motivation as an affective component desire to cooperate with strangers, (2) knowledge as a cognitive component – understanding and awareness, (3) skills as a behavioral component – personal ability to engage behaviors, and (4) financial performance as a final success result – companies' ability to gain competitive advantage and create future value. a transversal review of the four clusters reveals that icc as a portfolio of specialized competences whose complementary intellectual resources are crucial for the companies’ value creation process is insufficiently present in the communication practices. icc as a part of human capital is a key companies’ resource for creation of future value and should be therefore more considered in companies’ communication practices. the article contributes to the current literature on icc narratives. it seeks to provide explanation of which icc components companies focus most on in order to gain competitive advantage and financial performance. key words: intercultural competence; company performance, financial services, france jel classification: m14, l25, f23 introduction during the last two decades, the business and global environment have progressively been transforming into a knowledge-based, fast-changing, technology-intensive environment in which investments in human resource, information technology and research and development have become essential for the purpose of improving a company’s competitive advantage and final performance (canibano et al., 2000). itami and roehl (2009) suggested that resources consist of physical, human and monetary resources which are necessary for business operations to take place and information-based resources, such as management skills, knowledge, technology, consumer information, brand, reputation and corporate culture. the services sector, particularly, relies on knowledge or, more precisely, on the set of employee’s competences (vargo et lusch, 2017), as they are intangible goods. intangible capital such as technology, relationships with customers, brands, working culture, together with human capital influence on company’s value creation processes, production of cash flows and profits * e-mail: mpetkovic@singidunum.ac.rs 56 economic analysis (21, vol. 54, no. 2, 55-67) (bessieux-ollier et al., 2014). it was a matter of interest to understand how the companies of this sector develop their human resources’ competences, and especially the intercultural competence (icc) (arasaratnam & doerfel, 2005; waxin & barmeyer, 2008; bartel&radic, 2009; barmeyer & davoine, 2012). the interest in studying this topic lies in the fact that employees’ competences and human capital are the main drivers of companies’ competitiveness in the modern economy (radivojevic et al., 2019). however, even though the research has taken interest in studying the acquisition of the transnational human capital and thus of the icc (gerhards & hans, 2013), it has mainly been focused on the acquisition of this competence on an individual level, as an emerging component of the human capital (bartel-radic, 2009). the study deals with the topic of icc, understood as part of company’s intellectual capital or, on a broader level, human capital (gerhards & hans, 2013). the study is based on the theory explaining communication between people from different cultures, developed by gudykunst (2004). as a matter of fact, it is expected that the selected companies, as they provide services, focus on developing the competences of their human resources. more specifically, they focus on developing their icc, with respect to their international presence. the aim of this study is to make the lexical content analysis whose value lies in covering corporate news of one intellectual capital intensive and high-technological industry such as financial services industry in france. these analyses give the opportunity to list and sort all relevant terms with respect to their commonalities, to define clusters of news articles on the basis of these commonalities and to map them according to main topics related to the icc in such an international environment as it is in the selected companies. based on the understanding of the literature on icc, it was proposed a transversal review of the four clusters in which the topic of icc predominantly appears as a set of specialized competences and thus as part of the human capital that is decisive for the future value creation processes. the sample is composed of 4 biggest and sole french financial services companies on the paris stock exchange for the business year 2018. in the research paper, the lexical content analyses are implemented in order to answer the three main research hypotheses: (1) do the selected companies diffuse about icc; (2) if they do diffuse, about what do they talk about; and (3) if they do diffuse, how often or in which percentage. the paper first presents, in the section 2, the extant literature on human capital to introduce the review of studies conducted on icc. section 3 explains the data and research methodology used to develop the lexical content analysis dedicated to map the corporate news on icc in the multinational and international working environment as it is in the observed companies from the sample. section 4 explains the findings, i.e. the identification of key components of icc in the analyzed corporate news, and section 5 discusses the results, proposes a conclusion and draws some suggestions for future research. literature review importance of company’s human capital human capital refers to tacit and explicit knowledge that all employees possess and that can generate a future value (martín-de-castro et al., 2011). hsu and fang (2009) stated that human capital contains all business capital that lies in employees and that is not owned by a company. this capital can be taken out of a company and it includes employees’ and managers’ competences, skills, knowledge, attitudes, wisdom and commitment. based on the work of martín-de-castro et al. (2011), human capital has three dimensions, together with included variables: 1) knowledge – includes the following variables: formal education, specific training, experience and personal development. 2) abilities – include type of knowledge related to know-how: individual learning, collaboration-team work, communication and leadership. miloš petković 57 3) behavior – includes knowledge that leads individuals to do their tasks: having a sense of belonging and commitment, self-motivation, job-satisfaction, friendships, flexibility and creativity. more innovative and successful companies focus more on its intellectual capital, specifically on the human capital and other components that results with comprehensive competitive advantage. this is also the case even when a company relies intensively on knowledge and skills of its employees to generate better earnings and productivity. the information about its importance within a company might allow for human resources to be more effectively allocated, which would then enable the identification of gaps in skills and abilities of employees. this sense gives much better image to current and potential investors (albertini et al., 2021). purkayastha et al. (2021) investigated the role of human capital in a company’s future goals for internalization. company’s human capital education and experience support further international expansion. it is important to follow a different contribution and influence of intellectual capital components on the company’s final result because it does not each component influence the same (pap et al., 2021). the study by petković et al. (2020) proved a positive relationship between intellectual capital and its components on the final company’s financial result. you et al. (2021) explored the importance of human capital in developing new products. the study emphasized the company’s learning on the development of human capital and innovations. the findings prove new insights into how human capital can be linked with fostering innovations. however, companies do not tend to publish or present their indicators of human capital externally because of a high risk of losing talented employees to competitors. managers in companies are more focused on usefulness of human and customer (relational) capital, than structural (organizational) capital indicators. it was emphasized that even though the data on the human capital are published in the annual reports of companies, in the part of historical costs, they do not provide a more realistic image of the company, in particular of value creating elements on the long-term. also, due to the fact that accounting recognition of intellectual capital is missing, there are difficulties to implement different managerial tools for measuring, describing and presenting intangibles (bessieux-ollier et al., 2006). intercultural competence: a set of knowledge, motivation and ability in order to integrate into the professional world and to survive, they must demonstrate, in addition to the technical skills required in employment, new general skills that guarantee their adaptability, versatility, autonomy and effectiveness (johnson, lenartowicz, & apud, 2006; lancry & lemoine, 2004) and constantly update their knowledge (lainé, 2004). it is a process of intercultural learning, consisting of several stages specific for each individual, as it is depending on his/her personality and international experience (bennett 2004; waxin & barmeyer, 2008). therefore, according to studies done on this dynamic character of the icc (chen & yang, 2014), the number of stages varies from one individual to another. according to some authors (bennett, 2004; fritz, möllenberg, & chen, 2002; hammer, bennett, & wiseman, 2003), it is more appropriate to consider this intercultural learning as the acquisition of an intercultural sensitivity. this means that individual develops his/her sensitivity when meeting with foreign cultures, until he/she becomes interculturally competent. in other words, there is a shift from a strong attachment to his/her original culture (ethnocentrism) to the acceptance of other cultures (ethnorelativism) which requires a process of intercultural learning through six stages. after a phase of denial (1) (refusing to accept that the differences between cultures exist) and defense (2) (believing one culture superior to others), individual reaches the stage of minimization (3), when he/she becomes aware that differences exist, without changing his way of seeing the other. this ethnorelativism begins in the fourth stage, with accepting the culture of integration (4) and finding some positive aspects in it. it is important, according to bennett (2004), not to confuse acceptance with assimilation, which would be the act of "melting" into a culture by abandoning one's own. to accept a culture would be to increase one's well-being. thus, the individual adapts 58 economic analysis (21, vol. 54, no. 2, 55-67) (5) to the mechanisms of culture until integrating it (6), namely until being able to work in a new context. because of its multiform nature, icc can be defined as a situational adaptation (bartel radic, 2009), a means of negotiation or a cognitive capacity (hampden-turner & trompenaars, 2004; trompenaars & hampden-turner, 2008), a means of solving problems, or personal development (wang & kulich, 2015). it can be considered as an intercultural communication competence (arasaratnam & doerfel, 2005) that enables an individual to function effectively in diverse cultural contexts (caligiuri & tarique, 2012) and makes him culturally intelligent (ang et al., 2007). some studies have found that icc is a set of self-knowledge (knowing one's habits, emotional states, prejudices and reactions when working with others), social skills (knowing how to establish a relationship of trust with others, the ability to listen, to inspire confidence), cultural awareness (knowing one's own culture and codes, language and body language, non-verbal), and the culture in which one lives); knowledge of the organizations or micro-universes in which one works (school, university, hospital ...) and their rules (dusi, messetti, & steinbach, 2014). icc is a set of competences, such as: emotional (acquisition of empathy, knowing how to put oneself in the place of the other), cognitive (acquiring knowledge of intercultural management to understand the specificities of different cultures) and behavioral competence (the result obtained after two initial phases: the individual integrates his knowledge into his behavior) (barmeyer & davoine, 2012; waxin & barmeyer, 2008). similarly, gudykunst (2004), who developed a theory explaining the icc, considers that the latter is composed of the following three categories, each containing four elements: 1. knowledge, defined as the awareness (understanding) of what needs to be done in order to communicate appropriately and effectively. it comprises: 1) knowledge of how to gather information: searching for information or deeper understanding (strategies: passive, active, interactive) 2) knowledge of group differences: strangers identify with their groups so they can feel their self-concepts are not being confirmed if we focus only on similarities 3) knowledge of personal similarities: at the group and the individual level 4) knowledge of alternative interpretations: minimize misunderstandings/maximize the similarity; 2. motivation, defined as a desire to communicate appropriately and effectively. it comprises: 1) need for predictability: we do not see strangers’ behaviors’ predictable 2) need to avoid diffuse anxiety: lack of balance, feeling uneasy, tense, worried, fear of negative consequences 3) need to sustain our self-conceptions: consequence of high anxiety is that need to sustain our self-conceptions becomes important 4) approach-avoidance tendencies: group inclusion 3. ability to engage in the behavior necessary to communicate appropriately and effectively. it comprises: 1) ability to tolerate ambiguity: deal successfully with situations even when a lot of information needed to interact effectively is unknown; 2) ability to manage anxiety: if anxiety is too high, we are not able to communicate effectively 3) ability to empathize: involves cognitive, affective and communication competence (carefully listening to strangers; understanding their feelings; being interested in what they say; being sensitive to their needs; understanding their points of view) miloš petković 59 4) ability to adapt communication: requires both cognitive and behavior skills; adaptation of interaction goals; ability to adapt to the requirements posed by different communication contexts; assumption that perceptions of communication competence reside in the dyad. for the purposes of the research, we based the analysis of our corpus on gudykunst’s model. the next section explains the methodology adopted to analyze the corporate news of selected companies. methodology the research study is based on a top-down approach with specific keywords included that can be further grouped in more specific sub-clusters. the approach is considered appropriate to better understand how the text from the corporate news is structured and how is includes the components of icc. data sample explanation the research study relies on the corporate news in order to explore narratives on the topic of icc. the corporate news is publicly available and published on the official websites for the 2018 business year. the sample included 4 companies from the cac 40 paris stock exchange list. the list included four sole companies from the financial services industry: bnp paribas, axa, crédit agricole, société générale. the observed financial services industry belongs to the high technology industries that are highly intellectual capital intensive (francis & schipper, 1999). content analysis by textual statistical software the presence of specialized textual statistical software is becoming more important in the procedure of qualitative data analysis. it was proven that the iramuteq provides rigor qualitative textual data analysis (ramos et al., 2019). the main objective is to identify how words group to each other in a text segment, and then how they compare with other text segments. co-occurrence analysis is significant because it gives a final meaning of the observed words (ocasio and joseph, 2005). the computerized lexical content analysis was applied within the study with the iramuteq software because of the sample size, with 424 separate news, and in total 243,146 words. this method allows an opportunity for measuring strategic intentions through the textual analysis of the topic addressed in the corporate news. formatting the text corpus the corpus consists of the news of four companies (axa, bnp paribas, société générale, crédit agricole) published on their websites in 2018. building the corpus consisted of copying the body of the text in a word document, which resulted in 514 pages. the analysis of the corpus in the software is possible thanks to the dictionaries available in iramuteq. they help lemmatize the texts by conserving only the infinitive forms of the verbs and singular forms of the nouns, so that the software can classify the words into semantic categories. the analysis carried out is threefold, as presented in the next section. findings firstly, a step-by-step procedure (from phase 1 to phase 3, the order of the phases has an impact on the processed results) and selection of items from the following criteria are executed. the content analysis consisted of three phases: 60 economic analysis (21, vol. 54, no. 2, 55-67) phase 1: analysis of the entire textual corpus to reveal the main categories of the news narratives of the four companies selected this phase showed that the corpus has 10,714 forms, which covered 73,20% of the corpus. more precisely, this percentage is declined in 9,845 active forms, 10,714 lemmas, 6,766 textual segments and 4,321 hapaxes (words that appear only once in the corpus, which in this case were mainly some important years for these companies). these elements were classified into 4 categories (figure 1). figure 1. semantic clouds of 4 categories of corporate news published by observed companies source: author’s calculation table 1. categories revealed in the phase 1 category color code name % of forms analyzed category 1 red work 31.4 category 2 green integration 19.4 category 3 turquoise governance 35.2 category 4 purple performance 14 source: author’s calculation two of the four categories that emerged from the analysis represent expected themes in financial services and are characterized by a great coherence of the notions: category 3 covers topics in relation to the governance and organization (head, asset, chief, officer, executive, investment, management, corporate, etc.); category 4 consists of the vocabulary used to present financial results (rate, yield, inflation, price, decline, ratio, european central bank (ecb), growth, etc.). more precisely, regarding the research subject, these two categories did not contain any term that could help us identify the elements of the icc. on the other hand, category 1 and category 2, that were named respectively work and integration, contained quite heterogeneous elements. for instance, category 1 consisted, on the one hand, of the terms work, customer, digital, project, technology, and on the other hand, of the terms experience, need, learn, understand, intelligence, idea, person. put differently, this heterogeneity did not give this category a name that could semantically gather all the notions. similarly, category 2 involved notions such as initiative, social, positive, impact, woman, but also sustainable, commit, sustainable development goals (sdgs), diversity. the following sentences miloš petković 61 are representative of the terms “work” (1) and “initiative” (2): (1) “one of the challenges on a daily basis is to get people or departments that don’t usually communicate with each other to work together. you have to be able to get people together and create cohesion within the group, to get each person to see the shared challenges that will help them to collaborate.”; (2) present in 73 countries, bnp paribas has been supporting for many years several initiatives aimed at encouraging professional and social integration of young people; such as dream up, the international arts educational program for underprivileged young people”. in other words, this first level of analysis allowed to identify the categories that are more likely to be receptive of the components of icc. by the way, the semantic clouds in the figure 1 show us that category 1 and category 2 have some shared notions as they appear close to each other on the graph, whereas category 3 and category 4 are clearly separated. to obtain a more precise image of the categories 1 and 2, representing together 50.8% of the corpus, it was carried out a second level of analysis. phase 2: creating a sub-corpus from the initial corpus the second lexical content analysis consisted of the excerpt of the sub-corpus containing categories 1 and 2, which produced a four-category classification (figure 2). figure 2. creation of sub-semantic clouds from initial corpus source: author’s calculation table 2. categories revealed in the phase 2 category color code name % of forms analyzed category 1 red digital 22.4 category 2 green career 27.1 category 3 turquoise environment 29.5 category 4 purple diversity 20.9 source: author’s calculation this level of analysis gave a clear classification of the words into 4 categories, that were named digital (category 1), career (category 2), environment (category 3), diversity (category 4). 62 economic analysis (21, vol. 54, no. 2, 55-67) category 1 dealt with the topic of customer experience relying on the digital technology, as it gathers terms such as digital, service, customer, technology, client, market, transformation. category 2 makes extensive use of the career semantic field through the following notions: think, career, start, intrapreneur, job, work. category 3 covered the topics related to the environment (impact, sustainable, positive, social, environmental, development), whereas category 4, the least representative one in percentage (20.9%), covered several aspects of the diversity (woman, inclusion, young, diversity, foundation, gender, promote, school, equality, female, etc.). finally, this more granular analysis allowed to clearly separate the topic of diversity and to isolate it for a deeper understanding, to be able to analyze its components and the ones of the icc necessary to address them efficiently. phase 3: identifying the components of the icc in the cluster diversity finally, the phase 3 was necessary to clearly separate the elements of the diversity that the analyzed companies use in their communication practices to address this topic. it was important to understand what semantic fields are used the most to raise the topic of diversity and at what degree this is an important topic for the multinationals. the results show that there are 4 semantic categories that were named equality (category 1), youth education (category 2), awareness (category 3) and entrepreneurship (category 4), among which the category 2 has the highest percentage (37%), and the category 3 the lowest (16.9%). category 1 gathers notions such as equality, gender, female, man, staff, male, global, global, heforshe, top progress, parity, etc. the following sentence illustrates the topic of the category: “in order to advance gender equality, bnp paribas also takes active part in studies and research work. the group participated in a survey conducted by bva for the cesp (superior council of professional equality) and organized an internal colloquium on sexism in the workplace. the group also published the “agir contre le sexisme” (“take action against sexism”) kit, designed for all employers.” in category 2, the companies deal with the topic of education for young people and make an extensive use of the notions young, person, youth, refugee, integration, project, social, education, student, etc., as represented in the following sentence: “mcgill came a close second with their idea for her (higher education right) bonds to provide low cost loans to make it possible for low and middle income young women in india to access higher education.” category 3 clearly put at the forefront of the list the awareness as the quality to develop to understand the commitment to social problems such as gender-based violence and integration of employees with disabilities, employment discrimination or stereotyping in the workplace. the following sentence illustrates how companies consider resolving these problems: “if we are to combat every form of employment discrimination, i first need to change the way i see each other. the goal is to go beyond stereotypes and focus solely on the professional skills of each candidate. that notably means raising awareness among employees at the company, particularly among employment staff.” finally, category 4 tackles the subject of entrepreneurship. the notions that represent this category are entrepreneur, program, stanford (partnerships with stanford university that organizes trainings, workshops and intensive classes for women entrepreneurship), wealth, business, opportunity, meet, week, workshop, mentor, connected, etc. miloš petković 63 figure 3. creation of semantic clouds related to the components of icc source: author’s calculation table 3. categories revealed in the phase 3 category color code name % of forms analyzed category 1 red gender equality 23.4 category 2 green youth education 37 category 3 turquoise awareness 16.9 category 4 purple entrepreneurship 22.7 source: author’s calculation another representation of these categories is possible via iramuteq and that visually helps to better understand the links between the four categories of the cluster 4. in the figure 4, it is possible to observe that the main community of words is the one in the green halo, whose center is the word “support” that gathers terms such as project, france, employee, programme, business. three communities of words stem from this central one. the red halo gives us the information that this support is provided to young persons to promote social inclusion, education and commitment in different communities. the blue halo clearly indicates that women are supported by the human resources department as entrepreneurs, as female employees, and some partnerships, such as “heforshe” (a united nations initiative launched in 2014) are created to attain this goal. “women initiative foundation” is at the heart of the initiative taken to tackle this problem and appears as a topic linked to the one of woman (purple halo). finally, the yellow halo is a group of words gravitating around the topic of diversity or inclusion, and more precisely the promotion of diversity inclusion in the workplace. it was interesting to note the consistency of the policies of the studied firms regarding the implementation of these policies in all countries where they are present. for example, bnp paribas indicates that “staff – especially management personnel – receive training on diversity and inclusion that help them tackle stereotyping issues [in all countries where the group is present]”. 64 economic analysis (21, vol. 54, no. 2, 55-67) figure 4. similarities analysis of the cluster diversity source: author’s calculation to sum up the obtained results, the study was refered to the work of gudykunst (2004), as the objective is to identify the elements of the icc that the companies use in their communication to create value. therefore, the following excerpts of the communications on their websites allow us to understand what elements of icc are used the most, in a decreasing order: 1. knowledge of how to gather information; knowledge of group differences “the objective is to create and experiment measures to fight violence against women in order to effectively support victims amongst their employees, in cooperation with specialized organizations. concrete actions will be implemented such as online and faceto-face trainings to better understand domestic violence and its impact on work, sensitization kits bound for companies (posters, useful numbers, recommendations, etc.), mobilization events, etc.”; “what can banks do to promote youth integration? operating in every corner of the country, banking groups work closely with local populations. this gives them a unique position to observe the barriers to integration facing young people, especially in disadvantaged neighborhoods in cities and rural areas”; 2. ability to empathize “the bank also has policies in place to promote the hiring, retention and full workplace integration of employees with disabilities, providing training, raising awareness among employees across the group, and increasingly making use of service providers from the protected workers sector”. 3. motivation (mainly the absence of the need for predictability) “within the framework of the youth peacemaker network, wpdi’s flagship program that will be deployed in the flats area of cape town, 360 young leaders will receive trainings in new technologies, conflict resolution and business management, as well as the necessary resources to enable them to carry out their projects with every chance of success.” therefore, as showed in the figure 4, the development of the icc on the organizational level of the studied companies has its source in the knowledge (category support) supported by the ability to empathize or to understand (mainly youth and women in disadvantaged position) and the motivation to meet the other and integrate him/her in company’s reality. thus, icc is a process miloš petković 65 of learning that requires, according to the results of our study, the knowledge that enables (“gives the ability to”) the employees of these companies to encounter the “unknown” (the need for predictability being almost absent from the corpus). as indicated in the analyzed texts, companies manage to put it in practice by raising awareness among their employees, i.e. by enabling them to follow trainings and programs that aim at acquiring this knowledge to face the diversity. icc is therefore a competence acquired and/or reinforced by trainings and continuous learning and is considered as company’s means to efficiently face the diversity in all the countries where the company is present. discussion and conclusion the research paper aims to contribute to the discussion about the disclosure of icc in the corporate news of companies and thus further the understanding of the acquisition of icc on the organizational level and its importance in addressing the diversity internationally. in that case, the research presents what companies of the financial services industry publish and how much they pay attention on the topic of icc and its components. in view of unifying the vast corporate news, the study identified four main homogenous clusters using a lexical content analysis. the findings of the lexical content analysis of 4,424 separate news (texts), 243,146 different words by 4 companies from french cac 40 listed companies show that icc is necessary to efficiently address: gender equality among employees and their equal progress within a company; education and training of young, talented and skillful people; awareness of differences that exist within an organizational culture; and finally entrepreneurship that is accessible to both men and women. more precisely, the results show that service companies do communicate about their practices regarding the acquisition and mobilization of the icc. however, a low percentage of the news deals with this topic. as a matter of fact, 50.8% of the corpus (categories work and integration) covered elements potentially related to the icc. the phase 2 allowed us to excerpt from these 50.8% a sub-corpus that, this time, dealt specifically with the topic of diversity in 20.9% of the sub-corpus. this eventually means that only about 10% of the corpus concentrates on the topic of diversity, for which the icc is necessary. the research gives a general message that since the most intellectual capital and high technology companies employ high-skilled workers, they develop very successful internal and external social networks that can further have greater performance than other competitive companies, and consequently have higher economic growth. with respect to the literature on the icc, the results confirm that companies do not 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in the french financial services companies miloš petković0f*1 introduction literature review importance of company’s human capital intercultural competence: a set of knowledge, motivation and ability methodology data sample explanation content analysis by textual statistical software formatting the text corpus findings discussion and conclusion acknowledgment references microsoft word 2010_3_4.doc scienfitic review “home bias puzzle”. is it a puzzle or not? gavriilidis constantinos*, greece udc: 336.69 jel: g15 abstract – the benefits of international diversification have been well documented over the last decades. despite this however, investors seem unwilling to exploit this opportunity in order to limit the risk of their portfolio and they continue to invest the largest percentage of their wealth in domestic assets. this phenomenon is called the home bias puzzle and the given explanations for it have not been empirically proven to justify its existence. the purpose of this paper is to present a literature review on the opinions and possible explanations about the home bias puzzle. furthermore, concluding, it will try to answer whether the home bias puzzle is a puzzle or not. key words: home bias puzzle, international finance introduction harry markowitz (1952) was the first to identify the benefits of investing in a portfolio of assets rather than just in one asset. markowitz’s mean variance portfolio theory was based in two principles, holding constant variance and maximizing expected return, or inversely holding constant return and minimizing variance. according to these two principles, an efficient frontier was constructed and an investor could choose his preferred portfolio on the basis of his own risk and return preferences. grubel (1968) extended markowitz’s portfolio theory suggesting that portfolios should diversify internationally. also, levy and sarnat (1970) showed that correlations among security returns are the key element for reducing risk. when correlations among securities are low, investors could substantially reduce the systematic risk. international diversification principles state that the correlation among international markets are low so one could diversify its portfolio more effectively than just domestically, i.e. the investors could succeed the same or higher returns with lower risk. however, as relevant research shows, investors do not diversify their portfolios internationally and if they do, they do it in a small percentage. the investors’ behavior of investing heavily in domestic assets instead of diversifying their portfolio internationally is called the home bias puzzle. some of the possible explanations given for the home bias puzzle are: inflation hedging motives, institutional barriers, taxes on international investments and transaction costs, non traded goods, asymmetric information and others. however none of the given explanation has been proved to explain entirely this puzzle. * address: 64 m.katraki, 18758 piraeus, greece, tel: +306942641297, email: kgavriilidis@yahoo.com economic analysis (2010, vol. 43, no. 3-4, 7-14) 8 the home bias puzzle over the last years, barriers and costs in international investments have fallen dramatically. thus, one would expect that investors would take advantage of it and diversify their portfolio internationally and hold the world market portfolio of stocks. however, this is not the case, foreign ownership of equity remains rather low. french and poterba (1991), cooper and kaplanis (1994) and tesar and werner (1995) show that there still a strong home bias in investors’ behaviour. according to french and poterba (1991) the domestic ownership shares in the 1989 for the world’s five largest stock markets were: us 92.2%, japan 95.7%, uk 92%, germany 79% and france 89.4%. the question arising at this point is why investors heavily concentrate their investments in domestic assets, since international diversification offers significant benefits to the limitation of a portfolio’s risk. over the years, many researchers have tried to answer that question and to provide a logical and supported solution for the existence of the home bias puzzle. however, none of the given explanation has been proved to be the correct one. the most common explanations for this attitude of the investors are: asymmetric information, non traded assets, inflation hedging, several costs and barriers in equity trading, differences in expectations and empirical measurement problems. differences in expectations and asymmetric information a possible explanation of the home bias puzzle is investors’ behaviour and beliefs. french and poterba (1991) suggested that one possible reason for the home bias of investors is their optimism. their optimism that can beat their domestic market but not the foreign market or that can hedge inflation risks. similarly, investors are pessimistic as regarding foreign markets. furthermore, their perception of foreign markets as riskier, because of the lack of information they have on them, drives investors to heavily invest in domestic assets. the last one is the hypothesis of asymmetric information and states that investors invest in the securities they know more about. as solnik (1996) suggested, everything unknown is perceived as risky. the same stands for financial markets which investors are not familiar with. so, if investors do not hold enough information about a market, they simply won’t invest to it. gehrig (1993), introducing a simple noisy rational expectations model, showed that even in equilibrium, investors remain incompletely informed. furthermore, foreign assets seemed to be riskier than the domestic ones even without the foreign exchange rate risk. for this reason, according to the researcher, investors prefer to heavily invest in domestic assets and that is what generates the home bias puzzle. other researches supporting that asymmetric information plays an important role in risk perception are those of kang and stulz (1997), brennan and cao (1997) and coval and moskowitz (1999). coval and moskowitz (1999) extended the home bias phenomenon to domestic portfolios as well. they suggested that domestic investors prefer to invest to companies close to them. more specifically, according to their research, us fund managers seem to be willing to invest more in locally headquartered firms. that is because managers had more information on these companies rather than on firms located in other states. so, asymmetric information plays an important role in the investing preferences of even among local and non-local investors. gavriilidis c., «home bias puzzle», ea (2010, vol. 43, no, 3-4, 7-14) 9 similarly, brennan and cao (1997) developed a model of equity portfolio flows that was based in informational differentials among domestic and foreign investors. more specifically they used a dynamic generalization of the noisy rational expectations model of hellwing (1980), developed to a multi-asset setting by admati (1985). the main assumption of the model was that domestic investors are more informed about the domestic market than foreign investors. as the previous researchers, brennan and cao suggested that asymmetric information plays an important role in risk perception and portfolio formulation. another research by kang and stulz (1997) showed that foreign investors in japan prefer to invest in wellknow manufacturing firms, large firms, and firms with good accounting performance and low leverage instead of holding the japanese market portfolio. the researchers took data for the period 1975-1991 on japanese firms. their results indicated that foreign investors, investing in japan, hold 13.7% more in manufacturing firms than in the market portfolio, even though their returns were not greater than those of the market portfolio. furthermore, the volatility of their monthly return was 5.38% instead of 4.81% of the market portfolio. this phenomenon occurs because foreign investors do not have the same amount of information for the domestic companies as domestic investors have, and especially regarding small firms. so, foreign investors tend to invest more on firms that are relatively known and export their products even though these firms might be more risky and less performing than the market portfolio. non traded goods another possible explanation of the home bias puzzle is that the presence of non-tradable goods leads investors to bias their portfolios to domestic assets. non-tradable goods account approximately for 50% of aggregate consumption in modern economies. serat (1995) developed a continuous-time dynamic equilibrium model with two agents in complete markets, two tradable goods and two non-tradable goods. serat’s results indicated that the agents hedge consumption risk of non-tradable by investing in home tradable goods. that, according to the researcher, explains the home bias of the investors. baxter and jermann (1997) suggested that hedging for human capital risk can be a factor, though not so important, for the home bias of investors. according to them, human capital represents a large proportion of national income and is likely to be highly correlated to the returns of the domestic marketable assets. furthermore, their results suggest that diversified portfolios should short domestic tradable assets and take long positions in foreign tradable assets. however another research by baxter et al. (1998) suggested that, generally, the presence of non trade goods is not the reason that causes investors’ home bias. their model is a multicountry equilibrium model with complete security markets and individuals in each country value two consumption goods, one for traded and one for non-traded. these goods enter together to the individual’s utility function. also, the transportation of the traded good is costless and the residents of each country must consume all the endowments of non-traded goods. furthermore, the endowments of both goods are stochastic. the researchers after they characterize the optimal consumption allocations and determine the supporting, for these allocations, portfolio holdings come to the conclusion that even with the presence of non economic analysis (2010, vol. 43, no. 3-4, 7-14) 10 traded consumption goods, the benefits from international diversification would be very important. finally, coёn (2001) tested, by using wage as a proxy, whether human capital in an international capital asset pricing model could explain home bias. their results showed that this could not be the case and the researchers suggested that asymmetric information between domestic and foreign investors could more likely explain the home bias puzzle. inflation hedging one of the given explanations of the home bias puzzle is that investors prefer to hold domestic assets in order to hedge against inflation risks. however, there is no documented close relationship between the returns of the equities and the rate of inflation. though, solnik (1978) suggested that investors try to hedge property costs and not general inflation. that is because price indexes, which measure general inflation, do not take into consideration the relative price changes. and general inflation might differ from inflation in the property costs. so, domestic equity may be correlated with domestic property costs, and not inflation and hedge better these relative price changes than foreign equity. and thus investors prefer investing in domestic assets. however, this hypothesis has not been tested and empirically proved. the researches by adler and dumas (1983) and uppal (1993) suggest that the deviations from ppp (purchasing power parity) could lead investors to strongly invest in domestic assets in order to hedge different inflation. cooper and kaplanis (1994) used data of foreign equity holding from 8 countries in order to test whether hedging could explain home bias. their results indicate that such hypothesis does not stand and in some cases hedging is to the opposite direction towards to explaining home bias. taxes, transaction costs and barriers to equity trading another possible explanation of the home bias puzzle is the costs of cross-border investing. these consist of taxes, like withholding taxes, and various transaction costs. however, as cooper and kaplanis (1994) suggest the costs for such investments could not be the case for the home bias puzzle. specifically, ahearne et al. (2004) suggest that informational costs are an indirect barrier of international diversification and one of the most important factors behind investors’ home bias. also according to their results, when the direct barriers of international diversification were statistically significant, their economic importance was insignificant. another research by carmichael and coёn (2003) suggests that transaction costs can be the explanation for the home bias in investors’ portfolios. more specifically the researchers, by using a simple overlapping generations model, showed that in a world with no barriers in international investments, the induction of even a very small transaction cost, i.e. existing taxes, informational costs or other constraints, can generate a home bias in portfolio holdings. finally, tesar and werner (1995) examined the investment pattern of five oecd countries in the long run. they found that the turnover of foreign equity investments is higher than the turnover in domestic equity markets. this research shows that transaction costs or barriers in equity trading cannot be the case for the home bias of investors. gavriilidis c., «home bias puzzle», ea (2010, vol. 43, no, 3-4, 7-14) 11 empirical measurement problems glassman and riddick (2001) suggested that home asset bias could be due to omitted assets from the investors’ optimization model. as the authors write, most of the researchers use past returns in order to measure the expected returns in a portfolio maximization. however, this includes some drawbacks and investors usually adjust these past returns in order to optimize. firstly, transaction costs play an important role in determining whether investing in foreign assets is more attractive than investing domestically. solnik (1996) showed that the transaction costs vary across countries around 1-4% per year. these numbers, when subtracted from foreign assets’ expected returns, could make foreign assets less attractive. secondly, investors’ expectations play an important role in their investing practices. as shiller et al. (1991) suggested, domestic investors are more optimistic about the returns of the domestic market than the foreign investors are. a third issue for adjusting past returns is the estimation risk, i.e. the returns cannot be precisely estimated. in their paper, glassman and riddick tried to examine whether these adjustments of past returns could justify home bias. they used data from morgan stanley for six countries in the period 19851990. their results showed no evidence supporting that the adjusting returns could justify the home asset bias. then, the researchers tested whether the adjustments in assets’ variances could justify the presence of home bias. for example, if the perceived risk of foreign assets increases for some reason, then it is natural for the foreign assets to become less favourable. in order to see how much the variances of the assets should be adjusted, the researchers computed the needed adjustment by a combination of historical and extreme variances. in this case too, their results did not indicate that adjustments in variances could justify the home asset bias. finally, glassman and riddick examined whether adjustments to correlations by including omitted assets from the optimization problem could justify the existence of the home asset bias. such omitted factor could be human capital. then, the researchers combine the adjustments to returns, standard deviations and correlations. their results suggest that the characteristics of the omitted assets do not correspond to any known asset, and they exclude human capital, domestic or foreign bonds and domestic or foreign real estate. so, the authors conclude that the explanation of the home asset bias could lie under multiple omitted assets and left this explanation pending to further research. diversification costs exceed gains gorman and jorgensen (2002) suggested that the theoretical gains from international diversification are difficult to be captured in practice by investors. more specifically, the researchers used both the markowitz approach and the bayes-stein tangency “shrinkage” algorithm in order to estimate the expected returns and the covariance parameters. the results indicate that a 100% domestic portfolio performed as well or better than the tangency portfolios estimated by the two methods. thus, according to the researchers, the home bias of the investors is not irrational but justified since they are not able to benefit from international diversification. economic analysis (2010, vol. 43, no. 3-4, 7-14) 12 the interrelationship among the home bias puzzle and the equity premium puzzle the expected returns of stocks are higher than those of bonds. this is quite logical since one could expect riskier assets to have higher returns than safer assets. however, the size of the difference in the returns among these assets is what puzzling the researchers. this puzzle is called the equity premium puzzle and was first identified by mehra and prescott (1985). the excess expected return on an equity share of country m’s output is the following: { } ( )                   − −      +−=− rrrrr mm c c cov 1e , 1 2 11 ρ β “because annual consumption growth is fairly stable and the annual variability of major stock markets returns moderate, the covariance of consumption growth with returns, while positive, is too low to explain the huge equity premium unless the risk-aversion coefficient ρ is extremely high.” [obstfeld and rogoff 1996)] at this point is where the equity premium puzzle and the home bias puzzle come together. the question arising is that if investors are so risk averse as the risk-aversion coefficient implies, then why investors do not diversify internationally in order to exploit the benefits of international diversification and lower the risk of their portfolio. conclusion the tendency of investors to hold the largest percentage of their wealth in domestic assets rather than exploiting the benefits from international diversification is called the home bias puzzle. investors’ home bias has been puzzling researchers for many years and through time many possible explanations have been given for what causes the home bias puzzle. among them are: asymmetric information, non traded assets, inflation hedging, several costs and barriers in equity trading, differences in expectations and empirical measurement problems. there is also an approach that the home bias puzzle is linked to the equity premium puzzle. though, none of them has been empirically proved to be the correct one. the most promising explanations however, in my opinion, seem to be those of asymmetric information and differences in expectations. in other worlds, the solution of the home bias puzzle maybe lies into investors’ behaviour. if investors perceive foreign markets as more risky than the domestic ones or even if they think that can beat the domestic market easier than the foreign ones that can drive them to invest the largest percentage of their wealth in domestic assets. also, it could be our models that cannot predict accurately the expected returns and the optimization levels of portfolios. however, since neither of these explanations has also been empirically proved, we cannot disclose any of the other remaining proposed explanations. for that reason, my conclusion is that the home bias puzzle is indeed a puzzle that is pending to further research and a testable hypothesis. gavriilidis c., «home bias puzzle», ea (2010, vol. 43, no, 3-4, 7-14) 13 references adler, m. and dumas, b. (1983), “international portfolio choice and corporation finance: a synthesis”, journal of finance, vol.38, pp.925-983. admati, a. (1985), “a noisy rational expectations equilibrium for multi-asset securities markets”, econometrica, vol. 53, pp. 629-657. baxter, m. and jermann, u. j. (1997), “the international diversification puzzle is worse than you think”, american economic review, vol. 87, pp. 170-181. baxter, m., jermann, u. j. and king r. g. (1998), “nontraded goods, nontraded factors, and international non-diversification”, journal of international economics, vol. 44, pp. 211-229. brennan, m. j. and cao, h. h. (1997), “international portfolio investment flows”, journal of finance, vol. 52, pp. 1581-1880. carmichael, b. and coёn, a. (2003), “international portfolio choice in an overlapping generations model with transaction costs, economic letters, vol. 80, pp. 269-275. coёn, a. (2001), “home bias and international capital asset pricing model with human capital”, journal of multinantional financial management, vol. 11, pp.497-513. cooper, i. and kaplanis, e. (1994), “home bias in equity portfolios, inflation hedging, and international capital market equilibrium, review of financial studies, vol. 7, pp. 45-60. coval, j. d. and moskowitz, t. j. (1999), “home bias at home: local equity preference in domestic portfolios”, journal of finance, vol. 54, pp. 2045-2073. french, k. and poterba, j. (1991), “international diversification and international equity markets”, american economic review, vol. 81, pp. 222-226. gehrig, t. (1993), “an information based explanation of the domestic bias in international equity investment”, scandinavian journal of economics, vol. 95, pp. 97-109. glassman, d. a. and riddick, l. a. (2001), “what causes home asset bias and how should it be measured?”, journal of empirical finance, vol. 8, pp. 35-54. gorman, l. r. and jorgensen, b. n. (2002), “domestic versus international portfolio selection: a statistical examination of the home bias”, multinational finance journal, vol. 6, pp. 131-166. grubel, h.g (1968), “internationally diversified portfolios: welfare gains and capital flows”, american economic review, vol. 58, pp.1975-1999. hellwing, m. f. (1980), “on the aggregation of information in competitive markets”, journal of economic theory, vol. 22, pp.477-498. kang, j. and stulz, r. m. (1997),”why is there a home bias?”, journal of financial economics, vol. 46, pp. 3-28. levy, h. & m. sarnat (1970), “international diversification of investment portfolios”, american economic review, vol. 60, pp. 668-675. lewis, k. (1999), “trying to explain home bias in equities and consumption”, journal of economic literature, vol. 37, pp. 571-608. markowitz, h.m. (1952), “portfolio selection”, journal of finance, vol. 7, pp.77-91. mehra, r. and prescott, e. c. (1985), “the equity premium: a puzzle”, journal of monetary economics, vol. 15, pp. 145-161. obstfeld, m. and rogoff, k. (1996), foundations of international macroeconomics, mit press, cambridge, ma. serrat, a. (1995), “a dynamic model of international risk sharing puzzles”, mit working paper. shiller, r. j., kon-ya, f. and tsutsui, y. (1991), “speculative behavior in the stock markets: evidence from the u.s and japan”, nber working paper 3613. solnik, b. h. (1978), “international parity conditions and exchange risk”, journal of banking and finance, vol. 2, pp. 281-293. solnik, b. h. (1996), international investments, addison wesley, reading, ma economic analysis (2010, vol. 43, no. 3-4, 7-14) 14 stockman, a. and dellas, h. (1989), “international portfolio nondiversification and exchange rate volatility”, journal of international economics, vol. 26, pp. 271-289. tesar, l. and werner, i. (1995), “home bias and high turnover”, journal of international money and finance, vol. 14, pp. 467-492. uppal, r. (1993), “a general equilibrium model of international portfolio choice”, journal of finance, vol. 48, pp. 529-552. received: 17 july 2010 article history: accepted: 31 august 2010 microsoft word 2009_3_4.doc note from the editor-in-chief the current volume of economic analysis contains seven articles covering a wide range of topics from monetary strategy to entrepreneurship, knowledge firms and rural development. kallinterakis and lodetti explore association between herding and nonlinearities and market illiquidity: evidence from montenegro. research results suggest that herding is non-existent, irrespective of whether one corrects for thin trading or not. their findings also illustrate that the montenegrin market accommodates significant nonlinearities, which, despite being irrelevant to herding, undergo a substantial depression following the adjustment of returns for thin trading. neupauerová et al.’s article discussed exchange rate targeting as an very useful monetary strategy especially at the beginning of transition process in many countries. they tried to evaluate effectiveness of exchange rate targeting in the slovak republic and in the czech republic using statistic methods. their conclusions can serve as an experience to other countries that are just at the beginning of their transition process. vukotić and stošić in their article compared the rate of inflation in serbia with the rate of inflation in the european union (eu) with intention to find out how much serbia – as a potential candidate country to the eu – diverges from general price tendencies exhibited by eu member states. kapić in her analysis provides relevant information for the evaluation of the companyʹs profitability, assets reconstruction degrees and competitiveness degree in the financial abilities position. additionally, author concluded that many evaluation models use the money in cash flows from the regular business management as they provide the management with motives to record cash inflows as cash inflows from regular business management and outflows developed either by investments or by financing. đogić et al.`s article is focused on importance of entrepreneurship for development of bih economy. they concluded that the entrepreneurship development in bosnia and herzegovina requires the ending of the transition process and whereby the qualification of domestic enterprises to confront with the global market challenges. ending of the domestic enterprise transition process will initiate entrepreneurship as the main lever in the economic development. along with domestic enterprise restructuring, the basis of the entrepreneurship development in the following period, as a good therapy for the consequences of global economic crisis, will be formed by new entrepreneurship ventures mainly expresses via small and moderate enterprises. economic analysis (2009, vol. 42, no. 3-4, 5-6) 6 stefanović et al.ʹs article stresses that life-long learning politics is the basic premise of the company’s market competiveness considering the fact that the knowledge is the only resource that grows with use and not disburse. the main conclusion of the paper states that the most successful companies and national economies are those based on knowledge, or in other words highly educated and trained human resources. ivanović and jeločnik present the results of their empirical study, which provides evidence of previous and in next period expected apple production in the world, europe and serbia. my sincere appreciation goes to technical editor zorica božić. it has been an enjoyable experience working with her. i also wish to thank the contributors of the articles and the associate editors for the excellent work that they have done. thank you again. prof. dr mirjana radović marković editor-in-chief economic analysis ea09_3-4 samo prva strana.pdf page 1 microsoft word 2010_3_4.doc original scientific paper analysis of profitability in the banking sector of the federation of bosnia & herzegovina rovčanin adnan*, nuhić minela, mrkonja jasmina, university of sarajevo, school of economics and business, bosnia and herzegovina udc: 336.7(497.6) jel: g21 abstarct – in this research, authors will be focused on looking for relations between different performance indicators of banks in federation of bosnia and herzegovina (fb&h) in last five years what is period of consolidation and stabilization of banking sector. final result and essence of this analysis is to answer on question: will banks in fb&h be able to increase their profitability? using appropriate scientific methods, authors will answer on this question. key words: banking sector, profitability, liquidity, efficiency, roa (return on assets), roe (return on equity) introduction the role of banking sector in achieving economic growth, as well as regional and local development is recognizable. this claim is based on fact that reform processes in transition countries, as b&h, are based on reform of financial sector. strong financial sector has to support a development of real sector as the most important bearer of economic growth in general. therefore, financial sector should give an initiation to the real sector, but without corresponding growth of real sector, there is no strong financial sector. the main characteristic of banking sector in fb&h is that banks operations are based on international standards and principles, in function of growth and progress of whole system, its efficiency, stability, solvency, profitability and liquidity. banks have undertaken a lot of activities on enforcement of a new technology and increasing in a quality and multiplicity of products and services. it has resulted in rising competition to increase market share. regardless of these facts, banking sector of b&h is rigid and traditional, what is, in some way, positive. there are no huge returns on equity, as we will see in the body, but also there are no losses. for now, global financial crisis has affected on own banks in low measure, what is not case with flexible and opened financial system of development countries. very important aspect of performance analysis is profitability. we will research if profitability of own banks is settled and what is their position in compare with other transitional countries. we will be focused on five the biggest banks in assets and they are: raiffeisen bank, hypo alpe-adria bank, unicredit bank, hvb central profit bank and upi bank. * e-mail: adnan.rovcanin@efsa.unsa.ba, telephone: +387 61 54 14 00, fax: +387 33 27 59 94 rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 43 table 1 five largest banks ranked by value of assets in 2007 in 000 km no bank assets 1 raiffaisen 3.814.370.000,00 2 hypo alpe adria 2.225.106.000,00 3 unicredit 2.163.309.000,00 4 hvb cpb 1.408.739.000,00 5 upi banka 955.380.000,00 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. we will try to choose relevant indicators, which will point us to condition in banking sector and performance trends in future. final results, we will compare with other transitional countries and interpret in that large context. hypothesis: in federation of bosnia and herzegovina, there is possibility for increasing in profitability in banking sector. presumptions: decrease in liquidity results in increase in profitability. increase in productivity results in increase in profitability. the aim of this analysis is to test abilities for increasing in profitability of banking sector of fb&h. the subject of this analysis is performance of banking sector of fb&h. methods: analysis, synthesis, induction, deduction, comparison, description, statistics methods of regression and correlation. liquidity vs profitability analysis of liquidity risk of liquidity management is, with credit risk, one of the most important and complex segment of bank management. keeping of liquidity in market economy is permanent obligation of bank and main presumption for its survival on financial market. it is also one of the main presumptions for establishing and keeping confidence in banking system in every country. minimal standards which bank has to assure and keep in process of risk management are prescribed by decision on minimum standards for banks liquidity risk1 . above mentioned prescript is frame for risk of liquidity management and it contains qualitative and 1 federal banking agency of fb&h, decision on minimum standards for banks liquidity risk, it is required maturity adjustment of the remaining maturities up to the contracted maturity of assets and liabilities instruments, while the bank is required to: 1.2. engage at least 95% of its sources with maturity up to 180 days in the assets instruments with maturity up to 180 days; 1.3. engage a full amount of its sources with maturity up to 90 days in the assets instruments with maturity up to 90 days; 1.4. engage a full amount of its sources with maturity up to 30 days in the assets instruments with maturity up to 30 days.» economic analysis (2010, vol. 43, no. 3-4, 42-58) 44 quantitative regulations and requirement to banks. it prescribes limits for decade and daily minimum of cash of short term liabilities, as well as minimal limits for maturity adjustment the assets to the liabilities to 180 days. prescribed regulations to banks are very restrictive and it has resulted in very high liquidity of individual banks and banking sector in general. all banks constantly measure up to requirements and even more than prescribed minimum considerably. decade cash minimum of short term liabilities is 20%, and the daily minimum of cash is 10% of the same base. risk of liquidity is in high correlation with other risks and it is often negative affected on performance and profitability of banks. in this liquidity analysis, next indicators are analyzed: 1. liquid assets/ total assets 2. liquid assets/ short term obligations 3. credits/ deposits and credit obligations liquid assets include cash, deposits at other banks and securities for trade. figure 1 liquid assets / total assets ratio liquid assets / total assets 0 0,1 0,2 0,3 0,4 0,5 0,6 raiffaisen bank hypo unicredit hvb cpb upi bank other banks banking sector 2003 2004 2005 2006 2007 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. table 2 liquid assets / total assets ratio 2003 2004 2005 2006 2007 raiffeisen 0,48 0,45 0,43 0,39 0,33 hypo 0,51 0,50 0,50 0,22 0,23 unicredit 0,42 0,41 0,42 0,42 0,40 hvb cpb 0,45 0,46 0,41 0,46 0,47 upi banka 0,49 0,48 0,46 0,46 0,39 other banks 0,13 0,15 0,18 0,37 0,34 banking sector 0,36 0,37 0,38 0,37 0,35 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 45 all banks, except hvb central profit bank, in observed five years period, have chalked up a decrease of this ratio. that is understandable, in consideration that decrease in liquidity results in increase of profitability. it is interesting that all big banks, which we analyzed, have a trend of decreasing of this ratio, while other banks have increase to 2006, and then decrease of it. in banking sector it is continued the trend of decrease in liquidity. reason of that is increase of credits in assets. meanwhile, liquidity of banking system of fb&h is not endangered and ratio of liquid assets in total assets is settled. figure 2 ratio of liquid assets and short term obligations of individual banks and banking sector in period 2003-2007. liquid assets / short term obligations 0 20 40 60 80 100 120 140 raiffaisen bank hypo unicredit hvb cpb upi bank other banks banking sector 2003 2004 2005 2006 2007 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. table 3 ratio of liquid assets and short term obligations for individual banks and banking sector in period 2003-2007 2003 2004 2005 2006 2007 raiffeisen 9,46 9,44 9,42 11,00 6,03 hypo 0,00 0,00 unicredit 67,87 71,41 8,73 47,32 52,64 hvb cpb 112,79 115,66 36,71 64,62 50,44 upi banka 23,73 27,43 19,29 19,13 26,32 other banks 7,74 5,87 14,47 22,63 10,88 banking sector 15,42 17,38 63,90 62,20 58,10 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. economic analysis (2010, vol. 43, no. 3-4, 42-58) 46 the highest ratio had a hvb central profit bank and unicredit zagrebačka bank which had the most oscillations of it too. the most stable ratio had raiffeisen bank and upi bank. this stability is the result of successful liquid assets and short term obligations management. this analyze does not include hypo bank because it has not had short term obligations in 2004, so it would affect extremely on quality of this analysis. figure 3 ratio of credits and deposits with credit obligations for individual banks and banking sector in period 2003-2007 credits / deposits and credit obligations 0 0,2 0,4 0,6 0,8 1 1,2 raiffaisen bank hypo unicredit hvb cpb upi bank other banks banking sector 2003 2004 2005 2006 2007 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. table 4 ratio of credits and deposits with credit obligations 2003 2004 2005 2006 2007 raiffeisen 0,55 0,59 0,61 0,66 0,74 hypo 0,86 0,87 0,98 0,85 0,84 unicredit 0,61 0,60 0,60 0,61 0,63 hvb cpb 0,92 0,93 0,63 0,57 0,59 upi banka 1,00 0,51 0,53 0,56 0,68 other banks 1,00 0,62 0,66 0,73 0,78 banking sector 0,06 0,07 0,05 0,09 0,16 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. there is a trend of growth of ratio of credits and deposits with credit obligations and it means that credits are rising faster than sum of deposits and credit obligations. also it means that disposed sources of assets are more and more used for financing interest assets. *** rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 47 from what it is said, we conclude that banks in fb&h have a trend of decreasing in liquidity and it, according to our presumption, results in increasing in profitability. it means that own banks have started to invest their short term disposed assets and on that way they are trying to cut the opportunity costs. . meanwhile, liquidity of banking system of fb&h is not endangered and banks constantly measure up to requirements and even more than prescribed minimum considerably. banks still dispose by liquid assets which are not placed and in that way there is ability for improving their effectively. analysis of profitability profitability is the result of successful realization of business politics. upcoming results depend of the results in the past, which are analyzed through different indicators. in this profitability analysis, next indicators are analyzed: 1. net profit 2. return on assets – roa 3. return on equity – roe data about net profit of banks in fb&h for observed period are presented in following table. table 5 neto profit of banks in fb&h in period 2003-2007 in 000 km 2003 2004 2005 2006 2007 raiffeisen bank 20.271 21.146 24.229 27.739 26.132 hypo banka 528 7.212 12.009 7.231 17.088 unicredit 16.940 8.848 19.192 24.896 29.748 hvb cpb -6.616 -144 5.228 15.503 14.965 upi banka 3.596 3.889 3.360 751 1.528 other banks 13.505 6.068 19.818 17.224 21.057 banking sector 48.224 47.019 83.836 93.344 110.518 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. net profit has rise as an absolute value at all banks and average growth rate of banking sector is 23%. this rate is even more for individual banks and for example net profit of hypo alpe adria bank has grown at a yearly rate of 138%. according to financial result, we can conclude that profitability of banking sector is well. return on assets is ratio of net profit and average total assets. it is net profit per unit of assets and it includes two parts: incomes and costs (including taxes) assets total profitnet roa = (1) in ideal conditions, denominator should be daily average of values. into consideration that it is impossible to assure those values, it is often used monthly and quarterly average. economic analysis (2010, vol. 43, no. 3-4, 42-58) 48 data about roa are presented in the following table. table 6 roa of banks in fb&h in period 2003-2007 2003 2004 2005 2006 2007 raiffeisen bank 1,45% 1,04% 0,97% 0,90% 0,69% hypo banka 0,07% 0,68% 0,87% 0,43% 0,77% unicredit 2,41% 0,67% 1,22% 1,34% 1,38% hvb cpb -8,23% -0,02% 0,48% 1,21% 1,06% upi banka 1,37% 1,02% 0,76% 0,15% 0,16% other banks 0,56% 0,33% 0,89% 0,60% 0,64% banking sector 1,09% 0,72% 0,73% 0,87% 0,90% source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. figure 4 roa in the 2003-2007 period roa -10,00% -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% raiffeisen bank hypo unicredit hvb central upi banka ostale banke bankarski sekto 2003 2004 2005 2006 2007 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. roa of banks in fb&h is under international standard of 1% and reason of that is probably lack of assets investments. because of that in fb&h are hyper liquid. form what it is said, it is clear that there are still abilities for banking sector to increase its profitability. if banks increase theirinvestments, their profitability would be increased. return on equity (roe) is ratio of net profit and equity average. it is net profit per unit of equity. data about roe are presented in the following table. it is clear that return on equity is under international standard too and the reason could be same as for undersized roa. equity profitnet roe = (2) rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 49 table 7 roe of banks in fb&h in period 2003-2007. 2003 2004 2005 2006 2007 raiffeisen bank 22,12% 15,81% 14,30% 13,85% 9,35% hypo banka 0,75% 6,09% 8,55% 4,42% 9,52% unicredit 26,28% 8,46% 15,54% 16,79% 16,74% hvb cpb -32,38% -0,24% 6,07% 13,70% 11,68% upi banka 12,16% 11,62% 9,21% 2,03% 1,91% other banks 3,31% 1,37% 4,21% 3,01% 3,47% banking sector 10,08% 6,89% 7,83% 10,82% 12,19% benchmarking 12-18% source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. figure 5 roe of banks in fb&h in period 2003-2007 u grafiku nisam uspeo da izmenim ostale banke i banking sector (to treba izmeniti) roe -40,00% -30,00% -20,00% -10,00% 0,00% 10,00% 20,00% 30,00% raiffeisen bank hypo unicredit hvb cpb upi banka ostale banke bankarski sektor 2003 2004 2005 2006 2007 source: condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 20032007), fba, www.fba.ba. data prepared by authors. regressian model as it is already said, banks liquidity has a trend of decrease. meannwhile, it is still above prescribed minimun. it means that there is ability for decreasing liquidity to increasing profitabiliy. this constatation is based on high correlation of these two categories. correlation of variables liquid assets/ total assets and return on equity is -0,743 what proves high correlation. it is best to determine the type and degree of dependence of profitability and liquidity through such as the simple regression analysis. general regression model is: ebxay ++= (3) where yis dependent variable that is amount of roe, economic analysis (2010, vol. 43, no. 3-4, 42-58) 50 xis independent variable that is amount of liquidity assets/total assets , a and b represent regression parameters where a is segment of dependent variable and b is inclination., e is stochastic term or disorder (random mistake) which, basically, would reflect the effects of other factors that are not included in the model and accidental influences as well. model is presented in next figure. figure 6 regression line between liquidity and profitability in banking sector in fb&h y = -1,1815x + 0,5278 r2 = 0,5517 0,00% 2,00% 4,00% 6,00% 8,00% 10,00% 12,00% 14,00% 34,00% 35,00% 36,00% 37,00% 38,00% liquid asse ts/total asse ts r o e banking sector linear (banking sector) by using this simple regression model it is found that if banks decrease their liquidity for one percent, their profitability (roe) would be increased for 1,18 percent. it proves our hypothesis that there is ability for increasing profitability. therefore it is necessary to consider coefficient of determination r² which should be relatively high, so the analyzed appearances could give the adequate illustration of connection and interdependence. coefficient of determination r², which in this case is 0.5517, shows that this regression represents the adequate illustration of connection between these two variables and that 55,17% liquid assets/ total assets total variability is explained by the value roe. income and expenditures the total income in banks can be divided into two groups: interest income and noninterest income. the banking sector of fb&h, in its current development stage, is predominantly based on credits as the most important activity, which strongly determines the financial result. this is shown in the following table: we may conclude that the trend of credit expansion is continuing, which led to an increase in the proportion of credits in total assets. between 2003 and 2007 credits have risen at an average yearly rate of 27,6 % and have risen faster than banksʹ assets by 2,5%. this may have been the result of a high demand for credits, especially in the population sector. rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 51 because of the increase in credits, the interest income has also risen by 25,5% each year, in individual banks, as well as the banking sector. nevertheless, interest expenditures have also grown by 35,1% each year, which is more than the growth rate of interest income by 7,5%. this resulted in a smaller net income margin. the increase of interest expenditures is mainly the result of higher passive interest rates and higher interest rates on banksʹ liabilities. growing competition in the fb&h banking sector has had an effect to the decrease of the net interest margin. despite the decrease of the net interest margin, we notice an increase in profitability, mostly thanks to the effect of economy of scale. this means that the increase in volume of interest income more than covers the decrease of active interest rates and increase of interest expenditures. the proportion of total income in assets has continuously fallen because of a more dynamic growth of assets than the growth of income. a significant contribution to the growth of profitability has been given by the decrease of the capital-to-assets ratio. this ratio has fallen from 12,14% in 2003 down to 10,48% in 2007. non-interest income has seen lower growth rates (7,6%) and with its volume have not contributed as much to profitability. this type of income has been recording a constant growth in absolute amounts, but their participation in total income is actually falling, so the ratio in 2007 was 25,65%. such a low ratio indicates that the fb&h banking sector is undeveloped and predominantly directed toward traditional banking services e.g. credit. this ratio, in developed banking systems reaches beyond 50%. from this data, we see a potential to increase profitability, by widening the spectrum of bank services. as the process of consolidation and stabilization ends, the banking sector is going to enter a phase of more intense competition, which will result in better cost efficiency and development of non-interest business and products. combined with the continuous credit expansion, this will represent the main development trends in the fb&h banking sector. productivity productivity and profit represent two sides of the same phenomenon, two different perspectives to the same process – the process of continuous success, which every modern organiyation strives for. in the conditions of a global market, the productivity issue and the profit issue as its consequence poses itself as the key issue to every organized activity committed to create profit. there can be no profit without productivity, nor is there productivity which is not followed by new quality. productivity is the measure of success in doing business in relation to the used resources. the number of employees in the banking sector has grown at an average rate of 5,6% every year. it is interesting to view the relative number of employees, as the percentage employed in an individual bank compared to the banking sector. we may notice that there are relatively more employees in unicredit than hypo, although hypo has more assets. economic analysis (2010, vol. 43, no. 3-4, 42-58) 52 table 8 number of employees in the fb&h banking sector in the 2003-2007 period 2003 2004 2005 2006 2007 raiffeisen bank 1020 1109 1205 1351 1548 hypo 301 377 433 492 550 unicredit n/a 755 790 840 840 hvb cpb 71 454 451 476 465 upi banka 169 191 208 233 479 other banks 3383 2296 2470 2740 2829 banking sector 5394 5182 5557 6132 6711 source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. table 9 precentage of employees per bank in the period 2003-2007 2003 2004 2005 2006 2007 raiffeisen bank 19,91% 21,40% 21,68% 22,03% 23,07% hypo 5,58% 7,28% 7,79% 8,02% 8,20% unicredit 7,34% 14,57% 14,22% 13,70% 12,52% hvb cpb 1,32% 8,76% 8,12% 7,76% 6,93% upi banka 3,13% 3,69% 3,74% 3,80% 7,14% other banks 62,72% 44,31% 44,45% 44,68% 42,15% banking sector 100,00% 100,00% 100,00% 100,00% 100,00% source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. data prepared by authors. table 10 profit per employee as of 2003-2007 2003 2004 2005 2006 2007 raiffeisen bank 19.873,53 19.067,63 20.107,05 20.532,20 16.881,14 hypo 1.754,15 19.129,97 27.734,41 14.697,15 31.069,09 unicredit 37.644,44 11.719,21 24.293,67 29.638,10 35.414,29 hvb cpb -93.183,10 -317,18 11.592,02 32.569,33 32.182,80 upi banka 21.278,11 20.361,26 16.153,85 3.223,18 3.189,98 other banks 3.992,02 2.642,86 8.023,48 6.286,13 7.443,27 banking sector 8.940,30 9.073,52 15.086,56 15.222,44 16.468,19 source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. obviously, raiffeisen bank has the largest fluctuation in net profit per employee, and the decrease is evident in 2007. other banks have experienced a growth trend in net profit per employee, with a minor fall in 2007 in hvb and upi. generally speaking, the productivity expressed as net profit per employee has grown in the sector by 16,49%. if we take into consideration that the number of employees has risen by 5,6%, we may conclude that the productivity level can only rise until a certain level and that the growth rate of 16,49% is rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 53 unsustainable in the long run. however, we still predict an increase, possibly at a lower rate. the increase of productivity is an opportunity to increase profitability. this conclusion may be tested by using an alternative method of evaluating productivity assets per employee. table 11 assets per employee as of 2003-2007. 2003 2004 2005 2006 2007 raiffeisen bank 1.367.174,51 1.839.490,53 2.069.272,20 2.293.352,33 2.464.063,31 hypo 2.608.644,52 2.830.291,78 3.180.265,59 3.450.390,24 4.045.647,27 unicredit 1.560.044,44 1.741.540,40 1.996.367,09 2.213.645,24 2.575.367,86 hvb cpb 1.132.309,86 1.631.922,91 2.399.376,94 2.687.373,95 3.029.546,24 upi banka 1.551.295,86 1.999.272,25 2.114.394,23 2.170.244,64 1.994.530,27 other banks 714.141,00 808.114,11 900.434,82 1.052.840,88 1.157.507,25 banking sector 1.045.651,09 1.428.032,03 1.654.425,95 1.846.871,17 2.062.508,12 source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. the data from the table confirm the conclusion that productivity has a rising trend. assets per employee have increased by 18,51% each year. this result is fairly consistent with the previous conclusion, therefore we confirm that productivity can increase even more. equity the 2003-2007 period records a change of shareholders in the sector. the percentage of total government capital at the end of 2003 was 14,9%, while in 2007 this percentage was down to 9,7%. at the same time, private capital has risen from 85,1% in 2003 to 90,3% in 2007. foreign private capital has risen by 5% every year, while the share government-held capital has fallen by 10,1% every year. if we analyze the structure of foreign capital by countries, we can state that the vast majority (48,7%) is austrian capital, followed by italian (21,9%), turkish, slovenian, emirati and german capital. the growth of private capital is the result of continuous capitalization, founding new banks and sale of shares to private buyers. the following table shows the number of banks throughout the analyzed period. table 12 number of banks in fb&h in the 2003-2007 period 2003 2004 2005 2006 2007 domestic private capital 7 8 6 4 7 foreign private capital 12 10 12 14 12 government-held capital 7 6 6 5 3 total 26 24 24 23 22 source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. economic analysis (2010, vol. 43, no. 3-4, 42-58) 54 table 13 percentage of capital in fb&h banks in 2003-2007 period 2003 2004 2005 2006 2007 domestic private capital 19,70% 16,80% 8,00% 3,70% 10,90% foreign private capital 65,40% 65,30% 75,60% 82,40% 79,40% government-held capital 14,90% 17,90% 16,40% 13,90% 9,70% total 100% 100% 100% 100% 100% source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. private banks have better performances, so the change in shareholder structure has a positive effect on profitability. moreover, there is a strong positive correlation between the percentage of private capital and return on equity, 0,944. this means that growth of the proportion of private capital means higher profitability. considering the fact that there are still two banks awaiting privatization, it is evident that there will be an increase in profitability. the change in shareholder structure opens new opportunities for profitability growth. table 14 total private capital and profitability in the 2003-2007 period 2003 2004 2005 2006 2007 total private capital 85,1% 82,1% 83,6% 86,1% 90,3% roe 10,08% 6,89% 7,83% 10,82% 12,19% source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. at the same time, the integration and consolidation processes can result in better efficiency and synergy resulting in higher profits. table 15 equity multiplier and profitability in the 2003-2007 period 2003 2004 2005 2006 2007 roe 10,08% 6,89% 7,83% 10,82% 12,19% roa 1,09% 0,72% 0,73% 0,87% 0,90% em 9,247706422 9,569444 10,72603 12,43678 13,54444 source: information on banking system of the federation of bosnia and herzegovina as of 2003-2007. the equity-to-assets ratio is also known as em the equity multiplier, which is rising in the analyzed period. the growth of this indicator suggests that the proportion of equity in total liabilities is decreasing. this means banks are using the positive leverage effects by including more debt into their total liabilities. that being said, we have to bear in mind that regulation concerning capital adequacy is much stricter in fb&h – 12%, while the international standard is 8%. this means that banks in fb&h still have to maintain a higher level of capital than is required in other countries. the international standard of capital adequacy will have to be allowed here sooner or later, so that represents a chance to increase profitability. rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 55 transition countries – a short comparison in order to perceive a clearer picture of the real dimension of profitability of the banking sector in fb&h, we compared some indicators of profitability in transition countries. if we take into consideration that the transition processes in some of these countries started already in the 1990s and that all these countries are in a different stage of the transition process and a different development stage, it is clear that a simplified comparison does not provide a realistic perspective. still, the transition process is also the only common characteristic in all of these countries, so we may conclude that it is a valid frame for a comparison. the data showing return on equity and return on assets in transition countries in 2007. are shown in table 16. table 16 roe and roa in transition countries’ banking systems roe roa slovakia 9,7% 0,7% fb&h 12,19% 0,9% israel 19,7% 1,2% czech republic 23,1% 1,3% romania 11,5% 1,4% montenegro 11,6% 1,4% ukraine 12,7% 1,5% albania 21,0% 1,6% croatia 11,8% 1,6% belarus 10,8% 1,7% poland 25,6% 1,8% hungary 22,9% 1,8% lithuania 26,8% 2,0% latvia 24,2% 2,0% serbia 12,8% 2,1% bulgaria 25,4% 2,5% estonia 31,0% 2,7% russia 21,1% 2,8% turkey 24,4% 3,1% moldova 24,9% 4,0% source: imf global financial stability report, www.imf.org the banking sector of fb&h, compared to other transition countries, achieves a return on capital that is lower than the average of 19%. however, roe has grown by 20,9% every year the last four year, while the average in transition countries was 7,8%. roa is also one of the lowest in all the transition countries. only slovakia had a lower roa (0,7%) in 2007, while the transition countriesʹ average is 1,9%. roa has been growing by 7,7% each year for the past four years, which is 2% higher than the average growth in transition countries. roe on the other hand has grown at a higher rate than roa. this is characteristic of of transition countries because they represent markets with potentially higher growth rates and higher risks. economic analysis (2010, vol. 43, no. 3-4, 42-58) 56 in the process of integration of b&h into eu membership and automatically by accepting international banking standards, especially basel i and ii, we may expect higher profits. profit indicators would be closer to other countriesʹ indicators and benchmark standards, which could motivate new investments, not only in banks, but the whole financial sector. the 2008. financial crisis an overview so far, our analysis has been based on historical data in the 2003-2007 period, when the financial crisis still had not reached its climax and when bih had not been affected by the crisis. by abstracting the fact that the global financial crisis will lead to a global recession, which is going to spread from the bh economy to the bh banking system, we managed to state that the hypothesis was accepted. by testing the profitability factorsʹ future trend we were able to give the answer to the main question posed in this text. however, we must emphasize that b&h, sooner or later, will go through a difficult period of recession, so we presume that growth in profitability will not occur, at least not as dynamically as we expected, as long as there are any economic problems. specifically, we expect a slowdown in the current credit expansion. additionally, banks wonʹt take as many credits from foreign banks, especially their mother banks, which are subject to greater turbulence. fb&h banks will also try to reduce costs at a lowest possible level. what is not going to be under banksʹ control is the predicted recession that will result in higher unemployment rates. the crisis expected in companies will surely mean more credit risk. this is confirmed by the fact that as of the beginning of 2009, foreign orders will be cancelled. the population, as the largest borrower will also be hit by the crisis, in the sense that the number of unemployed people will rise as the result of the companiesʹ effort to cut costs. consequently, credit risk is also expected to rise in the population sector. these predictions surely do not diminish the value of previously given conclusions and analyses. moreover, banks will give their best effort so that a more significant drop in profitability would not occur. conclusion the main issue we intended to address in this text was do banks in fb&h can increase their profitability even more. we formed a hypothesis that states that there are possibilities to increase profitability. this means we focused on banks in fb&h. additionally, it was of interest to follow profitability factors for five largest banks, ranked by the value of their total assets in 2007. official reports from the federal banking agency were used to calculate and present relevant data, as they are audited and standardized. in our research we used scientific methods: analysis, synthesis, induction, deduction and description. we illustrated the most interesting and relevant data on charts. we selected four principal factors, which in our opinion determined profitability: liquidity, income and expenditure structure, productivity and equity. to ensure our assumption was correct, we calculated the correlation for all of them and proved that there is a strong correlation between these factors and profitability. rovčanin, a., et al., analysis of profitability, ea (2010, vol. 43, no, 3-4, 42-58) 57 liquidity indicators in banks are different from other entities. we analyzed three indicators: profitability was calculated as roa and roe. our general conclusion is that profitability has been growing. having calculated liquidity and profitability indicators, we were able to establish a correlation. we have shown that the correlation is negative, which is consistent with our assumption. we were also able to establish a linear regression with the following equation: y=-1,1815x+0,5278. the determination factor is 55,17% and it means that the growth in profitability is caused by lower liquidity with 55,17%. having in mind the fact that banks keep up a significantly higher average of liquid assets that required by law, by reducing the amount of liquid assets, profitability could be higher. the second factor was the structure of income and expenditure. non-interest income has recorded significantly lower growth rates and the financial result was not affected much by their volume. this type of income has constantly been growing in absolute amounts, however their proportion in total income is decreasing, and in 2007. it was 25,65%. such a low percentage indicates that the fb&h banking system is undeveloped and is mainly directed to traditional banking services. as the proportion of non-interest income in total income in developed banking systems reaches up to 50%, we find that this proportion will increase in the future. wider sets of services will contribute greatly to stability and profitability of the banking sector. productivity is also an important profitability factor. we measured it as profit per employee and assets per employee. we established a correlation of 0,53 for profit per employee and 0,47 for assets per employee. if the existing trend of increase in productivity persists, profitability will also rise. finally, the nature of capital is yet another profitability factor. with a higher proportion of private capital came higher profitability. 0,944 correlation confirms it. additionally, by calculating the equity multiplier we have shown that banks use more credit obligations to finance their activity, and that contributes positively to profitability when the financial results are positive. there are still two banks to be privatized and that will contribute to growth of profitability. by using more debt in total liabilities, profitability can rise even more. by comparing roa and roe of fb&h banks and other transition countries, it is evident that fb&h has lower indicators. that is slightly confusing, because in general transition countries have higher returns. the reason is that the financial system in fb&h is inflexible and strictly regulated. getting closer to eu membership, b&h will have to harmonize the domestic regulative with international standards. when that occurs, higher profitability may be expected. the purpose of the overview of the financial crisis was to anticipate any critics at the quality of our analysis. our principal argument is that the effects of the financial crisis are only to be seen on the 2008 annual reports, which are currently unavailable. also, we consider this crisis an anomaly, considering the fact that the crisis was not generated in our region. based on the available data we could predict that, in the long run, profitability can be economic analysis (2010, vol. 43, no. 3-4, 42-58) 58 increased. 2009 is going to be a very difficult year, so the results of our analysis may not be visible at first. finally, by logic induction and proofs, we may state that the hypothesis about the possibility of increasing profitability of the banking sector is confirmed. references brealey r., myers s, marcus a. (2007). osnove korporativnih financija. zagreb: mate. ćirović, m. (2001). bankarstvo. beograd: bridge company. hadžić f., efendić v. (2006). bankarstvo pregled predavanja i vježbi. sarajevo: ekonomski fakultet. hrvatsko udruženje banaka. (2007). profitabilnost hrvatskih banaka: između mita i stvarnosti. hub analize, broj 3. information on banking system of the federation of bosnia and herzegovina as of 31.12.2003., fba. available: http://www.fba.ba/en/publications/ information on banking system of the federation of bosnia and herzegovina as of 31.12.2004., fba. http://www.fba.ba/en/publications/ information on banking system of the federation of bosnia and herzegovina as of 31.12.2005., fba. http://www.fba.ba/en/publications/ information on banking system of the federation of bosnia and herzegovina as of 31.12.2006., fba. http://www.fba.ba/en/publications/ information on banking system of the federation of bosnia and herzegovina as of 31.12.2007., fba. http://www.fba.ba/en/publications/ imf: global financial stability report, www.imf.org; leko, v. (1998). rječnik bankarstva, zagreb: masmedia. narodna banka srbije. izveštaj o stanju u finansijskom sistemu republike srbije za 2006. godinu, www.nbs.rs orsag, s. (2003). vrijednosni papiri. sarajevo: revicon. pavković, a. (2004). instrumenti vrednovanja uspješnosti poslovnih banaka. zbornik ekonomskog fakulteta u zagrebu, godina 2, broj 1. rovčanin, a. (2007). upravljanje finansijama. sarajevo: ekonomski fakultet, 2006. 4. izdanje; condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 2003. available at: http://www.fba.ba/en/publications/. condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 2004. available at: http://www.fba.ba/en/publications/. condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 2005. available at: http://www.fba.ba/en/publications/. condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 2006. available at: http://www.fba.ba/en/publications/. condensed reports of external auditors on financial statements of banks in federation of bosnia and herzegovina in 2007. available at: http://www.fba.ba/en/publications/. somun-kapetanović, r. (2006). statistika u ekonomiji i menadžmentu. sarajevo: ekonomski fakultet. vanhorne j., wachowitz m. (2002). osnovi financijskog menedžmenta. zagreb: mate. zaklan d. (2000). bankarstvo u tržišnom makrosistemu. mostar: ekonomski fakultet univerziteta „džemal bijedić“. received: 17 september 2009 article history: accepted: 10 may 2010 microsoft word 2011_3_4_finalna ver.doc         notes from the editor‐in‐chief          the journal  is published  twice a year  in  issues that contain peer  articles and book reviews spanning all of the following subject areas  such  as  unemployment,  inflation,  economic  underdevelopment,  globalisation and international economic integration, finance, changing  forms and boundaries of markets and planning, organization culture  and behavior ,management,  transformation of industrial organizations  and economic systems, experimental studies in economics and uneven  development and instability in the world economy. in addition, the journal covers environmental and  ecological  issues,  economic  stabilization,  labor  relations, monetary management and   other  topics  within the discipline of economics. ea is also open to interdisciplinary or other submissions which  explore  innovative  approaches  including  critical  contributions  to  economic  theory,  debates  on  economic policy and interpretations of recent economic changes.  we occasionally publish special issues of the journal, devoted to a particular topic.    the main  text of a manuscript must be submitted as a word document  (.doc).  it  is  strongly  recommended that you use the author submission guidelines to help you to prepare your submission to  the journal. authors should submit their manuscripts online at eaoffice@ien.bg.ac.rs.        prof. dr. mirjana radović marković, frsa, fwaas, femaas          microsoft word 2010_1_2.doc scientific review innovation policy based on network paradigm pachura piotr*, czestochowa university of technology, the management faculty, czestochowa, poland udc: 330.354 jel: 031 abstarct – the aim of this paper is to present the role of cluster and network collaboration in innovativeness process and knowledge based economy. the paper describes the clustering pagadigm in eu policy and examples of the network creating process and organizing cluster initiatives in eu countries. according to the results of literary research it is possible to univocally state that the geographical proximity between enterprises of a similar profile of activity facilitates the achievement of a higher level of productivity and innovativeness. the clusters covering the spatial sphere of its location: producers, suppliers, service providers, research units, educational institutions and other units supporting a given sector became an important factor in the economic development of regions. the trend towards interaction and basing on the resources of business partners operating in a given location results from the new trends of management, among others, the school of resources in strategic management at the top with key competences and the open innovation paradigm. directing the regional policies of the eu along the concept of clusters also results from the wide impact of the progressing globalization on the essence of inter-regional competitiveness as well as regional cohesion (matlovič r., matlovičová k. 2008). increasingly lower costs of transport and communication and the simultaneous liberalization of international trade revealed the weaknesses of regional economies and exposed them to global competition. with regard to the increasing number of locations with attractive conditions for investment, european regions faced the necessity of offering foreign investors even more unique benefits. clusters became in this situation a magnet attracting a bunch of highly specialized resources of knowledge in a given sector which are not present in other locations. therefore, due to its practical application, the concept of the theoretical clusters regardless of whether the work of m. porter or as a stage in the evolution of industrial districts of marshall in the direction of the systems of innovation became one of the most important elements of economic, innovative and regional policies of the eu. the reasons for such a turnaround in the activities of the european commission have been previously indicated. it is possible to add that the traditional instruments of supporting economic growth and the competitiveness of regions, for instance by supporting whole branches of the industrial sector, have not succeeded and had to be replaced by a mechanism that is more adjusted to the challenges of the global economy. * address: armii krajowej 19b, 42-200 czestochowa, poland, e-mail: ppachura@zim.pcz.pl pachura, p., innovation policy based on network paradigm, ea (2010, vol. 43, no. 1-2, 126-133) 127 the network approach to innovation and the according theory of clusters became the central point of interest for the eu. a key element in the policies of innovation of the eu became the cluster-based policy. this type of policy is defined as a grouping of activities and instruments used by the authorities at various levels for the improvement of the level of competitiveness of the economy by stimulating the development of the existing cluster systems or their creation at first and foremost the regional level (brodnicki, szultka, 2004). among the elements that decide on the effectiveness of policies of supporting clusters the following assumptions can be listed (eda, 1997): • the driving strength of the cluster policy is the free market; • this combines various units of the regional economy; • this is based on cooperation and mutual activity; • this takes the form of a strategic nature and helps to shape a common vision; • this creates new value. involvement in initiating policies based on clusters can be naturally explained by the determination of eu member countries in the realization of the aims of the lisbon strategy whose achievement at the first deadline turned out to be impossible. clusters seem to be the appropriate direction for the realization of the innovative policies of the eu. from the point of view of the european commission, promoting policies based on clusters is to lead to the achievement of the aims of the lisbon strategy. the competing conglomeration of enterprises provides the possibility of access to the network filled with skills and abilities to generate innovation. they are becoming an effective environment in which it is easier to realize the initiation of new products immediately after their development in research laboratories. a policy based on clusters is not a separate element of activities on the part of national and regional authorities, but should be rather treated as an integral element of various policies. this is most frequently reflected in the assumptions of scientific policy or scientific and technological, innovative, economic, and regional development. in this way the idea of clusters penetrates into the strategy of development for regions, but is also taken into account in state programmes that are financed by the eu structural funds. most often however, the philosophy of policies based on clusters takes on a horizontal nature and finds itself in all the afore-mentioned policies. it fits in perfectly into the policies of regional development based on the model of the innovation system. clusters as a way of arousing the innovativeness of regions usually find themselves among the priorities of regional strategies of innovation. the cluster policy is part of the model of strengthening interactions within the framework of the so-called triple helix, or in other words, the system of interactions between the key players of the system of innovation: enteprises, scientific and research units and local authorities. the concept of clusters became a topic of interest for national and regional governments, organizations of entrepreneurs, international organizations particularly oecd countries and the eu in the second half of the 1990s. this interest can be observed through successive cluster initiatives, starting from the theoretical work explaining the essence of clusters to the attempts of working out the methodology of their identification and finally the guiding rules in the sphere of the policies of stimulating clusters in regions. these last initiatives are worth economic analysis (2010, vol. 43, no. 1-2, 126-133) 128 devoting more time to in order to illustrate the factors of success in undertaking activities within the framework of regional policies on behalf of the development of clusters, which has been done in the later stages of this paper. the guiding rules of the programme and the strategic documents of the eu took account of the concept of clusters relatively late as it occurred at the beginning of this century but it is necessary to explain this as a rather different approach to the issue of the innovativeness of regions. the efforts in this area were from the very beginning directed towards the issue of the systems of innovation, industrial districts and local innovative environments, which in their own essence are also based on the network paradigm of innovativeness. apart from the initiation of the afore-mentioned models of regional development, another trend of activity in the eu associated with clusters was the creation of networks of interaction between regions. the stimulation of networks of interaction appears in various aspects and policies of the eu. the scientific and research policies can be used here as an example together with its main instrument in the form of the framework programmes that support the networks of interaction of scientific centres and their relations with industry. in the middle of the 1990s, the eu started to place particular emphasis on the issue of regional innovativeness. the breakthrough moment was the passing of the lisbon declaration by the european council in 2000 and the acceptance of the aim of transforming the eu economy in the most competitive market based on knowledge in the world. in this context the policy of supporting clusters in eu member countries grew in importance and the regional authorities acknowledged that the foundation of competitiveness is that of small enterprises. the creation of an environment that is friendly towards the development of small firms became a priority, particularly through the stimulation of interaction between them and also creating interaction with the r&d sector. the strategy of development for eu member countries initiated with the aid of programmes financed by eu funds that were assigned priorities in the sphere of supporting networks of interaction at the level of enterprises and the area of r&d. the network model of innovativeness was accepted as binding, in which the theory of clusters fits perfectly. the activity of the eu commission in the area of creating a favourable regulatory framework and the popularization of knowledge on the topic of clusters is confirmed by many conceptual papers and documents among which the following can be mentioned: • “industrial policy in an enlarged europe” from 2002, in which the creation of innovative clusters became acknowledged as the key priority of the new industrial policy, • communiqué entitled “some key issues in europe’s competitiveness – towards an integrated approach”, according to which one of the proposed activities was to be the european project of identifying the best practices in the sphere of of initiatives of developing clusters, • programme document entitled “industrial policy in an enlarged europe” from 2004, in which the innovative policies and supporting initiatives based on clusters were listed as being of key importance (ślusarczyk b., 2008), • consultation document entitled “innovate for a competitive europe”, which states that the structural funds can support the internationalization of regional pachura, p., innovation policy based on network paradigm, ea (2010, vol. 43, no. 1-2, 126-133) 129 clusters, which according to the european commission became the effective mechanism of stimulating innovation. the policy of regional development based on clusters can be the effect of bottom-up initiatives, as well as resulting from top-down initiatives. the second type of operation is the effect of the activity of the local authorities, however the bottom-up activity is usually characterized by the activity of the branch environment. regardless of the way of realization of the cluster initiatives, a significant role should be attributed to the public authorities. according to m. porter, the role of the public factor in creating and stimulating the development of the cluster in the area of shaping the factors of production, related and supporting sectors, conditions of demand, as well as the strategy and rivalry between enterprises (porter m. 2001). the first paper that carried out a complex analysis on the effects of policies based on clusters realized in selected countries is the document entitled “the cluster initiative greenbook”. in this document the results of research into cluster initiatives were presented within the dimension of their effectiveness and range. interesting results were also presented within the framework of a range of oecd projects (oecd 2001) directed at the analysis of practical aspects of the functioning of clusters. the afore-mentioned projects were aimed at diagnosing the existing state in the area of cluster initiatives, as well as working out the guiding principles in the area of formulating and initiating innovative policies based on networks. a compendium of knowledge and a type of guidebook on the topic of shaping policies based on clusters is constituted by the work prepared by the non-governmental organization iked (international organization for knowledge economy and enterprise development) (anderson 2004). in the identification of the recommendations and factors of success in the realization of cluster initiatives the report prepared at the request of the ministry of trade and industry of great britain was also used (a practical guide...) . on the basis of the afore-mentioned documents it is possible to indicate the experience of particular countries in the area of initiating policies based on clusters. the results of research facilitate the creation of the basic recommendations for the practical formulation and initiation of the policies of regional development based on the concept of clusters. cluster initiatives most frequently appear in highly developed countries, mainly in the sectors of large technological intensities with regard to the following: it, telecommunications, medical equipment, production technology, pharmaceuticals, automotive. most initiatives were directed at the development of a specific cluster and were started between the years 1999 – 2002. the aims of creating cluster initiatives are very varied and can be classified within the framework of the following 6 categories: research and the creation of network interactions, education and training, innovation and technology, expansion of cluster, political activity, commercial interaction. within the framework of the distinguished categories of aims, most participants of clusters (over 75%) indicate the main aims of their participation in cluster initiatives as follows: the creation of interaction between enterprises and creating relations between people, development of their own company, easier access to new technologies and the ability to create innovation. initiatives that have a priority goal in promoting innovation and new technology achieve significantly greater success in the area of improving the competitiveness of particular enterprises. economic analysis (2010, vol. 43, no. 1-2, 126-133) 130 the process of creating and organizing cluster initiatives takes on different forms despite the fact that the nature of such initiatives enforces the principles of creating a partnership between the industrial sector, research and public authorities. the participation of particular parties is varied in individual cases. the idea of constructing a cluster is most frequently becoming an initiative of local authorities and the sector of enterprises at a more or less equal pace. a decidedly greater role in the aspect of financing cluster projects is played by public authorities. in over half of the clusters analysed, the main source of financing was the regional budget or national public units. in turn, the involvement of colleges in initiating clusters in their initial phase of development was very small, which clearly confirms the low financing coming from these units. a dominating role in managing clusters is played by the sector of enterprises, while the role of public authorities in some decisions is also envisaged. the involvement of local authorities, most often in the form of neutral organizational units, is to lead to the balancing of interests of the competing enterprises. the source of financing does not seem to have great significance in achieving results both in the aspect of competitiveness as well as the numbers of members of a cluster. according to the theory of clustering, most initiatives are directed in their own sphere in a given industrial branch or geographical zone. most existing clusters include units that are located within a radius of one hour’s drive. the aspect of geographical distances was indicated as a significant factor in facilitating mutual personal contact. clusters are not limited to the type of enterprises which can become its member. both direct competitors and foreign business units can freely participate in the aforesaid initiatives. the only restriction in this regard refers to one level in the value chain, which means for instance a greater role in including specific producers but not their suppliers and clients. the fundamentality of initiating policies based on clusters is becoming univocally confirmed by the benefits indicated which are provided to enterprises in these types of initiatives. entrepreneurs identify the success resulting from the membership of a cluster through the prism of competitiveness and achievement of business goals. most entrepreneurs confirm that the initiatives led to the improvement of their competitiveness and the most frequent effect is the tightening of interaction between the industrial sector and the r&d area. the factors that are decisive in the success of clusters include the following: the quality of the business environment, structure and way of running economic policies, as well as the internal strength of the cluster itself. within the framework of the first category two key factors should be listed which attract other firms to participate in the cluster initiative to the highest degree: the presence of an advanced scientific society and a high level of trust between firms, while also the public and private sectors. economic policy is also significant with such elements as: promotion of scientific research and innovation, the possibility of taking economic decisions at a regional level, protection of the high level of market competition. the trend of achieving better results in the area of competitiveness is visible through cluster initiatives directed at strong clusters. clusters with a significant economic meaning on the scale of the whole region or country and a longer history of existence are more attractive for new members. they usually attract the presence of enterprises that compete on an international scale. within the framework of research presented in the green book a range of factors was diagnosed that are decisive to the failure of cluster initiatives. the greatest significance is pachura, p., innovation policy based on network paradigm, ea (2010, vol. 43, no. 1-2, 126-133) 131 attributed to the lack of consensus in the area of taking action, as well as a clearly formulated vision for the initiatives and undefined aims of a quantifiable nature. significant meaning in the failure of initiatives is played by the issue of insufficient resources, both in infrastructure and financing. other elements that lead to unsatisfactory results are as follows: restriction of the range of membership to only groups of large enterprises, one level in the value chain or enterprises belonging to the location dictated. large significance in the failure of cluster initiatives is also played by a lack of trust in the initiatives undertaken by public authorities. a survey of the reports prepared up to now on the topic of cluster initiatives in various countries enables us to note that the policy of supporting clusters takes on various forms. in reality it does not only vary from the level of analysis accepted and the methodology applied in supporting the process of networking, but also the degree in which the policy based on clusters was initiated, as well as the instruments used for this purpose. the most frequent elements in the strategies of the development of clusters include: • strong competiveness of the economy and the reforms of economic policy in the area of market regulations, • supplying strategic information by way of foresight type projects, cluster analysis and internet portals, • agencies dealing in contacts with entrepreneurs and units supporting innovativeness e.g. innovation centres; • development programmes for the development of clusters financed by public funds; • establishment of centres of excellence connecting the industrial sector with the r&d area; • adhering to public procurement (public tenders); • construction of platform for public and private dialogue. in many countries the process of clustering was initiated by the establishment of allowances, platform and regular meetings involving enterprises and organizations from the business environment associated with a given branch. the motive for starting dialogue was the results of research projects, particularly the technological foresight, which aroused discussion and prompted joint action. generally speaking, the process of initiating clusters and other networks of interaction in a dimension of european regions takes on various forms depending on the political culture, way of institutionalizing the dialogue between the public sphere and the private sector, the size of the regional economy, but also depends on the scale of intervention of public authorities in economic life, as well as the degree of industrial and technological specialization of the region. in the afore-mentioned reports and expert analysis a set of key recommendations in the area of initiating policies based on clusters indicates the factors of success listed below (ibngr, 2002): • the main role should be accepted by the sector of enterprises, however public authorities take on the role of a catalyst in the development of the cluster in question. in such an arrangement, the expansion of the public and private sector partnership is key, • the aims of the initiated policies should be transparent and measurable, economic analysis (2010, vol. 43, no. 1-2, 126-133) 132 • clusters should be built on the basis of existing potential and avoid creating initiatives in branches which are not sufficiently developed or generally do not appear in a given location, • the presence of a large enterprise in a given branch which is seen positively as a source of new technologies, acquisition of expertise, client base and suppliers, as well as space for the development of human resources, • adequate technical infrastructure is essential together with a developed network of transportation and telecommunication connections, as well as an accessible base of attractive real estate for investors. institutional mechanisms are helpful here in the form of entrepreneurial incubators, scientific, technological and industrial centres, due to the conditions of mutual work in a specified physical space offered by them; • the presence of an entrepreneurial spirit, especially among employees of a scientific and research unit and large innovative enterprises which is to lead to the formation of spin-off and spin-out firms; • the possibilities of access to financial capital in the form of high risk capital (venture capital), networks of investors searching for innovative and prospering enterprises (the so-called business angels), loan funds and finally public programmes, finance programmes e.g. eu funds; • the development strategy of a cluster should be realized at an appropriate level of local government which facilitates the effective initiation, • in the initial phase of development of a cluster an analysis of the potential or existing concentration of enterprises of a given branch should be analysed making use of the existing clusters in other locations. the results of this analysis should be used for public debate with the aim of working out a wide social consensus, • the action taken should enable the increase in the specialization of cooperating enterprises and institutions with the aim of realizing economies of scale and range, division of labour, as well as development on a local scale of specialized factors of production which facilitates the strengthening of the competitive position of the cluster, • using the benefits accruing from the geographical proximity should be promoted by the establishment of associations of sub-suppliers or other forms of mutual interaction (e.g. associations of mutual credit guarantees) stimulating diffusion of knowledge and technology, as well as the processes of mutual learning, • in the case of highly technological clusters, one of the fundamental activities should be acknowledged as stimulating and creating flexible interactions at the level of industry and the academic sector, • for the achievement of success, it is essential to build clusters on the basis of formal and informal networks of interaction within which the information flows can take place. this type of social network that emerged on the basis of a high level of trust and social capital can be stimulated by strong institutional structures divided by cultural values and common goals; pachura, p., innovation policy based on network paradigm, ea (2010, vol. 43, no. 1-2, 126-133) 133 • the market success of a cluster is conditioned by the access to the base of skills understood as the highly skilled workforce; • mechanisms should be created that enable resignation from cluster initiatives in the case of their failure. in summing up, the results of the analysis of the conditioning of the initiated innovative policy directed at clusters, it should be first and foremost underlined that the key aim of this policy should be to strive towards the creation of a long lasting competitive advantage in the economy of the region. the way for achieving the afore-mentioned aim can become a strong innovative cluster or group of smaller innovative clusters functioning within the framework of a coherent system of innovation. the policy based on clusters should be supported by a set of other complementary actions within the framework of related policies, which leads to the gaining of synergy effects. this is therefore the policy which penetrates into other policies and in its own essence takes on a nature of horizontal activities. the concept of clusters is according to other models of development for innovative regions and should be treated in this way as a supplement for the models of the learning regions, regional systems of innovation and the innovative environment. all the afore-mentioned theories of regional development are based on the network paradigm of innovation and enable local spatial arrangements to meet the challenges of the global knowledge economy. references a practical guide to cluster development, department of trade and industry, dti, london andersson t., et al., the cluster policies whitebook, iked, 2004 boosting innovation. the cluster approach, oecd, 1999 brodnicki t., szultka s., tamowicz p., polityka wspierania klastrów. najlepsze praktyki. rekomendacje dla polski, niebieskie księgi, rekomendacje (policy of supporting clusters.best practices. recommendations for poland) no. 11, ibngr, gdańsk 2004 cluster based economic development: a key to regional competitiveness, eda, 1997 innovative clusters. drivers of national innovation systems, oecd, 2001 matlovič, r., matlovičová k., regionálne disparity a regionálny rozvoj na slovensku s osobitným zreteľom na prešovský kraj. [in:] e. rydz, a. kowalak (eds.), świadomość ekologiczna a rozwój regionalny w europie środkowo-wschodniej. wydawnictwo naukowe akademii pomorskiej, słupsk, 2008 porter m., porter o konkurencji, pwe, warszawa 2001 ślusarczyk b., the eu adjustments in the sphere of industrial policy [in:] microcad 2008. international scientific conference. economic challenges. miskolc 2008 received: 18 january 2010 article history: accepted: 22 april 2010 doi: 10.28934/ea.23.56.1.pp20-31 first online: march 31, 2023 preliminary report managers’ attitudes on sustainable development concept application in trading companies – evidence from serbia maja staletović11f* | srećko bačevac2 | mirjana stevanović3 | ljubica pantelić4 1 business college of applied studies „prof. phd radomir bojković“ kruševac 2 belgrade banking academy, faculty for banking, insurance and finance belgrade, belgrade 3 the college of academic studies „dositej“, belgrade 4 deposit insurance agency, belgrade abstract trading companies face various challenges brought about by the modern environment. for this reason, trading company managers try to adapt their business to various requirements of the environment. this is supported by the fact that recently there has been a global change in the structure of retail, with evidence in the following examples: new sales formats have appeared, there are new categories of retail companies, sales facilities are modernized, soft information is emphasized, flexibility and innovation in business are encouraged, the role of interest groups is valued, unpredictability is accepted as the norm of functioning, the offer of trade mark products is expanded, etc. however, as economic, environmental and social problems gain more and more importance, another very important topic that captures the attention of business managers is the sustainable development concept application. doing business in accordance with the rules of sustainable development implies that trading companies base their work on ecological and moral principles of sustainable social communities. in accordance with the importance that the sustainable development concept has today, the aim of the paper is based on the analysis of attitudes of employees in management positions in trading companies in the republic of serbia regarding the application of economic, ecological and social dimensions of sustainable development. the research results showed that the application of certain elements of sustainable development basic dimensions in their trading companies has been evaluated by the managers as good. keywords: sustainable development, trading companies, management, changes, environment jel classification: m14, q56 introduction in modern economic conditions, sustainable development is a serious and very important topic. this concept aims to promote equitable and equal development while achieving economic betterment, social well-being and environmental quality. the goal is to satisfy the needs of present generations and not neglect the needs of future generations. thus, it is necessary to develop a comprehensive attitude regarding the sustainable development concept application in all areas and at all levels. in the last few years, the sustainable development concept is increasingly used in the field of trade. proof of this can be found in published sustainable development reports of many successful companies in that area. the above reports differ in the detail of providing data on * corresponding author, e-mail: maja.staletovic@visokaposlovnaskola.edu.rs maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 21 sustainable activities. a more detailed presentation of data on sustainable activities is provided by trading companies that have leadership positions in the market, which is, to some extent, expected from them. these companies are significantly dedicated to the application of various elements of economic, ecological and social dimensions of sustainable development. regarding trading companies in the republic of serbia, this paper aims to analyze certain research results in order to view the application of sustainable development basic dimensions in trading companies in the republic of serbia. the paper is based on the following research hypothesis: trading companies in the republic of serbia operate in accordance with the basic elements of the economic, ecological and social dimensions of sustainable development. accordingly, a theoretical presentation of the importance of sustainable development concept application in trading companies was given at the beginning of the paper. thenceforth, in accordance with the goal and the set hypothesis, the research results were presented and the managers' attitudes regarding the sustainable development concept application in trading companies in the republic of serbia were analyzed. at the end, concluding remarks were given and the contribution of this research was pointed out. theoretical background the importance of sustainable development was recognized as early as 1972, when the club of rome pointed out the „dilemmas“ humanity faced at that time, primarily from the standpoint of accelerated exploitation of the most important natural resources (štrbac et al., 2012). in such conditions, the sustainable development concept was primarily associated with the need to stop further creating unbalanced relations between the environment and society. the goal was based on creating a more harmonious relationship between accelerated economic growth and a significantly degraded environment. the sustainable development concept is conceived as a category that should propagate and encourage economic growth without environmental degradation and with respect for the needs of all social community members. its task is reflected in creating the balance between economic, ecological and social spheres, which in turbulent economic conditions can bring great benefits. the main principle of sustainable development is based on ensuring intergenerational solidarity (withisuphakorn, 2019). it can even be said that sustainable development is the backbone of modern society. it is actually a concept that is gaining importance day by day in various sectors of the economy. the emergence of the sustainable development concept had a significant role in creating a change in global thinking, forcing companies to rethink the way they conduct their business (hami et al., 2015). many, especially companies that have a leadership position in the market, have become aware of the importance of the sustainability concept for their functioning. as trade and retail occupy a significant place in the economy of a country, likewise, the sustainable development concept has its place in retail (sokolov mladenović, 2017). however, with regard to the trade sector, the sustainable development concept application is relatively recent. the need for responsible behavior in trading companies is stimulated by the action of various dynamic environmental trends. firstly, we are talking about the increasingly developed awareness of consumers about the importance of responsible behavior of trading companies, the emergence of information and communication technology that provides the opportunity to transmit information about companies’ irresponsible activities among consumers at an enormous speed, the increasing interest of the media in socially responsible activities of companies, etc. in addition, trading companies, especially those engaged in manufacturing, have a certain contribution to environmental degradation, but also in creating or solving social community problems. today, retail is facing major challenges due to the high mobility of consumers, the need for a strong orientation toward monitoring and analyzing consumer behavior, and the transition to online trade (burilović, 2020). all these factors encourage trading companies to operate in accordance with sustainable development goals and principles. in his work, lazibat (2012) states the research 22 economic analysis (2023, vol. 56, no. 1, 20-31) results according to which consumers notice the following irresponsible activities of trading companies: • large trading companies can be a competition to smaller trading companies, • trading companies can be harmful to the environment when they generate a large amount of waste, • inadequate attitude towards employees, • inadequate attitude towards consumers, • non-compliance with legal regulations, • inadequate promotional material. rahdari et al. (2020) emphasize that the retail industry has a significant responsibility to society because its business model is broadly embedded within society, both in terms of suppliers in its upstream supply chains and downstream with consumers. stefaneska and borusiak (2015) emphasize that retail companies have a special role in implementing the concept of sustainable development. thanks to their position as intermediaries between manufacturing companies and consumers, trading companies are able to encourage responsible behavior of their interest groups, which can be of great importance for improving the quality of life of the entire social community. theoretical-empirical research shows that trade has the ability to influence the production process and the consumption pattern but also to encourage producers to favor the needs of consumers who prioritize the sustainability concept (sokolov mladenović, ćuzović, 2014). at the same time, the sustainable development concept with all its components in retail shows certain specificities, and based on them, companies strive to create and improve their longterm competitive advantage (sokolov mladenović, 2017). thanks to their position as intermediaries between manufacturing companies and consumers, trading companies are able to monitor the responsible operations of their suppliers and also influence the development of consumer awareness of the importance of sustainable development. a trading company can initiate the process of developing awareness among end-users that they are not only consumers but that they can be an important link in the procurement chain that can, by adopting the habit of ecological behavior, return a significant amount of raw materials, now in the role of a supplier (knego, 2012). the management of trading companies is responsible for ensuring the willingness to include a larger amount of organic products in their offer, eliminate the use of plastic bags, respect the principles of "fair" trade and consumption, offer organic products under the brand name, respect ecological principles when building sales facilities, use renewable energy sources, etc. essentially, trading companies are also expected to encourage the creation of new, sustainable habits of their suppliers, consumers and other social community members. business operation according to sustainable development principles and goals is especially expected of large and successful trading companies. according to their financial capacity, they are even expected to have a strategic commitment to sustainable development concept implementation. the foregoing means that sustainable development concept application should be continuous and not occasional. in addition, it is important that sustainable development concept implementation is not unilateral. it is necessary to simultaneously and equally take care of the application and balance of economic, ecological and social dimensions of sustainable development. this is also important because the mentioned areas are somewhat interconnected. zhang and jiang (2019) note that a company’s economic development will affect environmental degradation, but in turn, environmental pollution will also affect the development of companies. in addition, many studies show that consumers do not prefer to buy from socially irresponsible companies and that employees choose fair and responsible employers. it often happens that consumers hold trading companies responsible for the actions of other participants in the supply chain (for example, for product quality). for that reason, it is important that trading companies also encourage their suppliers to behave in accordance with the rules required by the sustainable development concept application. when choosing a supplier, a trading company can ignore those maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 23 who do not respect environmental protection criteria when manufacturing products, who exploit child labor, and who use impermissible technologies and materials in production that are harmful to human health and the environment (knego, 2012). given that an increasing number of stakeholders are showing interest in the responsible business of trading companies, the most successful retail chains regularly publish their sustainability reports, from which it can be seen which sustainable development components or dimensions represent an integral element of their business operation and creation of a long-term and sustainable competitive advantage (sokolov mladenović, 2017). reports on sustainable development provide an overview of realized and planned sustainable activities, as well as the challenges faced by companies during the implementation of their sustainable activities. regular disclosure of data on sustainable activities through sustainable development reports shows a strategic inclination to apply the sustainable development concept. recently, trading companies have been adopting various practices based on sustainable development concept application: eliminating the use of plastic bags, reducing co2 emissions, developing internal codes of good conduct, improving employment practices (e.g., employment of persons with disabilities), etc. (lavorata, 2014). comprehensive and continuous application of sustainable development basic dimensions can have a positive impact on the business performance of a company and thus on its ability to more easily face all the challenges that hinder sustainable functioning. the benefits that trading companies can have from sustainable development concept application are numerous. firstly, in dynamic economic conditions, sustainable development concept application represents a path that can help a trading company to better position itself on the market compared to its competitors. in addition, a sustainable business contributes to higher productivity, lower business costs, improved sales quality and increased sales revenue, improved consumer and employee satisfaction, and thus creates a base of loyal consumers and an image of a desirable employer, safe product quality and reliability, availability of necessary resources, etc. lee (2021) points out that due to the positive effects, social responsibility becomes an important strategic issue for businesses. for this reason, many successful companies view sustainable development not only as a moral issue, but also as their social obligation and, accordingly, become advocates of “solid” sustainable development. research methodology achieving economic, ecological and social sustainability is one of the most pressing goals societies are facing today (brenner, hartl, 2021). in the dynamic and turbulent environment in which retail companies operate, sustainable practices are posited as an opportunity for their progress and survival (marin-garcia, 2021). in line with the importance of sustainable business, this paper’s methodology is based on both theoretical and empirical research. firstly, using the analytical and descriptive method, and based on available sources that deal with the issue of sustainable development and sustainable development concept application in trading companies, the importance of sustainable development concept in modern, very turbulent business conditions was pointed out, followed by the encouraging factors of sustainable development concept application in the trade sector, as well as the importance of sustainable operations of trading companies. in the empirical part of the research, the authors provide the results of a descriptive statistical analysis of respondents' attitudes regarding the application of various elements of economic, ecological and social dimensions of sustainable development. in conditions when environmental pollution issues are becoming more serious and social sphere demands are increasingly high, sustainable development with its basic components becomes one of the unavoidable topics in business decision-making. managers of trading companies are becoming more aware of the importance of sustainable development concepts for the realization of business goals and results. accordingly, the investigated research sample (staletović, 2022) consisted of employees in managerial positions in trading companies in the republic of serbia. therefore, the research was conducted on the territory of the republic of serbia, between october 2021, and 24 economic analysis (2023, vol. 56, no. 1, 20-31) march 2022, with a sample of 103 participants. the research included trading companies of various sizes. the data collected through the questionnaire, which, apart from general questions about gender, the position of the participants, headquarters of trading companies, type of the sales facility, etc., also contained questions about key elements of the economic, ecological and social dimension of sustainable development, where the participants evaluated the application of the aspects of sustainable development basic dimensions using a five-point likert scale. the collected data were analyzed using the statistical program spss version 23. results analysis and discussion the trading sector plays a major role in the operations of the serbian economy. it is also one of its most vital parts. however, characteristics of the modern environment had a significant impact on the functioning of trading companies in the republic of serbia. today, when explaining the sustainable development concept, attention is focused on three aspects, i.e. economic, ecological and social sustainability (sokolov mladenović, 2017). in order to have a high-quality sustainable development concept application, it is necessary for trading companies to simultaneously devote themselves to the application of mentioned sustainable development dimensions. accordingly, the management of trading companies is expected to create economic value, but also to take care of environmental protection and to take into account social community demands. the question arises whether such a situation also exists with the management of trading companies in the republic of serbia. the research conducted by lovre and brankov (2016), related to the sustainability of the retail sector until 2013, showed that the trading sector in the republic of serbia was on the path to doing sustainable business. besides, lukić (2012) also points out that the application of the sustainable development concept in trading companies in the republic of serbia is at a lower level compared to some countries with a more developed market economy, which especially applies to domestic retail companies. for example, lukić (2016) states that energy costs in serbian trade are higher than in countries with a developed market economy. the reasons for this are very low energy management efficiency, insufficient use of modern energyefficient technology and equipment, unsatisfactory improvement of energy efficiency in existing and slowed construction of new energy-efficient office buildings and retail facilities, as well as a slight use of renewable energy sources (lukić, 2016). the results of the conducted research (staletović, 2022), obtained using the method of a direct survey of employees in managerial positions in trading companies in the territory of the republic of serbia, showed that managers believe that their trading companies are committed to implementing economic, ecological and social dimensions of sustainable development, which confirms the hypothesis set in this research. descriptive analysis results regarding the basic dimensions of sustainable development are presented below, for each dimension separately (table 2, 3, 4). primarily, it should be noted that the average value of the years of work of managers in their current position is around 9 years, which indicates that these are managers who are well acquainted with the operations of their companies and, accordingly, with the application of sustainable development concept thereof (staletović, 2022). consequently, they were able to assess with a greater degree of reliability the application of sustainable development basic dimensions in their companies. maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 25 table 1. descriptive statistics for years of work of the manager in the current position minimum maximum arithmetic mean standard deviation how many years have you been working in your current position? 1.00 35.00 9.01 7.20 source: staletović (2022) silvestre and tirca (2019) point out that one gets the impression that the change toward a more sustainable world is frustratingly slow and that organizations need to promote investment in the implementation of innovative approaches aimed at solving current and urgent sustainable challenges. sustainable development refers to the need to simultaneously alleviate poverty/improve standards of living and maintain or enhance vital natural capital necessary for future well-being (polasky et al., 2019). the economic dimension of sustainable development is based on the efficient use of available resources and productivity growth, which would represent an important source of competitive advantage, but all the while taking into account that negative environmental issues are minimized (ostojić, 2020). adequate application of the economic dimension of sustainable development implies that trading companies take into account rational use of available, especially scarce resources, encourage investments in less harmful technologies, improve employment, invest in sustainable training of their employees, in sustainable brands, etc. essentially, by implementing the economic dimension of sustainable development, trading companies should encourage investments in new types of development that would encourage the implementation of sustainable economic activities. the descriptive analysis presented in table 2 shows the assessment of the application of certain elements of sustainable development’s economic dimension. for example, the data show that within the economic dimension of sustainable development, managers have best assessed that the increase of energy efficiency can be productive for the company and that extending direct sales to online sales and monitoring market demands in terms of quality, price and quantity can all have an impact on trading company’s revenues from sale. on the other hand, it has been poorly assessed that the introduction of organic products in a trading company would contribute to the growth of sales revenue, that social responsibility performance affects the company’s financial performance, and that the introduction of ecological innovations can have a positive impact on the increase in sales revenue. however, regardless, the analysis shows that the application of sustainable development economic dimension elements in these companies is still assessed as good, which means that the managers of trading companies assess the application of certain sustainable development economic dimension elements as good or very good (the agreement ranged from 1 to 5, and the arithmetic mean is mostly between 3 and 4). 26 economic analysis (2023, vol. 56, no. 1, 20-31) table 2. descriptive statistics for basic elements of sustainable development economic dimension economic dimension of sustainable development minimum maximum am sd to what extent are the resources available to your trading company used rationally, i.e., in accordance with the rules required by sustainable development concept application 2.00 5.00 3.58 0.90 to what extent do you think a more efficient use of resources would affect the economic performance of your trading company 1.00 5.00 3.61 0.88 to what extent does social responsibility performance affect the financial performance of your trading company 1.00 5.00 3.14 1.00 to what extent is the awareness about the importance of sustainable cost management for achieving sustainable efficiency developed in your trading company 2.00 5.00 3.37 1.00 to what extent is your trading company committed to continuous investment in new jobs 1.00 5.00 3.46 1.13 to what extent would various professional trainings of your employees on sustainable development importance contribute to the growth of your income from the sale of goods 1.00 5.00 3.50 0.98 to what extent do you believe that encouraging your suppliers to behave in accordance with the sustainable development concept would positively affect the economic performance of your trading company 2.00 5.00 3.41 0.81 to what extent would the introduction of adequately marked, high-quality and at the same time affordable private labels in the offer of your trading company contribute to the growth of your sales revenue? 1.00 5.00 3.62 0.93 to what extent is your trading company committed to creating sustainable value for consumers 2.00 5.00 3.62 0.99 to what extent would the use and introduction of organic products in your trading company contribute to the growth of your sales revenue 1.00 5.00 2.94 1.07 to what extent does the need to keep up with market demand for quality, price, and quantity of merchandise affect your sales revenue? 1.00 5.00 3.65 1.03 to what extent can the introduction of eco-innovations in the business practices of your trading company contribute to the growth of your sales revenue 1.00 5.00 3.27 1.00 to what extent can expanding direct sales to online sales affect your sales revenue 1.00 5.00 3.74 1.20 to what extent do you believe the costs of solving environmental issues affect the selling price of your goods 1.00 5.00 3.28 1.02 to what extent can the increase in energy efficiency improve the profitability of your trading company 2.00 5.00 3.98 1.01 am – arithmetic mean sd – standard deviation source: staletović (2022) bojat and rebić (2019) point out that sustainable development should provide long-term economic benefits and reduce the negative effects of business activities on the environment. our planet’s ecosystem is very sensitive, as even small disturbances, such as global temperature changes in larger temporal and spatial scales cause unpredictable effects (nadoveza, pešić, 2020). due to strong pressure from society and stakeholders to reduce negative impacts on the maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 27 environment, companies are forced to focus on nature conservation and ecology (stojanović, 2021). damnjanović et al. (2020) state that large corporations in developed countries must consider the ecological component of sustainable development during every significant project due to extremely precise environmental legislation that very harshly sanctions non-ecological technological processes, used materials and environmentally harmful products. the data presented in table 3 show that the application of certain ecological dimension elements of sustainable development is assessed as good or very good (the arithmetic mean is also between 3 and 4). the exception is one element, i.e. the worst assessment is present regarding the knowledge of the terms "green sales facilities", "green product range", "green price", "green transport", "green technology". on the other hand, it is best assessed that the increase in the trading company’s participation in environmental actions would have an impact on improving the image of the company. in addition, there is a good assessment, for example, regarding the extent to which trading companies have reduced the use of plastic bags, etc. table 3. descriptive statistics for basic elements of sustainable development ecological dimension ecological dimension of sustainable development minimum maximum am sd to what extent do you take into account the requirements of the ecological dimension of sustainable development when making business decisions 1.00 5.00 3.21 1.11 to what extent would increasing the participation of your trading company in environmental actions organized at the local or wider social community level contribute to strengthening the image and reputation of your company 1.00 5.00 3.61 0.95 to what extent are employees in your company informed about the importance of environmental protection 1.00 5.00 3.41 0.99 to what extent are your sales facilities, processes and technologies following environmental sustainability requirements 2.00 5.00 3.27 0.82 to what extent does your trading company respect ecological principles of sustainability when using means of transport 1.00 5.00 3.12 1.04 to what extent would investing in functional and economical equipment which is compliant with ecological standards for storing and displaying goods contribute to the progress of your company 1.00 5.00 3.56 0.86 to what extent would the application and promotion of recycled material in order to preserve nature be productive for your trading company 1.00 5.00 3.52 1.00 to what extent is your trading company committed to designing a more sustainable way of using water throughout the supply chain 1.00 5.00 3.21 1.06 to what extent could adequate solutions for more responsible waste management be developed in your trading company 1.00 5.00 3.47 0.90 to what extent has the use of plastic bags been reduced in your trading company 1.00 5.00 3.58 1.17 to what extent does your trading company pay attention to energy efficiency 1.00 5.00 3.49 1.16 to what extent would the introduction of eco-label into your trading company’s business practices indicate compliance with high environmental protection standards 1.00 5.00 3.35 1.12 28 economic analysis (2023, vol. 56, no. 1, 20-31) ecological dimension of sustainable development minimum maximum am sd to what extent are your suppliers familiar with the importance and need to respect environmental requirements in their business 1.00 5.00 3.02 0.97 to what extent could your trading company work on developing an environmental protection policy with the aim of monitoring, measuring, reducing and preventing the release of pollutants into the environment? 1.00 5.00 3.00 1.16 to what extent are you familiar with the terms "green sales facilities", "green product range", "green price", "green transport", "green technology" 1.00 5.00 2.87 1.16 am – arithmetic mean; sd – standard deviation source: staletović (2022) in addition to the economic and environmental aspects, trading companies must not neglect the importance of the social dimension of sustainable development. pavlović and denčić-mihajlov (2020) state that the concept of a sustainable business causes companies to direct their resources more than ever toward solving important social issues. in accordance with the requirements of this sustainable development dimension, trading companies should be as fair as possible in respecting the needs of all social community members. in order to achieve this, it is necessary for them to include in their operations all basic elements incorporated in the social dimension of sustainable development. the research results shown in table 4 indicate that the best assessed is that trading companies can increase responsible behavior towards their employees in terms of ensuring occupational safety and fairer awarding of employees, as well as that there is an opportunity to work on promoting gender equality. on the other hand, the worst assessment is regarding the degree to which a company is dedicated to providing support to the social community through various activities. however, in this case, likewise, the application of mentioned elements within the social dimension of sustainable development is assessed as good. table 4. descriptive statistics for basic elements of sustainable development social dimension social dimension of sustainable development minimum maximum am sd to what extent could your trading company increase responsible behavior towards its employees in terms of ensuring occupational safety, security and health 1.00 5.00 3.88 1.08 to what extent could your trading company work to respect and promote gender equality? 1.00 5.00 3.72 1.10 to what extent is your business committed to employing people with disabilities 1.00 5.00 2.85 1.17 to what extent is your trading company committed to the professional development and training of its staff 1.00 5.00 3.21 1.12 to what extent could your trading company take care of the system of fair awarding of its employees 1.00 5.00 4.05 1.00 to what extent are the activities organized in your trading company aimed at informing employees about the importance of responsible behavior towards customers 1.00 5.00 3.29 1.14 to what extent could your trading company be more committed to complying with high standards of quality and safety of goods for human health 1.00 5.00 3.61 1.09 to what extent does your trading company support the implementation of projects aimed at involving customers in socially responsible actions 1.00 5.00 4.03 0.99 to what extent does your trading company take care of the safety and security of the storage space 2.00 5.00 4.02 0.97 maja staletović, srećko bačevac, mirjana stevanović, ljubica pantelić 29 social dimension of sustainable development minimum maximum am sd to what extent is your trading company ensuring that the goods it sells are accessible to the average consumer 1.00 5.00 2.95 0.98 to what extent is your trading company familiar with the terms "fair trade" and "fairtrade goods" 1.00 5.00 3.26 1.31 to what extent does your trading company support its suppliers with the aim of creating a sustainable supply chain 1.00 5.00 3.19 1.13 to what extent does your trading company work to raise citizens' awareness of a healthier lifestyle 1.00 5.00 3.19 0.98 to what extent do you think that the implementation of charitable projects by your trading company would have a positive effect on the trust of consumers and society 1.00 5.00 3.72 1.01 to what extent is your trading company committed to providing support to the local community through various socially responsible activities 1.00 5.00 2.10 1.20 am – arithmetic mean sd – standard deviation source: staletović (2022) dynamic economy, together with social equality and sustainable use of resources, create the foundations of sustainable development (jusufranić et al., 2019). with changing social norms and consumer attitudes, the need for businesses to consider and incorporate sustainability into their core strategies has never been more important (vadakkepatt, 2021). essentially, the analysis of the presented data shows that the application of economic, ecological and social dimensions elements of sustainable development in trading companies in the republic of serbia is assessed as good. it should be kept in mind that the future economy and our future in general largely depend on what we will do and how (mihajlović et al., 2020). accordingly, company managers have the task of making other employees aware of the importance of the sustainable development concept, its essence and the need to establish a balance between economic, ecological and social components of development (staletović et al., 2021). only through such joint effort that quality implementation of sustainable development can be achieved. conclusion the need for sustainable development concept application in trading companies especially gains importance with the emergence of a dynamic environment. in such conditions, simultaneous and equal application of economic, ecological and social dimensions of sustainable development is emphasized. it can be said that the managers of trading companies operating in the territory of the republic of serbia have become aware of the importance of sustainable development concept application in their business. the analysis of obtained results related to the attitudes of managers regarding the application of basic dimensions of sustainable development showed that trading companies respect certain elements of economic, ecological and social dimensions of sustainable development. however, it can also be concluded that some further improvements are still necessary in this regard. the contribution of research results can be viewed from a theoretical and empirical standpoint. the significance of the theoretical part of the research is reflected in the fact that the importance of sustainable development concept application in trading companies has been pointed out. the significance can also be seen in the fact that the factors that encouraged sustainable development concept application in trading companies were highlighted, as well as the benefits that trading companies can have from such application. the contribution of the empirical part of the research is reflected in providing a more detailed insight into the situation regarding the application of various elements of economic, ecological and social dimensions of sustainable development in 30 economic analysis (2023, vol. 56, no. 1, 20-31) trading companies in the republic of serbia. the research limitation is mirrored primarily in the inadequate number of papers dealing with the sustainable development issues in trading companies in the republic of serbia, making it harder to compare findings with similar scientific studies. the reason for this is precisely the existence of a small number of scientific studies that deal with applying fundamental dimensions of sustainable development in the trading sector of the republic of serbia. the limitation can also be reflected in the size of the sample 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(2019). discussion on environmental protection and company economic development. in iop conference series: earth and environmental science, 242(5), 1-6. article history: received: 20.12.2022. revised: 5.2.2023. accepted: 16.3.2023. microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp13-23 original scientific paper intentions to smoking cessation in the time of covid-19: evidence from serbia jovan zubović1* | aleksandar zdravković1 | olivera jovanović1 1 institute of economic sciences, belgrade, serbia abstract in this study, we examine whether the outbreak of pandemic has given incentive to smoking cessation and which factors are associated with such intentions, emphasizing change of economic conditions and smoking habits in the time of covid-19. data were collected through a telephone survey among a representative sample of the serbian adult population aged less than 65 years (n=1,002) from 11 to 19 may 2020. the current smokers reported whether the covid-19 pandemic had changed their tobacco products consumption, disposable income and intentions to cease smoking. among the current smokers, 26.3% reported that the covid-19 pandemic triggered intentions to cease smoking. on the other hand, 42.4% of smokers reported a decrease in income, while 22.7% of smokers reported increased smoking during the covid-19 pandemic. logistic regression reveals that occasional smokers are the most likely to stop smoking (or 4.17; ci: 2.18 7.99), while the majority of other factors (socio-demographic, economic, smoking habits) do not influence the odds of smoking cessation. lack of association between intentions to cease smoking and pandemic-related worsening of economic well-being might result from low cigarette prices in serbia. consequently, higher taxation of tobacco products is recommended to policymakers. keywords: smoking cessation, smoking habits, covid-19, serbia jel classification: e20, h20, c13 introduction the outbreak of the covid-19 pandemic and the follow-up containment measures have had severe outcomes on the population's mental health. a harsh impact of the epidemic on the population's mental health has been evidenced even before the outbreak of the covid-19 pandemic in studies examining the effects of the sars 2002-2004 epidemic (schäfer et al. 2020). an early covid-19 meta-analysis reveals that participants in the studies on threats posed by the pandemic frequently reported anxiety and depression (16%-28%) and stress (8%) as common psychological reactions to pandemic (rajkumar, 2020). the latter cross-country systematic overview of the effects of the pandemic on the general population reported high rates of symptoms of anxiety (6.33%-50.9%), depression (14.6%-48.3%), post-traumatic stress disorder (7%-53.8%), psychological distress (34.43%-38%), and stress (8.1%81.9%) (xiong et al. 2020). in addition to the pandemic's health-related concerns, the containment measures posed a serious threat to the population's economic well-being, following a sharp decline in economic activity. a downfall in economic activity reduced demand for working hours; for instance, estimated total working-hour losses in the second quarter of 2020 equals 495 million full-time jobs (ilo, 2020), endangering prospective long-term employment preservation. besides, the * corresponding author, e-mail: jovan.zubovic@ien.bg.ac.rs 14 economic analysis (2021, vol. 54, no. 1, 13-23) estimated loss of labour income during the first three quarters of 2020 amounts to us$3.5 trillion (ilo, 2020). smoking cessation under the threat of covid-19 is beneficial, as the evidence suggests that smoking cessation for four weeks or more is likely to reduce the risk of developing covid-19 and respective severe covid-19 complications (eisenberg & eisenberg, 2020). empirical research on the impact of covid-19 outcomes on smoking habits is still in progress; results are mixed and vary across countries:  france: the number of smokers who increased tobacco consumption (27%) exceeded the number of smokers who reduced smoking (19%). the increase in consumption is associated with participants 25-34-year-old (41%) and those who work at home (37%) (santé, 2020).  italy: smokers reported a reduction in tobacco consumption (especially those who smoke 5-10 cigarettes per day), while 3.3% of them quit smoking (di renzo et al, 2020). however, this survey was not implemented on a representative sample (76.1% females), so the results' reliability is limited.  the netherlands: stress appears to be associated with smokers who reported an increase (18.9%) and a decrease (14.1%) in tobacco consumption. also, the number of smokers who believe that during pandemic smoking cessation has got more difficult (24.7%) considerably exceeds the number of those who believe opposite (6.4%) (bommelé et al, 2020).  spain: the number of smokers, especially during the first week of lockdown, was reduced by four percentage points (from 13.9% to 9.9%). the health concern was the main reason for smokers to quit (lópez-bueno et al, 2020). however, the survey was not representative (the average age of participants in the sample is lower than in the population), so the results should be interpreted carefully.  poland: almost every second smoker reported an increase in smoking intensity after the pandemic declaration (45.2%), while 40% of them did not change smoking intensity. the results also showed the absence of the relationship between demographic characteristics and the changes in smoking intensity during pandemics (sidor & rzymski, 2020). like others, this survey was not representative (95% of respondents were women).  united states: most smokers (both manufactured and electronic cigarette) reported an increase in motivation to quit smoking (35.6% and 37.6%, respectively). the main reason was health concerns. however, significantly lower numbers reported an attempt to quit (22.9% of manufactured cigarettes and 21.2% of electronic cigarette smokers). on the other hand, tobacco use changes were similar across smokers and positively correlated (30.3% of manufactured cigarette smokers and 29.1% of electronic cigarette users reported increased tobacco consumption) (klemperer et all, 2020).  pakistan: since covid-19 pandemic, 14% of smokers (n=2,062) reported quitting. among other respondents who continue to smoke, 68% reduced, while 18% increased tobacco consumption. smokers were motivated to quit smoking more during the pandemic than before (41% of those who continue to smoke), while 21% were less motivated to quit. the survey was not representative, and it represents a longitudinal study on the same respondents covering the period before the pandemic start (september 2019, february 2020) and the period after (may 2020) (siddiqi et al, 2020).  turkey: results suggest that the covid-19 outbreak effectively reduced the smoking prevalence of the patients admitted to the smoking cessation clinic; 46.2% of patients who started smoking again or never stopped smoking quitted smoking in fear of covid19 (tetik et al, 2020). jovan zubović, aleksandar zdravković, olivera jovanović 15 regarding the high prevalence of tobacco use in serbia (37.9% in 2019), we recognized the need to research smoking habits during the pandemic caused by the covid-19 virus. in this study, we examine whether an outbreak of pandemic and follow-up containment measures have given incentive to smoking cessation and which factors are associated with such intentions, with particular emphasis on change of economic conditions and smokers' smoking habits in the time of covid-19. methods survey this survey is an extension of a national representative survey of tobacco products consumption in southeastern europe in serbia (lawless, 2015), which was implemented within the regional project "accelerating progress on effective tobacco tax policies in low-and middleincome countries" in cooperation with the university of illinois chicago and bloomberg foundation. it was motivated by the urgent need to maintain continuous records of the smoking habits under the changed health and economic circumstances posed by the pandemic, so the original questionnaire was adjusted to include several questions related to the pandemic. we conducted a telephone survey among a representative sample of the serbian adult population aged less than 65 years (n=1,002), including both smokers and non-smokers. the survey was conducted from 11 to 19 may 2020, 5 days since the government of serbia has declared an end of the state of emergency and abrogated all containment measures. variables the questionnaire used in the survey collected information on: (1) socio-demographic variables, including gender, age, education, and settlement characteristics. level of education is measured using official educational grading, but for research, it was categorized into three groups: primary (up to eight years of schooling), secondary (up to 12 years of schooling) and tertiary (15 or more years of schooling). similarly, age was grouped into four categories: 18-24, 25-34, 35-44, 45-65. variable type of settlement reflects whether the respondent's residence location is located in an urban or rural area. (2) economic variables, which depict the financial security of respondents. in particular, two variables are used: employment status and change of income since the outbreak of the pandemic. employment status reflects the overall financial security. it is measured by the official ilo classification of employment status, which is reclassified for research into three categories: full-time (ft) employed, non-ft employed and unemployed. prior expectations are that the unemployed are the most vulnerable to pandemic economic impact and, therefore, the most encouraged to quit smoking. change of income reflects whether financial security had improved or worsened due to implemented containment measures. the three options measure it: increased, did not change and decreased; the first two options are merged, following the aim of research to test expectations that worsening of financial security, in particular, stimulate intentions to cease smoking. (3) general smoking habits, i.e., whether a person is a smoker and if so, how frequently and what type of tobacco product consumes. a variable "smoking frequency" is defined to make a distinction between frequent and occasional smokers, whereby a smoker is regarded as a regular if consumes some tobacco product every day or occasional if does not consume it on an everyday basis. it is reasonable to assume that occasional smokers are more likely to cease smoking under severe circumstances. tobacco products used by smokers are classified into manufactured cigarettes, rolled cigarettes, and others. 16 economic analysis (2021, vol. 54, no. 1, 13-23) the category of other tobacco products encompasses predominantly vaping products such as e-cigarettes and heated tobacco. there are no prior expectations on the impact of this variable on intentions to quit smoking. still, the expensiveness of the manufactured cigarettes might be considered as an incentive to stop smoking. (4) impact of pandemic and related containment measures on current tobacco consumption and intentions to quit smoking. accordingly, three variables are specified in respect of pandemic outbreak: change in tobacco products consumption, switch to less expensive tobacco brands/products and intention to cease smoking. the questionnaire offers three options for response to tobacco product consumption changes: smoke more, same or less. the same or fewer options are merged since we were particularly interested in testing expectations that increased level of tobacco products consumption raises health concerns and stimulates smoking cessation. to assess whether economic worsening motivated smokers to spend less money on tobacco products, participants were asked if they have switched to less expensive tobacco brands or products. eventually, three options were available to smokers to state whether pandemic makes them think about smoking cessation: yes, no and already ceased but started again. similarly, the last two options are merged as they both reflect respondents' unwillingness to quit smoking. the level of significance was set at p≤0.05. descriptive statistics were used for presenting the socio-demographic and economic characteristics and smoking habits of the survey participants who are current smokers. differences in intentions to cease smoking (since pandemic outbreak) across different categories of smokers were assessed using the chi-squared test. a multinomial logistic regression model was fitted to evaluate associations of smokers' characteristics and smoking habits (predictors) and their intentions to quit smoking (dependent). the logistic regression results are presented as odds ratios (or) with 95% confidence intervals (ci). a p-value <0.05 indicates statistical significance. the analysis was performed using stata version 13.0. results the current smokers make up 40.9% of the total sample (n=410). the share of female smokers (53%) slightly exceeds the share of male smokers. almost half of the current smokers (47.3%) are aged 45-65 years. most of the smokers are secondary educated (57.6%) and live in urban areas (71%). also, smokers are predominantly full-time employed (51%). gender, age, employment, and type of settlement structures of current smokers subsample corresponds to respective structures of the full sample, whereas education structure is slightly different – the share of smokers with primary or secondary education is somewhat higher. most smokers consume tobacco products on an everyday basis (84.6%). manufactured cigarettes are the most frequently consumed type of tobacco products (81.7%). overall, 42.4% of the current smokers reported a decrease in income during the covid-19 state of emergency. around 23% of smokers reported an increase in the consumption of tobacco products since the pandemic outbreak. only 5.5% of smokers switched to less expensive tobacco brands or products. eventually, the pandemic made 26.3% of smokers think about quit smoking (table 1). jovan zubović, aleksandar zdravković, olivera jovanović 17 table 1. characteristics of serbian smokers (n=410) variables n (%)* socio-demographic gender female 217 (52.9) male 193 (47.1) age 18-24 45 (10.9) 25-34 81 (19.8) 35-44 90 (22) 45-65 194 (47.3) education primary 18 (4.4) secondary 236 (57.6) tertiary 156 (38.1) type of settlement rural 119 (29) urban 291 (71) economic employment status ft employed 205 (50.9) non-ft employed 43 (10.7) unemployed 155 (38.5) income change since covid19 pandemic higher or same 235 (57.6) lower 173 (42.4) smoking habits smoking frequency regular 347 (84.6) occasional 63 (15.4) tobacco product consumed cigarettes 335 (81.7) tobacco (cut) 57 (13.9) other 18 (4.4) the intensity of smoking since the covid-19 pandemic less than before 48 (11.7) same than before 268 (65.5) more than before 93 (22.7) switch to less expensive tobacco brands/products no 361 (94.5) yes 21 (5.5) intention to cease smoking no 302 (73.7) yes 108 (26.3) * missing values not counted. the chi-squared analysis shows no significant difference between those smokers who have started to think about quit smoking during the pandemic and those who have not, concerning variables expected to have predictive power: socio-demographic and economic characteristics and smoking habits. the only two exemptions are associations of intentions to cease smoking with gender and smoking frequency, as indicated by the significance of the chi-squared test at the 5% level (table 2). table 2. association between smokers' characteristics and smoking habits with intentions to cease smoking. variables intention to cease no yes chi-sq socio-demographic gender female 43.9 9.0 20.51* (0.00) male 29.8 17.3 age 18-24 8.5 2.4 3.52 (0.32) 25-34 13.7 6.1 35-44 17.6 4.4 45-65 33.9 13.4 18 economic analysis (2021, vol. 54, no. 1, 13-23) variables intention to cease no yes chi-sq education primary 3.7 0.7 4.23 (0.12) secondary 40.2 17.3 tertiary 29.8 8.3 type of settlement rural (ref) 20.5 8.5 0.81 (0.37) urban 53.2 17.8 economic employment status ft employed 37.7 13.2 0.35 (0.84) non-ft employed 7.4 3.2 unemployed 28.3 10.2 income change since covid-19 pandemic higher or same 42.9 14.7 0.25 (0.62) lower 30.6 11.8 smoking habits smoking frequency regular 65.6 19.0 17.37* (0.00) occasional 8.1 7.3 tobacco product consumed cigarettes 59.5 22.2 1.08 (0.58) tobacco (cut) 10.5 3.4 other 3.7 0.7 the intensity of smoking since the covid-19 pandemic less or same than before 58.1 19.3 1.45 (0.23) more than before 15.6 7.1 * p<0.05 multinomial logistic regression analysis confirms the results of chi-squared test results that intentions to cease smoking during the pandemic have been associated only with gender and smoking frequency. regression results show that male smokers have three-time higher probability to start thinking about quit smoking relative to female smokers (or=3.10; 95% ci: 1.91 5.04, p<0.001). the smokers who reported occasional consumption of tobacco products are even more likely to stop smoking during the pandemic (or=4.17; 95% ci: 2.18 7.99, p<0.001) compared with regular smokers (table 3). table 3. results of logistic regression variables indicator or (95% ci) socio-demographic gender female (ref) male 3.10* (1.91 5.04) age 18-24 (ref) 25-34 1.39 (0.55 -3.51) 35-44 0.96 (0.36 2.58) 45-65 1.45 (0.59 3.53) education primary (ref) secondary 1.88 (0.54 6.57) tertiary 1.09 (0.30 3.97) type of settlement rural (ref) urban 0.91 (0.55 1.50) economic employment status ft employed (ref) non-ft employed 1.35 (0.59 3.08) unemployed 1.04 (0.61 1.78) income change since covid19 pandemic higher or same (ref) lower 1.12 (0.68 1.84) smoking habits jovan zubović, aleksandar zdravković, olivera jovanović 19 variables indicator or (95% ci) smoking frequency regular (ref) occasional 4.17* (2.18 7.99) tobacco product consumed cigarettes (ref) tobacco (cut) 0.74 (0.37 1.47) other 0.37 (0.08 1.57) the intensity of smoking since the covid-19 pandemic less or same than before (ref) more than before 1.15 (0.66 – 1.99) note: dependent variable is: intention to cease smoking since the pandemic outbreak. * p<0.05 discussion theoretical expectations about the impact of pandemic outcomes on smoking habits depend on which dimension is considered: stress or economic well-being. a strong positive association between level of stress and nicotine withdrawal (lawless et al, 2015; kassel et al, 2003; stubbs et al, 2017; siegel et al 2017) or ptsd and smoking (lande, 2018) has been observed, while depressed smokers reported greater difficulty in quitting tobacco consumption (siegel et al, 2017; ho et al, 2019). consequently, issues with stress posed by the pandemic can be considered an incentive for smokers to increase smoking levels. on the side of economic well-being, loss of jobs and reduced incomes should work in the opposite direction toward a decline in smoking prevalence since the positive association between smoking and income is well documented in numerous studies on tobacco products' income elasticity (john, 2005; peng & ross, 2009; yürekli et al, 2010; tarantilis et al, 2013; zubović et al, 2018; jovanović et al, 2018, gjika et al, 2020). however, loss of income and uncertainty about future financial well-being is also a stress booster that can outrun financial incentives to decrease or quit smoking if the population perceives the loss of income as a temporary and short-term outcome of containment measures. the overview of the previous studies on the changes in smoking preferences and motivation to cease smoking since the covid-19 pandemic outbreak shows mixed findings across countries. for instance, smokers in countries heavily affected by the fast-spreading of covid disease, especially at the beginning of the pandemic, reported a reduction in smoking prevalence, like in italy (di renzo et al, 2020) and spain (lópez-bueno et al, 2020), or increased motivation to quit smoking like in united states (klemperer et al, 2020) and turkey (tetik et al, 2020). additionally, in such countries, covid-related health concerns appear as an important factor in reducing smoking prevalence (lópez-bueno et al, 2020; klemperer et al, 2020). the opposite case is poland, where containment measures successfully suppressed the initial spreading of disease, so the reported increase in smoking is likely the effect of quarantine-related stress (sidor & rzymski, 2020). most of the existing studies about the effects of the covid-19 pandemic on smoking habits examined associations with standard socio-demographic characteristics, health-related concerns, and individuals' motives. nevertheless, such studies neglect that smoking prevalence is not driven only by health concerns but also by economic concerns. the present study relies on our previous research on tobacco control policies in serbia, which indicates the association of smoking prevalence with smokers' income (vladisavljević et al, 2019). serbia was among the countries wherein very harsh containment measures with full lockdowns were applied after the pandemic outbreak. the measures effectively preserved public health (low number of diseases and deaths) but at a high price in lost income. indeed, 42.4% of smokers reported a decrease in income during the pandemic. the fear of pandemic outcomes also posed stress to individuals, being a likely cause of increased smoking, as reported by almost a quarter of current smokers (22.7%). the cross-country differences in findings on impact that pandemic has had on smoking prevalence are likely subjected to the cross-country differences in severity of pandemic effects 20 economic analysis (2021, vol. 54, no. 1, 13-23) (number of covid-19 decease and death cases), whereas mixed results on reactions of individual smokers to pandemic within a single country make identification of predictors more challenging. the survey results reveal that the covid-19 pandemic has motivated smokers in serbia to stop smoking. among the current smokers, 26.3% reported that the pandemic outbreak triggered intentions to cease smoking. opposite to our prior beliefs, logistic regression analysis did not confirm the association of intentions to cease smoking with a change in income (a proxy for financial well-being; or=1.12; 95% ci: 0.68 1.84; p=0.638) or change in intensity of smoking (a proxy for individual exposure to stress; or=1.15; 95% ci: 0.66 – 1.99; p=0.602). furthermore, logistic regression analysis reveals that occasional smokers are the most likely to stop smoking (or 4.17; ci: 2.18 7.99; p<0.001), while most socio-demographic factors (apart from gender) do not influence the probability of smoking cessation. this is expected since occasional smokers are less addicted to nicotine and typically smoke on occasions of social gatherings that were banned during the lockdown. gender is the only socio-demographic predictor found to be significant, as male smokers appeared to be more motivated to quit smoking (or=3.10; 95% ci: 1.91 5.04, p<0.001), which is in line with findings from previous empirical research on smoking cessation (lawless et al, 2015; siegel et al, 2017). lack of predictive power of socio-demographic characteristics in explaining variations of smoking habits during the pandemic is also observed in poland (sydor & rzymski, 2020), wherein the epidemic situation was like in serbia. the lack of association between intentions to cease smoking and stress-related increase in smoking is intriguing but not surprising as the previous research also shows that stress posed by the covid-19 pandemic has a mixed effect on motivation to quit smoking (bommelé et al, 2020). lack of association between intentions to cease smoking and worsening of financial well-being might be the consequence of the fact that prices of tobacco products are among the lowest in europe: the average weighted price in serbia in 2018 stood at €2.05 per pack, compared with the eu-28 average of €4.8. (vladisavljević et al, 2020). as reads in table 1, only 5.5% of smokers switched to less expensive tobacco brands and products, although 42.4% of smokers reported a fall in income. such results impose important policy recommendations that serbia's tobacco products need to be more heavily taxed, regardless of the pandemic. this is particularly important, as an increase in tobacco products' price in 2020 was among the lowest in the last 20 years (zubović et al, 2020). the survey's timing is a research limitation since the survey was conducted a couple of days after the termination of harsh containment measures when most of the population perceived that the pandemic is about to over and everything will get back to normal. bearing in mind that a new wave of the pandemic in europe has emerged since autumn 2020, we plan to conduct a new round of the survey after pandemic stabilization. conclusion covid-19 pandemic and respective containment measures severely affected public health and economic well-being and boosted current smokers' intentions to cease smoking. lower nicotine dependence appears as the most significant factor of the intentions to quit smoking during a pandemic. female smokers are less likely to quit smoking, in line with general findings that smoking cessation is gender sensitive. research results suggest that as much as 26.3% of all smokers showed intentions to quit smoking as result of pandemic outbreak. this is not a result of reduced income and increased stress, but rather of other factors, like health awareness. more prone to quitting are occasional smokers, mostly due to lower exposure to addiction. lack of association between intentions to cease smoking and pandemic-related worsening of economic well-being might result from low cigarette prices in serbia. jovan zubović, aleksandar zdravković, olivera jovanović 21 using different non-price measures, policymakers can inform smokers and non-smokers about harmful effects of all tobacco products. special attention should be dedicated to heated tobacco products and narghiles. policymakers in serbia should strengthen the control the implementation of law on tobacco during the time of the pandemic. increased intention of smokers to quit should be used as a signal that there is a need to promote tobacco control measures. consequently, higher taxation of tobacco products is recommended to policymakers as a tool that has been proven as most effective single control measure (vladisavljević et al, 2020; zubović et al, 2020). policy of higher taxation and subsequent drop in affordability of tobacco products will most likely restore expected significance of relationship between variations in income and smoking cessation preferences of individuals. acknowledgements this paper is a result of the research financed by the ministry of education, science and technological development of the republic of serbia. references bommelé, j., hopman, p., walters, b. h., geboers, c., croes, e., fong, g., quah, a., & willemsen, m. 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(2020). ekonomski aspekti kontrole duvana i empirijski nalazi u srbiji [economic aspects of tobacco control and empirical evidence from serbia]. institute of economic sciences, belgrade. article history: received: may 13, 2021 accepted: may 24, 2021 ea_2014_1-2 notes from the editor-in-chief the last five years, economic analysis has attracted an international readership that is primarily academic. however, the primary target group of our peer journal are not only sholars and researchers. we seek also students and professional audiences as well. the concept of the economic analysis is such that it gives the advantage to multidisciplinary approach to various subjects. it also emphasizes publishing of the scientific papers, which have an empirical and a research character. moreover, there is also the place in the journal for quality theoretical papers as well, reviews of the latest publications of national and international significance and scientific critiques and discussions. more information about the journal can be found on our website http://www.ien.bg.ac.rs/index.php/sr/asopis-ekon-analiza. we encourage potential authors to contact us if they have any questions about the relevance of their papers for submission. questions may be directed to the editorial office at eaoffice@ien.bg.ac.rs. yours, editor-in-chief acad. prof. dr. mirjana radović-marković doi: 10.28934/ea.21.54.2.pp94-103 original scientific paper the effect of fertilizer subsidy, food credit, and government expenditure on infrastructure towards food security: demand and supply sides galuh gusti karina1* | sofyan syahnur2 1 universitas syiah kuala, economic and business faculty, economic development departmen, banda aceh, aceh, indonesia 2 universitas syiah kuala, economic and business faculty, banda aceh, aceh, indonesia abstract this research aims to examine how fertilizer subsidy, food credit, and government expenditure on infrastructure affect the food security in aceh province (indonesia) by using a dynamic model based on error correction model method. this research classifies food security into supply side and demand side. the availability of energy and protein is the supply side and the consumption of energy and protein is demand side. using time series data, the findings of this research is the majority of variables have a favorable effect on aceh's food security both the supply and demand sides. as a result, shortterm food security is more consistent than long-term food security. key words: food security, fertilizer subsidy, food credit, government expenditure on infrastructure, error correction model jel classification: b23, o31, q18 introduction food security remains a major burden that needs to be tackled to reach the sustainable development goals. in recent years, food security has been widely considered to represent four critical pillars: availability, access, use, and stability. in addition, it should have three specific objectives namely guaranteeing adequate food supplies, maximizing supply flow stability, and ensuring that those in need have access to available resources (clapp et al., 2021). moreover, food security and environmental (ecological) sustainability are two challenges that must be tackled concurrently. the environment sustainability ensures sustained development, whereas food ensures life. considering the people's health and purchasing capacity, the food supply becomes a critical issue that requires immediate attention. food must be a priority, as it is the most fundamental necessity, aside from clothing and shelter (darma et al., 2020). given the current confluence of population growth, climate change, and shifting consumption patterns, future food and nutritional security also becomes a serious issue for both rich and poor people (coles et al., 2016). food insecurity was dramatically exacerbated by the 2007-2008 food price crisis, which continues to this day. as a result, it is viewed as a long-term failure of the global food system at the time, spurring the establishment of a global community to address agricultural and food security challenges. * corresponding author, e-mail: galuhgusti@mhs.unsyiah.ac.id galuh gusti karina, sofyan syahnur 95 in the short term, indonesia has three major challenges to food security: first, ensuring adequate food availability through trade and local production to meet national demands. second, safeguarding the poor's food consumption. third, alleviate family and national food insecurity (vysochyna et al., 2020). apart from a concern for the chronically disadvantaged groups left behind by market forces, food security requires little specific policy attention. of course, some of these programs may be food-related, as food is the most basic requirement of the impoverished (timmer, 2011). food insecurity frequently emerges as a result of a lack of food access, even when food supply is adequate. reducing food insecurity is possible only if food security is established at the household level. thus, the government places a high effort on meeting the needs of families when it comes to food. agriculture policies for rice, maize, wheat, millet, and sorghum, as well as initiatives concentrating on input subsidies and credit facilities, attest an ineffectual in reaching out to poorer farmers; this will affect the accomplishment of food security stability (sanga et al., 2021). governments play a critical part in the phenomenon of food security; their contribution is meant to expedite the achievement of national development goals. the government's obligation to safeguard domestic producers and consumers is supposed to result in the stabilization of food prices, which may be accomplished through food pricing laws that alleviate farmer concern and ensure that consumer food costs remain consistent. food pricing policy is a critical component of agricultural growth. food policy is separated into two components: input and output pricing. input price policy refers to the distribution of subsidies to farmers to assist them in overcoming cost and capital constraints; output price policy refers to the government's procurement price policy (arouna et al., 2020). credit policy is the other component of agricultural development policy. credit policy is also a component of the government's input price policy for farmers and agriculture business operators; in many countries, an appropriate supply of credit has a favorable effect on agricultural output and farm revenue (bidisha et al., 2017). other policies, particularly those relating to infrastructure development, must be incorporated to increase the effectiveness of agriculture policy. proper infrastructure, such as roads and irrigation, will enable economic mobility in agriculture. investing in road infrastructure reduces distribution costs and speeds up delivery, which benefits farmers. additionally, improved irrigation systems might act as a stimulus for farmers to increase their yield (bacior & prus, 2018). an investigation of how subsidies for fertilizer, food credit, and government spending on infrastructure contribute to aceh's food security was the goal of this study. this research classified food security into supply side and demand side. the availability of energy and protein is the supply side and the consumption of energy and protein is demand side. findings may be used to evaluate the impact of government expenditure, food credit, and fertilizer subsidies on aceh's food security, as well as the ways in which these policies might be improved. literature review food security is defined in indonesia as "the availability of sufficient food, both in quantity and quality, that is safe, equitable, and affordable," as stated in food law no. 7 of 1996, which states that "food security is a necessary condition for meeting household food needs as reflected in the availability of sufficient food, both in quantity and quality, that is safe, equitable, and affordable." this notion implies that food security is ultimately aimed at the home level. food security is composed of three major subsystems: availability, access, and absorption of food, whereas nutritional status is a byproduct of food security. food consumption is one measure that may be used to analyze the performance of food security. food consumption is divided into two, energy and protein consumption. syahnur et al., (2014) examined the influence of energy consumption on aceh's economic development in the long and short term using ecm (error correction model) and discovered that energy consumption had a purely positive effect in both time periods. another 96 economic analysis (21, vol. 54, no. 2, 94-103) indication is food quality, which may be quantified using food safety and nutritional content standards (reincke et al., 2018). appropriate inputs such as certified seeds, balanced fertilizer usage, automation, and agricultural loans all have a role. in indonesia, the government places a premium on suitable inputs. as a result, appropriate inputs are incorporated in agricultural price policy to assist farmers. agricultural pricing policy is a critical instrument for raising agricultural output, employment, and incomes in order to achieve food security. farmers must be compensated fairly in order to ensure food security and increase their earnings (dev & rao, 2010). as a result, governments must establish more explicit policies that handle agricultural risk management successfully in order to achieve long-term growth. it is vital to have the tools and knowledge necessary to recognize and identify food security's determinants, as well as the capacity to intervene to protect persons from food poverty (abdallah et al., 2021). numerous studies have been conducted on food security issues, including an in-depth analysis of the costs and returns associated with rice and wheat, the two most highly subsidized commodities that provide livelihoods for millions of farmers examine the effectiveness of agricultural pricing strategy in enabling farmers to earn a sufficient profit in order to enhance investment, technology, and productivity, and hence food security. a significant factor contributing to the rise in support prices is the rising cost of production as a result of an excessive concentration on getting input costs right. governments might compensate farmers for productivity losses by establishing local fertilizer production and subsidizing important intermediate inputs such as high-quality seeds, fertilizers, and pesticides. following that, because credit is the lifeblood of any business when it comes to increasing agricultural productivity and food security in developing countries, bidisha et al., (2017), discovered that credit benefits households' primary and secondary income streams, both of which have been shown to improve household food security. credit was associated with increased food supply, buying power, and food security, meaning that extending credit programs and making microcredit available to small and marginal farmers on a timely and nondiscriminatory basis might boost farm productivity and performance. microcredit, the study found, has a tendency to alleviate poverty and promote food security. to address agricultural productivity and food security concerns, numerous nations have enacted explicit policies for sustainable agricultural growth (chen et al., 2017). additionally, governments have devised subsidy programs to promote sustainable agriculture. as a result, the issue of food security is projected to be impacted. as a result, several research focus on agricultural subsidy programs, specifically their influence on productivity. xu & liao (2014), for example, built a risk insurance model to evaluate the impact of crop insurance subsidies on agricultural output and discovered that premium subsidies can continue to boost agricultural output. faced with unexpected output, peng & pang (2019) using a three-tier contract agricultural supply chain, we evaluated the effect of government subsidies on risk-averse farmers' output decisions. they emphasized that when subsidies grew, farmers' total goal production increased as well, and that subsidies favored risk-averse farmers. in addition, a few studies have looked at government expenditure in terms of food security impact. nugroho (2017), using panel data and the 3sls approach, the study also concluded that in order to boost agricultural production, the indonesian government should prioritize greater expenditure on agriculture and education. additionally, it is believed that investments in roads, irrigation, and power have a limited influence on agricultural development and a low marginal return on poverty reduction. abdul manap (2020) found that road infrastructure has a positive significant impact on the food security. households need a proper physical access to sell their products and to get food for their basic needs, and that will increase food security. the research mentioned indicates that there is a correlation between policy inputs (subsidies, credit) and government spending on agriculture and food security. this study uses the same method as syahnur et al.,(2014) error correction model (ecm) and also using energy consumption as one of the variable but this research is classified the energy consumption into galuh gusti karina, sofyan syahnur 97 demand side. this research also incorporate variables used in earlier research on the interplay between fertilizer subsidies, food credit, and government spending on infrastructure related to food security both in short-run and long-run. theoritical methodology this analysis utilized secondary time series data spanning the years 2013 to 2020. due to the scarcity of data, preliminary data processing was performed prior to doing additional study. the data are provided as time series spanning eight years, although the minimum number of observations required for time series data is n=30. due to these constraints, however, a linear interpolation of eight years of data into quarterly data was performed. thus, the data collection period is from the first quarter of 2013 to the fourth quarter of 2020. food security is the dependent variable in this study, whereas fertilizer subsidies, food credit, and government infrastructure investment are the independent variables. food security is defined by the availability of energy and protein, as well as their consumption. the selected variables are expected to have an effect on food security in the long and short term. where the variables used have an important role in agricultural development from the demand and supply side. the independent variables used are also classified as subsystems to achieve food security stability. the estimating model employed in this investigation is the error correction model (ecm) (ols). the ecm was developed to account for disequilibrium and to examine the long and short term causal relationships between cointegrated variables (syahnur et al., 2014). as a result, it is hoped that the shortand long-term behavior of the observed variables may be explained. the dependent variables used in this research is food availability and consumption, those variables divided into energy and protein. this dependent variable is represented by the indicators of food security both in demand and supply side. energy and protein availability is classified into supply side. the energy availability model is represented by equation 1 as follows. 𝛥𝛥𝑒𝑒𝑒𝑒𝑒𝑒𝑡𝑡 = 𝛾𝛾0 + 𝛾𝛾1𝛥𝛥𝑠𝑠𝑠𝑠𝑡𝑡 + 𝛾𝛾2𝛥𝛥𝑐𝑐𝑐𝑐𝑡𝑡 + 𝛾𝛾3𝛥𝛥𝑔𝑔𝑔𝑔𝑡𝑡 + 𝛾𝛾4𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝛾𝛾5𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝛾𝛾6𝑔𝑔𝑔𝑔𝑡𝑡−1 + 𝛾𝛾7 (𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝑔𝑔𝑔𝑔𝑡𝑡−1 – 𝑠𝑠𝑠𝑠𝑡𝑡−1) (1) equation 2 refers to the protein availability model as follows. 𝛥𝛥𝑝𝑝𝑒𝑒𝑒𝑒𝑡𝑡 = 𝛾𝛾0 + 𝛾𝛾1𝛥𝛥𝑠𝑠𝑠𝑠𝑡𝑡 + 𝛾𝛾2𝛥𝛥𝑐𝑐𝑐𝑐𝑡𝑡 + 𝛾𝛾3𝛥𝛥𝑔𝑔𝑔𝑔𝑡𝑡 + 𝛾𝛾4𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝛾𝛾5𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝛾𝛾6𝑔𝑔𝑔𝑔𝑡𝑡−1 + 𝛾𝛾7 (𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝑔𝑔𝑔𝑔𝑡𝑡−1 – 𝑠𝑠𝑠𝑠𝑡𝑡−1) (2) where eam refers to energy availability and pam is protein availability. sf, ct, and gi are fertilizer subsidy, food credit, and government expenditure on infrastructure, respectively. food consumption, which is the second indicators used, also divided into energy and protein consumption. this consumption classified into demand side. the energy consumption as follows. 𝛥𝛥𝑒𝑒𝑐𝑐𝑒𝑒𝑡𝑡 = 𝛾𝛾0 + 𝛾𝛾1𝛥𝛥𝑠𝑠𝑠𝑠𝑡𝑡 + 𝛾𝛾2𝛥𝛥𝑐𝑐𝑐𝑐𝑡𝑡 + 𝛾𝛾3𝛥𝛥𝑔𝑔𝑔𝑔𝑡𝑡 + 𝛾𝛾4𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝛾𝛾5𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝛾𝛾6𝑔𝑔𝑔𝑔𝑡𝑡−1 + 𝛾𝛾7 (𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝑔𝑔𝑔𝑔𝑡𝑡−1 – 𝑠𝑠𝑠𝑠𝑡𝑡−1) the protein consumption as follows. 𝛥𝛥𝑝𝑝𝑐𝑐𝑒𝑒𝑡𝑡 = 𝛾𝛾0 + 𝛾𝛾1𝛥𝛥𝑠𝑠𝑠𝑠𝑡𝑡 + 𝛾𝛾2𝛥𝛥𝑐𝑐𝑐𝑐𝑡𝑡 + 𝛾𝛾3𝛥𝛥𝑔𝑔𝑔𝑔𝑡𝑡 + 𝛾𝛾4𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝛾𝛾5𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝛾𝛾6𝑔𝑔𝑔𝑔𝑡𝑡−1 + 𝛾𝛾7 (𝑠𝑠𝑠𝑠𝑡𝑡−1 + 𝑐𝑐𝑐𝑐𝑡𝑡−1 + 𝑔𝑔𝑔𝑔𝑡𝑡−1 – 𝑠𝑠𝑠𝑠𝑡𝑡−1) where ecm and pcm are energy consumption and protein consumption, respectively. sf, ct, and gi are fertilizer subsidy, refers to food credit, government expenditure on infrastructure, 98 economic analysis (21, vol. 54, no. 2, 94-103) respectively. there is a technique that is followed in order to achieve the desired result: (1) the variables were converted into logarithmic forms, (2) stationary testing of all variables used to see whether the variables contained unit roots, (3) determination of the optimal lag, and (4) cointegration test to see if the variables used in the equation have a long-term relationship. in general, econometric approach, it is necessary to carry out the classical assumption test. the goal is to obtain an estimate that is best linear unbiased estimator (blue), then the estimation of the research model needs to be tested for classical assumptions consisting of normality test, multicollinearity test, heteroscedasticity test, and autocorrelation test. result prior to estimating time series data, a stationary test is undertaken. estimation of nonstationary data would result in the appearance of super inconsistencies and false regression, preventing the application of conventional inference methods. this research used the unit roots test. this study used the augmented dickey fuller test to find the unit root (adf). the variable is stationary if the adf tstatistic is greater than the probability value. the unit root test can be done on individual variables or on the entire study's variables (dependent and independent). the cointegration test employed in this study is the johansen test, which is designed to determine the long-run connection between two or more variables in a model. as stated in table 1, unit root test and cointegration test results are accomplished. table 1. unit root test and cointegration test result unit root test results (adf test) johansen cointegration test variables level first difference second difference models conclusion t-stat prob t-stat prob t-stat prob kk 1 cointegration of eqn(s) at the 0.05 level eam -1.59 0.47 -2.08 0.06 -6.44 0.00 kg 1 cointegration of eqn(s) at the 0.05 level pam -0.88 0.77 -2.79 0.07 -6.57 0.00 ck 2 cointegration of eqn(s) at the 0.05 level ecm -1.99 0.28 -2.77 0.07 -3.53 0.01 cg 3 cointegration of eqn(s) at the 0.05 level pcm -3.14 0.03 -10.19 0.00 -6.58 0.00 sf -1.87 0.33 -1.65 0.44 -6.51 0.00 ct -0.19 0.92 -5.42 0.00 -8.46 0.00 gi -1.12 0.69 -4.78 0.00 -7.84 0.00 source: own presentation, 2021 table 1 shows that all variables in this study are stationary using the second degree of integration test (second difference) and the cointegration test demonstrates that the variables are related in the long term which mean there is a link between food security and the independent variables. numerous assumptions must be adequately justified for multiple linear regression models in order for the resultant estimate to fulfill the requirements for the best linear unbiased estimator (blue). a normality test, a multicollinearity test, an autocorrelation test, and a heteroscedasticity test are used to verify these assumptions. these tests are sometimes referred to as classic assumption tests, and the results are shown in table 2. galuh gusti karina, sofyan syahnur 99 table 2. classic assumption test normality test heteroskedasticity test autocorrelation test models jaque berra prob obs*squared prob initial probability new probability eam 3.989 0.13 5.924 0.11 0.0000 0.0003 pam 0.026 0.98 4.016 0.25 0.0000 0.0008 ecm 2.781 0.24 7.854 0.04 0.0000 0.0004 pcm 2.523 0.28 5.662 0.12 0.0000 0.0001 source: own presentation, 2021 the jarque-bera test examines the normality of data by plotting the side. the estimated j-b probability value is larger than 0.05 in all models, indicating that 𝑢𝑢𝑡𝑡 residual is normally distributed. the heteroscedasticity test checks if a regression model has a residual unequal variance for a known independent variable. using the breuschn pagann godfrey test, the three regression models utilized had no heteroscedasticity issues. however, the energy consumption model has a heteroscedasticity issue. so, using the generalized least squares (gls) approach, we discovered obs*rsquared of 5.468656 with 0.1405. the chi-square probability is larger than 0.05, indicating no heteroscedasticity. a multicollinearity test is used to examine if independent variables are related. this test uses the variance inflation factor. the results of the multicollinearity test reveal that all independent variables in each model are not multicollinear. the centered vif value of each independent variable included in each model is less than 10. the breusch-godfrey serial correlation model reveals that all models have autocorrelation difficulties with a chi-square probability value less than 0.05, which is 0.0000. the autocorrelation problem makes the ols estimator inefficient, according to gujarati (1995), (has a minimum variance, both in small and large samples). so the os estimators' variance estimate is skewed, and the ols estimator's t-statistic is high. the general least square approach treats autocorrelation and generates a probability value that grows but stays below 0.05. as noted in the table, there is still autocorrelation when the chi-square probability value is examined. however, when additional autocorrelation indicators, such as the probability values of t-statistics, f-statistics, and durbin watson, are considered. if these signals are present, the restored model has avoided the autocorrelation problem. according to the food security agency, the condition of food security can be identified by one of the indicators, namely the availability of food for consumption. the availability of food is divided into two, namely the availability of energy and protein. food availability comes from food production in the region concerned, in this study is aceh. figure 1 show the condition of energy and protein availability in aceh from 2013 to 2020 by classifying energy and protein from vegetable and animal sources. according to (antika prycilla veronika, theresia puspitawati, 2021), the recommended availability of energy and protein is 2550 kcal/capita/day for energy and 55 grams/capita/day for protein. based on the two graphs above, the availability of energy and protein in aceh has met the recommended criteria. the average availability of energy in aceh each year is between 2550 to 2980 kcal/capita/day, while protein is between 71 to 89.6 grams/capita/day. energy availability is also increasing almost every year, except in 2014-2016 which decreased by 7 to 9 percent and in 2018 it decreased by 1.9 percent. the average increase is between 1.2 to 7 percent. as for the availability of protein changes between -7 to 9 percent. another indication of food security that may be utilized is the level of food consumption. food consumption indicators may be used to determine the quantity of food that families can get and eat. to evaluate the degree of nutritional absorption, food consumption is also separated into energy and protein consumption. according to the 2015 national food and nutrition association (wknpg), the recommended daily energy and protein intakes are 2200 kcal/capita/day and 57 grams/capita/day, respectively. by comparing the proposed requirements to the data in figure 1, it is clear that energy use continues to fall well short of the adequacy level. the growth of protein intake in aceh is seen in figure 4. according to the wknpg's guidelines and the statistics in figure 100 economic analysis (21, vol. 54, no. 2, 94-103) 4, protein consumption in aceh is still well below the adequacy threshold. during the research period, the acehnese population's protein consumption exceeded 50 grams/capita/day just once, in 2020, when it reached 53.75 grams/capita/day. prior to 2020, it was about 40 grams per capita per day, and even in 2015, it was just 37.33 grams per capita per day, much below the required requirement of 57 grams per capita per day. figure 1. development of energy & protein availability and energy & protein consumption per capita per day in aceh 2013-2020 source: aceh provincial agency most of the protein consumed is vegetable protein, if the average amount is 34.15 grams/capita/day, or 81 percent of the total protein consumed. meanwhile, animal protein consumed annually is 8.26 grams/capita/day or 19 percent of the total protein consumed. the next stage is to make an estimate using a model that has already been created. data processing is carried out by using the error correction model to determine the short-term behavior and longterm behavior of the factors that affect food security in aceh. in this study, food security is defined as the total of the values for energy availability, protein availability, energy consumption, and protein consumption. to examine the effect of the three independent variables utilized in this study on aceh's food security, four models were used: the energy availability model, protein availability model, energy consumption model, and protein consumption model. fertilizer subsidies, food credit, and government infrastructure spending are the independent factors. table 1 present the summary result of long term behavior of all models, and table 1 present the summary result of short term behavior of all models. table 3. summary of estimated result of long-term and short –term models variables long term short term eam pam ecm pcm eam pam ecm pcm coefficient sf -0.04 -0.008 -0.08 -0.12 0.14 0.03 -0.01 0.32 prob 0.32 0 0.05 0.65 0.00 0.00 0.18 0.00 coefficient ct 0.007 0.005 0.001 0.28 -0.004 -0.001 -0.005 -0.01 prob -0.13 0 0.50 0.94 0.01 0.00 0.02 0.00 coefficient gi -0.015 -0.01 -0.019 -0.03 0.013 0.002 -0.01 0.01 prob 0.13 0 0.5 0.05 0 0.05 0.11 0.16 coefficient c 7.01 3.94 7.98 5.17 0.002 0.005 0.01 0.20 prob 0.00 0.00 0.00 0.00 0.55 0.00 0.00 0.00 coefficient ect(-1) -0.22 -0.60 -0.40 -0.27 prob 0.02 0.04 0.03 0.00 r-squared 0.380 0.735 0.191 0.141 0.433 0.380 0.365 0.601 dw 0.398 0.388 0.436 0.374 0.769 0.688 1.041 1.310 f-stat 5.734 25.99 2.206 1.541 4.965 6.871 2.738 9.822 prob(fstat) 0.003 0.000 0.109 0.225 0.004 0.000 0.015 0.000 source: own presentation, 2021 galuh gusti karina, sofyan syahnur 101 in the long run model, the variable with a positive and significant influence is food credit in terms of food availability (energy and protein availability), as shown by a coefficient probability of less than 5%. the coefficient of determination of the model indicates the extent to which the independent variable may explain the dependent variable. according to the estimation findings, the coefficient of determination is 0.380594. this suggests that variance in the three independent variables accounts for 38.05 percent of the variation in energy availability. the coefficient of determination for the protein availability model is 0.735809. this suggests that variance in the three independent variables may account for 73.58 percent of the variation in energy availability. while the remainder is explained by factors not included in the model. in the short term model, major variables include fertilizer subsidies in the food availability (energy and protein) and protein consumption models, as well as government infrastructure spending in the energy availability model. the coefficient of determination in the energy availability model is 0.433067 for the short-term equation. this suggests that 43.30 percent of the variance in short-term energy availability in aceh can be explained by the three independent factors. in terms of protein availability, this value is 0.380594. this suggests that 38.05 percent of the variance in short-term energy availability in aceh can be explained by the three independent factors. the coefficient of determination for energy consumption is 0.365166. this suggests that 36.51 percent of the variance in short-term energy availability in aceh can be described by change in the three independent variables, and the coefficient of determination for protein consumption is 0.601768. this suggests that 60.17 percent of the variance in short-term energy availability in aceh can be explained by the three independent factors. conclusion several significant points may be deduced as a result of the topic that has been provided. in the long run, food credit has a considerable positive influence on food availability (energy and protein), implying that credit increases food availability. according to the law of supply, this results in a rightward shift of the supply curve. subsidized fertilizers have a short-term positive and considerable influence on food availability; they cut farmers' production costs, hence shifting the supply curve to the right. subsidized fertilizers also have a favorable and considerable influence on protein consumption. this is because they lower farmer prices, which lowers output costs. as a result, consumption increases, increasing the amount requested. government investment in infrastructure also has a positive and considerable influence on energy availability. this is because government construction of irrigation and highways facilitates distribution for farmers, resulting in increased production and a shift to the right of the supply curve. these findings conclude that aceh food security in the short term is more stable than the long-term food security. thus, all interest parties that in line with food security should pay attention to ensure the food security in aceh run well in the long term. they have to guarantee the distribution of fertilizer subsidies are equitably and transparently, and to create irrigation and roads to improve food distribution, thereby increasing consumption in all regions. credit should also be extended without 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(2014). crop insurance, premium subsidy and agricultural output. journal of integrative agriculture, 13(11), 2537–2545. https://doi.org/10.1016/s2095-3119(13)606747 article history: received: december 12, 2021 accepted: december 29, 2021 the effect of fertilizer subsidy, food credit, and government expenditure on infrastructure towards food security: demand and supply sides galuh gusti karina10f* | sofyan syahnur2 introduction conclusion references microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp163-178 original scientific paper empirical investigation of the impact of tertiary education on the economic growth of the european union countries vladimir nedić1* | dragan turanjanin2 | slobodan cvetanović3 1 academy of professional studies sumadija, kragujevac, serbia 2 faculty of management (fam), sremski karlovci, belgrade business academy for applied studies, serbia 3 faculty of economics – university of niš, serbia abstract the relationship between tertiary education and economic growth of the eu countries in the period 2000-2012 was examined in this paper, by using a developed econometric model in which the multiple regression method was applied and based on relevant data. the empirical research conducted did not confirm the starting hypothesis that the share of the highly educated in the structure of employees between 30 and 34 years in the eu countries in the period 2006-2012 had a positive impact on gdp per capita growth rate over this time interval. the search for the cause of the results obtained in this way should start from the selected observation period, which is characterized by the years before and immediately after the economic crisis of 2008 and 2009. also, there is an assumption that the education systems of eu countries do not sufficiently follow real development in the labor market, that is, they do not sufficiently educate people who are able to commercialize university-acquired knowledge for innovation and economic growth. in this light, the reorganization of the system of functioning of higher education as an increasingly important segment of state support for modernizing the higher education system and increasing its degree of efficiency in the modern conditions of adherence becomes a very popular topic. key words: tertiary education, economic growth, economic growth factors, eu countries jel classification: i250 introduction stable economic growth in the long run is an important material assumption of economic and social prosperity of countries. the list of drivers of economic growth is very broad. one of the main drivers of long-term economic growth is human capital, which represents a set of knowledge, skills and competences, levels of health status and many other components. the education system is the foundation upon which human capital construction is based. in this system, higher education is the platform on which the process of human capital construction under contemporary production conditions is based. it creates highly qualified professionals who are essential drivers of economic growth and development. education as a component of human capital has always attracted the interests of researchers around the world. in the field of economics, the question of the relationship between the level of education of the population and economic growth is particularly important for economic policy * corresponding author, e-mail: vnedic@kg.ac.rs 164 economic analysis (2020, vol. 53, no. 1, 163-178) makers. the answer to the question is whether the level of education drives economic growth or it differs, both in theoretical and empirical literature. the aim of this research is to examine the impact of education on the economic growth of eu countries in 2006-2012. the composition of the work consists of six sections. following the introduction, the second section of the paper provides an overview of significant theoretical and empirical studies of the interrelationships between education and economic growth of individual countries. for the purpose of empirical confirmation of the alternative hypothesis about the positive and negative impact of the growing share of persons who completed tertiary education in the population aged between 30 and 34 on the economic growth of eu countries in the period 2001-2012 is presented in the third section of the paper. also, as part of this section, a multiple regression model is being developed to investigate this impact. exploration of the research and discussion results is presented in the fourth section of the paper. concluding considerations are in the following fifth section and the list of used literature in the sixth section of the paper. review of significant research in principle, there are two different approaches to looking at the link between education and economic growth. the first approach starts from the view that human capital is not an input like any other, but a key driver of advancing innovation (nelson & phelps, 1966). identical views can be found in doms et al. (1997), caselli & coleman (2001), fabiani et al. (2005), falk (2005), bayo-moriones & lera-lopez, (2007) and many others. another approach was developed by lucas (1988) arguing that economic growth is based on the accumulation of human capital. he was followed by becker, murphy & tamura, 1990, rebelo, 1992, mulligan & sala-i-martin, 1992, baro & lee, 1992. there are a number of respectable empirical studies of education as drivers of economic growth. for illustrative purposes, bassu and bhattarai (2009, in deniz et al., 2011) conducted a survey on a sample of 47 countries between 1960 and 2007 which showed that in economically developed countries, economic growth was positively correlated with investment in education, while this link was negative in economically less developed economies with lower investment in education. on the other hand, krueger and lindhal (2001, in deniz et al., 2011) present their results on how average school years affect economic growth, and find that there is a positive and significant relationship between education and economic growth, especially in low-income countries levels of education of the population. acosta-ormachea and morozumi (2013) question whether a change in the structure of public spending can stimulate economic growth. their results showed that the reallocation of public spending between expenditures for national defense, economic infrastructure, health and social protection had no effect on economic growth. however, when changes in the structure of public expenditure involve an increase in investment in education, then there is robust evidence of an association with economic growth. sylwester (2000) comes to the conclusion that investment in education is positively correlated with future economic growth, and negatively correlated with current economic growth, suggesting that the effects of investment in education on economic growth can be realized over time. the results of his research also show that the link between investment in education and economic growth is more pronounced in oecd countries and that it is weaker in less developed countries. the results of pritchett's research (2001, in deniz et al., 2011) show that there is no significant correlation between investment in education and economic growth. chen and feng (2000) based their research on a survey conducted in 29 chinese provinces in 1978-1989 and they have come to the conclusion that higher education is the most important vladimir nedić, dragan turanjanin, slobodan cvetanović 165 factor for economic growth. therefore, these authors advocate a policy of rewarding the best individuals in the education sector, in order to motivate other individuals to invest more and more effectively in their education. barro (2001, in abhijeet et al., 2010) conducted a survey on a sample of 100 countries in 1965–1995. he came to the conclusion that economic growth was positively correlated with the initial levels of average adult male schooling. in contrast, economic growth was not significantly linked to the education of women in secondary and upper levels. he also concluded that highly educated women were not well placed in the labor market in many countries and therefore did not contribute to economic growth. abhijeet et al. (2010) explains that the link between education and economic growth depends on public spending, tax structure, production technology parameters. survey results have shown that the link between education levels and economic growth is non-linear, that is, growth in investment in education is not always accompanied by accelerated economic growth. vu, hammes and im (2012) distinguish between the impact of university and vocational education on economic growth. by empirically exploring the link between education and economic growth, they determine the existence of a two-way relationship: education encourages economic growth and growth increases education as per capita income rises. these authors refute the dominant view in science that tertiary education is a significant factor in stimulating economic growth over vocational education. they point out that vocational education provides practically applicable work skills and therefore contributes to higher productivity than university education, and thus it increases per capita income. on the contrary, the effect of university education on economic growth is often neglected and is caused by the higher relative costs of university education. the key argument relied on by the evidence of a negative relationship between the indicators analyzed lies in the distinction that exists between the number of years of education and the quality of education. actually, by increasing the number of years of education does not mean, a priori, a higher level of quality of higher education. moreover, it is often the opposite because of the fact that a larger education system often imposes the need to hire additional workers on lower criteria, or increase the number of students per teacher. some authors analyze higher education in certain specific areas as a factor influencing economic growth. for illustrative purposes, murphy, shleifer & vishny (1991) indicate that engineering education makes a greater contribution to development than higher education in the field of law. tiago (2007) proves that the enrollment rate in the faculties of engineering and computer science has a significant impact on economic growth. tsai, hung & harriott (2010) appeal to government subsidies for technology studies, as research shows that increasing the number of graduates in engineering, mathematics and computer science is a significant factor in improving the quality of the workforce, and thus driving economic growth. data and methodology starting from the above explanations, we further examine whether or not the growing proportion of people completing tertiary education in the population aged between 30 and 34 had a stimulating role in generating economic growth in eu countries in 2001-2012. in this sense, the hypothesis was made: ho: the economic growth of eu28 countries is positively correlated with the participation of persons who successfully completed tertiary education in the population aged between 30 and 34 in the period between 2001 and 2012. the alternative hypothesis is: 166 economic analysis (2020, vol. 53, no. 1, 163-178) h: the economic growth of eu28 countries is negatively correlated with the participation of persons who successfully completed tertiary education in the population aged between 30 and 34 in 2001-2012. in accordance with the defined hypothesis, we opted for the multiple regression method. specifically, we want to see how the dependent variable (in this case, the rate of economic growth) changes under the influence of the independent variable (the share of the highly educated in the total number of employees in the population between the ages of 30 and 34). the model we want to construct in our research will be enriched with additional variables that we also believe to have an impact on the real rate of economic growth and we want to control their impact on economic growth in the observed countries (figure 1 and table 1). figure 1. impact model source: authors table 1. list of variables in the model parameters parameters description independent 1 tertiary educational attainment, age group 30-34 (%) control variable 1 gross fixed capital formation (% of gdp) control variable 2 labor productivity per hour worked (annual % change) control variable 3 financial crisis (dummy) dependent real gdp growth rate (annual % change) source: authors data on the growth rates of real gross domestic product in eu countries are taken from eurostat. the calculation of the real growth rate of gross domestic product makes it possible to monitor the dynamics of the level of economic activity, both between different economies and over different time periods. the real rate of economic growth further excludes the impact of inflation on quantifying the level of economic activity at national level. independent and control variables participation of persons who have successfully completed tertiary education in the population aged 30-34 (%) is used as an acceptable and very suitable approach for quantitative and qualitative analysis. specifically, european statistics, in the area of higher education, monitors vladimir nedić, dragan turanjanin, slobodan cvetanović 167 this information in its official annual reports. higher participation of the highly educated in this age structure speaks of raising the level of education of the observed country. the first in the list of control variables is gross fixed capital formation (as percentage of gdp). it is a concept used in official national accounts such as the united nations system of national accounts (unsna), national income and product accounts (nipa) and the european system of accounts (esa). statistically, this variable shows the value of the acquisition of new or existing fixed assets by economic entities, the state and households (excluding entrepreneurs) reduced by the amount of alienated fixed assets. in short, it represents a component of gdp that is focused on investment, not personal consumption. there are numerous studies that trace the link between fixed capital investment and economic growth (romer 1987; delong & samers 1991, 1992, 1993). we particularly highlight the results of an empirical study in which, on the basis of data from 65 countries, from 1960 to 2000, a positive relationship was found between the average fixed capital investment rate and the average gdp per capita growth rate per employee (sorenson & whitta-jacobsen, 2010). the second in the list of control variables is labor productivity per hour worked (annual% change). this data is taken from eurostat and labor productivity per hour worked is calculated as the ratio between real gross domestic product (at constant 2005 prices) and engaged labor. engaged work is expressed by the total number of working hours recorded in one national economy. measuring labor productivity per hour provides a better insight into productivity levels, as compared to the conventional method of productivity per worker, since it eliminates the difference between full-time and part-time employees as a component of the workforce in different countries and different time periods. productivity growth is a result of capital growth, higher quality of workforce and advancement of technology. all these factors are connected to a work ethic and culture, the treatment of entrepreneurship in the economy, the ability of workers and managers to adapt quickly to any change. the third control variable is the global financial crisis that occurred during the analyzed period. specifically, the global economic crisis, which began in the united states in late 2008, quickly spilled over to the continent of europe. we witnessed that not only the global financial system was threatened with its emergence. almost all sectors of the economy in europe were exposed to the consequences of its emergence. all economies within the european union were exposed to the negative impact of the financial crisis. in some eu member states, the economic growth rate in 2008 was lower or even negative. in 2009, all eu countries experienced a negative economic growth rate. this is precisely the reason why we introduced an artificial binary variable in our research. in this paper, the financial crisis takes the form of an artificial binary variable, which we refer to as dumvar. the correctness of the decision to choose 2009 as a crisis year is also confirmed by the value of the artificial variable (financial crisis) in the observed period –it was the same in 2008 and 2009 and its value was 1, and in other years its value was 0. figure 2 illustrates the movement of the variables thus selected in the model. data for 2013 and 2014 were used for the observed period 2001-2012 because a positive time shift of 1 and 2 years with respect to the main independent variable was performed. tertiary educational attainment, age group 30-34. values are shown as eu28 averages. 168 economic analysis (2020, vol. 53, no. 1, 163-178) figure 2. moving average values of model variables for eu28 there is a slight but constant divergence of tertiary educational attainment, age group 30-34 and gross fixed capital formation, which shows the increasing influence of human capital in the economic structure of the eu 28. in the study presented, we will use a fixed effect statistical model (fe). when using fe we assume that something within the countries may affect the predictor or outcome variables and we need to control this. this is the rational view behind the assumption of the correlation between the entity's error term and predictor variables. fe removes the effect of those timeinvariant characteristics from the predictor variables so we can access the predictor net effect. another important assumption of the fe model is that those time-invariant characteristics are unique to the entity and should not be correlated with other entities characteristics. each entity is different therefore the entity’s error term and the constant (which captures individual characteristics) should not be correlated with the others entity’s error terms (wooldridge, 2003). if the error terms of two entities are correlated, then fe is not suitable for prediction. in this case the model should be replaced by random-effect modeling (re). for testing suitability of predicted model (fe vs re) we used the hausman test (greene, 2010). research results we begin our analysis with summary of descriptive statistics in table 2. table 2. descriptive statistics and variable names variable obs mean std. dev. min max real gdp growth rate 308 .0209416 .039242 -.177 .11 gross fixed capital formation 308 .2147175 .0413092 .106 .36 tertiary educational attainment 306 .3027026 .1083365 .089 .511 labor productivity per hour worked 297 26.65084 16.65616 3.6 64.9 financial crisis dummy 308 .1818182 .3863223 0 1 the mean real gdp growth rate is 2% and the standard deviation is almost two times greater. the explanatory variables (dependent variable and control variables) also showed great deviation. this could be one of indicators for using a fixed effect model in some future regressions of this paper. we suppose that every country has some characteristics which have vladimir nedić, dragan turanjanin, slobodan cvetanović 169 influence on real gdp growth differently. the meanings are based on observations from all countries and that could be the reason for great standard deviation. when we use fixed effect model to get entity error it is correlated with other predictors in entity. those entity errors are unobserved, time invariant characteristics of every country. table 3 represents correlation matrix between independent variable and predictors. table 3. correlation matrix between variables real gdp growth rate gross fixed capital formation tertiary educational attainment labor productivity per hour worked financial crisis dummy real gdp growth rate 1.0000 gross fixed capital formation 0.4172 1.0000 tertiary educational attainment -0.1991 -0.3394 1.0000 labor productivity per hour worked -0.2044 -0.4392 0.5671 1.0000 financial crisis dummy -0.5240 0.0642 0.0810 0.0117 1.0000 the simple correlation with growth rate of gdp and other predictors are all modest. interestingly, the correlation of real gdp growth rate is not even positively associated with the share of the population aged 30-34 who have successfully completed university (tertiary educational attainment). there is not strong correlation between independent variables which is good for our future regressions. according to tabachnick and fidell (1996), the independent variables with a bivariate correlation of more than 0.70 should not be included in multiple regression analysis. first we will run simple linear regression. the dependent variable we use is the real gdp growth rate. the independent variables are gross fixed capital formation, the share of the population aged 30-34 who have successfully completed university (tertiary educational attainment), labor productivity per hour worked eur per hour worked and we also include our dummy variable which represents financial crisis. the following regression is given in table 4. table 4. simple linear regression source df ms number of obs 295 f(4, 290) 66.57 prob > f = 0.0000 r-squared = 0.4787 adj r-squared = 0.4715 root mse = .02863 model 4 0.054567333 residual 290 0.000819759 total 294 0.001551018 real gdp growth rate coef. std. err. t p> |t| [95% conf. interval] gross fixed capital formation 0.4284406 0.0451483 9.49 0 0.3395806 0.5173005 tertiary educational attainment -0.0005963 0.0190053 -0.03 0.975 -0.0380022 0.0368095 labor productivity per hour worked 4.65e-06 0.0001281 0.04 0.971 -0.0002474 0.0002567 financial crisis dummy -0.0562147 0.004346 -12.93 0 -0.0647685 -0.047661 _cons -0.0601828 0.0124848 -4.82 0 -0.0847552 -0.0356105 the number of r-squared which is 47, 87 % of the variance of the dependent variable is the real gdp growth rate, explained by our regression model. adjusted r-squared has similar interpretation but we take into account the numbers of variables we have in our regression model. we are basically interested to find out if there is any evidence between our independent 170 economic analysis (2020, vol. 53, no. 1, 163-178) variable and dependent variable controlling for the other variables. we must formulate a null hypothesis in order to prove this. the null hypotheses tests the following model: ”there is no relationship between the real gdp growth rate and the share of the population aged 30-34 who have successfully completed university controlling for the gross fixed capital formation, labor productivity per hour worked (annual % change) and dummy variable which represents a financial crisis.” the multiple regression coefficients have a ceteris paribus interpretation. first what we noticed in this regression is that the p-value for the share of the population aged 30-34 years old who have successfully completed university (tertiary educational attainment) and labor productivity per hour worked (annual % change) are particularly high and suggest no significant effect of them. other variables are significant. we have two main reasons to believe that a model made with ols regression does not work. the first one is that our independent variable does not have a significant p value, and also one of the control variables does not have a significant p value. secondly, for the panel data, it is more acceptable to use the fixed effect or random effect regression model. in panel data, countries are observed at several points in time. two basic models for panel data analysis are the fixed effect model and random effect model. the panel data are useful when we suspect that the dependent variable depends on independent variables which are not observable but correlated with observed independent variables. if those omitted variables are constant over time, with a panel data estimator we will be able to consistently estimate the effect of our observed independent variables. econometric model we have a multiple regression model for 28 countries i = 1, ...28 which is observed at several time periods t = 1, ...11. itiitit ucxy   (1) where: yit is the dependent variable,  is intercept, xit is a k-dimensional row vector of explanatory variables,  is k-dimensional column vector of parameters, ci is country specific effect and uit is error overall term. the t (t = 11) observations for each country are summarized by the following matrices: the t observations for individual i can be summarized as: dependent variable yi, is represented by: as we have 4 independent variables in regression independent variable xi, it is represented by: for the overall error, term matrix is:  111, 11 5 1                         i i i i i y y y y y      411, 11 5 1                            i i i i i x x x x x      111, 11 5 1                         i i i i i u u u u u     let’s denote the last country in set i with n, (n =28), last year in set t with t, (t=11) and k in dependent variables in regression (k=4). now we can write nt observations for all countries and time periods as: vladimir nedić, dragan turanjanin, slobodan cvetanović 171  1, 28 1                         nty u y y y i      kntx x x x x i                         , 28 1      111, 11 1                         u u u u u i     the data generation process is described by linearity: itiitit ucxy   , where   0itue and   0ice . the model is linear in parameters, and  , individual effect ci and overall error uit. independence:  n iii yx 1 ,  , (independent and identically distributed). the observations are independent across individuals but not necessarily across time. this is guaranteed by random sampling of countries. strict exogenicity: e [uit|xi, ci] =0 the overall error term is assumed uncorrelated with the explanatory variables of all past, present and future time periods of the same individual. this is a strong assumption which for example rules out lagged dependent variables. this also assumes that the overall error is uncorrelated with the individual specific effect. further assumptions allow us to distinguish the random effects model and the fixed effects model (schmidheiny, 2011). the random vs. fixed effects model in the random effect model, the individual-specific effect is a random variable that is uncorrelated, with the explanatory variables. unrelated effect: e(ci|xi)=0. this assumption says that the individual-specific effect is a random variable that is uncorrelated with the explanatory variables of all past, present and future time periods of the same individual. this is a very strong assumption that economists usually do not like. from this we can early conclude that the random effect model would not be used in this paper. later on, we proved this by an appropriate test. in the fixed effects model, the individual-specific effect is a random variable that is allowed to be correlated with the explanatory variables. related effect: e (ci |xi) ≠0. variance effect: v (ci |xi) =c2< ∞; v (ci |xi) =ci2 (xi) < this assumes constant variance of the individual specific effect. identifiability rank ntkx  and )( ii xxe  where a typical element is iitti xxx _  and  t iti xtx /1 _ . this assumes that the explanatory variables are not perfectly collinear, that all regressors have non-zero within-variance. hence xit cannot include a constant or any other time-invariant variables (schmidheiny, 2011). 172 economic analysis (2020, vol. 53, no. 1, 163-178) results for the fixed effect regression model considering all the aforementioned facts, we do fixed-effect multiplication regression for independent, dependent and control variables. the results are shown in table 5. table 5. multiple regression using the fixed effect model fixed-effects (within) regression number of obs 295 number of groups 27 obs per group: min =9 avg =10.9 max =11 f(4,264)=91.65 prob >f= 0.0000 group variable : country r-sq: within =0.5814 between =0.3052 overall =0.0040 corr(u_i, xb) =-0.9347 real gdp growth rate. coef. std. err. t p> |t| [95% conf. interval] gross fixed capital formationi 0.6066615 0.0552892 10.97 0 0.4977976 0.7155255 tertiary educational attainment -0.1552425 0.0410749 -3.78 0 -0.2361187 -0.0743663 labor productivity per hour worked 0.0058452 0.0015107 3.87 0 0.0028707 0.0088197 financial crisis dummy -0.0562251 0.0039328 -14.3 0 -0.0639688 -0.0484814 _cons -0.2061999 0.0378701 -5.44 0 -0.2807657 -0.1316341 sigma u 0.08911076 sigma e 0.02529476 rho 0.92543315 (fraction of variance due to u_i) f test that a ll u i=0: f(26, 264) = 4.14 prob > f = 0.0000 based on the data contained in table 5, it follows that all the predictors have a statistically significant p value. it follows that, with the ceteris paribus clause, a 1% increase in the participation rate of the highly educated in the population between 30 and 34 has the effect of reducing the real gdp rate by 0.155 percentage points. the coefficient of determination is 58.14%. we attribute the negative impact to the presence of the economic crisis. recognizing this fact and the theoretical postulates that the effects of higher education on economic growth become more pronounced after a few years, we construct our time-delayed multiplier regression of one and two years (table 6). table 6. multiple regression using the fixed effect model with time lag for one year for share of the population aged 30-34 who have successfully completed university (tertiary educational attainment). fixed-effects (within) regression number of obs 268 number of groups 27 obs per group: min =8 avg =9.9 max =10 f (4,237)=87.81 prob >f=0.0000 group variable : country r-sq: within = 0.5971 between = 0.2809 overall = 0.0059 corr(u_i, xb) =-0.9347 real gdp growth rate coef. std. err. t p> |t| [95% conf. interval] gross fixed capital formation 0.6527613 0.0593155 11 0 0.5359084 0.7696142 tertiary educational attainment lag1 -0.1465833 0.0451384 -3.25 0.001 -0.2355071 -0.0576595 labor productivity per hour 0.0062278 0.0017638 3.53 0 0.0027531 0.0097024 vladimir nedić, dragan turanjanin, slobodan cvetanović 173 worked financial crisis dummy -0.0568216 0.0040386 -14.1 0 -0.0647777 -0.0488655 _cons -0.2307366 0.0460767 -5.01 0 -0.3215088 -0.1399644 sigma u 0.0946098 sigma e 0.0259203 rho 0.9301809 (fraction of variance due to u_i) f test that all u i=0: f(26, 237) = 3.85 prob > f = 0.0000 from table 6, we conclude that with the ceteris paribus clause, an increase in the participation rate of the highly educated in the 30to 34-year-old population by 1% and a oneyear delay in this effect results in a decrease in the real gdp rate of 0.146 percentage points. the coefficient of determination is 59.71%. table 7. multiple regression using the fixed effect model with time lag for two years for share of the population aged 30-34 who have successfully completed university (tertiary educational attainment). fixed-effects (within) regression number of obs 268 number of groups 27 obs per group: min =7 avg =8.9 max =9 f(4,210)=84.73 prob >f =0.0000 group variable : country r-sq: within = 0.6174 between = 0.2096 overall = 0.0144 corr(u_i, xb) =-0.9340 real gdp growth rate coef. std. err. t p> |t| [95% conf. interval] gross fixed capital formation 0.6998178 0.0641767 10.9 0 0.5733047 0.826331 tertiary educational attainment lag2 -0.1221088 0.049119 -2.49 0.014 -0.2189384 -0.0252793 labor productivity per hour worked 0.0062999 0.001992 3.16 0.002 0.0023731 0.0102268 financial crisis dummy -0.0568274 0.0041494 -13.7 0 -0.0650072 -0.0486476 _cons -0.2518971 0.055817 -4.51 0 -0.3619305 -0.1418636 sigma u 0.09502024 sigma e 0.0262978 rho 0.92885346 (fraction of variance due to u_i) f test that all u i=0: f(26, 210) = 3.53 prob > f = 0.0000 from table 7 it follows that with the ceteris paribus clause, the increase of participation of the highly educated in the population from 30 to 34 by 1% and the delay of this effect of two years have an impact on the decrease of the real gdp rate by 0.122 percentage points. the coefficient of determination in this case is the highest and it is 61.74%. also in this case, the correlation between entity error and predictors is different than zero, in our case it is -0.93. from a negative correlation value it can be concluded that the predictors are well included in the model, as the description of the predicted variable is better when the error is getting smaller. if we add to this the fact that the f test has a good value, we have confirmed that all coefficients are different from zero. from the standpoint of all these facts, we can construct a model. (realgdpgrowthrate)it = 0.6998(grossfixedcapital)it 0.1221(tertiaryeducational)it-2 + 0.0062(laborproductivity) it 0,0568 (dummy) it 0.2518 + ci + u it (2) 174 economic analysis (2020, vol. 53, no. 1, 163-178) figure 3 presents a graphical interpretation of the impact of the two most significant variables in the model on the growth rate of real gross domestic product with a time lag of the tertiary educational attainment variable of 2 years. a very dominant positive influence of the variable gross fixed capital (it) is clearly observed, as well as a negative influence, but the effect of the variable tertiary educational attainment (it-2) is significantly less influential. figure 3. 3d presentation of the impact model gross fixed capital and tertiary educational attainment on the real gdp growth rate. figure 4 illustrates that by extending the time shift from 0 to one or two years, the negative impact of the tertiary educational attainment variable on the real gdp growth rate is reduced. figure 4. presentation of the change in the impact of tertiary educational attainment on the real gdp growth rate as a function of time shift vladimir nedić, dragan turanjanin, slobodan cvetanović 175 hausman test for endogenity of the model in order to decide between fixed or random effects we run a hausman test where the null hypothesis is that the preferred model represents random effects vs. the alternative model which represents the fixed effects (green, 2008). it basically tests whether the unique errors uit are correlated with the regressors and the null hypothesis is that they are not. we also have to make the regression with the random effect model in order to compare the significance of an estimator versus an alternative estimator. the regression is shown in table 8. table 8. regression using a random effect with time lag of two years for share of the population aged 30-34 who have successfully completed university (tertiary educational attainment) random-effects (within) regression number of obs 241 number of groups 27 obs per group: min =7 avg =8.9 max =9 wald chi2 (4)=271.27 prob> chi2=0.0000 group variable : country r-sq: within = 0.5924 between = 0.1618 overall = 0.4999 corr(u_i, x) =0 (assumed) real gdp growth rate coef. std. err. z p> |z| [95% conf . interval] gross fixed capital formationi 0.5415416 0.0531542 10.19 0 0.4373612 0.645722 tertiary educational attainment lag2 -0.0303151 0.0263206 -1.15 0.249 -0.0819026 212724 labor productivity per hour worked 0.0003521 0.0001788 1.97 0.049 1.63e-06 7025 financial crisis dummy -0.0570723 0.0043802 -13.03 0 -0.0656573 484873 _cons -0.084596 0.0154517 -5.47 0 -0.1148808 543111 sigma u 0.00768588 sigma e 0.0262978 rho 0.07869572 (fraction of variance due to u_i) the result of hausman test is presented in table 9. table 9. the hausman test result fixed vs. random test coefficients (b) (b) (b-b) sqrt(diag(v_b-v_b)) fixed random difference s.e. gross fixed capital formationi 0.6998178 0.5415416 0.1582762 0.0359622 tertiary educational attainment lag2 -0.1221088 -0.0303151 -0.0917937 0.0414717 labor productivity per hour worked 0.0062999 0.0003521 0.0059479 0.0019839 financial crisis dummy -0.0568274 -0.0570723 0.0002449 b = consistent under ho and ha; obtained from xtreg b = inconsistent under ha, efficient under ho; obtained from xtreg test: ho: difference in coefficients not systematic chi2(4) = (b-b) ' [(v_b-v_b)^(-1)] (b-b)=59.25 prob>chi2 = 0.0000 (v_b-v_b is not positive definite) the realized hausman test resulted in a probability of almost 100%, which indicates the rejection of his null hypothesis about the adequacy of a multiple regression model with a 176 economic analysis (2020, vol. 53, no. 1, 163-178) random effect. by this, we confirm that an alternative hypothesis of the test has been proved, or that between the independent and control variables, on the one hand, and the residual uit, on the other, there is a correlation. this also speaks in favor of justifying the acceptance of the developed fixed-effect multiple regression model. the search for the cause of the results obtained in this way should start from the selected observation period, which characterizes the years before and immediately after the economic crisis. there is also the assumption that the education systems of eu countries do not sufficiently follow real developments in the labor market, that is, they do not sufficiently educate people who are able to put into practice the knowledge gained at universities in the knowledge that is rapidly commercializing into innovation and economic growth. we believe that future research must operate with an independent variable, the proportion of employees with tertiary education up to 64 years of age, and to include the years after 2012, which are characterized by more dynamic rates of economic growth in eu conclusion the use of the multiple regression statistical method rejected the starting hypothesis that the increase in the share of tertiary graduates in the total number of employees aged 30-34 had a positive impact on the economic growth rate of these countries in 2001-2012. the study confirmed the alternative hypothesis that the economic growth of eu countries was negatively correlated with the participation of persons who successfully completed tertiary education in the population between the ages of 30 and 34 in the period between 2001 and 2012. we can look for the cause of confirmation of the alternative hypothesis in the too narrow (in terms of the set age range from 30 to 34 years) population we observed as an exogenous variable or in the too short time series the study covered. a decrease in the negative impact of the exogenous variable is observed with an increase in the time lag relative to the observed economic growth as an endogenous variable. this may be an initial starting point for some future research, where on the one hand a) the exogenous variable would vary in terms of changing (above mentioned), the age range of the observed employee population, and on the other hand b) further increase the observed lag time relative to the endogenous variable (up to the limit allowed by available data). references abhijeet, c. 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(2003). further results on instrumental variables estimation of average treatment effects in the correlated random coefficient model. economics letters, 79(2), 185191. article history: received: january 26, 2020 accepted: march 27, 2020 ea_2014_3-4 udc: 005.511:334.012.63/.64(497.11) 005.336.1 jel: l20, l26 cobiss.sr-id 211784204 scientific review specifics of management in small and medium-size enterprises in serbia1 lazarević-moravčević marija2, belgrade banking academy, belgrade, serbia stevanović slavica, institute of economic sciences, belgrade, serbia belopavlović grozdana, belgrade banking academy, belgrade, serbia abstract – under modern conditions for performing business, an enterprise regardless of its size or business activity must be systematically directed and run. small and medium-size enterprises have certain characteristics that make them considerably different compared to large systems, therefore it is not realistic to expect that the management process in such organizations would develop in the same way as in the large systems. the fact is that the small business often does not involve a small investment, and the management of small enterprises is constantly faced with the problem of "poverty of resources" that leads to the conclusion that the success of smes is predominantly determined by the managerial skills of managers/owners. assuming that the owners/managers of smes adequately perceive the capabilities of their enterprise, make the right decisions, finding effective solutions in terms of organization and apply modern approaches to control and the success of the company definitely will follow. in this paper theoretical and empirical research has been carried out with the aim to identify the basic characteristics of successful management of smes in serbia. the research results indicate that the managerial capacity of managers/owners of smes is the main strength of the company, and one of the key sources of growth and development. when the influence of external factors is very unfavorable for business development, the management as an internal resource of organization is increasingly gaining importance in creating business success and competitive advantage. key words: smes, management, planning, competitive advantage, organizational structure, leadership, control 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education, science and technological development of the republic of serbia. 2 zmaj jovina 12, belgrade, serbia; marija.lazarevic@bba.edu.rs moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 105 introduction small and medium-size enterprises (smes) have certain characteristics that make them considerably different compared to large systems. in certain situations such specificities put smes in a privileged position, on the other hand, there are many features that limit their growth and make them inferior to large organizations. flexibility is the first and main advantage that stands out when it comes to smes. smaller organizations have the ability to adapt quickly to the new circumstances and market needs. unlike large companies that are characterized by sluggishness, the small enterprises without any major shocks can redirect to the new market demands, in terms of the required quality, design, after-sales services etc. also, in comparison with large organizations advantages can be found in the area of innovation, simple organizational structure, a small initial capital, ability of liaisonand collaboration. smaller companies are more prone to entrepreneurial ventures and adopt new technology solutions more quickly, especially if they do not require excessive contributions and investments. on the other hand, the problems confronting smes significantly threaten and challenge their survival and development. the factors limiting the development of small business can be found in both external environment and internal features of a small business. given that smes are not smaller versions of the large systems, it is unrealistic to expect that the key management activities in such enterprises are implemented in a manner that is appropriate for the large enterprises. due to the continuing lack of financial and human resources, smaller business volume, as well as a negative influence of factors from the external environment, the management of smes is forced to define special and in many ways specific approaches to planning, organizing and control. characteristics of planning in smes planning is the primary, and at the same time very complex phase of management in which a number of strategic and operational decisions is made on the basis of which the operations of an enterprise are then directed and coordinated. in fact, this is a phase of management which defines organizational goals determining the ways to achieve them. the need for planning exists in every enterprise, regardless of its size or business activity in which it is engaged in. the intensity of such need is determined by many factors such as corporate culture, management style, ambition of the manager/owner, size and structure of the business portfolio and the like (jovan todorović, 2004, p. 508). to these factors the features of environment should be added, especially those related to the industry in which the company operates (coulter, 2010, p. 315). a key issue related to the phenomenon of planning in the smes is whether the management in smaller organizations has enough time for effective planning due to the fact that it is burdened by numerous activities related to the implementation of the defined planned decisions. it is common opinion that spending time in an efficient manner means for managers to spend 60% of their time in planning and development, 25% on the current tasks and 15% on the routine tasks (avlijaš, 2008, p. 165). given that small business owners take on many roles and are not exclusively engaged in defining planning decisions but also in its implementation and control, it can be concluded that the planning in smaller organizations economic analysis (2014, vol. 47, no. 3-4, 104-117) 106 possess certain characteristics or that does not happen in the same way as in the large enterprises. with the aim to identify the basic characteristics and specifics of the planning in smes an empirical research has been conducted on a sample consisting of 102 entities in serbia (lazarević-moravčević, 2013, p. 196). when creating a sample the selective approach has been used. therefore the structure of the sample consists of enterprises that employ more than ten employees, achieve positive results and have a recognized potential for growth and development. according to the research results when making key decisions the management of smes in serbia takes into consideration the factors of endogenous and exogenous origin. besides numerous problems challenging them, the owners/managers of the smes have a clear intention and optimism about the direction in which they want their business grow. since the growth strategy is a dominant strategic orientation, it can be concluded that the managers in smes are characterized by ambition, desire for success and the tendency to accept risks. chart 1. characteristics of planning in smes source: authors' own research based on the results obtained, shown in chart 1, it can be seen that the key feature of the management of smes in serbia is the medium term planning. the absence of a long-term growth plan, especially present in the small business segment, is not an unexpected result, especially if we take into account the instability and volatility of the environment in which enterprises in serbia carry out their business operations. the results show that in the smes sector there is a practice of formalization of the planning process but only to a certain level. in this sense, the management of smes brings highly formalized decisions such as business policies, procedures and rules. the formalization or the adoption of permanent planning decisions improves the efficiency of decision-making and implementation of decisions and solves one of the major problems 0 10 20 30 40 50 60 70 long-term medium-term short term strategy business plan business policies procedures rules p la n n in g h or iz on p la n n in g d ec is io n s moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 107 facing the management in smes which is the "lack of time". the formalization shortens the time necessary for tasks of operational character, which also means that there is more time left to resolve issues of a strategic importance to the organization. therefore, it can be concluded thatformalization is desirable as long as results in an increase in efficiency without endangering the creativity and flexibility of the enterprise. business plan has been identified as a key business decision in the category of small and medium-sized enterprises. a business plan is a "road map" by which an entrepreneur defines his business, business expectations, sources of funding and the ways to obtain the lacking resources, as well as ways for rational use of resources ( dostić, serdarević-šestić, kulović, 2010, p. 6). business owners create this planning decision for the different needs of internal and external nature. a business plan is created when a company is launching a new business, but also when planning further business development in terms of introducing new products, markets, technologies, etc. also, the business plan is an essential document in situations when seeking financial assistance from the banks or other financiers. in such case, the planning decision has the role of a study that justifies the entrepreneurial idea. given that it can serve as a standard in control, the business plan could also be created for the internal needs of an enterprise. the structure of a business plan is determined by its purpose. therefore, differences in the individual structural elements of a business plan can occur depending on whether it is a new or already existing business. also the elements of a business plan depend on whether the business plan is created for internal use of an enterprise or to obtain funds from banks or from other investors when is necessary to adhere to the instructions given by financiers. the structure of a business plan is also determined by the characteristics of the activity (business) in which the enterprise operates, the environment in which operates, preferences and ambitions of the owner/manager etc. regardless of how it is structured and which elements contains, a business plan should be short, clear and well suited to its readers or users. it is recommended that a business plan for the small enterprisescontains 10-20 pages and 20-30 pages for medium-size enterprises, which means that in any case it is necessary to avoid verbosity and unnecessary information. through the analysis of environment the management of a market-oriented company gets an insight into the market potential of an industry, its competitive structure, identifies critical success factors, internal strengths and weaknesses, etc. taking into account the influence of competition on the business operations of enterprises, each market-oriented company when it comes to the planning of activities, needs to systematically make an analysis of the competitive environment. in this sense, an enterprise needs to get familiar with its competitors in terms of the market share, strengths and weaknesses, future steps and other aspects. since the analysis of the environment factors in an industry is of great importance for the business operations of enterprises, one part of the research has been conducted in order to establish whether the management of smes takes into consideration the behavior of competitors in the market when making key planning decisions. in the analysis it was assumed that competition is a key stakeholder, i.e. an important factor that directly determines the company's business operations. economic analysis (2014, vol. 47, no. 3-4, 104-117) 108 according to the research results, looking at the entire sample about 54% of managers know well enough their competitors in terms of their market share. on the other hand, the knowledge of future strategic steps taken by their competitors is very low. only 11% of managers of smes believe that they can predict the future moves of their competitors. similar results were obtained when assessing knowledge of the internal strengths and weaknesses of the competition. shown as percentages for the entire sample about 12% of managers know well enough their competition in the context of its internal weaknesses, while only 16% in the segment of its internal forces. chart 2. knowing the competition small enterprises, in % source: authors' own research chart 3. knowing the competition -medium-size enterprises, in % source: authors' own research 0 10 20 30 40 50 60 market share future moves internal weaknesses internal strength good enough good not enough 0 10 20 30 40 50 60 70 80 market share future moves internal weaknesses internal strength good enough good not enough moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 109 the results suggest that the management of smes is not characterized by a systematic approach and comprehensiveness in the process of analysis of factors related to the industry (competition) environment which results in a lack of knowledge regarding competition in terms of its market share, strengths and weaknesses and especially of its future strategic moves. since the actions of competitors may have a dramatic impact on the business operations of an enterprise, it is essential that a systematic and objective analysis of this environment segment becomes a practice of the smes. with the aim to overcome weakness identified in this domain, the use of certain techniques and models is recommended in order to achieve a better quality of analysis and to raise its objectivity and efficiency to a higher level. organizing and organizational design of small and medium-size enterprises defining the optimal organizational structure, or a structure that would enable an efficient use of available resources and performance of activities in an organization, is a complex and challenging task for the managers of modern enterprises, especially due to the fact that organizational design is determined by the numerous factors of external and internal nature, such as company size, life cycle phase of organization, management decisions, technology available to the company, relationships between organizational units, employees and so on (erić, 2000, p. 376). the influence also comes from a number of factors of the external environment, such as changes in the political and economic system, the intensity of competitive struggle, changes in the market in terms of consumer demands, resource availability, etc. due to the frequent changes in the environment factors, a well defined organizational structure can be an effective solution but only for a certain period of time. for this reason it is necessary to periodically review and modify the organizational design. some believe that the moderate changes in organizational design should take place at least once a year, while some radical changes should be implemented every 4-5 years. a redesign of organizational structure is necessary to carry out when the company introduces new products in its product range, new technology, or enters new markets, hires new people, shuts down production, narrows the market place, etc. more specifically, any change in the strategic orientation of a company will require an adaptation of the organizational structure and its change. by applying certain principles of organization3 smes management tries to find an optimal solution, or an organizational design which would logically connect the organizational units of the company, on the basis of which the conditions for the implementation and enforcement of strategic and operational decisions will be made. due to the fact that the smes are continuously facing the lack of financial and human resources, organizational solutions for many of such companies are unattainable. on the other hand, due to the smaller business volume the smes do not need to create the complex organizational structures. a very frequent form of organizational structure in smes, as confirmed by the results of the research, is the functional organizational structure. based on charts 4 and 5 it can be seen 3 specialization, departmentalisation, chain of command, span of control, centralization /decentralization, formalization. economic analysis (2014, vol. 47, no. 3-4, 104-117) 110 that in the category of medium-size enterprises a functional organizational structure covers about 92% and 43% of the small enterprises. chart 4. organizational structure medium-sized enterprises source: authors' own research functional organizational structure is characterized by clearly defined hierarchical levels, formalization, standardization, clearly defined jobs, tasks and roles of individuals. the advantages of this organizational form are clear and direct control, good communication and coordination of employees within the functions, specialization, savings based on the economies of scale, highly skilled workforce and a great ability to solve technical problems etc. on the other hand, the conflict of interest between certain functions, centralized decision making, unclear measuring of contribution of each functional area in the overall performance are considered to be primary disadvantages of this organizational form (erić, 2000, p. 359). according to its nature a simplified version of functional organizational structure is found in smes or a structure characterized by a smaller number of organizational units compared to the number of business functions that take place in the company. the studies have demonstrated that such organizational structures do not have separate places i.e. organizational units that would integrate activities of strategic importance for the growth and development of the company. the above primarily refers to the marketing activities, research and development. the absence of the above functional areas does not mean that the successful smes in serbia are not innovative or marketing oriented, but rather that they apply particular and very specific ways to perform those activities. the research results confirm that the small enterprises have, besides the functional organizational structures, the simple or informal structures. 43% 41% 0% 1% 15% functional structure simple structure divisional structure other refused to answer moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 111 chart 5. organizational structure small enterprises source: authors' own research a simple organizational structure is characterized by a high centralization, wide range of control, low specialization and departmentalization. the manager/owner makes all important decisions, participates in and supervises all business processes in the organization. the main advantage of a simple model of organization is a clear control system and a high level of flexibility. turbulent and dynamic conditions prevailing in the modern marketin which an enterprise operates, impose the need for permanent reviews and changes of the strategic behavior of a company. changes in the strategic orientation require adjustments in organizational terms. modern organizations are becoming smaller, simpler, more dynamic, more horizontal and open ( riderstrale, nordstrom, 2004, p. 195). the smes are adapting to the new requirements in terms of organizing or creatingan organizational design, and as one of the possible solutions that such companies may apply is the matrix organizational structure. basically this is a structure produced by combining functional and project (divisional) structure in order to minimize its limitations and disadvantages. an effective combination of vertical lines of communication and authority with the horizontal (lateral) lines, stands out as one of the main advantages of the matrix organizational structure. also, the matrix organizational structure is characterized by a high flexibility, efficient use of resources (resources and expertise are available on an equal basis to all projects), debureaucratisation of management (decentralized decision making), more efficient solving of complex problems, and the like. on the other hand, in this organizational structure one of the most important organizational principles i.e. the principle of unity of command has been broken. a dual system of management or the fact that employees are exposed to a dual supervision makes thesituation somewhat chaotic. the existence of the two key figures i.e. two managers (at the level of the project and at the level of the function) can cause a number of problems, which are usually manifested in the conflict of opinion and non-supporting attitudes 91% 5% 0% 4% functional structure simple structure divisional structure other economic analysis (2014, vol. 47, no. 3-4, 104-117) 112 between the functional and project teams. also, the lack of understanding and lack of support between these two groups in the organization is largely caused by the fact that the teams in projects and the teams in functions differ widely based on their motivation and mentality. while the experts within functions are focused on strengthening the competence, efficiency and better equipment of sector, the project teams are focused on meeting deadlines, conditions of the contract and work plan (brnjas, 2000, p. 309). the above disadvantage can be solved by strict defining of powers and responsibilities of managers at the both project and function level. although the use of matrix organizational structure is very limited, it may be an appropriate solution for smes that apply project-based work, or for businesses that are organized according to the functional principle, but intend to realize some project-based works in the coming period. one of the many options that are available to the management of smes, and which used in order to make the organizational structure more flexible is outsourcing. due to the lack of financial resources and unprofitability of establishing complex organizational structures, a great deal of activities can be transferred outside the company. in such case the enterprises develop certain management functions, and for the other business activities periodically engage external partners and consultants. by transferring those activities in which an enterprise cannot achieve uniqueness to other business entities, an enterprise acquires certain benefits, or eliminates bureaucracy, speeding up the decision making process, reducing costs, and most importantly focuses on the strengthening and upgrading of its core competence (so-called "core competence"). in the case of smes outsourcing and the use of services of specialized institutions are commonly used in the field of legal services, marketing, accounting, transportation, training and education, development of managerial skills, etc. leadership in smes leadership is a phenomenon that attracts the attention of experts for a long period of time. over decades many books and papers on the subject of leadership have been written in a quest for the most acceptable definition and interpretation of the role of leader in the creation of success of an enterprise. a significant part of the experts believes that the leadership plays a critical role in creating competitive advantage, but also that this category should not be equated with the management or entrepreneurship. generally it is believed that a leader is someone who is creative, transformer and innovator. such person approaches challenges with passion and without restraint. thanks to his/her charisma, expertise and communication skills, a leader motivates others and inspires members of the organization to take an action and to transform. on the other hand, the manager is a person who plans, organizes and controls. unlike an entrepreneur who identifies himself with the whole company, a professional manager identifies himself with the function performed in the company. his/her actions are primarily focused on the efficiency, as opposed to the leader who is focused on effectiveness. the character of a manager is determined by the persistence, rationality, analyticity, determination and prudence. an entrepreneur is the owner of the company, i.e. the person who runs the moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 113 business, takes the initiative and risk of success or failure of the organization. he is a visionary, a creative person who is dedicated to work to the maximum, but also someone who has a great need to control. the obsession of every entrepreneur is his/her business and organizational development. therefore, entrepreneurs are focused on changes, innovations, creation of new products and markets. the differences between the entrepreneurs and leaders can be found in the orientation, or in the means used to achieve a goal. while the entrepreneur is mainly focused on the task and goal, the leader is focused on people, i.e. the followers that he/she directs toward achieving the goal without coercion. under conditions of high uncertainty and turbulence, it is more than desirable that the owner or the person who runs the business, in addition to entrepreneurial and managerial skills, possess the ability to encourage, motivate and animate the members of the organization by his/her personal example towards achieving the goal. a lack of leadership qualities, as well as inability to achieve effectiveness and efficiency by taking risky undertakings, will cause a decline in the business performance and endanger the survival of the company. there is a perception that each organization throughout its life cycle in certain moments will have a greater need for individuals with managerial qualities, and in other moments will have a greater need for individuals who possess the qualities of leaders and entrepreneurs. generally in the early stages of business development a company needs people with entrepreneurial spirit and ideas. at the stage when an organization becomes more mature and stabilizes its business it is realistic to expect that the transformation from entrepreneurship to management will follow. on the other hand, in times of crisis, the organization is in need of leaders, i.e. individuals who possess the skill of managing and transforming organization (mašić et al., 2010, p. 427). taking into account that effectiveness and efficiency are indispensable for success, the modern organizations are in need of management that has the leadership and managerial and entrepreneurial abilities and skills. in fact, these three roles are not conflicting and can be successfully integrated in a single person. by combining the entrepreneurial, managerial and leadership energy the success will be guaranteed. the specifics of control processes in smes viewed in the light of conceptual sense the control in smes is not different from the control in large organizations. in the evaluation the management of smesmay use the same or similar techniques and instruments that are used in the large systems. the only significant difference between the control in the small and large enterprises is the extent to which the control is preformed. the assumption is that in the smaller organizations the control will be easier due to the smaller volume of activities, i.e. will require less time and energy. generally speaking a control mainly involves the control of effects and the control of behavior. the performance control (control of effects) aims to establish whether the planned performance is achieved, and the control of behavior is carried out in order to direct the behavior of employees towards achieving planned performance. such control is determined by the culture of organization, its system of constraints and rewards. practice has shown that organizations that have a strong organizational culture and a fair system of rewarding, in the economic analysis (2014, vol. 47, no. 3-4, 104-117) 114 process of control of behavior are less reliant on the constraints, i.e. rules, procedures and regulations (dess, lumpkin,eisner, 2007). control is an instrument used for assessing the validity of selection of a certain planning decision, as well as the efficiency of its implementation. evaluation of the business performance can be done by using a number of techniques and instruments, which are generally classified into two categories: traditional and contemporary. classic (traditional) approaches are based on the accounting concept of profit, i.e. on the information obtained from the financial accounting system. a set of regular financial reports is used for basic reports that show information about business results. the traditional approach that insists on presenting business results through financial sizes is widely used in enterprises despite certain deficiencies. the primary objections related to this approach for measuring and displaying of the business performance, are its excessive orientation to the past, short-term focus and a tendency to show profit as the main indicator of success. an excessive focus to short-term financial performance reflects the fact that the company neglects many other important elements or resources which in the long term can play an important role in creating competitive advantage, such as new product development, modernization of the production process, employee training, etc. therefore, taking into account the logic of modern business, according to which the "intangible" assets of the company are becoming a key source of the competitive advantage, the control of business performance should not be reduced only to the financial analysis, or analysis of the financial position and profitability of an enterprise. over-reliance on financial indicators in the analysis of business performance can lead to an investment in the potential short-term yields, and on the other hand may cause the negligence of the intellectual or intangible assets that generate growth of an enterprise. in accordance with the above, the control of business performance should be refined using the qualitative indicators.4 the research which was conducted in order to identify the specifics of management in the smes, found that in such enterprises there is a practice of business control from different perspectives. most of the managers surveyed analyze its business not only in terms of financial performance, but also from a consumer perspective, internal processes and innovation. shown by percentage 77% of managers said that they monitor the business performance not only using traditional, or quantitative financial indicators, but also some of the non-financial measures. viewing this in the light of the small and medium-sized enterprises, the success or failure from the aspect of non-financial nature which is extensively used in the assessment of business performance is customer satisfaction. results relating to the use of qualitative criteria in the analysis of business results, observed at the level of small and medium-sized enterprises are presented in chart 6 and 7. 4 the number of new customers, frequency of orders, number of complaints, total time of interaction with customer, customer satisfaction with quality and speed of delivery, time required to launch innovations, number of customers that have not re-used the product (service), efficiency of the production process, productivity per employee, workforce fluctuation, number of received suggestions and the like. moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 115 chart 6. criteria for measuring the business success in small enterprises, in % source: authors' own research in the category of medium-sized enterprises, in addition to customer satisfaction, as very important criteria for measuring business success are the employee satisfaction and the efficiency of the production process. chart 7. criteria for measuring the business success in medium-sized enterprises, in % source: authors' own research based on the research results, it can be concluded that the management of smes in assessing the business performance in addition to financial indicators also relies on certain qualitative criteria. the use of qualitative criteria in the analysis of business performance 0 5 10 15 20 25 30 other profitability of individual products customer profitability participation of new products in total sales rates to attract new customers customer satisfaction employee satisfaction efficiency of the production process 0 5 10 15 20 25 other profitability of individual products customer profitability participation of new products in total sales rates to attract new customers customer satisfaction employee satisfaction efficiency of the production process economic analysis (2014, vol. 47, no. 3-4, 104-117) 116 proves that the management of smes takes into consideration the role and importance of "intangible" assets in creating business success. conclusion the competitive advantage of smes in serbia is determined by a number of factors of external and internal nature. since that the negative impact of exogenous factors has been present throughout a long period, and that the environment in which the smes operate in serbia is not business-friendly, the key sources of competitive advantage should be sought in its internal strengths, primarily in the managerial skills of managers. in the modern business environment, the growth and development of an enterprise is determined by the ability of its management to create a clear vision and mission, identify factors critical for success, analyze competition, define planning decisions and formulate methods for the efficient implementation. only under the assumption that the management of smes is characterized by a proactive attitude towards events in the environment, flexibility and willingness to accept risk, there is a real chance to achieve the business success or growth and development of an organization. the results of empirical research prove that the activities taking place in the field of planning, organization and control in the smes in serbia require different approaches as compared to the solutions applied in the large systems. authorsresearch has shown that the planning process in the smes is flexible and less formal as compared to the planning in large organizations. due to its smaller business volume in smes more flexible forms of organizational structure prevail, such as the simple (informal) and functional organizational structures. the control is comprehensive and enriched by application of qualitative indicators of business success, which leads to the conclusion that the management of smes in serbia takes into consideration the role and importance of intangible assets in creating business success. references avlijaš, r. 2008. preduzetništvo i menadžment malih i srednjih preduzeća. belgrade: singidunum. brnjas, z. 2000. strategijski menadžment – teorijske osnove sa primerima iz prakse. belgrade: grmečprivredni pregled. coulter, m. 2010. strategijski menadžment na delu. belgrade: data status. dess, g. g., lumpkin, g. t., and eisner, a. b. 2007. strategijski menadžment – teorija i slučajevi. belgrade: data status. dostić, m., serdarević – šestić, m., and kulović, đ. 2010. biznis plan za mala i srednja preduzeća. sarajevo: school of economics and business. erić, d. 2000. uvod u menadžment. belgrade: čigoja štampa. lazarević-moravčević, m. 2013. faktori i pristupi u kreiranju konkurentskih strategija malih i srednjih preduzeća u srbiji. phd diss., belgrade: union university, belgrade banking academy. mašić, b., babić, l., đorđević-boljanović, j., dobrijević, g., and veselinović, s. 2010. menadžment – principi, koncepti, procesi. belgrade: singidunum. riderstrale, j.., and nordstrom, k. a. 2004. fanky business. belgrade: plato. moravčević-lazarević, m., et al., specifies of management, ea (2014, vol. 47, no. 3-4, 104-117) 117 todorović, j. 2004. strategijski i operativni menadžment. belgrade: conzit. specifičnosti upravljanja malim i srednjim preduzećima u srbiji rezime – u savremenim uslovima poslovanja preduzeće, bez obzira na veličinu ili delatnost kojom se bavi mora biti planski usmeravano i vođeno. mala i srednja preduzeća poseduju određene karakteristike koje ih čine bitno drugačijim u odnosu na velike sisteme, stoga nije realno očekivati da se proces upravljanja u ovim organizacijama dešava na istovetan način kao i u velikim sistemima. činjenice da mali biznis često ne podrazumeva mala ulaganja, kao i da se rukovodstvo malih preduzeća konstantno suočava sa problemom „resursnog siromaštva“ navode na zaključak da je uspeh msp prevashodno determinisan upravljačkim sposobnostima menadžera/vlasnika. uz pretpostavku da vlasnici/menadžeri msp na adekvatan način sagledavaju mogućnosti preduzeća, donose ispravne odluke, pronalaze efikasna rešenja u domenu organizovanja i primenjuju savremene pristupe kontroli, uspeh preduzeća ne može izostati. sa ciljem da se identifikuju osnovne karakteristike menadžmenta uspešnih msp u srbiji, u radu je sprovedeno teorijsko i empirijsko istraživanje. rezultati istraživanja ukazuju da upravljačka sposobnost menadžera /vlasnika msp jeste osnovna snaga ovih preduzeća, odnosno jedan od ključnih izvora rasta i razvoja. kada je uticaj eksternih faktora vrlo nepovoljan za razvoj biznisa, menadžment kao interni resurs organizacije sve više dobija na važnosti u kreiranju poslovnog uspeha i konkurentske prednosti. ključne reči: msp, upravljanje, planiranje, konkurentska prednost, organizaciona struktura, liderstvo, kontrola article history: received: 6 june 2014 accepted: 11 november 2014 ea_2015_3-4 notes from of editor-in-chief economic analysis (ea) publishes original research papers, case studies, conference papers, book reviews and other peer papers. ea aims for a high desk-rejection rate. manuscripts lacking theoretical foundation and methodological rigor will not enter the review process. editorial board is open to all interested parties that want to participate in the role of reviewer, as well as to those willing to contribute to the journal by their suggestions.would you be so kind to send your a short bio if you are interested to be our reviwers. in some of the future issues we plan to have guest editors from foreign universities, which will contribute to making this journal even more present in the international scientific community. please, submit your own research to ea and thus ensure that your articles reach the knowledgeable and international readership that they deserve. authors should submit their manuscripts online at eaoffice@ien.bg.ac.rs. 14th november, 2015. editor-in-chief acad. mirjana radović-marković, phd microsoft word 2011_1-2 scientific review    impact of electronic customer relationship management   (e‐crm) on efficiency of rent‐a‐car sector in bosnia and  herzegovina   peštek almir*, lalović anđela, university of sarajevo,   school of economics and business in sarajevo, bosnia and herzegovina   udc: 004:738:339; 338.46(497.6)    jel: l81         abstract – electronic customer relationship management system (e‐crm) is acknowledged  today as obligatory concept of customer relationship management in the world of services. therefore,  research on  impact of crm and e‐crm system to efficiency of rent‐a‐car agencies  in bosnia and  herzegovina is of crucial importance for companies and managers not only in rent‐a‐car industry, but  the tourism industry as whole.  the aim of this paper  is to explore the  impact of e‐crm on efficiency of rent‐a‐car agencies  in  bosnia and herzegovina. it explains if and how much is e‐ crm incorporated in everyday business of  rent‐a‐car agencies in bosnia and herzegovina. furthermore, it proves that those rent‐a‐car agencies  that have recognized the significance of e‐crm in everyday business, it leads to increase of agenciesʹ  profitability shown through the level of customer retention and attraction.  this  study  is  based  on  the  structured  personal  interviews  conducted  with  major  rent‐a‐car  agencies in bosnia and herzegovina. the research has several findings. firstly, rent‐a‐car agencies in  bosnia and herzegovina recognize the significance of e‐crm for everyday business. however, e‐crm  system  is mostly used by rent‐a‐car agencies that have  foreign  license/franchise. secondly, reasons  behind non‐usage of e‐crm in other agencies are mostly lack of capacities, insufficient knowledge of  information‐communication technologies of higher degree, as well as  financial constraints. thirdly,  rent‐a‐car agencies using the e‐crm consider it as contribution to pertaining the long‐term customer  relations and increase of profitability.    key words: customer relationship management, e‐crm, rent‐a‐car, bosnia and herzegovina  introduction  customer relationship management (crm) is precondition to successfulness of modern  age  companies.  development  of  technology  and  internet  has  lead  to  adjustment  of  companies to electronic and online business. corporate management, especially in customer  relationship management, is inventing new modalities of business with increase of internet  usage. the internet and online business has raised crm to higher level enabling companies  to provide web access for their buyers and suppliers. the electronic customer relationship  management (e‐crm) represents an upgrade of crm technologies and its usage of online                                                         * address: trg oslobođenja – a.izetbegović 1, 71000 sarajevo, bosnia and herzegovina; e-mail: almir.pestek@efsa.unsa.ba      economic analysis (2011, vol. 44, no. 1‐2, 47‐58)   48 resources and technologies based on the internet. chaffey and smith (2008) point out that the  essence of crm and e‐crm is not exclusively technology but also the complete culture of  customer relationship. according  to  jelassi and enders  (2008), e‐crm ultimately  leads  to  creation of long‐term relationship with customers, increase of buyer profitability and focuses  on high value buyers.   purpose  of  this  paper  is  to  explore  the  impact  of  e‐crm  on  efficiency  of  rent‐a‐car  agencies in bosnia and herzegovina. additionally, this paper aims at explaining the level of  incorporation of e‐crm in everyday business of rent‐a‐car agencies. in order to achieve the  purpose of the paper, we have established set of hypothesis. our main hypothesis is that the  use  of  crm  in  rent‐a‐car  agencies  that  have  recognized  the  significance  of  information‐ communication technologies leads to increase of their business results in long term. set of  five sub‐hypothesis has been created in order to support the main hypothesis:  1. the use of crm leads to retention of old and attraction of new customers.  2. rent‐a‐car agencies use information‐communication technologies more and more.  3. rent‐a‐car  agencies  more  and  more  recognize  the  significance  of  customer  relationship management system.  4. crm increases the profitability through retention of old customers.  5. crm leads to better profiling and better segmentation of customers.  long‐term relationships with customers: theoretical aspects of (e‐)crm  crm  is  business  strategy  applied  on  company  level  and  focuses  on  creation  and  retention of loyal and profitable relationship with customers in long‐term period through use  of technology. according to turban et al. (as cited in botha, 2004, pg. 292), crm represents  special approach  to customer service where  the main  focus  is on building  long‐term and  sustainable relationship with customers adding values to customers and business as well.  buttle (2009) considers crm as core business strategy that integrates internal processes and  functions with external networks to create profitable value for targeted customers.    e‐crm represents an upgrade of crm technology. additionally, it represents usage of  technology  for  providing  support  to  customer  interactions  with  little  or  no  human  interference on supply side (botha, 2004, pg. 293). although there are various definitions of  e‐crm, most of them have in its essence the necessity of online access, web interaction and  intensive customer relations. therefore, according to chaffey and smith (2008) crm and e‐ crm are not only technology but entire culture of customer relationship where the focus is  on the possibility for buyers to create the process of purchase and services by themselves. de  pelsemacker, geuens and van den bergh (2005) cite that the e‐crm means shift from the  practice that employees directly take care of customers to the one where a buyer is enabled  to use the self‐service tools and become active participants in buying and services process. e‐ crm, according to kincaid (2003) has four basic elements: information, process, technology  and human resources.   e‐crm  upgrades  traditional  crm  techniques  by  integrating  technologies  like  web,  wireless and voice technology making it fundamental part of entire companyʹs strategy for  customer relationship management (pan and lee, 2003, pg. 96). possibilities of search, online  forums, loyalty programmes, terms of payment (online credit card payments), questions and       peštek, a., et al., impact of e‐crm, ea (2011, vol. 44, no, 1‐2, 47‐58)     49 answers, possibilities of personalization of services to  individual online buyers and many  other e‐crm features contribute to  its significance for creation and retention of profitable  loyal customers in long‐term perspective.   zikmund, mcleod and gilbert (2003) cite that endeavours to retain current customers  through crm ultimately lead to increase of revenues and most often decrease of costs. they  point out that, despite initial high costs of crm system, the long‐term benefits are growing  higher over time because of repeated purchases and strengthening of the customer’s loyalty.  lee‐kelley, gilbert and mannicom (2003) have found in their study that introduction of e‐ crm  strategy  is  crucial  for  better  understanding  of  customersʹ  needs  and  desires.  additionally, it enables the creation of two‐way relationship between customer and supplier  resulting in customerʹs loyalty and increase of profitability. this is especially important in  rent‐a‐car sector where retention of customers is one of the greatest challenges for rent‐a‐car  agencies. information technologies and usage of e‐crm in rent‐a‐car agencies are becoming  imperative in order to ensure long‐term survival on market and higher profitability.   buhalis  and  oʹconnor  (2005)  consider  that  the  use  of  ict  should  be  in  context  of  development strategies  in tourist organizations (therefore rent‐a‐car agencies as well) that  will  be  oriented  towards  customers,  lead  by  profitability  and  enable  partnership.  in  the  context of this paper, we will consider the customer oriented approach having in mind that  the essence of e‐crm in rent‐a‐car agencies is the very focus on the customer itself.   each  customer in online community is special, different and lead by its own desires, experiences  and motives while interacting online with rent‐a‐car agencies providing services. therefore,  rent‐a‐car agencies should develop their e‐crm strategies that will enable them to approach  to each customer individually and personalize/adjust their offer to each specific customer.  according  to  buhalis  and  oʹconnor  (2005),  crm  systems  should  memorize  customerʹs  preferences  and  demands  in  current  for  the  future  use  of  services.  customer  satisfaction  depends largely of the possibilities of companies to be flexible and provide means/tools for  personalization of services (buhalis and oʹconnor, 2005, pg. 12).   the researches have shown  that customers use  in great scale  the possibility of online  search and reservations and at the same time have great confidence in online environment.  pease, rowe and cooper  (2007) cite  the example of european commission research  from  2004  according  to  which  customers  in  europe  have  the  most  confidence  when  they  buy  services  via  internet:  from  hotel  reservations  (46%),  airplane  tickets  (45%)  to  rent‐a‐car  agencies  services  (35%).  there  is  a  space  for  rent‐a‐car  agencies  to  use  the  potential  customers trust and improve their relationship with customer  in online environment. the  proof  for  this assumption  is  research  cited  by  kozak  and andreu  (2006)  where  47,6% of  respondents cited that they buy rental services via online agencies. more and more rent‐a‐car  agencies and other service providers in tourism are using e‐crm elements to enhance their  relations  with  customers  and  enable  direct  contact  with  end  users  through  different  programmes: loyalty programmes, possibilities of points collection etc.   rent‐a‐car sector of bosnia and herzegovina: brief overview   position of bosnia and herzegovina as balkan peninsula crossroads is of significance for  european transport‐communication system. during the last decade, significant means have     economic analysis (2011, vol. 44, no. 1‐2, 47‐58)   50 been  invested  in reconstruction and building the transport capacities,  facilities and roads.  existing  traffic  infrastructure,  position  of  bosnia  and  herzegovina  in  geographical  and  tourist sense, certainly represent the opportunity for development of rent‐a‐car sector in the  country.   according to above mentioned rent‐a‐car sector in b&h is still in growth phase and is  largely  characterized  with  lower  share  of  domestic  rent‐a‐car  agencies  compared  to  franchised  ones.  there  is  lack  of  secondary  data  in  this  field.  ademovic  m.  (2010)  has  conducted research of rent‐a‐car services market only for sarajevo region. the results of that  research showed that europcar asa‐rent has the largest market share in the canton (24%),  national car rental has 21%, followed by budget rent‐a‐car (18%) and champion ac (17%).  rent‐a‐car  agencies  working  at  the  territory  of  bosnia  and  herzegovina  are  mainly  stationed in sarajevo and have their branch offices in other b&h cities. at the territory of  canton sarajevo there are 17 registered rent‐a‐car agencies. most of the agencies use website  presentation of their business. however, even slight look at internet presentations of rent‐a‐ car agencies it is visible that most of the agencies use one‐way communication. at the same  time, those agencies that operate under franchise (like budget and europcar) use two‐way  approach to customers via their websites. having in mind that e‐crm is based on two‐way  communication  between  service  provider  and  service  recipient,  the  necessity  of  two‐way  communication approach is obvious.   exploring the application of e‐crm in rent‐a‐car agencies in bosnia and  herzegovina  methodology   our research was conducted  in  the period december 2010 –  january 2011  focused on  questions of existence of e‐crm systems in rent‐a‐car agencies in bosnia and herzegovina  and its efficiency. the research aimed at identifying:   • existing practice in rent‐a‐car agencies towards customers.  • existence of customer data bases in any form.  • existence of separate e‐crm system in rent‐a‐car agencies.   • ways of monitoring the successfulness of e‐crm system in rent‐a‐car agencies.   this research is of exploratory character since this field is not yet explored in bosnia and  herzegovina. therefore, it is necessary to provide better insight and understanding of usage  of e‐crm system in rent‐a‐car agencies in b&h.   for  the  purposes  of  this  research  conducted  telephone  interviews  were  conducted.  representatives  of  rent‐a‐car  agencies  (executive  directors,  marketing  managers,  sales  managers) working in bosnia and herzegovina were interviewed. the research plan was to  include 30 agencies and 17 agencies provided  their response  (meaning  the success rate  is  56%). questionnaire was developed by research team and was based on works of buhalis d.  (2003), chaffey, d. and smith, p.r. (2008), kincaid, j. w. (2003), chandra, s. and strickland,  t.j.  (2004),  ahmad,  i.  and  chowdry,  a.r.  (2008),  lee‐kelley,  l.,  and  gilbert,  d.,  and  mannicom, r. (2003), buttle, f. (2009) and robson c. (2005).       peštek, a., et al., impact of e‐crm, ea (2011, vol. 44, no, 1‐2, 47‐58)     51 findings and discussion  the sample of 30 rent‐a‐car agencies from entire bosnia and herzegovina encompassed  both  domestic  rent‐a‐car  agencies  and  those  that  work  under  licence/franchise  of  foreign  agencies.  by  number  of  employees,  most  of  the  rent‐a‐car  agencies  can  be  considered  as  small company (number of employees up to 50). in this structure, agencies that have up to 10  employees are predominant. there is a large discrepancy between agencies working under  franchise and domestic agencies regarding  the number of vehicles  in  their  fleet. namely,  franchised agencies have larger number of vehicles at their disposal. additionally, smaller  agencies donʹt have definite number of vehicles since during the season they hire additional  vehicles from other companies.     graph 1. structure by number of vehicles  12% 35% 30% 23% up to 20 20‐50 50‐100 over 100     graph 2. existence of strategy  24% 30% 46% has concrete strategy has strategic vision no concrete strategy     most of the companies have strategy set to 3‐5 years, but often it is just „strategic vision“  of directors rather than concrete formal strategy in written form. this is partially caused by  the fact that the companies who lack more concrete strategy are exactly those that have small  number of employees and often seem like „one‐man company“. generally, this is common  occurrence  in  tourism  industry. according  to research conducted by peštek a.  (2009)  the  total of 52% of respondents has concrete 3‐5 year strategy in a sample of 206 companies in  tourism  industry  in  bosnia  and  herzegovina.  therefore,  the  results  related  to  rent‐a‐car     economic analysis (2011, vol. 44, no. 1‐2, 47‐58)   52 industry are not surprising at all. graph 2 shows structure according to existence of strategy  in difference forms.   as it is shown, only 24% of rent‐a‐car agencies have concrete strategy. however, those  are mostly agencies that work under foreign licence/franchise.   since the basis for e‐crm is existence of customers data base, one of the questions during  the research was whether rent‐a‐car agencies in bosnia and herzegovina have customer data  base, and if yes, in what form is it and what are the collected data used for.     graph 3. existence of data base  82% 18% has customer database doesnʹt have customer database     as can be noticed from graph 3, high percentage of rent‐a‐car agencies has customer data  base in specific form. research findings show that customer data bases are mostly in simple  forms such as excel or outlook. most of the rent‐a‐car agencies avoid using more complex  software solutions for e‐crm often citing high prices of such software and weak possibility  to use them to maximum in b&h as reasons for avoiding. graph 4 shows the structure by  form of data base for those rent‐a‐car agencies that have data base in any form (82%)    graph 4. structure by form of data base  57%29% 14% excel outlook specialised software     the sample is based on criteria of existence of website of rent‐a‐car agency to enter the  sample. rent‐a‐car agencies mostly use their websites for promotion, establishing contact,  online reservations and communication with customers.          peštek, a., et al., impact of e‐crm, ea (2011, vol. 44, no, 1‐2, 47‐58)     53 graph 5. purpose of website  0 20 40 60 80 100 promotion establishing contact online reservations communication     according to data from graph 5, the promotion has most significant share when it comes  to purposes of using the website, while online reservations are in 3rd place by share. this has  significant  impact  to  e‐crm  system  in  rent‐a‐car  agencies  (considering  that  via  online  reservations company can gather important customer data that can be used afterwards for  segmentation and personalization of services).   most of  the rent‐a‐car agencies  (82%) collects data about their customers and archives  them  to data base. customer data vary  from basic data such as personal data  to  type of  vehicle rented, period in which the customer most often rents a vehicle, the history of using  services. way of collecting data varies between agencies: by direct contact (90%), via online  reservations (65%), by telephone books (23%), internet databases (30%) etc. graph 6 shows  the  ways  of  data  collection  in  rent‐a‐car  agencies  that  have  online  reservations  on  their  websites and those that donʹt have online reservations.      graph 6. collection of customer data in relation to online reservations  0 20 40 60 80 100 direct contact online reservations phone books internet databases doesnʹt have online reservations has online reservatoins      economic analysis (2011, vol. 44, no. 1‐2, 47‐58)   54 rent‐a‐car agencies that donʹt have online reservations mostly collect customer data via  direct  contact  and  phone  books  (which  is  surprising  since  this  way  of  data  collection  provides minimum of minimal data that could be used in future offers). it is interesting also  that agencies that have online reservations also use direct contact as data collection method  in higher percentage.   usefulness of data that rent‐a‐car agencies collect about their customers and archive to  data bases is differently perceived by rent‐a‐car agencies representatives: from monitoring  statistics where are the most customers from in order to advertise there, for communication  and  loyalty  programmes,  to  adjust  their  offers  to  concrete  client,  to  present  rent‐a‐car  services.   rent‐a‐car agencies in bosnia and herzegovina still use general approach to customers  without focusing on individual customer and pointing to offer which can encompass wider  segment of customers with special discounts and offerings. most of the rent‐a‐car agencies  still don’t use full capacity of customer data bases they own to create personalized services  and  approach  to  individual  client.  however,  their  recognition  of  usefulness  of  data  for  creation of offers and positioning towards clients is a positive trend.   majority  of  rent‐a‐car  agencies  doesnʹt  have  separate  system  of  (electronic)  customer  relationship management. while there is a number of rent‐a‐car agencies that recognize the  need for e‐crm system and introduce it or citing high prices of software for not introducing  it, there is a number of agencies that has no understanding of e‐crm or its implementation  possibilities within their agency.     graph 7. e‐crm as part of the business strategy  23% 11% 66% e‐crm part of the strategy e‐crm separate strategy doesnʹt exist     e‐crm  in rent‐a‐car agencies  is possible to present only for small number of agencies  interviewed. in those agencies that have e‐crm system, the significance of e‐crm is in the  possibility to know in every moment how many vehicles they have at their disposal, what  types of vehicles and how often customers use, statistical data on every rental so that they  can know the needs of specific client etc. for example,  if agency has personal data of the  customer in the e‐crm system and that user comes each year or rents a car in specific period,  the agency can prepare special offer  for  that client by using  the available data  from  that  system, check if the customer uses extra services like baby‐chair and similar. those agencies  that  are  in  the  process  of  development  of  e‐crm  system  usually  use  internal  system  by       peštek, a., et al., impact of e‐crm, ea (2011, vol. 44, no, 1‐2, 47‐58)     55 engaging ict companies who get the data from the agency and distribute specific and new  offerings further to special customers mailing lists.    graph 7 shows share of e‐crm system in entire business strategy of rent‐a‐car agencies  in b&h. the significant percentage of agencies (66%) does not consider e‐crm part of its  business strategy at all nor does it have separate e‐crm strategy. this is due to the lack of  knowledge about e‐crm system, lack of understanding of basics of e‐crm and the benefits  that it can bring to rent‐a‐car agencies in everyday business.    as  reasons  for  using  e‐crm  system,  those  rent‐a‐car  agencies  that  use  it  cite  the  possibility  of  improvement  of  relationship  with  their  customers,  quality  and  improved  communication with customers, better planning of service and offers development. at the  same time, the reasons for not using e‐crm system in rent‐a‐car agencies are high prices of  software and its maintenance, relatively small possibility for maximum usage of all e‐crm  features in regular business having in mind the size of b&h rent‐a‐car market.   indicators  of  impact  that  use  of  e‐crm  system  has  to  regular  business  in  rent‐a‐car  agencies that use e‐crm are expressed through improved continuous communication with  customers,  easier  planning  of  services  and  approach  to  customers,  as  well  as  market  segmentation. in order to estimate the successfulness of e‐crm system implementation, rent‐ a‐car agencies use statistical data and compare how  the  information gathered via e‐crm  system contributed to total increase of sales in specific period of time.   benefits from e‐crm  the main hypothesis of this research was that the use of crm in rent‐a‐car agencies that  have recognized the significance of information‐communication technologies leads to increase of their  business  results  in  long  term.  the  lead  hypothesis  is  tested  through  the  set  of  five  sub‐ hypothesis.   sub‐hypothesis 1 claims that the use of crm leads to retention of old and attraction of new  customers. rent‐a‐car agencies from the sample, 82% of interviewed, are using customer data  bases  in order to access the  information on certain customers and adjust  their services to  individual  customer  in  easier  way.  rent‐a‐car  agencies  use  data  bases  to  monitor  the  statistics of usage of rent‐a‐car services, dynamics of service usage by individual customers,  communicate with specific customers and personalization of services based on the finding of  customers characteristics for each individual customer in the data base. rent‐a‐car agencies  in bosnia and herzegovina still donʹt use e‐crm system in its full capacity. however, certain  number of agencies that use e‐crm system either in developed or initial phase, are mostly  agencies that have licence/franchise of foreign rent‐a‐car companies. it is interesting that the  rent‐a‐car agencies that have foreign licence/franchise use e‐crm system while other rent‐a‐ car agencies, although recognizing the significance of e‐crm system, donʹt use it for they  consider that the price of software solution for e‐crm and its maintenance is high and not  justified  for using them  in everyday business. rent‐a‐car agencies  that have developed e‐ crm system perceive the significance of this system for regular business and maintenance of  relationship with regular customers as well as establishing relations with new and potential  customers.  for  these  agencies,  the  significance  of  e‐crm  system  is  that  they  can  in  any  moment retrieve the information of how many vehicles they have in disposal, what type of  vehicle and how often customers rent, statistical data on every rental. in this way, they have     economic analysis (2011, vol. 44, no. 1‐2, 47‐58)   56 at  their  disposal  data  about  the  needs  of  individual  clients  –  from  the  type  of  vehicle  preferred by the client, rental period, special services like baby‐chair and other extra services  demanded  by  the  client.  having  such  information,  rent‐a‐car  agencies  that  use  e‐crm  system are establishing continuous contact with customers and are improving their relations  with  customers  through  personalization  of  services.  the  research  has  shown  that  those  agencies  that  use  e‐crm  system  are  positioning  e‐crm  as  important  part  of  the  entire  business  strategy.  additionally,  they  consider  that  the  use  of  e‐crm  contributes  to  improvement  of  relationship  with  customers,  quality  and  improved  communication  with  customers, as well as easier planning of services and offering development. therefore, it can  be  concluded  that  e‐crm  contributes  to  retaining  old  and  attracting  new  customers  by  which the sub‐hypothesis 1 has been accepted.   sub‐hypothesis 2 claims that rent‐a‐car agencies use information‐communication technologies  more and more.  all  17  respondents  from  the  sample  have  website.  websites  of  rent‐a‐car  agencies  mainly  provide  basic  information  about  the  agency,  contact  details,  vehicles  at  disposal  and  prices.  most  of  rent‐a‐car  agencies  (88%)  use  their  website  as  mean  of  promotion  and  for  establishing  contact  with  customers  (82%).  around  65%  rent‐a‐car  agencies use online reservations system via their websites. it is important element in e‐crm  system of rent‐a‐car agencies having in mind that this system represents the doors or entry  point for information on customers. that information will be then archived to data base and  used  in  future for personalization of services. 82% of respondents use data bases. mostly  those data bases are in excel or outlook form, while small number of agencies uses special  software solutions. agencies that use special software solutions for e‐crm are mainly those  that  work  under  foreign  licence/franchise.  existence  of  rent‐a‐car  agenciesʹ  web  sites  and  usage of data bases (or in certain agencies specialized e‐crm software) mean the increase of  usage of  information and communication  technologies  in everyday business and contacts  with customers. therefore, we can consider sub‐hypothesis 2 to be accepted.   sub‐hypothesis 3 claims that rent‐a‐car agencies more and more recognize the significance of  customer relationship management system. only 23% of rent‐a‐car agencies included e‐crm as  important part of their business strategy, 11% made separate e‐crm strategy. large number  of rent‐a‐car agencies donʹt use complex software solutions for e‐crm due to high prices of  software and its maintenance, as well as its complexity and inability to use all features to  maximum  in  b&h.  rent‐a‐car  agencies  that  use  e‐crm  system  consider  it  as  extremely  useful assistant in establishment of long‐term relationships with customers, improvement of  quality of communication with customers, as well as support for planning of development  and personalization of services to customers. although there is certain number of rent‐a‐car  agencies that donʹt use e‐crm that doesnʹt mean that they donʹt recognize its significance.  on  the  contrary,  most  of  the  rent‐a‐car  agencies  are  aware  of  the  importance  of  e‐crm  system for improvement of customer relations but they are unable to use it due to lack of  knowledge of information‐communication technologies, limitation in capacities and financial  constraints. the rent‐a‐car agencies partly use e‐crm system in its full, while one part of  agencies  use  segments  of  e‐crm  system  in  basic  shape  (such  as  data  bases  and  online  reservations but through very simple ict structure). the rent‐a‐car agencies thus recognize  the significance the  introduction of this system has for establishment of  long‐term quality  relationships with customers. herewith the sub‐hypothesis 3 can be accepted.        peštek, a., et al., impact of e‐crm, ea (2011, vol. 44, no, 1‐2, 47‐58)     57 sub‐hypothesis  4  claims  that  crm  increases  the  profitability  through  retention  of  old  customers.  according  to  statements  of  rent‐a‐car  agencies  representatives  that  use  e‐crm  system, its usage increases the possibility of maintaining long‐term relations with customers  and  planning  of  services  sales,  as  well  as  approach  to  individual  customer  through  personalization  of  services.  indicators  of  successfulness  of  e‐crm  implementation  are  statistics on increased sales in certain period of time after introduction of e‐crm system and  its active usage. e‐crm contributes to total sales, shortens the longevity of planning of sales  and influences the increase of profitability by enabling the retention of old buyers through  personalization of services based on gathered and archived data on customers. therefore, we  can accept the sub‐hypothesis 4 as justified.   sub‐hypothesis  5  claims  that  crm  leads  to  better  profiling  and  better  segmentation  of  customers. rent‐a‐car agencies that use e‐crm system perceive e‐crm as important segment  in business for the usefulness of collected data and easier way of gathering data via online  reservations.  significance of e‐crm to those rent‐a‐car agencies using it is that by using this  system agencies have information at disposal on what types of vehicles, to what period, in  what terms and additional services individual customers rent. on the basis of that, rent‐a‐car  agencies define segments of customers  to which  they approach with special services and  offers, personalized services based on the customer profile identified by e‐crm system. the  sub‐hypothesis 5 is then accepted.   having all five sub‐hypothesis tested and accepted,  it can be concluded that the main  hypothesis has been justified. therefore, we have proved that the use of crm in rent‐a‐car  agencies that have recognized the significance of information‐communication technologies  leads to increase of their business results in long term.  conclusions  forecasting  and  understanding  customer’s  characteristics,  needs  and  demands  for  personalized  services  by  using  e‐crm  system  can  contribute  to  business  promotion  and  ultimately  ‐  increase  of  profitability.  e‐crm  system  is  a  tool  for  assisting  the  everyday  business.  it  gathers  all  information  needed  about  customers,  archives  and  when  needed  organize  them  in  logical  sets  of  data  necessary  for  management  in  specific  moment  for  planning new packages of services based on customerʹs characteristics.   rent‐a‐car  agencies  working  under  licence/franchise  are  already  using  developed  software solutions for e‐crm system. this brings them improved long‐term communication  with customers. through retaining old customers by personalized approach assisted by e‐ crm, these rent‐a‐car agencies  improve their sales and  in the end  line the profitability of  their business. although software solutions for e‐crm are expensive, their usage is justified  with the fact that it can be considered as investment in long‐term relationship with clients,  retention of customers and increase of profitability in long term perspective. therefore, rent‐ a‐car agencies that have a long term perspective and want to survive at market should adjust  to new trends  in customer relationship management and  increase the use of  information‐ communication technologies in order to maintain the quality customer relations.   this  paper  provided  just  an  insight  into  significance  of  customer  relationship  management in rent‐a‐car agencies. further research within this field should lead towards     economic analysis (2011, vol. 44, no. 1‐2, 47‐58)   58 understanding  the development processes of e‐crm systems  in rent‐a‐car agencies  (from  decision for introducing e‐crm, establishment of system, to use or „return on investment“  from  using  this  system).  additional  research  should  be  conducted  with  regards  to  customer’s point of view and customer satisfaction.   this research was focusing exclusively on rent‐a‐car agencies as part of tourism industry.  recommendations for future research are to explore use of e‐crm in other parts of tourism  industry (tourist agencies, hotel industry, leisure, airline industry etc.) by using the similar  approach and methodology from this research.  references  ademović, minela. 2010. “istraživanje tržišta rent‐a‐car usluga”. unpublished  ahmad,  iftikhar,  and  chowdhury,  ataur  rahman.  2008.  “electronic  customer  relationship  management (ecrm) – customersʹ perception of value from ecrm features on airline e‐ticketing  websites.” ma thesis. lulea university of technology  botha, johan. 2004. e‐commerce. juta and company ltd  buhalis, dimitrios. 2003. etourism: information technology for strategic tourism management. prentice hall  buhalis,  dimitrios,  and  oʹconnor,  peter.  2005.  “information  communication  technology  revolutionizing tourism.” tourism recreation research, 30 (3), 7‐16.   buttle, francis. 2009. customer relationship management: concepts and technologies.  elsevier ltd.  chaffey,  dave,  and  smith,  p.r.  2008.  emarketing  excellence:  planning  and  optimizing  your  digital  marketing. butterworth‐heinemann  chandra, satish, and strickland, ted j. 2004. “technological differences between crm and ecrm”.  issues in information systems, 5 (2)  de pelsemacker, patrick, geuens, maggie, and van den bergh, joeri. 2005. foundations of marketing  communications: a european perspective. pearson education  jelassi, tawfik, and enders, albrecht. 2008. strategies for e‐business: creating value through electronic and  mobile commerce. prentice‐hall  kincaid, judith w. 2003. customer relationship management: getting it right!. prentice hall  kozak, metin, and andreu, luisa (ed.). 2006. progress in tourism marketing. elsevier   lee‐kelley, liz, gilbert, david, and mannicom, robert. 2003. “how e‐crm can enhance customer  loyalty.” marketing intelligence and planning, 21 (4), 239‐248.  pan,  shan  l.,  and  lee,  jae‐nam.  2003.  “using  e‐crm  for  a  unified  view  of  the  customer.”  communications of the acm, 46 (4), 95 – 99.  pease, wayne r., rowe, michelle, and cooper, malcolm (ed.). 2007.  information and communication  technologies in support of the tourism industry. idea group publishing  peštek, almir. 2009. “e‐marketing strategije u  industriji turzima u bosni  i hercegovini.” phd diss.  ekonomski fakultet u sarajevu   robson,  colin.  2002. real  world  research:  a  resource  for  social  scientists  and  practitioner  –  researchers.  blackwell publishing   zikmund,  william  g.,  mcleod,  raymond  jr.,  and  gilbert,  faye  w.  2003.  customer  relationship  management: integrating marketing strategy and information technology. john wiley & sons      article history:  received:  4 january 2011 accepted:  9 march 2011      microsoft word 2010_1_2.doc scientific rieview future stance of currencies in the international monetary system kotlebova jana*, economic university in bratislava, faculty of national economy, department of banking and international finance, slovak republic udc: 348.246; 339.743 jel: f31; g15 abstarct – the current global crisis is a manifestation of global imbalance. higher creation of savings in emerging economies compared to developed countries; higher investments of developed economies in comparison with developing countries; the current account deficit of the balance of payments in developed countries as opposed to the current account surplus of the balance of payments in emerging economies create new conditions for future stance of currencies in the international monetary system. the future aspect of the international monetary system is, at present, a major topic of discussion for monetary authorities as well as supranational institutions. the intention of this contribution is to highlight the main trends in its development key words: global imbalance, savings, investment, foreign exchange reserves, balance of payment, importance of currencies for the international market, international monetary system introduction we are in the fourth year of existence of the current global crisis, whereby the claim that it is in its final stage, is delivered with great prudence. according to the world economic outlook of the international monetary fund in october 2009 “after contracting by about 1 % in 2009, global activity is forecast to expand by about 3 percent in 2010, which is well below the rates achieved before the crisis”. global imbalance the global economy has been transformed from the so-called bipolar world, where countries were explicitly divided into rich and poor, and global economic growth was determined by developments in the usa and europe, into a world that can be described as multipolar, in which emerging and developing economies have been assigned a significant role from a global perspective. menbere tiruneh workie (2007, 29) since 2004 the global economy has vaulted to the current account surplus of the balance of payments thanks to developing countries. developed economies demonstrate a current account deficit of the balance of payments. the graph outlines the imf forecasts, which indicate the time at which the current account of the balance of payments in the aftermath of * tel.: 00421 905 225 931, e-mail: jana.kotlebova@euba.sk economic analysis (2010, vol. 43, no. 1-2, 61-69) 62 the global financial crisis should gradually decrease in the advanced economies, whereas further export growth is expected in emerging and developing economies. graph 1. development of the current account of balance of payments in major country groups ( % of gdp) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -2 -1 0 1 2 3 4 5 6 % o f g d p em erging and developing econom ies advanced economies source: author’s own processing, data from www.imf.org (2009 and 2010 – forecast of imf) if we compare savings and investment in the major country groups of the world, we can notice, that investments in advanced economies are not covered by the creation of savings; on the contrary, in the case of emerging economies and developing economies savings exceed investments. the basic breakdown of countries into two groups can thus indicate the fact that investments in more developed parts of the world are created because of the savings of less developed parts of the world. if we look at the global data, we can notice that investments and savings stand almost on the same level, which could testify to the maintenance of global equilibrium; however, a detailed analysis of these data, according to other subgroups, can lead to interesting facts. the unambiguous conclusion of the analysis of the relationship between savings and investment is that the driving force of the current global economy is the savings in the developing world and the newly industrialized asian economies. this tendency should be supported in the future by the fact that in these countries there is a strong population kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 63 growth, which creates space for the future growth of consumption and demand, which creates the prerequisites for their further economic growth. graph 2. the development of savings and investments in developed and emerging economies as % of gdp 15 20 25 30 35 40 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 % o f g d p advanced econom ies investment advanced econom ies gross national savings emerging and developing economies inves tm ent emerging and developing economis gross national savings source: author’s own processing, data from www.imf.org (2009 and 2010 – forecast of imf) foreign exchange reserves since 2005, it has been possible to monitor the higher creation of foreign exchange reserves in emerging and developing economies rather than in developed economies. the largest foreign exchange reserves (data to june 2008) are held by china (1.7 billion usd), japan (0.97 billion u.s. dollars), russia (0.55 billion usd). economic analysis (2010, vol. 43, no. 1-2, 61-69) 64 graph 3. development of foreign exchange reserves in the world since 1995 to present 0 1000000 2000000 3000000 4000000 5000000 6000000 7000000 8000000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 in m ill io n s o f u s d advanced economies emerging and developing economies total foreign exchange holdings source: author’s own processing, data from www.imf.org foreign exchange reserves are used to cover imports, foreign exchange interventions and balancing the movements in the capital and financial accounts of the balance of payments. as a result of more frequent financial crises in emerging economies, these incentives have been completed in order to protect the economy from the threat of loss of international liquidity (mainly due to a sudden outflow of capital). the main source of foreign exchange reserves in these countries is the net income from international trade and capital movements. graph 4. structure of global foreign exchange reserves from 2000 to present 0 10 20 30 40 50 60 2000 2001 2002 2003 2004 2005 2006 2007 2008 % usd gbp jpy chf eur other source: author’s own processing, data from www.imf.org kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 65 after the launch of emu, there has been a visible increase of the eur in the foreign exchange portfolio and a drop in dollars. however, the u.s. dollar still continues to hold a strong position in the currency structure of the foreign exchange portfolio (about 65%). importance of currencies for the international market when talking about international currencies, we are interested in the extent to which a certain currency is used outside the domestic economy (the place of its issuance). some authors, for example, e. g. lim, refer to it as a currency that is used ʺoutside the domestic economy by non-residents for transactions with residents of the domestic economy or with residents of third countriesʺ e. g. lim (2006). another approach attributes an international attribute to the currency based on its scope of usage as a currency of debt denomination issued by non-residents on the capital market. the european central bank assesses the international role of a particular currency based on the extent to which this currency is used as denomination for various financial assets and liabilities outside the area of its issuance, as a nominal anchor, reserve and intervention currency for central banks in certain third countries and as a parallel currency used by private agents in some geographically adjacent economies. at the same time, it assesses its importance as a currency (vehicle currency) in some segments of the global foreign exchange market. therefore, it assesses two major aspects: a) the importance of the currency for the international bond market, foreign exchange market and the international market for goods and services, b) the importance of the currency for third countries. the largest issuers in the international bond market are the globally operating financial institutions and corporations. as foreign currency denomination, they mainly use usd, eur or gbp. the international debt securities in usd are issued by european banks and corporations, whereas these securities in eur are issued by investment banks and corporations from the united states, great britain and some european countries outside the euro area. the importance of the international bond market in total activities of the international global capital market has fallen due to the development of further financial markets that are open to foreign investors. therefore, the international bond market is becoming a less significant indicator of a currency of international importance. central banks in emerging economies and sovereign wealth funds have become large global investors, and have become increasingly active in the issuance of government bonds, corporate bonds and shares in third countries. the stock market has gained a considerable market share and therefore, it dictates the denomination of its own assets, and the international role of currencies. for example, ch. thimann (2009, 10) in his study argues that: a) the international bond market is excessively denominated in usd and eur, and accounts for about 80% of the market, while on the dollar market segment eur emissions account for 60%, on the eur market the emissions from the usa and non-euro area countries account for 70% of emissions, economic analysis (2010, vol. 43, no. 1-2, 61-69) 66 b) the international bond market is relatively narrowly structured, financial institutions constitute 80% of the market, businesses, governments or international institutions account for the rest 20%, c) the choice of currency has been significantly influenced by entrepreneurial motives (control of balance, project financing, taxes) and by short-term cyclical factors (exchange rate predictions and interest rate differential). the international bond market, from the perspective of the narrow supply of debt instruments, does not have such a significant impact on the evaluation of the currency position as on the international currency. in a broader definition of supply of debt instruments, however, its impact on the role of currency in an international context is more significant, according to the imf data; up to 11.2 trillion usd bonds are held abroad out of the total volume of bonds (18.4 trillion u.s. dollars), whereas in the narrow definition, it is only 7.8 trillion usd. in comparison, foreign holdings of shares account for 8.8 trillion usd. graph 5. issuance of bonds with variable rates of interest by currency denominations 0 1000000 2000000 3000000 4000000 5000000 6000000 7000000 8000000 9000000 d ec .2 00 0 d ec .2 00 1 d ec .2 00 2 d ec .2 00 3 d ec .2 00 4 d ec .2 00 5 d ec .2 00 6 d ec .2 00 7 d ec .2 00 8 s ep .2 00 9 b il. u s d us dollar euro yen pound sterling sw iss f ranc canadian dollar other currencies floating rate total source: author’s own processing, data from www.bis.org kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 67 graph 6. issuance of bonds with fixed rates of interest by currency denominations 0 2000000 4000000 6000000 8000000 10000000 12000000 14000000 16000000 18000000 d ec .2 00 0 d ec .2 00 1 d ec .2 00 2 d ec .2 00 3 d ec .2 00 4 d ec .2 00 5 d ec .2 00 6 d ec .2 00 7 d ec .2 00 8 s ep .2 00 9 bi l. u s d us dollar euro yen pound sterling swiss franc canadian dollar other currencies straight fixed rate total source: author’s own processing, data from www.bis.org the previous graphs can be used to monitor that the euro is used as a currency denomination of bonds to a much greater extent than the usd. this tendency in the world started to create the euro in 2002 (commercial papers and bonds with floating interest rates), in the case of other debt securities, two years later, in 2004. the biggest difference with the preference of the euro as denomination against the usd has been recorded in bonds with variable interest rate. a few years ago, there were concerns about a tripolar monetary system in which three currencies were to play a key role usd, eur and the japanese yen. the current approach to the usage of currencies in the bond, foreign exchange and commodity markets in the world, however, suggests an entirely different trend. graph 7. development of the main pair usd/eur 0,8 0,9 1 1,1 1,2 1,3 1,4 1,5 1,6 1,7 i/ 99 v /9 9 ix /9 9 i/ 00 v /0 0 ix /0 0 i/ 01 v /0 1 ix /0 1 i/ 02 v /0 2 ix /0 2 i/ 03 v /0 3 ix /0 3 i/ 04 v /0 4 ix /0 4 i/ 05 v /0 5 ix /0 5 i/ 06 v /0 6 ix /0 6 i/ 07 v /0 7 ix /0 7 i/ 08 v /0 8 ix /0 8 i/ 09 v /0 9 ix /0 9 source: author’s own processing, data from www.ecb.int economic analysis (2010, vol. 43, no. 1-2, 61-69) 68 if we were to comment upon the first question, then, for example, m. d. chinn and j. a. frankel(2008, 4) argue that the usd will lose its position as the main currency due to the fact that the eur is a much more serious rival than the mark or yen used to be in the past, and the usa have already had a chronic current account deficit of the balance of payments for 25 years and 35 years of usd depreciation. it is assumed that this will happen in 2015. conclusion all the previously mentioned factors indicate the fact that the future development of the international monetary system will not continue in its conventional manner, but it will be fully affected by the approach of developed countries to developing world. on the question of the relationship between the usd and the euro there have been several discussions. jean-claude trichet (president of the ecb) has said that the further depreciation of the usd is unacceptable for the euro area since it would mean the artificial overvaluation of the euro, whose exchange rate would not reflect the real economic development of the euro area, which would cause additional risks to maintain its stability in the future. of course, it is necessary to take into account the further progress of economic integration in other regions of the world. for example, the countries of the gulf in 2010 are planning to launch a monetary union with a common currency. at present, the composition of a common currency basket is being analysed. the risk is that these countries are major oil exporters, and they have already joined the trade in this commodity in a currency other than usd, which in the future could mean a further depreciation of usd. similar integration schemes can also be observed in africa and asia, but their implementation is a matter of the distant future. as for the chinese yuan, china is among the economies with the highest foreign exchange reserves, increasing exports and high savings creation. moreover, in the past, they purchased large amounts of bonds denominated in usd, much of which is approaching maturity. moreover, the recovery of the u.s. economy is not realised in such a pace as it was planned by an optimistic scenario. the g20 requested, for example, the european commission to accelerate a further expansion of the euro area countries, which would protect their economies against the excessive volatility of exchange rates due to the financial crisis. the answer by the ec, however, to this proposal was unequivocal; the euro area would not abandon its enlargement strategy based on the fulfilment of the maastricht criteria, since it considers price and financial stability as its main priority. commenting upon the future outlook of the international monetary system there have been several discussions. perhaps, the proposal of france and great britain on the creation of the bretton woods ii system, which would again mean a return to the gold standard, whereas the main currency should be the imfʹs special drawing rights (sdrs). although this proposal is more or less criticized. major opponents argue that the imf membership (185 countries) is very different today than it was at its birth, since emerging and developing countries are more represented than developed ones, while those given the growing debts kotlebova, j., future stance of currencies in the ims, ea (2010, vol. 43, no, 1-2, 61-69) 69 can be a threat to the restoration of international stability. moreover, the triffin paradox, which is well known for the bws i failure, should be remembered. the increase in current account deficits of the balance of payments associated with the growth of public debt does not guarantee the basis for the international monetary system, which must meet the stability and other features such as liquidity and symmetry in international monetary relations. in regard to foreign trade in goods and services, the dominant currency denomination of transactions is still the american dollar, but here we can see a downward trend. changes in the exchange rate alternate the value of mutual obligations and claims of the parties entering into business. the future international monetary system has to meet three basic functions liquidity, symmetry and stability in the international monetary relations, which requires a unique management style. it is necessary to revisit the basic principles of the functioning of market mechanism in conditions of a globalizing economy, since the latest trends such as liberalization, both economic and financial integration point to the fact that the market is not always able to regulate shocks, to which the global economy is exposed. references aizenman, j., chin, m. d. and ito, h. 2008. “assessing the emerging global financial architecture: measuring the trilemma’s configurations over time.” nber working paper 14533, cambridge december 2008 chinn, m. d. and frankel, j. a. “the euro may over the next 15 years surpass the dollar as leading international currency.” nber working paper 13909 . cambridge april 2008, p. 4 kotlebová, j. and chovancová, b. “medzinárodné finančné centrá (zmeny v globálnej finančnej architektúre).“ bratislava: iura edition 2010 lim, e. g. “the euro’s challenge to the dollar: different views from economists and evidence form cofer (currency composition of foreign exchange reserves) and other data.” imf working paper no 06/153, washington: imf, june 2006 obstfeld, m., shambaugh, j. c. and taylor, a. m. “financial stability, the trilemma, and international reserves.” nber working paper 14217. august 2008 thimann, ch. “global roles of currencies.” ecb working paper no 1031, frankfurt: ecb, march 2009, p. 10 woodford, m. “globalization and monetary control.” nber working paper 13329, cambridge workie, m. t. “dynamika svetovej ekonomiky v roku 2006 a perspektívy na roky 2007 a 2008: globálny pohľad.“ in: vývoj a perspektívy svetovej ekonomiky – prínos informačných technológií a hrozby klimatických zmien. workie, m. t. bratislava: eú sav 2007, isbn 978-80-7144-159-5, p. 29 received: 6 january 2010 article history: accepted: 19 march 2010 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp72-83 original scienfitic paper econometric modeling and forecasting of interest rates in montenegro bojan pejović1* | vesna karadžić1 1 the university of montenegro, faculty of economics, podgorica, montenegro abstract the econometric modelling and forecasting have a growing importance in both the development of modern models and theoretical approaches and as bases for proper policy decision making. this paper investigates the possibility of applying the box-jenkins approach and vector autoregressive models in modelling and forecasting interest rates in montenegro. the motivation for this research lies in the fact that the interest rate level is one of the key determinants of the montenegrin economic development dynamic due to the specific characteristics of its financial market. the empirical analysis is done on the monthly values data of weighted average lending interest rate of banks on new loans in the period from december 2011 to january 2018. our research has proven that the box-jenkins approach and var models can be successfully used for modelling and forecasting the interest rate level in the montenegrin, quite a bank-centric, system. moreover, the results recommend the use of the box-jenkins approach and the estimated ar model for forecasting interest rate since it has better performances than the var model. the estimated ar model may find its application in helping the decision-makers to create better economic policy decisions. despite some limitations, regarding specifics of montenegrin economy and statistical base, to a certain degree our results are in accordance with research done for other countries. key words: forecasting, autoregressive models, interest rate forecasting, box‐jenkins, var, ar jel classification: c32, c51, c52, e43 introduction the topic of interest rates has been in the focus of the public attention over a long period, and as a consequence of the strong influence of interest rates on economic developments. the interest rate levels and its change significantly determine the companies’ decisions to invest, the decisions of individuals on savings and consumption, as well as the decisions of the authorities regarding monetary and economic policy. numerous scientific and professional papers deal with interest rate issues, due to their wide range of influence and importance in the economy. papers are often concerned with interest rates modeling and forecasting, as well as exploring the links, relationships and interdependencies of interest rates and many other macroeconomic indicators. the pronounced specifics of the montenegrin economy and its underdeveloped financial market make the level of interest rates one of the key determinants of economic development. in the complex structure of interest rates in montenegro, the average weighted active nominal * corresponding author, e-mail: bojanpejovic@hotmail.com bojan pejović, vesna karadžić 73 interest rate of banks on newly approved loans is especially highlighted, as a key determinant of the economy dynamism. many factors that operated in the past as well as numerous factors that still have impact have led to the formation of banks’ high-interest rates in montenegro. a very small market characterized by high operating costs, with insufficiently strong competitive forces between a large number of banks in the market, as well as a high share of bad loans, high customer risk with high existing indebtedness, and high country risk caused by fiscal imbalances have led to high active interest rates over a long period of time. the very high-interest rates on the part of banks and micro-credit institutions do not allow for the economic growth dynamization and development to the extent necessary to ensure the recovery of the economy after the 2008 economic crisis. due to the limited instruments of the central bank of montenegro and the absence of an emission function due to the introduction of euroization in montenegro, the level of interest rates is a critical factor on which further movement the overall economic dynamics will depend. to address the above-mentioned questions, the paper focuses on econometric modeling and forecasting the active interest rate on newly approved loans in montenegro. two theoretical approaches will be tested and two types of models, namely the autoregressive moving averages model and the vector autoregressive model will be evaluated using empirical data available from the central bank of montenegro for the 2011 to 2018 period. therefore, three research hypotheses are formulated, i.e. h1: box-jenkins approach provides a statistically significant interest rate forecast in montenegro. h2: var model provides a statistically significant interest rate forecast in montenegro. h3: box-jenkins approach gives better prognostic results compared to var model in case of interest rate in montenegro. the purpose of the research is to estimate and compare the models that can be used to model and forecast the interest rates aiming to determine a better model, the model that is best fit for the given case. the approaches used in this paper have been used by numerous other researchers and they usually produce the best results. forecasts of future interest rate values based on a model that proves to be the best have practical application through influencing decision-makers and increasing the quality of their decisions leading to the desired results. successful forecasting of future interest rate values helps better the perception of the reality in order to take preventative action on time, to anticipate future changes and adapt behavior to new circumstances. forecasting allows one to spot an undesirable trend on time so that it can act to eliminate it and achieve the desired results. the paper is structured as follows: a literature review is presented in the next section. the third section describes the methodology used for time series modeling and forecasting of interest rates. data analysis and empirical results are presented in the fourth section. prediction and evaluation of the model's prognostic performance are given in the fifth part. finally, conclusions and proposal for further research are presented in the last section of the paper. literature review numerous scientific studies have been carried out aiming to predict the future value of macroeconomic variables such as gdp, inflation, interest rate, etc. interest rate forecasting is a challenging topic, and many researchers are, therefore, concerned with it. there are certain differences in the subject matter of the research, which vary due to the specific nature of the national economy, the availability of data and the affinity of researchers. ahmed, vveinhardt, nawaz, and streimikiene (2017) have used the 6-month kibor rate for the four years from 2012 to 2015 to estimate an adequate arima model that can be used for 74 economic analysis (2020, vol. 53, no. 1, 72-83) forecasting. they confirmed the assertion that the arima model can be successfully used to forecast the kibor rate and that it is of great importance for decision-makers. alnaa and ahiakpor (2011) estimated the arima (6,1,6) model using monthly inflation data and the box jenkins methodology. based on the indicator and the calculated rmse, the effectiveness of the inflation forecasting model was confirmed. by creating an adequate var model, cologni and manera (2008) successfully introduced the relationship between oil prices, inflation, and interest rates and provided a useful tool for monetary policymakers. the researchers evaluated the var model for the possible impact of changes in oil prices on macroeconomic variables, monetary policy, and the economic system. different results have been achieved in different countries due to the countries' specificities. dua (2008) has shown that different models (arima-garch, lvar, bvar, vecm) should be used to predict interest rates in india depending on the type of interest rate and the forecast horizon. research has shown that the multivariate model outperforms univariate models when it comes to longer-term forecasts. the arima and var models were used to forecast inflation measured by the harmonized index of consumer prices (hicp) in austria. fritzer, moser, and scharler (2002) concluded that over a longer time horizon, the var model would provide a more accurate hicp forecast than the arima model, and its use is recommended in further studies. in the case of the inflation forecast, according to hoa (2017), the forecasting performance of the model depends on the time horizon in which the forecasting is made. it is confirmed that with monthly data the var_m2 model gives a better forecast, while for the quarterly data the ar (6) model provides a better inflation forecast. to obtain an optimal model for short-term interest rates forecasting, radha and thenmozhi (2006) compared the forecasting performance of three models: arima, arima-garch, and arima-egarch. depending on the type of interest rate, different models have different performances. for commercial papers, the arima-egarch model is the best, while for implicit yield 91 day treasury bill, overnight mibor rate and call money rates the arima-garch model gives the best forecasts. razak, khamis, and abdullah (2017) predict future gdp growth using the var and arima models. out-of-sample model forecast values are compared and the mean absolute percentage error (mape) results confirm that the var model is superior to the arima model in this case. according to zhang and rudholm (2013) in sweden, the ar (1) model gives the best gdp per capita forecast over the arima and var models, while the var model gives the worst forecast. methodology the two types of time series models, the univariate (arima) and multivariate (var), are utilized in this paper for the purpose of interest rate forecasting and models performance comparison. time series models known as arima models can be very successfully specified by implementing box-jenkins methodology (box & jenkins, 1976), a particularly significant specification methodology. box-jenkins methodology is a very popular and frequently used in academic research (ahmed et al., 2017; etuk, 2013, yuan, liu & fang, 2016; iqbal & naveed, 2016; seneviratna, & shuhua, 2013; moffat & david, 2016; okafor & shaibu, 2013; radha & thenmozhi, 2006; xue & hua, 2016; yuan, liu & fang, 2016). according to dimitrios (dimitrios, 2006) the name arima is derived from: ar = autoregressive, i = integrated, ma = moving averages. a univariate autoregressive model of moving averages (with or without the required series differentiation) in the general notation can be specified as: bojan pejović, vesna karadžić 75 if in the process of model specification series were differentiated in order to obtain the required stationarity, we are talking about integrated autoregressive models of moving averages, i.e. arima (p, d, q), where d represents the order of model integration. time series models that include more than one series are multivariate (multidimensional) models. in these models, the behavior of the dependent variable is explained by the action of several observed series, unlike univariate (one-dimensional) models where the behavior of the dependent variable is explained by the influence of the previous values of one series. the vector autoregressive (var) model is the most represented and commonly used model in the class of multivariate models. the attraction of the var approach, as proposed by sims (1980), is mainly that there is no reliance on the restrictions of economic theory to indicate which variables occur in each equation. in var, every variable in the system is assumed to be endogenous. this contrasts to the standard theory-based method in which causal relationships between the variables is implied. so, when we are not sure that a variable is truly exogenous, each must be treated symmetrically. take for example the time series affected by present and past values of x and, at the same time, the time series affected by present and past values of y. in this case, we will have a simple multivariate model: where both yt and xt are assumed to be stationary and uyt and uxt are uncorrelated white noise errors. the var model has been used extensively for forecasting and has achieved excellent results in scientific research (carriero, kapetanios & marcellino, 2009; gerdesmeier, roffia & reimers, 2017; sarantis & stewart, 1995; salazar & weale, 1999). the data are obtained from the central bank of montenegro. the data are of the time-series form, i.e. the monthly data from december 2011 to january 2018. the method of analysis in this paper is the ordinary least square (ols) which is used to estimate structural parameters of the model in such a way, so as to minimize the sum of the deviations of the actual observation from their model estimated values. it is one of the most commonly used methods in estimating econometric models and it produces the best, linear, unbaised estimates (blue) (koutsoyiannis, 1997). empirical work based on time series assumes that the underlying time series is stationary. the stationarity is an essential property in defining a time series process. a stationary time series is the one whose parameters, such as mean, variance, autocorrelation, etc. are all constant over time. hence, according to standard econometric procedure it is necessary to firstly check the data for possible non-stationarity. this need arises from the fact that if a time series data is non-stationary, the regression performed on variables with unit root would be “spurious” (granger and newbold, 1974) or “dubious” (phillips, 1987). stationarity can be tested by using several tests. in this paper the augmented dickey fuller (adf) test is implemented. secondly, it should be tested whether the identified non-stationary series are co-integrated. the variables are said to be co-integrated if they satisfy the condition that there exist at least (k1) cointegrating equations i.e. stationary linear combinations of individually non-stationary variables (maddala and kim, 1998). several diagnostic tests have to be done in order to check for the specification of the model, as well as for the possible problems of heteroscedasticity, autocorrelation, multicolinearity and residual normality. for that purpose jarque-bera (jb) test, breusch-godfrey test, var residual serial correlation lm test, breusch-pagan-godfrey test, var residual heteroscedasticity tests, empirical distribution test and var residual normality tests are employed. 76 economic analysis (2020, vol. 53, no. 1, 72-83) analysis and results this part of the paper presents the results of the empirical research that focuses analysing and modeling the empirical data on interest rates in montenegro. the interest rate dynamics is monitored from the 12th month (december) of 2011 (the first available data on interest rate (ir) published by the cbm) to the 1st month (january) of 2018 (the last available data). the banks’ average weighted active nominal interest rate on newly approved operations is recorded on an annual basis. the monthly consumer price growth rate (cpi) from december 2011 to january 2018 is also monitored, as the second time series. the descriptive statistics for the twotime series analyzed are presented in table 1. table 1. descripotive statistics source: own elaboration. according to jarque-bera value the analyzed ir and cpi time series are normally distributed. in table 2 the ordinary and partial autocorrelation function of the interest rate time series are presented. the autocorrelation coefficient declines slowly from 0.893 on the first lag to 0.186 on the 20th lag when it is not statistically significant. the standard error of the autocorrelation coefficient is calculated as =0.1162. based on the z critical values, the 95% confidence interval for the autocorrelation coefficient is . table 2. correlogram of interest rate lags(k) ac pac q‐stat prob 1 0.893 0.893 61.464 0.000 2 0.841 0.214 116.72 0.000 3 0.819 0.195 169.89 0.000 4 0.799 0.105 221.23 0.000 5 0.775 0.04 270.17 0.000 6 0.761 0.078 318.08 0.000 7 0.72 -0.105 361.62 0.000 8 0.702 0.054 403.6 0.000 9 0.65 -0.185 440.16 0.000 10 0.603 -0.091 472.08 0.000 11 0.563 -0.069 500.35 0.000 12 0.548 0.077 527.63 0.000 13 0.499 -0.112 550.62 0.000 series ir cpi sample 2011m12 2018m01 2011m12 2018m01 observations 74 74 mean 7.914 0.135 median 8.210 0.100 maximum 10.190 1.100 minimum 5.270 -0.800 std. dev. 1.380 0.407 skewness -0.212 0.279 kurtosis 1.707 3.178 jarque-bera 5.706 1.060 probability 0.057 0.588 bojan pejović, vesna karadžić 77 lags(k) ac pac q‐stat prob 14 0.433 -0.192 568.21 0.000 15 0.403 0.088 583.7 0.000 16 0.38 0.027 597.68 0.000 17 0.327 -0.077 608.24 0.000 18 0.283 -0.057 616.26 0.000 19 0.231 -0.066 621.72 0.000 20 0.186 -0.05 625.31 0.000 source: own elaboration. the results of augmented dickey-fuller (adf) unit root test are presented in table 3. based on the calculated probabilities, the null hypothesis is rejected for both time series at a 5% significance level. therefore, it is concluded that none of the two time series have a unit root and, hence, they both are stationary. table 3. unit root test series unit root test t‐statistic adf test statistic prob. ir augmented dickey-fuller -3.473 -6.284 0.000 cpi augmented dickey-fuller -2.901 -6.393 0.000 source: own elaboration. after examining and confirming the normality and stationarity of the interest rate series several different models were estimated using the box-jenkins methodology. based on statistical and econometric criteria, which will be shown below, it is concluded that the ar (1) model is superior to the other estimated ones. the chosen estimated model is shown in table 4. table 4. ar (1) model dependent variable: interest rate method: least squares sample (adjusted): 2012m01 2018m01 included observations: 73 after adjustments variable coefficient std. error t-statistic prob. c 10.2292 0.2068 49.4735 0.0000 @trend -0.0610 0.0048 -12.7987 0.0000 @month=12 -0.6417 0.1613 -3.9785 0.0002 ar(1) 0.4823 0.1021 4.7244 0.0000 r-squared 0.9030 akaike info criterion 1.2566 adjusted r-squared 0.8988 schwarz criterion 1.3822 s.e. of regression 0.4417 hannan-quinn criterion 1.3067 f-statistic 214.1232 durbin-watson stat 2.1871 prob(f-statistic) 0 inverted ar roots 0.48 source: own elaboration. in the specified model, the dependent variable ir (average weighted interest rate on newly approved loans) depends on the value of the interest rate in the previous period (ar(1)), the effect of the trend and the impact of the dummy variable (month=12). all independent variables in the model are statistically significant, at a 5% significance level. a coefficient of determination of 0.90 indicates that 90% of the variation of the dependent variable is explained 78 economic analysis (2020, vol. 53, no. 1, 72-83) by the model, so from the standpoint of that criterion the model is good, as confirmed by the fstatistic. values of information criteria: akaike, schwarz, and hannan-quinn are smaller in the model compared to other models evaluated. the estimated ar (1) model will be used as a benchmark in comparison to the corresponding var model. after analyzing a larger number of var models that meet the econometric criteria and are specified and estimated with and without a constant, with a larger and smaller number of lags, the model with the best characteristics is chosen as the final one. the specified model is representative of multivariate time series models and is used to be compared to a previously selected estimated model to represent the class of univariate time series models. table 5. var model dependent variable: interest rate sample (adjusted): 2012m03 2018m01 included observations: 71 after adjustments variable coefficient std. error t-statistic ir(-1) 0.4840 -0.1168 [ 4.14436] ir (-2) 0.2631 -0.1215 [ 2.16606] ir (-3) 0.2454 -0.1146 [ 2.14133] cpim(-1) -0.1319 -0.1560 [-0.84567] cpim(-2) -0.3090 -0.1593 [-1.94057] cpim(-3) 0.2377 -0.1546 [ 1.53713] r-squared 0.8879 akaike info criterion 1.4490 adjusted r-squared 0.8793 schwarz criterion 1.6402 s.e. of regression 0.4796 mean dependent 7.8625 f-statistic 103.0033 s.d. dependent 1.3806 source: own elaboration. based on the estimated model, we can see that the interest rate value at time t depends on the interest rate value from period t-1, t-2 and t-3, as well as the value of the price growth rate from period t-1, t-2 and t-3. the model does not contain a constant. the estimated model largely describes interest rate variations by endogenous variables, so a model determination coefficient of 0.887 indicates that approximately 89% of interest rate variations are explained by the model. the estimated var model meets all the validity conditions of the model. the diagnostic test results shown in table 6 prove that the model is characterized by the absence of autocorrelations, the absence of heteroscedasticity, and normality of the distribution of residuals. forecast results and models evaluation the real and projected interest rates based on the autoregressive ar (1) model are shown in figure 1. model ar (1) will be used in comparison with the specified vector autoregression model (var) to determine a superior model for interest rate forecasting in montenegro. the forecast with a deviation of +/2 standard deviations is presented, that is, an interval forecast of the interest rate for the next six months is given with a probability of 95%. we note that the real value of the interest rate is within the interval, with the exception of the 5th month. bojan pejović, vesna karadžić 79 4.0 4.5 5.0 5.5 6.0 6.5 7.0 m1 m2 m3 m4 m5 m6 m7 m8 m9 m10 m11 m12 m1 m2 m3 m4 m5 m6 m7 2017 2018 ir irtb irbb irf_dy1 figure 1. actual and model ar (1) forecast interest rate for the period 2018m1-2018m7 source: own elaboration the real value of the interest rate for the period 2017m1 to 2018m7 as well as the forecasted value of the interest rate for the period 2018m2-2018m7 with deviations of plus/minus two standard deviations is presented in the figure 2. we note that the real value of the interest rate does not go beyond the 95% confidence interval and is within the limits of plus/minus two standard deviations presented. 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 m1 m2 m3 m4 m5 m6 m7 m8 m9 m10 m11 m12 m1 m2 m3 m4 m5 m6 m7 2017 2018 ir (varscen) ir_bb ir_tb ir figure 2. actual and model var forecast interest rate for the 2018m1-2018m7 period. source: own elaboration. it is demonstrated in the figure 3. that the var model forecast is slightly lower than the ar(1) model forecast, and in this sense, the var model underestimates the interest rate to a greater extent than the ar(1) model does. deviation from this phenomenon occurs only in the fifth month when a sharp decrease in the interest rate to the level of 4 is noted, probably due to some external shock, possible cbm incentive measures or significant changes in the european capital market. a sharp decrease in the interest rate that occurred in the fifth month is not a common occurrence: the sample data indicate that such an occurrence is recorded for the first time in 2018 and requires a more detailed analysis. 80 economic analysis (2020, vol. 53, no. 1, 72-83) 4.6 4.8 5.0 5.2 5.4 5.6 5.8 6.0 6.2 6.4 m1 m2 m3 m4 m5 m6 m7 2018 ir_ar ir ir (varscen) figure 3. real and forecast interest rates based on ar (1) and var models. source: own elaboration an overview of the probabilities for the diagnostic tests: autocorrelation (breusch-godfrey test and var residual serial correlation lm tests), heteroscedasticity (breusch-pagan-godfrey test and var residual heteroscedasticity tests) and residual normality (empirical distribution test and var residual normality tests) for the both evaluated models are given in table 6. the tests are given in the appendix. with a 5% error rate, the null hypothesis is confirmed, so the models are characterized by the absence of autocorrelation, heteroskedasticity, and the normal distribution of residuals. table 6. diagnostic test results (probabilities) model autocorrelation (prob.) heteroscedasticity (prob.) residual normality (prob.) ar(1) 0.0994 0.2881 0.7338 var 0.7191 0.806 0.3646 source: own elaboration. after the statistical and econometric validity of the model is established, a comparison of the model's forecasting performance is investigated. in table 7 the real and forecasted values of interest rate and the most important calculated statistics are given based on which the choice of the optimal model is made. table 7. real values and ar (1) / var model interest rate forecasts with the most important statistics most important statistics february 2018 march 2018 april 2018 may 2018 june 2018 july 2018 interest rate (real) 6.25 6.11 5.88 4.37 5.67 6.01 ar model forecast 5.73 5.66 5.59 5.53 5.47 5.41 var model forecast 5.62 5.45 5.46 5.43 5.39 5.36 e ar(1) 0.52 0.45 0.29 -1.16 0.20 0.60 var 0.63 0.66 0.42 ‐1.06 0.28 0.65 mse ar(1) 0.27 0.24 0.19 0.48 0.39 0.38 var 0.40 0.42 0.34 0.53 0.44 0.44 rmse ar(1) 0.52 0.48 0.43 0.69 0.62 0.62 bojan pejović, vesna karadžić 81 source: own elaboration. based on the calculated statistics, and especially the most commonly used mse (mean squared error) statistics in model comparisons, it can be concluded that a first-order autoregressive model containing a trend and a dummy variable is superior to the estimated vector autoregressive model. the ar(1) model prediction error is higher only for the fifth month, which is caused by external shock and falling interest rate, as discussed previously. the values of all statistics for the first-order ar(1) model are less than the values of the var model statistics, which is consistent with the aim to specify a model with minimal forecast error and the best forecast performances. many other researchers who have researched within their national economies using the same methodology have come to similar results. it has been confirmed that the arima model can be successfully used in forecasting the kibor interbank rate, and recommendations have been made for its use in other countries when forecasting interest rates (ahmed, r.r., et al. 2017). interest rate forecasting in india was addressed by a group of researchers who came to the conclusion that different models (arima-garch, lvar, bvar, vecm) should be used depending on the type of interest rate and the forecast horizon (dua, p. 2008). in order to obtain the optimal model to forecast the short-term interest rate, the forecasting performance of the arima, arima-garch and arima-egarch models was compared (razak, n. a. a., et al., 2017). conclusion the two most frequently used types of time series models, the univariate and multivariate, are investigated in this paper for the purpose of interest rate forecasting and models performance comparison for the case of montenegro. box-jenkins methodology and vector autoregressive model approach have the greatest application and often give the best forecasts, compared even to more complex econometric models. applying the box-jenkins methodology, several univariate autoregressive models are specified, estimated and evaluated. based on the econometric criteria, primarily on information criteria and adjusted coefficients, the best model from the class of autoregressive models is selected, namely ar (1). accordingly, the first research hypothesis stating the box-jenkins approach provides a statistically significant interest rate forecast in montenegro is confirmed. alternative var model as one of the classes of multivariate models is specified. after var model estimation and evaluation, the second research hypothesis claiming the var model provides a statistically significant interest rate forecast in montenegro is proved. hence, it can be concluded that both approaches lead to the estimation of adequate models that can be used in modeling and forecasting interest rates in montenegro. to determine the optimal prognostic model, the forecast performance of previously estimated models, ar (1) in the class of univariate models and var models in the class of multivariate models, are compared. the comparison is done on the bases of actual forecast error, the mean square error, the root mean square error and the mean absolute error. the results of this analysis indicate that for interest rate forecasting in montenegro box-jenkins approach produces better prognostic results in comparison to the var model approach, i.e. the third research hypothesis is true. in this paper only two types of models have been analyzed, and it must be remembered that there could have been different results had other types of models been included in the analysis. the obtained results relate to time series that are short and of questionable quality, regarding var 0.63 0.64 0.58 0.73 0.66 0.66 mae ar(1) 0.52 0.49 0.42 0.61 0.52 0.54 var 0.63 0.65 0.57 0.69 0.61 0.62 82 economic analysis (2020, vol. 53, no. 1, 72-83) the montenegrin economy that is small, open and with specific foreign exchange regime (eurozation). the results could be different if the sample size and data quality is increased, so models need to be tested at different periods. 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(2016). comparison of china's primary energy consumption forecasting by using arima (the autoregressive integrated moving average) model and gm (1, 1) model. energy, 100, 384-390. zhang, h., & rudholm, n. (2013). modeling and forecasting regional gdp in sweden using autoregressive models. dalama university. article history: received: november 19, 2019 accepted: december 12, 2019 ea_2014_1-2 udc: 005.21:334.72.021 ; 336.71(497.7) jel: g21, g34 id: 207708684 professional paper corporate governance and bank performance: evidence from macedonia fidanoski filip1, skopje, republic of macedonia mateska vesna, skopje, republic of macedonia simeonovski kiril, skopje, republic of macedonia abstract – the role of banks is integral and significant to the economic development and private initiative of any country. therefore, we can read different and opposing studies in economic literature about various bank corporate governance regimes and issues. given the renewed attention on the corporate governance in banks with the global financial crises, this paper investigates the relevance of board size, board composition and ceo qualities in the macedonian banks and their performance. thus, the following paragraphs will elaborate on the development of hypotheses to test whether good corporate governance structure can contribute towards higher banks performance measured by return on assets (roa), return on equity (roe), cost-income ratio and capital adequacy ratio (car). we find that board size is only positively related to the bank’s profitability measures by roa. further, the research indicates negative association between board independence and roa and roe. also, the results stress that banks in macedonia which is managed by powerful ceos that hold this position for a longer period are more profitable than those with ceos serving their first four-years tenure. in addition, it is important to highlight that our research findings and insights is different and more important than some other studies, both practical and theoretical, as the primary object of study is commercial banks from insufficiently explored financial system and developing economy. key words: bank performance, board composition, board size, corporate governance, diversity theoretical background there is not company without corporate governance, and there is not corporate governance without company. every company has a corporate governance (steger and amann, 2008, p. 3). corporate governance has a long history. in his book an inquiry into the nature and causes of the wealth of nations, adam smith criticised the corporate form of business because of the separation of ownership and management. karl marx and adam smith did not agree on much, but they both thought that the corporate form of organisation was unworkable, and for remarkably similar reasons (monks and minow, 2003, p. 195). nevertheless, academic interest about corporate governance issues arises after publishing a pathbreaking book about separation of control and ownership in the corporations, wrote by berle and means (1932). they showed that shareholder dispersion creates substantial 1 e-mail: filipfidanoski@gmail.com fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 77 managerial discretion, which can be abused. this was the starting point for the subsequent academic thinking on corporate governance (tirole, 2006, p. 15). however, if management was the focal point for the 20th century, corporate governance is set to be the primary focus for the 21st century (tricker, 2012). the term corporate governance derives from an analogy between the government of cities, nations or states and the governance of corporations (becht, bolton and röell, 2003, p. 2). word governance is ancient, and comes from the greek word for steering (carrol and bucholtz, 2009, p. 123) but the phrase corporate governance is young. in the wave of recent corporate scandals, corporate governance practices have received tremendous attention from all interest group inside and outside from corporations. increased media coverage has turned transparency, managerial accountability, corporate governance failures, weak boards of directors, hostile takeovers, protection of minority shareholders, and investor activism into household phrases (tirole, 2006, p. 15). the governance of the corporation is now as important in the world economy as the government of countries (wolfensohn, 1999, p. 38). fine corporate governance from the banking perspective ensure that banks will operate in a safe and sound manner, and their every-day operations will comply legal norms and regulations while protecting the interests of agents (primary shareholders and depositors). the efforts for establishing good corporate governance arrangement in banks are associated with better performance in banks and national economies. eight principles of governance which support every good system of corporate governance are: transparency, rule of law, participation, responsiveness, equity, efficiency and effectiveness, sustainability and accountability (crowther and aras, 2009, pp. 26-30) good governance is an essential point for establishing the better investment and institutional environment which is fundamental for success of competitive companies and new venture creations. in this way, good corporate governance in banks facilitates the entrepreneurial success and extent the life-cycle of business entities. in particular, the countries that have implemented sound corporate governance practices generally experienced a vigorous growth of corporate sector and grasp more ability in attracting capital to lubricate the economy (sheikh and wang, 2012). mckinsey quarterly surveys suggest that institutional investors will pay as much as 28% more for the shares of well governed companies in emerging markets (thomsen, 2000). many scholars until now examined relationship between corporate governance and company performance from different perspectives2. hence, previous studies in this field were serious basis about proper shaping of this empirical research for macedonian banks. before assessing the role of banks in corporate governance, we must first define what we mean by this term. the cadbury committee define the corporate governance as the system by which companies are directed and controlled (cadbury, 1992, p. 15). yet, while shareholders delegate substantial powers to management, they need assurance that power will not be abused. how do shareholders know that the assets they own are not being mismanaged, or even embezzled? (monks and minow, 2004, p. 196). one of the most exploited definition 2 see shleifer and vishny (1997), gompers, ishii and metrick (2003), drobetz, schillhofer and zimmerman (2004), finegold, benson and hecht, (2007), lin and lee (2008) bebchuk, cohen and ferrel (2009) and bauer, eichholtz and kok (2010) for deeply and better understanding of the corporate governance issues and various firm performance ratios. economic analysis (2014, vol. 47, no. 1-2, 76-99) 78 about corporate governance written by shleifer and visny, give the answer on question about shareholders security. they define corporate governance in terms of financial interests of investors. in particular, they refer to corporate governance as dealing in which suppliers of finance to corporations assure themselves of getting a return on their investment (shleifer and visny, 1997, p. 737). board members who rock the boat might find they are left out in the cold (carrol and bucholtz, 2009, p. 128). from business ethics perspectives, corporate governance can be considered as an environment of trust, ethics, moral values and confidence as a synergic effort of all the constituents of society (crowther and aras, 2009). our integral and eclectic definition considers the corporate governance as a system which ensures that a company is run in the best (bona fide) strategic direction for all stakeholders. financial markets essentially involve the allocation of resources. they can be thought as the brain of the entire economic system, the central locus of decision-making: if they fail, not only will the sector's profits be lower than they would otherwise have been, but the performance of the entire economic system may be impaired (stiglitz, jaramillo-vallejo and park, 1993, p. 23). therefore, the important of banks as dominant players in financial games is critical for other economic agents. the banking sector is not necessarily totally corporate. banking as a sector has been unique and the interests of other stakeholders appear more important to it than in the case of non-banking and non-finance organisations. in the case of traditional manufacturing corporations, the issue has been that of safeguarding and maximising the shareholder’s value. in the case of banking, the risk involved for depositors and the possibility of contagion assumes greater importance than that of consumers of manufactured products. banks due atypical contractual relationship, in their corporate governance model should include the depositors and shareholders (macey and o’hara, 2003). further, the involvement of government is extremely higher in banks due to importance of stability of financial and economic system as well as because enlarged interest of all economic agents. stability of banks as a dominant figure in whole financial systems contribute for good functioning of national economy and promotes economic growth (hermes, 1994; levine, 1997; rajan and zingales, 1998; wurgler, 2000). good corporate governance plays a vital role in underpinning the integrity and efficiency of financial markets (ghillyer, 2012, p. 88). the basel committee on banking supervision (bcbs) placed emphasis on establishing and improving the corporate governance of financial entities, as well as compliance with supervisory standards. according to bcbs (2006), corporate governance for banking organisations is arguably of greater importance than for other companies, given the crucial financial intermediation role of banks in an economy. globalisation and the increased demand for better corporate governance are two major trends affecting banking; and the two trends are inexorably intertwined. good corporate governance depends on the board of directors and top management setting the proper culture and tone for the organisation (gup, 2007). board of directors is elected by the shareholders as the ultimate decision-making body of the banking organisation which has the responsibility of formulating adequate, effective bank policies and strategies. a higher cost of capital will hamper and hurt economic development. the governance of banking companies may be different from that of unregulated, nonfinancial companies for several reasons. for one, the number of parties with a stake in an institution’s activity complicates the governance of financial institutions. in addition, investors, depositors and regulators fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 79 have a direct interest in bank performance. on a more aggregate level, regulators are concerned with the effect governance has on the performance of financial institutions because the health of the overall economy depends upon their performance (adams and mehran, 2003, p. 124). the corporate governance of banks in developing economies is important for several reasons. first, financial system in developing economy, generally, has dominant banking characteristics from that reason that financial sector is too bank-centric. second, as financial markets are usually underdeveloped, banks in developing economies are typically the most important source of finance for the majority of companies. third, as well as providing a generally accepted means of payment, banks in developing countries are usually the main depository for the economy’s savings. fourth, many developing economies have recently liberalised their banking systems through privatisation/disinvestments, mergers and acquisitions, financial liberalisition, reducing the role of economic regulation and reducing foreign capital restrictions. consequently, managers of banks in these economies have obtained greater freedom in how they run their banks (arun and turner, 2004). finally, the best confirm for importance of corporate governance for banks in developing countries, especially in eastern europe, is a statement of managing director of croatian banking association zoran bohacek who says that, is not a question of whether we need corporate governance, but how to do it and survive. legal framework corporate governance of macedonian banks is a crucial item which is worth considering with great importance by the economists nowadays, as the banks are firm foundation of the economy of a country. this notation emphasises the importance of good corporate governance which can be achieved with a stable law regulating this subject i.e. in a stable institutional and legal environment which guarantee investor protection lege artis. historically, the basics of the corporate governance of the banks in the republic of macedonia were integral part of the law of banks and savings-banks (official gazette of the republic of macedonia, no. 31/93, 78/93, 17/96, 29/96, 30/97, 17/98, 37/98, 25/00). this law does not clearly define the responsibilities of the managing board and executive committee which encouraged confusion and institutional instability. taking into account the flaws of the above mentioned law, the law of banks was established in the 2000 (official gazette of the republic of macedonia, no. 63/00, 37/02, 41/02, 32/03, 51/03, 85/03). article 54 of this law, states that the governing bodies of a bank are the following: shareholders assembly, managing board, executive committee, risk management board, audit board as well as other authorities established by the statute. in this case, the supervision of the activities taken by the bank is performed by the managing board which is in charge of carrying out the same activities. finally, the recently used law concerning the establishment, management, supervision and financial activities of banks is the law of banks enacted in 2007 (official gazette of the republic of macedonia, no. 67/07, 88/2008, 118/2008, 42/2009, 90/09, 67/10, 26/13, 13/14). the previously mentioned law (article 82) supports the two-tier board system consisted of shareholders assembly, supervisory board, managing board, risk management board, audit boards as well as other authorities established by the statute. according to this law (article 88), the supervisory board is consisted of at least 5, but not more than 9 economic analysis (2014, vol. 47, no. 1-2, 76-99) 80 members; (article 92) the managing board is consisted of at least 2, but not more than 7 members. unlike the previously mentioned laws, this act makes clear distinction between the responsibilities of the boards. with regard to the law of banks as a lex specialis, there are few more laws and bylaws that need to be considered when regulating the activities of the banks. one of the important laws is the law on obligations (official gazette of the republic of macedonia, no. 18/01, 78/01, 4/02, 59/02, 5/03, 84/08, 81/09, 161/09) which concerns the relation between the banks and third parties. additionally, the law on securities (official gazette of the republic of macedonia, no. 95/05, 25/07, 86/07, 123/07, 140/07, 146/07, 7/08, 45/09, 57/10, 135/11, 13/13, 188/13) is applied for regulation of the methods and conditions for issuance and trading of securities; the manner and conditions for proper functioning of the securities market and authorised market participants, disclosure obligations of joint stock companies with special reporting obligations; members of management, directors and individual shareholders; prohibited acts in connection with the operation of securities etc. moreover, of a great importance is the manual on corporate governance of the shareholding companies in macedonia, 2008, as well as the oecd principles of corporate governance, 2004, especially useful for the super listed bank. other guidelines for corporate governance which can be used for reforming of the banking sector in macedonia are: white paper on corporate governance in south east europe, 2003; developing corporate governance codes of best practices, 2005; the eu approach to corporate governance, 2008; the international accounting standards; basel standards set recommendations issued by the basel committee on banking supervision to bank regulators which defines the minimum standards that need to be implemented by the banks for risk management, and so on. brief overview and evolution of the banking sector in macedonia macedonia has inherited the banking system from former yugoslavia in state ownership and with a structure in correlation with the prevailing planned economy. however, the reconstruction of the banking system started relatively late, in 1995, writing-off the old foreign currency saving, assets and liabilities in terms of foreign loans and sanation of the biggest macedonian bank. in the process of economic transition, macedonian banks experienced a number of reorganisations such as forced mergers, bail-outs, and changes in management. however, the heart of macedonian economy is still the commercial banks. in 2011, the activities of the banks continued to grow, although at a slower pace compared to the previous year, as reflected positively to the further increase of the degree of financial intermediation in the country. the growth of the deposits noticed a slowdown, which generally corresponds to the slowdown of the economic growth in this period. what is more, the economic entities continued to save more money in local currency. as well as that, macedonian banking system is stable, with high solvency and capitalisation, which is further improved during 2011. macedonian banks has not been in a need of state financial support in the past few years and hence there was no formal or informal state capital intervention in the domestic banking sector (nbrm, 2012). macedonian banking and financial sector is quite modestly developed. at the end of 2011, the banking industry in macedonia consisted of seventeen banks and eight savings fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 81 banks. for analytical purposes, the national bank (nbrm) groups the banks into three groups, according to the size of their assets: small, medium and large banks. banking network is spread over almost all cities in the country and consists of 413 business units (which includes the headquarters of banks), but the main concentration of the network remained in the capital city. compared with the previous year, the number of the business units fell by twenty-three. in the banking sector the downward trend of the number of employees continued. in 2011, the number of employees in banks fell by 41. additionally, continued the trend of quality improvement in regard to the qualification structure of the employees in the banking system (nbrm, 2012). due to the overwhelming importance for macedonian economy, bank operations and corporate governance are regulated by previously mentioned laws and bylaws. concretely, according to the legal acts, each bank in macedonia has established its own corporate governance structure compatible with the nature and scope of activities performed. the four most important bank’s authorities have a total of 304 members and they representing 5.1% compared with the total number of employees in the banks at the end of 2011. nevertheless, most of these people are members of the supervisory board (102 members). given the statutory requirement that at least one third of the members of the supervisory board must be independent members; these individuals participate with 34.7% of the total number of members of the board (or a total of 34 people). in terms of the functioning of the managing board, in a ten banks this board is consisted of two members, as the legal minimum is, and in the remaining seven banks, of three to five members. all of banks have special organisational risk management unit, while fourteen banks have special organisational unit for the control of concordance with the regulations (nbrm, 2012) and guidelines incorporated in basel standards. when taking into account the ownership structure of banking system, the financial institutions have dominant share in ownership structure of banking system. the foreign investments have increased almost double in 2011. thirteen out of seventeen banks in macedonia have dominant foreign ownership. concentration of banking system, measured through herfindahl-hirschman index is relatively high in all segments of the banking operations. despite the reduction of the herfindahl-hirschman index, at the end of 2011, there are still segments in which the concentration is above acceptable upper limit. highest concentration is observed in loans and deposits, while the concentration of credits for companies is slightly above acceptable level. only in total assets and deposits of enterprises, concentration is within the acceptable level (nbrm, 2012). hence, the nature and scope of competition practice is still serious headache for central bank authorities as the most important question for future developing of banking system. literature review and hypotheses development in 1919, michigan supreme court in the case of dodge v. ford motor co. ruled that a business exists for the profit of shareholders and the board of directors should focus on that objective (ferrel, fraedrich and ferrel, 2013, p. 41). board serves as a bridge between shareholders and managers (cadbury, 2002) playing a major governing role in the corporate governance framework. in accordance to banks, during good times, a board sets tone and direction. it oversees and supports management efforts, tests and probes recommendations economic analysis (2014, vol. 47, no. 1-2, 76-99) 82 before approving them and make sure that adequate controls and systems are in place to identify and address concerns before they become major problems. during bad times, a board that is active and involved can help a bank survive if it is able to evaluate problems, take corrective actions, and when necessary, keep the institution on track until effective management can be reestablished and the bank’s problem resolved (greuning and bratanovic, 2003, pp. 42-43). the study of corporate governance is complicated by the fact that the structure, role and impact of boards have been studied from a variety of theoretical and practical perspectives. numerous studies are dedicated on detection a link between corporate governance and performance, including the board of director’s characteristics such as financial dependence of directors, remuneration, diversity, size, independence, personal backgrounds, director service to other boards, etc. however, they are also many studies which investigate corporate governance in banks as differentia specifica. these aspects for corporate governance in banks are the new impulse for the academic researchers and policy makers in their mission to investigate and highlight the importance of board of director’s characteristics on the bank performance. however, it is important first to access to corporate governance issues in nonfinancial firms, and then to review the previous literature and findings in the field of bank organisations. in this research, have been used qualitative and quantitative data to penetrate an in-depth understand kind of relations between corporate governance and financial performance of banks. specifically, were used statistical and econometric models for obtain and processing information about respondents. board size board size is one of the most elaborated attribute in the literature and, in general, the relationship between board size and performance is found to be inversely related. there is the statement which suggests that only an odd number of people can lead a corporation, and three are too many (vance, 1983, p. 33). board size refers to the number of directors on the board. generally, this number may vary depending to firm size and differ significantly across various industries and countries (dehaene, de vuyst and ooghe, 2001). hence, one board size do not fits all. today, numerous theoretical or empirical studies suggest that larger boards lead towards worse firm performance (jensen, 1993; yermack, 1996; eisenberg, sundgren and wells, 1998; dalton, daily, ellstrand and johnson, 1999; singh and davidson, 2003; mak and kusnadi, 2005; de andres, azofra and lopes, 2005; cheng, 2008). this negative implication is caused by larger costs, increased asymmetric information, lower productivity, inadequate coordination and ineffective communication channels. when a board has more (than ten) members, it becomes more difficult for them all to express their ideas and opinions in the limited time available. a smaller board will be most likely to allow directors to get to know each other well, to have more effective discussions with all directors contributing, and to reach a true consensus from their deliberations (lipton and lorsch, 1992, pp. 65-68). smaller boards also avoid the groupthink in decision-making process. spencer stuart board index (2008) reports that worldwide, board size has been shrinking over the years and that there is a continued trend towards smaller boards. importantly, pathan and skilly (2010) document that board size of large and medium sized banks decreases in the period after sarbanes fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 83 oxley while small bank board size remains stable, more independent and therefore took less risk. smaller boards in bank organisations are believed to be associated with better governance quality and bank performance or not related with these outcomes (erkens, hung and matos, 2012). moreover, de andres and vallelado (2008) investigate 69 banks from 6 developed countries and show an inverted u-shaped relation between bank performance from the one side, and board size and outside board composition from the other side. thus, the excessive (not optimal) inclusion of more and more outside directors did not result in positive bank performances. likewise, grove, patelli, victoravich and xu (2011) report for a concave relationship between financial performance and board size in us commercial banks during crises. in search of the optimal board size in russian banks, pokrashenko (2012) confirm the u-shaped relationship between board size and performance and noted that optimal board size is between 6 and 11 directors. besides this useful suggestion, as we pointed out before, we must keep in mind premises that one size do not fits all. contrary to the previous findings, large board size improves corporate performance through enhancing the ability of the company to establish external connection with the environment and providing, on that way, rare resources for company operations (bacon, 1973; dalton, daily, johnson and ellstrand, 1999; kiel and nicholson, 2003; anderson, mansi and reeb, 2004; coles, daniel and naveen, 20083; arslan, karan and eksi, 2010; sheikh and wang, 2012; chang and duta, 20124). these studies found that board size have a positive impact on the stock market performance of company. in fact, the greater the need for effective external linkage, the larger the board should be (pfeffer and salancik 1978, p. 172). therefore, they are studies which reveal that larger boards is, on average, positively related with the bank performance i.e. larger boards lead to increased wealth of bank holding companies (adams and mehran, 2012) and better market performance (kutubi, 2011). hence, as pointed out by subrahmanyam, rangan and rosenstein (1997), booth, cornett and hassan (2002) and adams and mehran (2003), banks have larger and more independent boards than other (industrial and public utility) organisations. in sum, literature remains inconclusive but we support view that organisations with smaller boards performs better and, on that way, secure the financial health. correspondingly for our bank analyses, the following are the hypotheses that will be tested empirically with regard to the impact of the board size: h1a: the size of the supervisory board is significantly and negatively related to bank profitability measured by roa. h1b: the size of the supervisory board is significantly and negatively related to bank profitability measured by roe. h1c: the size of the supervisory board is significantly and negatively related to bank efficiency measured by ciratio. 3 the authors provide evidence that complex firms have larger boards with more outside directors. also, they find that the relation between tobin's q and board size is u-shaped. in other words, this paper suggests that either very small or very large boards are optimal in respect to firm value. 4 interestingly, chang and dutta (2012) investigate corporate governance issues and dividend policy and finds that firms with large board favor higher dividend payments to the stockholders. economic analysis (2014, vol. 47, no. 1-2, 76-99) 84 h1d: the size of the supervisory board is significantly and positively related to bank capital requirement measured by car. board composition once upon a time a directorship was a sinecure, involving an occasional meeting, some supportive questions, a fee and lunch but not now. more is expected of directors and members of all governing bodies than ever before, and the difference (positive or negative), directors can make to their companies is arguably greater than ever. the role of a director is crucial, challenging and potentially highly rewarding (tricker, 2003, p. 1). optimal board composition leads to better performance. hence, board composition is seen as a one of the main and most elaborated aspects in corporate governance texts. board composition is an important governance mechanism because the presence of nonexecutive directors represents an effective tool of monitoring the actions of the executive directors and of providing that they take policies which will enhance shareholders wealth by using low-cost mechanism (fama, 1980; coughlan and schmidt, 1985). non-executive directors are independent from the everyday company operations and from top managers. board independence means the proportion of independent non-executive directors relative to the total number of directors. empirical researches present mixed results about relationship between company performance and board independence from different perspective. advocates of board of director reforms support outside view in board composition i.e. situation when independent boards take a more active role in promoting the performance of the company (schellenger, wood and tashakori, 1989; barnhart, marr and rosenstein, 19945; beasley, 19966; dehaene, de vuyst and ooghe, 2001; peng, 2004; krivogorsky, 2006; dahya and mcconnell, 2007; eklund, palmberg and wiberg, 2009; nguyen and nielsen, 2010; sheikh and wang, 2012). regarding to the banks, almost do not exist papers which identified a strong positive relationship between the percentage of independent directors and performances of banks but exist a papers which suggest insignificant relations between bank performance and board composition in term of outside director presence (pi and timme, 1993; adams and mehran, 2012). despite these general conclusion, kutubi (2011) suggest statistically significant positive relationship between board independence and bank performance measured by tobin’s q. further, mishra and nielsen (2000) show that greater proportion of independent outside directors could ensure that ceo compensation programs are properly aligned with the goals of the bank shareholders. additionally, adams and mehran (2012) find that banks do not appear to be systematically choosing ineffective corporate governance structures. 5 barnhart, marr and rosenstein (1994) analyse the effect of board composition on firm performance. the output of this research is very significant (and unique) for corporate governance literature from the methodological approach and results. in particular, authors indicate a significant curvilinear relation between board composition and performance. 6 this paper examines the effects of board composition in both fraud and non-fraud companies. specifically, the results suggest that non-fraud firms have boards with significantly higher presence of outside directors than fraud firms and vice versa. interestingly, the role of audit committee in mitigating this state is minor and does not significantly affect the likelihood of fraudulent activities. fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 85 also, they reports for stable board composition of large banking firms, in a time span of thirty years, with the fraction of non-insiders directors7 which gravitates around 0.85. at this place is very important to highlight the results of study made by rosenstein and wyatt (1997). they investigate the stock market reaction of announcements about inside director appointments and find significantly negative reaction when inside directors own less than 5% of the firm's common stock, significantly positive when their ownership level is between 5% and 25%, and insignificantly different from zero when ownership exceeds 25%. these results underline the benefits of rare inside director's expert knowledge, but only when managerial and outside shareholder interests are closely aligned. on the other side, promoters of insider dominated boards find an inverse association between board independence and firm value. board independence also matter to the board size, growth and nature of ownership. hence, prevost, rao and hossain (2002) proof that the proportion of outsiders on the board is positively associated to board size, negatively related to future growth and nonlinearly related to inside ownership. additionally, other authors recognise that companies which add independent director (independent boards) tend to decrease corporate performance, especially stock market performance (arslan, karan and eksi, 2010). moreover, shan and xu, (2012) investigate the question of board independence and, on general, did not find significant relationship in terms of performance. in regard to the financial firms, erkens, hung, and matos (2012) provide some evidence that banks with the independent boards is faced with worse stock market positions during the crises period. wang, lu and lee (2012) used modified data envelopment analysis (dea) for estimation of bank performance and reveal a negative impact from board size and outside director presence. interestingly, subrahmanyam, rangan and rosenstein (1997) investigates the effects and role of outside and independent directors in market of corporate control activities and find that abnormal market returns have significantly and negative association with ratio of independent outsiders in every regression. in general, we agree with daily and dalton (1993) arguments and therefore we suppose that board with many independent directors show a high effectiveness and enhance performance. here from, the hypotheses to test the significance of the impact of board composition are defined with the following statements: h2a: the supervisory board independence is significantly and positively related to bank’s profitability measured by roa. h2b: the supervisory board independence is significantly and positively related to bank’s profitability measured by roe. h2c: the supervisory board independence is significantly and positively related to bank’s efficiency measured by ciratio. h2d: the supervisory board independence is significantly and positively related to bank’s capital requirement measured by car. board diversity as an integral composition issue has recently caught the attention of scholars, managers, shareholders and government. the reason for this conclusion probably lies in the possibilities for exchanging different ideas and using expert knowledge, especially 7 the category of non-insiders directors is considered as any of the directors who are not currently an officer of the banking firm’s headquarters. economic analysis (2014, vol. 47, no. 1-2, 76-99) 86 in declining periods. today various stakeholder groups began to emphasise the concept of board diversity as the one best way. arguments for diversity in the boardroom are both economic and ethical (van der walt and ingley, 2003). board diversity usually is positive related with financial ratios. conversely, board diversity can also generate various costs associated with coordination problems and decision-making times (forbes and milliken, 1999). further, board diversity may corrode cohesion and lead to a less cooperative and conflicts within group (lau and murnighan, 2005). in particular, hagendorff and keasey (2008) suggest that occupational, tenure and age diversity add value for banks whilst gender diversity did not create the economic value for shareholders. in addition, they conclude that the board with multiple directorships tends to be ineffective in pursuing his monitor function. our paper examines board’s exhibit heterogeneity due to personal background such as education (ph.d. holds) (berger, kick and schaeck, 2013), legal background (citizenship) and gender. qualified women’s and foreigners on boards should increase corporate performance through different expertise, advice, better judgment and proper decisions. naturally, it is necessary to provide empirical evidence for this intuitive/conventional wisdom and ex ante conclusions. in other words, it is important to consider glass ceiling phenomenon in bank board’s i.e. whether women in macedonian banks are able to break the glass barriers in bank hierarchy. ceo qualities power of ceo is determinated by the ceo tenure (graefe-anderson, 2009; dikolli, mayew and nanda, 2009; wulf, stubner, miksche and roleder, 2010; horstmeyer, 2011). the effect of a powerful ceo can be counterbalanced by other executives (berger, kick and schaeck, 2013). therefore, it is obvious that powerful ceo has a negative impact on bank performance. consequently, the significance of the impact of ceo qualities will be tested through the following hypotheses: h3a: the ceo power is significantly and negatively related to bank’s profitability measured by roa. h3b: the ceo power is significantly and negatively related to bank’s profitability measured by roe. h3c: the ceo power is significantly and negatively related to bank’s efficiency measured by ciratio. h3d: the ceo power is significantly and positively related to bank’s profitability measured by car. financial dependence of ceo (kesner, 1987; suklev, 2011) also can be used as a discipline mechanism which ensures better performance for banks. to the extent that ceo and other board members own stakes of the company, they develop shareholder-like interests and are less likely to engage in behavior that is detrimental to shareholders, particularly during crises period (fama, 1980; demsetz and lehn, 1985; fenn and liang, 2001; arslan, karan and eksi, 2010). the ceo will then have the same objectives as the shareholder and, on this way, financial or non-financial organisations can mitigate principal-agent problem and agency cost. in addition, morck, shleifer and vishny (1988) reveal that if the percentage of the manager’s stakes moves from 0 to 5%, performance goes up from 5 to 25%. if the percentage exceeds 25%, performance improves but very slowly. according to adams and mehran fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 87 (2003), ceo’s of financial companies has lower ownership (2.3%) that ceo’s of non-financial organisations (2.9%). this level of ceo ownership in banks, corresponding with mentioned percentages which accelerate bank performance in the study of morck, shleifer and vishny (1988). figure 1. the framework for the relationship between the corporate governance and bank’s performance empirical research the model in this section is investigated the relation between the corporate governance with the bank’s performance using ordinary least squares (ols) regressions. four measures are used to observe bank performance: return on assets (roa) calculated as profit after taxes divided by total assets of a bank; return on equity (roe) calculated as profit after taxes divided by total equity of a bank; cost-income ratio which is used as a quick test of efficiency which reflects the non-interest costs as proportion of net income; and capital adequacy ratio (car) expressed as proportion of financial capital to the risk-weighted assets. these four measures represent the dependent variables in the study. the board structure in this paper is described in three dimensions: board size, board composition and ceo qualities. it is important to note that the banking system in macedonia exhibits two-tier corporate governance composed of supervisory (sb) and managing board (mb). since the responsibilities of the members in the supervisory board are attributed greater importance for the bank’s corporate governance, the supervisory board is given preference to study its composition and size. hence, the majority of independent variables are derived from the data collected about the supervisory board, while few of them relate to the managing board. nonetheless, since the ceo always acts as president of the managing board and more importantly bears much of the responsibility for the bank’s performance, his qualities are given specific importance in the study and are analysed within a separate dimension. each of the independent variables is briefly explained in turn. the size of supervisory board (sbsize) and the size of managing board (mbsize) are both measured using a natural logarithm of the total number of members in each of them, which is aligned with the studies of de andres, azofra and lopez (2005) and jackling and johl (2009). board composition as a dimension of the board structure is represented with the following economic analysis (2014, vol. 47, no. 1-2, 76-99) 88 variables: supervisory board independence (sbindepend) which reflects the number of non-executive members as proportion of total number of members in the board; foreign members of supervisory board ratio (fsbratio) defined as proportion of members that have not acquired macedonian citizenship to the total number of board members; women members of supervisory board ratio (wsbratio) which, similarly, is defined as proportion of the women members to the total number of members in the board; and supervisory board educational ratio expressing the proportion of members in the supervisory board holding ph.d. the third dimension, described with the ceo qualities, includes the following measures as dummy variables: dummy for ceo to distinguish whether the ceo is foreign citizen (given value 1) or not (given value 0); dummy for ceo ownership which gets value 1 if the ceo owns bank’s shares and 0 if not; and dummy variable for the ceo power expressed as the longevity of the ceo serving on this position (value 1 for more than a four-year term or value 0 for exactly one term). the other variables inputted in the study are not directly related to the board structure, and are, thus, grouped as control variables. these include: bank’s age (age) calculated as a natural logarithm of the difference between the principle year of analysis and the year of bank’s foundation; credits/deposits ratio (cdratio) defined as proportion of bank’s total credits lend to its clients to the total deposits it keeps; and bank’s nature (banture) used as a dummy variable to denote whether the bank is a subsidiary of a multinational bank (given value 1) or not (given value 0). description of all these variables is presented in table 1. table 1. definition of variables variable definition measures of bank performance (dependent variables) return on assets (roa) return on equity (roe) cost-income ratio (ciratio) capital adequacy ratio (car) profit after taxes/total assets profit after taxes/total equity non-interest costs/net income financial capital/risk-weighted assets measures of board structure (independent variables) board size: size of supervisory board (sbsize) size of managing board (mbsize) board composition: supervisory board independence (sbindepend) foreign members of supervisory board ratio (fsbratio) women members of supervisory board ratio (wsbratio) supervisory board educational ratio natural logarithm of the total number of members in the supervisory board natural logarithm of the total number of members in the managing board proportion of non-executive members in the supervisory board proportion of foreign members in the supervisory board proportion of women members in the supervisory board proportion of members in the supervisory board holding fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 89 (edusbratio) ceo qualities: dummy for ceo (ceo) dummy for ceo ownership (ceoown) dummy for ceo power (ceopower) ph.d. 1: if the ceo is foreign citizen; 0: if otherwise. 1: if the ceo owns bank’s shares; 0: if otherwise. 1: if the ceo serves longer than one-term (4 years); 0: if otherwise. control variables (independent variables) bank’s age (age) credits/deposit ratio (cdratio) dummy for bank’s nature (bnature) natural logarithm of the difference between the principle year of analysis and the year of bank’s foundation credits/deposits 1: if a bank is subsidiary of a multinational bank; 0: if otherwise because of the large number of independent variables used in the study, three multiple regression analyses with limited variables have been developed in order to assess the relationship. each of the analysis uses a multiple regression model stated with the following equation: where: i represents the cross-sectional dimension of the data; represents the dependent variables in the model; represent the independent variables; represent the dummy variables; denotes the slope coefficient; and denote the coefficients of the independent and dummy variables respectively; represents the error term. firstly, a specific model was developed to assess the relation between the size of the supervisory and managing board with the bank’s performance, which can be expressed with the following regression equation: next, another one was developed particularly to measure the relation between the board structure with the bank’s performance and is stated with: economic analysis (2014, vol. 47, no. 1-2, 76-99) 90 the last of the models developed is to measure the relationship between the ceo qualities defined as dummy variables with the bank’s performance using the following equation: different methods are available to solve for the parameters in the given equation, but the most simple one is by using pooled ordinary least squares (ols), which is demonstrated in prior studies such as boone, field, karpoff and raheja (2007), coles, daniel and naveen (2008) and linck, netter and yang (2008). this method minimises the sum of squared vertical distances between the observed responses in the dataset and the responses predicted by the linear approximation to estimate the unknown parameters in the regression model. sample and data the sample used in the development of the model includes 15 out of 17 banks, thus representing 88% of its statistical population. the data collected for the study are extracted from several sources, including the official websites of the national bank of the republic of macedonia (nbrm) and the macedonian securities exchange commission, the official sites of the banks in question, and the financial and proxy statements published by the banks at the end of the year. in this way, the numerical data to calculate the dependent variables and some of the control variables are derived from the financial statements, the data about the board size and composition are extracted from the official sites of the banks and the official site of nbrm, the information for the ceo qualities are predominantly based on the publications on the website of the macedonian securities exchange commission, while the data for some variables such as the bank’s age and its ownership structure come from the proxy statements and some web pages on the bank’s official websites. the empirical data used as inputs in the study for the banks have been observed for the 2008-2011 period with a total number of 60 observations. analysis, findings and concluding remarks the findings from the first regression model (see in table 2a) demonstrate that the size of both, the supervisory and the managing board, are positively related to the bank’s profitability measured by roa. it means that any increase in the number of members in one of these boards is likely to result in increased bank’s profitability. this may be explained by the fact that the appointment of new members in each of the two boards will produce stronger decision-making process that may boost bank performance. in this way, the hypothesis stated as is rejected. with regard to the impact on the profitability measured by roe, none of the variables in the model has significant relation, which reflects to be unsupported. furthermore, a significant and positive relationship exists between the size of the managing board and the cost-income ratio, which implies that the macedonian banks with larger managing board will be able to improve bank’s efficiency better than those with smaller one. in relation to the capital requirement measured by the capital adequacy ratio, the banks with smaller managing board tend to hold a larger percentage of their liquidity assets against their risk-weighted assets as implied through the significant and negative fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 91 relation. a reasonable explanation for this could be that the smaller managing board cannot efficiently manage risk of the bank’s capital because the lack of financial expertise, which subsequently leads towards increased risk aversion. no significant relationship has been demonstrated between the size of supervisory board and ciratio, which implies that the hypothesis cannot be supported. however, the size of the supervisory board exerts significantly negative effects on the capital adequacy ratio and thus the hypothesis is rejected. the analysis also examines the impact of bank’s age as a control variable on each of the dependent variables and proves that there is a significant and positive relationship only to the capital requirement. that is, the macedonian banks usually tend to increase the financial capital held for liquidity purposes over time. importantly, the assessment of this model demonstrates no significance in the relation between bank’s age and its profitability, which means that the commonly used rationale that the old banks perform better results does not necessarily apply in the case with macedonia. table 2a. effects of board size on bank performance roa roe ciratio car c -0.146930*** (0.036525)** -0.376426* (0.220806) 1.080552*** (0.294811)** 0.609368*** (0.121774)** sbsize 0.056854*** (0.021467)** 0.103667* (0.129774) -0.216034*** (0.173268)** -0.138791*** (0.071570)** mbsize 0.032109*** (0.015318)** 0.088306* (0.092604) 0.276174*** (0.123641)** -0.276880*** (0.057071)** age 0.001694*** (0.005875)** 0.032068* (0.035518) -0.067618*** (0.047423)** 0.045025*** (0.019588)** no. of observations 0.25 60 0.08 60 0.10 60 0.41 60 signs *, ** and *** denote statistical significance at 10%, 5% and 1% level, respectively. robust standard errors are reported in parentheses. from the assessment of the variables in the second model (see in table 2b), it is visible that there is a significant impact in negative direction of the board’s independence measured by the proportion of non-executive members seated in the supervisory board to bank’s profitability measured by roa and roe. such conclusion strikes with numerous studies on this topic, including the study in the field of agency theory, and leads the hypotheses and to be unsupported. however, the findings show that there is a positive association of the proportion of non-executive members to the cost-income ratio, implying that an increase of this proportion in the supervisory board of macedonian banks is likely to boost bank’s efficiency. this subsequently leads to the conclusion that the hypothesis stated as cannot be rejected. the results also suggest the existence of a positive dependence of supervisory board independence on the capital adequacy ratio, meaning that the bank will usually prefer risk aversion and therefore hold more liquidity assets as result of the increase of outsiders within the board. the hypothesis thus cannot be rejected. the assessment of the regression model also yields results that prove the existence of a significant and negative economic analysis (2014, vol. 47, no. 1-2, 76-99) 92 relationship between the proportion of female members of the supervisory board and bank’s performance measured by roa, implying to the conclusion that the banks in macedonia with a large proportion of women do not perform better results than the others. in addition, the findings reveal a statistically significant and strong positive association of the women members of supervisory board ratio to the cost-income ratio, which suggests that the presence of female members in the supervisory board may still be justified that they can bring competences to improve supervision that is likely to boost bank’s efficiency. no significant relationship has been demonstrated in the relationship between the foreign members of supervisory board ratio and supervisory board educational ratio as independent variables and the dependent variables. table 2b. effects of board independence on bank performance roa roe ciratio car c 0.034611*** (0.012728)** 0.129448** (0.083492)* 0.490905** (0.278364)* 0.129339** (0.056086)* sbindepend -0.107632*** (0.031599)** -0.422532** (0.207277)* 1.720315** (0.691062)* 0.351122** (0.139239)* fsbratio 0.008632*** (0.017053)** -0.028457** (0.111958)* -0.199803** (0.372937)* 0.001963** (0.075141)* wsbratio -0.073939*** (0.026459)** -0.014992** (0.173555)* 1.241374** (0.578634)* -0.103572** (0.116586)* edusbratio -0.035476*** (0.025361)** -0.067783** (0.166352)* 0.507813** (0.554619)* -0.047632** (0.111748)* no. of observations 0.25 60 0.08 60 0.10 60 0.41 60 signs *, ** and *** denote statistical significance at 10%, 5% and 1% level, respectively. robust standard errors are reported in parentheses. when measuring the impact of the ceo qualities on bank’s performance (see in table 2c), the results suggest a significance and positive association of the number of terms serving as ceo and bank’s profitability measured by roa and roe. it means that the banks in macedonia managed by ceos that hold this position for a longer period of one four-year term are more profitable than those with ceos serving their first term as such. the hypotheses and thus cannot be supported. further in this analysis, there is a significant and negative impact of the length of term on bank’s efficiency measured by the cost-income ratio and on the capital requirement measured by the capital adequacy ratio as well. the first relationship proves the statement that the ceos that serve their first term at this position are better in improving bank’s efficiency than those serving longer, while the latter one the statement that the ceos with less history (record) in the bank are more adverse towards the risk and therefore would manage to hold larger portion of their potential for lending. in this case, the hypothesis cannot be rejected and hypothesis is rejected. it can be explained by the fact that the ceo needs time to learn all of the preferences and politics of the bank in order to improve his decision-making abilities towards bank’s risk management. in addition to these findings, the assessment of this model also reveals a fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 93 significant and negative relationship between the nationality of ceo and the profitability measured by roe. in other words, the banks with foreign ceo do not necessarily perform better results in the return of the capital invested by their owners. the analysis also demonstrates that the credits/deposits ratio has a significant and negative impact on the capital adequacy ratio, implying that a reduced credits/deposits ratio is likely to trigger an increase in the portion of lending potential held by the bank. logically, the reduced number of cdratio provoked by the reduced amount of money in form of credits to the customers results in increase of the liquidity assets and thereby car. for the impact of the ownership by the ceo and the status of a bank as a subsidiary or an independent financial institution, the probabilities in the analysis to each of the dependent variables show that there is no significance. table 2c. effects of the ceo qualities on bank performance roa roe ciratio car c -0.022575** (0.016339)* -0.050484*** (0.081246)** 1.516647*** (0.335307)** 0.431176*** (0.052103)** cdratio 0.003358** (0.017645)* -0.005299*** (0.087741)** -0.236314*** (0.362114)** -0.262123*** (0.056269)** ceo 0.005906** (0.012555)* -0.152681*** (0.062428)** -0.102785*** (0.257645)** 0.007739*** (0.040035)** ceoown 0.009195** (0.011204)* 0.018504*** (0.055712)** -0.092073*** (0.229926)** 0.002504*** (0.035728)** ceopower bnature 0.027622** (0.011243)* -0.003174** (0.009966)* 0.150764*** (0.055905)** 0.030742*** (0.049555)** -0.532734*** (0.230724)** 0.079570*** (0.204516)** -0.106066*** (0.035852)** 0.028610*** (0.031780)** no. of observations 0.25 60 0.08 60 0.10 60 0.41 60 signs *, ** and *** denote statistical significance at 10%, 5% and 1% level, respectively. robust standard errors are reported in parentheses. despite of the findings and the methodology used in this study, the results and the comments can still be biased because of several limitations including: manipulation 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(1996). higher market valuation of companies with a small board of directors. journal of financial economics, 40(2), 185-211. fidanoski, f., et al., corporate governance, ea (2014, vol. 47, no, 1-2, 76-99) 99 korporativno upravljanje i performanse banaka: slučaj republike makedonije rezime – uloga banaka je značajna za ekonomski razvoj jedne zemlje, ali uzima i značajnu ulogu u podsticanju privatne inicijative u njoj. iz tih razloga se može naći veliki broj različitih i suprotstavljenih studija i naučnih radova u oblasti ekonomije koji govore o raznim režimima i problemima korporativnog upravljanja u bankama. novi pogled na korporativno upravljanje u bankarskom sektoru dat je kroz analizu u ovom radu, uzimajući u obzir posledice velike svetske ekonomske krize. tema ovog rada jeste ispitivanje značaja veličine upravljačkog odbora, njegovog sastava i kvaliteta izvršnog direktora u makedonskim bankama uz praćenje njihovih performansi. u paragrafima koji slede se razrađuje hipoteza kojom se testira da li adekvatna struktura korporativnog upravljanja može doprineti višim performansama banaka koje su merene prinosima na aktivu (roa), prinosima na kapital (roe), odnosa između prihoda i troškova i racia adekvatnosti kapitala (car). ispitivanje je pokazalo da je veličina upravljačkog odbora pozitivno korelisana sa profitabilnošću banke koja je iskazana kroz roa. dalje, istraživanjem se došlo do zaključka o postojanju negativne povezanosti između nezavisnosti upravljačkog odbora i koeficijenata roa i roe. ujedno, rezultati su pokazali da su banke u makedoniji vođene izvršnim direktorima koji se na toj poziciji nalaze duži vremenski period profitabilnije od onih banaka u kojima izvršni direktori služe svoj prvi četvorogodišnji mandat. pored toga, važno je istaći da ovo istraživanje ima kako praktični tako i teorijski značaj koji se u mnogome razlikuje u poređenju sa drugim sličnim istraživanjima i studijama, obzirom da je primarni cilj ove studije analiza komercijalnih banaka u nedovoljno istraženom bankarskom sektoru zemlje u razvoju. ključne reči: performanse banke, kompozicija upravljačkog odbora, veličina upravljačkog odbora, korporativno upravljanje, raznolikost article history: received: 1 april 2014 accepted: 15 april 2014 ea_2012_3-4 prelinary report public debt geography sheremet evgeny*, peoples friendship university of russia udc: 336.27(100) ; 330.101.541 jel: e-32; g-15; f-42 id: 195853068 abstract – this article provides a macroeconomic analysis of public debt burden in the major economic regions, each region is considered from the standpoint of public debt and its ratio to key macroeconomic indicators, describing the current state of public debt and the prospects of fiscal policy in selected regions. key words: public debt management, exchange rate, debt burden, external and domestic public debt, total debt, debt sustainability introduction up to date, the level of borrowing in many countries is close to its bottom line, which was caused by the influence and aggravated by the economic crisis of 2008-2009 and became the trigger for the so-called "second wave" of the crisis. the key feature of this new crisis is the situation where all the borrowing countries are developed ones like the u.s., the eu states, japan and so on are problematic. thus, to make a logical assumption that in the event of defaulting on government bonds the world's largest economies (even partial) will be triggered by an even deeper downturn in the global economy, which could lead to a prolonged recession and a repetition of the great depression of the 30-ies of 20th century. the same course of events can drastically change the balance of powers, both on the economic map of the world, and at the political stage. the key question that arises today is whether it is reasonable shape the budget deficit by deficit spending? either should the budget be balanced each year? in any case, in order to carry out its functions fully, including the state must cope with the different variations that are the subject to a market economy and to conduct so-called countercyclical fiscal policy, in which the federal budget is matched with deficit during recessions and has a surplus in periods downfalls. this rightly suggests that the use of active fiscal policy is unlikely to provide a balanced budget in any given year. the key problem of the budget concept is that the ups and downs in the economic cycle may vary in depth and duration, and therefore, the task of stabilization is in conflict with the task of balancing the budget during the cycle. for example, a long and deep recession, followed by a brief period of prosperity and modest, would mean a large deficit during the recession, the little or no surplus at all for the period of prosperity and, therefore, cyclical deficit. and today the theory, written more than 50 years ago has suddenly become a reality. * peoples friendship university of russia, russia sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 47 the world was in a situation where economic cycles coincide in such a way that many states were not prepared for such a severe slowdown in economic growth. in addition, if during the great depression, the world has never been so globalized, but now the crisis is literally exported to the dollar and the euro in almost all parts of the world and this is happening due to "mutual responsibility", a situation in which all owe everything. at present, the developed and developing countries regardless of which group of countries they belong to, carry out the policy of government loans to domestic and foreign financial markets. and almost every country is a borrower or a member of the international financial organizations, whose loans actually provide the resources to countries with a developed, developing and transition economies. debt, fiscal and monetary policy of the state are inextricably linked, currency, inflation rate, the refinancing rate, the increase in government borrowing led to a reduction of investment resources in the economy, disruption of reproduction processes, reducing economic growth. sooner or later, borrowing beyond the state capacity that calls for cuts in social, investment and other purposes that are not related to the repayment and servicing of the debt. up to date, the total public debt has exceeded $ 40 trillion., which is 68% of world gdp. to fight the crisis and its consequences, most governments were forced to spend considerable sums of money, which eventually turned into the catastrophic growth of public debt, which led to a paradoxical situation today the most over credited countries in the world today turn out to be developed countries – such as the u.s., japan, canada and the states euro area. thus, in the context of the global economic crisis, the problem of public debt management has acquired a special significance. at this stage there is an objective that needs development and implementation of a qualitatively new debt strategy throughout the global financial system. figure 1. public debt to gdp ratio by countries, % (2011) source: compiled by the author using the tools on the site based on statistical data http://chartsbin.com www.imf.org economic analysis (2012, vol. 45, no. 3-4, 46-59) 48 in our opinion, one of the most significant criteria for assessing the level of public debt is the ratio of gross government debt to gdp. the level of debt in different countries varies considerably, and therefore the distribution of debt burden today is extremely uneven. however, according to our viewpoint, the geography of debt has certain patterns that we will try to identify. it is obvious that among the countries that being ranked as the advanced economy countries, the vast majority is in the red zone, those are the whole of north america, western europe, israel, japan. among the bric countries the situation is less straightforward russia and china are saddled with virtually no debt, because these countries have one of the highest gold reserves. on the other hand, brazil (as well as the rest of latin america, including the second-largest economy, argentina of the mainland) and india (as well as all the countries of saarc and asean) has a high ratio of public debt to gdp, and are at risk, although less than, for example, developed countries because, in our opinion, the economy of the bric countries enables a more flexible approach to monetary policy, which we shall mention later. figure 2. the value of debt top-20 + the russian federation ($ billion) in debt per person ($ / capita), the ratio of government debt to gdp ratio, % (2011) source: compiled by author based on data from www.imf.org, http://treasurydirect.org, http://cia.org, http://minfin.ru in absolute terms, an undisputed leader with the largest public debt are the united states. in 2011, the debt ratio to gdp in the world's largest economy has exceeded 100%, while the burden on everyone in the country increased almost up to $ 50,000, which is a very worrying sign. the second place belongs to the third world economy japan. considering relative terms the ratio has reached 200%. sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 49 the following countries are the european giants such as germany and italy, a little further are france, britain and spain. all the major economies of the old world are considerably burdened with debts. india and china are also among the first on the level of public debt in absolute terms, but due to the scale, both the country and the economy this figure is smoothed (in the case of china till 19%, india is saddled with more debt assuming relative size of its economy and this index already accounts to 52%). russia, thanks to action taken in the 2000s., today holds 123th place with 9% of public debt to gdp ratio and the absolute value of government debt does not exceed $ 36 billion. such a situation eventually had led to the fact that the world's rating agencies such as fitch and moody's had decided to lower the credit rating for developed countries. since the ratings had already been reduced for spain, belgium and italy. rating of greece due to risk of defaulting on sovereign bonds in the event of failure to provide assistance from the imf and the european mutual fund downgraded to “junk level” ca. in mid-february of 2012 the parliament of greece has finally adapted a program of spending austerity, both the european fund of stability and the european central bank made the first payment into the state budget in order to avoid technical default announcement on government bonds. in addition the investors, who had these bonds were made an offer of a "reassessment" of their securities with their subsequent partial redemption, as even with the powerful support of the largest countries in the european union greece is not able to pay all its obligations. the main thing is that the ratings of the largest and historically the most stable economies in late 2011 were also put to a review. thus, the credit rating of the u.s., germany, france, the uk could be reduced from the highest investment-grade aaa. a rating of italy, spain and many countries of eastern europe can fall down by one grade to a1 or a2. absolutely similar actions are taken in this by other major rating agencies such as fitch, s & p and dagong. thus, the credit risks have increased significantly, especially in developed countries, with the result that gives a kind of chain reaction in the entire world economy. since we were able to identify some regional and geographical relationship in economic integration, we will consider the situation with public debt in each region separately, grouped as follows: 1. nafta, including usa; 2. european union countries; 3. china; 4. japan; 5. saarc, including india and asean; 6. mercosur and including brazil and argentina; the united states and nafta as of november 17th 2011, total u.s. national debt amounted to $15.034 trillion. thus public debt reached 100% of u.s. gdp. economic analysis (2012, vol. 45, no. 3-4, 46-59) 50 figure 3. the u.s. public debt dynamics and debt to gdp ratio source: compiled by author based on data from “the historical tables: budget of the u.s. government – fiscal year 2011” historically, the budget expenditures of the united states exceed the revenues from the late 60s of the xx century (in 1970 u.s. budget surplus was recorded only four times in 1998-2001.). the national debt peaked at a ratio of gdp in 1946 due to the increased government spending significantly on defense, financed by the bonds, reaching 121.2% of gdp. the rapid growth of the u.s. economy (and, as a consequence, gdp) between 1965 and 1985 has reduced this value down to c.a. 40%. however, since the 1990s. public debt in the u.s. began to grow steadily. until the crisis of 2008-2009 (which began with the subprime mortgage crisis in the u.s.) increasing government spending, in fact, was compensated by rapid economic growth, while politicians and economists have been "distracted" by other problems. however, with a slowdown of the economy in the crisis and a sharp increase of government spending, the national debt has started to increase by 15-20% per annum. thus, in august 2011 the government had to increase the debt ceiling up to $ 15 trillion and the ratio of debt to gdp ratio reached 100%. at the same time the u.s. economy is the most important piece of a great mosaic called the world economy: first, the largest center of consumption, and secondly, the u.s. dollar is the world's reserve currency and the major means of payment for oil exporters, and third, the government bonds of the u.s. treasury (treasuries) considered as the benchmark treasury bonds, and reliability are the most popular means of storing capital. historically, many investors are willing to invest their money in the u.s. treasuries, even knowing that the rate of return on these securities may be lower than the inflation! largest holders of the u.s. treasury securities are japan and china. in case of technical default on the u.s. government bonds, these countries will suffer first. and they are the largest providers of products on the market, both the u.s. worldwide. that will start a chain reaction that would provoke an unprecedented decline in consumption and production, sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 51 respectively. following the u.s. dollar (in case of a default rate will fall a lot) will fall pound sterling as well, as the uk economy also depends heavily on the u.s. market. it will bring enormous consequences to the opec countries the fourth u.s. lender. the price of oil in this case may decline significantly, which negatively affects all economies dependent on exports of raw materials, including russia. with the default of the u.s. (which, as shown by the political events of the summer 2011 are more real than it might have seemed), the consequences can be enormous over the world. reserves in most countries will suffer huge losses, living standards will plummet in the u.s., consumption will be reduced, which in turn will degrade the production around the world. as a result the financial system will receive a great shock and the world will be for many years plunged into recession. not surprisingly, most experts tend to see the main threat to the world economy in the u.s. and more specifically in excessive public debt that was dramatically accelerated because of the crisis. thus there are still no any significant measures to reduce the level of debt are taken. the white house is aware of a problem for a long time, but the debate continues, there are a lot of populist statements, but still no real and acceptable solution is found. the approved plan to reduce the budget deficit at $ 2.4 trillion over the next 10 years does not hold water even in this case, the public debt of the country will rise to 150% of gdp by 2020. the u.s. neighbors’ public debt exceeds the "safe" level as well. canada and mexico were in a similar situation when, during a financial crisis, these countries were forced to loan a lot to support their banking systems and stimulate the economy as a whole. the situation in these countries is less critical, but in case of aggravation of the situation in the u.s. canada and mexico are to suffer from it more than anyone else, because nafta is historically oriented on the consumer market of the united states. the european union countries there are problems with critically high level of public debt not only in the u.s. the real debt crisis unfolded in a different financial center, emitting the second world reserve currency: the euro area. the last economic crisis has revealed serious imbalances in the fiscal policy in greece, where public debt reached 160% of gdp. stability of the common european currency was put in jeopardy. the decision to provide anthems with the financial assistance amounting to hundreds of billions of euros was taken, but this problem has much larger borders: the same problems occurred in ireland, spain and portugal. at the end of 2011, beginning of 2012 the situation became even more acute: there is a risk of escalation of debt crisis on one of the largest economies in the eu italy, whose debt (almost $ 2 trillion euro) exceeds the aggregate amount of debts of all mentioned above countries. the budget deficit of all the "problematic" countries since their accession to the eu and the euro area exceeded the maximum allowable level of 3%. during the crisis, deficit has been significantly increased and in some cases exceeded 15%. this is a disastrous impact on the level of public debt in these countries. the problem for small economies of the euro area is also the inability to print currency that could be used at least to nominally cover the debt. economic analysis (2012, vol. 45, no. 3-4, 46-59) 52 monetary union in the presence of advantages and has an obvious drawback the inability to implement a flexible fiscal policy. that is why the small euro area economy in the future will be even more dependent on germany and france. the leading eu countries such as germany and france do not extend beyond the established norm of 3%. however, italy and spain are experiencing significant difficulties in retaining this strip. that's why the most severe austerity measures introduced today in the "southern" european countries. it can be assumed that this situation will eventually lead to the fact that the position of germany and france will intensify following the debt crisis, while other eu countries, which have been prepared for the crisis to a lesser extent, may lose much of their "economic freedom". an interesting fact is that the biggest debt in europe is in germany over 2 trillion euros. however, thanks to a powerful economy on the one hand and effective fiscal policy and budget discipline on another, germany has a rate of debt to gdp ratio of 83% and this level is stable. the second-largest debt in italy (nearly $ 2 trillion euros), but due to the fact that its economy is much weaker than that of germany, and fiscal discipline suffers a lot, italy was recently ranked among the "problem countries" as well. it is obvious that the european stability fund won’t be able to cover the italian debt, so the country is considered as one of the main risk foci for the euro area. france on its debt and fiscal policy is very similar to germany and, in fact sarkozy and angela merkel have created a tandem, which promotes the idea of further integration of the european union, but under the auspices of the leading and most stable economies in europe, ie germany and france. perhaps in the history of the world, germany and france for the first time created a real union. however, with the election of new president of france, no one else has certainty that this tandem will continue to exist in its present form. after all, if the views of nicolas sarkozy and angela merkel in the regulation of debt were matching reducing government spending and stimulate production, francois hollande is a pronounced advocate of socialist and stimulate demand by increasing government spending. thus raises the question of whether two european politics finding a common approach to european debt problems. spain is still able to service its debt, but the pace of debt growth is very high. in addition, the situation in spain is complicated by the highest unemployment rate in europe. hence, a simple conclusion if no one works, there will be no money earned by the country. there are so called “problematic states”: greece, portugal, ireland. in all these countries, the ratio of debt to gdp exceeds 100%, and fiscal discipline to date is regularly violated. governments of these countries are taking the most severe austerity measures, hurting a lot any social activities and programs and causing unrest among citizens. according to statements of more successful neighbors in the european union there is no other choice for them, but to cut expenses and as a result decrease their living standards. but it would be a fair question, who led greece, portugal and ireland to the situation where they are today? on the one hand, of course, it is the fault of the governments of these countries, which cannot withstand the necessary fiscal discipline and year after year increased government spending. on the other hand, is it german, french, italian banks have not seen what was happening with fiscal discipline of these countries with dramatically increase in sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 53 government spending and growing debt? a few years ago it was already clear that the small european economies will be unable to pay its obligations. it is reasonable to assume that this was done with a reason. after all economic leverages has been historically one of the most effective tools of political influence. thus, we see that the current debt crisis is not a naive mistake of economists not keeping track for the budget deficit, but the prudent politicians using the most effective weapon of xxi century – the debt. moreover, such a radical reduction in government spending would inevitably result in a reduction of income, it entails a narrowing of the demand, which leads to contraction of the economy and ultimately exacerbate these problems. therefore any nation can be put on its knees. it is a fact that greece is the cradle of european civilization and there is something symbolic in the fact that the european civilization may begin its decline there as well. as noted above, there is a problem of high unemployment rate in europe. it should be noted that very high levels of unemployment are in spain (above 20%), italy (close to 10%), portugal (10.5%), ireland (13.2%), greece (10.2%). best results are showing all northern european countries: germany, austria, great britain and the benelux. figure 4. euro area public debt volumes and debt to gdp ratio source: compiled by author based on data from http://imf.org in this case, there is a correlation not only with the level of public debt, but to the level of fiscal deficit the more people work, the better the economy works, the more taxes the state collects. this is a very simple conclusion, but quite reasonable and actual especially in modern europe people want to work less and live better. summing up european debt problems we should note that with the current "weak" and inactive policy of european officials the debt problems of the old world may get worse. it is vital to tighten fiscal discipline, cut government spending and, as banal as it may sound, to work more. for now real problems are yet experienced by small states of europe. if, economic analysis (2012, vol. 45, no. 3-4, 46-59) 54 however, along with greece and other "problematic" countries there will be italy – the third euro zone economy – such a burden will become unbearable for the eu stability fund. default in at least one of the mentioned countries could cause a chain reaction throughout the euro area, destroying it which would entail a strong currency and the economic shock to the world. people’s republic of china paradoxically, another threat to the global economy lies in china, despite the fact that the level of public debt remains at quite a reasonable level of $ 428.4bn for such a huge economy, and the ratio of government debt to gdp ratio of is 35% only. during the global recession in 2008 china could hardly lose its gdp growth rate. stable yuan and competent crisis management policy aimed at stimulating domestic consumption, provided beijing more than a comfortable economic growth of 8-10% even in the hardest times. however, the trade imbalances (historically china exports much more than imports) and the chinese economy overheating are concerning experts lately even more. unlike europe, the u.s. and other developed countries china is not experiencing serious problems with public debt. the danger lies precisely in the excessive growth of the economy. the growth of welfare increases consumption and therefore increases inflation. in addition, distending "bubbles" in real estate and capital markets driving the government in a direction where it is becoming more difficult to control this process. the collapse of these bubbles could become a real threat to the global economy, causing billions in losses and shocks in the capital markets. the official inflation forecast of 3% in our opinion is undervalued. given this situation, if china will not dramatically change the current fiscal policy (quite “hard” and "non-market" already), the real inflation rate will continue to grow and may in the medium term achieve the level of more than 10%. active stimulation of domestic demand has its pitfalls. domestic strategic distortions are growing in chinese economy and although the chinese demand for commodities, as well as active investment policy of the chinese government now holds the entire global economy, the fact that they no longer have the opportunity to invest in dollar assets is a sign that china cannot endlessly keep the world on its shoulders. in addition, there is a high risk of deterioration in the trade balance of china in midand long-term. stimulating domestic demand, rise of living standards, increase of social spending (there are still no common retiring pension in china) may lead to sharp increase in government spending and therefore in imports, which can also adversely affect the future budgets of the country. chinese government is the largest holder of the u.s. and european government bonds. in case of default in these economies, china is going to lose a lot. overheating economy in china, which consumes almost on top at the u.s. led to a strong tightening of monetary policy in the country and the so-called practice of "hard landing" artificial measures inhibiting the chinese economy growth. yuan gradually growing stronger, despite the best efforts of the chinese government to keep this process under control. what new measures might take china's people's party to curb the growth of the national currency is unknown. nevertheless this is a risk factor for china's trading partners sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 55 as well. if in order to avoid further price increase the people's bank of china will continue to increase the reserve requirements and raising rates, chinese economy growth will decrease, reducing the demand for commodities. this will have an even greater pressure on prices for oil and metals, which again will affect the world economy as a whole. japan debt burden japan is one of major economical asian centers. it is not the first year the japanese economy suffering from the effects of "economic boom" that resulted in a "bubble". the main consequence is the level of public debt of 220% to gdp (11 trillion u.s. dollars) – largest among all developed economies. the volume of debt securities market of japan is second after the united states. ministry of finance of japan expects growth of public debt to a record of $ 997.71 trillion yen (12.167 trillion. u.s. dollars) in autumn 2012 – it will account for nearly 8 million yen or about $ 95k per capita. the beginning of this crisis is in early 1990s. the government was trying to stimulate domestic demand and investment, increasing the budget expenditures (34.6% increase in 1984-1990) and reducing the interest rate to zero. initially this kind of policy was a success – gdp grew during the 1984-1991 by 51.8% (at current prices). for japan, it was a golden age. for example, the u.s. imports for 1985-1990 increased by 46.7%, japanese imports increased by 80.4%. this marked the beginning of so-called "bubble economy". raising interest rates in the japanese central bank in 1990 gave the first impetus to the collapse. inflated prices for land and stocks fell for a short time, lowering the value of collateral bank loans. the economy began to accumulate, "bad debts", the banks began to reduce lending, exacerbating the decline. there was a vicious circle: a bad conjuncture squeezing out loans even worse conjuncture. by this time the international activities of japanese banks began to represent a threat to the western financial system. using low interest rate in the country, japanese commercial banks were providing cheap loans abroad. the volume of loans amounted to one third of total world output. in 1992 representatives of the western central banks have adopted a new rate of lending, which led to the need to reduce the amount of assets of japanese banks. the size of the disaster was enormous. the cumulative loss in value of the shares was 5 trillion u.s. dollars, and another 5 trillion was lost in the value of the land. this amount was comparable to the size of two years japanese gnp, although the living standard of most japanese was hardly affected. they lost profits from the "bubble" only. as a result to stimulate the domestic demand and to support national banking system the japanese government launched a program of mass domestic borrowings. in 1999-2003 the relative level of consolidated budget deficit reached 6-7.5% of gdp, ranking japan the first among developed countries by this parameter. in an effort to stimulate demand, the bank of japan reduced short-term interest rates on its loans a number of times and since 1999 the main landmark the refinancing rate of the bank of japan officially has repeatedly established at zero. till 2012 this rate never exceeded 0.3%, and in general over the years, the central bank conducted a de facto policy of zero economic analysis (2012, vol. 45, no. 3-4, 46-59) 56 interest rates. all other short-term interest rates on money market instruments are also sold with virtually zero returns. yields on long-term bonds fell in the same period, down to 0.71.6%. with each passing year it becomes increasingly difficult to refinance the debt domestic resources are not enough, and the country is increasingly turning to borrowing in foreign markets. on the other side, as well as in other developed countries, economic growth in japan is extremely low and highly unstable. country's financial situation deteriorated further in the spring of 2011 march 11 devastating earthquake and subsequent tsunami not only undermined the already volatile gdp growth, but also caused great damage to the economy, according to preliminary data, amounting to about $ 160bn. the government has to borrow again which is to increase even greater. and according to experts and governors there is no visibility how to reduce the country's debt burden. taking into account difficulties of the japanese government in the sale of its debt securities (investors are reluctant to invest in the bonds of a country with a record debt ratio to gdp), decreasing ratings and the increasing cost of servicing the debt, the probability of default of one of the largest economies in the world is increasing, although still remains low. first, the land of the rising sun has large reserves, and secondly, it can always devalue the yen, which, incidentally, is one of the most likely scenario, since japanese manufacturers, exporters are waiting impatiently for this event. the japanese economy needs a cheap yen and if for the people it may affect the living standards, for japanese export-oriented companies it will be a salvation. a risk for japan is a possible increase in government bond yields, which can make the unbearable burden of debt. another problem is demographic every year it becomes more and more costly to provide all social payments. a distinctive feature of the japanese system of debt associated with those who are investing in government securities. in japan, more than half of all outstanding obligations of the state is in state institutions government agencies and the central bank. at the same time, the share of foreigners in the market of public debt is several times lower than in other countries. this reduces market liquidity. however, it should be clear that it is impossible to normalize debt situation in japan without any external influence. nevertheless the country still retains the mentality of people unlike the americans, they do not live on credit, but rather “salting away” – accumulation of households is estimated at $ 9 trillion, which is a buffer on the path to default. another factor is the internal nature of debt distributed to the public agencies and corporations. summing up we can say that in case the current fiscal policy in japan won’t change dramatically it will be a time bomb. in this crisis, however, the country is unlikely to make its "valuable" contribution. sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 57 debt burden of india and asean in general, south-east asia holds a balanced budget policy and the level of public debt of most countries of saarc and asean kept within 50-60%. in many ways, this figure is achieved by a flexible fiscal policy. the example of india one of the promising bric countries. if you look closely at the graph of public debt to gdp ratio and the amount of debt we will not see any jumps and significant shifts in the crisis period 2008-2009. it looks like that the indian economy, significantly integrated into the global economy and having a strong dependence on the consumption in developed countries, was not affected by the crisis at all. however, if we turn our attention to the graph of cross-rupee exchange rate against the u.s. dollar, we see that the national currency of india dipped significantly in relation to all the world's reserve currencies. in fact, the indian government has graded the impact of the crisis by reducing the value of the rupee. living standards in india and in most countries of southeast asia is still quite low. lack of social guarantees from the government, and dependency on food imports and other essential commodities allow the government to "play" with the national currency rate is much broader than in the case of “solid” currencies. of course, such a policy has its drawbacks, such as the reduction of investment attractiveness and risks of social unrest on the part of the country's emerging middle class. but for now, we can say, india has the privilege and effectively uses it. debt burden of brazil and mercosur historically, the stability of the brazilian economy stemmed from the commodity sector, which gave a positive trade balance. thanks to a reasonable and restrained fiscal policy, the country managed to increase foreign exchange reserves, reduce public debt and as a result to make significantly lower real interest rates in the brazilian banking. the floating exchange rate, medium inflation rate and the strict fiscal policy are the three main components of the economic program in brazil. increasing productivity and high commodity prices contributed to the growth of brazilian exports. moreover, brazil has repeatedly made various measures to reduce the debt burden. for example, the country has reduced its debt burden in 2006 by shifting its external debt in to the internal one. debt to gdp ratio decreased in 2002-2008 from 79.8% to 63.6%. however, the crisis has hurt brazil export-oriented economy strong enough so the country was forced to enter the borrowing market increase its public debt. however, since 2010 the country continued the same course as before: total increase in public debt, reducing its ratio to gdp, clearly controlling the amount of borrowing and never exceeding the rate of economic growth. brazil one of the few countries that is really disciple in terms of budgeting and is going in line with its economic program. real exchange rate flexibility plays a significant role in the brazilian economy. the situation is not as straightforward as, for example, the indian rupee though. there is a negative effect because of currency volatility, and, until recently, its highest rate against the u.s. dollar and euro. no measures of the government – buy-out of the u.s. dollar by central bank of brazil in the spot market, or increase the tax on foreign investment in the stock economic analysis (2012, vol. 45, no. 3-4, 46-59) 58 market has not been successful. the high rate of real has a negative impact on brazilian exports, in particular, the export of raw materials and agricultural products. other latin american countries follow less restrictive fiscal policy, however, bringing the level of their debt to critical the vast majority of the countries hold the debt to gdp ratio at a level not exceeding 50%. references бочаров е. конкурентоспособность японской экономики во время кризиса 2008-2010 гг. // info-japan.ru. 29.06.2010.http://infojapan.ru/index.php?view=news_articles_full&newsid=53 cia. https://www.cia.gov/library/publications/the-world-factbook/geos/us.html colander, david and hrry landreth. 1998. "political influence on the textbook keynesian revolution: god, man, and laurie tarshis at yale", in o.f. hamouda and b.b. price, keynesianism and the keynesian revolution in america: a memorial volume in honour of lorie tarshis, cheltenham: edward elgar, 59–72. duval g. que peut faire françois hollande? // alternatives economiques. 07.05.2012 article web http://www.alternatives-economiques.fr/que-peut-faire-francois-hollande-_fr_art_633_58893.html eurostat. http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1& plugin= 1&language=en&pcode=tsieb090 european central bank statistical data warehouse http://sdw.ecb.europa.eu/browse.do?node=2018779 historical tables: budget of the u.s. government fiscal year 2011. washington: u.s. government printing office 2010 http://www.whitehouse.gov/sites/default/files/omb/budget/fy2011/assets/hist.pdf imf world economic outlook databases. http://www.imf.org/external/ns/cs.aspx?id=28 rbc analytics. http://top.rbc.ru/economics/12/08/2011/610249.shtml russobras. http://www.russobras.ru/economy_main.php s&p rating agency. http://www.standardandpoors.com/about-sp/key-statistics/en/us саакян а. «мыльный пузырь», «потерянное десятилетие» и новый период экономического роста // info-japan.ru. 27.11.2007. http://infojapan.ru/index.php?view=news_articles_full&newsid=21 treasury direct. http://treasurydirect.gov/np/bpdlogin?application=np based on imf.org and russia’s accounts chamber report 2011 treasury direct. http://treasurydirect.gov/np/bpdlogin?application=np the economist intelligence unit. http://gfs.eiu.com/default.aspx?registered=true u.s. government spending. http://www.usgovernmentspending.com/ 1http://www.whitehouse.gov/sites/default/files/omb/budget/fy2011/assets/hist.pdf sheremet, e., public debt geography, ea (2012, vol. 45, no. 3-4, 46-59) 59 geografski raspored javnog duga rezime – ovaj članak pruža makroekonomsku analizu javnog duga u glavnim ekonomskim regijama; svaka regija se razmatra sa aspekta javnog duga u odnosu na ključne makroekonomske pokazatelje, opisujući trenutno stanje javnog duga i izglede fiskalne politike u odabranim regijama. ključne reči: upravljanje javnim dugom, stopa razmene, zaduženost, spoljni i unutrašnji javni dug, ukupni dug, održivost javnog duga article history: received: 25 september 2012 accepted: 22 october 2012 doi: 10.28934/ea.22.55.2.pp66-78 first online: december 8, 2022 original scientific paper business process innovation of serbian entrepreneurial firms mihailo paunović1 | marija lazarević-moravčević1 | marija mosurović ružičić17f* 1 institute of economic sciences, belgrade, serbia abstract innovations are vital for improving living standards and can affect not only individuals but also institutions, economic sectors, and the whole country in many ways. this paper investigates the innovation performances of serbian entrepreneurial firms. it focuses on business process innovations related to product and business process development. the sample consists of serbian start-ups, which were founded in 2015, from five industries. the data about these entrepreneurial firms were collected via a questionnaire. the respondents assessed various statements about product and business process development innovations on a five-point likert scale (1-strongly disagree; 5-strongly agree). the statements were derived from several indicators within the balanced scorecard’s process perspective. they were modified to fit the new definition of business process innovation provided by the oecd/eurostat (2018) and according to the context of serbian entrepreneurial firms. the statistical analysis involved descriptive statistics, frequencies, reliability analysis, and one-way anova. the results indicate that most of the entrepreneurial firms introduced innovations that enabled them to operate more efficiently, improve their processes, establish certain routines, respond to customer complaints faster than their competitors, and develop a product or a service more quickly than their competitors. no statistically significant differences were found regarding introducing business process innovations among entrepreneurial firms from different industries. this paper can help policymakers assess the contribution of innovation to economic goals and monitor and evaluate the effectiveness of their innovation policies. keywords: innovation, entrepreneurship, business process innovation, serbia jel classification: o31, o32 introduction there are different interpretations of the innovation phenomenon in the professional literature. despite those differences, the expert community agrees that innovation is essential for the development of both the economy and society. innovation is a driver of economic growth (schumpeter, 1934); it affects employment growth and improves the quality of life (atkinson & ezell, 2014); and presents a condition for creating a competitive advantage (porter, 1985). innovation is important for all companies, regardless of their size or the activity they perform. companies that do not possess the ability to innovate lose their established positions in the market and are "doomed to fail" (drucker, 1996). in both theory and practice, innovation has been identified as a factor of growth, structure, transformation and the survival of various industries (barney et al., 1987; malerba, 2006). the * corresponding author, e-mail: marija.mosurovic@ien.bg.ac.rs mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 67 differences in growth rates between individual industries are well-known and obvious, as well as the fact that growth rates in certain industries constantly decline, while the other industries record highly intensive growth. high growth rates can be associated with a greater share of technological innovation in new products and processes and a high rate of diffusion of these innovations in the global economy. on the other hand, industries with a negative growth rate are generally characterized by a low rate of research and development intensity and a low rate of technological changes. however, the connection between technological progress and the growth of an industry does not necessarily mean that only technological innovations can encourage growth (freeman & louçã, 2001). similarly, it also does not always mean that the companies operating in low-tech sectors benefit less from their innovations. the results of innovation development in the market showed that a significant number of incremental improvements had better results in the market compared to the new technology itself (freeman, 1989; mosurovićruzičić & kutlača, 2015). innovations can result not only from scientific and technological knowledge, but also from the informal forms of knowledge and learning based on experience, increasingly depending, nowadays, on business process development as well. the strategic resource in the industrial society was capital, while in the post-industrial society (modern scientific and technological revolution), knowledge has become the basic productive force, i.e. leading to the creation of a "knowledge society" or "entrepreneurial society". by developing high technology, the factors of production, the structure of production, and business motives also keep changing. the problems of modern society can be solved and further developed on a new technological basis (ilić, 2003). innovations are needed by every company regardless of its size. the question of the influence of the size of an organization on its innovative ability has been discussed in numerous studies, and the agreement of the expert community has yet to be reached. some authors believe that larger firms are generally less efficient in introducing innovation compared to smaller ones (cooke et al., 1997; kamien & schwartz, 1975). dess et al. (2007) state that the larger the company is, the fewer innovative solutions there are. drucker's opinion is that it is not the "size" that is an obstacle to entrepreneurship and innovation, but the way of operational management and functioning of a company (drucker, 2020). furthermore, certain research has shown that small companies invest less in research and development due to a lack of financial resources; still, they conduct these activities more efficiently than large systems and can faster launch new products (burns, 2011). it is necessary to highlight the fact that the innovative activity of a company is not exclusively determined by financial capabilities, but this depends on the "stimulating organizational context in which such creative ideas arise and afterward get implemented (mosurović ružičić, 2012)". certain characteristics of small systems, such as simple organizational structure, effective communication and decision-making, strong organizational culture and employee commitment (kamenković & lazarević-moravčević, 2018; mosurović & kutlača, 2011; paunović et al., 2022) can encourage the innovative activity of these systems. also, the pressures from the environment (technology development, intense competition, changes in consumer demands, etc.) impose the need to review the existing business models and introduce innovative solutions related to a process or product. due to the lack of financial resources, small companies primarily implement innovations that do not involve high investments in research and development. these are usually innovations in the field of marketing and service delivery. we are talking about the innovations related to the application of new marketing methods which mainly involve certain changes in design, product packaging, promotion, placement, as well as the methods of defining the prices of products/services. the goal of innovation in marketing is to provide a better response to customer needs, to open new markets, or to ensure different product positioning in the market. small organizations are extremely innovative in the way how they manage customer relationships. smaller systems can find new ways to connect with customers and suppliers that 68 economic analysis (2022, vol. 55, no. 2, 66-78) enable them to reduce costs and time from ordering to the delivery of products. smaller organizations have proven to be extremely innovative in the market communication segment, especially during the crisis caused by the global outbreak of the covid-19 pandemic. due to the changes in consumer habits and behavior, there was a need to apply new approaches in market communication, implying the use of various online marketing tools (lazarević-moravčević et al., 2021). the authors of the paper investigate the innovation performance of entrepreneurial firms in serbia while focusing on business process innovation related to product and process development in companies. the paper starts with two research questions: (1) what is the innovation performance of entrepreneurial firms in serbia, and (2) does belonging to a specific sector impact the innovative performance of entrepreneurs? the methodology of the oslo manual, a guide for measuring innovation developed by eurostat and the oecd, will be used to define and analyze business process innovation. although there are different definitions in the literature, the term entrepreneurial firm is most often associated with start-ups not older than seven years. van praag and versloot (2007) define an entrepreneurial firm as a company meeting one of the following three criteria: (1) employing less than 100 people, (2) being founded less than seven years ago, and (3) a company which is new in the market. for these authors, the terms "entrepreneur" and "entrepreneurial firm" have the same meaning. accordingly, in this research, the term entrepreneurial firm means a start-up company in the republic of serbia, which was founded in 2015 and which has less than 100 employees. 203–218. theoretical background the etymological meaning of the verb innovate can be found in the latin language: innovare – to renew, to make something new again, and the noun innovatio means a new invention that improves a product or a method of work, a novelty, a change. the term innovation can be interpreted in different ways. according to schumpeter (1934), innovation represents conquering new markets, introducing new products and processes, using new raw materials, changing management and organization, etc. the same author points out that innovations are drivers of economic growth and that entrepreneurs, especially those who are inclined to take risks, are initiators of change and bearers of innovation. innovation includes technical, design, production, management and commercial activities for the purpose of launching a new or improved product/process in the market (freeman, 1982). the authors hill and jones (2007) interpret innovation as the improvement of a product, a production process, a management system, and the organizational structure of a company. stošić (2007) believes that „innovation implies the transformation of new ideas into new products/processes”. to put it differently, it can be understood as the process of turning an idea into a practical application realization. the definition of innovation generally refers to the development and successful conversion of an invention into a useful product (product innovation) or a technique (process innovation) considered worthy enough to be launched into the market, or to be used in a company. therefore, first of all, a distinction needs to be made between an invention and an innovation. innovation is the market realization of an invention. not all inventions end up becoming innovations, only the ones that have met the three basic classification requirements for a standard patent: (1) an invention needs to be new; (2) useful; (3) and to justify the inventiveness phase, i.e. "it needs to be non-obvious to experienced practitioners in the technological field" (semenčenko & kutlača, 2018). peter drucker believes that for the success of an innovation, it is necessary to perceive a need for it, and that innovation is not linked only to high-tech companies, but also to low-tech companies (drucker, 2020). mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 69 the growing attention that the innovation phenomenon attracts is related to a large number of factors that are partly determined by the economic discipline, and partly related to the increase in the empirical perception of the importance of technological factors for competitiveness and growth. for example, the number of empirical studies that underline the importance of technological innovation for achieving a competitive advantage is constantly increasing (castelli, 2012; farny & binder, 2021; nelson, 1988). according to the organization for economic co-operation and development (oecd), an innovation is "a new or improved product/process (or their combination) that is significantly different from a previous product/process and that is made available to potential users (product), or put into use (process)" (oecd/eurostat, 2018). in the latest edition of the oslo manual, a manual for measuring innovation, it is said that innovation changes the characteristics of one or more products or a business process, and, accordingly, a distinction is made between two basic types of innovation: product innovation and process innovation. in addition to the distinction between the two basic types of innovation in literature and practice, there is also a classification of innovations according to the degree of change they entail: radical and incremental innovations. radical innovations imply revolutionary changes and represent the abandonment of existing practices. on the other hand, incremental (gradual) innovations refer to the improvement of existing practices, i.e. products and services (dess et al., 2007). some authors make a difference between business model innovation, product process innovation, and marketing (latifi et al., 2021). different interpretations of the term business process innovation can be found in the literature. the author gershon (2009) believes that business process innovation implies the systems and methods for improving the business performance of an organization, while varela et al. (2020) state that a company implements business process innovation if it has introduced one or more business functions significantly different from previously introduced business processes. the oslo manual, whose methodology is mostly used in the paper, defines business process innovation in the following way: "a business process innovation is a new or improved business process for one or more business functions that differs significantly from the firm's previous business processes and which has been brought into use in the company" (oecd/eurostat, 2018, p. 72). business process innovations include improvements in various business activities such as producing goods and services, marketing and sales, information and communication technology, distribution and logistics, administration, etc. based on the above-mentioned, it can be concluded that the term innovation is broader compared to the development of new products, processes, or technology. innovation implies the introduction or change to a new state (johannessen et al., 2001). although there are innovations that are the result of a spur-of-the-moment idea, the majority of successful innovations are the result of a diligent and targeted search for innovation opportunities that can be spotted on rare occasions. the connection between entrepreneurship and innovation, as well as their impact on economic progress, has been proven in numerous studies. there is consensus that the entrepreneurial orientation of firms determines and improves their innovativeness (khalili et al., 2013; minafam, 2017; zen et al., 2016). most of those researches elaborate only on the technological dimension of innovation within the entrepreneurial framework (acs & gifford, 1996). there are some researches that observed just particular components of a business innovation process in terms of the relationship between corporate entrepreneurship and innovation performance (minafam, 2017), the relationship between innovation in business and smes performance (muparangi & makudza, 2020), etc. however, there are only a handful of studies that integrate all the elements of business process innovation. one of the reasons could be that the definition of business process innovation that we used in this paper is from the latest oslo manuel edition from 2018. 70 economic analysis (2022, vol. 55, no. 2, 66-78) entrepreneurship can be described most simply as a process in which an individual or a group of people uses an organizational effort to seize valuable opportunities and create value (drucker, 1996), and innovation is a specific tool of entrepreneurs, i.e. a means by which entrepreneurs use a change as an opportunity to perform various production or service activities (drucker, 2020). entrepreneurship begins with innovation, i.e. innovation is one of the basic characteristics of entrepreneurship. when talking about an entrepreneur, drucker notes that what successful entrepreneurs have in common are not certain personality traits, but a commitment to innovation. in fact, an entrepreneur is "an independent innovator, meaning that the activities of this individual include, but also go considerably beyond, technical inventions and their utilization" (baumol, 2002). innovation is the way entrepreneurs use existing and create new business opportunities. there are four types of sources of such opportunities within a company or an industry: (1) unexpected events, (2) inconsistencies, (3) the need to perform a process, and (4) changes in the structure of an industry or market. three additional sources also exist outside a company, i.e. in its environment: (1) demographic changes, (2) changes in perception, and (3) the emergence of new knowledge (drucker, 2002). it is necessary to emphasize the fact that entrepreneurship is present in different areas of human activities and implies different behaviors. the most significant are: taking the initiative, practical use of resources, and accepting risks (čičovački & kulić, 2022). the authors bolton and thompson (2004) find a connection between invention, creativity, and entrepreneurship. their opinion is that "creativity is the starting point, whether it is related to invention or finding new business opportunities. that creativity is transformed into a practical reality (a product or a service) by means of innovation. afterward, an entrepreneur puts that innovation into the context of the company and thus creates a value recognizable in the market". there is a difference between creativity and innovation, i.e. creativity is a part of the process of creating innovations. creativity contributes to the creation of innovations, but it can also be used for other things. on the other hand, to turn creativity and invention into a business reality, it is necessary to place them in an entrepreneurial context that primarily refers to identifying business opportunities. the relationship between creativity, invention, innovation, identifying business opportunities, and entrepreneurship is shown in figure 1. figure 1. creativity, invention, innovation, business opportunities, and entrepreneurship source: the authors based on burns (2011). invention innovation ability to spot opportunities ability to be creative competitive advantage mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 71 based on what has been said, it can be concluded that innovation and entrepreneurship are closely related and that, together, they can determine the development of an economy and society. innovation is a way how entrepreneurs exploit existing or create new business opportunities, and this does not happen by accident. the key role in their creation is played by entrepreneurs who are characterized by focus, persistence, and dedication. data and methodology the data on the entrepreneurial firms were obtained based on an online questionnaire that was sent to them via email. along with the questionnaire, the respondents were also sent a cover letter in which they were informed of the purpose of the research and the time needed to complete the questionnaire in order to motivate them to give their answers. within the first thematic unit, there were general questions describing the structure of the sample (table 1). in addition, the respondents evaluated various statements related to the implementation of innovations regarding product and process development in the company, using a five-point likert scale (1-absolutely disagree, 2-disagree, 3-partially agree, 4-agree, 5-absolutely agree). the questionnaire method of data collection was chosen since the research subject could best be approached in that way. having finished the data collection phase, the statistical data processing phase began in which the ibm spss (statistical package for the social sciences) software was used, enabling high-quality and analytically correct data processing. the research was conducted in compliance with the procedures characteristic of empirical research. the indicators of business process innovation were systematized at a general level based on several indicators in the alignment list in the process perspective section. they were further modified in order to fit the new definition of business process innovation given by the (oecd/eurostat, 2018), and the business context of the entrepreneurial firms in serbia. the statistical analysis included descriptive statistics, frequencies, reliability analysis, and the comparison of the arithmetic means of several samples (one-way anova). the sample included start-up companies established in 2015 from five different sectors from the territory of the republic of serbia. the initial database consisting of 1,131 companies was obtained from the ministry of economy of the republic of serbia. the founders of those companies were sent a questionnaire via email. between december 2018-april 2019, 140 valid answers were collected, indicating that the response rate was 12.38%. this study uses the definition of a start-up company provided by the global entrepreneurial monitor (gem, 2018), according to which an entrepreneurial firm or a start-up is a company old less than 42 months. when the survey was conducted, all companies participating in the research were less than 42 months old. table 1 shows the sectoral structure of the companies that participated in the research and that constituted the final sample. the structure of the sample showed that the majority of the companies from the wholesale and retail sector participated in the research, while the smallest number of the companies was from transport and storage. 72 economic analysis (2022, vol. 55, no. 2, 66-78) table 1. number of the companies that participated in the research sectors included in the sample number of the companies percentage in the sample 1. manufacturing industry 40 29% 2. wholesale and retail 46 33% 3. transport and storage 12 9% 4. information and communications 16 11% 5. professional, scientific, innovative and technical activities 26 18% in total 140 100% source: the authors regarding the size of the companies participating in the research, 130 are micro-enterprises, and only 10 of them are small enterprises. it can also be noticed that 56 companies have their headquarters in belgrade, 10 in novi sad, while the other companies have their headquarters in other towns in serbia. table 2 displays the descriptive performance indicators of the companies in the sample at the end of 2017. table 2. descriptive indicators for the companies in the sample at the end of 2017 arithmetic mean median standard deviation the minimum the maximum sales revenue (in thousands of dinars) 36,059 21,337 42,184 361 224,387 operating profit (in thousands of dinars) 1,707 518 5,590 -19,589 33,745 net profit (in thousands of dinars) 1,368 335 4,838 -19,856 28,706 number of employees 7 5 7 3 49 source: the authors the entrepreneurial firms participating in the research have an average of seven employees. the smallest number of employees is three, and the largest is 49. as for profitability, only 15 entrepreneurial firms have reported a net loss, while the remaining 125 have reported a positive net result. results and discussion on a five-point likert scale (1-absolutely disagree, 2-disagree, 3-partially agree, 4-agree, 5absolutely agree), the respondents rated six statements related to the introduction of business process innovations regarding product and process development in their companies. table 3 shows the results of the research. it shows the descriptive statistical indicators for each of the six statements based on which the innovative activity of the entrepreneurial firms in serbia was measured. mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 73 table 3. descriptive indicators for the statements based on which the innovative activity of the entrepreneurial firms was measured product and process development number of responses arithmetic mean standard deviation 1. our enterprise introduced numerous innovations that resulted in more efficient operations. 140 3.61 1.04 2. majority of employees are committed to introducing innovations that lead to the continuous improvement of the processes performed in the company. 137 3.69 0.94 3. certain routines have been established in our company, which has led to more efficient operations. 140 3.88 0.83 4. the innovations we introduced allowed us to respond to customer complaints more efficiently than our competitors. 136 3.96 0.93 5. the innovations we introduced allowed us to develop a product/service faster than our competitors (a shorter period from creating an idea to the market launch). 133 3.53 1.07 6. customer suggestions lead to the improvement of the processes that take place in the company. 140 3.46 0.98 source: the authors bearing in mind that the entrepreneurs rated their innovative activities on a five-point likert scale and that the mean values of all their answers were greater than three, it can be concluded that the majority of the entrepreneurial firms in the sample implemented business process innovations related to product and process development in the company. to be precise, 55% of the respondents cited that their company implemented numerous innovations that led to more efficient operations, 62% that most of their employees were committed to introducing the innovations leading to the continuous improvement of the processes they performed, 70% that the established routines in their company led to more efficient operations, 70% that their company introduced the innovations that enabled them to respond to customer complaints more efficiently than their competitors, 51% that their company introduced the innovations that enabled them to develop a product/service faster than their competitors, and 53% that certain customer suggestions led to the improvement of the processes taking place in their company. the research results indicated that entrepreneurial firms that participated in the study introduced numerous business process innovations that enabled them to operate more efficiently, improve the processes, establish certain routines, respond more quickly to customer complaints compared to the competition, and develop products/services faster than the competition. what is interesting is that more than two-thirds of the companies established routines that enabled more efficient operations and introduced innovations that enabled them to respond faster to customer complaints compared to the competition. furthermore, more than half of the surveyed companies paid attention to customer feedback and improved their processes accordingly. in order to determine whether there are statistically significant differences regarding the introduction of business process innovations among the entrepreneurial firms belonging to different sectors, a statistical technique was used to compare the arithmetic means of several samples (one-way anova). for this purpose, the companies belonging to transport and storage, information and communications, and professional, scientific, innovative and technical activities are classified as service companies in order to make their number similar to the number of the companies belonging to the sectors manufacturing industry (manufacturing enterprises) and wholesale and retail (trading companies). table 5 shows the results of a oneway anova test for business process innovations related to product and process development in the companies. since homogeneity of variance is a necessary assumption for using a one-way 74 economic analysis (2022, vol. 55, no. 2, 66-78) anova test, levene's test for equality of variances was conducted, whose results are displayed in table 4. table 4. the test of homogeneity of variances development of products and processes levene statistic sig. item 1 0.85 0.43 item 2 1.71 0.19 item 3 0.38 0.69 item 4 0.58 0.56 item 5 0.18 0.83 item 6 0.06 0.94 the results are significant at the 0.05 level source: the authors the results of levene's test for equality of variances are not statistically significant for any of the six statements that the respondents stated in the questionnaire, which indicates that the decision to use a one-way anova test is justified. table 5. descriptive statistics and one-way anova development of products and processes n mean std. dev. one-way anova f sig. item 1 manufacturing 40 3.58 1.13 0.41 0.67 trade 46 3.52 1.05 services 54 3.70 0.96 item 2 manufacturing 40 3.53 1.01 1.74 0.18 trade 44 3.61 0.95 services 53 3.87 0.86 item 3 manufacturing 40 3.90 0.84 0.48 0.62 trade 46 3.96 0.82 services 54 3.80 0.83 item 4 manufacturing 38 3.87 0.91 0.24 0.79 trade 46 4.00 0.99 services 52 3.98 0.90 item 5 manufacturing 37 3.59 1.04 0.56 0.57 trade 44 3.39 1.15 services 52 3.60 1.03 item 6 manufacturing 40 3.68 1.02 1.72 0.18 trade 46 3.48 0.96 services 54 3.30 0.96 the results are significant at the 0.05 level source: the authors the results of the one-way anova test are not statistically significant for any of the six statements that the respondents rated in the questionnaire, which indicates that there are no significant differences regarding the introduction of business process innovations among entrepreneurial firms belonging to different sectors. manufacturing companies (manufacturing industry), trade companies (wholesale and retail), and service companies (transport and mihailo paunović, marija lazarević-moravčević, marija mosurović ružičić 75 storage, information and communications, as well as professional, scientific, innovative and technical activities), on average, introduced an equal number of business process innovations related to product and process development in their companies. cronbach's alpha coefficient was used to determine the reliability of the measuring instruments. it measures the internal consistency and indicates how closely related the questions in the questionnaire are which measure the same type of influence. reliability means that the respondent should get the same result if he/she completes the questionnaire under exactly the same conditions at two different points in time, and two respondents who are identical in everything should get the same result (paunović, 2021). the general rule is when the value of this coefficient is above 0.7, it is considered acceptable. due to the fact that the value of cronbach's alpha coefficient is 0.775 for the instruments based on which the innovative activity of the entrepreneurial firms was measured, it can be concluded that they have adequate reliability. conclusion entrepreneurship and innovation represent the basic factor of technological progress, economic and social growth and development. more precisely, "innovativeness, entrepreneurship and economic development are inextricably linked, interdependent, and in continuous correlation" (šormaz, 2021). innovativeness represents one of the basic dimensions of entrepreneurial orientation. it implies the willingness of a company to permanently introduce new or improve the existing products and processes, and to find new markets and new ways of serving them. innovation is vital for every individual, organization, economic sector and economy as a whole. in dynamic business conditions, innovation represents a basic condition for the survival, growth and development of an organization and presents a source of competitive advantage. to the best of the authors’ knowledge, based on the review of the available literature, no similar research has ever been conducted in serbia, having entrepreneurial firms as its subject. some aspects of business process innovations of family businesses were analyzed (paunović et al., 2022); however, a comprehensive review of entrepreneurial firms has not been done. the paper analyzes the innovative ability of entrepreneurial firms in serbia. based on the research, it can be concluded that most of the surveyed entrepreneurial firms introduced innovations in business processes related to product and process development in the company. more precisely, most of the entrepreneurial firms introduced innovations that enabled them to operate more efficiently, improve processes, establish certain routines, respond faster to customer complaints compared to competitors, and develop products/services faster than competitors. in the paper, no statistically significant differences were found regarding the introduction of business process innovations among entrepreneurial firms from different sectors. this research indicates the importance of analyzing business process innovation in entrepreneurially-oriented companies, and represents only one perspective of the research topic. there are certain limitations of the analysis that can serve as a good basis for conducting further research. the geographical aspect of the research, which results from the fact that the research was conducted only in the entrepreneurial firms in serbia, is one of the shortcomings. companies from other countries were not included, which did facilitate data collection, but, at the same time, limited the use value of the collected data. the results of this research are valuable for decision-makers at all levels. the managers of entrepreneurial firms should pay attention to business process innovation elements in their strategies. on the other hand, the conclusions of this research could be useful for the policymakers at the governmental level to stimulate the entrepreneurial behavior of companies. the importance of entrepreneurship for economic development is essential, especially in the era 76 economic analysis (2022, vol. 55, no. 2, 66-78) of the digital economy when business process functions should be aligned with digital technology development (wang et al., 2022). the authors analyzed only one of the six types of business process innovations from the oslo manual, that is, only business process innovations related to product 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(2016). innovative entrepreneurship and competitive performance: the prime/brazil case. revista de negócios, 20(2), 40. https://doi.org/10.7867/1980-4431.2015v20n2p40-56 article history: received: 23.11.2022 revised: 6.12.2022 accepted: 8.12.2022 doi: 10.28934/ea.22.55.2.pp20-30 first online: november 1, 2022 original scientific paper covid-19 and serbian stock market response: a panel data approach bojan đorđević1 | sunčica stanković14f* 1 megatrend university belgrade, faculty of management zaječar, zaječar, republic of serbia abstract in this paper, the authors attempted to explore the relationship between the covid-19 coronavirus pandemic and the stock market in the republic of serbia. the main research variables on the stock market are the daily values of the belex 15 and belex line indices and trading volume. for the pandemic variables, official daily data on the number of new covid-19 cases in serbia, europe, and the world were taken. by applying the panel regression analysis for the period from 03/06/2020 to 12/30/2021, the empirical results show a positive and significant influence of the number of daily infected in serbia and europe on the stock market index value, at the same time, the influence of daily infected ones on trading volume is negative but statistically significant only when it comes to the new cases of coronavirus per day at the level of europe. the presented results indicate the resilience of the serbian capital market to internal and external shocks. keywords: covid-19, stock market indices, belgrade stock exchange, panel data analysis jel classification: c33, d53, i10 introduction the covid-19 pandemic, besides the uncertainty and panic, led to a temporary lockdown in many states and the slowdown of economic activities. almost two years after the pandemic started, the companies’ performance downfall is visible in all sectors, affecting the financial markets, specifically stock markets (okorie and lin, 2021). according to zaremba et al. (2020) and singh et al. (2020), in terms of the covid-19 crisis, the intervention of governments and central banks of numerous countries has significantly increased the volatility of the international capital market. at the same time, the official statistics of who mark the increase in the daily number of infections and deaths all over the world, along with the growing resistance of the population towards vaccination (world health organization, 2021). financial markets reacted quickly, reflecting the magnitude of the crisis potential. in march 2020, the s&p 500, euro stoxx 600, and nikkei 225 indices plummeted by 9.5, 8.3, and over 10%, respectively. a similar situation happened with the chinese financial market, affecting the value of the sse composite index of 7.72% and the szse component index of 8.45%. the indices of the belgrade stock market on the serbian capital market have experienced, during february and march 2020, a significant drop in their values, following global stock indices. companies’ stock prices and belex 15 and belex line index values continually and intensively kept plunging until march 24, 2020. since then, the values have been going up. the initial * corresponding author, e-mail: suncica.stankovic@fmz.edu.rs bojan đorđević, sunčica stanković 21 reaction of markets was brutal and escalated, which is commonly expected investors' behavior in times like these. on the other hand, there is an opinion that the market recovered by investors’ faith in normalization time and life and economic activities (naseem et al., 2021). crucial psychological moments and positive signs for investors, which also transmitted to the serbian capital market, came from the global vaccine manufacturers – first in the form of development announcements and later as the presence and distribution of covid-19 vaccines. bearing in mind the current state of the pandemic and the dynamic of price movements on global stock markets, the subject of this research is the covid-19 and serbian stock market response through the implementation of the panel regression analysis. the goal is to investigate relations between indices values and trading volume on the belgrade stock market on one side, and daily infections in serbia, europe, and the world, on the other. following the subject and goal of the research, there are two questions: 1) does the number of daily infected in serbia, europe, and the world affect the value of the belgrade stock market index? 2) does the number of daily infected in serbia, europe, and the world affect the volume of trading on the belgrade stock market? to answer the research questions, we structured the paper as follows: after the introduction, the second part gives a short literature review, reflecting on the most significant results; the third part presents research methods; part four exposes empirical results, while the last part portrays conclusions, restrictions, and recommendations for future studies. literature review the global pandemic contributed to an increase in research on covid-19 influence on financial markets. analyzing key indicators of pandemic effects on overall and local levels (the number of infected, deceased, and vaccinated, in correlation with prices and yield for most relevant global and regional stock market indices), most of the obtained results show a significant correlation and the effect of a current pandemic on market volatility and stock price movements. a short review of some latest research is set hereafter. singh et al. (2020) examined the pandemic impact on the stock markets of g-20 countries, using an event study to measure abnormal returns (ars) and panel data regression to explain the causes of ars. the observed window comprises 58 days after the news of the covid-19 outbreak was released on the international media, and the estimation window consists of 150 days before the announcement. the results confirmed the recovery of stock markets from the covid-19 negative impact. zaren and hizarci (2020) analyzed the possible effects of covid-19 on stock markets using daily stock indices data. the cointegration test using covid-19 daily infections and deaths was used to question possible outcomes on the stock markets. the sse, kospi, and ibex35 indices have a cointegration relationship with the number of infections, while ftse mib, cac40, dax30 indices don't. onali (2020) researched the effects of the pandemic on the dow jones and s&p500 indices. the outcomes confirmed the covid-19 crisis did not affect the us stock market returns. however, var models indicated the number of coronavirus-related deaths in italy and france had negative implications on stock market returns and positive ones on the vix returns. ali et al. (2020) tested the effect of the covid-19 crisis on the global financial market. analyzing periods of epidemic and pandemic, they stress the substantial effects of the pandemic on commodity and stock markets. the results show a negative correlation between gold price movements and the resistance of the chinese capital market. baker et al. (2020) gained results of the pandemic’s severe effect on the us stock market compared to the 20th-century historical crises. höhler and lansink (2020) measured the pandemic influence on the volatility of stocks of companies that manufacture and distribute consumer goods listed within the most relevant global stock market indices. the results show considerable effects of the pandemic on the growth of volatility of all companies’ stocks, apart from the ones of companies that produce and supply food. bai et al. (2020) used the garch-midas model to analyze the pandemic effect on stock markets in the usa, china, great britain, and japan. a significant impact on the international stock market was 22 economic analysis (2022, vol. 55, no. 2, 20-30) evident, but individually a small effect on the chinese stock market. lee and lu (2021) researched how the covid-19 pandemic affected the taiwanese stock market. the result was the stocks of companies with a higher level of corporate social responsibility (csr) are more resilient to the current crisis. ozkan (2021) tested a market efficiency hypothesis on the stock market of several developed countries. the gained results of econometric models indicate high power to predict abnormal yields during the pandemic. hsu and liao (2022) explored behavior in the us market, with stock volatility, trading volume, and yield as elementary variables on one side and the number of infected and deceased on the other side. there is a positive correlation between the coronavirus effect and stock price volatility and trading volume and a negative correlation between the pandemic and stock yield. amin et al. (2021) inspected the pandemic effect on stock market indices in north, central, and south america. through panel regression analyses, they deducted the number of infected has a considerable bad influence on stock price volatility, except for the south american countries, with no significant statistical correlation. sahoo (2021) and bora and basistha (2021) studied the covid-19 influence on the indian stock market, comparing stock index yields from two different periods – before the crisis and during one. the outcomes obtained by the regressional and garch model show a statistically significant positive correlation with stock market volatility and movements during the pandemic. tapaloglu et al. (2021) used the panel data analysis method to present the relationship between the pandemic and stock markets in turkey, belgium, germany, france, italy, spain, the united kingdom, the united states, china, and the netherlands. covid-19 data is based on the total number of cases and the total number of deaths, while stock market data relies on major stock indices of countries. there was a negative relationship between the total number of cases and the stock market and a positive one between the total number of deaths and the stock market. khalid et al. (2021) used a panel quantile regression model of 17 developed stock markets to show the pandemic's impact on stock market returns and volatility. they proved there is no significant impact of the coronavirus on stock returns. moreover, it had a positive effect on stock market volatility. research methodology to analyze the relation between daily infections in serbia, europe, and the world and index value on the belgrade stock market, that is, trading volume, we used daily data for the period 03/06/2020 to 12/30/2021. there is a time series (t) of 462 days, while the number of observed entities (n) is two (belex line and belex 15). therefore, the number of observations encompassed within these panel analyses is 924. due to the robustness of the data, the dependent variables are logarithmically transformed. data on daily infected was gathered from the web portal our world in data, while the information on index value and trading volume was from the belgrade stock exchange web page. table 1. description of the variables used in the regression analysis variable description source belex 15 indice b15 stocks of the 11 most liquid serbian companies daily data of b15 value belgrade stock exchange https://www.belex.rs/trgovanje/indek si/belex15/istorijski belex line indice bl stocks of the 34 serbian companies daily data of bl value belgrade stock exchange https://www.belex.rs/trgovanje/indek si/belexline/istorijski trading volume daily data of the number of stocks belgrade stock exchange https://www.belex.rs/trgovanje/indek si/belex15/istorijski https://www.belex.rs/trgovanje/indek si/belexline/istorijski bojan đorđević, sunčica stanković 23 variable description source number of new cases of coronavirus in serbia daily data who https://covid19.who.int/ number of new cases of coronavirus in europe daily data who https://covid19.who.int/ number of new cases of coronavirus in world daily data who https://covid19.who.int/ the dependent variables of the research are as follows: the first analysis – the belgrade stock exchange index value (belex 15 and belex line); the second analysis – tk trading volume. the independent variables in both analyses are the number of daily infections in serbia, europe, and the world. the description of variables is presented in table 1. the descriptive statistics of variables used in the analyses are given in table 2. it shows calculated values of the central tendency measures and variabilities. data on the number of observations, arithmetic mean, standard deviations, that is, the average deviation of arithmetic mean, minimal and maximal parameter values are in the columns. table 2. descriptive statistics of the research variable variable obs. mean std. dev min max stock indices values 924 1156.358 426.6729 606.62 1721.16 trading volume 924 1.08e+07 3.42e+07 26131 4.52e+08 serbia 924 2081.121 2438.846 0 9983 europe 924 156306 128847.1 1510 989061 world 924 540773.1 176226.8 25521 1934140 source: authors’ calculation the following graphs (figure 1 and figure 2) illustrate the movement of belgrade stock market index value, belex line and belex 15, and trading volume from march 6, 2020, to december 30, 2021. based on figure 1, it can be noted that the movement trend of both indices is uniform. after the start of the coronavirus pandemic, the value of both indices decreased, and then with the stabilization of the financial market, the value of both indices increased. živković (2022) also points to the marked volatility and uniform trend of the observed indices in the period from 2008-2022. figure 1. movement of stock market index values and trading volume on bse source: authors 50 0 10 00 15 00 20 00 mar2020 dec2021mar2020 dec2021 belex line belex 15 in de x va lu es 0 5. 00 0e +0 8 mar2020 dec2021mar2020 dec2021 belex line belex 15 tr ad in g vo lu m e 24 economic analysis (2022, vol. 55, no. 2, 20-30) research methods research methodology and data analyses are based on panel data, that is, on regression models of panel data (panel data regression model – pdrm). the preliminary part of econometric analysis evaluates different formulations of statistic models and then runs various tests to choose the most suitable model for research data, as well as econometrical diagnostic tests to check if the model presumptions are fulfilled (specification model errors, multicollinearity, auto-correlation, and heteroscedasticity). the analysis uses strictly balanced datasets (“full” time series). the least-squares model (pooled ols – pols), fixed-effect model (fe), and random-effect model (re) were used for testing. the following model is specified to explain the dependent variables by using independent ones: 𝑌𝑌𝑚𝑚𝑡𝑡 = 𝛼𝛼 + 𝛽𝛽1𝑋𝑋1,𝑚𝑚𝑡𝑡 + 𝛽𝛽2𝑋𝑋2,𝑚𝑚𝑡𝑡 + 𝛽𝛽3𝑋𝑋3,𝑚𝑚𝑡𝑡 + 𝑢𝑢𝑚𝑚 + 𝑒𝑒𝑚𝑚𝑡𝑡 (1) where: 𝑌𝑌𝑚𝑚𝑡𝑡 – dependent variable: in the first research ln(index value – iv), in the second research ln(trading volume – tv). 𝑖𝑖 – entity (in the first analysis: 1 = belex line value, and 2 = belex 15 value; in the second analysis: 1= belex line trading volume, and 2= belex 15 trading volume); 𝑡𝑡 – time (in both analyses: 1 = 06.03.2020.... 462 = 31.12.2021.). 𝛽𝛽 – coefficient for respective independent variables; 𝛼𝛼 – intercept; 𝑋𝑋1 – independent variable (number of daily infections in serbia s); 𝑋𝑋2– independent variable (number of daily infections in evropi e); 𝑋𝑋3 – independent variable (number of daily infections in the world w); 𝑢𝑢𝑚𝑚 – the individual impact of the ith entity; 𝑒𝑒𝑚𝑚𝑡𝑡 – the error term. results of econometric tests a) model 1 was evaluated through econometric tests, where the dependent variable of the stock market index value (iv) is given as a linear stochastic function of independent, i.e., explanatory variables: 𝐼𝐼𝐼𝐼𝑚𝑚𝑡𝑡 = 𝛼𝛼𝑚𝑚 + 𝛽𝛽1𝑆𝑆 + 𝛽𝛽2𝐸𝐸 + 𝛽𝛽3𝑊𝑊 + 𝑢𝑢𝑚𝑚 + 𝑒𝑒𝑚𝑚𝑡𝑡 (2) the random effects model was chosen as the most appropriate model (table 4). according to the determination coefficient, for the re model, 9% (r2 = 0.09) variations of the dependent variable are explained based on independent variables. the values of f statistics point to statistical significance re model (prob > f = 0.0000). hausman’s test checked whether the individual effects are correlated with regressors, in which case the fe model would be more suitable. according to hausman’s test results, the significance is higher than 0.05 (χ2 = 0.00, p = 1.0000). thus, we accept the null hypothesis claiming that the re model is more appropriate than the fe model. the justification of the re model is tested with the breusch and pagan lm test (lagrange multiplier) for testing the existence of individual effects. if the test significance is > 0.05, the null hypothesis (no heterogeneity between observed entities) cannot be rejected, which means pols is more suitable than the re model. the test results indicate the level of significance is lower than the set level (χ2 = 2.0e+05, p = 0.0000), so we can conclude the re model is more suitable than the pols model. ramsey reset test was used to check if the model bojan đorđević, sunčica stanković 25 is well-specified. the results gained (f(3, 917) = 0.62; prob > f = 0.6049) indicate no significant variables left out of the model. in the next step, with the use of the pasaran cd test, we looked for serial correlation problems in the model. the null hypothesis is – no serial correlation. the statistical significance of the test is higher than 0.05 (p = 0.4511), meaning the null hypothesis about the non-existence of a serial correlation can be accepted. also, wooldridge’s test for autocorrelation in the panel data indicates there is no serial correlation (p = 0.1910). white’s test was used for heteroscedasticity testing in model 1. if the χ2 statistic probability obtained by this test is higher than the error risk α (α = 5%), the null hypothesis cannot be rejected. the probability value of chi statistics in this test is 0.1121, and with the error risk of 5%, we cannot discard the null hypothesis, confirming the homoscedasticity errors in the model. results from the panel analysis for the re model indicate a positive and significant influence of the number of daily infections in serbia and europe on the index value of the belgrade stock market, while the effect on a global level is positive but not statistically significant. table 4. evaluation of random-effect model with index value dependent variable, and diagnostic tests index values coef. std. err. t p>|t| serbia 5.60e-06 8.97e-07 6.24 0.0001 europe 2.16e-07 1.79e-08 12.10 0.0001 world 1.15e-08 1.15e-08 0.99 0.321 constant 6.928381 .3817168 18.15 0.0001 diagnostic tests hausman’s test χ2(3) = 0.00; p = 1.0000 lm test chibar2(01) = 2.0e+05; prob > chibar2 = 0.0000 ramsey reset test f(3, 917) = 0.62; prob > f = 0.6049 pasaran cd test 0.438; p = 0.4511 wooldridge’s test f(1, 1) = 18.593; prob > f = 0.1910 white’s test χ2 (9) = 12.60; prob > χ2 = 0.1121 note: r squere = 0.09; prob > f = 0.0000; root mse = 0.39; number of observations = 924. source: authors’ calculation to test linear dependence between explanatory variables, that is, to probe the existence of harmful multicollinearity in a regression model, the variance inflation factor (vif), as well as tolerance factor – 1/vif, were used. based on the results in table 5, it can conclude the model has no harmful multicollinearity. table 5. multicollinearity test variable vif 1/vif serbia 1.56 0.640600 europe 1.73 0.577339 world 1.35 0.740278 mean vif 1.55 source: authors’ calculation b) model 2 was econometrically tested, where the dependent variable stock trading volume (tv) is presented as a linear stochastic function of independent variables: 𝑇𝑇𝐼𝐼𝑚𝑚𝑡𝑡 = 𝛼𝛼𝑚𝑚 + 𝛽𝛽1𝑆𝑆 + 𝛽𝛽2𝐸𝐸 + 𝛽𝛽3𝑊𝑊 + 𝑢𝑢𝑚𝑚 + 𝑒𝑒𝑚𝑚𝑡𝑡 (3) 26 economic analysis (2022, vol. 55, no. 2, 20-30) table 6. evaluation of re model with stock trading volume-dependent variable, and diagnostic tests trading volume coef. std. err. t p>|t| serbia -.0000211 .000022 -0.96 0.338 europe -8.83e-07 4.38e-07 -2.01 0.044 world -6.48e-08 2.83e-07 -0.23 0.819 constant 15.40123 .1904107 80.88 0.0001 diagnostic tests hausman’s test χ2(3) = 0.00, p = 1.0000 lm test chibar2(01) = 8.50; prob > chibar2 = 0.0018 ramsey reset test f(3, 917) = 0.60; prob > f = 0.5913 pasaran cd test 0.638; p = 0.3312 wooldridge’s test f(1, 1) = 17.904; prob > f = 0.1477 white’s test chi2(9) = 13.20; prob > chi2 = 0.1536 note: r squere = 0.13; prob > f = 0.007; number of groups = 2; number of obs. = 924. source: authors’ calculation the random effects model was chosen as the most appropriate model (table 6). as stated in table 6, parameters with the independent variable are statistically significant. the coefficient determination value denotes that 13% of the dependent variable variations (stock trading volume) are explained with the re model, and the f statistic values suggest statistical significance in the re model (prob > f = 0.007). by hausman test results, the significance is higher than 0.05 (χ2 = 0.00, p = 1.000), so we accept the null hypothesis the re model is more suitable than the fe model. the breusch-pagan lm test results point out that the significance level is lower than the set one (χ2 = 8.50, p = 0.0018), so the conclusion is the re model is more suitable compared to pols. the results from the ramsey reset test (prob > f = 0. 5913) prove there are no significant variables left out of the model, meaning the model specification is good. pasaran test statistical significance is higher than 0.05 (p = 0.3312), so the null hypothesis on serial correlation non-existence is acceptable. wooldridge’s test for autocorrelation in the panel data indicates there is no serial correlation (p = 0.1477). white’s test was used to test the model’s heteroskedasticity. the value of χ2 statistics probability in this test is 0.1536, which confirms the model errors are homoskedastic. according to the results for the re model, trading volume on the belgrade stock market is negative but not statistically significant for the number of daily infections in serbia and the world, while the number of newly infected in europe is negative on a statistically significant level. conclusion the conducted research had a goal to probe the correlation between the index stock value of belex15 and belex line, trading volume on the belgrade stock market on one side, and the number of newly infected in serbia, europe, and the world, on the other side. the results gained by the panel regression analysis for the random effect model (re), which was econometrically tested, well-specified, and most appropriate for the research, indicate a positive and significant influence of daily infections in serbia and europe on the belgrade stock market index value, while the global effect is positive but not statistically significant (model 1). these results are unexpected. however, soon after the beginning of the pandemic, when the value of both indices fell, the government took preventive measures, with the aim of maintaining economic stability, by supporting micro, small and medium enterprises. this package of economic measures to bojan đorđević, sunčica stanković 27 mitigate the consequences of the coronavirus included: tax policy measures (such as, for example, deferring the payment of payroll taxes), direct assistance to companies for employees (e.g., direct assistance to entrepreneurs who are taxed at a flat rate and who pay income tax real income, to micro, small and medium-sized enterprises in the private sector payment of assistance in the amount of the minimum), measures for liquidity of the economy (e.g. support to the economy through the development fund of the republic of serbia) and other measures (e.g. payment of 100 euros to all citizens of legal age). these preventive measures obviously had a positive impact on the serbian capital market. the obtained results are in accordance with the research results of waheed et al. (2020), who examined the impact of the covid pandemic on the karachi stock exchange and concluded that the covid pandemic has a diverse impact on developing economies, compared to developed economies, which faced serious declines in this period. in the second analysis (model 2), econometric tests also proved it is best to use the model with random effect (re). the results gained by the panel regression analysis for the random effect model (re) indicate a negative but statistically insignificant correlation between the number of newly infected in serbia and the world and the trading volume on the belgrade stock market. the number of newly infected in europe correlates negatively with the trading volume on the belgrade stock market on a statistically significant level. the obtained results are consistent with the results of research on other stock markets, where we refer to öztürk et al. (2020), zaren and hizarci (2020), onali (2020), đorđević and stanković (2021), naseem et al. (2021), who have empirically gained similar conclusions. according to the research results, r square records small values for both models (9% for the first and 13% for the second model). this means that only a small percentage of the variations of the dependent variable (in the first model stock market index value, and in the second stock trading volume) can be explained by means of independent variables (the number of daily infected in serbia, europe, and the world). this speaks in favor of the fact that variations in the capital market in serbia depend on other important explanatory variables, which should be included in the model. however, according to the subject of the research, only covid 19 variables were included in the research, and it can be concluded that these variables can explain a very small part of the variations in the serbian stock market. historically speaking, after the initial panic and significant fall of the belex 15 stock index (fall of over 200 index points) in february/march 2020, the serbian stock market recovered and somewhat adapted to the uncertainty caused by the pandemic. in 2021, there were two strategic moves to develop the capital market in serbia: 1. consolidation of the commercial bank (listed on the belgrade stock exchange: kmbn) by the slovenian nlb group, and 2. the strategic partnership of the belgrade and athens stock market (greece) was one of the ways to improve the capital market and set the stock market as a central piece of the serbian economy. this move would contribute to better visibility and attractiveness of home market securities to foreign investors who are present and trade in inconsiderable volume, not accounting for the current conditions (bbc news, 2021). we can conclude that, under the current turbulent conditions, there has been a quick recovery of the stock market, there was no greater capital outflow from the belgrade stock market, and the shock hasn’t been enormous and devastating. simultaneously, in 2020/2021, all other significant stock indices in europe and the world recorded a swift recovery and growth, a characteristic of stock markets. favorable information gained in 2020 from the covid-19 vaccination manufacturers (phizer, astra zeneca), and a set of economic measures of many countries, contributed to a better investors’ psychological climate in all markets. in a crisis, panic in the market is not in compliance with long-term investment strategies. the current pandemic is not only a possibility but also a necessity for investors to consider their investment portfolios and carry out a hedge and optimize. many authors and stock market analysts highlight the inclusion of gold as a safe asset, futures and options trade, 28 economic analysis (2022, vol. 55, no. 2, 20-30) and also the inclusion of some cryptocurrencies into portfolios for diversification and reduction of risk to a minimum. the limitations of this research are in its sensitivity to new information and data. for that, we need further research that would include new information and data on the subject, like stock yield and trading analysis, number of deaths, number of vaccinated people in serbia, europe, and on the global level, to secure valid information for politicians, investors, portfolio managers and ceos in the decision-making process. the crucial implication of this research is a further study on factors connected with pandemic waves that affect the volatility of the serbian stock market. in the end, the results of this study will be of use to the domestic and foreign professional public because they will provide valuable information on the behavior of financial markets in developing countries during the crisis. also, the study can be helpful to state decision-makers to implement the necessary activities and reduce the potential undesired effects of the current health crisis. references abuzayed, bana, elie bouri, nedal al-fayoumi, and jalkh naji. 2021. “systemic risk spillover across global and country stock markets during the covid-19 pandemic.” economic analysis and policy, 71: 180–197. https://doi.org/10.1016/j.eap.2021.04.010 adcock, christopher, xiuping hua, khelifa mazouz, and shuxing yin. 2014. “does the stock market reward innovation? 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2022 revised: october 19, 2022 accepted: october 21, 2022 https://doi.org/10.1016/j.jfs.2019.100721 https://doi.org/10.1093/rcfs/cfaa012 https://www.reuters.com/article/us-health-coronavirus-markets-chaos-iduskbn20z3wb https://www.reuters.com/article/us-health-coronavirus-markets-chaos-iduskbn20z3wb https://doi.org/10.1002/pa.2621 https://doi.org/10.1177/0972150920957274 https://doi.org/10.5539/ijef.v13n3p31 https://doi.org/10.1080/13504850210148125 https://doi.org/10.2307/1911841 https://doi.org/10.1002/pa.2290 https://covid19.who.int/ https://doi.org/10.1016/j.frl.2020.101597 https://doi.org/10.32951/mufider.70615 doi: 10.28934/ea.22.55.1.pp48-62 original scientific paper effects of consumer ethnocentrism, cosmopolitanism and cultural intelligence on the acceptance of foreign brands stefan zdravković17f* | dragana gašević2 1 univeristy of kragujevac, faculty of economics in kragujevac, department for business economics and management, phd student, kragujevac, serbia 2 high business school, novi sad, department for business economics and management, novi sad, serbia abstract globalization of the market has diminished the importance of national borders, so that an increasing number of companies are internationalizing their business. it is very important that the company’s management investigates the characteristics of the foreign market in which it wants to operate. it is necessary to formulate and implement adequate marketing strategy, which will take into account ethnocentric tendencies and the cultural framework of consumers. consumer ethnocentrism usually comes to the fore during crisis situations and a number of consumers want to strengthen the national economy by purchasing domestic products and services. on the other hand, a number of consumers have developed a high degree of cosmopolitanism and cultural intelligence, which implies preferences for foreign brands over domestic ones. the aim of this scientific paper is to identify some of the most important drivers of consumer ethnocentrism (patriotism, conservatism, dogmatism), and then to examine whether consumer ethnocentrism, cosmopolitanism and cultural intelligence through their basic factors (metacognitive, cognitive, motivational and behavioral factors) influence the formation of consumer attitudes towards foreign brands. it also examines whether the positive attitude of consumers towards foreign brands affects the loyalty of consumers to foreign brands, because it is necessary for companies to move from transactional marketing to customer relationship management, because loyal consumers are a stable source of income and enable long-term profitable business. empirical research was conducted using a survey method in the republic of serbia (belgrade, kragujevac). the results of the research showed that consumer ethnocentrism has a negative statistically significant impact, and consumer cosmopolitanism and cultural intelligence have a positive statistically significant impact on consumer attitudes towards foreign brands, and a positive attitudes implies consumer loyalty to foreign brands. key words: consumer ethnocentrism, consumer cosmopolitanism, cultural intelligence, foreign brands jel classification: a13, m21, m31 introduction due to the process of globalization and liberalization of international trade, an increasing number of companies are internationalizing their business, that is placing their brands on foreign markets (wong, polonsky & garma, 2008). consumer have a large number of alternative brands at their disposal in the purchasing process, so the formulation and implementation of an adequate marketing strategy is a great challenge for marketing managers of multinational companies (dey, alwi, yamoah, agyepong, kizgin & sarma, 2019). some consumers have pronounced ethnocentric tendencies and buy exclusively products and services of domestic origin. this enables the * corresponding author, e-mail: szdravkovic034@yahoo.com stefan zdravković, dragana gašević 49 strengthening of the national economy, increasing the employment of the population and increasing living standards (akbarov, 2022). also, consumers with expressed ethnocentric tendencies consider it their moral and ethical obligation to buy domestic products and services (souiden, ladhari & chang, 2018). one of the most important drivers of consumer ethnocentrism is patriotism, which is defined as a feeling of love, pride, attachment and loyalty to one’s country (sharma & wu, 2015). also, consumers who are conservative, respect traditions, customs, social institutions, norms and rules of conduct, usually have pronounced ethnocentric tendencies (jain & jain, 2013). ethnocentric consumers buy domestic products even in situations when they are inferior to foreign products in terms of quality, reliability and technical performance, which can be explained by dogmatism that represents beliefs and principles to be adhered to, although they don’t have logical explanations and scientific groundedness (shankarmahesh, 2006). on the other hand, the process of globalization has enabled the exchange of ideas, products, services, cultural values, so that a certain number of citizens have expressed cosmopolitanism, which reflects the tendency of these individuals to adapt to foreign cultures (prince, yaprak & palihawadana, 2019). these peoples are characterized by global prudence, a high level of information and monitoring of technological discoveries, a developed global consumer culture, and thus a desire to buy foreign brands (rabelo neto, sousa-filho & carneiro lima, 2022). modern trends show that people want to get to know foreign cultures, history and traditions of other countries, their customs and cultural heritage (yazdanshenas, 2021). traveling abroad has become much more affordable, so that when visiting foreign tourist destinations, people can make contact with the local population, exchange ideas and opinions and thus gain new authentic experiences and develop their cultural intelligence (bhardwaj, 2021). marketers points out that the very concept of cultural intelligence consists of a group of developed abilities. metacognitive and cognitive abilities include the possession of intercultural knowledge and skills, understanding of cultural differences and knowledge of norms, customs, legal systems of other countries. motivational abilities imply investing energy and a high degree of self-confidence in intercultural communication, while behavioral abilities imply adequate verbal and nonverbal behavior when communicating with people from other cultures (liu, wu, xu & chen, 2021). consumer decision to accept foreign brands is influenced by many factors. a brand is defined as a mark, symbol or any other characteristic that distinguishes the products and services of one seller from its competitors (gammoh, koh & okoroafo, 2020). the subject of this research is the analysis of the drivers of consumer ethnocentrism and its definition as a concept, as well as the definition of the concept of consumer cosmopolitanism and cultural intelligence and the analysis of their impact on consumer decision to accept foreign brands. it is also necessary to analyze whether consumers are ready to make long-term purchases after forming a positive attitude towards a certain foreign brand, because loyal consumers are one of the main goals of every company, because they enable long-term profitable business, and marketers also point out that it is much cheaper existing customer, rather than attract a new one. the research consists of five parts. after the introductory part, the concepts of consumer ethnocentrism, cosmopolitanism and cultural intelligence were defined within the literature review. their most significant drivers, factors, as well as methods and scales used for their measurement and analysis are listed. also, in this part, research hypotheses are conceived and the conceptual model of the study is presented. the third part deals with the research methodology and sample structure. empirical research was conducted on the territory republic of serbia using a survey method. data were analyzed through spss statistical software. from statistical analyzes, reliability analysis was used to determine whether the set research model was relevant, as well as regression analysis in order to test research hypotheses. the fourth part presents the results of these statistical analyzes, while the study concludes with the main implications of research that can be helpful to managers of multinational companies in internationalizing business and formulating an adequate marketing strategy. 50 economic analysis (2022, vol. 55, no. 1, 41-62) literature review ethnocentrism is a sociological concept that represents the tendency of people to see their culture as dominant and the best in relation to the cultures of all other countries (bizumic, 2019). from the basic concept developed consumer ethnocentrism, whose basic principle is the purchase of domestic products and services due to bias towards the home country and implies general care for the protection of the national economy, encouraging employment and can be seen as an ethical dimension related to the fact that the purchase of imported products is unpatriotic behavior (zdravkovic, sapic & filipovic, 2020). the purchase of foreign products and services has economic consequences for the domestic economy, leading to the closure of domestic companies and a decline in living standards (yen, 2018). governments of certain countires conduct marketing campaigns and appeal to citizens to buy domestic products. however, the question arises as to whether it is justified to direct citizens to buy domestic products, which are useally inferior to foreign products in terms of their level of quality, reliability, technical characteristics and performance (marinkovic, 2017). also, the application of protectionist economic policies leads to reciprocal measures of other countires and represents a significant barrier to the development of foreign trade and progressive economic relations with other countries (john & brady, 2011). consumers show ethnocentric tendencies to a significant extent during crisis situations. the covid 19 virus pandemic has caused significant geopolitical tensions and disrupted market supply. despite global appeals to find a common solution and show solidarity, consumers mostly decided to buy domestic products that were generally available on the market, and at the same time to support the domestic economy (he & haris, 2020). also, if there is animosity towards a country due to war or economic conflicts, consumers avoid buying products that originate from that country (lee, lee & li, 2017). for example, western countries imposed sanctions for russia in 2014 over the ukraine crisis, and russia retaliated with reciprocal measures banning the united states, canada, australia and the eu from exporting certain food and agricultural products to russia, such as meat, fish, fruit, vegetables (yormizoev, teuber & li, 2019). the conflict escalated in early 2022 year. due to the process of globalization, there is a decrease in cultural homogeneity, ie an increase in cultural heterogeneity, so that in every culture there is an increasing number of subcultures. in this way, regional ethnocentrism appears, so that, for example, the inhabitants of the autonomous province of catalonia buy only brands originating from catalonia, and refuse to buy foreign brands and even brands from spain, which is their home country, because they demand state independence (abdelwahab, jimenez, san-martin & prodanova, 2020). shankarmahesh (2006) states in his classification that there are four groups of drivers of consumer ethnocentrism: 1. sociopsychological factors (patriotism, conservatism, dogmatism and others) 2. economic factors (capitalism, economic development, living standards, etc.) 3. political factors (political propaganda, political history, manipulations of leaders, etc.) 4. demographic factors (such as gender, age, education). this research will examine whether patriotism, conservatism and dogmatism, as socio-psychological factors, have an impact on consumer ethnocentrism. patriotism represents the feeling of love or concern of an individual for his country, as well as the degree of connection of an individual with his nation and its symbols. patriotism encompasses the instrumental affiliation, of an individual realizes as a member of a certain nation (eg citizenship), while sentimental affiliation implies that personal values that an individual perceives as correct are complementary to national values (pentz, terblanche & boshoff, 2017). previous research has found a positive correlation between patriotism and consumer ethnocentrism (vida & reardon, 2008; marinkovic 2017; pavlovic & savic, 2017). conservatism implies respect for tradition, history, customs, social norms that are characteristic of a nation (zalega, 2017). previous research has found a positive correlation between conservatism and consumer ethnocentrism (javalgi, khare, gross & scherer, 2005; jain & jain, 2013). dogmatism implies beliefs and rules of conduct that must be followed, although they do not have an exact scientific basis (shankarmahesh, 2006). paul, gupta & tyagi (2021) found in their study that dogmatism stefan zdravković, dragana gašević 51 has a positive effect on ethnocentric consumer tendencies. based on the above research, the following research hypotheses can be formulated: h1a: patriotism has a positive statistically significant impact on consumer ethnocentrism. h1b: conservatism has a positive statistically significant impact on consumer ethnocentrism. h1c: dogmatism has a positive statistically significant impact on consumer ethnocentrism. most researchers use the cet scale (consumer ethnocentric tendency scale) created by shimp & sharma (1987), to measure consumer ethnocentrism. this scale contains 17 statements, although in field marketing research a smaller number of statements are generally chosen, which will be the approach in this research as well. the natid scale (the national identity scale) created by keillor & hult (1999), is also used to measure consumer ethnocentrism. this is essentially a scale for measuring national identity, but consumer ethnocentrism is one of its components. there are other scales that are less used in research, such as ceescale (consumer ethnocentrism extended scale) created by siamagka & balbanis (2015), which consists of five dimensions, prosociality, cognition, insecurity, reflexivity and habituation. there is also cesscale (revised consumer ethnocentrism scale) created by sharma (2015), which has three dimensions to measure ethnocentrism, affective reaction, cognitive bias and behavioral preferences. there are numerous studies in the academic literature that have found that consumer ethnocentrism (cet) has a positive effect on consumers’ decision to buy domestic products and services (deb & chaudhuri 2014; marinkovic 2017, pavlovic & savic 2017, sapic, filipovic & dlacic, 2019, zdravkovic, sapic & filipovic, 2020). based on the above, the following research hypothesis in the paper: h2: consumer ethnocentrism has a negative statistically significant impact on consumer attitudes towards foreign brands. cosmopolitanism is a concept that has a sociological genesis and implies a high degree of worldview, openness to other cultures and understanding the differences that exist between them. cosmopolitans differ from the local population because they went to travel beyond national borders and get to know the traditions, history and customs of other countries (srivastava, gupta & rana, 2021). cosmopolitanism has gained in importance due to the process of global integration, political cooperation and the development of international trade. consumer cosmopolitanism has developed from the basic concept, which refers to the economic dimension, ie it represents the preferences of cosmopolitans towards foreign products, services and brands (lee & mazodier, 2015). in his study, sapic (2017) found that consumer cosmopolitanism has a positive impact on consumers’ decision to accept foreign brands and visit foreign fast food restaurants. prince, yaprak & palihawadana (2019) found that consumer cosmopolitanism has a positive impact on consumer attitudes towards foreign brands, as well as on their intention to become loyal to certain foreign brands. from the above studies, the research hypothesis follows: h3: consumer cosmopolitanism has a positive statistically significant impact on consumer attitudes towards foreign brands. cultural intelligence (cq) is defined as a set of competencies that help an individual to adapt to an intercultural environment and to have a high degree of self-confidence when communicating with people from other cultures (presbitero, 2017). due to the global integration, there has been a significant increase in the number of business and tourist trips in the world, so that people improve their level of cultural intelligence by learning about the values of other cultures, their history, visiting cultural monuments, and landmarks, communicating with locals and learn a foreign language (zdravkovic & pekovic, 2021b). cultural intelligence has implications in the academic world, ie an increasing number of students believe that studying abroad is a valuable experience, because it allows, in addition to obtaining a degree, to get to know other cultures (bernadette & diane, 2016). also, cultural intelligence has implications in the business world, because employees in multinational companies come from different cultures, so it is very important that the leader and all members of project teams have developed a high level of cultural 52 economic analysis (2022, vol. 55, no. 1, 41-62) intelligence, which helps them achieve high business performance and thereby enabling business owners to meet the level of profit (chen, liu & portnoy, 2012). also, strategic partners come from culturally diverse backgrounds and need to have a developed level of cultural intelligence that allows them to know the legal and economic systems of other cultures, religious values, and they need this information for successful cooperation (cui, liu, xia & cheng, 2019). the most well-known way to measure cultural intelligence is the method of self-assessment and it involves individuals giving answers to 20 statements, which are used to determine their level of cultural intelligence (ang et al., 2007). also, an observer’s report is often used, where experts and supervisors summaraize their perceptions of one’s cultural intelligence (van dyne, ang & koh, 2008). ang, rockstuhl, & ng (2014) presented a cultural situation assessment test that measures cultural intelligence. respondents are shown pictures and given some time to think and then explain how they perceive the situation, and their non-verbal behavior is analyzed (views, facial expressions). ang, rockstuhl & tan (2015) have proposed combining different methods for measuring cultural intelligence, as they provide complementary information so as to increase the relevance and reliability of the results obtained. earley & ang (2003) state that there are four basic factors of cultural intelligence: metacognitive, cognitive, motivational and behavioral. metacognitive processes refer to understanding the cultural differences that exist between different nations (zdravkovic, 2021). in their study, ang & van dyne (2015) state that metacognitive cultural intelligence influences, among other things, consumer preferences for foreign product. cognitive cultural intelligence implies knowledge of the functioning of foreign social systems, institutions, knowledge of laws, norms and rules of conduct (yazdanshenas, 2021). the cognitive factor of cultural intelligence affects the ability of marketing managers in terms of recognizing positive signals from the market, proactively reacting and making good decisions in conditions of market uncertainty and incomplete information of economic actors. also, the cognitive factor influences the decision of consumers to buy foreign products and services (lorenz, ramsey & glenn richey, 2018). motivational cultural intelligence means investing energy and showing enthusiasm for getting to know other cultures, their values systems and communicating with the local population (pratono & arli, 2020). consumers with a high degree of motivational cultural intelligence visit foreign tourist destinations and buy foreign brands (frias-jamilena, sabiote-ortiz, martin-santana & beerli-palacio, 2018). behavioral cultural intelligence implies the application of certain verbal and non-verbal competencies that enable and individual to change the strength of tone, accent, facial expressions, body language and to better adapt to the intercultural situation (rahman, abdel fattah, hussain & hossain, 2021). zdravkovic & pekovic (2021a) found that behavioral cultural intelligence has a positive impact on consumers’ decision to buy foreign brands. based on the mentioned studies, the following research hypotheses can be formulated: h4a: the metacognitive factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. h4b: the cognitive factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. h4c: the motivational factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. h4d: the behavioral factor of cultural intelligence has a positive statistically significant impact on consumers attitudes towards foreign brands. it is very important that marketing managers formulate and implement a good marketing strategy that will influence consumers to form positive attitudes towards the brands of a given company and to achieve a certain degree of satisfaction when using the brand. however, it is not enough for a consumer to make one purchase, but the first purchase needs to be the beginning of a transition process whose end result is consumer loyalty (liu, li, mizerski & soh, 2012). it is necessary for companies to move from transactional marketing to customer relationship stefan zdravković, dragana gašević 53 management, ie to build a partnership with their clients, because a large number of loyal clients enables the company to continuously operate successfully and achieve all set goals, especially profits (anisimova, weiss & mavondo, 2019). based on the above, the following research hypothesis can be formulated: h5: the formed positive attitude of consumers towards a foreign brand has a positive statistically significant impact on consumer loyalty to a foreign brand. in order to facilitate the monitoring of the structure of the paper, research variables are presented through a conceptual model, as well as research hypotheses through which their interdependence will be analyzed (figure 1). figure 1. conceptual model source: authors research methodology empirical research was conducted on the territory of the republic of serbia (belgrade, kragujevac) at the end of 2021 year. the research was conducted by the method of a simple random sample, the questionnaire was distributed personally and electronically to the respondents, who evaluated the statements from the questionnaire using the likert scale with grades from 1 to 7 (1-absolutely disagree with the statement; 7-absolutely agree with the statement). the total sample consists of 305 respondents, who are segmented according to certain demographic characteristics (gender, age, education, status). an overview of the demographic structure of the respondents is given in table 1. the statements from the questionnaire are taken from relevant scientific papers in the field of marketing and management, which is a regular approach in field research. within the results of the research, all the statements that were used are listed, and by applying certain statistical analyzes, it was determined that they are internally 54 economic analysis (2022, vol. 55, no. 1, 41-62) consistent and can be grouped into factors, ie research variables. data were analyzed through statistical software spss, and from statistical analyzes, factor analysis and reliability analysis were applied to determine whether the statements used were internally consistent and whether the research model was relevant and reliable, while regression analysis was applied to test research hypotheses. table 1. demographic structure of respondents number of respondents percentage of respondents gender females 147 48.2 % male 158 51.8 % total 305 100 % age up to 20 years 41 13.4 % 21-30 years 118 38.7 % 31-40 years 52 17.0 % 41-50 years 56 18.4 % 51 years and older 38 12.5 % total 305 100 % education primary school 25 8.2% high school 143 46.9% college 137 44.9% total 305 100 % status unemployed 47 15.4% employed 98 32.1% student 118 38.7% retired 42 13.8% total 305 100% source: authors in the total sample of respondents, there are 147 women and 158 men. the largest number of respondents is between the ages of 21 and 30. most respondents have completed high school or college. when it comes to status, the largest number of respondents in the sample are students, followed by employees, and the number of unemployed and pensioners is approximate. research results the statements used in questionnaire were taken from relevant papers in the field of marketing. by applying factor analysis, statements are grouped into factors, ie into research variables (table 2). consumer ethnocentrism, consumer cosmopolitanism, attitude towards a foreign brands, loyalty to a foreign brand were measured by three statements. drivers of consumer ethnocentrism (patriotism, conservatism, dogmatism) and factors of cultural intelligence (metacognitve, cognitive, motivational and behavioral factor) were measured by two statements, because the questionnaire is quite extensive, ie to take less time from respondents when filling out the questionnaire. however, the results of factor analysis and reliability analysis show that the stated approach is correct, al obtained values are stable, research variables are measured through adequate statements and the research model is relevant and reliable. stefan zdravković, dragana gašević 55 table 2. research variables and corresponding statements research variables statements factor saturation adapted to the source patriotism 1. i am proud to be a citizen of the republic of serbia. 0.81 marinković (2017) 2. i am proud to see the flag of the republic of serbia waving. 0.77 conservatism 1. i respect the customs and traditions of serbian culture. 0.82 pentz, terblanche & boshoff (2017) 2. i support the work of social institutions in the republic of serbia. 0.78 dogmatism 1. i think that it is only right to buy products and services that originate from the republic of serbia. 0.83 shankarmahesh (2006) 2. i always buy serbian products and i do not need special reasons and explanations for such a decision. 0.82 consumer ethnocentrism (cet) 1. we need to buy products from the republic of serbia and strengthen the national economy. 0.79 zdravkovic, sapić & filipović (2020) 2. imports of goods cause economic consequences and reduce the employment of population. 0.78 3. i prefer exclusively the purchase of products and services originating from serbia. 0.75 consumer cosmopolitanism 1. i want to get to know the traditions and culture of other countries and to try foreign gastronomic specialites. 0.87 sapić (2017) 2. i believe that foreign products have a high degree of quality. 0.83 3. i am innovative and i want to buy foreign brands, because they have excellent performance. 0.81 cultural intelligence (cq) a) metacognitive factor b) cognitive factor c) motivational factor d) behavioral factor 1a) i try to improve my cultural knowledge by interacting with people from other countries. 0.83 ang et al. (2007) 2a) cultural knowledge helps me to adapt in a foreign environment. 0.81 1b) i know the social systems of other countries. 0.90 2b) i know the art and cultural heritage of other countries. 0.88 1c) i enjoy communicating with people from other cultures. 0.75 2c) i have confidence in intercultural communication. 0.73 1d) in intercultural situations, i apply appropriate verbal behavior (accent, tone). 0.76 2d) during intercultural communication i adjust my non-verbal behavior (body language, facial expression). 0.71 attitude towards a foreign brand 1. i prefer to buy foreign products. 0.91 son, jin & george (2013) 2. foreign brands have a high degree of quality. 0.87 3. foreign brands provide prestige in society. 0.85 loyalty to a foreign brand 1. i will continue to buy foreign brands in the future. 0.83 moller jensen & hansen (2006) 56 economic analysis (2022, vol. 55, no. 1, 41-62) research variables statements factor saturation adapted to the source 2. i am ready to recommend foreign brands to my family members. 0.81 3. i recommended foreign brands to my friends. 0.77 source: authors all assumptions for the application of factor analysis are justified. all statements were measured using an interval scale. the total number of respondents in the sample is 305, and the number of statements in the questionnaire is 26, and the condition for applying factor analysis is that in this ratio there are least 10 times more respondents in the sample than the findings in the questionnaire (jovetić, 2015). based on the factor analysis, statements are grouped into 11 main factor (patriotism, conservatism, dogmatism, consumer ethnocentrism, consumer cosmopolitanism, metacognitve, cognitive, motivational and behavioral factor of cultural intelligence, attitude and loyalty of consumer towards foreign brand). in the case of tests relating to the justification of the application of factor analysis, satisfactory results have also been obtained (table 3). table 3. kmo and bartlett’s test kaiser-meyer-olkin measure of sampling adequacy 0.765 bartlett’s test of sphericity approx. chi-square 548.068 df 10 sig. 0.000 source: authors the value of kaiser-meyer-olkin coefficient 0.765 is greater than the threshold of 0.60, which indicates that the conditions for conducting factor analysis are met (pallant, 2005). also, the value of the bartlett’s test shows statistical significance (χ2=548.068, sig=0.000), ie it confirms that there is a statistically significant correlation and internal consistency between the statements through which the research factor (variables) are measured. reliability analysis is also applied in the research, in order to examine the internal consistency between the used statements and to examine the relevance of the set research model. the results are presented in table 4. table 4. reliability analysis research variables cronbach’s alpha coefficient patriotism 0.78 conservatism 0.79 dogmatism 0.80 consumer ethnocentrism 0.80 consumer cosmopolitanism 0.84 metacognitive factor of cultural intelligence 0.81 cognitive factor of cultural intelligence 0.88 motivational factor of cultural intelligence 0.71 behavioral factor of cultural intelligence 0.72 attitude towards a foreign brand 0.88 loyalty to a foreign brand 0.80 source: authors stefan zdravković, dragana gašević 57 in order for the used statements to be internally consistent and for the research model to be relevant, it is necessary for the value of the cronbach’s alpha coefficient to be greater than 0.70 (nunnally, 1978), and such a result was obtained for all used research variables. multiple regression analysis was applied to examine the influence of patriotism, conservatism and dogmatism on consumer ethnocentrism (table 5). table 5. multiple regression analysis (dependent variable: consumer ethnocentrism) independent variables beta coefficient t test sig value vif coefficient patriotism 0.154* 1.990 0.057 2.282 conservatism 0.128* 1.701 0.090 2.160 dogmatism 0.263** 4.370 0.000 1.379 source: authors note: **-level of significance 0.01; *-level of significance 0.1 r2 = 0.458 the coefficient of determination is r2 = 0.458, which means that 45.8 % of the variability of the dependent variable consumer ethnocentrism is explained by a given regression model. the value of vif coefficient is less than the limit values 5, so there is no problem of multicollinearity (field, 2000). variables patriotism (β=0.154; sig=0.057), conservatism (β=0.128; sig=0.090) and dogmatism (β=0.263; sig=0.000) have a positive statistically significant impact on consumer ethnocentrism, so that research hypotheses h1a, h1b and h1c have been confirmed. multiple regression analysis was applied to examine the influence of consumer ethnocentrism, consumer cosmopolitanism and cultural intelligence (metacognitive, cognitive, motivational and behavioral factor) on attitude consumers towards a foreign brands. the results are presented in table 6. table 6. multiple regression analysis (dependent variable: attitude towards a foreign brand) independent variables beta coefficient t test sig value vif coefficient consumer ethnocentrism -0.296** -2.826 0.005 4.984 consumer cosmopolitanism 0.438** 6.737 0.000 2.308 cultural intelligence metacognitive factor 0.088 0.371 0.465 4.489 cognitive factor 0.240** 4.205 0.000 1.782 motivational factor 0.179** 3.650 0.000 1.318 behavioral factor 0.174** 3.514 0.002 4.480 source: authors note: **-level of significance 0.01; r2 = 0.675 the coefficient of determination is r2 = 0.675, which means that 67.5 % of the variability of the dependent variable attitude towards a foreign brand is explained by a given regression model. the value of vif coefficient is less than the limit values 5, so there is no problem of multicollinearity (field, 2000). variable consumer ethnocentrism (β= -0.296; sig=0.005) has a negative statistically significant impact on attitude towards a foreign brand, while on the other hand variable consumer cosmopolitanism (β=0.438; sig=0.000) has a positive statistically significant impact on attitude towards a foreign brand, so that research hypotheses h2 and h3 have been confirmed. cognitive factor (β=0.240; sig=0.000), motivational factor (β=0.179; sig=0.000), and behavioral factor (β=0.174; sig=0.002) of cultural intelligence have a positive statistically significant impact on attitude towards a foreign brand, while the influence of the 58 economic analysis (2022, vol. 55, no. 1, 41-62) metacognitive factor (β=0.088; sig=0.465) of cultural intelligence is not statistically significant, so that research hypothesis h4a has not been confirmed, while research hypothesis h4b, h4c and h4d have been confirmed. when the consumers forms a positive attitude towards a foreign brand, they perform the buying process. however, there is a lot of competition in today’s world market, so the goal of companies is to make the consumer loyal to their brands. the goal of every company is to move from transactional marketing to customer relationship management (crm), because loyal consumers are a source of long-term profitable business. due to the above, by applying a simple regression analysis, it examines whether the formed positive attitude of consumers towards a certain foreign brand, affects consumer loyalty (table 7). table 7. simple regression analysis (dependent variable: loyalty to a foreign brand) independent variable beta coefficient t test sig value attitude towards a foreign brand 0.606** 13.248 0.000 source: authors note: **-level of significance 0.01; r2 = 0.367 the coefficient of determination is r2=0.367, which means that 36.7 % of the variability of the dependent variable loyalty to a foreign brand is explained by a given regression model. variable attitude towards a foreign brand (β=0.606; sig=0.000) has a positive statistically impact on loyalty to a foreign brand, so that research hypothesis h5 has been confirmed. that is, the formed positive attitude of consumers towards a certain foreign brand has a direct impact on loyalty to the same brand. conclusion the research was conducted to examine whether patriotism, conservatism and dogmatism are the drivers of consumer ethnocentrism, as well as to examine the impact of consumer ethnocentrism, consumer cosmopolitanism and cultural intelligence (metacognitive, cognitive, motivational and behavioral factor) on consumer attitudes towards foreign brands. it was also examined whether the formed positive attitudes of consumers towards foreign brands affect their loyalty to foreign brands. the academic literature examines the individual impact of these determinants on the acceptance of foreign brands, but as the main contribution and originality of this research, we can mention the fact that a holistic and integrative approach was applied, ie the research model is designed to examine the common effect of all these determinants on consumer attitudes and loyalty to foreign brands. theoretical implications are reflected in the expansion of scientific knowledge about the impact of these determinants on consumer decision to accept foreign brands and arise from research hypotheses that become valid scientific knowledge. the results of research confirmed the results of previous studies that patriotism, conservatism and dogmatism have a positive impact on consumer ethnocentrism (pentz, terblanche & boshoff, 2017; marinkovic 2017; pavlovic & savic, 2017; paul, gupta & tyagi, 2021) also, the results show that consumer ethnocentrism has a negative impact on consumer attitudes towards foreign brands, while consumer cosmopolitanism and cultural intelligence (through cognitive, motivational and behavioral factors) have a positive impact on the acceptance of foreign brands, and similar results have been obtained through previous studies (sapic, 2017; zdravkovic, sapic & filipovic, 2020; zdravkovic & pekovic, 2021a, zdravković & pekovic, 2021b) this research didn’t prove that the metacognitive factor of cultural intelligence has a positive impact on consumer attitudes towards foreign brands, which can be explained by the fact that there are many young respondents in the sample, and metacognitive processes in humans develop with age. the formed positive attitude towards a foreign brand also stefan zdravković, dragana gašević 59 affects consumer loyalty, and the same result was obtained in the previous study (anisimova, weiss & mavondo, 2019). managerial implications are based on helping international marketing managers consider the factors that influence consumer’s decisions to accept foreign brands. it is necessary to formulate and implement an adequate marketing strategy that will take into account the ethnocentric tendencies of consumers and their cultural framework. also, it is necessary for companies to form as large a base of loyal consumers as possible, because they are a stable source of income and enable long-term profitable business. the transition from transactional marketing to customer relationship management should be the goal of every successful company. the limitation of research is reflected in the relatively small sample size and the fact that it was conducted on the territory of one country. cross-cultural research provides more comprehensive results because it allows the attitudes and opinions of members of different nations to be compared. in addition, the directions of future research could be based on the analysis of another drivers of consumer ethnocentrism (for example, national identity, animosity, materialism), as well as the inclusion of some more variables in the research model, which could be a significant determinants of foreign brands acceptance (eg country of origin image, consumer xenocentrism). references ang, s., van dyne, l., koh, c., ng, k.y., templer, k. j., tay, c. and chandrasekar, n.a. 2007. 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"consumption in fast-food restaurants in croatia and serbia". british food journal, 121(8): 1715-1729. article history: received: march 20, 2022 revised: april 5, 2022 accepted: may, 30, 2022 microsoft word 2011_3_4_finalna ver.doc review    book review  organizational behaviour and culture:   globalization and the changing environment  of organizations    edited by  professor mirjana radovic‐markovic      in  this  review  we  introduced  a  book  „organizational  behaviour  and  culture:  globalization  and  the  changing  environment  of  organizations“,  published  by  vdm  verlag  dr.  müller e.k ,germany, in july 2011.   the book represents a unique responses on a very actual and  generally  known  issues.  radovic‐markovic,  m.  in  forward  pointed out that this book focuses on a body of knowledge that  balances  and  requires  that  many  disciplines  should  be  brought  together  to  create  a  contemporary  approach  to  organization  behavior  and  transformation  (of  both  organization  and  the  individual) in a changeable business environment. her intention  as a book editor was  to explore the organization behavior, culture  and strategies relating to effective organizational and managerial performance.  at  the  micro  level,  it  covers  topics  such  as  organizational  behaviour,  organizational  changes  and  restructuring  of  entities.  on  the  other  hand,  the  book  deals  with  terms  of  organizational culture and behaviour examining their impact on economic development and  sustainable growth, when concerning macro level of investigation. these issues, due to the  financial crisis and rapid changes in global economic environment, became very important  for every economic entity.    the book consists of five parts. the first part, entitled globalization, organization behavior  and culture, deals with the issues of organizational behaviour, gender gaps and the influences  of  organizational  culture  on  enterprises  organizational  structure.  in  the  first  chapter,  organizational behaviour in a global context: gender issues, professor radovic‐markovic  stresses  two  most  important  issues  that  are  essential  for  all  modern  companies.  first  is  changes management, that requires from the company to frequently change its strategy and  structure in order to stay competitive in global economy. the second one, cultural diversity,  became  one  of  ordinary  problems  that  companies  in  transition  economies  face  in  recent  years. managing cultural diversity is one of the most important factors of competitiveness  nowadays. gender gap problems, radovic‐markovic addresses, still exist in modern times.  women in eu, earns on the average, 15% less than men (page 18). their participation in top     đukić, m., et al., book review, ea (2011, vol. 45, no. 3‐4, 82‐85)   83 management levels is also significantly lower. therefore, it is on economic policy creators to  find mechanisms for women equal access to economic and financial resources. as radovic‐ markovic  suggest,  female  entrepreneurship  is  one  of  the  major  factors  that  contribute  economic growth  in many developing countries. in the second chapter, ondrej jaško and  ana  jaško examined  the  influence of organizational culture on enterprises organizational  structure.  organizational  model  creation  is  highly  dependent  on  different  cultures  by  determining  business  strategy,  leadership  style,  motivation  etc.  when  evaluating  work  performances  it  is  necessary  to  consider  whether  corporate  culture  is  well  designed.  however, as the authors mentioned, this field is still not enough explored in modern papers  and there is lot of space for further investigations.   second  part  of  the  book  focuses  on  individual  organizational  aspects  such  as  communication  and  motivation  problems  in  modern  companies.  in  the  third  chapter,  managing  communication  in  changeable  business  environment,  authors  present  theoretical  approaches and importance of good communication for companies as well as for managers.  it is intuitive that good communication is vital part of every successful business. but, it is not  always easy to provide efficient communication to achieve coordination and integration of  organizational units on different levels. it is up to managers to provide good communication  using  proper  communication  techniques  of  oral,  or  nowadays  electronic  communication.  when considering environment, things become more complicated since we can do almost  nothing to control it. communication is very related to other management and organization  concepts.  chapter  four  observes  connection  between  communication  and  motivation.  professor  chambers  explores  how  communication  and  motivation  work  together  and  provides tactics as a some kind of guide for managers how to motivate their employees. she  suggests managers to be enthusiastic and friendly oriented toward their employees. people  included  in  projects  need  to  be  well  informed  about  project  progress  and  know  exactly  predicted  rewards  system.  creating  clear  short  term  and  long  term  goals  as  well  as  reasonable deadlines are also considered as tremendously important. considering all these  advices  good  communication  figures  as  a  key.  all  mentioned  concepts  are  developed  in  order to provide formula of business success. professor simandan developed theories that  explain success from completely different point of view. he investigated correlation between  geographical and  interindividual differences and outstanding entrepreneurial success. his  conclusion is that intelligence as well as place one grew up are from exceptional importance  for business success. however, he underlined, only by exploring one’s potentialities, one can  learn  the  things  one  is  good  at.  this  uncertainty  is  pure  wealth  for  him.  conclusions  obtained,  by  simandan,  should  be  motive  for  engaging  more  people  on  the  path  of  entrepreneurship.   in  the  third  part,  the  organizational  context,  readers  will  discover  a  lot  of  interesting  concepts and empirical findings that can be very helpful for understanding nature of modern  organizations.  cvijanovic  and  lazic  considered  importance  of  adequate  macro  organizational  restructuring.  once  created  organizational  entities  have  vertical  and  horizontal  connections.  linking,  dynamisation  and  coordination  within  macro  organizational entities represents a necessary macro organizational structure and it is often  called „harmonization“. the authors stress that modern company is doubtless in need for  performing periodical harmonization through soft structural modalities. as examples they     economic analysis (2011, vol. 45, no. 3‐4, 82‐85)   84 address  work  groups,  collegiate  boards,  commissions  etc.  this  means  need  for  behavior  harmonization too, both direct (through the chosen form), and indirect (through the chosen  model).  in  this  context,  stress  is  also  considered  as  one  of  the  objective  conditions  in  everyday business. in order to improve efficiency as much as it is possible, leaders sometime  increase stress level of their employees. respecting this issue, krumov, larsen and hristova  formulated several hypotheses to test impact of leadership styles on stress experienced by  employees. obtained results indicate the following:   • that demographic characteristics (gender, age, education, family status, number  of children in the family and total length of service in the organization) influences  strategies for coping with chronic stress.  • there are significant correlations between leadership style and perceived stress of  the employees in organizations.  • there are correlations between the leadership style and the strategies for coping  with the stress of the employees.  • the  respondents  perceived  stress  and  the  leadership  style  of  their  leaders  determine the desirable strategies for coping with professional stress.  authors summed up that, especially in time of crisis such as recent global financial crisis,  companies not led by ego‐based charismatic leaders do better than the average on the stock  market.  as  well  as  knowing  itself,  modern  and  competitive  company  need  to  be  future  oriented trying to predict future events and moves of their competitors. recognizing that  managers are often myopic concerning competitors and competitors moves are not always  rationally predictable, drossos and fouskas tried to develop conceptual model that will help  analyzing  competition  and  making  strategic  decisions.  by  their  findings,  successful  competition  analysis  should  include  w1  (sufficient  identification  of  competitors),  w2  (organizational  learning  from  competitor’s  strategies),  w3  (effective  prediction  of  competitor’s behavior) and w4 (successful implementation of competition analysis process  outcomes in firm’s competitive strategy formulation). sum of variables should be equal to 1.  model they developed can be very useful both for new and mature companies. economically  educated auditorium certainly recognize balance scorecard (bsc) concept as one of the well  known concept of strategic planning originated by robert kaplan. globa and gavurova in  chapter  9  examined  learning  and  growth  perspective  of  balanced  scorecard  system  and  focused  their  research  on  slovakia.  they  systematized,  examined  and  evaluated  chosen  attributes  of  the  bsc  system  within  the  process  of  its  implementation  in  the  slovak  organizations,  in  order  to  identify  potential  problems  and  to  propose  possible  solutions.  obtained results made them able to propose two implementation techniques of the morality  profile  into  the bsc strategy maps,  through  incorporation of ethics  into  the existing bsc  perspective or extension of the bsc system by the business ethics perspective. relationship  of  business  ethics  with  the  knowledge  management  is  underreported  in  the  relevant  literature.  however, sometimes management  that respect principles of good organization  restructuring, communication, motivation and proper leadership styles do not meet targets.  reasons for that could be various and sometimes not so evident. product design is one of the  factors that have to be taken into account. malikova performed an empirical investigation in  order to find out consumers criteria for buying products. research is focused on slovakian  and french market. her starting hypothesis was that consumer nationality determines the     đukić, m., et al., book review, ea (2011, vol. 45, no. 3‐4, 82‐85)   85 importance of the same packaging criteria. results she obtained approved that nationality  matters. consumer preferences in france, country with long experience strongly differ from  slovaks. implications of this finding are very useful. packaging designers should be aware  that  nationality  should  not  be  forgotten  when  targeting  foreign  markets,  creating  new  design, redesigning packaging etc.        the fourth part of the book is considering organizational culture and economic development,  and consists of two papers which observe organizational culture from aspects of economic  development and as competitive  advantage. lucian and silviu gave sum up  of  the  most  valuable  definitions  and  functions  of  organizational  culture  concept,  also  trade  off  in  orientation of organizational culture dimensions between various factors, as results towards  processes,  opened  towards  closed  system,  level  and  type  of  control  etc.  types  of  organizational cultures are important part of this paper because it includes classification of  organizational cultures and give analyses based on different features. they suppose that it is  nowadays absolutely necessary to understand functions of organizational culture in modern  enterprises, and to recognize factors that influence on it, both internal and external. the most  important are the national culture and the vision or mission of the organizationʹs founders.  the outline is concerning manifestation and types of organizational culture and it is a great  prelude for the next paper which is observing culture and cultural diversity from an aspect  of  competitive  advantage  for  economic  development.  after  the  cultural  development  process,  there  is  an  interesting  point  of  view,  presenting  culture  as  an  iceberg.  certain  elements of culture are visible to the bare eye and easily noticeable, while most of it is hidden  “under water” – deeply rooted in the value system of the organization.  redzepagic, eric and  stosic concluded that those organizations where there is harmony between the elements of  organizational  culture  and  the  formulation  of  a  strategy,  may  lead  to  better  business  performance, and may have a positive impact on the national economy as a whole.  the final part of this book is kind of mixture composed of three very important issues,  such as social psychology, entrepreneurship development and sustainable economic growth in eu. in  this chapter authors gave their opinion on a body of knowledge that balances and requires  that  many  disciplines  should  be  used  together  to  create  a  contemporary  approach  to  organizational  behavior  and  transformation  in  a  changeable  business  environment.  first  chapter recognizes problem of youth migration and distinctive reasons as economical and  psychological,  also  as  socio‐economic  inequalities  in  eu  countries.  last  paper  includes  information and analysis of support of woman entrepreneurship by european commission,  its aims and projects on promoting this issue.   after reading this book, we were delighted to share the impressions with the auditorium  and all interested readers from different economic areas as well as the authors whose field of  research cover psychology and sociology. due  to  its multidisciplinary approach  it can be  very useful  for  politicians,  engineers and all people  from practice  that run companies or  some company departments. we warmly recommend this book to students, researchers and  everyone interested in organizational behaviour, human resources and entrepreneurship.   mihajlo đukić, saša milivojević  institute of economic sciences  ea_2012_1_2 conference paper environmental taxation as a tool for sustainable development policy-state comparison of serbia and application of ecological taxation reform in european union* munitlak ivanović olja**, university educons, faculty of business in services, serbia golušin mirjana, university educons, faculty of organic agriculture, serbia udc: 502.12(497.11)(4) jel: q01; q59; h2 abstract – national strategy for sustainable development of serbia has given clear guidelines for the direction of the economy, respect for ecological principles, development and implementation of better social and institutional policies. environmental taxes and all other taxes, the fiscal revenue, but its application has special significance, because in addition to economic, it is ecological, institutional and social character, and as such it is an instrument of sustainable development. with this work the authors suggest moving the value of revenues from environmental taxes in the eu in the period 2005-2010. as this is a period characterized by economic problems caused by the crisis in all countries, there has been a decline in revenues from environmental taxes even in the most developed eu countries. n average, the eu has achieved the highest revenues from environmental taxes in 2008. the largest revenue from environmental taxes has made germany (eur 56.031,00 million) at the beginning of the period, while the lowest income in the value of (138,21 million eur) has made malta. it should be noted that a downward trend in the character of all countries except slovenia and estonia, which joined the eu in 2004. income that is realized by the collection of environmental taxes is significant and is measured in tens of million, but there is a possibility that the position of business entities that pay for it because it makes it difficult to become less competitive. this paper provides an overview of key economic issues in the use of taxation as an instrument of environmental policy. key words: sustainable development, environmental taxation, revenue from environmental taxes, trend, tax reform * this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education and sciences of the republic of serbia. ** address: vojvode putnika 89, sremska kamenica 21013, serbia, e-mail: oljaivanovic@eunet.rs munitlak ivanović, o., et al., environmental taxation, ea (2012, vol. 45, no, 1-2, 32-44) 33 introduction sustainable development consists form four mutually related subsystems: economic, ecological, social and institutional. application of those instruments which are simultaneously support all subsystems is encouraged.contemporary development of european countries is, apart from economic and financial problems (economic crisis) burdened by ecological problems and high requirements imposed by ecological standards. therefore, the role of government and economic integration, such as the european union to provide answers to questions on how to harmonize economic development without compromising the ecological environment. the active role of government in the implementation of economic instruments for environmental protection is necessary because market solutions do not provide the best results. how can sustainable development consists of four interrelated subsystems, preferred application of those instruments that support them in practice. the aim is to show that environmental taxes are an instrument that supports and influences the smooth development of the four subsystems of sustainable development. ecological tax is a fiscal instrument that has all the features of the tax. therefore the role of government is crucial because without legislation there will be positive effects, which makes use of environmental taxes (golušin, munitlak ivanović, 2009). for application of any fiscal instrument, including ecological taxation, it is necessary to have consistent legal regulations, which can be provided only by the state. the state relies on direct regulations which provide curtain pollution: if the environment pollution is banned above a defined level, that is, if the pollution is regulated by sanctions, then the maximal level of pollution is known in advance (coase, 1960). of all the subsystems that make up sustainable development, institutional development is the latest. this indicates the importance of environmental taxes as an instrument for the development of institutional subsystems. the existence of legislation is necessary for the implementation of environmental taxes. arthur pigou, theoretic of welfare economic, in 1912 gave an idea of implementing special instrument of tax system which would be in the function of preserving environment. pigou explained that ecological taxation introduction with the need to internalize external costs, which are made as a consequence of nature devastation (pigou, 1918). external cost is made outside the market, in the situation when economic situation of a certain business entity is influenced, positively or negatively, by other entity activities. ecological taxation is capable to correct market limitations and imperfections incurred by externalities. external effects occur when the market is unable to efficiently allocate resources. there are several ways to remove the negative consequences of externalities. according to the oecd division, there are following instruments (oecd, 1999): compensations and taxes for emissions, users’ compensations and taxes, compensation for products, performance and indemnification guarantee. transaction costs and public goods difficult to find adequate solutions, so there are limitations to the exclusive application of only one measure. in practice, the right to a quality environment is realized by a combination of these instruments: 1. subsidies for pollution reduction, 2. ecological taxation and penalties, economic analysis (2012, vol. 45, no. 1-2, 32-44) 34 3. transferable permits and 4. state regulation. each instrument has its own different effects and features that act differently on the allocation of resources and environmental costs, that have different redistributive effects this refers to the fact that environmental taxes are an important part of the ecological and economic subsystems of sustainable development. therefore, the authors emphasize the importance of environmental taxes and the amount of income that can collect in this way and trends of revenues made from ecological taxation. characteristics of environmental taxes as an economic instruments of environmental protection in parallel with growing awareness of the potential for "economic instruments" such as environmental taxes to improve the efficiency of environmental policy, there has been interest in the scope for tax reform using the revenues raised from environmental taxes. some countries that have been concerned about the impact—either economic or political—of high taxes on labour income, have used environmental tax revenues to reduce tax rates on labour incomes. sweden's 1991 reforms used revenues from new environmental taxes on energy to finance cuts in labour income taxes. similarly, a number of the uk's environmental tax measures have been accompanied by provisions to return the revenues through a reduction in the payroll taxes paid by employers. the political attractions of ‘packaging’ environmental taxes and tax reform in this way are, perhaps, obvious. the environmental gains, too, are relatively clear-cut, but the fiscal benefits of this type of tax substitution are much more contentious. “environmental taxation” and “environmental compensation” are strict legal regulations in different oecd countries. oecd countries' regulations make strict distinction between expressions „ecological taxation“ and „ecological compensation“ in terms of allocation of the financial means collected by compensations and taxations. ecological taxation is centralized revenue which is not primarily intended for environment protection, but it increases local and state revenues. “ecological compensation” paid for the use of a resource. for the state, both instruments bring revenues, but the revenues are allocated differently. ecological compensation is related to the cases when the dominant part of revenue is intended for covering costs and environment protection (e.g. financial means are collected through funds for protection of certain resources). this is in support of the fact that this instrument is a part of economic subsystem of sustainable development. ecological taxation is relatively new tax form, which for tax base takes physical unit of the substance which has harmful effect on the environment. on one hand, ecological taxation includes taxes directly imposed on goods which have impact on increasing of environment pollution, that is, have impact on scarce natural resources due to the degree of their pollution, and on the other hand, different compensations and similar fiscal duties (e.g. registration taxes, taxes for not compiling with ecological standards and regulations). ecological taxation influences limitation of ecological harmful products consumption. it reduces harmful emissions up to the level which is considered to be „sustainable“. munitlak ivanović, o., et al., environmental taxation, ea (2012, vol. 45, no, 1-2, 32-44) 35 rio declaration on environment and development (1992) define that, ecological taxation needs to be: a) efficient in terms of ecology – to achieve goals of environment protection at the least price b) efficient in terms of economy – to interfere as least as possible in resources allocation in the market c) simple in terms of taxation and administration d) „cheap taxation“ e) neutral in comparison to competition terms and free trade. ecological taxation reform process in member states of the european union the idea of ecological taxation reform is the intention to reduce pressure on environment by encouraging industrial producers to implement more efficient technologies (from the point of view of energy and resources consumption). ecological taxation reform is a process of implementation of ecological taxation parallel with abolishing ecologically harmful subsidies. consumers are encouraged to use more often goods produced in „ecological friendly“ way, which supports sustainable development concept and do less harm to the environment. fiscal duties (ecological taxation) are incorporated into the products' and activities' prices. producers and consumers are forced to take into consideration cost of polluting environment when making final economic decisions. this is a simultaneous and combined application of two principles: „producers pays“ and/or „consumer pays“. since the ecological taxation is incorporated into the selling price, the cost of taxation in the end pays the consumer. it means that this is a final application of the principle „consumer pays“. in the early 1990s, the process of ecological taxation started in eu articles. ecological tax reform „green tax reform“ was first implemented in sweden (1990), then in denmark (1993), spain (1995), netherlands (1996), great britain (1996), finland (1997), italy (1999), germany (1999), france (1999) and austria (1999). ecological taxation was imposed only for some products in serbia, in 2010 and ecological taxation implementation starts in 2013. „green tax reforms“ or ecological taxation reform, is enforced in one or a combination of the following ways (barde, 1999): • reduction or abolishing subsidies to production with ecologically harmful externalities, taxation imposing taxes on potentially dangerous substances to for the environment, • restructuring of the existing taxation system according to the criteria of environment protection, and • implementation of new forms of ecological taxation. in eu most frequent division of ecological taxations is the one based on the subject of taxation. in the practise, there are several divisions of ecological taxation depending on what is taken as the basis of the division (pirvu, clipici, 2010): 1. energy taxes: refer to energy sources used for transportation and households needs. the most significant taxed energy resources are diesel and gasoline, that is coal, fuel oil, electrical energy, natural gas, and all products which cause negative economic analysis (2012, vol. 45, no. 1-2, 32-44) 36 externalities. theese externalities not ecologically acceptable. these are, taxes on products which create pollution either at the moment of their consumption or at the moment of their production. the main advantage of energy taxes is the fact that it is becoming a form of the existing consumption taxation (value added tax, excise tax and other forms of general taxes on sales). this kind of taxation is more efficient and it has lower administration costs which makes its enforcement simpler and cheaper. 2. transport taxes: refer to the ownership of motor vehicles. taxes on services related to transport and transportation equipment are also included in this fiscal instrument. this tax can refer to selling of equipment and the import of transportation means and can be calculated annually though road tax. this form of taxation includes taxes on diesel, gasoline and other fuels used in transportation. 3. pollution taxes: refer to taxes on measured noise pollution, estimated emissions of gas and harmful materials into environment or managing of solid waste. the exception is tax on co2 which is included in energy taxes (steinbach, n., et al., 2009). this form of taxation is related to estimation of quality and quantity of released polluting material and measuring harmful emission. in terms of ecology, it is most efficient to directly tax the source of harmful emission. however, in most cases harmful emissions are hard to measure precisely. 4. resource taxes: refer to exploitation of mineral resources, water and forests. taxes on gas and oil extraction are excluded from this tax. they are meant to be calculated through the cost of consumption and do not have influence in the same way other types of ecological taxes do. methodology the subject of the analysis is determination of environmental tax revenue in the countries members in the european union, and monitoring of revenues based on ecological taxation. the subject of the analysis are iceland and norway, even they are not eu members (but they are situated in europe and belong to the group of developed countries). ecological taxation can improve imperfections of the market mechanism which are caused by externalities. table 1 shows environmental tax revenue in millions of eur, in all eu countries, iceland and norway in the period 2005-2010. on the basis of this table, table 2 was calculated. table 2 monitors environmental tax revenue trends in percentages year after year in each country individually. numerical data in the table 2 were calculated as chain indices. the level of environmental tax revenue in millions of eur from one year is related to the values of the same indicator in the previous year, for each country individually. all datas are based on eurostat data. table 3 represents different revenues collected by institutions for protection of environment in the western balkans countries. the main significanse of the table 3 is that shows the differences in calculations and differences in terminology. generally, european union has growth of the environmental tax revenue in the period 2005-2008, but since 2008 the revenue in eu generated through environmental taxes has a munitlak ivanović, o., et al., environmental taxation, ea (2012, vol. 45, no, 1-2, 32-44) 37 downward trend. tax revenues generated through ecological taxation in 2009 is decreased in relation to 2008 and in 2010 decreased in relation to 2009. table 1 indicates that level of tax revenue in the eu generated in this way in 2010 (286.602,86 mil eur) is almost identical to the values in 2006 (286.896,74 mil eur) table 1. environmental tax revenue in millions of eur geo/time 2005 2006 2007 2008 2009 2010 european union (27 countries) 280.737,30 286.896,74 296.304,06 303.564,96 296.996,98 286.602,86 belgium 6.845,10 7.083,60 6.846,80 6.989,60 6.790,60 6.874,10 bulgaria 648,38 695,02 767,26 1.033,64 1.218,89 1.060,50 czech republic 2.332,74 2.699,36 2.939,03 3.184,70 3.627,66 3.418,01 denmark 11.058,33 12.400,02 13.497,55 13.317,34 13.329,06 10.662,62 germany 56.031,00 55.159,00 55.732,00 54.205,00 54.538,00 54.164,00 estonia 203,46 254,58 293,42 353,11 379,25 413,00 ireland 3.740,00 4.090,19 4.417,35 4.678,42 4.506,83 3.781,20 greece 3.993,00 4.081,00 4.196,00 4.627,00 4.561 4.611,00 spain 16.857,00 17.630,00 18.396 19.124,00 17.840.00 17.163,00 france 38.683,00 38.550,00 39.660 39.828 40.061.00 39.927,00 italy 38.281,06 38.928,30 40.064,48 40.028,54 38.130,84 39.864,54 cyprus 506,97 481,34 483,34 535,22 542,3, 490,10 latvia 288,92 344,57 383,16 437,27 451,17 429,33 lithuania 492,39 481,91 433,77 507,97 533,95 543,22 luxembourg 838,89 892,65 891,93 953,8, 986,15 931,40 hungary 2.249,15 2.417,32 2.530,74 2.797,81 2.853,33 2.436,09 malta 138,21 158,21 171,98 205,34 200,51 194,89 netherlands 18.952,00 20.267,00 21.772,00 21.726,00 23.140,00 22.764,00 austria 6.350,18 6.445,72 6.401,79 6.621,73 6.795,09 6.658,16 poland 5.281,02 6.487,79 7.493,08 8.359,52 9.486,9, 7.944,34 portugal 4.478,84 4.557,71 4.603,88 4.783,40 4.406,32 4.202,98 romania 1.447,82 1.604,49 1.900,11 2.564,75 2.486,23 2.213,99 slovenia 899,87 919,83 934,31 1.038,43 1.119,53 1.260,83 slovakia 849,81 919,48 1.014,53 1.161,84 1.317,32 1.225,48 finland 4.924,00 4.861,00 4.993,00 4.934,00 4.992,00 4.553,00 sweden 8.154,39 8.445,47 8.648,32 8.856,76 8.934,30 8.212,71 united kingdom 46.211,77 46.041,18 46.838,23 50.711,77 43.768,75 40.603,37 iceland 284,27 365,91 332,10 355,03 181,08 134,85 norway 6.802,39 7.410,24 8.279,5, 8.535,85 8.148,46 7.370,71 source: eurostat statistical books, last update: 28.07.2011. economic analysis (2012, vol. 45, no. 1-2, 32-44) 38 the highest revenue was generated in 2008 at the time of the beginning of the first crisis wave. under such conditions, investment activities fall and consumption reduced, so it is logical to expect for revenues generated though ecological taxation to be reduced. the highest ecological taxation revenue has germany, followed by united kingdom and france. territorially smaller countries have substantially reduced revenues of ecological taxes: malta, iceland and cyprus. very interesting is the fact that the best results for that is the case of slovenia which in the same year, 2008, generated (1.038,43 mil eur), five times more ecological taxation than iceland. data in the table 2 were obtained on the basis of data presented in table 1 and formula for the calculation of chain indices. analyzing the datas whole eu we can see that the highest index was noted in 2007, while negative values are noted in 2009 and 2010. most countries have that trend. the countries which have positive index values in 2010 in relation to the previous year are: belgium, estonia, greece, italy, lithuania and slovenia. the most intense reduction of the index of environmental tax revenue have iceland, denmark and ireland. most countries have positive values of revenue growth in 2007 in compared to 2006. the highest index value in that period have romania, poland and estonia. these results can be explained with the fact that that was the period of accession of new countries to the eu. naimly, estonia and poland were integrated in 2004 and romania in 2007. accession to the eu means adapting to stricter ecological standards. high index values in 2008 in relation to 2007 were obvious. the highest revenue growth in that period had bulgaria followed by estonia, malta, lithuania, slovakia, latvia (the countries which became membero of eu in the last two enlargements in 2004 and 2007). the year of 2009 in compare to 2008 is the beginning of growth values fall of environmental tax revenue in millions of eur and in percentage. that trend is characteristic for the average for the whole eu. downward trend of fiscal revenues becomes clearer in 2010 in relation to 2009, since the crisis continues. out of 27 eu members, as many as 21 countries note negative revenue growth. the highest revenue reduction is noted in denmark. it is interesting that six countries made growth: slovenia (12,62%), estonia (8,90%), italy (4,55%), lithuania (1,74%), belgium (1,23%) and greece (1,10%). it is necessary to emphasize that estonia and slovenia in the considered period did not have negative revenue growth. the fact is that both countries were integrated in eu in 2004! the growing attention given to environmental aspects of tax policy partly reflects the higher profile of environmental issues in public, political and policy debate more generally. additional impetus for environmental tax reform has come from the recognition of the limitations of environmental policies pursued solely through conventional regulatory instruments. over a number of years, there has been a growing awareness that some environmental problems cannot be tackled purely as technical issues, to be resolved straightforwardly through regulations requiring the use of appropriate abatement technologies. munitlak ivanović, o., et al., environmental taxation, ea (2012, vol. 45, no, 1-2, 32-44) 39 table 2. overview in percentages of environmental tax revenue trends in eu member states in period 2005-2010. geo/time revenue growth in 2006 in relation to 2005 revenue growth in 2007 in relation to 2006 revenue growth in 2008 in relation to 2007 revenue growth in 2009 in relation to 2008 revenue growth in 2010 in relation to 2009 eu (27 countries) 2,19% 3,28% 2,45% -2,16% -3,50% belgium 3,48% -3,34% 2,09% -2,85% 1,23% bulgaria 7,19% 10,39% 34,72% 17,92% -12,99% czech republic 15,72% 8,88% 8,36% 13,91% -5,78% denmark 12,13% 8,85% -1,34% 0,09% -20,00% germany -1,56% 1,04% -2,74% 0,61% -0,69% estonia 25,13% 15,26% 20,34% 7,40% 8,90% ireland 9,36% 8,00% 5,91% -3,67% -16,10% greece 2,20% 2,82% 10,27% -1,43% 1,10% spain 4,59% 4,34% 3,96% -6,71% -3,79% france -0,34% 2,88% 0,42% 0,59% -0,33% italy 1,69% 2,92% -0,09% -4,74% 4,55% cyprus -5,06% 0,42% 10,73% 1,32% -9,63% latvia 19,26% 11,20% 14,12% 3,18% -4,84% lithuania -2,13% -9,99% 17,11% 5,11% 1,74% luxembourg 6,41% -0,08% 6,94% 3,39% -5,55% hungary 7,48% 4,69% 10,55% 1,98% -14,62% malta 14,47% 8,70% 19,40% -2,35% -2,80% netherlands 6,94% 7,43% -0,21% 6,51% -1,62% austria 1,50% -0,68% 3,44% 2,62% -2,02% poland 22,85% 15,50% 11,56% 13,49% -16,26% portugal 1,76% 1,01% 3,90% -7,88% -4,61% romania 10,82% 18,42% 34,98% -3,06% -10,95% slovenia 2,22% 1,57% 11,14% 7,81% 12,62% slovakia 8,20% 10,34% 14,52% 13,38% -6,97% finland -1,28% 2,72% -1,18% 1,18% -8,79% sweden 3,57% 2,40% 2,41% 0,88% -8,08% united kingdom -0,37% 1,73% 8,27% -13,69% -7,23% iceland 28,72% -9,24% 6,90% -49,00% -25,53% norway 8,94% 11,73% 3,10% -4,54% -9,54% to make any serious impact on some of the major environmental problems now facing policy-makers—acid rain, global warming, traffic congestion—environmental policies will economic analysis (2012, vol. 45, no. 1-2, 32-44) 40 need to achieve extensive and far-reaching changes to existing patterns of production and consumption. these changes inevitably entail substantial economic costs. the search for instruments capable of minimising these costs, and capable of achieving behavioural changes across all sectors, has led policy-makers in the last decade to pay much closer attention to the potential for incentive-based environmental regulation, through taxes, charges, tradable permits, and other ‘economic instruments’. in parallel with growing awareness of the potential for "economic instruments" such as environmental taxes to improve the efficiency of environmental policy, there has been interest in the scope for tax reform using the revenues raised from environmental taxes. some countries that have been concerned about the impact—either economic or political—of high taxes on labour income, have used environmental tax revenues to reduce tax rates on labour incomes (fullerton don, et al., 2007) different forms of taxes on environment protection in the countries of the western balkans in most western balkans countries the taxation reform has not started yet. ecological taxation reform is at the very beginning in this region. fact that there are several forms for collecting and calculation of revenues on environment protection. different counitres of western balkans region use not only different terminology (compensations, taxes, duties), but essentially there are different instruments which are treated differently. the way of calculation for collecting revenues by different instruments is different. it means that the revenues made by them are treated and are used for different purposes. depending on the kind of instrument, the revenues can be reinvested into environment protection or they can be centralized and directed as the state revenues or local management revenues. table 3. kinds of ecological taxation in the countries of western balkans country different forms of taxes on environment protection in the countries of the western balkans albania plastic containers taxes taxes on import of motor vehicles, carbon tax bosnia and herzegovina compensation for releasing of industrial water into water flows and using transportation means croatia compensation for emission of sulfur oxides expressed as sulfur dioxide compensation for emission of nitrogen oxides expressed as nitrogen dioxide compensation for non-harmful industrial waste disposal compensation for harmful industrial waste disposal special compensation for motor vehicles compensations for packaging materials and packaging waste compensation for waste tires management compensation for waste motor vehicle management munitlak ivanović, o., et al., environmental taxation, ea (2012, vol. 45, no, 1-2, 32-44) 41 country different forms of taxes on environment protection in the countries of the western balkans compensation for electrical equipment management compensation for co2 emission compensation for possessing waste batteries compensation for waste motor oils compensation for environment macedonia taxes on gasoline and diesel import tax on vehicles favoring new vehicles general tax on motor vehicles montenegro gasoline tax fossil fuels tax cfc tax serbia co2 emission tax taxes on using motor vehicles (enforcement delayed) eco taxes on special waste flow (enforcement delayed) eco taxes on new automobiles (enforcement delayed) sources: program of the foundation for environment protection and energy efficiency 2010-2012, zagreb, march, 2010; report on foundation for environment protection in bosnia and herzegovina 2010, fund for environment protection, march, 2011; fund for environment protection of the republic of serbia, belgrade, december 2011. it is obvious that croatia has made most progress in collecting and enforcement of tax reforms. among the abovementioned. croatia have 14 compensations (this equals taxation) collected by the fund for environment protection and energy efficiency of the republic of croatia. because of the crisis, revenues on ecological taxation made by the fund in croatia had an upward trend in the period 2004-2008, after which the revenue started to fall (foundation for environment protection and energy efficiency, 2010). as noted above and shown in table 3, environmental taxation in republic of serbia are included as an instrument of environmental protection in 2010, only for some products. the implementing of ecological taxation eco-taxes on special waste flow, using motor vehicles and eco-taxes on new automobiles are delayed until 2013 (fund for environment protection of the republic of serbia, 2011). albania, bosnia and herzegovina, macedonia and montenegro, have not made much progress in environmental taxation, comparison to republic of serbia (fund for environment protection, 2011). generally speaking, the western balkan countries have a much faster and stronger to become involved in the implementation of environmental standards if they want to become full eu members. conclusion environmental policy has been transformed over the past decade by the use of environmental taxes, emissions trading and other economic instruments. these allow stringent environmental policies to be introduced at lower economic cost than with lessflexible forms of conventional regulation, which dictate the abatement measures that firms economic analysis (2012, vol. 45, no. 1-2, 32-44) 42 must take. the cost-reducing flexibility in pollution abatement offered by economic instruments will become increasingly important, the higher the standards of environmental protection which are sought. the fact that there are differences between terms „ecological compensations“ and „ecological taxes“, both instruments bring revenues for the budget of the country. the difference is that the revenue from environmental compensations is reinvest in environmental protection but environmental taxes as a fiscal revenue of the state. ecological tax reform is aimed to encourage the production and consumption in environmentally suitable products and to discourage neither consuption or production “ecologicaly not friendly” products. due to the increase in the people’s exigencies related to the quality of the environment, many countries have shifted their focus on environmental taxes. despite the contradictory signals related to the efficiency of environmental taxes as well as to the downtrend in the revenues from such taxes at the level of the european union, the situation of the resources available to the state for the achievement of the economic and social policy objectives, also influenced by the current global context suggests that, in the future, the importance environmenta ltaxes might grow. the increase in environmental tax revenues, especially in the new member states, may generate an increase in the capacity to attract european funds, by providing for appropriate co-financing. as a result of the effects of the international financial crises, in the years 2008 – 2010 the collected fiscal revenues decreased, so that the european union member states have great difficulties in financing not only their environmental objective, but also all the objectives of the economic and social policy. most environmental taxes should be applied very carefully and taking into account the distortions that can be generated by such taxes in the economic environment. the popularity of higher energy taxation differs substantially depending on the stakeholders. while it is supported by the population, several enterprises, trade unions and the majority of governments, it is opposed by the energy intensive industry and some countries. other barriers of a legal, institutional or administrative nature are also discussed: energy (exemptions from part of the taxes, subsidizing more energy-efficient production technologies, solar heating systems, etc) and the prospects of the increase in the oil price that generated new pressures on the prices of goods and services, diminished the interest for the increase in environmental taxes. taking into account the changes that are currently taking place within the fiscal systems of the european union countries in the next few years we may see a revival of the views that appreciate the economic and social utility of environmental taxes. on the datas and research presented in this paper, it is obvious that revenues collected by ecological taxation are not negligible. thus they are measured in tens of millions of eur. ecological taxation contributes to total public revenue in a country, even they have limited fiscal significance. analyzing of flow of revenues made by collecting ecological taxes shows that revenues have downward trend, since 2008 (the beginning of the crisis). only two eu countries members (slovenia and estonia) did not have negative values. collection of ecological taxation contribute country with revenues and, in the same time encourages development of environmentally friendly production and consumption. however, producers who pay the environmental tax, the market less competitive than those manufacturers who do not. munitlak ivanović, o., et al., environmental taxation, ea (2012, vol. 45, no, 1-2, 32-44) 43 as research showed, croatia has made most progress in ecological area, in area of ecological taxation reform and collects most kinds of ecological taxes. the countries situated in western balkans which are (or tend to be) candidates for eu membership and those which are in this process should start with or intensify ecological taxation reforms. serbia, albania, bosina and herzegovina, montenegro and macedonia, must do the same and make more effort in order to implement ecological taxation reform and national strategy of sustainable development. references barde, j.p. 1999. “green tax reforms in oecd countries: on overview”. journal of business administration and policy analysis, 2(1): 145-156. coase, r.h. 1960. “the problem of social cost”. journal of law and economics, 3(1): 1-44. eurostat statistical books, last update: 28.07.2011. http://epp.eurostat.ec.europa.eu/portal/page/portal/product_details/publication?p_product_c ode=ch_11_2011_xls foundation for environment protection and energy efficiency. 2010. ”program of foundation for environment protection and energy efficiency 2010-2012”, zagreb: 23-25. foundation for environment protection and energy efficiency. 2010. ”program of foundation for environment protection and energy efficiency 2010-2012”, zagreb: 23-25 fullerton, leicester and smith. 2007. “envormental taxes reforming the tax systems for the 21st century”. mirrlees review, 4(1): 1-5. fund for environment protection of the republic of serbia. 2011. “information booklet”, belgrade: 1-24. fund for environment protection. 2011. “report on foundation for environment protection in bosnia and herzegovina”, sarajevo: 24-28. golušin, munitlak ivanović. 2009. “definition, characteristics and state of the indicators of sustainable development in countries of southeastern europe”. agriculture, ecosystems and environment, elsevier 4(2): 67-74. oecd. 1999. “survey on the use of economic insruments for pollution control and natural resources management in the new independent states”. eap task force, washington: 56-58. pigou, a.c. 1918. the economics welfare. london: macmilan. pirvu, clipici. 2010. “perspectives of the environmental taxes evolution in the european union”. the romanian economic journal, 38: 147-161. steinbach, palm, cederlund, georgescu, haas. 2009. “environmental taxes”, 14th meeting of the london group on environmental accounting canberra, discussion paper lg/14/18 27-30. united nation conference on environment and development “the rio declaration on environment and development”. rio de janeiro, june 1992: 1-19. economic analysis (2012, vol. 45, no. 1-2, 32-44) 44 ekološki porezi kao instrument politike održivog razvoja – komparacija stanja u srbiji i primene ekološke poreske reforme u zemljama članicama eu rezime – nacionalna strategija održivog razvoja srbije je dala jasne smernice za pravac kretanja ekonomije, poštovanja ekoloških principa, razvoj i primenu bolje socijalne i institucionalne politike. ekološki porez, kao i svi drugi porezi je fiskalni prihod, ali njegova primena ima posebni značaj, zato što pored ekonomskog, on ima ekološki, institucionalni i socijalni karakter, i kao takav on je instrument politike održivog razvoja. ovim radom autori ukazuju na kretanje vrednosti prihoda od ekoloških poreza u članicama eu u periodu 2005-2010. godine. kako je to period koji karakterišu privredni problemi usled krize u svim zemljama, uočen je pad prihoda od ekoloških poreza čak i u najrazvijenim zemljama eu. posmatrano u proseku, eu je ostvarila najviše prihoda od ekoloških taksi 2008. godine, da bi taj trend do 2010. godine beležio pad. najveći prihod od ekoloških taksi je ostvarila nemačka (56.031 mil eur) i to na početku posmatranog perioda, a najniži prihod u vrednosti od (138,21 mil eur) je ostvarila malta i to iste, 2005. godine. potrebno je naglasiti da trend ima opadajući karakter u svim zemljama osim u sloveniji i estoniji, koje su pristupile eu 2004. godine. prihod koji se ostvaruje naplatom ekoloških poreza je značajan i meri se desetinama miliona eur, ali postoji mogućnost da se položaj privrednih subjekata koji ga plaćaju otežava jer postaju manje konkurentni. od zemalja zapadnog balkana, koje nisu članice eu, ali su u procesu pripreme pristupanju, hrvatska je najdalje otišla u primeni zakona koji se odnose na ovu oblast i primenjuju čak 14 različitih ekoloških poreza. prema podacima fonda za zaštitu okoliša i energetsku efikasnost, prihodi fonda od ekoloških taksi su bili u velikom porastu od 2004-2008. godine da bi usled krize taj prihod tada počeo da beleži pad. ekološka poreska reforma „green tax reform“ je u zemljama eu počela krajem xx veka. (prvo je implementirana u švedskoj 1990.) u srbiji, nije sprovedena ekološka poreska reforma ali postoji nekoliko taksi (na emisiju co2 su najznačanije) pri čemu je primena nekih taksi odložena. ključne reći: drživi razvoj, ekološki porez, prihod od ekološkog poreza, trend, kriza, ekološka poreska reforma article history: received: 25 march 2012 accepted: 17 april 2012 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp20-38 scientific review socio‐economic impact of natural disasters in the republic of serbia jelena stanković1* | zoran tomić1 | jovica stanković1 1 the university of niš, faculty of economics in niš, department for accounting, mathematics and informatics, niš, serbia abstract the rapid technological and economic development caused the emergence of new risks and influenced the change in the frequency and effects of those already known. considering that characteristics of natural disasters vary in space and time, the aim of this paper is to perform a spatial and temporal analysis of their impact on the society and economic activities in the republic of serbia. for this purpose, data from the "desinventar" database were used for the period from 1996 to 2019. multidimensional data analysis shows that the effects of catastrophic risks are greater in less developed regions. moreover, the effects of low-scale disasters, which are generally not regarded as relevant from a macroeconomic point of view, further affect sustainable regional development. these disasters cause social, economic and environmental problems especially in the region of šumadija and western serbia. from the aspect of impact on economic activities, it can be concluded that these disasters significantly affect agricultural production in the entire territory of the republic of serbia. the results of this paper point to significant aspects of the effects of natural disasters, as well as potential ways to manage catastrophic risks in the republic of serbia. therefore, they can be considered a notable input for policy makers, insurance companies and other relevant stakeholders in disaster risk management. key words: natural disasters, socio‐economic impact, sustainable development, multidimensional data analysis, olap, disaster risk management jel classification: q01, q15, q54, g32, c55, c82 introduction natural hydrological, lithospheric and atmospheric processes have always caused certain losses. their transformation into extreme risks, or natural disasters, has taken place in parallel with the development of social, cultural, economic and political organization of the human society. the intensity of the extreme risk effects, both on the whole social-ecological system, and on the economic and financial subsystems, is determined by the vulnerability and exposure of the system to concrete risk. these determinants of extreme risks are dynamic and variable in space and time. vulnerability and direct consequences of natural disasters on the biophysical system and economy are greater in underdeveloped and developing countries, characterized by low levels of economic development, unstable political situation, unfavorable educational structure and insufficient awareness of natural disasters (alcantara-ayala, 2002; landerosmugica et al., 2016; gu, 2019). however, if indirect and synergistic effects are taken into account, * corresponding author, e-mail: jelenas@eknfak.ni.ac.rs jelena stanković, zoran tomić, jovica stanković 21 the intensity of the consequences of natural disasters in the most developed areas can take an enormous extent (o'brien et al., 2006; al kazimi & mackenzie, 2016), because development per se is not a guarantee of sustainability. moreover, there is evidence that natural disasters can have a positive impact on human capital accumulation, total factor productivity growth and gdp per capita growth, and on the volume of knowledge, spillovers between developed and developing countries. the socio-economic effects of natural disasters in europe are expected to be higher and more frequent in the future as climate change intensifies (naumann et al., 2015; alfieri et al., 2015). when it comes to the republic of serbia, the estimates based on climate modeling point to an increase in annual temperatures that is expected to be up to 1.0°c on average in the near future from 2016 to 2035, with an increasing trend to the end of the century (vukovic et al., 2018). these projections indicate the possibility of intensifying the present hazards, especially hydrological ones. projected impact of floods and droughts may be greater both in scope and duration, causing social, economic and environmental problems. with 17.1% of the area and 17.5% of the population at risk of natural disasters, the republic of serbia belongs to the group of countries that are at relatively high risk of multiple hazards (dilley et al., 2005). however, the intensity of natural hazards, typical of the territory of the republic of serbia, cannot be considered as dangerous. nevertheless, small and medium-scale natural disasters should not be underestimated, as they mark the problem of local society disaster risk. the uneven regional development of the republic of serbia has caused significant differences in the level of vulnerability of certain areas. vulnerability assessment on the basis of social and economic indicators shows that the largest number of municipalities in the republic of serbia can be characterized as low to moderately vulnerable. urban areas, especially regional centers, may be considered more vulnerable to natural disasters, primarily because of population size and population density (kovacevic-majkic et al., 2014). the floods that hit the balkan region in 2014 brought global attention to the high level of vulnerability and unreadiness of the republic of serbia and neighboring countries to manage such risks. according to the world bank study (2015), economic sectors in serbia, which are particularly vulnerable to natural disasters, are agriculture and production, transmission and distribution of electricity and heat. the purpose of this study is to analyze the impact of damages and losses caused by natural disasters in the republic of serbia and to report their spatial distribution. we use the data available in the "desinventar" database supported by the united nations office for disaster risk reduction, which contain historical data on damage caused by various disasters. taking into account the interdependence between the effects of natural disasters and the level of development of the society, we assume that less developed regions are more exposed to the effects of natural disasters. however, knowledge on the impact of natural disasters, as well as increased prevention measures should, over time, reduce the intensity of natural disasters, especially smalland medium-scale ones, which can be considered as seasonal risks. adding to this the existing intensity of the effects of natural risks in the republic of serbia, it is presumed that during the observed period the socio-economic impact of natural risks will decline. observing the social and economic effects of natural disasters in the period from 1996 to 2019, we pursue to reveal the changes in regional exposure to natural disasters as a solid direction to determine a potential strategy for managing catastrophic risks in the republic of serbia. hence, the results of this paper can be considered as a significant input for policy makers, insurance companies and other relevant stakeholders. considering its importance for economic and social development and sensitivity to climate change, special attention will be paid to the impact of natural disasters on agriculture. therefore, the paper is structured as follows: the second part of the paper provides an overview of the most important studies of the economics of natural disasters. the methodology framework of this research is elaborated in the part 3. the obtained results are presented in section 4, while section 5 concludes the presented work. 22 economic analysis (2020, vol. 53, no. 2, 20-38) the economics of natural disasters – a literature review modern social-ecological systems are exposed to a large number of mutually correlated risks, which represent a potential threat to the survival of the entire global system. despite the fact that risks can be categorized in different ways, the specificity of extreme risks is reflected in their intensity and frequency of occurrence. therefore, extreme risks or catastrophes can be characterized as all risks whose probability of occurrence is very small and the consequences are sudden and enormous (posner, 2004). natural disasters can be defined in different ways (lukic et al., 2013; ranke, 2016), since there is no consensus on the threshold of loss according to which the risk can be considered extreme. thus, natural disasters can be characterized as events caused by nature which consequences exceed the normal experiential range of each system individually. the significance of natural disaster risk reduction in the realization of strategies for sustainable development, which is highlighted in 25 targets of sustainable development goals (undp, 2015), has raised the question of the criteria for classifying this risk. the classification of natural disasters was primarily based on the criteria of major damage records providers, such as: munich re's "natcatservice", swiss re's "sigma", the "em-dat" database of the center for research on the epidemiology of disasters, the "glide" of the asian disaster reduction center, as well as the "desinventar" database of the social studies network in disaster prevention in latin america (below et al., 2009). the databases were initially designed for reinsurance purposes. they contain highly detailed information about the occurred catastrophic events, so they could be used by researchers, institutes, national and international organizations and other interested stakeholders. risks that arise from geophysical and geological, meteorological, hydrological, climatological, biological and extra-terrestrial events are recorded depending on different thresholds. in this way, databases like "sigma" and "emdat" set quantitative criteria for recording natural disasters. on the other hand, "natcatservice" and "desinventar" do not have quantitative thresholds and record catastrophic events as soon as any damage or impact occurs (kron et al., 2012). due to the fact that economic damages caused by natural disasters during the previous seven decades have increased 14 times (guha-sapir et al., 2004, p. 13), detailed databases, which do not neglect small damages, provide the necessary information for defining a strategy to manage these risks. the impact of natural disasters on agriculture is particularly significant. namely, 22% of economic impact, caused by medium and large-scale natural disasters, especially in developing countries, refers to agriculture, while 42% is on the crop subsector (baas et al., 2015, p. 5). these losses directly affect consumption, savings and investment in both developed and developing countries, but low-income countries are particularly vulnerable to these changes. at the same time, there is an ongoing debate among experts on whether and how natural disasters affect economic growth. contemporary researchers have given conflicting opinions about the effects, so studies can be divided into two major groups: the ones confirming the negative impact and others that show the positive impact of natural disasters on economic growth. the results obtained from the studies depend on numerous factors: the size of the country, geographical location, type of natural disaster, the level of economic development, the group of countries considered, the term in which the consequences are analyzed (long or short term), etc. however, it cannot be neglected that natural disasters have effects on the long-run growth, influencing the technology and natural resources, as well as the process of human and physical capital accumulation as the main determinants of the long-run growth (popp, 2006). the negative impact of natural disasters on economic growth has been confirmed in recent studies of catastrophic events in developing countries conducted by vigdor (2008), noy (2009) and strobl (2012). cavallo et all (2013) come to conclusion that extreme disasters, especially the ones that preceded radical political revolutions, have a negative impact on gdp in the short and long term. using a cross-country analysis, they provide records of large direct costs of natural disasters that do not significantly affect gdp in the short term. the gdp growth downtrend, in the short term, can be the result of transferring resources to sectors that largely depend on jelena stanković, zoran tomić, jovica stanković 23 natural resources, in order to recover losses (sadia et al., 2013). therefore, the reduced productivity in industry may be the result of conducted reconstruction activities (sardar et al., 2016). however, in the long run (e.g. 10 years after the disaster) large natural disasters cause a 10% decline in gdp per capita, especially in developing countries (cavallo et al., 2013). toya and skidmore (2007) find that countries with higher gdp per capita managed to reduce damages and monetary losses comparing to countries with lower gdp per capita. the authors show that the income increase made people more willing to invest in flood protection. the economic damage that a country could suffer from flooding depends on the frequency and severity of floods, the coastal area as well as the level of economic development (jonkman et al., 2008). on the other hand, there are studies that provide evidence of positive correlation between natural disasters and economic growth (albala-bertrand, 1993; tol, 1999; skidmore & toya, 2002). the authors, in these studies, empirically confirm the hypothesis of creative destruction. presenting the evidence that natural disasters provide opportunities for capital improvement and the adoption of new technologies, the authors evidence a long-term growing rate of gdp per capita in developing countries. these knowledge spillovers from one country, usually developed one, to developing, disaster-prone countries are conducted through trade channels (cuaresma et al., 2008; oh & reuveny, 2010). although creative destruction can boost economic growth in developing countries, the large-scale disasters may lead to a poverty trap (halledatte & bumas, 2009). by analyzing the impact of natural disasters on the annual gdp of vietnam, noy and vu (2010) find that disasters that affected a greater number of people resulted in lower economic growth, while more costly disasters actually stimulated a greater impact on economic growth in the short term. however, the macroeconomic impact differs depending on the geographical region, the ability to generate government and non-government fund transfers and access to foreign direct investment. in europe the most frequent disasters are floods and they affect the most people and cause most of economic damage both in western and eastern parts of the continent (banica et al., 2020). heat waves and storms also affect large share of european population, but droughts have the greatest impacts on agriculture as well as well-being of the people. however, international disaster relief decreased disaster-related fatalities in european countries for more than 30% revealing strong regional differences in disaster coverage (stromberg, 2007). the middleand low-income countries closest to the large donors are located in eastern europe and they received around 2.5 times as much relief for a similar disaster in some asian country. however, changes in national boundaries due to the break-up of the former soviet union and former republic of yugoslavia caused data ambiguities, which hinder the systematic regional analysis of natural hazards in transition economies (guha-sapir et al., 2014). according to relevant studies, the overall effect of natural disaster will depend on the kind of disaster (type, intensity, frequency, etc.), geographical location and national economy characteristics. contradictory results are obtained by noy and naulsri (2007), while some studies provide evidence that large-scale disasters have a negative impact on economic growth in the short term without clear effects in the long run (kim, 2010). moderate floods may even enhance annual gdp growth and agriculture growth in developing countries, while storms and droughts both moderate and severe have significant negative impact on economic growth (panwar & sen, 2019). therefore, an increasing number of studies are focused on the analysis of the mechanisms and channels through which growing effects are exercised and less on whether there are effects or not. one of the analyzed indicators concerning the impact of natural disasters on economic growth is the level of savings. natural disasters influence the behavior of economic agents in a different manner, so that individuals tend to be more conservative and increase savings after natural disasters or simply become self-indulgent and spend more at the expense of savings. luo and kinugasa (2018) identify two types of uncertainty in the postdisaster period that affect the behavior of economic agents: (1) after the disaster some people affected by the disaster will try to overcome the situation and recover in the long run using 24 economic analysis (2020, vol. 53, no. 2, 20-38) savings and other methods of self-insurance, or (2) after catastrophic damage some people expect their lives to be shortened due to illness and other shortcomings, which will affect the change in their behavior and attitude towards saving and spending in favor of consumption on the long term. researchers have shown that people who live closer to the epicenter of natural disasters live more comfortably, save less and invest more in alcohol, cigarettes and enjoyment (berleman et al., 2015). this phenomenon is known as "mercy hazard". it is a consequence of government financial support in the process of asset reconstruction destroyed during catastrophic events, which discourage victims to save. instead of promoting savings, it can be expected that natural disasters will have an impact on the country's fiscal cost in the medium and long term (koetsier, 2017). kellenberg and mobarak (2008) detect a nonlinear relationship between gdp per capita and the cost of natural disasters. studying the correlation between natural disasters and public debt on a sample of 163 countries, they provide evidence on public debt growth by 4.6 to 9.8% of gdp in the disaster recovery period. however, cavallo and noy (2010) show that due to the severe consequences of natural disasters, the poorest countries would have more difficulty adjusting their counter-cyclical fiscal policy to be able to finance the reconstruction of such damage. the number of natural disasters in the previous one hundred years has been increasing rapidly (cvetkovic & dragicevic, 2014) and global climate change has contributed to this growing trend. vulnerability of the republic of serbia to natural disasters is a consequence of geographical position, natural and socioeconomic features, so the trends in vulnerability variations reflect regional variability of vulnerability, an increase in vulnerability at a national level and increase in vulnerability differences between urban and rural areas (kovacevic-majkic et al., 2014). the most common natural disasters are floods, storms, earthquakes and droughts (gavrilovic, 2007), as well as forest fires and landslides. these risks can cause huge damage and impact overall gdp growth, as well as agricultural production (djuricin & bodroza, 2013). considering the fact that 80.60% of the municipalities are not capable of coping with these types of emergencies (radovic et al., 2015), it can be concluded that natural disasters present a significant factor in the sustainable development of the republic of serbia. therefore, in this paper we present spatial analysis of gdp and natural disaster occurrence and its influenza in order to provide a basis for the development of various instruments for disaster risk management in the republic of serbia. research design and methodology the analyzes of natural disasters in this study are conducted on the territory of the republic of serbia. the territory of south-eastern europe is exposed to diverse natural hazards due to its specific geographical location. however, the data on natural disasters that have occurred on the territory of the republic of serbia have not been systematically recorded in any national database. partial information can be found in reports of relevant services such as the republic hydro-meteorological service of serbia and the emergency management sector of the ministry of the interior of the republic of serbia. in order to provide a consistent analysis of the socioeconomic impact of natural disasters in the republic of serbia, we use data obtained from the international open access database "desinventar". the "desinventar" database was developed in 1994 by the network for social studies in disaster prevention in latin america (la red) as a conceptual and methodological tool for the construction of databases of losses, damages and effects caused by disasters. under the undp/seesac project national registration of disaster losses and damages was first developed using the unisdr tool "desinventar". this database provides very detailed information on the effects of disasters describing the event by 140 attributes. the data on disaster events that took place in the republic of serbia are available for the 34-year period from 1986 to 2019, which makes a total of 1,928 data entries. since economic loss data are recorded from 1996, we use annual data for the 24-year period from 1996 to 2019, which provides the available data set on natural disasters of 1,561 data entries. the structure of jelena stanković, zoran tomić, jovica stanković 25 this dataset enables us to perform multidimensional analysis using online analytical processing (olap) of data. the focus of olap is to provide a platform for analyzing data (e.g. effects of disasters) with multiple dimensions (e.g. disaster type, location, time) and multiple measures (e.g. people affected, number of houses destroyed or damaged). therefore, we design a data cube in order to organize the data by grouping it into different dimensions, and enabling overview and analysis of data from a number of perspectives. multidimensional data analysis involves the implementation of several standard olap operations. we perform the analysis by interactively extracting a fraction of the data by selecting the appropriate values for one or more dimensions, pivoting and rolling the data representation, and applying drilling techniques to change the detail of the data representation (reddy et al., 2010). the slice operation is the choice of a subset of a cube by choosing one particular value, or some range of values, for one of the dimensions of the cube. the dice operation represents the selection of one part of a cube by choosing one particular value, or some range of values, for multiple dimensions of the cube. the drill down/up operation allows us to navigate within different levels of the hierarchy for a particular dimension. drill up shows information from the level above (more aggregated information), while drill down shows information from the level below, characterized by a higher level of detail. the roll up operation refers to the calculation of aggregated data for one or more dimensions. the pivot operation presented in figure 1 allows us to rotate the cube in space to allow different views of the data. this changes the orientation of the dimensions in a report or graph, thus changing the perspective from which the data is viewed. figure 1. pivot olap operation source: adopted by authors based on kimball and ross (2015) in order to create data cube, we create four hierarchical dimensions and fact table (fact disaster) as follows:  geography dimension (dim_geography) with levels of country, region, and municipality,  date dimension (dim_date) with levels representing year, quarter, month and day,  disaster dimension (dim_disaster) for representing different types of disasters, and  impact dimension (dim_impact) for representing effects caused by disaster, i.e. financial losses, material damages and people affected. the damage records in this database provide information about location and municipality, but for the purposes of disaster analysis, they are observed at the level of the region to which the 26 economic analysis (2020, vol. 53, no. 2, 20-38) disaster location belongs, such as: the regions of belgrade, vojvodina, šumadija and west serbia and the region of south and east serbia. damages and losses occurred in these regions are observed at five-yearly intervals, based on data recorded on a daily basis. considering the disaster dimension, we classify natural disasters according to the physical cause of an occurrence as well as quantitative indicators. the qualitative criteria of a natural disaster are classified into six groups: geophysical (earthquake, mass movement, volcanic activity), meteorological (storm, extreme temperature, fog), hydrological (flood, landslide, wave action), climatological (drought, wildfire), biological (disease, animal incident, insect infestation) and extra-terrestrial (impact, space weather). quantitative criteria refer to the size of damages and losses. since the recording of natural disasters in the "desinventar" database does not imply the fulfillment of quantitative criteria, we use the criteria of the center for research on the epidemiology of disasters for this purpose. according to these criteria, for an event to be considered a natural disaster, at least one of the following criteria must be met: 10 or more people reported killed; 100 or more people reported affected; declaration of a state of emergency; call for international assistance. we use the number of casualties and the number of affected people as a criterion for the division of catastrophes by intensity, due to the fact that there is no evidence of economic damage for each event. for this reason, catastrophes, meeting at least one of the selected criteria, are categorized as large-scale disasters and the others as smalland medium-scale disasters. in this way, we create a new attribute (i.e. the scale of the disaster), allowing the effects of smalland medium-scale disasters and the effects of large-scale disasters to be compared. considering the purpose of this paper and the importance of particular attributes for assessing the socio-economic impacts of natural disasters, we use the following attributes to describe the intensity of disaster (impact dimension): the number of people affected (ap), the number of people died (dp), the number of damaged (damh) and destroyed houses (desh), damage in crops (damc) expressed in hectares and economic losses expressed in local currency (ecl). figure 2. the star schema of the data cube source: adopted by authors based on kimball and ross (2015) jelena stanković, zoran tomić, jovica stanković 27 the star schema of the data cube is presented in figure 2. after selecting the required data attributes, cleaning and preprocessing data, and calculating new attributes, dimension tables are populated and disaster data are stored in fact table through extract, transform and load process (etl) for enabling data analysis. results and discussion the vulnerability to natural disasters in the republic of serbia is certainly a consequence of geographical positioning. however, in addition to geographically conditioned factors, exposure and sensitivity to catastrophic risks are determined by socio-economic factors, such as population density, infrastructure quality and response capacity (dilley et al., 2005). due to the fact that natural risks of lower intensity mainly affect the livelihood of people in rural areas and smaller municipalities, we analyze the socio-economic impacts of natural disasters in the context of the observed regions development. thus, based on the general data of the regions (table 1), it can be concluded that the considered territorial units differ according to the area and number of inhabitants. the region of belgrade is the most densely populated in relation to the others. according to the level of gdp per capita, the regions of šumadija and western serbia and southern and eastern serbia are less developed than the belgrade region with a significant share of agricultural production in gdp. thus, the impact of natural disasters in these regions can have multiple effects, both on people's lives and on economic activities. table 1. regions in the republic of serbia – general data for 2018 regions number of municipalities area (km2) number of inhabitants* gdp per capita (000 rsd) gva agriculture, forestry and fisheries belgrade region 174 3,234 1,690,193 1,240 1.1% vojvodina region 446 21,614 1,861,863 705 14.9% region of šumadija and western serbia 1,935 26,493 1,924,816 489 11.4% region of southern and eastern serbia 1,967 26,248 1,505,732 476 8.5% * estimation made on june 30, 2018 source: authors' calculation, based on the data from the statistical office of the republic of serbia based on the data in table 2, it can be noticed that natural disasters in the republic of serbia are most often caused by climatological (35.55%) and hydrological factors (34.79%), while 28.31% of all disasters occur under the influence of meteorological risks. the spatial distribution is such that the largest number of disasters in the observed period affected less developed regions: the region of southern and eastern serbia (43.56%) and the region of šumadija (39.59%). when it comes to the intensity of consequences, a similar trend can be observed in all regions large-scale disasters participate with about 14 to 20% in the total recorded number of disasters, while the largest number of disasters (over 80%) can be characterized as smalland medium-scale (s&m). 28 economic analysis (2020, vol. 53, no. 2, 20-38) table 2. classification of natural disasters in the republic of serbia in the period from 1996 to 2019 type of natural disaster belgrade region region of southern and eastern serbia region of šumadija and western serbia vojvodina region large s&m large s&m large s&m large s&m geophysical 1 1 meteorological 1 11 47 89 32 199 3 60 hydrological 10 33 44 130 83 164 22 57 climatological 17 2 358 3 132 43 biological 1 9 5 3 3 total 72 680 618 191 source: authors' calculation, based on the data from the "desinventar" database if we analyze the time distribution of natural disasters in the republic of serbia, we can detect a growing trend in the previous decade. in fact, the largest number of disasters (about 65%) in all observed regions was recorded in the period from 2011 to 2015 (figure 3). this period was also characterized by one of the greatest catastrophes recorded in recent history the floods in 2014. however, such data should be taken with certain reserve, because the increase in the number of natural disasters may be a consequence of more up-to-date recording of catastrophic events in recent times. figure 3. the time and spatial distribution of natural disasters in the republic of serbia in the period from 1996 to 2019 source: authors’ calculation, based on the data from the "desinventar" database there are multiple effects of natural disasters. direct effects are reflected in material damage and human casualties. indirect effects can have an impact on the way of life and work of people, relationships and structures in society. it is therefore important to consider the impact of natural disasters on victims, but also on persons who under such circumstances have been denied access to public services, supplies, work or have had to be evacuated from their homes and relocated permanently or temporarily to other places. people who suffered such consequences are characterized as affected people in this paper, and in the entire observed period in the territory of the republic of serbia there were 686,860. we can conclude that 0 100 200 300 400 500 1996-2000 2001-2005 2006-2010 2011-2015 2016-2019 belgrade region region of southern and eastern serbia region of sumadija and western serbia vojvodina region jelena stanković, zoran tomić, jovica stanković 29 natural disasters affect the lives and work of 9.35% of the population, observed in relation to the average number of inhabitants in the republic of serbia in this period. over 50% of affected people were located in the region of šumadija and western serbia, while in the region of southern and eastern serbia there were 25.39% and in the region of vojvodina 18.12% of the total number of affected people. large-scale natural disasters in serbia, especially in šumadija and western serbia region, are very intense and their impact, contrary to expectations, does not decrease (table 3). during the last observed five-year period (2016 2019), a small number of large-scale disasters were recorded (6), as a result of which their impact on the population in the regions of southern and eastern serbia and šumadija and western serbia was much smaller. smalland medium-scale natural disasters, although more frequent, had a much smaller impact on the population, so that on average the number of affected people generally did not exceed 10 per event. therefore, we can conclude that every-day life and work of people are mostly affected by natural risks of high intensity, which hit 99.42% of the total number of affected people in the entire observed period. however, when it comes to the number of people killed, the data indicate a high mortality rate due to disasters of small and medium intensity. table 3. the number of affected people per natural disaster event in the republic of serbia period belgrade region region of southern and eastern serbia region of šumadija and western serbia vojvodina region apl aps&m apl aps&m apl aps&m apl aps&m 1996 – 2000 420.0 6,550.0 15.0 2,226.5 3.1 1,174.0 2001 – 2005 1,910.0 3,124.9 4.6 2,370.7 2006 – 2010 621.3 26.5 1,793.6 6.6 2,994.9 12.4 680.7 1.4 2011 – 2015 10,793.3 2.22 3,718.4 0.9 2,442.8 3.5 9,019.1 2.6 2016 – 2019 0.1 474.0 1.0 635.0 2.4 9.9 note: apl the number of people affected in large-scale natural disasters; aps&m – the number of people affected in smalland medium-scale natural disasters. source: authors' calculation, based on the data from the "desinventar" database due to the effects of natural disasters in the republic of serbia, 103 people died in the observed period, with 60% of people killed in large-scale disasters, and even 40% in smalland medium-scale disasters. the largest number of human victims is recorded in the region of southern and eastern serbia (45.16%), while in the regions of belgrade and šumadija and western serbia this indicator of social impact of natural disasters is identical (27.42%). however, in the case of šumadija and western serbia region, it can be noticed that large-scale disasters have almost identical impact in all observed time intervals, while in the region of belgrade the extremely high value of this indicator is due to disasters that occurred during the period 2011-2015 (table 4). large-scale catastrophes do not take human victims only on the territory of the region of vojvodina. also, in this area the effect of small and medium catastrophes is the least. on the other hand, 46.34% of the total number of people who died due to smalland medium-scale disasters are recorded in the region of šumadija and western serbia. in this region, consequences of these disasters are almost in the range of large-scaled ones. fatal outcome most often occurs as a result of floods, but also frost and snowstorms. 30 economic analysis (2020, vol. 53, no. 2, 20-38) table 4. the number of deaths per natural disaster event in the republic of serbia period belgrade region region of southern and eastern serbia region of šumadija and western serbia vojvodina region dpl dps&m dpl dps&m dpl dps&m dpl dps&m 1996 – 2000 1.0 2.0 2001 – 2005 1.0 2006 – 2010 1.7 1.0 2.0 1.3 2011 – 2015 17.0 6.0 3.2 1.0 1.3 1.1 1.0 2016 – 2019 2.0 1.0 1.0 note: dpl the number of people died in large-scale natural disasters; dps&m – the number of people died in smalland medium-scale natural disasters. source: authors' calculation, based on the data from the "desinventar" database when it comes to material damage, it can be noticed that natural disasters in the republic of serbia cause significant damage to property. the total number of damaged houses in the entire observed period is 85,494, of which one third is damaged in smalland medium-scale disasters. however, if we consider the average consequences on this type of property, it can be concluded that even disasters of this scale can cause significant damage (table 5). the damage is especially great in the region of šumadija and western serbia, where even 59.26% of all damaged houses in the observed period in the republic of serbia are located. the most common cause of damage is flood, resulting in as much as 61% of all damage to houses in this region, and also earthquake (24%). significant damages are recorded on the territory of southern and eastern serbia during the entire observation period, and the greatest risk is again the risk of flooding. extreme average damages on the territory of belgrade region in the period 2011-2015 occurred due to major floods in 2014, while in the case of vojvodina region, extreme average damages occurred in the period 2016-2019 due to hailstorms. table 5. the number of damaged houses per natural disaster event in the republic of serbia period belgrade region region of southern and eastern serbia region of šumadija and western serbia vojvodina region damhl damhs&m damhl damhs&m damhl damhs&m damhl damhs&m 1996 – 2000 124.0 270.0 850.0 341.5 454.3 210.0 2001 – 2005 439.5 169.0 294.3 65.0 298.3 2006 – 2010 165.7 135.0 401.6 29.6 338.4 348.3 91.7 64.1 2011 – 2015 5,067.0 39.9 352.6 31.5 323.3 81.2 89.0 169.3 2016 – 2019 8.0 89.2 195.0 66.4 3,434.5 note: damhl the number of damaged houses in large-scale natural disasters; damhs&m – the number of damaged houses in smalland medium-scale natural disasters. source: authors' calculation, based on the data from the "desinventar" database due to the effects of natural disasters on the territory of the republic of serbia, a total of 5,677 houses were destroyed in the period from 1996 to 2019, out of which 63.22% were destroyed due to the effects of large-scale disasters. however, the analysis of damages indicates the fact that the smalland medium-scale disasters cause serious damage to human property, with their impact being particularly pronounced in the regions of southern and eastern serbia and šumadija and western serbia (table 6). in the region of southern and eastern serbia, the biggest risk, which leads to the destruction of houses, are floods (96.48%), while in the region of šumadija it is the risk of earthquakes (68.24%), but also heavy rainfall (11.67%). as with other indicators, in this case, it can be presumed that the least developed regions in serbia are most jelena stanković, zoran tomić, jovica stanković 31 exposed to the effects of both large, small and medium disasters, which have serious consequences for the livelihood of people in these areas. table 6. the number of destroyed houses per natural disaster event in the republic of serbia period belgrade region region of southern and eastern serbia region of šumadija and western serbia vojvodina region deshl deshs&m deshl deshs&m deshl deshs&m deshl deshs&m 1996 – 2000 8.00 5.00 650.00 37.60 2001 – 2005 207.33 2006 – 2010 50.00 35.00 17.50 202.61 66.00 42.00 11.50 2011 – 2015 180.00 12.00 13.83 10.93 2.56 20.00 1.00 2016 – 2019 300.00 4.00 77.00 72.50 note: deshl – the number of destroyed houses in large-scale natural disasters; deshs&m – the number of destroyed houses in smalland medium-scale natural disasters. source: authors' calculation, based on the data from the "desinventar" database taking into account the contribution of agriculture, forest and fishing to gdp creation, especially in the regions of vojvodina and šumadija and western serbia, one of the indicators of the impact of natural disasters on the economy of the republic of serbia is damage to crops. this indicator is expressed in the area where the damage occurred (table 7). due to the effects of natural disasters, damage affected over 1,251,328 ha under crops in the observed period on the territory of the republic of serbia. the spatial distribution of the damage is as follows: 47.11% was recorded in the region of vojvodina, 28.83% in the region of šumadija and wester serbia and 23.20% in the region of southern and eastern serbia. in all these regions, extreme crop losses were caused by floods, while significant disasters caused by drought, hailstorms and floods can be identified as consequences of lowand medium-scale disasters. however, if we compare the average effects of these disasters, it can be seen that smalland medium-scale disasters can cause greater damage than large-scale ones. it is also concerning that these risks can be prevented, but that their impact on agricultural land is not reduced, especially in regions where this activity is of special importance for economic development. for example, in the territory of vojvodina, these natural disasters have up to 7 times greater impact than large disasters, while in the territories of southern and eastern serbia and šumadija and western serbia their effect varies, but, contrary to expectations, it does not decrease significantly. considering the fact that the area of agricultural land per farm in the republic of serbia is 6.16 ha (kovacevic, 2018), the issue of introducing effective preventive measures for reducing damages in agriculture caused by natural disasters becomes of great importance for regional sustainable development. table 7. the damage in crops per natural disaster event in the republic of serbia (in ha) period belgrade region region of southern and eastern serbia region of šumadija and western serbia vojvodina region damcl damcs&m damcl damcs&m damcl damcs&m damcl damcs&m 1996 – 2000 1,959 910 5,400 39,707 2001 – 2005 3,603 14,885 1,865 22,509 2006 – 2010 150 1,519 137 812 759 2,660 18,142 2011 – 2015 274 978 1,258 2,364 626 300 4,982 2016 – 2019 650 200 438 1,021 2,166 8,363 note: damcl – the damage in crops due to the large-scale natural disasters; damcs&m – the damage in crops due to the smalland medium-scale natural disasters. source: authors' calculation, based on the data from the "desinventar" database 32 economic analysis (2020, vol. 53, no. 2, 20-38) when it comes to economic losses, it should first be noted that the database records a loss in the local currency for only 30.17% of natural disasters in the territory of the republic of serbia. the largest number of economic losses was recorded in the region of šumadija and western serbia (47.35%) and the region of southern and eastern serbia (30.57%). on the territory of vojvodina, data are available for only 17.83% of the total number of recorded economic losses. the most up-to-date estimates are available for flood damage (46.92%) and hailstorm (19.53%). this situation indicates a lack of transparency of information on economic losses due to natural disasters. however, even on the basis of such a small number of estimated claims, it can be seen that the amount of damages is large and reaches 0.76% of the gdp of the republic of serbia (figure 4). the fact that damage assessments, caused by large natural disasters, are not widely available, is of particular concern because the assessment of economic losses is available for only 23.11% of damage caused by large-scale disasters, mainly floods (77.59%). figure 4. the value of gdp (in billions rsd) and economic losses (in logarithmic values) due to the natural disasters in the republic of serbia in the period from 1996 to 2018 source: authors’ calculation, based on the data from the "desinventar" database and the data from the statistical office of the republic of serbia in the case of natural disasters of small and medium scale, the damage was recorded in 31.53% of the total number of disasters of this type, and the largest number refers to floods (42.62%) and hailstorms (22.03%). due to the fact that the small number of losses is recorded, it is difficult to assess their impact on economic growth. however, if we compare the cumulative effects of these disasters in the entire period with the effects of only one extreme event, for example the extreme floods of 2014, it can be concluded that they can have a notable socioeconomic impact. thus, according to the records of the "desinventar" database, in the floods of 2014, 19,605 houses were damaged and 420 were destroyed. the floods affected the lives and work of 162,672 people, while 23 people lost their lives. the impact on agriculture can be measured by the damage in hectares, which only during these floods amounted to 72,375 ha. on the other hand, the cumulative effects of seasonal risk manifestations, which can be characterized as smalland medium-scale disasters, are many times greater. during the observed twenty-four-year period, as a consequence of such risks, 2,088 houses were destroyed in the republic of serbia, and 13.67 times more were damaged. moreover, 41 people lost their lives in these events, while 4,070 were forced to move permanently or temporarily out of their homes or suffered some other type of property damage. however, the greatest damage was done 0.00 0.02 0.04 0.06 0.08 0.10 0.12 0 1,000 2,000 3,000 4,000 5,000 6,000 lo g  v a lu e s b il li o n s r s d gdp (in billions rsd) economic loss (log value) jelena stanković, zoran tomić, jovica stanković 33 to agriculture that suffered losses of even 1,112,891 ha. taking into account the spatial distribution of these damages, it can be concluded that the least developed regions in the republic of serbia are most endangered. as the intensity of these risks does not decrease, it is obvious that more efforts and resources need to be invested in adapting to climate change in the republic of serbia in order to reduce the negative impacts on normal life and work and ensure the growth of agricultural production, which has strategic importance in serbia. conclusion the fact that crisis and emergency situations caused by natural disasters have become a part of everyday life is well-known. their frequency and consequences increase and endanger the safety of people, critical infrastructure and sustainable economic development. the tendency of society to minimize or eliminate its exposure to risk, on the one hand, and increased volume of human activities that directly or indirectly increase the likelihood of a large number of risks, on the other, cause the paradox attitude of society towards risk. the overall effect will depend on the various factors. some societies can be expected to learn from previous experiences of natural disasters to reduce vulnerability by better adaptation to risks. others, due to inability to respond to climate change and to manage risks adequately, endanger the daily life and work of people. in order to increase the resilience of societies to risk and reduce the consequences of disasters, it is necessary to consider everyday hazards and seasonal risks, which cause disasters of small and medium scale. such risks mainly affect less developed societies, creating a number of social, economic and environmental problems. the attention of institutions and the public is usually not focused on these types of disasters, although their cumulative effects may be equal to or greater than the effects caused by large-scale disasters. in contrast, the experiences gained from such disasters can be a good basis for defining a disaster management strategy. based on the data of the "desinventar" global database on disasters, we can conclude that small and medium-scale disasters dominantly affect the territory of the republic of serbia. their spatial distribution, despite the different geographical characteristics of individual regions, indicates the fact that natural disasters of lower scale cause greater damage to property and crops to people in less developed regions. thus, the regions of šumadija and western serbia and southern and eastern serbia suffered the greatest damage. these regions are most exposed to the effects of meteorological and hydrological risks, which, compared to other regions, cause the greatest socio-economic effects in these areas. bearing in mind that these are most often seasonal risks that have extreme manifestations in this area (such as floods, droughts, hail, and in some cases earthquakes), it can be concluded that a careful analysis of the effects of these risks over time could provide significant information on how to manage these risks, in order to prevent large-scale disasters. however, the time analysis of the natural disaster effects in the republic of serbia, especially smalland medium-scale disasters, indicates that their effects do not decrease over time. despite expectations, the average consequences of natural disasters are increasing significantly, affecting the daily life and work of people in these areas and causing large material and economic losses, which in recent years has reached 0.76% of gdp of the republic of serbia. this situation shows the basic lack of solid empirical evidence regarding the economic consequences of natural disasters inadequate choice of strategy for disaster risk management. risk reduction strategies, as well as risk financing strategies, are equally important. considering the fact that environment and natural resources are the most vulnerable determinants of sustainability development in the republic of serbia (djukic, 2012), the disaster management in the republic of serbia is comprehensively regulated by the law on disaster risk reduction and emergency management ("official gazette of rs", no. 87/2018), while some areas that may have an impact on the environment and the safety of citizens are regulated by special laws. the government of the republic of serbia defined the national strategy for protection and rescue in emergency situations ("official gazette of rs", no. 86/2011), which defines certain 34 economic analysis (2020, vol. 53, no. 2, 20-38) national coordination mechanisms and guidance programs to reduce natural disasters and the risk of accidents, protection, response and clean-up. in designing this strategy all relevant national and international documents and eu strategies are taken into account to ensure the implementation of recommendations for the development of systems for national protection. however, the conducted analyzes indicate a number of shortcomings of the existing system of protection and rescue, and the most important ones are (national strategy for protection and rescue in emergency situations, 2011): (1) institutional and organizational, (2) material and technical, (3) cooperation, coordination and availability of information, and (4) human resources and level of education. institutional and organizational drawbacks refer to the lack of conditions for consistent implementation of regulations. the implementation of the preventive measures is inadequate, and an additional limitation is the lack of current specialized cadasters. the drawbacks of a material and technical nature are primarily reflected in the unsatisfactory level of traffic and other infrastructure, as well as the equipment, means and vehicles of the emergency response services, which according to recent estimates are outdated and unreliable. strong cooperation of entities in the case of the protection and rescue system is lacking, both in the organization of preventive activities and in the organization of rescue activities in the republic of serbia. it can be said that the biggest drawback of the system is the insufficient cooperation of scientific and research institutions, as well as the insufficient cooperation among direct users of research. adequate coordination and cooperation do not exist even between the subjects of the protection and rescue system during emergency situations, and the inclusion of the state, in international and global systems, implies more intensive cooperation with international institutions. human resources and education are not at the expected level in terms of the number of staff, their specialization, qualifications and willingness to take an active role in the protection and rescue system. this system is financed by the funds provided from the budget of the republic of serbia, budgets of territorial autonomy and local government bodies, and also from the fund for emergency and other income in accordance with the law on emergency situations. allocated funds may be insufficient, especially when it comes to financing large-scale disasters such as the 2014 floods. for the purpose of creating effective development programs and its implementation, it is important that policy-makers completely understand the concept of sustainable development and measure its implementation in exact manner (todorovic, 2018). the reduction of risk factors is conditioned by the development of systems for identification, assessment and monitoring of risks and early warning systems. municipal governments are entitled to refine disaster risk management policies for regional risks implementing measures such as building policies, evacuation planning and emergency response. companies and households can also contribute to the regional policies for natural disaster reduction through disaster-resilient building practices. cost-benefit analyses of natural disaster risk reduction measures suggest that these prevention policies are economically desirable. macroeconomic models and empirical literature suggest that policymakers should strive to promote economic resilience by maintaining a vibrant, flexible, and diversified economy that is able to cope with shocks (botzen et al., 2019). besides this, it is necessary to build a culture of security and resilience at all levels based on knowledge, innovation and education. on the other hand, there are issues of modest offer of insurance against disasters. according to a special survey, which was carried out in the sectors of trade after the floods in 2014, only about 18% of industrial companies and 20% of retailers had insurance against natural disasters (rs government, 2014). however, premiums paid were very low in comparison with the cost of replacing partially or totally destroyed equipment, facilities and products, so that the effects of insurance compensation of damage after the floods of 2014 were not significant, as in the previous cases of natural disasters (jovanovic, 2014). this issue is caused by many factors, such as: lack of understanding of the need for such insurance and the benefits of providing disaster jelena stanković, zoran tomić, jovica stanković 35 insurance, unwillingness of local private insurers to offer this type of insurance, reinsurance absence due to high costs in relation to the risk modelling and insurance products against disaster development, as well as limited technical capacity of local insurers to meet the requirements of funding high-risk management against disasters. in an attempt to provide individuals, who cannot pay the premiums of insurance companies, insurance against catastrophic risks, 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"coping with floods, strengthening growth". south east europe regular economic report 7. article history: received: june 6, 2020 accepted: november 21, 2020 doi: 10.28934/ea.22.55.2.pp31-48 first online: november 1, 2022 preliminary report the quest towards obtaining a competitive advantage in organizations through managing the human capital nikaela wilson1* | iva vuksanović herceg25f* 1 university of belgrade faculty of economics, belgrade, serbia 2 university of belgrade faculty of economics, department of business economics and management, belgrade, serbia abstract the aim of this paper was to shed light on how managing human capital can contribute to obtaining a competitive advantage in organizations. this was done by conducting a literature review by examining and synthesizing the available literature from various research and scholars. moreover, it included research into the different perspectives pertaining to the elements and approaches of human capital as it relates to competitive advantage in organizations. the literature reveals that human capital plays a significant role as a contributor to obtaining a competitive advantage in organizations, which ensures high quality in the selection and recruitment of employees. based on the literature, certain challenges may be encountered regarding human capital, and these challenges may inhibit the attainment of competitive advantages. furthermore, the paper brings to light the approaches to utilizing human capital to achieve a competitive advantage. the resource base view and the human capital theory were the approaches discussed and considered relevant in navigating human capital towards a competitive stance. the distinctive character of the organization could be realized through the human capital concept; investing in employees bring about new ideas and solutions to the organization. while other resources are owned by the organization, such as technology and equipment, the human capital emanates from the employment relationship and could not be regarded as organizational-owned property but is also privy to its success. human capital is viewed as an essential component of intellectual capital. industry 4.0 was also seen as an important contributor to competitive advantage as the advanced technology seems to employ more modern ways of getting the job done. even though advanced technology is necessary, among other factors, the quest towards the achievement of competitive advantage lies in the role of adequately managing human capital because human capital neutralizes threats, exploits opportunities, and enhances organizational efficiency that has the potential to lead to a competitive advantage keywords: human capital, competitive advantage, intellectual capital, industry 4.0, resource-based view, employees jel classification: l21, m12, m54, o34 introduction various aspects of the global environment changes have pointed to the relevance of human capital in organizations. preceding research has revealed that organizations have become more aware that holding a competitive stance based on technology is volatile and that managing the intangible resources in terms of their human capital is a better approach to a more sustainable * corresponding author, e-mail: ivav@ekof.bg.ac.rs 32 economic analysis (2022, vol. 55, no. 2, 31-48) advantage (johanson, mårtensson & skoog, 2001). according to bontis, dragonetti, jacobsen & roos (1999), human capital is synonymous with the human aspect comprising the intelligence, the skillset, and the level of expertise found within the organization that gives it its unique trait. the term human capital often pertains to employees in general and considers what they collectively contribute to the organization in terms of the knowledge they possess, their overall job, their life experiences, and their skill sets. davenport (1999) opined those employees within the workplace are the ones in possession of these elements. therefore, managing such a resource within organizations is crucial to attaining a competitive advantage. one cannot discuss human capital without mentioning intellectual capital, as they are intertwined. numerous experts support the view that intellectual capital is vital in obtaining organizational performance (sydler, haefliger & pruksa, 2014). klein and prusak (1994) defined intellectual capital as the intellectual information that has undergone a formalized process that has enabled the capturing and leveraging to yield more valuable assets. the organizations’ innovative performance in compliance with vision 2020 requires both information and the management of intellectual capital as they are crucial areas for the majority of organizations, especially those that are knowledge-driven (gogan, artene, sarca & draghici, 2016). the term competitive advantage was coined by porter; he emphasized that it is achieved by the organization when the value perceived by the customers exceeds that of production (porter, 1985). wang (2014) further elaborated that competitive advantage is achieved when organizations display exemplary performances in comparison to their competitors by executing certain actions and displaying particular attributes that put them in more favourable positions than others. technological innovations and the competitive business world have been contributory factors that oblige organizations to manage a certain amount of capital toward sustaining and attaining a competitive advantage. the survival, relevancy, and continuity of organizations depend on how they are composed to respond to and compete with competitive challenges. the probability of organizational success depends on the effectiveness and management of organizational capital and resources (peteraf & bergen, 2003). similarly, kraja & osmani (2013) considered human capital as a main factor of competitiveness. kuehn (2018) views human capital as a significant asset that complements the structure of a company. a multitude of studies shows that human capital is a resourceful sector for determining organizational level in a competition (ndinguri, prieto & machtmes, 2012). in order to obtain a competitive advantage, there must be proper utilization and management of the human aspect and navigating it in such a way that the objectives of the organizations can be realized. it is generally perceived that the operation of the organization is also based on the knowledge which is obtained through its human base. the employees are the source of such knowledge, and the successful management of those that possess the knowledge can aid in building a solid infrastructure that can assist in obtaining such advantage. human capital is a substantial investment toward achieving a competitive advantage for organizations because it represents an employee’s natural ability that generates economic value (alnidawi, alshemery & abdulrahman, 2017). many researchers have established the fact that knowledge and human capital could guarantee organizations a competitive advantage. it upholds that human capital is capable of ensuring a competitive advantage for organizations. therefore, the concept is valuable for developing employees’ skills and abilities that eventually produce innovations in the organization (alnidawi et al., 2017). managing human capital encompasses coordinating and arranging the job duties of the people within the organization and managing them in a specific way so that the organization’s objectives can be accomplished. hence, organizations need to value human capital management in the company’s structure. it is important to emphasize that organizational performance may also be linked to human capital since employees’ knowledge and experiences are unavoidable components of competitive advantage (hili, gani, hamzah & rahman, 2017). human capital, therefore, ensures nikaela wilson, iva vuksanović herceg 33 that the organization enjoys an extended period of competitive advantages (liang & gong, 2017). it should also be pointed out that human capital can be considered one of the most important integrals of organizational assets because employees contribute ideas, exploit opportunities and propose recommendations for overcoming organizational challenges. without their relevant input, achieving a competitive outcome would be less likely to be attained. organizations need to value people and link the management of the market, products, services, finances, information, and customer needs to human capital. particularly, as human capital ensures that knowledge, skills and experiences are transformed into creative ideas, goods, and services for the organization (boon, eckardt, lepak, & boselie, 2018). an organization that seeks to accommodate dynamic changes, including political, economic, cultural, social, and technological changes in organizations, needs human capital elements and competitive advantage components to succeed (al-omari, alomari & aljawarneh, 2020). an organization’s ability to structure management methods toward creating policies and conditions that energize human minds to renew old ideas and innovate new approaches is essential in the process (aljawarneh & atan, 2018). furthermore, organizational resources may also be used to attain growth and ensure continuity (alwagfi, aljawarneh & alomari, 2020). the changes and challenges faced by several organizations, therefore, call for a review of competitive strategies (van sluijs & kluytmans, 1994). hence, the purpose of the study is to explore how organizations can achieve a competitive advantage; it aims to highlight the approaches and challenges through its human capital. the approaches to managing human capital can be made in various ways. however, the ways of using human capital to achieve a competitive advantage will be analyzed from the resource base perspective and human capital theory. it will also take into consideration intellectual capital and industry 4.0 in addition to highlighting the crucial role of human capital in maintaining and obtaining a competitive advantage. from this, it was hypothesized that managing human capital plays a contributory role in obtaining a competitive advantage. the concept of human capital, elements and approaches for achieving competitive advantage in organizations youndt, snell, dean & lepak (1996) described human capital as a concept that enables individuals to possess un-separated skills, knowledge, and competence to maximize organizational profits. cabrita and bontis (2008) emphasized that the human capital concept assists the organization in tapping and accumulating employees’ ideas and experiences. it encourages employees to devote time, effort, skills, and capabilities to the growth of the organization (seleim & ashour, 2007). widodo (2015) described human capital as employees’ ability to introduce changes and produce modern and contemporary ideas to support the organization while responding to market and technological challenges. human capital establishes a stepwise link between solutions and employees’ knowledge toward aspiring for organizational success (burma, 2014). memon, mangi & rohra (2009) opined that human capital could ensure productivity with the cooperation of employees. human capital could be adequately evaluated with certain indicators such as employee capability, employee motivation, organizational climate and structure, teamwork, efficiency, and leadership (chrysler-fox, pharny & roodt, 2014). the collection of employees’ energy, knowledge, experiences, sacrifices, loyalty, commitment and creative ideas constitute human capital (weatherly, 2003). thus, the individual’s skill, attitude and abilities establish the performance and productivity of the organization. human capital diagnoses the employees that possess intellectual skills, abilities and experiences that could propose suitable suggestions to customers’ wants through creative ideas. the worth of human capital is visible in organizational performance, productivity, relevancy and sustainability (delery & roumpi, 2017). alomari (2020) asserted that human capital is an 34 economic analysis (2022, vol. 55, no. 2, 31-48) inimitable rare resource that requires the organization’s ultimate security and protection against other competitors from reduplicating it. furthermore, a study conducted on the management of human resources as a mediating mechanism on the influence on the outcomes of organizations by jiang, lepak, hu & baer (2012) revealed that, once adequate effort is placed on developing the abilities of the employees, it makes them more effective and more competent employees. therefore, this can instill a feeling of comfort and belongingness in the mind of the employees. in turn, they might be more willing to share knowledge within the organization and be more productive, which can result in a better outcome. this can potentially improve the competitive stance of the organization. human capital elements for achieving competitive advantage in organizations human capital comprises various areas, and it is further discussed in the subsequent section as a contributor to competitive advantage in terms of employees’ natural and personal skills, employees’ commitment, employees’ knowledge, and employees’ innovative skills within the organization. employees’ natural and personal skills while natural skills are god-gifted abilities, personal skills encompass the experience attained from previous and existing job positions. the job skills are mostly acquired through training, workshop and work experiences (al-maghraby, 2004). al-tarawna & al-salihy (2004) argued that renewal skills, termination skills, evaluation skills, support skills, concentration skills, and coordination skills substantially complement human competence. these natural and personal skills that are honed by the employees serve as beneficial pivots in the pursuit of achieving competitiveness. human capital, in terms of employee skills, is used within the organization to obtain a competitive advantage. employee skill is one of the inescapable components of human capital that can generate advantages for the organization through competitive advantage strategies. the employee, if allowed and motivated by the structure, has the power to devote natural and personal skills toward acquiring organizational goals. the skills can also be shared with other employees while collectively discharging organizational tasks and activities. employees’ commitment zehir, gurol, karaboga & kole (2016) contended that organizations could acquire uniqueness through employees’ high performance, while commitment boosts employees’ performance in the organization (khalique & pablos, 2015). massingham & tam (2015) conducted a study on the relationship between human capital, value creation and employee reward. the study was done on employees from the second largest public sector organization in australia, based on three annual surveys between 2009 to 2011. the variables used were, first, employee capability; secondly, employee satisfaction; and thirdly, employee commitment. the findings from the study revealed that human capital is an important aspect of intellectual capital as there is an increased interest regarding how intellectual capital can be utilized to establish value in the organization. the main results revealed that employee capability and employee satisfaction had a positive relationship with the importance of work activity in a direct way. also, it was revealed that an employee’s capability only had a direct positive relation to the salary. however, as it pertained to employees’ commitment and the importance of job-related obligations, there was a direct negative relationship between them. similarly, it was revealed that no relationship existed between pay and the aspects of employee satisfaction and employee commitment based on the results that were obtained from the survey. furthermore, time commitment and management generate task fulfilment and effective performance for an nikaela wilson, iva vuksanović herceg 35 organization, thus strengthening organizational reputation among competitors. commitment enables employees to engage themselves in change and combine experiences together towards developing organizational capacity (massingham & tam, 2015). employees’ commitment helps organizations acquire a competitive advantage, retain survival and manage relevancy in the business vicinity (abu bakr, 2006). time management and commitment result in generating modern and productive products for potential beneficiaries in a short period because employees strongly dedicate their time to the organization to provide for the customers’ needs. hence, employee commitment magnetizes a large number of customers to the organization, thereby ensuring a competitive advantage. based on the literature, it is evident that employee commitment can be used to promote organizational work, competitive advantage strategies, growth, and outstanding performance. once employees display a level of commitment to achieving the organization’s objectives, it will be reinforced by the various outcomes. employees’ knowledge employees’ level of knowledge in operations, industry, profession, technology, dynamical and environmental changes adequately represents the significant role of knowledge in developing organizational competitive advantage (lau, chan & man, 1998). the knowledge that the employees possess is paramount as it can be a deciding factor in the advantage the organization garners over others and the position it holds in the industry. such a reservoir of knowledge serves as a catalyst for new service and product developments which can initially give the organization an edge over others. organizational tasks could only be discharged and achieved with job knowledge and competency. to achieve a competitive advantage, an organization needs a regulatory environment that provides knowledge and motivation for employees (alnidawi et al., 2017). employees’ innovative skills this is a process of transforming ideas into practice alongside producing innovative goods and creative services for customers’ needs (moorhead & griffin, 2000). innovation and creativity go hand in hand, ensuring sustainable competitive advantages. with the aid of creative and innovative tools, modern processes that generate value for customers, ideas that reduce production and delivery period so that the products can reach customers quicker, and initiatives that open opportunities and widen global professional networks could be achieved for organizations. it enables employees to modernize ways, approaches, and methods of running the affairs of the organization (al-sarn, 2000). innovation may appear in different forms, such as technical, product, managerial, and process innovation (al-saffar, 2008). innovations may as well propel other competitors into competition-race. the level of an individual’s innovative ideas is determined by an individual’s curiosity (sipa, 2018). according to yaseen dajani & hasan (2016), intellectual capital is a determinant that is a catalyst for innovation in the organization. furthermore, it can be viewed as an asset and a collection of knowledge that can be used for a given purpose in achieving a competitive advantage. galovska (2015) perceived innovation as a significant integral that defines organizational success. therefore, innovative skill allows an employee to boost productivity and achieve a competitive advantage for organizations through inventive means. it may be used for extraordinarily presenting ideas that solve issues in the competitive market and support organizational objectives and help in sustaining an advantage. 36 economic analysis (2022, vol. 55, no. 2, 31-48) intellectual capital and competitive advantage numerous studies have been conducted, displaying the relationship that exists between intellectual capital and competitive advantage. for instance, a study conducted by chahal and bakshi, (2015) on the relationship between intellectual capital and competitive advantage focused on the role that innovation plays in learning in organizations. the study was conducted on 144 banks in india. the findings revealed that intellectual capital had a positive and direct relationship with a competitive advantage. it pointed out that innovation had a mediating role between intellectual capital and competitive advantage. also, innovation and organizational learning played a part in competitiveness. furthermore, in another study conducted in jordan on telecommunications companies by yaseen et al. (2016) on the impact of intellectual capital on competitive advantage, it was revealed that relational capital and structural capital account for 48.4% of the competitive advantage, and both positively influence competitive advantage. based on this finding, it is safe to say that human capital has an indirect influence on competitive advantage since it is a part of relational capital. in response to globalization and competition among different organizations, a committed organization’s focus should perhaps be emphasized on creating a competitive advantage that transcends services provided by other competitors in the marketplace. the infrastructure of competitive advantage is needed to overcome functional, efficacious and highstandard market competition. the competitive strategies promote the status and relevancy of the organization over other competitors in the global marketplace (porter, 1985). similarly, a study was conducted by janošević, dženopoljac & bontis (2013) on 100 serbian companies on the influence that intellectual capital has on their financial performance. the intellectual capital efficiency was measured based on the value-added intellectual coefficient (vaic). findings revealed that the operating revenue, profit and net profit were not a consequence of the efficient utilization of intellectual capital in the companies. however, it was revealed that structural and human capital affect return on equity and return on asset, while physical capital affected the return on equity. the survey also revealed that intellectual capital had a minor impact on financial performance. the level of intellectual capital is a limiting factor in competitiveness growth. however, it should be noted that during that time, the serbian economy was going through a crisis. also, just as corporate performance cannot be assessed by using one measure, intellectual capital should not be analyzed from solely one perspective (janošević et al., 2013). the two common types of competitive advantage according to porter (1985), in general, competitive advantage can be viewed in terms of comparative advantage and differential advantage. the comparative advantage is an organization’s capacity to produce at a reduced cost compared to to others providing the same service or products. typically, this advantage is obtained by allowing the products or services to be sold at a cost that is lower than its rivals. while the differential advantage is achieved when the product or service produced can be differentiated from others and can be viewed as superior by the users. if the organization pays attention to its human capital along with the proper management of the employees, this can clearly put the organization in a better position than its competitors, which may be lagging behind in this area. the resource base perspective to achieve competitive advantage many researchers have been seeking to comprehend the components that act as deciding factors in the profit level of organizations. according to peteraf and bergen (2003), the main underlying presumption of the resource base approach is that organizations compete based on their capabilities and the resources that they have. the resource base view originated in 1984 by nikaela wilson, iva vuksanović herceg 37 wernerfelt, as a contributor to competitive advantage theory (fahy, 2000). wernerfelt (1984) alluded that a resource can be those tangible assets that contribute to the organization in terms of added strengths or weaknesses. nevertheless, those resources can either be of tangible or intangible nature, tangible in the form of skilled personnel, plant and machinery, and intangibles such as reputation, know-how, and expertise in marketing and the production processes (wernerfelt, 1995). similarly, barney (1991) reiterated that resources could be categorized into two main areas. first is the human capital aspect, such as intellect, training, and experience. second, the physical capital, such as the technology, equipment, and plant, and organizational capital, such as the structure. the dominant claim of this perspective is the argument that competitive advantage is derived from certain resources within the organization, and these resources are considered rare in other organizations or they are lacking in the competitors’ organizations. therefore, they are viewed as superior resources by the competition. according to bridoux (2004), this perspective implies that the resources in the organization provide the basis for a strategy, a strategy that can enable the organization to better exploit the resources within its own organization relative to that of the competition. similarly, donnellan & rutledge (2019) stated, as per the resource base model, it’s the unique resources and capabilities that account for the differences in the performance of the firm rather than the structural characteristics of the industry. it is further argued that the resources that are rare, not easily substituted, and hard to duplicate/imitate form the key set of the resources that give the firm a strategic advantage over others. therefore, by focusing on these components of the model, it might be easier to recognize the resources that could possibly provide a sustainable competitive advantage for the organization. the resource-based view is one of the common theories used to explain the organization's sustained competitive advantage. the underlying premise of this view is that organizations can obtain a strategic competitive advantage when they are in possession and control of assets that are scarce and non-substitutable and in an organization that is capable of handling them (kraaijenbrink, 2011). similarly, according to foss (1996), the resource base view is geared more towards the long term and provides a more detailed analysis of the competitor. this may be useful to ascertain any threat of imitation in the future by the competitor by analyzing the competitor’s capabilities and resources. additionally, the resource base perspective explores the collective groundwork based on an economic infrastructure by delving into the concept of human capital in establishing a competitive advantage for the organization. furthermore, due to this resource perspective, other academicians have used this application in prioritizing the human aspect as a means to explore how it assists the organization in obtaining a competitive advantage, as demonstrated by wright, mcmahan & mcwilliams (1994). similarly, youndt et al. (1996); jackson & schuler (1995) are proponents of this view as they sought to incorporate learning within organizations. furthermore, barney (1991) pointed out that there are several components that can create a competitive advantage and emphasized human capital as one of such components. he elaborated further that this type of competitive advantage occurs when the organization device a plan of action that differs from prospective competing organizations. in essence, from the perspective of the resource base view, competitive advantage is linked to any resource in the firm that differentiates it from its competitors. rose, abdullah & ismad (2010) conducted a study pertaining to an organization`s resources and competitive advantage as it relates to performance within the organization. it was concluded that looking at the competitive advantage from a resource point of view is important mainly as it may be applied as a framework or guide for organizations to improve their level of competitive advantage and overall performance through applying and manipulating the resources within the organization. 38 economic analysis (2022, vol. 55, no. 2, 31-48) a study conducted by donnellan & rutledge (2019) on jp morgan chase revealed how the resource base view was employed to synchronize the resources found in the company with its strategy to achieve its target of being the highest-ranked bank in the united states. this entailed the implementation of changes to their environment both internally and externally and fully exploiting the competencies and resources that were at their disposal. this case study indicates how the firm looks internally to find out the resource gaps that appeared within their organization. it revealed that they made the necessary adjustments to ensure they had the resources and abilities to yield much better returns. these changes led to an increase in their revenue. even though organizations cannot afford to prioritize only their internal resources and exclude others, what this case study revealed is that analysis using the resource-based view is crucial’, and organizations should not neglect internal operations if they want to maintain a competitive advantage. the resource base view strategizes the resources that may be useful for the growth of organizations (gerrard, 2005). it exposes the rapport between a firm’s performance and internal features (barney, 2001). the internal characteristics represent organizational resources, which may appear as physical, technological, or financial (mahoney, 1995). according to amit & schoemaker (1993), an organization’s capacity is largely seen in the organization and combination of resources alongside tacit elements such as expertise and knowledge. resources and capabilities constitute the core strategic sources of competitive advantage. in the presence of rare, valuable, non-substitutable, and imperfectly imitable resources, resources can ensure and guarantee a competitive advantage (gerrard, 2005). in this regard, the more organizations invest in capabilities, the higher they acquire a competitive advantage (eisenhardt & martin, 2000). approaches based on the theory of human capital according to armstrong and taylor (2014, p.70), managing people can be approached based on the human capital theory. this entails receiving certain answers by asking specific questions that are stated below: what are the main driving forces behind creating value in the organization? which skillsets do these individuals hold? what are the required skillsets necessary to achieve the organization’s essential objectives? what measures can be implemented regarding attracting, developing, and retaining these skills that they possess? what can be done regarding cultivating an atmosphere and culture that enables the promotion of learning that is beneficial in meeting the requirements of the employees and the organization? which measures can be implemented to incorporate and utilize the explicit component and tacit component of knowledge that is being generated? this theory assists in determining the impact that the employees have on the company and the overall worth they add to those that have a stake in the organization. in addition, it portrays that human resource practice is useful and worthwhile. it is valuable because it adds to the assets of the organization in terms of the return on investments. furthermore, it points in the direction and navigation of the prospective organization strategy that will communicate the relevant strategy and practice designed to boost the effectiveness of managing employees (armstrong & taylor, 2014). the underlying principle surrounding the human capital theory is that an individual’s learning abilities can be compared in terms of value to other resources that are a part of producing the services and products (lucas, 1990). the ability of the organization to obtain advantages from human capital does not rest solely on the specific skills of the employees. it also nikaela wilson, iva vuksanović herceg 39 depends on the ability of the organization to create and leverage the supply and demand side movement constraint to retain the human capital at reduced costs against that of rival firms. however, it is the assumption that employees might seek employment elsewhere if they are willing to accept a salary reduction (campbell, 2012). according to davenport (1999 p.10), human capital comprises knowledge such as iq, intelligence, general and work-specific knowledge; behaviour such as work expression, abilities, norms, and beliefs; skills that are needed to carry out the task such as physical body mobility of the job; personal talent that is innate to the individuals; and effort which is the use of their innate talents and abilities in addition to time. similarly, wuttaphan (2017) opined that the theory of human capital illustrates the importance of maximizing labour in addition to how employees’ knowledge, skills, and abilities can be accumulated within the organization that can contribute to improvements in the employees’ abilities. he elaborated further that the value of this theory is generally accepted as a way to improve the performance of the organization, so it relies on the above-mentioned attributes as a value creation concept in organizations. the general presumption of the human capital theory is that educated and well-trained employees lead to greater productivity. it maintains that investing in human capital can potentially result in a competitive advantage in the organization. tan (2014) summarized the criticism surrounding human capital theory (hct) on moral, empirical, practical, and methodological grounds. hct is harmful to hr because of its heavy reliance on educational measures while evaluating workforce competence. according to barro (1991), previous studies used registrations or literacy levels to determine national human capital. formal qualifications are a limitation of hct toward human capital. formal qualifications do not cover traditional accredited competencies acquired experientially or informally by an individual (colardyn & bjornavoid, 2004). furthermore, the absence of defending one’s educational attainment prevents hct from complementing hr (green and mcintosh, 2007). another limitation in hct is the workforce crisis and the ‘war for talent’. the role of hct in the hr field is to ensure positive performance through the configuration of competencies (cafferkey, 2018). winterton (2009) argued that the organization actively needs an individual’s intelligence and learning ability to demonstrate work performance. competitive advantage and managing human capital the probability of achieving organizational goals may be perceived through organizational commitment and the ability to influence its performance with human capital. human capital, including employees’ ability, skills and knowledge, is considered a tangible resource that contributes tremendously to organizational growth than any other organizational asset (garavan, morley, gunnigle & collins, 2001). human capital may also appear to enhance the performance of employees through training and organizational development programs (mahdi, nassar, & almsafir, 2019). providing an organizational environment that gives freedom to employees while aiming to utilize employees’ intellectual skills for organizational growth may also be a contributing factor. the environment should provide training and workshops that develop problem-solving and all interrelated skills for employees. as it pertains to the management context, the ways adopted by management to ensure competitive advantages for the organization are important. the organizational structure constructed and provided by management can add value to organizational goals. management should ensure that the structure provides for employees’ needs and specify conditions that promote interactions between processes and individuals. numerous motivational factors need to be adequately included in the organizational structure. in addition, organizations can nurture employees’ skills and competence to secure competitive advantages (gannon, roper & doherty, 2015). tacit knowledge is instrumental to competitive advantage and could largely be developed within the organization (chaudhry & 40 economic analysis (2022, vol. 55, no. 2, 31-48) roomi, 2010). the effectiveness of tacit knowledge development plays an important part in employees’ commitment to the organization (alnidawi, et al. 2017). barney (1991) researched the correlation between strategic competitive advantage and the organization's assets. the indicators used to represent the potential of the organization’s resources to bring about sustained competitive advantage were rareness, substitutability, value and imitability. the findings revealed that competitive advantage is based on the assets that the organization possesses, and the resources that are considered valuable, rare, inimitable, and nonsubstitutable possess the potential to bring forth a sustainable competitive advantage within the organization. therefore, managing human capital is crucial to achieving a competitive advantage within organizations. according to hitt & duane (2002), it is imperative that the management team properly manage such a resource within the organization, which involves the evaluation of the present talent repository and initiating the necessary adjustments to develop or acquire the relevant expertise from external sources and removing by means of layoff those human resources or those relationships that are external to the organization that is no longer beneficial. this also entails paying attention to the policies as they could be used to achieve organizational goals successfully. it is expected that management establishes policies that honour rewards, compensations, promotions, and career advancement since these are the factors that boost employees’ motivational spirit. the policies are anticipated to limit or eliminate pressures on employees so that employees can get inspired. the absence of effective management of human capital may downgrade the organizational level of performance in the marketplace. alnidawi et al. (2017) perceived the unavoidable role of human capital in creating a competitive advantage in companies. human capital management ensures the management of talent, individuals, and employees through retention, engagements, training, workshops, and development programs (human capital management, n. d.). hence, the concept could be used to develop, retain and attract customers to create value for the organization. industry 4.0 and human capital in achieving competitive advantage across the globe, the fourth industrial revolution is revered as the driving force behind technology, and technology propels formal or informal disruption while molding individuals. the impact of technology is two-fold; it can be predicted at times while unpredictable at other times, and it can be negative in one instance while positive in another. in the years ahead, artificial intelligence and automation will be more prevalent and will be transforming the work environment as employees begin to be more connected and engaged with smart machines. this type of human-to-machine interaction is expected to bring about a lot of benefits, including better productivity, work quality improvement in production and business performance (balalle & balalle, 2018). the study by kazancoglu & ozkan-ozen (2018) highlighted the transformation from conventional and old-fashion production processes to more digital, technologically equipped smart factories. the study revealed that demanding a high level of intelligence from the workers will contribute to an environment that will emphasize the importance of having the ability to handle complex matters, interact with modern interfaces, have knowledge of information technology, and solve problems, multi-tasking, and overall flexibility. in this regard, it is important that the organization’s management team pay keen attention to the human capital as they have the capabilities. industry 4.0 can help to create more knowledgeable workers that can influence worker productivity, improve quality, efficiency and determine the success level of the organization. the workforce will be significantly impacted by industry 4.0 since the transformation directly affect the employees. the traditional roles of the workforce decline as a result of the nikaela wilson, iva vuksanović herceg 41 introduction of high-tech equipment that is synchronized, which enable easy communication among these machines and equipment, which makes them more self-reliant. as such, the job descriptions are significantly transformed; one, in particular, is the interaction or interface between the employee and the machine (romero, bernus, noran, stahre, & fast-berglund, 2016). according to a paper published in the european patent office, by the year 2025, it is projected that 26-30 billion of devices, found in both the household and organizations, will be embedded with software and processors in addition to being equipped with the necessary sensors and connected to (iot) internet of things. they will be able to function independently, collecting or exchanging data among themselves. when they are merged with other technology, for instance, artificial intelligence and cloud computing, they will facilitate the automation of the business process such as the intellectual jobs that were previously performed by people. they have already been in use in various sectors ranging from areas in manufacturing, agriculture, the transportation industry and even health (meniere, 2017). industry 4.0 possesses a contradictory impact on role and performance. it may aggravate available structural imperfections and reduce the progress of climate crisis resolution. business organizations broadly need modern and updated rules for operations (cooper & kaplan, 1988). industry 4.0 has led to the synthesis of the physical and cyber world and propelled the ongoing movement towards a combination of innovation streams. the impact of industry 4.0 is ambivalent; it can pose both advantages and possible issues. if it is not properly managed, it can worsen the existing past structural imbalances as organizations cannot continue to operate under the former rules of the past (đuričin & vuksanović herceg, 2020). these types of changes will affect the management and prompt modern approaches to the business model, strategic vision and organizational structures. among all sectors, actionable information is considered the major requirement for achieving a competitive advantage. dynamic approaches enable business organizations to overcome data flows, critical infrastructure and actionable information challenges. several platforms, technologies and resources can generate room for competitive advantages (ardito, petruzzelli, panniello & garavelli, 2019). in general, since the onset of the 4th industrial revolution, it may be argued that the major difference observed is the technology used and how it is merging more and more in everyday human life and creating the demand for new skills. it’s happening at a more rapid speed and has led to a lot of innovation. challenges in utilizing human capital to acquire a competitive advantage the challenges of human capital may differ based on the type of organization, its location, the industry in which it operates, the type of business activities it engages in, and also the pool of talent. one of the fundamental issues with human capital is that, as opposed to other capital that the organization owns, such as the database, patents, etc., the human capital can simply exit the organization without returning (coff & raffie 2015). therefore, this proves why managing human capital should be seen as a priority and why it poses a long-term issue in firms as it relates to obtaining a competitive advantage. there are several factors that may inhibit the realization of competitive advantages through human capital. according to a research report by the society of human resource management, it was revealed that achieving greater levels of engagement among employees is a major challenge, as cited by 38% of the human resource personnel; also, leadership training was noted by 31%, sustaining a compensation level that was deemed competitive was noted by 29%; also a challenge to retain the top performers 26% and retention in general 25%, a specialist with the specific skill-sets 24%, while sustaining benefits that are competitive such as retirement health coverage, etc. was 24% (shrm, 2015). these are some of the challenges that were outlined according to human resource professionals. 42 economic analysis (2022, vol. 55, no. 2, 31-48) according to a study conducted by gonzalez (2008) on facing human capital challenges in the 21st century in selected arab countries, it was revealed that the demand for qualified employees is outgrowing the actual number of skilled personnel. with regard to the gulf countries, it should be noted that foreigners dominate the workplace. an employee’s skill, for instance, may need certain organizational inputs and support before implementation, of which the organization lacks the structure and policies to make it available and achievable. goals setting between employees’ promotion and organizational development may likewise delay the organization from achieving competitive advantages. high-number of feedback interventions may clash with organizational objectives, thus decreasing task fulfilment and performance. while positive feedback motivates employees to work more, negative feedback unfavourably affects employees’ strengths and feelings toward organizational assignments. a low level of knowledge, experience, training and information about organizational-task reduces employees’ support and participation toward achieving competitive advantage. mullins (2007) opined that education is a route for advancing their careers; if the organization intends to maintain high productivity levels, it is important that employees are given opportunities for education. the unavailability of motivational instruments may pave the way for employees’ light-hearted commitment to organizational objectives. excessive organizational objectives and customers’ feedback may be an issue for employees’ activeness in activities. it is the duty of employers to provide solutions to challenges faced by employees. however, it becomes a harmful situation when the employer’s knowledge, experience, exposure, and intellectual skills are far below the employee’s capabilities. factional conflicts may also be a major concern among employees because certain members may detest teamwork and cooperation, thus impeding knowledge-sharing within the organization. factional sentiments give room for selfish and sluggish attainment of objectives. factional conflicts imply that some employees would lack updates about the ongoing activities in the organization. investment priority between employees and the organization would have farreaching practical effects on competitive advantage, especially when employers prefer to invest in the organization instead of human capital resources. the highlighted issues, if left unaddressed, would impede the realization of human capital in the organization. the industry 4.0 revolution, with the digitalization of more and more aspects of the workplace and technology changing every day, might pose some challenges regarding keeping abreast of the latest developments. more organizations are embracing the latest technologies, which will create demand for new skills. this will place more demanding requirements on the low-skill employees since the task might require new skills that some employees do not have. therefore, the employees must seek to acquire better knowledge. if the opportunities are not provided, this might lead to frustration and reduced motivation. if employees are faced with these dilemmas at the workplace, it might dampen their productive spirits and hence, affect the organization’s competitive stance in a negative way. concluding comments the literature reveals that human capital plays a significant role as a contributor to obtaining a competitive advantage in organizations, especially in today’s age of global competition, producing value-worthy products and services is a major concern. a lot of effort has been placed into improving this. even though competitive advantage can be viewed in terms of comparative and differential competitive advantage, in essence, it can only be achieved through placing emphasis on the effective management of human capital since they are the driving force behind it. in a competitive market, organizations strive to be in a position that gives them an edge over others. human capital is the real resource; they possess the know-how, knowledge, and skills. if they deem their work environment satisfactory, this can lead to motivated employees; hence they’ll express a willingness to exert more energy and attention, which will ultimately lead to nikaela wilson, iva vuksanović herceg 43 better outcomes. this translates into improved production, yielding better results and fostering an environment that can create a competitive advantage. managing human capital ensures high quality in the selection and recruitment of employees so that available talent can be evaluated and needed value can equally be supported with investment. human capital management structures the performance expectations of the organization. the managers are the ones that assess organizational goals through employees’ commitments, capabilities, and contributions. therefore, managing human capital plays a role in enhancing employees’ performance in organizational assignments, duties, and obligations. based on the literature, there are certain challenges that may be encountered regarding human capital, and these challenges may inhibit the attainment of competitive advantages in organizations. human resource personnel and the availability of adequate training for the potential leaders in the rganization secure the top-performing employees. also, the integration of more technology in the workplace has posed a challenge since it requires employees to be retrained to obtain more advanced knowledge in this area. some employees do not possess the necessary skills and may also oppose learning. in addition, retaining and acquiring specialists can be considered among the challenges that organizations face. furthermore, employees’ reluctance to be team players and the lack of cooperation thereby restrict the sharing of knowledge. if knowledge is not being circulated, it may damper the spread of ideas, creativity, and the necessary knowledge that leads to innovation which can potentially affect competitiveness. the afore-spotlighted human capital elements depict how they complement the organization to acquire a competitive advantage. employees’ natural, personal and innovative skills, in addition to their commitment, knowledge, and experience, are instrumental to quality ideas and valuable advantages that realize organizational objectives. employees’ knowledge, particularly the one that is constantly updated with training and workshops, can navigate an organization to the advantageous side in all plans, services, and activities. besides, competitive advantage may be unachievable alongside an obsolete structure. a structure that lacks motivational factors would definitely discourage employees from using human capital to ensure competitive advantage. furthermore, the paper brings to light the approaches to utilizing human capital to achieve a competitive advantage for an organization. the resource base view and the human capital theory were the approaches discussed and considered relevant in navigating human capital towards a competitive stance. the distinctive character of the organization could be realized through the human capital concept; investing in employees brings new ideas and solutions to the organization. while there are other resources that the organization owns, such as technology and equipment, the human capital emanates from the employment relationship and could not be regarded as organizational-owned property but is also privy to its success. although training and experience additionally enhance human capital, it is essential to state that employees often come along with human capital to the organization. the effectiveness of human capital can be perceived in the employee’s productive capacities. employees’ energy, attributes, enthusiasm, knowledge, inventiveness, and life experience constitute human capital, thus contributing to achieving an organization's competitive advantage. furthermore, there is an increased interest in how intellectual capital is being utilized to establish value in the organization. human capital is viewed as an important component of intellectual capital. industry 4.0 was also seen as an important contributor to competitive advantage as the advanced technology seems to employ more modern ways of getting the job done. even though advanced technology is necessary, among other factors, the quest towards the achievement of competitive advantage lies in the role of properly managing human capital because human capital neutralizes threats, exploits opportunities, and enhances organizational efficiency that has the potential to lead to a competitive advantage. 44 economic analysis (2022, vol. 55, no. 2, 31-48) references abu bakr, m. h. 2006."human resources entrance to achieve competitive advantage." university house, alexandria, egypt. aljawarneh, nader mohammad saleh, and tarik atan. 2018. 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"human capital theory: the theory of human resource development, implications, and future." life sciences and environment journal 18 (2): 240-253. youndt, mark a., scott a. snell, james w. dean jr, and david p. lepak. 1996."human resource management, manufacturing strategy, and firm performance." academy of management journal 39(4): 836-866. zehir, cemal, yonca gurol, tugba karaboga, and mahmut kole. 2016."strategic human resource management and firm performance: the mediating role of entrepreneurial orientation." procedia-social and behavioral sciences 235: 372-381. article history: received: june 2, 2022 revised: october 19, 2022 accepted: october 20, 2022 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp145-155 scientific review the factors affecting the level of digital entrepreneurial competences of university students vladimir simović1* 1 institute of economic sciences, zmaj jovina 12, belgrade, serbia abstract this paper represents an overview of the academic literature in regards to digital entrepreneurial competences (dec) and an effort to outline the research which will be focused on measuring the level of dec of university students in serbia. the paper proposes the creation of dec assessment framework and the corresponding methodology which could be used for online dec assessment tool development. the tool would enable the assessment of digital entrepreneurial competences of the university students in serbia and the analysis of the factors underlying different levels of digital entrepreneurial competences. factors ranging from personal characteristics of the students to contextual and socio-economic factors are taken into consideration. key words: digital entrepreneurial competences, university education effectiveness, competence levels, online competence assessment tool jel classification: l26, j24, m13 introduction digital entrepreneurial competences (dec) represent a mixture of general digital competences and entrepreneurial competences. dec became very important with the advance of information technology and the emergence of it based business models. today’s entrepreneurs are expected to possess necessary set of competences to be able to anticipate changes on the market, react to them and initiate them (radovic-markovic et al.2019) main objective of this paper is to identify the types of factors which would have an impact on the level of dec the university students in serbia acquire during their university education. this paper should serve as a literature review of the similar research conducted in other competence areas in order to provide insight and a basis for a planned dec university students in serbia research. the basic assumption of this paper is that the system of formal education in serbia doesn't provide university students with the necessary set of skills and competences in the area of digital entrepreneurship. the academic literature doesn’t provide evidence of the mechanisms for measuring the level of dec a person possesses and acquires during the course of his/her education. some evidence in regards to general entrepreneurial education suggests that the lack of commonly accepted metrics for measuring the impact of entrepreneurial education represents the biggest challenge (egerova, 2016). having in mind the novelty of our approach * corresponding author, e-mail: vladimir.simovic@ien.bg.ac.rs 146 economic analysis (2020, vol. 53, no. 2, 145-155) the same statement applies in the area of digital entrepreneurial education. wilson et al. (2009) identify 3 levels of impact measures of higher education entrepreneurship: 1. level 1 refers to individual participants attitudes and beliefs held towards entrepreneurship and self-employment, 2. level 2 refers to entrepreneurship education course/program in regards to participation of departments, participation of students, junior or senior faculty members, 3. and level 3 refers to university wide output measures such as number of created new businesses and jobs, patents, technology licenses. the introductory part of the paper brings the relevant research and the current knowledge in the area of digital entrepreneurial competences with the special emphasis on the existing general digital and general entrepreneurial competence frameworks. the following part outlines the key aspects of the overall research of the level of the digital entrepreneurial competences of the students in serbia which will be based on the dec framework and corresponding dec methodology. the results of that research will provide the first empirical evidence of the level of dec the students in serbia acquire during their university education in universities in serbia. next chapter explains the methodology which will be used for the purpose of dec data processing in order to identify and analyze the factors affecting the levels of dec the students acquire during their university education. this chapter is followed by final considerations and a conclusion. digital entrepreneurial competences background as stated in the introductory part of this paper, the main purpose of this paper is to investigate the existing academic literature in search of the factors which would be important in terms of their impact on the level of dec of university students. to do so, this paper will, firstly address the relevant aspects of dec, which is a relatively new concept and in focus of a relatively small group of scientists, for now. following the strategic documents of the european union (european commission, not dated (n.d.)), creativity, entrepreneurship, learning-to-learn, digital competence and other 21st century skills and competences are emerging as more and more important for innovation, growth, and participation in a digital society and economy (eu science hub european commission, 2020). reference framework for lifelong learning identifies the digital competences as one of eight key competences for lifelong learning (the european parliament, 2006). they are associated with the use of full range of the digital technologies for communication, information and basic problem solving in different aspects of life (digital competence: the vital 21st century skill for teachers and students, 2020). digital entrepreneurial competences (dec) are a mixture of general digital competences and entrepreneurial competences. they are critical for the success of digital entrepreneurship as outlined by the world development report 2016 (van welsum, 2016). digital entrepreneurship is broadly defined as creating new ventures and transforming existing businesses by developing novel digital technologies and/or novel usage of such technologies, (european commission, 2015). ngoasong (2017) defines dec as a set of knowledge and skills required to search and acquire new information, to identify and pursue entrepreneurial opportunities and to innovate. the interest in dec is driven by the rising importance of digital entrepreneurship which has been viewed as a critical pillar for economic growth, job creation and innovation by many countries including the member states of the european union (zhao & collier, 2016). van welsum, (2016) proposes communication skills, new business opportunities identification and data exploitation as critical dec. thry may be acquired through formal education as per fayolle & gailly, (2015) european union’s entrepreneurship 2020 action plan. (european commission, vladimir simović 147 2020) emphasizes that the implementation of the entrepreneurship education in schools, colleges and universities is the strategic goal for all member countries. the overall social welfare is driven by the students' entrepreneurship (scuotto & morellato, 2013). the universities are more and more seen as driving force of the entrepreneurship in addition to their educational and research purpose (farsi et al. 2017). due to their tight association with general digital and general entrepreneurial competences dec are also tightly associated with relevant competence frameworks. the following frameworks are especially important:  digital competence framework for citizens digcomp (vuorikari et al., 2016) which recognizes 21 digital competences in total.  relevant competence areas and specific competences of digcomp framework are represented in the following table. table 1. digcomp framework competence areas digcomp framework competence area specific competences information and data literacy 1. browsing, searching and filtering data, information and digital content 2. evaluating data, information and digital content 3. managing data, information and digital content communication and collaboration 1. interacting through digital technologies 2. sharing through digital technologies 3. engaging in citizenship through digital technologies 4. collaborating through digital technologies 5. netiquette 6. managing digital identity digital content creation 1. developing digital content 2. integrating and re-elaborating digital content 3. copyright and licenses 4. programming safety 1. protecting devices 2. protecting personal data and privacy 3. protecting health and well-being 5. protecting the environment problem solving 1. solving technical problems 2. identifying needs and technological responses 3. creatively using digital technologies 4. identifying digital competence gaps source: the digital competence framework 2.0 ‐ eu science hub ‐ european commission, n.d.  e-competence framework which incorporates 40 digital competences divided into five proficiency levels (council of european professional informatics societies, n.d). this framework is relevant due to its focus on workplace digital competences. table 2 represents an overview of competence areas under e-competence framework. 148 economic analysis (2020, vol. 53, no. 2, 145-155) table 2. e-competence framework competence areas e‐competence framework competence area specific competences plan 1. is and business strategy alignment 2. service level management 3. business plan development 4. product / service planning 5. architecture design 6. application design 7. technology trend monitoring 8. sustainable development 9. innovating build 1. application development 2. component integration 3. testing 4. solution deployment 5. documentation production 6. systems engineering run 1. user support 2. change support 3. service delivery 4. problem management enable 1. information security / strategy development 2. ict quality strategy development 3. education and training provision 4. purchasing 5. sales proposal development 6. channel management 7. sales management 8. contract management 9. personal development 10. information and knowledge management 11. needs identification 12. digital marketing manage 1. forecast development 2. project and portfolio management 3. risk management 4. relationship management 5. process improvement 6. ict quality management 7. business change management 8. information security management 9. is governance source: council of european professional informatics societies, n.d  besides digital competences entrepreneurial skills are also considered as one of the key competences in accordance with reference framework for lifelong learning. (the european parliament, 2006). in order to improve entrepreneurial capacity of european citizens and organizations joint research centre (jrc) of the european commission on behalf of the directorate general for employment, social affairs and inclusion (dg empl) has created the entrepreneurship competence framework also known as entrecomp (bacigalupo et al., 2016). entrecomp consists of 15 specific entrepreneurial competences (european commission, n.d). entrecomp has 3 competence areas: 1. ideas and opportunities vladimir simović 149 2. resources 3. into action (bacigalupo et al.,2016) table 3. entrecomp framework competence areas entrecomp framework competence area specific competencies ideas and opportunities 1. spotting opportunities 2. creativity 3. vision 4. valuing ideas 5. ethical and sustainable thinking resources 1. self-awareness and self-efficiency 2. motivation and perseverance 3. mobilizing resources 4. financial and economic literacy 5. mobilizing others into action 1. taking the initiative 2. planning and management 3. coping with uncertainty, ambiguity and risk 4. working with others 5. learning through experience source: bacigalupo et al. (2016) besides europe, digital competence frameworks exist in other parts of the world. an example of competence frameworks in other parts of the world is the digital competence framework which was developed in 2019. this framework consists of 12 competence areas (québec, ministère de l’éducation et de l’enseignement supérieur, 2019). future research proposal this paper represents a fragment of a larger endeavor aimed at measuring the exact levels of dec the students in serbia acquire during their university education at heis offering it and entrepreneurship courses in their curriculums. the key challenge in regards to dec is to identify and bridge the gap between the competences the students acquire through formal education and the competences needed in real-life situations. to do so, the research needs to develop mechanisms for measuring the actual level of dec the students in serbia acquire during the course of their university education. around 33,47 % of higher education institutions (hei) in serbia (both state-owned and private) offer entrepreneurial courses in their curriculums alongside it (digital) courses. the data of the statistical office of the republic of serbia (serbian bureau of statistics, 2020) shows that in 2018 the number of hei graduates in serbia was around 42.500. it can be estimated that out of that number around 14.000 graduates leave the hei in serbia each year in possession of some level of dec. based on this estimation it can be assumed that by 2030 (with respect to the expected decline in total number of students in serbia) the number of these graduates would be between 100.000 and 120.000. no one knows and no one ever tried to measure the level of their dec and their readiness for the labor market. simovic & domazet (2020) propose the creation of the dec framework and corresponding methodology which can be used for the purpose of measuring the level of dec the students acquire during their formal university education. the most ambitious objective of the future research is to develop a completely new framework for dec. to do so, the research team need to:  use the existing digital and entrepreneurial competence frameworks, 150 economic analysis (2020, vol. 53, no. 2, 145-155)  conduct the analysis of the contemporary academic literature on this subject,  use its own experience in this field and periodical consultations with all interested stakeholders (policy makers in the field of education and science; academic institutions; students organizations; scientific research organizations; industry (companies)). this would be the first time that the existing general and entrepreneurial competence frameworks will be used to create a new dec methodology. using expert workshops and it lab experiments the draft version of dec methodology will be validated before being used to develop an online assessment tool which will measure the level of dec of the students in serbia. the tool will be used to measure the level of dec of the students in serbia and will provide an answer on the effectiveness of the system of university education in serbia in this regard. the dec methodology and the corresponding tool will focus on both cognitive and non-cognitive aspects of dec, as proposed by lackeus (2015). the only way to measure dec at the later stage of the research is to develop relevant framework as a set of fundamental competence areas. the dec framework will be used to develop a methodology for measuring dec the of the students in serbia. the methodology will later be used for development of an online dec assessment tool. similar attempts were made in other countries in regards to general digital competences. in the eu the digcomp framework and corresponding methodology was used to develop an online digital competence assessment tool called the digital competence wheel (skov, 2017). this tool is used to measure the level of digital competences and to find the ways to improve the critical ones. e-competence framework was used in estonia to help the universities develop the curriculums which would be better aligned with the market needs. an online tool developed on the basis of this framework is called e-cf profiling tool and is used to match the users profile with the one of 23 ict professional profiles built in the system (european commission, n.d.). the dec framework and associated methodology will be used to create an online tool which will be used for assessing the dec of the students who are attending the undergraduate and graduate programs in hei that offer it and entrepreneurial education in their curriculum. the online assessment tool will be developed using the best practice of other online competences assessment tools (the digital competence wheel, e-cf profiling, etc.). the subcontractors will be hired to develop the tool upon precise specifications. the assessment tool will be hosted at the institute of economic sciences (ies) servers and the participating students will be able to access it from anywhere via the internet. the tool will collect the data on students' dec which will be processed to draw valuable conclusions at the later stage. one of the main purposes of the planned research is to conduct the gap analysis. the purpose of gap analysis is to determine whether the system of formal it and entrepreneurial education on university level in serbia provides necessary dec to students which would enable them to start their own digital entrepreneurial projects and be a part of startup teams. the gap analysis will cover 2 aspects of dec of the students in serbia:  the perceived level of dec by the students using self-assessment method  the actual level of dec measured using real life scenarios and assignments the assessment of dec of the students in serbia will cover both dimensions using selfassessment and real life assignments integrated in the associated online assessment tool. the dec assessment of the students in serbia will provide valuable data which will be further processed using qualitative and quantitative methods in order to provide the realistic assessment of the efficiency of the educational system in serbia in the area of dec and policy recommendations for improvements. besides measuring the actual levels of dec the students in serbia acquire during the course of their formal education, the research should also answer the critical question whether the level of dec is preconditioned by different factors and if so, what factors would have more significant impact on the level of students dec than the others. vladimir simović 151 the factors underlying the level of dec the assessment of students dec would provide valuable data which could further be processed in order to determine the factors underlying different levels of students dec. considering the importance of dec for future growth and improved employability of the students on one side and the planned future research in this regard, it would be essentially important to identify the set of factors which would have the greatest impact on the level of dec. the analysis will cover the association of dec and different external factors (gender, age, education of parents, state/private university, educational profile, the age of the professor, etc.) to determine whether some factors have a greater impact on the level of students dec than the others. the analysis of the data collected using an online dec assessment tool will be conducted using two sets of statistical methods. at the first stage the methods of multivariate analysis to determine associations between the core dec and relevant predictors and control variables, such as main socio-demographic variables (gender; age; education of parents, etc.), contextual variables (region; year of study; private/state university, etc.), characteristics of courses (educational profile: economy, management, organization, engineering, science; characteristics of teaching staff: gender, age of professor, etc.), will be used. the data will be collected in a cross-sectional framework due to a final-year students will be targeted and the survey is anonymous. the point of applying the appropriate statistical technique is to assess the efficacy of the educational program in providing students with dec that will be helpful in building the comparative advantages and would increase employment chances of young graduates on the one hand or would be persuasive in choosing the entrepreneurial career on the other. in that respect, at least several types (groups) of dec will be recognized: starting with the basic (core) one which will be followed with more advanced competences. using the framework of structural equation modeling (sem) we will conduct both the confirmatory factor analysis and the explanatory factor analysis in order to validate the applied measurement scales and confirm the exact number of factors (anderson & gerbing, 1988). the set of variables that will be included in the analysis includes different scales of measurement. the self-assessment of the competences will be ranked on a four-point likert scale like in kuzminska et al. (2019), while other control variables will include nominal scale of evaluation (personal data) or categorical scale (binomial or multinomial) for characteristics of educational programs, gender, region and alike. in the following step, the principal component analysis (pca) will be used to extract the factors (kovačić, 1994). in spss statistical software that will be used for data analysis, for example, the kaiser-guttman rule will be applied for the selection of the exact number of factors with eigenvalues greater than one. goodness-of-fit indices will be undertaken for testing the specified measurement model. after acceptable empirical test values, the variables for further analysis will be calculated as unweighted arithmetic means of respective item scores. in the second step the linear probability and multiple response regression models will be employed. the dependent variables will be constructed using grades associated with each competence or if the data are grouped with the group of competences (dec; core / more advanced). predictor variables will be chosen from a pool of the variables that represent personal characteristics of students, contextual variables and characteristics of courses. appropriate goodness-of-fit statistics will be conducted to test for adequacy of constructed models. these models will be estimated so that the more reliable predictors of the current state of the level of student competences can be evaluated. not only single predictors will be examined, but also the interaction terms will be constructed (using, for example, gender of students of teachers in interaction with the other predictors) that will moderate the effects of 152 economic analysis (2020, vol. 53, no. 2, 145-155) single factors and help to better understand what causes the current level of student selfassessment of competences. also, potential gaps between the theoretical knowledge (students' self-assessment based on the survey questionnaire) and the practical one (assessed by supervisor through practical experiments) will be estimated. using the same set of the predictors the difference in the level of competences can be tested by using the battery of statistical tests (for example, chi-square or student t-test). also, a chow-test can be applied for testing structural differences in the estimates of parameters (chow, 1960). furthermore, in order to provide policy-oriented recommendations it would be useful to see whether there are the differences among the supply of the educational programs that offer courses for advancement of dec as well as are those differences associated with the ownership status of hei or educational profile of the studies. final considerations this paper was trying to address one very important aspect of university education and that is to propose and outline the research aimed at measuring the exact levels of dec the students in serbia acquire during their university education. universities on one side offer a combination of entrepreneurial and it courses in their curriculums which should provide students with some levels of dec necessary for real life situations. the problem is the absence of research which would provide empirical evidence on the efficiency of those educational programs. this paper provided a draft of the dec related research and measurement which would be based on the use of dec online assessment tool based on the corresponding methodology. the tool will integrate two types of assessment mechanisms: self-assessment tools and real life scenarios in the form of practical assignments as in the case of van deursen and van dijk (2011). self-assessment tools will evaluate the dec of the students using four estimation levels as proposed by kuzminska et al. (2019): foundation, intermediate, advanced and highly specialized. four point likert scale will be used for this purpose as in the case of lopez-meneses et al. (2020). real-life scenarios will be based on practical assignments designed to measure specific types of dec: digital literacy, communication and collaboration, problem solving, data security, business plan development, risk management, financial literacy, business opportunities identification, etc. real-life scenarios will be developed with the help of all stakeholders and especially digital entrepreneurs in order to represent the competence requirements of the contemporary market. the data regarding the level of dec the students in serbia acquire during their university education will further be used in order to determine the factors with the highest possible impact on the level of students dec. different factors ranging from personal to socio-economic and contextual will be examined in order to identify those with the highest impact on students’ competences. this finding would be important in order to maximize the factors with positive and minimize the factors with negative impact thus improving quality of the overall educational process on universities in serbia. conclusion this paper introduced new insights into the area of digital entrepreneurial competences in terms of developing a mechanism for university students dec assessment. the paper and the corresponding future research provide important advances beyond the state of the art in several key areas. different competence frameworks (digcomp, e-competence framework, digital competence framework, entrecomp) cover different aspects of general digital and entrepreneurial competencies as addressed in the introductory part of this paper. no dec framework exists up to date. this paper proposes systematization of the current knowledge in vladimir simović 153 the area of general digital and entrepreneurial competences and the use of the existing competence frameworks in order to provide the basis for a completely new (dec) framework. competence frameworks all have corresponding methodologies which are used for different kinds of assessments. in the case of digcomp, the methodology which included 54 measurable aspects of digital competences that substantiate 16 competences under four main competence areas was developed on the basis of this framework. no dec methodology exists up to date. the existing digital competencies assessment methodologies are focused on digital competences in general and/or entrepreneurial competences. the proposal presented in this paper is more specific and provides an advance in terms of developing methodology focused on the dec of the university students. the corresponding dec framework will serve as a basis for dec methodology development. competence assessment tools based on relevant frameworks and methodologies are used in various research. one research in ukraine conducted by kuziminska et al (2019) showed that the level of competency of professional usage of it is much higher for students than for teachers. another research was conducted by lopez-meneses et al. (2020) on a sample of students from one italian and two spanish universities in three areas of digcomp 2.1: information and data literacy, communication and collaboration and digital content creation. one of the main deliverables of the future research outlined in this paper is an online dec assessment tool which will be based on dec framework and corresponding methodology, also developed under the same research. this tool will be the only of its kind in the field. this research will, for the first time, conduct assessment of university students dec and provide the data on the levels of dec the students acquire during their formal university education. besides dec tool development and university students dec assessment, this research will provide evidence on the association of different levels of dec of university students and different socio-demographic and contextual factors. the methodology and corresponding online dec assessment tool will enable the system of formal education to effectively assess the level of dec the students acquire during the course of their studies and to conduct necessary adjustments and improvements in accordance with the results. it has been more than 3 years after the strategic documents regulating the development of it entrepreneurship and overall digital competences in serbia were adopted and now is the right time to assess the level of competencies the student acquires through the system of formal education. the potential for future extensions lies in the fact that in other relevant areas of formal education similar methodologies (and corresponding assessment tools) may be developed in order to assess the functional knowledge and skills of the students. references anderson, james c., and david w. gerbing. 1988. 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"educating the next wave of entrepreneurs: unlocking entrepreneurial capabilities to meet the global challenges of the 21st century." world economic forum: a report of the global education initiative. zhao, fang, and alan collier.2016."digital entrepreneurship: research and practice." 9th annual conference of the euromed academy of business. 14-16 september, warsaw, poland. article history: received: november 25, 2020 accepted: december 7, 2020 ea_2014_3-4 udc: 005.334:336.77 005.22 jel: g22 cobiss.sr-id 21178164 original scientific paper credit spread modeling: macro-financial versus hoc approach dudaković sanja1, franklin university switzerland abstract – the aim of this paper is to throw light on the relationship between credit spread changes and past changes of u.s. macro-financial variables when invariants do not have gaussian distribution. the first part presents the empirical analysis which is based on 10-year aaa corporate bond yields and 10-year treasury bond yields. explanatory variables include lagged u.s. leading index, russell 2000 returns, bbb bond price changes interest rate swaps, exchange rates eur/ usd, repo rates, s& p 500 returns and s&p 500 volatility, treasury bill changes, liquidity index-trsw, libor rates, moody’s default rates; credit spread volatility and treasury bills volatility. the proposed dynamical model explains 73% of the u.s. credit spread variance for the period 1999:072013:07. the second part of the article introduces the parameter estimation method based on higher order cumulants. it is demonstrated empirically that much of the information about variability of credit spread can be extracted from higher order cumulant function (85%). key words: credit spread modeling, arma parameter estimation, higher order cumulants, non gaussian arma models, dynamic regression introduction the predictability of credit spread has been assuming a new importance since both fixed income investors and financial managers need reliable predictions to make more money. for the past fifteen years, the source of the greatest variance between investment objectives and payoffs has been credit risk. there are two opposed micro-financial approaches to credit spread modeling, used in literature so far: the “structural” approach versus the “reduced” approach. however they have a common characteristic, which is the assumption that the main explanatory component of credit spread is a default risk. the market pricing of default risk can be analyzed using the “structural approach”, (merton, 1974), which is based on black and scholes option pricing model. the “reduced approach” to the pricing of default risk assumes that investors require excess return in order to cover the risk. in this context the pricing requires a measure of corporate default probability and the associated recovery rates. although conceptually very elegant, the structural models have had limited success in matching with empirical data. 1 address: via ponte tresa 29, lugano, switzerland, e-mail: sdudukovic@fus.edu economic analysis (2014, vol. 47, no. 3-4, 53-68) 54 elton, gruber and mann [2001] found that expected default losses are insufficient to explain the great part of the variability of credit spreads. using a reduced form model, they showed that the expected default loss can explain only up to 25% of credit spread. huang and huang (2003) used a structural model too, and verified that for investment grade bonds (baa and higher rating) only 20% of the spread is explained by the default risk. both models used historical default frequencies produced by moody’s and standard and poor’s. alternative estimates of default probabilities are provided by lando and skodeberg (2002) who used a continuous time analysis of rating transitions to improve the estimate of the default risk. collin-dufresne, golden and martin (2001) examined a firm level related risk as determinants of credit spread changes, spot rate changes, changes in the slope of the yield curve, changes in a firm leverage, changes in volatility, changes in the probability and magnitude of a large negative jumps. they concluded that the monthly changes in firm specific factors are not a driving force in credit spread changes. besides merton (1974), krishman, ritchken and thompson (2003), showed that the predictability of credit spread, based on the credit slope, largely depends on the maturity of the corporate bonds. zhang, zhou and zhu (2005), argued that the unsatisfactory performance of structural models may be in part attributed to the fact that the impact of volatility and jump risks are not treated seriously. they found strong volatility and jumps effects, which predict another 16% of credit spread. in this paper, it is first investigated how credit spread changes are explained by the changes of macro-financial variables such as: lagged changes russell 2000 returns, bbb bond price changes, u.s. leading index, interest rate swaps, exchange rates eur/usd, repo rates, s& p 500 returns and s&p 500 volatility, treasury bill changes and their volatility, liquidity index and moody’s default index (section 1). empirical dynamic regression model is discussed in section two. statistically speaking, credit spreads time series is non gaussian which means that its autocorrelation function does not provide sufficient statistics for arima-garch parameter estimation. cumulants (in frequency domain called polyspectra) have received the attention of the statistics and signal processing and wireless communications (zou, zhong & jiang ,2013). gianninakis (1990) derived cumulant based arima order determination method for communication signals, because second order cumulants for non gaussian signals vanish, higher order cumulants are generally nonsymmetrical functions of their arguments, and as such carry phase information about arma parameters. the section three of this article discusses some of the theory behind higher-order statistics, particularly as it applies to non gaussian signals arma parameter estimation. it then in details describes the steps taken towards constructing such an estimator. these steps are aimed to determine the credit spread arma model order which is necessary to provide accurate cumulant estimates using mathlab software, to examine the performance of a cumulant based arma parameter estimation for a non-gaussian credit spread time series, and to examine the ability of the cumulant based model to outperform the classical regression model. conclusion is given in section four. duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 55 the problem and the methodology it is well known that a credit spread represents the difference between the yield of a risky security (corporate bond) and that of a risk-free security of the same or similar maturity. the predictability of a credit spread is of paramount importance for both fixed income investors and financial managers. if prediction shows that the future credit spread will widen, the trader would sell the portfolio of corporate bonds and vice versa. on the other side, corporate finance managers would be able to lower the firm’s cost of capital by timing debt issuance. as pointed out by harvey (1999), if prediction is that credit spread will tighten, managers will support short term debt operations, will lock in interest rates today and wait until the spread really tightens to issue long term debt. the static multiple regression model for credit spread, as used almost everywhere, is not considered. instead, multiple integrated autoregressive ia –garch model is used.the rational for this choice is quite simple: the classical multiple regression model reflects instantaneous relationship. thus, even when the coefficient of determination is high, this model is of little use for forecasting whether statistically significant predictions of explanatory variables are not available. almost all explanatory variables used in literature so far, after being stationarized by making their first differences, have quickly vanishing autocorrelations which contain a marginal amount of information useful for their forecasting. let xit and yt be jointly stationary gaussian processes with finite first and second moments that can be treated as outputs from the linear autoregresssive integrated moving average ( arima) filters, whose inputs are white noise signals: uti and vt respectively: a1(z)* dxti= b1(z)* uit , i=1,2…k a2(z)* dyt= b2(z)* vt , where z is a backward shift operator: yt-1=zyt , yt-k =zkyt ; a(z) = 1-a1z-a2z2 …apzp and b(z) = 1-b1z-b2z2 …bqzq are ar and ma filters of orders p and q respectively, d is the first difference filter, dyt = yt yt-1 , i is the index of independent variable, k is the number of independent variables. the model of credit spread we use has iar-grach general form, as defined by box-jenkins (1976) and by bollerslev (1986), as a generalization of engle (1982). iar model has the form: k pi q dyt =σ σαij *xti-j + σβm *εt-m , (1) j=1 m=1 i=1,2...pi, j=1,2…k, m=1,2…q , economic analysis (2014, vol. 47, no. 3-4, 53-68) 56 while garch model is : ht =ω + γhτ−1ε2t-1 + δht-1 (2) where pi is the ar order or the series i, i is the index of independent variables and t is the residual white noise associated with yt, q is the ma order of the {εt} residuals and {ht} is volatility of the residuals. dynamic macro-financial model the corporate credit spread, or just the credit spread crsp, is usually measured as the difference between the yields of a defaultable corporate bond and of a u.s. government bond of comparable time to maturity. in this article, the credit spread is the difference between yields of 10 year aaa bonds and 10-year treasury bonds. its chart is presented in figure 1, for the period 1999:01-2014:07. a statistical description for aaa yields, 10-year treasury yields and the credit spread, are presented in table 1. table 1. descriptive statistics for credit spread dcrsp aaa tre10y mean -0.000402 7.080172 5.781264 median 0 7.17 5.81 maximum 0.41 9.01 8.28 minimum -0.64 4.96 3.33 std.dev. 0.116715 0.960916 1.1809 skewness -0.405155 -0.232654 0.06616 kurtosis 8.569198 2.456881 2.156968 observations 174 174 174 figure 1. credit spread chart the credit spread appears to be non -stationary, which is demonstrated by using the unit root test results: crsp duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 57 adf test statistic -2.20972 1% critical value* -3.47 5% critical value -2.878 10% critical value -2.576 *mackinnon critical values for rejection of hypothesis of a unit root. the first difference of the credit spread has autocorrelations (ac) and partial autocorrelations (pac) different from zero, as presented in table 2. table 2. autocorrelations (ac) and partial autocorrelations (pac) lags 1 2 3 4 5 6 7 8 9 10 ac 0.348 -0.06 -0.125 -0.184 -0.128 -0.009 0.007 0.03 -0.014 -0.061 pac 0.348 -0.21 -0.033 -0.157 -0.029 0.008 -0.043 0.01 -0.066 -0.042 the best time series model obtained by using aic criterion is arima (2,1,0) with coefficients presented in table 3. as it can be seen from the table, this model explains only 16.25% of the credit spread variance. table 3. arima model dependent variable: d(crsp) included observations: 172 variable coefficientstd. error t-statistic prob. ar(1) 0.42333 0.074555 5.67813 0 ar(2) -0.2072 0.07458 -2.7778 0.0061 r-squared 0.16245 mean dependent var 0.0003 explanatory variables as mentioned above , the following explanatory variables are used : s&p 500 composite index returns and its volatility, three months treasury bill rate and corresponding volatility, libor rate, repo rate, swap rate, russell 2000 index, eur/usd exchange rate, liquidity index and u.s. leading index. their meanings are explained bellow. by using the unit root test, it is shown in table 4, with 99% confidence, that all the variables are non stationary, whilst s&p 500 returns, russell 2000 returns and u.s. leading index are stationary time series. the s&p 500 is one of the most commonly used benchmarks for the overall u.s. stock market. it is a market-value weighted index, which means each stock's weight in the index is proportionate to its market value. s&p 500 returns are calculated as usually: sp500rt= (sp(t)-sp(t-1)) /sp(t-1) (3) economic analysis (2014, vol. 47, no. 3-4, 53-68) 58 table 4. unit root test augmented dickey-fuller test results variable adf test statistic 1% critical value* -3.472 5% critical value -2.880 10% critical value -2.576 sp500r -6.527 tre3m -1.905 swap5 -2.194 swap10 -2.042 uslead -4.762 russel2000 -7.253 euro -1.489 default rate -1.791 libor6m -1.881 trsw -1.868 reporate -2.132 prime rate -1.959 *mackinnon critical values for rejection of hypothesis of a unit root. stock market returns are expected to be negatively correlated with bond market returns. the best arma model is arma (1,1) whose coefficients are presented in table 5. table 5. arma (1,1) dependent variable: sp500r included observations: 164 variable coefficientstd. error t-statistic prob. c 0.0080 0.0033 2.4567 0.0151 ar(1) -0.6321 0.2498 -2.5301 0.0124 ma(1) 0.6760 0.2454 2.7545 0.0066 r-squared 0.0346 mean dependent var 0.0081 three months treasury bill rate, t bills. by definition, this rate is a debt obligation issued by the u.s. government and backed by its full faith and credit, having a maturity of one year or less. treasury bills are considered the safest securities available to the u.s. investor, and so the yield of these securities is considered risk-free. these securities do not pay a coupon, and the interest earned is estimated by taking the difference between the par value and the purchase price of the bond, with time adjustments. in this analysis the t-bills with 3 months maturities are the only t bills that are significant for credit spread variations. their best arima model is presented in table 6. as it can be seen from the table the series has significant volatility of the garch (1,1) residuals. interest rate swaps can provide forward indication of credit spread direction. interest rate swaps are used to hedge interest rate risks as well as to take on interest rate risks. if a treasurer is of the view that interest rates will be falling in the future, he may convert his fixed interest liability into floating interest liability; and also his floating rate assets into fixed duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 59 rate assets. if he expects the interest rates to go up in the future, he may do vice versa (the floating side of the swap would usually be linked to another interest rate, often the libor). in an interest rate swap, the principal amount is never exchanged; it is just a notional principal amount. in a word, interest rate swaps are financial tools that potentially can help issuers to lower the amount of debt service. we use two swap indexes, which are significant for the credit spread changes: a 5-year swap and 10-year swap index, taken from bloomberg. table 6. arima model dependent variable: d(tre3m) coefficientstd. error z-statisticprob. ar(1) 0,9074 0,046431 19,543 0 ma(1) -0,6521 0,08504 -7,6682 0 variance equation c 0,00428 0,001808 2,36827 0,0179 arch(1) 0,2094 0,059513 3,51855 0,0004 garch(1) 0,65998 0,082713 7,97914 0 r-squared 0,24012 mean dependent var-0,0164 the best arma-garch model coefficients for the series swap5 and swap10 are presented in tables 7 and 8 respectively. as it can be seen from the tables, self predictive power or arima models is fairly low for both series. a liquidity index is consider to be an estimate of changes in the difference between yields of the 10-year swap index and 10-year treasuries, trsw, as suggested by collin-dufresne, goldstein and martin (2001).the best arima model is given in table 7. table 7. arma-garch model coefficients for the series swap5 table 8. arma-garch model coefficients for the series swap10 dependent variable: d(swap5) included observations: 173 coefficient std. error z-statistic prob. ar(1) -0.415908 0.263282 -1.579707 0.1142 ma(1) 0.58401 0.262362 2.225973 0.026 variance equation c 0.090758 0.046474 1.952889 0.0508 arch(1) -0.102324 0.04004 -2.555525 0.0106 garch(1) 0.152989 0.485436 0.315159 0.7526 r-squared 0.033673 mean dependent var -0.0217 dependent variable: d(swap10) included observations: 173 coefficient std. error z-statistic prob. ar(1) -0.69404 0.194109 -3.575512 0.0003 ma(1) 0.808037 0.1549 5.216516 0 variance equation c 0.028355 0.054337 0.521849 0.6018 arch(1) -0.036194 0.049834 -0.726295 0.4677 garch(1) 0.690456 0.645622 1.069443 0.2849 r-squared 0.01843 mean dependent var -0.0228 eur/usd exchange rate was the only shorter time series used in this article. the missing values are obtained by using a weighted average of the foreign exchange value of the u.s. dollar against a subset of the g7 index currencies that circulate widely outside the country of issue, issued by the board of governors of the federal reserve system for the period 19911999.its arma –garch model parameters are presented in table 10. economic analysis (2014, vol. 47, no. 3-4, 53-68) 60 it is not unusual that instead of eur/usd exchange rate, researchers use ted spread, or treasury rate – eur/usd exchange rate (harvey 1999). since the credit spread already contains treasury rate yields, we prefer to use the exchange rate itself. table 9. arma-garch model table 10. arma –garch model parameters dependent variable: d(trsw) method: ml arch (marquardt) sample included observations: 172 coefficient std.error z-statistic prob. ar(2) 0,7312 0,1241 5,8926 0,0000 ma(1) -0,7426 0,0538 -13,7959 0,0000 ma(2) -0,8315 0,0925 -8,9858 0,0000 ma(3) 0,6565 0,0893 7,3553 0,0000 variance equation c 0,0019 0,0003 6,7920 0,0000 arch(1) -0,0776 0,0034 -22,8489 0,0000 garch(1) 1,0186 0,0089 115,0676 0,0000 r-squared 0,2884 dependent variable: d(eur/us) date: 03/09/14 time: 12:00 included observations: 174 after adjusting endpoints coefficient std. error z-statistic prob. ma(1) 0,464845 0,088904 5,22861 0 ma(2) 0,004959 0,072703 0,068205 0,0094 variance equation garch(1) -0,128229 0,014563 -8,805107 0 1,025287 0,017666 58,03805 0 r-squared 0,165566 mean dependent var -0,0009 the u.s. leading index, as issued by the conference board, is a composite average of ten components: average weekly hours (weight .189), average weekly initial claims for unemployment insurance (.026), manufacturers' new orders, consumer goods and materials (.049), vendor performance, slower deliveries diffusion index (.027), manufacturers' new orders, non-defense capital goods (.012), building permits, new private housing units (.018), stock prices, 500 common stocks (.033), money supply, m2 (.306), interest rate spread, 10year treasury bonds less federal funds income ratio (.323), index of consumer expectations (.017). dudukovic (2005) demonstrated the causality between the credit spread and the u.s. leading composite index returns and showed that leading index explained up to 30% of credit spread changes. arma-garch model for uslead percent changes, usleadr, is presented in table 11. repo rate as explanatory variable are suggested by lando (2002). it is well known that the market for repurchase agreements involving treasury securities (known as the repo market) plays a central role in the federal reserve’s implementation of monetary policy. transactions involving repurchase agreements (known as repos and reverses) are used to manage the quantity of reserves in the banking system on a short term basis. by undertaking such transactions with primary dealers, the federal reserve bank, through the actions of the open market desk, can temporarily increase or decrease bank reserves. by definition, repo rate is the rate of return that can be obtained from selling a debt instrument future contract and simultaneously buying a bond or note deliverable against that future contract with borrowed funds. the best arima-garch model for those rates is given in table 12. duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 61 table 11. usleadr table 12. the best arima-garch model dependent variable: usleadr100 included observations: 173 coefficient std. error z-statistic prob. ar(2) 0.939386 0.034147 27.51011 0 ma(2) -0.772158 0.077257 -9.994679 0 variance equation c 0.356773 0.069682 5.120015 0 arch(1) 0.108312 0.051191 2.115844 0.0344 garch(1) -0.814267 0.256766 -3.171236 0.0015 r-squared -0.004185 mean dependent var 0.0032 dependent variable: d(repo3) included observations: 169 after adjusting endpoints coefficient std. error z-statistic prob. ar(1) 0.855709 0.077274 11.0737 0 ma(1) -0.606855 0.112583 -5.390271 0 variance equation c 0.019547 0.011925 1.639159 0.1012 arch(1) -0.034796 0.002004 -17.36755 0 garch(1) 0.548244 0.282948 1.93761 0.0527 r-squared 0.225874 mean dependent var -0.0124 the russell 2000 index measures the performance of the smallest 2000 companies in the russell 3000. it is published by the frank russell company. the index itself is considered to be the benchmark for all small-cap mutual funds. the best arma-garch model is presented in table 13. default rate. we use moody’s monthly default rates for all corporate u.s. issuers (available on bloomberg and, discontinued in 2002). a significant positive relationship between the credit spread and default rates is reported in by huan and hong, 2003, where the standard regression analysis is used to explain credit spread changes.the best arima-garch for default moody’s default rates is presented in table 14. table 13. default rate table 14. moody’s default rates dependent variable: r2000r included observations: 173 after adjusting endpoints coefficient std. error z-statistic prob. ar(1) 0,375244 0,278737 1,346228 0,1782 ma(1) -0,267793 0,295763 -0,905432 0,3652 variance equation c 5,52e-05 6,70e-05 0,824652 0,409 arch(1) 0,058571 0,056084 1,044343 0,0296 garch(1) 0,92554 0,067004 13,81327 0 r-squared 0,022226 mean dependent var 0,0097 dependent variable: d(mdefaultr) included observations: 136 coefficientstd. error z-statisticprob. ar(1) 0,82976 0,087785 9,45222 0 ma(1) -0,5206 0,141277 -3,6852 0,0002 variance equation c 0,00042 0,000245 1,72445 0,0846 arch(1) 0,03117 0,035966 0,86661 0,3862 garch(1) 0,91387 0,049796 18,3525 0 r-squared 0,21959 mean dependent var -0,0017 dynamic model empirical results the proposed dynamic regression model , is tested by using e-views software. different model equations are used, with different lags for independent variables. the resulting model is chosen as one for which all the variables were statistically significant, according to t-values and p values. according to table 15, credit spread determinants are proven to be: u.s. leading index, russell 2000 returns, interest rate swaps, s& p 500 returns, treasury bill changes, liquidity index and moody’s default rates. economic analysis (2014, vol. 47, no. 3-4, 53-68) 62 table 15. macro-financial crsp model dependent variable: d(crsp) date: 03/09/14 time: 12:00 included observations: 135 variable coefficient std.error t-statistic prob. usleadr100(-1) -0.04 0.01 -3.27 0.00 usleadr100(-3) 0.03 0.01 3.03 0.00 d(swap5(-2)) 0.04 0.02 1.89 0.12 d(swap10(-1)) -0.28 0.03 -9.27 0.00 d(tre3m(-2)) -0.14 0.04 -3.95 0.00 d(crsp(-1)) 0.33 0.06 5.34 0.00 d(tre3m(-1)) 0.15 0.03 4.30 0.00 sp500r(-1) 0.21 0.12 1.72 0.11 r2000r(-1) -0.28 0.11 -2.54 0.01 d(mdefr(-1)) -0.08 0.04 -2.04 0.11 d(mdefr(-2)) 0.11 0.05 2.20 0.03 d(trsw(-1)) -0.30 0.04 -7.61 0.00 variance equation c 0.00 0.00 1.79 0.07 arch(1) -0.06 0.07 -0.91 0.36 garch(1) 0.70 0.17 4.18 0.00 r-squared 0.729435 mean dependent var0.002 surprisingly, the volatilities of s&p 500, the volatility of credit spread and the volatility of treasury bills are neither significant for credit spread changes, nor for the change of rsquared. this could be seen from table 16, which has to be read as the bottom part of table 15. the same holds for repo rates, libor and us&eur exchange rate .this contradicts huang and kong, 2003 and lando 2005. the real credit spread and its iar-garch model are presented in figure 2. table 16. dependent variable: d(crsp) variable coefficient std.errort-statistic prob. crspvol 0,667885 0,86558 0,771606 0,442 spvol 0,218875 5,63366 0,038851 0,969 tbill3mvol -0,322887 0,30795 -1,04851 0,297 repo3(-1) 0,001459 0,00684 0,213343 0,831 duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 63 figure 2. real credit spread differences and its iar-grach model. the residual volatility obtained by using garch model is presented in figure 3. figure 3. credit spread volatility hoc approach to credit spread modeling the new approach to the credit spread forecasting, suggested in this paper, is based on arimagarch model (engel -boleslev1996). the model building, as usually, consists of three steps: model identification (order determination using akaike's information criterion – aic), parameter estimation and model testing. the main premises in this methodology is that each stationary time series is treated as the output of ar(p), ma(q) or arima filter, which has as the input uncorrelated non gaussian shocks known as "white noise" :a(z)* dyt= b2(z)* vt ,where vt is a white non gaussian noise , z is a backward shift operator: yt-1=zyt , yt-k =zkyt , a(z) = 1-α1z-α2z2 -αpzp and b(z) = 1-β1z-β2z2 …βqzq are ar and ma filters of orders p and q respectively, d is the first difference filter, dyt = yt yt-1 , dkyt=yt yt-k as for volatility its model is given by engle (1982) : p q h t =α 0 +∑α i r 2 t-i + ∑β j h t-j (4) i=1 j=1 in which pt represents stock prices, {rt} represent random returns, ht is the conditional volatility, αi is autoregressive, and βj is the moving average parameter as related to the squared stock market index residuals. -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 1999-2013 d(crsp): real and model monthly data crsp crsp-model 0 0.001 0.002 0.003 0.004 0.005 0.006 0.007 1 31 61 91 121 151 d (c r s p ) v o la til ity months garch variance garch variance economic analysis (2014, vol. 47, no. 3-4, 53-68) 64 an equivalent arma representation of the garch (p, q) model is given by: p q e t 2 = α 0 +∑(αi+β i )e 2 t-i +ν t ∑β j ν t-j (5) i=1 j=1 where t = et2 ht and, by definition, it has the characteristics of (i.i.d) white noise. in other words, the garch (p, q) volatility model is an autoregressive moving average (arma) model in et2 driven by white noise t .the rt2 is stationary if ( i+ i)t 1   the aim of this paper is to take a new direction which leads back to the essence of time series analysis. namely, it is argued that the sufficient statistics for credit spread is defined in terms of the higher order cumulant (hoc) function. it is hypothesized that the hoc model extracts the information about the credit spread , better if arma parameters are calculated by using both second, third and fourth order cumulant functions. a new method of parameter estimation for non gaussian processes is based on the higher order cumulants. the third c3y and the fourth order cumulants c4y are defined by gianninakis (1990): c3y(τ1,τ2)= (∑(y(t)y(t+τ1)y(t+τ2))/n, c4y(τ1,τ2)= (∑(y(t)y(t+τ1)y(t+τ2) y(t+τ3))/n, oyet a. (2000, pg 4) and zou at all.(2013) proved that efficient arma parameters can be obtained by using a modified set of yule walker equations where autocorrelations are replaced by third or fourth order cumulants: p ∑ αi c3(k-i,k-l) = c3(k,k-l) , k≥l≥q+1 (6) 1=1 p ∑ αi c4(k-i,k-l, k-m) = c4(k,k-l, k-m) , k≥l≥ m≥q+1 (7) 1=1 swami (1989) developed the matlab routine arest which enable ar parameter estimation using both the second and the third order cumulants . once the ar residuals are calculated, the ma parameters can be calculated by using the routine maest which uses the least squares set of equations: q q ∑βi c3(n-i,n-i)-∑β i2c2(n-i) =c2(n) , n= -q…,2q (8) 1 1 where both second and third order cumulants are used. duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 65 with the above theory in mind, the higher order cumulants are used for credit spread arima modeling. the forth order crsp cumulants are presented in figure 4.the different factors discussed here were investigated using matlab and its higher-order spectral analysis (hosa) toolbox. matlab was used to calculate estimates of the data's third-order cumulants, as well as to estimate arma model parameters. further residuals analysis is done using e-views. the obtained cumulants based model parameters are presented in table 18. the model and the real credit spread data are presented in figure 5. figure 4. third order cumulants for credit spread first difference figure 5. cumulant based credit spread model -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 1 22 43 64 85 106 127 148 169 1999:10-2013:07 credit spread -cumulant based model crsp crsphos economic analysis (2014, vol. 47, no. 3-4, 53-68) 66 table 18. cumulant based arima estimates dependent variable: dcrsp method: cumulant based least squares date: 12/02/07 time: 18:57 sample(adjusted): 4 174 included observations: 171 after adjusting endpoints convergence achieved after 30 iterations backcast: 1 3 variable coefficientstd. error t-statistic prob. ar(1) 0,939886 0,152151 6,177341 0 ar(2) 0,668867 0,217999 3,068214 0,0025 ar(3) -0,71802 0,114241 -6,28511 0 ma(1) -0,1833 0,103085 -1,77816 0,2911 ma(2) -0,35279 0,167842 -2,10191 0,0371 ma(3) 0,166202 0,08135 2,043051 0,1616 r-squared 0,857758 mean dependent var 0,0075 concluding remarks the credit spread predictability, defined as the difference between aaa corporate bond yields and 10 year treasury bond yields, has assumed a new importance since both investor managers as well as corporate finance managers need credit spread predictions to make more money. the multiple lagged iar-garch model for the u.s. credit spread is made in this paper for the period 199:01 to 2013:07. as explanatory macro-financial variables we investigated: u.s. leading index, russell 2000 returns, interest rate swaps, s&p500 returns, treasury bill changes, liquidity index and moody’s default rates, s&p 500 volatility, credit spread volatility, treasury bill volatility, exchange rates eur/usd, repo rates and libor rates. all the volatilities, repo rates, libor rate and exchange rates were not found to be causally related to credit spread changes. however, credit spread determinants are proven to be the following macro variables: u.s. leading index, russell 2000 returns, interest rate swaps, s& p 500 returns, treasury bill changes, liquidity index and moody’s default rates. the obtained macro model significantly improves predictability of credit spread changes. structured models based on micro independent variables, default rate and recovery rate, have explanatory power which varies from 20% to 50%.the proposed model explains 73% of the credit spread variability. the advantage of the lagged model over the classical instantaneous multiple regression models like (huang and kong, 2003) is that our model enables prediction, since the model relates future credit spread change and the current and past values of the explanatory variables or their changes. the second part of the paper introduces the estimation method based on higher order cumulants.namely, it is argued that the sufficient statistics for credit spread is defined in terms of the higher order cumulant (hoc) function. it is hypothesized that the hoc model duduković, s., credit spread modeling, ea (2014, vol. 47, no. 3-4, 53-68) 67 extracts the information about the credit spread, better if arma parameters are calculated by using both second, third and fourth order cumulant functions. a comparison with a dynamical regression model is also provided. ultimately, it is demonstrated that much of the information about the variability of the credit spread can be extracted from higher order cumulants. in fact the coefficient of determination obtained by regression for credit spread data is .729 while the coefficient of determination obtained by using the third order cumulants and applying hos method appears to be .857. this demonstrates the fact that the hos based arma estimation achieves statistically higher coefficient 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creditnog spreda macro-finansijskom metodom i metodom kvr rezime – cilj ovog rada je da objasni promene kreditnog spreda u zavisnosti od promena macro-finansijskih variabli koje nemaju gausovsku raspodelu. prvi deo rada predstavlja empirisku analizu baziranu na spredu između prinosa desetogodišnjih korporativnih aaa obveznica i državnih zapisa sa desetogodišnjim rokom dospeća (10ytb). makrofinansijske variajable uključuju indekse kao što su vodeći indeks rasta (us leading index), stock market indeksi russel 2000 i s&p500, s&p volatilitet, kurs eur/usd, repo interesna stope, promene cena bbb korporativnih obveznica, promena cena državnih ili trezorskih zapisa (tbills), indeks likviditeta, referentna kamatna stopa libor, moody stopa otpisivanja, volatilitet kreditnog spreda i volatilitet trezorskih zapisa. predloženi diniamicki regressioni model objasnjava 73% varianse kreditnog spreda u sad-u. drugi deo rada uvodi estimaciju parametara arma model kreditnog spreda, baziranu na kumulantima višeg reda kvr. demonstrirano je empiriski da uvedeni metod estimacije ekstrahuje 85% informacije o varijansi kreditnog spreada. ključne reči: modeliranje kreditnog spreda, ocena arma parametara, kumulanti višeg reda, ne-gausivi arma modeli, dinamička regresija article history: received: 30 july 2014 accepted: 2 november 2014 doi: 10.28934/ea.20.53.1.pp105-117 scientific review implementation of two – dimensional model of corporate social responsibility in serbian companies saša virijević jovanović1* | tatjana janovac1 | dragana nešović2 1 university business academy, faculty of applied management, economics and finance, departement for management and business, belgrade, serbia 2 university union, nikola tesla, faculty of law, security and management, department for law, niš, serbia abstract the aim of the paper is to point out the possibilities of measuring the effects of corporate social responsibility (csr) on the basis of two dimensional model, developed by quazi ali m. and o’brien d. (2000). the problem of measuring the effects of csr occurs mainly due to the fact that it is difficult to estimate how qualitative factors contribute to competitiveness. the two-dimensional csr model measures the corporate social responsibility from two perspectives. one is the company’s approach towards society, while another represents the cost / benefit ratio of csr. therefore, the model belongs to the category of socio-economic models. in order to make a contribution towards the further researching of the model application, the empirical test have been made on the sample of 33 companies in serbia. according to quazi ali m. and o'brien d., the survey was based on a questionnaire consisting of 25 statements that covered significant issues in the field of corporate social responsibility. factor analysis was used as a statistical method in the research. the survey indicated that the majority of respondents recognize the significance of corporate social responsibility application. however, the respondent’s opinions are divided between two extremes: companies oriented toward long-term goals, which show interest in society and companies that focus on short-term, purely profit-oriented goals, which take a negative stance on csr. key words: corporate social responsibility, two – dimensional csr model, business and society jel classification: a14 introduction corporate social responsibility (csr) in the contemporary economic and social environment has become a critical business function in organization and an “inescapable priority” (porter and kramer, 2006). also, in recent years, the importance of csr is highly recognized by national and regional authorities, who have taken legislative initiatives in order to promote and support practice of socially responsible business. therefore, the scientific public is increasingly considering the possibility of measuring the level of corporate social responsibility, as well as its effects on the social environment and business. over the past years, multiple models of corporate social responsibility have been developed by numerous authors. however, most of the models were descriptive and only a few have been empirically verified. australian authors, quazi and o'brien have defined a wider approach to corporate social responsibility, noting that the organization should strive to build sustainable relationship with * corresponding author, e-mail: sasavirijevic12@gmail.com 106 economic analysis (2020, vol. 53, no. 1, 105-117) social environment. as a result of such approach, the authors have designed the two dimensional csr model, which was the subject of this paper. the main advantage of the model is the possibility of application in different cultures and industries. therefore, it has attracted the attention of other researchers, who have continued to test its validity in different socio-cultural contexts, such as: spain (de la cruz and suarez, 2005), brazil (filgueiras et al. 2012), mexico (ortega et al. 2016) etc. regarding the findings of quazi and o'brien, the aim of the paper is to point out the possibilities of measuring the effects of corporate social responsibility on the basis of two approaches, a social perspective and the cost / benefit ratio. empirical research was conducted in serbian companies from june to august 2019. the sample included 136 managers and ceos from 33 companies. in interpreting the obtained data spss program was used, with its functions of descriptive statistics and factor analysis. corporate social responsibility concept – theoretical background social responsibility as a practice of organizations has existed for several centuries, before the emergence of the first theoretical approaches (schwartz and cragg, 2009). however, the first written records of corporate social responsibility date back to 1899 and are related to the work of andrew carnegie. the scientific study of this concept was introduced by chester barnard (carroll, 1999) in 1938, who analyzed the responsibility of organizations in the publication "the functions of the executive” (chester, 1968). when it comes to the modern concept of csr, many consider that its founder was the prominent american scientist, howard bowen (carroll, 1999). in 1953 bowen published a book “social responsibilities of the businessman” in which he indicated that the private business success will be judged regarding its contribution to the general welfare (bowen, 1953). later, in 1960 keith davis claimed that businessmen have to reexamine their contribution to the society (davis, 1960). the very same year william c. frederick considered that businesses’ resources should be put on disposal for the sake of higher social goals. (frederick, 1960). in recent years, pitter drucker was also a great proponent of the concept. he was well-known by his statement that “leaders in every single institution and in every single sector have two responsibilities. they are responsible and accountable for the performance of their institutions, and that requires them and their institutions to be concentrated, focused, limited. they are responsible also, however, for the community as a whole” (knapp, 2007). within the pages of the new csr theory, there is a special place for archie carol, who linked the concept with the idea of conscious capitalism (carroll, 2015; wagner-tsukamoto, 2019). corporate social responsibility today is an important academic field, which confirms the growing attention to the subject. this is supported by the fact that most successful large companies now publish substantial information on their social and environmental impacts (crane, mcwilliams et al., 2008). furthermore, there have been made great efforts in order to harmonize csr practices globally and to define standards that will guide business actions in social environment. there are many definitions of corporate social responsibility in the current literature. however, there is no single established definition, especially if one consider different theoretical approaches around the world (malecki, 2018). carroll has introduced the following definition: "the social responsibility of business encompasses the economic, legal, ethical, and discretionary expectations that society has of organizations at a given point in time" (carroll, 1979). according to one of the most commonly cited definition, csr is regarded as the responsibility of business sector that has to be aware of its influence on the society (european commission, 2019). in order to meet its social responsibilities, the enterprises and their stakeholders should saša virijević jovanović, tatjana janovac, dragana nešović 107 define business strategies that will integrate environmental, social, ethical and human rights interests (meglio, 2019; rasche, morsing, moon, 2017). some authors emphasize the importance of discretionary business practices in csr definitions (kotler and lee, 2005; sales, 2019; bittar-godinho and masiero, 2019). the word discretionary refers to the fact that there is no law that obliges companies to act socially responsible, but they do so voluntarily. other authors propose normative approach and insist that csr is about managing business operations “in a manner that meets high social and environmental standards” (fisher and lovell, 2003). there are also attitudes that csr definition should involve economic and legal concerns (carroll and shabana, 2010). measuring corporate social responsibility measuring the effects of corporate social responsibility is a demanding process, as it should show how the csr activities of an organization affect society, as well as how it contributes to competitiveness. some studies indicate that the measurement of csr effects is highly dependent on the industry, product type, and social issues in question (mullerat, 2010). considering the problems of measuring the effects of csr, lantos points out that the results of such empirical research are often ambiguous, and does not indicate whether the organizations are better or worse in fulfilling social responsibilities (lantos, 2001). the process of measuring csr is particularly difficult regarding the fact that it is not easy to assume how qualitative factors such as morale of the employees, corporate reputation, public relations, and other contribute to profitability and competitiveness. however, through different periods of csr history, different models have been developed in order to measure the company’s performance in society. in 1979, carroll was the first who introduced the corporate performance model (csp). the model presented four different types of social responsibilities: economic (“make profit”), legal (“obey the law”), ethical (“be ethical”), and philanthropic (“be a good corporate citizen”) (carroll, 1979). the csp model served as a solid base for developing other approaches to measuring csr (schreck, 2009), such as watrick and cochran’s model (1985) and wood’s model (1991). from carroll’s csp model to the present day, csr methodology has enriched its history with different models, which can be classified in many ways. according to the classification, which is widely represented in the literature csr models can be divided into three categories (liangrong, 2009): 1. socio-economic models, 2. the stakeholder model, 3. triple bottom line model. the two – dimensional model of csr the findings in this study are based on a two-dimensional csr model. it was developed by quazi ali m. and o’brien d. (2000) in order to measure the corporate social responsibility from two perspectives. one is the company’s approach towards society, while another represents the cost / benefit ratio. therefore, the model belongs to the category of socio – economic models. when developing the model, the authors defined two goals: 1. to create a corporate social responsibility model that will be applicable across different cultures and 2. to empirically verify the model by examining how managers perceive csr. 108 economic analysis (2020, vol. 53, no. 1, 105-117) the model consists of two axes, horizontal and vertical and four quadrants, shown in figure 1. the company's position in the model depends on how it perceives the csr and its benefits. figure 1. a two-dimensional model of corporate social responsibility source: (quazi and o’brien, 2000) the horizontal axe connects two extremities: “wide responsibility” on the left and “narrow responsibility” on the right. the left position represents a wider social approach to business, which implies that the company should be interested in community development as well as involved in protection of the environment, nevertheless the fact that it does not have a legal obligation. the right position, on the other hand, is in line with the old, classic business approach, which emphasizes that the company should be focused solely on short-term goals, such as to maximize profits. supporters of this concept consider that the company has only one sole social responsibility, which is to provide products for the society, while making a profit and respecting legal regulations. vertical axe of the model represents two extreme positions, regarding the consequences of the company’s social action. the benefits from csr are shown on the top of vertical axe, and costs from csr activity are situated at the bottom. companies that focus on short-term, mainly profitoriented goals show concern about the costs that arise from csr activity, and therefore they are oriented toward the lower, negative positions. unlike the companies that are oriented toward long-term goals and show interest in society. these companies have a position within the upper positive extremes of the model (filgueiras et al. 2012). the intersection of two axe made four quadrants in the model that represent company’s approaches toward csr: the classical view, the socio-economic view, the modern view and the philanthropic view. the classical approach is applied by those organizations whose managers think that there is no reason to invest in social responsibility activities as they do not contribute to profitability. the socio – economic approach recognizes that csr provides some benefits to the organization, such as good customer and supplier relations (liangrong, 2009). the modern view is applied by organizations that are aware of the added value created by responding on societal needs and perceiving net benefits from its csr programs (jamali, sidani, khalil, 2009). saša virijević jovanović, tatjana janovac, dragana nešović 109 the philanthropic quadrant represent the widest approach to corporate social responsibility in which business agrees to show an altruistic and ethical sense of doing something right for society (kaplan, serafeim, tugendhat, 2019). implementing the two – dimensional model of corporate social responsibility in serbian companies – empirical study the aim of this study was to explore the possibilities of measuring the effects of csr on the basis of two dimensional model. the model has been empirically tested on the example of serbian companies in order to demonstrate its application. the survey was conducted from june to august 2019, on a sample of 40 companies in the territory of serbia. the response rate was 82.5% (33 companies). the data were first analyzed by descriptive statistics. then the factor analysis method was applied, which allowed finding simpler data structures. the sample description the sample has included companies with more than 10 employees in the sectors of information and communication, trade, finance and transportation. the respondents in the study were 136 managers and ceos, responsible for csr strategies in the selected companies. regarding the industry of 33 serbian companies that participated in the research, the structure of the sample was the following: finance 19,9% (27 respondents), trade 44,1% (60 respondents), transport 11.8% (16 respondents), information and communication 24,3% (33 respondents), presented in figure 2. frequency percent valid percent cumulative percent valid finance 27 19.9 19.9 19.9 trade 60 44.1 44.1 64.0 transport 16 11.8 11.8 75.7 information and communication 33 24.3 24.3 100.0 total 136 100.0 100.0 figure 2. sample description regarding the type of industry source: author's calculation based on spss the second feature that has described the sample was the number of employees. regarding this feature, the most numerous (28,7%) were the respondents coming from companies that have 30-40 employees (figure 3). frequency percent valid percent cumulative percent valid 10-20 37 27.2 27.2 27.2 20-30 38 27.9 27.9 55.1 30-40 39 28.7 28.7 83.8 40-50 12 8.8 8.8 92.6 >50 10 7.4 7.4 100.0 total 136 100.0 100.0 figure 3. sample description the number of employees in companies source: author's calculation based on spss 110 economic analysis (2020, vol. 53, no. 1, 105-117) instruments and procedures the empirical research was based on the questionnaire, developed by quazi ali m. and o'brien d. it was consisted of 25 statements related to important issues of csr. for each statement, the respondent indicated the degree of agreement, which was presented as a grade from 1 to 5 (meaning: 1 = strongly disagree; 2 = disagree; 3 neutral; 4 = agree and 5 = strongly agree). in interpreting the obtained data spss program was used, with its functions of descriptive statistics and factor analysis. results the survey indicated that the majority of respondents recognizes the significance of corporate social responsibility application. more than 90% of respondents consider (strongly agree 26, 5% and agree 64%) that social responsibility presents and important factor for competing in the market. figure 4 shows the descriptive statistics of respondent’s answers regarding positive statements about csr. the arithmetic means of their answers were higher than 4, which corresponds to the highest grades from likert scale. n minimum maximum mean std. deviation the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution 136 1 5 4.11 .696 social responsibility is an effective basis for competing in the market 136 3 5 4.17 .578 business should realize that it is a part of the larger society and therefore it should respond to social issues 136 3 5 4.26 .561 contributing to the solution of social problems can be profitable for business 136 3 5 4.20 .569 corporate social action programs can help build a favorable image for a business. 136 3 5 4.20 .499 valid n (listwise) 136 figure 4. descriptive statistics of respondent’s answers regarding positive statements about csr source: author's calculation based on spss and quazi and o'brien’s model in general, respondents' answers were ranked between two extremes: managers who see business as a part of the larger society, which is therefore not limited on its economic role, and managers who consider social responsibility acts as a cost disadvantage. however, the majority of respondents had positive attitudes toward the concept of csr, which could be classified within the modern quadrant in two-dimensional model of csr. the greatest heterogeneity in respondent’s answers was obtained in the statements regarding the issues of csr regulation, the role of business in society as well as the costs of csr programs. at the same time, those were the questions on which respondents answered negatively toward the concept of corporate social responsibility. figure 5 illustrates respondent’s answers regarding the statement that business can avoid further regulation by adopting social responsibility programs. saša virijević jovanović, tatjana janovac, dragana nešović 111 frequency percent valid percent cumulative percent valid strongly disagree 13 9.6 9.6 9.6 disagree 24 17.6 17.6 27.2 neutral 37 27.2 27.2 54.4 agree 40 29.4 29.4 83.8 strongly agree 22 16.2 16.2 100.0 total 136 100.0 100.0 figure 5. respondent’s answers on question “business can avoid further regulation by adopting social responsibility programs” source: author's calculation based on spss and quazi and o'brien’s model frequency percent valid percent cumulative percent valid strongly disagree 23 16.9 16.9 16.9 disagree 61 44.9 44.9 61.8 neutral 27 19.9 19.9 81.6 agree 22 16.2 16.2 97.8 strongly agree 3 2.2 2.2 100.0 total 136 100.0 100.0 figure 6. respondent’s answers regarding the statement “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business” source: author's calculation based on spss and quazi and o'brien’s model also, it should not be ignored that 18, 4% of respondents consider that social involvement may be suicidal for the marginal firm advantage (figure 6). in order to analyze attitudes towards csr in more detail, we have selected the variables that had the greatest heterogeneity in answers and subjected them to the method of factor analysis. the data was tested with kaiser-meyerolkin (kmo) test in order to measure the suitability for structure detection. bearing in mind that the result was 0.754, which was higher than the proposed minimum of 0.6, we have concluded that the data was suitable for the factor analysis (figure 7). kaiser-meyer-olkin measure of sampling adequacy. .754 bartlett's test of sphericity approx. chi-square 260.546 df 28 sig. .000 figure 7. kmo and bartlett's test of the selected sample source: author's calculation based on spss 112 economic analysis (2020, vol. 53, no. 1, 105-117) r eg u la ti o n i s n o t su ff ic ie n t to e n su re b u si n e ss b eh a v es i n a s o ci al ly r es p o n si b le w ay a b u si n es s th at i g n o re s so ci al r es p o n si b il it y m ay h av e a co st a d v a n ta g e o v er a b u si n e ss th at d o es n o t s o ci al i n v o lv em en t m ay b e su ic id al f o r th e m ar g in al f ir m , f o r th e h ig h c o st s in v o lv ed m ay t h ro w i t o u t o f b u si n es s b u si n es s is p ri m ar il y a n e co n o m ic in st it u ti o n a n d i t is m o st s o ci al ly r es p o n si b le w h en i t at te n d s st ri ct ly t o i ts e co n o m ic in te re st s it i s u n fa ir t o a sk b u si n es s to b e in v o lv e d i n so ci al r es p o n si b il it y p ro g ra m s as i t is al re a d y d o in g t o b y c o m p ly in g w it h s o ci a l re g u la ti o n s b y t ra n sf er re d t h e co st o f so ci al i n v o lv e m e n t to s o ci et y , b u si n es s m a y w e ak en i ts i m ag e w it h t h e p u b li c t h e in cr e as in g i n v o lv em e n t o f b u si n es s in so ci al r es p o n si b il it y m a y l ea d t o i n cr e as in g ex p ec ta ti o n s o f so ci et y a s to t h e b u si n es s co n tr ib u ti o n b u si n es s ca n a v o id f u rt h e r re g u la ti o n b y ad o p ti n g s o ci al r es p o n si b il it y p ro g ra m s c o rr el at io n regulation is not sufficient to ensure business behaves in a socially responsible way 1.000 -.361 -.318 .223 -.210 -.215 .141 .225 a business that ignores social responsibility may have a cost advantage over a business that does not -.361 1.000 .751 -.208 .512 .428 -.099 -.261 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business -.318 .751 1.000 -.134 .530 .482 -.076 -.158 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests .223 -.208 -.134 1.000 .019 -.032 .152 .235 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations -.210 .512 .530 .019 1.000 .301 .123 -.147 by transferred the cost of social involvement to society, business may weaken its image with the public -.215 .428 .482 -.032 .301 1.000 -.015 -.198 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution .141 -.099 -.076 .152 .123 -.015 1.000 .197 business can avoid further regulation by adopting social responsibility programs .225 -.261 -.158 .235 -.147 -.198 .197 1.000 figure 8. correlation matrix source: author's calculation based on spss and quazi and o'brien’s model in order to find correlation coefficients between variables, we have used correlation matrix from spps program, presented in figure 8. the results indicated significant number of correlation coefficients higher than 0,3. the strongest correlation (0,751) was determined between the variables “social involvement may be suicidal for the marginal firm, for the high saša virijević jovanović, tatjana janovac, dragana nešović 113 costs involved may throw it out of business” and “a business that ignores social responsibility may have a cost advantage over a business that does not”. figure 9 represents the communalities that indicate the amount of variance in each variable that is accounted for. initial extraction regulation is not sufficient to ensure business behaves in a socially responsible way 1.000 .583 a business that ignores social responsibility may have a cost advantage over a business that does not 1.000 .772 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business 1.000 .699 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests 1.000 .654 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations 1.000 .682 number of employees 1.000 .614 by transferred the cost of social involvement to society, business may weaken its image with the public 1.000 .653 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution 1.000 .639 business can avoid further regulation by adopting social responsibility programs 1.000 .405 extraction method: principal component analysis. figure 9. communalities source: author's calculation based on spss and quazi and o'brien’s model the table of total variance explained (figure 10) shows that two factors have eigenvalues greater than 1. together, they account more than 53% of the variability in the original variables. component initial eigenvalues extraction sums of squared loadings total % of variance cumulative % total % of variance cumulative % 1 2.883 36.040 36.040 2.883 36.040 36.040 2 1.387 17.337 53.377 1.387 17.337 53.377 3 .860 10.756 64.132 4 .792 9.904 74.037 5 .721 9.013 83.049 6 .687 8.584 91.633 7 .434 5.424 97.058 8 .235 2.942 100.000 extraction method: principal component analysis. figure 10. total variance explained source: author's calculation based on spss and quazi and o'brien’s model the eigenvalues and component numbers are presented on a scree plot in figure 11. the diagram shows that the last big drop occurs between the two and three components. 114 economic analysis (2020, vol. 53, no. 1, 105-117) figure 11: scree plot source: author's calculation based on spss component 1 2 regulation is not sufficient to ensure business behaves in a socially responsible way -.550 .292 a business that ignores social responsibility may have a cost advantage over a business that does not .864 .079 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business .846 .202 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests -.290 .610 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations .656 .429 by transferred the cost of social involvement to society, business may weaken its image with the public .632 .190 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution -.151 .658 business can avoid further regulation by adopting social responsibility programs -.426 .479 extraction method: principal component analysis. a. 2 components extracted. figure 12. component matrix source: author's calculation based on spss and quazi and o'brien’s model figure 12 shows component matrix with the loadings of eight variables on the two factors extracted. the first factor is highly associated with the statements “a business that ignores social responsibility may have a cost advantage over a business that does not” and “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business”. the second corresponds most strongly to the variables “the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution” and “business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests”. the findings indicate that the variables related to the cost issues of csr programs were grouped into one factor, while the variables related to the social dimension of business were grouped into second factor. these results are in accordance with the basic principles of two dimensional csr model, which implies a social perspective and the cost / benefit ratio. saša virijević jovanović, tatjana janovac, dragana nešović 115 component 1 2 social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business .858 a business that ignores social responsibility may have a cost advantage over a business that does not .816 it is unfair to ask business to be involved in social responsibility programs as it is already doing to by complying with social regulations .794 by transferred the cost of social involvement to society, business may weaken its image with the public .659 the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution .685 business is primarily an economic institution and it is most socially responsible when it attends strictly to its economic interests .680 business can avoid further regulation by adopting social responsibility programs .593 regulation is not sufficient to ensure business behaves in a socially responsible way -.357 .448 extraction method: principal component analysis. rotation method: oblimin with kaiser normalization. a. rotation converged in 5 iterations. figure 13. pattern matrix source: author's calculation based on spss and quazi and o'brien’s model the rotated solution indicated the existence of a simpler structure (figure 13), with both components having significant factors. the interpretation of the components is consistent with the statement that the largest number of respondents' negative answers regarding csr referred to two issues: social perspective of business and the costs of csr programs. conclusion this research has emphasized the importance of using the methodology in measuring corporate social responsibility. therefore, the paper has analyzed the application of twodimensional model of csr that belongs to the category of socio economic models, and represents two approaches towards csr, a social perspective and the cost / benefit ratio. when selecting a model of csr, we have also had in mind its possibility of application in different cultures and industries. the research was conducted in 33 serbian companies on a sample of 136 respondents (managers and ceos). the survey indicated that the respondent’s opinions are divided between two extremes: companies oriented toward long-term goals, which show interest in society and companies that focus on short-term, purely profit-oriented goals, which take a negative stance on csr. the greatest heterogeneity in respondent’s answers was obtained in the statements regarding the issues of csr regulation, along with the stands toward the costs of csr programs. however, the survey indicated that the majority of respondents realizes the importance of creating the added while responding on societal needs and perceiving net benefits from its csr actions. in that terms, the answers correspond with the modern quadrant in two-dimensional model of csr. in order to further data processing, the factor analysis method was applied. the suitability of applying this method was confirmed by kaiser-meyer-olkin test, with a result of 0.754. the analysis included eight variables with the largest differences in responses. the correlation matrix indicated a significant number of positive correlation coefficients. the strongest 116 economic analysis (2020, vol. 53, no. 1, 105-117) correlation (0,751) was determined between the variables “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business” and “a business that ignores social responsibility may have a cost advantage over a business that does not”. by applying the method of principal component analysis two components were identified. the first factor was highly associated with the variables “a business that ignores social responsibility may have a cost advantage over a business that does not” and “social involvement may be suicidal for the marginal firm, for the high costs involved may throw it out of business”. the second corresponded most strongly to the variable “the increasing involvement of business in social responsibility may lead to increasing expectations of society as to the business contribution”. finally the research resulted in defining pattern matrix, that presented simpler structure with two components having significant factors. the interpretation of the components is consistent with quazi and o'brien’s approach which is based on two dimensions: social perspective of business and the costs of csr programs. references bittar-godinho, j., and masiero, g. 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(1991).” corporate social performance revisited”. academy of management review, 16(4): 691-718. article history: received: november 1, 2019 accepted: december 10, 2019 implementation of two – dimensional model of corporate social responsibility in serbian companies saša virijević jovanović115f* | tatjana janovac1 | dragana nešović2 introduction corporate social responsibility concept – theoretical background measuring corporate social responsibility the two – dimensional model of csr implementing the two – dimensional model of corporate social responsibility in serbian companies – empirical study the sample description instruments and procedures results conclusion references microsoft word 2010_1_2.doc scientific review foreign direct investment and global economic crisis ślusarczyk beata*, czestochowa university of technology, the management faculty, czestochowa, poland udc: 339.727.22 jel: 016 abstarct – in the article author defines globalization its features and effects. furthermore, it presents the characteristics of foreign direct investment with its crucial role in the process of globalization and development of national economies. then author discuss the reasons of the latest world economic crisis and its dissemination all over the world. in the light of economic crisis the article presents the role played by foreign direct investment in global economy. author also presents changes in the juxtaposition of top sources and influx countries of foreign direct investment. finally, author considerate government actions accelerating influx of foreign direct investment. globalization of world economy and foreign direct investments contemporary world economy is completely different from the economy of twenty or thirty years ago. one of the most important differences is the intensification of the process of globalization. this trend results in the widening influence of international capital on national economies and the changing characteristics of company operation. the location of production plants, research and development, as well as other activities of companies more and more often becomes independent of the existing national borders. (buiter, lago, stern 1997; nowicka-skowron, kot 2003) globalization is not a new phenomenon; it was a long time ago that people and corporations began to engage in long distance trading. what is more, for thousands of years people have invested into economic enterprise in foreign countries. actually, the waves of globalization observed nowadays are very similar to those observed in the past. however, the politics and technological development of the last several decades has caused an extraordinarily accelerated development of foreign trade, cross border investments and migration of population in comparison to what was observed in the past. for instance, since 1950 the value of world trade has increased twenty times, and the value of foreign investments between the years 1997 and 1999 nearly doubled, increasing from $468 billion to $827 billion. having these facts in mind, thomas friedman summarized the present wave of globalization with the words “further, faster, cheaper and deeper.” (friedman 2002) globalization is defined in a variety of ways. according to a. szymański, “the process of globalization refers to the increase in free flow of capital, goods and production factors among countries. thus, it is a gradual disappearance of economic borders and a sharp quality improvement in the mobility of production factors.” (szymański 2001) * armii krajowej 19b, 42-200 czestochowa, poland, e-mail: jagoda@zim.pcz.czest.pl ślusarczyk, b., fdi and global economic crisis, ea (2010, vol. 43, no. 1-2, 134-141) 135 g. gierszewska and b. wawrzyniak define globalization as “the process of changing the national perspective from which one views the rules and regulations of conduct, occurrences, behavior, activity, and principles held, into a global perspective [translation mine].” (gierszewska, wawrzyniak 2001) globalization can be defined as the process of interaction and integration among people, enterprises and governments of various countries, a process shaped by international trade and supported by information technology, and influencing the environment, culture, political systems, economic development, and the quality of life of societies all over the world. (www.globalisation101.org) regardless of a definition of and an approach to the phenomenon of globalization (e.g. j.a. scholte describes it as a five-dimensional phenomenon (scholte 2005)) it can be proved that globalization functions within two main spheres: economic and social one. the first of these comprises finance, technology (in connection with research and development as well as the knowledge-based economy), market and market strategies (especially competition). as for the social sphere, it comprises culture, lifestyle, consumption models, management, legal regulations, and also political concepts. (pakulska, poniatowska-jaksch 2008) on the other hand, a. zorska points out the following characteristic features of globalization (zorska 2007): • in the sphere of foreign direct investments (fdi) there have occurred the changes in the structure of their branches and geography, and all over the world there has been recorded an increase of their share in general gross investment expenditure with reference to fixed assets; • the expansion of the process of globalization is possible due to an intensity of international connections within branches and sectors of industry, etc.; • the range of forms of steady cooperation between companies is widening (joint venture, strategic alliances) in all value chain links and the partnership enterprises in the international market; • the number and significance of transnational corporations is growing in the economic structures of the world, entailing the change of relations between the state and the corporations (more and more often corporations influence the decisions of governments in particular countries). these are the foreign direct investments that play a crucial role in the process of globalization, at the same time supporting the development of national economies. the flow of capital in the shape of fdi facilitates an access to technologies, know-how and management skills, accelerating the integration of national economies with international markets, production and distribution networks, and strengthening the international competition of companies and whole national economies (unctad 2002). foreign direct investment (fdi) is the most advanced way of entering foreign markets, being an international transfer of capital in order to open an affiliated company in another country and exercise control over it. first of all, fdi is about capital investments, but also about intra-company re-invested profits and loans. the word “direct” indicates that the foreign investor has an influence over the activity of a company abroad. this fact differs fdi economic analysis (2010, vol. 43, no. 1-2, 134-141) 136 from a portfolio investment, which does not make it possible to influence the activities of companies abroad. (pakulska, poniatowska-jaksch 2004) foreign direct investment is a type of investment which entails long-term relationships and continuous involvement and control of an entity which has its headquarters in one of the national economies towards another entity, which has its headquarters in another country. in the case of fdi the investor can directly influence the management of a company in another country. the invested capital amounting to 10% of shares constitutes a defining feature of a fdi (unctad 2004, kot 2006). foreign direct investment is not only a simple transfer of financial capital aiming solely at making profit within the framework of the global company strategy. it is more accurate to say that the financial capital constitutes an instrument which renders it possible to transfer across borders a set of production factors in order to exploit them in a more effective manner, and also facilitates making a better use of competitive advantage in the foreign market. thus, apart from the transfer of capital, there takes place also the transfer of technology, knowledge, management methods and the marketing. there can be distinguished two basic forms of foreign direct investment: (krzak 2005) • greenfield investments (independently starting new operational facilities from the ground up); • brownfield investments (taking over an already existing company and restructuring it, or a cooperation with a local partner in the form of a joint venture enterprise). greenfield investments are characteristic of developing countries and consist in a foreign investor building new facilities from the ground up in the host country. each country looks forward to greenfield investments, since this type of investments entails increasing production assets and creating new jobs (assuming that the national competition is not eliminated in this way). (krzak 2005) on the other hand, brownfield investments in the shape of mergers and takeovers are a dominating form of investment in developed countries and usually take place when the controlling interest in one business entity is acquired by another business entity, or when two entities, situated in two different countries, agree to join their activities. if the invested capital is utilized to purchase the already existing assets, there follows modernization and more rational organization of work. foreign direct investment at the time of global economic crisis the still growing economic, financial and social interdependencies which result from globalization have twofold consequences. on the one hand, these consequences are positive: influx of foreign capital, scientific and technological development, expansion of potential customers’ market, increasing effectiveness of economic activities, investment boom, and economic growth. on the other hand, a disadvantage of globalization is the fact that national economies become very sensitive to economic fluctuations in geographically distant regions. this is especially noticeable in the sphere of finance. the present world economic crisis has its roots in the subprime mortgage loans. over the years of economic boom, the intermediaries responsible for organizing mortgage loans, given the incentive of high commissions, persuaded the people with small loans to accept mortgage loans with low ślusarczyk, b., fdi and global economic crisis, ea (2010, vol. 43, no. 1-2, 134-141) 137 upfront fee or no upfront fee, and without checking out the loans. a serious crisis in the field of subprime mortgage loans started in july 2007, with the bankruptcy of two hedge funds (making their profit on small disparities in the exchange rate of various currencies) of the american investment bank bear stearns (the economic times, 2008). the world economic market has undergone considerable change since 2007, when the continuous noninflationary growth took place. as was forecast, the year 2008 proved that the crisis was endangering not only american economy, but world economy as well. (sachs 2008) towards the end of summer 2008 it seemed that the influence exercised by growing prices of energy would be diminished and the slumping economy was on its way to recovery. however, the autumn of 2008 brought a series of various interdependent upheavals. the improvement in housing economy triggered off credit crunch and continuous drop of stability in the financial market, combined with the threat of increasing inflation, dramatic fluctuations in the price of petroleum, and raising prices of goods accelerated by the weakening of american dollar. the results of all these factors became even more severe with a sudden rise in food prices (committee on economic… 2008). between september 2008 and march 2009 the economy was receding at the pace of 5.5%. financial institutions lost trillions of dollars, euros and french franks. financial liquidity of a majority of institutions became threatened and the stock exchanges suffered severe drops. central banks provided the support of hundreds of trillions worth, and the scope of their intervention was not limited to supporting markets but also included preventing the bankruptcy of individual institutions. according to the forecasts of a majority of economists, the crisis had to influence mainly “ripe” economies, such as the ones found in western europe, since they were tightly connected financially with the usa. however, in reality the crisis has made an impact on the whole world. (jahnson 2008) one of the results of the crisis in the mortgage market in 2007 in the usa was the unprecedented influx of investment funds into developing markets and markets which were undergoing a transformation. in september 2007, the funds investing money in the frontier markets gathered 15.7 billion dollars net from the investors. this was the largest sum in the history of this type of investment. between early september and 25th october 2007, the funds in question gathered nearly 34 billion dollars, i.e. more than during the whole 2005 and 2006. (jóźwik 2007) therefore, it can be concluded that in 2007 there already took place another increase in portfolio investments. the funds which attract the most money of the investors are especially those which invest in asia, latin america, and specialize in bric countries (brazil, russia, india, china), and are global emerging funds. the year 2006, when the tendency for growth was observed, was actually the third year in a row of the increase in foreign direct investment, the situation being a worldwide phenomenon (unctad 2007). in 2006, the considerable influx of foreign direct investment (fdi) amounted to usd 1.3 trillion, which meant the increase by another 38% in comparison with 27% in 2004 and 29% in 2005, as well as reaching the level close to that observed in 2000, when the record value of 1.3 trillion dollars was set up for fdi. the influx of fdi was noticeable in all major subregions: in developed countries, developing countries, and in countries undergoing transformations, i.e. in southeastern europe and in the commonwealth of independent states. the growth tendency discussed above has been present throughout the last 26 years. however after uninterrupted growth in fdi activity in economic analysis (2010, vol. 43, no. 1-2, 134-141) 138 the period 2003–2007, global fdi inflows fell by 14% in 2008 to $1,697 billion, from a record high of $1,979 billion in 2007 (see figure 1). figure 1. fdi influx worldwide and in particular groups of economies, 1980-2008 (bln usd) 0 200 400 600 800 1000 1200 1400 1600 1800 2000 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 developing economies developed economies transition economies source: author’s elaboration based on unctad fdi/tnc database fdi flows fell further as the financial crisis entered a tumultuous new phase in september 2008 following the collapse of lehman brothers (one of the largest financial institutions in the united states), and as major developed economies fell into, or approached, economic recession. in contrast, developing and transition economies saw fdi inflows rise in 2008 to record levels for both. worldwide foreign investment reached the value of usd 12 trillion; the type of investment in question was made mainly by transnational corporations (tnc). the group of transnational corporations comprised about 82 000 parent companies and 810 000 foreign affiliate companies. (wir 2009) according to business forecasting, the turnover, value added and export of the tnc in 2006 increased by 18%, 16% and 12% respectively. while the influx of fdi into developed countries increased by 45% and reached the value of usd 857 bln, the influx into developing countries amounted to usd 379 bln (21% increase), and the influx into economies undergoing a transformation amounted to usd 69 bln (68% increase), reaching the highest level in history. however, the international stature of tnc has not insulated them from the worst global recession in a generation. the 4.8% reduction in inward fdi stock worldwide was reflected in the decline in value of gross product, sales and assets, as well as employment of tncs’ foreign affiliates in 2008, a marked contrast to huge doubledigit growth rates in 2006 and 2007. the united states regained the leading position with reference to the influx of foreign direct investment, leaving behind great britain and france. among developing countries ślusarczyk, b., fdi and global economic crisis, ea (2010, vol. 43, no. 1-2, 134-141) 139 and the countries whose economies were undergoing a transformation, nearly all regions noticed a considerable increase in the influx of fdi in 2006. only in oceania, south america and the south african republic there was an outflow of fdi. in the group of developing countries the influence of fdi was the most significant in china, hong kong (china) and singapore. as for the economies undergoing a transformation, the largest influx of fdi was observed in russia. developed countries still remained the major source of investments (84% of all investments made). in 2006, the largest exporter of foreign direct investments were the united states (usd 217 bln). the usa was followed by the eu countries, i.e. france (usd 115 bln), spain (usd 90 bln) and great britain (usd 79 bln). the role played by developing economies and economies undergoing a transformation as a source of foreign direct investment was still growing. in the group of developing economies, the most important part was played by hong kong (china), with usd 43 bln, and in the group of economies undergoing a transformation the most important role was played by russia, with usd 18 bln. the value of foreign direct investments flowing out of these two groups of countries amounted to usd 193 bln, i.e. 16% of the overall world outflow of fdi. united states stayed still on the top fdi source country all over the world after crisis effects dissemination but there are changes on next places of the juxtaposition of top sources of fdi outflows. there are france, germany, japan and then united kingdom as a main fdi sources (see figure 2). figure 2. developed countries: top 10 sources of fdi outflows 2007-2008 (bln usd) 312 220 156 128 111 86 78 77 68 58 378 225 180 74 275 50 60 96 94 29 0 50 100 150 200 250 300 350 400 united states france germany japan united kingdom switzerland canada spain belgium netherlands 2007 2008 source: author’s elaboration based on unctad fdi/tnc database economic analysis (2010, vol. 43, no. 1-2, 134-141) 140 conclusions governments actions are very important in fdi acceleration, it is especially important in case of crisis. the governments implemented measures accelerating the influx of fdi during 2006 and at the beginning of 2007, however, at this time in some sectors of industry, especially those of “strategic” significance, there were introduced new restrictions with reference to takeover of assets by foreigners, or such measures which assured a larger share of governments in the profits. such tendencies were observed especially in mining industry. in 2006 there were made the total of 147 government decisions making a given country more fdi-friendly, while the 37 government decisions were made to the contrary, in 2008, 110 new fdi-related measures were introduced, of which 85 were more favorable to fdi, compared to previous year, percentage of less favorable measures for fdi remained unchanged (wir 2009). in 2008 and the first half of 2009, despite concerns about a possible rise in investment protectionism, the general trend in fdi policies remained one of greater openness, including lowering barriers to fdi and lowering corporate income taxes. references buiter w., lago r., stern n.: promoting an effective market economy in a changing world, [in:] sabot r., szekely p. (eds): development strategy and management of the market economy, vol. 2, clarendon press/oxford university press, oxford, 1997. committee on economic affairs and development provisional report “oecd and the world economy” july 11th, 2008. development and globalization: facts and figures. united nations, new york and geneva 2004. friedman t. l.: longitudes and attitudes. exploring the world after september 11., farrar, straus and giroux. new york 2002. gierszewska g., wawrzyniak b.: globalizacja. wyzwania dla zarządzania strategicznego, poltext, warszawa 2001. jahnson p.: americans should mount their blessings. forbes, june 30, 2008. jóźwik t.: pieniądze płyną na rynki wschodzące, forbes 12/2007. kot s.: global trends in foreign direct investment, [in:] kościelniak h (ed): processes of capital supply in production enterprises, wyd. wzpczęst częstochowa 2006. krzak m.: źródła wzrostu. forbes 12/2007. nowicka-skowron m., kot s.: logistic aspects of the economyʹs globalization and integration [in:] r. borowiecki (ed): management of organizations during economic integration and globalization, wyd. ae kraków, warsaw-cracow 2003. pakulska t., poniatowska-jaksch m.: korporacje transnarodowe a globalne pozyskiwanie zasobów, oficyna wydawnicza sgh, warszawa 2009. pakulska t., poniatowska-jaksch m.: bezpośrednie inwestycje zagraniczne w europie środkowowschodniej. koncepcja kapitału zagranicznego w polsce, oficyna wydawnicza sgh, warszawa 2004, sachs j.: ameryka w końcu zapłaci swoje rachunki. europa nr 14 (209), 2008. scholte j.a., globalization: a critical introduction, palgrave macmillan; 2rev ed edition 2005. szymański a.: globalizacja, wyzwania i zagrożenia, difin, warszawa 2001. the development dimension of foreign direct investment: policies to enhance the role of fdi, in the national and international context – policy issues to consider, united nations conference on trade and development, washington dc, 23 september 2002. the economic times: global financial crisis: the story so far. september 21, 2008. ślusarczyk, b., fdi and global economic crisis, ea (2010, vol. 43, no. 1-2, 134-141) 141 world investment report 2009, transnational corporations, agricultural production and development. united nations, new york and geneva, 2009. www.globalisation101.org zorska a., korporacje transnarodowe. przemiany, oddziaływania, wyzwania, pwe, warszawa 2007. received: 15 january 2010 article history: accepted: 21 april 2010 ea_2013_3-4 finalna ver preliminary reports inflation, market structure and globalization. a sectoral study for mexico benita maldonado francisco javier, monterrey institute of technology, department of system & industrial engineering, mexico1 udc: 339.137.2(72) ; 336.748.12 ; 339.56(72) jel: c23, d4, e31 id: 203725068 abstract – this article discusses the importance of market structure as a determinant of inflation. the research analyzes part of those called „necessary structural reforms” announced in recent years in mexico. taking into account the long tradition in openness generated in recent decades, i capture the sectoral level differences between openness and competition by considering 15 of 23 manufacturing sectors into the oecd industrial classification over the period 1990-2009. estimations using panel data models shows that openness has a positive effect on inflation, this is, firms that import the most tend to increase the costs on their final products. however, inflation decreases when market competition increase. key words: inflation, market competition, trade openness, mexico introduction researchers commonly conclude that mexico's slow growth, despite its reforms, is a consequence of its inefficient financial system and lack of contract enforcement. hence, in recent years, the mexican government has tried to implement a series of economic reforms to strengthen the country's fundamentals and increase its ability to cope with external shocks. the return of the institutional revolutionary party (partido revolucionario institucional, pri) to the presidency, after twelve years out of power, promises an agenda of free enterprise, efficiency and accountability. this new government is pushing for reforms that could bring major new private investment; re-configure the labor market; promote the educational development; break with monopolistic markets and a banking reform bill to boost growth and lending. because of the progress that has been made, the government is confident that mexico will be able to leave recent crisis behind and start the new agenda with a stable and growing economy. thus, the aim of this article is to evaluate how the market competition structure as well as the globalization (openness trade) influences the behavior of inflation dynamics. identifying this relationship, it is possible to reason about potential reform impacts on the competitive structure may have on the price level. this paper offers the first empirical evidence for the role of market competition and openness in explaining inflation in mexico. since mexico is one of the most liberal of the medium sized economies in the world, the domestic price level cannot remain immune to external shocks. consequently, this paper 1 ave. eugenio garza sada 2501 sur, monterrey, nl. 64849, mexico. e-mail <francisco_benita@hotmail.com>. benita, m.f.j., inflation, market structure, ea (2013, vol. 46, no, 3-4, 26-36) 27 provides an overview of key aspects in how those called necessary structural reforms impact in mexican economy. the document, empirically explores the effect of market structure and openness on inflation using panel data for manufacturing sectors over the period 1990-2009. the study recognizes that market structure changes can take place independently of the effects of globalization, and so can productivity changes. in addition to the analysis related to trade openness, this study shows that, increased globalization is still found to increase inflation, suggesting that globalization can affect inflation through other channels beyond trade-related channels. this particular outcome is an interesting result, helpful to policy makers, in order to measure the influence of openness on the price levels. this article is organized as follows. the first section reviews the background for this research by pointing out the methodological issues involved in measuring inflation, market competition and trade openness. empirical model specification for analyzing this process is defined in the second section. the third section presents the results of the analysis. final section concludes the paper. background the effect of inflation on economic performance is a complex topic. it is important, because if the inflation has real effects, governments can influence economic performance through monetary policy. thus, there is a little theoretical consensus on how inflation affects economic performance; several empirical works look for a negative influence of inflation on growth. in the aftermath of important inflationary episodes in developed countries during the late 1970s and early 1980s, the mainstream economics concluded that inflation was one of the major burdens to economic growth. therefore, the best policies to follow were to struggle against it; consequently, the autonomy of central banks would become the key factor for economic growth in the long run. classical dichotomy claims there are no real long run effects coming from demand shocks or expansionary demand policies. typically, a central bank can carry out a combination of three main functions. first, it might have a macroeconomic function both through the exercise of a discretionary monetary policy which affects price levels and, in some cases, through its exchange rate policy. second, it might have a sector-level and microeconomic function of providing support and regulatory and supervisory services oriented towards maintaining the health of the banking sector. third, the central bank often has a special relationship with the state and can carry out several secondary functions, among which acting as its banker and fiscal agent, or its economic consultant. three conditions have been identified by the economic literature that requires governmental intervention through some form of regulation. the first condition is related to the possible existence of natural monopolies and is generally considered to bear scarce relevance for the case of financial service regulation. the second condition relates to the possible existence of externalities due to financial and banking crisis; the potential negative consequences for the whole sector have been advocated to justify regulations in support of the system. finally, the last condition involves information asymmetries between the seller (who has more information) and the investor (papi, 2005). economic analysis (2013, vol. 46, no. 3-4, 26-36) 28 however, the inflation concept has been an interesting topic for both, economic theory and public policy. according to the standard time-inconsistency theory (kydland and prescott, 1977; barro and gordon, 1983), discretionary policymaking has an inflationary bias. this leads to the proposition that greater central bank independence reduces inflation (rogoff, 1985), and its empirical relevance is a subject of much research: cukierman (1992) provides a valuable comprehensive analysis of central bank decisions, of the various effects of policy on inflation, and of the feedback from inflationary expectations to policy choices; alesina and summers (1993) investigates whether one can find a correlation between central bank independence and the level and variability of real economic variables such as growth, unemployment, and real interest rates concluding that central bank independence promotes price stability; campillo and miron (1997) explain the differences in inflation performance across countries finding that institutional arrangements play almost no role in determining inflation outcomes. thus, central bank independence and the nature of exchange rate arrangements are not empirically important determinants of inflation rates; fuhrer (1997) takes a critical look at the theory of inherent inflationary bias and the proposed solutions to the bias, focusing particularly on mechanisms for ensuring central bank independence and on inflation targeting. it then examines the robustness of the empirical results that are often used to support the validity of the solutions. finally brumm (2000) presents evidence purporting to show that if an inflation regression equation is expanded to include not only their proxy for central bank independence but other regressors as well, then the negative correlation between inflation and central bank independence vanishes. the empirical evidence from 1990s based on theoretical precepts from 1980s, proved to be an important reference in order to re-configure the measures of monetary policy, especially in developing countries such as mexico2. therefore, central bank's strategy (3) was limited inflation targeting (mexico's case in particular). as a nominal anchor for monetary policy with a public and explicit commitment to maintain economic discipline, inflation targeting is being promoted as a general framework in order to reduce and control the inflation rate, improve predictability, accountability and transparency (sheridan, 2001). it is also argued to improve the output-inflation trade off (clifton, leon and wong, 2001), as well as to reduce output variability (svensson, 1997). on the other hand, with the global economy being increasingly integrated and having soaring cross-border trade and capital flows, much attention has been directed in recent studies to examining the effects of trade openness on inflation. it is possible to identify two main approaches. borio and filardo (2007) and ball (2006) argue that the inflation rate that the monetary authorities consciously aim at may not be independent of the real structure of the economy. for example, more flexible labor markets and nominal wages may lower the 2 from 1970s through the mid-1990s the economy lurched from one crisis to another, its monetary and fiscal framework a source of instability that impeded long-term growth. by adopting best practices in central banking later 1990s, mexico began installing a framework that has proven remarkably successful. 3 although an historical outline of the bank of mexico shows different modalities, or levels, of autonomy. the current one is called “institutional autonomy”, based on a constitutional mandate that determines the central bank’s functions, a self-governing directive body, and administrative and budget independence (turrent y díaz (2007). benita, m.f.j., inflation, market structure, ea (2013, vol. 46, no, 3-4, 26-36) 29 costs of bouts of deflation, and hence allow the authorities to aim for more conservative inflation rates. likewise, more competitive goods and services markets may reduce the incentive for monetary authorities to resort to „surprise inflation” as a means of keeping output or employment above its „equilibrium” level. also, the authorities may have less than full control over the inflation dynamics over short term horizons. central banks may not have the appropriate „model” of the economy, may be unable to identify accurately the sources of the forces affecting it and/or may be unable to offset them completely. finally, across currency areas, exchange rates may fail to fully reflect inflation conditions. in steady state, as a first approximation, differences in desired inflation rates by those central banks setting policy in the various areas will translate into differences in the rates of change of exchange rates across them. in the approach of rogoff(2003), sachsida, galrão and loureiro (2003), loungani and razin (2005), helbling, jaumotte and sommer (2006), pain, koske and sollie (2006), cox (2007) and sbordone (2008) it is arguable that the market structure influences the levels of inflation notoriously, hence, the market power increases the product's value. the role of product market reforms in achieving the objective of higher and sustainable noninflationary growth has recently received a lot of attention amongst policy makers and academics. the economic literature has explored quite extensively the link between product market competition and the price level, concluding that higher competition leads to a lower price level. hence, the basic channel emphasized both in policy debates and empirical studies as potential carrier of globalization effects on inflation dynamics is trade integration, which especially when accompanied by policy incentives, is argued to bolster competition. increased competition, the argument goes, creates two effects: a direct effect of containment of costs, by restraining increases in workers’ compensations and reducing real import prices, and a second, indirect effect of creating pressure to innovate, which contributes to increasing productivity. higher productivity in turn further lowers production costs: if markups are constant, lower production costs reduce the pressure on prices. drawing on this literature, this paper utilize the deflators of manufacturing industries as inflation rates following the works such neiss (2001), cavelaars (2003) and binici, cheung and lai (2012). the investigation of the relationship between product market competition and inflation is however less prominent in the literature and represents the focus of this paper. concentrating on price levels rates rather than inflation, i am interested in finding possible links between product market competition and price formation which persist for a prolonged period of time. estimation for the mexican case in the 1990s, the country experienced a variety of monetary and exchange rate regimes. empirical and theoretical works (esquivel and razo, 2003 and garcés, 1999) postulated that monetary aggregates, the nominal wages and the exchange rate are the main factors that have the highest impact on inflation. (1) economic analysis (2013, vol. 46, no. 3-4, 26-36) 30 where are the inflation, the monetary supply, the nominal wages and the exchange rate. in all the studies, the relation between the explanatory variables and the inflation are positive. despite the classical theoretical models, as i mentioned above, it is reasonable to assume that these factors are not the only causes which influence the dynamics on the prices. according to binici, cheung and lai (2012), i consider the following function: (2) where includes factors as trade openness and market structure. following sarel (1996) and a khan y senhadji (2001), i transform the inflation rate to logs in order to avoid that the extreme observations distort the regression results. hence, the inflation of sector in year is given by: this function is linear for inflation rates less than unity, and logarithmic for rates larger than unity. this approach is focused on the nonlinearities and threshold effects of inflation on growth. hence empirical research found a significant negative effect of inflation on economic growth and also found that there exists a nonlinear relationship, this transformation is suggested. the log transformation also helps in smoothing time trend in the dataset and provides best fit in panel data regression controlling inflationary gaps among the manufacturing sectors. on the other hand, the price-cost margin (pcm) is used as a proxy for the intensity of market competition. this indicator is a popular measure of market competitiveness where a high pcm suggests a low level of market competition, formally the pcm for the sector in the year is given by: , where va is the value added, lc the labor compensation and ov the value of total output. this proxy for the intensity of market competition has widely been used to measure monopolistic markup (domowitz, hubbard and petersen, 1986; prince and thurik 1992; campa and goldberg, 1995 or boulhol, 2008). the import openness (imo) and the import penetration index (impi) are used in order to capture other effects of globalization not explained by market structure and productivity changes; formally the indicators for the sector i in the year t are given by: and where im and ex are the value of total imports and exports respectively. these variables measures sectors' openness or integration in the world economy. the indicators represent the combined weight of total trade in its economy, a measure of the degree of dependence of domestic producers on foreign markets and their trade orientation (for exports) ant the degree of reliance of domestic demand on foreign supply of goods (for imports). a large share of imports would indicate a greater importance of foreign produces relative to domestic producers, in other words, a higher share of imports in domestic demand would indicate stronger import competition in the sector. in addition, i consider the usual economic factors as the logarithm of gdp per capita to control for the potential impact of a country economic development on inflation; the growth benita, m.f.j., inflation, market structure, ea (2013, vol. 46, no, 3-4, 26-36) 31 in the exchange rate; the m2 money supply growth as a proxy for stance of monetary policy; and a time dummy variable for the year 1994 which controls the structural change after the economic crisis. using panel data, the empirical relationship between the inflation for sector in year and its possible determinants are given by: (3) where represents the sectoral fixed effects, is a matrix of sector-specific explanatory variables and the random error. the method of panel corrected standard errors is used in order to taking into account the complexity of error process and deal with contemporaneous correlation, panel heteroskedasticity and serial correlation4. the desegregation sectoral-level is given by the oecd structural analysis industry database. this article examines annual data for 15 form 21 total manufacturing sectors over the period 1990-2009. the sectors considered are: 15 food products and beverages; 16 tobacco products; 19 leather, leather products and footwear; 20 wood and products of wood and cork; 21 pulp, paper and paper products; 22 printing and publishing; 23 coke, refined petroleum products and nuclear fuel; 24 chemicals and chemical products; 25 rubber and plastics products; 26 other non-metallic mineral products; 27 basic metals; 28 fabricated metal products, except machinery and equipment; 29 machinery and equipment, n.e.c. (not elsewhere classified); 34 motor vehicles, trailers and semi-trailers and 35 other transport equipment. results figure 1 presents a mapping of the growth rate of inflation over the period 1990-2009 as well as the average of pcm, imo and impi by manufacturing sector. from the figure it is seen a homogeneous process of inflation growth rate (around 0.11), but not on market competition and openness. it is interesting the dynamic of sectors 16, 20, 22 and 26 where the high market concentration is associated with a lower level of openness. on the contrary, the sectors 24, 25, 28, 29 and 35 present the opposite, less market concentration and higher levels of openness. this initial results highlights the key point; the positive relationship between market competition and trade openness. 4 the f-test of fixed effects confirms the joint significance of sectoral effects, and then results of the hausman test favour fixed effects over random effects. results are not included but available upon request. economic analysis (2013, vol. 46, no. 3-4, 26-36) 32 figure 1. sectoral development in inflation, market competition and openness, 1990-2009 source: author's own calculation based on data from oecd structural analysis industry database. as a preliminary exercise figure 2 illustrate trend over time, the value reported is the annual average for each variable. the intensity of market competition reported no significant variation; the values fluctuate around the average, 0.27. this result suggests that in general, market power has not changed significantly in the last two decades5. on the other hand, the trade openness variables present an interesting behaviour; for both of them, the level has increased since the early 1990s. it is remarkable that the levels are lower than the average for the period 1990-1997, they increased markedly since 1997. this perform illustrate the effects of the trade liberalization in mexico from mid-1990s. figure 2. indicators behaviour over time period source: author's own calculation based on data from oecd structural analysis industry database. 5 this, of course, does not imply that in the period the market structure remained relative constant for each sector. in other words, it is possible that it has been modified within sectors. benita, m.f.j., inflation, market structure, ea (2013, vol. 46, no, 3-4, 26-36) 33 table 1 reports the baseline regression results for model specifications. model 1 tries to explain the inflation via market structure, pcm are used as a proxy. models 2 and 3 accounts for the effects of trade openness; imo and impi are included separately. models 4-5 consider market competition structure and trade openness simultaneously, imo is included in 4 and impi in 5. finally, specification 6 includes all variables. table 1. market competition and trade openness; sectoral effect, 1990-2009 model variable 1 2 3 4 5 6 pcm 0.320* 0.537** 0.535** 0.540** (0.173) (0.240) (0.234) (0.241) imo 0.069* 0.139** 0.018 (0.037) (0.060) (0.073) impi 0.121** 0.207** 0.185* (0.058) (0.084) (0.111) log of real per capita gdp 0.957*** 0.951*** 0.943*** 0.934*** 0.924*** 0.925*** (0.143) (0.144) (0.143) (0.139) (0.138) (0.138) exchange rate growth 0.326*** 0.329*** 0.323*** 0.312*** 0.303*** 0.303*** (0.114) (0.114) (0.113) (0.111) (0.110) (0.109) m2 growth 0.007 0.017 0.019 0.014 0.018 0.018 (0.154) (155) (0.154) (0.150) (0.148) (0.148) 1994 crisis -0.167** -0.174** -0.172** -0.165** -0.162** -0.162** (0.081) (0.081) (0.080) (0.078) (0.078) (0.078) note: robust standard errors in parentheses; *** p<0.01, ** p<0.05, * p<0.1. source: author's own estimations. the control variables not only help to account for spurious relationships, they measure the impact of any given variable above and beyond the effects of other variables. in all regressions, the controls have the correct sign and are significant at least at the 5 percent, except the money supply growth. for example, rising in real gdp per capita does indeed raise the prices in manufacturing products, which means that relative demands change with per capita income. in the same line, a fall in the exchange rate growth can cause cost push inflation because it leads to increase in the prices of imported products such as essential raw materials, components and finished products. the not significant coefficient for money supply growth can be explained by the fact that prices did not respond immediately to monetary shocks, suggesting that even the enterprises could anticipate an increase in the money supply; prices did not change instantly, but would take time as labor contracts are renegotiated. models 1 and 2-3 separately show the effect of trade sectoral competitiveness and trade openness, respectively. over all, the results confirm the positive relationship between market structure and inflation; higher market competition tends to be associated with lower inflation (models 1, 4, 5 and 6). note that this relationship is consistent with prominent literature, e.g. economic analysis (2013, vol. 46, no. 3-4, 26-36) 34 binici, cheung and lai (2012) show that inflation decreases as competitiveness, measured by markup, increase. on the other hand the results for models 2-6 overturn the conventional wisdom that there is a negative relationship between trade openness and inflation. the finding suggests that there is a statistically significant positive relationship between openness and inflation meaning that outward orientation is inflationary. the more open the economy, the stronger this effect, and the more costly it is to inflate. this positive relationship is possibly due to the importance of imports in total trade, especially since 1994 (see figure 2). here, however, export demand also affects the terms of trade. this implies that inflation is dependent on export demand and the impact changes in export demand have on inflation depends on the degree of openness. discussion product market reforms are likely to promote a more competitive economic environment. the results suggests that higher product market competition reduces inflation, therefore contributes to a more stable macroeconomic environment, this is likely to be beneficial for growth and would support the policy call needed structural reforms. although on the agenda, initially being considered to spur telecommunications competition as well as provide lending incentives to local banks instead of imposing interest rate guidelines by decree. the plan would also increase the role of the development banks in fostering greater credit availability in mexico’s economy and thus, manufacturing firms benefited from the reforms to the services sectors. despite the fact descriptive statistics present the positive relationship between market competition and trade openness. in other words, manufacturing sectors where the high market concentration is associated with a lower level of openness and the opposite, manufacturing sectors with less concentration and more openness trade. the estimations present statistical evidence for openness as a constraint on policymakers' incentives to deflate. this interesting result, attached to the considerable degree of openness in mexico to foreign trade, indicates that the traditional closed economy explanation for the inflationary process is no longer important. however, the evidence from the empirical literature on trade and inflation is mixed. perhaps more surprisingly, theoretical predictions regarding trade and inflation are also ambiguous. finally, due to the given political situation in mexico, it is essential to consider measures that denote the competitive dynamics of markets and promote productivity of the factors. otherwise the benefits, in terms of inflation targeting, based on openness will not be exploited and used to push economic growth. references alesina, a., and summers, l. 1993. „central bank independence and macroeconomic performance: some comparative evidence.” journal of money, 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nekoliko godina u meksiku. uzimajući u obzir dugu tradiciju u otvorenosti ekonomije koja je generisana poslednjih decenija, razmatran je, na sektorskom nivou, razlike između otvorenosti ekonomije i konkurentnosti u 15 od 23 proizvodna sektora prema oecd industrijskoj klasifikaciji za period 1990-2009 godine. analiza je sprovedena koristeći model panela podataka koji pokazuje da otvorenost zemlje ima pozitivan efekat na inflaciju, što firmama koje uvoze povećava troškove poslovanja, pa samim tim i troškove krajnjeg proizvoda. ujedno, inflacija opada kako se povećava stepen tržišne konkurencije. ključne reči: inflacija, tržišna konkurencija, spoljna trgovina, meksiko article history: received: 18 june 2013 accepted: 29 september 2013 microsoft word 2011_3_4_finalna ver.doc original research paper    studying the effect of foreign direct investment  on economic growth in greater and   traditional middle east countries   behname mehdi*, department of economics of the university of shiraz, iran   udc: 330.322(5‐19);(61)    jel: f21; f43     studija efekta stranih direktnih investicija na ekonomski rast  velikog i tradicionalnog bliskog istoka        abstract  –  this  article  tries  to  study  whether  foreign  investment  in  the  greater  and  traditional middle east leads to economic growth. we have selected 21 countries of this zone for the  time period 1980‐2008. due to lack of endogenous relationship between variables, the two equations  have been estimated separately. fdi affects economic growth directly and  indirectly. indirect effect  means interaction term. infrastructures and economic stability have a special significance in foreign  investment  attraction.  furthermore,  oil  extraction  has  a  positive  effect  on  foreign  investment  attraction and economic growth while technology gap has a negative effect on fdi and gdp variables.    key words: foreign direct investment, economic growth, greater and traditional middle east;  panel data  introduction   after  1980’s,  developing  countries  practiced  some  policies  for  fdi  attraction;  policies  such as giving subsides, decreasing tax, economic stabilization, etc... neoclassical economics  believes that increase of fdi leads to increase of gdp growth per capita. therefore, due to  importance of this criterion, most countries seek to attract fdi today. in the past, foreign  investors were willing to give some advantages for establishing a site in host countries. but  nowadays, everything has changed and it is the host countries which give advantages for  fdi. however, while many studies indicate the positive effect of fdi on gdp, some other  studies prove otherwise. therefore, it seems necessary to conduct this test for the greater  and  traditional  middle  east  countries  in  order  to  find  which  hypothesis  is  true  for  the  middle east.   in this study, effect of fdi on economic growth of the greater and traditional middle  east countries has been studied. the difference of  this study with other studies  is  in  the  statistical sample (greater and traditional middle east) and study of oil extraction effect on  gdp and fdi. oil exporting countries have been considered as dummy variables. the other                                                         * e‐mail: mehdi_behname@yahoo.com; tel‐fax: 00987116276371    economic analysis (2011, vol. 45, no. 3‐4, 35‐43)   36 distinction of this study is its taking into consideration the indirect effect of human capital on  gdp and fdi.   in a recent study of the literature, hanson (2001) concludes that evidence that foreign  direct  investment  generates  positive  spillovers  for  host  countries  is  weak.  aitken  and  harrison’s (1999) in venezuela do not support the positive spillovers hypothesis.  in a review  of  micro  data  on  spillovers  from  foreign‐owned  to  domestically  owned  firms,  gorg  and  greenwood (2002) argued that the effects are mostly negative. borensztein, de gregorio, lee  (1998)  and  xu.,  b.,  (2000)  show  that  foreign  direct  investment  brings  technology,  which  translates into higher growth only when the host country has a minimum threshold of stock  of  human  capital.  lipsey  (2002)  takes  a  more  favorable  view  from  reviewing  the  micro  literature and argues that there is evidence of positive effects.  theoretical issues  until commencement of the globalization process in 1980’s, the developing countries did  not have a positive belief on foreign investment and mostly believed that they had dropped  out the imperialistic from the door but this policy (foreign investment) was trying to enter  from the window. but from 1980’s on, due to abundant advantages of foreign investment in  economy, most of  these countries not only changed  their mind but also sought  to attract  foreign investment by offering attraction policies.   economic growth is one of the indexes very important to all countries of the world and  for growth of which the countries devise many special plans and policies since increase of  economic growth indicates increase of social welfare and increase of the country’s economic  development in long term. in economics, many variables are effective on economic growth;  for instance technology, physical capital, human capital, etc..     meanwhile,  foreign capital  is one of  the variables which bring  the  mentioned growth  under its effect.   foreign  investment  may  affect  economic  growth  in  two  direct  and  indirect  ways.  its  direct effect is that foreign investment increase the level of production, employment, added  value and export. these factors directly increase gdp; for instance, employment increases  the individual’s income and this income increment is directly calculated in gdp. likewise is  for added value and export. on the other hand, foreign investment increases gdp indirectly  as well; for  instance, transition of technology, knowledge and know‐how through  license,  imitation  and  job  training.    besides,  externalities,  technology  spillover,  human  capital  formation,  efficiency  and  productivity  are  the  factors  which  indirectly  increase  gdp  in  economic growth.   in  regard  to  the  relationship  between  fdi  and  economic  growth,  it  is  believed  in  neoclassical economics that fdi only have effects on the level of gdp per capita yt/popt and  not on the rate of economic growth yt – y 1−t  /y 1−t . it means that fdi is not the economic  growth  engine  in  long  term.  in  contrast,  in  the  modern  theory  of  economic  growth  it  is  believed  that fdi affect the  level of production per capita and economic growth (nuzhai  falki, 2008).   although  many of  the  theories  indicate  that fdi  results  in  economic growth  through  some  factors  such  as  transition  of  technology,  technology  spillover  and  increase  of       behname m., studying the effect of fdi, ea (2011, vol. 45, no, 3‐4, 35‐43)   37 productivity, there are other theories which take opposite position. the later theories forecast  that fdi is harmful to resource allocation at presence of preexisting trade, price and other  financial disorders and it decreases economic growth (boyd and smith, 1992). this case is  mostly observed in developing countries. but the main problem of such countries may be in  their weak economic structure; for instance, improper infrastructures, weak human capital,  traditional  and  old  technology,  etc.,  which  does  not  provide  the  capability  required  for  attracting advanced technology and knowledge.   methodology  heterogeneous unit root test     to conduct co‐integration test for the panel data like time series data it is necessary to  perform stationarity test. of course, it should be taken into consideration that panel unit root  test has higher power than time series unit root test.  in order to consider unit root in panel data, the following autoregressive model can be  used:  yit = ρ i yit‐1 + δi xit + ε it                  (1)  where i = 1, 2, …, n indicates the countries and t = 1, 2, …, t stands for time. xit indicate the  exogenous variables,  ρ i indicates autoregressive coefficient, and ε i is the error term. if �pi�  ≤ 1,  ∀ i, the considered series is stationary , and if �pi�= 1, yi has unit root. llc, brt and  hardi unit root tests suppose that  ρ i =  ρ ,∀ i. in this scenario, yit‐1 coefficient is used for all  homogeneous  cross  ‐section.  but  ips  and  fisher  tests  are  conducted  with  supposition  of  heterogeneous coefficient meaning ρ i (costantini, martini, 2010).   since the economic structures of the greater middle east countries are independent from  each other, we use ips test.   im, pesaran test for every sample of cross‐ section data is as follow:   it p j jitijitiiit i yyy ερβα +δ++=δ ∑ = −− 1 1             (2)  where ρ i is the number of lags in adf regression.    the zero and alternative hypotheses are as follow:                                                                  (3)    model   the  model  selected  for  studying  the  effect  of  fdi  on  economic  growth  is  the  model  developed by alfaro et al., (2004), durham, (2007), which is   ⎩ ⎨ ⎧ = ∀= ioneleastatfor sisomefor h h i i ii 0 '0 : ,0: 1 0 pβ β β    economic analysis (2011, vol. 45, no. 3‐4, 35‐43)   38 itititititit xhumfdiyy εβββββ +++++= − 432110  (1)         (4)  where i  is the country’s index, t  is the time index, y in the logarithm of real gdp per capita,  fdi is foreign direct investment, hum is human capital and x is the vector of other variables  which have effect on economic growth  including  inflation,  infrastructure  (telephone  line),  capital formation, population growth, technology gap, dummy variables or interactions.    technology  gap is gapit = yimax – yit / yit where gdp per capita of iran country has been  considered as the maximum gdp. inflation can be a proxy for economic stability (barro and  sala‐i‐marin, 2004, p.520). number of telephone lines has been used as infrastructure proxy.  the coefficients of human capital, infrastructure, and fixed capital formation are expected to  be positive since these variables attract foreign investment.     since we consider the model to be endogenous, the following equation indicates the  effect of growth on fdi:  itititititit xhumfdiyfdi μααααα +++++= − 432110         (5)  results and data  data  the data set includes 21 countries of greater and traditional middle east throughout the  period 1980‐2008.   the data required for fdi has been collected from unctad, imf and world investment  report. the national accounts data such as growth per capita and inflation has been collected  from growth data resources. number of telephone lines, human capital, population, etc.,  have been collected from undata, wdi, undata and the world bank group.   the  reason  why  we  have  selected  the  middle  east  countries  as  samples  is  that  the  economic  structure  of  such  countries  is  almost  similar  and  they  are  among  developing  countries. the mentioned time period has been selected because of accessibility to data. to  study the effect of oil extraction on attraction of foreign investment and economic growth,  we consider two groups of dummy variables: first, oil exporting countries member of the  middle east and the non oil exporter countries. if a country is included in the oil exporting  group,  the  dummy  variable  is  equal  to  one  for  this  country  and  equal  to  zero  for  other  countries.  empirical results  having  conducted  durbin‐wu‐hausman  endogenous  test  (augmented  regression  test  which is referred to as dwh), we came to the conclusion that the data related to the time  period 1980‐2008 had not been endogenous; but fdi and gdp variables were endogenous  for the time period 1983‐2008; it is why we have selected the first period as the time period,  but with the single equation.       behname m., studying the effect of fdi, ea (2011, vol. 45, no, 3‐4, 35‐43)   39 unit root  before  estimating  panel  data  model,  unit  root  test  is  to  be  performed  for  variables’  stationarity and avoiding spurious regression. in this study, we use im, pesaran, shin test for  unit root, the results of which have been presented in table (1).     table 1. unit root test of panel data(1980‐2008)    gdp  growth  fdi  inflow  pop  growth  inflation  rate  telephone  line  hum  capital  cap  growth  gap  technology  ‐2.99*  ‐8.13*  ‐4.32*  ‐3.81* ‐2.39* ‐4.32* 3.13*  5.13*  * the variables are stationary at the 5% confidence level    the results indicate that all variables are stationary at the 5% confidence level and we are  not led to spurious regression. hausman test is used for selecting fixed effects and random  effects model and indicates that random effects model is acceptable.   the  results  related  to  equation  (1)  have  been  presented  in  table  (2).  column  1  has  considered all variables except fdi. all variables’ sign accord with the theory. increase of  physical and human capital leads to increase of economic growth. technology gap causes  decrease  of  national  production.  coefficients  of  inflation  and  telephone  variables  are  not   significant. negative coefficient of population indicates that gdp per capita is decreased by  population increase.   in  the  second  column,  we  also  add  fdi  to  the  model.  results  indicate  that  fdi  has  positive effects on economic growth. in column 3, we enter dummy variables which indicate  the  effects  of  oil  on  gdp.  oil  export  increases  economic  growth.  in  column  4,  we  have  entered  the  interaction  of fdi  ×human  capital which  indicates  the  positive  effect of  this  variable on economic growth.    table 2. gdp growth is dependent variable (1980‐2008)    (1)  (2)  (3)  (4)  constant  4.2  3.13  5.13  11.21  (1.3 1)  (1.12)  (0.37)  (2.01)**  population growth  ‐0.29  ‐0.36  ‐0.38  ‐0.42  (‐2.32)**  (‐1.12)  (‐2.11)**  (‐2.13)**  capital growth   0.31  0.21  0.51  0.72  (8.21)***  (4.21)***  (4.44)***  (5.32)***  human capital    1.21  0.29  0.49  0.33  (2.32)***  (6.31)***  (5.49)***  (3.92)***  telephone line  0.53  0.36  0.42  0.51  (0 .32)  (0.71)  (2.04)**  (0.72)  inflation  0.32  0.41  0.37  0.21  (0.18)  (0.19)  (2.09)**  (0.13)  technology gap   ‐0.19  ‐0.34  ‐0.37  ‐0.12  (2.14)**  (‐3.71)***  (‐3.90)***  (‐0.12)  fdi     0.071  0.18  0.03     economic analysis (2011, vol. 45, no. 3‐4, 35‐43)   40   (4 .37)***  (5.31)***  (2.01)**  oil exporting dummy      0.35  0.32      (2.29)**  (0.71)  non oil exporting dummy      0.41  0.51      (0.35)  (0.32)  fdi x human capital         0.51        (2.01)**        ** significant at the 5% level;         *** significant at the 5% level       values in parentheses are t‐statistics    table  3  presents  the  results  of  the  second  equation.  gdp  growth  has  a  positive  and  significant effect on fdi since foreign investors seek a high purchase power for selling their  products. inflation rate and technology gap have negative effects on fdi flow. availability of  human capital is considered to be a positive factor for foreign investors. likewise it is for the  interaction of gdp and human capital. equation estimation indicates that availability of oil is  a proper motivation for doing investment.    table 3. fdi inflow is dependent variable (1980‐2008)    (1) (2) (3) constant  ‐3.27 ‐6.39 ‐9.25 (‐3.21)*** (‐4.21)*** (‐4.37)*** gdp growth  0.012 0.09 0.71 (4.37)*** (4.55)** (3.35)*** human capital    0.04 0.15 0.21 (2.01)** (2.22)** (3.35)*** inflation  ‐0.12 ‐0.17 ‐0.35 (‐2.12)** (‐1.2) (‐2.01)** telephone line  0.32 0.53 0.81 (2.01) (2.90)*** (3.39)*** technology gap   ‐0.39 ‐0.55 ‐0.77 (‐0.25) (‐2.08)** (‐0.35) oil exporting dummy  0.71 0.82 (5.31)*** (4.51)*** non oil exporting dummy  0.02 0.02 (0.21) (0.22) fdi x human capital   0.35 (2.55)**                    ** significant at the 5% level                     *** significant at the 1% level                    values in parentheses are t‐statistics       behname m., studying the effect of fdi, ea (2011, vol. 45, no, 3‐4, 35‐43)   41 conclusion  in this research we studied the effects of fdi on economic growth for the greater and  traditional middle east countries during the period 1980‐2008. the test results indicate that  the  two  variables  gdp  and  fdi  are  endogenous  only  for  the  period  from  1993  to  2008.  therefore, we have used two equations separately for the entire sample. this study indicates  that  there  is  a  strong  complementary  relationship  between  gdp  and  its  interaction  with  human capital and fdi. likewise  is  for  interaction of fdi with human capital and gdp.  effects of technology gap and inflation on fdi attraction are negative, meaning the investors  select  those  countries  for  investment  which  have  higher  technologies  and  more  stable  economy.  oil  exploitation  has  positive  effects  on  gdp  and  foreign  investment  attraction  since investors can easily reach an important raw material.   policymakers  should  make  clear  policies  with  regard  to  the  variables  important  for  investors. policymakers have to pay special attention to economic stability due to the fact  that  economic  instability  is  a  negative  criterion  for  an  investor.  due  to  the  positive  relationship between gdp and fdi as well as the relationship between fdi and technology  and infrastructures, the increase of the later variables’ level should be taken into account in  host countries because promotion of technology and improvement of infrastructures attract  foreign investment, and the fdi itself leads to increase of gdp and social welfare, a criterion  sought by all economists.   *  the  greater  middle  east  is  a  political  term  coined  by  the  bush  administration  to  englobe  together  various  countries,  pertaining  to  the  muslim  world.  the  countries  are  turkey, bahrain, kuwait, oman, qatar, saudi, united arab emirates, iraq, jordan, lebanon,  syria, iran, egypt, pakistan, algeria, mauritania, libya, morocco, tunisia, sudan, somalia.  references  aghion, p., d. comin, and p. howitt.,  (2006). “when does domestic saving matter  for economic  growth?”, nber working paper 12275.  agosin, mr., and ricardo mayer., (2000)“foreign investment in developing countries: does it crowd  in domestic investment?”, unctad discussion paper no 146, geneva: unctad.  ahmad  m.h.,  alam  s.  and  butt  m.s.,  (2003)“foreign  direct  investment,  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technology  diffusion,  and  host  country  productivity  growth”, journal of development economics 62, 477‐493.        apstrakt  ‐  ovaj  rad  pokušava  da  pruči  da  li  strane  direktne  investicije  u  velikom  i  tradicionalnom bliskom istoku dovode do ekonomskog rasta. u radu su analizirane 21 zemlje u ovoj  zoni u periodu od 1980‐2008. godine. zbog nedostatka endogenih veza između varijabli, dve jednačine  su  procenjivane  odvojeno.  uticaj  sdi  na  ekonomski  rast  direktno  i  indirektno.  indirektni  efekat  podrazumeva    interakciju  uslova.  infrastuktura  i  ekonomski  stabilnost  imaju  poseban  značaj  za  privlačenje stranih  investicija. osim toga, ekstrakcija ulja  i ekonomski rast  imaju takođe pozitivan  efekat na privlačenje stranih investicija dok tehnološki nedostatak ima negativne efekte na sdi i gdp  varijable.  ključne  reči:  strane  direktne  investicije,  ekonomski  rast,  velika  britanija  i  tradicionalni  bliski istok, panel podataka        article history:  received:  21 november 2011  accepted:  12 december 2011          ea_2014_1-2 udc: 330.342(55) ; 005.5:378.4 jel: o31, l26 id: : 207712012 original scientific paper institutional factors affecting academic entrepreneurship: the case of university of tehran farsi jahangir yadolahi1, modarresi meisam 2, university of tehran, faculty of entrepreneurship motavaseli mahmoud3, university of tehran, faculty of economics salamzadeh aidin 4, university of tehran, faculty of entrepreneurship abstract – the role of universities has been highlighted in the social and economic development of communities with the addition of entrepreneurial mission to the educational and research missions of the universities. thus, the subjects related to the academic entrepreneurship and commercialization of knowledge has recently been taken into consideration by many researchers and politicians in various countries. in iran, concept of academic entrepreneurship is newly established and is in its initial stages of formation and institutionalization. considering this gap in the literature, identifying institutional factors which affect academic entrepreneurship in iran is the main objective of this study. for this purpose, the institutional economy theory of north (1990) was used to investigate the formal and informal institutional factors that foster academic entrepreneurship in iran. in this study a mixed approach was implemented, taking advantage of interviews and a questionnaire to collection the data from the experts involved in academic entrepreneurship activities in university of tehran. for sampling purposes, the objective judgmental method was used as a non-probability sampling approach. data collection and analysis continued until theoretical saturation was reached. then, 41 semi-structured and open interviews were conducted. the quantitative sample size was calculated based on the cochran’s formula (60 persons). findings revealed that main formal institutional factors that affect academic entrepreneurship in iran include as follows: (i) rules, structure and governance of the university, (ii) entrepreneurship and business training programs, (iii) university-industry relationship, (iv) governmental policies and regulations, (v) intellectual property laws, and (vi) educational and research structure of the university while principle informal institutional factors include: (i) method of enforcing rules, (ii) political considerations, (ii) role models and academic reward system, and (iii) academicians' attitudes toward entrepreneurship. key words: academic entrepreneurship,institutional factors, university of tehran 1 associate professor, faculty of entrepreneurship, university of tehran, e-mail: jfarsi@ut.ac.ir 2 phd candidate of entrepreneurship, faculty of entrepreneurship, university of tehran, e-mail: meisam.modarresi@yahoo.com 3 full professor, faculty of economics, university of tehran motavaselim@yahoo.com 4 phd candidate of entrepreneurship, faculty of entrepreneurship, university of tehran, e-mail: salamzadehaidin@gmail.com, (corresponding) economic analysis (2014, vol. 47, no. 1-2, 139-159) 140 introduction “education” and “research” were the main issues in the mission of universities in the past, but today, with the developments at the global arena and changes between three main operators at national innovative systems (i.e. industry, government and university), the third mission also has been delegated to the universities, that is academic entrepreneurship and participating in socio-economic development of the communities (etzkowitz, 1998: 832; etzkowitz et al., 2000: 314). in fact, globalization process has caused universities to have new responsibilities in the social and economic promotion of regions, scientific advantages of market and reduction of public capitals. therefore, universities should act entrepreneurially and should commercialize results of research activities and finally ought to make new initiatives such as establishing new knowledge-based companies (guerrero et al, 2006). generally, universities should be able to establish appropriate links between the university, entrepreneurs and industry (yusof and jain, 2007). an entrepreneurial university applies different strategies and new institutional arrangements with the aim of establishing effective cooperation with government and private-sector industries in terms of production and application of technology and technical know-how (guerrero and urbano, 2010). academic entrepreneurship can include all entrepreneurial behaviors of academicians like setting up new companies at the university, setting up research centers with the industry, paving a suitable way for protecting intellectual properties, and licensing of research results carried out at the university (rothaermel et al., 2007: 2). entrepreneurship in iran's universities started with the approval of karad plan in 2006. the vision of this plan is setting up the topmost entrepreneurship centers at the universities of the country to establish a developed and dynamic community comprised of individuals with economic self-sufficiency and high education levels. although this plan has been successful to some extent at the universities in the field of entrepreneurship education, iranian universities face new challenges for attaining the envisioned perspective and with the aim of reinstating at the current changeable and developed world (farsi et al, 2012). some of these challenges are related to the policy-making level issues, structure of higher educational system and its planning, while some of which are related to the rules and environment, level of resources and inputs, level of processes, performance and outputs (ne'mati, et al., 2005: 123). given the vital and key role of academic entrepreneurship in promoting social and economic development and also significance of entrepreneurship status at the higher education system in the country's 20-year vision plan, identifying all dimensions of academic entrepreneurship in the institutional and rooted attitudes seems necessary with the aim of facilitating and promoting activities of academic entrepreneurship. accordingly, the main issue of this study is: "which institutional factors affect academic entrepreneurship in iran?" farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 141 literature review institutional approach and academic entrepreneurship institution has not been clearly defined and elaborated in the literature. sometimes, institution refers to organizations (e.g. bank as a financial institution), sometimes to basic rules governing relations between individuals (private ownership institution), and sometimes to an individual or a situation (presidential office) and even to an insignificant thing like contract papers. the environment is a set of fundamental legal, social and political rules that are governed by political and economic activities (davis and north, 1971). the institutional theory emphasizes the key role of institutions on the economic development and is regarded as one of the most appropriate frameworks for analyzing institutional factors that foster academic entrepreneurship and changes in the third generation education systems. the effect of institutions on entrepreneurial and startup activities has been previously analyzed by researchers. according to north's (1990, 1994) views, organizations adapt their strategies and activities to the environmental opportunities and limitations which provide formal and informal institutional frameworks for them (guerrero and urbano, 2010). in this respect, there are many researchers who have worked on the relationship between institutions and academic entrepreneurship (guerrero et al, 2006; guerrero and urbano, 2010). it is now accepted that institutions determine the rules in a community and/or formally saying, those are limitations that have been designed by human beings and form the interactions between them (north, 1990: 1994). therefore, the institutional texture contributes to economic performance, especially, through encouraging entrepreneurial behaviors and should be described comprehensively (yusof and jain, 2007). north (1990) identified two types of institutions: formal institutions (rules, institutions and regulations, etc.) and informal institutions (traditions, approaches and culture, etc.). he also emphasizes that role of institutions in a community in that they decrease uncertainty through creating a stable structure (but not necessarily efficient) in the interactions of individuals (north, 1990). some researchers in the field of entrepreneurship propose the application of north’s view in the analysis of making new investments in the institutional texture (veciana and urbano, 2008). thus, researchers argue that entrepreneurs as leaders and organizers of new venture creation have been influenced by environmental factors (both formal and informal) when dealing with rules and regulations pertinent to the entrepreneurial activities and informal norms that have been resulted from socializing and learning processes and thus have an influence on the educational, social, economic and political norms. therefore, considering north’s views regarding institutions, based on which institutions can be considered as formal (e.g. political and economic rules) and informal (e.g. norms, values and approaches), institutional factors fostering academic entrepreneurship can be studied in two fields: (i) formal institutional factors, and (ii) informal institutional factors. in this study, research related to the factors stimulating academic entrepreneurship is first studied with the adoption of institutional outlook and then, the research framework and theoretical model are designed and proposed. economic analysis (2014, vol. 47, no. 1-2, 139-159) 142 effective institutional factors in academic entrepreneurship a great number of practical and theoretical studies are carried out with regard to the study of effective factors on academic entrepreneurship (moray and clarysse, 2005; ranga et al, 2003; guerrero et al, 2006; rothaermel et al, 2007; sooreh et al, 2011) which can be studied through the institutional outlook. the most important relevant studies have been analyzed in this section. for instance, hamilton (2009) divides effective institutional factors on the academic entrepreneurship into two groups: formal institutions which include intellectual property laws and scientific capitals publishing institutes and informal institutions which include trade methods and social norms. in view of moray and clarysse (2005), the determinant institutional factors in knowledgebased entrepreneurial ventures include the reward systems, the entrepreneurial culture of the university, intellectual property policies and organizational structure in general. wright et al. (2009) introduce managers of university, organizational culture, sub-culture and resources accessible at universities as effective institutional arrangements that stimulate academic entrepreneurship. moreover, ranga et al. (2003) have studied entrepreneurial universities and dimensions of knowledge production in a case study in belgium and identified two groups of institutional factors that result in the promotion of knowledgebased entrepreneurship: regional and national policy factors and university internal factors. regional policy factors include macro policies related to innovation, bills supporting research and innovation bills. these researchers emphasize external factors of university on the governmental policies and rules. the university internal factors which have been identified by these researchers include variety of financial resources, measures of university lecturers, internal dimensions of research groups and number of active groups. in the one hand, ponomariov and boardman (2009) introduced research and development (r&d) investments, financial procurement of industry, quality of university and in general, patent registering rate at the university as the most important commercializing motivations of the universities at the institutional level. on the other hand, shane (2004) enumerates three important intra-organizational factors that contribute to knowledge commercialization activities: university policies, performance of responsible institutions in licensing and their relationship with industry, and characteristics of the university. the university policies include as follows: transferring exclusive or non-exclusive licensing, sharing the risks inherent in these licenses, freedom of action of the university faculty and researchers for entering into activities and commissioning businesses based on their research activities, using academic resources for establishing new ventures based on academic knowledge and technology, the manners of sharing the profits obtained from commercialization of technology and financial contributions of the university in commissioning new firms. performance of the responsible institutions in a study by shane (2004) includes rate and type of financial resources of these institutes, officials’ level of specialty and personnel of these institutions and networks of newly-established companies. in a study by shane, qualities of the university includes culture of encouraging or obstructing entrepreneurship at the university, existence of entrepreneurial patterns at the university, reliability, validity and the quality of the university, provision of research budget from industries or public and governmental budgets. farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 143 sporn (2001) introduced mission of the university, structure and process, organizational culture, way of management and centralized or decentralized decision making are the most important effective factors in the adaptability of the universities. in a study of procedures of commercialization of research activities by the university faculty, göktepe-hultén (2008) classified factors of presence of inventors in patent activities into internal and external factors. in addition, he grouped each of these internal and external factors into enablers and triggers. the triggers (solving a research question, job satisfaction, social and personal rewards, reputation, promotion, personal income and benefits, and job security & alternative career options) and the enablers (scientists' career life cycle, scientific human capital, industrial experience & diversity of career, image & confidence, and social capital & networks) in internal factors, and the triggers (new academic culture, social imprinting, scientific discipline & industrial relevance, industrial funding and resources, and society, culture and location) and enablers (patent legislation (ownership of patents), ttos, third mission, and university strategy & policy) in external factors are considered simultaneously. fini et al. (2009) divided reinforcing factors of university faculties for creating a new business into four groups: (i) local context factors, (ii) government support mechanisms (iii) support mechanisms at the university level, and (iv) factors associated with the individual’s level. local context factors refer to the research commercialization opportunity, supportive institutional context, fertile local context, supportive academic environment, accessing technologic know-how, previous investments in the development of market demand technology and contagion effect (imitating others). support mechanisms at the university level include rules related to patenting, academic patented technology, university investments in stocks, rules related to the academic firms, business plan competitions, technology transfer offices, accessing laboratories and infrastructures, and availability of academic incubators. factors related to the individual level in this study include obtaining laboratories’ equipment, obtaining research grants, attracting prominent university faculty, participating in economic and technological development of the country, participating in boosting employment, personal income, prestige and reputation, new ideas and networks for the applied research. the”organic paradigm” of commercialization of laperche (2002) introduces key knowledge commercialization factors as follows: rules, technical progress, strategy of university, and economic and entrepreneurial environment. in laperche’s model, the technical progress refers to the research and development costs while economic and entrepreneurial environment refers to the macro-economic indicators. guerrero et al. (2006) and guerrero and urbano (2010) have selected the theory of institutional economics and north’s study (1990) as the base of their research and have embarked on classifying results and factors identified by formal and informal instructional factors. guerrero et al (2006) studied formal and informal institutional factors fostering the creation of entrepreneurial universities in spain. the formal institutional factors identified in this study include structure and governance of the university, academic entrepreneurship structures, entrepreneurship training method and role models, and academic reward system. incorporating the theory of institutional economics and also the resource-based approach, guerrero and urbano (2010) studied effective formal and informal factors in the development of entrepreneurial university (guerrero and urbano, 2010). in addition to the economic analysis (2014, vol. 47, no. 1-2, 139-159) 144 institutional factors introduced by guerrero et al (2006), these researchers also considered capacities and internal resources as effective factors in development of entrepreneurial university. sooreh et al. (2011) proposed a new framework for entrepreneurial universities in iran, merging the input-process-output-outcome (ipoo) model of salamzadeh et al. (2011) and informal and formal institutional factors proposed by guerrero et al. (2006) which led to framework with nine building blocks. then, they measured the importance-performance of each building block to evaluate the entrepreneurial universities in iran. their study led to clarification of weaknesses and strengths of iranian universities in this respect. the present study is more aligned with the three recent studies mentioned above in terms of objectives and content and is also similar in their methodology i.e. institutional approach. accordingly, the study was taken into consideration as an initial base for designing the theoretical framework of the research in the next section. theoretical framework in this section, the theoretical framework for this research is presented in order to show the relation between components of the study. since starting an explorative case study without a theoretical framework is futile, we employed a theoretical framework to enrich the research results, organize interviews, and collect and manage data and avoid any bias in the research (eisenhardt, 1989). accordingly, guerrero et al. (2006) classification with regard to the effective institutional factors in the development of an entrepreneurial university was selected as the base to attain an appropriate theoretical framework. this framework was selected because of its suitable method in adopting and employing the theory of institutional economics in the identification of factors. as a matter of fact, it is assumed that all subjects related to the effective factors in academic entrepreneurship can be studied in subsets of formal and informal institutional factors. selecting the study by guerrero et al. (2006) as the base of the research and thorough reviewing of relevant studies, the researchers designed a model, based on which, extant factors in the model will be studied and adjusted at the next stages thanks to the exploratory nature of the research. in designing the research model, based on a study by guerrero et al. (2006) and the model offered by them, the following six factors were considered as the initial and basic factors: (i) rules, structure and governance of the university, (ii) structures of academic entrepreneurship, (iii) entrepreneurship education programs, (iv) academicians' attitudes toward entrepreneurship, (v) entrepreneurship teaching method, and (vi) role models and academic reward system. also, based on a study by hamilton (2009), the factor of intellectual property laws was added to the set of factors and the factor of academic entrepreneurship culture was added to the set of factors according to a study by sporn (2001). it should be noted that the governmental rules and policies were also added to the set of factors based on a study by ranga et al. (2003). the factor of university-industry relationship was also added based on a study of etzkowitz (2002) to the set of factors affecting academic entrepreneurship. fig. 1 has been accepted as the theoretical framework of the present study. however, the components of this framework had to be adjusted during conducting interviews. we adopted a theoretical framework to avoid the risk of partial understanding when describing the phenomenon. farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 145 figure 1. theoretical framework of the research (based on literature) institutional factors affecting academic entrepreneurship formal factors (ff) informal factors (if) • rules, structures, and governance of the university • academicians' attitudes toward entrepreneurship, • governmental rules and policies, • teaching methods of entrepreneurship • academic entrepreneurship structures, • role models and academic reward system, and • intellectual property laws, • entrepreneurial culture • entrepreneurship education programs, and • university-industry relationship methodology the present study discusses both practical and theoretical sides of entrepreneurial universities in iran. the methodology is both qualitative and quantitative and is known as the exploratory mixed method. in this study, the factors were extracted from the literature review in the first stage. the qualitative method was used for interviewing academic experts to explore these factors and clarify the degree of their importance and/or awareness of other potential factors. then, at the next stage, a questionnaire was used as the quantitative method to collect the necessary data. at this stage, questionnaires were distributed among the experts involved in academic entrepreneurial activities and the collected data were analyzed by the factor analysis method. finally, institutional factors affecting academic entrepreneurship in iran were identified. these stages are illustrated in fig. 2. figure 2. research design economic analysis (2014, vol. 47, no. 1-2, 139-159) 146 the in-person interviews involved three groups of individuals bearing interest in commercialization namely, professors experienced in commercialization of university research in the engineering faculty of the university of tehran, scholarly professors in university entrepreneurship and commercialization of research, and managers & policy makers in small business development center (sbdc) of university of tehran. the selection criteria were: (i) ten years of experience at the minimum for the experienced professors, (ii) scientific publications related to commercialization of university research and entrepreneurship for the scholarly professors, and (iii) two years of experience at the minimum for the managers and policy makers in sbdc. for sampling purposes, the objective judgmental method was used which is considered as one of the non-probability sampling methods. the sampling and interviews continued until the analysis and investigation process reached theoretical saturation. therefore, 41 semi-structured and open interviews were conducted. the length of the interviews ranged from 30 minutes to 60 minutes, with a previous contextualization about the research. the quantitative sample size was calculated based on the cochran’s formula (60 persons). totally, more than 70 questionnaires were distributed to reach 60 sound ones. in the qualitative section, the judgmental sampling method has been used up to the saturation level for selecting the university faculty members, managers and informed experts with the aim of collecting information for the quantitative dimensions of the research while in the quantitative section, the simple randomized sampling method has been used with the aim of selecting individuals for the collection of data for the quantitative dimensions of the research. validity and reliability of research tool based on the research by eisenhardt (1989), three techniques were used for the purpose of increasing the validity and reliability of the qualitative data. first, the answer guessing technique was used to avoid the respondent’s deviation from the topic of discussion when answering open-ended questions. afterwards, the interviewees were ensured about their anonymity and confidentiality of the answers so as to increase the accuracy of answers and statements. it should be noted that, each interviewee was informed in advance about the purpose of the research. internal stability or consistency was also determined through the cranach’s alpha test of reliability. accordingly, after the distribution of questionnaires among experts and collecting the necessary data, finally, a number of 60 questionnaires were eligible for study. a reliability value of 0.87 was obtained for the questionnaire in the spss software. findings and results qualitative phase in this study, interviewees were requested to answer the following main questions: (i) in case of fulfilling an entrepreneurial activity, please explain the nature of your activity and mention details and relevant challenges. (ii) in your opinion, which factors influence the academic entrepreneurial activities in iran? farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 147 table 1. final coding table from results of interviews second phase coding first phase coding interviewee code f or m al i n st it u ti on al f ac to rs governmental policies and rules • financial support • expert system • governmental laws i5,i14,i11,i12,i15,i19,i21, i23, i7,i9,i18,i21,i24, ,i10,i13,i25,i26,i6, ,i20,i8, ,i22 i29,i27,i30,i31,i32,i34,i37,i38,i36,i40,i41 marketing structure • marketing skill • communication networks with the market i1,i5,i7,i14 i23, ,i6,i10,i12,i17,i18 i2 ,i14,i25,i9,i16,i30,i33,i34,i38 rules, structures and governance of the university • university rules • university processes and procedures • organizational structure of the university i3,i9,i14,i23,i24,i27,i28,i29,i32 i34,i35,i36,i37,i38,i41 academic entrepreneurship structures • sbdc structure • structure of science & technology park and incubators i6,i21,i22, ,i10,i14,i23,i9,i17,i20,i24,i25,i26,i36 entrepreneurship education programs • entrepreneurship education • business management skill i3,i13,i17,i18,i24,i26 ,i25,i1,i2,i5,i6,i22,i31,i37,i39,i40 university– industry relationship • adaptation of academic projects and requirements of industry • shared vision of university and industry i10,i15,i16,i22 ,i24,i4,i13,i6,i11,i23 i26,i29,i30,i31,i36,i37,i41,i32,i38 university research structure • transparent research procedures and strategy • research evaluation system i3,i5,i8,i14,i19,i22 ,i30,i32,i33,i35,i36,i39,i40 intellectual property laws • transparency of intellectual property laws • editing intellectual property laws i1,i17,i15,i18, i23,i6,i13,i15 ,i24 i27,i30,i31,i33,i41 economic analysis (2014, vol. 47, no. 1-2, 139-159) 148 in fo rm al i n st it u ti on al f ac to rs procedure of enforcing laws • observing standard criteria and work conscience • simplicity and clearness of processes and procedures • motivation of state-run sector i7,i8,i9,i21,i5 ,i24 ,i13,i21 i14,i19,i11, ,i16,i18,i12,i23 ,i22 ,i2 ,i6,i15,i27,i29,i35,i36 i33,i38,i37 academicians' attitudes toward entrepreneurship • mental image from business environment • academic entrepreneurship perspective i6,i9,i15,i16,i26,i8,i21,i23 i3,i10,i11,i20,i5,i22,i25 ,i4 i28,i29,i30,i31,i35,i36,i38 role models and academic reward system • effectiveness from experience of others • academic reward system i9,i15,i6 ,i16,i20, i23,i3,i5,i10 ,i14,i18,i21,i8,i17,i24,i1,i33,i37,i39,i41 political considerations • international political relations • foreign political-trade relations • election campaign • stability of state-run managers i4, i5,i7,i16,i19,i10,i25 i22,i23,i12, i18,i26,i28,i32,i41 quality of educational system • presenting applied education • quality-oriented education system i13,i17,i18,i24,i29,i30 ,i31,i32,i34,i35,i37,i39,i40 farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 149 (iii) how these factors affect all stages of academic entrepreneurship? to thoroughly examine the interviewees’ responses, the researcher attempted to use coding of verbal statements of the interviewees and also to identify and extract institutional factors affecting academic entrepreneurship. the matrix structure of the data analysis and the data on institutional factors affecting academic entrepreneurship in iran– which have been extracted from transcripts of interviews thanks to the north’s model (1990) of institutions (formal and informal institutional division)– are shown in two groups of formal and informal institutional factors in table 1. generally, the analysis of the interviews has produced five new institutional factors (marketing structure, procedure of enforcing laws, political considerations, quality of the education system and research structure of the university) that have been ignored in the literature. marketing structure and university research structure were identified as formal institutional factors while the procedure of enforcing laws, political considerations and quality of the education systems were recognized as informal instructional factors in the qualitative analysis section. also, institutional factors like how entrepreneurship is thought and academic entrepreneurial culture, which has been extracted from the literature, were regarded as insignificant in view of the interviewees and were somewhat ignored by them. quantitative phase factor analysis of data was done for the 15 factors using the key factors technique. the data were put to the varimax rotation analysis and finally, kmo9 test result was equal to 0.74. the results obtained from kmo (kaiser-meyer-olkin) and bartlett’s tests were significant at the 0.05 significance level. this indicates the proportion degree of data for the implementation of factor analysis. the total variance clarified by the factor analysis is also equal to 89% which is valid. kmo and bartlett’s tests table, communalities rate table, and also rotated component matrix are illustrated in the appendix section. the results of factor analysis are shown in table 4. table 2. results of factor analysis results of factor analysis after varimax rotation institutional factors affecting academic entrepreneurship variance percentage of total clarified variance cumulative percentage of variance rules and structure and governance of the university 7.325 18.375 18.375 procedure of enforcing laws 5.837 14.592 32.969 entrepreneurship and business education programs 4.804 12.015 44.984 university – industry relationship 4.343 10.875 55.859 governmental policies and rules 3.167 7.915 63.138 political considerations 3.055 7.637 71.411 role models and academic reward system 2.671 5.174 76.505 academicians' attitudes toward entrepreneurship 1.905 4.362 80.947 intellectual property laws 1.832 4.586 85.533 education – research structure of the university 1.641 4.102 89.635 economic analysis (2014, vol. 47, no. 1-2, 139-159) 150 the factor analysis divided indicators into 10 factors. the indicators for each factor are explained in this section. it has been tried that coding be done without losing the conceptual accuracy of the factors. the codes and contents of the 10 factors are as follows: factor of rules, structure and governance of the university: the factor analysis placed six factors in the first factor, including the mission of the university, formulating intellectual property laws, university rules, university organizational structure, independency of the university from government (internal decision makings), independency of the university from government (in financial terms), mission of university and rules of university. focusing on these six indicators, we can understand that these indicators are primarily related to the rules, structure and governance of the university. moreover, the indicators which have been classified directly as the subset of factors extracted from the literature, the indicator of formulating intellectual property laws has also been included in this factor. this indicator requires formulating a strong intellectual property system in executing and following up results of entrepreneurial activities. procedure of enforcing laws factor: standard criterion and work conscience and incentive system of public sector has been included in one factor. these indicators have been grouped in a factor along with the indicators like processes and procedures, stability of governmental managers, sbdc structure, structure of science and technology park and incubator. since these indicators have a very close relation with the rules and regulations governing the office and state-run sector activities and also have a very significant effect on how and with what quality the rules are implemented, title of procedure of enforcing laws was reinstated for this factor. the third factor, coded as “business and entrepreneurship education programs”, was considered with five indicators. indicators of business management skills and entrepreneurship education were initially included in the subset of entrepreneurship education programs. in this regard, indicators of marketing skill from the marketing structure factor and presenting applied education from the quality of education system and also indicator of entrepreneurial applied education from the factor of entrepreneurship education system were placed in this factor. in general, these factors have a general relationship with each other and thus, can be considered consistent. since these indicators are primarily included in the field of entrepreneurship education, this factor was coded the business and entrepreneurship education programs. the forth factor coded as “university-industry relationship” include the following indicators: agreement of university projects and industry needs, entrepreneurial interests and experiences of university faculty, shared vision of university and industry (common objectives), shared vision of university and industry (scientific synchronization) and communication networks with the market. due to the existence of primary indicators of university-industry factor and its relevant indicators, as were added to them in factor analysis, this factor was coded as the “university-industry relationship”. in addition to the three primary indicators of factor of industry and university relation, other indicators which had a high correlation with this factor were loaded onto this factor. indicator of entrepreneurial interests and experiences of university faculty has been included in this factor for having appropriate communication links with this factor. moreover, the marketing farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 151 communication networks indicator can also be of paramount importance for the university in terms of creating a specific process and procedure for transferring outcomes of the university to the market and including it in this factor can also show its high correlation. the primary indicators of the factor of governmental policies and rules, as the fifth factor, were included wholly in the final factor and no change was done to it. this factor was placed at the fifth rank with having the same four primary indexes in terms of significance. with its three indicators, the political considerations factor was included in one subset. from among four indicators, which had been considered initially for the political considerations factor, the factor analysis approved three indicators for the same factor and included only one factor coded as “stability of governmental managers” in the other factor coded as “procedure of enforcing laws”. in explanation of this indicator, posing the following subject seems necessary: “as being placed at the sixth rank, political considerations factor is regarded as an informal institutional factor which plays an important and effective role in governmental policymaking procedure.” having the indicators of political considerations, this factor took the same name of ‘primary factor’. primary indicators of role models and academic reward system formed the seventh factor under codes of the role models and academic reward system by being included in tandem with each other along with the indicator of academic entrepreneurial vision in terms of significance. this factor is posed as informal institutional factor affecting academic entrepreneurship. the majority of the factors which have received low ranks among the final 10 factors have been comprised of three indicators and statistically, that is the least necessary number of indicators for a factor in the factor analysis. so, the factors which have been placed at the end of formal and informal institutional factors’ list are less consistent and significant than the institutional factors placed at the upper part of list. subsequently, the last three factors which are comprised of three indicators will be explained. the eighth factor coded as “academicians' attitudes toward entrepreneurship is an informal institutional factor which has the following indicators: mental image of business environment (in economic terms), mental image of business environment (in terms of ethical issues), and cultural values with relation to entrepreneurship in one subset. the factor coded as "formal institutional factor of intellectual property laws" was placed at the ninth rank with the indicators of transparency of intellectual property laws, simplicity and transparency of processes and procedures, and intellectual property laws evaluation process. finally, formal institutional factor of "education and research structure of the university" was placed at the tenth rank with the indicators of transparent research strategy and procedures, research evaluation system and quality-oriented procedure in the education system. discussion and conclusion in this study, 10 factors were extracted from the literature review within the framework of formal and informal institutional factors for the purpose of determining the institutional factors affecting academic entrepreneurship. thus, guerrero et al (2006) model was chosen as a base, details of which were explained and discussed earlier. following the extraction of effective institutional factors from the literature, they were submitted to the academic experts. having extracted the effective institutional factors from the literature, the identified factors were presented to academic experts. doing this, and economic analysis (2014, vol. 47, no. 1-2, 139-159) 152 including the interviews in the methodology were for the purpose of complementing and adding new potential factors which were achieved by interviewing the academic experts. after interviewing the academic experts, other factors viz. "marketing structure, procedures of enforcing laws, political considerations, and quality of the education system and research structure of the university" were added to the initial model. all in all, 15 factors were studied and presented to the relevant experts in the form of 41 indicators of those factors within the framework of a questionnaire. factor analysis was carried out after executing processes related to designing questionnaire, testing validity and reliability of the tests, sending questionnaire and receiving relevant data. the factor analysis divided the indicators into 10 factors. formal institutional rules, structure and governance of the university, informal institutional factor concerning enforcement of laws, formal institutional factor of entrepreneurship and business education programs, formal institutional factor of universityindustry relationship, formal institutional factor of governmental policies and rules, informal institutional factor of political considerations, informal institutional factor of role models and academic reward system, informal institutional factor of academicians' attitudes toward entrepreneurship, formal institutional factor of intellectual property laws, formal institutional factor of research-education structure of the university. these factors are illustrated in fig. 3 as the research’s ultimate model. figure 3: model of institutional factors affecting academic entrepreneurship (self elaborated) institutional factors affecting academic entrepreneurship formal factors (ff) informal factors (if) • governmental policies and rules • procedure of enforcing laws • marketing structure • academicians' attitudes toward entrepreneurship • rules, structures and governance of the university • role models and academic reward system • academic entrepreneurship structures • political considerations • entrepreneurship education programs • quality of educational system • university– industry relationship • university research structure • intellectual property laws generally, it can be said that each of the identified factors, if invigorated and strengthened, can create a motivation for entering academic entrepreneurial activities and also can be useful as an enabling and supporting factor to promote and facilitate the academic entrepreneurship process. under such circumstances, output and efficiency of academic entrepreneurial activities will also be appropriate. in case of weakness of each of the mentioned factors, these factors will operate as an obstacle at all stages (input, output and process) of academic entrepreneurship and will also impede the academic entrepreneurship activities. while comparing the present study with the previous studies, mentioning this point seems necessary that a great number of theoretical and experimental studies are found with farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 153 relation to the research on factors affecting academic entrepreneurship (moray and clarysse, 2005; rothaermel et al, 2007; guerrero et al, 2006; ranga et al, 2003; salamzadeh et al, 2011; sooreh et al, 2011; guerrero et al, 2013). but most studies have dealt with the subject in a classified form. also, only few studies have used the institutional approach for studying institutional factors affecting academic entrepreneurship. yusof and jain (2007) introduce the institutional factors, which most researchers have focused on including institutional policy, higher education policy, triple spiral model, national and socioeconomic development policies. the similarity between the previous research and the current study is the identification of most of the factors under study. it should be noted that most factors identified in the previous studies have been identified and approved in this study, as well. moreover, comprehensive reviewing of the literature and familiarity with the institutional discussions greatly helped the researcher in conducting interviews and doing the qualitative and quantitative analyses and also designing the questionnaire and hence the accuracy of the contents and results of the research. accuracy and precision in the identification of all institutional factors affecting the academic entrepreneurship and vastness of identified factors and sub-branches affecting academic entrepreneurship due to the native and local situation of a country is the distinguishing aspect of the present study in relation with the previous studies. the new factors identified in this study, which had been fallen into oblivion in previous studies, are as follows: procedures of enforcing laws and political considerations which have been identified as informal institutional factors affecting academic entrepreneurship and education-research structure which has been identified as formal institutional factor affecting academic entrepreneurship. as mentioned previously, native and local situation of the country has been very effective in presenting new results. for example, procedures of enforcing laws and/or political considerations in many countries may not be considered as an effective institutional factor in academic entrepreneurship but thanks to the present institutional structure in iran, these factors especially the factor of procedures of enforcing laws plays an important role in facilitating and promoting academic entrepreneurial activities. policy implications given the findings and results obtained from the study and identifying and ranking institutional factors affecting academic entrepreneurship in iran, the following practical suggestions are recommended for the policymakers in the science and technology field and policymakers in the field of industry and entrepreneurship and also managers and policymakers at the universities: (i) according to the results of this study, the factor entitled "rules, structure and governance of the university" was identified as the most important formal institutional factor affecting academic entrepreneurship. many researchers (guerrero et al, 2006: guerrero and urbano, 2010: clark, 1998: sporn, 2001, salamzadeh et al, 2011) have put special emphasis on this factor. different organizational arrangements at the universities can result in different tendencies toward getting involved in commercialization of results of universities' fundamental research activities (farsi et al, 2011; tanha et al, 2011). if the university adopts professional bureaucracy, comprised of traditional boundaries and economic analysis (2014, vol. 47, no. 1-2, 139-159) 154 structures at its organizational structure, commercialization tendencies of the university can be assumed limited. certainly, the universities which reorganize their activities merely based on disciplinary lines, they have partial strategic objectives for being involved in commercialization of results of researches. (debackere and veugelers, 2005, 329) with due observance to the significance of this subject, universities are recommended to take giant stride towards improvement of structure, process and way of governance of the university and move towards decentralized decision making to facilitate and promote entrepreneurial activities at the university. also, clear-cut definition of entrepreneurship mission for the university and induction of this contemplation to the university lecturers and students for changing their approach and attitude to the entrepreneurship subject is of paramount importance. (ii) factor of entrepreneurship and business education programs was the other important formal institutional factor identified in this study (results of the factor analysis). evidence shows that scientists have almost partial resources and market knowledge. some market information is necessary for the university faculty and researchers with the aim of identifying commercial value of new knowledge and also participating in technology transfer activities (vohora et al., 2004). so, entrepreneurship skills training seem necessary at the university. the studies carried out with relation to the effects of entrepreneurship education and entrepreneurial activity indicates a positive effect for entrepreneurship trainings (urbano et al, 2005; charley and libecap, 2003). most of interviewees have also pointed to the lack of business skills as an important obstacle for being involved in entrepreneurial activities. thus, managers and officials of the education ministry are recommended to plan entrepreneurial training programs from the basic levels of education and officials of the science ministry and managers of the universities should also pay attention to this issue and commission entrepreneurial education programs for university students as mandatory curricula at the universities. it is also suggested that practical programs be designed in the field of entrepreneurship to increase the capacities of the faculty. (iii) in this study, the factor of "procedures of enforcing laws" has been identified as the most important informal institutional factor affecting academic entrepreneurship (results of factor analysis). this subject is of paramount importance which can affect all other formal and informal factors. this factor has been emphasized by the interviewees at the qualitative stage when conducting interviews. failure in enforcing laws and/or incorrect enforcement will lead to an unhealthy environment and formation of rent-seeking and destructive entrepreneurship. undoubtedly, the government is considered as an important influential factor for the creation of a healthy entrepreneurship environment, based on which, the government should be held responsible for policy making, coordinating and implementing policies. if advantages of getting involved in illegal entrepreneurial activities exceed costs, entrepreneurs show more tendencies toward destructive entrepreneurship which is detrimental to the economic development. in contrast, if there are motivations for implementing productive entrepreneurship then it will become widespread. in each of two cases, entrepreneurs evaluate existing incentives at the environment both in legal terms (formal rules of north) and in terms of cultural values and common norms (informal rules of north) (baumol, 1993). in view of most interviewed entrepreneurs, appropriate macro farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 155 policies have been adopted in national level. there are many approvals and rules in line with helping entrepreneurs and new companies but these policies, rules and approvals have remained unchanged in macro level and have not been pierced into the mid and executive layers of the business environment. practically, these policies have not been executed due to the optional performance and/or weakness of managers and staff of executive organizations at all and/or have not been executed accurately. generally, there is not any supervision on accurate fulfilling and executing macro policies of the government in line with helping entrepreneurs. adhered to criteria and work conscience, simplicity and clearness of processes and procedures and motivation of public sector are regarded as three important factors in appropriate enforcing rules in view of interviewees. so, government is recommended to plan on the mentioned three factors with the aim of executing the approved rules in the best form possible. in this line, the following strategies are proposed: establishing a powerful supervisory system for preventing illegal communications, rent-seeking and nepotism in the governmental sector, involving government employees of related departments in commercialization and its profits for creating motivation, and more facilitation of procedures and processes related to the commercialization at the university and relevant organizations (iv) university-industry relationship has been identified as the other important formal institutional factor in this study (results of factor analysis). universities are in dire need of permanent resources and capital. the activities like research contracts, granting license and spin offs can follow long-term income for the universities. units should able be to establish constructive relation between university and industry and should link them appropriately. these units should also create efficient and constructive relationships between different beneficiaries at the university and industry. generally, the activities occurred between university and industry can be classified into three groups: (i) activities related to the education and business activities, (ii) activities related to the laboratory services, for example: research centers with appropriate infrastructures like laboratories, equipment and human resources, etc. which, many businesses lack, (iii) consultation services which the university faculty provide for businesses, and to transfer of results of studies to the businesses through means such as making research contracts, rewarding and establishing technology-based firms (gassol, 2007). therefore, the relationship between university and industry seems necessary and is profitable for the two sides, results of which can lead to the promotion of academic entrepreneurship processes. for a better relationship of the university and industry in the country, it is proposed that common objectives for the university and industry be defined in line with the development vision of the country. also, it is proposed that common specialized meetings and sessions be held between the university and industry for exchanging views and identifying common problems as well as introducing capabilities of the university to the industry for taking advantage of constructive viewpoints of academicians. moreover, it is proposed that the amount of import in some capable industries be limited so as to facilitate the cooperation between the industry and university. economic analysis (2014, vol. 47, no. 1-2, 139-159) 156 future directions the results of the present study particularly evince a need to investigate the challenges in the intellectual property laws and their effect on academic entrepreneurship. because, whereas, it was expected that this factor i.e. intellectual property laws be recognized as a very important and effective factor in academic entrepreneurship in the country, it was among the least important factors coming one to last. it seems that lack of motivation and involvement of the university faculty at the commercialization stage and weak performance of information service centers related to the intellectual property can be regarded as the most important reasons of the said issue. also intellectual property laws at the universities have many ambiguities at the practical and enforcing stage. since supporting ownership of intellectual properties is a key factor in facilitation of technology transfer and creation of motivation for commercializing results of studies, clarifying effects of intellectual property laws on the academic entrepreneurship in the future studies will be very helpful. in the present study, identifying and ranking institutional factors affecting the academic entrepreneurship was discussed. the role and effect of each one of the factors identified in the academic entrepreneurship can be studied at the next studies. also, the present study has discussed the institutional factors affecting academic entrepreneurship activities and has not studied its various stages including input, processes and output of academic entrepreneurship concept, separately. the future studies can concentrate on the factors affecting the entrance of academicians to the academic entrepreneurship activities, factors affecting academic entrepreneurship process and/or factors affecting the success of academic entrepreneurs. references baumol, w. 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(2009). dynamics of science-based entrepreneurship, journal of technology transfer, 35(1): 1-15. yusof, m. and jain, k.k. (2007). categories of university-level entrepreneurship: a literature survey, international entrepreneurship and management journal, 6(1): 81-96. institucionalni faktori koji utiču na akademsko preduzetništvo: analiza studije slučaja univerziteta u teheranu rezime – univerziteti imaju istaknutu ulogu u društvenom i privrednom razvoju zajednice, s dodatkom njihove preduzetničke i istraživačke misije. u skladu s tim, akademsko preduzetničko znanje i komercijalizacija tog znanja su od nedavno postali predmet interesovanja naučnika i političara u mnogim zemljama. koncept akademskog preduzetništva je tek odnedavno ustanovljen u iranu,tako da se nalazi još u svojim početnim fazama nastajanja i institucionalizacije. s obzirom na tu prazninu u literaturi, rad identifikuje institucionalne činioce koji utiču na akademsko preduzetništvo u iranu,što je glavni cilj ove studije. u tu svrhu, korišćena je u radu teorija institucionalne ekonomije koju je postavio naučnik sever (1990), s ciljem da se istraže formalni i neformalni institucionalni činioci koji podstiču akademsko preduzetništvo u iranu. u ovoj studiji, implementiran je mešoviti pristup istraživanja ,tj. iskorišćeni su intervjui i upitnici za prikupljanje podataka od strane stručnjaka koji sudeluju u akademskim preduzetničkim aktivnostima na univerzitetu u teheranu. vršena je selekcija uzorka u nekoliko koraka do objektivne procene. kvantitativna veličina uzorka je izračunata na farsi jahangir, y., et al., the case of university of tehran, ea (2014, vol. 47, no, 1-2, 139-159) 159 temelju cochranove formule (60 osoba). rezultati istraživanja su pokazali da su glavni formalni institucionalni faktori, koji su imali uticaja na akademsko preduzetništvo u iranu, ogledaju u: (i) pravilima, strukturi i upravljanju univerzitetom, (i ) preduzetništvu i poslovnim programima obuke, (iii) vezi između univerziteta i industrije, (iv) vladine politike i propisa, (v) zakona o intelektualnom vlasništvu, i (vi) obrazovnoj i istraživačkoj strukturi univerziteta, dok se principi neformalnih institucionalnih činilaca odnose na: (i) način sprovođenja pravila, (ii) političkih razloga, (ii) „role“ modela i sistema akademskog nagradjivanja, i (iii) akadermskih stavova prema preduzetništvu. ključne reči: akademsko preduzetništvo, institucionalni činioci, univerzitet u teheranu article history: received: 22 may 2014 accepted: 5 july 2014 ea_2012_1_2 notes from the editor-in-chief economic analysis (ea) publishes original research papers, case studies, conference papers, book reviews and other peer papers. the spring issue is an exploration into the nature of sustainable development under impact of the crisis, green growth as a generator for overcoming the crisis and environmental taxation as a tool for sustainable development. in addition, this issue covers other topics such as foreign direct investment and political risk (case study), macro-prudental-old or new view at the financial stability and pest analysis of serbia. ea aims for a high desk-rejection rate. manuscripts lacking theoretical foundation and methodological rigor will not enter the review process. please, submit your own research to ea and thus ensure that your articles reach the knowledgeable and international readership that they deserve. since 2013, registration and login are required to submit items online. there you can also check the status of current submissions. all information is on the site www.ien.bg.ac.rs thank you! editor-in-chief prof. dr. mirjana radović-marković, frsa, fwaas, femaas ea_2014_1-2 udc: 336.744 ; 004.738.5:339 jel: e42. f31 id: 207707660 original scientific paper demystifying bitcoin: sleight of hand or major global currency alternative? malović marko 1, institute of economic sciences, belgrade, serbia abstract – bitcoin, a peculiar crypto-currency has been the loudest buzzword in global finance over the last year or so, both for its spectacular and seemingly robust appreciation trend as well as for more recent equally ostentatious demise. after reviewing the history of bitcoin and specificities of its cyber-construct, this paper adds to the critical analysis of bitcoin as an international currency alternative. lately, its volatility has been so excessive that it arguably cannot serve as a store of value. in addition, notwithstanding bitcoin's rising if bumpy credibility as a medium of exchange, since it has been immediately converted (by chief vendors) in either of the leading world currencies upon payment due to its extraordinary exchange rate volatility, bitcoin's unit of account potential appears to be dubious too. moreover, bitcoin's next to none correlation with other major currencies' movements renders it unsuitable for managing fx risk or hedging purposes. finally, having in mind that it lacks formal reserves or deposit-insurance scheme to back it up yet it's also prone to hacking, bitcoin resembles and behaves more like a pyramidal investment vehicle than a global currency alternative. nevertheless, technology that made it be may still spawn an evolution in the way we posses things, transfer ownership and pay for goods and services in the near it-ridden future. key words: bitcoin, crypto-currency, functions of money, global currency alternative, litecoin introduction bitcoin, a peculiar crypto-currency has been the loudest buzzword in international finance over the last year or so, both for its spectacular and seemingly robust appreciation trend as well as for more recent equally ostentatious demise. it's maximum historical value hovered around 1300us$ in early december 2013 (although maximum daily close stopped at 1238us$), where from it fell to as low as 125us$ on february 21st this year. bitcoin is encrypted digital floating currency used within a computerized or phabletised peer-to-peer network and whose value and raison d'etre is generated and approved only by the spontaneous consensus of its users. stricto sensu, bitcoin with capital 'b' denotes the entire technology and an open-source software network released in 2009, while bitcoin with 1 institute of economic sciences, belgrade, marko.malovic@ien.bg.ac.rs. this paper is a part of research projects: 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements) and 47009 (european integrations and social and economic changes in serbian economy on the way to the eu), financed by the ministry of education, science and technological development of the republic of serbia. the usual disclaimer applies. malović, m., demystifying bitcoin, ea (2014, vol. 47, no, 1-2, 32-41) 33 lowercase 'b“ denotes the actual virtual currency devised back in 2008 when its specification and proof of concept was originally published via cryptography mailing list by an unknown entity pseudo-named „satoshi nakamoto“. strange as it may sound, bitcoin won the hearts of not only cyber-geeks but also much wider audience practically overnight and in less than two years became widely accepted and passionately sought global electronic currency. after reviewing the history of bitcoin and specificities of its cyber-construct, this paper adds to the critical analysis of bitcoin as an international currency alternative. just before and in the early days ofinternet, prominent figures in international finance like paul krugman or joseph stiglitz frequently repeated that world is not an optimum currency area and that cannot be such thing as the 'globo', i.e. truly international worldwide accepted pecuniary denominator which could be secure, politically unbiased, practical, fast to deploy and resilient to printing press abuse. however, can there be a globo in cyber space after all? could cyber space constitute an optimum currency area? may it happen that bitcoin/bitcoin overpowers american dollar and chinese renminbi on its way to the currency throne of international trade facilitator? is it conceivable for bitcoin to become a leading international reserve currency too at some point? in trying to answer these and related pertinent questions troubling bitcoin's volatile existence and robust popularity, the rest of this paper is structured as follows. section 2 reviews the history of bitcoin and its cyber-construct. section 3 deals with critical analysis of bitcoin as an international currency alternative, tackling both its peculiarities and more conventional functions of money. section 4 draws lessons from the essay and sheds some light on future allies of arguably fruitful research in this regard. history of bitcoin and its cyber-construct when launched and embraced six years ago by a handful of computer nerds, bitcoin was an exotic, stateless, nerd-related digital currency equipped with original software by satoshi nakamoto (pseudonym2) released under the mit licence that traded for couple of dollar cents and much curiosity. bitcoin hasn’t been secured by sovereign inventories of monetary gold or fx reserves of any kind nor it relies on any central clearing authority. and yet bitcoin has managed to grow in value almost geometrically3 and attract many a user because it apparently has found a way to by-pass the proverbial weaknesses of gold-linked and fiat currencies. namely, not a single government nor supranational authority can possibly interfere with existing or future supply of bitcoin, since the crypto-currency has been envisaged as an electronic money delivered and driven by complicated mathematical algorithms which are closely tying the growth rate of money supply to the amount of 2 in an online profile, he/she or them said he/she/they lived in japan. his/her/their email address was from a free german service. google searches for the name turned up no relevant information [benjamin wallace, 2011]. nevertheless, one of the main reasons why the author or authors of bitcoin haven’t been identified as yet is the fact that he/she/they never foresaw nor subsequently claimed any royalties from or property rights over the bitcoin platform [david yermack, 2013]. 3 only during november 2013 bitcoin’s exchange rate relative to us$ strengthened fivefold, whereas even contemporary much lower parity stands substantially taller than original 4.9 us cents which was bitcoin’s introductory value back in 2009 [yermack, 2013]. economic analysis (2014, vol. 47, no. 1-2, 32-41) 34 bitcoins already in circulation and up to the predetermined absolute limit [satoshi nakamoto, 2008]. according to problem-set algorithms made by nakamoto (2008), new bitcoins are “forged”, or rather awarded to pc users whose computers successfully solve(d) prespecified mathematical tasks. as a matter of fact, financial platforms take a lot of power to run and are expensive and insecure to be launched and maintained by one entity only. with bitcoin, individuals and/or groups willing to dedicate computer processing power to support the network are rewarded with bitcoins. there are 12 million bitcoins circulating presently, while the total of 21 million could be ‘discovered’ at most, by or near the year of 2140.4 bitcoin’s subunit is called satoshi, where one satoshi equals 10-8 of a bitcoin. therefore, bitcoin is designed around the idea of cryptography as a way of protecting the creation of liquidity while enabling utmost public transparency of money transfer, rather than relying on banks, clearing houses or otherwise defined central(ised) authority. limited and to the extent inevitable reflation is being distributed evenly (by central processing units’ power of devices engaged in money creation) between the so-called miners and consequently all network members. miners are owners of computers responsible for world-wide-web prospecting, uncovering, claiming, activating or, if you will, injecting newly acquired bitcoins into the global monetary circulation. in addition to mathematically limiting money creation and denying forgery, nakamoto (2008) developed an operating procedure for preventing the so called double spending, the long standing weakness of digital currency that one and the same electronic money unit may be illegally spent over and over again. his novel idea introduces an on-line ledger that records every single bitcoin transaction. the ledger is created through code-breaking work, done by a network of powerful personal computers owned by bitcoin “miners”, that validates each transaction [carter dougherty, 2014]. bitcoin uses public-key cryptography5, peer-to-peer network, and hashcash cpu cost protocol6 to process and verify digitally made payments. bitcoins are sent (or signed over) from one address to another with each user potentially in possession of multiple addresses. each order flow is publicly broadcast by being included in the so-called blockchain of bitcoin transactions with common origination, so that none of the coins can be spent twice. soon enough (after a 100 minutes give or take) each payment is locked in time by processing power which further extends the blockchain. namely, data blocks are randomly assigned with a header, which miners compete in trying to match with a ‘nonce’, an arbitrary number used only once, to get alphanumeric code (called hash) of prespecified dynamic difficulty. all in all, one can obtain bitcoins either by outright buying them or by receiving them in exchange for goods and/or services, other than 4 see chart 1 in the appendix. 5 public-key cryptography is a method of digital data protection which consists of an encrypted algorithm that is turn requires two keys to operate. public key is informatics datum or mathematical parameter that serves the purpose of encrypting plaintext or confirming a digital signature, while private key unlocks (deciphers) text or creates a cyber-version of ‘john hancock’. 6 cpu cost protocol forces a moderately hard data processing time on behalf of service requester which enables service provider to easily verify counterparty authentication and hopefully prevent denial of service attacks, spam abuse and alike. it is arguably simple and does not rely of central server, but it’s also prone to both type 1 and type 2 errors. in other words, it might either stuck the good transaction sent from computer with insufficient computing power or the malevolent illegitimate transaction might get through if the complexity net were lowered. malović, m., demystifying bitcoin, ea (2014, vol. 47, no, 1-2, 32-41) 35 originally claiming the currency through the ‘mining’ process [wallace, 2011]. users ought to have an internet access and downloaded bitcoin in order to be able to make or receive payments to/from another public address. apart from the keys briefly explained above, bitcoin generates a virtual ‘wallet’, i.e. digital account, or multiplicity of them, for network’s clients. a transfer request floats on the bitcoin cyber network until picked up and packaged within a data block [thomson-reuters, 2014]. when proper hash is computed, respective network clients are, for the time being, credited with 25 bitcoins per data block.7 hash is then assigned to the next transaction block, binding them forever in transparent and neat public history ledger which nakamoto (2008) dubbed a blockchain. thus, internationally mobile digital currency was born and accepted in less than four years on a tide of user-enthusiasm amidst and in spite of pressing financial and economic crisis worldwide. nonetheless, how safe is to tell it a fortune? what does it take for a currency to become the truly global, omnipresent, world money? critical analysis of bitcoin as an international currency alternative in my opinion, if bitcoin were to claim a seat in the leading global currencies club, let alone crowd out any of the regular members, it would have to fulfil four criteria: 1) to be safe, secure and reliable to buy, use or hold 2) to capture significant share of denomination in both invoicing and financing international trade, 3) to develop reasonably liquid derivative markets for risk management purposes and finally 4) to become respectful reserveas well as vehicle currency in international finance. let us preliminarily reflect on the fulfilment of the aforementioned criteria, with facts and data disposable thus far. it goes without saying that global currency acceptance criteria trace their grassroots in well-known functions of money, namely money as medium of exchange, unit of account, store of value (treasure) and world-wide common denominator. when it comes to safety, code for bitcoin is written beautifully, hence the probability of that being hacked is currently reasonably small, but security of wallets and supporting platforms on its way to outside world is simply appalling. the recent demise of mt. gox, one of the chief exchanges for bitcoin both in japan and more globally, is the case in point.8 even before 127,000 customers were mugged online in this particular mt. gox incident, bitcoin showed signs of weakness in that it’s encrypted format is difficult, but not impossible for 7 every four years (or exactly every 210,000 blocks later), number of bitcoins assigned to miners halves. for instance, first couple of thousand blocks earned their miners 50 bitcoins even though consisted of one birth transaction only. today, and approximately until 2017, blockchains will be worth 25 bitcoins a piece, while burdened with hundreds of thousands of transactions per block [wallace, 2011], [thompson-reuters, 2014]. from thereon, as the number on miners and claims goes up, the number of bitcoins awarded will exponentially decrease, e.g. transaction blocks assembled in 2139 will yield only one satoshi each, whereas those made in 2140 would have to rely on imposing a small transaction fee in the secondary market [ian gordon-vadim iaralov-david woo, 2013]. 8 mt. gox, a tokyo-based exchange, filed for bankruptcy in february after realising hackers had nicked some 850,000 bitcoins/480 mill.us$ in cyberspace, or circa 6% of all bitcoins in circulation [dougherty, 2014]. similarly, flexcoin bank storing bitcoins in hot wallets (online accounts) was closed down after being robbed just a week after mt.gox’s bankruptcy when hackers stole another 896 bitcoins worth over 600,000 us$ [kiran moodley, 2014] economic analysis (2014, vol. 47, no. 1-2, 32-41) 36 hackers to break and electronically steal. in other words, for all the users not able or not willing to mine their own bitcoins, an hour or two time lag before payment receipt information is received will henceforth prohibit wider audience utilisation of bitcoin. as pointed out by gordon, iaralov and woo (2013), when dealing with anonymous counterparty, a minimum 50 minutes wait is presently inevitable for enough blocks to be mounted to the chain, thereby protecting the transactors from double-spending. alas, exactly this window of opportunity represents a security breech in bitcoin exchanges, adding a credit risk on a top of fx risk exposure for bitcoin owners. ironically, the very anonymity guaranteed to counterparties which gave bitcoin such abrupt and widespread popularity, in these cases leave many bitcoin users/investors with little recourse as to retrieval of stolen funds while dealing with outside financial world [ibidem]. in conclusion, as to the first criterion of truly international currency status, bitcoin is generally very safe and attractive to buy and hold, especially as compared to cash. as a medium of exchange, it is visibly superior to e-banking and money wiring due to much lower transaction costs and astounding speed of transfer. it’s rather convenient to move around, since it comes in fairly large appreciated denomination as opposed to leading sovereign currencies (the largest dollar and yuan bill is 100 units only). in addition, a considerable anonymity it offers draws users in large numbers not only from the economic and (il)legal underworld, but also those wishing to evade abnormally steep taxation, capital controls or full-fledged confiscation. all the pros notwithstanding, bitcoin appears to be extremely unsafe to use for purchases, since it is currently vulnerable to hacking, especially when exchanged for other conventional currencies. with regard to the second criterion, bitcoin has come a long way and still offers a reasonably promising future. as bunch of commerce hastily migrates online these days, growing number of producers and merchants seem to be ready to accept digital cryptocurrency as means of payment.9 the first purchase of goods&services with bitcoin was a pizza, yet more recently, people have been using bitcoins to buy overseas villas, foreign automobiles, drugs&narcotics, arms, proprietary software etc. in a nutshell, international trade facilitated by bitcoin attracts either technology-enthusiasts or anarcho-libertarians who abstain from currencies connected with sovereign governments or indeed the mainstream international financial order. however, governments may and in all likelihood will, at some point unilaterally or multilaterally, impose series of controls and fees on bitcoin platforms in order to minimise illicit and black market activities or simply to do way with digital competitions which might bite into their shares of international seignorage [gordon-iaralovwoo, 2013]. moreover, the use of bitcoin’s decently encoded and pretty transparent transactions ledger can in fact be traced back by governments with enough funds and knowhow to do so, which will probably drive out (and away) some of money laundering and other illegal transactions from bitcoin as their denominator, rendering it with ambiguous popularity consequence. further still, ambiguities don’t stop here: in denmark and a number of other countries, one doesn’t have to pay taxes on transactions carried out through bitcoin which is definitely prosperous for bitcoin as medium of trade. to top it all off, however, vast 9 the list of famous e-commerce platforms that are accepting bitcoins includes among others: e-bay, paypal, tesla automotives, the pirate bay, silkroad (cracked down by us authorities), virgin galactic, zynga and so forth. malović, m., demystifying bitcoin, ea (2014, vol. 47, no, 1-2, 32-41) 37 majority of contemporary trade invoiced in bitcoin comes either from china or the usa, while both of their governments have severely limited -and publicly distanced themselves fromutilisation of bitcoins [yermack, 2013]. according to american irs classification, for example, bitcoin is not even considered to be a currency, but property, which invokes capital gain tax as an undesirable repercussion for bitcoins prominence in international trade. additional problem represents the practice of involving third party intermediation that accepts bitcoins and pays with conventional internationally accepted fiat money or gold, either already upon or immediately after the exchange of goods&services has been made. finally, bitcoin is in no way connected with national or international banking system, is not protected by any sovereign or supranational deposit insurance scheme and hence does not feature as international loans denominator at all. to the extent, conventional financial industry has pretty much abstained from the whole crypto-currency mania thus far. instead, investment euphoria seems to have been enhanced if not sparked by lobbying efforts of computer manufacturing and energy producing industry, since the whole business heavily relies on powerful cpus rarely encountered in regular pcs and enormous consumption of electricity.10 the latest novelty the introduction of litecoin11, financially diluted and (in respect to thus far required computer power) less demanding light-weight version of bitcoin, which is to roam those same bitcoin networks in parallel with original bitcoins, arguably lends itself to overall confusion, information asymmetry and downgrading sentiment towards the indigenous digital currency’s standing. in terms of the third criterion, bitcoin’s exchange rates vis-à-vis other leading currencies in the world exhibit next to no correlation whatsoever with values of either currencies or other financial assets for that matter, which makes it utterly useless for hedging fx risk in any direction [yermack, 2013]. perhaps that explains why there are no (not even plainvanilla) derivative contracts out there in the market offering the usual forward exchange rate agreements for bitcoin. at last, bitcoin’s global store of value function must be evaluated through the lens of its unprecedented volatility, ranging from less than five cents to over 1200us$ and back to inbetween 300/400us$ at the time of this writing, which makes it spot-on evident that bitcoin’s instability cannot be matched by those of otherwise notoriously volatile gold and silver, let alone the leading reserve currencies.12 put differently, bitcoin stands no chance of becoming internationally embraced reserve currency nor inter-currency unit of account vehicle for as long as it demonstrates such an unacceptable volatility.13 therefore, it should come as no surprise that some of the leading figures in international finance designated it as speculative investment at best or poorly masked ponzi game even [alex crippen, 2014], [nouriel 10 see chart 2 in the appendix. 11 apparently, litecoin is envisaged to provide faster transaction confirmation and yield less value per more realistic mining effort tuned down to cpu’s most households already posses up until the entire supply of 84 mill. litecoins is claimed. 12 yermack (2013), for instance, calculates bitcoin’s 2013 volatility (i.e. before the great plunge of early 2014) in the vicinity of 133%, whereas volatility of gold amounts to about 20% and that of the leading world currencies falls between 8 and 12% (see chart 3 in the appendix). by mid april 2014, bitcoin lost more than 60% of its value since the late 2013 peak. 13 see chart 4 in the appendix. economic analysis (2014, vol. 47, no. 1-2, 32-41) 38 roubini, 2014]. worse still, spectacular volatility of bitcoin is in turn additionally hurting its medium of exchange and unit of account functions, thereby closing the vicious circle bitcoin’s been spinning in as of late [gordon-iaralov-woo, 2013]. even though bitcoin’s wild gyrations in worth effectively relate it more closely to speculative investment vehicle than to a major global currency, clever technical design that bitcoin rests upon and respectful post-bubble purchasing power of more than 7 billion us$ may still spear-lead the process of pretty futuristic metamorphosis of the consumer-finance industry as we know it [the economist, 2014*]. open source software and public observance (i.e. peer-to-peer audit) of each and every transaction crack-opens the door for third parties to take and tweak existing technology to many different directions and fascinating offspring. for example, funds could be programmed to lend or collect themselves following a contractual decryptying clause, banks might start using crypto-currencies for inter-affiliate cash management, flats and cars soon could be entered/jump-started only with temporary (lease) or permanent (sale) set of public and private digital keys [the economist, 2014]. this may well sound like sci-fi curiosity at the moment, but as a matter of fact, many techstartups are deeply involved in developing precisely such commercial applications already. thus, despite the fact that bitcoin arguably failed to meet at least three out of four criteria for becoming a major global currency, incredible technological legacy it stems from may define entirely new and formidably important functions of money that digital crypto-currencies and crypto-currencies only could serve. one of those futuristic functions may prove to bring about that crucial junction which irrevocably transforms society over time. such a change, consequently, might reserve a currency throne and historical memory for bitcoin after all. conclusion having in mind that it lacks formal reserves or deposit-insurance scheme to back it up, yet it's also prone to hacking, bitcoin resembles and behaves more like a pyramidal investment vehicle than a global currency alternative. investment euphoria seems to have been enhanced if not sparked by lobbying efforts of computer and energy producing industry, since the whole business heavily relies on powerful cpus rarely encountered in regular pcs and colossal consumption of electricity. besides, bitcoin's next to none correlation with other major currencies' movements renders it unsuitable for managing fx risk or hedging purposes. it’s unit of account function is practically non-existing, thus compromising it for invoicing or vehicle-currency usage. bitcoin’s role as an international store of value is dramatically conceded by its bubble-like volatility pattern. in turn, bitcoin’s enormously unstable exchange rate undermines its otherwise promising utilisation as an international means of payment. nevertheless, technology that made it be may still spawn an evolution in the way we posses things, transfer ownership and pay for goods and services in the near it-ridden future. malović, m., demystifying bitcoin, ea (2014, vol. 47, no, 1-2, 32-41) 39 appendix chart 1. actual and projected bitcoin supply source: gordon, iaralov, woo (2013) chart 2. long-term volatility of bitcoin’s exchange rate source: thomson-reuters (2014) economic analysis (2014, vol. 47, no. 1-2, 32-41) 40 chart 3. short-term volatility of bitcoin as compared with other legal tenders source: gordon, iaralov, woo (2013) chart 4. explosive growth in effort and size of the ‘mining’ industry source: yermack (2013) references crippen, a. (2014), “buffet blasts bitcoin as ‘mirage’: stay away!”, cnbc news, march 14th, http://www.cnbc.com/id/101494937. malović, m., demystifying bitcoin, ea (2014, vol. 47, no, 1-2, 32-41) 41 dougherty, c. (2014), “the rise of bitcoin: is it real currency if it doesn’t come from the mint?”, bloomberg, mimeo. gordon, i.-iaralov, v.-woo, d. (2013). “cause and effect bitcoin: a first assessment”, bank of america & merril lynch fx and rates global research, december 5th. the economist (2014). “bitcoin’s future: hidden flipside”, the economist, march 15th. the economist (2014*) “money from nothing”, the economist, march 15th. moodley, k. (2014) “another bitcoin site bites the dust”, cnbc news, www.cnbc.com. nakamoto, s. (2008). “bitcoin: a peer-to-peer electronic cash system”, mit, cambridge, ma, mimeo. roubini, n. (2014). “bitcoin is a ‘ponzi game’”, the wall street journal, march 10th. thomson reuters (2014). “the knowledge effect: bitcoin graphic of the day”, thomson reuters, mimeo. wallace, b. (2011). “the rise and fall of bitcoin”, wired magazine, november 23rd, mimeo. yermack, d. (2013). “is bitcoin a real currency?”, nber working paper 19747, cambridge, ma, december. demistifikovanje bitnovca: lakrdija ili ključna alternativa globalno prihvaćenim valutama? rezime – bitnovčić, naročita kripto-valuta najglasnije je ponavljan termin u globalnim finansijama u poslednjih godinu dana, kako zbog svog spektakularnog trenda aprecijacije tako i zbog nešto skorijeg a jednako upadljivog gubitka vrednosti. nakon osvrta na istoriju bitnovčića i osobenosti njegove softverske konstrukcije, članak daje skroman doprinos analizi bitnovčića kao alternativne svetske valute. u poslednje vreme, međutim, kolebljivost kursa bitnovčića je tolika da on jamačno ne može poslužiti kao čuvar vrednosti. nadalje, ne prenebregnuvši njegovu rastuću iako truckavu kredibilnost kao razmenskog sredstva, potencijal bitnovčića za funkciju obračunskog sredstva je takođe krajnje upitan, budući da svi glavni e-trgovci smesta konvertuju prihode u bitnovčićima u neku od vodećih svetskih valuta zbog njegovog nestabilnog pariteta. štaviše, skoro potpuno odsustvo korelacije između vrednosti bitnovčiča i kretanja vodećih svetskih valuta čini ga nepodobnim za upravljanje fx rizikom ili pak defanzivno pokrivanje rizika. najzad, imajući u vidu da bitnovčić nije poduprt formalnim deviznim rezervama niti šemom depozitnog osiguranja, a pritom je vrlo podložan hakerskim napadima, bitnovčić podseća na i ponaša se više kao piramidalna investiciona tvorevina nego kao ozbiljna alternativa međunarodno prihvaćenom novcu. pa ipak, tehnologija na kojoj počiva još uvek može iznedriti evoluciju u načinu na koji ćemo posedovati imovinu, prenositi vlasništvo i plaćati za dobra i usluge u doglednoj informatički vođenoj budućnosti. ključne reči: bitnovčić, kripto-valuta, funkcije novca, alternativa svetskom novcu, laganovčić article history: received: 1 april 2014 accepted: 16 april 2014 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp118-138 research paper military logistics vs. business logistics: a comparative analysis slobodan aćimović1 | veljko mijušković1* | marko golubović2 1 university of belgrade, faculty of economics, department for business economics and management, belgrade, republic of serbia 2 morph networks, belgrade, republic of serbia abstract military logistics as a specific area of logistics management makes the difference between a wellsupplied and self-sustainable army which due to an efficiently created supply chain, can perform it’s military actions more efficiently, and an army that, due to insufficient commitment to military logistics activities creates an inefficient army that is cut off from food, water, and other basic resources without which the army can’t function. military logistics implies a complex system, formally separate, but essentially very close to business logistics. the aim of this review paper is to point out the features that distinguish military logistics management from business logistics management, but also to point out the complexities and limitations that military logistics brings with it. the methodology used for pointing out the abovementioned goals will be literature review and comparative analysis. the key determinants of the difference will be presented through the organization of the logistics supply chain, the subjects, participants and goals it involves, but also the risk, the corresponding law, logistics process management approach, innovations, organization systems, and the basic methods of transportation that military logistics brings with it. the given specifics need to be analyzed and compared with the key features of business logistics, where through the examples from practice will be pointed out the points of contact, but also the key differences between these two areas of logistics. the results of the analysis show that specifics of military logistics make this branch of logistics special, formally separated, but essentially very close to the area of business logistics. key words: military logistics, business logistics, defense system, comparative analysis jel classification: m20, m21, m29 introduction efficient management of military logistics, as one of the main features of a well-organized military organization, has determined the difference between successful and unsuccessful military campaigns in the history of military theory. each adequately organized army paid equal attention to the military strategy and the methods of combat, as well as to military logistics and efficient ways of supplying the army. poor organization of military supply chains has often been one of the key factors in the collapse of the entities and states represented by the military. military logistics as a specific area of logistic management makes the difference between a well-supplied and self-sustaining army which due to an efficiently created supply chain, can * corresponding author, e-mail: veljko.miljuskovic@ekof.bg.ac.rs slobodan aćimović, veljko mijušković, marko golubović 119 perform it’s military actions more efficiently and an army that, due to insufficient commitment to military logistics activities creates an inefficient army that is cut off from food, water, and other basic resources without which the army can’t function. however, even the recurring history that regularly reminded military leaders of the importance of logistics did not contribute to its more detailed research until the beginning of world war ii, when for the first time serious resources and research were directed towards military logistics. since the topic of military logistics is usually studied in military circles, there are not so many papers that analyze the relationship between business and military logistics. papers that do research the connection between these two logistics branches usually explore specific areas of military logistics such as thought leaders, the theory of reasoned action analyzed on the examples of military logistics officers, etc. military secrecy (confidentiality), as will be stated later in the paper, prevents in-detailed and extensive research on this topic. the basic research hypothesis tested within this paper, which is of review nature, is: h1: the specifics of military logistics make this branch of logistics special, formally separated, but essentially very close to the area of business logistics. the methodology used for testing h1 is focused on literature review and comparative analysis. following the research hypothesis, the first and second part of the paper deal with the theoretical aspect (concept and significance) of military and business logistics, as well as its key principles. assuming that one of the basic goals of both military and business logistics is the efficient organization of its key subsystems: transport, warehousing, inventory, procurement and logistics information system, within the third part of the paper a comparative analysis of the management organization of these two specific areas of logistics is performed. military logistics: concept and significance military logistics has many definitions. they can usually be found in national defense strategies or military manuals. the most precise definitions are usually made by the military academies. however, each army has certain activities that it considers part of its military logistics, while other countries have some specifics of their own. an additional problem in defining is the institution of military secrecy (confidentiality) which prevents academic research in certain fields, as no army fully reveals its way of organizing to the public. as there are no historical sources that definitively determine the origin of the word logistics, it is considered that the word logistics originated from the greek logos, which primarily means account (tepić et al., 2011). we find a similar problem in the term military logistics, which was not treated as a separate discipline in relation to business logistics, and therefore as a term it was used exclusively in military circles. the mission of military logistics implies the delivery of all necessary military materials and information to bases, battlefields, or other key military points such as military ports, stations, friendly lines (stanojević et al., 2018). in addition to delivery, military logistics also deals with the analysis of demand based on inputs delivered by logistics officers in the field, the acquisition of required resources, and only then the distribution that is followed by maintenance. so, every military logistics must, first of all, give an answer to the question of what the army needs, then how to get there and only then how to deliver what is required. the serbian army defines military logistics in article 45 of the law on defense, where “the logistical support of the serbian army is realized in the function of meeting its needs in the following activities: 1. production, modernization, and maintenance of weapons and military equipment; 2. supply of weapons, military equipment and other resources; 3. general logistics needs; 120 economic analysis (2021, vol. 54, no. 1, 118-138) 4. planning, construction, and maintenance of infrastructure facilities; 5. transportation of people and resources; 6. health protection, safety and health at work protection, veterinary protection, environmental protection, fire and explosion protection and other types of protection. “(službeni glasnik rs, 2018) as it can be seen, the very concept of military logistics is broader than business logistics, because military logistics in addition to transport and storage includes many other activities such as medical health activities, maintenance of critical military infrastructure, transport of specific materials and equipment, but also veterinary protection and activities military logistics in humanitarian disasters, pandemics (example of using the army for civilian purposes due to the covid-19 pandemic), etc. an interesting part of military logistics that is usually neglected are the so-called internal relocations of soldiers and their families. due to their specific activities, military personnel often moves, and behind such a complex task there are even more complex logistical activities. according to the u.s. department of defense, over $1.7 billion is invested annually to transport over 600,000 units of equipment during internal relocations alone (solis, 2003). due to the wide range of logistics activities, the cooperation of logistics and non-logistics staff is of key importance, given that logistics activities have a strong impact on the operational part of the army. as the military operating practices observed a decline in the quality of performance of duties due to poor communication between logistics and non-logistics staff, which usually leads to a misunderstanding of the function of logistics officers, military science has been devoted to ways of improving relations between the two branches of the military which must intensively cooperate in order to achieve an optimal result (andrejić et al., 2011). a retired army general of the united states, denis reimer points out that "there can’t be a revolution in military affairs without a revolution in military logistics" (anderson et al., 2007), as military logistics entails the full efficiency of the operational part of the army. traditionally, logistics analysts have always viewed certain military logistics activities separately from the transport itself, such as the activities of maintenance and repair of equipment, or the methods of organizing storages and bases (zeimpekis et al., 2015). regardless, the development and improvement of military logistics itself have always been integrated, i.e. although certain activities were observed and researched separately, they were viewed as part of a complex and integrated unity as most if the military logistics activities are multidisciplinary and multifunctional (juskowiak et al., 2004). one of the best examples of the impact of militarylogistical maintenance activity on the efficiency of the operational part of the army is the fact that doubling the maintenance of an f-16 fighter aircraft provides a 70% increase in flights (andrejić et al., 2009). this data provides insight into the potential of increasing the combat readiness of an army by increasing logistics capacities. as it can be seen, the importance of military logistics stems from the needs of military personnel and equipment. the two key resources that the military must have at all times are fuel and ammunition (bates, 2003). tanks without fuel will not move, a soldier without food will be no more than a pile of meat with a rifle, and a base without electricity will be a traditional roman tent that cannot survive in the conditions of modern warfare. of course, logistics alone cannot win the war, but in combination with strategic and operational military management, logistics is becoming the main driving force of military operations. development of military logistics although the notion of logistics is of more modern date, military logistics has been the subject of study for thousands of years. it was first perfected by the greeks during the reign of alexander the great. his empire has suffered from the problem of overextension from which all large empires have suffered. namely, this problem occurs when the territory of the empire is so slobodan aćimović, veljko mijušković, marko golubović 121 vast and wide that it is almost impossible in a military sense (but also in the economic and administrative sense) to supply every critical point of the empire. alexander's empire stretched from modern macedonia in the west, all the way to the area that is today known as india in the east. one part extended to modern-day egypt as well, which was a key food supply point for alexander's troops. given that the key food center was egypt in the south, the center of recruitment in the west (mercenaries, greeks, macedonians and balkan tribes), the expansion of the empire created the need to develop military logistics and supply chain that provided routes of key resources and recruits that enabled alexander's long-term state of war and the conquest of the most remote territories. after the collapse of the empire of alexander the great, the basics of military logistics have been written down and kept as the strictest war and state secret and were inherited by the romans. the romans were the first to perfect specialized logistics channels, and perfect them with modern ways of supplying food and water. they were the first to create military warehouses and military bases, which included key supply points and logistics operations. it is precisely the strategically placed bases that eliminate the effect of overextension, and this organization of logistical activities enabled the romans to be a self-sustaining army, from which the longstanding status of a great power arose. however, the development of logistics after the fall of the roman empire was doomed to centuries of use of outdated methods of storage and transport. during the middle ages, most resources were invested in military strategy and weapon technology, completely neglecting the military logistics development. mild signs of improved military logistics were seen in the 14th century, in the maritime warfare of the english army. namely, england is one of the first countries to improve transportation by water, as the geographical position of the country is such that it requires a strong focus on the navy. problems arose not only when crossing the english channel, but also on the return, because english soldiers had to have an efficient return after landing on the territories of brittany, which in the case of warfare in the 14th century was very dangerous as they can take heavy fire while trying to cross the channel. the english were the first nation to create specific logistic channels through water surfaces so they can reduce losses due to crossing the various water surfaces such as english channel, both on arrival and on return which in most cases was more dangerous (lambert, 2011). english military logistics were successful despite the difficult bureaucratization of the english (later british) empire for three key reasons: 1) by the insular nature of britain which gave the sea an important influence on branches of supply, 2) by the partnership of the state and the private sector, and 3) by the ideas and ethics that both united the state and gave its bureaucracy a special administrative culture (morriss, 2011). it will be determined later that these three factors are crucial when it comes to developing the military logistics branch. however, a glimmer of hope for military logistics appeared during the napoleonic wars. the very term logistics was the inspiration for the military rank of logistics officer (fr. maréchal des logis) in the french army, where this area is being formalized for the first time (milovanović et al., 2009). these officers had the task of perfecting the logistical activities that enabled napoleon to ignore the problem of overextension for many years (komarek, 2019). the further development of military logistics is reduced to the repetitive use of outdated methods from the time of the napoleonic wars, so the period of the 19th century was important in the military-logistical sense exclusively due to the development of the railway. along with the development of the railway, strategies for sabotaging railway systems were being developed, which in relation to other means of transport of that century (steamships, riverboats, trucks) were more susceptible to attacks, and it was necessary to develop serious strategies for defending railways and wagons. (hess earl, 2017). for the first time, serious investment in military logistics could be seen only in the second world war. a little-known fact that most military strategists agree on is that the german army 122 economic analysis (2021, vol. 54, no. 1, 118-138) lost world war ii largely thanks to the logistical superiority that the allies had. the germans viewed logistics officers as part of an inferior military cadre and invested 80% of their resources in military technology, while the allies invested vast resources in new and more modern logistics methods (boog, 1982). this completely erroneous strategy was best seen during the operation barbarossa in 1941, when the german army invaded the soviet union. due to poorly organized military logistics (the german leadership put all its focus on the operational part of the army), the german army did not arrive in time to occupy the key point of military supply moscow. it did not succeed in ukraine either (the key point of oil supply) or in the north during the siege of leningrad (the key point of norwegian oil supply). in addition, the supply lines of the german army were getting longer, the trucks were damaged due to poor infrastructure, and the consequence was the weak morale of the soldiers at the front. the extremely inaccessible terrain forced the german army to use traditional modes of transport which were inefficient in the conditions of modern warfare. the soviet leadership was aware of the weak investment of the german army in logistics capacities, and focused its activities on the sabotage of the railway, which at that time was the only developed distribution channel for the germans. precisely on this example, one can see the direct and indirect dependence of the operational part of the army on military-logistical activities. on the other hand, the soviet union also had several diplomatic and natural allies. the natural allies were the climatic conditions (russian winter) and the massive geographical area of the soviet union, which prevented efficient supply chains of the aggressor army. the diplomatic allies reflected through a number of military-logistics corridors aimed at supplying the soviet union with allied forces, such as the extremely important but complex "persian corridor" (leighton et al., 1995). after world war ii, all military theorists began a more detailed study of military logistics, which over time proved to be one of the key causes of lost wars. for the first time in the 1950s and 1960s, armies around the world introduced the concept of military logistics into their strategies, which is associated with the procurement, maintenance and transportation of military facilities, materials and personnel (ballou, 2006). due to the formation of block division and the cold war, both hegemons (the ussr and the usa) begin serious investment in military logistics, development of critical and national infrastructure. the goal was to perfect the military logistics management so that the troops and their equipment are always ready in case of conflict with the other side (milenkov, et al., 2015). even the military strategy is elaborated in such a way that one of the key military activities involves cutting the enemy's supply chain and attacking the production and transport facilities of the other side. wars in the second half of the 20th century took place in the most remote places, such as the war for the falkland islands between britain and argentina. this conflict is specific because of the logistical problems that the british army encountered during the conflict. due to the great distance and guerrilla warfare of argentinian soldiers, the british army found itself facing a problem of mobility. mobility is determined by “the comprehensive readiness of a nation’s transportation network, depots and ports to respond to the crisis within the time frame necessary”(privratsky, 2014). britain completely underestimated argentina's readiness for war, and britain's readiness to react (mobility) was extremely low, which led to major problems during operations in the falkland islands. through this brief historical overview, we can see the importance and the development of military logistics. today, military logistics is the focus of every serious military force in the world, and serious investments are made in military logistics activities so that the operational part of the army always has the support and efficiently performs its tasks with the help of military logistics. slobodan aćimović, veljko mijušković, marko golubović 123 key principles of military logistics principles in their original form imply certain rules that guide a certain discipline. like any logistics, military logistics is based on several key principles such as prevision, integration, continuity, efficient response, and improvisation (walden, 2006). prevision as a key principle of military logistics implies the identification, then the accumulation and maintenance of resources and information necessary for the smooth functioning of the army. military logistics uses prevision (forecasting) as the basic way of identification, accumulation and maintenance, where, based on pre-determined parameters, it analyzes resources and information without which the army cannot function. integration implies the dependence of the operational (strategic) part on the logistical part of the army. this interdependence conditioned the integration of these two military areas as only integrated ones can bring the desired effects. therefore, integration implies the cooperation of military logistics and strategy. continuity as a principle exists in every logistics area and implies the existence of a stable and regular military supply chain. the military supply chain is not a short-term one, nor does it exist ad hoc for the needs of a particular mission. above all, it has continuity, i.e. it is permanent and functions as a continuous connection of different actors. an efficient response as a principle of military logistics implies efficient filling of gaps on the ground. in reality, it is a classic qr management system (quick response) which in military logistics has been developed with the help of various military information systems such as logfas-sdm developed by sap, or gcssarmy, lmp/plm, and sale systems. improvisation is a special principle of every logistics and implies the ability to adapt. due to unknown factors and the state of war, military logistics must always be ready to improvise and adapt on the terrain. this type of improvisation implies constant innovation, which is necessary because there is no universally acceptable way of managing military logistics, nor is it possible to create it. this conclusion can be justified by the fact that no logistics work is done twice due to differences in the field, subjects, but also the essence of the logistics work that differs from case to case. the given principles are closely connected and inseparable, so they can be viewed exclusively as a whole and as integrated key principles of military logistics. it is possible to analyze them separately and improve their activities, but it is necessary to take into account the integration and interdependence of the given principles during the analysis in order to create a comprehensive solution. business logistics: concept there are numerous definitions of business logistics and there is no one universal definition used, both in practice and in academic research. logistics as a dynamic, but also a new discipline is still evolving and the lack of universally achieved guidelines should come as no surprise. like military logistics and the supply chain, business logistics, and the supply chain represent the bloodstream of a company that carries out its activities behind a screen (keegan et al., 2017). the first time the term business logistics was mentioned in its true form was in 1964 in the book of james l. heskett "business logistics: management of physical supply and distribution" (heskett, 1964). a comprehensive definition of business logistics has been provided by the council of supply chain management professionals. for the council, logistics management and supply chain management form two separate instances in which supply chain management forms a broader area defined as the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities, and collaboration with 124 economic analysis (2021, vol. 54, no. 1, 118-138) channel partners (suppliers, intermediaries, third parties and consumers) whose main goal is to satisfy consumer demands (vitasek, 2013). logistics management activities, on the other hand, by definition of the council, “typically include inbound and outbound transportation management, fleet management, warehousing, materials handling, order fulfillment, logistics network design, inventory management, supply/demand planning, and management of third-party logistics services providers. to varying degrees, the logistics function also includes sourcing and procurement, production planning, and scheduling, packaging and assembly, and customer service. it is involved in all levels of planning and execution--strategic, operational and tactical. logistics management is an integrating function, which coordinates and optimizes all logistics activities, as well as integrates logistics activities with other functions including marketing, sales manufacturing, finance, and information technology” (vitasek, 2013). as can be seen, logistics management is a narrower discipline than supply chain management itself and is the part of it that forms the foundation of any enterprise. confusion most often occurs when using these terms as synonyms where the term logistics is older, but also simpler than the term supply chain (milovanović et al., 2011). the physical distribution itself is only one of the elements of logistics management, which includes many other activities besides physical distribution, where the difference is made exclusively between marketing logistics and physical distribution. the same situation is with supply chain management as logistics is only one part of the supply chain and as such, the supply chain is a broader concept than logistics management and supply chain management itself is the integration of all business activities from primary supplier to the final consumer (cooper et all., 1997). the best way to understand the difference is through the use of marketing analogies. it is impossible to put all marketing jobs under one organizational cap, usually the marketing organizational unit means promotional activities, but that does not mean that jobs like sales, market research, etc. do not fall under marketing activities (aćimović, 2006). thus, marketing as an organizational function is not the same as marketing as a business philosophy of the company, and therefore logistics as an organizational function is not the same as the supply chain as the business philosophy of the company and the entire distribution channel, because it implies a broader concept than logistics activities (aćimović, 2006). although the topic is controversial and there is no consensus among the professional and academic public, we will consider physical distribution management as a synonym related to logistics as an inseparable part of it, while we will view the supply chain as a broad term that includes logistics management. development and importance of business logistics globalization as a process of liberalization and increasing interdependence of the world has brought numerous changes in the xx and xxi century. the changes were felt in all spheres of business life, including the sphere of logistics activities. the interdependence of the world and the growing connection forced the companies to internationalize, which had to be accompanied by successfully organized logistics processes that would be able to deliver the desired product to consumers at the right time and in the right place. although primarily a military discipline, which formally separated from it only recently, it essentially had its own development and trends that it developed in parallel with the development of military logistics. however, deeper research of business logistics and the way in which it can increase the value and enable better competitiveness in the market of a company did not occur until the second half of the xx century. under the influence of globalization, stronger internationalization and interdependence of the market, but also the increasing costs of slobodan aćimović, veljko mijušković, marko golubović 125 logistics activities, business logistics is beginning to be the subject of detailed research by the company's management. the basic importance of business logistics is in creating added value for the company in order to become more competitive in the market. namely, until the second half of the 20th century, companies improved their business in numerous ways in order to create value for consumers. investing in the product itself or the production and technology was the most common one. in the specific case of investment in production, the basic idea stems from the fact that it is not wise to reduce production costs through low-quality substitutes or low-quality materials, but it is much more rational to invest in new technology or machine that can produce more products per hour and thus be more efficient in responding to product demand. a similar situation exists when we talk about improving the value of products through the improvement of the marketing branch. through creating a brand, we influence the identification and creation of awareness about our product. through the creation of special and special sales techniques, we influence the increase of trust, which enables us to sell more easily and efficiently. it is in this form of innovation and value creation that comes at the end of the 20th century in logistics activities. the basic idea was to reduce costs while achieving the same or better quality. logistics activities were unfairly neglected in this process because in that period the cost structure could not be better monitored, and thus determine that a huge part of the costs are actually borne by logistics processes and that we can reduce costs by more efficient management in logistics processes. since paying more attention to innovation in logistics activities, many companies have succeeded, not only in their original intention to reduce costs but also in adding value to consumers through faster and more affordable deliveries around the world. through numerous modern management models, the company's products and services become available to anyone at any time. however, why have innovations in the field of logistics activities been so successful? there are a number of reasons, but it is certainly one of the key time savers. the man of the 20th and 21st century lives a dynamic and fast life. the internet has taken communication to a much higher level, and many things are happening much faster than they would otherwise. such technological innovations have created a man who considers time his most precious resource. instead of traveling for a few hours to the warehouse to pick up the ordered construction material, usually by his own transport, he now has the option of having the same material delivered to his home, business or chosen address within a few hours. in that way, the entrepreneur becomes much more efficient, and numerous products whose availability was an unimaginable concept at the beginning of the 20th century now become available with one click. in addition, lower transport costs, but also better organization of logistics activities imply a lower price of logistics activities, and thus a lower price of products, which enables price competitiveness of products or services on the market and improvement of logistics capacities. hence the importance of business logistics. as in any area of business management, the company strives to improve the efficiency of individual sectors. by improving the organization of the work of logistics activities, value is undoubtedly created for consumers. military logistics vs. business logistics: a comparative analysis comparison factors in order for the comparative method to be successful, it is necessary to define comparison criteria that have been singled out due to certain factors that make business or military logistics specific. therefore, it is important to note that there are many specifics of both logistics and that we would go beyond the scope of this paper if we analyzed absolutely every part of the logistics process, either in military or business terms. during the analysis of the specifics, some key 126 economic analysis (2021, vol. 54, no. 1, 118-138) criteria were singled out, which will serve as defined criteria for comparison. as comparison criteria we will define: 1. key activities, organization of flows, and goals of logistics activities, 2. logistics channels and key actors in logistics processes, 3. organization of transport activities, 4. risk and corresponding law, 5. logistics process management approaches, 6. innovations, 7. logistics organizational structures. comparative analysis comparison factor 1: key activities, organization of flows, and goals of logistics activities the notion of business and military logistics is extremely important as a criterion of comparison of how certain similarities and differences can be drawn from the definitions themselves. in order to determine the degree of matching, it is necessary to break down the parts of the key business and military logistics activities, and thus determine the basic factors that make business and military logistics specific. military logistics includes activities such as: 1) production, modernization, and maintenance of weapons and military equipment; 2) supply of weapons, military equipment and other resources; 3) general logistics needs; 4) planning, construction, and maintenance of infrastructure facilities; 5) transportation of people and resources; 6) health protection, safety and health at work protection, veterinary protection, environmental protection, fire and explosion protection and other types of protection. on the other hand, business logistics includes activities such as: 1) transportation management; 2) warehouse management; 3) inventory (stock) management; 4) information management, and 5) customer service management. as noted, military logistics encompasses a wider range of activities than business logistics. thus, we can state that joint activities of both types of logistics represent the transportation management, warehousing, inventory (stock) management, information management, and customer service management. thus, the key activities of business logistics are inherent in military logistics as well. military logistics include additional activities that are specific exclusively due to the very subject of military-logistical activities, such as production, modernization and maintenance of weapons and military equipment. specificity does not arise so much from the activities themselves (production, maintenance, modernization), but from the objects of the same (military equipment and weapons). another specificity of military-logistics activities are planning, construction and maintenance of infrastructure facilities. the difference again arises not from the activities themselves (planning, construction and maintenance of infrastructure facilities), but from specific types of infrastructure facilities, such as critical infrastructure and national logistics systems. national logistics systems are a term that is mostly used in military logistics as they represent the logistics capacity of a country. they are also used in business terminology and represent the entire infrastructure capacity of a particular economic entity such as countries or economic unions. on the other hand, critical infrastructure is a term inherent in military logistics. in business logistics, there are more important and less important roads or warehouses that are extremely important for the logistics channel and whose loss would have a negative impact on logistics processes. however, in military logistics, the consequences of the loss of such types of critical infrastructure are much greater because the risk of loss includes broader activities, as will be explained later in the paper. the third and key specificity of military logistics is reflected in the health and medical activities that business logistics simply do not know. activities such as health care, safety and slobodan aćimović, veljko mijušković, marko golubović 127 health at work do not fall under business logistics activities. finally, it can be stated that activities in support of environmental protection, veterinary, health care and other types of protection are activities specific to military systems as part of military activities during a state of emergency or the use of the army for civilian purposes. business logistics also has an impact in the field of the environment (green supply chain and reverse logistics) but does not directly deal with the above mentioned activities. these similarities and differences can be shown in table 1. table 1. key logistics activities of military & business logistics key logistics activities military logistics business logistics transportation management   warehouse management   inventory (stock) management   information management   customer service management   production, modernization and maintenance of weapons and military equipment   planning, construction and maintenance of infrastructure facilities   health protection, safety and health at work protection, veterinary protection, environmental protection, fire and explosion protection and other types of protection   source: authors during the organization of military transport activities, special attention is paid to the organization of military logistics activities. depending on the danger and the substance of the object of transport, a special method of transportation is chosen. this is how we distinguish the so-called controlled items such as money, mail, or precious metals, and sensitive items that may pose a danger to public safety such as weapons, ammunition, explosives, etc. (haraburda, 2016). the goals of military logistics in a narrower sense can be divided based on the object and purpose of military logistics. purpose based goals include the creation of material, infrastructural and health conditions for life, work and execution of dedicated tasks of the serbian armed forces, while object-based goals include only labour, production and services that need to meet individual and general needs of the defense system as whole (andrejić et al., 2016). if we look at the goals in a broader sense, it can be noted that both military and business logistics have the same goal to satisfy the end-users (customer service management). the difference is reflected in the fact that in the case of business logistics the final users are consumers (civilians), and in the case of military logistics the final user is the operational part of the army. in addition to this common goal, military logistics also has a specific goal in the form of supporting the operational part of the army in eliminating enemy forces. therefore, military logistics does not achieve this goal directly, but indirectly through support to the operational part of the army. in addition to the given goals, it is necessary to analyze a separate marketing goal of logistics management, which must fulfill the so-called 5r concept (five rights): 1) the right product, 2) in the right place, 3) at the right time, 4) in the right condition, and 5) by the right costs (christmas et al., 2019). finally, there is a clear similarity between the key activities between military and business logistics, where the differences are essentially reflected in the subject of their activities, which is becoming increasingly mixed given the growing influence of the private sector on military logistics activities. 128 economic analysis (2021, vol. 54, no. 1, 118-138) comparison factor 2: logistics channels and key actors in logistics processes when we analyze logistics channels, we primarily analyze physical distribution channels, so the key difference between military and business logistics channels is of a marginal and terminological nature. here one can see the importance of this comparison factor as the logistics channels and the actors form the pillar of any logistics process. thus, both military and business channels include direct, indirect and flexible channels, because both combine the use of intermediaries. the only difference is that military terminology sees as an additional intermediary the military bases within which warehouses may or may not be located. thus, military warehouses can be the same as business ones, created separately for the purpose of storing and manipulating a certain good. like business warehouses, military warehouses have specific warehouses that serve to store hazardous materials, specific products, etc. strategic and operational bases are terms inherent in military logistics and business logistics does not know them, although there are similarities with distribution centers or the warehouses themselves, with the notion that military bases are far broader and more complicated than the warehouses and distribution centers. the use of bases enables the reduction of the costs of maintenance, transition, security operations, transport and deployment of the army as the supply chain itself is reduced and divided into several parts (lostumbo et al., 2013). during the organization of the logistics channels, various actors also appear. actors inherent in business logistics are wholesalers, retailers and international intermediaries (sales agents, freight forwarders, 3pl and 4pl participants), while actors inherent in military logistics are private contractors, military bases, operational centers, checkpoints, logistics officers, and the state as the buyer, seller, manufacturer (dedicated state-owned enterprises), or state as a monitoring instance. it can be noted that the joint actors certainly represent the state (regulatory body), producers (outside the competence of the state) and warehouses as key intermediaries. wholesalers and retailers also appear in military activities, but only as a source of supply (food, equipment, spare parts, semi-finished products) or a source of sales where the military industry can sell its products (weapons, ammunition, etc.) to retailers such as shooting ranges, weapons stores for civilian use, etc. the military also trades internationally with other countries. however, this type of trade is specific, and it is under a special legal and organizational framework, as the arms trade is usually under the jurisdiction of the state itself. in conclusion, it can be noted that the logistics channels are identical, but that the key difference stems from the actors where the state plays the biggest role in military logistics activities, while in business logistics activities there are several actors that can have a dominant influence such as wholesalers or other intermediaries such as 3 pl and 4 pl providers, international freight forwarders, etc. the key intermediary that connects business and military logistics are private contractors which are the main entry point of private sector to the military sphere. private contractors combine the private and military sectors in an efficient manner, and represent an instance that is slowly but surely taking over certain military activities, which in some cases include logistics operations. comparison factor 3: organization of transport activities when it comes to organizing transport activities of necessary goods and information, business and military logistics use all transportation methods, with superpowers such as the united states and the russian federation most often using air traffic because of speed (o 'hanlon, 2009), and therefore one of the key related activities of military strategy is to secure the airspace to keep the supply chain secure. this is especially evident in military logistics, which has specific services, which include, among other things, logistics services such as technical, quartermaster, medical, veterinary, traffic and construction services. the key difference is reflected in the manner of physical distribution in a state of emergency or war. during the peacetime period, the way of organizing transport activities in business and slobodan aćimović, veljko mijušković, marko golubović 129 military logistics are in most cases the same, with military logistics emphasizing road and rail traffic due to cost reductions. in a state of war, military logisticians prefer faster and more efficient modes of transport, and air traffic is usually used. as a state of war is a specific state, the state usually approves much higher costs for the needs of the army, and thus the army can in most cases afford the use of air routes. the best example of the use of air roads during a state of war is certainly the way of delivering the necessary ammunition and manpower to the front line. the use of railways and trucks would be inefficient due to high risk (enemy actions), and thus the airline (provided that the airspace is under the control of one side) is the fastest and safest mode of transport in the army. along with the state of war come special types of transport itself (transport with the lights off while using alternative routes) which business logistics does not have to use. additional specificity is in the security of transport vehicles. this is of course also realized in business logistics through companies that provide security services, but in military logistics this role is taken over by the army itself, depending on the transport vehicle. the third specificity implies greater flexibility of the army in choosing transport routes. take for example the need to transport a particular product on a route that includes several alternative routes. the final destination is separated from the main roads by a water surface. in this case, business logistics is limited by national logistics capacities, i.e. already created roads, and would be forced to choose a truck-ship route or to use an airplane. on the other hand, military logistics is much more flexible and has the ability to create new routes for the needs of the military. thus, with the cooperation of military engineers, a temporary bridge can be created, which will enable a cheaper and integrated type of traffic. after analyzing the given specifics, one should not make the wrong conclusion that military logistics does not take into account cost analyzes. it does so on the same level as business logistics, but with a key difference in the relationship between peace and war, where the state of war introduces much greater state influence, while on the other hand, business logistics largely depends on the market itself. all other activities related to the transport and physical distribution, such as loading and unloading are similar. other methods are used as well such as cross-docking method, pallets, intermodal transport, combination of different transport methods, etc. when we analyze costs, we need to analyze the most common costs. this will be presented through a tabular presentation of the costs of maintenance and use of selected vehicles of the slovenian armed forces in table 2. table 2. cost calculation results for the selected vehicle – slovenian armed forces no. description value in eur/km partial share in % overall share in % 1 maintenance costs 1.1 preventive maintenance 0.15 14.7 7.6 1.2 remedial maintenance 0.72 70.6 36.6 1.3 fixed maintenance cost 0.15 14.7 7.6 total maintenance costs 1.02 100 2 direct use cost 2.1 variable cost of use 0.61 64.2 31.0 2.2 fixed cost of use 0.31 32.6 15.7 2.3 decommission cost 0.03 3.2 1.5 total direct use cost 0.95 100 3 total cost of use 3.1 total cost 1.97 100 source: grašić, leon, lerher tone, and bojan rosi. 2016. “evaluating costs of vehicle use in military logistics”. tehnički vjesnik, 23(6): 1679-1686 table 2 shows the values of maintenance costs and direct use of selected vehicles, the cost per kilometer expressed in euros as well as their percentage where the total cost per kilometer for 130 economic analysis (2021, vol. 54, no. 1, 118-138) the selected vehicle is 1.97 eur. an additional interest is reflected in the share of different cost categories. as can be noticed, the largest share in the costs has the remediation that falls under the category of maintenance costs, whose overall share in the costs is 51.8%. other costs represent the costs of using military vehicles where variable costs of use have a 31% overall share, while the total share of costs of use is reduced to 48.2%. from these data, it can be concluded that a large part of the costs goes to maintenance, which shows the great importance of this category of military-logistics activities, without which the organization of transport activities would not be complete. an additional factor that greatly influences the choice of the method of physical distribution is the development of the army itself, as well as the economy of the country that the army protects. the us military has much greater resources than e.g. of the german army and as such has greater possibilities. however, analyzing the conflicts throughout history and the role of logistics, one trend can be noticed in them, and that is that the country with most resources does not always win wars. thus, logistical problems in the form of route, transport and security choices were best seen in afghanistan, where coalition forces led by the us military had major problems, although they were well funded, while terrorist units used traditional modes of transport with domestic knowledge and much more traditional vehicles that were more successful in these conditions than modern technology. here we come to the final specificity of logistics operations when it comes to the way of organizing transport activities, which are innovation and resourcefulness. the key specificity is in the form of similarities, where innovation and resourcefulness are imperatives when it comes to the organization of logistics processes. in the end, if the military and business transport vehicles were placed next to each other, the only difference would be seen in the colors and the way of securing them. it is in this specificity that the similarities of business and military logistics, which are constantly learning from each other, can be best seen. comparison factor 4: risk and corresponding law the biggest difference between business and military logistics is reflected in the risk that participants in logistics processes have. while a failed organization of business logistics processes for one company can become a major factor of elimination from the market, for military logistics a failed organization of military logistics processes can lead to the loss of human lives. the problem in measuring risk is that the analysis cannot take into account the logistics itself, but also the company or the army as a whole, because each logistics represents the bloodstream of every company or army. therefore, absolutely every action on the logistical side has a causal relationship with the entire company or the army (each action has a consequence) and this effect is called the "butterfly effect". in order to better understand the “butterfly effect”, it is necessary to show it on a practical example from business practices. the question we need to ask is how one logistical mistake can lead the whole company to bankruptcy? if the company does not dedicate resources to logistics systems, in the long run, there is a dysfunction of other departments as all departments are integrated into one system. on the other hand, delays in deliveries lead to dissatisfied consumers and partners. these two "marginal" mistakes, when neglected for a long period of time, can lead to loss of income and waste of resources, which is already becoming a serious problem that can lead to elimination from the market. the situation is similar to military logistics. unsuccessfully achieved goal in the form of protection of territorial integrity, sovereignty and human lives is a possible consequence of the poor organization of military logistics systems. on the other hand, in peacetime, the risk is much higher in business logistics, because all costs that the military makes can be covered through state aid, while that is less likely to happen in business logistics, and therefore the military is not slobodan aćimović, veljko mijušković, marko golubović 131 threatened by elimination from the market, thus the military logistics can maintain constant high costs precisely through the state apparatus, which enables greater sustainability. on the other hand, bankruptcy in the market is inevitable if the company does not know how to control the incurred costs. if we look at the corresponding (competent) law as one of the specifics, we will notice great differences. the army is under the jurisdiction of special legal acts related to military activities, and usually, completely special and specific rules apply to the army and its activities due to the nature of its work. these acts can be both international and national, and the situation is further complicated if we take into account that the logistics activities of the army include both veterinary and ambulance vehicles. thus, in the case of military logistics, we have international humanitarian law in the form of the geneva conventions, but also every other type of military law that states usually regulate by special acts. on the other hand, business logistics operate under a wide range of legal acts that cover areas such as commercial law, traffic law, law of obligations, corporate law, international law, but also numerous international conventions governing logistics activities. comparison factor 5: logistics process management approaches one of the interesting things about the military in relation to business logistics are the approaches to managing logistics processes, which in most cases coincide. thus, in all logistics activities, we have certain methods that are used by both business and military logistics, such as push and pull methods, cross-docking systems, digitalization of logistics processes, etc. however, here it is necessary to pay special attention to the jit management approach (just-intime), which does not exist in military logistics, i.e. it is used under modified conditions. jit approach implies the acquisition of materials at the right time, that is, at a time when these materials are needed. the question is why this system is partially implemented in the army? the answer to this question is very complex but can be summed up by reason of the nature of military activities. as can be noticed, one of the important (but not the only) factors that is a determinant on the success of military operations are resources. at the global level, resources that are important in both military and business terms are regularly traded. the key difference is the fact that in business logistics a surplus of products is a negative indicator as well as a shortage of products, while in the army a surplus of resources can mean one form of competitive advantage over the enemy. what distinguishes military production in a state of peace from production in a state of war are three sources of procurement in the army: 1) classical sources (key sources of resources received by the army from the state), 2) portable resources (resources that the army carries with it during relocation as e.g. basic military equipment) and 3) resources acquired by the military in the field (captured resources, equipment, land use) (kress, 2002). as one of the main tasks of military logistics is to ensure the sustainability of the operational part of the army through an efficient supply chain, excess resources allow the army greater sustainability, because in case of war it is not possible to simply purchase the missing resources. the negative effect of this type of management is reflected in the possibility of taking over the given resources by another army, which is one of the key military strategies. regardless, the jit management approach is used in the military in an amended edition, where in some cases it is applied (peacetime period) and in others it is not. modern methods of warfare bring military logistics to a position where the avoidance of the application of jit systems is increasingly abandoned, and we are increasingly noticing their implementation in militarylogistics processes. comparison factor 6: innovations when we analyze innovations, both military and business logistics innovate in their own way. in the army, it is usually intensively innovated during the war, when due to the risk of losing 132 economic analysis (2021, vol. 54, no. 1, 118-138) one's life, the army is forced to be better and more efficient than the other army. here one can draw a parallel between innovations in business logistics and military, where business logistics is constantly innovating due to the daily effect of competition. in business logistics, innovation is necessary, because innovation is one of the factors of the company's comparative advantage that provides a more efficient supply chain and thus adds value to the final product. innovations in military logistics are mostly reflected in terms of artificial intelligence and its use in cyber defense, i.e. defense of information capacities of one country. innovations in this area are realized more intensively than others because absolutely all armies in the world are potential victims of cyber-attacks by various entities such as terrorist organizations and other military forces (destre, 2018). cyber-security is extremely important because it falls under the category of critical infrastructure. according to the definition given by the united states department of defense, critical infrastructure means “systems and assets, whether physical or virtual, so vital to the united states that the incapacity or destruction of such systems and assets would have a debilitating impact on security, national economic security, national public health or safety, or any combination of those matters” (us department of defense, 2020). the protection of critical infrastructure does not only mean the protection of given terms, but also the protection from the impact that natural disasters, technical or human error, intentional acts such as terrorism, etc. may have on the infrastructure (kruszka et al., 2019). 39 140 197 257 245 295 290 0 50 100 150 200 250 300 350 2010 2011 2012 2013 2014 2015 2016 figure 1. attacks on u.s. critical infrastructure 2010-2016 source: authors calculations by cybersecurity & infrastructure security agency 2010-2016 reports (us cybersecurity & infrastructure security agency, 2010-2016) figure 1 shows the number of attacks (incidents) on critical us infrastructure in the period from 2010 to 2016 based on reports from the us cyber security and infrastructure security agency. there is a trend of increasing attacks on critical infrastructure after 2010 as a result of increased investment in the cyber capacities of countries. the trend of an increasing number of incidents towards critical infrastructure shows the necessity of each state to protect itself from such attacks that can disable the entire system of one state, from which the collapse of logistics systems can have irreparable consequences. the importance of protection against cyber attacks slobodan aćimović, veljko mijušković, marko golubović 133 is also shown in the fact that the us stopped publishing data on attacks after 2016 due to the growing number of attacks in order to avoid panic among the population. military neutral states like serbia have a higher degree of military innovation compared to countries under the protection of military alliances like nato or odkb members, given that the policy of military neutrality requires constant monitoring, analysis and creation of new ways to protect serbia's military interests. on the other hand, countries that have a very active army around the world, such as the united states, innovate every day. this can be seen in the constant improvement of airborne military logistics operations which are becoming the dominant mode of transport in high power logistics systems. thus, the united states is constantly improving the way cargo enters aircrafts by simplifying documentation procedures, but also by improving technology (application of the “internet of things”, virtual reality, cargo tracking), which further enables digitalization of military logistics activities (condon et al., 2004). the military takes over the ideas of the industrial revolution 4.0 and applies most of the principles of a given revolution as business logistics. the key issue is security. however, through technological innovations in cyber-security and data protection, there is the possibility of creating a completely separate data storage system that is very difficult to compromise. comparison factor 7: logistics organizational structures most common mistake in organizing military logistics activities is neglecting them. this is visible during the organization of numerous military logistics systems where a large number of resources are invested in the operational part of the army, while obsolete technologies and outdated equipment are used for the auxiliary part of the army. thus, military logistics systems are the first to be hit when certain austerity measures need to be introduced, and the military usually uses vehicles produced during the cold war, and in some cases during the second world war. this treatment stems from the fact that many armies around the world are giving up logistics activities as important, and are openly neglecting them. precisely because of such an attitude towards logistics systems, inefficient ways of organizing military logistics systems arise. military logistics systems around the world are usually arranged as a separate entity within the military. although there is a desire among logistics officers to improve logistics activities, numerous external factors that they 3 business logistics is organized is more flexible and subject to change. there are many ways of organizing in business logistics, but some of the most important are functional, divisional and matrix organizational model (aćimović et al., 2020). in essence, the dilemma arises within the degree of centralization of each organizational structure. this is a particularly important issue in the field of military logistics, because military logistics in most cases use centralized logistics systems, as there are special organizational units for logistics activities. in business logistics, both centralized and decentralized systems are appearing, but due to the desire for control, more and more people are moving towards a centralized way of management. although the decentralized way of management takes into account the needs of each unit separately, it requires high costs and overlapping responsibilities with a loss of control, which can lead to uncoordinated work within the company. the centralized way of organization solves the problem of coordination, but on the other hand, there is no insight into the special problems of certain organizational units. a good way of organizing logistics processes is impossible to determine without a detailed analysis of the environment in which the company operates, and depending on many factors, the way of the organization will be different. it is essentially impossible to imagine military logistics as decentrali3zed, because that would lead to the loss of control of the military command, which is based on a hierarchical principle and which requires clearly defined competencies. one type of decentralization is achieved by delivering inputs from the field to the supreme command, which makes decisions based on those inputs that take into account the special requirements of all 134 economic analysis (2021, vol. 54, no. 1, 118-138) parts of the army. this type of management requires investments in information systems that will enable a clearer understanding of the situation on the ground by the competent officers. precisely because of the complexity of this topic, armies around the world have begun to transfer such activities to private contractors and intermediaries who perform them instead. the com3bination of private sector innovation and the possibility of flexible organization of logistics activities with the military seems like a never more relevant topic that can eliminate numerous problems of military logistics such as lack of funding and strictly centralized structure. however, one needs to be extremely careful with the use of private contractors as they can bring a number of problems. results of the comparative analysis after analyzing the given specifics of military and business logistics, we can notice that these two logistics branches coincide to a greater extent than they differ. this is not surprising considering that the root of business logistics is in the military and that both developed and learned from each other simultaneously. the differences stem from the very nature of the action, but the essence is the same to meet the needs of end-users. table 3 shows the results of the comparative analysis. table 3. results of the comparative analysis of military & business logistics comparison factors business logistics military logistics key activities management of transportation, warehousing, inventory (stocks), information and customer service as part of basic logistics activities basic business logistics activities + specific military activities: 1) production, modernization, and maintenance of weapons and military equipment; 2) supply of weapons, military equipment and other resources; 4) planning, construction, and maintenance of infrastructure facilities 6) health protection, safety and health at work protection, veterinary protection, environmental protection, fire and explosion protection and other types of protection. organization of flows regular and recurring flows of products, services and information regular and recurring flows of military products, services and information the goal satisfy the needs of the end-user (consumer ) satisfy the needs of the end-user (army ) logistics channels direct, indirect and flexible direct, indirect and flexible key actors wholesalers, retailers and international intermediaries such as sales agents, freight forwarders, 3pl and 4pl providers, etc. private contractors, military bases, operational centers, checkpoints, logistics officers as well as the state in the capacity of buyer, seller, manufacturer (dedicated stateowned companies) and monitoring. organization of transport activities railways, road traffic, water traffic, air traffic and pipelines different depending on the state of emergency risk bankruptcy loss of territorial integrity, slobodan aćimović, veljko mijušković, marko golubović 135 comparison factors business logistics military logistics sovereignty and human lives corresponding law commercial law, traffic law, law of obligations, corporate law, international commercial law, etc. international humanitarian and military law logistics process management approaches in addition to the jit management approach, business logistics also implement mrp systems, drp systems, adc systems, etc. limited use of jit management approach innovations highly innovative due to market competition innovative only in certain situations of “never-ending war”, military neutrality, or cyber-security defense logistics organizational structures centralized and decentralized systems strictly centralized logistics system source: authors the analysis shows the necessity of cooperation between military and business logistics on a daily basis, through the growing role of intermediaries such as private contractors who increasingly take over certain military activities such as logistics. therefore, in the end, it is necessary to give certain recommendations for further improvement to both the professional and academic community: 1. greater academic research is needed in the field of military logistics, where today this type of logistics studies major in military schools such as the military academy and it is necessary to include experts from various fields such as economy, political, security and organizational sciences; 2. in countries where this is not the case, it is necessary to clearly define the position of military logistics in the organizational sense by creating a special administration for logistics activities; 3. in order to eliminate the bureaucratic influence of the state on logistics activities, the military can redirect secondary activities to private contractors who will perform certain services more efficiently and cheaply; 4. in order to eliminate the problem of control and communication between the military and private entrepreneurs, it is necessary to clearly differentiate which activities the military can and cannot redirect to the private sector with a clearly defined analysis; 5. it’s necessary to understand the specifics of military logistics when analyzing its efficiency and take into account all the determinant successes listed in the paper; 6. it’s possible to implement successful elements of organization and management of business logistics in order to achieve optimal results, i.e. use innovations in the private sector and implement them in the military (and vice versa) as far as possible and in the way that is possible; 7. adjust military and business trends to the situation in the field and analyze the situation through factors specific to the situation in which the military or company is; and 8. demonstrate the positive impact of the private sector on the military sector and vice versa by introducing the private sector to military needs and pointing out the potential that the military sector brings. regardless of the implementation of the given recommendations, in order for them to be successful, it is necessary to connect the academic and professional community and create an open and two-way communication between them in order to complement and learn from each other. in addition, the issue of military logistics, but also military activities are not reserved 136 economic analysis (2021, vol. 54, no. 1, 118-138) exclusively for military science, so it is necessary to integrate other disciplines such as economic, traffic, political science and security, in order to have a more in-detailed analysis and understand the specifics of military activities. conclusion military logistics implies a complex system, formally separate, but essentially very close to business logistics. as unsung heroes of history, military logisticians have shown the importance of logistics operations in the army, which through the development of modern technology has become one of the most important factors to the success of military operations. the first part of the paper analyzed the concept, significance, development and principles of military logistics. the second part of the paper analyzed the complexities of business logistics, where the specifics of business logistics and development of business logistics have shown the unbreakable link between business and military logistics, but also the complexity of defining the same concept given the fact that it is a young developing discipline. in the third part of the paper, the specifics of military and business logistics were analyzed using a comparative analysis. the comparison criteria were defined first, and then a comparison was made through the defined criterion. the comparative analysis has shown a high degree of matching of both military and business logistics, and thus proved the research hypothesis (h1) that speaks of the uniqueness of military logistics, which is formally separate, but essential very close in the field of business logistics. in order to eliminate the negative effects of the private contractors, at the very end of the paper, eight key recommendations to the academic and professional public were given, with special emphasis on the need for greater academic research not only in military schools but across universities to better understand the issues of military logistics processes that cannot be understood by relying solely on military, economic, political, security or traffic sources but only by a combination of the same. the results of the comparative analysis in the third part of the paper shows a high degree of matching of both military and business logistics. these results show the importance of military logistics in the new types of war that are usually fought on global levels. today, business and military logistics remain two formally different, but essentially inseparable units with the same root, facing the same future, striving to achieve the same goal to satisfy the needs of the final user, be it a consumer or a soldier on the ground. references aćimović, slobodan, veljko mijušković. 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(2015). military logistics: research advances and future trends. hamburg, germany: springer. article history: received: january 14, 2021 accepted: april 29, 2021 microsoft word 2010_3_4.doc original scientific papers relevance of the insurance organizations on the financial market balaban mladenka*, institute of economic sciences, serbia simeunović ivana, belgrade banking academy, serbia marković miljka, unicredit bank, serbia udc: 336.02(497.11) jel: g2; g22 abstarct – financial markets in serbia are characterized by the under development of the capital market and more than poor offer of all financial instruments. besides this, great level of risk is present and non market control of risk management in the insurance sector is visible. insurance organizations in serbia are mostly visible on the currency market, in its by far most expensive segment – credit-deposit market. reason for this can be found in the fact that low degree of development of life insurance sector (below 10%) which is a sign that the insurance organizations in serbia have very modes financial means. key words: financial markets, insurance sector, life insurance, development, financial instruments introduction modern financial markets are being characterized by several processes: globalization, internationalization and deregulation. apart from this we have witnessed mergers and acquisitions for the financial institutions. classic banks are slowing die away and letting new institutionalized investors in this field, with insurance organizations as their flagships. due to more and more severe consequences of natural disasters, as well as due to terrorism related risks, we are witnessing mergers of capital on the insurance market. in that way, the overall role and importance of the insurance organizations as institutionalized investors has been dramatically increased, thus influencing the current flows on the capital market. the position of insurance organization on the financial market can be roughly introspected from two aspects – aspect of the insurance organization as investor, i.e. as investor in paper bonds issued by other organizations and from the aspect of actuator of means by issuance of its own bonds, stocks or instruments of debt. in the first case, which will be the object of our examination, the organization is dealing with the investment risk, just like any other investor, while in the second case; the organization becomes an investment risk, bigger or smaller, for other investors. risks in the insurance organizations management insurance organizations are being exposed to numerous risks, which can be adequately ranked into three categories: * address: zmaj jovina 12, belgrade, serbia, e-mail: mladenka.balaban@ien.bg.ac.rs economic analysis (2010, vol. 43, no. 3-4, 59-69) 60 1. technical risks 2. investment risks 3. nontechnical risks (they don’t belong into any of the two mentioned groups) income from the premiums is still the main source of income of every insurance organization, but, with time, they tend to more and more focus on the income of investing their financial equities (funds) on the market of capital. during the “stock exchange boom” in the 1990’s capital of the insurance organizations shifted (its larger portion) into stock and bonds of other corporations, thus increasing the investment risk, and on top of it, one should add substantial non-credit sales based on financial derivates. besides all this, the organizations started issuing specific bonds and its derivates in order to finance certain types of risks covered by the insurance policies, most commonly catastrophic risk (so called “catastrophe bond, catastrophe swaps etc.). due to the constant turbulences on the stock exchanges, capital of the insurance organizations started to shift to the financial instruments with fixed dividends (state issued bonds), reducing the investment risk on that way, but the income as well, looking at the trend of low interest rates. investment structure of the insurance companies differs from one country to another, but it differs as well from the type of insurance that is offering. the process of risk management comprises mainly from: 1. risk evaluation (with the faze of risk analysis which has risk identification, description and rate of risk, and risk recalculations) 2. offers on how to treat the risks (choosing the correct measures and approaches which can be used on managing the risk) 3. decision making 4. report (external and internal) and communications concerning the risk 5. monitoring and re-evaluating the entire risk management process well designed and structured investment has to incorporate the following steps: 1. formulating and development of the strategic and tactical investment policy 2. enforcement of the investment policy in the adequate organization based on clear and precise investment mandate 3. control, measurement and analysis of previously achieved investment score and undertaken risks 4. feedback in terms of the entire process enforcing in managing investments of the insurance companies, we can use standard portfolio management. it represents a continuous evaluation, changing and readjusting the portfolio (its structure) according to the investor’s aims and goals. integral parts of this dynamic process are the portfolio analysis and portfolio selection. through portfolio analysis we can get to see determination of future risks and dividends of specific bonds and stocks, as well as the overall effect in term of dividends and risks of specific groups of bonds and stocks taken into account all together. general portfolio strategy can be based on regular purchase and sell of different kinds of financial equity depending on the belief whether the price of that equity id bigger or lesser than real price (active investment strategy) and on the expectation of profits by gained difference and scope of trade, i.e. on the belief that the current prices of equity are real ones delic, a., the organizational structure, ea (2010, vol. 43, no, 3-4, 59-69) 61 (passive investment strategy) while keeping existing equity on the long run in conviction that the positive effect will be achieved by selling later in the future. portfolio selection represents a choice of specific bonds and stocks in which would be prudent to invest, as well as the setting up the ratios between certain groups of stocks and bonds in the entire investment volume. in the portfolio selection we conduct a periodic measurement of the results according to some specifically determined parameter or standard (for example, stock exchange index) and if the results are not satisfactory, a change of profile is being initiated. risk can be measured as a relatively measurable probability of creating losses of profits in the value of acquiring certain paper bond. there are different kinds of risks (interest rate, currency, risk of payment, inflation), but we can distinct system risk of the market which is associated with the global market trends. in the portfolio analysis β – ratio represents the most common measurement of the system risk, and it measures relative discrepancy of the price of paper bonds in relation to some specific reference market average. the concept of managing resources in the insurance organizations itself, thus investment management, has more evolved in terms of concept of synchronized management of both equity and passive balance, i.e. means and obligations. analysis of liability management is, in fact, management of business, so the decisions about means and passive balance are coordinated and represent a permanent process of formulation, implementation, monitoring and re-evaluation of strategy which deals with equities and passive balance with the aim of acquiring financial goals in the framework of given set of tolerances and risk limitations. role of institutionalized investors on the world market in the main concept of capital market development, one of the key positions is reserved to founding and further development of the financial institutions like stock exchanges, institutional investors (investment funds, privatization funds, pension funds, insurance organizations), broker – dealer houses, central clearing agencies, agencies for settlement and transfer of paper bonds. in almost every highly industrially developed country, institutionalized investors are holding more than 50% of all issued paper bonds. clearly visible rapid economic expansion of institutionalized investors during the last 50 years is based on their potential of minimizing the risks. decline in the significance of individual investors and strengthening positions of institutionalized investors does not necessarily mean a decline in number of individuals who own bonds and stocks. on the contrary, there has never been, in the entire history of capitalism, such dispersion of stocks at such a large number of small stock holders. the reason for this can be found in that they are not showing up in person on the market, but rather leaving institutionalized investors to invest on their behalf. whether we are talking about fiscal or political reasons, it doesn’t really matter, but in the baseline lays the fact that institutionalized investors are far more successful in stocks and bonds trading than individuals. investment funds and investment organizations, as institutionalized investors of non deposit nature, represent the purest financial intercessor who are dealing with the aim of strengthening the competition, increase of depth, or capacity of secondary market, economic analysis (2010, vol. 43, no. 3-4, 59-69) 62 mobilizing and collecting the capital from wider and more diversified sources, small investors, owners of capital, and their investment into diversified portfolio of paper bonds, all in order to reduce the risk of small investors investments. this position of investment funds, with the goals mentioned above, which is being accomplished during their operations, puts them into position of institution that has enormous influence on the development, stability and increase of the paper bonds capital market. this is not the case just in the countries with the well established paper bond markets, but it is being implemented in the countries that are still in the beginning faze of market operation (like the countries that are in transition, for example). the role of foreign investment funds in the countries that are in transition is a question of its own. so far, experiences have shown that foreign investment funds are, in fact, risk and full of speculative capital, and using their position on the new market they are acquiring stocks of more prospect organizations. countries that are in transition have dissimilar ideas when it comes to these funds. even though they can bring substantial amounts of highly needed foreign capital, often necessary, one should exercise extreme caution. let’s examine what happened in russia. when they first arrived on the market of this country, moscow has “flourished”, but, when they, under the influence of the market fall, withdrew quickly with their capital, they’ve left shattered capital market. in the countries with highly developed market economy, pension funds are being considered as the most significant institutionalized investors which are, tending to fulfill the most significant goals (safety and liquidity of the investment), investing via capital market it larger portion of available means into paper bonds, while, on the other hand, part of means are being invest directly into companies through means of credit, or as mortgage over real estates. we can discuss the significance of the pension funds as the institutionalized investors through the example of the u.s. in the u.s. there are over 20.000 pension funds, with only one holding more than 10$ dollars, and has more than 65.000 participants, while 30.000 people are receiving pensions based on the right gained by long term investments. we may find interesting the portfolio of this fund ant the main investment lines. they are investing primarily in the bonds and stocks of american companies, government issues state bonds, 17% is being invested outside us, primarily in japan and germany, while there is just a small portion that is being invested into lesser developed countries. one can discuss about the role, possibilities and limitations of the insurance organizations as institutionalized investors by examining the data saying that overall sales of insurance organizations in the 2005. excided roughly $10 dollars worldwide. quality means from life insurance are participating with almost 4/5 in the overall sales. in the investment portfolio of world known insurers, 50-60% is taken by paper bonds with fixed dividends and loans (except mortgage). after them there are bonds and stocks and funds with 15-20%, while the mortgage loans are visible with 10-15%. almost 90% of overall investments are covered with these three types of insurance investments worldwide. with the countries with slightly distinct inflation in the last 7-15% are investments in real estates. while the private pension funds and insurance organizations are the main participants on the capital market in the countries of highly developed market economy, they are not delic, a., the organizational structure, ea (2010, vol. 43, no, 3-4, 59-69) 63 playing an important role on the financial markets of the countries that are in the process of transition. investing the means of insurance companies in the world insurance organizations as the institutionalized investors are very important participants in the financial market, primarily on the capital market. based on the data of investment means overall of all investment organizations worldwide from 1998 until 2007. (table 1) we can grasp their significance as participants on the financial market. table 1. overall investment means of the companies worldwide (in eur) year investment means 1999 170,4 2000 200,9 2001 232,2 2002 221,3 2003 215,4 2004 208,2 2005 198,5 2006 183,9 2007 190,4 2008 206,7 level of development of financial market in one country dictates the structure of investment of insurance organizations. more developed financial markets with bigger number of different financial elements are offering much wider scope of possibilities for adequate investments. in the following table (table 3) structure of investments by top 10 insurance organizations worldwide will be shown (ing group, assicuracionni generali, nippon life insurance, aviva, dai-ichi mutual life insurance, meiji yasuda life insurance, sumitomo life insurance, met life, prudential). table 2. structure of investments (%) by top 10 insurance organizations worldwide year bonds stocks real estate loans commercial papers other total 1999 68,7 14,0 7,8 1,8 6,8 0,9 100,0 2000 70,6 12,8 6,6 1,9 7,2 0,9 100,0 2001 72,5 12,4 5,5 2,1 7,2 0,3 100,0 2002 71,9 14,1 4,4 1,8 7,4 0,4 100,0 2003 71,4 17,2 4,0 1,5 5,6 0,2 100,0 2004 69,0 20,9 3,8 1,7 4,4 0,2 100,0 2005 65,1 25,4 3,6 1,1 4,3 0,5 100,0 2006 67,3 24,6 3,4 1,2 3,1 0,4 100,0 2007 69,2 22,2 3,4 1,1 3,4 0,7 100,0 2008 69,5 22,6 3,2 1,4 2,8 0,5 100,0 source: insurance information institute economic analysis (2010, vol. 43, no. 3-4, 59-69) 64 as for real estate in the portfolio of these insurance organizations, a tendency of constant fall can be noticed. loans followed that same tendency, and so are the commercial papers. we can conclude from this table that bonds are taking larger portion of the portfolio, but significantly less than life insurance specialized organizations. here we have larger portion of corporate and short term bonds. there is a significant increase in share trading, which of course, affects the risk of the portfolio. there are no drastic changes with the loans and commercial papers. table 3. structure of investments (%) by swiss re 31.12.2004. 30.06.2005. 31.12.2005. 30.06.2006. bonds 81,18% 80,48% 85,64% 85,52% shares 7,65% 8,98% 4,87% 5,28% policy loans, mortgages and other loans 6,95% 6,75% 5,88% 5,72% investment real estate 1,85% 1,64% 1,57% 1,38% other investments 2,35% 2,15% 2,04 2,10% source: swiss re, interim report 2006 investment structure of swiss re shows that the highest portion in overall investment goes to bonds (average portion of 83.21%). certain increase of investment in stocks is visible in the first part of 2007. in reference to 2007 of 5.28%. also there is a notable tendency of fall of investments in policy loans, mortgages and other real estate loans. table 4. structure of investments (%) by lloyds 31.12.2004. 30.06.2005. 31.12.2005. 30.06.2006. bonds 47,17% 50,89% 54.18% 53,83% shares 9,09% 6,66% 6,32% 5,68% policy loans, mortgages and other loans 4,68% 4,92% 3,21% 3,86% investment real estate 38,96% 37,30% 34,68% 34,16% other investments 0,10% 0,23% 1,61% 2,47% source: lloyds annual report 2006 during the analyzed period there is a dominance of instruments with fixed income, 5% on average. after them, with average of 4% are investments in shares. structure of investments depends highly on the level of economic growth and political factors, shows the outline of equities one of the most well known insurance organizations in japan nippon insurance company. we can observe this from the following table. delic, a., the organizational structure, ea (2010, vol. 43, no, 3-4, 59-69) 65 table 5. structure of investments (%) by nippon insurance company 31.03.2004. 31.03.2005. 31.03.2006. domestic bonds 32,61% 33,19% 34,53% domestic stocks 14,16,% 17,55% 17,56% foreign paper bonds 13,69% 13,67% 13,69% policy loans, mortgages and other loans 26,52% 24,32% 22,16% real estate 4,31% 4,06% 3,87% other investments 2,36% 1,77% 1,51% source: nippon insurance company annual report 2006 from this table we can see that the average portion of stocks in the structure of nippon insurance company portfolio is 33.48% which is on significantly higher level than lloyds and swiss re. during analyzed period an increase of invested means into stocks of domestic organizations, which are giving good results in the given period. based on the portfolio structure analysis of these three insurance companies for three years we can see that they invest means by taking into account the principle of safety, thus protecting their capital. base models and investment structure of us and eu based insurance funds soon there will be no distinct line between banking sector and insurance sector, for the banks are more and more taking an active role in the insurance field, while the insurance organizations are dealing with creating, production and trading of banking products. in the western europe, this aspect of institutionalized and business oriented interconnection of banks and insurance organizations created a whole new term: “bank – verscherungs” (bankinsurance). base models and investment structure based insurance funds according to the market limits in the us and eu for certain segments of financial markets. would look something like this: table 6. investment market limits (%) in the us and eu type of insurance limit in the us limit in the eu life insurance currency market – up to 10% capital market – up to 80% other markets – up to 10% currency market – up to 5% state bond market – up to 80% other markets – up to 15% insurance of assets currency market – up to 30% capital market – up to 60% other markets – up to 10% currency market – up to 10% state bond market – up to 60% other markets – up to 30% health insurance currency market – up to 40% capital market – up to 30% other markets – up to 30% currency market – up to 0% state bond market – up to 90% other markets – up to 10% pension insurance currency market – up to 20% capital market – up to 70% other markets – up to 10% currency market – up to 0% state bond market – up to 80% other markets – up to 20% source: world bank economic analysis (2010, vol. 43, no. 3-4, 59-69) 66 models and patterns of insurance organizations investments are, by default, limited and conditioned with the character of their obligations, i.e. passive structure. taking into account that in life insurance we have stable long term sources of means, it is natural for the investments organizations who deal with this category of insurance, to invest primarily on the capital market, on state bond market and mortgage market. in that way the due date of maturity of both equity and passive, with the steady income sources. when dealing with asset insurance, however, basic form of investment is stocks and corporate obligations. this is conditioned by the fact that they have smaller and more insecure reserves, with high risk of potential damages. shares are favorable means for investments, for they have bigger dividends, especially shown through capital income. in some countries these institutions are legally obligated to invest significant portion of their capital (even in some cases up to 90%) from the base premium reserves of all sorts, as well as from their other funds and reserves, into state issued bonds which have loan character with long term expiry date (in some cases dye date is longer than 50%). insurance sector in underdeveloped countries of the market economy is showing some degree of expansion, first exposition on the financial markets. participation of the insurance organizations as institutionalized investors from the beginning of this century in overall transactions in the financial markets, have reached incredible 30% in the us and 22% in the eu. based on these indices, a large number of conclusions can be drawn, but one is the most important: participation of the insurance sector in serbia (with 1.8%) is 12 times smaller than the participation of the same sector in the eu, or 16 time smaller than the insurance sector in the us. insurance organizations equity management has two primary objectives. first, securing necessary level of solvency and financial stability through means of relation harmonization between equities and obligations. second one is creating profits. investment potential of the insurance organizations depends primarily from development of life insurance and pension insurance. specific characteristics of these forms of insurances can be analyzed through long term duration of the insurance contracts, but they can be analyzed from the fact that integral part of commitments is largely very detached from the insurance premium deposits. this allows investing of the larger reserve share in short term instruments, which significantly diminish the necessity for the liquidity of investments. in the us, there are more than 25% long term loans that are being supplied by the long term life insurance organizations, and ¾ of all insurance equities are originating from these organizations. uk based insurance organizations own more than 20% of share capital of all organizations registered on the london stock exchange. in large number of cases overall share packet owned by the insurance organizations does not exceeds 10% of the company’s’ share capital. in a limited number of cases, the insurance organizations own control package of shares of large organizations. besides this, insurance organizations are participating in financing ore management of these organizations through different means of investment organizations. leasing operations are commonly used, in which they successfully compete against specialized firms. one of the conditions for approving mortgage loans is making insurance delic, a., the organizational structure, ea (2010, vol. 43, no, 3-4, 59-69) 67 contract. main reason for such a wide use of these operations was the tendency to widen the client structure. usually 10-20% of all asset insurance equities and 1-3% of life insurance equities are composed of highly liquid short term investments, such as currency means and their equivalents, short term bank deposits, deposit certificates, commercial bonds. paper bonds with steady dividends are participating with more than ½ of all investments by the insurers in the us and in the large number of insures in europe (germany, france). apart from all this, 50% of those investments are related to state and municipal bonds. investments of insurance organization means in serbia when investing means on the financial market insurance organizations can be faced with unpredicted increase of interest rates, which may lead to decline in value of their investment. also, badly formed, or high risk portfolios of paper bonds will not ensure sufficient rate of income. therefore it is of vital importance to carefully form investment portfolio, which will, with minimal risk, facilitate maximum rate of income, and in the same time guarantee certain level of liquidity of the insurers in the case of increased number of insurance based payouts in terms of those mathematically predicted. means of the insurance organization technical reserves in serbia, according to the insurance act (subpart 114), can be invested into paper bonds issued by the state, central bank and international financial institutions, without any limitations. for investments in other activities, certain limitations apply. table 7. investment market limits (%) for means of technical reserves in serbia type of investment limitation stocks 30% organized and non organized 25% organized 5% non organized bonds 5% non organized real estate 10% non life 30% life deposits 30% 10% (in one bank) source: ministry of finance, republic of serbia serbian capital market is underdeveloped, and there is no secondary market yet, therefore secondary stock sell does not exist, and privatization stocks are very risky for investments. current legislative allows investments of the technical reserve means in stock with the 30% limitation. this kind of limitation, in this stage of development at least, is not necessary. in the following table we can analyze the legal limitations of guaranteed reserves means. economic analysis (2010, vol. 43, no. 3-4, 59-69) 68 table 8. investment market limits for guaranteed reserves means (%) in serbia type of investment limitations stocks 60% both organized and non organized 10% organized (2% of one issuer) bonds 10% non organized (2% of one issuer) stocks and bonds 10% organized (of one issuer) real estate 30% non life 60% life deposits 60% (20% in one bank) source: ministry of finance, republic of serbia financial markets in serbia are characterized by the underdevelopment of the capital market and poor selection of financial instruments. besides, there is a big factor of risk present, and the non market control in the risk management of insurance sector. participation of the insurance sector on the financial market in serbia is 12 times smaller than the participation of this sector in the eu. insurance organizations in serbia are primarily investing in short term financial market (75%), where that sector invests in the eu in the capital market (70%). domestic insurance organizations are operating primarily on the currency market, in its most expensive and least transparent segment, bilateral credit-deposit market. we may conclude that the portfolio of serbia’s insurance organizations investments very poor and unfavorable when contrasting to the structure of portfolio in more developed countries. insurance organizations and pension funds represent most significant institutionalized investors in more developed countries. in serbia, insurance sector is not developed entirely; they have very limited capacity of the insurance organizations; with modest collection of insurance premium based means. life insurance makes 12% at most in overall insurance portfolio, which is a cleat indicator that insurance organizations have on their disposal very modest means and cannot call themselves institutionalized investors. apart from amelioration of life insurance distribution in the foreseeable period, it has to come to further development and expansion of the capital market, in order for the insurance organizations to operate sad the institutionalized investors. according to the act, means of technical reserves can be deposited and invested into: 1. paper bonds issued by the state, central banks, international financial organizations 2. bonds or other paper bonds, which are being traded with on the organized paper bond market, whose issuer is organization with residence in serbia 3. bonds, or other paper bonds which are not being traded with on the organized paper bond market, whose issuer is organization with residence in serbia 4. stocks which are being traded with on the organized paper bond market 5. stocks which are not being traded with on the organized paper bond market, if their issuer is domestic organization and if they have been issued as paper bonds in accordance with the paper bonds and other financial instruments act 6. depositing and investing with banks with residence in serbia delic, a., the organizational structure, ea (2010, vol. 43, no, 3-4, 59-69) 69 7. real estate and other real rights over real estates and assets means of technical reserve can be hold in cash in the register and in bank accounts. current investment possibilities for insurance organizations on the serbian financial market after adopting insurance organizations act and transfer of monitoring function to national bank of serbia made possible to regulate operations of these entities more thoroughly. on the other hand, by adopting paper bonds and other financial instruments act, legal entities act, forming the paper bond committee as a standalone institution, as well as enlisting larger amount of paper bonds to belgrade stock exchange, conditions have been met for further development of financial market in serbia. conclusion having in mind still turbulent and not enough developed financial market in serbia, insurance organizations should exercise extreme caution, and with extended analysis to reach their investment decisions. in the case when they do not have adequate infrastructure for making sound decisions, due to legal obstructions, they should delegate this process, in accordance to the “prudent investor rule”, to licensed and competent organizations or individuals. even though investing in serbia is still young and underdeveloped branch, without proper financial instruments, it is very promising, and with proper legislative, that follows positive trends from the foreign markets of the eu and the us, with input and understanding from the government, it can achieve excellence, while avoiding all traps and misleading from the process of transition, by looking and closely analyzing the mistakes made by other countries that have completed the process of transition. with healthy financial climate, and the existence of financially strong, stable institutionalized investors, everybody can find this way of doing business useful, the government, the insurance institutions and shareholders. references kočović j., šulejić p., osiguranje, ekonomski fakultet, beograd, 2002 kočović j., mogućnosti i ograničenja plasmana sredstava osiguravajućih kompanija, zbornik radova, vrnjačka banja, 2005 mishkin f., the economics of money, banking and financial markets, harper collins, new york, 2005 rejda g. e., principles of risk management and insurance, addison wesley, new york, 2005 vaughan e., baughan t., osnove osiguranja i upravljanje rizicima, mate, zagreb, 2002 zakon o investicionim fondovima, sl. list republike srbije insurance information institute, www.iii.com swiss re, sigma, various issues, www.swissre.com www.iii.org www.investicioni-fondovi.com www.minrzs.sr.gov.rs www.nbs.rs received: 15 september 2010 article history: accepted: 1 november 2010 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp68-78 original scientific paper use of information technologies in educational purposes – case from serbia danijela stojanović1* | ivana domazet1 1 institute of economic sciences, belgrade, serbia abstract secondary education in developing countries is largely based on obsolete teaching methods and technologies. the aim of this paper is to analyze the use and preferences of mobile technologies for the needs of education among the high school population, with special emphasis on social media. the paper presents researches conducted in 2016 and 2020 in one high school, based on the analysis of questionnaires on the practice and preferences of using mobile technologies and social media for educational purposes. results obtained show that the advantages of mobile learning in high school practice are still not sufficiently utilized, since students rarely use the internet on mobile phones or tablets to acquire new knowledge or information in the educational process. it is noticeable that the trends in the use of information technology in domestic high schools are at approximately the same level as in other countries, as well as that there is room for improving the application of modern information technology in education process. the results of the research are important for future studies, since this was conducted on a sample of high school of economic students, and the possibilities of applying this method of work on different educational profiles arises. key words: information technology, digital media; e‐learning; mobile learning; high school education jel classification: a21 introduction mobile technologies and social media have become an integral part of the lives of a large part of the world's population (adel, thomas, & ludovic, 2011; european commission, 2014; tomić, 2015). historically, mobile technologies and social media were originally used for entertainment, personal needs and direct communication (traxler, 2007; radenković, despotović-zrakić, labus, & vulić, 2011). over time, these technologies have gained greater application in business communication and collaboration (domazet, zubović, & lazić, 2018; pavlović, vukmirović, & domazet, 2020). today, the trend of using these tools in teaching is more and more present, as well as the growing interest of the academic community and the growth of the number of various researches related to these topics (al-bahrani & patel, 2015; petrović, stojanović, & labus, 2018; domazet & simović, 2020). the basic idea is to reach a level where mobile devices and applications are not considered a problem in the education process, but as a tool available to lecturers to improve educational practice (stojanović, bogdanović, petrović, mitrović, & labus, 2020; petrović, jezdović, stojanović, bogdanović, & despotovićzrakić, 2017). * corresponding author, e-mail: danijela.stojanovic@ien.bg.ac.rs danijela stojanović, ivana domazet 69 the use of mobile technologies and social media allows the combination and integration of several levels of learning processes that have been observed so far:  there are changes in the time and place of learning learning is no longer just a desk or classroom, learning can be continuous, in any place with the internet access (sølvberg & rismark, 2012);  there is a combination of formal and non-formal learning and a combination of individual and learning with others (wong & looi, 2011);  the combination and perception of knowledge from different teaching areas in practice is enabled. having in mind the specifics of the serbian educational system, which, above all, must be harmonized with world trends, the assumption is that there is room for inclusion of communication and exchange of knowledge through social media in secondary education, especially in vocational high schools, and within them with scientific areas, which are characterized by dynamic development. for the purposes of this paper, two studies on the practice and preferences of the use of mobile technologies and social media by high school of economics students were conducted, based on similar researches in other school systems. the idea was to identify similarities and differences with experiences from other countries based on the obtained results, and to spot the space for most effective improvement of practice in terms of using these technologies in the education process. this is supported by the eu kids online report (smahel et al., 2020), a survey conducted on a nationally representative sample in 19 european countries (including serbia). the aim of the research was to gather information on the use of the internet and digital technologies by children and young people. in addition to the results of research in other countries, this report presents the most important results of research that was conducted in serbia in the period autumn 2017 summer 2019. a random, stratified sample, representative of the school population of children aged 9-17, was used. the criteria used for the sampling strategy, which ensured the representativeness of the sample of this research, were: the age of the child, the gender of the child, region and urban/rural area. the research covered a large number of topics in the field of digital media use among children and youth. some of the topics are: access to and use of the internet and digital technologies, digital skills and technologies, risks (digital violence, exposure to harmful content) and opportunities on the internet, social context (mediation by adults and peers in the use of digital devices and the internet). literature review academic research on the use of mobile devices and social media in the field of education has been intensified since 2005, with the student population being analyzed most often, followed by primary and secondary school students. the most frequently analyzed social media used in the education process are facebook, blogs, twitter and instagram (tess, 2013; czarkowska, gumkowska, & gumkowska, 2017). the first research was conducted on the territory of developed western eu countries, where mobile technologies first came to life. in comparison to the survey conducted on the territory of great britain (blair, millard, & woollard, 2014), students in serbia use facebook less than their british counterparts, and incomparably more the instagram. recent researches are increasingly covering areas of developing societies, such as african countries. in addition to the analysis on the practice and efficiency of the implementation of the education process through mobile technologies and social media, a large number of researches included the development of special applications for specific educational needs on the analyzed sample. (petrović, stojanović, & labus, 2018; bogdanović, barać, jovanić, popović, & radenković, 2014). the ultimate goal of application of individual studies usually identified in the improvement of the entire state education system, after synchronized education of lecturers, 70 economic analysis (2020, vol. 53, no. 2, 68-78) improving access to the internet and mobile technologies and motivating students to use modern technologies for the purpose of acquiring and exchanging knowledge and learning about curricula and activities. (zollo, 2019; stojanović, bogdanović, despotović-zrakić, naumović, & radenković, 2019; stojanović et al., 2020). the largest number of studies on the use of mobile technologies in the field of education, conducted so far, has shown that these devices have a positive effect on learning efficiency in high schools and colleges. (petrović, stojanović, labus, bogdanović, & despotović-zrakić, 2017; karabatzaki et al., 2018). studies have also shown that pupils and students are using modern technologies in the field of education and learning the least, although they state that they are very open to the future application of these technologies in learning. when we talk about the ways in which pupils and students use mobile technologies in the field of education, previous academic studies have shown that they exchange, combine and create new internet content (halder, halder, & guha, 2015). the internet also enables joint work on solving problems set by lecturers. in addition to the process of learning and knowledge exchange, mobile technologies can be used for the needs of easier and more efficient organization of teaching activities and communication between teachers and students (stojanović et al., 2019). the increase in the intensity of the use of modern technologies in the field of education comes with the greater engagement of lecturers and their inclusion on social media, which are already used by students (labus, despotović-zrakić, radenković, bogdanović, & radenković, 2015). social media has proven particularly effective in specific vocational schools, such as ict schools, language learning schools or medical schools. (hajli, bugshan, lin, & featherman, 2013; khalitova & gimaletdinova, 2016). although mobile technologies and social media offer great benefits in the field of education, primarily because it is assumed that students are already familiar with these communication tools and do not hesitate to accept and use them (stojanović et al., 2019; domazet, simović & lazić 2014), certain studies have shown that sometimes there is aversion to use these learning technologies by pupils and students, due to the desire to isolate private and "student" life and the fear of being overloaded with always available and practically endless contents (jones, blackey, fitzgibbon, & chew, 2010; michailidis, kapravelos, & tsiatsos, 2019). nevertheless, a large number of lecturers, but also the wider community, are wary of using modern technologies for educational purposes. they are apprehensive about various types of abuse, cheating in the learning process and other psychological, pedagogical and social consequences, which use of these technologies, and connecting teachers and students through social media, could bring (ertmer, 2005; asterhan & rosenberg, 2015). an additional precondition for the efficient use of mobile technologies in education is the adequate supply of secondary schools with modern equipment and technology. in addition, continuous theoretical and practical education of teachers is necessary, so that they would be the first to understand and accept the role of mobile devices, the internet and social media in the teaching process, and then to convey this to students (mannila et al., 2018; ministry of education sciences and technological development, 2017). methodology and results in order to analyze the use of mobile technologies, and especially social media among the high school population in serbia, two surveys were conducted at the school of economics in belgrade. in the period february-march 2016, the first research on the practice and preferences of using mobile technologies and social media was conducted among high school students. in order to get the data up to date and to overcome the time distance of four years, the research with the students of the same school was repeated in the period february-march 2020. on that occasion, an identical questionnaire was used as a research instrument as for the survey conducted in 2016. likewise, the sample was structured in the same way as in 2016 and the survey was danijela stojanović, ivana domazet 71 conducted in the identical period of the year (february-march) to ensure full comparability of the obtained results. the aim of the survey was to determine the current state of application of mobile technologies and social media in education. students' opinions on the possibilities of improving the teaching process in secondary vocational education by introducing mobile technologies and social media that would make the learning process more efficient and attractive were also included in this survey. the first results of the research were published in 2016 (stojanović, bogdanović, & nedeljković, 2016). before creating the questionnaire, previously conducted researches on similar topics in other school systems were analyzed in detail (bogdanović et al., 2014; kuzmanović, pavlović, popadić, & milosevic, 2019). the questionnaire, which was used in this research, was designed to enable a comprehensive analysis of the use of mobile technologies among high school students. it consisted of three parts. in the first part of the questionnaire, students were offered answers where by circling one or more offered answers, the student would have the opportunity to express their opinion. in the second part, the students had the opportunity to express their position on some of the offered claims. likert's five-point answer scale was used here, where students could choose one of the five options offered: 5 always, 4 often, 3 sometimes, 2 rarely, 1 -never. the third part of the questionnaire contains open-ended questions, where students had the opportunity to give their opinion, as well as recommendations, suggestions or critics. a total of thirty questions were asked, grouped as follows: a) mobile phones number of mobile phones, frequency and purpose of use; b) internet on a mobile phone time and place of use, frequency, purpose and manner of use for acquiring new knowledge, information and educational purposes; c) use of social media via mobile phones; d) tablet devices frequency of use; e) internet on tablet devices purpose and manner of use for acquiring new knowledge, information and educational purposes; f) the role of professors in encouraging the use of mobile phones for educational purposes; g) student suggestions for greater use of mobile phones for educational purposes. the research was attended by 170 students with very good or excellent success of the third and fourth grade of the high school of economics within the section "economics and entrepreneurship”. all respondents were between 17 and 19 years old, of whom 35.1% were male and 64.9% female students. the students voluntarily agreed to contribute to this research based on the obtained results, similarities and differences with experiences from other countries can be identified and space for future more efficient improvement of the practice of using these technologies in the educational process can be defined. the research was done on the basis of a questionnaire on the use of mobile phones and social media for educational purposes. results the results of a survey conducted in 2016 showed that high school students use mobile devices intensively, so that out of the total number of respondents, 94.59% of them use a mobile phone several times during the day, while the remaining 5.41% use this device once a day, which means the questionnaire contained high-ranking answers. none of the respondents answered the offered options: sometimes, rarely and never. while the results for answering the same 72 economic analysis (2020, vol. 53, no. 2, 68-78) question in 2020 showed that almost all students, 97.30% of them use a mobile phone several times during the day, and only 2.70% use a mobile device once a day. similar to most other countries today, students use mobile devices primarily to access the internet, with 75.68% of respondents, while the remaining respondents use mobile devices to make phone calls, write messages, listen to music, play video games and other purposes. it is interesting that the results of the research conducted in 2016 and 2020 gave identical results, expressed in percentages, in terms of using the internet, playing video games and listening to music. the difference occurred when using a mobile phone for making phone calls and writing messages, where the percentage of usage decreased. when it comes to social media and tools for communication via mobile phones based on the internet, a survey conducted in 2016 showed that high school students use instagram the most (37.84%), while the use of other tools is uniform, with an obvious lack of skype communication service practice. the results of the survey conducted in 2020 showed a slightly different structure (figure 1). in figure 1, it can be seen that students, in 2020, stated that facebook and whatsapp are used much less, while search, viber and skype service are not used by anyone. the frequency of using the instagram application increased from 37.84% in 2016 to 72.97% in 2020. the same is the case with the use of the youtube service, which students use in a higher percentage in 2020 (21.62%), compared to its use in 2016, when it was 13.51%. figure 1. frequency of using different applications via mobile phone source: authors’ survey the results of the conducted researches in 2016 and 2020 showed certain minor differences in the answer to the question where students use the internet on their mobile phones the most. in 2016, 78.38% of respondents said that students most often use mobile phones at home, while in 2020 that number slightly decreased, so the number of respondents who use the internet on mobile phone at home was 72.97%, while some respondents opted for the option "other" (16.22%). respondents also stated that they use them the most in the afternoon and evening. 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% search facebook youtube instagram viber skype whatsapp 2016 2020 danijela stojanović, ivana domazet 73 while in 2016 the results of the survey showed that 72.97%, of respondents used internet on their mobile phones in that time of the day, in 2020, that number increased to 83.78%. students who participated in the research in 2016 stated that they rarely use tablet devices, i.e. 67.57% of respondents said that they never use tablet devices, while 13.51% of them use tablets once or twice a week. the results of the survey from 2020 showed that the respondents stated that they never or rarely use tablet devices (91.89%). answering this question, a large percentage (40.54%) said that they did not have a tablet device. in contrast to the observed practice with mobile phones, where instagram is the most frequently used application, the answers on use of tablets obtained in 2016 show that students use these devices for "other" purposes (50%), while the second frequency 25%, was recorded in the use of tablets for games and listening to music. the results of the survey conducted in 2020 show a slightly different structure. out of a total of 220 students who declared that they have a tablet, 40.91% use these devices for youtube, which increased compared to 2016, when it was 15%. what has also changed regarding the answers to this question is the reduction of the number of answers for "other" purposes to 27.27%. the conducted research showed that students largely use mobile phones for information purposes. in 2016, approximately 60% of respondents said that they were informed about various topics via mobile phone at least once a day, while in 2020 that number decreased to 45%. the number of respondents in 2016 stated that they use a mobile phone for these needs 45 times a week in a percentage of 24.32%, while in 2020 the percentage increased to 32.43%. when it comes to the areas that students are most interested in via mobile phones, the structure of the obtained answers is shown in table 1. table 1. frequency of using mobile devices for information on different topics field device type year 2016 device type year 2020 phone tablet phone tablet politics 2.70% 5.26% 0.00% 0.00% economy 0.00% 0.00% 0.00% 4.55% black chronicle 2.70% 5.26% 0.00% 0.00% sports 21.62% 0.00% 18.92% 9.09% culture and art 0.00% 0.00% 5.41% 4.55% general information 27.03% 21.05% 32.43% 18.18% fun 45.95% 68.42% 43.24% 63.64% source: authors’ survey in a survey conducted in 2016, the results showed that respondents, using the internet on a mobile phone, acquire new knowledge during learning through professional sites (51.43%), then through popular sites such as wikipedia (31.43%) and through social media (17.14%). the results of the 2020 questionnaire show a different structure. wikipedia is used in an extremely high percentage (70.27%), followed by professional sites (21.62%) and finally social media (8.11%). 74 economic analysis (2020, vol. 53, no. 2, 68-78) figure 2. using the internet on a mobile phone to acquire new knowledge source: authors’ survey the results, detailed in table 2, show that students who participated in the research rarely use the internet on mobile phones or tablets to gain new knowledge while learning about the curriculum and to be informed about school activities. the obtained results also confirm that the frequency of using social media for these purposes is even rarer. these results are similar to the results obtained in other surveys on this topic. table 2: frequency of using mobile devices to acquire new knowledge using the internet to obtain information about school activities device type year 2016 device type year 2020 phone tablet phone tablet little use (once a week) or not at all 59.46% 96.15% 48,65% 86,96% using social media to obtain information related to school activities device type device type phone tablet phone tablet constantly (several times a day) 5.41% 4.00% 16.22% 0.00% little use (once a week) or not at all 48.65% 92.00% 45.94% 86.96% using social media to acquire new knowledge and information about the school curriculum device type phone constantly (several times a day) 8.11% 5.41% little use (once a week) or not at all 67.57% 54.06% source: authors’ survey when it comes to communication between students and teachers at school, a survey conducted in 2016 showed that it takes place via e‐mail (58.33%), sms (22.22%) and mobile phones when making phone calls (5.56%). the analysis of the results of the research conducted in 2020 showed that students largely use whatsapp (44.44%) in communication with teachers. the results additionally show that the participation of the viber application has increased compared to 2016, as well as that students continue to use e-mail to a certain extent (22.22%), although the participation of this service has significantly decreased compared to 2016. students use e‐mail, to communicate with teachers, when they participate in the development of various 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00% through professional sites through social media through popular sites (e.g. wikipedia) 2016 2020 danijela stojanović, ivana domazet 75 projects, seminar papers and other forms of work that require the sending of certain materials of various formats. when it comes to work and communication with teachers and other students that do not require the use of written materials on a larger scale, students prefer to use whatsapp and viber applications. figure 3. the way of communication with teachers at school source: authors’ survey of the 170 students who filled out the questionnaire on the use of mobile phones and social media for educational purposes, in 2016 and 2020, none stated that they communicate with school teachers via skype or facebook, although these internet communication channels have very wide application and possibilities. researches have shown that the practice of using mobile technologies and social media among high school students is at approximately the same level as in other education systems where similar surveys have been conducted (kuzmanović et al., 2019). conclusion teaching activities based on "blackboard and chalk" cannot provide students with enough new knowledge that they need for further education and professional work. the importance of the application of mobile technologies in education is great in terms of providing opportunities for quality education. on the other hand, social media, due to its wide distribution and comprehensive application, is one of the fastest forms of exchange of information, experiences and knowledge, which can significantly contribute to the improvement of secondary education. the obtained results confirm the assumption that there is room for improving the application of modern information technologies in the domestic educational system. having in mind the experiences from other countries, it can be assumed that students would be more interested and motivated for this type of pedagogical-educational innovation if lecturers would encourage the use of mobile devices, internet and social media for teaching and learning purposes. it is quite certain that the educational process in high schools would therefore be significantly improved and raised to a much higher level, and students would get a up-to-date and more efficient education system suitable for modern technological development. new methodological approaches to teaching in secondary schools, based on modern information technologies, can contribute to better vertical integration of the entire educational process, which in addition to secondary and higher education, includes the labor market. in 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 2016 2020 76 economic analysis (2020, vol. 53, no. 2, 68-78) addition, new technologies and methods of distance learning are an important instrument of education in conditions of various emergencies and crisis situations when circumstances do not allow the continuous performance of traditional, face-to-face teaching. the application of modern technologies in education and distance learning models can provide high quality and continuity of learning in specific, irregular circumstances and should be developed in such a way that decision and policy makers accept distance learning models as solutions to ensure continuity of education. acknowledgements this paper is a result of the project financed by the ministry of education, science and technological development of the republic of serbia. references adel, b. y., thomas, l., & ludovic, r. 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(2019). instagram as a pedagogical tool to enhance undergraduate students’ critical thinking on specialized knowledge: a qualitative experiment. representing and redefining specialised knowledge: variety in lsp, 245–280. article history: received: august 17, 2020 accepted: november 3, 2020 microsoft word 2010_1_2.doc original scientific paper do minimum wage changes influence employment? vokorokosová renatá*, technical university of košice, faculty of economics, department for banking and investment, slovakia udc: 331.526 jel: j31; j24 abstract – greater number of foreign working studies does confirm the theoretical assumption that minimum wage increases negatively change the amount of employed people. contrary to these, there is, however, a completely different persuasion on this issue among some economists. this article picks out minimum wage as an important part of employment research investigating two files; the number of working people aged 15 – 64 and all working labours. key words: working force, minimum wage, ageing index, labour productivity introduction although there are several factors (like economic growth, foreign investments, education of workers, average wage, living wage1), effecting the number of employed persons, discussions are, however, held at the most about the relation between minimum wage2 and employment just on when setting in new level of minimum wage. among majority of employment and minimum wage empirical literature3 (e g. brown, gilroy and kohen 1981; neumark and wascher 1992; card and krueger 1994; welch 1976; oecd 1998; eriksson and pytlikova 2004) there are papers testing the relationship between minimum wage and employment of teens and young generation, skilled workers (e. g. brown, gilroy and kohen 1983; ragan 1977). test results for minimum wage influences upon employment rest on existing theoretical models. there is a basic competitive model (neoclassical theory accepts that employment declines when minimum wage rises; if the level of minimum wage exceeds the market clearing wage, supply of labours increases while demand declines), followed by alternative – modified specifications. the basic competitive model posits a labour market with many identical companies and homogeneous workers (zavodny 1998). it rests on the behaviour of a labour force so that the additional unit of labour takes the work only if wages are enhanced. thus the value of the last unit of labour (marginal product) declines as labour increases. however, this approach (model) does not consider any differences as to ability, experience or knowledge of labour forces (samson 2008). * address: nemcovej 32, 040 01 košice, slovakia, e-mail: renata.vokorokosova@tuke.sk 1 living wage: a wage which is enough to buy the necessary things in daily life (longman dictionary, 1978). 2 minimum wage: the lowest wage permitted by law, by a rule, or by agreement, for certain work (longman dictionary 1978). 3 in slovakia there is a need of empirical research papers devoted to minimum wage and employment. for more information see e. g. vokorokosová 2008; barošová 2008; eriksson and pytlikova 2004. economic analysis (2010, vol. 43, no. 1-2, 83-90) 84 on the contrary, alternative or sometimes called dynamic models4 (e.g. substitution model of labour force) focused on two types of labours: skilled and no skilled and compare the level of minimum wage with that of a market clearing wage5. skilled and unskilled workers if being employed, one can suppose, that minimum wage changes increase the number of skilled workers employed while decrease the number of unskilled workers in the working process. monopsony model – another alternative model denotes a single employer that, if requiring additional unit of labour has to increase the wage levels of all his workers. the aim of this paper is to examine the impact of minimum wage changes upon the employment status of employed people regardless the age as well as of that aged 15 – 64. the paper proceeds as follows: section two provides a brief history of minimum wage relating to slovakian legal environment. section three puts details to empirical arrangement and the outcomes. section four concludes. history of minimum wage minimum wage was for the first time approved in new zeeland (1896) later in australia (1899), followed by great britain (1909). in 1912 the state massachusetts in the usa appointed the minimum wage to women and children work. minimum wage was legally introduced in the usa in 1938, in france in 1950 and in holland in 1968. within the eu setting the minimum wage is in the competence of individual economies. according to eurostat and the european foundation for the improvement of living and working conditions there are 20 countries which introduced some kind of national minimum wage (set legally or through collective bargaining). six countries (denmark, finland, germany, austria, italy, and sweden) approved minimum-wage tariff settled in sector collective bargaining. e. g. cyprus introduced the minimum wage for six selected professions (barošová 2008). minimum wage in slovakia minimum wage along with mechanism for its setting are in slovakia defined in the law 633/2007, collection of laws, on minimum wage, involved in law 354/2008, collection of laws, and in law 460/2008, collection of laws6. thus in slovakia, according to the latest version of the law, the minimum wage level is for the appropriate calendar year appointed by the government of the slovak republic. for individual sectors, it is, however, allowed to settle up a higher minimum wage level than that legally defined. the sum of the minimum wage is adjusted owing to the economic and social conditions of two previous years coming just before the calendar year for which the level of minimum 4 dynamic models do not consider negative impacts of minimum wage changes on employment due to e. g. substitution effects among workers regarding their qualification. 5 market clearing wage is the result of an upward-sloping labour supply curve and a downwardsloping labour demand curve. the market labour supply curve is upward sloping; individual firms are however, facing a horizontal labour supply curve. 6 introducing a new law on minimum wage the hitherto legislative regulations became void. the previous law set reduced rates towards selected groups of employees titled to lower rate of 50 % and 75 % from the minimum wage. vokorokosová, r., do minimum wage changes influence, ea (2010, vol. 43, no. 1-2, 83-90) 85 wage is to be determined. the sum of monthly minimum wage for the coming calendar year is adjusted according to the national average wage index (law on minimum wage in slovakia, current version). description of model and data models based upon time series usually apply for lagged variables (e. g. minimum wage) assuming that a certain time has to pass since the effects of minimum wage changes can occur (brown, gilroy and kohen 1981). lags are usually set empirically (hatrák 2007). standard statistical model takes a form tti k i it utxy ++= ∑ = γβ 1 (1) whereas yt is employment to population ratio, xti stands for relevant variables e g. minimum wage, price index, unit labour costs, etc; t is a time variable, ut is random error term, t stands for time, β1, ..., βk are parameters, which ceteris paribus indicate relation between independent variables and dependent variable, γ points out relation between trend variable and employment. in this article the testing of effects of minimum wage7 (see values of kaitz index on graph 1) for changes upon employment8 (see graph 2) rests on the standard statistical model (1) using quarterly data (1996 q2 – 2009q1) from the database of the statistical office of the slovak republic (sosr). graph 1. kaitz index reference: graphical layout based upon sosr data. 7 variable minimum wage is expressed as proportion of minimum wage to national average wage. 8 employment denotes employment rate which is the ratio of the working labour force currently employed to the total population in given age. the organization for economic co-operation and development defines the employment rate as the percentage of the working age population (ages 15 to 64 in most oecd countries) who are currently employed. economic analysis (2010, vol. 43, no. 1-2, 83-90) 86 models (model 1: age groups together; model 2: ages 15 – 64) meet assumptions of classical regression. variables are integrated of first order i (1). they are co integrated, that means, their linear combination is i (0), and it is stationary. lags of exogenous variables were set empirically. it is evident that the value of kaitz index expressed as a share of minimum wage to average wage level in national economy under slovak conditions moved from about 33 % at the beginning of the observed period to about 42 % in the first quarter of the year 2009. value of the kaitz index varies along with the level of average wage in national economy in corresponding quarter. the level of minimum wage is set forth in advance and remains unchanged for the entire year in slovakia. regression (2) expresses the relation between minimum wage and employment of both of the investigated structures files (one that encompasses all employed people; second that involves workers in the age 15 64) along with a control variable labour productivity. ,21 1312110 ttttt uyxxy ++++= −−− ββββ (2) whereas yt is a time series expressing rate of employment of observed file; x1t is a share of minimum wage to average wage; x2t denotes labour productivity; ß0,1,2,3, express parameters; ut denotes random error term. tables 1, 2 present the results – values of coefficients. graph 2. employment rate reference: graphical layout based upon sosr data. employment rate of observed files seems to be quite stable although some changes occurred during 1998 and 2003. a disemployment between 1998 and 2001 was a result of reforms provided for e. g. public finances, taxes, social system and public administration. in the following period, there was an increasing demand for labour mainly in those companies absorbing foreign capital that flew e. g. to automobile industry and attendant establishments. peculiar for 2001 was the increased number of economically active population year-on-year by 44 800 people. year-on-year rose the employment by 22 000 people (domonkos and vokorokosová, r., do minimum wage changes influence, ea (2010, vol. 43, no. 1-2, 83-90) 87 pániková 2007). in addition to this one must also take into consideration the demographic changes in the economy. the share of inhabitants at the post productive age to that of pre productive age (see graph 3: ageing index9 of inhabitants together; men; women) keeps rising. graph 3. ageing index reference: graphical layout based upon sosr data. the ageing of inhabitants tends to increase as the values of the ageing index becomes larger for all observed files (men and women; men; women) achieving the highest values for women category (its value changed from 108.92 % in 1996 to 184.21 % in 2008). from 2007 to 2008 the value of the index increased in the corresponding file (women) for about 7.31 percentage point. ageing index for men finished in 1996 at the value of 55.07 % while in 2008 at the value of 85.44 %. in 1996 the value of the ageing index in the category of men and women together obtained about 81 % while in 2008 it got about 134 %. so it seems that in 2008 there were about 134 inhabitants at the post productive age coming to 100 inhabitants at the pre productive age (0-14). the number of inhabitants decreases in general, however, as death rate declines and the length of life becomes longer; there are more and more older people at the post productive age (over 65 years). this is, however, a general tendency also in other countries. this may result in the shortage of labours necessary for a certain type of economic sector (puchá 2005). a possible solution might be the inflow of foreign labours which could reduce existing gap on the labour market. 9 ageing index is calculated as the number of persons 60 years old or over per hundred persons under age 15. in slovakia it takes following form: 100 140 65 ∗ − = +´ ai . economic analysis (2010, vol. 43, no. 1-2, 83-90) 88 table 1. values of coefficients and standard errors. ls (least squares) variables model 1 (age groups together: men and women) elasticity constant -8.413664** (2.995541) mw_aw(-1) 0.144191** (0.028492) 0.102 er(-1) 1.077487 (0.048238) prod(-1) -0.067289** (0.028022) -0.047 r2 0.931 n number of observations 52 numbers in parentheses denote standard errors, r2 – coefficient of determination. **significance at 5 % investigation results (see table 1) of minimum wage changes (expressed as a share of minimum wage mw to average wage – aw -) and their effects upon employment status (expressed as employment rate er of men and women) did not confirm a negative relation between these two variables. there is a negative connection between employment and labour productivity – prod. if the share of minimum wage to average wage changes by 1 %10, the employment rate increases by about 0.102 %. all variables are used in a lag form. any changes in minimum wage/average wage or in labour productivity tend to take some time until their effects become evident. the lags of variables were set empirically (for one period of observation that is one quarter). table 2 .values of coefficients and standard errors. ls (least squares) variables model 2 (age groups 15 – 64) elasticity constant -9.997505 (3.552217) mw_aw(-1) 0.168097** (0.033406) 0.119 er15_64(-1) 1.081321** (0.049301) prod(-1) -0.080012 (0.032629) -0.056 r2 0.929 n number of observations 52 numbers in parentheses denote standard errors, r2 – coefficient of determination. ** significance at 5 % 10 based upon calculations of arc elasticity which takes the following form: y x dx dy e xy */ = . vokorokosová, r., do minimum wage changes influence, ea (2010, vol. 43, no. 1-2, 83-90) 89 there is a positive relation between minimum wage changes and employment rate of labours aged 15 – 64 (see table 2). like in previous model (model 1), a negative relation was proved among employment rate of corresponding file and labour productivity. a 1 % increase of minimum wage/average wage in national economy seems to increase the employment rate of the file under review by about 0.119 % while a 1 % increase of labour productivity tends to decline the employment rate of labours aged 15 – 64 by about 0.056 %. conclusion outcomes obtained in this paper do not confirm the theoretical assumption that minimum wage changes have disemployment effect. in both of the files observed (employment of men and women regardless age; employment of labours aged 15 – 64) the positive effect of minimum wage/average wage changes to employment status were found out. if economy is rising, minimum wage can be rising too. this in fact motivates people working even those voluntary unemployed (discouraged) ones. as there is a lack of empirical studies in slovakia coping with minimum wage influences upon employment, this article may reduce the existing gap in this research and be useful for institutions having decision right about minimum wage settings. pros and cons of minimum wage in economy are often discussed, but a certain level of minimum wage can protect domestic labour market from the outflow of domestic labours to foreign countries mainly in the neighbourhood where they can earn minimum wage higher than it is in their domestic country. it can even prevent the labour market from the inflow of a cheap labour from abroad. nowadays it is not about abolishing the minimum wage in countries where it already exists, but it is often discussed in economies which still do not have any kind of guarantee of minimum earning. beside other advantages it presents a country´s interest to handle the issue of poverty and willingness to ensure a certain level of living also for those which earn the lowest amount of money. since there are still different opinions on how the minimum wage changes effect employment, working papers relating to this issue in different countries are a good source of valuable information for all subjects involved in this matter. references barošová, m. 2008: fungovanie a vývoj minimálnej mzdy v slovenskej republike. fórum sociální politiky 5/2008. brown, ch. gilroy, c. kohen, a. 1981: effects of the minimum wage on employment and unemployment. journal of economic literature. vol. xx. brown, ch. gilroy, c. kohen, a. 1983: time-series evidence of the effect of the minimum wage on youth employment, journal of human resources. . card, d. krueger, a. 1994: minimum wages and employment: a case study of the fast-food industry in new jersey and pennsylvania. american economic review. domonkos,t. – pániková, l. 2007: analýza a modelovanie dopytu po práci v podmienkach slovenskej ekonomiky. infostat, bratislava. eriksson, t. – pytlikova, m. 2004: firm-level consequences of large minimum-wage increases in the czech and slovak republics. labour, vol. 18, no. 1. hatrák, m. 2007: ekonometria. bratislava: iura edition. economic analysis (2010, vol. 43, no. 1-2, 83-90) 90 neumark, d. – wascher, w. 1992: employment effects of minimum and subminimum wages: panel data on state minimum wage laws. industrial and labour relations review, vol. 46, no. 1. oecd 1998: statutory minimum wages, employment and poverty. oecd employment outlook. puchá, n. 2005: komparatívne a konkurenčné výhody v novej ekonomike. in: zborník príspevkov zo 4. medzinárodnej doktorandskej konferencie: ekonomické, politické a právne otázky medzinárodných vzťahov. ekonomická univerzita bratislava, fakulta medzinárodných vzťahov. ragan, j. 1977: minimum wages and the youth labour market. review of economics and statistic 59. samson, š. 2008: dejiny ekonomických teórií – ekonomické myslenie v predhistórii, klasická a neoklasická ekonómia. košice: elfa. vokorokosová, r. 2008: minimálna mzda a konkurencieschopnosť. košice: elfa. welch, f. 1976: the minimum wage legislation in the united states. evaluating the labour market effects of social programs, princeston university. zavodny, m. 1998: why minimum wage hikes may not reduce employment. federal reserve bank of atlanta. economic review, q2. law on minimum wage in slovakia (current version of minimum wage law) www.wikipedia.com www.statistics.sk longman dictionary of contemporary english, 1978. received: 8 january 2010 article history: accepted: 7 march 2010 ea_2012_3-4 original scientific paper determinants of brand equity and its causes & consequences a study of automobiles oil from peshawar region pakistan shahzad khan*, university of science & i-t, peshawar pakistan udc: 005.936.43 ; 658.626 jel: m32 id: 195855116 abstract – the word brand equity is known to every marketer and they wish that they have positive brand equity for their brands. the question arises why customers will play extra amount for one particular product? there are many variables which create brand equity. these variables include brand awareness, familiarity, brand image, association, loyalty, preferences and availability. but it is important to find that how each of these variables contribute towards brand equity for auto mobiles oil. to find out which of these variables contribute how much towards brand equity a sample of 100 auto mobile oil users has been contacted from peshawar region. on the basis of their responses a regression and correlation analysis was conducted. findings and results of the study shows that brand loyalty and brand familiarity has more influence on brand equity in case of automobile oil in peshawar pakistan key words: brand equity, brand awareness, brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability introduction positive brand equity is the critical success factor for any company for long term survival and enjoying tremendous profit. the question why a customer will pay additional amount of money for a particular brand? for the very same purpose this research has been conducted. but there are many variables which contribute for brand equity. how ever these variables can vary from brand to brand and segment to segment. this research is focused on determinants of brand equity that what are the factors that create brand equity and how much these variables contribute towards brand equity for automobiles oil in peshawar region. research finds seven variables brand awareness, brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability from previous researches. research is focused on that how these variables are contribution towards the brand equity of automobiles oil in peshawar region pakistan. * lecturer city university of science & i-t, peshawar pakistan, shahzadkhan.lecturer@gmail.com, tel: +92-91-3339405596 shahzad, k., determinants of brend equity, ea (2012, vol. 45, no, 3-4, 60-66) 61 literature review tanmay chattopadhyay, shradha shivani and mahesh krishnan (2009) brand equity is the amount generated by the firm just because of it brand image. but charging this additional amount is not an easy job. the effort behind it is effective marketing mix. there are many ways to aware target market about their product. advertising is one of the major among them to create mass awareness in mind of consumers. according to eda atilgan, safak aksoy and serkan akinci (2005) for brand equity its is important to have brand awareness because without awareness consumers don’t pay extra attention towards brands and even don’t pay as the brand is not exposed to them. according to hamed m. shamma and salah s. hassan (2011) brand familiarity in term of usage or experience is an important factor which can influence consumer towards brand equity. that is just because on the basis of experience consumers can decide either the brand is according to their requirements or not. even the post purchase behavior is also dependent upon the brand familiarity or first time use of product. according to u. thiripurasundari and p. natarajan (2011) brands take years to create its brand image. although there are many reasons that contribute for making their brand image but this is the brand image because of which company can charge extra from their customers. this is the brand image which contributes towards brand equity. emari hossien (2011) brand association in terms of any ways can be a reason for brand equity. maha mourad, christine ennew and wael kortam (2010) that country origin can be a reason for brand association. eda atilgan, safak aksoy and serkan akinci (2005) describes in their study that customer loyalty is based on various brand characteristics like price, product quality and post purchase services. these factors directly responsible for customer loyalty. manoj pandey & dr. j.k. raju (2009) describe that customer loyalty is the major factor which create brand equity. aaker, d.a. (1991) preferring a brand over its competitor means that brand has some features which compels consumers to prefer a brand over its competitors. for brand preference the brand characteristics are primarily responsible. when a brand is preferred over its competition it mean consumer are willing to pay even more for that product. but however it depends upon nature of product and market structure and competition strategies. owais (2000) in his study describe that availability is the realistic factor in consumer purchase decision. companies make it available its products every where in market because it should be convenient for the buyers that not to waste time and energy cost for the purchase of one particular brand. consumer can only pay and buy if the product is available in market. if it is not in reach of consumers they can not allocate its purchase resources for it. theoretical frame work of the study there are two variables discussed in this study, i.e. dependent and independent variables. the below figure shows the brand equity depends upon brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. the theoretical frame work of the study includes all those variables that are identified from literature brand familiarity, brand image, brand association, brand loyalty, brand economic analysis (2012, vol. 45, no. 3-4, 60-66) 62 preferences and brand availability are independent variables of the study. while brand equity is dependent upon mentioned variables. study identified the relationship among above variables. on the basis of these variables a conclusion and recommendations is provided. methodology as this research is focused on the brand equity of automobiles oil. for research purpose the branded automobiles oil consumers of peshawar region are targeted. a sample of 100 was selected for data analysis. the four automobiles companies were taken under considerations i.e zic, shell, total and volvien. the likert scale questionnaire is designed for collecting the data from the mention sample. the number of participants who contacted was 100. for data collection among 100 consumers a research instrument was distributed. the response from respondent was 100% and regression and correlation analysis is conducted on mentioned sample size. reliability of scale the table 1 below shows the reliability of the data collected from respondents. the following table show that the data collected from mentioned sample is reliable and respondents answered accurately. because the variables are exceeding from 70% which is the standard of acceptance for reliability. b r a n d e q u i t y brand awareness brand familiarity brand image brand association brand availability brand preference brand loyalty research framework of the study shahzad, k., determinants of brend equity, ea (2012, vol. 45, no, 3-4, 60-66) 63 table 1. reliability of the scale of the study s.no variables cronbach’s alpha 1 brand equity 0.820 2 brand awareness 0.813 3 brand familiarity/usage 0.799 4 brand image 0.911 5 brand association 0.745 6 brand loyalty 0.760 7 brand preference 0.803 8 brand availability 0.918 the above table calculations suggest that the responses given by respondents of the study are reliable. hypotheses of the study and regression analysis an overview of the hypothesis related to the relationship of brand equity with brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. in order to test the hypothesis of the study eight hypotheses are developed. study shows that there is significant relationship between the brand equity and following hypothesis. objectives hypothesis relationship between brand equity and its determinants. h:1 there is a positive relationship between brand equity and brand awareness. h:2 brand familiarity/usage has an impact on brand equity.. h:3 there is a positive relationship between brand image and brand equity. h:4 brand association has an impact on brand equity h:5 brand loyalty has a significant impact on brand equity. h:6 brand preferences has an influence on brand equity. h:7 brand availability has a relationship with brand equity. table 2 below shows significance relationship between the dependent and independent variables. it explains that the brand equity has a significant relationship with brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. table 2 show that the overall model is highly significant. table 2 below shows significance relationship between brand equity and brand awareness. there is significant relationship exist between brand equity and brand awareness (t-statistic = 27.213 and pvalue= 0.000). there is a significant relationships exist between brand equity and brand familiarity (t-statistic = 33.620 and p-value= 0.000) which mean that brand familiarity has an impact on brand equity. economic analysis (2012, vol. 45, no. 3-4, 60-66) 64 table 2. regression results for variables of the study. determinants of brand equity s. no dependent variables independent variable adjusted r square f b st. error t p. value 1 brand equity brand awareness 0.673 17.107 0.173 0.286 27.213 0.000 2 brand equity brand familiarity 0.792 21.169 0.321 0.212 33.620 0.000 3 brand equity brand image 0.697 18.304 0.401 0.271 17.411 0.000 4 brand equity brand association 0.325 32.453 0.720 0.252 28.841 0.000 5 brand equity brand loyalty 0.894 31.412 0.732 0.293 39.112 0.000 6 brand equity brand preference 0.782 27.987 0.383 0.413 33.230 0.000 7 brand equity brand availability 0.577 13.120 0.297 0.610 17.113 0.000 table 2 above shows that there is a significant relationships exist between brand equity and brand image (t-statistic = 17.411 and p-value= 0.000) which mean brand image has an impact on brand equity. there is significant relationship exist between brand equity and brand association (t-statistic = 28.841 and p-value= 0.000). there is significant relationship exist between brand equity and brand loyalty (t-statistic = 39.112 and p-value= 0.000). there is a significant relationships exist between brand equity and brand preferences (t-statistic = 33.230 and p-value= 0.000) which mean brand preferences has an impact on brand equity. study shows that there is significant relationship between brand equity and brand availability (t-statistic = 17.113 and p-value= 0.000). hence the above result shows that brand equity is dependent upon above mentioned variables. correlation analysis as shown in table 3 below, there is strong association between brand equity and brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. survey demonstrates that there is a strong relationship between brand equity and awareness with correlation coefficient (r = 0.701). table 3. correlation analysis for variables of the study determinants of brand equity s. no dependent variables independent variable r r square 1 brand equity brand awarenes 0.701 0.491 2 brand equity brand familiarity 0.898 0.806 3 brand equity brand image 0.746 0.556 4 brand equity brand association 0.453 0.205 5 brand equity brand loyalty 0.917 0.840 6 brand equity brand preference 0.811 0.657 7 brand equity brand availability 0.521 0.271 shahzad, k., determinants of brend equity, ea (2012, vol. 45, no, 3-4, 60-66) 65 for brand familiarity and brand equity correlation coefficient is (r = .898). which mean that brand familiarity has a strong influence on brand equity. as shown in table 3, there is strong association between brand equity and brand image with correlation coefficient (r = .746). there is a weak relationship exist between brand equity and brand association with correlation coefficient (r = .453) there is a very strong correlation between brand equity and brand loyalty with correlation coefficient (r = .917). which mean that brand equity strongly dependent upon customer loyalty towards automobiles brand. brand equity has a strong relationship with brand preference correlation coefficient (r = .811). which mean that brand preference has strong impact on brand equity. there is a week relationship exist between brand equity and brand availability with correlation coefficient (r = .521). which mean that brand availability can weekly affect brand equity. conclusion research finds that brand equity has a significant relationship with brand familiarity, brand image, brand association, brand loyalty, brand preferences and brand availability. all factors play a vital role in creation of brand equity for automobiles oils. but findings of research show that brand loyalty contribute more with correlation (r = .917) toward brand equity for automobiles oil, in comparison of other variables of study. the second prominent variable is brand familiarity/usage with correlation (r = .898) which contribute more toward the brand equity for branded automobile oil. over all between all variables the vital role is from brand loyalty and familiarity. hence it is concluded that all variables has influence on brand equity but brand loyalty and familiarity has greater influence on brand equity towards automobile oil in peshawar pakistan. references aaker, d.a. 1991. „managing brand equity.“ the free press, new york, ny. chao p. 1998. “impact of country of origin dimensions on product quality and design quality perceptions,” j. bus. res, 42(1): 1-7. eda atilgan, safak aksoy and serkan akinci. 2005. “determinants of brand equity a verification approach in the beverage industry in turkey.” marketing intelligence and planning, 23 (3): 237-248. emari hossien. 2011. “determinants of brand equity: offering a model to chocolate industry” world academy of science, engineering and technology, (59): 1205-1213. hamed m. shamma and salah s. hassan. 2011. “integrating product and corporate brand equity into total brand equity measurement.” international journal of marketing studies, 3 (1): 1120. maha mourad, christine ennew and wael kortam. 2010. “descriptive evidence on the role of corporate brands in marketing higher education services.” service science, 2(3):. 154-166,. manoj pandey & dr. j.k. raju. 2009. „analyzing relationship between brand perception and customer loyalty in life insurance industry.“ the journal contemporary management research, 3 (1). economic analysis (2012, vol. 45, no. 3-4, 60-66) 66 owais mufti, shahzad khan and zafar zaheer. 2011. “impact of rational and emotional factors in creating consumer motivation, a study of policy holders of state life insurance corporation in kpk, pakistan”. european journal of social sciences, 24 (iv): 546-552. tanmay chattopadhyay, shradha shivani and mahesh krishnan. 2009. “determinants of brand equity a blue print for building strong brand: a study of automobile segment in india.” african journal of marketing management, 1(4). 109-121. u. thiripurasundari and p. natarajan. 2011. “determinants of brand equity in indian car manufacturing firms?.“ international journal of trade, economics and finance, 2 (4): 346-350. determinante vrednosti brenda i njegovi uzroci i posledice: studija na primeru automobilskih ulja u peševarskoj regiji pakistan rezime – reč „vrednost brenda“je poznata svakom trgovcu,koji želi da ima dobre trgovačke marke za prodaju.postavlja se pitanje zašto bi kupci suviše plaćati za jedan određen proizvod? postoje mnoge varijable koje odredjuju vrednost trgovačke marke. ove varijable uključuju svesnost o brendu, poznavanje njegovog izgleda, odanost brendu, njegovo preferiranje i dostupnost istog. pored toga, važno je otkriti kako svaka od tih varijabli doprinosi vrednosti brenda automobilskih ulja. da bi se saznalo u kojoj meri neka od ovih varijabli doprinosi vrednosti brenda automobilskih ulja, korišćen je uzorak od 100 korisnika automobilskih u peševarskoj regiji. na temelju njihovih odgovora, uradjena regresiona i korelaciona analiza. nalazi i rezultati istraživanja pokazuju da je lojalnost brendu i poznavanje brenda od najvećeg uticaja na njegovu tržišnu vrednost, kada je reč o automobilskim uljima u peševar, pakistan. klju:ne reči: vrednost brenda, svesnost o brendu, poznavanje trgovačke marke, izgled, odanost brendu, preferiranje brenda, raspoloživost article history: received: 15 july 2012 accepted: 9 august 2012 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp24-40 scientific review impact of digitalization on the labour market: the case of north macedonia verica janeska1* | aleksandra lozanoska1 1 the ss. cyril and methodius university in skopje, institute of economics – skopje, department of demography, skopje, north macedonia abstract the impact of digitalization on the labour market is very complex and is manifested in different conditions for job creation and job protection, changed needs for occupations and skills, coping with skills mismatch and labour shortage etc. the aim of the research is to determine the possible implications of digitalization on the labour market in north macedonia, by analyzing relevant labour market indicators and the results of employees’ survey based on identified hypotheses. the analysis of the labour market indicators shows that despite the positive changes, the situation on the macedonian labour market remains unfavorable i.e. low employment rates, growing skills mismatch and labour shortages in conditions of still high unemployment. the survey results indicate that the digitalization may not cause serious job losses, but it can lead to significant shifts in the employment structure (regarding sectors, occupations, skills, nature of jobs, pressure on the lower skill levels etc.). the influence of digitalization on the labour demand will depend on the employment sector and job profile, as well as on the investments in technology and relevant experience to use it. also, digitalization could reduce the labour shortages caused by demographic ageing. the survey results show that digitalization will impose changes in the education and professional expertise, management style and organizational culture, as well as in trade union organizations. the findings of this research are meaningful for policy makers, state institutions, employers, trade unions and other stakeholders. the digitalization implies need for coherent approach of all involved parties in north macedonia. key words: digitalization, labour market, skills, jobs, education, management relations, trade unions, north macedonia jel classification: o30, j2, j6, j51, j53, i25 introduction in the last decade there has been a large increase of researches related to digitalization and labour market. their results are illustrating the complexity of digitalization’s impact on the labour market and the need for profound research of certain aspects. they should be seen in the context of the current and expected situation on the labour market due to economic and demographic changes. nowadays, when the world is faced with covid-19 pandemic of global dimensions, digitalization of the work is even more actual issue. in new circumstances, this process is significantly speeded up and helps the normal function in all areas where it could be applied. * corresponding author: verica@ek-inst.ukim.edu.mk verica janeska, aleksandra lozanoska 25 the labour market in north macedonia in the last few decades was faced with many problems, which are continuously transforming and becoming more emphasized. they are manifested in low employment, high unemployment and inactivity of the working-age population, as well as growing mismatch of the supply and demand on the labour market. the reforms in the educational process, made towards compulsory secondary education and encouragement of the young people to continue in high education, didn’t take in consideration the labour market needs. it resulted in growing occupational mismatch, rise of the job vacancies in circumstances of still high unemployment and high values of youth neet4f1 indicators (janeska, lozanoska, 2018). at the same time north macedonia is face with population and labour force aging, as well as huge emigration abroad, particularly of the highly educated population. having on mind the necessity and the speed of digitalization process, as well as the complex situation on the macedonian labour market, we consider that is very important to identify how the digitalization will affect certain aspects on the labour market in the country. the aim of the paper is to determine the possible implications of digitalization on the labour market in north macedonia, by analyzing relevant labour market indicators and the results of employees’ survey based on identified hypotheses discussed in recent theoretical and empirical researches. the methodological approach of the study is based on literature review, analysis of labour market data and indicators for north macedonia and survey realized for the needs of this research. therefore, a questionnaire related to the impact of digitalization on the jobs and work was created and the survey was conducted in june-july 2020. the added value of this research derives from linking the analysis related to changes and current situation on the labour market in north macedonia and survey results on the employees’ opinions about the impact of digitalization on jobs and work. without the pretense of comprehensiveness, the paper provides grounds for discussion on different impacts of digitalization on the labour market in the country. with this research, initial knowledge was gained for various aspects, which due to their complexity implies further profound research for each of them. literature review numerous researches show that digitalization brings transformations in all sectors of activity. one of them (macías, 2018) points out that there are several ways to transform the economic processes through the digital technology. they are related to flexibility of production (due to the processing power), availability of information (digital technologies make data more available), network effects (creating demand-side economies of scale, through social networks, software systems and digital industrial applications), and zero marginal costs (because the digital goods are non-rival and infinitely expandable). at the same time digitalization implies great transformations of the working conditions, due to the mass use of networks, internet and the available online platforms. many studies confirm that this new ways of work provides flexibility of the lifestyle, freedom of action, but also brings disadvantages associated with the sacrifice of financial security, the unpredictability of incomes, the need to learn new skills, the increase of the risk of unemployment for workers with specific qualifications. digitalization also brings changes in labour legislation, because employment changes considerably, through the use of online platforms, through remote work etc. (vasilescuet al., 2020). the new technological advances imply the re-skilling of the labour force and changing the world of work, including job substitution, transformation, creation, and lose. the innovation cycle is faster than the changes in the labour market and people’s skills. thus, the current economic environment requires digital knowledge for a large share of the jobs, because 1 neet – persons not in employment, education or training. 26 economic analysis (2021, vol. 54, no. 1, 24-40) digitalization uses information technology infrastructure and the internet, as technological support. as a result, the imbalances on the labour market growth are reflected in increasing the duration of unemployment, in long-term unemployment and higher structural unemployment (cedefop, 2018). all this implies great challenges on the labour market. the impact of digitalization on the labour market can be observed through different aspects that reflect the complexity of its functioning. thus, according the recent researches, technological change in general and digitalization in particular, will most likely induce structural change. under the assumptions that the digitalization is going to have large impact on the technical equipment of the economy in the future, considerable effects on the composition of employment can be expected. digitalization may, if everything is assumed equal, increase job turnover and, in doing so, facilitate an even more efficient division of labour within the economy (walwei, 2016). economic literature is discussing that the possible results of technological change can be seen either in “capital-skill complementarity” or in a polarization of skills (krusell et al., 2002; autor et al., 2003). in the case of capital-skill complementarity the demand for highly skilled workers performing creative tasks will increase further, while low-skilled workers in comparison are most likely to lose their job (“skill-biased technological change”). by contrast, the hypothesis on polarization of skills implies more risks for workers with medium skills assuming that nonmanual routine tasks are more threatened by digital technologies than low-skilled workers often performing manual non-routine tasks (“routine-biased technological change”) (goos et al., 2014). the impact of digitalization on the labour market is very complex issue. many researches are setting different hypotheses related to one or more aspects considering this impact. one comprehensive research by klaus fuest and co-authors is compiling a list of 12 hypotheses on the future of work in the age of digitalization (fuest et. al., 2017). in addition, these hypotheses are elaborated and without pretensions to completeness, supplemented by the views of other authors or the results of recent studies on the same aspects. the first hypothesis is that the digitalization creates jobs, meaning that new technologies pave the way to new products and services – and hence to new occupations. oecd evidence shows that 65% of kids today will do jobs that have not yet been invented. being a lifelong learner is the most important attribute for success, and will grow in importance in our dynamic and competitive world. knowing one’s own learning style and developing the self-discipline and determination to grasp new skills throughout a lifetime will be critical (oecd, 2016). the digitalization reduces costs for setting up a business and finding employment, as well as creates opportunities for small companies to innovate and grow faster (by making it easier to distribute products, market services and reach a global audience). this is of great importance for job creation opportunities by successful start-ups. for example, around 3% on average across all countries — creates a disproportionate amount of jobs, from 21% (in netherlands) to 52% (in sweden) of the total job creation by micro startups (calvino, et. al., 2015). it also impacts traditional companies, which can reduce their marginal cost of production. this has a growth effect on supply and helps to push up demand for labour force. a 2015 report by the fraunhofer institute found that european companies which are intensive users of robotics are less likely to offshore production to low-wage regions, simply because robots improve their cost position so much that they can stay in high-wage regions (european commission, 2017). second hypothesis is that automation protects jobs. in traditional industries, the efficiency gains realized by greater automation help make products and services more affordable (by boosting demand for them), raises competitiveness and prevents work from being offshored to locations with low labour costs (fuest et. al., 2017). instead of equating automation with job displacement, manufacturers should approach modernization as a means of freeing up factory workers to fill more productive and meaningful roles. in fact, it is predicted that up to 133 million new roles may emerge as companies embrace automation and uncover new opportunities for humans to work alongside machines, because the labour relationship between verica janeska, aleksandra lozanoska 27 humans and machines evolves, as well as the required set of skills (wef, 2020). it implicates that proactive reskilling efforts over time will be necessary in order to protect workers and support the future needs of advanced manufacturing companies. such an approach is beneficial both for workers and global population that will benefit from employed workers, but also for companies that can innovate more quickly with a better skilled workforce. the statement that jobs are put at risk when labour productivity increases, is the third hypothesis in fuest’s research. but, when discussing this hypothesis we need to have in mind that in almost all developed economies, labour productivity growth is gradually slowing down. the results of recent researches are confirming that in eu-28, growth in labour productivity has been slowing steadily in last decades, and the european commission even speaks of a european “productivity gap” (neufeind and priesmeier, 2020). over the period 2008-2016, annual growth in euro area labour productivity per person employed slowed to an average of around 0.5% (based on a three-year moving average), from an average of around 1.1% over the course of the decade to 2007. if we consider only the post-crisis period of recovery from 2013 to 2016, euro area labour productivity growth averaged just 0.6% per year (ecb, 2017). economists refer to this phenomenon as a "productivity crisis" mainly caused by the lack of investment in technology. there are and many other discussions and researches on the relation between digitalization and productivity. namely, the productivity is mainly linked to job quality because it has the potential to create more non-routine jobs and because workers who are performing routine activities, and who are replaced by machines, are induced to reallocate their labour supply in intense non-routine occupations and to perform tasks with a higher marginal productivity’ (keister, lewandowski, 2016). some research suggests that productivity gains will possibly lead to higher wages and lower working hours (muñoz-de-bustillo et al., 2017). related to this hypothesis the general impact of digitalization on economic productivity is also subject of debate. researchers point out that in the past, innovation and technology have not always led to an immediate increase in productivity and that the effects of implementing digital technologies are not fully realized until several years later (valenduc, vendramin, 2016). besides that, they warn that digitalization will only lead to increased productivity if organizational changes occur at the same time. in this context is the fourth hypothesis that the speed of the technological transformation is overestimated. it takes a long time for innovation to unfold its impact on a broad scale. investment in technology must reach a critical mass, while extensive experience of handling it is needed, especially in industrial processes. delgado is discussing that implementing new technology includes several steps. they refer to necessity to provide continuous updates on all available information about the new technology; increasing efficiency by encouraging questions from employees and including them when selecting new technology tools; informing the workers by highlighting new opportunities created by technology and how it will support the processes and organizational culture; and the workers should recognize the growing value of new technology in the workplace and to take the opportunities to gain new skills or adapt their existing skills to new challenges (delgado, 2018). fifth hypothesis is focused on the assumption that the digitalization leads to structural changes in the economy, related to the nature of jobs that will be available in the future. the digitalization doesn't reduce the total number of working hours, but it will reduce the number of hours worked by people with fewer skills. this means that routine activities with little complexity and a modest level of interpersonal interaction are at risk. the bruegel foundation indicates that the percentage of jobs at risk of substitution by information communication technology (ict) is even higher in europe than in the us (54% compared with 47%), particularly in southern europe where employment in occupations at high risk of substitution is higher (bowles, 2014). certain studies debate on the changes in the labour supply resulting from the development of digitalization. there are authors that seriously challenge the scale of this substitution, arguing that jobs are bundles of tasks rather than a simple reflection of one kind of 28 economic analysis (2021, vol. 54, no. 1, 24-40) task. even if some tasks are substitutable by machines, this does not imply that the whole job will disappear, as many jobs require a combination of tasks and related skills. a eurofound report analyzing eu jobs in terms of skills and tasks is underlining that they are bundled together, with only a limited number of jobs remaining focused on routine mono-tasks (eurofound, 2016). in other words, as jobs increasingly tend to require various skills, and notably intellectual and social skills, they are not easily substitutable by machines or technology. this is especially referring to the service sector, which includes the vast majority of eu jobs. it means that the implications of the technical change are mediated by many factors generating a significant degree of inaction in terms of structural change. sixth hypothesis states that the effects of digitalization on employment are highly specific and demand individual answers. the impact of digitalization on jobs will not be evenly distributed nor happen at a steady pace. it is most likely to be concentrated in certain jobs, selected sectors and particular geographical areas. for example, machine learning, which underpins advancements in artificial intelligence (ai), is already being adopted by a range of industries, affecting even high-skill jobs like finance or law. other workers or sectors, for example long-haul truckers, are not predicted to be affected immediately, but when adoption of automated trucking begins, the change may be sudden as cost savings of up to 30% could result in a drop of demand for truckers in europe and the united states (itf, 2017). due to great changes in the population development worldwide, the seventh hypothesis opens the discussion about the mutual benefit of demographics and digitalization. in terms of the working-age population decrease and intensified aging of the existing labour force, automatons can provide valuable help, stepping in where human resources are lacking, but also providing better support to people as they go to work, relieving them of heavy physical labour (for example in construction). the mutual effects of demographic and technological changes can be seen in several aspects (basso, jimeno, 2019). first, changes in labour supply affect factor prices (wages and the price of robots), altering the relative profitability of labour-intensive and automated sectors. second, demographic changes affect savings and the interest rate, altering the amount of resources available for investment in capital accumulation, innovation, and automation. third, as the efficiency of r&d may depend on the age structure of population, the need of new goods is also affected when the population age structure changes. based on these aspects it can be concluded that a fall in fertility leads the economy to a new balanced growth path with lower gdp per capita growth, a higher degree of automation, and a lower labour income share. the eight hypothesis is that the education will take on even greater importance in the future world of work in terms of intensified digitalization. the digitalization imposes the need for employees to acquire new skills and qualifications and to accept the necessity for lifelong learning. it requires substantial investment and far-reaching reforms across all levels and forms of education. jobs created by new technologies predominantly require high skills. frey & osborne (2016) estimated that almost half of all the new jobs require high skills (such as data scientists, cloud architects, security analysts etc.). european centre for the development of vocational training (cedefop, 2016) figures for the past decade and its estimates for the next decade suggest that occupations that require either low/elementary or high skills are growing in importance, while the mid-skilled professions are almost non-exclusively decreasing in importance. in order to avoid a skills mismatch between labour supply and demand, education and learning programmes need to target more technical, creative and entrepreneurial skills demanded by automation (european economic and social committee, 2017). in this context and social aspect should not be neglected. so, in the process of acquiring new skills and qualifications, it is important that children from socially deprived families get equal chances for good education as those from wealthier social strata (fuest et. al., 2017). the assumption that when choosing their job, young people should attach great importance to the purpose and meaning of their activity is the ninth hypothesis. loyalty toward employers is verica janeska, aleksandra lozanoska 29 slowly diminishing, while switching jobs and choosing the right one is becoming common practice. the results of recent study show that the sense of belonging to a company for the employees nowadays is determined by being recognized for accomplishments at work, by valuating their contributions in meetings, having feeling comfortable of being themselves at work etc. (huppert, 2017). the young people often start their careers in more routine jobs and subsequently move to jobs with higher problem-solving content. transitioning from jobs at greater risk of automation to those at lower risk is an opportunity for young women and men to find work that best suits their interests and skills, and to progress to higher wages, better working conditions and improved career prospects (ilo, 2020). that is why a management style that expresses appreciation and nurtures personal strengths, as well as modern organizational culture, are key factors for employee retention. the tenth hypothesis is that there will be a shift in the work methods used, moving away from a focus on presence and toward a focus on results. for career beginners in particular, the freedom to choose where and when work is done is significant. the increasing importance of digital technologies and the rapid pace of change in employees’ roles and competencies make fundamental change at the workplace essential. for example, a majority of swiss employees are now reliant on digital technologies, and their work involves primarily knowledge-intensive roles requiring high levels of creativity and interaction (deloitte, 2018). this research emphasizes that a modern workplace that meets these criteria must be designed to promote flexibility, collaboration and connectivity, if it is to improve employee performance and satisfaction. digitalization is bringing change to the boardroom, imposing a need for a new type of manager. this is the eleventh hypothesis that is focusing on the role of the managers who at the same must realize efficiencies in existing business and driving the transformation toward new business models. these managers should steer the organization, change the working processes and set an example to the staff, not just by living out a value-based management style. digitalization also requires employers to create new forms of management, which means that it has to evolve, for instance, by providing guidelines to employees rather than trying to control all the risks. new technologies can, in fact, facilitate both the monitoring of employees and the recording of work activities, making it easier for employees to prove that certain tasks have been carried out, in both cases monitoring the outcome rather than the process (european economic and social committee, 2017). this could increase the workers’ level of motivation, by providing more freedom and responsibility to organize their own work. no less important is to involve the employees when significant decisions are made, in terms of both informing and consulting with them. all above discussed hypothesis related to the future of work in the age of digitalization implicates new forms of work requiring someone to represent workers' interests, which is twelfth hypothesis. when employers become customers and regular staff becomes "gig workers", there is a shift in the balance of power between the contractual parties (fuest et. al., 2017). to uphold social cohesion in situation where working relationships are becoming ever more virtual, what used to be "employees” must develop a new solidarity and organize themselves. a research (voss and riede, 2018) has shown that trade unions and workers representation bodies expect a weakening of workers’ participation and the erosion of collective bargaining at national and/or company level, which can be one of digitalization’s most important risks. therefore, trade unions need to build new competences, must adapt and more actively address and campaign on the issue of digitalization and the future of work. it was noted that trade unions need to develop new competences and make better use of digital technologies for communication and lobbying work, mainly by engaging more strongly in forms of digital communication such as interactive websites, online platforms or other means of electronic communication. the results of this research also point out that most online workers were demanding legal protection, appropriate working time, good working conditions and especially health and social security protection. 30 economic analysis (2021, vol. 54, no. 1, 24-40) they are aware of the risks and problematic working conditions which digitalization and on-line works entails. the elaborated twelve hypotheses and a brief overview of some recent researches related to the relevant issues of each of them, unequivocally show the complexity of the impact of digitalization on the labour market. in addition, they indicate that all the observed aspects are very compound for themselves and that each of them should be subject of more profound research. main features of labour market in north macedonia the impact of digitalization on the labour market in north macedonia is in close relation to its features. main characteristics of the macedonian labour market are relatively low employment, accompanied with informal employment, then high unemployment, as well as inactivity of significant part of the working-age population. besides that, current and expected demographic trends in the country should be taken into account. more detailed picture of the macedonian labour market can be drawn if we take a closer look at the changes and the structure of employment and unemployment. also we compare last available labour market indicators for north macedonia with the average of eu-28. in last decade the employment rates noticed an increase, but the data for 2019 shows that they are still significantly lower than the average of eu-28 (table 1). this statement also applies to employment by gender and age, with employment rates for women and youth (aged 15-24 years) remaining very low (44.7% and 20.7% respectively). table 1. labour market indicators for north macedonia and eu-28, 2010 and 2019 north macedonia eu-28 2010 2019 2019 employment rate (per cent population aged 15-64) 43.5 54.7 69.2 employment rate of men (per cent population aged 15-64) 52.8 64.4 74.4 employment rate of women (per cent population aged 15-64) 34.0 44.7 64.1 employment rate (per cent population aged 15-24) 15.4 20.7 35.7 employment rate (per cent population aged 25-54) 55.8 66.8 81.1 employment rate (per cent population aged 55-64) 34.2 45.1 60.0 fte employment rate (per cent population aged 20-64) 48.1 59.2 73.9 employment in services (per cent total employment) 51.5 54.5 70.5 employment in industry (per cent total employment) 29.0 31.1 24.1 employment in agriculture (per cent total employment) 19.1 13.9 3.6 self-employed (per cent total employment) 13.1 11.9 13.5 part-time employment (per cent total employment) 5.9 4.4 19.1 unemployment rate (per cent labour force) 32.2 17.4 6.4 youth unemployment rate (per cent labour force 15-24) 53.7 35.6 14.4 youth unemployment ratio (per cent population aged 15-24) 17.9 11.4 6.0 long-term unemployment rate (per cent labour force) 26.7 13.1 2.6 source: state statistical office of north macedonia, labour force survey 2010 and 2019; eurostat data distribution of employment by sectors corresponds with the structure of the macedonian economy. despite the increase in the period 2010-2019 the share of employed in services in north macedonia is significantly lower that eu-28, while the participation of the employed in industry was and remains higher due to its increase in manufacturing and construction. regardless of the decrease of the share of employed in agriculture in total employment, in north macedonia it remains more than three times higher than the average of the eu-28. despite of this fact, self-employment rate in north macedonia could be assessed as low. usually the higher share of employment in agriculture is associated with self-employment, but this deviation is the verica janeska, aleksandra lozanoska 31 result of relatively high informal self-employment, especially in agriculture. extremely low and decreasing part-time employment is also in relation to the undeclared work in the country. lfs data for 2019 shows that about 128.000 persons (that is 16.1% of the total employment) were informally employed. the unemployment is long-term problem in north macedonia. although the unemployment rate was almost halved in the period 2010-2019, it is two and a half times higher than the eu-28 average. despite the manifested changes, the main features of unemployment also are unfavorable. in 2019 the youth unemployment rate (35.6%) and long-term unemployment rate (13.1%) remained extremely high. besides unemployment, inactivity is also great problem in north macedonia. in this respect indicative are the neet indicators, particularly of the young population, that refers to the share of population that is neither in employment nor in education and training. in 2019 neet indicators, for the total population aged 20-34 amounts 31.2% and for particular five year age groups they are as follows: 25.8% (20-24), 34.9% (25-29) and 32.1% (30-34) (eurostat, 2019). these indicators are about two times higher compared to the average for eu-28. unemployment and inactivity imply the obsolescence of acquired knowledge and skills of human resources, which are, among other things, important for the digitalization process. current unfavorable situation on the macedonian labour market will get worse due to the socalled “demographic effect” implying that young cohorts entering the labour market will be by far smaller than older cohorts who will retire. in last two decades population in north macedonia is in a process of intensive demographic ageing due to low birth rates (since 2019 natural population increase is negative) and huge permanent emigration abroad of young and highly educated population. the iom world migration report 2020 shows that north macedonia, with an emigration rate of about 25%, is in the group of top 20 countries of emigration worldwide in 2019 (iom, 2019). so, on mid and long term decline of labour supply and more intensified labour force ageing could be expected (janeska, lozanoska, 2018a). as for the other features of the labour market, in context of digitalization it is important to point to the mismatch of the supply and demand of the labour force. the skills needs analysis of the employment agency, which has been realized since 2007, displays that there is a continuous shortage of labour force with tertiary education in certain fields (especially programmer, mechanical engineer, construction engineer, doctors, computer scientists, technological engineer etc.) and constant increase of those with vocational education for technical professions and medical staff (mechanical technician, medical nurses, construction technician, electro technician, welder, glassmaker, tinsmith, driver of cargo vehicle, operator with construction machines etc.) (esa, 2020). this is a result of the increasing coverage of young people with tertiary education. this implies great change in the structure of labour supply by skills level, which is manifested in an increasing share of academics within the working-age population and bottlenecks, particularly concerning occupations requiring medium skills level. on mid and long term this will cause serious challenges on the macedonian labour market in context of digitalization, due to the expected lower inflow of new generations of labour force and less attractiveness for attracting labour force from abroad. at the same time increased recruitment difficulties and skills shortages are noticed in the number of job vacancies. the job vacancy rate has increased from 1.23% (2012) to 1.77% (2019) and the number of vacancies was almost doubled (from 4729 to 9053, respectively). the highest number of job vacancies (3114 in 2019), was recorded in the occupations service and sales workers (state statistical office of north macedonia, 2020). this is confirming the complexity of the skills mismatch on the macedonian labour market. an empirical analysis of occupational mismatch by comparing the ratio of people with a given education level working at an inappropriate skill level to all workers within that same education level, show that it is higher for people with a tertiary level of education than for those with an upper secondary level of education across all years. at the higher level of education, the overall 32 economic analysis (2021, vol. 54, no. 1, 24-40) degree of occupational mismatch rose from 19.6% in 2012 to 22.2% in 2017, while for the intermediate level of education it remains almost the same (14.8% and 14.3%, respectively) (blazevski-mojsoska, 2019). over-skilling as the proportion of employed people who are overeducated is manifested due to the lack of jobs for certain profiles of workers, leading some of them to accept work which requires lower qualifications. the abovementioned analysis shows that the highest incidence of over-skilling is observed among services and sales workers. as for the under-education it occurs among the higher occupations (for example managers) and among technicians, associate professionals and clerical support workers. all above mentioned features should be taken into consideration when observing the results of the survey about the impact of digitalization on the macedonian labour market. survey results in order to obtain knowledge about the attitudes of the employees in north macedonia on the impact of digitalization on the labour market, associated with elaborate hypotheses in this paper, a survey research based on questionnaire was realized. for the analysis of the gathered data qualitative research have been used. qualitative research gives opportunity the acquired answers and opinions to be related to different research phases and to be used for verification of the discussed hypothesis (mesihovic, 2003). in this paper the attained answers were put in relation to the current situation in north macedonia and were also discussed in terms of the elaborated hypotheses. the questionnaire was divided in two subsections. the first part refers to demographic and socio-economic data (sex, age, education and occupation) of the respondents. in the second part of the questionnaire, the questions were related to the impact of digitalization on the labour market. they were based on the above elaborated hypotheses, but modified considering the current characteristics of the labour market in north macedonia. the part of the survey consisted of 12 close-ended questions, among which some with single or multiple choice, while others with ranking scale. this approach in formulating the questionnaire was chosen in order to provide information to the respondents for possible impacts of different aspects of the digitalization and at the same time to give them opportunity to choose and to express their attitudes in context of the present situation on the labour market in north macedonia. the questionnaires were send by e-mail to the human resource management departments of different institutions (ministries, agencies, public enterprises, banks, insurance companies etc.), with request to distribute them to at least 5 of their employees. the answered questionnaires were sent back by e-mail. the survey was conducted in the period june-july 2020, in time of the covid-19 pandemic, which undoubtedly has reflected on the responses from the institutions and the number of the filled questionnaires. the research was realized in new reality imposed by the lock-down, the increased number of persons who started to work from home, the emphasized need to be on-line in order to stay connected and to finish everyday work tasks. this was additional incentive for the employees from these institutions to be involved in the discussion on the importance and the impact of the digitalization in north macedonia. with the survey were gathered 85 questionnaires. out of them 15 were not completely filled and were excluded from the analysis. so, 70 gathered questionnaires were numerated upon their receipt and the answers were noted in one excel table. it was designed for purpose the answers for each question to be sorted. afterwards, they were presented in separate tables and figures. the application of qualitative research is based on thematic analysis, provides authenticity and gives certain qualitative values of the research (neuman, 2006). the results of the survey were interpreted through thematic analysis related to jobs and labour demand; structural changes in the economy and impact in different sectors; demography and education; management styles and organizational culture; trade unions. the answers on the questions were verica janeska, aleksandra lozanoska 33 analyzed in context of the previous researches, available data and existing situation on the labour market in north macedonia. main features of the respondents related to gender, age, education and occupation are:  dominant share of women – two thirds (67.1%) of the respondents are women and one third (32.9%) are men.  relatively balanced share of youth, middle-aged and older workers – 14.3% of the respondents are young (20-29 years), 25.7% are younger middle age employees (3039), 32.9% older middle age employees (40-49), 15.7% are aged 50-59 years, and 11.4% are 60+.  prevailing respondents with tertiary education – more than four-fifths (88.6%) of the respondents have tertiary education, and the share of those with higher and secondary education is relatively small i.e. 2.9% and 8.5%, respectively.  majority of the respondents are economists, lawyers and engineers from various fields. the survey results regarding the question about whether the digitalization will create new jobs and occupations show that two thirds of the respondents (58.6%) think that the application of new technologies will condition the emergence of new products and services, and with that of new occupations. this to some extent confirms the hypotheses that digitalization creates jobs. still, relatively high is the share of those who think that it depends on the sector and the profile of the work (more than one third of the respondents i.e. 35.7%). only 5.7% of the respondents don’t think that the digitalization creates new jobs and occupations. in the last decade (2010-2019) the digitalization of the work processes is continually increasing, but with different intensity depending on the nature of jobs. it is predominantly emphasized in the financial sector, in some industrial branches, as well as in the public sector, particularly in the inter-institutional communication, records and exchange of data through interoperability platforms etc. along with these changes, the increase of the number of employees was noticed. in the context of the creation and protection of jobs, the respondents were asked what they think about the automation impact on the protection of jobs. almost equal is the share of respondents who see positive impact from automation on increase of the demand for products and services (31.4%) and on rise of the competitiveness (30.0%). about two fifths of the respondents don’t expect automation to protect the jobs (38.6%). the answers of this question correspond with the existing situation in north macedonia. in terms when there isn’t wide application of the automation it is impossible realistically to determine its impact on the job protection. significant share of respondents reflects that the productivity increase which is a result of the digitalization will not considerably put at risk the jobs. so, according 57.1% of the respondents, being less employed will generate more output, while 42.9% think that the digitalization will not put at risk the jobs due to low productivity levels and due to relatively small investments in fixed assets and new technologies. the available data show that the productivity level in the macedonian economy was and remains relatively low and with oscillating trend (trpeski, 2019). technological improvements have significant impact on the labour market. in this regard, almost 80% of the respondents share the opinion that the impact of technological speed on labour demand will depend on the investment in the technology, as well as on the experience for its use (figure 1). 34 economic analysis (2021, vol. 54, no. 1, 24-40) figure 1. the impact of technological transformation speed on the labour demand source: survey research of the authors the respondents had an opportunity to rank their answers on the question how the digitalization leads to structural changes in the economy and impacts the labour market, related to three aspects (figure 2). highest rank is given to the statement that the digitalization will impact the nature of jobs (by 47.1% of the respondents) and that it will increase the pressure on the lower skill levels (by 39.7%). as for the impact of digitalization on the labour demand, almost half of the respondents gave rank two. the answers of the respondents on the first two aspects of this question correspond with the changes in the scope and structure of the job vacancies. namely, in the last decade they have increasing influence on the labour demand, as well as great impact on the nature of jobs. their statements to the third aspect of the question are also relevant. in the coming years should be expected increased pressure on the employed and unemployed persons with low education level5f2, whose share in 2019 was about 18% and more than 25%, respectively. figure 2. digitalization leads to structural changes in the economy and impacts the labour market source: survey research of the authors concerning the effects of digitalization in different sectors, 94.3% of the respondents consider that it is specific and require a single answer in each sector. only 5.7% think that they are the same in all sectors. тhe fund for innovations and technology development of north macedonia (fitd, 2020), continously is announcing calls for accelerating the technological 2 low education level refers to persons without education, with incomplete primary education and primary education. verica janeska, aleksandra lozanoska 35 development of the public (mainly for municipalities) and private sector. thus, they announce calls for submission of project proposals for financing under the support instrument – cofinanced grants for technological development for accelerated economic growth. majority of the companies and institutions which can use this opportunity are from the following sectors: trade, education, health, agriculture, construction, energy, catering etc. in north macedonia demographics and digitalization will be of mutual benefits on middle and long-term. it is particularly emphasized in current situation of negative natural population increase, enormous emigration abroad and intensified demographic ageing. by giving rank one, 42.9% the respondents confirm that the digitalization will mitigate the consequences of the large labour force emigration abroad, 27.9% of the respondents stated that the digitalization will alleviate the declining inflow of new labour force and emphasized lack of workers and 32.4% that it will liberates the employees from certain manual/physical work (figure 3). figure 3. digitalization is mitigating the demographic consequences of aging and labour shortages source: survey research of the authors when it comes to the digitalization and the changes in education, two thirds of the respondents (66.7%) gave highest rank on the need for significant investments and far-reaching reforms in all levels and forms of education (figure 4). this answer corresponds with the current situation in north macedonia in this area. namely, in progress are strategic reforms in the primary education and continuous improvement of the programs for secondary and high education, which among other, are determined by the digitalization process. about 38% of the respondents also gave rank one for the need to continuously improve competencies and skills of the employees. similar percentage of the respondents (36.8%) recognized the significance of the opportunities for good education for socially disadvantaged children. in the period 2010-2019 the poverty rate (laeken indicator) of children and youth (0-17 years) is in range from 32% to 28%. in these circumstances the coverage of these children with good education is of great importance for their inclusion on the labour market (state statistical office of north macedonia, 2021). 36 economic analysis (2021, vol. 54, no. 1, 24-40) figure 4. digitalization imposes changes in the education source: survey research of the authors the results of the survey also show that when choosing a job, young people pay more importance to the style of management that respects their personal affinities, which is seen by giving rank one on this statement by 39.7% of the respondents (figure 5). by ranking two, 45.7% that is majority of the respondents recognize the importance of professional expertise to work in a company, while 36.8% of them, by ranking two, distinguish the rising importance of the organizational culture for attracting talents. in terms when there is paradox situation on the macedonian labour market, with high labour supply, but lack of skilled workers, it is expected that the workers will look to work in companies and institutions that respects their personal affinities and professional expertise. figure 5. digitalization and the importance of professional expertise and organizational culture source: survey research of the authors the previously stated is confirmed with the answer on the question related to the digitalization impact on the necessary changes in the organizational culture from the aspect of the methods of work and the need to shift the focus of work from physical presence to results. about 73% of respondents have noted that it depends on the activity and the profile of work. besides changes in the organizational culture, the digitalization implies the need for a new type of managers. in this respect, respondents gave highest rank for the necessity of changes in the work processes (46.3%) and for applying a value-based management style (47.8%). most of the respondents (40.3%) gave rank two on the statement that the digitalization will require application of new business models (figure 6). verica janeska, aleksandra lozanoska 37 figure 6. digitalization implies the need for a new type of managers source: survey research of the authors digitalization imposes new forms of work, which presuppose changes in the ways how worker’s interests are represented by the trade union organizations, which is acceptable for almost half of the respondents (46.8%). still, more than one third of the respondents (35.7%) answered that they don’t know if this kind of changes are necessary to happen. survey results more or less are confirming the hypotheses and show that regarding the impact of digitalization there will be challenges in different aspects of the macedonian economy, especially on the labour market. conclusion based on the desktop research, labour market features in north macedonia and survey results on the impact of digitalization on macedonian labour market, several conclusions can be noted. numerous theoretical discussions and empirical researches are confirming that the digital technologies fundamentally change the nature and meaning of work. the literature review and elaborated hypothesis on the impact of digitalization on the labour market shows the complexity of this issue and that it influences many aspects. the process of digitalization of work in the last decades has gone through various stages and there is no doubt that in new circumstances of covid-19 global pandemic it will be significantly modified and accelerated. considering the complexity of the digitalization process, the impact on the macedonian labour market will depend on its features. despite the positive changes, the current situation is still unfavorable due to low employment rates and high unemployment rates, as well as mismatch of the supply and demand on the labour market. it implicates recruitment difficulties in circumstances when there is a rising number of job vacancies and still high unemployment. at the same time the macedonian labour market is faced with occupational mismatch, over-skilling and under education. the survey results more or less are confirming the elaborated hypotheses and indicate that the digitalization may not cause serious job losses, but it can lead to significant shifts in the employment structure (regarding industries, occupations, skills, nature of jobs, pressure on the lower skill levels etc.). the influence of digitalization on the labour demand will depend on the employment sector and job profile, as well as on the investments in technology and relevant experience to use it. also, digitalization will reduce the labour shortages caused by demographic aging. digitalization is a process which will impose serious policy responses. the results of this research are meaningful for policy makers, state institutions, employers, trade unions and other stakeholders in north macedonia. the digitalization implies need for coherent approach of all 38 economic analysis (2021, vol. 54, no. 1, 24-40) involved parties. it will impose the need for reforms in all levels and forms of education, changes in management style, organizational culture, work processes and application of new business models, as well as, union organization. so, the role of the state is very important, since creating policies and undertaking appropriate measures is necessary to support the public and private sector in their process of digitalization. the study provides an insight of digitalization’s impact on the labour market in north macedonia, and the findings may help in creation of related policies. the attention of policy makers in the country should be focused on:  reforms in all levels of educational process, related to the impact of digitalization on the labour market;  support of the lifelong learning process and continuous skill improvements of the employees in public and private sector;  equal attention on the investment in the technology and on the skills and experience for its use;  changes in the regulatory framework;  adjustment of labour market programmes and creation of flexible labour market policies which can provide job security;  retention of talents in the country and talent management in public institutions and private companies;  promotion of new management style and organizational culture;  more attention on social dialogue as a mean for establishing supporting measures. the research confirms the complexity of this issue and offer additional knowledge on the ways in which digitalization influence different areas such as labour supply and demand, productivity, labour force aging, job transformation, management style, organizational culture etc. having in mind this, inevitable is the fact that in the process of digitalization, north macedonia will be faced with big 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"digitalization and structural labour market problems: the case of germany". international labour office, september, p. 4. https://doi.org/10.1371/journal.pone.0232032 wef. 2020. global agenda: "in the age of automation, technology will be essential to reskilling the workforce", https://www.weforum.org/agenda/2020/03/how-tech-can-lead-reskilling-inthe-age-of-automation/ (last accessed: 20.02.2021). article history: received: february 25, 2021 accepted: may 4, 2021 microsoft word 2009_3_4-korigovano.doc review book review corporate governance, performances measurement, and normative coordination of internal control systems by professor valter cantino, phd in his book “corporate governance, performances measurement, and normative coordination of internal control systems”, published by company data status from belgrade, professor valter cantino, phd, with his professional, pragmatic and simple approach, elaborates the corporate governance, performances measurement, and normative coordination of internal control systems. as such, this book presents the precious source which offers the unique cognition regarding the fact that the author lives and works in italy. it is not necessary to emphasize how important is for serbian economic public to acquaint with the experiences and practise in italy through this significant book, especially at the moment when serbia traces its way towards eu members and when the serbian companies face the chalenges of radical changes in their business operations. this book is also popular among students, both masters and phd studies, for dynamic business environment, where changes create changes. the productivity is imposed to companies as an imperative, and they are not only expected to note changes in time and react faster and more efficiently than competition, but the companies should be the initiators of these changes. by intensive changes, the environment creates the pressute to management to adjust continually to requests for costs reduction, companies transformation along with efficiency increas, management effectiveness, that professor cantino writes about. it is also important to mention that the translation of this book into serbian is a result of strategic cooperation between faculty for management, university of turin and bba and institute of economic sciences from belgrade. the cooperation started with tempus project buona, and along with book of professor valter cantino, dean of faculty for management, university of turin, the result of this cooperation is master program at belgrade banking academy, that enables students to get dual diploma. for publisher data status, this book presents the first edition translated from italian into serbian. professor valter cantino”s book consists of four chapters: • the first chapter examines the corporate governance and companies” business operations evaluation zdravković, a., et al., book preview, ea (2009, vol. 42, no. 3-4, 86-90) 87 • the second chapter examines the business risks and internal control systems • the third chapter deals with the funcitioning of control undersystems in companies according to the rules of italian law, analyzed as the task of the most important menagars and organs • the fourth chapter discusses the integrated models for measurement, control and coordination of business performances the first chapter starts with the analysis of relation between companies and environment with special view on political and legal environment as a context in which the corporate governance rules, and affect, as a part of legal regulations. the experiences proved that former governance systems were not reliable enough and the result was break-up of big companies, numerous affairs and scandals. thus, the legislators took measures in order to modify the governance rules. professor valter cantino used the case of italy to show the changes in governance rules of a company, realized in in the set of new laws, codes, regulations. the alternative governance models were introduced by the reform of company law. analysing the corporate governance as “team of management rules and procedures which the management and control system consists of, and defining legal and moral obligations to be obeyed by economic subject in performing its economic activity”, the author provides the basic model characteristics of corporate governance which companies can apply. starting with shareholders structure and structure stability, the author indicates the differencies between private, partnership and public companies, giving the detailed analysis of corporate governance model in italy. the civil law reform in italy offered the italian companies the new solutions and possibilities to choose the model that suits most their governance dynamics. the basic characteristics of italian models are completed with scheme reviews which define clearly the role of control organs. as a result of company trasnsformation process, the management faces the growing pressure due to stronger competitiveness and continual tendency for efficiency increase as well as challenge of founding the solution for greater transparency towards all interested parties. in this context, professor valter cantino focuses on the strategy which enables the company to realize the goals and achieve the the expected results. regarding the fact that even the potentially successful strategies do not achieve the a priori expected results, and that a number of assumptions affect the transformation of strategic tendencies into desired results, the author defines the strategy diagram. the company success depends mostly on its ability to adjust to changes and to face the pressures of environment. the author presents the basic characteristics of companies with performances, that provide concept definition of corporate performances governance along with the elements, the modern organiations should affect, in order to become the same. according to the author, professor valter cantino, in economic sense, the risk is a condition for existence of a company. the company’s business operations and decision processes are carried out in the circumstances of uncertainty. indicating the close connection between the risk management systems and internal control systems, the second chapter of the book examines business risks and internal control system. the author emphasizes that the internal control is an integral part of management system and risk control. in uncertain circumstances the task of a company”s management is to govern the business risk potrfolio economic analysis (2009, vol. 42, no. 3-4, 86-90) 88 and in that context, to be acquainted both, with risks, which jeopardize the goals realization and with the actions which should be taken to prevent and control them. thus, only by the consolidation of risk management system and internal control the efficient corporate governance could be reached. the internal control system is becoming a crucial element for efficient management of a company. it is the control which is carried out within a company, in order to provide goals realization and maintenance of the state of formal and vital regulations. the internal control has an important role in risk management process by its own control and advisories. under the company’s risk management professor valetr cantino considers the following activities: risk defining, that encompasses the review of risk processes and potential risk analysis, and control system projections, that includes preventive control system analysis and evaluation of remained risks. the numerous financial scandals initiated the necessity for strengthening a company’s internal control system systematicallly by the corporate governance norms with a special accent on management responsibility. the author illustrated the evolution of business risk management model and internal control system in usa and europe. the third chapter explores systematically the norms and procedures regarding a company’ organs that are incorporated into a company’ control system, with special view on internal auditing function, function of head of financial department and advisory body, on the case on corporate governance in |italy. according to the definition of the institute of internal auditors, the internal auditing presents “independent and objective, control and advisory system, aimed at better efficiency in organization”. in this part, the author explains how the operational control concept, which is performed by internal auditing, contributes to the goals realization and operational risks management process. a special attention is given to the control system realization of the head of finance. the need of the italian companies to be present on the international financial markets requires the adjustment to the international practice, which resulted the approach of head of finance function to ‘international model’, cfo, and in author’s opinion these two functions will probably cover one another in future.in this context, the foundation of internal accounting and management control system is of great importance for head of finance to realize his operational activities successfully. the author illustrated graphically the project for evaluation and internal control system coordination dividing it into five stages: evaluation, analysis, process view,corrective activities and monitoring. the goals and associated activities of each of these stages are explained in details. eight years ago, for the first time, the italian legislation introduced the term criminal liability for organizations that is added to the individual criminal liability. in order to prevent itself from this kind of liability for possible individual criminal liability, a company has to apply a relevant prevention organizational model. upon detailed description of all possible aspects of criminal liability, which could be transferred on a company, the author discusses about legal recommendations regarding the establishment of “preventing model”. the conclusion is that the preventing control system can protect a company from responsibility only if there is no possibility that the criminal act has been done due to the ignorance or wrong interpretation of regulations and directives in a company. zdravković, a., et al., book preview, ea (2009, vol. 42, no. 3-4, 86-90) 89 the effective implemenation of preventive regulation mechanism in a company requires a corresponding advisory body, authorised for periodical functioning check up. the author systematizes the various tasks and activities which are in charge of advisory body, emphasizing the significance of its autonomy, independency and professionalsim that enables a company to perform its ethic codex. professor valter cantino begins his presentation of integrated model for measurement, control and business performances coordination by description of legal changes which enlarged the importance of organizational part of a company, which is in charge of financial management and control, that is, its head chief financial officer (cfo) in business performances measurement process. speaking about more and more complex and strict demands for tracing the economic and financial data, financial management and control are faced with, as a result of severe normative system, the author focuses on a problem of unsufficient economic efficiency, that could occur as a consequence of such coordination. having in mind the fact that the research activities are more and more exposured to the growing demands of normative coordination, the effective result could be reached by transfer from separatecorporate governance solutions to holisitc ones. to contribute successfully to performances measurement and normative coordination, integrated into control system of a company, the organizational part for financial management and control has to establish a systematic and fruitful cooperation with other services, incorporated in the process of data processing and information regarding the management and financial issues. the author refers to clearly defined hierarchical structures between cfo and subjects who perform control activities within complete corporate governance project, with special accent on relation modalities of cfo and board of directors. the information systems, management control and human resources organiazation and development are typical section which take part in information process of a company performances. from the view of information technologies, the author points out two important aspects for elaboration of economic and financial information: regular evaluation of incorporated procedures coordination with information processes and effectiveness of information instruments in integrated management of a company. the special attention is given to erp information systems (enterprise resource planning) in controlling the data coordination, especially in consodilation of a group of companies and difficulties in realization of procedures which differ from existing procedures. by law, the cfo function is to confirm the identical statements in accounting books and official documents which a company submits to the market. the completeness of assumptions on continual business procedures monitoring and specific checks of proper control are inevitable pre-conditions for objective and credible review of a company’s performances. in this context, the author analyses the concept of relation between cfo and internal auditing as customer-supplier, whereas the service for internal auditing provides information regarding the adequacy,and functionality of internal control system. in addition, the cooperation between cfo and advisory body, which contributes to transparency of control system, is also of great importance. finally, professor valter cantino, analyses the implementation of integrated measurement model, control and normative coordination of business performances. the first economic analysis (2009, vol. 42, no. 3-4, 86-90) 90 illustration shows the model which, by synthetic presentation of relations between management instruments, internal control systems, and coordination with internal rules, results the coherent corporate governance model, including the instruments for business performances measurement and coordination with internal and external norms. the second illustration, which refers to “spider’s net of norms, depicts the internal control system and corporate governance rules as “railtracks connected by ties, specific domains regulated by relevant norms. thus, by adding the new norm ties, a company can safely trace its future way. zdravković aleksandar, institute of economic sciences, belgrade beraha isidora, institute of economic sciences, belgrade domazet ivana, institute of economic sciences, belgrade microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp79-94 original scientific paper current trends and future progress in the banking risk and capital management: worldwide experience and republic of serbia case study nenad milojević1* | srdjan redžepagić2 1 mirabank a.d. belgrade, belgrade, republic of serbia 2 université côte d'azur, graduate school in economics and management, groupe de recherche en droit économie et gestion cnrs (umr 7321), nice, france abstract the financial institutions risk and capital management are intensively, constantly developing and transforming. starting from 80s of the last century, world economy, including banking had significant progress and changing. aware of this, basel committee on banking supervision (bcbs), central banks, regulators and business banks were searching for the adequate solutions for the risk and capital management. regulation related to capital adequacy, measuring, methods and management had one of the central places in the attention of the mentioned institutions. these methods had achieved significant improvement and they are today very comprehensive and sophisticated. however, mentioned institutions were constantly coming to conclusions, that risk and capital management, measuring and methods, should be improved, so that it would be adequate and efficient. the global economic crises had especially important impact on the stated processes. the needs for the new basel iii improvement (in some institutions called basel iv), were strong. since basel iii improvement publications and other recommendations for the risk and capital management progress are available, further effects analysis can be conducted. in this paper, comprehensive analysis of the risk and capital management progress is performed. additionally, recommendations for the improvement of the banking risk and capital management are defined in the paper. for this purpose analysis of the actual risk and capital management and all major factors which are dominantly influencing and shaping worldwide banking risk and capital management is performed. based on this, special case study for the republic of serbia has been conducted with the simulations and stress tests. key words: banking, risk and capital management, capital adequacy jel classification: g21, g32 introduction financial institutions capital and risk management progress is intensive. some of the most important institutions involved in this process are: bcbs, central and business banks, other institutions involved in the financial sector regulation, external agencies responsible for the credit rating assessment, etc. basel capital standards, i.e. basel i, ii, iii and other related regulations were enabling and stimulating banking risk and capital management (brcm) development in the world. * corresponding author, e-mail: nenad.m.milojevic@gmail.com 80 economic analysis (2020, vol. 53, no. 2, 79-94) it is expected that brcm development will be implemented primarily through the continuation of the progress, improvement and full implementation of the reformed basel iii standard. further, full application of international accounting standards (ias) and international financial reporting standards (ifrs), which are specifically related to the risk management segment, such as ifrs 9, will continue to mark the development of risk management in the coming years. the development of brcm will continue to determine further improvements in banks' recovery and restructuring plans. the adaptation of brcm, new market conditions and challenges, such as new financial technologies, contemporary digital banking, will continue to play an important role in the coming period. in doing so, some risks take on new forms and characteristics, and some are further enhanced by importance. banks and other financial market involved parties have significant hopes in the field of artificial intelligence and machine learning, which are expected to have a strong impact on the development of banking, including the development of risk management, in the coming years. the development is conditioned by both macro prudential needs and micro aspects, i.e. the need for banks to improve their current practices and adapt to new market conditions. in this part of paper the major aims are highlighted. the goals are including analysis of the current key tools for the global brcm and recommendation definition for the improvement. special focus in the goals achieving is on the currently actual capital and risk indicators, applied in today’s banking: total capital adequacy ratio (car), tier i ratio, common equity tier 1 (cet1) ratio and other. the research has taken into account other brcm measures standards (like ifrs 9, etc.). analysis is taking into consider developed banking sectors / economies experience (like eu and other) and developing economies and smaller banking sectors (for example in countries like the republic of serbia and other). the aim is to outline the key elements that should mark brcm development and then to outline the most important challenges along the way. additional goal of the paper is to formulate recommendations for the successful implementation of new trends in brcm. regarding the research geographical scope it is important to highlight that the paper has worldwide focus and relevant recommendations, but it is more concentrate on the europe countries and especially on the countries like republic of serbia (for which in the paper is conducted few special analysis). based on the comprehensive analysis of the brcm (historical, current and future potentials), the research achievements could be valuable for the financial institutions (in serbia, eu and non-eu countries, etc.) and its brcm, but also for the other institutions and parties involved in financial development, control, financial stability strengthening and creating conditions for sustainable economic growth. the key starting hypothesis of the research is the following: using global and domestic experience, published studies, analyzes and databases, it is possible to define perspectives and recommendations for further development of brcm. methodology which is applied in this research is dominantly characterised by the following. most relevant publicly available historical and contemporary world experience, research results, analysis and databases for the topic of this research will be used. specifics of the developed banking sectors / economies (especially eu), as well as developing economies and smaller banking sectors (like banking sector of the republic of serbia, etc.), will be taken into consider. this should result with adequate overview and analysis of the thesis, as well as conclusions in this research. for this purpose, among others, research includes analysis of the actual brcm and related regulation, as well as possible future development. additionally, the goal is to define recommendations for the improvement of the brcm. for the previously mentioned, especially the following methods will be relevant: descriptive, inductive – deductive, analytical – synthetic and comparative analysis. regarding relevant references, research results, analysis which will be taken into consider for this research, among others, following should be highlighted:  bcbs capital standards, analysis and recommendations are representing bases for the brcm development during last decades; nenad milojević srdjan redžepagić 81  central banks and other banking regulatory bodies worldwide analysis and published documents and databases;  various published research, working papers and other documents of the experts and institutions are directly or indirectly involved in the banking worldwide. current basel iii risk and capital management standard the worldwide economic crisis have strongly influenced on the basel iii measures conducting and its urgent and precise application. one of the new standard goals is to decrease the likelihood of new economic crisis advent and to enable terms for the sustainable economic progress. on the following figure basel capital framework development is presented. the figure has marked stage of current status of standard application in the eu and serbia since they are representing major examples for the implementation in this paper. figure 1. development of the basel (“b”) risk and capital management framework source: authors to reach the current capital adequacy basic formula, here is presented formula development which is chronologically stated bellow, from the basel i to the basel iii. 8% ratio adequacy capital risk creditrwa capital regulatory  (1) 8% ratio adequacy capital risk market and creditrwa capital regulatory  (2) 8% ratio adequacy capital risk loperationa and market credit,rwa capital regulatory  (3) at the start, bcbs presented revision of the provisions of basel ii in 2009 and 2010. very soon the provision were called basel iii framework (bcbs, 2011 and 2013, adrian, 2018). in the meantime, basel iii standards are updated and implementation has started in eu and other countries, including republic of serbia. modifications were very ambitious and challenging for supervisors and commercial banks (milojević, 2016). one of the important issues was providing 82 economic analysis (2020, vol. 53, no. 2, 79-94) a significant amount of additional capital for a large number of banks. this was one of the reasons why gradual implementation (table 1) of certain segments of the basel iii framework was defined for the period of 2013 – 2019. in the newest basel iii revision, for some regulatory segments, defined period is: 2022 – 2027, but as of 27 march 2020, bcbs announced prolongation for one year, i.e. 2023-2028 (for more information: bcbs, 2020). basel iii framework is applied on all continents, similar like the previous international frameworks. already in 2015, basel iii was applied (or the application is ongoing) in 122 jurisdictions (bcbs, 2015, “implementation of basel standards a report to g20 leaders on implementation of the basel iii regulatory reforms”). successful implementation has been countries during last years, so it can be concluded that significant progress has been achieved worldwide (bcbs, 2019, “seventeenth progress report on adoption of the basel regulatory framework”). basel iii framework is focused on banking capital strengthening. particularly the capital quality is important, but basel iii focused also on the risk treatment. with the basel iii implementation, liquidity risk and liquidity management has very increased importance. like defined in the basel iii implementation plan, in the period 2013 2019, regulation for the next segments has gradually become valid: new liquidity ratios, leverage ratio, capital buffer, and higher capital ratios minimum prescribed levels. table 1. initial basel iii framework timetable 2013 2014 2015 2016 2017 2018 2019 leverage ratio parallel run 1 jan 2013 – 1 jan 2017 disclosure starts 1 jan 2015 migration to pillar 1 cet1 ratio 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5% capital conservation buffer 0.625% 1.25% 1.875 2.5% cet1 plus capital conservation buffer 3.5% 4.0% 4.5% 5.125 5.75% 6.375 7.0% phase-in of cet1deductions 20% 40% 60% 80% 100% 100% minimum tier 1 regulatory capital 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0% minimum total regulatory capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% minimum total regulatory capital plus conservation buffer 8.0% 8.0% 8.0% 8.625 9.25% 9.875 10.5% regulatory capital instruments that no longer qualify as non-core tier 1 capital or tier 2 capital phased out over 10 year horizon starting from 2013 source: authors, based on data from: bcbs (2011 and 2017) with the basel iii implementation, leverage ratio is returned in the capital and risk management as important indicator. during previous century leverage ratio has been used in the financial institutions managing, but few decades ago it was suppressed by the more sophisticated basel indicators. as part of the basel iii framework, leverage ratio is a non-riskbased leverage indicator that includes off-balance sheet exposures and serves as a backstop to the risk-based capital requirement. it has an additional role in the protection of the financial system from the extremely high level of leverage. treatment of the systemically important financial institutions requires special treatment. based on this bcbs defines new instructions. stated institutions must keep additional capital buffers. namely, during the global financial crisis very high amounts of capital injections were required for the stated institutions (and financial systems) recovery. nenad milojević srdjan redžepagić 83 the countercyclical and macro prudential measures are representing important contribution of the basel iii to the financial stability strengthening. in this important task, bcbs has cooperation with many other institutions which has role in the financial stability and micro and macro regulation. the capital buffers implementation has central place in the countercyclical and macro prudential measures improvement (milojević, 2016). with the implementation of these measures, improved brcm is giving contribution to the financial stability, but also to the optimal balance between of banking and economic growth (milojević, 2014). the liquidity risk has especially important place in the basel iii framework. the two most important liquidity risk basel iii indicators are: liquidity coverage ratio (lcr) and net stable funding ratio (nsfr). the lcr is requesting from financial institutions to keep adequate level of excellent quality liquid assets to stand a one month stressed funding scenario which have prescribed regulators. 100% days calendar 30 r the nexttflows oveet cash ou total n assets ity liquid high-qual  (4) nsfr is a long term structural indicator defined with the aim to address liquidity mismatches and to cover the entire balance sheet with focus on the stable funding sources. 100% funding stable of amount required funding stable of amount available  (5) stated two liquidity risk ratios are together with internal liquidity adequacy assessment process (ilaap) bringing new, improved liquidity risk management. however, implementation of the basel iii liquidity risk ratios is demanding, so the bcbs decided that its implementation needs to be phased. similar opinions can be seen in the various analysis and paper of the researchers and different involved institutions during the implementation preparation. for example, könig (2015) was highlighted importance of the carful implementation of the new basel iii liquidity risk management, so that the potential negative effects would not materialize. in the segment of pillar 2 requirements, basel iii framework has brought revised risk management and supervision. some of the improvements are related to the following segments:  corporate governance, risk management and stress tests;  treatment of the risk generated by the off-balance sheet items and securitisation instruments;  concentration risk treatment;  guidelines for the financial institutions long term risk and return management;  financial instruments valuation and accounting treatment;  supervisory colleges and other. basel iii has also brought more detailed and stricter pillar 3 requirements, disclosure strengthening and market discipline. with the stated basel iii framework, significant progress in the brcm development has been achieved. however, this progress needs to be continued. related to the bcbs prepared the revision, i.e. finalization of the basel iii framework in 2017. the start of the new framework, in some worldwide countries is characterized by the following capital adequacy presented in figure 2. 84 economic analysis (2020, vol. 53, no. 2, 79-94) figure 2. capital adequacy (regulatory capital to risk-weighted assets) of the different countries as of world, as of q4 2018 source: authors, based on: international monetary fund (2020) and national bank of serbia (2019), “annual financial stability report 2018”. on the previous figure variation of capital adequacy level of the different counties worldwide are presented. the major risk for the capital adequacy in that moment was credit risk, which is traditionally most significant risk worldwide during last decades. as the credit risk worldwide level illustration bellow are presented values of nonperforming loans npl level (one of the major credit risk indicators) of the same countries. figure 3. npl to total gross loans of the different countries as of world, as of q4 2018 source: authors, based on: world bank (2020) and nbs (2019), “annual financial stability report 2018”. nenad milojević srdjan redžepagić 85 expectations for the banking risk and capital management development in the next period basel iii reforms from 2017 are representing part of the brcm development that will be one of crucial elements in the following years. these reforms are in some institutions already called basel iv standard, but in the current official bcbs document is called revision or basel iii reform (bcbs 2017, “basel iii: finalising post-crisis reforms”). the reform from 2017 is focused on the risk-weighted assets (rwa) revision. this should restore the rwa calculation credibility and improve the comparability of financial institutions capital adequacy indicators. rwa is a risk measure which defines the minimum regulatory capital level that financial institution needs to keep. this is the reason why importance of rwa is crucial in the modern brcm. basel iii reforms should additionally strengthen brcm framework and eliminate its disclosed weaknesses. for example, huge rwa values variations between financial institutions can not be always connected with the level of risk in the financial institution portfolio and this have negative impact on the capital adequacy ratios (car) trustworthiness. this was one of the major reasons for the reforms. rwa internal models should enable better brcm in comparison to the standardised approaches. on the other hand, sometimes usage of internal model has unjustified reduced the capital requirement. additionally, some assets classes are very hard for the trustworthy treatment by the internal models. this is the reasons for the basel iii reforms restrictions (and in some cases removing) of the internal model usage. table 2. timetable for the finalising basel iii framework implementation 2017 standard update date of application reformed credit rwa standardized approach 1 january 2022 reformed credit rwa internal ratings-based approach 1 january 2022 reformed credit valuation adjustment treatment 1 january 2022 reformed operational risk treatment 1 january 2022 reformed market risk framework treatment 1 january 2022 leverage ratio reformed exposure definition: 1 january 2018 revised exposure definition: 1 january 2022 g-sib buffer: 1 january 2022 output floor 1 january 2022: 50% 1 january 2023: 55% 1 january 2024: 60% 1 january 2025: 65% 1 january 2026: 70% 1 january 2027: 72.5% (steady state calibration) source: authors, based on data from: bcbs (2017), “finalising basel iii ‐ in brief”. it is important to highlight that bcbs has as of 27 march 2020, announced prolongation for one year basel iii finalization deadlines. the prolongation is related to the providing options for financial institutions and regulatory bodies to react to current financial stability priorities related to the coronavirus disease (covid-19) on the worldwide economy. the initial basel iii finish framework deadline was postponed for one year, i.e. to 1 january 2023. the output floor finalization and provisions regarding transitional cap on the rwa enhancement is also postponed for one year to 1 january 2028. one year postponement is also valid for the reformed market risk standard and pillar 3 provisions (bcbs, 2020). 86 economic analysis (2020, vol. 53, no. 2, 79-94) the reforms are demanding, so the implementation is phased during 10 year period, which should be finished in 2028, based on the new plan. the reformed standardised approach for credit rwa should increase the risk sensitivity, but with goal to stay simple approach. it should offer variation of risk weight instead of flat risk weight. this should be especially valid for the residential and commercial real estate. revised standardised approach should be less dependent on the credit ratings of the external credit rating agencies. with this revision, non-ratings-based approach is precisely defined. the revised credit rwa internal ratings-based (irb) framework is not allowing the possibility for advanced irb (airb) usage for the financial institutions and large corporate exposure treatment. irb approach will not be allowed for the equity exposures treatment. when the bank is using irb approach it will need to apply the minimum levels for the pd (probability of default) and other relevant parameters. revised operational risk framework is focused on simplification. instead of 4 actual approaches, only one standardised approach will be possible for the application. this approach will have increased risk sensitivity compared with current standardised approach. new standardised approach will include financial institutions history of the losses from the last 10 years. with the implementation of the rwa changes, improved, more precise capital adequacy calculation should be expected. cet1 ratio will keep its central place in the capital adequacy management. the value of cet1 ratio for the few selected european counties, as of q2 2019 is presented on the figure 4. figure 4. cet1 ratio of the different european countries as of q2 2019 source: authors, based on: european central bank (2019), nbs (2019), “banking sector in serbia ‐ second quarter report 2019” and croatian national bank (2019). with the standard revision from 2017, a leverage ratio buffer for global systemicallyimportant banks (g-sibs) is involved (bcbs, 2017). leverage ratio can be simply defined as: nenad milojević srdjan redžepagić 87 measure exposure measure capital ratio leverage  (6) more detailed basel iii formula for the leverage ratio is the following: 3% exposures sheet balance off and on sinstrument 1 tier additional 1 cet capital i tier ratio leverage    (7) the next section of the basel iii revision is dedicated to the revised output floor, which is limiting the financial institutions capital benefit amount that can be obtained from the use of irb approach in comparison to the standardised approach usage. when the financial institutions calculate rwa based on irb approach it cannot be lower than the 72.5% (on the aggregated level) of the rwa computed by the standardised approaches. this means that the limit for the financial institutions benefit from the usage of irb approach is set to 27.5%. during 2018 and 2019, bcbs has continued work on the basel iii finalization, like additional revision of the market risk, as well as pillar 3 disclosure. the start of implementation should be also postponed for one year to start of 2023, based on the bcbs announcement as of 27 march 2020 (bcbs, 2020). the valuation of financial instruments and the recognition of the credit losses will keep important place in the brcm development in the next period. starting from 2018, ifrs 9 has central place in the stated field. movement of the impairment, i.e. provisions will be important for the next period (similar like in previous period). this is the reason for the simulation which has been conducted in the next chapter of this paper. the following figure is presenting ratio of bank npl to total gross loans of the different european countries as of q2 2019, taking into account that credit risk still has domination in the total risk management and npl level is one of the major credit risk indicators. figure 5. ratio of bank npl to total gross loans of the different european countries as of q2 2019 source: authors, based on: european central bank (2019), nbs (2019), “banking sector in serbia ‐ second quarter report 2019” and croatian national bank (2019). 88 economic analysis (2020, vol. 53, no. 2, 79-94) this segment of the paper is highlighting other important issues which could be important for the future trends in the worldwide brcm. the adaptation of brcm on the new market conditions and challenges (milojević, 2016), economy innovations (caseiro & simões 2019, milojević, 2014), new financial technologies, contemporary digital banking, will continue to be important in the coming period. in doing so, some risks will take on new forms and characteristics, and some are further enhanced by importance. example for this would be cyber security risk which is related with the new digital trends in the banking and its development. the well known financial risks like credit risk and liquidity risk can get modifications in its effects and management based on the new digital banking trends and combination of old and relatively new risks. financial institutions are already investing significant amounts in the information security and protection of the cyber risk (aldasoro, i. et al, 2020). it is expected that this trend would continue during following years. banks and other market players have significant hopes in the field of artificial intelligence and machine learning, which are expected to have a strong impact on the development of banking, including the development of risk management, in the coming years. the development is conditioned by both macro prudential needs and micro aspects, i.e. the need for banks to improve their current practices and adapt to new market conditions. financial institutions had significant investments in the research of artificial intelligence and machine learning application in the banking (kolanovic & krishnamachari, 2017, financial stability board, 2017). brcm was one of the important segments of the stated research. big hopes are related to the improvement of the brcm, based on the application of the artificial intelligence, machine learning, deep learning and big data analytics (leo, m. et al, 2019). some of the area were the application results of the stated tools can be seen in the last period is the credit risk management, particularly credit scoring (addo, p.m. et al, 2018), ratings, stress testing and similar. this topic requires that new research will be conducted during next years, with the aim to maximise the positive effects, but also to reduce the potential risks of the non adequate implementations. the careful and adequately prepared further implementation of the artificial intelligence, machine learning, big data analytics and deep learning can have further positive impact, especially on the following brcm areas: capital adequacy, credit, liquidity, foreign exchange, interest rate and other market risk, operational risk, information security risk and other connected segments. at the end of this segment it is important to state the impact which covid-19 virus will have on the worldwide society, economy and inevitably on the financial market and trends in the brcm. since the world is still faced with extremely strong challenge of the covid-19 on all the segments of the world society it is hard to predict what impact it will bring on the brcm in the future period. the changes in this filed will be conducted. some risks will have changed or updated treatment. previously stated can happened to the operational risk, liquidity risk, etc. as of 27 march 2020 bcbs announced prolongation for one year basel iii finalization deadlines (bcbs, 2020). also, new instructions from the bcbs and other institutions can be expected. however, detailed and compressive analysis (including future perspective, quantitative study, simulations, stress tests, etc.) of this topic can be conducted in some future period, when further covid-19 impact information and the response of the world society will be available. methodology and analysis presented in this paper can be basis for the future papers, i.e. brcm analysis which can include covid-19, among other elements relevant for the analysis. simulation of the effects which could be generated by the changes in the risk and capital management bcbs (with the participation of many regulatory bodies and institutions) has conducted several comprehensive basel iii monitoring, analysis and quantitative impact studies. in october 2019, bcbs has published basel iii monitoring report. in this report (among others) results of the quantitative study can be seen. it includes expectations of the basel iii revision and nenad milojević srdjan redžepagić 89 measures which will be introduced during following years, until 2027 (bcbs, 2019), i.e. 2028 after already explained one year prolongation. the stated bcbs report is very detailed and useful for the analyses of the future brcm. here are highlighted few results which are very relevant for the analysis conducted in this chapter. table 3. transitional, complete phased-in initial and final basel iii accord cet1 ratio of the group 1 banks in the basel iii monitoring report cet1 ratios 31 december 2018 transitional initial basel iii cet1 ratio (%) 12.9 complete phased-in initial basel iii accord cet1 ratio (%) 13.0 complete phased-in final basel iii accord (2027 / 2028) cet1 ratio (%) 12.2 source: authors, based on bcbs (2019 and 2020). in the stated bcbs report group 1 banks are those with tier 1 capital higher than eur 3 billion and are worldwide present. all other banks are classified in group 2 banks. based on the presented table data, can be concluded that cet1 for group 1 banks in the complete phased-in final basel iii accord is reduced for 5.4% in comparison to the transitional opening basel iii cet1 ratio. cet1 for group 1 banks in the complete phased-in final basel iii standard is reduced for 6.2% in comparison to the complete phased-in opening basel iii cet1 ratio. taking into account size (and other characteristics) of the banks from group 1 and group 2, for the further simulations with which will be simulated potential impact in the banking sector of the republic of serbia, more relevant are results of the group 2 banks. table 4. transitional, complete phased-in initial and final basel iii accord cet1 ratio of the group 2 banks in the basel iii monitoring report cet1 ratios 31 december 2018 transitional initial basel iii cet1 ratio (%) 15.8 complete phased-in initial basel iii accord cet1 ratio (%) 15.4 complete phased-in final basel iii accord (2027 / 2028) cet1 ratio (%) 13.0 source: authors, based on bcbs (2019 and 2020). based on the presented table data, conclusion is that cet1 for group 2 banks in the complete phased-in final basel iii accord is reduced for 2.8 percentage points (pp) or 17.7% in comparison to the transitional opening basel iii cet1 ratio. cet1 for group 2 banks in the complete phased-in final basel iii accord is reduced for 2.4pp or 15.6% in comparison to the complete phased-in opening basel iii cet1 ratio. simulation of the effects: republic of serbia example although banks from group 2, can be significantly different from banks from the republic of serbia, further research will use the group 2 as a starting point for the following simulation, taking into account that in this moment it is the best possible comprehensive publicly available source for the simulation which will be conducted. if in the next period would happened that similar data which are more appropriate for the republic of serbia are available, new simulation can be conducted and probably more precise results can be expected. in the meantime it would be valuable to conduct first analysis with available data, so that the first conclusion could be taken into account. 90 economic analysis (2020, vol. 53, no. 2, 79-94) the starting point for our simulation of the complete phased-in final basel iii standard cet1 ratio of the republic of serbia banking sector is the data as of 30 june 2019. cet1 ratio of the republic of serbia banking sector, as of 30 june 2019 was 22.07. in the first presented simulation applied on the serbian banking sector, cet1 ratio has reduction of 15.6% (based on the previously explained group 2 banks cet1 ratio reduction in the complete phased-in final basel iii in comparison to the complete phased-in opening basel iii cet1 ratio). the result is that the cet1 ratio of the republic of serbia banking sector is reduced from 22.07% to 18.63%. this simulated cet1 ratio value is still relatively high and on respectable level (significantly higher than the regulatory minimum). table 5. simulated complete phased-in final basel iii accord cet1 ratio of the republic of serbia banking sector cet1 ratios basel iii cet1 ratio (%) as of 30 june 2019 22.07 simulation 1: complete phased-in final basel iii accord (2027 / 2028) cet1 ratio (%) 18.63 simulation 2: complete phased-in final basel iii accord (2027 / 2028) cet1 ratio (%) 18.16 source: authors, based on bcbs (2019) and nbs (2019), “banking sector in serbia ‐ second quarter report 2019”. similar conclusion is valid for the simulation 2 of the complete phased-in final basel iii cet1 ratio of the republic of serbia banking sector. in the second simulation applied on the serbian banking sector, cet1 ratio has reduction of 17.7% (based on the previously explained group 2 banks cet1 ratio reduction in the complete phased-in final basel iii in comparison to the transitional initial basel iii cet1 ratio). the result is that the cet1 ratio of the republic of serbia banking sector is reduced from 22.07% to 18.16%. similar like in simulation 1, this simulated cet1 ratio value is still relatively high and respectable level (notably above than the legislation minimum). besides previously basel iii finalization simulation, in this research it is conducted additional capital adequacy simulation which is taking into account impairment, i.e. provisions movement. after a long preparation for the implementation, ifrs 9, started to be valid in 2018. implementation of the ifrs 9 had significant impact on the banking during previous years. its impact is also strongly present today and it will be during following years. according to the european banking authority (eba) report, the ifrs 9 average impairment increase in the eu financial institution (first-time application: year 2018) was: 9% (european banking authority, 2018). stated ifrs 9 impairment movement of the first-time application had following impact on the cet1 ratio in eu: simple average reduction: 51 bps (european banking authority, 2018). in the stated research for the relatively smaller banking sectors, like republic of serbia banking sector, most interesting are the results for the smaller banks. in this eba research, banks with the total financial assets below eur 100 billion are classified as smaller institutions compared with other banks (european banking authority, 2018). ifrs 9 average impairment increase in the eu smaller financial institution was: 7% (european banking authority, 2018). ifrs 9 implementation has strong impact on the worldwide financial institutions parameters, processes, business, including current trends and future progress in the brcm. based on this, the research included stress test that is explained in following part of the paper. movement of the provision is especially important for the capital adequacy. the research included conducted stress test on the republic of serbia banking sector capital adequacy data. ifrs 9 impairment movement has shown that the amount of provisions can be volatile and harder to predict and planed in comparison to the old impairment standard (the international accounting standard 39 ias 39). this is increasing importance of the impairment and credit risk stress tests relevance nenad milojević srdjan redžepagić 91 for the next years. with this idea, our starting positions for the republic of serbia banking sector capital adequacy stress test are the data as of 30 june 2019. the applied data are from the nbs report: banking sector in serbia second quarter report 2019 and its statistical annex. our stress test included both eba report provisions increases: 9% (based on whole eba sample) and 7% (based on eba smaller financial institutions sample). major assumptions of our stress test are presented in this paragraph. increase in the provisions is directly reducing capital (i.e. cet) in the full amount (by the negative impact on the profit / loss). in the same time, full amount of provision increase will reduced credit rwa. although the reduction of the crwa has positive impact on the capital adequacy, the reduction of the capital has much stronger (negative) impact on the capital adequacy. major formula for our stress test is following: rwa 1 tier equity common ratio 1 tier equity common  (8) the result of our stress test is in the table. republic of serbia banking sector cet1 ratio is reduced for 0.27 and 0.21pp respectably, but the average cet1 ratio has stayed relatively high and in accordance to regulatory minimum. table 6. basel iii accord cet1 ratio of the republic of serbia banking sector – provisions increase stress test results cet1 ratios basel iii cet1 ratio (%) as of 30 june 2019 22.07 basel iii cet1 ratio (%): stress test 1: provisions increase 9% 21.80 basel iii cet1 ratio (%): stress test 1: provisions increase 7% 21.86 source: authors, based on european banking authority (2018) and nbs (2019), “banking sector in serbia ‐ second quarter report 2019”. previously conducted quantitative analyses of this paper (basel iii finalization and impairment stress test) are based on the serbian banking sector data as of 30 june 2019. it can be concluded that the capital adequacy has stayed on stable and significantly higher value than the regulatory minimum. as the additional support of the previous conclusion, the paper research included conducted additional descriptive statistics analysis of total car of the republic of serbia banking sector (its average values) for the period 2009 q1 – 2019 q2. figure 6. total car of the republic of serbia banking sector during period 2009 2019 source: authors, based on: nbs (2019), “annual financial stability report 2018”and nbs (2019), “banking sector in serbia ‐ second quarter report 2019”. 92 economic analysis (2020, vol. 53, no. 2, 79-94) in this longer period, the research has included 42 observations and lots of regulatory changes in the capital adequacy calculation in the serbia (basel ii, basel iii, ifrs 9, etc.). the reason for applying analysis in this case on total car is that this ratio has longest time series, so it enables forming of 42 observations. from the descriptive statistic it can be concluded that during this period total car of the republic of serbia banking sector, has stayed relatively stable and significantly higher than the regulatory minimum. the average total car during this period was 20.87%. regulatory minimum was first 12% and then with basel iii standard aligned to 8%, but total car of the serbian banking sector has stayed above the prescribed regulatory minimum even with its minimal value in this period of 16.40%. table 7. descriptive statistics of total car of the republic of serbia banking sector for the period 2009 q1 – 2019 q2 indicators of descriptive statistics total car mean 20.87 median 21.05 standard deviation 1.57 kurtosis 1.15 skewness -0.81 minimum 16.40 maximum 23.68 number of observations 42 source: authors, based on: nbs (2019), “annual financial stability report 2018”and nbs (2019), “banking sector in serbia ‐ second quarter report 2019”. taking into account previous analysis and results, our recommendations for the successful implementation of new trends in brcm is related to continuation of careful planning, analysis, stress testing and quantitative impact study of the effects. conclusions in this paper, worldwide banking risk and capital management progress has been analyzed. the research has been particularly concentrate on europe and especially on the serbia. the expectations for the future development of the risk and capital management are presented. the research included analyses of the already implemented basel iii accord, as well as basel iii finalization, which will be implemented during following years. effects of the ifrs 9, as well as possible future movement of the credit risk impairment were also in the focus of this research. the digital banking, new financial technologies and other new trends in the banking are changing risk and capital management. banks are increasing usage of the artificial intelligence, machine learning, deep learning and big data analytics in the risk and capital management. the paper highlighted which factors have potential to be crucial for the future risk and capital management. stated factors are particularly connected with the planned application of the basel iii revision, but also to the new technologies, innovations and new risks. well known financial risks are getting new forms, while some new risk segments are getting on the importance. various simulations and stress tests have been conducted in this research with the main, final focus on the capital adequacy impact. taking into account european and worldwide experience, the research included special simulations and stress tests on the example of the republic of serbia banking sector. the capital adequacy has stayed stable in the research example. the results of the mentioned example, i.e. conducted simulations and stress tests were crucial for the conclusions highlighted in the next paragraph. nenad milojević srdjan redžepagić 93 the stated results have shown that strong and stable capital adequacy of one banking sector can be very important factor for the planned implementation of the basel iii finalization standard. additionally, high level of capital adequacy and capital buffers can be very precious in the case of the stress scenarios and various negative impacts that worldwide economy and banking can be faced. 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stefanović saša,2 real estate institute, belgrade, serbia hanić hasan, belgrade banking academy, belgrade, serbia erić dejan, institute of economic sciences, belgrade, serbia abstract – in this paper we analyzed mortgage securities as a source of financing credit activities in the mortgage market of the european union. although they basically provide the same products – mortgages, credit institutions differ in the way of financing their activities. while some institutions finance their activities by deposits, others issue mortgage securities (mortgage bonds and mortgage-backed securities) through the capital market. this analysis based on relevant literature and appropriate statistical data showed that the importance of mortgage securities vary from country to country. at the level of the european union its overall importance is very high, since more than ¼ of all credit activities on the mortgage market are financed by these instruments. moreover, it has been proved that mortgage bonds and mortgage backed securities in many ways satisfy various needs of creditors. the selection of the instrument depends on the creditor's and investor's requirements and it is determined by historical, legal and regulatory framework, as well as with the structure of the mortgage market in which the creditor operated. in many countries, mortgage bonds and mortgage backed securities are accepted as alternative and complementary source of finance, which results in the coexistence of these two types of mortgage securities. historical data and recent trends suggest that, in the future, both of these instruments (especially mortgage bonds) will represent a significant source of financing credit activities in the mortgage market. key words: mortgage, mortgage market, mortgage securities, mortgage bonds, mortgagebacked securities. 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education, science and technological development of the republic of serbia. 2ljubice ivošević-dimitrov 17/6, belgrade, serbia; sstefanovic@institutzanekretnine.rs 70 economic analysis (2015, vol. 48, no. 1-2, 69-85) introduction the performance of the eu mortgage market in the last fifteen years has been positive, despite the economic weakness in some european countries, particularly in the period during and after the economic crisis. year after year, the share of the mortgage compared to total bank lending is increasing, leading to increased competition among financial institutions in order to preserve or strengthen their market positions. the growth of mortgage lending in the eu is a result of many factors. among them the most pronounced are the decline in interest rates, deregulation of the financial sector, the rapid development of technology (especially the internet) and in some european countries benefits from lower taxations and an increase in households’ disposable income. the aforementioned increase in the total amount of outstanding mortgage loans indicates that mortgage loans are gaining in importance in the european economies. at the same time, the share of mortgage loans in total loans in the last decade significantly increased, reflecting the growing importance of the mortgage market in the financial system. as a result of these trends, credit institutions are trying to create new products to win the market, as well as to diversify and find cheaper sources of funding for their lending activities. despite the growth in the mortgage market, individual markets are separated and not related to each other cross-border loans account for only 1% of the total loans. the main reason for the underdevelopment of cross-border lending is the existence of multiple barriers, such as different regulations related to the registration of real estate, foreclosure and insolvency. that is why the european commission has set itself the goal to achieve greater integration of the mortgage lending sector, as part of the road towards a single market for retail financial services. in the european union, the creditors in the primary mortgage market can be classified into a few dominant groups: mortgage banks, building societies, universal banks, cooperatives and saving banks. as the participants of the primary mortgage market are financial institutions with different missions, their financing activities are carried out by different mechanisms and financial instruments. savings institutions are established and operate in order to promote citizens' savings, and use retail deposits as their main source of funding of mortgage loans. on the other hand, mortgage banks, are non-deposit financial institutions that are financed through the capital market, primarily by issuing mortgage bonds in the process of “on-balance-sheet” securitization. also, development of the “offbalance-sheet” and, to a lesser extent, synthetic securitization (mbs issuance), offered an one more alternative way of financing the primary mortgage market, in order to deepen its liquidity and risk transfer. in order to present methods of financing credit institutions through the capital market for mortgage lending purpose, in this paper, after defining the main characteristics and the size of the mortgage market of the eu, we will present the funding mechanisms through mortgage bonds and mortgage-backed securities, importance and the size of their markets, and carry out a comparative analysis of these instruments, and points to the prospects of their use in the future. stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 71 basic characteristics and mortgage market volume in the european union the european union makes a single economic market, but yet within its borders maintained the diverse legislation governing not only the area of the primary mortgage market, but also the conditions and terms under which they may take the contemporary financial transactions related to the raising of funds for funding mortgage lending activities (stefanović, 2009, p.39). mortgage lending is regulated at the level of each country individually. for now, there is no single regulation that deals with mortgage loans, except the european code on home loan banks (code of conduct), whose guidelines creditors themselves accepts. some are indirectly related to mortgage finance, for example directive 89/647/eec which determines the level of solvency of the credit institution, and in directive 92/121/eec concerning the permissible risk exposure of credit institutions to a single client or group of connected clients, in the amount of 25% of capital. in addition, the basel capital accord is used, which defines the level of capital for financial institutions engaged in mortgage lending. although mortgage loans can be approved for other purposes, in 2013 over 80% of mortgage loans were housing loans (emf, 2014). this trend was encouraged by fiscal policies which favored the purchase of homes in relation to the rent (e.g. in the netherlands) and the expectations of an increase in income due to lower interest rates, which reduce the cost of borrowing and raise consumer confidence. another important factor that influenced the outstanding mortgage loans balances is generally an increase of house prices in many european countries. year on year, the share of the mortgage lending compared to total bank lending is increasing, leading to increased competition among financial institutions in order to preserve or strengthen market positions. to this day they created new products such as mortgage loans that can be used as consumer loans, loans related to pension funds, or flexible mortgage loans, which can be adapted to the uncertain revenue developments. in eu countries there are several different types of mortgage loans, with different interest structures. they can be classified into three groups: mortgage loans with fixed, mixed and variable (floating) interest rates. the duration of mortgage loans varies. in sweden, the netherlands, denmark and portugal the usual period is 30 years, in spain about 20 years, while in italy is the shortest, usually 10 years. according to the european mortgage federation (emf, 2014) lending based on mortgage is increasing. growth of european mortgage market is especially evident, if one takes into account the fact that the outstanding debts under the mortgage loans almost tripled in the last 15 years from 2.3 billion euros in 1996, more than 6 billion euros in 2007 (before the escalation of the mortgage and financial crisis), to 6.7 billion euros in 2013, recording significant annual growth rates, especially in the pre-crisis period. comparison of movement of mortgage debt in the eu and the euro zone compared to the us (where the decline of mortgage debt in the post-crisis period) are given in the following graph. 72 economic analysis (2015, vol. 48, no. 1-2, 69-85) graph 1. mortgage debt outstanding in the eu and the euro zone compared to the us, 2002-2013 (million euros) source: emf, 2014 from a total of 6,680 billion euros mortgage debt outstanding at the end of 2013, the largest part refers to the united kingdom (1,532 billion euros), germany (1,209 billion euros) and france (902.6 billion euros), which together represents more than 55% of the european mortgage market, followed by the netherlands (632 billion euros) and spain (613 billion euros), while at the least are croatia (8 billion euros), slovenia (5.3 billion euros), bulgaria (3.51 billion euros), malta (3.3 billion euros) and iceland (2.8 billion euros), as shown in the graph below. graph 2. the total mortgage debt outstanding in the eu, 2013 (million euros) source: emf,2014 stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 73 total mortgage debt outstanding in 2013 compared to the previous year at the eu level registered a decrease of -0.2% (in the euro zone recorded a modest growth of 0.1%). the highest growth rates of the surveyed countries, were recorded in romania (6.4%, france (3.7%), and belgium (3.2%), while the greatest decrease had spain (-4.5%), greece (-4.8%) and hungary (-7.4%). mortgage funding mechanisms in the european union, the creditors in the primary mortgage market can be classified into several dominant groups: mortgage banks, building societies, universal banks, cooperatives and savings banks (suarez, 2009, p. 154). although mortgage borrowers are offered the same product a mortgage loan, these institutions are distinguished by the way of financing its assets. while some of them are based on the savings of its citizens, promoting savings as their primary mission, and through various incentive s, others its mortgage lending activities finance by issuing mortgage securities mortgage bonds (mb) and mortgage-backed securities (mbs). savings institutions are established and operate in order to promote citizens' savings, and retail deposits are their main source of mortgage loans funding. mortgage banks are nondeposit financial institutions that are financed through the capital market, primarily by issuing mortgage bonds in the process of the so-called “on-balance-sheet securitization”, and mortgage-backed securities issuance in the process of the so-called “off-balance-sheet securitization” and represent an alternative system of financing the primary mortgage market, in order to deepen its liquidity and risk transfer. according to the latest estimates by the european mortgage federation (emf, 2014), mortgage credit institutions provide funding as follows: deposits from individuals about 67 per cent of all sources of financing, mortgage bonds account for about 20 per cent and about 5 per cent mbs – in difference of 1 per cent in 1998 (hardt &manning, 2000, p. 10), while the rest belongs to other forms of financing. as you can see the dominant source of funding for credit institutions in the eu are still savings deposits, while the mortgage bonds are the second most important source of financing, while mbs in the third place, with a notable increase in the pre-crisis period, stagnation and decline participation in certain the last few years. mortgage bonds mortgage bonds (suarez, 2009, p. 181) are bonds covered by mortgage loans and are a category of covered bonds, which include bonds covered by the public-sector loans and by ship loans. mortgage bonds are secured by clearly identified mortgage assets. in accordance with the a “cover principle” issued mortgage bonds must be all the time secured by mortgage loans, at least the same nominal amount and at least the same interest rates. in all european countries, issuance of mortgage bonds is regulated by laws which define the criteria for qualifying assets that can serve as collateral for bonds and other specific requirements. in most cases, mortgage loans are designated as collateral for covered bonds 74 economic analysis (2015, vol. 48, no. 1-2, 69-85) and kept as separate pools of coverage. in some countries, the total mortgage loans and total assets from the balance sheet of the issuer serve as cover for bonds. instead of binding of each individual mortgage bonds for individual claims from a pool of mortgage cover all mortgage loans serve as collateral for the total amount of mortgage bonds issued on the market. simply, every mortgage loan, when it satisfies the legal requirements added to the existing pool of mortgage loans. also, from a pool automatically withdrawn all loans which are paid prior to maturity or who for some other reason no longer satisfy the criteria. a high number of mortgage loans in a pool are an important factor to neutralize credit risk. in addition, the security of mortgage bonds contributes to the right of preferential claim over the collateral, which is enjoyed by the owners of these bonds in the event of bankruptcy, as well as strict control requirements and supervisory authorities, which are subject to all the institutions of the issuers of mortgage bonds. security features in these financial instruments, allows providers of mortgage loans in the primary market to finance on the capital market at lower interest rates, which, in turn, enables credit borrowers financing residential real estate at the lowest and most stable interest rates. the special character of mortgagebonds (as type of covered bonds) has been enshrined in the amendments of the directive 85/611/eec directive on undertakings for collective investments in transferable securities (ucits) in 1988. article 22(4) of this directive sets out a number of criteria that mortgage bonds must meet(directive 88/220/eec; hardt & lichtenberger, 2001, p. 21; suarez & vassallo, 2004, p. 37): • they must be issued by credit institutions, and in accordance with legal provisions, to protect bondholders; • they are subject to special supervision by public authorities; • the sums deriving from issuance of mortgage bonds must be placed in assets that provide sufficient cover for the liabilities deriving from the bonds until maturity; • in the event of bankruptcy of the issuer, sums deriving from the issuance of mortgage bonds must be used as a priority to repay principal and interest becoming due. • issues must be notified to the european commission. another cornerstone of covered bond regulation at eu level is the capital requirement directive (crd). basel ii has been implemented in the european union via the crd. transposition of the crd corresponds to the national authorities. mortgage bonds creation process is shown in the figure below. stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 75 figure 1. mortgage bonds creation process source: hardt & manning (2000) when a mortgage lender issues mortgage bonds, it keeps both the bonds and the loans on its balance sheet. that is mortgage bonds are “on-balance-sheet” instrument (suarez, 2009, p. 181). this means that the mortgage lender is responsible for the bonds credit risk, and the source for payment of principal and interest on bonds makes the overall cash flow of the issuer. in this process, the mortgage bank executes all phases of the process: from issuing bonds to financing loans. from the standpoint of the investors, mortgage bonds, in essence, represent the credit risk of the issuer, but at the same time include additional security claims on the underlying mortgages and precise and strict legal standards governing the issuance of these bonds. in fact, in most countries, in case of a issuers bankruptcy, mortgage loans, which were used as collateral for bonds, are put aside from the bankruptcy estate and cash flow that is generated by the same, used for timely payment of bonds (quasi bankruptcy isolation), and because of this, mortgage bonds, usually do not carry high risk. the level of security that mortgage bonds offers to investors, allows credit institutions to raise funds from capital markets at low cost, so that they can approve more mortgage loans at attractive interest rates. mortgage bonds in the financial system of the eu play a similar role as government bonds. they, as well as government bonds, can be used (stefanović, 2009, p. 72): • issuance of mortgage bonds in the as a relatively safe investment for financial institutions that the law mandates a conservative investment strategy (lower risk and higher liquidity), i.e. as a source of financial assets for pension funds, insurance companies and credit institutions; • by the central bank in the process of monetary regulation that is as the basis for repo and reverse repos or as collateral for granting lombard loans to commercial banks; • as a basis for the assessment of interest rates on risk-free or low-risk assets that are used in the process of calculating the value of other bonds in the financial market, especially in the case when there is reduced liquidity and activity in the government bonds market. 76 economic analysis (2015, vol. 48, no. 1-2, 69-85) eu is regulated in different ways. in many countries the rights to issue these bonds are assigned to specialized credit institutions whose activities are strictly regulated and supervised by regulators. this is the situation in germany, france, austria, switzerland, luxembourg, poland, hungary and the scandinavian countries. in some countries, however, the issuance of mortgage bonds is not limited to specialized institutions greece, spain, czech republic and portugal. germany has the longest tradition of issuing mortgage bonds (hypothekenpfandbrief, pfandbrief). the model of german mortgage bonds, almost 250 years old (first issued in prussia in 1767), to a large extent, has been used in other european countries. pfandbrief issuances are under strict regulation and are issued by 45 german financial institutions. denmark has a very strong mortgage market. issuers of mortgage bonds (realkreditobligationer) are specialized mortgage banks, and in their operations are restricted from mortgage lending and related activities. swedish mortgage bonds (bostadsobigationer) are issued by specialized licensed mortgage companies. there are five of these institutions, four of which are in the ownership of commercial banks and one that is government owned. in france, mortgage bond obligations foncieres (ofs) are issued by sociétés de crédit foncier (scf) and obligations de financement de l'habitat (oh) are issued by sociétés de financement de l'habitat (shf). austria, also has pfandbrief and only three institutions are responsible for issuing them. of these, two are mixed mortgage banks, and one is a regulatory institution (pfandbriefstelle der österreichischenlandeshypothekenbanken) that combines the issuances of mortgage bonds for eight public mortgage banks (landeshypothekenbanken). in spain mortgage bonds (cedulas hipotecarias) may be issued by any credit institution: commercial banks, savings banks, credit cooperatives and specialized financial institutions (hardt & lichtenberger, 2001; suarez & vassallo, 2004; stefanović, 2009). graph 3. total mortgage bonds outstanding in the eu, 2013 (million euros) source: ecbc, 2014 stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 77 the total amount of covered bonds outstanding in eu countries in 2013 (ecbc, 2014) acounted to slightly more than 2.4 trillion euros. mortgage bonds accounted for 1.9 trillion euros, public sector bonds 429 billion euros, 11 billion euros of ship bonds, and 73.5 billion euros in bonds based on a combination of the previous three types of collateral. the volume outstanding of mortgage bonds at the end of 2013 is as follows: denmark (360 billion euros), spain (335 billion euros) and sweden (218 billion euros), followed by france (203 billion euros) and germany (200 billion), while at the very bottom slovakia (4 billion euros), cyprus (1 billion euros) and poland (0.7 billion euros). during 2013, mortgage bonds were issued in the amount of 334.5 billion euros. the issuance volume of these securities is shown in the graph below. graph 4. total mortgage bonds issuance in the eu, 2013 (million euros) source: ecbc, 2014 the largest issuances of mortgage bonds in 2013 was recorded in denmark (150 billion euros), sweden (52 billion euros) and germany (33.6 billion euros), while the least emissions were in hungary (0.6 billion eur) and poland (0.1 billion euros). mortgage-backed securities mortgage-backed securities (mbs) are usually created in the process of off-balance sheet (true sale) securitization. this type of financing is the so called “off-balance-sheet” financing. basically in this process mortgage loans are removed from the balance sheet of credit institutions, and transferred to a separate (bankruptcy remote) legal entity special purpose vehicle (spv), which creates, and issues mbs to the secondary mortgage market. spv issue mbs while credit institution usually continue to participate in the process as servicer (a "collector" of interest and principal of underlying mortgage loans) and perpetrator of other "back" function. the purpose of the introduction of the spv in this process is the isolation of 78 economic analysis (2015, vol. 48, no. 1-2, 69-85) the cash flow underlying mortgage loans from the credit risk of the originating institution (stefanović, 2006, p. 420). as figure 2 shows, sales of loans resulting in their removal from the balance sheet of originating institution. mortgage originator frees any requirement for capital adequacy and provisions for risks on these assets. figure 2.mortgage-backed securities creation process source: hardt & manning (2000) mbs investors are buying securities that are based on cash flow of securitized assets, and these investors have no any right of recourse to the mortgage creditor and even in the event of its bankruptcy. also investors assume the full credit risk and prepayment risk of underlying mortgage loans (suarez & vassallo, 2004, p. 44). unlike the united states, in eu mbs are created not only through off-balance–sheet securitization, but also (to a lesser extent, especially after the crisis of 2008) in the process of synthetic securitization. the main feature of synthetic structures are that assets are not remove from the balance sheet of the originator, which is suitable for european credit institutions, especially when the mortgage collateral are often from different countries and are subject to different jurisdictions. most of the structural elements of this type of securitization are similar to off-balance-sheet securitization. the key difference is that the originator does not sell any assets of the issuer mbs (spv or some other institution). instead originator enters credit default swaps (cds) or e.g. credit linked notes (cln) with the issuer in respect to the specified pool of mortgage loans (reference pool). mbs issuer pays originator an amount equal to any credit losses incurred by a pool of assets, and originator pays a fixed premium to the issuer, usually quarterly, and therefore, the originator's exposure to credit risk is transferred to the mbs issuer. however after the outbreak of the global financial crisis, the use of this mechanism is significantly reduced (stefanović, 2009, p. 27). the development of securitization markets in the eu began in the 80s of the 20th century, firstly in the uk (where today is, in addition to the netherlands, the largest market for mbs), and then in other developed eu countries. looking for cheaper sources of funds and the need for liquidity in the capital markets, some eu countries have developed their own stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 79 models for securitization. the process of securitization is a preferable source of funds only in the event of large issuance. the costs of securitization in developed countries are ranging between 1.5 per cent and 3.5 per cent above euribor (blommestein et al., 2011, p.6). also, assets need to be rated. the rating is a very expensive (and has been shown in the case of mbs also an unreliable, and subject to manipulation – especially before the financial crisis of 2008) process. the solution to this problem is the creation of a reliable ratings methodology. in order to promote securitization in the eu, the european securitization forum – esf (now days it is division of the association for financial markets in europe afme), was established, which represents the interests of all participants in the process of securitization in the eu. membership is open to all institutions involved in the process of securitization. many european countries have adopted (and after the crisis redefined) specialized laws on securitization, while some of them, such as the united kingdom thanks to the present anglosaxon legal system, carried out only amendments to the existing laws in the segment relating to the specifics of securitization transactions. administrative and legal national requirements are often barriers that are overcome with improvised solutions. european monetization of assets through securitization (similarly as in the united states) is the largest in the area of mortgage lending – 67 per cent of the total securitization whereby the residential mortgage backed securities (rmbs) represents 54 per cent, and the commercial mortgage-backed securities (cmbs) 13 per cent of total mbs issuance in the eu (afme, 2014). the total volume of mbs outstanding at the end of 2013 (emf, 2014) accounted in the uk (252.1 billion euros) and the netherlands (249.7 billion euros), followed by spain (118 billion euros), while at the very bottom were greece (4.2 billion euros) and austria (1.8 billion euros), as shown in the following graph. graph 5. mbs outstanding in the eu, 2013 (million euros) source: emf, 2014 80 economic analysis (2015, vol. 48, no. 1-2, 69-85) during 2013 mbs (graph 6) were issued in 7 eu countries. the largest volume of mbs issuance was recorded in the netherlands (38.6 billion euros), uk (8.4 billion euros) and spain, followed by italy (5.7 billion euros), belgium (2 billion euros), while the volume in portugal (1.3 billion euros) and ireland (1 billion euros), was at a much lower level and recorded a historical minimum. graph 6. mbs issuance in the eu, 2013 (million euros) source: emf, 2014 mortgage bonds and mortgage-backed securities: a comparative analysis despite the fact that mortgage bonds and mbs belong to the group of insured bonds issued on the capital market, which, ultimately, using the same collateral (mortgages), these two instruments have almost no other common characteristics. the isolation of underlying mortgage loans and their removal from originator balance sheets, are the fundamental difference between mortgage bonds and mbs. mortgage bonds differ from mbs (suarez, 2009, p. 196)that the loans are not transferred. instead of that, the originator itself sets up the fund and issues the securities. because they are covered by the underlying mortgage loans and originator's other assets mortgage bonds have a very strong guarantee. the downside of this is that the bonds are also subject to the originator's business risk. the credit institution retains responsibility for the bond's credit risk until maturity, as well as for prepayment risk. on the contrary, mbs are not subject to the originator’s risk, as they are held by an spv. because the originating institution transfers the credit risk, the prepayment risk and the market risk to the spv along with the loans themselves, these risks are assumed by the investor, who will require much higher rates of interest than on mortgage bonds. comparison of these securities is presented in the table below, see table 1. stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 81 table 1. comparison of mortgage bonds and mortgage-backed securities criteria mortgage bonds mortgage-backed securities mortgage bond production bundled process unbundled process type of securitization (balance sheet treatment) assets remain on the balance sheet of the originating institution („on-balance-sheet securitization“) generally, assets are removed from the balance sheet of the originating institution („offbalance-sheet securitization“) source of principal and interest payments issuer cash flow collateral cash flow credit risk issuer investor market risk investor investor prepayment risk issuer investor investor protection in event of issuer bankruptcy bankruptcy privilege: the bondholder has a priority claim on assets in the event that the issuer becomes bankrupt (quasibankruptcy remoteness) bankruptcy remoteness is built into the structure of the mbs. (the bankruptcy of the originating institution does not affect the servicing of the mbs.) credit quality in addition to the asset quality, it depends mainly on the strength of the originating institution and the legal framework in addition to the asset quality, it depends mainly on the strength of the structure created over-collateralization defined by law usually required for a high credit rating tiered capital subordination is inherent in the system (e.g. requirement to respect certain ltv ratios) a structure distinguishing structure between senior and subordinating securities needs to be created collateral pool − individual components of the asset pool are substitutable − mainly heterogeneous assets − eligible assets defined by lawltv ratios and sound property valuation methods) − individual components of structure the asset pool are (in general) not substitutable − mainly homogeneous assets − eligible assets are not necessarily defined by law interest payment typically yearly typically monthly principal redemption bullet form amortization and prepayments sources: hardt & lichtenberger, 2001, p. 27; suarez, 2009, pp. 197-198 mortgage bonds and mbs are instruments that in various modes satisfy the financial needs of creditors. the selection of instruments depends on the needs of creditors and investors. it’s determined by the historical, legal and regulatory frameworks and the structure of the mortgage market of the country where the lenders operate. in many countries, mortgage bonds and mbs are considered complementary and alternative financing instruments (mbs are sometimes used as collateral to issue mortgage bonds), 82 economic analysis (2015, vol. 48, no. 1-2, 69-85) which results in the coexistence of these two types of mortgage securities, as is the case in spain, france, germany, uk, italy, the netherlands, portugal, ireland, austria, greece and belgium. graph 7. mortgage bonds vs. mbs in percent of total mortgage securities outstanding, selected eu countries, 2013 source: author’s calculation based on emf data in the graph, there is a noticeable difference in the use ratio of the mortgage bonds and mbs across the eu. in some countries (italy and portugal), both instruments are equally represented. we note that some countries (france, germany, spain, austria, greece) prefer the system of mortgage bonds, on the other hand in the uk, belgium, the netherlands and ireland mbs representing a more used source of financing for mortgage lending purposes. graph 8. mortgage bonds and mbs issuance in the eu, 2003-2013 (million euros) source: author’s calculation based on emf, ecbc, and afme data stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 83 mortgage bonds at the eu level represent a significant and more stable source of funding for mortgage loans in comparison to the mbs. it is noticeable (graph 8) that the mortgage bonds (except for the period 2006-2007) all the time more important source of funding. comparison of movement of mortgage bonds and mbs issuance in the eu (where the mbs issuance decline in the post-crisis period), using historical data, suggest that both of these instruments (especially mortgage bonds) in the future will represent a significant source of financing credit activities in the mortgage market. concluding remarks despite the growth of the mortgage market in the european union, individual markets are quite separate and not related to each other to great extent. in each country there are a great variety of mortgage products, prices, customers, and the available contracts and institutions that are active in the market. differences in the mortgage products and institutions are the result of historical differences in the demographic, political and regulatory frameworks, as well as consumer preferences. mortgage lending is increasing, which indicates that mortgage loans are gaining importance in european economies. in the european union, the creditors in the primary mortgage market can be classified into: mortgage banks, building societies, universal banks, cooperatives and savings banks. although, mortgage borrowers are offered the same product a mortgage loan, these institutions are distinguished by the models of financing its assets. while some of them are based on deposits and through various incentives, others, however, its activities finance by issuance of mortgage securities mortgage bonds and mbs on the capital market. the dominant source of funding for credit institutions in the eu are still savings deposits, while the mortgage securities second most important (1/4 of all sources), which makes them a significant funding mechanism. mortgage credit institutions provide funding as follows: deposits from individuals about 67 per cent of all sources of financing, mortgage bonds 20 per cent, and mbs about 5 per cent (with a notable increase in the pre-crisis period, stagnation and decline participation in certain the last few years), while the rest belongs to other forms of financing. mortgage bonds are a very important component of financial intermediation in the mortgage markets of most countries in the eu. they belong to a group called covered bonds that are secured with a clearly identified mortgage assets. in this process, the mortgage bank executes all phases of the loan approval, from issuance of bonds to finance loans. from the standpoint of investors, mortgage bonds, in essence, represent the credit risk of the issuer, but at the same time include additional security claims over the mortgage and precise and strict legal standards governing the issuance of these bonds. mbs are usually created in the process of off-balance sheet (true sale) securitization. this type of financing is the so called “off-balance-sheet” financing. basically in this process mortgage loans are removed from the balance sheet of credit institutions, and transferred to a separate (bankruptcy remote) legal entity special purpose vehicle (spv), which creates, and issues mbs to the secondary mortgage market. the purpose of the introduction of the spv in this process is the isolation of the cash flow underlying mortgage loans from the 84 economic analysis (2015, vol. 48, no. 1-2, 69-85) credit risk of the originating institution. in addition to this mechanism mbs may arise from synthetic securitization, but this mechanism is now less used. despite the fact that the mbs and mortgage bonds belong to the group of insured bonds issued on the capital market, which, ultimately, using the same collateral (mortgages), these two instruments have almost no other common characteristics. mortgage bonds and mbs are instruments that in various ways meet the financial needs of creditors. the selection depends on the needs of creditors and investors and is determined by the historical, legal and regulatory frameworks and the structure of the mortgage market of the country where the lender operates. in many countries, mortgage bonds and mbs are considered complementary and alternative financing instruments, which results in the coexistence of these two types of mortgage securities, what leads to a moment where mbs can be used as collateral for mortgage bonds. mortgage bonds at the eu level represent a significant and more stable source of funding for mortgage loans in comparison to mbs. statistical data and recent trends, suggest that both of these instruments (especially mortgage bonds) will represent a significant source of financing credit activities in the mortgage market in the future. references association for financial markets in europe (afme). 2014.securitisation data report, fourth quarter 2013. blommestein, hans j. et al. 2011.“outlook for the securitization market”. oecd financial market trends, 2011(1). directive 88/220/eec (available at:http://eur-lex.europa.eu/legalcontent/en/txt/pdf/?uri=celex:31988l0220&from=en) european covered bond council (ecbc). 2014. ecbc european covered bond fact book 2014. european mortgage federation (emf). 2014. hypostat 2014. hardt, judith, anddavid manning. 2000. european mortgage markets: structure, funding and future development, emf and oecd june 2000. hardt, judith, and jung-duk lichtenberger. 2001. "the economic and financial importance of mortgage bonds in europe." housing finance international 15(4): 19-29. stefanović, saša. 2009. hipotekarna tržišta i instrumenti. beograd: zadužbina andrejević. stefanović, saša. 2006. „sekjuritizacija aktive: koncept, ekspanzija i nove tendencije kontekstu globalizacije finansijskih tržišta“, ekonomske teme br. 1-2/2006, 417-426 suarez, jose l. 2009. european real estate markets. palgrave macmillan. suarez, jose l., and amparo vassallo. 2004. “european mortgage market:an overview 1992-2003”. university of navarra iese business school working paper 562. stefanović, s., et al., mortagage securities, ea (2015, vol. 48, no. 1-2, 69-85) 85 hipotekarne hartije od vrednosti kao izvor finansiranja hipotekarnih kredita u evropskoj uniji rezime u radu je izvršena analiza hipotekarnih hartija od vrednosti kao instrumenta finansiranja kreditnih aktivnosti na hipotekarnom tržištu evropske unije. iako u osnovi nude isti proizvod – hipotekarni kredit, kreditne institucije se razlikuju po načinu na koji finansiraju svoje aktivnosti. dok se neke od njih baziraju na depozitima, druge, pak, svoju delatnost finansiraju putem tržišta kapitala emisijama hipotekarnih hartija od vrednosti hipotekarnih obveznica (mortgage bonds mb) i/ili hipotekarnih založnica (mortgage-backed securities mbs). analiza zasnovana na relevantnoj literaturi uz korišćenje odgovarajućih statističkih pokazatelja ukazuje da njihov značaj varira od zemlje do zemlje, ali da je na nivou eu izuzetno velik s obzirom da se preko ¼ svih kreditnih aktivnosti na hipotekarnom tržištu eu finansira ovim putem. takođe, pokazalo se da su mb i mbs instrumenti koji na različite načine zadovoljavaju finansijske potrebe kreditora. izbor instrumenta zavisi od potreba kreditora i investitora, a određen je istorijskim, pravnim i zakonskim okvirima kao i strukturom hipotekarnog tržišta zemlje u kojoj kreditor posluje. u mnogim zemljama ovi instrumenti se smatraju alternativnim i komplementarnim izvorima finansiranja što ima za posledicu koegzistenciju ova dva tipa hipotekarnih hartija. analiza istorijskih podataka i aktuelnih kretanja na tržištu pokazuje da će i u budućnosti ova dva tipa instrumenta (naročito hipotekarne obveznice) predstavljati značajan izvor finansiranja kreditnih aktivnosti na hipotekarnom tržištu. ključne reči: hipotekarni kredit, hipotekarno tržište, hipotekarne hartije od vrednosti, hipotekarne obveznice, hipotekarne založnice article history: received: 30 may, 2015 accepted: 10 june, 2015 2013_1_2 preliminary report creative cash flow reporting – the motivation and opportunities1 stevanović slavica2, institute of economic sciences, belgrade, serbia belopavlović grozdana, lazarević-moravčević marija, belgrade banking academy, belgrade, serbia udc: 657.05 ; 005.32 jel: g3, l2, m42 id: 198577932 abstract – company's stakeholders make business decisions based on information presented by management. the quality of decisions, among other things, depends on the quality and reliability of information in the financial reports. business practice demonstrates that managers tend to present a false picture of the financial position and profitability of the company, often in cooperation with the owners of the capital. procedures that management and investors take, in order to create a false impression about the performances of the enterprise, the contemporary literature defines as creative financial reporting. presentation of better financial performance than realistic one provides misleading signals about the company, while the users of information are misinformed. the goal of this paper is the analysis of opportunities to implement creative cash flow reporting and the factors that encourage the company’s management and the owners of the capital to wrong and misleading interpretation of performance items. after the presentation of the main motive of creative financial reporting, we shall focus on examples of erroneous classification of cash flows. earnings management and the shaping of cash flows may be realised within and beyond the boundaries of accounting regulations on several ways, but a special review in the paper is dedicate to creative reporting procedures of cash inflow and outflow related to receivables, investments, liabilities, and expenses. consequences of creative reporting on cash flow and other performances could be serious both for stakeholders and for survival of the company, which is discussed in the last part of the paper. key words: creative financial reporting, creative cash flow, classification of cash flows, unsustainable cash flows introduction financial reports are an important resource, especially for the shareholders, and other company’s interest groups, which based on the presented accounting information, assess the company’s performance. financial statements information required for the stakeholders should be relevant, and in the same time free of information risk. multiple cases of financial reporting fraud, in the past two decades have undermined confidence in financial reports 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. 2 institute of economic sciences, zmaj jovina 12, belgrade, serbia; e-mail: slavica.stevanovic@ien.bg.ac.rs stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 29 reliability and managers integrity. the role of managers is to manage company’s assets and capital in the interests of the owners, but all the rights acquired by their agent’s position, create a space to meet their own interests, which are often in conflict with the interests of the shareholders. managers can use their accounting discretion to influence the content of financial reports. final selection of the accounting policy and possible hidden intentions of managers affect the reality of reported performances. manipulation of financial reports is known as a creative financial reporting. the very term of creative is usually associated with something positive and innovative. when it comes to financial reporting that is not the case. creative financial reporting includes procedures that management takes in order to conceive a false impression about the company’s performance. the nature of accounting information based on accrual basis, to great extent facilitate the creative reporting. the choice between alternative methods of evaluating certain assets, income and expenses items, gives managers a chance to express overstated or understated company’s earnings and net assets, in accordance to advance the goals and signals they want to send to the public. the values of the financial reports items resulting accounting estimates may also be subject to fraud, which undermines the reality of the presented company’s financial position and performance. in addition to the personal benefits to the management to accomplish unreal presentation of company’s performance, the owners of the company may also put pressure on management to participate in the financial reporting fraud. the motivation for creative financial reporting the manager’s motives to implement financial reporting fraud may be psychological, egocentric, or ideological, but in most cases the economic benefit is the main motive that encourages illegal activities (dušan milojević, 2006). guide by the desire to achieving personal benefits and pressures of the owners, managers conduct activities that result in false financial reports. the company that under conditions of strong competition is not able to maintain a good position in the market can resort to creative reporting of results and cash flows. in this way, the company is trying to avoid the consequences of public disclosure of reducing demand and sale of its products, loss and low net cash flow. manager's personal benefit in form of bonus payments and other incentives depends on the degree of firm's performance, which enhance the managers with poor integrity to manage profit and cash flows in a way that distorts the reality. increasing the market share price, easier obtaining and a lower cost of capital, lack of expected results in the application of the chosen strategy, and relativism of the present monopoly position (dejan malinić, 2008), may be significant motifs for displaying more favourable company's performance then they really are. strong and stable net operating cash flow is a sign of a high quality earnings that easily can affect the growth of share prices. by fictitious increase in share price, earning per share, maintaining a stable income and on that basis payment of stable or higher dividends, the company wants to make shares attractive to new shareholders. expressed good performance more easily attracts capital of creditors and others, under favourable conditions, which is always a key motivation for the creative accounting presence. the interest rate, the degree of binding constraints, the need for some kind of loan guarantees, among other things, depends on the cash flow performances. economic analysis (2013, vol. 46, no. 1-2, 28-39) 30 activities such as accounting manipulations, results better financial performances displaying in comparison to the companies from the same industry, or in comparison with the previous periods that blur image. sometimes companies attempt to increase artificially earnings and net assets in order to realize prognosis or to make up bad financial indicators. financial benefit in a form of misappropriation of assets by employees is also accompanied by manipulation of the company’s financial reports, with the idea to hide illicit activities by accounting records and supporting documents. literature mentioned three factors, referred as the «fraud triangle», often combine to lead individuals to commit fraud: pressure or an incentive to engage in fraud; a perceived opportunity, and the ability to rationalize fraudulent behaviour (centre for audit quality, 2010). earnings management may be motivated by increasing the accounting information use value for all interest groups or, which is not rare in practice, by distorting reality of reported earnings in order to meet some of the goals set in advance. earning management strategy known as increasing income involves multiplied expression of periodic income attempting to show a more favourable picture of the enterprise achievements. aggressive assets depreciation in the current period in order to present an increase in earnings in the period to come is exercised within the big bath strategies. the income strategy, on the other hand, comprises decreasing income in periods of good success, and its increase during the periods of bad achievements, in attempt to conceal the instable income (john j. wild, k.r. subramanyam, robert f. halsey, 2007). management may seek to influence the amount of the presented profit by implementation of earnings management activities, while the assembly of the shareholders has the final decision about the distribution of the profit. unrealistic reported values of company's assets, liabilities, income, and expenses threaten the quality of reported earnings, while the net cash flows trends does not match such movements. for this reason, the cash flow statement is used as a source of information needed for analysis of income quality. comparing the amount and net income trends with net cash flow may indicate the presence of irregularities and creative financial reporting. analyses of cash flow, used to detect the problem of profit quality, do not mean that there is no possibility of shaping the amount and structure of cash flows. the reason for failing to detect fraud and its resulting effects on profit and net assets of the company, may be deliberately expressing of cash flows by the management. as the earnings could be the subject of management, the management board can exert influence on the reported net cash flow from operating activities. misstatement of cash flows provides misleading signals about the sustainability of financial performance, misleading the users of that information. being aware that report users may detect manipulations with earnings by comparing cash flow and profitability trends, managers can access the erroneous or false reporting of cash flows of the company. there are situations when the high presented net cash flow from operating activities does not prove the quality of operating income, but the inclination of the company’s management to manage net cash flows from operations. aware of the importance that information on cash flows from operating activities has for users of financial reports, managers are prone to manage cash flow. by presenting a good financial performance, companies tend to attract investors, creditors, and others. it is therefore important to know whether the higher inflows than outflows of cash from operating activities are the sign of real ability of the company to stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 31 generate cash from operating sources, or they are result of misclassification and other funds’ manipulations. creative cash flow reporting means that management undertakes the actions in order to create a false impression of the cash flows, primarily, on cash flows from operating activities. to the public they are tending to send signals that the company is able to generate cash and cash equivalents, although sources from operating activities are not, or at least not to that extent sustainable. creative cash flow reporting can be executed within the boundaries of generally accepted accounting principles (gaap) and other accounting regulations or their disruption. actual cash flows and flows presented in the statement of cash flows often do not overlap, which could be due to false reporting by the company’s management. committed manipulations conceal the real picture about the ability of the company to generate cash. expression of unsustainable cash flows should also be considered creative reporting (charles w. mulford and eugene e. comiskey, 2005). some of the opportunities of creative accounting practices, when it comes to reporting cash flows, will be presented in the following. opportunities for creative cash flow the value of cash and cash equivalents to the end of the particular accounting period is presented in the balance sheet and the statement of cash flows. the users of mentioned financial reports assume that the information about the cash balance and changes are reliable. the fact is that the audit of the financial statements provides additional security in the reliability of reported values, but it does not provide an absolute guarantee that the presented information is true and correct. due to the fact that audit procedures are not the same for all parts of the assets, the tendency to fraud and embezzlement by management and employees depends on the nature of the company’s assets. cash is a part of assets verified by an auditor using the independent confirmation addresses to the bank. as confirmation is the external source of audit evidence, it can be concluded that the cash is not often the subject of management’s fraud. cash is in contrast to other balance sheet items exempt from problem of accounting estimates and accounting options.. yet, the possibility of overstating of cash inflows and understating the outflows influences the reality of presented structure of cash flows. management is unlikely to be resorted to deliberately false the presentation of the cash balance, but the cash flows and their elements are an area that management could take advantage of the planned manipulation. the shaping of cash flows from operating activities by the company’s management, with the aim of creating the image of the successful generation of cash from operating activities, is understandable given the importance of the amount and trend of net cash from operations in the process of evaluating investments and the calculating company’s stock price. frauds in the area of cash collection and payments are generally accompanied by manipulation of transactions of sale, purchases, investments, debt payments, and other ones that have resulted in a change of cash. cash transactions do not reflect the actual events in the reporting period in the following situations: paying obligations regarding material procurement that really has not been received, turning out invoices to customers at prices economic analysis (2013, vol. 46, no. 1-2, 28-39) 32 that are lower than the prices defined by business policy, employees are calculated and paid based on greater number of hours of work in relation to the actual spent time, the subsidiaries receive higher interest rates than currently paid, double duties paid by suppliers invoices, etc. (milojević, 2006). receivables and related cash flows. the rule is that an increase in the receivables balance in relation to the previous period, as a result of unpaid claims, leads to a decrease in net cash flow. inversely is with the decrease in the receivables balance, which affects positively the net cash flow from operations. increasing net cash flows are interpreted differently depending on the reason of reducing claims and increasing cash inflows. decrease in receivables could be the result of current billing, or claims deriving from the previous period. the collection of outstanding claims will increase net cash flows from operating activities, but it is important to note that this source of cash is not of sustainable. management frauds incurred by presenting fictitious sales, and on that basis introduction of non-existing customers and fictitious receivables, leads to overstated earnings. cash flow statement can help in the discovery of similar financial fraud, but the fact that the statement of cash flows can be subject to management manipulation, is a disadvantage in detecting the fraud. the more convincing is the presentation of the fictitious customers and sales revenue if it is expressed the collection of fictitious sales and receivables, while the operating profit and operating cash flows are moving in the same direction and does not attract the attention of reports’ users. as an example, we can present a company whose management reported fictitious equipment purchase together with fictitious account receivable from the partners with which it already operates (charles w. mulford and eugene e. comiskey, 2005). based on fraudulent purchases of new equipment are presented outflows from investment activities, while the collection of receivables from non-existent customer, leads to increase of inflow from operating activities. fictitious operating cash inflows and investing cash outflows are equal, so that mentioned transactions have no impact on the cash balance at the end of the period, but have resulted in overstated net operating cash flows. advance payments by customers can be a significant source of cash from operating activities of the company, but the increase in income on this basis does not present a stable source of cash. advances payments by customers as balance sheet item, could be used to overstate net operating cash flows. an example is the company enron, whose management together with overstated income, presented overstated cash flows from operating activities, which, at least for some time, avoided the analysts suspects in reality of the earnings. overstated net operating cash flow is the result of misclassification of inflows based on bank loans. related parties have borrowed from banks and paid in advance to the company enron the oil. the bookkeeping of enron showed the customer deposits, while cash flows were classified as operating cash flows (mulford and comiskey, 2005). the classification of cash inflow arising from financing activities as an inflow from operations is an example of company’s reporting practice beyond the boundaries of generally accepted accounting principles. overstating net operating cash flow for the current year could be the result of presenting inflow based on securitization or sale of receivables as operating cash flows. securitization and sale of receivables results a decline in the receivables balance, which is presented in cash flow statement as an cash inflow provided by operating activities. the accelerated collection stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 33 of account receivable, the future cash inflows from operating activities are reported in the current accounting period. generating cash inflow from operating activities in the artificial way in the current period will be reflected in the next accounting period as a reduction of net operating cash flow (mulford and comiskey, 2005). the fact is that the newly created account receivables will substitute those sold, so it will only increase the amount of receivables beyond the previous sold values, and thus lead to an increase of cash outflows from operating activities. investments in notes receivable create in an enterprise doubts concerning the treatment of cash inflow from their collection. options are the classification of cash flows and changes in the notes receivable balance as operating or investing cash flows. most of the companies classify the cash flows based on notes receivable as cash flows from operating activities. using the other option could be exercised an overstating operating cash flows. in this case, the increase in notes receivable is presented as a reduction of net cash flow from investing activities, and thus, the cash flows from operation is increased for the same amount. management that mentioned financial receivables classify as part of the investing cash flows, could consciously increase the receivable balance. the accumulation of uncollected receivables reduces the net investing, instead of net operating cash flow, and creates a space for creative reporting and overstating net operating cash flow. investments and related cash flows. cash flows from company’s financial assets generally are viewed as cash flow from investing activities. classification of cash flow arising in connection with the purchase and sale of financial assets depends on their classification. when financial assets are classified as held-to-maturity investments, and available-for-sale financial assets, the corresponding cash inflows, and outflows are classified within the investing cash flow section. cash used for buying (provided from selling) of financial assets held for trading, is included in operating cash flows. classification of financial assets by purpose shall be made in accordance with the accounting policy of the company, based on criteria that require international accounting standards. four categories of financial instruments are defined in international accounting standard 39. financial instruments held for trading generally are used with the objective of generating a profit from short-term fluctuations in price or dealer’s margin (ias 39, 2011). by reclassification of available-for-sale financial assets on financial assets held for trading, management of the company can create and send the wrong signal about the cash generating capabilities, demonstrating the cash inflows and outflows in favour of net cash flows from operating activities. if buying and selling of financial assets is not active and frequent, it is not appropriate the classification as financial assets held for trading. after the sale of incorrectly reclassified assets as assets held for trading, there is an increase in net operating cash flows, although their buying decreased net cash flow from investing activities. cash from operating activities, generated due to the incorrect classification of financial assets is not sustainable. unsustainable net operating cash flows should be excluded, in order to create the real picture of cash flows from operating activities. investing in the purchase of some part of assets indicates to investing cash flows, but the classification of cash flows from investing activities depends on the kind and purpose of the assets to be purchased. the rule is that expenditure incurred by purchasing assets allocated for doing business in the longer term, represents a part of investing cash outflows, and economic analysis (2013, vol. 46, no. 1-2, 28-39) 34 potential inflows based on their sale, a part of cash inflows from investing activities. expenditures incurred due to purchase of assets intended to be used for the production of goods (materials) or sell (goods), by its nature, cannot be part of cash flows from investing activities. their purpose will determine the classification of the outflow based on current procurement as cash outflow from operating activities. misclassification of assets and related expenditure has an impact on the structure of the cash flows. treating the current assets as part of fixed assets, or investing instead of displaying operating cash outflows, leads to overstated net operating cash flow. liabilities and related cash flows. management disposes with the possibility to use the flexibility of generally accepted accounting principles when presenting wanted cash flows from operating activities. approved overdraft on cash account opened at the bank, creates the ability to boosting operating cash flow. generally accepted accounting principles are not definitive in the cash-flow classification of overdrafts. overdraft is seen as a short-term loan from the bank, where cash flows from the use of overdrafts and related interest payment are viewed as financing cash flows. classification of overdrafts as cash flows from operating activities is explained by the fact that this type of company's loans is mostly used to settle current liabilities. presenting overdraft as a current liability and thus, its turn into operating section of cash flow statement, could lead to overstated net cash flow from operating activities. cash flow from operations generated by increasing overdraft is unsustainable, which is one more reason not to be taken into account when evaluating the performance of the enterprise. account payable as balance sheet item is the result of temporal mismatch of assets purchase and execution of payments for that. although account payable is a form of financing company from suppliers, the cash flows from payment of these liabilities and change of account payable balance are reported as cash flows from operating activities. management can use extension payments to suppliers as a tool to increase net operating cash flow. it is important to known in which percentage the account payable balance increase presents the source of cash from operating activities, because it is a source that is not sustainable. suppliers may approve the company’s defer payment of current liabilities at the end of the current year, instead of the beginning of the following year. this method does not violate the generally accepted accounting principles, but the ability to generate cash flow for two consecutive accounting periods is misted. time mismatch between the transaction of revenue recognition and the one of receivables paid by customers, among other, can lead to dilemmas in terms of classification of cash inflows. collection of revenues from sale in the period before it is made their recognition affects the expression of inflows in the form of increased liabilities based on advance payment. the fact that is the true source of funding provided by the customers, could lead to the conclusion that the related cash inflow have to be presented within the financial section of cash flow statement. yet, customer deposits are a source of cash flow from operating activities, which is explained by the fact that the company will deliver, on that basis, goods or services to the customer. unrealistic reported net cash flow from operating activities could be a result of a misclassification of customer deposits inflows, or forcing advance payments from customers. stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 35 expenses and related cash flows. operating costs can be one of the areas of fraud, in case of their wrong capitalization. expression of certain expenses as capital expenditures or an increase of value of property, plant and equipment, rather than as expenses in the income statement, results in increase of net income and cash flows from operations. the profit is increased in the absence of expenses that are capitalized. recognition of the incurred expenditures as operating expenses in the income statement, would affect the increase of cash flows from operating activities at the time of their payment. making an incorrect capitalization of costs, the cash expenditures recognized in the balance sheet would be described as part of investing cash outflows, which overstates the net operating cash flow, and understates the net cash flow from investing activities. capitalization of software development costs instead of their treatment as a expenses, is an example of reducing the net investing cash flows, instead of net cash flows from operating activities. unlike expenses that should not be capitalized, the capitalization of development costs is possible within legislation acceptable limits. capitalization of subsequent software development costs is performed at the time of reaching technological feasibility, but concerning the percentage of capitalization, companies can adopt different policies. recognizing the expenditures in terms of software development as periodic expenses will affect the statement of comprehensive income and cash flow statement by showing lower profit and lower net cash flow from operating activities. during the capitalization of these expenditures, cash outflows would be included in the investing section of the statement, having no effects on cash flows from operations, thus, they will be reported unrealistically. incorrectly percentage of capitalization of development costs lead to overstated net cash flows from operating activities, even in the absence of a final capitalization effect on profit. effects on the profit are missing during equalization of amortization of capitalized software development costs in the previous period and the amount of expenses capitalization in the current period. changes of company’s capitalization policy have an impact on reported cash flows from operations. capitalization percentage magnification compared to the previous period has the effect of increasing cash flows from operations, because a larger part of cash outflow is included in investing cash flows. it could be concluded that the capitalization of operating expenses leads to incorrect higher operating profit, and cash flows from operations, because instead of showing cash outflows based on operating expenses within operating section of the statement, the outflows, are presented as investing cash flows. companies of equal capital intensity would have reported different net cash flows from operating activities, if one company purchases equipment through operating leasing, and the other one, the same equipment buys. the company that rents equipment through leasing, the expenditures for leasing presents as cash outflows from operating activities. expenditures for purchased equipment are viewed as capital expenditure, thus, a company that is committed to purchase of equipment would have a decrease in net investing cash flow (white, sondhi and fried, 2003). misrepresentation of outflows from operating leasing as investment, rather than operating cash outflows, lead to overstated net cash flow from operating activities. economic analysis (2013, vol. 46, no. 1-2, 28-39) 36 consequences of creative cash flow reporting positive cash flows represent the aim that owners and management tend to achieve. whether and how the company is able to generate cash from operating activities is the crucial information for users of financial reports. potential investors, creditors and analysts are interested in sources, use and cash flow trends, because on that basis they assess the performance of the company. the company with the positive cash flow, with increasing trends from period to period, has no problems with the financing of necessary investments and repayment of maturing obligations. it is in the situation to invest in new business, relying mostly on internal sources of financing. credit conditions for potential external funding investments are certainly favourable for liquid and solvent companies. the above mentioned can be a stimulus for expression of cash flows higher or lower than the actually achieved cash inflows and outflows. stakeholders' decisions on capital investment, loan approval, initiation and continuation of business relations with the company and employment, based on unreliable and unrealistic accounting information would be erroneous. after a period the effects of manipulation on income, net cash flow from operating activities and the share price will become evident, company’s security violated, and the trust of persons associated with the company shaken. misclassification of cash flows, mostly to net cash flow from operating activities resulting in an overstatement of net cash flow from operations. since in that case the value of net cash flow from investing or financing activities is understated for the same amount, the effects of fraud on the total net cash flow will be absent. the fact that the amount of net cash flow as a whole, is not affected by the activities implemented by company’s management, does not eliminate, nor justify the presence of creative cash flow reporting, especially if taken into account that the value of net cash flow as a whole has the lowest information value. misclassification effects of cash flow presented in the table 1 are an example of aggressive capitalization of expenditure. the consequence of showing cash outflow from investing activities instead of operating cash flow, regardless of being erroneous misclassification due to ignorance or with specific purpose, is the overstated net cash flow from operations. table 1. the impact of erroneous classification of cash flows cash flows realistic unrealistic net cash flow provided from operating activities 350.000 overstated net cash flow used for investing activities (730.000) understated net cash flow provided in financing activities 400.000 unchanged net increase in cash and cash equivalents 20.000 unchanged overstated cash inflow, understated cash outflow, and recorded fictitious transactions affect the quality of the reported net cash flow from operating activities. the example of table 2, indicates the change in cash flows due to false reporting of cash flows. since the adequate decisions making by users of financial statements, among other things depend on reliability and comprehensiveness of information of cash flow trends, the better presented stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 37 cash flows in relation to the real cash flow, create a false impression of the ability to generate cash for operating, investment, and financing activities. table 2. the impact of false reporting of cash flows cash flows realistic unrealistic net cash flow provided from operating activities 350.000 overstated net cash flow used for investing activities (730.000) unchanged net cash flow provided in financing activities 400.000 unchanged net increase in cash and cash equivalents 20.000 overstated decisions made based on unrealistically reported cash flow items, and items of other financial reports, resulted in lost return on investment, lost investment, opportunity costs arising from missed better investments (dejan malinić and nikola stevanović, 2009). at long-term period, losses suffer all users of creative financial statements, because they consider them as a reliable source of information about the performance of the company. the most serious consequences of creative reporting still bear investors, particularly the investors to companies with significant dispersion of ownership and minority shareholders of companies in which there is one or a few large owners. consequences for the company are also dramatic because the company could go bankrupt, and if survive, it would be hard to regain the trust of investors and creditors, to attract the capital and to continue operations. material loses are accompanied by new created distrust of the system of financial reporting and the accounting profession. therefore, all that troubles cannot be recovered by material or prison punishment to the management, which is the most responsible for manipulation activities (malinić, 2008). concerning the fact that an efficient financial reporting system generates accurate, objective information about the company’s performances, provides a reliable basis for making good business decisions, strengthens the confidence of investors and creditors, decrease investment risk and provides lower costs of capital, it is clear what consequences creative financial reporting has for the capital market. the distrust of investors, lack of interest in investment, increased capital costs, inefficient capital market, is factors that adversely affect the economy of the country. conclusion manipulations of earnings and cash flows of the company are possible in practice if there are certain personal motives or pressure of management by owners of the capital. earning management may be accepted as a regular business practice if there are no materially significant violations of accounting rules, a deliberate intention of creating a misleading impression about the company performances, and if it contributes to the achievement of stakeholders’ interests. on the other hand, managers may often use their accounting discretion to manipulate earnings, which certainly affects the reliability of the financial reports. economic analysis (2013, vol. 46, no. 1-2, 28-39) 38 cash flow analysis can be used as a tool for discovering creative reporting on company’s profit, but even the cash flows can be subject to manipulation. while cash flows, by their nature provide much less opportunities for manipulation in relation to income, the practice have revealed the presence of creative cash flow reporting, which can be seen in examples of creative reporting of cash inflows and outflows related to receivables, investments, liabilities and expenses. aware of the information importance that cash flows from operating activities has for the users of financial reports, the managers often tend to present their company as one able to generate cash and cash equivalents by misclassifying cash flows, although sources from operating activities are not, or at least not to the extent sustainable. however, the possibility of manipulative management of cash flows as a real category is significantly lower compared to the possibilities of creative earnings shaping which represents the accrual accounting item. true and objective information about the cash flow and other company’s performances provide a reliable basis for making good business decisions and strengthen the confidence of investors, creditors and other stakeholders. stakeholders’ decisions on investment, credit approval, initiation and continuation of business relations, made based on unreliable and unrealistic accounting information will be incorrect. after some time, the effects of fraudulency on income, net cash flow from operating activities and stock prices will become evident, the security of the company violated and the investors’ confidence of the company undermined. references center for audit quality. 2010. deterring and detecting financial reporting fraud—a platform for action. international accounting standard 39: financial instruments: recognition and measurement. 2011. www.ec.europa.eu (accessed february 2, 2013). malinić, dejan. 2008. kreativno finansijsko izveštavanje: motivi, posledice i etički izazovi, in tranzicija i posle u regionu nekadašnje jugoslavije, belgrade: the serbian association of economists. milojević, d. 2006. revizija finansijskih izveštaja, belgrade: faculty for trade and banking and belgrade banking academy. mulford, c., and comiskey, e. 2005. creative cash flow reporting: uncovering sustainable financial performance, new jersey: john wiley & sons. stevanović, n. and malinić, d. 2009. fenomenologija bilansa: informaciona moć, rizici i posledice, ekonomika preduzeća, special issue tajne bilansa: menadžerski pristup, belgrade: the serbian association of economists. white, g., sondhi, a., fried, d. 2003. the analysis and use of financial statements, new jersey: john wiley & sons inc. wild, j., subramanyam, k.r. and halsey, r. 2007. financial statement analiysis, new york: mcgraw-hill/irwin. stevanović, s., et al., creative cash flow reporting, ea (2013, vol. 46, no, 1-2, 28-39) 39 kreativno cash flow izveštavanje motivacija i mogućnosti rezime – stejkholderi preduzeća donose poslovne odluke na osnovu informacija koje su prezentovane od strane menadžmenta. kvalitet donetih odluka, između ostalog, zavisi od kvaliteta i pouzdanosti informacija u finansijskim izveštajima. poslovna praksa pokazuje da su menadžeri skloni da prikažu pogrešnu sliku o finansijskom i prinosnom položaju preduzeća, često i u saradnji sa vlasnicima kapitala. postupci koje menadžment i investitori preduzimaju u cilju stvaranja pogrešnog utiska o performansama preduzeća, savremena literatura definiše kao kreativno finansijsko izveštavanje. prikazivanjem boljih finansijskih performansi nego što one stvarno jesu, pružaju se obmanjujući signali o preduzeću, a korisnici infomacija dovode u zabludu. cilj rada je analiza mogućnosti za sprovođenje kreativnog cash flow izveštavanja i faktora koji menadžment preduzeća i vlasnike kapitala podstiču na pogrešno ili lažno prikazivanje performansi preduzeća. nakon prikazivanja glavnih motiva kreativnog finansijskog izveštavanja, ukazujemo na primere pogrešne klasifikacije novčanih tokova. upravljanje dobitkom i novčanim tokovima menadžment može sprovoditi u okviru i izvan granicama računovodstvene regulative na više načina, ali je u radu poseban osvrt na postupcima kreativnog izveštavanja priliva i odliva gotovine koji su vezani za potraživanja, plasmane, obaveze i rashode preduzeća. posledice kreativnog izveštavanja o cash flow i ostalim performansama preduzeća mogu biti ozbiljne kako po stejkholdere, tako i po opstanak preduzeća, što je i obrazloženo u poslednjem delu rada. ključne reči: kreativno finansijsko izveštavanje, kreativan cash flow, klasifikacija novčanih tokova, neodrživi novčani tokovi article history: received: 15 february 2013 accepted: 6 may 2013 doi: 10.28934/ea.22.55.1.pp12-29 preliminary report state and perspectives of agricultural land acquisitions ana budak11f* 1 advokatska kancelarija dr ana budak / independent researcher, serbia abstract despite being marginal in both the general and scientific public, land acquisitions have brought agricultural land in the unprecedented focus of interest. the causes of these changes are the consequence of, inter alia, the growing world population, which undeniably leads to the increased need for agricultural products. therefore, in this article, the most relevant cause of agricultural land acquisitions is considered – growing food demand. the history suggests that the acquisitions of agricultural lands are not a new phenomenon, but rather a new wave of déjà vu. the latest wave of agricultural land acquisitions, according to the general understanding, started with the global financial crisis. the growing demand for land acquisition began, which led developing countries to realize that the purchase of agricultural land, despite its potentially negative effects, could catalyze economic development. the main goal of this paper is to review and explore the state and perspectives of agricultural land acquisition on a global level. the research uses data from the land matrix database and employs historical method, conceptual analysis of law, classification method, content analysis, synthesis, systematic literature review, and descriptive statistics method. we drew the conclusion that more than a third of all the cross-border land acquisitions were caused by the growing food demand. the results of the research show that the growth of land acquisitions follows the growth of the world population, implying that the demand for agricultural land will not be stagnant for at least three more decades, i.e. land acquisitions undeniably are in continuo. key words: agricultural land acquisitions, agricultural land, agricultural land market, causes of agricultural land acquisitions jel classification: f21, f60, q15 introduction although agricultural land acquisitions are not a new phenomenon, it indeed is significantly accelerated in 2008 by the global food crises when a large number of investors, perceiving a growing food demand, saw great potential for profit in agricultural land. in most cases, investors invest because of the demand for food, biofuels, or, in general, for the sake of making a profit. when they invest in food, they do so primarily because there is no suitable land for agricultural production in their home countries. illustrative in that sense is the example of the countries of the middle east. in addition to growing food demand, the increase in the number of international acquisitions of agricultural land was influenced by policies to attract foreign direct investment. nevertheless, after more than a decade of accumulation of world capital, poverty and hunger remain persistent. faced with the need for rural development, states are seeking assistance in investing in agricultural land. in other words, they are starting to work on attracting foreign direct * e-mail: ana.budak@legis.rs ana budak 13 investment in agriculture. this is because they see it as a means to achieve their goals which include, but are not limited to, the revitalization of the agricultural sector. namely, decades of neglecting agriculture have taken their toll and led to low productivity and stagnation of agricultural production in many countries (sharma, lahiri, neogi & akhter, 2021). some of the notable examples include african countries (mfaniseni wiseman & mfundo mandla, 2018), and transition economies (kuhn & bobojonov, forthcoming). in this regard, as one of the possible solutions, foreign direct investments in agriculture are imposed. this could significantly contribute to filling this financial gap in the agricultural sector. in such circumstances, although agriculture has been at the back of investors' priorities for decades, it has deservedly gained importance in recent decades. however, there are some legal restrictions and specificities in certain countries related to land acquisitions. some of these legislations are motivated by the aim of protecting family farms. namely, family farms are considered to be among the best social tools for poverty reduction in many countries. for example, in poland, there is a restriction which is reflected in the fact that foreign legal entities can acquire agricultural land up to 1,000 hectares (dla piper, 2021), while for natural persons this limit is set at 300 hectares (interlegal, 2021). on the other hand, hungary is the only member state of the european union that completely forbids legal entities to style property rights on agricultural land, which means that the ban applies not only to foreign but also to domestic legal entities. this absolute ban on legal entities acquiring ownership of agricultural land became part of hungarian legislation in 1994 and has been part of the legal system ever since. similarly, in serbia, privately owned agricultural land cannot be acquired by foreign legal entities, while the acquisition of state-owned agricultural land is reserved for domestic natural persons (budak, 2021). the emergence of the interest of world investors in agriculture is seen by many host countries as an opportunity for development and even as a solution to the problem of rural development. in other words, until almost a decade ago, investors were practically not interested in investing in the agricultural sector. notably, it is of interest to know what has changed. we investigated whether this can be partly explained by the emergence of another wave of the "gold rush", where agricultural land is considered a commodity and worth investing in. to illuminate this uncharted area, we examined the crucial causes of modern agricultural land acquisitions. examples of modern acquisitions include chinese companies' increasing investments in agricultural land in african countries or south america (which is in line with its going global policy). other examples include large-scale agricultural land acquisitions by transnational companies, supported by some governments. which is often called neocolonialism in the literature. for example, between 2004 and 2009, ethiopia leased 1.48 million hectares of agricultural land for approximately 1 usd for 2.5 hectares (globalvoices, 2020). the government of mozambique has concluded a contract with the london company and left 30,000 hectares of agricultural land to it for the production of bioethanol. the move has been sharply criticized as the land was originally pledged to local communities involving more than 1,000 families (united nations, 2020) certainly, among the most important investments are the ones that originated from the european union. the member states of the european union are becoming one of the most important actors in the world when it comes to the acquisition of agricultural land. namely, conducted research (antonelli, siciliano, turvani & rulli, 2015) indicates that the member states of the european union have concluded 23% of all concluded land agreements in the world. others (borras jr et al., 2019) state that it is difficult to estimate the exact extent of "land grabbing" committed by european union companies, given that a large number of these transactions are in the "gray zone", which makes it very difficult to establish precise categorizations. this will be the case, for example, when a european union corporation buys goods from a reputable foreign company, and those goods come from a country that has been "grabbed" by peasants. by 2019, 14 economic analysis (2022, vol. 55, no. 1, 12-29) european union companies have concluded a total of 909 land contracts covering 23 million hectares of land worldwide. modern acquisitions of agricultural land differ from those already seen, inter alia, in new causes. moreover, host countries, especially developing ones, have been shown to pursue active policies to attract investment in agricultural land to enable economic development and modernization of agriculture. at the same time, developed countries, driven by the need to meet the demand for food and biofuels, are starting to buy agricultural land in large quantities. the theory has identified several causes that, on a global level, lead to modern acquisitions of agricultural land. as a rule, they are reduced to demand for food, biofuel production, land availability, and prices, weak legal and institutional frameworks and policies of the european union. in this paper, the demand for food will be examined as, in the author's opinion, the most significant cause of agricultural land acquisitions. the perspective we adopt is global in order to maximise the generalizability of our results. in addition to the analysis of the policies of the host countries and the policies of the countries of origin of investments, the paper seeks an answer to the question of the long-term tendency of agricultural land acquisition: whether their number will decrease, increase, or stagnate. furthermore, the paper points out that it should be borne in mind that the causes of the acquisition of agricultural land differ from the so-called "triggers" that led to them, such as the world food crisis. the work is organized as follows. the first part of the paper describes the methodology. in the second part of the paper, we describe general tendencies and causes of agricultural land acquisitions. the third part presents the key causes of agricultural land acquisitions and their relationship with the increase in world population. the fourth part of the paper presents the dynamics of agricultural land acquisition. based on the analysis in these chapters, the relevant conclusions are drawn, as well as their practical implications. data and methodology data the research uses data from the land matrix database, which includes only one transaction with over 200 hectares (land matrix initiative, 2020b). the land matrix initiative prepared two reports that represent a kind of compilation of international land transactions the first one in 2012 and the second one in 2016. these reports show a smoothing of the curve when it comes to international transactions, which would mean that we are witnessing a period of stagnation in the acquisition of agricultural land. as of 2016, a new report has not yet been made. for this reason, the author of this paper decided to do it herself, based on available data on international transactions for the period 2000-2020. year, based on which the dynamics of agricultural land acquisition was presented. the aforesaid limitation of 200 hectares must be borne in mind when drawing conclusions about agricultural land acquisitions and their implications. first of all, it could be rightly pointed out that the figures in this database are underestimated due to such incompleteness of the database. namely, it is very likely that there is a huge number of contracts that individually have less than 200 hectares, but together make up a huge acquired area that has not been recorded. however, the most prominent authors who study the acquisition of agricultural land think that this database is a good basis for research. they state that the mentioned database provides valuable, but approximated information on the scale of this phenomenon, emphasizing that this is the case if readers are warned about weaknesses and limitations related to data (rulli & d'odorico, 2013). although fast data collection is very important, especially when we need fast information, their level of inaccuracy must be acceptable, i.e. their limitations must be clearly stated (scoones, hall, borras, white & wolford, 2013). therefore, the data we have can be the basis for creating an image of this ubiquitous phenomenon, for making political decisions and ana budak 15 initiating social actions, primarily of small farmers, for shaping international politics, but with the restriction that these data must not be taken unreservedly. however, the paper focuses on this database, given that it is the most complete database in this area and that it is, of course, invaluable for monitoring this phenomenon. data are collected using the "snowballing" method, where one data source is the starting point for further research. given the speed with which information changes, as well as the scarcity of information, primary data sources are given priority over publicly available reports, which is achieved, inter alia, by cross-checking available data. data are obtained using a variety of data collection methods, including a network of partners in host countries, through which data are collected from regional and national coordinators, research associates, experts and ngos, public and private actors, individuals (who are allowed to submit available data), peer-reviewed papers, reports of local and international organizations and non-governmental organizations, research papers dealing with this topic, governments of individual countries, companies' websites and other publications, such as annual reports and media reports. it is likely that the figures, in cases where the state has transparent data, i.e. when reports are the main sources of the database, are likely to be underestimated. on the other hand, if there is no transparency of data in the country, i.e. if the media and non-governmental organizations are the main sources of data, it is very possible that the figures will be overestimated. so, having in mind the possibility that various actors, depending on their interests, will "beautify" the data, one gets the impression that, in this way, a kind of balance is created between the data. methodology considering the multitude of facets to this phenomenon, different methods of analysis were applied. in order to review the development of this phenomenon, the historical method was used. to understand the key terms, a conceptual analysis of the law was used. the classification method was used to disentangle the key concepts in the research, while the content analysis and synthesis were used to present the causes of the agricultural land acquisitions. to describe the existing knowledge about the phenomenon, the content analysis was combined with the systematic literature review. in order to understand the magnitudes, patterns, and dynamics of the change to this phenomenon more clearly, in this article we used the method of descriptive statistics. this method was also employed to visually clarify the considered variables and their dynamics over time, which complements the historical method also used in our analysis. such a combination of methods allowed us to draw empirically based conclusions. it should be useful to define the main concepts and definitions we use further in the analysis. land matrix database (land matrix initiative, 2020b), which we use, defines a land deal as “any intended, concluded, or failed attempt to acquire land through purchase, lease, or concession for agricultural production, timber extraction, carbon trading, industry, renewable energy production, conservation, and tourism in lowand middle-income countries”. the data includes deals that: “entail a transfer of rights to use, control, or ownership of land through sale, lease, or concession; have been initiated since the year 2000; cover an area of 200 hectares or more; imply the potential conversion of land from smallholder production, local community use, or important ecosystem service provision to commercial use.”. we think that agricultural land acquisitions could be defined as the establishment of control (purchase, lease, concession, or otherwise) over large areas of land (agricultural or forestry) by investors (foreign or domestic, or investors who are a combination a natural person, a private company, government or investor who is a combination of these actors) for the production of food, biofuels, speculative or other reasons. the general trends and causes of agricultural land acquisitions for the first time in decades, there is consensus among policymakers that the agricultural sector in poor countries urgently needs investment to address hunger and poverty, as well as to ensure 16 economic analysis (2022, vol. 55, no. 1, 12-29) economic growth. (spieldoch & murphy, 2009). with this in mind, the host country should pursue a liberal trade policy in order to attract as many investors as possible and thus contribute to economic growth. on the other hand, how trade liberalization will affect other aspects of the daily life of the average resident of that country is a question that does not necessarily have a positive outcome. in any case, concluding contracts that deal with agricultural land transactions, without an adequate strategy for attracting foreign direct investment, i.e. without previously clearly set goals of the host country (what investments it wants to attract and what it expects from them), often leads to negative effects of such investments. the most common adverse effects are effects on rural development, effects on competition, effects on the environment, effects on food security, and effects on human rights. given the undeniable need for investment, developing countries often pursue an intensive policy of attracting foreign direct investment in agriculture as they see it as one of the main means of economic growth and modernization of the economy. for instance, some research (gerlach & liu, 2010) has shown that sub-saharan african agriculture needs at least 21 billion usd a year to reduce the poverty and malnutrition of its population. it must be admitted that it is a goal that this region will find very difficult to achieve on its own. in such circumstances, host countries, especially developing ones, welcomed the foreign direct investment, considering it a unique opportunity for economic development, infrastructure improvement, development of new technologies, and improvement of know-how in agriculture. (fernández, 2017). therefore, foreign direct investment can be one of the levers of the economic development of these countries. the primary goal of attracting foreign direct investment in agriculture is, for example, to modernize agricultural production, new technologies, access to or better integration into the world market, or increase exports. these and similar goals are set by the state as primary in concluding contracts. simultaneously with the need of developing countries for investments, after the world crisis in 2008, investors saw agricultural land as a means of reducing risk, i.e. a "dam from inflation". in that sense, the acquisition of agricultural land can be motivated exclusively by lucrative goals (cotula, 2013). in addition, agricultural land can be considered an attractive investment not only because of the current prices at which it will be possible to make a profit but also because of the growing trend of demand for agricultural products. hence, as the increased demand for food inevitably leads to an increase in land prices, investors often buy large areas of land to make a profit by reselling. in effect, investors perceive the profit, i.e. the difference between the low price at which they bought the land and the price of its later sale at a much higher price. therefore, it could be said that the cause of modern acquisitions of agricultural land is the "expected reciprocal profit" of investors in relation to the host country that expects economic development from the investment (ojulu, 2013). it is estimated that the projected annual rates of return of investors in agricultural land are 10-40% in europe and up to 400% in africa (grain, 2008). in this sense, the organization "grain" (grain, 2016) concluded that making a profit is the dominant cause of the latest wave of agricultural land acquisitions. land matrix database (land matrix initiative, 2020b) detects a total of 18 causes that lead to the acquisition of agricultural land: biofuel production (contracts concluded for this reason have a total of 4,544,851 hectares), demand for food (7,826,132 hectares), livestock, non-food agricultural products, agriculture (unspecified), tree planting, deforestation/forest management, carbon sequestration, forests (indefinite), mining, oil/gas exploitation, tourism, industry, reserve creation, land speculation, renewable energy, other and many causes. ana budak 17 figure 1. causes of agricultural land acquisitions (% of all concluded contracts) source: (nolte, chamberlain & giger, 2016) for most of the concluded contracts, both in terms of number and acquired areas, agriculture is the dominant cause of the acquisition of agricultural land. figure 1 shows that the demand for food is one of the main causes of agricultural land acquisitions, with a total of 38% of all agricultural land acquisitions. in second place is agriculture (indefinitely), which can include various crops with a variety of applications (for the production of food, animal feed, fuels, and industrial materials, e.g. palm oil, which is used for food, fuel, and cosmetics). in third place are biofuels with 21% of all contracts. however, one should keep in mind that theory (anseeuw, wily, cotula & taylor, 2012b) distinguishes the so-called "triggers" of a certain phenomenon from its causes. in this sense, the "trigger" for the emergence of agricultural land acquisitions would be the global crisis of 2007/2008, while the causes can be numerous. it is very difficult to distinguish the causes of agricultural land acquisitions, given that they are often intertwined and interconnected, especially with the emergence of so-called "flexible crops".2f1 in any case, there are many potential causes that literature and practice have recognized, but also an unlimited number of possible motives that guide each investor when investing. these causes will depend not only on each investor but also on the various factors that shape the local environment in which the investor invests social, economic, or other. the emergence of flexible crops is a logical consequence of multiple crises (borras, franco, gómez, kay & spoor, 2012). consequently, investors were given the opportunity to diversify risk. risk diversification is extremely important from the perspective of profit maximization, as a primary goal of every market-oriented subject. under those circumstances, the farmer will grow the crop and produce from it what is the most profitable for him at that moment (food, animal feed, biofuel, industrial materials). precisely due to the existence of these "flexible crops", it is not easy to separate the causes of food demand and biofuel production, since the same product can be used for both food and biofuel production. in this sense, the investor's investment plan may change as time passes in response to changes in international prices and other incentives (cotula, 2013). this is because investors make a decision on the method of investment based on the legal regime of ownership, control, and management in the given circumstances, based on which they conclude which of the offered 1 the four currently most popular "flexible crops" are corn, oil palm, soybeans, and sugar cane. the increase in world production of these crops has been significant in the last 50 years, with the largest increase in the last two decades. many large-scale investments are located in this sector. more about this: (borras, franco & wang, 2013) 18 economic analysis (2022, vol. 55, no. 1, 12-29) opportunities gives them the greatest opportunity to enter and exit the investment (campanale, 2013). there is nothing new when it comes to reusable crops. for example, in the philippines, coconut is considered a "tree of life" because each part of this plant has its use and value. however, for a single agricultural product with multiple uses to be considered "flexible", it must be possible to change the multiple uses according to profit (borras jr, franco, isakson, levidow & vervest, 2016). however, the infrastructure needed to promptly replace one use with another requires huge investments, so only those actors who possess such technology can benefit from flexibility. in other words, small farmers do not benefit from flexible crops as they do not have the necessary financial capacity (genoud, 2018). for these reasons, it can be said that flexible crops have the potential to worsen already unequal power relations between small and large farmers. in such a state of affairs, large farmers have the opportunity to profit from the production of such crops, while small ones do not have that opportunity. it is also pointed out that flexible crops deepen the commoditization of land through additional standardization and speculation. therefore, it can be concluded that crop flexibility can be an important limiting factor when it comes to small farmers' access to land (genoud, 2018). the crucial causes of agricultural land acquisitions and their relation to the growing world population the key causes of agricultural land acquisitions are primarily driven by increasing world population (which has been shown to lead to rising food prices), policies to attract foreign direct investment in agriculture led by host countries, especially developing ones, and policies pursued by countries of origin of the investment. in addition, since they are persons with predominantly lucrative motives, investors are investing for the reason that they perceived an exceptional increase in the prices of agricultural land. all of the above highlights the demand for food and biofuels as the two most important causes of agricultural land acquisitions, then the difference in prices and availability of agricultural land, as well as the weak legal and institutional framework of the host countries. in addition, european union policies have been shown to be a significant cause of agricultural land acquisitions. in the literature (anseeuw et al., 2012b) the water demand is most often cited as a key cause of agricultural land acquisitions. water scarcity is increasingly one of the main obstacles to agricultural production, leading to increased demand for water sources. first of all, we have in mind the countries of the middle east, in which declining water reserves have led investors to increased demand for agricultural land abroad. for this reason, saudi arabia completely abandoned the production of food for its own needs in 2007. some authors (cotula, 2013) point out that water is the main cause of the modern trend of foreign direct acquisitions, given that "land in arid and semi-arid areas would not be useful without water". the water demand was caused by many factors, but the literature most often mentions the fact that there is no unlimited oil, climate change, growing concern for energy security, and interest in renewable energy sources, which results in increased biofuel production and hydropower (mehta, veldwisch & franco, 2012). such acquisitions are referred to in the literature as water grabbing and green grabbing. data from the non-governmental organization "grain" show that the acquisitions concern water as much as land, considering that, with only a few exceptions, each concluded contract included access to water (grain, 2016). likewise, a general pattern was observed that investors are not interested in land that is not supplied with water for production. this is because there is no point in using the land without water (mehta, veldwisch & franco, 2012). the literature states that agricultural land acquisitions, as a rule, are concentrated in areas with safe water sources and that the demand for food and biofuels will increase the pressure on water sources (anseeuw et al., 2012b). this is because the production of all agricultural goods (excluding fish) requires, directly or indirectly, the use of both land and water. given that about 86% of all known water ana budak 19 sources are used in the production of agricultural products, acquisitions of agricultural land represent, to a large extent, the demand for water sources (rulli, saviori & d’odorico, 2013). the problem is that the quantities of water that will be needed to carry out a particular project are not explicitly stated in the contracts (woodhouse, 2012). therefore, it is necessary to assess the required and available water for each contract (mehta, veldwisch & franco, 2012). it could be concluded that the term "green grabbing" means acquisitions carried out in the name of environmental protection. just like "land grabbing", "green grabbing" has a negative connotation in the literature. however, it does not always have to be motivated by speculative reasons or result in negative effects. in other words, the demand for agricultural land has increased not only due to increased demand for food or biofuels, but also due to the need to reduce environmental degradation, and sometimes this is indeed the only or primary motive of investors. nevertheless, it could be said that water sources have not yet reached the significance of the key cause of the acquisition of agricultural land. in a world in which, according to previous estimates, there will be a gap between supply and demand by 2050, it can be concluded that the demand for food is still more important. as the main cause of the acquisition of agricultural land, it is certainly joined by the production of biofuels, as a ubiquitous reaction to the fight against climate change. such a gap has led many investors to invest in agriculture, since, in the foreseeable future, they perceived an exceptional increase in the price of agricultural land. since investors are persons with predominantly lucrative motives, this was a completely expected scenario. having in mind the above, the author limits her work to studying, in her opinion, the most relevant cause of the acquisition of agricultural land the demand for food. this is because the water demand, although undeniably present, is still subsidiary and accessory in the acquisition of agricultural land in the sense that it appears as a naturally necessary condition for the use of agricultural land, and not as a goal in itself. all things considered, water is a necessary, but not a sufficient factor for attracting foreign direct investment (which does not mean that it will not be the one in the future). world food crisis 2007/2008 convinced many investors that they could not fully rely on the international market, i.e. that it would be increasingly volatile in the future, and that, therefore, it could not be trusted when it came to food security. the united nations special rapporteur on the right to food (de schutter, 2008) pointed out that the increase in food prices on the international market during this period was "unprecedented in its scale and brutality". namely, many countries have become concerned about how they will feed their nations in security. therefore, the interests of low-income countries whose economies are largely based on agriculture have met the interests of high-income countries, which are the largest importers of food and exporters of capital. hiincome countries that lacked agricultural land and water to meet their food needs realized that it was in their interest to transfer food production abroad. so, they realized that it is better to acquire land abroad and produce food themselves than to depend on the supply on the international market (de schutter, 2011). about 38% of all concluded contracts were concluded precisely for food production (nolte, chamberlain & giger, 2016). however, there are different opinions on this issue, namely that most of what is produced on the acquired land is not food (hall, 2011). yet, the facts refute such claims. namely, food production as a cause of acquisitions plays a big role everywhere in the world, and especially in europe. according to data from the database "land matrix" (land matrix initiative, 2020b), food is the main cause of agricultural land acquisitions, leading to a total of 7,826,132 acquired hectares, of which 2,685,887 hectares in eastern europe, 2,572,746 hectares in latin america and the caribbean, 2,123,023 hectares in africa, and 374,222 hectares in asia. acquisitions motivated by food production most often come from china, india, south korea, saudi arabia, and qatar (anseeuw et al., 2012b). situations in these states vary significantly. for example, china is incredibly "self-sufficient" when it comes to food. however, it has a huge population, and its agricultural land is disappearing due to industrial development. with 40% of all farmers in the world and only 9% of the total agricultural land in the world, it is not surprising 20 economic analysis (2022, vol. 55, no. 1, 12-29) that the demand for food is highly ranked among china's political goals (grain, 2008). china and india currently have enough food for the needs of their population. however, both countries have high population growth, so agricultural land and water sources are under great pressure due to increased urbanization and industrialization. these causes lead investors from these countries to invest abroad to meet the future food needs of their people. the same is the case with middle eastern countries, such as saudi arabia, where there is not enough agricultural land to meet the future food needs of its population (friis & reenberg, 2010). moreover, the countries of the middle east face other problems. since they are located in the desert, they are in short supply when it comes to arable land and water, so they do not have opportunities for food production. on the other hand, they own large amounts of oil and money, which gives them enough space to rely on food imports. the global food crisis has negatively affected these countries. namely, given that they depend on food imports from abroad (especially from europe), as well as that their currencies follow the us dollar (except kuwait, but only since 2008), the simultaneous increase in food prices on the world market and the fall of the us dollar meant that these countries were affected by "additional" inflation. their account for imported food jumped rapidly from 8 to 20 billion us dollars. given that the majority of their population are low-paid migrant workers, it is necessary for these countries to provide food at reasonable prices (grain, 2008). their goal is to secure food supply through direct ownership or control of agricultural land abroad and, as far as possible, to exclude traders and other intermediaries in order to reduce the cost of food imports by 20-25% (grain, 2008). under such circumstances, saudi arabia realized that, given the growing scarcity of water, it would make sense to stop producing wheat by 2016 and, instead, produce it and export it back from abroad, ensuring, of course, that the whole process is under their control. the idea was to conclude agreements with islamic states, which would allow their companies access to the land and allow them to export the produced products back to their country. at the same time, as host countries, they would, in turn, receive oil and capital. most affected by this policy were sudan and pakistan, a large number of southeast asian countries (burma, cambodia, indonesia, laos, philippines, thailand, and vietnam), followed by turkey, kazakhstan, uganda, ukraine, georgia (the list is not exhaustive) (grain, 2008). however, the literature states that the allegations of substitution for oil/gas and capital have not been verified, i.e. that there is no evidence for them, but that they are "excessive and uninformed allegations based on secondary sources" (woertz, 2013). it seems that the large increase in demand for agricultural land is mainly the result of the increased need for food due to the growing population. for example, according to research by some authors (faure, 2015), the population of the middle east is expected to double from 30 to 60 million by 2030, and therefore, food imports from these countries, which already are 60%. are expected to increase. namely, the growth of the world's population is one of the basic factors that determine the demand for food.3f2 the relationship between population growth and agricultural land acquisition is presented in figure 2. from figure 2 it can be concluded that the growth of agricultural land is accompanied by world population growth, which indicates a positive impact of world population growth on increasing demand for agricultural land in the world. it is also clear from the aforementioned figure that the linear growth trend of the acquired areas of agricultural land follows the growth of the world population. therefore, we conclude that this trend is likely to continue in the future. the increase in population and food consumption will increase at least until 2050 when it will flatten to about 9 billion people. increased competition for land, water, and energy, overfishing, and the urgent need to reduce the impact of food production on the environment, will affect our ability to produce food. with all this in mind, the world faces a threefold challenge: to combine the 2 due to the increase in world population there is an increase in demand for agricultural land. given that the supply of agricultural land is fixed, this inevitably leads to an increase in agricultural land prices. ana budak 21 rapidly growing demand for food with supply, while taking care to do so in an environmentally and socially sustainable way, and simultaneously ensuring that the world's poorest people are not hungry (godfray et al., 2010). therefore, the question arises how, sustainably, to produce more food? in the past, the primary solution to food shortages was to put new areas of agricultural land into use or find new places to fish. however, since the early 1960s, world cereal production has more than doubled, while, at the same time, agricultural land has increased by only 11% (from 4.5 to 5 billion hectares) and arable agricultural land has increased by only 9 % (from 1.27 to 1.4 billion hectares) (pretty, 2008). it can be concluded that in about 6 decades we have managed to double food production, while for that purpose we have increased the area of agricultural land by slightly more than 1/10. undoubtedly, we have become much more productive, which is, inter alia, a consequence of new technologies and knowledge applied in agricultural production. having in mind that new technologies and knowledge, as a rule, are available to developed countries, the conclusion is that, on the wings of globalization, new technologies and knowledge should be allowed to cross the borders of developed countries and spill over into less developed ones. this should be allowed in order to increase productivity, which would have a positive effect not only within the borders of the host country but, ultimately, in the world as a whole. figure 2. world population growth and the area of acquired agricultural land through international acquisitions over time source: prepared by the author based on data from the land matrix database (land matrix initiative, 2020b) food demand is projected to increase not only due to world population growth but also due to dietary changes4f3, which are associated with the economic development of developing countries. opportunities for food production are limited in many countries around the world, especially due to limited water availability, but also due to reduced productivity and climate change (anseeuw et al., 2012b). many investment institutions, such as deutsche bank, have pointed out that agricultural production can be increased in two ways: by increasing yields and increasing arable land (deutsche bank group, 2009). we should especially keep in mind the fact that the supply of agricultural land is practically fixed, which means that the supply is predetermined and that we cannot increase it in accordance 3 it is interesting to note that 77% of people's caloric intake is derived from only 12 basic foods: wheat, rice, corn, beef, lamb, pork, chicken, soy, palm oil, potatoes, milk, and sugar (anderson, 2014). -1000000 0 1000000 2000000 3000000 4000000 5000000 6000000 7000000 8000000 9000000 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 areas (ha) world population (thousands) linear (areas (ha)) 22 economic analysis (2022, vol. 55, no. 1, 12-29) with the possible growth of demand. however, there are suggestions in the literature by which such an obstacle can be overcome. for instance, having in mind the non-multiplicity as one of the characteristics of agricultural land, it seems that, within the given land fund, it is possible to redistribute it. in other words, it is necessary to take such measures aimed at using the available land as efficiently as possible (keča, 1993). increased demand for agricultural land could have been predicted according to long-term projections of imbalances in the relationship between world supply and food demand (campanale, 2013). according to the estimates of the food and agriculture organization of the united nations, it is assumed that, in order to feed 9 billion people in 2050, the production of agricultural products in the period from 2005 to 2050 should increase by 70% globally and almost 100% in developing countries. therefore, insufficient production growth will lead to higher and more volatile prices (food and agriculture organization of the united nations, 2011). in that sense, the value of owning agricultural land is increasing in the world of growing demand for agricultural products, especially food. it has become clear that agricultural land has turned into a commodity in which investors saw an opportunity to secure profits. the question that arises is whether the acquisition of agricultural land can lead to meeting the increased demand for food while promoting sustainable development. in that sense, it is pointed out that the governments of the host countries generally approve foreign direct investments, even in cases when their population does not have enough food, which is the case of madagascar, sudan, or cambodia. in such circumstances, large-scale agricultural land acquisitions motivated by the food security of richer countries in the poor (where people are starving) are seen as unethical (zoomers, 2010). although such understandings can be justified and even understood, it seems that they are not completely grounded. it seems that such an attitude does not take into account the fact that there was a famine in the mentioned countries even before the arrival of investors. also, it is a fact that investors did not come to the mentioned countries by fraud and took the food previously produced in those countries to their home countries. on the contrary, they came, invested in production, produced it themselves by investing capital, and exported the finished product to their home countries. in addition to the above, the need for food is physiological and therefore not related to the question of where the food producer comes from. in other words, the fact that an investor comes from a rich country should not be discredited as unnecessary and bad. on the contrary, rich countries, as well as poor countries, need a certain amount of food. unlike poorer countries, some developed countries do not have enough (adequate) land for agricultural production. in this regard, there is a need for the proper distribution of natural resources in order to feed all those who live on the planet. of course, the problem of hunger is not related to the rich, but to the poor countries in which investors, as a rule, invest. considering the aforementioned, it should be borne in mind that rich countries would not be able to efficiently produce enough food to meet the nutritional needs of their population. likewise, poor countries would not be able, despite sufficient resources available for their production, to produce enough food for their own needs, due to low yields resulting from outdated agricultural production. in such circumstances, we can conclude that there is a need to reconcile the interests of rich and poor countries, i.e. the need to allow foreign investors access to agricultural land, provided that they contribute to the food security of poor countries or at least not endanger it. the dynamics of agricultural land acquisitions the analysis conducted in this part of the paper aims to review the current state of agricultural land acquisitions and draw relevant conclusions about what we can expect in the future. figure 3 shows that agricultural land acquisitions remained low until 2005, with a slight increase between 2002 and 2006. the sudden increase in acquisitions in the period from 2006 to 2014 can be ana budak 23 explained by the global food crisis of 2007/2008. in any case, the above data could indicate a steady and long-term trend of interest in agricultural land. figure 3. international transactions concluded agreements 2000-2016 source: (nolte, chamberlain & giger, 2016) figure 3 shows a leveling off in the period from 2014, but the authors point out that this does not necessarily mean that fewer agricultural land contracts have been concluded, but that it may also be a consequence of the need for time to reach information on concluded contracts to the public. at this point, we are not able to say with certainty whether the stated stagnation reflects the true picture of things or whether it is just a hoax caused by the need for a certain period to pass for some information to reach the public. however, it should certainly be mentioned that something like this has already happened in the previous report from 2012 (anseeuw et al., 2012a)5f4. this report showed a sharp and steep decline in the acquisition of agricultural land in 2010, which, as the new report showed, was not the case, but probably a consequence of the lack of information about the concluded contracts at the time when the report was made. in fact, the new report from 2016 showed that the report from 2012 did not present the real state of affairs when it comes to 2010. the next and last report to date, and since the land matrix database has existed, shows the leveling of agricultural land acquisitions in the period from 2014. however, the authors are skeptical that we are witnessing a period of stagnation in agricultural land acquisitions and believe that this is because data on international transactions do not reach the public (immediately), which is why there seems to be stagnation. however, this assumption of the author of the aforesaid report from 2016 has not been verified to date, since a new report, which could confirm such an assumption, has not been made yet. for this reason, the author of this paper decided to do it herself, based on available data on international transactions for the period 2000-2020. 4 the comparison with the above report is significant since only two reports of this type exist. namely, land matrix prepared two reports that represent a compilation of international land transactions, the first one in 2012 and the second one in 2016. 24 economic analysis (2022, vol. 55, no. 1, 12-29) figure 4. number of international acquisitions of agricultural land greater than 200 ha in the world source: prepared by the author based on data from the land matrix database (land matrix initiative, 2020b) having in mind the previous knowledge about the acquisition of agricultural land, as well as what they have shown in practice, it seems that the second possibility mentioned by the authors of the 2016 report is more probable. namely, it is likely that it is not stagnation of acquisitions, but only ignorance of the media transactions. this is supported by the results of this research presented in figure 4, from which it can be concluded that in the period from 2014 there was no flattening of the curve. on the contrary, there was a large increase in the number of acquisitions of agricultural land. it can be concluded from figure 4 that from 2001 until the beginning of the global food crisis in 2008, the number of concluded land contracts was relatively negligible. the peak of growth in the number of concluded contracts on agricultural land, which are related to the deals of acquiring over 200 hectares, was recorded in 2013 when there were a total of 114. after 2013, the number of concluded land contracts decreased steadily, to reach a constant 20-40 contracts per year. despite the above data, which show a decrease in the number of concluded contracts on agricultural land, the above should be taken with a grain of salt, since it is possible that a large number of concluded contracts have not been recorded yet. in other words, the true scale of land transactions is likely to be visible only in a few years. from figure 5 it can be concluded that the areas of acquired agricultural land through international acquisitions of agricultural land were at a low level until 2008, i.e. until the beginning of the global food crisis, when a large increase in acquired agricultural land was recorded. the data show that the highest number of acquired hectares was in 2013 when more than 3,500,000 hectares of agricultural land were acquired. as figure 4 shows, the fact that prima facie, the acquired areas in recent years are negligible should not be taken without reservation. this could be, as in the previous case, only a consequence of the delayed data on the acquired areas. 0 20 40 60 80 100 120 number of acquisitions ana budak 25 figure 5. areas of acquired agricultural land through international acquisitions over time source: prepared by the author based on data from the land matrix database (land matrix initiative, 2020b) this small experiment conducted by the author of this article based on available data also speaks about the long-term growth trend of this phenomenon (land matrix initiative, 2020a). by january 2019, over 1,500 international transactions at the global level were completed, which are related to the deals of acquiring a total of 47.3 million hectares of agricultural land. by september 2020, the number of international transactions had increased by 20%, i.e. from cca. 1,500 to cca. 1,800 hectares. simultaneously, the acquired area had increased by 40.35%, i.e. from cca. 47.3 to cca. 79.3 million hectares. to put this figure into perspective, the entire balkan is spread over about 47 million hectares. eight years after the publication of the report "seized!", which has captured the attention of the public, which is still abating, grain has published another report entitled "how big, how bad?" (grain, 2016). this report contains data documenting almost 500 cases of agricultural land acquisitions covering 30 million hectares worldwide. however, the inherent limitation of this database should be borne in mind since, similar to the land matrix database, it includes only certain transactions, i.e. a large number of contracts were not even considered. in other words, it is likely that the scale of the phenomenon is underestimated and that we are talking about much larger areas. the danger is that land deals not included in the database (the ones referring to the land acquisitions of less than 500 hectares) make up a considerable share in total acquisitions. likewise, the reader might wonder how it is possible that the acquisition of agricultural land according to the grain database counts a significantly smaller number of acquired agricultural land than the land matrix. it is only a methodological difference that arises from the different definitions of the term. namely, the land matrix database considers only those land contracts that cover an area of 200 hectares or more, while the farmlandgrab.org platform, which grain uses as a basis for its research, considers only those contracts related to the deals of acquiring over 500 hectares. an additional limitation of the data from the platform is that it takes into account only contracts concluded after 2006, which have not been terminated, in which the investor is a foreigner and which are concluded for food production. from all the above, it can be concluded that the true scale of land transactions (both in number and in the acquired area of agricultural land) is probably much larger than the current data show, but that this will be visible only in a few years, i.e. when data on international transactions made in the last few years will be made public. in any case, it can be concluded that agricultural land acquisitions show a long-term growth trend. 0 500000 1000000 1500000 2000000 2500000 3000000 3500000 4000000 areas (ha) 26 economic analysis (2022, vol. 55, no. 1, 12-29) conclusion bearing in mind that in some developing countries agriculture has been neglected for decades, it is not surprising that states stimulate investors to invest in the agricultural sector since it is seen as one of the efficient and quick solutions to problems that have long been out of the state's financial radar. in this sense, it seems that investment in agricultural land should probably be encouraged rather than hampered, especially given the fact that they can be a lever of economic development. however, the eternal controversy regarding this issue does not abate. particular suspicion regarding investment in this sector stems from the fact that acquisitions bring with them several potentially negative effects. for this to happen, host countries must pursue welldesigned policies to attract foreign direct investment, based on well-designed development strategies. in other words, international transaction agreements must not be concluded on an ad hoc basis if the chances of negative effects of agricultural land acquisitions are to be minimized. it could be said that the recommendations for the policy of attracting foreign direct investment are: to ensure the rule of law and an adequate legal and institutional framework in advance (if they are weak, these countries have a great chance to experience the negative effects of agricultural land acquisitions), as well as to ensure non-discrimination of investors and good business conditions. it turned out that one-third of all concluded contracts on agricultural land acquisitions were concluded for food production. namely, the increased demand for food, i.e. agricultural products, has resulted in increased demand for agricultural land. the result of this increased demand is a large number of investments in agriculture, especially in developing countries where land is often considered underused. investments in these countries are no surprise. on the contrary, they are only a reflection of investors for whom making a profit is always a motive, even if it was a secondary one, as in this case when the main motive is to satisfy the need for food. the research showed that the growth of the acquired areas of agricultural land follows the growth of the world population. this indicates the positive influence of the increase of the world population on the increase of the demand for agricultural land in the world. in addition to the above, it has been shown that the linear growth trend of the acquired areas of agricultural land follows the growth of the world population. therefore, we conclude that this trend is likely to continue in the future, i.e. that it is unlikely that the demand for agricultural land will decrease. world population growth will continue to be the background cause that will manifest itself through, inter alia, increased demand for agricultural products. this is supported by the conservative assessment of the world bank (deininger & byerlee, 2011), that in developing countries, 6 million hectares of agricultural land will be put into use every year until 2030. furthermore, the paper showed that the number of international acquisitions of agricultural land over 200 hectares, i.e. the biggest number of acquired hectares in the world, was in 2013. likewise, it was concluded that the true scale of land transactions (both in number and in the area of acquired agricultural land) is probably much higher than the current data show. furthermore, this will be visible only in a few years when data on international transactions made in the last few years will hopefully be made public. in any case, it can be concluded that agricultural land acquisitions show a long-term growth trend. all things considered, it can be concluded that the acquisitions of agricultural land are in continuo. given the aforesaid, there is a need for policies to attract foreign direct investment in agriculture to be designed to maximize benefits and minimize potential drawbacks. this is because agricultural land acquisitions, on the one hand, have the potential to create new jobs, bring new technologies, knowledge, improve existing or build new infrastructure and improve agricultural production but, on the other hand, they can worsen the existing environmental situation, living standards, food security, rural development, competition, and human rights. in any case, concluding contracts dealing with agricultural land transactions, without an adequate strategy for attracting foreign direct investment, i.e. without previously clearly set goals ana budak 27 of the host country (what kind of investments it wants to attract and what it expects from them), often leads to negative effects of such investments on the host country. for this not to happen, host countries must pursue well-designed policies to attract foreign direct investment, based on well-designed development strategies. in other words, international transaction agreements must not be concluded on an ad hoc basis if the chances of negative effects of agricultural land acquisitions are to be kept to a minimum. it could be said that the recommendations for the policy of attracting foreign direct investment are to ensure the rule of law and an adequate legal and institutional framework (this is because it turned out that, if they are weak, these countries have a great chance to experience the negative effects of agricultural acquisitions land), as well as to ensure non-discrimination of investors, and good business conditions. the mechanisms that would enable this could be the subject of some future research. references anderson, kym. 2014. 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"globalisation and the foreignisation of space: seven processes driving the current global land grab." the journal of peasant studies, 37(2): 429-447. article history: received: november 11, 2021 revised: march 8, 2022 accepted: april 5, 2022 https://landmatrix.org/publications/ https://www.dlapiper.com/en/us/insights/publications/2019/07/real-estate-gazette-35/fewer-restrictions-on-the-acquisition-of-agricultural-land/ https://www.dlapiper.com/en/us/insights/publications/2019/07/real-estate-gazette-35/fewer-restrictions-on-the-acquisition-of-agricultural-land/ doi: 10.28934/ea.21.54.2.pp68-81 original scientific paper customer experience and integrated marketing communication in the automotive lubricants market tatjana cvetkov-čikošev1 | ivana domazet20f* | valentina vukmirović2 1 nis ad, belgrade, serbia 2 institute of economic sciences, belgrade, serbia abstract with the advent of new digital communication channels, the use of media for marketing purposes is changing dynamically and fundamentally. also, the manners of using different media sources in order to obtain the requested information are diversified, which inevitably affects when, where and in what way potential customers choose certain brands. accordingly, the aim of this paper is to identify the way in which customer makes the decision to purchase and consume a particular brand. this implies analyzing the key points of contact between the brand and customers, which leads to the desired profitability of the behavior of targeted customers. this paper presents the results of a research conducted in 2018, within the relevant group of respondents, for the automotive lubricant industry and the observed brand nisotec. the obtained results indicated the complexity of the decision-making process of targeted customers, because they differ in the manner and degree of traditional and digital media use, customer behavior and attitude towards the industry and other interests, which conditions the brand response in terms of creating an optimal strategy of integrated marketing communications. key words: customer experience; customer journey; decision making; integrated marketing communication; digital communication channels; automotive lubricants market jel classification: m31, m21 introduction contemporary manners of doing business pose certain challenges to marketing practices, which is the result of a fact that customers, brands and media are fundamentally changing. technology, and especially the internet, is changing the way in which people communicate and establish interactions. with the frequent appearance of new media, customer habits are changing, as well as the manner in which they choose and use different media sources. consequently, this affects the time, place and way of selecting a brand. nowadays, customer attention is fragmented more than ever, and consuming several media sources at the same time means that customers are no longer passive, in the sense that they only receive information about brands through mass media such as print or tv, and remember or store them for later consideration. instead, customers are now active and seek information as needed through search engines, mobile devices, blogs and brand websites. new ways of communicating, however, allow for greater personalization of message content, time and location of message delivery, allowing businesses to use multiple types of media to achieve specific communication goals. * coressponding author, e-mail: ivana.domazet@ien.bg.ac.rs tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 69 besides communication, i.e., choosing what and how to communicate, and at which points of contact, the focus of businesses is on customer experience, because customers now communicate with businesses through multiple points of contact and multiple channels and media. this results in more complex customer paths, from expressing interest for a product to realizing purchase and providing recommendations for others. the aim of this paper is to identify customer trajectories, critical points of contact and adequate marketing communication as a response to this, which leads to profitable customer behavior. the focus of this paper is the empirical testing of various forms of marketing direct and indirect communication and measuring the effects of promotional activities on the sale of the nisotec brand of motor oil products in the automotive lubricants market, i.e., identifying which marketing communication strategies contributed to achieving the company's goals regarding the customer journey. from a broader perspective, this paper seeks to identify the way in which the customer makes the decision to buy and consume a particular brand, recognize critical points of contact, and identify responses in the form of adequate communication, which leads to the desired profitable behavior of targeted customers. in the focus of the analysis are the types and effects of motor oil brands marketing communication, customer confidence in the analyzed brand, as well as their visibility. in this regard, the subject of analysis in this paper is the concept of integrated marketing communications (imc). imc refers to the concept of marketing activities planning, based on the realization of added value through the integration and synergistic action of various strategic activities such as advertising (propaganda), direct marketing, sponsorship, pr, and digital communications. in addition to the application of the imc concept, which should serve as a basis, the emphasis within the modern communication strategy should be placed on digital communication. today, digital communication takes precedence over traditional marketing, in terms of the achieved effects but also participation in annual marketing budgets. literature review terms such as experience, experience management, customer/consumer experience, brand experience, customer experience management, as well as many similar derivative terms, which are basically synonymous, are gaining in importance in academic and professional literature (domazet, 2018; lemon & verhoef, 2016). although the term customer experience is used in the literature, numerous authors talk about the experience alternately connecting it with both customers and consumers (yakhlef, 2015). anyhow, when talking about the digital environment, there is a difference. online customer experience is an implementation of the concept of customer experience in the online environment (domazet, neogradi & simović, 2019). however, the term "user experience", which is widely used today, comes from the field of user interface design and refers to the aspect that is described as experience. the user experience is defined as “the overall interaction with the object as well as the thoughts, feelings, and perceptions that result from that interaction” (albert & tullis, 2013). however, in relation to the quality of service or loyalty, and even satisfaction, this topic is not thoroughly researched in scientific papers. also, this term is often associated with entertainment industry organizations, such as amusement parks. anyhow, where there are services, but also products, and customers, experiences will be whether they are good, bad, or neutral. every service comes with experience and all services or products, whatever they are, can engage customers emotionally (berry & carbone 2007). many people equate experience with amusement, being only one type of desirable reaction, besides gaining someone's attention. in addition to amusement, as a domain of experience, learning occurs when the customer actively participates in informing, concluding, acquiring new knowledge and skills, i.e. when the customer's intellect is actively involved (domazet, đokić & milovanov, 2018). 70 economic analysis (21, vol. 54, no. 2, 68-81) customer experience management strengthens companies to lead consumer/user knowledge to improvements that lead to financial gains, such as (havíř, 2017): • improving customer retention and loyalty • higher consumption of existing users • optimized process of acquiring new users • reduced customer service costs • increased brand awareness and its strength. managing user experience is more than a system of measuring and acting on the basis of user feedback. it is a discipline that begins with executive management and becomes a company culture. a commitment to customer research, employee involvement and continuous program innovation is needed. reducing and closing the gap between what the company offers and what the user experience really is, requires data on experiences, and systems that will use them appropriately (domazet, 2007). in general, there is a certain gap between the perception of companies and customers in relation to what is experienced (klaus & maklan, 2013). most companies, as many as 80 percent, describe the experience they deliver as superior, and only eight percent of customers describe the experience they receive in the same manner. differentiation based only on traditional elements is no longer sustainable and growing number of authors consider customer experience as a new element of differentiation. to establish long-term relationships with customers, the number of points of contact with customers is increasing. therefore, there is a need to manage what customers experience in each of the points of contact. companies are facing accelerated fragmentation of media and channels, and the management of this phenomenon, the so-called omni-channels, is the norm in today’s business. in addition, social networks lead to more complex relationships among users, which poses a new challenge for companies. companies have less and less control over the experience and the overall path of users, which creates new places to interact with the brand (hanić & domazet, 2011). both academia and practice agree that the overall user experience is a multidimensional construct that includes several components thinking, emotions, behavior, feelings, and the social component that are a response to what a company offers all the way to user decision making (schmitt 1999; verhoef et al., 2009). anyhow, experience alone can relate to specific aspects of the offering, such as brand or technology, and consists of individual company and customer contacts at contact points. also, experience is gained at each point of contact in multiple stages of a single user’s decision making (verhoef et al. 2009). researching the user experience is a very important challenge for researchers in the years ahead, due to the growing number and complexity of brand and customer contact points, and the belief that a strong, positive experience within the user path results in several levels positive word of mouth, loyalty growth and higher conversion rates of each point of contact with the brand (de bruyn & lilien, 2008). the user experience is a dynamic process, traveling with the company along the shopping cycle through different points of contact with the brand. the process consists of a pre-purchase phase, a purchase phase and a post-purchase phase. in each phase, experience is gained through points of contact, of which only a few are under the control of companies. the first phase includes all user interactions with the brand and its category, before the transaction or purchase. these behaviors include recognizing the need for specific product or service, searching for information, and considering product purchase. in the second phase, the purchase process itself is observed, including selection, ordering and payment. although this activity takes the least time to perform, so to speak it is a matter of seconds, the most attention in the marketing literature is paid to this very phase. many researchers deal with the influence of marketing activities on the purchase decision e.g., kotler and keller (2017), see marketing mix and its influence, and berry, carbone and hackel (2002) who argue on environment and atmosphere. tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 71 on the other hand, research findings on optimal product assortment conclude that, sometimes, too much information make customers stop searching for products as they are overwhelmed with options. therefore, this often results with customers giving up on their purchase intentions. similar conclusions are obtained when it comes to online behavior (mcgrath, 2010). the third phase consists of interactions with the brand after the purchase use or consumption, expressing interest in additional services and brand engagement. at this stage, the product or service is a critical point. accordingly, many researches deal with the experience of product consumption or use, the decision to return the product, buy it again, or tell someone, praise the product and retell their experience. in addition to these topics, loyalty is also mentioned as an important phase of customer-product interaction. in the post-purchase phase, customers may re-purchase the product or considerate other alternatives. in this paper, the customer journey path is discussed in the context of automotive lubricant industry. both customer and company aspect are observed. key points are identified, including those in which customers continue or interrupt their journey, with the aim of optimizing and improving the points that the company can manage. integrated marketing communication concept companies focus on the manners in which users interact with multiple points of contact. moreover, companies' focus is on observing how customers progress from consideration, search and purchase to use, repurchase and eventual dissemination of good impressions and experiences to others. analysis of customer journey path, i.e. user experience, is an important step in understanding it, in order to maximize the effects of marketing communications. the aim of the analysis is to describe that path and understand the options and choices in each of the phases. in the paper batra and keller (2016) two communication models are combined into one concept, including different media and their capabilities on the one hand and user decisionmaking paths and points of contact on the other, ensuring aim fulfillment, i.e. reaching desired outcome. this model answers questions about the effects of various types of communication and communication platforms which best encourage the achievement of communication goals in each of the phases of the customer path. moreover, the model provides an insight into the manner in which all of these options can be integrated to maximize the effects of business communications. according to the authors, a model which is clear, understandable and dynamic was needed by both managers and academia. therefore, the research conducted in this paper builds upon it, exploring the possibilities on the example of automotive lubricants market. in order to develop a well-integrated marketing communications program, it is of interest to first understand how communication fits into the customer decision-making path. the resources available to the customer, his or her mindset in receiving and processing different messages, as well as the outcomes of these messages are equally important (kerr, patti, 2015). it is important to recognize what knowledge, attitudes and tendencies towards certain actions each customer has, plus the level of customer interest in a certain message, product or service. the outcomes of communication are numerous, from familiarity, transmitting information or creating emotional connections and establishing trust, to taking action and recommending a brand (cvetkov-čikošev, 2019). which outcome will occur, and to what extent, depends on the effects of the interaction, customer characteristics, the content of the message and the context in which it is processed. 72 economic analysis (21, vol. 54, no. 2, 68-81) figure 1. the influence of different factors on communication source: batra & keller (2016) many studies indicate that customer characteristics, i.e. motivation, ability and opportunities to understand communication, affect the intensity and direction of that understanding, i.e. the outcomes of communication. if there is no motivation, ability and opportunity, the communication itself can result with no outcome or lead to an unwanted outcome (misunderstandings, inadequate actions, etc.). motivation and abilities are clear characteristics of potential customer. the possibility of processing communication in general is determined by the way in which that communication takes place, which channel of communication is used, as well as the context in which the message is received. the motivation or desire to comprehend an information varies in relation to whether and how customer perceives the brand as helpful in performing a certain task. the complexity of this process is increased by the level of risk and the level of importance of the category itself the geolocation of the user for receiving and interpreting the message on a mobile device or the level of search, e.g. retargeting in online advertising. situational factors also affect the aspect of the emotional state of the user and the willingness and desire to obtain information. in addition, the manner in which customer processes information depends on previous knowledge and knowledge of the brand and category. at the beginning of the search for the category, potential users will probably not be able to understand in detail the comparison of different attributes. anyhow, they should still understand which brands are more or less relevant and which will enter the selection and be elected at the moment of making a purchase decision. interactions between motivation, ability, and situational factors have a significant impact on communication planning (pickton & broderick, 2004). for example, sms messages about a brand can be received in a moment of high motivation, but the situation might not be suitable for adequate processing of the message. messages received through social networks, from verified sources and friends, have high credibility, but it can happen that these friends cannot provide the level of detail that is needed to make a purchase decision. tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 73 the aims of communication can be: • creating familiarity and recognition the foundation of any brand or marketing activity is creating awareness and ensuring that the brand takes up enough space in memory, and that it is thought of in the right way, in the right place and at the right time. according to keller (2009), a good place of a brand in memory is achieved when the brand is associated with different clues category, situations or needs. in some cases, for example with new products, it is necessary to be aware of the unmet needs and the brand that addresses that need. • transmitting detailed information after creating awareness, it is necessary to convince customers of product or service benefits. convincing customers of brand performance is based on the importance of the benefits that the brand or service has for consumers, and the understanding that the brand is able to meet those benefits more appropriately. in today's world, where there is too much information and little attention, it is a great challenge to efficiently deliver detailed information about a particular product or service. • creating brand image and personality the most successful brands offer two types of benefits for customers, both tangible and intangible ones. brand stories can be told through different types of people and situations in which they use the brand and thus paint the image that is built around the brand. the brand personality is in fact compiled of all human qualities that customers assign to the brand honesty, competency, amusement, which influences customer self-perception and customer-brand relationship. • building trust even in a situation where customers receive and process information, it is possible that they will not use it to make a judgment and decision if they do not consider it credible and trustworthy. literature indicates that one often encounters the "source effect", which speaks of the important role that the source has, i.e. credibility, expertise, likeability, etc. in order to process a particular message. customers are increasingly skeptical and knowledgeable, and there is a great need for authentic messages and products. social networks and communication on these channels with friends and acquaintances indicate the great importance of messages that originate from wellknown, trusted sources, in relation to distant sources clearly motivated to sell the product. • provoking emotions the importance of emotional, social and symbolic influence on the motivation to buy a product has been well-known both in theory and practice. brands can increase their overall perceived value by adding emotional or social benefits in addition to functional ones. the messages that brands send can influence this perceived added value, through, for example, the mechanism of cultural significance. a wide range of benefits helps to evoke emotions that influence consumer decision making. • inspiring action received, processed and accepted message may influence preferences and choices, but not necessarily lead to action and desired behavior. the causes can be various, but the essence is the lack of appropriate connection between understanding, influence and behavior (lazarevićmoravčević, 2019). therefore, it is often necessary to send special messages that aim at a certain action, i.e. the behavior of customers who are already positively oriented towards the brand. • building loyalty after the interaction with the product or brand, customers evaluate the level of their satisfaction, how much their expectations are in line with product experience, which is usually the result of marketing activities, i.e. communications. satisfaction management is an essential part of a broader goal strengthening loyalty and avoiding customer churn. 74 economic analysis (21, vol. 54, no. 2, 68-81) • connecting people customer satisfaction should lead to repurchase and loyalty, but not necessarily to brand recommendation. the recommendation and wom are extremely important in the service sector, without which potential users cannot obtain tangible and credible evidence of quality and trust. in order for a recommendation to be made, customers should be in frequent contact with the brand and the brand should influence the development of brand love. one of the ways that brand love can be developed is by taking into consideration the role that the brand has for the customer. the brand can become symbolically and emotionally important, not just functionally. moreover, the messages that the brand sends to current customers should be motivating in the sense that they want to convey them to their friends and acquaintances. methodology and results for the purposes of a research conducted in this paper, a survey questionnaire was developed. it included questions related to visits and purchases at gas stations, as the sale of nisotec oils and lubricants is mostly realized at gas stations due to its greatest availability in this sales channel. moreover, questions related to brand and automotive lubricants market knowledge, as well as the use of different sources of information on these products were included. the research was conducted at the novi sad fair in may 2018, on a sample of 800 respondents who visited the fair event. the questionnaire, as a research instrument, focused on the analysis of the effects of the type and manner of communication of motor oil brands, consumer confidence in the analyzed brands, as well as their visibility. the structure of the respondents was conditioned by the fact that they were visitors of the fair, thus forming an unrepresentative sample (table 1). the largest number of respondents were visitors from vojvodina and belgrade, compared to the shares of these regions in the nationally representative sample. also, the structure differs by age and gender in relation to the structure of the sample for the brand tracking studio the visitors of the novi sad fair were mostly men and older drivers in relation to the representative sample. table 1. sample structure gender in % male 77% female 23% total 100% age (years) in % 18-30 11% 31-50 42% more than 50 47% total 100% driver in % yes 82% no 18% total 100% source: authors' research tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 75 the questionnaire consisted of the demographic set of questions, including age, gender, car ownership and driving status. the following segments of the research were: knowledge and use of motor oil brands, and the influence of communication on decision making, as well as the application of different types of communication of the nisotec brand. the empirical research resulted in primary data that represented a valuable and compatible analytical segment with secondary data from the research study (brand tracking), which has been conducted by nis for several years. results the analysis of responses of different age groups was mostly conditioned by differences in attitudes towards technology, and the use of different types of media. changes in media use, especially by younger generations of customers, have caused advertisers to rely less on traditional media and more on other types of direct marketing, such as internet advertising, direct advertising, consumer-generated advertising, and buzz marketing. as a result of social networks emergence and their rapidly growing popularity, companies are realizing the need to be present in digital media and are beginning to develop marketing plans for digital communications. generation y members, the so-called millennials, represent an important market segment for which digital marketing content is created. the upbringing of this generation was accompanied by the development of digital technologies, which influenced the way they think, approach information and process them (vukmirović, kostić-stanković & domazet, 2020). undoubtedly, the effects of digital marketing communication on this market segment will be even more evident when correlated with realized sales results. in this regard, it is believed that the internet and social networks, as well as new technologies, have empowered generation y to actively participate not only in collecting information about products and brands, but also in the process of their creation and improvement (domazet, lazić & simović 2014). as a consequence, the role of the customer during the value creation process changed. they are no longer a passive factor to which the value created by companies is simply delivered. customer has become an active factor that has a significant role in the value creation process, i.e, co-creator of value. the results of a research conducted in this study indicated that the highest influence on decision making has the recommendation of mechanics (chart 1). as many as 80% of survey participant said that this manner of communication has a high or highest influence on their decision-making (grades 4 and 5, on a scale of 1-5). the second most trusted source are family members and friends, or their recommendations, which were especially emphasized by female participants, who seem to be much less cognitively involved in the choice of motor oils. also, they are much more susceptible to the adoption of information from sellers at gas stations, and react to actions and promotions. 76 economic analysis (21, vol. 54, no. 2, 68-81) figure 2. distribution of answers on the most trusted sources of information when deciding on motor oil brand purchase source: authors' research observing the communication of the nisotec brand, graph 2 indicates that the majority of survey participants has noticed marketing communication initiatives at gas stations, followed by sales promotions. the fact is that that many automotive lubricants customers visit nis petrol gas stations, and the employees at the gas stations perform their task conscientiously and recommend nisotec to customers. on the other hand, it is even more important that customers who shop at nis gas stations are aware of company's communication initiatives. similarly, customers are highly aware of sales promotion initiatives. in the case of gas stations as communication channels, the aim to introduce fuel customers with an additional range, more precisely the nisotec range, has been met. interestingly, although survey participants were fair events visitors, only 40% of respondents confirmed that they noticed promotion initiatives during fair events, probably thinking of another fair they visited or not considering fair events as a type of communication. there is a difference between subgroups on this issue. namely, men noticed race and driver sponsorships significantly more than women, while women more often notice friends' recommendations and advertisements in newspapers and magazines. the respondents from the group of older than 50 years stated that they had noticed any communication from nisotec to a lesser extent when compared to the younger respondents. respondents between 30 and 50 years of age are more likely to say that they have noticed advertising in newspapers and magazines and on the radio, as they use those media to collect information more often than respondents from other age groups. 79,9 38,1 22,8 16,9 11,1 9,0 6,9 6,9 6,3 6,3 6,3 5,8 5,3 mechanics' recommendation friends' recommendation actions and promotion recommendation at ps web page presence at fairs tv advertisement fb page radio fb ads newspapers and magazines sposorship of races and drivers banners top 2 boxes tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 77 figure 3. distribution of answers on the channel through which nisotec brand advertising was noticed source: authors' research observing the attitudes of different groups of respondents, the most important aspect of communication is its impact on purchase intention. namely, certain types of communication are easier to remember, remain in memory longer and generally have a greater or lesser reach. in general, it is clear that advertising at gas stations will be the most frequently mentioned type of communication as visitors to the fair and nis stand are more likely to be the visitors of gas stations. also, visits to gas stations are a relatively frequent activity. understandably, when making a contact with employees it is somewhat inevitable to obtain information about a particular sales promotion initiative, including nisotec brand. on the other hand, research results imply that there are differences between those who are aware of the brand and those who purchase it, in relation to the type of communication they prefer. namely, respondents who do not purchase the brand, but are aware of it, notice radio advertisements and sponsorship collaborations with professional drivers more often. in that sense, it can be said that these two channels of communication affect the brand's popularity and attractiveness. anyhow, as these respondents do not purchase the brand, the awareness itself is not an important motivator which will lead to a purchase decision. nisotec customers respond favourably to advertising on digital channels, especially on the official website, as well as social media networks. even though the popularity of these media within survey sample was not high, it still indicates that there are those who can remember the advertisements distributed through these channels. it should be borne in mind that the respondents were not shown nisotec advertising visual solutions, which would lead to higher scores in memory. also, the role of digital channels seems to be twofold as they allow for the distribution of detailed information on the quality of lubricants, product tests performed and other information that give credibility to this brand. 58,7 43,9 39,2 13,2 11,1 11,1 10,6 8,5 7,4 5,8 4,8 0,5 0,5 7,9 recommendation at ps actions and promotion presence at fairs friends' recommendation newspapers and magazines sposorship of races and drivers tv advertisement radio mechanics' recommendation banners web page fb ads bilboards none 78 economic analysis (21, vol. 54, no. 2, 68-81) table 2. most trusted sources on motor oil information which sources of information do you trust the most when choosing motor oil brand? nisotec customers other customers motor oil quality 67.1% 50.9% mechanic/auto repair shop recommendation 39.7% 50.7% price 39.6% 27.4% friends' reccommendation 21.3% 16.9% location of motor oil vendor 27.9% 12.8% motor oil brand 18.4% 11.6% recommendation from gas station employees 15.7% 4.3% advertisements 1.4% 1.1% other 0.0% 1.1% source: brand tracking study 2018, authors' interpretation on the other hand, the very fact that brand official website site exists and is regularly updated, indicates that the brand cares about its customers and builds trust and confidence. when it comes to advertising on social networks, younger respondents generate more favourable reactions. apart from service information, to some extent there is an expectation of rewards for loyalty, be it a discount or promotional material. the activations on social networks which are rewarded, result with increased visits and higher number of engagements. taking into consideration the results of the brand tracking study, which aims to monitor specific indicators such as knowledge, use, trust, recommendation and loyalty, which are observed as a measure of communication success, it can be concluded that marketing activities were successfully implemented. it has already been shown that certain types of communication have different characteristics and potentials, and that certain channels have different audiences, which generally and differently consume different content distributed through these media channels. table 3. familiarity of automotive lubricant brands which brands of automotive lubricants from the list do you know? 18 – 24 yr. 25 – 34 yr. 35 – 44 yr. 45 – 54 yr. 55 – 64 yr. castrol 71.7% 80.8% 84.5% 82.5% 80.8% shell 57.5% 66.9% 68.7% 68.4% 65.2% optima-modriča 53.7% 57.4% 68.5% 71.2% 73.9% mobil 56.4% 66.7% 64.9% 62.2% 61.8% galax 44.3% 52.2% 58.3% 60.3% 63.3% nisotec 55.6% 55.0% 58.9% 56.0% 45.5% total 49.0% 52.2% 53.1% 49.9% 48.3% luk oil 39.7% 40.5% 41.0% 38.9% 39.6% mol 24.9% 29.5% 31.5% 30.1% 30.3% texaco 16.7% 25.6% 28.4% 29.9% 31.3% fenix-fam kruševac 16.9% 21.8% 29.3% 28.3% 30.4% prista oil 8.4% 9.3% 11.1% 8.7% 10.7% none 3.6% 0.9% 0.7% 1.2% 1.0% source: brand tracking study 2018, authors' interpretation tatjana cvetkov-čikošev, ivana domazet, valentina vukmirović 79 when it comes to brand awareness, the results do not differ statistically among different age groups. this leads to the conclusion that marketing communication initiatives were appropriately created in order to be processed by all categories in an adequate way to make an impact. in addition, many correlations were tested, where for the purposes of this paper one proven correlation was presented. the results presented in table 4 indicate that there is a relationship between brand use and brand satisfaction. these results are an important predictor of future behaviour, as satisfied customers are more likely to repurchase a product they are satisfied with. table 4. correlation of nisotec brand use and brand satisfaction mlpi_1 nisotec mlcss_1 nisotec mlpi_1 nisotec pearson correlation 1 .247* sig. (2-tailed) .034 n 334 74 mlcss_1 nisotec pearson correlation .247* 1 sig. (2-tailed) .034 n 74 75 *. correlation is significant at the 0.05 level (2-tailed).1f1 source: authors' research this research does not explore in detail the decision-making path, i.e. it does not consider the very beginning of customer journey in which customers a brand research is conducted. in addition to all the above mentioned, we can conclude that satisfied customers are promoters of the brand, which provide recommendations to their friends and acquaintances. besides gas stations, sales promotions, and fair promotions, friends' recommendations are remembered by every third respondent. arguably, this percentage could be even higher, considering the possibility that respondents might have had difficulties recalling advertising initiatives at the moment of answering a questionnaire. the idea of integrating marketing communication for nisotec brand has always been present. anyhow, the main step has been made by considering the customer journey concept and introducing this way of thinking. this includes reflecting on which stage is the customer when the company wants to propose the move to the next purchase phase and what activities should be undertaken to achieve the desired outcome. this implies that the company should know what information, in which manner and through which media should be delivered to the customer in order to provoke desired behaviour. when each type of customer passes through this cognitive filter, the company can comprehend which activities overlap, which are important for everyone and which are necessary to carry out. although this process is demanding, especially in the beginning of its implementation, and that nis company is still in initial phase in terms of changing the established ways of thinking, it is very effective, and the assumption is that effects are yet to be seen. 1 in the legend of the table, next to the correlation coefficient, one or two stars are added. one star indicates that the correlation is statistically significant, with a margin of error of 0.05, and two indicates that the correlation is statistically significant with a margin of error of 0.01. in this case, there is a possibility of an error of 0.05. * 80 economic analysis (21, vol. 54, no. 2, 68-81) conclusion research results presented in this paper have a twofold significance. on one hand, they contribute to the development of the field of user experience through application in practice. on the other hand, they encourage marketing practitioners to further research the application of this concept in other industries. in the case of the nisotec brand, the leading brand of motor oil in the automotive lubricants market, integrated marketing communications have a positive effect, while individual communication channels have different effects on different types and customer segments, which is the expected result according to basic product characteristics. digital channels such as forums, websites and social networks mostly influence the segment of younger customers who use these channels more intensively. this leads to the conclusion that for younger generations, those who are not familiar with life without the internet and mobile phones, digital communication channels are very important. therefore, brands must adapt their appearance and the content of messages they distribute via digital communication channels. therein lies the biggest challenge, how to captivate their attention, activate and engage them and turn them into loyal customers and brand ambassadors. however, additional research is needed in terms of younger generation's attitudes, as they are the active participants in creating marketing communication. this research found that the younger generations consume and create content differently, but it is necessary to learn more about their attitudes, in order to create an adequate mix of digital marketing communications. in the ideal scenario, with new knowledge, young people would be engaged in communication activities and satisfied with the interaction with companies. accordingly, improved results would be achieved and the newly created, mostly digital communication. the same could be applied to other target groups, i.e. those that are not yet the independent drivers. essentially, they have the greatest market potential for the company, because of the fact that they are entering the world of drivers and car use, and the question is how familiar are they with the concept of motor oil, the manners and reasons for its usage as well as the available brands of this product in the market. references albert, w., and tullis, t. 2013. measuring the user experience: collecting, analyzing, and presenting usability metrics. newnes. usa. batra r., and keller k.l. 2016. 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"customer experience within retail environments". marketing theory, 15(4):545-564. article history: received: july 28, 2021 accepted: august 19, 2021 http://ebooks.ien.bg.ac.rs/1451/ http://ebooks.ien.bg.ac.rs/1451/ customer experience and integrated marketing communication in the automotive lubricants market tatjana cvetkov-čikošev1 | ivana domazet20f* | valentina vukmirović2 introduction literature review integrated marketing communication concept methodology and results results conclusion references ea_2014_3-4 udc: 330.341.1(4-672eu) 005.591.6:334.012.63/.64 jel: o1, l26 cobiss.sr-id 211779852 original scientific paper european growth: a crisis exit strategy ben abdesslem amel1, larefi, university of bordeaux, france kauffmann pascal, crdei, university of bordeaux, france abstract – while the european union (eu) is facing a further aggravation of the recession, accompanied by the consequences of the 2008 global financial crisis, the support for economic activities is proving to be more than necessary. primary concerns of member states must be based on increased efforts in competitiveness, employment, innovation, and assistance for small and medium-sized enterprises (sme), to boost economic growth on a short-term basis or on a longer-term horizon. in this regard, this article firstly suggests that the temporary support for economic activities is absolutely necessary and the possible arrangements are examined in detail. in addition, more emphasis must be put on innovation, as it plays a crucial role for economic growth. particular attention is also drawn to smes, their potential impact on the productive fabric and their financial constraints. the concluding remarks are focused on the european market size, and the antagonism between competition policy and industrial policy is highlighted. key words: economic growth, european union, innovation, small and medium-sized enterprises, industrial policy introduction in the light of some historical macroeconomic results that are deemed unsatisfactory and the current economic policies, one can confirm that growth is not a high-priority for european union (eu) and its member states. the evidence is obvious for them, especially since it is within the competence of the countries themselves to reduce unemployment, as stated in the treaties. spain, greece, italy and portugal illustrate the singular and important obstinacy of fiscal orthodoxy among most southern european countries (as well as france), leading them to a vicious circle of recession, and even depression. concerning the eu (the level at which we are developing the following reflection), the situation is similar. in the framework of financial assistance mechanisms, and more generally the stability and growth pact (sgp), the balancing of public accounts has become a central obsession for both the european commission and the european central bank (ecb). however, the union and its member states have not always been as little concerned about economic growth, both at the cyclical level as well as the structural level. 1 avenue léon duguit, 33608 pessac, france, e-mail: amel.ben-abdesslem@u-bordeaux.fr economic analysis (2014, vol. 47, no. 3-4, 3-19) 4 firstly, at the time of the great recession of 2008-2009, the necessity of an economic boost in europe was shared by nearly all members. the commission, clearly convinced that the poor economic circumstances resulted from a shortfall in demand, wanted to promote fiscal policies inspired by keynesian thought. conscious that the eu budget, in terms of financial means (capped at 1.27% of eu gdp), was not adapted to a quick and massive economic recovery effort through demand, the commission worked on coordinating national economic stimulus plans and ensuring their consistency in all member states. by avoiding free riding behaviors, the commission will also modestly contribute to the overall endeavor in terms of expenditures. secondly, at the structural level, the commission has been the lynchpin of the lisbon strategy since 2000. with very high ambitions in terms of competitiveness, research and development (r&d), employment and growth in europe2, the failure of the lisbon strategy has been sufficiently explored to not dwell on it3. however, european authorities have deemed necessary to give it a direct continuation in the early years of this decade through the europe 2020 strategy. even though we cannot explain why the new initiative would ignore its predecessor's mistakes (lack of cohesion between the national policies, inadequate range of incentive and coercive tools, weak governance), it is a laudable desire. concerns related to growth potential in the union seem unquestionably well founded. the following work is based on the belief that economic growth must take the priority in european public policies, both for the union and its member states, at the cyclical level as well as the structural level. furthermore, we are of the view that there is no inherent incompatibility between supporting aggregate demand in the short-term and strengthening growth potential in the mediumto long-term. to support these beliefs, we emphasize that it has become an absolute necessity to quickly bolster economic activity in europe (section 2). we recall that a growth strategy can also be an effective process for a public-sector deleveraging. in a third section, we discuss the possible modus operandi of a demand stimulus, which leads us to favor some forms of public investment. in a fourth section, we emphasize the role of innovation as a key driver of economic growth. we will then focus on the incorporation of small and medium-sized enterprises – following the example of the german mittelstand – within the productive fabric of europe (section 5). lastly, as concluding remarks, we will focus on the european market size and the exploitation of possible scale effects. a temporary support to economic growth the analysis of the eu macroeconomic path since the outbreak of the 2007 financial crisis is relatively easy. this is particularly true in the euro area. what is intriguing is the incapability of main economic policy actors (member states, european commission, ecb, 2 this strategy has been agreed upon following the lisbon summit of 2000. its aim was to make the eu the most competitive economy in the world, and the most efficient in terms of innovation as well as information and communication technologies. 3 the midterm “kok report” (2004) had already provided a severe and worrying conclusion regarding the ambitious objectives of the lisbon strategy and the efficiency of the “open method of coordination”. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 5 imf for countries under financial assistance) to make the proper diagnosis and to find the appropriate remedy. table 1. gdp growth 2005 2006 2007 2008 2009 2010 2011 2012 2013 eu 2.2% 3.4% 3.2% 0.4% -4.5% 2.0% 1.6% -0.4% 0.1% france 1.8% 2.5% 2.3% -0.1% -3.1% 1.7% 2.0% 0.0% 0.2% germany 0.7% 3.7% 3.3% 1.1% -5.1% 4.0% 3.3% 0.7% 0.4% united kingdom 3.2% 2.8% 3.4% -0.8% -5.2% 1.7% 1.1% 0.3% 1.7% finland 2.9% 4.4% 5.3% 0.3% -8.5% 3.4% 2.8% -1.0% -1.4% spain 3.6% 4.1% 3.5% 0.9% -3.8% -0.2% 0.1% -1.6% -1.2% greece 2.3% 5.5% 3.5% -0.2% -3.1% -4.9% -7.1% -7.0% -3.9% ireland 6.1% 5.5% 5.0% -2.2% -6.4% -1.1% 2.2% 0.2% -0.3% portugal 0.8% 1.4% 2.4% 0.0% -2.9% 1.9% -1.3% -3.2% -1.4% united states 3.4% 2.7% 1.8% -0.3% -2.8% 2.5% 1.8% 2.8% 1.9% japan 1.3% 1.7% 2.2% -1.0% -5.5% 4.7% -0.5% 1.4% 1.6% source: eurostat the great recession of 2008-2009 is undoubtedly a demand-side crisis, and not a supplyside problem, as krugman (2009) underlined at an early stage. banking and financial problems raised by the subprime mortgage crisis have spread to the mainstream economy, through a credit crunch and negative wealth effects caused by the collapse of some asset markets. from these observations, fairly consensual, keynesian stimulus plans have emerged, as mentioned in the introduction. these plans to support aggregate demand have produced the expected effects. on one hand, economic activity did not decline dramatically as it did during the 1930’s great depression and on the other hand, the early stages of economic recovery have appeared in 2010 (see table 1). however, the turning point concerning fiscal policies has proved to be disastrous in the eu, and particularly in the euro area. these policies have prematurely prioritized a return to equilibrium of public accounts, with the aim of reducing sovereign debt. the consequences were immediate. deprived of the support of public expenditure, the economic activity slowed down and declined nearly the entire euro area. this was particularly true in countries under the troika’s supervision (greece, ireland and portugal). because of market pressure and european budgetary rules, this also occurred in other countries, which were hoping for a budgetary consolidation (spain, italy). the turning point concerning fiscal policy stance in europe naturally coincides with the outbreak of the greek crisis at the end of 2009 and the beginning of 2010. at that time, the historical high level of public debt in the european monetary union (emu) appeared to be an invalidating phenomenon that prohibits maintaining expansionary economic policies. this argument is a red herring in several ways. the average debt (as a percentage of gdp) is higher in the united states or in the united kingdom than in europe, not to mention japan. the problem stems less from the debt itself than its cost, largely determined by mimetic capital markets, and the institutional structure economic analysis (2014, vol. 47, no. 3-4, 3-19) 6 of the euro area, which is not a federal government. in this context, it needs to be taken into consideration that emu member states acquire debt in a currency other than their domestic currency. furthermore, the euro area countries are under the auspices of a central bank other than their official lender of last resort, unlike the federal reserve in the united states or the bank of england in the united kingdom. table 2. unemployment in europe, percentage moreover, from a macroeconomic perspective, the well-known fact that a growth initiative might be a valuable debt reduction strategy is neglected by european authorities. the historical example of the united kingdom's experience after the second world war proves it. the country had emerged from the worldwide conflict with a massive sovereign debt (more than 200% of gdp) but had succeeded to reduce it through three steps – that are ignored by contemporary mediterranean europe. the first element is moderate inflation (4 to 8% per year) that erodes the real value of the debt4. the second one is time frame: the public debt of the uk returned to acceptable levels not after a few years, but several decades later. finally, the strong growth registered during the post-war economic boom had led decisively to reduce the sovereign debt ratio. the famous equation that links this ratio (dt) to the primary government balance (bt as a percentage of gdp), gdp growth (g) and to the average interest rate on debt (it) sums up itself the macroeconomic debate in the euro area (see box 1). those krugman (2012) calls “the austerians” seek to reduce in priority the primary budget balance (bt), while hoping that capital markets will approve this – orthodox – choice with lower interest rates (it). the italian – and even further the spanish – experience demonstrates that the success of this policy is by no means guaranteed. in addition, these countries have exacerbated unemployment (see table 2) and, by doing so, they have reduced their growth potential, as a long period out of the job market plays a strong role in de-training and de-motivating employees. conversely, a policy to exit the debt crisis would offer a twofold advantage. it would seek to reduce the debt-to-gdp ratio without depending excessively on global finance – nor be limited to future fiscal balances with a deadly policy spiral of “austerity-recession-reinforced 4 germany refuses to consider it (even in the writings of the imf’s chief economist olivier blanchard). 2005 2006 2007 2008 2009 2010 2011 2012 2013 eu 9.0 8.2 7.2 7.0 9.0 9.6 9.6 10.4 10.8 france 8.9 8.9 8.0 7.5 9.1 9.3 9.2 9.8 10.3 ge rmany 11.3 10.3 8.7 7.5 7.8 7.1 5.9 5.5 5.3 unite d kingdom 4.8 5.4 5.3 5.6 7.6 7.8 8.0 7.9 7.5 finland 8.4 7.7 6.9 6.4 8.2 8.4 7.8 7.7 8.2 spain 9.2 8.5 8.2 11.3 17.9 19.9 21.4 24.8 26.1 ire land 4.4 4.5 4.7 6.4 12.0 13.9 14.7 14.7 13.1 unite d state s 5.1 4.6 4.6 5.8 9.3 9.6 8.9 8.1 7.4 japan 4.4 4.1 3.9 4.0 5.1 5.1 4.6 4.3 4.0 source: eurostat ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 7 austerity” – and it will help to provoke demand stimulus that is requested by a majority of macroeconomists. box 1. the dynamics of the debt-to-gdp ratio let dt denote a country's public debt at year t. yt refers to its gdp, it stands for the interest rates on debt and bt is the primary budget balance (excluding interest expenditure and with b>0 indicating a surplus). by construction, public debt is as follows: dt = dt-1 + it . dt-1 – bt the evolution of the debt-to-gdp ratio is given by: = (1 + it) – we use lowercase letters to refer to gdp ratios and g represents growth rate. dt = dt-1 . bt all other things remaining equal, the debt ratio decreases in case of primary surpluses (bt > 0). however, its dynamic is also governed by the comparison between the economy's growth rate and the interest rate on debt. as long as it is less than g, the debt ratio may decrease, even without primary surpluses. conversely, when the cost of debt is below the growth rate, the ratio can increase even with an equilibrium on the primary budget balance (known as the snowball effect). the necessary surpluses to simply stabilize dt become increasingly higher. in the following discussion, we examine in what extent a strategy in favor of economic growth could be organized in the euro area. we also demonstrate how it should be accompanied by a structural policy designed to enhance potential growth. a growth strategy coordinating short and long term objectives the first obstacle, unfavorable to keynesian policies in europe, is the weak macroeconomic governance system in the euro area. ineffective during normal times, it becomes a tremendous handicap when a serious crisis occurs. it should be noted that there is an apparent lack of authority and reactivity of the economic and financial affairs council (ecofin) and the eurogroup. the macroeconomic decision-making process itself is lacking in the euro area. this is a serious concern, and it is perceived as such by main partners5. the total absence of exchange rate policy illustrates this fact ably (kauffmann 2013). more fundamentally, the fiscal policy framework of member states is problematic. concerning the sgp, even though it requires an appropriate monitoring of sovereign debt 5 the famous remark attributed to h. kissinger “who do i call if i want to speak to europe?” still applies today, especially for the euro area. t t y d t t y d 1− t t y b g i + + 1 1 economic analysis (2014, vol. 47, no. 3-4, 3-19) 8 ratios, it has capped public deficits at 3% of gdp in a caricatural manner. in addition to the fact that this threshold percentage has no serious macroeconomic justification, it applies to a balance that is not adjusted for the cyclical position of an economy. as we currently observe, this may lead countries near recession to reduce their public expenditure or to raise their taxes to comply with the pact, which is procyclical. far from correcting these problems, the 2011 reforms, which are referred as the “six-pack”, have reinforced the disciplinary function of law as well as the threat of sanctions in the event of failure. in addition to the stability pact, the member states of the euro area have adopted in 2012 a new fiscal compact. the treaty on stability, coordination and growth (tscg) introduces two new rules imposed on the member states, which are likely to cause deleterious effects on public expenditure. the first constraint is the debt brake, with a maximum structural deficit of 0.5% of gdp imposed on the signatory countries. the second constraint is the introduction of a form of automatism concerning the reduction of sovereign debt, once it exceeds the threshold of 60% planned by the sgp. the combined effects of the sgp and the tscg on fiscal policies have been devastating in the euro area: the first one prevents the free play of automatic stabilizers in case of severe cyclical downturns; the second prohibits any feasible discretionary stimulus. it is evident that a european growth strategy will have to overcome these inconsistent constraints. the invocation of exceptional circumstances would temporarily suspend the application of these laws, as it has been done for the sgp during the great recession. it should be recognized that the second obstacle to a european growth policy is germany itself, for several reasons. first of all, for the euro area, this country has demonstrated some of the highest macroeconomic performance. therefore, the need for an economic stimulus through demand is less important than elsewhere. however, this situation is evolving since germany’s economic growth continues to slow down, driven by weak economic conditions in most of its neighboring countries, which are also its export customers. this leads to the second reason why germany appears as a problem: its growth strategy is based on exports and is regularly held up as a model. the “internal devaluation” strategy (reduction of production costs and prices, especially through lower wages) has been recommended to southern european countries – through the so-called hartz reforms – as it is supposed to be germany’s cornerstone to its current success. this kind of statement contains a twofold error, which can ironically be analyzed as a kantian approach. firstly, an internal devaluation strategy has more chance to succeed if it is performed in isolation, and in a context of sustained growth, as it was the case for germany in the early 2000s. the current situation is different: a race to the bottom in costs is simultaneously prescribed to several countries, and in a recessionary environment. secondly, if all euro area countries had based their growth strategy on exports like germany, we would have to wonder where the net importers are. this is the reason why, in the following discussions, we rule out the crisis exit strategy based on the “germanization” of the euro area, which is an unfounded fallacy. the different components of aggregate demand that need to be supported are neither final consumption expenditure nor exports, but public and private investment6. 6 the important question of the exact funding arrangements is further discussed below (project bonds, new european credits, eib loans, etc). ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 9 these measures to support economic activity are first and foremost, by their very nature, short-term measures, designed to strengthen effective growth. from a medium-term perspective, priority should be given to investment for several reasons. the first one is that investment will ensure future economic gains, as long as selected and financed projects are productive. the second reason – which is at least as fundamental – is that the impact of this demand component will directly combine short-term objectives to boost economic growth with long-term objectives. the last one is related to the proven existence of sectors that lead to a public stimulus for structural reasons. the commission has identified several potential areas of intervention (railway networks, digital economy, energy, etc.) with a view to support growth and the internal market (european commission, 2012). rather than perceive them – like european authorities – as a way to reinforce competition and to lower internal borders, we believe that collective investments and private investments – and consequently short-term demand – should be explicitly supported, as well as, through them, other key factors for future growth such as innovation. innovation, a key driver for economic activity highlighted by several studies, we consider innovation a major source of economic development in modern times (veblen, 1898; schumpeter, 1911). evolutionary economists have understood this in a comprehensive manner, through the concept of innovation systems (freeman,1987), as a network of organizations that creates new processes, subsequently used socially and economically, thereby promoting growth, employment, competitive positions of nations, and business development. a theoretical approach of innovation the new endogenous growth theories, developed in the 1980s, have given to innovation a central role in their models (romer,1986; lucas, 1988; aghion et al., 1998). technological adaptation and innovation are presented as the key drivers for the long-term growth of an economy, and productivity growth is explained by schumpeter's “creative destruction” phenomenon, as innovations have the capacity to accelerate the obsolescence of existing technologies and to implement more efficient processes. these new theories have offered a better understanding of innovation and its role on a country's economic performance, even though their interpretations are often considered simplistic by some economists. among those expressing criticism is jones (1995), who noticed that although the number of scientists and engineers involved in r&d has strongly increased, the productivity growth had not been significant. endogenous growth approaches present a basic vision of the innovation process, but have nevertheless highlighted its role within an economy. many studies of the technological frontier as well as of imitation and innovation schemes have been substantially extended and have provided us with a better understanding of innovation as a whole, combining both institutional and innovation dynamics. the relationship between institutions and new processes affects a country's economic performance (north, 1998). structural policies may vary according to whether growth regimes are characteristic of a catching-up economy or not, and their impacts on productivity economic analysis (2014, vol. 47, no. 3-4, 3-19) 10 growth depend on the distance from the technological frontier, usually symbolized by the united states. for an economy that is lagging behind technologically, growth sources are indeed capital accumulation and imitation; while more advanced countries enjoy economic growth where innovation is the main driver, with intense competition, a flexible labor market and a sustained investment in higher education (acemoglu et al. 2006). an economy that is near the technological frontier – like european union – needs to exploit its innovation potential and to invest more in higher education to put the economy back on the path of growth (aghion, cohen 2004). a supply of skilled labor may induce companies to invest more in r&d; conversely, an increase in innovative activities and in the r&d sector generally encourages further efforts in education and qualification (romer,2001). the complement between higher education policy and innovation policy could fuel economic growth and increase the low level of r&d expenditures in the eu. insufficient incentives to innovate after the post-world war ii economic expansion, the eu has registered poor macroeconomic performance. while it is considered a key to a sustained and sustainable growth, the low innovation capacity partly explains these disappointing results. the united states and japan have invested considerably in r&d, while europe has lagged behind. in the 1990s, the united states had intensified their efforts to enhance new technological knowledge and japan had invested in basic research, whereas a paradox had emerged among european countries. for many years, member states focused on a rather archaic division of labor and had been limited to an imitation role, while public authorities should have promoted fundamental research in specific centers, and the role of companies should have been to innovate, with more organic cooperation between the different actors (cohen & lorenzi 2001). in 1993, the european commission has highlighted the problems related to innovation. europe has had difficulties to “convert scientific breakthroughs and technological achievements into industrial and commercial successes.” table 3. gross expenditure on research and development, gdp ratio 2005 2006 2007 2008 2009 2010 2011 2012 eu 1.82% 1.84% 1.84% 1.91% 2.01% 2.01% 2.05% 2.06% france 2.11% 2.11% 2.08% 2.12% 2.27% 2.24% 2.25% 2.26% germany 2.51% 2.54% 2.53% 2.69% 2.82% 2.8% 2.89% 2.92% united kingdom 1.70% 1.72% 1.75% 1.75% 1.82% 1.77% 1.78% 1.72% finland 3.48% 3.48% 3.47% 3.70% 3.94% 3.90% 3.80% 3.55% spain 1.12% 1.20% 1.27% 1.35% 1.39% 1.40% 1.36% 1.30% united states 2.49% 2.55% 2.62% 2.76% 2.81% 2.73% 2.67% na japan 1.32% 1.39% 1.40% 1.47% 1.70% 1.76% 1.84% na source: eurostat,2005-2012. empirical studies have indicated that investments in r&d that lead to patents result in significant growth of productivity gains in developed economies (edworthy,wallis 2006). under the europe 2020 initiative, an objective of 3% of gdp to invest in r&d must be achieved to reduce the lag behind main competitors. despite a satisfactory scientific basis, ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 11 the innovation capacity remains insufficient in europe. for years, gross expenditure on r&d (gerd) has paled in comparison to principal partners without any member state being able to reverse the trend. even though the eu has registered a slight increase of its gerd, the effort has not been sufficient to reach the same level of japan or the united states (see table 3). public and private expenditure in higher education has also been relatively low compared the united states7, where 41% of the american population aged 25 to 64 have higher education degrees, against 44% in japan and only 25% in the eu11. however, these data should be qualified, as there are some disparities between european member states. significant efforts in terms of education, research and innovation have been undertaken in scandinavian countries. finland, sweden and denmark have indeed invested in r&d, at higher levels than the united states. according to the oecd, to achieve the objectives of the lisbon strategy, seven hundred thousand more researchers were needed in europe. the gap between the eu and its main competitors is essentially due to the fact that the european economy is specialized in the medium-high technology sector, but not in the promising new high-technology sectors such as information and communication technologies (ict), electronics, nanotechnologies or biotechnologies. the united states has strong capital accumulation in the ict sector, whereas europe has been focused on employment policies that encourage low-skilled labor, especially through reductions in social security contributions on low wage earners. this partly explains low gains of labor productivity in europe relative to the united states. the rapid diffusion of ict across the atlantic is also due to the important fall in the relative prices of these goods and services. since the 1990s, it appears that the ict investment has been an important determinant of productivity gains. between 1995 and 2000, ict investments have induced a gdp growth per capita of 0.3% to 1%, according to empirical studies (jorgenson et al. 2002; cette et al. 2002). information and communication technologies are tightly linked to innovation and help to accelerate the diffusion of information, to encourage networking among companies, to reduce geographical distances and to improve communication. the eu could benefit from a stronger investment in ict. this also applies to nanotechnologies, biotechnologies and more generally to high technologies. the challenge facing the eu remains to redirect and reinforce the innovation system, especially through the increase in r&d expenditure and a major effort to invest in high technologies and higher education. the economic crisis has created financial obstacles for many companies and has led to a decline in r&d investment. it is essential to counteract this tendency and to stimulate technical progress in the most promising sectors, as innovation can contribute to boosting the economy. while the eu has considerable scientific potential, the economic recovery should be accompanied by a more intense diffusion of ict and by a higher level of education, to increase productivity gains. public support could play a key role to reinforce the innovation process among european countries, which have more and more difficulties to access sources of funding. 7 18% of private expenditure are reserved to educational institutions in the eu-15, as against 66% in the united states and 68% in japan. economic analysis (2014, vol. 47, no. 3-4, 3-19) 12 the financing of innovation and public intervention the financing of innovation presents particular challenges. the difficulty of obtaining a complete return on investment is holding investors back from investing in innovation. information asymmetry and moral hazard have a tendency to increase the costs of obtaining external financing. even if this is true for all firms, it is especially so for innovative companies (hall 2005; hall & lerner 2010). the financing of innovative companies can be provided by standard forms of investment. however, the specific characteristics of innovation make it more difficult to access finance, whether they use internal resources or financial intermediaries. this is the reason why the intervention of public authorities to encourage innovation is essential. more than 35% of gerd in europe come from the public sector. the challenge is the articulation of public and private funding. the public sector should primarily finance projects that could not find investors through private funding, especially at the beginning of the growth cycle. public intervention should be digressive with the development of the project and the authorities cannot be the only actor to finance innovation because unintended consequences might appear. direct support provides immediate financial benefits to a company's income statement. such is the case of eu funds operating on two separate budget lines: the framework program for research and technological development (fp) and the regional policy (via the european regional development fund, the european social fund and the european agricultural guarantee fund). indirect support also encourages a company's development while improving its environment (via r&d tax credits, seed funds, business incubators, etc.). the european commission has proposed an investment of 88 billion euros for research and innovation, as part of the new community framework program “horizon 2020” which assembles all eu funding programs, including the current framework program for research and technological development (fp7), the competitiveness and innovation framework program (cip), and the eu contribution to the european institute of innovation and technology (eit). the objective is to stimulate growth and employment, as well as reducing administrative burdens. the european investment bank (eib) and the european commission have implemented in 2012 a joint initiative to stimulate investment in the sectors of transport, energy and ict. the europe 2020 project bond initiative is fundamentally different from the so-called eurobonds. project bonds are private debt and are issued by project companies to finance large-scale infrastructure projects. neither the european commission nor the member states will therefore issue such bonds. capital markets are considered to be an alternative source of funding and a useful long-term financial instrument to trigger innovation in these specific sectors. through financial supports, public intervention promotes and encourages private investors, and even more so during an economic decline. even if the economic literature does not help to evaluate the efficiency of public authorities' activities for innovation, the revival of economic growth should be facilitated by a public reinforcement on promising sectors such as high technologies. some financial supports – especially direct – should be reassessed. however, many public interventions contribute to the development of european small and medium-sized enterprises (smes), which stimulates economic growth and the diffusion of innovation. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 13 the contribution of small and medium-sized enterprises in the face of globalization and the acceleration of technological change, businesses with fewer than 250 employees are considered key actors in the productive structure and contribute substantially to the eu's economic growth. almost 21 million european companies are smes – more than 99% of all businesses (apart from the financial sector). europe's future prosperity depends, among other things, on the growth potential of these companies. the economic role of smes in europe small and medium-sized enterprises lead to a process that replaces incumbent firms by new market entrants, potentially more innovative and efficient. this process contributes to the productivity growth attributable to technical progress and essentially stems from the existing sustainable smes. this incumbent-entrant dynamics have an impact on the overall productivity. the creation of more productive smes that replace the least efficient firms largely explains the american productivity growth in the 1990s (foster et al., 2002). these “creative destructions” that can be generated by economic crises help to strengthen the productive fabric. even though there is a less important impact during a recession, reinforcing assistance to the creation of innovative smes and encouraging the growth of existing startup companies could assure a positive result on productivity growth. the situations in europe and the united states do not differ by the number of new startups but by their fate (bartelsman et al., 2005). the establishment of a support plan for french smes during the 2008 global crisis has improved their financial health. the economic stimulus plan helped more than twenty thousand companies and their survival rate has reached 89% at the end of june 2011. despite the considerable growth potential of european smes, liquidity constraints undeniably lead these startups to bankruptcy. smes have also helped to provide long-term employment, jobs creation being negatively associated with a firm’s size (birch, 1981; storey & johnson 1987; davis et al., 1998). they account for around two thirds of industrial employment in europe and the commission has estimated that they provided 85% of jobs created between 2002 and 2010. employment creation justifies why smes should be supported. however, despite growth potential and job creations, european smes are facing many challenges. barriers to sme growth structural barriers to the development of smes are numerous. one of the most difficult obstacles remains the struggle to access external financing sources. this impediment should be considered as important as labor market rigidities. indeed, smes play a key role to the diffusion of technical progress but have to face the difficulties inherent to financing of innovation. venture capital is often chosen to overcome the problem. the financial capital is provided to risky investments and should have a positive impact on companies’ growth prospects (engel, 2002). the sme is partly financed out of its own resources and the remaining part is provided by a special fund, maintained by external investors and managed by venture capitalists, who are supposedly able to reduce information asymmetry. based on his own economic analysis (2014, vol. 47, no. 3-4, 3-19) 14 business network and his technical as well as market knowledge, the venture capitalist will help the company to grow. its intervention is primordial during the early-stage of the company. on the informal market, some intermediaries can finance these startups, such as business angels who invest in innovative smes with a strong potential. these high net worth investors intervene during the seed and start-up stage or during the launch of new products, they are particularly motivated by the return on investment and are relatively keen to take higher risks. europe is lagging behind concerning the financing of its early-stage companies and smes’ monitoring. there are near 75 thousand business angels in the eu, as against 265 thousand in the united states. american smes were given the necessary capacity to finance and secure their development. their business angels have rapidly expanded thanks to fiscal incentives and deductions of investment losses. in europe, given the particularly heterogeneous nature of the region in terms of capital gains taxes, the efforts concerning fiscal incentives for venture capital investments must be accentuated. a reduction in capital gains tax would reward investors, at least cost to the government. in the united states, the reduction in capital gains has generated a positive and decisive impact on venture capital investments and on the degree of risk-taking by business angels (lerner 1998). tax credits should be limited to more risky investments and oriented towards early-stage smes, to encourage investors and further venture capital investments. the european commission has tried to support such financing by the establishment of a european system in december 2011, to help managers commercialize venture capital funds on a european basis. they will raise additional capital and the obstacles related to cross-border transactions will be reduced. crowd-funding could provide an alternative source of financing. this participatory approach, which involves individuals with relatively small amounts of money to invest, is only an epi-phenomenon in the world of venture capital financing. while american congressmen have passed a law to facilitate this type of financing (through the jumpstart our business startups act), european smes are facing restrictive national regulations to the development of crowd-funding. however, crowd-funding could be inefficient in selecting potential entrepreneurs and could also lead to fraud and misuse. as signals of project quality are weak and information asymmetry is exacerbated, investors’ potential returns are unlikely to justify the risk taken. other instruments and initiatives could help smes to access financing. examples include – but are not limited to – mezzanine capital (subordinated debt) that facilitates access to bank credits and supports intangible investment projects, but are poorly developed in europe. some joint european resources initiatives for smes such as “jeremie” could also improve access to financing through structural funds. these initiatives allow member states to invest in venture capital funds, guarantee funds or loan funds. given these financial constraints, european smes barely reach the critical size to export, and only one in five is operating internationally. challenged by the fierce foreign competition, an expansion abroad would support the long-run viability of a business, but would also boost economic growth and strengthen competitiveness. exportation is often considered as too expensive or risky and many smes do not expect to internationalize their activities. however, german smes have the capacity to reach the critical size required. the german mittelstand – and its many medium-sized smes – is frequently perceived as a model ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 15 to follow and has enhanced the reputation of the “made in germany” seal of quality thanks to the enviable performance of its industries. while french and british smes were affected by the global financial crisis, germany’s prosperity owes a great deal to the mittelstand and to the strength of its large number of medium-sized enterprises. without actually leading to a german-inspired model based on export-dependence, public and private investments would enable more european smes to internationalize their activities. because several asian countries have experienced an economic take-off, german smes has become highly specialized, especially in high value-added capital goods, in sectors such as automotive, chemistry, precision engineering and electrical engineering. the mittlestand is also notable for – and is playing a pioneering role in – the transition to a resource-efficient and lowcarbon economy. therefore, these smes have become the essential suppliers of major industrial groups and have benefited from a strong international demand. think small first: an sme-friendly environment to tackle the obstacles impeding the development of european smes, a more suitable environment must be provided. because growth potential and employment creation in the european industry depends on the dynamism of its companies, more efforts are required to encourage the establishment, development and internationalization of smes. in this regard, the adoption of the “small business act” for europe in december 2008 was undoubtedly a useful action plan. taking its inspiration from the american small business act, the recent initiatives aim to contribute to the achievement of ambitious objectives targeted by the europe 2020 strategy. to boost economic growth, the european commission and its member states are committed to establish several political and legislative measures of which one of the main goals is to support smes and reduce the obstacles that hinder their development and restrict job creation. with a 1.1 billion euros budget over the 2007-2013 period, the competitiveness and innovation framework program (cip) facilitates venture capital investments and provides loan guarantees for smes. according to the commission, each sme with a guaranteed loan could create an average of 1.2 jobs, and 300,000 smes have benefit from the cip financial instruments by 2013. the european investment bank (eib) has contributed to the development of smes by releasing 40 billion euros of loans to 210,000 companies between 2008 and 2011, to help innovative enterprises and to implement the lisbon strategy. the central role of the eib in raising funds to finance european smes – and by extension innovative companies – needs to be strengthened to meet the objectives of the europe 2020 program. special emphasis should be given to small business investment companies (sbics) to finance smes in their startup and growth phases. by implementing a european supervisory board (with a public-private team) and with some help from the eib, business angels and the financial market, it should be possible to raise enough funds to invest over several years in the most dynamic smes. some improvements have been observed in public procurement. smes have less administrative burdens since the introduction of the small business act (sba) and are encouraged to work together in order to offer joint bids. the main challenge for smes lies in the diversity of national and local environments and on the principle of subsidiarity. even though all eu member states recognize the importance economic analysis (2014, vol. 47, no. 3-4, 3-19) 16 of the sba and its rapid implementation, the countries have chosen various methods of implementation and obtained different results. access to financing and to public procurement is generally facilitated but the future of the sba will depend on the determination of european countries to follow the commission’s initiatives. an enhanced governance of the sba should provide the expected results. the global economic environment has dramatically changed in the past few years and the efforts to encourage the creation, development and internationalization of smes must form the heart of the new integrated industrial policy of the eu. member states should take into account the needs of smes in their economic policies in order for the european industry to remain a driver of economic growth. concluding remarks: european union must take advantage of its market size europe does not have a true top-down industrial policy such as the one endorsed by france in the 1980s. the union is pursuing instead a bottom-up industrial policy inspired by the german standortpolitik8. its initiatives towards smes provide an eloquent illustration. however, sectoral actions to strengthen the productive fabric in europe remain exceptional. galileo is one of the few industrial projects that are truly supported by the eu. by contrast, the union does not interfere in sectors where the combined effect of increasing returns (or spatial externalities) and the size of the european internal market could be a decisive advantage for the competitiveness of manufacturers. indeed, in productive activities where economies of scale are real (besides aeronautics, some energyrelated sectors, railway equipment, some aspects of the new green economy, etc.), a policy of “european industrial champions” could succeed. given its importance – often among the main international priorities – the single market can transform a european champion into a worldwide industrial leader. if not, it will still be a significant player on markets that are only allowing a few large competitors. the european pusillanimity is often involved and blamed, in several matters. firstly, europe’s major competitors – and especially china – are using this type of leverage. the chinese case and its numerous successes have even largely contributed to the recent rehabilitation of the industrial policy, at least in emerging countries (rodrik,2004). secondly, as pointed out by aghion et alii (2011), the question is no longer to know whether or not the industrial policy should have a sector-based component, but to understand how to implement it with a maximum efficiency and a minimum of detrimental effects. finally, the structural economic phenomena are undoubtedly related to the classical economics idea that the market is better than the state at making the right investment choices. the environmental crisis or the issues of energy mix are significant examples. in europe, the competition policy has so far taken precedence over the industrial policy. the merger control policy is indeed occasionally constraining the creation of large companies. the concern to limit market power prevails over the development of the productive apparatus. similarly, public procurement cannot be used selectively within the eu, as was the case in france and as it is still occurring among the major competitors (united 8 literally “industrial production policy”, dealing with the competitiveness of the “made in germany”. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 17 states, japan, china, etc.). submitted by the european commission, the recent request for international reciprocity concerning the opening of public procurement cannot hide the naivety (related to neo-liberal beliefs) that is characteristic of the eu policy in this matter over the past twenty-five years. to a certain extent, a similar idea is behind the state aid control. state aid is indeed prohibited by the treaties, but can be compatible with the logic of the internal market (article 107 tfeu). the real circumstances authorized by the commission remain unclear. the article 107-3 stipulates that the “aid to promote the execution of an important project of common european interest” and the “aid to promote the economic development” are potentially permissible. it seems that a legal uncertainty could be found to promote an active industrial policy, with sectoral state aid. moreover, industrial policy and competition policy are less antagonistic than what the consensus of the past twenty-five years was suggesting (aghion et al., 2011). in particular, some state aid could target specific sectors, without favoring one company over another, as long as the sector concerned has not reached a high degree of concentration. the risk of “cherry picking” (where incumbent companies are favored by the political action) is therefore limited. the eu has also identified – as part of the europe 2020 strategy – several promising sectors, considered as decisive for the future competitiveness. this includes, in particular, the digital economy, biotechnologies, photonics, nanotechnologies, etc. consequences still have to be drawn from state aid issues, particularly when fixed production costs are high (and therefore important scale effects). these state aid measures would benefit from a european approach, because all attempts by member states to give advantage to a local company will be avoided, while the pertinent scale is the internal market as a whole. references acemoglu, d., aghion, p. & zilibotti, f. 2006. 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"why is economics not an evolutionary science?" the quarterly journal of economics, 12(4): 373–397. evropski rast: kriza izlazne strategije rezime – dok se evropska unija suočava sa sve jačom recesijom, propraćenom posledicama globalne finansijske krize iz 2008. godine, pokazuje se da je više nego potrebna podrška privrednim aktivnostima. primarne brige zemalja članica se zasnivaju u nastojanju da povećaju konkurentnost, zaposlenost, inovacije i pomoć malim i srednjim preduzećima, kako bi podstakle ekonomski rast u kratkom ili dugom roku. u tom smislu ovaj rad najpre ukazuje na to da je apsolutno neophodna privremena podrška privrednim aktivnostima, a detaljno su i razmotreni mogući aranžmani. pored toga, treba staviti akcenat na inovacije jer one igraju ključnu ulogu za povećanje ekonomskog rasta. posebna pažnja je usmerena na sektor malih i srednjih preduzeća, njihov potencijalni uticaj na produktivnost i finansijske poteškoće. u zaključnom delu smo se fokusirali na veličinu evropskog tržišta i istakli smo netrpeljivost između politike konkurentnosti i industrijske politike. ben abdesslem, a., et al., european growth, ea (2014, vol. 47, no. 3-4, 3-19) 19 ključne reči:. ekonomski rast, evropska unija, inovacije, mala i srednja preduzeća, industrijska politika article history: received: 5 september 2014 accepted: 30 november 2014 microsoft word 2011_1-2 original scientific paper    a new approach to causality testing   duduković s. sanja*, franklin collage, switzerland   udc: 336.7; 330.55    jel: 43        abstract – a new causality test based on higher order cumulants (hoc) is proposed in this  paper. the test can be applied on non gaussian time series. the methodological novelty is the usage of  a  two‐  step  method  based  on  digital  whitening,  which  is  performed  by  arma‐hoc  filter.  to  substantiate the method further, an empirical analysis of the relationship between  the interest rate  spread and real gross domestic product (gdp) growth is presented for the period 1982:q1 ‐2010:q1.  the spread  is measured as a difference between 10‐year bond yields and three‐month treasury bill  rates in the us. the fist step applies arma‐hoc models to obtain white residuals from a quarterly  term spread (ts) and gdp growth. the second step tests the dynamical correlation of ts and gdp  growth residuals. the results show  that  the proposed  test can capture  the  information about non  gaussian properties of the random variables being tested. the test is compared with the granger‐sims  causality test. the paper questions the reliability of the granger test    key  words:  non  gaussian  time  series,  causality  testing,  higher  order  cumulants,  granger‐sims test, box‐hough test, arma‐hoc test  introduction   the availability of large data sets of high frequency time series in finance and economics  has led to the settlement of some old disputes regarding the nature of the data but it also  generated new challenges.  a set of properties common across many financial variables, instruments and markets,  has been observed and classified in independent studies as “stylized facts”. one of the most  important stylized properties of asset returns and financial variables in general, besides the  absence of correlation,  is heavy tails or existence of higher order moments and tail  index  which is finite and higher than two and less than six (cont 2001).  the methodology widely used to test the occurrence of causality is known as grangerʹs  methodology. actually, wiener was the first to state a causality definition by suggesting that  xt  is causal  to yt  if xt  reduces  the  mean square  prediction error  of  yt. granger explored  wienerʹs definition further. sims gave content to grangerʹs definition by assuming that xt (,  yt) are jointly covariance stationary gaussian processes and proving the causality theorem.  the  theorem  states  that  for  xt  and  yt,  having  autoregressive  representations,  yt  can  be  expressed as a distributed lag function of current and past xt with residuals which are not  correlated  with  any  values  of  xt,  past  or  future,  if  and  only  if  yt  does  not  cause  xt  in  grangerʹs terms. the application of the granger‐sims methodology is usually used with two                                                         * address: via ponte tresa 29, lugano, switzerland ,e‐mail: sdudukov@fc.edu     economic analysis (2011, vol. 44, no. 1‐2, 5‐14)   6 objectives: to test the causality between different economic variables and simultaneously to  define  lags  for  which  that  causality  exists.  therefore,  while  searching  for  the  lag  identification, authors are forced to ignore the fact that residuals from the test models might  be uncorrelated. having realized shortcomings of the ad hock filter while applying granger‐ sims tests, hough and pierce (1977) introduced the causality test based on the correlation  between driving white noises  for xt   and yt, ut and vt respectfully. although box  (1970)  introduced  the  idea  for  the  first  time,  this  test  has  not  brought  a  wide  attention  in  econometrics.   the empirical part of the paper tests causality between gdp growth and the term spread.   in fact, over the last decade empirical researches have demonstrated positive relationship  between the slope of the yield curve and real economic growth. the predictive power of the  term spread has been recognized beyond the academic research arena. the conference board  uses the yield spread in constructing its index of leading indicators. the fact that the yield  curve  slope  changes  across  the  business  circle  is  used  by  researches  which  investigated  recession and power of the term spread to predict  it. the slope of the term structure has  often been represented in the economic literature as the spread between long term bonds and  short term treasury bills.   the first papers, dealing with the us data, found a significant relationship between the  term spread and real activity with lead times between 1 to 8 quarters (chen (1991), estrella  (1991), harvey (1995), dotsey (1998), bonser (1977), ang (2003). guided by the intuition that  during recessions, upward sloping yield  curves  indicate  bad  times  today,  but  also better  times  tomorrow,  researchers  predicted  gdp  growth  using  ls  regression.  bonser‐neal  further established) at what horizons the yield spread best aids in predicting real growth.  on the other side, the cause of a possible relationship between the term structure and  gdp growth according  to taylor  (1993)  is monetary policy reaction  function. his model  contains philips curve, the dynamic is curve, fisher equation, the expectations hypothesis  and a monetary policy rule. estrella explored the model and found a positive relationship  between the spread and gdp growth. although the results obtained for different periods  show strong relationship between the term spread and gdp growth, they also demonstrate  that the relationship might not be stable over time.  the  aim  of  this  paper  is  to  propose  and  to  apply  the  hoc  based  causality  test  to  investigate a dynamical relationship between  the  term spread and real gdp growth. the  novelty of the paper is the two‐step hoc based test, which is based on the assumption that a  possible  cause  of  the  instability  of  the  relationship  are  non  gaussian  properties  of  the  variables that can be captured by   higher order moments‐cumulants. in the first step, two  time series are whitened using time series models (arima models based on higher order  cumulants) in order to obtain the prediction errors known as innovations. in the second step,  causality between white innovations is performed using the pierce & hough test. this test  appeared to be useful in eliminating potential influence of a third, unknown variable and  appreciating the fact that xt might not be the only variable that explains yt. to sustain the  theoretical analysis, the first part of the empirical analysis is done with the us term spread  (ts)  data  and  real  gdp  quarterly  data.  the  sample  spans  the    period  from  1989:  q1  to  2010:q1.       duduković, s., a new approach to causality testing, ea (2011, vol. 44, no, 1‐2, 5‐14)     7 the  paper  is organized as  follows: the second section  provides  a brief review  of  the  traditional approach to causality testing used in literature so far. the third section introduces  the hoc based test. the fourth section contains a statistical data description and empirical  results obtained using the hoc test. the last section contains the conclusion.  problem formulation and methodology   granger‐sims causality test  the most popular method for testing statistical causality between stock prices and the  economy is “granger‐causalityʺ test proposed by c.j.granger (1969). according to granger,  x causes y if the past values of x can be used to predict y more accurately than simply using  the  past  values  of  y.  in  other  words,  if  the  past  values  of  x  statistically  improve  the  prediction of y, then we can conclude that ʺgranger‐causesʺ y. if the sum of the squared  residuals that remain after getting econometric model between yt and xt is denoted by ssr,  the test gets the form:  ssr0 (yt /(yt‐1 + xt‐1) < ssr1 (yt / yt‐1 )  , if  xt granger causes yt   to compare two variances, the f test is to be used.  it should be pointed out that given the controversy surrounding the granger causality  method,  the  empirical  results  and  conclusions  drawn  from  them  should  be  considered  suggestive rather than absolute. this is especially important in light of the ʺfalse signalsʺ that  the test has generated in the past.  box‐hough test   as it was theoretically proven in the literature, the alternative causality test is based on  whitening filtration of xt and yt, or by testing “whiteʺ residuals of the both variables xt and  yt.  this  test  is  supposed  to  eliminate  a  possibility  of  having  a  relationship  between  two  variables when both are driven, or influenced by some third variable. further ,it was proven  by hough (1977) that if there is a dynamical correlation between yt prediction errors and  past  xt  prediction  errors  we  can  say  that  xt  drives  or  causes  yt.  vice‐versa,  if  there  is  a  dynamical correlation between yt prediction errors and past xt prediction errors we can say  that xt drives yt.if prediction errors of xt drive yt and prediction errors of yt drives xt, there  is a feedback between two variables.  pierce and haugh have formally defined causality restrictions regarding the correlation  coefficient ρuv between driving white noises for yt and xt, ut and vt :    ρuv)(k)>< 0  for every k>0  xt causes yt  ρuv (k)> < 0  for every k<0  yt causes xt  ρuv (0)> < 0    instantaneous causality  later  on,  box  and  haugh  (1977)  proved  that  ρuv  has  an  asymptotically  normal  distribution with variance 1/(n‐k), where n is the number of observations and thus enabled  causality testing and k being the lag size.     economic analysis (2011, vol. 44, no. 1‐2, 5‐14)   8 the  rational  behind  this  test  might  be  explained  by  two  facts:  a  dynamical  cross  correlation between two stationary variables gives false signals about the relationship if the  transfer functions of the arma models that are used to describe xt and   yt are linked; white  residuals, from arma models, have one more meaning: one step ahead prediction errors for  xt and yt, or innovation. therefore one can say that xt causes yt if xt innovations cause yt  innovation.  hoc based test    let xt and yt be  jointly stationary non gausian processes with finite first, second, third  and  forth  moments  that  can  be  treated  as  outputs  from  the  linear  arima  filters,  whose  inputs are white noise signals: ut  and vt  respectively:    a1(z)* dxt= b1(z)* ut                    (1)    a2(z)* dyt= b2(z)* vt                    (2)    where z is a backward shift operator : yt‐1=zyt , yt‐k =zkyt    , a(z) = 1‐α1z‐α2z2 ‐ …αpzp   and  b(z) = 1‐β1z‐β2z2 ‐ …βqzq     are ar and ma filters  of orders p and q respectively, d is the first  difference filter, dyt = yt ‐ yt‐1 ,  dkyt=yt ‐ yt‐k  .  it is worth stressing that the main premises in this methodology is that each stationary  time series is treated as the output from ar(p), ma(q) or arima(p,d,q) filter, which has as  the input uncorrelated and non gaussian shocks known as ʺnon gaussian white noiseʺ.  given the time series xt and yt observed at a regular sampling interval it is necessary to  define  the  relationship  between  them:  as  xt  causes  yt,  yt  causes  xt,  feedback  or  independence.  the  empirical  research  problem  in  this  paper  is  to  identify  relationship  between the ts and the gdp growth.  in this article, arima (p,d,q) time series modeling is based on  higher order cumulants  .the later type of the model is used since it was found that ignoring non gaussian nature of  both  time  series  significantly  reduce  the  power  of  the  causality  test.  nonetheless  the  cumulants based arma estimates are shown to be asymptotically optimal by friendler b.  and porat b. (1989), the arma models based on higher order cumulants have been used so  far only  in the area of non gaussian digital signal processing and have not been used  in  finance and economics due to its numerical complexity.  arma parameter estimation using cumulants   giannakis (1990), was the first to show that the ar parameters of non‐gaussian arma  digital signals can be calculated using the third‐ and fourth‐order cumulants of the output  time series given by:  c3x(τ1,τ2)=  (∑(x(t)x(t+τ1)x(t+τ2))/n,               (3)  c4(τ1,τ2,τ3,)=  (∑(x(t)x(t+τ1)x(t+τ2) x(t+τ3))/n ‐   ‐c2x(τ1) cx(τ2‐τ3) ‐ c2x(τ2) cx(τ3‐τ1)‐c2x(τ3) cx(τ1‐τ2),          (4)       duduković, s., a new approach to causality testing, ea (2011, vol. 44, no, 1‐2, 5‐14)     9 where n is a number of observations and where the second‐order cumulant c2x(�) is just the  autococariance function of the time series xt..  the  zero  lag  cumulant  of  the  order  three,  c3x(0,0)  normalized  by  �x3  is  skewness  γ3x;  c4x(0,0,0) normalized by �x4 is known as kurtosis γ4x.  a new method of  the ar parameter estimation  for non‐gaussian arma  (p,q) digital  signals is based on the modified yule‐walker system where autocorrelations are replaced by  third or fourth order cumulants (gianninakis ‐1990):  p  ∑ αi c3(k‐i,k‐l)             = ‐   c3(k, k‐l)                                          k≥l≥q+1                           (5)  1=1  p  ∑ �i c4(k‐i,k‐l, k‐m)     = ‐   c4(k, k‐l, k‐m)                               k≥ l≥ m≥q+1                    (6)  1=1  silva  isabel  and  silva  edvarda  (2006)  considered  modified  yule‐walker  parameter  estimation for the pth‐order integer‐valued autoregressive, inar(p) process . in particular,  the asymptotic distribution of the yule‐walker estimator was obtained and it was shown that  this estimator is asymptotically normally distributed, unbiased and consistent.   the  efficient  ma  parameter  estimation  can  be  performed  by  applying  one  of  the  algorithms related to signal processing , for instance, q‐slice algorithm (swami 1989).q –slice  algorithm uses autoregressive residuals calculated after estimating the ar parameters of the  arma model.  following  up,  the  impulse  response  parameters  ψi  of  the  pure  ma  model  can  be  estimated using cumulants (8):       ∞  xt=∑ψjat‐j                                              i=1.2…∞               (7)       0          p        ∑ αi c3(q‐i,j)  ψj =−−−−−−−−−−−−             j=1,2…q              (8)         p        ∑αi c3(q‐i,0)  or by using :         p        ∑ αi c4(q‐i,j,0)  ψj =−−−−−−−−−−−−             j=1,2…q              (9)         p        ∑αi c4(q‐i,0,0)    the  ma  parameters  of  the  arma  model  are  obtained  by  means  of  the  well  known  relationship       economic analysis (2011, vol. 44, no. 1‐2, 5‐14)   10              p   βj=     ∑αi ψ(j‐i )     j=1,2…q                (10)               i=1                                                                               data description and empirical results   granger test results  real  gdp  data  are  taken  from  bloomberg,  10‐year  treasury  bonds  and  three‐month  treasury bills rates are taken quarterly from the web page economagic.com for the period  1982:q1‐ 2010 :q1. figure 1 shows how all variables change.    figure 1. gdp growth and interest rate yields    term spread and gdp growth in u.s. -2 -1 0 1 2 3 4 a pr -8 2 a pr -8 5 a pr -8 8 a pr -9 1 a pr -9 4 a pr -9 7 a pr -0 0 a pr -0 3 a pr -0 6 a pr -0 9 2008:q2‐2010:q1 (% ) term spread gdp grow th     statistical  data  description  is  obtained  using  e‐views  program  and  it  is  presented  in  table 1. table 1  shows  that both  variables are non‐gaussian,  according  to  the skewness,  kurtosis and the jarque‐bera test for normality.    table 1. data description    tspread gdpch  mean 1.910 0.014  median 1.910 0.014  maximum 3.730 0.032  minimum ‐0.670 ‐0.010  std. dev. 1.086 0.007  skewness ‐0.181 ‐0.021  kurtosis 2.029 5.790  jarque‐bera 4.970 14.824  probability 0.083 0.001  observations 111 111          duduković, s., a new approach to causality testing, ea (2011, vol. 44, no, 1‐2, 5‐14)     11 the results of the granger causality test between the growth data and the term spread  (ts)  for  the  lags  l, 2…8 are presented  in table 2. the  test shows a  feedback relationship  between the term spread and gdp change for the quarters 1 and 2. it also shows that term  spread does granger cause gdp change across three quarters, while gdp change granger  causes term spread over next two quarters.    table 2. granger causality test results    sample: 1982q1 2010q1 lags   null hypothesis: obs f‐stat. probab. 1   tspread does not granger cause gdpch 110 7.29281 0.00805   gdpch does not granger cause tspread 4.60339 0.03417 2   tspread does not granger cause gdpch 109 6.24964 0.00273   gdpch does not granger cause tspread 4.35234 0.0153 3   tspread does not granger cause gdpch 108 5.23773 0.00212   gdpch does not granger cause tspread 1.66559 0.17919 4   tspread does not granger cause gdpch 107 3.05684 0.02025   gdpch does not granger cause tspread 1.22396 0.30564 5   tspread does not granger cause gdpch 106 1.73825 0.13331   gdpch does not granger cause tspread 0.68063 0.63919 6   tspread does not granger cause gdpch 105 1.75143 0.11794   gdpch does not granger cause tspread 0.20243 0.97524 7   tspread does not granger cause gdpch 104 2.22299 0.03955   gdpch does not granger cause tspread 0.68615 0.68342 8   tspread does not granger cause gdpch 103 1.58693 0.14056   gdpch does not granger cause tspread 1.30233 0.25324   hoc based causality test results   the hoc based test, proposed  in  this article,  is based on digital whitening. residuals  from the gdp change and term structure data are obtained by using higher order moments  as explained above. the best arma model for a gdp change is found to be arma(4,4) . the  model  parameters  (table  3)  are  estimated  using  fourth  order  cumulants  and  matlab  toolbox hosa likewise, the best model for the term spread appeared to be ar(1,4) model,  which is presented in the table 4.    table 3. gdp arma‐hoc model    variable coefficient std. errort‐statistic c 1.38106 0.146811 9.407083 ar(1) 0.128982 0.068527 1.88222 ar(2) 0.143497 0.080827 1.775364 ar(3) 0.171894 0.055231 3.11225 ar(4) ‐0.046561 0.010904 ‐4.27013 ma(1) 0.274197 0.046255 5.927944 ma(2) 0.242425 0.121984 1.98735 ma(3) ‐0.081094 0.018375 ‐4.41332 ma(4) 0.268694 0.048755 5.51115     table 4. term spread arma‐hoc model    variable coefficient std. errort‐statistic c 1.82815 0.282767 6.46522 ar(1) 0.991982 0.051261 19.35151 ar(4) ‐0.151676 0.046951 ‐3.23052   the  gdp  cumulants  and  ts  cumulants  are  calculated  using  equations  (3)  and  (4).  original ts 3‐th order cumulants and  cumulants of the obtained residuals are presented in  figure 2. similarly 3‐th order cumulants related to gdp variable are presented in figure 3.  the test states: if there  is a statistically significant dynamical relationship between the  current  gdp  residuals  and  past  ts  residuals  ts  causes  gdp;  if  there  is  a  statistically  significant dynamical relationship between the current ts residuals and past gdp residuals  gdp causes ts. if both hypotheses cannot be rejected, then there is a feedback relationship  between the ts and gdp.     table 3. hoc test results    dependent variable: resgdp method:hos included observations: 108 after adjustments variable coefficient std. error t‐statistic f  rests ‐0.061 0.118 ‐0.517 0.267 rests(‐1) 0.021 0.113 0.182 0.033 rests(‐2) 0.298 0.108 2.745 7.533 rests(‐3) 0.056 0.113 0.499 0.249 rests(‐4) 0.012 0.004 2.812 4.012 rests(‐5) ‐0.092 0.113 ‐0.814 0.663 rests(‐6) 0.224 0.108 2.078 4.319 rests(‐7) ‐0.069 0.109 ‐0.638 0.913 rests(‐8) ‐0.097 0.108 ‐0.899 0.663       figure 2. third order ts cumulants and arma‐hoc residuals        the results presented in the table 3 strongly prove that innovations or prediction errors of  the term spread cause the innovations of percent changes of the real us gdp for the lags 2,  4 and 6. for all the other lags, f test shows a non significant causality. figures 2 and 3 further  demonstrate that arma‐hoc filters captured successfully non‐gaussian properties of the  gdp and ts changes . namely, both residuals have cumulants reduced to zero  ,which made  application of the new arma‐hoc test possible         duduković, s, a new approach to causality testing, ea (2011, vol. 44, no, 1‐2, 5‐14)     13 figure 3. third order gdp cumulants and arma‐hoc residuals        conclusion  a new causality test based on hoc (higher order cumulants) is presented in the paper.   the paper further provides two theoretical contributions. firstly, the proposed test solves  the problem of “spurious causality” as a result of the wrong model order selection based on  the second order moments, which then necessary leads to colored residuals and the wrong  causality  lag.  the  second  theoretical  contribution  is  achieved  by  using  higher  order  cumulants to estimate model parameters and capture non gaussian properties of the original  time series.   to substantiate  the analysis, hoc base  test was applied  to  test causality between  the  term spread and real gdp data  in  the us  for  the period 1982:q1  ‐2010:q1. the obtained  results clearly show that interest rate spread significantly influences the gdp growth in the  second, fourth and sixth quarters.   however, the percentage of the explanation of the gdp growth variability achieved by  using the term structure as the explanatory variable in the last two decades is much lower  than it was shown in the literature for the period 1970‐1990.  there are two possible reasons for this finding: granger causality test overestimates the  coefficient of determination due to the wrong model order or, most probably, the same test  doesn’t  capture  higher  order  moments  of  the  variables  that  are  statistically  related.  as  demonstrated in this paper, the non gaussian properties of the related variables are captured  by the proposed arma –hoc test.       economic analysis (2011, vol. 44, no. 1‐2, 5‐14)   14 references  ang, andrew, piazzesi monika and min wei. 2006 .ʺwhat does the yield curve tell us about gdp  growth ?”. journal of econometrics, elsevier,  131(1‐2) : 359‐403   bollerslev tim. 1982. ”generalized autoregressive conditional heteroskedasticity“. in arch selected  readings ,ed by engle robert, 42‐60. oxford university press,.  bosner‐neal,  catherine  and  timothy  r.  morley.  1997.  ”does  the  yield  spread  predict  economic  activity?“ economic review,  82 (3): 37‐53.   cont  rama.  2001.  ”empirical  properties  of  asset  returns:  stylized  facts  and  statistical  issues”.  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      article history:  received:  15 february 2011 accepted:  31 march 2011                2013_1_2 scientific review world urbanization prospects and the problem of its infrastructural provision batishcheva svetlana1, department for economy and investment of kyiv city state administration, kyiv, ukraine udc 911.375.1 ; 711.7/.8 jel: h54, o49, r53 id: 198578700 abstract – this article describes world urbanization prospects, discovers some peculiarities of city growth in different regions, and makes the analysis of dependencies in economic growth and infrastructure investments. as a result, considerable discrepancies in urbanization process and its infrastructure provision are revealed, and new sources of finance for solution of this problem are offered. key words: infrastructure, urbanization, capital investment, infrastructural fundraising introduction population and its spatial distribution are the matter of particular importance in the strategic decision-making at the state and the supranational level, because these determine the structure and dynamics of resources consumption. the process of urban growth, associated with the formation of early states, has started in the iv early iii millennium bc [modelski, devezas and thompson, 2008]. however, today the academic and practical researches are focused on the processes of xx xxi centuries, which some authors describe as mega urbanization [firman, 2009; taubenböck, 2011]. in the recent years, one can observe a shift of urbanization paradigm. previously it was considered as a problem for development; now the scientific community and policy makers understand the inevitability of urbanization and perceive it as the engine of economic growth [the world bank, 2009]. the purpose of this paper is to study world prospects and some regional differences in urbanization processes, to identify problems of infrastructure provision and to suggest some solutions. trends and projections of global urbanization the main organizations that study population growth in the most of the world’s countries are the united nations, the world bank, and the united states census bureau, all of which use the deterministic approach. however, for planning purposes probabilistic projections are useful. the most common approach to contending uncertainty in population 1 department for economy and investment of kyiv city state administration, kyiv, ukraine keepclear@yandex.ru, +38 066 990 56 43 batishcheva, s., world urbanization prospects, ea (2013, vol. 46, no, 1-2, 72-81) 73 projections is the scenario, or high-medium-low approach. other approaches to producing probabilistic population projections include ex-post analysis, time series methods, and expert-based approaches. the bayesian hierarchical model is about to assess the uncertainty of the range of possible future outcomes based on the country's current situation and past trend [adrian e. raftery, nan li, hana ševčíkovác, patrick gerland, gerhard k. heilig, 2012]. according to the un forecasts until 2050, urbanization will occur mainly in the less developed countries (all regions of africa, asia (excluding japan), latin america, the caribbean, melanesia, micronesia and polynesia). at the same time, the population of urban areas of africa and asia by the year 2050 will not exceed 65%. as it is now, the most urbanized areas will be north america (88.6%), latin america and the caribbean (86.6%), europe (82.2%). in general, the part of the urban population of the planet will be 67.2% [the un, 2011]. the un projections of the proportion urban in 2050 tend to be slightly higher than the preliminary projections by the bayesian urban projection model, but this method is appropriate to use when studying certain country forecast, which gives more specified results [alkema, gerland and buettner, 2011]. according to the world bank, urban population is projected to reach 5 billion by 2030; fully two-thirds of the world’s population will then be urban. ninety percent of this growth is taking place in developing countries. around 5 million people migrate every month to cities in developing countries, in search of jobs and better access to services [the world bank, 2009]. urban growth is highly concentrated in a few hundreds cities and will continue to be. mc kinsey global institute suggests that just the top 600 cities will contribute nearly 65% to global gdp growth in the period till 2025. in 2012, 20% of world’s population reside in these cities. according to mentioned forecasts, another 440 cities in the developing countries will deliver 47% of global economic growth in estimated period [mc kinsey global institute, 2012]. it should be noted that the definition of urban area is a fundamental problem for urbanization research. there is no global standard for urban environments. the definition of urban area varies among countries and sometimes it even varies over time within a single country. in the un methodology a number of inhabitants is the main indicator of urban territory (it can vary from 200 to 20 000 people in different states). in many countries other criteria are also taken into consideration in statistical surveys: population density (canada, usa), municipality (hungary, spain, finland), primarily employment in non-agricultural sectors (armenia, azerbaijan, georgia, lithuania, moldova, poland, russia, ukraine), distance between dwellings (france, romania, sweden) [the un, 2011]. mc kinsey global institute defines cities as broad metropolitan areas integrated into a connected urban region that include 150,000 or more inhabitants in developed regions and 200,000 or more inhabitants in developing regions [mc kinsey global institute, 2012]. all mentioned additional factors, which are taken into account in determining the urban settlement, are associated with certain infrastructure, that lets distinguish urban and rural areas. economic analysis (2013, vol. 46, no. 1-2, 72-81) 74 economic sense of infrastructure is ambiguous and has changed during years. the majority of sources point out that this notion came to economic literature from military terminology in 40-s of xx century. the notion of infrastructure was getting wider alongside with development of new technologies, scientific and technological progress and production growth. all definitions of infrastructure can be divided into two groups. on one hand, infrastructure is the set of service systems to maintain production and life support. other notions emphasize on the role of infrastructure as a set of institutions which support all economic activities. in our opinion, these two definitions can be combined and infrastructure can be defined as the system of institutions and organizations which are to create conditions for production and distribution of goods and sustain human life activities. these two groups of definitions reflect classification of infrastructure into soft and hard infrastructure, which is widely spread in western economic publications. hard infrastructure is limited to capital assets that serve the function of conveyance or channelling of people, vehicles, fluids, energy, or information, and which take the form either of a network or of a critical node used by vehicles, or used for the transmission of electro-magnetic waves. soft infrastructure includes both physical assets such as highly specialized buildings and equipment, as well as non-physical assets such as the body of rules and regulations governing the various systems, the financing of these systems, as well as the systems and organizations by which professionals are trained (professional training, accreditation and discipline) [towry-coker, 2011]. in soviet economic literature infrastructure is regarded as human services, nonmanufacturing business which doesn’t generate profit, as a sphere of activity but not sphere of production, where added value is not produced. since the late 80's of the xx century western economists have paid considerable attention to the study of the relationship between infrastructure and the productivity, and its impact on economic development. the first generation of studies is based on the production function and cost function; further researches are related to models of economic growth, and the econometric models (vector autoregression). summarizing the results of many studies, we can say that each of these approaches to the identification of the factors of economic growth justifies the postulate that the infrastructural improvement has a positive effect on the economic growth. at the same time, the most controversial issue is the degree of influence of infrastructural factors, the direction of causality between productivity and infrastructure, as well as the effectiveness of certain types of infrastructure. the researchers also suggest that the effectiveness of public capital investment in infrastructure varies from country to country, regions and sectors [torrisi, 2009]. today cities, not states, create of the world's infrastructure of transport, communications, finance, education, and cities are the "engines" of development. it is important to understand that the process of urbanization means not only increase in the number of cities’ inhabitants and populated areas, it also means a change in the structure of production, employment, environment and social standards, i.e. require decent infrastructure. according to the mc kinsey global institute projections till 2025, cities are expected to need to build commercial and residential buildings equivalent to 85% of today’s building batishcheva, s., world urbanization prospects, ea (2013, vol. 46, no, 1-2, 72-81) 75 stock or an area the size of austria. nearly 80.0 billion cubic meter increase in municipal water demand is expected in the world’s cities until the mentioned year [mc kinsey global institute, 2012]. regional features of urbanization processes we must consider some regional peculiarities of urbanization and pursue condition of urban infrastructure as urbanization consequence. developed countries have urbanized mostly gradually. the growth of cities in north america and europe is generally associated with industrialization. it began in the late xix early xx centuries, and it’s the technical progress that has paced urban upturn. growth of cities went on gradually, thus urban areas provide inhabitants with decent accommodation and conditions for human development. cities in developed countries of western europe and north america, in general, have well infrastructure and can be considered a sample to follow, although, every city is in some way more or less comfortable for living. developing countries today are facing rapid migration that often defines the process of cities growth with only slight influence of authorities. china economy shows the fastest grows in the world nowadays. due to the enormous volume of cheap rural work force, massive infrastructure development is the foundation for sustainable economic growth and competitiveness. functional and fiscal decentralization, that was the result of the tax reform in 1994, significantly increased the financial incentives and the ability of local authorities to develop infrastructure. despite this, in recent years the chinese economy demonstrates signs of overheating, because there is still a substantial gap between the infrastructure needed for high growth, and possibilities. the policy of active investment in infrastructure (15% of gdp) keeps being principal in country growth policy [pravakar sahoo, ranjan kumar dash, geethanjali nataraj, 2010]. according to chinese statistics, in early 2012, the urban population exceeded 50% [national bureau of statistics of china, 2012]. however, many scientists dispute this number. the researchers note that the policy of accelerated development has led to the forced urbanization, which spilled over into violent eviction of farmers from their lands. many migrant workers, who live in cities, cannot have city residents’ rights, and thus far, they cannot be considered as part of the urban population. in many big cities in china, apartments are empty. housing prices in beijing and shanghai are significantly higher than the average income of citizen, 85% of urban population in china is in need of housing improvement, but they cannot afford it. in most chinese cities, short-term economies of scale are in priority. as a result, many urban localities do not meet the needs of city inhabitants; not take into account environmental aspects, aesthetics [sahoo , dash, nataraj, 2010]. when analysing the current approach of the chinese authorities to urban growth stimulation, one can predict that insufficient investment in human capital may lead to crisis in urbanization processes, similar to that occurred in the former soviet republics. urbanization in the ussr was, in fact, a by-product of rapid industrialization. soviet model of urbanization showed significant contradiction between considerable quantitative and inadequate qualitative changes. the rapid growth of the urban population went well ahead of the adaptation of the former rural residents to the urban way of life, urban culture. economic analysis (2013, vol. 46, no. 1-2, 72-81) 76 the growth of cities has led to a fundamental change in the settlement system and productive forces distribution in the vast territory, but it was not supported by the social priorities of the state. it should be noted still, that urban development in the ussr was carried out according to certain standards of utilities and social infrastructure provision. these standards reflect the desire to minimize the level of investment in nonmanufacturing sector. however, the state provided all strata of society with free education and health care. this ultimately stimulated cultural, spiritual and physical development of the population, as confirmed by the high level of education and well-being of the soviet union in the late 80's of the xx century. the crisis of the soviet model of urbanization came together with the crisis of the soviet model of the state in general, and until today, it has a negative impact on the development of the independent republics of the former ussr. as a result, the significant part of the population does not possess one of factors of production such as entrepreneurial ability. this happened because urban settlements were formed to serve large industrial facilities, which were the base for local economy. today, these cities are dying, because the former employees of state factories are not ready to work independently. in this case, the solution to the crisis is in creation of a new type of city citizen [pivovarov, 2001]. today we can observe significant imbalances in the territorial and economic development of the countries of the former soviet union, including urban infrastructure. this resulted in the lack of housing and utilities under the threat of collapse in cities. in the literature, this phenomenon has got the name of false urbanization or pseudourbanization. pseudo-urbanization is the condition in which a large city has formed in an area without a functional infrastructure to support it. a city in which significant growth in the absence of adequate infrastructure has taken place is deemed as “pseudo-urbanized” [rengasamy, 2009]. some researchers argue that urbanity is a typically western species of the genus economic and civic culture, and a western phenomenon by its nature [anton zijderveld, 1998]. this even resulted in rejection by some western scholars as true cities many cities developed in post world war ii in developing countries, in making distinction of them from the urbanization of the west and in regarding them as “pseudo-urbanization” or “subsistant urbanization” which is something negative and needed to be stopped or avoided through government efforts and policies [xue, 2010]. pseudo-urbanization is typical for developing countries. we should consider the example of india, which like china has one of the highest economic growth rates. at the same time, many of the major cities of india have spacious slums – areas with poor housing, which does not meet sanitary requirements, without necessary social and transport infrastructure. according to the un forecast, by 2020 the number of people living in slums, will be about 1.4 billion people, 33.1% of the urban population will be living without sanitation and hygiene conditions, mainly in africa and asia [the un, 2011]. this prognosis lets to tell that the urbanization process in the world is uneven and erroneous. it is aimed to provide the productive sector with workforce, but exposes millions of people to a miserable existence. batishcheva, s., world urbanization prospects, ea (2013, vol. 46, no, 1-2, 72-81) 77 infrastructure needs and the sources of their funding the best way to describe the present situation in the sphere of infrastructural provision of cities is to use notion proposed by d. worster infrastructure trap. that is how he named the consequences of construction and development of the irrigation system in the xix century in california (usa). water supply infrastructure for agricultural needs in the region was originally created by the owners of the land. due to the growing production and demand for water, they founded utility company, and it used borrowings to finance the development of the system. because of the lack of private funding, construction projects were held up several times; after that the ecosystem of the local rivers became impossible to restore. hard ecological situation has led to the centralization of infrastructure management in the state bodies. nevertheless, today one can establish the fact of failure of public financing for maintenance and development of infrastructure, and the question of search of new investment resources is on the agenda [worster, 1994]. thus, the economic growth achieved due to infrastructure investment reaches “environmental dead-end”, because natural resources of regions are limited, and the intensification of production cannot be infinite. at the same time, world urbanization and increase of infrastructural needs seem objective. the oecd projects that infrastructural needs in the next decade will increase significantly under the influence of global economic growth, technological progress, climate change, urbanization. besides the existing infrastructure is aging rapidly, and permanent budget deficits in many countries makes its renovation difficult. this results in a shortage of traditional sources for investment, that’s why alternative ways of funds attraction are to be found, as well as optimization of the use of the existing infrastructure is to be implemented. rough estimates of oecd show that by 2030 the total investment needs of the member countries for telecommunications, roads, railways, electricity and water supply will amount up to 2.5% of world gdp. if one adds the facilities for electricity, oil, gas and coal production, investment needs of oecd countries will reach the level of 3.5% of world gdp. these numbers don’t include the cost of development of airports, ports and warehouses infrastructure. mostly funds are required to create new infrastructure [the oecd, 2007]. these estimates relate to 34 oecd member countries, which are developed countries and already have sufficient infrastructure for normal human existence. assessment of needs for infrastructure investment to the developing and poor countries may considerably exceed mentioned oecd forecasts. for many countries, crisis is time and incentive to reconsider the policy and change priorities of state regulation, to define new models of economic growth. at the same time, the post-crisis economic policy of the united states, china, and india shows that infrastructure investments are still government priority. given estimations prove that infrastructural needs cannot be satisfied with traditional sources of financing. oecd strongly recommends that member countries use the possibilities to attract business to the implementation of infrastructure projects (publicprivate partnerships, resources of pension funds and other large institutional investors), as well as an opportunity to diversify and expand the traditional sources of revenue, which, in essence, means an increase in the tax burden [the oecd, 2007]. economic analysis (2013, vol. 46, no. 1-2, 72-81) 78 the last trend in western europe and the u.s. is an entrepreneurial city. many municipalities have entered into a struggle for limited resources. this resulted in businessled urban development, technological innovation, striving for social and environmental sustainability. this is often coupled with aggressive marketing: to become an eu ‘capital of culture’ or to host the olympic games or some international trade fairs etc. one of the determinative factors of this tendency is infrastructure. private sector domination of the city can result in a decline of public services and infrastructure; the marketization of educational institutions; assistance for business as the first priority of local government [vakoulenko, 2004]. an investment activity in certain region depends on the condition of the object for investment, and on territorial factors of the region for investment. it is important to note that infrastructural factors can be identified in both mentioned groups of factors. thereby, urban infrastructure is an important factor in investment decision making. increased competition between cities make leaders at the local and state level to create strategies that would enable them to effectively compete on the investment resources market and to finance infrastructure projects. if taking into account the oecd forecasts, it is clear that own resources of municipalities and raised funds cannot cover enormous need for infrastructure investments. in this case, the issue of infrastructure traps demand the alternative approaches to its solution. we suggest considering the original (and the simplest) way to finance infrastructure projects – collective funding by stakeholders, i.e. users of the infrastructure, city residents. because of current size of infrastructural needs, estimated projects cost this idea seems to be impossible to implement, but this source of funding worth to be evaluated. nowadays infrastructural fundraising is widely spread for social, scientific and cultural projects. in usa volunteering and philanthropy is especially widespread. according to the annual report on philanthropy for the year 2011, charity contributions for the mentioned period for the spheres of education, human services, health, public society benefit, arts, culture and environment are equal to usd 141.31 billion (47.4% of total raised amount) [the giving usa foundation, 2012]. these funds are not regulated by government and local authorities, but still are invested into projects which gain profit for the whole society. there is evidence of collective financing of infrastructure needs from ukraine. the project of construction of the "children's hospital of the future" in capital city kiev is procured solely by private contributions. it is important to note that the ukrainians, as well as other citizens of the former soviet union, after the collapse of the financial system in the early 90's of the xx century are not likely to invest their savings. at the same time, due to the mass media advertising the charity fund, which organized the hospital construction, managed to raise uah 154.5 million of donations (about 19 million us dollars) during 2006 – 1st half of 2012. this fundraising involved 633 businesses and 10,280 individuals [the official internet page of charity fund "children's hospital of the future", 2013]. it should be noted that the hospital was not built (as of february 2013), but the raised amount confirms the readiness of citizens to invest in the urban infrastructure development. if this project had been implemented successfully by local authorities under the proper control, it would have had a significant positive effect for the citizens who invested their money, and for the politicians who would have realized the wishes of voters. batishcheva, s., world urbanization prospects, ea (2013, vol. 46, no, 1-2, 72-81) 79 legislation of russian federation provides for the possibility of self-taxation of citizens – to impose onetime payments to address specific local issues. the decision to enforce selftaxation procedure must be made by local referendum. in russia self-taxation is the most spread in kirovskaya region. during the years 2006-2009, 99 local referendums were conducted and rur 5.2 million was raised for municipal needs in this region [nikita belyh, 2009]. unfortunately whole country statistics is absent. financing of election campaign in the united states can be a good example of funding for political initiatives. the main source to provide campaign activities is donations from citizens. surely elections are not financed only by private contributions of citizens, but the overall collected amounts impress on. for instance, according to the u.s. federal election commission data, during the presidential campaign of 2012 all candidates raised 584.2 million usd of individual contributions less than 200 dollars [the federal election commission, 2013]. these facts prove that political ideas can give the ground to attract funding, because citizens expect to receive indirect benefits of these donations. right coverage and the use of pr-technologies can make municipal infrastructure projects to be successful crowdfunding projects, because of high gain for the donators, even though it cannot be expressed in monetary terms (because as a result social objects of common use are created). thus, we can talk about the prospects of elaboration of infrastructure fundraising. by this notion we mean the process of raising funds and other resources on non-reimbursable basis for the municipal infrastructure projects implementation. we believe that such initiatives should come from the local governments, because the creation and renovation of infrastructure include construction projects, which are better to control centrally. conclusion on the one hand, acceleration of urbanization processes has a positive effect on economic development, because it helps to concentrate material, financial, and human resources in one place and to use them more effectively. on the other hand, in many cities, increasing in the number of inhabitants goes much faster than the development of infrastructure. inability to meet the investment needs for infrastructure development requires a search for new sources of funding. in this paper, we propose the way to attract household savings to finance infrastructure projects. in our opinion, the implementation of infrastructure fundraising is possible only at the municipal level. this idea is consistent with current trends of entrepreneurial cities appearance, when strategic planning functions are passed to the local level. self-taxation implementation requires additional study of the social and economic conditions and public opinion in certain city in order to identify the prior needs of citizens and their willingness to finance infrastructure projects. further theoretical studies on this question should be carried out using a multidisciplinary approach, namely to study the behavioral characteristics of individuals in a certain economic conditions, individual disposition to charity donations, the effect of the collective and society influence in this regard. it is useful to develop practical tools of financial pr to raise private funds to finance infrastructure projects. economic analysis (2013, vol. 46, no. 1-2, 72-81) 80 references alkema, l., gerland, p., and buettner, t. 2011. “probabilistic projections of urbanization for all countries.” 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strategic planning at local and regional level. uzhgorod: patent. world bank. 2009. world development report 2009: reshaping economic geography. washington, d.c. batishcheva, s., world urbanization prospects, ea (2013, vol. 46, no, 1-2, 72-81) 81 worster, d. 1994. under western skies: nature and history in the american west. oxford: oxford university press. xue, f. 2010. chinese city and urbanism. evolution and development. singapore: world scientific publishing co. pte. ltd. zijderveld, a. c. 1998. a theory of urbanity: the economic and civil culture of cities. new brunswick, new jersey: transaction publishers. svetske urbanizacijske perspektive i problem infrastrukturnih mera rezime – ovaj članak opisuje svetske urbanizacijske prospekte, otkriva neke od osobenosti razvijanja grada u različitim regionima, i pravi analize zavisnosti ekonomskog rasta i ulaganja u infrastrukturu. kao rezultat, uočene su značajne razlike u urbanizacijskim procesima i u infrastrukturnom snabdevanju, novi izvori finansiranja, nude se za rešavanje ovog problema. ključne reči: infrastruktura, urbanizacija, kapitalne investicije, infrastrukturni fandrajzing article history: received: 17 march 2013 accepted: 29 april 2013 doi: 10.28934/ea.22.55.1.pp76-89 original scientific paper an evaluation of the short-term skills trainings targeting the roma ethnic minority lara lebedinski110 f* 1 institute of economic sciences, belgrade, serbia abstract this paper studies the impact of short-term skills trainings targeting youth in the roma ethnic minority. in order to better understand the impact of the program, we contrast outcomes of roma and non-roma. participants of these short-term skills trainings were predominantly males in their twenties. six months after the training end the impact estimates of skills trainings for roma are 15.55 percentage points while for non-roma we find an impact of 28.60 percentage points. in international comparisons these impacts are very large suggesting that the program has an exceptionally high impact on participants. it is difficult to pinpoint the reasons why roma and non-roma have different impact estimates, but potential explanations are differences in background characteristics (education and working experience) and differences in the content of the trainings that these two groups attended. key words: active labour market policies, short-term skills trainings, roma ethnic minority jel classification: c22, j0, j68 introduction the goal of this paper is to examine how roma participants of short-term skills trainings performed on the labor market after attendance of skills trainings implemented by the german development cooperation and german agency for international cooperation (giz). in the recent years, the german development cooperation and giz as implementing agency have supported several projects aiming to improve the position on the labor market of the most vulnerable groups in serbia through the provision of short-term skills trainings. the trainings lasted from a few days up to 8 months. this paper includes data on roma participants from two different programs.11f1 the youth employment program (yep) project was designed with the goal to support young people in serbia in improving their labour market situation. while the project included a number of different employment initiatives targeting disadvantaged groups, in this paper we examine only participants of short-term skills trainings. in particular, we examine only vocational trainings institution (vti) based trainings– i.e. skills trainings for labor market.12f2 vti based trainings are * e-mail: lara.lebedinski@ien.bg.ac.rs 1 "youth employment promotion" (yep) and "inclusion of roma and other marginalised groups in serbia" (inr). 2 the yep program included also employer based-trainings – i.e. skills trainings for known employers. employer based-trainings were mostly public-private partnerships (ppp) between private sector companies and giz. the ppp agreements specified that employers should employ at least 70% of the lara lebedinski 77 trainings taking place exclusively at a training institution and are not firm based. it should be noted that some of the yep skills-trainings targeting exclusively roma were shaped according to the needs and interests of this specific group.13f3 another group of participants included in this paper are non-roma participating in one of the two projects, we include them to be able to benchmark the results of the roma population.14f4 the goal of the inr was to support the government of serbia in implementing the strategy for the social inclusion of roma, and in this paper we focus on one element of this support, i.e. skills trainings. young people in serbia experience difficulties when entering the labour market (marjanović, 2016). being both roma and young poses additional challenges. roma are considered to be a vulnerable group both in serbia and in the region. on average, they have a very low educational attainment and are overrepresented in the informal labour market where jobs are insecure and wages are low. it is very difficult to break out of this vicious cycle of poverty, but one way to support them is to include them in skills training which can potentially help them find better and more secure jobs. this paper studies the impact of short-term skills trainings on labor market trajectories of roma and non-roma participants. using propensity score matching, we find that both roma and non-roma participants who attended short-term skills trainings have a higher likelihood to be employed six months after completing the training. the estimated impact of the program is large in international comparison. the paper proceeds as follows. in the second section we provide a literature review, in the third section of the paper we discuss the descriptive statistics with the aim to describe the participants of the skills trainings and their labor market outcomes before and after the skills trainings. the main part of the paper is in the fourth section, the impact analysis which relies on matching methodology and selects a control group of individuals who are similar to the participants of short-term skills trainings. we contrast the findings of non-roma and roma participants. section four provides impact estimates on the employment of training participants. section five summarizes the findings and concludes. literature review young people have a lower employment rate than the general population (o'higgins, 1996). there are two main reasons for this stylized fact: first, young people face barriers when entering the labour market and second, they face difficulties to stay attached to the labour market, i.e. keeping a stable and well-paid job (eichhorst and rinne, 2018). with no or little work experience, young people face difficulties finding their first job and getting a foothold in the labour market. a well documented feature of labour markets in transition and in particular serbia is that the education systems do not provide much practical experience and are not well aligned with the labour market needs (aleksić et al., 2021; rokicka, 2019). as a result, firms need to make significant additional investments in human capital to help young workers become independent in their work and for this reason companies try to avoid employing labour market entrants. additionally, a number of youth graduate in fields and professions which are not demanded on the labour market. in times of economic downturn and lower demand, young people are the first ones to get fired due to tenure based mandatory severance pay (verick, 2019) and this makes them vulnerable in uncertain economic periods. we turn now to the characteristics and specificities of the ethnic group that is in the focus of this study. roma experience a disadvantage on the labour market in terms of lower employment trainees under any form of formal contract. we include only vti based trainings, because no roma were reported to be participants of employer-based trainings. 3 at some point, yep had a task to base its programs on the needs of the roma people in order to motivate more roma to participate in yep measures. 4 inr project 78 economic analysis (2022, vol. 55, no. 1, 76-89) and lower wages and this is particularly reflected in the outcomes of women (o'higgins, 2012). roma are overrepresented in the informal labour market where wages and job security are lower than in the formal labour market (lebedinski, 2020). in order to help the young generation to improve their life conditions, it would be important to invest in the education of roma. however, the educational attainment of roma children is far below the attainment of non-roma. in serbia, the school attendance among roma in the age group 7-9 years is 86% and it falls to 66% in the age group 13-15 years (brüggemann, 2012). in order to improve the attendance of roma children in compulsory education, a number of countries have introduced roma teaching assistants into schools. these people help and support roma children at school. serbia also has assistants in schools since 2008, but their effectiveness is limited as they are expected to work with a large number of roma pupils (battaglia & lebedinski, 2015; 2017). roma are disadvantage not only on the labour market and at school, but they also experience worse health outcomes than the majority of the population (doyle, 2004). in addition to this, informal employment implies that in some countries they do not have access to health services (mihailov, 2012). active labour market policies can be grouped into four different categories: (i) classroom or on the job trainings, (ii) job search assistance, (iii) subsidized private sector employment and (iv) subsidized public sector employment. in general, almps have small effects (card et al., 2010; 2018). skills trainings fall into the first category, i.e. classroom or on the job trainings, and it has been shown that they have smaller short-term effects, but the impacts increase in the medium to long-term. however, skills programs targeting youth have been less successful than skills programs with other groups. a meta-study looking only at youth programs confirms the finding that the result of youth employment programs are unsatisfactory (kluve et al., 2019). with regards to job search assistance programs, these are considered low-cost interventions and previous meta studies have shown that they have a small, but positive impact on the employment rate (card et al., 2010; 2018). subsidized private sector employment are less effective in the shortterm, while some positive impacts have been found in the mediumto long-term. past metaanalysis (card et al., 2010; 2018) have shown that both shortand long-term effects of interventions should be evaluated. some intervention impacts can be only short-lived or other positive impacts (or even negative) can be revealed only after some time. moreover, different types of almps can be more beneficial for some groups than for others and heterogenous impacts should be considered when deciding on which almp type to implement to target a specific group. this is not the first study to examine the causal impact of active labour market policies in serbia. an extensive past study by bachmann et al. (2019) looked at the impact of skills trainings in serbia implemented as part of the same yep program funded by the giz. bachman et al.'s (2019) study examined the impact of skills trainings on the overall youth population, while this paper focuses on the roma youth population. the previous study found that 8 months after the training end the participants of vocational trainings institution based trainings in the program had a 16 percentage points higher likelihood to be employed than the matched control group. further results indicate that the medium-term effect size is large than the short-term impact. sample overview and descriptive statistics sample overview the initial sample had 594 individuals from two different programs (yep and inr), out of which 519 participated in short-term skills trainings of the yep program and another 75 in the shortterm skills trainings in the inr program. the yep program target young people and therefore the participants of this program can be both non-roma and roma. the analysis includes both nonroma and roma for comparison purposes. lara lebedinski 79 for this paper, we retrieved data from the national employment service (nes)15 f5 on the periods of registered employment and registered unemployment. we do not have administrative nes data for all short-term skills participants for three main reasons. first, in order to get access to the nes administrative data, participants had to give their unique identifier (jmbg). some participants did not give their jmbg when registering for the training and we could not retrieve their data from nes. second, we can only access data for participants who ever registered with nes and some individuals never did so and are therefore not present in the nes administrative dataset. third, we had to exclude some participants from the analysis because their administrative data was inconsistent. for instance, for few participants we had overlapping employment and unemployment spells and such individuals were excluded. starting from a sample of 594 participants of yep and inr, among the 347 non-roma, 306 were identified in the nes administrative dataset and from both programs there are 203 roma in the nes dataset. in total, our nes dataset contains 509 participants (306 non-roma and 203 roma) i.e. beneficiaries of yep and inr that could be identified in the nes data. table 1. sample size nes data and survey data total nes data yep non-roma 347 306 roma 172 169 inr (only roma) 75 34 total 594 509 note: only vocational trainings institution based trainings. source: author's calculations based on nes and survey data descriptive statistics we start by discussing descriptive statistics of the socio-economic characteristics and labour market status before and after the participation in the training. table 2 shows the sociodemographic characteristics according to the administrative data for the whole sample (column (1)), separately for yep non-roma (column (2)), yep roma (column (3)) and participants of inr (column (4)). in columns (5) and (6), we compare non-roma and roma participants of yep (column (5)) and roma from yep and from inr project. the reason to compare non-roma and roma is to understand whether the roma are more disadvantaged than the non-roma among yep participants. second, we compare roma from the yep and the inr project (column (6)) with the aim to understand whether these two groups of participants differ. the available time span from the administrative data does not allow to examine employment six months after for participants of the inr project and this outcome is not reported for them. first, we summarise the socio-demographic characteristics: • participants of skills-trainings are predominantly males in their twenties who finished secondary education. among roma, there are more females than among non-roma, most likely due to the content of the training that they attended (e.g. there were a number of trainings attracting mainly females, such as trainings for manicure, pedicure, hairdressers, etc.) • roma participants of skills trainings are less educated than non-roma participants, most roma finished only primary school. inr participants are less educated than yep roma. almost three fourths of inr participants have finished at most primary school. 5 national employment service is the public agency with the mandate to provide job-brokering services in serbia. 80 economic analysis (2022, vol. 55, no. 1, 76-89) • roughly half of the participants belong to a nes target group (these are individuals who belong to some vulnerable group and are considered difficult to employ). a much larger share among roma than among non-roma belongs to the nes target groups.16f6 this is true for both programs. note that not all roma are registered as such in the nes dataset. the reason is that nes has self-reported ethnicity information and some roma prefer not to report their ethnicity to nes. second, with respect to the formal employment before the trainings, we note the following: • on average, the individuals in our sample were either unemployed or unregistered in the week prior to starting the training. there are no differences in terms of labor market status between non-roma and roma in the week prior to the beginning of the training with the exception of participation in almps. roma were somewhat more likely to be included in almps than non-roma, but the participation in almps is minor. third, we find the following for formal employment after the training: • most interestingly, with respect to the formal employment status after 6 months, we find that 20% to 21% of roma were employed (depending on the program), while this share stood at 55% for non-roma. table 2. socio-economic characteristics and labor market outcomes of participants according to nes data, by type of training total n=509 non-roma yep n=306 roma yep n=169 inr n=34 p-value yep p-value roma (1) (2) (3) (4) (5) [(2)-(3)] (6) [(3)-(4)] personal-level variables female 23.2% 10.3% 42.2% 47.1% <0.001 0.61 age on 06mar2020 27 (23-32) 29 (25-33) 24 (21-30) 24 (20-31) <0.001 0.90 highest level of education <0.001 0.007 primary school or less 27.8% 12.7% 46.1% 73.5% three-years vet school 28.6% 31.3% 29.2% 2.9% four years secondary school (vet or general) 33.6% 41.6% 22.1% 17.6% university/college or higher 10.0% 14.4% 2.5% 5.9% nes target group*: belongs to nes target group 56.2% 37.5% 83.8% 91.2% <0.001 0.27 surplus of employees 4.2% 6.5% 0.6% 0.0% 0.004 0.64 single parents 2.7% 0.7% 5.2% 8.8% 0.002 0.41 unemployed parents 14.8% 10.7% 20.1% 26.5% 0.006 0.41 internally displaced people 2.5% 1.4% 3.9% 5.9% 0.088 0.60 recipient of social assistance 18.8% 5.5% 40.9% 32.4% <0.001 0.36 roma 24.2% 0.0% 61.0% 64.7% <0.001 0.69 other vulnerable 0.8% 1.4% 0.0% 0.0% 0.14 status in 7 days before training start employed 18.0% 23.4% 8.3% 11.8% <0.001 0.51 unemployed 47.9% 46.2% 52.1% 44.1% 0.21 0.40 6 we rely on the previous paper to define nes target groups. nes classifies individuals into target groups in order to be able to target vulnerable groups with their programs. lara lebedinski 81 total n=509 non-roma yep n=306 roma yep n=169 inr n=34 p-value yep p-value roma (1) (2) (3) (4) (5) [(2)-(3)] (6) [(3)-(4)] almp 1.8% 0.9% 3.6% 2.9% 0.029 0.86 out of labor-force 1.5% 1.2% 1.8% 2.9% 0.57 0.66 unregistered 45.4% 44.2% 47.9% 44.1% 0.43 0.68 number of days in 360 days before training start employed 67 (±110) 88 (±121) 31 (±73) 37 (±86) <0.001 0.68 unemployed 126 (±137) 117 (±135) 138 (±140) 156 (±143) 0.10 0.49 almp 3 (±24) 1 (±12) 7 (±36) 7 (±40) 0.010 0.99 out of labor-force 7 (±45) 5 (±37) 9 (±53) 20 (±65) 0.31 0.29 unregistered 154 (±142) 146 (±141) 173 (±142) 138 (±140) 0.043 0.19 status in 7 days after training end employed 19.9% 20.2% 19.5% 17.6% 0.85 0.80 unemployed 36.4% 36.4% 39.1% 23.5% 0.56 0.086 almp 0.7% 0.6% 1.2% 0.0% 0.46 0.52 out of labor-force 0.9% 0.3% 1.8% 2.9% 0.071 0.66 unregistered 53.0% 50.0% 55.0% 73.5% 0.28 0.046 status within 7 days after 6 months from training end employed 42.6% 55.2% 21.3% n.a. <0.001 n.a. unemployed 23.9% 18.8% 37.9% n.a. <0.001 n.a. almp 0.7% 0.3% 1.8% n.a. 0.071 n.a. out of labor-force 0.7% 0.6% 1.2% n.a. 0.46 n.a. unregistered 30.6% 26.3% 38.5% n.a. 0.005 n.a. number of days in 180 days after 6 months training end employed 62 (±69) 79 (±70) 29 (±53) n.a. <0.001 n.a. unemployed 53 (±67) 43 (±61) 72 (±75) n.a. <0.001 n.a. almp 1 (±10) 1 (±8) 2 (±15) n.a. 0.29 n.a. out of labor-force 2 (±14) 1 (±6) 3 (±21) n.a. 0.077 n.a. unregistered 60 (±68) 54 (±65) 72 (±74) n.a. 0.007 n.a. notes: *multiple answers possible. continuous measures are summarized by the median, followed by the interquartile range in brackets (p25-p50). or by the mean followed by ± and the standard deviation in brackets. out-of-labor force are individuals who registered with nes, but are not actively searching for work for some justifiable reason (e.g. they are sick, on maternity leave, etc.). a p-value of 0.05 or smaller implies that a difference is statistically significant at 5%. n.a. not available. source: author’s calculations based on nes dataset. finally, in figure 1 we turn to the graphical presentation of the trajectories of labor market outcomes for the non-roma and roma trainees (data shown in table 2). each graph shows the percentage of individuals by registration status in each week where 0 denotes the training end. we denote with a vertical line the maximum and minimum duration of the training relative to the training end. before entering the training, both non-roma and roma had a low likelihood to hold a formal job. among the non-roma the formal employment rate was somewhat above 20%, while the share of employed roma was approximately 10%. somewhat less than 40% of non-roma were registered unemployed before the training start and the rest, approximately 40% were neither 82 economic analysis (2022, vol. 55, no. 1, 76-89) registered employed with croso (social insurance central register) nor registered unemployed with nes. following the training start, the employment rate increases somewhat for non-roma and it increases sharply for the roma by approximately 20 percentage points until the end of the training. the reason for this finding is that roma were given employment contracts by yep during the period of trainings which made it possible to pay them a pocket money. after the trainings ended, there is a positive effect on employment for both non-roma and roma, but this effect is more strongly pronounced for non-roma. the employment rate rises above 50% over the observed period, while the employment rate of roma increases above 30% (first row of graphs). on the other hand, both the share of unemployed and the share of those not registered is falling. figure 1. percentage of individuals by labor market status (0 denotes the training end) source: author’s calculations based on nes dataset impact analysis the descriptive analysis provides an indication that the short-term skills training improved the employment rate of participants. in this section we aim to identify the causal impact of the training: we want to compare the actual labour market outcomes of participants with the counterfactual outcomes, i.e. the potential outcomes had they not attended the skills training. the main evaluation problem and challenge in this type of exercise is that participants were not randomly selected for the training. first, the participants belong to a disadvantaged group (both non-roma and roma) and this is a consequence of the selection criteria of the yep project. presumably, the participants have worse employment opportunities than the average person of their age. second, participants were likely actively searching for work and this is how they found out about this opportunity to attend a short-term skills training. this implies that the participants lara lebedinski 83 were very motivated to find options to improve their labor market situation. conversely, a high level of motivation implies that the participants would possibly have a higher chance of employment even in the absence of the training program.17f7 the main challenge is to identify a credible control group and we follow the methodology which has been used in a previous study (bachman et al., 2019) to estimate the causal impact of labour market programs in serbia. the identification strategy employed is a statistical matching methodology based on the seminal paper of sianesi (2004). the idea is to select from the the potential control group, i.e. all people from the nes database, a smaller control group ("matched control group") which has similar socio-demographic characteristics and a similar labour market history to the treatment group. the estimated impact of a specific skills training program is the comparison of labour market outcomes between the treated group and the "matched control group". we estimate in this way the impact for each skills training separately.18f8 assessment of matching quality in table 3 we compare the giz yep trainees with the matched sample. the comparison sample is constructed for non-roma and roma jointly. the control sample counts 8,093 individuals and the intervention sample is reduced to 239 participants among which 61 are roma. the reason that the number of training participants falls is because we select only trainings with at least 18 participants. remember that we had to exclude roma from the inr project because we did not have their labor market outcomes for the period 6 months after the trainings. with the exception of the roma variable there were no significant differences before the training took place. six months after the training ended, there is a significant improvement in employment for the participants of giz trainings. these findings suggest that matching i.e. the selection of the control group was very successful and that the program improved the labor market outcomes of participants. table 3. comparison of giz trainees with matched control group total n=8,332 control n=8,093 treatment n=239 p-value personal-level variables age on 01apr2019 28 (24-33) 28 (24-33) 28 (24-32) 0.45 1=female 16.1% 16.1% 15.5% 0.79 highest level of education 0.96 primary school or less 21.8% 21.8% 21.8% three-years vet school 29.0% 29.0% 28.5% four years secondary school (vet or general) 38.0% 37.9% 39.7% university/college or higher 11.2% 11.2% 10.0% nes target group*: belongs to nes target group 48.9% 48.8% 53.1% 0.18 surplus of employees 5.3% 5.3% 5.0% 0.83 single parents 1.2% 1.2% 1.7% 0.48 unemployed parents 14.0% 14.0% 15.1% 0.63 internally displaced people 1.4% 1.4% 2.1% 0.36 7 note that roma in yep and in inr were reached mostly through roma associations, who went directly to the settlements, informed them and introduced them to the trainings; otherwise they would not be in a position to look for such programs or employment by themselves, especially women. we still believe that their choice to enter this program demonstrates that they had a higher level of motivation to find employment than other roma with similar characteristics. 8 details about the methodology can be found in bachmann et al. (2019). 84 economic analysis (2022, vol. 55, no. 1, 76-89) total n=8,332 control n=8,093 treatment n=239 p-value recipient of social assistance 10.9% 10.8% 13.8% 0.14 roma 17.8% 17.6% 25.5% 0.002 other vulnerable groups 0.0% 0.0% 0.0% 0.12 status in 360 days before training start employed 22.8% 22,8% 22,1% 0.74 unemployed 37% 37% 38,5% 0.58 almp 1.1% 1,1% 1,4% 0.44 out of labor-force 1.9% 1,9% 2,2% 0.80 unregistered 37.0% 37% 35,8% 0.60 number of days in 360 days before training start employed 82 (±124) 82 (±124) 79 (±117) 0.74 unemployed 133 (±141) 133 (±141) 138 (±135) 0.58 almp 4 (±27) 4 (±27) 5 (±31) 0.44 out of labor-force 7 (±44) 7 (±44) 8 (±47) 0.80 unregistered 133 (±141) 133 (±141) 128 (±131) 0.60 status in 7 days after training end employed 25.7% 25.8% 23.4% 0.42 unemployed 39.0% 39.0% 38.9% 0.97 almp 1.6% 1.6% 0.8% 0.35 out of labor-force 2.0% 2.1% 1.3% 0.38 unregistered 33.3% 32.8% 35.8% 0.88 status in 7 days 6 months after training end employed 33.0% 32.5% 49.4% <0.001 unemployed 30.9% 31.1% 22.6% 0.005 almp 1.4% 1.4% 0.4% 0.19 out of labor-force 1.8% 1.9% 0.4% 0.099 unregistered 33.6% 33.7% 28.9% 0.12 number of days in 180 days 6 months after training end employed 52 (±75) 52 (±75) 67 (±69) 0.001 unemployed 61 (±77) 61 (±77) 51 (±65) 0.056 almp 2 (±18) 2 (±19) 1 (±6) 0.12 out of labor-force 3 (±23) 4 (±23) 1 (±13) 0.12 unregistered 60 (±77) 60 (±77) 57 (±66) 0.50 notes: *multiple answers possible. continuous measures are summarized by the median, followed by the interquartile range in brackets (p25-p50). or by the mean followed by ± and the standard deviation in brackets. a p-value of 0.05 or smaller implies that a difference is statistically significant at 5%. source: author’s calculations based on the nes dataset. impact estimates figures 2 and 3 display the evolution of labor market outcomes of participants sample and respective matched group sample for non-roma and roma. the respective impact estimates and their statistical significance19f9 at selected month (3, 6, 9 months) are reported below each graph. the matching quality can be visually confirmed by examining the labor market evolution of the outcomes for treated and control group prior to entering the training. remember that, starting from the left in each graph, the first vertical solid line marks the beginning of the longest training. the second vertical solid line marks the median start of the training and the third solid line marks the end of the training. 9 roughly, an absolute t-value of |1.96| indicates statistical significance on the 5 percent confidence level. lara lebedinski 85 the positive intervention impact on employment for non-roma rises gradually and it reaches 28.60 percentage points after 6 months (26 weeks) as shown in figure 2. conversely, the share of registered unemployed falls over the observed period suggesting that those who were registered unemployed are the ones who found employment. the share of individuals who are neither registered with nes nor employed remains unchanged over the time frame. some of these individuals are certainly informally employed, but we do not have a means to prove this claim. turning now to the intervention impact for roma, we note that there is a similar positive trend for employment over time as observed for the non-roma. the impact estimates for employment are 15.55 percentage points after six months for roma. also, for roma, the graphs suggest that the registered unemployed are the ones who found employment as their share decreases gradually over time. again, the share of individuals who are neither registered with nes nor employed is constant. when comparing the impact on non-roma and roma, we observe a much larger effect for non-roma. it is difficult to pinpoint the exact cause, but possible reasons include the following. first, roma are less educated and younger (so they presumably have less experience) than nonroma and both of these factors affect the employability of individuals. second, roma attended different trainings20f10 than non-roma which might not necessarily offer the same labor market opportunities. it is possible to compare the estimated impact size to an international review of vocational training program impacts from 12 evaluations from 8 countries. it should be noted that such comparisons have several caveats. first, the content, intensity and duration of trainings in each setting is different and similarly, the background of the participants is different. second, this international review uses survey data while this paper relies on administrative data. third, the impact estimates in this paper are 6 months after training end while the international review provides estimates after 12 to 18 months. it is not clear in which direction these differences can bias the results, but having these caveats in mind, we can compare the key outcome formal employment. the impact size of comparable programs in other countries ranged from no impact up to an impact of the size of 8 percentage points on formal employment. this is much lower than the impact estimates of the size 15.55 percentage points that we found for yep roma participants or equivalently 28.60 percentage points for yep non-roma participants and we conclude that the program is very successful also in international comparison. finally, based on the findings in this paper, it is possible to recommend the continuation of the program. the program targets a disadvantaged group and additional job search support after the training end would be very valuable. furthermore, to ensure that such a high and positive impact persists, it is recommended to continue monitoring the implementation and conduct impact evaluations on a regular basis after different time periods (e.g. after six months, 12 months, 18 months, two years and longer). 10 the difference between the trainings for non-roma and roma derives from the fact that some trainings were shaped specifically having in mind the interests of the roma. 86 economic analysis (2022, vol. 55, no. 1, 76-89) figure 2. share of treatment and matched control group in each labor market status by week relative to training end: non-roma source: author's calculation based on nes dataset lara lebedinski 87 figure 3. share of treatment and matched control group in each labor market status by week relative to training end: roma source: author's calculation based on nes dataset 88 economic analysis (2022, vol. 55, no. 1, 76-89) conclusion in this paper we have examined the labour market outcomes of roma after their attendance of short-term skills trainings. we provide additionally data for non-roma as a benchmark. the descriptive statistics reveals that participants of the skills trainings are predominantly males in their twenties who finished secondary education. among roma, there are more females than among non-roma, most likely due to the content of the training that they attended (e.g. there were a number of trainings attracting mainly females, such as trainings for manicure, pedicure, hairdressers, etc.). a comparison between non-roma and roma shows that roma participants are, on average, less educated. according to administrative data, the individuals in our sample were mostly either unemployed or unregistered in the week prior to starting the training. the impact analysis suggests a positive causal impact of the skills trainings of the size of 28.60 percentage points after 6 months on employment for non-roma. we conjecture that the individuals who find employment after the trainings are those who were registered unemployed prior to the training start (and not unregistered). compared to the control group, for non-roma the share of registered unemployed falls by 18 percentage points and the share of unregistered falls by 5.8 percentage points. for roma, the impact analysis suggests a positive causal impact of 15.55 percentage points on employment after 6 months. we believe that individuals who were formally registered unemployed before attending the skills trainings are the ones who found employment as a result of the program. in international comparison, these estimates are very high suggesting that the program has an exceptionally high impact on program participants (both non-roma and roma). we note that the impact estimates on employment are different between non-roma and roma. it is difficult to pinpoint the exact cause, but possible reasons include the following. first, roma are less educated and younger (so they presumably have less experience) than non-roma and both of these factors affect the employability of individuals. second, as some trainings for roma were shaped in line with their interests, as a result, some roma attended different trainings than non-roma in terms of content which ultimately might not offer the same labor market opportunities. acknowledgements we would like to thank data analysis.code for the stata for sharing the jonathan stöterau references aleksic, d., 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(2009). who is hit hardest during a financial crisis? the vulnerability of young men and women to unemployment in an economic downturn. iza discussion paper no. 4359. article history: received: january 12, 2022 revised: june 9, 2022 accepted: june 13, 2022 ea_2015_1-2 udc: 35.07 34.047:331.108.2(4-672еу:497.11 jel: h4, h83 cobiss.sr-id: 216162316 original scientific paper the emergence and consolidation of the administrative capacity criteria within the eu enlargement policy bonomi matteo1, scuola superiore sant’anna, pisa, italy abstract – the article gives a critical assessment of the emergence, development and consolidation of the administrative capacity criteria for entering the european union (eu). the administrative capacity criteria emerged for the first time during the 5th european enlargement (2004-07) under soft political conditionality, showing a limited impact. the criteria gained importance during the accession process of croatia, reflecting some changes in eu enlargement policy in order to address the specificities of the western balkan countries. the article concludes that these criteria today have become a central part in the new eu enlargement strategy, posing strict conditions to be fulfilled by all candidate countries if they want to proceed in their path towards the eu. it will be sustained that this reorientation represents a major change in the nature of eu enlargement policy. key words: administrative capacity criteria, eu enlargement policy, public administration reforms, ceebs, western balkans introduction this article aims to give a critical assessment of the emergence, development and consolidation of the administrative capacity criteria for entering the european union (eu). it analyses how the eu has started to apply some specific accession conditions for influencing domestic changes in public administration of candidate countries, not in relation to a specific eu policy area but in relation to the general – or horizontal – administrative structures of a candidate country. the administrative capacity criteria emerged for the first time during the 5th european enlargement (2004-07) under soft political conditionality, they gained importance during the accession process of croatia, and by now have become a central part in the new enlargement strategy of the european commission which aims in particular to address the specificities of the western balkan countries. the emergence and consolidation of administrative capacity criteria has been a real path breaking issue in eu enlargement policy for several reasons: (1) it has opened a new area of direct influence of the eu that is not traditionally associated with eu competences and that had never been involved in previous enlargements – the administrative capacity criteria are not part of the acquis communautaire, the main body of eu legislations; (2) it has cast an 1ph.d. in politics, human rights and sustainability, florence, italy, m.bonomi@alumni.sssup.it. 2 economic analysis (2015, vol. 48, no. 1-2, 1-18) unprecedented attention to the implementation phase of the reform strategies in candidate countries – the adoption of new legislations represents, in fact, just a first step for modernizing public administrative systems; (3) it has brought about a reorientation of eu enlargement policy – since the pursuing of the administrative capacity criteria needs a high priority within the agenda of the european commission in order to have some chances to succeed. all these reasons have made the application of the administrative capacity criteria a very innovative policy within the eu enlargement strategy but, at the same time, they are also responsible for the limited impact in regards to central east european and baltic countries (ceebs). while the success of eu conditionality depends mainly on both (a) the costs of domestic adaptation and (b) the external push of the eu (börzel and risse 2003), the application of administrative capacity criteria represents a case of extreme variation regarding both factors: (a) proceeding towards a comprehensive reform of the domestic administrative system implies very high political and material costs for internal political actors; and (b) a consistent application of eu conditionality in this field and the credibility of the threat of denying membership upon these criteria, the two most important elements determining the strength of eu external push, have faced several problems. in fact, the absence of an administrative acquis rendered the task of defining common standards in this field particularly difficult, while denying membership on this basis was at odds with other eu goals. the limits that emerged in the application of the administrative capacity criteria during the 5th eu enlargement are, however, at the basis of the actual reorientation of the eu enlargement policy. for addressing the specificity of western balkans, the european commission has renewed its attention regarding the administrative capacity criteria, which have become today a central part of the new enlargement strategy. this new strategy aims to reinforce the credibility of eu transformative power and tries to overcome the shortcomings of the past in applying the administrative capacity criteria through three fundamental improvements: (1) by giving high priority to administrative criteria within the agenda of the commission – that have become, together with the rule of law and economic governance, one of the three pillars of the new eu enlargement strategy (european commission 2014); (2) by providing a new framework for both benchmarking performances and guiding local policy-makers in the reform process – with a strong focus on implementation phase of the administrative reforms (oecd 2014); (3) by the introduction of special groups on public administration reform within eu delegations – with the aim of shaping a more structured dialogue with the enlargement countries and ensuring political commitment and leadership in the reform process. moreover, the role of the administrative capacity criteria within the eu enlargement agenda opens several questions about eu enlargement policy and, more generally, about the nature of the eu integration project and the system of governance that it generates. in fact, the absence of horizontal administrative rules within the main body of european legislations is not an accidental or contingent feature, but instead it is something that is deeply rooted in the sui generis nature of the eu system, directly deriving from the functional and incremental path that european integration has undertaken from its very beginning (cassese 2003: 94-7). the ambiguous status of administrative power within the eu has, therefore, a prima face bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 3 impact on eu enlargement policy, by exacerbating the contrast between the requirements of technical and sectoral alignments to european policies – covered by the acquis – and more general transformative ambitions of the eu as a system of governance. the paper will address these issues in the following way. section two presents eu competences and influence in relation to the administrative system of the member states. section three describes the emergence of the administrative capacity criteria in the context of the 5th european enlargement and the problem of definition of common administrative standards. section four synthesizes the limits of the application of the administrative capacity criteria in the ceebs. section five describes how the accession of croatia highlighted the necessity to renew the accession toolbox for improving administrative capacity in the western balkans. section six introduces the administrative capacity criteria in the context of the new eu enlargement strategy. section seven makes some concluding remarks. eu influence on the administrative system of the member states: an open debate the eu and its member states have a very peculiar style of public administration and rules enforcement characterized by an “indirect implementation” of the vast majority of eu rules and norms by national authorities, that is balanced by several routes of european influence on national public administrations (schwarze 1992; 1996). the cornerstone of this atypical architecture can already be found in article 5 of the treaty of rome,2 establishing the principle of loyal cooperation between european and national authorities, which has been taken over, in a slightly modified form, by the treaty of lisbon (now art. 4 par. 3 teu). article 5 represented a delicate compromise between the respect of national sovereignty and the necessity not to jeopardize the tasks and the goals pursued through european institutions. not surprisingly, this article has been read in two diametrically opposite ways. on the one hand, it has been considered as a norm safeguarding the prerogatives of national executives, stating the member states’ general competence for implementing community law (lenaerts and nuffel 1999: 392). on the other, it has been interpreted, in connection with the sanctioning powers of the european court of justice (ecj) and under the principles of effectiveness of ec law and non-discrimination, as opening a further breach of national autonomy, as a source of direct european influence on national administrative systems (bieber and vaerini 2004: 388). the arguments in favour of this second interpretation derive mainly from the important case law developed by the ecj. while the development of secondary legislations by european legislative bodies tends to be sectoral and related to specific policy areas, the activity of the ecj is by its very nature more general, establishing common principles that frame the interpretation of eu law. acting in this way, the ecj has established some common horizontal (non-sectoral) principles that are binding for national administrations, 2“member states shall take all appropriate measures, whether general or particular, to ensure fulfilment of the obligations arising out of this treaty or resulting from action taken by the institutions of the community. they shall facilitate the achievement of the community's tasks. they shall abstain from any measure which could jeopardise the attainment of the objectives of this treaty” (art. 5 of the treaty of rome). 4 economic analysis (2015, vol. 48, no. 1-2, 1-18) such as proportionality, non-discrimination, legitimate expectations, duty to give reasons, legal certainty and transparency (schwarze 1992; 1996). however, in support of the first type of reading, we have to note that these common principles are very general and their implications for concrete policies are far from clear (page 2003: 173). moreover, if we compare the overall administrative and executive powers within the eu with the legislative and judicial ones, we have to note how their expansion has been limited and very cautious toward a field that has always been perceived, especially in continental europe, as lying at the real core of national sovereignty3 (cassese 2003: 94-7; tuori 2010: 207ss). not only does the direct implementation of european norms, such as in monetary policy or competition law, still represents an exception rather than the rule, but provisions within the eu treaties with some implications for the member states’ administrative systems are also very few.4 if we look at secondary legislations, we can observe that certain policy areas, such as common agricultural policy, environmental protection or electricity norms, require the creation of certain regulatory bodies by national authorities (demmke 2002). however, eu secondary legislations with direct effect on the horizontal aspects of the national administrative system are rare. the most notorious exception is given by public procurement rules, which have established some kind of common european administrative rules that bind national regulatory authorities (drijber and stergiou 2009). the difference between these two interpretations is clearly very sharp, and it is not surprising that the topic has attracted increasing attention of many scholars studying europeanization (page and wouters 1995; knill 2001; olsen 2003; goetz 2001; kassim 2003; heidbreder 2011; 2014; 2015). applied to the topic of the administrative power within the eu, the europeanization research paradigm has been utilized by scholars to study the level of convergence between public administrations within the eu, asking whether it is possible to speak about the emergence of a european model of public administration, or we still witness the persistence of deeply differentiated national administrative systems. moreover, the europeanization literature has drawn attention to the existence of many types of mixed bodies within the eu system of governance, composed of both national and european officials – such as the various consultative bodies and comitiology that have an important role in guarantying the continuity between legislative and administrative acts. this new brand of literature has also suggested how, within these governance bodies, informal rules, regular contacts, best practices and benchmarking could have an impact on shaping a european administrative space. 3 a good example of member states’ resistance to the penetration of eu laws into national administrative systems is given by the fact that public administration had been exempted from the application of the provisions guarantying freedom of movement and non-discrimination of workers until 1980, when the european court of justice had imposed some limitations on this exemption (ziller 1998). 4examples include, of course, the above mentioned art. 4 par. 3 of teu, especially in connection with the european court of justice’s power to sanction member states that do not fulfil their obligations, art. 2 of teu on general principles of the eu, and art. 197 of teu on voluntary administrative cooperation. bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 5 this discussion has, however, failed until now5 to give final evidence to sustain that convergence among the administrative system of the member states is taking place or that a common european model of public administration is emerging (heidbreder 2011; 2014; 2015). while the eu has certainly had a growing impact on the development of national administrations, it seems that it has been just one among many intervening variables. in fact, marked differences still persist among public administration models of the eu member states. the emergence of the administrative capacity criteria in the context of the 5th european enlargement and the problem of definition of common standards considering all the specificities that still characterize the administrative power within the eu system of governance, the late emergence of the administrative capacity criteria during the fifth european enlargement represented a real path breaking issue in eu enlargement policy, opening a new area of direct influence of the eu that is not traditionally associated with eu competences. even if the sectoral administrative capacities of candidate countries have always posed some concern during previous eu enlargements, the introduction of a general assessment of the horizontal administrative capacities of the candidate countries represented a completely new issue in the enlargement process. the emergence of the administrative capacity criteria was an expression of both the scepticism of western european countries and the european commission towards the administrative structures of east european countries and the tightening of eu conditionality, mainly due to the increased complexity of eu policy making after the completion of the internal market and the adoption of the treaty of maastricht. as highlighted by a. j. g. verheijen (2000: 8), the main reasons for the introduction of the administrative capacity criteria can be summarized as follows: firstly, “sectoral capacity cannot develop in isolation; even if capacities in key sectoral areas are brought up to the required levels, the effect of this will be at most temporary if the overall administrative system is not functioning effectively”; secondly, it was “important to guarantee that the european policy process will be able to function effectively with 27+ member states”. the introduction of these new criteria was therefore linked to the concerns of absorbing 12 new countries without disrupting the eu policy process. especially the high heterogeneity of the potential new member states from central eastern europe and the baltic, with the legacy of their communist past, was seen as a serious threat to the politico-administrative system of the union, in which national administrations have a crucial role in enforcing european rules, while the principles of loyal cooperation and mutual trust have a pivotal importance. the administrative capacity criteria was included only recently into the process of specification of the conditions for entering the eu. while the main conditions for new accessions had been formulated at the copenhagen european council in 1993, at that time no explicit reference was made to the horizontal administrative capacity criteria. the so-called copenhagen criteria included three fundamental groups of conditions: (1) the stability of institutions guaranteeing democracy, the rule of law, human rights and respect for and 5we have to keep in mind that ‘convergence’ has turned out to be a really multifaceted concept that renders difficult to take a final position on the issue (pollitt 2001). 6 economic analysis (2015, vol. 48, no. 1-2, 1-18) protection of minorities; (2) a functioning market economy and the capacity to cope with competition and market forces within the internal market; (3) the ability to take on the obligations of membership (european council 1993). it is only with the conclusion of the madrid european council in december 1995 that it was made explicit, for the first time, that the horizontal administrative capacities of candidate countries would be assessed (european council 1995). afterwards, it was introduced as a criterion in its own right for the first time in the commission opinions of june 1997, and then started to appear regularly, from november 1998 onwards, in the commission regular reports on progress. from its very beginning, however, the assessment of the horizontal administrative capacity has encountered various problems in its application (verheijen 2000; 2003; dimitrova 2002; bugarič 2006). the specific problems of the administrative criteria can be summarized in three main features: (1) the lack of administrative experience of the commission; (2) elusiveness of the standards; and (3) the lack of a clear legal basis for eu intervention in national administrations. these are clearly three deeply interconnected issues deriving from the peculiar status of the administrative powers within the eu. in fact, the criteria for eu membership have always involved a sectoral approach implied in the chapterby-chapter negotiations, while there are no clear competences of the eu regarding public administration of the member states. the commission itself was lacking the necessary experience in this field, having always dealt with sectoral technical administrative requirements. moreover, the heterogeneity of the administrative systems of the old member states represented a problem for defining common european standards for public administration. in other words, even after the decision to proceed with the assessment of the horizontal administrative capacities of candidate countries, the definition of european standards in this field proved to be an extremely elusive task. these problems have been partially mitigated by the intervention of sigma6 upon the request of the european commission in the second half of the 1990s. the sigma programme is a joint initiative of the oecd and the european union, mainly funded by the eu, that came to play an intermediary role between the commission and the candidate states in relation to the horizontal administrative capacities requirement. sigma had a fundamental impact on the definition of common standards by its twofold activity of elaborating the normative basis for administrative capacity criteria and operationalizing the administrative capacity criteria. between 1998 and 1999, sigma published two important papers that elaborate the notion of “european administrative space” (eas) (oecd 1998; 1999). even though the eas was initially recognized as just “a metaphor” (oecd 1999: 6) and it was openly stated that “no common agreement yet exists” (oecd 1999: 15) on common administrative law in the eu, the eas soon appeared to be utilized by sigma as the fundamental notion in justifying and elaborating the administrative capacity requirements.7 in other words, within documents produced by sigma, the eas soon became a synonym of “non formalized acquis 6 sigma stands for support for improvement in governance and management. 7“candidate countries will need to develop their administrations to reach the level of reliability of the european administrative space and an acceptable threshold of shared principles, procedures and administrative structural arrangements. there is a minimum standard of quality and reliability of public administration that candidate countries should attain” (oecd 1999: 15). bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 7 communautaire”, under a strong convergence hypothesis, representing “a common european general administrative law” (oecd 1999: 16). the eas is presented as a systematization of some common administrative law principles – including reliability and predictability; openness and transparency; accountability; efficiency and effectiveness – that have progressively emerged through several driving forces “such as economic pressures from individuals and firms, regular and continuous contacts between public officials of member states and, finally and especially, the jurisprudence of the european court of justice” (oecd 1999: 6). in addition to giving a contribution to the normative justification and doctrinal elaboration of the administrative requirements, sigma has played an even more important role in the operationalization of the criteria. from the general explanation of the common european administrative law principles, sigma formulated a new system of baseline assessment for the definition of minimum standards for public administration. the sigma baseline assessment, which was elaborated in strict cooperation with the european commission, identified six main areas involved in the horizontal administrative capacity assessment: civil service, policy-making and coordination, pubic expenditure management systems, public procurement, internal financial control and external audit. the introduction of the baseline assessment represented a fundamental tool in the elaboration of minimum standards and in promoting capacities in public administration of candidate countries, having a clear influence on commission’s reports from 1999 onwards (verheijen 2000: 17-8). even if the intervention of sigma presented clear limits in both its doctrinal elaborations and policy implications, the shortcomings seem to be related mainly to the ambiguities of the administrative power within the eu. the work of sigma represented therefore an important step towards a better definition of horizontal administrative requirements, marking the final stage for the specification of the administrative capacity criteria in the context of the fifth european enlargement. convergence: a dysfunctional myth? the limits of the application of the administrative capacity criteria to ceebs despite the difficulties in shaping the administrative capacity criteria and the lengthy process of their specification, many reports have shown how eu conditionality had a clear impact on promoting reforms of the public administration in the central east european and baltic countries (ceebs).8 this is not surprising, given the context of strong europeanization that characterized the fifth eu enlargement, in which the influence of the european commission went beyond its powers with regards to states already members (grabbe 2006: 8while before 1997 only poland, hungary and the baltic states had adopted some kind of legislations in this field, as a consequence of eu pressure all ceeb countries adopted new legislations between 1997-2002, with romania and bulgaria continuing to adopt new pieces of legislation until their accession to the eu (as shown by various reports of the commission). the fact that all candidate countries adopted new laws in a relatively short period of time is a good indicator that suggests that eu conditionality indeed had an impact. moreover, as highlighted by dimitrova, even if the reaction of the countries were not the same, the contents of the new legislations were quite similar and the influence of the european principles quite clear (dimitrova, 2005: 81). 8 economic analysis (2015, vol. 48, no. 1-2, 1-18) 52-4). nevertheless, it was at the same time clear how the exercise of eu conditionality in this field has been far from unproblematic. in fact, countries reacted differently to this specific part of eu conditionality, showing different degrees of internalization of european principles of public administration as defined by the commission and sigma. by the end of the process many shortcomings and dysfunctionalities emerged in the ways the administrative requirement had been applied, in the types of effects that it had exercised and, especially, in the long-term sustainability of the reforms that had been promoted through eu conditionality. what lies at the very core of the strategy adopted by the commission and sigma is the reform of the civil service, that should be the first step in promoting horizontal administrative capacities and in this way a catalyzer for other reforms (ziller 1998; verheijen 2000; dimitrova 2005). the commission strongly insisted on adopting new legislation in this field, with the aim of creating a reliable civil service characterized by professionalism, neutrality and independence from the political system, in line with the classic continental rechtsstaat tradition, marginalizing other available models such as new public management (bugarič 2006: 218). the rationale behind this choice of the commission and sigma can be explained by the specific strategy to deal with post-communist administrations, which appeared very dysfunctional in the pre-accession period, where the public services seemed characterized by strong influence of political parties, lack of mobility of the personal, low salaries and poor social considerations (bossert and demmke 2003; verheijen 1995; 2003).9 while it is quite difficult to accurately describe the model that was sponsored as a simple derivation from the common administrative principles of the eu and its member states, this strategy aimed to stabilize the administrative structures of ceeb countries and guarantee their regularity and predictability. this was perceived as a necessary alignment with the rule of law tradition and, therefore, was considered a fundamental precondition for performing adequately, and in a reliable manner, within the eu system. moreover, the success of this kind of reform should have helped to reach a better definition of the state-society relationship, offering a solid base for further efforts of modernization that could also be open to more managerial types of arrangements. however, the results of eu conditionality in this field fell far behind this ambitious approach. as shown by several reports and various scholars,10 new legislations have been 9in fact, the ambiguous legacy of the recent communist past was working in a twofold way. on the one hand, during the previous regime, there was no clear separation between state and society, and no specific law distinguishing public and private employment. within this context, public administration was under direct and strict control of the political system, working as a fundamental instrument of oppression and leaving a strong lack of political neutrality in the ceeb countries’ administrative culture (könig 1992; verheijen 1995). on the other hand, the first reaction to the communist legacies during the early transition period was dominance of anti-statist and neoliberal ideology that gave priority to liberalization, deregulation and privatization, underestimating the role of the state and marginalizing reforms in this field (verheijen 2003: 490). as a consequence, during the early transition period, the reform of public administration was not considered a priority on the reform agenda, with the only exception of hungary that adopted a civil service law already in 1992. 10 evidence about the limited impact of eu conditionality in this field derives from sigma assessments and documents and eu regular reports, but is also almost unanimously stated within secondary literature. bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 9 often lacking of successive implementation and the overall approach seemed to be too legalistic. instead of seeing the adoption of a new law as a starting point for a broader strategy of reform of the public administration, the adoption of new civil service legislations seemed to have become a goal in itself. moreover, the problem of politicization looked far from being resolved; on the contrary, the various plans for reforming the public administration often became themselves the expression of new waves of politicization, with the ruling political parties suspending the previous reform programs in order to launch their own initiatives (mayer-sahling 2004: 98). at the end of the negotiations with the candidates, the commission’s final reports highlighted the huge gap between legislation and implementation, asking for more efforts in this regard. other important areas covered by eu initiatives were the promotion of new training programs and the re-organization of policy-making and coordination, including the development of dedicated structures for the management of eu affairs. given the context described above, it is not surprising that the results have been quite limited also in these fields. as reported by verheijen (2000), even if a large number of training schools and institutes were established, the results had been quite modest. among the main problems in carrying forward these initiatives were financial constraints, low priority, the reluctant use of training as an element of reform programs and a generally negative experience with ‘imported’ training. at the same time, as far as the re-organization of the policy-making and coordination is concerned, it was the field in which sigma and the commission’s assessments were the most negative. at the end of the negotiations, the policy-making and implementation processes of ceebs still had many features of the previous system, such as top heavy co-ordination, duplication of functions and lack of clearly defined accountability structures. while the dedicated structures for the management of eu affairs were judged sufficient for transposing the acquis, strong concerns were expressed regarding the ability of the public administration of the new member states to work within the eu policy system. however, the most negative feature that emerged from these initiatives was the lack of sustainability of the reform of the public administration. in fact, at the time of accession the commission’s comprehensive monitoring reports highlighted the necessity to continue with reform initiatives, without effectively having at work, within the eu, any type of instrument to influence the development of public administration once a country has obtained eu membership. as shown by meyer-sahling in a sigma paper on the sustainability of civil service policy in the eight ceebs five years after accession (meyer-sahling 2009),11 there has been a high discrepancy between pre-accession and post-accession policy. with the only exception of lithuania – and all baltic states, with some qualifications, that continue with the pre-accession path – all the other countries have shown a policy reversal. on the one hand, hungary and slovenia presented “constructive reform reversals”, since new reform initiatives took place after accession but without the general framework provided by the commission and sigma, leading to an increasing gap with respect to european principles. slovakia, poland and the czech republic, on the other hand, are classified as countries with “destructive reform reversals”. in this case, all three countries dismantled the reforms of the civil service that were initiated before accession without providing a policy reorientation. 11 see also meyer-sahling 2011. 10 economic analysis (2015, vol. 48, no. 1-2, 1-18) overall, the results in the application of the administrative capacity criteria in ceebs have been, at best, modest. several factors interfered in mitigating the effect of eu conditionality. firstly, the late introduction of administrative criteria and the lack of clarity on the standards substantially slowed down the process, leaving little space for the implementation of new legislation. secondly, eu conditionality in this field has been weak. on the one hand, horizontal administrative requirements never reached high priority on the agenda of the commission, with limited eu funds dedicated to the construction of a better public administration. on the other, the threat to deny membership to a candidate country on the basis of its lack of administrative capacities was not credible. a third negative factor is the lack of domestic ownership of these reforms, since they were strongly dependent form external stimuli. the results obtained by eu conditionality in this field did not reach a sufficient degree of internalization and institutionalization before accession and remained locked in the domestic domain. given the lack of powers of the eu in this field, the administrative developments after eu accession, diverging often from the european principle of public administration, seemed to depend almost exclusively from internal political constellations. from this perspective, however, what appears more problematic is the nature of eu intervention in this field. the efforts made by the commission and sigma to construct the horizontal administrative requirements as a sort of “non formalized acquis communautaire”, implying a strong convergence hypothesis, does not seem to have contributed to major clarity and success of eu conditionality in this field. during accession negotiations, the process of approximation of a candidate country to the acquis communautaire implies a specific status. after accession the acquis becomes part of the domestic legal order of a member state, and the specific goals of functional integration that are covered by eu laws turn out to be deeply plugged in the ordinary functioning of the state. this is clearly not so in the case of administrative standards, in relation to which not only there is no administrative acquis, but the existence of informal rules leading member states’ public administrations towards convergence seems to be problematic. this opens the question whether it wouldn’t have been better to have openly thematized eu requirements for public administration as an effort of external assistance to institution building and state consolidation, rather than as an approximation to common european standards. the administrative capacity criteria in the western balkans: the accession of croatia and the necessity to renew accession toolbox after its emergence and application through soft conditionality during the 5th european enlargement, the administrative capacity criteria have rapidly gained importance with the eu enlargement process reaching the western balkans, receiving an even greater attention during the accession of croatia and becoming today, together with the rule of law and economic governance, one of the three pillars of the new eu enlargement strategy (european commission 2014). the rising importance of the administrative capacity criteria within the agenda of the commission can again be seen as an expression of both stronger political conditionality utilized by the eu to address the specificities of the western balkan region, and the result of the experience that was gained during the previous enlargements. more generally, the approximation of the eu enlargement policy to the western balkans seemed to bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 11 generate a dilemma between stability and efficiency, requiring a serious adjustment in the eu “accession toolbox”. as noted by tanja a. börzel, “on the one hand, the eu has offered the western balkans a membership perspective to stabilize the region and overcome problems caused by weak and contested statehood. on the other hand, it is the limited statehood of western balkan countries which undermines their compliance with eu norms and rules” (börzel 2011: 5). within this context of limited statehood that has, in different ways, characterized all the countries of the region, the efforts made by the commission to give today a central role to the administrative capacity criteria seems to represent a fundamental part of a reorientation of the eu enlargement policy. the limits of the “old approach” in relation to the western balkans emerged clearly during the process of negotiations and accession of croatia. even if stronger political conditionality was applied to croatia (bojinović and urlić 2015)12 and some efforts were made to renovate the eu enlargement strategy, the innovations of the overall approach have been quite limited, since the accession strategy that the commission has followed seemed to be largely on the path of the 5th eu enlargement. in relation to the administrative capacity criteria, the eu decided to put a greater emphasis on addressing administrative reforms from the early stage of the accession process and the eu and sigma provided extensive support to croatia’s public administration reform. however, the final result was limited in terms of its wider impact and sustainability. although eu conditionality did have some impact, as illustrated by several pieces of legislation, such as the general administrative procedures act (groß and grimm 2014), or in establishing new training structures, such as the national school for public administration, at the end of the negotiation process in 2011 the croatian public administration still appeared rather weak. the vicissitudes of the strategy of state administration reform can be seen as really emblematic of the difficulties that croatia has faced in producing a comprehensive review of its administrative structures. after a period of fragmented europeanization of public administration that started in 2001 with the signing of the stabilization and association agreement, croatia adopted a new strategy of state administration reform in 2008, a general framework that was to produce a final effort of modernization before accession (koprić 2008; 2011). however, the strategy suffered of considerable weaknesses. in fact, the strategy was adopted by the government but not by the parliament, it appeared to be highly normative without clear indicators for its monitoring and implementation, and it did not include a financial plan. whereas a special body to watch over the implementation of the strategy was established in autumn 2008 – the national council for evaluation of state administration modernisation – it was dissolved in summer 2009 (koprić 2011). at the end of the negotiations period the implementation of the strategy had been quite limited, since the croatian authority simply announced that the “implementation of the strategy was satisfactory”, but without providing any data sustaining such a statement (as reported by sigma baseline assessment of 2011, oecd 2011: 8). 12including post-conflict resolution and cooperation with other international institutions such as the international criminal tribunal for the former yugoslavia, the council of europe in relation with minority rights and the regional cooperation council with respect to regional post-conflict cooperation and reconciliation. these additional conditions are being applied to all the western balkan countries. 12 economic analysis (2015, vol. 48, no. 1-2, 1-18) the difficulties of croatia in consistently implementing the public administration reform strategy show very clearly some of the weaknesses of the current eu approach that affect all the countries of the region, primarily the problem of taking internal ownership of the reform initiative. whereas a substantial improvement of administrative capacities was needed, the weakness of the administrative capacities and the internal fragmentation of powers biased the ability to adequately implement the strategy. more precisely, the croatian case suggests three main groups of problems: (1) the problem of orientation, in terms of elaborating a credible long-term strategy; (2) the problem of motivations, given by low incentives and politicization of the administrative system; (3) and the problem of implementation, due to bureaucratic resistances and corruption. these difficulties exacerbate the problem of internal ownership that already was present in the ceeb countries, making the interplay between the external incentives and support provided by the eu and the internal actors very complicated. moreover, we have to bear in mind that croatia represents, together with serbia, the frontrunner regarding its administrative capacities, that scores better in comparison to macedonia or albania, with kosovo13 and bosnia and herzegovina being at the very bottom (elbasani 2008; 2012; börzel 2011). in different ways all these countries have suffered of limited statehood, that raises serious concerns about the decoupling between formal structures and rule-consistent behaviour. this problem of decoupling has been notoriously present also during accession of the ceeb countries (grzymala-busse 2004), but in a more moderate form. as stressed by börzel, all ceebs “suffered from weak capacities […] but were largely consolidated states” (börzel 2011: 11). on the contrary, in the western balkans, the lack of administrative capacities is more pronounced and seems to derive from the fragility of state sovereignty in both its internal and external dimensions. this is translated, in more concrete terms, in a high malleability of internal formal institutions to external influences but a low degree of effectiveness of these rules, leading to a greater gap between the legal framework and informal praxis. from this perspective, the report written by meyer-sahling for sigma on civil service professionalization in the western balkans (meyer-sahling 2012) illustrates the case rather well. on the one hand, western balkans countries have appeared to be very open to external influences and they outperform ceebs civil service systems – all except lithuania – in terms of their formal-legal alignment to the european principles of public administration (as defined by sigma), showing a medium-high level of fit. on the other hand, the main problem is the lack of rule effectiveness. in fact, despite this formal-legal alignment, the rules are poorly implemented, often failing to achieve the designed outcomes. all this seems to highlight a weakness of internal political agency in both dealing with the demands coming from external actors, which would easily penetrate the internal domain, and making internal rules effective. 13this designation is without prejudice to positions on status, and is in line with unscr 1244/99 and the icj opinion on the kosovo declaration of independence. bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 13 the new enlargement strategy and the administrative capacity criteria: the eu as a state builder in the western balkans? given these difficulties, after the closing of the negotiations with croatia the eu has undertaken a major transformation of its enlargement policy from 2012 onwards, producing in the arch of three years a general reorientation of its enlargement strategy (european commission2012; 2013; 2014). through its annual communications on the enlargement strategy and main challenges, the european commission has progressively shaped a new enlargement strategy based on the three pillars: the rule of law, economic governance and public administration reform. in 2012, the communication of the commission has introduced a new approach to the rule of law by changing the negotiations framework for montenegro and for future negotiating countries – this new framework is today applied also to serbia that started negotiations in january 2014. the new framework strengthens political conditionality, overcoming the traditional way of opening of the negotiation chapters and giving priority to the chapters on judiciary and fundamental rights and justice, freedom and security, in order to put the rule of law at the core of eu enlargement policy. in 2013, a new strategy on economic governance and competitiveness has been formulated, strengthening the economic dialogue with enlargement countries. the new strategy introduces new mechanisms of coordination and preparation of national reform strategies, which now include both macroeconomic and fiscal programs and structural reforms. finally, in 2014, a new approach on public administration reform has been introduced. the new three-pillars approach is characterized by a strong focus on fundamental reforms, that have to be addressed early in the enlargement process. it represents a clear effort to overcome the limits of eu policies in the past, especially those related to the fragmentation of chapter-by-chapter negotiations that has exposed eu power, exercised through conditionality, to high degrees of dispersion (grabbe 2001). the new approach aims to strengthen the credibility of eu transformative power by elaborating a more holistic approach in which the strategy’s three pillars are clearly strongly interdependent, having a mutually reinforcing impact among themselves. the strengthening of the rule of law has an impact on economic development and on public administration. effective, reliable and predictable legal and administrative systems represent the basic infrastructure for economic dynamism and for attracting foreign investment. and an open and efficient public administration that is capable of properly implementing political decisions and representing the rights of its citizens lies at the very basis of mutual trust between the rulers and the ruled, of political legitimacy and of democratic governance. one of the most significant features of the new eu enlargement strategy is its strong focus on horizontal aspects of candidate countries’ governance, which do not bear any particular relation with eu policies and functional integration. in other words, the three pillars approach focuses eu conditionality on pushing for reforms that could be desirable and pursued regardless of future effective accession to the eu by a candidate country, and that could be well framed also in terms of national interests. this of course does not mean that the strategy is not related to eu integration. however, despite the sometime alleged antagonism between european integration and national sovereignty, the new approach shows how a well functioning national system, capable of formulating national interests in a 14 economic analysis (2015, vol. 48, no. 1-2, 1-18) coherent manner and implementing them consistently, represents a fundamental premise for eu membership. from this perspective, the central role of public administration reforms in the new eu strategy, that represents a fundamental step for empowering national public institutions, is not surprising. the high priority given to the administrative criteria aims to increase eu external push and internal ownership at the same time by making horizontal administrative requirements fundamental obstacles for accession and framing them in terms of national interest. another important part of the strengthening of the eu external push has come from a further clarification of eu administrative requirements through a new sigma initiative to support the commission – the principles of public administration (oecd 2014). through this initiative, the sigma has produced a renewed baseline assessment according to the six priority areas specified by the commission, which include: strategic framework for public administration reform; policy development and coordination; public service and human resources management; accountability; service delivery; and public financial management. these sigma principles provide a new framework for both benchmarking performances – defining 19 key requirements of a functioning public administration – and providing a guide to local policy-makers in the reform process – shaping 48 key principles that focus on implementation, evidence based monitoring and performance of the system in practice. the introduction by both the commission and sigma of a special focus on the strategic framework for public administration reform represents one of the main innovations of the new approach. it puts an unprecedented emphasis on the necessities of a political commitment and political leadership in candidate countries regarding the reform process, providing new means of technical coordination and a monitoring framework for the implementation of the reform strategies. moreover, in order to shape a more structured dialogue with the enlargement countries, new special groups on public administration reform have been introduced. the special groups on public administration reform have already met in albania, kosovo, the former yugoslav republic of macedonia, montenegro and serbia, becoming part of the eu delegation to these countries. these special groups on public administration reform aim, in particular, to stimulate long-term political support and better coordination of reform initiatives at the local level. overall, the new approach on public administration reforms aims to reinforce the credibility of eu transformative power and tries to overcome the shortcomings of the past by both strengthening eu external push and increasing local ownership and leadership of the reform process. the positive effects of the new approach have been evident in serbia and montenegro, the two countries of the region presently negotiating eu membership, as both countries have adopted new action plans for the implementation of the national public administration reform strategies by the end of 2014, in close cooperation with the special groups on public administration reform within the eu delegations and sigma. however, the administrative capacity criteria do not address only countries actually negotiating eu membership, but all candidate and potential candidate countries, making eu conditionality today stricter, but more coherent than in the past. the fulfilment of the administrative capacity criteria is today one of the fundamental preconditions for entering the eu, in relation to which all western balkans countries have to conform if they want to proceed in bonomi, m., the emergence and consolidation, ea (2015, vol. 48, no. 1-2, 1-18) 15 their path towards the eu; an underestimation of the administrative capacity criteria could substantially delay and jeopardize their possible accession. 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(1996). administrative law under european influence: on the convergence of the administrative laws of the eu member states. london: sweet & maxwell. tuori, k. 2010. ratio and voluntas. the tension between reason and will in law. helsinki: ashgate. verheijen, a. j. g. 1995.constitutional pillars for new democracies. leiden: dswo press. verheijen, a. j. g. 2000. “administrative capacity development: a race against time?” wrr working documents, 107. verheijen, a. j. g. 2003. “public administration in post-communist states”. in handbook of public administration, ed. peters, b. g. and pierre, j., 489-99. london: sage. ziller, j. 1998. “eu integration and civil service reform”. in preparing public administrations for the european administrative space, oecd, sigma paper 23, 136-54. paris: oecd publications. nastanak i konsolidacija kriterijuma administrativnih kapaciteta u okviru politike proširenja eu rezime – ovaj članak daje kritičku ocenu nastanka, razvoja i konsolidacije kriterijuma administrativnih kapaciteta za ulazak u evropsku uniju (eu). kriterijumi administrativnih kapaciteta su se prvi put pojavili prilikom petogprošrenja eu (2004-07) usled slabog političkog uslovljavanja, gde su kriterijumi imali ograničen uticaj. kriterijum dobija na značaju u procesu pristupanja hrvatske, pokazujući određene promene u politici proširenja euu cilju rešavanja specifičnosti zemalja zapadnog balkana. zaključak je da su ovi kriterijumi danas postali glavni deo nove strategije proširenja eu, predstavljajući stroge uslove koje treba da ispune sve zemlje kandidati ukoliko žele da nastave na svom putu ka eu. ovo preusmeravanje predstavlja veliku promenu u prirodi politike proširenja eu. ključne reči: kriterijumi administrativnih kapaciteta, politika proširenja eu, javne administrativne reforme, ceeb, zapadni balkan article history: received: 28 may, 2015 accepted: 1 june, 2015 doi: 10.28934/ea.23.56.1.pp85-94 first online: june 30, 2023 original scientific paper does real income and population matter in evaluating domestic trade performance? evidence from nigeria musa nakorji1 | emmanuel enebeli1 | yunah bulah1 | seyi akadiri6 f*1 1 research department, central bank of nigeria, nigeria abstract domestic trade has been a key sector in the nigerian economy in terms of economic sustainability, following its performance and resiliency in both tranquil and turbulent periods. using autoregressive distributed lag (ardl) model for the period 2012q3 to 2022q3, this study examines the impact of factors driving trade growth in nigeria. the findings show that growth in the country’s population and per capita income are the major factors driving domestic trade growth in nigeria in both short-run and long-run periods. also, changes in exchange rates positively impact domestic trade growth in the long-run period; information technology, in terms of growth in numbers of internet subscriptions, as well as trade openness, do not have a significant impact on trade growth. we suggest that the government expand internet coverage across the country and intentionally deepen the awareness of growing trade globalisation and its benefits to citizens and the nation’s economic growth. keywords: domestic trade, economic growth, nigeria, ardl model jel classification: f10, f15, f40, f49 introduction this study examines the determinants of domestic trade performance in nigeria given the rising contributions of the sector to the economy. trade has contemporarily been one of the driving forces of nigeria’s economy in both tranquil and turbulent periods. from the last two recessions of 2016 and 2020, the services sector showed stronger resilience to external shocks, respectively, caused by the global crude oil market supply glut and the covid-19 pandemic. amidst the services sector, trade and ict subsectors have remained the intrinsic drivers of the sector’s performance over the years. however, this study aims at examining the possible driving factors behind domestic trade performance in nigeria. currently, there is an increasing pursuit for trade expansion by the nigerian government, following the signing of the african intercontinental free trade agreement (afcfta). with deliberate efforts towards the development of basic infrastructures such as railway system, inter-city road networks, seaports, and airports, the country aims at increasing government’s generated revenues, creating more job opportunities and improving of citizens’ welfare. thus, this study will enlighten stakeholders on the performance of the domestic trade subsector and possible factors facilitating growth in the sector. the nigerian economy, like most emerging economies, has witnessed a continuous shift from a resource-oriented to a services-driven economy. within the period of 1990 to 2000, the industry sector contributed about 46.5 percent share of the gdp, followed by the services sector with a * corresponding author, e-mail: ssakadiri@cbn.gov.ng 86 economic analysis (2023, vol. 56, no. 1, 85-94) share of 35.5 per cent while the agricultural sector share of the gdp averaged 18.1 percent. however, between 2001 and 2010, there were major changes in three sectoral contributions to the gdp. the services sector surpassed the industry sector to become the largest, as its share of gdp grew to 43.1 percent. the industry sector had the second largest share of the gdp during this period (32.4 percent), while the agriculture sector improved further in the decade, having a share of 24.5 percent of the gdp. from 2011-2021, the services sector takes up over half of the share of real gdp (52.40 percent). the agriculture sector’s share of the real gdp (24.46 percent) during this period inched up to being the second largest, away from the consistent third. the industry sector with a share of 23.14 percent, declined from a once dominating sector to less than half the share of the services sector. according to the country’s national bureau of statistics (nbs) data, the size and value of domestic trade in the economy have continued to grow over the years. slowed by the negative impact of the covid-19 pandemic, the sector in 2020 plummeted to negative 8.49 percent growth, with a total value of n10.46 trillion and a 14.94 percent share of the gdp. however, the sector’s performance rebounded in 2021, following the government’s interventions aimed at ameliorating the impact of the pandemic. trade gdp recorded a value of n11.36 trillion, with a growth rate of 8.62 percent and a 15.69 percent share of the overall gdp in 2021. subsequently, the sector’s gdp value stood at n11.94 trillion in 2022, with a growth of 4.54 percent and 16.00 percent share of the overall gdp. various empirical studies have shown that trade can be determined by various factors which include household consumption expenditure, government expenditure, foreign income, money supply, exchange rate, trade liberalization, domestic income, gdp per capita, trade openness and population, among others. such studies include akototo & sakyi (2019), he (2019), alhanom (2016), correia (2008), keho, (2021), nageri, ajayi, olodo & abina (2013), abdullahi & suleiman (2008), abasiakan, sani & obiezue (2021), ganbaatar, huang, shuai, nawaz & ali (2021), yasar, akalin erdogan & sarkodie (2022), taşseven & yılmaz (2021), márquez-ramos (2007), mbogela (2019), van (2002), edwards & alves (2006), among others. looking at the literature, akototo & sakyi (2019) find that foreign income and money supply are positive and significant determinants of trade in the short run. a study by he (2019) also finds that the real exchange rate has a positive effect on bilateral trade between china and us. however, a study by alhanom (2016) finds that real exchange is an insignificant determinant of trade balance in both the short and long run, while domestic income and foreign income appear to be important determinants of trade balance in the long run. yasar, akalin erdogan & sarkodie (2022) finds that the gdp per capita of partner countries has a positive impact on china’s export. it is therefore evident that most reviewed studies have focused on the determinants of international trade – import and export. also, reviewed studies have revealed that there is little empirical literature on the determinants of domestic trade in nigeria. the objective of the study is therefore to examine the major factors driving domestic trade growth in nigeria. this is because the focus of the study is on the determinants of domestic trade and not international trade. the study will then test the hypothesis of whether internet subscription, per capita income, trade liberalisation proxied by export minus import, an exchange rate (usd) and population affect domestic trade growth in nigeria. the remainder of the study is organised as follows. section 2 describes factors driving the domestic trade performance in nigeria. section 3 contains data descriptions and estimation methods, while section 4 contains the empirical results and analysis. lastly, section 5 is devoted to the study’s conclusion and policy recommendations. concept of domestic trade domestic trade refers to the exchange of goods and services between the citizens of a country. it comprises all purchasing, selling, and trading activities of every kind carried out within a musa nakorji, emmanuel enebeli, yunah bulah, seyi akadiri 87 specific nation, such as nigeria. a domestic market is one where supply and demand for goods and services take place exclusively within one country. in this situation, the vendors and the main clients typically come from the same country and interact while exchanging goods and services. there are factors that might drive domestic trade as empirically verified by literature akototo & sakyi (2019), he (2019), alhanom (2016), correia (2008), keho, (2021), nageri, ajayi, olodo & abina (2013). factors driving domestic trade performance in nigeria i. technological innovations advancement in technological innovations has continued to propagate the online trading marketplace. traders now leverage various innovations and tools to carry out trading and make money online. most major towns and cities all over the world make use of the internet, and the rise in internet penetration has been driven by technological innovations through the emergence of smartphones that has applications to facilitate trade. the major advantage of technological innovation is that it made trading more accessible. it is therefore significant to emphasise that online trading has gathered pace over the last few years. for instance, this innovation has brought about the online marketplace and malls such as konga, jumia, amazon, alibaba, etc. studies by freund & weinhold (2004), banerjee, bhattacharya, dave & koner (2018) haltenhof (2019), bai (2019), chen, huang, zheng, & zhang (2019) and rodriguez-crespo, marco & billon (2021) stressed the positive impact of technological innovation on trade. ii. trade openness trade liberalisation through openness has contributed to domestic trade in nigeria. openness to trade helps in providing the domestic economy with the needed goods and services for human satisfaction and welfare. ijirshar (2019) noted that trade liberalisation facilitates knowledge diffusion and competition in the domestic market, which leads to greater economic efficiency. due to the link between trade and the overall economy, fetahi-vehapi, sadiku & petkovski (2015) and fagbohun & adekoya (2016) noted the positive impact of trade openness. however, studies by fatima, chen, ramzan & abbas (2020) stressed that trade openness may have a negative impact. iii. population growth growth in the population of a country affects the level of trade within an economy. an increasingly rising population results in a rise in consumer demand for goods and services, which affects the level of domestic trade. a study by savaş (2008) supports the assertion that growth in population had a strong positive impact on the economy. however, a growing population exerts pressure on available existing resources within an economy. this assertion was supported by peterson (2017). iv. per capita income this is one of the indicators that may affect the level of domestic trade within an economy. it measures the level of output within an economy relative to the population and reflects the total wellbeing and welfare of a given population. this means that the ability of a county's population to share its total production is demonstrated by allocating the total production to each head of the population. the higher the per capita income, the higher the standard of living. in relation to trade, fagbohun & adekoya (2016) stated that per capita income is positively and significantly related to trade. however, onyendi (2021) tried to stress a negative relationship between per capita income and trade in his study. 88 economic analysis (2023, vol. 56, no. 1, 85-94) v. exchange rate this is one of the factors that affect domestic trade within an economy. changes in exchange rates have an impact on the cost and prices of imported products, services, and exports. because imports and exports account for a sizable portion of the economy (cbn, 2016), an appreciation in the exchange rate may lead to improved domestic trade and a depreciation may lead to lower trade within the domestic economy. it is worth noting that the local demand for foreign currencies, the country's trade balance, and the health of the economy affect the exchange rate. razak, n., & masih, m. (2018) assert a long-run asymmetric relationship between exchange rate and trade. yakubu, sani, obiezue, & aliyu (2019) also found a long run relationship, however, a negative relationship in the short run. data and method of estimation the steps taken to achieve the study’s objective are outlined in this section. the data definitions, model specification, descriptive statistics and stationarity test results are explained in the first part. the methods of analysis are presented in the second part. model specification and data to estimate the determinants of domestic trade performance in nigeria, the study collates quarterly data on nigeria’s domestic trade, internet subscription, per capita income, trade liberalisation proxied by export minus import, an exchange rate (usd) and population from the national bureau of statistics (nbs) database. the choice of the variables was based on variables used from other empirical studies (nuroglu, 2010, alhanom, 2016, yasar, akalin, erdogan & sarkodie 2022 and mbogela 2019) the data range and observations were limited to 2012q3 to 2022q3 because of available data on internet subscriptions in the country. the data was further converted to their growth rate before further analyses were carried out.the descriptive statistics for the set of variables are presented in table 1, where: gtrade denotes the growth rate of domestic trade; gisub denotes the growth rate of internet subscription; gpci denotes the growth rate of per capita income; gtlib denotes the growth rate of trade liberalisation; gexr denotes the growth rate of exchange rate; and gpop represents the growth rate of population. we assumed that there is a functional equation linking the trade growth with identified drivers in this study. this equation is specified below: gtrade = f(gisub, gpci, gtlib,gexp,gpop) (1) table 1. descriptive statistic gtrade gisub gpci gtlib gexr gpop mean 0.748928 4.576010 0.264567 -45.46200 2.705499 0.626506 median 1.561049 2.687445 2.879939 -18.58146 0.726718 0.651345 maximum 22.16414 39.72413 15.03314 283.9531 31.41846 5.164787 minimum -15.68458 -6.060874 -15.45733 -1500.701 -19.31964 -3.443714 std. dev. 8.110612 7.554986 8.929318 266.5548 7.434767 0.999110 skewness -0.021437 2.614966 -0.602315 -4.157478 1.303455 0.670117 kurtosis 3.186997 12.87316 2.041414 23.59055 8.980312 18.45066 jarque-bera 0.061343 208.0524 3.950031 821.8490 70.93352 400.8652 probability 0.969794 0.000000 0.138759 0.000000 0.000000 0.000000 sum 29.95710 183.0404 10.58266 -1818.480 108.2200 25.06026 sum sq. dev. 2565.499 2226.035 3109.576 2771006. 2155.755 38.93060 observations 40 40 40 40 40 40 musa nakorji, emmanuel enebeli, yunah bulah, seyi akadiri 89 unit root test to further ascertain the time series properties of the variables, the study conducts unit root test using the augmented dickey-fuller approach as presented in table 2. from the result, gtrade and gpci are stationary at the first difference, while the rest of the variables are stationary at level. the mixed order of integration among the variables underpins the use of the autoregressive distributed lag model (ardl)/bounds test technique in achieving the objective of the study. table 2. augmented dickey-fuller unit root test variables level first difference order of integration intercept trend and intercept intercept trend and intercept gtrade -2.749 -2.695 -16.999*** -16.773*** i(1) gisub -3.474** -4.0316** i(0) gpci -2.290 -2.228 -37.236*** -36.706*** i(1) gtlib -6.009*** -6.238*** i(0) gexr -4.334*** -4.415*** i(0) gpop -6.936*** -6.852*** i(0) note: ** and *** represent statistical significance at 5% and 1%, respectively method of estimation the ardl technique applied in this study is as in pesaran & pesaran (1997) and pesaran et al. (2001). the technique offers versatility irrespective of the level of integration of the variables and it is useful where the series are stationary at level, at first difference or mutually integrated. following the objective of the study, we specify the ardl model as shown in equation 2. ∆𝐺𝐺𝑇𝑇𝐺𝐺𝐴𝐴𝐺𝐺𝐸𝐸𝑡𝑡 = 𝜎𝜎0 + ∑ 𝜑𝜑𝑖𝑖∆gtrade𝑡𝑡−𝑖𝑖𝑃𝑃𝑖𝑖=1 + ∑ 𝛾𝛾𝑗𝑗∆gisub𝑡𝑡−𝑗𝑗 𝑞𝑞1 𝑗𝑗=0 + ∑ 𝜕𝜕𝑙𝑙∆gpci𝑡𝑡−𝑙𝑙 𝑞𝑞2 𝑙𝑙=0 + ∑ 𝜔𝜔𝑚𝑚∆gtlib𝑡𝑡−𝑚𝑚 𝑞𝑞3 𝑚𝑚=0 + ∑ 𝜌𝜌𝑛𝑛∆gexr𝑡𝑡−𝑛𝑛 𝑞𝑞4 𝑛𝑛=0 + ∑ 𝜏𝜏𝑠𝑠∆gpop𝑡𝑡−𝑠𝑠 𝑞𝑞5 𝑠𝑠=0 + 𝜎𝜎1gtrade𝑡𝑡−1 + 𝜎𝜎2gisub𝑡𝑡−1 + 𝜎𝜎3gpci𝑡𝑡−1 + 𝜎𝜎4gtlib𝑡𝑡−1 + 𝜎𝜎5gexr𝑡𝑡−1 + 𝜎𝜎6gpop𝑡𝑡−1 + 𝜀𝜀𝑡𝑡 (2) where gtrade denotes the growth rate of domestic trade; gisub denotes the growth rate of internet subscription; gpci denotes the growth rate of per capita income; gtlib denotes the growth rate of trade liberalisation; gexr denotes the growth rate of exchange rate; and gpop represents the growth rate of population. ∆ is the difference operator, 𝜀𝜀𝑡𝑡 stands for the stochastic error term. 𝜎𝜎0 is the intercept term. 𝜑𝜑, 𝛾𝛾, 𝜕𝜕, 𝜔𝜔, 𝜌𝜌 and 𝜏𝜏 represent short-run parameters. 𝜎𝜎1𝜎𝜎6 are the long-run parameters. the optimum lags are represented by 𝑞𝑞1, 𝑞𝑞2, 𝑞𝑞3, 𝑞𝑞4 and 𝑞𝑞5. the optimum lag lengths for the study were automatically selected by the eviews statistical software before further analyses were conducted. the study applies the bound test in equation 2 and upon the confirmation of a co-integration relationship among the variables, the study estimates the error correction form of the model as specified in equation 3. ∆𝐺𝐺𝑇𝑇𝐺𝐺𝐴𝐴𝐺𝐺𝐸𝐸𝑡𝑡 = 𝜎𝜎0 + ∑ 𝜑𝜑𝑖𝑖∆gtrade𝑡𝑡−𝑖𝑖𝑃𝑃𝑖𝑖=1 + ∑ 𝛾𝛾𝑗𝑗∆gisub𝑡𝑡−𝑗𝑗 𝑞𝑞1 𝑗𝑗=0 + ∑ 𝜕𝜕𝑙𝑙∆gpci𝑡𝑡−𝑙𝑙 𝑞𝑞2 𝑙𝑙=0 + ∑ 𝜔𝜔𝑚𝑚∆gtlib𝑡𝑡−𝑚𝑚 𝑞𝑞3 𝑚𝑚=0 + ∑ 𝜌𝜌𝑛𝑛∆gexr𝑡𝑡−𝑛𝑛 𝑞𝑞4 𝑛𝑛=0 + ∑ 𝜏𝜏𝑠𝑠∆gpop𝑡𝑡−𝑠𝑠 𝑞𝑞5 𝑠𝑠=0 +𝜆𝜆𝐸𝐸𝐶𝐶𝑇𝑇𝑡𝑡−1 + 𝜀𝜀𝑡𝑡 (3) where 𝐸𝐸𝐶𝐶𝑇𝑇 represents the error correction term and 𝜆𝜆 denotes the parameter of the adjustment term. finally, the study conducts post-estimation diagnostic tests to ensure that the fundamental assumptions of the ordinary least squares (ols) estimator are not violated. 90 economic analysis (2023, vol. 56, no. 1, 85-94) results and analysis ardl bounds test the bounds test result presented in table 3 indicates the existence of cointegration among the variables in the model. comparing the computed f-statistic value (10.167) with the upper bound critical values, the study observes that the null hypothesis of no cointegration cannot be upheld. we conclude that there is cointegration among the variables in the model, hence the reason for the ardl long-run estimation. table 3. bounds test result sign. level upper bound lower bound 10% 3 2.08 5% 3.38 2.39 2.5% 3.73 2.7 1% 4.15 3.06 f-stat. 10.167 ardl long-run estimates the result of the ardl long-run model is presented in table 4. the result indicates that growth in per capita income (gpci), the rising exchange rate (gexr), and growth in the country’s population (gpop) have a significant influence on domestic trade growth in the long run period. this is because as the income of individuals increases, they tend to increase their demand for the consumption of domestic goods, which influences trade. the result is in line with the study by yasar, et al. (2022) whose findings show that gdp per capita of partner countries has a positive impact on china’s trade. also, a rise in population has a potential influence on domestic trade in nigeria. a study by nuroglu (2010) finds a positive impact of population on trade for exporter countries. at the same time, growth in internet subscription (gisub) and trade liberalization (gtlib) do not have a significant influence. table 4. ardl long-run estimates variable coefficient std. error t-statistic prob. gisub -0.033416 0.055051 -0.606989 0.5507 gpci 2.223111 0.394191 5.639685 0.0000 gtlib -0.000424 0.001587 -0.267034 0.7922 gexr 0.110867 0.040338 2.748420 0.0124 gpop 4.845203 1.629187 2.974001 0.0075 c -3.146608 1.136740 -2.768099 0.0119 note: d(gtrade) is the dependent variable ardl short-run estimates the result of the ardl short-run estimation in table 5 shows that growth in domestic trade is significant in the previous one, two and three quarters, however, the outcome is negative in the latter two quarters. the short-run result also shows that growth in per capita income and population are positive and significant in the current quarter but negative and significant in the previous quarter. furthermore, the error correction coefficient which measures the speed of adjustment from short-run disequilibrium to long-run equilibrium shows a slow adjustment speed of about 35.73 percent per quarter (142.9/4%). musa nakorji, emmanuel enebeli, yunah bulah, seyi akadiri 91 table 5. ardl short-run estimates variable coefficient std. error t-statistic prob. d(gtrade(-1)) 0.370677 0.130267 2.845513 0.0100 d(gtrade(-2)) -0.237605 0.088174 -2.694715 0.0139 d(gtrade(-3)) -0.366800 0.072184 -5.081450 0.0001 d(gpci) 1.928713 0.129186 14.92975 0.0000 d(gpci(-1)) -0.802557 0.252383 -3.179921 0.0047 d(gpci(-2)) 0.248251 0.175557 1.414080 0.1727 d(gpci(-3)) 0.750625 0.121873 6.159065 0.0000 d(gpop) 4.903263 0.288786 16.97890 0.0000 d(gpop(-1)) -1.504431 0.435217 -3.456733 0.0025 cointeq(-1)* -1.429306 0.148597 -9.618668 0.0000 note: d(gtrade) is the dependent variable diagnostic tests the study subjects the estimated ardl model to some diagnostic tests to ensure that the estimates conform with the assumptions of the ordinary least squares (ols) estimator. the diagnostic tests result is presented in table 6. the study observes the absence of serial correlation and establishes that the residuals are homoscedastic and normally distributed. finally, the ramsey reset test result indicates that the model has been correctly specified. table 6. diagnostic tests test test type test statistic p-value serial correlation breusch-godfrey serial correlation lm test 1.246 0.331 heteroscedasticity breusch-pagan-godfrey 0.446 0.943 normality jarque-bera test 0.456 0.796 specification ramsey reset test 2.371 0.140 stability tests to ensure that the parameter estimates are not susceptible to gradual or sudden structural instability, the study subjects the model to a stability test which guarantees the policy relevance of the estimates. the cusum and cusum of squares tests for gradual and sudden parameter instability presented in figures 1 and 2 show that the parameters of the estimated model are stable and there is no evidence of structural breaks since the cusum blue lines in the graphs lie in between the significant red lines. -15 -10 -5 0 5 10 15 iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii 2017 2018 2019 2020 2021 2022 cusum 5% significance figure 1. cusum test 92 economic analysis (2023, vol. 56, no. 1, 85-94) -0.4 0.0 0.4 0.8 1.2 1.6 iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii 2017 2018 2019 2020 2021 2022 cusum of squares 5% significance figure 2. cusum of squares test conclusion and policy recommendation this study explains the contributions of domestic trade to nigeria’s economic growth and growth sustainability. developments in information technology, in the form of increased internet subscriptions; per capita income; trade openness; changes in the exchange rate (naira per us dollar); and growth in population were identified as possible influencers of domestic trade performance in nigeria. the findings of the study show that growth in the country’s population and per capita income are among the major factors driving trade growth in nigeria in short-run and long-run periods. also, changes in exchange rates positively impact domestic trade growth in the long-run period. therefore, empirical analysis conducted using the ardl technique shows that changes in per capita income and population are among the major drivers of trade performance in nigeria. following the results of this study and a review of other countries experiences, the study recommends the following policy actions to help expand domestic trade performance in the country. i. improve internet penetration and usage in the country’s hinterlands. ii. increase awareness through formal/informal education on the benefits of trade networking that accompanies innovations in ict. iii. sustain development trade-enhancing infrastructures across the country; 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(2022). trading kuznets curve: empirical analysis for china. empirica, 49(3), 741-768. article history: received: 25.4.2023 revised: 21.6.2023 accepted: 30.6.2023. corruption as an obstacle to pandemic response: a covid-19 case study bruno škrinjarić10f* | jelena budak1 | allison carragher2 introduction literature review data and methodology data sources empirical methodology and variables results descriptive statistics estimation of latent constructs model estimation discussion and conclusion acknowledgments references managers’ attitudes on sustainable development concept application in trading companies – evidence from serbia maja staletović11f* | srećko bačevac2 | mirjana stevanović3 | ljubica pantelić4 introduction theoretical background research methodology results analysis and discussion conclusion literature corporate news disclosure and competitive advantage: what factors influence s&p 500 companies’ competitive advantage during 2022 economic crisis? miloš petković12f* introduction literature review corporate news communication and disclosure the link between corporate disclosure and competitive advantage being competitive in crisis moments data and methodology data sample explanation qualitative analysis by statistical software preparing the text corpus results and discussion reinert’s method results word cloud analysis results conclusion acknowledgement references exploring the economy – environment interactions in the western balkans: a panel data analysis petar mitić13f* | aleksandra fedajev2 | milena kojić1 introduction literature review data and methodology results discussion and policy implications conclusion acknowledgments references is there a relationship between country development and citizens’ level of digital skills? marija antonijević14f* | aleksandra bradić-martinović1 | jelena banović1 | đina ivanović1 introduction literature review and hypotheses methodology results conclusion acknowledgments references impact of continuing education on stable employment and wages of men and women in serbia kosovka ognjenović5f*1 introduction literature review data and methodology results and discussion conclusion acknowledgements references cairó, i. & cajner, t. (2018). human capital and unemployment dynamics: why more educated workers enjoy greater employment stability. the economic journal, 128(609), 652–682. https://doi.org/10.1111/ecoj.12441 doerr, a. (2022). vocational training for female job returners effects on employment, earnings and job quality. labor economics, 75 (april), 102139. https://doi.org/10.1016/j.labeco.2022.102139 does real income and population matter in evaluating domestic trade performance? evidence from nigeria musa nakorji1 | emmanuel enebeli1 | yunah bulah1 | seyi akadiri6f*1 introduction concept of domestic trade factors driving domestic trade performance in nigeria i. technological innovations ii. trade openness iii. population growth iv. per capita income v. exchange rate data and method of estimation model specification and data unit root test method of estimation results and analysis ardl bounds test ardl long-run estimates ardl short-run estimates diagnostic tests stability tests conclusion and policy recommendation references ea_2014_1-2 udc: 336.774.3(497.11) ; 659.231:336.717.061 jel: h27, f10, g14 id: 207706380 original scientific paper the conceptual model of the credit information exchange system in global terms simović vladimir1, institute of economic sciences, belgrade, serbia ranković marko, sas, belgrade, serbia abstract – in current conditions, there are few rare initiatives regarding credit information exchange outside national borders. all of them have significant disadvantages and can only be applied on a limited number of countries. this paper proposes conceptual model of a credit bureau in global terms which succesfully solves the aforementioned problems and enables efficient credit information exchange in global terms. our results point to the fact that efficient credit information exchange in global terms is preconditioned by an adequate model of national credit bureau, international standards of credit reporting and unique identification of natural persons and legal entities. the basis of the conceptual model of a system for credit information exchange in global terms is a national credit bureau model which is organized in a manner which enables simple information exchange and distribution of accurate and reliable data to its users. a variation of such model is commercially used by the banking sector in serbia. key words: credit information exchange, international standards, credit bureau, model introduction the contemporary business environment in which creditors exchange information about credit line users, features the existence of a large number of credit bureau models and the lack of standardization of their business processes. these circumstances cause limitations in business operations of credit bureaus, which questions the basic purpose of their existence. one of the main indicators of a credit bureau’s capability to efficiently exchange credit information and build a reputation of a respectable institution is related to the data accuracy in its database and in its credit reports, respectively. the research conducted in various countries refers to the fact that information which comes from credit bureaus contains a significant percentage of errors. the research conducted in the usa in 2004 by the national association of state pirgs (2004) shows that there is 78% of errors in the credit reports of the largest national bureaus. an independent study was conducted in germany in 2009 (korczak et al, 2009) which showed that there is 45% of errors in the reports of the largest national credit bureau schufa. the research conducted in serbia on a sample of the national credit bureau (simovic et al, unpublished paper) showed that the reports of this institution contain 38% of errors. among the mentioned economies, the lowest percentage of materially 1 zmaj jovina 12, belgrade, serbia, e-mail: vladimir.simovic@ien.bg.ac.rs economic analysis (2014, vol. 47, no. 1-2, 3-18) 4 significant errors is present in the serbian credit bureau reports (approximately 5% compared to the usa where it is 25% and germany, where it is approximately 35%). the standardization of credit bureau business processes at the national-economy level represents the basic assumption of the credit information exchange process in global terms. if the final objective is the improvement of the credit information exchange process in global terms, we deem that it is essential to define standards to which the existing credit bureaus will adapt, and which will be the guiding point for newly created credit bureaus while establishing their business operations. when establishing the standards, the starting point should be the best practices of credit bureaus in the world, their advantages and limitations which should be minimized by necessary improvements. the initiatives for defining credit report standards must originate and be implemented by an institution which operates globally. we suggest that the world bank should be the initiator of this project, having in mind the significance and great experience of this institution, regarding the initiatives for national credit bureau development in developing countries. the starting point of this paper is the fact that there is a clearly defined need for credit information exchange in global terms but to this very day neither a commercial solution nor a conceptual proposal has been made which would efficiently satisfy the mentioned need and solve the problem of credit information exchange in global terms. the aim of this paper is to propose the model for credit information exchange in global terms which would successfully overcome the limitations of the rare initiatives currently operating internationaly and which wuold make the process of credit information exchange efficient. methodology used are qualitative methods. the basis for the succesful process of credit information exchange in global terms consists of a reliable credit information exchange system at the national-economy level. for that reason, before we define the conceptual proposal of the credit information exchange model in global terms, we will present the national model assumptions. literature review credit bureau and its characteristics are analysed by different authors in economic literature. jappelli et al. (2002) pointed out the fact that implementation of the credit bureau in a national economy lead to credit market development and decrease of credit risk. djankov et al. (2007) show that the effectiveness of different systems for the exchange of credit information varies between countries, depending on the degree of economic development. luoto, et al. (2004) identify three possible levels of exchanging information between credit institutions. the lowest level means there is no exchange of information. in these circumstances, financial institutions exclusively possess information about users of their own services. the next level means the exchange of negative information between creditors; they share information about the unsettled payments and debts of their clients. the most sophisticated level of information exchange between financial institutions is the exchange of both positive and negative information on the credit activity of their service users. simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 5 international finance corporation (2006), in its survey made in argentina and brazil, indicated that the exchange of positive and negative information between creditors, concerning credit activities of the debtors, lead to decrease in rate of unsettled financial obligations under credits by 22% (e.g. argentina), and 45% (e.g. brazil), compared to situation when only negative information were exchanged between creditors. a small number of authors deals with the subject of credit information exchange in global terms. one of the authors (jentzsch, 2007) presents two models of credit information exchange outside national borders. they are direct and indirect approach models. as it will be disscused later, these models have singnificant conceptaul and functional limitations which makes it difficult to use them extensively. it is worth mentioning that the association of consumer credit information suppliers (accis) is working for the establishment of a network of credit bureaus across europe under a project called the ‘key factor system’, which would ideally provide lenders with access to cross-border records through their national credit bureau (ferretti, 2008). proposed model of the credit bureau information exchange system at the nationaleconomy level model of the credit bureau information exchange system at the national-economy level can be organized in various ways. of all the active credit bureau business models in global terms, the model which we discuss below displays the best performance with regard to the accuracy of data in its database [3] and also has the highest application potential within the global credit bureau model. this model is used commercially by the credit bureau in serbia (simovic et al, 2011). this model emphasizes two key aspects of the credit information exchange: 1. the method of gathering credit information from creditors and other institutions 2. the method of matching credit information and generating credit reports creditors forward credit information to the credit bureau in standard format (e.g. xml).the procedure for credit information forwarding to the credit bureau by creditors is automated and based on taking relevant data from the production database of creditors, formatting and forwarding information. if this process is not automated because of the technological limitations of the creditor, the credit bureau can supply the creditors with the tools in a form of an application in which it is necessary to enter information in a prescribed format. the promptness of information in the credit bureau database will depend on whether the process of forwarding credit information from creditors is automated or manual. if this process is manual, daily update of credit information in the credit bureau database could not be expected (because of the significant loss of time and the need to hire staff for these jobs.) information, which creditors forward to the credit bureau in one of the alternative ways, goes through the validation process which checks for logic and syntax errors. the information which does not meet the xml schema specification and the requirements related to syntax and logic validity, is rejected by the credit bureau and returned to creditors for correction (it is shown with red arrows in figure 1). in this phase, it is of key importance to monitor the corrections made by creditors, which requires the formation of a specific economic analysis (2014, vol. 47, no. 1-2, 3-18) 6 department in the credit bureau. the data which meets the prescribed validation requirements is put in the private bases which every creditor has within the credit bureau database (it is shown with black broken arrows in figure 1). that ends the process of forwarding credit information by creditors. figure 1. proposed credit bureau model at the national-economy level source. authors when any of the creditors or other institutions which are a part of credit bureau operations sends a request to the credit bureau (it is shown with blue arrows in figure 1) in order to obtain a credit report for a specified natural person or legal entity, a search of all creditor’s private databases is performed, based on a unique identifier. an important assumption of this process, related to the privacy protection, is the fact that the credit bureau can access the private databases of creditors based only on a written consent of the natural person or legal entity for whom the credit report is generated. all the credit information related to a specified natural person or legal entity (identified by using a unique identifier) is loaded in the reporting database of the credit bureau and a unique credit report is generated. the credit report is distributed to the creditor that sent the request to the credit bureau (it is shown with green arrows in figure 1). the participation of creditors and other institutions in the credit bureau operations must be regulated by law. the state interests, which consist of achieving numerous positive effects by implementing the national system for credit information exchange, must be above single interests of credit bureau founders, creditors and other institutions participating in the operations of the national credit bureau. simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 7 the sources of credit information must be extensive. all institutions, which possess data that could be significant for financial accountability and discipline assessment of individuals or legal entities, must be a part of credit bureau operations. currently, these institutions are banks, leasing companies, state funds, ministries, credit-card companies, pension funds, insurance companies, mobile phone operators, trade associations, law courts, tax authorities, utility companies, etc. the wider the circle of organizations forwarding credit information about credit lines users, the more realistic is to assess the risk for each applicant while making credit decisions. the larger source of credit information will make the bureau's coverage ratio at least about 80% in the period of 3 to 6 years since the beginning of credit bureau operations. the information accuracy in the reports of the credit bureau optimal model is conditioned by the existence of a unique identifier and application of data validation rules. the said accuracy should be periodically checked by independent analyses, which should indicate possible issues and contribute to the further quality and accuracy improvement of data (the implementation of new validation rules, the improvement of data update, etc.) the minimum information necessary to obtain and keep in the data base of the credit bureau includes: • information about natural persons and legal entities • positive and negative information regarding the financial behavoiur of the aforementioned user groups • historical information for the period of at least 3 years having in mind the fact that the issue of privacy and privacy protection represents a significant assumption of credit bureau operations (which is differently regulated by legislation in international terms), additional attention must be paid while creating a optimal model proposal for a credit information exchange system . an efficient solution regarding privacy is possible thanks to the unique technical basis of this model. namely, every creditor gathers and stores credit information about its service users in its private database kept in the credit bureau database. practically speaking, that means that only the creditor has access and the right to use the credit information (this does not affect the privacy of the user). the credit bureau does not have access to the data in private databases of creditors, nor can it have unauthorized access. the only circumstance under which the credit bureau accesses confidential credit information of credit line users, which are in the private databases of creditors, is when the credit report is generated. the written consent of the user is the condition for the credit bureau to submit a request, which is based on a unique identifier, for gathering all the credit information about the user from various private databases of creditors and generating a single credit report. by signing the consent, the user agrees that the credit bureau can gather information about him/her and form a single credit report which will be used by a certain creditor to make a credit decision. this solution regarding privacy and access to confidential credit information is far more efficient and applicable in glogal terms than the mechanisms applied by the existing credit information exchange systems in which a credit bureau gathers credit information and has access to it and can even correct it at any moment. this manner of gathering credit information leaves possibility for misuse (selling information to marketing companies, theft of information, etc.) economic analysis (2014, vol. 47, no. 1-2, 3-18) 8 the aforementioned conceptaul proposal of the credit bureau model at the national economy level has its limitations (which is confirmed by the fact that there are errors in credit bureau reports in serbia based on this model of credit information exchange). the said limitations can be simply removed by improving the rules of logical and sintax data validation and improving the system for identification of natural persons and legal entities. what gives a comparative advantage to this model in comparison to others currently in use is the fact that the percentage of materially significant errors in reports of credit bureaus applying this model is considerably lower than in the business models of other credit bureaus existing in global terms. furthermore, from the organizational point of view this credit bureau model is far simpler for implementation since, unlike other models, it uses the organizational infrastructure of banks and other creditors, which eliminates additional expenditure for its implementation. adapting the existing credit bureau business models to the conceptual proposal experiences of developed and developing countries show that very often there are several private credit bureaus at the national-economy level (in some cases from 3 to 4). the economic logic behind this form of organizing credit information exchange activities at the national economy level is the fact that creditors often do not possess all the information regarding risk for a single applicant for a credit line and his/her financial discipline in different areas (debt settlement for a line of credit, utility companies debt settlement, mobile phone operators debt settlement, failed complaints based on various grounds related to financial obligations, personal bankruptcies, etc.) in some economies (e.g. japan) the attempt to solve this problem was made by implementing the national system for credit information exchange among credit bureaus, but this attempt has not given the expected results because of the fact that the data from different credit bureaus have different format, that it is very difficult to collect credit information about one applicant (which can be found in the databases of a larger number of credit bureaus), that duplicate credit files appear, that certain credit bureaus are not involved in the operations of the national system, etc. in the countries where the national credit information exchange system among credit bureaus does not exist (the usa and great britain), the issue of having insight into the overall financial status of a single applicant for a credit line is resolved by creditors taking all credit reports about the applicant from all credit bureaus. that increases the expenditures for creditors (paying the fee for the credit report) or for credit line applicants, which depends on the pricing policy of credit bureaus. furthermore, there is a possibility for credit information inconsistency which comes from different credit bureaus, but is related to a single applicant (different information about a single applicant from different credit bureau databases, which is based on the same grounds,). for the credit decision-makers (creditors), this manner of organizing credit information distribution brings increased error risk in credit bureau reports , because of the different credit information gathering method which is applied by each of them. the best manner to illustrate this example is in the usa where there is 78% of errors in various credit bureau reports. the national system for credit infromation exchange should be single. in other words, it is necessary that a national economy has only one credit bureau in order to jusify its purpose. simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 9 only at the level of one credit bureau it is possible to do timely corrections and provide consistency and compatibility of data which are in its database. individuals who do not agree with this standpoint would ask: „what should be done if we have large national markets with a considerable number of potential credit line users and creditors?“ the answer is simple the credit bureau should involve all potential creditors in its operations. offices of creditors involved in the credit bureau operations should also function as the offices of the credit bureau (where credit line users can receive information, solve complaints, etc.). with the formation of a single national credit bureau, it is possible to gather, process, collect, and store credit information and generate credit reports that will allow creditors to make optimal credit decisions. the problem with the standpoint of organizing the process of gathering and distribution of credit information at the national-economy level is the fact that there are several credit bureaus in a large number of national economies. according to our opinion, this problem can be solved by the regulatory policy of these countries' governments. the policy would cover the obligations regarding unification and standardization of gathering, processing and storing credit information and generating credit reports of the mentioned credit bureaus. every economy's national interest is banking sector stability and its basic assumption is the optimal allocation of resources of banks and other creditors working in the banking sector, which is prerequisite for a reliable system of credit reporting. furthermore, the national interest of every economy is the controlled expansion of credit activity (which benefits from credit information exchange), but also the increase in users' financial discipline in a large number of fields. when fixed and accepted credit information exchange standards exist at the national economy level (which are in accordance with international standards), solving the issue of a large number of national credit bureaus could be regulated in one of these alternative ways: 1. if we have credit bureaus which cover the same market segments at the national level (based on the industry and geographical area), it is necessary to conduct the market re-segmentation from a spatial point of view, and determine segments (in the same kind of industry) which certain bureaus will focus on (this option is for geographically large national economies).we deem that, if national economies with a large number of bureaus would go through a process of credit reporting standardization, it would be irrational for them to have a larger number of credit bureaus which cover the same market segments. that would unnecessarily duplicate credit information and increase the probability of error and duplicate credit files. 2. at the national-economy level, the market could be segmented according to industries of interest for gathering information about financial accountability of users (banking and leasing companies market, mobile phone operators market, the market of relevant information, which come from the public sources, for assessing the applicant's credit standing for a credit line, etc.) given that, every credit bureau could focus on one or more segments. economic analysis (2014, vol. 47, no. 1-2, 3-18) 10 by conducting market segmentation at the national level (whether from the geographical aspect or the aspect of industry) we would avoid data overlap and eliminate the appearance of duplicate credit files of a single user, which come from more credit bureaus. the following issue which should be solved is the manner of generating single credit reports (single user reports which contain all the relevant information about his/her financial discipline and accountability in servicing financial obligations). the mitigating circumstance is the previously conducted standardization of credit reporting, but the limiting factor is establishing the national interlinking system which would gather information from a large number of credit bureaus and generate a single credit report. figure 2. shows the national interlinking system. the state should make it obligatory for all the credit bureaus operating within its borders to be a part of this system in order to achieve successful functioning of the interlinking system. credit bureaus are not obligated to forward credit information to the interlinking system. it is only important that this system can receive credit information about a natural person or legal entity existing in all the credit bureaus' databases based on the request of a creditor or other institution using credit information and with the given authorization of the credit bureau involved in the system. figure 2. model of the interlinking system for national economies with a large number of credit bureaus source: authors therefore, the generating process of a single credit report which contains all the relevant financial information about a natural person or legal entity is conducted as follows. an institution which forwards certain credit information to a credit bureau, forwards the request for a single credit report to the mentioned credit bureau. the authorized credit bureau formats the request so that it is understandable to the interlinking system, approves and forwards it to the interlinking system. according to the received approved instruction, this national interlinking system credit bureau 1 financial institutio trade organizatio credit bureau n tax authority court credit bureau 2 financial institution mobile operator simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 11 system accesses databases of all credit bureaus in the system and, based on the unique identifier for natural persons (personal number, social security number, id card number, etc.) or legal entity (tax id number, registry code), collects information related to the mentioned persons and generates a single credit report. having in mind that each credit bureau in the system gathers credit and other financial information about a certain market segment, that eliminates the possibility of duplicate information about a natural person or legal entity. the critical point of this model is the unique identifier for natural persons and legal entities, which should enable collecting all the information regarding an entity found in databases of different credit bureaus and enable generating of a single credit report. the interlinking system could have the control function besides the operative function, in order to increase the efficiency of the system for credit and other financial information exchange at the national-economy level. the function features are as follows. all the requests for correction of data which are in credit bureaus' databases are forwarded to the interlinking system which monitors the correction and that increases the efficiency of credit bureau operations. a conceptual model of the credit information exchange system in global terms the aforementioned standardization process for credit information exchange and the proposal for the optimal model of a credit bureau at a national level represent a good methodological framework for defining key assumptions of the credit information exchange system which would operate in global terms . the question which should be answered is whether it is necessary to exchange credit information in global terms. the answer to the question is affirmative and the reasons for that are numerous. the principal cause of the increased need for credit information exchange is the increased mobility of people and capital. furthermore, creditors which operate in one market are more and more inclined to track natural persons and legal entities debts abroad in order to accurately assess their financial position. attempts to define a model which could enable credit information exchange outside national borders are rare and isolated in existing circumstances. one of the authors who deals with this subject is jentzsch (2007). this author points to the fact that, in contemporary terms, the development of credit information exchange occurs with acquisitions and mergers by leading world credit agencies (equifax, experian, creditinfo), thanks to which they spread their network to a larger number of countries or through partnerships with national credit bureaus (schufa, bkr). it is a fact that this approach improves credit information exchange but only between credit bureaus of countries in which subsidiaries of these major systems operate. the other significant shortcoming of this credit information exchange approach is the fact that the aforementioned major systems have limitations (a great percentage of errors in their credit reports, problems with collecting credit information about clients, etc.). that brings out the question of the purpose of the credit information exchange process outside national borders, which is based on the business model with apparent limitations. economic analysis (2014, vol. 47, no. 1-2, 3-18) 12 the aforementioned author suggests two alternative models related to credit information exchange among credit bureaus in several national economies. the first is the direct approach model based on contracts among credit bureaus from more countries (the indirect model approach). figure 3. shows how both models function. the direct model approach shows that the creditor in country a is directly linked with the credit bureau in country b. in this model of credit information exchange outside national borders, taking part in credit bureau operations is based on the principle of reciprocity. it means that the creditor in country a is obligated to forward its credit information to the credit bureau in country b. the indirect approach model implies that the creditor in country a addresses the credit bureau in its parent country with the request for the credit report of the applicant in country b. the credit bureau in country a, which signed a contract with the credit bureau from country b, forwards the request to the credit bureau in country b. the credit bureau in country b forwards the credit report to the credit bureau in country a, which forwards it to the creditor in country a. figure 3. models of cross-border credit information exchange source: jentzsch, n, do we need a european directive for credit reporting, cdsifo dice report, vol.5, issue 2, 2007. both suggested models for credit information exchange outside national borders have considerable limitations which restricts their intensive use. the key limitations of the direct approach model are: 1. this model may solve the problem of the applicant who is active in a small number of countries (2, mostly 3). if it is necessary to gather credit information about the applicant who has financial obligations under credit lines in a large number of countries, this model could not be applied. in such circumstances it would be necessary that all creditors from all countries have direct access to credit bureaus which operate on the territories of these countries. furthermore, one simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 13 more question remains unsolved: how will the creditor which gathers credit information about the applicant know in which countries the applicant is active? it is assumed that the applicant himself would give that information to the creditor, which stimulates information asymmetry (instead of eliminating it). 2. if this model were based on the assumption (the only possible) that, while assessing the applicant’s credit standing for a credit line, the creditor used credit reports from all credit bureaus involved in the model, the expenditure of acquiring these reports would be enormous. the additional problem is related to the analysis of the information present in the credit reports of various credit bureaus (the issue of data format, data kind, the degree of comprehensiveness, the creditor involved in information interpretation should hire additional staff, etc.) the aforementioned expenditures would increase the price of creditor’s services and make credit lines to costly for applicants. the key limitations of the indirect approach model are as follows: 1. as it is presented in the direct approach model, one of the key limitations is the lack of information on the applicants financial obligations in different national economies under various credit lines (information asymmetry). in this model, the additional problem is the fact that, if such information exists, the credit bureaus of the national economy where the creditor operates must have a bilateral agreement with the credit bureau of the country in which the applicant has financial obligations under one or more credit lines. 2. expenditures for acquiring credit reports from a large number of credit bureaus. 3. if standards for credit information exchange do not exist, the issues could be different credit information formats, different level of detail in information presented in credit bureau reports, different kind of data, (positive and negative) etc. this brings us to the conclusion that the direct and indirect approach models, proposed by jentzsch, can be applied in a limited number of countries. having that in mind, the basic purpose of these models is lost. the aforementioned limitations of these models make it difficult for creditors to obtain reliable information regarding the applicant's financial accountability. as a result, we will present a model of credit information exchange system in global terms which efficiently solves the mentioned issues (figure 4) hypothetically speaking, the credit bureau model operating in global terms would be very simple if all, or most, national economies implemented the proposed national model of the system for credit information exchange, assuming that the standards for credit information exchange were defined by a respectable international institution (world bank or other institution). figure 4. represents the proposal of the conceptual model of the credit bureau which would operate in global terms. as it can be seen, the basic assumption of this model is the implemented models of the credit information exchange system at the national level. figure 4. the conceptual model of the credit information exchange system in global terms source: authors simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 15 with this model, even the national economies with a large number of credit bureaus whose operations are in accordance with the proposal made earlier, can be involved in the credit information exchange system in global terms. gathering credit information from creditors, within the model, is conducted in the manner and rate explained in the part related to the optimal model of credit bureaus at the national level. the creditors forward credit information only to national credit bureaus, whose databases store that information. it is necessary for the system to have interlinking mechanism whose task is to, based on the creditors request from any country which is the part of the system, forward the request to credit bureaus of all other countries in the system. the interlinking mechanism does not have a database at its disposal, but only the function to direct creditors’ requests to credit bureaus of all countries that are part of the model. two operations take place when the creditor in country a forwards the request for a credit report to the national credit bureau. based on the unique identifier, the national credit bureau collects all information regarding the applicant in question, which exists in the database and loads it in the reporting base. concurrently, the national credit bureau forwards the request to the interlinking mechanism (only it has access to the databases of all national credit bureaus in the system) which further forwards the request to databases of all other national credit bureaus involved in the model. based on the unique identifier (which must be unique for all the countries in the model) all credit information about the applicant in the databases of national credit bureaus are collected and, using the interlinking system, are directed to the reporting base of the credit bureau of the national economy a. according to the information in the reporting base of the credit bureau in the national economy a, a single credit report is generated. the report contains information about the applicants’ credit activity within national borders, as well as abroad (if such activities occurred). the proposed model of the credit information exchange system in global terms efficiently solves the problems identified in models which jentzsch (2007) mentioned: • the issue of information asymmetry is solved since the model offers simple gathering of credit information related to a single applicant and from all national economies in which he is active (the condition is that the economies are in the system). • additional expenditures issue is solved by using a single credit report for assessing the applicant’s financial position. • the issue regrarding data format, data comprehensiveness and data kind is solved by standardization at the national level. one of the circumstances, which is favorable for organizing credit information exchange in global terms in proposed manner, is the information technology advancement. this simplifies and lowers the cost of creating the necessary infrastructure for involving domestic creditors in the national credit bureau system and connecting national credit bureaus in global terms. having in mind all these aforementioned facts, we can suggest that the two basic assumptions for successful implementation of the credit bureau model operating in global terms are: economic analysis (2014, vol. 47, no. 1-2, 3-18) 16 • standardization involving data format, validation rules (adapted to the local economy), data import into databases of national credit bureaus, credit information collecting, and scope and kind of credit information which is the subject of a credit report. • unification of unique identifiers in global terms. the unique identifier is essential for successful collecting credit information and generating reliable credit reports. we could overcome the issue of the non-existing universally applied unique identifier for private and legal persons by defining the standards for unique identifiers for the mentioned categories of credit line users. if this solution is not possible in global terms, having in mind the limitation regarding standardization and the need to involve a large number of national economies with implemented national credit bureaus, we deem that it is applicable in regional terms, such as the european union. the strong need for integration at eu level in different fields (the example of forming a single payments market with sepa initiative) brings us to the conclusion that, in the field of credit information exchange, it is necessary to define common standards and implement solutions which will enable eu creditors to assess risk of every applicant's credit line and enable optimal resources allocation. conclusion this paper points out that it is necessary to form the model of the national system which has a high degree of business performances in order to establish the optimal model of the system for credit information exchange in global terms. based on characteristics of the model of the credit bureau in serbia, the proposal for the model of the national system for credit information exchange is formed. it is suggested that the key assumptions of the national model of the credit bureau are the methodologies of gathering and collecting credit information which originates from various sources. we pointed out that standardization of credit reporting, which should be initiated and implemented by an international institution, plays the key role in establishing the model of the national and global credit bureau respectively. additionally, unification of the system for identifying private persons and legal entities, as well as the determination of regulatory authorities to regulate operations of such a system has a significant role. it is suggested that the existing models of credit bureaus currently operating in global terms could adapt to the conceptual proposal by modifying their business operations according to standards of credit reporting, even if there is a large number of credit bureaus at the national-economy level. by assuming that the international standards of credit reporting are adopted, that private and legal persons unique identification exists, according to the said standards, and that there is political will for establishing the efficient credit information exchange system in global terms, the paper defines the conceptual proposal of the model for the credit information exchange system in global terms. it is a very simple model based on the interlinking system. it can efficiently overcome the limitations of the systems for credit information exchange outside national borders, which are currently in use. simović, v., et al., the conceptual model of the credit, ea (2014, vol. 76, no,1-2, 3-18) 17 references djankov, s. mcliesh, c, shleifer, a, private credit in 129 countries, journal of financial economics, 84, 2007: 299-329. ferretti, f. the law and consumer credit information in the european community – the regulation of credit information systems, routledge-cavendish, 2008. international finance corporation, (2006) credit bureau knowledge guide, world bank group, washington dc, usa jappelli, t, pagano, m, information sharing, lending and defaults: cross country evidence, journal of banking and finance, 26 (10), 2002. 2017-2045. jentzsch, n, do we need a european directive for credit reporting, cdsifo dice report, vol.5, issue 2, 2007, pp. 48-54. korczak, k., wilken, m., verbraucherinformation scoring, gp forschungsgruppe, institut für grundlagen-und programmforschung, munchen, juni 2009 luoto,j, mcintosh, c, wydick, b, credit information systems in less-developed countries recent history and a test, economic development and cultural change 55, 2004: 313-334 national association of state pirgs, mistakes do happen: a look at errors in consumer credit reports, june, 2004. simovic, v, vasković, v, ranković, m, malinić, s, the accuracy of the information presented in credit bureau reports: research and comparative analysis, unpublished paper simović, v, vasković, v, poznanovic, d, performance evaluation of the serbian credit bureau model, african journal of business management, vol.5(11), 2011. pp 4594-460. konceptualni model za razmenu kreditnih informacija u globalnim okvirima rezime – u trenutnim okolnostima, postoji svega nekoliko inicijativa za razmenu kreditnih informacija van nacionalnih granica. sve one imaju značajnih nedostataka i mogu se primeniti samo na ograničenom broju zemalja. u ovom radu je predložen konceptulni model kreditnog biroa koji bi funkcionisao u globalnim okvirima i koji na efikasan način rešava pomenute probleme i omogućava efikasnu razmenu kreditnih informacja u svetskim razmerama. rezultati predstavljeni u ovom radu ukazuju na činjenicu da je efikasna razmena kreditnih informacija u globalnim okvirima uslovljena modelom nacionalnog kreditnog biroa, adekvatnim međunarodnim standardima za razmenu kreditnih informacija i jedinstvenim identifikatorom za fizička lica i privredne subjekte. osnova konceptualnog modela kreditnog biroa u svetskim razmerama je adekvatan model nacionalnog kreditnog biroa koji omogućava jednostavnu razmenu i distribuciju tačnih i pouzdanih kreditnih informacija korisnicima. varijanta takvog modela kreditnog biroa je u komercijalnoj upotrebi u srbiji. economic analysis (2014, vol. 47, no. 1-2, 3-18) 18 ključne reči:. razmena kreditnih informacija,međunarodni standardi, kreditni biro, model article history: received: 13 july 2013 accepted: 18 july 2013 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp121-132 original scientific paper the role of balanced scorecard models in the assessment of board of directors performance jelena peković1* | stefan zdravković1 | goran pavlović1 1 university of kragujevac, faculty of economics, department for business management, kragujevac, serbia abstract there are a number of performance management systems that are used as mechanisms to control corporate operations, and one of the well-known is the balanced scorecard. business control is a fundamental issue, and the board of directors is an important internal control mechanism for improving the performance and competitiveness of corporations. the board of directors represents the link between the owner and the manager and his task is to constantly monitor the manager and to make sure that they carry out their activities in a way that will maximize profits for the owners of the capital. for the board to perform its role, its members need to have the appropriate competencies. the specific knowledge, skills, abilities and experiences of board members represent human capital. the subject of the research is to examine the possibility of applying the balanced scorecard model in the performance evaluation of the members of the board of directors and to examine the impact of the compensations of the board members, which are viewed as a factor of motivation and investment in human capital (hce), on the financial performance of the company, namely the rate of return on the total invested capital and the total invested assets (roe and roa). the results of the research showed that the balanced scorecard is an applicable model for evaluating the performance of the members of the board of directors, and that the level of compensation of the board members is positively correlated with the financial performance of the company. key words: balanced scorecard, board of directors, human capital, compensation of board members, financial performance jel classification: o21, m41, e24 introduction modern business conditions are characterized by a turbulent business environment, increasing pressure from competition, a high degree of risk and uncertainty, and incomplete awareness of economic actors. an effective corporate governance system is essential for companies to achieve good business performance. it is necessary for certain control mechanisms to determine whether managers carry out their business activities in order to maximize profits for owners of capital. board members represent an important internal control mechanism. kaplan & norton (1992) have designed one of the most famous performance management systems, the balanced scorecard (bsc). the model includes financial and non-financial benchmarks. the bsc model starts from a defined mission, vision, goals and strategy of the company and defines specific goals, tasks, benchmarks and initiatives from four basic causal * corresponding author, e-mail: jelenapekipekovic@gmail.com 122 economic analysis (2020, vol. 53, no. 2, 121-132) relationships: financial perspective, customer perspective, internal business process perspective and learning and growth perspective. the paper particularly emphasizes the application of the bsc model in the performance evaluation of board members, with particular reference to the learning and growth perspective, which encompasses the knowledge, competencies, abilities and compensations of board members, which can also be seen as human capital of the company (hce), and to the financial perspective, where the most significant financial criteria are the return on invested capital (roe) and the return on total invested assets (roa). previous research has used a qualitative approach when examining the impact of board members' compensation on a company's financial performance (higgs, 2003; edlin, 2005; parker, 2007). the contribution of this research is reflected in the implementation of the quantitative approach, where the compensation of board members is viewed as an element of the human capital of the enterprise and their impact on financial performance is examined. this determines whether board members have a significant impact on business results, or whether companies should allocate significant cash to board members. human capital can be defined as a set of knowledge, skills, experiences, attitudes, dedication, innovation and competence of employees (wang, wang, & liang, 2014). the main carriers of the so-called human capital is the members of the board of directors and other employees, who, by implementing specific competencies, enable them to create value for the company and achieve sustainable competitive advantage (ghorbanhosseini, 2013). by building unique human capital, companies enhance their business performance (alnacher & alhajjar, 2017). the financial perspective encompasses a variety of benchmarks, the most significant of which are roa and roe, which simultaneously measure asset efficiency and the earning capacity of an enterprise. the subject of the research is to examine the possibility of applying the balanced scorecard model in the performance evaluation of the members of the board of directors and to examine the impact of compensation of the board members, considered as an element of human capital (hce), on the financial performance of the company, namely the rate of return on invested capital (roe) and total invested assets (roa). the aim of the study is to determine the validity of the balanced scorecard model for evaluating the performance of board members, and to determine whether board members' compensation, as an element of human capital (hce), has a positive or negative impact on a company's financial performance (roe and roa). based on the review of works in the existing literature, the qualitative methodology will determine whether the balanced scorecard model is applicable for evaluating the performance of the members of the board of directors, while the quantitative methodology will determine whether the human capital of the members of the board of directors has a positive impact on the financial performance of the company. the empirical survey includes a sample of 35 companies that, according to the agency for business registers, earns high net profit during 2017. in these companies significant funds are earmarked for the remuneration of the members of the board of directors, which makes them suitable for analyzing the impact of the board members' compensation on the financial performance of the company. literature review balanced scorecard as a performance management model kaplan & norton (1996) developed the balanced scorecard concept and suggested that the vision and strategy of a company be more specifically defined from four basic, interconnected perspectives: 1. financial perspective – how to see shareholders, the primary goal is to implement a strategy that will maximize profits for equity owners; jelena peković, stefan zdravković, goran pavlović 123 2. customer perspective how customers see us, the primary goal is to achieve some degree of customer satisfaction and loyalty, thus ensuring the company has a long-term profitable business; 3. perspective on internal business processes what processes help us to achieve a sustainable competitive advantage, how effective they are; 4. learning and growth perspective what kind of human capital we need to gain competitive advantage. kaplan & nagel (2004) propose a three-part bsc program that includes: 1. enterprise scorecard harmonized list of results at company level; 2. board scorecard harmonized list of board results; 3. executive scorecards harmonized list of executors' scores. harmonized list at the company level implies that top managers, starting from a defined company strategy, develop goals, tasks, benchmarks and initiatives through the four outlined perspectives. this ensures that the strategy is translated into operational terms. figure 1 shows the balanced scorecard model. figure 1. conceptual framework for balanced scorecard source: kaplan, r.s., and norton, d.p. 1992. “the balanced scorecard measures that drive performance“. harvard business review, 70(1): 71‐79 after building the harmonized list at the company level, it is necessary to build the harmonized list at the board level. that is, the board of directors should evaluate and approve the corporate strategy map and the corporate level harmonized list. a harmonized list at this level also contains four perspectives: (kaplan & nagel, 2004) 1. financial perspective identical to that in the harmonized list of results at the enterprise level, the goal is to maximize value for equity owners; 2. stakeholder perspective this is a broader perspective than at the company level, because it is now important to respect the interests of all stakeholders; 3. perspective on internal business processes explains how the board contributes to the achievement of shareholder goals and relates to performance monitoring, reward systems etc.; 4. learning and growth perspective captures human capital as a source of competitive advantage, related to the specific skills, knowledge and capabilities of board members. financial perspective customer perspective internal business process perspective vision and strategy learning and growth perspective 124 economic analysis (2020, vol. 53, no. 2, 121-132) this research examines whether the balanced scorecard model is applicable to assessing the performance of board members, with particular reference to linking the learning and growth perspective with the financial perspective. that is, it examines how board members with their competencies, knowledge and skills, generally viewed as human capital (hce), affect the financial performance of a company (roa and roe). epstein & roy (2004) propose that the harmonized list be used to evaluate the performance of board members. the model is presented in table 1. table 1. balanced scorecard model at the board level perspective goals measures financial perspective long-term and short-term earnings roa,roe, eva, share price interest group (stakeholders) perspective ethical behavior and respecting the law, high level of corporate management and responsibility, identifying interest group needs employee satisfaction. customer satisfaction, number of meetings with stakeholders intern business process perspective efficient crisis management, company plans evaluation, compensation systems business performance during crisis, clear goals for board members, number of hours spent in defining corporate strategy learning and growth perspective improving board of directors structure, skills and knowledge of board members vaic, hce, training for board members source: epstein, m. j. and roy, m. j. 2004. “how does your board rate”. strategic finance, 28‐29. finally, a harmonized list of results also needs to be built at the executive level. the ceo builts harmonized list to ensure that the executive team performs activities and tasks in accordance with a strategy approved by the board. application of balanced scorecard model at board level there are numerous studies in the literature, which have examined whether the balanced scorecard model is applicable to the performance evaluation of board members. northcott & smith (2011) conducted a survey in new zealand with a view to reviewing the experiences of board members in applying the balanced scorecard model. large companies were selected for the sample to ensure that the effectiveness of the board of directors of some of the most influential companies in the country was examined. through a semi-structured interview, 35 board members expressed their views and experiences on the balanced scorecard approach. in addition to experience in applying the balanced scorecard model, additional criteria for selecting board members participating in the survey were that respondents were board members of at least two companies and spent at least three years in that position. in this way, it is ensured that the respondents can draw on the experiences of different companies as well as having spent sufficient time in the company. the contribution of the paper is reflected in the fact that their perceptions of the balanced scorecard model were expressed by the members of the board, who had experience in the practical application of the model. based on the processed interview results, the study concluded that the balanced scorecard is applicable at the board level and is a useful tool for evaluating the performance of board members. members of the board of directors indicated through interviews that the balanced scorecard model can be a very effective performance management system, and that by combining different goals and benchmarks from four basic perspectives, the performance of board members can be evaluated. jelena peković, stefan zdravković, goran pavlović 125 the study conducted in the territory of egypt (hussein & mansour, 2017), aimed to identify opportunities for the implementation of the balanced scorecard model in evaluating the performance of board members in the case of production companies. data were collected through questionnaires and in-person interviews, from three different samples: board members, manufacturing company managers, and financial analysts at brokerage firms. the results of statistical analyzes have shown that the balanced scorecard is an effective tool for evaluating the work of board members. the balanced scorecard model provides a comprehensive analysis and evaluation of the work of board members. based on the four model perspectives, it is possible to examine by appropriate benchmarks how members of the board of directors influence shareholder value creation, profit maximization, interest group satisfaction, internal business process efficiency, etc. the contribution of the paper is to provide empirical evidence on the feasibility of applying the balanced scorecard model, where by combining different indicators from four basic perspectives the performance of the board members can be evaluated. hoque (2014) provides an account of research on the balanced scorecard model as a mechanism for evaluating the performance of board members over the past 20 years. the research includes an overview of 114 papers published in accounting journals and 67 papers in management area. among other things, in the aforementioned papers, members of the board of directors spoke about their experiences in applying the balanced scorecard model in interviews, and there is empirical evidence that the model can be used to look at the impact of board members on shareholder returns, profit maximization, stakeholder satisfaction and more. based on the above, it can be concluded that the balanced scorecard model is applicable for performance evaluation of the members of the board of directors. however, the author suggests that it may be desirable that there be studies in the literature that will address the difficulties as well as potential failures in the implementation of the balanced scorecard model. such examples would be of benefit to companies planning to introduce a balanced scorecard model in their operations. chavan (2009) looks at the implementation of the balanced scorecard model in australian corporations. the growing importance of the model is discussed and the problems that companies face during implementation are explored. the case study method has been applied, the balanced scorecard model is being considered in two multinational corporations in australia. the first company did not achieve an appropriate level of profit, so it introduced a balanced scorecard model in its operations to analyze the impact of employees, including board members, on the profits made. the other company had extremely high operating costs, so with the introduction of the balanced scorecard model it improved the cost analysis and control. the results showed that it is possible to implement the model, but the limitation states that the outcomes may differ for smes. domanović (2017) points out that in the republic of serbia consistent application of the balanced scorecard model is achieved by those companies which are under the influence of foreign capital and are compelled to submit to the foreign owners business reports in accordance with the latest trends in measuring and managing the efficiency of companies. managers who have implemented the balanced scorecard are generally satisfied with the effects of applying the model on company performance. the best-rated performance is that the model provides a better understanding of stakeholders, clarifies and ensures that employees have a better understanding of the company strategy, increases owner satisfaction and provides an expanded customer base. also, the model is suitable for evaluating the performance of board members and considering their impact on the financial performance of the company. based on the above papers, which examined the possibility of applying the balanced scorecard model in the performance evaluation of the members of the board of directors, and in accordance with the subject and objectives of this research, the following research hypothesis can be formulated: h1: the balanced scorecard model can be used to evaluate the performance of board members. 126 economic analysis (2020, vol. 53, no. 2, 121-132) this research links the learning and growth perspective with the financial perspective from the balanced scorecard model. the objective is to determine how board members, through their compensation, viewed as human capital (hce), affect the financial performance of the company (roa and roe). if the members of the board of directors have an influence on the business results of the company, then it is justified to allocate significant funds to the board members. human capital and financial performance intellectual capital is defined as a kind of combination of intangible resources, which enables one company to survive in the market. one of the most well-known classifications implies that the components of intellectual capital are human, structural, and relational capital (meritum, 2002). human capital can be defined as a set of knowledge, skills, experience, attitudes, commitment, innovation and competence of employees (wang, wang & liang, 2014). human capital is considered to have four components (fitz-enz, 2000): elements that each employee brings to the work process (intelligence, energy, enthusiasm, experience, skills, emotional intelligence, and the like), ability to learn (promotion, imagination and creativity), ability to act (conversion of data into information for action) and motivation (information and knowledge sharing, development of team spirit and goal orientation, compensation of board members and other employees). modern business conditions require the construction of unique human capital, and it’s important to know that there is a difference between general and specific human capital. general human capital is acquired through education and may in some ways be accessible to all, but it will not lead to sustainable competitive advantage as it can be easily copied. that is why it is crucial to build specific human capital, which is unique to a given company and its employees. building specific human capital can be achieved by providing training, fostering creativity and innovation, respecting employees' ideas, involving employees in the decision-making process (luthans & youssef, 2004). the resource-based approach assumes that resources are a source of sustainable competitive advantage if they are rare, valuable, difficult to imitate, and unsuitable for substitution (barney, 1991). human capital is a critical resource for differentiating financial performance between different businesses and also a key source of competitive advantage for businesses. intangible resources enable the company to achieve sustainable competitive advantage and significantly affect its financial performance. the members of the board of directors can significantly contribute to the achievement of positive financial performance with their competencies, which are considered as human capital of the company. there are numerous studies in the literature on how board members, with their knowledge, skills, competences, which can generally be seen as human capital, affect a company's financial performance. previous research (babić & slavković, 2016) examines how board members influence organizational innovation with their competencies and dynamic capabilities. the paper applies a qualitative methodology based on the description, comparison and interpretation of scientific results in a defined problem area. an integrative model of interdependence of the board of directors and top management structure in the development of organizational innovation is defined. the study points out that the intellectual capital (human, structural, social and cultural capital) of boards of directors is the basis of the transformation processes through which the board of directors adds value to the organization. yadav & chakraborty (2017) examined how board members, with their competencies, skills and abilities, which are viewed as human capital (hce), influence the rate of return on total invested assets (roa). the sample contains 74 companies from different industries. the independent variable human capital is part of intellectual capital, so the methodology of vaic (value added intellectual coefficient), developed by professor ante pulic, was used to measure its impact. vaic represents the added value of intellectual capital, which is calculated when total costs are deducted from total revenues (excluding compensation for board members who are jelena peković, stefan zdravković, goran pavlović 127 viewed as an investment in human capital). subsequently, human capital (hce) is calculated when the previously determined vaic value is divided by the total earnings paid to board members in one year (hc). a financial indicator of roa is obtained when the net profit after tax is divided by the total invested assets or assets of the company. the results of correlation analysis (pearson coefficient) and regression analysis (β coefficient) show that human capital has a positive statistically significant influence on the financial performance of the company. in other words, members of the board of directors influence their asset efficiency (roa) through their competencies, which are viewed as human capital (hce). nguyen, nguyen, locke & reddy (2017) examined the impact of human capital on the financial performance of listed companies in vietnam. the research starts from a resource-based approach, according to which intangible resources are a key source of competitive advantage for companies. the research methodology includes a panel analysis of 315 companies, the results of which are observed over a four-year period. the results showed that human capital has a positive impact on the rate of return on total invested capital (roe) and the rate of return on total invested assets (roa). the study's recommendation is that companies in vietnam should invest cash in improving the competencies of board members because they have a significant impact on the financial performance of the company. a previous study (berezinets, garanina & ilina, 2016) points out that human capital is a set of knowledge, experience and skills of board members. the research was conducted to explain the relationship between human capital and financial performance of a company. the research applied qualitative methodology, that is, by reviewing already existing papers in the literature, it was found that the members of the board of directors influence their financial performance on the companies. the authors suggest that companies should pay great attention to the selection of candidates to be appointed to the board of directors, as they can significantly contribute to the achievement of positive financial performance. saravanan & mayur (2017) examined how human capital and board composition (external and internal members) affect the financial performance of banks. the methodology of the survey included a panel analysis for a period of five years within which the operations of 40 banks in india were analyzed. the results of the study showed that the board members competence influence the rate of return on invested assets (roa). also, the study's recommendation is that the board of directors is dominated by externally elected members to ensure independence from managers. the results show that banks dominated by external board members have improved financial performance. makkonen, wiliams & habersetzer (2018) examined how national diversity and personal innovation of board members affect a company's financial performance. the sample included a large number of firms within the european union, and the data collected related to the number of patents, research projects, innovation of companies, as well as the national diversity of board members. the practical implications of the study show that greater national diversity can increase innovation, and ultimately that board members improve their efficiency and effectiveness of internal company processes with their innovation, creative suggestions, and ideas, and thus contribute to better financial performance. the paper analyzes how members of the board of directors, through their compensations, which are a factor of motivation and investment in human capital, affect the financial performance of the company. the balanced scorecard approach is applied and emphasis is placed on linking the learning and growth perspective with the financial perspective. that is, board members' compensation is viewed as human capital (hce), and the impact on the return on invested capital (roe) and the return on invested property (roa) is examined. based on the aforementioned papers, which examined among other things how members of the board of directors through their competences, knowledge, skills, abilities, which can generally be viewed as human capital, influence the financial performance of the company, and in accordance with 128 economic analysis (2020, vol. 53, no. 2, 121-132) the subject and objectives of this research, formulate research hypotheses and present a conceptual model: h2a: board members with their compensations, which are viewed as an investment in human capital (hce), have a positive statistically significant impact on the rate of return on total invested capital of the company (roe). h2b: board members with their compensations, which are viewed as an investment in human capital (hce), have a positive statistically significant impact on the rate of return on total invested assets of the company (roa). figure 1. research model source: authors research methodology based on the review of works in the existing literature, the qualitative methodology will determine whether the balanced scorecard model is applicable to the performance evaluation of the members of the board of directors, while the quantitative methodology will determine whether human capital has a positive impact on the financial performance of the company. the empirical research includes a sample of 35 companies that operate in the republic of serbia and which, according to the data of the agency for business registers, stand out in 2017 according to the realized net profit. when to comes to the criterion of enterprise size, the sample contains 32 large, 2 small and 1 medium enterprises. the structure of the sample from the aspect of the enterprise sector criteria is as follows: manufacturing industry 14, mining 2, electricity supply 5, information and communication 4, wholesale and retail 4, professional, scientific and innovation activities 1, traffic and storage 3, arts, entertainment and recreation 1, administrative and support service activities 1. data on total assets and capital are taken from the balance sheets of companies, while data on operating income, total costs and net profit are taken from the income statement of companies. information on the costs of remuneration to the members of the management and supervisory boards is available in the audit report with the financial report that is the subject of the audit. all the above reports for the selected 35 companies are available on the website of the agency for business registers. in these companies significant funds are allocated for the remuneration of the members of the board of directors, and therefore such companies are suitable for analyzing the impact of the compensations of the board members, seen as an investment in human capital (hce), on the financial performance of the company (roe and roa). a particularly useful measure of intellectual capital is the so-called vaic model (value added intellectual coefficient). according to the above model, value added (va) is obtained when from the total revenue (tr) is deducted from the total cost (tc), except for those costs related to the remuneration of the members of the board of directors, which are not treated as a cost, but as an investment in human capital. the model can be expressed quantitatively as follows (pulic, 2000): va=tr‐tc (1) hce roe roa jelena peković, stefan zdravković, goran pavlović 129 in order to determine how value is realized, all components of intellectual capital (human, structural and relational) must be considered. however, given the scope of this paper, only human capital (hce), which can be quantified when the previously determined value added (va) is divided by the total remuneration paid to board members in one year (hc), will be considered further, which can be quantitatively represented as: hce=va/hc (2) financial indicators (roa and roe) are obtained when the total profit after tax is divided by the total invested assets, that is, the assets of the company (roa) and when the net profit after tax is divided by the total invested capital (roe) (janošević & dženopoljac, 2015) descriptive statistical analysis will be applied in the work to determine the mean values, average deviation, maximum and minimum of the achieved financial performance. also, the paper applies a simple linear regression analysis to determine whether board members, through their compensation, which are viewed as investment in human capital (hce), affect the rate of return on total invested capital (roe) and the rate of return on total assets invested (roa). based on the results of the regression analysis, a decision will be made to confirm or reject the research hypotheses. data processing will be done through the statistical software "spss v.20". results of the research the study used descriptive statistical analysis to determine the mean values, average deviation, maximum and minimum of financial performance achieved. the results obtained are shown in table 2. table 2. results of descriptive statistical analysis (note: data are expressed in thousands of dinars) net earning revenue total costs board members compensations total assets capital am 5934446,2 43959398 36174268 8,150,85 85667263,77 51477942 sd 7971056,9 55239310,2 43382573,4 4,389,42 178506147 12457724 max 40455606 252112496 166423480 19,544,00 986972352 68451877 min 1880549 100 327607 1,234,00 482830 194062 source: agency for business registers, the data calculation was performed by the authors note: am‐arithmetic mean; sd‐standard deviation based on the results, it can be concluded that the companies in the sample earn on average 5.9 billion dinars of net profit, 43.9 billion dinars of business income, while the total costs are on average 36.1 billion dinars. the average allocation of funds for the remuneration of the members of the management and supervisory boards is rsd 8.1 million, the average value of assets is rsd 85.6 billion and the share capital is rsd 51.4 billion. the largest discrepancy between the observed enterprises occurs in terms of asset value, where the standard deviation value is highest. the highest net profit in the sample was rsd 40.4 billion and the lowest was rsd 1.8 billion. the largest amount of funds for the remuneration of the members of the management and supervisory board was allocated by the company, which allocates rsd 19.5 million for this purpose, and at least rsd 1.2 million. simple regression analysis is used to examine the impact of board members and their compensation, knowledge, skills and abilities, generally viewed as investment in human capital (hce), on return on invested capital (roe) and return on invested assets (roa). the results obtained through the statistical software "spss v.20" are shown in table 3 and table 4. 130 economic analysis (2020, vol. 53, no. 2, 121-132) table 3. results of simple regression analysis (dependent variable: roe) independent variable β t sig. hce 0.286* 1.712 0.096 source: authors note: * ‐ coefficients are significant at level 0,1 table 4. results of simple regression analysis (dependent variable: roa) independent variable β t sig. hce 0.307* 1.852 0.073 source: authors note: * ‐ coefficients are significant at level 0,1 as both sig. values are less than 0.1 (0.096; 0.073), it can be concluded with 90% probability that members of the board of directors, through their compensations, which are viewed as investment in human capital (hce), affect the rate of return on invested capital (roe) and the rate of return on invested assets (roa). the values of the β coefficient (0.286 and 0.307) show that the members of the board of directors, with their compensations, which are considered as an investment in human capital, significantly influence the earning capacity of the company and the efficiency of the use of assets. however, the dependent variables in the research model (roe and roa) are influenced by many factors other than human capital. discussion the board of directors represents an important internal control mechanism, as it oversees the work of managers and protects the interests of the owners of the capital by advocating for a strategy that will maximize profits. the paper analyzes the balanced scorecard model as a mechanism for evaluating the performance of board members. based on a review of existing literature and analysis of papers examining the possibility of applying the balanced scorecard model in the performance evaluation of board members (northcott & smith, 2011; hussein & mansour, 2017; hoque, 2014; chavan, 2009; domanović, 2017), as and based on the suggestion of the author epstein & roy (2004) to use the balanced scorecard model to evaluate the performance of the board members, it can be concluded that the model is applicable for evaluating the performance of the board members, so hypothesis h1 is confirmed. the empirical research involved linking the learning and growth perspective with the financial perspective from the balanced scorecard model. that is, it was investigated how the members of the board of directors influence their financial performance with their compensations, knowledge, abilities, competencies, which are generally viewed as an investment in the human capital of the company, where the most important criteria were the rate of return on invested capital and the rate of return on invested assets. the results of the regression analysis showed that human capital (hce) has a positive impact on the rate of return on total invested capital (roe) and the rate of return on total invested property (roa), so h2a and h2b are confirmed. conclusion numerous previous studies have analyzed the balanced scorecard as a model for evaluating the performance of board members. the research was predominantly of a qualitative nature. the contribution and originality of the work is reflected in the fact that the balanced scorecard model has been analyzed with the aim of linking learning and growth perspectives and financial jelena peković, stefan zdravković, goran pavlović 131 perspectives, to examine in the empirical research how members of management approve their compensation, which is viewed as an investment in human capital (hce), affect the financial performance of the company (roe and roa). also, the paper emphasizes the importance of intellectual capital as a very important resource for achieving competitive advantage. few intellectual capital surveys have been conducted on the territory of the republic of serbia, so this fact gives more weight to the research, as it indicates that the owners of serbian companies should invest significant resources in intangible resources, and that great care should be taken in choosing candidates who will be appointed to the board of directors because they, with their competencies, can have a significant impact on the financial performance of the company. theoretical implications are reflected in the extension of scientific knowledge of the balanced scorecard model, as well as the impact of human capital on financial performance. the importance of the work is reflected in the fact that it was realized at the moment when the republic of serbia is in the process of transition, which creates the basis for research in similar economies, as well as the possibility of comparing the obtained results with the results of the conducted research after the transition process of the serbian economy is completed. managerial implications are reflected in the presentation of the results obtained to businessmen and experts, who, by building a unique human capital in the company, can achieve high financial performance. owners need to recognize the importance of intangible resources and invest more substantial funds in building a unique human capital. it is well known that an economy cannot be competitive unless its businesses are competitive. it is necessary to link the microeconomic and macroeconomic aspects, and the results of the research indicate that human capital has an effect on increasing the competitiveness of companies, and on the basis of this, the competitiveness of the serbian economy is increasing. there were some limitations to the research. first 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the indian banking sector“. corporate governance: the international journal of business in society, 17(3): 466-489. wang, z., wang, n. and liang, h. 2014. “knowledge sharing, intellectual capital and firm performance“. management decision, 52(2): 230-258. yadav, s. and chakraborty, a. 2017. “board structure and value creation: a human capital efficiency approach. globsyn management journal, 1(2): 1-10. article history: received: may 5, 2020 accepted: september 23, 2020 ea_2012_3-4 scientific review halfway between the midterm and the finals: a crash-course in development policy for serbian leaders malović marko*, institute of economic sciences, belgrade, serbia udc: 330.34:316.42(497.11) ; 330.341.1/.4 jel: f43, f63, o11, o43 id: 195850764 abstract – twelve years into transition process, serbia doesn’t have consistent, if any, let alone coherent economic development policy. this review is therefore aimed at serbian (and alike transition countries’) policy-makers and stake-holders in an effort to distill the ever-green lessons available (thus far pretty much ignored) to be drawn from the relevant body of theoretical and empirical literature on development economics synthesized since the lifting of the “iron curtain”. starting with boomerang effect of benignly neglected development in favour of mirage-growth, article tackles heretical third path paradigm, empirically (un)confirmed growth determinants, hush-hush impact of inherited timeand scale dependence of potential growth, (i)relevance of human development index, state vs. market correction, trade liberalisation and openness fables, as well as some monetary symptoms of underdevelopment. the sole purpose of this policy paper is one last attempt to debunk a knot of development myths and misconceptions still firmly entrenched in serbian professional discourse, its policy-makers and regime’s academicians alike. key words: economic development, economic growth, institutions, sequencing of reforms, human development index, transition, development fables, serbia introduction for at least half a century or so, serbia doesn’t have consistent, if any, let alone coherent economic development policy. this article has no intention of either providing thorough historical background or stylized facts in respect to serbia’s (recent) growth performance and development efforts, since there are too many papers as well as studies of such nature circulating around already and largely to no avail. serbia and several other european transition economies have severely underscored in this process on several crucial junctions since the fall of berlin wall and dissolution of ex-yugoslavia: some of the lost opportunities and mistakes made by wrong-doing or failing to act are indeed likely to prove irrevocable; many could still be mended in time and with higher opportunity costs. this review is * associate professor, institute of economic sciences, belgrade, serbia, marko.malovic@ien.bg.ac.rs. this paper is a part of research projects: 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements) and 47009 (european integrations and social and economic changes in serbian economy on the way to the eu), financed by the ministry of education, science and technological development of the republic of serbia. the usual disclaimer applies. economic analysis (2012, vol. 45, no. 3-4, 1-13) 2 therefore aimed at serbian (and alike transition countries’) policy-makers and stake-holders in an attempt to distill the ever-green lessons available (thus far pretty much ignored) to be drawn from the relevant body of theoretical and empirical literature on development economics synthesized since the lifting of the “iron curtain”. the hour is getting late, times are unappealing, nonetheless, our generation must decide the economic (and hence demographic and political) fate of the serbian sovereignty. the rest of the article is organised as a two dimensional matrix. one dimension is deciphering components of economic development in a small open economy like serbia’s as distinct fromyet inclusive of economic growth and its determinants, the other is a string of development fables (deeply rooted in minds of serbian policy-makers so far) which have been proved erroneous or at least ambiguous on either theoretical or empirical grounds, but evidently still deserve one last round of debunking. following introduction, development fables and misconceptions are separated in seven sections each dealing with particular and characteristic aspect of development policy mayhems. at last, in section nine i go on to conclude. serbian growth vs. economic development in serbia: race to the bottom?! one could venture to say that for at least half a century or so, serbia doesn’t have consistent, if any, let alone coherent economic development policy. after the civil war in exyugoslavia, the un sc orchestrated sanctions 1992-1995 against serbia (and then montenegro), excessive damage to infrastructure and industry during the 1999 nato aggression and the subsequent fall of milosevic’s regime, serbia doesn’t have a growth strategy either, apart from expecting miraculous waterfalls of foreign aid and/or commercial fdi which both dried out ahead of or coinciding with the global financial meltdown. economic growth is typically identified by positive dynamics of a synthetic indicator of marketable economic activity as measured by nation’s gdp or its per capita equivalent [ljubomir madzar, 2002]. initially impressive at the turn of the millennium, serbia’s growth was recorded from a rather low base and fueled with momentarily abundant infusions of aid, privatisation revenues and accelerating foreign indebtedness, proceeds of which have not been productively invested but instead squandered through current consumption of (largely imported) goods and services. over the last 15 years total absorption in serbia typically exceeded its gdp by ¼, another symptom of accumulating unsustainability of its external (balance of payments deficit) and more recently internal (budget deficit) imbalances. the inevitable protracted depression has therefore been merely validated by the global double dipped recession serbian leaders are excusing themselves with. on the other hand, what has been happening with indicators of economic development in serbia during that time? economic development presupposes crucial and highly sensitive roles for the macroeconomic, ethical, natural and psychological environment that public policies are supposed to generate, transform and/or preserve. sure enough, economic growth is important, perhaps the largest component of development process, certainly the most visible one. yet economic development captures the colossal, panoramic magnitude of output spawning effort coupled with simultaneous restructuring and qualitative fermentation of the socio-economic fiber. economic development assumes fine-tuning of structural and institutional adjustment in accordance with growth dynamics, yet aiming at malović m., halfway between the midterm, ea (2012, vol. 45, no, 3-4, 1-13) 3 harmony between output enhancing milestones and deeper development of society. benign neglect of serbian education system, ridiculous l’art pour l’art proliferation-of-publications zeal in science, deterioration and dissipation of capital and functionality of serbian health protection system, they all initially seemed as neutral if not harmless, in other words decoupled from temporarily increased and promising growth rate, only to backfire with tremendous destruction. there’s a deep-rooted sense of dissatisfaction, irritation and despair among citizens and key social actors in contemporary serbia. both distribution of income and opportunities have been visibly worsening, all the macroeconomic indicators are chronically deteriorating (unemployment over 25% and harsh treatment of those employed especially in informal sector) while entrepreneurs as well as employees express significant ambiguity in their business/consumption decisions, i.e. in improvement prospects either across the global economy or in serbian economy itself, for the foreseeable future. one of the chief conclusions of this article underlines the boomerang effect of benign neglect or even saving on foregone investment in human development index and efficacy of institutions throughout chaotic transition of the serbian economy. that failure already proves to cause far-reaching malfunction much more serious from unsatisfactory growth dynamics or industrial structure still miles behind the pre-transitional 1989 statistics. namely, there is no successful let alone sustainable economic transformation without social consensus. social consensus, in addition, owes to and draws from the quality of institutions and cultural pretext of a given society, more or less hovering around rawls’s theory of justice and relationship between economic inequality and redistribution incentives [madzar, 2002]. according to madzar’s (2002, p.85) interpretation of rawls’s rewarding criterion, rising economic inequality is socially acceptable and economically optimal for as long as it marginally improves the well-being of the poorest societal member and all the others in the pecking order at least up to the member with an average national income in per capita terms. not only the so-called washington consensus, as the ruling ideology of the last wave of globalisation, but also internal political clashes, policy failures and underdeveloped or outright devastated institutions steeply engrossed economic inequality within serbia and in international comparison too [branko milanovic, 2006]. nevertheless, as correctly noted by pasquale tridico (2011), one can still identify exemplary pairs of relatively low gdp per capita dynamics and high indicators of economic development in societies where income is more evenly distributed. in other words, if you’re deep underwater and you spend too much oxygen too soon on your muscles while failing to adjust your heart beat and leave enough oxygen for the brain, you are likely to faint and drift down even deeper. this finding should serve as a sobering lesson for future reform(er)s. third path is not a mortal sin but necessity! that being said, our hypothesis of non-existing growth strategy in serbia (and through better part of the so-called western balkans and developing world) does not imply the absence of growth and development ideology, which was exogenously, indiscriminately and even fanatically adopted served as the (in)famous washington consensus. although its initial intent, content and intellectual legacy has been substantially different, for neo-colonial purposes of post-industrial capitalism it could be safely boiled down to 4 rules: devaluate, deregulate, liberalise and privatise. development economists had too often fallen an economic analysis (2012, vol. 45, no. 3-4, 1-13) 4 embarrassing pray of belief in the “one right way,” a universal fix for underdevelopment [dani rodrik, 2009], policy-makers from small open transition countries even more so, whereas real casualties regardless of the fashion of the day had obviously been economies and people of nations where those experiments have been so linearly applied. as a matter of fact, development theory is “(…) rich and flexible enough to justify many different policies, depending on the constraints and opportunities defined by the context” [dani rodrik and mark rosenzweig, 2009, p.3]. in all those instances, “(…) there is no unique correspondence, as the washington consensus and other general recipes suppose, between policies and outcomes” [ibidem]. in addition, ricardo ffrench-davis (2000, p.5) warns that the right reforms can all too easily be carried out in the wrong way, with some of the neoliberal reforms too loaded with ideology and poor comprehending of how imperfect, emerging, thin markets actually work. neoliberal doctrine dictated by the washington consensus, which was religiously embraced by majority of academic economists and all the policy makers in serbia over the last decade, exhibited total disregard for the intermediate position between the poles of “indiscriminate liberalisation and arbitrary interventionism” [ffrench-davis, 2000], whilst development economics is in its essence an applied discipline, prone to get simplified and routinized in and by practice: this is why serbian leaders have to possess knowledge or hire top-trained advisors, demonstrate political courage and intellectual honesty to resist a temptation to substitute sense of nuance and constructive criticism for pre-packaged instant solutions [rodrik, 2009]. therefore, it is a malevolent myth that serbia’s policy-makers shouldn’t search for unusual, tailor-made, context dependent set of macroeconomic reforms, since almost every country that succeeded in achieving above average growth and by managing to sustain it has been named an ‘economic miracle’, actually pursued unorthodox development strategy and has kept away from ideological highways. arguably, both political and economic plane for maneuvering to that end has shrunk in the last decades (albeit to a certain extent due to serbia’s own decisions), however, leading development economist agree in that there is always room for "soft" industrial policy, wherein the objective is to form and protect a process whereby government, industry and cluster-level private entities collaborate on interventions to increase productivity, competitiveness, technological or capital formation or even market share and/or size, for instance by means of green subsidies, trade finance, improving regulation, supplying infrastructure, developing fund raising skills and awareness etc…[rodrik-rosenzweig, 2009]. in other words, if you’re pushed down the strong current towards the giant waterfall abyss, you cannot and shouldn’t try to swim upstream, but you sure as hell shouldn’t be paddling downstream either: in real life, salvation is often perpendicular to dominating extremes. chief determinants of growth and legacy of the current locus on a growth trajectory by deploying somewhat different conceptual and methodological view points, a wide array of studies pinpointed give-or-take the same chief determinants of economic growth in small open transition economies [geogre petrakos et alia, 2007]. in the perhaps most representative of those, barro (1997) identifies (via careful cross-section as well as panel regression analysis of more than a 100 countries from 1965 until the late 1990s) high malović m., halfway between the midterm, ea (2012, vol. 45, no, 3-4, 1-13) 5 incidence of top quality upper level schooling,1 health investment (as measured by life expectancy), low fertility, thrifty public welfare schemes, favourable terms of trade, the rule of law and basic democracy as chiefly conducive to faster and steadier growth. high fertility rate effect is plainly unfavourable in the short-run and net terms, for rising proportion of economy’s investment which must be providing for new workers tends to pro rata cause lowering of capital per labourer ratio, but may nevertheless trigger some positive aspects, for higher fertility per se is creating at least some additional aggregate demand, (in serbia even a tax income!) etc. despite its direct short term impact in barro’s (1997) regressions appears to be clearly negative on growth, due to affirmative effects on development and possible reverse causality effects its longer term impact may well be positive -and moreover requiredfor maintaining the pattern of sustainable development. the latest existing macro-evidence on the relationship between fertility decline, which ages a population, and savings, is weak or non-existent, even though the life-cycle model of savings predicts that savings should rise as a consequence of aging. the allegedly positive impact of fertility decline on savings has in fact been a principal motivation for population control polices [rodrik-rosenzweig, 2009]. pierre-richard agenor and peter montiel (2008, p.614) in extending david romer’s earlier model demonstrate as a side effect that population growth (i.e. net fertility rate) endogenously fuels economic growth in the medium to long run after all. finally, rodrik and rosenzweig (2009, p.7) lament that often times “the limitations of empirical methods and of data (see below) imply that only a limited set of interventions will be well-supported by causal evidence”. some degree of democracy (preserved property rights, effective antitrust legislative, freedom of speech, political right to vote) is doubtlessly good for economic growth but too much politicised democracy beyond the rule of law index may give rise to disorganisation and populism or to the other extreme solidify the growth-retarding power of influential interest groups [barro, 1997]. serbian development experience shows that the two extremes under certain chaotic circumstances may in fact even coexist for a while. although not explicitly modeled in barro’s regression, technological progress (i.e. innovation and r&d activities) do play a pivotal role in economic development by extending the needs, goods and markets we know of and by increasing productivity and growth [petrakos et alia, 2007]. continuous technical progress may not be essential for the very impetus of initial growth, yet it is sine qua non for avoiding diminishing returns to kick in. however, it’s appropriate to remind once more that increasing returns are not a precondition for economic development [agenor-montiel, 2008]. primordial purpose of modern technology adoption at this stage of serbian development is to enable achieving quality, packaging, aesthetical and safety standards necessary for expanding to foreign markets and overcoming low production series disability. economies of scale imperative for closing the gap between effective (especially local) demand and production capacity – and sustaining higher rates of utilization, enable not only lowering of marginal costs but also increases in effective productivity and economic substance out of which further iterations of r&d 1 interestingly, several econometric specifications in barro’s (1997, pp.20-21) study fail to confirm the hypothesis that education of females is key to economic growth, but it proves to exert net positive influence of female upper level education on economic development (life expectancy, infant mortality with a plus sign and fertility rate as negatively correlated) economic analysis (2012, vol. 45, no. 3-4, 1-13) 6 activities could be financed. transitional dynamics of the legendary uzawa-lucas model of endogenous growth in a two-sectorial economy, similar to serbian constellation in that physical capital allocation in science and education sector is almost non-existing, whereas human capital in goods-producing sector is still below its steady-state level, by and large reproduces the same hump-shaped boomerang effect in conclusion [robert barro and xavier sala-i-martin, 2004, pp.251-267]. abstracting from a complicating fact that serbian consumption to capital ratio was above its steady state level due to non-productive spending of financial aid and privatisation revenues, in a constellation of relative scarcity of human relative to physical capital, average product and rate of return in the goods-producing sector monotonically rise toward their steady-state values, and vice versa for the science and education sector. in time, allocation shifts toward production and away from r&d sector. long term effectiveness of such an evolution could easily be questioned in a slightly altered framework. furthermore, it is evident that thriving of science and education sector isn’t possible if it’s stuck with human capital only. human capital cannot reproduce a sustainable, let alone superior posterity by relying solely on itself. physical as well as financial capital in high concentrations are also critical! be that as it may, next to none of the empirical studies features sme explosion in its statistically significant epicentre. no doubt, small and medium firms can considerably contribute to job creation and economic activity but require big firms and greater, carefully wrapped production/marketing/supply-chain systems they could lean on to and become functional part of. sme expansion is, hence, as a rule of thumb, more the consequence than a determinant of economic growth. it is in order to admit that many additional determinants of growth, attempted in some of the relevant empirical studies, like the impact of ethnic diversity, geography, political regime or international political pressure, haven’t been resolutely estimated and still yield mixed, unclear or no influence on growth trajectory [petrakos et alia, 2007, pp.10-11]. in terms of demographics, serbia’s free-falling population needs a formidable national and economic awakening if we are to preserve ourselves as a nation and even minimal welfare-state. on a top of it, since such a copernican turnaround unlikely as it is wouldn’t be sufficient neither in light of demographic nor economic constraints, serbia must quickly decide how, how many and where from her immigrants may come, as well as in which parts of the country their inhabitance is most urgently needed. this decision is inextricably linked with the master plan for geographical anatomy of the economy and all its agglomeration, infrastructure, production clusters and alike loci. obviously, cocktail of ethnicities within and international pressures from outside, be that close neighbourhood and global economic powers, merely scratches the complexity of political factors’ influence on economic growth. although out of the scope of this review paper, it ought to be stressed that issues of governance, politics, and political power are no longer a sideshow; they constitute a central event in the national economic development arena [rodrik-rosenzweig, 2009]. moreover, and irrespective of the aforementioned determinants, international crosssection growth differences stem firstly and foremost from each country’s existing or starting level of output, so if its current output is below the steady state level, catching up process provided adequate technology transfer has been put in place fills max 2.5% of the gap annually [barro, 1997]. thus, extent to which growth is semi-exogenous and dependent on malović m., halfway between the midterm, ea (2012, vol. 45, no, 3-4, 1-13) 7 the acquired stage of development [steve dowrick, 1995], dictates conditional catch-up – low initial stocks or productivity levels predict relatively rapid growth, at the onset temporarily robust to even total absence of institutional reform. however, for some variables (such as human capital) and for some examples (such as transition countries like serbia) the opposite may be the case in the medium run – “(…) a low starting point inhibits subsequent growth, implying that relatively poor economies fall behind or are caught in a low-development trap” [dowrick, 1995, p.27]. in other words, if your lungs capacity is small enough, you may never resurface even if your diving technique and bottoming out angle are impeccable. institutions matter but there’s no institution without investment in human capital institution matter, since there is a path dependency in (r)evolution of institutions, which is why even the second best institutions serve societies better than the detrimental void of none at all [dani rodrik, 2008]. that, in turn, leads us to conclusion that transitional gradualism is almost always preferred to shock therapy [tridico, 2011]. it is the well-suited interaction between capabilities (often times quantified by the hdi human development index) and meticulously perfected morphology of institutions which taken together and together only gives birth to sustainable economic growth and development. better institutional framework does not comprise only efficient, pragmatic, well-functioning and equal-opportunity agencies, supplemented by standards and commonly accepted informal professional and consumerist associations, but also implies a national climate in which political, social and institutional elites empower people and provide them with freedom and enlighten them with opportunities [ljubomir madzar, 2002, 2008], [tridico, 2011]. in the end of the day, two fundamental factors stretch themselves above the economic development process: 1) social capital embodied in financially and demographically strong middle class of a given society as well as in its democratic institutions, favoured by 2) heavy investment in education, health and protection of creative and speech liberties. they are mutually reinforcing, because there’s no strong middle class without control of corruption, or general acceptance of: values such as accountability, civil society involvement in public affairs, virtues of trust, honesty, solidarity, integrity, reputation, professionalism etc. that notwithstanding, endogenous growth drivers did not and cannot do miracles in a setting where capital formation is alarmingly low: strong correlation between physical investment and economic growth is a well-known empirical fact [ffrench-davis, 2000]. productive investment is the most fundamental determinant of economic growth as earmarked by both neoclassical and endogenous growth theories2 [petrakos et alia, 2007]. in other words, provided you cherished a healthy pair of lungs and improved on your goggles, your bottoming out should be gradual, like scuba-divers, economies need to make occasional stops on their way out so that institutional adjustment can take place and account for the depth you’re at, but all the watches, belts, rules and regulations in the world cannot help you survive if you don’t have money to spend on flippers and an oxygen tank. 2 for a more formal neoclassical framework of growth theory in small open economy context see e.g. marko malovic (2000). for excellent and highly rigorous review of endogenous growth models consult barro and sala-i-martin (2004, chs. 4-5 ). economic analysis (2012, vol. 45, no. 3-4, 1-13) 8 neither government intervention nor market forces are panacea for the shortcomings of the other government nonproductive consumption should be kept at minimum, since in tranquil times big government spending and long lasting benefit schemes aren’t conducive to growth. public safety nets ought to be generous and trustworthy, but short lasting, while extraordinary harsh times (global financial crisis, deep recessions and alike) may call upon additional stimulus packages, not all of which have to be pecuniary in nature [marko malovic, 2011]. again, agenor and montiel (2008) wedge a caveat in that some public investment which is not directly productive may evidently contribute to productivity, overall development process and growth indirectly, for example, built in infrastructure, health and education enhancements, spending on fostering institutions that safeguard property rights. on the other hand, even flat out productive government expenditures directly supportive of output-generating effort of the real sector may have an allocatively ambiguous longer term impact on economic growth if they are not selective enough or alimented through distortionary taxation [agenor-montiel, 2008]. public investment might be inefficient at the margin if it is mis-directed in accordance with political or rent-seeking objectives; on the other hand, to the extent that market investment exhibits sub-optimal performance due to coordination paradigm, principal-agent issues or free-rider problems, public investment might be more productive or to the very least superior in terms of effectiveness. it is nowadays ever more loudly recognised that small open transition economies like serbia have to embed the healthy draft of private initiative and individual incentives in an overarching framework of public action that promotes restructuring, diversification as well as alliances, and technological dynamism beyond what market mechanisms on their own would be or have been able to generate [dani rodrik, 2007]. in other words, bay-watch rescue and coast-guard are always welcome, unless we take them for granted. international openness, trade and capital flows fables international openness doesn’t enable economic development per se. although typically statistically significant, unfavourable terms of trade don’t represent the boat-sinking, key element of weak growth performance in transition economies like serbia.3 in order for trade liberalisation (which in serbia took place too sudden and way too early in the post-sanctions and war era, but let the bygones be the bygones…) to be successful, the present value added by new exportable activity must be greater than the present value subtracted due to destruction of existing ones (importables and import substitutes) [ffrench-davis, 2000]. it should be preceded by labour refroms, restructuring, reshuffling of industrial policy and export promotion strategy. trade liberalisation in wise and successful historical examples did not shy away from infant-industry arguments, import-substitution components of 3 this is not to say that j. bhagwati’s paradigm of immiserising growth cannot once again become binding in parallel with protracted depression and super-weak domestic demand in small open transition economies which have been impacted most severely by the cocktail of washington consensus culminating in the ongoing global crisis. malović m., halfway between the midterm, ea (2012, vol. 45, no, 3-4, 1-13) 9 overall export promotion strategies and so on and so forth. time horizon for that undertaking on-the-ground evaluation of trade liberalisation and acompanied altered development paradigm shouldn’t really be longer than two political cycles, for the serious expansion of tradables share in gdp and equilibrating trend in balance of payments to become visible. where applied on its own and irrespective of carefully devised growth strategy blueprint, trade liberalisation and capital openness exploded right in policy-makers faces. strongly-held professional priors about the impact of trade and financial opening on growth -cherished either on ideological basis or as a rent-seeking calculushave been considerably weakened by the results of the latest generation of cross-country regressions [rodrik-rosenzweig, 2009]. having said that, even though international competitiveness is usually reanimated and balance of payments adjustment initiated via tweaking the exchange rate, it ought to be attained through structural adjustment and continuing increase in productivity rather than by never ending competitive devaluations, low wages and tax exemptions (typically biased toward foreign investors) [ffrench-davis, 2000]. as a mirror-image of disappointing results in terms of staggering growth dynamics and worsening current account balance of serbia a full decade after trade liberalisation have been carried out, the question of international capital/financial flows as means of propping them up arose. there has been many a misunderstanding of economic laws in the area of international finance. for years serbian policy-makers were stirring under influence of the so-called lawson doctrine, implying that no current account deficit is too big or excessively chronic if authorities can cut deals to finance it [marko malovic, 2008]. costly consequences of such a fable were twofold. first and more apparent of the two was the worrisome explosion of foreign debt.4 second was increasing reliance on inward foreign direct investment (hereafter fdi) as means of growth financing. moreover, an apodictic generally accepted view has spread -equally among academia, politicians and mediathat fdi is the underlying cause and driving determinant of economic development. at least half a dozen of objections could be confronted with the aforementioned reasoning. obvious in swelling disconnect between sky-rocketing external indebtedness and anemic growth record is that there is no one for one relationship along the capital investment economic growth nexus. similarly, privatisation-induced on one and autonomous fdi inflows on the other hand are frequently driven by drastically opposing determinants and wildly different investors’ logic. further still, fdi in serbia are often domestically leveraged and with capital flow reversals are being resold to domestic savers making it volatile and unreliable source for growth financing [marko malovic, 2010]. these are probably but a few of the factors behind barro’s (1997) econometric evidence on fdi and investment ratio suffering from reverse causation. in addition, crucial is the empirically delivered nuance vis-à-vis the effect of fdi on economic growth: it exhibits fragile dependence on whether existing fdi complement or substitute domestic investment. in the end of the day, it turns out that it’s not about large inflows of fdi causing high growth rates, but about strong growth serving as “a magnet” for subsequent autonomous fdi. put differently, if one desires to attract more serious fdi and abstain from those investments which are simply after ready-made domestic market, one has to have robust growth underway already, rather than other way around [malovic, 2010]. 4 in late 2000, fry accumulated little over 12 bill. $ foreign debt, while serbia in 2012 (without kosovo and metohija’s portion of debt) owes nearly 24 bill.€. economic analysis (2012, vol. 45, no. 3-4, 1-13) 10 likewise, eu membership is not a decisive factor for deeper development and quicker catch-up processes of transition (candidate) countries since we can observe starkly different convergence speeds among them (even after the eu accession) [tridico, 2011]. by the same token, aspiring eu membership could serve even less so as an economic growth strategy. adopting eu standards and legislation, however, is a step in right direction to that end. monetary issues – impeding or otherwise? hyperinflation is definitely detrimental both for economic development and more narrowly for economic growth, yet moderate inflation rates of 10-15% or even 20% may under certain conditions be growth-friendly [barro, 1997]. in any case, it is extremely difficult to spur development catch up processes with rather low single digit annual reflation characteristic for oecd economies. validation or condemnation of grass root causes of double-digit inflation in serbia is quite another matter, of course. corruption and unprecedented lack of competition in certain market segments aside, there could be serious deficiencies in particular inflation targeting design currently applied in serbia, but this is not to say that inflation targeting as such has failed in western balkans or developing world and that it should be abandoned altogether. even though i would always vote for managed floating as opposed to free float, serbia should by all means avoid government inspired manipulation with exchange rate in order to ease the burden of foreign-currency denominated annuities maturing to be paid… efficient regulation of volatile short term cross-border capital movement is inevitable if we are to preserve exchange rate flexibility and relative autonomy of monetary policy making. it is not unheard of and if reasonably devised it wouldn’t scare off benevolent international investors. a variation of tobin taxes on the way in may be the first step to be taken. as in many other developing countries in transition, high interest rates and anxious investment climate tend to be overly hospitable to high-risk intangible portfolios, hence are in no way development-friendly, they are leverageand bubble-friendly. fine-tuned government intervention is required on this front. in any case, monetary realm employs us to remain analytically cautious – or in the words of rodrik and rosenzweig (2009, p.7): “distinguishing symptoms of underdevelopment from root causes of underdevelopment is key to setting the right policies”. conclusion intention of this policy brief has been to recapitulate chief determinants of economic growth and principal components of economic development as a multidimensional transformation process, yet by simultaneous highlighting of a dozen or so development fables and misconceptions firmly entrenched in serbian professional discourse, its policymakers and regime’s academicians alike. first of all, sensitive interrelationship between economic development and growth has been laid out, with explanation for race to the bottom features of that relationship in (not only) serbian context. further still, it has been argued that third way is neither ideological malović m., halfway between the midterm, ea (2012, vol. 45, no, 3-4, 1-13) 11 heresy nor strategic blunder but development imperative of small open economies in transition. thirdly, an empirical review and revision of growth determinants has been carried out, with special attention to legacy of current locus on a growth trajectory. in addition, i reaffirmed the importance of institutions for economic development and reuttered that there’s no institutions without investing in human capital. however, it has been further stressed that human capital cannot reproduce itself like a one-cell organism, but instead benefits from inputs of financial and physical capital too. contrary to still prevailing belief, article argued that neither government intervention nor market forces can be panacea for the shortcomings of the other. equally important, paper dealt in extenso with openness, trade and capital flows fables, including fdi as an growth financing engine, lawson’s doctrine, and briefly with alarming external indebtedness in serbia. some monetary symptoms of underdevelopment, political factors as well as geography cum demographic issues were given due consideration too. serbian economy is in grave danger. the world is stirring, whereas serbia’s past economic mistakes coupled with multidimensional facets of its development constraints make its economy less governable to begin with. any reasonable development pattern is at the verge of time-inconsistency. to overturn such a negative trend, radically stronger institutions, smaller but firmer and more daring state, revolutionary different system of values (enforced exogenously) in serbian society, skillful and politically-compatible immigration and loads of capital are needed. if serbia manages to usher three out of five, the other two will most probably follow. or else, the light may go out, and soon. references agenor, pierre-richard and montiel, peter. 2008. “development macroeconomics”. princeton and oxford: princeton university press, 3rd edition, ch. 17 and ch. 19. barro, robert. 1997. “determinants of economic growth-a cross-country empirical study.” the lionel robbins lectures, cambridge, ma: the mit press, passim. barro, robert and salla-i-martin, xavier. 2004. economic growth. cambridge, ma: the mit press, 2nd edition. dowrick, steve. 1995. "the determinants of long-run growth." rba annual conference volume, in: palle andersen & jacqueline dwyer & david gruen (eds.), productivity and growth reserve bank of australia. ffrench-davis, ricardo. 2000. “reforming the reforms in latin america.” oxford, uk: macmillan press in association with st antony’s college, passim. madzar, ljubomir. 2002. “theory of production and economic growth”, belgrade: federal secretariat for development and science, ch.1. madzar, ljubomir. 2008. the missing dimensions in the evaluation of macroeconomic performanse of the republic of serbia. belgrade: samizdat passim. malovic, marko. 2000. “theoretical aspects of the growth mechanics and development strategy for a small underdeveloped economy.” ekonomski anali, (145 and 146): 191-208, 111-133 (in serbian). malovic, marko. 2008. “on balance of payments crisis in serbia: if it ain´t broken, why fixing it might still be a good idea?”economic analysis, (01-02):.24-47. economic analysis (2012, vol. 45, no. 3-4, 1-13) 12 malovic, marko. 2010. “fdi transfusion in serbia: are we getting the blood type that we need?”, in šoltes, v. et alia “influence of global economic crisis on cee region-possible way out”, visegrad fund, faculty of economics of tu košice/bba/ies, košice, slovakia. malovic, marko. 2011. “evaluation of institutional effectiveness of european labour markets under financial crisis”, in zubović, j. (ed.) active labour market policies and employment issues, institute of economic sciences, belgrade (in serbian). milanovic, branko. 2006. worlds apart: measuring international and global inequality. princeton university press/undp/european commission, (serbian edition). petrakos, george, arvanitidis, paschalis and pavleas, sotiris. 2007. “determinants of economic growth: the experts’ view”, dynreg working paper #20, eu 6th framework-program for research and technology, mimeo. rodrik, dani. 2007. one economics, many recipesglobalization, institutions and economic growth. princeton and oxford: princeton university press. rodrik, dani. 2008. second best institutions. jfk school of government, harvard university, mimeo. rodrik, dani. 2009. “diagnostics before prescription.” journal of economic perspectives symposium, jfk school of government, harvard university, cambridge, ma, mimeo. rodrik, dani and rosenzweig, mark. 2009. “development policy and development economics: an introduction.” handbook of development economics, 5, north-holland, amsterdam-n. york. tridico, pasquale. 2011. institutions, human development and economic growth in transition countries. london-n. york: palgrave-macmillan, passim. na pola puta između kolokvijuma i ispita: pripremni čas iz politike privrednog razvoja za srpske funkcionere rezime – dvanaest godina nakon političkih promena i lansiranja procesa ekonomske tranzicije, srbija i dalje nema vremenski konzistentnu, ako ikakvu, a ponajmanje logički koherentnu politiku privrednog razvoja. ovaj rad je stoga namenjen srbijanskim kreatorima ekonomske politike (i donosiocima odluka u srbiji sličnim tranzicionim privredama) u naporu da probere i pažnju javnosti usmeri na više puta proverene lekcije (u srbiji dosad uglavnom upadljivo ignorisane) iz relevantne teorijske i empirijske građe u oblasti ekonomije razvoja sintetisane nakon pada „gvozdene zavese“. počevši od bumerang efekta benigno zapostavljenog razvoja u korist iluzornog rasta, članak tretira jeretičku paradigmu „trećeg puta“, empirijski (ne)potvrđene determinante privrednog rasta, zataškavani uticaj nasleđene vremenske i kvantitativne zavisnosti potencijalnog rasta, (ne)relevantnost indeksa ljudskog razvoja, državnu nasuprot tržišnoj korekciji, bajke o trgovinskoj liberalizaciji i otvorenosti, kao i neke monetarne simptome nedovoljne privredne razvijenosti. prevashodna svrha ovog primenjenog eseja jeste poslednji pokušaj da se razmrsi gordijev čvor razvojnih iluzija i zabluda još uvek čvrsto uvreženih u srpskom profesionalnom diskursu, kako među kreatorima ekonomske politike tako i među akademskim ekonomistima. malović m., halfway between the midterm, ea (2012, vol. 45, no, 3-4, 1-13) 13 ključne reči: privredni razvoj, privredni rast, institucije, redosled reformi, indeks ljudskog razvoja, tranzicija, razvojne iluzije, srbija article history: received: 3 october 2012 accepted: 23 october 2012 microsoft word 2009_1_2.doc world economy crisis and the possible impacts it might have on bosnia and herzegovina adnan rovčanin, faculty of economics, university of sarajevo, sarajevo, b&h amra kožarić, faculty of economics, university of tuzla, tuzla, b&h key words: instability of global economy, emerging crisis, global economic recession, bosnia and herzegovina jel: f01, f33. abstract – at the end of 20th and the beginning of 21st century, the international community, through various forms of action plans and ambitious steps, has engaged itself to solve problems of the birth and wide increase of instability of global economy, that many countries stages of development and transitional economy have faced. nevertheless, the results of this have not been very impressive. the concern still exists that the new and even worse global recessions will take place as well as the wide spread of global instabilities on the international markets. as far as it looks, situation is more serious than the governments are ready to admit. the economists and world leaders are greatly presenting pessimism because of those issues. the uncertainties on the markets, globally looked at, are staying very great. in conditions like those, discussions will be focused on what steps should be taken to soften the risks at the financial markets and how the instability, that describe the world economy in the 21st century, could decrease. hence the first part of this paper is discussed the current situation as well as the modern problems that the global economy faces, where the combinations are made from available information about modern discussions about international economic relations, global economy and crisis, so that all the actors of the global financial system are ready to asses the global future options and their possible impact on their lives. special focus in this research, as the second part of the paper, is put on bosnia and herzegovina, a transitional country in development stage, that lies in very poor economic state and which is threatened by a big blow of world instabilities and crisis. introduction the modern international economic relations are presenting the fact that things arenʹt looking great on the international financial markets. the overwhelming and accelerated liberalization of international movement of capital, frequent speculative blows on the international monetary system and national financial systems, the birth and development of financial abnormalities and global financial crisis, inadequate determined regimes of foreign currencies are just some of the global prevalent financial problems that came with the last decade. the characteristics mentioned above are intensifying parallel with the problems of increased scope of international financial transactions and intense transfer of financial instruments, the integration of international financial markets (especially the euro currency market, the international bonds market and the foreign currency market), the inconsistencies in the foreign currency politics with macroeconomic performances, the problems in creating a stable currency configuration, increased system risks as well as the problems in keeping up the international liquidity. economic analysis 1-2 (2009) 65-78 66 despite the fact that current coordination of macroeconomic politics is on the global level, the biggest monetary problems that the world economies are facing, especially the economies of the countries in developing phases, have made the impression the global economy is more unstable today, than it was in the past decades. the inadequate, decelerated, and unsatisfactory activities of international financial institutions, especially imf, in the solving of international financial crisis (before in the case of mexico, brazil, russia and eastern asia, and now in the case of usa and the whole europe), and supporting development of developing countries are presenting more serious problems inside the global economy. this is all generally usurping the world financial scene and greatly impacts the deepening of unbalances and financial crises in the global economic arrangement up to several years. unfulfilling the criteria of efficiency in the world financial systems is causing the appearance of great fluctuations that are quickly dispersing throughout the whole world. the instabilities and economic unbalances have become global and systematic, and the attempts of certain countries to come over this excessive and crisis are simply not enough. concerning with that, question is what kind are those global problems that are facing the industrially developed countries and developing countries, that have consequently caused the need, or raison dʹetre for timely action and reform of global economic arrangement, global economy, and the need to redefine the direction of activities of international financial institutions in the context of solving of all the mentioned financial instabilities, (economic and financial) crisis, and recessions? according to, and regarding to our determined aforesaid topic in this paper, we set up next hypothesis: instabilities on the international financial markets, and amending on the international monetary market, inflation movements and global riots in the global financial system, essential affect on the new economic system which lead global economy to the serious crisis state. respecting the beforehand fitted topic and hypothesis, we will set up objectives of the research: identification global and actual problems of global economy and identification and analyzed rate of concern from global economic recession, and in finally implications of these world instability trends on the weak, insufficiently developed, transition economy of bosnia and herzegovina. before we look at the factual state in which the world economy is in, we will make few references: since this is a very complex and extensive theme, we will give our best to present the most important trends and describe them abbreviated and sublimation, everyone is slightly interested to spot trends as well as the impact on the personal state in the countries, but everything is based on predictions. economic situation in the world today can be presented in four key determinants: • new global economic system: in the past 30 years or so, dramatic changes had occur as: affirmation and appearance of eu, strong of japan, asia and phenomena that are chine and india; • (predicted) economic indexes of the situation and growth (gdp, interest rate, inflation, foreign currencies, deficit of the balance of payment); • e n e r g y g e n e r a t i n g p r o d u c t (crude oil, gas, coil), food (wheat, rice, corn, soy) and minerals (iron, aluminum, copper, colored metals), bio e n e r g y g e n e r a t i n g p r o d u c t –one billion people are living with less than a $1 daily, 400 million people are living with less that $2 daily, or 1,5 billion people are living on $1-2 a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 67 daily. there is famine, and in over 90 countries, the threats of protests because of food prices are inevitable. the price increase in the past (2008.) year is one of the greatest in history; • the credit crisis–huge losses for the banks because of the wrong full investments in bonds, based on mortgages, increase in the real estate values have made the markets too hot, the transformation of credits into stock products like derivatives, bonds. because of this transformation of credits into stocks, the risks have been fogged and the market has been brought to delusion. certain banks have lost up to $100 billions, and the total losses are about $1 trillion. the effects of this crises are expanding to eu, australia and canada. current condition and the main problems of world economy the question that will start the discussion is an obvious one, a question if the continuance of the modern global economy is anticipated, the economy that was typical by huge increase and change during the 90ʹs of the 20th century? the fact remains that the global unbalance has spread rapidly in the past few years and reached a point for which most are saying that it is a climax, and that itʹs leading to global concern. in addition to that, the adequate tendencies are not existence yet, the ones that could correct the imbalances. if those kind of indicators are not implemented and if it is proven and assessed that the current situation is unstable (or better said, if the current worrying situation has proven to be true), the result could be the crisis. which form could be expected from such crisis? well, the closest form would be the world recession. because of that, most of the leading world economists are showing great concern of the birth of the potential global world economic recession that would come from the distance between the industrial and developing countries, and as the main problems of world economy would inflation and rapid drop of dollar value comparing to the euro and the pound of sterling. considering the rebalance on the world monetary market, the crises on the real estate marked (mortgage market), not just in the mostly developed countries such as usa, but in the developed world, this inflation movements are followed by great unemployment, increase in liabilities, the payable balance imbalance, the deficits in the budgets and the mess in the global financial system, all brought to the fact that the global economy is in a very serious state. the important fact is that the world crises could lose at the financial markets, and as many are saying, this is one of the hardest economic crises since the great depression and the end of the wwii. it is hard to predict how much deeper the real estate prices will drop in the usa and how long the crises at the mortgage loans market is going to last, but itʹs very important to emphasis that this thatʹs happening in the world economy is the new thing for the economic politics, and that the economy doesnʹt have great experience in this department. this fact is supported by the research of the two american economists paul krugman and ex boss of the feb alan greenspan, who made a statement that this is one of the worst crises yet. even martin wolf has written for the financial times that the capital dream of a free market has long been woken up, a the reason why the economists and the financial experts cannot agree on the character of the crisis is explained as follows: “one reason is the complexity of the crises, and the other is the fact that this crises is something brand new...“, and then he adds: “this crises is extremely complicated, it involves the economic analysis 1-2 (2009) 65-78 68 macroeconomic elements that are creating deficit on the world monetary market, and the feb politics is very questionable. to continue, there are inflation movements and finally, mess in the sole of the global financial system. the news is that the financial system today is different than the one of the past. real estate price drop in the usa was unheard of. attachment of this fact to the world economy, is without a president. this is brand new, and we do not have much experience with that.“1 the main reason which effect global economy, martin wolf assume the mortgage credits and real estates in usa: “we donʹt know how many people will have losses, we donʹt know the proportion of these losses, and also we donʹt know the government’s instrument for resolving this problems. i am assured that global recession is c o m i n g i n t o e x i s t e n c e , and because of that, global economy, global financial system and usa economy is need to be heal. off course it could be my guesses, and it could show that i was wrong. economic, financial crises attack developing countries”.2 c o n s e q u e n t l y , those countries reach the recession, protectionism, inflation, higher oil prices, interest rates, volatility of exchange rates, etc. all in all, financial and economic experts think that the basic characteristic of future will be the occur of the international financial crises, the international financial institutions (imf, world bank, wto) are completely unready to deal with them. because of the number of international financial crises, today developed countries organize numerous world economic forums (wef). especially, we emphasize the forum in davos (january of 28th – february of 02nd 2009) where the basic topic was usa crisis, new global financial system and its possible reform, expanding the crisis in other regions (europe, asia, africa), the reform of the international monetary fund (imf) and the world bank, and decreasing the protectionism, poverty, investments in energy sector, climates changing, etc. anyway, todayʹs crises wonʹt be resolved in nearly future. the new era of crisis management and global recession seek for more sophisticated dimensions and political tools. that new era should introduce the new discipline-crisis prevention and crisis resolution, and to put in the first place the role and the power of the international financial institutions (imf, the world bank). that institutions should be prepared to manage with global economy. hence, today is deadline for any other comments and for starting public discussions, we donʹt have time for promises, we need cooperation between developing and developed countries, we need to solve this chaos in global financial system right now!. destiny of the global economic: world economic crises which was the basic characteristic of the world economy in past year (2008)? because of finance worldwide ferment which was begin since more of two years, the global economy is confront with big imbalance how between certain countries, that’s like inside certain national economy. in the process of economic recovery it is necessary to relief and/or elimination of that imbalance. it is hard to tell with what speed or successful it will happen. the fact that the parts of the global economy are in different level of business circles it can have a twosided influence on the next trend of economic growth. it can act like dynamic and stability performance for preserving the global growth, which required strong worldwide 1available: [http://www.poslovni.hr/32169.aspx], (3.4. 2008.) 2ibidem. a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 69 coordination and cooperation, but also can contribute the consolidation of the worldwide protectionism. because of that the consolidation of the international integration and the step up of international assets flows for whose bring the economic protocol, it will make a new challenge. currently, the countries who was affected with global finance crises and recession are gradually recovering, but their recover is not enough for now. next progression will depend of the future structural reforms in that economy. [greenspan a., (2007), 8.] the crises of the global economy and that’s issue are present the main discussion. as the awake about changes broad the world, the discussion about international relations and crises are opening the question which gain the new and exhausted discussion. in the beginning of the 21st century it is said the most about the features of the new century. discussion about the possible global changes was got the frenetic extension of field, and it was abetment with the growth hope that’s the peace between the people and the growth of prosperity during the 21st century years in the future will stay. many people are kept the breath on that promises of the stabile future of the world. however, our era doesnʹt have its name or define character. we are living in the period of which passed a few different wars. these e t i q u e t t e donʹt talk enough about transition time of world history. we left all behind us, but still we donʹt believe in the future. the world got into new century. but, how we can think about global future, when currently the global financial system is threaten by financial collapse?. * * * from day to day, somehow we had a few ideas that couldnʹt get off our mind, and all information which we got and read form our thinking, lead us to conclude that destiny of the global economic is world economic crises. why we think so? namely, almost the whole world production is based on oil, and as we expect that barrel will amount $200, surely in future there will be higher prices of foodstuff and (non) foodstuff. forward, we also emphasize higher prices in energy sector, service sector [salvatore d., (2006), 794.] … and for rapid changing of alternative form of energy there is no time, from day to day us dollar is decreasing, even today it achieve the lowest rate with regard to euro, and when us dollar is very low, that means that “something doesnʹt respond well“. there are also, a huge credit crisis, a huge fear from recession, inflation cycle... usa is b e l l w e t h e r of the world, and every adventure in state is reflection on the rest of the world. how the land lies, usa has a unlikely future, unfortunately, the same destiny is prescribe for the rest of the world. but, price of oil isnʹt just a main reason for our panic. one of the basic fears is so called; domino effect, caused by the recognition of kosovo, where will be tense political situation for short period of time, and where will economic circumstances make worse or more difficult. also, we emphasize that, global heating will cause less yield in agrarian sector, and hereby the famine of the basic food stuffs. economic behold, with the increasing the demand, the price will be higher, which means that it could effect global economy. list of the factor that could effect on global economy is a p p r e c i a b l e . take just banal example of the protest against price increasing and oil across the world. politicians care, but they donʹt know how to deal with the current situation. inadequate passed dimensions didnʹt solve the economic diseases! economic analysis 1-2 (2009) 65-78 70 do we have a reason to get worried...? generally speaking, yes! not paying attention to the measures that are currently being taken, with the goal to avoid financial crisis of greater volume, many countries in europe and usa believe in the economy worsening in year 2009. most of the population of the four european countries and usa believed that the economy situation in 2008 was getting worse in comparing to the situation in the past year (2007). this was shown in the financial times research that presented that 61% of great britain, 55% of france, 54% of spain, 57% of italy and 54% of usa population believed in worse economy in the current year. the population poll on this something differs in germany where 33% of the population believe in the economy to worsen, while 47% think that the situation will pretty much stay the same. nevertheless, the research was done from january of 10th to 21st of this year through the internet, and it was done on a sample of 6676 adults ranging from 16 to 64 years of age, in france, germany, great britain and usa, as well as the adults ranging from 18 to 64 years of age in italy. most pessimism was presented through the economy outlook of every particular country. having said that, when we are talking about the situation in the personal finances department in 2008, people tend to be more optimistic. also, 44% of italy, 43% of great britain, 41% of american, 38% of germany and the same amount of spain population see their personal finances staying the same in this year. (diagram 1.) d i a g r a m 1 . p r o g n o s i s o f g l o b a l e c o n o m y s i t u a t i o n i n 2 0 0 8 3 0 10 20 30 40 50 60 70 great britain france italy spain germany usa do you think economy will be better or worse in 2008.? (%) better niether better nor worse worse pessimism is greatly dispersed in the countries of europe and usa. global dispersion pessimism is shown in the new research by the financial times (2008) that showed that 80% of italians, 67% of french, 52% of americans and 41% of great britain population seem to think that the situation in their countries are bad. german and spanish are divided as far as this goes, meaning that 36% think that situation in germany is going worse, and that opinion has 38% of the spanish. also, 28% of germans and 30% of spanish believe that the situation is good. the research has also showed that pessimism is not only concerning the current state, but it is present when its talked about the near future. 65% of italians, 59% of 3available: http://www.poslovni.hr/32169.aspx], (3.4. 2008.); http://www.seebiz.eu/bih/analize/najvece-prijetnjesvijetu-recesija,-nafta-i-nedostatak hrane,5961.html, (3.4. 2008.) a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 71 americans, 56% of french, and only 2% of the british believe in that. 49% of germans and 48% of the spanish believe that their country is going in the bad direction. on the other hand, the population of those two countries are showing the greatest optimism, meaning that 39% of germans and 30% of the spanish believe that thing are going in the right direction. the negative feelings are mostly connected to the opinion about economic situation in separate countries. so, 75% of italians, 70% of french, 63% of americans, 52% of spanish and 45% of british believe that the situation is dissatisfactory because of the unsatisfactory economic state. the only ones who believe that their country is standing tall regarding this question, are germans that showed this in 39% of their population. some of the many reasons for such pessimism are poor state in the justice system and unsatisfactory situation as far as employment goes. when itʹs talked about education in a certain country, a great part of the population believe that the situation is going for the better. (diagram 2.) d i a g r a m 2 . p e s s i m i s m i n e u r o p e a n d u s a i n 2 0 0 8 4 0 10 20 30 40 50 60 70 80 great britain france italy spain germany usa how is the situation in your country? (%) good bad besides the intensive world financial magma of the twenty first century, the highest developed countries still believe that the recession could be avoided. ministers of finances of the g-7 countries concluded that the world economy is pretty solid, but it is being threatened to become unstable. thus, countries that are the part of the seven mostly developed countries of the world have concluded that basic indicators of the world development and economy are solid and that the recession, especially in usa, as well as anywhere else could be avoided. at the same time we are warned that instability present on the markets is increasing thanks to the weakening of the american economy, d y s f u n c t i o n of the financial sector, as well as the high prices of oil and merchandise. but, the g-7 countries have shown the readiness to take drastic measures individually and together to secure global stability and market growth. american minister of finances henry paulson has said that todayʹs financial turmoil are serious and he has added that despite the problems, he is anticipating american economy to continue growing and that it will not come to recession, meaning that the percentage of the 4available: http://www.suvremena.hr/5995.aspx,, (3.4. 2008.) economic analysis 1-2 (2009) 65-78 72 increase of economic growth in 2009 will be on the satisfactory level. but, paulson has mentioned that certain market risks are facing this scenario, but he is predicting strong growth of the rapidly growing economies, but it will weaken in the future (diagram 3). very soon, his prediction has been shown as a mistake. d i a g r a m 3 . i m f p r e d i c t i o n s o f e c o n o m i c g r o w t h i n t h e w o r l d i n 2 0 0 9 ( % ) 5 0 1 2 3 4 5 6 7 8 9 10 china india world great britain japan euro zone usa imf predictions of economic growth in the world in 2008. (u%) economic growth the oil prices since the beginning of 2007. have been continuously growing, and their movement presented the threat to the economic growth in 2008 and also will be in 2009. the continued growing changes in the foreign currencies, before all in the currencies between the euros and the dollars, could lead to jolts on the international financial markets, further interest growth on the capital markets and the negative effects on the world economic growth. as we can see in the diagram, analysts believe that the economic growth on the global economy level will decrease. the reasons for this is the volatility in the oil and oil derivative prices due to the growth of demand, decrease of the monetary and fiscal stimulants in most of the countries, growth of interest rates and geopolitical tension. economists of the imf are predicting that the growth of the world economy (that has been growing in the rate of 4,9% last two years, in 2008 was 3,7%), is 2,2% in the current year. imf is cautioning to the risk that decrease of economic growth could be greater, predicting that there is 25% probability of that happening. if the growth of the world economy in the next two years was to be under 3% or less, that would, by the imf criteria, mean world recession. generally speaking through the world regions, after the intermission at the beginning of the 21st century, eu came over the stagnation and met greater growth rates of gdp (2-3,5%) in the period from 2005. to 2007. usa had more consistent growth in the period from 2003. to 2007. with over 3% annually. china all those years has gdp growth over 10% and india about 8%, russia between 6 and 8% and brazil between 5 and 7%. after the beginning of the credit crisis in 2007. the growth has been revised in eu to 5-2%, in usa 1-2%. the interest rates in usa were about 2-3% in the period from 2002. to 2007., where in the six months the discount rate of the federal reserves has been brought down to 2%. the interest rate of the ecb has been 5% for almost a year, the interest rate in china is 7-8%. the inflation in eu 5available: http://www.poslovni.hr/58372.aspx, (3.4. 2008.) a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 73 reaches 3,4% in most of the g-7 countries (the goal is to be under 2%), in usa about 3,5%. china and russia have inflation close to 10%. [imf, (2007), 9-12.] besides this, the world bank has in its «world economic predictions for 2008.», predicted also slowing down of the global economy growth down to 3,3% form last yearʹs 3,6%. considering «world economic predictions for 2008.» global growth will come up to 3,6% in the future. in 2007, global growth has been decreased to 3,6% after it was documented in the year before to be at 3,9%. world bank is starting that the activity deceleration in 2007. has been due to weaker growth in the countries of high gdp, but the developing countries have softened greater deceleration for the global growth thanks to strong growth of 7,4%, that almost stayed the same comparing the year before. the authors of this report have highlighted increased uncertainty of the current period, as well as few serious risks that have contributed to global growth deceleration. the inter demand for products of the developing countries could significant weaken, and the m e r c h a n d i s e prices could drop since the weakened real estate market in the usa and the new jolts to the financial markets will push american economy into recession. in the upcoming years of the bank, recovery of the global economic activities is anticipated as well as the economic growth of the developing countries. the growth of real gdp is anticipated also with about 7,1 %, while the countries with high gdps should achieve modest growth of about 2,2%. [world bank, (2008), 1-2.] the beginning of deeper crises of bosnia and herzegovina economy kemal kozaric, b&h central bank the governor has stated that the only way out of the possible crises in b&h can be seen only in domestic production. imf is concerned that in this country, due to inflation pressure on the food prices (the predicted inflation rate for 2008 is 2,6%) and e n e r g y g e n e r a t i n g p r o d u c t prices, and devaluation would considering many experts predictions in this area, be a punishments for all b&h residents. but despite those problems b&h imf office will be shut down. the cause of this is not the obvious one, that everything in b&h is great and there no need for them anymore, but it is not that the state in b&h is desperate, so they are leaving us (the inner restructuring of imf is in progress because it was necessary to decrease staff numbers due to decreased budget, and due to the same problem it was necessary to shut down resident offices in the countries that don’t have program with the fund). well, the governor kozaric said that this international organization is leaving due to decreased imf administration, but it still will be present in b&h through regular discussion and cooperation. with that is important to explain the reason for their living the right way. it is the same case for all the countries in the region that don’t have to stand by arrangement, and the stronger relationship with imf. they have played an important role in the period after war in b&h, have helped in the making of the central bank and have given technical help, but the greatest concern for the fund are three determinants, such as: they are aware of economic growth, there is progress that the inflation is under control, but they are expecting the fiscal board of b&h to start functioning, and they want to see them in action, and the recently accepted fiscal board code, creating such board and long-term solution to the profit division question and as it is predicted, the payroll code will bring more order in this area in the institutions. but they are still concerned over the inflation pressure prices of food and e n e r g y g e n e r a t i n g p r o d u c t . this is familiar to the bh public as well, so they are concerned too, especially over the consumption economic analysis 1-2 (2009) 65-78 74 increase in the federation of bh. the fund is satisfied because bh will sign the agreement about stabilization and joining the eu and it is anticipating positive effects to have on bh. but, bh authorities are doing next to nothing to soften the price increase blows, or to stop the oil crisis. for example, serious countries are already using own instruments to increase or initiate food production. bh governments should find or create funds to initiate domestic food production. last year bh spent about a billion km for import of foods that it already has. governments must stimulate domestic manufacturers or diminish some of their liabilities in order to help them. there is a lot of untouched agricultural ground, also, this country has a great climate and people who could work. governments could find some relaxation in the tax department as well, do they need to drop the vat rate or introduce “swimming axis” to gas, but they are the ones to decide. when oil comes to question, it’s too bad that oil refinery in bosanski brod still hasn’t started working because there aren’t any domestic crude oil refineries. no matter what the situation in bosnia looks like, there will not be currency devaluation, because it would be a punishment for its residents. for example, all credits would devaluate. that would be a shock and such measure that would shake everything bh worked on so far. they will definitely not take that adventure. the world economy crisis will not worsen bh stability. bh currency is stable and it has a 100% coverage, and amount 400 million km in free reserves as a “security” for domestic currency. bh analysts are conscious of the fact that crises is coming, but world banks, that were exposed on the american mortgage market, are not active in the region, so the first crises wave would avoid bh. we just need to watch what will happen next. according to information of eminent magazine «dnevni avaz» (june of 17th 2008.) population of bosnia and herzegovina have been very interested in this subject. namely, this magazine asked a question to population of bosnia and herzegovina (which were selected with s t o c h a s t i c example): «do you support the attitude of the central bank of bosnia and herzegovina, to not to devaluate km (convertible money), because this action (devaluation) would not effect on moderation of inflation in bosnia and herzegovina? here are the results of voting population of this country: diagram 4. the population against the devaluation of km the population of bosnia and herzegovina against the devaluation of km 71% 20% 9% yes no i don't know as you can see from presented diagram, most of the population support the attitudes of the central bank of bosnia and herzegovina, considering that this is adequately instrument for struggle against the currently state (not to use devaluation as a monetary instrument). a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 75 we should be prepared for the next crises and that’s why financial stability is important, which depends on all the segments of the financial sector. commercial banks have announced increase in interest rates, but central bank shouldn’t expect a big increase in that department. interest rate formation is free on bh market, but it’s inevitable that commercial banks are selectively choosing clients with good credit history and the ones who can finance their liabilities, so that significant increase of interest rates isn’t expected. interest rates in bh are on the average as in croatia, somewhat less in serbia, but somewhat greater in slovenia, meaning that bh is in the regional frames. it should be highlighted when saa starts being used, much food will come from eu that will be cheaper and if bh authorities do not react, domestic production would not be compatible again. but, it’s obvious that such strategy is not existence, no one takes concern over it. the e n e r g y g e n e r a t i n g p r o d u c t could be used because there is power shortage in the world, so bh should throw itself into energy production for which we posses the potential to export as well as to compensate for the oil we need to import. anyway, we shouldn’t be fooled, because significant world crises could shake the groundwork of bh economy. we are reminded that imf analysts have warned us that bh is in the group of especially threatened countries of the southeast europe. we highlighted that bh liabilities are high, because with export we are barely covering half of the import, so we should be afraid of foreign investments on the bh markets. the current shakes on the world financial market could disrupt the owing balance consumption and debt repayment in bh. it is explained that banks in every crisis are covering themselves first and their businesses in the mother countries. that’s why they are ready to write off daughters abroad, decrease the credits or completely withdraw from some markets. in such case, bh could be left without new loans. it is highlighted that we should watch the happening on the world market as well as the serious warning that are coming out way. the key question is if the current shakes of the world market will impact bh economy and how will they impact. we should find the answer to that as fast as possible so that we could get ready for what’s expected in the future. it is looking like, it is going to be tough for bh where it will depend on outer factors, with huge outer owning, deficit in merchandise trade, dependence of he whole economy on the service sector, credit liabilities or residents with long term housing credits, high ratio between the dependants and the on the employed…in this whole situation “the bright points” could be seen from the perspective that europe, eu actually, has a chance to become more powerful that usa, where they will not blindly listen to usa commands and where possibly, by entering eu, bh could be better then if it didn’t come into eu. and finally, bh could achieve greater economic growth rates only if it lessens public spending and fiscal deficit, and increases business surrounding. potential growth of gdp in bh is around 6,2% now. so, for a faster growth economic reforms are necessary, smaller role of the government and smaller fiscal deficit, faster privatization, increase of business surroundings, more efficient b u r e a u c r a c y , bigger flexibility on the labor market and the judicial reforms. further limitations of public expenses are still staying as a key question, because they would decrease the deficit of the current account of payment balance and the total liabilities of the country. but the increase in the public spending in bh is making imf concerned. before the bh government lies great homework, like stopping the inflation increase and deficit of the current account. general manager of the imf, straus kahn, has economic analysis 1-2 (2009) 65-78 76 stated that before the bh government lies great homework, the one stated above, but he added in the final solution to the inner liability question, with the goal to keep the fiscal stability and remove possible risks associated to everything mentioned above. until when will the price growth of the necessary basic articles keep up in bh, and does that mean that it’s just the beginning of the deeper crisis of its economy? when and will the crisis end soon…? prognosis of all the financial experts are correct, until they are shown as wrong. the same thing is happening in global crisis predictions that shook the world of finances after the breakdown of mortgage market in the usa and while some, few months ago, were saying that the worst is over, now there are many more who are predicting the end of the crisis. as the time passes by, their prediction are for the longer time period. many analysts are sure that the crises will last for another year and a half, but majority using their authority is warning us that the worst period still hasn’t passed and there still will be market shakes global banks are on the great quest for partners to recapitalize them, while best european banks are calmly observing. the happenings with big groups. the question is, how long will they be able to calmly observe the neighborhood. for the first time we are faced with the fact that crises came from the west, and not the east. for the first time the undeveloped east wasn’t too greedy in the race to achieve the greatest profit, growth possible. the banking market in the eastern europe is almost untouched, because the old countries of eu are tampon zone towards eastern europe since it was them. that were financially attached to usa, where the crises aborted, so the crises actually did come from the west countries and not developing market. the cause of the crisis is found in banks and their refinancing trough complex financial instruments such as derivatives. simply put the banks where buying bad and breakable assets since we should find something good in everything that’s bad, the banks in eastern europe will have less available money on the international capital market that will decrease already huge credit owning in the population, but not to make everything so bright, the same thing could happen in the b&h credit economy whose growth depends on foreign investments for now. the end result could be their decrease in growth, which is exactly what is happening. although b&h is not connected to american economy, b&h still has biggest trade with the countries of eu. that also shore be hit whit this, so we should hope that this crisis will pass by and the great shakes will not happen because the whole world is connected, and so that includes b&h as well. but, looking of the researches of many analysts, they are saying the financial crisis will continue hitting the world economy for an certain period of time, even until 2012 (average 24 years). the fact is the one we can’t escape from, that the crises come from the west. banking market of the southeastern and eastern europe should overcame the crisis but the question pending is how hit will the real economies be. economic declaration in the usa in the future will lead to new credit problems begins in the area of mortgages, the consumer credits auto loans, is still unpredictable. the liquidity shortage in the financial system that was brought up by credit crisis will surely loot for few more years. financial institutions from the whole world, such a city group on a ubs, have last over $300 billion in last value and credit trough out the credit crisis that has stored the collapse of the commercial mortgage market, but many are saying that the worst part of the crisis is over ever since in march of 2008 bear a. rovčanin, a. kožarić / ea 1-2 (2009) 65-78 77 sterns was rescued with help of federal reserved. the worst is over but the crises isn’t over yet. it is clear that the american economy will decrease grown in the next period, but the recession is not likely unless the hand of price increased of oil and product continues. if the price increase continues with the same speed, recession in the usa will be unavoidable. the dramatic oil price growth on the american market has increased concerns over inflation and the consumer buying power. usa shocks have collapsed after record growth in oil prices and government confession that the unemployment financial crises isn’t over yet, and it is safe to expect more market shocks, and we still question if the worst is over yet. conclusion we came in the 21st century with faith that the global unbalance and crises will diminish. we looked at this century as a new epoch with evened out economic growth and balanced working and living conditions. but, unfortunately, every time period brings its own traps. it looks like that the good macroeconomic politics, reliable institutions, real regulatory frame, timely reactions, and a good intentions do not have a alternative. world economy is in the unusual period and bosnia and herzegovina can’t impact new resource findings or world food prices, but in the frame of its limits it can do more then it is already doing. at the beginning of 21st century, significant orderly relations and more balanced economy growth has been anticipated, but food shortages come pong, with the enormous jump of prices of the basic food articles in the world, and the sole existence of great amount of people is in question. everything that made the groundwork of the world economy is brought to question, and the crises of mortgage is bringing in to question the stability of the financial system. solution of the world economy crises is in the macroeconomic management, and that eu and usa should start working together as far as the dollar currency goes, payment deficit, and to soften the credit crises but, should be high lighted that b&h is not in the first arrangement of countries that are impacted by the happenings in the world economy, but also that it is not able to stored a good position in the circle in which its economy works. changes around that country are much faster then in it, and that’s the only problem that we can impact, the other things are objection. the only was for bit to smoothen dimmer relations is trough the interests of economy that could be part of the regional story. the world crises was caused by poor economic management, usa, the country playing the part of the cradle of liberal capitalism, has a hard time in managing economy and regulation of the outer system, but considering its impact on global economy, those problems are sipping through the other countries of the world. in the world today, the biggest problem is the political instability caused by war and crisis that lessen the business optimism, in the usa before all but in the other countries as well. consequences of financial crisis will be demolishing for usa economy firstly, but will have same impact on the global economy as well. but, it is possible to recover, because is a great deal of free capital so the investments should be focused on manufacturing. although, the feeling of the possible recession should be eliminated, usa and eu have totally different goals. if we continue with friends like, oil price growth, increase of imbalance of food, decrease in dollar value or increase in inflation, recession is unavoidable. economic analysis 1-2 (2009) 65-78 78 references greenspan a., (2007), the age of turbulence, penguin group, washington d.c. http://www.poslovni.hr/32169.aspx http://www.poslovni.hr/32169.aspx http://www.seebiz.eu/bih/analize/najvece-prijetnje-svijetu-recesija,-nafta-i-nedostatak hrane,5961.html http://www.suvremena.hr/5995.aspx http://www.poslovni.hr/58372.aspx imf, (2007), annual report., washington d.c. available: [http://www.imf.org]. salvatore d., (2007), international economics, ninth edition, john wiley & sons, inc., new york. world bank (2008), global development finance: the role of international banking-review, analysis, outlook, washington d.c. available:[siteresources.worldbank.org/intgdf2008/resources/gdf_complete_web-appended6-12.pdf]. ea_2014_1-2 udc: 330.55(498:4-672eu) ; 330.45:517.521 jel: o47, o2 id: 207709964 preliminary report the intensity of convergence process in the european union simionescu mihaela1, institute for economic forecasting of the romanian academy, bucharest, romania abstract – the objective of this research is to analyze the differences between romania and the european union regarding the convergence process. in this paper we were interested in determining the forecasting horizon for which romania, in certain conditions, might have a value of gdp per capita that is closer to the average of eu (25 countries) and we obtained that 18 years are necessary for romania to achieve the convergence compared to eu average of gdp per capita. the co-integration approach suggested that in the last 15 years there is a divergence of the romania economic growth and the eu-25 average. this research might be developed by taking into account other measures of economic convergence. key words: beta convergence, gdp per capita, regression, co-integrated series introduction the convergence analysis is made from the point of view of closeness of homogeneity state and the existence of conditions that might facilitate the realization of these objectives. for measuring the intensity of convergence process the beta indicator based on regression analysis is seldom used in studies. the approach based on co-integrated series also provides important information regarding the realization degree of convergence process. from the economic development perspective of the countries in a community there are situations when the co-integration analysis has a high utility. these situations are: linear and persistent economic growth, when there are different rates of economic growth, the knowledge of a statistical equilibrium regarding the economic evolutions between countries. this paper consists in several parts. after a brief introduction, a short literature review is made, underlying the latest results regarding the beta convergence assessment. the results indicated that the tendencies in the last 15 years do not close the economic growth convergence from romania to the average eu economic growth. almost 18 years are necessary for romania to have a value of gdp per capita that is closed on the eu-28 average. a short part dedicated to main conclusions was presented in the end. literature review barro and sala-i-martin (1996) presented sigma and beta indicators as suitable indicators for measuring the convergence degree and the speed for the convergence realization. beta 1 5, calea 13 septembrie, bucharest, email: mihaela_mb1@yahoo.com economic analysis (2014, vol. 47, no. 1-2, 103-110) 104 parameter indicates the speed for convergence process when the sign is negative. frenken kochn at al. (2005) and quah (1996) consider the beta an unsuitable indicator for the economic growth real convergence. there are few beta approaches: club convergence, absolute beta convergence, and conditional beta convergence. the sigma and beta tools are related and reciprocal checked. davide furceri (2005) gave a mathematical relationship between the beta and sigma-convergence. quentin wodon and shlomo yitzhaki (2006) showed that in the univariate setting the sigma-convergence implies the beta-convergence. therefore an important caution is necessary for the interpretation of the beta-convergence as notion. terry robinson (2007) analyzed the convergence of european gas prices since 1978 by applying several tests: a simple test for beta convergence, a cointegration test and the approach of nahar and inder’s. hassan mohammadi and rati ram (2012) used a simple model of beta-convergence for consumption of energy per-capita. unconditional beta-convergence patterns are in accordance with sigma-convergence versions. thomas m steger (2012) observed that linear growth model for subsistence consumption can reproduce the beta-divergence. giuseppe bruno, riccardo de bonis, andrea silvestrini (2012) analyzed the sigma and betaconvergence for some financial instruments like shares, insurance products, debt securities and deposits. they observed the beta-convergence of shares and insurance products. monfort, cuestas, and ordóñez (2013) utilized a cluster analysis, putting in evidence the existence of two convergence clubs in eu-14, the eastern european countries being divided in two groups. pedro verga matos and horacio haustino (2012) tested the beta-convergence and sigma-convergence in the corporate governance models, observing a significant evidence of convergence within countries. vu (2013) observed that practitioners make an important mistake by using the final calculation from the logarithmic measure of gap to make the interpretation of the convergence speed of gap in level expression. laurent weill (2013) analyzed the improvement in eu bank competition by applying sigma and betaconvergence for panel data. the authors observed a convergence in bank competition for eu members. mariusz próchniak and bartosz witkowski (2013) checked the time stability of the beta convergence for gdp using two samples: eu15 and eu27. the authors also verified the stability and strength of specific factors of growth. m. simona andreano, lucio laureti and paolo postiglione (2013) assessed the economic growth of north africa and middle east countries using the conditional beta-convergence. the measurement of convergence intensity in eu-28 the intensity of this process depends on many factors like the analysis period or the economic and social conjuncture of the particular period. the regression analysis measures the marginal reaction of the effect (gdp per capita) for change in cause (in condition expressed as low relative development level in initial stage). the analysis is completed by a check using t test. a non-linear model is proposed, but it could be linearized: , i=1,2,…,n countries simionescu, m., the intensity of convergence process, ea (2014, vol. 47, no, 1-2, 103-110) 105 the base period development level (for example. gdp) development level after t time units parameter representing the regression slope the error in order to measure the polarization the following variant is used: the central level around which the i regions polarize, i=1, 2,…, n in order to test the significance of the slope t computed is determined: if computed t is greater than the critical value (t taken from the table for a level of significance alfa ( ) and n-2 degrees of freedom), the significance is confirmed. the slope shows the increase in average rate when the development level decreases with one unit. so, we expect a negative sign for the parameter. the beta coefficient expresses a rational relationship confirmed by the economic theory, actually by the neoclassic theory of the economic growth that concerns about the inverse relationship between the convergence intensity and the distance compared to stable equilibrium state. the input is represented by the development level in different past periods and it is analyzed using the regression analysis. the result may confirm or not the economic theory. the coefficient expresses a state on a certain time interval and for all the analyzed regions. the way to express the relationship has an average character, but it is the result of estimation process. therefore, the check of coefficient significance is necessary. the slope expresses a potential (a repeatedly situation) of the low developed countries to register a superior rhythm compared to developed countries. there are many causes for this situation of inequality; among them one could enumerate the low level of beginning and the entrainment effect. the potential expressed by the level and the sign of beta has a character of average that is different from a country to another. however, a propensity for convergence may be evidenced. the result estimated for the slope is compatible with the convergence only is the sign is “minus” and there is a significant level at least in t test terms. there is a risk for beta coefficient to represent a biased estimation, fact known as galton fake. another limit would be that there might be almost equal conditions for the countries in economic analysis (2014, vol. 47, no. 1-2, 103-110) 106 the sample regarding savings rate, depreciation rate and population growth. these conditions and the technology conduct mostly to a polarization process. the non-linear model could be extended by adding up new variables. the condition of low level does not compulsory implies a high level of increase. but only for a low reference base that could be initially easy to surpass. however, in time the overcome becomes more difficult. if we suppose that there are strong efforts to surpass the leaders. the investments should be taken into account. in this case the model is: in order to apply the model, some details should be established. the base year is 1995. the proportion refers to base year and to the final year 2012 and to level of gdp per capita in that year for the 28 countries, but also for the base year in those countries. )log(296,02428,0log 28 1 0 0 i i it y y y ⋅−= after the application of t test regarding the significance of the slope the t computed is 3.2, fact that refers that the parameter differs from zero. the parameters are significant according to f test. the negative sign confirms the expectations and also the economic theory. the low value of the coefficient of determination of the economic growth ( 264,02 =r ) indicates the existence of other causes. we are interested to determine the forecasting horizon for which romania, in certain conditions, might have a value of gdp per capita that is closer to the average of eu (25 countries). therefore, the average indices are computed using the indices from 2003-2012 based on annual rates of gdp in constant prices. the average index of growth for eu 25 is 1.022, while the average index for romania is 1.078. the initial levels are based on the values registered for 2010 and the growth rate from 2011 and 2012. the following levels in pps thousands euro were computed: 25.5 for eu and 10.2 for romania. the future moment denoted by t is computed as: = the result is quite far in time (almost 18 years). co-integrated series and the convergence a non-stationary time series with a certain trend that becomes stationary (no trend) by computing the differences of order d between successive terms is co-integrated of order d. two time series are co-integrated of order d,b if the integration order of each data series is identical and there is a linear combination with an inferior degree of integration that is b. we start from two time series representing the gdp per capita in country a ( ), respectively in country b ( ). if the time series have a linear trend, the differences of order one are integrated of order 1 and there is a linear combination between the two series that is simionescu, m., the intensity of convergence process, ea (2014, vol. 47, no, 1-2, 103-110) 107 integrated of order 0, then the initial time series are co-integrated of order 1,1: . in order to have a convergence process the average differences for an interval t should be inferior to the initial difference between the development levels: in other words, the two time series with different trends there is the following relationship: the values of gdp per capita in pps thousands euro for romania and eu-25 are presented in the following table. table 1. gdp per capita in pps thousands euro year eu-25 (x) romania(y) 1999 18.8 4.8 2000 19.5 4.9 2001 19.9 5.2 2002 20.2 5.4 2003 20.4 5.7 2004 20.9 6.2 2005 21.3 6.4 2006 21.9 6.9 2007 22.5 7.4 2008 23.6 8.3 2009 24.9 9.4 2010 25.7 11.4 2011 26.2 11.9 2012 26.3 12.1 source: eurostat the first order differences between the consecutive terms of the time series are computed in the following table: economic analysis (2014, vol. 47, no. 1-2, 103-110) 108 table 2. the differences between the gdp per capita values eu-25 (x(t)-x(t-1)) romania (y(t)-y(t-1)) 0.7 0.1 0.4 0.3 0.3 0.2 0.2 0.3 0.5 0.5 0.4 0.2 0.6 0.5 0.6 0.5 1.1 0.9 1.3 1.1 0.8 2 0.5 0.5 0.1 0.2 0.7 0.1 source: own computations figure 1. the evolution of gdp per capita in eu-25 and romania during 1999-2012 in eu and romania the gdp per capita presents a linear growth tendency. the computed averages for each data set regarding the gdp increased, fact that shows the trend presence. the first order differences have an oscillating evolution around a constant. therefore, we can conclude that the initial time series are co-integrated of order 1. after estimating the parameters we have the following regression model: y=14.66531+0.9974*x and the linear combination is: z=y(-14.66531+0.9974*x) the time series are co-integrated of order one, because both data series are integrated of order one and the linear combination has a lower order of integration. the consequences are: the estimations of parameters are over-consistent and the evolutions in time characterize the simionescu, m., the intensity of convergence process, ea (2014, vol. 47, no, 1-2, 103-110) 109 processes in a static equilibrium. a high value of the parameter expressed in a standard form is a condition of closeness in time of the evolution that started from a higher level. the tendencies are described below: • for the evolution of the gdp per capita in pps for romania: x=22.2928+0.3051*t and the standard level is 0.3051*(8.366/0.541)= 4.718 • for the evolution of the gdp per capita in pps for eu-25: y=7.5714+0.2997*t and the standard level is 0.2997*(8.366/0.836)= 2.999 the slopes represented by the coefficient of time variables (0.3051 for romania and 0.2997 for eu-25) and the standardized values regarding the slope (4.718 for romania and 2.999 for eu-25) showed that the tendencies in the last 15 years do not close the economic growth convergence from romania to the average eu economic growth. conclusions in this paper we were interested in determining the forecasting horizon for which romania, in certain conditions, might have a value of gdp per capita that is closer to the average of eu (25 countries) and we obtained that 18 years are necessary for romania to achieve the convergence compared to eu average of gdp per capita. the co-integration approach suggested that in the last 15 years there is a divergence of the romania economic growth and the eu-25 average. this research might be developed by taking into account other measures of economic convergence. references andreano, m.s., laureti, l., postiglione, p. (2013), economic growth in mena countries: is there convergence of per-capita gdps?, journal of policy modeling, 35, issue 4, july–august 2013, 669-683. barro, r.x., sala-i-martin. (1996), convergence across states and regions, brooking papers on economy activity, 1. bruno, g., de bonis, r., silvestrini, a. (2012), do financial systems converge? new evidence from financial assets in oecd countries, journal of comparative economics, volume 40, issue 1, february 2012, 141-155. frenken kochn, t., verburg, f., gran, o. (2005), variety and regional economic growth in netherlands, emaee. furceri, d. (2005), β and σ-convergence: a mathematical relation of causality, economics letters, volume 89, issue 2, november 2005, 212-215. matos, p.v., faustino, h.c. (2012), beta-convergence and sigma-convergence in corporate governance in europe, economic modelling, volume 29, issue 6, november 2012, 2198– 2204. mohammadi, h., ram, r. (2012), cross-country convergence in energy and electricity consumption, 1971–2007, energy economics, volume 34, issue 6, november 2012, 18821887. monfort, m., cuestas, j.c., ordóñez, j. (2013), real convergence in europe: a cluster analysis, economic modelling, volume 33, july 2013, 689-694. economic analysis (2014, vol. 47, no. 1-2, 103-110) 110 próchniak, m., witkowski b. (2013), time stability of the beta convergence among eu countries: bayesian model averaging perspective, economic modelling, volume 30, january 2013, 322-333. robinson, t. (2007), have european gas prices converged?, energy policy, volume 35, issue 4, april 2007, 2347-2351. steger, t.m. (2012), economic growth with subsistence consumption, journal of development economics, volume 62, issue 2, august 2000, 343-361. quah, d. (1996), twin peaks: growth and convergence in models of distribution dynamics, economic journal, 106. vu, k.m. (2013), a note on interpreting the beta-convergence effect, economics letters, volume 118, issue 1, january 2013, 46-49. weill, l. (2013), bank competition in the eu: how has it evolved?, journal of international financial markets, institutions and money, volume 26, october 2013, 100-112. wodon, q., yitzhaki, s. (2006), convergence forward and backward?, economics letters, volume 92, issue 1, july 2006, 47-51. intenzitet procesa konvergencije prema evropskoj uniji rezime – cilj ovog istraživanja je da analizira razlike između rumunije i evropske unije uzimajući u obzir proces konvergencije. u ovom radu želeli smo da predvidimo vremenski horizont u kom će rumunija, pod određenim uslovima, dostići vrednost bdp po stanovniku koji je približan proseku eu (25 zemalja) i utvrdili da će joj biti neophodno 18 godina da dostigne prosek bdp-a po stanovniku. kointegracioni pristup ukazuje na to da u poslednjih 15 godina postoji divergencija ekonomskog rasta rumunije i proseka zemalja eu-25. ovo istraživanje moglo bi se unaprediti uzimajući u obzir i ostale mere ekonomske konvergencije. ključne reči: beta konvergencija, bdp po stanovniku, regresija, kointegrisane serije article history: received: 23 january 2014 accepted: 2 march 2014 doi: 10.28934/ea.23.56.1.pp1-19 first online: march 29, 2023 original scientific paper corruption as an obstacle to pandemic response: a covid-19 case study bruno škrinjarić10 f* | jelena budak1 | allison carragher2 1 institute of economics, zagreb, croatia 2 carnegie europe, brussels; institute of economics, zagreb, croatia abstract this research explores the relationship between corruption and pandemic outcomes by investigating whether european countries with higher levels of corruption were less successful in fighting covid19. data were analyzed using exploratory factor analysis and structural equation modeling techniques. results indicate that corruption prevalence and poor bureaucratic quality both decrease trust in government, and this effect is persistent notwithstanding the socioeconomic conditions or geographic attributes of a country. trust in government, coupled with stringency measures, is positively associated with the number of new people vaccinated and, thus, fewer covid-19-related deaths. furthermore, corruption undermines trust in the government and its institutions and, through this mechanism, prevents the suppression of the pandemic. unlike other scarce studies that looked at the direct link between corruption and vaccination only, we also investigated the impact of corruption on the outcomes of government pandemic restriction measures and added several contextual variables into the model. we found that corruption poses a significant obstacle to the pandemic response. our findings suggest to policymakers that their best weapon against covid-19 is vaccination and that renewed efforts to eradicate corruption and establish trust between governments and citizens can positively impact vaccination rates and limit the most devastating effects of the pandemic. keywords: corruption, trust in government, vaccination, covid-19, population health, europe jel classification: d73, i18 introduction corruption and its causes and consequences have been assessed from many different points of view. however, the understanding of corruption in circumstances of global disasters, such as the situation caused by the covid-19 pandemic, is rather limited (collins et al., 2020; greer et al., 2020). the pandemic generated social, economic, and governance crises (oecd, 2020) that opened opportunities for corruption (rose-ackerman, 2021), where the latter remains largely unexplored. the goal of this research is to investigate the relationship between levels of corruption and disastrous consequences of the covid-19 pandemic on the european continent by seeking to determine if countries where corruption is more dominant were less effective in combating the covid-19 pandemic and examining which factors explain the variations. our intuition is that societies where there is more corruption, poor bureaucracy, and poor socio-economic conditions * corresponding author, e-mail: bskrinjaric@eizg.hr 2 economic analysis (2023, vol. 56, no. 1, 1-19) do not trust the government and thus faced more institutional impediments to effectively coping with the pandemic and witnessed worse outcomes. concerns that corruption and low levels of trust in government could further distort efforts to fight the pandemic were raised in the early days of the outbreak before a vaccine was available. however, there has been little scientific study on whether corruption stands as an impediment to efficiently fighting covid-19 and, if so, whether the situation changed when vaccination became largely available. beyond corruption, could related determinants such as institutional quality and a government’s capacity to conduct sound policy measures mitigate the expected negative effects of the covid-19 pandemic? does the country’s health infrastructure play a key role in affecting the new cases of infection and covid-19-related deaths? considering these contextual factors and the overall socioeconomic conditions of a country, this research sheds new light on neglected aspects of fighting the covid19 pandemic in europe. our contribution to the literature is that, unlike other scarce studies that looked at the direct link between corruption and vaccination only, we looked at the impact of corruption on the outcomes of government pandemic restriction measures. secondly, we use a large sample of european countries. this gives us the right amount of heterogeneity between countries to explore relationships between different variables but also enough homogeneity in terms of geographical effects, season effects, and the general level of development. considering the contextual variables in a structural equation modeling (sem) model, the findings allow us to derive data-driven policy implications/recommendations. thirdly, we use detailed monthly data on the level of corruption, bureaucracy quality, and socioeconomic conditions for the observed countries in order to analyze changes in the relationships among variables throughout the waves of the pandemic and the introduction of vaccines. this paper is structured as follows: following the introduction, the literature review is provided in section 2. the research methodology and data sources are presented in section 3. in section 4, the empirical results of descriptive statistics, exploratory factor analysis, and a structural equation model are provided. finally, the conclusions, including suggestions for further research, are presented in the final section. literature review the abundant literature on determinants of corruption (treisman, 2000; elbahnasawy and revier, 2012) finds that low democratic standards (kolstad and wiig, 2016) and political risks and instability (serra, 2006) are positively associated with corruption, while the quality of political institutions is negatively associated with corruption (lederman et al., 2005). furthermore, there is ample empirical evidence that corruption impedes growth and is associated with lower levels of economic development (d’agostino et al., 2016). the relationship between the prevalence of corruption and the covid-19 pandemic has two components. firstly, corrupt rent-seeking might increase in times of crisis (such as wars, natural disasters, or a pandemic) due to market distortions mirrored in shortages that lead to price increases, illegal trade, and profiteering. a global ‘corruption wave’ during the covid-19 pandemic was observed in europe, with cases of misuse of public procurement and purchasing equipment on the grey market (steingrüber et al., 2020). the (initially limited) availability of vaccines further created opportunities for rent-seeking behavior and corruption (goel and nelson, 2021; undoc, 2020) throughout the vaccine value chain (transparency international, 2021). this corruption contributes to supply chain issues, thus depriving citizens of their ability to access medical supplies and receive quality health care (teremetskyi et al., 2020). in times of pandemics, the implementation of anti-corruption policies is endangered (amundsen, 2020; estrada, 2020), resulting in more corrupt societies becoming even more vulnerable to crises (yamen, 2021). bruno škrinjarić, jelena budak, allison carragher 3 on the other hand, the covid-19 pandemic has also given governments a chance to gain more legitimacy, enhance governance, and increase the level of trust in public institutions. messner (2020) explored institutional and cultural factors that influenced the covid-19 outbreak and found that a strong institutional context, including low corruption and high political participation, is negatively associated with the outbreak. ezeibe et al. (2020) concentrated on nigeria and explored the effect of political distrust on covid-19 spread. they concluded that boosting public sector accountability helps stem the spread of covid-19 by motivating citizens to obey safety measures. relevant research also indicates a strong negative relationship between corruption and effective government (mohamadi et al., 2017; schwab and sala-i-martín, 2015). it is reasonable to assume that in corruption-free environments, governments and societies can respond to pandemic challenges promptly, and in a well-organized and responsible manner. transparency, public trust, and government accountability are all seen as crucial to the effective and rapid response to a pandemic (rose-ackerman, 2021). in the initial covid-19 outbreak stages, most governments imposed non-pharmaceutical intervention measures such as lockdowns, travel bans, movement restrictions, and social distancing (megna, 2021), as well as public health and economic measures (chilton et al., 2020). some countries, such as switzerland and nordic countries, invoked new or amended laws on epidemics to allow for the implementation of stricter measures (francetic, 2021). the urgency of the crisis called for immediate policy responses. the late introduction of social distancing and lockdown measures seems to worsen the effects of the first wave (as arnold et al. (2022) showed for england). success in implementing these non-pharmaceutical interventions is dependent on trust, good communication (balog-way and mccomas, 2020; cairney and wellstead, 2021), public perceptions of risk, and behavioral responses to personal protection (dryhurst et al., 2020; mamen et al., 2021). nevertheless, further studies show that the success of the severe measures imposed during the first wave of the pandemic had a contrary effect in the later stages, primarily due to a reduction in public trust in actions undertaken by the government (sagan et al., 2022), with the level of trust varying significantly among countries (sabat, 2020). since the outbreak of the pandemic, several studies have contributed to the assessment of public policies to control the incidence of covid-19 (haug et al., 2020; saez et al., 2020). national responses across the globe have been shaped by two sets of factors: i) the capacity of the healthcare system and health infrastructure readiness, and ii) the governance quality from an organizational perspective, the administrative ability to operationalize actions, and political leadership (capano et al., 2020). literature on healthcare systems and policy responses to covid19 pointed out heterogeneity in regulations and operationalization of measures among countries (berger et al., 2021), concluding there are no one-size-fits–all policy recommendations. the capacity, organization, management, and other characteristics of health infrastructure garnered attention as the costs of covid-19 were expected to be higher in countries with less developed health systems and higher population densities (mckibbin and fernando, 2020). as covid-19 imposed an extra burden on health systems and hospitals (winkelmann et al., 2021), the combination of rather limited supply and increased demand for health services, and the lack of strict clinical acuity-based criteria for the allocation of health and medical resources, might lead to more corruption, especially in public procurement in the health sector (teremetskyi et al., 2020). nations with lower corruption prevalence have evidenced slower pandemic growth (attila, 2020; farzanegan, 2021), which suggests corruption stands as an obstacle to the efficient and effective fight against covid-19. finally, wealthier economies providing better socioeconomic and health conditions to citizens should be better equipped to handle the negative effects of the pandemic (bokhari et al., 2007), despite the negative economic consequences of covid-19 (see e.g. bodroža & lazić (2021) for western balkans). however, inversely, developed countries also tend to have older populations, which contributed to higher death rates due to covid-19. 4 economic analysis (2023, vol. 56, no. 1, 1-19) there is less research linking vaccination, corruption, and government efficiency, and the existing research has yielded contradictory results. vaccination is regarded as a powerful tool in the fight against pandemics, both to alleviate the burden on hospitals and health workers and to reduce fatalities. however, the public reactions to covid-19 vaccines have varied from strong demand to ‘anti-vax’ behaviors (benoit and mauldin, 2021), with different responses reflecting differing levels of trust in governments and science at both the individual and societal levels (debus and tosun, 2021; grawitch and lavigne, 2021). jelnov and jelnov (2022) showed that government accountability contributes to the success of vaccination campaigns, with higher vaccination rates observed in more liberal and less corrupt countries. farzanegan and hoffmann (2021) found a negative relationship between countries’ corruption prevalence and vaccination rates. on the other hand, this relationship was found to be positive in a comparative study of the 50 us states, indicating that corruption might also work as a ‘greasing mechanism’ in vaccine delivery and priority access (goel and nelson, 2021). data and methodology data sources this research is based on three data sources: (1) summarized data on the covid-19 pandemic (hereinafter: covid dataset) by ritchie et al. (2020); (2) data on economic, financial, and political risk ratings for 140 countries (hereinafter: prs dataset), obtained from the prs group (prs group, 2021); and (3) data on health system infrastructure (hereinafter: who dataset), taken from the world health organization (who, 2021). the covid dataset includes data directly related to covid-19, including new confirmed cases and deaths, total confirmed cases and deaths, data on hospitalized patients, and data on covid-19 tests and vaccinations, as well as healthrelated data. the prs dataset contains political, social, and economic data for various countries around the world. among others, it includes estimates on a country’s corruption level, bureaucracy quality, democratic accountability, government stability, and socioeconomic conditions. finally, the who dataset includes data on hospital capacity and health infrastructure. the covid dataset is reported on a daily basis, the prs dataset on a monthly basis, and the who dataset on a yearly basis; upon merging these three datasets, they were all transformed to a daily basis covering the period from february 1st, 2020, to december 31st, 2021. our analysis focuses on a set of 34 european countries (table 2 in appendix), as this gives us the right amount of heterogeneity among countries to explore relationships between different variables, but also enough homogeneity in terms of geographical effects, seasonal effects, and the general level of development. empirical methodology and variables our empirical model to be tested is presented in figure 1. vaccination rate is a mediation variable between latent construct trust in government (govttrust) and two outcome variables: (1) new cases of covid-19 (new cases); and (2) new deaths connected to covid-19 (new deaths). govttrust represents the government’s capacity to carry out sound policies and citizen readiness to follow government recommendations. it is estimated from a set of manifest variables (items): (1) corruption index, (2) bureaucracy quality index, and (3) socioeconomic index. these manifest variables are highly constant over time (figure 5 in the appendix), suggesting that pre-pandemic levels are very similar to those in the analyzed time frame. trust in government is hypothesized to affect the vaccination rate, which in turn affects new cases and new deaths attributed to covid19. bruno škrinjarić, jelena budak, allison carragher 5 figure 1. empirical model source: authors’ own work. note: “demographic” and “health” are in bold as these represent matrices of variables. additional variables which are hypothesized to affect the vaccination rate and two dependent variables are the stringency index and specific country group effects. the stringency index enters the model as a 7-day moving average, as it takes some time for stringency measures to affect both vaccination rates and new cases/deaths. country group effects enter the model as a set of dummy variables. demographic is a matrix of variables capturing a country’s demographics: namely, median age and population density. health is a matrix of variables capturing a country’s health infrastructure: specifically, the number of hospital beds and the universal health care (uhc) service coverage index. we also add gdp per capita (ppp) to account for the general wealth of an economy. a more detailed description of all variables used in this research is presented in table 3 in the appendix. there are two stages to our empirical methodology. firstly, we test the latent construct govttrust for dimensionality, consistency, and reliability. cronbach’s alpha (ca) coefficient, alphaif-deleted indicator, and different correlations were used to analyze the reliability of measurement scales. exploratory factor analysis (efa) was used to examine the dimensionality of the measurement scale, whereby the measurement models specified that each manifest variable (scale items) was loaded by only one latent construct (factor), and the independence of measurement errors was assumed (kline, 2015). secondly, after testing and estimating the latent construct (variable) govttrust, structural equation modeling (sem) was used to estimate the empirical model. results descriptive statistics figure 2 presents a distribution of corruption, bureaucracy quality, socioeconomic conditions (measures available on a monthly basis), and estimated trust in government in selected european countries as averages during the 2020–2021 period. corruption is lowest in nordic countries (denmark, finland, norway, and sweden), closely followed by austria, germany, iceland, ireland, netherlands, switzerland, and the uk. conversely, the highest corruption rates are recorded in non-eu eastern european countries like russia, belarus, serbia, moldova, albania, and ukraine. govttrust corruptionε 1 bureaucracy qualityε 2 socioeconomicε 3 gdp per capita vaccination rate ε 4 stringency index new deaths ε 5 country group new cases ε 6 demographic health 6 economic analysis (2023, vol. 56, no. 1, 1-19) the relationship between corruption and bureaucracy quality essentially divides european countries into two groups: those in which corruption is higher than bureaucracy quality and vice versa. socioeconomic conditions have been traditionally the most favorable in northern european countries like denmark, finland, and sweden; and in western european countries like belgium, germany, netherlands, and switzerland. countries with low corruption and high socioeconomic conditions have higher trust in government and vice versa. figure 5 in the appendix shows that these trends are rather stable over time. figure 2. corruption, bureaucracy quality, socioeconomic conditions, and estimated trust in government in selected european countries (average 2020–2021) source: authors’ own work. figure 3 displays the distribution of people vaccinated with one dose at least (per hundred) and estimated government trust in selected european countries from the beginning of 2021 onwards when the vaccine was made available to the public. the solid black line represents a linear trend between these two variables, illustrating that trust in government is positively correlated with vaccination rate. bruno škrinjarić, jelena budak, allison carragher 7 figure 3. vaccination rates and estimated trust in government in selected european countries source: authors’ own work. figure 4 presents a scatter diagram for the analyzed european countries showing four dimensions: (1) population vaccination rate (people vaccinated with one dose at least per hundred inhabitants); (2) total covid-19 deaths per million inhabitants; (3) average level of trust in government during the period 2020-2021 (those with a score below the median are designated as low-government-trust countries, and those above the median high-government-trust countries); (4) time horizon throughout 2021 with balances at the end of each month. trust in government is highest in denmark, finland, norway, and sweden (nordic countries), followed by austria, germany, iceland, ireland, the netherlands, switzerland, and the uk (marked in black). on the other hand, the lowest rates of government trust were recorded in eastern european countries that are not members of the eu, such as russia, belarus, moldova, serbia, and ukraine (marked in light gray). considering the time horizon, the vaccination rate progression is clearly visible. it is very low in the first quarter of 2021 in all countries, regardless of the level of government trust (given that the vaccine became available only at the beginning of 2021), and rising in the second and the third quarters of 2021, most significantly in countries with a higher government trust rate (which reached vaccination rates of over 70 percent). finally, looking at the correlation between vaccination rate and covid-19 deaths, it is evident that this association is stronger (in the sense of a higher absolute value of the correlation coefficient) in countries with a higher government trust rate. in other words, the increase in the population vaccinated in highgovernment-trust countries is correlated with fewer deaths from covid-19. 8 economic analysis (2023, vol. 56, no. 1, 1-19) figure 4. vaccination rate and total covid-19 deaths in selected european countries source: authors’ own work. the presented situation regarding the spread of the virus and associated deaths, vaccine dynamics, and non-pharmaceutical measures applied vary across european countries. this indicates some trends and relationships worthy of an in-depth investigation, where institutional factors of public trust in government should be considered. estimation of latent constructs list and descriptive statistics of manifest variables (items) used to estimate the latent “trust in government” variable are presented in table 4 in the appendix. ca coefficients and item correlations are shown in table 5 in the appendix. a ca coefficient value of 0.9225, coupled with measurement scale reliability analysis results, indicate that the measurement scale used to construct the govttrust variable possesses a satisfactory level of reliability. measurement scales’ convergent validity and dimensionality were analyzed by efa (table 6 in the appendix) and results show that these scales possess convergent validity and are one-dimensional. hence, the group of items can be considered a unique measurement scale that measures the perception of latent structures. model estimation latent construct govttrust estimated in the previous subsection, together with other variables, were then entered into the sem framework. results of this model are shown in table 1, which is presented in three panels – panel a shows the results of measurement equations (equations used to estimate latent construct); panel b details the results of structural equations (main equations bruno škrinjarić, jelena budak, allison carragher 9 in our model); and panel c enumerates goodness of fit indicators for the overall model. regarding the measurement equations (table 1, panel a), both an increase in socioeconomic conditions and bureaucracy quality are positively related to government trust, while a corruption increase is inversely associated with government trust. structural equation results (table 1, panel b) are divided into three parts: first, we examine the connection of various variables with the number of new people vaccinated; second, we consider covariates of new covid-19 cases; and third, we investigate covariates of new deaths attributable to covid-19. during the interpretation of these results, the reader should keep in mind that all dependent variables are in “per million of the population” units to account for different population sizes. table 1. estimated sem results panel a: measurement equations non-standardized standardized trust in government bureaucracy 1.000 (-) 0.875*** (0.006) corruption -1.342*** (0.011) -0.911*** (0.006) socioeconomic 1.506*** (0.012) 0.822*** (0.006) panel b: structural equations non-standardized standardized new people vaccinated stringency index 0.002*** (0.000) 0.203*** (0.010) country group (benchmark: central and eastern europe) western europe -0.015** (0.006) -0.039 (0.016) southern europe 0.048*** (0.004) 0.106*** (0.010) northern europe 0.034*** (0.005) 0.082*** (0.012) trust in government 0.044*** (0.003) 0.195*** (0.014) new cases new people vaccinated -1.278*** (0.035) -0.750*** (0.018) stringency index 0.006*** (0.000) 0.334*** (0.016) country group (benchmark: central and eastern europe) western europe -0.042*** (0.012) -0.063** (0.019) southern europe -0.137*** (0.014) -0.179*** (0.019) northern europe 0.019* (0.011) 0.027 (0.015) total people vaccinated 0.002*** (0.000) 0.214 (0.014) median age 0.007*** (0.001) 0.056 (0.011) population density 0.042*** (0.012) 0.037*** (0.011) gdp per capita -0.001 (0.000) -0.024 (0.017) hospital beds -0.226*** (0.021) -0.142*** (0.013) uhc -0.001 (0.001) -0.020 (0.015) new deaths new people vaccinated -12.940*** (0.417) -0.523*** (0.015) stringency index -0.139*** (0.003) -0.528*** (0.012) country group (benchmark: central and eastern europe) western europe -2.835*** (0.149) -0.298*** (0.015) southern europe -3.025*** (0.177) -0.272*** (0.016) northern europe -0.322** (0.131) -0.031*** (0.013) total people vaccinated -0.010*** (0.002) -0.066 (0.012) median age 0.185*** (0.017) 0.107*** (0.010) population density 0.283* (0.150) 0.017*** (0.009) gdp per capita -0.017*** (0.005) -0.057 (0.015) 10 economic analysis (2023, vol. 56, no. 1, 1-19) non-standardized standardized hospital beds -0.838*** (0.262) -0.036*** (0.011) uhc -0.016* (0.009) -0.022 (0.013) panel c: goodness of fit indicators n 9,925 chi-squared statistic 8,238.81*** rmsea 0.044 cfi 0.927 tli 0.917 gfi 0.920 notes: *** p<0.01, ** p<0.05, * p<0.10. standard errors are in parentheses. cfi comparative fit index, gfi goodness of fit index, rmsea root mean square error of approximation, tli tucker-lewis index. since this model is estimated once covid-19 vaccines were readily available, the number of observations (9,925) is different from that reported in table a1 in the appendix. source: authors’ own work. the first part of our model, which examined the effects of different variables on vaccination rates, reveals that trust in the government is positively and significantly related to new people being vaccinated. on average, a one index point increase in trust in government (all other things held constant) will increase the number of new vaccinations by 0.044 per million citizens (a similar interpretation is for the standardized estimated coefficient as well). the stringency index is also positively and significantly related to the level of trust in the government, where a unit increase in this index, ceteris paribus, will increase the number of newly vaccinated by 0.002 per million citizens, on average. this suggests that citizens who trust their government and its pandemic response efforts are more likely to get vaccinated and that trust in government is a stronger incentive for vaccination than strict government policies. the second part of our model, in which we considered new cases of covid-19 (per million), shows that a unit increase in new people vaccinated, all other things held constant, will lead to a decrease in new cases by 1.278 cases per million citizens. somewhat surprisingly, there is a positive association between the stringency index and the number of new cases, although the magnitude of this effect is very small. this can partly be explained by a certain lag between the introduction of stricter measures and the time taken for them to reduce new cases. median age and population density are both positively associated with new covid-19 cases, given that covid19 has been disproportionately lethal among older populations and higher population density facilities transmission of the virus (mckibbin and fernando, 2020). the third part of our model, focusing on factors connected to new deaths attributable to covid19, indicates that the number of new people vaccinated is also again negatively correlated with new deaths, with this magnitude being far greater than the one on new cases. this is in line with communications regarding the covid-19 vaccine that the primary goals of vaccination are to reduce fatalities and to alleviate the symptoms of the virus, while it does not eliminate the possibility of transmission. this relationship would be expected to be different for pandemics in which a virus was completely prevented by a vaccine. the stringency index in this case is also negatively associated with the number of new deaths, albeit to a much smaller magnitude. this result is also in line with the trend presented in figure 4, where most countries began reducing restrictive measures once the vaccine became readily available. as with the number of new cases, median age and population density are also positively associated with new deaths, and these effects are of a higher magnitude. in terms of healthcare infrastructure, both the count of available hospital beds and accessibility of healthcare (universal healthcare index) are, as expected, negatively associated with the number of new deaths. bruno škrinjarić, jelena budak, allison carragher 11 discussion and conclusion corruption, including the quality of bureaucracy and socioeconomic conditions, is significantly associated with a loss of confidence in the government. this trust in government, in combination with covid-19 government response strategies administrated and other effects stemming from specific country groups has been associated with an increase in people vaccinated, which in turn had been shown to reduce new covid-19 cases and new covid-19 deaths. this means that corruption seriously erodes trust in government, and this mechanism weakens the pandemic response. unlike other scarce studies that looked only at the direct link between corruption and vaccination, we also considered non-pharmaceutical interventions and the impact of corruption on pandemic outcomes, with several contextual variables included in the sem model. this broader analysis shows the negative effects of corruption on efficiently fighting covid-19 through both government policies and vaccination campaigns. the results of this paper are in line with previous research. our findings are similar to those of jelnov and jelnov (2022), who also find higher vaccination rates in countries that are perceived as less corrupt. their data show that a unit increase in corruption perception index (index scaled 0 to 10) is related to a 1 percentage point decrease in vaccination rate. farzanegan and hofmann (2021) analyze the association between public corruption and covid-19 vaccination rates in more than 90 countries worldwide and find that corruption in 2020 can explain about 50% of vaccination progress by mid-2021. these findings also hold practical relevance for policymakers. obtained results demonstrate that non-pharmaceutical interventions and vaccination are effective tools to reduce the spread of covid-19 and to minimize its fatality, although vaccination should be the primary target. this is despite claims to the contrary by anti-vax and anti-restriction communities. the model also indicates that government trust is a key component of an effective vaccination campaign and an effective response to covid-19. this leads us to believe that more needs to be done to eradicate corruption and build trust between citizens and governments. anti-corruption programming and efforts to increase public trust should be included in global health policy. current covid-19 challenges should not reduce funding or focus on such efforts, as corruption is severely undermining pandemic relief measures. lastly, this study is not without limitations and open questions for future research. first, a standard challenge in any latent variable estimation stems from the possibility of omitting an important item which is connected to the latent construct being measured. instead of relying on nationwide questionnaires on trust in government, which is prone to self-evaluation bias, we utilize the prs dataset with measures of various economic and financial risks for each country. however, future research is encouraged to use additional variables to approximate trust in government, such as government stability or democratic accountability. second, in spite of the limited data available, this research takes into account country-level sociodemographic attributes such as median age and population density; and for country-level healthcare, infrastructure is approximated by the number of hospital beds. these data were amended with country-level indicators on various key daily indicators related to the pandemic. future research is suggested to add demographic, social, and economic data on those who were affected and/or died from covid-19 to the model and estimate it on an individual level, (some initial attempts were already made by rieger and wang (2021)), and to expand the geographic scope of the research beyond the european continent to see if our findings remain consistent. thirdly, this research focused exclusively on the covid-19 pandemic, but future research is encouraged to determine whether these findings hold true for other past pandemics. fourth, there may also be an issue with the direction of causality, i.e., it is also possible that increased levels of covid-19 cases and deaths negatively impact government trust. lastly, instead of performing a general equilibrium analysis, this research performs an average analysis for given countries. during a pandemic, there are likely 12 economic analysis (2023, vol. 56, no. 1, 1-19) to be other spillovers and externalities, such as decreased mental health, increased levels of anxiety, disruptions of global value chains, etc., which we do not estimate. acknowledgments this research has been fully supported by the institute of economics, zagreb under the grant “tvoj grant@eiz” (project no. 3220). references amundsen, i. 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(2021). tax evasion, corruption and covid-19 health risk exposure: across country analysis. journal of financial crime, 28(4), 995-1007. doi: https://doi.org/10.1108/jfc-102020-0220 16 economic analysis (2023, vol. 56, no. 1, 1-19) appendix table 2. list of countries that entered analysis country frequency a percent cumulative albania 602 2.86 2.86 austria 615 2.93 5.79 belarus 612 2.91 8.7 belgium 636 3.03 11.73 bulgaria 603 2.87 14.6 croatia 615 2.93 17.53 czech republic 610 2.90 20.43 denmark 613 2.92 23.35 estonia 613 2.92 26.26 finland 642 3.06 29.32 france 647 3.08 32.4 germany 644 3.06 35.46 greece 614 2.92 38.39 hungary 607 2.89 41.27 iceland 612 2.91 44.19 ireland 611 2.91 47.09 italy 640 3.05 50.14 latvia 609 2.90 53.04 lithuania 611 2.91 55.95 moldova 603 2.87 58.82 netherlands 613 2.92 61.73 norway 614 2.92 64.66 poland 607 2.89 67.54 portugal 609 2.9 70.44 romania 614 2.92 73.36 russia 640 3.05 76.41 serbia 605 2.88 79.29 slovakia 605 2.88 82.17 slovenia 606 2.88 85.05 spain 639 3.04 88.09 sweden 639 3.04 91.13 switzerland 615 2.93 94.06 ukraine 608 2.89 96.95 united kingdom 640 3.05 100.00 total 21,013 100.00 note: a frequency in this table refers to days observed in each country. bruno škrinjarić, jelena budak, allison carragher 17 table 3. description of variables used in analysis variable description values source: covid dataset a new cases new confirmed cases of covid-19 (7-day smoothed) per million people in the total population. new deaths new deaths attributed to covid-19 (7-day smoothed) per million people in the total population. new vaccinations daily number of people receiving their first vaccine dose (7-day smoothed) per hundred people in the total population. stringency index government response stringency index: composite measure based on 9 response indicators including school closures, workplace closures, and travel bans. (oxford covid-19 government response tracker, blavatnik school of government) 0 – 100, 100 = strictest response gdp per capita gross domestic product at purchasing power parity (constant 2011 international dollars). median age median age of the population, un projection for 2020. population density number of people divided by land area, measured in square kilometers. source: prs dataset b corruption corruption index: a measure of corruption within the political system concerned with actual or potential corruption in the form of excessive patronage, nepotism, job reservations, ‘favor-for-favors’, secret party funding, and suspiciously close ties between politics and business. 0 – 6, higher values indicate higher corruption bureaucratic quality bureaucratic quality index: a measure of the strength and expertise to govern without drastic changes in policy (autonomous from political pressure) or interruptions in government services (established mechanism for recruitment and training). 0 – 4, higher values indicate higher quality socioeconomic conditions socioeconomic conditions index: a measure of the socioeconomic pressures at work in a society that could constrain government action or fuel social dissatisfaction. this index consists of unemployment, consumer confidence, and poverty. 0 – 12, higher values indicate better conditions source: who dataset hospital beds hospital beds per thousand people, which include inpatient beds available in public, private, general, and specialized hospitals and rehabilitation centers. in most cases, beds for both acute and chronic care are included. uhc index coverage index for essential health services (based on tracer interventions that include reproductive, maternal, newborn and child health, infectious diseases, noncommunicable diseases, and service capacity and access). 0 – 100, higher values indicate better services other variables country group 1 – central and eastern europe, 2 – western europe, 3 – southern europe, 4 – northern europe notes: a definition, methodology and sources behind all variables from covid dataset are available here https://github.com/owid/covid-19-data/tree/master/public/data. b definition, methodology and sources behind all indices from prs dataset are available here https://www.prsgroup.com/wpcontent/uploads/2018/01/icrgmethodology.pdf. definition, methodology and sources behind all indices from who dataset are available here https://covid19.who.int/data. 18 economic analysis (2023, vol. 56, no. 1, 1-19) table 4. descriptive statistics of latent constructs’ items latent construct item mean standard deviation minimum maximum govttrust corruption 2.42 1.18 0 4.5 bureaucracy 3.03 0.95 1 4 socioeconomic 7.70 1.39 4.5 11 note: “st. dev.” denotes standard deviation. table 5. item correlations and cronbach alphas latent construct item inter-item correlation item-rest correlation cronbach alpha alpha-ifdeleted govttrust corruption 0.8084 0.8340 0.9225 0.8940 bureaucracy 0.7681 0.8648 0.8689 socioeconomic 0.8179 0.8268 0.8998 table 6. exploratory factor analysis results panel a: eigen values factor eigen values percentage of explained variance cumulative percentage of explained variance 1 2.30986 1.0804 1.0804 2 -0.0731 -0.0342 1.0462 3 -0.0987 -0.0462 1.0000 panel b: eigen vector latent construct item f1 govttrust corruption -0.8697 bureaucracy 0.9011 socioeconomic 0.8610 bruno škrinjarić, jelena budak, allison carragher 19 figure 5. long-run trends (1985-2021) of corruption, bureaucracy quality, and socioeconomic conditions in selected european countries source: authors’ own work. article history: received: 16.1.2023. revised: 20.3.2013. accepted: 27.3.2023 ea_2015_3-4 udc: 330.101.5 001.891:330 cobiss.sr-id: 220023052 original scientific paper the limits of the scientific method in economics and business: a critical view radović-marković mirjana1, institute of economic sciences, belgrade, serbia abstract – the purpose of this paper is to discuss the limits of scientific method in economic research.in the paper is pointed out that despite the scientific method, which encounters a great applicability in economics and business, when forecasting future economic developments in question, its capabilities is very limited. therefore, the modern scientific method should synthesize rationalism and empiricism in this context, the paper concludes with the assumption that knowledge of mathematical logic, including all its abilities, is in itself highly valuable and is an important supplement to the already existing scientific methodology that cannot be ruled out in economic research. key words: economic theory, scientific method, economic research introduction the social sciences deal with people or groups of people, companies, economies, and societies, i.e., with their individual and collective behavior. they are trying to determine objectively existing causal links between occurrences, as in certain areas of social life, and society itself as a totality of social relations. "these sciences can be classified in disciplines such as psychology as the science of human behavior, sociology as the science of social groups, and economy as the science of companies, markets, and economies." (bhattacherjee, 2012, p. 1) but unlike the social sciences, the natural sciences have studied natural phenomena, such as matter, the earth, heavenly bodies, or the human body (examples of the natural sciences are physics, chemistry, medicine, and astronomy, etc.). there is a significant difference between the natural and social sciences. while in the natural sciences there are certain patterns of relations among the phenomena that occur with such regularity that laws are derived, there are no such principles in the social sciences. in fact, unlike the natural sciences, which in their nature seek the universal laws of natural phenomena, the social sciences are of special importance in the practical application of theoretical models. this is consistent with the opinion of the founder of economics adam smith who considered himself to be more a philosopher, who is constantly looking for opportunities to 1 zmaj jovina12, belgrade, serbia, e-mail: mirjana.radovic@ien.bg.ac.rs 2 economic analysis (2015, vol. 48, no. 3-4, 1-8) achieve the prosperity and well-being of people, than a scientist in search of universal economic laws (jacobs, nagan, zucconi, 2014). each of the social sciences, with some minor exceptions, attempts to understand and explain certain aspects of social reality. economy is sometimes celebrated as the queen of the social sciences, which acts as an injection into the engine of the other social sciences (duhs, 2006). in the economic literature, one can often recognize that this is the ideal that economic science should strive for in its development to contribute the other scientific disciplines. this is the first thought on science and the principles of their development. scientific theory a theory can be defined as a general and, more or less, comprehensive set of statements that describe different aspects of a phenomenon (babbie, 1998; hagan, 1993; senese, 1997). a theory also may represent an attempt to provide an explanation about reality, or a way to classify and describe events and even predict the future of events (hagan, 1993). every theory consists of the following elements (radovic, 1996): • a series of definitions that precisely explains the variables used; • a number of assumptions that provide a brief description of the conditions under which a theory is applied; • one or more hypotheses which are derived from the assumptions on which a theory rests; • the hypotheses that can be tested using different techniques. "the main purpose of any theory consists in the fact that it should show how different things are associated with one another" (radovic, 1996, p. 161). namely, if one knows the kind of route two variables take, then one can easily find out if one of them changes with the change of the other one. assumptions also play an important role in the formation of a theory. they often involve a form of describing and presenting a theory. "they can also serve as an indirect test hypothesis, and sometimes they are used in order to define the conditions under which it is expected that a theory be valid" (radovic, 1996, p. 162). economic theory a theorist says that parameters are important and asks how they can be measured. for example, the laffer curve shows the relationship between tax rates and tax revenues. the scientist, after whom the laffer curve was named, considered that high tax rates are the main culprits for the existence of low national savings, low investment, and the recession. one axis is applied to the tax rate, and another axis to tax revenues that are realized through the application of appropriate tax rates. "the popularity of the laffer curve is reflected in the fact that it can explain to everyone in six minutes what is discussed in six months" (varian, 1989, p.4). here, we have taken as an example, as laffer analysis shows, the good and bad sides of the same economic theory. the downside of this theory can be seen in the fact that what the theory predicts could happen in real life, but not necessarily. basically, actually practice has denied this theory. "after the reduction in tax rates, tax revenues did not increase, but have radović-marković, m., the limits of the scientific method, ea (2015, vol. 48, no. 3-4, 1-8) 3 also reduced, which contributed to an increase in the budget deficit." (kulic, 2009, p.46) the good side of this theory is that it uses a simple analysis. in addition, it tells us which parameters are relevant for drawing conclusions, which one would not be able to know without a theory. considering that the purpose of any theory is to explain a phenomenon, it is often a certain abstraction, simplification and generalization, and as such generally has characteristics of an hypothesis. "that is, if the practice confirms the hypothesis, then that hypothesis turns into a scientific theory." (radovic, 1996, p. 163) friedman (1953) is considered to have a good economic theory that provides accurate and useful predictions, while samuelson (1947) pointed out that economists should formulate theories based on a "practical concept". thus, they are ideally logical equivalent to their characteristics described. in recent years, economic theory has found itself more than ever being reconsidered under the influence of a major financial crisis, which was reflected in the numerous debates among economic experts who have questioned the new keynesian theory and the views of its main successor minsky, as well as modern monetary theory and the austrian school of economics. this can be considered fully justified, given that when there is an economic crisis, there comes a crisis to the economic theory, as joanne robinson noted decades ago (robinson, 1981). the economic philosophy as the basis of economic theory "from the beginning, the economy has sought to break free of the feelings and choices for itself, and to have the status of a science."(robinson, 1962). chronologically speaking, the initial use of philosophy in economics can be attached to the names of john stuart mill and william vevel, whose works in the 19th century, when they occurred, had been paving the way for a further development of economic philosophy. in the late 19th and early 20th centuries, logical positivism appeared that is associated with the "formalist revolution" in economics (radovic, 1996, p. 151). then, for the first time, it raised a question concerning the general problem of the relationship between scientific theories and scientific principles. in particular, the role of economic philosophy was singled in the work of heilbroner (1996), and is reflected in the importance he gave it for determining the contributions of social welfare. prominent economists, such as robinson, myrdal, higgins, and heilbroner, felt that economic philosophy is the essential basis for the establishment of economic theory. therefore, the understanding of economic philosophy, underlying an economic theory, is a prerequisite for understanding the many controversies in the science of economics. in addition, there was also an increasing need for establishing relations between "pure theory" and "applied theory", as well as the separation of those theories that can be tested from those whose settings can not be tested and proven, with the help of different methodological instruments. the objectivity of science is based on a constant checking of theory into practice. therefore, research funding at any time consists for those theories that have not been disproved (robinson, 1962). the success of a theory is measured by the ability it has to exact 4 economic analysis (2015, vol. 48, no. 3-4, 1-8) the prediction of a phenomenon with the ability to control this phenomenon. however, the designing and testing of a theory is particularly difficult in economics and the other social sciences, due to both the insufficient accuracy of theoretical concepts and the inadequacy of instruments for their testing. also, it is very difficult to refute those theories that "do not work". for example, marx's theory has survived decades in the socialist bloc countries before being discredited as inefficient in terms of stimulating economic growth and social welfare. the above mentioned example and other similar examples show that, unlike theories in the natural sciences, theories in the social sciences are rarely perfect; this fact provides many opportunities for further research. quantification of the economic theory the quantification of the social sciences is not new. it was introduced in the 1920s, when sociology and economics were young sciences. today, their quantification is needed to consolidate their status as a science (mccloskey, 2005). paul samuelson (1947) and kenneth arrow (1951) advocated it a few decades later, especially for the use of mathematics in economic research. the genesis of the development and application of mathematical economics, based on logic and other methods, finds roots in the works of the french scientist kurnoa (1960). also complementarities are the theoretical and empirical tests encountered in the works of kuznet (1966), goldsmith (2000), friedman (1953) and others. in recent times, there are also many supporters of the mathematization of economics. for example, edesess (2012) offers a mathematical approach to some of the key problems facing an economic theory by launching a series of economic debates. on the side, one theorist who advocates the mathematization of economy is the scientist mccloskey (2005). he believes that common complaints are not acceptable concerning the application of mathematical and statistical methods in economics. in fact, in his own opinion, the advocates of this view are those scholars who emphasize the superiority of the natural sciences in relation to the social sciences (mccloskey, 2002). also, the famous scientist l. walras once pointed out that "many economists, who do not know mathematics, appear as the biggest critics of its application in the investigation of economic principles." (walras, 2010) there is a view among economists that it is difficult to use mathematics in economics, and therefore they argue that it is better to use some other methods that are not based on mathematics. however, edesess (2012) believes that the excessive use of mathematics in economics is not the source of all the problems and general confusion, but the fact that we should all use a mathematical model, when something in fact cannot be measured by the use of mathematical models, is senseless. in fact, according to his opinion, mathematics is used too much in economics, and too much of it is of a poor quality. "this arrogance is at the mathematical core of the critical state of economic theory that has exacerbated the financial crisis." (edesess, 2012) in other words, the economy can not overly rely on accurate mathematical models, considering that economics and mathematics cannot be equated. "are we going to choose a mathematical or theoretical approach to economic analysis is not of such significance, but how important the benefits of mathematics in terms of improving the analysis and greater explicitness at each level of reasoning is." (radovic, 1996, p.153) also, mathematical economy should be seen as a specific approach to economic radović-marković, m., the limits of the scientific method, ea (2015, vol. 48, no. 3-4, 1-8) 5 analysis, which is no different from today's focus on non-mathematical economy. the main difference between "mathematical economics" and "theoretical economics" is the fact that the economy in mathematical assumptions and conclusions is expressed in mathematical symbols instead of in words. in addition, the "language" that uses mathematical economy is characterized by conciseness and greater precision, which in theoretical economics is not always the case. (radovic, 1996, p. 154). although numerous mathematical methods proved to be useful in a large amount of economic research, mathematical logic has a high practical value given its rich set of tools used to explain verbal premises and statements in a very precise and clear form. namely, the value of this method is in its ability to reduce the complexity of a problem down to its utmost simplification and explanation. having this in mind, the exploration of applicative features of the logical method ends with a conclusion that this method is yet to become very important in the research of modern economic phenomena and issues characterised by high complexity of interrelations and interconditionality. in the end, it can be concluded that although the quantification of social and economic phenomena from the start of application had a lot of supporters but even more opponents, mathematics and methodological knowledge have passed the test of time and have lost none of their importance to the present day. the scientific method for a clear perception of the concept of research, one must know the meaning of the scientific method. the two terms, research and scientific method, are closely related. they are the common feature of all scientific research methods and techniques, although they can vary greatly from one science to another science. "the scientific method is the search for truth through logical considerations, i.e., it is trying to achieve an ideal combination of experimentation, observation, and logical arguments" (ostle and mensing, 1975, p. 2). "the scientific method refers to a standardized set of techniques that are used to zoom in on scientific knowledge, such as how to conduct a valid observation, how to interpret the results, and how to generalize these results" (bhattacherjee, 2012, p. 5). the scientific method should meet these four criteria: repeatability: under this criterion, there is an opportunity for repeated scientific research and to provide similar, if not identical, results; accuracy: theoretical concepts must be defined with such precision that they and others can be used as a definition for the measurement of these concepts and testing theories; probability: a theory must be provided in a way that it can be tested. theories that can not be tested are not considered scientific theories; simplicity: when there is more than one explanation for a phenomenon, scientists have still to accept the simplest and most logical explanation. the natural and social sciences are based on the same logic of the scientific method. truthfulness is proved empirically, and the empirical method is based on its practical applicability in society. using the scientific method is the most important tool in the study of 6 economic analysis (2015, vol. 48, no. 3-4, 1-8) the social sciences since it allows us to not only learn lessons from certain social sciences, but also to understand their synthesis. the limitations of the scientific method in economics and business: do we need more precise and accurate predictions in economy? despite the scientific method, which encounters a great applicability in economics and business, when forecasting future economic developments in question, its capabilities are very limited. this opinion is confirmed by the american philosopher peirce, who concluded that there are no new ideas derived from the analysis of the past with the help of inductive and deductive logic; the two forms of logic used by modern scientific methods (martin, 2011). the predictions in the recent past have proved to be completely wrong. yet, on the fact that a kind of prediction was better than nothing, governments of modern states and large corporations insist on projections of conjectural developments. they deal with forecasts of employment rates, inflation rates, and an increase or decrease in the gross domestic product; almost every aspect of strategic enterprise management refers to the future, from planning to the production of goods and sales for business expansion or the opening of a new organization. nevertheless, these predictions of the future by economists in certain segments have been very limited, given that some aspects that are related to the other social sciences are not taken into account. however, in recent years, things are beginning to change, thanks to those scientists who bring down the barriers among the scientific disciplines (ioannides & nielsen, 2007; beckert, 2013; poli, 2014). in line with this, there are discussed in scientific circles the opportunities resulting from the anticipation of climate change to the economic crisis. predictions are particularly associated with a high degree of risk due to their failure to meet the conditions of the economic crisis. the problem is that "in terms of fundamental uncertainty, expectations can not be understood as a result of the calculated optimal choice, taking into account all available information, but on the potential interpretation of the situation in the context of the prevailing institutional structures, cultural patterns and social networks" (beckert, 2013, p. 325).in addition, extrapolating the future to be a straight-line projection of the past is neither accurate, nor is it helpful in creating better understanding and newer ideas (martin, 2011). these considerations are gathering researchers from different scientific disciplines in order to have an interdisciplinary dialogue, which should serve as a basis for both understanding and policy making for future decisions. a better and more complete understanding of future trends and their effects will improve theories and models in economics and other social sciences. these improvements will greatly benefit those who explicitly seek to create a "ready society." in this way, there will be a more efficient use of modern technology not only for exploring the boundaries of human endeavor (poli, 2014), but also for improving a response to the challenges of a global society. conclusion quantification of social and economic phenomena has since its early days of implementation attracted numerous followers but even more opponents .the paper does not dwell on whether mathematical or theoretical approaches should be implemented in radović-marković, m., the limits of the scientific method, ea (2015, vol. 48, no. 3-4, 1-8) 7 economic research; it rather discusses the possibilities of implementation of the mathematical and logical method for the purpose of enhancing economic analysis. besides, the paper goes on, although numerous mathematical methods proved to be useful in a large amount of economic research, mathematical logic has a high practical value given its rich set of tools used to explain verbal premises and statements in a very precise and clear form. having this in mind, the exploration of applicative features of the mathematical and logical methods ends with a conclusion that these methods are yet to become very important in the research of modern economic phenomena and issues characterised by high complexity of interrelations and interconditionality. finaly, the paper is meant to draw attention of the scientific society and provoke discussion on the limitations of implementation of the scientific method in economics. hence a larger number of new papers is expected to be published on this topic which has so far been approached from the theoretical aspect rather than from the practical one. references arrow, k. 1951. social choice and individual values. john wiley & sons, inc., new york, chapman & hall, limited, london. babbie, e. 1998. the practice o!ebcial research, 8th ed. belmont, ca: wadsworth publishing. beckert, j. 2013a. “capitalism as a system of expectations: toward a sociological microfoundation of political economy.” politics and society, 41(3), 323-350. bhattacherjee, a. 2012. social science research: principles, methods, and practices. 2nd edition, creative commons attribution, florida. duhs, l.a. 2006. “is economic philosophy a subject worth teaching?” australasian journal of economics education. 3(1 & 2). edesess, m. 2012. an attack on paul krugman. advisor perspectives. http://www.advisorperspectives.com/newsletters12/20-krugman2.php friedman, m. 1953. "the methodology of positive economics." in the methodology of positive economics, 3-43. chicago: university of chicago press, pp. 3-43. goldsmith, e. 2000. is science neutral? the ecologist, vol. 30, no. 3, may 2000. hagan, f. e. 1993. research methods in criminaljustlce and criminology, 3rd ed. new york macmillan. heilbroner, r. 1996. “the embarrassment of economics”. challenge, nov/dec, 46-49. ioannides, s., nielsen, k. 2007. economics and the social sciences: boundaries, interaction and integration. edward elgar publishing. jacobs, j., nagan, w., zucconi, a. 2014. “unification in the social sciences: search for a science of society.” cadmus, 2(3 october 2014): 1-22. kulić, m. 2009. finansijska i ekonomska načela oporezivanja, škola biznisa. na internetu: http://www.vps.ns.ac.rs/sb/2009/2.6.pdf kuznets, s. 1966. modern economic growth. new haven, yale university press. martin, r. 2011. the limits of the scientific method in economics and the world.reuters. http://blogs.reuters.com/great-debate/2011/11/10/a-better-blueprint-for-economics/ (retrived:27 october ,2015). mccloskey, d. 2005. history of economic ideas. xiii (3,2005):85-102. 8 economic analysis (2015, vol. 48, no. 3-4, 1-8) poli, r. 2014. “anticipation: a new thread for the human and social sciences?” cadmus, 2(3, october 2014): 22-49. radović, m. 1996. ”ekonomska analiza na novim (kvantitativnim) osnovama” u uvod u metode ekonomske analize-teorijsko filozofske osnove naučnog metoda, ur. aničić. r. ekonomski fakultet u beogradu. robinson, dž. 1981. ekonomska filozofija. beograd, istraživačko-izdavački centar sso srbije. robinson, dž. 1962. economic philosophy.watts, london samuelson, p. a. 1947. foundations of economic analysis. cambridge, harvard university press. senese, j. d. 1997. appljed researc h methods in crimi nal justice. chicago: nelson-hall. walras, l. 2010. elements of pure economics. routledge library editions: economics. varian, h. 1989. handbook of industrial organization. vol. 1, pp. 597-654. ograničenja primene naučnog metoda u ekonomiji i biznisu: kritički osvrt rezime – svrha ovog rada je diskusija na temu ograničenja naučnog metoda u ekonomskim istraživanjima. u radu smo istakli da uprkos velikoj primeni u ekonomiji i poslovanju, naučni metod ima ograničene mogućnosti posebno kada su u pitanju buduća ekonomska kretanja. dakle, savremeni naučni metod treba da osigura sintezu racionalizma i empirizma. u tom kontekstu, kao zaključak istraživanja dajemo pretpostavku da je poznavanje matematičke logike, uključujući sve njene mogućnosti, samo po sebi vredan i važan dodatak već postojećoj naučnoj metodologiji koja se ne može isključiti iz ekonomskih istraživanja. ključne reči: ekonomska teorija, naučni metod, ekonomsko istraživanje article history: received: 14 november, 2015 accepted: 17 november, 2015 ea_2014_3-4 udc: 005.332.8:339.56(497.6) 336.143.232 jel: h60, h62, h63, h68 cobiss.sr-id 211784972 original scientific paper effects of foreign trade on budget equilibrium case study of bosnia and herzegovina alihodžić almir1, university of zenica faculty of economics, bosna and herzegovina đonlagić dženan2, school of economics and business university of sarajevo, bosna and herzegovina abstract – the analysis of economic trends in bh in 2012 recorded further weakening of economic activity. primarily, this is a result of stagnant economies of the eu and the region. in the first trimester of 2013 year, exports grew in real terms by 19% and imports by 13%, which led to the real growth in the trade deficit to about 7%. the given deficit significantly reduced the earlier estimate of economic growth for the first trimester in which the strong export growth, coupled with an increase in industrial production represented a very important step forward compared to the previous year. the main objective of this paper is to discuss the global financial crisis, the movement of the budget deficit in bh for the period 200 2012, as well as monitor the constraints set by the maastricht treaty that the amount of the budget deficit should not exceed 3% of the gdp and the interdependence of imports of goods and nominal gdp. key words: imports of goods, exports of goods, indicators of foreign trade, budget deficit, criteria of convergence introduction fiscal policy is a modern financial policy that contains a component of social economic policy implemented by public finance management measures of restrictive or expansionary fiscal policy. it is also associated with the economic and political dimensions of social policy, which permanently loses neutrality effects on reproduction (kešetović et. al., 2012, pp. 26). one of the most important tasks of fiscal policy is to manage the budget deficit – i.e. manage its excess of expenditures over revenues. in an open economy, it ultimately must balance the net saving in the private sector, as well as the balance of current account payments with the rest. therefore, properly defining and then measuring the budget deficit is one of the main tasks of the fiscal policy but there is no single perfect measure and deficits but for different purposes using different definitions and define its different measurement. the most commonly used definition of the deficit is the conventional deficit and it measures the difference between the cash total government revenue and total cash 1university of zenica – faculty of economics, email: almir.dr2@gmail.com, almir_alihodzi@yahoo.com 2 school of economics and business university of sarajevo, email: dzenan.djonlagic@efsa.unsa.ba economic analysis (2014, vol. 47, no. 3-4, 121-135) 122 expenditures, which must be financed by new borrowing. this measure is also called the deficit and the need for the public sector borrowing public sector borrowing requirement. a surplus (deficit) budget represents the excess of government expenditures over tax revenues in a given period, usually one year, while on the other hand the budget surplus occurs when tax revenues exceed government expenditures (mishkin, 2010, pp. 12). budgetary expenditures include salaries of public servants, purchase of goods and services, government investments, interest on the public debt, transfers and subsidies. on the other hand, the budget revenues include the obligations, duties, interest on state property, transfers, surpluses of public enterprises and proceeds from the sale of public assets. the given concept of deficit measures government expenditure and lending taken for the implementation of public policies, with revenues from taxes, grants and payment of the loan, and without future borrowings or impaired state of liquid reserves. the advantage of this concept is a comprehensive view of the overall financial condition of state and its impact on monetary conditions, domestic demand and external accounts. in practice, it is difficult to find conventional deficit on purely cash basis. typically, a combination of cash and budget deficit is used. the budget deficit on a cash basis is the actual result of budgetary funds assets and liabilities, while the budget deficit on an accrual basis arises when assets and liabilities are recorded at the time of issuance of an order, not at the time of occurrence of actual cash flow. a delay in the performance of its obligations to suppliers and creditors or default on budget revenues results in arrears whose size can significantly affect the budget deficit. financial indiscipline or high inflation contributes to the increased occurrence of arrears increasing the difference between conventional, cash budget deficit and the calculation of the budget deficit (institute of public finance, 2013). in most countries, poorly managed fiscal policy is the main cause of many problems such as high inflation, high budget deficits and low economic growth. the way out of this situation requires an appropriate fiscal adjustment. therefore, if the current government spending is not financed from the current tax and non-tax state revenues, it can quickly lead to the growth of aggregate demand, and ultimately inflation. this is particularly true in countries where the state has allowed funding from the primary issue of the central bank. therefore, it is necessary that the state, as well as all other participants borrow only on the market. in addition, in excessive government borrowing from banks, it is often the main factor affecting the overall monetary expansion, and appropriate fiscal adjustments are also needed to stop the expansion (golomejić raspudić, 2011, pp. 144). the total trade deficit in bh in 2012 increased by of 1.3% compared to the 2011. negative economic growth was reflected in real decline in domestic demand and exports, decreased investment financing by local banks and the fall in industrial production (bh directorate for economic planning, 2013). the paper is structured in three parts. the first section describes the basic settings of the budgetary convergence and opportunities of deficit financing, and impact of global financial crisis on the budget deficit of individual eu countries and the western balkan countries. the second part is devoted to the analysis of the budget deficit in bh and opportunities for sustainability in the long term. the third part describes the possible application of regression model, where it will be determined by strength and direction of relationship between alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 123 variables such as: (1) the importation of goods in bh, and (2) the movement of nominal gdp. at the end of the study, concluding remarks are given. justification for budgetary convergence and deficit financing deficit financing has proved so far to be insufficiently effective means of increasing economic growth and modernization of economy, but on the other hand it is quite effective in supporting the overall demand in the economy, particularly in terms of demand when the economy shows a tendency of sharp decline. first, this deficit financing involves the realization of a long-term economic program, which comes to the fore, where deficit financing and public debt is becoming an important factor for the program. increase of budget deficit in all economies followed by an ongoing growth of the public debt for its coverage is the reality of modern market economies (komazec, ristic, 2011, pp. 107-108). candidate countries for joining the monetary union had a lot of problems in reaching the set convergence criteria. in fact, most problems occurred in achieving the criteria of budget deficit and public debt, which has forced the country to a very strict fiscal discipline and caused a number of social protests in the member states. the reasons for this situation should be look for in the method for covering the budget deficit. the budget deficit of candidate countries mainly covers the real financial income/tax, which directly affects the living standards of population and ultimately can cause serious social protests. similarly, reducing the budget deficit to a level of 3% of gdp means savings that can influence the level of flexibility and efficiency of fiscal policy and employment. therefore, these facts were the main reason for many economists to criticize the proposition for which the budget deficit should amount to 3% and public debt 60% of gdp. these figures were obtained in a manner based on the principle that determines the amount of the budget deficit, which is needed to stabilize the public debt. the budget deficit is expressed as follows: � = � ∙ � �1 where: � − the level at which public debt is stabilized (steady state) expressed as a% of gdp; � − the growth rate of nominal gdp; and � − government budget deficit expressed as a% of gdp – a. in order to stabilize public debt at 60% of gdp and the budget deficit must be brought to a level of 3% of gdp provided that the nominal gdp growth rate is at 5%. the suggestion that was put in this way of calculating refers to the fact that it came to the conclusion that the public debt stabilizes at 60%, not to say 50% or 70%. as a justification, it is stated that the maastricht agreement specified percentage of 60%, as well as the fact that at that time most of the relationship between public debt and gdp ratio was 60% (furtula and marković, 2010, pp. 30-31). the second reason is based on future nominal growth rate of gross domestic product. if the nominal growth rate of gdp is greater than (less than) 5%, the budget deficit that stabilizes the public debt to 60% increases above (decreases) 3% (đonlagić, 2006th, pp. 48). economic analysis (2014, vol. 47, no. 3-4, 121-135) 124 the question that deserves attention relates to why the budgetary convergence was insisted on? the most important reason should be sought in connection with the budget deficit rate of inflation, as a country in which there is a high percentage of public debt to gdp and urges the government of the country to adopt measures that will cause unexpected inflation. the situation has a negative impulse to the owners of the state, i.e. long-term bonds, which leads to a significant reduction of their real value. on the other hand, the government of such countries realizes gains with respect to the real value of debt decreases. using the sudden inflation to reduce the real value of government debt in a high charge state reflects negatively on the country's low charge. under the circumstances, the convergence criteria was set, which provides an optimal relationship between government debt and gdp. for example, when a highly indebted country achieves a debt reduction to the required level, it will not have to use the mechanism of a sudden inflation, where its association with poor indebted countries will not pose a threat in terms of an increase in the inflation rate in the eu. unlike defined convergence criteria, there is a legitimate question: what criteria are missing, which can be considered very important? santini (2011) considered that the criterion of missing long-term relationships is a balanced relationship with the rest of the world, i.e. the requirement for a balance of payments. the following table illustrates the movement of tax revenues based on the surplus / deficit on the current account of balance of payments. table 1. movement of tax revenue on the basis of deficit / surplus in the current account balance the share of indirect taxes in total taxes tax revenues in the event of a deficit in the current account of balance of payments tax revenues in the event of a surplus in the current account 0 0 there is no reduction in tax revenues >0<1 the increase in tax revenues in proportion to the share of indirect taxes l (credit) increase in tax revenue in the present and the reduction of the tax capacity in the future reduction in tax revenue in proportion of indirect taxes s savings reducing tax revenue in the present and increasing tax capacity in the future 1 increasing the taxable amount of deficit l increase tax revenue in the present and the reduction of the tax capacity in the future reducing the size of taxable surplus s reduction in tax revenue in the present and increasing tax capacity in the future source: santini, g. (2011). a possible approach to the reform of tax system of republic of croatian, journal: economics, year 18, no. 1, zagreb, pp. 121 depending on the extent to which the tax system is of an expendable type with the clause ceteris paribus, the budget deficit is reduced/increased. thus, the classification of tax revenues based on the division of tax according to the criterion of time allows the quantification of tax revenues based on the deficit/surplus of the current account balance, that tax revenues from domestic and disposable domestic product. therefore, identification of tax revenue on the basis of the current account balance, as well as certain future tax corrects the size of the public debt. in addition, santini (2011) considers that the criteria of the alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 125 budget deficit and public debt should be supplemented by the following criteria: (1) marginal tax presses matched with income per capita to countries with lower income per capita had a smaller share of the state in the final distribution of gdp and, that is, with the growth of income per capita share of the state in the final distribution of gdp a progressively growing, and (2) agree on the maximum difference in the total indirect tax revenue of individual members of the eurozone, where countries with less income per capita had a higher proportion of indirect in relation to the direct taxes, which in extreme instances contributed to the increase in export competitiveness of less developed countries. influence of debt crisis on the budget deficit in the eu cumulative current account deficits over a longer period demanded constant sources of funding, such as the net inflow of foreign direct investment, portfolio investment, credit transactions on the account to reduce the foreign exchange reserves of the country. any borrowing abroad has its limits, i.e. the creation of net foreign debt, creates an obligation in the future. the table below illustrates the tendency of movement of current account deficit of some eu countries for the period 1992 2008. t a b le 2 . t h e te n de n cy o f cu rr en t a cc o u nt d ef ic it o f so m e e u c o u nt ri es a nd t he w o rl d f or t h e p er io d 1 9 9 2 2 0 08 s ou rc e: f ab ri s, n ., k il ib a rd a , b . ( 20 08 ). a n al ys is o f th e su st ai n ab il it y o f cu rr en t ac co u n t d ef ic it o f m o n te n eg ro , m o n te n eg ri n c en tr al b an k d iv is io n o f r es ea rc h , s ta ti st ic s an d i t , p od go ri ca , p . 1 0 , a va il ab le a t: ht tp :/ /w w w .c bcg .o rg /s li ke _i _f aj lo vi /f aj lo vi /f aj lo vi _p u bl ik ac ij e/ ra dn e_ st u di je /a n al iz a_ od r% c 5% b e iv os ti _d ef ic it a. pd f c o u n tr y 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 a rm en ia -4 6, 3 -6 ,0 -3 ,8 0 -1 7, 0 -1 8, 2 -1 8, 7 -2 2, 1 -1 6, 6 -1 4, 6 -9 ,5 -6 ,2 -6 ,8 -4 ,5 -3 ,9 -1 ,4 -4 ,0 -4 ,2 a u st ra li a -3 ,5 -3 ,1 -4 ,8 -5 ,2 -3 ,7 -2 ,9 -4 ,8 -5 ,3 -3 ,8 -2 ,0 -3 ,8 -5 ,4 -6 ,0 -5 ,8 -5 ,5 -5 ,7 -5 ,6 a ze rb ai ja n -1 6, 6 -1 2, 2 -5 ,5 -1 3, 2 -2 5, 9 -2 3, 1 -3 1, 9 -1 3, 1 -3 ,5 -0 ,9 -1 2, 3 -2 7, 8 -2 9, 8 1, 30 15 ,7 0 31 ,4 39 ,9 b u lg ar ia -4 ,4 -2 4, 7 -0 ,4 -0 ,2 0, 2 4, 1 -0 ,5 -5 ,0 -5 ,6 -5 ,6 -2 ,4 -5 ,5 -6 ,6 -1 2, 0 -1 5, 8 -2 0, 3 -1 9, 0 e st o n ia n /a 1, 2 -6 ,8 -4 ,2 -8 ,6 -1 1, 4 -8 ,7 -4 ,4 -5 ,4 -5 ,2 -1 0, 6 -1 1, 3 -1 2, 3 -1 0, 0 -1 5, 5 -1 6, 9 -1 5, 9 g eo rg ia n /a n /a -3 3, 8 -1 8, 3 -1 2, 6 -1 2, 8 -1 2, 8 -1 0, 0 -7 ,9 -6 ,4 -8 ,4 -9 ,3 -1 2, 2 -9 ,8 -1 3, 8 -1 5, 7 -1 5, 2 k az ak h st an -5 1, 6 -8 ,6 -7 ,8 -1 ,3 -3 ,6 -3 ,5 -5 ,5 -0 ,2 3, 0 -5 ,4 -4 ,2 -0 ,9 0, 8 -1 ,8 -2 ,2 -2 ,2 -1 ,1 m al ay si a -3 ,7 -4 ,6 -7 ,6 -9 ,7 -4 ,4 -5 ,9 13 ,2 15 ,9 9, 4 8, 3 8, 4 13 13 15 17 14 1, 3 m o ld o v a -6 ,9 -1 6, 7 -3 ,1 -4 ,6 -1 ,7 -6 ,2 -4 ,1 -1 3, 4 -8 ,2 -9 ,4 -5 ,6 -4 ,6 -1 6, 5 -3 5, 8 -4 0, 7 -4 0, 5 -3 6, 6 m al ta n /a n /a n /a -1 1, 9 -1 2, 6 -6 ,7 -6 ,5 -3 ,7 -1 2, 5 -3 ,8 -2 ,7 -2 ,8 -6 ,3 -8 ,0 -6 ,1 -9 ,4 -8 ,2 p o rt u g al -0 ,2 0, 3 -2 ,3 -0 ,1 -3 ,5 -5 ,8 -7 ,1 -8 ,5 -1 0, 2 -9 ,9 -8 ,1 -6 ,1 -7 ,7 -9 ,7 -9 ,4 -9 ,2 -9 ,2 r o m an ia -7 ,8 -4 ,7 -1 ,7 -4 ,5 -6 ,7 -5 ,4 -7 ,1 -4 ,1 -3 ,7 -5 ,5 -3 ,3 -5 ,8 -8 ,4 -8 ,7 -1 0, 3 -1 3, 8 -1 3, 2 se rb ia n /a n /a n /a n /a n /a n /a n /a n /a -1 ,7 -2 ,4 -7 ,9 -7 ,0 -1 1, 7 -8 ,5 -1 1, 5 -1 4, 7 -1 5, 0 sl o v ak ia n /a -6 ,3 4, 3 1, 9 -9 ,8 -9 ,1 -9 ,5 -4 ,8 -3 ,3 -8 ,3 -8 ,0 -6 ,0 -7 ,8 -8 ,6 -8 ,3 -5 ,3 -4 ,5 sp ai n -3 ,5 -1 ,1 -1 ,3 -0 ,3 -0 ,2 -0 ,1 -1 ,2 -2 ,9 -4 ,0 -3 ,9 -3 ,3 -3 ,5 -5 ,3 -7 ,4 -8 ,6 -9 ,8 -1 0, 2 t u rk ey 0, 1 -3 ,1 3, 1 -0 ,3 -1 ,2 -1 ,1 1, 0 -0 ,7 -5 ,0 2, 4 -0 ,8 -3 ,3 -5 ,2 -6 ,2 -7 ,9 -7 ,5 -7 ,0 u k ra in e -3 ,0 -2 ,9 -3 ,2 -3 ,1 -2 ,7 -2 ,7 -3 ,1 5, 3 4, 7 3, 7 7, 5 5, 8 10 ,6 2, 9 -1 ,5 -3 ,5 -6 ,2 u sa -0 ,8 -1 ,3 -1 ,7 -1 ,5 -1 ,6 -1 ,7 -2 ,4 -3 ,2 -4 ,3 -3 ,8 -4 ,4 -4 ,8 -5 ,5 -6 ,1 -6 ,2 -5 ,7 -5 ,5 alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 127 from the table above it is clear that the united states, turkey, estonia, slovakia, romania, bulgaria and other countries, have had for years a balance of payments deficit above 5% of gdp. based on the analysis, it can hardly be concluded that some of the observed countries were on the verge of an economic crisis. some advocates believe that countries can have years of current account deficits, and the economy does not suffer because of this if the deficit is used to finance private investment. on the other hand, the budget deficit could lead to the inability of the state to remit abroad. some analysts cite for example the case of russia from 1998, when the russian government was unable to pay the outstanding balance to abroad. the fact that the current account deficit does not matter if it is a result of private sector deficit lowson doctrine1 proved to be wrong, when the asian financial crisis occurred between 1997 and 1998, where in spite of budgetary imbalances there was still the crisis due to the high external indebtedness of the private sector (central bank of montenegro, 2008). measures taken by the governments of the member states in 2008, 2009 and 2010 were primarily aimed at supporting the financial system and mitigating the effects of the crisis that affected the real sector. the measures meant increase of insured deposits, issuing guarantees for liabilities of banks and recapitalisation of financial institutions. table 3. basic monetary and fiscal indicators in euro zone and eu for 2008 -2011 parameters 2008 2009 2010 2011 euro zone gdp (millions of euro) 9.241.541 8.922.208 9.176.138 9.420.834 budget deficit (millions of euro) -196.366 -566.498 -569.469 -390.708 (%gdp) -2,1 -6,3 -6,2 -4,1 public expenditure (%gdp) 47,1 51,2 51,0 49,5 public revenues (%gdp) 45,0 44,9 44,8 45,4 public debt (millions of euro) 6.489.962 7.135.458 7.833.349 8.227.833 (%gdp) 70,2 80,0 85,4 87,3 european union gdp (millions of euro) 12.472.988 11.754.729 12.278.824 12.650.044 budget deficit (millions of euro) -303.470 -806.992 -800.906 -560.834 (%gdp) -2,4 -6,9 -6,5 -4,4 public expenditure (%gdp) 47,1 51,1 50,6 49,1 public revenues (%gdp) 44,7 44,2 44,1 44,7 public debt (millions of euro) 7.763.975 8.764.582 9.826.981 10.433.926 (%gdp) 62,2 74,6 80,0 82,5 source: erić, d., djukić, m. (2012),financial markets in times of crisis, the institute of economic sciences, belgrade banking academy – faculty for banking ,insurance and finance, belgrade, pp. 382. greece had the highest deficit in 2009, i.e. 15.8%, and later in 2010, after severe austerity measures, it was reduced to 10.6%. the level of public debt in greece at the end of 2010 amounted to 144.9% of gdp (erić and djukić, 2012, pp. 382-383). as it can be seen, in 1 this doctrine was named after nigel lowson and it clarifies the extent to which the current balance deficits reflect the decisions of private savings and investment, and there are no disturbances and expectations are rational and there is no reason that the government operates. economic analysis (2014, vol. 47, no. 3-4, 91-135) 128 relation to 2010, budget deficit of the euro zone and eu in 2011 was reduced, while the public debt recorded an upward trend. in the euro zone, the deficit ratio to gdp decreased from 6.2% in 2010 to 4.1% in 2011, while in the eu it dropped from 6.5% to 4.4%. the public debt to gdp in the euro zone increased from 85.4% to 87.3% in late 2011, while in the eu it recorded growth of the indicator from 80% to 82.5% only one year later. at the time of joining the emu, greece shows a high level of budget deficit, which it sometimes seems to be the only country that has not met any of the fiscal conditions of eligibility for the monetary union. in addition, apart from fiscal conditions, greece basically did not meet any of the criteria for convergence, where the range in long-term interest rate in relation to the three countries with the lowest interest rate always showed a higher value than any other member state of the emu. likewise, the inflation rate was at a satisfactory level, only at the time of entry into the union. table 4. the current account deficit as % of gdp in the european union for the period 2011 2012 no. country currency 2011 2012 in mil./currency % of gdp in mil./currency % of gdp 1. belgium euro -13.777 -3,7 -14.852 -3,9 2. bulgaria bgn -1.492 -2,0 -624 -0,8 3. czech republic czk -124.943 -3,3 -169.003 -4,4 4. denmark dkk -33.018 -1,8 -72.470 -4,0 5. germany euro -20.230 -0,8 4.090 0,2 6. estonia euro 186 1,2 -46 -0,3 7. ireland euro -21.268 -13,4 -12.461 -7,6 8. greece euro -19.834 -9,5 -19.360 -10,0 9. spain euro -100.402 -9,4 -111.641 -10,6 10. france euro -105.392 -5,3 -98.196 -4,8 11. italy euro -60.016 -3,8 -47.633 -3,0 12. cyprus euro -1.132 -6,3 -1.127 -6,3 13. latvia lvl -509 -3,6 -187 -1,2 14. lithuania ltl -5.848 -5,5 -3.666 -3,2 15. luxembourg euro -98 -0,2 -359 -0,8 16. hungary huf 1.194.947 4,3 -531.585 -1,9 17. malta euro -183 -2,8 -226 -3,3 18. netherlands euro -27.009 -4,5 -24.405 -4,1 19. austria euro -7.385 -2,5 -7.684 -2,5 20. poland pln -76.094 -5,0 -62.698 -3,9 21. portugal euro -7.543 -4,4 -10.596 -6,4 22. romania ron -30.911 -5,6 -16.822 -2,9 23. slovenia euro -2.298 -6,4 -1.418 -4,0 24. slovakia euro -3.498 -5,1 -3.107 -4,3 25. finland euro -1.539 -0,8 -3.662 -1,9 26. sweden sek 7.160 0,2 -18.307 -0,5 27. uk gbp -118.632 -7,8 -97.794 -6,3 average: 2011 2012. -118.217 -7,8 -86.510 -5,6 alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 129 source: http://epp.eurostat.ec.europa.eu/cache/ity_public/2-22042013-ap/en/2-22042013-ap-en.pdf (access to date: 10.8.2013. at the end of 2011, the lowest ratio of the budget deficit and gdp was recorded in luxembourg (0.3%), finland (0.6%) and germany (0.8%), while hungary, estonia and sweden recorded a surplus of 4.3 %, 1.1% and 0.4% of gdp individually. also, according to eurostat data, the seventeen member countries had a deficit in excess of 3% gdp and to ireland (13.4%), greece (9.5%), spain (9.4%), united kingdom (7, 8%), slovenia (6.4%), cyprus (6.3%), lithuania (5.5%), romania (5.6%), france (5.3%), poland (5.0% ), slovakia (5.1%), the netherlands (4.5%), portugal (4.4%), italy (3.8%), belgium (3.7%), latvia (3.6%) and czech republic (3.3%). thus, one can conclude that, with respect to 2010, all eu member states in 2011 reduced the ratio of the budget deficit and gdp. also, at the end of 2012 the positive percentage of gdp was recorded in germany (0,2%), while all other observed countries of the european union had a negative value of percentage of gdp. the largest negative percentage of gdp recorded in the following countries: spain (-10,6%), greece (10,0%), ireland (-7,6%), portugal (-6,4%), cyprus and uk (-6,3%). management and potential for sustainability of budget deficits in bh bosnia and herzegovina has certain advantages in terms of movement of macroeconomic stability criteria, such as price stability and exchange rate stability, which are secured based on managing monetary policy through currency board arrangement since 1997. however, there are some delays in the fulfilment of structural reforms, among which a slow development of financial markets stands out, particularly money market and government securities market. the main challenges for the near future in the integration of bosnia and herzegovina into the european monetary union are expected in the area of public finance, with a focus on reducing the budget deficit and stabilizing the public debt as a segment of the implementation of effective fiscal policy in state of bosnia and herzegovina. the most important criteria in the context of integration of bosnia and herzegovina can be divided into two categories: first, the conditions arising from the feasibility study and the stabilisation and association agreement, which have been designed by the european union for all candidates for membership in the european union and, secondly, the conditions arising from the copenhagen criteria applicable for all candidates. on the other hand, the conditions arising from the maastricht treaty, known as convergence criteria, refer to the european monetary union and they need to be met by each member state of the european union prior to the introduction of euro as a common currency and accession to the european monetary union. the main goal of the fulfilment of the convergence criteria is to create a stable macroeconomic environment for the introduction of the common currency of euro and for the integration of the monetary system of bosnia and herzegovina into the european monetary union (đonlagić, 2006th, pp. 197-198). the maastricht criteria established boundaries of sustainability of the budget deficit to gdp which amounts to 3%. a legitimate question is whether the set boundaries are the condition for sustainability of the economic activity? in the continuation, we will use the regression model to test the interrelatedness of movement between imports and nominal gdp. economic analysis (2014, vol. 47, no. 3-4, 91-135) 130 stopping the growth of expenditures in relation to revenue decline was indeed insufficient to prevent further escalation of primary deficit, which in 2009 amounted to 3.9% of gdp. in fact, the deficit projection that the government did was much higher than that which actually occurred. consolidated bh has achieved a deficit of around 1 billion bam, as measured by the gdp amounts to 3.9% (expenditure approach), i.e. 4.4% of gdp a (production approach). implementation of these measures has had the greatest impact in 2010, where for the first time a decline followed by stagnation of social benefits compensation of employees. restrictive expenditure policy is continued in 2011, despite the significant growth of social welfare, which is largely achieved through savings in the area of material costs and subsidies. therefore, with revenue growth of 4.6%, primary deficit has been reduced to only 0.6% of gdp in 2011 (bh directorate for economic planning, 2012). in 2012, the trend of limiting spending continued with the primary objective of reducing the fiscal deficit. according to the fiscal rules adopted by the imf and the plan is that the fiscal deficit is at the level of 2011. in 2012, the same as the year before, the trend of deficit financing through the issuance of government treasury bills and bonds was continued with the aim to primarily regulate debts on various grounds. in 2012, the government of the federation of bosnia and herzegovina issued treasury bills in five emissions in the total value of 120 million bam. in addition, the republic of srpska issued bonds in three emissions in the total value of 112.8 million bam (cbbh, 2012). the table below illustrates the foreign trade indicators in bh for the period 2008. 2012. table 5. trends in foreign trade indicators for the period 2008 2012 indices 2008 2009 2010 2011 2012 total (2008 – 2012) index 1 2 3 4 5 6 7 8(6/2) export of goods 6.711.690 5.530.377 7.095.505 8.222.112 7.857.962 35.417.646 117,07% growth/export (of %) (17,60) 28,30 15,88 (4,43) import of goods 16.286.056 12.348.466 13.616.204 15.525.428 15.252.942 73.029.096 93,66% growth/import (of %) (24,18) 10,26 14,02 (1,75) balance of trade (export – import) (9.574.366) (6.818.089) (6.520.699) (7.303.316) (7.394.980) total trade 22.997.746 17.878.843 20.711.709 23.747.540 23.110.904 108.446.742 100,49% coverage of import by exports 41,2% 44,8% 52,1% 53,0% 51,5% source: http://www.dep.gov.ba/dep_publikacije/ekonomski_trendovi/archive.aspx?langtag=bsba&template_id=140&pageindex=1 (adaptation by author) from the table above, it is clear that the total value of imports for the period 2008 2012 amounted to bam 15.252.942, while the total value of exports for the same period was bam 35.417.646. maximum coverage of imports by exports was recorded in 2011 of 53%, whereas in 2012 there was a slight decline amounting to 51.5%. in 2012, imports were valued at 15.2 billion bam, which resulted in a decline in imports of about 1.8% over the previous year, alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 131 while exports declined by 4.4% in 2012, and reached a value of 7,8 billion bam. in all countries of the region except croatia, rates of decline in the value of imports were recorded, while in the export, positive growth rates were achieved by croatia and slovenia. most notably, the decline in exports was recorded in macedonia and serbia of about 10% compared with the previous year. the export-import ratio was reduced in all countries except slovenia, where slovenia has the highest export-import ratio that exceeds 95%. in countries with lower levels of per capita income, it is obviously a higher share of foreign trade in gdp. the graph below illustrates the change in import-export and export-import ratio for the year 2012 in the countries of the region. according to the central bank of bh (cbbh), the current account deficit balance of payments recorded a slight nominal increase of about 21 million bam or 0.9%, where in 2012 it amounted to 2.45 billion bam and represents a trend of increased deficits. therefore, in relative terms, the current account deficit in 2012 amounted to 9.5% of gdp which is the same level as in 2011. the increase in the deficit current account was primarily affected by the foreign trade deficit and decrease of the surplus in the services account (graph 1). graph 1. the current account deficit and merchandise account deficit as participation in gdp in bh for the period 2007 2012 source:// http://www.dep.gov.ba/default.aspx?langtag=bs-ba&template_id=139&pageindex=1 report on development of bh, 2012, economic planning, 2013, p. 10 (adaptation by author's) analysis of the interdependence of imports of goods and nominal gdp in bh regression equations are based on empirical data, where by the solution of the equation we can see that the change in imports of goods have a direct impact on nominal gdp in terms of increases or decreases. a simple linear regression model expresses a relationship between the two parameters as follows: �� = � ��� � �� � = 1,2,……�, �1 where: � dependent variable, � � unknown parameters that need estimate, and �� stochastic variable (error distances) economic analysis (2014, vol. 47, no. 3-4, 91-135) 132 in the regression model, which will be the subject of analysis, we will follow the mutual dependence of the movement of imported goods in bh and nominal gdp sector of the government of bh for the period 2008 2012. also, in this paper we will provide the analysis of variance, and hypothesis on the significance of the regression variables, the null hypothesis, which is the independent variable contention that does not significantly affect the dependent variable, and hypothesis 1, which assumes that the independent variable has a significant effect on the dependent variable. �� ….�� = 0 �� ….�� ≠ 0 based on the scatter diagram, i.e. the coefficient of correlation (r = -0.11513) it can be concluded that among these variables there is a statistical correlation of negative direction, i.e. that the increase in the value of imports of goods will affect the reduction in the value of nominal gdp. the chart below illustrates the interrelationship between imports of goods and nominal gdp for the period 2008 2012. graph 2. simple linear regression line between the imported goods in bh and nominal gdp for the period 2008 2012 source: calculation by author the empirical ratio f = 3.53 (table 5) certainly shows that the regression model is statistically significant. the coefficient of determination is ��= 0,013256, i.e. the model is interpreted to 1.32% deviation. based on these parameters, as well as indicators of the regression analysis, it can be concluded that the applied model with the statistical point of view has rather good features. y = -0.0005x + 24162 r² = 0.0133 0.00 5,000.00 10,000.00 15,000.00 20,000.00 25,000.00 30,000.00 0 5,000,000 10,000,000 15,000,000 20,000,000 n o m in al g d p imports of goods in b&h alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 133 table 6. pearson product moment correlation between imports of good and nominal gdp of government of bh variable 1 variable 2 mean 14185760 15770,5 variance 2,21e+12 30535723 observations 4 4 df 3 3 pearson correlation -0,798766 covariance -917571721 correlation -0,1151353 determination 0,013256145 t – test 19,00186 simple linear regression ungrouped date value s.e. t – stat beta 57878,22 22518,84 2,570213 elasticity -0,00297 0,001581 -1,87758 regression analysis of variance anova df sum of squares mean square regression 1 58447985 58447985 residual 2 33159184 16579592 total 3 91607169 f test 3,525297 sorce: calculation by author the regression equation is equal: � = 0,0005 � � 24162 "� = 0,0133 according to the above equation, if the value of imports of goods increased by one percentage point, indicator of nominal gdp will be reduced by an average of about 0.0005 percentage points. parameter estimation is statistically accurate. therefore, the analysis of relationships between the parameters imports and nominal gdp sectors of bh government on the basis of model adopted and data showed that among the above parameters there is a strong statistical linear relationship in the opposite direction. this confirms the null hypothesis that imports of goods and services, has no significant impact on gross domestic product. economic analysis (2014, vol. 47, no. 3-4, 91-135) 134 conclusion an analysis of macroeconomic indicators in bh in 2012 recorded a trend of weakening economic activity. first of all, the results of this situation should seek the stagnant economies of eu and the countries of the region. negative economic growth is manifested through a real drop in domestic demand and exports, the decline in investment funding and the decline in industrial production. this situation is reflected in the bh economy in terms of public finance statistics. as you can notice, the current account deficit in bh has overrun the limits set by the convergence criterion of 3% of gdp in the last few years, which will inevitably decline in gross domestic product, and ultimately to a deepening decline in economic activity. in order to reduce the deficit by the end of the year, certain levels of governments have already implemented certain measures designed to reduce total expenditure, and thereby reduce the deficit, and for the purpose of approving the new. in line with all above, there is still the problem of financing the deficit. in the early years, the deficit financing was achieved through borrowing, both domestic and foreign. entity governments for this purpose performed bond emissions. to achieve sustainable growth model in bh, attention must be paid to the level of reduction of the trade deficit, work on increasing the level of exports, reduce the level of consumption and higher levels of investment and employment. the only current assumption of deficit financing, which of course is not justified, is in part an increase in public debt. bh should certainly continue to implement restrictive fiscal policy measures and cuts in public spending in order to improve the fiscal position. specifically, in addition to the nominal convergence criteria, bh should seek to achieve real convergence criteria in terms of creating the environment for foreign direct investment, harmonization of labour market and the proper transformation and homogenization of the real sphere of economy. references bh directorate for economic planning. 2012. http://www.dep.gov.ba/default.aspx?langtag=bsba&template_id=139&pageindex=1, economic trends, annual report bh directorate for economic planning. 2013. http://www.dep.gov.ba/default.aspx?langtag=bsba&template_id=139&pageindex=1 bh directorate for economic planning. 2012. http://www.dep.gov.ba/fiskodr/archive.aspx?langtag=bs-ba&template_id=140&pageindex=1 central bank of bosnia and herzegovina. 2012. annual report, http://www.cbbh.ba/index.php?id=31&lang=bs the central bank of montenegro. 2008. analysis of the sustainability of current account deficitmontenegro,http://www.cbcg.org/slike_i_fajlovi/fajlovi/fajlovi_publikacije/radne_studije/anali za_odr%c5%beivosti_deficita.pdf đonlagić, dz. 2006. evropska monetarna unija i bosna i hercegovina. sarajevo: ekonomski fakultet u sarajevu univerzitet u sarajevu. erić , d., and đukić, m. 2012. finansijska tržišta u uslovima krize. beograd: institut ekonomskih nauka, beogradska bankarska akademija – fakultet za bankarstvo, osiguranje i finansije. european commission – eurostat. 2013 http://epp.eurostat.ec.europa.eu/cache/ity_public/222042013-ap/en/2-22042013-ap-en.pdf alihodžić, a., et al., case study of bh, ea (2014, vol. 47, no. 3-4, 121-135) 135 european commission – eurostat 2013 eurostat. 2013. pocketbook on the enlargement countries, no. ks – 30 – 12 – 129 – en – c. furtula, s., and marković, d. 2010. monetarni sistem evropske unije. kragujevac: ekonomski fakultet u kragujevcu. kešetović, i., đonlagić, dž., and rička, ž. 2012 javne finansije. sarajevo: ekonomski fakultet u sarajevu. komazec, s., and ristić, ž. 2011. monetarne i javne finansije. beograd: etnostil. mishkin, f.s. 2010. ekonomija novca, bankarstva i finansijskih tržišta. zagreb: mate doo. golomejić, r. z. 2011. “koordinacija monetarne politike i politike upravljanja javnim dugom u hrvatskoj: stanje i izazovi”, zbornik radova s konferencije, institut za javne finansije, zagreb, 2011, pp. 143 – 170, http://www.ijf.hr/upload/files/file/knjige/javni-dug-2011.pdf santini, g. (2011). “mogući pristup reformi poreznog sustava rrepublike hrvatske”, časopis za ekonomsku teoriju i politiku, godina 18, (1): 99 – 130, zagreb.. institute of public finance. http://www.ijf.hr/hr/korisne-informacije/pojmovnik-javnihfinancija/15/proracun/266/proracunski-deficit/268/. efekti spoljne trgovine na budžetsku ravnotežu studija slučaja bosne i hercegovine rezime –.analizom kretanja ekonomskih trendova u bih u 2012. godini zabeležen je nastavak slabljenja ekonomskih aktivnosti. pre svega, ovakvo stanje rezultat je stagnacije ekonomije zemalja eu i regiona. u prvom tromesečju 2013. godine, robni izvoz je realno porastao za 19%, a uvoz za 13% što je dovelo do realnog rasta vanjskotrgovinskog deficita za oko 7%. dati rast deficita bitno je umanjio ranije procene ekonomskog rasta za prvo tromesečje u kome je snažan izvozni rast praćen rastom industrijske proizvodnje predstavljao jako bitan iskorak u odnosu na prethodnu godinu. osnovni cilj u ovom radu je razmatranje uticaja globalne finansijske krize na kretanje budžetskog deficita u bih za period 2008. 2012., kao i praćenje ograničenja koje je postavljeno mastrihtskim ugovorom da visina budžetskog deficita ne smije preći 3% gdp-a kroz međuzavisnost uvoza roba i nominalnog gdp-a. ključne reči: uvoz roba, izvoz roba, spoljnotrgovinski indikatori, budžetski deficit, kriteriji konvergencije article history: received: 18 february 2014 accepted: 14 june 2014 microsoft word 2009_3_4-korigovano.doc original scientific paper nonlinearities, herd behaviour and market illiquidity: evidence from montenegro?* kallinterakis vasileios**, university of durham, department of economics and finance, united kingdom lodetti maria, british american tobacco, netherlands udc: 336.761(497.16) jel: g10, g15 abstract – research in finance has shown that herd behaviour is associated with nonlinear dynamics in both developed and emerging stock markets. however the latter are characterized by thin trading which has been found to amplify nonlinearities in returns by enhancing their serial dependence. if so, then the association between herding and nonlinearities may be subject to the thin trading bias. as this issue has never explored before, we investigate this in the context of the new securities stock exchange of montenegro. results indicate that correcting for thin trading bears a notable impact upon the observed nonlinearities, yet not the estimated herding, which appears insignificant in all test key words: herding, thin trading, nonlinearities, montenegro introduction research in finance has produced widespread evidence in favour of herding being associated with nonlinear return dynamics in capital markets, both developed as well as developing (lux, 1995; lux and marchesi, 1999; wagner, 2002). however, emerging stock exchanges are typified by thin trading, which has been found to amplify nonlinearities (solibakke, 2005; saadi et al., 2006) as it tends to enhance the serial dependence in the structure of the return-generation process (lo and mackinley, 1990; miller et al, 1994; antoniou et al, 1997; siriopoulos, 2001; solibakke, 2001). despite the above mentioned association between thin trading and nonlinearities, the potential for thin trading producing a bias over nonlinear herding estimations has never been explored in finance, even though many herding studies have been undertaken in emerging markets. we aim at filling this gap by addressing this issue in the context of montenegro’s new securities stock exchange (nex) which is one of the most recently (2001) established markets in the world and which has never been the subject of any research in finance before. our study covers the period between march 2003 and may 2008 and is conducted on the premises of the nex20 index which constitutes the market’s main index. the rest of the paper is structured as follows: section 2 provides a brief overview of the herding literature, * acknowledgements: we are grateful to mladen koljensic for his invaluable help with data from the new securities stock exchange of montenegro. ** address: 23/26 old elvet, durham dh1 3hy, united kingdom, e-mail: vasileios.kallinterakis@durham.ac.uk. economic analysis (2009, vol. 42, no. 3-4, 7-17) 8 while section 3 delineates the evolution of montenegrin capital markets; section 4 discusses the data (4.1), the methodology employed (4.2) and presents some descriptive statistics (4.3). section 5 presents and discusses the results; section 6 concludes. herd behaviour: theory and empirical evidence the notion of herding pertains to the behavioural similarity following from the interactive observation of opinions, information, actions or the payoffs of those actions (hirshleifer and teoh, 2003). if the individual chooses to align his/her mode of action to that suggested by others, then he/she will exhibit convergence in that direction. under such circumstances, one’s priors are expected to be sidelined in favour of the observed consensus, thus giving rise to phenomena of collective dynamics. in psychological terms, imitation has often been assumed to be driven by the behavioural biases of the human nature itself. hirshleifer (2001) noted how conformity can lead people to copy the actions of those around them. such an imitative tendency may be explained through individuals’ interactive communication, which could be described as either explicit (when people are conversingshiller, 1995) or tacit (when people observe others’ choices, for example in fashion-bikhchandani et al, 1992). drawing from earlier findings of cognitive psychology, prast (2000) demonstrated how the interplay of congruity and cognitive dissonance is capable of facilitating herding among individuals. investors, however, may resort to imitative behaviour due to sheer informational reasons; devenow and welch (1996) showed that a person might find herding appealing if she possesses no information, perceives her information less reliable compared to others’ or considers others better informed. if an investor considers the actions of her peers highly informative, it is likely she will end up suppressing her private information and allow herself to be drawn into an informational cascade (banerjee, 1992; bikhchandani et al., 1992), thus leading to a slower aggregation of information into the market and rendering the public information pool poorer. career/reputational considerations may prompt market participants to conform to the line implied by the perceived consensus. this has been found to be the case particularly among investment professionals (e.g. fund managers and financial analysts) who are subject to relative performance evaluation vis-à-vis their peers. as scharfstein and stein (1990) have shown, such a situation may encourage professionals to align their conduct in line with the perceived benchmark in order to avoid deviating largely from it and run a professional risk. the issue here is that “bad” professionals will find it more attractive to mimic the actions of their “good” peers so that they improve their image, thus jamming the evaluation process. however, “good” professionals might also resort to herding if they feel that the risk by going-it-alone exceeds the corresponding benefit, especially if they wish to protect their image and reputation (graham, 1999). what is more, investment professionals are subject to a certain framework of conduct that may actually itself foster commonality in their behavior (de bondt and teh, 1997). research (olivares, 2003; voronkova and bohl, 2005; kominek, 2006) has shown, for example, that funds in some cases may be restricted in the choice of stocks they are allowed to invest in by the regulatory authorities, thus ending up holding portfolios of similar composition. kallinterakis, v. et al., nonlinearities, herd behavior, ea (2009, vol. 42, no, 3-4, 7-17) 9 a key finding surrounding much analytical as well as empirical research in herding is that herd behaviour is associated with nonlinearities in the structure of returns. these findings indicate that in the presence of herding, asset returns will deviate from the paradigm implied by rational pricing models which incorporate linear frameworks in their design. the presence of herding has been shown to be associated with nonlinearities inducing bubbles and crashes (lux, 1995; lux and marchesi, 1999; equíluz and zimmermann, 2000; wagner, 2002; xie et al., 2002), excess kurtosis (cont and bouchaud, 2000) and reduced cross-sectional return dispersion (chang et al., 2000; caparelli et al., 2004; gleason et al., 2004; henker et al., 2006; caporale et al., 2008). however, an issue here arises as many of these studies have been undertaken in emerging capital markets, a typical feature of which is thin trading. as many studies have illustrated (lo and mackinley, 1990; miller et al., 1994; antoniou et al., 1997; siriopoulos et al., 2001; solibakke, 2001; solibakke, 2005; saadi et al., 2006) thin trading is particularly conducive to nonlinearities in asset dynamics due to the fact that it delays the incorporation of information into securities’ prices. therefore, prices tend to reflect information emanating from trades of previous sessions and end up changing at a lower frequency, which leads them to exhibit increased serial dependence. as antoniou et al. (1997) and siriopoulos et al. (2001) further demonstrated correcting for thin trading tends to reduce these phenomena, thus suggesting that thin trading introduces a bias in nonlinear empirical estimations. in view of the above though, the following question arises: is the herding estimated on the premises of nonlinear models robust to thin trading? if the aforementioned serial dependence of returns dissipates following the adjustment for thin trading, does the latter also occur to herding estimates in nonlinear frameworks? it would therefore be interesting to examine whether herd-related nonlinearities persist after thin trading has been accounted for in emerging markets. our study aims at covering this gap by examining the impact of thin trading over herding at the nonlinear dimension utilizing the empirical design proposed by chang et al. (2000). more specifically, we perform our tests on the premises of the new securities stock exchange (nex) of montenegro for the period between march 2003 and may 2008. we consider our study to be contributing to existing herding research in two distinctive ways: a) it assesses for the first time the impact that thin trading may bear in an illiquid market upon nonlinear herding estimations b) it measures herding in a market which has never been investigated before in finance. capital markets in montenegro capital markets were first introduced in montenegro in the early 1990s with the foundation of the montenegro stock exchange in 1993. however, it was not before 2000-1 that investors’ interest began to pick up following the launch of the mass privatization programme. it was during that time that the securities and exchange commission was set up as the key regulatory authority in the stock exchange. by the end of 2001, a second trading venue, the new securities stock exchange (nex) was established operating on the basis of electronic trading, which formally commenced on march 4th, 2002 (popović, 2004). it economic analysis (2009, vol. 42, no. 3-4, 7-17) 10 is interesting to note here that, although the country’s population hovers around 650,000 inhabitants, 430,000 of them (popović, 2004) hold a shareholding position; the number of actively trading investors has been estimated at 10 percent of the population and their investment behaviour has been noted to be mostly based on word-of-mouth, rather than fundamentals (sofia echo, july 9th, 2007). despite the large number of listed companies in both the montenegro stock exchange and the nex (over 400), trading activity is mostly concentrated among very few (a dozen or so) stocks (popović, 2004), thus raising the issue of thin trading there despite the gradual increase of investors’ participation (radanovic, 2006). data and methodology data our data includes the daily closing prices and daily trading volume of all historical constituents of the nex20 which is the main index of the new securities stock exchange accommodating the twenty largest listed stocks (popović, 2004). the choice of the new securities stock exchange instead of the montenegro stock exchange was motivated here by the unavailability of data for the montenegro stock exchange. the data covers the period beginning march 2003 when the nex20 was launched and ending may 2008 and was obtained from the new securities stock exchange. according to the historical constituent lists of the nex20 obtained from the nex, the total number of stocks that have been included at any point during that period in the composition of the index equals 50. methodology the first attempt in finance to trace herding through nonlinearities was undertaken by chang et al. (2000) who aimed at detecting herding through the dispersion of returns using the cross-sectional absolute deviation (csad) of returns for that purpose: fti n i pit rrn csad −−= ∑ = , 1 1 ββ (1) where iβ represents the systematic risk of the individual security i, pβ reflects the systematic risk of the market portfolio, tir , is the return of the individual security i at time t, fr is the risk free rate, and n is the number of securities in the market portfolio. as henker et al. (2006) illustrated, equation (1) can equivalently be expressed as: ∑ = −= n i tptit rrn csad 1 ,, 1 (2) where tir , is the return of the individual security i at time t, tpr , is the return of the market portfolio at time t and n is the number of securities in the market portfolio. in the present framework, the market portfolio is formed by the 20 constituent stocks of the nex20, whose composition varies over time; moreover, returns here are calculated as the first logarithmic difference of daily closing prices. according to chang et al. (2000), an increased clustering of returns around the market average is indicative of herding; therefore, a decreasing cross-sectional absolute dispersion kallinterakis, v. et al., nonlinearities, herd behavior, ea (2009, vol. 42, no, 3-4, 7-17) 11 would suggest the presence of herding. however, herding here is not reflected in the crosssectional absolute dispersion per se, but rather in the relationship between the cross-sectional absolute dispersion and the market return. chang et al. (2000) argued that this relationship is of nonlinear nature, since herding can give rise to dynamics not predicted by rational pricing models; to formalize this nonlinear relationship in an empirical framework, chang et al. (2000) proposed the following test: ( ) tuptmupuptmupupt rrcsad εγγα +++= 2 ,2,1 (3) ( ) tdowntmdowndowntmdowndownt rrcsad εγγα +++= 2 ,2,1 (4) where tmr , is the equal-weighted market portfolio (in our case, the nex20-portfolio) return and the up/down superscripts denote up/down market days. chang et al. (2000) employ the above two regressions in order to account for possible directional asymmetries in herd behaviour contingent upon market direction. in other words, the authors want to test whether herding exhibits any differences during periods of upversus down-markets. as herding is assumed here to be related to market nonlinearities, we are particularly interested in the 2γ -coefficient. in view of what we mentioned above, a negative and statistically significant estimate for 2γ would be suggestive of the presence of significant herding. to test for the robustness of our results, we also estimate equations (3) and (4) using the volumeweighted cross-sectional absolute dispersion in order to control for any impact of heavily traded stocks in our estimates. however, despite the fact that the nex20 index includes the largest stocks in the new securities stock exchange, many of them realize a number of non-trading days (popović, 2004), thus raising the issue of the thin trading bias here. in order to adjust for thin trading, miller et al., (1994) proposed correcting for it by using a methodology based on a moving average process reflective of the number of non-trading days. however, given the complexity of identifying non-trading days, miller et al., (1994) have demonstrated that the correction for thin trading can be accomplished using an ar (1) process, as follows: ttt eraar ++= −121 (5) where tr is the individual stock return at time t; 1−tr is the individual stock return at time t1 and te is the error term. realized returns can then be adjusted as follows: ( )21 a e r tadjt − = (6) where adjtr is the return at time t after thin trading has been taken into account. antoniou et al. (1997) pointed out that an assumption underlying the miller et al. (1994) approach is that the adjustment for thin trading is taken to be constant throughout time. they argue that this assumption may be inappropriate when dealing with emerging markets as they may well accommodate substantial windows of trading inertia. as the latter constitutes a feature of the market under investigation here, equation (5) is estimated economic analysis (2009, vol. 42, no. 3-4, 7-17) 12 recursively. once individual returns are adjusted for thin trading, they are then used to recalculate the cross-sectional absolute dispersions (equaland volume-weighted ones) and reestimate equations (3) and (4). table 1. sample statistics for the nex20-portfolio returns (rm.t) and the cross-sectional absolute deviations (csad), using different versions of the nex20-portfolio, i.e. equal-weighted, equalweighted with returns corrected for thin trading, volume-weighted, volume-weighted with returns corrected for thin trading (* = indicates significance at the 1 percent level). serial correlation at lag nex20 portfolio designations v ar ia b le s number of observa tions m ea n v ar ia n ce m ax im u m m in im u m 1 2 3 5 20 df test rm.t 1299 0.0013 0.000617 0.4662 -0.4566 -0.17 -0.02 0.03 -0.01 0.02 -42.92* equal-weighted csad 1299 0.0208 0.001645 0.8755 0.0000 0.41 0.09 0.07 0.07 0.05 -23.23* rm.t 1296 -0.0214 2.7643 13.5678 -12.2209 0.23 0.05 0.05 -0.01 0.07 -30.13* equal-weighted adjusted for thin trading csad 1296 1.9706 4.1835 24.3206 0.0304 0.24 0.24 0.21 0.24 0.14 -28.75* rm.t 1299 0.0083 0.0030 0.7729 -0.4167 0.02 -0.01 0.01 0.07 0.06 -35.23* volume-weighted csad 1299 0.0304 0.0032 0.8395 0.0000 0.15 0.02 0.01 0.04 0.01 -31.00* rm.t 1296 0.2018 19.1461 70.3693 -51.3972 0.08 -0.01 0.00 0.02 0.05 -33.89* volume-weighted adjusted for thin trading csad 1296 2.7300 15.4109 69.9199 0.0195 0.07 0.07 0.02 0.04 0.01 -14.48* descriptive statistics table 1 presents some statistics for the nex20-portfolio returns ( tmr , ) and their corresponding cross-sectional absolute dispersions (csad), both equaland volumeweighted ones, before and after adjusting for thin trading. it is interesting to note here that the means and variances of both the nex20-portfolio returns and their cross-sectional absolute dispersions exhibit a notable increase following the correction for thin trading. this is indicative of thin trading bearing a substantial presence in the nex-market. the first order autocorrelations for the cross-sectional absolute dispersions’ series appear quite high, and always assume higher values for each nex20-portfolio designation (equal-/volumeweighted) prior to adjusting for thin trading. in view of this, all standard errors of the estimated coefficients here are adjusted for heteroscedasticity and autocorrelation, in line with chang et al. (2000). finally, the dickey – fuller statistic suggests that all cross-sectional absolute dispersions’ series exhibit stationarity. results discussion table 2 presents the estimates obtained for equations (3) and (4) of the chang et al. (2000) model on the premises of both the equalas well as the volume-weighted nex20-portfolios, before and after adjusting for thin trading. the α coefficient, reflective of the average value of the cross-sectional absolute dispersion of returns, is found to be positive and significant in all tests at the 1 percent level; interestingly enough, its value appears to rise dramatically following the adjustment for thin trading in all cases. this is something perhaps to be kallinterakis, v. et al., nonlinearities, herd behavior, ea (2009, vol. 42, no, 3-4, 7-17) 13 expected as in the presence of thin trading, individual stocks’ series would include a number of zero-observations, thus rendering the dispersion of stocks’ returns around their mean tighter. regarding the 1γ coefficient, it is also found to be significantly (1 percent level) positive for all tests, thus being suggestive of a positive linear relationship between the crosssectional absolute dispersion and the tmr , . this indicates that the cross-sectional absolute dispersion increases with the absolute value of the nex20-portfolio returns and it is in line with the findings of chang et al. (2000), caparelli, et al. (2004), gleason et al. (2004), henker et al. (2006) and caporale et al. (2008). an interesting feature of our results relates to the fact that volume-weighted tests furnish us with consistently lower 1γ estimates compared to equal-weighted tests, both prior to and after correcting for thin trading. this indicates that the above documented positive linear relationship between the cross-sectional absolute dispersion and the tmr , becomes weaker (i.e. the dispersion increases at a decreasing rate) when taking the impact of trading volume into account. we also notice that there seems to be a general trend1 for up1γ to be greater than down 1γ . this means that dispersions increase at a lower rate during periods of market declines compared to periods of positive market returns; however, the f1 test statistic in table 2 used to test the null hypothesis downup 11 γγ = shows that the null hypothesis is accepted in all cases, thus implying that up1γ is not significantly different from down1γ . table 2. regression results for the chang et al. (2000) model. up-market model down-market model test statistics α up 1γ up 2γ adjusted r2 α down 1γ down 2γ adjusted r2 f1 f2 equalweighted 0.0080 (14.52)* 1.1702 (31.34)* 1.4551 (13.84)* 0.883 0.0073 (11.11)* 1.3324 (30.3)* 1.2578 (11.08)* 0.930 0.0000000000000421908 0.0000000000000017753 equalweighted adjusted for thin trading 0.6905 (12.21)* 1.4593 (25.32)* -0.0200 (-3.06)* 0.752 0.8328 (13.32)* 1.0204 (15.89)* 0.0395 (4.23)* 0.690 0.0000000000000032968 0.0000000000000048689 volumeweighted 0.0074 (7.81)* 1.0208 (33.18792)* -0.0437 (-0.88) 0.884 0.0127 (12.56)* 0.6028 (12.9)* 2.2043 (15.37)* 0.875 0.0000000000000241761 0.0000000000000002042 volumeweighted adjusted for thin trading 1.1350 (15.9)* 0.8828 (35.16)* 0.0011 (2.62)* 0.929 1.0438 (16.24)* 0.8209 (26.29)* 0.0029 (3.53)* 0.789 0.0000000000001185930 0.0000000001631320000 this table reports the estimated coefficients of the following set of regressions (standard errors in brackets): ( ) tuptmupuptmupupt rrcsad εγγα +++= 2 ,2,1 1 with the exception of the equal-weighted case prior to adjusting for thin trading. economic analysis (2009, vol. 42, no. 3-4, 7-17) 14 ( ) tdowntmdowndowntmdowndownt rrcsad εγγα +++= 2 ,2,1 f1 and f2 statistics test respectively the following null hypotheses: downup 11 γγ = and downup 22 γγ = ; * = indicates significance at the 1 percent level. with regards to 2γ , it is found to be significant (1 percent level) for nearly all tests2, thus being indicative of a significant nonlinear relationship between the cross-sectional absolute dispersion and the tmr , ; however, its sign is mostly positive3, thus failing to generate much evidence in favour of herding here. it is further interesting to observe that correcting for thin trading leads to a substantial depression of the 2γ coefficient; while 2γ assumes values above unity in absolute terms before adjusting for thin trading, its values decline well below unity in absolute terms once thin trading has been corrected for, with the exception of the up 2γ coefficient in the volume-weighted tests. the decline of the 2γ coefficient after thin trading has been adjusted for constitutes a very important finding here as it indicates a positive impact of thin trading over the nonlinear relationship between the cross-sectional absolute dispersion and the nex20-portfolio returns. this finding is in line with evidence documented in the literature regarding the contribution of thin trading to nonlinearities. antoniou et al. (1997) and siriopoulos et al. (2001) showed that adjusting for thin trading in nonlinear market efficiency tests tended to reduce the magnitude of the nonlinear components in the turkish and greek stock exchanges respectively. solibakke (2001; 2005) showed that thin trading accounted for the most part of the nonlinear dynamics observed in the structure of stock-returns in norway; according to the evidence he presented, the most illiquid securities in the oslo stock exchange were those typified by the most consistent and pronounced nonlinearities. saadi et al. (2006) argued that, given transaction costs, noise investors have a tendency to delay their trades in order to observe informed investors’ behaviour and that this delay in anticipation of new information gives rise to nonlinear trends in asset prices. saadi et al. (2006) pointed out that nonlinearities due to market imperfections are even more likely in emerging markets, given their particular features such as thin trading, low liquidity and high presence of noise traders and argued that these features imply greater complexity of the nonlinear dynamics characterising asset prices. although we notice that there exists a general tendency4 for down2γ to be higher than up 2γ , the hypothesis downup 22 γγ = cannot be rejected here as the results from the f2 test-statistics in table 2 accommodate very small values, equal almost to zero. our results, thus furnish us with some interesting findings on the impact of thin trading over nonlinear herding estimations for the first time in the literature. first of all, the absence of herding in the new securities stock exchange appears robust to correcting for thin trading on the premises of the chang et al. (2000) nonlinear model framework; conditioning upon volume and market direction further confirms this finding. although the relationship between the cross-sectional absolute dispersion of returns and the market returns in the 2 with the exception of the volume-weighted case prior to correcting for thin trading in up-markets. 3 with the exceptions of the up2γ in two cases: equal-weighted adjusted for thin trading; volumeweighted unadjusted for thin trading. 4 with the exception of the equal-weighted case prior to adjusting for thin trading. kallinterakis, v. et al., nonlinearities, herd behavior, ea (2009, vol. 42, no, 3-4, 7-17) 15 context of the nex20 index is found to accommodate significant nonlinearities, the increasing nature of this relationship implies that herding is absent. perhaps more interestingly, though, correcting for thin trading appears to confer a notable impact over these nonlinearities, since the latter endure a major decline following the adjustment for thin trading. since the impact of thin trading over herding has been examined here for the first time in a nonlinear framework, we consider our findings to contribute substantially to the finance literature. conclusion a series of studies have attempted to detect herding through nonlinearities in returndynamics in both developed and emerging capital markets. however, although the latter are normally expected to be characterized by thin trading, its impact over herding estimates has largely been overlooked despite the positive association between thin trading and nonlinearities widely documented in the literature. our research aims at covering this gap by examining the impact of thin trading over herding in the new securities stock exchange of montenegro on the premises of the nex20 index. results seem to suggest that herding is non-existent, irrespective of whether one corrects for thin trading or not. however, our findings also illustrate that the montenegrin market accommodates significant nonlinearities, which, despite being irrelevant to herding, undergo a substantial depression following the adjustment of returns for thin trading. references antoniou, a., ergul, n. and holmes, p.r. 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(2005), “institutional traders’ behaviour in an emerging stock market: empirical evidence on polish pension fund investors”, journal of business, finance and accounting, 32(7) and (8), pp. 1537-1560. kallinterakis, v. et al., nonlinearities, herd behavior, ea (2009, vol. 42, no, 3-4, 7-17) 17 wagner, f. (2003), “volatility cluster and herding”, physica a, volume 322, pp. 607-619. xie, y., w., b-h, quan, h., yang, w. and hui, p.m. (2002), “finite-size effect in the equíluz and zimmerman model of herd formation and information transmission”, physical review e, vol. 65, 046130-1-6. received: marc h 2009 article history: accepted: july 2009 microsoft word 2009_3_4-korigovano.doc research report cash flow statements jadranka kapić*, university of sarajevo, faculty of economy, sarajevo udc: 336.347.731.1 jel: g10, g15 abstract – financial statements are aimed at providing information that can be used by investors and creditors to forecast, compare and evaluate potential money in cash flows for their needs by the amount, the time schedule and the characteristic risks. the purpose of financial statements is to provide the beneficiaries with information to forecast, compare and evaluate the financial position, profit and loss levels and financial position changes, that is, the information on how the company acquired and spent the money, and on the company’s debts and repayment of debts, and on the capital transactions, including payments of dividends and other distributions to the proprietors, as well as all other factors that influence the company’s liquidity and ability to pay. this information should be useful to a wide circle of beneficiaries in the business decision-making process. in their views of the purposes of financial statements, the international accounting standards committee indicates that «economic decisions of financial statement beneficiaries require evaluation of the companyʹs ability to produce cash and cash equivalents, as well as the time schedule and the certainty of their production,1 pointing, naturally, to the basic financial statements, that is, the balance sheets, as financial statements on financial positions (item 16), and the profit and loss balance, as the financial statements on the company’s performance (item 17), but also to the financial statements on the changes in the financial positions, primarily as financial statements (item 18), the unsurpassable information sources for the forecast, the comparison, and the evaluation of the company by the beneficiaries. key words: capital, cash flow, financial statements, decision-making process, investment basic categories of the financial statements financial statements are based on cash and cash equivalents, that is, money in cash flows and cash equivalents. by money, financial statements define money in the cash register and money on the giro and other bank accounts, including the overdraft on the bank accounts (international accounting standards – ias-7, items 6 and 8). cash equivalents are not money in a restricted sense as the aforementioned categories, but in this case they are short-term investments with the expiration date up to three months (ias-7, item 7). these are liquid or easily and swiftly cashable short-term investments. item 7 of the international accounting standards says: «in order to characterise investments as cash equivalents, they should be swiftly replaceable by a defined amounts of money and they cannot bear any significant value changes». * e-mail: jadranka.kapic@efsa.unsa.ba 1 international accounting standards committee (iasc), framework for preparation and presentation of financial statements, international accounting standards, london, 1997, item 15. kapić, j., cash flow statements, ea (2009, vol. 42, no. 3-4, 38-49) 39 purposes of developing financial statements financial statements are financial statements that are derived from the managerial need for additional information required for the decision-making process. at the global level today, the benefits from these statements are multiple, and even so great that they increasingly overshadow the information from the status balance and the profit and loss balance. external and internal beneficiaries of financial statements are interested in the information on the sources and methods of legal persons realising cash receipts, and what are the reasons for and what are the scopes of cash expenditures by various activities. the purposes of financial statements, that is to say, the benefits that these statements provide to external and internal beneficiaries, can be systemised in the following way: a) legal persons evaluate potentials to accomplish future cash flows; b) to provide legal persons with the possibility to evaluate their liabilities to the creditors, to pay the dividends, and to evaluate the needs of legal persons for external financing; c) to provide evaluations of causes which differentiate the net profits from the net cash flows, and to provide correlations between cash receipts and cash expenditure; d) to provide evaluations of cash flows and various non-cash investments and financial activities influences on the financial position of the legal persons during the accounting period. ias-7 (items 3, 4, and 5) say the following about the benefits from developing financial statements on cash flows: 1. legal persons need money to manage their own businesses, to pay their liabilities and for the yield payments to their investors. therefore, this standard requires that all legal persons present their financial statements. 2. financial statements provide information that beneficiaries can use to evaluate changes in legal person’s net assets, their financial structure (including liquidity and ability to pay), and their ability to influence the cash flows amounts and the time schedule to accommodate to the changing circumstances and opportunities. 3. information on cash flows makes it possible for legal persons to evaluate their abilities to produce cash and cash equivalents and for beneficiaries to develop models to evaluate and to compare current values of different legal person’s future cash flows. 4. financial statements increase comparability, which is used by different legal persons to develop statements on business profits and losses, because it eliminates the effects of different accounting procedures for the same business changes. 5. historic information on cash flows is often used to indicate the amounts, the time frames and the certainty of future cash flows. it is additionally useful when checking the correctness of previous future cash flows evaluations and when exploring the correlations between the profitability and the net cash flow, and the influence of price changes. economic analysis (2009, vol. 42, no. 3-4, 38-49) 40 how to present financial statements in accordance with the international accounting standard 7, financial statements are developed on the basis of three activity types of legal persons, and these are: a) business activities; b) investment activities; c) financial activities. legal person’s business activities are those activities that are primarily focused on the production and the sale of products and commodities, and the service provision. in other words, these are the activities that are not investments or financial activities. international accounting standard 7, item 6, defines business activities in the following way: «business activities are legal person’s principal income-making activities, as well as other activities, with the exclusion of investments and financial activities». on the side of expenditure, investment activities include legal person’s investments in debtor’s (bonds and other debts) and proprietor’s (stocks) securities, as well as investments in other fixed assets (investments in equipment, real property and similar), as well as authorisation of loans, credits and similar. on the side of receipts, these activities include sales of investments in debtor’s and proprietor’s securities, as well as sales of fixed assets, refund equity authorised loans and similar. according to the international accounting standard 7 (item 6), investment activities are «acquisition and alienation of fixed assets and other investments that are not included in the cash equivalents». according to the international accounting standard 7 (item 6), financial activities are «those activities that lead to changes of levels and compositions of legal person’s personal capital and liabilities based on the loans taken». specifically, financial activities on the side of receipts include acceptance of cash from the proprietors (stock emission) and, on the side of expenditure, cash refunds to proprietors on invested assets (dividends), as well as repurchases of stocks (acquisition of personal or treasury stocks). additionally, financial activities on the side of receipts include legal person’s debts (credits, emission of bonds) and, on the side of expenditure, debt refunds (this does not include the payments interest, which comes under the business activities). influences of changes in capital, liabilities and non-cash assets on the financial situation changes as investments and financial transactions, any business activity has their own direct influence on the balance, that is, on the legal person’s financial situation. the most adequate baseline for the influence analysis of the changes developed on the balance, that is, the investments and the financial transactions; is the balance equation. during the period for which the balance is broken up, business activities influence the development of revenues and expenditures, and the difference between these two (net profit) represents a proportion of the capital (equity) in the balance. additionally, in their finality, investments and financial activities have an influence on the assets, the liabilities and the capital status changes. influence of business, investment and financial activities can be presented in the following way by using the balance equation: assets = liabilities + capital kapić, j., cash flow statements, ea (2009, vol. 42, no. 3-4, 38-49) 41 the balance equation can be broken down and written as: c + nca = l + se (1) where: c – cash and cash equivalents; nca – non-cash assets; l – liabilities (long-term and short-term); and se – share capital. legal person’s cash and cash equivalents are obtained by: c = l + se – nca (2) potential changes of cash and cash equivalents are the outcomes of changes in liabilities or in capital or in non-cash assets. this is presented in the following way: c = l + se – nca (3) any given transaction, that is, the developed business changes, in the dual bookkeeping system subject to accounting records has for its consequence changes on the side of debts and claims at least on two accounting accounts. this means that the equation (3) can be explained in the following way: increase in cash and cash equivalents = increase in liabilities or increase in capital or decrease in non-cash assets alternatively: decrease in cash and cash equivalents = decrease in liabilities or decrease in capital or increase in noncash assets however, any developed business change, as well as any investment or financial transactions, does not necessarily bear money features, that is, does not necessarily have cash receipts or expenditures as a consequence. thus, for instance, payment of a single liability by an emission of other liabilities does not necessarily have to result with a decrease in cash and cash equivalents. additionally, dividend payments in tangible assets (equipment, commodities) or by dividend stocks are not cash transactions, et cetera. the subjects of financial statements are only those business changes, and investment and financial activities, which for a consequence have receipts or expenditure cash and cash equivalents. outcomes of analyses and transactions that are subjects to accounting records, and which have influence on cash and cash equivalents, should be coded by «p», «i», and «f» or by other codes adapted to computer data processing (business, investment and financial activities). in this way, legal persons will have a significantly easier job when developing financial statements. cash receipts and cash payments from business, investment and financial activities to develop financial statements, it is primarily necessary to define detailed cash receipts and cash expenditures by individual activities. economic analysis (2009, vol. 42, no. 3-4, 38-49) 42 cash receipts and cash payments from business activities these are cash receipts and cash payments from the principal business activity performed by a legal person: • sale for cash to buyers; • collection of claims from buyers; • received advances from operating activities; • receipts from collected interest, royalties, compensations, provisions; • cash refunds from the suppliers; • receipts from winning lawsuits in legal proceedings, penalties; • receipts from refunding, donations, subsidies and similar. cash payments are: • payments to employees for salaries and other; • payments to commodity suppliers and service providers; • payment of taxes and penalties; • cash expenditure for interest; • cash refunds to buyers (for defective or returned commodities and similar); • given advance payments for operational activities; • donations in cash and similar. cash receipts and cash payments from investment activities cash receipts are: • receipts realised by the sale of tangible and intangible fixed assets; • receipts from the sale of proprietor’s securities (stocks) or from the sale of investments in debtor’s securities (bonds and similar); • receipts from the sale of debts; • receipts from investments (interest, dividends, shares, compensations and similar). cash payments are: • expenditure for the purchase of tangible and intangible fixed assets; • payments for investments in proprietor’s securities or debtor’s securities (bonds) and for the purchase of debts, financial placements and loans for other legal persons. cash receipts and cash payments from financial activities cash receipts are: • cash receipts from emissions of proprietor’s securities (stocks); • cash receipts from emissions of debtor’s securities (bonds); • receipts from loans or credits received from financial institutions. cash payments are: • dividend payments and payments for repurchases of proprietorʹs (treasury) stock emissions; • payments for the repayment of loans or credits (equity only). kapić, j., cash flow statements, ea (2009, vol. 42, no. 3-4, 38-49) 43 cash flows from business, investment and financial activities according to the ias-7 ias-7 does not specifically differentiate cash receipts and cash payments by individual activities, but gives a review of cash flows by business, investment and financial activities. cash flows from business activities (ias-7, item 14) are: a) «cash receipts from the sale of commodities and service provision; b) cash receipts from royalties, compensations, provisions and other revenues; c) cash payments to the suppliers for commodities delivered and services provided; d) cash payments to the employees and for the employee accounts; e) cash receipts and cash payments form insurance companies, by way of premium and claim settlements, annuity and other benefits from insurance policy; f) cash payments or tax refunds on profits except when these cannot be specifically related to financial and investment activities; g) cash receipts and payments based on contracts concluded for the purposes of closing business deals or for the trading purposes». cash flows from investment activities contain the following (ias-7, item 16): a) «cash payments for the acquisition of real property, plants and equipment, intangible assets and other fixed assets. the aforementioned payments include payments related to the capitalisation of development expenses and real property, plants and equipment building at one’s own expenses; b) cash receipts from the sale of real property, plants, equipment, intangible assets and other fixed assets; c) cash payments for the acquisition of stock-holder’s capital instruments and debtor’s instruments of other legal persons and shares in joint ventures (except for payments for those basic instruments that are considered cash equivalents or for the instruments held for business and trading purposes); d) cash receipts from the sale of stock-holder’s capital instruments and debtor’s instruments of other legal persons and shares in joint ventures (except for the payments for instruments that are considered cash equivalents or for the instruments kept for business and trading purposes); e) cash advance payments and loans given to other persons (except for advance payments and loans given by financial institutions); f) cash receipts from the repayments of advance payments and loans given to other persons (except for advance payments and loans from the financial institutions); g) cash payments based on contracts for futures contracts, forward (deferred) contracts, option contracts and swaps (compensation contracts, except when these contracts are held with an intention to be trading with them or if the payments are presented as financial activities; and h) cash receipts based on the futures contracts, deferred contracts, option contracts and swaps, except when these contracts are held with an intention to be trading with them or if the cash inflows are presented as financial activities». economic analysis (2009, vol. 42, no. 3-4, 38-49) 44 cash flows from financial activities (ias-7, item 17) are: a) «cash receipts from the emission of stocks or from other instruments of stockholderʹs capital; b) proprietorʹs cash payments for acquisition and stock repurchases from legal persons; c) cash receipts from taking credits and loans, from issuing bills of exchange, from bond emissions, from taking mortgage credits and from other short-term or longterm loans; d) cash repayments of loaned amounts; and e) cash payments from leasing beneficiaries in the name of unsettled obligation reductions that are related to the financial leasing». in ias-7, financial statements do not give precise definitions of neither cash receipts nor expenditure for interest nor dividends. thus, in ias-7, item 33 says the following: «paid interest and received interest and dividends can be classified as cash flows from the business activities, since they are included in the definition of profits or losses. alternatively, paid interest and received interest and dividends can be classified as cash flows from the financial activities or cash flows from the investment activities, because they represent expenses from the acquisition of financial assets or yields from investments». however, american generally accepted accounting standards (us gaap) give a precise definition of receipts and payments for interest, as well as dividends, which can be helpful in the classification of these receipts and payments. receipts and payments from interest are classified under business activities. receipts from dividends are classified under business activities, while payments for dividends are classified as financial activities. methods of developing financial statements there are two methods by which financial statements are developed, and these are the direct and the indirect methods (ias-7, item 18). according to the ias-7, item 19, legal persons are stimulated to develop financial statements by the direct method. this method provides beneficiaries with information that could be useful in the evaluation of future cash flows, which is not provided by the indirect method. information on cash receipts and cash payments for developing financial statements by the direct method (ias-7, item 19) can be defined both: a) «from legal person’s accounting records; and by b) matching revenues from the sale and the expenses of products sold (in financial institutions, revenues from interest and similar revenues, and expenditure for interest and similar expenditures) and other items of the profit and loss balance for: i. changes in the supplies status and in claims and obligations from business operations, during the accounting period; ii. other non-cash items; and iii. other items, where monetary effects represent cash flows from investment and financial activities». kapić, j., cash flow statements, ea (2009, vol. 42, no. 3-4, 38-49) 45 by indirect method and according to the ias-7 (item 20), statements on cash flows from business activities are developed by matching net profits or losses for the following effects: b) «change in the supplies status and in claims and liabilities from business operations during the accounting period; c) non-cash expenditures, such as: amortisation; reservation; differed taxes; unrealised positive and negative exchange rate differences; undistributed profits from attached companies and minority interests; and d) any other item whose monetary effects represent cash flows from investment or financial activities». fundamental difference between these two methods is reflected in presenting cash flows from business activities: direct method present principal types of cash receipts and payments from business activities, and after that the sum, that is, the cash flows. business individuals deciding for this method, in the segment of statements related to business activities will present a minimum of the following types of cash receipts and payments: a) money in cash received from the buyers, including other cash receipts, for instance, advance payments, wages, and similar; b) receipts from both interest and dividends; c) other receipts from business activities; d) cash payments to employees, tangible assets and commodities suppliers and service providers, including insurance and advertising companies and similar; e) payments for interest; f) payments for taxes; g) other business activities based payments. indirect method: cash flows from business activities are defined indirectly by matching, that is, adapting legal person’s net profits with the effects from: a) changes, such as increase or decrease in supplies, claims and liabilities; b) amortisation of fixed assets, and revenues and expenditures from the sale of long-term assets (which are related to investment activities), as well as revenues and expenditures from allowance (of debts related to financial activities). in the indirect method, process of cleansing or recycling net profits on cash flows from business activities is frequently done by the following formula, according to the us gaap (fasb), which is not in opposition with ias-7: net profits (losses). + amortisation of tangible fixed assets. + amortisation of intangible fixed assets. + amortisation of discount on emitted bonds. amortisation of premium on emitted bonds. + expenditure from the sale of tangible and intangible fixed assets. incomes from the sale of tangible and intangible fixed assets. + decrease in buyer’s claims in business activities. economic analysis (2009, vol. 42, no. 3-4, 38-49) 46 increase in claims from buyers in business activities (including claims for interest and dividends). + decrease in supplies. increase in supplies. + increase in liabilities of the suppliers, as well as in other liabilities, such as: differed payments; salaries and wages liabilities; custom fees and taxes liabilities; interest liabilities (except for dividends liabilities that are included in the financial activities). decrease in liabilities to the tangible assets and commodities suppliers and advance payments of expenses (active time differentiations), for instance, advance insurance payments, wages, advertisements and similar. + decrease investments in branch offices (expenditures by sharing method). increase in investments in branch offices (incomes by sharing method). = cash flows from business activities. if using the direct method, cash flows from business activities in cash flow statements are then calculated in separate working notes by matching net profits. contrary to the direct method, the indirect method makes the matching in the cash flow statement framework. example of developing financial statements based on the trial balance on 31/12/2007, after making all entries in the books, stock-holding company «x» presented a trial balance that follows. develop financial statements by direct and indirect method based on trial or gross balance. in the next section we shall present direct and indirect methods of developing flow statements. trial balance for the «x» stock-holding company for the accounting period 01/01/2007 to 31/12/2007 initial status turnover during the year turnover total balance on december 31 account account title debt claims debt claims debt claims debt claims 022 equipment 17.000 2.000 19.000 19.000 029 correction of values 11.500 500 12.000 12.000 050 shares in attached legal persons 14.000 1.000 14.000 1.000 13.000 120 finished products in storage 19.000 44.000 47.000 63.000 47.000 16.000 211 buyers 13.000 69.000 64.500 82.000 64.500 17.500 200 giro account 11.500 11.500 23.000 23.000 400 subscribed paid capital (nominal) 17.000 2.000 19.000 19.000 440 accumulated profit 19.000 19.000 19.000 kapić, j., cash flow statements, ea (2009, vol. 42, no. 3-4, 38-49) 47 460 profit in the current year 7.350 7.350 7.350 508 liabilities for long-term credits 15.000 1.000 1.000 15.000 14.000 543 suppliers 12.000 53.000 55.000 53.000 67.000 14.000 546 liabilities for income taxes 3.150 3.150 3.150 600 incomes from the sale of products 69.000 69.000 69.000 69.000 650 expenses of the sold products 47.000 47.000 47.000 47.000 654 management, sale and administration expenses 11.500 11.500 11.500 11.500 700 difference between revenues and expenditure 10.500 10.500 10.500 10.500 total: 74.500 74.500 318.500 318.500 393.000 393.000 88.500 85.500 «x» stock-holding company – financial statements on cash flow from 01/01/2007 to 31/12/2007 (by direct method) a business activities 1. cash receipts from the payment claims 64.500 2. cash payments for the paid liabilities to the suppliers (53.000) cash flows from the business activities 11.500 b investment activities 1. cash receipts from the sale of long-term investments 1.000 2. cash payments for equipment purchases (2.000) cash flows from investment activities (1.000) c. financial activities 1. cash receipts from stock emissions 2.000 2. cash payments for the partial equity repayment (1.000) cash flows from financial activities 1.000 net cash flows (a + b + c) 11.500 cash at the beginning of the accounting period 11.500 cash at the end of the accounting period 23.000 increase (decrease) in cash 11.500 23.000 – 15.000 economic analysis (2009, vol. 42, no. 3-4, 38-49) 48 financial statements on cash flows «x» stock-holding company from 01/01/2007 to 31/12/2007 (by indirect method) a business activities 1. net profit 7.350 2. amortisation 500 3. decrease in claims from buyers (4.500) 4. payment of liabilities to the suppliers 2.000 5. increase in liabilities for profit taxes 3.150 6. decrease in inventories 3.000 cash flows from business activities 11.500 investment and financial activities show no difference when compared to the direct method. conclusion financial statements developed according to the iasf shows the cash inflows sources that the company received during the accounting period, and the purposes for which this money was used. financial statements are the integral part of the business management analyses based on that they provide relevant information on cash assets management outcomes and information on the companyʹs liquidity and ability to pay. specifically, this analysis provides relevant information for the evaluation of the companyʹs profitability, assets reconstruction degrees and competitiveness degree in the financial abilities position. additionally, many evaluation models use the money in cash flows from the regular business management as they provide the management with motives to record cash inflows as cash inflows from regular business management and outflows developed either by investments or by financing. references bailey t. georgette: delotte & touche, international accounting standards, guide to preparing accounts, accountancy book, london, 1998. belak dr vinko: professional accounting by iasf and croatian tax regulations, zgombić & partners– zagreb, 2006. cairns, d.: international accounting standards guide (vodič za primjenu međunarodnih računovodstvenih standarda), faber & zgombić plus, zagreb, 1996.(translated from english language). davidson s., stickney p., wiel r.: financial accounting, the dryden press new york.1988. hartman p. bart; harper m. robert; knoblett a. james; reckersj. m. philip: intermediate accounting. west publishing company, minneapolis, st. paul, new york, los angeles, san francisco, 1995. hennie van greuning: international accounting standards in financial statements – practical guide – new revised edition, mate d.o.o. zagreb, 2006. (translated from english language). horngern t. charles; foster george; datar m. srikant: cost accounting with managerial emphasis, tenth edition, prentice hall, upper sadle river, new jersey, 07458, 2001. kapić, j., cash flow statements, ea (2009, vol. 42, no. 3-4, 38-49) 49 fischer. m. paul; taylor. j. william: advanced accounting, sixth edition, south-western college publishing, cincinnati, ohio, 1995. kapić dr reuf: external revision. first edition, tuzla university, tuzla faculty of economy, 2000 (eksterna revizija, prvo izdanje, univerzitet u tuzli, ekonomski fakultet tuzla, 2000.). meigs f. robert; meigs b. walter: accounting:the basis for business decision, ninth edition, mate d.o.o. zagreb, 1999 . (translated from english language). škarić – jovanović dr kata: financial accounting. second edition, publishing centre by faculty of economy in belgrade, belgrade 2008. van horne j. c., wac howicz j. m.: fundamentals financial management, ninth edition, mate d.o.o., zagreb, 2002.(translated from english language) international financial reporting standards,(2004), and fbih accountants, auditors and financial workers association, 2006, mostar . (translated from english language). received: 15 march, 2009 article history: accepted: 5 september, 2009 doi: 10.28934/ea.23.56.1.pp32-42 first online: april 10, 2023 preliminary report corporate news disclosure and competitive advantage: what factors influence s&p 500 companies’ competitive advantage during 2022 economic crisis? miloš petković12f* 1 singidunum university, faculty of business, belgrade, serbia abstract this paper aims to explore corporate news related to the topic of the competitive advantage of s&p 500 companies in the period of the economic crisis in 2022. the observed companies are the biggest us companies listed on the new york stock exchange (nyse). the computerized qualitative analyses were done on 200 corporate news from january 2022 until november 2022, with 13,361 pages and 5,294,836 words. the research results prove that the us biggest companies disclosure intensively in public about their competitive advantage with 90.29% including text samples from initial corpus text. the companies disclosure about 4 main topics (factors) during this year’s crisis: (1) profitability; (2) financial market performance; (3) products and services; (4) top management leadership. the research article contributes to the current literature on competitive advantage narratives, how the biggest companies tend to achieve competitive advantage during the economic crisis and address messages to their stakeholders. these messages could be of the highest importance mostly because of existing uncertainties and high levels of risks. keywords: corporate news disclosure, competitive advantage, s&p 500 companies, economic crisis jel classification: m14, l25, h12 introduction the main company’s goal is to gain a long-term competitive advantage. in such a dynamic, global, and competitive market as it is at the moment, gaining a competitive advantage is not an easy task. in the last three decades, the market has changed dramatically. to better adapt to the continuously evolving global market, companies used their flexibility and efficiency in combination with advanced technology. this includes all different types of the latest technology that will result in better performance (li et al., 2020), and further sustainable competitive advantage (sakas et al., 2014). the focus completely changed, from supply-based, where the focus was on producers, to demand-based and complete concentration on customers. even though we are witnessing radical changes, quantitative and financial factors of success remained the same (petković et al., 2020). because of that, companies are looking for more advanced tools that will not only focus on financial factors, but on non-financial perspectives as well (jackson et al., 2020; tsai et al., 2016). * e-mail: mpetkovic@singidunum.ac.rs miloš petković 33 the studies published by bodnaruk et al. (2015) and campbell et al. (2014) proved the influence of qualitative data in the full-text corporate fillings (10-k form) and corporate news on companies’ final performance. the authors talked about the usefulness of such qualitative data in reducing risks coming from the external environment. public news disclosure influence significantly on investors’ attention and perception. unlike newspaper media, corporate news is written by the company’s management to communicate the company’s performance as well as potential plans. odders-white & ready (2008) talked about the influence of qualitative information on a company’s performance, precisely on asset value and stock prices. such corporate news and information can improve an existing company’s performance, lead to competitive advantage and reduce risk, especially in crisis moments. the main research objective is to explore corporate news disclosure in the s&p 500 biggest companies related to the topic of competitive advantage. corporate news disclosure will lead us to the main factors (independent variables) that influence competitive advantage during the 2022 economic crisis. international monetary fund (2022), in its latest annual report, talks about rising economic risks coming from the previous pandemic crisis, current economic challenges and high levels of uncertainties linked with higher inflation and interest rates, a drop in employment and investments, and higher levels of risk across different industries. the research results can, even more, motivate top managers and decision-makers to focus on the selected factors and to invest in them, which will result in constant and long-term competitive advantage. until now, the main focus was on immediate and short-term results such as profits, sales, and share prices, and not so much on long-term constant and stable economic benefits. the study is focused on s&p 500 companies listed on new york stock exchange (nyse) because it is a sample of the most profitable companies (uygur, 2019), but also the most successful (wang et al., 2022) in the world. the research has three main contributions to the literature. first, we contribute to the literature by proposing the factors that impact on company’s competitive advantage. the research paper results proved to us that four main factors create a company’s competitive advantage in crisis moments. second, we document that factors related to competitive advantage are very intensive and cover almost all corporate communication. without high frequency, it is difficult to expect the impact of the selected four factors on final performance. finally, we highlight indicators and precise narratives of each factor, which is explained in cluster text formations. it is of the highest importance to take into consideration precise indicators of each factor in order to gain long-term competitive advantage. companies’ decision-makers should focus on these indicators, invest and monitor their performance over time. the research paper is composed of five main sections. section 2 presents the literature review. section 3 works on the research methodology, whereas section 4 explains the final results. finally, section 5 concludes the paper. literature review corporate news communication and disclosure corporate communication is seen as a powerful tool in investment decision as they provide information about a firm’s plans, strategies, business models and further development. very often, corporate and qualitative news is followed by quantitative information presented in the company’s accounts (albertini et al., 2021). corporate communication is especially important in improving and growing a company’s reputation, brand and corporate image. it can be seen as a tool for market expansion only if a company shares positive and mixed information (heinberg et al., 2018). public communication is very important because it injects the necessary information into the market and facilitates the investors’ decision maker processes. it can also significantly influence the predictability of certain financial performances (ozik & sadka, 2013). campbell et al. (2014) highlighted the benefits of the possibility for companies to publish and disclose the information freely provided by top management. the free-text risk factor significantly reduces 34 economic analysis (2023, vol. 56, no. 1, 32-42) potential risks for all current and future investors. kravet & muslu (2013) confirmed the previous statement and expanded with the justification that changings in companies’ text disclosure influence future investments in that company. attention paid to the 10-k fillings has to be the highest because it shapes the company’s future growth. news in corporate publications is a very important tool for communication with its key stakeholders. this corporate communication can clarify different confusion in the market, reduce risk, limit uncertainty for the market participants, and improve performance. companies communicate variables that they want to improve (aman & moriyasu, 2022). one of the most important stakeholders of every organization is the customer. transparency of corporate disclosure sends an important signal to customers (higgins et al., 2020). it also brings the sincerity of a company’s motives. it is very important what the factors present in their corporate disclosure are (liu et al., 2022; peschel & aschemann-witzel, 2020). the link between corporate disclosure and competitive advantage authors kim et al. (2022) worked on the relationship between corporate managerial disclosure and investors’ attention on twitter. 715 unique companies with 86,891 tweets were included in the study. the findings showed that companies with highly positive earnings use this platform to publish even more posts related to earnings information, which resulted in even higher earnings improvement. on the other side, companies with bad earnings publish posts mostly related to non-earnings-related information on twitter. it is also very important that companies strategically decide the format of tweets (whether qualitative or quantitative information) and the tone of earnings tweets (whether positive or negative). continuous and sustainable strategic publications led these companies to long-term advantages compared to their competition. authors aman & moriyasu (2022) proved that corporate news communication impact significantly company’s competitive advantage. moreover, a company’s returns and liquidity increase more when news is disseminated by corporate disclosure rather than mass media. a study published by liu et al. (2022) proved that transparent corporate disclosure brings higher customer confidence and improves competitive advantage. studies published by bodnaruk et al. (2015), campbell et al. (2014), loughran & mcdonald (2011), tetlock (2007), and tetlock et al. (2008) justified the relationship between the value and impact of qualitative information on stock market performance. studies proved that full-text corporate filings shed light on the usefulness of this information. kravet & muslu (2013) confirmed that changings in corporate news disclosure influence stock market prices, trading volume, and stock return volatility. corporate news disclosure increases or decreases risks that are further associated with financial market performance and, finally, with the company’s competitive advantage. einwiller & carroll (2020) confirmed that negative corporate communication significantly influences final success. being competitive in crisis moments authors petković et al. (2020) discussed the importance of gaining a company’s competitive advantage. gaining a competitive advantage is not an easy, short-term task. it comes from a longterm period of investments, both financial and non-financial. each company is part of a vast global market. unfortunately, companies’ performance and competitive advantage do not depend on themselves only. companies’ performance and competitive advantage depend on major industry, macro and global events (baker et al., 2020). the recent crisis showed us that each company has to adapt to new circumstances in order to stay competitive in the market. these new crisis circumstances brought a high level of risk and uncertainties, oscillations of values in resources, higher interest rates, and inflations (ding et al., 2021). burdekin & tao (2021) stated that crisis moments caused significant fluctuations in global markets, starting with energy, cryptocurrencies, and capital resources. miloš petković 35 according to uddin et al. (2022) company’s competitive advantage allows corporate resilience and the possibility to better and faster overcome difficulties during crisis moments. this position is possible to achieve only with managerial abilities, investor sentiment, and customer loyalty. customer loyalty creates additional value and provides a sustainable competitive advantage as well as financial benefits during crisis moments. customer loyalty reduces systematic corporate risk (dou et al., 2021). in his study, petković (2022) focused on public disclosure of the biggest us banks during the period of crisis. it was qualitatively proven that financial institutions disclose intensive topics that they want to improve, such as profitability, economic growth, utilization of resources, and environmental activities. literature suggests that companies have to focus on organizational systems, processes, management practices, leadership styles, and corporate communication to provide sustainable, productive, and effective results (hasan & cheung, 2018). given that those segments give results, their role, even more, becomes important during shocks, crises, or restructurations (boubaker et al.,2022; nemlioglu & mallick, 2020). data and methodology data sample explanation the research paper focuses on corporate news related to corporate performance in the period of the economic crisis in 2022. the period of observation was from the 1st of january 2022 until the 22nd of november 2022 (when data was exported). corporate news is publicly available news. the sample includes the 500 biggest us companies that belong to the s&p 500 indexed companies. the companies are listed on the new york stock exchange (nyse). qualitative analysis by statistical software to proceed with lexical qualitative analysis of the selected sample of corporate news, using ‘bibliometrix package’ from the r software made it possible to characterize the sample. for the study, a protocol for performing textual analysis was created by iramuteq software developed on python language (interface de r pour les analyses multidimensionnelles et de questionnaires) (ratinaud, p., 2014). the software gives a rigorous textual data analysis in the field of management sciences (goulart et al., 2020). this method is used to link the word to its natural context because meaning depends on the position of the word in some semantic space. two rules have to be considered: first, words are considered important according to their frequency in the corpus text; second, words are linked to the lemma they belong. both singular and plural words belong to the same lemma (albertini et al., 2021). within the corpus text, each article is known as the initial context unit (icu). each text segment that forms each class is defined as elementary context unit (ecu). qualitative data analysis allows us to identify the association between text segments and their retrieval (souza et al., 2018). for the purpose of our study, reinert’s method and word cloud analyses were used for clustering and analyzing the corpus text. reinert’s method reveals the main topics of companies’ disclosure (aversa et al., 2022). the word cloud analysis identifies the lexicographical formations of words with the highest representativeness within the corpus text (lee, 2020). the research study sample was composed of 200 articles of full text, 5,294,836 words, and 26,373 forms. a computerized lexical content analysis method allowed us to identify the strategic intentions of the topic expressed in the companies’ official corporate news. preparing the text corpus the research paper corpus text was composed of 200 articles in 2022. the corporate news was obtained from the clarivate database proquest. the corpus text was created by copying the body of the text of each article into a text document. the corpus text was composed of 13,361 pages of 36 economic analysis (2023, vol. 56, no. 1, 32-42) pure text. after the whole text was copied into the text document, it was applied to the iramuteq software. the iramuteq software possesses the english dictionary related to managerial topics. the software’s dictionary will allow the whole corpus text to lemmatize into different categories or clusters. lemmatization of texts conserves singular forms of nouns and infinitive forms of verbs in order to be grouped into semantic categories or clusters. results and discussion reinert’s method results this first level of the analysis showed us that the corpus was made of 5,294,836 words, with 26,373 different forms. this phase covered 90.29% words of the whole starting corpus text, 151,074 text segments, 30,348 forms, 26,373 lemmas, 19,957 active forms, and 6,416 supplementary forms. such a high-level percentage means that the companies communicated about the same topics during the observed period. the elements previously presented are grouped into 4 main clusters or categories (figure 1). figure 1. a factorial representation of 4 semantic clouds source: author’s calculation miloš petković 37 figure 2. dendrogram of 4 main clusters of corpus text source: author’s calculation table 1. categories revealed in phase 1 category name % of forms analyzed category 1 profitability 34.79% category 2 market performance 34.70% category 3 products and services 19.16% category 4 leadership 11.35% source: author’s calculation figures 1 and 2 allowed us to understand more dynamically the most important relationships between the categories (variables) in a factor plan. to be considered in the clustering analysis, each word must be repeated a minimum of ten times in the corpus text. as we can see, all four categories are independent and homogeneous from each other, and we do not have overlapping. this means that the selected companies were communicating very precisely and very intensively about these four topics. category 1 consists of vocabulary related to profitability (cash, income, payment, revenue, net income, profit, finance, money, etc.). category 2 talks about the market performance of the company (share, price, market, eps, dividend, index, yield, stock, value, etc.). category 3 covers words related to the company’s products and services (product, service, goods, price, production, demand, supply, etc.). finally, category 4 communicates vocabulary related to top management and leadership (leader, president, management, director, executive, chairman, etc.). from the relationships between categories in figures 1 and 2, we can state that category 2 – market performance correlates towards category 4 – leadership, category 4 – leadership towards category 1 – profitability, and category 3 – products and services. we can conclude that performance in the financial market depends on the performance of the leader of the company, whereas the company’s top management performance depends on profitability and products and services. this level of analysis proved to us that categories 1 and 3 shared notions and appeared to be very close to each other on the figures. both categories were communicated dominantly with 34.79% and 34.70%, respectively, during the 2022 economic crisis. most companies' public disclosure is spent on communicating their profitability and product offerings. on the other side, category 4 and category 2 were separated. the percentage of communication in these categories was 19.16% and 11.35%. four main variables or categories are presented in the factor plan. the factorial analysis produces distances of words and proximity from the initial corpus text. this analysis includes the calculation of chi-square correlation values for each variable, frequencies, and contingency table 38 economic analysis (2023, vol. 56, no. 1, 32-42) that crosses the active forms and the variables. x-axis (or factor 1) refers to the distribution and distance from variables. y-axis (or factor 2) indicates a tangibility of the relationship between variables. the position of the variable is very important and shows us how these four variables are distributed. the factor plan has abscissa with the value of factor 1 (positive and negative abscissa) and ordinates with the value factor 2 (positive and negative ordinate). class 2 was found in an area of negative abscissa and ordinate. classes 3 and 4 were found in an area of positive abscissa and ordinate. class 1 was found in an area of positive abscissa and negative ordinate. from the above mentioned, we can conclude that classes 1 and 3 are close distance with a strong tangible relationship. similar research focused on the importance of voluntary disclosure in a company’s letters to shareholders on final performance. on a european sample of companies, albertini (2021) proved that lexical analysis of top management disclosures on continuous innovations, managerial competencies, and stakeholder values significantly improves competitive advantage. nevertheless, authors albuquerque et al. (2020), berman et al. (2019) and huang et al. (2021) expand and state that stakeholders’ loyalty reduces risks and keeps firms’ value stable during uncertain times. (petković, 2022) proved intensive corporate news disclosure on factors that positively influence the biggest us banks' performance. word cloud analysis results the word cloud analysis showed us the most frequent words related to the main 4 factors in the corpus text. in table 2 and figure 3 below, the results are presented: table 2. first 10 most frequent active forms form frequency pos year 30,894 nom share 27,033 nom net 23,500 nom million 22,400 nom company 20,648 nom price 20,040 verb asset 19,385 nom value 19,282 verb total 16,232 nom revenue 16,184 nom source: author’s calculation the word cloud analysis allowed us to visualize better the lexicography of the most representative and most frequent words investigated in the corpus text. given that the words year, share, net, million, company, price, asset, value, total, revenue, and others were investigated for the specific sample of companies, we found it relevant. the result shows us that the research sample is emblematic of the investigation of the corpus text. miloš petković 39 figure 3: word cloud analysis source: author’s calculation conclusion the research tends to contribute to the literature about the disclosure of competitive advantage in a company’s corporate news. the paper presents what the biggest us companies publish and how much attention they pay to factors influencing competitive advantage. companies are encouraged to share their strategic intentions in public disclosure with their stakeholders in order to reduce uncertainties. the research qualitatively explored corporate news disclosure on the topic of competitive advantage during the economic crisis. the research paper was focused on the 500 biggest us companies indexed on the s&p 500 list from january to november 2022. the corpus text included 200 different articles and 5,294,836 words on 13,361 pages. the research study covered 90.29% of the whole corpus text, which confirmed that produced clusters or factors represented most of the corporate communication. the study identified 4 main clusters related to profitability, market data, products and services, and leadership. from the 4 given factors, we can conclude that the achievement of competitive advantage of the biggest us companies depends on 3 internal factors: the company’s profitability, products and services, and top management leadership, and 1 external factor: financial market performance. the paper limitations come from the sample of only publicly listed companies that met our requirements. future research papers can also cover smaller and medium size companies in a separate sample. smaller and medium-sized companies have very limited or very specific corporate communication, which is completely different from large-size corporations’ communication. moreover, the research could be extended to working on listed companies from other countries. finally, future research can combine both quantitative and qualitative methods within the same studies. 40 economic analysis (2023, vol. 56, no. 1, 32-42) acknowledgement the research paper is supported by the research project (decision no. wgb-2/13/z/2020) by the wroclaw university of economics, wroclaw, poland. references albertini, e. 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(2022). a grey-based correlation with multi-scale analysis: s&p 500 vix and individual vixs of large us company stocks. finance research letters, 48, 102872. https://doi.org/10.1016/j.frl.2022.102872 article history: received: 29.11.2022. revised: 19.3.2023. accepted: 31.3.2023. microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp118-132 original scientific paper modeling wealth effect in consumption function based on system of national accounts (sna) data ivana jovanović1* 1 statistical office of the republic of serbia, belgrade, serbia abstract the study explores the influence of housing wealth, as well as other wealth variables, on consumption in the frame of life cycle-permanent income theory. the sample consists of three former socialist countries and the model used was based on models initially developed for advanced economies, most notably norway and the netherlands. the paper, based, where necessary, on a compiled data set, uses a more complete list of variables than similar studies and relies on comparative analysis to come to plausible results and interpret them. the results differ from those obtained in other studies for the same or similar type of countries or even the same economies, and that is that movements in value of housing stock do not influence consumption of households. in addition, the paper explains why housing wealth is not part of consumption function in former socialist countries with certain macroeconomic structure, and that is low part of unpaid mortgage debt in the financing structure of housing wealth. the reason is that mortgage financing causes the price movements of housing wealth to influence consumption, especially in developed countries where workforce is highly mobile and financial innovations are present and mortgage financing dominates housing stock. key words: system of national accounts, wealth effect, consumption function, economic transition, johansen’s procedure jel classification: c01, e01, e21, e37, e60, p1, p2, r20 introduction wealth effect in consumption function is a phenomenon known since as early as the days of keynes, and it means that consumption is influenced not only by current or permanent income but also by wealth. by wealth we mean housing wealth (hw), or value of houses influenced by physical stock and prices, securities or market shares held by households (sec) and other financial assets like savings decreased by financial liabilities most notably mortgage liabilities (fafl). system of national accounts (sna) worldwide, and it counterpart in europe, european system of accounts (esa), as internationally developed accounting framework for macroeconomic statistics is source of data for the wealth effect analysis. while data for other sample countries (slovenia and czech republic) were readily available in the eurostat´s database, serbian data had to be constructed for this study as serbia is still on its way to harmonize statistics with european and world standards. * e-mail: ivanakirovic@gmail.com ivana jovanović 119 is wealth effect present in former socialist and transition countries similar to serbia, as regards their economic history? which components of wealth are statistically significant in their consumption function? are there similarities between sample countries? how is their economic structure different from, for example the netherlands whose macroeconomic model contains all components of wealth (see second part)? the aim of the research was to explore the consumption function in similar countries like serbia, i.e. former socialist (post) transition countries on the basis of system of sna data by sectors and to compare the results within the sample but also with the models of developed countries. comparative analysis was aimed to give answers about the mechanism of influence of wealth effect components on consumption. not only we come to decisive and different result than similar studies, we also offer the explanation of mechanism of influence of the housing wealth on consumption which is original contribution of the study. the paper consists of five parts: literature review, data and the methodology, research results and interpretation, mechanism of impact of housing wealth and other wealth variables on consumption and conclusion and implications. literature review this paper explores consumption modeling based on permanent income-life cycle theory models, in developed countries. according to the life cycle–permanent income hypothesis, consumers estimate their long–term ability to consume (hall, 1978 in jovanovic, 2016) based on wealth (modigliani) or permanent income (friedman). hall (1978) points out that permanent income is unobservable category. the wealth effect – the effect of financial and non-financial asset prices and value on consumption – has been analyzed by several economists, including keynes, as mentioned earlier (“windfall changes in capital values as a major factor capable of causing changes in propensity to consume”, speight 1990, ch.6 in brodin and nymoen 1992, p 433). park (1996, p. 48) points to deaton (1972), who emphasized, in the context of a modified lifecycle hypothesis, that rapid changes in financial assets play a substantial role in determining private consumption. the relevance of physical assets (see park 1996, p. 48), including land and housing, to consumption has been tested only sporadically in the literature. perhaps the irrelevance of physical wealth like land in explaining private consumption behavior in the western hemisphere is due largely to the fact that in recent years the region has experienced little change in physical asset prices compared to far-east asian countries (i.e., japan, korea, and taiwan). deaton (blinder & deaton,1985), points out that consumption depends only on part of gross disposable income which is made up of salaries and not on capital income like dividends and rents, because their discounted value is a part of wealth. we want to stress that other approaches, as regards the consumption function model, in developed countries, like the netherlands (centraal planbureau, 2010, see second part) and norway (brodin, nymoen, 1992; also see rimini model in bårdsen, g. et al, 20101), take wealth as a sum of all the wealth components, housing wealth as well financial saving and liabilities of the households. de bonis and silvestrini (2011) separate housing wealth but take stock market shares together with other forms of financial assets and liabilities and find for eleven oecd countries that all variables are significant. wealth effect in developed countries is, as we have seen from the examples and before mentioned references, taken in models in those countries for the demand projections for conducting monetary policy for example the ecb (jovanovic, 2012), 1 the rimini model is based on quarterly data. the quarterly national accounts are the most important data source together with other statistics from the national accounting system and from norges bank’s database for financial sector balance sheets (findatr). see, kjetil & fredrik, 2001. also, see appendix 2. 120 economic analysis (2020, vol. 53, no. 1, 118-132) norwegian central bank or for other governmenet policies (for example, the netherlands). due to a different structure of the post-communist and post socialist countries, we take housing wealth and financial assets and liabilities separately and stock market shares owned separately as well, as we suppose that components of wealth of households have a different impact on consumption than in developed countries, which make separation of wealth components necessary. other studies of under developed countries include countries from the sample, but also developing asian countries (so called emerging economies). one study apply panel framework of analysis, without financial assets and liabilities component, with only stock market shares as regards financial assets and proves that housing wealth is significant (ciarlone, 2012). some individual studies concerning czech republic (šonje, 2012) prove significance of housing wealth in a model with only two variables, real wage next to the housing wealth, in the short run. in šonje et al. (2014) the authors do not come to decisive conslusion due to short time series for a group of former transition countries in a panel framework of analysis. weyerstrass et al. 2001, in model for slovenia, do not provide conclusion on the significance of the influence of housing wealth on consumption, as the model consists only of gdi and first lag of consumption and do not pass the specification tests (autocorrelation and heteroscedasticity). our study takes in the account the full list of variables, based on developed countries model, but all taken separately. the importance of our study is that wealth components are taken separately and that their list is complete, and we come to the decisive conclusion as regards the influence of housing wealth on consumption, which turned out to be not significant by all three sample countries and the financial assets decreased by liabilities and market shares proved significant. analysis was done on the basis of johansen’s procedure, and error correction model which passed all specification tests. data and the methodology three former transition countries were analyzed: serbia, czech republic and slovenia. until the third quarter of 2008, there was a steady increase in the value of consumption and other macroeconomic variables like housing wealth, gross-disposable income and financial market shares in the world economy, and also in the sample countries, when the effects of financial and economic crises due the read from the mortgage market in the united states started to be visible, and a drop was witnessed in the sample and in the world economy. even before the crisis, slovenia and czech republic reached the level of highly developed countries, whereas serbia is still middle income country. the sample for this research was formed with czech republic and slovenia, because it was presumed that they should be compared due to the relatively similar economic history. as we will see, one of the similarities is the high proportion of fully owned houses by households, which turn out to be a crucial element to explain the result of this study and difference with other highly developed countries with different background, like the netherlands. the model used is compiled based on models in developed countries and differ from the existing models in relevant literature for the sample countries because the list of variables is more complete. it differs from the model of the netherlands (see next section), in that, among others, that all wealth components are taken separately. in the netherlands, the fafl component is highly negative (see table 4), whereas, hw had a steady growth (graph1) so that adding of all wealth components including securities is understandable in case of the netherlands. ivana jovanović 121 econometric model in use in centraal plaanbureau in the netherlands centraal planbureau (cpb) (de jong 2011, centraal planbureau 2010)2 has developed a long term and a short term consumption model ecm, „equilibrium error correction model“. wealth variable is a sum of components in long term model. the idea is that as the wealth of the households as a total rises in the long run, the saving, securities, net housing wealth (housing wealth decreased by mortgage liabilities), consumption rises in the long run. in short run, on the other hand, taking loans, using savings or selling of securities (which leads to decerease of wealth) causes the rise of consumption. in short run, households can decide to refinance their mortgage under more favorable conditions because the rising of house prices is usually followed by the fall of the mortgage interest rate, or, in developed countries they can make use of financial innovation allowed in most developed countries, which is, to get consumption loan based on the overvalue (higher value of dwelling compared to mortgage debt) so that the consumption rises (centraal planbureau, 2010).3. this channel works in the long run as well (see ludwig & slᴓk, 2002)4. in short run, rise of the prices of market shares can result in fall of wealth, due to a selling of the securities, which boosts consumption in the short run. in the ecm model of the cpb, which explains short term variations of consumption, for hw and sec the price variations are taken in the account, next to the term which describes the adjustment to the cointegration relation, because of the explained influence of the prices of dwellings and securities in the short run on consumption and saving. interesting is that, in the long run, increasing wealth leads to increase of consumption, whereas, in the short run, it is vice versa. the short term deviation from the cointegration relation is adjusted to it via the ecm coefficient. in the dutch short run model, the effect of the prices of the dwellings is visible clearly, whereas in the long run model dwellings are part of a total wealth. dutch mortgage debt is substantial, as we have seen before, so that decrease of total wealth with that figure substantially adjusts wealth total, and the correction of saving only, with mortgage liabilities, would yield a negative net financial assets (see table 4, ratio fafl/gdp is negative for the netherlands which also means that fafl variable is negative). in dutch model of cpb (de jong, 2011), two types of households are distinguished: lch households (those who behave in conformity with the „life cycle hypothesis”) and rot (from engl. „rule of thumb“) households. lch households own financial and non-financial assets (dwellings) and are capable to adjust their consumption during the life cycle in accordance to their total life capital or ltw („life time wealth”). this aggregate consists of assets (financial, like stock market shares, savings, decreased by loans, mostly mortgage loans and non-financial i.e. dwellings) and salaries and social benefits. these households invest in houses, save in the form of stocks and other securities and have access to financial market. they take loans and invest to absorb the shocks and smooth the consumption during time. these households adjust their portfolio dependent on the relative performances of stocks and deposits. even probability of death is a presumption which makes aggregate consumption function possible (blanchard 1985, in de jong 2011). rot household, on the other hand, don’t have access to a financial market and spend all their income every month. as a consequence, they don’t accumulate financial assets and shocks in their gdi influences directly their consumption. long term model (cpb 2010)5 is: 2 dutch central bank uses the similar model. see de nederlandsche bank 2011. 3 this possibility is available in the netherlands since 2004. 4 their model comprises of housing and stock market wealth and disposable income as a whole, not only labour income. wealth components are proxied by their prices. 5 first part of model concerns lch and second of rot households. 122 economic analysis (2020, vol. 53, no. 1, 118-132) 𝐶 ß 𝜆 (𝑊𝑔 + (1 𝜙 ) 𝐿𝐷2 + (1-𝜙 𝑂𝐷2 + – + 𝜙 𝐿𝐷2 + 𝜙 𝑂𝐷2 𝑅 = 0.99, time span 1971 – 2008 (annual data) description of variables abbreviation: c – long term level of consumption of households ß– rate of the time preference of money 𝜆 –probability of death 𝑊𝑔– net assets of households (pension capital excluded) 𝜙 – proportion for rot households 𝐿𝐷2 – income of work (without dividends and interest6) 𝑂𝐷2 – social benefits of the households 𝜙 – proportion for rot households 𝑟 – long term interest rate, net (after tax on salaries and social security contributions) 𝑝 – expected rate of net salaries θ – risk premium the fourth element is for discounting of the future flows of work income and social and pension benefits. short term model is (cpb, 2011): ⁼ c1 c2 1-q65 c3 δ𝑟 + c4 + c5𝑤 𝑤 + c6 1-𝑤 𝑤 c7 𝑙𝑛𝑐 – 𝑙𝑛𝑐∗ + c0 𝑅 = 0.88, time span 1973 – 2008 (annual data) description of variables abbreviation: c – short term consumption c* – long term consumption ldc – available work income of households q65 – pressure of ageing of the population (65⁺/20-65years) odc – social benefits of households 𝑤 – housing wealth (mutations concern average price7) 𝑤 – value of securities (shares) of households (mutations concern price movements) 𝑤 binnary variable for shares (take value 1 when rise) 𝑤 – percentage of households that own shares 𝑟 real interest 𝑙𝑛𝑐 – 𝑙𝑛𝑐∗ – ecm term („error correction model”) we can see that in a short consumption function, components of wealth (housing and securities i.e. market shares) are given separately, while, in the long term function they are taken together. reason for this is that in short run price movements of housing stock and stock market 6 dividends are implicitly captured in capital from shares, which is part of total net assets, under presumption that the price of shares is equal to the present value of future dividend flows, idem, pg. 12. interests are present in ltw (life time wealth) ß, 𝑟 , idem, pg. 11. on the contrary to this concept, in model of central bank of the netherlands (de nederlandsche bank, dnb), gdi as a total income is a variable. (dnb, 2011) 7 𝑤 = 𝑝 𝑊 , housing wealth is a product of average change of annual price and average housing stock last year. idem 𝑤 . cpb, 2011, pg.12. ivana jovanović 123 shares influence consumption markedly, presented as variables 𝑤 and 𝑤 . these price movements influence conscious decisions about augmentation and decrease of saving, i.e. consumption, and the measure in which the consumption will deviate from long term cointegration relationship (the level of the ecm parameter). for example, rising of share prices can result in their selling or additional taking of loans so that consumption can rise in comparison to the long term level defined by the cointegrating relation. with time, this decision about decrease of savings (or augmentation of liabilities) brings consumption back to the equilibrium level because lower level of wealth means lower level of consumption in the long run. interest rate in the short run model is interest rate on commercial credits. the model the base for analysing the wealth effect in sample countries` consumption function is the quarterly var model made up of the sna defined variables, c, gdi, fafl, sec, hw and sal where c – household consumption8 gdi – gross disposable income of households (excluding property and gross mixed income n case of serbia) sal – salaries fafl – savings (s) and transaction deposits (d) of the households decreased by financial liabilities or loans (l) by banks, end of period hw – housing wealth, value of household residential property, end of period sec – value of securities (shares) in the hands of households, end of period variable_sa – de-seasonalized variable quarterly data run from q1 2004 up to q2 2014. seasonality was excluded by the use of x12 census model. level data were available for czech republic and slovenia from the eurostat database, and it was somewhat necessary to construct quarterly data as regards hw variable, as quarterly stock data are not, whereas flow data are available on quarterly basis. logarithms of data were used. for serbia, the stock data of all variables were compiled and constructed by the author, based on data of the statistical office of the republic of serbia (sors), the data of the national bank of serbia, financial exchange and the securities commission of the republic of serbia. the data for the gdi were based on household budget survey conducted by sors. in jovanovic (2016), more details are given about the construction of serbian data. the methodology the paper employs cointegration analysis in order to determine the significance of individual wealth components in consumption, and analysis of macroeconomic ratios. in already mentioned paper, jovanovic (2016), we have dealt with the methodology of the johansen’s procedure and all additional testing, on the example of serbian data. the same was applied to two other countries of our sample, czech republic and slovenia. the paper uses the relevant quantitative methods of time series analysis. firstly, the presence of the season component is tested in the time series and the series de-seasonalized where necessary, then the nonstationarity of time series is established, and lastly cointegration and vector autoregression (var) analysis are implemented. next to johansen’s procedure, which resulted in one cointegration vector in cases of serbia and czech republic, augmented dickey fuller unit root and zivot endrews tests of unit root, in cases of structural breaks were applied. specification tests were applied to vecm (vector error correction model). also constrain tests with bartlett 8 institutional household sector as defined in sna 124 economic analysis (2020, vol. 53, no. 1, 118-132) correction helped to establish appropriate model i.e. to determine variables that enter cointegration relation. comparative analysis of macroeconomic ratios which put into relation mortgage loans and housing stock, enabled deeper interpretation of the research results (the netherlands versus sample countries) and to discover the mechanism of effect of housing wealth on consumption. graph 1. the netherlandshousing wealth source: eurostat research results and interpretation vecm passed all specification tests. johansen’s procedure, resulted in one cointegration vector in cases of serbia and czech republic. fafl and sec vaiables are found significant and enter the cointegration relation with consumption in both serbia and czech republic. their sign is positive. in case of fafl variable, the sign can be negative in ecm, and that is the case for serbia (see table 2 in appendix 1). in short run, households can take commercial loans and increase consumption, but after some time, increased loans or decereased fafl will cause consumption to fall (via ecm parameter) to the equilibrium level found by cointegration relation. the more detailed results are presented in anex 1. here, we summarize in short, the research results presented in table 1,2 and 3 and in appendix 1. slovenia: no cointegration found czech republic : c = 0,101fafl + 0,477sec + 4,449 ecm (error correction model) param. = -0,3 (-4,428) serbia: c = 0,098fafl + 0,145sec + 6.340 ecm param. = -0,806 (-8,59) in tables 1, 2 and 3 the results after application of johansen’s procedure and ecm specification tests are summarized and results for slovenia (var of differenced variables): 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 300000 400000 500000 600000 700000 800000 ivana jovanović 125 table 1. results of the johansen´s procedure for serbia results variables serbia level of integration cointegration relation (coeffic.) consumption i(1) 1 gross disposable income salaries i(1) net financial assets i(1) 0,098 securities i(1) 0,145 housing wealth i(1) ecm parameter (t-statitics) ‐0.806 (‐8.59) ecm, jarque bera norm. test 0,92 ecm, breusch godfry autocorrelation test 0,08 ecm r², adjusted 0,64 source: author’s analysis based on application of johansen’s procedure and usual tests table 2. results of the johansen´s procedure for czech republic results variables czech republic level of integration cointegration relation (coeffic.) consumption i(1) 1 gross disposable income i(1) salaries i(1) net financial assets i(1) 0,101 securities i(1) 0,477 housing wealth i(1) ecm parameter (t-statitics) ‐0.28 (‐5.59) ecm, jarque bera norm. test 0,45 ecm, breusch godfry autocorrelation test 0,36 ecm r², adjusted 0,68 source: author’s analysis based on application of johansen’s procedure and usual tests table 3. results of the johansen´s procedure and var of first differences for slovenia results variables slovenia level of integration cointegration relation (coeffic.) consumption i(1) gross disposable income i(1) salaries i(0) net financial assets i(1) securities i(1) housing wealth i(2) ecm parameter (t-statitics) ecm, jarque bera norm. test ecm, breusch godfry autocorrelation test ecm r², adjusted var of first differences: variables commerc. loans interest rate, gdi, sec 126 economic analysis (2020, vol. 53, no. 1, 118-132) var of first differences: normality 0,11 var of first differences: portmanteau autocorrelation test up to lag 12 0.07-0.24 var of first differences, r², adjusted 0,24 source: author’s analysis we see from tables 2 and 3 that ecm models for serbia and czech republic, as well as the var of the first differences for slovenia pass the specification tests. additional variable, interest rate on commercial loans was introduced for slovenia in order that model pass the specification test (autocorrelation and normality of residuals). now, we present the table 4 with comparative macroeconomic ratios, for the sample countries as well as for the netherlands. table 4. macroeconomic ratios comparative analysis fl/gdp fafl/gdp hw/gdp nethw/gdp sec/bdp nethw/ hw fl/hw serbia 14% 6% 5,41 5,27 5% 97% 3% slovenia 23% 14% 1,76 1,53 11% 87% 13% czechia 21% 15% 1,14 0,94 6% 82% 18% netherlands 118% -52% 1,22 0,08 24% 6% 97% source: eurostat and authors calculations we see that relatively high proportion of housing is fully owned by households in former socialist countries (ratio nethw/hw is almost 100 in three sample countries), whereas in the netherlands predominant part of housing if financed by mortgage debt (ratio of financial liabilities of the households, which is predominantly mortgage debt fl/hw amounts to almost 100%). mecahism of impact of housing wealth and other wealth variables on consumption several channels of influence of wealth variables on consumption in developed countries are presented in the relevant literature. campbell & coco (2005) have determined that the saving from precaution changes by households with mortgages when house prices change, and that this channel is insignificant at households with no budget restraint, or which own the house. they found that changes in consumption as a result of change in house prices are the biggest with elderly population and close to zero by young people who rent houses. credit terms become more relaxed when house prices rise. in great part of literature for developed countries the macroeconomic effect of house prices on consumption is linked to financial liberalization which made possible the financing of consumption from the positive difference of the house in comparison to the mortgage value (for example aouki et al., 2014). ludwig & slᴓk (2002) housing wealth is significant variable in the consumption function in the netherlands as well as in other developed countries. if we look at table 4, we see that almost all housing stock in the netherlands is financed through the mortgage financing. the opposite is truth for the sample countries. last column of table 4 shows that the percentage of financing of housing wealth in countries amounts 3 – 18% while in the netherlands it is 97%. it is obvious, then, that here lies the answer how the housing wealth prices fluctuations impact consumption in the long run. the effect of the housing wealth on consumption goes through mortgage financing and workforce relocation. that is why the effect of housing wealth on consumption can be visible only if the proportion of mortgage financing is relatively high in the total of housing wealth, and that is not the case in sample countries, so the housing wealth effect is there not present. ivana jovanović 127 here we go in detail about the mechanism of housing wealth on consumption, next to the effect of financial innovations which we mentioned in the part about centraal planbureau methodology. in the periods when the house prices rise, the possibility to sell the dwelling present no burden to owner household, in a situation of divorce, moving to elderly accommodation (see campbell & cocco, 2005) or relocation for other reasons like work, which is common in the netherlands. in the situation of bursting of big housing bubble like in 2010 in the netherlands, when houses prices dropped by 15% and more, household naturally became more cautious with spending, increased their savings to cover the potential loss of selling the house, and therefore the negative impact on consumption is obvious to explain. the opposite happens when the house prices rise. given that fafl variable is significant in sample countries, and effects positively consumption, mortgage finance that dominates fl obviously influences consumption, because mortgage loans present increase of financial burden on the households. share of securities in comparison to gdp is significant only in the netherlands, so that we conclude that the channel through which securities influence consumption in the sample countries is through the expectations of the public captured on the financial exchange. furthermore, as securities variable is highly correlated with the housing wealth (for serbia, correlation coefficient is 0.57) we can expect that the studies which don’t take into account sec variable could find hw statistically significant (as šonje, 2012). conclusion and implications the main result of the paper is that housing wealth is not significant in the long run in sample countries. effect of the housing wealth on consumption goes through mortgage financing and workforce relocation and financial innovations linked to mortgage financing which are present in developed countries. the insignificance of housing wealth in the sample countries is explained by the fact that relatively high proportion of housing is fully owned by households in former socialist countries, while in the netherlands predominant part of housing if financed by mortgage debt. the effect, of mortgage financing on consumption will be visible on the macro level in countries where mortgages are dominant in the financing of the housing stock, which is not the case in countries from our sample. the effect of stock market shares is most probably captured through the expectations channel. securities enter the cointegrating relation in all sample countries. gdi is not significant except in the var of first differences in slovenia. salaries did not enter the cointegration relation. net financial assets are found significant and enter the cointegration relation in all sample countries. until the mortgage proportion in financing the housing wealth stock is at the relatively low level, quarterly data on housing wealth will not be relevant for modeling consumption in serbia. future research could rely on the sors data, once available, and panel data analysis, but it is not expected that this research avenues will yield relatively different results. some other research study based on sors time series can confirm or disapprove the soundness of compiled data from this study. however, same result for two analyzed countries with similar macroeconomic ratios, serbia and czech republic, could be taken as a proof of soundness of the results and data quality compiled for serbia. this research, starting from models developed for countries like norway and netherlands, added more explanatory variables in the analysis. this way, the paper contributed to the existing literature in the field of studying wealth effect in former transition countries. by adding variables, separately, like net financial assets and stock market shares, anovel result different from those for other panel and individual studies (ciarlone, šonje et al.), emerged – housing wealth does not exert significant influence on private consumption in analyzed former transition economies. 128 economic analysis (2020, vol. 53, no. 1, 118-132) acknowledgements this paper is the result of collaboration with gorana krstic, professor of economic statistics at the university of belgrade who kindly initiated and defined the scope of this research and zorica mladenovic, professor of econometrics at the university of belgrade, who kindly provided expert help in the field of applied econometrics. references55 aoki, k., proudman, j., vlieghe, g. 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(2001). slopol1: “a macroeconomic model for slovenia.” international advances in economic research. february, vol. 7, issue 1, pp 20–37 ivana jovanović 129 appendix appendix 1 more results of johansen´s procedure table 1. results for serbia: testing imposing restrictions ß (1) α (1) variables equations c_sa 1 (na) dc_sa ‐0.806 (‐8.590) gdi_sa 0.000 (na) dgdi_sa -0.467 (-2.682) hw_sa 0.000 (na) dhw_sa 0.000 (0.000) sec ‐0.145 (‐12.518) dsec 0.000 (0.000) fafl ‐0.098 (‐10.734) dfafl 0.000 (0.000) constant -6.340 (-62.911) test of restricted model: χ²(5) = 8.988 [0.110] with bartlett correction: χ²(5) = 5.166 [0.396] source: author´s analysis table 2. ecm model for serbia variable parameter estimate t statistics zᵼ-1 -0.806 -8.59 dc_saᵼ-1 0.31 2.84 dsecᵼ-1 -0.079 -2.133 dsecᵼ-2 -0.152 -3.786 dfaflᵼ-2 -0.043 -2.123 dc_saᵼ-3 0.362 3.035 dfaflᵼ-3 -0.082 -3.961 dfaflᵼ-4 -0.089 -3.673 source: author´s analysis 130 economic analysis (2020, vol. 53, no. 1, 118-132) table 3. matrices for czech republic ß (1) α(1) variables equations c_sa 1 (na) dc_sa ‐0.300 (‐4.428) fafl_sa ‐0.101 (‐1.846) dfafl_sa 0.060 (0.487) sec ‐0.477 (‐18.040) dsec -0.556 (-2.149) constant -4.449 (-8.527) model adequacy: autocoorelation tests: lm(1): χ²(9) = 14.861 [0.095] lm(2): χ²(9) = 4.746 [0.856] normality test: χ²(6) = 5.612 [0.468] source: author´s analysis note: see notes by table 5 table 4. ecm model for czech republic variable parameter estimate t statistics zᵼ-1 -0.28 -4.42 dc_saᵼ-1 -0.33 -1.6 dc_saᵼ-2 -0.5 -2.61 dfafl_saᵼ-1 0.65 5.21 dfafl_saᵼ-2 0.27 1.71 dfafl_saᵼ-3 0.25 1.91 source: author´s analysis ivana jovanović 131 table 5. trace test for var(4) c, fafl, gdi, sec, dhw slovenia i(1)-analysis r p-value p-value* 0 0.000 0.457 1 0.000 0.325 2 0.001 0.278 3 0.009 0.241 4 0.210 0.328 model adequacy: autocoorelation tests: lm(1): χ²(10) = 23.710 [0.536] lm(2): χ²(25) = 23.838 [0.529] normality test: χ²(25) = 11.918 [0.291] source: author´s analysis notes: a) p* is bartlett‐corrected p‐value b) lm(1) is the ljung box test based on the estimated auto‐ and cross‐correlations of the first t/4 lags. see dennis (2006), p.51 c) lm(2) is the test for the nth order autocorrelation, idem d) test for normality is the doornik‐hansen test, idem 132 economic analysis (2020, vol. 53, no. 1, 118-132) appendix 2 interest rate transmission mechanism from rimini model (norway central bank) figure 1. interets rate channels in rimini given constant exchange rate source: bårdsen, g. et al., 2010, pg. 13 article history: received: november 27, 2019 accepted: may 23, 2020 money market rates (3-month euro-nok) bank deposit and lending rates nominal exchange rate households: disposable income wealth loans housing prices expectations enterprises: income wealth loans stock prices expectations private consumption housing investment business sector fixed investments productivity production employment output gap inflation wage-setting unemployment doi: 10.28934/ea.21.54.2.pp20-29 original scientific paper the impact of import, export and fdi on the economic growth of the western balkans countries darko marjanović10f* | isidora beraha1 | vladimir simović1 1 institute of economic sciences, belgrade, serbia abstract macroeconomic stability is one of the important factors influencing the growth and development of national economies in today’s modern global economy. economic policy should create conditions for macroeconomic stability and economic growth based on increased investment, exports, savings, productivity, and competitiveness, while reducing macroeconomic imbalances, especially the fiscal deficit, inflation, and the current account deficit. in order to achieve macroeconomic stability, as well as sustainable economic growth, it is important to pursue a rational economic policy and carry out accelerated structural reforms. the main objective of the paper is to analyze the impact of key indicators, i.e., export and import of goods and services and fdi on economic growth of the western balkans countries. such an analysis is important to show the state of the economy and predict its stability. the research focuses on the countries of the western balkans, while the analysis uses secondary data from the unctad database for the period 2011-2020. the research results indicate that serbia is progressing much faster than other countries of the western balkans. in the coming period, a growth trend can be expected in all western balkan countries, which will result in better economic development and increasing openness to new investments. key words: macroeconomic indicators, economic growth, export and import, fdi, wb countries jel classification: o11, f21 introduction a stable macroeconomic environment is very important for business operations, and thus for the development of the competitiveness of an economy (marjanović & domazet, 2021). to achieve macroeconomic stability and sustainable economic growth, it is necessary to pursue a rational economic policy and carry out accelerated structural reforms. macroeconomic policy is a set of government activities aimed at achieving the most important economic goals. nowadays, it is generally accepted that all macroeconomic policy activities should be aimed at maintaining the general balance and stimulating economic growth. effective macroeconomic policy implies the sustainability of determining factors, i.e., harmonization of objectives and instruments, setting realistic objectives, harmonization of macroeconomic policy measures, selection of the most efficient measures, and timely action. national economic policy makers strive to achieve a general macroeconomic balance, which is accomplished by quantitative and qualitative consideration of trends in macroeconomic indicators and responding to their movements. the selection of macroeconomic instruments * corresponding author, e-mail: darko.marjanovic@ien.bg.ac.rs darko marjanović, isidora beraha, vladimir simović 21 varies among countries, with developed countries relying on a smaller number of instruments such as conducting fiscal and monetary policy with reference to foreign exchange policy while others are guided by income distribution policy and foreign exchange policy, in addition to mandatory fiscal policy (public spending and taxes) and monetary policy (money supply and interest rate). inadequate conduction of one policy can be a constraint on another, which has a negative impact on macroeconomic stability. the goal of macroeconomic policy is to provide sustainable economic stability in the country and thus provide conditions for economic growth. traditional macroeconomic analysis attempts to answer the question of how one economy reacts to different policies and institutions. macroeconomic results are usually measured to determine the extent to which decision makers in a country have achieved their pre-set goals. they represent the starting point and one of the most important elements for formulating a national economic development strategy. macroeconomic indicators show the position of a country in the international economic system. however, it is very difficult to assess and rank countries based on these individual criteria alone. for this reason, many international organizations such as the international monetary fund (imf), the world bank and united nations conference on trade and development (unctad) compile various indices that combine several individual indicators and thus measure the level of development, stability of the financial system and many other parameters. in the coming period, structural and institutional reforms should gradually strengthen the potential growth of countries that have not yet joined the eu, helping them to prepare for the accession process. one of the main goals of these countries is certainly to preserve macroeconomic and financial stability, as this would contribute to better implementation of structural and institutional reform programs in order to achieve faster and more inclusive growth, job creation and a better standard of living. literature review the main macroeconomic indicators are used to describe the state and efficiency of a national economy. unlike other types of indicators, they are directly related to each other. macroeconomic indicators are not only mutually related within one economy, but between different economies as well (mukhamediyev et. al., 2018). the relationship between economic growth and macroeconomic indicators has long been a popular issue of debate in the literature of economic development (tas et al., 2013). in order to adequately create macroeconomic policy, it is necessary to provide accurate and timely information on the current state of economic activity (sédillot & pain, 2003). accordingly, it can be concluded that macroeconomic policy is a set of activities undertaken by the government of a country to achieve the most important economic goals (marjanović & zubović, 2020). consequently, economic growth, high employment, price stability and balance of payments are the basic goals of macroeconomic policy of a country. one of the main tasks of each country is to increase production and exports, which should aim to achieve stable economic growth over time (marjanović & domazet, 2018). according to bakari & mabrouki (2017), exports and imports can play a crucial role in the economic development of every country. in this regard, they conclude that exports and imports are considered one of the main drivers of economic and social development. exports and imports of goods and services are part of a current account within a country's balance of payments. the results of most empirical research show that openness to international trade encourages economic growth. tahir & azid (2015), in their research on a sample of 50 developing countries in the period from 1990 to 2009, prove that openness to international trade has a positive and statistically significant impact on economic growth. however, they point out that developing countries should focus on importing new technologies and capital goods instead of consumer goods. ulaşan (2014) empirically proves that openness to international trade alone does not contribute to economic growth without previously established institutions and the existence of macroeconomic stability. in the research that included 28 eu countries for the period 2010-2019, the authors analysed the import of goods and concluded that that “imports of goods” is negatively associated with “private consumption 22 economic analysis (21, vol. 54, no. 2, 20-29) expenditure at current prices”, “consumption of fixed capital”, and “gross domestic product” and positively associated with “harmonised consumer price index” and “gross operating surplus: total economy” (costantiello et al., 2021). according to nguyen (2011), the export-led growth hypothesis is based on several assumptions. first, exports contribute to higher levels of specialization in production, which in turn leads to higher productivity as well as increased economic growth. also, as exports grow, resources are allocated more efficiently by shifting factors to more productive export sectors. the inflow of foreign direct investments (fdi) also plays an important role in stimulating economic development of all countries, and particularly of developing and transition countries. therefore, it is not surprising that they are considered an effective way to raise the comparative advantages of a country, as well as a significant source of economic development, modernization, growth of production, exports, employment, and income (domazet & marjanović, 2018). iamsiraroj & ulubaşoğlu (2015) conducted research on a sample of 140 countries in the period 1970-2009 and found that fdi have a positive impact on economic development. in addition, they point out that this connection applies equally to the most developed countries, as well as to developing countries and countries in transition. accordingly, the positive effect of fdi is greater in more open trade countries, and in countries with more developed financial sectors. in their research, pjanić & mitrašević (2021) concluded that attracting fdi for most countries is a necessary condition for increasing production and exports to a level that will allow the country, among other things, to achieve stable economic growth. it is very important that governments create an adequate business climate for investors since it is one way to attract fdi (hagemejer & tyrowicz, 2011). when competing to attract fdi, countries can increase the supply of public inputs, subsidies, or tax incentives to foreign investors (vukšić, 2013). sabir et al. (2019) concluded that the institutional quality has a positive impact on the inflow of fdi. according to the presented conclusions, the coefficient of corruption control, government efficiency, political stability and rule of law are more important for fdi inflow in developed countries compared to developing countries, which clearly indicates that institutional quality is an important determinant of fdi in developed countries. data analysis and findings since the economic development of a country is largely influenced by actively pursued macroeconomic policy, this paper seeks to present the current state of national economies of the western balkans in terms of selected macroeconomic indicators. the objective of the paper is to show the mutual relationship and position of each of the observed economies by a comparative analysis of selected macroeconomic indicators. the analysis focuses on (a) imports and exports of goods and services and (b) inflows of fdi. the analysis is based on the available secondary data from the unctad database for the period 2011-2020. the first part of the analysis aims to present the annual imports and exports of goods and services in the western balkan economies in the period 2011-2020 (table 1). exports and imports of goods and services are part of the current account within a country's balance of payments, with exports consisting of goods and services produced in the country and sold to foreign buyers, while imports are goods and services purchased from abroad by residents of one country. darko marjanović, isidora beraha, vladimir simović 23 table 1. import and export of goods and services and foreign trade deficit (in million u.s. dollars) source: unctad, 2021. in terms of import of goods and services in the analysed ten-year period (2011-2020), it can be clearly concluded that serbia ranks first in the region. with a higher level of public investment and infrastructure works, it is almost certain that this will be reflected in the increased need for the import of equipment. germany and china stand out as the most relevant trade partners with a share of 13.3% and 12.5% in the total imports of serbia in 2020, respectively (jovičić et al., 2020). in the coming period, the growth of imports of goods and services in most countries in the region will be driven by the growth of domestic demand. in terms of exports of goods and services, new investments and continued expansion of export supply are expected to provide high growth in exports in the medium term. after eliminating the consequences of the covid-19 crisis, the recovery of exports of goods and services in all countries of the western balkans is expected. these countries mainly rely on the demand in the eu and the region, which is not surprising considering that during 2020 the largest part of exports was placed on the eu market, cefta and the market of the eurasian union countries. in order to strengthen cooperation between the countries of the region, in the framework of the open balkan initiative (colloquially known as mini-schengen), an agreement was signed between serbia, northern macedonia, and albania with an aim to facilitate import, export, and movement of goods, along with the abolition of border control between these countries from january 1, 2023 (the government of the republic of serbia, 2021). figure 1. import of goods and services, figure 2. export of goods and services, 2011-2020. (million u.s. dollars) 2011-2020. (million u.s. dollars) source: authors based on the unctad (2021) source: authors based on the unctad (2021) import of goods and services wb country 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 albania 7644 6753 6882 7291 5969 6384 7288 8234 8291 6913 bosnia and herzegovina 11608 10532 10824 11513 9560 9741 11176 12359 11923 10390 montenegro 2975 2769 2807 2820 2511 2823 3215 3748 3667 2961 north macedonia 7983 7496 7656 8525 7569 7917 8924 10469 10912 9864 serbia 24456 23256 25154 25654 22355 23843 27408 32679 33832 29746 export of goods and services albania 4765 4400 4615 4921 4166 4610 5535 6491 6524 5064 bosnia and herzegovina 7541 6744 7311 7556 6778 7123 8424 9471 8927 7462 montenegro 1900 1672 1815 1810 1699 1757 2012 2304 2360 1188 north macedonia 5934 5382 5836 6699 6064 6326 7294 8772 9018 8281 serbia 17140 16336 20319 21122 19171 21186 24506 28199 29256 27693 foreign trade deficit albania 2879 2353 2267 2370 1803 1774 1753 1743 1767 1849 bosnia and herzegovina 4067 3788 3513 3957 2782 2681 2752 2888 2996 2928 montenegro 1075 1097 992 1010 754 1203 1203 1444 1307 1773 north macedonia 2049 2114 1820 1826 1505 1591 1630 1697 1894 1583 serbia 7316 6920 4835 3184 3184 2657 2902 4480 4576 2053 24 economic analysis (21, vol. 54, no. 2, 20-29) in the period 2011-2019, except for 2012 and 2015, albania had been recording an increase in exports, which, among other things, had had a positive impact on its economic growth. despite higher electricity imports as a result of drought, the current account deficit was reduced due to tourism and exports of services. also, number of tourist visits decreased by 60%, which reduced the albanian exports. according to the instat (2021), in the first five months of 2021, the value of exports amounted to 177 billion albanian levs (all), which is an increase of 40.9% compared to 2020, and the value of imports amounted to all 354 billion, which is an increase of 30.5% compared to the previous year. the trade deficit amounted to all 178 billion, which is an increase of 21.7% comparing to the same period last year. as for bosnia and herzegovina, the lack of progress in harmonization with eu regulations in the field of agriculture and rural development, food safety, veterinary, phytosanitary policy and fisheries continued in 2013, thus preventing exports of animal products to the european union. on the other hand, the external imbalance was significantly reduced due to the stagnant private consumption and imports. the structure of exported goods in 2018 was unfavourable, with the largest share of low value-added goods. the country's trade performance still lags behind other countries in the region due to burdensome administrative trade procedures and limited export promotion capacity. according to the agency for statistics (2021), in the first eight months of 2021, exports amounted to km 8,749 million, which is an increase of 32.5% compared to the same period in 2020, while imports amounted to km 13,290 million, which is an increase of 22.6% compared to for the same period last year. the coverage of import by export amounted to 65.8%, while the foreign trade deficit amounted to km 4,541 million. exports of montenegro, whose share in world trade has been declining since 2008, began to grow again in 2011. on the other hand, its share in imports peaked in 2008 and has been declining since then. in 2015, the total value of exports of goods and services amounted to as much as 103.4% of gdp. however, net exports had a negative impact on montenegrin economic growth. in 2020, the loss of the tourist season due to the covid-19 pandemics and one of the worst recessions in europe, led to a drop in exports of goods and services by about 50%. also, imports decreased by 18%, thus affecting net exports that accounted for almost 50% of the total decline in gdp. according to the monstat (2021), in the first seven months of 2021, the total foreign trade of montenegro amounted to about 1.59 billion euros, which is a 12% increase compared to the same period in 2020. exports of goods amounted to 235.2 million euros, which is an increase of 17.6% compared to the comparable period last year, while imports increased by 11.1% amounting to 1.36 billion euros. given that approximately 50% of exports of northern macedonia was oriented towards eurozone economies, the eurozone crisis in 2011 led to a decline in the country’s exports. limited credit growth slowed the growth of import, so the trade deficit increased slightly. however, economic activity of northern macedonia in 2016 was significantly supported by the export growth due to technological and investment zones, which also improved the country's trade balance. foreign trade was under great pressure due to weaker economic activity of key trading partners, which jeopardized its development model based on exports and fdi. the pandemics has seriously affected exports, especially foreign manufacturing companies that are integrated into global value chains and receive most of their inputs from abroad. according to the official data of the state statistics office (2021), the total value of exported goods from the republic of northern macedonia in the first seven months of 2021 amounted to 246,265,451 thousand denars, which is an increase of 34.5% compared to the same period in 2020. the value of imported goods in amounted to mkd 335,526,575 thousand which is a 33.9% increase compared to the same period last year. the trade deficit amounted to mkd 89,261,124 thousand, while the coverage of import by export amounted to 73.4%. the record level of fdi in 2019 affected the growth of imports and thus the growth of the current account deficit. however, serbia's external balance has improved significantly since the world financial crisis in 2008, when the current account deficit was almost 20% of gdp, until darko marjanović, isidora beraha, vladimir simović 25 2019, when it was reduced to 7%. despite the challenges posed by the pandemics, export of goods remained relatively stable. according to the statistical office of the republic of serbia (2021), the total foreign trade of serbia in the first seven months of 2021 amounted to 33 billion u.s dollars, which is an increase of 35.4% annually. exports increased by 38.9% amounting to 14.33 billion u.s. dollars, while imports increased by 32.8% amounting to 18.68 billion u.s. dollars. trade deficit was 4.35 billion u.s. dollars, which is an increase of 16.1% year-on-year. serbia has the largest volume of foreign trade with countries with which it has signed free trade agreements, while eu countries account for 61.9% of its total trade. germany is the largest single foreign trade partner of serbia. the value of exports of goods in the first seven months is around 1.5 billion euros, while the value of imports is around 2.0 billion euros. the second most important partner are the cefta countries, with which serbia has a surplus of about 1.2 billion euros. in the observed period, export to cefta countries amounted to around 1.80 billion, and import amounted to around 630 million euros. the second part of the analysis presents the state of fdi inflow in the western balkan economies in the period 2011-2020. (table 2). due to the lack of domestic investment potential, the countries of the western balkans are trying to get involved in international flows in order to attract investors from other countries. (marjanović et al., 2020). table 2. fdi inflows in western balkan countries, 2011-2020. (in million u.s. dollars) source: unctad, 2021. the countries of the western balkans are very attractive locations for foreign investors (marjanović & đukić, 2020). in the observed period (2011-2020), the inflow of fdi to these countries amounted to around 53,455 million dollars. investments came mainly from the countries of the european union, russia, and china. fdi in albania in 2012 financed about 70% of the current account deficit, which was a 10% increase compared to the previous year. most fdi was concentrated in the financial intermediation, services and industry sectors. in 2016, fdi was mainly concentrated in the oil sector, and it slowed down as a result of the falling crude oil prices. however, fdi inflow remained relatively stable at around 8-9% of gdp due to major energy projects, such as the trans-adriatic pipeline and the statkraft/devoll hydropower project. in addition, albania's economic growth in 2017 was mostly driven by the high level of fdi in the energy sector. also, the low level of savings was largely financed by fdi inflows. fdi in albania increased by 1.3% in the second quarter of 2021 compared to the previous year. net fdi inflow increased by 2.4% in the second quarter of 2021, compared to the first quarter of the same year. in the second quarter of 2021, the largest volume of foreign investments in albania, in the amount of 64.3 million euros, comes from the netherlands, followed by italy with 32.7 million euros and turkey with 25.1 million euros (the bank of albania, 2021). in 2013, bosnia and herzegovina recorded a decline in the fdi inflow, representing only 1.9% of its gdp. restrictions on fdi continued to apply in the media sector where a 49% foreign capital limit was set. fdi net inflows fell from 2.6% of gdp in 2014 to about 1.4% of gdp in 2015, which is a poor result compared to the neighbouring countries. despite the legal framework that provided favourable treatment to foreign investors, bosnia and herzegovina had a very low fdi inflow amounting to only 2% of its gdp in 2018. almost 63% of fdi in bosnia and herzegovina comes from the european union, mainly in the finance, retail and tourism sectors. total wb country 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 albania 876 855 1.266 1.111 946 1.101 1.149 1.290 1.288 1.107 bosnia and herzegovina 497 395 276 550 361 350 492 574 400 371 montenegro 558 620 447 498 699 226 559 490 417 529 north macedonia 479 143 335 273 240 375 205 725 446 274 serbia 4.932 1.299 2.053 1.999 2.348 2.352 2.878 4.091 4.270 3.440 26 economic analysis (21, vol. 54, no. 2, 20-29) investments in 2020 amounted to km 625.6 million, which is a decrease of 7.5% compared to 2019. based on the data of the central bank (2021), in the first quarter of 2021, fdi amounted to km 271.8 million, which is an increase of 14.6% compared to the first quarter of the previous year, when it amounted to km 237.2 million. given that the amount of fdi in the previous year was expected to decrease due to the coronavirus pandemics, its amount in the first quarter of 2021 (km 271.8 million) was compared with the average of the first quarter in the previous five years (2016-2020). the average amount of fdi in the first quarter amounted to km 268.1 million, which indicates that a more modest increase of 1.4% was achieved. despite a sharp slowdown in economic growth, montenegro's fdi inflow in 2011 remained at more than 10% of gdp. in 2011, in addition to tourism, fdi was a major driver of montenegro's economic growth. in 2020, almost 45% of the current account was financed by net fdi inflows. net fdi rose by 50% despite a 15% drop in fdi inflows, mostly because fdi outflows fell by 58% in 2020. according to the data of the central bank of montenegro (2021), in the first six months of 2021, the net fdi inflow amounted to 205.6 million euros, which is a decrease of 20.7% compared to the same period in the previous year. as a result of reduced debt investments, the total inflow of fdi was 349.6 million euros, which is a decrease of 7.75% compared to 2020. fdi inflows in the form of intercompany debt amounting to 162.6 million euros represented 46.5% of the total inflow, which is a decrease of 34.4% compared to the same period last year. in the period 2011-2014, attracting fdi was a key goal aimed at achieving higher rates of economic growth and reducing unemployment in north macedonia. the country was successful in attracting greenfield investments in 2011, especially in the auto parts industry. in 2016, the growth of export capacities financed through fdi had a large impact on the reduction of trade deficit, however, fdi inflows remained relatively modest despite favourable factors such as numerous tax incentives, strong protection for entrepreneurs, and simple business start-up procedures. in the first quarter of 2020, despite the crisis caused by the pandemics, fdi significantly increased. according to the national bank of north macedonia (2021), in the first half of 2021, fdi amounted to 288.2 million u.s. dollars, compared to the net inflow of 139.6 million euros in the same period in 2020. in the first six months of 2021, the inflow of fdi increased mainly as a result of registered net inflows from reinvestment of earnings and capital, and to a lesser extent due to lending between companies. an overly complicated system of business-related laws and regulations hampered the competitiveness of the serbian economy in 2012, and negatively affected fdi inflows, which is a key factor stimulating private sector growth and unemployment reduction. however, in 2015, serbia achieved a significantly higher level of fdi compared to the previous year, amounting to 5.4% of its gdp. a significant part of fdi was directed towards production, which had a positive impact on competitiveness, as well as on the production and export base of the economy. in 2019, serbia achieved a record high level of fdi, which stimulated imports, increased the current account deficit, and the level of foreign exchange reserves. since 2015, the net fdi inflows in serbia have consistently exceeded the current account deficit, reaching 7.8% of gdp in 2019. according to the unctad (2021), serbia attracted 3.44 billion u.s. dollars of fdi in 2020, which is over 50% more than the value of total fdi in southeast europe in the year of the covid-19 pandemics, which reached 6,11 billion u.s. dollars. in 2020, fdi inflows remained strong despite the coronavirus pandemics, while in the first seven months of 2021, inflows amounted to 2.14 billion euros. western balkan countries lag significantly behind serbia in terms of fdi inflows. in terms of fdi per capita, montenegro ranks first. however, the level of investment per capita in the western balkan countries is significantly lower compared to the countries of the european union. in the western balkans, investments amount to around 2,600 euros per capita, while in the european union they amount to around 14,300 euros (sanfey et al., 2016). darko marjanović, isidora beraha, vladimir simović 27 figure 2. share of fdi attracted by western balkan countries (2010-2020), in % source: authors based on the unctad (2021) in the previous ten years, most foreign investments were directed to serbia (29,662 million u.s. dollars), which makes up 55% of the total amount of all investments in the countries of the western balkans. it is followed by albania with 10,989 million u.s. dollars (21%), montenegro with 5,043 million u.s. dollars (9%), bosnia and herzegovina with 4,266 million u.s. dollars (8%) and northern macedonia with 3,495 million u.s. dollars (7%). in the period 2011-2020, more than half of the amount of foreign investment was directed to serbia. this is primarily a result of the serbian economic policy which has created favourable conditions for the arrival of foreign investors. however, according to the achieved level of economic development, the countries of the western balkans lag behind the developed economies of the eu. in the coming period, the focus is to be on attracting as much fdi as possible, given that they can significantly affect the economic growth of the western balkans (marjanović & đukić, 2020). conclusion the analysis of macroeconomic indicators is an important tool for measuring economic performance of a country. it provides the data necessary to assess the overall state of an economy. macroeconomic policy is a set of activities aimed at stimulating economic growth. accordingly, a well-conducted macroeconomic policy plays an important role in the development of the economies of the western balkans. this paper aims to analyse the selected macroeconomic indicators to show the state and position of individual economies in the western balkans, while the research focuses on imports and exports of goods and services and inflows of fdi. in each of the observed years, the analysed economies recorded trade deficit, which does not necessarily mean that it has a negative impact on economic development. given that trade deficit is financed by borrowing abroad or fdi, if foreign debt or foreign investment is invested in productivity growth, trade deficit can become a source of long-term economic growth. if this trend continues, it is quite possible that most western balkan countries will need new fiscal consolidation, which could jeopardize their already weak growth prospects and slow their progress, thus putting into question their accession to the european union. also, the development model of an economy cannot be based exclusively on fdi if the level of domestic private investment and public investment is insufficient or incorrectly channelled. macroeconomic and financial stability, better investment, and business environment, and the implementation of infrastructure projects, are factors that can contribute to investment growth. in order to increase investments, it is necessary to ensure macroeconomic and financial stability, create an adequate business environment and implement infrastructure projects. all of the above point to the 28 economic analysis (21, vol. 54, no. 2, 20-29) conclusion that the economic development of the western balkan countries is determined by fdi, imports and exports. in the first half of 2020, the impact of the covid-19 pandemics on economic activity was more negative than expected. the imf expects the recovery to be slower than previously forecast. the pandemic has negatively affected both foreign trade and the inflow of fdi in all western balkan countries. serbia is currently in the most favorable position compared to other western balkan countries, given that the actively pursued economic policy has contributed to the creation of a favorable investment climate. the overall conclusion is that the set of economic measures adopted by the serbian government have not endangered the country's macroeconomic and fiscal stability. compared to other european countries, serbia has solid economic parameters, while adequately adopted measures have prevented a deeper recession. in accordance with the covid-19 situation at the global level, serbia needs to preserve all important indicators and adopt economic measures to easily cope with the global crisis that has affected the whole world. the risk of a prolongation of the pandemics and its strong impact on certain economic sectors should be considered. policy makers in all western balkan countries should develop several economic policy alternatives and crisis mitigation measures in line with different global scenarios. to minimize investment reduction, it is necessary to further strengthen cooperation with the eu and neighbouring countries, continue improving business environment and preserve macroeconomic stability. acknowledgements this paper is financed by the ministry of education, science and technological development of the republic of serbia. references agency for statistics of bosnia and herzegovina. 2021. 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www.srbija.gov.rs/vest/565375/srbijaseverna-makedonija-i-albanija-potpisale-tri-dokumenta-za-bolju-regionalnu-saradnju.php (accessed september 15, 2021). vukšić, g. 2013. “developing countries in competition for foreign investment.“ the journal of international trade and economic development, 22 (3): 351-376. article history: received: october 4, 2021 accepted: october 14, 2021 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3119685 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3119685 the impact of import, export and fdi on the economic growth of the western balkans countries darko marjanović10f* | isidora beraha1 | vladimir simović1 introduction literature review acknowledgements references microsoft word 2010_3_4.doc original scientific paper exchange policy and economic growth: effect of the real effective exchange rate misalignment on the growth of tunisia sfaxi hend*, university of nice – sophia antipolis, cemafi, france redžepagić srdjan, institute of economic sciences, serbia udc: 339.74(611) jel: f31 abstarct – the collapse of the system of bretton woods pushed tunisia adopted various policies of exchange to avoid imbalances of the balance of payments. since, this country aimed to maintain or to improve its external competitiveness in order to balance its current account through the promotion of exports, this contribute to start again the economic growth. by specifying an equation of economic growth of tunisia, it’s showed that the real effective exchange rate misalignment, indicator of external competitiveness, has negative effect on the economic growth. the fall of real effective exchange rate misalignment, these last years, then explained partly the stabilization of the growth rate of this country can especially since 2001 when the tunisia softened its policy of exchange rate. a flexible policy of exchange is then desirable to start again the economic growth. key words: exchange policy, real effective exchange rate misalignment, external competitiveness, economic growth, tunisia introduction the nominal exchange rate is defined as the number of units of a foreign currency which are exchanged against a domestic currency unit. in the developing countries, the real exchange rate is often expressed as the multiplication of the nominal exchange rate by the ratio of the domestic prices at the foreign prices (kamar, 2005). the multilateral exchange rates (effective nominal exchange rate and effective real exchange rate) express the value of the local currency of a country compared to the whole of the currencies of its partners (balanced according to the trade who bind the country concerned to his partners). a fall of the effective real exchange rate represents a rise of the total competitiveness of the country and, conversely, a rise of the effective real exchange rate represents a fall of this competitiveness. one lays down finally the exchange rate policy like the whole of the public interventions for the choice of a regime of exchange allowing to achieve certain goals. since the collapse of the system of bretton woods and the generalization of external imbalances, tunisia chose successively several exchange policies in order to balance its current account and continue to control its capital account. the purpose of it was to maintain * post-doc at the university of nice – sophia antipolis, cemafi. e-mail: hendbenahji@yahoo.fr economic analysis (2010, vol. 43, no. 3-4, 15-28) 16 or improve its external competitiveness and to promote its exports thereafter (for balance of current account). these policies aimed, moreover, to maintain it or to increase in the economic growth. in this article, we seek to know if tunisia succeeded in balancing and/or to increase its economic growth in its policy of exchange, especially these last years, and if the policy of total liberalization of its of exchange rate envisaged in 2014 is likely to have reflect positive on its economic growth. the economic growth was always one of the subjects most covered in economy because of the importance of the goodwill for the population and of the diversity of the factors which could influence it. however, the theoretical and empirical studies which treat effect of the exchange policy on the growth remain still rare. traditional models of balanced or optimal growth do not even take hopes the economic policies of them to explain the growth and the endogenous models of growth perceive the budget policies and of commercial opening like growth promoters but under certain conditions and without evoking the effect which the exchange policy could have on the economic growth. but the new contemporary theoretical and empirical approaches (edwards (1988, 1989), razin and collins (1997), domaç and shabsigh (1999), béreau, lopez villavicencio and mignon (2009)) study the impact of exchange policy on the growth and this through the effect of real effective exchange rate misalignment (section 1). the real effective exchange rate misalignment is being defined as the deviation of real effective exchange rate from its equilibrium level. an exchange policy which generates a positive real effective exchange rate misalignment resulting in an overvaluation of the currency was often shown to be a source of loss of external competitiveness especially in the developing countries as tunisia where the external demand for the domestic products is very elastic at the prices. this loss of competitiveness will generate, thereafter, a fall of exports and a deceleration of the economic growth. on the other hand, when the real effective exchange rate misalignment generates an undervaluation of the currency, it could restart again the economic growth (section 2). it will be shown that this assumption is true for tunisia by specifying an equation of economic growth in which the growth is explained by several macroeconomic variables of which misalignment of the effective real exchange rate (section 3). theoretical and empirical study of the effect of the misalignment of the effective real exchange rate on the economic growth edwards (1989, 1990) was the first who has studied the effect of the misalignment of the effective real exchange rate on the economic growth in a study on twelve emergent countries during the period 1965-1985. he showed that, more the positive misalignment of the real exchange rate is high, more the growth is weak. razin and collins (1997) stressed that the misalignment of the real exchange rate can affect, on the one hand, the domestic and foreign investment (an overvaluation of the currency is sign of a raising of prices of the domestic goods compared to the international prices) and thus the process of accumulation of the capital and, on the other hand, the competitiveness of the exchangeable goods whose sale abroad constitutes a significant source of the growth in the open economies. i order to show their thesis; these authors used a model in panel for fixed purposes on a sample of 93 countries over the period 1975-1992. sfaxi h., et al., exchange policy and economic growth, ea (2010, vol. 43, no, 3-4, 15-28) 17 in the same direction, domaç and shabsigh (1999) underlined that a bad management of the exchange rate can involve an overvaluation of the currency and a fall of the growth. according to these two researchers of the international monetary international monetary funds, a currency is described as overvalued (undervalued) when its real exchange rate is the highest (the lowest) that its equilibrium level, the real effective exchange rate misalignment being able to refer to these two situations. however, the notion of misalignment was often associated in the case of overvaluation of the exchange rate, especially in the developing countries. for them, the misalignment of the exchange rate has unfavorable effects on the growth through: 1. the loss of external competitiveness by the raising of exports prices, that has for the effects the deterioration of the current balance and the reduction of the exchanges with outside, from where an unfavorable impact on the production. 2. a fall of the foreign investments; indeed, the misalignment of the real exchange rate involves distortions of the prices of the domestic goods compared to the international prices, what has unfavorable effects on the foreign investments thus causing the fall of the production. 3. the unfavorable effect on the domestic financial markets which results by the increase in uncertainty on these markets and in the encouragement of the speculation against the domestic currency. if overvaluation continue, then several companies or banks can fall in bankruptcy because of the speculation; in this last case, the country is likely to pay the full price to save its financial system. from this report, domaç and shabsigh (1999), tried to release the impact of real effective exchange rate misalignment on the economic growth of egypt, of jordan, of morocco and of tunisia over the period 1970-1995. they determined the real effective exchange rate misalignment for each country. the authors used three different measurements of the equilibrium of the real effective exchange rate: a measurement according to the purchasing power parity (cassel (1992), balassa (1990), agarwala (1983) and cottani and al. (1990)), another one utilizing the black market exchange rate premium (edwards (1989, 1990)) and at the end a measurement using methodology of edwards (1989) (developed also by cottani and al. (1990), ghura and grennes (1993)) who expresses the real effective exchange rate according to fundamental (terms of trade, trade openness…). then, the authors thought equations which express the rate of economic growth (growth rate of per capita gdp) in function of the real exchange rate variability, of the real effective exchange rate misalignment, investments (investments/gdp), growth rate in terms of trade and population growth. these estimates aimed to release the effect of the real effective exchange rate misalignment on the growth. using the method of ordinary least squares (ols) to estimate these equations for each country and each measurement of the real effective exchange rate misalignment, the authors found that, in each estimated equation, the real effective exchange rate misalignment had a significant and negative effect on the growth. the two researchers of the imf conclude that, during the years 70 and 80, four arab countries considered (egypt, jordan, morocco and tunisia) policies of exchange adopted which had as result an overvaluation of the exchange rate. empirical results found for each economic analysis (2010, vol. 43, no. 3-4, 15-28) 18 measurement of the real effective exchange rate misalignment, and for each country, underline the unfavorable impact of this last on the economic growth coming from these exchange policies. on the other hand, these authors notice that liberalization and economic policies of reforms proposed by these countries at the end of the years 80 and at the beginning of the years 90 have resulted, in the majority of the cases, a reduction of the misalignment of the real exchange rate and increased by this fact the prospects for growth in these countries. béreau, lopez villavicencio and mignon (2009) empirically studied the relationship between the misalignment of the effective real exchange rate and the economic growth. they considered a nonlinear model as a panel for a sample made up of several developed countries and under development. their results show that: • there is a positive and significant relation between the growth and the misalignments when the national currency is underestimated. indeed, according to them, the undervaluation of the currency increases competitiveness, which stimulates the national production, the investment and exports and reduces the imports. it follows an improvement of the current balance, the gdp and employment. • overvaluations affect the growth negatively. indeed, according to them, the overvaluation of the currency is often the consequence of inconsistencies in the decisions of economic policy, leading to an increase in the probability of appearance of crises of balance of payments and exchange, thus harming the economic growth1. effect of the exchange policy on the competitiveness and the economic growth of tunisia tunisia applied mainly two exchange policies since the fall of the system of bretton woods; from 1973 till 1986, tunisia adopted fixed exchange policy. since the devaluation of 1986, tunisia applies the intermediary exchange policy; it set up crawling band policy. this mode consists to target the exchange rate to a basket of currencies and to fix a band of fluctuation; the central rate and band of fluctuation are given according to their objectives and inflation. the monetary authorities proceeded thus: • from 1986 till 1989, within the framework of the plan of structural adjustment, the central bank put lower level the nominal effective exchange rate gradually until the real effective exchange rate reaches its equilibrium level (near to 100 according to the theory of purchasing power parity) with an aim of gaining in competitiveness (domaç, shabsigh, 1999). • during the nineties, the nominal effective exchange rate was given so as to keep the real effective exchange rate constant (application of the theory of ppp); the 1 for more references on the theoretical and empirical literature on the effect of the misalignment of the real exchange rate on the economic growth, please refer to the phd thesis of hadj amor, thouraya. (2007). variabilité du taux de change réel, intégration financière internationale et croissance économique : une application aux économies émergentes. university of nice – sophia antipolis, cemafi, p. 158-171. sfaxi h., et al., exchange policy and economic growth, ea (2010, vol. 43, no, 3-4, 15-28) 19 monetary authorities aimed to preserve competitiveness (imf, 2002). during this decade, an interbank market of exchange was created in 1994, and, in 1997, the approved intermediaries resident and not residents, were authorized in the long term to constitute counterparts in the exchange transactions for the account of their customers resident and this, with the title of the operations of imports of goods and services and of the financial transactions for one duration maximum twelve months and of the operations of export for one duration maximum nine months. • until 2001, tunisia widened the band of fluctuation of nominal exchange rate; this policy was installation with an aim of applying the recommendations of the imf which aim at softening the exchange policy (imf, 2003) with an aim of improving competitiveness. in order to observe the effect of the exchange policy on the economic growth of tunisia, we chose to study the impact of the real effective exchange rate misalignment, which could provide the exchange policies, on the growth of this country. the real effective exchange rate misalignment, is considered as measurement of external competitiveness of tunisia owing to the fact that this country produced generally exports of goods (for example the textile) whose elasticity of the request external by report to the prices is very strong (ben marzouka and safra (1994)). thus, in the case of tunisia, the misalignment of the real exchange rate, when it results in an overvaluation of the currency, has negative effects especially on the economic growth through the loss of external competitiveness; indeed, since flows of capital do not circulate freely towards or starting from this country, the misalignment of the effective real exchange rate has few effects on the foreign investments and the financial markets. empirical study of the effect of the misalignment of the effective real exchange rate on the economic growth of tunisia working method we chose to analyze the relation of ʺmisalignment of the of real exchange rate vs economic growthʺ by using the method of domaç and shabsigh (1999) i.e. we will estimate initially the misalignment of the effective real exchange rate of tunisia then we will study the impact of this last on the economic growth by using the ols method. to determine the misalignment of the effective real exchange rate of tunisia, we estimated the rate of effective real exchange of balance by using the method of el badawi (1994). this author defined the equilibrium real effective exchange rate as that which makes it possible to carry out the simultaneously domestic and external balance. the variables which affect these balances are called “fundamentals”. based on the model of edwards (1989)2 2 the model of edwards (1989) of the real exchange rate was prepared for the developing countries. it takes into account the macroeconomic variables which could affect the real exchange rate as the control of the capital and the barriers tariff. it estimates a relation of long term between the real exchange rate and several structural factors which it calls ʺthe fundamentalʺ. it thus obtains an economic analysis (2010, vol. 43, no. 3-4, 15-28) 20 (utilized by domaç and shabsigh (1999)), el badawi has advanced a model improved of determination of the equilibrium real effective exchange rate. he proposed an econometric method (those of the engle and granger (1987)) who allows to determine the fundamentals which have a relation of long term and short term with the real effective exchange rate. for determine the fundamental which defines the real effective exchange rate, it was proceed (engle and granger (1987): • it was selected some economic variables (nominal effect exchange rate, commercial opening, changes in net reserves, terms of trade, the net total flows of the capital, total public consumption compared to the gdp) who can affect the domestic and external equilibrium of tunisia ; we test the stationnarity (adf test) of their values taken in logarithms to determine the order of integration of each variable (fundamental variable); if a variable is not integrated of order 1, then we cannot include it in our model. • the test of co-integration was made (johansen, 1988) to determine if there is only one or several vectors of co-integration between the variables which were retained. method of engle and granger could be applied only in the first case. • once that the assumption of the existence of only one vector of co-integration is checked, it could pass at the first level of the method of engle and granger. we estimate the long term relation between the fundamental ones and the real exchange rate of balance by using the method of the method of « least squares »; where testing the following relation: t32t1t ...)reslog()totlog()elog(c)elog( ε++β+β+β+= (1) where: log(e) measured the logarithm of real effective exchange rate defined in the certain of tunisia, log(e) the logarithm of nominal effective exchange rate defined in the certain of tunisia, log(tot) the logarithm of terms of trade (export unit values/ import unit values ) of tunisia, log(res) the logarithm of ratio of the changes in net reserves to gdp of tunisia. it is necessary also that the term of error is stationary so that the relation of co-integration is accepted. • the second step consists in estimating the relation of short term or the dynamic relation (through the ols method) which is represented by what is called “the model with correction of error”. it should be checked that the coefficient associated with the force of recall is negative and significant. that makes it equation of the balance of the real exchange rate by using the method of least squares ordinary. however, in the empirical analyses, the variables are supposed to be independent, but it proves that some among them like, for example, flows of capital, the productivity, the domestic credit and the public consumption, are correlated. thus, several variables then appeared non significant in the equation. in the model of edwards, almost all the variables must be included in the equation, otherwise, the estimated equilibrium real exchange rate does not coincide with this model (zhang, 2002). sfaxi h., et al., exchange policy and economic growth, ea (2010, vol. 43, no, 3-4, 15-28) 21 possible to conclude that there is a return towards the balance of the effective real exchange rate. the values of fundamental balance obtained by applying the filter hodrick-prescott3 (linjouom, 2004) make it possible to determine the values of balance of the effective real exchange rate. the misalignment of the effective real exchange rate is then calculated as the difference between the effective real exchange rate and its level of balance4. the method of calculation of the effective real exchange rate of balance according to the theory of the purchasing power parity was rejected because this theory was very criticized in the literature (dufrenot, mathieu and mignon (2001)), and with fact the object of controversies in work of williamson (1994), and that using the reference to the black market of the exchange rate was not taken into account because the black market of the currencies is limited in tunisia. then, for studying the effect of the real effective exchange rate misalignment on the economic growth of tunisia, we have estimated the equation of economic growth for this country. on the basis of estimated equation by domaç and shabsigh, we have specified the equation of economic growth of tunisia for the period 1975-2007, in which we have only retained the following variables: the real effective exchange rate misalignment, the investments and the growth rate in terms of trade, and we have rejected the variables population growth and real exchange rate variability because the population increased in a regular way and the exchange rate was not very volatile in tunisia the latest decades. with these variables, we added the government expenditure related to gdp and growth rate number of children inscribed in primary education. indeed, the government expenditure could have an direct effect on the rate of the economic growth through the consolidation of stock of capital of the economy via the public investment in infrastructure or the investment of the public companies, or indirectly, by increasing the marginal productivity of the factors of production offered by the private sector thanks to the expenditure of infrastructure, education like that concerning other public services. however, the rise of the government expenditure could have negative effects on the economic growth through the increase of the budget deficit and the eviction effect which it exerts on the private investments. indeed, a study of the effect of the government expenditure on the growth in tunisia showed that during the years 80, increase of the government consumption expenditure involved a rise of the interest rate and, thereafter, a fall of the private investments; it’s so called “eviction effect” (chaabane and ghorbel, 2005). moreover, growth rate number of children inscribed in primary education could have an effect on the economic growth of tunisia owing to the fact that this variable constitutes a measure of the human capital5, as the determining factor 3 the filter hp breaks up the variables into transitory and permanent components; we retain the permanent components as being the bearable values of the fundamental ones. 4 to have more detail on the method of calculation of the effective real exchange rate of balance and of the misalignment of the effective real exchange rate, to refer to the article of sfaxi benahji, h. (2008). « choix des politiques de change dans les pays en développement : etude de la compétitivité de la tunisie », panoeconomicus, n°3, p.353-367. 5 this variable was selected as a measurement of the human capital because it does not have all the statistics on the rate of schooling in primary education, out of secondary and to the university and on the rates of growth of the number of pupils inscribed in secondary and university education. economic analysis (2010, vol. 43, no. 3-4, 15-28) 22 of the growth in the developing countries. indeed, put aside the role that it exerts on the capital as a factor of production, the human capital takes part in the growth of the productivity through the efforts as regards research and development; it contributes thus to the revival of the economic growth. during three last decades, tunisia showed its will to regard the human capital as factor essential to the growth and this by developing education. however, the participation of education in the qualification of the labor remains weak, which justifies sometimes negative relations between the level of education and the rate of growth. indeed, for lack of vocational training, a great number of pupils, once finished the school, are found with unemployment (gabsi and abdelkafi, 2005) 6. thus, while using ols method, we estimated the following equation of the economic growth of tunisia: tt5t4t3t21t mestotipgeig ν+α+α+α+α+α= (1) where: g measured growth rate of per capita real gdp of tunisia, i investment in percentage of gdp of tunisia measured by variable “gross capital formation” in percentage of gdp, ge government expenditure of tunisia in percentage of gdp, ip growth rate number of children inscribed in primary education in tunisia7, tot variation rate in terms of trade of tunisia, the terms of trade are calculated by the ratio of the export unit values to import unit values, mes estimation of real effective exchange rate misalignment of tunisia. results and interpretation the estimation of the effective real exchange rate of long term of tunisia over the period 1975-2007 gave the following results: )reslog(09.0)totlog(53.0)elog(96.08.2)elog( ***)92.2(**)48.2( t ***)56.13(***)78.3( t +−+= − 8 (1) 95.0r 2 = 95.0r 2 = according to the equation (1’), the appreciation of the effective real exchange rate of tunisia is the result of the appreciation of the effective nominal exchange rate, of the increase in the reserves of exchange and the deterioration of the terms of trade9. 6the statistics relating to these variables come from the data bases of the world bank (world development indicators 2009) and of the international monetary funds (international financial statistics online 2009). 7data of number of children inscribed in primary education in tunisia relating to years 1983 and 1987 were added by linear interpolation. 8the values between brackets correspond to the test « t of student », * mean that the variable is significant to 10% of breaking value, ** mean that the variable is significant to 5% of breaking value and *** mean that the variable is significant to 1% of breaking value. 9the total variables commercial opening, net flows of capital and the total public consumption compared to the gdp appeared non significant. thus, we have not included them in the equation of the effective real exchange rate. sfaxi h., et al., exchange policy and economic growth, ea (2010, vol. 43, no, 3-4, 15-28) 23 by using the filter hp, we obtain the values of balance of the effective real exchange rate which we use to calculate the misalignment of the effective real exchange rate of tunisia (the econometric results are detailed in appendix 1 and the misalignment of the effective real exchange rate is represented in graph 1). then, the estimate of the equation of the economic growth of tunisia gives the following results: t *)8.1( t )2.0( t ***)9.4( t ***)9.3(***)9.4( t mes1.0tot01.0ip7.0ge7.0i5.0g −−−− −−−−= (2) 5.0r 2 = 5.0r 2 = according to the equation (2’), it is noticed that the variable tot is not significant, what confirms the results of domaç and shabsigh. on the other hand, variables i, ge, ip and mes have a significant effect on the economic growth and have the awaited signs as predicted by several theoretical and empirical studies. indeed, the investment was always an engine of economic growth, initially because of its direct impact on the growth since it is regarded as a component of the final request, with the keynesian direction of the term; then, whether it is private or public, it can indirectly induce the growth through the increase in the capacities to produce. moreover, in tunisia, investment was always one of the explanatory variables of the growth and especially since the introduction of many reforms (tax, etc…) making it possible to encourage the private investments. the government expenditure and the growth rate number of children inscribed in primary education have a negative impact on the tunisian growth for reasons which one evoked above. with regard to the real effective exchange rate misalignment, it is noticed that it has a negative and significant effect on the rate of economic growth, i.e., when the value of the real effective exchange rate misalignment is positive, the growth rate drops according to our estimates. so an overvaluation of the currency entrained a loss of external competitiveness and a deceleration of the growth. we could thus conclude that a exchange policy from which entrained an overvaluation of the tunisian dinar has harmful effects on the economic growth of tunisia. on the other hand, when the currency is undervalued i.e. the value of the real effective exchange rate misalignment is negative, then the country gains in external competitiveness and the growth rate increases. this thesis confirms the allegations of the tunisian authorities which aim, since 2001, cause a drop in the course of the dinar below its equilibrium value (as defined by the theory of the ppp) in order to gain in competitiveness and to start again the growth. moreover, by observing the graph 1, it is remarked that the real effective exchange rate misalignment was strongly reduced from 1994, date which tunisia started to open its foreign exchange market and to liberalize its money market and especially since 2001 (it did not exceed 4%) year where it widened the limit of fluctuation of the rate of exchange. we could remark that starting from this date, the growth rate of per capita real gdp of tunisia was stabilized and remained positive. thus, the policy of softening of the exchange rate of caused to reduce the real effective exchange rate misalignment and to encourage the tunisian economic growth. however, the real effective exchange rate misalignment remains positive economic analysis (2010, vol. 43, no. 3-4, 15-28) 24 (although in a less proportion), what harms to the economic growth of this country. we thus recommend to tunisia to continue its policy of softening of the tunisian dinar, to see to let float its currency in particular in the 2014, because that would make it possible this country to reduce even more the real effective exchange rate misalignment and better promote the economic growth. graph1 evolution of the economic growth and the real effective exchange rate (in %) -15% -10% -5% 0% 5% 10% 15% 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 g mes sources: world development indicators (2009), author’s calculations conclusion the economic growth depends of several factors where the exchange policy is one of them. this thesis was treated very little by the economic theory; however the exchange rate could play a dominating role to start again the growth. in this study, we estimated the effectiveness of the exchange policies adopted by tunisia by evaluating the effect of the real effective exchange rate misalignment on the economic growth. since 1986, tunisia handled its nominal effective exchange rate in such a way that the real effective exchange rate is stable or below its equilibrium value (according to the theory of the absolute ppp). consequently, tunisia started again its growth thanks to the competitive exchange rate. indeed, we have shown that, a positive misalignment of the effective real exchange rate, as the indicator of loss of competitiveness of tunisia, has a negative effect on the growth. since the tunisian exchange policy aims at cause to drop the real effective exchange rate misalignment, then this policy could have only positive effects on the growth. however, we notice that, in spite of the efforts of the tunisian authorities, this country continuous to record positive values of the real effective exchange rate misalignment; thus, the flexible exchange policy characterized by the exchange rate more competitive and in conformity with the movements of the market would be adapted better for tunisia to promote its economic growth. sfaxi h., et al., exchange policy and economic growth, ea (2010, vol. 43, no, 3-4, 15-28) 25 appendix picture 1. adf test on log(e), log(e), log(tot) and log(res) log(e) log(e) log(tot) log(res) p 1 1 1 1 model with trend and intercept ns (t of trend= -1.86) ns (t of trend = -2.08) ns (t of trend =2.91) ns (t of trend = 2.56) model with intercept ns (t of intercept= 1.83) ns (t of intercept = 0.96) ns (t of intercept = 0.73) ns (t of intercept = -1.35) i(0) model without trend nor intercept ns (t=-1.89) ns (t=-1.92) ns (t=-0.64) ns (t=-0.83) d(loge) d(loge) d(logtot) d(logres) p 1 1 3 3 model with trend and intercept ns (t of trend = 1.05) ns (t of trend = 0.2) ns (t of trend = 0.07) ns (t of trend = 2.41) model with intercept ns (t of intercept = -2.1) ns (t of intercept = -2) ns (t of intercept =-1.48) ns (t of intercept = 1) i(0) model without trend nor intercept s in 1% (t =-3.01) s in 5% (t =-2.57) s in 5% (t =-1.95) s in 1% (t =-3.85) with p : number of lags, ns : not stationary (critical value : 5%), s : stationary (critical value : 5%), i(0) :test in level and d(loge), d(loge), d(logtot) and d(logres) are first difference respectively of log(e), log(e), log(tot) and log(res). picture 2. co integration test on log(e), log(e), log(tot) and log(res) series: loge loge logtot and logres eigenvalue likelihood ratio 5 % critical value 1 % critical value hypothesized no. of ce(s) 0.582732 46.08839 39.89 45.58 none ** 0.356215 18.99356 24.31 29.75 at most 1 0.114343 5.341443 12.53 16.31 at most 2 0.049606 1.577242 3.84 6.51 at most 3 *(**) denotes rejection of the hypothesis at 5%(1%) significance level l.r. test indicates 1 cointegrating equation(s) at 5% significance level economic analysis (2010, vol. 43, no. 3-4, 15-28) 26 picture 3. specification of the equation of long term of real effective exchange rate of tunisia variables equation log(e) 0.96 (13.56)*** log(tot) -0.53 (-2.48)*** log(res) 0.09 (2.92)*** c 2.8 (3.78) r squared 0.95 adjusted r squared 0.95 adf test on residu model without trend nor intercept stationary in 5% (t =-2.21) picture 4. estimate of the term of correction of error of the equation of the short term of real effective exchange rate of tunisia variable coefficient t-statistic resid01 (t-1) -0.27 -2.2 sfaxi h., et al., exchange policy and economic growth, ea (2010, vol. 43, no, 3-4, 15-28) 27 references agarwala, ramgopal. 1983. “price distortion and growth in developing countries”, world bank staff working papers, n°575. balassa, bela. 1990. “incentive policies and export performance in sub-saharan africa”, world development, vol.18, 383-391. ben marzouka, tahar et safra mongi (1994). monnaie et finances internationales : approche macroéconomique, l’harmattan, paris. béreau, sophie, lopez villavicencio antonia and mignon valérie. 2009. « currency misalignments and growth : a new look using nonlineair panel data methods », cepii working paper n°2009-17. cassel, karl gustav (1922). money and foreign exchange rate after 1914, mac millan, new work. chaabane, abdelkader et ghorbel abdelfettah. 2005. “l’effet d’eviction : fondements théorique et vérification empirique pour le cas de la tunisie”, projet femise intitulé : « analyse des investissements publics de croissance et les difficultés de leur financement : etude des cas de cinq pays partenaires méditerranéens : maroc, tunisie, turquie, egypte, liban », fem 22-26. nice. cottani, joakim, cavallo domingo and khan m shahbaz. 1990. “real exchange rate behavior and economic performance in ldcs”, economic development and cultural change, vol 39, 61-76. domaç, ilker and shabsigh ghiat. 1999. “real exchange rate behaviour and economic rate growth: evidence from egypt, jordan, morocco and tunisia”, imf working paper, wp/99/40. washington d.c, 10-11. dufrenot, gilles, mathieu laurent et mignon valérie. 2001. “la détermination des taux de change réel d’equilibre : une revue de la littérature théorique et empirique récente», université paris 12, laboratoire erudite. edwards, sebastian. 1989. “real exchange rates, devaluation and adjustment”, the mit press, cambridge, ma. edwards, sebastian. 1990. “real exchange rates in developing countries: concepts and measurement”, in tj grennes, ed., international financial markets and agricultural trade, westview press, boulder, co. el badawi, ibrahim (1994). estimating long run equilibrium real exchange rate, in williamson, j. 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sfaxi benahji, hend. 2008. “choix des politiques de change dans les pays en développement: etude de la compétitivité de la tunisie”, panoeconomicus, n°3, 353-367. williamson, jean (editor) (1994). estimating equilibrium exchange rates, institute for international economics, washington d.c. xiaopu, zhang. 2002. “equilibrium and misalignment : an assessment of the rmb exchange rate from 1978 to 1999”, working paper n°127, centre for research on economic development and policy reform, stanford university, 8. received: 3 september 2010 article history: accepted: 1 november 2010 microsoft word 2010_1_2.doc original scienfitic paper economic assessment of selected bank mergers in the centraleast europe region in comparison with developed countries tej jakub*, ekonomická fakulta tuke, košice, slovakia udc: 336.7(4) jel: g15; e44; g34 abstract – my intention is to clarify the process of merging from the economic point of view, especially impact on financial results after the merger itself. examine and analyze differences in financial results, measured by using various ratio indicators, market value of shares and capital adequacy in the region of central and eastern europe in comparison with developed markets in the world. key words: economic situation, merger, the indicators of profitability, market value of shares, capital adequacy introduction nineties was characterized by a large number of mergers and acquisitions worldwide. this phenomenon belongs in the past decades to the preferred part of economic theory and practice. by the volume of capital bank mergers and acquisitions belong to highest rank of operations. they are closely linked with the globalization process and thanks to it very often cross national borders. economic assumptions of mergers wave in last decade is the rapid development of information technology, reducing the cost of communication and transport, markets deregulation and privatization. in particular, acquisitions are an integral part of the restructuring process in transition economies. merger itself has not always met planned expectations. there is no guarantee of achieving economies of scale, risk diversification and improvement of solvency. to fulfill all positive effects, it is necessary to prepare in advance more than just a basic plan and strategy. it is necessary to include regional specificities and all other relevant variables. material and method the intention of article is to clarify the processes of mergers from an economic perspective and impact on financial results after the merger itself. based on data from annual reports, it examines and analyzes the impact of mergers on banksʹ financial results, measured by various ratios or market value of shares and capital adequacy in the region of central and eastern europe in comparison with developed markets in the world. * address: boženy němcovej 32, košice, slovakia, e-mail: jakub.tej@tuke.sk tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 35 achievement and discussion merger usually means the process of merging two or more separate economic entities, which occurs through direct connection to their net assets. the merger, in most cases means the merger of relatively strong and equally important subjects, which is reflected in many aspects. the merger must be decided by the general assembly of all participating companies. as arguments for mergers and acquisitions is tend to be given many reasons. separations of reasons in favor of the merger and against them are widely various, and what some studies have considered clearly positive, others resolutely refuse. as an example, we can use the impact of mergers on employment and the expected impact of mergers on the effectiveness of the newly created bank. but the problem remains that many mergers are justified economically inefficient. analysis shows that the main problem is merging different corporate culture of companies. only few projects, of mergers and acquisitions have more than a basic plan how to solve this problem. others fail because of incorrect valuation of assets or hidden liabilities of the company [5, p. 243]. complicated structure of conglomerates, which occur after the merger, very often requires more administrative personnel. the preserved remains specialized, however often mutually competing departments. on the other hand are after mergers and acquisitions expected savings from reductions in staff or expenses costs (table. 1). these benefits would mean social costs in terms of increased unemployment. the problem in terms of social costs is also closing branches, usually associated with reducing supply of banking services, job cuts may not be the rule. table 1. estimates of cost savings in bank mergers (in% of total costs) sbc-ubs 23 bank of scotland-natwest 22 bank austria-credit anstalt 18 bankamerika-secpac 17 wells-first interstate 17 chemical-chase 16 swedbank-forenings 15 lloyds-midland 14 vereinsbank-hypobank 14 fortis-generale 11 source: davis, s. i. 2007 [2, p. 97] the most important argument for the merger is synergy. synergistic effect is based on the premise that combining two formerly separate companies involves an increase effect on the coupling value that is added to the sum of the merging companies. it is known that such effects arise when combining two companies, for example, that in newly established company arise economies of scale, reduce some costs, lower distribution costs and marketing costs, disposal of surplus or unused assets, or just using them. we can say that the 90th were synergies reason and argument of many mergers in the financial sector. acquisition of a economic analysis (2010, vol. 43, no. 1-2, 34-43) 36 major market positions, or the emergence of oligopoly or even monopoly, should be reflected in the growth of the value of the bank and decrease the value of competing banks however most of the studies decrease the value of rival banks didn’t demonstrate [1, p. 135]. the motive for mergers and acquisitions may also be to circumvent quotas, tariffs and other restrictions in foreign trade, reduce dependence on foreign trade or invest in a safe and predictable environment. for successfully manage of merger is very important to make valuation of both banks, which want to merge. financial valuation of bank aims to make its value by a sum of money. the potential of bank is then evaluate by cash equivalents. valuation methods can be divided into these main groups [4, p. 12-13]: 1. methods based on income analysis, 2. methods based primarily on an analysis of current market prices, 3. valuation methods based on cost (the cost of purchasing the property). researched bank mergers were divided into groups according to the region in which they took place. the first group included the mergers in developed economies such as japan, usa, gb, spain and republic of south africa. the second group included mergers acquisitions in transition economies of central and eastern europe. the oldest is the acquisition of csob by belgian kbc in 1999 in the czech republic. in it, kbc has acquired 65.69% stake for 40 billion czk. followed by series of austrian erstebank acquisitions in the czech republic, slovakia and romania. the other from region are the acquisition of komerční banka by french societe generale in 2001 in the czech republic, where there was a transfer of 60% of the shares for 40 billion czk and fresh unibanka merger with hvb bank in slovakia in 2007. table 2. the value of mergers under the merged total assets (eur million) merging banks total assets total mitsubishi tokyo fg + ufj holdings 2005 (japan) 779 338 593 396 1 372 734 jp morgan chase + bank one 2004 (usa) 955 077 269 512 1 224 589 sumitomo + sakura bank 2001 (japan) 500 886 414 775 915 661 royal bank of scotland + natwest 2000 (gb) 532 455 309 873 842 328 barclays + absa 2005 (jar) 785 852 51 009 836 861 santander + abbey 2004 (spain) 504 704 248 857 753 561 sg + kb 2001 (czech) 512 500 12 175 524 675 ersteg + bcr 2006 (romania) 181 703 13 519 195 222 kbc + csob 1999 (czech) 156 218 6 557 162 775 ersteg + ss 2001 (slovakia) 80 114 4 643 84 757 ersteg + cs 2000 (czech) 54 935 12 410 67 345 unibanka +hvb bank 2007 (slovakia) 1 504 2 178 3 682 source: own calculations based on annual reports of banks capital adequacy sense of capital adequacy is based on the assumption that the larger the capital of financial institutions, the more resources shareholders put in. and the greater will be their tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 37 interest for the proper operation of the institution not to lose this money, but to maximize their value. graph 1. capital adequacy ratio (%) 10 11 12 13 14 15 16 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author in case of problems means lower value of capital adequacy for the shareholders and depositors a higher probability of loss. when bank will be successful in its activities, the lower value of the capital adequacy means for shareholders higher probability of evaluation invested investments, but for clients only their deposit interest. raising capital adequacy means better security for clients, but on the other hand it means a reduction in institutions profit contributing to the unit of capital [9, p. 195]. from the previous graph 1 captivate an increase in capital adequacy of banks from central and eastern europe. this can be explained by the some restructuring and reducing the risk before merger, or consistent acquisition partner selection. however, the level of the years after the merger seems to be overly cautious, since the recommended minimum threshold is at 8%. conversely, banks from developed world economies reported relatively stable levels without significant trends at around 12%. profitability ratio indicators from all of profitability indicators, each of which focuses on a different type of profitability, was included in the analysis one of representative from each category. representations of the course are also most worldwide prevalent roe and roa. graph 2. shows the development of bank’s profitability ratio indicator r1 (net banking product * 100/ bankʹs business income) three years prior to the merger till period of three years after the merger. it is clearly visible that the group of banks from central and eastern europe after the merger increased the share of net banking product up to 75%. in the second group of banks throughout the whole period a clear downward trend with small stagnation economic analysis (2010, vol. 43, no. 1-2, 34-43) 38 in mergerʹs year, which means focusing on other areas, mainly on income from fees and commissions, or profits from financial operations. graph 2. bank’s profitability ratio indicator r1 40 50 60 70 80 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author graph 3. bank’s profitability ratio indicator r3 0 10 20 30 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author r3 indicator works with net profit before tax (r3 = net profit before tax * 100 / bankʹs business income + operating income + other income) and thus eliminates any tax differentials in all countries. already one year before the merger can be seen profit growth in both groups of banks, which continued also in subsequent years. so this indicator describes the merger as a great way how to increase net profit before tax. tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 39 graph 4. personal profitability r4 250 300 350 400 450 500 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author personal profitability ratio shows the effect which brings unit of labour in proportion to net banking product (graph 4). in international comparisons it is necessary to use net profit before tax due to different levels of taxation in different countries, and also apply profit to one employee. this comparison may indicate overstaffed banks or not very successful interbank organization, poor levels of technical equipment or in the extreme case low skilled and expertise of employees. optimization of branch network and reducing the number of employees is among the core theme of mergers. one might assume that after the merger it comes just increase of this parameter. however, in a group of banks from central and eastern europe was no bigger increase acting, even in the merger year there was a slight decline. and since labor costs were not growing by way to be able to explain this trend, mergers in this direction had not brought the desired effect. conversely group of banks from developed economies, recorded an increase to almost twice its value from the year before the merger and the trend seems to be strong enough also for the future. graph 5. return on equity – roe -30 -20 -10 0 10 20 30 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author economic analysis (2010, vol. 43, no. 1-2, 34-43) 40 graph 5. shows the performance of banks as measured by roe. it indicates to shareholders how effective their investments in shares are. visible is a positive increase in banks in central and eastern europe. already one year before the merger they reached a significant positive value and growth trend is maintained until the end of the period. by contrast the group of mergers in developed economies has value of roe still in the range 10 to 20% without significant changes in the mergerʹs year. thus the merger did not bring any significant effect to shareholders in the long run. graph 6. return on assets – roa 0,2 0,4 0,6 0,8 1,0 1,2 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author the fundamental problem of the indicator roe as the primary indicator of bank profitability, is that it does not take into account a possible leverage factor. the bank may indeed very easily increase its roe by increasing the total debt, namely use capital to cover a higher amount of assets. therefore, the analysis must be considered simultaneously with the second indicator roa. graph 6 roa shows how effectively assets are used to make a profit, then how much one unit of assets earns in average. the international standard is regarded as a value of 1.00 and as we can see, central european banks are reaching that point immediately one year after merger. in contrast with second group which are slightly below the standard and don’t exceed value of 0.8 throughout whole period of time. the following shape of curve caused japanese banks and their long-lasting crisis in its banking sector, which is marked by huge credit losses and overcapacity. market value indicator the most important indicator from this category is now considered the market price of shares, which immediately takes into account all relevant information affecting their level and is a very important tool for investors (graph 7). tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 41 graph 7. market price of shares 80 100 120 140 160 180 200 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author note except slovenská sporiteľňa, bcr, hvb bank and uni bank, which shares are not publicly traded. one year after the merger took place as expected, fall in central banks stock prices, but it was already deleted the next year and a year later, the average price reached 170% of the initial value. the curve of banks from developed economies has fall in mergerʹs year, but the following period was marked by a sharp strengthening price of shares up to 190% of initial value in the third year after the merger. graph 8. total loans / total assets ratio 35 40 45 50 55 60 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author one of the most important indicator for financing small and medium-sized enterprises (sme) belongs the volume of total loans to total assets (graph 8). which are in the banking practice divided in loans to households and small entrepreneurs, large corporate clients, special funding and loans to smeʹs. now we pay attention just to the last item which is drew in graph 9. economic analysis (2010, vol. 43, no. 1-2, 34-43) 42 graph 9. sme’s loans / total assets ratio 9 10 11 12 13 14 15 16 -3 -2 -1 year of merger 1 2 3 central and eastern europe developed countries source: author the share of smeʹs loans to total assets has a very similar trend as total loans to total assets. we can observe a significant trend of divergence in two groups since year before the merger, which is getting stronger every following year. mergers in the our region didn’t contributed to a better allocation of loans for small and medium-sized enterprises, but commercial banks are now paying increasing attention to the segment of small and mediumsized enterprises [8]. which do not provide such large volumes of transactions as large corporate customers, but better margins and future potential. this led in 2008 to increase of lending volume to this segment about the fifth, sometimes up to 30 %. conclusion the success of the merger affects many factors. we could say most important are managing rationalization of operations, gaining access to new banking techniques, optimizing economies of scale, portfolio diversification, synergy, and not least the success of the merger determine choosing of financing method of the merger. assessment of the merger success after several years of difficult, but most obvious way seems to be using different analytical methods and ratio indicators that can provide a fairly comprehensive view of economic performance following years after the merger compared to the years before the merger. all indicators should be monitored and assessed in longer period of time and it should be noted that even slight changes in the indicator level may indicate changes in the range of customers or changes in the financial market. the capital adequacy is showing some differences between merger groups. central and eastern europe region in the second year after the merger amounted value exceeding 15 %, so although in the eyes of clients were more secure, on the other hand, this meant reduction in institutions profit contributing to the unit of capital. profitability indicators also speak in favor of the merger in central and eastern europe region. mergers in our region didn’t contributed to a better allocation of tej, j., economic assessment of selected bank mergers, ea (2010, vol. 43, no, 1-2, 34-43) 43 loans for small and medium-sized enterprises, but commercial banks are now paying increasing attention to the segment of small and medium-sized enterprises. better results of banks in transition countries in central and eastern europe, is generally attributed to a significant restructuring and rationalization process, which took place before the merger itself to attract acquisition partners. to evaluate the impact of mergers on banksʹ financial results can be done not only with using these methods and indicators, but also in other ways. summary the study gives an overview of the economic situation coupled with the merger of banks in the area of central and eastern europe in comparison with developed markets in the world. it applies to different types of mergers of banks ratio indicators, the market value of shares and capital adequacy. attention turns also to the issue of smeʹs loans measured by the range of indicators. references baláž, p., verček, p. globalizácia a nová ekonomika. bratislava: sprint, 2002, s.135. isbn 80-89085-067. davis, s. i. bank mergers. lessons for the future. london: macmillan 2000, s. 97. isbn 978-0-312-235529. kotulič, r., király, p., rajčíniová, m. finančná analýza podniku. bratislava: iura edition, 2007. 206 s. isbn 978-80-8078-117-0. mařík, m. určování hodnoty firem. 1. vyd. praha: ekopress, 1998, s. 12-13. isbn 80-7079-938-2. polouček, s. bankovnictví. 1. vyd. karviná: su v opavě 2005, s. 243. isbn 80-7248-264-5. polouček, s. a kol. bankovnictví. 1. vydání. praha: c. h. beck, 2006, s. 490. isbn 80-7179-462-7. rákoš, j. základy finančnej analýzy. in: manažment projektov v regiónoch. prešov: manacon, 2005, s. 83-100. isbn 80-89040-27-6. tej, j., brecik, m., krasnodębski, a. small and medium enterprise one of the aspects of the regional development. in: acta agraria et silvestria. vol. xliv/2: series agraria; sekcja ekonomiczna. kraków: wydawnictwo oddzialu polskiej akademii nauk, 2005. tej, j. ml., tej, j. ekonomické zhodnotenie fúzií vybraných bánk v regióne. in: anno 2009. prešov: pu v prešove 2009, s.191-202. dostupné na: http://www.pulib.sk/elpub2/fm/kotulic10/index.html, isbn 978-80-555-0005-8. received: 11 january 2010 article history: accepted: 23 march 2010 ea_2012_1_2 original scientific paper macro-prudential view of financial stability momirović dragan*, university union belgrade, faculty of business and industrial managemenet mladenovac, serbia zdravković dragan, svecom doo, beograd udc: 330.33.012 jel: e-32; g-15; f-42 abstract – the paper points out the key features of "macro prudential" new framework, accepted by all relevant international institutions, in an effort to mitigate the externalities that can lead to vulnerability of the financial system and trigger a systemic risk. the emergence of the term dates back to the seventies, which over time have been almost forgotten, that was resurrected again in the second half of 2008, after a major global economic crisis. there is no single universal precise definition of "macro prudential", although most definitions contain several common characteristics. i focus on systematic risk, defines the key objective "macro prudential" or the regulation and supervision of the financial system as a whole rather than individual institutions. to limit the risk of global financial shocks, suggest different macro prudential indicators and instruments for assessing the health of the financial system and its vulnerability to shocks. the regulation and supervision of the financial system used macro prudential tools that are designed to enable efficient control policies, with particular focus on improving the resilience of the financial system impact of systematic risk. macro prudential analysis focuses on factors that may threaten the stability of the financial system and the interrelationship between macroeconomic and financial stability. macro-prudential application is based on rules or discretion, the entire system or individual financial institution, national or global level. key words: macro-prudential, macro-prudential instruments, macro prudential indicators, macro prudential tools, macro-prudential analysis introduction after the great depression in the second half of 2008 year almost forgotten name "macroprudential" is "like a phoenix from the ashes" suddenly became the most widely used term in economic literature and economic debates. initiatives have emerged from the major relevant organizations and institutions in order to identify future sources of risk and adoption of operational guidelines in the form of recommendations aimed at preventive action, possibly on a possible, future global economic crisis. initiatives have focused on issues of implementation and development process in macro-prudential damping systematic risk and resilience of the financial system from future shocks and earthquakes, in particular, from the standpoint of international integration with post-ante implications. * dragomomirovic@gmail.com economic analysis (2012, vol. 45, no. 1-2, 45-58) 46 a key approach to the international community has a strong international focus on the analysis of financial stability, which has increased the scope of analytical challenges for economic policy makers. innovations are already visible through greater government commitment to effective cross-border cooperation, in regular exchanges of information and so on, and on the horizon and the formation of new frameworks for cooperation. it is the subject of this paper is that on the basis of relevant literature, point to the theoretical aspect, key terminology and the main features macro-prudential process, in order to clerks in the absence of literature in the serbian language, initiate further discussion on the specifics macro-prudential approaches have the appearance of systemic risk, due to the effects of shocks and external elements, which may cause the vulnerability of the financial system. the paper consists of eight parts. the first part indicates the origin and evolution of the term "macro-prudential" in the second part discusses different approaches to defining "macro-prudential", the third part deals with a number of definitions of systemic risk on the basis of which is determined by a key objective macro-prudential from which they derive, and other intermediate goals in the fourth explains the macro-prudential indicators used for assessing the vulnerability of the financial system and is mainly related to the health of individual institutions and the macroeconomic variables, in the fifth points to a wide array of instruments that can be used for amortization of systemic risk, with the aim of adapting existing macro-prudential tools toward the development of prudential standards and to mitigate the negative tendencies that can produce systematic risk, in the sixth discusses macro-prudential tools that can be used for monitoring with special emphasis on improving the resilience of the financial system from the impact of externalities, and amortization of pro-cyclical trend of market participants, in the seventh based on the reference frame imf considers macro-prudential analysis with special reference to its role in the timely identification of factors that endanger or likely to cause financial instability, and then the crisis. finally, it discusses the implementation macro-prudential perspective. origin and evolution "macro-prudential" the international financial crisis that emerged in the second half of 2008 has sharply risen, "the old idea whose time has come" (borio, 2009) almost neglected macro-prudential orientation. the emergence of the term "macro-prudential" two-dating the late seventies, when used in the debates of the bank for international settlements (bis) to indicate a systematic relationship between the broad orientation of regulatory and supervisory framework and macroeconomics. later, during the mid-eighties, the term "macroprudential" was first used by the general public the economic, in the context of the ecsc (european coal and steel community) report on the "innovations in international banking, devoting several paragraphs to the" macro-prudential policy." the report is defined as a policy "that broadly promote security and stability of financial systems and payment mechanisms." in a report titled "macro-prudential issues related to financial innovation for the period 1980-90. whatever. "examines how financial innovation can cause a risk to the entire financial system" (clement, 2010) with special emphasis on securitization and derivatives markets, as major carriers of growth in capital market activities. i report, points to certain weaknesses that specifically relate to regulatory arbitrage, low-risk evaluation of momirović, d., et al., macro-prudential view, ea (2012, vol. 45, no, 45-58) 47 new instruments, the overestimation of their own liquidity risk due to the invisibility of the interconnectedness of financial institutions (risk of concentration risk), delay in payment and settlement due to the enormous increase of transactions and stronger growth in total debt. the report was intended for the basel committee, expressing different views and concerns on the one hand ecsc, on the other bank auditors who are focused on individual institutions. the conclusion was that the preferred approach of functional institutional control, with the ability to avoid gaps in regulation. in the future the term "macroprudential" has almost ceased to be used except in the bis documents, especially the ecsc, but in public statements and written documents rarely could find. only after the report ecsc in 1992 years linked to developments in international banking relationships, "macroprudential" gets a new look. the report was criticized by a group of g10, which are related to the role and interaction of banks in non-traditional markets, especially in the derivatives markets, insisting, at the same time, to examine the links between different segments of the interbank market and the active players in them, and to consider macro-prudential issues that may arise from these aspects. ecsc working group is in a later report brockmeijer report from 1995 years, which treats issues in measuring market size and macro-prudential risks in derivatives markets kept this term, and the main features of the report relating to the lack of transparency in the derivatives market, market concentration in several institutions, whose decisions can affect liquidity. at the same time, the term appears in the annual report of the bis in 1997 years, the part that deals with the evolution of central banking. in any case, the term used for the analysis of policies to improve the stability of the entire financial system, with particular focus on mutual, interactive relationship between institutions and markets. macro-prudential term, the later nineties began to be used outside of central banking. in particular, the term is expressed 1997th years in the wake of the asian crisis. mmf was first pointed out macro-prudential analysis, 1998 years as "effective control of banks, which must be continuously present. this is mainly achieved through an external (off-site) supervision in macro-prudential and micro scale. macro-prudential analysis is based on macroeconomic and market intelligence data and focus on important developments in asset markets, other financial intermediaries as well as macroeconomic trends and potential imbalances. the main policy is to monitor the development of better statistics, which should assess the vulnerability of the financial system, the so-called macro-prudential indicators. "(imf, 2000) it was only the beginning of the new century began the first efforts toward a more precise definition macro-prudential process with the aim of finding some implications toward building new architecture macro-prudential solutions. the architect of this effort was the then director general of bis e. who in a speech in 2000 the "international conference of banking supervisors macro-prudential and comparative view of macro-prudential regulation and super-review", advocated that financial stability can be achieved by strengthening macro-prudential perspective. he pointed to two different aspects macroprudential approach. the first aspect focuses on the entire financial system with the aim of limiting the costs of financial distress in the real sector. second, it refers to the recognition that the overall risk depends on the behavior of financial institutions. micro-prudential approach is defined as limiting the risk of failure of individual institutions. the result of the adverse effects of externalities is included. economic analysis (2012, vol. 45, no. 1-2, 45-58) 48 later, this perspective has developed borio (2003). during this period, use of the term becomes widely accepted and used together (for example, imf 2000). after that, many countries have gradually begun to increasingly use the term macro-prudential perspective, as already suggested by the works of knight (2006), white (2006) and bis (2008), to the outbreak of major global crisis in the second half of 2008 years received an extraordinary impetus and importance in the direction of application in order to combat the spread of infection to the crisis. the term is widely accepted by politicians and the academic community that fought (2009) cited a reference, "to paraphrase milton friedman might say that we are all macro-prudential now." the old idea whose is coming. terms used in wide academic and political circles have two dimensions. deliberately styling the two views is intended to indicate the orientation of the two co-exist with each other in the existing framework macro-prudential perspective. the first orientation focused on the overall financial system and is aimed at limiting the macroeconomic costs of episodes of financial distress. such an approach is viewed as the aggregate risk depending on the overall behavior of financial institutions, and their interconnection, and exposure to (endogenous). the second orientation is subsequently recognized by many researchers and policy makers, and addresses the risks outside the financial system (exogenous) and focused on the individual agents who are primarily related to asset prices, credit market conditions and other economic activities. in parallel, the use of the term remains ambiguous. in some situations the term is used interchangeably with prudential approach in order to limit the impact of procyclicality in the financial system as a major cause of financial instability. in other cases it is still unclear in terms of benefits designed to indicate the approach to address widespread or systematicsystematic risk. the definition of "macro-prudential" in economic literature there is no single, precise, uniform definition of "macroprudential". basically, the definition varies depending on the needs of research, although in fact can elaborate several common characteristics most definitions. (future group of thirty, 2010) 1. "macro-prudential" seeks to monitor, assess and provide appropriate policy responses to the development of the financial system as a whole rather than focusing on individual financial institutions or to single isolated policy measures, 2. macro-prudential "aims to improve the resilience of the financial system and to mitigate systemic risks that arise and propagate in the internal financial system through the relationship of institutions on the basis of joint exposure to shocks and trends of behavior of financial institutions in the pro-cyclical situations in a way to increase extreme financial cycles 3. macro-prudential "used on a regular basis a lot of tools to control the degree of solvency required to mitigate pro-cyclical tendencies, but they are applied in order to reduce systematic risk and increase resilience of the financial system to absorb this risk, momirović, d., et al., macro-prudential view, ea (2012, vol. 45, no, 45-58) 49 4. recognizing the complementary nature "macro-prudential" in other areas of economic policy, supervisors responsible for implementing macro-prudential policies, either through a new coordinating organization or as part of existing institutions, must inform and be informed of the monetary, fiscal and other government policies, and to give primary responsibility of other entities in these areas. borio (2009) the most prominent advocate in the bis survey "macro-prudential", gives the following definition: "the basic definition of "macro-prudential" a belief or perspective of the regulatory and supervisory arrangements." on the premise of the basic definitions, he defines three basic functions of access control and surveillance "macro-prudential", referring to the objectives, focus and risk characterization. by the same author, other definitions out of context bis have such importance. he cites two interpretations, the first "macro-prudential" seen as a synonym for any effective policies to promote financial stability and limit systemic risk, noting that such a definition is too broad, and before they could be used as a "policy of financial stability. further, argues that any policy can have significant impact on financial stability, citing, monetary and fiscal policy. according to him, the original term to promote a different use of prudential tools in the direction of the search for better financial stability. (see, borio, 2009) the second view sees "macro-prudential" as a synonym for any effective policy or just as any regulatory and policy relating to too many big problems are the same or neglect, or systematic important financial institutions (sifi-s). for each individual financial institution can be "systematically unimportant" but collectively may be "systematically important" always when there is a possibility exposure to risk, no matter if in question assets or debt. this definition does not recognize the time dimension of the problem and ignores the correlation between exposures to all institutions. also, the economic literature is therefore considered that the definition of "macroprudential" can be distinguished on several grounds, as a criterion for success, a balance between aggregate and sector approach, a balance between rules and discretion. objectives "macro-prudential" "macro-prudential" focuses on the interaction between financial institutions, markets, infrastructure and the wider economy. (committee on the global financial system, 2010). determination macro-prudential goals require the prior definition of systemic risk. there are many definitions of systemic risk. thus, ferguson (2010) defines systematic risk "as a situation characterized by the following three basic criteria: 1) some important set of financial asset prices are sharply separated from the base, or (2) the availability of credit market functioning in the country and perhaps internationally a significant distortion, with the result (3) the aggregate spending deviates (or is likely to deviate) significantly above or below the capacity of the economy to produce.” this definition of systemic risk caused some confusion among many, that ambiguity causes (difference from base rates) with effect (distortion of financial markets, credit availability and aggregate consumption). besar, d., and other authors (2009/2010) instead of the previous proposed definition that covers non-financial and financial systematic risk, "the economic analysis (2012, vol. 45, no. 1-2, 45-58) 50 systematic risk conjunctures when the initial disturbance transmitted through the interconnections that link businesses, households and financial institutions with each other , leading to the result of failure or degradation of these networks." analogous to the previous definitions, milne (2010) provides a definition of financial instability, indicating that the systematic risk occurs when there is "widespread collapse of financial flows." at the same time, it means the result, but not necessary materialization of systemic risk of the financial system. because this risk can be achieved in one part of the financial system (example market distortions derivatives 2005 years, when ford and general motors lost its investment rating) and not extend to the entire financial system and not cause interruption of financial flows. imf, fsb, bis and g20 propose the following working definition of systemic risk: the risk of distortion of financial services that is caused by damage to all or certain parts of the financial system and has the potential serious adverse effects on the real economy (caruna, 2010) . as noted by milne, the emergence of financial instability, has certainly resulted in the reduction of economic activity, but also involves systematic risk, although such a phenomenon inevitably leads to downward phase conjunctures cycle and transformation of economic activity, with a tendency to expand the systematic risk, the trend water in a deep recession, less depressed. basically systematic risk comes from two sources: (bank of england, 2009) 1. there is a strong tendency to common financial firms, and firms and households, that is too much at risk in the period of the revival of the credit cycle and become too averse declining 2. individual banks usually do not take into account the spillover effects of their activities on the risk in the rest of the financial infrastructure. the immediate goal "macro-prudential"4 is to limit the risk of episodes of global financial troubles, her ultimate goal is to avoid or restrain those costs generated by the real sector. in addition to this, a key, a widely accepted goal, other indirect, practical goals, not less, important is: • strengthening the resilience and the ability of the financial system from the impact of economic and other adverse aggregate shocks and stress, • focus on the risk of the entire financial system and not on individual institutions, • active causing limitation (mitigating) the financial risk, direct the focus on financial imbalances, • limiting the risk of episodes of global financial troubles, to cover the costs of macroeconomics, • enhancing the adaptability of the system stability and security of providing credit and other financial services, thereby focusing on finding sources of direct address systematic sources. define macro prudential policy objectives, not simply whether they are formulated in broad and a qualitative sense.for very complex and multiple nature of the financial system is, the creators and theorists, serious challenges in the design and development of quantitative characterization of multiple operating stability. momirović, d., et al., macro-prudential view, ea (2012, vol. 45, no, 45-58) 51 table 1. macro-prudential objectives within the general objectives and instruments: a stylized comparison objectives how to improve the resilience of the financial system to shocks cycle how to mitigate the financial the general approach to achieving goals recalibrate micro tools taking into account the systematic risk using dynamic tools in response to the financial cycles key characteristics of the instruments they can be micro or macro style (i.e., institutional-specific elements in the implementation and calibration the tendency towards a macro-style: widely used, for example, all banks or markets the frequency adjustment generally less or maybe once (for example, in response to structural changes in the system), and frequent change and possible adaptation they have a tendency to periodic monitoring and frequent adjustments in response to changes in the financial cycle source: report submitted by the committee on the global financial system, macro-prudential instruments and frameworks: a stocktaking of issues and experiences cgfs papers no 38 2010 macro-prudential indicators evans (2000) and hilbers (2000) attempted to determine the definition of indicators macro-prudential stating that they are "indicators of health and stability of the financial system that can be used to assess its vulnerability to shocks." macro-prudential indicators generally include micro-prudential indicators of the financial health of individual institutions and the macroeconomic variables that may affect the stability of the financial system. total micro-prudential indicators express the state of the financial health of institutions, and macroeconomic variables are leading indicators that signaled the economy, the variables that could potentially affect the health of the financial system. table 2. summary indicators macro-prudential aggregate macro-prudential indicators macroeconomic indicators capital adequacy aggregate capital ratios the frequency distribution of capital ratio asset quality lending institutions sect oral credit concentration foreign currency-denominated lending nonperforming loans and provisions loans for losses-making public sector entities risk profile of assets connected lending leverage indicators economic growth aggregate growth rates the sector decline balance of payments the current account deficit adequacy of reserves external debt (including the maturity structure) terms of trade composition and maturity of capital inflation volatility of inflation economic analysis (2012, vol. 45, no. 1-2, 45-58) 52 aggregate macro-prudential indicators macroeconomic indicators borrowing entity financial leverage, the ratio corporate profitability other indicators of corporate status household indebtedness management of safety expense ratio earnings per employee growth in the number of financial institutions earnings and profitability return on assets return on equity income and expenditure structural indicators of profitability liquidity central bank credit to financial institutions segmentation of interbank rate deposits in respect of monetary aggregates loans-to-deposits ratios maturity structure of assets and liabilities (liquidity assets ratios) measures of secondary market liquidity sensitivity to market risk foreign exchange risk interest rate risk equity price risk commodity price risk market-based indicators market prices of financial instruments, including equity indicators of excess yields credit rating sovereign yield spreads interest and exchange rates volatility in interest and exchange rate level of domestic real interest rates exchange rate sustainability exchange rate guaranteed lending and asset price boom lending boom asset price boom contagion effects trade spillovers financial markets correlation other factors directed lending and investment government's recourse on the banking system arrears in the economy source: staff team, macro-prudential indicators of financial system soundness led by owen evans, alfredo m. leone, mahinder gill, and paul hilbers imf washington dc 2000 macro-prudential instruments "macro-prudential" uses a wide range of instruments to address and mitigate systemic financial risk, including the instruments used to achieve other economic goals. the emphasis is on developing and adapting existing instruments macro-prudential micro-prudential tools, aimed at strengthening prudential standards and limiting activities that may cause increased systemic risk. the standards and restrictions often vary, which requires their adjustment to alleviate the financial cycle. in this context, it is necessary to dynamically adjust the instruments (in accordance with the macro-financial stability), designing such a framework will be able to withstand and prevent financial "excesses" and episodic shocks that may arise under the influence of various externalities. (momirović, 2010) momirović, d., et al., macro-prudential view, ea (2012, vol. 45, no, 45-58) 53 in table 3 some examples are shown macro-prudential instruments relating to the main factors that may affect or limit the risk, as well as components of the financial system. these macro-prudential instruments are used to promote flexibility and limit exposure of the financial system from shocks and vulnerability affected by externalities. table 3. macro-prudential instruments-the vulnerability of financial systems and components v u ln e ra b il it y components of the financial system bank deposit or recipients nonbanking investors securities financial infrastructure balance sheet debt agreements l e v e ra g e , ⋅ equity ratio ⋅ weight risk booking ⋅ restrictions on profit distribution ⋅ ceiling of credit growth ltv ceiling debt service / income ceiling maturity margin / limit difference between the market value of securities and the value of their coverage l iq u id it y o r m a rk e t ri sk ⋅ liquidity / reserve fx borrowing limit ⋅ currencyharmonized limit ⋅ limitation of open fx positions valuation rules (egg the imf) the local currency or fx reserve balance of the central bank trade exchange c o n n e ct io n ⋅ the concentration limits ⋅ the systematic addition of capital charges ⋅ subsidiary contracting opposite sides source: report submitted by the committee on the global financial system, macro prudential instruments and frameworks: a stocktaking of issues and experiences cgfs papers no 38 may 2010 macro-prudential tools macro-prudential tools for managing systemic risk can be centered on four groups: (the group of thirty, 2010) 1. avoiding the levels of leverage, systematic risk, 2. ensuring a sufficient level of liquidity to well functioning markets, 3. prevention of excessive credit expansion, economic analysis (2012, vol. 45, no. 1-2, 45-58) 54 4. the regulation of market activities that could pose a systematic risk. macro-prudential tools are designed to enable efficient control policies, with particular focus on improving the resilience of the financial system to systemic risk of stroke caused by economic shocks. emphasis is on alleviation of internal risks arising from the interaction between companies and markets and pro-cyclical tendency of market participants. tools "macro-prudential" not primarily intended to prevent the economic cycle or to eliminate risk entirely, but are targeted at the worst effects of systematic risk. thus, macro-prudential tools are applied to all important institutions and activities based on the signals of macroeconomic indicators, regardless of whether they agree with it or not. there are two approaches in the implementation and enforcement macro-prudential tools, including: 1. variable approach, 2. fixed access. variable access refers to the use of tools in situation countercyclical capital depreciation, by changing variables to adjust automatically, or through regular modification macroprudential auditor depending on macro-prudential indicators that fluctuate with economic cycles. these tools are mostly used to limit pro-cyclical tendencies and associated risks that increase the economic crisis. fixed access refers to the use of tools such as the ratio of gross leverage, and the relationship between the ratios of financing; however, they do not have to be adjusted during the economic cycle. their goal is to build a more resilient financial system to systemic risk of stroke. macro prudential analysis macro prudential analysis is required, according to imf (2006), "financial soundness indicators (guide.de defines the reference frame, which includes four elements: 1. assessment of risk in the financial system from shocks, 2. application of indicators of financial stability, 3. analysis of micro-interactions, 4. monitoring the macroeconomic situation. macro prudential analysis focuses on factors that may threaten the stability of the financial system and the interrelationship between macroeconomic and financial stability. this further implies the ability to timely detect and identify factors that may threaten or cause vulnerable financial institutions to reduce credit risk, which if allowed to grow can cause an increased number of non-performing loans and lead to the inability of the banking system to perform its obligations. approach to macro prudential analysis is to monitor indicators from different sources and trying to identify a wide range of indicators, which could indicate an increase of imbalance at the macro level and which may represent potential sources of financial hardship. an important aspect of the analysis is the inclusion of structural and qualitative information in macro prudential analysis. (woolgord, 2001) momirović, d., et al., macro-prudential view, ea (2012, vol. 45, no, 45-58) 55 figure 1. components of macro prudential analysis source: davis, p., macro prudential analysis and financial soundness indicators brunel university west london, yahoo.com/group/financial stability, 2010 application macro-prudential the implementation macro-prudential framework is necessary to consider the limitations macro-prudential access and choice of tools will be applied. very important is whether the application should be based on rules or discretion. the application is based on the rule have better credibility and greater transparency, and lack of flexibility and the possibility of obsolescence due to market development. in addition, it may be more important to macro prudential regulation is based on our own attitude, that actors form their own policies based on their own judgments about the risks that are identified through recommendations macroprudential supervisor. it is important, point to the possibility of a combination of "limited discretion" and some rules in order to properly identify potential bubbles and realize their seriousness. then, there is a problem macro prudential application framework, is first applied to the entire financial system or individual institution. the balance between different objectives macro-prudential policy will depend, in any case, the focus of policy makers on the overall market or individual institutions. if the focus is on individual institutions within the larger economic cycle, then measures should be designed so that influences the balance of individual institutions. greater focus should be to mitigate credit cycle, thereby protecting the real economy from financial sector activity, and in that sense, the greater the need for tools aimed at the entire system. then, there is a problem of national or global approach. a new approach macroprudential control is much easier to implement at the international level to identify potential shocks than to answer them. it is important to have in early warning of the risks involved relevant international institutions (eu, g20, and imf). it is important to what is already working on international level early warning exercises. the basel committee is already economic analysis (2012, vol. 45, no. 1-2, 45-58) 56 working on developing tools to strengthen macro-prudential both sources of systematic risk, and developing tools to improve the resilience of individual institutions through countercyclical safety at the micro level, as a framework for the protection of the economy at the macro level. regardless, the international macro prudential framework is probable; in the future the main focus will be on a strong national government oversight and accountability for individual institutions and the management of national economies. efficient implementation macro-prudential framework includes the necessary institutional adjustments and international coordination, with a clear mandate, accountability and transparency. instead of conclusion on his way evolutionary, since the late seventies to the occurrence of major financial crises in the second half of 2008 year , the term "macro-prudential" was largely unknown and little used in the economic literature, they are talking about a small number of written works. virtual appearance, after the crisis has caused a flood of usage of the term by all relevant institutions. therefore, the focus has evolved to “macro-prudential ", especially in the works of the bis, which has clarified the term by bringing him in connection with its antonyms "micro-prudential". in this, the narrow sense, closer to its origin "macro-prudential" refers to the use of tools macro-prudential the explicit aim of promoting the stability of the financial system as a whole rather than individual financial institutions. from the very goals macro-prudential resulting control quality, the clarification of the risk of bubbles and the concretization of corrective measures to be taken, both at national and global level. "macro-prudential," seeks to reconcile the goals, knowledge and experience and control of various instruments. identification of target macro-prudential simultaneously requires customization tools macro prudential tools that are used to achieve these goals. there are many specific tools that can be used for the conduct of other policies, but is an important selection of suitable, whose selection should be based on a detailed assessment of potential impacts of activities targeted at specific segments of the economy, primarily in signaling the appearance of systemic risk and stress. no matter which instrument or combination macro-prudential tool is selected, it is important to weigh their potential impact on the real economy and financial institutions. the idea of applying macro-prudential aims to reduce pro-cyclicality and limit systemic risk, because they can have significant short-term impact on financial institutions, shareholders and all economic actors, which may reflect a temporary decrease in growth, increasing or reducing debt, reducing the return on capital and other economic variables. momirović, d., et al., macro-prudential view, ea (2012, vol. 45, no, 45-58) 57 references bank for international settlements. 1986. “recent innovations in international banking”, report prepared by a study group established by the central banks of the group of ten countries. basel. 78th annual report. bank for international settlements, basel. besar, d., p. et al. “systemic" risk in financial services”, british actuarial journal 14, an earlier version presented in the 2009/2010 sessional meetings is available www.actuaries.org.uk/knowledge/publications/. borio c. 2003. "towards a macro prudential framework for financial supervision and regulation?”. cesifo economic studies, 49(2/2003): 181–216. also available as bis working papers, 128. borio, c. 2009. “the macroprudential approach to regulation and supervision”. 2009 borio, c "the macroprudential approach to regulation and supervision". borio, c. 2009. "implementing the macroprudential approach to financial regulation and supervision". banque de france, financial stability review, no... 13 – the future of financial regulation. borio, c. 2010. „implementing a macroprudential framework: blending boldness and realism“. bank for international settlements, borio, brockmeijer report. 1995. issues related to the measurement of market size and macroprudential risks in derivatives markets, report prepared by a working bis quarterly review, march 2010 65group established by the central banks of the g10 countries, basel, february. caruna, j. 2010. “systemic risk; how to deal with it?”. bis. committee on the global financial system. 2010. “macroprudential instruments and frameworks: a stocktaking of issues and ehperiences”. cgfs papers, 38. clement, p. 2010. “the term “macroprudential”: origins and evolution“. bis quarterly review, march 2010. crockett, a. crockett, a. 2000. “marrying the microand macroprudential dimensions of financial stability”. bis speeches. davis, p. davis, p. macroprudential analysis and financial soundenees indicators brunener university west london, yahoo.com/group/financial stability evans, o. 2000. “macroprudential indicators of financial systems soundness”. imf occasional paper, 192. ferguson, rw. "should financial stability be an explicit central bank objective”. in challenges to central banks of globalized financial systems, ed. p. ugolini, a. ugolini, a. schaechter and m. and m. schaechter stone, washington dc: international monetary fund. group of thirty financial reforms: a framework for financial stability. 2009. washington future group of thirty washington, dc 20036. 2010. „enhancing financial stability and res diligence: macroprudential policy, tools, and systems”. imf. 2006 financial soundness indicators (the guide). knight, m. 2006. “marrying the micro and macroprudential dimensions of financial stability: six years on”, speech delivered at the 14th international conference of banking supervisors, bis speeches. milne, a. and m. onorato. 2010. “risk-adjusted measures of value creation in financial institutions”, european financial management, in press. momirović, d. 2010. “makroprudencijalne perspektive i novi izazovi za centralne banke”. finance, journal of theory and practice. 1-6/2010, beograd. economic analysis (2012, vol. 45, no. 1-2, 45-58) 58 report submitted by the committee on the global financial system. 2010. „macroprudential instruments and frameworks: a stocktaking of issues and experiences”. cgfs papers 38. staff team led by evans, o., leone, gill m. mahinder and p. hilbers. 2000. “macroprudential indicators of financial system soundness”. washington: imf. the group of thirty. 2010. “enhancing financial stability and resilience macroprudential policy, tools, and systems for the future”. washington. woolford, j. 2001. “macro-financial stability and macroprudential analysis”. reserve bank of new zeeland: bulletin, 54(3). makroprudencijalni pogled na finansijsku stabilnost rezime – u radu se ukazuje na ključne karakteristike „makroprudencijala“ novog okvira, prihvaćenog od svih svetskih relevantnih institucija, u nastojanju da se ublaže eksternalije koje mogu dovesti do ranjivosti finansijskog sistema i izazovu sistematski rizik. nastanak termina datira još iz perioda sedamdesetih godina, koji je tokom vremena skoro bio zaboravljen, da bi ponovo vaskrsnuo, u drugoj polovini 2008, nakon velike globalne ekonomske krize. ne postoji jedna univerzalna precizna definicija „makroprudencijala“, mada većina definicija sadrži nekoliko zajedničkih karakteristika. sam fokus na sistematski rizik, definiše ključni cilj „makroprudencijala“, odnosno regulisanje i nadzor finansijskog sistema u celini a ne pojedinačne institucije. da se ograniči rizik od globalnih finansijskih šokova, predlažu se različiti makroprudencijalni indikatori i instrumenti za procenu zdravlja finansijskog sistema i njene ranjivosti na šokove. u regulisanju i nadzoru finansijskog sistema koriste se makroprudencijalni alati koji su dizajnirani tako da omogućavaju efikasnu politiku nadzora, sa posebnim fokusom na poboljšanje otpornosti finansijskog sistema na udar sistematskog rizika. makroprudencijalna analiza fokusira se na faktore koji mogu ugroziti stabilnost finansijskog sistema, kao i na međusobnu povezanost između makroekonomskih kretanja i finansijske stabilnosti. primena makroprudencijala zasniva se na pravila ili diskreciju, na ceo fiansisjki sistem ili pojedinačnu instituciju, nacionalnom ili globalnom nivou. ključne reči: "makroprudencijal", makroprudencijalni instrumenti, makroprudencijalni indikatori, makroprudencijalni alati, makroprudencijalna analiza article history: received: 25 march 2012 accepted: 17 april 2012 microsoft word 2009_3_4-korigovano.doc original scientific paper can exchange rate targeting stabilise inflation pressures in transition countries? case of the slovak and the czech republic neupauerová marianna, technical university of košice, faculty of economics čisárik peter, p. j. šafárik university in košice, faculty of public administration udc: 339.748(437.6:437.3) jel: e50, e52, e58 abstract each monetary strategy with its targeting has its strengths and disadvantages. however, exchange rate targeting can be very useful especially at the beginning of transition process as it helps to stabilise inflation. we try to evaluate effectiveness of exchange rate targeting in the slovak republic and in the czech republic using statistic methods. our conclusions can serve as an experience to other countries that are e.g. just at the beginning of their transition process. key words: exchange-rate targeting, inflation targeting, inflation rate, slovakia, the czech republic targeting in a monetary strategy central banks have several monetary strategies at their disposal. among the most common we can mention; exchange rate targeting, monetary targeting, implicit inflation targeting and explicit inflation targeting. according some economists e.g. patat (2002, 88), a final goal of a monetary policy should be first of all price stability. it is not in a conflict with other real economic goals at least not in a long term. the logic of patat idea is described in the picture 1: picture 1. positive effects of the price stability targeting source: patat, 2002 neupauerová, m. et al., exchange rate, ea (2009, vol. 42, no, 3-4, 18-28) 19 consequently, it may seem that the most suitable monetary strategy would be inflation targeting. however, it is not possible to apply inflation targeting in every country and at the beginning of transition process. it is believed, that even exchange rate targeting can help to stabilise turbulent inflation rate at the beginning of transitions. aspects of exchange rate targeting in the case of exchange rate targeting, exchange rate serves as a nominal anchor. final goal is low and stable inflation rate. a central bank applying exchange rate targeting tries to ensure stability of its exchange rate through interest rate changes and direct foreign exchange interventions. stabilised currency should enable to “import” low inflation from a reference country. in general, the reference economy is usually a developed country with stable macroeconomic indicators (rybková 2005, 23). a central bank usually applies the targeting when it uses fixed peg arrangements as an exchange rate system. this system can be divided into three subcategories: 1. crawling peg, 2. nominal exchange rate with wide or narrow oscillation bands, 3. central parity depending on one reference currency or more currencies (currency basket). currency basket can be very useful measurement in small and open economies at the beginning of their transition process. foreign currencies in the basket should be chosen according to their importance in external commerce with a chosen small and open economy. e.g. in the case of thailand it could be japanese yen and american dollar. in the slovak republic, currency basket comprised from the very beginning of the its existence, i.e. since 1993 five currencies: usd (american dollar) 49,6 %, dem (german mark) 36,1 %, ats (austrian shilling) 3,7 %, chf (swiss frank) 9 % and frf (french frank) 2,9 %. however, shortly afterwards, it was obvious that only two currencies had real importance in external commerce of the slovak republic. in 1994, currency basket comprised only two currencies: usd (american dollar) 40 % and dem (german mark) 60 %. the czech republic applied the same basket with the similar ratio: usd (american dollar) 35 % and dem (german mark) 65 %. consequently, we can expect quite strong relationship between inflation rate in germany and inflation rate in slovak respectively in the czech republic. probably the most important advantage of the exchange rate targeting is the positive effect of a reference country on inflation rate. the targeting can be recommended in the case of small and open economies where exchange rate influence significantly price level evolution. the weakness of the targeting can be an important drop of monetary policy autonomy. there is also a risk of unfavourable supply or demand shocks from the reference country to country in transition. another disadvantage can be lost of signals concerning market creating of domestic interest rates (rybková 2005, 22). advantages and disadvantages of the exchange rate targeting can be summarised as follows: main advantages of the strategy based on exchange rate targeting are following (nell, 2004, 8): economic analysis (2009, vol. 42, no. 3-4, 18-28) 20 • central bank uses automatic mechanism: a. depreciating factors cause monetary policy restriction. b. appreciating factors lead to monetary policy release. • central bank is characterised by high transparency. consequently, time inconsistency is lower. • advantage for transition countries aiming disinflation is that exchange rate targeting is good signal for creation of private sector expectations. disadvantages of this strategy are e.g. following: • domestic interests are less followed. • economy looses its independency in monetary field. • economic chocks are transferred from external chocks more sensitively. • vulnerability caused by financial crises is higher. • capital controls are necessary in order to prevent speculative attacks in the capital field. effectiveness of exchange rate targeting in the slovak and in the czech republic in 1990’ is analysed in the following part of the paper. exchange rate targeting in the slovak and in the czech republic we have tried to test relationship between inflation rate in the reference country i.e. germany and inflation rate in the slovak republic and in the czech republic during 1990’. in other words, if imported inflation from germany helped to stabilise inflation evolution during transition process in the two countries while their central banks were applying exchange rate targeting. we have used statistic methods in evaluation of this relationship. the case of the czech republic time series of inflation rates in germany and in the czech republic were tested by rybková (2005, 24). it is represented in the following figure: figure 1. relation between cpi in the czech republic and germany 90 95 100 105 110 115 120 125 130 ja n93 a pr -9 3 ju l-9 3 o ct -9 3 ja n94 a pr -9 4 ju l-9 4 o ct -9 4 ja n95 a pr -9 5 ju l-9 5 o ct -9 5 ja n96 a pr -9 6 ju l-9 6 o ct -9 6 ja n97 a pr -9 7 ju l-9 7 o ct -9 7 c p i a n n u al c h an g e czech republic germany source: rybková (2005, 24) neupauerová, m. et al., exchange rate, ea (2009, vol. 42, no, 3-4, 18-28) 21 it is obvious from the graphic that time series of inflation rate in the czech republic is more and more similar to the inflation evolution in germany over the observed period. initial inflation pressures had been stabilised. the graphic ends at the end of the year 1997 as it is end of exchange rate targeting in the czech republic. since 1998 the targeting was substituted by implicit inflation targeting and later on by explicit inflation targeting. adjusted coefficient of determination adj r² reached 95,89 that is high value of correlation between the two time series (rybková 2005, 24). yet, it is important to test if it is not only seeming correlation. it is possible to use regressive analysis of residuals of both time series to deny seeming correlation. figure shows that there are neither cyclical nor seasonal elements. thus, residuals can be calculated as values of time series minus values of trend function. it was possible to deny hypothesis on independence of residuals. in conclusion; residual values of both time series are dependent and original assumption about dependence of both time series was correct (rybková 2005, 25). the case of the slovak republic we have tried to evaluate time series of inflation rates in germany in comparison with slovakia: figure 2. relation between cpi in the slovak republic and germany 90 95 100 105 110 115 120 125 130 ja n v -9 3 a v r9 3 ju il -9 3 o ct -9 3 ja n v -9 4 a v r9 4 ju il -9 4 o ct -9 4 ja n v -9 5 a v r9 5 ju il -9 5 o ct -9 5 ja n v -9 6 a v r9 6 ju il -9 6 o ct -9 6 ja n v -9 7 a v r9 7 ju il -9 7 o ct -9 7 czec h republic germany source: own representation according to statistical office of the slovak republic data observation ends in december 1998 when national bank of slovakia stopped to apply fixed peg arrangements and exchange rate targeting. slovakia lost its nominal anchor, however central bank adopted new nominal anchor only since 2000. consequently, slovakia was without any nominal anchor during one year. this situation was extremely dangerous. despite very cautious and rational policy of the national bank of slovakia since its creation economic analysis (2009, vol. 42, no. 3-4, 18-28) 22 in 1993 till nowadays, this measurement was very risky. however, fortunately, nothing malignant happened to slovak economy during this period. evolution of this comparison is very similar as it was in the case of comparison between german and czech inflation. even we can prove that the correlation between the time series is high as the value of adjusted coefficient of determination adj r² is 93,24. it is little bit lower than in the case of the czech republic. it can be explained by higher volume of external commerce between the czech republic and germany than between slovakia and germany. consequently, ration in the currency baskets was slightly different. analogically, we tested if the correlation is not only seeming one. using trend analysis, trend function and f-test we can deny hypothesis on independent residuals. as they are independent, we can confirm original idea that time series concerning inflation rate time series in germany and in slovakia are dependent. overall evaluation of exchange rate targeting exchange rate targeting had positive effect on stabilisation of inflation rate in slovakia and in the czech republic. the targeting can be recommended also in the case of other countries especially if they are at the beginning of their transition process. moderate evolution of inflation in the slovak republic (sr) and czech republic (cz) at the beginning of transition process since 1993 to 1998 can be observed in comparison with chosen countries in the table 1. picture 2. inflation rate (consumer prices) – europe, in january 2008 source: index mundi neupauerová, m. et al., exchange rate, ea (2009, vol. 42, no, 3-4, 18-28) 23 up to now, inflation rate in slovakia and in the czech republic was comparatively low. consequently, we consider application of exchange rate targeting and currency basket to be very successful. it created favourable fundaments for macroeconomic stability. even today, the two countries are among the economies with low inflation rate in europe as it can be seen in the picture 2. in january 2008, inflation rate was 2% in germany, 2,6% in the czech republic, 2,7% in the slovak republic, 4,1% in poland, 6,6% in romania, 7,8% in hungary and bulgaria. table 1. average annual inflation in chosen countries, 1993 – 1998 country sr cz slovenia hungary poland romania bulgaria inflation, % 10,6 11,3 15,6 20,9 23,6 123,7 282,1 source: ilo yearbook of statistics 1998 success of exchange rate targeting in slovakia and in the czech republic was underlined by parallel application of monetary targeting, i.e. targeting of monetary aggregates. this combination seems to be very efficient in the case of both countries and can be recommended also for other countries especially at the beginning of their transition process. exchange rate targeting should have positive effect in transition countries on inflation stabilisation if the currency is anchored to a suitable foreign currency. however, evolution in financial markets, bank sector, monetary instruments and macroeconomic stabilisation of the transition country enable application of inflation targeting gradually. aspects of inflation targeting another possibility how to stabilize inflation evolution in an economy is inflation targeting. inflation targeting represents a monetary strategy based on absence of intermediate monetary policy objectives. central bank aims final goal that is again low and stable inflation rate. this goal should be attained directly through monetary instruments, usually through interest rates. bernanke, laubach, mishkin, posen (1999) define inflation targeting as a framework for monetary policy that is realized through public announcement of official quantified goals (or scales) for inflation rate. the rate is quantified for one or several future periods. this goal quantification should be accompanied by an explicit confirmation that low and stable inflation is a long-term primary monetary policy goal. five basic elements of inflation targeting (nell 2004, 12): • public announcement of mid term inflation goals by a numeric way. • price stability is a primary, final and long-term goal. role of other goals is just secondary and they are taken into account only for short term. • transparent and clear communication of plans, objectives and decisions towards public. monetary measurements are publicly announced too. all changes in monetary policy are explained to economic agents. economic analysis (2009, vol. 42, no. 3-4, 18-28) 24 • high rate of monetary authority accountancy. • economic agents that know precisely central bank strategy behave consistently with primary goal and consequently it fortifies activities of a monetary authority. conditions for an implementation of inflation targeting are following (nell 2004, 13-18): • central bank should have sufficient level of independence and thus it can fully bear responsibility for achieved results • central bank has to give up other nominal anchors in order to avoid a conflict between previous nominal anchors and price stability as a new anchor and new final goal. that is the reason why fixed exchange rate system usually is not compatible with inflation targeting. • declaration of price stability as a final goal itself does not express precisely what does it mean in fact. it is necessary to determinate an explicit numeric inflation target. • inflation targeting is characterised by dependence of goals and by independence of instruments. inflation targeting should be announced together by central bank as well as by government. that would mean indirect commitment of government to fortify inflation targeting by its fiscal policy. • fiscal policy should not be dominating policy in an economy. that is very common feature in transition countries. consequently, there is bigger risk of high inflation because of direct and indirect financing of state budget deficit. thus, pumping of central bank finance by government should be restricted (restrictions of so called credit links). monetary and fiscal policy should be coordinated. it means that fiscal inflation pressure should be eliminated in practise (brucháčová 2000, 28). • accountancy, transparency and comprehension of monetary strategy. • there should be certain assumptions for financial stability, financial system and institutional development in the economy. it enables independency in monetary instrument application. more developed financial markets enable better functions of the channels of monetary transmission and thus, more effective application of monetary policy. • central bank should be able to predict future evolution of macroeconomic indicators to aim an inflation goal in a more realistic way. the more precisely is evolution predicted, the more adequate monetary instrument is chosen. correct predictions require sufficient understanding of effects of monetary transmission channels; sufficiently long time ranks of macroeconomic variables and above all low sensibility of economy to different external and transformation chocks. • external stability, i.e. limited fluctuations of exchange rate is important as well. monetary strategy in the form of inflation targeting can be realised in two modifications: a) explicit inflation targeting (“full-fledged inflation targeting”) b) implicit inflation targeting (“light inflation targeting“) neupauerová, m. et al., exchange rate, ea (2009, vol. 42, no, 3-4, 18-28) 25 explicit inflation targeting central bank fulfils all five above-mentioned elements of inflation targeting in this monetary strategy. monetary authority predicts explicitly inflation rate and announces explicitly and publicly numeric value of inflation goal in mid term. it meets its engagements strictly and precisely. monetary policy is in this case relatively straightforward, outright: application of a unique main monetary instrument unique operational objective unique nominal anchor (i.e. unique final goal) implicit inflation targeting central bank fulfils only some aspects of five above-mentioned elements of inflation targeting in this monetary strategy. monetary authority realises sort term and explicit predictions. it sets value of final goals in short term in implicit way, i.e. not officially. it does not have to meet targeted value so strictly and precisely. there is not such a big public control. monetary policy is in this case less straightforward, outright: application of several main monetary instruments mixed package of operational objectives several nominal anchors (i.e. several final goals) main reason for implication of implicit inflation targeting instead of explicit one is partial or complete absence of necessary conditions for monetary strategy in the form of inflation strategy. central bank has for instance insufficient knowledge about transmission channels, thus it applies several instruments and goals. implicit inflation targeting should be just temporary strategy before implementation of proper explicit inflation targeting. obstacles of inflation targeting implementation economies in the process of transition usually have to face several obstacles, therefore they can not implement inflation targeting from the very beginning. frequent obstacles for a small and open economy in transition can be following: • small and open economy is much more vulnerable to external chocks in comparison with other countries. thus, it is more complicated to forecast macroeconomic evolution and to maintain external stability of the economy, for instance exchange rate. transition countries have to face numerous unusual chocks because of the transition process itself (e.g. price deregulations, political and social changes). economic analysis (2009, vol. 42, no. 3-4, 18-28) 26 • other complications in predicting are connected with short time ranks of transition economies. these economies have at their disposal relevant macroeconomic data only after implementation of market economy. however, these difficulties will be gradually eliminated. • insufficient understanding of the channels of monetary transmission represents another obstacle for inflation targeting. • during first years of transitions, central banks prefer more often administrative monetary instruments in comparison to direct, i.e. market instruments. however, according to economic practise as well as economic theory, application of administrative instruments is considered to be less effective than application of market instruments. though, overall employment of market instruments is not possible from the very beginning as financial markets, systems and institutions are not sufficiently developed as it would be desirable. • less developed and less stable financial markets cause changes in price signals of assets. price changes do not provide enough information; even some signals about economic fundaments and market expectations can be incorrect. • fiscal policy should be in harmony with central bank monetary policy. otherwise, achieving of targeted objectives and goals is more complicated. monetary strategy in the form of inflation targeting can hardly exist in such a heterogeneous environment. • very important obstacle of inflation targeting is impossibility to control fully final goal by central bank. if the final goal of price stability is expressed through e.g. consumer price index (cpi) and changes in indirect taxes, price deregulations and other modifications are often realised by government, central bank can control and influence just small fraction of cpi. in the case of transition countries changes in indirect taxes and price deregulations are usually very frequent. thus, some countries target rather core or net inflation. for instance, check republic at the beginning of inflation targeting, i.e. since 1998 aimed index of net inflation. since april 2001 czech national bank targets overall inflation through consumer price index (cpi), and since 2004, after joining european union through harmonised cpi (cnb 2006). changes in net or core inflation are easier to predict than changes in overall inflation. however, indicators of core or net inflation are less understandable and accountable for public. this is in conflict with basic condition of transparency in inflation targeting. thus, some countries target overall inflation from the very beginning as e.g. poland since 1998 (brucháčová 2000, 26). basically, choice of inflation targeting indicator is a compromise between transparency and responsibility of central bank. if central bank chooses indicator of net or core inflation, its goal is mostly long-term trend of inflation evolution. choice of overall cpi indicator means that central bank wants to reduce even short-term inflation fluctuations. evaluation of inflation targeting in chosen countries if inflation targeting is applied when an economy is ready to meet above mentioned obstacles, it can lead to positive effects. however, declared targeting sometimes differs from neupauerová, m. et al., exchange rate, ea (2009, vol. 42, no, 3-4, 18-28) 27 real inflation rate. in the figure 3 we can compare success in inflation targeting in the czech and slovak republic, hungary and poland. there is the smallest difference between targeted and real inflation in the case of slovakia. in the czech republic, real inflation was lower than targeted one at the beginning of inflation targeting, respectively, real inflation was situated in the lower part of targeted zone. opposite evolution was in hungary where real inflation was in the upper part of the targeted zone or above it. polish central bank managed to fulfil its goal only twice during nine year targeting. figure 3. inflation targeting in visegrad countries success of inflation targeting depends on common effort of central government and monetary authority. the republic of serbia has implemented inflation targeting since january 1, 2009 following memorandum on the new monetary policy framework adopted in august 2006 (national bank of serbia 2008, 2). it declares coordination in economic policy. economic analysis (2009, vol. 42, no. 3-4, 18-28) 28 basic conditions for efficient targeting are fulfilled, however only reality will be able to test its capacity. conclusion exchange rate targeting seems to be an efficient measurement in stabilisation of inflation in countries in transition. however, it is necessary to choose a suitable foreign currency to which the domestic currency is anchored. combination of exchange rate targeting with monetary targeting can be even more successful. inflation targeting increases transparency of central bank policy and in general, it enables to reduce inflation rate even more. yet it can be applied only if a certain level of macroeconomic stabilisation is already achieved and if there is a common effort of government and central bank to meet targeted goals. references bartóková, ľ. 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(2008): “režim inflačného cielenia a konvergenčná stratégia.” in: biatec : odborný bankový časopis. roč. 16, č. 5, p. 26-29. ilo (1998): “yearbook of international labour statistics.” ilo, geneva in: marcinčin, a. a beblavý, m. 2000. hospodárska politika na sovensku 1990 – 1999. bratislava: centrum pre spoločenskú a mediálnu analýzu. isbn 80-968147-1-0 index mundi. (2009): “inflation rate (consumer prices) – europe.” in the internet: http://www.indexmundi.com/map/?t=0&v=71&r=eu&l=en mirdala, r. (2008): “vplyv makroekonomických šokov na vývoj menového kurzu a output vo vybraných krajinách sve (v modeli svar).” in: ekonomický časopis, 2008, roč. 56, č. 8 national bank of serbia. (2008): “memorandum of the national bank of serbia on inflation targeting as monetary strategy.“ in the internet: www.nbs.rs/export/internet/english/30/memorandum_monetarna_strategija_122008_eng.pdf nell, m. (2004): “monetary policy strategies – overview and evaluation.” working paper nbs. march neupauerová, m.; vravec, j. (2007): “monetary strategies form the perspective of intermediate objectives.” in: panoeconomicus. vol. 53, no. 2, p. 219-233. statistical office of the slovak republic data. (2008): “consumer price index.” in the internet: http://portal.statistics.sk/showdoc.do?docid=9513 received: november 2008 article history: accepted: july 2009 ea_2013_3-4 finalna ver notes from the editor-in-chief this issue of economic analysis is a special edition comes on the occasion of fifty-five years since the founding of the institute of economic sciences, which is the publisher of this peer journal. in this context, there is something more than the usual number of articles that are thematically divided into three segments: finance and banking, investments and competitiveness and employment and well-being. a great number of the articles take a tour through different approaches of the relationship between globalization, finance, investments, competitiveness or employment in terms of a global economic crisis. what gives the special quality to these papers is the fact that most of them are original scientific empirical papers, and as such they give a special contribution to the topics addressed in the journal. since this year, the journal is categorized with m52 by the ministry of education, science and technological development of the republic of serbia. thank you for the great work by all reviewers, and authors. we also expect your valuable contribution in the next year 2014. editor-in-chief professor dr. mirjana radović-marković, academician world academy of arts and sciences, united states academia europaea, london, united kingdom royal society of arts, london, united kingdom euro mediterranean academy of arts and sciences, athens, greece bulgarian academy of sciences and arts, sofia, bulgaria serbian royal academy of science and arts, belgrade, serbia (vice-president) microsoft word 2009_1_2.doc book preview: modern management concepts and topical issues (revised and adopted book for indian market) by prof. m. a. omolaja & prof. m. radović-marković publisher for us market: aardvark global publishing, salt lake city, ut, october, 2008, isbn -13: 978-1-4276-3508-2 publisher for indian market: himalaya publishing house pvt. ltd., mumbai, india publication date: april, 2009 pages: 596 in 21st century, globalization, privatization and liberalization process ignoring political boundaries has made the world into one village socio-economically and technically. either wto regime or regional organization regime pleads trade liberalization and multilateral trade regime for increasing share of developing countries in the global economic growth and income. however, giant multinational companies have been emerging in the world trade. in the labor market, good, efficient, and skill management and management students are in the great demand. in this context, this book, modern management: concepts and topical issues written by management gurus, prof. m. a. omolaja & prof. m. radovic-markovic is very relevant and urgent essential as a basic hand book. each of the 14 chapters provided a thorough explanations of managerial concepts supported by case studies and (or) figures to give clarity or visual representation. the collection of concepts will serve as a historical lens that managers can use to guide managerial practices, and researchers can use to guide studies. key terminologies and roles were introduced to refine the context. the context reinforced by beliefs that managerial skills are as essential as leadership skills. the context that centered on motivation gave me a better understanding of behaviors, approaches, perspectives, and positions of graduate learners who experience difficulties completing their dissertations. omolaja and radovic-markovic should be commended for applying the holistic approach, which various cultures and subcultures will appreciate. as a basic hand book of management guru mantra (key formulas), it insights minutely each and every core subject and issue of management and its relevancy in the simple layman’s language for uniform attraction and attention towards the book and also for making highly utility product to all (manager, administrator, students, etc). this adequately focuses on the principles and practice of management in the contemporary industrial and even governmental settings with a great deal of details. this is systematically presented into economic analysis 1-2 (2009) 79-80 8 the fourteen chapters arranged by chapter i nature of management, chapter ii management function, chapter iii organization in modern management, chapter iv specialized management technique, chapter v control in modern management, chapter vi corporate policy, chapter vii corporate strategy, chapter viii operational environment, chapter ix corporate objectives, chapter x managing employee at work, chapter xi organizational behavior, chapter xii employee’s motivation, chapter xiii basic tool of management and chapter xiv communication theory. they can be rearranged into four major parts: • part i-management chapters, part ii-organizational chapters, part iii-corporate body and • part iv-communication theory. if all relevant chapters are rearranged, it will get extreme excel and continuity. objectives of the book are to provide basic skills to all personnel engaging in multinational companies, corporate office and companies etc. in this, the authors are successful to justify it. theoretically, its presentation, structure, style and writing are interestingly motivated to me. i wish it would be effective to all readers, despite its lengthy chapters. however, in my notice, the authors have ignored practical sides of management for supplementing theoretical discussion and presentation. besides it, it doesn’t cover evolutionary part of management and trend of the world with out which the book seems to be incomplete. thus, unlink ages with market and real world that may be counter product when in market competition may erode quality and standard of the book because the reader needs completeness, real world picture and practical paradigm. despite these digestible shortcomings, its reflection is marvelous for basic foundation and skill of management. therefore, its usefulness to common people as well as academic and professional will be significantly noticeable and worthwhile. dr raghu bir bista, assistant professor, tribhuvan university, nepal and akamai university, usa microsoft word 2010_1_2.doc scientific review information resources for financial monitoring in enterprises kościelniak helena*, czestochowa university of technology, the management faculty, poland udc: 65.012.12 jel: d83 abstarct – for their operation, organizations employ a particular combination of human, financial, material and information resources. except for land, capital and labour, information has become the fourth means of production since it is used for achievement of the goals. not all information that appear in economy becomes a means of production; this happens only in the case of information which shows nature of economic resources. w. olejniczak emphasizes that a set of information, in order to become an economic value for an enterprise, must form an ordered set. financial monitoring is one of the most creative tools for management, allowing for creation of new information and decision-related resources. key words: financial monitoring, production, management, enterprise, decision-making, information information gap in the process of decision-making under conditions of changing economy, information performs three functions (penc 2001): • it is a commodity; transactions might concern information-related products (particular type of information saved on a suitable carrier) or information services which consist in acquisition and making available a particular piece of information, • it is a resource, i.e. a group of particular pieces of information collected in suitable carriers, available to potential users, used in widely understood social and economic life, • it is a production factor. • it is emphasized that information sets might be analysed in three aspects (olejniczak 1989): • syntax – by investigating the relationships between symbols representing economic information, without consideration of its content, • semantics – by investigating the content of economic information and the method of its representation by means of symbols, * address: armii krajowej 19b, 42-200 czestochowa, poland economic analysis (2010, vol. 43, no. 1-2, 91-98) 92 • pragmatics – by investigating economic information from the point of view of its value for the recipient. solving decision problems is connected with continuous accumulation of information. the difference between information which decision-makers would like to have and the information that can be actually acquired is termed ‘information gap’; it denotes sensation of lack of information, knowledge or understanding of a problem, which is necessary in decision-related situation. this indicates that it is of a highly subjective nature while its main properties include: • reference to a particular subject (lack of information sensed by a person is not necessarily sensed by another), • susceptibility to time factor (with the course of time and acquisition of information, the gap can be extended or reduced), • fuzzy information (limits opportunity to define its scope) (flakiewicz 2002). figure 1. the concept of information gap in the process of decision-making source: (rabin, jackowski 1988) for the purposes of management, it is essential that a particular quality of the prepared information, being the basis for decision-making, is ensured. this problem was emphasized by j. penc. the author argues that proper decision is composed of 80% of information, 10% of inspiration (invention) and 10% of managers’ intuition (sensing) (penc 2001). functional properties of information obtained from users are presented in table 1. collected information p ro gr es s in d ef in it io n of th e pr ob le m a nd a cq ui si ti on of in fo rm at io n moment of final definition of the problem and making a decision information gap needed information resoruces used for definition of the problem (money, kościelniak, h., information resources for financial monitoring, ea (2010, vol. 43, no. 1-2, 91-98) 93 table 1. quality features of output information feature characteristics of output information reliability factual (according to actual state) description of economic events and states selectivity adapted to the characteristics of the problem or used method of management addressability adapted to individual need of a particular recipients, determined by the nature of the tasks they perform relevance relevant to particular demand for information (providing recipients with convenient tools for searching and extraction of data) right on time delivered on demand in right time (during decision situation) or periodical data within clearly defined deadlines requested form alphanumerical (text, tabular or graphical) with the level of detail (elementary data or aggregated, levels of summaries) and the carrier (screen, printouts, magnetic carriers) according to the recipients demands source: (niedzielska 1998) maintaining quality features of information affects its value, suitability and usefulness within information base in a particular enterprise. position of financial monitoring in information base in enterprises monitoring is an informational mechanism which allows for tracking quantitative and qualitative changes of some predetermined objects of observations, using particular techniques of registration. subject literature points to the following functions of monitoring: • collecting and processing of information and distribution of this information (kowalczyk 2003), • formation of normative models, formation of empirical models and assessment of information and information processes (oleński 2001), • definition of research areas in enterprises subject to monitoring, definition of standards and criteria for these areas, selection of rules for response to deviations and creation of organized forms of informational feed (leszczyński 2002), • identification and selection of object of observation, description of objects by means of a pattern, registration of the results of object operation, comparison of patterns to the results, ordering and making available the results and patterns (mytlewski 2007). on the basis of the abovementioned functions, it can be concluded that monitoring can be perceived as: • observation and suitably organized registration of all the parameters, events, situations connected with object operation, which might affect functioning of the whole object or its considerable part, economic analysis (2010, vol. 43, no. 1-2, 91-98) 94 • current control of execution of the plan along with confrontation of the degree of using budget with the plan for the performed tasks, • arduous research work allowing for assessment of decision accuracy and its correction as need arises, • informing decision-makers about possible threats and forcing them to respond. application of the concept of monitoring for operation of companies allows for separation of a research area for financial monitoring from the wholeness of its business activity. financial monitoring is a tool for management in the area of functioning of financial processes in enterprises. it is understood as a process of continuous economic and financial analysis supporting the process of making decisions by managers. figure 2. place of financial monitoring in management system source: (skowronek_mielczarek, leszczyński 2007) implementation of financial monitoring calls for meeting the following conditions: • definition of the need for continuous analysis, • proper description of financial events resulting from company’s operation using particular methodology. investigating of information needs in a company requires methodical approach; example of such approaches are presented in table 3. management function management tools planning organization leadership controlling key areas analysis methodology standards high frequency f in a n cia l m o n ito rin g decision and information flow kościelniak, h., information resources for financial monitoring, ea (2010, vol. 43, no. 1-2, 91-98) 95 table 3. methodical approaches used to define information needs of users method description application by-product investigation of needs is a sideeffect since its main goal is to investigate final product used during development of subsystem problems; advantages include laboureffectiveness and short time necessary for investigations; disadvantages: in most of cases decision – maker needs are only partially met total study investigating of bigger group of executives the critical areas of activities are defined, however, it requires use of considerable resources critical success factor the areas which should be under constant supervision of management are defined analysis of progress in realization of tasks allows on current assessment of management performance; high labourconsumption of work key indicator system rests on selecting of key indicator of ‘health’ within an organization aimed at collecting of the data which can be processed into different sets of information it allows for separation of common types of functions, whose performance requires relevant information. an attempt to identify environment and to define hierarchy of goals is also made; difficulties include objective definition of these goals/functions and decomposition. business information characteristics study on the basis of information model of organization, so called unique resources are defined, which facilitates analysis of current databases and problems encountered by management, a set of unique identifiers, characterizing management objects within an organization are created. the identifier and relating data comprise ‘resources’ with actual data, which allows for highlighting problems which impact on company performance. elimination of ‘information scatter’ between information system and needs, shortens the process of improving of insufficient information which can not be recognized through another analysis; it accelerates production of software fourfold on average. business process model aims at recognition of basic, initial units which initiate processing of input information realized in next phases, such as: preparation of general plan, verification of economic processes in companies and their units. it is possible to create, in a written form, a model of the processes which occur in organization and the analysis of the needs and flows in organization connected with these processes and, in consequence, it allows for recognition of data transferred between economic processes in the organization. economic analysis (2010, vol. 43, no. 1-2, 91-98) 96 method description application enterprise activity matrix rests on a theory of organization with limited number of tasks (activities) and these tasks being performed by means of subject of labour available in a company. in consequence, a matrix including all activities within an organization can be created. it mainly requires definition of activities in organization (what is being done), environmental conditions (how it is being done) and subjects of activities (what is used to perform the activities) it gives management a view of everything what happens or should happen through the method of task assignment and a demanded information system characteristics information control net model formal model of determination of users needs in office environment; it is formed by graphical techniques and standard notation, which forms a framework for collecting data, imposes coherence, completeness, logical organization and is conducive to comparison of alternative procedures, preparation of forms and data sets. used for representation and analysis of flows of information in progress, procedures for activities simplifies them and automates overlaying activities. source: (kisielnicki, sroka 1999) financial monitoring suits very well to the methodical approaches listed in the table. it combines features of all the described methods used for determination of users’ informational needs. financial monitoring is a system which integrates the methods of processing and flow of different streams of information with management system (komorowski 2001) and supports management in supervising the most significant components in operation of entities (kisielnicki, sroka 1999). a. skowronek-mielczarek and z. leszczyński point to important and specific features of financial monitoring, including (skowronek-mielczarek, leszczyński 2007): • selection of key areas of management of company’s finance, • definition of standards and reference bases, which become the basis for assessment and verification of activity, • application of tools for modern financial analysis, • continuous observation and registration of changes in the investigated financial processes. in consideration of the features of monitoring it is remarkable that it comprises the basis for creation of new informational and decision-related resources for enterprises. system of kościelniak, h., information resources for financial monitoring, ea (2010, vol. 43, no. 1-2, 91-98) 97 monitoring supports management of enterprises through early warning and assessment of threats during operation of businesses. it also reduces information gap (see figure 3). figure 3. information system and financial monitoring source: own study on the basis of (mytlewski 2007, rabin, jackowski 1988) summary to sum up, it can be concluded that monitoring system, being a subsystem for information systems in enterprises, overtakes the tasks of information system and is in tune with it in terms of functions, language and tools. moreover, monitoring system integrates management and formal requirements. in target model, it should lead to reaching a compromise between interests of all parties which communicated the demand for information in enterprises through giving them access to any profile of information. references flakiewicz w., systemy informacyjne w zarządzaniu (uwarunkowania, technologie, rodzaje), wydawnictwo c.h. beck, warsaw 2002 kisielnicki j., sroka h., systemy informacyjne biznesu. placet, warsaw, 1999 komorowski: planowanie finansowanie w przedsiębiorstwie. odidk, gdańsk 2001 kowalczyk s., informacja w monitorowaniu otoczenia organizacji, [in] red. r. borowiecki, m. kwieciński, monitorowanie otoczenia. przepływ i bezpieczeństwo informacji. w stronę inteligencji, kw, zakamycze 2003 leszczyński z., monitoring finansowy w zarządzaniu małym i średnim przedsiębiorstwem; [in] zarządzanie małym i średnim przedsiębiorstwem. uwarunkowania europejskie. red. m. strużycki, difin, warsaw 2002 łukasik-makowska b., niedzielska e., społeczeństwo informacyjne – już teraźniejszość czy dopiero perspektywa? [in:] informacja w społeczeństwie xxi wieku, red. a. łapińska, uniwersytet warmińskocollected information real area of enterprise information system in enterprise needed information financial monitoring information gap gap reduction economic analysis (2010, vol. 43, no. 1-2, 91-98) 98 mazurski, olsztyn 2003mytlewski a., monitoring ekonomiczny przedsiębiorstw, wydawnictwo uniwersytetu gdańskiego, gdańsk 2007 niedzielska e., informatyka ekonomiczna, wydawnictwo akademii ekonomicznej, wrocław 1998. olejniczak w., projektowanie systemów informacji ekonomicznej w przedsiębiorstwie, pwe, warsaw 1989 oleński j., ekonomika informacji, pwe, warsaw 2001 penc j., decyzje menedżerskie – o sztuce zarządzania. beck, warsaw 2001 rabin j., jackowski e. m., handbook of information resource management, marcel dekker, new york 1988. skowronek-mielczarek a., leszczyński z., controlling. analiza i monitoring w zarządzaniu przedsiębiorstwem, difin, warsaw 2007. received: 12 january 2010 article history: accepted: 7 march 2010 ea_2013_3-4 finalna ver original scientific paper mechanisms to explain fdi impacts in less developed countries growth: the case of the industrial development level in turkey, egypt and morocco mani pierre eric1, gredec university of nice-sophia antipolis, nice, france udc: 339.727.22(1-773) ; 338.121(560+620+64) jel: f21, o14 id: 203727116 abstract – the industrial development level proposed in this essay is the key factor to explain how foreign direct investment (fdi) impact may turn from positive to negative. it is shown that, the role of fdi inflows in host countries’ growth will be effective for those applying not only the right policies, but also raising their local aggregate industry level up from a certain threshold (without necessarily applying home country content policies). interaction between industrial development level and fdi may also be considered to be the second and long term effect of the fdi on a country’s growth. hence, when lacking or too weak, industrial development level may be crushed by fdi, turning the interaction from positively impacting on growth to play the malign role, and then explaining why in some countries fdi appear negatively related to local development. key words: fdi, growth, net outward investment position, industrial development level, less developed countries introduction what the matter with fdi impact is? that’s a question worthy of interest; many works have been published about the effects of fdi in the host countries. although those studies cover numerous different countries, doubts and questions still remain concerning the real impact of foreign investments in emerging and developing countries. hypotheses differ greatly about the ways to earn a positive impact from fdi. for instance, blomstrom et al. (1994) writing about the effect of fdi in host countries, argue that: „ a positive growth-effect of fdi may be real whether the country is sufficiently rich”2. following the argument of the previously quoted authors, poor countries are excluded from having any positive impact from fdi in their development. a sizable number of studies are discussing these issues, but their findings diverge either in their conclusions, or in the theoretical background relative to the impact of foreign investment in less developed countries. it may not be surprising within the field of economics to disagree on concepts or theories; in the present case it is assumed that countries lacking capital to boost their development should benefit from long term capital flows coming from abroad. in the main two opposing concepts or approaches, in the 1 pierre eric mani, eric.mani@gmx.com 2 duyster, nguyen, patterson, sander (2009) “foreign direct investment absorptive capacity” https://smartech.gatech.edu/bitstream/handle/1853/35267/1238510767_hn.pdf;jsessionid=a514b1099f e67a027daee69a39dc003f.smart1?sequence=1 economic analysis (2013, vol. 46, no. 3-4, 87-107) 88 economic literature for the impact of fdi, the first one which predicts positive effects is known as benign, and the second, malign is completely the contrary, seeing fdi as a problem for the country’s welfare. we also underline the fact that the present essay does not cast on the impact of fdi in host countries, we stressed on a particular factor: that the industrial development level is the missing link that might explain the discordance between facts and theory. this variable must be integrated into the system to better appreciate the fdi impact on a developing country’s growth for instance, and should be criterion enabling to conclude to a positive or a negative impact. a closed idea was put forth by carkovic and levine (2002) about a certain „interaction term from income per capita and fdi”3, that enabled them rejecting the earlier above assumption by blomtsrom et al.(1994). for empirical tests, we apply the net outward investment position model of dunning and use it as a proxy for the aggregate industrial development. time series models are applied for each country after carefully specifying their features. the results show a positive and significant impact of both related fdi variables for turkey, while egypt and morocco failed in showing any positive and significant impact. the findings are in accordance with theoretical development arguing that countries with a high industrial development level are more suitable to get fdi impacts. our essay is articulated as it follows, the first part discusses briefly the concepts of benign and malign fdi, and then, the second part introduces the concept of aggregate industrial development, and presents the net outward investment approach used to proxy industrial development, finally part three and four present the empirical estimations and discuss the economic meaning of the results. the two main approaches about fdi impact the section focuses on both concepts below for a brief presentation of their meaning and in order to underline some misunderstandings in their use. the benign and more classical approach is presented first, thereafter the malign approach follows. the benign approach international trade theories fail in their endeavor to position fdi against trade. fdi was often considered to be a substitute for trade, but recent findings have shown a more complementary relationship between them, to the point that trade openness was proved to be relevant as a determinant for fdi flows in some cases. impacts of trade openness and fdi are two subjects still under discussion, particularly for poor countries. when asking about the impacts of fdi in the host countries, one refers indirectly to the impact of trade openness, since a complementary relationship between them has been proven. models often analyze trade and investment together; for instance the neo-institutional model predicts three mechanisms will benefit from trade and investment4. we borrow the second of the three mechanisms which states that: „trade and investment are expected to create positive externalities 3 wan x.(2010) “a literature review on the relationship between foreign direct investment and economic growth” international business research, vol 3, n°1, jan. 2010 4 for more information see matthias beck and nataliya acc-nikmehr (2007) “the failed promise of foreign direct investment:some remarks on ‘malign’ investme nt and political instability in former soviet states” page 10 mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 89 which extend to a process where the introduction of new products and processes by foreign firms creates spillovers for the domestic economy” (teece, 1977)5. this affirmation may implicitly assumes that processes to capture externalities from fdi are automatic or autonomous, but there was formerly no such a thing in most for poor countries. the economic literature acknowledges the fact that a positive effect of fdi can be found, but such effects follow different mechanisms to impact on a country’s development. following that logic, borenstein et al. (1998) proposed „a threshold of human capital” as one such mechanisms conducive to positive fdi effects. although in many cases empirical findings tend to confirm the earlier proposition, it may still be stressed that a specialized human resource on particular fields is what foreign multinationals are often looking for. firms themselves are the institutions which create the need for that specialized human capital and often invest in interior training; by so doing, they anticipate host country governments’ action in creating centers for specialized training. the case of central and eastern european countries integrated into the european union clearly illustrates the point. studies show that those countries earlier in their integration process already had an significant pool of human resource, but the labor forces’ background could not make them useful enough for foreign investor operators, thereby turning the effect a little bit less important mechanism for catching fdi effects6. a second reason could be that, since fdi in less developed countries mainly focuses on assembly activities, human capital may not be of a relevant importance because employment in such activities doesn’t need any particular skill (according to the center-periphery outsourcing model).the misunderstanding in the benign fdi’s case is solely within the use of the concept. mechanisms explaining the positive impact of fdi on countries are considered to be „stylized facts”. unfortunately within the analysis, countries’ idiosyncrasies are not taken into account. moran (1998) wrote that „perhaps the most prevalent version of the beneficial conceptualization begins with a stylized description of how fdi may help the host country to break out of the vicious cycle of underdevelopment”7 the same author continues with a clear description of what he means by stylized facts, according to the latter description, he assumed that „under reasonably competitive conditions-which the foreign presence will enhancefdi should raise efficiency, expand output, and lead to higher economic growth in the host country”. the question here then is whether the fdi fall to enhance competition, should there be any positive effect on the local market structure? the main problem in this theoretical concept is that even as fdi assets are taken for granted. yet, multinational firms are not eager to share their competitive advantage or their technologies with local firms. in addition, according to the multinational theory, foreign investments are motivated by market imperfections because they are able to garner advantages from those imperfections, thanks to their interior resources and capabilities. therefore, multinationals will tend to create more imperfections in the market in order to weaken competition. fdi is designated wherever it goes to make profits for their owners, so the impact they will have on a country depends on 5 teece (1977) is quoted by matthias beck and nataliya acc-nikmehr (2007) in page 10 6 although less than expected, a certain positive impact of fdi in central and eastern european countries have been found. those countries still trail the european 15 group countries concerning the assumed convergence which was told to be boosted by foreign investments. 7 moran t. h. (1998) foreign direct investment and development. page 19 economic analysis (2013, vol. 46, no. 3-4, 87-107) 90 different factors, obviously linked to the theoretical conceptualization which proposes them, and specific to countries (between rich and poor countries, the effects of fdi tend to differ. for the former they are often positive, but for the latter they are either positive or negative according to the country specificities). the conventional theory believes that, the fdi impact should be positive because they will increase country capital accumulation, they will increase currencies reserve, increase demand for workers and then may result in an increase of wages, and finally may drive poor countries to converge. in the aftermath of this somehow naïve belief of theory about the positive impact of fdi, the next paragraph discusses the opposed effects and its conceptual misunderstanding. the malign approach this section focuses on the negative effects that fdi are supposed to have on the host countries’ development. as stated previously, foreign multinational assets are not granted to the host countries. however since these countries are supposed to benefit from the investments, the way those benefits should be raised is the real problem in which most theoretical conception are rooted when evaluating the malign side of fdi. in the economic literature, two main approaches try to show how expectations of welfare from fdi could turn from positive to negative. they underlined the negative impact of government policies in developing countries, when trying to keep control over foreign investments (moran, 1998). on the one hand, moran (1998) shows that, within the neoclassical concept8 of promoting fdi, industrial sectors which are attracting foreign investor will receive subsidies from the government for exports („ export requirement strategy”), while other sectors will progressively fall. although the other hypothesis9 behind the idea remains questionable, the neoclassical framework may in some ways be assumed to cause the negative impact by promoting the development of some sectors only. in those countries, resource sectors are emerging, while overall country welfare often decreases in the course of time. in such situations, the view that fdi effects on the host countries are negative may be justified. on the other hand, moran (1998) again introduces the „ strategic – trade framework ”, which differs from the previous analysis’ hypothesis. in this case, imperfect competition is assumed, and government policies may be to focus on local „infantindustry”. the „infant-industry” needs protection against foreign investors, but moran’s question was about the choice of the industrial sector on which to focus; governmental policies under imperfect competition assumption are not targeted towards foreign investments. in such an environment, cooperation relations between foreign subsidiaries and local industries are not promoted; externalities and spillover effects should be difficult to catch. this strategy cannot help developing countries to close the technological gap; therefore, they will not be able to escape from the malign effect of fdi because of their weak competitiveness. the country’s development will not be possible as a consequence of the above inconvenient policies. the whole subject of host countries policies toward foreign investor is well known under the expression of „domestic content requirement” that have also been denounced by moran(1998) and the conventional theory, considered to be inefficient. 8 the concept is based on the perfect competition assumption. 9 the hypothesis is that “production costs in the local market must be higher than world prices” this hypothesis shouldn’t be a motivation for foreign investor to locate in developing countries. mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 91 another important point that may wipe out the positive effects of fdi to negative in host countries is „the repatriation of benefit”(beck and acc-nikmehr, 2007 and moran, 1998). unfortunately not much has been said about this point. nevertheless, it is well known from the macroeconomic theory that the balance of payment will be impeded along the way by such practices, finally turning developing countries from capital importers to capital exporters. repatriating profits is not an isolated event; on the contrary, such practices could be seen as a consequence of the „vanishing of investment opportunities” (or poor investment opportunities) in less developed countries, due to the absence of local demand, inadequate policies and to the lack of sustainable growth of the host industrial environment, this is the incapacity of host countries to absorb fdi stocks. the misunderstanding in the malign approach of fdi most of times is also rooted on chosen hypotheses. many analyses already view fdi itself as negative. for instance, beck and acc-nikmehr (2007) underlined that moran implicitly hypothesized (in an analysis) that „ rather than contributing to institutional development and productivity, certain types of fdi have the potential to undermine existing institutional growth trajectories and, in so doing, forestall future economic growth and development”10. radical views on the impact that foreign multinationals will have on host countries’ development are critical. mainguy (2004)11 said that the malign view of fdi impact is from marxist analysis, according to which, capital will be accumulated for capitalists only, so the repartition of activities in industrial sectors is affected, because of the technology dependence of host countries. for marxist analysts, fdi appears to be a continuity of imperialism with a different form, and the location in „extra-capitalists” countries is obviously negative. here below, we quote some cases of empirical studies to illustrate how they dealt with the problem of fdi impacts. empirical survey of fdi impacts this paragraph describes how fdi impacts have been analyzed in less developed countries, with examples of some countries that will be studied in the empirical work. until now studies appraising fdi impacts outline some common characteristics. in particular, they outline the possibility for a double impact, direct and indirect impact. they also show that those impacts are country specific; that is to say the mechanisms by which fdi will impact differ from country to country or group of countries. there are studies that attempt to measure the impact within econometric models including more than a single variable (fdi flows or stocks and other variables) that affect economic growth, but there are also studies that try directly to search the causality, if any, between fdi and country growth. in our samples of countries, turkey has often constituted a case study. bilgiç (2007) analyses the export-led growth strategy of turkey from fdi. according to him, in 2005 turkey was ranked 23rd largest exporter. however, the export effect was quickly compensated for by an increase in the imports of intermediate goods. such 10 beck and acc-nikmehr (2007) “the failed promise of foreign direct investment: some remarks on ‘malign’ investment political instability in former soviet union” http://eprints.whiterose.ac.uk/3471/2/beck12007.pdf page 16-17 11 mainguy c. (2004) « l’impact des investissements directs étrangers sur les économies en développement» revue région et développement n°20 -2004 economic analysis (2013, vol. 46, no. 3-4, 87-107) 92 goods represented 60% of the total amount of import of the country (bilgiç, 2007). in his empirical test for the fdi impact on growth, he found a positive and significant impact of fdi in the growth of turkey despite the huge amount of imports. in another test for causality between fdi and growth, however, he found that fdi was not a granger cause of growth in turkey, which means fdi might not cause growth, however, they still have a certain impact on enhancing growth possibilities. other studies confirm these results such as johanson (2008) and hisarciklilar, kayam, kayalica and ozkale.12 in a 2010 report on morocco from oecd, the flows of fdi are characterized as „reflecting the opportunities offered by the privatization programme13” there is a lack of case study of fdi impact in egypt and morocco, although their case is briefly included in the study of hisarciklilar, kayam, kayalica and ozkale. when a causality test is conducted for many mediterranean countries, the results for egypt and morocco show that fdi do not cause economic growth. with the imports picture showing a striking rise to $130 billion in 2006 from $8 billion in 1980 (emrah bilgiç, 2007) , turkey’s case helps to emphasize the necessity for host countries to dispose of an industrial development level capable of supplying foreign multinational needs for intermediate goods. as we can see in the below graphics, fdi flow in some countries may not be enough to drive economic growth. quick observations among the three countries indicate a large gap of the total flows. turkey shows a very different picture as the increase of flows after 2004 is almost five times higher. the pick of fdi inflows in turkey which seems to be the same in egypt have reached more than $20 billion in 2007 while in egypt it was only $12billion followed by a nonstop decrease and finally divestment after 2010. morocco seems to follow a different logic mostly because of the low amount of fdi inflows and also because they are correlated with the country privatization program which begun in 1994. we also pictured out the importance of the fdi stocks in the national economy, reporting the fdi stocks to the national gdp. the corresponding graphic shows a very different picture with the two small economies (egypt and morocco) having the best percentage. fdi stocks in morocco hit the highest level, weighing more than 51% of total gdp in 2007. 12 here is illustrated a case of benign fdi, despite a deeply unfavorable trade balance the above studies show a significant impact of fdi on turkey’s growth. their findings are based on the neoclassical concept of stylized effects of fdi in host countries. 13 oecd (2010), "the role of foreign direct investment in morocco's economic development", in oecd, oecd investment policy reviews: morocco 2010, oecd publishing. doi: 10.1787/9789264079618-3-en pp 5 mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 93 graphic 1. fdi flows per country14 14 for scale’s matter we rather present each country with a different graphic economic analysis (2013, vol. 46, no. 3-4, 87-107) 94 graphic 2. fdi stocks reported to gdp for each country the aggregate industrial development level concept we assume that foreign investments are not only oriented to natural resources, and that foreign multinationals apply a vertical division of labor to include poor host countries in the production process of some parts of their final products. here is another relevant issue for countries which is related to the nature of the incoming foreign direct investment. efficiency oriented fdi may be less beneficial than import substitute fdi, in the sense that the content for the former is mostly poor, resulting in restricted technology transfer and low value added by host countries, while the latter are supposed to bring green field subsidiaries whose production will be destined for the local markets. following the first inflows of fdi into the host countries, some authors observe an initial positive impact on balance of payments. the role of government policies appear then to be of relevant, because they will try to increase the positive effects brought about by the initial flows of fdi. this phenomenon should be seen as the first expected impact that fdi has on the host country’s development, by focusing on the export led development strategy. some studies show that unfortunately this impact in developing countries last for a very short term (hossai, 2005)15, because foreign investors quickly turn to increasing their imports to fill the need for incremental exports. the reason this happens is that foreign multinationals need „intermediate goods and services” that cannot often be supplied within the host countries, mostly because of the non existence of a competitive sector that could produce these intermediate goods. evidence and lessons may be taken from west european multinationals when extending their activities into nearby countries. the success of fdi in hungary for example is not just related to the proximity parameter, but it is most due to the availability of local suppliers to respond promptly and accurately to the needs for intermediate goods. the same success was not seen either in greece or in 15 hossain m. a. “impact of direct investment in bangladesh’s balance of payments: some policies implications” pn 0805 mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 95 morocco, egypt or tunisia. west european companies present a good example since the strategies they have adopted to extend their activities into nearby destinations focused mostly on mergers and acquisitions, meaning that similar companies existed at the host countries, but with certainly a different technological frontier. it seems misleading to conclude that the impact of fdi on poor countries can solely be appraised from the stylized facts, showing that, the first impacts on economic growth from fdi may last quickly. the real fdi impact measured in empirical work matches only with the short term. focusing solely on the latter impact may drive us to an underestimation of the full fdi impact, whether positive or negative. in the extraction of natural resources, foreign investors seldom face competition in developing countries, because of huge amounts of investments that constitute an irreversible barrier to entry for local industries.16 but when applying a vertical division of labor, it is assumed that host countries will be able to supply some intermediate goods and services. yet, the host countries capacity to supply foreign investor needs is conditioned by the presence of initial industrial development (not necessarily with a strong local content policy) before the foreign entry, which will match with fdi to sustain a positive impact. once a high level of industrial development is controlled, we then assume that cooperation relations have been established between foreign multinationals and the local industry. in such a case, fdi must have a second impact by interacting with the local industry, which will be supplying the intermediate goods and services, thereby diminishing the amount of imports. the export-led development strategy will be successful in this case, and the host country welfare promoted. for macroeconomic purposes, the use of the industrial structure may not be appropriate; if such is the case, we then substitute a more aggregate variable, for it one which takes into account the entire industrial development level and its international competitiveness. moran (1988)17 stresses that „how competitive the industry and the economy are where the fdi takes place” is important to understand the „interaction between fdi and host country development”. the interaction of both fdi and aggregate industrial development offers more opportunities for sustained growth in developing host countries. whether or not a host country lacks such a threshold of industrial development the expected positive impact from fdi slumps, and finally vanishes. the key role of the industrial development level is to interact with fdi in a way that will enhance the expected impacts of foreign multinational activities. a host country with a high level of industrial development is more likely to benefit from fdi. in the case of less developed countries, strong industrial development of the local industry is necessary because it will contribute to enhancing the technological composition of fdi, and strengthening the ability of the local industry to learn by reaping externalities from fdi, then 16 we have recently witnessed a situation in cameroon where a korean company claimed to have discovered an important stock of diamond, which however were already extracted by local villagers with very poor and inefficient means. despite the local opposition, this part of the country has been conceded to the korean company. in the aftermath of this concession, local villagers still wait to see the social benefits of this huge investment. the first accreditation of these diamonds should be issued this year to allow their commercialization. 17 moran, t. 1988. foreign direct investment and development. chap. 1, page 21. economic analysis (2013, vol. 46, no. 3-4, 87-107) 96 resulting in the expected competitive market. picciotto (2003)18 showed in her study that, when subcontracting relationships exist between the foreign multinationals and local industries, the former often transfers some technologies the latter needs to supply intermediate goods responding to the multinational standards. the ability to understand the foreign technology requires some strong initial level of industrial development that developing countries lack in most cases. host countries should have promoted their own industrial development before allowing foreign entrance in their local markets. for empirical purposes, the industrial development level is modeled below. dunning’s idp model as a proxy for industrial development level the convergence hypothesis among its main principles suggests that, poor countries should be able to duplicate production methods and technologies, and that their rate of diminishing capital return is slower than in developed countries. this hypothesis will barely hold as long as all the mechanism to enable host countries reaping benefits from fdi will not clearly be identified. the aim while trying to draft of a model of the level of industrial development of poor countries is to find the best proxy to be used as a variable in econometric models. the best proposition to fit the needs must be a macroeconomic variable, one that shows the strength of competitiveness in the host country’s industry. those hypotheses exclude the possibility for the local country’s domestic capital stock to be used as a proxy despite fitting one of the conditions. the model chosen for this study is the investment development path (idp) first proposed by dunning (1981). this approach introduces the net outward investment (noi) position of a country as the difference between the outward fdi stock and the inward fdi stock of a country. the proxy for industrial development level will be the noi, particularly because it fits both previous criteria well. an important particularity is that this variable comes from an evolutionary approach, which stipulates that: „with an economic development, a country’s noi faces different stages”19. it means that both capabilities, either to attract foreign investment or to become a foreign investor in other countries depend upon the economic growth of the country. dunning (1981) proposed five different steps followed by countries either as an fdi destination or as an outward investor. the industrial development level will not follow any steps; however, it should be influenced by those steps in a certain way. on the one hand, countries that demonstrate the first step comply with the original model simply fdi destination, without any outward investment because of their low level of development. that group of countries will expect only the first impact of fdi, in their balance of payment, capital accumulation and employment, and will receive less impact from fdi, sometimes showing mitigate conclusion in empirical studies20. on the other hand, less developed countries evolution is confined to the second step because of their weak internal market growth. they are characterized by a broad negative noi. 18 piccioto b. «l’investissement direct vers les nouveaux adhérents d’europe centrale et orientale ce que l’élargissement pourrait changer», notre europe 2003. 19 mold a. (2004)“the investment development path hypo thesis : evidence from the portuguese case-a panel data analysis” page 3 revue region et développement n° 20 20 should we remember for example the mitigate conclusion of empirical researches over north africa commercial openness with european union members? mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 97 the problem with using noi as a proxy for industrial development level is that the focus is confined to a set of industries only: those that are internationalized. however, that set of industries sheds light on the competitiveness of the host countries, and should be seen as a comparable macroeconomic feature. in fine, the model to be estimated in the study takes the following form for each country: (1) the variable represents the logarithm of gdp in current prices at time t; represents a set of independent variables at time t, while is the error term. (2) (this is t original definition by dunning) (3) is assumed to capture the interaction between the inward fdi and the host country industrial development level. means the outward flow of foreign investment and is the inward foreign investment, while is the net outward investment position, as defined in the model by dunning in order to arrive at the best estimations of the regression, we add two more control variables into regression. the first one commercial, and the second the percentage of tertiary enrolment, both variables are very none in the model to enhance fdi effects. the proxy for commercial openness is the ratio of the sum of exports and imports divided by gdp values. the final regression to be estimated is the following: (4) where this is a time series model and the specification will depend on the quality of the data we have from each country. that is we cannot assume what the best estimator will be for each country, but the simplest one may be the ordinary least square (ols). we intend to study the quality of the data first through analysis of stationary hypothesis. accordingly one specific model will be specified for each of the country. empirical work and economic meaning of the results. data for the empirical work have been collected from two sources; the world bank provided data for exports and imports that was used to compute the commercial openness observations, the tertiary education enrolment in percentage of total school enrolment, and the gross development product (gdp). the unctad database provided data for both inward and outward fdi stock. the sample period is from 1980 to 2011. the inward fdi data are convert with the logarithm for two main reason, first to control for non stationary variance, and secondly to avoid eventual collinearity with the generated observations for . before processing to the stationary test, we first selected the optimal lag number for each variable. this simple process has the advantage that, while running the stationary test, we economic analysis (2013, vol. 46, no. 3-4, 87-107) 98 will know exactly the limit of lags for the variable, and will then be able to progressively them from zero to the optimal, as long as the presence of the unit roots hypothesis will not be rejected. the best way to get the optimal lag to assess the series using information criterion procedures. the commonly used are akaike’s information criterion, schwarz’s information criterion, and hannan and quinn information criterion. the common assumption is that the optimal lag is the one predicted by the three information criterion. the maximum number of lags introduced for each case is 3. table 1. lag’s selection test result (with maxlag(3)) turkey morocco egypt #lags #lags #lags lngdp 1 1 1 lnfdi 2 1 3 school 3 1 1 cop 1 3 2 fdinoi 3 1 3 the next step in this empirical work is to run stationary tests, we choose to use phillipsperron unit-roots test, which is robust21 related to the augmented dickey-fuller. we folowed the three steps for the unit-roots test starting with the regression integrating a trend, then regression with a constant, and then regression without constant and trend. the null hypothesis of no unit-root has not been rejected for each variables. the test were run with the lags from zero to the maxlags as suggested from the above table. we run the test again after first differencing the variables, the results show that all our variables are stationary, that’s is i(0), or the unit-roots hypothesis was accepted. table 2. phillips-perron stationary test results turkey morocco egypt unit root unit root unit root lgdp i(1) i(1) i(1) lfdi i(1) i(1) i(1) school i(1) i(1) i(1) cop i(1) i(1) i(1) fdinoi i(1) i(1) i(3)22 once the variables are differentiated (using the first differences), we first check for any possibility of cointegration among variable. this step is necessary since we have the variables for turkey and morocco showing the same level of integration i(1). the 21 the robustness of the test relies on the general form of heteroskedasticity (robust to serial autocorrelation), and that users may not feel obliged to specify the numbers of lags 22 we had some particular troubles with this variable, as it shows an i(3). mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 99 cointegration hypothesis assumed that there is a long term relationship that always sends back the variables to certain equilibrium. this relationship shows that if a set o variables (dependant and independent variables) show the same level of integration like those in our specification, there might be a vector of their difference showing an inferior level of integration. for the purpose of this study we follow the two-step engel-granger test. first step: determination of the residual for each country before the differentiation. for this step, we run a simple ols model before the first difference of the variable, and we predict residuals, for each of the countries. the estimated ols model and determination of predicted residuals appear below. second step: after the prediction of the residual, the next step is to run the dick-fuller test to check for unit-roots hypothesis. if the null hypothesis is rejected, that is the residual is i(0), then we have a case of cointegration, and we must run a model of error correction integrating a lagged predicted residual as explanatory variable. if this variable in the final model is significant negatively, the model specification is good; otherwise we have to run a different model. table 3. dfuller test for predicted residual turkey z(t) 5% value p. value morocco z(t) 5% value p. value lag 1 lag 0 trend -2.067 -3.580 0.5647 trend -4.331 -3.580 0.0028 const -2.243 -2.986 0.1909 const -4.366 -2.986 0.003 nocons -2.288 -1.950 nocons -4.441 -1.950 we use the same above technique to determine the suitable number of lags. results for each country are shown in individual table. turkey shows a stationary predicted residual, for the regression with no constant. we can see that the z(t) value (-2.288) is smaller than the critical value at 5% (-1.950). we will then apply a model of error correction, with expectation that it will meet the above condition that is the lagged predicted residual must be significant negative. for morroco, all the z(t) value reject the null hypothesis of unit-roots, meaning we have a second case of error correction model, since the predicted residual here is also stationary. for turkey and morocco, the model that will be used here is the following: (5) economic analysis (2013, vol. 46, no. 3-4, 87-107) 100 where is the lagged predicted residual for the error correction model. the following tables contain the results for turkey and morocco. we have checked for possibility of residual autocorrelation by performing the breusch-godfrey test. this test happens in steps. step1: we run a normal ols estimation and we predict the residuals. step2: we run an auxiliary ols regression using the predicted residuals as dependent variables, and including one lag of the residual in the regression as independent variable. then we have to compute the statistic (r²*n)23 and compare to the chi-squared statistics at 5%. if the computed value is greater than the chi-squared statistic, then the null hypothesis of no residual autocorrelation can be rejected. following the results of the tests, both regressions will be estimated using the prais-winsten estimator of time-series, with ar (1), as the tests show that we cannot reject the null hypothesis of autocorrelation of residuals. we have reported the test’s statistics in bold into the small tables. table 4. test output and prais-winsten estimation for turkey scalar list n r2 nr2 turkey robust r²=0.4830 n = 31 coef. std. err. t p>t r² = .51802003 .5427158 .1099069 4.94 0.000 nr² = 16.058621 .0051867 .0017515 2.96 0.007 . scalar chi15=invchi2 (1, .05) .0060775 .0130094 0.47 0.644 . scalar list chi15 -.1722078 .050429 -3.41 0.002 chi15 = 3.8414588 -. 302232 .1300224 -2.05 0.029 _cons .0664891 .0261755 2.54 0.018 as expected, we see the lagged residual significant and negative here which means our model is correctly specified. table 5. test output and prais-winsten estimation for morocco n = 29 morocco robust r²=0.4970 r² = .42702798 coef. std. err. t p>t nr² = 12.383811 coef. std. err. t p>t . scalar chi15= invchi2 (1, .05) .1699077 .240335 0.71 0.487 . scalar list chi15 -.0401275 .022467 -1.79 0.087 chi15 = 3.8414588 -.0002511 .008114 -0.03 0.976 .0295516 .0227886 1.24 0.227 -.7018424 .1703423 -4.12 0.000 _cons .040329 .0236139 1.71 0.101 23 r² is from the auxiliary regression, and n is the number of observation mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 101 we can also do the same earlier remark that the lagged residual is significant negative, confirming that the model for morocco is also well specified. the regression for egypt can now be estimated with the normal ols method. but our first estimation looks very poor as the p-value is very higher than 5%. we can easily see that computed statistic nr² (0.18097813) is inferior to the chi-squared value, which means we can accept the null hypothesis of no autocorrelation of residuals. table 6. test output and glm estimations for egypt scalar list n r² nr² egypt robust n = 28 coef. std. err. z p>z r² = .0064635 nr² = .18097813 .0025285 .0017015 1.49 0.137 . scalar chi15=invchi2 (1.05) -.0516638 .0269838 -1.91 0.056 . scalar list chi15 -.0035651 .0051928 -0.69 0.492 chi15 = 3.8414588 .084927 .1642549 0.52 0.605 _cons .0301787 .026189 1.15 0.249 performing a model for egypt shows a lot of challenge, first because of the strange level of integration for , and also because the mco estimation does not give a satisfactory result. we must advise that egypt had a lot of missing observations, the school variable had almost half of the observations missing, that we automatically generated on stata. we decide to perform with the generalized linear model, as this is the most general statistical model that we believe may give better estimation. results interpretation and their economic importance the aim of the estimated regression was to check the significance and the sign (positive or negative) of two main variables. the first one is the variable of interest of the present study , a proxy for industrial development level; this variable is what we have called in the course of this study, the long term impact of fdi. besides, there is the so called stylized effect of fdi, that we designed by the short term impact of fdi, this impart can last very quickly and whenever this happens without an existing local industrial development, which could enhance with foreign firms to generate a competitive market, they fdi impact simply wiped out. as we could redefine it at this point of the research, the general hypothesis of this study aimed to converge with the belief that the interaction of local industrial development and fdi help enhancing the positive impact of fdi on least developed countries. the regression specifications are related to some characteristics of each country, then we have morocco and turkey modeled in the same manner, while egypt comes out with a different model specification. we were unable to predict the sign for , this can be positive or negative according to the country, and to the level of fdi it is receiving. positive simply means fdi are a blessing for the country, while negative shows the malign effect. this study also tries to show that, the malign effect could mainly be felt on the long term. economic analysis (2013, vol. 46, no. 3-4, 87-107) 102 the first regression for turkey overwhelmingly show the short term and long term fdi effect positive and significant on the country’s growth at 1% and 5% respectively. this definitely means turkey has already caught up or is at the point to do so, then appearing with a developed country picture in this study. the effect shows here confirm our intuitions that fdi are successful whether they promote competition. however, we see the commercial openness with a negative and significant sign. this is certainly due to the fact that trade openness comes with a reduction of country revenue and taxes from imported products and services. this finding is in the same vein with yanikkaya (2003)24 findings that trade barriers are positively linked to economic growth, so trade openness normally has the negative effect that our results pictured out. in his study, he showed that giving more emphasis on trade policies than on trade volume25 may conduct to wrong conclusions. we also found school impact on growth to have a positive impact but not enough to be significant. in the case of turkey the percentage of enrolment at the tertiary education level appears with no significant impact on growth. this may be probably due to the choice of the variable, but we couldn’t point out this positive and significant impact. they are many studies portraying the effect of education economic growth in turkey. most of them use different education levels; our findings on education are same with those of deniz and dogruel(2008)26 that university level (tertiary education) has no impact on economic growth. the results from morocco show a very different picture, and emphasize the difference of the development level with turkey. the fdi impact on short term is showing a positive sign, but not significant on growth. the more impressive with the results for morocco is the negative sign we observe for the coefficient of the interaction between industrial development level and fdi. this long term impact of fdi although non significant has an apparently influence or will have some at long term if suitable actions are not designed. we observe while running this research that, the inward fdi has a better coefficient and better student statistic alone than when pooled together with the variable for the interaction between fdi and country’s industrial development level. we somehow felt this may be caused by a possible collinearity among variable, but after checking out, we reject the possibility of collinearity as the variance inflation factor (vif) obtained after an ols regression was less than 10 and 1/vif>0.01. we then go forward saying that there is no fdi impact in moroccan economic growth, and that the industrial development level in morocco if any, will be impacted negatively as the amount of fdi will be increasing, this is a case of competition destructive fdi instead of competition enhancing. our findings are supported by existing works and statistics showing that the behavior of fdi in morocco has been for a very long time determined by the strategy of privatization initiated by the government. the oecd investment review (2010) observed however that, „the entry of foreign investors has a 24 yanikkaya h. 2003. “trade openness and economic growth: a cross-country empirical investigation.” journal of development economics, 72(2003) 57-89. 25 this is using like in our study import and export data for trade volume. yanikkaya in his trade and growth survey, somehow highlighted that, volume variables are better off than policies variable, because of the lack of clear definition of trade openness. 26 deniz z., and dogruel s. 2008. “desagregated education data and growth: some facts from turkey and mena countries”. http://www.luc.edu/orgs/meea/volume10/pdfs/paperbydeniz&dogruel.pdf, jel classification j24, o43 mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 103 positive impact on employment and labour skills and facilitates the expansion and internationalization of moroccan enterprises”27. this impact here is mostly the short term which may last quickly, this explains probably why we observe a positive impact but non significant. the percentage of tertiary school enrolment here as a proxy for the level of instruction showed a positive sign, but is not significant at 10% level. north african countries however have a certain level of high educated persons, but this may not be enough to boost growth, or their skills are not suitable, particularly if this variable effect is to enhance fdi impact. we find trade openness coefficient in morocco also negative and significant. mansouri (2009)28 found in his study that fdi was negative and non significant in morocco, while he showed that the interaction between fdi and trade openness was positive and significant on the country’s growth, the real impact of trade openness is still difficult to capture. we pointed earlier in this study that the case of openness to european union of north africa countries never showed the expected positive impacts, outlining mainly a mitigate impact. results from egypt show exactly the same behavior than the earlier from morocco. both coefficients for fdi and fdi’s interaction with industrial development are non significant at 10%. their signs are exactly the same with those of the moroccan regression (i.e positive for fdi alone and negative for fdi interacting with industrial development level). only trade openness shows a negative and significant coefficient. school is also positive but not significant at a 10% level, however, its impact in egypt is slightly better than in the other countries, as we obtained a p-value of 13.7%, while morocco has for the same coefficient 22.7% and turkey 64.4%29. the negative impact of the fdi interacting with industrial development level is more relevant in egypt than in morocco with respective p-value49.6%, and 97.6%. the fdi interaction with industrial development level can be dropped from the regression of morocco. conclusion and policy review we tried to identify the long term impact of foreign direct investment into country’s growth. we perform a critical theoretical survey that aims at highlighting the reasons that may drive fdi from positively impacting to either zero significant impact or to completely negative. we used the net outward investment position of a country to capture the industrial development level of a country and its competitive position. to the question whether fdi have any impact in less developed countries, we confirm that this is true whether we can find both short term and long term positive and significant impacts. this means that fdi should further a country’s development on two main points; the first being the so called stylized facts and the second one that we identified in this study as the interaction between fdi and the local industrial development. our empirical research find 27 oecd investment review. 2010. “the role of foreign direct investment in morocco’s economic development.” http://www.keepeek.com/digital-asset-management/oecd/finance-andinvestment/oecd-investment-policy-reviews-morocco-2010/the-role-of-foreign-direct-investment-inmorocco-s-economic-development_9789264079618-3-en 28 mansouri b. 2009. effets de l’ide et de l’ouverture commerciale sur la croissance économique au maroc. 29 we should remind that the less the p-value of coefficient, the more the impact is relevant on the dependant variable economic analysis (2013, vol. 46, no. 3-4, 87-107) 104 this interaction existing, positive and significant for turkey, while morocco and egypt show both no fdi impact on growth and a possibility of fdi malign impact at long term. the research regarding fdi impact on growth may still be ongoing as we really don’t know all the mechanisms that may help us catching their impacts. however, this study clearly underlined one of the most important, that many studies have thought of, to be important without being able to prove it empirically. this method may show the impact of fdi on most of the developing world to be non significant or even malign in some case. the true from the observed facts and statistics can’t be refuted; we barely saw multinationals action in poor countries related with their growth. asian nations are getting out of this short list because of their very strong policy commitment toward foreign investors. foreign direct investments don’t enhance growth in poor less developed nations, should these countries continue investing their sparse means to attract, and compete with rich one on fdi, probably no. less developed countries should rely on aid development funds to first get a certain local industrial development that will be able to reap externalities from multinationals. those local firms will then be part of the industrial realm of the host country, contracting with foreigners to provide intermediary services and goods, and any expertise, while learning by doing and enhancing managerial knowledge, and some basic technologies. the responsibility is not only from foreign investors, most of the countries are unable to absorb the bulk of foreign capitals, due most of times to the wick industrial level of countries. at this point, policies matter, as means to create a better environment and best legislation so that foreign direct investments could have defined frameworks for their activities. a foreign investor usually enters into contract with host countries, weak negotiations may derive in the loss of most expected positive impacts. country local content of fdi production then seems to be unavoidable. i am grateful to: mr. c. berthomieu, director of cemafi30 for his helpful remarks and advices mr. x. richet, my former thesis’ supervisor for his advices mrs. j. berben, english teacher in cemafi, for her help on the language. mr. i. thiam, former phd’s student in cemafi references adewimu, s. 2006. „the impact of fdi on growth in developing countries. an african experience.” master thesis. http://www.essays.se/essay/dea2c1c2c7/. bacic, k., racic, d., and ahec-šonje, a. 2004. „the effect of fdi on recipient countries in centraland eastern europe”. eiba conference, december 2004. page 1-21 barry, f. 1999. „fdi and industrial structure in 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(2005) „does foreign direct investment always enhance economic growth?.” kyklos, 56-2003fasc. 4 491-508. mold, a. 2004. „fdi and poverty reduction: a critical reappraisal of the arguments.” revue région economic analysis (2013, vol. 46, no. 3-4, 87-107) 106 et développement, 20. moran, t.h. 1998. foreign direct investment and development. chapter 1, 2 & 3. institute for international economics. nilsson, j. 2008 „fdi and economic growth-can we expect fdi to have a positive impact on the economic growth of sub-saharan africa” http://www.divaportal.org/diva/getdocument?urn_nbn_se_uu_diva-9229-2__fulltext.pdf. oecd investment review. 2010. „the role of foreign direct investment in morocco’s economicdevelopment.” http://www.keepeek.com/digital-asset-management/oecd/financeand-investment/oecd-investment-policy-reviews-morocco-2010/the-role-of-foreign-directinvestment-in-morocco-s-economic-development_9789264079618-3-en. qiu l.d., and wu, c. 2001. „development of foreign direct investment and evolution of industrial structure: case of hong kong.” http://www.bm.ust.hk/~larryqiu/japan.pdf. reeve, a.t. 2002 „factors endowment and industrial structure” fbr international finance”. discussion paper 731. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=320889. sahoo, p. 2006 „foreign direct investment in south asia: policy, trends, impact and determinants.” adb institut discussion paper 56. tambunan, t. 2004 „the impact of foreign direct investment on poverty reduction. a survey of literature and a temporary finding from indonesia”. faculty of economics,university of trisatki, indonesia, 2004 tusad, yased (2004) „fdi attractiveness of turkey, a comparative analysis.” http://www.tusiad.us/content/uploaded/turkey-foreign-direct-investmentattractiveness.pdf. unité de recherché 047 de l’ird. 2006. “institutions et impact des ide dans les pays en développement le secteur de la grande distributionau mexique”. 7 et 8 septembre. wan, x. 2010. „a literature review on the relationship between foreign direct investment and economic growth.” international business research, 3(1). world investment report 1999, foreign direct investment and the challenge of development. yanikkaya, h. 2003. „trade openness and economic growth: a cross-country empirical investigation.” journal of development economics, 72(2003): 57-89. mehanizmi uticaja stranih direktnih investicija na rast manje razvijenih zemalja: primeri nivoa industrijskog razvoja turske, egipta i maroka rezime – nivo industrijskog razvoja koji je predočen u ovom radu je ključni faktor za objašnjenje kako se uticaj stranih direktnih investicija (sdi) može promeniti sa pozitivnog na negativni. prikazano je da uloga upliva sdi-a na rast neće imati efekta samo ako se primene odgovarajuće mere, već da mora postojati rast agregatnog nivoa industrijske proizvodnje sa određenog minimalnog nivoa. interakcija između nivoa industrijskog razvoja i sdi može se smatrati kao drugi i dugoročni efekat sdi na rast zemlje. dakle,u nedostatku ili prilikom niskog nivoa industrijskog razvoja, može doći do gušenja od strane sdi, što dovodi do pretvaranja interakcije sa pozitivne na negativnu, objašnjavajući zašto se u pojedinim zemljama sdi pojavljuje u negativnoj konotaciji sa lokalnim razvojem. mani, p.e., mechanisms to explain fdi impacts, ea (2013, vol. 46, no, 3-4, 87-107) 107 ključne reči: strane direktne investicije, rast, spoljna neto pozicija, nivo industrijskog razvoja, manje razvijene zemlje article history: received: 22 july 2013 accepted: 17 october 2013 microsoft word 2010_1_2.doc original scientific paper the upsurgence of clusters in the light of globalization matray myriam*, institut d’administration des entreprises iae université jean moulin lyon 3 centre de echerche magellan equipe euristik, france udc: 005.44 jel: o21 abstract – clusters, as system of companies anchored in a region, contribute and ensure the long-term world competitiveness of national production. the object of this paper is to demonstrate that globalization opens restrictions on growth potential, which can be exploited by the clusters in order to position themselves on the world markets by maximizing on the benefits of global competition. thus, clusters use the advantages of globalization (including a myriad of networks), channeling the negative effects the latter may cause (taking as an example industrial espionage which has become increasingly prevalent). clusters can therefore be a means for firms to be competitive at a time of globalization and, at the same time, be integrated in the process. portraying a policy of growth, most european countries – such as france have adopted this new industrial policy, which is being introduced in its turn in some mediterranean countries (like morocco for instance). key words: cluster, globalization, competitiveness, knowledge sharing, networks introduction globalization has released potential for growth; this process is conducive to the accumulation of skills, knowledge sharing, the intensification of the networks (via information and communication technology ict), the synergy companies... yet it puts the companies in a new competitive “playground”. in the light of this, businesses adapt themselves, and new industrial policies are put in place to maximize on the process of globalization without being caught out by the competition it may generate. the clusters development policy comes into the framework of. the challenge of these clusters is to geographically group together firms, public and private research, laboratories and training organizations engaged in a partnership approach to create synergies in order to build innovative cooperative projects recognized nationally &/or globally. the potential benefit of grouping together companies is not a new invention. marshall1 described this process as “industrial district” and used the term “industrial atmosphere” to describe the dynamism generated by cooperation and exchange of know-how within the district. since then, local productive systems (spl) have been organized following the concept of the industrial district in prato, near florence in tuscany, which constitutes the first empirical study2 on this type of industrial concentration by g. becattini3 at the end * address: roanne 42 300 (france), e-mail: myriam.matray@gmail.com 1 marshall, a. (1890), principles of economics, london: macmillan. 2 in italy this type of territorial industrial concentration was highlighted by g. becattini, usa by a.scott and france by c. courlet. economic analysis (2010, vol. 43, no. 1-2, 9-24) 10 1970s. bories-azeau and loubès4 highlight that there is a difference between the concept of local productive systems spl and clusters. spls were identified in 1997 by the ciadt (interministerial committee for regional development) as “a group of companies and institutions geographically close who work together in the same field.” the afore mentioned authors write: “unlike the centered networks, dominated by one or more large enterprise and clusters5, which are subject to a new industrial government strategy, the spls are closely linked local networks, where power is shared amongst their members and consist primarily of small and medium size enterprises smes”. they also distinguish by their branch. an spl is more oriented toward more traditional industries (textile...), unlike a cluster which specializes in industries with high added value requiring heavy investment (micro-nano technologies...). figure 1. definition of a cluster6 the purpose of this paper is to underline the paradox that the cluster is an industrial policy to maintain national competitiveness arising from the adverse effects of globalization (relocation, the race for innovation, increased competitiveness, industrial espionage...), whilst wishing to position itself to face competition in the global market. therefore the clusters adapt their development to globalization: first they take globalization to the advantage of their development, to then be integrated into the globalization to meet international competition. for these reasons, the “cluster industrial policy” is bolstered. it has been 3 becattini, g. (1992), “le district marshallien : une notion socio-économique”, in benko, g. and lipietz, a. (1992), les régions qui gagnent, paris, puf. 4 bories-azeau, i. and loubès, a. (2007), “emergence d’un acteur collectif territorial et réseau d’entreprises : l’exemple de camdib”, revue recemap, october 2007. 5 // http://www.competitivite.gouv.fr. or: // http://www.observatoiredespoles.com/ and // http://polescompet.canalblog.com/ 6 source figure 1 : carel, s. (2005), “la politique française de développement de réseaux d’entreprises localisés, technopôles, spl, pôles de compétitivité : quels enjeux pour les territoires ?”, la politique française de développement de réseaux d’entreprises localisés, septièmes rencontres de théo quant, january 2005. // http://thema.univ-fcomte.fr/theoq/pdf/2005/carel-theoquant05.pdf joint by 3 common goals: innovative projects partnership approach international renown public &/or private research training centers firms matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 11 established in europe and is developing in mediterranean countries because it is an alternative to international competition companies face daily. globalization, the strength of clusters according to michalet7 c-a, “globalization is a multidimensional phenomenon, which encompasses three main elements: the development of trade and the relocating of production and financial movements. these three elements are interdependent.” globalization releases growth potential, yet is causing positive and negative effects. increased competitiveness is particularly favorable to consumers but it can also cause the collapse of a company which fails to stand up to the adversity of competition. globalization allows to increase the panel of knowledge fostering innovation, but it can facilitate industrial espionage, fires the race for innovation and diverts traditional consumer goods in exchange for increasingly more high tech goods. globalization has no borders; it is a-territorial which may cause an issue as to identification of territory. the list of positive and negative impacts of globalization is exhaustive. in our article we will put forward the core elements of globalization in clusters. the a-territoriality of globalization and the anchor-hold of clusters paradoxically national &/or global clusters attach importance to the territory in which they are implanted; it reconciles the global and the local. this new industrial policy, which has been created to further global competitiveness, thinks “global” but acts “local”. thus, the cluster will use the benefits of globalization advantageously to the extent of the networks, by applying “trade flows”8 beyond borders, to develop itself. the agglomeration of enterprises businesses in the field of information technology stand to gain by being able to access technological networks. the advantages constituted by network outsourcing increase by the number of users. marshall defined this as non-pecuniary outsourcing which increases profit. this network outsourcing may explain a paradox: in general, information and communication technology ict allows to decentralize the relationship between producers and buyers, which should allow them to use the means of television as a more comprehensive tool of communication for instance video conferencing through webcams. yet, ironically the tendency is for clusters to concentrate in agglomeration; taking as example operators, they will tend to seek zones where the demand is strongest and these are invariably high-density areas. the implantation of clusters takes into account these “centripetal forces”9 to facilitate their integration into the territory in which they are to be located and for quicker development. in this sense, the network does not exclude the notion 7 michalet, c-a. (2003), “comptes rendus d’auditions, mondialisation: une chance pour l’environnement ?”, 12 march 2003. // http://www.senat.fr/rap/r03-233/r03-23355.html 8 term used to define an aspect of globalization by michalet, c-a. 9 reference to the ʺcentripetal forceʺ on the location of economic activity, analysis developed by krugman, p. economic analysis (2010, vol. 43, no. 1-2, 9-24) 12 of proximity. colletis10, the specialist in geographical economics, highlights the fact that the connection of networks is not automatic between the different actors if they do not know each other, as they need to be built on trust between them. there is in fact no need, indeed, to be close to innovate: the development of communities of shared practices around the free software is an illustration, but it facilitates cooperation. the identity of a cluster whereas globalization comes along with a decline of the idea of nation state, the cluster integrates into a dynamics of co-construction between the territory which it is implanted and itself. however, it is not sufficient for the cooperation of the organization of the cluster, it must be perceived as a process in the construction of an identity so that each member feels totally integrated in the project. this identity is primarily based on the construction of social links through reciprocal exchange of rules and values. this sharing of rules and values in an entrepreneurial environment is particularly reflected in the third part of the following sections of the economic intelligence which encompasses: • industrial espionage with the aim to gain pertinent strategic information, • the protection of storage of information heritage. • and the manner of expression which influences the propagation of information or rules of conduct. the latter can be referred to as “formal capital” as defined by y. bertacchini and l. oueslati, which they describe as a set of rules and common procedures (published in “entre information et processus de communication: l’intelligence territorial”, 2003. // http: // www.isdm.org). this third point highlights the role of the formal structure, actually the efficient functioning of a cluster requires: • common opportunities: the ability to work on a common project being the underlining condition to be integrated as a member of the community, • the ability of the members to cooperate determined by the capacity of the members to organize themselves, • and common rules. the adoption of common rules will allow a high level of reliability favorable to collective research, which will consequently lead to the competitiveness of the cluster. the communal territory plays its role within the pole, in the following quotation thoenig j-c. and waldman c.11 bring to light the importance of the common values passed on by the specific geographical area: “the success and the survival of a company lie in its capacity to conquer, to define and to develop a territorial and economic community. a territory is established by multiple stakeholders (customers, suppliers, employees, civic associations, circles of experts, etc.) whom the company federates around its project, by means of common values and interests, shared identities, and lasting partnerships. the reference to its territory constitutes its code of conduct”. everyone identifies with their own roots; the expression of 10 colletis, g. (2005), “entreprises et territoires : proximités et développement local”, published in: entreprises, réseaux et territoires, 22 march 2005. 11 thoenig, j-c. and waldman, c. (2005), de l’entreprise marchande à l’entreprise marquante, editions d’organisation. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 13 blaise pascal, “the truth lies on this side of the pyrenees, the wrongs beyond”, or another common expression, “to each their own truth”, both reflect this territorial culture and illustrate the relativism which is a doctrine according to which no one opinion is absolutely true, each bearing meaning solely with regards to an active point of reference. this point of reference which can be an individual, a company, a culture, an industrial branch (chemistry, textile, toys & games...), a place. these traditional forms of territorial anchoring seal the future in such way that the crisis of a company becomes the crisis of the territory, and the decline of an organization rhymes with social drama (perrat, and zimmermann, 2003) such as the decline of the textile spl in roanne. as has been noted through the notion of identity, rules, and skills specific to the cluster, its identity shapes itself by ʺthe identification with the internal environment and the differentiation with the external environmentʺ (bouchet y., bertacchini y., noël l.). thus, the adherence to the cluster can be explained by the shape of the social networks it is made up of. between a-territoriality and territoriality the cluster can be assimilated to a specific territory, a place. the place becomes a pole, a center connected with other centers. jean-louis guigou, a delegate to land settlement and to regional function datar (from 1997 till 2002), highlighted the role of the territory faced with globalization by quoting: ““if globalization imposes itself on us, territorialisation depends on us”. this quotation, which i often used, is somewhat simplistic.” but it underlines this powerful dialectic between the global and the local that some american academics illustrated through the concept of “glocalization”. if our societies have indeed considerably increased their interdependence and their flow of exchange, and if companies have become more and more international and sometimes have given the impression of nomadism, territories are nevertheless becoming more and more strategic supports of the contemporary economic development, if they know how to organize themselves.”12 in this way, the cluster integrates this notion of territory. its location is carefully chosen and is proportional to its renown. it is also assimilated to the city in which it is to be implanted. so the cluster will gradually be made reference to by the city of the pole and vice-versa. the success of the pole will also be assimilated to the success of the city in which it is implanted as the latter benefits from positive externalities. thus, the cluster channels globalization by offering it a specific space. this territorial anchorage allows it to build up a physical and moral reason in order to eventually project itself on the global markets. the accumulation of skills in globalization and the sharing of knowledge within the cluster according to the latest work of michalet13 the traffic of goods, capital and technology is more and more intra industrial and intra enterprise. that is to say outer market. the cluster integrates this idea and favors the collaborative research. 12 foreword by guigou, j-l., in loinger, g. and nemery, j-c. (1998), “recomposition et développement des territoires, enjeux économiques, processus, acteurs”, l’harmattan. 13 michalet, c-a. (2007), mondialisation, la grande rupture, la découverte. economic analysis (2010, vol. 43, no. 1-2, 9-24) 14 cluster: factor for uniting agents this bringing together of actors, companies, researchers... is made all the easier as globalization allows a stake in their network, their research (with the example of the portals of information) and even if they come from different countries. it is the materialization of “brainstorming”, making to unite a diversity of agents coming from different backgrounds with the objective to create common motor driving innovative projects through the clusters. actually, one of the first factors of success of a cluster is the joint presence on a common geographical location with public or private research centers and companies specialized in high technologies as well as local economic actors. the aim being to facilitate the exchange of information between these actors in order to set up a process of communication by appropriate networks with the intention to transferring of skills and diffusing innovation. the pole functions with a logic of collective intelligence14, catalyst of collective wealth, sharing of knowledge: essential elements to facilitate and to activate research upon which this entrepreneurial culture is founded. this collaborative research generates innovation aiming for competitiveness on a national or international level. however, it is to be emphasized that the collective intelligence is a perpetual process15 and the information passed on in this way is the conveyor of competitiveness because it represents the strategic information, which belongs to the pole in question and to none other. the challenge is to constantly try to acquire new information in the advent of scientific breakthroughs. the sharing of the knowledge in the lap of the cluster globalization and in particular ict globalization gives everyone access to the required data bases, but these latter ones will only become information once they have been treated and they will only constitute knowledge once they have been assimilated and retranscribed by way of strategic decisions for the future of the pole. amongst the advantages of a cluster is the sharing of information. zimmermann puts forward the following characteristic within firms: the greater the degree of sharing (intervention of a large number of groups in the same scheme), the better is the ʺalchemyʺ of the functioning of the pole. the creation of the network is not immediate; trust is indispensable between the members all the more as not the whole of the information can be passed on by ict. as a matter of fact, explicit knowledge can be transmitted by distance, whereas the implicit knowledge can only be conveyed face to 14 collective intelligence “is specifically to enhance the diversity of knowledge, skills and ideas which are in a community and to organize this diversity of knowledge, skills and ideas which are present in a community and to organize this diversity in a creative and productive dialogue”. quote of zara, o. (2005), “le management de l’intelligence collective: vers une nouvelle gouvernance”, m2 éditions, 2005, in knauf, a. (2006), “le rôle des acteurs dans un dispositif régional d’intelligence économique: la place de l’informédiaire en tant que médiateur et animateur du dispositif” 2006. // http://hal.inria.fr/docs/00/10/73/12/pdf/knauf_numeroie2006_corrige.pdf 15 zartarian, m., centraliens, november 1998, in carayon, b. (2003), intelligence économique, compétitivité et cohésion sociale, la documentation française, p. 111 : “economic intelligence has fundamentally three main vocations: control and protection of scientific, technological and competitive storage of information heritage detention of threats and opportunities that the company may face constitution of influence strategies for the companies. the process is continuous, permanent and heuristics, with the aim to improve the competitiveness of the company by giving it the means to know and understand its environment to illuminate its decisions.” matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 15 face. whilst ict, ie tools, should logically amplify the functioning of a virtual economic system, the reality is quite the contrary: interpersonal communication or “face to face” remains essential as is apparent in the structure of a pole. it begs the question as to how to allow the exchange of strategic information in this competitive environment? ict networks are easily seen through, “pirated”, by the same token “face to face” remains an ie tool in the same way as ict. in that way the interest in a neutral public space contributes to the process of the ie: restaurants, cafeteria... often in these places, described by i.n. fisher as “social spaces” for informal meetings with implicit exchanges. the paradox of the “ie is to be immaterial and remote and yet close to all”16. the most expressive example remains that of “the city” (london’s financial center) where bankers and traders daily exchange strategic information (economic surveillance...). this process, as long as it continues, ensures the life of london’s financial market. neutral public areas are indispensable just like trust, which has to reign between the agents. information, knowledge and inventions have to be brought together and protected; therefore trust is fundamental within the cluster (bertacchini y., bouchet y., and noël l.) 17. according to bertacchini y. and herbaux p.: “a territorial intelligence is an organizational culture based on sharing and treatment of the signals from the economic actors who are destined to supply decisive information to the leaders, at the appropriate time”. mohellebi d. and dou h. (2007) highlight that the passing on of information springs from a corporate culture, that is to say to sensitize and motivate the members. the clusters shape strategic places of exchanges of information, thanks to the neutral spaces where trust reigns and gradually establish a business atmosphere and a corporate culture resting on exchange and cooperation. these phenomena mobilize the exchange of decisive information in the clusters which constitute a “competitive advantage” (porter, 1990). the storage of information heritage of the cluster and globalization the clusters are connected to other places via ict. in fact, with globalization, not to be marginalized, the adoption of icts is fundamental. the ict, the main tools of economic intelligence ie, are defined as all the techniques applied in the treatment and the transmission of information, mainly computing, internet and telecommunications. just as the pole benefits from a national and international renown by appropriation of the ict. the clusters need broadband telecommunication networks and all other contributions of the icts in order to function and develop themselves. icts also allow potential market expansion (electronic commerce). the globalization of icts has nevertheless its limits as far as safety and ethical terms are concerned. in the event ie intervenes to protect storage of information heritage. thus, the icts are limitated as regards to the exchange of information in competitive environment. indeed, bouchet y., bertacchini y., and noël l., note that trust is a process built without experience and consequently is contingent upon the safeguard of information. furthermore, authors like ivan samson, observe that smes implanted in a 16 author’s quote 17 bouchet, y. and bertacchini, y. and noël, l. (2008), “construire la confiance dans les échanges numériques, cas dans un pôle de compétitivité”, isdm informations, savoirs, décisions & médiations, 3rd quarter 2008. economic analysis (2010, vol. 43, no. 1-2, 9-24) 16 territory which is holder of positive externalities continue to develop strategies for competition and cooperation18 amongst themselves. these lines of thought demonstrate the interest of clusters which wisely use globalization to maximize on its own development. the cluster channels the negative effects globalization may cause (absence of identity status due to the a territoriality; the skepticism of the exchange of strategic information via ict, hence the interest of face to face; the fear of espionage hence the need for the pole to restore confidence and security of information) and uses the benefits globalization provides (a myriad of networks, globalization of ict and its absence of virtual borders). gradually the new industrial policy of clusters has proven its strength in the light of globalization and plays the role of a policy for growth to gain the required competitiveness to integrate itself in the stream of globalization. the industrial policy of a cluster the objective of this policy is twofold; internal development of the territory in which it is located and external development namely: • disseminate innovation (f. perroux) in the territory in which the cluster is located, develop territorial economic activity • promote competitiveness national and worldwide renown. thus, in order to achieve the objectives of the pole what matters, according to j. savatier19, is the will for putting in place networking actors, yet this will is evolutionary, just like social networks which make up the pole. thus, according to edward s. et al (2004) “networks experience endogenous development related to the transformation of links, objectives and members [...] but also changes in the external environment.” to adapt to these changes and promote cooperation ei is fundamental as it maintains the renewal of information on a daily basis in order to have data updated through the process of spying being conducive to research. ei also maintains the notion of trust through the protection of storage of information heritage. as an extension to the first part, the emphasis will be on the cluster as a component of integration into the globalization process. the objectives of an industrial policy of clusters as illustrated in france thus, in order to assimilate these economic changes associated with globalization an industrial policy focused on the territory was established by the ciact (interministerial committee for planning and competitiveness in territories). from 2005 to 2007, 71 clusters were officially recognized as such in france, amongst which 7 were distinguished as world clusters and 10 as potential world ones. 18 bouchet, y., bertacchini, y. and noël, l. (2008), “construire la confiance dans les échanges numériques, cas dans un pôle de compétitivité”, isdm informations, savoirs, décisions & médiations, 3rd quarter 2008. 19 savatier, j. (2007), “ table-ronde d’ouverture “l’innovation et l’anticipation des mutations économiques et sociales : perspectives européenne”” in “innovation et anticipation des mutations économiques et sociales”, seminar organized by the european commission, diact and dgefp, bordeaux, 22-24 october 2007. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 17 history of the establishment of clusters; new industrial strategy of government. figure 2. history of the establishment of clusters 2002 implementation of a strategic committee by jean-pierre raffarin ciadt of 13 december 2002. 2003 establishment of an ʺindustrialʺ working group 2004 datar report – “france, an industrial power”february blanc report ʺfor an ecosystem of growthʺ march financial bill for 2005 presented by nicolas sarkozy (art. 24) ciadt of 14 september 2004 call for presentation of projects of ʺclustersʺ november 2005 closure of the call for presentation of projects 28 february 2005 completion of inquiry by technical experts of projects may 9 establishment of the group of qualified actors may 16 proposal of the interministerial working group to government end june ciadt of 12 july 2005 – official recognition of the 67 cluster projects ciadt of 14 october 2005 validation of draft contracts and field of r & d. decree of 14 october 2005 – “interministerial committee for planning and development of territories” ciadt is renamed “interministerial committee for planning and competitiveness in territories” ciact. 2007 5 july 2007, 71 clusters are officially recognized source: jacquet, n. and darmon, d. (2005), “les pôles de compétitivité. le modèle français”, documentation française, coll. etudes n°5225. criteria of quality selected for agreement of cluster f. leroy20, head of mission, member of the working group ʺclustersʺ, management of entreprises, minefi, outlines the main objectives of clusters namely: • strengthen competitiveness of the national territory, • boosting economic development, • create or maintain jobs in industry, • and attracting investment and expertise at european level and globally. in view of this, in order to be recognized as a cluster, a draft project of pole must meet the specified criteria defined in november 2004 by the government. the following four criteria are decisive: • a development strategy consistent with the economic development of the territory of the pole, • a development strategy consistent with the local dynamism and performance of the economic fabric in the light of international competition, • sufficient international recognition, both industrially &/or technologically. the projects submitted must eventually pave the way to a leading position worldwide in their specific fields. the second criterion refers to a distinction between the poles with the 20 leroy, f. (2005), “pôles de compétitivité : de l’appel à projets à la labellisation”. entreprises, réseaux et territoires, 22 march 2005. economic analysis (2010, vol. 43, no. 1-2, 9-24) 18 main focus on technological research activities and the strength of interactions between research centers and companies working on the development in a field of technology by comparison to the dominant industrial poles which cluster companies with more concretely applied r & d and consequently is closer to the immediate market. • a partnership between actors and a structured, operational management. • in actual fact, the quality and efficiency of r & d partnerships between agents (industrials, researchers, lecturers...) are the main criteria for official recognition of a cluster. • the ability to create synergies in research and development and bring new wealth with high added values. the ultimate goal is to improve the competitiveness of the french offer on international markets. in europe, the lack of competitiveness persists and is worsening specifically in view of a stronger euro. the new policy allows to draw benefits from this situation with companies benefitting from the disinflationary effect of the strong euro on the cost of raw materials in particular. europe places high value on quality, this being the only way it can face competition dominated by cost. the purpose of the clusters is to accentuate europeʹs competitiveness with the desire to achieve the goals set in 2000 by the lisbon summit21. the initiative of clusters in the mediterranean countries via the euromediterranean partnership with the example of morocco mediterranean countries having specialized in low cost production for a long time, are feeling the brunt from competition, especially in traditional sectors (e.g. textiles), from india, from asia or eastern countries. they are also faced with the dumping of international monetary exchange. the cluster policy is at its initial stages. it is in their interest to integrate this new perspective to update and show off the advantages of their know-how through globalization. the challenge is to assert themselves in gathering their expertise to give a quantitative and qualitative added value to production, a competitive advantage in order to revitalize the mediterranean economy on the international market. hence the establishment of support plans with the financial aid of the european union. since the autumn of 1995, the barcelona process, provides a framework for relations between the eu and the countries of the southern shores of the mediterranean and with the objective to work towards building a euro-mediterranean shared prosperity and progressive introduction of free trade. it is a turning point in the relations between eu and its 21 this strategy of clusters puts forward the regional appeal. it was highlighted at the lisbon summit in 2000, at which the heads of states set the objective to make europe the leading world region for its competitiveness by 2010, « the most dynamic economic knowledge and the most competitive in the world able to sustain a lasting economic growth » by investing 3% of the gross domestic product gdp. seven years on, it has severely fallen behind as none of the countries have stuck to the set objectives except finland (in particular with the development of nokia, the renowned telecommunication cluster) and sweden. the only two countries having honored their engagement to dedicate 3% of their gdp to r&d activities. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 19 mediterranean neighbors. through this process, the european commission supports specific projects to sustain development through an expansionary fiscal policy. thus, the launch of a european neighborhood policy to support the euro-mediterranean partnership, has been initiated for numerous projects amongst which the meda projects (acronym for measure adjustment). similarities of local policies with europe appear as the emergence of the policy initiative of clusters combining endogenous growth, territorial economic intelligence leading to world renown. the trend of “glocalization” is gradually becoming a widespread policy of regional development for global competitiveness. the barcelona ii conference, held in november 2005, led in particular to a stronger political partnership. thus morocco manages to do the bulk of its trade with the european union, which, on 13 october 2008, awarded it the “advanced status”, setting it halfway between partnership and membership. morocco is the first of the mediterranean partner countries to have been awarded this status which strengthens the partnership: the opportunities for cooperation with the european union are providing a broader and more liberal trade, an enhanced political dialogue, exchanges relating to foreign and internal security policy issues and allowing access to certain programs and community agencies with budgetary support as of 2013. initiation by mediterranean countries to engage partnerships since 2004, the mediterranean partners and libya except turkey who began negotiations with the european union on 3 october 2005 are also included in a new set up: the european neighborhood policy started in march 2003 for the countries not belonging to the union. the following tables highlight the positioning of the mediterranean countries compared to the eu. table 1. economic indicators of the mediterranean countries and the eu economic indicators algeria morocco tunisia european union population (2007) 33 333 216 33 757 175 10 227 157 490 426 060 rate of growth (2006) 3 % 7.3 % 5.2 % rate of growth of the 27 (2007) countries 2.9 % unemployment rate (2006) 9.7 % 1 13.9 % 8.5 % source: http://www.statistiques-mondiales.com/index.html 1 http://www.imf.org/external/np/ms/2007/fra/061107af-1.gif table 2. progression of growth rate of the mediterranean countries growth rate progression 2002 2 2005 3 2006 2007 2008 3 algeria 4.1 % 5.3 % 3 % 6.5 % 5.4 % morocco 3.2 % 1.8 % 7.3 % 3.2 % 4.9 % tunisia 1.7 % 4.2 % 5.2 % 5.8 % north african countries 5.2 % source: http://www.statistiques-mondiales.com/index.html 2 statistics of the world bank. // http://www.worldbank.org/data/countrydata/ countrydata.html 3 according to the fmi report, “les perspectives de l’économie mondiale”. economic analysis (2010, vol. 43, no. 1-2, 9-24) 20 table 3. mediterranean countries and their trade volume 2002 algeria morocco tunisia balance of payment (% of gdp) 7.7 % 2.9 % -3.5 % trade volume with the eu (mio €) 22 377 13 992 13 629 eu balance of trade (mio €) -6 201 1 402 1 539 direct foreign investment (mio usd) 1 100 428 794.8 source: statistics of the world bank http://www.worldbank.org/data/countrydata/ countrydata.html the levels of development of the partner countries are very unequal, particularly in terms of population and gdp. with the extension of the eu on 1 may 2004, the eu has integrated two out of the twelve mediterranean partners22 namely cyprus and malta. the mediterranean countries with the highest population have been statistically identified (algeria, morocco, tunisia) in order to establish a comparison with the european union. in 2002 these countries had already recorded trade with the eu with growth rates of 4.1% for algeria, 3.2% for morocco and 1.7% for tunisia respectively. now set in a growing phase, the mediterranean countries continue to increase their growth rates with 3% for algeria, 7.3% for morocco and 5.2% for tunisia in 2006; the drops being mainly due to drought and rising oil prices. thus the north african countries have an estimated growth rate of 5.2% for 2008 while the 27 european union countries stagnated with a growth rate of 2.9%. the euromediterranean partnership is of equal importance to each. it allows the eu to expand its markets and formally establish constructive partnerships, as in the field of textile following the dismantling of multi-fiber agreement mfa in 2005. as for the mediterranean countries the barcelona process allows to uphold past relations with the eu, to position themselves as partners with the eu in the face of competition from new entrants from eastern countries into the eu, which increasingly monopolize the eu budget, and can to acquire new markets by teaming up with the eu as united front facing up to competition from emerging countries. this partnership now englobes thirty-seven countries of which twenty-seven being eu member countries and ten being mediterranean partner countries. the cluster policy: the emergence of a new strategy in mediterranean countries through the meda program… in order to further optimize the euro-mediterranean partnership, the agreement provides tools for financial cooperation to support the economic move within the mediterranean partner countries. it revolves around various support plans such as the meda projects, projects from the femip (facility for euro-mediterranean investment and partnership)... the interest in this research focuses on the meda projects in morocco. the meda program, agreed by the european council of cannes in june 1995, is one of financial instruments for the implementation of the euro-mediterranean partnership. through this program, the 22 the twelve mediterranean partners are algeria, cyprus, egypt, israel, jordan, lebanon, malta, morocco, syria, tunisia, and turkey. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 21 european union provides financial and technical assistance to mediterranean partners to enable them to achieve the objectives set out in the barcelona declaration bearing three components: political, economic and social. the main focus being on the economic element which has as its objective to progressively establish a free trade. the economic component has facilitated financial cooperation through various support projects such as the meda program and loans from the european investment bank. thus, a global budget is granted by project not by country. it is the european commission which, in collaboration with each individual mediterranean partner, is developing programs to aid the economic transition, funded under meda. these programs can take different forms including “private sector development support, economic transition support, sustainable socio-economic development support and structural adjustment programs support”23. the beneficiaries of funding by the meda program are the states, the regions, the local authorities, government agencies and non-governmental organizations within eu countries and mediterranean partner countries. the role of meda program in morocco the meda program aims to adapt to the new dynamics of competitiveness through sustainable development, job creation and wealth. it allowed the establishment of support project units (uap), meda project management entities. in morocco, they focus in particular on human resources development24 (education, training), of which three specifically selected fields of activity drive its economy: tourism, textiles, the new information technologies and communication (ntic). these projects emphasize (vocational training, skills-based approach) and develop these fields in order to meet the needs of social and economic development in view of international expansion. what is the relation with the cluster policy? the importance of the role of training. this method involves the process of economic intelligence in companies in a given geographical territory. the capital of human training &/or else the presence of appropriate infrastructures are the first phase of emergence to initiate a cluster policy. the governance aspect may also intervene in such instances as uneven geographical location of information and communication technologies (icts) in a territory and a country (importance of the role of clusters regarding the distribution of innovation and transmission of knowledge). in this context y. bertacchini stresses the utter importance of ict territorial integration with an initiative of information and communication “at risk of being marginalized nationally and internationally” 25. as a result governance can cover all or part of the draft economic development, hence the importance of integrating the functioning of a cluster in mediterranean countries. expected results for 2010 results forecast for 2010 would be: 23 “union européenne et méditerranée”, la documentation française. // http://www.ladocumentationfrancaise.fr/dossiers/europe-mediterranee/index.shtml 24 some projects have also focused on the development of infrastructures, trunk roads, and other fields of activity. 25 bertacchini, y. and oueslati, l. (2003), “entre information et processus de communication: l’intelligence territoriale”. // http://www.isdm.org economic analysis (2010, vol. 43, no. 1-2, 9-24) 22 • “in tourism, training of 72 000 young people, including 18 000 through apprenticeships and upgrading of human resources; • in textile, training of 75 000 young people, including 30 000 through apprenticeships, the achievement of a basic literacy skills program for the benefit of 50 000 workers and upgrading of human resources; • in ict, training of 63 000 young people and upgrading of human resources”26 the interest to define these objectives is to emphasize the achievement of training in these three driving fields. these support plans, including the meda program, constitute the beginnings of an industrial policy of clusters for the mediterranean countries. according to michalet ca., globalization is not yet a global phenomenon. only some countries are concerned: in addition to the countries of the triad eu, north america and japan there are fifteen emerging economies: china, india, the newly industrialized countries (the dragons) and the asian tigers in asia, mexico, chile and brazil in latin america, poland, hungary, slovenia and the czech republic in central europe. thus, countries on the sidelines of globalization seek to attract foreign investment (one of the four objectives of the cluster policy) because they fear marginalization. in this way the mediterranean countries wishing to become more industrialized, to increase their export in order to better position themselves vis-à-vis competition and therefore to be able to be integrated in the flow of globalization. conclusion the cluster is defined as “a system of enterprises rooted in a region where interactivity helps to secure long-term global competitiveness of national production” 27; this quotation reflects the fact that the pole is a territorial representation of globalization. so, it was demonstrated in the first part that the cluster, in order to develop, incorporates in its functioning that which globalization brings with it. furthermore, this policy was created to be consistent with market expectations, which are ever more demanding, and its everincreasing race for innovation. consequently this policy is reflected in relation to these new conditions, which are becoming relentlessly more difficult to fulfil (importance of innovation, importance of investment in research and training, particularly in higher education, complexity of innovative processes...). this policy proposes development prospects. with this logic, competitiveness clusters gradually become a model of industrial performance. in effect, changing technology and accelerating markets have brought about the change. what is now required is to combine expertise in the diverse fields of technology with a speedy and well-timed reactivity on the market of innovations. these two major issues make the process of “collaborative innovation” unavoidable. accordingly the clusters have permitted to put in place those conditions imposed by globalization and, paradoxically, in order to remain or to be integrated in the globalization process, to allow the country in which they are implanted optimum competitiveness. the cluster is primarily a policy of growth hence the interest to continue to support this policy in european countries and to introduce it in mediterranean countries so that everyone can take a stand in the light of 26 meda website of morocco. // http://www.meda2-fp.ma/ 27 samson, i. (2008) under the direction of., l’économie contemporaine en leçons, dalloz. matray, m., the upsurgence of clusters, ea (2010, vol. 43, no, 1-2, 9-24) 23 competition and confirms their position in global markets. the dominant overall configuration of the financial profitability is fragile, the industrial policy of clusters might therefore become the basis for a “new governance”, to correct, to channel the excesses of globalization. as the term “governance” highlights, it is also important to clarify the role of institutions for the implementation of poles. the author colletis mentions the need for institutional agents for the creation and sustainability of the pole, whether it be in infrastructure, equipment, funding research programs, partnerships with the region, department, local organization or chambers of trade and industry. european funds for the establishment of clusters in france or government aid through projects such as meda programs in mediterranean countries show how imperative involvement of institutional bodies is for the credibility of a project, for its launch and for its sustainability over time. references angelier, j-p. 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(2005), le management de l’intelligence collective : vers une nouvelle gouvernance, m2 éditions. received: 30 march 2009 article history: accepted: 19 october 2009 ea_2012_3-4 original scientific paper foreign direct investment and economic growth: evidence from asian selected countries soleimani sheida*, department of economics of shiraz university, iran behname mehdi**, department of economics of ferdowsi university of mashhad (fum), mashhad, iran udc: 339.727.22(5)"1980/2010" ; 338.1(5) jel: f21, f43 id: 195856140 abstract – the purpose of this paper is to investigate the influence of foreign direct investment (fdi) on economic growth in asian countries for the years 1980-2010. the ips unit root test indicates that variables are stationary in level and hausman test proves that we should apply the random effects model. having estimated the model we come to the conclusion that fdi has positive and significant effect on economic growth and variables such as human capital, economic infrastructure and capital formation have positive effect on gdp. however, population, technology gap and inflation have negative effect on the economic growth. key words: foreign direct investment, economic growth, asia, panel data introduction one of the main concerns of the governments is to promote development and welfare level of the country. in the past two decades, fdi has been known as an important factor for growth and development. in the recent years, the asian countries such as thailand, malaysia, indonesia and china have attracted a significant portion of the fdi of the world. this action has been influential on economic growth in asian countries, in a way that the economic growth has been increased to 7.7% in southern asia in 2005, 13.8% in pakistan, 8% in afghanistan, 8% in bhutan and 8% in india. the capital flow to asian countries initiated in 1990 with an increasing rate following a decrease in 1980. the fdi has been increased in asian developing countries from 396 million dollars in 1980 to 102,066 million dollars in 2001. this rate is equal to 13.9% of the whole fdi in 2001 (unctad 2002). the world bank reports illustrated the capital growth in southern asia to be 23.6 billion dollars in 2005. this major share of this growth belongs to india attracting a considerable fdi of this region. in pakistan, privatization and natural resources has caused the increase of fdi which was 1.1 billion dollars in 2004 to 2.2 billion dollars in 2005. the paper aims to shed a * department of economics of shiraz university, iran, sheidasoleimani22@yahoo.com ** department of economics of ferdowsi university of mashhad (fum), mashhad, iran, mehdi_behname@yahoo.com economic analysis (2012, vol. 45, no. 3-4, 67-74) 68 light on whether fdi has had any share in the increase of economic growth in asian countries or not. so many researches have been done in this regard. borensztein and gregorie & lee (1978) proved that fdi in an endogenous model provides the grounds for growth in developed countries. blomstorm and kokko (1997, 1998) asserted that fdi provides economic growth in developing countries. on the other hand, balasubramanyan et al. (1996) indicated that fdi, plays more important role in economic growth as compared to export. carkovic and levine (2005) also showed that fdi leads to the increase of economic performance. however, gorg and greenaway (2004) proved that fdi does not have any influence on economic growth. behname (2011a, 2011b, 2011c) shows that gdp has a positive effect on fdi and fdi also has a positive effect on gdp. theoretical issues application of industrial policies such as tax and subsides to attract fdi signifies great benefits of foreign capital for the host countries. the multinational firms bring about advantages such as advanced technology, trade secret, brand name and trademark, management techniques and marketing strategies (dunning 1993). but the most important effect of fdi is the increase of growth in the host country. we could examine the effect of fdi on economic growth within the framework of the growth models. in neoclassical growth model, it is believed that fdi just influences the per capita output level and has no effect on growth rate. however, in modern theories of economic growth, it is believed that fdi is effective on growth rate and level. based on the recent theories, the main factor influencing the growth rate is the high technology in advanced countries which is transferred to the developing countries through fdi (borensztein et al 1998). because of the absence of essential grounds for the formation and improvement of technology in developing countries, these countries have to import these technologies into their country through fdi. on the other hand, through the spillover of technology to other domestic sectors, national economy would benefit this system. when the production technology is improved at the national level, the products would be supplied with higher quality and lower cost, and consequently, national production and per capita output would increase. in other words, technology is the potential source of productivity profits through spillover to domestic enterprises. borensztein et al (1998) proved that the difference in level of human capital in different countries influences the level of attracting technology which finally would affect the economic growth. so, possessing human capital cause the increase of growth rate. on the other hand, it is to be considered that fdi cause the promotion and elevation of the level of human capital and improve the management techniques in developing countries. fdi also could increase production and economic growth through the improvement of infrastructures. the multinational enterprises for extraction and transporting raw materials and also sales of final products are forced to modify the transportation and communication systems. the modifications of these infrastructures facilitate transportation of products and therefore, production process is improved. the effect of fdi on economic growth depends on the conditions of the host country. these conditions include trade openness, high rate of soleimani, s., et al., fdi and economic growth, ea (2012, vol. 45, no, 3-4, 67-74) 69 saving and the existence of human capital. the highness of these criteria improves the conditions of host country's enterprises through demonstration, and contract effects, as well as the increase of exports. data and methodology before estimation of the model, we should be ensured of the stationarity of variables. dickey-fuller, (1981) augmented dickey and phillips-perron tests are used to measure the stationarity of time-series variables, however, for panel data which have higher power compared with time-series, other tests are applied. these tests are: im, pasavan and shin (2003), levin, lin and chu (1992). among different unit root tests in econometrics literature, the llc and ips are more famous than others. both of these tests have been made based on adf. assuming that data are homogeneous, llc test has been made for dynamics of autoregressive coefficients for all panel parts. however, ips more generally considers heterogeneity of this dynamics. the benchmark model of autoregressive is as follows: ititiitiit xyy εδρ ++= −1 (1) where shows i = 1,2,…n of the countries from the times of t=1,2,….,t. itx are exogenous variables in the model. iρ is the autoregressive coefficient and itε is the static process. if iρ <1, iy is weakly stationary and if iρ =1, then iy has a unit root. in this paper, ips test was used for the unit root, because the economic structures of the respective countries are different. table 1. unit root test and panel data gdp inf pop hu inv fdi ope -3.44* -4.21* -3.13* -2.45* -2.09* -4.53* -2.54* the variables are stationary at the 5% confidence level. as defined in table 1, all the variables were significant in 5% level. it means the variables are stationary, and so, spurious regression is avoided. the hausman (1978) test was used to select the fixed effect or random effect models. this test shows that the random effect model should be applied. economic analysis (2012, vol. 45, no. 3-4, 67-74) 70 methods the main variables for economic growth in this study include investment, population growth, gdp per capita, infrastructure (telephone line), inflation, productivity, human capital and foreign direct investment. this paper applies the panel data model for estimation of the parameters for southern asia countries (e.g. bahrain, iran, saudi arabia, qatar, kuwait) we have chosen these countries because ones have the same economic structures and they are exporting oil countries. the basic specification for the model is itititititititit bxfdiinvhupopinfg εββββββ +++++++= 543210 where g is the real gdp per capita growth of country i, inf is infrastructure, pop is the population growth and hu is human capital in the host economy. fdi is the foreign direct investment and inv is gross capital formation as a percentage of gd. the group of x includes a group of variables to test the robustness of results (e.g. dummy variables, interaction of fdi with other variables, inflation…). we could consider the endogenous form of the model i.e. fdi to be a dependent variable. the technology gap is measured by the following: ( ) ititit yyygap /max−= where the gdp per capita of iran is used as y max. before proceeding to estimate panel data, we carry out unit root tests to examine whether the variables are stationary. the data set used covers 6 countries over the period 1980-2010. the sources of variables are undata, the world bank group, unctad and growth data resources. empirical results the results of the main equation are shown in table 2. the specifications of column 2.1 are based on the main variables of fdi, hu and pop. the effect of human capital and foreign investment variables on economic growth is positive and significant. behname (2011a) and borensztein et al (1998) show the same results for the different countries. fdi such as domestic investment increase aggregate demand and aggregate demand augment domestic output. the effect of population on growth is positive, but insignificant. we insert inv to the equation to explain column 2.2. this equation shows that capital formation has positive effect on economic growth. in this column all of the variables are positive and significant. if population has a high human capital, increasing it augment gdp. in equation 2.3 the infrastructures are also inserted. the proxy required for infrastructure is the telephone line. in this clarification the infrastructure has positive effect on economic growth, but fdi has no effect on growth. aitken et al (1997) show the same results in their study. in explanation 2.4, we insert technology gap. this variable has negative effect on growth, and in this equation, fdi has positive and significant effect on economic growth. in explanation 2.5, we insert the interaction relation of technology gap and fdi, which has negative effect on economic soleimani, s., et al., fdi and economic growth, ea (2012, vol. 45, no, 3-4, 67-74) 71 growth. these variables affect gdp in an indirect way. in the last explanation, we insert infr inflation rate, as an economic risk, into the equation which has negative effect on economic growth. table 2. impact of fdi on per capita gdp growth 2.1 2.2 2.3 2.4 2.5 2.6 constant 3.12** 1.21 1.33** 2.31** 1.22 -1.31 (-2.32) (1.09) (2.09) (2.22) (0.42) (-1.14) pop 0.42 0.12** -0.51** -0.13 0.14 0.21** (1.02) (2.05) (-2.13) (-1.21) (-1.01) (-2.15) hu 0.93** 0.71** 0.92** 0.31** 0.21** .23** (2.11) (1.21) (2.12) (2.01) (2.13) (2.27) fdi 0.19** 0.39** 0.45 0.22** 0.31*** 0.11* (2.12) (2.11) (1.01) (2.11) (3.52) (1.91) inv 0.13** 0.21** 0.21 0.25** 0.20** (2.31) (2.30) (1.33) (2.12) (2.35) inf 0.25** 0.22** 0.63 0.22** (2.00) (2.31) (1.13) (2.04) gap -0.09** -0.11** -0.07 (-2.16) (-2.08) (-1.24) fdi*gap -0.14** -0.21 (-1.98) (-0.91) infr -0.29** (-2.10) notes: t-values reported in parentheses; *** significant at 1% level; ** significant at 5% level; * significant at 10% level. table 3 shows the results of fdi equation. this table studies the effect of gdp on fdi. in equation 3.1, the effect of economic growth and human capital on fdi attraction has been positive, while population shows negative effect. based on this table, economic growth, human capital, trade, capital formation and economic infrastructure have positive and mostly significant effect on attracting foreign capital, while population and economic risk, inflation, leads to the decrease of foreign investment. aitken & harrison (1999) and de mello (1997) show the same results. here ope is openness that a positive effect on fdi, it means that openness and fdi have a complementary relationship. economic analysis (2012, vol. 45, no. 3-4, 67-74) 72 table 3. impact of growth on fdi inflow 3.1 3.2 3.3 3.4 3.5 3.6 constant -2.19** 2.19*** 1.34** -2.21** -2.50 -1.44 (-2.00) (3.32) (2.11) (-2.14) (-1.21) (-1.51) gdp 0.09** 0.02** 0.02 0.03** 0.04** 0.03** (2.32) (2.28) (1.17) (2.01) (2.11) (2.01) hu 0.30** 0.325 0.21* 0.32 0.23** 0.03 (2.14) (1.11) (1.98) (1.32) (2.14) (1.03) pop -0.24** -0.35** -0.28 -0.21 -0.24** -0.23 (-2.22) (-2.11) (-1.02) (-1.14) (-2.28) (-1.37) ope 0.02** 0.03** 0.05** 0.04** 0.10 (2.31) (2.16) (2.10) (2.14) (1.29) inv 0.32** 0.52* 0.25** 0.02** (2.09) (9.88) (2.15) (1.98) infr -0.15** -0.13** -0.14** (-2.01) (-2.50) (-2.24) inf 0.21*** 0.21** (3.22) (2.16) fdi*gap 0.36** (2.06) notes: t-values reported in parentheses; *** significant at 1% level; ** significant at 5% level; * significant at 10% level. conclusion the study examines the influence of foreign direct investment (fdi) on economic growth in asian selected countries for the years 1980-2010. having applied the stationarity, it has been concluded that all the variables are stationary and we would not be trapped with spurious regression. the hausman test shows that our selection is random effect model. in two other separate tables, we examined the effect of fdi on economic growth, and the effect of gdp on fdi. in each table, we insert variables into the equation separately to be compared. the results of fdi effect on growth indicate that fdi has significant and positive effect on economic growth in asia region. with regard to these facts, we come to the conclusion that it is necessary for the countries of asia to attract the fdi in order to improve growth and welfare of their country. on the other hand, the second table, the effect of gdp on fdi, indicates that factors such as human capital, trade, economic infrastructure and capital have positive effect on attracting fdi. so, the countries located in this region are able to increase their fdi and consequently the growth of their country by emphasizing these variables. among other factors effective on economic growth, we could mention economic infrastructure, human capital, decrease of technology gap and capital formation which soleimani, s., et al., fdi and economic growth, ea (2012, vol. 45, no, 3-4, 67-74) 73 increase the growth. however, the population growth, the increase of technology gap, and inflation increase leads to the decrease of economic growth. based on the obtained results, the countries of asia should devote their most attention to economic infrastructure and capital formation, since it directly increases gdp and affects it indirectly through attracting fdi. references aitken, b. j., hanson, g. h., & harrison, a. e. 1997. “spillovers, foreign investment, and export behavior.“ journal of international economics, (43): 103-132. aitken, b. j., & harrison, a. e. 1999. „do domestic firms benefits from direct foreign investment?.“ american economic review, (89): 605-618. akinlo, a. e. 2003. „globalisation, international investment and stock market growth in subsaharan africa“. institute of developing economies v.r. f series, 382. balasubramanyan, v. n., salisu, m., & sapsford, d. 1996. „foreign direct investment and growth in ep and is countries.“ the economic journal, (106): 92-105. behname, 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social development, united nations, new york. direktna strana ulaganja i ekonomski rast: dokazi iz odabranih zemalja rezime – svrha ovog rada je da istraži uticaj direktnih stranih ulaganja na privredni rast u azijskim zemljama u periodu izmedju 1980 i 2010 god. koršćen je ips jedinični test. nakon procena ,došlo se do zaključka da direktna strana ulaganja imaju pozitivan i značajan uticaj na privredni rast ,dok varijable kao što su ljudski kapital, privredna infrastruktura i kapital imaju pozitivan učinak na društveni bruto proizvod. međutim, stanovništvo, tehnološki jaz i inflacija imajui negativan učinak na privredni rast. ključne reči: direktna strana ulaganja, privredni rast, azija, panel podataka article history: received: 17 july 2012 accepted: 23 october 2012 microsoft word 2009_3_4-korigovano.doc review conference review on the occasion of successful completion of the tempus project „business university of the new age in serbia-bbabuona”, realized jointly by the belgrade banking academy; school of management (saa), university of turin; and law school, university of seville, in premises of the institute of economic sciences in belgrade on july 22nd, 2009 was held the international conference: ʺbusiness opportunities in serbia: the case of italian business sector and role of management educationʺ. conference was supported by the institute of economic sciences, belgrade chamber of commerce and iceinstituto nazionale per il commercio estero, ufficio di belgrado. the vice-president of the government of the republic of serbia and the minister of economy and regional development, mr. mlađan dinkić, opened the conference. in his presentation minister took chance to emphasize on the importance of international cooperation, especially of foreign investments and transfer of knowledge. he presented the case of joint venture made by fiat and zastava, and the importance of italian investors in serbian transition process. he mentioned several very important italian companies operating in serbia, including banca intesa, generalli insurance, sai fondaria and many others who have enabled serbian industry to overcome transitional problems, and become competitive on international level. the first session of the conference, attended by a number of guests, was dedicated to the most significant results of cooperation between bba, saa and the university of seville in a framework of tempus project. the introductory welcome speech gave professor hasan hanić, dean of bba, professor stefan dukiandjiev, international coordinator of tempus belgrade office, professor guiseppe dutto, professor of saa and the head coordinator of buona project, professor miguel angel adame, professor of law school seville and professor valter cantino, dean of saa. professor dutto, as a coordinator of tempus buona project presented the achievements of the project and briefly gave insight of what buona brought to belgrade banking academy. after less than one year of cooperation within the tempus project “business university of the new age in serbia (buona)”, saa, the university of turin, school of management and bba (belgrade banking academy) have reached an agreement economic analysis (2009, vol. 42, no. 3-4, 91-94) 92 on widening their cooperation beyond the scope of tempus and initiating joint master&mba study program: financial / banking and business management. according the agreement at the end of their studies, students will be granted two diplomas, a serbian master, and one issued by the university of turin, which is a strong certification of the quality of the bba master & mba program. the cooperation involves the following basic features: • joint development of program curricula • joint development of courses. under the tempus buona project, serbian professors spend in average two weeks at saa where, in close cooperation in with italian professors, they select literature, develop courses contents, and become acquainted with modern teaching methodologies. • delivery of part of the lecturers by italian professors • mandatory study visits of serbian students to turin to attend classes and visit italian businesses • development and introduction of european quality standard system at bba. the agreement, signed by the rectors of the two universities saa and bba belong to, i.e. the university of turin and the union university of belgrade has a far reaching strategic relevance for both bba and the serbian education community, considering that according to the latest surveys, and the university of turin is ranked no. 1 among large italian universities. the implementation of superior standards in the education process and the enforcement of european quality procedures will open unique opportunity for serbian students to obtain master and/or mba diplomas by studying at bba in belgrade, which will be valid all over europe. with a new study program “financial banking and business management”, belgrade banking academy in cooperation with prestigious partner from europe1 the saa of the university of turin, provides students in serbia with the opportunity to study in belgrade according to the highest european standards and achieve both the master bba degree an the other one recognized in eu countries, which opens the door for better employment in financial institutions and companies throughout europe, by equal conditions granted to students from other european countries. the courses at the mmb studies are performed by remarkable teachers from the university in turin (italy) seville (spain), and other european universities, together with top national professors trained at european universities in the frame of tempus program. the textbook literature is in english and serbian. the way of taking exams will be completely adjusted to the partners’ respecting eu standards. in order to further strengthen equivalence with international standards a seven days professional visit and internship at the university of turin will take place. in accordance with serbian law on higher education and bologna declaration, upon the successful completion of the master studies, the student will be granted academic title graduated manager – master. the students of mmb, thanks to the use of modern teaching methods, will acquire complex knowledge and professional skills in various management disciplines, as well as general management, and will be capable to 1 in the year 2008 the university in turin, comprising the saa, was entitled the best quality university in italy. zubović, j., conference review, ea (2009, vol. 42, no. 3-4, 91-94) 93 work in banks and companies covering practically all business activities and, by gaining adequate experience, to achieve top management careers in serbia, eu countries, and other countries of developed market economy. upon completion of additional courses earning 30 ects and having defended their thesis, the students will be granted by saa and bbamba diploma (master in business administration). the second part of the conference celebrated the presentation of italian companies in serbia. the main presenters were the representatives of leading italian companies doing business in serbia and official representatives of italy: • dr. thomas botzios, first secretary of embassy of the republic of italy in belgrade, • dr. fabio corsi, national institute of italian foreign trade in belgrade, • giovanni de filippis, general manager fiat group automobiles, • dr. giancarlo miranda, vice president of executive board coo banca intesa ad. belgrade, • dr. christian neu, vice general director of fondiaria sai group, • dr. romano rossi, owner of progetti international • dr. ivano canteri, global marketing manager, chamber of commerce, turin – centre for foreign investments dr botzios presented the role of italian embassy in attracting italian companies to invest in serbia. he also gave an insight of investment framework which foreign investors are facing in serbia. his speech opened a topic presented by dr corsi about economic cooperation between italy an serbia. in the year 2008 italy was the third trade partner of serbia. according to statistical office of the republic of serbia the total exchange between the two countries amounted to 2,2 billion euro, 1,47 billion euro of which, italian exports into serbia (+13% a rise compared to the same period of 2007) and 763 million euro of italian imports from serbia (-4,5% compared to the previous year). the balance of trade amounted to 713 million euro in favour of italy. dr corsi gave the insight of business opportunities for italian companies in serbia. he briefly introduced serbian business environment, including legal and economic details. further on he emphasised on the importance of italy as a trading partner, being third most important trade partner after russia and germany with total foreign exchange reaching 2.2 billion euro. in the second part of presentation dr corsi explained what key industries in serbia with an interesting perspective are for italian investors. the next presentation was made by mr giovanni de filippis representing fiat group automobiles in serbia. he gave us the complete perspective of the way his company is operating, what is there organisational structure, what are their affiliations worldwide and finally he explained on what basis the joint venture agreement between zastava and fiat were set. economic analysis (2009, vol. 42, no. 3-4, 91-94) 94 dr miranda the coo of banca intesa belgrade made the presentation of their company activities in serbia. he showed us ho their clients are, what is their market share, how did they expand since entering serbian market, and finally what they expect in the future of the financial industry in serbia. dr neu from fondaria sai group spoke about considerations of a foreign investor in the serbian insurance market. at the beginning he introduced us to fondaria sai group giving all structural and financial data of their international operations. it was followed by the perspective on the serbian economic and political landscape, giving statistical detail on how serbia is trailing in insurance business compared to countries in the region. with detailed presentation of serbian insurance market he assured us that serbia has its perspective in this industry, and that all regulatory obstacles have been removed for this industry to become fast-growing. at the end of his presentation dr neu presented the achievement of the ongoing transformation program of ddor, novi sad. dr rossi from progetti international made presentation of his company operations in serbia and he spoke about the cooperation set between his company and belgrade banking academy and the institute of economic sciences in belgrade. the final presentation in the second part of the conference was made by dr canteri from the turin chamber of commerce of the region piemonte in italy. the third part was dedicated to of bba teachersʹ, ies researchers and other authorsʹ papers presentation. at the beginning of this session deputy deans at bba – professors zvonko brnjas and predrag dedeić talked about the role of management and financial education in contemporary business. this was followed by over 15 presentation of scientific papers. those presentations made this conference not to remain only promotional from the aspect of business cooperation between italy and serbia, but it set a very strong foundation for such cooperation based on scientific research made by prominent researches in this area. to conclude, the international conference business opportunities in serbia was a very important meeting, especially in the period of hard economic crisis, to enable sustainable development of economy in serbia, focusing on financial industry which has to give pace to all other economic sectors of the serbian economy. it is necessary to support such conferences and we hope to see even more of them in the future. zubović jovan, institute of economic sciences, belgrade ea_2014_3-4 udc: 336.781.5 005.334 jel: e43, f31 cobiss.sr-id 211781644: scientific review interest rate swaps pepić marina1, national bank of serbia, belgrade, r. serbia abstract – interest rates changes have a huge impact on the business performance. therefore, it is of great importance for the market participants to identify and adequately manage this risk. financial derivatives are a relatively simple way of protection from adverse changes in interest rates. interest rate swaps are particularly popular because they reduce interest rate risk to a minimum with a relatively low initial cost and without great risk, but also because of the fact that there are many modifications of the standard swap created to better satisfy the different needs of market players. key words: interest rate risk, standard interest rate swap, non-standard interest rate swaps introduction due to the large impact that interest rates changes have on the business performance, it is very important appropriately to manage this type of risk. financial derivatives (futures, options and swaps) are a very simple way to minimize interest rate risk, which is why they are extremely popular, and their use in the world is increasing drastically year by year. according to the bank for international settlements, from all financial derivatives traded on the otc market, interest rate derivatives have recorded the largest market value, primarily interest rate swaps. however, this is not the case in serbia. in serbia, the interest rate derivatives market does not exist. thus, this paper aims to highlight the possibilities offered by this type of derivatives when it comes to protection against interest rate risk. in the paper first will be explained basic concepts related to the interest rate swaps. after that it will be explained, with an example, how standard interest rate swap can be used as a tool for protection against interest rate risk. after that, some non-standard variants of interest rate swaps, created to better satisfy different needs of market participants, will be briefly discussed. finally, at the end of the paper attention will be drawn to the advantages and disadvantages of the interest rate swaps. interest rate swap interest rate swaps appeared in the u.s. in the eighties because of the increased need for financial instruments that could be used to eliminate the interest rate risk. interest rate swap is an agreement between two parties in which they agree to exchange sequence of interest payments (peterson drake, fabozzi, 2010, p. 378). interest is calculated on the notional 1 karadjordjev trg 3, belgrade, marinapepic@hotmail.com economic analysis (2014, vol. 47, no. 3-4, 69-80) 70 principal that is never exchanged. on agreed dates, one party has an obligation to make payments calculated at a variable rate and the other side has to make payments at a fixed / variable rate. thus, one set of payments must always be at a variable rate linked to a reference interest rate (usually libor). if the dates on which the parties have to make payments coincide, usually is paid only the difference in interest. set of payments calculated at a fixed rate is the fixed leg of the swap, and the set of payment calculated at a variable rate is the variable (floating) leg of the swap. the party which pays at fixed rate and receive at variable rate is the buyer of the swap (long position) while the swap seller (short position) is considered to be the party that pays at a variable rate and receive at a fixed interest rate. swap rate – by contracting the interest rate swap parties agree to exchange set of interest payments on agreed future dates, where, as noted above, one set of payment is calculated at a fixed, and the other at a variable rate. the variable rate is linked to a reference rate, while fixed-rate is set in the way that present value of future payments that parties would exchange are equal in the time of swap initiation. hence, swap rate is fixed rate at which one set of interest payments is calculated and which provides equality of present values of future payments at the time of concluding the swap agreement (cvitanić, zapatero, 2004, p. 302). obligations of the party that will pay a fixed rate are known in advance. however, this is not the case for the party that pays at a variable rate, because variable rate changes depending on the change of reference rate to which it is bound. the value of futures for the period is usually taken as an estimation for the variable rate and in that way obligations are calculated. the value of the swap – in the moment when it is signed value of the swap is equal or close to zero, i.e. the present values of cash flows that counterparties will exchange are equal. however, over the time the value of the swap changes depending on the interest rates movements in the market, because interest rate shifts change the present value of the cash flows that parties pay or receive. the value of the swap is equal to the difference between the present value of cash flow that party receives and the present value of the cash flow that the party pays (fabozzi, 2000, p. 578). swap spread in the swap market, the convention is to set the floating leg at libor and quote only the fixed rate (reilly,brown,2003, p. 1018). in the table below, the first column represents swap maturity, the next two are offer and bid quotes for each maturity, and the last one is the bid spread over the benchmark t-bond (government bond with the same maturity). for example, the bank is quoting for 5-years swap 5.25% and 5.19%, which means that the bank is willing to pay a fixed rate of 5.19% and receive libor, and to pay libor and receive a fixed rate of 5.25%. the bid-offer spread is therefore 6 basis points. the bid-offer spread is not the same as swap spread. say the 5-year t-bond (benchmark bond) is trading at a yield of 4.88%. the 5-year swap bid and offer rates in the example are 31 basis points (the difference between 5.19% and 4.88%) and 37 basis points (the difference between 5.25% and 4.88%) above the yield on tbond, so the bank could quote the swap rates also as a swap spread (spread over the t-bond yield): ‘37–31’. this means that the bank is willing to pay 31 basis points above the t-bond yield and receive libor or to receive 37 basis points above the t-bond yield curve and to pay libor (choudhry, 2005, p. 110). pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 71 table 4. swap spread swap quotes spread 1 4,50 4,45 +17 2 4,69 4,62 +25 3 4,88 4,80 +23 4 5,15 5,05 +29 5 5,25 5,19 +31 10 5,50 5,40 +35 source: eales and choudhry ,2003, p. 77. thus, swap spread is the spread over the t-bond yield curve. swap spread is a function of conditions on swaps and bonds markets, as well as of the credit risk of counterparties. swap yield curve a large number of swap contracts led to the formation of the yield curve for different maturity swap contracts. swap yield curve is created based on swap rates for different maturities (fabozzi, 2007, p. 96). swap termination there are four ways in which parties can get out of the swap (chance, 1998, p. 583). these are: 1) close out party coming out of the swap pays / charges present value of the swap to the counterparty. 2) sale transferring the swap to a third party after which this party takes over all obligations from the swap agreement by the end of the contract period. the party that is getting out of swap transfers the swap to a third party by paying / charging the present value of the swap. 3) neutralization of the existing swap by entering into a new swap with the same conditions (same fixed and variable interest rate and payment period), but on the opposite position (cash flows are opposite compared to the first swap). 4) using a previously bought option to terminate the swap. standard interest rate swap the most common and simplest type of interest rate swap is a standard (plain vanilla or generic) swap. it involves the exchange of a set of periodic interest payments calculated at a fixed rate for a set of periodic payments calculated at a variable rate in the agreed period of time. both sets of interest payments are calculated on the notional principal that is never exchanged. the variable interest rate is linked to a reference interest rate (libor rate and the t-bill). interest rate swaps are used to neutralize the interest rate risk related to the difference in sensitivity of assets and liabilities to interest rate movements. it can be used to transform the interest rate sensitive assets into interest rate-insensitive, and vice versa, and to transform the interest sensitive liabilities into interest rate insensitive and vice versa (hull, 2003, p. 127). transforming liabilities suppose an investor tend to borrow $ 1 million at a floating rate. however, additional debt at the variable rate will undermine compliance between interest rate sensitive assets and liabilities. in the event of rising interest rates in the market, the increase in the liabilities will be greater than the increase in income, as interest-sensitive liabilities exceed by one million dollar the interest-bearing assets. the result would be, therefore, decline in the net interest margin and investors profitability. to avoid this risk, the investor will want to convert $ 1 million of liabilities with variable interest rates in the $ 1 economic analysis (2014, vol. 47, no. 3-4, 69-80) 72 million liability insensitive to interest rates movements, tiding interest-sensitive assets to interest-sensitive liabilities. entering into interest rate swap will enable him this. therefore, the investor will contract interest rate swap under which he will be required to pay at fixed rate and receives at variable rate. variable income from the swap will be equal to the losses from the additional variable debt, and the net result will be a fixed obligation from swap. transforming assets interest rate swaps can be used to transform variable income into fixed income and vice versa. suppose that investor b issued bonds in the amount of million dollars, and the funds invest at a variable rate. this will disturb the balance between interest sensitive assets and liabilities, as interest sensitive assets will be for $ 1 million bigger than the interest-sensitive liabilities. therefore, he will enter the swap, same as investor a, but in the opposite position. if interest rates fall, the fall in income on the active side will be greater than the costs fall on the passive side, and the result will be a drop in profits. by entering into interest rate swap, the investor b eliminate this interest rate risk by converting $ 1 million of assets with variable income to $ 1 million of income with fixed income. in this case, if interest rates fell, the decline in interest sensitive income would be equal to drop in costs and profitability would remain unchanged. therefore, investor b will enter into interest rate swap in which he will have to pay at variable rate, and receive at fix. profit/loss in swap would neutralize variable income from investments, and the net result will be a fixed income from the swap. between investor a and investor b, for example, could be contracted interest rate swaps as follows: investor a pays to investor b a fixed interest rate of 5% per annum on the $ 1 million (notional principal) for the next 3 years, and the investor b pays to investor a 6m libor plus 1% on $ 1 million in the same period, with the half year payments. 6m libor at the time is 3.2%. figure 1. interest rate swap source: author the first exchange of payments will be six months from the time of the swap contract. the investor a has to pay 5% per year on a million dollars, so in six months he will have to pay $ 25,000 (5% * 0.5 * $ 1,000,000). investor b will be required to pay interest equal to the value of 6m libor at the time of swap contracting plus 1% on a million dollars for six months, i.e. he will have to pay $ 21,000 ((3.2% +1%) * 0.5 * 1.000. 000 dollars). the second set of payments will be for another six months, or one year from the swap contract. for investor fixed rate 5% over 3 years libor + 1% over 3 year receives b pays pays receives a pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 73 a amount to be paid is the same, $ 25,000. however, investor b will have to pay the interest rate equal to the value of 6m libor at the time of the first exchange of payments plus 1% on a million dollars for six months. if 6m libor was then, for example, 3.8%, investor b will have to pay $ 24,000 ((3.8% +1%) * 0.5 * 1,000,000). until the end of the swap, investors would exchange payments four more times every six months as set out in table 2. table 5. interest rate swap, an example 6m libor cash flow at float. rate cash flow at fixed rate net cash flow for fixed rate payer net cash flow for fixed rate receiver 0 3,2 1 3,8 21.000 25.000 -4.000 +4.000 2 4,3 24.000 25.000 -1.000 +1.000 3 4,5 26.500 25.000 +1.500 -1.500 4 4,6 27.500 25.000 +2.500 -2.500 5 4,9 28.000 25.000 +3.000 -3.000 6 5,4 29.500 25.000 +4.500 -4.500 total +6.500 -6.500 source: author like forwards, each side in the swap must have a lot of information about the other side to be sure that the contract will be fulfilled. the need for information on one side, and the problem with low liquidity of swap market may limit the use of swaps. however, hiring intermediaries, such as investment banks and especially large commercial banks, solve these problems. they have the ability to collect information about the creditworthiness and reliability of the parties at low cost, and are able to match them in swap. because of these, investors rarely enter in a swap directly and bank mostly occurs as intermediaries. in this case, investors do not enter into a swap with each other, but with the bank. swap between investor a and investor b will probably look as shown on graph below, where a bank or other intermediary will appear between investors. figure 2. interest rate swap with intermediary source: author fixed rate 5,05% over 3 years fixed rate 4,95% over 3 years libor + 0,95% over 3 year libor + 1,05% over 3 year receives b pays intermediary pays receivespays receivespays receives a economic analysis (2014, vol. 47, no. 3-4, 69-80) 74 investor a agrees to exchange with the bank a fixed interest payment of 5.05% for an variable interest payment of 6m libor plus 0.95%. on the other hand, the bank enter into a swap agreement with investor b, in which it have to exchange a fixed interest payments of 4.95% for variable payments at the rate of 6m libor plus 1.05%. notional principal is $ 1 million, and the contract period is 3 years, with the exchange of payments every six months. on the one hand, the bank makes a profit on the difference between 5.05%, received from investors a, and 4.95% that pays to investor b, and on the other hand on the difference between 6m libor plus 1.05%, which receive from investor b, and 6m libor plus 0.95%, that pays to investor a. so in this case the bank earns a total of $ 2,000 (0.2% * $ 1,000,000) as a mediator in the interest rate swap. investor a and investor b voluntarily give up profits entering into swap (they receive 0.05% less and pay a 0.05% more), because this agreement brings two significant benefits. first, the bank is able to match the two sides, which probably would not have been possible without her help. second, in this way investors avoid the risks associated with the creditworthiness of the counterparty. these advantages of doing business with a bank as intermediary are reason why both investors will likely be ready to engage her, although that costs. non-standard interest rate swap interest rate swaps are traded otc. these are not standardized contracts and can fully adapt to the different market needs, and in time, a large number of basic swap contract modifications appeared. in the literature usually the following types of interest swaps could be found (hull,2003; fabozzi,2007) basis swap the interest rate swap in which both sets of payments are calculated at different variable interest rates (chance, 1998, p. 636). if the investor took a loan, for example, of one million pounds on which he pays 1m libor and at the same time invest funds at interest rate 1m tibor plus 30 basis points, the difference between these two rates will determine the investors profit. if the current 1m tibor equal 1m libor plus 10 basis points, it means that the investors will be earning 40 basis points. however, market rates do not change always in the same direction and intensity so that if there is a change in the relationship between two rates and interest rate spread will be changed. if investor wants to capture the initial interest rate spread he can enter into interest rate swap. cancelable swap the interest rate swap in which one party has a right to terminate the swap on one or more agreed dates (hull, 2003, p. 603). terminating the swap is the same as entering in the opposite swap. if the swap is cancelable on a single date, then this swap is to the party who has the right to cancel it the same as the standard swap plus a long position in an option to enter into the opposite swap. to the other side it is the same as the standard swap and a short position in the option to entry into the opposite swap. for example, a tenyear swap with the right to cancel it after 6 years is the same as the standard ten-year swap and option to enter an opposite four-year swap. if there are a number of possible cancellation dates, then this swap to the party who has the right to cancel it is the same as a standard swap plus a long position in bermuda swaption to enter the opposite swap, and to the other side is the same as the standard swap and short position in bermuda swaption to enter the opposite swap. for example, a five-year swap with the possibility of cancellation between pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 75 2nd and 5th year is the same as the standard five-year interest rate swap and bermuda swaption to enter the opposite swap that matures in five years. compounding swap from the standard swap differs only in the fact that there is only one exchange of payments (hull, 2003, p. 595). at the end of the swap period counterparties exchange all the payments. cancelable compounding swap is a swap in which one party has the possibility to terminate the swaps on certain dates (hull, 2003, p. 604). in the case when the party that has right to do so terminate the swap, both counterparties at the time of termination pay the compounded value of all the payments up to the time of termination of the swap. conditional (accrual) swap is a swap in which the interest is calculated only for the days when floating interest rate was within a certain range or below/above agreed level (hull, 2003, p. 603). when it comes to standard swap the fixed rate interest is calculated by multiplying the interest rates and the number of days for which the calculation is made (the number of days in the month or quarter) and dividing with the number of days in the year. however, in this type of swap, interest is calculated only for those days when the variable rate was below/above or within some agreed range, so the notional principal is not multiplied by the total number of days in the period, but by the number of days in which the variable interest rate fulfilled agreed condition. (hull, 2003, p. 127) yield curve swap is the swap in which both set of payments are related to the same rate, but a different maturity (martellini,priaulet,priaulet,2003, p. 345). for example, an investor can enter in swap to receive 3m libor rate and to pay 6m libor rate. non-parallel shift in the yield curve in this case result in interest rate spread changes for the investor. ascending (step-up or accreting) swap is a swap in which, unlike most of the swaps where notional principal is constant, the notional principal increases over time (arditti, 1996, p. 291). suppose that an investor take a loan that he pulls in installments, so over the time the value of the debt increases. in this case he will arrange a swap with notional principal that increases over time. descending (amortizing) swaps are those in which the notional principal decreases over time (kolb, 1999, p. 633). for example if the investor borrowed funds at a variable rate, since it was better at the moment, but he wants the debt at fixed rate, he will initiate a swap. in addition, if the funds are invest so that the investor expects every month that he will be able to repay some of the debt, he will initiate a swap in which notional principal decreases over time. rollercoaster swap is a combination of the previous two types of swaps. notional principal in this case, first increases and then decreases (arditti, 1996, p. 291). it is used when the value of debt is growing at first, and after some point begins to decline. index amortizing swap is a swap in which the notional principal is decreasing depending on the level of interest rates (chance, 1998, p. 636). the lower the interest rate, the greater the reduction in notional principal. libor in arrears swap is the one in which floating-rate of interest is calculated at the floating-rate observed on day of payment, opposed to a standard swap where the payment is calculated at floating-rate value observed on the day of the last payment (hull, 2003, p. 599). economic analysis (2014, vol. 47, no. 3-4, 69-80) 76 constant maturity swap is the interest rate swap that allows the fixation of duration of funds received under the swap (chance, 1998, p. 638). this assumes periodical adjustments of floating rate, with the exception that in this type of swap, floating rate is usually related to swaps rate of a certain duration (rather than libor). for example, a variable interest payable semi-annually can be linked to a five-year swap rate. differential swap is a swap in which interests are calculated at floating rates related to the different currencies (hull, 2003, p. 601; chance, 1998, p. 637). for example, paying 6m sterling libor on notional principal of 100 million pounds, and receiving 6m euro libor on the same principal. zero-coupon swap is an extreme example of the swap. in this case, a fixed interest rate is equal to zero, and payment is made at swap cancelation at fair swap value (arditti, 1996, p. 292). it is used in situations where a party has liquidity problems until swap cancelation. prepaid swap is the one in which one party (usually the party that pays at a fixed rate) at the time of swap initiation pays the present value of all his payments during swap life, and then receives payments on agreed dates (at variable rates) (fabozzi, 1996, p. 172). besides these, there are swaps in which the interest is not calculated at the same notional principal. for example, paying on the principal of $ 100 million, and receiving the payments on the notional principal of $ 150 million. swap as a basis for other derivatives futures swap forward/futures swap is the interest rate swap in which the exchange of interest payments start on agreed future date. an investor ,who plans to borrow in two months $ 100 million for a period of 5 years at the rate of libor, and expected that interest rates will rise in two months, and wants to fix his costs, may do so by entering into forward swap under which he will be paying a fixed rate on the notional principal of $ 100 million over 5 years, and receiving a libor, with the exchange of interest payments starting in two months (arditti, 1996, p. 291) . after two months, interest rates have risen, but the investor will still lend funds as planned. the increase in borrowing costs due to a higher rate will be offset by the increase in inflow from the swap, and the investors cost will depend only on pre-agreed fixed swap rate. therefore, by initiating the forward swap investor fixes his obligations without any additional cost and protect against interest rate risk in the event of unfavorable movements in interest rates. however, this strategy prevents the investor to benefit in the event of favorable market movements. in fact, if interest rates fall after two months, opposite to the investors’ expectations, his costs would not be lower because the savings from borrowing at a lower rate would be neutralized by reduced inflows on variable leg of the swap. swaption swaption some options may be embedded into the swap. callable swap gives the right, but not the obligation, to the party that pays at fixed rate to terminate the swap (arditti,1996, p. 298). party will use his right if there is a fall in the market rates because it can then enter pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 77 into a new swap at a lower rate. swap with a put option gives the right but not the obligation, to the party that receives a fixed rate to terminate the swap, and he will do so if market rates increase, because than he can enter into a new swap to receive at higher fixed rate. these features built into swap are not the same as swaption. swaption is a separate option that gives the holder the right to enter into swap. call (payer) swaption gives the owner (purchaser) right to enter into swap in which he has an obligation to pay at pre-arranged fixed rate (kolb, 1999, p. 639-640). he will use his right if market rates rise, because then contracted rate will be lower than the market, and therefore the amount to be paid. time (receiver) swaption gives the owner right to enter into swap in which he has an obligation to pay at a variable rate. this option will be used if market rates fall, because then costs are lower while he has to pay at a lower rate than the market. swaption are similar to the forward swap except that in this case there is no obligation to enter into swap. swaption buyer, therefore, has the possibility to protect himself from adverse market movements, but also to gain on the positive. if, for example, investor can borrow in three months at a variable rate for a period of 5 years, and wants the liability to be at a fixed rate, he will buy swaption that allows him to enter into the five-year swap in which he will be paying at a fixed rate of 10%, and receiving at a variable rate. after three months, if the market rate is less than 10%, he will let the swaption expire. however, if the market rate in three months is more than 10%, he will use the opportunity of entering into swap and consequently will have liability at fixed rate of 10%. so in this way the investor wants to ensure that in three months, regardless of how much is the market rate, he will pay no more than 10%. advantages and limitations of interest swaps in order to eliminate the interest rate risk, investors, instead of engaging in interest rate swaps, may alter their balance sheets converting assets with fixed interest rate in interestsensitive assets and vice versa. however, such a strategy would be more expensive for several reasons. first, institutions have significant transaction costs when they are rearranging their balance sheets. second, different financial institutions have informational advantages in giving loans to certain customers (mishkin, eakins, 2006, p.665). therefore, the adjustment of the balance sheet, in order to eliminate the interest rate risk, may result in the loss of these benefits, which financial institutions are generally not ready to give up. interest rate swap solves this problem by allowing institutions to convert fixed rate assets in interestsensitive assets, or vice versa, without any changes in the balance sheet. in this way, high transaction costs are avoided, and the financial institution can continue to grant loans when they have comparative advantages. interest rate swap has a huge advantage over other financial derivatives. in fact, contrary to the interest rate futures and options that are used for a much shorter period of time (usually no longer than one year), swaps can be concluded for a very long time, sometimes even 20 years (mishkin, eakins, 2006, p.665). if the financial institution has to manage the interest rate risk in the long period, the financial futures and options won't be very useful, but interest rate swaps would be. economic analysis (2014, vol. 47, no. 3-4, 69-80) 78 the third advantage of the interest swaps is that they allow the two institutions to exploit their comparative advantage in borrowing in the markets at a fixed or variable interest rate. suppose that investor a has a better credit rating and can either borrow a million dollars at variable interest rate, let’s say, libor plus 2%, or to issue bonds with a fixed interest rate of 7%, while investor b can borrow a million dollars at the rate of libor plus 2.5% or to borrow at a fixed rate of 9% (mishkin ,eakins, 2006, p. 665). investor a has better conditions, i.e. he has an absolute advantage in borrowing at fixed and at a variable rate, because he has a better credit rating. however, investor a has a comparative advantage in borrowing at fixed interest rate, while investor b has a comparative advantage in borrowing at a variable interest rate. by entering into swap, both institutions would lower their borrowing costs. the ability to exploit comparative advantage in borrowing at variable interest rates as opposed to borrowing at fixed rates is an important swaps feature that has greatly contributed to great popularity of swaps. possibility of using the comparative advantages when it comes to borrowing is often the subject of criticism. the frequently asked question is how the possibility of arbitration did not result in equality of the spread between the fixed and the spread between variable interest rates at which investors with different credit rating may barrow. the reason for this is in the nature of contracts available when it comes to borrowing at a fixed and variable rate. when it comes to borrowing at variable interest rate there is possibility of periodic adjustments of the interest rate, so if the credit rating of investor change interest rate can be adjusted. however, this possibility does not exist when it comes to borrowing at fixed interest rate. the difference in the spread between the rates for investors of different credit rating reflects the likelihood that they go bankrupt. in the short run, likelihood that the situation will worsen is not big so the spread in rates is lower than in the long run. in fact, statistics show that, with time, the probability, that position of investors with lower credit rating will worsen increases faster than the probability that a credit rating of investors with higher credit ratings will deteriorate. therefore, with the increase of the borrowing period, increase rates at which investors with different credit ratings can borrow. although interest rate swaps have significant advantages that make them very popular within financial institutions, they also have some drawbacks that limit their usefulness. swap market, as well as forward market, may suffer from a lack of liquidity. in addition, the parties often find it difficult to connect each other to agreed swaps. in addition, swaps are subject to the same default risk as forward contracts. however, the default risk in the swap is not the same as in other instruments because it applies only to interest, while the risk for the full amount of the notional principal does not exist, because it is never exchanged. if one party would not be able to fulfill its obligations and pay the interest, the other side could simply stop paying its obligations. in addition, if counter party is no able to fulfill his obligations, it does not have to be bad for the other side. for instance, if it comes to interest rates fall, the party that pays at fixed rate and receive at variable interest rate will be in a worse position, so it would be suitable for this side if the counterparty stops with fulfilling its obligations and if it comes to the termination of the swap. these disadvantages are successfully overcome with the help of intermediaries, such as investment banks and especially large commercial banks, which have the ability to collect pepić, m., interests rate swaps, ea (2014, vol. 47, no, 3-4, 69-80) 79 cheaply information on the creditworthiness and reliability of the parties, and are able to match them in swap. of course, interest rate swaps bear risks for banks that occur as an intermediates and that is way there is a series of regulations designed to limit the risk to which they may be exposed based on financial derivatives. conclusion financial derivatives, primarily interest rate swaps, are extremely popular hedging instruments against adverse changes in interest rates. its popularity interest rate swaps owes primarily to the fact that they provide protection against risk in a relatively simple manner and without high initial costs. in addition, interest rate swaps do not carry a high risk because the notional principal is never exchanged, but only the interest payments, and one counterparty may simply cease to perform its obligations if the other counterparty stops fulfilling its obligations. moreover, in practice, due to the need to adapt to the different needs of market participants, a large number of modifications of the standard interest rate swap incurred. interest rate swaps market suffers from certain drawbacks, but they are successfully overcome, so that in developed countries, interest rate swaps are far leading by the value of notional principal and the gross market value in relation to other financial derivatives. references arditti, f. d. 1996. derivatives a comprehensive resource for options, futures, interest rate swaps and mortgage securities, boston: harvard business school press. chance, d. m. 1998. an introduction to derivatives and risk management, 5th ed. fort worth, harcourt college publishers. choudhry, m. 2005. fixed-income securities and derivatives analysis and valuation, princeton: bloomberg press. culp, c. 2004. risk transfer – derivatives in practise. new jersey: john wiley and sons. cvitanić, j. and zapatero, f. 2004. introduction to the economics and mathematics of financial markets, cambridge: mit press. eales, b. and choudhry, m. 2003. derivative instruments: a guide to theory and practice, oxford: butterworth heinemann. fabozzi, f. j. 1996. measuring and controlling interest rate risk, new hope, pa: frank j. fabozzi associates. fabozzi, f. j. and mann, s. v. 2005. the handbook of fixed income securities, 7th ed. new york: mcgrawhill professional. fabozzi, f. j. 2007. fixed income analysis, 2nd ed. new jersey: john wiley and sons. peterson d. p. and fabozzi, f. j. 2010. the basics of finance an introduction to financial markets, business finance, and portfolio management, new jersey: john wiley and sons. hull, j. c. 2003. options, futures and other derivatives. 5th ed. new jersey: prentice-hall. kolb, r.. 1999. futures, options and swaps. 3rd ed. cambridge: mass, blackwell publishers. martellini, l., priaulet, p. and priaulet, s. 2003. fixed-income securities valuation, risk management and portfolio strategies, chichester, england: john wiley and sons. mishkin, f. s. and eakins, s. g. 2006. financial markets and institutions, boston: addison-wesley. reilly, f. k. and brown, k. c. 2003. investment analysis and portfolio management, 7th ed. mason, ohio: south-western/thomson learning. economic analysis (2014, vol. 47, no. 3-4, 69-80) 80 stephens, j. 2002. managing interest rate risk – using financial derivatives. chichester, england: john wiley and sons. kamatni skupovi rezime – promene kamatnih stopa imaju veliki uticaj na uspešnost poslovanja. zbog toga je za tržišne učesnike od velikog značaja da prepoznaju i adekvatno upravljaju ovim rizikom. finansijski derivati predstavljaju relativno jednostavan vid zaštite od neželjenih promena kamatnih stopa. kamatni svopovi su naročito popularni s obzirom na to da omogućavaju svodjenje kamatnog rizika na najmanju moguću meru uz relativno male inicijalne troškove i bez velikog rizika, ali i zbog činjenice da na tržištu postoje različite modifikacije standardnog svopa kako bi se što bolje prilagodili različitim potrebama tržišnih subjekata. ključne reči: kamatni rizik, standardni kamatni svopovi, nestandardni kamatni svopovi article history: received: 25 october 2012 accepted: 15 may 2014 microsoft word 2011_3_4_finalna ver.doc original research paper    optional approach for investment projects valuation and it’s  appliance to the project of producing healthy organic food   rovčanin adnan*, nuhić minela, sejdić amila, university of sarajevo, faculty of  economics, bosnia and herzegovina   udc: 330.322; 338.439   jel: q18; o22    opcioni pristup za vrednovanje investicionih projekata i  njihova primena na projekte u proizvodnji organske hrane        abstract – the aim of this paper is to present the appliance possibilities of optional approach  to  investment  projects  valuation,  as  well  as  new  theoretical  and  methodological  framework  of  investment analysis, to project of producing and selling healthy organic food.  unlike  traditional  methods  of  project  valuation,  this  new,  contemporary  approach  provides  valuation of management flexibility and possibility of adjustment (correction of previous decisions) in  accordance to the market conditions. in light of dramatic changes and increasing risks and uncertainty  in  investment decision‐making,  it  is necessary to complete the traditional approach by optional,  in  order  to  make  more  rational  allocation  of  resources.  the  necessity  of  using  optional  approach  is  reflected from the fact that the results of projects valuation according to the traditional and modern  approach may be contradictory.   this paper presents the black‐scholes and binomial option pricing model, and appliance of option  valuation  is shown on  the project of producing and selling healthy organic  food and healthy  food  restaurant  as  an  extension  activity.  while  traditional  methods  of  valuating  investment  projects  valuated the project of producing healthy organic food as unprofitable, the optional approach shows  that this project is acceptable, which confirms the importance of this approach    key words: real options, flexibility, risk, uncertainty, project valuation, organic food  introduction  investment project valuation is a specific way of measuring the benefits and costs ratio  during  defined  project  lifetime.  the  purpose  of  these  methods  is  to  quantify  arguments  about  acceptability  or  unacceptability  of  the  specific  project.  general  classification  of  investment projects valuation methods is in two groups, traditional and modern methods,  whereby the traditional methods of valuation include the standard discount cash flow (dcf)  method of analysis, or all those methods of assessment that do not consider the opportunity  costs  (benefits)  based  on  investment  in  project.  conventional  methods  are,  therefore,  the                                                         * address: trg oslobođenja ‐ alija izetbegović 1, sarajevo, bosnia and herzegovina, tel. +387 33 27 59  49, e‐mail: adnan.rovcanin@efsa.unsa.ba       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   45 method of net present value (npv), the internal rate of return method, the annuity method,  cost  recovery  method  and  the  coefficient  of  profitability.  on  the  other  hand,  modern  methods are based on access to opportunity, which means they take into account not only  the gross benefits  (costs) of  investment, but also missed  investment effects  (open,  ʺclosed  downʺ  investment  opportunities  (options)).  by  this  method,  it  is  possible  to  evaluate  the  flexibility  of  the  project,  respectively  possibility  of  adjustment  (correction  of  previous  decisions), in accordance to the market changes.  according to traditional approach, project value is just a simple difference between the  present value of returns and the present value of investment, while the optional approach  considered the project value more widely, as a difference of direct costs and benefits of the  project  (npv),  corrected  for  the  balance  of  the  closed  (open)  options,  after  starting  the  project. whereas the project with a real option is always worth more, or at least the same as  the  project  without  this  (these)  option(s),  it  is  clear  that  the  traditional  approach  underestimates the project value, and that the project is considered in a strictly deterministic  and static conditions. in conditions of increasing uncertainty, risk and changes, conventional  approach  is  becoming  less  relevant  for  the  assessment  of  projects,  and  in  the  valuation  process must include the value of real options.  there are three main real options that may arise in the process of valuation project as  follows:  • option to abandon  • option to expend   • option to contract  respecting that real options have the following similarities with financial options:  • represent the right, but not the obligation (as well as financial options);  • invested  funds  is  the  irreversible  investment  (the  price  paid  for  the  financial  option is non‐refundable);  • can not have a negative value (as well as financial options);    table 1. analogy between financial and real options (rovčanin, 2005, 551)      in the valuation process they can be equated with the financial, call and put options, and  model developed for valuation of financial options can be applied to real options with prior  stock price   investment expenditure of optional  project length of time till optional project risk free rate rate of return of alternative project  risk of investment project  s k t r  σ2  financial option  real option exercise price of option  time to expiration of option present value of optional project  risk of returns on stock    economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   46 introduction of certain analogies. so the option to abandon is equated with the financial put  option, the option to expend is equated with the financial call option, while the option to  contract is also a variant of the call option. models that are commonly used to evaluate the  financial and real options are the black‐scholes and the binomial model, which are presented  below.  in  order  to  evaluate  real  options  of  projects  by  models  mentioned  above,  it  is  necessary to previously make further analogy between elements of investment opportunities  and elements of european call and put options.  binomial option pricing model   binomial tree   binomial option pricing model finds its starting point in short time intervals in which the  stock price or some other related assets can take two values. given that recognizes only two  possible results, it has called the binomial model. the model observes the trend in the stock  price and other related assets over short time intervals throughout the life of the option.   the process of the binomial option pricing model consists of several stages, as follows:  1. making the pricing binomial trees;  2. calculating the options value in each final node of binomial tree;  3. progressively calculating the options value in each previous node. the value in the first  node represents the value of the option.  the model is based on several assumptions. it assumes the existence of perfect financial  markets, without disruptions and transaction costs. risk free  interest rate  is constant, and  stocks pay no dividends. binomial model  is based on  the binomial  tree which represents  price movements’ model of stocks or other related assets in the future. at the end of each  interval, possible future stock prices are being determined. this price evolution forms the  basis for options valuation. each node in the tree represents a possible price of a stock or  other forms of related assets in a specific time point.     figure 1. binomial tree    s  su sd suu  sud  sdd   the price tree is formed by going forward from valuation date to the date of expiry, or  maturity.   assumption is that the price of related assets is going to grow u (up) times or decrease d  (down) times for each step along the tree, where by definition is u ≥ 1 and 0 ≤ d ≤ 1. if the       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   47 symbol  of  the  current  price  is  s,  then  the  price  in  the  next  period  will  be  ussu ⋅=   or  ,dss d ⋅= where the probability that the price s is going to rise to su is p, and that is going to  decrease to sd, 1‐p. following the shown tree, the expected stock price for one time interval  can be calculated as a weighted average of two prices which are the result of movement of  current stock price to up or down. it can be shown by following formula:  du spsp ⋅−+⋅ )1(                    (1)  the value of call  options  in  the  final nodes of  the  tree  is calculated  as  the difference  between spot prices of related assets and the executive price of option. if the difference is  negative, the value of the option is 0. in one period binomial model, the value of call option  is equal to: )0 ,( ksmax u −=  in first final node, and  )0 ,( ksmax d −= in second final node.  the value of put option is: max (k‐su, o) on the first final node, and max (k‐sd, o) at the  second final node of binomial tree, where the k is exercise price, while s is the spot price of  related assets.  after completing the evaluation of options at each final node, we access to the valuation  of options on each previous node, starting from the final to the first node of the tree, where  the final result is value of the option.  replicating portfolio   binomial model is based on the principle of arbitration, claiming that the price of options  should match  the cost of creating alternative portfolio position, which will have  identical  effects  on  the  financial  investors.  the  model  is  based  on  the  idea  of  creating  risk  free  synthetic portfolio that is consisted of, in the case of call options on stocks, short positions in  call option and long in stocks on the basis of which it is made, whereby the first fully covered  by another.(šoškić, 2001, 319). in the case of put options, the synthetic portfolio is made of  short positions in put options and short positions in related assets. 1   mathematically it can be written, for call option:   cshv −⋅=                      (2)   where is:        du du ss cc h − − =            (3)  and  c  is  value  of  the  call  option  at  the  time  t0,  while  cu  and  cd  are  values  of  corresponding  call  option  price  associated  by  the  shift  of  property  to  the  up  and  down.  expression  (2)  represents  a  risk‐free  portfolio,  which  rejects  the  risk‐free  yield,  and  is  composed of h‐related assets and the amount of call options issued to the related assets. in  this sense, h is the number that shows how many units of property must be hold for each  issued call option to date projections of growth and falling prices of related assets, if we want  to have a risk‐free portfolio. starting  from  the probability of growth or decline of related  assets prices, it is necessary to determine the risk‐free portfolio that will produce the same  outcome, regardless of whether it will happen the first or second situation.                                                         1 damodaran, a. real options: facts and fantasy,  http://pages.stern.nyu.edu/~adamodar/pdfiles/execval/optval.pdf , (accessed 03 june 2010 )     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   48 dduudu chschsvvrv −=−===+⋅ )1(             (4)   solving system of equations for v, using expressions (3) and (4) and inserting in formula  (2) and  expressing c, formula  for calculating the value of call options is:   1)1( −+ − − + − − = r ss cscs s ss cc c du uddu du du              (5)     the same logic can be applied to the valuation of put options. specifically, the difference  is  reflected  in  the  opposite  position  of  the  holder  of  the  option  by  the  related  assets,  in  relation to the position of the holder of the call option, so the differences arise only in signs,  i.e. v=h⋅ s+h, and still is:  s ss cc r ss cscs x du du du duud ⋅ − − −+⋅ − − = −1)1(             (6)   where x – is value of put option at time t0.  probability of price movements of related assets   it has already been pointed out that the binomial model is based on only two possible  prices outcomes of related assets in the next specific time point, while the probability that the  price of related assets is going to the increase on su, is p, and is going to fall on the sd, 1‐p.  starting  from  the  expected return r, expected stock price can be calculated  through a  specified time interval. if we assume that:   du spsprs ⋅−+⋅=+⋅ )1()1(                 (7)  here is:  du dr ss srs p du d − −+ = − −+⋅ = 1)1(                 (8)  if  we  express  s  over  su,  sd,  r,  p,  from  the  form  (7),  and  insert  in  the  form  (5),  by  rearranging it is obtained formula for calculating the value of call option (9).  [ ]du cpcpr c ⋅−+⋅ + = )1( 1 1                 (9)  or, on the basis of the form (7), (8) i (9):  ⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + ⋅⎟ ⎠ ⎞ ⎜ ⎝ ⎛ − −− +⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + ⋅⎟ ⎠ ⎞ ⎜ ⎝ ⎛ − −+ = r c du ru r c du dr c du 1 1 1 1             (10)  multioperiodic model   if  one  interval  is  divided  into  several  smaller  intervals,  binomial  model  is  going  to  extend. in the case that binomial tree has only two time intervals, initial price of related asset       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   49 c cu cd cu cud  cdd  s  su  sd  sud sdd s will match the value of call option c. after the first time interval, expected prices of related  assets are su i sd with corresponding values of call and put options cd i cu, and xu i xd.     figure 2. multiperiodic binomial model – price of related asssets and value of  call option    possible price of related assets, after the second interval, are: suu and sud, which are  achievable in the case that after the first interval price of related assets has grown, and sdu  and sdd, which are achievable in the case that the price of related assets after the first interval  has fallen, and corresponding values of option are cuu, cud, cdu and cdd.  given that current price of call option from binomial tree with one interval is equal to:  [ ]du cpcpr c ⋅−+⋅ + = )1( 1 1                 (11)  expected valued of  call options, in the end of first interval for expecting movement of  price to upwards, is going to be:   [ ]uduuu cpcpr c ⋅−+⋅⋅ + = )1( 1 1               (12)  and for expecting movement to down:   [ ]dddud cppcr c ⋅−+⋅⋅ + = )1( 1 1                (13)  if the previous expressions (12) and (13) are inserted in model of present value of call  option,  form  (11),  it  is  obtained  the  value  of  call  option  for  binomial  model  with  two  intervals.  [ ]dduduu cpcppcp r c ⋅−+⋅−⋅+⋅⋅ + = 22 2 )1()1(2 )1( 1         (14)  if model is being spread, from the number of periods with observed periods one to n,  option pricing formula will take the form2:   [ ]0 ,max)1( )1( 1 0 kdsupp k n r c knkknk n k n −−∑ ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ + = −− =           (15)                                                         2 benninga, s. et al. the binomial option pricing model,   http://finance.wharton.upenn.edu/~benninga/mma/mier63.pdf, (accessed 03 june 2010)  su    economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   50 this formula is recursive, it works backwards, starting from financial result of option on  day of maturity.   black‐scholes model  the  black‐scholes  model  is  one  of  the  most  important  concepts  in  modern  financial  theory. it was developed in 1973 by fisher black, robert merton and myron scholes and is  still widely used today, and regarded as one of the best ways of determining fair prices of  options.3 since the binomial model for pricing options converges on the black‐scholes model,  it is considered to be a special case of binomial model when the price process is continuous  and the number of iteration is infinitive.4 still, the black‐scholes model has not been derived  from binomial. the model was established before the binomial.   the assumptions of the black‐scholes model  there are several assumptions underlying the model:  • no dividends are paid out during the stocks life5  • option can only be exercised on the expiration date (therefore, it can only be used  in valuing the european options, but not american)  • markets are efficient which suggests that market movements cannot be predicted  • no commissions are charged while buying or selling options  • interest rates remain constant and known (the model uses the risk‐free rate in its  calculations)  • stock returns follow a lognormal distribution (the lognormal distribution is often  used to summarize the probability of different price changes)  the black‐scholes formula  the idea behind the black‐scholes model is hedging against the written call option with a  risk‐free portfolio. this portfolio is a replicating portfolio. if it is dynamically rebalanced it  will always match  the pay off on  the call option  that was written. therefore,  the present  value of this portfolio equals the present value of the call option.  [ ] [ ]loanbankpricesharedeltaoptioncallofvalue −⋅=          (16)  tzerobondsoptioncallofvalue ,0 −δ=               (17)  0sδ  is the long position in stock. it is not an entire share of stock but a fractional share of  stock  signified  by  delta.  this  long  position  is  combined  with  a  short  position  in  a  zero‐ coupon bond maturing in the future on time t  which is the same time when the call option  that we wrote will be presumably exercised. the short positions quantity equals the strike  price of the option  k . but since the strike price is a price on the significant date in the future,                                                         3 http://www.investopedia.com/terms/b/blackscholes.asp (accessed 1 septmeber 2010)  4 calculating option value using binomial with an indefinite number of subperiods is too complicated.  5 merton altereted the standard black‐scholes model to incorporate an annual dividend yield in the  formula which made the model usefull for dividend paying stocks.        rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   51 it  is necessary  to present value  that strike price by discounting  it with a discount rate  r   which  is risk‐free rate. still  the probability  that option expiries  in  the money and will be  exercised should also be considered. so the present value of the strike price is multiplied by  )( 2dn , a cumulative normal distribution function which represents the probability of the  option being exercised. so on the right side, beside  0sδ   is a probability adjusted present  value of the strike price:  rtkednsoptioncallofvalue −−δ= )( 20             (18)  also  0sδ needs  adjustments.  just  like  with  the  short  position,  cumulative  normal  distribution  function  )( 1dn   is  used. )( 1dn   represents  delta  )(δ or  how  many  fractional  share of stock should be long.   rtkednsdnoptioncallofvalue −⋅−= )()( 201             (19)  the  previous  formula  is  actually  the  black‐scholes  formula.  value  of  call  option  is  usually singed by c. so here is complete black‐scholes formula:  rtkednsdnc −⋅−= )()( 201                 (20)  where  t tr k s d σ σ ) 2 ()ln( 2 1 ++ =                   (21)  t tr k s tdd σ σ σ ) 2 ()ln( 2 12 −+ =−=               (22)  c = value of call option  )(dn  = cumulative normal distribution function6  k  = strike (exercise) price of the option  0s  = current value of the underlying asset (price of the stock now)  t  = life to expiration of the option  r = risk‐free interest rate  σ  = volatility of stock price and stock return rate (standard deviation)  e  = exponential term (2.7183)  ln  = natural logarithm   using the same analogy, the black‐scholes formula for put option is:  012 )()( sdnkednx rt −−−= −                 (23)  where is  x = value of put option.  the value of option value depends upon a number of current stoke price, strike (exercise)  price, time until expiration, risk‐free interest rate and standard deviation σ  .                                                         6 it is a probability that a normally distributed random variable will be less than or equal to d.    economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   52 ),,,,( 0 σrtkscc =                   (24)  standard  deviation  is  critical  variable  in  this  model.  the  reason  for  this  is  that  small  changes in standard deviation cause significant changes of the option value.   variables in the black‐scholes model  the call option value depends upon a number of factors:  • current stock price   0s   • strike (exercise) price  k   • time until expiration t   • risk‐free interest rate  r   • standard deviation σ .  ),,,,( 0 σrtkscc =                   (25)  current stock price  higher  the  current  stock  price,  higher  the  value  of  call  option.  the  measurement  of  sensitivity of current stock price changes is delta. the delta is a measure of the relationship  between an option price and the underlying stock price.   )( 1 0 dn s c ==δ δ δ                    (26)  since the  )( 1dn  is a probability, delta is a value between 0 and 1. for a call option, a  delta of 0.50 means a half‐point rise in premium for every dollar that the stock goes up.   gamma  is  sensitivity  of  delta  to  unit  change  in  the  underlying.  gamma  indicates  an  absolute change in delta.   2 0 2 s c δ δ =γ                       (27)  for example, a gamma change of 0.150 indicates the delta will increase by 0.150 if the  underlying price increases or decreases by 1.0. results may not be exact due to rounding.  strike (exercise) price  if the strike price increases, the value of a call option will decrease. however, the exercise  price does not change, so this measurement has sense only  in aspect of valuing the same  option with different strike price for purpose of comparing.  time until expiration   if the time until expiration is longer, the value of a call option is lower. theta is sensitivity  of option value to change in time. theta indicates an absolute change in the option value for  a ʹone unitʹ reduction in time to expiration.  t c δ δ θ =                       (28)       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   53 the option calculator assumes ʹone unitʹ of time is 7 days. for example, a theta of ‐250  indicates  the  optionʹs  theoretical  value  will  change  by  ‐.250  if  the  days  to  expiration  is  reduced by 7. results may not be exact due to rounding.7  risk‐free rate  if the risk‐free rate increases so will the value of a call option. rho is sensitivity of option  value to change in interest rate. rho indicates the absolute change in option value for a one  percent change in the interest rate.   r c δ δ ρ =                       (29)  for example, a rho of .060 indicates the optionʹs theoretical value will increase by .060 if  the interest rate is decreased by 1.0. results may not be exact due to rounding.  standard deviation  standard  deviation  is  critical  variable  in  this  model.  the  reason  for  this  is  that  small  changes in standard deviation cause significant changes of the call option value. if standard  deviation increases the value of call option will decrease. vega is sensitivity of option value  to change in volatility. vega indicates an absolute change in option value for a one percent  change in volatility.   δσ δc vega =                     (30)  for example, a vega of 0.090 indicates an absolute change in the optionʹs theoretical value  will increase by 0.090 if the volatility percentage is increased by 1.0 or decreased by 0.090 if  the volatility percentage is decreased by 1.0. results may not be exact due to rounding.  advantages and limitations of the black‐scholes model  the main advantage of the black‐scholes model  is speed  ‐  it  lets you calculate a very  large  number  of  option  prices  in  a  very  short  time.8  although  understanding  the  model  seems hard and complicated, using it is more than simple. just a couple of mathematical and  statistic operations and the value of call option has been calculated. the black‐scholes model  was designed  to value options  that can be exercised only at maturity and on underlying  assets  that do not pay dividends. however,  in practice, assets do pay dividends, options  sometimes get exercised early and exercising option can affect the value of the underlying  asset. adjustments exist. while they are not perfect, adjustments provide partial correction to  the black‐scholes model.9  also, option prices are very sensitive to changes in volatility. volatility however cannot  be directly observed and must be estimated. estimating volatility is a problem which is often  solved by using historical data or already estimated volatilities for specific industries or even                                                         7 http://www.optionseducation.org/advanced/volatility_greeks.jsp (accessed 1 september 2010) 8 http://www.hoadley.net/options/bs.htm (accessed 5 september, 2010)  9 http://pages.stern.nyu.edu/~adamodar/  (accessed 5 september, 2010)     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   54 companies.  these  last  estimations  are  usually  done  by  organizations  and  companies  themselves mostly by using previous price behavior, in other word historical data.  relation between binomial and  black‐schloes models  inputs  for black‐scholes model, as a special variant of binomial model, can be  used for approximation of factors u and d, using following equations:   ttr eu δ⋅+δ⋅− = σσ )2 2 1 (                   (31)  ttr ed δ⋅−δ⋅− = σσ )2 2 1 (                   (32)  where  tδ  is one of n intervals during the period t in which price of related assets has  been changed, while ohter symbols from edited equations are explained previously. by this  approximation,  probability  of  moving  asset  price  to  upward  is  determined  by  following  expression:   du de p tr − − = δ⋅                     (33)  the project of producing healthy organic food  this part of the paper illustrates the appliance of presented methodology to the project of  producing healthy organic food. to show this methods practically, the project has to have  an  option of some kind. this  project  can  be  expanded  by  opening  an organic restaurant  which represents our call option. in this way organic food production has added optional  value of restaurant which increases the value of the project. the net present value (npv) of  the project is calculated for the next five years.10 the calculation includes only net cash flow  per year and present cash flow per year using 12% discount rate and it is given in table  as seen  in  the  table,  the projects net present value  is negative  (npv=‐3.641,22 bam).  using only traditional valuation methods this project would be considered unprofitable and  would  not  be  accepted.  but  as  said  before,  traditional  methods  ignore  the  possibility  of  options. now we will see the results of option based valuating methods. opening an organic  restaurant  is an extension of  the  primary  project of producing healthy organic  food. the  decision to vertically integrate and invest in a restaurant should be made 3 years after the  start of producing healthy organic food.                                                           10 the five year calculation is given because this is agricultural project, and it is common for this kind  of project npv to be calculated for five years.        rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   55 table 2. net present value calculation of healthy organic food production (in bam11)    year of project  0  1  2  3  4  5  net cash flow  ‐112.500  13.062,5  21.972,5  31.640,95  42.137,48  53.538,1  present net cash  flow (12%)  ‐112.500  11.662,946 17.516,342 22.521,404 26.779,131  30.378,958  net present  value (nvp)  ‐3.641,22  source: authors’ calculation    total investment costs will be 250.000 bams, of which 150.000 will be provided by own  funds and 100.000 by credit funds. these funds will be used for the object itself, construction  and interior, equipments and craft resources. this calculation is given for 10 years, during  which the income raises by 3% mostly because the potential customers number is expected to  grow by 5‐10%.12 also, the goal is to double the sales of first year in the third year. this will  enlarge the material costs which will be rising by the year. costs such as payroll, marketing,  sales and other expenses are rather constant.  the net cash flow, present net cash flow, and net present value of the restaurant project  are given in table 3. used discount rate is also 12%.    table 3. net present value calculation of organic restaurant project (in bam13)  year of  project  0  1  2  3  4  5  6  7  8  9  10  net cash flow  ‐250.000  47.750  56.750 65.977 75.437 85.138 95.087 105.291 115.758  126.496  137.513  present net  cash flow  (12%)  ‐250.000  41.522  42.911 43.381 43.131 42.329 41.109 39.583  37.842  35.958  33.991  net present  value (npv)  151.756  source: authors’  calculation    net  present  value  of  this  project  is  positive,  therefore  the  project  is  acceptable.  net  present value is 151756 bams, which is a very high npv since it represents 60,7% of initial  investment. traditional methods can only calculates npv of these projects, but fail to show  correlation between them. the next part of this paper will show the value of organic food  production project, but with an existing option of organic food restaurant project.                                                          11 bam is international code for bosnia and herzegovina convertible mark, 1€=1,95583bam.  12http://www.bplans.com/organic_restaurant_business_plan/market_analysis_summary_fc.cfm  (accessed 5 september, 2010)  13 bam is international code for bosnia and herzegovina convertible mark, 1€=1,95583bam.     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   56 30.547,05 0 0 64.814,52 0  0  0 137.523,03  0  14.396,8  values  of  variables  for  black‐scholes  calculation  are  strike  price 000.250=k   bams,  current stock price  756.1510 =s bams and time to expiration  3=t  years. estimated risk‐ free rate in bosnia and herzegovina is 6%. the variable which has the most influence on the  result is the one which is also the hardest to predict – standard deviation. based on world  calculation of volatility for different kind of industry, standard deviation for food industry is  30%.14 inserting the above data in formulas (21) and (22), we calculate the values of  1d  and  2d and based on that the values of n(d1) and n(d2):  3582761,01 −=d    8778914,02 −=d   190001322,0)( 360068311,0)( 2 1 = = dn dn   using  known  inputs,  calculated  inputs  and  formula  (20),  the  value  of  call  option,  according  to  black‐scholes  is  14.967,13  bams.  binomial  model  gives  similar  results.  according  to  the equations  (31) and  (32), we have calculated u and d  factor  for binomial  model  and  they  are  1,37  and  0,75  respectively.15  next  figure  presents  possible  value  of  optional project in next three years.     figure 3. possible value of healthy organic restaurant project    in  the  next  phase,  according  to  described  methodology,  value  of  expend  options  is  calculated. value on first node is value of option and it is 14.396,8 bams.                                    figure 4. value of expend option                                                                         14 www.business‐spreadsheets.com   15 we assumed that  1=δt , it means that there is only one period each year.  207.426,13 113.837,87 155.597,13 283.517,91 212.677.15  116.719,69  85.393,95 387.523,03  64.057,13  151.756,20       rovčanin, a., et al., optional approach, ea (2011, vol. 45, no, 3‐4, 44‐58)   57 strategic value of the project of producing healthy organic food by traditional, black‐ scholes and binomial model is presented in next table:    table 4. value of project of producing healthy organic food      traditional approach  modern approach  black‐scholes model binomial model value of the project  ‐3.641,22 11.325,91 10.755,53  investment decision  not accepted  accepted  accepted     source: authorsʹ calculation  conclusion  evaluation efficiency of capital investment without optional approach, i.e. without taking  into account real options, is not realistic and realiable basis for making investment decisions.  presented  project  of  producing  healthy  organic  food  is  the  example  which  can  serve  for  better understanding of real options and their valuation, but also it points out to necessity of  using an optional approach to the evaluation of investment projects, as an additional tool to  conventional valuation methods. indeed, these traditional methods evaluated the project of  producing healthy organic food as unacceptable, with a net present value of ‐3641.22 bams.  the option of extending of this project to projects of healthy food restaurant is evaluated by  modern methods, by black‐scholes and binomial model. according to black‐scholes model,  value of project is 11.325,91 bams, and according to binomial is 10.755,53 bams.  references  benninga, s., et al.(1997): the binomial option pricing model,   http://finance.wharton.upenn.edu/~benninga/mma/mier63.pdf, (accessed 03 june 2010);  bodie, z.et al. (2006): počela ulaganja, mate, zagreb;  brzaković, t. (2007): tržište kapitala‐ teorija i praksa, čugura print, beograd;  damodaran, a. (1999): applied corporate finance, john wiley & sons, new york;   damodaran, a.: option pricing theory and applications,    http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/option.pdf, (accessed 08 may 2010);  damodaran, a.: real options: facts and fantasy,   http://pages.stern.nyu.edu/~adamodar/pdfiles/execval/optval.pdf, (accessed, 03 june 2010);  damodaran, a.: the promise and perile of real options,   http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1295849, (accessed 03 june 2010);  orsag, s. (2003): vrijednosni papiri, revicon, sarajevo;  orsag, s. (2006): izvedenice, hufa, zagreb;  rovčanin,  a.  (2000):  savremene  metode  ocjene  efikasnosti  investicija,  ekonomski  fakultet  u  sarajevu,  sarajevo;  rovčanin, a. (2006): upravljanje finansijama, ekonomski fakultet u sarajevu, sarajevo;   rovčanin, a. (2005): opcioni pristup vrednovanju kapitalnih ulaganja, ekonomski pregled, zagreb.  šoškić, d.(2001): hartije od vrednosti: upravljanje portfoliom  i  investicioni  fondovi,   ekonomski  fakultet  beograd, beograd;  www.real‐options.de, (accessed 08 may, 2010);   www.damodaran.com, (accessed 03 june, 2010).     economic analysis (2011, vol. 45, no. 3‐4, 44‐58)   58 http://www.optionseducation.org/advanced/volatility_greeks.jsp   (accessed 1 september 2010)  http://www.investopedia.com/terms/b/blackscholes.asp (accessed 01 septmeber 2010)  http://www.hoadley.net/options/bs.htm (accessed 5 september, 2010)  http://pages.stern.nyu.edu/~adamodar/  (accessed 5 september, 2010)  http://www.bplans.com/organic_restaurant_business_plan/market_analysis_summary_fc.cfm  (accessed 5 september, 2010)        apstrakt  –  cilj  ovog  rada  je  da  prikaže  mogućnosti  primene  opcionog  pristupa  prilikom  vrednovanja  investicionih projekata, kao  i novi  teorijski  i metodološki okvir analize  investicija za  proizvodnju i prodaju zdrave  organske hrane.   za razliku od tradicionalnih metoda procene, ovaj novi, kompleksni pristup obezbeđuje fleksibilno  upravljanje i mogućnost prilagođavanja (korigovanja prethodnih odluka) u skladu sa okolnostima na  tržištu. u  svetlu dramatičnih promena  i narastajućih  rizika  i neizvesnosti prilikom  investicionog  odlučivanja,  neophodno  je  dopuniti  tradicionalni  pristup  opcionim,  u  cilju  racionalnije  alokacije  resursa. neophodnost korišćenja opcionog pristupa ogleda se u činjenici da rezultati procene vrednosti  projekata u skladu sa tradicionalnim i modernim pristupom mogu biti kontradiktorni.   ovaj rad predstavlja black‐scholes i binomni model model vrednovanja opcija, i primenu opcionog  vrednovanja ilustrovanu na proizvodnji i prodaji zdrave organske hrane i restorana zdrave hrane kao  dodatne  delatnosti.  dok  su  tradicionalni  pristupi  vrednovanja  investicionih  projekata  procenili  projekat za proizvodnju zdrave organske hrane neprofitabilnim, opcioni pristup pokazuje da je ovaj  projekat prihvatljiv, što potvrđuje značaj ovog pristupa.     ključne reči: realne opcije, fleksibilnost, rizik, neizvesnost, vrednovanje projekata, organska  hrana        article history:  received:  27 october 2011 accepted:  14 december 2011          ea_2015_3-4 udc: 005.412:334.72.64 005.511 cobiss.sr-id 220072972 original scientific paper importance and role of fast growing companies – gazelles in modern economies brnjas zvonko1, institute of economic sciences, belgrade, serbia vulićević vukica, belgrade, serbia čanaićević divna, belgrade, serbia abstract – the importance of small and medium enterprises (smes) for the development of national economies is undeniable and it is in many works stand out as a generally accepted position. in this paper, attention is focused at a specific segment of smes which comprise particularly dynamic companies that are characterized by fast and steady growth, ability quickly to adapt to market conditions and continuously to function at a high level of performance. these firms are now known as gazelles, the name which was in the 80s of last century first coined by british author david birch. gazelles represent relatively small part of total and according to number of studies their share in the total number of companies in national economies is accounting from 3% to the most 5%. interest for this companies, both at macro level by the creators of economic policy, as well as at micro level by businesses, in recent years is exceedingly increased because of their high potentials for resolving the issue of (un)employment and creating multitude of new products and services and added values which they are created for the society as a whole. in the paper the definitions of these companies are elaborated, the basic features and key factors of their business operation are analyzed, as well as their state (level of development) and their future development prospects in the european union and the republic of serbia. the authors of the paper have used research methods in accordance with the specifics and complexity of the subject of the analysis, relying on the current domestic and international literature and internet sources. the research results clearly showed that gazelles can be an important part of the answer to deep and comprehensive economic and social crisis with which modern societies face today in the world. key words: small and medium enterprises, gazelles, business growth, employment, strategy introduction one may say that it is generally accepted that small and medium enterprises (sme) are the foundation of national economic development and the key of growth, dynamics and flexibility, both in the most developed industrialized countries and on emerging markets. they are the dominant form of business organization, accounting for 95% to 99% of total 1 12 zmaj jovina 12, belgrade, serbia, vvvz@eunet.rs brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 45 businesses in national economies employing between 60% and 70% of total working population in some countries (erić d., berdaha i., đuričin s., kecman n., jakšić b., 2012). subject of the present paper is a specific group of smes attracting plenty of attention in theory and practice, most often denoted as fast growing companies with colorful name – „gazelles“. attention of economic policy creators, as well as theorists, has been attracted as it has been found that they provide significant contribution to social well-being, creation of new businesses and jobs. they are also believed to provide high investment return, promote regional development and contribute to manager and employee satisfaction. therefore, in recent years, numerous governments structured their economic development incentive policies, especially in the segment related to smes, so as to grow more gazelles in the form of one of the basic priorities. one should also note that in spite of undivided attention and importance given to the subject sme group, their growth and success, theoretic literature focused on the subject topic is relatively deficient and researches are meager and fragmented. economic support programs are insufficient, limited and lack required focus. in other words, they are usually broadly defined targeting all smes, and very rarely exclusively focused on the fast growing segment in this very broad group of firms, especially gazelles. definition of fast growing companies gazelle in line with the aforementioned statement indicating that no special respective attention was paid to subject firms, one may say that there is still no generally accepted definition of gazelles as the fast growing segment of smes, nor there is any special agreement about crucial criteria possible definition would be based on. author connected to the first broadly accepted definition of gazelles and the one who was the first to point to their importance is david birch (birch at al, 1981). studying the silicon valley boom in usa in 1980’s, he concluded that from so many firms only three percent will continue to exist and develop. he called this small group of firms and dynamic companies – gazelles. david birch used the term gazelles to describe companies continuously generating high growth rates during a given period. he found that most of the subject companies were created as parts of smes, especially in the segment of new and highly innovative companies. according to his research, on average, two thirds of all businesses are sme creations. additionally, relevant studies showed that in comparison to other companies or companies created during the current year, share of subject companies is very small in all economies, ranging between 2% and 5%. in addition to identifying the phenomenon of fast growing companies and engineering the term gazelle, david birch also set the principal elements to be used in applying subject definition. according to david birch, these are: selected growth indicator, measurement method, time period of measurement, as well as other additional criteria. according to him, growth is viewed as relative or absolute growth, or as a combination of two dimensions, and the period of company growth measurement is three years. subject methodological issues and their balancing are very important to create the base of statistical monitoring for gazelles, as well as to implement relevant comparative analyses of the relevant phenomenon 46 economic analysis (2015, vol. 48, no. 1-2, 44-61) in different countries or researches. empirical criterion of gazelle definition is mainly attached to the pace and intensity of sales growth. indicators commonly used to identify gazelles are the sales tendencies and/or number of employees. the most frequent and the most important respective growth indicators are as follows: • type 1: absolute growth agt1t2 = abs(xt1-xt2) measuring the sales growth or employment growth as a difference between the share/size in the first and the share/size in the last year of observation, • type 2: relative growth rgt1t2 = (xt2/xt1)-1 measuring the sales growth or employment growth as a ratio of the share/size in the first and the share/size in the last year of observation, • type 3: birch index: bit1t2=│agt1t2│*rgt1t2 measuring the sales growth or employment growth as a combination, i.e. the product of absolute and relative growth. although there are, apparently, numerous definitions of fast growing small and medium enterprises – gazelles, one may notice that they are also based on very similar indicators, and that they differ, before all, in the limit values of the subject indicators. all subject definitions start from specific growth indicators, measuring methods and include specific measuring period. the most frequent definition of gazelles is oecd’s definition, which is based on the following baseline assumptions: • average employment growth of 20% in a three year period, • minimum of 10 employees in the base year, • 72.8% growth in the final year three versus the starting base year (dautzenberg k, ehrlinspiel m., gude h., käser j., schultz p. t., tenorth j. at al., 2012) research conducted by david birch from 1980’s proved to be the stimulus of numerous researches of fast growing small and medium firms and of a quest for answers to following questions: what are their basic characteristics, who are the owners, what is their growth and how many of them in total smes mass generate prominent growth rates. researches were firstly conducted in usa, while similar significant researches, coverage wise, were conducted in 17 european countries as late as in 1996. as of that year, 500 most dynamic european companies are ranked within the implementation of the europe’s 5002 project. more than 30 countries today implement systematic research of the subject topic. between 1994 and 2011, 3 meta-studies and 22 empirical studies were implemented as regards to the subject topic. aforementioned empirical studies were based on individual company data collected in late 1990’s and mid 2000’s. five of 22 studies were carried out in usa, two in canada, while other were implemented in the european countries, three in germany and finland, two in spain and one in the great britain and one in the netherlands. additionally, four studies were also about comparative analyses of several eu countries and several american countries. aforementioned met-studies indicated that gazelle companies are not numerous, i.e. that their share in total number of companies is small. on the other hand, their contribution to 2 europe's 500 is the european organization and network platform of fast growing companies and their owners/entrepreneurs (see: http://www.europes500.eu/) brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 47 creation of new jobs in proportionally bigger and in average terms more important versus other type of companies. subject studies, baseline of which was the oecd’s definition, found that only 2% to maximum 5% of total number of companies may be classified as gazelles. however, 60% 70% of all newly created jobs may be attributed to the subject companies. therefore, in spite of their small share in the total number of companies, gazelles generate outstanding employment contribution. results of empirical studies of fast growing smes indicate several common characteristics of gazelles exceeding the narrow framework of the homogenous indicator, such as multi-year continuous growth, and they introduce additional indicators in the methodological framework. some of these characteristics of gazelles that are most frequently referred to in the aforementioned studies are as follows: • innovation: growth is closely linked to company’s innovation ability including continuous change of products, processes and organization managerial practices. • cohesion of marketing and technology: gazelles are distinctively market oriented firms, connecting technology and markets and adapting their products to respond to consumer trends and client needs. • organization and management: gazelles have decentralized, participatory organizations ready to adapt. • team work: subject firms stimulate team work among all employees through daily communications introducing modern decision making techniques, developing skills and alike. • networking: gazelles are integrated in the respective communication business networks with firms – business partners, as well as various private and social institutions. considering aforementioned, gazelle phenomena proved to be more complex than initially implicated in the first studies. some of the researches show that the sectors, such as education, hygiene services, as well as the high-tech sector, generate outstanding number of gazelles. other researchers showed that subject companies are not representative in high technology branches, but anyway, in highly industrialized countries, gazelles are de facto characterized as tending to be high-tech, research and innovation oriented. many gazelles are not necessarily high-tech companies, but copiers of existing technological and business models or their respective mix generating success from appropriate timing or in the market niche to reach required profitability. characteristics of gazelles as economic development drivers comparative strengths and economic performance of gazelles come from their specific features, such as: flexibility in adapting to changes, ability to create high performance products, ability to ensure fast delivery of products, etc. subject characteristics providing for efficient use of knowledge and technology are those that ensure fast growth typical for gazelles. generally, are fast in research and discovery of new market opportunities, thus, improving their productivity and efficiency in continuous manner. successful gazelles are capable of finding development opportunities in places of market discontinuity or there were they can produce goods different from existing ones. using the subject opportunities 48 economic analysis (2015, vol. 48, no. 1-2, 44-61) provides for generating impact on both supply and demand, thus, playing unique role in the growth of economic activities, as well as creating new additional values. gazelles and growth fast growth and high performance abilities of the company are dependent on numerous factors, such as (figure 1): business strategy, internal resources and know-how, leadership and management practices, as well as on macro-economic factors, such as availability of workforce, market efficiency, capital market presence and efficiency, tax system stimulations, intellectual property and innovation safeguards, etc. (moreno a. m., j. c. casillas, 2000). figure 1. company growth determinants source: moreno a. m., casillas j. c. (2000) high-growth enterprises (gazelles): a conceptual framework fast growth is possible in two situations: formation of the new company created to use innovations of technological-marketing nature in ceasing market opportunities not identified by competition and/or existing company is introducing new strategies, procedures, conduct and similar. subject changes, if radical, may contribute to strong company growth. however, one must be aware that fast growth, in addition to a series of positive effects, involves certain risk caused by dramatic changes on all levels of company business. potential problems may occur when the sudden company growth creates urgent need for outstanding resources to align capacities and predefined goals of fast growth. subject issues may be very sensitive in case of discrepancy between the existing and new skills and knowledge among employees required for the company to operate in newly created environment. growth of gazelles is by default very fast and strong. usually, as a consequence of strategic change and restructuring on all levels of organization and strategic links between the companies and their environment. there are key strategies that, seemingly, help companies to become gazelles and survive on the market as such. important element of strategy implementation is the ability of the company to learn from the growth in a certain period and then to apply the lessons learned in the next period. on the other hand, the biggest limitation or barrier to growth, in most cases, is the use of inadequate strategy mix. brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 49 one german study from 2012 (dautzenberg et al, 2012), focused on studying conduct of the gazelle firms, surveyed entrepreneurs indicated that the growth strategy was planned as early as in the first steps of company establishment. as regards to the growth motives, all surveyed indicated that it was planned strategically or closely attached to their business model involving „company growth or disappearance“, since the market conditions required certain company size for it to be successful. analyses of the company growth nature, however, showed that it was not always continuous and that companies may be subject to non-linear forms of growth, with frequent booms and plunges, and that in spite of all of that they continue to grow in long term. anyhow, regardless of all differences in approaches to defining gazelle firms, understanding what is the driver of fast sme growth is crucial both for managers striving to become or remain competitive, and for the governments responsible for national economies and creation of new jobs. gazelles and innovation one of gazelles’ fast growth factors and source of their diversity is connected with innovations. members of pro inno europe3 research team highlighted that the growth is linked to the company ability to innovate not only products but processes, too. lately, focus in given to process management domain, such as organizational structure, human resources management and accounting systems. gazelles are characterized by the fact that innovations are not only introduced in production domain, but practically in all domains of operations, including managerial, organizational and technical innovations within the company. there are opinions that innovations in gazelles are oriented more on changes in resource management approach and introduction of new organizational structures, than on creation of creating new technologies or products in general sense. fast growing companies succeeding with the help of innovative approach in marketing, organization and/or distribution may be found in all spheres of business. gazelle analysis in germany concluded that 76% of the subject companies have created innovations and that their innovativeness is above the average of the subject economy (dautzenberg et al, 2012). among surveyed companies, around 80% introduced production or service innovations, while around 37% introduced innovated business methods and processes. size and young age of gazelles almost all studies focused on gazelles indicate that the majority of gazelles are small enterprises. almost 70% of gazelles start as small firms (less than 20 employees in the first reporting year). for example, in spain, ¼ of all fast growing start-up firms and 20% of newly established businesses surviving first four years of operation grow so fast that they pretend to be gazelles (lópez-garcia, p. & puente s., 2009). it is estimated that around 70% of all 3 innovation cooperation (pro inno europe ®) is the new initiative for analysis and development of incentive innovation policies pretending to become the central point of analysis of innovation policies and development europe wide (http://cordis.europa.eu/innovation/en/policy/pro-inno.htm). 50 economic analysis (2015, vol. 48, no. 1-2, 44-61) gazelles in eu are small enterprises, while medium enterprises make for 30%. however, starting from birch and medoff (birch & medoff, 1994) gazelle definition saying that gazelles are companies with the annual sales growth of at least 20% continuously in a 4 year period and that they exceed 100,000 $ of revenues in base year, acs research team (acs et al. 2008) concluded in the study that companies creating new jobs are not either small nor large, but that they are gazelle firms of medium size. age of gazelles is an interesting issue. baseline assumption of david birch, exceedingly long presumed in gazelle analyses, is that fast growing firms are predominantly young newly established firms and, thus, gazelles are by default young companies. research conducted in usa in 2008 found that, however, average age of fast growing companies is as much as 25 years (acs z. j., et al. 2008). researchers showed that employees of gazelles are significantly better educated versus employees of other companies. on average, majority of gazelle founders possess important long term professional experience and, thus, it is believed that one of the most important factors of company growth in this professional experience of founders and employees. aforementioned study of gazelles conducted in germany (dautzenberg et al, 2012) presented data on the age group of founders: one half founded their companies between 30 and 39, 28% between 40 and 49 while 20-29 and 50-59 age groups of founders each take 12%. gazelles are usually formed by teams of three members. among surveyed ceos, 41% worked in leading management positions. as far as the education is concerned, 54% of founders indicated completed trainings in techniques and sales, 38% with economic degrees and degrees in social sciences; one of 10 founders holds phd and more than 60% of surveyed have more than ten years of doing business. strategic aspects of gazelle operations clear vision of future provides necessary orientation for decision making within the entire company and, thus, provides significant contribution to reaching competitive strengths. successful gazelles are characterized by application of clear differentiation strategies, customer care and smart use of available resources in the environment, so as to reduce risks and uncertainties with parallel provision of new knowledge and innovations. subject companies are successful due to their close contact with the customers, listening to identify customer needs and requirements, constant product improvement and, thus, ensuring superior position versus relevant competition. developing strong link with customers facilitates gazelle’s better response to customer needs and better preparation for adaptation to necessary changes in the environment. focus on quality, clients and distribution are by far the most important growth drivers and in that context of marketing it plays key role. dynamic organizational capacities of the company are based on its ability to connect internal forces with external needs. subject perspective dictates that creating key competences and skills is required for company success in dynamic environment. crucial factor safeguarding survival of smes, and especially gazelles, on the highly competitive market is human resources management, including style, personnel, skills and common values. style is related to grouping staff by similarities in thinking and conduct, strengthening organizational culture and involving employees in decision making processes; brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 51 staff is related to special individuals, engaged and specially trained by the company for specific task in line with their abilities. skills are related to the fact that employees possess special skills required for company strategy implementation. common values, related to clear vision and organizational culture, indicate that all employees strive to the same guiding values. gazelle firms in the european union quantitatively speaking (in terms of total number of companies, number of employees, turnover and similar), gazelles bear relatively low importance for total economies of the european union countries. on the other hand, researches proved that most important trends of european economy are connected with fast growing companies, particularly gazelles. for example, comparing to the average, gazelles provide more significant contribution to sales growth than to the employment growth in the total economy; then, young production firm generate more contribution to sales growth and less to employment growth, while service companies generate more significant contribution in both domains, sales growth and employment growth. importance of gazelles for economies of eu countries table 1 shows data of official statistics on total number of small and medium enterprises, number of gazelles and number of fast growing firms in individual eu countries. column „all companies” presents the number of companies in existence as far back as of 2004 that are still active in 2010. column „gazelles” present the number of all companies of not more than 5 years in existence with the average annual growth rate above 20% in the last three years. column „fast growing companies“presents all companies with the average annual growth rate of 20% in a three year period. according to subject data, the highest number of gazelle firms in 2010 was active in france (1,432), italy (1,388), bulgaria (1,368), and the great britain (1,214), etc. note that countries such as luxembourg and malta have no gazelles and that rather low number of gazelles was active in cyprus (78), slovakia (56) and greece (32). table 1. number of smes with 10 to 249 employees in individual eu countries, 2007 and 2010 type of company/ year all companies gazelles fast growing companies other companies 2007 2010 2007 2010 2007 2010 2007 2010 belgium 24.996 24.996 208 212 924 922 23.864 23.862 bulgaria 25.362 25.362 1.368 1.368 3.570 3.570 20.424 20.424 czech republic 2.230 2.230 78 78 222 218 1.930 1.934 germany 181.988 181.988 100 400 9.206 9.206 172.382 172.382 denmark 27.980 27.980 286 286 3.274 3.274 24.420 24.420 greece 1.484 1.504 32 32 240 252 1.212 1.220 estonia 153.3724 153.325 1.175 1.174 5.840 5.838 146.310 146.311 finland 18.336 18.336 156 156 806 806 17.374 17.374 france 157.807 157.810 1.433 1.432 6.802 6.801 149.563 149.564 ireland 23.772 23.772 315 315 890 890 22.568 22.568 52 economic analysis (2015, vol. 48, no. 1-2, 44-61) type of company/ year all companies gazelles fast growing companies other companies 2007 2010 2007 2010 2007 2010 2007 2010 italy 213.974 213.975 1.388 1.388 6.996 6.996 205.591 205.591 lithuania 10.820 10.820 432 432 112 112 10.276 10.276 luxembourg 2.794 2.794 0 0 4 4 2.790 2.790 latvia 9.154 9.154 136 136 906 906 8.112 8,112 malta 380 380 0 0 28 28 352 352 netherlands 64.041 64.041 666 666 3.257 3.258 60.121 60.120 poland 78.584 78.584 571 571 6.008 6.008 72.005 72.004 sweden 13.074 13.073 178 178 732 732 12.163 12.163 slovakia 8.404 8.404 56 56 760 760 7.588 7.588 great britain 154.103 154.103 1.214 1.214 10.585 10.586 142.304 142.306 source: http://epp.eurostat.ec.europa.eu/ as far as the fast growing companies are generally concerned, the great britain is leading with 10,568, then germany with 9,206, italy with 6,996 and france with 6,802 of these companies. gazelles and fast growing companies in eu countries share of gazelle firms by countries is shown in the study conducted by the european consortium innova sectorial innovation watch, in january 2011 (mitusch & schimke 2011). research included analysis of gazelle firms share by countries within two specific samples: one making 10% of fast growing companies and the other making 5% of these firms. research was based on the database of cis iv4. table 2 shows that countries with the highest number of gazelles in the sample making 10% of all growing firms is bulgaria with 2,197, italy with 1,268, romania with 1,148 and spain with 805. simultaneously, gazelle firms in aforementioned countries have the highest relative share in the group of fast growing firms: 27.4% in bulgaria, italy – 15.8%, romania – 14.3% and spain – 10.1% (mitusch & schimke 2011). table 2. share of gazelle firms in total number of firms by individual eu countries country 10% growing firms 5% growing firms number of gazelles share of the sample % number of gazelles share of the sample % belgium 115 1,4% 46 1,2% bulgaria 2.197 27,4% 1.206 30,1% czech republic 214 2,7% 101 2,5% 4 cis (community innovation surveys) are statistical researches of innovations in companies in the science and technology segment of eu. producing cis data is on voluntary basis for all member countries. cis iv was implemented on the basis of 2002-2004 reference period in the following countries: belgium, bulgaria, czech republic, denmark, germany, estonia, greece, spain, finland, france, hungary, italy, lithuania, latvia, portugal, romania, slovenia, sweden, slovakia, norway and island. brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 53 country 10% growing firms 5% growing firms number of gazelles share of the sample % number of gazelles share of the sample % germany 108 1,4% 49 1,2% estonia 228 2,9% 113 2,8% spain 805 10,1% 349 8,7% greece 15 0,2% 4 0,1% hungary 245 3,1% 113 2,8% italy 1.268 15,8% 559 13,9% lithuania 290 3,6% 165 4,1% latvia 477 6,0% 242 6,0% norway 191 2,4% 92 2,3% portugal 240 3,0% 108 2,7% romania 1.148 14,3% 639 15,9% slovenia 241 3,0% 104 2,6% slovakia 236 2,9% 119 3,0% source: mitusch k. & schimke a.(2011), gazelles – high-growth companies, consortium europa innova sectorial innovation watch if we analyze the number of gazelles within the sample made of 5% of all fast growing firms in eu, situation is very much similar to previously described: highest number and the highest relative share is again attached with bulgaria with 1,206 gazelles (30.1% of the total number of firms); than romania with 639 gazelles (15.9% share); third is italy with 559 gazelles (13.9% share); and then spain with 349 gazelles (8.7% share); etc. gazelles by individual sectors in eu countries aforementioned study (mitusch & schimke 2011) showed representation of gazelles by industries and sectors in eu. research identified gazelle shares by sectors and industries within 5% and 10% groups of all growing companies in eu within nace5 double digit classification of industries. table 3. gazelle shares in total number of companies by sectors in eu, 2011 industry/sector gazelles in 10% fast growing firms gazelles in 5% fast growing firms no. of firms % no. of firms % mines and quarries 141 1,8% 73 1,8% food, drinks and tobacco production 549 6,9% 250 7,0% textile production and textile products 505 6,3% 267 6,7% leather and leather items production 89 1,1% 47 1,2% wood production and wood and cork products; celluloses production, paper production and paper products 286 6,6% 146 3,6% publishing, printing and reproduction of 113 1,4% 59 1,5% 5 nace (european classification of economic activities) is a statistical classification of economic activities in the european community and a subject of eu legislation. 54 economic analysis (2015, vol. 48, no. 1-2, 44-61) industry/sector gazelles in 10% fast growing firms gazelles in 5% fast growing firms no. of firms % no. of firms % recorded materials production of coke, oil derivates and nuclear fuels; production of chemicals and chemical products 124 1,6% 53 1,3% production of rubber and plastic products 181 2,3% 89 2,2% production of other metalloid mineral products 219 2,7% 113 2,8% production of base metals 74 0,9% 32 0,8% production of metal products excluding machinery and equipment 369 4,6% 149 3,7% production of machinery and equipment 278 3,5% 132 3,3% production of electrical and optical equipment 332 4,1% 164 4,1% production of means of transportation 172 2,2% 94 2,3% furniture production; n.e.c. production recycling 341 4,3% 181 4,5% electric power, gas, steam and hot water 65 0,8% 31 0,8% civil engineering 971 12,11% 465 11,6% sale, maintenance and repair of motor vehicles and motorbikes; fuel retail 100 1,3% 48 1,2% wholesale and sale brokerage, excluding motor vehicle and motorbikes sale 1,127 14,1% 589 14,7% retail sale and sale brokerage, excluding motor vehicle and motorbikes sale; repair of personal goods and household goods 121 1,5% 57 1,4% hotels and restaurants 71 0,9% 39 1,0% road transport; pipeline transport; water transport, air traffic 431 5,4% 232 5,8% financial brokers, excluding insurance and pension funds; insurance and pension funds, excluding compulsory social insurance; support activities in financial brokerage 190 2,4% 99 2,5% real estate 44 0,6% 20 0,6% leasing machinery and equipment 14 0,2% 8 0,2% computer and related activities 237 3,0% 1174 2,8% research and development and other business activities 547 6,8% 262 6,5% source: mitusch k. & schimke a.(2011), gazelles – high-growth companies, consortium europa innova sectorial innovation watch table 3 shows that most gazelles within the 10% fast growing companies in eu was in the sector of wholesale and sale brokerage with 1,127 recorded gazelle firms (14.1% of total); sector of civil engineering included 971 gazelles (12.1% of total); to be followed by the sectors of food, drinks and tobacco production with 549 gazelles (6.9% of total), textile production and textile brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 55 products with 505 gazelles (6.3% of total) and research and development with 547 gazelles (6.9% of total). sectors with the lowest number of gazelles in this segment of fast growing firms real estate with 44 gazelles (0.6% of total) and leasing machinery and equipment with 14 gazelles (0.2% of total). relative ratios are almost identical when subject data are analyzed for the segment of 5% fast growing firms: sector of wholesale and sale brokerage in this segment also recorded the highest number of gazelles with 589 gazelle firms, i.e. 14.7% of the total number of fast growing firms in the sector; sector of civil engineering had 465 gazelles (11.6% of the total number of firms); to be followed by the sector of food, drinks and tobacco production with 250 gazelles (7.0% of the total number); sector of textile production and textile products with 267 gazelles (6.7% of the total number) and research and development with 262 gazelles (6.5% of the total number). sectors of real estate and leasing machinery and equipment are with the lowest number of gazelles in this segment: 20 and 8, i.e. 0.6% and 0.2%, respectively. gazelles in the republic of serbia the republic of serbia’s ranking is relatively low compared to eu countries in terms of entrepreneurship and innovations. measured by the global entrepreneurship development index or gedi6, which is used as an indicator of the quality of entrepreneurship and innovations, which have been influenced by individual and institutional factors, in 2014 serbia ranked 68 out of 130 countries, which is below most of the countries in the region. although, judging strictly from the standpoint of european standards of innovations, economic power and competitiveness, it is still early to talk about dynamic entrepreneurship in serbia – in its research the republic institute for development for the period 2003-2007 identified 532 dynamic enterprises out of which 53 firms can be classified as the most dynamic ones– gazelles (the ministry of economy and regional development, the republic institute for development, the national agency for regional development, 2008). in this research, gazelles were identified as small and medium-sized enterprises that were employing in 2003 up to 20 people and not more than 250 respectively; that their number of employees and their total revenues in 2007 increased by 30% compared to 2003; that their business was continuously solid and that they weren’t part of a larger systems, that is, a holding. in 2007, gazelles in serbia made up 0.1% of the total number of enterprises and 1.0% of the total number of employees; they managed 0.3% of the equity, generated 1.0% in total revenues and 1.3% in total gain. it is argued that serbian gazelles recorded a dynamic growth of employment and total revenues, primarily, thanks to their investments in technical and technological resources and applying the cutting edge methods and standards taken from successful countries; but also thanks to continuous professional education of employees, continuing improvements of customer relations, product and/or service quality and aspiration towards winning over new positions in the market. 6 global entrepreneurship development index (http://thegedi.org/research/gedi-index/) 56 economic analysis (2015, vol. 48, no. 1-2, 44-61) the advantage of these enterprises is primarily in what is considered a fast revenue growth and market share usually accompanied by an increase in company value. their greatest weaknesses, on the other hand, are mainly associated with the fact that they have not achieved the necessary economies of scale and therefore occasionally enter the zone where they generate losses. in addition, they are usually faced with constraints related to financing of their business activities, and have difficulty to reconcile growth and profitability. the biggest obstacle in obtaining funds for these enterprises is a brief period of existence, which is why they do not have sufficient credibility among investors, and often record a high level of indebtedness, which prevents further borrowing. the aforementioned research of dynamic entrepreneurship in serbia was related to the dynamic (fast-growing) and most dynamic small and medium-sized enterprises gazelles. key findings in this study are the following: • in 2007, in serbia there were 532 dynamic enterprises, out of which 53 were gazelles with 43,311 employees. • dynamic enterprises accounted for only 0.6% of the total number of enterprises, but in the analyzed period (2003 to 2007) they doubled the number of employees to 22,000. • these companies have generated 4.5% of the total profits of the economy as a whole in 2007, which is as high as 1.3% more than in the base year, 2003. • all business indicators have doubled in the analyzed period, in addition to profits, which tripled. • total revenue of these companies, in the reporting period increased by 116.8%, and the number of employees increased by 104.8%. as regards the size of gazelles in the serbian economy, in 2003, most of them were small (37), while in 2007 those were medium-sized enterprises (32). in this four-year period, six companies-gazelles grew into large enterprises and created 8,020 new jobs. nine of the ten most important gazelles from the analyzed group of companies were operating in the manufacturing industry and trade. table 4. 2007 business indicators attributable to gazelles by sectors in serbia sector no of enterprise s no of employees total profits, in mil rsd equity, in mil rsd gain, in mil rsd gazelles total 53 100,0 10.630 100,0 58.289 100,0 11.285 100,0 4.147 100,0 agriculture, hunting and forestry 4 7,5 455 4,3 2.460 4,2 843 7,5 219 5,3 manufacturing industry 18 34,0 4.109 38,7 21.330 36,6 3.583 31,8 1.336 32,2 construction industry 10 18,9 2.028 19,1 5.874 10,1 1.029 9,1 514 12,4 trade 14 26,4 2.771 26,1 22.820 39,1 4.567 40,5 1.778 42,9 traffic, storage and communications 3 5,7 678 6,4 3.542 6,1 1.013 9,0 199 4,8 real estate business 4 7,5 589 5,5 2.263 3,9 250 2,2 102 2,5 source: ministarstvo ekomomije i regionalnog razvoja, republički zavod za razvoj, nacionalna agencija za regionalni razvoj, izveštaj o malim i srednjim preduzećima i preduzetništvu za 2008. godinu brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 57 table 4 shows the distribution of gazelles by sectors. the largest number of new companies is doing business in manufacturing industry (18), and they employ the largest number of employees (4,109); followed by trade (14) in which these companies achieved the highest total profits, and own the largest capital and benefit most. it may also be noted that gazelles are scars in the transport, storage and communications (3); the fewest number of employees is recorded in the sector of agriculture, hunting and forestry, and the lowest total profits, equity and gains are recorded by gazelles in the real estate business. the subsequent research that was conducted in 2009, showed the vitality of dynamic companies and gazelles. despite the transition problems they managed to create 965 new jobs (846 in the gazelles), while the total number of employees in the business sector in the period from 2007 to 2009 decreased by about 51,000. the results of research of fast-growing enterprises in serbia for the period 2009 2013 were published in a 2015 study (jakopin, e., 2015). in it fast-growing companies were defined as companies that met the following multiple criteria in the reporting period: (i) continuous operation for a period of 5 years from 2009 to 2013; (ii) the average profits above average in the business sector, ie. greater than 63,000 eur in 2013 (iii) the positive value of gdp per employee in 2009 and 2013, which is not below average in the business sector in the last reporting year, ie. it was not below € 12,400 per employee, (iv) at least the same number of employees in 2013 compared to 2009. (c) at least two times faster growth in business profits than the growth of business profits of the rest of the business sector in the period 2009 to 2013 .; (vi) the cumulative gains generated in the period 2009 to 2013; (vii) all sociallyowned, state-owned and public companies were excluded, as well as companies from the sector real estate business sector, public administration and mandatory social insurance, other services, households as employers and activities of exterritorial organizations and bodies; (viii) subsidiaries that are part of larger economic units were excluded. subject criteria were met by 1.103 enterprises in 2013, 1.2% of the total number of enterprises in serbia. this group of companies was then subjected to application of the methodological indicator for identification of gazelle firms developed the father of this concept, david birch, which is based on the analysis of change in the number of employees and the change in the newly created value. this was the method used to arrive to the estimation that serbia had 156 gazelle firms operating during the observation period, which was around 14% of fast growing companies. analysis of results achieved by dynamic companies defined as previously described, and gazelles within them, during the observation period (2009-2013), which was characterized by a global financial crisis and generally very difficult business environment, indicated that they demonstrated resilience to crisis blows and that they managed to overcome the crisis fast and achieved outstanding performance. the following research results are the best description of the importance of dynamic entrepreneurship and gazelles: • employment growth: dynamic companies increased employment by 120.7%, and by 203.5% in case of gazelles (the entire economy registered an employment reduction by 7.3% during the same period) • growth of business activities: business activities of dynamic companies presented through business revenue tendencies grew by 251.1%, and 257.6% in case of 58 economic analysis (2015, vol. 48, no. 1-2, 44-61) gazelles (the entire economy registered growth of only 2.9% during the same period), • growth of gross value added: dynamic companies increased gav by 251.1%, and 224.7% in case of gazelles, while the entire economy registered 3.7% reduction, • profit growth: profit generated by dynamic companies increased by 249.1%, and 228.6% in case of gazelles, and 15.1% in case of the entire economy; • trade growth: trade results of dynamic companies increased 2.3 times, export 2.9 times, and deficit by 2.2% (non-financial sector registered unchanged trade values, export increased 1.2 times, export dropped by 13%, and the trade deficit was as much as 2.5 lower than previously). considering aforementioned, one may conclude that gazelle firms in serbia have very much the same general characteristics as the one identified in case the subject firms in other world economies, including the most developed. there are few of them (not more than few percentages of the total number of companies), but they generate outstanding contribution in terms of employment, growth and total business results of the national economies. conclusion within the total sme corpus, so-called gazelles, dynamic small and medium size companies, play special role, and many authors believe that they are the biggest development potential of the national economies. present paper elaborated the issue of the definition of this specific group of companies; gazelle phenomenon was explained, as well as their specific features and characteristics making them so unique. the most important results of gazelle related researches conducted in usa, european union and, in the final part in serbia, were presented. results of the subject research clearly indicate that gazelles may be an answer to numerous problems faced by economies today characterized by deep, prolonged and comprehensive economic and social crisis. these companies have clearly demonstrated superior potentials for job creation, export growth and innovative processes and activities. they contribute to social well-being by creating new jobs, promoting regional development and, also, generate high capital return to investors. principal characteristics of gazelles are innovativeness, both in production and process domains, as well as management practices. their management and organizational flexibility facilitates faster and streamlined adaptation to changes, providing for strong market orientation, focus on quality, clients and distribution. strong links with consumers and maximum utilization of employees indicate that successful strategic management of the company leads to constant and stable growth, both large and small and medium enterprises, including gazelles. characteristics and performance described, generated by dynamic companies and particularly gazelle firms in the previous period, are another confirmation that subject companies should be given special attention of economic policy creators and that, thereto, their creation and then supported development should be identified as strategic goal of the national economic development. set of measures to achieve this should range between those impacting creation of business development friendly environment in general, especially brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 59 environment characterized by innovativeness and entrepreneurship, and those specifically supporting establishment and sustainable development of dynamic and gazelle firms. some of incentives to be definitely included are as follows: • stimulating financing models – this should include measures such as capital market development and introduction of versatile development project financing forms adequate for dynamic and particularly gazelle companies. this is about introducing the forms of financing such as the risk-capital and venture capital, investment securities and other. • provision of non-financial incentives – as subject companies are mainly small and medium enterprises, they by default lack business system improvement resources, such as strategic planning and management systems, contemporary information technology systems, human resources management systems and similar, and thus, relevant support should be definitely provided in this sense. • support for international operations – dynamic and gazelle companies have international market potentials, but in that sense (at least in initial growth stages) they, by default, nee support in learning about foreign markets, business networking on international markets, adopting required standards and entering relevant distribution channels. • supporting development and especially implementation of development projects – smes, by definition, and especially dynamic and gazelle companies tend to be innovative and entrepreneurial. this implies readiness to invest in projects long lasting in character sustainability of which has to be observed through long-term perspective. considering limited resources of subject companies, starting implementation of such projects and then successful implementation would require relevant support in terms of innovation policy, intellectual property protection, tax and other financial incentives and similar. formulating and consistently implementing aforementioned measures of development and support to dynamic and especially gazelle companies would generate significant contribution to more dynamic national economy as a whole and better performance, thus, creating conditions required to find solutions for numerous social problems. references acs z. j., parsons w. and tracy s. 2008. high-impact firms: gazelles revisited. washington: corporate research board. adižes, i. (2007). težnja ka top formi. novi sad: asee. ahmad, n. & petersen d. r. 2007. high-growth enterprises and gazelles preliminary and summary sensitivity analysis. paris: oecd-fora. birch, d. (1981): “who creates jobs”. public interest 65. birch, d. l., haggerty, a. und w. parsons 1998. who's creating jobs?. cambridge: ma: cognetics. birch, d. l., & medoff, j. 1994. “gazelles.” in labor markets, mployment policy and job creation, ed. l. c. solmon &a. r. levenson. boulder, co: westview. boljević, a. 2007. strategijsko planiranje kao odlučivanje o pravcima razvoja preduzeća. subotica: univerzitet u novom sadu, ekonomski fakultet, brinkley i. knowledge economy and enterprise – a knowledge economz working paper. www.theworkfoundation.com 60 economic analysis (2015, vol. 48, no. 1-2, 44-61) brnjas, z. 2000. strategijski menadžment. beograd: privredni pregled. dr jakopin, e. 2015. dinamičko preduzetništvo – konkurentnost privredni rast, institucionalne promene kao determinanta privrednog razvoja srbije. univerzitet u kragujevcu-ekonomski fakultet. draker, f. p. 2006. moj pogled na menadžment. adižes, novi sad. dess, g. g., lumpkin, g. t., eisner, a. b. 2007. strategijski menadžment, teorija i slučajevi, treće izdanje. data status, beograd. dautzenberg k., ehrlinspiel m., gude h., käser j., schultz p. t., tenorth j. at al., 2012. study on fast growing young companies (gazelles). bundesministerium für wirtschaft und technologie. draker, f. p. 2006. draker iz dana u dan. novi sad: adižes. đorđević, d., anđić, ž. mala i srednja preduzeća i proces upravljanja, www.indmanager.edu.rs entrepreneurship at a glance 2014. oecd publishing, paris. erić, d. d., berdaha, a. i., đuričin, o. s., kecman, đ. b, jakšić, b. b. 2012. finansiranje malih i srednjih preduzeća u srbiji, www.pks.rs europe's 500 je evropska organizacija i mrežna platforma za rastuće kompanije i njihove preduzetnike (pogledati: http://www.europes500.eu/) gazelle companies – characteristics and development patterns appendix 2 – entrepreneurship and innovations, www.tillvaxtanalysis.se henrekson, m. & johansson, d., gazelles as job creators – a survey and interpretation of the evidence, research institute of industrial economic, www.ifn.se high-growth enterprises, what governments can do to make a difference. (2010). oecd studies on smes an entrepreneurship, www.oecd.org inić, p. b. 2006. strategic management. beograd. branimir inić. jakopin, e. 2013. dynamic entrepreneurship – the engine of economic growth and development in serbia, www.scindeks-clanci.ceon.rs jancyak, s., bares, f., high growth smes: the evolution of the gazelles and samo evidence from the field, www.expertise.hec.ca kontić, j. 2010. strategije rasta preduzeća. beograd: zadužbina andrejević. lópez-garcia, p. & puente s. 2009. what makes a high-growth firm? a profit analysis using spanish firmlevel data, doocumentos de trabajo n.°0920. banco de españa nacionalna agencija za regionalni razvoj u 2013. godini, www.narr.gov.rs ministarstvo ekomomije i regionalnog razvoja, republički zavod za razvoj, nacionalna agencija za regionalni razvoj. izveštaj o malim i srednjim preduzećima i preduzetništvu za 2009. godinu, www.narr.gov.rs mitusch k. & schimke a. 2011. gazelles – high-growth companies. consortium europe innova sectoral innovation watch. mihailović, b. 2007. formulisanje strategije preduzeća, monografija, institut za ekonomiku poljoprivrede, beograd moreno a. m., casillas j. c. 2000 high-growth enterprises (gazelles): a conceptual framework, http://www.researchgate.net/publication/ pavlović, n., tomić, d. 2007. upravljanje rastom i razvojem preduzeća. novi sad: alfa-graf. penezić, ć. n. 2010. preduzetništvo, savremeni pristup. novi sad: akademska knjiga. preduzeća sa tendencijom brzog rasta traže informacione sisteme. www.vibilia.rs strategija razvoja konkurentnih i inovativnih msp 2008-2013. www.klasterpolux.rs study of fast growing young companies (gazelles) – summary. www.bmwi.de vaidyanathan, n., how to spot a gazelle (with binoculars)!. www.smbconnect.in vemić, m. 2013. “evaluation of knowledge-based high-growth enterprises in serbia's economic development.” online journal of applied knowledge management, 1(2, 2013), www.iiakim.org vujadinović, m. 2011. “država pomaže „gazelama“.” ekonometar, 01.07.2011., 26. http://cordis.europa.eu/innovation/en/policy/pro-inno.htm brnjas, z., et al., gazelles in modern economies (2015, vol. 48, no. 3-4, 44-61) 61 www.ebart.rs http://epp.eurostat.ec.europa.eu/ www.vibilia.rs značaj uloga brzog rasta kompanija gazele u savremenoj ekonomiji rezime – značaj malih i srednjih preduzeća (msp) za razvoj nacionalnih ekonomija je nesporan i on se u brojnim radovima ističe kao opšteprihvaćeno mesto. u ovom radu pažnja je usmerena na jedan od vrlo specifičnih segmenata msp koje čine posebno dinamične firme koje se karakterišu brzim i stabilnim rastom, sposobnošću brzog prilagođavanja tržišnim uslovima i funkcionisanju na kontinurano visokom nivou performansi. ove firme su danas poznate pod već široko prihvaćenim nazivom – gazele, koji je 80-tih godina prošlog veka prvi skovao britanski autor david birch. gazele su relativno malobrojne i prema istraživanjima njihovo učešće u ukupnom broju firmi u privredama pojedinih zemalja kreće se na nivou od 3% do najviše oko 5%. interesovanje za ove firme poslednjih godina izuzetno je poraslo i to kako na makro nivou na strani kreatora ekonomske politike, tako i na mikro nivou na strane biznisa, zbog njihovog potencijalno izuzetno velikog značaja za rešavanje pitanja (ne)zaposlenosti, kreiranja novih proizvoda i usluga i dodatne vrednosti u savremenim društvima u celini. u radu su obrađena pitanja načina definisanja ovih firmi, analizirane su osnovne karakterstike i ključni faktori njihovog poslovanja, kao i stanje i perspektive ovih preduzeća u zemljama eu i u srbiji. autori su u radu korisitli istraživačke metode u skladu sa specifičnošću i složenošću predmeta analize, oslanjajući se na aktuelnu domaću i međunarodnu literaturu i internet izvore. rezultati istraživanja su jasno pokazali da gazele mogu da budu važan deo odgovora na duboku i sveobuhvatnu ekonomsku i socijalnu krizu sa kojima se danas suočavaju savremena društva u svetu. ključne reči: mala i srednja preduzeća, gazele, rast poslovanja, zapošljavanje, strategije article history: received: 16 november, 2015 accepted: 17 november, 2015 microsoft word 2010_3_4.doc scientific research paper the organizational structure and organizational culture interdependence analysis with a special reference to bosnian and herzegovinian enterprises delic alisa*, nuhanovic senija, univerzity of tuzla, faculty of economics, bosnia and herzegovina udc: 658(497.6) jel: l21 abstract – the aim of this paper is to point to the very nature of the relationship between the organizational structure and organizational culture as very important mechanisms by means of which enterprises set their employeesʹ behavior on the target course, or direct their efforts at accomplishing organizational goals, respectively. besides the examination of the phenomenon of the organizational structure and organizational culture at the general level, the paper also includes the analysis of empirical study results entailing bosnian enterprises. the research was made for two reasons. the first one was to identify the formalization and centralization level. the second one was to identify dominant organizational types of the structure and the culture (using the charles handy’s culture typology). the research analysis was made with respect to the interaction between organizational structure and organizational culture on one hand, and the point of view of the national culture and transitional processes characteristic of the area on the other hand. key words: organizational structure, organizational culture, types of organizational structure, types of organizational culture the term and importance of organizational culture since the 80-s the attention of the increasing number of theoreticians has been drawn to the organizational culture concept, which has become the subject to important researches and studies. however, the time reference does not necessarily imply that the phenomenon was not recognized as important in the organizational life earlier. the very beginnings of psychological approach to the organizational theory can be traced all the way back to the max weber’s theory, who regarded culture as the term involving common values. at the beginning of the 20th century henry fayol entailed the principle of common shared values into fourteen basic principles of management and organization /lʹesprit de corps/. from a modern organizational theory perspective, the substance of the principle refers to the organizational culture of enterprises. a number of aspects of organizational culture were thrown light on by the “human relation” school, founded by elton mayo. a systematical way of studying the organizational culture phenomenon can be related to pettigrew and his article under the name of on styding organizational cultures (1979); the * phd adisa delic, faculty of economics, univerzity of tuzla, tuzla, bosnia and herzegovina, e-mail: adisa.delic@untz.ba, phone: 00387 061 33 18 30 delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 71 book titled corporate cultures (terrence deal & allan kennedy, 1982); geart hofsted, who studied the differences between national cultures; and e. schein; and his book organizational culture and leadership (1985), in particular (nebojsa janicijevic, 1997, 13-28). note that most of the authors had been writing about the organizational concept climate up to the 80-s, when the term was replaced with the organizational concept culture. the corporate climate was regarded as an “obvious” expression of the organizational culture. we can explain the increasing interest in the organizational culture by the fact that traditional mechanistic models of managament have been identified as inadequate for ensuring the organizational efficiency and contrary to human nature. hence, a new concept was needed to describe and interpret the nature of individual actions in organizations in the context of enhancing their working performances (mats alvesson & per olof berg, 1992). the most important authors in the 21st century dealing with different dimensions of organizational culture by using the extensive research of the 20th century, are: joanne martin (in her book (organizational culture: mapping the terrain (2002)) she describes the potential usefulness of an awareness of different perspectives on organizational culture); edgar schein (his three distinct editions of organizational culture and leadership /1985, 1992, 2004/ headline his extensive publication list, and his work is referred to by many authors as providing a base line of understanding on organizational culture), and mats alvesson (he has produced understanding organizational culture (2002) as a summary and expansion of his publications on organizational culture)1 in spite of significant research attention drawn to the organizational culture there is no single definition related to the concept. analyzing literature on the management and organizational theory field, one can conclude that the number of organizational culture definitions equals the number of authors dealing with the issue. the table 1 gives you an insight of its most important definitions.the organizational culture denotes a whole complex made up of values, beliefs, basic assumptions and symbols shared by the members of an organization. having the listed characteristics, the organizational culture has a wide and intensive influence on the business of an enterprise. however, its influence can be two-sided. on one hand, it can be a “secret formula to a success”, but on the other hand it can be “a silent killer” of an enterprise (janicijevic, 1997, 29). namely, the organizational culture may represent a strong cohesive force joining and enhancing the employees’ efforts set on the target course of an organization. however, if the cultural contents set the organizational understanding and action in the direction which is not conforming to business needs and strategies, in some cases it will become a destructive force deteriorating the business of an enterprise. such extreme potential organizational culture impacts on an enterprise support the fact that it is an important phenomenon in the organizational life, which needs to be run adequately in order to achieve positive effects on the business of an enterprise as well as to avoid its possible negative impacts. thus, special attention needs to be drawn to its potential use. 1 clayton, b, fisher, t, bateman, a, brown, m and harris, r, organizational culture and structure, http://consortiumresearchprogram.net.au/html/images/stories/documents/ru4literview_section2.pdf (accessed february, 2010) economic analysis (2010, vol. 43, no. 3-4, 70-86) 72 table 1. revision of organizational culture definitions author, source definition of organizational culture gareth morgan, images of organization, thousand oaks, ca: sage publications, 1997, p.141. “…active living phenomenon through which people jointly create and recreate the worlds in which they live”. terrence deal and allan kennedy, corporate culture: the rites and symbols of corporate life, reading, ma: addisonwesley, 1982. “…the way things get done around here” geart hofstede, cultural constraints in management theories, academy of management executive, 7(1), 1993, p. 89. “...the collective programming of the mind which distinguishes one group or category of people from another“ edgar schein, organizational culture and leadership, in classics of organization theory. jay shafritz and j. steven ott, eds. fortress worth: harcourt college publishers, 2001, p. 373 -374. “...a pattern of shared basic assumptions that the group learned as it solved its problems of external adaptation and internal integration that has worked well enough to be considered valid and therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems”. schein, who was one of the most influential authors in this field, justifies the need for understanding the culture in his publication by the name of the corporate culture survival guide: “culture matters because it is a powerful, latent, and often unconscious set of forces that determine both our individual and collective behavior, ways of perceiving, thought patterns, and values. organizational culture in particular matters because cultural elements determine strategy, goals, and modes of operating. the values and thought patterns of leaders and senior managers are partially determined by their own cultural backgrounds and their shared experience. if we want to make organizations more efficient and effective, then we must understand the role that culture plays in organizational life” (schein, 1999, 14). in his organizational culture and leadership (2004), the author emphasizes that while it is easy to observe what happens in organizations, an understanding of culture helps to explain why things happen. further, understanding how leaders create culture and how culture defines and creates leaders, illuminates leadership–a critical variable in defining success or failure.2 schein writes, ʺthe bottom line for leaders is that if they do not become conscious of the cultures in which they are embedded, those cultures will manage themʺ (schein, 2004, 375). it is significant that schein uses the plural ʺcultures.ʺ in this way he suggests that members of a group culture may also belong to subcultures within an organization. it is evident that organizational culture has a multiple importance in the organizational life. first, the culture ensures a higher level of cooperation between employees. second, culture can simplify decisionmaking and the implementing, because common shared beliefs and values provide organization members a consistent set of basic assumptions and preferences. third, culture can initiate an efficient and sound communication. namely, 2 ibid. delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 73 common assumptions enable taking action without the need for verbal or oral communication. they also give guidelines for a clear interpretation of received messages. fourth, culture makes “clan” control in an organization easier, as common values, beliefs and group norms direct individual behavior (john pearce & richard robinson; 1997, 383). fifth, culture enables a higher level of identifying individual with organizational goals. organizational culture typology as we have discussed earlier, there is no such a thing as a single definition of organizational culture, which implies that there is no single organizational climate typology. the table 2 shows a review of organizational culture typology clasified according to different criteria and authors. the aim of the classification is to create assumptions for a relatively quick and simple assessment of a specific organizational culture in an organization. however, the culture typology has its disadvantages since it represents culture by far more simple than it really is. hence, when analyzing organizational culture of each enterprise, one has to take into account all specific qualities peculiar to it. in this research we used the culture classification set up by rodger harrison, later modified and upgraded by charles handy. according to this classification, there are four basic culture types: power culture, role culture, task culture and people culture. when identifying the cultural types handy drew on greek gods, whose characteristics are compatible with the characteristics of a certain cultural type.3 table 2. cultural types 3 for detailed reading see: handy, c.1995. bogovi menadžmenta, zelind, beograd, p. 19. culture types culture types based on power distribution /handy (1976)/: power or club culture: power resides at the centre of a web, its spokes representing functional organizational elements role culture: power resides in the over-arching roof; communication between the pillars, or functional areas of the organization, is possible only by passing information through heads of each department task culture: power is distributed through a flexible lattice structure, or a net, that can be reinforced or denuded of resources dependent upon the demands of a particular project; lattice nodes are big or small reflecting task importance or priority people or existential culture: power is shared, depending on expertise, between individuals who cluster within the organization in a substantially autonomous way, forming a galaxy of stars. culture types based on management / deal ˛& kennedy (1982)/: tough guy, macho culture: this culture is essentially entrepreneurial, and is marked by individualists who take high risks and get rapid feedback on whether their actions were right or wrong; it lacks cooperation and long-term maintenance work hard, play hard culture: this culture is associated with fun and action, with employees encouraged to maintain a high level of low risk activity; it is typical of good team workers and high achievers, often young people; it is difficult to maintain senior staff bet-your-company culture: this culture is associated with big-stakes decisions, where years pass before employees know whether decisions have paid off; technical expertise is respected and economic analysis (2010, vol. 43, no. 3-4, 70-86) 74 source: berwyn clayton, thea fisher, andrea bateman, mike brown and roger harris, organizational culture and structure, http://consortiumresearchprogram.net.au/html/images/stories/documents/ru4literview_section2.pdf (february, 2010) the term and definition of organizational structure the process of the organizational pattern is for the most part focused on adopting adequate forms of organizational structure, as each organization can be regarded and analyzed according to its organizational structure. when using the term “organizational structure” one usually means “the map showing different positions within an organization”.4 in its very meaning “structure” denotes pattern (composition). organizational structure is nothing but the a set of interrelated and integrated elements making up a system, which is autonomous on its own, more or less flexible and which can be destructed or even restructured into a new system over the time. theoreticians whose subject of interest is related to the organizational phenomenon have defined the term of the organizational structure in different ways in the broadest sense of its meaning. some of the definitions are given in the table 3 providing the base for differentiating the basic denominator, as well as the differences in understanding the structure. table 3. review of organizational structure definitions author, source definition of organizational structure thompson, j d, organization in action, new york, mcgraw-hill, 1966, p.51 “structure is the internal differentiation and patterning of relationships.ʺ jackson, j h and morgan, c p, organization theory, second ed., prentice hall, 1982, p.81 “…the relatively enduring allocation of work roles and administrative mechanisms that creates a pattern of interrelated work activities and allows the organization to conduct, coordinate, and control its work activities” o’neill, j w, beauvais l l, and scholl, r w, the use of organizational culture and structure to guide strategic behavior: an information processing perspective, the “…the degree of centralization of decisionmaking, formalization of rules, authority, communication, and compensation, standardization of work processes and skills, 4 http://www.ryerson.ca/~mhr405lecs/strclec.html personalities of successful people have well developed patience process culture: this culture is a bureaucracy associated with little or no feedback; employees find it hard to measure what they do; instead they concentrate on how it’s done culture types based on approach to change/ ken parry & sarah proctor-thomson (2003)/: transformational culture (change): this culture encourages and supports innovation and open discussion of issues and ideas, challenges become opportunities, not threats, employees go beyond their self-interests and strive towards achieving organizational goals. transactional culture (status quo): this culture focuses on everything in terms of explicit and implicit contractual relationships. individualism and self-interest is strong, and employees do not identify with organizational mission or vision. commitment is short term. delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 75 journal of behavioral and applied management, vol.2, no. 2, 2001, p.133, and/or control of output by acceptance of only adequate outcomes”. as already stated, organizational structure is a system of formal procedures prescribing the allocation of work and roles and the coordination of employees acting in the framework and around it. in other words, an organization is not a group of randomly chosen people but rather a well-planned combination of groups and individuals working in a coordinated way in order to achieve the goals of the organization.5 organizational structure specifies the way people should act in performing their everyday activities. it is the backbone around which other groups cluster and other organizational components rely on. dimensions of organizational structure there are different typologies of structural dimensions in the literature on the organizational theory (for example, see john harold jackson & cyril p. morgan, 1982; henry mintzberg & james biran quinn, 1991, 332). most of the listed include the following structural dimensions: a) specialization (the division of labor within the organization; the distribution of official duties among a number of positions); b) standardization (procedures which occur regularly, legitimized by the organization, having rules that cover circumstances and apply invariably); c) formalization (the extent to which rules, procedures, instructions, and communications are written); d) centralization („place” where the authority making legitimate decisions which affect the organization is located). 6 formalization and centralization as the dimensions of the organizational structure are of special importance to this work, as both of them are frequently associated with the characteristics of organizational culture. organizational structure forms: u, m, h and x there are different types of organizational structure in the literature on organizational culture and strategic management, which are known under the following names: u, m, h and x forms. u-form (standing for unitary form) of organization is characteristic of enterprises with technologically integrated processes resulting in a single product or a very narrow product assortment. this form of structure, the characteristics of which were first described in details by alfred chandler in his strategy and structure, could be equated with functional organizational culture. an eminent theoretician in the literature on this field, oliver e. willams, established the term “organizational m-form” to refer to the organizational structure of a multidivisional character7 the u-form is suitable for the early phases of an enterprise’s life cycle. however, with growing and development of an enterprise and its diversification, the form becomes 5 miller, d, the genesis of configuration, academy of management review, 12, 1987, p. 686. 6 krokosz-krynke, z, organizational structure and culture: do individualism/collectivism and power distance influence organizational structure? (http://www.sba.muohio.edu/abas/1998/krosz.pdf (accessed february 2010) 7 willamson, o e. 1975. markets and hierarchies: analysis and antitrust implications, free press, p. 152-154 in hill, c.: oliver williamson and the m-firm: a critical revew, journal of economic issues, 19(3), 1985, p. 731-751, http:www.nottingham.ac.uk/business/hier/hiermod7.htm (march, 2006). economic analysis (2010, vol. 43, no. 3-4, 70-86) 76 inefficient for at least two reasons: 1) occurrence of control cumulative loss; 2) progressive communication pressure on the top (top management), which is a result of radial expansion of the form. 8 the problems faced by an enterprise with the dominant u-form cause the transition to a new form of multidivisional character: m-form. the x-form of organization (mixed or hybrid) denotes a combination of different structural forms (most frequently uform or m-form). 9 here, it is important to emphasize the existence of so called h-from of organization, which is peculiar to holding companies. 10 the organizational culture and structure as mechanisms setting employees’ behavior on the target course individuals enter enterprises with different motives, experience and values. these natural individual differences set the members of an organization on numerous and often divergent courses. since an enterprise has to set its employees’ behavior on the course of achieving its strategic goals, it has to develop mechanisms minimizing the differences between individuals in order to direct their efforts at common goals (o’ neil, beauvais and scholl, 2001, 131). the employees’ efforts are joined by organizational culture by means of coordination and control. on the other hand, organizational structure is a mechanism directing its employees’ behavior through common shared values, norms and other substantial elements. the importance and use of these mechanisms in the process of setting the organizational behavior on accomplishing strategic goals differ according to different factors, the most important of which according to j. w. o’neil, l. b. beauvais and r. w. scholl are: the level of the complexity of tasks performed by employees and the level of their graphical dispersion. what follows is a detailed argument discussion to support their attitude. organizations often face different problems related to informational uncertainty and lack of clarity caused by today’s turbulent and unpredictable environment. organizations with the employees performing complex tasks face challenges, which are by far more different than the ones faced by the organizations the employees of which perform simple and repetitive tasks. similarly, organizations with geographically dispersed employees face the problems different from the ones faced by the organizations the employees of which perform tasks in a closely shared environment. the difference becomes obvious especially in cases when dispersed organizational units are interdependent or when they are extremely mutually differentiated. complex tasks on one hand and geographical dispersion of employees on the other hand increase uncertainty and the lack of clarity and aggravate information exchange. according to o’neil, beauvais and scholl, the less processed the 8 qian,y, rronald, g and xu, c, coordination and experimentation in m-form and u-form organizations, journal of politicaleconomy, december, 2005., http://elsa.bearkeley.edu/~yqian/coordination%20 and%20experimentation.pdf. (accessed april, 2006). 9 http://www.stanford.edu/~jchong/articles/soc363a/willamson%20%20%multidivizional%structure.pdf (accessed march, 2006) 10 chandler, a, the functions of the h q unit in the multibuseness firm, strategic management journal, vol 12, 1991., p. 31-50., http://www.gsia.cmu.edu/bosch/bart.html (accessed february, 2006) delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 77 information is by an organization, the less probable is that the employees behave in a consistent way to accomplish strategic goals.11 organizational structure and culture are very important mechanisms for reducing the uncertainty and the lack of clarity, which makes employees actions on the field of accomplishing strategic goals more efficient and effective. however, despite different nature of their impacts on this field, it needs to be stressed that they are not mutually exclusive. in other words, the existence of the first mechanism does not imply that the other one is not necessary. namely, some organizations can be very structured and possess strong culture at the same time, where each of the mechanisms points to different aspects of task complexity and geographical dispersion. on the other hand, there are organizations which do not posses the basic structure or culture but they use other mechanisms for setting the employees’ behavior on the target course.12 the connection between culture and structure organizational culture impact on effectiveness and efficiency of doing business in enterprises is partly and indirectly realized through organizational structure, affecting its two dimensions in this way: formalization level needed for the purpose of coordination and decision centralization level (janicijevic, 1997, 180-182). organizational culture affects the organizational structure formalization level and its choice of coordination mechanism through its connection to uncertainty, changes and the risk (hofstede, 1991). namely, if the organizational structure contents involve the tolerance of risk and uncertainty, the level of organizational structure formalization will be lower and vice versaif organizational culture has deep-seated opposition to risk and uncertainty, the organizational structure level will be higher. the decision-making centralization level in an enterprise is affected by so called the power distance. in this connection, the power distance is, as defined by hofstede, the level at which the members of a culture accept the fact that the power is unequally distributed in the social system (hofstede, 1991). the power distance in organizational structure implies the high decision-making centralization level/ autocratic style of leadership/ while the low distance power implies decisionmaking decentralization /democratic style of leadership (janicijevic, 1997, 180 -182). operating through the given dimensions, organizational structure considerably affects the structural type of the enterprise. the connection between organizational culture and organizational structure types is shown in the table 4. table 4. the relationship between organizational culture and organizational structure types uncertainty avoidance/ formalization power distance/centralization high low high task culture / bureaucratic structure power culture/ enterprenurial culture low people culture/ professional structure task culture/inovative structure 11 oʹneil, j.w l., beauvais, b and scholl, r w, the use of organizational culture and structure to guide strategic behavior: an information processing perspective, the journal of behavior and applied management, winter/spring, vol. 2 (2), 2001, p.131. 12 ibid., p. 137. economic analysis (2010, vol. 43, no. 3-4, 70-86) 78 source: janicijevic, n.: organzaciona kultura – kolektivni um preduzeća, ekonomski fakultet, beograd, 1997, p. 182) hence, it is evident that organizational culture and structure are mutually connected. this connection is for the most part realized through two processes: culture institutionalization and structure legitimization. on one hand, culture institutionalization is the process in which assumptions, beliefs and values in enterprises are embedded in its structure. on the other hand, structure legitimization is accepting structure by employees because it conforms to their cultural assumptions, beliefs and values (janicijevic, 1997, 180182)13 characteristics of organizational structure and organizational culture in bosnian and herzegovinian enterprises14 the subject and goal of the research nowadays, the business environment is the source of a vast number of challenges and opportunities on one hand. on the other hand there are multiple threats which can have a negative impact on an enterprise business. hence, the basic task of todayʹs theory as well as practice is to monitor those trends and enterprise business adaptation in all segments of new demands. from the economic perspective, one has to be aware of the fact that the late 80-s and beginning of 90-s brought about the beginning of the transitional period form the socialist into the market economy not only for bosnia and herzegovina, but for many other countries, too. here, it is clear that bosnian enterprises have to make an additional effort in the field of their strategic positioning on the market. the biggest number of bosnian and herzegovinian enterprises entered the process of transition to the market economy with the dominant organizational culture type, which has proved to be an inefficient and ideologically motivated concept. hence, the imperative is to see to what level have the managers of bosnian enterprises managed to transform the structure into the form of the structure adequate for market business conditions in the transitional period. from that point on, dominant organizational structure type identification and its dimension analysis (here, formalization and centralization), which is one of the goals of this empirical study, could be a very important management system input in bosnian enterprises. the need to identify the dominant organizational culture types comes from its importance for adequate human resource control in the terms of achieving organizational goals. during the long process of transition, the human resource in bosnian enterprises has been disintegrated and degraded, and needs the ultimate restructuring. the new development and integration into systematic changes need to be motivated with cultural forms different from the present ones. in this context, there is a very important question to be 13 ibid., p. 183 -184. 14 this part of the work contains the results of the project under the name of „analysis of the level of coordination between organizational culture and structure in bosnian and herzegovinian enterprises“, which was approved and financially supported by the minsitry of education, science, culture and sport of the tuzla canton in bosnia and herzegovina. delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 79 askedwhich types of organizational culture determine the actual employees’ behavior in bosnian and herzegovinian enterprises? as already stated, organizational structure is a mechanism which sets the employees’ behavior on the courses which are not divergent. organizational culture is also a mechanism for setting the employees’ behavior on the target course via common values, norms and other forms of substantial elements. although each of the mechanisms is unique on its own for its influence on the individual employee’s behavior within an organization, they need to be compatible and coordinated. in this way, the mechanism would give a positive synergetic effect on business performance of an enterprise. starting from that point, aside from the identification of organizational culture and structure dominant types, it is imperative to identify the level of their compatibility in bosnian enterprises, which is one of the goals of this empirical study. the definition of the basic group, the research instruments and data processing the main group of this research is composed of one hundred enterprises dispersed on the bosnian territory and operating in different fields. for the research purpose questionnaires have been used as the main instrument for data collection. they were distributed to enterprise managers with a possibility of being filed in by the executive manager of each enterprise, or a member from the top-five group. ninety-four questionnaires were filled out and sent back to us, which was a satisfying result, considering the specimen. the questinnaire was designed according to the substantial elements of the subject research, in which for the most part, closed form questions were used. those were: a) questions with a choice of list answers b) questions with a choice of intensity answers. in the questions with the choice of intensity answers the likert’s type scale was used. one part of the questionnaire offered a possibility to express one’s opinion on a defined problem. the part of the questionnaire identifying the organizational culture types is based on the organizational culture typology, which was developed by handy (handy, 1995) relating to the harrison’s works. the descriptive analysis of a mutual connection between given data was used when processing it. the research results the research results show that 58.51% of the specimen enterprises have a functional organizational structure (u-form of the structure). this type of structure is an adequate organizational solution to small and medium businesses which produce one or a few homogenous products. namely, the growth and development of an enterprise imply the diversification of production and the extension of product assortment, expansion to new markets, orientation to different customers, which involves the type of organizational structure which is more developed than the functional one. in today’s dynamic and unpredictable business conditions, the u-form of the structure does not provide enough flexibility for an enterprise. keeping this fact in mind, the managers of bosnian enterprises should initiate the implementation of organizational restructuring, so that the u-form of the structure can change into one of the forms adequate for the new business conditions. however, the empirical research (see table 5 and figure 1) related to the use of the m-form as well as the use of the x-form, point to the tendency of the “transition” from the dominant u-form of the economic analysis (2010, vol. 43, no. 3-4, 70-86) 80 structure to the m-form of the structure, and possibly the transition to so called dual organizational structure, such as the matrix structure, which would be a satisfying solution taking into account the environment. the empirical research included four indicators of centralization or decentralization level in decision-making within an organization. the research results point to the following: the decisions in bosnian enterprises are for the most part made by the managers without involving or consulting the subordinate in the process. the average figure in this field is 3.36 with the standard deviation of 1.45, which points to a bigger variation of empirical research in the average value. however, by analyzing the table, one can see that 77.21% of the managers answered the questions with “i fully agree, “i agree” or “i partly agree”, which still points to a high centralization level. the subordinate are less involved in the process of setting the target goals (the average figure in this field is 3.27 with a standard deviation of about 1.41). the level of assigning tasks in the written form and the communication level by the top-down system in bosnian enterprises are more or less of the same intensity (the average figure is 3.4 with the standard deviation of about 1.46). table 5. organizational structure types in bosnian enterprises organizational structure type freq. % functional organizational structure (organization based on the type of job functions) 55 58,51 % teritorial organizational structure (organization oriented to the main markets) 10 10,64 % subject organizational structure (organizational structure oriented to products) 2 2,13 % buyer organizational structure (organization oriented to the main customers) 13 13,83 % project organizational structure 1 1,06 % matrix organizational structure (combination of functional and project) 3 3,19 % mixed organizational structure (two or more types of divisional units are combined on the same organizational level) 7 7,45 % hibrid organizational structure (function and division components are combined on the same level) 3 3,19 % source: the results of the empirical research the research results point to a relatively high use of certain formal control mechanisms in bosnian enterprises, such as respecting strict rules and precisely defined procedures (the average figure in this field is 3.37 with the standard deviation of 1.45). a less frequent use of the written task forms regulating employees’ behavior was traced (the average figure is 2.89 with the standard deviation of 1.41). the average figure of agreeing with the answer in which the formal control in the enterprise resides on the superior controlling all activities done by the subordinate is 3.61 with the standard deviation of 1.53. empirical research shows that the dominant type of organizational culture in bosnian enterprises is the role culture. its existence was found in 43, 66% of enterprises. however, one can notice that the task culture also has a big share, which is 30, 97%. the power culture (15, 44%) and people culture (9. 93%) are not characteristic for bosnian enterprises. delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 81 figure 1. organizational structure types in bosnian enterprises o rg an iz atio n al s tru c tu re ty p e 58,51% 10,64% 2,13% 13,83% 1,06% 3,19% 7,45% 3,19% functional organizational structure (organization based on the type of job functions) teritorial organizational structure (organization oriented to the main markets) subject organizational structure (organizational structure oriented to products) buyer organizational structure (organization oriented to the main customers) project organizational structure matrix organizational structure (combination of functional and project) mixed organizational structure (two or more types of divisional units are combined on the same organizational level) hibrid organizational structure (function and division components are combined on the same level) source: the results of the empirical research table 6. the centralization level in bosnian enterprises the level of agreeing/ disagreeing the level of centralization/ decentralization in an enterprise i fully agree i agree i partly agree i disagree i fully disagree 13 23 46 9 3 all decisions in the enterprise are made by the top managament, without involving or consulting the subordinate 13,82 % 24,46 % 48,93 % 9,57 % 3,19 % 3 34 48 4 5 the subordinate are not included into the process of setting organizational goals 3,19 % 36,17 % 51,06 % 4,25 % 5,31 % 11 26 48 9 0 the superior assign tasks in the written form 11,70 % 27,65 % 51,06 % 9,57 % 0 communication is strictlty made by the top-down system 19 28 29 8 10 (source: the results of the empirical research) taking into account the theoretical definition of the connection between organizational culture and organizational structure, according to which the role culture corresponds to a economic analysis (2010, vol. 43, no. 3-4, 70-86) 82 bureaucratic organization, one can say that there is a mutual influence between the organizational culture and organizational structure in bosnian enterprises. since the use of the u-form of organizational structure implies a relatively higher level of governing centralization and a higher level of respecting the rules and procedures by the top-down system, it also affects the formalization of human relations or the task culture development in an organization. however, there is an open possibility that the nature of the dominant organizational culture type in bosnian enterprises contributed to the adoption of the u-form of the structure. figure 2. the centralization level in bosnian enterprises) 0 10 20 30 40 50 60 i fully agree i agree i partly agree i disagree i fully disagree t he le ve l o f ag re ei ng / d is ag re ei ng the level of centralization/ decentralization in an enterprise all decisions in the enterprise are made by the top managament, without involving or consulting the subordinate the subordinate are not included into the process of setting organizational goals the superior assign tasks in the written form communication is strictlty made by the top-down system source: the results of the empirical research table 7. formalization level in bosnian enterprises the level of agreeing/ disagreeing formal control is based on: i fully agree i agree i partly agree i disagree i fully disagree 23 21 21 26 3 respecting strict rules and precisely defined procedures 24,46 % 22,34 % 22,34 % 27,65 % 3,19 % 10 23 26 17 18 a vast number of written documents regulating emloyeesʹ behavior 10,63 % 24,46 % 27,65 % 18,05 % 19,14 % 14 40 30 10 0 superior monitoring all activities of the subordinate 14,89 % 42,55 % 31,91 % 10,63 % 0 % source: the results of the empirical research delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 83 figure 3. formalization level in bosnian enterprises 0 5 10 15 20 25 30 35 40 45 i fully agree i agree i partly agree i disagree i fully disagree t he le ve l o f ag re ei ng / d is ag re ei ng the level of formalization respecting strict rules and precisely defined procedures a vast number of written documents regulating emloyees' behavior superior monitoring all activities of the subordinate source: the results of the empirical research table 8. organizational culture types in bosnian enterprises organizational culture type frequency (12 questions with 4 possible answers in the survey) percentage power culture 168 15,44% role culture 475 43,66% task culture 337 30,97% people culture 108 9,93% source: the results of the empirical research a relatively high presence of the task culture, which is characterized by individual creativity and entrepreneurial spirit in an organization, partly confirms an earlier stated possibility that there is the transition from the dominant u-form to the m-form in bosnian enterprises. thus, it is possible to identify a mutual connection between organizational culture and organizational structure in this field: on one hand, organizational task culture involves the introduction of a more flexible structural form; on the other hand the “transition” of the organizational structure from rigid to more innovative forms implies the development of the task culture. economic analysis (2010, vol. 43, no. 3-4, 70-86) 84 figure 4. organizational culture types in bosnian enterprises 15,44% 43,66% 30,97% 9,93% organizational culture type power culture role culture task culture people culture source: the results of the empirical research conclusion the organizational structure and culture are effective mechanisms setting and integrating their employees’ behavior on the target course, so that they can be more efficient and effective in performing and accomplishing organizational goals. theoretical and empirical researches show that the organizational structure and organizational culture are interdependent. the interdependence is for the greatest part manifested in two processes: culture institutionalization and structure legitimating. the institutionalization of culture is a process in which cultural elements, such as assumptions, beliefs and values are entailed into the structure of an enterprise. structure legitimating is a process in which the structure gets accepted by the employees, because it conforms to their cultural assumptions, beliefs and values. the results of the empirical research made in bosnian enterprises show that the dominant type of the organizational structure is the u-form of the structure. the form is characterized by a high centralization level of decision-making and a high level of behavior formalization. hence, it is often identified with the bureaucratic organization. the results also show that the role culture is the dominant organizational culture type in bosnian enterprises, which points to a high level of its interdependence with the organizational culture. the results of the research in these fields are partly compatible with the results of the research by hofstede. namely, he classified the ex yugoslavian countries into the group of countries characterized by a high level of power distance and a high level of uncertainty avoidance. this could explain a relatively high centralization level in bosnian enterprises. however, a less frequent use of written documents regulating employees’ behavior (the average figure is 2.89 with the delic, a., et al., the organizational structure, ea (2010, vol. 43, no, 3-4, 70-86) 85 standard deviation of 1.41), and a relatively big share of the task culture in bosnian enterprise (30, 97%) show that the formalization of relations in these enterprises is still average. this can be explained with a possible collective national culture impact on the development of informal relations between organization members, which is compatible with the results of the researches made in serbia (janicijevic, 2003, p-p 45-63). it is natural though that the empirical research the results of which have been presented has its limitations. namely, it needs to be taken into account that the research results would be more objective if the questionnaire had not only included the top managers but the subordinate in bosnian enterprises as well (this went beyond the researchers’ possibilities, since 94 enterprises were included). the instrumentarium based on handy’s culture classification used for the purpose of identifying organizational culture types was quite simple in the terms of the complexity of the organizational culture phenomenon. references alvesson, m and karreman, d. 2001. odd couple: making sense of the curious concept of knowledge management, journal of management studies, vol.38, no.7. alvesson, m. 2002. understanding organizational culture, sage, london. chandler, a. 1991. the functions of the h q unit in the multibuseness firm, strategic management journal, vol 12, (http://www.gsia.cmu.edu/bosch/bart.html (accessed february, 2006) clayton, b, fisher, t, bateman, a, brown, m and harris, r, organizational culture and structure, http://consortiumresearchprogram.net.au/html/images/stories/documents/ru4literview_section2.p df (accessed february, 2010) daft, r l. 1995. organization theory & design, fift edition, weat publishing company. deal, t e and kennedy, a a. 1982. corporate culture: 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2001.the use of organizational culture and structure to guide strategic behavior: an information processing perspective, the journal of behavior and aplled management, winter/spring, vol. 2 (2). parry, k and proctor-thomson, s. 2003. leadership, culture and performance: the case of the new zealand public sector’, journal of change management, vol.3, iss.4, pearce, a j and robinson, r d. 1997. formulation, implementation and control of competitive strategy, sixth edition, irwin, chikago qian,y, rronald, g and xu, c, coordination and experimentation in m-form and u-form organizations, journal of political economy, december, 2005., http://elsa.bearkeley.edu/~yqian/coordination%20 and%20experimentation.pdf.(accessed april, 2006.). schein e. 2001.organizational culture and leadership, in classics of organization theory, shafritz, j, and ott, j s, eds. fortress worth: harcourt college publishers. schein, e. 2004. organizational culture and leadership, 3 rd ed, jossey-bass, san francisco. schein, e. 1999. the corporate culture survival guide: sense and nonsense about culture change, jossey-bass, san francisco. thompson, j d. 1966. organization in action, new york, mcgraw-hill,. received: 17 june 2010 article history: accepted: 2 september 2010 ea_2014_1-2 udc: 005.334 ; 005.521:334.7 jel: d49, m31 id: 207712524 professional paper suspension of managerial decisions in relation to the risks in the business todorović brankica1, school of economics, uzice, serbia abstract – this paper analyzes the importance of the elasticity of managerial decisions in different territories on the example of coca-cola hellenic group (cch group). suspension of managerial decisions is an important part of the product life cycle. previous studies have indicated the price elasticity different approaches depending on the life cycle stage through which the product moves. bearing in mind the business risks and “sensitivity” consumer prices, cch group 's own market divided into three segments: the country in which the sale has been established, developing and emerging countries. on the basis of this division is made portfolio marketing mix, in order to find "the right product at the right time in the right location at the right price". in addition to achieving the economic benefits to the countries it operates in, the company generates direct, indirect and induced impact on economic development. key words: elasticity, market segments, risks introduction "coca-cola" is produced in the world since 1886, and in serbia since 1997. the cch group is one of the largest bottlers of non-alcoholic ready-to-drink beverages in europe, operating in 28 countries. for more than 120 years of product sales "coca-cola" observed the movement that corresponds to the concept of product life cycle. however, doing business in different countries points to the need for the concept of product life cycle and resilience management decisions supplement the risk analysis of countries in which it operates. today's sale under a number of country risk, ranging from political, economic, social to financial. in emerging and developing countries, are subject to the risks of operating which include potential political and economic uncertainty, government debt crises, application of exchange controls, reliance on foreign investment, nationalization or expropriation, crime and lack of law enforcement, political insurrection, terrorism, religious unrest, external interference, currency fluctuations and changes in government policy. 1 bdanica@neobee.net todorović, b., risks in the business, ea (2014, vol. 47, no, 1-2, 160-172) 161 financial risks of operating in emerging and developing countries include risks of liquidity, inflation, devaluation, price volatility, volatile energy prices, currency convertibility and transferability, country default and austerity measures resulting from significant deficits as well as other factors. the cch group has a balanced mix of markets, including more mature in its established markets and developing countries and markets with high-growth potential in its emerging countries. this balance allows to minimise external financing of its long-term growth and limit its exposure to the effects of potential economic or political instability in some of territories . based on established a strategic tool which is called ''obppc'' (occasion, brand, price, package, channel), achieved sales growth. in addition to the economic benefits realized and the impact on the country in which they carried on. it is the direct, indirect and induced impacts on employment growth and gdp. effects of production groups is reflected in the provision of public goods in a socially responsible activities. elasticity of managerial decision-part life cycle of the product analytical aspects of theoretical assumptions about the life cycle of products in the market based on the premise that the product life cycle is a function that in each period t ≥ 0 (0 indicates the time of launch of the product on the market), the intensity of reflected achieved sales of products on the market, expressed in quantitative or indicative values. the life cycle of the product can be used to predict the demand, as well as to compare different brands of similar products (hatton, 2000). if the company understands the process of product development and market that is able to handle the product in a proactive manner (levitt, 1962). the typical s curve shows the relationship of the concept of sales over time. with the appearance of products on the market, increasing sales and profit because they invest in products and sales channels. unit profits are increasing in the growth and decline, due to competitive pressure in the maturity stage (levitt, 1965). if the level is determined by the sale, then the life cycle stage of the life cycle stages that can be used to explain the sale level (hunt, 1983). the traditional concept of product life cycle ignores the competition and the fact that sales of products function marketing (wind & claycamp, 1976). sales growth declines over time, why should monitor demand trends, techniques and competitors (wiersema, 1982). generally, scholars agree that the price of the product varies due to the different elasticity at certain stages of the life cycle of product (dean, 1950). however, about the size of prices in certain phases of the life cycle, there are different views: 1) product price should be higher in the initial stages of the life cycle mickwitz (1959) first pointed to the fact that management decisions need to be flexible and different as the product moves from one stage of the life cycle to another. empirical testing of this hypothesis comes from parsons (1975). the conclusions of the testing, supports the theory mickwitz the elasticity of demand varies over time. economic analysis (2014, vol. 47, no. 1-2, 160-172) 162 management activities should be higher in the first years of the product life cycle, which prevents penetration imitative products. dino (1985) identified three stages of the fall in prices of electronic products: market launch, growth and maturity. the relationship between the product and the price, and can be represented as follows: new product introduction rate should be as high as possible with intensive promotional activity; product price is reduced movement of products through different phases due to the pressure of competition and the stage of saturation of the product, the market price is formed as a standard and as such must be accepted by buyers and sellers (schafter&roper, 1985). 2) the price of the product reaches a minimum at the stage of maturity the analysis of 43 german product, simon (1979) has established a dynamic model of sales, according to which the price elasticity decreases in the introduction stage and growth, reaches a minimum at the stage of maturity and increases in the stage of decline. that the price of the product has a minimum value in stage of maturity indicated macmillan (1982). the cost of advertising and promotion are the most important at this stage. sales can not expand the market without additional marketing efforts and loyal customers. 3) prices are falling at various stages of the life cycle, and in the later stages can be increased (wernerfelt, 1985). identical conclusion came karnani (1984) based on an analysis of market share in the various stages of the product life cycle. product is essential to build market share as early as possible in the growth phase because the value of shares in market fell most at this stage. reduction of the share is slower in the later stages. markets of the cch group the cch group has primary responsibility for controls, the customer relationships and route to market in each of its territories and develops and implements its own sales and marketing strategy in each of its relevant territories in a formula: availability; affordability; acceptability; activation and attitude (prospectus, 2012). availability means placing the cch group’s range of products within easy reach of consumers in the "right" package, in the "right" location, at the "right" time. affordability means offering a wide variety of desirable, premium quality products, in packages appropriate for the occasion, at the "right" price. in doing so, the cch group aims to reach as many consumers as possible while taking into account the differing levels of purchasing power in the territories in which it operates. acceptability means supplying an extensive and growing range of products that meet the highest quality standards in each country, enhancing their acceptability to consumers. activation means motivating consumers to choose the cch group’s products by improving product availability and attractiveness at the point of purchase and by building brand strength in its local markets. the cch group achieves this in close cooperation with its customers through the placement of cold drink equipment, such as coolers and vending machines, the provision of todorović, b., risks in the business, ea (2014, vol. 47, no, 1-2, 160-172) 163 signage and other point of sale materials and the implementation of local marketing and promotional initiatives. attitude is about the way the cch group’s sales representatives and its people behave every day in their interactions with the customers ensuring that the cch group meets their needs with an objective to become a preferred supplier. the cch group divides its territories in which it operates into three reporting segments2: 1) established countries, which are italy, greece, austria, the republic of ireland, northern ireland, switzerland and cyprus; these countries have traditionally enjoyed a relatively high degree of political and economic stability and have broadly similar economic characteristics. they typically exhibit higher levels of disposable income per capita relative to the cch group’s developing and emerging countries, which enhances the affordability of the cch group’s products, especially its more profitable single-serve packages designed for immediate consumption. 2) developing countries, which are poland, hungary, the czech republic, croatia, lithuania, latvia, estonia, slovakia and slovenia; all of the cch group’s developing countries have market-oriented economies. the developing countries generally have lower disposable income per capita than its established countries and continue to be exposed to economic volatility from time to time. the cch group’s developing countries are typically characterised by lower net sales revenue per unit case than in its established countries. tccc’s3 products were introduced in the early 1990s in most of the cch group’s developing countries, where they have since become established premium brands. in addition, consumers tend to be more price-sensitive in the cch group’s developing countries than in its established countries. consequently, the cch group’s products often face competition from local non-premium brands, which, in a number of cases, have been present in the market for many years and remain popular with consumers. 3) emerging countries, which are the russian federation, romania, nigeria, ukraine, bulgaria, serbia (including the republic of kosovo), montenegro, belarus, bosnia and herzegovina, armenia, moldova and macedonia. these territories are, according to the cch group, exposed to greater political and economic volatility and have lower per capita gdp than the developing or established countries. as a result, consumer demand in the this countries is especially price sensitive, making the affordability of the products even more important. the cch group seeks to promote its products through a strategic combination of revenue growth management, packaging and promotional programmes taking into account local economic conditions. 2 pages. 57-58, prospectus, 2012. 3 tccc (the coca cola company) is one of the largest independent bottler. tccc could exercise its rights under the bottlers’ agreements with the cch group in a manner that would make it difficult for the cch group to achieve its financial goals. for more details see "bottler's agreements" in part iv: "cch relationship with tccc, kar-tess holding and other related parties", page 118, prospectus, 2012. economic analysis (2014, vol. 47, no. 1-2, 160-172) 164 most of the cch group’s emerging countries are characterised on average by lower net sales revenue per unit case than its established and developing countries. the cch group believes that its emerging countries provide significant growth opportunities. some of the factors that influence these growth opportunities include relatively low consumption rates, population size (especially in the russian federation, nigeria and ukraine) and favourable demographic characteristics. like any company, coca-cola system depends on the economic environment in which it operates (see table 1). table 1. swot analysis of the market in the territories cch group s tr en g th s established countries the availability of a large number of products political and economic stability established countries o p p o rt u n it is developing countries brand products gdp growth political stability developing countries emerging countries the low price of the product household consumption size of countries and favorable demographic characteristics emerging countries w ea k n es se s established countries different preferences about consumer the financial crisis established countries t h re at s developing countries lower net income per unit of product the financial crisis developing countries emerging countries distribution system political and economic instability unemployment the financial crisis emerging countries macroeconomic conditions had been positive in the cch group’s developing countries in years prior to 2008, with all territories experiencing positive real gdp growth. however, economic growth has slowed or reversed in the last three years as a result of the global financial and credit crisis. in 2012 and 2011, gdp growth and unemployment stabilised in the cch group’s developing countries compared to 2010, when gdp growth declined and unemployment increased. currency fluctuations can have an impact on the cch group’s net sales revenue in its developing countries, particularly in times of high economic volatility. the cch group’s emerging countries were the first to be affected by the global financial and credit crisis of 2008. since then, the cch group has not experienced concrete and sustained evidence of recovery. todorović, b., risks in the business, ea (2014, vol. 47, no, 1-2, 160-172) 165 even though gdp appears to have stabilised and in some cases returned to growth in 2011 and 2012 in some of these territories, unemployment remained at relatively high levels and currencies were very volatile, particularly in the first half of 2012. the following table illustrates certain key economic indicators for the territories within each segment for the year ended 31 december 2012 (see table 2). table 2. economic indicators for the territories of cch group the cch group’s country total volume (million unit cases) country population (million) gdp per capita ($) established countries 670,9 90,7 35,609 developing countries 393,4 77,2 13,945 emerging countries 1.011,9 412,9 6,732 all territories 2.076,2 580,9 12,202 source: prospectus relating to coca-cola hbc ag (2012) a substantial proportion of the cch group’s operations, representing 61,6% of net sales revenue in the 2012, 61,4% in the 2011 and 57,7% in the 2010, is carried out in its emerging and developing countries (see table 3). table 3. the share of sales in the total sales to various territories (%) 2010. 2011. 2012. established countries 42,3 41,6 38,4 developing countries 16,9 17 16,3 emerging countries 40,8 41,4 45,3 source: prospectus relating to coca-cola hbc ag (2012) the largest increase in total sales from 2010 to 2012 was recorded in emerging countries. reduction of the share in sales of products the company recorded established countires (see figure 1). economic analysis (2014, vol. 47, no. 1-2, 160-172) 166 figure 1. the share of sales in the total sales to various territories (%) 42,3 41,6 38,4 16,9 17 16,3 40,8 41,4 45,3 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% but, although the decline, in recent years, the cch group has experienced significant growth in a number of its developing and emerging countries. as its business continues to grow and the level of its investment in such countries increases, is faced with the challenge of being able to attract and retain a sufficient number of qualified and experienced personnel in an increasingly competitive labour market. the company ability to sustain its growth in these countries may be hindered if it is unable to successfully meet this challenge. some of emerging and developing countries lack the institutional continuity and strong procedural and regulatory safeguards typical in its established countries. these risks are prevalent in the russian federation, nigeria and romania, which are the largest territories of the cch group’s emerging countries reporting segment in terms of volume. the lack of institutional continuity also exacerbates the effect of political uncertainty in the cch group’s emerging and developing countries, which in turn, could adversely affect the orderly operation of markets, consumer confidence and consumer purchasing power, thereby reducing the profitability and limiting its growth prospects in these emerging and developing countries. institutional uncertainty is a risk that is particularly pertinent to the russian federation and nigeria. problems in these countires also is in some emerging and developing countries where corruption can create a difficult business environment. portfolio marketing mix instruments in the territories in which it operates cch group the cch group offers its products in anrange of flavours and package combinations which vary from country to country. beverages are offered in both refillable and non todorović, b., risks in the business, ea (2014, vol. 47, no, 1-2, 160-172) 167 refillable packages and in a range of flavours designed to meet the demands of its consumers. the main packaging materials for the beverages are pet packaging, glass and cans. also, customers are offered fast food restaurants and other immediate consumption outlets with fountain products. this group produces, sells and distributes sparkling, still and water beverages in all of its territories. in the 2012, sparkling beverages accounted for 68% of the sales volume (coca-cola 41%, fanta 10%, sprite 7%, bonaqua 5% and nestea 5%). still and water beverages, principally, bonaqua, dorna and valser waters, cappy juices and powerade, together with nestea, accounted for approximately 32% of the sales volume. the cch group, together with tccc, conducts market analyses to better understand unique shoppers and purchase occasions in different trade channels. the principal focus has traditionally been on the core sparkling brands: coca-cola, coca-cola light, coca-cola zero, fanta and sprite, including the still drink categories of ready to drink tea, energy, juice, sport drinks and water. this full portfolio of products provides consumers with a range of choices to meet their refreshment, well-being, health and fitness needs. product portfolio refers to starting or acquiring new brands as the cch group has done in the past with dobry, nico and rich in the russian federation, bankia in bulgaria, rosa, next and su-voce in serbia, and lilia and lilia frizzante in italy. the most important trend generally affecting the future consumption channel in the cch group’s established countries is an increasing concentration of the retail sector. the cch group has taken initiatives to consolidate its production network by rationalising facilities, through consolidation, relocation of manufacturing lines, and streamlining of warehouses. the cch group’s business in italy encompasses the manufacture and distribution of the products of tccc, as well as water products of fonti del vulture s.r.l. across all of italy, excluding the island of sicily. in the greek combined still and water beverages category, where it is the leading producer of fruit juices with its amita and frulite brands in terms of sales volume and value. in the austria sparkling beverages portfolio includes mezzo mix and almdudler, a popular national sparkling beverage, as well as the energy drinks burn and monster. sparkling beverage brands in switzerland include ali and kinley, water category brands include valser mineral water, nestea ice teas, minute maid juices, powerade sports drinks and monster in the energy sub-category. mix of sparkling, still and water beverages provides the cch group with flexibility to address the changing preferences and tastes of swiss consumers. in the hotel, restaurant and cafe channel, representing nearly 40% of the swiss volume, the distribution system for nonalcoholic ready-to-drink beverages relies primarily on wholesalers that are highly concentrated. the strategy in the republic of ireland and northern ireland has been to diversify its portfolio of sparkling, still and water beverages. the cch group’s brands in the juice subcategory include fruice, pure juice and oasis. in developing countries consumers in these markets have shown an increasing interest in branded beverages associated with well-being and fitness, such as water and juices. cch economic analysis (2014, vol. 47, no. 1-2, 160-172) 168 group is committed to maximising these opportunities by introducing existing and new products, flavours and packages in both the future consumption and the immediate consumption channels. poland is the cch group’s largest developing country in terms of both population and sales volume. the portfolio of water brands in poland includes kropla beskidu and multivita kropla mineralow, whilst its portfolio of energy brands was enlarged with the addition of the monster brand. the cch group has invested in cold drink equipment, an upgrade of its aseptic line to improve production reliability and reduce costs, a new environmentally friendly water bottle and new sparkling beverages packages were introduced. hungary is the largest bottler of non-alcoholic ready-to-drink beverages. the cch group’s sparkling beverages brands in hungary include kinley and lift, while still and water beverages brands include naturaqua mineral water and naturaqua emotion (flavoured water). the cch group distributes a portfolio of premium spirits, including brown-forman, bacardi martini products and a hungarian spirit called r´ezangyal. in some of the cch group emerging countries, consumers are showing particular interest in juices and branded waters. in general, the cch group’s emerging countries have a relatively undeveloped distribution infrastructure and a fragmented retail sector. the cch group produces and sells in the russian federation other products of tccc, such as popular local brands fruktime and dobry lemonade, as well as schweppes-branded mixer products, "kruzhka i bochka", which is a traditional malted beverage called "kvass" and juice brands in the russian federation include rich and dobry. the cch group’s sparkling beverage brands in nigeria include a range of schweppes products and limca. still beverages category brands include eva bottled water, dorna water, schweppes-branded mixer products, cappy juices and nestea ice tea, burn energy drinks and illy cafe. in all territories group develops strong relationships with its customers by combining market, consumer and shopper insights with execution at the point of sale. the cch group supports such market execution by conducting regular customer satisfaction surveys which assess its competence using a variety of measures, from supply chain reliability, sales force effectiveness, delivery of strong product and marketing promotions, through to overall responsiveness and issues resolution. also works closely with tccc to execute coordinated brand and commercial strategies for each of its established, developing and emerging countries. the cch group seeks to integrate consumer marketing and sponsorship activities with its retail promotions. at the same time, these sponsorship initiatives complement the cch group’s local initiatives, which involve active participation of events, from musical and entertainment promotions to cultural and festive occasions and variety of national celebrations. todorović, b., risks in the business, ea (2014, vol. 47, no, 1-2, 160-172) 169 impact of business policy cch group on economic development of serbia which is part of developing countries coca-cola hellenic serbia is located in zemun and occupies an area of about 65.000 m2. coca-cola beverage products to local bottlers of coca-cola hellenic serbia, which buys syrup concentrate from coca-cola. the business is divided into three units: coca-cola hellenic serbia (soft drinks), vlasinka (mineral water) and fresh&co (soft drinks and fruit juices). product portfolio includes leading global brands such as coca-cola, coca-cola zero, fanta, sprite, schweppes, nestea, burn and ultra energy, then local brands such as rosa, next, su-fruit and joy. the bottling plant employs local workforce and generates revenue directly at the factory, but also supports employment, income and tax revenue throughout the economy by purchasing goods and services from suppliers and selling their products through a widely diversified distribution network (including hotels, restaurants and supermarkets) where a large part of the revenue depends on the consumption of coca-cola products. therefore, the influence of coca-cola on the development of serbia is seen as: direct (associated with the coca-cola system), indirect (associated with trade partners and suppliers) and induced (related to household consumption) (table 4). table 4. direct and indirect contribution to the "coca cola" development of serbia type of impact amount number of employees in the coca-cola system direct 1.300 the number of jobs in the economy thanks to jobs in the coca-cola system (ratio 1:13) indirect 18.500 local procurement indirect 69 million euros tax direct 3 million euros bdp direct 345 million euros source: „socio-economic impact of the coca-cola system in serbia4“ (2011) coca-cola system employs 1.300 people and indirectly provides work for 18.500 people in the serbian economy (or 0,62 percent of the total workforce in serbia). the sectors that are closely related to coca-cola hellenic serbia as sugar production, transport and trade. the cost of sugar companies are associated with 450 jobs in sugar production, and indirectly with 110 jobs in agriculture. transport of raw materials and transport finished products relating to 200 jobs. traders involved in the sale of coca-cola products to consumers, bind to 13.000 jobs: 11.000 jobs in the horeca sector (direct consumption) and 2.000 jobs in retail (deferred consumption). value added per worker realizes that coca-cola is above the national average. direct value added coca-cola system is 25 million (0,08 percent of gdp) and is connected to the 345 million euros of added value for the serbian economy (or 1,18 percent of gdp). coca-cola paid 3 million euros in taxes makes 1,6 percent of total tax revenue serbia. 4 the study "socio-economic impact of the coca-cola system in serbia" is based on an economic model that consists of "pulling" to the balance sheet of coca-cola system in tables and means of production in the various branches of the serbian economy. economic analysis (2014, vol. 47, no. 1-2, 160-172) 170 in addition it provides, ''private goods to consumers in the form of soft drinks, coca-cola also provides "public goods'' in serbia as a whole, regardless of whether the inhabitants of serbia buy the products or not. these public goods appear in various forms, but include social responsibility activities in areas such as environmental protection, education, assistance to socially vulnerable groups, promoting an active lifestyle and sponsorship of local activities including sports and cultural events. conclusion the company's operations in different parts of the world is influenced by a large number of opportunities and threats. within certain groups of countries appear different risks so that the need for a comprehensive market analysis of individual countries to make their business more secure. market segmentation allows a deeper analysis of market access company and customer needs. in relation to the identified risks form the price of the product and make decisions about the types of products and distribution methods, in which the reflected and flexibility of management decision in relation to market segments. the existence of flexibility in management decisions, leading 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(2007). customer relationship management-competitiveness improvement tool. economic analysis. 40(3-4): 1-7. economic analysis (2014, vol. 47, no. 1-2, 160-172) 172 elastičnost menadžerskih odluka u odnosu na rizike u poslovanju rezime – ovaj rad analizira značaj elastičnosti menadžerskih odluka na različitim teritorijama na primeru coca-cola hellenic grupe (cch grupe). elastičnost menadžerskih odluka je važan segment životnog ciklusa proizvoda. dosadašnje studije su ukazivale na različite pristupe cenovne elastičnosti u zavisnosti od faze životnog ciklusa kroz koju se proizvod kreće. imajuću u vidu poslovne rizike i “senzitivnost” potrošača na cene, cch group je svoje tržište podelila na tri segmenta: zemlje u kojima je razvijena prodaja, zemlje u kojima se razvija prodaja i zemlje u kojima je prodaja nerazvijena. na osnovu ove podele izrađen je portfolio instrumenata marketing miksa, kako bi se pravi proizvod našao u pravo vreme na pravoj lokaciji po pravoj ceni. ostvarivanjem ekonomske koristi u zemljama u kojima posluje, kompanija utiče direktno, indirektno i indukovano na privredni razvoj. ključne reči: elastičnost, tržišni segmenti, rizici article history: received: 22 february 2014 accepted: 12 march 2014 ea_2013_3-4 finalna ver scientific review convergence instruments of western balkan countries tomljanović marko1, faculty of economics, university of rijeka, rijeka, croatia kandžija tomislav, county of primorje and gorski kotar, rijeka, croatia kandžija jelena, attorney at law, zagreb, croatia udc: 339.923:061.1eu ; 339.96(4-672eu:4-15) jel: e0, r0, o4 id: 203725580 abstract – the fundamental objective of the eu regional policy is to reduce differences in development between regions in europe. eu is directing structural funds to the regions which need help, and in that way eu helps to raise the level of employment and living standards. financing is based on 4 main principles of regional policy. for the candidate countries are intended the preaccession instrument ipa. candidate countries have problems in using that intended resources due to inefficient public administration. new member countries allocate the majority of resources from the esf (european social fund), erdf(european regional development fund) and the cohesion fund, with special emphasis on growth, employment and european territorial cooperation. these objectives also form the basis of the financial perspective 2014. 2020. during that financial perspective the total amount for regional policy in eu budget will be near to 32%. key words: eu, erdf, esf, cohesion fund, regional policy, convergence, western balkan countries introduction western balkan countries were affected by political and war turbulences in early 90s, and that situation largely determined their further economic development. these countries, characterized by economic and social crisis, are searching for a way to improve living standard population. also, fundamental objective of these countries is accession to the eu. in the accession, these countries must use the pre-accession funds. also, it is very important to examine the allocation experience of new eu member countries. recent trends in the european union, marked by several rounds of enlargement, have led to regional disparities and the growing gap between developed and underdeveloped regions and counties. to reduce these regional disparities it is necessary to introduce the concept of regional policies and instruments of implementation. the preamble of the treaty establishing the european community (also known as the treaty of rome) called for the strengthening of the economy in europe and ensures the harmonious development by reducing the differences existing between the various regions, and concern for the less developed regions. implementation of regional policy objectives is achieved through 4 main instruments: erdf, esf and cohesion fund. pre-accession instrument ipa (instrument for pre-accession assistance) is available for candidate countries of the western balkan. 1 adress: venuccieve stube 11, 51000 rijeka, e-mail: mtomljanovic98@gmail.com economic analysis (2013, vol. 46, no. 3-4, 37-51) 38 this paper aims to define basic characteristics and instruments of eu regional policy, analyze financial perspective 2014-2020 and to show the level of exploitation of the structural funds and pre-accession programs in new member countries, candidate countries and potential candidate countries from western balkan. eu regional policy regional policy is an instrument of encouraging adaptation to new developments and common policies, and includes financial support for projects of restructuring the problematic areas. reducing regional disparities is an essential condition for every economic and political progress of the eu. comparing the development of different regions, usually as a criteria is taken into account the value of gdp per capita, unemployment rate, etc. one of the most important objectives of the european union is to achieve economic and social cohesion. (kandžija; cvečić, 2008.) as general objectives, along with the already mentioned economic and social cohesion, can be defined also: (kandžija; cvečić, 2010.) • the representation of awareness of regional issues in other public policies; • coordination of regional policies in the countries; • providing financial instruments to encourage the development of less developed areas. the most important elements that negatively affect the achievement of these goals are: high concentration of economic activities and population in the central metropolitan areas; significant regional differences in the level of gdp and employment; limited availability of certain services in the regions and cities; socio-economic problems in remote and isolated areas. (belić, 2008.) regional policy is based on five main principles (kandžija; cvečić, 2010.) 1. concentrations: available resources are concentrate on regions whose gdp per capita does not exceed 75% of the eu average; 2. co-financing: member states of the structural funds must supplement national funds and loans from the european investment bank; 3. programming: the commission tries to focus national policy priorities with conditioned program of regional development; 4. partnership: all stages of policy implementation should be carried out in cooperation with national authorities, regional and local authorities and the relevant economic and social partners. 5. subsidiarity – deciding down to the level closest to the citizen. for quality establishment and implementation of regional policy, member states should establish a proper legal framework that assumes budgeting and financing for regional development. for the realisation of this condition it is necessary the functioning of the institutions in the member states that manage financial resources of funds. regional policy requires a high level of harmonization with other common policies such as social and market competition policy. (škabić – kersan, 2005.) tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 39 when development of different regions is compared, usually as criteria is taken in consideration the value of gdp per capita, unemployment rate, etc. indicators of development are observed at the level of the statistical regions nut, which are comparable in population across the eu. (bajo and alibegović, 2008.) table 1. categories of nuts (nomenclature of territorial units for statistics) regions according to population level minimum population maximum population nuts i 3 000 000 7 000 000 nuts ii 800 000 3 000 000 nuts iii 150 000 800 000 source: bajo, a., alibegović, j. 2008. according to the classification given in table 1. eu territory is divided into 92 regions nuts i, 269 nuts ii regions and 1 293 nuts iii regions. regional policy can be observed from two viewpoints. redistributive regional policy aims to reduce the developmental differences with a key role of the state. an active policy aims to encourage economic growth and competitiveness by recognizing endogenous development and solving the causes of unequal development. here is the key role of regional actors. (moussis, 2009.) the financing of regional policy is conducted with three funds: european regional development fund; european social fund; cohesion fund. structural funds finance multi-annual programs which make development strategy prepared in cooperation of regions, member states and the european commission. regional policy is a major user of the eu budget funds. that share reached, from initial value of the 11.5% (1984.) to a value of 32% in the financial initiative 2014th 2020. increasing regional disparities are reflected in the fact that 10% of the population live in the richest regions, which include 19% of eu27 gdp, while the poorest 10% includes 1.5% of gdp. (belić, 2008.) regional policy key goal is reducing regional disparities within the eu countries based on different rates of unemployment and the different heights of the gdp. achieving economic and social cohesion is a precondition for economic and social growth. 4. cohesion policy within the financial perspective 2014– 2020. cohesion and regional policy have been defined with the aim of reducing economic and social disparities between the member states by helping regional development. cohesion policy has contributed to prosperity in the eu. it has to become, considering the economic crisis, a driving force for economic development and competitiveness. cohesion policy has in the past 10 years directly helped the opening of more than one million jobs. from cohesion funds was also co-financed the construction of more than 2000 kilometres of highways and 4,000 kilometres of railway lines. cohesion fund also helped to establish around 800 000 small and medium-sized enterprises. figure 1. budget resources for cohesion policy in the previous budget period economic analysis (2013, vol. 46, no. 3-4, 37-51) 40 0 50 100 150 200 250 300 350 400 milijarde eura 1989. 1993. 1994. 1995. 2000. 2006. 2007. 2013. 2014. 2020. source: european commission, dg budget data from figure 1 shows the constant increase in funds for cohesion policy from the year 1989. to 2014. according to the european commission's proposal for the next seven-year budget period, for cohesion policy is intended up to 376 billion euros. for direct support of the development and competitiveness of all european regions are aimed the remaining 336 billion euros. total amount for cohesion policy will be aimed at slightly more than 32% of the european budget. table 2. structure of the cohesion policy in the period of 2007. 2013. 2007. – 2013. operative goals erdf i esf convergence abandonment of convergence cohesion fund regional competitiveness and employment erdf i esf european territorial cooperation erdf source: european commission, dg budget european commission has proposed a number of important changes in the design and implementation of cohesion policy: focusing on the priorities of smart, sustainable and inclusive growth in europe 2020; rewarding success; support for integrated programming process; focus on results monitoring to achieve agreed objectives; strengthening territorial cohesion; simplification of execution. tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 41 table 3. cohesion policy structure for the period from 2014 to 2020 2014. – 2020. ultimate goals categories of regions fund investment in growth and jobs less developed regions erdf i esf transition regions cohesion fund developed regions erdf i esf european territorial cooperation erdf source: european commission, dg budget unlike the previous budget period, within the perspective of the 2014-2020., number of targets is reduced and the focus is put entirely on growth and employment, and european territorial cooperation. according to the proposal of the european commission, 162,6 billion euros, (48,3% of the total), is intended for regions with gdp per capita below 75% of the european average. this category includes all three croatian statistical regions. for the more developed regions, whose gdp is above 90% of the european average, is planned 53,1 billion euros (15.7%). the european commission has introduced a category for transition regions, whose gdp is between 75 and 90% of the european average and for them it provided 39 billion euros (11.6%) of the funds for cohesion policy. for territorial cooperation is intended 11.7 billion euros (3.48%), and for the cohesion fund 68.7 billion euros (20.4%) of which 10 billion is reserved for the transport network. amount of approximately one billion euros is planned for remote areas and regions with low population density (northern region). the most important instruments of cohesion policy in the financial perspective 2014th – 2020th are european regional development fund (erdf), european social fund (esf) and the cohesion fund. erdf aims to strengthen economic, social and territorial cohesion by removing imbalances between regions. the fund supports local and regional development focusing on the following areas: (omondi; pipero; napini, 2005.) • research, development and innovation; • improving access to information and communications technology; • climate change and the transition to a low-carbon; • business support to small and medium-sized enterprises; • general economic interest services; • telecommunications, energy and transportation infrastructure; • increasing institutional capacity and efficient public administration; • health, education and social infrastructure; • sustainable urban development. economic analysis (2013, vol. 46, no. 3-4, 37-51) 42 in more developed regions and those in transition, for example, at least 80% of erdf resources at national level must be allocated for energy efficiency and renewable energy, innovation, and to support small and medium enterprises. in less developed regions investment priorities are wider, reflecting higher demand for development. they must allocate at least 50% of erdf resources for energy efficiency and renewable energy, innovation and to support small and medium enterprises. the focus on sustainable urban development has also enhanced and it should be achieved by investing at least 5% of erdf resources. for innovative activities in the field of sustainable urban development from the erdf is allocated 0.2% of the annual budget. 50% of the funds intended for the most remote and rarely populated regions must be allocate to activities that contribute to the modernization and diversification of the economies of the region with special emphasis on research and innovation, information and communication technology, and competitiveness of small and medium enterprises. (belić, 2008) european social fund is the main eu financial instrument for investing in human resources. esf increases the employment opportunities for citizens, promote better education and it improves the situation of people at poverty risk. fund is focused on four thematic objectives: employment and support labour mobility; promoting social inclusion and combating poverty; investment in education, skills and lifelong learning; increasing institutional capacity and efficiency of public administration. at least 20% of the esf must be allocated for promoting social inclusion and combating poverty. programs must also concentrate funding on a limited number of priority investments to determine the details of each thematic goal. (kandžija; cvečić, 2008) cohesion fund (cohesion fund, cf) is financing projects which improve the environment and develop transport infrastructure within the trans-european transport networks. cohesion fund is open for greece, portugal and spain, and after 2004. for new member states. interventions that can be financed from the cohesion fund are: trans-european transport network (trans-european transport networks); transport infrastructure (outside the ten-t) contributing to environmentally sustainable urban and public transport, interoperability across the eu transport networks and encouraging inter-modal transport systems; environmental infrastructure in order to adopt eu standards for environmental protection; effective use of energy and renewable energy sources. (kandžija; cvečić, 2010) funds for the european territorial cooperation, within the framework of the financial perspective 2014th – 2020th can be allocated in the following way: 73.24% for cross-border cooperation; 20.78% for transnational cooperation; 5.98% for inter-regional cooperation. financial perspective 2014–2020 is focused on 11 thematic areas. these thematic areas are: 1. strengthening research, technological development and innovation; 2. increasing access, use and quality of information and communication technologies; 3. increase the competitiveness of small and medium-sized enterprises, agriculture and fisheries sectors; 4. supporting transition to a low carbon economy in all sectors; 5. adaptation to climate change, prevention and risk management; tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 43 6. environmental protection and promoting resource efficiency; 7. promoting sustainable transport; 8. promotion of employment and labour mobility; 9. promoting social inclusion and combating poverty; 10. investment in education, skills and lifelong learning; 11. strengthening institutional capacity and efficient public administration. allocation of european funds in western balkan candidate and potential candidate countries ipa is the main instrument for pre-accession assistance to candidate countries and potential candidates. ipa covers the period of 2007-2013 and it replaced previous assistance programs ispa, phare and sapard. ipa was established in 2007th by council regulation no. 1085/2006. the financial value of the seven-year period is 11.468 billion euros. allocation of funds to the beneficiary countries is contained in the multi-annual indicative financial framework adopted for a three year period. the main objective of the ipa is to help the candidate countries and potential candidate countries in the harmonization and implementation of the acquis communaitare and to prepare them for the use of structural funds. most of the funds are intended for turkey, croatia and bosnia. table 4. indicative amount of ipa funds allocated for the period 2011-2013 country amount planned (in mil €) croatia 430 iceland 28 macedonia 304,76 turkey 2586,9 albania 257,73 bih 314,22 montenegro 91,28 serbia 587 program for multiple users 520,97 cross – border cooperation 214,28 total 5538,75 source: www.safu.hr mentioned funds should act as a catalyst to encourage reforms in the potential member countries and to support the countries on the path to european integration. eu aid will have a direct impact on the daily lives of citizens by contributing to improvement of the rule of law, governance, social conditions and economic prosperity in a situation of global economic crisis which affected all the regions of europe. these countries have right to use the ipa funds until they become members of the eu. economic analysis (2013, vol. 46, no. 3-4, 37-51) 44 the european commission has earmarked for croatia the amount of 910,2 million euros in the period until 2012. table 5. ipa financial allocations for croatia in period of 200-2012 (amounts in millions of euros) ipa components 2007. 2008. 2009. 2010. 2011. 2012. transition assistance and institution building 49,6 45,4 45,6 39,5 39,9 40,9 cross – border cooperation 9,7 14,7 15,9 16,2 16,5 16,9 regional development 45 47,6 49,7 56,8 58,2 59,3 human resources development 11,4 12,7 14,2 15,7 16 16 rural development 25,5 25,6 25,8 26 26,5 27,3 total 141.2 146 151,2 154,2 157,1 160,4 sources: www.safu.hr the funds allocated to croatia trough the ipa program are growing from year to year, and for the year of 2012 the planned amount was up to 160,4 million of euros. the funds are directed primarily toward the transition assistance and institution building and regional development. table 6. implementation of ipa funds in croatia ipa component budget (mil of €) % contracted % granted ipa i. – 2007. 45 90% 50% ipa i. – 2008. 42 27% 20% ipa i. – 2009. 42 11% 11% ipa ii. – 2007. – 2009. 8 64% 36% ipa iii – 2008. – 2009. 143 29% 7% iii a transport 54 20% 4% iii b –environmental protection 54 25% 2% iii c – regional competitiveness 35 48% 20% ipa iv – 2007. – 2009. 38 71% 9% ipa v. – 2007. – 2009. 51 12% 0% total 512 35% 13% source: lejour; merver; verweij, 2010. the biggest problem in the croatian pre-accession period is inadequate public administration at all levels from the lowest operational level, which is characterized by lack of skills and knowledge, as well as lack of motivation and poor mobility of employees, up to the highest political levels, where there are individuals without the necessary management competence and knowledge. these difficulties resulted in contracting only slightly more than one third of the total funds available through the five ipa components. croatia is still facing with a regional underdevelopment, centralization and the key issue unprepared and insufficiently competitive economy and especially the sector of small and tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 45 medium enterprises. ipa founds should help the sector of small and medium enterprises to adapt and to strengthen their competitiveness, but only under the condition of good ability to use potential funds. (www.safu.hr) ipa funds granted to the republic of serbia for the period of 2007-2013 is shown in table 7. table 7. ipa funds granted to the republic of serbia for the period of 2007 2013 component 2007 2008 2009 2010 2011 2012 2013 transition assistance and institution building 181.4 179,4 182,5 186,2 190,5 190 203,1 cross – border cooperation 8,2 11,4 12,2 11,7 11,3 12,1 11,6 total 189,6 190,9 194,7 197,9 201,8 202,1 214,7 source: http://ec.europa.eu//regional-policy/sources/docgener/informat/serbia during the budget period from 2007. to 2013. in serbia were granted funding related to the use of ipa components i and ii, transition assistance, institution building and crossborder cooperation. total absorption of ipa funds in serbia is over 95%, which ranks serbia among states with the highest rate of utilization of ipa funds. signing the stabilization and association agreement (saa) is an important strategic step for bosnia and herzegovina on its path to eu membership. during a transitional period of six years, bosnia and herzegovina will improve its legislation towards the most important rules of the eu internal market table 8. the financial assistance to bosnia and herzegovina from ipa in period from 2007 to 2010 year program available granted % contracted 2007–2010 component i. transition assistance and institution building 295.279.276 165.695.785 56.11% 2007–2010 component ii. cross – border cooperation 10.319.302 4.766.385 46.19% source: http://ec.europa.eu//regional-policy/sources/docgener/informat/bosnia during the period from 2007 to 2009 for bosnia and herzegovina has been allocated the amount of about 266 million euros trough ipa funds, and for the period from 2010. to 2013. about 434.1 million euros. the total value of the current financial assistance within the first two components of ipa funds has shown that bosnia and herzegovina still has plenty to work on the development of its own institutional capacity. until now, bosnia and herzegovina has used about 50% of the approved budget, which shows a clear focus on the further process of strengthening their own capacity and further development of the institutional framework. these indicators provide a course of action for the development of bosnia and herzegovina. economic analysis (2013, vol. 46, no. 3-4, 37-51) 46 the next section outlines allocation of structural and cohesion funds in new member states: bulgaria, romania and slovenia. during the observed budgetary period the biggest resources were allocated in poland (67 billion euros). figure 8. allocation of eu cohesion funding 0 10000 20000 30000 40000 50000 60000 70000 milion euros belgium bulgaria czech republic denmark deutschland estonia ireland greece spain france italy cyprus latvia lithuania luxembourg hungary malta netherlands portugal poland romania slovenia slovakia finland sweden united kingdom source: regional policy – inforegio, 2011 during the study period, bulgaria allocated 6.8 billion euros. table 9. allocated resources in bulgaria from certain funds fund total erdf 3 205 132 218 esf 1 185 459 863 cohesion fund 2 283 036 163 source: european commission, directorate-general for regional policy bulgaria allocated majority of resources from erdf. figure 9. areas of bulgaria allocation from the erdf and the cohesion fund 0 5 10 15 20 25 30 35 % culture energy environmental protection and risk prevention information society investment and social infrastructure rtdi, invation and enterpreneurship transport urban and rural regeneration tourism source: http://ec.europa.eu//regional-policy/sources/docgener/informat/bulgaria tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 47 observing the direction of funds from the erdf and the cohesion fund, it is evident that bulgaria is focused on the areas of transportation, environmental protection and risk prevention and rtdi, innovation and entrepreneurship. figure 10. areas of bulgaria allocation from the esf 0 5 10 15 20 25 30 35 % improving access to employment and sustainability improving human capital improving social inclusion improving the adaptability of workers and enterprises reforms in employment and inclusion strengthening institutional capacity information society source: http://ec.europa.eu//regional-policy/sources/docgener/informat/bulgaria during the study period, bulgaria's budget from esf was focused in the areas of improving access to employment and inclusion, environmental protection and risk prevention, increasing the adaptability of workers and enterprises and strengthening institutional capacity. in the period from 2007 to 2013, romania allocated 21,5 billion euros from the eu structural funds. (table 10) table 10. allocated resources in romania from certain funds fund total erdf 7 739 813 871 esf 3 684 147 618 cohesion fund 6 552 423 028 source: european commission, directorate-general for regional policy romania allocated majority of resources from erdf. economic analysis (2013, vol. 46, no. 3-4, 37-51) 48 figure 11. areas of romania allocation from the erdf and cohesion fund 0 5 10 15 20 25 30 35 % culture energy environmental protection and risk prevention information society investment and social infrastructure rtdi, invation and enterpreneurship transport urban and rural regeneration tourism source: http://ec.europa.eu//regional-policy/sources/docgener/informat/romania majority of resources in romania were allocated for environmental protection and risk prevention, transportation and rtdi, innovation and entrepreneurship. figure 12. areas of romania allocation from the esf 0 5 10 15 20 25 30 35 % improving access to employment and sustainability improving human capital improving social inclusion improving the adaptability of workers and enterprises reforms in employment and inclusion strengthening institutional capacity tehnical assistance source: http://ec.europa.eu//regional-policy/sources/docgener/informat/romania in the observed period, romania's esf resources are largely allocated to the areas of improving human resources, improving adaptability of workers and enterprises and the improvement of access to employment and sustainability. during the study period, slovenia allocated 4,1 billion euros from eu structural funds. (table 11) tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 49 table 11. allocated resources in slovenia from certain funds fund total erdf 1 933 779 408 esf 755 699 370 cohesion fund 1 411 569 858 source: european commission, directorate-general for regional policy slovenia allocated majority of resources from erdf. figure 13. areas of slovenia allocation from the erdf and the cohesion fund 0 5 10 15 20 25 30 % culture energy environmental protection and risk prevention information society investment and social infrastructure rtdi, invation and enterpreneurship transport regeneration of the villages and towns tourism source: http://ec.europa.eu//regional-policy/sources/docgener/informat/slovenia most of the funds from the erdf and cohesion fund slovenia allocated to rtdi-areas, innovation and entrepreneurship, transportation and environmental protection and risk prevention. figure 14. areas of allocation of slovenia from the esf 0 5 10 15 20 25 30 35 40 45 % improving access to employment and sustainability improving human capital improving social inclusion improving the adaptability of workers and enterprises reforms in employment and inclusion strengthening institutional capacity technical assistance information society source: http://ec.europa.eu//regional-policy/sources/docgener/informat/slovenia economic analysis (2013, vol. 46, no. 3-4, 37-51) 50 most funds allocated from the esf, slovenia has focused in the areas of sustainability and improving access to employment, improving human resources and increasing the adaptability of workers and enterprises. conclusion regional policy is an instrument of encouraging adaptation to new development and common policies, and includes financial support for projects of restructuring the problematic areas. reducing regional disparities is an essential condition for every economic and political progress of the eu. financing of regional policy is conducted with three funds: european regional development fund; european social fund; cohesion fund. ipa is the main instrument for pre-accession assistance for candidate countries and potential candidates. ipa covers the period of 2007-2013 and it replaced previous assistance programs ispa, phare and sapard. the main objective of ipa is to help the candidate countries and potential candidate countries in the harmonization and implementation of the acquis communautaire and to prepare them for the use of structural funds. references omondi, r., and lo pipero, c., and napini, f. 2005. a guide to european union funding for ngosacessing europe' s largest donor.“ bruxelles: bruxelles ecas. kandžija, v., and cvečić, i. 2008. makrosustav europske unije. rijeka: ekonomski fakultet, sveučilište u rijeci. kandžija, v., and cvečić, i. 2010. ekonomika i poiltika eu. rijeka: ekonomski fakultet, sveučilište u rijeci. belić, m. 2008. eu fondovi – vodič kroz europske fondove 2008. – 2013. zagreb: novum. moussis, n. 2009. acess to european union – low, economics, policies. rixensort european study service. škabić – kersan, i. 2005. koliko je hrvatska spremna iskoristiti sredstva regionalne politike eu? – primjer istre. zagreb: zaklada friedrich ebert. bajo, a., and alibegović, d. 2008. javne financije lokalnih i regionalnih vlasti. zagreb: školska knjiga. lejour, a. and mervar, a. and verweij, g. 2010. „the economic effect of croatia´s accession to the eu“, economics discussion papers, the open-access, open assessment e-journal. samardžija v. 2003. croatia´s preparation for eu accession. global development network, southeast europe, wiiw. prokopova, a. 2006. „focus on eu funds – programmes, tools and goverment institutions“, seeeurope.net. investing in europe's future. 2010. „fifth report on economic, social and teritorial cohesion“.bruxelles: european commission. bošnjak, s. 2009. kohezijska politika eu i instrumenti njena razvoja. osijek: ekonomski fakultet osijek. http://ec.europa.eu//regional-policy/sources/docgener/informat/bulgaria. http://ec.europa.eu//regional-policy/sources/docgener/informat/slovenia. tomljanović, m., et al., convergence instruments, ea (2013, vol. 46, no. 3-4, 37-51) 51 http://ec.europa.eu//regional-policy/sources/docgener/informat/romania. http://ec.europa.eu//regional-policy/sources/docgener/informat/bosnia. http://ec.europa.eu//regional-policy/sources/docgener/informat/serbia. http://www.safu.hr/hr/primjeri-uspjesnih-eu-projekata-u-rh/projekti/. instrumenti konvergencije zapadnog balkana rezime – osnovni cilj regionalne politike koju sprovodi evropska unija je da se smanje razlike u razvoju između različitih regiona evrope. eu usmerava strukturne fondove ka regionima kojima je pomoć potrebna radi podizanja nivoa zaposlenosti i životnog standarda. finansiranje se zasniva na 4 osnovna principa regionalne politike. za zemlje koje su kandidati za pristupanje eu predviđeni su ipa fondovi. zemlje kandidati imaju problema u korišćenju dobijenih sredstava zbog neefikasne državne uprave. nove zemlje članice alociraju većinu sredstava iz esf (evropskih socijalnih fondova), errf (evropskih regionalnih razvojnih fondova) i kohezionog fonda sa posebnim akcentom na privredni rast, zaposlenost i evropsku regionalnu saradnju. ovi ciljevi ujedno čine osnovu finansijske perspective za period 2014-2020 godine. tokom tog perioda ukupan iznos sredstava predviđenih za regionalnu politiku će biti oko 32%. ključne reči:: eu, erdf, esf, kohezioni fond, regionalna politika, konvergencija, zemlje zapadnog balkana article history: received: 21 april 2013 accepted: 29 august 2013 doi: 10.28934/ea.22.55.1.pp63-75 original scientific paper stock markets integration between western europe and central and south-eastern europe: latest trends jelena minović18f* | irena janković2 | vlado kovačević3 1 institute of economic sciences, department for environmental economics, belgrade, serbia 2 university of belgrade, faculty of economics, department for economic policy and development, belgrade, serbia 3 institute for agricultural economics, 11060 belgrade, serbia abstract the aim of the paper is to examine the stock market integration between western europe and selected countries of central (austria, czech republic, poland, hungary, slovakia, and slovenia) and southeastern europe (greece, croatia, serbia, bosnia, bulgaria, and romania). in order to achieve this goal, we used a bivariate bekk model to obtain time-varying covariances and correlations for the period april 15, 2013 march 29, 2019. our results showed that austria has the highest degree of integration among countries in central europe, followed by the czech republic, poland and hungary. additionally, greece has the highest degree of integration among all countries in south-eastern europe, followed by romania, and croatia. thus, stock markets of central europe are more integrated with western europe than stock markets of south-eastern europe. key words: stock market integration, multivariate garch, bekk model, central europe, south-eastern europe jel classification: g15, f36, c32, c58, o16 introduction financial integration is a term used to explain the level and the strength of financial market connectedness across various markets. the higher connectedness usually results in the higher financial and broader economic integration of countries. more precisely, the connectedness measures are tracking the degree of co-movement of market returns and volatility behaviour within and across markets and asset classes. as in bracker et al. (1999), we interpret a greater degree of co-movement to reflect greater capital market integration. bekaert & harvey (1995) found that some emerging markets exhibit time-varying integration. while the integration of financial markets can bring benefits in the form of broader economic integration and connectedness of countries it in parallel may affect the investors’ portfolio choices. if “financial integration is high, the benefits of diversification may be reduced. the degrees of financial integration provide valuable insights into capital flows across countries and enhance awareness of market co-movements” (chen et al., 2014). the focus of analysis in this paper is financial integration between central and south-eastern europe (see) and western european stock markets. more developed european countries started * corresponding author, e-mail: jelena.minovic@ien.bg.ac.rs 64 economic analysis (2022, vol. 55, no. 1, 63-75) economic and monetary integration decades ago. as a result, significant convergence among interest rates, gdp growth rates and other macroeconomic indicators occurred in the pre-crisis period. after the global financial crises, 2007-2008, many unresolved disbalances came to surface that resulted in a debt crisis in the eurozone in 2010-2012. the adoption of the euro and unique monetary policy appeared to be insufficient for broader economic integration of euro area member states. further fiscal integration was necessary for a more stable economic and monetary union. as bekaert et al. (2013) showed “membership in the eu significantly lowered discount rates and expected earnings growth differentials across countries. in contrast, the adoption of the euro was not associated with increased integration”. the countries of central and south-eastern europe faced significant changes in the previous three decades. while central european countries shifted relatively fast from communism and social ownership to market oriented economies, the transition process was slower and more painful in a certain number of south-eastern european countries especially in the balkan region. while most of these countries developed bank-based financial systems, their financial markets developed to a certain extent allowing the measurement of co-movements and estimation of the level of financial integration. the stock market of central europe is characterised by greater depth and liquidity in comparison to south-eastern european countries. although balkan equity markets have been active for a relatively short period of time, consequently lacking in a substantial market depth regarding the listed companies and capitalisation, inflows of international portfolio investments and trading activity have still been increasing (syriopoulos, 2011). marjanović & đukić (2020) stand out that the western balkan region has been an attractive destination for foreign portfolio investment in recent years. the paper aims to examine the capital market integration for selected countries of central and south-eastern europe. to achieve this goal, we have followed the methodology of horvath & petrovski (2013). we used the bivariate bekk model to obtain time-varying covariance (comovements) and then correlations. we have selected the period from april 15, 2013, to march 29, 2019. for the countries of central europe we have investigated: austria, czech republic, poland, hungary, slovakia, and slovenia, and for south eastern europe we have selected: greece, croatia, serbia, bosnia, bulgaria, and romania. correlation between selected countries of southeastern europe and developed countries is found to be around zero, except for greece (average correlation coefficient is about 0.4), croatia whose average correlation coefficient is about 0.2, bulgaria (with an average correlation coefficient 0.1) and romania (with average correlation coefficient 0.3). this value of the correlation coefficient (integration) is still much lower in comparison to the selected central european countries (average value of the correlation coefficient is over 0.7 for austria, about 0.4 for hungary and poland and around 0.5 for the czech republic), except for slovakia and slovenia. on average, south-eastern european countries appeared to be less integrated with western europe than central european countries. the paper consists of five parts. the introduction is presented in the first section. a discussion of related literature is presented in the second section. the third section explains the research methodology and used data. the fourth section contains the results of the analysis, and discussion. the conclusion is presented in the fifth section. literature review horvath & petrovski (2013) examined the stock market integration between western europe and selected countries of central (the czech republic, poland and hungary) and south-eastern europe (macedonia, croatia and serbia). by estimating multivariate garch models in the period 2006-2011, they found a higher level of integration between western and central europe. the correlation between see stock markets and developed european markets was found to be zero. they also conclude that the crisis period did not significantly change the degree of stock market integration between investigated groups of countries. jelena minović, irena janković, vlado kovačević 65 tilfani et al. (2020) used dynamic analysis (or the detrended cross-correlation analysis, dcca) in order to investigate “the evolution of integration in central and eastern european stock markets”. they found that stock markets of “czech republic, hungary, croatia, poland and romania are most integrated, while some of eastern european stock markets such as bosnia, montenegro, serbia and slovakia are less integrated”. büttner & hayo (2011) analysed “the determinants of stock market integration among eu member states for the period 1999-2007”. these authors utilized “bivariate dcc-mgarch models to estimate dynamic conditional correlations between european stock markets”. further, they tried to explain the comovements by “interest rate spreads, exchange rate risk, market capitalisation, and business cycle synchronisation in a pooled ols model”. taking care of differences between euro area countries and old and new member states of the eu they evaluated the impact of the introduction of a common currency on financial market integration. they concluded that stock market integration processes are enhanced by the size of market capitalisation but impeded by fx risk between old member states in the eu and the euro area. interest rate spreads and business cycle synchronization, also help explaining equity market integration. chen et al. (2014) investigated the stock market integration between the frontier and leading markets over the period 2000–2011. they used time-series analysis and concluded that leading markets could granger-cause frontier markets. authors found the frontier markets' relationship with leading markets to be dependent on different regions' characteristics. they stressed that the global financial crisis had largely influenced the causality between the frontier and leading markets. chen (2018) investigated the comovements of “stock market returns of a group of 34 countries at the global and regional levels, simultaneously”. the author used a bayesian dynamic latent factor model. he compared the comovements between developed and emerging markets across regions and found the significance of different factors for the fluctuations of stock markets. he found the global factor to be an “important source of fluctuations for most markets and the regional factor as another important reason for the fluctuations in emerging markets, especially markets in south america and east asia regions, but not in most developed markets”. his results suggest “that the degree of a market's comovements with international stock markets is closely associated with its own country's integration into the global economy”. égert & kočenda (2007) analysed “comovements among three stock markets in central and eastern europe and interdependence, which may exist between western european and central eastern european” (cee) stock markets. these authors employed the var framework (granger causality tests) on the 5-minute tick intraday data for stock indices. their “results showed the bidirectional causality for returns as well as volatility series”. they found “no robust cointegration relationship for any of the stock index pairs or for any of the extended specifications”. fratzscher (2002) followed the integration process of stock markets in europe since the 1980s. by implementing a trivariate garch model with time-varying coefficients, he found that: european stock markets have become significantly integrated from 1996, that euro area got important position among global financial markets and finally, that european stock market integration is to a large extent explained by monetary unification and elimination of fx rate volatility. hardouvelis et al. (2006) examined whether the 1990s in europe, in parallel with regulatory harmonization, and the introduction of the single currency, were characterized by higher stock market integration. they concluded that a decrease in interest rates and inflation rates differentials coincided with higher stock market integration for analysed countries except for the uk that decided not to enter the euro area. kenourgios & samitas (2011) analyse “long-run relationships among five balkan emerging stock markets (turkey, romania, bulgaria, croatia, serbia), the united states, and three developed european markets (uk, germany, greece), during the period 2000–2009”. they confirm long-run cointegration between balkan markets within the region and globally. additionally, they 66 economic analysis (2022, vol. 55, no. 1, 63-75) implement “the ag-dcc multivariate garch model to capture the influence of the global financial crises on the correlation dynamics among developed and balkan stock markets”. they conclude that stock market dependence is heightened supporting the herding behaviour during the 2008 crisis. lean & teng (2013) examined “the financial integration of the u.s. and japan and two emerging economies china and india with the malaysian stock market”. they used “a dcc-mgarch approach to examine the correlations among these countries in a time-variant manner”. according to them, it was apparent that “financial integration between malaysia and china started to evolve in april 2004. strong financial integration between the stock markets in india and malaysia” was examined. on the other hand, “the volatility spillover effect from the us to malaysia ceased, especially in the short term. accordingly, the study suggests that in the long run, investors in malaysia could profit from diversifying their portfolios in china and japan relative to india and the u.s”. guidi & ugur (2014) investigated “the integration between south-eastern european stock markets (bulgaria, croatia, romania, slovenia and turkey) and their developed counterparts (germany, the uk and the usa)”. they analysed the period 2000-2013 and found static cointegration between see markets and the german and uk market (but not with the usa market). the dynamic cointegration analysis showed time-varying cointegration among the see and developed markets, especially during crisis. they conclude that diversification benefits did exist during the period that included crises, despite evidence of dynamic cointegration during most of the crisis period. al nasser & hajilee (2016) examined “stock market integration among five selected emerging stock markets (brazil, china, mexico, russia, and turkey) and the world’s major developed stock markets (the us, uk and germany)” in the period 2001-2014. they used “the bounds testing approach to cointegration and error-correction modelling to determine the shortand long-run relationship between emerging stock market returns and the returns of the developed stock markets”. their results indicate the existence of “short-run integration among stock markets in emerging countries and the developed markets”. however, the authors indicate that in the “longrun, stock price indices in all emerging countries show a significant relationship only with germany stock market index”. alotaibi & mishra (2017) assessed “the degree of stock market integration and gained insights on its variation through time for the six member countries of the gcc (bahrain, kuwait, oman, qatar, saudi arabia, and the united arab emirates)”. these authors developed an international financial integration index for gcc stock markets and analysed the period from june 2002 to october 2013. they utilized “an international asset pricing model of time-varying market integration and dcc-garch methodology”. authors showed that “there are wide ranges in the degree of integration for gcc stock markets and none of them appeared to be under complete segmentation”. they found that “trade openness, financial market development, turnover and oil revenue had a significant positive impact on the integration index of gcc stock markets. the global financial crisis had a significant negative impact on the integration index”. narayan et al. (2014) examined the “patterns and causes of stock market integration of selected emerging asian countries against the us, australia, china, and india for the period” 2001-2012. they used the “arma-dcc-garch framework to derive the correlations for 22 pairs of countries using daily, weekly, and monthly returns”. these authors found that the time-varying bilateral correlations were highly volatile. they suggest that apart from the global financial crises (20072009), the “underlying economic and financial conditions have also been responsible for the higher correlations between analysed stock markets”. syriopoulos (2011) examined “the dynamic interdependencies, linkages and causality effects between major balkan equity markets (romania, bulgaria, croatia, turkey, cyprus and greece) and developed equity markets (the us and germany)”. this author utilized error-correction vector autoregression models to investigate financial integration, causality effects and jelena minović, irena janković, vlado kovačević 67 cointegration vectors. his results show that “the balkan markets follow a common path of growth and become gradually more integrated with the mature international markets”. methodology and data data in this analysis we choose daily closing levels of following indices: the stoxx europe 600 index, atxprime (vienna stock exchange), px (prague stock exchange), bux (budapest stock exchange), wig (warsaw stock exchange), sax (bratislava stock exchange), sbitop (ljubljana stock exchange), atf (athens stock exchange), crobex (zagreb stock exchange), belex15 (belgrade stock exchange), birs (bosnian stock exchange), sofix (sofia stock exchange), and bet (bucharest stock exchange). “the stoxx europe 600 index represents large, mid and small capitalization companies across 17 countries of the european region: austria, belgium, denmark, finland, france, germany, ireland, italy, luxembourg, the netherlands, norway, poland, portugal, spain, sweden, switzerland, and the united kingdom”.9f1 similar to horvath and petrovski (2013), we have used the stoxx europe 600 index as the benchmark for developed european stock market movements. however, horvath and petrovski (2013) used data for the period 2006-2011, and instead of bosnian, they used the macedonian index. compared to paper by horvath and petrovski (2013), we have significantly expanded the scope of countries. while these authors used three countries from central and three countries from south-eastern europe, we have selected twelve countries for the period 2013-2019. the daily closing prices of the indices are chosen from april 15, 2013 to march 29, 2019. the source of data is the website: https://www.investing.com/indices/ (as in minović, 2022). we study the daily returns, which are represented by the logarithmic difference of prices using the equation: rt=(log(pt)-log(pt-1))x100, (1) where pt is the closing price of a stock index on a trading day t, and pt-1 is the closing price of a stock index on a trading day t-1. table 1 presents the key indicators of all observed stock exchanges, such as the year of establishment, market capitalization, and the relevant index. table 1. key indicators central europe austria czech republic hungary poland slovakia slovenia year of establishment 1771 1993 1990 1991 1991 1989 market capitalization (eurmill) 102,050 23,574 25,231 140,113 index atxprime px bux wig sax sbitop see greece croatia serbia bosnia bulgaria romania year of establishment 1876 1991 1992 2001 1997 1995 market capitalization (eurmill) 33,525 18,004 4,576 1,968 13,685 18,160 index atf crobex belex15 birs sofix bet source: federation of european securities exchanges statistics, december 2018; https://investopress.com/european-stock-exchanges; belgrade stock exchange; banja luka stock exchange; bratislava stock exchange; ljubljana stock exchange. 1 https://www.investing.com/indices/ https://www.investing.com/indices/major-indices https://investopress.com/european-stock-exchanges https://www.investing.com/indices/major-indices 68 economic analysis (2022, vol. 55, no. 1, 63-75) multivariate garch model: the bekk model “engle & kroner (1995) proposed a quadratic formulation for the parameters that ensured positive definiteness of conditional variance-covariance matrix ∑t, and this became known as the bekk model” (brooks et al. 2003). according to “this model, the number of parameters increased linearly with the number of assets. therefore this model is relatively covetous and suitable for a large set of assets” (de goeij and marquering, 2004). “the bekk model follows the following form: ' ' ' ' 0 0 1 1 1 1 , q pk k t ki t i t i ki ki t i ki k i k i c c a a b bε ε− − − = = = = ∑ = + + ∑∑∑ ∑∑ (2) where c0 is a lower triangular matrix, and aki and bki are 𝑁𝑁 × 𝑁𝑁 parameter matrices (hafner and herwartz, 2006). based on the symmetric parameterization of the model, ∑t is almost surely positive definite on provision that c0c0’ is positive definite” (tsay, 2005; minović, 2009). as proved by “engle and kroner (1995), the necessary condition for the covariance stationarity of the bekk model is that the eigenvalues, i.e., the characteristic roots of * * * * 1 1 1 1 ( ) ( ) q pk k ik ik ik ik i k i k a a b b = = = = ⊗ + ⊗∑∑ ∑∑ should be less than one in modulus”. “hence, the process can still render stationary even if there is an element with a value greater than one in the matrix. this condition is different from the stationary condition required by the univariate garch model, that is, the sum of arch and garch term has to be less than one” (minović, 2009). also, “the bekk model is not very flexible and can, therefore, be misinterpreted. however, if the covariance demonstrates a different degree of persistence than the volatilities, it is obvious that either the volatility or the covariance process can be misinterpreted” (baur, 2004; minović, 2009). using the mgarch model, we obtain time-varying variances and covariances between stock market returns. in this way, it is possible to calculate a time-varying correlation coefficient, i.e., conditional correlations defined by the following equation: ρ12,𝑡𝑡 = 𝜎𝜎12,𝑡𝑡 �𝜎𝜎11,𝑡𝑡𝜎𝜎22,𝑡𝑡 (3) where conditional variances are 𝜎𝜎11,𝑡𝑡, 𝜎𝜎22,𝑡𝑡, respectively, and conditional covariance is 𝜎𝜎12,𝑡𝑡. minović (2008) wrote about “application and diagnostic checking of multivariate garch models in serbian financial market”, while njegić et al. (2018) used three types of “bekk-garch models in order to analyses the dynamic nexus and bidirectional spillover effect between stocks and exchange rates in major emerging markets”. results and discussion table 2 presents the unit root results for the original series (logp) and their daily returns (ri,t). the augmented dickey-fuller (adf) test was used. the results in table 2 show that the original series in levels are not stationary, while daily returns are stationary. after obtaining the stationary return series, the volatility modeling of the same, followed by employing univariate garch models (for detail see minović, 2022). subsequently, the mgarch methodology (bekk model) was applied to calculate time-varying variances and covariances (equation (2)). then, using equation (3), all the time-varying correlation coefficients presented in figures 1 and 2 were calculated. jelena minović, irena janković, vlado kovačević 69 table 2. unit root tests adf europe (stoxx) austria (atxprime) czech republic (px) hungary (bux) poland (wig) slovakia (sax) slovenia (sbitop) logp -3.124 -2.099 -2.427 -2.380 -2.334 -2.320 -2.266 return -38.048 -35.686 -37.771 -38.150 -35.497 -44.806 -37.055 greece (atf) croatia (crobex) serbia (belex15) bosnia (birs) bulgaria (sofix) romania (bet) logp -1.575 -2.433 -2.072 0.155 -1.352 -2.603 return -22.506 -14.994 -35.711 -37.624 -37.351 -22.627 source: authors’ estimation note: critical value (at 5% level) is -3.413. schwarz's automatic selection of the lag length has been used for the unit root tests. figures 1 and 2 show the time-varying correlations for indices of selected central and southeastern european countries and the stoxx 600 indices. table a1 in appendix a presents descriptive statistics of stock market returns for all analysed indices. minović (2022) described possible causes of volatility decline or volatility increase for these analysed markets. the austrian index is found to have the highest volatility in the second and third quarters of 2015 (correlation ranges from 0.4 to 0.9), followed by the third quarter of 2016, while the stoxx 600 index had the highest volatility in the third quarter of 2015 and the second quarter of 2016. the czech index had higher volatility at the end of the third quarter of 2015, then in the first and third quarters of 2016. however, the largest variation of the correlation coefficient in the case of the czech republic was in the fourth quarter of 2017 (correlation ranges from 0.0 to over 0.7). the hungarian index had pronounced volatility over the whole observed period, however it was the highest in the third quarter of 2015. although the average value of the correlation coefficient for hungary is 0.4, there is a remarkably variable correlation starting from 0.1 to 0.7 in some periods. the polish index had strong volatility in the first quarter of 2014 and the third quarter of 2015. the average value of the correlation coefficient for poland is about 0.4, with the value of this coefficient was greatly varying in the first quarter of 2014 and the third quarter of 2016 (the value is 0.1 to 0.8). the slovak sax index had pronounced volatility, especially in the period around the first quarter of 2015. although the average value of the correlation coefficient for slovakia is about 0.0, a highly variable value of this coefficient was observed over the analysed period (from -0.4 to over 0.3). the slovenian index had the highest volatility at the end of the third quarter of 2015, while the largest variation in the correlation coefficient for slovenia was recorded just then and in the first quarter of 2018. the average value of the correlation coefficient is about 0.1, while this coefficient takes values from -0.05 to 0.4 in individual periods. the correlation coefficients for slovakia and slovenia are found to be the lowest among all central european countries analysed and in terms of values, are closer to the correlation coefficients characteristics of south-eastern europe. judging by the values of correlation coefficients, it can be said that all analysed markets of central european countries are integrated with the western european market with the exception of slovakia. 70 economic analysis (2022, vol. 55, no. 1, 63-75) austria czech republic hungary poland slovakia slovenia figure 1. time-varying correlations for central europe source: authors’ estimation the greek index showed strong volatility, especially in the third quarter of 2015. during this period, the correlation coefficient for greece varied from -0.2 to 0.6, although the average value of the correlation coefficient for greece for the whole observed period was about 0.4. the croatian index had the highest volatility in the second quarter of 2017 (then the correlation coefficient for croatia is negative). however, the correlation coefficient in the observed period varied greatly from negative values to positive values (from -0.2 to 0.6). the average value of the correlation coefficient for the whole observed period for croatia is around 0.2. high volatility of the serbian index was observed, with the highest volatility in the first quarter of 2019. the average value of the correlation coefficient for serbia is about 0.0 in the whole observed period. figure 3 shows a highly variable correlation coefficient for serbia, whose values range from -0.4 to 0.6 in individual periods. similar to the serbian index, the bosnian birs index is very volatile and also had the highest volatility in the first quarter of 2019. in addition, a variable property of the correlation coefficient for bosnia is observed, ranging from -0.5 to 0.4. the average value of the correlation coefficient for bosnia for the whole observed period was about 0.0. this result implies that the serbian and bosnian capital markets are not markets that are integrated with the western european market. the bulgarian index had strong volatility, especially in the third quarter of 2014 and the fourth quarter of 2016. the average value of the correlation coefficient for bulgaria was about 0.1 for the whole observed period. the value of the correlation coefficient for bulgaria varies greatly from -0.4 to 0.7. the volatility of the romanian index was highest at the end of the fourth quarter of 2018 and at the beginning of the first quarter of 2019. the average value of the correlation coefficient for the whole observed period for romania was about 0.3, while in figure 0.4 0.5 0.6 0.7 0.8 0.9 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_atxprime -0.2 0.0 0.2 0.4 0.6 0.8 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_px .0 .1 .2 .3 .4 .5 .6 .7 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_bux .0 .1 .2 .3 .4 .5 .6 .7 .8 .9 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_wig -.4 -.3 -.2 -.1 .0 .1 .2 .3 .4 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_sax -.1 .0 .1 .2 .3 .4 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_sbitop jelena minović, irena janković, vlado kovačević 71 2 one can observe a highly variable character of the correlation coefficient. the value of the correlation coefficient for romania ranges from -0.4 to 0.8. from the results obtained for southeastern europe, it can be concluded that the greek market is the most integrated with the western europe market among all other analysed southeast european markets. according to the level of integration, the romanian, croatian and bulgarian capital markets follow the greek market. greece croatia serbia bosnia bulgaria romania figure 2. time-varying correlations for south eastern europe source: authors’ estimation our results are in accordance with those of horvath & petrovski (2013), in that the degree of comovements between western and central europe was found to be higher than the degree of comovements between western and south-eastern europe. the correlation between selected countries of south-eastern europe and the developed countries is around zero, except for greece (average correlation coefficient is about 0.4), croatia whose average correlation coefficient is about 0.2, bulgaria (with an average correlation coefficient 0.1) and romania (with an average correlation coefficient of 0.3). this value of the correlation coefficient (integration) is still much lower than for the selected central european countries (average values of the correlation coefficient are over 0.7 for austria, around 0.4 for hungary and poland and around 0.5 for the czech republic), except for slovakia and slovenia. serbian, bosnian and slovakian stock markets are not significantly integrated with the western european market (with an average correlation coefficient 0.0). additionally, our results coincide with those of tilfani et al. (2020) about the stock markets of central and eastern european integration. -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_atf -.4 -.2 .0 .2 .4 .6 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_crobex -.4 -.2 .0 .2 .4 .6 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 corrrel_stoxx_belex15 -.6 -.4 -.2 .0 .2 .4 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 corrrel_stoxx_birs -.4 -.2 .0 .2 .4 .6 .8 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_sofix -0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0 ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i ii iii iv i 2013 2014 2015 2016 2017 2018 correl_stoxx_bet 72 economic analysis (2022, vol. 55, no. 1, 63-75) table 3. the average value of the correlation coefficient central europe austria (atxprime) czech republic (px) hungary (bux) poland (wig) slovakia (sax) slovenia (sbitop) aver. aver. correl. coeff. 0.74 0.51 0.41 0.43 0.03 0.10 0.37 see greece (atf) croatia (crobex) serbia (belex15) bosnia (birs) bulgaria (sofix) romania (bet) aver. aver. correl. coeff. 0.39 0.16 0.03 -0.06 0.11 0.25 0.15 source: authors’ calculation table 3 presents the average values of the correlation coefficients. the average correlation coefficient of the whole of central europe is much higher than the average correlation coefficient of southeast europe. from these results, it follows that the stock exchanges of central european countries are more integrated with western europe than the stock exchanges of southeast european countries. conclusion this paper examines the degree of stock market integration for selected central and southeastern european countries from april 15, 2013, to march 29, 2019. we followed the idea and methodology of horvath & petrovski (2013). for central europe (ce), we have selected the following countries: austria, czech republic, hungary, poland, slovakia, and slovenia, while for south-eastern europe (see) we have selected the following countries: greece, croatia, serbia, bosnia, bulgaria, and romania. to obtain the degree of individual market integration, conditional correlation coefficients were calculated for each selected country using the multivariate garch model, i.e., bivariate bekk. our results showed that austria (the correlation coefficient of 0.7) has the highest degree of integration among all countries in central europe, followed by the czech republic (the correlation coefficient is 0.5), poland and hungary (the correlation coefficient is 0.4). additionally, greece (the correlation coefficient is around 0.4) has the highest degree of integration among all countries in south-eastern europe, followed by romania (the correlation coefficient is around 0.3), and croatia (the correlation coefficient is around 0.2). this result could be due to greece's membership in the eurozone since 2001, which is not the case for the other see economies studied. it emphasizes the possible significance of shared monetary (currency) regimes in understanding capital market co-movements. in comparison to other economies in central europe like as austria, czech republic, poland, hungary, and slovenia, slovakia's stock exchange is less integrated with western europe (we) capital markets. this result could be due to slovakia's geographical, cultural, and institutional distance from western europe financial markets, which could lead to reluctance on the part of we investors to put their money into the slovakian economy. when we aggregated the correlation coefficients along the entire territory of central and southeastern europe, we found that the average value of this coefficient for central europe is around 0.4, while the average value of the coefficient for south-eastern europe is around 0.1. serbian, bosnian and slovakian stock markets are not significantly integrated with the western european market. we can conclude that the stock markets of central europe are more integrated than the stock markets of south-eastern europe. this result coincides with horvath & petrovski (2013) but covers a broader range of countries and a different time frame. our results about the stock markets of central europe integration coincide with tilfani et al. (2020). similarly to our results tilfani et al. (2020) found that serbian, bosnian and slovakian stock markets are less integrated. the research in this paper may be of benefit to potential portfolio investors looking to diversify their portfolios. the obtained results show that the conditional correlation coefficient is negative jelena minović, irena janković, vlado kovačević 73 in most cases, i.e., periods in the case of slovakia, serbia and bosnia. therefore, it can be concluded that these markets can potentially be good for portfolio diversification but taking into account the fact that see markets bear specific types of risks as well as political and strategic factors that could change investor market preferences. radišić (2011) states that without having the information necessary to plan a strategy for entering a foreign market (and therefore strategies for making an investment decision), it is impossible to imagine the realization of an investment by a portfolio investor. investors, on the other hand, would not be willing to invest in the shares of corporations if they were to be a part of a highly corruptive society (radišić, 2011). goel & budak (2006) emphasize that comprehensive reforms are needed in transition countries to reduce corruption, while estrin and uvalić (2013) state that government instability, frequent early elections, high unemployment rates, high public debt and poor economic recovery are factors which impede foreign investments in the balkan region. economic policymakers in see countries must make every effort to improve their performances and indicators to make their countries more attractive for investments (radišić, 2011). future research could extend over a longer period to include more countries. additionally, in future research, it is possible to use some other versions of the mgarch model instead of the bekk model. acknowledgements the authors acknowledge the financial support of the ministry of education, science and technological development of the republic of serbia. this paper was presented at the international scientific conference econometric modelling in economics and finance at the institute of economic sciences in belgrade in october 2019. we are grateful for the constructive and useful comments made by participants of this conference. references al nasser, omar m., and massomeh hajilee. 2016. 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"revisiting stock market integration in central and eastern european stock markets with a dynamic analysis." post-communist economies 32(5): 643-674. tsay, ruey s. 2005. analysis of financial time series. john wiley & sons, new jersey. jelena minović, irena janković, vlado kovačević 75 appendix table a1. descriptive statistics of stock market returns stoxx atxprime px bux wig sax sbitop mean 0.008 0.008 0.003 0.025 0.008 0.02 0.011 median 0.023 0.032 0.021 0.031 0.017 0.000 0.003 maximum 1.785 1.549 1.942 2.158 1.305 3.960 1.507 minimum -3.167 -2.865 -2.047 -2.718 -2.530 -4.052 -2.1060 std. dev. 0.408 0.450 0.362 0.453 0.397 0.474 0.326 skewness -0.527 -0.500 -0.461 -0.1200 -0.541 -0.005 -0.254 kurtosis 7.825 5.504 6.097 5.027 5.921 12.508 6.055 jarque-bera 1554.131 447.457 648.776 263.204 601.564 5586.649 595.553 prob. 0.000 0.000 0.000 0.000 0.000 0.000 0.000 obs. 1529 1477 1491 1480 1488 1483 1490 atf crobex belex15 birs sofix bet mean -0.014 -0.003 0.007 -0.003 0.012 0.012 median 0.039 0.000 0.003 0.000 0.007 0.017 maximum 5.098 0.994 1.217 2.235 2.449 2.961 minimum -7.764 -1.351 -1.739 -2.808 -2.057 -5.164 std. dev. 0.954 0.234 0.283 0.344 0.313 0.385 skewness -0.902 -0.486 -0.275 -0.465 0.076 -1.983 kurtosis 13.400 7.121 6.054 13.403 10.408 31.289 jarque-bera 6764.046 1107.717 602.028 6799.445 3378.740 50694.92 prob. 0.000 0.000 0.000 0.000 0.000 0.000 obs. 1457 1483 1501 1496 1477 1491 source: authors’ estimation article history: received: april 19, 2022 revised: june 3, 2022 accepted: june 14, 2022 doi: 10.28934/ea.21.54.2.pp118-127 preliminary report information and communication technology’s skills among the working population of serbia jelena banović1* | dejana pavlović1 1 institute of economic sciences, belgrade, serbia abstract major social shifts in the economy conditioned by information and communication technology (ict) have led to equal shifts in the labor market. in this paper, the use of ict skills in serbia is presented through an analysis of the microdata from the survey “the usage of information and communication technology on individuals/households in the republic of serbia for 2020”. results showed that internet users have increased in the last five years. according to results, in 2020, 78.4% of people between 16 and 74 used computers in the last three months. the number of unemployed who used a computer in 2020 was 83.6%, and the number of employed who used a computer was 92.7%. students used computers 99.8% in 2020. on the other hand, 96.3% of employed used the internet in 2020, while 89.2% of unemployed used internet at the same period. the use of e-government web services is almost present to the same extent among students, the employed and unemployed. unlike online shopping, students are most likely to use e-government services, even though the employed and unemployed both use online shopping equally. however, comparing statistical data, serbia is not at the european level in ict usage , which can significantly jeopardise individuals' position in the labor market. there are substantial distinctions between youth and older individuals, especially regarding advanced skills. this affects the creation of digital exclusion, which increases the lack of resources that can be employed in better-paid jobs. the main solution for solving the digital divide is education to ensure equal competitiveness for all individuals on the labor market. key words: ict skills, working population, serbia, labor market jel classification: j40, j64 introduction information and communication technology (ict) and digitization have led to rapid changes in all spheres of society – education, trade, international economy, and health, including significant changes in the labor market. ict skills are essential for every individual to learn and work while accessing information on the internet and finding reliable data. considering its role in the process of social transformation, ict creates new business opportunities and employment possibilities. the development of ict has conditioned faster changes in the labor market to which the working-age population must adjust. many authors say that the development of ict skills is one of the most critical factors for the growth of the european labor market (postula et al., 2021; herman 2020). the impact of ict on the labor market is primarily reflected in evolving business dynamics, changes in working conditions, and the skill requirements an individual must possess to perform a particular job. having ict skills allows individuals to carry out a manifold of work * corresponding author, e-mail: jelena.banovic@ien.bg.ac.rs jelena banović, dejana pavlović 119 related tasks. it enables them to communicate over online channels, find information and use a computer in general. since the internet assists with decision-making and problem-solving skills, multiple european countries are developing strategies to help individuals in the labor market to develop basic and advanced ict skills and internet and computer skills. ict skills have become a mandatory requirement for employment in today’s job market. moreover, possessing ict skills allows individuals to become more competitive in labor market. in contrast, a lack of these skills can reduce employment opportunities or result in a potential job loss. ict skills provide an opportunity to create new jobs and improve existing ones. still, they also undoubtedly have had an impact on the obsolescence of numerous positions and professions which ict has made redundant. despite its low-barrier access, benefits from information and communication technologies can remain untapped if the user does not have the needed skills and competencies to use ict. according to eurostat report, general developments in the labor force for people with an ict education (2021) labor force in eu that had an ict education was more than 2 million persons, and by 2020, this number increase to 2.9 million. around 2.7 million persons aged 15-74 in the eu were employed and in possession of an ict education, and 219.000 persons with ict education were unemployed. if we observe this situation according to the gender of respondents, eurostat report employed persons with an ict education by sex (2021) stated that men accounted an 82.8% of the 2.7 million persons in the eu who were employed and in possession of an ict education. women accounted for only 17.2% of labor force who were employed and with an ict education. if we observed the age of the respondents, 65.7% of employed individuals in the eu with ict education were aged from 15 to 34 years. a number of young populations with ict education from 2010. to 2020. was growing 2.7% per annum. if we observe a level of internet usage in the households in 2020, national statistical centers of different countries conduct a questionnaire created according to the eurostat methodology using of ict in households. data shows that that the highest percentage is in scandinavian countries, that are considered as a leader in using of ict and digital technologies – island has the biggest score – 98% of using the ict in households, the netherlands with 97%, finland 96%, sweden 94%. also, the united kingdom with 97%, slovenia, austria and lithuania and poland 90%, hungary on annual basis noted 88% and turkey 91%. surrounding countries shows that montenegro stated 80% in using of ict by household, north macedonia 79%, and bosnia & herzegovina 73% (eurostat, 2021). on the other hand, data for using of the internet by individuals in 2020. shows that dominant are scandinavian countries – island has 99% of using the internet by individuals, norway 98%, sweden and finland 97%. also, croatia noted 80% of individuals who use the internet, italy 81%, the czech republic 89%, bulgaria 74%, austria 89% and romania 85% of individuals. balkan countries have a lower percentage – north macedonia 84%, montenegro 79%, and bosnia & herzegovina 74%, and serbia 80%. (eurostat, 2021). the aim of this paper then is to analyze ict skills among all those active or inactive of working age in the labor market of the republic of serbia, with a focus on active and passive individuals on the labor market, by applying the results of cross-tabulation on microdata from survey ict usage by individuals. this survey is conducted annually by the statistical office of the republic of serbia, according to the eurostat methodology. data covers the territory of the republic of serbia, without ap kosovo & metohija. the reference period was three months before the telephone interview (yearbook of sors, 2021). the results of this paper will be useful for the implementation of future strategies in the field of employment and ict usage in the republic of serbia. literature review the digital economy is vital for innovation, economic growth, and employment. the spread of ict has had a major impact on the labor market as well as what digital skills are essential to 120 economic analysis (21, vol. 54, no. 2, 118-127) function in the workplace and in society. the impact of ict on the labor market is not universally the same by economy or sector (picatoste et al., 2018). according to valsamis et al, scandinavia is a world leader in digital development, while newer eu member states and southern european countries lag far behind. according to the european commission’s digital agenda for europe (2014), there has been a rapid rise in those who are online, yet almost 50% of all internet users have insufficient ict skills necessary to be competitive employees. the digital agenda also states that ict skills must be treated as a priority. therefore, a number of international strategies, policymakers and politicians have stressed the importance of digital skills to achieve competitiveness and sustainable goals (agenda 2030). according to an oecd 2014. report, ict skills among adults are of great importance as lacking such skills poses the biggest risk of losing one’s jobs in the current workforce transformation (oecd, 2014). the same report states that adults are most at risk, as a significant number of them do not have computer and internet skills, while youth are generally familiar with computers and have wider access to the internet at home (oecd, 2014). this highlights the potential skills mismatch between those who possess the strongest ict skills, namely young people, and those who use them in the workplace. according to bejaković and mrnjavac (2020), digitalization of the economy causes market polarization, which has thus caused an increase in demand for those who have digital skills to successfully perform tasks dictated by new technologies. in 2006, sung and ashton (2006) in their study of 294 employers in the uk, pointed out that the adoption of ict was vital in forming new work practices to allow for better communication, innovation, and support in the development of new products and services. murawski and bick (2017) pointed out that many authors have highlighted the impact of ict and digital transformation on external factors while neglecting the role of digital skills of the workforce in this process of change. in 2011, brynjolfsson and mcafee concluded that the pace of technological innovations is proliferating, along with the use of advanced software technologies, thus turning workers without basic digital skills obsolete. in 2000, the uk government launched a life-learning program to increase the employment rate by acquiring and improving digital skills (brown, 2000). however, it must be noted that although there is the strive for every individual to possess ict skills that is not always possible. there are significant gaps in maintaining basic or advanced skills, and they are most often related to the age, gender, demographic characteristics, and education of individuals in the labor market. this situation creates a significant digital exclusion. according to bejaković & mrnjavac (2020), it could also increase social exclusion due to a lack of technological resources to teach digital literacy to the poor or marginalized groups. in this case, these groups of people risk remaining unemployed or losing jobs because they are becoming uncompetitive in the labor market. when it comes to young people, authors state that they gain digital skills during formal and non-formal education (van dorsen, van dijk, 2014) and they manage well in the digital environment. however, youth employment is a global challenge. although they are a part of the digital environment, not all young people have the skills needed in the digital economy. young people in countries such as norway, finland, sweden, denmark, and canada record a high level of use of ict at home, but when it comes to using these technologies at work, the percentage is less than average (oecd, 2014). therefore, it is necessary to strengthen their capacities through education and training for them to enter the labor market as ict literate as possible. on the other hand, if we consider the gender of the individuals in the labor market, numerous studies have shown a large gap in ict literacy between the genders (hafkin, huyer 2007; moghaddam, 2009; wamala, 2012; perifanou, economides, 2020). women had less access to the internet and fewer internet skills than men, while their reasons for using the internet and computers were completely different (fallows, 2005). of course, this gap has narrowed over the years in developed countries, with slighter differences among the younger female population than the older female population. however, the majority of the 3.7 billion people that are not online are jelena banović, dejana pavlović 121 female. the digital gender gap is still present in developing countries, thus creating a strong need for addressing the digital gender divide. according to itu, on the global level, women and girls use the internet 12.5% less than men and boys. in underdeveloped countries, only 15% of women used the internet in 2019, compared to 86% of women in developed countries (itu, 2021). methodology our research is based on the microdata of the survey “the usage of information and communication technology on individuals/households in the republic of serbia for 2020”. the data is provided by the statistical office of the republic of serbia (sors) that carried out the first of such surveys in 2004. through a pilot survey. from 2006. to 2020, the survey was conducted annually following eurostat methodology. the usage of ict is performed either by telephone or in-person interview. the aim is to provide data on the usage of information and communication technologies among individuals/households and enterprises in the republic of serbia. the statistical office of the republic of serbia (sors) carried out the same survey in 2020, splitting it into two forms: one on individuals/households and another on enterprises. the target population consists of households in which at least one member is between 16 and 74 years of age who are collected in a two-phase, stratified sample.1 the three months preceding the telephone interview were taken to be the reference period, wherein the sample included 2800 households and 2800 individuals. furthermore, the survey was conducted based on a representative sample of 2800 households in the republic of serbia and whose response rate was 91.9% (2.574 households). the interview was done both by telephone but would allow for a third party to answer questions should the original interviewee be unavailable. there were a total of 2574 respondents, 1605 of whom were women and 969 men. by age, the majority were over the age of 55 (between 65 and 74 36.7% and between 55 and 64 22.2%). the smallest share was those between 16 to 34 years of age (roughly 13%). from all respondents, only 50.5% achieved a secondary-level education. of the total number of respondents, approximately 32% were employed and 16.7% unemployed (table 1). table 1. descriptive statistics number % income up to 300 euros 755 36.7% 300-600 euros 731 35.5% more than 600 euros 573 27.8% region belgrade 611 23.7% vojvodina 735 28.6% šumadija and western serbia 701 27.2% south and eastern serbia 527 20.5% age 16-24 151 5.9% 25-34 181 7% 35-44 319 12.4% 45-54 408 15.8% 55-64 571 22.2% 1 the data does not account for any representation from the autonomous province of kosovo. 122 economic analysis (21, vol. 54, no. 2, 118-127) 65-74 944 36.7% gender female 1,605 62.4% male 969 37.6% education level lower than secondary 432 16.8% secondary 1,300 50.5% tertiary 842 32.7% employment status employee 818 31.8% unemployed 430 16.7% student 52 2% other 1,274 49.5% total 2,574 100% source: statistical office of the republic of serbia (sors), 2020. since 2015, the usage of ict survey consists of on a comprehensive questionnaire grouped according to the following modules (statistical office of the republic of serbia-sors, 2015): ● module a: access to information and communication technologies; ● module b: use of computers and internet; ● module c: use of e-government; ● module d: use of e-commerce; ● module e: privacy and protection of personal data; ● module f: trust, security and privacy; ● module g: internet of smart devices; ● module h: respondent‘s socio-demographic background information. in our paper, through implementing a cross-tabulation, the data gathered was used to analyse differences in the ict compared against those who were actively employed and those who were officially unemployed. we are focused on the usage of computers, mobile/cellular phones and the internet (module a and b). module c of the same survey tabulates e-government usage, e-trade and e-skills. results according to the date of sors from 2020, the number of internet users increased in comparison with last 3 years. additional, in 2020 more than 3.800.000 people aged between 16 to 74 used computers in the last three months or 78.4% of them. comparing with last year, it is increased by more than 6.500 of individuals. in 2020, 72.4% of individuals used a computer, which is about 2 p.p. more than 2019. also, since 2018, the number of active internet users has increased among all regardless of whether the respondent was employed (both employee and self-employed), unemployed or a student. the most significant rise in usage may be noted among the unemployed, whose computer use grew from 74.6% in 2018 to 83.6% in 2020. and their active internet use grew from 79.0% to 89.2% in the same time. nevertheless, active internet use saw a substantial increase among the employed as well, growing from 89.7% to 96.3%. jelena banović, dejana pavlović 123 table 2. computer and internet users by employment status, 2018-2020. working population 2018 2019 2020 computer users (in the last 3 months) [%] total 70.7 71.9 72.4 employed 86.8 90.3 92.7 unemployed 74.6 77.1 83.6 students 100.0 100.0 99.8 other 44.0 45.3 52.3 internet users (in the last 3 months) [%] total 73.4 77.4 78.4 employed 89.7 93.3 96.3 unemployed 79.0 83.4 89.2 students 100.0 100.0 100.0 other 45.5 53.6 60.4 source: statistical office of the republic of serbia (sors), 2020. in serbia, according to the data from 2020 (sors, 2020), 81.3% of individuals never carried out learning activities over the internet, 6.5% of them doing online courses and 4% of individuals had communication with instructors or students using websites or portals. it can be seen in table 3 that unemployed are most likely to neither seek any online learning materials nor to do an online course. while the overall percentage remains high for all groups as relates to their ever having carried out learning activities on the internet, it remains lowest for students (60.2%). both employed and unemployed are also most likely to have never carried out learning activities on the internet (76.4%-employed and 84.5%-unemployed). table 3. use of the internet, 2020. questions of use of the internet employment status which of the following learning activities have you carried out over the internet for educational, private or professional purposes in the last three months? employee unemployed student other total doing an online course 8.1 5.7 17.1 4.3 6.5 finding online learning materials (audiovisual materials. online learning software. electronic textbooks...) 22.7 13.5 37.2 12.7 17.4 communication with instructors or students using websites or portals 4.9 3.0 9.6 3.3 4 never carried out learning activities over the internet 76.4 84.5 60.2 86.1 81.3 source: statistical office of the republic of serbia (sors), 2020. the unemployed are also the least likely to purchase items online, where 34% have never done so. on the question “which of the following activities did you perform over the internet for private purposes?” in the sample, 83.3% of unemployed stated that they are using the internet for telephoning/video calls, or 88% of unemployed sending messages via whatsapp, viber, skype. unemployed are not interested in selling a good or product online or within e-banking. while about 30% of students and employed individuals are using e-banking for private purposes. 124 economic analysis (21, vol. 54, no. 2, 118-127) according to data, 97% of students telephoned over the internet/video calls and 89.4% of students participate in social networks. students are the most likely to use the internet and other it as they have the highest percentage overall of use which may also be evidenced by their frequency of purchasing items online (table 4). this may be biased due to the fact that students skew younger, and youth has been raised in an environment in which online purchasing is a norm in the target country as opposed to purchasing in person or through other means. table 4. use of e-commerce, 2020. questions of use of the e-commerce employment status when did you last (for private purpose) buy? employee unemployed student other total in the last three months 47.7 36.7 61.5 21.5 36.1 more than three months ago (less than a year) 14.5 13.6 6.8 8.3 11.8 more than a year ago 7.4 15.8 11.8 5.9 9.1 never used it 30.3 34.0 19.8 64.3 43.0 source: statistical office of the republic of serbia (sors), 2020. according to the data 2020, more than 1.415.000 individuals use websites/apps of public authorities to obtain information. or to be more precisely, 34% of individuals obtain information from public authorities’ websites, 25.2% downloading/print official forms and 23.9% send completed forms. if we focused on individuals by employment status, both employed and unemployed benefit equally. according to data from 2020, 44.6% employed and 39.3% unemployed obtained information from public authorities’ websites, while in downloading/printing official forms and sending completed forms employees are larger users than students and unemployed persons (table 5). table 5. use of e-government, 2020. questions of use of the e-government employment status for which of the following public authorities’ services have you used the internet in the last 12 months? employee unemployed student other total obtaining information from public authorities websites 44.6 39.3 49.9 18.1 34 downloading/printing official forms 35.5 27.5 26.7 12.9 25.2 sending completed forms 33.9 26.7 25 11.7 23.9 source: statistical office of the republic of serbia (sors), 2020. discussion and conclusions most authors have adhered to the conclusion that developing digital skills is the most important indicator for both european and global labor market development, which might improve economic growth and macroeconomic factors. accordingly, international strategies, policymakers and politicians emphasize the importance of digital skills in order to achieve competitiveness and sustainable goals (agenda, 2030). our research conducted in the paper has focused on the characteristics of employed, unemployed and students, as well as to what extent they are users of ict skills. according to the micro-data (2020), students (i.e. youth), are more likely to be beneficiaries of the ict sector than either the employed and the unemployed. in serbia there is not a large number of studies focusing on usage of ict among the working population. one of them jelena banović, dejana pavlović 125 is research conducted in 2012. research on digital literacy evaluation was conducted within pharmacy based on a sample size of 1077 respondents (68% of them were employed within pharmacy and 32% were students) (lakic et al., 2012). the research indicated that digital literacy among students was significantly higher than that of the employed. when removing students from the data set and then comparing the employed and unemployed, there is no substantial difference found in computer and internet use. use of e-government web services is almost present to the same extent among students, the employed and unemployed. however, unlike online shopping, students are most likely to use egovernment services, even when the employed and unemployed both use online shopping equally. compared to eu countries, serbia lags behind them in using ict skills. regardless of their status in the labor market, there are substantial distinctions between youth and older individuals, especially when it comes to advanced skills. this affects the creation of digital exclusion, which in turn increases the lack of resources that can be employed in better paid jobs. those lacking digital skills are at a higher risk of remaining unemployed, or, when they do have a job, becoming unemployed, as not possessing digital skills makes them less competitive in the labor market. similar to the rest of the world, the ict sector is considered to be the most promising and fastest growing industry in serbia which sets the trend for competencies required from university graduates in serbia (anđelković-labrović et al. 2020). ict companies tend to recruit graduates who possess specialized knowledge in ict, management and economy, which calls for the implementation of multidisciplinary educational courses (fren 2020). accordingly, the digital serbia initiative states that careers in digital business require specialized knowledge in "data analysis, bioinformatics, cloud computing, the internet of things, machine learning, artificial intelligence, virtual reality, as well as management, finance, accounting, marketing and entrepreneurship" (dsi 2020). similarly, smes in serbia look for candidates with compound skills. these include ict skills, technical and social skills, foreign language skills, communication and negotiation skills as well as the willingness to work in a team and continuously improve one’s knowledge. therefore, in order to be competitive in the digital labour market, young graduates should develop a complex set of ict and soft skills which conform to employers' requirements. technological innovation has been growing in pace with the use of advanced software technologies, making those who do not have basic digital skills more likely to become redundant in a competitive labour market. life-learning programs have long been launched in developed eu countries in order to increase the employment rate through the acquisition and improvement of digital skills of individuals. therefore, in order for digital skills to be advanced, especially among the unemployed, training needs to be introduced by the government of the republic of serbia to ease entry into the labor market for the unemployed. acknowledgment this paper is a result of the research financed by the ministry of education, science and technological development of the republic of serbia. this paper is a result of the project “impact of ict on unemployment factors in spain and serbia a comparative analysis for practical recommendations” funded the science fund of the republic of serbia. references bejaković, p., mrnjavac, ž. 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(2007). women and gender in ict statistics and indicators for development. women’s empowerment and the information society: special issue, (4), 2. pp. 2541 moghaddam, g.g. (2009). information technology and gender gap: toward a global view. the electronic library, (28), 5. pp. 722-733. wamala, c. (2012). empowering women through ict. spider ict4d series no. 4. stockholm university. https://www.diva-portal.org/smash/get/diva2:506080/fulltext01.pdf anđelković-labrović, j., milinković, i., petrović, n., & kovačević, i. (2021). expected competencies from university graduates for employment in serbia. management: journal of sustainable business and management solutions in emerging economies. perifanou, m., economides, a. (2020). gender gap in digital skills in greece. proceedings of the 20th international rais conference on social sciences and humanities. pp. 21-26 fondacija za razvoj ekonomske nauke fren. (2020). analiza perspektivnih zanimanja u sektoru ikt-a. https://fren.org.rs/publikacija/analiza-perspektivnih-zanimanja-u-sektoru-ikta/ digital serbia initiative. (2020). master studies 4.0. https://www.dsi.rs/master-40-itbiznis/programi/ article history: received: december 9, 2021 accepted: december 28, 2021 https://www.diva-portal.org/smash/get/diva2:506080/fulltext01.pdf https://fren.org.rs/publikacija/analiza-perspektivnih-zanimanja-u-sektoru-ikt-a/ https://fren.org.rs/publikacija/analiza-perspektivnih-zanimanja-u-sektoru-ikt-a/ https://www.dsi.rs/master-40-it-biznis/programi/ https://www.dsi.rs/master-40-it-biznis/programi/ information and communication technology’s skills among the working population of serbia jelena banović10f* | dejana pavlović1 introduction literature review methodology results discussion and conclusions acknowledgment ea_2016_1-2 udc: 621.395.721:004.77]:336.71 336.717:336.745 jel: o312, o16, g21 cobiss.sr-id: 224800524 professional paper mobile money empowering people living at bottom of pyramid and boosting socio-economic development in a big way agrawal reena1, finance & accounting and entrepreneurship jaipuria institute of management, vineet khand, gomti nagar, lucknow, india abstract – hardly anyone would disagree that mobile money is an engine of financial inclusion and has the potential to outreach millions of people, living at the bottom of pyramid and those living in remote areas. the current study was taken up to investigate the impact of mobile money access on the people living at the bottom of pyramid. the aim was to: (1) understand the concept of mobile money, (2) explore the relevance of mobile money in economic growth, (3) capture the growth of mobile money worldwide, (4) explore the socio – economic impact of mobile money and (4) discuss vital insights for traditional financial institutions and policy makers. the study revealed that mobile money had positive impact on financial inclusion. it also enhanced the economic opportunities for the large unbanked population living at the bottom of pyramid. the increase in the mobile penetration and use of mobile internet, among the people living at the bottom of pyramid in the developing countries, clearly reflect at the potential of mobile money, in bringing the financially excluded in the economic mainstream and thus help in sustainable socio-economic development. key words: mobile money, financial inclusion, payments, remittances, socio-economic impact introduction as the age old traditional financial institutions fail to provide access to elementary banking services to millions of people living at the bottom of pyramid and people living in the remote areas. mobile money, a recent innovation by the technology companies, bridged the financial service access gap in a big way, consequently permitting socio-economic betterment particularly among the financially excluded groups in developing countries. as more and more people living at grass root level enthusiastically adopt ordinary mobile phone, smart phones and internet services, technology paved way for socio-economic 1 assistant professor, ph: +91-522-2394296, 97, fax: +91-522-2394295, email: reena.agarwal@jaipuria.ac.in, dr.agrawal.reena@gmail.com 16 economic analysis (2016, vol. 49, no. 1-2, 15-23) development in the developing countries. in this context the current research paper seeks to investigate the developmental role of mobile money. objective of study hardly anyone would disagree that mobile money is an engine of financial inclusion and has the potential to outreach millions of people, living in remote areas and also those living at the bottom of pyramid. the current study was taken up to investigate the impact of mobile money access on the people living at the bottom of pyramid. the aim was to: (1) understand the concept of mobile money, (2) explore the relevance of mobile money in economic growth, (3) capture the growth of mobile money worldwide, (4) explore the socio-economic impact of mobile money and (4) discuss vital insights for bankers and policy makers. research methodology this was an empirical research. the research was built on secondary sources of information. the facts and figures were collected from large number of publically available sources such as research papers, periodicals, and government documents, reports by private agencies, newspaper articles and websites. research implication the study provides useful insights to the traditional financial organization and will help them to envision tactics to benefit from the ongoing economic transformation. the study will enthuse the policy-maker to bring new reforms to stimulate financial outreach to through digital podia. the study will also give food for thought to the researchers and academicians, who can take up future research, to examine the impact of digitization on poverty reduction, employment generation and economic development. overview of literature financial inclusion plays a significant role in abating poverty. it empowers the underprivileged and provides them with an opportunity to save, invest, borrow, spend, have smooth consumption and insure against vulnerabilities in their lives (world bank, 2014). but, still enormous proportion of the population in developing countries, lacks access to the basic financial services (asli and klapper, 2012). inaccessibility to elementary financial and banking services, restricts the ability of the deprived groups to save, borrow, invest and take part in formal and informal economic mainstream activities, which aim at smoothing consumption and curtailing poverty (dupas and robinson, 2008). according to (hishigsuren, 2006) information, communication, and technology (ict) helped in creating branchless banks via mobiles, automated teller machines (atm), point-ofsale (pos) networks etc., consequently it facilitated improved outreach, quicker processing, reduced operational costs and increased customer satisfaction. ict served dual purpose sustainability and improved outreach to the poor (brynjolfsson and hitt, 2000). one facet of ict that has attracted maximum attention is, the efficacy of mobile phone in enhancing agrawal, r., mobile money, ea (2016, vol. 49, no. 1-2, 15-23) 17 financial inclusion and thereby, boosting economic growth (levine, 2005). in 2000 with the introduction of smart money, the world’s first electronic cash card linked to mobile phone, mobile payment services gained grip across countries and continents (ernst and young, 2014). the agent-based mobile money services provide mobile phone-enabled, person-to-person (p2p) payment, transfer of money, allows users to store money on their mobile phones in an electronic account and deposit or withdraw money at one of agent locations (hughes and lonie, 2007; morawczynski, 2008; mas and morawczynski, 2009; morawczynski, 2009; morawczynski and pickens 2009).millions of people use their phones as mobile wallets to receive and send payments , pay utility bills and purchase air time (wishart, 2006; mendes and alampay, 2007). mobile money is popular in remote areas and among migrant laborers for domestic and international remittances (kravtsov, 2013; owens, 2015). digital payment services like m-pesa, tigo pesa, airtel money, easypaisa, b kash are some of the prominent mobile money services which help in promoting financial inclusion as they process recurring, small-value high volume transactions distantly and provide a wideranging financial services, at near marginal cost. finding of the study the concept of mobile money mobile money (m-money) refers to a variety of financial services provided to the consumers via mobile phones. the services include transfers, savings, credits and billets (dolan, 2009 and oecd, 2006). it can be person-to-person transmission of funds either domestic or international, or person-to-business payment for goods and services through mobiles (dolan, 2009). according to (desai, 2010) a service can be classified as mobile money if the service allows : (i) bill payments, storage of value, p2p remittances and bulk payments, (ii) utilizes network of agents outside bank branches for cash in or cash out transactions, and (iii) customers are able to use the service without being previously banked. according to hope et al (2012), mobile money is an electronic payment system that enables remittance of money to and from an electronic account that can be accessed thru mobile. in person cash deposits and withdrawals are enabled through network of retail agents. mobile-money includes services such as remittance, micro-payments, purchase of air-time etc. being offered to the unbanked through mobile technology. growth in mobile money services the mobile money industry is growing rapidly. this growth has been largely driven by mobile network operators (mnos). davidson and pénicaud (2012) in their survey found that in the beginning of 2009, there were seventeen mobile money services for the un-banked worldwide; this number rose to one hundred and twenty three in april 2012, with another ninety three planning to launch. while according to desai (2012), there were one hundred and fifty live mobile money services for the un-banked in seventy two nations, forty one were launched in 2012. further, davidson and pénicaud (2012) also found that, in june 2011, the providers of mobile money services administered approximately one hundred and forty 18 economic analysis (2016, vol. 49, no. 1-2, 15-23) two million transactions. of these, about thirty million were payments: payment of utility bills, bulk payments and transfers. the remaining transactions comprised of cash in, cash out, and airtime top ups. during the first six months of 2011, the volume of transactions administered on a monthly basis by mobile money service providers increased at annualized rates of fifty nine percent and thirty six percent respectively. rapid growth is expected in both the value and the volume of mobile payments transactions worldwide, with nonbanking organizations accounting for enormous growing proportions (ernst and young, 2014). socio-economic impact of mobile money services it has been documented that there is a positive relationship between mobile money adoption and financial inclusion (bold et. al., 2012; porteous, 2006; jenkins, 2008; ehrbeck et al., 2012). according to jenkins (2008) “it is mobile money’s ability to facilitate financial inclusion that gives it its enormous potential for development impact……….financial inclusion being the precondition for effective economic participation ……..to being able to integrate one’s small business with large market players”. the erstwhile studies revealed that the adoption of basic mobile phones, enhanced the economic opportunities for the large unbanked population and can bring sustainable growth in the region (bishop et. al., 1999; adb, 2003; butler, 2005; elijah & ogunlade, 2006; ssewanyana, 2007; business week, 2007; srivastava, 2008; etim, 2011, 2012; economist, 2012;). mobile money has been identified as a feasible tool to provide basic financial services to millions of unbanked populations in living in urban and rural areas. mobile money created a relatively cheaper and more accessible electronic payment ecosystem that has broadened and deepened the financial service sector. more importantly, an effective agent network ensured that more people are financially included by increasing the number of access points for transactions, and plummeting the transaction cost, particularly in remote areas. a critical success factor for the mobile money was the spread of ubiquitous agents, so that consumers could transact safely and easily, close to their home or work place. the numerous other economic benefits that accrued were: it augments commerce and trade; it facilitates microfinance, it offer ease of remittance, it provides safe and secure alternative to hard currency and plastic money. so one of the most significant impact is the change in the pattern of remittances (mbiti and weil, 2011). apart from enhancing financial inclusion and increasing e-commerce there were job creation, financial empowerment and reduction of cost of transaction. by bypassing banks and other financial institutions that charged fees on money transfers, the system could save money that could be channelized to other ventures. remittances are a lynchpin between families and communities at home and economic migrants. together official and informal transmittals, played momentous role in augmenting human capital growth, by facilitating underprivileged peoples to meet trivial financial needs (desai, 2010; porter, 2009). the benefits of mobile money stretch beyond individual and family levels to companies and societies. aker et al. (2010) revealed that the distribution of financial assistance under the welfare schemes, for people to cope with adverse condition, was executed economically thru mobile money, in comparison to the conventional expensive mechanisms of transfer. they argued mobile money was convenient and inexpensive. jack and suri (2014) found that right agrawal, r., mobile money, ea (2016, vol. 49, no. 1-2, 15-23) 19 to use mobile money services enabled risk sharing by considerably decreasing the costs of remittances amongst family and friends. they found that households which subscribed to mobile money service were able to cushion themselves against consumption volatilities when struck by income shocks, by receiving remittances from a wide pool of members in their social networks. discussion financial exclusion is a major impediment to growth in developing countries (schumpeter, 1912; king and levine, 1993; and levine, 1997). a sizeable number of people in developing nations, are rural dwellers who seldom have access to banking services, in spite of their huge dependence on transmittals from economic migrants for social security and poverty mitigation. therefore there is a terrible need for the expansion of an effective mechanism for remittance of funds particularly for people who dwell in remote areas. the development of mobile money (m-money) has significantly facilitated access to finance through the mobile platform, and has the largest rate of adoption all over the world, especially in the developing countries. mobile money has had a positive qualitative and quantitative socio-economic impact on many of the world’s poor, it continues to meet a broad spectrum of base user needs from directly creating revenue generation opportunities to indirectly supporting survival. the merits of mobile money come from the efficacy of the services delivered through the digital route. store of value and means of remittance without reliance on cash, is beneficial when security is an issue. remittances, both within political boundaries and across nations is crucial in most developing nations, because of the migrant labor force. given the low level of personal disposable income particularly for the people living at the bottom of the pyramid, meaningful financial inclusion will be restrained, short of social government-to-person (g2p) cash transmissions. government should use mobile money services to transfer benefits of social cash transfer schemes directly to the beneficiary`s mobile. this will reduce the cost of payment, make deliveries efficient and convenient for recipients and would also prevent the pilferages. using these services would enhance development benefits in the society (bold et al. 2012). the ubiquity of mobile phones, allow the un-banked to have access to basic banking services through mobile, making mobile phones play the role of “branchless bank” (jack and suri, 2011; martinez and mckay, 2011). it is therefore imperative that traditional financial institutions, work in partnership with mobile network operators, to deliver mobile based basic financial services (jenkins, 2008) to the unbanked people. at the same time the policy makers and the regulators constantly need bring desirable policy and regulatory reforms to stimulate financial outreach through digital podia to the people living at the bottom of pyramid, to accomplish financial inclusion and poverty alleviation and ensure sustainable development (ehrbeck et. al., 2012). conclusion the current study was taken up to investigate the impact of mobile money access on the people living at the bottom of pyramid. the study revealed that mobile money had positive 20 economic analysis (2016, vol. 49, no. 1-2, 15-23) impact on financial inclusion. it also enhanced the economic opportunities for the large unbanked population living at the bottom of pyramid. the same way as mobile phones changed the face of telecom connectivity, they hold the potential to transform the financial inclusion landscape. with the unique attributes such as low cost, ease of use, scalability and ubiquity, when aligned with the right business model in an enabling ecosystem, can truly accelerate the integration of the un-banked and the under-banked groups in the society into the mainstream economy. the increase in the mobile penetration and use of mobile internet among the people living at the bottom of pyramid in the developing countries, clearly reflect at the potential of mobile money, in bringing the financially excluded in the economic mainstream and thus help in sustainable socio-economic development. references aker, jenny c. and isaac m. mbiti. 2010. “mobile phones and economic development in africa.” journal of economic perspectives, 24(3): 207–32. asia development bank 2003. “toward e-development in asia and the pacific”. asian development bank. asli, demirguc-kun and klapper, l. 2012. “measuring financial inclusion: the global findex.” world bank policy research working paper, 6025. bishop, a. p., tidline, t. j., shoemaker, s., & salela, p. 1999. “public libraries and networked information services in low-income communities.” library & information science research, 21(3): 361-390. bold, chris, porteous, david, and rotman, sarah. 2012. “social cash transfers and financial inclusion: evidence from four countries”. consultative group for assisting the poor (cgap), february 2012: 1-20. brynjolfsson, e., and hitt, l. m. 2000. “beyond computation: information, technology, organizational transformation and business performance.” journal of economic perspectives, 14(4): 23–48. business week. 2007. upwardly mobile in africa. retrieved october 3, 2007, from http://www.businessweek.com/magazine/content/07_39/b4051054.htm butler, rhett. 2005. “cell phones may help save africa”. https://news.mongabay.com/2005/07/cell-phones-may-help-save-africa/ (retrieved on may 2, 2016). davidson, neil, and pénicaud, claire. 2012. “state of the industry: results from the 2011 global mobile money adoption survey”. gsma, london. desai, k. 2010. 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“the mobile makes its mark”. in katz, j. e., handbook of mobile communication studies. cambridge, massachusetts: the mit press, 15–27. ssewanyana, j. 2007. “ict access and poverty in uganda”. international journal of computing and ict research, 1(2): 10-19. the economist. 2012. “mobile money in africa press 1 for modernity: one business where the poorest continent is miles ahead”. the economist, april 28, 55. wishart, n. 2006. micro-payment systems and their application to mobile networks: examples of mobile enabled services in the philippines. infodev publications, idrc. world bank 2014. world financial development report on financial inclusion. washington dc. mobilni novac u ulozi osnaživanja ljudi koji žive na dnu piramide i jačanje finansijske inkluzije u velikom stilu rezime –malo ko se ne bi složio da je mobilni novac pokretač finansijske inkluzije i ima potencijal da dosegne do miliona ljudi koji žive na dnu piramide i onih koji žive u udaljenim područjima. ovaj rad ispituje uticaj pristupa mobilnom novcu na ljude koji žive na dnu piramide. cilj je bio da se: (1) razume koncept mobilnog novca, (2) istraži značaj mobilnog novca u ekonomskom rastu, (3) istraži rast mobilnog novca širom sveta, (4) istraže prednosti mobilnog novca i (5) razmatraju vitalna shvatanja tradicionalnih finansijskih institucija i kreatora politika. rad je otkrio da mobilni novac ima veoma pozitivan uticaj na finansijsku inkluziju. takođe, poboljšava ekonomske mogućnosti za velike delove stanovništva koji nemaju pristup bankama. nove političke inicijative, reforme i strateška udruživanja agrawal, r., mobile money, ea (2016, vol. 49, no. 1-2, 15-23) 23 operatera mobilne telefonije i tradicionalnih finansijskih institucija mogu dovesti finansijski isključene ljude u ekonomske tokove i mogu pomoći u održivom razvoju. ključne reči: mobilni novac, finansijska inkluzija, plaćanja, doznake article history: received: 6 march, 2016 accepted: 12 june, 2016 microsoft word 2011_1-2 scientific review    strategic management theory: concepts, analysis and  critiques in relation to corporate competitive advantage  from the resource‐based philosophy  omalaja m.a.*, eruola o.a., international college of management and technology, nigeria   udc: 005.52    jel: l26  abstract – the concepts, theory and practice of strategic management have become prominent  in modern management literature especially in this new millennium for one obvious reason: that is,  because of the complex, nebulous and dynamic nature of contemporary corporate governance. this  phenomenon has in turn become a matter of concern to academics and professionals alike on the field.  consequently, the main objective of this paper is to present an overview of strategic management with  particular emphasis on its concepts, theory as well as its linkage with the resource‐based philosophy of  the firm’s competitive advantage. a review of the relevant literature was conducted and a connection  between strategic management theory and competitive advantage from the recourse‐based philosophy  of the  firm was  identified. it was  found that the resource‐based model  is one of the main strategic  management  theories applicable  to explain organizational performance, and  it  is also a part of the  larger  management  theory  family  which  has  evolved  to  suit  the  managerial  requirements  of  the  modern complex organizations and also the business environments within which the organizations  operate.  examining  organizational  competitive  advantage  from  this  school  of  thought  allows  the  organizations  to  measure  the  significance  of  its  internal  resources  and  capabilities  in  particular  towards attaining a competitive advantage, and hence to provide further support and extension to the  philosophical approach.    key words: competitive advantage, corporate governance,  firm performance, resource‐based  philosophy, management theory, strategic management  introduction  complementary  to  the  concept  of  policy  is  what  is  known  in  modern  management  parlance as strategy. strategy is the broad determination of the goals of an undertaking and  the specification of alternative courses of action to be taken to achieve the predetermined  goal  of  the  undertaking.  according  to  alfred  d  chandler,  corporate  strategy  is  the  determination of the basic long term goals of an enterprise and the adoption of courses of  action and allocation of resources necessary to carry out the goals. again, igor h ansoff is of  the opinion that strategy provides a broad concept of the firms business, set forth specific  guidelines by which the firm can conduct its search and subject the firm’s selection to the  most  attractive  opportunity.  to  d.  c.  rogers,  strategy  is  the  mode  of  plan  of  action  for  allocating scarce resources to gain competitive advantage, achieve an objective and capitalize                                                         * e‐mail: president@icmtinternational.com     economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   60 on a perceived opportunity at an acceptable level of risk. james brian quinn propounded that  corporate strategy is used to describe the whole future activities of a business. it is the plan  that determines how an organization can best achieve its desired end in the light of opposing  pressures  imposed  by  competition  and  limited  resources,  in  the  words  of peter drucker,  strategy  is  the  company’s  basic  approach  towards  achieving  its  overall  objectives.  it  is  a  careful,  deliberate  and  systematic  approach  to  clarifying  corporate  objectives,  making  strategic decisions and checking progress toward the objective.  by this chain of definitions, it could be observed that strategy is the pattern of decisions  in  a  company  that  determines  and  reviews  its  objectives,  purposes,  goals,  produce  the  principal  policies  and  plans  for  achieving  these  goals  and  defines  the  range  of  business  which  the  company  is  to  pursue,  the  kind  of  economic  and  human  organization  it  is  or  intends to be and the nature of economic and non‐economic contributions it intends to make  to  its  beneficiaries.  essentially,  corporate  strategy  deals  with  product‐market  positioning;  that is, how the firm will select marketing and products areas in which it will compete (i.e.  choice of product marketing combination), the direction in which the firm will seek to grow  and develop, the profit and growth objectives it seeks to achieve, the interaction within the  firm and its external parameters (the world around or environmental domain), its internal  adjustment policies and programs to changes  in marketing places or other elements  in its  external environment; the competitive tool the company will employ such as price changes,  offering quality discount to customers,  introduction of new product  lines, employment of  consultancy services as well as the way in which the company will configure its resources.   strategy development as in the case of policy formulation can be viewed as a decision  making  process  which  is  primarily  concerned  with  the  development  of  organizations  objectives,  the  commitment  of  its  resources  and  the  environmental  constraints.  in  formulating a strategy, the most basic steps to be taken would include the following though  not strictly in the order of descending magnitude:  a) identifying  the  company’s  mission:  that  is,  the  long  term  objectives  of  the  organization  implied  by  the  organization’s  mission.  remember  that  mission  is  broader than objective. the strategy to be formulated has to be directed towards  the long‐term objectives of the organization,  b) corporate  analysis:  that  is,  capability  analysis.  these  are  analyzes  of  the  company’s weaknesses and strengths in terms of marketing capability, personnel  capability,  etc.  these  are  mainly  internal  analysis,  which  seeks  to  establish  the  “how”  of  taking  advantages  of  the  opportunities  available,  and  secondly  to  address how to overcome or correct the weaknesses manifested too.  c) examining  the  value  system  of  the  company  with  reference  to  what  and  what  the  management cherished that is,. management preference. the value analysis helps  up to know what we can really and reasonably achieve and commit ourselves to,  and  d) analysis of the societal values. since the organization operates within the society,  after examining the values‐system of the organization, emphasis should be shifted  to the values of the society in general. societal values to a greater extent influence  the values of the organization. in contrast, the organization can influence societal  values via corporate advertising.     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     61 what is strategic management?  having  explained  the  term  “strategy”  in  some  details,  how  then  can  we  explain  or  describe  strategic  management?.  strategic  management  is  the  process  and  approach  of  specifying  an  organization’s  objectives,  developing  policies,  programmes,  paradigms  and  plans to achieve these objectives, and allocating resources so as to implement the policies,  programmes, paradigms and plans. in other words, strategic management can be seen as  management of combined components of  the  three stages of  the strategy process;  that  is,  strategy development, strategy implementation and strategy evaluation (some management  philosophers refer to the  first stage as strategy  formulation but i prefer  to call  it strategy  development because it is policy that is formulated while strategy is usually developed).     figure 1. corporate strategy model (adapted from gerry j., kevan s. and richard w. (2008),  exploring corporate strategy, page 12        strategic management involves understanding the strategic position of an organisation,  strategic  choices  for  the  future  and  managing  strategy  in  action.    strategic  management  involves exploring and management of an organizational corporate strategy. it also involves  modeling and analysing the overall corporate strategy of the system to include the strategic  position  of  the  organisation,  strategic  choices  by  the  organisation  and  strategy  in  action  within and around the organisation may be represented as in figure. 1.  the  strategic  position  is  concerned  with  the  impact  on  strategy  of  the  external  environment,  an  organization’s  strategic  capability  (resources  and  competencies),  the  expectations and influence of stakeholders as well as the cultural and historical influences  such as organizational, sectoral and national historical parameters. strategic choices involve  understanding the underlying bases for future strategy at the business unit, corporate and  international levels and the options for developing strategy in terms of both the directions     economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   62 and method of development. strategy in action is concerned with ensuring that developed  strategies are working in practice. this usually include a thorough consideration of strategy  development processes in the organisation, structuring and restructuring (reengineering) the  organisation to support effective and efficient performance (optimal productivity) in terms of  organizational structures, processes and relationships. it also includes resourcing strategy,  strategic change and practice of strategy. from this analysis, strategic management can be  said to underline the importance of managers with regards to organisational strategy      what is a theory?  theory  in  modern  english  is  a  concept  which  originally  derives  from  classical  greek  philosophy,  for  example  that  of  plato,  and  is  derived  from  ancient  greek  theoria,  which  original meant ʺa looking at, viewing, beholdingʺ. it is a well‐substantiated explanation of  some aspect of the natural world; an organized system of accepted knowledge that applies in  a variety of circumstances to explain a specific set of phenomena; ʺtheories can incorporate  facts and laws and tested hypothesesʺ; ʺtrue in fact and theory.ʺ theories are analytical tools  for understanding, explaining, and making predictions about a given subject matter. there  are theories in many and varied fields of study, including the arts and sciences. a formal  theory is syntactic in nature and is only meaningful when given a semantic component by  applying it to some content (i.e. facts and relationships of the actual historical world as it is  unfolding). theories  in various fields of study are expressed  in natural  language, but are  always constructed  in such a way  that  their general  form  is  identical  to a  theory as  it  is  expressed  in  the  formal  language  of  mathematical  logic.  theories  may  be  expressed  mathematically, symbolically, or in common language, but are generally expected to follow  principles of rational  thought or  logic. theory  is constructed of a set of sentences, which  consist entirely of true statements about the subject matter under consideration.   however, the truth of any one of these statements is always relative to the whole theory.  therefore, the same statement may be true with respect to one theory, and not true with  respect to another. this is, in ordinary language, where statements such as ʺhe is a terrible  personʺ cannot be judged to be true or false without reference to some interpretation of who  ʺheʺ  is  and  for  that  matter  what  a  ʺterrible  personʺ  is  under  the  theory.  sometimes  two  theories have exactly the same explanatory power because they make the same predictions.  a pair of such theories is called indistinguishable, and the choice between them reduces to  convenience or philosophical preference.  the  form  of  theories  is  studied  formally  in  mathematical  logic,  especially  in  model  theory. when theories are studied in mathematics, they are usually expressed in some formal  language and their statements are closed under application of certain procedures called rules  of  inference.  a  special  case  of  this,  an  axiomatic  theory,  consists  of  axioms  (or  axiom  schemata) and rules of inference. a theorem is a statement that can be derived from those  axioms  by  application  of  these  rules  of  inference.  theories  used  in  applications  are  abstractions of observed phenomena and the resulting theorems provide solutions to real‐ world  problems.  obvious  examples  include  arithmetic  (abstracting  concepts  of  number),  geometry (concepts of space), and probability (concepts of randomness and likelihood).     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     63 gödelʹs incompleteness theorem shows that no consistent, recursively enumerable theory  (that  is, one whose  theorems  form a recursively enumerable set)  in which  the concept of  natural numbers can be expressed, can include all true statements about them. as a result,  some  domains  of  knowledge  cannot  be  formalized,  accurately  and  completely,  as  mathematical  theories.  (here,  formalizing  accurately  and  completely  means  that  all  true  propositions—and only true propositions—are derivable within the mathematical system.)  this limitation, however, in no way precludes the construction of mathematical theories that  formalize large bodies of scientific knowledge.  to sum up, a theory is a supposition or a system of ideas intended to explain something,  especially one based on general principles independent of the thing to be explained such as a  theory of evolution. a theory is also a set of principles on which the practice of an activity is  based such as a theory of education or a theory of music. a theory is an idea used to account  for  a  situation  or  justify  a  course  of  action.  for  instance,  a  professional  manager  (or  management  consultant)  may  assert  that  my  theory  would  be  that  the  place  has  been  seriously mismanaged. a theory may also be taken as a collection of propositions to illustrate  the principles of a subject such as management theory or the theory of strategic management.   other examples of theories are:  atomic theory; the theory that all matter is made up of tiny indivisible particles (atoms).  according to the modern version,  the atoms of each element are effectively  identical, but  differ from those of other elements, and unite to form compounds in fixed proportions,   attribution theory; a theory that supposes that one attempts to understand the behavior  of others by attributing feelings, beliefs, and intentions to them,   bohr theory; a theory of the structure of atoms stating that electrons revolve in discrete  orbits around a positively charged nucleus and that radiation is given off or absorbed only  when an electron moves from one orbit to another,  correspondence theory; the theory that states that the definition or criterion of truth is  that true propositions correspond to the facts,  domino theory; the theory that a political event in one country will cause similar events  in neighboring countries, like a falling domino causing an entire row of upended dominoes  to fall   field theory;  a  theory  that  explains  physical  phenomena  in  terms  of  a  field  and  the  manner in which it interacts with matter or with other fields   galois theory; a method of applying group theory to the solution of algebraic equations  game theory; the branch of mathematics concerned with the analysis of strategies for  dealing with competitive situations where  the outcome of a participantʹs choice of action  depends  critically  on  the  actions  of  other  participants.  game  theory  has  been  applied  to  contexts in war, business, and biology  quantum  field  theory;  a  field  theory  that  incorporates  quantum  mechanics  and  the  principles of the theory of relativity, and   theory‐laden; denoting a term, concept, or statement that has meaning only as part of  some theory, so that its use implies the acceptance of that theory.        economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   64  strategic management theory  having explained both the terms strategic management and theory, what then is strategic  management  theory?  a  strategic  management  theory  may  be  said  to  be  a  supposition,  proposition or a system of  ideas  intended to explain the origin, evolution, principles and  applications  of  strategic  management.  strategic  management  theories  actually  stem  mainly  from the systems perspective, contingency approach and information technology approach  to corporate management. in the light of this background, following david (2005) and mohd  khairuddin hashim (2005), among the common strategic management theories noted and  applicable to modern industrial and governmental organizations are the profit‐maximizing  and  competition‐based  theory,  resource‐based  theory,  survival‐based  theory,  human  resource based theory, agency theory and contingency theory.   the profit‐maximizing and competition‐based theory is based on the notion that a business  organization’s main objective  is  to maximize  long  term profit and developing sustainable  competitive advantage over competitive rivals in the external market place. the industrial‐ organization  (i/o)  perspective  is  the  basis  of  this  theory  as  it  views  the  organization’s  external  market  positioning  as  the  critical  factor  for  attaining  and  sustaining  competitive  advantage, or in other words, the traditional i/o perspective offered strategic management a  systematic  model  for  assessing  competition  within  an  industry  (porter,  1981).  this  is  tantamount to economist philosophy of business objectives. on the other hand, the resource‐ based theory stems from the management philosophy that the resource of firms’ competitive  advantage  lies  in  their  internal  resources,  as opposed  to  their  positioning  in  the  external  environment. that is rather than simply evaluating environmental opportunities and threats  in  conducting  business;  competitive  advantage  depends  on  the  unique  resources  and  capabilities  that  a  firm  possesses  (barney,  1995).  the  resource‐based philosophy  of  the  firm  predicts that certain types of resources owned and controlled by firms have the potential and  promise  to  generate  competitive  advantage  and  eventually  superior  firm  performance  (ainuddin et al., 2007).  the survival‐based theory centres on the concept that organizations need to continuously  adapt  to  its  competitive  environment  in  order  to  survive.  this  differs  from  the  human  resource‐based theory, which emphasizes the importance of the human element in the process  of  strategy  development  of  organizations.  in  addition,  the  agency  theory  stresses  the  underlying important relationship between the shareholders (or company owners) and the  agents  (or  company  managers)  in  ensuring  the  success  of  the  organizations.  finally,  the  contingency  theory draws  the  idea  that  there  is no one or  single best  way or approach  to  manage organizations. organizations should then develop appropriate managerial strategy  based on the situation and condition they are experiencing. in short, during the process of  strategy  development,  implementation  and  evaluation,  these  main  strategic  management  theories will be applicable to management of organizations as tools to assist them in making  strategic and guided managerial decision. these strategic management theories can best be  depicted as per figure 2.   for  the  purpose  of  this  assignment,  besides  the  systems  perspective,  contingency  approach and the other main strategic management theories mentioned above, the resource‐ based theory (rbt) of the firm’s competitive advantage will be the underlying theoretical  foundation applied and fundamental basis of the variables and their ensuing relationships     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     65 that will be analysed. hence, this paper will focus especially on the internal attributes (i.e.  resources,  capabilities  and  systems)  of  the  organization  towards  attaining  competitive  advantage.  although  there  are  some  minimal  external  dimensions  and  elements  (i.e.  interactions) to be considered, these elements are mainly inherent within the organization.  hence, it justifies the adoption of the rbt as the main research tenet.    figure 2. strategic management theories (adapted from david, 2005; mohd khairuddin hashim,  2005)    urvival   theory                                         analysis of the resource‐based theory  the pursuit of competitive advantage is indeed an idea that is at the heart of much of the  strategic management literature. understanding sources of sustained competitive advantage  has  become  a  major  area  of  study  in  strategic  management.  the  resource‐based  theory  stipulates  that  in  strategic  management,  the  fundamental  sources  and  drivers  to  firms’  competitive advantage and superior performance are mainly associated with the attributes of  their resources and capabilities which are valuable and costly‐to‐copy (barney, 1986, 1991,  2001a; conner, 1991; mills, platts and bourne, 2003; peteraf and bergen, 2003). building on  the assumptions  that strategic resources are heterogeneously distributed across  firms and  that  these  differences  are  stable  overtime,  barney  (1991)  examines  the  link  between  firm  resources and sustained competitive advantage.   human resource‐based theory  human    resource‐ based  theory strategic  management  theories  contingency  theory  resource‐ based   theory  survival   theory  agency   theory  profit  maximization  & competition  based theory     economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   66 four  empirical  indicators  of  the  potential  of  firm  resources  to  generate  sustained  competitive advantage can be value, rareness, inimitability, and non‐substitutability. in barney  (1991),  firm  resources  include  all  assets,  capabilities,  organizational  processes,  firm  attributes,  information,  knowledge,  etc.  controlled  by  a  firm  that  enable  the  firm  to  conceive  and  implement strategies  that  improve  its efficiency and effectiveness. a  firm  is said  to have a  competitive advantage when it is implementing a value creating strategy not simultaneously being  implemented by any current or potential competitors. furthermore, a firm is said to have a sustained  competitive advantage when it is implementing a value creating strategy not simultaneously being  implemented  by  any  current  or  potential  competitors  and  when  these  other  firms  are  unable  to  duplicate the benefits of this strategy (barney, 1991). barney (1991) further argued that to have  the potential to generate competitive advantage, a firm resource must have four attributes:  (a) it must be valuable, in the sense that it exploits opportunities and/or neutralizes threats in  a firm’s environment; (b) it must be rare among a firm’s current and potential competition;  (c)  it  must  be  imperfectly  imitable;  and  (d)  there  cannot  be  strategically  equivalent  substitutes for this resource. this conceptual notion can best be displayed as per fig. 3     figure 3. barney’s (1991) conceptual model (newbert, 2007)                                    competitive advantage is perhaps the most widely used term in strategic management,  yet  it  remains  poorly  defined  and  operationalized  (ma,  2000).  ma  (2000)  makes  three  observations  regarding  competitive  advantage  and  conceptually  explores  the  various  patterns of relationship between competitive advantage and firm performance, namely: (i)  competitive advantage does not equate to superior performance; (ii) competitive advantage  is a relational term; and (iii) competitive advantage is context‐specific. in addition, ma (2000)  further  examines  three  patterns  of  relationship  between  competitive  advantage  and  firm  performance,  namely:  (i)  competitive  advantage  leading  to  superior  performance;  (ii)  competitive  advantage  without  superior  performance;  and  (iii)  superior  performance  without  competitive  advantage.  the  ultimate  purpose  of  ma’s  (2000)  article  is  to  help  generate  a  healthy  debate  among  strategy  scholars  on  the  usefulness  of  the  competitive  advantage construct for our theory building and testing. ma (1999b) has also argued that  valuable, rare  resource/capability  competitive  advantage  performance  valuable, rare  inimitable, non‐ substitutable  resource/capacity  sustained  competitive   advantage  sustained  performance     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     67 competitive advantage arises from the differential among firms along any dimension of firm  attributes and characteristics that allows one firm to better create customer value than do  others.  generic sources of competitive advantage include ownership of assets or position; access  to distribution and supply; as well as proficiency – knowledge, competence, and capability –  in business operations. it has also been further argued that in order to achieve and sustain  competitive advantage, a firm needs to creatively and proactively exploit the three generic  sources, preempt rivals attempt at these sources, and/or pursue any combination of proactive  and  preemptive  effort.  this  submission  advances  an  integrative  framework  that  helps  management  practitioners  systematically  analyze  the  nature  and  cause  of  competitive  advantage.     figure 4. anatomy of competitive advantage      competitive  advantage  is  the  basis  for  superior  performance.  understanding  the  anatomy of competitive advantage  is of paramount  importance  to general managers who  bear  the  ultimate  responsibility  for  a  firm’s  long  term  survival  and  success.  ma  (1999)  advances an integrative framework called select to help general managers systematically  examine  the  various  facets  of  the  anatomy  of  competitive  advantage:  its  substance,  expression, locale, effect, cause, and time‐span. it has been reasoned that by analyzing the  causes  of  competitive  advantage  helps  a  firm  create  and  gain  advantage.  studying  the  substance, expression, locale, and effect of competitive advantage allows the firm to better  utilize the advantage. examining the time span of competitive advantage enables the firm to     economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   68 fully exploit  the advantage according  to  its potential and sustainability  (ma, 1999a). this  concept can be represented in a diagram as per fig. 4.  the resource‐based strategic management philosophy of the firm has emerged in recent  years  as  a  popular  theory  of  competitive  advantage.  the  term  was  originally  coined  by  wernerfelt in 1984 (fahy, 2000) and the significance of this contribution is evident in its being  awarded  the  strategic  management  journal  best  paper  prize  in  1994  for  reasons  such  as  being “truly seminal” and an “early statement of an  important trend  in  the field”  (zajac,  1995; cited  in fahy, 2000). fahy (2000) has reasoned that the principal contribution of the  resource‐based theory of the firm has been as a theory of competitive advantage. its basic  logic  is a relatively simple one. it starts with the assumption that the desired outcome of  managerial effort within the firm is a sustainable competitive advantage (sca). achieving an  sca allows the firm to earn economic rents or above‐average returns. in turn, this focuses  attention on how firms achieved and sustain advantages.   the resource‐based theory contends that the answer to this question lies in the possession  of  certain  key  resources,  that  is,  resources having  the  characteristics  of  value,  barriers  to  duplication and appropriability (fahy, 2000). this view is not dissimilar to the one proposed  by barney (1991). an sca can be obtained if the firm effectively deploys these resources in  its  product‐markets.  therefore,  the  rbt  emphasizes  strategic  choice,  charging  the  firmʹs  management  with  the  important  tasks  of  identifying,  developing  and  deploying  key  resources to maximize returns (fahy, 2000). in summary, following fahy (2000), the essential  elements of the resource‐based view are as follows:   (i) sustainable competitive advantage and superior performance; \  (ii) the characteristics and types of advantage generating resources; and  (iii) strategic choices by management.  the resource‐based  theory  is  indeed an alternative perspective  to analyze competitive  advantage  compared  to  that  put  forward  by  the  i/o  perspective.  as  porter  (1991)  highlighted, there are four attributes of the proximate environment of a firm that have the  greatest  influence  on  its  competitive  advantage,  namely,  factor  conditions,  demand  conditions,  related  &  supporting  industries,  and  firm  strategy,  structure  and  rivalry.  o’shaughnessy  (1996)  re‐affirms  the  validity  of  michael  porter’s  contribution  to  the  discourse on competitive advantage, but suggests that his (porter’s) theory is weakened by  its neglect of cultural factors and historical antecedents. mazzarol and soutar (1999) study of  structure, strategy (marketing & entry) and competitive advantage outline a model of the  factors  that  are  critical  to  the  establishment  and  maintenance  of  sustainable  competitive  advantage  for  education  services  enterprises  in  international  markets.  the  variables  are  conceptualized  as  industry  &  foreign  market  structure;  quality  image,  market  profile,  coalition  formation,  forward  integration,  expertise,  culture  and  information  technology.  whereas,  the study by burden and proctor  (2000) on  training and competitive advantage  found  out  that  meeting  customer  needs  on  time,  every  time,  is  a  significant  route  to  achieving and sustaining competitive advantage, and  training  is a  tool  that organizations  should use to succeed at this.   however, a study by gupta and mcdaniel (2002) on knowledge management (km) and  competitive advantage investigates the vital link between the management of knowledge in  contemporary organizations and the development of a sustainable competitive advantage.     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     69 the  variables  are  conceptualized  in  terms  of  organizational  effectiveness,  efficiency,  core  competency,  costs;  knowledge  harvesting,  filtering,  configuration,  dissemination  and  application. also, goh (2004) has identified that the field of knowledge management (km)  has emerged strongly as the next source of competitive advantage. nevertheless, lin (2003)  has further suggested that technology transfer (tt) can be a significant source of competitive  advantage  for  firms  in  developing  countries  with  limited  r&d  resources.  tt  was  conceptualized in terms of technological learning performance, organizational intelligence,  causal  ambiguity,  firm  specificity,  complexity,  maturity,  employee  qualification,  and  innovation orientation.  fahy, farrelly and quester (2004) have also  found out  the  increasingly  important role  played by sponsorship in the marketing mix that has given rise to the view that it should be  considered  as  a  significant  strategic  activity  with  the  potential  to  generate  a  sustainable  competitive advantage  in the market place. however, ma (2004) has further advanced an  integrative framework on the determinants of competitive advantage in global competition  namely creation & innovation, competition, cooperation and co‐option. whereas de pablos  (2006) explained that the competitive advantage of a transnational organization lies to a great  extent in its ability to identify and transfer strategic knowledge between its geographically  dispersed and diverse locations. in a study of strategic focus and competitive advantage by  cousins (2005), it was found that firms defining their competitive advantage as being cost‐ focused will generally consider supply as playing merely a cost‐reduction role, i.e. passive  and supportive, whereas firms viewing their competitive advantage as being differentiated  will see supply as strategic,  i.e. as a distinctive capability. the variables are measured  in  terms  of  business  development,  market  share,  relationship  development;  cost  focus,  differentiation and collaboration.   in addition, liao and hu  (2007) also  further  investigate  the  inter‐relationships among  environmental uncertainty, knowledge transfer (kt) and competitive advantage, which was  conceptualized as ambiguity, complexity, partner protectiveness; organizational kt, group &  procedural  movements;  reduce  dependency,  kt  effect,  technology  development  and  technology transfer (tt). in spite of the vast conceptual and empirical study conducted on  the notion of competitive advantage, flint and van fleet (2005) have nonetheless argued that  there is no clear definition of competitive advantage (ca) that is applicable in general term  i.e. applicable in any dimension or criteria. following ma (2000), as far as the research on  (sustainable)  competitive  advantage  is  concerned,  it  is  hereby  suggested  that  researchers  must first validate the research question and research design, and decide on the dependent  and  independent  variables  to  be  applied:  are  competitive  advantage  and  firm  (financial)  performance  equitable,  which  means  other  independent  variables  (or  indeed  moderating  and/or  mediating  variables  such  as  organizational  structures,  top  management  team  composition and style, human resource management, etc) influencing its outcome; or indeed  both are different concepts and constructs, which implies that firm (financial) performance  indeed depends upon its competitive advantage position. also, clear and specific definition  and direction of the concept of (sustainable) competitive advantage will also further enhance  the validity of the academic research in this specific strategic management area.  as for the continued relevancy and validity of the resource‐based theory on sustainable  competitive advantage, it  is agreeable with fahy  (2000) that greater understanding of  the     economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   70 dynamics of resource development continues  to be essential  in advancing resource‐based  theories of competition. we are of the opinion that though rbt has had its critics, it is still  relevant  and  valid  in  conceptually  explaining  and  underpinning  the  notion  of  firm’s  sustainable competitive advantage. hence, by  incorporating evolutionary advancement as  well  as  rapid  technological  changes  involving  firm’s  resources,  researchers  could  further  explore empirical evidence on these factors impact and effect on firm’s competitive forces.  then only the strength of the rbt could be enhanced via acknowledging that resources are  dynamic in nature, and a firm’s deployment of its resources in creating and sustaining its  advantages might also contextually differ from one firm to another, though the basis of rbt  on  sca  being  resources  having  the  criteria  of  value,  rareness,  inimitability  and  non‐ substitutability (vrin) continue to be the relevant and valid conceptual foundation.  furthermore, other studies have indeed provided support on the importance of having a  good  strategy  to  attain  competitive  advantage  from  the  resource‐based  theory.  a  well  developed  and  implemented  strategy  can  have  significant  effect  on  the  attainment  of  competitive advantage level (richard, 2000; arend, 2003; powell, 2003; porter and kramer,  2006). the resource‐based view have  indeed provided an avenue for organization to plan  and execute its organizational strategy via examining the position of its internal resources  and capabilities towards achieving competitive advantage.  critiques on the resource‐based theory  fahy  (2000)  has  reasoned  that  through  its  insights  into  the  nature  of  competitive  advantage,  the  resource‐based  theory  of  the  firm  has  already  made  an  important  contribution to the field of strategic management. the rbt, which has benefited from the  rigour  of  its  economic  origins,  greatly  enhances  our  understanding  of  the  nature  and  determinants  of  sustainable  competitive  advantage  (sca).  it  helps  to  explain  why  some  resources are more advantage‐generating than others and also why resource asymmetries  and  consequent  competitive  advantages  persist  even  in  conditions  of  open  competition.  however, as fahy (2000) noted, the vast majority of contributions within the rbt have been  of a conceptual rather than an empirical nature, with the result that many of its fundamental  tenets still remain to be validated in practice. in addition, there were some debates regarding  both  the nature and  the determinants of competitive advantage and  the relevancy of  the  resource‐based philosophy. the most notable were the debates in academy of management  review  (2001)  between  barney  (2001)  and  priem  and  butler  (2001)  on  the  relevancy  and  validity of the resource‐based approach to sustainable competitive advantage, following and  based on barney’s  (1991) article, and also  further dialogues  from various scholars on  the  same issue as published by academy of management review (2001 and 2002).  the resource‐based theory has been criticized for exhibiting circular reasoning in that one  of  its fundamental elements, namely, value, can only be assessed  in  terms of a particular  context (barney, 1991; kay, 1993; cited  in fahy, 2000). resources may  lead to competitive  advantage  but  this  in  turn defines relevant competitive structures, which  in  turn  defines  what is a valuable resource, and so on (schendel, 1994; cited in fahy, 2000). a way out of this  circularity  is  to  see  the  relationship  between  resources  and  advantage  as  a  longitudinal  process (porter, 1991; cited in fahy, 2000). however, much of the resource‐based literature  takes  resource  stocks  as  given  and  pays  insufficient  attention  to  the  process  of  resource     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     71 development.  this  is  an  important  oversight,  as  the  ways  in  which  resources  are  accumulated  within  the  firm  are  characterised  by  factors  such  as  time  compression  diseconomies,  interconnectedness,  asset  mass  efficiencies  and  causal  ambiguity  (dierickx  and  cool,  1989;  cited  in  fahy,  2000).  as  such,  greater  understanding  of  the  dynamics  of  resource  development  is  indeed  vital  in  furthering  the  resource‐based  perspective  on  competitive advantage. without such comprehension, the problem of circular reasoning can  never be solved.   critics further argued that rbt  logic as paradoxically  infused with contradictions and  ambiguities.  its  logic,  they  argue,  has  produced  seemingly  incompatible  implications  for  managerial scholarship and practice (priem and butler, 2001). for example, its logic suggests  that  the ability  to measure a resource means  that  this resource will be  less  likely  to be a  source of  sustained competitive advantage.  also,  this  logic suggests  that  there cannot be  “rules  for riches”, yet  it can be used  to generate managerial prescriptions concerning how  firms can achieve strategic advantage through their resource deployments (priem and butler,  2001a; lado et al., 2006). studies concerning resource‐based view have indeed concentrated  on the attributes of resources to attain competitive advantage, covering areas such as inter  alia  the  resource  substitution  effects  (yoo  and  choi,  2005),  complementary  innovation‐ producing  resources  (king,  covin  and  hegarty,  2003)  and  consumer  value  perspective  (priem,  2007).  more  efforts  are  needed  to  extend  the  rbt  from  merely  examining  the  resource attributes (peteraf and barney, 2003; rodriguez and rodriguez, 2005) to analyzing  the extent of the relationship between these resources and other related variables towards  achieving competitive advantage level (armstrong and shimizu, 2007). by moving towards  this direction, such a study will not only improve the rigour of the rbt but also sustain the  continued relevance of the rbt of competitive advantage in strategic management (meyer,  2006; hambrick and chen, 2008).   further, as mentioned, based on the studies by oliver (1997), barney et al. (2001), hitt et  al.  (2001),  makadok  (2001),  afuah  (2002),  adner  and  helfat  (2003),  miller  (2003)  and  sapienza et al. (2006), while a lot of attention has been paid to those attributes of capabilities  that  lead  to  competitive  advantage  of  firms,  a  lot  less  attention  has  been  given  to  the  deployment of capabilities and supporting empirical evidence of these capabilities. as such,  as far as resources, capabilities, competitive advantage and performance of organization are  concerned,  by  introducing  systems  into  the  relationship  equation,  it  is  expected  that  the  study will be able to fill  in the gap that currently exists  in the  literature as mentioned by  critics of the resource‐based philosophy. indeed, we need to examine further the approaches  and techniques of exploitation and manipulation of resources and capabilities pertaining to  organization by including systems as the influencing factor that will affect the relationship  between those variables under probe. thus, it is indeed critical to examine the relative extent  of  the  relationship  between  organizational  resources,  capabilities,  systems,  competitive  advantage and performance in aggregate.   this  will  extend  support  to  the  rbt  of  competitive  advantage.  organizational  performance has been examined from various approaches, namely, inter alia, the transaction  cost  perspective  (hennart,  1991;  carter  and  hodgson,  2006;  king,  2007),  the  theory  of  constraints perspective (watson, blackstone and gardiner, 2007), and also the resource‐based  view perspective (leiblein, 2003).      economic analysis (2011, vol. 44, no. 1‐2, 59‐77)   72 chandler’s thesis   chandler’s thesis or theory postulates that the administrative structure a company adopts  should be suitable for the business strategy which it has chosen. alfred d. chandler (1962)  studied  some  american  companies  in  1962  and  observed  that  since  1918,  many  of  the  companies  had  changed  from  functional  to  multi‐divisional  structures.  in  the  functional  structure, the organizations activities were divided into series of specialized functions such  as  marketing,  finance,  production  and  personnel.  the  coordination  of  such  functional  arrangement was undertaken by the general manager as the chief executive. in contrast, a  multidivisional structure is the one in which the activities of the organization are divided  into a series of autonomous multi‐functional divisions. these divisions are usually product  divisions although divisions organized along geographical lines are also common. despite  the  fact  that  the  divisions  in  the chandler’s  study  were  responsible  for  operations,  broad  strategic decisions were undertaken by a general office which monitored and coordinated  the performance of the divisions. hence in the multi‐divisional structure, it is the product  division rather than the functional divisions which are responsible for operating decisions.  based on his study, chandler observed that these administrative (structural) changes were  mainly the result of changed strategies in the companies concerned. he therefore concluded  that structure follows strategy and that the most complex type of administrative structure is  the result of several basic strategies. in other words, a new strategy creates new structural or  administrative  demands  since  information  through  geographical  dispersion;  vertical  integration  and  product  diversification  add  new  resources  and  new  activities  to  the  company. although the old administrative set up could still be used to administer the new  activities,  it  is  likely  to  become  increasingly  inefficient  as  the  company  becomes  more  diversified  and  expanded.  however,  it  is  important  to  note  that  there  is  no  one  administrative structure that is suitable for all organizations at all time. the organizational  structure  that  is most suitable depends upon  the corporate strategy  that  is chosen by  an  organization.  according to d. f. charnon (1973) in his contribution to the journal of business policy,  vol. 3, no 1, 1973 titled “corporate strategy and organization structure in british industries”, the  british companies have tended to follow much the same course as their counterparts in the  usa although in the united kingdom, product diversification and structural changes were  much more gradual and came very later than the situation in the usa. structural changes  after large scale product diversification was much closer in the uk and the changes from a  functional to a multi‐divisional structure was often achieved by a more gradual transition,  first to a type of holding company structure, and  eventually to the ultimate adoption of the  multi‐divisional system. in order to overcome much of these multi‐dimensional problems of  division, regrouping and integration, it is important that the administrative structure of the  organization be well suited to tackle them. in the concepts of corporate strategy by d. w. jones  (1971), edited by keneth andrew, andrew illustrated that the nature of the corporate strategy  must be made to dominate the design of the organizational structure and process, that is, the  principal criterion for all decisions in organizational structure and behavior should be that  they are relevant to the achievement of organizational goals and objectives. this  is why in  both the chandler’s and charnon’s analyzes, it was the extreme changes in corporate strategy  which  promoted  the  ferocious  changes  in  the  administrative  structure  which  eventually     omalaja, m.a., strategic management theory, ea (2011, vol. 44, no. 1‐2, 59‐77)     73 brought  the  replacement  of  the  functional  structure  by  the  multi‐divisional  structure  in  highly diversified firms.   conclusion  strategic management theories have evolved over time in order to suit the internal and  external  needs  of  organizations  and  also  to  fulfill  the  requirements  of  the  external  environments. however, strategic management theories need to be extended especially to  cater for the notion of competitive advantage of the firm. competitive advantage is a relative  notion. it can be viewed from various perspectives, notably the industrial‐organization (i/o)  and resource‐based philosophy. the i/o perspective views the organization external market  positioning  as  the  critical  factor  for  attaining  competitive  advantage,  which  means  the  traditional i/o perspective offered strategic management a systematic model for assessing  external  competition  within  an  industry.  alternatively,  examining  organizational  competitive  advantage  from  the  rbt  is  indeed  crucial  as  it  can  be  used  as  a  conceptual  guideline  for business organizations  in particular  to enhance  their competitive advantage  position  and  performance  via  application  and  manipulation  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corrigendum: tersoo iorngurum, gauging the effects of modern payment technologies adoption on the demand for money in nigeria. economic analysis: applied research in emerging markets 2019, vol. 52, no. 2, pp. 12-27. https://doi.org/10.28934/ea.19.52.2.pp12-27 the author of the article: tersoo iorngurum, gauging the effects of modern payment technologies adoption on the demand for money in nigeria. economic analysis: applied research in emerging markets 2019, vol. 52, no. 2, pp. 12-27, have informed the editorial office of the error in the published text. because of the technical omission of the author, economic analysis journal has to add the second author: godwin chukwudum nwaobi professor of economics veritas university abuja. the authors have requested for this error to be corrected. the authors of this paper are: tersoo iorngurum veritas university abuja, nigeria and godwin chukwudum nwaobi, veritas university abuja. link to the corrected article https://doi.org/10.28934/ea.19.52.2.pp12-27 doi: 10.28934/ea.22.55.2.pp79-90 first online: december 15, 2022 preliminary report key features and challenges of the china-western balkan countries merchandise trade development elena jovičić18f* | danijela stojanović1 1 institute of economic sciences, belgrade, serbia abstract the western balkan countries’ economic growth and development largely depend on the integration of national economies into international trade flows. bearing in mind the expanding presence of china in the western balkans and the considerable increase in bilateral trade over the previous decade, it is of great importance to focus on the strategies for overcoming main challenges and fostering more balanced trade in the forthcoming period. regarding that, the main aim of the research was to analyze trade flows and patterns and investigate the trade intensity between the western balkan countries and china. furthermore, the research attempted to determine the main challenges and to consider the strategic approach to their overwhelming, including better exploiting the opportunities provided by trade cooperation with china in the rapidly changing global environment. the paper used desk research a descriptive analysis of data on merchandise trade between six western balkans countries (albania, bosnia and herzegovina, montenegro, croatia, north macedonia, and serbia) and china. the analysis was based on the data available in the un comtrade, trade map, and wto statistical databases for the period 2016-2021. in addition, the trade intensity index (tti) was also used in the paper in order to discover how intensively the western balkan countries were trading with china. however, despite the rapid trade growth with china, its share in the wb countries' total trade remains at a relatively low level of about 8%. the trade deficit also increased significantly, indicating a deepening of the asymmetry in the economic relations of the observed countries. although the trade intensity index (tii) also confirms the deepening of trade relations, the tii value of 0.24 in 2021 indicates that trade between the western balkans and china is not developed at a desirable level, and there is considerable room for improvement. keywords: china, western balkan countries, merchandise trade, exports, imports, challenges jel classification: f1, f5 introduction being almost non-affected after the 2008 financial crisis, china has continued its “go global” approach, which led to the increase of various chinese actors’ presence around the world (shambaugh, 2013). since 2008, chinese outward foreign direct investments have grown significantly (dong et al., 2011; jin et al., 2016), while china became the world’s leading exporter and second-major importer of merchandise goods in 2012 (gurría, 2014). * corresponding author, e-mail: elena.jovicic@ien.bg.ac.rs 80 economic analysis (2022, vol. 55, no. 2, 79-90) along with the intensification of china's economic presence worldwide, and especially in the region of central and eastern europe, the previous decade was marked by the dynamic development of relations with the countries of the western balkans (wb) in the field of economic and other aspects of bilateral and multilateral cooperation. china committed itself to expanding economic and political ties with central and eastern europe (cee), including the western balkan countries, by initiating the so-called china-cee mechanism (formerly known as the “16+1” and later as the “17+1” mechanism or platform). namely, the cee-china mechanism was founded in 2012 in warsaw as an initiative that will gather countries from cee and china with the aim of enhancing mutual economic, political and cultural relations (zakić & radišić, 2019). since 2015, china has been deeply engaging the wb countries to an unprecedented degree and has had a profound impact on this region in recent years (pavlićević, 2019). trade and investment activity have both been significantly increasing, attracting chinese companies’ interest in different strategically important investments and infrastructure projects in the wb region (vangeli, 2019). intensive economic cooperation between western balkan countries and china continued even during the covid-19 pandemic crisis, and there was a rise in the total trade exchange recorded (the highest growth rate of trade of the western balkans countries was achieved precisely with china). this positive dynamic was primarily the result of the effective realization of measures to prevent the spread of the virus and the role of china in providing assistance to the countries of the western balkans in the fight against the pandemic, primarily as the most important or even the sole supplier of protective and other medical equipment and pharmaceutical products necessary for the treatment of the sick (beraha & jovičić, 2021). although the growing trade and expanding investments are often mentioned in the context of the deepening cooperation between the western balkans and china, it seems that investments still attract much more attention from scholars than trade. trade, again, could play a vital role in the western balkans’ efforts to promote its economic growth and more stable and balanced trade relations with china. in accordance with the above-mentioned, the main aim of the research was to analyze trade flows and patterns and investigate the trade intensity between the western balkan countries and china. in addition, the research attempted to determine the main challenges and to consider the strategic approach to their overwhelming, including discovering the measures for better exploiting the opportunities provided by trade cooperation with china. theoretical background international trade, i.e. exports and imports, is one of the key drivers of economic development (bakari & mabrouki, 2017). the scientific literature extensively discusses the relationship between trade openness and economic growth, and the majority of empirical studies' findings support the idea that trade openness promotes economic growth (çetintaş & barişik, 2009; busse & königer, 2012; huchet et al., 2018; marjanović & domazet, 2018; gurgul and lach, 2014). in addition to promoting faster growth, international trade supports productivity improvement, providing better living standards and lower income inequality (cerdeiro & komaromi, 2017). in terms of international trade significance, an enhancement of exports is of particular importance. eberhard-ruiz and calabrese (2018) claim that a country's level of export competitiveness is crucial for its successful participation in the global economy and international trade but also for managing the eventual deterioration of the trade balance. nguyen (2011) and atkinson (2013) consider exports to support increased specialization in production by more efficient resource allocation, which boosts productivity and consequently promotes more robust economic growth. countries could benefit from export-led economic elena jovičić, danijela stojanović 81 growth because it facilitates foreign exchange inflows, increases production, creates new employment opportunities, and increases the overall commercial volume (temiz dinç & gokmen, 2019). furthermore, export trade diversification is essential since it makes economies more adaptable to changes in demand, enables more effective inclusion of small and mediumsized enterprises, and promotes innovation (songwe, 2019). export-led growth is essential for boosting economic growth in developing countries (hakobyan, 2017). it may be especially significant for small (or relatively small) open economies (like western balkan countries), which rely much more on cooperation with external partners (baranenko & đukić, 2012). this confirms ilahi et al. (2019) claiming that “in the past several years, exports have contributed strongly to growth and economic convergence in many small open countries, aspiring western balkan countries to embark on an export-led growth and convergence path.” although most countries experienced the positive effects of net exports on growth in the post-crisis period, the wb region still lags behind, primarily due to “a lack of openness, reliance on low-value products, and weak structural competitiveness” (ibid). shimbov, et al. (2019), by using an export sophistication index, reveal that export sophistication has a positive and significant impact on the wb countries’ economic performance, while the research outcomes support the idea that greater involvement in global production networks, along with improved institutional environments, promotes the export enhancement and, as a result, accelerates economic growth. on the other side, authors found that this process in the wb countries “is driven more by the sophistication in medium-skill and technology-intensive manufactured goods rather than through sophistication in high-skill goods” (ibid). in this regard, bearing in mind its growing presence in the region, china appears as one of the trade partners that could encourage export growth as well as more effective involvement of the companies from the wb countries in the global value chains (gvcs). however, most of the authors (zakić, 2022; beraha & jovičić, 2021; gigov & poposka, 2022; szunomár et al., 2020; jaklič & svetličič, 2019; jacimovic, et al. 2018; yue, 2018; matura, 2019; and others) generally conclude that despite the intensive development of economic cooperation, the wb countries have not fully benefited from trade with china – trade remains unbalanced, leading to significant trade deficit growth in most countries in the region. data and methodology the paper used desk research a descriptive analysis of data on merchandise trade between six western balkans countries (albania, bosnia and herzegovina, montenegro, croatia, north macedonia, and serbia) and china. for the purpose of the research, the data was retrieved from the un comtrade, trade map, and wto statistical databases for the period 2016-2021. merchandise trade structure was observed at the harmonized commodity description and coding systems (hs) 2-digit level. for the sake of a more coherent approach, the data was collected so that china was observed as a reporting country on merchandise exports and imports (reporter), while the countries of the western balkans were considered partner countries (partner). in addition, the trade intensity index (tti) was also used in the research in order to measure how heavily the western balkan countries were trading with china. tti is defined as “the share of one country’s exports going to a partner divided by the share of world exports going to the partner” (world bank, 2010). the tii approach determines whether the value of trade between two countries exceeds or falls short of what would have been anticipated based on their relative significance in world trade by evaluating bilateral trade status based on both a country's global trade status and its trade partner's economy size (maryam et al., 2018). the mathematical definition of tii is as follows: 82 economic analysis (2022, vol. 55, no. 2, 79-90) tij = (xij/xit)/(xwj/xwt) (1) where xij and xwj are the values of the country i’s exports and of world exports to country j, while xit and xwt are the country’s total exports and total world exports respectively (world bank, 2010). an index with a value greater than one denotes a high level of trade intensity between the two economies. conversely, a lower estimate of the index (if it is less than one) denotes less bilateral trade intensity between the partner countries. results and discussions according to the un comtrade data, the total merchandise trade between the wb countries and china was steadily growing in the period 2016-2021, so the total trade volume amounted to 7.3 billion us dollars in 2021, which represents an almost threefold increase compared to 2016 (figure 1). continuous positive annual growth rates were also recorded on both the wb countries’ imports and exports sides, except for 2016 and 2018, when there was a slight y-o-y decline in total exports. robust import volume growth overshadowed an increase in exports, which resulted in a worsening of the trade balance. namely, the trade deficit significantly widened to around 3.3 billion us dollars in 2021, or it was almost 99% higher compared to 2016. figure 1. the wb-china trade dynamics over the period 2016-2022, in mil. usd source: un comtrade database compared to 2020, the total wb countries’ trade with china saw a remarkable rise of almost 40% in 2021, driven by a sharp increase in exports (87%) and a more moderate increase in imports (27%). the significant export growth contributed to the trade deficit reduction in 2021– the trade deficit increased by only 6% compared to the previous year. such an impressive dynamic determined by high y-o-y growth rates was, among other things, the result of a low base from 2020 caused by a decrease in economic activity as well as trade flows due to the negative impact of the covid-19 pandemic. however, it should be mentioned that a proactive approach enabled china to position itself as an important external participant in the western balkans region during the pandemic and accelerate bilateral trade relations. due to the success in the fight against the covid-19 virus, i.e. the speed with which it managed to restore full production after the complete lockdown of provinces and cities and take advantage of the 4% 16% 14% 15% 23% 39% 0 5 10 15 20 25 30 35 40 45 2016 2017 2018 2019 2020 2021 -4000 -2000 0 2000 4000 6000 8000 exports imports total trade balance yoy growth elena jovičić, danijela stojanović 83 increase in demand, china, for instance, became one of the few countries with which trade growth has been achieved in 2020 (beraha & jovičić, 2021). observed by individual countries, the largest share in the total trade with china in 2021 was achieved by serbia (44%), followed by croatia (32%), while the share of other countries was much more modest: albania 10%, north macedonia 8%, bosnia and herzegovina 4%, and montenegro only 1% (figure 2). in terms of exports, the dominant position of serbia was even more pronounced, with a share of as much as 49%, while the shares of north macedonia, croatia, albania, bosnia and herzegovina, and montenegro were 18%, 17%, 8%, 7%, and 1% respectively. figure 2. the share of individual countries in total trade between the wb countries and china source: un comtrade database during the period 2016-2022, serbia was the only country that recorded a continuous annual increase in total trade (see figure 3), but also in both exports and imports, confirming the fact to be the most important chinese trade partner among the other five countries. however, apart from montenegro, the positive growth rates of total trade in 2021 compared to 2020 were achieved by all countries: north macedonia and serbia’s trade with china saw an increase of 55% and 52%, respectively, followed by bosnia and herzegovina (42%), croatia (36%), and albania (16%), while trade between montenegro and china reduced by 37%. figure 3. the western balkans-china total trade annual growth rates source: un comtrade database 0,44 0,32 0,1 0,08 0,04 0,01 serbia croatia albania north macedonia bosnia and hercegovina montenegro 2016 2017 2018 2019 2020 2021 -60 -40 -20 00 20 40 60 80 100 albania bosnia & herzegovina montenegro croatia north macedonia serbia 84 economic analysis (2022, vol. 55, no. 2, 79-90) based on the analysis of the trade structure, it could be concluded that there were no significant changes during the observed period. the low-value-added goods were the backbone of the western balkan countries’ exports, while the more sophisticated goods were imported from china (table 1). table 1. the western balkans-china exports/imports composition in 2021: key commodity groups* exports imports albania • ores, slag and ash (55%) • iron and steel (24%) • articles of apparel and clothing accessories, not knitted or crocheted (9%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (18%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (12%) • furniture; bedding, mattresses, mattress supports, cushions and similar stuffed furnishings (8%) bosnia & herzegovina • articles of apparel and clothing accessories, not knitted or crocheted (26%) • wood and articles of wood; wood charcoal (26%) • ores, slag and ash (17%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (27%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (14%) • pharmaceutical products (11%) croatia • ships, boats and floating structures (50%) • wood and articles of wood; wood charcoal (16%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (12%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (24%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (15%) • toys, games and sports requisites; parts and accessories thereof (7%) montenegro • ores, slag and ash (56%) • beverages, spirits and vinegar (14%) • optical, photographic, cinematographic, measuring, checking, precision, medical or surgical instruments and apparatus; parts and accessories thereof (13%) • iron and steel (12%) • plastics and articles thereof (11%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (11%) north macedonia • iron and steel (61%) • miscellaneous chemical products (11%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (10%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (26%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (21%) • miscellaneous chemical products (6%) elena jovičić, danijela stojanović 85 exports imports serbia • ores, slag and ash (39%) • copper and articles thereof (31%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (10%) • machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (34%) • electrical machinery and equipment and parts thereof; sound recorders and reproducers, television image and sound recorders and reproducers, etc. (21%) • articles of iron or steel (7%) * the percentage share of major commodity groups in wb countries’ imports from/exports to china source: authors’ based on the trade map data in terms of imports, there was a remarkable average annual growth rate over the previous five years in imports of pharmaceutical products in all wb countries except albania and croatia: montenegro had a 938% increase, bosnia with 210%, serbia with 138%, and north macedonia with 120%. on the export side, serbia had a record average annual growth rate of copper exports of 809%, while albanian iron and steel exports increased by 248% on average. despite these positive tendencies, the share of the wb countries’ goods in total chinese imports is still negligible, with about 3% in 2021. observed by the individual countries, it is even less. if taking a look at the sum of the main three export commodity groups in each country, not one country reached even 1% in the imports of china. for instance, even the sum of the 3 top commodity groups (ores, slag and ash + copper and articles thereof + electrical machinery and equipment and parts thereof, etc.) of exports of serbia (that otherwise has a leading position among other wb countries) was less than 1% of total imports of china in 2021. trade intensity index development it was chosen to employ the trade intensity index (tti) approach in the study to carry out a more thorough analysis of trade relations between western balkans and china. as already mentioned in the methodology part, this approach enables the assessment of the bilateral trade intensity level based on the country’s status in international trade and its trade partner’s economy size (jovičić et al., 2020). as can be seen in table 2, although the tti value has been rising over the last six years, reflecting the fact that the trade relations between the wb countries and china have been strengthened, the tii value of 0.24 in 2021 indicates that trade between given partners is “under-represented.” this implies that there is undoubtedly considerable room for improvement. table 2. trade intensity index of the wb region and china 2016 2017 2018 2019 2020 2021 0.14 0.16 0.12 0.15 0.18 0.24 source: authors’ calculations based on un comtrade and wto databases the evaluation of tti between the individual wb countries and china gives a more complicated picture (table 3). namely, the value of tti has been changing across the countries during the period 2016-2022. albania and montenegro were the only two countries that closed (albania) or surpassed (montenegro) the value of tti numerically equal to one in some particular years. trade between the rest four countries (bosnia & herzegovina, croatia, north macedonia, and serbia) and china has been underrepresented. meanwhile, the value of tti has been increasing in the last few years. 86 economic analysis (2022, vol. 55, no. 2, 79-90) table 3. trade intensity index of the wb individual countries and china albania bosnia & herzegovina montenegro croatia north macedonia serbia 2016 0.66 0.08 0.93 0.12 0.10 0.11 2017 0.82 0.09 1.72 0.11 0.15 0.12 2018 0.34 0.10 0.97 0.11 0.06 0.11 2019 0.35 0.11 0.96 0.08 0.19 0.17 2020 0.28 0.10 1.34 0.07 0.29 0.22 2021 0.42 0.13 0.22 0.12 0.34 0.32 source: authors’ calculations based on un comtrade and wto databases main challenges hampering the trade relations enhancement regardless of the deepening economic relations with china, which was, among other things, reflected in an increase in the trade volume, the wb countries still face many challenges and issues that should be overwhelmed. one of the main challenges is the fact that despite the intensive dynamic of trade relations development with china, its share in the wb countries’ total trade still remains at a rather modest level of around 8%. in 2021, china's participation in total imports of the wb was 11%, and in exports only 3%, while the eu appeared as the most important foreign trade partner of the countries of the western balkans with a share of 81% in exports and 58% in imports (eurostat, 2022). another issue is the fact that the trade is strongly in favor of china, which means that the countries of the wb record a continuous deficit. this fact in itself would not be so worrying because china generally has a positive balance with most countries around the world, but the challenge is that when it comes to the wb region, the trade deficit with china has been steadily deepening over the last few years, and this is particularly relating to serbia, croatia and albania (figure 4). figure 4. the western balkans-china trade balance, in bln. usd source: un comtrade database one of the key obstacles that remain is poorly diversified exports, which applies to all western balkans countries. namely, the backbone of exports in the previous period comprised 2016 2017 2018 2019 2020 2021 -002 -002 -001 -001 -001 -001 -001 000 000 000 000 000 albania bosnia & herzegovina montenegro croatia north macedonia serbia elena jovičić, danijela stojanović 87 ores, iron and steel, coppers, wood and wood products, as well as construction materials such as sand and concrete. all these products represent products with low added value, which means a very unfavorable position for the wb countries compared to china. furthermore, trade cooperation is often slowed down by barriers to market access like subsidies, capital restrictions on foreign investments, lack of transparency, and complicated regulation in china. the delay in the agreements’ implementation, which refers primarily to acquiring export licenses, could also be mentioned in this concern. a challenge that also defines trade cooperation is the absence of a strategic approach and lack of institutional support, which is the problem all six countries continuously face. in addition to that (but in some manner as a consequence of the lack of a strategic approach), “insufficient access to information, language and cultural barriers, mistrust and risk of fraud” appear as serious obstacles as well (gigov & poposka, 2022). the global market situation should also be considered in the context of the key obstacles. namely, the trade flows, as well as global value chains, had barely recovered after the disruptions caused by the covid-19 pandemic when the ukraine-russian federation conflict and consequent energy crisis took over the role of the major blow to the global economy. the growing geopolitical tensions and economic turbulences have already had a negative impact on the gvcs and global trade flows, which means the new disruptions in the trade relations between china and other countries worldwide, including the wb region, could also be expected in the forthcoming period. recommendations for the overwhelming of key obstacles considering the above-discussed key challenges, one can get the impression that the prospects for the development of trade relations in the upcoming period are not very promising. however, it should be borne in mind that there is still a significant potential that, with an appropriate strategic approach, the wb countries can use to improve the current situation. regarding the opportunities, the size of the market should be taken into account, as well as the growth of the purchasing power of chinese consumers, which means that there is definitely room for more intensive promotion of domestic companies to enter the chinese market. with full appreciation of china's economic superiority, the countries of the western balkans have certain comparative advantages on which the further development of trade relations with china should be based. this primarily refers to the price competitiveness of highly educated human resources in the field of advanced technologies and potential in the field of agricultural production and processing food (beraha & jovičić, 2021). it is necessary to encourage the attraction of investments in strategically important sectors that could produce greater added-value products. in this regard, work should be done to promote the inclusion of the countries of the western balkans in the global value chains of chinese producers and, in this way, also contribute to increasing exports of higher value-added products and helping productivity gains and income growth. having in mind similar trade patterns of the western balkan countries and close economic and trade cooperation inside the region, it is worth considering the development of a joint tactical approach to exports enhancement, the removal of trade barriers, and to the better positioning of the domestic companies on the chinese market. moreover, the cooperation in this context should be deepened not only among the wb but also with other countries of the cee region since most of them are participating in the china-cee mechanism. the authors completely agree with the crucial recommendations offered by gigov and poposka (2022) regarding the fact that “all wb countries, except serbia, have a limited understanding of china in terms of its goals, opportunities, politics and public policies”, which appears as one of the major challenges that should be overwhelmed. namely, gigov and poposka (2022), in this context, conclude that it is necessary to acquire expertise and knowledge and 88 economic analysis (2022, vol. 55, no. 2, 79-90) create a strategy that will enable policymakers to make decisions based on current and adequate information. along with attracting chinese investments, western balkan policymakers should be more proactive in initiating negotiations to improve trade relations and promote exports to maximize national interests. it should be mentioned in this regard that serbia was the first country in the wb region to take an important step on the path of the development of the strategic approach towards trade relations encouragement with china by the announcement of the free trade agreement conclusion that should be signed by the end of 2022. currently, it is difficult to predict all benefits and risks the fta will bring since all details and obligations are yet to be specified. nevertheless, it is expected that the fta would further strengthen the economic relations between serbia and china by delivering enhanced investment and trade opportunities. conclusion involvement in international trade flows contributes to the improvement of competitiveness and encourages economic growth and development of national economies. international trade is of special importance for developing countries since it, among other things, enables the realization of the effects of economies of scale, a higher degree of capacity utilization, attracting foreign direct investments, increasing employment, and technological advancement. trade undoubtedly represents a very important aspect of economic cooperation between the countries of the western balkans and china, and the deepening of relations during the past decade has resulted in the continuous growth of bilateral trade. whereby the intensification of trade cooperation and the acceleration of foreign trade occurred, especially after the accession of the countries of the western balkans to the belt and road initiative, i.e. the china-cee mechanism, which is an integral part of the belt and road initiative aimed at the development of china's economic relations with central and eastern europe. regardless of the deepening economic relations with china, which was, among other things, reflected in an increase in the trade volume, the wb countries still face many challenges that should be overcome. primarily, it refers to the deepening trade deficits, poorly diversified exports, lack of the appropriate strategic approach and support to the domestic companies willing to enter the chinese market, and, finally, the situation on the global market. in the forthcoming period, efforts should be made to attract chinese investments in strategically important sectors as well as to promote the inclusion of domestic companies in the gvcs of chinese producers in order to enable greater production of higher added value products and as well as contribute to export diversification. of great importance also is the development of comprehensive strategies and more proactive western balkan policymakers’ approach to export promotion and initiating negotiations that would lead to the enhancement of economic relations with china based on better 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(2012). securities market theory: possession, repo and rehypothecation. journal of economic theory, 147(2), 477–500. d’amico, s., fan, r., & kitsul, y. (2018). the scarcity value of treasury collateral: repo-market effects of security-specific supply and demand factors. journal of financial and quantitative analysis, 53(5), 2103-2129. longstaff, f. a. (2000). the term structure of very short-term rates: new evidence for the expectations hypothesis. journal of financial economics, 58(3), 397-415. covid-19 and serbian stock market response: a panel data approach bojan đorđević1 | sunčica stanković14f* introduction literature review research methodology research methods results of econometric tests conclusion references the quest towards obtaining a competitive advantage in organizations through managing the human capital nikaela wilson1* | iva vuksanović herceg25f* introduction the concept of human capital, elements and approaches for achieving competitive advantage in organizations human capital elements for achieving competitive advantage in organizations employees’ natural and personal skills employees’ commitment employees’ knowledge employees’ innovative skills intellectual capital and competitive advantage the two common types of competitive advantage the resource base perspective to achieve competitive advantage approaches based on the theory of human capital competitive advantage and managing human capital industry 4.0 and human capital in achieving competitive advantage concluding comments does the increase in the number of registered patents affect economic growth? evidence from romania and bulgaria ivana domazet16f* | darko marjanović1 | deniz ahmetagić2 | marija antonijević1 introduction literature review data analysis and findings conclusion acknowledgements references business process innovation of serbian entrepreneurial firms mihailo paunović1 | marija lazarević-moravčević1 | marija mosurović ružičić17f* introduction theoretical background data and methodology results and discussion conclusion acknowledgements references key features and challenges of the china-western balkan countries merchandise trade development elena jovičić18f* | danijela stojanović1 introduction theoretical background results and discussions trade intensity index development main challenges hampering the trade relations enhancement recommendations for the overwhelming of key obstacles conclusion acknowledgements references sedmi aa1* | bb2 | vv3 osmi aa1* | bb2 | vv3 deveti aa1* | bb2 | vv3 deseti aa1* | bb2 | vv3 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp59-71 original scientific paper estimation of price elasticity of demand for cigarettes in bosnia and herzegovina – macro data analysis dragan gligorić1* | saša petković1 | anđela pepić2 | jovo ateljević1 | borislav vukojević3 1 university of banja luka, faculty of economics 2 university of banja luka, entrepreneurship and technology transfer centre 3 university of banja luka, faculty of political science abstract tobacco consumption continues to be behavior engaged in by a large percentage of bosnia & herzegovina (bih) citizens. according to the official statistics, nearly half of the state’s adults, that is about 1,200,600 people, consume tobacco products on a daily bases. the state excise policy is one of the main available tools for reducing smoking prevalence because cigarette prices are under the direct impact of this policy. after its introduction in the second half of 2009, the specific excise tax on cigarettes has increased every year and was the main driver of cigarette price increase. in order to provide research-based evidence for more effective tobacco taxation policies in bih, in this paper we estimate the price elasticity of demand for cigarettes using the macro-level data for the period 2008 to 2017, on a semi-annual basis. the results have shown that the increase in prices of cigarettes has a statistically significant impact on cigarette consumption, at a level of 1%. the estimated price elasticity coefficient is in the range from -0.71 to -0.83, depends on the selected control variables used in the model. it means that the increase in real cigarette prices for 10% led to a decrease in cigarette consumption in the range from 7.1% to 8.3%. key words: demand, cigarettes, prices, elasticity, income, excise jel classification: e20, h20, c13 introduction smoking is an endemic problem in bosnia and herzegovina (bih). in 2016, the smoking prevalence in bih was close to 40% with a significant difference between men (46.9%) and women (28.5%), yet, the gender gap has been diminished over time, as the smoking prevalence is increasing among women (world bank, 2018). among youth, tobacco use prevalence among girls (9.7%) is significantly lower than among boys (15.5%). bih is among the top 10 countries in the world for cigarettes consumption (world atlas, 2018). level of tolerance towards smoking in bih, like in the neighboring countries, is relatively high yet with a tendency to decline. research evidence shows that smoking is among the leading preventable cause of death worldwide. bosnia and herzegovina is not an exception. based on the current percentage of people smoking in bih, premature deaths attributable to smoking are projected to be as high as 600,000 in the next 40 years (world health organization, 2016). * corresponding author, e-mail: dragan.gligoric@ef.unibl.org 60 economic analysis (2020, vol. 53, no. 1, 59-71) the state excise policy is one of the main available tool for reducing smoking prevalence (by reducing smoking initiation and increasing smoking cessation) and smoking intensity because the cigarette prices are under direct impact of this policy. the effects of tobacco taxation on smoking prevalence and smoking intensity depend on the price elasticity of demand for cigarettes. the first attempt to empirically estimate impact of tobacco taxes on the demand for of tobacco product in developing country was made by chapman and richardson (1990). using annual data for the period 1973-1983 they estimated excise tax elasticities of –0.71 for cigarettes and –0.50 for other tobacco products. previous research indicates that the price elasticity of demand for tobacco products in high-income countries is in the range from – 0.25 to – 0.50, with many clustering around – 0.40. a modest number of research conducted in low and middle-income countries (such as bih) have shown that demand for tobacco product is more responsive to changes in prices, estimated price elasticity has fallen mostly in the range between 0,5 and -1 (chaloupka et al., 2000; selvaraj et al., 2015). recent research conducted in the republic of serbia, based on aggregate level data for period 2002-2016, showed that price elasticity ranged between -0.76 and -0.62 (jovanovic, o. et al., 2018). so the larger effect of price increase on demand for tobacco can be expected among countries with lower levels of income, but also among socio-economic groups with lower levels of income, and among youth (al-sadat, n., 2005). this implies that state excise policy in these countries can be effective in reducing tobacco consumption. nevertheless, only a few low and middle-income countries have calculated their country-specific estimates of the price responsiveness of the cigarette market. lack of data or research capacity is often the reason why this information is not available (ross and al-sadat, 2007). the specific excise on cigarettes introduced in bih in 2009 and has increased every year. ad valorem excise, calculated on the retail price of cigarettes, stayed at the same level of 42% retail price. specific excise increased, from an initial level of 3.83 eur per 1000 cigarettes stick in the 2009 to 34.5 eur per 1000 cigarettes stick in 2017. this is the main reason for the increase in the cigarettes prices for about 175%, in the period 2008-2017. however, given the low industry price, retail cigarette prices in bih are among the lowest in europe. at the same time, budget revenues from specific and ad valorem excise were constantly increasing, despite a significant drop in consumption of cigarettes. regardless of observed the positive trends in cigarettes consumption and budget revenues, policy makers are often in a dilemma whether or not to continue with the trend of increasing specific excise tax. in order to provide research-based evidence for more effective tobacco taxation policies in bih, it is necessary to estimate prices’ elasticity. in this study, we developed the econometrics model of cigarettes demand based on the macro level data. to our best knowledge, this is the first estimate of the price elasticity of cigarettes demand for bih. following this introduction, the second section presents the data related to cigarettes consumption in bih, the short descriptive analysis and methodology. the third section presents and discusses the results of the regression analysis, while the fifth section concludes the paper. data and method to estimate the impact of an increase in the price of cigarettes on cigarette consumption, we use data for consumption and price of cigarettes. consumption of cigarettes accounts for over 97% of total tobacco products in bih in 2017 (indirect taxation authority of bih, 2018)1 and conclusions based on the analysis of consumption of cigarettes are valid and representative. data related to cigarette consumption and prices in bih are available for the very short period (2008-2017). we have collected data for the last ten years on the semi-annual level, to have 1 this estimate is based on only reported consumption. all informal sales, such as of cut tobacco on the street or in the farmers market, is not part of this estimation due to the lack of a reliable and unique assessment of the illicit market. dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 61 sufficient data for implementing time-series analysis. this period of analysis is relevant for bih, taking into account that specific excise on cigarettes was introduced in 2009. the time-series data for the period 2008-2017 are summarized in table 1. the per-capita consumption of domestic and imported cigarettes is calculated based on the semi-annually data of the number of issued excise stamps on tobacco and cigarettes sticks, provided by indirect tax authority of bih and the size of the adult population (aged 15 years or older). the excise stamp is issued for each cigarettes pack, and therefore, the number of issued excise stamps is equal to the number of cigarettes pack. consumption of cigarettes in the sticks is derived from the number of cigarettes per pack which mainly contain 20 sticks, but there exist packs with 18 and 24 sticks as well2. the indirect tax authority of bih provided us with detail semi-annual data, so we were able to calculate the exact number of cigarette sticks sold. the real tobacco consumer price index (cpi) we calculated using the average price of cigarettes and general cpi in bih. calculation of average price of cigarettes is based on the total value of issued excise stamps for domestic and imported cigarettes and the number of cigarettes (value/quantity), on the semi-annually basis, declared for sale in bih3. hence, we used official data, provided by indirect taxation authority, on the number of cigarettes and the total value of cigarettes to calculate average prices of cigarettes. then, based on the average prices of cigarettes, we created nominal tobacco price index. the average price of cigarettes pack in the first period (2008p1) is used as a base value and tobacco cpi index (2008p1=100) for the first period got value 100. for each next period, we calculated index as the ratio between the average price per pack for that period and the average price per pack in the base period, multiplied by 100. to obtain real tobacco cpi, we deflated it using general cpi in bih4. the purchasing power is one of the main determinants of aggregate demand and demand for a particular product. the most often used measure for purchasing power in the country is real income measured by real gross domestic product (gdp) per capita. we have also used real gni per capita as a proxy for real income. bih has the significant amount of unilateral transfers from abroad, and it means that gni per capita (gdppc + unilateral transfers pc) could be a better approximation of income for the estimation demand for cigarettes. the data on real income is available in the online publication of the agency of statistics of bih on a quarterly basis and we recalculate it on semi-annual basis. data on unilateral transfer is available in the balance of payments statistic in central bank of bih database also on quarterly basis and we recalculate it on semi-annual basis. also, as a proxy for purchasing power, we used real net average wages, provided by the national statistics agency. tobacco control policies other than cigarette taxes can also be an important determinant of demand for cigarettes (ross and al-sadat, 2007). we created two variables related to tobacco control environment in bih between 2008-2017. first tobacco control variable is “tlaw”, which is related to the introduction of law on tobacco of bosnia and herzegovina in 2010. law on tobacco has introduced stricter conditions in the field of tobacco production and trade. variable tlaw takes the value of 0 for the period 2008p1 – 2010p1 and value of 1 for the period 2010p22017p2, because it came into the force in may 2010 5. second tobacco control variable is “aban”, 2 until second half of 2014, every cigarette pack contained 20 cigarettes stick. since then, cigarette packs with either 18 or 24 cigarette sticks accounted on average only 0.66% of all sold cigarettes. therefore, the difference in number of cigarettes stick in cigarettes pack (two below and four above) has not statistically significant influence on tobacco cpi, during the calculation average price of cigarettes pack. 3 indirect taxation authority provided us with detailed data of the value and the number of issued excise stamps, number of cigarettes sticks (corresponding to the particular excise stamps) on semi-annual basis. 4 we calculated semi-annual general cpi (2008p2=100) using monthly inflation rates which are available on http://www.bhas.ba. 5 law on tobacco adopted in parliament bih in mid-april 2010, came into the force in may 2010, therefore its possible effect on cigarettes consumption could be expected in second half of 2010. 62 economic analysis (2020, vol. 53, no. 1, 59-71) and it reflect the adoption of code on commercial communications in december 2015 6. this code prohibited all forms of commercial communications related to cigarettes and other tobacco products, guns, firearms and pyrotechnical means, as well as opium drugs. variable aban takes value of 0 for the period 2008p1 – 2015p1 and value of 1 for the period 2015p2-2017p2. this two variables, “tlaw” and “aban” are summarized in tobacco control index “tcindex”. therefore, “tcindex” is the sum of two dichotomus indicators “tlaw” and “aban” (ross & al-sadat, 2007). therefore, variable tcindex takes value 0, for the period 2008p1-2010p1, value 0 for the period 2010p1-2015p1 and value 2 for the period 2015p2-2017p2. table 1. cigarette consumption, cigarettes prices and real income in bih, 2008p1 – 2017p2 period consumption of cigarettes (in eur) number of issued excise stamps (number of cigarettes pack) average prices of cigarettes (per pack) real tobacco cpi consumption (cigarettes per adult) real income (gdp pc) in eur real disposable income (gdp pc) in eur real net average wages (in eur) 2008 p1 212,670,325 261,540,001 0.81 100.00 1663 1789.1 2111.2 2229.0 2008 p2 240,964,705 299,359,999 0.80 99.33 1904 1884.2 2231.6 2378.4 2009 p1 229,652,884 282,960,000 0.81 101.73 1801 1765.0 2057.5 2468.4 2009 p2 244,288,614 251,930,000 0.97 119.66 1604 1792.8 2090.0 2433.6 2010 p1 263,831,212 239,180,000 1.10 134.96 1525 1776.7 2031.2 2421.6 2010 p2 218,533,349 215,344,360 1.01 121.46 1373 1794.2 2081.4 2395.2 2011 p1 294,236,356 232,391,160 1.27 149.20 1493 1827.2 2073.5 2388.6 2011 p2 305,416,626 241,090,000 1.27 147.70 1549 1839.2 2105.9 2382.0 2012 p1 282,548,074 195,360,000 1.45 167.19 1265 1861.6 2099.3 2377.8 2012 p2 317,968,842 218,854,500 1.45 166.37 1417 1848.1 2133.8 2362.2 2013 p1 293,572,563 180,221,775 1.63 186.88 1175 1878.8 2114.2 2358.0 2013 p2 245,014,137 148,870,000 1.65 191.16 971 1974.4 2289.2 2407.8 2014 p1 251,223,010 142,299,500 1.77 205.45 935 1925.4 2175.6 2406.6 2014 p2 290,028,786 159,298,000 1.82 212.48 1047 1979.7 2305.5 2419.2 2015 p1 290,416,345 147,811,500 1.96 229.96 978 2019.3 2267.3 2423.4 2015 p2 301,082,405 151,360,000 1.99 235.08 1000 2070.3 2339.5 2449.8 2016 p1 271,521,809 127,055,000 2.14 254.04 841 2024.3 2251.9 2473.2 2016 p2 294,837,486 137,330,000 2.15 254.46 909 2224.0 2482.4 2489.4 2017 p1 272,084,486 118,815,000 2.29 269.58 788 2052.8 2299.7 2490.0 2017 p2 293,329,175 124,440,000 2.36 275.89 826 2349.1 2612.3 2493.6 source: world bank data, 2018; indirect taxation authority of bih, 2018 to generate “per person” measures we used a number of inhabitants from the world bank database, due the poor quality of population data from the national statistics agency. also, the lack of official population statistics in bih has prevented us from using other control variables (such as male to female ratio, education, etc.). average nominal price of cigarettes significantly increased in the last ten years (for about 175%). excise duties (ad valorem) represented 49% of the price (before vat) until the introduction of specific excise in second half of 2009. by introduction of specific excise, the base for ad valorem excise calculation is changed, from price before vat, to retail price with vat. as a consequence, the rate of ad valorem excise changed from 49 % of the price before vat to 42% of retail price (price with vat) to keep roughly the same ad valorem excise burden of the retail price. specific excise duties increased from an initial level of 3.83 eur per 1000 cigarettes stick 6 the code on commercial communication came into force in january 2016. dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 63 in the 2009 to 34.5 eur per 1000 cigarettes stick in 2017, which is the main reason for the increase in cigarettes prices. this trend is visible in graph 1. figure 1. average nominal prices of cigarettes (per pack) source: indirect taxation authority of bih, 2018 along with the rise in the price of cigarettes, caused by the increase in excise duties, consumptions of cigarettes per adult decreased rapidly. the trend is shown on graph 2. consumption of cigarettes in the half-year period decreased from the value of 1904 per adult in the second half of 2008 to 826 cigarettes per adult in second half of 2017. 1663 1904 1801 1604 1525 1373 1493 1549 1265 1417 1175 971 935 1047 978 1000 841 909 788 826 400 600 800 1000 1200 1400 1600 1800 2000 2008 p1 2008 p2 2009 p1 2009 p2 2010 p1 2010 p2 2011 p1 2011 p2 2012 p1 2012 p2 2013 p1 2013 p2 2014 p1 2014 p2 2015 p1 2015 p2 2016 p1 2016 p2 2017 p1 2017 p2 consumption of cigarettes per adult (in stics) figure 2. consumption of cigarettes per adult (in sticks) source: indirect taxation authority of bih, 2018 64 economic analysis (2020, vol. 53, no. 1, 59-71) to estimate the demand for cigarettes, we used the following conventional model in linear functional form: const = α + β0 rtcpit + β1 rincomt + β2 tcontrolt + εt where const is aggregate consumption of cigarettes per capita, rtcpit is real tobacco cpi, and rincomt is real gdp per capita (alternatively we used also gni per capita or real wages), tcontrol are tobacco control variables. we used all variables in logarithm (log-log model)7, except tobacco control variables. tobacco control variables are dummy variables (tlaw and aban) or the sum of dummy variables (tcindex) and we put them directly in the regression, without logging. before testing for unit roots, because we use semi-annually data, we have to test our variables for the seasonal components. semi-annually, quarterly and monthly data usually tends to have seasonal components in variations. the seasonality becomes an issue in analysis of time series stationarity, as typical unit root tests do not deal with possibility of seasonal integration. autocorrelation function is a useful tool for analysis of presence of seasonality in time series. high value of autocorrelation coefficient at season lag s indicates presence of additive seasonality, while high and slowly declining autocorrelation coefficients on seasonal lags s, 2s, 3s, etc. indicate multiplicative seasonality. in addition, very high (close to one) and slowly declining autocorrelation coefficients on seasonal lags s, 2s, 3s, etc. of the time series after removing trend component (i.e. using first difference) also indicate high probability of seasonal integration (mladenovic et all., 2005). in order to analyze presence of seasonality, we estimate autocorrelation of up to forth order of logged time series (recommended level is at least 2s lags), both for level and first difference as shown in the table below: table 2. autocorrelation coefficients variable level first difference ac(1) ac(2) ac(3) ac(4) ac(1) ac(2) ac(3) ac(4) lcons 0.832 0.659 0.515 0.376 -0.371 -0.003 -0.117 -0.057 lrtcpi 0.851 0.707 0.546 0.411 -0.617 0.235 -0.211 0.335 lrincome 0.598 0.688 0.43 0.37 -0.626 0.354 -0.124 0.066 lrdincom 0.466 0.682 0.313 0.39 -0.697 0.536 -0.378 0.324 lrwage 0.44 0.114 0.083 0.025 0.316 -0.144 -0.127 -0.119 the estimated values of the autocorrelation function for the first differences reveals that time series most likely are not seasonally integrated, but lrtcpi, lrincome and lrdincom likely have seasonal component. as type of seasonality is hard to identify solely on the basis of autocorrelation in case of semi-annual data, we run autoregressive regressions up to second order, including also seasonal dummy to identify presence of the additive seasonality and seasonal autoregressive component to identify presence of the multiplicative seasonal component. the results of estimation for seasonal dummy and seasonal autoregressive component (coefficients for constant, trend and common autoregressive components are 7 in many economic situations (particularly price-demand relationships), the marginal effect of one variable on the expected value of another is linear in terms of percentage changes rather than absolute changes. in such cases, applying a natural log to both dependent and independent variables may be appropriate. relationship where both y and x are log-transformed, are commonly referred to as elastic in econometrics, and the coefficient of log x is referred to as an elasticity also, we can directly (from log-log model) obtain standard errors of estimated coefficients without using bootstrap procedure (wilkins et all, ruso et all, 2008; mulugeta et all., 2013). dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 65 omitted) shows that logged price index has additive seasonality, while real income and real disposable income have multiplicative seasonality, as shown in the table below. table 3. seasonal dummy and seasonal autoregressive component original lcons lrtcpi lrtcpi_sa lrincome lrincome_sa lrdincom rdincom_sa lrwage s_2 0.0565 -0.0564** -0.001 0.0557 -0.000 0.0617 -0.000 0.0014 (0.0328) (0.0189) (0.0110) (0.0497) (0.0023) (0.0397) (0.0021) (0.0026) sar(2) -0.0541 -0.4518 -0.454 0.5969*** -0.520* 0.4050** -0.354 0.1944 (1.4259) (0.3080) (0.3023) (0.1565) (0.2786) (0.1720) (0.3140) (0.3318) we use tramo/seats statistical tool, being the only software solution that supports seasonal adjustment of the semi-annual time series, to eliminate seasonality from price index and income variables. then we rerun autoregressive regressions on the seasonally adjusted data for these three variables (in the table indicated with sa suffix). after adjusting, seasonal components have been removed from price index and real disposable income, while seasonality still remained in real income, but statistical significance declined. table 4. seasonally adjusted variables period/ variable 2008 p1 2008 p2 2009 p1 2009 p2 2010 p1 2010 p2 2011 p1 2011 p2 2012 p1 2012 p2 rincom 1842.61 1836.41 1800.14 1777.33 1784.55 1796.51 1824.70 1845.69 1855.49 1857.71 rdincom 2187.18 2163.17 2107.86 2060.66 2055.53 2066.30 2086.21 2097.52 2111.85 2114.26 rtcpi 96.43 103.20 98.12 124.33 130.00 126.35 143.96 152.97 162.17 171.39 period/ variable 2013 p1 2013 p2 2014 p1 2014 p2 2015 p1 2015 p2 2016 p1 2016 p2 2017 p1 2017 p2 rincom 1876.43 1975.24 1931.36 1976.55 2030.42 2043.45 2084.36 2134.18 2160.64 2230.49 rdincom 2160.37 2226.28 2235.58 2263.51 2303.41 2294.52 2327.28 2379.85 2416.93 2484.73 rtcpi 182.26 195.87 201.31 216.94 225.91 239.56 249.93 258.95 265.57 280.53 having two variables with no seasonal component and three variables with seasonal component, we proceed further analysis with seasonally adjusted data for price index, real and real disposable income to avoid effects of seasonality on results of regression. we applied the dickey-fuller test for unit root on a logarithmic data (ateriou and hall, 2016, p.361). table 5. unit root test variable dickey‐fuller test for levels test statistics results consumption (lcons) -4.224 integrated at zero order i (0) real tobacco cpi (lrtcpi), seasonally adjusted -3.170 integrated at zero order i (0) real gdp pc (lrincom), seasonally adjusted -2.282 integrated at first order i (1) real gni pc (lrdincom), seasonally adjusted -2.898 integrated at first order i (1) real wages (lrwage) -3.914 integrated at zero order i (0) dickey-fuller test indicates that real income and real disposable income have unit roots in levels, but not in the first differences, so we can conclude that these three time series are first order integrated. 66 economic analysis (2020, vol. 53, no. 1, 59-71) regarding to the results of unit root test, which indicate that our variable are integrated at zero order and first order, we can apply two econometrics model:  the ordinary last squares (ols) on time series data, when we use variables in levels if they are i(0) and variables in first difference if they are i(1). due to the fact that variables which are integrated i (1) are logged real gdp and logged real disposable income their first differences (dlrincom and dlrdincom) are real growth rates of gdp and real growth rates of disposable income. consequently, our differenced variables represent a significant economic variable and can be used in ols estimation.  the autoregressive distributed lag (ardl) model which is preferable when dealing with variables that are integrated of different order, i(0) and i(1). the reparameterized result gives the short-run dynamics and long run relationship of the considered variables. if we have very short time series, ols model, if it can be applied, give much more reliable results than ardl (giles, 2013). in this analysis, we use ordinary last squares (ols) on time series data, due to the very short time series (10 years and corresponding series of 20 semiannually data). results we estimated several versions of our model. as a proxy for real income, we use real gdp, but also real disposable income, due to the significant amount of inward unilateral transfers from abroad, which significantly affect purchasing power in bih. the results of unit root test suggest us to use income variables in their first difference, which are in the fact real growth rates. because of the unexpected insignificance of this two proxy for real income, we also used real net average wages to check our results. we started with only two independent variables, real tobacco cpi (seasonally adjusted) and real income growth rate (proxy by real gdp pc growth rate, seasonally adjusted) in order to estimate the elasticity of demand for cigarettes. then, we introduced tobacco control variable in the model, one by one. first, we introduced variable tlaw, and then aban. at the end, we estimated the model which is the summary for all tobacco control polices, “tcindex”. the results for different versions of our model are summarized in table 6. each of our models includes income and prices, but tobacco control policy variables have introduced in the model one by one. as we write above, we used all variables in logarithm except tobacco control variables. these results suggest that real prices of tobacco products have a negative and statistically significant impact on the consumption of cigarettes, at 1% level of significance. this result is in line with our expectation. the increase in cigarettes prices for 1% led to a decrease in cigarettes consumption by in the range of 0.78% to 0.84%. the regression coefficient of real income growth is positive, which is in line with our expectations, but this coefficient is not statistically significant. table 6. linear demand model for cigarettes – (real income growth is proxied by gdp pc growth rate) variables (1) (2) (3) (4) lcons lcons lcons lcons lrtcpi -0.827*** -0.778*** -0.839*** -0.790*** [0.077] [0.133] [0.101] [0.097] dlrincome 0.250 0.342 0.189 0.215 [1.404] [1.454] [1.479] [1.431] tcindex -0.029 [0.064] tlaw 0.015 dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 67 variables (1) (2) (3) (4) lcons lcons lcons lcons [0.076] aban -0.043 [0.066] constant 11.355*** 11.131*** 11.408*** 11.173*** [0.392] [0.635] [0.482] [0.487] observations 19 19 19 19 r-squared 0.913 0.914 0.913 0.916 f statistic (prob.) 0.000 0.000 0.000 0.000 d-w d-statistic 2.061 1.928 2.120 2.002 breusch-pagan / cook-weis. test for heter. (prob > chi2) 0.809 0.832 0.763 0.769 jb test (prob.) 0.890 0.921 0.876 0.916 ramsey reset test (prob.) 0.763 0.721 0.741 0.823 multicolinearity test (vif) 1.50 3.28 2.06 1.83 standard errors in brackets *** p<0.01, ** p<0.05, * p<0.1 our control variables, which represent implemented tobacco control policy in bih, are not significant. their introduction in the model did not improve the model, which is shown by adjusted r-square. including different control variables in our model did not lead to significant changing in the value of price elasticity coefficient and we can conclude that our estimated coefficient of elasticity is stable. the validity of the overall regression was confirmed by f statistics whose probability is 0.000, or less than 0.01, and at the level of 1% of significance, we can say that the estimated model is statistically significant. independent variables explain more than 91% variance in the dependent variable, which shows adjusted r-squared. a lot of bih residents are employed or were employed in western europe. as a result, unilateral transfers from abroad significantly contribute to the domestic purchasing power of bih household. in the last ten year, the share of unilateral transfers in real gdp is about 15%, which is visible from the table 1 if we compare gdp pc and gni pc. taking into account this fact, we suspected that the insignificance of real income growth rate measured by real gdp pc growth rate is the result of using the wrong variable for the measuring purchasing power. therefore, we dropped gdp per capita growth rate from the model (variable dlrincom) and introduced gni per capita growth rate in the model (first difference of logarithm of real disposable income dlrdincome), also seasionally adjusted. table 7. linear demand model for cigarettes – (real income growth rate is proxied by gni pc growth rate, i.e. real disposable income growth rate) variables (1) (2) (3) (4) lcons lcons lcons lcons lrtcpi -0.776*** -0.756*** -0.799*** -0.736*** [0.094] [0.133] [0.103] [0.112] dlrdincome -1.200 -1.010 -1.908 -1.279 [2.001] [2.223] [2.350] [2.037] tcindex -0.016 [0.068] tlaw 0.051 [0.083] aban -0.046 [0.065] constant 11.106*** 11.012*** 11.189*** 10.905*** [0.478] [0.641] [0.506] [0.564] 68 economic analysis (2020, vol. 53, no. 1, 59-71) variables (1) (2) (3) (4) lcons lcons lcons lcons observations 19 19 19 19 r-squared 0.915 0.915 0.917 0.918 f statistic (prob.) 0.000 0.000 0.000 0.000 d-w d-statistic 2.039 1.970 2.244 1.993 breusch-pagan / cook-weis. test for heter. (prob > chi2) 0.745 0.767 0.615 0.757 jb test (prob.) 0.868 0.888 0.761 0.934 ramsey reset test (prob.) 0.458 0.477 0.528 0.571 multicolinearity test (vif) 2.27 3.86 2.82 2.37 standard errors in brackets; *** p<0.01, ** p<0.05, * p<0.1 introducing the new variable as a proxy for purchasing power did not result in the significance of these variables in the model. variables “dlrdincome” is not statistically significant. the regression coefficient of real disposable income is negative, which is not in line with our exaptation, but this coefficient is not statistically significant. increasing in cigarettes prices for 1% led to a decrease in cigarettes consumption by in the range of 0.74% to 0.80%. the variables, which represent tobacco control policies are not statistically significant. to check the impact of purchasing power on demand for cigarettes again, we created the model with a new variable which is often used in the literature as a proxy for the purchasing power – real average wages, obtained from national statistics agency. the results of the different version of models are presented in table 8. table 8. linear demand model for cigarettes – (real income is proxied by real wages) variables (1) (2) (3) (4) lcons lcons lcons lcons lrtcpi -0.786*** -0.730*** -0.846*** -0.747*** [0.076] [0.138] [0.127] [0.083] lrwage 0.194 0.207 0.450 0.637 [1.012] [1.036] [1.121] [1.086] tcindex -0.032 [0.066] tlaw 0.048 [0.082] aban -0.077 [0.071] constant 9.980 9.642 8.714 7.137 [5.849] [6.024] [6.344] [6.376] observations 20 20 20 20 r-squared 0.906 0.907 0.908 0.912 f statistic (prob.) 0.000 0.000 0.000 0.000 d-w d-statistic 1.985 1.858 2.171 1.947 breusch-pagan / cook-weis. test for heter. (prob > chi2 0.675 0.694 0.619 0.746 jb test (prob.) 0.786 0.826 0.7692 0.939 ramsey reset test (prob.) 0.455 0.444 0.486 0.644 multicolinearity test (vif) 1.54 3.66 2.98 1.88 standard errors in brackets *** p<0.01, ** p<0.05, * p<0.1 dragan gligorić, saša petković, anđela pepić, jovo ateljević, borislav vukojević 69 once again, variables which represent purchasing power was not statistically significant. the coefficients of the tobacco control variables were again not statistically significant. impact of real tobacco prices is statistically significant, and estimated coefficients of price elasticity have a wider range of value. increase in cigarettes prices for 1% led to a decrease in cigarettes consumption in the range of 0.73% to 0.85%. the reason for the non-significance of real income growth, real disposable income growth and real wages on consumption of cigarettes in our models can be in the fact that bih has experienced a significant increase in this variable in the observed period. it is possible, that higher income allowed smokers to consume higher-priced brands, without increasing in quantity of consumption (john, 2008). adjusted r square in all models is slightly above 90%. we applied the ramsey regression specification error test for all models. those tests indicated that we did not exclude any important variables from our model. such exclusion would result in biased estimates. the durbin–watson test assessed the autocorrelation of ols model residuals. if residuals are correlated, ols estimates are unbiased. we found the values of the reported d statistic to be closer to the value two which implies that the residuals from linear regression are uncorrelated in all estimated models. the breusch–pagan/cook–weisberg test showed that residuals of the ols model have constant variance. therefore, no heteroscedasticity exists that would reduce the reliability of our hypothesis testing and cause ols estimators to be inefficient. the assumption about the normality of the residual in our models is satisfied, which has been verified using jarque – bera normality test. value of variance inflation factor suggests that out models don’t suffer from the multicollinearity problem. conclusion the specific excise on cigarettes introduced in bih in 2009 and has increased every year, from an initial level of 3.83 eur per 1000 cigarettes stick in the 2009 to 34.5 eur per 1000 cigarettes stick in 2017. ad valorem excise, calculated on the retail price of cigarettes, stayed at the same level of 42% retail price. the analysis for the period 2008p1-2017p2 shows that average prices of cigarettes increased by about 175%, while consumption of cigarettes decreased for more than 50%. the main reason for an increase in prices of cigarettes was continuous increasing of specific excise. in order to estimate the impact of increase in cigarette prices on the demand for cigarettes in bih, we developed three models, with three different measures of income. the only variable, which has significant impact on demand for cigarettes, was logarithm of real cigarette cpi. value of estimated coefficients was in the range of -0.73 to -0.85, and the estimated coefficient was stable across different models and different versions of a particular model. this implies that an increase in prices of cigarettes for 1% led to a decrease in the consumption of cigarettes in the range of 0.73% to 0.85%. this results are in line with previous research, conducted in low and middle-income countries (such as bih), which found that price elasticity of demand for cigarettes is in the range between -0.5 and -1 (selvaraj et al., 2015, jovanovic et al., 2018). results of our analysis suggest that the state excise policy is an effective tool for reducing cigarette consumptions in bih. if policy-makers in bih continue with the policy of increasing excise taxes, the consumption of cigarettes will decrease. acknowledgements this paper is a result of international research project "accelerating progress in taxation of tobacco and tobacco products in lowand middle-income countries". this research is funded by 70 economic analysis (2020, vol. 53, no. 1, 59-71) the university of illinois at chicago’s institute for health research and policy through its partnership with the bloomberg philanthropies. references agency for statistics of bih. 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(2007). analysis of tobacco demand, world bank, economics of tobacco toolkit. http://siteresources.worldbank.org/intph/resources/3demand.pdf article history: received: november 28, 2019 accepted: february 21, 2020 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp71-91 original scientitic paper corporate governance of the companies listed on the belgrade stock exchange: metadata analysis based on the results of the methodology g20/oecd questionnaires ivana ljutić1* 1 university union belgrade, belgrade banking academy abstract the present article addresses the ex-post metadata statistical analysis of the corporate governance questionnaire of the listed companies at belgrade stock exchange. the period is 2013-2020, with 50 reports filed as public information at the official website of the exchange. methodology is based on the standardized approach promulgated on the ifc technical support to the exchange. it reflects fully the g20/oecd corporate governance principles and corporate governance assessment quality based on this method. the statistics consisted of handling of large and voluminous data with 50 questions, while the question no. 3 was included as a number but not as a question in the reports. statistical calculation allowed us to make some conclusions and recommendations. at the same time, we are aware that those reports were not assured or audited internally within the companies, externally by the auditors or by the stock exchange itself. the main goal of our analysis was to give a standard and harmonized overview on the quality of corporate governance of issuers at the belgrade stock exchange, which in turn could be compared with the relevant exchanges worldwide, also to be used for policy makers, regulators and issuers to make practical steps to further improve the quality of corporate governance key words: corporate governance, listed companies, belgrade stock exchange, balanced scorecard, g20/oecd/ifc jel classification: o16, g3, g34, m41, m42 introduction as any other deep and profound economic crisis this one shall have a dire consequence on the business performance of the companies. it is at the same time a chance for the positive changes that companies in serbia could and should embrace the culture of corporate transformation. stakeholders in the corporation existing and the potential as new investors shall have more sharp focus on the corporate governance, corporate social responsibility and overall business and financial performance. the economic crisis shall certainly have negative impact on the quality of corporate governance and social democratic values. regulatory bodies and agencies should be aware of that fact and take into the account of their regulatory actions to countermeasure the before mentioned negative effects. companies could react twofold. to behave fully reactively and resist change, or to embrace it, seeing their long-term strategic goals. the overall global economic and social landscape is going faster and faster into a direction of drastically * e-mail: ivana.ljutic@bba.edu.rs 72 economic analysis (2021, vol. 54, no. 1, 71-91) environmentally and socially conscious and accountable doing business. if the companies and serbian national economy shall not opt to go into this and the only perspective and real direction that will pave the way to peril for the serbian companies, economic growth, no doubt. the shift waiting serbian companies and the need for change in the sphere of corporate governance is opportunity to embrace change, to adjust, to harmonize, to be socially responsible and sustainable, since this is the only way out. we are in front of the long-term changes in the pattern of work. work from home and distance working regardless of the conservative management negative reaction shall turn into a “new normal “whenever the costs are at stake, and the costs shall be even more at stake from now on. consequently, the effective corporate governance shall become more important than ever since the investors and stakeholders are more interested in the going concern of the business and in the sustainability. it becomes even more important not only “what “the companies do but rather “how “they do it. ifc as a member of the world bank group is representing in serbia and globally the biggest development institution. its activities were focused to promote the private sector in the serbian transitional economy. expanding and growing listed companies are promoting employment and standard of living, economic growth and social stability, while attracting and productively mobilizing the inflow of capital into businesses. in order to ensure sustainable development and growth in serbia joint stock companies have been assisted in the time span extending over few recent decades, helping them to attract the capacity for investments, for which is the only solid foundation the highest quality of corporate governance and social responsibility. the equally important aspect on this strategic footstep orientation is to inform the general public while increasing the public awareness on the role and significance of the quality of corporate governance. good corporate governance is a model for the issuers to attract the domestic and foreign investors in the private sector, and shall be even more and increasingly important in the forthcoming economic crisis 2021 onwards. serbian issuers which follow the international standards of good corporate governance principles founded by the g20/oecd shall improve corporate economic efficiency, performance of the top management, board of directors, protect the interest of shareholders, stakeholders and the public interest as well. this study with its preliminary results is aiming to instigate and stimulate the management board to clearly define objectives and goals at the interest of shareholders and stakeholders, while at the same time increasing the efficient use of the scarce resources. the broader goal is also to spread this attitude and orientation towards increasing quality of corporate governance to all private and public companies also in serbia. oecd principles of corporate governance as a foundation of the scorecard analysis one of the leading, respected and influential think-thank is the organization of economic cooperation and development – oecd, as a pioneer in this field. they have published the first set of corporate governance principles in 1999 (oecd, 1999) and revised version in 2004 (oecd, 2004). the so-called oecd principles are focused on the legal and regulatory frameworks for the corporate governance and the level of national jurisdiction (compliance online, 2020). oecd principles are promoting the following key aspects:  creating effective and efficient regulatory framework for the corporate governance;  protecting the shareholders and keyholders rights;  treatment of shareholders on an equitable base;  ensuring the position and interest of other stakeholders in the regulatory framework;  information disclosure and reporting transparency;  duties and responsibilities of the management board. ivana ljutić 73 corporate governance as a pillar of equity investments supported by the strong an efficient capital markets, rule of law, clearly defined and separated responsibilities of the complex system of the regulatory and supervisory bodies and institutions, as well as the strong legal and regulatory enforcement authorities. principle of corporate governance are one of the central pillars of the globalization, while the corporate law evolves via domestic mechanisms, so it is very important for serbia to follow the international trends. corporate governance mechanisms also become a vital part of the international agreements. this fact is enabling serbia to harmonize with the unwritten international standards and regulation, also to be a part of the positive development by producing the real changes in the quality of corporate governance. (sachs, 2019). basic shareholder rights could be grouped into the following:  secure registration of ownership rights;  secure transfer and convey of shares;  availability of the timely and relevant information about the company;  right of shareholders to participate and vote in the general shareholders meetings;  share in the company’s profits. the equitable treatment of shareholders including the minority and foreign shareholders is rather complex requirement to be implemented in countries like serbia, since the legal profession does not fully grasp the economic ratio and context. from the regulatory point of view the rights of minority shareholders have not been addressed adequately, taking into the account that the renewed national stock market is rather small, slow, and not with so many issuers and investors. closely with that the role of stakeholders should be readdressed. issuers should have a better sense and communication with minority shareholders and stakeholders in general (the world bank, 2020). the reaction of the serbian regulatory community has been strengthening minority investor protection, but the outcome could not be assessed right now, as the market is slowing down. further studies should clarify the level of good intentions turn into a positive practice of protecting minority shareholders. the topic of adequate and timely and accurate disclosure is material in corporate reporting in every sense. the external audit function is not well understood, accepted and the role of its influence on the quality and transparency of the national financial reporting system and in the national economy as a whole (the world bank, 2016). the effective monitoring and control of the operations of the board, with a focus on the accountability, especially in the view that the forthcoming reforms in eu and in uk in 2021., and onwards shall directly define the responsibility of the top management for the materiality in corporate reporting (jones, 2021). the foreseeable future is that the company directors shall be considered personally liable for the accuracy of financial statements and very soon for the whole framework of non-financial information reporting, as reflected in the forthcoming eu regulation (legislative, 2021). eu has been firmly determined to review and update the non-financial reporting directive before the april 2021. the balanced scorecard for corporate governance (bscg) could be portrayed twofold as important guidelines for the domestic issuers but also very relevant for all savvy and conscious corporate governance and corporate socially responsible companies in serbia. peković, zdravković & pavlović (2020: 121-132), (raičević, et al., 2018: 92-102) focused on the model to explain the role of balanced scorecard in assessment of the performance of board of directors, one of the most important feed-back mechanism of corporate results. equally important is that the information from the bscg is a beacon and orientation for the corporate strategies and the impact of the corporate sector in the national, regional and global economy. the advantage of this approach is in its simplicity, understandability and efficient application in the corporate practice, as well as important information for the financial 74 economic analysis (2021, vol. 54, no. 1, 71-91) institution like the belex and national and international regulatory bodies (belex, serbian sec, national bank of serbia, ministry of finance of serbia) (seskar, 2014: 2). research methodology the balance scorecard methodology promoted by the ifc, based on the globally standardized, widespread and accepted methodology created and continuously curated by g20/oecd, has been introduced at the belgrade stock exchange (belex) by the ifc. this global financial institution has created the set of two toolkits which distils practical experience of 17 developed and developing countries. these toolkits are offering practical advice on building corporate organizations that are educating and training company directors on the best practices of corporate governance (ifc, 2003, 2005). ifc assisted belex and issuers in obtaining know-how, training, implementation and subsequently it has been introduced at the official public website of the belex. joint stock companies (companies) listed at the primary and secondary securities listings where the companies are filing and publicizing the questionnaires. we have covered the period 2013-2020, accessing the individual filed questionnaires from the different issuers, various years. for some issuers there were more than one, but all without any regularity. the statistical metadata analysis has been consistently applied to all 50 questionnaires. it has been applied consistently g20/oecd balanced scorecard methodology of questionnaires to report on the level of overall quality of corporate governance. the questionnaires were not enlisted in a structured data base, but at the random public access register. the names of the companies are not relevant for the overall conclusion on the level of the quality of corporate governance of issuers at belex. this metadata analysis could be helpful for further research as it is a standardized methodology which is offering full consistency and compliance with the similar studies and research globally, since all stock exchanges and issuers are strictly following the methodological and reporting guidelines envisaged by the ifc based on the g02/oecd methodology. orderly regulation of the national capital markets is a crucial to strengthen the national economy (gurria, 2019: 1). globalization trends increases the integration of capital markets, business, interdependence of investors and issuers. different legal, regulatory systems, economic and social systems, cultural traditions are also a solid foundation for the harmonization of the regulation and practice of corporate governance. g20/oecd methodology is improving and “standardizing” the so-called global language of corporate governance, improving the regulatory and operational framework (oecd, 2017). in turn this is the best guidance for the belex, investors, stakeholders, issuers and the general public in serbia. as improved quality of the corporate governance is ensured and the long-term sources of capital are increasing to inflow to the companies as investors are increasing confidence in the corporate performance and from now on even more of the agility and integrity of issuers. g20/oecd principles of corporate governance help policy makers in serbia to evaluate and improve the legal, regulatory and institutional framework. this in turn is supporting the economic efficiency, sustainable growth and financial stability of the transition economy as serbia is. principles developed by the oecd corporate governance committee in cooperation with the world bank are very useful for the policy makers in serbia since they are offering in practice clear clarifications what is going in that so called “harvard black-box” of corporate governance of issuers at belex. methodology is backed by the belgrade stock exchange belex code, and the serbian chamber of commerce and industry relevant codes ccis code, and practice of corporate governance in serbia (zivkovski, 2020), with the full backing of the serbian securities and exchange commission (seskar, 2014: 1-2) (ebrdm, 2016: 1). according to seskar, methodology was mainly the mirror image of the german approach with the full support and backing of the global corporate governance forum sponsored and supported by the world bank/ifc (global, ivana ljutić 75 2016: 1,12), but in earnest this is ifc implementation of the g20/oecd approach. mirror image of this methodological approach is governance scorecard for institutional investors globally (institutional, 2019). corporate governance is the key ingredient and the solid foundation of the stock markets expansion, investment and economic growth. the need of entrepreneurs in serbia to raise financing to fuel the corporate growth is moving from the debt towards the equity market (isaksson, 2017: 5-6). those market/s should be attractive to investors, transparent to stakeholders, protecting the rights of minority shareholders and preserving the corporate social responsibility (ifc, 2016: 31). controlling the majority shareholders could be only effectively implemented and addressed through the real and potential mechanisms to address the corporate governance issues stemming from the such uncontrolled power of the majority shareholders and top management teams (nenova, 2005: 181-222), (ljutić, 2013). it promotes the private sector, stabilize the national economy and the financial and banking system. countries with strong corporate governance and financial systems even if some are the emerging economies like serbia could be attractive to foreign investments. what is worrisome in serbia is the instability and the lack of motivation of the institutions like belex, serbian sec, central bank, not wholeheartedly to support the need for continuous process of improvement of the quality of corporate governance. adoption of the code, improvement and continuous work on is a positive strategic option, but the real value of scorecard is practical opportunity to measure something until now almost unmeasured but more than important to attract the domestic and foreign investors (oicv-iosco, 2016). in essence the application and practice of corporate governance looks like the “bridge too far.“ in the transition economies like serbia with a relatively weak analytical community and rather low demand for such information there is no real push for improvement. quality of corporate governance gives companies wide opportunity for benchmarking, aiming to improve the quality of the corporate governance performance, while the costs are kept at minimum. the common component building blocks of the corporate governance scorecard are logical and complementary leading to a final scoring. on the other hand, we are facing with the objective obstacle that the issuing companies are somehow reluctant to “open up the heart and mind, “since the picture portrayed is rather a wide-angle landscape photo which reveals a lot between the lines. as we know the best remedy for viruses and bacteria is the sunlight, and also for investments the full information of the public about the corporate governance and social responsibility of the issuer. logical starting assumption is that the issuers are attracted to the idea to lure equity investors. at the same time the importance of application of the eocd corporate governance code and guidelines is at the top of priorities of the securities regulation at the national level (gobiernocorporativoarg, 2019). the structure of the balanced scorecard of corporate governance of issuers in serbia the scorecard methodology is consisted of six broad conceptual areas: i ensuring an effective implementation of the corporate governance principles including the aspect of corporate social responsibility ii equitable treatment of shareholders (e.g., shareholders' meetings) iii management model – responsibilities and functioning of the board iv corporate executive bodies and secretary of the company v supervision, control and independent external audits vi transparency and disclosure to each broader group of related and consistent questions it has been allocated adequate weighted ponder expressed in percent. these ponders are expression on the relevancy of each area, and all in all are leading to the total maximum score of 100%, e.g., reflecting the full 76 economic analysis (2021, vol. 54, no. 1, 71-91) compliance expressed in the answers given by the issuers, but not audited or in any other way reviewed by the belex either/or external auditors. serbian promulgation of the bscg at the beginning has been a pilot and test study. in focus were the companies from financial and banking sector, later on manufacturing and services. at the start the whole project was based on the voluntary and confidential base, as it was logical then. the reviewers additionally organized pilot on site visits, with the adequate representations on both sides (belex, scci, ifc with company representatives: executive board members, cfos, secretaries). the primary focus was on the legal compliance followed by selected advices, recommendations, suggestions, swot approach. initial assessment by the founding team at belex was that the key benefits of the introduction and application of the bscg (seskar, 2014: 2) were:  better understanding, valuation and assessment of the corporate governance practice of issuers in serbia;  tracing of the map for better and continuously improving quality of corporate governance and social responsibility (virijević-jovanović, at al., 2020: 105-1117);  principles of corporate governance at the belex in serbia are supporting investment and generating growth, while the operational efficacy and quality is the critical factor for the quality assessment. the impact on the domestic corporate and financing laws is immensely positive, and located problems and neuralgic spots should be solved and dismantled, in order to create a common new framework of reference of the quality of corporate governance of issuers (siems, 2017: 1);  harmonization with the leading international practice, as the balance scorecard in essence is very useful proven in practice management tool.  capacity to review the standards as minimum requirements looking into the future how to raise the bar of continuous improvement. the change and the reform of corporate reporting from the mainly financial towards nonfinancial with an emphasis on the integrated, reporting, environment-social responsibilitygovernance (esg), sustainability, green, is leading towards the creation of the unified global standards. this trend is now evolving under the auspices of the ifac/iasb with the full support of all other voluntary bodies and organization. based on the preliminary information and hints the new robust standards will cover the aspects of management responsibility for the overall reporting, while there will be introduced new mechanisms for the review, auditing and external assurance of the corporate governance and social responsibility as significant pillars of the expected new forms of non-financial reporting. the open question is the level of assurance and verifiability of the corporate governance and social responsibly information issued by the companies (ifac, 2020). survey of the standardized ifc/g20/oecd questionnaires of the quality of corporate governance of issuers at belgrade stock exchange the methodological approach we have adopted is based on the standardized widely acclaimed and approved methodology introduced, developed continuously and applied in practice by the ifc in almost all the member countries. the main purpose of this reporting by the issuers in the period 2013-2020, was to give an overview insight into the practice with a goal the external users of information could determine the level and quality of corporate governance, to identify the problems and to solve them proactively in order to make companies issuers more productive. the methodology based on the balanced scorecard approach is giving an excellent inroad to analyse the interaction in practice of the norms and real performance, based only on the reports of issuers, for which in turn issuers are legally and regulatory liable. this approach has given us the opportunity to obtain a deeper insight into: ivana ljutić 77  the current and in the prolonged period the quality of corporate governance practice in joint stock companies and banks at the listing of belex;  the level and quality of compliance of issuers with the pertinent serbian corporate and related legislation and with the national and international codes of corporate governance;  to further locate and pinpoint the bottlenecks and problems in practice. applied statistical metadata methodology in this research we have focused and covered all the published corporate governance questionnaires of issuers at belex, period 2013-2020. all in all, all the publicized 50 reports by various issuers for the covered period, with 50 standardized questions (note: question number 3 does not exist, but that was not a problem for the proper analysis), which in turn is a stable approach to handle and include all the publicly available data reports. we were not able to conduct individual interviews with the representatives of issuers, as this was not the goal of this initial study. we have statistically covered the final data and then we have processing, statistically summarizing, and presenting the analysis of the results we have obtained. the issuers and respondents are legally liable for the truthfulness of the data, and as the data has been publicized at the official website of the belex, as it is public information revealed, not more than that. our role and goal of research was clearly not to critically overview and objectively deeper assess the value of data, although we stress that we do not express negative opinion on that either. the answers were on three levels or types with grades, yes (1), partly (0, 5), no (0). timeframe of the survey the surveys were conducted by the issuers and reported by belex in the period from 2013 until 2020. survey coverage in the survey we have covered all 50 questionnaires supplied by the issuers, whose questionnaires we were able to locate at the official website of belex. 78 economic analysis (2021, vol. 54, no. 1, 71-91) summary of quality of corporate governance survey of issuers at belgrade stock exchange figure 1. scorecard for the corporate governance code in serbia: overview of results and the final grade (total score) source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. the flowchart (figure 1) is representing the balanced scorecard with the accompanying (figure 2), is showing that the commitment to the corporate governance principles and corporate governance social responsibility is 100%, assembly and shareholders 75%, board of directors 85%. while it is full 100% for the executive directors, 92.5% for the supervision and control activities, transparency and publicity 87.50%. the overall score of the quality of corporate governance is rather high with 89.25% out of the maximum based on the scorecard standard 100% (figure 3). standard standard 10% 15% 100,00% 10,00% 100,00% 15,00% standard standard 15% 20% 75,00% 11,25% 100% 89,25% 92,50% 18,50% standard standard 20% 20% 85,00% 17,00% 87,50% 17,50% weight factor: weight factor: individual grade: individual grade: weight factor: weight factor: individual grade: individual grade: board of directors transparency and publicity standard individual grade commitment to corporate governance principles and social responsibility executive directors weight factor: weight factor: individual grade: individual grade: assembly and shareholders final grade supervision and control ivana ljutić 79 figure 2. scorecard for the corporate governance code in serbia source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. figure 3. final score per group of questions source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. commitment to corporate governance principles and social responsibility assembly and shareholders board of directors executive directors supervision and control transparency and publicity 100,00% 75,00% 85,00% 100,00% 92,50% 87,50% 10,00% 11,25% 17,00% 15,00% 18,50% 17,50% commitment to corporate governance principles and social responsibility assembly and shareholders board of directors executive directors 80 economic analysis (2021, vol. 54, no. 1, 71-91) figure 4. final grade source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. table 1. i connitment to corporate governance principles and social responsibility (10%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 1. has the company adopted its own code of corporate governance or has it applied another organisation's code of corporate governance? 1 33% 33,00% 2. have applicable corporate governance principles been incorporated into the company acts and are they easily available to all stakeholders? 1 33% 33,00% 4. does the company publish in its annual reports the information on its business operations' compliance with the corporate governance principles or provide explanations for any departure from the principles, in line with article 368 of the law on commercial entities? 1 34% 34,00% 100% 100,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021. all the companies on the sample have responded positively on all the three criteria of commitment to corporate governance principles and corporate social responsibility. they all have adopted their own code of corporate governance, applied the principles, incorporated in the company internal regulation, with easily accessible information to stakeholders. annual reports and related information were publicized jointly with the compliance of the principles of corporate governance, that is easy, but in essence formal and necessary first inroad step into the right direction. on the following figure 5, is portrayed that compared to the balanced scorecard grade criteria, issuers have achieved full compliance, that is excellent itself. 82% 84% 86% 88% 90% 92% 94% 96% 98% 100% 1 100% 89,25% standard individual grade ivana ljutić 81 figure 5. commitment to corporate governance principles and social responsibility source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. table 2. ii assembly and shareholders (15%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 5. does an invitation for meeting of the shareholders assembly include all the prescribed elements and information, including the shareholders day details and information on shareholders' rights to participate in the activities of the shareholders assembly and propose items of the agenda, with timeframe for exercising these rights, as well as the description of voting procedures, either by proxy, absentee ballot or electronically? 1 8,33% 8,33% 6. is the invitation for meeting of the shareholders assembly, with all relevant explanations and information submitted to the stock exchange for the purpose of publishing in the regulated market, i.e., mtp belex, immediately after its sending (publishing) to shareholders? 1 8,33% 8,33% 7. are the materials for the meeting of the shareholders assembly available on the company website? 1 8,33% 8,33% 8. has the company established some of legally prescribed options for online participation in the assembly activities, and if so, in which manner? 0,5 8,33% 4,17% 9. does the company publish adopted decisions and minutes of the meetings, immediately, i.e., within prescribed deadlines, after the meeting? 1 8,33% 8,33% 10. what materials, decisions and other relevant documents related to the shareholders' assembly, if any, are also prepared and published in english? 1 8,33% 8,33% 11. has the company adopted the shareholders' assembly rules of procedure and does this or other company act set forth rules and procedures which ensure that shareholders are provided with timely answers to all relevant questions concerning the assembly? 1 8,33% 8,33% 12. has the company clearly defined its dividend policy and the procedures and deadlines for its distribution? 1 8,33% 8,33% 13. has the company issued shares in the previous year with restriction on shareholders' option to buy new emissions of the company shares? 0 8,33% 0,00% 32% 33% 33% 33% 33% 33% 34% 34% 34% question 1 question 2 question 4 standarni weight factor score 82 economic analysis (2021, vol. 54, no. 1, 71-91) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 14. has the company established its mechanism for prevention and settlement of possible conflicts between its shareholders and the company? 1 8,33% 0,00% 15. is comprehensive information on the proposed nominees available to the shareholders' assembly when selecting board members, particularly the information on any relations to the company, affiliated parties, competitors and main business partners of the company? 1 8,33% 8,33% 16. are shareholders enabled to exercise their rights to unrestricted participation in the shareholders' assembly activities and decision-making? 0,5 8,33% 4,17% 100% 75,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021. aspects of the assembly and shareholders relationship covered the wide criteria, from the invitation to the shareholder assembly (regular annual, other), invitation, supplied materials and related information available on the company website. issuers have partly established some form of the legal prescribed options for online participation at the assembly activities (question 8). all other aspects like publication decisions and meetings minutes, dissemination of relevant information and documents, adopted rules of procedure for shareholders’ assembly are handled on a timely bases with prompt responses, transparent dividend policy. it is evident that the companies have not issued shares in the previous year (question 13). it is significant the positive response of issuers on the company which has established its mechanism for prevention of settlement of possible conflicts between its shareholders and the company. the process of selection of the board members, revealing the information on any relations to the company (e.g., related party transactions) has a positive response, while the shareholders was only partly enabled to exercise their rights to participate in the activities of the shareholders’ assembly, which a fact which should attract attention in the further subsequent research. figure 6. assembly and shareholders source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. 0,00% 1,00% 2,00% 3,00% 4,00% 5,00% 6,00% 7,00% 8,00% 9,00% standarni weight factor score ivana ljutić 83 table 3. iii boards of directors (20%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 17. which governance system has the company set up? 1 10% 10,00% 18. do the company acts define in more detail the competence of the board of directors, i.e., the company's supervisory board? 1 20% 20,00% 19. do the company acts define criteria for required expert and professional knowledge and experience, as well as other conditions for appointment of board members? 0,5 10% 5,00% 20. does the board of directors prepare analyses and assessments of the quality and efficiency of its activities minimum once per year, and propose measures and activities for their improvement, notifying shareholders of the above measures? 1 10% 10,00% 21. are independent directors, i.e., independent members of the supervisory board under any obligation to inform the company and its shareholders of all changes which may affect their status in terms of independence? 1 10% 10,00% 22. has the company adopted a transparent and publicly available remunerations policy for the board of directors members and is the remuneration amount dependent on their contribution to attaining corporate financial and nonfinancial results and business goals? 1 20% 20,00% 23. has the company's board, apart from the law-prescribed audit commission, formed any other commissions as well, specifically other expert advisory bodies? 0,5 10% 5,00% 24. are the remunerations which are paid to the company's commission members included in the remunerations policy for the company's commission members, i.e., determined within the framework defined by the company's assembly? 0,5 10% 5,00% 100% 85,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021. the composition of the board of directors, adopted governance system, the important role of external independent directors and also the composition and functioning of the supervisory board is more than important and positive response also for the transparent and publicly available remunerations policy for the board of directors and members (e.g., measured contribution to financial and non-financial performance. on the other hand, the partly implementation of the law request to establish the audit board (commission) and other expert advisory bodies is the reflection of the not full and adequate understanding of the important and more than useful role of this control mechanism. this is also a clear indication that also remuneration for these bodies is not adequately regulated, since the companies are probably reluctant to use the full possibility of potential full contribution while at the same time to pay those external experts adequately. the neuralgic spots could be observed in the following figure 7, on the response to the questions 19, 23 and 24. 84 economic analysis (2021, vol. 54, no. 1, 71-91) figure 7. board of directors (20%) source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021. table 4. iv executive directors (15%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 25. do the company's acts clearly define the authorizations and responsibilities of the executive directors? 1 20% 20,00% 26. do the company acts set the criteria which define the required expert and professional knowledge and experience, as well as other requirements that a person must meet to be appointed an executive director? 1 20% 20,00% 27. has the process of work evaluation of executive directors by the non-executive directors of the board of directors, or by supervisory board, been established and is applied, in case of a two-tier system? 1 20% 20,00% 28. do the remunerations for the executive board members comprise the fixed and variable parts (bonuses, motivation, etc.) depending on their performance in achieving financial and nonfinancial results and the company’s business objectives? 1 10% 10,00% 29. does the company have efficient mechanisms to provide the accurate, timely, comprehensive, and egalitarian reporting to the company's board members by the executive directors, specifically, which procedure is applied when reporting to the nonexecutive directors and/or members of the supervisory board on all issues relevant to business operations, financial status, and potential risks to the company's assets? 1 10% 10,00% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% question 17 question 18 question 19 question 20 question 21 question 22 question 23 question 24 standarni weight factor score ivana ljutić 85 criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 30. do the executive directors report to the company's board on the issues under art. 416 of the law on commercial entities, specifically in terms of giving qualitative opinion and analysis of important issues which significantly impacted company's operations in the reporting period, including the view and analysis of significant company's business risks and future long and short-term perspectives of the company? 1 10% 10,00% 31. does the company have the function of the corporate secretary and, if yes, specify the assigned duties and responsibilities. 1 10% 10,00% 100% 100,00% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021 board of the executive directors, as it would be expected has been well approached as a top management body and that is reflected in corporate practice. the issuers have clearly defined their authorization and responsibilities, set up the clear criteria for the expert advice (requirements of the appointment of the executive director/s). that follows the process of work evaluation of executive directors by the non-executive directors or by the supervisory board. also are important aspects of management reporting, opinions, analysis, strategic perspectives of the company, the significant role of the company secretary. all responding questions got positive response from all the companies included in the sample, see figure 8 below. figure 8. executive directors source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% question 25 question 26 question 27 question 28 question 29 question 30 question 31 standarni weight factor score 86 economic analysis (2021, vol. 54, no. 1, 71-91) table 5. supervision and control (20%) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2 1 0,5 0 yes partly no 32. is there the audit commission in the company? 1 15% 15,00% 33. are there any bodies and/or persons appointed for the activity of internal audit? 1 15% 15,00% 34. do the company acts more specifically regulate the issues under article 452 of the law on commercial entities? 1 15% 15,00% 35. are there any mechanisms and rules for performing supervision and control established at the company level, as well as the activity indicators that should suggest to the internal audit that the preventive audit and control need to be performed? 1 10% 10,00% 36. do the systems of internal audit include the insider information affairs? 0,5 15% 7,50% 37. does the external auditor of the company inform the audit commission on the issues under art. 453 of the law on commercial entities? 1 10% 10,00% 38. does the external auditor prepare a separate internal document for the company's board (letter for management), comprising key shortfalls identified during the procedures of control, company’s accounting and operative procedures, including the suggestions for their improvement? 1 10% 10,00% 39. does the external auditor attend the meetings of the shareholders assembly where the reports on performed audits and company's financial reports are reviewed? 1 10% 10,00% 100% 92,50% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021 supervision and control are narrowly focusing on the important aspects of the introduction of the audit committee or commission, internal audit function and department, at the corporate level, as the usage of key performance indicators (kpi), as well as on the effective functioning of the internal audit on the preventive manner and as a control mechanism. all those criteria (questions 32. to 35.) are having a full positive response. the companies have been somewhat not so disciplined following the pattern that the internal audit assure the quality of internal information. the cooperation between the external audit function and company’s audit commission is positive. the external auditors prepare a separate internal communication to the audit commission, e.g., informing them on the quality of internal control system, and what is very valuable positive outcome is the attendance of external auditor to the meetings of shareholders assembly (figure 9). ivana ljutić 87 figure 9. supervision and control source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021 table 6. vi transparency and publicity criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 40. does the company have a clearly defined and publicly accessible disclosure policy which defines principles, rules and procedures of reporting to shareholders, relevant authorities, public, and other interested parties? 1 10% 10,00% 41. does the company publish its business reports including the report of the external auditor in compliance with the laws, by-laws, and regulations of the stock-exchange? 1 5% 5,00% 42. do the company’s business reports include all law-prescribed elements, notably elements prescribed under art. 289 of the law on commercial entities and art. 50 of the law on capital market? 1 10% 10,00% 43. apart from information defined in the law on capital market, does the company establish and immediately publish the data which may impact the price of shares of the company and the shareholders' status? 1 10% 10,00% 44. are the updated data on the company's insiders publicly accessible, including data on the number of company's shares/ratio of shares owned by them? 1 10% 10,00% 45. does the company publicly announce the biographies data of the members of the company board, members of the audit commission, and person responsible for internal supervision of business? 0,5 5% 2,50% 46. does the company publicly announce the data on transactions with affiliated persons and deals with persons having special authorizations in the company, and their affiliated persons? 0,5 10% 5,00% 0% 2% 4% 6% 8% 10% 12% 14% 16% standarni weight factor score 88 economic analysis (2021, vol. 54, no. 1, 71-91) criteria: responses (1) standard weight factor (2) score (3)= (1)x(2) 1 0,5 0 yes partly no 47. does the company report to the public on individually paid remunerations and other financial and non-financial rules and benefits gained by the holders of coordination, management and supervision functions in the company, as well as by the company’s board’s commissions members? 0,5 10% 5,00% 48. does the company use its own internet page to publish all relevant information? 1 10% 10,00% 49. is the company's internet page organized in the manner as to enable a simple access to information relevant to investors? 1 10% 10,00% 50. are all relevant investment information published in the english language as well? 1 10% 10,00% 100% 87,50% source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/ izdavaoci. accessed: february 8th-march 2nd, 2021 aspects of transparency and publication of the relevant information are covered in the last segment of this questionnaire (questions 40 to 50). it has included starting from the public free access of information, publication, business reports and of the insider information. somehow companies are not so willing to publicize the full biographical information of the members of the board and on the transactions with affiliated persons (questions 45 and 46). also, companies are somehow not fully opened up and transparent in revealing information on individually paid remunerations (e.g., financial and non-financial rules and remunerations of the members of the top management and supervisory board (question 47). aspects of the internet webpage for the publication of the company relevant information, pages simple to be accessed supplied with information relevant to investors, stakeholder and general public, have being covered fully. it is very positive that all that information has been published also in english language for this segment see the following figure 10, on the transparency and publicity. figure 10. vi transparency and publicity source: own metadata statistics based on the corporate governance questionnaires of issuers (50 reports of 50 questions), belex, covered period: 2013-2020, issuers news: https://www.belex.rs/trzista_i_hartije/vesti/izdavaoci. accessed: february 8th-march 2nd, 2021 0% 2% 4% 6% 8% 10% standarni weight factor score ivana ljutić 89 conclusion in the article we have analyzed the practical implementation of the g20/oecd principles of corporate governance of the issuers at the belex, period 2013-2020. as this is rather a prolonged period, with no so many issuers, even with the change of the structure of reporting companies we have selected in the statistical sample of all 50 filed questionnaires of the corporate governance we have obtained. the standard methodology is founded on the original principles envisaged by the organization for economic cooperation and development (oecd) in 1999 (original principles), the last third version 2014-2015, as a result of the active involvement of the group of the largest developed countries (g20) as was adopted at antalya summit, turkey, november 2015. the current economic crisis from 2020 and afterwards has not been reflected in the principles since the crisis is in its early starting stages, but also strongly present and very deep with the negative consequences on the investments, sustainability and economic growth. this article is pointing out to the drastic and urgent need to improve the quality of corporate governance, to think creatively based on the results of this analysis how to implement much needed recommendations based on the oecd principles. unresolved issues and goals should be stressed not mainly from the aspects of quantitative analysis but from the point of view of qualitative improvements. this study is showing evidently that the stress and focus is on the formal implementation, from the transparency, standardized high quality disclosure of financial and increasingly stressing from now on even more the importance of non-financial disclosure, increased social responsibility as a key to open the doors to investors to finance the future economic growth and social stability. acknowledgements i express my sincere thanks to mr. nikola m. stajić, master, ba 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(2020). “corporate governance in serbia.“ https://www.ceelegalmatters.com/serbia/12586-corporate-governance-in-serbia. article history: received: march 7, 2021 accepted: april 9, 2021 doi: 10.28934/ea.23.56.1.pp57-68 first online: may 15, 2023 preliminary report is there a relationship between country development and citizens’ level of digital skills? marija antonijević14 f* | aleksandra bradić-martinović1 | jelena banović1 | đina ivanović1 1 institute of economic sciences, belgrade, serbia abstract this paper examines the relationship between citizens' level of digital skills and country development. country development is measured by gross national income per capita (gni p.c.), while digital skills are measured by the world economic forum. data were gathered from the world bank databases for 2019 from 135 countries worldwide. correlation analysis was used for the analysis. the results of the correlation analysis show a significant strong positive linear relationship between digital skills and gni p.c., indicating the importance of country development in developing adequate levels of the crucial skills of the 21st century – digital skills and vice versa. keywords: digital skills, development, gross national income per capita, correlation analysis jel classification: f63, j24 introduction globalization and technological innovations have contributed to a change in the way how individuals and the economy function. james (2021) states that most innovations are created in developed countries. the same author notes that digital technologies are primarily developed in and for the usage of affluent countries concerning their socio-economic conditions, including attitudes, skills, income, and infrastructure. regarding this, citizens in developing countries, especially rural areas, lack digital skills. developed countries are usually the setters in innovations, so developing countries lag in their adoption (bara, 2016). in this regard, comin & mestieri (2018) state that despite reducing lag, developed countries are ahead in the diffusion of technology. according to baliamoune-lutz (2003), time lag and diffusion of innovation depend on the level of the country’s income. regarding this, in developing countries, income per capita constraints ict diffusion. also, karjaluoto et al. (2002) and lee et al. (2002) state that an increase in income is positively related to the adoption of innovation. kolaković et al. (2009) indicate that success in using digital resources depends on the level of development. bradić-martinović & banović (2018) confirm differences between developed and developing countries regarding accessing ideas, knowledge, and modern ict. oecd points out that in developing the digital economy in countries, the crucial roles play the following elements: ict infrastructure, ict skills, finance, and regulation, as well as the interplay * corresponding author, e-mail: marija.antonijevic@ien.bg.ac.rs 58 economic analysis (2023, vol. 56, no. 1, 57-68) between them (dahlman et al., 2016). the coronavirus accelerated the adoption of digital products/services and highlighted the importance of digital channels and, consequently, the possession of required digital skills. the committee for the coordination of statistical activities (2020) states that developing countries are less equipped to use information and communication technologies to minimize the disruption due to coronavirus. regarding this, it can be concluded that developing countries should improve their position since there is a possibility that another similar event will occur in the future. in the fourth industrial revolution era, it is crucial to understand how to use digital tools and communicate through digital channels. regarding this, it is significant to possess the appropriate level of digital skills in the digital world when performing everyday activities. thus, digital skills are needed for daily digital communication, doing a job, executing digital banking transactions, etc. european parliament & council also highlights the importance of digital competencies, considering they represent lifelong learning competencies (european parliament & council, 2006). individuals can acquire the required skills in this digital world by learning and experiencing them in practice (ivanović & simović, 2020). also, all individuals should continuously develop digital skills in every stage of life (ivanović & antonijević, 2022), so it is a never-ending process. those who are digitally skilled have more success in finding a job. also, the international telecommunication union itu (n.d.a) points out that digital skills are required for the future since nine out of ten jobs need these skills in europe. therefore, digital skills have become essential for individuals who want to be a part of the labor market, considering that around 90% of jobs require an appropriate level of digital skills. lazić et al. (2023) emphasized the significance of digital competencies, especially for people with disabilities, considering the opportunities for their employment through freelance platforms. possessing proper digital skills is significant, especially in developing countries, since billions of the young will participate in the labor market (unctad, 2018). individuals who lack digital skills are threatened to lose their job due to their lower competitiveness in the labor market (banović & pavlović, 2021). according to domazet et al. (2018), developing cooperation between three sectors—ict, education, and private—can help generate a synergy effect and be advantageous to all parties. no recent literature explores the relationship between the level of digital skills and development. given that developed and developing countries differ in terms of digital infrastructure (center for strategic and international studies csis, 2022; james, 2021) and education (wiley, 2021; oecd et al., 2020), authors expect that there is a relationship between development, measured by gross national income per capita, and citizens' level of digital skills, measured by a 7-point likert scale determined by the world economic forum. this paper is structured as follows. after analyzing the relevant literature, the authors examined the association between the level of digital skills and gni per capita. the results of the correlation analysis indicate that the country's development plays a vital role in the citizens' digital skills and vice versa, considering that the authors found a strong positive relationship between the level of digital skills and the gni p.c. the last part of this paper includes suggestions and directions for further research. literature review and hypotheses eshet (2004) indicated the crucial role of digital skills in the twenty-first century. all industries have been exposed to changes under the influence of digital technologies, which consequently underlines the need for possessing the appropriate level of digital skills. thus, digital skills have become essential in an individual's everyday activities. different terms correspond to skills related to ict and digital technologies, such as ict skills, it skills, digital literacy, information literacy, technology skills, 21st-century skills, and digital skills, so all mentioned terms are synonyms (bejaković & mrnjavac, 2020). unesco defined digital skills as "a range of abilities to use digital devices, communication applications, and networks to marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 59 access and manage information. they enable people to create and share digital content, communicate and collaborate, and solve problems for effective and creative self-fulfillment in life, learning, work, and social activities at large" (unesco, 2018). according to eurostat, there are four levels of digital skills. these levels are based on the european digital competence framework (digcomp) and individuals’ digital activity in the last three months. regarding this, the following individuals’ levels of digital skills are identified by braun et al. (2020): 1. individuals with above-basic digital skills “individuals who have performed all of the following activities: sending/receiving emails, participating in social networks, installing software and applications, using online banking, using word processing software, using advanced spreadsheet functions to organize and analyze data such as sorting and filtering”. 2. individuals with basic digital skills “individuals who have sent/received emails, installed software and applications, and used spreadsheet software (without advanced functions such as sorting and filtering)”. 3. individuals with low digital skills “individuals who have sent/received emails, installed software and applications, but have neither used word processing, nor spreadsheet software nor have used software to edit photos, videos or audio files”. 4. individuals with no digital skills individuals who “have not performed any relevant activities, despite declaring having used the internet at least once during the past three months”. international telecommunication union itu (2018a) identifies three types of digital skills: basic, intermediate, and advanced. an explanation of all these types is given in detail below in table 1. table 1. types of digital skills type explanation basic “elementary skills for executing basic tasks. include “hardware (for example, using a keyboard and operating touch-screen technology), software (for example, word processing, managing files on laptops, managing privacy settings on mobile phones), and basic online operations (for example, email, search, or completing an online form)”. intermediate “enable us to use digital technologies in even more meaningful and beneficial ways, including the ability to critically evaluate technology or create content. these are effectively job-ready skills since they encompass those skills needed to perform work-related functions such as desktop publishing, digital graphic design and digital marketing”. advanced “those needed by specialists in ict professions such as computer programming and network management. these include artificial intelligence (ai), big data, coding, cybersecurity, internet of things (iot), and mobile app development”. source: international telecommunication union itu. (2018a). digital skills toolkit. available on https://www.itu.int/en/itu-d/digital-inclusion/documents/itu%20digital%20skills%20toolkit.pdf. accessed september 25, 2022. oecd (2004) differs the following three categories: basic users, advanced users, and ict specialists, while cedefop (2015) points out basic, moderate, and advanced ict skills. international telecommunication union itu (2021) differs three types of digital skills: 1. basic: “copying or moving a file or folder, using copy and paste tools to duplicate or move information within a document, sending emails with attached files, and transferring files between a computer and other devices”; https://www.itu.int/en/itu-d/digital-inclusion/documents/itu%20digital%20skills%20toolkit.pdf 60 economic analysis (2023, vol. 56, no. 1, 57-68) 2. standard: “using the arithmetic formula in a spreadsheet, connecting and installing new devices, creating electronic presentations with presentation software, and finding, downloading, installing and configuring software”; 3. advanced: “writing a computer program using a specialized programming language”. paset et al. (2021) identify the following digital skills levels: basic/foundational, intermediate, advanced, and highly specialized. digital skills are becoming central for developing and developed countries (international telecommunication union itu, 2018a). the results of the international telecommunication union itu (2018b) research showed that the digital skills divide existed between developing and developed countries since the average percentage of individuals with basic digital skills amounted to 46% and 65%, respectively. furthermore, the gap was higher in terms of standard skills (20% in developing countries and 49% in developed countries). the least developed countries characterized the highest gap between access to the internet and the actual use of the internet. the vast digital skills gaps are often associated with less wealthy economies due to inappropriate digital education and training (wiley, 2021). insufficient skills were identified in developing countries, especially in the case of the poor (international telecommunication union itu, 2021). according to oecd et al. (2020), there was a digital divide between the more vulnerable and less educated on one side and the rich and more educated on the other. additionally, the same authors indicated that new technologies must be incorporated into education to develop digital skills. therefore, teachers have a crucial role in digital transformation by including ict in teaching. information telecommunication union itu (n.d.b.) data showed that overall digital skill levels should be enhanced in numerous countries. this conclusion is based on the fact that less than 40% of respondents worldwide reported engaging in basic digital skills activities in 76 countries for which data were available in 2021. also, less than 40% of respondents reported performing some of the activities comprising standard digital skills in 70% of countries. additionally, more than 10% of respondents reported carrying out activities involving advanced digital skills in 15% of observed countries' information telecommunication union itu (n.d.c). according to eurostat data, 54% of the eu population (age range 16 – 74) had at least basic digital skills in 2021. the top 3 countries with the highest scores were the netherlands, finland, and ireland, while the lowest had romania, bulgaria, and poland (digital skills & jobs platform, 2022). in serbia, bradićmartinović & banović (2018) found that slightly lower than 50% of respondents had no or had a low level of digital skills in 2017. however, the study's results did not differ significantly from the eu average (42.8%), i.e., more precisely, 17.3% had no digital skills, while 25.5% had a low level of digital skills. one key factor determining ict access is income level (dewan et al., 2005). thus, the authors indicated that ict's affordability increases with income. nipo et al. (2014) also supported these findings. vicente & lopez (2008) stated that countries with higher education and income levels express better ict access. maji & laha (2021) also highlighted the crucial roles of income, education, economic openness, and urbanization in overcoming the digital divide. results of recent studies showed that the digital divide was determined primarily by income level, educational level, internet affordability, freedom of the economy, citizens’ gender and age, urbanization, and foreign direct investments (aikins, 2019; cruz-jesus et al., 2018; fang et al., 2019; huxhold et al., 2020; otioma et al., 2019; pachis, 2018; song et al., 2020). in 2021, there was still a digital divide between developing and developed countries, considering that 96% of 2.9 billion offline people lived in developing countries (international telecommunication union itu, 2021). according to the latest data from the international telecommunication unionitu (n.d.b), around 4.9 billion individuals worldwide used the internet in 2021. when the pandemic started, the number of internet users in developing countries increased by 13.3% (international telecommunication union itu, 2021), indicating the importance of being online. regarding country development, 90% of people used the internet marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 61 in developed countries and 57.1% in developing countries (international telecommunication unionitu, 2021). regarding this, those who are unconnected need to develop appropriate skills to become connected. wiley (2021) stated that those economies that lead to digital skills development were considered the most resistant. moustakas et al. (2018) also highlighted the importance of a skilled labor force for improving economic productivity and growth. due to the pandemic, the demand for workers with digital skills is still increasing. the pandemic indicates the significance of reducing the digital skills gap. also, it has underlined the critical role of an adequate level of digital skills (eu4digital, 2021). additionally, the pandemic has disclosed the gaps between developed and developing countries in adopting digital technologies (misra, 2022). misra (2022) has pointed out that the main obstacles to achieving digital inclusion in developing countries are ineffective implementation and investment approaches related to digital skills. olczyk & kuc-czarnecka (2022) revealed that the digital economy and society index (desi), which measures the eu's digital performance, was an important predictor of changes in gdp per capita in eu countries. furthermore, rozite et al. (2019) found that digital skills statistically impact gdp per capita in the eu. additionally, aniela et al. (2019) stated that in 2015, eu countries can be classified into four clusters (very high level, high level, medium level, and low level) based on their gdp and the percentage of individuals who have basic or above-level digital skills, indicating similarities within groups and dissimilarities among groups. by analyzing the literature, the authors have identified a lack of studies that examine the association between digital skills and development, especially on a global level. based on all the above, two hypotheses were formulated: h1: there is a significant positive relationship between the level of digital skills and gni p.c. the following section presents a detailed insight into the characteristics of the sample and the statistical tools the authors used to test the defined hypothesis. methodology world bank databases were used to examine the presence of a linear relationship between the level of digital skills and development. since the most recent digital skills data available was from 2019, the authors conducted the analysis using data from that year. the study included 135 countries worldwide, 52 developed (38.52%) and 83 developing countries (61.48%). data for some african and asian countries were missing, and they were excluded from the analysis. table 2 presents the summary of the variables used in the analysis. table 2. summary of the variables variable explanation data source digital skills in your country, to what extent does the active population possess sufficient digital skills (e.g., computer skills, basic coding, digital reading)? [1 = not all; 7 = to a great extent] https://govdata360.worldbank.org gni per capita gni per capita, atlas method (current us$) https://data.worldbank.org the world bank classification for 2019 was used, which classifies countries into four income groups (low, lower-middle, upper-middle, and high-income) based on the thresholds determined by the amount of gni p.c. in usd. it is important to note that on july 1 each year, the world bank updates the classification of countries, considering that changes in population, inflation, income https://govdata360.worldbank.org/indicators/he6227f5e?country=bra&indicator=41400&viz=line_chart&years=2019,2019 https://data.worldbank.org/indicator/ny.gnp.pcap.cd https://data.worldbank.org/indicator/ny.gnp.pcap.cd 62 economic analysis (2023, vol. 56, no. 1, 57-68) growth, and exchange rates influence gni p.c. and that the thresholds must be adjusted for inflation (world bank, 2019). according to nielsen (2011), high-income countries are considered developed, while low, lower-middle, and upper-middle countries are considered developing countries. gni per capita in u.s. dollars was used to express the level of development as proposed by paulozzi et al. (2007). table 3. presents the summary of income groups, countries' classification by development level, and the codes used in the analysis. table 3. classification of countries by income group and development income group gni per capita (usd) the codes of the income group level of development low income < 1,026 1 developing lower-middle income 1,026 3,995 2 upper-middle income 3,996 12,375 3 high income > 12,375 4 developed source: world bank, available on https://blogs.worldbank.org/opendata/new-country-classificationsincome-level-2019-2020 16.9.2022 and nielsen, l. (2011). imf working paper–classifications of countries based on their level of development: how it is done and how it could be done. international monetary fund. the level of digital skills was measured using publicly available 7-point likert scale data from the world economic forum, which were based on assessments made by research teams from each country's institute on a scale ranging from 1 to 7. based on the available data, the authors calculated the global average digital skills score to be 4.22. considering that the maximum score is 7, it can be concluded that there is a space for improving the level of digital skills globally. from the aspect of development, developed countries had, on average, a higher level of digital skills (4.81) compared to developing ones (3.86). table 4. descriptive statistics – digital skills income group n mean std. deviation std. error 95% confidence interval for mean min max lower bound upper bound 1 13 3.33 .42933 .11908 3.0752 3.5941 2.74 4.03 2 33 3.84 .54702 .09522 3.6433 4.0312 2.45 5.06 3 37 4.07 .62451 .10267 3.8602 4.2766 2.91 5.37 4 52 4.81 .55497 .07696 4.6557 4.9647 3.52 5.83 total 135 4.22 .75070 .06461 4.0992 4.3548 2.45 5.83 source: authors' calculation in income group 1, mozambique had the lowest score for digital skills, while the gambia had the highest score. in income group 2, the lowest score was recorded in angola, while the philippines had the highest score. the lowest and the highest values in income group 3 had paraguay and malaysia, respectively. in income group 4, panama had the lowest, while finland had the highest digital skills score. in serbia, the score for digital skills was 4.09. this score is slightly above the average of serbia's income group (upper-middle income). the descriptive statistics for gni per capita are presented in table 5. https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2019-2020 https://blogs.worldbank.org/opendata/new-country-classifications-income-level-2019-2020 marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 63 table 5. descriptive statistics – gni per capita in usd income group n mean std. deviation std. error 95% confidence interval for mean min max lower bound upper bound 1 13 701.54 196.505 54.501 582.79 820.29 240 950 2 33 2223.03 947.841 164.998 1886.94 2559.12 1070 3980 3 37 7007.03 2414.146 396.883 6202.11 7811.94 4010 12120 4 52 37003.46 20030.484 2777.728 31426.94 42579.98 12620 84260 total 135 16784.59 20416.586 1757.180 13309.20 20259.99 240 84260 source: authors' calculation in income group 1, burundi had the lowest gni p.c., while guinea had the highest. in income group 2, the lowest gni p.c. was recorded in angola, while the philippines had the highest value. the lowest and the highest gni per capita income group 3 had sri lanka and costa rica, respectively. finally, in income group 4, romania had the lowest, while switzerland had the highest gni p.c. gni per capita in serbia was 7040 usd in 2019. this amount was slightly above the average of the upper-middle income group serbia belongs to. correlation analysis was used to test the defined hypothesis and examine the relationship between two variables, i.e., development (measured by gni per capita) and the level of digital skills (measured by a seven-point likert scale). considering the presence of the outliers, we applied spearman correlation analysis. results analysis of the association between the level of digital skills and gni p.c. shows that a higher level of digital skills corresponds to a higher gni p.c. dots on the graph (figure 1) represent pairs of digital skills and the income level with the belonging code of the income group above the dot. figure 1. scatter plot for the level of digital skills and gni p.c. (us$) source: authors based on world bank data 332 3 3 4 4 3 4 2 4 4 22 33 3 4 3 1 1 22 2 4 1 4 3 3 3 4 4 4 4 3 3 22 4 1 4 4 3 1 3 4 2 4 3 12 2 4 4 233 4 4 4 3 4 3 3 2 44 2 2 4 3 2 4 4 3 11 3 1 4 2 4 3 32 3 21 3 2 4 4 2 2 4 4 2 4 3 3 2 4 4 4 4 3 1 4 2 3 4 4 4 4 3 4 3 4 4 22 3 4 2 3 1 2 44 4 4 212 20 10000 20000 30000 40000 50000 60000 70000 80000 90000 0 1 2 3 4 5 6 7 g n i p er c ap ita digital skills 64 economic analysis (2023, vol. 56, no. 1, 57-68) even though a positive relationship between these two variables is identified, it should be pointed out that there is an influence of some other factors, such as the development of digital infrastructure, quality of the educational system, availability of the latest technology, etc. a correlation analysis was applied using the spearman coefficient to examine the presence of a statistically significant association between digital skills and gni p.c. considering the presence of outliers, the authors used spearman's correlation. a statistically significant (p<0.01) strong positive linear relationship was found between the level of digital skills and gni per capita, i.e., development, considering that the value of the correlation coefficient is 0.72 (table 6). therefore, the null hypothesis that there is no linear relationship between the level of digital skills and gni per capita was rejected. table 6. results of the spearman's correlation total sample digital skills gni per capita digital skills 1 .720** sig. (2-tailed) 0 0 gni per capita .720** 1 sig. (2-tailed) 0 0 n 135 135 ** correlation is significant at the 0.01 level (2-tailed) source: authors' calculation this result shows a strong link between development and digital skills, i.e., the higher level of gni per capita corresponds to a higher level of digital skills, and vice versa. due to the lack of literature examining the relationship between digital skills and development, particularly globally, there was a limitation in comparing research results. our findings support the previous studies conducted in the eu by rozite et al. (2019) and aniela et al. (2019). therefore, the results of our analysis highlight the significant role of income in developing citizens' appropriate level of digital skills. furthermore, digital skills play an important part in driving economic development. this study contributes to the expansion of the literature in this scientific field, given that it provides for the first time an insight into the relationship between the development and the level of digital skills on a global level. conclusion digital transformation is rapidly changing the way how society and the economy function. in the 21st century, all individuals need digital skills to interact, study, work, access online services, and find necessary information (european commission, n.d.). the development of digital skills significantly contributes to overcoming poverty and empowering the poor (urvashi et al., 2017). since there are differences between developing and developed countries, it is significant to explore the relationship between country development and the citizens’ level of digital skills. in this regard, this paper aims to examine a positive linear relationship between the level of digital skills and country development measured by gross national income per capita (gni p.c.). the analysis covered 135 countries worldwide, considering that the data for predominantly african and asian countries were unavailable. the data were collected from the world bank databases for 2019. to test the formulated hypothesis, correlation analysis was used. a strong positive relationship was found between the level of digital skills and gni p.c. considering that the correlation coefficient amounts to 0.720. this result indicates a higher level of gni per capita. i.e., country development corresponds to a higher level of digital skills, and vice versa. thus, the results of our analysis highlight the important role of country development in enhancing citizens’ marija antonijević, aleksandra bradić-martinović, jelena banović, đina ivanović 65 level of digital skills, and the significance of citizens’ level of digital skills in improving country development. based on the findings of the study, there are several implications and policy recommendations. firstly, the study highlights the importance of increasing access to digital technologies and infrastructure in promoting country development. governments should invest in expanding access to high-speed internet, computer hardware, and software, especially in rural and underdeveloped areas, to ensure citizens can access the digital resources necessary to develop their digital skills. secondly, the study suggests that digital skills education and training investments can effectively enhance the development of the country. thus, governments should prioritize the higher incorporation of digital skills in their education systems and provide training programs to the workforce to ensure that citizens have the necessary skills to thrive in the digital economy. finally, policymakers should consider the findings of this study in their efforts to close the digital divide and promote digital inclusion. even though this study contributes to expanding the scope of the literature related to this scientific field, this research has some limitations. firstly, the data for predominantly african and asian countries were unavailable, which could limit the generalizability of the study's findings. secondly, the study only examined the correlation between the level of digital skills and country development, which does not imply causality. thirdly, other factors that may affect a country's development and the level of digital skills were not considered. the above limitations suggest the need for further research to better understand the complex interplay between digital skills and country development. future studies should aim to expand research by incorporating more countries into the analysis. furthermore, researchers should include other relevant variables, such as the development of digital infrastructure, availability of the latest technology, quality of the educational system, etc. additionally, they should consider using more precise and reliable measurements of digital skills, such as observing the percentage of the population with the respective level of digital skills (e.g., above-basic, basic, low, and no digital skills). moreover, further research should focus on examining causality and developing more sophisticated statistical models and techniques to analyze and identify causal relationships. acknowledgments this paper is supported by the ministry of science, technological development and innovation of the republic of serbia. references aikins, s.k. 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asmild et al., 2004; andersen & petersen, 1993; donthu & yoo, 1998; tone, 2001; tone, 2002; tone & tsutsui, 2009; tone & tsutsui, 2010; fare et al., 1994; fare, grosskopf & roos, 1995; moreno, 2010; vaz, camanho & guimarães 2010; wang & lan, 2011; moreno & maria, 2011; vaz & camnho, 2012; lau, 2013; lee, 2013; gandhi & shankar, 2014; al-refaae, 2015; anand & grover, 2015; majumdar & asgari, 2017; barros & alves, 2004; barros, 2006; bambe, 2017; qiu & meng, 2017; sarmento, renneboog & matos, 2017; ko et al., 2017; hsu, 2018; haidar, 2018; * corresponding author, e-mail: radojko.lukic@ekof.bg.ac.rs 40 economic analysis (2020, vol. 53, no. 2, 39-50) camanho, portela & vaz, 2009 ; caves, christensen & diewert, 1982; jorge & suárez, 2009; melo & sampaio, 2018; yu & ramanathan, 2009; busu, vargas & gherasim, 2020; cheng, chu & ohlson, 2020). however, the national literature in this area lags significantly behind (lukic, 2018; lazic & domazet, 2019; radović-marković, brnjas & simović, 2019; lukic & hadrovic zekic, 2019; lukic, hadrovic zekic & crnjac milic, 2020). it can be claimed that according to our knowledge, there is no extensive study dedicated to the analysis of efficiency and productivity of trade companies in serbia, which is predominantly based on the dea approach. in that sense, this paper represents a special scientific-professional contribution. the basic research hypothesis is that continuous measurement of profitability and efficiency of trade provides a basis for international comparison and its improvement by imposing appropriate measures and adequate control of internal and external factors. this setting fully refers to trade in serbia, which is empirically investigated here primarily from the point of view of profitability and efficiency. empirical knowledge of the legality of trade and factors that determine its performance and adequate control of key factors can significantly contribute to improving the overall profitability and efficiency of trade in serbia in the future. the methodology of research of the problem discussed in this paper, in accordance with the defined basic hypothesis, is based on the strategic profit model and dea analysis. in order to transform the initial data into useful information and draw appropriate conclusions, certain statistical analysis techniques are also used here. for the purpose of researching the profitability and efficiency of trade in serbia, the empirical data contained in the publications and financial reports of the business registers agency of the republic of serbia were used. they are “produced” in accordance with the relevant international standards, so there are no restrictions in terms of international comparison of the obtained research results in this paper. research methodology the research of the issues stated in this paper is based on the application of the strategic profit model and dea analysis. in addition to the basic methods of descriptive analysis, standard techniques of correlation analysis were used in the paper. strategic profit model the strategic profit model indicates the key determinants of return on assets and return on equity. their adequate control can significantly improve returns on assets and capital. return on assets is determined by the formula: 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑠𝑠𝑒𝑠𝑡𝑠 𝑥 (1) the return on assets is, as can be seen from this formula, d function of the return on sales and the turnover ratio of the assets. return on equity is determined by the following formula: 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 𝑥 𝑥 (2) return on equity is therefore a function of return on sales, the ratio of turnover of assets and financial indebtedness, i.e. the return on assets and financial indebtedness. radojko lukić, hasan hanić, milica bugarčić 41 dea models in the context of a brief theoretical analysis of the dea model, the ccr model and the bcc model will be presented in briefly. the ccr model is based on a fixed or constant scale yield. this means that a proportional increase in all inputs results in the same proportional increase in all outputs. the dual of ccr efficiency is expressed as: 𝑀𝑖𝑛 𝜃 under restrictions ∑ 𝜆 𝑥 𝜃𝑥 𝑖 1 … . . 𝑚 ∑ 𝜆 𝑦 𝑦 𝑘 1 … . . 𝑠 𝜆 0 𝑗 1 … . . 𝑛 (3) where θ the technical efficiency of dmu units is 0, λ is a dual variable for identifying comparable inefficient units. if the value of θ * is equal to one, the observed unit of dmu is technically efficient. the concept of the ccr model was modified by the introduction of the bcc model (by bankercharnes-cooper) by replacing the constant scale yield (crs) with the variable scale yield (vrs). a dmu unit operates under a variable scale yield if the increase in input does not result in proportional changes in output. the bcc model is shown as: 𝑀𝑖𝑛 𝜃 under restrictions ∑ 𝜆 𝑥 𝜃𝑥 𝑖 1 … . . 𝑚 ∑ 𝜆 𝑦 𝑦 𝑘 1 … . . 𝑠 ∑ 𝜆 1 𝑗 1 … . . 𝑛 𝜆 0 𝑗 1 … . . 𝑛 (4) the bcc model divides the technical efficiency (te) obtained by the ccr model into two parts: 1) pure technical efficiency (pte), which ignores the influence of scale size by comparing a dmu unit with units of similar scale and measures how a dmu unit uses inputs under exogenous conditions; and 2) scale efficiency (se), which shows how scale size affects efficiency, formulated as follows: 𝑆𝐸 𝑇𝐸 / 𝑃𝑇𝐸 (5) 42 economic analysis (2020, vol. 53, no. 2, 39-50) profitability of trade in serbia the original data used for the analysis of profitability and efficiency of trade in serbia are shown in table 1. table 1. initial data for measuring the profitability and efficiency of trade in serbia, 2013 2019 dmu (i) number of employees (i) earnings per employee (in thousand rsd) (i) assets (in thousand rsd) (i) equity (in 000 din) (in thousand rsd) (o) sale (in thousand rsd) (o) net profit (in thousand rsd) 2013 193210 151978 2160474 746992 2891518 89730 2014 191621 154833 2157564 761305 2594602 86955 2015 159621 164718 2197931 805009 2731999 95265 2016 206092 180367 2324843 859749 3009651 105238 2017 208020 194924 2375290 920992 3172393 122727 2018 219373 218410 2524897 1007972 3361094 121816 2019 222049 238022 2682931 1073056 3608329 139409 cagr 2.01% 6.62% 3.14% 5.31% 3.21% 6.5% note: authors’ calculation of annual growth rates using cagr calculator (compound annual growth rate calculator). (i) – input elements. (o) – output elements. source: business registers agency of the republic of serbia recently, the indicator of earnings per employee has been used more and more often to measure the profitability of companies, regardless of their activity, including trade companies. among other influences, this measure expresses the influence of “hidden characteristics” (for example, skills) of employees on the profitability and efficiency of companies. table 2 and figure 1 show earnings per employee who works in trade in serbia for the period 2013 2019. table 2. net profit per employee and earning per employee who work in trade in serbia year net profit per employee (in thousand rsd) earnings per employee/sale (in percentage) 2013 0.464417 5.26 2014 0.453786 5.97 2015 0.596820 6.03 2016 0.510636 5.99 2017 0.589977 6.14 2018 0.555292 6.50 2019 0.627830 6.60 source: authors’ calculations radojko lukić, hasan hanić, milica bugarčić 43 figure 1. net profit per employee and earnings per employee who work in trade in serbia source: authors’ calculations during the analyzed period, earnings per employee in serbian trade increased steadily. this was, among other things, influenced by the improvement of the "quality" of human resources management in serbian trade and the improvement of the culture of relations between employees and consumers. this was certainly contributed by the greater presence of foreign retail chains in serbia, which invest significantly more in the training and education of employees. table 3 shows the strategic profit model return on assets of trade in serbia. as the data in this table indicate, table 3. strategic profit model return on assets of trade in serbia year return on assets return on sale asset turnover ratio 2013 4.15% 3.10% 0.041533 2014 4.03% 3.35% 0.040302 2015 4.33% 3.49% 0.043343 2016 4.53% 3.50% 0.045267 2017 5.17% 3.87% 0.051668 2018 4.82% 3.62% 0.048246 2019 5.20% 3.86% 0.051961 source: authors’ calculations table 3 shows the strategic profit model return on assets in trade in serbia. as the data in this table indicate, in 2019 the return on assets in trade in serbia increased significantly, which is a consequence of the increase in both the return on sales and the asset turnover ratio table 4 shows a strategic profit model – return on equity in trade in serbia in 2019, the return equity in trade in serbia also increased significantly. this was influenced by an increase in return on sales and asset turnover ratio, on the one hand, and a decrease in financial indebtedness, on the other. 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 2013 2014 2015 2016 2017 2018 2019 net profit per employee (in thousand rsd) earnings per employee/sale (in percentage) 44 economic analysis (2020, vol. 53, no. 2, 39-50) table 4. strategic profit model – return on equity in trade in serbia year return on equity return on sales asset turnover ratio financial indebtedness 2013 4.15% 3.10% 0.041533 2.892232 2014 4.03% 3.35% 0.040302 2.834034 2015 4.33% 3.49% 0.043343 2.730319 2016 4.53% 3.50% 0.045267 2.704095 2017 5.17% 3.87% 0.051668 2.579056 2018 4.82% 3.62% 0.048246 2.504928 2019 5.20% 3.86% 0.051961 2.500271 source: authors’ calculations it can be concluded that all analyzed indicators reveal that there has been a significant increase in the profitability of trade in serbia recently. factors that influenced this are the following: improvement of general economic conditions, low inflation, stable exchange rate, low bank interest rate, significant inflow of foreign direct investments (increasing presence of foreign retail chains in the serbian retail market), more efficient management of sales, costs, assets and profits, accelerated digitalization of the entire trade business and others. trade efficiency in serbia the assessment of trade efficiency in serbia was performed using dea analysis with constant and variable yield. the following are used as input variables: number of employees, earnings per employee, assets and equity, and as output: sales and net profit. table 5 shows the descriptive statistics on input / output data. table 5. statistics on input/output data statistics on input/output data number of employees earnings per employees (in thousand rsd) assets (in thousand rsd) equity (in thousand rsd) sale (in thousand rsd) net profit (in thousand rsd) max 222049 238022 2682931 1073056 3608329 139409 min 159621 151978 2157564 746992 2594602 86955 average 199998 186179 2346276 882154 3052798 108734 sd 19674.8 30354.2 184656 115331 329218 18271.8 source: authors’ calculations by software dea model = dea‐solver lv8.0/ccr(ccr‐i) in the observed period (2013 2019), almost all input / output data were from 2016 above the average for serbian trade. this had a positive effect on her overall performance. table 6 shows the correlation matrix of input / output data. table 6. correlation matrix on input/output data correlation number of employees earnings per employee assets equity sale net profit number of employees 1 0.75677 0.77928 0.74712 0.81175 0.74553 earnings per employee 0.75677 1 0.99507 0.99931 0.9549 0.97268 assets 0.77928 0.99507 1 0.99085 0.96466 0.96467 equity 0.74712 0.99931 0.99085 1 0.94954 0.97371 sale 0.81175 0.9549 0.96466 0.94954 1 0.95619 source: authors’ calculations by software dea model = dea‐solver lv8.0/ccr(ccr‐i) radojko lukić, hasan hanić, milica bugarčić 45 based on the numerical values of the correlation coefficients given in the last column of the extended correlation matrix, it can be concluded that there is a strong positive correlation between the input and output data. table 7 and figures 2 and 3 show the efficiency of serbian trade measured using the dea model: ccr (ccr-i; ccr-o). table 7. efficiency of trade in serbia – ccr model no. dmu model = ccr‐i model = ccr‐o score rank score rank 1 2013 1 1 1 1 2 2014 0.929 7 0.929 7 3 2015 1 1 1 1 4 2016 0.9671 6 0.9671 6 5 2017 1 1 1 1 6 2018 0.9904 5 0.9904 5 7 2019 1 1 1 1 average 0.9838 0.9838 max 1 1 min 0.929 0.929 st dev 0.027 0.027 source: authors’ calculation by software dea model = dea‐solver lv8.0/ ccr (ccr‐i; ccr‐o) according to the ccr model, with input and output orientation, trade in serbia was efficient in 2013, 2015, 2017 and 2019, while in other observed years of the analyzed period (2014, 2016 and 2018) it was (slightly) less efficient. in order to improve the efficiency of trade in serbia in these years, and in general, it was necessary to manage human capital, assets, equity, sales and profits more efficiently. figure 2. efficiency of trade in serbia (ccr-i) source: authors’ calculations 46 economic analysis (2020, vol. 53, no. 2, 39-50) figure 3. efficiency of trade in serbia (ccr-o) source: authors’ calculations table 6 and figures 4 and 5 show the trade efficiency in serbia measured using the bcc model with input and output orientation (bcc-i; bcc-o). table 6. efficiency of trade in serbia – bcc model no. dmu model = bcc‐i model = bcc‐o model = bcc‐i model = bcc‐o score rank score rank rts of projected dmu rts of projected dmu 1 2013 1 1 1 1 constant constant 2 2014 1 1 0.9998 5 increasing increasing 3 2015 1 1 1 1 constant constant 4 2016 0.9727 7 0.9693 7 constant constant 5 2017 1 1 1 1 constant constant 6 2018 0.9912 6 0.991 6 constant constant 7 2019 1 1 1 1 constant constant average 0.9948 0.9943 no. of increasing rts=1 no. of increasing rts=1 max 1 1 no. of constant rts=6 no. of constant rts=6 min 0.9727 0.9693 no. of decreasing rts=0 no. of decreasing rts=0 st dev 0.0103 0.0115 source: authors’calculation by software dea model = dea‐solver lv8.0/ bcc (bcc‐i; bcc‐o) according to the bcc model with input orientation (bcc-i), trade in serbia was efficient in 2013, 2014, 2015, 2017 and 2019, and inefficient in 2016 and 2018. according to the bcc model with output orientation (bcc-i), trade in serbia was efficient in 2013, 2015, 2017 and 2019, and inefficient in 2014, 2016 and 2018. based on both dea models (ccr and bcc) with input and output orientation, it can be concluded that trade in serbia was efficient in 2019. this was favourably influenced by external and internal factors, with a special contribution given by two factors: bigger number of foreign retail chains on the serbian market, as well as the accelerated digitalization of the entire trade business. radojko lukić, hasan hanić, milica bugarčić 47 figure 4. efficiency of trade in serbia (bbc-i) source: authors’ calculations figure 5. efficiency of trade in serbia (bbc-o) source: authors’ calculations conclusion based on the conducted research, it can be concluded that there has been a significant increase in the profitability of trade in serbia recently. according to the ccr model, with input and output orientation, trade in serbia was efficient in 2013, 2015, 2017 and 2019, and inefficient in 2014, 2016 and 2018. according to the bcc model, with input orientation (bcc-i), trade in serbia was efficient in 2013, 2014, 2015, 2017 and 2019, and inefficient only for two years of the analysed period in 2016 and 2018. according to the bcc model, with output orientation (bcc-o), trade in serbia was efficient in 2013, 2015, 2017 and 2019, and inefficient in 2014, 2016 and 2018. based on all used dea models (ccr and bcc), with input and output orientation, it can be concluded that trade in serbia was efficient in 2019. 48 economic analysis (2020, vol. 53, no. 2, 39-50) factors that contributed to the improvement of profitability and efficiency of trade in serbia are as follows: improvement of general economic conditions, low inflation, stable exchange rate, low bank interest rates, significant inflow of foreign direct investment (increasing presence of foreign retail chains in the serbian retail market), more efficient management of sales, costs, assets and profits, accelerated digitalization of the entire trade business and others. references al‐refaie, abbas, et al. 2015. 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"an assessment of operational efficiency of retail firms in china." journal of retailing and consumer services 16(2): 109-122. article history: received: november 15, 2020 accepted: november 27, 2020 doi: 10.28934/ea.23.56.1.pp69-84 first online: june 13, 2023 original scientific paper impact of continuing education on stable employment and wages of men and women in serbia kosovka ognjenović5 f*1 1 institute of economic sciences, welfare economics department, belgrade, serbia abstract this paper examines whether continuing education and training contribute to overall job security and to narrowing the gender wage gap, thereby mitigating the potential effects of employer discrimination. data from the serbian survey on income and living conditions are used, focusing on 2020 and estimating wage regressions. the main results show that participation in continuing education and training has a positive effect on wages and contributes to reducing the wage gap, especially for individuals who were previously unemployed and participated in some form of additional training. this paper contributes to understanding the importance of training and its impact on employment stability and workers' wages in the post-transition economy. the findings presented in this paper are advisory to both policymakers and management. in general, it can be stated that trained employees are better suited to do tasks and, especially if they are satisfied with the knowledge acquired in the company, contribute to a stable environment that makes it easier for them to meet the demands of competition. on the other hand, this implies the empirically confirmed assumption that competition may be negatively correlated with employer discrimination. however, employee participation in continuing education and training in serbia is still below the optimal level. keywords: employees, employment, serbia, training, wage differences jel classification: j31, m53 introduction the extent and structure of gender discrepancies in the labor market are usually studied in terms of paid work in the main job. analysis of this practice is important in the modern organizational environment because it can have far-reaching economic and social consequences for the formation of the overall labor supply and active inclusion. although there is a general trend toward wage convergence, owing to the better observed characteristics of women, gender differences in wages remain substantial. one of the explanations is based on the finding that, in parallel with the improvement in observed characteristics (including educational attainment and years of work experience), women have also improved their unobserved characteristics (blau and kahn, 2003). this claim is due to the fact that wage models do not account for investments in improving personal qualifications and skills. in other words, due to the limitations of available microdata, relevant explanatory variables that measure investment in personal development over working life cannot be accounted for in the empirical model (brown, moon and zoloth, 1980). a low female employment rate is positively correlated with the gender wage gap (fortin, bell and * e-mail: kosovka.ognjenovic@ien.bg.ac.rs 70 economic analysis (2023, vol. 56, no. 1, 69-84) böhm, 2017). moreover, the higher the proportion of female employees in the firm, the lower the wage gap is (fanfani, 2022). existing trends in the serbian labor market speak to the need for such an analysis. the unexplained gender wage gap persists in the serbian labor market (vladisavljević, avlijaš and vujić, 2015), although it is smaller than in most european countries (hedija, 2017). greater flexibility led to an increase in non-standard forms of employment and further contributed to widening wage gaps in the labor market, with fixed-term contracts predominating (albanese and gallo, 2020). moreover, gender gaps in employment have remained constant over the years, reflecting a slow absolute increase in female employment. investment in education and training remains moderate, resulting in low relative workforce participation in lifelong learning. considering the increasingly demanding global demand for skills (european commission, 2022), the participation rate of the adult population of serbia in some form of education or training is significantly lower compared to the eu-27 average 19.8% versus 45.1% (statistical office of the republic of serbia, 2018). regarding the intention of enterprises to carry out some form of continuing vocational education and training, the difference between serbia and the eu-27 is much smaller. in serbia, 49.2% of companies carry out some form of continuing vocational training, compared to 67.4% in the eu-27 (statistical office of the republic of serbia, 2022b). the strategic framework for employment policy in serbia for the period 2021-2026 is based on improving the position of women in the labor market, reducing gender inequalities, and strengthening the educational structure of the workforce (government of the republic of serbia, 2021). in addition, it is suggested that global indicators of the quality of human capital and the quality of employment should be included in monitoring the achievement of the goals of this strategy (ognjenović, kuzmanov and pavlović, 2021). to illustrate, the gender employment gap has widened to 15.2 percentage points, while the gap between male and female labor force participation rates increased to 15.9 percentage points in 2021. this slight widening of the gender gap in the labor market can be partly attributed to the impact of the covid-19 pandemic. at the same time, the gender gap in employment and labor force participation in the eu-27 was 11.5% and 12.1%, respectively, in 2021, but decreased slightly compared to 2020. according to the 2018 structure of earnings survey, the gender pay gap in serbia and the eu-27 was 9.6% and 14.4%, respectively (statistical office of the republic of serbia, 2020; eurostat, 2022). analyses of european labor markets show that training programs are an effective tool that contributes significantly to overall employment stability (zweimüller and winter-ebmer, 1996; doerr, fitzenberger, kruppe, paul and strittmatter, 2017). on the other hand, international experience often shows ambiguous results. social support measures for women (e.g., parental leave) may lead to greater participation of women in on-the-job training after their return to work. on the other hand, they may also discourage employers from investing in on-the-job training for women, thereby promoting discrimination against women (blau and kahn, 2003). those who have higher educational attainment, who are more committed to fulfilling job tasks, and younger employees have a higher probability of entering a firm-provided training as evidenced in numerous studies (picchio and van ours, 2013; filippetti and iammarino 2019; barrenecheaméndez, ortín-ángel and rodes, 2022). thus, the main research question in this paper is whether continuing education and training (cet) contribute to mainstream job security and reduce the gender wage gap, thereby mitigating the potential effects of employer discrimination. this hypothesis is examined using data from the survey on income and living conditions (silc), focusing on the year 2020. this year was also chosen because the survey microdata includes a variable that measures monthly wages (independent of total annual income from work). the remainder of the paper is organized as follows. the next section contains a current literature review on the topic studied in this paper. this is followed by a section of the paper that discusses the methodology and explains the data. the main findings are presented in a separate section, followed by discussions and conclusions of the paper. kosovka ognjenović 71 literature review the empirical literature suggests that there is a positive relationship between employment stability (including workers' wages) and the provision of training. this training can be provided by firms or initiated by workers through the offering of training providers outside the firm. the literature addressing workplace learning does not clearly delineate the terms used to explain motivation to learn and participate in training, making it difficult to measure their effects and interdependencies in empirical studies (kochoian et al., 2022). continuing education cannot be studied separately from digitization. the effects of digitization on the labor market are usually studied from a global perspective. they do not differ significantly when observed only in an isolated labor market, such as a post-transition economy. janeska and lozanoska (2021) found that the impact of digitization on the north macedonian labor market can be observed against the background of the changing employment structure. that is, the changes in the labor market are reflected in the economic sectors, occupations, job profiles and qualifications. when examining the impact of digitalization on the serbian labor market, bradić-martinović and banović (2018) found that women need to improve their digital skills to catch up with their counterparts. in different contexts and countries, there is empirical evidence of the positive effects of jobrelated training on employability, job retention, wages, and career advancement. table 1 provides an overview of the selected literature on this topic. gender wage differentials may be due to monopsonistic characteristics or the tight structure of the labor market, but also to women's preference for more flexible working conditions. this is evident from a study published by fanfani (2022), which examined taste-based discrimination among manufacturing employers in an italian industrial region. examining wage differentials in the two european countries and canada, fortin et al. (2017) found that the increase in wages in the top percentile of the wage distribution may be associated with the increase in the unexplained portion of the gender wage gap. differences in students' propensity to compete while still in education may be related to later gender differences in labor market outcomes (blázquez et al., 2018; lüthi and wolter, 2021) and women's aspirations for top corporate positions (hoyer et al., 2020). similarly, the adoption of professional values during the education of young practitioners early in their careers may be reflected in their subsequent success in the labor market (jackson et al., 2022). participation in job-related training and employment stability are positively related, and this relationship may also contribute to sustained wage growth. it is also important to note that higher levels of education trigger further participation in all types of continuing education. kramer and tamm (2018) have empirically confirmed a positive relationship between education and continuing training on german data of adults over the life course. on-the-job training can be used as a companion strategy in recruiting workers by offering the same level of training for the same job and then using trainees' skills for selection purposes (barrenechea-méndez et al., 2022). cairó and cajner (2018) also show that complementarity between education level and job-related training can lower separation rates, but has no effect on job matching rates. however, studies can be found that show that job-related training or another type of training can significantly improve employability and job stability (mamaqi et al., 2012; picchio and van ours, 2013). studies using spatial or sector-specific data may show some degree of inconsistency with the original hypothesis with respect to several other socioeconomic factors (filippetti et al., 2019). 72 economic analysis (2023, vol. 56, no. 1, 69-84) , table 1. summary of relevant literature author state method results barrenechea-méndez et al. (2022) spain cross-sectional data; ols and ordered probit (+) relationship between on-the-job training and selection blázquez et al. (2018) 15 eu countries and japan cross-sectional data; multinomial logit and ols (+) relationship between cognitive competencies of university students and wages cairó & cajner (2018) u.s. cross-sectional data; search and matching model education and job-related training reduce unemployment duration and employment volatility (labor market volatility) doerr (2022) germany the german federal employment agency’s data on training vouchers provided to job returners; propensity score matching (+) relationship between training vouchers and (re)employment and wages of women returning to work fanfani (2022) italy matched employeremployee data; 2-way fe regression (+) relationship between the gender gap in firms' wage policies and tastebased discrimination filippetti et al. (2019) italy panel data from the survey on labor participation and unemployment; probit and 2-step control function (+) relationship between training and employment stability, the differences by region fortin et al. (2017) canada, sweden, and the uk administrative data on wages and lfs; counterfactual analysis using reweighting estimator and oaxaca-blinder an increase in top wages reveals a growing share of the unexplained gender gap gay & borus (1980) u.s. longitudinal data from four employment and training programmes; limited dependent variable models and maximum likelihood insignificant relationship between participation in sponsored training and job placement in the long-run hoyer et al. (2020) the netherlands self-administered 3-round experiments with university students; probit and ols the importance of gender differences in competitiveness is reflected in the lower participation of women in top positions jackson et al. (2022) australia self-administered survey of owners and business and hr managers; analysis of variance (anova) job-related training strongly correlates with young trainees' adoption of job-related values and employment stability kramer & tamm (2018) germany national education panel study; ols and instrumental variable estimator (+) relationship between education and participation in training lüthi & wolter (2021) switzerland matched survey data of students with administrative records of gender differences in competitive behaviour in class are significantly kosovka ognjenović 73 author state method results apprentices; binary and multinomial probit associated with later outcomes in real life and the labor market mamaqi et al. (2012) spain cross-sectional data; binary logit model (+) relationship between employment stability and continuing training picchio & van ours (2013) the netherlands longitudinal data from the european community household panel (echp); dynamic unobserved effects probit (+) relationship between on-the-job training and employability schmidt (2009) u.s. and canada the job training and job satisfaction survey; analysis of variance (anova) temporary workers' satisfaction with on-the-job training differs by type of job, status, and tenure zweimüller & winterebmer (1996) austria administrative data on unemployed, men; bivariate probit (+) relationship between participation in training programmes and employment stability source: the author based on collected papers. empirical studies pointing to the importance of training for the unemployed also cannot be ignored, whether it is training in the context of european labor market policy (zweimüller and winter-ebmer, 1996) or institutionally supported training in the us labor market (gay and borus, 1980), whose role is to contribute to reduced volatility in the labor market or to facilitate job placement. using the austrian labor market as an example, doerr (2022) has shown that training can improve the reemployment and wages of women returning to work. considering that temporary workers also play an important role in the functioning of companies, it is important for hr departments hiring these workers to obtain feedback on their satisfaction with on-the-job training (schmidt, 2009). statistical facts prior to the pandemic covid-19, serbia was well on its way to reducing the gender wage gap, and a legal framework was adopted that made this possible (ognjenović, 2021). however, the wage gap remains significant (table 2). according to eurostat's methodologically standardised structure of earnings survey, the unadjusted gender wage gap in serbia increased slightly before the covid-19 pandemic (statistical office of the republic of serbia, 2020). this may be influenced to some extent by a slight increase in the gap between men's and women's wages in the private sector, a redistribution of working hours in favour of more working hours for men, and the type of employment contract. although the gender wage gap in serbia is smaller than the eu-27 average of 14.4% in 2018, it is still larger than in some former transition countries in central and eastern europe (cee) (eurostat, 2022). table 2. the gender wage gap in serbia, in % country | year 2014 2018 serbia 8.7 9.6 note: this table depicts the unadjusted gender wage gap extracted from eurostat’s structure of earnings survey that excludes public administration, defence, and compulsory social security and includes full-time and part-time jobs. source: eurostat, 2022. 74 economic analysis (2023, vol. 56, no. 1, 69-84) as figure 1 shows, the largest wage gaps between men and women remain in the two former baltic transition countries (estonia and latvia), the two former cee transition countries (the czech republic and slovakia), and the two old eu member states (austria and germany). these differences are due not only to the institutional framework, which is uniform across the eu, but also to sociocultural factors, which vary from country to country, and most importantly, full-time and part-time jobs are included. women working part-time usually have lower wages, contributing to a wider pay gap. for example, austria and germany, where one of the largest unadjusted gender wage gaps is identified, have more women engaged in part-time jobs. figure 1 depicts the gender wage gap for both full-time and part-time employees. any further analysis of the unadjusted gender wage gap across eu countries would require taking into account the differences in the distribution of working hours of employees. however, data on the gender wage gap by working hours are not available for all countries. figure 1. the unadjusted gender wage gap, in %, in europe according to the eurostat’s structure of earnings survey source: eurostat, 2022. source: eurostat, 2022. the gender wage gap is widest in serbia compared to other countries in the process of accession, but at the same time, it is smaller than in some neighboring countries that are already members of the eu. according to the share of part-time employees, serbia is more similar to countries, such as montenegro and macedonia, with which it is compared. when only salaried workers are considered, the differences among employees according to the share of part-time jobs are small. the share of part-time employees in serbia does not exceed four percent and is more than twice as high as in these two countries. the unadjusted gender wage gap for serbia, shown 0 5 10 15 20 25 30 eu -2 7 es to ni a a us tr ia cz ec hi a g er m an y sl ov ak ia la tv ia fi nl an d fr an ce n et he rl an ds d en m ar k h un ga ry li th ua ni a b ul ga ri a m al ta sw ed en sp ai n cr oa ti a ir el an d cy pr us g re ec e sl ov en ia po rt ug al po la nd b el gi um it al y r om an ia lu xe m bo ur g m on te ne gr o n . m ac ed on ia a lb an ia se rb ia 2014 2018 kosovka ognjenović 75 in table 2, is more in line with the pay gap of full-time employees, which was 9.9% in 2018 (eurostat, 2022). when low-skilled women drop out of the labor force or engage in part-time employment or employment with reduced benefits, this further increases their financial vulnerability (doerr, 2022). this has practical implications for public policy, which may be reflected in women's subsequent position in the labor market or their recognition by the pension and social security systems as potential benefit recipients. measures to support the most affected sectors of the economy, including those in which women are overrepresented, aim to maintain balanced employment and prevent job loss due to a greater risk of contagion. previous findings show that the gender wage gap is likely to be correlated with the economic sector (hedija, 2017; fanfani, 2022), while education forms a negative relationship with the gender wage gap (ognjenović, 2021). narrowing down the discriminatory patterns in wage determination requires further attention. this will be explored in the following sections. data and methodology additional variables will expand the human capital portion (𝑥𝑥′𝛽𝛽) of the wage model (1) to perform this empirical exercise and assess its impact on reducing gender inequality in the labor market. thus, the first set of variables includes age (age and age squared), education (education dummies), and work experience (experience and experience squared), the second set (𝑧𝑧′𝛾𝛾) includes all other socioeconomic (marital status, number of preschool children, health status) and work-related characteristics (permanent contract, managerial position, region, ownership, industry), while (𝑤𝑤′𝛿𝛿) includes dichotomous variables, such as female and continuing education dummies, and their interaction term 𝜀𝜀 represents an error term in the wage regression. the mathematical notation of the wage model can be expressed in the following form: 𝑦𝑦 = 𝛼𝛼 + 𝑥𝑥′𝛽𝛽 + 𝑧𝑧′𝛾𝛾 + 𝑤𝑤′𝛿𝛿 + 𝜀𝜀 (1) in applying this methodological approach, we first need to examine whether the variable “continuing education and training” has a statistically significant effect on the gender wage gap by estimating the wage model (1), which includes a female dummy as a proxy for the gender wage gap. this variable refers to employees pursuing further education and participating in training while working without specifying the form of this training. to examine whether training affects employment stability, we may compare the employment tenure of those who participated in training and those who did not, as well as total work experience. however, only the total work experience variable is available in the data sample. the high correlation between earnings and work experience of those previously unemployed and who participated in additional training may indicate the validity of this relationship. in conducting this experiment based on the silc data, it is important to keep in mind that the percentage of participants in additional education and training is significantly lower than when analysing data from the continuing vocational training survey for the simple reason that the research is conducted on other sample units. this survey refers to professional development training that companies provide to their employees (statistical office of the republic of serbia, 2022b). these variables indicate whether someone found a job and was previously unemployed and whether they participated in additional education and training. according to the proposed strategy for empirical estimation, it can be assumed that further education and training are observable characteristics that can affect gender inequalities in wages and contribute to employment security. the latest data from the survey on income and living conditions in serbia (statistical office of the republic of serbia, 2022a) are used to empirically explain the theoretical relationship in the estimated model and draw valid conclusions for policy recommendations. the sample includes the population older than 17 years. the sample includes 4,168 observations, of which 45.2% are women. the dependent variable is the average monthly net wage divided by the number of hours worked in the same month. a 76 economic analysis (2023, vol. 56, no. 1, 69-84) logarithmic transformation was applied to the average hourly wage thus obtained so that the dependent variable can be expressed in terms of hourly wage rates. the average hourly wage rate of men is 5.550, while the standard deviation (sd) is 0.420, and that of women is 5.446 (sd =0.391). the dispersion of the average hourly wage rate of women is smaller than that of men. the interquartile rank of the average hourly wage rate of women is 0.511, and that of men is 0.542. the descriptive statistics, including mean, standard deviation, minimum and maximum values, of the dependent and explanatory variables included in the empirical wage model are presented in table 3. except for average hourly wage, age, and working experience are continuous variables, while all other variables are dichotomous variables. for the categorical variables of education level, urbanization level, business size, and economic sector, the categories of low education level, sparsely populated area, microenterprise, and macro sector of agriculture were excluded from the econometric modelling. the average work experience is 16 years (17 for men and 15 for women), while the average respondent is 41 years old (about the same age for both sexes). this indicates that in serbia, on average, a person does not enter the labor force until after the age of 25. given that only 19.7% of respondents have a university degree, this would be more consistent with the finding that nonstandard forms of employment, especially among young people, or late entry into employment, are represented to a significant extent. table 3. descriptive statistics of the sample variable mean s.d. min. max. socioeconomic characteristics average hourly net wage in log 5.512 0.409 3.904 8.286 age in years 41.407 11.491 18 77 experience in years 16.220 11.114 0 45 education low educated 0.075 0.264 0 1 medium educated 0.727 0.445 0 1 high educated 0.197 0.197 0 1 marital status and children marriage 0.635 0.481 0 1 presence of children 0.223 0.417 0 1 gender female 0.452 0.498 0 1 health status poor health 0.019 0.136 0 1 job-related characteristics type of employment permanently employed 0.802 0.398 0 1 responsibility level managerial position 0.143 0.350 0 1 region serbia-north region 0.453 0.498 0 1 degree of urbanization thinly populated area 0.312 0.464 0 1 intermediate populated area 0.295 0.456 0 1 densely populated area 0.393 0.488 0 1 firm size micro firms 0.327 0.469 0 1 small-sized companies 0.472 0.499 0 1 medium and large-sized companies 0.201 0.401 0 1 ownership privately owned 0.635 0.481 0 1 kosovka ognjenović 77 variable mean s.d. min. max. economic sector agricultural sector 0.015 0.123 0 1 manufacturing & construction sector 0.025 0.025 0 1 services sector 0.956 0.205 0 1 continuing education continuing education and training 0.015 0.122 0 1 previous employment status unemployed 0.075 0.264 0 1 no. of observations 4168 source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). the proportion of workers who participated in additional education and training is low only 1.5%, as estimated from a complete sample. however, the participation rates for men and women differ, showing that women are more likely to participate in training than men. the participation rate for the latter is 1.3%. and for the former 1.7%. to some extent, this may be related to the larger proportion of women who were previously unemployed and found a job in the last twelve months. the data show that the corresponding rates for women and men are 8.1% and 7.1%. some other studies show that women are more likely to participate in continuing education than men, and this is not only a characteristic of the serbian labor market. in the eu countries, women with high education, those employed in the services sector, and those who occupy positions in the public sector are more inclined toward participation in continuing education (picchio and van ours, 2013; doerr, 2022). when it comes to mothers with small children and part-time workers, picchio and van ours (2013) found a low probability of their participation in further education, explaining this result by the fact that income from work is a less significant source of their total income. results and discussion the gender wage gap is positively correlated with labor force participation and unemployment rates, as shown in numerous empirical studies for advanced economies (blau and kahn, 2003; fortin, bell and böhm, 2017). low employment is the trigger for the existence of the wage gap. the labor force participation and employment rates of men and women in serbia have not changed significantly in recent years. the only slight widening of the gap can be partly attributed to the impact of the pandemic. according to the labor force survey of the statistical office of the republic of serbia for 2021, the labor force participation rates for the population aged 15 and older were 62.9% and 47.0%, and the employment rates were 56.5% and 41.3% for men and women, respectively. many observable and unobservable factors can cause gender gaps to widen for men and women. some of these differences relate to participation in additional education and training and observing their impact on employment stability and potential discrepancies in wages between men and women. table 4 provides the main characteristics of participants in additional education and training and nonparticipants for comparison. as can be seen, those who practice participation in continuing education are younger (the average age of participants is almost 28 years, while that of nonparticipants is 42 years). the average age difference between the participants and those who did not participate in continuing education is almost 14 years and is statistically significant (p<0.001). accordingly, participants are less experienced (they have an average of four years of professional experience) and are better educated (25.4% of participants with a high level of education compared to 19.7% of nonparticipants), while people with a low level of education have almost no chance of participating in additional education and training, according to silc data. this is consistent with previous findings indicating a high correlation between educational attainment and participation in cet (kramer and tamm, 2018). the participation rate of women is 78 economic analysis (2023, vol. 56, no. 1, 69-84) predominant among participants (52.4%), while there is no obvious difference in participation in cet depending on previous employment status. however, the revealed differences are not statistically significant at conventional levels. table 4. characteristics of wage earners by participation in cet variable nonparticipants participants difference age in years 41.614 27.905 13.709*** experience in years 16.406 4.127 12.279*** education low educated 0.076 medium educated 0.727 0.746 -0.019 high educated 0.197 0.254 -0.057 previous employment status unemployed 0.075 0.079 -0.004 gender female 0.450 0.524 -0.074 no. of observations 4105 63 note: p < 0.001 ***; p < 0.01 **; p < 0.05 *; p < 0.10 ‡. differences between means of categorical variables are tested using z-test. source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). table 5 shows the distribution of actual values of average hourly wages, measured in log units, as a function of socioeconomic characteristics for the entire sample of men and women and for those who were previously unemployed and found a job within the last twelve months. table 5. log values of the average hourly net wage for men and women by main personal characteristics variable all unemployed men women differ. men women differ. age age [18-29] 5.458 5.427 0.031 5.354 5.349 0.005 age [30-54] 5.573 5.465 0.108*** 5.410 5.290 0.120‡ age 55 and more 5.575 5.524 0.051 5.244 5.444 -0.200 experience experience [0-5] 5.450 5.421 0.029 5.354 5.322 0.032 experience [6-15] 5.540 5.422 0.118*** 5.460 5.326 0.134 experience [16-25] 5.588 5.522 0.066** 5.154 5.443 -0.289 experience [26-35] 5.609 5.521 0.088** 5.377 5.196 0.181 experience [36-45] 5.606 5.504 0.102‡ 5.682 education low educated 5.390 5.197 0.193*** 5.161 5.220 -0.059 medium educated 5.506 5.372 0.134*** 5.358 5.279 0.079‡ high educated 5.837 5.813 0.024 5.614 5.619 -0.005 no. of observations 2286 1882 162 152 note: p < 0.001 ***; p < 0.01 **; p < 0.05 *; p < 0.10 ‡. source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). comparing the average hourly wages of young workers at the beginning of their careers (ages 18-29), prime-age workers (ages 30-54), and workers over age 55 for the entire sample and for those who were previously unemployed, both distributions show that the wages of those who kosovka ognjenović 79 remain employed (employees who have not experienced a break in employment in the last year) are higher on average. men also earn higher wages than their female counterparts, with the only exception being older workers who have recently found a job, which shows that women earn higher wages on average. however, this result may be due to a small number of sampling units, which translates into low dispersion in the data. total work experience in the sample ranges from zero to 45 years. the distribution of work experience includes the newly employed (with no previous work experience) up to five years of total work experience and continuously shows the intervals within the range of ten years between the lower and upper limits of the interval. for the entire sample, men have higher wages than women on average across all intervals of work experience. the wage gap is smallest for workers with fewer years of work experience. it increases proportionally as they reach higher levels of work experience, confirming the statistical significance of revealed differences. however, for workers who have replaced their current employment status with their previous unemployment status, the difference in actual wages is smaller, and for a given level of work experience (between 16 and 25 years), women earn higher wages on average. the resulting difference in wages is not statistically significant. in the distribution of wages by educational attainment for the entire sample, women cannot match the wages earned by men with similar educational attainment. however, this difference is smallest for those with high levels of education, but it is not statistically significant. women with low levels of education who were previously unemployed can achieve higher wage premiums than men. the wage gap between men and women who were previously unemployed is also much smaller for individuals with a medium level of education. in contrast, highly educated women are at a slight advantage since they are paid more relative to men. however, the revealed difference in pay is not statistically significant. table 6 summarizes the results of estimating the wage models. the modeling strategy was to estimate the models to a full sample of workers and to those who left unemployment within the last twelve months. the main research hypothesis is to examine the impact of participation in continuing education and training on wages and, indirectly, how the presence of this variable in the wage model affects wage differentials between men and women. the importance of the gender wage gap in the wage model is captured by the dichotomous variable that measures the proportion of women in the sample of employees. table 6. the estimates of the regression model variable all unemployed estimate std. error estimate std. error socioeconomic characteristics age 0.006 0.005 0.020 0.013 age^2 -0.000** 0.000 -0.000 0.000 experience 0.009*** 0.002 0.008 0.008 experience^2 -0.000 0.000 -0.000 0.000 education medium educated 0.106*** 0.022 0.108‡ 0.066 high educated 0.411*** 0.026 0.392*** 0.108 marital status and children marriage 0.010 0.013 -0.052 0.051 presence of children 0.012 0.014 0.005 0.059 gender female -0.095*** 0.011 -0.042 0.043 health status poor health -0.127*** 0.040 -0.190 0.123 job-related characteristics type of employment 80 economic analysis (2023, vol. 56, no. 1, 69-84) variable all unemployed estimate std. error estimate std. error permanently employed 0.032** 0.015 0.007 0.045 responsibility level managerial position 0.192*** 0.017 0.180 0.205 region serbia-north 0.125*** 0.011 0.098** 0.048 degree of urbanization intermediate populated area -0.031** 0.014 0.078 0.065 densely populated area -0.029** 0.013 0.078 0.053 firm size small-sized companies 0.106*** 0.013 0.102* 0.052 medium and large-sized companies 0.139*** 0.014 0.175*** 0.050 ownership privately owned -0.111*** 0.012 -0.030 0.055 economic sector manufacturing & construction sector 0.375*** 0.052 1.005* 0.491 services sector 0.150*** 0.040 0.205* 0.089 continuing education continuing education and training 0.184*** 0.057 0.236*** 0.069 intercept 4.995*** 0.097 4.489*** 0.254 model fit statistics f-statistics (p) 92.12 (0.00) 5.14 (0.00) r2 0.309 0.208 no. of observations 4168 314 note: p < 0.001 ***; p < 0.01 **; p < 0.05 *; p < 0.10 ‡. excluded categories are low education, sparsely populated area, microenterprise, and macro sector of agriculture. source: the author based this on silc 2020, statistical office of the republic of serbia (2022a). the variables capturing the level of human capital development significantly determine the wage distribution implying further that those are the leading factors in explaining the gender wage gap as it is previously proved in empirical studies (vladisavljević, avlijaš and vujić, 2015; ognjenović, 2021). both the wage-age and wage-experience profiles emerge, as theoretically expected, as indicative of the depreciation of human capital due to aging. it is well known that age is a proxy for total work experience when the data do not include a variable on work experience because of a lack of continuity in work experience due to a high rate of undeclared work or termination of employment for other reasons. therefore, these two variables may be highly correlated. however, estimating the empirical model with alternate inclusion of the two variables does not affect the precision of estimates of other variables in the model, so both variables are retained. education, especially that acquired at institutions of higher learning, generates a high wage premium. for those who have been unemployed, prior work experience does not make a significant difference in the wage premium, while an educational degree still makes a significant wage premium. other personal characteristics of workers have very small effects on wages and are not statistically significant. previous research shows that family situation has a strong influence on a person's decision to actively participate in the labor market (vladisavljević, avlijaš and vujić, 2015). marriage can also have a positive impact on wages; in particular, it has been empirically confirmed that men earn a significant wage premium if they have a wife or partner (ognjenović, 2021). workers living in families with preschool-aged children can expect positive effects on wages, but the results are mixed and do not always show statistically significant wage gains. kosovka ognjenović 81 similar results, showing no significant impact on wages, are obtained for a subsample of previously unemployed individuals. when job-related characteristics are the focus of analysis, permanent employment has the largest and statistically significant impact on wages, although the share of atypical forms of employment is increasing. the responsibility level associated with a managerial position in a firm has a statistically significant impact on wages. the leadership position rejects nearly one-fifth of higher wages, both for all employees and those employed in the last twelve months. it is interesting to note, however, that the percentage of wage growth that comes with a position of responsibility in the company accounts for only half of the potential wage growth of employees with higher education. this finding does not change when only previously unemployed individuals are considered. health problems lead to a 13% decline in average hourly wages, while for those who have been employed in the past 12 months, poor health lowers hourly wages by 19% on average; however, these effects are not statistically significant at conventional levels. employer characteristics are an important factor in examining the gender wage gap as workers' human capital characteristics are. for example, fanfani (2022) examined gender discrimination in the workplace based on employer tastes in an industrial sector of a highly developed area in europe. the author found that employer discrimination and women's preference for a more flexible form of employment were significant determinants of gender wage differentials in large manufacturing firms. results were derived from combining data on employee and employer characteristics. workers, both the entire sample and those who were previously unemployed, in firms in the northern areas of serbia can expect higher wages on average than workers in the rest of serbia. in addition, medium and large firms, as well as small firms, paid higher wages than micro firms, so workers in these firms can expect significant wage increases regardless of whether they were affected by unemployment in the past year. despite the fact that wages in the service sector are higher on average than in other sectors of the economy, it is an interesting finding that private firms operating in manufacturing and construction have higher wage gains. this result is not so surprising if it is related to the fact that the regional distribution, ownership, and size of the company significantly determine the level of the average wage in the sample of data analyzed. the estimate of the dichotomous variable manufacturing and construction may be inaccurate because it is based on a small fraction of the sample of previously unemployed individuals. regression estimates did not change significantly when this variable was excluded. the research hypothesis investigating the impact of continuing education and training on workers' wages was tested and confirmed using the estimated models. indeed, all workers in the sample can expect slightly less than one-fifth higher average hourly wages if they continue their education (𝜹𝜹� = 0.184; p<0.001), while those who were previously unemployed earn more than one-fifth higher average hourly wages (𝜹𝜹� = 0.236; p<0.001). it is just not known whether it is general training or training for a specific job. it is certainly an encouraging result that additional training generally has a positive effect on average wages, but it has an even more pronounced effect on the wages of workers who were unemployed in the previous period. the increase in wages is indirectly related to the stability of employment. thus, through the relationship between participation in additional education and training and wages, the effect on employment security can be confirmed and mediated. when analysing the wage model, it is also important to consider that self-selection into employment may play an important role in calculating the value of the coefficients. the aim of this study was to show the positive role of additional education and training on workers' wages, and any further study on this topic would require a more precise definition of the variable "continuing education and training". all estimates of the tobit model are available on request from the author. the inclusion of a dichotomous variable corresponding to the proportion of women in the sample shows that this part of the labor force earns on average 0.095 lower log hourly wages than their male counterparts, while the estimated wage gap is twice as small in the sample of previously unemployed individuals; however, the estimate is not statistically significant. although women 82 economic analysis (2023, vol. 56, no. 1, 69-84) make up less than half of the sample of formerly unemployed individuals, the inclusion of the interaction term between the dummy variable "female" and "continuing education and training" suggests an additional positive effect of further education on women's wages. this means that a significant part of the total effect of the variable "continuing education and training" is due to the increase in women's wages due to participation in education. conclusion this paper examines whether continuing education and training contribute to overall job security and to narrowing the gender wage gap, thereby mitigating the potential effects of employer discrimination. data from the serbian survey on income and living conditions are used, focusing on 2020 and estimating wage regressions. the main results show that participation in continuing education and training positively impacts wages and contributes to reducing the wage gap, especially for individuals who were previously unemployed and participated in some form of additional training. it was shown that all workers in the sample could expect to earn slightly less than one-fifth of a higher average hourly wage if they continued their education, while those previously unemployed make more than one-fifth of a higher average hourly wage. furthermore, some specific results also show that each additional month of participation in training increases women's wages in a way that contributes to narrowing the gender wage gap, with an estimated contribution of 0.08 percentage points. ognjenović (2021) further found that the difference in educational attainment by gender helps reduce the gender wage gap by almost four percent. vladisavljević, avlijaš and vujić (2015) previously reached similar conclusions for a different country sample. the gender wage gap is calculated using the wage model as the difference in the adjusted values of men's and women's hourly net wages. again, this leads to a generalized conclusion because it is not known what type of additional education is involved, as this is not apparent from the silc data. it can only be assumed that it is job-related training. therefore, it is necessary to consider the results concerning the level of education, which will still be the subject of future research. any further examination of the impact of participation in continuing education and training on the gender wage gap would require additional analysis, including a more significant sample of participants. since their share in the data used for the analysis in this paper is small, it remains for future research. this will provide the answer to the question of why the companies provide training and how they select employees to be trained. this paper contributes to understanding the importance of training and its impact on employment stability and workers' wages in the post-transition economy. empirical evidence shows that the effects of additional education and training on employment and earnings are positive, as seen in the work of zweimüller and winter-ebmer (1996), doerr et al. (2017), cairó and cajner (2018), doerr (2022) and others. the results presented in this paper are relevant for both policymakers and management. in general, it can be stated that trained employees are better suited to work tasks and, especially if they are satisfied with the knowledge acquired in the company, contribute to a stable environment that makes it easier for them to meet the demands of competition. on the other hand, this implies the empirically confirmed assumption that competition may be negatively correlated with employer discrimination. however, employee participation in training is still below optimal levels, as all data sources used in this study indicate the below-average involvement of employees in serbia in additional education and training. acknowledgements the research presented in this paper was funded by the ministry of science, technological development and innovation of the republic of serbia under contract number 451-03-47/202301/200005. note: the author dedicates this work to her cat mićko (2007-2022). kosovka ognjenović 83 references albanese, a., & gallo, g. 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(1996). manpower training programmes and employment stability. economica, 63(249), 113–130. https://doi.org/10.2307/2554637 article history: received: 29.4.2023 revised: 29.5.2023 accepted: 5.6.2023. https://doi.org/10.1016/j.labeco.2020.101815 https://doi.org/10.1016/j.ijme.2022.100692 https://doi.org/10.28934/ea.21.54.1.pp24-40 https://doi.org/10.28934/ea.21.54.1.pp24-40 https://doi.org/10.1007/978-3-030-89582-2_4 https://doi.org/10.1016/j.econedurev.2017.11.004 https://doi.org/10.2298/stnv2102123o https://doi.org/10.1016/j.econedurev.2012.08.004 https://doi.org/10.1080/13678860902982082 https://doi.org/10.1057/9781137460981_10 https://doi.org/10.2307/2554637 ea_2019_2 doi: 10.28934/ea.19.52.2.pp71-92 original scientific paper ageing and productivity: an exploratory analysis of the portuguese case mariana monteiro1* | marta simões2 1 faculty of economics, university of coimbra, coimbra, portugal 2 ceber and faculty of economics, university of coimbra, coimbra, portugal abstract the portuguese labour force is ageing rapidly, corresponding to an increase in the share of older cohorts in the workforce, and there are no prospects that this situation will slow down. this study carries out an empirical analysis of the impact of workforce ageing on labour productivity in the portuguese economy considering data for the period 1971-2017. we investigate the main channels through which these demographic changes affect labour productivity, the accumulation of factors of production, physical or human capital, and total factor productivity (tfp), based on a cobb-douglas production function. the results from the estimation of our var model defined according to the aggregate production function that includes the capital-output ratio, educational attainment, tfp and an indicator of workforce ageing, and the corresponding impulse-response functions analysis do not allow us to identify any impact of the growth rate in the proportion of older workers on the growth rate of labour productivity. for the time being it thus seems that workforce ageing has not posed a serious threat to the portuguese economy, but this situation could rapidly change in the near future given the dismal demographic forecasts that project that the portuguese population will decrease from 10.5 millions of people in 2012 to 8.6 millions in 2060 (ine 2014). key words: labour productivity, workforce ageing, transmission mechanisms, portugal, var jel classification: e23, j11, o30, o47 introduction the portuguese economy almost stagnated during the 21st century and income levels are diverging from the average income per capita levels of the 28 european union member states (eu28). between 1996-2000 portuguese real gdp grew at an annual average rate of 4.08%, higher than the eu28, 2.92%; however, in the period 2001-2017, which encompasses the 200708 economic crisis, the sovereign debt crisis and the subsequent period of economic and financial assistance by the ecb, the european commission and the imf (2011-14), this rate decreased to 0.45% against 1.42% for the eu28 (pordata). this trend has been mainly explained by decreasing contributions from productivity (alves, 2017; national productivity board, 2019). portugal’s hourly productivity levels are indeed well below those of the eu28 (68%; 2000-2017). simultaneously, demographic ageing proceeds at a fast pace. between 1997 and 2017 portugal recorded the fourth largest increase of the old age dependency ratio (oadr) that stood at 32.5% in 2017 (eu28 29.9%), eurostat (2018). the portuguese population is getting older and the workforce is no exception. the proportion of the younger age groups of the * corresponding author, e-mail: mariana.monteiro14@outlook.com 72 economic analysis (2019, vol. 52, no. 2, 71-92) workforce, 15-24 and 25-34 years old, has decreased: in 2000 they represented 27.9% and 29% of the workforce, respectively; while in 2017 they represented 20.5% and 21.6%. on the other hand, the older age groups, 45-54 and 55-64 years old, which in 2000 represented 24.5% and 20.8% of the workforce, respectively, in 2017 increased their participation in the workforce to 28.4% and 25.7% (pordata). as portugal is getting older, is this ageing population bad for productivity and thus growth? this is the research question posed by the present study. previous studies have highlighted the economic importance of population ageing, including its impact on economic growth through productivity (nagarajan, teixeira & silva (2016); feyrer (2007; 2008); aiyar, ebeke & shao (2016); acemoglu and restrepo (2017; 2018)). an older workforce presents higher levels of experience and more firm/task/occupation-specific knowledge, which in turn has a positive impact on productivity resulting in faster output growth. also, as argued by galenson, (2019) the nature of creativity differs over the lifetime of individuals resulting in different types of innovations and thus productivity improvements but do not disappear in older individuals and can even increase with age. however, productivity may change over the life cycle because physical and cognitive abilities change with age. over the life cycle and as they get older, workers may suffer a depreciation of their knowledge and lose cognitive and physical abilities and it could also be the case that older workers are less inclined to take risks like becoming entrepreneurs or moving to a different career where they could be more productive; in addition, the difficulties of adapting to new technologies might also increase, reducing their productivity and thus output growth. however, acemoglu and restrepo (2017; 2018) pose that as the workforce ages firms are more likely to adopt technology that improves productivity such as robots. the relationship between age and productivity is thus not easy to establish, as evidenced in micro-level studies such as van ours & stoeldraijer (2011) and more generally in who (2015). we investigate workforce ageing contribution for productivity dynamics in portugal over the period 1971-2017. the empirical approach makes use of a var model inspired by the cobbdouglas aggregate production function to distinguish between the effects of workforce ageing (the proportion of the labour force aged 55-64 years) through factor accumulation, physical and human capital, and total factor productivity. to determine these impacts, we use impulseresponse functions (irfs) analysis and employ the standard cholesky decomposition. next we determine the cumulative impacts of workforce ageing on output per worker growth. the data used was retrieved from the portuguese national statistics agency (ine), pordata, the pwt and ameco databases. the paper proceeds as follows: after the introduction, the second section contains a brief review of the relevant literature. the next section describes the empirical strategy and the data used. the fourth section presents and discusses the main results and the final section gives some concluding remarks. literature overview according to ine, in 2017 portugal recorded a fertility rate of 1.37 children per woman, well below the replacement rate (2.1 children per woman). at the same time, the old age dependency ratio stands at 32.5 persons aged 65 and over (age when they are generally economically inactive) per 100 persons aged between 15 and 64 (persons of working age). as a result, the portuguese population is rapidly ageing, a source of concern at the political level and for society as a whole. in this context, understanding the economic mechanisms through which an ageing population affects a country's long run macroeconomic performance becomes a priority in order to design and implement the most effective and timely policies to prevent its potential economic costs. previous empirical studies on the topic also provide important background for a better understanding of the portuguese context. mariana monteiro, marta simões 73 population ageing slows growth in several ways, the most obvious of which is the fact that there will be less workers and, ceteris paribus, workforce shrinking due to demographic change will result in less aggregate output. nagarajan, teixeira & silva (2016) carry out an extensive review of the theoretical literature on population ageing and economic growth, highlighting different mechanisms of transmission, most of which result in slower economic growth. as the population gets older, we observe changes in consumption and savings patterns that can have detrimental effects on growth. on the hand, older people tend to consume more health related services and other goods related to old age, which can result in a higher relative weight of these sectors within the economy. if these are sectors with low potential for productivity improvements, aggregate productivity will slow down and so will national output growth. on the other hand, according to standard life-cycle consumption theory savings decreases in old age, leading to less capital accumulation and thus stifling growth. another mechanism of transmission is related to government interventions. population aging affects both public revenues and expenditures. on the one hand, tax revenues decrease as retired workers pay less income taxes; on the other hand, as the number of retired workers increases and the average life expectancy becomes higher, there will be a greater allocation of government resources to spend with the elderly (pensions, health, etc.), which in other demographic contexts could be directed to other purposes, such as public investment, and in this way promote growth. in addition, retired workers have higher educational attainment levels and, therefore, earn higher pensions. the increased spending on the elderly associated with lower tax revenues could result in an increase in the public deficit, leading to higher interest rates, less investment and growth. also, if those that are still working and firms have to pay higher taxes, this could act as a disincentive to work and as a disincentive for firms to invest. as a result, there could be a fall in productivity and output growth. finally, the influence of population ageing on growth might happen through productivity, which according to the authors is the mechanism of transmission with the most discrepant arguments and evidence. some authors argue that workers of different ages are not perfect substitutes and so different signs can emerge in term of the relationship between an ageing workforce and productivity. on the one hand, older workers have higher levels of experience and firm/task/occupation specific knowledge with associated higher levels of productivity. additionally, in modern knowledge based economies, creativity is an important driver of innovation and in this way productivity. according to galenson (2019), p.3 “creativity is not the prerogative of the young, but can occur at any stage in the life cycle. (...) the bold leaps of fearless and iconoclastic young conceptual innovators are one important form of creativity. (...) but there is another, very different type of creativity, in which important new discoveries emerge gradually and incrementally from the extended explorations of older experimental innovators.” on the other hand, over the life cycle workers become less productive because of weakened cognitive and physical abilities. it could also be the case that older workers are often less inclined to take risks like becoming entrepreneurs or moving to a different career where they could be more productive. if the latter effects are stronger than the former, population ageing, if it translates into an increase in the proportion of older workers, will be detrimental to growth, through a reduction in aggregate productivity. however, other authors argue that with modern economies increasingly mechanized/automated, the loss of physical and cognitive abilities by older people will not be relevant for aggregate productivity if firms become more likely to adopt technology that increases productivity, such as an increase in the use of robots in production and automation of tasks, as population gets older (acemoglu and restrepo 2017;2018). according to acemoglu and restrepo (2017; 2018), there will be an endogenous response of the economy to an ageing workforce. if, as population ages, the supply of workers declines relative to demand, wages will increase. faced with higher wages firms will have an incentive to invest in technologies that make labour more productive and this in turn promotes growth. the former discussion seems to imply that the issue is essentially empirical. a few recent studies make an attempt to assess the impact of population/workforce ageing on economic 74 economic analysis (2019, vol. 52, no. 2, 71-92) growth, highlighting in most cases the productivity channel. werding (2008) and feyrer (2007;2008) have explored the idea that workers from different age groups have different levels of productivity. to identify the impact that the age composition of the workforce may have on output growth per worker and on the growth rate of tfp, werding (2008) uses data for 106 countries, including 27 oecd economies, from 1960 to 2000, and estimates a model where the dependent variable is the growth of tfp and the main explanatory variables the different age groups. the results suggest the existence of an inverted u relationship between the proportion of workers belonging to different age groups and productivity. thus, up to the 40-49 years old group productivity is increasing; but from the age of 50 workers' contributions to productivity become less and less important. feyrer (2007; 2008) also concluded that demographic changes in the workforce have a significant correlation with labour productivity and output growth rates. thus, differences in the age structure of countries explain their differences in productivity. the same inverted u relationship was found between the proportion of workers belonging to different age groups and their productivity. the econometric models considered as dependent variables either the growth rate of output per worker or the growth rate of tfp. the sample covered 87 countries, also focusing on oecd countries alone (19 oecd countries in feyrer (2007) and 21 in feyrer (2008)) with data ranging from 1960 to 1990. the findings for both samples were consistent in showing that a very young or very old age structure is detrimental to the growth rate of output per worker. in both cases the regressions are derived from a cobbdouglas production function with physical and human capital in order to identify the most relevant mechanisms of transmission from ageing to growth, input accumulation or productivity. the authors find that the latter is the most important one. based on the same empirical approach, aiyar, ebeke & shao (2016) focus on the eu member states for the period 1950-2014, confirming also that workforce ageing leads to slower labour productivity growth. they also identified as the main underlying transmission mechanism tfp growth. the authors additionally estimated models to identify policy measures that can alleviate the negative effects of demographic change, concluding that the most important ones are better health conditions, innovation, human capital accumulation, labour market flexibility and a lower tax burden. in an even more recent study, poplawski-ribeiro (2019) uses the same methodology to reassess the empirical relationship between workforce ageing and tfp growth focusing on a panel data set composed of at least 32 and at most 73 advanced economies (aes) and emerging market economies (emes) over the period 1985–2014. one of the main contributions of poplawskiribeiro (2019) is the consideration of the age structure of employed workers and not the labour force, measured as the ratio of older employed workers (ages 55–64) to the total number of employed workers. the results show that ageing slowdowns tfp growth particularly in aes, but also in emes. maestas, mullen & powell (2016), liu & westelius (2017) and daniele, honiden &. lembcke (2019) tackle the issue from the perspective of us states, japanese prefectures and oecd regions, respectively. maestas, mullen & powell (2016) use data on the variation in the rate of population aging across u.s. states over the period 1980-2010 to estimate the economic impact of ageing on state output per capita. the results suggest moderate reductions in economic growth associated with population aging at the state-level, with about 2/3 of the total effect of population aging on the growth of gdp per capita arising from slower productivity growth. liu & westelius (2017) use data for 47 japanese prefectures over the period 1990-2007 to estimate the impact of the shares of 10-year age groups of the working age population (ages 20 to 69) on productivity. the results show that the age distribution of the working age population had a significant impact on total factor productivity, corresponding to a clear inverted u productivity pattern amongst age groups, with the excluded age group 40–49 being the most productive. the evidence found by daniele, honiden & lembcke (2019) for 1802 tl3 regions in 19 oecd countries over the 2006-14 period through the estimation of an empirical model where labour productivity is regressed on the ratio of old (aged 50 or more) to young workers (aged between 20 and 49) points also to a negative relationship, stronger in predominantly urban and mariana monteiro, marta simões 75 intermediate regions. this difference, according to the authors, could be due to the heterogeneous impact of ageing on productivity growth across sectors: tradable services are the sectors in which ageing has the most negative impact on productivity growth and these tend to concentrate in cities. different from the previous studies, acemoglu and restrepo (2017; 2018) provide evidence that ageing can meaningfully accelerate growth. data for 49 countries between the early 1990s and 2015 and for the us states reveal a strong positive correlation between the change in the ratio of the population above 50 to those between 20 and 49 and the change in the number of robots (per million of labour hours). estimates of the impact of ageing on gdp per capita from 1965 to 1990 and 1990 to 2015 reveal a positive association leading the authors to conclude that countries undergoing more rapid population ageing adopted more robots, which resulted in faster productivity and output growth. for the portuguese case, according to albuquerque (2015), the reduction of the working age population relative to the total population has already had an impact on the dynamics of output per worker. the authors observe the period 1999-2014 and perform a decomposition exercise disaggregating the portuguese real gdp per capita growth rate into four components: demographic, which consists of the working age population relative to total population; employment, which relates the number of workers to the total working age population; working hours, which is the ratio between the number of hours worked and the total number of workers; and productivity per hour, measured as gdp per hour worked. the first component, the demographic one, presented small but steady negative contributions, amounting to around 0.194% on average. most of the reviewed studies find a negative association between the age structure of the population/workforce and aggregate productivity but controversies remain, making it important to conduct an empirical study directed only at portugal to gain a better understanding of the effects of population ageing on productivity in this specific case. as van ours & stoeldraijer (2011) and more generally who (2015) point out, based on individual data workers’ productivity does not seem to fall with age because, for instance, even if there are negative impacts resulting from weakened physical and cognitive abilities these can be compensated for by the life and work experiences of older workers. other offsetting effects include the type of occupation, the type of tasks involved in the workers’ job and the age diversity of working teams. empirical strategy and data to investigate the impact of workforce ageing on productivity we estimate a var model defined according to a standard cobb-douglas aggregate production function, with human capital, as in hall & jones (1999), feyrer (2007; 2008) and aiyar, ebeke & shao (2016), highlighting potential differentiated effects of workforce ageing. the approach adopted by feyrer (2007; 2008) and aiyar, ebeke & shao (2016) is adapted to country specific analysis in the context of a var model as suggested by bação, gaspar and simões (2019). hall & jones (1999) assume that output, y, is produced according to the following production function: yt=ktα(atht)1-α (1) where k is the stock of physical capital, h is the amount of human capital-augmented labour used in production, a is total factor productivity and α is the capital share. output per worker, y, can thus be written as: yt=ktα(atht)1-α (2) 76 economic analysis (2019, vol. 52, no. 2, 71-92) where k represents the stock of real capital per worker, h is human capital per worker, a is total factor productivity (tfp) and α is the share of capital in output, assuming values between 0 and 1 and usually set at 1/3. the production function described in (2) can be also rewritten as: yt=(k/y)tα/(1-α)atht (3) where k/y is the capital output ratio. applying logarithms and first differences to both sides of equation (3) allows us to arrive at equation (4), where the δlog’s are the log-growth rates of the variables: δlogyt=[ α/(1-α)]δlog(k/y)tδlogat+δloght (4) this decomposition makes it possible to estimate the impact of workforce ageing on real output per worker considering its influence through the growth rate of the capital-output ratio, the growth rate of human capital per worker and the growth rate of tfp. thus, it is possible to analyse separately two effects, the effect via factor accumulation (physical and human capital) and the effect via tfp. for this purpose, a var (autoregressive vector) model is estimated (based on bação, gaspar & simões 2019) consisting of four endogenous variables ordered1 as follows: the growth rate of the proportion of older workers; the growth rate of human capital per worker; the growth rate of tfp and the growth rate of the capital-output ratio. the general var model of order p is given by equation (5), where x represents the column vector including the four variables described before. xt=α+β1xt-1+ β2xt-2+…+ βpxt-p+εt (5) the var approach is appropriate since it allows to treat all variables as endogenous. in addition, it allows us to obtain the reaction from each variable to a shock in one of the other variables, in particular we want to analyse how each component of the cobb-douglas production function reacts to a shock in the growth rate of the proportion of older workers and, based on these results, we determine the cumulative impact on the growth rate of output per worker. output per worker y is measured as the ratio between gdp at constant 2010 prices and the number of workers (or hours worked), both retrieved from ameco. workforce ageing is measured as the proportion of workers aged 55-64 in the labour force and was obtained from pordata. the capital stock data at constant 2010 prices is also from ameco. human capital per worker data was retrieved from the penn world table 9.1 and corresponds to a human capital index based on average years of schooling and an assumed rate of return to education, available from 1971 to 2014. to obtain the remaining 3 missing observations, the average growth rate of the former 10 years was calculated and used to obtain the values for the years 2015, 2016 and 2017. tfp was computed according to equation (2), using the time series mentioned above: from ameco we used the number of employees, real gdp at constant 2010 prices and the capital stock at constant 2010 prices; and from the pwt we used human capital per worker. the growth rate of total factor productivity had thus to be estimated; we did so based on the aggregate production function (equation 2) and setting α, the capital share, to one third, as is customary. figure 1 contains data on output per worker and workforce ageing for portugal and the eu28 over the period 1971-2017. from the inspection of figure 1, part (i), it is possible to see that portuguese output per worker is well below that of the eu28 average. in 1995 output per worker in portugal amounted to €30221.73 while the average eu28 worker produced € 47430.20. in 2017, these values were respectively € 37567.84 and € 60216.24, corresponding to 1 see the explanation for the ordering adopted in the next section. mariana monteiro, marta simões 77 an annual growth rate of 1% for portugal and 1.1% for the eu28. from graph (ii), figure 1, we can see that the proportion of workers aged 55-64 in the labour force both in portugal and the eu 28 shows a strong positive trend. in 2001 the figures were quite close, around 16%; in 2017, the values were, respectively, 20.6% and 20.1%. (i) outuput per worker (ii) workers aged 55-64 (proportion of the labour force) figure 1. output per worker and workers aged 55-64 as a proportion of the labour force, portugal and the eu28, 1971-2017 source: ameco, ine, pordata. figure 2 presents the annual growth rate of the proportion of older workers in portugal from 1971 until 2017 where it is possible to observe a steady increase since the mid-90s that however seems to be decelerating since more or less the year 2010. figure 2. workers aged 55-64 as a proportion of the labour force, annual growth rate, portugal, 1971-2017 source: pordata and authors’ computations. in figure 3 it is possible to observe the behaviour over time of the human capital index for portugal over the period 1970-2017, both in levels and growth rates. the level of human capital shows a strong positive trend, going from 1.4 in 1971 to 2.5 in 2017. as for its growth rate, it has remained positive for almost the entire period under analysis, however between 2000 and 2005 it recorded negative values, although very close to zero. 78 economic analysis (2019, vol. 52, no. 2, 71-92) (i) levels (ii) annual growth rate figure 3. human capital per worker, in levels and growth rates, portugal, 1971-2017 source: pwt 9.1 and authors’ computations. in figure 4 (i) it is possible to observe tfp in levels (2010=100) and growth rates. from 1971 to around 1990, the increase was considerable, from a value of 71 to a little over 100 but from then onwards tfp stagnated and shows a tendency to decrease during most of the 21st century. the respective growth rate thus shows a quite irregular behaviour but towards lower values at end of the period. (i) levels (ii) annual growth rate figure 4. total factor productivity, in levels and growth rate, portugal, 1971-2017 source: authors’ computations. finally, figure 5 presents the capital-output ratio series, in levels and growth rates. this variable, as can be seen from figure 5 (i) shows a positive trend over the period under analysis that came to a halt in 2012, decreasing ever since. regarding the growth rate of this variable, it is possible to observe alternating periods of positive and negative growth over the years. in more recent years, in particular since 2013, it recorded negative values in every year. mariana monteiro, marta simões 79 (i) levels (ii) annual growth rate figure 5. capital-output ratio, in levels and growth rate, in portugal, 1971-2017 source: authors’ computations. results before estimating the var model described in the previous section it is necessary to test for the stationarity of the variables included in order to avoid the spurious regressions problem. table 1 contains the results of four different unit root and stationarity tests (kpss and adf, with and without trend). the values in bold indicate stationarity and, as can be observed, the growth rates of output per worker and the growth rate of the proportion of older workers are stationary. human capital per worker, tfp and the capital-output ratio are also stationary in first differences. lastly, the log growth rates of output per hour worked (yh) and ptf per hour worked (ah) are also stationary according to the four tests. given these results we will use the variables in first differences in our var model to avoid spurious regressions. also, since according to the results in table 1 the variables ∆logy and ∆logw55 are only stationary with a trend, we also include a trend when estimating the var model. table 1. unit root and stationarity tests results (p-values) kpss trend adf trend kpss adf y < .01 0.998 < .01 0.099 ∆log y > .10 2.1e-5 < .01 0.97 w55 0.01 1 < .01 1 ∆log w55 0.097 0.049 0.042 0.111 h < .01 0.901 < .01 0.256 ∆log h > .10 0.395 < .01 0.726 a < .01 0.71 < .01 0.14 ∆log a > .10 0.1023 > .10 1.04e-05 ky > .10 0.056 < .01 0.232 ∆log ky > .10 0.011 > .10 0.0016 yh 0.028 0.339 < .01 0.858 ∆log yh > .10 0.004 > .10 0.0005 ah > .10 0.145 > .10 0.064 ∆log ah > .10 0.0009 > .10 0.0001 source: authors. the order of the var model was selected by setting a maximum order of two; this choice comes from dividing the result of the formula suggested by schwert (1989) for univariate ar models by the number of variables included in our model (four). the formula is thus: 80 economic analysis (2019, vol. 52, no. 2, 71-92) lmax = int([12(t/100)0.25]/4) (6) where int(.) is the integer part of the argument and t is the number of observations. the rationale for adjusting schwert’s formula in this way is that the same number of lags of each variable will be present in each equation of the var model; therefore, the four variables will be consuming degrees of freedom in every equation of the var model – the division by four takes this into account (see bação, gaspar & simões 2019). for both versions of the var model the information criteria and the likelihood ratio test points to one lag see table 2. table 2. number of lags to include in the var model source: authors. table 3 presents the estimated coefficients for the lagged growth rate of the proportion of older workers (∆log w55) in the equations for the other variables in the var model. in model 1, tfp was computed taking into account the number of workers (a). in model 2, tfp was computed taking into account hours worked (ah). most of the estimates are not statistically significant. the exceptions are the coefficients in the equation of tfp adjusted for hours worked and the equation of the capital-output ratio (model 2). in the first case, the sign is positive indicating that faster growth of the older workers group benefits economic growth via tfp. contrarily, the impact on the growth rate of the capital-output ratio is negative. the same signs apply in model 1, although the coefficients are not statistically significant. in any case, the magnitude of the estimated coefficients is large and could assign to growth rate of the proportion of older workers an important role in the evolution of productivity and the capitaloutput ratio. for the growth rate of human capital per worker, the influence is positive in both models, although never statistically significant. table 3. coefficients of the lagged growth rate of the proportion of older workers (∆log w55) in the other equations of the var (t = 45) coefficient std. error t-ratio p-value model 1 ∆log h 0.0678 0.0549 1.236 0.2240 ∆log a 0.4907 0.4567 1.075 0.2892 ∆log ky −0.5556 0.3463 −1.604 0.1167 model 2 ∆log h 0.0758 0.0542 1.399 0.1698 ∆log ah 1.385** 0.5291 2.617 0.0126 ∆log ky −0.6766* 0.3551 −1.905 0.0641 note: ***; **; * indicate statistical significance at the level of 1, 5 and 10%, respectively. source: authors’ computations. in a var model the correct way to assess the importance of ageing is by analysing the impulse-response functions. the difficulty is that this requires an assumption about the structure of the relationship between the variables in the model. here we employ the standard cholesky decomposition, which imposes a recursive structure on the shocks that change the variables so that the first variable in the var model reacts contemporaneously only to a shock to itself; the second variable reacts contemporaneously to a shock in itself and in the previous variable; the third reacts contemporaneously to a shock to itself and to the previous two lags loglik aic bic hqc 1 608.167 -26.553* -25.580* -26.192* 2 622.507 -26.478 -24.856 -25.876 mariana monteiro, marta simões 81 variables and, finally, the last variable in the model reacts contemporaneously to shocks to all the four variables in the var model. the growth rate of the proportion of workers aged 55-64 will be the first variable that appears in the var model since we believe that this is the variable that takes more time to adjust to shocks due to the fact that it is related to individual decisions made at least 15 years before on whether or not to have children. in this way we do not expect it to be influenced by shocks to the other variables, i.e. it is the most rigid variable. the growth rate of human capital per worker is also related with individual decisions regarding education, work experience, training opportunities provided in the workplace, public spending on education, etc. so it makes sense to be one of the model’s variables that takes more time to adjust and thus we place it in the second place in terms of the ordering of the variables in the var model. productivity might depend to a great extent on age and knowledge (education, work experience, etc.), thus the growth rate of tfp will be the third variable to be included in the model so that it may react contemporaneously to its own shocks and to shocks to the proportion of older workers and to human capital. finally, the growth rate of the capital-output ratio is the last variable to appear in the var model as this is the least rigid and thus adjusts most rapidly. this variable corresponds to the amount of physical capital available per unit of output, so if overall productivity changes, which depends on age and human capital, the amount of capital needed to produce each one unit of output also changes. also, since we consider the capital-output ratio and, according to the production function, output depends on the other variables included in the var, we expect it to adjust more rapidly. therefore, we will assume that the capital-output ratio will react contemporaneously to all the structural shocks in the other variables of the model. the estimated impulse-response functions and the 90% confidence intervals (grey lines) are shown in figure 6 based on the results from table 3 for var model 1, i.e. without adjusting for hours worked. given the irfs and the responses of the variables δlogh, δloga and δlog(k/y), it is possible to determine the impact of a shock to δlogw55 on the growth rate of output per worker using equation (4). (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure 6. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 1 from table 3 source: authors. 82 economic analysis (2019, vol. 52, no. 2, 71-92) the impulse-response functions are also not significantly different from zero (the confidence interval never excludes zero). nevertheless, the prevailing effect is negative: an increase in the proportion of older workers would appear to decrease tfp in a more intense way than the contemporaneous positive effect it has on human capital per worker and the capital-output ratio. consequently, the estimated impact of a temporary increase in the proportion of older workers would immediately shift down the growth rate of output per worker, as shown in figure 6, part (iv). the shift corresponding to a one-standard-deviation temporary shock in the δlogw55 would amount to about -0.0078 percentage points of the gdp per worker growth rate. however, in the following years the variable records positive values, reaching its maximum value after four years with the value of 0.0018, as expected, since the var model is stationary and so the long-term effect tends to zero. we also carried out the impulse response analysis considering output and tfp adjusted for hours worked using the results for var model 2 presented in table 3. the estimated impulseresponse functions and the 90% confidence intervals (grey lines) are shown in figure 7. the behaviour of the irfs of the different variables is similar to that of the previous model and again the results are not significantly different from zero (the confidence interval never excludes zero). a temporary shock of a standard deviation to ∆logw55 as a negative immediate impact on ∆logyh. in the following years the variable records positive values, reaching its maximum after three years (0.006) and approaching zero from then onwards as expected in a stationary var model. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure 7. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 2 from table 3 source: authors. overall, the results from the previous irfs analyses do not confirm the fears that the ageing of the portuguese workforce has resulted in substantial losses in terms of output growth at the national level. in fact, the results do not endorse any impact. from the reviewed arguments put foreword to explain a potential relationship between population ageing and economic growth, it seems that for the portuguese economy, so far, the productivity decline associated with weakened basic capacities (physical and cognitive) to do things as workers get older and the fact that they become less willing to take risks such as moving to a new job or start a new business is mariana monteiro, marta simões 83 being compensated by the positive productivity impact of their higher levels of experience, more firm/occupation/task-specific knowledge and higher creativity or by the fact that portuguese firms are reacting to labour shortages by introducing new technologies that increase labour productivity, as defended by acemoglu and restrepo (2017; 2018). finally, in order to get a broader view of the impact of demographics on productivity we extended the baseline var model to include other demographic variables corresponding to the different groups representing the age structure of the labour force (w45 proportion of workers between 45 and 54 years old; w35 proportion of workers between 35 and 44 years old; w25 proportion of workers between 25 and 34 years old). we leave out the proportion of younger workers, i.e. the 15-24 age group (w15), since the sum of the different age structure variables corresponds to 100% of the labour force. additionally, we include the total dependency ratio (id), i.e. the ratio between the number of people between 0 and 14 years old and the number of people aged 65 and over relative to the working age population (15-64 years old). table 4. coefficients of the lagged growth rate of the proportion of different age groups (∆logw55; ∆logw45; ∆logw35; ∆logw25) and of the dependency ratio (∆logid) in the other equations of the var model 1 ∆logw55 ∆logw45 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh 0.093 0.0617 1.510 0.1400 0.099 0.080 1.236 0.2246 ∆loga 0.085 0.4815 0.1765 0.8609 −1.269** 0.6243 −2.032 0.0498 ∆logky −0.349 0.3688 −0.9472 0.3501 0.677 0.4782 1.415 0.1659 ∆logw35 ∆logw25 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh −0.018 0.0636 −0.2796 0.7814 −0.032 0.0564 −0.5651 0.5756 ∆loga 0.851* 0.4966 1.714 0.0953 0.186 0.4399 0.4239 0.6742 ∆logky −0.583 0.3804 −1.532 0.1346 −0.295 0.337 −0.8750 0.3875 ∆log id coef. std. error t-ratio pvalue ∆logh -0.081 0.1149 −0.7088 0.4831 ∆loga 2** 0.8971 2.229 0.0323 ∆logky -1.41** 0.687089 −2.045 0.0484 model 2 ∆logw55 ∆logw45 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh 0.101 0.0614 1.648 0.1084 0.101 0.0861 1.171 0.2495 ∆logah 1.187 ** 0.5701 2.082 0.0447 −0.231 0.7996 −0.2889 0.7743 ∆logky −0.477 0.3742 −1.274 0.2110 0.549 0.5249 1.047 0.3024 ∆logw35 ∆logw25 coef. std. error t-ratio pvalue coef. std. error t-ratio pvalue ∆logh −0.016 0.0640 −0.2431 0.8094 −0.027 0.0605 −0.4424 0.6609 ∆logah 1.181 * 0.5940 1.988 0.0546 0.184 0.5621 0.3272 0.7454 ∆logky −0.613 0.390 −1.572 0.1251 −0.435 0.3690 −1.179 0.2462 84 economic analysis (2019, vol. 52, no. 2, 71-92) ∆log id coef. std. error t-ratio pvalue ∆logh -0.072 0.1161 −0.6211 0.5385 ∆logah 1.511 1.0782 1.402 0.1698 ∆logky -1.47** 0.7078 −2.079 0.0451 note: ***; **; * indicate statistical significance at the level of 1, 5 and 10%, respectively. source: authors. from the inspection of the results in table 4 it is possible to see that, in what concerns the proportion of older workers, they remain basically unchanged. the lagged growth rate of the proportion of workers aged 55-64 is only statistically significant in the equation of the growth rate of tfp per hour worked, again with a positive sign. as for the other age groups, the vast majority of the estimated coefficients are not statistically significant. exceptions include: the proportion of workers aged 45-54 that show a negative impact on tfp (model 1) and the proportion of workers aged 35-44 that reveal a positive and statistically significant coefficient in the equations of both tfp and tfp per hour worked. the remaining statistically significant coefficients refer to the dependency ratio, which shows a positive impact on the equation of the growth rate of tfp (model 1) and a negative impact on the equation of the growth rate of the capital-output ratio. the estimated impulse-response functions and the 90% confidence intervals (grey lines) based on the results from table 4 for var models 1 and 2 are shown in figures 8 and 9, respectively. the behaviour of the irfs of the different variables is similar to that of the previous model and again the results are also not significantly different from zero (the confidence intervals never exclude zero). the results from these irfs also do not confirm the fears that the ageing of the portuguese workforce has resulted in substantial losses in terms of output per worker growth at the national level. the irfs for the remaining age groups and the dependency ration can be found in the appendix, figures a.1 to a.8. again the results are also not significantly different from zero (the confidence interval never excludes zero) rendering the age structure of the workforce and the overall population no role in the explanation of the dynamics of labour productivity in the portuguese economy. (i) human capital (ii) tfp mariana monteiro, marta simões 85 (iii) capital-output ratio (iv) output per worker figure 8. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 1 from table 4 source: authors. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure 9.impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of older workers (∆logw55) based on var model 2 from table 4 source: authors. conclusion population ageing, in particular of the workforce, is an issue that europe, and especially portugal, have to face in a serious manner if they want to implement timely policies that can help avoid its potential economic costs. with ever-lower fertility rates and an ever-increasing average life expectancy, the old age dependency ratio and the proportion of older workers (aged 55-64) are increasing steadily, with potential important economic implications in the short and the long run. we investigated the contribution of workforce ageing for productivity dynamics in portugal over the period 1971-2017. the empirical approach makes use of a var model inspired by the cobb-douglas aggregate production function to distinguish between the effects of workforce ageing (the proportion of the labour force aged 55-64 years) through factor accumulation, 86 economic analysis (2019, vol. 52, no. 2, 71-92) physical and human capital, and total factor productivity. to determine these impacts, we used impulse-response functions (irf) and employ the standard cholesky decomposition. next we determined the cumulative impact of workforce ageing on output per worker. the results indicate that using workforce ageing in first differences (not levels) fits the data better, so ageing affects the level of output per worker (temporary growth effect). yet, workforce ageing is generally not statistically significant in the equations of the other variables in the var model. the irfs are also not significantly different from zero, but the performance of our var model may be affected by some series behaviour (e.g. the capital stock decline in recent years), requiring more investigation in the future. the fact that no significant impact on productivity was found might be an indication that older workers’ negative productivity impact due to the depreciation of knowledge and physical/cognitive capabilities is being exactly offset by the positive impact from their higher levels of experience, more firm/task/occupation-specific knowledge and higher creativity. policies such as broadening access to better health services, workforce training and lifelong learning can reduce the adverse impact so that it does not surpass the positive effect. yet, the rapid pace of technological development can make experience less relevant and a negative impact can emerge in the data. however, as argued by acemoglu and restrepo (2017) as the workforce ages firms are more likely to adopt technology that improves productivity such as robots and a positive impact on tfp could emerge. for the time being it thus seems that workforce ageing has not posed a serious threat to the portuguese economy, but this situation could rapidly change in the near future given the dismal demographic forecasts that project that the portuguese population will decrease from 10.5 millions of people in 2012, to 8.6 millions in 2060 (ine 2014). this paper suggested a methodology (based on bação et al. 2019; hall & jones, 1999; feyrer 2007, 2008; aiyar et al. 2016) to quantify and identify the mechanisms of transmission from population ageing to macroeconomic performance in country-specific situations. this is important for a more effective policy design that helps fight potential negative economic performance impacts of ageing. it is important to emphasize that each country is unique in terms of its characteristics and both the effects and the type of measures may differ from country to country. in any case, future comparative analyses with other ‘younger’ countries in a panel data context could help identifying productivity gains from slowing population ageing. from a macroeconomic performance perspective our findings thus do not confirm the pessimistic predictions concerning the negative impact of ageing on productivity and long run macroeconomic performance. our analysis, however, does not provide a definite answer to workforce ageing impacts on productivity growth in portugal. we used a var model defined according to a cobb-douglas production function to identify the impact of ageing on output per worker through factor accumulation and productivity. alternative approaches include considering different types of production functions and/or alternative modelling approaches such as an ardl model with output per worker growth as the dependent variable and additional explanatory variables. our aim was to implement the most robust analysis of the research question posed in this study, “is workforce ageing a threat to productivity and in this way economic growth?” but there are issues intrinsic to the data that may constitute important limitations. first, carrying out time series econometric analysis with a short data coverage might hamper the robustness of the results. second, the specific behaviour of some of the series used in the analysis, such as the physical or human capital series, may have a detrimental impact on the performance of our simple var model. acknowledgements we would like to thank pedro bação for his helpful comments and suggestions. the usual disclaimer applies. mariana monteiro, marta simões 87 references acemoglu, d. & restrepo, p. 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(1989). tests for unit roots: a monte carlo investigation. journal of business and economic statistics, 7(2), 147-160. van ours, j.c. & stoeldraijer, l. de economist (2011). age, wage and productivity in dutch manufacturing. de economist 159(2), 113–137. werding, m. (2008). ageing and productivity growth: are there macro-level cohort effects of human capital? cesifo working paper no. w2207. who (2015). world report on ageing and health. geneva: world health organisation. 88 economic analysis (2019, vol. 52, no. 2, 71-92) appendix (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.1. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 45-54 (∆logw45) based on var model 1 from table 4 source: authors. (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.2. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 35-44 (∆logw35) based on var model 1 from table 4 source: authors. mariana monteiro, marta simões 89 (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.3. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 25-34 (∆logw25) based on var model 1 from table 4 source: authors. (i) human capital (ii) tfp (iii) capital-output ratio (iv) output per worker figure a.4. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the dependency ratio (∆logid) based on var model 1 from table 4 source: authors. 90 economic analysis (2019, vol. 52, no. 2, 71-92) (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.5. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 45-54 (∆logw45) based on var model 2 from table 4 source: authors. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.6. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 35-44 (∆logw35) based on var model 2 from table 4 source: authors. mariana monteiro, marta simões 91 (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.7. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the proportion of workers aged 25-34 (∆logw25) based on var model 2 from table 4 source: authors. (i) human capital (ii) tfp per hour (iii) capital-output ratio (iv) output per hour worked figure a.8. impulse-response functions of log-diffs (percent) to a temporary change in the growth rate of the dependency ratio (∆logid) based on var model 2 from table 4 source: authors. 92 economic analysis (2019, vol. 52, no. 2, 71-92) article history: received: november 5, 2019 accepted: november 25, 2019 ea_2014_1-2 udc: 658.155.2 jel: g35, g12 id: 207708172 scientific review identification and evaluation of factors of dividend policy omerhodžić sead1, tuzla university, faculty of economy, tuzla, bosnia and herzegovina abstract – dividend policy determines the ratio between the earnings distributed to shareholders and the earnings retained in the company. even though retained earnings are one of the most important funding sources used for financing corporate growth, the accrued dividends represent stakeholders' cash flows. should the cash be reinvested in business operations or should it be paid out to investors in equity? the decision might seem simple, but it provokes a surprising number of controversies. despite thorough theoretical and empirical analyses aimed to explain their omnipresence, dividends remain one of the biggest puzzles in corporate finances. this paper starts by determining the term of dividend and stating the types of dividends. this is followed by a discussion on dividend policy and optimal dividend policy and an analysis of factors that managers should have in mind when forming dividend policy. considerable attention is given to the leading dividend theories which try to answer the question about the role of dividends in maximizing the value of a corporation, as well as to practical instructions offered to managers in an attempt to achieve this goal. other related issues are also discussed, such as dividend reinvestment plans, stock dividends, and share repurchase. finally, two surveys are presented. the aim of conducting the surveys was to determine the attitudes of managers on dividend policy and to identify factors which the managers viewed as decisive when establishing a concrete dividend policy. key words: dividend, types of dividends, optimal dividend policy, share price, dividend theories, stock dividends, share repurchase, surveys introduction it is often emphasized in literature that the three main groups of decisions companies make, more important than all others, are decisions about the choice of investment alternatives and allocating capital to investment projects, decisions on the way of their financing which, among other things, involves finding the optimal capital structure, and decisions about dividends. the dividend decision, determined by the company's dividend policy, affects the amount of paid out earnings of the company compared to the amount of earnings that the company retains and reinvests. when the company changes its payment of dividends, it can change one of these remaining policies. by reducing the amount of distributed dividend, the company can retain more funds for investment and avoid procuring funds from external 1 univerzitetska 8, tuzla, bosnia and herzegovina, e-mail: sead_o@bih.net.ba omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 43 funding sources. also, the company can finance capital expenditures mostly by incurring debt, which freesup cash for dividends. the central principle of financial management is that managers make decisions that lead to the maximal wealth of shareholders, which is reflected in the share price of the company. the decision to pay out dividends compared to retaining earnings is often confusing because it includes many opposing forces. both professionals and corporate managers continue to disagree on whether the value of a company is independent of its dividend policy. the challenge faced by the board of directors and the management is to balance these forces in order to maximize the contribution of their dividend policy to increasing the shareholders' wealth. definitions and types of dividends dividends are the payments that the corporations make to their owners, shareholders. dividends have a tendency to be seen both by the management of the company and by the shareholders who receive them as an equivalent to interest payments to creditors who approved loans, as a compensation to shareholders for delaying consumption, etc. dividends are often vividly described as rewards to shareholders in the form of distribution of profits from the previous or current year and as an important determinant of the share price (mclaney, 1997). some investors use the dividend yield as a risk measure and as investment screen, investing in shares with a high dividend yield (damodaran, 1999). dividends represent the only regular channel for transferring corporate assets to shareholders. in that context, it can be stated that dividends represent proportional distribution of corporate assets to shareholders within the framework of the current and accumulated net earnings. corporations usually pay dividends in cash and thus the dividend refers to the money paid from the earnings (ross, westerfield, jordan, 2006). also, corporations periodically pay dividends in shares and some forms of assets. for example, the u.s. whiskey producers, in addition to regular dividends, also distributed extra dividends in the forms of their products to their shareholders. all dividends, with the exception of stock dividends, reduce the total equity of the corporation. since the dividends are paid out from the net earnings, dividend per share is usually lower than earnings per share. however, the shareholders do not receive only the yield based on dividends. to them it is important that the company is doing well and that the market price of its share is rising, because that is the way they generate yield on a different basis, as a difference in share price. that other source of income for a shareholder is called capital gain. however, one should keep in mind that when investors sell their shares, they are paid by other investors and not by the corporation. except when the corporation is repurchasing its own shares (which is a form of dividend payout), only the corporation's money paid to investors is the payment of dividend. as we have mentioned already, dividends are usually paid in cash. regular cash dividends are paid on a quarterly basis, but a small number of companies declare them on a monthly, semiannual and annual basis. the term “regular” indicates only that the company economic analysis (2014, vol. 47, no. 1-2, 42-58) 44 expects to be able to maintain payments in the future. if the company does not want to give that kind of promise, it usually declares both regular and extra dividend. investors understand that extra dividend might not be repeated. another type of dividend is liquidating dividend, which refers to any kind of dividend not based on the earnings. liquidating dividends imply returning the investment to shareholders, not the earnings. for example, liquidating dividends can be a consequence of selling the entire company or only one of its parts and distributing assets. finally, the term special dividend is mostly reserved for payments that are not likely to be repeated. the amount of dividend can be shown as: (a) dividend per share – the sum of monetary units per share, (b) dividend yield – the rate compared to the share market price, and (c) dividend payout ratio – paid dividends (in monetary units) compared to the net profit. dividend payout ratio usually refers to the percentage of net profit paid to shareholders in cash. this indicator is calculated by dividing the total amount of paid dividends (in monetary units) by net profit, and it is also often seen as the indicator of the generosity of the company's dividend policy or the lack of one (gallagher, andrew, 1997). dividend payout ratio of 30%, for example, tells us that the corporation pays out dividends. however, caution is advised. by focusing on the presented earnings and the dividend payout ratio, we ignore the key for the payout of dividends. that key is cash. when a company makes profit, that usually results in money that flows into in the company. however, profit and cash flows do not necessarily happen at the same time. the table 1 illustrates these time differences. table 1. selected financial data for the corporation x for the current year sales (all on credit payment due in next year) km 2.000.000 total expenses 800.000 net profit 1.200.000 cash received this year km 0 table 1 shows that the corporation x showed earnings in the amount of 1.200.000 km this year, but that it did not receive any cash. the corporation would not be able to pay out dividends, except by using the money from previous earnings. if the corporation thinks that a certain dividend payout is crucial for preserving its value, it can even choose to incur debt to obtain cash needed to pay out dividends. it sometimes happens that corporations incur debt to obtain cash for dividend payout when it is expected that the dividend payout is of vital importance for regular shareholders. dividend policy dividend policy is an important theme in corporate financing since dividends represent a large cash expense for many corporations. at first sight it can seem obvious that a company always wants to return as much as possible to their shareholders by paying out dividends. however, it can seem equally obvious that a company can always invest money for its shareholders instead of paying it out. that is the reason why dividend policy is needed. that omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 45 is the area in which the shareholders are very much interested, but at the same time it is the area used by the corporate management to preserve the interests of the company by taking account of the possible connection between dividends and the company's market value. dividend policy refers to the payment policy used by the management when determining the amount and patterns of distribution to shareholders over a period of time (baker, powell, 2005). it is considered that dividend policy includes three questions (brigham, houston, 2004): (a) which part of the earnings should be distributed? (b) should the distribution be in the form of cash dividends or share repurchase? and (c) should the company maintain a steady, stable growth rate of dividends? we can safely say that the central question of dividend policy is whether the available earnings will earn more money for the shareholders if the company stays in business with the aim of financing growth, or if the earnings are distributed to them as a cash dividend or share repurchase. dividends are important because the timing and the sum of expected dividend payments of the company determines the value of its share. what is less clear is whether or not the time patterns of dividends (more now compared to more later) are a contentious question. this is the question of dividend policy and it is not easy to give a definitive answer to it. it should be kept in mind that a direct dividend payout benefits the shareholders, but that it also influences the ability of the company to retain the earnings in order to use the possibility of growth. dividend policy provides guidelines for balancing the opposed forces that surround the decision whether or not to pay out a dividend or retain the earnings. even though the total income of the company, after taxes, belongs to its shareholders, the corporations usually distribute only one part as cash dividends, if they are able to do so, and they reinvest the remaining income in the additional assets. when a company retains the earnings, such earnings appear as retained earnings in the equity section in the balance sheet. we would like to also add here that the retained earnings as a source of funds has a few advantages, the most important of which are the following (bradley, 1978): (a) a cheap source, (b) does not have the right to vote, (c) does not impose restrictive regulations on the management, (d) the company has an unlimited use of funds, (e) the issuer does not pay a fixed yield, as would be the case with bond issue, and (f) collateral is not needed. furthermore, when deciding about the amount of money that should be distributed to shareholders, financial managers have to have in mind that the company's goal is to maximize value for shareholders. consequently, the target dividend payout ratio should to a large extent be based on whether investors prefer dividends compared to the capital gain. this preference can be considered in relation to the model of the valuation of ordinary shares which assumes that dividends per share will grow by a constant growth rate in every period never expecting it to change. the constant growth model is also known as gordon growth model, named after the financial economist gordon who developed it and made it widely known. according to this model, the price of an ordinary share is determined in the following way: p0 = d1/(ks – g). it is obvious that the price of an ordinary share according to the given formula depends on three factors: (a) the expected dividend in the following period, d1, (b) requested rates of return, ks i (c) rates of growth of the company's dividends, g. along with other constant factors, if the company decides to increase the cash dividend, d1, the share price of the company should increase. still, by increasing its dividend, the company economic analysis (2014, vol. 47, no. 1-2, 42-58) 46 reduces its growth rate (g), which tends to lower the price of the company's share. the reduction of the growth rate happens because retaining a smaller amount of earnings reduces the available cash for obtaining additional assets. since the increase in the asset base is crucial for the growth of the company, having a reduced amount of retained earnings reduces the expected growth rate, g, and lowers the price of the share, p0. therefore, changes in dividends result in opposing the forces which can increase or reduce the value of the ordinary share of the company. we can draw a conclusion that the optimal dividend policy establishes balance between the current dividends and the future growth which maximizes the price of the ordinary share of the company (brigham, 1991). we will also mention that companies need a strategic policy for dividend payouts because market participants (current and potential shareholders) mostly do not like surprises. unregulated dividend policy means that those shareholders who liked the previous dividend cannot be sure whether they will like the next one. this insecurity can lead to the fall of the price of company's shares. when shareholders do not get what they expect, they often express their dissatisfaction by selling their shares. one well planned policy applied to the corporation and its business strategy can prevent unpleasant surprises for market participants and protect the share price. factors affecting dividend policy there are several factors which affect dividend policy, the most important of which are the following: (a) legal rules, (b) liquidity position, (c) the need to pay off debt, (d) restrictions in debt contract, (e) rate of expansion of assets, (f) profit rate, (g) stability of earnings, (h) access to capital markets, (i) control, and (j) tax position of shareholders. details about these factors will be presented in the following section. one of the factors that determine the extent to which the company will pay out dividends instead of retaining earnings are legal rules. this rules state that dividends must be paid out from the earnings (profit) – whether from current earnings or from the earnings from previous years, which is shown on the balance sheet in “retained earnings”. state laws emphasize three rules; (a) the net profit rule, (b) capital impairment rule and (c) insolvency rule. the net profit rule states that dividends can be paid out from past and current earnings. capital impairment rule protects the creditors by forbidding dividend payout from the capital. dividend payout from capital would mean distributing the investment in the company, not the earnings, and such dividend is called liquidating dividend. the insolvency rule states that corporations cannot pay out dividends as long as they are insolvent, i.e. as long as their liabilities exceed the value of their assets. dividend payout under such circumstances would mean giving the funds to the shareholders which rightfully belong to the creditors. one of the factors affecting dividend policy of companies is its liquidity position. profits that are kept in retained earnings, which appears on the right side of the balance sheet, are usually invested in the assets needed for work. retained earnings from past years are already invested in facilities and equipment, supplies and other assets, meaning that they are not being retained as cash. therefore, even if the company has record earnings it may not be able to pay out cash dividend due to its liquidity position. growing companies, of course, omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 47 even those very profitable ones, usually have an urgent need for funds. in such situation, the company can choose not to pay out cash dividends. the need to pay off debt also determines the company's dividend policy. when the company sells its debt as a way of financing expansion or using it as a replacement for other forms of financing, it faces two alternatives. it can return the debt on the maturity day by replacing it with another form of securities. however, the decision to retire a debt will mostly require retaining the earnings. dividend policy is also affected by restriction in debt contract. debt contracts, especially when a long-term debt is involved, frequently restrict the ability of the company to pay cash dividends. such restrictions, designed to protect the position of a lender, usually state that (a) future dividends can be paid out only if the earnings were made after signing the loan contract (i.e. they cannot be paid out from past retained earnings) and that (b) dividends cannot be paid out when the net working capital (working capital minus short-term liabilities) or the indicator of current liquidity (working capital, cash being one of its parts, divided by short-term liabilities) are below a certain level. company's dividend policy also depends on the rate of expansion of assets. the bigger the need for assets, the bigger the possibility that the company will retain earnings rather than paying them out. if the company wants to obtain assets from external sources, a natural source for that lies in current shareholders who already know the company. but, if the earnings are paid out as dividends and are subjected to a high tax rate of personal income tax, only part of them will be available for reinvestment. profit rate also affects dividend policy. the expected rate of return on assets determines the relative attractiveness of paying out earnings to shareholders in the form of dividends (who will use them elsewhere) or of using them in this (current) company. stability of earnings is also one of the factors which affects dividend policy. the company that has relatively stable earnings is often able to make a rough assessment of its future earnings. it is therefore more likely that such company will pay out a larger percentage of its earnings than the company with variable earnings. an unstable company is not sure whether the earnings they hope for will be achieved in the years to come and it is more likely that they will retain a part of current earnings. it will be easier to maintain a lower dividend if earnings decrease in the future. access to capital markets also determines dividend policy. understandably, an easier access to capital markets and a wider range of alternative sources of financing make the pursuit of dividend policy easier. possible restrictions face the management with a serious dilemma: whether to give up on profitable projects and jeopardize the future cash flow and future gain or to reduce or completely give up on dividends and face the effects of unfavorable information signaling. it should be mentioned that large, affirmed companies with the record profitability and stability of earnings have an easy access to capital markets and other forms of external financing. on the other hand, potential investors see small or new companies as more risky. their ability to increase capital or debt funds from capital market is limited and they have to retain more earnings for financing their business operations. affirmed companies will therefore probably have a higher rate of dividend payment than new or small companies. economic analysis (2014, vol. 47, no. 1-2, 42-58) 48 one of the important variables that affect dividend policy is the effect of alternative sources of financing on the control situation in a company. if the company practices the policy of larger dividend payouts, it is to be expected that it will reach for external sources of financing, either because it needs additional capital for new investment or to finance dividends themselves. the consequence of this activity can be control dilution in the situations when shareholders from the control group do not subscribe a sufficient number of new shares. relying on internal financing with the aim of maintaining control reduces the dividend payout. and finally, the tax position of shareholders greatly affects the desire for dividends. in relation to that, it should be mentioned that there can sometimes be a conflict of interests in large corporations between shareholders in high tax grades and those in low tax grades. the former can prefer low dividend payout and high rate of retaining earnings hoping for the appreciation of the company's equity. the latter can prefer a relatively high dividend payout. dividend policy in such companies can be a compromise between a low and high payout – medium payout ratio. if one group comes to dominate the company and sets, for example, the low payment policy, the shareholders who want an income will probably send their shares with time and find higher yielding shares. in that way, to a certain extent at least, the company's dividend policy is determined by the type of shareholders that company has – and the other way around. this is called the clientele effect on dividend policy. leading dividend theories as we have already asserted, corporations take a large number of various factors into account when deciding about the character of their dividend policy. financial experts are trying to combine these factors into dividend theories about the way in which dividend policy affects the company's value. leading dividend theories, which help the pursuit of dividend policy, are the following: (a) residual theory of dividends, (b) stable dividend theory, (c) dividend clientele theory, (d) signaling dividend theory, (e) “bird in the hand” theory, (f) tax preference theory, and (g) dividend irrelevance theory. residual theory of dividends is widely known. this theory is based on a hypothesis that the amount of dividends should not be the company's focus. instead, the primary subject of discussion should be the determining of the amount of retained earnings for investing within a company. since dividends come from the “residue”, or leftover earnings, the theory is called residual theory. according to this theory, corporate companies follow four steps when deciding on the rate of dividend payout (brigham, 1991): (a) determine the optimal capital budget, (b) determine the amount of equity needed for financing that budget, (c) to the extent possible, use the retained earnings to supply the equity, and (d) pay out dividends only if the available earnings are higher than needed to support the optimal capital budget. if the company strictly follows the residual dividend policy, then the dividends paid put in any year can be expressed in the following way (brigham, houston, 2004): dividends = net income – retained earnings required to help finance new investments = net income – [(target equity ratio)(total capital budget)]. omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 49 determining the amount of dividends, according to the theory of residual dividends, will be shown by using one example. let us assume that the corporation y needs 10 million km for financing its eligible projects of capital budgeting (table 2). table 2. the application of the residual theory of dividends on the example of corporation y investment needed for new projects 10.000.000 km optimal capital structure 30% debt – 70% equity needed equity funds 70% × 10.000.000 km = 7.000.000 km available earnings 12.000.000 km residual earnings 12.000.000 km – 7.000.000 km = 5.000.000 km amount for dividend payout 5.000.000 km the corporation y has earnings in the amount of 12 million km. it needs equity funds in the amount of 70 percent out of 10 million km or 7 million km, so that what is left is leftover earnings in the amount of 5 million km for dividends. if available earnings were 20 million km instead of 12 million km, then the dividend payout would be 13 million km (20 million km – 7 million km). however, if the available earnings were 6 million km instead of 12 million km, then dividends would not be paid out. as a matter of fact, additional financing by equity in the amount of 1 million km should be increased by issuing new ordinary shares. theory of residual dividends focuses on the optimal using of earnings generated from the perspective of the company. this dividend theory, therefore, ignores the shareholders' preference concerning the regularity and the amount of dividend payout. if the company applies the theory of residual dividends, when the earnings are high and the eligible projects of capital budgeting are small and few, dividends will be high. in contrast, when the earnings are high and there are many big eligible projects waiting to be financed, dividends cannot be paid out if the theory of residual dividends is applied. dividend payouts would not be regular and the amounts would not be predictable. stable dividend theory is the theory which requires the payout of the same amount of dividends per share in a series of consecutive accounting periods. as we have already asserted, the essence of the residual approach is that dividends are paid out only after all other profitable investment opportunities have been used up. naturally, a strictly residual approach can lead to a very unstable dividend policy. if the investment opportunities are rather high in one period, dividend will be either low or zero. conversely, dividend can be high in the following period if it is considered that investment opportunities are not promising. the company can choose between at least two types of dividend policies. first, each quarterly dividend can be a fixed part of the earnings in that quarter. in this case, dividends will vary during the entire year. this is a cyclical dividend policy. second, each quarterly dividend can be a fixed part of annual earnings, which implies that all dividend payouts will be equal. this is a stable dividend policy. corporate officers generally agree that stable dividend policy is in the interest of the company and its shareholders and the stable dividend policy will thus be more frequent. economic analysis (2014, vol. 47, no. 1-2, 42-58) 50 most companies that pay dividends try to follow the policy of stable dividend per share for four reasons (baker, powell, 2005): (a) many managers think that stable dollar dividend policy leads to higher share prices, (b) shareholders frequently rely on dividends to provide a stable source of income to supplement their current consumption, (c) stable dividend policy gives less chance of transmitting false information content, and (d) legal listing of shares requires dividend stability in many countries. we will also mention that instead of absolute stability, both corporations and shareholders rather opt for the policy of relative stability which assumes gradual changes in dividend payouts (generally in the ascending line) in relation to the trend line of net income, while trying to avoid short-term net income fluctuations of the amount of dividends. choices of this kind are primarily motivated by the fact that dividend stability attracts investors and it is therefore believed that this kind of policy leads to the increase in the market price of shares. dividend clientele theory is based on the attitude that investors find certain companies attractive in part due to their dividend policy. dividend policy should therefore reflect the clientele effect as well. for example, young investors might want the value of their portfolios to grow from capital gains and not from dividends so they search for companies that retain earnings instead of paying out dividends. in relation to that, it should be mentioned that share prices have a tendency to increase when the earnings are retained and the resulting capital gains are not taxable until the shares are sold. if there really is a clientele effect, it means that at least some percentage of the company's shareholders acquired shares because they like the company's dividend policy. if the company is inconsistent in its dividend policy, many shareholders will sell shares, because they do not know whether the level of dividends will suit their preferences or not. the lack of popularity of shares would have a negative effect on share price and thus the cost of capital as well. even if a certain company was rather consistent in its dividend policy, but then initiated a big change, some of its investors who particularly liked the previous dividend policy (that may be the case with all shareholders) would probably want to switch to shares of the company with dividend policy that they find more acceptable. even though it might be the case that new clientele finds the dividend policy attractive, the friction caused by one group of investors selling to a new group of investors would have a negative effect on shareholders. signaling dividend theory is based on the premise that the management of the company knows more about its future financial prospects than shareholders. according to this theory, if a company declares a dividend higher than the one predicted by the market, this will be interpreted as a signal that future financial prospects are brighter than expected. investors assume that the management would not have raised the dividend if they did not think that they could maintain it. as a result of this signal of good future prospects, investors buy more shares, causing the share price to increase. in contrast, if the company lowers its dividend, the market sees this as a signal that the management expects bad earnings and does not think they can maintain the current dividend. if raising the dividend should act as a signal, it seems reasonable to ask ourselves why the management does not only issue a declaration. surely a declaration would be much less ambiguous then the increase of dividend. maybe managements think that actions speak louder than words (mclaney, 1997). omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 51 the “bird in the hand” theory claims that shareholders prefer to receive dividends instead of the earnings being reinvested in the company on their behalf. according to this theory, the value of the company will be maximized by a high dividend payout ratio because investors think that current dividends are less risky than potential capital gains. even though investors should expect to benefit from retaining and reinvesting earnings in their company since the future share prices will increase, there is uncertainty about whether that benefit will actually be realized. in other words, “a bird in the hand is worth two in the bush” (gallagher, andrew, 1997). tax preference theory states that, since capital gains are subject to lower tax burden than dividends, investors prefer to own the retained earnings of the company than to be paid dividends. hence, increasing the dividends, according to this theory, would result in the fall of share price and the growth of requested rate of return on equity. there are three tax-related reasons that support the opinion that investors would prefer low dividend payouts to high dividend payouts. those reasons are the following (brigham, houston, 2004): (a) long-term capital gains are generally taxed at a rate of 20 percent, whereas the income from dividends is taxed at effective rates that can reach as much as 38,6 percent. (b) income taxes are not paid as long as shares are not sold. due to the effect of time value, a dollar of paid taxes in the future has a lower actual cost than a dollar paid today. (c) if the shares are owned by someone until that person's death, there is no tax on all capital gains – beneficiaries who receive the shares can use the value of shares on the day of death as their purchase value and thus completely avoid capital gains tax. dividend irrelevance theory considers that a company's dividend policy does not have an effect on the company's value or on its cost of capital. according to this theory, there is no optimal dividend policy. one dividend policy is as good as any other. the notion that dividends are irrelevant originates from the pioneer work of m. miller and f. modigliani (m&m) entitled dividend policy, growth, and the valuation of shares, published in 1961. in that work, m&m claim that the value of a company is determined only by its earnings power and its business risk. in other words, m&m claim that the value of the company depends only on the earnings produced by its assets and not on whether those earnings are distributed in dividends or retained. it should be kept in mind that m&m put their analysis in the context of contemporary capital market with rational investors. the key assumptions of this ideal version of capital market are the following: (a) no flotation, transaction, and agency costs, (b) no taxes, (c) equal and free access to information – investors are symmetrically informed, (d) rationality of investors, and (e) investors cannot influence the price of securities. therefore, under very restrictive assumptions, m&m provide a generally accepted argument for dividend irrelevance. the theory by miller and modigliani and the messages to corporate practitioners about the importance of dividend payouts are completely clear and as it seems, correct in the context of set limitations. what we cannot afford to miss is that the problem with most of the existing dividend theories is that they neglect the consideration of the potentially complex interactions between different elements. another problem is that every theory usually assumes the “one size fits all” approach when testing in order to generalize findings. hence, dividend decisions, like investment decisions and financing decisions, require a compromise (damodaran, 1999). economic analysis (2014, vol. 47, no. 1-2, 42-58) 52 however, unlike with the latter decisions, it seems that little agreement exists on where to find the compromises that are supposed to lead us to the “right” dividend policy. having all of this in mind, we can conclude that dividend policy clearly represents a dynamic process with a number of interconnected affects that make the existence of a general model that would lead to the optimal dividend policy for any occasion practically impossible. this fact forces us to make a difficult conclusion that dividend decisions represent an area where the ability to make good judgment calls still plays a big part. guidelines for establishing dividend policy the aim of dividend policy is to maximize its contribution to increasing the shareholders' wealth. the task that the board of directors and the management face is the decision about who can make the better use of money – the company or its owners. practical instructions available to companies which try to achieve this aim are reflected in the following (baker, powell, 2005): • the company should consider its investment opportunities and avoid further reductions on profitable projects in order to pay out dividends. the point of the analysis is to determine whether the company's opportunities are better than the ones available to investors. if the expected return from the available discretionary projects exceeds the opportunity cost of capital, the company should have a lower dividend payout. if it cannot put the retained earnings to good purpose, the company should distribute more to its shareholders. a higher target payment is not an acknowledgment of failure. • companies should rely heavily on retained earnings as the source of equity. companies should avoid issuing new equity unless it is needed for financing profitable investments. the sale of new shares includes the costs of flotation costs and a negative market reaction to such sale. • if the company is paying out dividends, it should consider paying them on a regular basis from the available cash flow. consistency, where possible, is important because a large number of investors depend on dividends. when a company establishes dividends, it has an implicit responsibility to maintain them through a regular business cycle. incurring debt in order to maintain a regular dividend can be accepted if it is within reasonable bounds and if the management expects the earnings to increase. • companies should avoid reducing or omitting dividends unless the current dividend level is unsustainable in the long run. one of rare aspects of dividend policy, on which a widespread agreement exists, is that the management should not accidentally reduce a once established dividend rate. dividend reinvestment plans many corporations offer a dividend reinvestment plan based on which the shareholders reinvest their dividends instead of receiving them in cash. dividend reinvested plans are popular because they provide shareholders with an opportunity to buy additional shares omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 53 without creating provision costs that accompany regular purchases that shareholders make through a stockbroker. to companies, dividend reinvestment plans represent a way to increase the rate of retaining earnings without voting and declaring the lowering of dividend payouts. dividend reinvestment plans have various characteristics. there are plans of reinvesting in the existing and new shares. plans also differ according to investment limits, according to determining the price of reinvestment and according to the way of managing dividend reinvestment plans (orsag, 2003). stock dividends in addition to cash dividends, the distribution of value to shareholders can be done by distributing dividends in the form of shares (stock dividends). stock dividends are not real dividends because they are not paid in cash. the effect of stock dividends is the increase in the number of shares owned by every shareholder. since there are more outstanding shares, each share is simply worth less. stock dividends are usually expressed in percentages. to take an example, a 20 percent stock dividend means that the shareholder gets one new share for every five shares s/he currently owns (increase by 20 percent). since every shareholder gets a 20 percent increase in shares, the total number of outstanding shares is increased by 20 percent. as we will see, every share is worth around 20 percent less at one point. a typical financial manager is aware of the many complexities of the real world and thus the decision on stock dividends is not treated lightly in practice. usually, in addition to using the distribution of stock dividends to retain earnings in the company, distribution of stock dividends can also be an indicator of higher future profit. the reason for that is the fact that earnings would have to be retained only if it is possible to invest them profitably. if, however, the profitability of the company does not increase, dilution of earnings will occur. therefore, the management that proposes the issuing of stock dividends should be committed to achieving a higher profitability. a stock dividend is very similar to stock splits. specifically, the process of stock splitting, as well as the process of distributing stock dividends, leads to the actual increase of the number of shares (in inverse proportion to the reduction of their nominal value) while the fixed capital remains unchanged. even tough at first sight it might seem that the effects of the two actions are the same or similar, it has to be emphasized that there is a significant difference between them from a financial and accounting point of view. in support of the process of stock splitting, it is stated that the market price of shares falls at a slower rate than the proportion in which their splitting was done (petty, keown, scott, martin, 1993). repurchase of own shares as an alternative to cash dividend payouts, corporations can choose to pay the earnings to the owners by repurchasing ordinary shares outstanding. when repurchasing shares, the company exchanges the assets for some part of its outstanding shares. ordinary shares acquired by the company issuer become treasury shares. such shares have no voting rights, economic analysis (2014, vol. 47, no. 1-2, 42-58) 54 are not included in the calculation of earnings per share and do not meet the requirements for dividend payout. even though the primary source of funds used for financing the repurchase is the available amount of funds, companies sometimes use debt and other sources. there are two main types of the repurchase of shares: (a) the situation in which the company has money available for distribution to its shareholders and it distributes that money by repurchasing shares and not by paying cash dividends, and (b) the situation in which the company concludes that its capital structure is overburdened by equity and it sells its debt and uses the funds to repurchase its shares. there are certain benefits as well as weaknesses to the repurchase of own shares. the advantages of the repurchase of own shares can be summed up in the following (brigham, 1991): • announcement of repurchase is often seen by investors as a positive signal because repurchase is often motivated by the management's conviction that the shares of the company are underrated. • shareholders have a choice when the company is repurchasing shares – to sell them or not to sell them. however, shareholders have to accept the dividend payout and pay the tax. therefore, those shareholders who need cash can sell some of their shares, whereas those who do not need additional cash can simply keep their shares. from a tax point of view, both types of shareholders get what they want. • the third advantage is that repurchase can remove a large block of shares looming over the market and keeping the share price low. • dividends are “sticky” in the short run which is the reason why the management is hesitant to increase the dividend if the increase cannot be maintained in the future – managerial aversion towards the reduction of cash dividends. therefore, if the surplus of cash flow is seen as being only temporary, the management can prefer to choose a distribution in the form of share repurchase and not to declare an increased cash dividend which cannot be maintained. • repurchase can be used for making big changes in the structure of capital. weaknesses of the repurchase of own shares include the following (brigham, 1991): • shareholders may not be indifferent between dividends and capital gains, and the price of shares can benefit more from cash dividends than from repurchase. cash dividends are mostly reliable, repurchases are not. furthermore, if many companies announced regular, reliable repurchase programs, improper accumulation of taxes could become a threat. • shareholders who are selling their shares cannot be completely aware of all the implications of the repurchase or they cannot have all relevant information about the present and future activities of the corporation. however, companies mostly announce repurchase programs before they engage in them in order to avoid potential lawsuits by shareholders. • corporation can pay a high price for repurchased shares at the expense of the remaining shareholders. if its shares are not used for active trade and if the corporation wants to acquire a relatively large amount of its shares, then the omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 55 offered price can be above its equilibrium level, and then start declining after the corporation suspends its repurchase operations. survey results since there are certain reasons for and against dividend payouts and since there is a lack of consensus about the effects of dividends on value, it is necessary to determine the factors which managers take into account the most when making the dividend decision. baker, farrelly and edelman conducted a survey among managers in 1985 about their attitudes on dividend policy and showed their level of agreement with a series of statements. their findings are summarized in table 3 (baker, farrelly, edelman, 1985). table 3. management beliefs about dividend policy statements of management beliefs agree no opinion disagree 1. a firm’s dividend payout ratio affects the price of the share. 61% 33% 6% 2. dividend payouts provide a signaling device of future prospects. 52% 41% 7% 3. the market uses dividend announcements as information for assessing firm value. 43% 51% 6% 4. investors have different perceptions of the relative riskiness of dividends and retained earnings. 56% 42% 2% 5. investors are basically indifferent with regard to returns from dividends and capital gains. 6% 30% 64% 6. a shareholders are attracted to firms that have dividend policies appropriate to the stockholder’s tax environment. 44% 49% 7% 7. management should be responsive to its shareholders' regarding dividends. 41% 49% 10% this research clearly shows that, whether they are right or wrong, managers think that their dividend payout ratio affects the company's value and act as a signal of future prospects. they also work under the assumption that investors choose companies with dividend policies that suit their wishes and that the management should respond to their needs. we will also show the findings of the research conducted in big companies in splitdalmatia county which is also related to the attitudes of managers on dividend policy. the findings of that research are presented in table 4 (vidučić, 2004). economic analysis (2014, vol. 47, no. 1-2, 42-58) 56 table 4. attitudes of managers on dividend policy in large companies of split-dalmatia county attitudes on dividends rating grade shareholders should be informed about the changes in dividend policy 1 it is necessary to define the target rate of dividend payout 2 when assessing securities, investors use information about dividends 3 payment of dividends is a signal of the company's success 4 this research showed that financial managers think that shareholders should be informed about the changes in dividend policy. furthermore, they think that it is necessary to determine an optimal dividend payout ratio. according to managers' attitudes, this indicator ranges from 20 to 70%. likewise, managers think that investors use information about dividends to assess the value of shares and that the payout of dividends is a signal of company's success. it can be assumed that the clientele effect also plays an important role, while the tax effect can be described as marginal. this is understandable if we keep in mind the fact that individuals do not pay tax on dividends, whereas tax on dividends and capital gains of the corporate sector is taxable at the same rate. conclusion all corporate companies have to face the problem of finding a suitable dividend policy which can be summarized in simple terms as deciding which part of the earnings to retain in a company for the purpose of reinvesting and which part of the earnings to distribute to shareholders through dividends. the main problem is the need for finding the optimal dividend policy which would maximize the market value of a company. we can safely state that dividend policy is one of the most controversial areas of financial management. a number of reasons can be found for the payout of high dividends and an equal number against dividend payout. legal rules are important because they provide a framework for the formulation of dividend policy. however, within its boundaries, financial and economic sector have the biggest influence on dividend policy. financial experts are trying to combine these factors into dividend theories about the impact of dividend policy on the price of an ordinary share. on the one hand, some argue that because of the tax advantages related to the reception of dividends, in relation to price appreciation, some companies should reduce or even stop dividend payouts and consider alternative ways of returning money to shareholders. on the other hand, many claim that increasing the dividend acts as a positive financial signal and that there are investors who prefer dividends, regardless of tax disadvantages. finally, there is a school of thought which claims that dividend policy does not affect the value of an ordinary share. in short, there is some truth in all of these points of view and it is possible to reach a consensus on the points on which they agree. the reality is that dividend policy requires a compromise between additional tax liability which can be created for some investors and potential signaling and benefits from free cash flows. in some cases, a company can decide not to increase or not to start paying dividends because its shareholders are in high tax grades and are particularly averse towards dividends. in other cases, increase in dividends may occur. omerhodžić, s., factors of dividend policy, ea (2014, vol. 47, no. 1-2, 42-58) 57 a key question, does the dividend policy affect the owner's wealth and if it does, does the dividend payout increase it or not, does not have a single answer. various theories of dividend policy have to be considered in order to formulate a concrete dividend policy out of their recommendations. therefore, decision to pay or not to pay dividends as well as decision on their hight depends on the specificity of each company and is in no way simple. the “magic formula” does not exist. the optimal or ideal dividend policy is unusually complicated and is in the final analysis determined to a large extent by the management's ability to make the right call. references baker, h.k., farrelly, g.e. & edelman, r.b. (1985). “a survey of management views on dividend policy”, financial management, vol. 14(3). baker, h.k., powell, g.e. (2005). understanding financial management: a practical guide, blackwell publishing ltd, oxford. bradley, j.f. (1978). administrative financial management, fourth edition, the dryden press, hinsdale, illinois. brigham, e.f. (1991). fundamentals of financial management, sixth edition, the dryden press, orlando. brigham, e.f. & houston, j.f. (2004). fundamentals of financial management, tenth edition, thomson, south-western, ohio. damodaran, a. (1999). applied corporate finance: a user′s manual, john wiley & sons, inc. gallagher, t.j. & andrew, jr., j.d. (1997). financial management: principles and practice, prentice-hall international, inc., new jersey. mclaney, e.j. (1997). business finance: theory and practice, fourth edition, pitman publishing, london. orsag, s. (2003). vrijednosni papiri, revicon, sarajevo. petty, j.w., keown, a.j, scott d.f. & martin, j.d. (1993). basic financial management, prentice-hall, inc., englewood cliffs, new jersey. ross, s.a., westerfield, r.w. & jordan, b.d. (2006). corporate finance fundamentals, seventh edition, mcgraw-hill, international edition. vidučić, lj. (2004). “kontroverze politike dividendi”, zbornik radova sveučilišta u rijeci, ekonomski fakultet. weston, j.f. & copenland t.e. (1986). managerial finance, cbs college publishing, new york. identifikacija i evaluacija faktora politike dividendi rezime – politikom dividendi se određuje omjer između zarade distribuirane dioničarima i zadržane u firmi. iako su zadržane zarade jedan od najvažnijih izvora sredstava koji se koristi u finansiranju korporativnog rasta, obračunate dividende predstavljaju tokove gotovine za dioničare. treba li gotovinu reinvestirati u poslovanje ili je treba isplatiti investitorima u dionički kapital? economic analysis (2014, vol. 47, no. 1-2, 42-58) 58 odluka se može činiti jednostavnom, ali izaziva iznenađujuću količinu kontroverze. uprkos iscrpnim teorijskim i empirijskim analizama da se objasni njihovo sveprožimajuće prisustvo, dividende su i dalje jedna od najvećih zagonetki u korporativnim finansijama. u ovom radu se najprije određuje pojam dividende i navode oblici dividendi. nakon toga se raspravlja o politici dividendi i optimalnoj dividendnoj politici, te analiziraju faktori koje menadžeri trebaju imati u vidu kod oblikovanja politike dividendi. znatna pažnja se posvećuje vodećim dividendnim teorijama, koje nastoje da daju odgovor na pitanje kakva je uloga dividendi u maksimiranju vrijednosti korporacije, te praktičnim uputstvima koja stoje na raspolaganju menadžerima u pokušaju da postignu ovaj cilj. takođe, raspravlja se i o drugim povezanim pitanjima, kao što su planovi reinvestiranja dividendi, dividende u obliku dionica i otkup dionica. konačno, predstavljaju se i nalazi dva anketna istraživanja čiji je cilj bio utvrđivanje stavova menadžera o politici dividendi, odnosno identifikuju se faktori koji su u najvećoj mjeri opredjeljivali menadžere pri uspostavljanju konkretne dividendne politike. ključne riječi: dividenda, oblici dividendi, optimalna politika dividendi, cijena dionice, dividendne teorije, dividende u obliku dionica, otkup dionica, anketna istraživanja article history: received: 24 september 2013 accepted: 10 october 2013 microsoft word ea_2020_1_final.docx doi: 10.28934/ea.20.53.1.pp28-41 original scientific paper the role of online shopping in the republic of serbia during covid‐19 đina ivanović1** | marija antonijević1 1 institute of economic sciences, belgrade, serbia abstract this paper investigates the role of online shopping during severe covid-19. the main aim is to see whether this virus and implemented measures of reducing the spread of contagion brought by the government of the republic of serbia, resulted with changes in consumer behaviour. the data was collected from 408 respondents from the republic of serbia using an online questionnaire. the questionnaire lasted from 07th april until 04th may. data were analysed using the chi-square test. results of this study revealed that there is a significant association between purchasing online before and after the appearance of the covid-19. also, the authors conclude that there is no significant association between gender and the decision to purchase after the appearance of the covid-19. the main three motives for online shopping in the period during covid-19 were that too many stores are working only online, reducing health risk, and saving time. the most frequently online bought products by the respondents, were food (groceries), medicines and books (magazines, newspapers). the contribution of this paper, even though the analysed sample is not national representative, lays in the fact that there is almost none research of this topic in our country. key words: online shopping, online purchasing, republic of serbia, covid‐19, consumer behaviour jel classification: d81, d91 introduction contagious diseases covid-19 is caused by a virus (sars-cov-2), i.e. severe acute respiratory syndrome. the name covid-19 was given because it was discovered by the end of 2019 in wuhan, china. this virus represents a new strain of coronavirus that has not been previously identified in humans. (european centre for disease prevention and control, 31st march 2020). until 05th april 2020, this pneumonia caused 1,093,349 confirmed cases and 58,620 deaths in 209 territories (world health organization, 2020). one of the countries where this virus is registered in the republic of serbia. serbia confirmed the first case of coronavirus (covid-19) on 06th march 2020. in response to the detection of the covid-19, the president of the republic of serbia announced a state of emergency in this country on 15th march (the government of the republic of serbia, 2020). the first coronavirus death in serbia was confirmed on 20th march. on 01st may 2020, the total number of infected cases was 9,205. also, the total number of tested people was 9,205, and the mortality rate was 2.01%. in table 1, the statistics of covid-19 deaths is presented. * corresponding author, e-mail: djina.ivanovic@ien.bg.ac.rs đina ivanović, marija antonijević 29 table 1. the statistical data of covid-19 deaths in the republic of serbia gender number of deaths average age male 113 67.85 female 72 total 185 source: ministry of health of the republic of serbia covid‐19, 1st may 2020. as we can see from the table above, the male seems harder hit by the virus than women. the average age is 67.85. the trend of coronavirus daily cases is presented in figure 1. figure 1. the trend of coronavirus daily cases source: statistics of covid‐19 in the republic of serbia the cities most affected by the virus in serbia were belgrade and niš (the third-largest city in serbia). table 2 shows cities/municipalities in serbia with the most significant participation in total positive cases of coronavirus. table 2. percentage of positive cases of coronavirus in cities/municipalities in total cases in serbia city/municipality % belgrade 26.77 niš 13.76 ćuprija 2.80 leskovac 2.76 kruševac 2.49 source: ministry of health of the republic of serbia covid‐19, 1st may 2020. because of the high mortality rate of the population and the people identified as belonging to the at-risk group, the government of the republic of serbia brought measures to reduce the spread of covid-19. some of the measures were: forbidding movement of the population in a certain period, closing malls, bars, restaurants, beauty salons and other places which are more visited. the first mentioned measure, and the most important measure, is presented on the timeline below (figure 2). 30 economic analysis (2020, vol. 53, no. 1, 28-41) figure 2. measures during march, april, and may in the republic of serbia source: authors research this measure of forbidding movement of the population during march, april, and may affected on grocery opening hours. most grocery stores were open until 2 hours before curfew. also, the delivery of some stores was working during curfew with the permission of the authorities. as seen above on the timeline, the total number of hours people can not move several consecutive days was 278. literature review considering that covid-19 has hit many countries in the world and changed people's buying behaviour, in this part, the two studies are presented as an overview on online shopping during severe epidemics such as sars and mers. the first study refers to the sars in hong kong during early 2003, which significantly changed consumer behaviour. in february 2003, only 1.5% of hong kong companies sold goods or services online. over 63% of the population had internet access, but only 3.2% of internet users purchased online. forster & tang (2005) found that demand for online shopping grew during sars in response to the growing fear of contagion. they collected data for this investigation from hong kong's largest online supermarket park’n shop. the questionnaire covered the period 16th february 2003 15th june 2003. the results showed that the products which consumers mostly bought were rice, cooking oil, canned goods, consumable foods, frozen foods, cleaning products and toiletries. the most important conclusion of this research was that the demand for online shopping had been closely related to the spread of contagion. the second study refers to the mers-cov (middle east respiratory syndrome coronavirus), which was identified in south korea in 2015. jung et al. (2016) found, based on debit and credit card transaction information, that consumer behaviour was changing because of the spread of đina ivanović, marija antonijević 31 the contagion. the data was collected using a mobile app developed by a korean company, which automatically registers transactions that consumers received from the bank via sms. information for each transaction included consumer identifiers, date, time, the amount paid and the retail store name. the complete transaction data collected during 2014 and 2015 included only 1,521 consumers out of 11,225. consumers between the ages of 20 and 30 made up about 70% of the sample. the average consumer had 12.3 transactions per month. grocery expenditures had the largest share of total expenditures. the researchers found that there was a significant decline in transaction volume during the period of may and june 2015, but buyers increased e-commerce expenditures by 5.25% because of fear of contagion. because one of the aims of this study is to identify the factors that influence the purchase decisions during covid19, the analyse of motives for shopping will be presented in the following text of the paper. the core motives for purchasing products and services can be explained by consumers level of needs and trust. hennig-thurau et al. (2003) conducted an empirical study on 2,900 people in germany. the experiment resulted with the conclusion that people quickly buy products and services when they have more information about that product (previous experience of buying it or previous experience of others) and also when their privacy is secured. according to singh & sirdeshmukh (2000), highly technical competence can be a factor to influence the trustworthiness. the online trustworthiness (trust) is the basic and essential element for building a relationship with consumers (kumar & dange, 2012). the example in which we can see the relation of trust and rise of sale is a company like dell. dell has reached 18 million dollars in sales through the internet during the first quarter of 1999 (us department of commerce, 1999), even before the experiment done in germany. li & zhang (2002) made figure 3 based on 35 studies which were directed to online shopping attitude. figure 3. research model of consumers' online shopping attitudes and behavior source: li and zhang (2002) figure 3 shows us five factors (antecedents) which automatically combined gives us "attitude towards online shopping", which is cored in our minds and represent the first step in the process of buying a product online. next step is the intention to shop online, which is defined as the need for buying. third step "decision making" is defining as the period of time in which consumer needs to decide whether he/she will buy something or not. in the end, we purchased as a result. these four steps caused consumer satisfaction. antecedents, in this case, are independent variables, and the steps in this figure are dependent variables. that means that 32 economic analysis (2020, vol. 53, no. 1, 28-41) attitude, intention, decision making and online purchasing as steps, depends on the external environment, demographics, personal characteristics, vender (service) product characteristics and website quality. many models allow us to find factors that influence purchasing decisions. lohse & spiller (1998) made an integrative model of consumer trust in internet shopping (figure 4) figure 4. an integrative model of consumer trust in internet shopping source: kumar & dange (2012) as we can see from figure 4, two key factors affect consumer trust in internet shopping. the first one is perceived trustworthiness of internet merchants, which are mainly directed to the integrity of consumer, and the second one is the external environment which is directed to external factors: third party recognition (seller) and legal framework. vasić et al. (2019) made a model which has six factors that affect consumer satisfaction of buying a product online. in figure 5, we can see those factors. figure 5. a conceptual model of consumer satisfaction source: vasić et al. (2019) the definition of privacy according to anderson (2001) cited by norjihan and zailani (2009) is "the ability and/or right to protect our secrets, the ability and/or right to prevent the attempt to our personal space. information availability means how much is the information about the product or service accessible. it is very important because it gives us a clear opinion about the item which we have searched for. shipping, as the third factor, is a link in the supply chain that directly affects the consumer and triggers their satisfaction (hedin et al., 2006) cited by vasić et al. (2019) quality is defined as the consumer's judgment about a product's overall excellence or superiority (chen & dubinsky, 2003). price is the cost at which something is obtained (merriamsecurity information availability shipping quality pricing time customer satisfaction đina ivanović, marija antonijević 33 webster, --). moreover, the last one, time, is defined as a duration which is needed for purchasing. these factors, when they are fulfilled, result in consumer satisfaction. the third group of authors made a model named "factors, filtering elements and filtered buying behaviour (fff model)" which is the combination of internal and external factors. internal factors depend on individual construction of a person. other external factors are that influence a consumer shopping decision from the outside (see figure 6). figure 6. online consumer buying behaviour motive model, factors (f), filtering elements (f) and filtered buying motive (f); (fff model) source: kumar & dange (2012) the core of this model comes from the distribution of external factors from the author warner and internal from the author malcolm (kumar & dange, 2012). as we can see, the combination of these factors gives buying motives. the filtering elements of the product and/or service are security, privacy and trust concern. definition of those three is, how much is safe to buy something, how much our data is safe and how much are we familiar with the product and/or service, retrospectively. after filtering, we have filtered buying motives which help us to buy, which is a final step in the process. online shopping in the republic of serbia table 3 shows us the frequency of online purchases of individuals in the period 2009-2019 in serbia measured in percentage table 3. frequency of online purchases of individuals (%) in period 2009-2019 in serbia frequency of online purchases year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 in the last 3 months 6.5 6.1 9.3 16.6 19.3 21.6 22.7 26.3 28.3 30.9 34.2 over 3 months ago (less than a year ago) 4 4.5 5.1 5.4 9.2 10.2 10.6 12 13 14.6 9.7 over a year ago 2.1 2.4 3.7 4.7 7 8.8 9 7.1 8.8 9.1 13.1 i have never used 87.4 87 81.9 73.3 64.5 59.5 57.7 54.6 49.9 45.4 43 source: statistical office of the republic of serbia 34 economic analysis (2020, vol. 53, no. 1, 28-41) as you can see from the table 3, the share of those who have been shopping online in the last three months has increased from 6.5% in 2009 to 34.2% in 2019%. the participation of those who have never bought is noticeable decreasing through this period. table 4 shows the category of goods which individuals bought or ordered over the internet for private use in the previous 12 months. table 4. category of goods or services which individuals in serbia bought or ordered over the internet for private use in the previous 12 months (percetage of individuals) category 2018 2019 clothes, sports goods 55.5 63 household goods (furniture, toys...) 22.6 37.9 travel, holiday accommodation 6.4 25.3 electronic equipment 18.3 17.7 tickets for events 5.3 17 books/magazines/newspapers 12.2 15.6 telecommunication services 2.6 14.6 medicines 8 10.7 video games software and upgrade 4.6 10.7 films, music 3.2 8.3 hardware 4.8 7.9 food or groceries 4.4 6.3 source: statistical office of the republic of serbia most people bought clothing and sports equipment online, as well as household goods and reservation of accommodation (table 4). if we compared this data with the countries in the eu28 in 2019, we could see roughly the same trends. in the first place was category clothes, sports goods (about 65%), in the second place was travel, holiday accommodation (about 55%), and in the third place was household goods (about 47%) (eurostat, 2020). table 5. number of times people in serbia shopped for private use in the previous 3 months (percentage of individuals) frequency of online shopping in the previous three months 2017 2018 2019 1-2 times 57.7 57 53.2 3-5 times 31.6 27.2 30.6 6-10 times 5.6 10.2 9.4 more than 10 times 5.1 5.6 6.8 source: statistical office of the republic of serbia most individuals purchased online 1-2 times in the last three months (table 5). also, there was an increase in those who bought over ten times. comparing with the data of eu-28 countries we can see that about 34% of respondents bought 3-5 times, about 32% 1-2 times, 17% 6-10 times, and 10% more than ten times in the previous three months. the highest percentage of respondents in the republic of serbia spend less than eur 50 on online shopping. đina ivanović, marija antonijević 35 table 6. money spent by individual on online shopping in the previous three months in the republic of serbia (percentage of individuals) money spent on online shopping 2017 2018 2019 less than eur 50 47.7 55.4 59.7 50 to less than eur 100 25.3 23.4 24.8 100 to less than eur 500 17.2 17.3 12.6 500 to less than eur 1 000 3.2 2.1 0.9 eur 1 000 and more 2.6 0.7 1 i don't know 4 1.2 1 source: statistical office of the republic of serbia therefore, according to the latest available data, about 85% of respondents spend less than eur 100 on online shopping. research methodology data and methods the main aim of this paper is to give an overview of the consumer behaviour on online buying platforms after the appearance of the covid-19 in the republic of serbia. the authors examine the association between purchasing online before and after the appearance of the covid-19, and also the association between gender and purchasing online after the appearance of the covid19 using chi-square test with significance level of 5%. for the purpose of this study, the authors made an online questionnaire and shared with people on social networks: facebook, linkedin, instagram as main methods, and whatsapp and viber as secondary. the facebook profiles (7 profiles) used for sharing this questionnaire, had more than 100 friends and less than 1,000 friends in their network. on the other hand, we also used one facebook group for sharing (precisely "nauka bez cenzure") which had 2,100 members. the authors used one linkedin profile with precisely 938 people in its network. instagram social media has a different strategy for sharing. the basic profiles can not share links through stories or another way, but business profiles and the ones with more than 50,000 followers can. the instagram profile which had been used for sharing the link of the questionnaire (method was through the story with option swipe up) had more than the required number of followers. on the story of this profile, swipe up lasted for 24 hours (maximum time of one instagram story posted). the time chosen for publishing posts was the time which the authors estimated (based on some research) as the most frequently at the day of publishing. the questionnaire consisted of 14 questions. approximate time for filling it up was less than 5 minutes. the questionnaire lasted from 7th april until 4th may. the authors wanted to cover almost beginning of the appearance of the covid-19 in our country, the critical period (peak period) and the ending of it (tail). the questionnaire questions were divided into two sections, i.e. purchasing behaviour before and after the appearance of the covid-19. the first section included three general questions (gender, years and location during covid-19). the section which refers to the period before the appearance of the covid-19 had only three questions (did they buy online before the appearance of the covid-19, how often, and which method of payment they used). in the second section which refers to the period after the appearance of the covid-19, had seven questions (three precisely like in the previous section but with the difference of time – directed after the appearance of the covid-19; and other questions motives for buying online, category of goods or services people bought, how many times people bought, and how much money they spent on online shopping). the only one question (the 36 economic analysis (2020, vol. 53, no. 1, 28-41) reasons for not buying) is directed to ones who did not ever buy online. the questionnaire had as a result of 490 responses. about results in the first stage, the authors checked the responses and validated them. after validation, the number of valid responses was 408. that means 82 responses (16.73%) of the total number were not included in analysis. the rejected responses were mostly from the female who was under 25-34 years. the reasons for the rejections were different. the most common reason was that respondents checked that they did not buy anything in the period after the appearance of the covid-19, but anyhow they answered on the questions directed to only those who bought. the sample consisted of 17.89% male and 82.11% female. the most common location of the respondent was belgrade (67.65%), novi sad (6.62%), niš (2.94%), užice (1.47%), kraljevo, šabac and sremska mitrovica with 1.23%. other cities were below 1%. the authors can conclude that this results which will be shown in the following text, are not nationally representative. the structure of the respondents by age category was shown in figure 7. figure 7. the structure of the respondents by age category source: authors as we can see from figure 7, the highest percentage of respondents belong to the 18-24 age category (39.22%), even though by the results of the hootsuite website in january 2019 in the republic of serbia, mainly social media audience was in the age category of 25-34 (30%). the lowest percentage shown on the figure 7, is in the 65-74 age category (0.74%). table 7. category of goods or services which respondents in serbia bought or ordered over the internet for private use in the period after the appearance of the covid-19 (percentage of respondents) category % clothes, sports goods 49.4 household goods (furniture, toys...) 17.2 travel, holiday accommodation 1.3 electronic equipment 15.3 đina ivanović, marija antonijević 37 category % tickets for events 0.3 books/magazines/newspapers 25.6 telecommunication services 2.9 medicines* 24.4 video games software and upgrade 1.9 films, music 1.9 hardware 1.9 food or groceries 26.9 *pharmaceuticals and hygiene products source: authors' calculation comparing the table 7 with the table 4, the authors can conclude that respondents from the not national representative sample, bought in the higher amount the categories of food (groceries), medicines and books (magazines, newspapers). on the other side, travel, holiday accommodation, and tickets for events had purchasing reduction by respondents. in table 8, the authors represent the main five motives of the respondents for purchasing online after the appearance of the covid-19. table 8. general motives for online purchasing after the appearance of the covid-19 (percentage of the respondents) motives % too many stores are working only online 48.66 reducing health risk 36.09 saving time 31.46 obligation (curfew) 27.82 lower costs 20.86 source: authors' calculation the measures of the government of the republic of serbia had effects on consumer behaviour, so one of the main reasons for purchasing online is that many stores which had been closed (obligation after the government measures) offer their products or services online. table 9 represents motives for only those respondents who did not purchase before the appearance of the covid-19 but purchased after. table 9. top 3 motives of the respondents who did not purchase before the appearance of the covid-19 but purchased after the appearance of the covid-19 (percentage of the respondents) motives % reducing health risk 46.15 too many stores are working only online 46.15 lower costs 15.38 source: authors' calculation comparing table 9 with table 8, obligation (curfew), as a measure of the government of the republic of serbia did not have so much impact on the purchasing behaviour of the respondents who did not purchase before the appearance of the covid-19 but purchased after it. the authors 38 economic analysis (2020, vol. 53, no. 1, 28-41) can conclude that based on both tables, mainly cause for online purchasing is that too many stores are working only online. hence, the percentage is the highest in both tables. for the analysis of the hypothesis, the authors used software spss statistics 25. the chisquare was used for testing the hypothesis as it was previously mentioned. the definitions of them are as follows: h1: it is assumed that there is a significant association between purchasing online before and after the appearance of the covid-19 h2: it is assumed that there is a significant association between the gender and the purchasing online after the appearance of the covid-19 in the following text, the authors explained the results of testing h1 and h2, respectively. h1: it is assumed that there is a significant association between purchasing online before and after the appearance of the covid‐19 figure 8 shows us the consumer behaviour (whether they purchased online or not) after the appearance of the covid-19. figure 8. the consumer behaviour before and after the appearance of covid-19 source: authors as we can see from figure 8, 74.1% of the respondents who not purchased before continued with that habit after the appearance of the covid-19. the results of the chi-square test, which tested the association between purchasing online before and after the appearance of the covid-19 is shown in table 10. table 10. chi-square tests a. 0 cells (0.0%) have expected count less than 5. the minimum expected count is 16.54. b. computed only for a 2x2 table source: authors' calculation 76.0% 24.0% 25.9% 74.1% purchased before not purchased before online purchasing purchased after not purchased after value df asymptotic significance (2‐sided) exact sig. (2‐sided) exact sig. (1‐sided) pearson chi‐square 55.257a 1 .000 continuity correctionb 52.927 1 .000 likelihood ratio 50.730 1 .000 fisher's exact test .000 .000 linear-by-linear association 55.122 1 .000 n of valid cases 408 đina ivanović, marija antonijević 39 the p-value (p=0.000) is lower than the alpha (α=0.05), so the authors reject the null hypothesis there is a significant association between the purchasing before and the purchasing after the appearance of the covid‐19. h2: it is assumed that there is a significant association between the gender and the purchasing online after the appearance of the covid‐19 figure 9 shows us consumer behaviour (by gender) before and after the appearance of the covid-19. figure 9. the consumer behaviour (by gender) before and after the appearance of covid-19 source: authors as we can see from figure 9, 68.5% male respondents and 69.6% female respondents, purchased after the appearance of the covid-19. the results of the chi-square test, which tested the association between gender and purchasing online after the appearance of the covid-19 is shown in table 11. table 11. chi-square tests value df asymptotic significance (2‐sided) exact sig. (2‐sided) exact sig. (1‐sided) pearson chi‐square .032a 1 .859 continuity correctionb .001 1 .970 likelihood ratio .032 1 .859 fisher's exact test .889 .480 linear-by-linear association .032 1 .859 n of valid cases 408 a. 0 cells (0.0%) have expected count less than 5. the minimum expected count is 22.37 b. computed only for a 2x2 table source: authors' calculation the p-value (p=0.859) is higher than the alpha (α=0.05), so the authors remain null hypothesis there is no significant association between the gender and the purchasing after the appearance of the covid‐19. 69.6% 68.5% 30.4% 31.5% female male did you purchased online? yes no 40 economic analysis (2020, vol. 53, no. 1, 28-41) conclusion results of this study revealed that there is a significant association between the purchasing online before and after the appearance of the covid-19. the percentage of respondents in the republic of serbia, who did not purchase online before the appearance of the covid-19, but purchased after, was 24%. the percentage of respondents who purchased online before and after the appearance of the covid-19 was 76%. also, the authors conclude that there is no significant association between gender and the decision to purchase after the appearance of the covid-19. precisely, 68.5% of male respondents and 69.6% of female respondents were purchasing online after the appearance of the covid-19. the three main motives for online shopping were that too many stores are working only online, reducing health risk and saving time. for those who did not purchase online before the appearance of the covid-19, but purchased after, the first two motives for purchasing online, are the same as previously mentioned. the difference is the third, which were lower costs. most respondents purchased online the following category: food (groceries), medicines and books (magazines, newspapers). the respondents who did not purchase online before the appearance of the covid-19, but purchased after, bought mostly clothing and sports goods and household goods, secondly food and books, magazines, newspapers. in further research papers, the authors will analyse whether the customer behaviour change in the meantime and will mitigation measures have a significant impact on the population. one of the main factors in the future analysis will be consequences of the mitigation measures of the government of the republic of serbia precisely, 100 eur to each adult who signs for it. acknowledgements this paper is supported by the ministry of science and technological development of the republic of serbia. references chen, z. and dubinsky, a. 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"electronic word of mouth: motives for and consequences of reading customer articulations on the internet". international journal of electronic commerce. 4. pp. 51-74. hootsuite (2019). social media audience. https://hootsuite.com/ jung, h., park, m., hong, k. and hyun, e. (2016). "the impact of an epidemic outbreak on consumer expenditures: an empirical assessment for mers korea". sustainability. 8. p. 454. kumar, v. & dange, u. (2012). "a study of factors affecting online buying behavior: a conceptual model". ssrn electronic journal. li, n. and zhang, p. (2002). "consumer online shopping attitudes and behavior: an assessment of research". electronic commerce customer relationship management. pp. 508-517 đina ivanović, marija antonijević 41 lohse, g.l. and spiller, p. (1998) "electronic shopping". communications of the acm. 41. pp. 8187. merriam webster. (2020). https://www.merriam-webster.com/ ministry of health of the republic of serbia covid‐19. https://covid19.rs/homepageenglish/ norjihan a.g. and zailani m. s. (2009). "personal information privacy protection in ecommerce". wseas transactions on information science and applications. 3. pp. 407-416. singh, j., sirdeshmukh, d. (2000). "agency and trust mechanisms in consumer satisfaction and loyalty judgments". journal of the academy of marketing science. 28. pp. 150–167. statistical office of the republic of serbia (2020). https://www.stat.gov.rs/en-us/ statistics of covid‐19 in the republic of serbia (2020) https://covid19.data.gov.rs us department of commerce (1999). https://www.commerce.gov/ vasic n., kilibarda m. and kaurin t. (2019) "the influence of online shopping determinants on customer satisfaction in the serbian market". journal of theoretical and applied electronic commerce research. 14(2). pp. 70-89 world health organization (2020). https://www.who.int/ article history: received: may 20, 2020 accepted: june 4, 2020 cip каталогизација у публикацији народна библиотека србије, београд 33 economic analysis / editor-in-chief ivan stošić. vol. [42], no. 1 (2009) . belgrade : institute of economic sciences, 2009 (belgrade : donat graf). 29 cm polugodišnje. je nastavak: economic analysis and workers' management = issn 0351-286x. – drugo izdanje na drugom medijumu: economic analysis (belgrade. online) = issn 2560-3949 issn 1821-2573 = economic analysis (belgrade) cobiss.sr-id 169576460 2013_1_2 professional paper operational risk – challenges for banking industry knežević marija1, procredit bank, belgrade, serbia udc: 005.334:336.71 jel: g32 id: 198578188 abstract – operational risk covers wide range of events that either produce no effect on financial result of the institution or can strongly harm it. although it is present in the banking activity from its origins, industry interest increases during last decades of xx century. basel ii gave significant incentives in managing operational risk processes in banks all over the world. new, basel iii regulation imposes improvement in operational risk management indirectly, through guidelines for better management of liquidity and credit risk, thus emphasizing the importance of the most intangible factors of operational risk – internal factor contained in inadequate processes and procedures. in serbian banking system the most important contribution of basel standard implementation was raising awareness of the presence of this kind of risk, although it is still in the initial phase. high impact on the operational risk drivers has macroeconomic environment, banking system structure and client type that are offered financial support. having in mind that banks offers in serbia are primarily oriented toward retail clients, it is not surprising that the most important factor of operational risk, regarding number of risk events, are human errors with 54% in total. however, majority of financial losses are derived from clients’ frauds, more than 70%. in this paper, author indicates the most important factors and events of operational risk that are present in retail banks in serbia and their sources as a key element in mitigating their negative effects in the future. key words: operational risk, basel regulation, banking sector, operational risk factors, operational risk events, internal processes, frauds, human errors. introduction among numerous financial risks that are inherent to the banking activity, special place belongs to operational risk. its uniqueness comes not only from the fact that it follows every banking transaction from the beginning to the end, but also due to its fluid form and interconnections with other risks. it is quite often hard to make distinction between credit or market risk and operational risk on the other hand. however, industry interest in this matter emerged after several big losses that occurred in the late years of xx century. most of these cases were originated by internal frauds or inadequate process and procedures which encouraged employees to involve in activities that exposed banks to higher risk in order to achieve personal gains. one of the latest operational risk events is certainly libor fraud case that was discovered in the summer 2012 which could be also treated as the biggest scandal in banking industry! banks, that are members of the committee in charge of determination libor (one of the most important interest rates in finance) on a daily basis, reported 1 marijaknezevic@yahoo.com knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 41 incorrect data on interest rates they offer money to each other in order to present their financial situation more healthier, especially in period of crisis. these fraud activities of banks lasted six years with senior management involvement. having in mind worth of loans and contracts linked to libor, it is estimated that clients around the world were damaged with 1.5 trillion usd! after revealing scandal, crime investigations were opened and are still in progress. up to now, barclay bank was fined with 450 million usd, and swiss based ubs bank with 1.5 billion usd for manipulating with libor. recognizing importance of operational risk for modern banking, basel committee for banking supervision (through basel ii and iii), gave significant incentives in managing operational risk processes in banks all over the world. in serbia the most important contribution of basel standard implementation was raising awareness of the presence of this kind of risk, although it is still in the initial phase. operational risk management is still in initial phase and the purpose of the paper is to identify the main drivers of operational risk that domestic banks are faced with. the paper is organized as follows: the first section gives general characteristics of operational risk, section 2 analyze the most important and potential factors of operational risk in serbia, and section 3 concludes. main characteristics of operational risk definitions of operational risk goes from the broadest that describe it as all risks that are not originated by market or credit risk to the most used basel ii definition. according to it, operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. this definition includes legal risk, but excludes strategic and reputational risk (basel committee on banking supervision, 2006). by this, all major drivers of operational risk are covered. people (human factor) can produce operational risk events through unintentional errors during work, criminal activities, insufficient training or number of employees, and bad management. external events, as a source of operational risk, comprise numerous events that result in physical damages on the bank property such as natural disasters (earthquakes, floods, volcanoes etc.) or catastrophes like wars, robberies or losses incurred by third parties. risk events that are connected with it system are relatively easy to detect although they vary from hardware malfunctioning to abuses of databases. the most difficult to identify and detect are potential operational risks embodied into internal processes and procedures. unlike other mentioned major operational risk drivers, weaknesses of internal processes are still in a way ignored. all improvements in managing operational risk are mostly connected with countable and easily detected events. internal processes weaknesses are less noticeable and strong commitment and willingness of management is required to recognize them and later on to solve. special challenge regarding this type of risk driver is to recognize weaknesses that results from moral hazard problem and some authors propose changes in definition of operational risk in order to include it as integral part (savic ana, 2012, 18). moral hazard is the consequence of existing information asymmetry on the financial markets. it occurs when the lender is subjected to the hazard in which the borrower has an incentive to engage in activities that are undesirable (immoral) from the lender's point of view, that is, activities that make it less likely that the loan will be repaid (mishkin frederic s. 2006). special type of moral hazard risk is principal agent problem which occurs because managers (agents) have more information about investments than principals economic analysis (2013, vol. 46, no. 1-2, 40-52) 42 (owners) so they could have incentives to engage in activities that are not desirable for owners and expose the firm to the higher risk in order to make more profit and personal gains through bonuses for example. there are large number of examples how moral hazard can produce operational risk losses. financial crisis that hit the world in 2008 is the most viable example of that. managers greed for bonuses and profits in large banks that faced biggest problems, led to enormous losses. above mentioned libor scandal also could be regarded as risk event that are coming from moral hazard. still, the question remains would it be possible and feasible for banking management to recognize and admit it. moral hazard, as a source of operational risk is not inherent only to internal processes but it is also source of the risk in events derived from people or externally. for managing operational risk of crucial importance is the fact that risk events originated by people, inadequate internal processes or it system are controllable because they occur within the bank, whereas those coming from external events are not. that is why it is hard to find appropriate strategy to mitigate them. main characteristic of operational risk losses and events is that their frequency and severity are disproportional, which means that events that bear high, severe loss occur very rarely in the life cycle of the bank. in contrast, events that occur with high frequency usually do not produce big losses. these two dimensions of the risk – frequency and severity are key elements that influence its treatment and produce problems for bank management because it is difficult to translate them into risk projections. due to that, loss distribution curve is specific, i.e. it has fat tails, indicating that frequency of high severe risk events is small. figure 1. loss distribution of operational loss events source: osterreichische nationalbank (2006:14) knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 43 for events that occur quite often it is possible to calculate and project potential loss, which is then treated as expected loss and some loss reserves could be formed. on the other hand, unexpected losses refer to events that could not be anticipated as they did not occur within bank in respective period of time, so bank is supposed to have enough capital to cover them. in case of occurring events that produce catastrophic loses it is possible that bank could not survive them. depending on the combination of loss frequency and severity, bank opts for one of the strategies to manage the risk. in case of low frequency, low severity events, banks would usually choose to bear the risk; dealing with high frequency low severity risks assumes proactive risk management actions in order to mitigate its consequence; in contrast, negative effect of low frequency, high severity risks could be mitigated using insurance plans. figure 2. matrix on operational risk management as a function of imact potential and frequency of the related events source: osterreichische nationalbank (2006:15) however, there could not be unique strategies applicable to all banks as operational risk is bank specific, which requires understanding of main drivers that create operational risk profiles. undoubtedly, operational risk is present in all products and services that banks offer, in all internal processes and it could be caused by all employees within bank. in contrast to other business risks, bank is exposed to operational risk in every moment and in every phase of any process from its beginning to its end. that is why operational risk area is broader than area of other business risks. main differences from credit and market risk are: • majority of losses are specific for the certain bank; • higher risk exposure do not assume higher profit but conversely; economic analysis (2013, vol. 46, no. 1-2, 40-52) 44 • exposure to operational risk do not depend on value and volume of transactions or bank portfolio which makes diversification poor technique for risk mitigation; • development of sophisticated hedging instruments for credit and market risk contributed to higher exposure to operational risk; • operational risk exposure are immanent not only to banks but as well to other market participants; • measurement and managing techniques for operational risk are less developed than for credit and market risk. multidimensional nature of operational risk emphasizes necessity of constant improvements risk management techniques because it allows: • early detection of potential problems before their escalation. in that way, it is possible not only to lower loss, but also, to save resources that could be redirected on business volume increase; • enhance quality of capital allocation; • more efficient strategic decision making process because management of the bank is informed about business segment that bear the highest risk; • higher profitability and stability of doing business. recognizing importance of operational risk for modern banking and financial systems, basel committee included in basel ii capital accord capital charge for it. basel ii gave strong contribution for improving risk management function – primarily by standardization of definition, proposing guidelines for loss data collection, introducing methods for calculating minimum capital. new, basel iii regulation imposes improvement in operational risk management indirectly, through guidelines for better management of liquidity and credit risk, thus emphasizing the importance of the most intangible factors of operational risk – internal factor contained in inadequate processes and procedures. after escalation of financial crisis in 2008, it turned out that one of the most important sources of turmoil was insufficient liquidity for covering systemic risk derived from extreme credit losses. capital level in banks that suffered the most was not enough to absorb all potential losses which indicated that risk management process in most of the banks was inadequate (basel committee on banking supervision. 2009). that is why all changes that are implemented in basel iii could be regarded as an attempt to improve internal processes (which are one of the sources of operational risk) that consequently leads to the enhancement in operational risk management. it stresses importance of enhancement risk management function within banks with more active involvement of senior management. by changes in credit risk weights used in internal models and introduction of minimum standards for adequate liquidity level through two new ratios, liquidity coverage ratio and net stable funding ratio, once again failures in internal processes before crisis are confirmed. implementation of new standard should result in lowering operational risk. main drivers of operational risk in serbia management of operational risk in serbia is relatively new discipline. first time it was defined by law on banks in 2006, when banks were obliged to form data bases for collecting operational risk events. that was the first step in the process of basel ii implementation. it knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 45 was the regulation that gave the most important contribution for raising awareness of the importance of managing operational risk. basel ii implementation in 2012 resulted in numerous benefits for the whole banking sector. the most important of them are: • standardization of the operational risk definition; • standardization of risk events and losses collection on banking system level; • development of monitoring system; • development of operational risk management process within banks; • basis for implementation of complex quantitative techniques for managing operational risk. still, the process of managing operational risk is in initial phase and there is a lot of work to do in the future in its improvement. analyzing operational risk drivers in serbia assumes that macroeconomic situation and overall business climate should be taken into account as they impose most common risk events. higher level of corruption, weak legal system, and high unemployment rate positively contributes to realization of some risk event such as clients’ frauds and forgeries. that indicates that most of threats for the banks are coming from external events. period of pre-crisis expansion in serbian banking system (from 2001 to 2008) additionally exposed banks to new operational risk threats. multiple increases of placements and assets, development of new products, rise in employees’ number and organizational units accompanied with mergers and acquisitions was faster than improvement and adjustment of working process and procedures. prevailing operational risk events strongly depend on dominant client structure of the bank that on the other hand influences organizational structure, corporate culture and working processes of the institution. majority clients in the banking system in serbia are retail customers – households, private individuals, entrepreneurs and small businesses. according to the data of association of serbian banks, 97% of total clients within sector as of the end of 2012 are retail clients. having in mind that banks are the most important participants on the financial market, operational risk losses either realized or potential can strongly harm the whole system. in the next section key factors of operational risk in retail business is discussed. key factors of operational risk inherent to retail banking offering financial services to retail clients differs from orientation on large corporate clients or investment banking. specifics are following: • labor intensive business model which is demanded by large number of clients that proceeds transactions of relatively small amounts; • high level of decentralized decision making process; • higher operational expenses (personnel and administrative) per product unit; • large outstanding number of loans and active accounts; • widespread branch network and • higher level of loan portfolio diversification. every working process in retail segment is labor intensive, especially in loan activity. credit analyses rely not only on official financial data of the client, but also on soft economic analysis (2013, vol. 46, no. 1-2, 40-52) 46 information that clients confine to loan officers. that, on the other hand, requires adequate number of employees and branch network to serve all potential clients and build up strong relations with clients which at the end results in wide range of threats and challenges from operational risk stand point from all defined sources – people, processes and external events. people as a source of operational risk retail banks on average have more employees than large corporate banks. main characteristics of operational risk events that are driven from employees’ behaviour or their work in retail banking are following: • higher possibility of unintentional errors caused by overtime or tiredness due to the large number of everyday transactions, in order to serve large number of clients, during the period of expansion, accompanied with growing number of employees, risk of insufficient training of employees and consequently higher percentage of accidental errors increases. according to the proposed basel ii matrix, which is adopted by national bank of serbia, this type of risk event would be categorized as execution, delivery & process management, within business line retail banking, originated by human factor. • inadequate level of control large amount of transactions as it requires high expenses, which can open a room for internal frauds, but also for unintentional errors or failure to meet a professional obligation. • internal thefts and frauds due to high level of decentralization in decision making process which is in high correlation with moral hazard risk. business model and working process with this specific client segment basing credit analyses sometimes on informal income sources, lack of verified documentation, but also insufficient control of employees from higher management contribute to higher risk. financial reports of retail business are not audited so it is easier for responsible employees to forge them. this could be also treated as moral hazard problem. it would be ‘higher’ if there is a bonus system based on individual productivity of employees and achieved performances of their organizational unit. in order to mitigate this risk, empirical data shows that banks usually implement following: • determination of time intervals when number of orders reaches peaks; • determination of adequate number of employees for execution volume of transactions; • procedure implementation control; • individual productivity control; • promoting e-banking transactions. one of the methods for mitigation risk of internal frauds is more strict internal controls which have benefits both for detecting internal as well as external frauds and forgeries from clients. it includes checking of credit documentation, client visits and rechecking their financial performances. moral hazard problem from the agency problem point of view could be partially mitigated through long-term promises and bonus systems for employees that during career knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 47 achieve required results. these suppose that employees within banks should anticipate some kind of long-term commitment with shareholders and the bank (myerson roger, 2012). since long-term bonuses and fringe benefits expectations are of crucial importance for motivation and behaviour in line with shareholders interest, investors’ ability to trust them depends on long-term profit expectations. internal processes as a source of operational risk it goes without saying that the most difficult driver of operational risk lies in internal processes and procedures. operational risk inherent to internal processes and procedures is hard to distinguish from the risks that result from people because they actually create them! failures and omissions in processes could be unintentional due to misunderstanding of process essence or intentional with the aim of acquiring more profit by exposing institution to higher risks which is the result of moral hazard. in retail banking, the most important potential factors of operational risk from inadequate or failed internal processes are: • overlapping of responsibilities and fails within processes. labor intensive business model assumes waste number of processes. if they are not set in adequate manner, overlapping of responsibilities or duties can occur which leads to inefficiency and omissions during work. • apart from unintentional failures, procedures can contain those that allow acquiring personal gains or expose bank to higher than accepted risk in order to achieve higher profit. these kinds of fails are more likely to exist if management bonus system is directly dependent on achieved profit in certain period of time. here, we have moral hazard risk, in the form of principal agent problem. • if procedures do not cover all aspects of the process, there is a possibility of breaches the responsibilities. the biggest threat in internal processes comes from moral hazard problem, but still it is not identified in that manner. apart from these, internal processes inadequateness could be present in other processes. systems of internal and external control are the first measure in mitigating risk inherent in bank processes. contribution to it comes also from: • regular monitoring of bank management by shareholders, and monitoring of decentralized organizational structures from top management; • applying restrictive covenants. by this measure investors can define areas and projects that are prohibited for financing; set rules and conditions for loans disbursements, determine acceptable ratios of liquidity, solvency and loan portfolio quality. it is important that proscribed covenants do not include shortterm profitability requirements, but the ones that support long-term sustainable stable business results of the institution. profitability indicators directly support moral hazard problem. faced with high profit targets, managers could be more prone to more risky activities in order to achieve personal gains. • existence of independent operational risk unit within the bank is of crucial importance for identifying these kinds of risks. process of risk identification economic analysis (2013, vol. 46, no. 1-2, 40-52) 48 should be more concentrated on analyzing these hidden risks instead of countable high frequency, low severity risk events. external events as a factor of operational risk external factors, as a source of operational risk are not under bank control. if we exclude catastrophic and events that cause physical damage on bank assets, in retail banking higher exposure to operational risk comes from: • higher possibilities of clients’ frauds and forgeries. in the working environment characterized by high level of corruption, it is easier to forge documentation on clients’ financial results as well as issuance of false certificates on their property. • in entrepreneurial segment, moral hazard problem is more present in comparison to large enterprises. at the same time, entrepreneurs are managers and owners and entrepreneurial personal income is directly dependent on company’s income. that is why there is a higher risk that entrepreneur would misuse borrowed funds from the bank and invest them in more risky ventures in order to maximize own fortune. • furthermore, entrepreneur tendency to misuse borrowed funds in order to increase own fortune is directly dependent on the companies financing choices [wu yan, 2008] and it is higher within those that finance their activity primarily using banking loans i.e. in finance structure have higher share of debt. entrepreneurs follow the well-known economic principle that marginal benefits of effort should equal its marginal cost. higher debt share in finance structure assumes lower marginal benefit of invested effort of the entrepreneur. that is why their motivation for further efforts is reduced and they are more prone either to misuse borrowed funds which mean that higher indebtedness increases moral hazard risk that on the other hand exposes bank to higher risk. in this case moral hazard problem is negatively correlated with chosen financing model. in serbia, most of entrepreneurs are financing their activity through banking loans. that is why this issue is important to risk management within banks. however, these risk factors are not under bank control. in order to mitigate these risks possible solutions could be: • more strict control of used funds including visits to clients; • applying reporting covenants that oblige clients to report banks on used funds on regular basis; • applying restrictive covenants in case clients misuse borrowed funds for purposes other than agreed with the bank; • applying contract clauses that preserve value of collateral during the life time of the loan. in serbia, for example, mortgage value is reestimated and adjusted to market conditions every 3 years. beside that, majority of banks require collateral insurance during life time of the loan, which is additional security in case client do not repay the loan. all these measures increase operational costs of the banks and consequently interest rates that clients pay, so again there is a tradeoff between risk and profit. in the first two years of basel ii implementation and reporting on operational risk events, as it was expected in the beginning of the process, research on operational risk events has knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 49 shown that risk events are mainly driven by human factor (people) as 54% of total number of events is originated from it (knezevic marija, 2010, p. 101). the most common type of risk event is unintentional errors caused by overwork and tiredness. on the other hand, only 16% of total losses are derived from this source. among business lines, payments and settlement line is the most exposed to negative effects of operational risk. in this line, 91% of risk events and 20% of realized losses are caused by unintentional errors. typical risk event is wrong data entry in processing client transactions. these events usually do not result in loss because it is possible to recover payment order, which explains disproportion between number of events and losses volume. that is the example of risk event with high frequency and low severity. moreover, it is countable and easily recognized, so it could be additional reason of domination in first phases of data collection. in contrast to number of risk events, majority of realized and potential losses are coming from external factor – 81% of total and 43% of total risk events! out of that, external frauds contribute with 70%. business line retail banking is the line that is under strongest negative effect of external factor and generally operational risk. figure 3. operational risk events and losses within retail banking business line source: data taken from (knezevic 2010) in this line, 91% of all losses and 49% of all risk events have occurred. majority of them (72%) are coming from external events, that is from frauds. thefts and frauds form clients in most cases are realized through forged documentation on their financial results in loan approval process. common types of false documentation are economic analysis (2013, vol. 46, no. 1-2, 40-52) 50 forged data on overestimated values on mortgages, false documentation on financial result of clients or false income statements. usually, risk event is discovered after certain period of time when client stop to repay loan instalments. time lag between date of risk events and time of discovery vary between few months to several years, which make estimation of potential losses and application of sophisticated quantitative methods very hard and complex. these types of events reflect the real nature of operational risk events – that risk events cause financial effect with time lag, do not have regular intervals and that financial loss could be severe. in retail banking there could be a lot of such cases with individually low amounts of loss. although it can harm single institution it is not likely that it would in short period transfer the loss on the whole banking system. problem for the sector arises when big clients with significant amount of debt at few banks commit such a fraud. in the worst case scenario this could lead to bank bankruptcy. recently, several loss cases caused by clients’ frauds were released with significant amounts of losses. we will mention some of them: group of clients, through ownership in related companies, from 2007 to 2012, have committed series of frauds and forgeries by which hypo bank experienced loss of 15 million chfs. during 2007, based on forged documentation on estimated value of collaterals, they received a loan for the purpose of privatization state companies. after privatization, through mutual trading and decreasing share values of privatized companies, indebted companies bankrupt. hypo bank couldn't recover lended funds and crime investigations against suspected is still in process. the most striking operational risk event in last decade that occurred in serbia is for sure case of agrobanka, that bankrupt in 2012, with the loss of almost 300 million eur. to its end led several events starting from forged documentation on mortgages and other collaterals, misusing of funds, weak procedures and internal controls, to the involvement of senior management in fraud activities in order to acquire personal gains (moral hazard). investigations regarding these fraud cases are still in process. this event sharply unsettled financial market, but still it is the question whether it was recognized as a pure operational risk event that could be realized in any other institution. conclusion in modern banking, operational risk remains one of the biggest challenges that whole industry is facing with, although it does not receive deserved attention. banks are more concerned with rising credit risk caused with still present illiquidity in the system and unsettled market conditions characterized by high inflation, gdp growth stagnation, rising unemployment and sharp exchange rate fluctuations. it is sometimes hard to distinguish risk factors deriving from credit and operational risk as they are interconnected and that is why some risk events wrongly treated. management of operational risk is focused on easily countable and controllable, usually high frequency – low severity risk events and their sources (for example number of unintentional errors). resources are directed to satisfy regulatory requirements – to collect risk events data and determine minimum capital. regulation do have positive impact on improving risk management functions within banks, but itself is not enough to assure stable knežević, m., operational risk, ea (2013, vol. 46, no. 1-2, 40-52) 51 and sound banking system as it cannot substitute importance of proactive risk management in the process of risk mitigation. for the time being, the highest threats are coming from external events that are not controllable. however, single institutions cannot do much in mitigating these risks. in order to mitigate them, joint actions of all participants in the market are needed. one of the possible solutions could be exchange of risk events data between banks within the same system and forming so called black lists of clients. as banks are not reluctant to share in house information, of key importance is the role of regulator that could be kind of intermediary, at least in first phases. the key question in front of banks managers is how to deal with operational risk in the future and how to recognize it among numerous risk events that occur every day? how to put stress on the most important ones hidden in the procedures and processes and motivated by moral hazard? first of all, it is imperative to admit and accept the fact that operational risk is one of the most important risks that institutions are facing with, not the residual. then, redirect resources from countable, controllable and high frequency low severity losses on more sophisticated risk events. enhancing internal models of risk management and independent risk units remain of crucial significance. references basel committee on banking supervision. 2006. “international convergence on capital measurement and capital standards (a revised framework, comprehensive version)“. http://www.bis.org/publ/bcbs128.pdf (accessed march 15, 2013). basel committee on banking supervision. 2009. “strengthening the resilience of the banking sector”. www.bis.org/publ/bcbs164.pdf (accessed march 30, 2013) knezevic, marija. 2010. “operational risk in microfinance institutions”, master thesis. belgrade university mishkin, frederic s. 2006. monetarna ekonomija, bankarstvo i finansijska tržišta. novi sad: data status. myerson, roger b. 2012. “a model of moral-hazard credit cycles”. http://home.uchicago.edu/~rmyerson/research/bankers.pdf (accessed march 30, 2013 ). osterreichische nationalbank. 2006. “guidelines on operational risk management”. www.oenb.at/en/img/operational_risk_screen_tcm16-49652.pdf (accessed march 30, 2013). savic, ana. 2012. opeartivni rizici u bankama. beograd: zadužbina andrejević. wu, yan. 2008. “capital structure and moral hazard within entrepreneurial firms”. citeseerx.ist.psu.edu/viewdoc/summary?doi=10.1.1.192.6708 (accessed march 30, 2013). economic analysis (2013, vol. 46, no. 1-2, 40-52) 52 operativni rizik izazovi za bankarski sektor rezime – operativni rizik pokriva širok spektar događaja koji, ili ne daje nikakave efekte na finansijski rezultat, ili može jako da naškodi finansijskoj instituciji. iako je prisutan u aktivnosti banaka od samog početka, interesovanje bankarskog sektora za operativni rizik je poraslo tek poslednjih decenija xx veka. bazel 2 je dao značajne podsticaje u procesima upravljanja operativnim rizikom u bankama širom sveta. bazel 3 uvodi napredak u indirektnom upravljanju operativnim rizikom, kroz smernice za bolje upravljanje likvidnošću i kreditnim rizikom, čime naglašava značaj najvažnijih faktora operativnog rizika interni faktor u okviru neadekvatnih pocesa i procedura. u bankarskom sistemu srbije najveći doprinos implementaciji bazelskih standarda je imalo podizanje svesti o prisustvu ove vrste rizika, iako je još uvek u početnoj fazi. najveći uticaj na faktore rizika imaju makroekonomsko okruženje, struktura bankarskog sistema i vrsta klijenata kojima se pruža finansijska podrška. imajući u vidu da su banke u srbiji uglavnom orijentisane na sektor stanovništva, ne čudi da je najbitniji faktor operativnog rizika, uzimajući u obzir broj rizičnih događaja, ljudska greška sa 54%. takođe, većina finansijskih gubitka su izazvani zbog prevara klijenata, više od 70%. u ovom radu autor ukazuje na najvažnije faktore i događaje operativnog rizika koji su prisutni u poslovima sa stanovništvom u srbiji, kao i njihovih izvora kao ključnih elemenata u ublažavanju negativnih efekata u budućnosti. ključne reči: operativni rizik, bazelska regulativa, bankarski sektor, faktori operativnog rizika, događaji operativnog rizika, unutrašnji procesi, prevare, ljudski greske article history: received: 31 march 2013 accepted: 20 may 2013 ea_2012_1_2 professional paper pest analysis of serbia* stošić ivan **, institute of economic sciences, belgrade, serbia nikolić draško, institute of economic sciences, belgrade, serbia zdravković aleksandar, institute of economic sciences, belgrade, serbia udc: 005.33 (497.11) jel: m11 abstract – the main purpose of this paper is to examine the impact of the current serbian macro-environment on the businesses through the implementation of pest analysis as a framework for assessing general or macro environment in which companies are operating. the authors argue the elements in presented pest analysis indicate that the current macro-environment is characterized by the dominance of threats and weaknesses with few opportunities and strengths. consequently, there is a strong need for faster implementation of structural changes in order to eliminate or minimize the impact of weaknesses and threats of the current macro-environment and create more favorable business climate that would enable companies to formulate effective strategies and to raise their business performances. key words: pest analysis, serbia, business climate, macro-environment, strategic management, enterprises introduction the main purpose of this paper is to examine the impact of the current serbian macroenvironment on the businesses entities. the paper aims to: a) indicate the importance of monitoring the macro-environment in the modern world, b) present the concept of pest analysis as one of the key instruments for monitoring the trends in the macro-environment; c) analyze actual trends in key segments of the macro-environment of serbia and d) identify the impact of macro-environment factors on the business performances of the serbian enterprises. operations of business entities are not done in a vacuum, but in the constellation of many factors, which directly or indirectly, more or less influence the efficiency of the companies. without taking into account the impact of relevant environmental factors, it is not possible to formulate an adequate strategy or to conduct profitable business. so, in order to be * this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of education and sciences of the republic of serbia. ** zmaj jovina 12, belgrade, serbia; ivan.stosic@ien.bg.ac.rs economic analysis (2012, vol. 45, no. 1-2, 59-73) 60 successful, the company and its management has to take into consideration what is happening in the environment to examine the opportunities and threats and to respond to the changes, all leading to formulation of adequate strategy for taking advantage of opportunities and minimize threats in the environment. the environment can be classified in different ways, but most often the division is made based on quality of effects: the positive (a lot of chances, a little threats, relatively easily predictable, without a lot of norms with limiting character) and negative (a lot of danger, full of threats, unpredictable, with lots of restrictive norms); dynamics: a stable and predictable with small changes, dynamic with large and predictable changes and turbulent with large and unpredictable changes; and possibility of control and the degree of influence of the environment: external (macro and industry) and internal (todorović, j. 2003). regarding business activities of enterprises, it is important to monitor changes occurring in the macro-environment, having in mind that those factors of the environment significantly affect the quality of the business performances. the intensive changes of business conditions are an important characteristic of the modern world. the best evidence supporting this statement is the world economic crisis and the changes that it has brought this in terms of business performances of individual countries. examples of countries considered successful until recently (ireland, iceland, maybe tomorrow some other country) are facing the huge crisis that has negative and in some cases devastating effects on businesses of corporations. in such circumstances, with increasing speed and volume of changes, which are especially characteristic for recent years, the need to conduct an external analysis, including analysis of the macro-environment, in contemporary terms becomes increasingly important and has greater influence. having this in mind the basic objective of this paper is to examine the impact of general economic environment to the business entities in serbia through the implementation of pest analysis literature review and methodology the conceptual framework of pest analysis is used as the primary method for identifying the influence of the macro-environment on the strategic and operational management processes of economic entities. namely, pest analysis is a useful tool for understanding changes in the market, the business situation and defining the potential and direction of future activities (kotler, p. 1998). pest analysis is a common conceptual framework for analyzing the macro-environment (pest-acronym: political, economic, socio-cultural, technological): • p political and institutional environment • e economic environment • s socio-cultural environment • t technological environment stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 61 figure 1. scheme of pest analysis concept source: envisioning strategy, http://marketsmart.co.nz/?page_id=117 there are also numerous extended variants of the pest analysis, such as pestel, or pestle, which include as a separate element an analysis of the legal (legal) and environmental (ecological) as a separate element or steepled, indicating that even demographic environment should be analyzed in particular (byars, l. 1991; cooper, l. 2000; coutler, m. 2010). consideration of p political and institutional environment implies primarily analysis of the impact of political and legal parameters, and especially some specific laws and regulations governing certain activities (e.g. environmental protection, consumer protection, antitrust law, labor law, etc.). also, the analysis of political and institutional environment implies certain perceived political changes (the stability of government, elections, political trends, etc.) that can have a powerful impact on business activities (thompson, j. 2002). consideration of e economical environment includes analysis and forecasts of basic macroeconomic indicators and parameters (economic trends, taxes and tax administration, exchange rates, interest rates, trends in employment and unemployment rates, etc.), as well as changes in business conditions and economic policy which can have very direct influence on business conditions and economic performance. s socio-cultural environment involves understanding, analysis and forecast of basic socio-cultural indicators, such as customs, beliefs, attitudes, culture, lifestyle, etc. also, analysis of the social environment includes an analysis of key demographic indicators, which are of strategic importance (population, age and gender structure of population, qualifications structure, geographic dispersion of population, income levels and distribution of income, other demographic indicators). t technology segment involves understanding, analyzing and forecasting the main technological parameters, primarily the development and implementation of new manufacturing technologies, new information technologies, new materials, obsolete technology, technology transfers, etc. economic analysis (2012, vol. 45, no. 1-2, 59-73) 62 the macro-environment of various countries and industries has been extensively analyzed based on the pest analysis concepts. starting from the author experience in the analysis of the economic environment in serbia (stošić et. al. 2009), and based on earlier research conducted on specific elements of the macro-environment (stošić, i. 2007), the paper attempts to point out to the key problems of the current business climate and its effects on conducting the business and implementation of structural changes in serbia. starting from the mentioned conceptual framework for the implementation of pest analysis, and limiting to key elements and characteristics of the macro-environment, current pest analysis of serbia is presented below. results and discussion p political and institutional environment – during previous period, starting from 2001, serbia has become a member of all key international organizations: un, osce, imf, world bank, ebrd, council of europe, cefta and the partnership for peace program of nato. in april 2008 the stabilization and association agreement (saa) between serbia and the european union (eu) was signed. in early 2010 serbia had submitted a formal request candidacy for eu membership and had actively worked towards meeting the action plan to accelerate the gaining of candidate status. in march 2012 serbia was finally granted candidate status for eu membership. however, despite great progress, the existing political and institutional environment can not be considered stable enough and propulsive. in particular, from late 2000, intensive transition process characterized by the adoption of numerous new laws and establishment of a large number of new institutions (agencies, independent regulatory bodies, etc.) has started in serbia. only in the last four years, the national assembly of serbia adopted nearly 1,000 legal acts, including numerous laws. comprehensive reform of the legislation affected the "anatomy and physiology" of the business in serbia. changes in this area were numerous and great, but unfortunately, often incomplete, since the adoption of new laws was not accompanied by the adoption of a number of secondary regulations, which would allow the operationalization and implementation of new legislation. also, current trends are strongly influenced by political factors related to the upcoming elections, the pace of eu accession and the eventual determination of the starting date for negotiations with the eu. serbia is also significantly burdened with the problems relating to the status of kosovo and metohija. for successful operation of business entities the existence of a stable, not too prohibitive political and institutional environment is crucial. unfortunately, everything mentioned above indicates that the impact of the current political and institutional environment on the management of strategic and operational management, despite significant progress, is not too favorable primarily due to a number of changes, ambiguities of political reforms and present risks. e – economic environment – serbian economy in the period 2001–2008 was characterized by dynamic growth of gross domestic product (gdp) with annual average rate 5.4%, which is mostly driven by growth of so-called tertiary sector (services), followed by increase in stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 63 international exchange and internal demand, then increase in investments based on large inflow of foreign capital due to different reasons. gdp per capita in 2008 in serbia reached the level around 4445 eur. nevertheless, after long period of growth, serbian economy in 2009 stepped into recession, mostly under the influence of global financial crisis. switching from the expansion to recession shed light on many weaknesses of domestic economy (high trade deficit, low level of competitiveness, high rate of unemployment, etc.) and emphasized issue of large budget deficit and possibilities for its financing. serbian economy in 2010 recorded slight recovery and first signs of recession exit, reflected mostly through growth of gdp, resurging of industrial production, increase in export, households savings, foreign currency reserves, etc. table 1. basic indicators of economic trends in serbia in the period 2008-2011 indexes – previous year = 100 2008 2009 2010 2011 gross domestic product1– constant prices 2002 103,8 96,5 101,0 101,9 physical volume of production industry 101,1 87,9 102,5 102,1 agriculture 108,5 101,0 99,4 100,8 construction 104,2 80,1 93,7 117,7 wholesale and retail2 wholesale turnover– constant prices 117,0 102,7 111,1 117,3 retail turnover constant prices 106,7 85,1 100,5 82,4 transportation – total 100,4 85,2 106,2 108,1 transport of passengers 102,2 86,6 101,8 109,0 transport of goods 95,3 81,1 120,8 106,0 postal and telecommunications 139,0 128,1 … 115,6 catering 101,0 88,8 99,5 101,5 tourists – nights 100,1 92,2 94,9 104,2 external trade import in usd 124,3 76,0 117,4 120,3 export in usd 124,0 70,7 104,2 120,2 employees 99,9 94,5 95,1 97,2 prices consumption prices 111,7 108,4 106,5 111,0 inflation – current growth 108,6 106,6 110,3 107,0 average wages net of taxes and contributions nominal – total 118,0 108,8 107,6 111,1 real – total 103,9 100,2 100,7 100,3 source: statistical office of the republic of serbia 1 estimation for 2010 and 2011; source: data of serbian statistical office, 2012. 2 net of vehicles retail economic analysis (2012, vol. 45, no. 1-2, 59-73) 64 unfortunately, during 2011 recovery has started to diminish gradually. since the beginning of second, and especially third quarter in 2011, almost all leading macroeconomic indicators have indicated slowing of the economy growth. at the same time, regarding the expectations of second wave of global crisis, risks of new recession have emerged. accordingly, modest level of domestic demand in line with decrease in real wages and pensions has reflected on the decrease in turnover and limitations on possibilities for successful operations of considerable number of business entities. financing of the ongoing production was also adversely affected, due to the high interest rates and extension of payments settlement, and number of illiquid enterprises turned to be very large. all of these worsened the situation on labor market, too, which recorded unfavorable movements in 2011. taking into consideration indicators of basic economic variables in 2011, the following remarks could be observed: • total economic activity in serbia, after the favorable results in first quarter, when 3.4% growth of gdp was recorder, started to slow down. consequently, 1.9% of gdp growth in 2011 was estimated, which was far below from the initial expectations. • as the consequence of slowing down of economic activity, interruption of wages and pensions growth, as well as under the influence of uncertainty and consumption restraints, demand on domestic market in 2011 was on very low level. beside this, particularly unfavorable movements were recorded in households’ consumption. at the same time, in 2011 investments increased. the structure of domestic demand in 2011 relative to 2010 was characterized by investment growth (from 18.8% to 20.4%), mostly due to investments of fiat and nis, as well as investments in infrastructural projects), decrease in government consumption (from 19.2% to 18.8%) and decrease in households consumption (from 79.3% to 77.2%). • industrial production increased in 2011 for 2.1%. however, during the second, and especially third and fourth quarter, growth of industrial production recorded the slowdown. accordingly, industrial production in serbia, apart from the recorded growth in 2011, failed to reach pre-crisis level in 2008. • the total foreign trade of the republic of serbia in 2011 was increased by 20.3% and amounted to usd 31,916.1 million • in 2011 export of the goods was 11,767.7 millions usd, or 20.2% higher relative to 2010, while import was 20,139.4 millions usd or 20.3% higher relative to previous year. export generally was affected by slowdown of economic activity worldwide, thus during the several last months in 2011 it was considerably lower. such trends in international trade had an impact on continuation of decrease in deficit and improvement in cover of import by export. in 2011 trade deficit was 8,362.7 millions of usd or 20.5% more than in 2010. at the same time, coverage of import by export was equal as in previous year at the level of 58.5%. stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 65 although in 2011 certain positive trends in export were recorded, products of lower level of manufacturing traditionally dominated. more specifically, in 2011 structure of export was dominated by products for the further reproduction 60.8% (12,253.4 millions of usd), then consumption goods 19.7% (3,972.1 millions usd) and equipment 13.4% (2,690.7 millions usd). the main export markets for serbia in 2011 were germany (1,329.7 millions usd), italy (1,307.5 millions usd) and bosnia and herzegovina (1,191.2 millions usd). in 2011 value of import also significantly increased. the products for the further reproduction dominated in the import structure according to the product use (12,253.4 millions usd) with 60.8% share, followed by consumption goods (3,972.1 millions usd) and equipment (2,690.7 millions usd) with shares 19.7% and 13.4% respectively. unclassified goods participated with 6.1% (1,223.2 millions usd). the main import partners were russian federation (2,657.1 million usd), germany (2,176.3 millions usd) and italy (1,801.7 millions usd). the biggest international trade exchange was realized with countries that signed the free trade agreements with serbia. the eu member countries participated in serbian international trade exchange with more than 50% (primarily germany and italy, then austria and hungary). more specifically, the largest surplus was recorded with montenegro, bosnia and herzegovina and albania. the largest deficit was recorded in trade with russian federation due to the import of oil and gas, then china, germany and hungary. current account deficit in 2011 was larger for 885 millions eur relative to the previous year and recorded the value of 2,967.8 millions eur, mainly due to the increase in trade deficit and to the certain extant due to the increase of net outflows of income, more specifically net outflows of interest and income of foreign direct investments. the total balance of payments in the 2011 recorded the 1,801.5 millions eur surplus, while 928.7 millions eur deficit was recorded in the same period in 2010. external serbian debt by the end of december 2011 was around 24.125 billions eur. the external debt of public sector was 10.8 billions eur, wherein over the 80% belongs to central government. the debt of private sector was 13.3 billions eur, wherein around two thirds was created by the companies and one third by banks. prices of consumption goods in december 2011 relative to 2010, increased for 7.0%, while average annual growth was 11.0%. with such increase, at the end of 2011 interim inflation reached the upper limit of targeted inflation (6%). the key driver of inflation decrease, which was quite high in 2011 especially in the first half of the year, was diminishing of cost pressures on prices of manufactured food, decrease in inflation expectations and low level of aggregate demand. restrictive monetary policy implemented at the end of 2010 and the beginning of 2011, was relaxed in the second half of the year 2011. this was observable throughout decrease in reference interest rate (as well as change in policy of reserves). namely, national bank of serbia in jun 2011 decreased reference interest rate (due to the diminishing inflation pressures) and at the end of the december 2011 it was 9.75%. at the end of 2011 foreign reserves of the republic of serbia were at satisfactorily high level (covering about eight months of imports, and about 430% of the money supply m1) and economic analysis (2012, vol. 45, no. 1-2, 59-73) 66 amounted to 12.06 billion eur, with the net foreign reserves of the national bank of serbia (net of foreign currency by banks mandatory reserve, as well as withdrawals from the imf) stood at around eur 6.66 billion. previous 2011 was characterized by high short-term volatility, but the exchange rate at the annual level was stable, with minimal intervention of the national bank of serbia (net sales of 45 million eur, mainly in december). in 2011 serbian currency dinar lost significantly less than the value of other currencies in the region (the hungarian currency has depreciated by 11.7%, poland 10.8%, turkey 3.8%, czech republic 3.5% and romania 2.5%). trend of dinar nominal depreciation started during the global financial crisis was followed by the real depreciation of dinar in 2009 and 2010, which improved the competitiveness of enterprises in the sector of tradable goods and led to a significant increase in exports to the eu. on the other hand, real depreciation adversely affected the balance of companies which have taken foreign currency loans without hedging foreign currency risk. the inflation rate is higher than the target, and the growth of unit labor costs have led to real appreciation of the exchange rate in the second half of 2010, which adversely affected the competitiveness of the economy. although it is likely that national bank of serbia (nbs) will not allow sudden changes in exchange rates and that the trend of nominal depreciation will continue in the future, the high exchange rate fluctuations, which are significantly higher than serbia in the region (vlastimir vuković, and aleksandar zdravković, 2011) and nbs problems with inflation control have the negative impact on businesses operating abroad and financed by borrowing abroad. figure 2. global ranking of serbia in terms of business conditions source: http://www.doingbusiness.org/~/media/fpdkm/doing%20business/documents/annualreports/english/db12-fullreport.pdf the current economic and market environment in serbia is not very favorable and competitive compared to other countries in the region. surveys of the world bank, presented stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 67 the report "doing business 2012", where conditions were analyzed based on 10 parameters in terms of ease of doing business (starting from the commencement of business, securing permits, hiring, lending to business opportunities through the protection investors, contracts, and the closure of businesses) indicate that the business environment in serbia in 2011 is ranked at 92nd position among 183 countries. in world bank reports 2008 serbia occupied 86th position in 2008, 90th position in 2009, 90th position in 2010, and 88th position in 2011. of particular concern is that changes in terms of improving business conditions in serbia are very slow in almost all areas of business, except for start-ups, registering property and getting credit. while other western balkan countries (notably macedonia, albania and croatia), according the world bank assessments, progress in terms of business conditions, serbia stagnated or falling behind. figure 3. improvement in conditions for business in serbia in the period 2005-2011 source: http://www.doingbusiness.org/~/media/fpdkm/doing%20business/documents/annualreports/english/db12-fullreport.pdf the existing unfavorable ranking of serbia in terms of business conditions is caused by many factors, including the following: • for the establishment of enterprises in serbia 7 different procedures are required, averaging 13 days. in addition, the rank of serbia, when it comes to establishing and developing business enterprises lowered in 2011 year (92nd position) than in the previous year (81st). it is obvious that the conditions in other countries for the establishment of enterprises, particularly smes, significantly improved compared to serbia. last registered reforms and changes in the legislation, which decreased 11 required procedures, and shortened the time required for the establishment by 23 days, were carried out in 2009; • in obtaining various types of permits for construction, power connections, telephone, approvals from inspections and other agencies necessary to launch the business, companies are faced with 19 procedures, for which fulfillment is needed economic analysis (2012, vol. 45, no. 1-2, 59-73) 68 to spend on average 279 days. in this respect, serbia is lagging behind the average for central and eastern europe and holds the highly unfavorable 175th place among 183 countries in the world; • in terms of registering property serbian recorded enormous progress. registering property now requires 6 procedures and takes on average 11 days instead of the previous 91 days. thanks to reforms in 2011, the registration has been reduced, allowing serbia to improve its ranking from 98th to 39th position; • when it comes to getting credit, serbia has a very solid position and in terms of this indicator has the highest rank among all the indicators that are analyzed by experts of the world bank (24th place); • in terms of investor protection serbia holds 79th position and in that respect is better ranked than many neighboring countries. however, because of the implementation of further reforms in this area, serbia has deteriorated its rank over the previous year for five positions (macedonia, bosnia, and croatia); • republic of serbia is among the countries with a complex system of taxes – annually it is required to make payments 66 times. for the preparation, calculation and payment of taxes and other obligatory giving, companies even spend 279 hours and in addition the total system is not transparent enough. no significant changes were registered in this regard over the last three years, and in this respect serbia is at 143rd unenviable position! • in terms of foreign trade liberalization serbia takes 79th position (one lower than year before), but since 2007 no significant reforms have been registered in this area; • processes of business terminations and the companies shut down still take too long and cost too much. yet in this field are observed certain changes, which improved the rank of serbia – from 101st position in 2009 to 86th position in 2011; • the efficiency of the legal system is not satisfactory. to charge disputed claims arising from commercial contracts in serbia, one should spend on average 495 days and go through 36 procedures, and costs of liquidation of receivables from insolvent companies is very high (on average about 31%). no changes are registered in this regard over the last three years! it is disturbing that the analysts at the world bank report "doing business 2012," noted the progress in relation to previous report on only one area (the registration of ownership of property). in the same period, the fyr macedonia has made reforms in four areas and improved its ranking from 34th to 22nd position. rank of montenegro remained unchanged despite the reforms in three areas. b&h has made reforms in two areas, but it was still the lowest ranked country in the western balkans in terms of business conditions. albania has made reforms in one area and deteriorated its rank in the previous year by 5 places. croatia has made reforms in one area and worsened its ranking over the previous year in one place. s socio-cultural environment – among many factors surrounding this segment we will retain our focus on only two of them, which are especially important in understanding the impact on the consumers purchasing power and consumption models (kotler, 1998), which stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 69 are related to trends in earnings and consumption, as well to the movement of employment and unemployment. table 2. business conditions in serbia and the countries in the region criterion/country/rank s er b ia m ac ed o n ia m o n te n eg ro b & h a lb an ia c ro at ia starting a business 92 6 47 162 61 67 dealing with construction permits 175 61 173 163 183 143 getting electricity 79 121 71 157 154 56 registering property 39 49 108 100 118 102 getting credit 24 24 8 67 24 48 protecting investors 79 17 29 97 16 133 paying taxes 143 26 108 110 152 32 trading across borders 79 67 34 108 76 100 enforcing contracts 104 60 133 125 85 48 resolving insolvency 113 55 52 80 64 94 business conditions 92 22 56 125 82 80 source: world bank: doing business, 2012. the existing level of wages and pensions is among the lowest in the region. the average net wage paid in 2011 totaled 37 976 rsd, or about 360 eur, and average pension totaled 21 189 rsd, or about 200 eur. the major part of personal income population is primarily spent on the basic essential needs (about 58% of salaries and pensions are being spent on food, drink and accommodation), which has a limiting effect on the development of a number of productions for the domestic market. this fact is not making a market of serbia being too attractive for foreign investors. at the same time, under the influence of uncertainty and refraining from spending in times of crisis, and in terms of weakening the purchasing power to demand and restructuring essential needs, the demand on the domestic market was low in 2011. as a result, the turnover of retail trade was, comparing 2011 to 2010, decreased by 7.3% in current prices and by 16.7% in constant prices. neither the improved conditions of sale (through deferred payment of up to 90 days) nor available consumer bank credits failed to stop the high real decline in volume of turnover in retail trade. serbia has a low employment rate (only 49% of the population aged 20-64 years is employed, while the eu average is 68%) and high unemployment (23.7%, which represents one of the greatest economic and social problems of our society). economic crisis had a large negative impact on the labor market of serbia in the last three years. as a result, the total economic analysis (2012, vol. 45, no. 1-2, 59-73) 70 number of formally employed in 2011 was 1746 thousand, which represent the reduction of about 260 thousand compared to 2008, while the unemployment rate, according to the survey of labor force in the republic of serbia, reached a record level of 23.7% in november 2011. t technological environment – the latest innovation union scoreboard report, which is intended to assist in monitoring of the implementation of leading initiative "european union 2020 innovation" through a comparative assessment of innovation performance of the eu27 member states and the relative strengths and weaknesses of their research and innovation system, shows that serbia is a country with the largest relative increase in public spending in r&d in 20113. serbia doubled its public investment in r&d in 2011, reaching 0.65% of gdp4. also, serbia has increased the allocation for this purpose by 22% over the past 5 years, more than any other country in europe (average growth among the eu27 countries was 4%, while the most successful eu states in 2011 luxembourg and portugal had 19% and 13% growth respectively). however, allocations of enterprises for research and development in the past five years have been declining (8% eu average). industrial growth and employment are dependent on the part of industry that can not rely solely on their own resources, knowledge and innovation in order to fully benefit from certain competitive advantages (production, location, infrastructure, etc.) and contribute to structural adjustments in the manufacturing sector industry of national economy. it is unrealistic to expect that this sector will be able to create conditions for the production, with high added value that depend on long-term research and development projects or application of process and organizational innovations, without adequate and controlled support from the state. innovation gap of serbia is best illustrated by the fact that serbia is at the 29th position out of 34 european countries and belong to the last group of countries with a modest system of innovation and with even modest impact on their economy. weakness of serbia is the intellectual property, including patents, registered under the international agreement on patents. revenue from overseas patents and licenses of serbia is at the 46% of eu average. in terms of innovation relative advantage of serbia lies in human resources, transparency, quality and attractiveness of the research system and the effects (results). when it comes to education, serbia has above-average results by the percentage of young people between 20 and 24 who have completed secondary education, while in terms of people between 30 and 34 with tertiary education serbia is at 59% of eu average. in a new national research project cycle (2011-2014) a total of 11,615 researchers are involved, of which 1,714 of them are young researchers under 30 years of age who were included in the project for the first time. one third of the national scientific capacity for is to be engaged within large interdisciplinary projects5. information and communication technology (ict) is the infrastructure of the knowledgebased society. the speed of transition to knowledge-based society depends on the quality 3 maastricht economic and social research institute on innovation and technology, 2012. 4 coordination of research policies with the western balkan countries, 2011. 5 ibid. stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 71 and scope of application of ict in all spheres of society (business, public and private life). the positive trend of development of information and communication technologies, however, the development of ict is still not sufficiently robust to serbian reached the eu27 average and the advanced countries in the region6. the research results of the statistical office show that serbia has over 2.4 million internet users in 2010, an increase compared to 2009 by 2.3%. the greatest use of the internet is in companies (97%) which is approximately the level of the eu27 average (98%) and most eu countries. however, the use of the internet in households (39%) is significantly below the eu27 average (70%) of all member states except bulgaria (33%). concerning usage of internet by individuals serbia has a slightly better position (44%), although it is significantly below the eu27 average (71%) and all eu members. besides the increase in the use of the internet, the same trend follows areas of ebusiness and the introduction of e-government7. conclusion for current and c business of enterprises it is of particular importance to consider the changes occurring in the macro-environment, as the factors of the environment significantly affects the quality of the business. this paper is an attempt to systematically, through the conceptual framework of pest analysis, examine issues regarding the impact of macro-environment on strategic and operational management processes of economic entities in serbia. the current state of key elements of the macro-environment in serbia based on observation and analysis performed by authors can be summarized as follows: table 3. pest analysis of serbia key elements opportunities threats p political and institutional environment the eu accession process – candidate status political instability the electoral cycle the adoption of numerous laws harmonized with eu practices problems related to the status of kosovo and metohija obtaining a schengen visa implementation and enforcement of laws strengthening accountability and efficiency of executive authorities the high level of corruption political influences in governing state-owned enterprises e economic environment a satisfactory level of macro-economic stability turbulent business environment the increased interest of foreign investors recession risk the development of agriculture, energy, infrastructure slow and incomplete structural reforms reindustrialization of serbia the high budget deficit and its financing encouraging entrepreneurship and smes the level of public spending 6 ministry of finance, republic of serbia, 2011a. 7 statistical office, republic of serbia, 2012. economic analysis (2012, vol. 45, no. 1-2, 59-73) 72 opportunities threats loan terms the growing public and external debt fluctuations of exchange rate poor results of privatization the high level of informal economy low energy efficiency s socio-cultural environment the existing human capital the low employment rate and high unemployment rate declining of population and its aging the low purchasing power and living standard worsening situation of vulnerable groups social inclusion t technological and environment increased public investment in r & d the lag in innovation advances in ict technologies, increased use of electronic commerce low private sector investment in r & d increased investments in the modernization of industry "brain drain" the level of education, open research systems unfortunately, the performed pest analysis of serbia indicates that the impact of the current macro-environment is not very favorable for the business. namely, the elements presented in pest analysis indicate that the current macro-environment is characterized by the dominance of threats and weaknesses with few opportunities and strengths. consequently, there is a strong need for faster implementation of structural changes in order to eliminate or minimize the impact of weaknesses and threats of the current macroenvironment and create more favorable business climate that would enable companies to formulate effective strategies and to raise their business performances. references byars, lloyd. 1991. strategic management: formulation and implementation – concepts and cases. new york: harpercollins. cooper, lee. 2000. "strategic marketing planning for radically new products", journal of marketing, 64 (1). 1-15. coordination of research policies with the western balcan countries. 2011. progress report on recent developments regarding s&t cooperation in/with wbc. wbc-inco.net (accessed february 17, 2012). coulter, mary. 2010. strategijski menadžment na delu, 100-110. belgrade: data status. envisioning strategy. 2009. pest analysis. smehro.wordpress.com (accessed january 23, 2012). european bank for reconstruction and development. 2011. "transition report 2010 recovery and reform". kotler, philip. 1998. marketing management – analysis, planning, implementation, and control, 9th edition. englewood cliffs: prentice-hall. stošić, i., et al., pest analysis of serbia, ea (2012, vol. 45, no, 1-2, 59-73) 73 maastricht economic and social research institute on innovation and technology. 2012. "innovation union scoreboard 2011". ministry of finance, republic of serbia. 2011a. "izveštaj o razvoju srbije 2010". ministry of finance, republic of serbia. 2011b. "ekonomski i fiskalni program republike srbije za 2012. godinu". serbian innovation fund. 2012. "izveštaj o ostvarivanju programa rada za 2011. godinu". statistical office. republic of serbia. 2012. www.webrzs.stat.gov.rs (accessed february 27, 2012). stošić, ivan, cotič, gordana, and nikolić, draško. 2009. "the impact of the global financial crisis on transition changes in serbia", in financial system integration of balkan countries in the european financial system: impact of global financial crisis, 138-147. nice: university of nice sophia antipolis and institute of economic sciences. stošić, ivan. "results and problems of serbian real sector privatization" in economic analysis 2007 (1-2) institute of economic sciences. thompson, john. 2002. strategic management, 4th edition. london: thomson learning. todorović, jovan. 2003. strategijski i operativni menadžment, 78-92. belgrade: conzit. vuković, vlastimir and aleksandar zdravković. 2011. "the inflation and exchange rate in the five balkan countries from maastricht convergence criteria prospect" contemporary issues in the integration processes of western balkan countries in the european union. ljubljana: international center for promotion of enterprises and institute of economic sciences world bank. 2012. doing business 2012. www.worldbank.org (accessed january 5, 2012). pest analiza srbije rezime glavni cilj ovog rada je da ispita uticaj trenutnog srpskog makrookruženja na preduzeća kroz implementaciju pest analize kao okvir za procenu opšteg ili makro okruženja u kojem posluju. autori raspravljaju o tome da elementi predstavljeni u pest analizi ukazuju na to da trenutno makro okruženje karakteriše dominacija pretnji i slabosti sa nekoliko mogućnosti i prednosti. shodno tome, postoji snažna potreba za bržu implementaciju strukturnih promena u cilju eliminisanja ili minimiziranja uticaja slabosti i pretnji trenutnog makro okruženja i stvaranje povoljnije poslovne klime koja će omogućiti kompanijama da formulišu efektivne strategije i da poboljšaju svoje poslovne performanse. klju:ne reči: pest analiza, srbija, poslovna klima, makro okruženje, strategijski menadžment, preduzeća article history: received: 18 april 2012 accepted: 11 may 2012 ea_2012_1_2 conference paper sustainable development under impact of the crisis – global and national dimensions* đukić petar*, university of belgrade, faculty of technology and metallurgy, republic of serbia udc: 502.12; 502.131.1 jel: q01; q56 abstract – economic crisis threatens the cardinal principles of all strategic development documents, including the concept and practice of sustainable development. its implementation, by definition, depends on the current economic performance and trends which are defined by many determinants that, in the short to medium term, can not be totally predicted. however, sustainability as a complex category also refers to the reaction of system in crisis situations. does the company, city, transport system and energy function in conditions of natural disaster, even wars – it has always been considered the a key issue of social order and organization and preparation of an emergency, then in the strict sense, it can not be put in the context of sustainability. the concept of sustainable development means peace and co-operative conditions, but should not exclude the possibility of response to emergencies. moreover, sustainable development is the characteristic of a social system that easily exceeds the emergency, but which also does not turn current economic trends and socio-political processes from the direction that ensures the long term social and environmental compatibility with economic and technological processes and ways of life style. the global economic crisis has placed priority short-term goals such as output growth, investment and employment, and often the survival of entire national economies and regions, the monetary area and other communities. serbia is facing difficult challenges that are not only affecting the sustainability of economic growth but also, despite the conventional view, there are indications for a different model of growth and development, based on new structural conditions and opportunities provided through the „green“ economy, the new „green“ investments, energy efficiency, social and cultural inclusion. key words: global economic crisis, sustainable development, economic sustainability, priority of development goals, employment, green economics, energy efficiency, social inclusion * this paper is done under the project „modeling of serbia’s development and integration into global trends in light of the economic, social and political movement“, record number 179038, funded by the ministry of education and science, republic of serbia * karnegijeva 4, 11000 belgrade, djukic@tmf.bg.ac.rs economic analysis (2012, vol. 45, no. 1-2, 1-18) 2 many questions have been asked about the consequences of global economic and financial crisis, which are related relating to the sustainability of the current economic system. in early 2012, the fourth year of crisis and in its second wave, participants of the world economic forum gathered in davos (switzerland). this meeting for long time characterized as a summit of business and politically most powerful people in the world. most of the questions this year may be reduced to one essential: does capitalism have a future? if so, how then should look like the model of „responsible capitalism“ to ensure planetary economic and social future in the twenty-first century? just ten days after world economic forum conference 2012, at a meeting on kopaonik, or so-called „serbian davos“, organized by the serbian economists association, it is revealed the official reduction in the growth rate of gross domestic product for 2012 from 1–1,5 percent to only 0–0,5 percent, of course under the relentless pressure of binding statistics and imf forecast. the key conclusion of the prime minister of serbia, at the opening of the conference, was that serbia needs savings this year, which will be provided saving the state apparatus (referred to as business travel and use of official cars) but this does not go to the expense of citizens and pensioners.1 without the analysis of basic economic postulates about the correlation between consumption and production, or the amount of real income and employment, on this occasion it should be only noted that attitude toward the fundamental principles of sustainability in a crisis, is a typical, expected short-term, reaction of politicians before elections (and those in the executive branch). prospects for their direct action, almost by definition, are related to the next elections, so the question is – does it really make sense to have a dialogue on sustainable development with them. on the other hand, it is more than evident that, in light of general economictechnological and development changes related to global warming, energy efficiency, use of renewable resources, water availability, food and arable land, today more than ever is necessary to recognize long-term consequences of the crisis current trends and the anti-crisis measures, in order to recognize generally acceptable coordinates of sustainability and more or less implement them. the crisis and sustainability – economic theory and ethics in global terms theoretically, the concept of sustainability and strategies for sustainable development in today’s world are facing three key challenges or threatening factors. these are: • terrorism as a global phenomenon, and consequently „sabre rattling“ in the world of big military-political contradictions, • the global geo-physical and climate changes, and • the current economic and financial crisis in the world. this finding of the author of this paper is based on the results of the monograph sustainable development – utopia or a chance for serbia (djukic 2011b: 17-24). 1 prime minister on 6 march, „recalled the agreement with the imf according to which current consumption should not threaten the established deficit, despite the reduced inflow into the state coffers, and said that spending cuts will not jeopardize the payment of pensions and wages in the public sector“ (danas, march 7, 2012) jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 3 the first fact, although very threatening, is not the topic of this article, the second is only partially, and the third could perhaps be objected that it is only a temporary (cyclical) phenomenon and, as such, does not represent a permanent challenge for the theory and practice in question here. however, it could be argued that crises, as such, are inevitable, and that sooner or later they emerge as an integral part (phase) of any life cycle. than, this analysis could also be applied to any, past, present and future crisis as an obstacle to the realization of the sustainable concept (djukic 2009). if we start from the pure practice, one might ask: if the global crisis is an extraordinary situation in every way, could it be considered as a sufficient reason to stop talking and start acting in the long-term interest of survival in accordance with the planetary laws and interests of future generation? some kinds of answers to this issue are trying to give not only representatives of the major economies of the world, experts and business sectors, but also of institutions such as un, eu, and also fierce critics of the existing market system and globalization of world economics, politics and social relations. each of them interprets the crisis in its own way as a huge obstacle, but also a challenge for what follows after it. and that what follows largely depends on the current analyses, strategies and measures taken. the founder and first instigator of the aforementioned world economic forum in davos, prof. klaus schwab, at the january 2012 meeting said verbatim: „we are in an era of fundamental change that urgently requires new ways of thinking. we have a general crisis of morality, we are not willing to invest in the future, we are undermining social harmony and we are in danger of completely losing the trust of future generations.“2. if you just select and connect the key words and phrases in this sentence: „new thinking“, „moral“, “trust“, „social harmony”, and finally „future generations“, there is no doubt that it is a critique from the perspective of sustainable growth. more precisely, it attemps to arrange a global world, not only economically, by the principles which were conceived in 1987 in the un report our common future prepared but also by brundtland commission. sustainable development was first defined in quite general terms as “development toward meeting the needs of present generations without jeopardizing the possibility of future generations to meet their own need“ (brundtland, 1987). later, at the united nations conference on environment and development in rio de janeiro in 1992, it was adopted the co-called rio declaration. it contains 27 principles of sustainable development and recommends that each country does have its own national strategy for sustainable development, in order to achieve jointly defined objectives (djukic 2011: 8). the moral dimension, as an inevitable issue in theory and practice of sustainable development, is discussed in detail in one of the most famous and best textbook of environmental economics. (goodstein 2010: 23-25). goodstein analysis of theoretical sustainability is primarily economic, and illustrated with nice practical examples but it is too american. what is missing is the applicability of the theory of sustainable development on the strategic positioning of the less developed countries or countries in transition and many developing countries. programmes concerning the practical sustainability of planetary change, not only climate but also the economy, technology, lifestyle and the impact of all 2 according to: http://www.slobodnaevropa.org/content/davos_da_li_kapitalizam_ima_buducnost/24461895.html economic analysis (2012, vol. 45, no. 1-2, 1-18) 4 these factors on the environment and resources, are considered mainly as a separate externality and as an economic category. in the history of economic thought, the moral dimension of economic theory and practice was not only a product of the great challenges such as global crises (as is the case today) or destructive wars or global climate changes. most major economic scienties from the past of economic theory such as samuelson, galbraith, marshall, keynes, marx previously, and adam smith to some extent, in many reflections stated their own opinions about moral beliefs and the principles that govern or should govern economic behaviour of humans. simply put, the moral dimension of human individual and social action can not be separated from his/her economic activity (djukic 2008: 105-108). it is understood that the ethical component of the economy had to be thoroughly searched by economists who, after the sixties, began systematically to be occupied with a field of economics of environmental protection and natural resources. during sixties and seventies worked economists who have began to treat pollution and congestion also economically i. e. economic aspects of environment and natural resources. of these, more than others, in this area, were engaged in unconventional “green-minded” authors mishan, knees and boulding (djukic 2011c: 10, 11). in 1972 when the un conference on the human environment was held under the slogan „only one country“ and that same year published the previously mentioned the limits to growth, at that same time it was already emerging the conscious that the life processes on earth are interdependent and that a very planet is a unique life system which rests on a fragile balance that must be maintained only in the communion (jovanovic gavrilovic, 2006: 53-58) today, on the moral aspects of global politics and economy are increasingly discussing not only politicians and representatives of developing countries, but also many experts from the developed parts of the world, such as western and northern europe, asia, and north america. moral principles and aspects are especially emphasized in the analysis of global politics and economics in the fight against climate change (giddens 2010). ecological theory in serbia also discussed the ethical phenomena related to the environment and resources, but not concrete enough, which would link economic development with the ethical principles, although such attempts have been made (various authors, 1996). therefore, this paper insists on the integrated understanding of sustainability as it is shown in figure 1. namely, the positive development in economic, social and environmental spheres are considered to be sustainable in a practical sense only if they lead to overlap of all three motives, i. e. if economic growth and investment, market-based, are environmentally friendly and don’t jeopardize social balance, or if that threat can be compensated by some other factors of the sustainability aiming intergenerational justice. the key term for understanding is overlapping of all three objectives: economic growth, nature conservation and environmental protection, as well as social balance, which is the essence of sustainability. it should be also understood that the overlapping of interests of economy efficiency and environmental preservation leads to tolerance, of economic development and social system towards fairness, and of economy and environment to life-giving. jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 5 figure 1. visualization of the sustainable development by graphic model depicting overlapping of spheres, i. e. sustainable goals, according (djukic 2011c, 37) concretization of (un)sustainability in crisis in the so-called second wave of global economic crisis, when the european union definitely remains in deep recession, in an attempt to save what can be saved (euro, and confidence in the common monetary system and economic community in general), and even china was forced to reduce the growth rate at about 7.5 percent, it could be even discussed about the positive potential of the creation of a new sustainable system of functioning economy and society during the crisis. as a reminder, already during the first wave of global crisis (2008–2010) which has required huge government incentives in the economy, banks and various businesses around the world, to prevent the collapse, there was, more or less, orientation that anti-crisis financial packages should be focused more to „green-economy“ or measures leading to sustainability. since the package of public investments to overcome the crisis, not enough attention is recognized aimed to sustainability. according to green peace remarks, even in 2008, most of the economic stimulus plans could stimulate the country’s rapid growth in greenhouse gas emissions, and even affect withdrawal of the so-called green initiatives. packages of tax cuts, lending and stimulation of additional spending, are not in accordance with environmental assurances made by the governments in order to approve funds. a more detailed examination shows that the „green“ consumption (funds directed to sustainable development) makes only a small part of a larger financial pie (financial times,„how green environment society economy tolerant sustainable fair life-giving economic analysis (2012, vol. 45, no. 1-2, 1-18) 6 is my stimulus“ (2009) as the part of the total stimulus package of 486 billion u.s. dollars, said representative of the green peace, japan will spend only 2.6 percent on “green” projects. out of the chinese intervention package that totalled 586 billion dollars, according to the findings and advice of experts, it should be invested as much as 38 percent in the “green” projects and the so-called low carbon activities; but „green“ package of china will likely remain very modest. in terms of environmental responsibility in the crisis atmosphere, slightly lead the individual eu countries and usa. package of massive intervention of u.s. president obama, will be largely aimed at millions of „green jobs“ through reconstruction projects of federal buildings to make them more energy efficient and also to plan the reconstruction of the national electric power network for transmission of electricity in order to raise energy efficiency. germany and france are leading by the participation of „green“ investment in europe. germany will even direct 13 percent of its package towards low-carbon industries. most the theorists of “green” and sustainable development give the best grade, from the standpoint of sustainability of emergency financial points in the global crisis, to south korea (financial times, 2009) this insistence on sustainable development and „green projects“ that are mentioned in the context of global measures of intervention and stimulation of recovery in the latest crisis, may appear as a kind of exaggeration. however, if we take into account previous responses to crisis challenges and accelerated development that follows, which is anticipated after every crisis, including the current, it becomes much clearer how important it is that the latest structural and other emergency anti-crisis measures are oriented towards sustainability. besides, the key positive changes in the structure of the global economy that shifted production to lower levels of many emissions (lead, sulphur and nitrogen compounds, and chlorofluorocarbon) or to energy efficiency and lower material intensity, were stimulated by the effects of stagflation and structural crisis that appeared along with it in late seventies. serbia at the time of crisis: the official search for sustainability perhaps serbia today is economically too weak, and tired of the most pressing short-term and especially those in transition and longer-term structural problems, for progress in the conceptualization and implementation of measures for sustainable development. however, the design of possible post-crisis development trends, and many so-called structural changes that will inevitable inevitably follow, is the basic premise of the sustainability of each system and the sustainability of development in general. the priority of economic growth it is understood that many experiences with the recent, very ambitious, official planning of growth and development in serbia, do not favour those who advocate a strategic overview of sustainable way in the economic future. for that are legally responsible official „models“ by which governments are trying to boost the economic momentum, and at any price to ensure the planned growth of gdp and employment, at least in the minds of people. jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 7 such an optimistic scenario was officially promoted in late 2010 when the concept of „serbia 2020“, through so-called „new growth model“, even projected an average growth rate of 5.8 percent per year, which should double gdp for a decade (7,500 euro per capita, and more than 400,000 new jobs). nominally, „the post-crisis model of economic growth and development of serbia 2011-2020“ aspired to fit into „new growth model“ even the detailed strategic launch of industry with an average growth of 7,5 percent, then its ten-year growth would be 106.2 percent. it was also planned the revitalization of agriculture and increase of its share in gdp to 39.7 percent, and in particular the restructuring of the public sector, strengthening the energy sector, up to the positive turnaround in exports and investments on which such growth should be based. development consequences would include the share of fixed investment in gdp even by 28 percent, with annul growth of 9.7 percent, reduction in government spending from 12.5 to 12.4 percent at the end of period, etc. (stamenkovic, ed. by, 2010: 8-10). the data available tells a different story. figure 2. comparative indexes of global gdp and gdp of serbia (1989= 100) source: author's calculation, based on imf data and official statistis of serbia neither is starting position of serbia favourable, nor the actual circumstances of the above-average growth in the „new model“, are based on not at all realistic assumptions. instead of growth rate of 4-5 percent at the beginning of the period and the average of 5.8 percent for the entire period, in 2011 growth achieved was less than 1 percent, with staggering odds for 2012. if we take into account the same starting position of the index volumes of the world economy and economy of serbia in 1989 (100), it can be stated that the index of the world economy today is about 170, and serbia’s is only 72 (fig. 2). opportunities for the success of serbia on the basis of the effects of market reforms and the establishment of institutions that promote economic growth and development, as soon as 0 20 40 60 80 100 120 140 160 180 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 world economy gdp of serbia economic analysis (2012, vol. 45, no. 1-2, 1-18) 8 possible, are not considered/exploited very good. serbia’s competitiveness is at 95th place in the world ranking of 139 countries according to indicators of the global competitiveness index (world economic forum 2011). the latest analysis of the heritage foundation shows that serbia is by economic freedom only in 98th place out of 179 ranked countries (index of economic freedom 2012). in both cases, in the region of southeast europe, bosnia and herzegovina have the lower ranks. in terms of market conditions and other reform prepositions (structural changes, institutions, infrastructure, macroeconomic balance, depth and level of development of the market, the competition, the efficiency of state administration, as well as other indicators such as political stability), serbia is still far behind its competitors, therefore it could not be argued that serbia has requirements for quality and sustainable growth following the crisis. how, then, the assumptions of such latently very problematic economic growth can be treated in terms of environmental and social sustainability? in terms of dramatic deepening of the crisis, it can be answered on these questions only on a more or less bad or acceptable way. but that does not mean that these issues should be postponed for better times. it is the present state of serbia in a world full of contradictions and threatening tendencies, which should be a reason to strategic confrontation of attitudes and harmonization of concepts for sustainable management of the crisis and its aftermath. in any development programme or strategy paper, which marks the paths of economic development of serbia, has never been made the slightest attempt to conduct an integrated economic-environmental accounting, which would at least shed light on all the external consequences of (un)sustainability of current economic trends. environmental policy and the consequences previous statement does not refer only to aforementioned, actually already useless document – strategy “serbia 2020”. until now, environmental costs and benefits, and other economic consequences of economic developments on the environment and natural resources, have never found place in the strategic national projections and binding national documents.3 in fact, despite the official introduction of the principle “polluter–the consumer– user–pays” (law on environmental protection, 2007), neither at the macro nor at the microeconomic level there was no attempt to internalize externalities in terms of environmental accounting. already at the beginning of the last decade of the twentieth century, united nations introduced the system of ecological national accounts (system of national accounts – sna) and the european union member countries since 2011 have an obligation to calculate and present the environmental or “green” gross domestic product (djukanovic, jovin, 2011). in this respect, serbia is still acting as part of the world for itself. it is interesting that the very records and monitoring of the devastation of nature and effects of pollution, in serbia are not accepted as part of its international obligations since the federal republic of 3 the exception in this respect seems to be national strategy for sustainable development (group of authors, 2009) which was unfortunately adopted in early may 2008, just before the start of the economic crisis in serbia. therefore, its principles, and projections, which related to the period to 2017, are practically abandoned, and operationally useless. jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 9 yugoslavia (in the early nineties of the twentieth century) when it was required of serbia. financial reporting is an important component of economic sustainability. the countries of developed world today in their national accounts, largely record net externalities or so-called „green“ net product. future financial statements of companies and countries should be a true and fair representative of their profit or loss as well as the movement in value of assets, liabilities and capital. these reports should also include information from environmental accounting. however, such an accounting in serbia has not yet been given appropriate attention. already in 1992, as a result of the maastricht treaty, the european federation of accounting experts from brussels forwarded to serbia questionnaire on environmental accounting. however, due to the negligence of the former federal government, as well as professionals from the association of accountants and auditors, that important questionnaire was neither filled in nor forwarded back. because of that our country was automatically excluded from research and development projects of environmental accounting.4 (djukanovic, 2010). the situation has not significantly been improved until today because every crisis is definitely moving away society, the state and economy from the concept of sustainable development as well as „green“ accounting. unfortunately, this applies to many other aspects of sustainability. considering the drastic decline in industrial production in early last decade of the twentieth century, kyoto protocol didn’t have direct and rapid consequences on serbia. as such, it could be ratified immediately after the democratization of the 2000th (for yugoslavia as a whole). its formal acceptance was done only in 2007. this meant as a relatively bad signal, especially to the european climate change policy. sustainability and the crisis in serbia – the practic manifestations economic and social issue some of the basic indicators of economic behaviour in a crisis are better to be mentioned at the beginning of this segment of the analysis. during the winter of 2011/2012, a few very huge and important events happened in serbia, which are indicators of the sustainable impact of this crisis. just a few of these are as follows: • in late 2011, imf has frozen precautionary arrangement under which serbia has been allowed to draw nearly 2 billion dollars, officially because of spending without control. • gdp growth in serbia is every day less likely. that is confirmed not only by the imf projections (reduction in the anticipated rate from 3 percent even to 0.5 percent), but also according to the forecasts of the serbian government. • probable decrease in investments in 2012 (regardless of the official inflow of two billion dollars in 2011) primarily due to bad signal sent by the withdrawal of one of the most important foreign investors (u.s. steel serbia). 4 this paradox was first noticed by dragojevic, d. and lekic, d. in the paper „development and application of environmental accounting and auditing“, finance 11−12, economic survey, belgrade, p. 1000 (2001) economic analysis (2012, vol. 45, no. 1-2, 1-18) 10 • that caused that smederevo municipality representatives, after the referendum held on january 18, 2012. at which they officially and clearly said „no“ to the refinery (comico oil) because of environmental unsuitability, under the pressure of crisis, they changed their mind and gave in, so the contract to at least invest in a refinery became certain.5 • budget of serbia is in a constant rebalancing, therefore because of the reduction in revenues, almost all items are under the pressure of inevitable reductions. bravely and loudly „no“ to increase in vat, obviously will turn into a „yes“; but if it must be then, that bitter fruit of the crisis, at the time of finishing this paper, is „generously“ left to new government. • finally, important news, which remained without adequate response last year, is that in last year’s revised budget in september 2011, was unspent environmental fund, intended to so-called „green items“ of 2.5 billion dinars, which was diverted to subsidies for the construction of housing (act on amending the budget of the republic serbia for 2011).6 sustainability of energy – a priority of the first order it can be considered as a truly emergency situation when the temperatures in serbia were almost a month (late january – late february 2012) below freezing and the snow threatened to paralyze transport and communications, water supply etc. however it can not be said that the heating based on electric power (the form of final energy of vital importance) is normal and sustainable. specifically, the households during heating season are becoming a major consumer of electricity in serbia, and in terms of increased consumption (even in summer), there is a growing threat for the system to collapse. in order that power system of serbia was able to function at all, it was necessary to take urgent measures by the state administration, to switch off almost half of the domestic industry, and even for fortnight also schools, kindergartens and even universities. this is proved by the results of industrial production, which suggest that in january 2012, the serbian industrial production was 12 percent lower compared to january last year, and even 8 percent lower compared to february previous year. 5 according to a previous offer, refinery construction project would cost between $250 and $400 million. the planned capacity is 100,000 barrels; a fuel produced would be in line with european standards. during three years of construction, it would be hired over three thousand construction workers. these economic facts in emergency conditions become predominant, so the positive response of local government has imposed itself. 6 in rebalanced budget all other items on the level of expenditures have increased, while revenues were substantially reduced, so the overall budget deficit for 2011 was raised to 4.5 percent of gdp. but, according to may calculation, due to reduced growth rates by the end of the year, budget minus was increased at least to 4.7 percent of real gdp. this is, of course, done with the help of additional government borrowing, which is another indicator of the „sustainability“ of the fiscal system in crisis. jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 11 figure 3. the average price of electricity per (euro/kwh) in serbia and reference countries source: eurostat and energy agency of the republic of serbia figure 4. the energy intensity of serbia (2004) – comparison some countries around source: eurostat and energy agency of the republic of serbia 0 0.5 1 1.5 2 2.5 3 3.5 kirghizia kazakhstan uzbekistan ukraina turkmenia tajikistan russia gorgia moldoa belarus azerbaijan arrmenia slovenia slovakia poland lithuania letonia hungary estonia czech republic romania bulgaria croatia macedonia bosnia and herzegovina albania serbia eu25 energy intensity 2004. (toe/000.usd) 0.2698 0.2282 0.185 0.1603 0.1553 0.1554 0.1365 0.1323 0.1151 0.1099 0.0976 0.0823 0.0813 0.0689 0.0627 0.0646 0.048 0 0.05 0.1 0.15 0.2 0.25 0.3 denmark germany netherlands united kingdom hungary slovakia slovenia czech republic croatia greece romania bulgaria albania montenegro macedonia bosnia and herzegovina serbia economic analysis (2012, vol. 45, no. 1-2, 1-18) 12 notwithstanding the emergency weather conditions, one could not claim with certainty that serbia had to fall into lock operation of the electricity, as well as many other systems in crisis. reconstruction and modernization of energy is a process that is supposed to have been happening for almost a decade. although it can not be said that in this respect nothing has been done, the results are more than cautionary. despite the fact that serbia has s slightly higher gross national product compared to bosnia and herzegovina, albania and macedonia, currently, electricity in serbia is the cheapest in the region. the comparison of electric power prices in serbia and reference countries in the region shows that serbia charges cheapest electricity in europe (only 0.048 euros on average per kwh, figure 3). regardless of income level and living standard, data on the losses, both technical and economic, that are recorded high at the regional level (18 percent on line) show that electric power system of serbia is constantly working on the verge of „breaking“. during this winter, daily electricity consumption was on an unsustainable maximum already in early november 2011, daily more than 140 million kwh. during icy days in february 2012, despite a very expensive import and restrictions in the industrial sector, as well as in some public institutions, consumption was permanently above 150 million kwh. regardless of the extraordinary difficult climate conditions this year, there are usually huge seasonal fluctuations in electric power consumption. because of that the households as major consumers are motivated to use electricity for heating, as the cheapest form of heating in a large part of local communities. the energy intensity of serbia can be measured only with the former soviet union countries, which are extremely rich in energy (figure 4.) energy security is also important as one of the key indicators of the sustainability of society, economy and ecosystem. in our country, it is under constant pressure of bad heritage and the problematic structure of primary sources and distribution, and consumption of energy in general (janjic, 2011). environmental sustainability at the greatest shock general ecological conditions i. e. environmental and natural resources in serbia as the most vulnerable area of sustainability are under constant pressure from the crisis. here are some examples: 1. in recent years, fewer and fewer funds are allocated in serbia for environmental protection. according to the unece in (2007) environmental legislation in serbia was „complicated, fragmented and dispersed“ since „many required sectored permits are issued by ministries separately, while integrated permits have not been implemented yet". things in this regard are absolutely not improved. 2. according to the plans and projections in the same report, it was stated that serbia spent 0.6 percent of gdp for environmental protection in 2007, for 2009, it was planned 0.9 percent, while for 2012 the plan was 2.6 percent, and for 2015 even 2.4 percent of gdp. the budget rebalance in 2011 says the opposite. 3. state of pollution by sectors shows the following: • air pollution is under constant pressure from the „dirty“ energy that actually must function at existing and unsustainable ways, with the dominance of thermal jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 13 power plants that burn mostly bad, and „dirty“ lignite. air pollution is also under pressure of risky traffic, as well as „dirty“ chemical and metallurgical plants, refineries, etc.. • water pollution is one of the most pressing, multidimensional problems of economic, organizational and technological nature, but it is certain that ¾ municipalities in serbia has no device for purification, and only 1 percent have solved the problem of complete chemical mechalical and bio purification (including tercial treatment) (djukic 2008a: 133-148) • land in serbia is under pressure from devastation and eco-degradation, actually without strategy of sustainability management, so this problem is in the shadow of the unrestricted and unplanned use of the land, erosion, chemical and other pollution. • out of the total waste in serbia, only few per mill is treated on sustainable way, because serbia practically has no separation and waste reduction at source. serbia also doesn’t have recycling or proper disposal centres of already selected waste, and a few sanitary landfills do not represent a significant amount of waste measured by amount of bulk and so-called illegal dumps (djukic 2011b) sustainable development and crisis as an obstruction or an opportunity it can not be claimed, by any means, that the economic crisis does not jeopardize the cardinal principles of all strategic development documents, including the concept and practice of sustainable development. since each of the assumptions is related to some current circumstances, the practice and theory of sustainable growth are also caused by current economic performances and trends which, in the short and long term, depend on many determinants that can not be totally predicted. the european dimension however, sustainability as a category refers precisely to the reaction of system in crisis situations. does the company, city, transport system or energy function in conditions of natural disaster, or even wars? that question was almost always seen as the key problem of social order and organization i.e. of society preparation for an emergency. however, current position from the standpoint of theory and practice of sustainable development requires that the global crisis, as the emergency situation in all respects, to be considered as sufficient reason to adopt another concept harmonized with the principle of intergeneration justice. this is the exact way how the crisis is trying to be treated by responsible societies and organizations, which are looking for some kind of sustainable response to current challenges. european commission is resolute: "the crisis exposed fundamental problems and unsustainable trends in many european countries. it also made clear just how interdependent the eu's economies are. greater economic policy coordination across the eu will help us to address these problems and boost growth and job creation in future" (europa 2020). economic analysis (2012, vol. 45, no. 1-2, 1-18) 14 responsible governments, and companies, ngos and international institutions are doing just so. it is understandable that their own answers offer not only un, eu, g-20 but also those fierce critics of the current market and „globalization“ of world order, economy, politics and social relations, either being on the left or right position. the european union is trying to get out of the current crisis stronger that it did at the end of the crisis from the thirties of the twentieth century, which was the most destructive crisis ever recorded. in this sense, new european strategy promotes the following aims which europe 2020 should develop: • „smart growth" (education, knowledge and innovation); • "sustainable growth" (greater efficiency of resources, greener and more competitive economy) and • "inclusive growth" (higher employment, and economic, social and territorial cohesion) such a vision of the european social-market economy of the 21st century has been built on the partnership between european commission and member states. while member states set national targets, identifying growth disorders and set policy for them, the commission evaluates the progress, give policy recommendations and develop an initiative to stimulate sustainable growth and employment at the eu level“ (europe 2020). reply of serbia maybe today's serbia is economically too weak and tired for progress in the design of post-crisis flows, the structural changes that inevitably follow and sustainability of its system and development in general. perhaps the european goals such as a smart, sustainable and socially inclusive growth are unknown for serbia, full of threatening and shocking data on ten percent poverty and unemployment of about 24 percent. is it possible even in a crisis to talk about establishing a new sustainable system of functioning the economy and society, based on the rule of institutions, better education, culture? on many questions of similar meaning one can only look for more or less bad or acceptable answers in the circumstances of drastic deepening of the crisis. but that does not mean that these issues should be postponed for better times. serbia had the misfortune to have been effectively insulated from the global trends that have led to the sustainability, both from any reform cuts in countries in transition, and from the world growth moving towards the knowledge-based economy in the last decade of the twentieth and early twenty-first century. political heritage, market disintegration of yugoslavia, the sanctions of the international community, and finally the nato bombing, and then the crisis related to the transformation of the system and the assassination of the prime minister of the first democratic government – all this took valuable time and depressed the qualitative development resources of the country. and just when a more dynamic period of growth had started, linked to a greater inflow of foreign investment in the conditions of world economic conjuncture 2004-2008, it came shock caused by the global and national economic crisis. in this attack have appeared all cracks of prior bad heritage and bad carried out institutional reforms. serbia has been jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 15 grabbed by macroeconomic and financial instability in a recession period, and thus had weaker and weaker prerequisites for sustainable development. however, that has not brought into question, by no means, all the opportunities for using at least the principle of "step-by-step" towards sustainability, which is implicitly given in the national strategy and advocated by the author of this paper. one of the huge problems is that the national strategy of sustainable development was adopted in early may 2008, and the signs of severe recession have shown in the third quarter of that year, so almost all quantitative projections regarding the allocation and expenditure for the "sustainability" had to fall in deep waters. then, since 2009, almost all short-term projections have been directed towards increasing production and employment, regardless to environmental and other developmental consequences. thus, for example, in the revision of the budget for 2012, all development items were actually over budget for except for one position. authorities did not expend the funds provided for environmental and natural resources and during analysis and explanation in parliament, it was said that the authorities did not know how to use the funds, and if so, the funds “were not even necessary”. the second effect is, due to the structure of the line ministry for regional planning, mining and the environment, that these funds were diverted to the subsidies for construction of housing – that is to recruit people and capital in a crisis, regardless of the outcomes and economic efficiency. another huge problem for the strategic positioning of sustainable development in serbia is that the national strategy for sustainable development itself, which was to serve as an umbrella development document, was adopted quite late, when many of the sector strategies had already existed: for example, the energy development strategy until 2014, strategy for combating poverty, strategy to joining the eu and so on. space for action in crisis necessary systematic measures to be applied in times of crisis as soon as possible could be roughly divided into the followings: economic, organizational, technological fields. those relating to education and encouragement of knowledge-based economy. 1. economic measures (and the factors) of the sustainability make a wide range from already heavily used instruments concerning the reduction of anthropogenic pressures on the environment (reclamation of devastated agriculture and industrial land, clearing irrigation channels, the regulation and elimination of illegal dumps), to simplification of the financial support to many projects of energy efficiency, recycling and dematerialization of production, or incentives for cleaner production, and those actions that produce quick effects through the application of the principle of "polluter pays" and so on. it is understandable that without usual economic instruments, based on the internalization of externalities, either through economic prices and energy market, or through a restructuring process of large systems with strong external effects, serbia can not significantly move its position to the sustainability of agriculture, energy, tourism, and industry. 2. organizational measures, on the one hand, should be used as administrative measures concerning public procurement, which should be better controlled, however limited due to the effects of the crisis, not only to prevent corruption, but also because of preference of so economic analysis (2012, vol. 45, no. 1-2, 1-18) 16 called "green" public expenditures. on the other hand, the organization of cleaning and restoration of degraded areas would have to be delegated to responsible and competent professionals who would support the partnership of private and public sector. organization of the measures and actions for sustainable development is not just about the nation but also about the regions. that is the way in which treatment of waste should be interpreted, as well as realizing unique strategies of fighting for cleaner balkan space, waterways, air and environmental quality of the food. 3. technological incentives to sustainability, of course, are worthless without economic stimulus (especially without the application of the principle of "polluter pays"). legal, financial and other incentives to "green" technologies are very important as well as researches related to energy efficiency. the so-called "green economy" is not just a platitude but a matter of the organized measures of the state, business sector and ngos. 4. finally, the crisis in serbia should be the trigger to start building a different system of education, which would increase the level of usable knowledge in the economy as well as in sustainable development in general, through a serious related activities: from the education system and science, to learning and education to work, training and retraining for the workforce in the new conditions. knowledge is a factor of production with very positive externalities. it will become, from day to day, in serbia and abroad, all the more important determinant of competitiveness of national economies and thus sustainability of their economic and social systems. concluding remarks it is the present state of serbia in a world full of contradictions and threatening tendencies (of terrorism, extending crisis and severe consequences of climate change) that would have to give rise to strategic confrontation of attitudes and compliance of concepts for sustainable management in the crisis and aftermath. "green economy" is not just a phrase for all those who are trying to show, even in a campaign of restructuring the public sector, how people still have a chance (even a minor chance) for employment after termination of (parts of) their respective companies. that is an opportunity for the world, europe, the balkans and serbia to become a better place for living. environmental standards and sustainability criteria will assert itself, sooner or later, as one of the key assumptions of the business, production and export of goods and services. the european union has paved its way to achieve sustainable energy, cleaner production, energy efficiency and social cohesion, not opposing environmental and social goals of economic efficiency. however, europe 2020 does not have so ambitious starting position as the lisbon strategy, written for the prospects to 2010. realism prevailed over rival ambitions. in serbia, things are largely different. the concept "serbia 2020" proved to be too ambitious and completely useless, in fact even before its implementation. in the year of political elections all government strategies are actually in the shadow of inter-party struggle and cheap political propaganda. in fact, in that propaganda there is no single word about “sustainable development”, but it is largely talked about a variety of “patents” for quick and permanent overcoming the crisis. jovanović gavrilović b., et al., green growth, ea (2012, vol. 45, no, 1-2, 1-18) 17 this paper is intended for those who strive for sustainability “step by step” as well as opportunities for the citizens of serbia and the region of southeast europe to trace the different future in accordance with the interests of those who stay and come into this world, with all its advantages, disadvantages and limitations. references act on amending the budget of the republic serbia for 2011. „environmental economics; rescuing environmentalism“, apr 2/2005, the economist print edition. „how green is my stimulus“ (2009). financial times, 4 march. www.ft.com/greenbailout 4.3. 2009 brundtland gro harlem, et all. 1987. our common future. oxford university press, oxford. djukanovic, slavisa, and slobodanka jovin. 2010. (the accounting of natural resources and environment). finansije, belgrade, no 1-6/2011 (in serbian only). djukic, petar m. 2008. „economic changes and ethic acting“. in moral and economy, ed. veselin vukotic, et all., centre for economic research, institute for social sciences, belgrade, pp. 103120 (in serbian only). djukic, petar m. 2008a. „economy and ecology of water for the new millennium: presumptions of sustainable use of water resources in serbia". in technology backwardness of the serbian economy, journal economic horizons, no 1, may 2008, pp. 133-148 (in serbian only). djukic, petar m. 2009. “economic policy in a condition of crisis: continuity of reforms or measures in the time of need”. in economic policy of serbia in 2009 and challenges of world economic crisis, ed. m. jaksic and a. prascevic, belgrade: scientific society of economists of serbia with academy of economic sciences, and economic faculty, university of belgrade. (in serbian only). djukic, m. petar. 2011. (sustainable development utopia or chance for serbia), belgrade: faculty of technology and metallurgy, university of belgrade (in serbian only). djukic, petar m. 2011a. „economic development of serbia – between a new growth model and old practice“. in new developmental strategy of the economy of serbia: the challenge of the economic policy for 2011, ed. j. bajec. and m. jaksic, belgrade: scientific society of economists of serbia with academy of economic sciences, and economic faculty (in serbian only). djukic, petar m. 2011b. sustainable development utopia or chance for serbia, belgrade: faculty of technology and metallurgy, university of belgrade (in serbian only). djukic, petar m. 2011c. „europe – balkan – serbia – in the light of sustainable development concept“. in balkan and eu, ed. v. vukotic, belgrade: institute of social sciences, pp. 159-168 (in serbian only) europa 2020, a strategy for smart, sustainable and inclusive growth http://ec.europa.eu/europe2020/priorities/economic-governance/index_en.htm giddens, anthony. 2010. the politics of climate changes. cambridge: polity press ltd, 2009, serbian translation clio, belgrade. heritage foundation 2012. index of economic freedom, http://www.heritage.org/index/default, approach 16. iv 2012. http://www.epi2010.yale.edu/file_columns/0000/0148/saisana_saltelli_2010epi_eur.pdf. janjic, dusan. 2011. „serbia and eu: energetic security challenge“. in balkan and eu, belgrade: centre for the economic research, institute of social sciences (in serbian only). jovanovic gavrilovic, biljana. 2006. “sustainable development – essence of the concept and possibilities of measuring”. in sustainable development scg – institutional adopting to eu economic analysis (2012, vol. 45, no. 1-2, 1-18) 18 solutions and practice, ed. m. vujosevic and m. filipovic, faculty of economics, university of belgrade (in serbian only). stamenkovic, stojan et al. 2010. the post-crisis model of economic growth and development of serbia 2011-2020. usaid and fund for the development of economic science, faculty of economics, university of belgrade (in serbian only). unece. 2007. environment perfeormance reviews, republic of serbia, second review, economic commission europe, comitee on environment policy. united nations, new york, geneva http://www.unece.org/fileadmin/dam/env/epr/epr_studies/serbiaii.pdf. održivi razvoj u uslovima krize – globalni i nacionalni aspekt rezime – ekonomska kriza ugrožava kardinalne postulate svih strateških razvojnih dokumenata, pa i koncepta i prakse održivog razvoja. njegovu realizacija po definiciji je uslovljena aktuelnim ekonomskim rezultatima i tokovima koje, na kratak i srednji rok, određuju mnoge determinante koje u celini nije moguće predvideti. međutim, održivost kao kompleksna kategorija odnosi se i na reakcije sistema u kriznim situacijama. da li društvo, grad, saobraćajni sistem ili energetika funkcionišu u uslovima prirodnih katastrofa, pa i ratova to se oduvek smatralo ključnim pitanjem društvenog uređenja i organizacije, odnosno pripreme društva za vanredne situacije, pa se ne može u strogom smislu dovesti u kontekst održivosti. koncept održivog razvoja podrazumeva mirnodopsko i kooperativno stanje, ali ne bi trebalo da isključi mogućnost reakcije na vanredne situacije. šta više, održivi razvoj i jeste svojstvo društvenog sistema da lakše prevazilazi krizna stanja, ali i da ne skrene aktuelne privredne tokove i socio-političke procese sa pravca koji na dugi rok obezbeđuje socijalnu i ekološku usklađenost sa ekonomskotehnološkim postupcima i načinom života ljudi. svetska ekonomska kriza nametnula je prioritet kratkoročne ciljeve kao što su rast proizvodnje, investicija i zaposlenosti, a ne retko i opstanak čitavih nacionalnih privreda i regiona, monetarnih zona i drugih zajednica. srbija je u teškim izazovima koji se tiču održivosti ekonomskog rasta ali se, uprkos uobičajenim shvatanjima, pred njom ukazuju šanse jednog drugačijeg modela rasta i razvoja, zasnovanog na novim strukturnim pretpostavkama i prilikama koje se pružaju kroz "zelenu" ekonomiju, nove "zelene" investicije, energetsku efikasnost, socijalnu i kulturnu inkluziju. ključne reči: globalna ekonomska kriza, održivi razvoj, ekonomska održivost, prioritet razvojnih ciljeva, zaposlenost, zelena ekonomija, energetska efikasnost, socijalna inkluzija article history: received: 5 february 2012 accepted: 17 june 2012 ea_2015_3-4 udc: 005.941 005.57 cobiss.sr-id: 220027916 preliminary reports knowledge management as imperative for economic growth and development baltezarevic vesna1, faculty of culture and media, belgrade, serbia baltezarevic radoslav, alma mater europaea, belgrade, serbia jovanovic dragana, faculty of culture and media, belgrade, serbia abstract – we are now living in times of global business activity and the knowledge economy. knowledge-based resources represent the organizational know-how as the knowledge of employees, organizational production processes, and overall knowledge of one collective. knowledge management has long been recognized as a factor necessary for the development of business organizations. only those managers that embrace knowledge as the most important resource can expect to be better positioned than the competition. know-how is very important segment of overall knowledge that is deposited within the organization. the value of knowledge is much more important than all other forms of assets that an organization possesses. but knowledge cannot be communicated without the interested employees. so, managers have to create the business environment which uses adequate business communication. good communication stimulates ideas and creativity of employees. management must be able to manage business information and achieve active participation in communication with employees and exchange the intellectual capital values with them. key words: knowledge economy, know-how, knowledge management, intellectual capital, communication introduction the human society as a whole is exposed to constant change. contemporary economy is facing the values of intellectual capital. however, often a huge part of the intellectual potential of employees is not available to the organization. employees who are not positively stimulated do not want to share their knowledge and experience with others. such knowledge remains hidden in their consciousness. hidden knowledge’s transfer from implicit to explicit knowledge is possible only when employees feel belonging to the collective. the creation of such an organizational culture where employees understand that they are important for business is only possible with a good business communication. 1 vesnabal@gmail.com baltezarević, v., et al., knowledge management, ea (2015, vol. 48, no. 3-4, 62-68) 63 in today’s knowledge-based, high-tech environment, education, experience and skills become outdated very quickly, sometimes even before they are ever put to use (luthans, 2004). the ability of individuals and groups to quickly adapt to new demands and evergrowing range of constant challenges, determines their position in society. the accelerated pace of life and new technology still cannot affect the human need to interact with other people, because man possesses constant urge to communicate. competitive advantage indicates the power of a company, product or an economy in relation to others. the modern economy is directed more towards knowledge and latest technologies. therefore, the traditional concept of organization has been increasingly orienting towards ‘intelligent organization’, ‘virtual organization’, ‘organization based on the knowledge’, and so on. the idea of the new organization is dating back to the distant 1937. when ronald kouzea, in his theory of organizations, argued that “... bound to investigate and explain the causes and consequences of these changes in order to understand that a major transformation is due to the introduction of new economic organization” (fukuyama, 2007, p.57). nowadays, many organizations are aware that the only way to win and keep a competitive advantage is to learn faster than the competition. only those companies that embrace knowledge as the most important resource can expect to be better positioned than the competition. the ability to think quickly, the ability to collect and channel the knowledge available within the collective and thus consolidate that knowledge in the right way is a list of skills required of today's managers. the concept of ‘intelligent organization’ is based on knowledge that is deposited in the minds of talented individuals. such knowledge, in the theory, is called tacit knowledge. “tacit knowledge cannot be bought in the market in a form that would be appropriate for direct use” (zack, 1999. p.128). the transfer of tacit knowledge requires a certain amount of confidence and contacts. “tacit knowledge is a combination of cultural, emotional and psychological background that is on the margins of human consciousness” (tuomi, 19992000). today's business trends, the global crisis and the brutal struggle for survival in the market, are directing the organization towards a ‘new’ concept that is increasingly becoming based on ‘intangible capital’ and not on tangible assets. such an approach demands a new form of organization that is facing the intellectual capital. know how is what creates value, but also leads to new knowledge. modern technology facilitates the transfer of knowledge. reconciliation of businesses with the challenges of the modern era increasingly indicates interaction with the progress of science and technology, but it can be done only with people (baltezarevic, v. et al., 2013, p. 265). learning and adapting to new communication and business methods is imperative for the survival in a business environment. the management must know first how to get an answer if knowledge currently exists and what kind of knowledge is missing. in western literature we are faced with a new field of the economics, which, is referred to as knowledge-based economy or knowledge economy and information-based economy or information economy. economy of knowledge is recognized as the processes of creation, and use of knowledge. new economists who promote knowledge-based economy argue that such economy is a key determinant of development. knowledge, innovation and new ideas 64 economic analysis (2015, vol. 48, no. 3-4, 62-68) are pushing the boundaries of social and economic growth. “european social model, with its developed systems of social protection, given the transformations that lead to the knowledge economy” (baltezarević, v. & baltezarević, r. 2013, p. 431). knowledge management knowledge management is the ability to creating profits and leading position in the market with placement of collective knowledge. knowledge assets created computerized collection, storage, distribution and direction of corporate knowledge. modern technology contributes to the incorporation of knowledge into new products. development and use of knowledge within the organization must be under the control of management, which must ensure that conditions are created not only to make knowledge base, but also for its codification and transfer. generating knowledge includes all activities that convey new knowledge. successful society is defined as a learning society. this new society demands employment and personal development of every individual (baltezarevic, v. et al., 2013, p. 264). new demands are: achieving efficiency with the use of knowledge and innovative solutions in all areas of business. managers must create the conditions that employees have to possess large scale of skills both for individual and team work. it means that the corporate environment creates opportunities for the development of organizational intellectual potential, involvement of employees in the social network and facilitating the exchange of knowledge in the decision-making process. these requirements can be fulfilled only if the people are satisfied with their business position. knowledge is necessary for the individual’s personal and professional development. only lifelong learning can ensure that employees follow and apply new technology and new knowledge. knowledge managers have to create successful knowledge strategies related to the fact that the value of accumulated knowledge is sharing with employees because it is the only way to newly created values. people must be informed about all strategies and all aspects of a new added knowledge. but, managers must take into account the needs of the employees if they wish their positively respond to organizational changes. most important is to establish a knowledge base of their needs, relationships and opportunities. people will determine organizational success and knowledge must be a systematic process (skyrme & amidon, 1997). if managers want knowledge to be an organization resource that guarantees success in the market, it means the overall functioning of the management in order to recognize the needs of employees, service users and of all potential business partners. the sharing of knowledge is possible only with people. through contact with other people we fulfill both our individual and collective needs (walters, 2000), this is why ‘relationship management’ represents an important aspects of work. modern business challenges for a competitive position in the market modern business is facing challenges that require quick and adequate response to all challenges. however, the speed of response depends on the ability to absorb change better and faster than the competition. so-called baltezarević, v., et al., knowledge management, ea (2015, vol. 48, no. 3-4, 62-68) 65 ‘intelligent’ organizations are standing out with their ability to adapt to the demands of the fourth revolution. such organizations have their strategic objectives clearly definite: motivation, training of employees and creating a better organizational climate. knowledge-based resources include both tacit and organizational know-how stored in personnel, organizational manufacturing processes, and relationships (baltezarevic v., et al., 2013, p. 264). the management style and attitudes towards employees affect the ability of creating an organization based on knowledge. partnership approach to governance, which is characterized by involving employees in the decision-making process and creating business strategies affect the cohesion of employees and commitment to achieving business goals of the organization. that effect, stemming from the management modality, to a large extent, depends on the personal values and attitudes of group members (rot, 2006, p. 143). factors of external and internal environment, biological, psychological and social nature, have a constant effect on humans and lead to the disruption of the harmonious inner balance. a man is perceived as a product of society represented by the environment, as the cultural and behavioral contexts of an individual are the consequences of the society and the culture that person was born into and is living within. human capital can be a key source of competitive advantage because it is so difficult for competitors to replicate (barney 1991). psychological capital is not only concerned with “who you are” but also, in the developmental sense “who you are becoming”, your “best self” (luthans, et al., 2007:20). positive psychological capital consists of self-efficacy, hope, optimism and resilience, and is associated with a number of favorable outcomes for employees. employee attitudes affect their business behavior and their contribution to the work. role of social groups man is a social being with a potent desire to belong, both at the individual and larger social group levels. one needs organization to feed the need for social connection with shared beliefs and expectations, as well as to have someone to communicate one’s ideas to, and to share the dualistic satisfaction of one’s own life within a group, while being accepted as an equal member of the team, and as an individual. how successfully is the modern man coping with a globalized, alienated world where there is less and less time for face-to-face contact? usually only a small group of people can successfully cope with the unstoppable current of daily changes. they are able to build their own social capital. however, individuals continue to be social beings in a formal workplace with their needs as the individual beings within the organizations (haslam, 2001). social capital is precious for any organization because of its impact on the actions of individuals in the organization structure: “the actual and potential resources embedded within, available through and derived from the network of relationships possessed by an individual or a social unit” (nahapiet & ghoshal, 1998, p. 243). members of social groups to feel satisfied and to freely engage in a deeper interaction need to feel safe and accepted in the organizational system they have joined. for the creation of such business environment, the managers are most responsible. if management does not understand the importance of employment relationship within the social networks that will 66 economic analysis (2015, vol. 48, no. 3-4, 62-68) negatively affects the functioning of the organization and achieving the projected goals (krackhardt, 1990). through establishing of social relations with other people, feelings, needs and knowledge are shared. social networks coexist and influence each other (monge & eisenberg, 1987). social capital facilitates the development of intellectual capital and exchange of knowledge within the social group. consequently, social capital can impact not only economic transactions, but also production, loyalty and risk taking (nahapiet & ghoshal, 2000). employees transferred their social model from private life in the business sphere. they connect with other employees in order to build such social chain. at the beginning of this process people must gain trust in each other and establish the communications channel with the two-way flow. trust and social capital are closely related. trust as cooperative behaviors is important in a range of organizational activities and processes such as team work, leadership and goal setting (mayer, et. al, 1995). the goal of successful organizational culture must be based on the needs of human capital. employee satisfaction is important for their integration and acceptance of business strategy in the organization. this means that managers must achieve good opportunity for business communication, socialization and integration of each employee. recognizing of their individual goals and needs ensures the creation of trust between employees and management and facilitates achieving the leadership position of the organization. conclusion a modern organization is an interaction of visionary abilities of a leader, and skills and know-how of the management. however, knowledge must “abandon” the individual framework and become a shared resource. knowledge is best utilized within a group, because people who know each other converse more intensively than strangers. members of a group must share the same vision, and become well acquainted in order to establish mutual trust. knowledge managers must first establish the same kind of positive relationship with its employees. the social life is focused on communication contacts which are realized within the organization; communication is still considered a central component of effective business processes with priority given to the respect of the personality of each employee which discourages any form of psychological harassment. communication and organizational culture together are necessary for a good organizational climate. only those employees who feel as respected members of the collective wish to contribute to the success of the organization. such organizational environment is possible only if management applied good system which is based on open communication, knowledge, confidence and business skills related to leadership positions in the market. companies that embrace knowledge as the most important resource can expect to be better positioned than the competition. learning and adapting to new communication and business methods is imperative for the survival in a business environment. baltezarević, v., et al., knowledge management, ea (2015, vol. 48, no. 3-4, 62-68) 67 references baltezarevic, v. & baltezarevic, r. 2013. the role of communication in intellectual capital management, education and employment opportunities for entrepreneurs. belgrade: faculty of business economics and entrepreneurship. baltezarevic, v., baltezarevic r., paunkovic j. & žikic s. 2013. the role of intellectual capital in serbia, the third international symposium of natural resources management. zajecar: faculty of management. fukuyama, f. 2007. građenje države (state building). beograd: filip višnjić. barney, j. 1991. “firm resources and competitive advantage.” journal of management, 17, 99– 120. haslam, s. a. 2001. psychology in organizations: the social identity approach. london: sage. krackhardt, d. 1990. "assessing the political landscape: structure, cognition and power in organizations". administrative science quarterly, 35(2): 342-370. luthans, f., youssef, c. m., & avolio, b. j. 2007. psychological capital: developing the human competitive edge. oxford, united kingdom: oxford university press. mayer, r.c., davis, j.h., schoorman, f.d. 1995. “an integrative model of organisational trust.” academy of management review, 20, 03, 709-715. monge, p. r., & eisenberg, e. m. 1987. emergent communication networks. in handbook of organizational communication, ed. jablin, f. m. p., linda l.; roberts, karlene h.; porter, lyman w., 304-342. newbury park: sage publications. nahapiet, j., & ghoshal, s. 1998. "social capital, intellectual capital, and the organizational advantage". academy of management review, 23(2): 242-266. nahapiet, j. & ghoshal, s. 2000. “social capital and the organizational advantage.” in knowledge and social capital, ed. eric lesser, 119-157. oxford and boston, butterworthheinemann. rot, n. 2006. psihologija grupa, (psychology of groups). beograd: zavod za udžbenike i nastavna sredstva. skyrme d. j.&. amidon d. m. 1997. business intelligence http://www.skyrme.com/pubs/knwstrat.htm tuomi, i. 1999-2000. “data is more than knowledge: implications of the reversed knowledge hierarchy for knowledge management and organizational memory.” journal of management information systems 16, 3. 103-117. walters, d. 2000. “virtual organizations: new lamps for old?” management decision, 38,5/6, 420-436. zack, m.h. 1999. “developing a knowledge strategy.” california management review, 41(3), 125-145, p.128. 68 economic analysis (2015, vol. 48, no. 3-4, 62-68) upravljanje znanjem kao imperativ za ekonomski rast i razvoj rezime – mi sada živimo u vremenu globalnih poslovnih aktivnosti i ekonomije zasnovane na znanju. resursi zasnovani na znanju predstavljaju organizacioni know-how (znati kako) kao znanje zaposlenih, organizacioni proizvodni procesi, odnosno celokupno znanje jednog kolektiva. upravljanje znanjem je odavno postalo neophodno za razvoj poslovnih organizacija. samo oni menadžeri koji prihvataju znanje kao najvažniji resurs mogu očekivati da će biti u boljoj poziciji od konkurencije. know-how je vrlo važan segment celokupnog znanja koje je deponovano unutar organizacije. vrednost znanja je mnogo značajnija od svih ostalih oblika imovine kojima organizacija raspolaže. ali znanje ne može da se razmenjuje bez zainteresovanih zaposlenih. tako menadžeri moraju da kreiraju poslovno okruženje u kome je zastupljena adekvatna poslovna komunikacija. dobra komunikacija stimuliše ideje i kreativnost zaposlenih. menadžeri bi trebalo da budu u stanju da upravljaju poslovnim informacijama i da obezbede aktivno učešće u komunikaciji sa zaposlenima sa kojima razmenjuju vrednosti intelektualnog kapitala. ključne reči: ekonomija znanja, know-how, upravljanje znanjem, intelektualni kapital, komunikacija article history: received: 14 november, 2015 accepted: 17 november, 2015 ea_2016_3-4 udc: 339.56(497.6:497.5) 339.5.057.7(497.6) jel: f14, f15, f53 cobiss.sr-id: 228331532 original scientific paper impact of croatia's accession to the european union on the trade orientation of bosnia and herzegovina malović marko1, institute of economic sciences, belgrade, serbia škorić rade abstract – the paper analyses the impact of accession of croatia, bosnia and herzegovina’s traditionally most important regional trading partner, to the european union on the trade exchange volume and foreign trade orientation of bih. although the saa offered bih “on paper” a more liberal and favouringly asymmetrical trade approach in relation to the cefta 2006 agreement valid until croatia’s accession to the eu, especially in the segment of the agricultural production circulation, the statistical data on mutual trade show unambiguous and significant reduction in the volume of foreign trade, more pronounced in bih export, particularly in the trade of agricultural products. this confirms once again that only several classes of non-tariff barriers have a decisive influence on at least a short-term negative bilateral trade impact of croatia’s accession to the eu, which bih tries to compensate by increasing exports to other traditional partners, first italy and germany (segment of industrial products in a timely manner focused on the eu core), but also serbia and turkey (less picky and in favour of markets). since much milder decline in imports of bih from croatia is not accompanied by a significant comparative increase in direct foreign investments from croatia to bih, the volume of bilateral trade exchange could be increased in medium-term manner either by fulfilling different standards, certificates of compliance and certification laid down in the eu (which would result in an increase in bih exports) or by a possible incorporation of concessions that croatia enjoyed within the cefta 2006 in the saa with bih (which would result in an increase in bih imports). key words: bih, cefta, croatia in the eu, foreign trade introduction geographical proximity, common history, the same language caused and predetermined a natural connection between bosnia and herzegovina and croatia in 1 institute of economic sciences belgrade and university of i. sarajevo, and university of i. sarajevo, respectively. malović expresses gratitude for the financial support of the ministry of education and science of r. serbia on the projects no. 47009 (european integration and socio-economic changes in serbian economy on the road towards eu) and no. 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements). 26 economic analysis (2016, vol. 49, no. 3-4, 25-39) political terms. such connection is also reflected through mutual trade exchange, and therefore the croatian market was the second most important export market for bih, while croatia was absolutely the biggest exporter to the bih market. after the disappearance of yugoslavia, bih and croatia were found again under “one roof” by signing an agreement in bucharest in 2006, according to which bih became a member of cefta2, thus joining together with moldova, serbia and montenegro other cefta members, as well as croatia that became the member of cefta in 2003. this period can be regarded as a golden period in terms of trade exchange between bih and croatia, which led to a significant increase in trade, especially to the outbreak of the so-called financial crisis. a new milestone in the history of trade relations between the mentioned countries is croatia’s accession to the european union. after croatia joined the european union, bih for the first time bordered a country that is the eu member. by leaving the cefta agreement, croatia lost all previous preferences enjoyed as a signatory to the agreement, and further trade between bih and croatia was asymmetrically regulated by the stabilisation and association agreement.3 the advantage of establishing new regional trade integrations between the mentioned group of countries, economists almost instinctively view it through the prism of now a legendary theory of trade creation and trade diversion by jacob viner. however, baldwin and wyplosz (2010) understandably draw attention to the ambiguity and imprecision of the trade creation and trade diversion paradigms: not only does the viner’s theory insinuate that the cost-benefit analysis of (not) joining the newly formed regional trade integration requires quantitative changes, where the analysis is actually dominated by cost-price increments, but viner’s theory does not take into account all the effects (e.g. benefit from more favourable imports), where it is in fact completely useless for the analysis of the application of non-tariff barriers. indeed, in the case of bih, watanabe (2012) stresses that the saa is more than just technical issues agenda for the implementation of trade facilitation, that there is a whole range of essential goals set (in the field of safety, phytosanitary, accounting and many other community standards) that bih has not yet fulfilled, although the lion's share of bih products had duty free access to the unique eu market significantly before the signing of the saa, on the basis of the preferential trade agreement in 2000, which was then reinstated. bih often does not possess the technology for reaching these standards, but when it does it lacks laboratories for certification of its products, although, for instance, certificate issuance by laboratories in zagreb costs about eur 25,000 per product [watanabe, 2012, page 52]. therefore, after croatia joined the european union on 1 july 2013 and left the cefta agreement, certain changes were inevitable, and so bih – faced with a series of non-tariff barriers on until recently accessible croatian market was slowly finding alternative markets for sales of its products, while the impact of croatia on bih market was gradually fading. whether this trend that has emerged from croatia’s transition from one to another regional economic integration is just a temporary phase in trade relations between bih and croatia, or croatia’s accession to the european union has nevertheless significant effects on trade 2cefta central european free trade agreement 3 hereinafter: saa malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 27 exchange and foreign trade orientation of bih, will be assessed hereinafter. this question is particularly interesting insofar as the established theoretical assumptions of further trade liberalization embodied by saa’s superiority in relation to the cefta deal imply intensification instead of lessening of trade exchange after croatia’s accession to the eu. even if we allow a certain margin of masking recent foreign trade by introduction of horizontal foreign direct investment from croatia to bih, where the investments after croatia’s eu accession did not drastically vary, empirical data suggests the opposite outcome in relation to the theoretical prediction. theory of regional economic integrations in the second half of the twentieth century, a large number of regional economic integrations was created in almost all continents. without a doubt, the most important integration in this period was the european union (signing of the maastricht treaty in 1993). during this period, cefta was established (1994) by the czech republic, hungary, poland and slovakia. origins and goals of regional economic integrations economic integrations usually occur in two ways. the first way is the political will of a country that is strong enough to impose such idea to geopolitically smaller countries. the second one is based on economic agreements between sovereign countries. this is a common way to create integrations in the twentieth century, and usually involves some kind of an institutional form of association. the reasons for the emergence of regional integration are primarily economic and political. primarily political motives were behind the most developed and biggest economic integrations. regional economic integrations emerged mostly as economic ties between the national and world markets. regional economic integrations are primarily aimed at intensifying trade between the member countries of the integration, through a process of reduction or complete elimination of both tariff and non-tariff restrictions. as a rule, this results in an increase in purchasing power of population of the regional integration, because of the decrease in prices of imported goods. transfer of capital between countries of regional integration becomes a lot easier, while multiple barriers to movement of capital are eliminated. this leads to mutual benefits to both the foreign investor and the host country. ultimate goal of regional economic integration is the economic development of the integration member countries and increase in the welfare and living standards of the population in the integration member states [jovanović, 2004], [mike-frederick, 2007]. basic forms of regional economic integration regional economic integrations represent various forms of fusion of economies of two or more countries that are usually close in the geographical area. theoretically speaking, there are several basic forms of economic integrations. balassa (1961)4 presented the concept by 4 bela balassa, a hungarian economist and a consultant for the world bank 28 economic analysis (2016, vol. 49, no. 3-4, 25-39) which economic integrations have five stages in their development, starting from the freetrade area as the simplest form, to an economic and political union as the most complex form of regional economic integration. in fact, the literature identifies from the preferential trade agreement, through free trade zone, partial and full customs union, the common market, the single market, to full economic and monetary union, total of seven so far empirically verified degrees of regional economic and trade integration [kovačević, 2000], [pelević-malovićvučković, 2004]. cefta in the western balkans (cefta 2006) cefta 2006 represents geographical relocation of the former central european zone (i.e. association) of free trade to the area of the so-called western balkans. the western balkans is a relatively new term used by the european union and euro-atlantic structures since the beginning of xxi century in order to, above all, mark the countries in the balkans that are not members of the european union (except turkey). this imply: serbia (including kosovo and metohija within the framework of the united nations resolution 1244), croatia, bosnia and herzegovina, albania, macedonia and montenegro. it should be noted that moldova also joined the cefta agreement, although it does not belong to this geographical area. the reason why moldova entered cefta can be found in political or geopolitical domain, given that the trade between moldova and the cefta member states from the western balkans is at the level of statistical error [botrić, 2012]. croatia’s accession to the cefta agreement marked the expansion of the cefta to the territory of the western balkans. when most of the “old” cefta member states joined the eu, except croatia, romania and bulgaria, there was a need for cefta expansion, since its current format did not have the specific purpose for further existence. the logical step for extension, and it can be said the only one possible, led to the western balkans. although they signed the cefta agreement in 2006, romania and bulgaria have never become members of the “new” cefta, given that they joined the european union on 1 january 2007. cefta 2006 bearing in mind that the “old” cefta proved to be a good preparation for the european union accession, the logical decision was to introduce a new form of the agreement by amending the old agreement and the simultaneous accession of new members. hence the title of the agreement “agreement on amendment of and accession to the central european free trade agreement”, usually referred to as cefta 2006. the agreement consists of two parts, the main text and annexes to the agreement. the main text of the agreement has only four articles, such as: accession, the parties, amendment of cefta, and entry into force (articles listed in order). annexes to the agreement are the backbone and a vital part of the agreement, in particular annex i, which essentially defines all relevant issues regarding the regulation of trade relations and other issues of importance for both the economy of the signatory countries as well as for the very functioning of the cefta agreement, while annex ii acts as a kind of bypass between previous numerous bilateral agreements and the new unique agreement. malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 29 figure 1. stages in the cefta development legend: cefta's founding members (left cefта in 2004), slovenia (expansion of 1996, left cefta in 2004), romania (expansion of 1997, left cefta in 2007), bulgaria (expansion of 1999, left cefta in 2007), croatia (expansion of 2003, left cefta in 2013) 5 , expansion of 2006 cefta 2006 is an improved version of the previous agreement, which consisted of a series of bilateral agreements. compared to bilateral agreements, cefta agreement is far more complex and comprehensive. besides being a plurilateral agreement, it includes some new issues that were not covered by the previous agreement or it significantly improves the provisions that were insufficiently precise and effective in application in the bilateral agreements. annex i of the agreement as the creator of the trade regime within cefta the manner of trade exchange in the area covered by cefta is defined by the annex i of the agreement. annex i of the main agreement has 52 articles divided into seven chapters, and nine sub-annexes. annex i is a very extensive document written on approximately 450 pages. we will mention three chapters that are most important for the subject of our paper. chapter 1 “general obligations applicable to trade in all goods”. the first chapter includes articles 2 to 6 of the agreement. as the title suggests, this chapter defines the general obligation of all parties involved in trade of both industrial and agricultural products. more specifically, it determines: classification of goods in the trade, basic duties, the rounding manner for reduction, ban on the import and export of quantitative restrictions and measures having equivalent effect, and the abolition of all existing ones on the date of entry into force of the agreement, ban on the introduction and abolition of existing customs duties on exports, the standstill clause and the abolition of 30 economic analysis (2016, vol. 49, no. 3-4, 25-39) customs duties that are not in accordance with article viii gатт6 1994. the problem in establishing free trade is non-tariff barriers, which hinder the full achievement of one of the priorities of the cefta agreement – the establishment of truly free trade zone as of 31 december 2010. according to data from the chamber of commerce of belgrade, from 2009 to 2013, 114 different non-tariff barriers were found within cefta, while a total of 73 are removed. serbia registered 26 different types of barriers that were implemented by other members of cefta. all signatories of the cefta agreement are formally committed to remove existing barriers and not to introduce new ones. meanwhile, as the most developed country with the longest participation in the western balkan incarnation of cefta, it seems that croatia benefited the most from the implementation of the cefta agreement. chapter 2 “industrial products” this chapter consists of only two articles. the first article determines the scope and at the same time define what is implied by industrial products. these are products classified within the chapters 25-97 of the harmonized commodity description and coding system, with the exception of products that, according to the wto agreement on agriculture, are considered agricultural products. these products are listed in sub-annex 1. the second article defines abolition of import duties, charges having an equivalent effect to customs duties and import duties of a fiscal nature and schedules of the abolishment. chapter 3 “agricultural products”. as with industrial products, the first article of the chapter establishes the scope of agricultural products and at the same time defines them. in addition to the standard classification under which agricultural products are considered products classified within the chapters 1-24 of the harmonized commodity description and coding system, agricultural products include some industrial products that are considered agricultural products according to the wto agreement on agriculture. bearing in mind the specificity of agricultural products, the second article of the chapter regulates the lowering or elimination of import duties, charges having equivalent effect and import duties of a fiscal nature on the products listed in sub-annex 3. this sub-annex represents a consolidated overview of all bilaterally agreed tariff concessions for agricultural products. unlike industrial products, agricultural products have not been fully liberalized among the parties to the bilateral agreements. this chapter also provides that the parties will not be limited in the pursuance of the respective agricultural policies, but without prejudice to the concessions granted under article 10 (customs duties on imports). it also explicitly stipulates that all parties shall refrain from the use of export subsidies, and abolish any such existing subsidies, in their mutual trade. 6 general agreement on tariffs and trade – gatt can be considered as the forerunner of the world trade organization as we know it. malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 31 cefta agreement with respect to the stabilisation and association agreement in this part of the paper, the attention will be paid to the differences, i.e. similarities between the stabilisation and association agreement7 and the cefta agreement with regard to regulation of trade relations between the parties. the importance of this lies in the fact that the trade relations between croatia and bosnia and herzegovina were regulated with the saa on 1 july 2013, not with cefta agreement as in previous years. saa with bih annex i of the saa with bih determines and defines bih concessions on import of industrial products originating in the community. tariff rates for the group of the most sensitive products will be reduced under the following schedule: on the date of the agreement, customs duties will be reduced to 90% of the basic duty, on 1 january of the first year after the entry into force of the agreement, duty shall be reduced to 80%, in second year to 60%, in third year to 40%, in fourth year to 20%, and after the expiry of five years they will be completely abolished. for products from the group of very sensitive products, customs duties will be reduced in the following order: on the date of the agreement, customs duties will be reduced to 75% of the basic duty, on 1 january of the first year following the date of entry into force of the agreement, the duty will be reduced to 50% of the basic duty, in second year to 25%, and in third year they will be completely abolished. customs duties on imports of sensitive products will be reduced by 50% the date of the agreement, and totally abolished on 1 january next year. import duties on products not included in annex i will be abolished in its entirety on the date of entry into force of the agreement. annex iii of this agreement defines bih tariff concessions on imports of agricultural products originating in the community. customs duties on non-sensitive products shall be abolished on the date of entry into force of the agreement. for products from the group of sensitive products, customs duties will be reduced to 50% of the basic duty on the date of entry into force of the agreement, and will be completely abolished on 1 january next year. customs rates on highly sensitive products shall be reduced in the following schedule: on the date of the agreement, customs duties will be reduced to 75% of the basic duty, on 1 january of the first year to 50%, on 1 january of the second year to 25%, and in third year they will be completely abolished. for agricultural products from the group of the most sensitive products, customs duties will be reduced under the following schedule: on the date of the agreement, customs duties will be reduced to 90% of the basic duty, on 1 january of the first year following the date of entry into force of the agreement the duty will be reduced to 80%, in second year to 60%, in third year to 40%, in fourth year to 20%, and after the expiry of five years they will be completely abolished. special group of products consists of products whose import will be limited by quotas, which will not have customs duties on imports, but customs duties will be applied by the mfn principle/clause. this group of products includes: products of pork, beef and sheep meat and live animals. 7 hereinafter: saa 32 economic analysis (2016, vol. 49, no. 3-4, 25-39) bosnia and herzegovina has the privilege of exporting almost all products to the eu market, except for certain types of fishery products, which represent a minor part of bih exports8. differences between the cefta agreement and saa according to the cefta agreement, trade of industrial products between bosnia and herzegovina and croatia is free of duty, while in the case of agricultural products, preferential tariffs and tariff quotas are reciprocally/symmetrically applied for a number of basic agricultural products and foodstuffs. from this perspective, bosnia and herzegovina should have an advantage in trade with croatia, because it will be able to export almost all products without tariff and quantitative restrictions, and on the other hand, 73 products are protected by quantitative restrictions on imports from the community to bosnia and herzegovina, and 275 products remain under full customs protection after the expiry of five years from the date of entry into force of the agreement. trade exchange between bosnia and herzegovina and croatia before and after croatia’s accession to the european union geographical closeness and a number of other factors, such as similar consumers’ taste and common history, influence the extremely strong connection of these countries in terms of trade. therefore, they largely depend on one another, and to a certain extent, they are mutually dependent in terms of trade. trade between bosnia and herzegovina and croatia before croatia joined the european union trade exchange between bih and croatia accounts for the lion's share of the total intracefta trade. therefore, trade between croatia and bosnia and herzegovina is one of the main drivers of intra cefta trade. trend of increasing volume of foreign trade between croatia and bih is continued by bih joining the cefta agreement in 2007, and such trend is maintained until the first serious impacts of the global economic crisis on their economies in late 2008 and much of 2009, which caused a significant decrease in the volume of trade exchange. however, the main impact of the global economic crisis was followed by re-consolidation and a gradual increase in trade. nevertheless, it should be noted that bih exports is not significantly reduced in the years of the strongest impact of the global economic crisis, as it was the case with croatia exports, which recorded a significant drop. 8 it should be noted that the interim agreement is currently in force, and the saa is blocked because of political issues. interim trade agreement can be considered as a shortened version of the saa, which applies only to trade issues. interim trade agreement entered into force on 1 july 2008. malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 33 chart 1. trade exchange between bih and croatia (in thousands of usd)9 croatian market is by far the most important market for the export of products from bih, and nearly half of total exports of bih to cefta members was made to croatian market. furthermore, bih is absolutely the biggest importer of croatian products among cefta members. chart 2. trade between bih and cefta countries10 after croatia, serbia is the largest importer from bih, importing almost 30% of bih exports to the cefta market. serbia is a major exporter to the bih market, so that the export of serbia accounts for 36% of total import of bih from cefta countries. exports to the croatian market accounts for 15% of total exports of bih in 2012, while imports from croatia is also about 15%. speaking strictly in numbers, the value of exports of bih amounted to usd 765 million, while imports recorded a value of usd 1,446 million. 9 source: bih agency for statistics 10 source: cefta trade portal http://www.ceftatradeportal.com/ 34 economic analysis (2016, vol. 49, no. 3-4, 25-39) speaking of the structure of trade, the biggest section relates to trade in industrial products, while the smaller part, but not negligible one, relates to trade in agricultural products, especially imports of agricultural products into the market of bih. chart 3. structure of trade in bih 11 having analysed the chart 3, we can say that trade of agricultural products during the observed period under almost constantly recorded a slight growth, and therefore, the negative effects of the global economic crisis do not have a decisive influence on trade in agricultural products. however, the negative effects of the global economic crisis are clear and obvious on trade in industrial products, so trade was significantly reduced in 2009, but recorded growth afterwards, but this growth was mild when it comes to the export of industrial products originating in bih to the croatian market. trade between bosnia and herzegovina and croatia after croatia’s accession to the european union when croatia joined the european union in mid-2013, croatia left the cefta agreement, and since 1 july 2013, trade relations between croatia, on the one hand, and bosnia and herzegovina, on the other hand, have been regulated by the stabilisation and association agreement. chart 4 clearly indicates that trade between observed countries slowed down after croatia joined the european union, i.e. continues to decline, given that trade in the past period varied in intensity, with periods of growth and decline. although exports of bih in the second half of 2013 did not decline compared to the same period of 2012, the situation is quite different when it comes to the first half of 2014 compared to the first half of the previous year, with a large decrease in exports by as much as 25%. imports also recorded a slight decline, so the imports in the second half of 2013 was by 11% lower than in the same period of the previous year. the trend of reduced imports and exports continues in the 11 source: bih agency for statistics malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 35 following period, so the exports in the second half of 2014 was by 15% lower than in the same period of the previous year, while imports decreased by 7% in the same period. chart 4. trade between bih and croatia (in thousands of usd)12 even based on this not so particularly complex chart it can be concluded that exports of bih to croatia suffers significantly after croatia’s accession to the eu, while imports are decreased but not in a particularly great extent. due to such developments, exports of bih to croatia as well as the part of the economy suffer significant consequences, contrary to the expectation that the export-oriented part of the economy of bih would take advantage of more favourable access to the croatian market. chart 5 clearly indicates the extraordinary reduction in the volume of exports of agricultural products and food industry products from bih to croatia. exports in the second half of 2013 was almost halved compared to the first half of 2013, i.e. it declined by more than 40%. the same trend continued in 2014, so exports in the first half of 2014 decreased by incredible 59% compared to the same period of previous year and by 30% compared to the second half of 2013. imports also recorded a significant drop, but not as drastic as in the case of exports. imports in the second half of 2013 decreased by 17% compared to the first half of the same year, but if we compare the imports in the second half of 2013 with imports in the same period of the previous year, we can conclude that imports declined by more than a third (34%). 12 source: bih agency for statistics 36 economic analysis (2016, vol. 49, no. 3-4, 25-39) chart 5. trade exchange of agricultural products between bih and croatia (in thousands of usd)13. these are quite worrying figures, which cannot be attributed as a consequence to any other event except to croatia’s accession to the european union and to all effects that this event entails. floods in may that had major implications on agricultural production both in bih and croatia, do not have a decisive influence on the trade exchange, since a huge drop in trade occurred immediately after croatia joined the european union, i.e. in the second half of 2013. as an additional argument in favour of the thesis that croatia’s accession to the eu has a negative impact on the volume of trade between the observed countries is the fact that export of products from bih to croatia amounts to less than 11% of the total exports of bih in 2014 as opposed to 15% in 2012. croatia’s share in total import of bih also decreased from 15% in 2012 to 11.4% in 2014. in absolute value, exports recorded a value of usd 648 million, while imports amounted to usd 1,256 billion. finding alternative markets? for the period until 1 july 2013, we can say that the economy of bih was vitally linked to the croatian market. however, after croatia’s accession to the european union there was a gradual change in trade orientation of bosnia and herzegovina, although the croatian market continues to be one of the most important markets. in other words, loss of a significant part of the croatian market, the economy of bih tries to compensate it through the increase in the exports to other markets, mainly to the markets of countries indicated in chart 6. 13 source of data: bih agency for statistics malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 37 chart 6. growth/decline in exports/imports with major trading partners in the first half of 201414. chart 7. intra cefta trade of bih plus croatia (2014)15 if we compare chart 7 and chart 2, we see that croatia’s participation both in import and export in bih decreased, and although this decrease is not large in scale it is not negligible. the share of croatia in exports of bih was reduced by 6 percentage points, while imports in bih decreased by 7 percentage points. it seems that this situation benefited serbia the most, which increased the share of exports to bih market by 8 percentage points. change of export orientation is particularly noticeable when it comes to exports of food and agricultural products. 14 source: bih agency for economic planning 15 source of data: bih agency for statistics and the cefta trade portal 38 economic analysis (2016, vol. 49, no. 3-4, 25-39) chart 8. exports of food and agricultural products of bosnia and herzegovina to most important partners (in thousands of usd)16 it is interesting to note that only exports to croatia fell in the reporting period, while exports to other eu member states at the same time increased slightly. this can be explained by the fact that exporters who meet the required standards for food exports to the eu market, mainly choose to export to germany, italy or any other member state where they can get better prices of their products. however, the most significant trend that is obvious from chart 8 is a large increase in exports of food and agricultural products to the markets of countries that are not members of the european union. conclusion although the saa offered bih “on paper” a more liberal and favouringly asymmetrical foreign trade approach in relation to the cefta 2006 agreement valid until croatia’s accession to the eu, especially in the segment of the agricultural production circulation, the statistical data on mutual trade show unambiguous and significant reduction in the volume of foreign trade, more pronounced in bih export, particularly in the trade of agricultural products. this confirms once again that only several classes of non-tariff barriers have a decisive influence on at least a short-term negative bilateral trade impact of croatia’s accession to the eu, which bih tries to compensate by increasing exports to other traditional partners, first italy and germany (segment of industrial products in a timely manner focused on the eu core), then to nearby and brotherly serbia (segment of agricultural and food industry products that do not meet eu standards), but also to turkey as an export destination with a high presence of diaspora. since much milder decline in imports of bih from croatia is not accompanied by a significant comparative increase in direct foreign investments from croatia to bih, the volume of bilateral trade exchange could be increased in medium-term manner either by fulfilling different standards, certificates of compliance 16 source of data: bih agency for statistics of malović, m., et al., impact of croatia’s accession to the eu, ea (2016, vol. 49, no. 3-4, 25-39) 39 and certification laid down in the eu (which would result in an increase in bih exports) or by a possible incorporation of concessions that croatia enjoyed within the cefta 2006 in the saa with bih (which would result in an increase in bih imports). since in the latter case, the volume of trade increased in favour of croatia and at the expense of bih, the behaviour of the bosnian-herzegovinian exporters is somewhat rational. those who managed to timely achieve high and meticulous standards of production and trading on the eu single market, chose the segments of the market that are more capable of payment, while others waiting for more organized support of the state in the form of a coherent and systematic export promotion strategy of economic growth of bih (that is still missing), opted for neighbouring and less demanding markets outside the eu. reference balassa, b. 1961. “towards a theory of economic integration.” kyklos, 14(issue 1): 1-17, february. baldwin, r. and wyplosz, c. 2010. “evropska ekonomska integracija.“ (editors м. crnobrnja and m. malović), data status, belgrade. botrić, v. 2012. “intra-industry trade between the european union and western balkans: a close-up.” eiz working papers, no. 1202. watanabe, м. 2012. “the price of eu membership: implications of the stabilization and association agreement to the bosnia and herzegovina’s policy reform.” journal of international studies and research development, university of niigata prefecture, mimeo. jovanović, м. 2004. evropska ekonomska integracija. belgrade: faculty of economics, belgrade. mike a. and frederick n. 2007. the economics of european union. oxford university press. kovačević, м. 2002. međunarodna trgovina. belgrade: faculty of economics, university of belgrade. pelević, b. malović, m. vučković, v. 2004. uvod u međunarodnu ekonomiju. 4th edition. belgrade: cid faculty of economics, university of belgrade. internet links agency for statistics of bosnia and herzegovina: http://www.bhas.ba the republic of serbia, republic institute for statistics: http://webrzs.stat.gov.rs/website/ belgrade chamber of commerce: www.kombeg.org.rs/komora/udruzenja/udruzenjetrgovine.aspx?veza=1404 cefta trade portal: http://www.ceftatradeportal.com/ central bureau of statistics of croatia: http://www.dzs.hr/ eurostat: http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ europa.rs: http://www.europa.rs/ the world trade organization: http://www.wto.org article history: received: 25 november, 2016 accepted: 15 december, 2016 ea_2015_1-2 udc: 339.727.22 jel: g11, k33, o16 cobiss.sr-id: 216168460 preliminary reports foreign direct investments – the standard of fair and equitable treatment of investments on the example of a case of the international center for settlement of investment disputes (icsid) musabegović ismail1, union university, belgrade banking academy – faculty for banking, insurance and finance, belgrade, serbia galetin milena, educons university, faculty of business in service, sremska kamenica, serbia mitić petar, educons university, faculty of business economy, sremska kamenica, serbia abstract – foreign direct investments (fdi) have a tendency of growth, which will, in accordance with projections, be continued in the future. the increasing number of fdi triggers an increase in the number of cases related to them. after defining the term of international capital movements and its manifestations in the first part of the paper, in its second part the authors give an overview of foreign direct investment, both globally and in the region. the third part deals with the investment disputes before the arbitration court, while in the fourth section, a case of the international center for settlement of investment disputes (icsid) is presented. as the case of violation of the principle of fair and equitable treatment of investments is in the main focus of this paper, it is the subject of а deeper analysis. in this paper, the authors use methodology which is characteristic for social sciences: descriptive and historical method, comparative analysis and case study. key words: foreign direct investments, investment disputes, international investment arbitration introduction international movement of capital is present for more than a century, and the majority of capital flows are going from developed countries to the developing countries and underdeveloped countries. in other words, those who possess an extra capital are ready to place it in those countries that have a shortage of capital. as one of the most important forms of international capital movements, fdi play an important role in any economic system. besides the potential problems that fdi can produce in the receiving country, most of the authors agree that fdi are certainly desirable and have 1zmaj jovina 12, belgrade, serbia,ismail.musabegovic@bba.edu.rs musabegović, i., et al., fdi the standard of fair and equitabre, ea (2015, vol. 48, no. 1-2, 86-97) 87 an overall positive effects on the recieving economy. it is, nevertheless, important to emphasize that foreign investors might be faced with different obstacles when investing in the economy of other countries. therefore, during the negotiations in the course of implementation of the investment itself, as well as in case of a dispute, a special attention shall be directed towards the protection of foreign investors. in addition to other things, it is to be achieved through standards of treatment of investments and foreign investors. one of those is the standard of fair and equitable treatment, which is analyzed in this paper through an icsid case. international movement of capital the conflict between the growing global economic interdependence, as well as the fragmentation of world political and economic system, composed of sovereign states, is a constant potential problem in the area that regulates international money flows. this conflict, in essence, is the conflict between politics and economics. therefore, the relation between the state and the market, as the materialization of the relation between politics and economics, represents a significant factor in international development. this relation is becoming more often a common topic in theoretical debates, and most importantly because of the fact that strong market forces in the form of cash, trade and foreign direct investments are trying to override national borders, to avoid political control and to integrate the world, while the tendencies of the governments, i.e. national states, are to restrict, channel and place economic activities in the service of certain state interests. the market logic is to locate economic activities, where they are most productive, and the state logic is, in essence, to control the process of economic development (musabegović, 2007, p. vii). international movement of capital considers the transfer of real and financial assets between entities of different countries with delayed countertransference for a certain period of time, with the purpose of achievement of certain economic and political interests of the transfer participants (unković, 1980, p. 32). what stands out is the fact that, in the modern world ruled by globalization, international movement of capital is inevitable, because no country can exist as an independent entity, isolated from the need to import and export the capital. motives for movement of capital are different, such as: earning profits, development of production capacities for product placement to third markets, reducing the difference on the level of economic development between the countries, technology transfer and so called know how transfer, entering and winning the new markets, using cheaper labor force and cheaper raw materials for production, etc. there are three distinctive forms of international movement of capital: international lending or movement of loan capital, international portolio investments and foreign direct investments (rakita, 2006, p. 320). in the international economic relations the term loan capital implies the specific form of international movement of capital which transfers the purchasing power directly in the form of a loan from the country of the loan provider to the country of the loan recipient to be used for any kind of production or consumption purposes. the essence of loan capital is the tendency of international equalization of differences in supply of capital and the needs for capital from country to country (gračanac, 2009, p. 34-35). when we consider the portfolio investments those imply holding of foreign 88 economic analysis (2015, vol. 48, no. 1-2, 86-97) securities by local residents and vice versa. the sole objective of portfolio investors is gaining an income on the basis of securities, with no interest in control over the enterprise. the third form are foreign direct investments. “foreign direct investments (fdi) are the category of investment that reflects the objective of establishing lasting interest by a foreign investor (direct investor) in certain or any other legal entity (direct investment receiver) in an economy that is different from the one of the direct investor. the lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise, with the significant degree of influence on the enterprise management.” (oecd, 2008, p. 234). there are different forms of fdi, and a division to which most of the authors in this field agree indicates that there are following forms: (a) greenfield investments parent company (usually multinational corporation) starts a new venture in a foreign country by building a completely new operational, technological, organizational and financial infrastructure (b) brownfield investments a company with foreign investment initiates the operations in a building or in an area that has been previously used for manufacturing or other type of activities, where there is already a certain infrastructure existing (gračanac, 2009, p. 41) (c) joint ventures are business arrangements between two or more parties, usually economic entities, which have agreed to consolidate their resources in order to achieve the specific objectives of the partnership. joint ventures provide the advantages by reducing the risks in penetrating the new markets, by allowing the consolidation of resources for large investment projects, etc. each participant is responsible for profits, losses and expenses in connection with joint venture. moreover, there are two additional forms of fdi frequently mentioned in economic literature as separate forms. (d) cross-border acquisitions – take-over or incorporation of existing companies in one country to a company in another country. from a legal point of view, a company which is the subject of take-over ceases to exist. (e) crossborder mergers merging of two companies from different countries that continue to operate as a new, unique company. global and regional overview of fdi barrios, gorg and strobl (2005) state that fdi flows have increased dramatically over the last three decades or so, while moosa and cardak (2006) argue that fdi has assumed increasing importance over time, becoming a prime concern for policy makers and a trendy debatable topic for economists. this was further verified by sandalcilar and altiner (2012) who stated that the importance of fdis has increased almost in all countries with the globalization process intensified with 1980s due to their positive impact on economic growth. according to data from the world investment report 20142, after a decrease in 2012, fdi record an increase at the global level, in 2013 by 9%, to $1.45 trillion. developing economies were leading by fdi inflows in 2013. fdi flows to developed countries were increased by 9% to $566 billion (39% of global flows), while developing countries have reached a new maximum of $778 billion (54% of global fdi flows). a total of $108 billion were invested in 2 unctad, world investment report 2014, http://unctad.org/en/publicationslibrary/wir2014_en.pdf musabegović, i., et al., fdi the standard of fair and equitabre, ea (2015, vol. 48, no. 1-2, 86-97) 89 transitional economies. fdi outflows from developing countries also reached a record level. transnational corporations (tncs) from developing countries are increasingly investing in foreign companies from developed countries that are located in their regions, turning them into their branches. developing countries and countries in transition have jointly invested $553 billion i.e. 39% of global fdi outflows, compared with only 12% in the early 2000s. united nations conference on trade and development (unctad) projections are that fdi flows could rise to $1.6 trillion in 2014., $1.7 trillion in 2015. and $1.8 trillion in 2016. however, unctad notes that regional instability, political uncertainty and sensitivity in some emerging markets may negatively affect the expected increase of fdi (unctad, 2014, p. ix). lack of capital and modern technology, underdeveloped export channels and low domestic savings are characteristic for countries in transition. the inflow of fdi is significant primarily due to economic reforms and technological progress, human resource development, increase of foreign-currency reserves and creation of a competitive market. some countries in transition have limiting factors that reduce the inflow of fdi, affecting primarily the unprepared ones, and are related to: trade deficit, unemployment due to transformation of the ownership structure in the process of privatization, increasing the competition, as well as the balance of payments deficit that may occur due to a greater influx of these investments in the non-tradable goods sector. fdi inflows towards the countries in transition are taking place simultaneously with the abandonment of centrally planning systems while introducing modern market business mechanisms. the role of fdi in countries in transition grew in proportion to the speed of transformation and reform towards a market economy, while attaining a certain degree of economic stabilization and growth (veselinović, 2004, p. 31). in addition to the economic transformation, macroeconomic stability, the government's readiness to support fdi inflows, the adequacy of leading the economic policy, political factors (sanctions, wars, bilateral and multilateral agreements with other countries) are factors that influence the fdi. the following table shows the fdi inflows of selected countries of the region. table 1. fdi inflow in the countries of the region from 2004 to 2013. (million $) 2005. 2006. 2007. 2008. 2009. 2010. 2011. 2012. 2013. serbia 1.609 4.256 3.439 2.955 1.959 1.329 2.709 365 1.034 bosnia and herzegovina 595 555 1.819 1.002 251 230 435 366 332 albania 262 324 659 974 996 1.051 1.031 855 1.225 macedonia 97 433 693 586 201 211 422 93 334 montenegro 478 622 934 960 1.527 760 558 620 447 bulgaria 3.923 7.805 12.389 9.855 3.385 1.601 1.864 1.375 1.450 romania 6.483 11.367 9.921 13.909 4.844 2.940 2.670 2.748 3.617 croatia 1.788 3.423 4.925 5.938 3.346 490 1.517 1.356 580 source: world investment report 2007; world investment report 2008; world investment report 2012; world investment report 2014. 90 economic analysis (2015, vol. 48, no. 1-2, 86-97) bulgaria, romania and croatia, all three members of the european union (eu) had the most significant fdi inflows over the past ten years. the assumption of most of the experts is that this was primarily due to improved infrastructure and greater political and economic stability in these countries, which reduces the potential risks for foreign investors. an upward trend of fdi in most countries is noticeable until the drastic fall that was most evident in 2009, which was a direct consequence of the global financial crisis. at that time, fdi records a decrease in all countries except albania and montenegro. furthermore, if we look at other countries in the region, we can notice that during the crisis romania, bulgaria and croatia achieved significantly higher fdi inflows than other countries in the region, which again points to the importance of political and economic stability, and developed (or more developed) infrastructure. investment disputes together with the inflow of fdi, there has been a constant growth in the number of disputes between one state (host state) and investors (nationals of another contracting state)3. the majority of these cases have been entrusted to the international center for settlement of investment disputes (iscid), an autonomous international institution founded in 1966 on the basis of convention on the settlement of investment disputes between states and nationals of other states4. according to the icsid annual report 20135, the number of newly registered disputes that are solved before the center was 43. it represents the largest number of such cases in one fiscal year until now and indicates that icsid is very important institution regarding international investments and economic development.6anyhow, 3 this type of arbitration between individuals (natural persons/legal persons) and the state is of a more recent date, while the disputes between states with regard to this issue are known from the late 18th century. namely, the disputes related to foreign investments were international disputes between investor’s state and the receiving state, and they were based on diplomatic protection, which has been proved ineffective. see: singh, sachet and sharma, sooraj, investor-state dispute settlement mechanism: the quest for a workable roadmap (january 31, 2013). merkourios, vol. 29, no. 76, pp. 88-101, january 2013. available at: http://ssrn.com/abstract=2219248 and stanivuković, м., international arbitration, official gazette, 2013, pp. 26. 4 convention on the settlement of investment disputes between states and nationals of other states (the icsid convention), 575 unts 159, 4 ilm 524 (1965), also called the washington convention, concluded in 1965, entered into force in 1966; currently has 159 states signatories; the republic of serbia ratified the convention in 2007; it is interesting to note that some states abandoned the convention (for example, bolivia 2007, ecuador 2010, venezuela, 2012), see: schreuer, c., denunciation of the icsid convention and consent to arbitration, chapter 15 in “the backlash against investment arbitration”, waibel, m., kaushal, a., kyo-hwa chung, l., balchin, c., pp. 353-368, 2010, available at: http://www.univie.ac.at/intlaw/wordpress/pdf/denunciation_icsid.pdf 5 source: icsid annual report, available at: https://icsid.worldbank.org/icsid/frontservlet?requesttype=icsidpublicationsrh&actionval=view annualreports 6 the conditions for the dispute to be resolved by conciliation or arbitration organized by icsid are available at: www.worldbank.org. according to the unctad data for 2013, 61% of disputes between investors and the host state were resolved before the icsid, 26% before the uncitral, and 5% musabegović, i., et al., fdi the standard of fair and equitabre, ea (2015, vol. 48, no. 1-2, 86-97) 91 besides the resolving of investment disputes before the icsid, which are to be discussed in this paper, it is important to point out that there is a possibility that disputes between the host state and a foreign investor could be resolved before other institutions and in accordance with different rules, such as uncitral arbitration rules7, international chamber of commerce8, london court of international arbitration9, arbitration rules of the chamber of commerce in stockholm10, the dubai international arbitration center11 and others12. settlement of investment disputes before international court of arbitration is sometimes provided by bilateral investment treaty (bit)13 or the provisions of the multilateral / regional agreement, such as, for example, north american free trade agreement (nafta)14 and the energy charter treaty15 (ect). in the arbitration dispute, which is the subject of our analysis, the dispute between the company swisslion llc skopje and republic of macedonia, there was such an agreement agreement between the macedonian government and the swiss federal council on the promotion and reciprocal protection of investment, signed on 26 september 1996.16 infringement of standard of fair and equitable treatment of investment (fet) swisslion llc skopje v. macedonia (icsid case no. arb / 09/16) prior to reviewing the case, it is necessary to point out the characteristics of bit's concerning the protection of the foreign investor’s rights. namely, the majority of bilateral investment agreements foresees that, in the event of an investment dispute, it will be before the chamber of commerce in stockholm. source: unctad, recent developments in investor state dispute settlement (isds), may 2013, p. 4, http://unctad.org/en/publicationslibrary/webdiaepcb2013d3_en.pdf 7 arbitration rules of the united nations commission on international trade law, source: http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/2010arbitration_rules.html 8 international chamber of commerce arbitration rules, 2012, available at: http://www.iccwbo.org/products-and-services/arbitration-and-adr/arbitration/icc-rules-of-arbitration/ 9 london court of international arbitration, available at: http://www.lcia.org//dispute_resolution_services/lcia_arbitration_rules.aspx 10 stockholm chamber of commerce, arbitration institute of the stockholm chamber of commerce, available at: http://www.sccinstitute.com/skiljedomsregler-4.aspx 11 the dubai international arbitration center, available at: http://www.dubaichamber.com/en/about-us/initiatives/dubai-international-arbitration-center 12 as a rule, ad hoc arbitral tribunals act on the basis of the uncitral arbitration rules, while other systems of resolving disputes in arbitration contained herein are constitute the so called institutional arbitration. 13http://www.italaw.com/investment-treaties,https://icsid.worldbank.org/icsid/frontservlet according to the unctad, serbia has concluded 49 bits until june 1, 2013. 14 north american free trade agreement, 1992, http://www.naftanow.org/agreement/default_en.asp; 2012investment agreement between china, japan and south korea. 15 energy charter treaty, 1994, 34 ilm 360 (1995), http://www.encharter.org/fileadmin/user_upload/document/en.pdf 16 swisslion llc skopje v. macedonia, former yugoslav republic of (icsid case no. arb/09/16) 92 economic analysis (2015, vol. 48, no. 1-2, 86-97) resolved before the international arbitration (and not before the courts of the host country)17. in addition, bits generally contain the provisions which protect the foreign investors from expropriation, provide standard of fair and equitable treatment of investment (fet), the standard of national treatment, most-favored-nation treatment, full protection and security of investment.18 in the dispute swisslion llc skopje v macedonia, among other things, there was a violation of the standard of fair and equitable treatment (fet)19, which, according to some of the authors (maniruzzaman, 2012), more broadly could be considered as a breach of the principle of good faith and honesty, so it will be analyzed in more details. the prosecutor in this dispute-company swisslion llc from skopje initiated in 2009 the arbitral proceeding against the republic of macedonia, according to the arbitration rules of icsid, due to breach of the agreement between the macedonian government and the swiss federal council on the promotion and reciprocal protection of investment. the swisslion llc is a swiss company owned by rodoljub drašković, serbian citizen. the company has successfully operated in macedonia, and decided, at a certain point, to acquire shares of agropold, socially owned macedonian company facing bankruptcy. it was done in two installments – with the first installment swisslion llc acquired 26.58% stakes in agropold. soon after, swisslion llc won the tender where the government offered to sell agropold shares owned by macedonian fund for pension and disability insurance and thus gained additional 5,339 shares. finally, swisslion llc bought another 788 shares from private persons and thus became the majority owner in agropold, with a share of 55.72%. when the company swisslion llc succeeded in its intention and agropold began to operate efficiently and to make profit, the macedonian authorities have taken radical steps to restore its stake in agropold. according to claims of the company swisslion llc, macedonian authorities have requested from second basic court in skopje to order interim measures which would make the company unable to exercise its rights on the basis of agropold's shares. since this has not produced the expected results, the state attorney has initiated the proceeding against the company swisslion llc before the commission for securities, with the intention to freeze the second tranche of shares. the decision of the constitutional court was that the securities commission is not authorized to do so. the commission then issued an order that incapacitates the company swisslion llc to vote and gain dividend based on the part of shares acquired in the first tranche. however, the supreme court annulled this decision. after that, following the governments’ request, the court determines interim measures in order to restrict the disposal of shares from the second tranche. accordingly, the court makes a decision that the agreement on sale of shares (the agreement), which was 17 in fact, most of the modern bits contain a so-called cafeteria clauses that allow the foreign investors to choose whether to initiate proceedings before international arbitration court or a national court. closely related to this is the so-called fork in the road clause which means that once the choice has been made between these two options, it is binding. 18 see: cvetković, p., international law of of foreign investments, zadužbina andrejević, belgrade, 2007, pp. 22-32. 19 see: fair and equitable treatment standard in international investment law, oecd directorate for financial and enterprise affairs working papers on international investment, 2004. musabegović, i., et al., fdi the standard of fair and equitabre, ea (2015, vol. 48, no. 1-2, 86-97) 93 concluded when purchasing shares from the second tranche, was terminated and performs their transfer to the ministry of economy (ministry), without any compensation. macedonian officials have initiated the criminal proceeding against the general manager of the company swisslion llc, executive director of agropold and swisslion representatives, stressing that the company swisslion llc, wants to arrogate agropold by concluding a fictive loan agreement. as a mean of security for the fulfillment of this contract a mortgage was put over the society agroplod’s property. although the state attorney rejected all allegations, the following day the most important news in media was "criminal charges against agropold and swisslion", while the decision of the state attorney was never published. the company swisslion llc argued that there has been violation of the following provisions of the agreement: 1. macedonia illegally expropriated the shares of the second tranche, which is contrary to article 5. of the agreement 2. macedonia has failed to fulfill its obligations towards swisslion llc, and thereby violated article 12. of the agreement 3. macedonia unreasonably diminished the right of disposal of the company swisslion llc in the investment, which is contrary to article 4(1) of the agreement 4. macedonia treated the investment of company swisslion llc unjustly and unfairly, which is in contradiction with article 4(2) of the agreement.20 the arbitration court determined that macedonia violated the article 4(2) of the agreement because it failed to act in accordance with the principle of fair and equitable treatment towards the investment of the company swisslion llc, while other claims of the company swisslion llc, on violations of the provisions of the agreement, were rejected. as for the standard of fair and equitable treatment, the following is predicted by the agreement: each party shall, within its territory, ensure equitable and fair treatment to investments of investors of another contracting party ...21 court of arbitration considered that it was not necessary to go into a detailed analysis of the principle of fair and equitable treatment of investments, but it took into consideration the guaranties which foreign investors have on the basis of it22. moreover, interpretation of article 4 of the agreement should include the intention of the parties, which was stated in the preamble... among other things “creation and maintaining the favorable conditions in the territory of one contracting party/state for the investments by investors of the other 20 swisslion llc skopje v. macedonia, former yugoslav republic of (icsid case no. arb/09/16); onayeva, s., torterola, i., international arbitration case law, swisslion llc skopje v. the former yugoslav republic of macedonia, school of international arbitration, queen mary, university of london, https://docs.google.com/viewer?a=v&pid=sites&srcid=aw50zxjuyxrpb25hbgfyyml0cmf0aw9uy2 fzzwxhdy5jb218d2vifgd4ojq4ytvjztgzytdjm2nimgq 21 para. 272. 22 para. 273. 94 economic analysis (2015, vol. 48, no. 1-2, 86-97) contracting party” and recognizing “the need to promote and protect foreign investments with the aim of fostering the economic prosperity of both states”23. according to the opinion of the court of arbitration, there was a violation of the fet standard in this case, especially relating to the response of the ministry, or the lack of timely response to swisslion llc company’s requests that its investments were made in accordance with the contract of sale of shares; some actions of the securities commission; and finally, the publication that the ministry of internal affairs launched an investigation against the company swisslion llc, while the public prosecutor's decision has never been published24. in fact, taking into account all the facts, the court of arbitrationfound out that the ministry had an obligation to respond to swisslion company’s written and verbal requests about justification relating their decisions regarding investments25. there is also violation of fet in the failure of ministry to include company swisslion llc in consideration of questions regarding the violations of the agreement.26 as for the actions of the securities commission, the standpoint is that the request of the state prosecutor was aimed at imposing additional obligations to swisslion llc company through an administrative procedure27. besides that, the court of arbitration points out that the publication of the ministry of internal affairs, that an investigation was launched against the company swisslion llc, contributed to the deterioration of the status and reputation of the company swisslion llc in macedonia. also, the court of arbitration fully accepted the statement of the witness, the general manager of the company swisslion llc that all these actions caused a lot of media attention and affected both the production as well as the confidence that the company had among clients and suppliers.28 the court of arbitration in washington brought the decision that macedonia is obliged to pay the indemnity in the amount of 350,000 euros to swisslion llc company for the minor breach of fet standard in the bit concluded between switzerland and macedonia29. 23 para. 274. 24 para. 275, 276. 25 para. 285. 26 para. 291. 27 para. 296, see para. 292. etc. 28 para. 297-299. 29 according to dolzer: " in a broad sense, acceptance of the standard is a response to the danger of the “obsolescent bargain” which may threaten an investor who was welcomed by the host state before his investment, who sunk its money into the project, but who later on finds itself subject to the upper hand of the host state.... the acceptance of the standard is directly linked to the fundamental moral and legal grounding of the notion of fairness, anchored in a universally accepted sense of justice, but also in classic rules of customary law governing the protection of foreign nationals and companies... often is has been assumed that the traditional capital-exporting countries in general have stood for a wide version of the standard, whereas southern countries preferred a narrow one. however, from today’s perspective, this generalisation is flawed. what is well-known is that the united states has turned to a narrow approach. what has received less attention is that china, with the most bits worldwide except for germany, has adopted the widest possible approach, that is, an unqualified version of fet. essentially, the united states has become concerned about the need to defend cases concerning inward investments as respondent, while china has focused on its role as outward investor and the need for fair treatment of chinese investments abroad. in other words, the fet standard does not, at least not today, pitch northern and southern states against each other. the landscape of investment arbitration has been transformed musabegović, i., et al., fdi the standard of fair and equitabre, ea (2015, vol. 48, no. 1-2, 86-97) 95 conclusion the importance of fdi is undeniable, especially from the aspect of the receiving country. in our region, the fdi inflow was satisfactory, and most of the states recognized the positive effects of this form of international movement of capital. countries have created official incentives for foreign investors, such as: tax incentives, various subsidies and other incentives, shortening of procedures for registration of enterprises, etc. after the decrease of fdi inflow in the region, which was a direct consequence of the global financial crisis, there are significant potentials for increasing the inflow, on the basis of an extensive analysis of relevant institutions and authors, although we still have no quantitative confirmation of this tendency. with the expectation of an increased inflow, and the increased number of fdi in the region, it is necessary to pay due attention to the potential disputes that may arise as a result of the movement of capital, especially those that may arise between an investor who is a citizen of one country and another country – the receiving country. from the case presented in this paper, one can see the importance of conduct of the receiving country, and (dis)respect of the standard of substantive treatment of fdi, and that protection of fdi in the region is still not an adequate one. in the specific case of the securities and exchange commission of the former yugoslav republic of macedonia (msec) has violated the basic principles of investor protection, making regulatory and supervisory role of the international organization of securities commissions (iosco) meaningless. in this way, msec has sent a message to future investors that there are still significant difficulties in applying market mechanisms. all in all, market mechanisms were not applied, or are being applied selectively, and only in certain cases, and to a certain point these mechanisms are respected and have institutional support. references arbitration rules of the united nations commission on international trade law,http://www.uncitral.org/uncitral/en/uncitral_texts/arbitration/2010arbitration_rules. html(17.10.2014). barrios, s., gorg, h., & strobl, e. 2005. „foreign direct investments, competition and industrial development in the host country.“european economic review, 49, 1761-1784. convention on the settlement of investment disputes between states and nationals of other states (the icsid convention), 575 unts 159, 4 ilm 524 (1965). cvetković, p. 2007.međunarodno pravo stranih investicija.beograd: zadužbinaandrejević. dolzer, r. 2014.fair and equitable treatment: today’s contours, 12 santa clara j. int’l l. 7 gračanac, a. 2009.globalno bankarstvo. fakultet za uslužni biznis, sremska kamenica. international chamber of commerce arbitration rules, http://www.iccwbo.org/productsand-services/arbitration-and-adr/arbitration/icc-rules-of-arbitration/(17.10.2014). in the past decade, and the role of fet with it". source: dolzer, r., fair and equitable treatment: today’s contours, 12 santa clara j. int’l l. 7 (2014), pp 12, 13; http://digitalcommons.law.scu.edu/scujil/vol12/iss1/2 96 economic analysis (2015, vol. 48, no. 1-2, 86-97) london court of international arbitrationhttp://www.lcia.org//dispute_resolution_services/lcia_arbitration_rules.as px(17.10.2014). maniruzzaman, m. 2012. „the concept of good faith in international investment disputes – the arbitrator’s dilemma“, http://klуwerarbitrationblog.com/blog/2012/04/30/the-concept-ofgood-faith-in-international-investment-dispуtes-%e2%80%93-thearbitrator%e2%80%99s-dilemma-2/ (02.11.2014). moosa, i., and cardak b. 2006. „the determinants of foreign direct investment: an extreme bounds analysis.“journal of multinational financial management, 16: 199-211. musabegović, i. 2007.transnacionalne korporacije i globalni finansijski tokovi.beograd: beogradska bankarska akademija. north american free trade agreement, http://www.naftanow.org/agreement/default_en.asp (17.10.2014) oecd directorate for financial and enterprise affairs working papers on international investment, fair and equitable treatment standard in international investment law, 2004. oecd, oecd benchmark definition of foreign direct investment, 4th editionhttp://www.oecd.org/fr/daf/inv/statistiqуesetanalysesdelinvestissement/fdibench markdefinition.htm (15.10.2014.) rakita, b. 2006.međunarodni biznis i menadžment.beograd: ekonomski fakultet. sandalcilar, a. r., & altiner a. 2012. #foreign direct investment and gross domestic product: an application on eco region (1995-2011).“international journal ofbusinessand social science, 3(22): 189-198. schreuer, c.2010.denunciation of the icsid convention and consent to arbitration, chapter 15 u “the backlash against investment arbitration”,waibel, m., kaushal, a., kyo-hwa chung, l., balchin, c. stanivuković, m. 2013.međunarodna arbitraža.belgrade: službeni glasnik. stocholm chamber of commerce arbitration institute of the stocholm chamber of commerce, http://www.sccinstitute.com/skiljedomsregler-4.aspx (17.10.2014) swisslion llc skopje v. macedonia, former yugoslav republic of macedonia (icsid case no. arb/09/16) the dubai international arbitration center, http://www.dubaichamber.com/en/aboutus/initiatives/dubai-international-arbitration-center, (17.10.2014) unctad, recent developments in investor state dispute settlement (isds),http://unctad.org/en/publicationslibrary/webdiaepcb2013d3_en.pdf (17.10.2014) unctad, world investment report 2007, http://уnctad.org/en/docs/wir2007_en.pdf (10.11.2014.) unctad, world investment report 2008,http://уnctad.org/en/docs/wir2008_en.pdf(10.11.2014.) unctad, world investment report 2012,http://уnctad.org/en/pуblicationslibrary/wir2012_embargoed_en.pdf (10.11.2014.) unctad, world investment report 2014,http://уnctad.org/en/pуblicationslibrary/wir2014_en.pdf (10.11.2014.) unkovic, m. 1980.međunarodnokretanjekapitalaipoložajjugoslavije.belgrade: naučnaknjiga. musabegović, i., et al., fdi the standard of fair and equitabre, ea (2015, vol. 48, no. 1-2, 86-97) 97 veselinović, p. 2004.“uticaj stranih direktnih investicija na razvoj nacionalne ekonomije.”ekonomski horizonti, 6(1-2): 29-42. ekonomski fakultet univerziteta u kragujevcu. strane direktne investicije – standard poštenog i pravičnog tretmana investicija na primeru slučaja međunarodnog centra za rešavanje investicionih sporova (icsid) rezime – strаne direktne investicije (sdi) imаju tendenciju rаstа. premа projekcijаmа, ovаj trend će se održаti i u budućnosti. sve veći broj sdi izаzivа i povećаnje brojа slučаjevа koji se odnose nа njih. nаkon definisаnjа pojmа međunаrodnog kretаnjа kаpitаlа i njegovih mаnifestаcijа u prvom delu rаdа, u drugom delu аutori dаju pregled strаnih direktnih investicijа, kаko u svetu tаko i u regionu. treći deo se bаvi investicionim sporovimа pred аrbitrаžnim sudom, а potom, u četvrtom delu je prikаzаn slučаj međunаrodnog centrа zа rešаvаnje investicionih sporovа (icsid). kаko je slučаj kršenjа stаndаrdа poštenog i prаvičnog tretmаnа investicijа u fokusu ovog rаdа, on je detаljnije prikаzаn. u ovom rаdu korišćenа je metodologijа kаrаkterističnа zа društvene nаuke: deskriptivni i istorijski metod, uporednа аnаlizа i studijа slučаjа. ključne reči: strаne direktne investicije, investicioni sporovi, međunаrodnа investicionа аrbitrаžа article history: received: 1april , 2015 accepted: 2 june, 2015 doi: 10.28934/ea.22.55.1.pp30-47 original scientific paper just-in-time strategy implementation challenges and the organizational structure dimensions jelena erić nielsen1 | vesna stojanović aleksić1 | ana todorović spasenić16f* 1 the university of kragujevac, faculty of economics, department for management and business administration, kragujevac, serbia abstract the implementation of the just-in-time (jit) strategy will be successful only if each individual in the organization is maximally involved and committed to independent work tasks, with a maximum contribution to teamwork with other employees and active participation in decision making, but also planning, organizing and activity control. this research starts from the assumption that the way of organizing production lines, teamwork of employees and relationships with suppliers, as factors of successful implementation of jit strategy, determine the parameters of the organizational structure of production companies in serbia, whose output does not have the status of the final product, but other companies use it as an input in production. the subject of the research is a detailed analysis of the impact of the implementation of jit strategy on the organizational structure of the production company, in order to point out the importance of harmony in the relationship between jit strategy the parameters of organizational structure. the goal of the research is to crystallize the strength of the relationship between the organizational structure dimensions-factors of successful implementation of the jit strategy, aiming to make relevant theoretical and practical conclusions about the impact of each dimension of the organizational structure on achieving the maximum benefit of implementation jit strategy by manufacturing companies. the research results showed that an adequate organizational structure is a pillar of efficient and effective implementation of jit strategy in this category of manufacturing companies, because this production model requires strong cooperation within the company, where plants and processes must be arranged to generate efficiency and increasing productivity, while minimizing the total cost of production. internal cooperation, whose pillar is a decentralized type of organizational structure, and cooperation with suppliers are key prerequisites for manufacturing companies, without or with minimal inventories, to ensure that production size meets demand requirements quickly and efficiently. key words: jit strategy, organizational structure, internal cooperation, cooperation with suppliers jel classification: m10, m11, d20, d24, l11, l23 introduction producing only as much as required, in the smallest possible batches, with the fewest errors allowed, and in possibly short cycles, is the basis for the successful implementation of a just in time (jit) strategy by manufacturing companies. customer orders dictate the course of the process, determine what will be procured and to what extent, as well as what will be produced and in what period, while neutralizing the costs of keeping stocks of materials and finished * corresponding author, e-mail: vesnasa@kg.ac.rs jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 31 products. the organizational structure that encourages the commitment and teamwork of employees in the processes of planning, organizing and controlling is one of the key factors for the success of production without warehousing/stocking, as production based on the just in time principle is often called. the subject of the research is the analysis of interdependence in relation to the factors of successful implementation of the jit strategy the dimensions of the organizational structure of the company. given that the defined goals of the company are the basis for the formation of the strategy, it is clear that there is a conditional connection between the strategy and the organizational structure. the business practice has shown that change in strategy affects a change in organizational structure (e.g. expansion of the market requires changes in the production program, work organization and staff training), but also that changes in organizational structure may be conditioned by non-strategic moves (e.g. unplanned capacity reduction). a chief benefit of the jit business strategy is that it provides a substantial cost saving and continuous product improvement, thus enhancing the business profitability (green & inman, 2006; abdallah & matsui, 2007; bond, green, & inman, 2020). the parameters of organizational structure are an important factor in the successful implementation of the jit strategy (germain, droge, & daugherty, 1994; white, ojha, & ching-chung, 2010; kartika & wijaya, 2015; phogat & gupta, 2017; smith, 2019; taghipour, hoang, & cao, 2020), and therefore they must be harmonized as to achieve the following goals: reducing storage and handling costs, reducing the need for working capital and improving the competitive advantage of the company. the main goal of the research is to point out that the organizational structure of the company must be adjusted to the goals and strategy opted for, in this case the jit strategy, and it is important to take into account the existence of an inverse relationship in interdependence. all previous research on the relationship between the implementation of the jit strategy and the parameters of the organizational structure analyses the interdependence in one direction, while this research seeks to indicate the existence of consistency between the variables in both directions, with special reference to business practice manufacturing companies whose customers do not have the status of final consumers. this research, compared to previous research on this topic, performed a different grouping of success factors of the jit concept, in accordance with the specifics of business practices of manufacturing companies that do not produce consumer goods. literature review challenges of jit strategy implementation just in time (jit) is a business philosophy that extends throughout the organization and emphasizes a proactive approach to operations management (mazany, 1995). it is considered a production methodology that aims to improve overall productivity through waste removal and quality improvement. in the manufacturing/assembly process, jit ensures cost-effective production and delivery of only the required quality parts, in the right quantity, at the right time and in the right place, using minimal equipment, materials and human resources (voss & robinson, 1987). the implementation of the jit strategy is based on the elimination of all waste sources during purchasing, production and sales activities (claycomb, germain, & dröge, 1999). it is a strategy whose basic idea is the organization of production based on the timely management and movement of goods (ahmad, mehra, & pletcher, 2002; green & inman, 2006; abdallah & matsui, 2007; bond, green, & inman, 2020). each production company, oriented to the realization of jit strategy goals, in accordance with the specifics of its production activity, must develop its own production management process, which aims at efficient and timely planning of enterprise resources (erp) which is a link between harmonization of market requirements process (shingo & dillon, 1989; turnbull, olivert, & wilkinson, 1992). in a large number of manufacturing companies, especially those that do not produce consumer goods, all processes are initiated by 32 economic analysis (2022, vol. 55, no. 1, 30-47) the customer (turnbull, olivert and wilkinson, 1992; fiedler, galletly and bicheno, 1993; smith, 2019), which dictates what and to what extent production dynamics will be procured, without accumulating stocks of materials and finished products. bae and kim (2008) argue that prefabrication and jit delivery are important components of the lean procurement system. behrouzi and wong (2011) believed that there are four performance measures to assess supply chain performance lean: waste elimination, continuous improvement, jit, and flexibility. hopp and spearman (2004) concluded that efficient and effective supply chain management and customer/supplier relationship management is key support for the successful implementation of the jit concept. these authors point out that it is wrong to equate the concept of jit with "make-to-order production" (hopp & spearman, 2004), because this type of production organization will not contribute to the realization of jit goals without implementing continuous improvement, kanban system, even production load, employee involvement, standardization and total productive maintenance. the key factors for the successful implementation of the jit strategy can be classified into three categories (koufteros & vonderembse, 1998; abdallah & matsui, 2007; kartika & wijaya, 2015; barkhordari & denavi, 2017; liu & nishi, 2020): • organization of production lines successful implementation of jit strategy is determined by the way of organization of production lines, ie. the jit concept requires equipment layout of setup reduction and the implementation of preventive maintenance, with the aim of reducing the risk of production downtime and the implementation of the kanban pull system (system of maximum control of stock levels and reduction of overproduction). the authors (white & ruch, 1990; davy et al., 1992) emphasize the “equipment layout of setup reduction” as an important factor in the success of the implementation of jit production concept, but the analysis of the business practice of manufacturing companies found that the machines in the surveyed companies are distributed by plants according to the criterion of similarity. there are clearly defined norms for these activities, and their observance is monitored through the records of the duration of all work operations on the given machines (companies keep these records manually, through excel spreadsheets or information systems). all deviations in the defined norms are a signal for taking corrective measures in the form of redeployment of equipment and additional training of employees in order to reduce the time spent. that is why in further research the factor “equipment layout of setup reduction” is integrated into the factor “monitoring the duration of work operations”, because recording the time consumption for all activities on the machine, including settings, it gets insight into what needs to be corrected and improved in the organization of production lines, in order to generate the realization of jit goals. • relationships with suppliers building long-term partnerships with suppliers, based on fairness, trust and loyalty, ensures the timely delivery of basic materials, which ensures compliance with the agreed deadlines for delivery of the final product to customers. partnerships with suppliers are an important factor in jit procurement, as soon as it directly affects the reduction of inventory costs (abdallah & matsui, 2007; phogat & gupta, 2017). building long-term partnerships with suppliers has stood out in business practice as one of the key factors for quick and efficient response to changes in procurement needs and compliance with agreed delivery deadlines, especially in conditions of disturbances in the global market like the current ones caused by the covid-19 pandemic. there was a delay in the procurement of goods, primarily from imports, due to retention at the borders and epidemiological measures. representatives of the surveyed companies, filling in the questionnaires, clearly stated that the partnership is an important driver of compliance with delivery deadlines, but that in a pandemic, it is an important factor in minimizing delays. jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 33 • teamwork of employees teamwork of employees, in the field of decision making and problem solving, is one of the key predictors of generating motivation of employees to maximally contribute to achieving the goals of jit concept implementation (fullerton & mcwatters, 2001; abdallah & matsui, 2007; phogat & gupta, 2017; taghipour, hoang, & cao, 2020). chang and lee (1996) pointed out that continuous training of employees is important for the successful implementation of the jit concept, but that communication and teamwork among employees much more determine the success in achieving goals. it is very important to stimulate teamwork and communication among employees, especially in the field of knowledge and experience exchange, because in this way it will stimulate faster and more efficient solution of all business problems, but also the improvement of business in all domains. • implementation of quality management system (qms) defining qms procedures and external verification of their compliance (factors “total quality control” and “focused factory”), in accordance with qms regulations, is one of the important factors for successful implementation of the jit concept (white & ruch, 1990; davy et al., 1992; phogat & gupta, 2007). this factor is not included in the analysis of business practice because all surveyed companies have verified business in accordance with iso9001, which is the result of qms principles and standards that are checked every year by external auditors, and the award of certificates of all processes. the advantages of implementing the jit strategy in production and sales are: improving product quality, safer production flow, higher productivity, reducing storage and handling costs, reducing the need for working capital and improving the competitive advantage of the company. the previously listed advantages most often outweigh the implementation problems: missed sales contracts, production delays caused by delays in raw materials, high logistics management costs, and an increase in transportation costs per unit of shipment. organizational structure as a factor of the successful implementation of the jit strategy the organizational structure, as an important base of a company's competitive advantage, should be proportional to the organizational goals and capabilities of employees (soltani, altaha, & taheri, 2013). the goals and strategy of the company are one of the most important internal factors that determine the organizational structure. without an adequate organizational structure, it is not possible to generate an efficient and effective implementation of any business strategy, as shown by the author's research on this topic over the last thirty years (hall & saisas, 1980; miller, 1986; galbraith, 2002; brayan & joyce, 2007; chan kim & mauborgne, 2009; tran & tian, 2013; bozkurt, kalkan, & arman, 2014). the parameters of the organizational structure are an important factor in generating the motivation of employees to maximally contribute to the realization of set business goals. the organizational structure also stood out as an important factor in the successful implementation of the jit strategy in supply, production and sales (phogat & gupta, 2017; smith, 2019; taghipour, hoang & cao, 2020; liu & nishi, 2020). numerous studies on the factors of successful jit strategy implementation have indicated a significant impact of organizational structure parameters on generating jit strategy implementation goals, primarily cost reduction, continuous product improvement and improving business profitability (germain, droge, & daugherty, 1994; white, ojha, & ching-chung, 2010; kartika & wijaya, 2015; phogat & gupta, 2017; smith, 2019; taghipour, hoang, & cao, 2020). each of the dimensions of the organizational structure influences some of the factors of successful implementation of the jit strategy. business efficiency and harmonization of employee behaviour in the company are determined by the dimensions of the organizational structure (hall & saias, 1980; galbraith, 2002; clavercortes, pertusa-ortega & molina-azorin, 2012). the organizational structure allows employees to 34 economic analysis (2022, vol. 55, no. 1, 30-47) understand their roles and contributes to easier coordination, control and communication. it is a central structural dimension of organizational design that must be aligned with the goals, strategy, specifics of process technology and the specifics of the environment in which a particular company operates (miller, 1986; kavale, 2012; soltani, altaha, & taheri, 2013; tran & tian, 2013). formal regulation of business units and activities, as well as defining the relations between these components, is in fact a system that has been designed in the long run and formally sanctioned by company documents. the dimensions of organizational structure can be classified as follows (hax & majluf, 1983; miles & snow, 2003; brayan & joyce, 2007; chan kim & mauborgne, 2009; kavale, 2012; villadsen, 2013): • specialization specialization of individuals and organizational units is the result of the division of labour as a basic activity of organizational design in the company. the division of labour has its horizontal and vertical dimensions. the horizontal dimension refers to the number of work tasks performed by one individual in the company, and the vertical dimension shows whether the individual is only the executor of the work or can control the work he performs. this parameter of the organizational structure provides insight into the level of concentration and stress of individuals in the company during the performance of work tasks, as well as the degree of employee turnover. • departmentalization departmentalization is the division of companies into narrower organizational units and defining their size. grouping organizational units creates an image of the organizational structure of the company, which is shown through the organizational scheme. the main focuses of departmentalization are goal orientation, specialization of executors and the range of control based on minimizing the number of subordinates to one manager. • coordination/control coordination/control is a parameter of the organizational structure that provides a strong connection between the organizational parts of the company. companies use one or combine several coordination/control mechanisms: 1) the existence of a chain of command, based on the harmonization of objectives at different levels of the hierarchy and supervision during their implementation, 2) standardization of inputs, work processes and outputs, 3) representation of mutual harmonization as a form coordination, based on equal and professional relationship and direct communication of participants in the execution. • centralization centralization and decentralization are manifestations of the delegation of authority, the process of delegating decision-making authority from senior executives to lower-ranking executives. centralization means control from one place in the company, and decentralization means the division of control from several places in the company. the level of horizontal and vertical centralization, as well as the complexity of communication channels provide a complete insight into the centralization of management/decision-making in the company. vertical centralization is an indicator of centralization in the domain of strategic decision-making for the entire company, and horizontal centralization in the domain of decision-making at the level of the organizational unit. the high level of centralization of management/decision-making is characterized by the complexity of communication channels, which is often highlighted as one of the key shortcomings of this emerging form of delegation of authority. a large number of researches can be found in the literature on the topic of the importance of harmonization of organizational structure and jit strategy for improving organizational performance. claycomb, germain, and dröge (1999) surveyed 200 logistics companies to identify the impact of jit strategy implementation on business performance, including organizational performance, mentioning the importance of organizational structure-jit strategy compliance to generate performance improvement. abdallah and matsui (2007), in their research on the impact of jit production on the performance of this system, mentioned the importance of organizational jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 35 design for generating jit strategy implementation goals. kartika and wijaya (2015) also pointed out the importance of the human resources sector in generating compliance in relation to organizational structure implementation of jit strategy in sales. barkhordari and denavi (2017) cite the alignment of organizational design and jit strategy as one of the important predictors of establishing efficient and effective supply chain management. the organizational structure was also mentioned as a factor in the successful implementation of the jit supply strategy by the authors liu and nishi (2020), emphasizing that the success of the implementation of this strategy significantly depends on achieving the goals of the supply chain management. koufteros and vonderembse (1998) investigated in more detail the impact of organizational structure on the level of success of jit strategy implementation. the authors pointed out that the jit production system is a kind of innovation that generates a competitive advantage for companies. organizational design stood out as the basis for generating maximum benefits from the implementation of the jit strategy, including improving competitiveness. the focus of the study was on centralization, complexity and formalization as characteristics of the organizational structure that determine the success of jit strategy implementation. the impact of the implementation of the jit strategy on the dimensions of the organizational structure of the company has been demonstrated in the research of the authors green, inman, and birou (2011). the authors pointed out that the organization of production lines, cooperation with suppliers and teamwork of employees are important factors in generating goals for the implementation of the jit strategy. specialization and decentralization stood out as parameters of the organizational structure with the greatest impact on the success of the implementation of the jit strategy in sales. this study confirmed the conclusions of germain, droge, and daughtery (1994), as well as green and inman (2006). the authors pointed out that high specialization and decentralized management/decision-making are the parameters of the organizational structure that most contribute to the realization of the positive effects of the jit strategy on building long-term partnerships with customers. the previously listed researches argue that the successful implementation of the jit strategy in supply/production/sales significantly depends on the organizational structure of the company. the dimensions of the organizational structure actually represent the base of generating the goals of the jit strategy implementation. the high level of integration among employees in the company, specialization (high horizontal and low vertical), performance control and active participation in decision-making, stood out as the characteristics of the organizational structure that contribute most to improving the competitive advantage of companies that implement this strategy. the implementation of the jit strategy is more successful with the support of an appropriate organizational structure (kartika & wijaya, 2015; smith, 2019). research design and results the initial research model (figure 1) and hypotheses were formulated on the basis of analysis of professional and scientific literature from the domain of the influence of organizational structure dimensions on the success of jit strategy implementation, using the following research methods: descriptive method, analysis and synthesis method, inductive and deductive method. the combination of the previously listed methods generated the necessary data for compiling the questionnaire, which had the status of a basic tool in the research. empirical research was conducted, using the survey method, with the aim of processing the collected data, a combination of descriptive, correlation and regression statistical analysis, to crystallize the impact of organizational structure dimensions on the success factors of jit strategy implementation, and thus confirm or challenge the results of previous research topic. 36 economic analysis (2022, vol. 55, no. 1, 30-47) methodology and sample in order to identify the impact of the implementation of the jit strategy on the dimensions of the organizational structure of the company, an empirical study was conducted on a sample of 63 companies in the republic of serbia (company headquarters classified according to statistical regions of the republic of serbia). the research included companies from the domain of the production sector of the economy 40% of companies belong to the industrial sector, and 60% to the sector of manufacturing crafts (the structure of the sample is shown in table 1). the sample structure is dominated by large and medium-sized manufacturing companies. data were collected by the method of employee surveys, during september 2020. the questionnaire was sent to the e-mail addresses of 69 production companies in the territory of the republic of serbia, and the response rate was 91%. all surveyed companies operate in accordance with the requirements of iso 9001 standard (have qms certificates) and produce goods that are not intended for final consumers, but are used as material/semi-finished product/spare part in other manufacturing companies. a simplified baseline research model is shown in figure 1. figure 1. baseline model for research of the relationship between factors of successful implementation of jit strategy and dimensions of organizational structure source: authors’ research the initial hypotheses on which the research is based are (figure 1): h1: the way of organization of production lines, as a factor of successful implementation of jit strategy, determines the dimensions of organizational structure. h2: supplier relations, as a factor in the successful implementation of the jit strategy, determine the dimensions of the organizational structure. h3: teamwork, as a factor of successful implementation of jit strategy, affects the dimensions of organizational structure. table 1. profile of surveyed companies (n = 63) profile of surveyed companies number of companies (n) percentage (%) manufacturing activity industry 25 40% manufacturing craft 38 60% headquarters (criterion statistical regions of the republic of serbia) belgrade 12 19% east serbia 7 11% west serbia 17 27% south serbia 9 14% šumadija 6 10% vojvodina 12 19% years of business jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 37 profile of surveyed companies number of companies (n) percentage (%) up to 10 years 15 24% 10-20 years 29 46% over 20 years 19 30% source: authors’ research the factors of successful implementation of the jit strategy have the status of independent variables, and the dimensions of the organizational structure have the status of dependent variables. all previously listed variables are evaluated over three statements, using a five-point likert scale. representatives of the surveyed companies, by filling out the questionnaire, expressed their views on the statements, with grades from 1 to 5, where 1 means "absolutely disagree with the given statement", and 5 "absolutely agree". the collected data were processed through spss software, with descriptive, correlation, and regression statistical analysis. descriptive statistical analysis was conducted with the aim of assessing the homogeneity of data by enterprises. the focus of the correlation analysis was a detailed analysis of the existence and strength of the relationships among all the variables that are the subject of the research. after that, a regression analysis was conducted, with the aim of identifying the impact of independents on the dependent variables, which will highlight the dimensions of the organizational structure that dominantly determine the success of the implementation of the jit strategy. research results the obtained results of descriptive statistical analysis are presented in tables 2 and 3. according to the variables, for each of the statements, by implementing descriptive statistics, the arithmetic mean and standard deviation were calculated. table 2 presents the results of descriptive statistics for findings related to independent variables factors of successful implementation of jit strategy in manufacturing companies, and table 3 results related to dependent variables dimensions of organizational structure of manufacturing companies in the republic of serbia. table 2. results of descriptive statistical analysis factors of successful implementation of jit strategy statements relating to independent variables mean std. deviation organization of production lines monitoring the time duration of operations in the production 3.46 1.2550 implementation of preventive maintenance with the aim of reducing the risk of production downtime 2.84 1.0350 implementation of kanban pull system 3.44 1.2924 relationships with suppliers intensive work on the development of long-term partnerships with suppliers 3.81 1.0295 timeliness of deliveries by strategic suppliers 3.18 1.1150 quality of delivery of strategic suppliers 3.62 0.7917 teamwork teamwork on improving the quality of production 3.78 1.0387 teamwork on improving the cost efficiency of production processes 3.41 1.0570 teamwork in the field of problem-solving 3.33 0.9672 source: authors’ research the table 2 presents the current situation in the field of implementation of jit strategy by manufacturing companies in the republic of serbia. it can be noticed that most attention is paid to intensive work on the development of long-term partnerships with suppliers of strategic 38 economic analysis (2022, vol. 55, no. 1, 30-47) materials (arithmetic mean 3.81), with the aim of ensuring timely deliveries (arithmetic mean 3.18) of materials of satisfactory quality (arithmetic mean 3.62), without unnecessary stockpiling. significant attention is paid to teamwork among employees, primarily in the field of improving the quality of production (arithmetic mean 3.78) and generating cost efficiency (arithmetic mean 3.41). the negative side of the current situation in the field of implementation of jit strategy by companies in serbia is the fact that the least attention is currently paid to the implementation of preventive maintenance, with the aim of reducing the risk of production downtime (arithmetic mean 2.84). although the representatives of the surveyed companies gave satisfactory assessments regarding the monitoring of the duration of production operations (arithmetic mean 3.46) and the implementation of the kanban pull system (arithmetic mean 3.44), the fact is that insufficient commitment to preventive maintenance can lead to collapse in the production process and cancel positive effects of previously enumerated determinants of the organization of production lines. the values of the standard deviation, for all statements, range from 0.79171.2924, which indicates a similar degree of disagreement (heterogeneity) of the respondents in the assessments of all nine statements. table 3 presents the specifics of organizational structures of the surveyed companies. it can be noticed that all parameters of the organizational structure were evaluated in the range of 3.033.65, which implies the existence of moderate specialization (arithmetic mean 3.59), i.e. employees, as representatives of the surveyed companies, stated that in them there is a moderate range of activities assigned to one job, but there is no independence in performing tasks and controlling their execution in each company. some of the surveyed employees stated that this is one of the advantages of the companies in which they work, and these are employees who value work with less concentration and stress (average score 3.56). regarding the criteria for grouping organizational units, the orientation towards goals (arithmetic mean 3.65) and the orientation towards the specialization of executors (3.56) dominate, which coincides with the existence of moderate specialization. the existence of a chain of command, based on the harmonization of objectives at different levels of the hierarchy and supervision during their implementation, and the standardization of inputs/work processes/outputs are predominantly coordinated / control mechanisms in the surveyed companies (arithmetic mean 3.62). in the surveyed companies, there is a mediocre centralization in the domain of decision-making, somewhat higher in the vertical than in the horizontal direction, with the lack of excessive complexity of communication channels (arithmetic mean 3.09). the values of the standard deviation range from 0.8837-1.3779, which implies the existence of relative homogeneity of the respondents' attitudes regarding the parameters of the organizational structure in the production sector of the republic of serbia. table 3. results of descriptive statistical analysis – dimensions of organizational structure statements relating to dependent variables mean std. devaition specialization there is a high level of specialization horizontally/vertically 3.59 1.1018 work with less concentration and stress 3.56 1.1184 high degree of fluctuation due to monotony 3.27 0.8837 departmentalization goal orientation as a focus of departmentalization 3.65 1.0948 execution specialization as a focus 3.56 1.0743 range of control focus on minimizing the number of subordinates to one manager 3.51 1.1053 coordination/control existence of a chain of command 3.62 1.0690 standardization of inputs, workflows and outputs 3.62 1.0690 representation of mutually harmonization 3.44 1.0438 centralization high centralization in the horizontal direction 3.05 1.2238 jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 39 statements relating to dependent variables mean std. devaition high centralization in the vertical direction 3.14 1.3779 complexity of communication channels 3.03 1.2948 source: authors’ research for each of the previously listed independent and dependent variables, a reliability analysis was performed according to cronbach’s alpha coefficient model, whose values range from 0 to 1 (leech, barrett, & morgan, 2005). nunnally (1978) recommends that the confidence threshold should not be less than 0.7, which is not violated in this study (table 4). table 4. values of cronbach's alpha coefficients reliability of statements variable cronbach’s alpha organization of production lines 0.977 relationships with suppliers 0.914 teamwork 0.954 specialization 0.952 departmentalization 0.981 coordination/control 0.985 centralization 0.961 source: authors’ research after the reliability analysis, a correlation analysis of all variables was performed in order to identify the relationship that exists between each of them. the results presented the existence of a statistically significant correlation among all variables that are the subject of research. all statistically significant correlations are indicated in table 5 with ** (** denotes p≤0.01). guided by cohen's recommendation (cohen, 1988), all correlations can be considered strong because the relationship between each of the two variables is shown by a correlation coefficient greater than 0.5, which is an indicator of a strong relationship. a statistically significant positive correlation was identified between all factors generating the successful implementation of the jit strategy, as well as between these factors and specialization, departmentalization and coordination/control, as parameters of organizational structure (r>0.9). statistically significant, strong, negative, the correlation was observed in the relation of centralization-factors of successful implementation of jit strategy, which implies that centralized management and decision-making negatively affects the efficient and effective implementation of jit strategy of surveyed companies. the existence of a negative correlation was identified between centralization and other dimensions of the organizational structure, which indicates that the surveyed companies do not apply fully centralized management and decision-making because they are aware of their negative impact on business and the positive effects of jit supply/production/sales strategy. this confirmed the results of research on the negative impact of centralization on the creation of an organizational design that will encourage the best possible results of the implementation of the jit strategy. table 5. results of correlation analysis organization of pl relationships with suppliers teamwork specializ. depart. coord/control centr. organization of pl 1 0.950** 0.978** 0.965** 0.965** 0.962** -0.879** relationships with suppliers 0.950** 1 0.966** 0.937** 0.928** 0.920** -0.839** teamwork 0.978** 0.966** 1 0.965** 0.967** 0.962** -0.862** specialization 0.965** 0.937** 0.965** 1 0.928** 0.987** -0,905** departmentalization 0.965** 0.928** 0.967** 0.982** 1 0.989** -0.872** coordination/control 0.962** 0.920** 0.962** 0.987** 0.989** 1 -0.884** centralization -0.879** -0.839** 0.862** -0,905** -0.872** -0.884** 1 *pl-production lines source: authors’ research 40 economic analysis (2022, vol. 55, no. 1, 30-47) after the correlation analysis, four regression analyses were conducted, with the aim of identifying the impact that each of the factors of successful implementation of the jit strategy has on each of the parameters of the organizational structure of the company. in the first regression, the influence of the factors of successful implementation of the jit strategy on specialization as a dependent variable was analysed (table 6). the model as a whole explains 94.1% of the variance of the dependent variable (r2 = 0.941; p <0.01). table 6. table of regression coefficients specialization as a dependent variable unstandardized coefficients standardized coefficients t sig. b std. error beta organization of production lines .403 .130 .476 3.095 .003 relations with suppliers .042 .133 .039 .315 .754 teamwork .470 .188 .462 2.499 .010 source: authors’ research the organization of production lines stood out as a factor in the successful implementation of the jit strategy, which mostly determines the level of horizontal and vertical specialization in the surveyed manufacturing companies (p <0.01). the impact that teamwork has on the level of specialization (p = 0.01) can also be considered quite significant. representatives of the surveyed companies stated that monitoring the duration of operations, implementation of the kanban pull system and teamwork affect specialization by encouraging a high level of horizontal and a low level of vertical specialization, i.e. the focus is on employees performing a narrow range of similar work tasks, having independence in their work and being able to control the work tasks they perform. stimulation of teamwork among employees statistically most significantly determines departmentalization (table 7), i.e. manner and focus of grouping of organizational parts of surveyed companies (p <0.01). the model as a whole explains 93.8% of the variance of the dependent variable (r2 = 0.938; p <0.01). table 7. table of regression coefficients departmentalization as a dependent variable unstandardized coefficients standardized coefficients t sig. b std. error beta organization of production lines .341 .140 .374 2.432 .018 relations with suppliers .123 .143 .106 .856 .395 teamwork .769 .203 .702 3.798 .000 source: authors’ research the organization of production lines and teamwork among employees are factors that predominantly determine the mechanisms of coordination and control in the surveyed companies (table 8). monitoring the duration of operations, preventive maintenance, and implementation of the kanban pull system determine the combination of coordination/control mechanisms that companies with a jit strategy will apply. the same impact has stimulation of teamwork among employees in the field of improving the quality and cost efficiency of production processes. the overall model shown in table 8 explains 93.6% of the coordination/control variance as a dependent variable (r2= 0.936; p <0.01). jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 41 table 8. table of regression coefficients coordination/control as a dependent variable unstandardized coefficients standardized coefficients t sig. b std. error beta organization of production lines .450 .142 .505 3.164 .002 relations with suppliers .181 .145 .158 1.248 .217 teamwork .663 .205 .620 3.229 .002 source: authors’ research table 9. table of regression coefficients centralization as a dependent variable unstandardized coefficients standardized coefficients t sig. b std. error beta organization of production lines -.938 .065 -.879 -14.394 .000 relations with suppliers -.151 .095 -.839 -12.063 .000 teamwork -1.104 .083 -.862 -13.308 .000 source: authors’ research in the next regression, centralization has the status of a dependent variable (table 9). the model explains 77.3% of the variance of the dependent variable (r2= 0.773; p <0.01). the regression coefficients in table 9 showed that all factors of the jit strategy statistically significantly affect centralization as a dependent variable (p<0.01), and the values of the t test clearly indicate the negative impact, which confirmed the results of the correlation analysis. the conclusion is that centralization negatively affects the success of the implementation of the jit strategy. decentralization, primarily in the field of decision-making, is a key predictor of efficient organization of production lines, stimulating employees to contribute to building long-term partnerships with suppliers and making decisions, and solving problems as a team. the greatest contribution of decentralization is reflected in the motivation of employees to maximally contribute to the efficient and effective implementation of the jit strategy. discussion of research results the results of the correlation analysis indicated the existence and strength of the connection between the factors of successful implementation of jit strategy and dimensions of organizational structure, while the results of regression analysis enabled conclusions on the impact of each factor of jit strategy on each dimension of the organizational structure of surveyed manufacturing companies in serbia. summarizing the conclusions of the previously described analyses, the final conclusions about the initial hypotheses are drawn: • the way of organization of production lines, as a factor of successful implementation of jit strategy, statistically significantly determines the dimensions of organizational structure (specialization, departmentalization, coordination/control and centralization) partially confirmed hypothesis h1. the results of correlation analysis indicated a strong correlation between the way of organizing production lines and all parameters of the organizational structure of the company, but the results of regression analysis showed that monitoring the duration of operations, preventive maintenance, and implementation of the kanban pool system statistically significantly determine high horizontal and low vertical specializations, a combination of coordination/control mechanisms and decentralized decision-making. the influence of the organization of production lines on the manner and focus of departmentalization, by regression statistical analysis, did not stand out as statistically significant. the results of the research actually show that the specialization of employees in performing a narrow circle of related production activities 42 economic analysis (2022, vol. 55, no. 1, 30-47) affects a good knowledge of the production process, the duration of activities and the work of machines on which they are performed (with knowledge of working standards for each machine). in a conversation with the representatives of the production of the surveyed companies, it was stated that the employees are trained to keep records of machine standards and to eliminate the most frequent failures on a number of related machines and to operationally fully know the machines on which they work, and these are machines that make up one production plant, for example: 1) operation and repairs of several different lathes in tool department, with regular updating of records on scrap which are the basis for the implementation of corrective measures 2) operation, minor repairs and adjustments for machines that produce several different variants of springs/bearings/cups, 3) handling, installation of furnaces (temperature adjustment) and solving delays in the operation of furnaces for different alloys of brass, lead, aluminium in foundries. that is why specialization determines efficient control over the duration of production activities, as well as fast and efficient resolution of a large number of production delays, which is directly reflected in the goals of kanban pull system implementation control of inventory levels and minimization of waste in production. employees in production plants, under the supervision of the operational manager, in most of the surveyed companies manually, via excel spreadsheets or records in the information system, work performance for each operation on a given machine (comparison with standards), enters material consumption for each operation and records scrap, which are very useful data sources for defining preventive and corrective measures in the cooperation of operational-strategic management in the field of eliminating downtime and waste in production. the practice of the surveyed companies showed that the combination of coordination/control mechanisms (standardization of inputs, outputs and processes) and decentralized decision-making stimulate qualified personnel to be more committed to efficient production activities, regular monitoring of deviations from working standards for each production machine and efficient performance of preventive and ongoing maintenance activities, which is the core of successful implementation of jit strategy in production. • relations with suppliers, as a factor in the successful implementation of the jit strategy, statistically significantly determines the dimensions of the organizational structure partially accepted hypothesis h2. the construction of long-term partnerships with strategic suppliers, according to the results of correlation analysis, is strongly positively correlated with specialization, departmentalization and coordination/control, but the strength of the impact on them, according to regression analysis, did not stand out as statistically significant. decentralization has the strongest impact on the quick and efficient reaction to the supplier's moves and minimizing all problems that may arise in business cooperation with the supplier, primarily delays in delivery. the results of correlation and regression analysis showed that centralization of management and decision making harms the successful implementation of jit strategy in manufacturing companies, because it discourages employees from building long-term partnerships with suppliers and working as a team to improve quality/cost efficiency and efficiently solve all problems in supply/production/sale. the business practice of the surveyed companies presented that the involvement of employees in planning, organizing, and controlling the production activities, stimulates them to monitor the timeliness of procurement and respond quickly to any delay in delivery of strategic raw materials, in the aim to prevent production delays and exceeding agreed delivery deadlines final product to customers. partner relations between the supplier and the manufacturing company are the core of greater motivation of suppliers to generate satisfaction and loyalty of manufacturing companies as their customers by respecting all agreed terms of cooperation. the surveyed companies stated that the importance of developed partnerships and stimulating employees, primarily in the supply department, to contribute to their maintenance, is jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 43 most pronounced in conditions of market instability, such as those caused by the covid19 pandemic. during the period end 2020 the first half of 2021 was marked by a "rampage" of metal prices on the stock market, with a shortage of a large number of raw materials, and developed partnerships crystallized as a lifeline because suppliers always had in mind the needs of their most loyal customers (production reduction did not include orders from strategic partners). teamwork, as a factor in the successful implementation of the jit strategy, statistically significantly affects the dimensions of the organizational structure fully confirmed hypothesis h3. stimulating teamwork among employees, in the field of quality improvement and cost efficiency, as well as in the field of fast and efficient problem solving, dominantly dictates the creation of an organizational structure that will contribute to the efficient and effective implementation of the jit strategy. the results of correlation and regression analysis showed that teamwork is the only factor in the successful implementation of the jit strategy that statistically significantly determines all dimensions of the organizational structure of the surveyed manufacturing companies in serbia. high horizontal and low vertical specialization, combining coordination/control mechanisms and decentralized decision-making are parameters of organizational structure that, according to the business practice of surveyed manufacturing companies, stimulate employees to maximally engage in the efficient and effective performance of work tasks and so contribute to generating maximum benefits from the implementation of jit strategy in production. in a conversation with representatives of surveyed companies, it was stated that training and development of employees in all domains is an important factor in achieving the goals of the jit concept, but that it is much more important to stimulate communication and teamwork among employees to create the stimulating environment for respecting all the principles of application of the jit concept in procurement, production, and sales. teamwork of employees of the surveyed companies (all organizational parts of the company) in the period 2020-2021. was most pronounced in the detailed parallel analysis of business risks in the covid-19 pandemic, analysis of the current situation in the implementation of sales plans and production/supply plans arising from them, in order to find preventive solutions to all potential delays in procurement, production, and sales. it can be concluded that an adequate organizational structure is one of the key factors in the successful implementation of the jit strategy in the surveyed manufacturing companies. high horizontal and low vertical specialization, goal-oriented departmentalization, combination of coordination/control mechanisms and decentralized management/decision-making are parameters of organizational structure that stimulate the realization of jit strategy implementation goals: production in accordance with market needs, high product quality, short production cycle, pull a system based on appropriate planning techniques, efficient material management, reduction of inventory levels, engagement of all employees and building long-term partnerships with customers and suppliers. the research singled out specialization and decentralization as dimensions of the organizational structure with the greatest impact on the success of the implementation of the jit strategy, which confirmed the conclusions of previous research on this topic. koufteros and vonderembse (1998) proved that high centralization of management negatively affects the success of the implementation of the jit production system, which coincides with the results of this research. the results of statistical analyses confirmed the conclusions of germain, droge, and daughtery (1994), green and inman (2006), and liu and nishi (2020), that high specialization and decentralized management/decision making are the parameters of organizational structure that contribute most to the realization of positive effects of jit strategy to build long-term partnerships with customers and suppliers, as key partners in the supply chain. the organization of production lines, cooperation with suppliers and teamwork of employees, as factors of successful implementation of jit strategy, individually determine at least two parameters of organizational structure, showed the results of testing initial hypotheses, which reaffirmed the conclusion of green, inman and bureau (2011). decentralization is a parameter of the 44 economic analysis (2022, vol. 55, no. 1, 30-47) organizational structure that mostly determines the motivation and entrepreneurial innovation of employees (eric nielsen et al., 2019), which directly reflects on their productivity, and thus contributes to generating goals for the implementation of the jit strategy. teamwork of employees is the core of successful implementation of jit strategy and is the statistically most significant factor that determines all parameters of organizational structure. representatives of the surveyed companies stated that the dimensions of the organizational structure significantly determine the motivation and commitment of employees in the field of organizing production lines, building long-term partnerships with suppliers and teamwork in various areas of improvement (confirmed conclusions kartika and wijaya, 2015). the research confirmed that the implementation of the jit strategy will be successful only if each employee in the company is maximally involved and committed to the independent execution of work tasks (which was also emphasized by koufteros and vonderembse, 1998). training of employees to work as a team on monitoring the efficiency of kanban pull system implementation is the basis of cost efficiency and timeliness of the production process, smith points out in the research on jit strategy (smith, 2019), which is confirmed by the results of this research. the fact is that the organizational structure should follow the jit strategy (brayan & joyce, 2007; bozkurt, kalkan, & arman, 2014), and the teamwork of employees is an essential factor to generate maximum benefits for the manufacturing company through their compliance (koufteros & vonderembse, 1998; fullerton & mcwatters, 2000; abdallah & matsui, 2007). theoretical/practical implications and further directions of research this research brings together the conclusions of the previously listed authors, but, unlike previous research on this topic, a two-way relationship has clearly crystallized between the factors of successful implementation of the jit concept the parameters of organizational structure. it has been proven that the parameters of the organizational structure must be adjusted to the goals of jit strategy implementation, but at the same time, without the support of the appropriate organizational structure and its parameters, it is impossible to generate a positive influence of successful jit concept on the realization of set goals. the research represents a deeper analysis in this domain, with special reference to the production segment of the economy, whose outputs represent significant inputs in other industries. no research so far has focused exclusively on the business practice of this category of companies, and since their outputs are inputs in other companies, their success in implementing the jit concept significantly determines the success in managing their customers' supply chains. this indirectly points to the importance of compliance with the factors of successful implementation of the jit concept the parameters of the organizational structure for building partnerships of companies in the field of this production sector with its customers and suppliers, and thus the management of all relationships in the supply chain. the results of the research provide guidance to managers of this industry segment on what needs to be corrected and improved in the field of harmonization of jit factors and organizational structure parameters in order to generate goals for the implementation of this strategy, while signal how to establish efficient and effective supply chain management, supplier relationship management, logistics management and customer relationship management. monitoring the evolution of the dimensions of the organizational structure, with an analysis of how this evolution affects the generation of goals for the implementation of the jit strategy, would significantly improve research in the field of the interdependence of organizational structure and implementation of the jit strategy. research in this domain would significantly improve and monitor the way in which changes in the factors of successful implementation of jit strategy, organization of production lines/relationships with suppliers/teamwork, determine the evolution of the dimensions of the organizational structure. it is important, in the coming period, to deepen the analysis of the impact of compliance on the relationship factors of successful implementation of jit concept-parameters of the organizational structure of manufacturing jelena erić nielsen, vesna stojanović aleksić, ana todorović spasenić 45 companies on the realization of supply chain management goals of their customers, who use the outputs of these companies as inputs in production. this will significantly deepen the research in the field of correlation of jit goals and supply chain management goals that are intertwined, but also the importance of partnership between participants in the supply chain in order to generate the goals of the jit concept. conclusion the research proved the existence of a strong feedback correlation between the factors of successful implementation of the jit concept the parameters of the organizational structure, through the analysis of business practices of manufacturing companies that do not produce consumer goods. the results showed that the parameters of the organizational structure must be adjusted to the principles of the jit concept, but that at the same time it is impossible to implement this strategy and realize its goals without the support of the appropriate organizational structure. high horizontal and low vertical specialization, goal-oriented departmentalization, a combination of coordination/control mechanisms and decentralized management/decision-making are dimensions of organizational structure that stimulate the realization of jit strategy implementation goals: production in accordance with market needs, high product quality , short production cycle, pull a system based on appropriate planning techniques, efficient material management, reduction of inventory levels, engagement of all employees and building long-term partnerships with customers and suppliers. the research represents a deeper analysis in the domain of implementation of the jit concept in the manufacturing sector whose outputs represent significant inputs in other industries. no research so far has focused exclusively on the business practice of this category of companies, and since their outputs are inputs in other companies, their success in implementing the jit concept significantly determines the success in managing their customers' supply chains. this indirectly points to the importance of compliance with the factors of successful implementation of the jit concept the parameters of the organizational structure for building partnerships of companies, in the field of this production sector, with its customers and suppliers, and thus the management of all relationships in the supply chain. the goals of the jit concept implementation are intertwined with the goals of establishing efficient and effective supply chain management, about which deeper analyses can be conducted in 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international journal of operations and production management, 7(4): 46-52. white, r., ojha, d., and ching-chung. 2010. ’’a competitive progression perspective of jit systems: evidence from early us implementations.’’ international journal of production research, 48(20): 6103-6124. white, r.e. and ruch, w.a. 1990. ’’the composition and scope of jit.’’ operations management review, 7(3/4): 9–18. article history: received: january 24, 2022 revised: april 28, 2022 accepted: may 25, 2022 ea_2016_3-4 udc: 005.521:334.7(497.11) 005.591.6 jel: l20, a11 cobiss.sr-id: 228339980 original scientific paper innovation analysis of the sector of small and medium enterprises and entrepreneurs (smes) in the republic of serbia prljić katarina1, faculty of business economics and entrepreneurship, belgrade, serbia mijalković jovana, faculty of organizational sciences, belgrade, serbia prljić stefan, faculty of engineering, kragujevac, serbia abstract – innovations have become not only an important determinant of a company’s successful development but also their requirement. today, innovative enterprises are the key driver of competitiveness, increased productivity, employment and overall economic development. research shows that serbia belongs to the group of less developed european countries whose development is not driven by knowledge and innovation. therefore, the main objective of this paper is to look at the current state of innovation in small and medium companies and enterprises in the republic of serbia and the factors that affect this situation. in terms of methodology, this work is based on the use of existing literature and available statistical data. based on the analysis, it was concluded that the small and medium enterprise sector (sme) in serbia has a very small number of innovative companies. by using the tool innovate in a selected organization, it has been attempted to highlight the opportunities that this tool offers to improve innovativeness of an organization key words: innovation, small and medium enterprises, entrepreneurs, serbia, innovate introduction innovation in today's business environment is one of the most important factors for the survival and development of enterprises and entrepreneurs because it makes it possible to quickly adapt to constant changes in the environment and respond to market demands, which are becoming increasingly complex. according to narayanan (2001), innovation is important for the company because it allows it to cope with the competition in the increasingly demanding market. the modern concept of innovation promotes the view that innovations are the introduction of all novelties in the structure and functioning of enterprises, which contribute to increasing the economic efficiency and effectiveness of business operations (betz, 2001). the ultimate goal of any innovation is to improve business (milosevic, vujičić, 2012). with the help of innovations it is possible to quickly adapt to changes in the environment, satisfying the needs and demands of customers, improving 1 corresponding author:prljic katarina, kaca-p@live.com 82 economic analysis (2016, vol. 49, no. 3-4, 81-96) business and operation of enterprises and the development of the economy .successful innovation in the sme sector provides a sustainable competitive advantage and encourages their growth and development. the company’s work on the realization of innovative activity leads to improve overall performance of the enterprise. it is safe to say that innovation (vujicic, djuricic, vukadinovic, 2013) is located in the heart of success of any organization, as it allows the organization to improve product quality and reduce costs, increase efficiency and increase sales. innovation must be a continuous process. the implementation of an innovative culture that includes all segments of the organization would favour conditions for the development of creative individuals. the organization will become innovative with the possibility of relying on its own resources and will further enable even faster development of innovations (vujicic, djuricic, vukadinovic, 2013). literature review in today's business environment, innovations are considered as one of the most important factors for the survival and development of enterprises (vujicic, nikitovic, minkov, 2016). schumpeter (1942) claimed that innovations include: product innovation, process innovation, organizational innovation and innovations that lead to the opening of a new market and ensure the development of new sources of supply of raw materials. drucker (1996) believes that innovation is a specific tool for entrepreneurs; the means by which they use change as an opportunity for the execution of various production or service activities. tidd and bessant (2009) point out two key characteristics of innovation, which we must be aware of: • innovation is not a single event; innovation is a process that must be managed. • impacts on the process must be managed in order to influence the outcome, which means that the process must and can be managed. a greater degree of innovation represents greater investments and higher risk, which is why the results of research aspects of innovation risks have an analytical approach, and should be based on (liberatore 1990): • identification of current and prospective challenges for at least the next 3-5 years in order to take in account the fact that the competitors are likely developing their own program; assessment of the relative strengths and weaknesses of the company compared to the competitors for each product line and each market, as a basis for assessing the corresponding benefits which would result in increased investment in this area; • estimation of risks, costs and problems for different combinations of investments, including adaptation (acceptance) of already developed technologies and initialization of your own research, again in comparison to analogue activities of competitors; • researching the changes that should be made in the fields of finance, marketing, personnel and organizational elements that are determined to be necessary for the appropriate use of innovation potential. schumpeter (1982) claimed that economic development brings qualitative changes that are crucial and they are driven by innovation in different historical periods. innovation itself prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 83 is a function of three main factors: first, the creation of new knowledge in science, technology and in management (basis of innovation); secondly, the availability of highly educated, programmed workforce capable of using new knowledge to improve productivity (may be a result of the quality and quantity of the educational system); third, the existence of entrepreneurs capable and willing to take the risk of transforming the innovation into business (zjalić, 2007). generally speaking, innovation is an idea which has been successfully applied in practice. according to organization for economic cooperation and development (oecd) and the oslo manual for measuring innovation, there are four different types of innovation: • product innovation: it represents a new or improved product or service, in terms of technical specifications, components, materials, software, adaptation to the needs of users or other functional characteristics; • process innovation: it refers to new or improved method of production or delivery, in terms of techniques, equipment or software. • innovation in marketing: includes new marketing methods related to changes in the design or packaging of the product, its launch, promotion or price. • innovation in the organization: refers to the new organizational method in the firm’s management, workplace organization or external relations. the type of innovation for which the company defines is essentially a function of the nature of innovation, the impact of changes on the players in the value chain, competence and the company’s familiarity in the field of innovation (levi-jaksic, 2001). analysis of the sector of small and medium enterprises and entrepreneurs (smes) in the republic of serbia smes are very important economic segment of each country and their primary role is similar for each country in which they operate (milošević, vujičić, 2012).the small and medium enterprises and entrepreneurs in serbia achieved steady growth and we can say that it is one of the most important drivers of economic growth and development of serbia because it makes 99.8% of active companies, employs nearly 2/3 of employees in the nonfinancial sector and accounts for about 30% of gdp in the formation of serbia (ministry of economy, national agency for regional development, 2014). in serbia, in 2013, operated 315 906 economic entities, which is 1,762 less than in 2012. it is estimated that in 2013 sme sector accounted for about 34% of the gdp of the republic of serbia. observed by company size, there were no significant changes compared to the previous year. 84 economic analysis (2016, vol. 49, no. 3-4, 81-96) figure 1. number of economic entities in the period from 2004 to 2013. source: report on smee for 2013, 2014. the structure of the largest smes are micro enterprises (303,927), while small and medium enterprises (11.485) dominate in all the observed indicators (53.6% of employment, 60.9% of turnover, 60.8% of gva, 75.2% of exports, 76.1% of imports mesp (ministry of economy, national agency for regional development, 2014) table 1. indicators of the sme sector in 2013 by enterprise size source: ministry of economy, national agency for regional development (2014) if we make a comparative analysis of the basic indicators of the sme sector in selected countries of the eu and serbia in 2013, we can conclude that the qualitative indicators of the level of development of the sector (employment by the company and gva per employee) are lower than the eu average and most of the observed countries (table 2.) prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 85 table 2. basic indicators of business activities of the sme sector in chosen eu countries and serbia in 2013. eu 27 bulgaria cze hungary poland romania slovenia serbia 2012 2013 entreprises no in 000 20614.1 314.0 948.3 570.0 1391.0 532.5 106.5 317.2 315.4 employes no in 000 87092.3 1474.1 2376.8 1809.9 5494.0 2717.2 413.9 782.0 768.6 bdv billion eur 3430.0 12.1 47.9 26.6 89.8 26.7 11.9 8.6 8.5 sme on 1000 inhabitants 41.0 43.1 90.2 57.5 36.1 26.6 51.7 44.1 44.1 employees no per entreprise 4.2 4.7 2.5 3.2 3.9 5.1 3.9 2.5 2.4 bdv per employee in 000 eur 39.4 8.2 20.2 14.7 16.3 9.8 28.8 11.0 11.1 participation in non financial sector in percents entreprises no 99.8 99.8 99.9 99.9 99.8 99.7 99.8 99.8 99.8 employees no 66.7 75.9 69.7 73.0 68.1 67.0 70.3 65.1 64.9 bdv 57.8 61.9 55.5 53.8 51.8 52.2 62.7 55.8 54.1 source: ministry of economy based on data from eurostat, dg enterprise and industry and sors with the analysis of the total turnover of the sme sector in 2013, it can be concluded that a decisive influence on the turnover of smes in 2013 was made by micro enterprises (39.1%; 39.3% in 2012) and by type of organization doo (68.0 %; 72.0% in 2012). table 3. total turnover sme sector in 2013 according to the size and organizational structure of business entities source: ministry of economy based on sors small companies with limited liability generate 25.5% of the turnover of smes, or 6.4% of the turnover of non-financial sector (ministry of economy, national agency for regional development, 2014). innovation in sme sector in serbia serbia is, according to the world economic forum for 2015, ranked 94th position on a list of 140 countries, i.e. maintained the same position as in 2014 (144 countries) with the value of the global competitiveness index of 3.89. the global competitiveness index (the global competitiveness index gci) measures the average multiple macroeconomic and 86 economic analysis (2016, vol. 49, no. 3-4, 81-96) microeconomic components, which are individually evaluated on a scale from 1 to 7. all measured parameters are grouped into twelve pillars: pillar 1 institutions; pillar 2 infrastructure; pillar 3 macroeconomic environment; pillar 4 health and education; pillar 5 higher education and professional training; pillar 6 the efficacy of the market goods; pillar 7 labor market efficiency; pillar 8 financial market development; pillar 9 technological readiness; pillar 10 market size; pillar 11 business sophistication; pillar 12 innovation (nešić, 2008). these twelve pillars of competitiveness are grouped into three separate units, depending on the manner of economy management: fundamentals driven economy, efficiency driven economies and innovation driven economy. figure 2. consolidated gci pillars source: drzeniek-hanouz, m. dusek, m . the arab world competitiveness report 2013. serbia is among the countries with the efficiency-driven economies. the stage of development in which the economy of a country is located, is thereby determined by the level of annual gross domestic product per capita (gdppc). the economy of a country is said to be located in the first phase of development, its annual gdppc is less than 2,000 usd. countries whose annual gdppc is between 2000 and 3000 usd, are on the transition from the first to the second phase of development, while countries with annual gdppc between 3,000 and 9,000 fall within the second phase of development. countries transitioning to the third phase are those with gdppc between 9000 and 17000 thousand usd, while highly developed countries are countries with annual gdppc more than 17,000 usd (albijanić, 2011) (figure 3). prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 87 figure 3. stages of economic development to gdp stages of development gdppc (in usd) phase ifactor driven economies < 2000 the transition from phase i to phase ii 20003000 phase iiefficiency driven economies 30009000 the transition from phase ii to phase iii 900017000 phase iii-innovation driven economies > 17000 source: klaus & xavier, 2011, p. 10 compared to 2014, serbia has the biggest decline in the value of the index recorded in the field of business sophistication (-0.13 index points), followed by -0.09 in the macroeconomic stability pillar, institutions lost -0.03 index points. slight decrease was recorded in health and primary education (-0.02), higher education and training (-0.02), technological readiness (0.02), market size (-0.02) and the smallest decline in the value of index points was recorded in the field of innovation (-0.01). in 2011, serbia had the innovation factor 2.99, 2.96 in 2012, and in 2013, 2014 and 2015 it increased again. macedonia has the largest increase in the last five years (2010 105th place, and in 2015 62) and serbia is almost back to the same ranking as in 2011 (95th place 2011, 94th place 2015) (figure 4). figure 4. index value of factors of innovation for serbia and neighboring countries in the period 2011-2016. source: global competitiveness report 2011—12, global competitiveness report 2012—13, global competitiveness report 2013—14, global competitiveness report 2014—15, global competitiveness report 2015—16 88 economic analysis (2016, vol. 49, no. 3-4, 81-96) analysis of innovation in the smes in serbia research on innovation activities in businesses in serbia in the period 2010-2012, conducted by the republic statistical office on a sample of 3,500 businesses (sample frame were active business entities obtained from the statistical business register, which contains 11841 business entity with 10 or more employees) showed the highest participation in innovative activities of big businesses. organizations research has shown that manufacturing businesses are more innovative than service businesses. table 5. business entities by innovativness, activity and size, 2010-2012 total innovators non innovated businesses innovators’ participation total 11841 5280 6561 44,6 small businesses 9057 3691 5366 40,8 average businesses 2264 1245 1019 55,0 large businesses 520 344 176 66,2 manufacturing businesses 4122 2007 2195 48,7 service businesses 7719 3273 4366 42,4 source: http://webrzs.stat.gov.rs/website/repository/documents/00/01/21/40/ia01_285_srb=bkorekt.pdf results of research on innovation activities in businesses in serbia in the period 20122014, conducted by the republic statistical office on a sample of 3587 businesses (sample frame were active business entities obtained from the statistical business register, which contains 16659 business entity with 10 or more employees) have shown that the size of the business entity is a key factor for innovative activities of enterprises (table 6). according to this study, there were 37.4% of small business innovators, 52.7% medium enterprises innovators and 68.1% of large companies innovators. table 6. business entities by innovativness, activity and size, 2012-2014 total innovators business entities that have not innovated participation of innovators total 16659 6739 9920 40,5 small businesses 13863 5182 8681 37,4 medium businesses 2253 1187 1066 52,7 large businesses 543 370 173 68,1 manufacturing businesses 4865 1977 2888 40,6 service businesses 11794 4762 7032 40,4 source: http://webrzs.stat.gov.rs/website/repository/documents/00/01/89/77/ia01-276-inovacije_2014.pdf research in the period from 2012-2014.godine showed that over 68% of large businesses are innovative, just over half of medium-sized businesses and more than 37% of small businesses. innovative activities are equally represented at manufacturing and service businesses, where innovation was introduced by just over 40% (sors, 2015). prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 89 looked at the representation type of innovation towards the territory and the size of the business entity, it is noticeable that share of businesses (innovators) in product and process innovations is same as well as that share of innovative businesses decreases with decreasing their size. table 7. representation of types of innovations in serbia according to the size of a business entity businesses – innovators non innovators territory size product/service innovations manufacturing process innovations abandoned innovations organizational innovation marketing innovation republic of serbia total 20,4 20,2 10,9 24,9 23,8 59,5 small 18,5 17,4 9,6 21,9 21,2 62,8 medium 27,8 31,2 13,4 37,9 35,8 46,5 large 39,4 43,1 32,6 47,1 37,9 31,8 source: republic statistical office, 2015.stated by innovative activities of enterprises 2012-2014. of the total number, 18.5% of small companies have introduced product innovation or service, 17.4% the production process innovation, 21.9% innovation in the organization, 21.2% innovation in marketing. in medium-sized enterprises 27.8% of companies have introduced innovative products or services, production process innovation 31.2, 37.9% innovation in the organization and 35.8 % marketing innovation (national bureau of statistics, press innovative activities of enterprises 2012-2014, 2015). however, research over a period of 2012-2014.godine showed that there were factors that hinder innovation, such as lack of own financial resources and difficulties to obtain government grants and subsidies (table 8). table 8. factors that were obstacles to innovation activities, 2012-2014. factors significance large medium small irrelevant lack of own finances 67,6 18,4 11,0 3,0 lack of credit 44,4 31,6 17,1 6,9 lack of personnel 11,7 43,8 22,8 21,7 government grants and subsidies issue 55,6 25,2 10,2 8,9 partnership issue 20,2 33,8 27,5 18,5 uncertain requirement for innovations on the market 37,2 31,8 18,6 12,4 high competition 26,0 39,7 17,5 16,8 source: http://webrzs.stat.gov.rs/website/repository/documents/00/01/89/77/ia01-276-inovacije_2014.pdf factors that were an obstacle to innovation activities (table 8.) can be divided into internal and external. on internal factors, companies can directly influence and neutralize them, while the external obstacles can not be directly affected; they have already been forced to adapt to them if possible. 90 economic analysis (2016, vol. 49, no. 3-4, 81-96) research on the status, needs and problems of small and medium enterprise (sme) which was conducted in 2013 on a sample of 2555 smes found that smes are not as committed to innovative business because only every fifth company has enforced its own innovative activities, and every sixth realizes innovative collaboration with other companies or institutions. the same survey showed that the majority of innovative companies operate within the surveyed smes (figure 5). figure 5: innovative actions to the shape the economic entity source: national agency for regional development, 2013 as for the introduction of a new product or service, small (35%) and medium-sized enterprises (40%) indicated that they have introduced a new product, process or service which has led to improvements in their business. figure 6: new product / process or service according to the shape of the economic subject source: national agency for regional development, 2013 after a number of innovative activities, in the period 2010-12. with 47.5% serbia was located between the member states (behind germany, luxembourg, ireland and italy, and in front of the bulgarian, polish and romanian) (http://ec.europa.eu/eurostat/statisticsexplained/index.php/innovation_statistics). prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 91 figure 7. share of innovative enterprises by main type of innovation, 2010–12 (% of all enterprises) source: eurostat, 2015 analyzing innovative enterprises by type of innovation in some countries in the period of 2010-2012, we can see that companies in serbia had the highest organizational innovations and then marketing innovation (figure 8). the growing importance of innovation in business requires that management innovation activities line-up with the necessary seriousness at the company level. since the company emerged as an entrepreneurial form of organization of economic life, had a growing active attitude towards innovation. "such an approach is constantly gaining in importance, and we are approaching a stage where there will be only innovative companies, because all the other will just collapse due to neglect innovation. in other words, we approached when innovation becomes the essence of existence"(pokrajac, 2002) because innovations are enabling companies to create added value, meet the needs of consumers and the needs of the company. if serbia want to make economic progress and development, it is necessary to develop a competitive economy based on knowledge, innovation and new technologies (ivkovic, čukanović, vujicic, 2012). improving the innovation activities of companies by applying the tool innovate innovate is a tool that was created with the support of icip project (improving innovation and competitiveness of small and medium enterprises) and the secep (support to enterprise competitiveness and export promotion agency) funded by the european 92 economic analysis (2016, vol. 49, no. 3-4, 81-96) union. it is used for diagnosis, which encourages serbian companies to improve their innovation management in order to improve competitiveness. this tool can be applied to all organizations and can be used with or without external assistance and without relying on the financial data of the organization. innovate tool provides information on the performance of the organization in the management of twenty-one aspects or "dimensions" of management innovation, comparing its current practice with one of the four pre-defined reports that can be easily represented graphically. it was designed to achieve two objectives: 1. it helps the owner / manager of the company estimate the extent to which the company currently holds with 21 dimensions of innovation management (objective 1); 2. it helps to decide how to raise the company to a higher level (objective 2). by using the innovate questionnaires, 21 dimensions of innovation management are considered. after interpreting the results obtained, economic entities can be divided into four levels, namely: 1. innovative companies with an international perspective (level 4); 2. companies that have a strategic view of the business (level 3); 3. companies that accept external advice and the need for planning (level 2); 4. non innovative traditional companies (level 1). this tool is completely free and available on the website of the national agency for regional development (http://narr.gov.rs/index.php/aktivnosti/podrshkapreduzetnishtvu/alat-za-dijagnostifikovanje-inovativnosti) for all organizations wishing to carry out their own self-assessment. innovate also contains a number of templates that can help the company to develop and implement an action plan to improve innovation management, using: • swot analysis version of the familiar tool that helps management detect the strengths and weaknesses of the company, together with the potential threats and opportunities. • pest analysis is a powerful technique used to analyze the external (macro) environment in which each company operates (works). it complements the swot analysis that examines the internal environment. pest analysis allows the company to identify important trends (movements) and drivers that shape the external environment. • tool for strategic analysis and the "road map" a tool for analysis which indicates long-term strategic goals of the company (whether they are harder or easier to achieve), and then their relation to the key short-term objectives, to barriers and competition and to the markets and partners. • action plan turns a road map to a concrete action plan. it includes a clear specification of all project tasks and their time schedule, where the responsible personnel and deadlines are clearly defined. • resource detector that helps the company identify the resources to which it is entitled, and which will assist in the implementation of the action plan (http://www.preduzetnickiservis.rs/). prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 93 applying the tool innovate for the analysis of innovation management in the organization a case study by applying the tool innovate which contains 21 questions (annex 1) a conclusion was reached about where the analyzed organization is standing. by filling out the questions that are classified in the following groups: • innovation strategy, managing ideas and attitude to changes • development of products and application technology, intellectual property, it systems management • clients and products database, market horizon, awareness and perception of the market • expectations regarding the company's growth, internal investment in innovation and finance growth • planning, decision making, external advice • qualifications and employee training in connection with the academic environment, business networking • reputation it has come to the position of the organization within the given dimensions of innovation management. compared to the 4 levels, this organization is located between level 2 and level 3. level 2 includes organizations that accept external advice and the need to plan for a level 3 organizations with a strategic view of the business. the results showed that this organization is between levels 2 and 3 (figure 9). figure 9. position of the organization in relation to the 4 levels of innovation management by applying the tool innovate source: authors based on data the tool innovate radar diagram in figure 10 shows the different aspects of innovation in the respective organization based on the "best in class" (level 4). diagram resource measures dimensions which are under the direct control of the company. 94 economic analysis (2016, vol. 49, no. 3-4, 81-96) figure 10. dimensions of innovative resources-management in the organization by using the tool innovate source: authors based on data the tool innovate based on the radar charts it was concluded that the observed organization has the best results in the training of employees, management systems and information technology. there is room for improvement in decision-making, planning, financing growth and internal investment. the highest attention should be paid to intellectual property where they recorded the worst results. innovate tool shows the "results" as a result of "resources". the advantage of "resources" is that they can be improved using feedback from the "results". results obtained by innovate questionnaire in the observed organization showed where the organization is located based on the development of products, application of technology, expectations regarding the company's growth and reputation in relation to the company best-in-class (figure 11). based on figure 11. it can be concluded that the observed organization achieved the best results with the expectations of growth for the company and that all of the other dimensions should be improved. figure 11. results source: authors based on data the tool innovate prljić, k., et al., innovation analysis of the sme’s, ea (2016, vol. 49, no. 3-4, 81-96) 95 conclusion large competition in the market compels companies and entrepreneurs to develop innovative industry because innovations are not only a successful development and implementation of ideas and knowledge but also the basis of competitive advantage. innovation in companies that do business in serbia is a prerequisite for its competitiveness because of these innovations enable companies to create added value, meet the needs of consumers and the needs of the company. good innovation policy will allow the introduction of changes and innovations in the way of doing business with the aim to improve the situation and achieve a competitive edge. research conducted in recent years in serbia has shown that innovation in smes in serbia is at a low level, as a company’s development of innovation is far behind compared to the same sector in developed countries. accordingly, it is necessary to create favorable conditions for innovation, raising awareness about the necessity of innovation, creating a favorable climate that supports and encourages innovation. in the process of the development of innovation for sme the state should take a leading role and provide conditions for dynamic development, innovation, innovative smes and competitive economy based on knowledge and innovation. references albijanić m. 2011. “kvantifikacija uticaja intelektualnog kapitala na konkurentnost.” phd dis. beograd: univerzitet singidunum. drucker, p. f. 1996. inovacije i preduzetništvo, praksa i principi. beograd: grmeč drzeniek-hanouz, m., dusek, m. 2014. the arab world competitiveness report 2013. eurostat, statistics explained, http://ec.europa.eu/eurostat/statisticsexplained/index.php/innovation_statistics ((accessed may 5, 2016) global competitiveness report 2011—12, global competitiveness report 2012—13, global competitiveness report 2013—14, global competitiveness report 2014—15, global competitiveness report 2015—16 hausman, a. 2005. “innovativeness among small business: theory and propositions for future research.” industrial marketing management, 34 (8), 773-782. ivković d., čukanović karavidić, m.,vujičić, s. 2012. “small and medium-sized enterprises as a factor of serbian economy.” economic analysis, 45 (3-4): 27-40, issn 1821-2573, cobiss.sr-id 195852812. beograd: institut ekonomskih nauka. jakšić-levi, m. 2001. strateški menadžment inovacija. beograd: fon klaus, s., & xavier, s. 2011. global competitiveness report 20102011. world economic forum 2011. liberatore m., ed. 1990. selection and evaluation of advanced manufacturing technologies. springer-verlag. milošević d., vujičić s. 2012. menadžment malih i srednjih preduzeća. beograd: visoka škola za poslovnu ekonomiju i preduzetništvo. ministarstvo privrede, nacionalna agencija za regionalni razvoj. 2014. izveštaj o malim i srednjim preduze ćima i preduzetništvu u 2013., beograd 96 economic analysis (2016, vol. 49, no. 3-4, 81-96) narayanan, v. k. 2001. managing technology and innovation for competitive advantage. new jersey: prentice-hall inc. national agency for regional development. 2013. report on smee for 2012 national bureau of statistics. 2015. press innovative activities of enterprises 2012-2014 nešić, s. 2008. konkurentnost privrede srbije. beograd: srpski ekonomski forum. pokrajac, s. 2002. tehnologija, tranzicija i globalizacija. beograd: savez naučnih stvaralaca srbije. republic statistical office. 2015. stated by innovative activities of enterprises 2012-2014., rzs. 2014 http://webrzs.stat.gov.rs/website/repository/documents/00/01/89/77/ia01-276inovacije_2014.pdf rzs. 2015. http://webrzs.stat.gov.rs/website/repository/documents/00/01/21/40/ia01_285_srb=bkore kt.pdf schumpeter, j. a. 1942. capitalism, socialism and democracy. new york: harper. tidd j., bessant j. 2009. managing innovation: integrating technological, market and organizational change. chichester: j. wiley and sons vujicic, s., djuricic, z.,vukadinovic, s. 2013. , the significance of innovation and projects for development of entrepreneurship in serbia,, avada 2013, conference ,,current interdisciplinary research in management and administration, litvanija vujici, s., nikitovic, z., minkov, đ. 2016. ,,influence of innovation on the competitiveness of small and medium enterprises and entrepreneurs in serbia.” international scientific conference leadership and organization development, kiten, bulgaria zjalic, lj.m. 2007. “inovativnost nezaobilazan činilac razvoja.” medjunarodni problem, 59 (1): 155-182 http://www.preduzetnickiservis.rs article history: received: 16 october, 2016 accepted: 10 november, 2016 doi: 10.28934/ea.22.55.2.pp1-19 first online: october 21, 2022 original scientific paper repo rates as reference interest rates: testing the expectations hypothesis of the term structure of interest rates sanja nenadović10f* 1 phd candidate, university of belgrade, faculty of economics, department for statistics, belgrade, serbia abstract the subject of this paper is the consideration of the role of the repo market and the quality of repo rates in the formation of reference interest rates that would be used to assess the value of financial instruments and derivatives. unsecured money markets carry a certain level of risk; thus, the question arises whether the existing reference interest rates should be replaced by repo rates or other interest rates on secured loans. through operations on the short-term money market, central banks try to influence interest rates with long maturities. one of the most well-known theories that considers the question of the relationship between short-term and long-term interest rates is the expectations hypothesis. in this paper, the expectations hypothesis is tested on the example of daily data of overnight interest rates related to secured interbank loans. two samples were used, and term premiums were estimated for both short-term (up to one year using libor interest rates) and longterm maturities (from two to ten years using ice swap interest rates). the hypothesis is tested using two traditional econometric tests. the first test examines the relationship between the long-term change in the overnight rate on secured loans and term premiums for different maturities. the second test examines the relationship between the short-term change in long-term rates from the unsecured market and term premiums. by applying both tests together, it should be determined how well the overnight interest rates on secured interbank loans predict long-term interest rates on unsecured loans. the tests were also applied to the overnight interest rates of interbank loans that are not secured in order to get a better comparative picture. the results show that collateralized interest rates are good indicators of benchmark interest rates and, in some cases, even more accurate predictors of long-term interest rates keywords: reference interest rates, repo rates, expectations hypothesis, ibor transition, collateralization jel classification: g12, g17, g20 introduction repo markets provide financial institutions with the necessary cash, so they play an essential role in managing short-term cash fluctuations. in addition to the necessary cash, the repo markets provide access to securities, enabling the efficient functioning of secondary markets. the regulatory definition of high-quality liquid assets (hqla), as part of the liquidity coverage ratio (see basel committee on banking supervision, 2001), recognizes the importance of the * e-mail: sanja_bgd@yahoo.com sanja nenadović 9 repo market for the liquidity of the secondary securities market. defining high-quality liquid assets includes the existence of an active repo market. repo, which has hqla as collateral, serves to mitigate credit and liquidity risks, so interest rates on such loans are suitable for the role of reference rates. there are two main segments in the repo market, bilateral and tri-party repo. the bilateral repo market consists of investors and collateral owners who exchange money and securities directly without a clearing bank. bilateral repo transactions may allow general collateral or impose restrictions on eligible collateral (special repo transactions). in addition to investors and collateral owners, the tri-party repo market includes the participation of clearing banks that enable settlements. clearing banks act as intermediaries, administrative processing details between the two parties in a repo transaction. tri-party repo is used to finance general collateral (so-called general repo transactions), where investors accept any collateral in securities. here, the centralized settlement mechanism minimizes operational risk. the issue of benchmarking became more urgent after the british regulator announced that banks would no longer be required to implement libor after 2021. moreover, the monetary policy caused declining market liquidity has undermined previously reliable unsecured benchmarks, such as eonia, the overnight rate. consequently, reference interest rate administrators have been looking for virtually risk-free interest rates that would serve as a replacement for existing reference interest rates. the repo rates emerged as the first logical solution. as liquidity has migrated from unsecured money markets in recent decades, the question arises whether the investor should use repo rates instead of ibor reference rates. some markets have already done that. reference rate administrators have chosen the secured overnight financing rate (sofr) for the usd, swiss average overnight rate (saron) for the chf, the canadian overnight repo rate average (corra) for the cad, the overnight repurchase rate (thor) for thb, etc. however, one of the main disadvantages of repo rates is the significant variations in their amount depending on collateral quality. such variations suggest that market microstructure issues could have played a more significant role in explaining repo rate movements (hull and white, 2013). one attempt to circumvent these problems is the mts / nex markets family of repo rates (rfr), in which the statistical filter shortens the upper and lower quartiles of daily repo rates. 1f1 another objection to using repo rates in constructing yield curves is that there is no way to determine the complete maturity structure of repo contracts. there are not enough maturity repo transactions in all repo indices to extend the yield curve to more maturities. the reliance on market swaps could mitigate the unavailability of repo transactions in extrapolating time rates. consultations initiated by isda (see isda, 2020) related to the transition to rfr rates suggest continuous compounding of overnight rates throughout the observed period. still, repo market plays a critical role in the transmission of monetary policy and the overall functioning of the financial system. in the euro area, repo market is the largest segment of money market. the euro repo market has grown significantly in the last couple of decades. realized repo transactions in 5 most active countries of the euro area (uk, france, germany, italy and spain) reached 234.5 billion euros in 2018.2f2 in us, 2.5 trillion us dollars are financed using repos on average daily in 2021.3f3 large volumes on repo market have an impact on financial stability, and therefore this market should not be neglected when discussing the scope of money market interest rates that should be considered as reference interest rates. 1 source: https://www.icmagroup.org. 2 source: https://sdw.ecb.europa.eu. 3 source: https://www.sifma.org. 10 economic analysis (2022, vol. 55, no. 2, 1-19) the main research question of the paper addresses the suitability of collateralized interest rates as reference interest rates. in particular, it tests the eligibility of these rates with traditional tests of the expectations hypothesis, such as those proposed by campbell and shiller (1991). answering the aforementioned research question is important from the standpoint of asset pricing, since adequate reference rates, in addition to carrying minimal risk, should be solid predictors of future interest rates, both short-term and long-term. literature review numerous authors have dealt with the issue of repo rates and the role of the repo market. the earliest works relate to special repo rates and the effects of the special repo market. one of the best-known in this field is duffie (1996), which discusses the theoretical factors that lead to special repo rates lower than most interest rates on loans with similar maturities and risk profiles. jordan and jordan (1997) deal with a similar issue, empirically confirming the previous hypothesis. fisher (2002) explains the close relationship between the price premiums of securities and special repo rates on the same securities. buraschi and menini (2002) deal with the link between liquidity risk and repo rates. they quantify the amount of average liquidity premium contained in the difference between general and special repo rates, which they claim is variable over time. vayanos and weill (2008) show that liquidity and the fact that some of the securities are special are two components of the price premiums of securities and derive a theoretical model that includes the absence of arbitrage. recent works are more focused on the general repo market. bartolini, hilton, sundaresan, and tonetti (2011) discuss general repo markets and collateralization associated with these markets. gorton and metrick (2012) investigate the link between the 2007-2008 financial crisis and the repo market, showing that changes in the libor -ois spread highly correlate with repo rates. bottazzi, luque and páscoa (2012) examine how securities markets and repo markets coexist within the general economic equilibrium. huh and infante (2017) point to the importance of the role of repo transactions in brokerage in the securities market. the components of the difference between repo rates and rates on unsecured loans are empirically analyzed by nyborg and rösler (2019), using data on general repo rates on overnight transactions. there are some recent papers focused on the role of repo market in general economic environment and its behaviour during debt crisis. armenter and lester (2017) provide a model that includes key features of the federal funds market and instruments introduced by the federal reserve. they use this model to study the effects of overnight reverse repurchase agreements on federal funds rate and other factors in the economic environment. boissel, derrien, ors and thesmar (2017) analyze a segment of the repo market during the eurozone sovereign debt crisis. they show that during the crisis of 2011, repo rates strongly respond to movements in sovereign risk, in particular for giips countries, indicating significant ccp stress. d’amico, fan and kitsul (2018) quantify the scarcity value of treasury collateral. they estimate the impact of security-specific demand and supply factors on the repo rates of u.s. treasury securities and find an economically and statistically significant scarcity premium. arrata, nguyen, rahmouni-rousseau and vari (2020) test the interactions between the pspp and repo rates using empirical data. their results show a negative correlation between bond purchases and associated repo rates. however, repo markets and collateralization do not mean the total absence of credit risk. the parties in repo transactions may still fail to fulfill their obligations. the presence of credit risk leads to the need for careful selection of contractual parties to perform repo transactions as efficiently as possible. government bonds are the most commonly used collateral in the repo market. the risk with these bonds is minimal (especially credit risk) as governments meet their obligations. although there is no risk-free financial instrument, by minimizing the impact of the sanja nenadović 11 credit risk of counterparties, then adequate collateral management, and implementing operational efficiency, repo can significantly reduce credit and liquidity risk. in addition, most repo transactions are overnight. that is why it is less risky than interest rates on long-term loans. however, an overnight rate not secured by collateral, regardless of the rate in question, carries a risk precisely because of the non-coverage by collateral. some authors, such as longstaff (2000), argue that an overnight rate is a better indicator of a risk-free rate due to borrowing. he tests the validity of the expectations hypothesis on the example of short-term usd repo rates. corte, sarno, and thornton (2008) further expand the test, which they also apply to the example of short-term usd repo rates. however, these papers do not test how reasonable repo rates are in estimating the forward-term structure of interest rates from the unsecured market (for example, libor and swap markets), which would allow repo rates to play the role of reference interest rates. expectations hypothesis of the term structure of interest rates the expectation hypothesis assumes that the yield on a long-term bond is equal to the average expected yield on a short-term bond over the life of the long bond plus some constant risk premium. most tests examine the ability of implicit interest rates to predict future yields. test results generally indicate that forward yields are biased predictors of future interest rates (see fama, 1984; campbell and shiller, 1991; and bekaert, hodrick, and marshall, 1997). campbell and shiller (1991) proposed the most famous tests of the expectation hypothesis, also used in this paper. these tests focus on predicting the difference in yields between longterm and short-term bonds. according to the hypothesis, predicting this difference should reflect the weighted average change in yields on short-term bonds over the life of the long-term bond and changes in yields on long-term bonds over the life of the short-term bond. the equation represents the relationship between the long-term and the expected short-term rate �̅�𝑟𝑡𝑡 𝑛𝑛 = 1 𝑘𝑘 ∑ 𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 ) + 𝑐𝑐𝑛𝑛,𝑚𝑚 𝑘𝑘−1 𝑚𝑚=0 (1) in which 𝑛𝑛 = 𝑘𝑘𝑘𝑘 denotes the maturity of the long-term rate, which is equal to the product of the maturity of the short-term rate (𝑘𝑘) and its time-frequency (𝑘𝑘). assuming rational expectations, the expression also applies �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 = 𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 ) + 𝜐𝜐𝑡𝑡+𝑚𝑚𝑚𝑚 𝑖𝑖 = 0, … , 𝑘𝑘 − 1 (2) where the 𝜐𝜐𝑡𝑡+𝑚𝑚𝑚𝑚 process is a white noise process, i.e., an error term of the �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 . substitution ( 2 ) in ( 1 ) gives �̅�𝑟𝑡𝑡 𝑛𝑛 = 1 𝑘𝑘 ∑ �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚𝑘𝑘−1 𝑚𝑚=0 − 1 𝑘𝑘 ∑ 𝜐𝜐𝑡𝑡+𝑚𝑚𝑚𝑚 + 𝑐𝑐𝑛𝑛,𝑚𝑚. 𝑘𝑘−1 𝑚𝑚=0 (3) in order to ensure stationarity, a short-term rate is deducted from both sides, which gives 1 𝑘𝑘 ∑ �̅�𝑟𝑡𝑡+𝑚𝑚𝑚𝑚 𝑚𝑚 − �̅�𝑟𝑡𝑡 𝑚𝑚 = 𝛼𝛼1 + 𝛽𝛽1(�̅�𝑟𝑡𝑡 𝑛𝑛 − �̅�𝑟𝑡𝑡 𝑚𝑚)𝑘𝑘−1𝑚𝑚=0 + 𝜔𝜔(𝑡𝑡 + 𝑛𝑛 − 𝑘𝑘). (1) equation ( 4 ) represents the first test of the expectations hypothesis. the null hypothesis is that the slope coefficient 𝛽𝛽1 is equal to one. error 𝜔𝜔(𝑡𝑡 + 𝑛𝑛 − 𝑘𝑘) must be orthogonal to the constant and the difference between the long-term and short-term rate. the ordinary least squares method is suitable for estimating the unknown parameters. in contrast, the standard errors are calculated by the general method of moments due to hansen (1982), since overlapping observations cause serial correlation. 12 economic analysis (2022, vol. 55, no. 2, 1-19) the equation (1) is equivalent to (𝑛𝑛 − 𝑘𝑘)𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚 𝑛𝑛−𝑚𝑚) = 𝑛𝑛�̅�𝑟𝑡𝑡 𝑛𝑛 + 𝑘𝑘�̅�𝑟𝑡𝑡 𝑚𝑚 + 𝑛𝑛𝑐𝑐𝑛𝑛,𝑚𝑚. (5) by subtracting (n-m)�̅�𝑟𝑡𝑡𝑛𝑛 from both sides, it is clear that 𝐸𝐸𝑡𝑡(�̅�𝑟𝑡𝑡+𝑚𝑚 𝑛𝑛−𝑚𝑚) − �̅�𝑟𝑡𝑡 𝑛𝑛 = 𝑚𝑚 𝑛𝑛−𝑚𝑚 (�̅�𝑟𝑡𝑡 𝑛𝑛 − �̅�𝑟𝑡𝑡 𝑚𝑚) + 𝑛𝑛 𝑛𝑛−𝑚𝑚 𝑐𝑐𝑛𝑛,𝑚𝑚. (6) it is obtained by applying relation ( 2 ) to equation (6) and introducing parameterization �̅�𝑟𝑡𝑡+𝑚𝑚 𝑛𝑛−𝑚𝑚 − �̅�𝑟𝑡𝑡 𝑛𝑛 = 𝛼𝛼2 + 𝛽𝛽2 𝑚𝑚 𝑛𝑛−𝑚𝑚 (�̅�𝑟𝑡𝑡 𝑛𝑛 − �̅�𝑟𝑡𝑡 𝑚𝑚) + 𝜗𝜗(𝑡𝑡 + 𝑘𝑘). (7) regression (7) represents the second test of the expectations hypothesis. the ols specification uses the orthogonality of the error 𝜗𝜗(𝑡𝑡 + 𝑘𝑘) according to the constant and the adjusted difference between the long-term and short-term rate at the moment 𝑡𝑡. the null hypothesis is that the slope coefficient is 𝛽𝛽2 equal to one. equations (4) and (7), viewed together, fully reflect the expectations hypothesis. equation (4) represents the relationship between term premiums and long-term changes in short-term interest rates. in contrast, equation (7) represents the relationship between term premiums and short-term changes in long-term interest rates. if one is valid for each 𝑛𝑛 and 𝑘𝑘, then the other is valid for each 𝑛𝑛 and 𝑘𝑘. however, for specific values 𝑛𝑛 and 𝑘𝑘, one may be valid, while the other may not necessarily be valid (see cambpell and shiller, 1991). empirical results this chapter will present the test results of the hypothesis given by equations (4) and (7). the idea is to test the extent to which overnight interest rates secured by collateral are good predictors of interest rates with longer maturities, which are collateral-free. two alternative samples are analyzed, a shorter one (the so-called subsample) covering the period from 3.4.2018 until 7.10.2021, and longer, which covers the period from 2.1.2001 until 7.10.2021. the emphasis is put on the shorter sample to compare better results between new interest rates published from 2018 (e.g. sofr) and those for which data historically reached far. at the same time, the period after 2018 eliminates the period of the financial crisis in 2008. on the other hand, the tests of the expectations hypothesis show bias in smaller samples (see bekaert, hodrick, and marshall, 2001), so a larger sample was analyzed to test the stability of estimates. table (1) provides an overview of summary indicators for both samples. table 1. descriptive statistics of daily interest rate series subsample whole sample interest rates subsample size mean sd min max sample size mean sd min max effr 1284 1.15 0.99 0.04 2.45 7584 1.44 1.64 0.04 6.67 sofr 1284 1.16 1.03 0.01 5.25 1284 1.16 1.03 0.01 5.25 libonusd 1281 1.15 0.99 0.05 2.40 7581 1.49 1.66 0.05 6.87 eonia 1284 -0.42 0.05 -0.50 -0.25 1375 -0.42 0.05 -0.50 -0.25 ester 738 -0.55 0.01 -0.58 -0.51 738 -0.55 0.01 -0.58 -0.51 liboneur 1281 -0.53 0.06 -0.60 -0.44 7581 1.15 1.69 -0.60 5.77 repoeur 1277 0.10 0.07 -0.03 0.38 1368 0.10 0.07 -0.03 0.38 sonia 1284 0.39 0.31 0.04 0.71 7584 2.02 2.08 0.04 6.93 libongbp 1284 0.38 0.30 0.03 0.70 7584 2.06 2.10 0.03 7.00 repogbp 88 0.48 0.01 0.45 0.49 6388 2.31 2.10 -0.25 6.74 saron 1284 -0.72 0.02 -0.79 -0.63 7583 0.23 1.01 -1.69 3.72 sanja nenadović 13 subsample whole sample interest rates subsample size mean sd min max sample size mean sd min max libonchf 1284 -0.79 0.01 -0.89 -0.75 7584 0.29 1.12 -1.16 4.58 tona 1284 -0.04 0.02 -0.08 -0.01 7582 0.07 0.15 -0.08 0.71 libonjpy 1284 -0.09 0.02 -0.21 -0.03 7584 0.09 0.19 -0.21 1.58 repojpy 1825 0.21 0.19 0.07 0.76 source: author’s calculations. no data for the jpy denominated repo rates due to data unavailability. data and calculation methodologies the libor and ice swap interest rates data come from the refinitive (thompson reuters). the data are publicly available for other series of interest rates used in the paper. interest rate data for five major global currencies are analyzed: the us dollar (usd), the euro (eur), the british pound (gbp), the swiss franc (chf) and the japanese yen (jpy). table 2 provides an overview of the interest rates used in this paper. the term premium is the difference between interest rates with a maturity of more than one day (libor and swap) and overnight interest rates, whether they relate to transactions covered or not covered by collateral. for each series of overnight interest rates, an analysis was performed on the same yield curves constructed from libor (for shorter maturities ) and swap (for longer maturities). sofr and saron represent secured interest rates for usd and chf. sofr, which the federal reserve bank of new york announced in april 2018 as an almost risk-free rate, is the average of transactions weighted for overnight repo rates on securities in the us repo market, and it replaces the libor dollar. saron is an overnight repo rate for the swiss franc, developed by the swiss national bank (snb) and the swiss stock exchange as a risk-free rate that changes the swiss franc libor. for the british pound, the euro and the japanese yen, repo rates are used as indicators of collateralized rates. these are overnight gilt repo rates with general collateral for gbp. the bank of england publicly reported these data until 2.6.2018. the observation period for gilt repo rates is 4.1.2000 to 29.6.2018. table 2. an overview of analyzed interest rates interest rate currency tenor (s) * collateral coverage effective federal funds rate (effr) usd on no secured overnight financing rate (sofr) usd on yes euro short-term rate (ester) eur on no european overnight index average (eonia ) eur on no overnight repo rate for eur eur on yes sterling overnight index average (sonia) gbp on no overnight repo rate for gbp gbp on yes swiss average overnight rate (saron) chf on yes tokyo overnight average rate (tona) jpy on no overnight repo rate for jpy jpy on yes london interbank offered rate (libor) all 5 currencies on, 1w, 1m, 2m, 3m, 6m, 12m no ice swap rate all 5 currencies 2y, 3y, 4y, 5y, 6y, 7y, 8y, 9y, 10y no source: author’s calculations. on – overnight; w – week; m – month; y – year. 14 economic analysis (2022, vol. 55, no. 2, 1-19) the tokyo repo rate / overnight transaction (% (t + 1)) is used for jpy. data are published by the bank of japan and are available for the period from 30.10.2007 to 26.10.2012. due to daily data unavailability, the euro data for repo rate are approximated. the data on the daily level of the eonia index are modified with the difference between the monthly data for the eonia index and monthly bank repo transaction rates for the euro area. data on banking rates are published by the european central bank and are publicly available. the observation period is 31.12.2018 to 4.1.2021. the data are observed at a daily frequency. all the rates are continuously compounded zerocoupon rates, calculated using the formula �̅�𝑟𝑡𝑡 𝑛𝑛 = 𝑙𝑙𝑛𝑛 � 1 1+𝑓𝑓 𝑟𝑟𝑡𝑡 𝑛𝑛� 1 𝑓𝑓 (8) where 𝑓𝑓 represents day count convention. the assumption is that every month has 30 days and the year 360. for the number of days shorter than 30, the exact number of days is used for the given period. interpolated values have replaced missing data (non-working days, for example). swap rates are also zero-coupon interest rates, calculated using the bootstrap method with a semi-annual frequency. hypothesis testing results tables 3 and 4 show the results of regression tests of equations (4) and (7) using the data described in the previous chapter. the tables show slope estimates and their standard errors that include newey-west corrections (newey and west, 1987). estimates show a slight increase in interest rates on us dollar-denominated loans in the subsample. the results for the remaining four currencies indicate the absence of a correlation between the level of estimates and the term structure of interest rates. a negative sign appears in the repo rate for the british pound and saron interest rates. at the significance level of 5%, the coefficients for interest rates sofr, effr, liboronusd, repo rate for eur, liboronchf, tona and liboronjpy deviate statistically significantly from zero. on the whole sample, the estimates differ from those on the subsample. similar to the results in the subsample, estimates of the slope of interest rates on us dollar-denominated loans grow up to 12 months. the estimates remain relatively unchanged for the remaining maturities, varying around one. a similar pattern is not observed for other currencies. the statistical significance of the coefficients changed at the interest rates for the japanese yen, whose coefficients are not significantly different from zero on the whole sample. most estimates are statistically significantly different from zero in the long-run part of the curve. in both observed samples, the collateralized rates sofr and repo eur have an advantage over non-collateralized rates. their estimates are relatively closer to unity and with a similar level of precision as estimates for non-collateralized interest rates. repo gbp has much less favourable results than sonia and libor on rates on the subsample. however, such results are prone to a small sample bias (for the gbp repo, only 88 observations were available). on the whole sample, the results for the gbp repo are more favourable and closer to the results of non-collateralized rates. this similarity of the results is especially noticeable in the short-term part of the curve. the results favour a collateralized rate for the japanese yen on the short-term part of the curve. in this part of the curve, repo slopes are closer to one than the slopes for tona and libor on rates. the only currency where the results speak in favour of the superiority of non-collateralized rates is the chf. the estimates for saron deviate far from the ratings for the libor on rate, which are closer to unity. similar conclusions are reached in analyzing the results for both observed samples. sanja nenadović 15 table 3. the results of equation (4) testing source: author’s calculations of ols estimates for slope coefficients (newey-west standard errors with n-m-1 lag in parentheses). * statistical significance at 5% the slope estimates for equation (7) in both samples are pessimistic in many cases, which are results similar to those published by campbell and shiller (1991). they show that estimates have a negative, therefore erroneous, sign for different subsamples that they analyze at different periods and sample sizes. the exceptions to this "rule" are the interest rates for usd and gbp for the shorter sample, where the ratings are positive. also, for a larger sample, the slopes of the long-run part of the curve have a positive sign, but they deviate from the unit. for most interest rates, as 𝑛𝑛 increases, the slope estimates with positive signs also increase, while for the negative ones, the estimates decrease as 𝑛𝑛 increases, all moving away from unity. slope estimates are wildly inaccurate in many cases, with reasonably high newey west standard errors. the statistical significance of the estimated slopes (at a significance level of 5%) on the shorter sample exists for the us dollar for maturities greater than 12 months, the repo rate denominated in the british pound for maturities over six years, and the tona interest rate for maturities up to 3 months. the situation is slightly better for all currencies except eur in the sample, especially for shorter maturities (up to 12 months), where many coefficients deviate statistically significantly from zero. when comparing results between collateralized and non-collateralized rates, there is no significant difference in the results. similar behaviour in terms of signs, the statistical significance of coefficients and deviations of estimates from the unit exist with collateralized interest rates. due to the unavailability of data for �̅�𝑟𝑡𝑡+𝑚𝑚𝑛𝑛−𝑚𝑚 which are non-observable data, the regression-based equation (7) is approximated by �̅�𝑟𝑡𝑡+𝑚𝑚𝑛𝑛 . bekaert, hodrick, and marshall (2001) note that this change in variables leads to an upward bias in predicting the slope coefficient. 16 economic analysis (2022, vol. 55, no. 2, 1-19) values greater than one are expected under the null hypothesis, even asymptotically. however, since the exact approximation is used for all series, they are all exposed to the same bias, so it is possible to compare their estimated values. table 4. the results of equation (7) testing source: author’s calculations of ols estimates for slope coefficients (newey-west standard errors with zero lags in parentheses). * statistical significance at 5% sanja nenadović 17 the regressions (4) and (7) indicate that the expectations hypothesis may be valid for the us dollar, where the hypothesis for sofr holds a higher probability relative to effr and libor on rates. table 5 gives the results of hypothesis testing 𝛽𝛽1 = 1 and 𝛽𝛽2 = 1. only the results for which the null hypothesis cannot be rejected at the significance level of 5% are presented. in the first test (𝛽𝛽1 = 1), the hypothesis cannot be rejected at relatively longer maturities for the usd interest rates (effr, sofr and libor on). estimates of coefficients for maturities of 12 months do not deviate significantly from the unit in both samples. on the whole sample, other maturities for which the coefficients do not deviate significantly from the unit are 2, 3 and 6 years. on the whole sample, the collateralized interest rate (sofr) recorded better results in higher p values than the non-collateralized interest rates (effr and libor on). as for the second hypothesis 𝛽𝛽2 = 1, it cannot be rejected for shorter maturities, namely usd 6m, gbp 1w and gbp 1m. the slope estimates of these pairs do not deviate significantly from the unit on the subsample. the exception is libor on for the one-week term premium, where the slope estimates do not deviate significantly from the unit on both observed samples. for the us dollar, the collateralized rate sofr has similar results as non-collateralized rates, while for the british pound, non-collateralized rates have better results at these maturities. table 5. slope constraint tests in equations (4) and (7) beta1=1 n f(1.n) p effr 12m 1279 0.00 0.95 effr 12m 7579 1.19 0.28 effr 2y 2620 2.40 0.12 effr 3y 2620 2.22 0.14 effr 6y 2620 1.84 0.18 sofr 12m 1279 0.35 0.56 sofr 2y 1279 0.01 0.92 sofr 3y 1279 1.00 0.32 libonusd 12m 1279 0.00 0.95 libonusd 12m 7579 0.74 0.39 libonusd 2y 2620 1.87 0.17 libonusd 3y 2620 1.73 0.19 libonusd 6y 2620 1.76 0.18 beta2=1 n f(1.n) p effr 6m 1278 0.16 0.69 sofr 6m 1278 0.30 0.59 libonusd 6m 1278 0.09 0.76 sonia 1w 1281 1.13 0.29 sonia 1m 1281 0.15 0.70 libongbp 1w 1281 0.16 0.69 libongbp 1w 7581 1.66 0.20 libongbp 1m 1281 0.11 0.74 source: author's calculations (only the results for which 𝐻𝐻0 is not rejected). conclusion this paper analyses the eligibility of repo rates in forming reference interest rates by checking the validity of the expectation hypothesis. reference interest rates should be indicators of riskfree interest rates, and the expectations hypothesis is one of the essential theories of the term structure of interest rate on risk-free loans. other contributions from the literature have not given the repo rates as risk-free rates much attention so far. the main reason is the presence of considerable variability in their amount, which is a consequence of different collateral quality structures. in addition, there is no way to determine the entire maturity of the structure of repurchase agreements, which constitutes a 18 economic analysis (2022, vol. 55, no. 2, 1-19) serious potential obstacle for future research. therefore, most authors use some of the interest rates on unsecured loans that do not face the above problems. the paper applies the traditional tests of the expectation hypothesis proposed by campbell and shiller (1991). the hypothesis on daily data for 15 overnight interest rates is tested, in which five of them are covered with the general collateral. five currencies were considered: usd, eur, gbp, chf and jpy. the term structure from libor and ice swap interest rates for all five currencies is constructed. the analysis was conducted on shorter and longer samples to compare different interest rates better. some of the overnight interest rates for which the hypothesis was tested are relatively new (e.g. sofr and ester), so there is limited data availability. based on the results of testing the expectations hypothesis, the conclusion is that overnight interest rates covered by collateral are equally good predictors of term premiums as their unsecured rivals. in some cases, they have proven to be even more precise indicators (for example, sofr regressed to the swap rate in equation (7)). when we add to that the fact that collateral contributes to lower credit risk, it can be concluded that there is no reason not to apply repo rates as an official benchmark for risk-free interest rates. relatively low credit risk is a significant advantage of repo rates worth considering and far outweighs the disadvantages of repo rates, which are mainly methodological. quantifying this advantage could be a topic for future research in the area of repo rates and collateralization. acknowledgements i wish to thank milos bozovic, branislav boricic, dejan soskic, irena jankovic and two referees for their comments on the previous version of this paper. literature isda. 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(2008). a search-based theory of the on-the-run phenomenon. the journal of finance, 63(3), 1361–1398. article history: received: july 4, 2022 revised: september 30, 2022 accepted: october 3, 2022 microsoft word 2010_1_2.doc guest editor’s notes the current volume of economic analysis provides a collection of original scientific papers and scientific reviews covering a wide range of topics from small and medium enterprises (sme) research to price stability and employment research, business logistics and business valuation. the most of articles were originated through the international cooperation in education and science of visegrad group countries and serbia in the field of the investment, banking and business, especially oriented on the small and medium enterprises. this scientific collaboration is currently cofinanced by visegrad strategic program project “strengthening the educational and scientific collaboration among faculties of economics within v4 and countries of south eastern europe” of international visegrad fund. within the frame of this project we have slowly but surely established international educational and scientific network of teachers and researchers from czech republic, hungary, poland, serbia and slovakia (see www.ekf.tuke.sk/ivf to recognize all eight project partners involved). the network coordinates the mobility of faculties´ project personnel; prepares workshops and meetings on best practices in educational and scientific areas within topics like investment, banking and business. we are also pleased to present the most of here published papers personally during the international scientific conference “economic prospect in the second decade of the 21st century” (14. – 15. april 2010) organized by belgrade banking academy and institute of economic science in belgrade. this current volume of economic analysis journal covers wide range of economic topics, there you are erős’s paper focuses on the growth theory and discusses the question whether or not government policies can be used to influence the long run growth rate of the economy. the author summarize the theoretical and empirical literature of the relationship between fiscal policy and long run economic growth shortly on the one hand, and on the other hand used the parameter estimates of a third generation study of developed countries to evaluate the fiscal policy actions taken in hungary and in ireland. she also mapped the explanation for the differences in these two countries’ reactions to some of the similar fiscal policy changes. the next three contributions are aimed at theory of investment and business valuation, especially applied in the financial sector. first one by horvátová proceeded with bank and financial institution valuation enlarging the last contributions in theory of investment value by r. c. merton using the risk-neutral valuation model and its variants. very close to this topic is the contribution focuses on the bank mergers in the central-east europe region. in the second one the author tej examined and analyzed differences in financial results in the central and eastern europe region in comparison with developed markets. finally, in more theoretical oriented paper by glova the author attempts to address key issue in designing algorithm for estimating of yield curve. the author proposed the application of matrix theory in yield curve points estimation. in her scientific review kotlebová discusses the future stance of currencies in the international monetary system. she mentioned the higher creation of savings in emerging economies compared to developed countries; higher investments of developed economies in comparison with developing economic analysis (2010, vol. 43, no. 1-2, 7-8) 8 countries; the current account deficit of the balance of payments in developed countries as opposed to the current account surplus of the balance of payments in emerging economies create new conditions for future stance of currencies in the international monetary system. she also highlighted the main trends in the future development the imf. milecová’s article analyzes the differences between the harmonized indices of consumer prices and the national consumer price indices on the theoretical as well as on the practical levels. author deals with defining the differences between the indices not only in the euro area and in v4-countries, but also in serbia. the main differences are geographic and population coverage and owner-occupied housing. using statistical methods the author test hypothesis of the difference between different the indices measuring price stability. vokorokosová in her paper addresses the influence and dependency between minimum wage increase and the amount of employed people. this article picks out minimum wage as an important part of employment research investigating two files; the number of working people aged 15 – 64 and all working labours. kościelniak reviews and analyzes information resources for financial monitoring in enterprises. grabara’s article focused on business realations in reverse logistics outsourcing, as key aspect of the cost reduction used in companies during fighting for survival, keeping or increases in sales levels and profits. more and more often observed tendencies to concentrate commercial and production companies lead to rise of demand for outsourcing in a reverse logistics chain. gubik’s paper intends to introduce the reader to the characteristics of supplier-purchaser relationships of smalland medium sized enterprises, based on an empirical research’s experiences using the questionnaire and its statistical evaluation. according to author’s opinion, we can draw conclusions on the intention to cooperate concerning the nature of the buyer-supplier relationships of companies, so a wide range of information can be concluded on smalland medium sized enterprises’ partnerships. please allow me to express my sincere appreciation to prof. dr mirjana radović marković for confidence. last but not least i want to thank all contributors and reviewers for their excellent work that they have done. jozef glova microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp104-117 research paper intellectual capital investments and company’s profitability: french context miloš petković1* | milica đorđević2 1 singidunum university, faculty of business, belgrade, serbia 2 university of niš, faculty of science and mathematics, niš, serbia abstract the purpose of this paper is to investigate the effects of r&d investments on the company profitability, with special focus on the french most innovative companies. the study is divided into three parts aiming to address the three key research questions raised in the study: the first research question examines the influence of r&d investments on company intangible assets; second research question calculates efficiency of capitalized or transformed intangible assets value coming from r&d investments, whereas the third research question examines generated returns on capitalized assets. the method used in this study is the efficiency of intellectual capital (eic) method developed by krstić and bonić (2016). this method investigates the process of intellectual capital (ic) value creation within french companies. the study proves that r&d investments influence positively the intangible assets value after a long-term period of investments. after the new intangible assets are created and developed, they positively influence their efficiency, whereas the impact on the company profitability is not determined in the same year. the main research limitations come from the fact that the observed sample of companies is small, and the access to the financial information related to the r&d expenses is limited to the official accounts of companies, whereas companies are not obliged to disclose this information by accounting rules. this study confirms that high-innovative french companies transform long-term r&d investments into concrete intangible assets values. on the practitioners’ side, the study represents a motive for managers to focus more on the investments in ic that will create a concrete value and generate further economic benefits from that value, rather than to concentrate only on short-term improvements of financial performance. key words: r&d expenditures, investments in ic, ic, return on assets methods, financial performance, france jel classification: e22 introduction global economy has dramatically changed during the last thirty years. the change in the form of transition from industrial economy to knowledge-based economy was a revolution in the corporate world. these changes are mostly influenced by the global information and technological trends which put emphasis on the innovation and ic as the key factors of global competition (petković et al., 2020). growing awareness and importance of intangible assets are coming directly from the increasing difference between market and book value of companies (lev, 2001). because of the importance of intangible assets, companies’ investments are about * corresponding author, e-mail: mpetkovic@singidunum.ac.rs miloš petković, milica đorđević 105 50% only in the sphere of intangible assets, precisely in (r&d), personnel development, infrastructure (fuller, 2002). kaplan and norton (2004) documented that 75% of the market value of us companies comes from intangible assets. according to lev and schwartz (1971), all company’s intangibles make up its own ic. ic is everything known by everybody in a company, and it brings a necessary competitive advantage to the company (serenko and bontis, 2004; stewart, 1991). the company competitiveness, attractiveness, and financial performance are driven by its ic. the topic of investments in ic brings a debate because if a company decides to invest in intellectual resources and expects improvement in competitive advantage, managers should measure the return on them. in order to manage ic properly, it is of high importance to measure them in the right way. the treatment of ic in a company accounts has been changed drastically. the main decision relates to capitalizing investments in ic, as this can transform knowledge into concrete value. the ic investments have the main ability to make contributions to more than one production cycle and lead to the accumulation in the form of an asset. however, this is where the greatest difficulty lies because organization must measure these investments consistently and systematically over time (belo et al., 2014; bloom and van reenen, 2010). the aim of this study is to make an empirical investigation of effects of investments in r&d on the company financial performance by implementing the eic model developed by krstić and bonić (2016). the sample is composed of 61 french companies over the period from 2008 to 2016. in the research paper, the complex statistical regression analyses are implemented in order to answer the three main research hypotheses: (1) following the investments in intellectual capital; (2) capitalization of investments intellectual capital into concrete assets value; and (3) measuring the influence of capitalized assets on the company’s financial profitability. the paper is organized as follows. section 2 presents the theoretical background and literature review of the ic investments in company performance. section 3 explains developed research methodology. section 4 presents empirical findings, whereas section 5 concludes the paper. literature review the conceptualization of ic investments a unique definition of ic investments has not been found until now because it mainly depends on the purpose of a study. on one side, investments are understood as expenditures for ic components. on the other side, some researchers perceive investments in ic as intangible investments, knowledge-based investments, intangible activities, etc. (lentjushenkova and lapina, 2014). according to piekkola (2011), the ic investments are capital formation expenditures of a company. the definition of “investments” is not only focused on financial performances, but also on non-financial performances, such as productivity, quality and improvement (lentjushenkova and lapina, 2014). many researchers consider ic investments as the key-drivers of financial company performance. based on the literature, ic investments are linked to value factors (dumay, 2012). according to molodchik et al. (2012) ic investments are the ic part concentrated on improving company competitive advantage and financial performance that will further cause an increase in the company value. the study by rodriguez-castellanos et al. (2011) proves that companies investing in ic have a better financial performance. 106 economic analysis (2021, vol. 54, no. 1, 104-117) r&d expenditures as ic investments most of the researchers link ic investments to r&d expenses (bandeira and afonso, 2010). researchers define ic investments as different kinds of costs or expenditures, such as r&d expenditures, advertising expenditures, labor costs, etc. this approach is used mainly because it is easy to collect this financial information from financial statements and annual reports (lentjushenkova and lapina, 2014). bandeira and afonso (2010) prove that market treats r&d expenses as investments in ic, more precisely in structural capital. martín-de-castro et al. (2011) state that the structural capital is composed of technological and organizational capital. making a decision to invest in a company ic requires setting a company goal and estimating the amount of necessary financial resources. for instance, if a company decides to invest in its r&d, the same company must also invest in hiring qualified employees that will be able to perform and realize pre-planned r&d activities. at the same time, these qualified employees must be trained and educated continuously in order to keep their level of qualification competitive. finally, if a company invests in its r&d and hires qualified personnel, it is necessary to focus on stakeholders’ demands and requirements because it is not possible to imagine and generate future benefits without that (lentjushenkova and lapina, 2014). investments in ic very often do not generate immediate results and returns. some period is necessary to produce effects on company performance. the results today must come from the investments made in previous periods (garcía-zambrano et al., 2018). results from investments in ic components vary from each other. for instance, the study by awano et al. (2010) proved that investments in ic produce results after 3-5 years regarding training, reputation and branding, and 4-7 years regarding r&d and software. according to the study by khamoussi halioui (2013) the capitalization of r&d expenses is possible in france, but it is up to the management to decide whether to expense or capitalize. it is important to understand that the capitalization process is highly risky process, mostly because the investments belong to high ic intensive companies. the same author explains that based on the ifrs/ias it is possible to capitalize r&d expenses, only under certain conditions, whereas under gaap this is not allowed. under gaap, it is only possible to expense r&d expenses. based on the synthetized literature review of various studies by lentjushenkova et al. (2016), some of the potential outcomes of ic investments are: profit growth, future costs reduction, market share growth, productivity growth, business value improvement, customer satisfaction, and staff loyalty improvement. r&d expenditures and company financial performance r&d investments differ from other types of investments by their nature and other attributes, such as company specificity, information asymmetry, and high level of uncertainty and risk (holmstrom, 1989). r&d costs are not intangible assets. r&d expenses often result in the development of patents or copyrights (product, process, idea, formula, etc.) (warfield et al., 2008). research activities are planned search or critical investigation focused on the discovery of new knowledge, whereas development activities are translation of research findings into a concrete plan or design for a new product or process (warfield et al., 2008). it is proved that investments in r&d are seen as an important form of investments in hightechnology (karl-heinz, 2005). most studies prove that r&d positively influence productivity, profits, sales, and employment growth of a company (lentjushenkova and lapina, 2014). chauvin and hirschey (1993) reveal that advertising and r&d expenditures have large and positive effects on corporate market value. this indicates higher future cash flows for companies with greater r&d and advertising expenses. maggina (2011) states that one company makes decisions at least one year before investing in r&d and the forecast is around 90% adequate when using a logit specification. chang and hsieh (2011) investigated the relationship between r&d investments and operating, financial and market performance of a company. the miloš petković, milica đorđević 107 association between these variables is proved to be positive and statistically significant. this is a proof that r&d investments are used as a source of “value creation” based on the taiwanese example (chang and hsieh, 2011). megna and klock (1993) state that investments in r&d are directly related to the number of patents, or, to be more precise, directly related to increase in a company book value. lev (2004) investigated the r&d investments of the textile company dupont for the period from 1985 to 2000. the investments have influence on two thirds of the increase in the value generated within a company. return on assets methods for ic measurement according to marr et al. (2003) the starting reason for measuring ic is that it helps companies in determining their corporate strategies. the successful corporate strategy implementation will further enable the company diversification and expansion plans. additionally, companies will benefit by establishing management compensation systems for upcoming years, together with appropriate communication with key external stakeholders. kontic and čabrilo (2009) argue in favor of ic measurement by taking into considerations all risks of not measuring it. labor shortages, low productivity, skills mismatches or talents going to competitors are only some of the consequences of not measuring ic within a company. until now, there have been many possibilities to use ic in the value process creation of an organization. following the luthy’s work (1998), sveiby categorizes measurement methods in the following four groups:  direct ic methods (dic),  market capitalization methods (mcm),  return on assets methods (roa) and  scorecard methods (sc). roa methods are: economic value added (eva™), market value added (mva™), human resource accounting (hra), value added intellectual coefficient (vaic™), calculated intangible value (civ), knowledge capital earnings (kce), eic method developed by krstić and bonić (2016). the eic methodological framework is developed by krstić and bonić (2016) for measuring the efficiency of the total ic of a company, by means of calculating the partial efficiency measures of ic components. this method combines the financial accounting valuation with the market valuation by determining the value of the ic from two parts: the ic disclosed on the balance sheet of an enterprise, and the undisclosed ic. as regards the roa methods, which are the monetary group of methods, their major strength is that these methods are suitable for comparison of different companies in the same sector of activities. on the other side, their main weakness is the lack of information constituting ic. the roa methods are characterized by utilizing financial information from financial statements. they are very easy for calculation because financial information is mostly available. they are very often used in acquisition and merger processes as indicators of success or comparison of performance of intangible assets that are a subject of transactions (gogan, 2014). the most implemented method in practice is certainly the pulic’s vaic method (pulic, 2000). many previous studies proved a positive relationship between ic and a company financial performance by using the vaic method (chu et al., 2011; joshi et al., 2013; pal and soriya, 2012). śledzik (2012) investigated the efficiency of ic in the banking sector in poland for the period 2005-2009, and concluded that the ic efficiency was to a great extent depended on the human capital efficiency. gigante (2013) analysed 64 banks in europe for the period 2004-2007, and determined the correlation between ic and financial performance of the analysed banks, while the correlation between ic and market value was not confirmed. 108 economic analysis (2021, vol. 54, no. 1, 104-117) sardo and serrasqueiro (2017) studied the impact of ic on the financial performance measured by roa in the 8 european countries for the period 2004-2015, and concluded that ic efficiency had a positive impact on financial performance. data and methodology innovativeness of french companies the book published by hollanders et al. (2016) proves that french economy is highly innovative. innovative performance increased in the period from 2008 to 2012, declined briefly from 2013 to 2014, and continued increasing again from 2015 until today. the innovative performance is 10% higher than the european average in 2010, and it is 9% higher than the european average in 2015. french strength lies in open, excellent and attractive systems and innovators. the best performing indicator is seen in non-eu doctorate students who have the opportunity to start and successfully realize their research in france. furthermore, france has marked highly positive growth in most of the indicators, such as license and patents, international scientific co-publications and new doctorate graduate papers. the french economy distinguishes itself from other european economies by high growth in smes innovating inhouse, innovative collaboration of smes, and product/service innovations. according to triki-damak and halioui (2013), france as a country spends a lot of resources on innovations. france is 10th most innovative country in the european union that invests 1.31% of gdp in r&d expenditures. according to younes (2015), france is seen as the second most r&d intensive country in the european union by the economics of industrial research and innovation (eiri). based on the study of department for business innovation & skills (2012), france occupies 7th place in europe regarding the level of investments in intangible assets. based on the same study, france spends 1.2% gdp on scientific r&d, 2.3% on organizational competence (excluding trainings), and 4.1% of gdp on other investments in intangible capital, which is almost 10% of gdp in total. it is evident that scientific r&d, other product developments, design and research in the part of innovative property, and firm-specific human capital and organizational capital in the economic competency part all play a crucial role with the biggest ratio in the whole french economy. in all three main areas: computerized information, innovative property, and economic competencies, measurement indicators are higher than 1.0 in total which means that companies invest more in intangibles than in tangible assets. these ratios are the main proof that the french economy is highly innovative (barnes and mcclure, 2009). data and research sample the study is focused on the data gathered by the financial database “point risk”. it comprises of financial information from the financial statements of french companies during the period 2008-2016. in the sample are only included companies from high-technology industries with the percentage of intangible assets in total book value higher than 40%. this indicator confirms high level of intangibility of company assets. the data contains 11 high-technology french industries. the classification of industries is proposed by francis and schipper (1999). the high-technology industries covered by the study are: computed hardware, research, development, testing services, drugs, computer programming, software, data processing, computer and office equipment, electrical industrial apparatus, telephone communications, household audio, video equipment, audio receiving, telephone communications, and electrical machinery and equipment, excluding computers. the initial sample started with 495 observed companies, and after inclusion of companies with miloš petković, milica đorđević 109 intangible assets in total book value higher than 40%, and exclusion of companies with missing data, the final sample is composed of 61 companies. conceptual research model and hypotheses high-technology companies are recognized as highly innovative companies. the level of innovativeness of these companies can be identified based on the level of achieved revenues from sales which is used for investments in r&d. namely, for competitive advantage of hightechnology innovative companies it is very important them to substantially invest in r&d, i.e. to have as high as possible research intensity indicator (rii). however, it is not only important to make substantial investments in r&d activities every year during a long-term period, but also to efficiently use those investments. their efficient usage means providing innovations of products and processes, which have to be effected in the prospective growth of gross profits from year to year during investment period. the efficiency of r&d investments is observed through return on research capital (rorc) indicator. investments in r&d, through innovation process in high-technology companies, are transformed i.e. capitalized in the value of generated intangible resource, which is recorded as visible intangible assets in the balance sheet, but also as invisible intellectual resources (human, structural, and relational). economic efficiency of high-technology companies requires achievement of high economic efficiency in the use of intangible assets (as visible intellectual resource disclosed on the assets side of the balance sheet) and high economic efficiency in the use of invisible intellectual resource, which is not disclosed on the assets side of the balance sheet due to the limitations imposed by accounting standards (ias 38, primarily). for ic managers it is of utmost importance to measure and monitor the indicator of efficiency of intangible assets investments (as visible segment). the efficiency of intangible assets investments determines the profitability of high-technology companies, which is measured by traditional indicator such as roa. this framework shows how investments in r&d and efficient usage of intangible assets determine the efficacy (profitability) of high-technology companies. key variables in the research conceptual framework are the following: rii, rorc, ic value added (icva), intangible assets and goodwill (iag), eiag, and roa. rii is the first given variable and it is defined as expenditures in r&d divided by the company sales. this indicator differs across different sectors of activities, whereas high-technology companies have the highest r&d intensity indicator (milkovich et al., 1991). rorc is calculated as quotient between gross profit of the current year and r&d expenditures from the previous observed period. this indicator shows how much of company gross profit in the current year comes from the r&d expenses from the previous period (christensen and derek van bever, 2014). the formula is presented: rorc = gross profit (t) average of r&d expenditures (t − n, t − 1) iag is a part of ic which is disclosed on the balance sheet. total ic (ic), consisting of both the ic which is not visible (δic) and the ic which is visible on the balance sheet (iag), can be presented in the following way (krstić and bonić, 2016): ic = iag + δic or ic = iag + hc + src 110 economic analysis (2021, vol. 54, no. 1, 104-117) where hc denotes human capital (invisible in the assets side on the balance sheet), and src denotes structural and relation capital (invisible in the assets side on the balance sheet). icva is a very important variable in this conceptual model. the earnings before interest and tax (ebit), as the financial result, requires a correction by several categories which would lead to the creation of the category of icva. it can be calculated by the following formula (krstić and bonić, 2016): icva = ebit + dfa + amia + iml + pe dfa is the depreciation of fixed or non-current assets, amia denotes the amortization of intangible assets with an identifiable useful life, iml represents an impairment loss of intangible assets with indefinite useful lives (goodwill), and pe stands for personal expenses or gross salary of employees and managers (net salary + salary taxes), other investments in human resources development such as cost of education, training, etc. another way of calculating ic value added is (krstić and bonić, 2016): icva= ebitda + pe where ebitda denotes the earnings before interest and tax, depreciation and amortization. the control of economic efficiency in the use of intangible assets and goodwill, as a part of total ic (ic) that is visible or recorded on the assets side of the balance sheet, requires the measurement of efficiency of intangible assets and goodwill (eiag). this performance indicator shows how many units of icva can be generated per every 100 monetary units of the employed intangible assets and goodwill. this is actually the indicator of return on intangible assets and goodwill and the formula for the calculation is (krstić and bonić, 2016): eiag = icva iag roa is a traditional indicator for company profitability which is calculated according to the following formula. roa = ebit as where as denotes assets. the main goal of the study is to investigate how profitable the capitalization process of r&d expenses, seen as investments in ic, is in the french context. three research goals coming from the main goal are:  investigate how the r&d intensity indicator together with return on research capital (rorc) impact on the intangible assets (iag);  investigate how the capitalized intangible assets (iag) impacts on the efficiency of intangible assets (eiag);  investigate how the efficiency of intangible assets (eiag) impacts on the company profitability;  in order to fulfill the above stated goals, the following hypotheses are tested: h1: investment in r&d of high-technology companies in the forms of research intenstity indicator and return on research control impact positively and create value in the balance sheet, (specifically create intangible assets and goodwill – iag). miloš petković, milica đorđević 111 h2: capitalized and created intangible assets (iag) influence positively on the efficiency in the use of visible ic disclosed on the balance sheet (eiag). h3: efficiency of intangible assets indicator (eiag) together with capitalized value of intangible assets (iag) determine the achieved level of firm profitability (efficiency) measured by roa. research results and discussion model 1 following random variables are observed: iag (dependent), rorc, rii (independent) and control variables size and industry of companies (also independent). linear connection between those variables is tested: 𝒚 = 𝐥𝐧(𝑰𝒂𝒈), 𝒙𝟏 = 𝑹𝒐𝒓𝒄, 𝒙𝟐 = 𝑹𝒊𝒊, 𝒙𝟑 = 𝑺𝒊𝒛𝒆 and 𝒙𝟒 = 𝑰𝒏𝒅𝒖𝒔𝒕𝒓𝒚. the following multiple regression model is considered: 𝑦 = 𝛽 + 𝛽 𝑥 + 𝛽 𝑥 + 𝛽 𝑥 +𝛽 𝑥 +ε where ε is white noise. it is necessary to evaluate the model, to examine whether the regression is statistically significant and if so which of the coefficients are statistically significant. table 2. model 1 statistical results 𝜷𝟒 𝜷𝟑 𝜷𝟐 𝜷𝟏 𝜷𝟎 𝛽 coefficients 0.035 1.577 0.258 -0.001 11.818 sbi errors 0.099 0.128 0.054 0.001 0.404 𝑅 0.742 f-statistics 40.193 56 ss 132.522 46.159 -0.131 -0.119 -0.657 t-statistics 0.349 12.352 4.802 -1.126 29.227 t-critical 2.003 f-critical 2.537 using the least squares method regression coefficients are estimated: 𝑦 = 11.81797 − 0.00153𝑥 + 0.25846𝑥 + 1.57679𝑥 + 0.03471𝑥 model 1 has the starting 𝜷𝟎 with the coefficient of 11.818. the model 1 shows that on the capitalized value of intangible assets (iag) negatively influences return on research capital (rorc) with the coefficient of -0.001. on the other side, positive influences come from research intensity indicator (rii) with the coefficient of 0.259, size with the coefficient of 1.578, and industry with the coefficient of 0.035. errors in estimating coefficients are: 𝑆 = 0.404, 𝑆 = 0.001, 𝑆 = 0.054, 𝑆 = 0.128, 𝑆 = 0.099. the coefficient of determination of the model is 𝑅 = 0.742. realized value of test statistic is 𝐹 = 40.193. the critical area is 𝑐 = (2.537, +∞). the value of test statistic is into the critical area, which means that the regression is statistically significant. then the following hypotheses are tested 𝐻 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 𝑏 𝑖𝑠 𝑛𝑜𝑡 𝑠𝑡𝑎𝑡𝑖𝑠𝑡𝑖𝑐𝑎𝑙𝑙𝑦 𝑠𝑖𝑔𝑛𝑖𝑓𝑖𝑐𝑎𝑛𝑡 versus 𝐻 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 𝑏 𝑖𝑠 𝑠𝑡𝑎𝑡𝑖𝑠𝑡𝑖𝑐𝑎𝑙𝑙𝑦 𝑠𝑖𝑔𝑛𝑖𝑓𝑖𝑐𝑎𝑛𝑡 (𝑖 = 1, … ,4) . realized values of test statistics are: 𝑡 = 29.227, 𝑡 = −1.126, 𝑡 = 4.802, 𝑡 = 12.352, 𝑡 = 0.347. 112 economic analysis (2021, vol. 54, no. 1, 104-117) the critical area is 𝑐 = (−∞, −2.003) ∪ (2.003, +∞). values of test statistics 𝑡 and 𝑡 are out of the critical area which means that the null hypotheses 𝐻 and 𝐻 are accepted while the null hypotheses 𝐻 , 𝐻 and 𝐻 are rejected because values of test statistics 𝑡 , 𝑡 and 𝑡 are into the critical area. thus, it can be concluded that the coefficients 𝑏 , 𝑏 are 𝑏 statistically significant, while coefficients 𝑏 and 𝑏 are not statistically significant. model 2 following random variables are observed: eiag (dependent), iag (independent) and control variables size and industry of companies (also independent). linear connection between those variables is tested. let it be: 𝒚 = 𝑬𝒊𝒂𝒈, 𝒙𝟏 = 𝐥𝐧(𝑰𝒂𝒈), 𝒙𝟐 = 𝑺𝒊𝒛𝒆 and 𝒙𝟑 = 𝑰𝒏𝒅𝒖𝒔𝒕𝒓𝒚. the following multiple regression model is considered: 𝑦 = 𝛽 + 𝛽 𝑥 + 𝛽 𝑥 + 𝛽 𝑥 +ε where ε is white noise. it is necessary to evaluate the model, to examine whether the regression is statistically significant and if so which of the coefficients are statistically significant. table 3. model 2 statistical results 𝜷𝟑 𝜷𝟐 𝜷𝟏 𝜷𝟎 𝛽 coefficients -1.092 0.254 1.221 16.087 sbi errors 0.189 0.166 0.336 2.399 𝑅 0.388 f-statistics 12.055 57 ss 85.779 135.201 t-statistics -5.766 1.532 3.630 6.703 t-critical 2.002 f-critical 2.766 using the least squares method regression coefficients are estimated: 𝑦 = 16.087 + 1.221𝑥 + 0.254𝑥 − 1.092𝑥 model 2 has the starting 𝜷𝟎 with the coefficient of 16.087. the model 2 shows that on the efficiency of intangible assets indicator (eiag) positively influence capitalized value of intangible assets (iag) and size with coefficients 1.221 and 0.254, respectively. on the other side, the independent variable industry negatively influences with the coefficient of -1.092. errors in estimating coefficients are: 𝑆 = 2.399, 𝑆 = 0.336, 𝑆 = 0.166, 𝑆 = 0.189. the coefficient of determination of the model is 𝑅 = 0.388. realized value of test statistic is 𝐹 = 12.055. the critical area is 𝑐 = (2.766, +∞). the value of test statistic is into the critical area, which means that the regression is statistically significant. then the following hypotheses are tested: 𝐻 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 𝑏 𝑖𝑠 𝑛𝑜𝑡 𝑠𝑡𝑎𝑡𝑖𝑐𝑎𝑙𝑙𝑦 𝑠𝑖𝑔𝑛𝑖𝑓𝑖𝑐𝑎𝑛𝑡 versus 𝐻 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 𝑏 𝑖𝑠 𝑠𝑡𝑎𝑡𝑖𝑠𝑡𝑖𝑐𝑎𝑙𝑙𝑦 𝑠𝑖𝑔𝑛𝑖𝑓𝑖𝑐𝑎𝑛𝑡 (𝑖 = 1,2,3) . realized values of test statistics are: 𝑡 = 6.703, 𝑡 = 3.630, 𝑡 = 1.532, 𝑡 = −5.766. the critical area is 𝑐 = (−∞, −2.002) ∪ (2.002, +∞). value of test statistic 𝑡 is out of the critical area which means that the null hypothesis 𝐻 is accepted while the null hypotheses 𝐻 , 𝐻 and 𝐻 are rejected because values of test statistics 𝑡 , 𝑡 and 𝑡 are into the critical area. thus, it can be concluded that the coefficients 𝑏 , 𝑏 and 𝑏 are statistically significant, while coefficient 𝑏 is not statistically significant. miloš petković, milica đorđević 113 model 3 following random variables are observed: roa (dependent), iag, eiag (independent) and control variables size and industry of companies (also independent). linear connection between those variables is tested. let it be: 𝒚 = 𝑹𝑶𝑨, 𝒙𝟏 = 𝐥𝐧(𝑰𝒂𝒈), 𝒙𝟐 = 𝑬𝒊𝒂𝒈, 𝒙𝟑 = 𝑺𝒊𝒛𝒆 and 𝒙𝟒 = 𝑰𝒏𝒅𝒖𝒔𝒕𝒓𝒚. the following multiple regression model is considered: 𝑦 = 𝛽 + 𝛽 𝑥 + 𝛽 𝑥 + 𝛽 𝑥 +𝛽 𝑥 +ε where ε is white noise. it is necessary to evaluate the model, to examine whether the regression is statistically significant and if so which of the coefficients are statistically significant. table 4. model 3 statistical results 𝜷𝟒 𝜷𝟑 𝜷𝟐 𝜷𝟏 𝜷𝟎 𝛽 coefficients 0.013 0.009 -0.001 -0.002 -0.119 sbi errors 0.007 0.013 0.009 0.021 0.182 𝑅 0.057 f-statistics 0.026 0.427 ss 1.699 0.643 -0.131 -0.119 -0.657 t-statistics 2.003 t-critical 2.537 using the least squares method regression coefficients are estimated: 𝑦 = −0.119 − 0.002𝑥 − 0.001𝑥 + 0.009𝑥 + 0.013𝑥 model 3 has the starting 𝜷𝟎 with the coefficient of -0.119. the model 3 shows that on the return on assets (roa) negatively influence capitalized value of intangible assets (iag) with the coefficient of -0.0025, and efficiency of intangible assets indicator (eiag) with the coefficient of 0.001. on the other side, positive influences come from size and industry with coefficients 0.009 and 0.013 respectively. errors in estimating coefficients are: 𝑆 = 0.182, 𝑆 = 0.021, 𝑆 = 0.009, 𝑆 = 0.013, 𝑆 = 0.008. the coefficient of determination of the model is 𝑅 = 0.057. realized value of test statistic is 𝐹 = 0.845. the critical area is 𝑐 = (2.537, +∞). the value of test statistic is into the critical area, which means that the regression is not statistically significant which means that observed variables are not linearly related. the study results confirm that intellectual capital investments influence on economic benefits, with a certain delay. the effects of intellectual capital investments depend on the types of investments and type of profits expected. the same results were confirmed by the authors vaisanen et al. (2007). the studies published by bontis (1998), seggie et al. (2007), seleim et al. (2004), sharabati et al. (2010), and wang and chang (2005) confirmed also highly positive relationship between investments in intellectual capital, and its components and final company’s performance. conclusion ic is the main strategic driver of company value. in order to improve company value and performance, managements and decisions-makers invest in ic components. the purpose of our study was to examine ic investments on the high-innovative sample of french companies. 114 economic analysis (2021, vol. 54, no. 1, 104-117) the research covered in total 61 french companies over the period from 2008 to 2016. for the purpose of this study three regression models were developed in an attempt to provide the empirical investigation of the impact of investments in ic on the company profitability. results from this research confirm that r&d expenditures influence positively on the value creation, in our context in creation of intangible assets within company value. this value creation process comes from an eight-year period of investments. once created the intangible assets value impacts the efficiency of intangible assets, whereas the impact on the final company profitability immediately in the next year is not determined. the increase in company profitability does not come immediately after the new intangible assets value is created. these findings add value to managers, who put their daily efforts to stay competitive in a fast growing and turbulent french market, as it is at the moment. limitations from this research fall to the sample size that was limited due to the number of companies that had available data and operate in france, as well as an availability of financial information from company official accounts. the focus on future research will be on following the economic benefits and improvements of financial performance in the upcoming years, instead of only on immediate results. also, the research would be extended on observing different industries and different samples of companies in order to propose the most intellectual-capital intensive and appropriate sectors for long-term investments, such as investments in intellectual capital. acknowledgement the first author is supported by the research project (decision no. wgb-2/13/z/2020) by wroclaw university of economics, wroclaw, poland. we would like to thank to reviewers for their valuable suggestions that resulted with the improvements of our paper. references awano, g., franklin, m., haskel, j. and kastrinaki, z. 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(2015). “r&d expenditures and earnings targets: evidence from france”. journal of economics, finance and accounting, vol. 2 no. 2, pp. 164-180. article history: received: january 16, 2021 accepted: may 25, 2021 ea_2014_3-4 udc: 005.332:005.44 jel: f2, f6 cobiss.sr-id 211781900 conference paper the impact of globalization on the business ristovska katerina1, ristovska aneta, university ss. cyril and methodius, management, faculty of economics, skopje abstract – the modern liberal, capitalistic and economic action becomes a conglomerate of factors and reasons, analysis, information, means, mediums, skills and predispositions. in terms of minimized barriers and openness of the world, the inevitable process of the globalization and the business actions represent projects that are facing success potentials, as well as risk and failure potentials. the indisputable accent on these aspects is certainly the success and the reliability of the business ventures for which the ultimate goal is the economic satisfaction, minimizing the risks as well as the establishment of long-term experiences in order to maintain a particular enterprise in a particular environment. the participation on the world's global markets, the internationalization and the transfer of the business activities on all geographic meridians, encountering different and often uncertain environments is a constant business story of the international economic activity for at least three centuries ago. the global economic interaction is as old as it is old the society in its more or less organized form. from the industrial revolution until today, there is ongoing irreversible global economic integration. the reasons are simple, business and profits do not recognize borders, national and cultural unsurpassed characteristics, where more or less a mutual benefit of certain cooperation is recognized, a business connection is immediately established. key words: globalization, internationalization, business, global markets, economic integration introduction the global changes in the world, changes in political, economic and business activities as well as the development of technology, transport and communications, impose the need for enterprises in its struggle for survival, to change their strategies and go out from the borders of their own country. limited market, competitive pressure, demand for cheaper resources and the dynamics of the postmodern era, forcing business leaders to change their focus from traditional targets to alternative measures for successful business and the entrance on global markets, with the purpose of making competitive advantage. the impact of globalization on the business international business is a term used to describe all commercial transactions, in general, (private and governmental, sales, investments, logistics and transport) which occur between 1 master in mba, st. franc preshern 122, 1000 skopje, email: katerina.ristovska@gmail.com economic analysis (2014, vol. 47, no. 3-4, 83-89) 84 two or more regions, countries and nations beyond their political borders (radebaugh & sullivan, 2007). international business refers to those business activities which include crossborder transactions of goods, services or resources between two or more nations. transactions of economic resources include capital, skills, people for international production of physical goods or services, such as finance, banking, insurance, construction (joshi, 2009). according to rugman and collinson, international business analyzes transactions that take place across national borders in order to meet the needs of individuals and organizations. these economic transactions consist of trade (imports and exports) and foreign direct investment (rugman, collinson, & hodgetts, 2006). according to ball, international business is a business whose activities are carried out beyond the borders of their country and here not only include international trade and international production but growing service trade in areas such as transport, tourism, advertising, construction, retail and mass communication (ball, mcculloch jr., frantz, geringer, & minor, 2002). the companies that are active in international business are called multinational enterprises. multinational enterprise is an enterprise or corporation that owns substantial resources and performs various business activities through a network of branches located in different countries and each branch form its business strategy, based on the different market characteristics (cavusgil, knight, & riesenberger, 2008). multinational company is based in one country but has business activities in several countries. there are opinions that the multinational company is one that is so structured that conducts business or property held in many countries or a company is organized into global production parts. the reasons why a company becomes a multinational, ansoff separates the two categories (ansoff, 1984): • operational needs: providing materials, equipment, technology and release of surplus production; • strategic needs: ensuring the inviolability of future changes in the external environment, steady growth (maintaining historic patterns of growth, avoiding stagnation caused by saturation, increasing the volume of business, increasing the rate of growth) and better profitability. the development of international business activities coincided with widespread phenomenon of globalization of markets (cavusgil, knight, & riesenberger, 2008). the globalization of markets refers to the growing economic integration and the growing interdependence of countries worldwide. internationalization of the companies refers to the tendesncy of the companies to systematically increase the international scope of their business activities, while globalization refers to a makrotrend intensive economic relations between the countries in the world. globalization encourages companies to internationalize and to substantially increase the volume and types of cross-border transactions in goods, services and capital. also, the globalization leads to rapid dissemination and diffusion of products, technology and knowledge in the world, regardless of the origin. the process of globalization is a natural process that is a result of the growing and accelerated process of generalizing of the character and process of production. the development of science, engineering and technology and the expansion of markets for goods, worldwide, lead to internationalization of economic and financial developments and their global deployment. if globalization is understood as a process that leads to greater ristovska, k., et al., the impact of globalization, ea (2014, vol. 47, no. 3-4, 83-89) 85 economic integration of national economies, as a process of fragmentation of the world economy and the international economy, than the globalization is a process of opening of national economies through the removal of economic and financial boundaries of national economies and thus their transformation into an international economic and financial market (jovanovski, 2007). globalization is a worldwide trend, through which economies in the world lose their borders and connect to each other. the companies are no longer imprisoned in their borders and can implement a wide range of business activities around the world. many companies are present in markets around the world, procured their raw produce or conduct research and development worldwide. trade barriers fall and global trade between countries in goods and services is growing faster than domestic production. as a result of this, companies can not afford the luxury to assume that the success of the domestic market will lead to longterm profitability (cullen & parboteeah, 2010). the flow of money across national borders is freer, and companies seek better financing rates in the world and investors everywhere are looking for a more favorable return on investment. globalization, developed from economic aspect, has two main components: the globalization of markets and globalization of production. the globalization of markets refers to the merging of historically different and separate national markets into one big global market. in recent years, constantly is discussed that the tastes and preferences of consumers in different countries and nations begin to resemble on a global level and the way that they help in the creating of a global market. the companies that offer standardized products worldwide, help in the creation of a global market. the most common global markets are not the markets for mass consumer products, because there are still differences between countries in terms of tastes and preferences, which still have great meaning and a sort of brake on globalization, but these are the markets for industrial goods and materials that have universal need the world. the globalization of production refers to the tendency of the companies to find suppliers of goods and services from locations around the world, in order to realize the advantage of national differences in price and quality of the factors of production. companies do this in order to reduce overall costs and thereby to improve the quality or to improve the functionality of their product offering to compete more effectively(hill, 2008). in economics, internationalization is seen as a process of increased involvement of enterprises in international markets (susman, 2007). the process of globalization, the fight for survival, constant pressure and the need to preserve and strengthen the market position, force the companies to be willing to constantly innovate and explore opportunities for achieving competitive advantage and expanding business activities outside the domestic market. entrance of the companies in the global market becomes inevitable not only because of limitation of the domestic market but also because of the globalization; the domestic market share is under threat from foreign competition (bartels, buckley, & mariano, 2009). there are several specific factors that promote globalization and guide enterprises to strive for business development and growth through the international and global operations and include: political changes, development of technology, international business climate, market development, expenses and competition (ball, mcculloch, geringer, minor, & mcnett, 2001). economic analysis (2014, vol. 47, no. 3-4, 83-89) 86 • political changes. the globalization trend of unifying and socializing the global community, as well as, forming preferential trade agreements and groupings such as nafta and the european union, which united more nations in a single market, allow the companies significant market opportunities. two aspects of this trend, which contribute to the globalization of business operations are: progressive reduction of barriers for trade and foreign investment by most governments, which leads to intense opening new markets by international companies, which also exported them and build production facilities in them, and the privatization of most of the industry in the former communist countries, as well as opening up their economies to global competition. • development of technology. the development of computing and communication technologies has enabled increased flow of ideas and information across the borders of the countries, providing introduction of the consumers with the goods worldwide. internet and networking have enabled smaller companies to compete globally, as a result of the rapid flow of information, regardless of the physical location of the seller or buyer. also, allows international companies to hold corporate meetings among managers from headquarters and branches, without wasting unnecessary time for travel. • international business climate. the development of communication and information technologies have contributed to the process of globalization, but also provided instruments that facilitated the processes of globalization. newly emerging markets also recognize the economic benefits, technological development and growth opportunities that globalization provides them. • development of markets. information and communication technologies, the rapid development of international tourism, widespread cultural exchange and improved the living standards, in many developing countries have contributed to the emergence of a group of consumers in different countries and regions of the world with similar educational profiles, lifestyle, purchasing power and for good products, as well as, aspirations for high quality. this scenario, in combination with the liberalization of international trade and the availability of global distribution channels, opens great opportunities for companies that want to offer their products to global markets. large market potential exist outside of the domestic market, that is why the companies go out on the foreign markets, generate sales and have opportunities for profit that cannot be achieved at home. • expenses. the liberalization of trade and investment flows, which emerged in the 80s of the last century, which inexorably moved forward, is a stimulus for globalization of the businesses. trade liberalization, global consumer habits, rising development costs and the need for economies of scale, pressure from foreign competitors in the domestic market as well as the development of information and communication technologies, are considered drivers of the globalization. because of the need to introduce new products and investment in research, development and innovation, achieving economies of scale, reduce costs and access to cheaper raw materials; companies are forced to plan activities, taking into consideration the global market. economies of scale and cost reduction are the main goal of management. that is why companies decide to locate production in countries where the cost of developing and producing are smaller. • competition. one of the reasons that the companies join global strategies is the need of maintaining or gaining a competitive advantage in foreign markets and avoiding ristovska, k., et al., the impact of globalization, ea (2014, vol. 47, no. 3-4, 83-89) 87 competition in the domestic market. competition in international markets is huge and growing, with more multinational competitors who win markets worldwide. the companies improve their competitive position by opposing competitors in international markets or premature intrusion into the domestic market of the competitor in order to destabilize or to suppress its development. as the globalization increases the speed and prevalence, and for the companies more opportunities are opening easily, to perform on the international markets. the managers develop and adapt strategies for internationalization in order to transform their organizations into globally competitive enterprises. managers seek to coordinate the supply, production, marketing and other activities based on international activities. the organization of the company globally is a challenge and requires strategic positioning, organizational skills, a high degree of coordination and integration, attention to the needs of individual markets and the implementation of common processes. the strategy, in an international context, is an organization plan for positive positioning, compared to the competitors. this plan lead the company to selected customers, markets, products and services in global markets, not just a particular international market. the strategy in an international context should help managers to formulate a strong international vision, allocation of scarce resources on the world, the participation of the major markets, implementation of global partnerships, and involvement in competitive activities in response to global rivals and establish activities that add additional value on a global level (cavusgil, yeniyurt, & townsend, 2004). when the companies compete outside of their country, they face a number of challenges and pressures. these pressures and challenges to maintain competitiveness, require from the companies cut costs, in order the consumers do not evaluate their products or services as too expensive. this leads to the need to locate production facilities in places where production costs are lower, and the development of high standardized products in most countries. in the context of the pressure to reduce costs, managers must strive to be ready to respond to local pressures to adapt products to local market requirements, where the company is active. this requires differentiation of their offer and strategies in different countries, in order to preserve the tastes and preferences of consumers, but also the differentiation of distribution channels, management of human resources, and government regulations. because the strategies and tactics for differentiation of products and services in local markets create additional costs, they can also lead to increased costs for the company. these two pressures that enterprises face, resulting in four basic strategies that the companies use to compete in the global market. these strategies are: international, global, multi-domestic and transnational strategy (dess, lumpkin, & taylor, 2004). the strategy that will be chosen by the company depends on the pressure faced by cost-cutting and the importance of adapting to local markets. conclusion today, the word international company is quite a common phenomenon, which reflects actual business transactions and large expanses between a number of people from different cultures and with different approaches. what unites them in the complex network of relationships is the need of development, rapid exchange of resources and tools and economic analysis (2014, vol. 47, no. 3-4, 83-89) 88 integrated cooperation, which should contribute to ensuring cooperation and ensure the transfer of capital. can be concluded that today's decisions for crossing domestic borders and internationalize the business is a prerequisite for serious growth and development of a business entity. as such, he is always searching and analysis of potential areas where the company from small or medium business entity would become a corporate organization striving to constantly expanding and increasing its own portfolio. to make a decision to invest outside of the own borders is a complex and comprehensive process. this process is achieved through several stages and approaches that contain a longterm comprehensive analysis and scanning newly elected investment location. references ansoff, h. i. 1984. implementing strategic management. prentice-hall international, englewood cliffs, nj. ball, a. d., wendell, h., mcculloch, jr., frantz, l. p., geringer, j. m., minor, s. m. 2001. international business – the challenge of global competition. international edition, mcgraw-hill. bartels, l. f., buckley p., mariano g. 2009. multinational enterprises’ foreign direct investment location decisions within the global factory. unido, vienna. cavusgil, t. s., yeniyurt, s., townsend, j. 2004. “the framework of a global company: a conceptualization and preliminary validation”. industrial marketing management, 33. cavusgil, t., knight, g., riesenberger, j. 2008. international business: strategy, management and the new realities. prentice hall. cullen, b. j., parboteeah, k. p. 2010. international business, strategy and the multinational company. taylor & francis. daniels, d.j., radebaugh, h.l., sullivan, p.d. 2007. international business: environment and operations. prentice hall. dess, g., lumpkin, g.t., taylor, m. 2004. strategic management: creating competitive advantages. hill, w. l. c. 2008. global business today. mcgraw-hill irwin. joshi, m. r. 2009. international business. oxford university press. jovanovski, t. 2007. megjunarodni finansii. skopje: euro-mak kompanii. susman, i. g. 2007. small and medium-sized enterprises and the global economy. edward elgar publishing. uticaj globalizacije na poslovanje rezime – savremene liberalne, kapitalističke i ekonomske aktivnosti postaju konglomerat brojnih faktora i uzroka, analiza i tumačenja, podataka, medija, sposobnosti i predispozicija. kroz minimiziranje barijera i širenje otvorenosti ka svetu, neizbežni proces globalizacije omogućava poslovnim projektima potencijale za uspeh, ali istovremeno sa sobom nosi rizik od neuspeha. neosporni akcenat na polju globalizacije jeste uspeh i pouzdanost poslovnih poduhvata koji za krajni cilj imaju ekonomsko zadovoljstvo, minimiziranje poslovnog rizika kao i uspostavljanje dugoročnih iskustava kako bi se poslovanje određenog preduzeća održalo u dužem vremenskom periodu u određenom okruženju. internacionalizacija, učešće na globalnim tržištima i obavljanje poslovnih ristovska, k., et al., the impact of globalization, ea (2014, vol. 47, no. 3-4, 83-89) 89 aktivnosti na svim geografskim meridijanima, uz različita i često neizvesna okruženja, najmanje tri veka predstavljaju suštinu međunarodnih poslovnih aktivnosti preduzeća. globalna ekonomska aktivnost, u više ili manje organizovanom obliku, je stara koliko je staro društvo. tekuća globalna ekonomska interakcija se odvija neprekidno, od industrijske revolucije do danas. razlozi za globalizaciju su jednostavni, poslovna dobit ne poznaje granice, nacionalne i kulturološke karakteristike se zadržavaju a poslovna veza se odmah uspostavlja, osobito ako se radi o saradnji koja donosi obostranu korist. ključne reči: globalizacija, internacionalizacija, poslovne aktivnosti, globalno tržište, ekonomska integracija article history: received: 8 april 2014 accepted: 16 august 2014 ea_2014_3-4 udc: 338:339.137.2(4-672eu) jel: o24, f10 cobiss.sr-id 211780364 original scientific paper competitiveness of the european union: pre-crisis trends and impact of the financial crisis makrevska disoska elena1, university ss. cyril and methodius in skopje, faculty of economics skopje, republic of macedonia nenovski tome, university american college skopje, republic of macedonia abstract – this paper has the aim to point out the risks of reducing the eu competitiveness by analyzing the indicators of price and cost competitiveness, as well as the structural and technological aspects of competitiveness. the influence of the world crisis on the competitiveness and export performances of the eu is in the focus in order to show at what extent the global downturn may have aggravated previously existing needs for readjustment of the functioning of the union. not only that the crisis showed that the problems in the union were not created recently, but also it demanded urgent needs of new improved policy in order to regain the competitiveness strength and performances. the reformulated strategy needs to be based on openness and innovation, with investment in research and development. long-term expectations are to be made comprehensive structural changes in order to overcome structural differences between individual member states and to increase the overall competitiveness. additionally, trade barriers are needed between individual member states to be removed and higher individual and aggregate rates of economic growth are to be achieved. it is clear that the effects of deep integration of the eu has not yet been achieved, and expected benefits may not be realized, if internal and external balance of the union is not maintained. key words: competitiveness, trade, exchange rate, technology, productivity introduction over the past two decades, european union (eu) managed to hold its position on the world market, competing with the usa and japan, and as well as with new rivals such as china and india. but even before the crisis, the productivity growth started slowing down and the eu faced with the serious challenges of losing world market positions due to the loss of competitiveness. under the term ’’competitiveness’’ in the literature can be found many different definitions. generally, an economy is competitive if it does things that are likely to encourage economic growth. the simple measure of economic growth is the value of the 1 postal adress: blvd. goce delchev, 9v, 1000 skopje, republic of macedonia, e-mail: elenam@eccf.ukim.edu.mk makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 21 gross domestic product (gdp). but, if a country is increasing its gdp that would not mean that the country’s competitiveness has improved. for instance, if the growth is based on natural resources and their favorable price developments, the gdp will grow (gdp= quantity multiplied by prices), but the economy will not have significant improvements in the competitiveness. in case, the reason for the dynamics and the quality of economic growth is determined from the level of labor productivity, then we can make difference. in the macro economy it is widely accepted that the difference in labor productivity is the reason for the great differences in the level of economic growth in the countries in the world economy (mankiw, 2010). krugman (1996) has also declared that the real essence of competitiveness is reflected in the productivity. still, many economists believe that not only the quantity of economic production is important, but also the quality of living of the people (aiginger, 2004). that would mean, greater opportunities for education, healthy life, rich cultural life etc. that can be measured by the second indicator of economic growth, gdp per capita. higher the gdp per capital means higher living standards of the population. still, gdp per capita does not take into account the country’s ability to distribute the gained wealth in a fair manner (it is calculated on average level). another weakness is that we can get wrong conclusion. for example if we have the same value of the gdp, but decreasing growth rates of population, we will get higher gdp per capita. some authors (haiman & altena, 2007) find the linkages between competitiveness and trade (traditional theories). popular discussion often views ‘competitiveness’ as a way to narrow the current account deficit of the balance of payments. that can be measured by the growth of the export of the market share (participation of the total value of the export in the total world export). the essence of this theory is compounded by openness to trade tending to be associated with openness to ideas. especially for small economies, openness to trade should boost economic growth by increasing domestic competitive pressures (from imports) and allowing domestic producers access to wider markets and so economies of scale (from exports). still these theories do not take into account the quality of the product or the service or the branding of the products. on long run, non pricing factors (structural and technological aspects) such as: research and development, regulatory regime and other have significant influence on the competitiveness of the products and of the economy. finally, if we summarized all the above mentioned views, the competitiveness of one country can be defined as ability of the country to compete on the world market, with final goal to increase the wealth of the country and the living standards (ottaviano at al., 2009). the definition according to the traditional theories will be applied in the context of the paper. in the first section, the trends in the world trade and eu trade are analyzed, from the creation of the european economic community to 2010. in the second section the discussions about the indicators of competitiveness will take place. the approach towards the eu competitiveness will be analyzed according to the traditional approaches that consider the successful export performance – either in terms of export growth or export market share and by the standard indicators of cost and price competitiveness. to determine the price competitiveness, the real effective exchange rate is used. cost competitiveness is analyses by the ulc (unit labor costs) in manufacturing sector and consumer price deflator in order to see the trend of the movement of the real effective exchange rate. also, additional data from economic analysis (2014, vol. 47, no. 3-4, 20-34) 22 the global competitiveness report (world economic forum, 2013) and of europe 2020 strategy will be integrated in the paper in order to give multi-dimensional concept of competitiveness. in order to overcome the flaws of the traditional theories in the third section, technological aspects and other aspects of the non-price competitiveness of the eu will be elaborated. this paper has the aim to point out the risks of lowering the eu competitiveness. the influence of the world crisis on the competitiveness and export performances of the eu is in the focus in order to show at what extent the global downturn may have aggravated previously existing needs for readjustment of the functioning of the union. not only that the crisis show that the problems in the eu were not created recently, but also ask for urgent need of new improved policy in order to regain the competitiveness strength and performances. the methodology of this research is based on quantitative analysis. it will be presented in a form of time series analysis for the case of eu, concerning the period 1958-2012, and for the indicators of competitiveness 2000-2012 in order to point out the dependence among observations at different points in time. core suppliers of the needed data will be the euro stat, international monetary fund and un comtrade databases. the expected outcome of the research is to summaries the main reasons that contribute to loss of the world trade positions of the eu which will lead to conclusions about the future prospects of the eu and need for high productive strategy. trends in the world trade and trade of the eu global external imbalances widened persistently over the last several years. international trade flows contracted sharply in the fourth quarter of 2008 and first quarter of 2009 mainly due to the decline in the economic activity and aggregate demand, which was result of the beginning of the world economic crisis, the percentage decline of the world trade in 2009 compared to 2008 was 22.73% (table 1). table 1. annual growing rates of the world trade by region and selected economies (%) 2006 2007 2008 2009 2010 2011 2012 world 15,38% 15,24% 15,45% -22,73% 21,79% 19,54% 0,30% north america 11,90% 7,97% 8,83% -23,56% 22,97% 15,62% 3,54% south and central america 21,07% 19,66% 24,51% -24,32% 27,84% 26,41% 0,61% europe 14,24% 16,58% 12,41% -23,60% 12,75% 17,63% -4,87% commonwealth of independent states 27,61% 26,10% 34,58% -35,28% 28,83% 32,69% 2,89% asia 16,27% 15,23% 16,87% -18,60% 31,42% 20,09% 3,31% others 21,15% 18,83% 31,00% -25,11% 24,16% 25,55% 4,80% european union (27) 14,07% 16,35% 11,88% -23,62% 12,50% 17,24% -5,23% intra-trade 13,84% 16,39% 9,88% -23,54% 9,88% 15,92% -6,93% extra-trade 14,54% 16,29% 15,83% -23,76% 17,45% 19,55% -2,34% source: eurostat, comext database; national statistics; global trade atlas; imf, international financial statistics. http://www.wto.org/english/res_e/statis_e/quarterly_world_exp_e.htm makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 23 regarding the regions, the exceptional decrease was noticed in the commonwealth of independent states (c.i.s) of 35.28% in 2009, while the region of asia has the lowest slowdown in the volume of trade of 18,6% on annual basic. still, the decline in the trade has high degree of synchronization across countries, as a result of the developed and closely connected financial market and transmission power of the informational technologies. the downfall of the total trade of eu was 23,62% in 2009 compared with 2008. the declining foreign demand in the wake of the 2008/09 global economic downturn hit the eu’ export sector particularly hard. this led to increasing concerns about the prospects for eu` exports and competitiveness, particularly at a time when exporters had already been struggling to adjust to the fiercer competition and other structural changes resulting from globalization. while partly reflecting the relatively high openness of the european economy, this has also prompted increasing concerns about the competitiveness of the union. trends in exports and imports may serve to calculate the value of the current account of the european union. trade balance of union in the reviewed period had a mainly negative value , i.e. value of imports is higher than the value of export and is worsening over the last decade. since 2002 the trade deficit is widening, and it reached the highest negative value in 2008 (525,1 billion euros). the recovery was in 2009, when the trade balance showed positive tendencies. according to the data from euro stat only in the period 1993-1998, the eu exerted a positive trade balance (figure 1). figure 1. trade balance of eu (billions euros/ecu) source: еurostat, (2011): external and intra-eu trade: a statistical yearbook, data 1958 – 2010, european commission, luxemburg, *the data cannot be consistent on the yearly intervals because of the lack of data so far, european policymakers seem to have watched the growing imbalances without much concern, in the hope that the eu will be largely unaffected (ahearne, jürgen, 2005). additionally, the trade account balance, as well as the current account balance has never constituted a condition for acceptance of a single currency. even in maastricht criteria for entry in the euro zone, there are no restrictions on trade or current account deficit. under article 143 of the treaty on the functioning of the european union, only countries countries that have not yet adopted the euro may receive financial assistance to deal with have problems in the balance of payments (treaty of the functioning of the european union). the reason why the eu does not allow for funding the deficit in the trade account is because it is considered that no economy cannot be exposed to speculative attacks of the common currency. therefore, deficits between countries that are already members of euro economic analysis (2014, vol. 47, no. 3-4, 20-34) 24 zone should be financed through short-term financial markets, without the need for intervention by the monetary authorities. the problem is systematic. the trade deficit of the eu is a result from the countries that traditionally achieve trade surplus (luxembourg, finland, the netherlands and germany) and countries with traditionally high deficits (greece, portugal and spain). however, the deficit in the trade account of greece, portugal and spain was balanced until the mid1990s. obviously, the process of convergence of these countries in the monetary union impacted negatively on the country, resulting in deepening deficit due process of adaptation to the eu. just for example, the spain balance of trade increased in 2006 approximately four times more compared in 1999 (trading economics database). interesting is that the crisis created cyclical movements in the trade balance of the eu countries. the countries that traditionally have trade surplus, experienced lowering of the trade balance, and vice versa for the countries with the trade deficit. by approaching price and cost competitiveness this research will try to give an answer to these problems. approaching price and cost competiveness of the eu competitiveness of the eu as a main global trade leader is achieved by the advantages of the existence of the common market. the eu is the world`s largest exporter with well positioning in the global value chain. still, the common market of the eu is fragmented by the domestic producers that do not use the advantages of the economies of scale as a result of not synchronized policies. with the beginning of the economic crisis, many of the structural weaknesses of the union were revealed. as the private demand remain resilient and the public expenditure increased the internal imbalance of the union. slugging international demand and poor economic outlook limited the potential for export. the trends of the export of the eu is moving almost in the same direction as the total trade of the eu. export growth reached its peak in 2007 with 17% annual growth, and experienced decline in 2009 of 23%, compared with 2008. after the short recovery the export showed 5% decrease in 2012 compared to the previous year. according to the share of the export of the eu in the world export, the relative indicator is slowing down (figure 2). with the exception of the period 1958-1960, the union had the highest share in the value of world exports in the whole observed period. in 1996, eu had a 20.8% market share of the world trade in goods (excluding intra-eu). this market share has been lowered by competitive pressures from emerging economies, falling to 16% in 2010. the second largest world exporter were usа, whose share has been declining gradually since 2000. the most remarkable development is that china as fastest growing economy from 2005 onwards become the third largest exporter in the world, followed by japan as the fourth largest world exporter. thus, if we make comparison, we can see that the rise in the export share of china for 10 p.p. from 1996 to 2010, has been fairly affected by the eu (fall of 4,8 p.p.), usa (4,6 p.p.) and japan (3,7 p.p.) over the same period. makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 25 figure 2. participation of the countries in the total world export of goods source: еurostat, (2011): external and intra-eu trade: a statistical yearbook, data 1958 – 2010, european commission, luxemburg, *the data cannot be consistent on the yearly intervals because of the lack of data the eu's export performance varies significantly between markets. the eu shows a decrease in market shares on some of the most dynamic importing markets during the last decade. the largest gain is in the usa market, where the eu accounted for over one fifth of the import market in 2007. this performance coincided with shrinking shares of japanese and to a lesser extent, of canadian and asean exports in the same market. conversely, the eu loses market shares on the brics markets. the small market share loss of eu products on the rapidly expanding chinese market could, however, have a large impact in the long run. this appears to be mainly associated with the unfavorable trends in price competitiveness of the eu. measured in terms of relative export prices, european central bank estimates that the euro area price competitiveness deteriorate by around 10% between 1999 and 2008 (ecb, 2010). the decrease in the price competitiveness is confirmed by the movements of the nominal effective exchange rate, given in figure 3. an increase of this indicator suggest an appreciation, which indicated lowering of the price competitiveness. the appreciation of the exchange rate was from 2002 to 2009, after it experienced depreciation until 2012. the figure show that the euro zone has lower price competitiveness compared with the eu as an economy of 27 member countries (not taking into consideration croatia, because of the lack of data). figure 3. nominal effective exchange rate (index 2005=100) source: european commission, http://ec.europa.eu/economy_finance/db_indicators/competitiveness/data_section_en.htm * ic 36 = group of 36 industrial countries y = -0.0011x + 0.2067 r² = 0.1906 eu usa china japan south korea ea17 vs eu27 ea17 vs ic36 eu27 vs ic36 economic analysis (2014, vol. 47, no. 3-4, 20-34) 26 still, the price competitiveness differs from country to country. high price competitiveness is achieved for germany, france, austria and finland. losses in price competitiveness is recorded in most of the countries were at the same time experienced decline in the export estonia. malta, cyprus, greece. the losses in market shares have coincided with a degradation of cost competitiveness, measured by the unit labor costs. the rise in the real effective exchange rate indicate lowering of the cost competitiveness. as a consequence of the strong growth of real wages since 2002 in most of the countries, ulc has increased both in the eu and euro area as a whole (figure 4). figure 4. real effective exchange rate (ulc) (index 2005=100) source: european commission, http://ec.europa.eu/economy_finance/db_indicators/competitiveness/data_section_en.htm despite the intensive wage growth which is a long term trend, during the whole period from 2002-2011, the peripheral member states register high unemployment rate, which indicates low wage sensitivity to the unemployment movements (figure 5). additionally the cyclical effect of the crisis caused losses in the labor productivity, meaning faster decline of output relative to employment during the slump. between the first quarters of 2008 and 2009, production decreased by 19% while hours worked fell by 8%. (european commission. 2013). figure 5. fluctuations in eu ulc are mainly caused by variations in labor productivity growth source: european commission, (2013): european competitiveness report 2013:toward knowledge driven reindustrialization, european commission, commission staff working document swd(2013)347 final, p.28 ea17 vs eu27 ea17 vs ic36 eu27 vs ic36 makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 27 therefore, as a result of the insufficient labor productivity achievements, despite the introduction of new technologies and good business practices, the economic growth in the union was slowing down. in other words eu is not an optimal currency area, except the lack of wage flexibility, the eu does not have convergence in the business cycles, has low mobility of labor force and capital. in this regard, it can be concluded that in the event of economic shock, when there is no flexible foreign exchange regime and autonomous monetary policy in the member states, the labor mobility or wage flexibility cannot recover the differences among the economies in the monetary union (trpeski, kondratenko, jankoski, 2013). therefore there is limited potential growth of national spillovers. this argument is supported by the regional competitiveness index (rci) calculated by the european commission, which measures the different dimensions of competitiveness at the regional level in eu countries. rci reveals substantial differences in competitiveness within some countries. in france, spain, the united kingdom, the slovak republic, romania, sweden and greece the level of variability across regions is particularly high. thus, large gap in regional competitiveness is harmful for national competitiveness and consequently for the union as a whole (the world economic forum, 2014). nonprice competitiveness while for most eu countries price competitiveness has been a critical factor in shaping relative export performance with respect to major direct competitors – most notably developed economies – other non price-related factors play a part. generally, non-price competitiveness comprises the structural and technological aspects of competitiveness. in this context, factors such as research and innovation, infrastructures, as well as the regulatory and tax framework of a country, are critical because they affect the prospects of achieving higher productivity growth and thus competitiveness in the medium and longer term (ecb, 2010). the european competitiveness report (2013) shows that the eu has comparative advantages in most manufacturing sectors (15 out of 23) accounting for about three quarters of eu manufacturing output. they include vital high-tech and medium-high-tech sectors such as pharmaceuticals, chemicals, vehicles, machinery, and other transport equipment (which includes aerospace). in the high tech sectors, the eu has comparative advantage in pharmaceuticals but lags behind in the rest of this broad category (computers, electronics, and optical equipment). even in the medium high-tech sectors, eu comparative advantage is lower than for the us and japan. more importantly, china and the other emerging industrial economies are quickly gaining ground in the knowledge intensive sectors and rather than merely assembling high-technology products they are now producing them. even though the data in table 2 confirm that the china is a leader in high tech industries, still this is not a reliable data. it is a result of the offshore activities of the usa and eu for a low cost production. economic analysis (2014, vol. 47, no. 3-4, 20-34) 28 table 2. comparative advantage by technology intensities in manufacturing, 2011 high tech medium high tech medium low tech low tech eu 0,85 1,14 0,89 1,01 japan 0,73 1,59 0,86 0,16 usa 0,88 1,22 0,96 0,68 brazil 0,32 0,76 0,87 2,5 china 1,56 0,72 0,85 1,29 india 0,4 0,49 1,93 1,33 russia 0,08 0,45 2,74 0,49 source: un comtrade the type of specialization of the countries can explain the cyclical movements in the trade balance. since, there is a difference between elasticity of different categories of goods and services, trade in services, except for transport, declined with less dynamics than trade in goods. in the trade in goods investment good register the greatest reduction. contrary to these trends, the trade of traditional “un cyclical” sectors, such as food, beverages and pharmaceutical products, was far more resilient. consequently, countries that entered the global economic crisis with large trade deficits had a significant improvement in the condition of the trade account during the 2008 2010. countries that had substantial trade surpluses had note lowering of the positive balance in the trade. this suggests that the decline in trade surplus of the countries that traditionally generate a positive trade balance (germany, france, austria, belgium and netherland) is due to the elasticity of world demand for capital intensive products and investment goods, in which these countries are highly specialized. conversely, countries with trade deficits (greece, spain, cyprus, slovenia and finland) that have high specialization in consumer goods, had slightly reduced exports due to the global “un elasticity” demand (mauro, foster, lima, 2010). these developments are cyclical, i.e. they are occurring due to the impact of the economic cycle in which the world economy is. thus, after the crisis, current trends in the trade balance will be present again. consequently, the existence of different economic structures of the countries is a systemic problem for the union . although it can be equated with the imbalance globally, there is a significant difference. globally, the adjustment are achieved through exchange rate movements, while within the monetary union (such as the eu) that must be achieved through fiscal adjustment and coordination of policies within the member countries (mrak, 2010). we believe that decreased labor productivity of the union is important and influence negatively not only for price, but also for non-price competitiveness. labor productivity, and especially multi-factor productivity, is often seen as indicator of technical progress. increased labour productivity means more output is produced with less labor, which can be due to technological or organizational improvements and other non-observable factors. makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 29 reasons behind loss of the eu competitiveness in order to explain why european growth came down from the extraordinary levels it reached during the golden age (1950-1973), and most importantly the technological lagging of eu behind usa we will compare the indicators of labor productivity and labor input between eu and usa. table 3. levels of eu-15 relative to the usa, in ppp, (usa=100) 1950 1973 1995 2004 gdp per capita 45,5 76,8 74,9 74,1 gdp per working hour (labor productivity) 39,5 75,4 98,3 90,3 working hours per head of population (labor input) 115,2 101,9 76,2 82,1 source: ark, van b., o’mahony, m., timmer, p. m., (2008) "the productivity gap between europe and the united states: trends and causes", journal of economic perspectives, volume 22, number 1, pages 25–44 according to the numbers in the table 3, the problem is ascribed entirely to a relative fall in labor input (from index of 115,2 in 1950 to 76,2 in 1995 and 82,2 in 2004 compared with the usa). the reason for this is: a) the ratio of population of employed to the population of working age is higher in usa 74% (oecd database) compared with eu of 68% (euro stat database) . the data shows that are that employment rate (age group 20-64) is still below the objectives set in "europe 2020" of 75% of the population. b) the structure of the working population has aged considerably in recent decades. between the 1960 and 2000 the average dependency ratio (defined as number of persons aged 60 or more years per 100 persons aged 15-59 years) for the eu-15 rose from 26 to 35. at the same time, the dependency ratio for the united states remained almost constant at around 25. during the period 1995-2015, the population above the standard retirement age, 65 years, will increase by 17 million (30%). within this group the very old, those over 80, will increase by 5.5 million or 39% (blanchard, 2004). c) fall of the utilization rate of labor in europe compared with usa which is a result of the sustainable preference for leisure due to the higher social protection of the workers and also by the labor rigidness of the european market. taking into consideration that the average hours worked are much shorter in eu and the employment rate is much lower compared with the usa, we can get artificially boosted indicator of the productivity. as the data show the productivity in eu did not decrease, just opposite the index gdp per working hour increase from 75,4 in 1975 to 98,3 in 1995. then decreased to 90,3 in 2004, but still remain below usa (index=100) (table 2). this indicator should be revised in order to compare the real productivity gap between eu and usa. according to cette (2004), the european productivity level should be revised downwards, which suggest that the productivity gap between eu and usa remain substantial. the main turning point for widening the productivity gap is considered to be since 1995. taking into account indicators of annual productivity growth, in the usa, average annual labor productivity growth accelerated from 1.2 percent during the period 1973–95 to 2.3 economic analysis (2014, vol. 47, no. 3-4, 20-34) 30 percent during 1995–2006. comparing the same two time periods, annual labor productivity growth in the european union declined from 2.4 to 1.5 percent (ark, o’mahony, timmer, 2008). in the mid-1990s, there was a burst of higher productivity in industries producing information and communications technology equipment (ict), and a capital-deepening effect from investing in information and communications technology assets across the economy. in turn, these changes were driven by the rapid pace of innovation in information and communications technologies, fuelled by the precipitous and continuing fall in semiconductor prices. europe has been lagging behind the usa not only in ict investment but also in total productivity growth in ict producing as well as ict using industries. practically, the period of the two oil shocks 1973-’74 and 1978-’79 marked the end of the fast growing industries like chemical and automotive industry, production of plastics and artificial fibers, which have been the main driving force of economic growth in the postwar period. for thirty years, between 1950 and 1973 europe enjoyed a “golden age” of growth, stability and social cohesion. all industries were replaced by new industrial sectors with high added value, such as electronics, chemicals and pharmaceuticals, computer technology and telecommunications. although newly industrialized economies-japan and "economies tigers" of southeast asia, at that time were trying to increase the competitiveness of these industries, especially electronic, still in the information technology products and bio pharmaceutical products usa, had a big competitive advantage (dyker, 1999). also, eu is lagging in the investment in research and development (r&d). according to the objectives set out by the european commission (2010a), "europe 2020", each eu should consider costs for r&d to be amounted 3 % of its national gdp (same as in the lisbon strategy). in the period 1995 2010, the cost of r&d calculated as a percentage of gdp in the eu and the euro area are relatively fixed, and moving with an average value of 1.8 % of gdp, which is below the set limit. eu and the euro area have only a higher spending rate on r&d than china. within the eu, only sweden and finland with 3.7 % exceeding the target. other countries that have a higher than average rate of union are: germany (2.69 %) and denmark (2.85 %). in 2008, japan had the highest percentage of allocation of 3.45 %, followed by south korea with 3.36 % and 2.76 % in the usa. south korea has significant rise in the cost during the reporting period. it seems that the lisbon strategy for making the eu the world’s most competitive economy is a failure. still, an extension of the failed approach is in the works. after lisbon strategy, the europe 2020 strategy has emerged with some principle tasks, but central ideas of the lisbon strategy have been kept. the lisbon answer has been the “open method of coordination. it was to aim at the middle ground, where key policy domains remain a national competence but are recognized as being of common interest. eu continue with the lisbon-type reforms and developed new instruments of economic governance, especially with the beginning of the economic crisis. some authors (wyplosz, 2010) state that lisbon strategy should die a peaceful death and that a brand new model is needed. we believe that the model is adequate, even though there is no explicit productivity growth target formulated in the europe 2020 strategy, but trends in labor productivity are monitored as one of its main indicators. the countries from eu makrevska disoska, e., et al., competitiveness of the eu, ea (2014, vol. 47, no. 3-4, 20-34) 31 need to find their own ways of adjusting to the opportunities and dislocations of the new information and communications technologies. we believe that large extent of the reforms should remain under the member states` authority, which can bring higher incentive for its implementation, thus contributing to accomplish common interest. when one country becomes more productive, it benefits (through demand) the whole eu and raise the productivity of the rest of the countries. there also, need to be ensure greater labor mobility and flexibility of the common market, that can help the union to improve the competitiveness and also to be able to face adverse shocks in the future much easier. conclusion data for foreign trade of the eu show that the integration process and the introduction of the euro had contributed for the union to become the biggest "trade player " in the world. however, there has been a gradual of trading positions of the eu. that is not only a result of the economic crisis, but due to the major structural weaknesses (shortcomings) of the eu. in other words, the situation in the foreign account is created due to the gap in productivity, which led to a real depreciation of the exchange rate in favor of countries that have traditionally been exercising surplus. at the same time, most of the other member states of the eu realized permanent foreign trade deficit that, among other things, was a result of the large discrepancy between labor productivity and wages, whose ultimate effect was perceived in shrinking or stagnant rates of economic growth of these countries. it turned out that the economy of eu has a series of structural inconsistencies and numerous drawbacks in its economic system. the lack of compliance of the internal policies, was one of the most important reasons for the occurrence of asymmetric shocks in the union, reducing the competitiveness of the economy eu and strengthening the negative effects from the existing economic crisis. among the member states of the eu was created gap in prices for homogenous products. even thought, the purpose of the single market was to allow free movement of goods, service, capital and labor, the goal was not met due to different price levels. the difference in prices and production costs have caused a negative impact on trade flows in the union. eu shows a decrease in market shares on some of the most dynamic importing markets during the last decade, especially asean market. the orientation of the trade towards the emerging countries can be suggestion for the rest of the member states for faster out of the crisis and balanced trade account in the future. but on the other hand it is needed to boost the trade relations between eu countries in order to gain and improve the trade conditions in the common market. long-term expectations and needs for the common market is to make a comprehensive structural changes in order to overcome structural differences between individual member states to increase the overall competitiveness and individual, to remove trade barriers between individual member states and to achieve higher individual and aggregate rates of economic growth. it is clear that the effects of deep integration of the eu has not yet been achieved, and expected benefits may not be realized, if the internal and external balance of the union is not achieved. economic analysis (2014, vol. 47, no. 3-4, 20-34) 32 according to our opinion, the eu needs changes in the long term strategy which should be oriented towards targeting specific systematic problems of individual member states of eu. the reforms need to be make in order to enhance competitiveness, seen as a priority. when one country becomes more productive, it benefits (through demand) the whole eu and raise the productivity of the rest of the countries. even thought the relationship between labor productivity and market share gain is not straightforward, we tried to point out that decreased labor productivity growth in the case of eu influence on the declining share of the world market. firms and industries from eu are facing tough competition from low-cost producers (especially from the asian countries) and therefore they are forced to rationalized their production in order to survive. in that direction, the measures need to be oriented towards decrease in the employees` protection and higher initiative for regional and mobility of the labor force. additionally, if the competitiveness of the union is not improved, the balance in the trade account will be provided by increased unemployment, particularly in certain sectors which are 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(2010). the global downturn and its impact on euro area exports and competitiveness. frankfurt: european central bank. mrak, mojmir. 2010. “eurozone crisis: what went wrong and where do we stand now?”. working material. slovenia: university of ljubljana: 4-8 gianmarco i.p., ottaviano, taglioni, d. and di mauro, f. 2009. "the euro and the competitiveness of european firms". economic policy, 24 (57): 5-53. trading economics, http://www.tradingeconomics.com/spain/balance-of-trade (accessed april 2, 2014) treaty of the functioning of the european union, http://eurlex.europa.eu/lexuriserv/lexuriserv.do?uri=oj:c:2008:115:0047:0199:en:pdf (accessed march 14, 2014) un comtrade database, http://comtrade.un.org/ (accessed march 12, 2014) world economic forum. 2014. "the global competitiveness report 2013-2014", http://www3.weforum.org/docs/wef_globalcompetitivenessreport_2013-14.pdf (accessed april 20, 2014) wyplosz, charles. 2010. "the failure of the lisbon strategy", http://www.voxeu.org/index.php?q=node/4478 (accessed march 7, 2014) konkurentnost evropske unije: trendovi pre krize i uticaj finansijske krize rezime – cilj rada je da se ukaže na rizike od smanjenja konkurentnosti eu analizirajući pokazatelje cene koštanja i konkurentnosti, kao i strukturne i tehnološke aspekte konkurentnosti. uticaj svetske krize na konkurentnost i izvozne performanse eu je sve više u fokusu kako bi se ukazalo na to koliko globalna kriza može da oteža već postojeće potrebe za sanacijom funkcionisanja unije. ne samo da je kriza pokazala da problemi u uniji nisu nedavno nastali, već je nametnula hitne potrebe za poboljšanje nove politike kako bi povratila snagu konkurentnosti i performansi. preformulisana strategija treba da se zasniva na otvorenosti i inovacijama, uz ulaganja u istraživanje i razvoj. dugoročny očekivanja treba da budu sveobuhvatne strukturne promene u cilju prevazilaženja strukturnih razlika između pojedinih država članica i povećanje ukupne konkurentnosti. pored toga, neophodno je i da se uklone trgovinske barijere pojedinih država članica kao i da se postignu više pojedinačne i ukupne stope privrednog rasta. jasno je da još uvek nisu postignuti efekti duboke integracije u eu, a očekivane koristi ne mogu se realizovati ukoliko se interni i eksterni bilans unije ne održava. economic analysis (2014, vol. 47, no. 3-4, 20-34) 34 ključne reči: globalizacija, internacionalizacija, biznis, globalna tržišta, ekonomska integracija article history: received: 8 september 2014 accepted: 23 november 2014 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp1-12 original scientific paper the puzzle of relationship between the economic growth and happiness: an inter-country analysis yazdan naghdi1* | hamid amir taemeh2 | soheila kaghazian1 1 the islamic azad university, west tehran branch, faculty of economics, department of economics, tehran, iran 2 phd student of economics in firuzkuh, islamic azad university abstract in economic research, the relationship between economic growth and happiness is ambiguous. happiness does not show a positive or negative dependence on economic growth over time. based on the theoretical foundations and using interdisciplinary concepts in economics, e.g. political economy, technology philosophy, generalized method of moments (gmm), and data of 153 countries over the period 2000–2018. the total number of observations in this research is 13,770. also, the model of this research has been estimated by the software eviews. this paper tries to show that the one-dimensional look at economic growth and ignoring the growth consequences, including emotional gap, environmental degradation, and oligarchy (lack of healthy democracy), have a crucial role in creating growth and happiness. the main purpose of this study is to accept or reject the theory of easterlin, called the “easterlin puzzle”. according to easterlin puzzle, the growth and development of countries do not increase the happiness of the people in those countries. based on the model estimated in the present study for 153 countries, the theory of easterlin is not approved, and economic growth has had a small but significant effect on shortand long-run happiness in these countries. key words: emotional gap, economic growth, happiness, gmm model, oligarchy jel classification: d60, fo2, o17, q50 introduction for neoclassical economists, the measures of well-being include wealth, asset, consumption, or the sum of money held by each individual. however, happiness has a special place in the concept of welfare. according to empirical studies, happiness is very important in human economic performance, because life satisfaction will improve people’s intelligence, competence, and productivity. while grief reduces productivity. so, countries where people are happy, economic growth is often higher (li and lu, 2009). there are many factors that affect happiness. variables such as life expectancy, income distribution, education, social freedom, employment, etc. are all factors that affect the happiness in a society. economists have always wondered whether economic growth bring happiness. in order to answer this question, and based on empirical studies, we try to examine if the puzzle of easterlin paradox (easterlin, 1974) is confirmed in different countries. according to easterlin paradox theory, economic growth does not make people and communities happy. whereas, according to many economists, increasing * corresponding author, e-mail: y_naghdi@yahoo.com 2 economic analysis (2021, vol. 54, no. 1, 1-12) economic growth will increase prosperity, and increase the happiness of individuals in a society. the main purpose of this study is to investigate the puzzle of easterlin paradox. most research in iran have addressed the effects of inflation and unemployment on happiness. yet, the main feature of the present study comparing to other research is the wide range of 153 countries and using social, political, and economic indices to study the effects of these variables on happiness. while these two features have not been taken into consideration. the remainder of this paper is organized as follows. section 2 describes the theoretical foundations with respect to the oligarchy, technology, and the economic growth model. section 3 reviews the empirical literature on the subject matter, and provides a summary of the literature in a table. in section 4, the ambiguity of growth and happiness are explained. section 5 introduce and estimates the model, and finally section 6 concludes the paper. literature review for the first time, the debate of happiness and its effect on the economy was studied by easterlin in the united states. he showed that with the economic growth, happiness in the united states did not increase much. so, for the first time, easterlin paradox came up. according to this puzzle, there is no relationship between economic growth and people’s happiness. the paradox states that at a point in time happiness varies directly with income both among and within nations, but over time happiness does not trend upward as income continues to grow. various theories have been advanced to explain the paradox, but the paradox itself is solely an empirical generalization. yet, almost all post-easterlin economists rejected this theory (stevenson and wolfers, 2008). so, it has always been a question among economists whether economic growth can bring happiness. the existence of the paradox has been strongly disputed by other researchers. kanbe and ratzel (2010) said that the evidence shows an inverse ushaped relationship between income and happiness. they claim that in the early stages of economic growth, happiness increases until it reaches its maximum point, and then along with economic growth happiness will decrease. because the demand for higher income requires more work and more work reduces utility and happiness. economics science is organized according to growth patterns, and almost one-dimensional economic growth is the main goal of government planning in most countries. entrepreneurship and creativity move in the direction of further growth, and it seems that any scientific theory that can accelerate economic growth is more valuable. yet, the economic growth has had very significant effects, such as an increase in the emotional gap, environmental degradation, the consolidation of oligarchy systems, which we have very little thought about. economic growth has increased much, but there have also been paradoxes, one of which is the paradox of growth and happiness. emphasizing that economic growth is valuable and essential for community life, we try to show that although economic growth and the increase in consumer goods and services bring about happiness, its negative effects on other aspects of life impose a great deal of suffering on communities, resulting in a decline in happiness in communities. in order to better understand and take a different look at the economic growth, it is necessary to first study the two concepts of oligarchy and technology, then look at economic growth models. democracy and oligarchy can government impact directly on happiness? wagner et al. (2009) who conclude that higher-quality institutions increase satisfaction with democracy. for this reason good governance can also impact on happiness. better rule of law, lower corruption, less regulation of political participation are all associated with higher degrees of satisfaction. therefore, there is a positive relationship between democracy and happiness. yazdan naghdi, hamid amir taemeh, soheila kaghazian 3 in a simple sense, oligarchy refers to a form of government in which a small group controls the power and authority of the country. in other words, the country is run by few people. oligarchs are the clever dictators who, with the appearance of democracy, use the functions and thoughts of the dictatorial system to maximize their personal interests at the expense of the poverty and suffering of the citizens. in almost 85% of countries, there is oligarchy with different ranges. douglass north emphasized the role of security and the military in shaping and sustaining oligarchy. the game of security begins: the group that overthrows security, or the group that provides security, seizes power, and always keeps the fear of insecurity alive for the sake of self-preservation. oligarchs as political geniuses set themselves up with enough knowledge to achieve their goals, quickly destroy competitors, seize key resources, and, after the stability of their rule, begin to form exploitative political and economic institutions. oligarchy systems by exploiting institutions disrupt the process of natural economic growth in society. unless the inclusive institutions are formed, and citizens break the vicious circle of oligarchy, they will always be in poverty and economic crises. the cause of poverty and wealth in different countries is more involved with politics than it is about economics. it is the policy that determines the process of economic growth and development that brings about prosperity or poverty in societies. in almost every continent, oligarchy is associated with the industrial economy, affecting the path of economic growth and development in many countries. chart 1 shows the average trend of oligarchy in all countries around the world over the period 1800–2010. in many countries, oligarchy has entered the form of democracy, and has had its destructive effects. chart 1. oligarchy flow (1800–2010) source: world history website technology technology is the focal point of many fields such as philosophy of science, political science, sociology, mathematics and technical sciences, ethics, religion, history, anthropology, etc. technology cannot be fully defined, and therefore cannot be controlled or guided. as long as natural order was established in the world, and technique and technical development on the one hand and civilization elements on the other hand did not destroy nature, the question of technology did not make sense. but the development of technology in the industrial and postindustrial era and the changing pattern of production have given rise to a rationality that seeks to achieve certain goals. harnessing social realities through tools and techniques led to the conquest of rationality focused on the vehicle-goal chains, and the components of civilization not based on this rationality were vanished. the oligarchs adopted new patterns of production that were based on the structure of socio-economic classes. the unequal distribution of means of production among 4 economic analysis (2021, vol. 54, no. 1, 1-12) social groups created such classes. on the other hand, the authority of cultural traditions was called into question. the most outward manifestation of technology and the rationality that governs it is to conquer nature for the benefit of man. if we accept the definition of technology as applied science, we must say that science has been organized in the new world according to the pattern of technology, because the more a discipline was applied, the more it served human. in other words, the rationality of technology, that is, the means–end rational was spread to other sciences, even the human sciences, so that philosophy was overrun by science, and no longer determined the legitimate status of science. the naturalistic epistemology foundations determined the legitimate status of science. scientists interrogate nature as a slave under the master, unaware that the slave will overtake the master someday. water crisis, all kinds of pollution, extinction of species, global warming, etc. are the calamities rationality has created in short-run for mankind. technology, like any other phenomenon, has always unknown characteristics and numerous facets. technology is not the mere result of our decisions, planning, and policies. the phenomena and events of this world always have consequences that are not under our control. in order to understand technology, it is necessary to study these five themes: tools, using tools, methodology, cognitive and normative framework, and socio-technical systems. a tool is something that has a causal or a characteristic that, if used in a certain way, a certain purpose is achieved. technology is an artificial (man-made) tool, not a natural one, and it requires learning. methodology1f1 is the description of the method, that is, what happens in practice to achieve the goal. in methodology, it is difficult to describe what actually happens in practice. in other words, it requires skill. the cognitive-normative framework refers to a behavioral and educable model that regulates social relationships and reactions to which most people adhere, and are punished by law if they disobey. in addition, the cognitive-normative framework guides people on how to respond in different situations. technology encompasses all the material and spiritual possessions of societies. technology cannot only be expressed in terms of equipment. knowledge, skills, culture, value, legal system, and other factors must also be included. on the other hand, the personality of technology can be examined in three domains: technology as hardware, technology in law, and technology as system. in fact, technology encompasses all of these concepts. defining technology is defining and combining all these concepts together. the important point is that technology with all its complex, unknown, and uncontrollable dimensions has become the main engine of economic growth models. it seems that the process of producing goods and services is more involved in the technology cycle than is appropriate to the needs and priorities of consumption. the impact that technology has had on the production process has had negative, unknown, and unpredictable effects on other aspects of human life. technological development brings economic growth. however it also enhances social wealth on the one hand by increasing the income levels and wealth and causes certain social problems on the other hand. technological development makes very important contributions to the economic and social-cultural life. a study conducted in america reveals that people work more than the past; virtues like industriousness and self-discipline are more valued; entrepreneurship increased and people increased their technological capabilities for their new careers. however in spite of these positive developments, the fluctuations and uncertainties created in the commercial life by the technological development caused uncertainties in the job positions of the employees. while technological development eliminated certain jobs and work areas and 1. for further reading, see the philosophy of technology translated by taqavi (2009) and his lectures on the philosophy and science and technology, faculty of philosophy, sharif university of tehran. yazdan naghdi, hamid amir taemeh, soheila kaghazian 5 made a negative impact to employment on the one hand, it created new job opportunities and taught other methods to perform the jobs on the other hand (hülya kesici,2015) economic growth models perhaps the most prominent growth models are the harrod–domar model, solow–swan model, and the new r&d model. the growth pattern of harrod–domar emphasized capital accumulation, and was very useful in its time. with the industrial revolution and the emergence of technology, and the transformation in weaponry, european colonization brought wealth to europe, which provided the resources needed to produce industrial goods. new industries and technologies that needed investment were expanded with european colonial funding, and the role of technology became very crucial. the solow–swan model institutionalized the role of technology-based knowledge in production. the knowledge part of which was applied in human resources (training, management, and resource allocation), and a part was applied in machinery was the main growth factor. the solow–swan model that perhaps is the most effective model of economic growth led to communities, which because of natural and geographical conditions, and most importantly for the plunder of resources by the colonists, were frustrated by the improvement of their lives, to get closer to the developed communities. it can be said that the solow-swan model best served to increase the well-being of poor countries that has been one of the important and valuable impacts of modern science and technology. yet, the excitement of production created by technology and other factors has continued in all countries. new models of economic growth extended the boundary of technology-based knowledge, and made technical creativity and innovation a major driver of economic growth. the innovation economy and the entrepreneurial economy shaped by new ideas, and extended the new technologies as the engine of growth in the process of production of goods and services. growth models were developed based on human capital specialized in technology, and the human mind became the technical center of all economic processes. considering the growth models, the following can be considered: 1. economic growth is valuable. communities enhance the growth of knowledge for enhancing technical knowledge. as a result, other aspects of knowledge in the social, ethical, and family sectors do not grow proportionally to the growth of technology knowledge. 2. the process of training and acquiring skills in countries to achieve technology-based science that leads to more productivity is costly. so, people need to spend a lot of time on training. due to the high rate of technical science growth and the high rate of science depreciation, people have no time to acquire science to grow other aspects of life. 3. economic growth takes a lot of time. that is, people have to constantly think about growth, and work constantly to align themselves and society with growth indicators. 4. measuring the economic growth is almost straightforward. in other words, the rate of economic growth and the material and human resources, as well as the time devoted to growth, are quite measurable. but other growth aspects of life, perhaps even more valuable, have been forgotten. the average national production in the world has increased. productivity and product diversification has raised, and this is a result of the good performance of growth models, in which new technology and science lie. along with this growth, we destroyed the environment, run out energy resources, and transformed the earth’s face. perhaps this is the biggest shock that economic growth has had. yet, the paradox is that many people are poor, and suffer from hunger. in industrial civilization, although the human wealth has increased dramatically, equitable distribution has not occurred, and the income gap and consequently the emotional gap 6 economic analysis (2021, vol. 54, no. 1, 1-12) between the society’s classes is expanding. the distribution of wealth and income has always been one of the main unresolved issues of the economy (piketty, 2014). the rapid change in technology has disengaged and enslaved human beings. this rapid change has led to insecurity, and has greatly weakened family structure, and created new suffering and anxiety in communities. as a result, the economy of happiness was formed, as economic thinkers gradually realized that the human satisfaction and happiness in industrial societies was declining. economic growth has directly and indirectly caused problems in societies. the paradox led to create research in this direction, some of which are reviewed in the following. previous experimental studies studies on the effect of economic growth on happiness are reviewed in table 1. table 1. studies on the relationship between economic growth and happiness scholar title results richard easterlin (2002) economy of happiness statistical research in selected countries shows that health, ethics, religious beliefs, and democracy are more effective than happiness in economic growth. val dusek (2006) philosophy of technology economic growth has become involved in the technology cycle rather than bringing prosperity to people, and has become a tool for technology growth. luigino and porta (2007) economy of happiness econometric models and mathematical optimization models in selected countries show that rising levels of income and gdp in countries have not only had an effect on happiness, but have also, in some cases, reduced the happiness and well-being of communities. eisler (2007) real wealth of nations research by statistics and psychology observations shows that protecting the environment and ethics against economic growth can increase happiness in societies. li and lu (2009) happiness and development they used social variables such as suicide rate to study the relationship between happiness, and development, and for economic variables, they used the logarithm of gdp and capital share. results of this study showed a positive significant relationship between growth and happiness. dutt and radcliff economy, happiness, and politics economic growth and happiness have no significant relationship. economic growth is a necessity for happiness, but economic growth has not followed happiness growth. acemoglu and robinson the cause of poverty and richness in countries statistical and historical research across all the countries of the world in the last 500 years show that politics was the main driver of economic growth and development in countries that increase the happiness and satisfaction of societies. sacks et al. (2012) costs of economic growth more economic growth leads to higher growth in life satisfaction. palacios-huerta (2013) forecasting the next 100 years from an economic perspective happiness has a positive impact on community well-being and environmental protection. ricardo (2015) how does philanthropy guide people? ethical crises in the process of economic growth have reduced the happiness of societies. humans need altruism more than economic growth to be happy. waldinger (2015) what makes our lives happy? he shows on the continent of america that the main factor in happiness was social communication, and that economic growth had no significant relationship with happiness. yazdan naghdi, hamid amir taemeh, soheila kaghazian 7 scholar title results marks (2017) happy planet index (hpi) using the econometric panel data model for 167 countries, he showed that gdp growth had no significant relationship with the happiness level of societies. whp (2017) world happiness report (whr) results showed that there was no significant relationship between economic growth and happiness, and emphasized the crisis of happiness in the world. according to the results of table 1, there is an ambiguous relationship between economic growth and happiness. the ambiguity of growth and happiness from the statistical data in chart 2 it can be seen that, despite the high economic growth rate in the world, the rate of happiness is almost constant. therefore, it can be said that there is a vague relationship between happiness and economic growth. a survey of the average per capita income of countries and their level of happiness in the last century (1972–2016) reveals the ambiguity of the two variables. chart 2. world average of per capita national production and happiness (1972–2016) source: world happiness index (whi) report (2018) model introduction and estimation in the present study, variables has been selected, so that they have the greatest impact on the happiness level of the communities along with economic growth. these variables are: emotional gap (eg) resulting from inequality, environment (env), democracy (dem), domestic product (gdp), and happiness (hpi).  emotional gap (eg) resulting from inequality according to wilkinson (2010), atkinson (1970), and wilkinson and pickett (2010), economic inequalities, e.g. income inequality, reduce well-being and happiness in societies at a significant level, and create emotional gaps. in addition, surveys and reports by hpi, whr, and hdr that show the effect of countries’ per capita income inequality on their life expectancy and satisfaction level confirm the effect of inequality on the reduction of happiness. these reports indicate that income inequalities cause emotional gaps in societies, and drastically reduce people’s satisfaction. emotional gaps due to unequal distribution of income and wealth in society has have a profound effect on the education level, social skills, and physical health of individuals. emotional gaps reduce motivation and hope for community life skills and endeavors. in addition, emotional gaps reduce creativity and entrepreneurship in most small firms (and even large firms). on the 0 2 4 6 1972 2016 whi-gdp gdp happiness 8 economic analysis (2021, vol. 54, no. 1, 1-12) other hand, emotional gaps increase the dissatisfaction with life, and enhance crime (crime economy). this index has been studied by the uk inequality research agency and the development plan for all countries. statistical data of the average income of 0.10% of the highest level of community income over the average of 0.10% of the lowest level of community income in all countries of the world is represented by the united nations development program as r/p ratio, which have been used in this study.  environment (env) countries contribute to environmental degradation according to the six indices that are part of the world bank’s development data. countries with one-dimensional programs that prioritize economic growth have the most effect on environmental degradation, reducing the well-being of their nation and the planet as a whole. the environmental degradation index has been measured and explored by the global footprint for all countries.  democracy (dem) the oligarchy and democracy in the societies have a profound effect on happiness and shaping the path of economic growth. the global democracy ranking and freedom house classify countries in terms of democracy in four groups: full democracy, flawed democracy, hybrid regime (noncentralized state), and authoritarian regime. accordingly, they consider five principles for measuring and ranking democracy in countries: 1. the electoral process and the plurality of parties, 2. government structures, 3. political freedoms, 4. political culture, 5. civil liberties.  gross domestic product (gdp) gross domestic product per capita based on purchasing power parity (ppp$) across countries is used to show the level of economic activity and economic growth of countries.  happiness (hpi) following the paradoxes in economic growth and happiness in the world, the happy planet index (hpi) was launched to measure happiness at the planet level. hpi measures sustainable prosperity and happiness, and compares how countries use their natural resources to achieve sustainable levels of prosperity and happiness. the four indices of life expectancy, satisfaction, inequality in life achievements, and environmental degradation are used. according to li and shi (2019), li (2015), lin and lu (2009), cogoy (2009), bruni (2009), and dutt (2010), equation 1 has been used to assess and determine the effect of variables on happiness. the experimental model of this study is taken from previous studies and modified: 𝐻𝑃𝐼 = 𝛽 𝐺𝐷𝑃 + 𝛽 𝐸𝐺 + 𝛽 𝐸𝑁𝑉 + 𝛽 𝐷𝐸𝑀 + 𝛽 𝐻𝑃𝐼 + eit + vi (1) the statistical data collected from 153 countries over the period 2000–2018. 𝐻𝑃𝐼 is happiness level, 𝐻𝑃𝐼 is lagged happiness, 𝐸𝐺 is emotional gaps of the societies, 𝐸𝑁𝑉 is countries’ environmental impact and degradation, 𝐷𝐸𝑀 is democracy level, 𝐺𝐷𝑃 is domestic product per capita, 𝑒 is error term that includes all unobserved economic effects, and 𝑉 is fixed effects in each country. we take the logarithm of the model, and calculate the model’s first-order difference. this will remove all variables, e.g. the fixed effects of countries that are fixed over time, and cause estimation problems. ln (𝐻𝑃𝐼 ) = 𝛽 ln (𝐺𝐷𝑃 ) + 𝛽 𝑙𝑛(𝐸𝐺 ) + 𝛽 ln (𝐸𝑁𝑉 ) + 𝛽 ln (𝐷𝐸𝑀 ) + 𝛽 ln (𝐻𝑃𝐼 ) + 𝑒 + 𝑉 (2) yazdan naghdi, hamid amir taemeh, soheila kaghazian 9 ∆ln (𝐻𝑃𝐼 ) = 𝛽 ∆ln (𝐺𝐷𝑃 ) + 𝛽 ∆𝑙𝑛(𝐸𝐺 ) + 𝛽 ∆ln (𝐸𝑁𝑉 ) + 𝛽 ∆ln (𝐷𝐸𝑀 ) + 𝛽 ∆ln (𝐻𝑃𝐼 ) + ∆𝑒 (3) table 2. estimating the effects of variables on happiness in short-run prob. z coefficients variables 0.00 4.69 0.45 ∆ln (𝐻𝑃𝐼 ) 0.00 5.99 0.25 ∆ln (𝐺𝐷𝑃 ) 0.00 -5.33 -1.25 ∆ln (𝐸𝐺 ) 0.00 -6.59 -0.36 ∆ln (𝐸𝑁𝑉 ) 0.07 -1.87 -0.52 ∆ln (𝐷𝐸𝑀 ) 153 countries 0.0006 j-statics source: research findings as expected, environmental degradation (env) caused by new technologies has a negative effect on happiness. the emotional gap (eg) that results from the unequal distribution of income and wealth also has a negative effect on happiness. in addition, oligarchy and flawed democracy (dem) have a negative effect on happiness. as predicted, economic growth and increasing commodity production (gdp) in societies had a positive effect on happiness. humans are happy with material and economic opportunities. provided that this economic growth does not have a negative outcome, and does not damage other aspects of life. furthermore, due to the coefficient sign of the happiness variable with one lag (𝐻𝑃𝐼 ), it can be seen that the happiness of the previous period has a positive significant effect on the current happiness. in table 3, the relationship between variables in the long-run has been estimated. long-run coefficients are calculated indirectly through the partial adjustment method(𝜃 = ). the estimates still confirm the theoretical foundations. the effect of long-run economic growth on happiness has increased. long-run environmental degradation has also caused human suffering, and emotional gaps and unhealthy democracy in most long-run oligarchies because of the psychological effects on human life have a greater negative effect on happiness, and still create the greatest level of suffering. the environmental degradation caused by economic growth also has a negative effect on people's happiness. for example, air pollution caused by economic growth causes people to get sick and upset. among the research variables, the lack of democracy has the negative impact on happiness. in other words, if democracy is less, people are sadder. also, income inequality (eg) has a greatest negative effect on happiness. so governments need to do more to reduce income inequality. humans are greatly damaged by the cruelty of emotional and oligarchy in the long-run, and happiness in societies drops sharply. by comparing the results of the shortand long-run estimates, it can be seen that both shortand long-run economic growth have a positive significant effect on happiness. the long-run effect of economic growth on happiness is greater than the short-run. in addition, shortand long-run estimates do not confirm easterlin paradox. that is to say, contrary to easterlin’s view, the economic growth of countries has increased people’s happiness in both shortand long-run (although the results of this study are not for the whole world, but only for 153 countries, over the period 2000–2018. while this relationship was ambiguous, according to chart 2, which explored the relationship between growth and happiness over a longer period for the whole world). furthermore, according to nili, babazadeh khorasani, and shadkar (2015), abounouri and eskandari (2016), and jaafari (1981), raising the per capita income will increase the people’s satisfaction and happiness. as a result, wealthier countries are happier than other countries. results of these studies, like that of the present study, do not confirm the easterlin paradox. 10 economic analysis (2021, vol. 54, no. 1, 1-12) table 3. comparing the variables’ effect on happiness in the shortand long-run z-statistic short-run z-statistic long-run variables 5.99 0.25 7.43 0.45 ∆ln (𝐺𝐷𝑃 ) -5.33 -1.25 -6.21 -2.27 ∆ln (𝐸𝐺 ) -6.95 -0.36 -3.45 -0.65 ∆ln (𝐸𝑁𝑉 ) -1.87 -0.52 -2.57 -0.94 ∆ln (𝐷𝐸𝑀 ) source: research findings sargan test is used in (gmm) models to determine the appropriateness of the estimate. this test used to determine the valid over identifying restrictions. sargan test has a 𝜒 distribution. in performing the sargan test, with respect to j-statistic, the instrumental variable rank, and the number of regressions in the model, the probability value equals 1 that is higher than 0.05, and the j-statistic value equals 0.0006. in terms of autocorrelation, the error term has first-order ar(1) correlation, and does not have the second-order ar(2) correlation. according to the tests, the moment method is verified, and the generalized method of moment (gmm) has been used properly. the general meaningful of (gmm) model is confirmed by the wald test. the arellando-bond serial correlation test was performed and the validity of the gmm model was confirmed (z=-1.83). conclusion in this study, based on social, political, and environmental variables and the data from 153 countries over the period 2000–2018, we found that economic growth had a positive significant effect on happiness (the easterlin paradox is rejected). economic growth is very valuable, and no society can achieve happiness without economic growth, but the negative consequences of economic growth, including environmental degradation resulting from one-dimensional thinking and partial selfish rationality in societies, have created a lot of suffering for humans. the environmental degradation caused by economic growth also has a negative effect on people's happiness. for example, air pollution caused by economic growth causes people to get ill and upset. among the research variables, the lack of democracy has the negative impact on happiness. in other words, if democracy is less, people are sadder. also, income inequality (eg) has a greatest negative effect on happiness.. so governments need to do more to reduce income inequality. humans in all societies with all levels of economic growth suffer from emotional gaps, social inequalities, environmental degradation, and oligarchy. the ambiguity of economic growth and happiness, rather than being an economic phenomenon, is because of policies and ethical crises of policymakers. thus, economic growth along with reducing inequality and poverty, preserving the environment, enhancing democracy, and meeting the basic needs of society increases the effect of economic growth on happiness. the results of this study were the same as the results of sacks (2012) and palacios-huerta (2013) studies, but the results of this study were not the same as the results of li and shi (2019), li (2015) and mark (2017) studies. therefore, it can be said that the relationship between happiness and economic growth is ambiguous. countries examined in the model are: argentina, armenia, australia, austria, bahrain, bangladesh, belgium, bolivia, brazil, bulgaria, bhutan, canada, chile, china, colombia, costa rica, croatia, cyprus, czech republic, denmark, ecuador, egypt, el salvador, estonia, fiji, finland, france, qatar, germany, ghana, greece, guinea, hong kong, hungary, iceland, india, indonesia, iran, ireland, palestine, italy, jamaica, japan, jordan, kazakhstan, cambodia, kenya, south korea, kuwait, kyrgyzstan, lebanon, lithuania, libya, malawi, mali, maldives, malaysia, macedonia, malta, mauritius, mexico, mongolia, morocco, namibia, nepal, netherlands, new zealand, norway, nigeria, pakistan, panama, new guinea, paraguay, senegal, serbia, sierra yazdan naghdi, hamid amir taemeh, soheila kaghazian 11 leone, peru, philippines, poland, portugal, romania, russia, rwanda, oman, singapore, slovak republic, slovenia, south africa, spain, sri lanka, syria, sweden, switzerland, taiwan, thailand, togo, tobago, tunisia, turkey, timor-leste, tanzania, uganda, ukraine, eritrea, united arab emirates, england, united states, uruguay, vietnam, venezuela, yemen, zambia, and zimbabwe. references abounoori, e., & eskandari, j. 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(2012). the new stylized facts about income and subjective well-being. emotion, 12(6), 1181–1187. stevenson, b., & wolfers, j. (2008). economic growth and subjective well-being, reassessing the easterlin paradox, university of pennsylvania and nber. the 2008 world congress on naep measures for nations, may 14 2008. waldinger, r. (2015). what makes good life. www. ted .com. wagner, m., schneider, f., & halla, a. (2009). the quality of institutions and satisfaction with democracy in western europe: a panel analysis. european journal of political economy, 25, 3041. wilkinson, r., & pickett, k. (2010). the spirit level: why equality is better for everyone. london: penguin. world happiness report (whr). retrieved from https://worldhappiness.report/ article history: received: october 10, 2020 accepted: april 29, 2021 doi: 10.28934/ea.21.54.2.pp41-54 preliminary report the impact of the covid-19 crisis on the serbian economy consequences and recovery marija lazarević-moravčević10f* | sandra kamenković2 1 institute of economic sciences, belgrade, serbia 2 university union belgrade, belgrade banking academy, belgrade, serbia abstract the subject of this paper is the analysis of the consequences of the corona crisis on the serbian economy. the focus is on the analysis of the crisis effect, taking into account the sectoral structure of the serbian economy and the distribution of business entities by size. the assumptions are that the crisis did not affect all business sectors equally, as well as that the size of the company is a factor that significantly determines the organization's ability to respond to the crisis. the paper also analyzes the effectiveness of measures taken by economic policy makers in order to mitigate the consequences of a pandemic. desk-research method was used in the paper, primarily analyzing papers and publications from scientific journal and other professional literature, as well as official data, databases and reports of relevant institutions. in conclusion, the authors state that it is extremely difficult to predict the pace at which the serbian economy will recover from the crisis, especially under the assumption that the pandemic may continue. recovery from the crisis is determined by a number of factors: measures that the state will implement in the upcoming period, the company's ability to adapt to new business conditions, the pace of vaccination, the further course of the pandemic, events in the environment. key words: economy, sector, effects, measures, covid crisis, support, small and medium enterprises jel classification: m21, e60 introduction ever since it was registered in china, the covid-19 virus has become a key global threat. the virus is spreading rapidly and intensively, affecting all parts of the world creating pressure on economies. the pandemic have caused immediate economic effects and consequences. the world is facing a recession, whose end is not possible to envisage now. according to certain estimates, „the virus reduced global economic growth in 2020 to an annualized rate of -3.4% to -7.6%, with a recovery of 4.2% to 5.6% projected for 2021. global trade is estimated to have fallen by 5.3% in 2020, but is projected to grow by 8.0% in 2021. major advanced economies, which comprise 60% of global economic activity, are projected to operate below their potential output level through at least 2024” (congressional research service, 2021). the pandemic has prevented or limited the functioning of many economic entities. the most endangered were companies operating in high-contact activities. companies operating in these activities were forced to limit or suspend operations for several months. it is estimated that “93% of the world’s workers were living under some form of workplace restrictions as a result of the global pandemic and that 8.8% of global working hours were lost in 2020 relative to the fourth * corresponding author, e-mail: marija.lazarevi@ien.bg.ac.rs 42 economic analysis (21, vol. 54, no. 2, 41-54) quarter of 2019. losses in working hours in 2020 were approximately four times higher than during the global financial crisis in 2009” (international labour organization, 2021). the covid-19 pandemic has significantly affected the labour market, especially in the united states, and less in central asia and europe. global job losses during 2020 amounted to 114 million jobs, compared to 2019 (international labour organization, 2021). in european economies, there were no major shocks in the labour market thanks to the measures taken in order to protect companies from bankruptcy and to maintain the number of employees. according to the ilo report, during 2020, employees lost their jobs mainly in the services sector, i.e. in activities where it was not possible to organize work from home. thanks to the measures implemented in the segment of fiscal and monetary policy, the economic decline during 2020 was smaller than expected at the global level. in order to prevent the spread of the virus, protect the population and the economy, most countries have reacted in a similar way borders were closed, measures for social distancing are established, support is provided to the most vulnerable segments of society and the economy. despite the fact that the “covid-19 pandemic has been recognized “as a major exogenous shock that has altered the competitive landscape for both small and large firms (wenzel, stanske, lieberman, 2020)”, large firms are significantly more willing to face the crisis. in european countries, the most important, but currently the most sensitive segment of the economy is the sme sector. this segment of the economy represents the "backbone of the european real economy because it employs about two thirds of employees and participates in the creation of more than 55% of total value added in the non-financial business economy" (european investment bank, 2020). the crisis caused by the pandemic covid-19 resulted in the decrease of income and employment levels of many small businesses. a significant number of smes were forced to suspend operations (accommodation and food services, recreation and entertainment) or to operate at reduced capacity (transport, manufacturing, construction). in order to maintain business activities, most eu countries have provided significant support to smes and using various financial tools they covered all or part of the costs incurred due to the closure, suspension or slowdown of operations (international trade centre, 2020). in fact, in most economies rapid solutions were applied to support the sme on the basis of direct funding, tax incentives, financial guarantees, loans with low interest rates and other (grondis, slusarczik, hussain, androniceanu, 2021). due to the great uncertainty related to the future course of the epidemic, the effects of the crisis cannot be precisely determined. according to the forecasts made by the international monetary fund, the world economy will experience a stronger recovery during 2021 and 2022. “global growth is projected at 6% in 2021, moderating to 4.4% in 2022” (imf, 2021). in january 2021, the world bank released its updated economic forecast, which indicated that global economic growth would reach 4.3% in 2020 and 4.0% in 2021, compared with june 2020 projections of -5.2% for 2020 and 4.2% in 2021, but rise by a slower rate of 3.8% in 2022 (world bank group, 2021). both reports state that the speed of recovery of individual countries will be different. the intensity of overcoming the crisis will be determined by the pace at which vaccination is carried out and the support measures that will be taken by the states. the covid-19 pandemic has caused general recession, including the serbian economy (fic, 2020). despite the fact that the crisis has caused a decrease in gdp, exports and foreign demand, total production (especially industrial), a decrease in the growth rate, the impression has been gained that its impact is milder compared to other economies. “the current account deficit was reduced to around 4.3% of gdp in 2020, primarily due to lower outflows of net income of foreign economic entities and, in part, a lower foreign trade deficit (international bank for reconstruction and development, 2021)”. during 2020, the growth of government debt was also recorded. in november 2020, government debt amounted to 56.8% of estimated gdp, compared to 52.0% at the end of 2019 (oecd, 2021). employment did not decline, primarily thanks to state program of marija lazarević-moravčević, sandra kamenković 43 fiscal incentives. on the other hand, the support that helped the economy survive also meant high budget costs (international bank for reconstruction and development, 2021). in order to mitigate the negative effects of the crisis in serbia, a comprehensive package of monetary, fiscal and banking measures has been implemented. interventions carried out by the government and the nbs were primarily aimed at preventing bankruptcy and dismissal during the state of emergency. the goal was to recover the economy from the initial shock. “most measures introduced by the republic of serbia are related to labour and deferral. also, measures related to financial instruments have not been left out either, however they are less intensive comparing to other countries“ (beraha, đuričin, 2021). the implemented measures cannot be effective and sufficient, assuming that the crisis continues and generates long-term changes in market conditions. the lack of a planned approach in resolving the secondary effects of the crisis may undermine the position of companies in serbia and their competitive advantage (united nations, 2020). similar to other economies, the crisis in serbia did not affect all sectors equally. according to some estimates “69% of the sector was immediately affected by the pandemic, while 31% of the sector was left without an immediate negative impact, but with possible indirect and subsequent negative consequences” (fic, 2020). some sectors have managed to adapt to the new situation, such as the it sector, food and beverage production and agriculture, and to hire new employees (privredna komora srbije/usaid, 2020). the long-term effects of the crisis on the serbian economy cannot be accurately estimated. it is possible to assess the consequences of current events and the measures applied in the fight against it. on the other hand, it is difficult to assess secondary and tertiary effects. potential (secondary) effects are a consequence of the primary ones and will occur if the crisis continues. the tertiary effects of the crisis arise as a result of changes in the international market due to the limited movement of people, goods and capital (institute of economic sciences, 2020). also, the economy and overall well-being of serbia are significantly influenced by events in the eu, as the dominant trading partner (united nations, 2020). the paper analyzes the consequences of the crisis on the performance of the serbian economy, observed from the aspect of individual sectors and the most sensitive segments of the economy small and medium enterprises. in addition, the paper chronologically presents the measures taken with the intention to minimize the impact of the crisis, as well as proposals that would make the most sensitive segments of the economy more resilient to the effects of the crisis. sectoral analysis of economic activity in serbia during the pandemic majority of sectors experienced some kind of change during the covid-19 pandemic. while some activities struggled with a large decline, some experienced a large increase in business volume, which implies that the pandemic crisis did not affect all activities uniformly. epidemiological restrictions worldwide had a strong negative impact on activities such as accomodation and food services, the aviation industry, the automotive industry, the non-essential goods manufacturing industry, as well as part of the international logistics industry, due to difficult global transport, complicated administrative procedures and breaking delivery deadlines. on the other hand, restrictions and the health situation made huge impact on pharmaceutical industry, food and other essential food retail, video game industry, online sales, logistics providers related to providing delivery to each individual consumer. it is necessary to mention that the business registers agency of serbia in its annual report publishes the summary results of the sectors according to the classification of activities (kd) 2010. as a result, we have in some way averaged results of the sector, because according to the classification e.g. the manufacturing sector includes the production of pharmaceutical products and medical equipment, which due to a sharp increase in demand recorded a sharp increase in 44 economic analysis (21, vol. 54, no. 2, 41-54) business, but also the production of motor vehicles and furniture, which due to rising risks related to future incomes, recorded decrease in demand and decrease in activity. the data from the annual bulletin of financial statements for 2020 published by the business registers agency are presented in tables 1 and 2 and they confirm these findings. table 1. net business results of serbian companies by sectors of activity net result (in millions of rsd) index 2019 2020 2020/2019 wholesale and retail trade 74.345 134.858 181,4 manufacturing 116.268 130.894 112,6 construction 33.878 58.484 172,6 information and communication 37.551 44.921 119,6 electricity, gas, steam supply 3.973 26.166 658,6 agriculture, forestry and fishing -4.652 9.712 n/a real estate activities 23.709 4.156 17,5 mining 1.163 16.728 7,0 arts, entertainment and recreation 6.491 1.370 21,1 transportation and storage 11.389 -11.539 n/a accommodation and food service activities 1.332 -9.183 n/a source: apr (2020) annual bulletin of financial statements, https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf there are 6 sectors in the group of activities that made higher profits in 2020 compared to 2019. in the wholesale and retail trade sector, the result was 81% better than in 2019, with an increase in the number of employees by over 4.500. the next sector with profit growth is the manufacturing sector, which grew by over 12%, noting that this sector recorded the largest increase in the number of employees of over 17.000. the construction sector recorded a growth of net results of 72% compared to 2019, with an increase in employees by 3.543 workers, while the information and communication sector recorded a growth of profitability of 19%, with an increase in the number of employees by 11.279 workers. the largest increase in profitability was recorded in the electricity supply sector, whose net result after the fall in 2019 compared to 2018 by 45%, in 2020 compared to 2019 increased over 6 times, with a decrease in the number of employees by over 500 workers. higher profits were also made in the agricultural sector, which after a loss in 2019, made a profit in 2020. growth was achieved by sectors where the impact of epidemiological restrictions was minimal, such as construction sector, agricultural, electricity supply sector, and especially those where epidemiological restrictions actually stimulated demand, such as wholesale and retail sector, which includes online trade, food and beverage wholesale, computer equipment wholesale, then manufacturing, where the trade in medical equipment and pharmaceutical products is classified, as well as the information and communication sector, which includes telecommunications, programming and information service activities. sectors that performed positively in 2020, but significantly worse than in 2019, are the real estate sector, the mining sector and the arts, entertainment and recreation sector, which achieved 17.5%, 7% and 21% of the profit realized in the previous year. the crisis has the hardest negative impact on the transport and storage sector, which lost almost 12 billion rsd. this is not surprising given that in some periods during 2020, borders were closed or at least with significant restrictions on moving from one country to another to prevent the spreading of the virus. however, a large loss at the level of 9.2 billion rsd was scored by the sector of accommodation and food services, also for very obvious reasons during the pandemic period. these data more than obviously explain the fact that the measures of the economic policy https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf marija lazarević-moravčević, sandra kamenković 45 of the government of serbia regarding the issue of sectoral assistance were directed especially in these two sectors. it is interesting to point out that in the transport and storage sector the number of employees increased by 70, while in the accommodation and food services sector decreased by 458 workers, which may suggest that despite the sharp decline of activity in these sectors, government measures in the form of subsidies mitigated the decline of employees in the accommodation and food services sectors, i.e. maintained the number of employees at the similar level in the transport sector. table 2. number of companies and number of employees by sectors number of companies number of employees 2018 2019 2020 2018 2019 2020 wholesale and retail trade 34.074 33.044 32.107 219.373 223.116 227.618 manufacturing 17.969 17.735 17.381 367.282 374.840 391.855 construction 8.670 8.984 9.323 72.479 78.003 81.546 transportation and storage 6.639 6.810 6.883 99.228 99.912 101.935 administrative and support service activities 3.991 4.108 4.139 76.413 83.165 83.122 other sectors 34.512 35.352 36.278 306.458 315.326 331.878 source: apr (2020) annual bulletin of financial statements, https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf impact of the pandemic on performance sme sector in serbia the crisis caused by the covid-19 pandemic has affected all economic entities small and large organizations. it also confirmed the fact that the size of the company is a factor that significantly determines the ability to resolve crisis situations. large companies were better prepared to deal with the crisis, while the micro and small business segment was hit hard. their excessive sensitivity can be explained by the fact that this is the segment of the economy that is the least liquid and has the lowest credit rating (ien, 2021). in addition, these companies mainly operate in the most affected sectors. they are financially constrained and have little opportunity to diversify their business (ceves, 2020). on the other hand, their flexibility is responsible for the relatively successful resistance to the pressures caused by the crisis. it is known that smaller organizations have the ability to quickly adapt to new circumstances and market needs. unlike large companies, which are characterized by sluggishness, small companies can more easily reorient themselves to new market demands (kamenković, lazarević-moravčević, 2018). seen in the context of the sme sector, it is expected that the organizations that belong to the category of medium-sized enterprises show the greatest resistance to the crisis. the explanation can be found in the fact that these companies have the characteristics of both small and large systems. organizations that belong to the category of medium-sized enterprises have not lost their flexibility, and on the other hand, they have certain similarities with large systems (capacities, resources and structure) that allow them to attract financial resources and more easily overcome the crisis. in fact, medium-sized companies are “closest to the ideal combination of capital and flexibility, which enables them to successfully deal with the crisis caused by the covid-19 pandemic (ceves, 2020)”. despite the fact that the crisis affects all the important segments of business (plans for investment, liquidity, ability to collect receivables, negative trends in demand, supply chains) can be concluded that companies in serbia demonstrated a certain level of resistance and readiness to adapt to new market conditions (usaid, 2020). in the initial stages of the crisis, most companies managed to keep their workers, thanks to savings, loans and financial support provided by the state (united nations, 2020). in spite of the expectation that mass layoffs will be one of the key consequences of the crisis, official statistics indicate opposite trends. https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf 46 economic analysis (21, vol. 54, no. 2, 41-54) based on the data presented in the table 3, it can be concluded that the growth trend in number of economic entities belonging to the category of medium-sized enterprises has continued. also, in these companies a positive trend in the number of employees has been identified. on the other hand, decrease in the number of employees was recorded in the category of small enterprises. an interesting observation is that despite the reduction in the number of micro enterprises in 2020, the number of employees in this segment of the economy has grown. table 3. number of enterprises and employees in the sme sector (2018-2020) number of enterprises number of employees medium enterprises 2018 1.387 232.991 2019 1.497 253.876 2020 1.815 273.115 small enterprises 2018 10.387 313.435 2019 11.036 321.391 2020 11.617 316.247 micro enterprises 2018 93.689 236.575 2019 93.085 236.639 2020 92.257 237.035 source: apr (2020) annual bulletin of financial statements, https://www.apr.gov.rs/upload/portals/0/gfi_2021/godisnji_bilten_2020/biltensi2020.pdf during the crisis maintaining employment levels is not recognized as a problem facing the sme sector in serbia. problems can be identified in the area of maintaining revenue and net profit levels. "the crisis has negatively affected the company's income, so the business reality is significantly worse than expected (ceves, 2020)", especially in the segment of micro companies. compared to 2019, the segment of small enterprises achieved total revenue decrease by 5%, while reducing total expenses by 6%. in this segment of the economy was also observed reducing the number of employees (5.144). small companies achieved the most dynamic growth of a positive net result of 34.2%. growth was achieved primarily under the influence of business activity of companies in the wholesale and retail trade sector (serbian business registers agency, 2021). figure 1. small businesses revenue and expenditure trends (2017-2020) source: based on data from the annual bulletin of financial statements 2018, 2019, 2020, https://www.apr.gov.rs/ 2500000000 2600000000 2700000000 2800000000 2900000000 3000000000 3100000000 2017 2018 2019 2020 total income total expenses https://www.apr.gov.rs/ marija lazarević-moravčević, sandra kamenković 47 a negative tendency in the movement of total revenues was also noted in the segment of micro enterprises. this is the most numerous segment of the economy that achieved a decline in total business activity with a negative result, as well as a significantly impaired financial position. during 2020, micro enterprises recorded a decrease in total revenues by 13%, with an almost identical decrease in total expenditures. compared to 2019 the number of micro enterprises decreased by 828 (serbian business registers agency, 2020). micro enterprises were the only ones to operate with a loss of 13,310 million dinars, which is 16.4% less compared to 2019 (serbian business registers agency, 2021). figure 2. micro enterprises revenue and expenditure trends (2017-2020) source: based on data from the annual bulletin of financial statements for 2019 and 2020, https://www.apr.gov.rs/ a negative tendency in the movement of total revenues, especially in the field of microenterprises, is a result of reduced business activity. micro, as well as a significant number of small companies mainly operate in labour-intensive activities, i.e. in sectors where personal contact is extremely important. during a pandemic these organizations were often exposed to business interruptions. however, the total revenues and expenditures within the sme sector are certainly affected by the change in the number of economic entities. it can be stated that the largest contribution to the growth of overall profitability was given by medium and small enterprises. medium-sized companies are the only segment of the economy that has recorded growth in total revenues and total expenditures. also, these companies are recognized as the most financially stable part of the economy. on the other hand, negative impact of the crisis is the largest in the segment of micro enterprises. during 2020 the financial position of these companies was significantly impaired (serbian business registers agency, 2020). according to a survey conducted by usaid in cooperation with the serbian chamber of commerce on a sample of 1.000 companies, the crisis has disrupted certain plans and activities of many smes in serbia. forecasts of businessmen in serbia are becoming less optimistic in terms of plans, future income, and volume of activities and employment of new workers. on the other hand, they believe in ability to retain current employment level. companies are planning to continue their activities (usaid, 2020) and most of them do not intend to introduce permanent changes in their business, due to the pandemic (ceves, 2020). the biggest problem for smes in serbia remains the lack of access to various sources of funding (usaid, 2020; ceves, 2020). despite the fact they are still the most dominant source of financing, the share of own funds in business financing during 2020 is declining. on the other hand, businessmen in serbia do not find alternative solutions in bank loans or professional investors. in addition, the following problems 1250000000 1300000000 1350000000 1400000000 1450000000 1500000000 2017 2018 2019 2020 total income total expenses https://www.apr.gov.rs/ 48 economic analysis (21, vol. 54, no. 2, 41-54) have been identified: unfair competition, legal uncertainty due to unclear regulations and lack of transparency in the adoption of regulations, lack of investment options, and unavailability of qualified human resources. according to the results of the mentioned research, businessmen in serbia positively evaluate certain aspects of the regulatory environment procedures and regulations related to inspection supervision, vat refund procedures. on the other hand, they negatively assess the amount of taxes and contributions on salaries, as well as the efficiency of the work of the state administration (usaid, 2020). the crisis that companies are currently facing has given online business a completely new role and meaning. all the benefits of online business have now come to the fore. in the new circumstances, it is realistic to expect a growing number of companies that rely on modern technological solutions in their business. the need to introduce alternative options is also a consequence of changes in the behavior and habits of consumers during the crisis (lazarevićmoravčević, domazet, lazić, 2021). during the crisis, the benefits of internet business have become significant. the number of companies that use the internet as a communication channel is constantly growing, as well as the number of companies that own a website. the website is owned by 84.4% of companies, which is an increase of 0.8% compared to 2019 and an increase of 1.8% compared to 2018 (republic statistical office, 2020). there is a noticeable increase in the number of visits to informative internet portals, as well as an exponential growth of communication on social networks. also, there is an increase in demand for streaming platforms, i.e. for video conferencing and online education (domazet, 2020). figure 3. measures taken or planned in response to the crisis in serbia source: usaid (2020) annual survey of 1.000 serbian businesses, https://saradnja.rs/wpcontent/uploads/2020/11/anketa-1000-preduze%c4%87a-2020..pdf companies are increasingly recognizing the importance of digital solutions for business improvement and see them as the primary response to the crisis (usaid, 2020). in the pandemic business environment, a significant number of smes were forced to adapt to online business. exactly, the best business results achieved companies that operate in sectors where this was possible. adaptation to digital business is also determined by the size of the company. compared to large ones, smaller organizations can more easily focus on online business. the visibility of small businesses, their products and services can be improved by applying certain solutions offered by modern information technology (lazarević-moravčević, 2019), especially in conditions of a pandemic crisis. factors limiting this transformation are the lack of financial and human resources, with state support playing a major role (vidas-bubanja, 2021). 34% 23% 17% 17% 9% opening new advertising channels digital marketing, etc. strengthening existing online business channels changes to the production algorithm or introduction of new product opening of new sales channels (introduction of electronic shops through web shop) opening new billing channels (online billing cards, etc.) marija lazarević-moravčević, sandra kamenković 49 therefore, it can be concluded that the sme sector has been significantly affected by the crisis. however, the consequences are less than expected thanks to the support measures taken by the state in order to maintain a certain level of business activity and employment. in the coming period, the performance of the sme sector will be determined by support measures, but also by the ability of companies to accept modern forms of business and investment. analysis of implemented economic policy measures in serbia during the pandemic since 2014, when fiscal consolidation measures were launched, most macroeconomic indicators in serbia have recorded a positive trend. fiscal consolidation lasted from the end of 2014 to the end of 2017, with the aim of reducing the fiscal deficit, which was 6.2% of gdp, as well as reducing the share of public debt in gdp, which amounted to 67.5%. the trend of reducing the deficit started in 2015, and in 2017 a surplus appeared. the share of public debt in gdp started to decline in 2017, and at the end of 2019, this indicator was at the level of 52.9% (ministry of finance, republic of serbia, public debt administration, quarterly report, december 2019). these reductions are actually very significant, because in the unplanned situation of the pandemic crisis, they gave space to the economic policy makers for the inevitable borrowing in order to mitigate the negative effects of the pandemic crisis. fiscal and monetary measures to mitigate the negative economic effects of the pandemic have been introduced in most countries around the world. in general, they can be grouped in 3 directions, tax policy measures, direct budget incentives measures and liquidity preservation measures. the first package of economic policy measures was adopted in april 2020, and the measures as well as the budget for them are presented in table 4. table 4. measures and budget in the first package of economic policy measures name of the measure amount in billion rsd 1. tax policy measures 161 1.1. postponement of payment of taxes on salaries and contributions for the private sector with the beginning of collection no earlier than 2021 (march-may 2020 or april-june 2020) 140 1.2. postponement of payment of advance income tax in the second quarter of 2020 21 2. direct assistance to companies for employees 97.3 2.1. direct assistance to entrepreneurs who are taxed at a flat rate and who pay real income tax, micro, small and medium enterprises in the private sector in the amount of 3 minimum wages (march-may 2020 or april-june 2020) 92.8 2.2. direct assistance to large companies in the private sector assistance in the amount of 50% of the net minimum wage for employees who are temporarily removed from work 4.5 3. measures for liquidity of the economy 264 3.1. support to the economy through the development fund of the republic of serbia 24 50 economic analysis (21, vol. 54, no. 2, 41-54) name of the measure amount in billion rsd 3.2. guarantee scheme to support the economy through banks 240 of which 25% state guarantee 20 4. other measures 86 4.1. moratorium on dividend payments until the end of the year, except for pes 16 4.2. payment of 100 eur to all adult citizens 70 total measures 608,3 source: ministry of finance of the republic of serbia the total value of economic support measures in the first package was slightly less than 610 billion rsd (which is about 11% of gdp), but it is important to note that the amount includes both public and private funds that are engaged. namely, in the part that refers to credit support to the economy through banks, out of 240 billion rsd, 60 billion rsd refers to state guarantees. when the difference is subtracted, the amount of 430 billion rsd is a burden on public finances, which is slightly less than 8% of gdp. having this in mind, the impact of economic measures is not the same on the budget deficit and public debt, i.e. the impact on public debt is, given the methodology of calculating public debt in serbia, 430 billion rsd, while the impact on the budget deficit is slightly less than 370 billion rsd (fiskalni savet, ocena antikriznog programa ekonomskih mera, 2020). from the first package, tax policy measures had the greatest impact on the budget result, and within them the dominant effect was the postponement of liabilities to the private sector for taxes on salaries and contributions, followed by payment of minimum wages to the private sector and then payment of 100 eur to adult citizens, and at the end the state guaranteed commercial bank loans. companies were allowed to postpone the payment of taxes and contributions on salaries and profit taxes, regardless of the company activity, but with the condition that the number of employees is not reduced by more than 10%, and that they do not pay dividends until the end of 2020. wage allowance included the payment of 100% of the minimum wage from the budget to sole traders and employees in micro, small and medium enterprises, as well as direct aid to large enterprises in the amount of 50% of the minimum wage paid to employees who are temporarily removed from work, but their employment continues after the state of emergency. tax policy measures, as well as direct assistance measures, were largely used and proved to be very expedient, as they prevented the sudden decline in the number of employees that was expected at a time when many activities had to completely stop the work process. the program of financial support to the economy took place through the two channels. the first channel involved loans granted by the state to enterpreneurs directly through the development fund of republic of serbia. the loans were intended for entrepreneurs, micro, small and medium enterprises and agricultural farms, and were approved for a period of 36 months with a grace period of one year. the maximum loan amount depended on the size of the company and ranged from 5 million rsd for entrepreneurs and micro companies, 25 million rsd for small companies, to 50 million rsd for medium-sized companies. the second channel involved lending to companies through commercial banks with a state guarantee for these loans. the same group of companies, entrepreneurs, micro, small and medium enterprises had the right to apply, with the maximum allowed loan amount of 350 million rsd. the purpose of the previously listed measures was to preserve production capacities and employment in the private sector, predominantly in the part of small and medium enterprises, and it can be stated that this purpose was achieved with the first package. marija lazarević-moravčević, sandra kamenković 51 in addition to the measures on the supply side, the state also envisaged a measure on the demand side, which included the payment of 100 eur to each adult citizen. the purpose of this measure was a fiscal stimulus to increase domestic demand. although 70 billion rsd were planned, considering the number of registered citizens, the implementation of this measure in the end cost 72 billion rsd, or about 610 million eur. since there were no funds available in the budget of serbia for this measure, it was financed by government borrowing. this measure was quite questioned, as it was non-selective, which was not the practice in other countries that implemented a similar measure. also, one of the arguments against this measure is that the problem with aggregate demand in serbia is not a consequence of lower purchasing power, but a consequence of the impossibility of population movement and thus the purchase of goods and services. also, another aspect of stimulating growth by increasing the income of citizens is emphasized in serbia, which is a small and open economy, the dominant part of the increase in income spills over to imported goods, leading to an increase in trade deficit, lower foreign exchange supply and foreign exchange market pressure. the second package of economic policy measures was adopted in july 2020 and included the postponement of the payment of taxes on salaries and contributions for the private sector for august 2020, then direct assistance to entrepreneurs who are taxed at a flat rate and who pay taxes on real income, micro, small and medium-sized enterprises in the private sector in the amount of 60% of the minimum wage (august-september 2020), as well as direct assistance to large enterprises in the private sector assistance in the amount of 50% of the net minimum wage for employees who are temporarily removed from work. the total value of this package was 66 billion rsd, or about 1.2% of gdp. bearing in mind that during july, and partly in august, the health situation deteriorated considerably, economic activity decreased, and these measures have a positive impact on maintaining production capacity and preventing the growth of unemployment, it can be stated that the measures in this package were completely justified. the third package of measures was actually a sectoral package, which was formulated in the form of subsidies to companies operating in the tourism industry. the package was in the form of two public calls and had a value of 1.6 billion rsd, or 0.03% of gdp. the first public call included grants to hotels in the amount of 350 eur per individual bed and 150 eur per accommodation unit, for all hotels in the private sector. the application deadline was september 15, 2020. the condition was that in the period until the end of 2020, the number of employees will not be reduced by more than 10%. the second call was intended for travel agencies, only to those who have a license, and the application deadline was december 4, 2020. according to the ministry of trade, tourism and telecommunications (2020), the third package was used by 312 hotels and 90 travel agencies. it can be stated that these sectoral measures were adequate because the sectoral analysis shows that the tourism sector was indeed the most endangered in terms of declining activity. these measures made it possible that, despite the sharp decline in activity, the decline in number of employees was not so sudden, which was the purpose of the measure. the fourth package of economic policy measures was adopted in february 2021. the package includes direct assistance in the form of payment of 50% of the minimum wage for 3 months (march-may 2021), for entrepreneurs, micro, small, medium, but this time also large companies. considering that it includes about 1.4-1.5 million employees in the private sector, the amount of 69.8 billion rsd is planned for the measure. in addition to this assistance, the food service and tourism sector, tourist guides and car rental agencies are provided with support in the amount of another entire minimum wage, for which 2 billion rsd are intended. sectoral assistance also includes the repetition of the measure from the previous package, a non-refundable aid for hotels in the amount of 350 eur per bed and 150 eur per accommodation unit, for which 1.7 billion rsd are allocated. this package also envisages support to the sector of passenger transport and road traffic, considering that according to the data from the annual report of the agency for business registers, this sector recorded the largest decline in net results 52 economic analysis (21, vol. 54, no. 2, 41-54) in 2020. the assistance includes the payment of 600 eur per month for each bus in a period of 6 months, and the total value of the measure is around 2.6 billion rsd. the measure of aid for 1.7 million pensioners of 50 eur costs 10 billion rsd, while all adult citizens will receive 30 euros twice, one payment was in may 2021, and the other is expected in november 2021. considering that in the previous package, about 6.2 million citizens applied for the measure of non-refundable aid, it is estimated that this measure will be worth about 43 billion rsd. in the sum these two measures, the one-time non-refundable aid costs over 50 billion rsd, or around 440 million eur. according to the statements from the ministry of finance, the packages of adopted measures are worth a total of 953 billion rsd, or about 8 billion eur. the measures implemented since the beginning of the pandemic can be declared as adequate. they were focused predominantly on the sme sector, which, as all analyzes show, was really the most endangered. if we analyze the sectoral assistance, the measures were also adequate in the sense that additional assistance was provided to the tourist trade, food service and transportation sectors, which, according to the business registers agency of republic of serbia, suffered the largest decline in activity and were therefore the most vulnerable sectors. the most contested measure is the one of one-time assistance to all adult citizens in the amount of 100 eur in 2020 and 60 eur in 2021, as well as one-time assistance to pensioners in the amount of 5000 rsd in 2020 and 50 eur in 2021. considering that borrowing is necessary for this measure, the position is that the measure of assistance to adult citizens should have been selective, in the sense that it should have been directed to socially endangered categories, who most needed help. also, in order to reduce additional government borrowing, it was possible to abandon some projects envisaged in the budget for 2021, which are not a priority at the moment, such as increased equipment of the security sector, financing the airport in trebinje, certain subsidies, and redirect that money in the envisaged economic measures. the main objection to the adopted measures is their non-selectivity. assistance to companies was the same for all companies, regardless of the achieved business results and the sector in which they operate, even though all data indicate that the sectors are affected differently. the nonselectivity of this measure has been partially corrected by additional assistance to particularly vulnerable sectors such as tourism and transport. the measure of the so-called helicopter money is especially non-selective, since all citizens received the same amount of money, although it is clear that it did not mean the same to everyone and that selective assistance to the most endangered categories would be significantly better. conclusion the covid-19 pandemic has brought radical changes to the lives of every individual and organization. many activities are stopped or restricted. a large number of organizations are forced to suspend or reduce business. the globally recession is certain, but the question remains how long it will take and how to mitigate the effects of the crisis. the crisis did not affect all activities and economic entities equally. data from the annual report of the business registers agency of the republic of serbia clearly show that the sectors of wholesale and retail, manufacturing, construction, information and communication, electricity, gas, steam supply and agriculture in 2020 in serbia performed significantly better than in 2019. on the other hand, the sectors that have suffered the largest decline in economic activity are transportation and storage, and accommodation and food service activities. it has also been proven that the size of a company determines its readiness to face a crisis. compared to large and medium-sized, small and micro companies showed greater sensitivity. their excessive sensitivity can be explained by the fact that this is the segment of the economy that is the least liquid and has the lowest credit rating. in addition, these companies mainly marija lazarević-moravčević, sandra kamenković 53 operate in the most affected sectors. they are financially constrained and have little opportunity to diversify their business. having in mind the previous fact, the economic measures adopted in serbia seem to be adequate. they were mostly intended for the sme sector, which proved to be the most vulnerable part of the economy. the measures included assistance through tax deferral, grants in the form of minimum wages and measures through more favourable lending in order to overcome the problem of illiquidity. also, measures that included additional assistance to certain sectors were also targeted towards the most affected sectors of transportation and accommodation and food service activities. another proof that the measures were adequate is the fact that despite a significant decline in activity, there was no significant decline in the number of employees in the serbian economy. the measures taken by the state can be considered effective because they have given immediate results. however, if we take into account the fact that the support implied high budget spending, the question arises whether the measures are justified and sustainable, especially assuming that the crisis can continue and generate long-term changes in market conditions. further recovery of the economy, especially the sme sector, will not be determined solely by the measures that the state plans to implement, but also by the ability of companies to adapt to the new business conditions. the paper also points out the fact that in the crisis period, all the benefits of online business have become significant. modern information and communication technologies have been recognized as one of the key factors for overcoming the difficulties faced by smaller organizations during the crisis. references agencija za privredne registre (2021). godišnji izveštaj o poslovanju privrede, available at: https://www.apr.gov.rs/upload/portals/0/gfi_2021/makroekonomska_saopstenja/godisnj i_izvestaj_o_poslovanju_privrede_u_2020.pdf agencija za privredne registre. 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(2020). “strategic responses to crisis”. strategic management journal, 41:7-18. article history: received: july 29, 2021 accepted: october 5, 2021 https://www.ien.bg.ac.rs/sr/black-swan-in-the-world-economy-2020/ https://documents1.worldbank.org/curated/en/965271619455150688/pdf/subdued-recovery-serbia-country-note.pdf https://documents1.worldbank.org/curated/en/965271619455150688/pdf/subdued-recovery-serbia-country-note.pdf https://www.intracen.org/uploadedfiles/intracenorg/content/publications/itcsmeco2020.pdf https://www.intracen.org/uploadedfiles/intracenorg/content/publications/itcsmeco2020.pdf https://www.imf.org/en/publications/weo/issues/2021/03/23/world-economic-outlook-april-2021 https://www.imf.org/en/publications/weo/issues/2021/03/23/world-economic-outlook-april-2021 https://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/documents/briefingnote/wcms_767028.pdf https://www.ilo.org/wcmsp5/groups/public/---dgreports/---dcomm/documents/briefingnote/wcms_767028.pdf http://www.javnidug.gov.rs/default.asp?p=128&menuitem= https://www.oecd.org/south-east-europe/covid-19-crisis-in-serbia.pdf https://www.oecd.org/south-east-europe/covid-19-crisis-in-serbia.pdf https://saradnja.rs/wp-content/uploads/2020/07/zajedno-kroz-krizu_pks-usaid-anketa-iii-faza.pdf https://saradnja.rs/wp-content/uploads/2020/07/zajedno-kroz-krizu_pks-usaid-anketa-iii-faza.pdf http://publikacije.stat.gov.rs/g2020/pdf/g202016015.pdf https://serbia.un.org/sites/default/files/2020-09/seia_report%20%281%29.pdf https://saradnja.rs/wp-content/uploads/2020/11/anketa-1000-preduze%c4%87a-2020..pdf https://saradnja.rs/wp-content/uploads/2020/11/anketa-1000-preduze%c4%87a-2020..pdf https://openknowledge.worldbank.org/bitstream/handle/10986/35647/9781464816659.pdf https://openknowledge.worldbank.org/bitstream/handle/10986/35647/9781464816659.pdf marija lazarević-moravčević, sandra kamenković 55 the impact of the covid-19 crisis on the serbian economy consequences and recovery marija lazarević-moravčević10f* | sandra kamenković2 introduction sectoral analysis of economic activity in serbia during the pandemic impact of the pandemic on performance sme sector in serbia analysis of implemented economic policy measures in serbia during the pandemic conclusion references ea_2014_3-4 udc: 336.226.14 005.52:330.143 jel: h25, h32, d92 cobiss.sr-id 211785228 original scientific paper corporate taxation and investment: the case of the split rate corporate tax system in macedonia gruevski ilija1, gaber stevan2, “goce delcev” university, faculty of economics, stip, macedonia abstract – the majority of experts agree that taxes are distortionary in nature. this is relatively true for all of the different groups of taxes, but for the corporate taxes is exceptionally obvious. the existence of the corporate tax system can affect the company’s behavior in number of ways and one of the most criticized is the ability for distortion of the choice of the sources of finance. in the following article, we explore the effects from corporate taxation on investment, through the methodological frame of the effective marginal tax rates. the objective is to analyze the investment decision in the case of isolated implementation of corporate taxes which means that the effects from the so-called “double taxation”, induced by the personal taxes are not taken in consideration. we hope to prove that these conditions generate “uneven” distribution of the burden across the projects covered with different sources of finance. also, we intend to test and explore the properties of some alternative corporate tax systems which are widely known as neutral, such as: the comprehensive business income tax system (cbit), the imputation corporate tax system (ict), the full imputation corporate tax system (fict), the allowance for corporate equity tax system (ace) and the split rate corporate tax system (srct). in addition, we support our findings with a practical example: the case study from the implementation of the split rate corporate tax system in macedonia key words: corporate income tax, taxation, cost of capital, effective marginal tax rate, corporate tax system, source of finance, debt, new equity issues, retained earnings introduction corporate taxation is very complicated matter if we consider the fact that the corporate tax base (i.e. the corporate income) cannot be limited only at the corporation observed as a form of a legal entity. usually, after the initial taxation at corporate level, corporate profits are distributed to the shareholders in a form of dividends, capital gains or interest payments, and are subject to additional taxation at personal level. consequently, the effects from corporate taxation, very often depend on the cross-effects from the personal taxation. but, regardless the interaction with the personal income tax, the process of corporate taxation on 1 ilija.gruevski@ugd.edu.mk. 2 stevan.gaber@ugd.edu.mk. gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 137 itself, might result with some interesting effects that can be described as distortive in nature (gruevski, 2013). it is very difficult to define tax distortion because of its complex nature, therefore it is desirable to be explained with reference to a neutral tax system.theoretically, a neutral tax system generates equal tax burden across the economic agents, without any tendencies to change the relative prices between factors of production. however, the overall implications of these distortions depend on the response of economic agents: a given tax system will have large distortionary effects on the economy (i.e. high deadweight losses or excess burden) when the elasticities of substitution are high and small distortionary effects when the elasticity of substitution is low (leibfritz, thornton,bibbie, 1997, pp. 91). there is strong evidence that all taxes are potentially distortive, but the majority of experts agree that the corporate tax has an exceptionally strong impact on the relative price of the capital, and therefore on the corporate firm’s finance and investment decisions. the corporate tax system can affect the company’s behavior in a number of ways. first, it influences the choice of the sources of finance. empirical studies confirm that high corporate tax rates could increase the cost of equity-financed investment because of the treatment of the interest payments as a deductible item on the tax base. consequently, that will reduce the total amount of equity-financed investment of the firm. also, there is evidence that certain types of taxation create a preference to more frequent use of retained earnings as a source of finance instead of equity (e.g. preferential tax treatment of capital gains over dividends; or taxation of capital gains upon realization). secondly, if the corporate tax system generates excessively high tax burden, than it can depress the overall investment activities in the domestic economy. in international context, corporations might trigger tax planning activities to shift taxable income from affiliates in high tax countries to affiliates in low tax countries. next, corporate tax can seriously affect market dynamics on mergers and acquisitions as well as the legal organizational form chosen by the firm. except these, there are many other examples of corporate tax influence on the company’s behavior. the focus of our analysis is the possibility of the system to create distortions of the choice of the different sources of finance. for example, it is commonly accepted that debt has privileged treatment as a source of finance, as a result of the usual and widely excepted treatment of the interest expenses. normally, since interest payments are tax deductible from the corporate tax base, the system subsidizes the debt source investment by reducing the discount rate. so, debt is considered as tax preferred as compared to equity. the last triggers unfavourable behaivour of the company, to use more borrowed capital, thus increasing the risk of bankruptcy and insolvency of the firm. similarly, retained earnings are more preferred to new equity issues since capital gains are usually taxed upon realization or eventually exempted from taxation when reinvested. this puts the old mature companies in superior position as they possess more abundant accumulated reserves, on the contrary to the young emerging enterprises (gruevski, 2013). there is some solid evidence that particular corporate income tax (cit) systems could relieve the corporate tax differences, as well, and produce a higher neutrality between debt and equity as opposite to the previous examples. according to the oecd (2007), the following tax systems are considered as neutral with abilities to effectively eliminate the difference between debt and equity: the full integration tax system (fit), the dual income tax economic analysis (2014, vol. 47, no. 3-4, 136-157) 138 system (dit), the allowance for corporate equity tax system (ace), the allowance for shareholder equity tax system (ase), the comprehensive business income tax (cbit) etc. for example, the fit system treats the corporation as a pass through entity and allocates all the corporate profit at shareholder level, where it is subject to taxation under the personal income tax. for the cit already paid on distributed profits, the stockholders will be granted with a tax credit in amount of the tax liabilities paid at corporate level. as a result, tax treatment between debt and equity will be ultimately equalized. another great example is the cbit system. this regime successfully eliminates the need for integration between the corporate and personal taxes on equity by restricting the possibility for deduction of the interest expenses. in fact, interest expenses are no longer deductible from the corporate income tax base and at the same time are exempt from taxation at personal level. the result is neutrality and indifference between debt and equity. similar effects are determined within the other tax systems mentioned above (oecd, 2007). “there are a variety of approaches that countries have adopted to try and alleviate this “double” taxation through the integration of the personal and corporate income tax systems” (devereux ,griffith, 1999, pp. 48). they are summarized in 3 different categories: imputation systems, classical systems and split rate system. essentially, the purpose of the imputation tax system is to effectively offset a portion (partly integrated tax system) or the entire corporate income tax (fully integrated tax system) levied on distributed profits against the shareholders tax liability. this could be realized in a form of tax credit of alternatively, in a form of tax exemption. under the classical tax system, distributed profits are taxed at corporate level and again at personal level, which means that there are no tax reliefs available. the third option is the split rate system, which implements two different (split) mandatory tax rates, one to distributed earnings, and the other to retained earnings. usually, there are 2 known different strategies concerning the split rate system. first, is the strategy to apply a lower rate on distributed profits which will serve to compensate for the personal tax paid on dividend income. this approach in the policy might restore neutrality between debt and external equity. the other strategy is to levy a lower split rate on retained accumulated earnings instead on distributed profits. the aim of this strategy is to generate incentives for reinvestment of retentions, and therefore, reduce the chances for their consumption in a form of dividend distributions. it is very common to the countries with consumption-based cit systems, for example, such as estonia and macedonia, as it stimulates savings and investment in corporations. across the system’s ability to equalize the treatment of debt and retained earnings, this strategy will additionally create preferences to retentions over external equity. the integration of corporate income tax and personal income tax could be found at the dividend relief system (alternatively, the dividend deduction system), which can take 2 forms: the dividend relief system at shareholder level; and the dividend relief system at corporate level (cnossen, 1993). the first one resembles to the imputation tax system, and it’s designed for reduction of the burden on equity-financed investment for the resident shareholders. the second concept permits partial or full deduction of the gross dividends paid from taxable corporate profits (the corporate tax base). this will have strong impact on the foreign investors as it leaves them to escape from taxation in the source country. as a gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 139 result, foreign investors benefit from the dividend relief system at corporate level, ultimately inducing foreign investment in the host country (oecd, 2007). in the following text, we explore the potential (theoretical) effects from corporate taxes on investment through the methodological frame of the effective tax rates. since the research is more focused on the allocation criteria, it is recommended that the measurements should be expressed at marginal level and should include the methodology of the effective marginal tax rate. the general intention is to analyze the investment decision in the case of isolated implementation of the corporate taxes, which implies a condition of total abstraction of the personal taxes3. we hope to prove that these conditions generate “uneven” distribution of the burden across the projects covered with different sources of finance. also, the intention is to analyze the effects from the implementation of previously mentioned corporate tax systems. here we consider the following: the comprehensive business income tax system (cbit), the imputation corporate tax system (ict), the full imputation corporate tax system (fict), the allowance for corporate equity tax system (ace) and the split rate corporate tax system (srct). hopefully, this will contribute to the full picture of the effects from the process of taxation on investment at corporate level (gruevski, 2013). basic methodological framework most of the authors agree that the best way to evaluate the effects from taxation on investment is through measurement of the effective marginal tax rate (emtr). the measurements of effective tax rates may not be straightforward, but since the incentive for additional investment is function of the marginal tax rate, thisrequires a precise definition of the margin involved (king,fullerton4, 1984). in that context,the marginal investment is established as: “a small increase in the level of real investment in the domestic nonfinancial corporate sector, financed by an increase in the savings of domestic households” (king and fullerton, 1984, pp. 8). they propose the effective marginal tax rate as a ratio between the tax wedge and the pre-tax rate of return: (1) constructed as it’s shown, the emtr determines the share of return on a marginal unit of investment which is cut by taxation. actually, emtr represents a relevant indicator of the system’s efficiency properties as it determines the extent of the available incentives built in the system. the most important component of the emtr is term (p~ – s) which is also called “tax wedge” and it is an expression of the difference between the preference to invest and the preference to save. this term (the total tax wedge) can be divided into 2 parts: a) the investment tax wedge and b) the savings tax wedge. (leibfritz, thornton and bibbie, 1997). the second term is measured as (r – s) and it represents the effective tax burden on the saver’s income. the first term which is crucial for our analysis is measured as a difference 3this condition ignores the effect from the “integrated double” taxation. as a result, measurements of the effective corporate tax burden are expressed usually, at corporate level. 4thebasicstudyonmarginaleffectivetaxrateswas performed bykingandfullerton (1984). because of its explicit theoretical foundations it’s considered as a pioneer methodology in this field. p sp emtr ~ ~ − = economic analysis (2014, vol. 47, no. 3-4, 136-157) 140 between the investor’s rate of return before taxes (the cost of capital) and the real interest rate (p~ – r) and it’s an expression for the effective tax burden on the investor’s (or company’s) capital income. depending on the relation between p~ and r, we can distinct 3 different conditions. the first condition is when the effective tax burden is positive (p~> r) and as a result of that, the tax system depresses the investment activities.the second one is when the effective tax burden is equal to 0 (p~ = r), when the tax system is neutral to the investment decision. the third and the most preferrable condition from the investor’s point of view is when the effective tax burden is negative (p~< r), when the tax system supports the overall investment. in perfect economies without presence of taxes, the cost of capital is identical with the real interest rate (p~= r) and the economic agents are completely indifferent between the investment decision and the decision to save. the existence of the national tax system diverges the difference between the cost of the capital and the interest rate and therefore creates a positive tax wedge (p~> r). identical concept of the emtr is also advocated by devereux and griffith (1999, 2002, 2003). the methodology developed by devereux and griffith extended the already existing concept proposed by king and fullerton, which resulted in a standardized methodology accepted by the most economic organizations and institutions.the effective marginal tax rate on corporate income is defined identically as previously mentioned, where p~is the cost of capital (pre-tax rate of return on investment) defined as: δ πγ ρ π ππδρ − −+ + − −+ −++− = )1)(1( )1( )1)(1( })1(){1(~ t f t a p (2) where: symbol t is the corporate income tax rate; symbol ρ is known as the shareholders discount rate, which in absence of personal taxes generates value equal to the nominal interest rate (ρ = i); symbol π is the inflation rate in the curent period; symbol a is the net present value of tax depreciation allowances; symbol δ is the economic (true) depreciation rate; symbol γ is the tax discrimination variable developed to measure tax discrimination between new equity and distributions. if we consider md to be the personal tax rate on dividend income, z the effective personal tax rate on capital gains andc the tax credit rate allowed for dividends paid, then: )1)(1( )1( cz m d −− − =γ (3) under the condition of absence of the personal taxes, and if the tax credit rate is zero (z = md = c = 0) this variable yields of 1 (γ = 1); and, symbol f from the expression above represents the financial constraints variable and its value depends from the source of finance. according to devereux and griffith (1999), if the project is financed by reinvestment of retained earnings, the financial constraints variable fre gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 141 will always generate value of zero (fre = 0). if the project is financed through new equity issues, than the financial constraints variable fne is measured as: )1( )1( ρ γρ + − −=nef (4) but since the value of tax discrimination variable is 1, this implies also that fne = 0 (fne = fre = 0). if the firm borrows external debt (bonds or bank loans) to finance its project, than, in that case the financial constraints variable fde is measured as: )1( )1( )1( )]1([ ρ ρ ρ ργ + −− = + −− = titi f de (5) in order to simplify the calculation for the purpose of better illustration of the effects, we propose some simple, but very useful assumptions. for example, if the net-present value of depreciation allowancess is asumed 0 (a = 0), there is no inflation in the economy (π = 0, ρ = r), the rate of economic depreciation is assumed to be 0 (δ = 0) and there is always positive real interest rate (r > 0), than expression [2] for the cost of capital will automatically transform to: )1( )1( )1( ~ t rf t r p − + − − = (6) and expression [5] for the financial constarints variable fde will obtain value of: )1()1()1( )1( r rt r rtrr r trr f de + = + +− = + −− = (7) in the following section we use these analytical components to calculate and investigate the effects from the implementation of corporate taxes on the economic performance of the firm. (gruevski, 2013). theoretical effects of corporate taxes on investment it must be noticed once again, that the measurements of the effective tax ratesare expressed only at corporate level, under the assumption of ignorance of the personal taxes. first, the usuall, common treatment of investment will be presented, in order to determine the effects from the most common tax practicies. than, the effects from the implementation of the comprehensive business income tax system (cbit), the imputation corporate tax system (ict), the full imputation corporate tax system (fict), the allowance for corporate equity tax system (ace)and the split rate corporate tax system (srct) will be analyzed additionally. the usuall, most common treatment debt. lets analyze the case of debt finance investment. for example, if the project is financed with debt, than the most common practice allows the corporation to deduct the economic analysis (2014, vol. 47, no. 3-4, 136-157) 142 interest payments from its corporate tax base. this means that the value of financial constraints variable fde from expression [7] will occur in expression [6] for the cost of capital: r t tr t rt t r t r r rt t r t rf t r p = − − = = − − − = − + + − − = − + − − = )1( )1( )1()1()1( )1( )1( )1()1( )1( )1( ~ (8) from here, it is easy to determine the value of the investment tax wedge: 0~ =−=− rrrp (9) this indicates on the fact, that when the investment project is financed with external debt, the corporate tax system is neutral to the investment decision. new equity issue and retained earnings. since the tax discrimination variable γ is equal to1, this implicates identical values of the financial constraints variables in the cases when the project is covered with new equity issues and retained earnings (fne = fre = 0). this will result with elimination of the second term of expression [6], thus generating value for the cost of capital of only: )1( ~ t r p − = (10) if term [10] is integrated in term [9], than the investment tax wedge will generate value of: )1()1()1( )1( )1( )1( )1()1( ~ t rt t rtrr t trr t t r t r r t r rp − = − +− = − −− = − − − − =− − =− (11) the result implicates that there is a positive tax burden on corporate income in every case of equity financed investments. actually, this is the exact reason why, it is thought for the corporate income tax to be a “tax on the return on equity”. simply, since interest payments are in fact tax deductible from the corporate income tax base, debt source of finance is considered as tax preferred as compared to the equity source of finance. the key factor influencing this condition is called „tax shield“ effect seen in term rt from expression [7]. actually, the system subsidizes the debt source investment by reducing the cost of capital in proportion of the value of this previousely described effect. the value maximizing firm will frequently tend to use more borrowed capital as part of its strategy for optimization of the capital structure, but in terms of the economic efficiency, this is a classical distortion because it increases the risk of bankruptcy and insolvency of the firm (gruevski, 2013). comprehensive business income tax system (cbit) the question which is raised here is: “what might the authorities do, to eliminate this equity-debt related distortion and to equalize the treatment between debt and equity”. one of the answers is to implement the so-called “comprehensive business income tax system gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 143 cbit”. actually, this system successfully eliminates the need for integration between the corporate and personal taxes on equity by restricting the possibility for deduction of the interest expenses. in fact, interest expenses are no longer deductible from the corporate income tax base. “the corporation is therefore indifferent between debt, newly issued equity and retained earnings as source of finance of its investment under the cbit” (oecd, 2007, pp. 89). since deductions of interests are not allowed, all the positive effects are effectively eliminated from term [6]: rt = 0. as a result, the value of fde will generate value of zero (fde = fre = fne= 0), thus equalizing the tax treatment between the different sources of finance. (gruevski, 2013). imputation corporate tax system (ict) another great example for neutral corporate tax system is the so-called “imputation corporate tax system ict”. basically, “with an imputation system of corporation tax, part of the company's tax bill is imputed to the stockholders” (king and fullerton, 1984, pp. 22). if c is considered to be the tax credit rate (or the rate of imputation), than the tax discrimination variable in absence of the personal taxes will be rewritten as: )1( 1 c− =γ (12) this will have certain implications on the other relevant variables, such as the cost of capital, where in expression [6], the tax discrimination variable γ will reappear: )1( )1( )1( ~ t rf t r p − + − − = γ (13) now, let’s analyze the effects on the different alternative investments. debt source of finance. the financial constraints variable for the investments financed with external debt under the conditions of the imputation tax system is calculated as: )1()1( ][ )1( )]1([ r rt r rtrr r trr f de + = + +− = + −− = γγγ (14) if term [14] is imputed in expression [13], the result for the cost of capital will be: r t tr t rt t r t r r rt t r p = − − = − − − = − + + − − = )1( )1( )1()1()1( )1( )1( )1( ~ γ γ (15) from here, if the investment tax wedge is calculated, it is obvious that the ict system does not generate any other signifficant effect for the investments covered with debt: 0~ =−=− rrrp (16) new equity issues: since γ has value different from 1, the financial constraints variable in case of investment supported with new equity issues is measured as: economic analysis (2014, vol. 47, no. 3-4, 136-157) 144 )1( )1( r r f ne + − −= γ (17) inserting the term [17] in the expression [13], the cost of capital will generate value of: γγ γγ γ γ γ γ γ γ γ γ )1()1()1( )1( )1( )1( )1( )1()1( )1( )1( )1( )1( ~ t r t rrr t r t r t r t r t r r r t r p − = − −+ = − −− − − = = − −− − − = − + + − − − − = (18) for the value of the tax discrimination variable from expression [12], the cost of capital will transform to: )1( )1( )1( )1( )1( 1 )1( ~ t cr c t r c t r p − − = − − = − − = (19) and the investment tax wedge to: )1( )( )1( )1()1( )1( )1( )1( )1( )1(~ t ctr t rcrt t rtrrcr t tr t cr r t cr rp − − = − − = = − +−− = − − − − − =− − − =− (20) this means that the corporate tax burden on the investments financed with new equity issues, under the conditions of this system depends from the interrelation of the corporate income tax rate t and the rate of imputation c. also,it indicates on the negative correlation between the tax burden and the imputation rate. as a conclusion, corporate systems with higher degree of imputation will support investments covered with new equity issues. retained earnings. it is very interesting that in this particular case, the imputation tax system does not generate any additional effect. because, the financial constraints variable for the alternative financed with retentions is always zero (fre = 0), the result for the investment tax wedge is identical as the one from expression [11]. if the last three 3 alternatives are compared, it can be noticed that the imputation system is effective only for the second one. so, it is especially designed for alleviation of the burden for the projects primarily financed with equity issues (gruevski, 2013). full imputation corporate tax system (fict) in theory, this system treats the corporation as a pass through entity and allocates all the corporate profits at the shareholder level, where it is subject to taxation under the personal income tax. “under full integration (full imputation), all corporate earnings – distributed dividends, retained profits and interest payments – are allocated to shareholders and bondholders and are taxed at the personal level at the personal income tax rate” (oecd, 2007, pp. 86). actually this system represents another variant of the imputation corporate tax gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 145 system, where the imputation rate c (or the available tax credit rate) is equal to the tax liabilities paid at corporate level t (c = t): )1( 1 )1( 1 tc − = − =γ (21) it is already mentioned that these systems (the imputation systems) do not affect the investment financed with debt and retentions. consequently, the results for these investment alternatives are the same as in the previous section. yet in the following paragraph we present the analytical proof only for the alternative with new equity issues. new equity issues. if the conditions for the fict (c = t) are implemented, the investment tax wedge from expression [19] will become: 0 )1( )( )1( )(~ = − − = − − =− t ttr t ctr rp (22) this implies on the conclusion that the fict system effectivelly removes the tax differences between external equity (new equity issues) and debt and at the same time favours external equity instead of retentions (gruevski, 2013). allowance for corporate equity tax system (ace) another alternative is the allowance for corporate equity tax system proposed by michael devereux andharold freeman (1991) and by the institute for fiscal studies (1991). “under the ace system companies are allowed to deduct an imputed normal return on their equity from the corporate income tax base, parallel to the deduction for interest on debt“(michael devereux and peter birch sorensen, 2006, pp. 34). this „symetric“ approach in corporate taxation, should ultimetelly ensure neutrality between debt and equity. the experts suggest that prefferably, the allowance on the corporate income tax base should equal the nominal interest rate. according to them, this should allow for the normal return on equity to remain tax free, while the pure rents and exstra profits should stay within the channels of taxation. for example, it is very interesting that croatia has already tested this form of corporate income tax in practice, in the period from 1994 to the beginning of 2001. „the imputed rate of return to equity, denoted as „protective interest“ (pi), was equal to 5 per cent plus the rate of increase of industrial product prices“ (devereux and sorensen, 2006, pp. 36). in the following text, the effects from the implementation of this system are explored. debt. when the investment project is financed with external debt, the corporate tax system under the ace regime remains neutral to the investment decision. this means that the investment tax wedge will generate value of 0, since interest payments are deductible from the tax base. new equity issue and retained earnings. it was already mentioned that the usuall, normal treatment of the return on equity, always results in a positive value of the investment tax wedge, as presented in expression [10]. with the introduction of the ace system, companies will be allowed to deduct (or reduce) the normal return on equity from their corporate profit tax base. it is thought that the nominal interst rateis a true representation of the normal return on equity, but in our case, that would be the real interest rate r, since the economic analysis (2014, vol. 47, no. 3-4, 136-157) 146 inflation rate is assumed to be 0. so, the process of deduction of r from the corporate base decreases the corporate tax liability of the firm for the value of rt.5 if the shareholders discount rate (in this case r) is adjusted for the value of the generated tax benefit, it can be measured as: r – rt = r(1 – t), and if this is integarted in expression [9], for the cost of capital it could be written: r t tr p = − − = )1( )1(~ (23) once again producing a value for the investment tax wedge of zero. to conclude: introducing the ace system effectively removes the tax differences among debt and equity, and produces neutrality similarly to the cbit system. but, unlike the cbit system which lifts the smaller, zero wedge of debt finance, equilizing it with the higher positive one of equity finance, the ace system does the aleviation in reverse direction. actually, it lowers the positive wedge of equities, bringing it to zero wedge level of debt finance investment. split rate corporate tax system (srct) another option for alleviation of the corporate income tax burden is the split rate corporate tax system – srct. “under a split rate system there are 2 different statutory tax rates, one that applies to retained earnings, the other to distributed earnings” (devereux, griffith, 1999, pp. 48). tax authorities might choose between the 2 different strategies concerning the split rate system. first, is the strategy to apply a lower rate (alternatively zero rate) on distributed profits which will serve to compensate for the personal tax paid on dividend income. the other strategy is to levy a lower split rate (optionally zero rate) on retained accumulated earnings instead on distributed profits. in the following section, the effects from the alternative strategies described above are additionally analyzed. taxation of distributions, retained profits exempt from taxation (td, t = 0).the first option is the strategy of taxation of distributed profits with retained profits exempt from taxation, which implies the condition of (td, t = 0). the implementation of the terms of this condition generates value for the tax discrimination variable of: )1( )01( )1( )1( )1( d dd t t t t −= − − = − − =γ (24) and adequatelly, different value for the cost of capital: )1( )1( )01)(1( )1( )01()1( )1( )1( ~ dd t rf r t rfr t rf t r p − + −= −− + − − = − + − − = γ (25) 5as it can be seen, this benefit for the company is similar to the previous “tax shield” effect, but unlike the case of debt finance investment, where its presence is in the financial constraints variable, here in the case of equity finance investment, it occurs directly within the cost of the capital, through the shareholder’s discount rate. gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 147 in practice, republic of macedonia and estonia already have an experience with this variant of split corporate tax system. the aim of this strategy is to generate strong incentives for reinvestment of retained profits, and reduce the chances for their consumption in a form of dividend distributions. now the effects on the different investment alternatives are compared, to see if the previous thesis can be properly confirmed. debt. the financial constraints variable for investments financed with debt under the conditions of the split tax system (td, t = 0) is calculated as: 0 )1( )]01([ )1( )]1([ = + −− = + −− = r rr r trr f de γγ (26) for the cost of capital as: rr t r r t rf rp dd =−= − + −= − + −= 0 )1( )1(0 )1( )1(~ (27) and for the investment tax wedge: this is an obvious confirmation that even the split rate system that allows taxation of distributed profits and at the same time exempts the retained profits, will not affect the neutral position of the external debt as a source of finance. retained earnings (fne = fde = 0). since fne = 0, then the result for the investment alternative financed with retained earnings is identical with the case of debt finance investments. new equity issues. similarly, since γ has value different from 1, the financial constraints variable in case of investment financed with new equity issues is measured as: )1( )1( r r f ne + − −= γ (29) if the value of tax discrimination variable from expression [24] is considered, than: )1()1( )11( )1( )]1(1[ )1( )1( r rt r tr r tr r r f dddne + −= + +− −= + −− −= + − −= γ (30) by inserting it in expression [25], the cost of capital will obtain value of: )1()1()1()1( )1( )1()1( )1( )1( )1( )1(~ dd dd d d d d d d d d d t r t rtrtr t rt t t r t rt r t r r rt r t rf rp − = − +− = − − − − − = = − − −= − + + − −= − + −= (31) and the investment tax wedge: economic analysis (2014, vol. 47, no. 3-4, 136-157) 148 )1()1()1( )1( )1()1( ~ d d d d d d dd t rt t rtrr t t r t r r t r rp − = − +− = − − − − =− − =− (32) an interpretation can be given to the previous that this variant of the split rate system (td, t = 0), generates a positive tax burden on the investment financed with external equity which depends generally from the corporate tax rate applied on distributed profits td. with this approach in the tax policy, the authorities try to “convince” the investor not to distribute the profit, but to reinvest it, since the tax burden for the second alternative is significantly lower. also, this approach in the policy restores the neutrality between debt and retained earnings. taxation of retained profits, distributions exempt from taxation (td = 0, t).the second option is the strategy of taxation of retentions (retained profits) with profit distributions exempt from taxation, which in this case implies the condition of (td = 0, t). the implementation of the terms above, generates value for the tax discrimination variable of: )1( 1 )1( )01( )1( )1( ttt t d − = − − = − − =γ (33) and once again, adequatelly, there is different value for the cost of capital: )1( )1( )1( )1( 1 )1( )1()1( )1( )1( ~ rf t r t t rf t r t rf t r p +− − = − − + − − = − + − − = γ (34) many of the developed countries, especially the ones with excessively high tax burden, such as germany and japan, very often used or use this variant of split rate taxation, as an appropriate method for compensation of the personal tax levied on dividend income. additionally, the effects from its implementation are given for every investment alternative. debt. the financial constraints variable for investments financed with external debt under the conditions (td = 0, t) is measured as: )1)(1()1( )1( ][ )1( )1( )]1([ )1( )]1([ )1( 1 )1( )]1([ rt rt r t rtrr r t trr r trr t r trr f de +− = + − +− = = + − −− = + −− − = + −− = γ (35) by integrating the value for fde in expression [34] for the cost of capital, the result will be: r t tr t rtr r rt rt t r rf t r p = − − = = − − =+ +− − − =+− − = )1( )1( )1( )1( )1)(1()1( )1( )1( ~ (36) and for the investment tax wedge: gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 149 0~ =−=− rrrp (37) once again, it has been proved that the neutral position of the external debt as a source of finance is unaffected by the process of corporate taxation in absence of personal taxes, regardless the implemented type of corporate tax system. new equity. if the value of tax discrimination variable from expression [33] is considered for the purpose of calculation of the financial constraints variable fne, it will result in: )1)(1()1)(1()1( )1( )1( )1( )11( )1( ] )1( 1 )1( )1( [ )1( ] )1( 1 1[ )1( )1( rt rt rt rt r t rt r t t r r tt t r r t r r r f ne +− = +− − −= + − − −= + − −− −= = + − − − − −= + − − −= + − −= γ (38) this result from the calculation clearly indicates on the identical values between the financial constraints variablefdeand fne (fde = fne). consequently, a total identity will be established between the values of the investment tax wedge p~– r, for the investment alternatives financed with debt and new equity issues. retained earnings. in this alternative, since fre = 0, then the value of cost of capital will become: )1( )1(0 )1( )1( )1( ~ t r r t r rf t r p − =+− − =+− − = (39) and the one for investment tax wedge: )1()1()1( )1( )1( )1( )1()1( ~ t rt t rtrr t trr t t r t r r t r rp − = − +− = − −− = − − − − =− − =− (40) if a conclusion is made from the implementation of the split rate system with the terms of taxation of retained profits and exemption of distributed profits (td = 0, t) it will indicate that this variant generates a positive tax burden on the investment financed with retentions. with this approach in the tax policy, the authorities actually equalize the treatment between debt and new equity with intention to deliver a certain compensation for the excessive tax burden levied on dividend distributions (gruevski, 2013). table 1 from below, presents the summary of the analyzed effects and conclusions. economic analysis (2014, vol. 47, no. 3-4, 136-157) 150 table 1. the effects from corporate (business) taxation on investment performance (only corporate taxes) the usuall, normal treatment investment tax wedge (p~ r) debt 0 newequity issues )1( t rt − retained earnings )1( t rt − coprehensive business income tax system (cbit) debt )1( t rt − new equity issues )1( t rt − retained earnings )1( t rt − imputation corporate tax system (ict) debt 0 new equity issues )1( )( t ctr − − retained earnings )1( t rt − full imputation corporate tax system (fict) debt 0 new equity issues 0 retained earnings )1( t rt − allowance for corporate equity tax system (ace) debt 0 new equity issues 0 retained earnings 0 split rate corporate tax system (srct) taxation of distributed profits, retained profits exempt from taxation (td, t = 0) debt 0 gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 151 new equity issues )1( d d t rt − retained earnings 0 taxation of retained profits, distributed profits exempt from taxation (td = 0, t) debt 0 new equity issues 0 retained earnings )1( t rt − source: summary and review of authors’ calculations case study: the split rate corporate tax system in macedonia one of the main priorities for the macedonian tax authorities was the determination to redesign the corporate tax system and to create a consumption-based corporate income tax, which is strategically known to be more developing oriented corporate income tax. practically, this strategic approach means that the corporate income tax burden is excessively targeted to its shares that are intended mostly for consumption, while the parts of income whose purpose is to be saved or reinvested are generally levied with lower burden or eventually exempted from taxation (manfred rose and rolf wiswesser, 1998). with other words, the purpose was to effectively switch or redirect the tax incidence from the company to the burden of the shareholder. motivated by the chronic deficit of capital, the authorities made some very simple, but above all brave solution: they introduced the so-called “split rate corporate tax system – srct” in 2009. from all of the european countries at that time, only estonia and macedonia were experiencing the same theoretical concept and the same modality of the corporate income tax system: it was the taxation of distributions, retained profits exempt from taxation (td, t = 0). originally, themeasure was called “tax exemption on undistributed earnings” and it was basically intended to createincentives for reinvestment of the profits. precisely, all the retentions were exempted from the corporate income tax, while the distributions of the profit were taxed with the regular corporate income tax rate of 10%. we must notice that there were other reforming measures, such as the implementation of the flat tax rates on corporate income and personal income tax base (from 15% in 2006 to 12% in 2007 and to 10% in 2008), but here, we don’t give much attention on them, because they are more relevant from the shareholder’s point of view.despite the fact that the economic crisis gained on intensity in the following years, the government didn’t change its tax policy course, and no other significant tax code alterations have been done after 2009. in the following text we evaluate the effect from the tax code derogations, focused on the introduction of the scrt system in the period from 2006 to 2013, with the help of the methodology of emtr. first, we present the effects on the tax discrimination variable, since it’s the basic indicator of the tax preference between the external equity and the retentions. economic analysis (2014, vol. 47, no. 3-4, 136-157) 152 then, we present the calculated values of the cost of capital and the emtrs according to the sources of finance.6 as it is already noted, one of the most important variables is the tax discrimination variable γ, which is used to measure tax discrimination between new equity and distributions. in 2006, the imputation corporate tax system was in force in macedonia, allowing a tax credit or alternatively, an imputation rate on dividend distributions in amount of 50% from the personal income tax liability on dividend income. considering that the adequate tax rate in 2006 was established at 15%, the effective tax credit rate c was equal to 0,075 (0,15 * 0,50 = 0,075). so, the implications on the tax discrimination variable in 2006 are the following: 0811,1 925,0 1 )075,01)(01( )01( )1)(1( )1(2006 == −− − = −− − = cz m d γ (41) it is obvious that the value of γ is higher than 1, indicating on the generated tax preferences to new equities over retentions. after that, the imputation corporate tax system was abolished, since the authorities banned the possibility for the tax credit. in the circumstances of absence of personal taxes and the tax credit (z = md = c = 0), the tax discrimination variable automatically yields value of 1 (γ = 1).in macedonia, this was a case in 2007 and 2008: 1 )01)(01( )01( )1)(1( )1(2008,2007 = −− − = −− − = cz m d γ (42) this means that in this period, the corporate tax system was neutral between the two different forms of equities. then, in 2009 the split corporate tax system was introduced, and the value for the tax discrimination variable was altered once again. since retained profits are not taxed (t = 0) and corporate profits are taxed only when they are distributed with 10% tax rate (td=0,1), the parameter γ for the period 2009 to 2012 is calculated as: 9,01 )01( )1,01( )1( )1( 200820132009 = − − = − − =− γγ t t d (43) the value of the tax discrimination variable, which is less than 1, is confirmation to the fact that the system favors the retentions over the external equity.now, it’s time to compare the facts trough concrete numbers: the values of the cost of capital and the emtrs for the different financial alternatives. table 2 from below, shows the estimated values of the cost of capital in macedonia in the period 2006-2013. as a general rule, this indicator is important because it reflects the optimal size of an investment. the results indicate that in every case of investment financed with 6we must notice that these calculations are made according the assumptions of the devereux & griffith approach and the relevant tax code parameters in macedonia, which include all the elements from expression 2. therefore, the actual results might differ from the theoretical values, because much of these elements were assumed abstracted during the theoretical analysis. gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 153 retained earnings and new equity issues, the cost of capital is higher or equal to 5%, which is the initial assumed level of the real rate of return. in the case of retained earnings, the highest value of 5,93% is measured in 2006, while the lowest of only 5,02% in the period 2009 to 2013. on the contrary, the projects financed with external equity register their lowest value of 5,30% in 2006 and the highest of 5,79% in 2009 to 2013. this “switch” in the tendencies of the cost of capital between new equities and retentions is mainly due to the substitution of the previous imputation tax system with the split rate system. also, it is clear that in 2007 and 2008, identical values are registered for the cost of the capital for both of the cases, indicating on the neutral position of the corporate system, which is in accordance with the theoretical findings (gruevski,gaber, 2013). table 2. the cost of capital in macedonia, 2006-2013 (%) the cost of capital (p~) 2006 2007 2008 2009/2013 retained earnings (mean) 5,93 5,73 5,59 5,02 new equity issue (mean) 5,30 5,73 5,59 5,79 debt (mean) 4,70 4,77 4,82 5,02 overall mean: 5,31 5,41 5,33 5,28 source: authors’ calculations estimated values of the effective marginal tax rates are presented in table 3.the significance of this measure is seen in the fact that the allocation efficiency of the system depends largely on the effective marginal tax burden levels. therefore, emtr is appropriate for measuring of the extent of the available incentives built in the system. concerning the results of the emtrs by source of finance, a similar condition can be generalized as in the previous case of the cost of capital. basically, investments with retained earnings and new equity issues generate positive values of emtrs. positive values of emtrs indicate that the cost of capital for these investments is higher than the real rate of return, meaning that in these cases there is a positive taxation on the marginal unit of investment. for example, for the investments covered with retained earnings, the highest value of 15,58% is registered in 2006, and the lowest of only 0,39% from 2009 to 2013. the projects financed with new equity issues measure their lowest value of 5,58% in 2006 while the highest of 13,66% in 2009 to 2013. once again, this confirms the change in tax treatment between external equity and retained earnings. until 2006, a priority was given to the development of the stock market, which was supported with adequate tax measures. for example, companies were “encouraged” to actively participate in the capital market with the implementation of the imputation tax system. a tax credit on dividend distributions was allowed to effectively lower the corporate tax burden on new equity issues for stimulation of the market expansion. in the next period, the tax policy course was altered once again when the imputation system was abolished in 2006 and the split rate system was introduced in 2009. this time investment and economic growth took more importance because the split rate system stimulates the process of reinvestmentof the profit. in the same context, it is obvious that the marginal tax rates between debt and retained earnings are effectively equalized in the period from 2009 to 2013 (0,39%). obviously, this effect is once again due to the implementation of the split rate system under the conditions that require taxation of distributed profits and exemption of economic analysis (2014, vol. 47, no. 3-4, 136-157) 154 retained profits. the last fact is prove that theory has found an empirical confirmation in the practice, because this system is known for its abilities for alleviation of the effective tax burden between these two alternative sources of finance (gruevski, gaber, 2013). table 3. effective marginal tax rates in macedonia, 2006-2013 (%) emtrs 2006 2007 2008 2009/2013 retained earnings (mean) 15,58 12,62 10,54 0,39 new equity issue (mean) 5,58 12,62 10,54 13,66 debt (mean) -6,57 -4,88 -3,75 0,39 overall mean: 4,86 6,78 5,77 4,81 source: authors’ calculations in addition to the basic analysis, we present the trend lines and the international comparison of the emtrs in the observed period as well. the trends are illustrated in figure 1, and the comparative analysis in figure 2. figure 1. emtrs by source of finance in macedonia, 2006-2012 source: authors’ calculations figure 2. emtrs and cit rate by country, 2012 (%) source: authors’ calculations, the centre for european economic research (zew), 2012 15.58 12.62 10.54 0.39 0.39 0.39 0.39 5.58 12.62 10.54 13.66 13.66 13.66 13.66 -6.57 -4.88 -3.75 0.39 0.39 0.39 0.39 4.86 6.78 5.77 4.81 4.81 4.81 4.81 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 2006 2007 2008 2009 2010 2011 2012 emtrs by source of finance retained earnings new equity issue debt overall mean linear (retained earnings) linear (new equity issue) 0 10 20 30 40 50 e st o n ia b e lg iu m b u lg a ri a c ro a ti a c ze c h r e p u b li c it a ly r o m a n ia s w it ze rl a n d ir e la n d d e n m a rk h u n g a ry a u st ri a f in la n d g e rm a n y c a n a d a u n it e d k in g d o m s p a in ja p a n emtrs by country emtr (mean) cit rate gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 155 it is clearly seen that the trend lines for debt and external equity are lightly upward slopping while the retentions manifest strong decreasing tendencies. the synergetic effect from this results in a slight downward slopping trend line for the overall emtr by source of finance, meaning that the overall tax burden is decreasing over time. on the other side, the comparison between the estimated overall values of emtrs in 2012 shows that macedonia belongs to the group of countries with extremely low effective marginal tax burden, positioned on the 4th place from the observed group of countries, with emtr of 4,81%. this means that the statutory corporate tax rate which is officially 10% is more than twice lowered resulting in an effective tax rate of 4,81%. lower emtr demonstrate only belgium with 4,7%, latvia with 4,2% and estonia with the lowest 3,6%. the other countries have significantly higher emtrs mostly ranging from 10% to 20%, and on the bottom of the list, with highest values of emtrs are positioned spain with 33,2%, usa with 34,3% and japan with exceptionally high 42,1%. decreasing values of the indicator in the observed period, as well as the comparatively low emtr, represent a clear picture of the determination of the macedonian tax authorities to improve the overall conditions of the business environment for investment (gruevski,gaber, 2013). conclusions this article firstly explores the theoretical effects that arise from the isolated implementation of corporate taxes with the help of the marginal analysis. with an appropriate application of its analytical components, we investigated the investment decision and the economic performance of the firm. the first step was focused on the usuall, normal treatment of investment. the result implicated that corporate taxes create “uneven” distribution of the burden across the projects covered with different sources of finance. actually, in the case of equity financed investments there was a positive tax burden on corporate income, while the debt covered investments took neutral position. in the second step, the effects from the alternative corporate tax systems were analyzed. for example, the comprehensive business income tax system (cbit) successfully eliminates the tax differences between debt and equity by elimination of the possibility for deduction of the interest expenses. in the imputation corporate tax system (ict), part of the company's tax bill is imputed to the stockholders, and the effect from the imputation depends from the interrelation of the corporate income tax rate and the rate of imputation. the full integration corporate tax system (fict) represents a variant of the imputation corporate tax system, where the imputation rate is equal to the tax liabilities paid at corporate level. then there is the allowance for corporate equity tax system (ace), that allows to the companies to deduct an imputed normal return on their equity from the corporate income tax base. under a split rate corporate tax system (srct) there are two different statutory tax rates, one that applies to retained earnings, the other to distributed earnings. the first policy option is the strategy of taxation of distributed profits with retained profits exempt from taxation, which is aimed to generate strong incentives for reinvestment of retained profits. the second option is the strategy of taxation of retentions (retained profits) with profit distributions exempt from taxation, which is usually intended to deliver a certain compensation for the excessive tax burden levied on dividend distributions. economic analysis (2014, vol. 47, no. 3-4, 136-157) 156 in addition, we support our thesis with a practical example: the case study from the implementation of the split rate corporate tax system in macedonia. for that purpose the paperevaluates the effective marginal tax rates by source of finance, according to the methodology based on the devereux-griffith approach. the measurements found empirical evidence and confirmation of the theoretical thesis. references cnossen, s. 1993. what kind of corporation tax?. international bureau of fiscal documentation. devereux, m.p., griffith, r. 1999. the taxation of discrete investment choices. the institute of fiscal studies, warwick university. devereux, m.p., griffith, r., klemm, a. 2002. “corporate income tax reforms and international taxcompetition”. economic policy publications, 35. devereux, m.p., sorensen, p.b. 2006. the corporate income tax: international trends and options for fundamental reform. european commision economic papers, brussels. devereux, m.p., griffith r. 2003. evaluating tax policy for location decisions. international tax and public finance. earnst & young. 2010. the e&y 2010 worldwide corporate tax guide. elschner, c., overesch, m. 2007. trends in corporate tax levels in europe. intereconomics. gruevski, i. 2012. “corporate tax reform in republic of macedonia”. conference proceedings 1st international conference south east european countries toward european integration 20th october 2012 elbasan – albania. gruevski, i. 2013. “corporate taxes and their potential effects on investments.” economic development, 153-170. gruevski, i. 2013. “effective marginal tax rates on corporate income in the republic of macedonia” economic development, journal of the institute of economics skopje, 15 (3/2013): 129 –147. gruevski, i. and gaber, s. 2013. “indicators of the corporate income tax burden in macedonia”. balkan social science review, 2: 223-251. gruevski, i., gaber, s. and gaber, v. 2013. “effective tax burden on investment at corporate level in macedonia”. perspectives of innovations, economics & business, 13 (2): 19-31. king m.a., fulerton d. 1984. the taxation of income from capital: a comparative study of the united states, the united kingdom, sweden and germany”. university of chicago press; king, m.a. 1977. public policy and the corporation. london: chapman and hall. king, m.a. 1983. the relative taxation of capital and labor income. consultancy study for the economics and statistics department, an oecd study, paris. leibfritz, w., thornton, j., bibbie, a. 1997. taxation and economic performance. an oecd study, paris. oecd. (2000). alternative tax burden measures. an oecd study, paris. oecd. (2007). fundamental corporate tax reform. a tax policy studies, paris. rose, m.,wiswesser, r. 1998. tax reform in transition economies: experiences from croatian tax reform process in the 1990s. london: publicfinancein a changing world, macmillan. ruiz, f.m.m., gérard, m. 2007. summary, description, and extensions of the capital income effective tax rate literature. oxford: international taxation handbook. salanie, b. (2000). the economics of taxation. massachusetts: the mit press cambridge. the centre for european economic research. 2012. zentrum für europäische wirtschaftsforschung (zew). оveresch, m. 2005. the effective tax burden of companies in europe. cesifo dice report. gruevski, i., et al., corporate tax system in macedonia, ea (2014, vol. 47, no. 3-4, 136-157) 157 korporativno oporezivanje i investicije rezime – veći deo autora slaže se da su porezi distorzivni po prirodi. ova tvrdnja je relativno tačna za sve grupe poreza, ali je posebno očigledna za poreza na dobit kompanija ili tzv. korporativni porez. u literaturi je dobro poznata činjenica da primena poreskih sistema korporativnog dohotka može dovesti do mogućnosti raznih distorzija ponašanja firme, a jedna najkritikovanija je mogućnost neravnopravnog ili pogrešnog izbora na izvor finansiranja firme. zato, u sledećem radu, mi ćemo pokušati da istražimo efekte koji proizilaze iz implementacije korporativnih poreza na investicionu odluku firme, i to uz primenu metodološkog okvira efektivnih marginalnih poreskih stopa. krajni cilj je da se analizira proces donošenja investicione odluke uz izolovanu implementaciju poreza na dobit, što znači da su kombinovani efekti takozvanog “dvojnog oporezivanja”uzrokovani od paralelne primene personalnih poreza kapitalnog dohotka. nadamo se da ćemo pokazati da opstojanje ovakvih uslova oporezivanja generisati “nejednaku” distribuciju poreskog opterećenja kroz različite projekte finansiranim sa različitim izvorima kapitala. isto tako, cilj nam je da istražimo karakteristike nekih alternativnim poreskih sistema korporativnog dohotka, koju su nadaleko poznati po svojim “neutralnim” poreskim osobinama, kao što su: poreski sistem korporativnog dohotka na širokoj osnovi (the comprehensive business income tax system cbit), integrirani ili imputirani poreski sistem korporativnog dohotka (the imputation corporate tax system ict), poreski sistem korporativnog dohotka uz punu integraciju (the full imputation corporate tax system fict), poreski sistem korporativnog dohotka sa odbitkom u visini akcionarskog kapitala (the allowance for corporate equity tax system ace) i sistem poreza na dobit sa razdvojenom stopom (split rate corporate tax system srct). u nastavku rada, prikazujemo podršku našim teoretskim tezama sa praktičnim dokazima: studija slučaja iz implementacije i primene poreza na dobit za razdvojenu stopu u makedoniji. ključne reči: porez korporativnog dohotka, oporezivanje, trošak kapitala, efektivna marginalna porezna stopa, poreski sistem korporativnog dohotka, izvor finansiranja, zajam, emisija akcionarskog kapitala, zadržana dobit article history: received: 1 september 2014 accepted: 15 november 2014 ea_2016_1-2 udc: 336.717 339.13 jel: g21, g17 cobiss.sr-id: 224804620 original scientific paper comparative analysis of levels of banking sector markets concentration in cee region kaličanin tijana,1 belgrade banking academy, belgrade, serbia hanić azra,2 belgrade banking academy, belgrade, serbia abstract – banking sector is an important development factor of the total financial and economic system. number of banks and dispersion of their individual shares defines competitive structure of banking sector, manifested by its concentration. market concentration may be presented as a function of a number of enterprises competing in a market and their individual comparative market shares. concentration analysis is significant with regard to the fact that the level of concentration demonstrates relations among competitors in a market, as well as influence each competitor has on consumers, branch and economy as a whole. starting from 2008 crisis, domino effect of which hit banking sector and has had a huge impact on it, authors of this paper aimed at establishing a level of market concentration of the banking sector in serbia and countries in the region in 2015 by application of a large number of market concentration indicators. key words: market concentration, banking sector, cee region, competition introduction market of a country is as developed as its competition is able to function on it. competition has to be constantly stimulated and protected by mechanisms in line with the european integration processes and policy focused on market economy development. competition as such has been a particularly sensitive issue in transitional countries such as serbia and countries in the region. initial structural changes brought about raising an issue and need for a higher competiveness level in serbia and elsewhere. every country aspiring to join the eu and integration processes ought to develop legal norms and apply eu regulations. theory of competition has been developing together with economic sciences. complexity and dynamics are two main characteristics of every economic system. however, every economic system and its specifics differ from state to state and depend on the period in time in question; hence competition occurs in different forms in practice. competition concentration and intensity ratio has been grounded on harvard and chicago school 1 zmaj jovina 12, belgrade, serbia, e-mail: tijana.kalicanin@bba.edu.rs 2 zmaj jovina 12, belgrade, serbia, e-mail: azra.hanic@bba.edu.rs 60 economic analysis (2016, vol. 49, no. 1-2, 59-72) findings. naturally, other schools have had an influence on understanding this relation, however economists from the above mentioned schools have had the most powerful impact on application of antimonopoly policy in america. establishing whether a commercial entity has a market power or not depends not only on the market structure but on a number of other factors as well, such as: number and market power of a competitor, substitution in consumption capacity, price character, barriers in getting in and out of the market, technological development, innovations, etc. (labus, 2008, pp. 177). central and east european financial system has been rapidly developing last couple of years, contemporary regulations have been introduced and new financial institutions have been established contributing to maintenance of macroeconomic stability in the region. nonetheless, macroeconomic sector in the region, underdeveloped even before the recession took place, has been a highly risky place for investments and unstable in comparison with the western europe. certain reforms were carried out in 90s in the cee region. they included privatization of state run banks and opening of local financial sectors towards foreign investors. banks thus lost their primary role, free assets mobilisation function, public trust in baking system was weakened due to inability of deponents to have their assets at their disposal, as well as because of bad experiences with several pyramidal banks during that decade (erić, jović, 2012, pp. 6). world economic crisis has spilt over to europe through financial institutions (banks in the first place) present in american financial market. the first world crisis signs in the region reflected in both drop in liquidity in financial sector and hindered reform of financial institutions as well. slowed down economic activities came as a result of withdrawal of deposits from banks by citizens, hindered credit activities of banks towards economy and population, increased foreign investment costs, reinforced pressure on foreign exchange rate, as well as credit risk uplift (bošnjak, 2008, pp. 14). lack of capital increased the value of financial assets, already limited, which has thus slowed production and economic growth down. shortage of innovativeness in financial sector has been present in serbia and neighboring countries (western balkans ones in particular) due to shallow and underdeveloped market, political, economic and credit risk, high poverty rate, underdeveloped stock exchange business element, currency oscillations, a high inflation level and other microeconomic indicators, such as: foreign trade deficit, public debt, foreign direct investment flow, etc. in addition to this, transitional countries share common banking sector issues: instability of industrial structure, nonexistence of firm rules, narrowed assortment to key services only, excessive capital price, absence of clear strategic objectives (tipurić, kolaković, dumičić, 2002, pp. 470). levels of concentration considering the fact that market power and market share concepts are often used as synonyms in economic literature, market power measurement procedures are most frequently reduced to measuring market concentration, while a firm’s market share scope is kaličanin t., et al., comparative analysis, ea (2016, vol. 49, no. 1-2, 59-72) 61 a main indicator of market power. this paper continues analyzing concentration level in the market and indicators measuring it, which have most often been applied to the banking sector. branch offer concentration is a very important feature of market structures and holds a prominent position in studying them. the offer concentration implies a level total range of offers or sale in one market is concentrated on a smaller number of firms (jakšić, et al., 2006, pp. 327). in order to establish offer concentration level market shares of individual participants have been most often used. individual firms are constantly trying to increase their market shares due to a positive correlation between market share and profitability. a higher market share leads to a higher level of offer concentration (amato and wilder, 2004, pp. 412). a huge number of factors have an impact on offer concentration levels in a market. they can however be divided into main ones, crucial for determining a concentration level, and auxiliary, bearing less importance in definition of offer concentration. main factors determining offer concentration level are the following: 1. number of competitors doing business in the market, 2. dispersion of market shares among competitors, and 3. entry and exit barriers from a branch. this research will focus on impact the number of participants in the market have and dispersion of the market share among them. indicators used to measure concentration level need to take these elements into consideration pertaining to markets with more than one participant on the offer side. there is no need to measure offer concentration with classic monopolies since there is only one firm with 100% market share. each offer concentration indicator is at the top level in this type of market (šaj, 2005, pp. 171). methodology this research has analyzed concentration levels in banking sectors of the republic of serbia, croatia, bulgaria, montenegro and bosnia and herzegovina through a comparative analysis. it is important to underline that previous empirical research has proved that application of one market concentration indicator may lead to relatively contradictory conclusions on banking market concentration level since each indicator applied in this paper has both its advantages and disadvantages. aiming at obtaining the clearest possible picture of banking sector concentration, one needs to apply a whole range of indicators. applied indicators have been used against granted loans and collected deposits sums of each individual bank, as two main items in a bank’s balance sheets. herfindahl – hirschman index is a sum of the squares of market share of firms within an industry (martin, 2002, pp. 336). generally speaking, a higher numeric value of hhi indicates lower competitiveness intensity, i.e. a greater economic power of market participants. hhi, due to its set-up, has analytical advantage over concentration ratio, which has been reflected in the fact that this index gives higher ponder to larger firms. it can be presented by the following equation (šaj, 2005, pp. 172): 62 economic analysis (2016, vol. 49, no. 1-2, 59-72) ��� = � ��� � � where ‘si’ stands for market share of ‘i’ firms, and ‘n’ stands for a total number of firms in the market. importance of this index is reflected in the fact that even though it looks at individual market shares of all firms in a branch, it recognizes separately presence of firms with large market shares, significantly increasing its value (lipczynski and wilson, 2001, pp. 110). theoretically speaking, this index can have values between 0 and 10000. in case of atomized offer when there is a huge number of producers and when each offer is around 0 and index value is around 0. index value with monopolies is 10000, since a monopoly firm’s offer equals whole branch’s offer (begović, et al., 2002, pp. 33). figure 1. market types by hhi values source: begović, b., bukvić, r., mijatović, b., paunović, m., sepi, r. and hiber, d., 2002, pp. 35 low index value therefore suits competitive industry without dominant players. should all firms have equal shares, then reciprocal index value reflects a number of firms in a given industry. when shares differ, reciprocal index value indicates ‘equivalent’ number of firms in the industry. applicability of the statistics (statistical measure) aiming at disclosure and further prevention of harmful monopolies setting up, is however directly linked to a respective market definition (which primarily relies on substitution concept) (hanić, 2011, pp. 5). share index of an ‘n’ firm or a concentration ratio is an indicator, i.e. a sum of market shares of ‘n’ largest firms on the market and is a very simple to understand as such (waldman and jensen, 2001, pp. 95). it can be presented as a following formula (savić, 2000, pp. 4): crn = ∑ � �� where ‘xi’ stands for individual market share of an ‘i’ firm: xi = (qi/q)100 hhi index value offer concentration value hhi < 1000 low concentration value 1000 ≤ hhi ≤ 1800 medium concentration value 1800 ≤ hhi ≤ 2600 high concentration value 2600 ≤ hhi ≤ 10000 very high concentration value hhi = 10000 monopoly concentration value kaličanin t., et al., comparative analysis, ea (2016, vol. 49, no. 1-2, 59-72) 63 where ‘qi’ is an offer of ‘i’ firm and ‘q’ is an offer of whole branch. ‘n’ in practice is a number between 4 and 10. government’s agencies in charge of following offer concentration levels in a country stipulate a number of firms that would be calculated against this indicator, using this coefficient as an official indicator (martin, 2002, pp. 337). in case of an atomized offer when there is a limitless number of producers, its share is around zero hence index values is a round zero, too. contrary situation is with a monopoly, when there is one producer only, the production of which equals the total branch production and index value is 100 (waldman and jensen, 2001, pp. 95). a borderline between low and high levels of branch offer concentration, measured by this index, cannot be unified and largely depends on the market itself. eu considers a high level of offer concentration when cr4 index exceeds 25. unlike the eu, in the us borderline cr4 index value is 50, hence markets with index above 50 are considered to be high concentration ones; those between 25 and 50, moderately concentrated, and the ones below 25, non-concentrated markets (savić, 2000, pp. 6-8). level of concentration can be established by lorenz curve as well, which is an important instrument used in statistical analysis. it was named after american economist lorenz who designed this curve first. it was initially applied only when studying equality of distribution of financial profits among members of a society (a state) (šolak, 1996, pp. 38). application of lorenz curve in reviewing levels of offers’ concentration in a market, aims at illustrating equality in distribution of market shares among firms. figure 2. lorenz curve source: lipczynski, j., wilson j., 2001, pp. 109 (% offer; % business entities from the smallest to the largest) x axis shows firms from the smallest to the biggest (in percentages), and y axis shows percentage of offer at firm’s disposal in interval from 0 to 100% offer. line 0a at 45 degrees is seen as a total equality line, i.e. balanced distribution of offers among producers. if firms are along this line, then all firms are of same size. therefore, for example point c shows that 50% of firms looks after 50% production and offer on the given market. it then implies that remaining 50% firms looks after 50% production and offer on the same market 64 economic analysis (2016, vol. 49, no. 1-2, 59-72) (lipczynski and wilson, 2001, pp. 110). to conclude, competition on this market is made of firms of identical size. distribution of market share is balanced among individual firms and this is somewhere halfway between a total equality and a total inequality of market shares. main disadvantage of lorenz curve is the fact that it is primarily focused on unbalanced distribution of market shares among individual firms. number of firms in establishing concentration level does not play an important role hence one firms with 100% market share and ten firms with 10% market share each will be at the same 45 degrees curve. gini coefficient as a concentration measurement tool has been based on lorenz curve’s underpinning logic. starting from the given lorenz curve chart, gini coefficient can be defined by the following equation (bajec, et. al., 2005, pp. 17): g = � ��� ∑ (�� − � � �� � )�� where ‘n’ stands for a number of firms, ‘μ’ is an average firm’s sale on the given market, ‘ri’ is a rank an ‘i’ firm is holding (firms are ranked by sale scale or marker share from the smallest to the biggest) and ‘qi’ is sale scale of an ‘i’ firm. main disadvantage of this indicator is the fact that it neglects number of firms and is exclusively focused on inequality in offer among them. industrial branch with two firms of identical size has the same gini coefficient value as industry with 100 firms of same size, even though competition structure of these two industries is completely different (lipczynski and wilson, 2001, pp. 110). it is particularly difficult to establish coefficient for a market with one firm only. result will be 0 for this market if the above written equation is strictly applied, which implies that offer is equally distributed among firms (one in this case). entropy coefficient is a sum of market shares of individual firms and natural logarithms of their reciprocal values as in the following formula: ∑ = = n i xi xiei 1 1 ln where ‘xi’ stands for market share of an ‘i’ firm expressed in relative numbers. coefficient value is defined between two extreme cases: value ei =0 where one firm sets up the whole offer and value ei = log (n) when in on branch there are n firms of the same size. entropy coefficient reflects a level of stability in a branch. market stability is assessed from a seller’s viewpoint. market is stable when buyers have difficulty in or cannot change a seller at all. this is a monopoly situation when one firms sets up the overall branch offer. market is unstable when buyers can relatively easy change a seller which is a case when there is a large number of offer making participants on the market. entropy coefficient value, unlike other analyzed concentration indicators, is inverse to the concentration level (smaller entropy coefficient implies a higher level of concentration on the market and vice versa). kaličanin t., et al., comparative analysis, ea (2016, vol. 49, no. 1-2, 59-72) 65 this indicator has been taken from theory of information where it was used to assess certainty level of a decision. in addition to this, it can be used to measure uncertainty in different market structures. when there is one firm only on the market, uncertainty for a monopolist to keep a buyer is a minimal, since the buyer has neither options to choose a different sellers, nor can he/she find a substitute to meet his/her needs. opposite scenario is with a full competition and a maximal uncertainty, due to a huge number of firms with equal market shares, so that consumers can choose who they will buy a product from, as well as which product they will be using to meet their needs (ilić, et. al., 2003, pp. 213). main advantage of entropy coefficient is reflected in the fact that it can be divided into components unlike other concentration indicators. this is most often done when there are groups of firms belonging to different clusters by size, different industries or different countries. thus entropy coefficient can be established within different groups as well as among different groups. results and discussion next table shows maker shares of leading banks, five leading banks and ten leading banks from selected cee region countries. serbia has the lowest value cr1 concentration coefficient with banca intesa has the largest market share in granted loans and collected deposits of 15.7% out of 30 banks. bulgaria and montenegro follow. in bulgaria leading unicredit bank has the largest market share of 17,8% in loans, i.e. 18,66% in deposits. montenegrin commercial bank ad podgorica has a similar share in the marker when it comes to loans and deposits, i.e. 18,12% and 17,00% respectively. leading banks in croatia and bosnia and herzegovina have a far larger share on banking markets in these countries. unicredit bank mostar participates with 24,85% in the total amount of granted loans in b&h and 25,88% in collected deposits. zagrebačka bank zagreb has the largest market share of all, 26,82% in loans and 24,87% in deposits. application of cr1 coefficients underlines that there are two groups of leading banks, firstly those taking up almost one fifth of the overall banking market and secondly those that take up one fourth. unicredit bank, present in three out of five analyzed markets, is a leading in bosnia, but second largest in serbia by market share size. table 1. banking sector concentration ratio in 2015 country cr1 cr5 cr10 loans deposits loans deposits loans deposits serbia 15,75 15,73 55,17 55,19 77,53 77,58 b&h 24,85 25,88 70,23 71,44 92,31 91,28 mne 18,12 17,00 66,92 69,12 96,12 96,79 croatia 26,82 24,87 74,43 73,15 93,58 92,65 bulgaria 17,80 18,66 59,05 55,11 82,92 79,57 source: authors 66 economic analysis (2016, vol. 49, no. 1-2, 59-72) out of 30 banks in serbia and 28 in bulgaria, the first five banks have a sum market share of 55,17% in loans and 55,19% in deposits, i.e. 59,05% in loans and 55,11% in deposits respectively. there is an equal number of banks in b&h and montenegro, 17, and five largest ones in b&h have a sum market share of 70,23% and 71,44%, while in montenegro that figure is slightly smaller, 66,92% in loans and 69,12% in deposits. out of 27 banks in croatia, market share of five leading ones has the highest value in comparison with previously analyzed countries, 70,23% in loans and 71,44% in deposits. application of cr5 coefficient underlines that out of two groups of banks, one with 17 banks in banking market and the other with 27-30 banks, five leading banks on croatian banking market has the highest market share. application of cr10 coefficient leads to approximately same results. market shares of ten leading banks in croatia, b&h and montenegro take up 91-96% of total banking market in loans and deposits; in bulgaria ten leading banks participate with 82,92% in the total amount of granted loans and slightly less, 79,57% in total amount of collected deposits. based on the results, it can be concluded that ten leading banks have the smallest sum market share in the serbian banking market in comparison with leading banks from analyzed countries, i.e. 77,53% total loan market and 77,58% total deposit potential market. table 2. herfindahl-hirschman index of cee region banking sector in 2015 country hhi 1/hhi loan deposits loans deposits b&h 1342 1476 0,0007 0,0007 serbia 817 814 0,0012 0,0012 mne 1137 1158 0,0009 0,0009 croatia 1472 1386 0,0007 0,0007 bulgaria 921 865 0,0011 0,0012 source: authors based on the results obtained by application of herfindahl-hirschman index, it may be concluded that selected countries can be divided into two groups of markets, nonconcentration and medium concentration markets. serbia with hhi value of 817 in loans and 814 in deposits belongs to the first group, i.e. low concentration level market. similar market structure is to be found in bulgaria as well, with hhi values for loans and deposits are 921 and 865 respectively. three remaining countries, b&h, montenegro and croatia have much higher values of applied hhi on loans and deposits, which puts them into the second group of countries with a medium concentration. b&h has the highest hhi values for loans – 1342 and 1476 for deposits and croatia with almost inverse values 1472 for loans and 1386 for deposits. montenegro has somewhat lower hhi values than previous two countries, i.e. 1137 for loans and 1158 for deposits, nonetheless belongs to the same group as b&h and croatia – medium concentration markets. having in mind a negative correlation of this index with the level of competition, it may be concluded that there is a lower level of competitiveness in bosnian, montenegrin and croatian banking markets than in the serbian and bulgarian one. sub-columns within 1/hhi kaličanin t., et al., comparative analysis, ea (2016, vol. 49, no. 1-2, 59-72) 67 column show how many banks would be able to reach given hhi values, provided there are equal market shares. table 3 shows entropy coefficient and relative entropy values against loans and deposits of the cee regional banking sector in 2015. column log (n) illustrates maximal entropy values, namely values providing that all banks have equal market shares. obtained entropy values for loans and deposits are contrasted to maximal entropy in order to establish dispersion of market shares, i.e. levels of instability and uncertainty. total entropy has certain shortcomings when entropy in a number of countries in banking sector is reviewed. when there is a different number of banks in analyzed countries, entropy coefficient should be adjusted and made comparable among countries. relative entropy coefficient is to be calculated in this context. calculated entropy e and maximal entropy for a given number of banks ratio provides for relative distance concentration indicator, ranging from 0 (the highest concentration) to 1 (the lowest concentration). this indicator takes differences in number of banks in analyzed countries into consideration and is a significant corrector of results obtained on the basis of the total entropy. table 3. entropy coefficient and relative entropy of the cee region banking sector in 2015 country entropy relative entropy loans log (n) deposits log (n) loans deposits b&h 1,00 1,23 0,99 1,23 0,80 0,80 serbia 1,21 1,47 1,20 1,48 0,81 0,82 mne 1,00 1,14 0,99 1,14 0,87 0,86 croatia 0,98 1,43 1,01 1,43 0,69 0,70 bulgaria 1,16 1,44 1,19 1,44 0,81 0,82 source: authors relative distance concentration results underscore that there is a high level of instability and uncertainty present in almost all analyzed countries, i.e. bank services beneficiaries have significant substitution possibilities. relative distance concentration is the only indicator in this group of applied indicator in a positive correlation with competition, i.e. a higher value of this indicator implies stronger competition in the market. advantage of this coefficient is reflected in the fact that enables comparison among countries having taken differences in number of banks into consideration. the results show that banking market structure is a low concentration one, pointing at a high level of competition. the strongest intensity of competition is to be found on montenegrin banking market with relative entropy amounts at values of 0,87and 0,86 for loans and deposits respectively. bulgaria and serbia follow with same relative entropy values, namely 0,81for loans and 0,82 for deposits for serbia and 0,80 for both in bulgaria. the lowest level of competition in banking markets in comparison with all analyzed countries is present in croatia based on relative entropy values results. 68 economic analysis (2016, vol. 49, no. 1-2, 59-72) table 4. gini coefficient of the cee region banking sector in 2015 country gini coefficient loans deposits b&h 54,59 55,57 serbia 59,24 59,28 mne 43,28 44,73 croatia 72,63 71,35 bulgaria 60,87 57,18 source: authors it may be concluded by application of gini coefficient and analysis of the results presented in the table above that croatia with values of 72,63 for loans and 71,35 for deposits is in a group of high concentration markets, i.e. that there is a group of banks with large market shares and a group of banks (a larger group than the first one) with small market shares. main issue with this coefficient is that it fails to take a number of banks into consideration. however, value of this coefficient closer to 100 indicates presence of several leaders in the market, i.e. those with large market share, and that rest of the market is divided into a large number of individual small market shares of other business entities. in line with this, it can be concluded that these two groups of market shares are quite equal in serbia, bosnia and herzegovina and montenegro. gini coefficient for bulgaria is 60,87 for loans and 57,18 for deposits, which points at a slightly larger dispersion of market shares than in other countries. this is however smaller than on the croatian banking market. bearing on mind that gini coefficient does not take differences in numbers of business entities, i.e. banks into consideration, it is important to have in mind number of banks on the market when analyzing this coefficient so that values are correctly interpreted. values can otherwise lead to misconception and misinterpretation of results. in order to avoid making this mistake, it is recommended that lorenz curve is created, the logic of which is a foundation for this coefficient, and which offers a clear graphic illustration of market shares dispersions. charts 1-10 show lorenz curves against market shares of loans and deposits of the cee region banks in 2015, clearly illustration marker shares dispersion. x axis shows market shares of banks from the smallest to the highest (in percentages), and y axis shows percentage of offer (granted loans and collected deposits)at banks’ disposal in their balance sheets, in intervals from 0 to 100%. charts illustrate that market distribution between loans and deposit is a very similar one, therefore it will be further on analyzed together. should we take 20% of the best ranked banks into consideration (i.e. 20% of banks with the highest market shares), 20% of largest banks in montenegro has 20% of the market, 60% of markets in serbia, bulgaria and bosnia and herzegovina, while 20% of the best ranked banks in croatia has a share of up to 80%, which has been reiterated by the previous gini coefficient analysis. if the curve at the beginning is closer to x axis, from left to right, it implies presence of banks with a very small market share (1% each and smaller), and a number of these banks depends on the length of the curve near x axis. kaličanin t., et al., comparative analysis, ea (2016, vol. 49, no. 1-2, 59-72) 69 40% of the best ranked banks in b&h and serbia have 80% market shares; the same group of banks in montenegro has around 75%. two fifth of the best ranked banks in bulgaria have 85% share of the total bulgarian banking market, while in croatia, the same percentage of the best ranked banks totals to even 95% of the market share, implying that remaining 60% banks ‘share’ no more than 5%. it can be noted in all charts that a point on the curve above number 40 (representing 60% of the best ranked banks) is close to x axis. this, further on, points at the fact that 40% of the worst ranked banks ‘share’ rest of the market. 40% of banks in montenegro with the lowest market shares share around 10% of the total market share. the curve is at approximately same distance from x axis in case of serbia, bulgaria and bosnia and herzegovina. accordingly, 40% of the worst ranked banks in above countries total to only 5% of the overall banking market. croatia’s 40% of the worst ranked banks share only a couple of percentages of the total banking market considering loans and deposits. what is significant with lorenz curve and visible at first glance is that the larger the surface on the right, the more market leaders present, i.e. groups of banks (proportionally smaller) with a significant market shares in the overall banking market. contrary to this, larger surface on the left implies presence of proportionally larger number of banks sharing a very small percentage of the total marker share. chart 1. lorenz curves – loans and deposits, cee region, 2015 0 20 40 60 80 100 0 20 40 60 80 100 mne loan equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 mne dep equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 srb loan equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 srb dep equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 b&h loan equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 b&h dep equals lorenz 70 economic analysis (2016, vol. 49, no. 1-2, 59-72) source: authors conclusion herfindahl-hirschman index values describe two levels of market concentration, i.e. low concentration and medium ones. even though hhi values obtained in montenegro, bosnia and herzegovina and croatia are above 1000, which groups them among medium concentration market structures, these values fail to reflect a genuine competitiveness bearing on mind presence of market leaders contributing to a higher index value with their marker shares. application of cr1 concentration ratio demonstrates a huge difference among market shares of leading banks, ranging from 17-27%. unicredit bank runs business in three out of five analyzed banking markets and is a leading one in bosnia and herzegovina and bulgaria, while in serbia it comes second best after banca intesa. gini coefficient shortcomings, providing an incomplete picture of market concentration, have been overcome by creation of lorenz curves, graphically presenting differences among banking sectors market structures in the cee region. serbia, bulgaria and bosnia and herzegovina have the most similar distribution of market shares. montenegro results show the smallest proportional number of banks in relation to the total number of banks with market share up to 1% and at the same time banks with a significant market share. the most striking dispersion and deviation, in comparison with other analyzed countries, has been found on croatian banking market, where 11 banks share 3% of the total market, while 6 out of 27 share up to 80% of the market. it could be concluded that banking sector market structures of these selected countries are similar with a high competitiveness level by the cee regional market concentration level analysis applying a cluster of selected indicators. even though some coefficient values are contradictory and once their shortcomings are removed – taking a number of banks into 0 20 40 60 80 100 0 20 40 60 80 100 bulgaria loan equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 bulgaria dep equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 croatia loan equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 croatia dep equals lorenz kaličanin t., et al., comparative analysis, ea (2016, vol. 49, no. 1-2, 59-72) 71 consideration, presence of market leaders and putting obtained and maximal values into ratio – comparative analysis among countries proves feasible, providing a realistic picture of banking sector market structures individually. aiming at drawing good quality conclusions about market structure (nature of the market and relations among respective competitors) in banking sector, qualitative assessment of common and specific elements typical for this sector is necessary along with a level of concentration quantitative analysis. in dealing with this topic, various reports by organizations and institutions have been studied, based mainly on analysis of one or maximum two most frequently applied concentration indicators (cr and hhi). aiming at obtaining the clearest possible picture of market competition in financial sector, it is recommended that decision makers in respective institutions and regulatory bodies incorporate analyses of a maximal number of concentration indicators in their reports on level of concentration in financial sector. references amato, louis, and ronald p. wilder. 2004. “global competition and global markets: some empirical results.”international business review, 13: 412. bajec, jurij, katarina stanić, paola pagliani and daniel varga. 2006. “srbija – pokazatelji humanog razvoj.” ujedinjene nacije – program za razvoj, 17. begović, boris, and boško mijatović. 2003. “corruption in serbia, center for liberal democratic studies. http://www.cipe.org/pdf/corruption/corruption.pdf. bošnjak, marinko. 2008. “ključne makroekonomske neravnoteže kao izazov ekonomske politike.” ministarstvo finansija republike srbije, 14. erić jović, mira. 2012. “banke i osiguranja u srbiji 2001-2011, poređenje sa zemljama u regionu.” business info group. http://www.big.co.rs/upload//2013-06/banke_i_ osiguranja_u_srbiji_2001_2011_i_poredjenje_sa_zemljama_regiona.pdf. hanić, hasan, mihajlo kočović and marija jovović. 2012. “komparativna analiza koncentracije tržišta osiguranja srbije, hrvatske i slovenije.” x međunarodni simpozijum iz osiguranja, 11. ilić, milan, ljubodrag savić, slobodan cvetanović, and zora arsovski. 2003. industrijski menadžment. kragujevac, srb: ekonomski fakultet. jakšić, miomir, and aleksandra praščević. 2006. makroekonomska analiza. beograd, srb: centar za izdavačku delatnost ekonomskog fakulteta. labus, miroljub, and tim cullen. 2008. analiza tržišne koncentracije: primer c │c marketa. beograd, srb: belox advisory services. lipczyinski, john, john o. s. wilson, and john a., goddard. 2009. industrial organization: competiton,strategy, policy. harlow, england: prenticehall/financial times. martin, stephen. 2002. advanced industrial economics. oxford, uk: blackwell publishers ltd. savić, ljubodrag. 2000. „tržišne strukture u jugoslovenskoj industriji”, industrija, 1/4: 4-8. shy, oz. 2005. industrijska organizacija – teorija i primena. beograd, srb: ekonomski fakultet u beogradu. šolak, njegoš. 1996. statistika za menadžere kvaliteta. mladenovac: srb: t&k print. 72 economic analysis (2016, vol. 49, no. 1-2, 59-72) tipurić, darko, marko kolaković, and ksenija dumičić. 2002. “istraživanje promjena u koncentraciji hrvatske bankarske industrije 1993-2000.” ekonomski pregled, 5-6: 470-494. waldman, don, and elizabeth jensen. 2001. industrial organization: theory and practice. michigan, usa: addison wesley longman. www.nbs.rs www.cb-mn.org www.bnb.bg www.hnb.hr www.cbbh.ba komparativna analiza nivoa tržišne koncentracije bankarskih sektora cee regiona rezime – bankarski sektor je značajan faktor razvoja ukupnog finansijskog i ekonomskog sistema. brojnost banaka i disperzija njihovih pojedinačnih udela određuju konkurentsku strukturu bankarskog sektora, koja se iskazuje koncentracijom. koncentracija tržišta se može predstaviti kao funkcija broja preduzeća koja međusobno konkurišu na tržištu i njihovih pojedinačnih relativnih tržišnih učešća. analiza koncentracije je bitna s obzirom na to da stepen koncentracije ukazuje na odnos među konkurentima na određenom tržištu kao i na uticaj koji svako od konkurenata ima na potrošače, granu i privredu u celini. počevši od krize 2008. godine koja je domino efektom pogodila bankarski sektor i imala veliki uticaj na isti u ovom radu autori su želeli da utvrde nivo tržišne koncentracije bankarskog sektora srbije i zemalja u regionu u 2015. godini upotrebom većeg broja pokazatelja tržišne koncentracije. ključne reči: tržišna koncentracija, bankarski sektor, cee region, konkurencija article history: received: 8 may, 2016 accepted: 12 may, 2016 ea_2014_1-2 udc: 338.1 ; 339.137.2 jel: f29 id: 207710988 scientific review competitiveness and development of national economy knežević vladimir1, ivković dragan, vujičić slađana, faculty of business economics and entrepreneurship, belgrade, serbia abstract – this paper examines the relation between the two, may be the most pressing, phenomena of the world economy: competitiveness and development. of course both can be interpreted in several ways, but the most operative way is to consider competitivenes by the methodology of the world economic forum's global competitiveness index, and the development by the gross of domestic product per population. the intent is to determine what is the conection between these two indicators in general, and to pass the question in such a way, and to establish a methodology for further analysis of individual groups of countries considered in the report of the world economic forum's global competitiveness in the world. therefore, we use correlation analysis between the observed indicators for the economy after 2005, since the above-mentioned study and implement competitiveness, with an accent on the last mid-term because of current events. the answer to the question: what is the relationship between these indicators in the timeline for all countries concerned is excpected. it is also important for the countries of the former yugoslavia as a guide in the efforts to retrieve the position in the world economy. key words: competitiveness, development, correlation, crises introduction economic development is the eternal subject, not only in the economy, but in the history of mankind in general, as a necessary prerequisite to any other progress of human civilization. it is the same is in the twenty-first century. as always, this issue is permanently actualized by possible recession, which has larger proportions, and is often called the global crisis. such is the case today, when the world economy still is not fully recovered from the initial shock of the crisis, which was conceived in the u.s financial sector at the end of the year 2007. as usual, the disorder is the system of concentric circles spread to other developed countries, and according to the conditions of globalization of the world economy, affecting virtually every corner of the globe. although the deepest recession in most countries recorded in the period 2008-2009, the recovery does not run at the desired speed. problems of economic development are even more important for the country's late transition to make an effort to get closer to the developed economies of europe, and those are the economies of the western balkans. suggested as a general prescription is competitiveness increasing. 1 corresponding author:knežević vladimir, vknezevic40@yahoo.com economic analysis (2014, vol. 47, no. 1-2, 111-126) 112 in the world of science, competitivenes is a category of newer, more specifically defined in the modern form at the end of the last century. it was the last decade of the twentieth century, the strong momentum of science and the development of global markets, highlighted as never before, the issue of competition in both at micro, and as the newer phenomenon, and competitiveness at the macro level, and there are several different concepts about it. literature review in theoretical sense, in terms of country competitiveness report, the foundation was laid by profesor porter (rakić, 2003). according to him, the main segments which determine competitiveness of countries and companies in terms of business are: 1. factors of conditions; 2. terms of demand; 3. related and supporting industries; 4. strategy, structure and rivalry companies. factors of conditions which may be natural (inherited) or produced (acquired) were divided into five categories, namely: 1. human resources; 2. physical resources; 3. knowledge; 4. capital; 5. infrastructure. under section two, we have something what we call in other words: the characteristics of the goods and services. according to this view, the market is the engine because progress is the only force that compels companies to technical progress and innovation in business. demand conditions can be further decomposed into the following factors of competitiveness: 1. the structure of domestic demand; 2. the size and rate of growth of domestic demand; 3. the rapid growth of the domestic market; 4. way of directing local products and services in foreign markets. related and supporting industries are element of competitiveness of a country which has rounded, while diversified economic structure. in this way, the export companies, which are at the end of the value chain, have advantages over foreign competitors, because of the better local support. local support is the most effective of all related and supporting industries, due to geographical proximity, as well as due the common cultural milieu in which they operate. contacts and co-ordination of business partners are much better and always first established between companies within the national economy. strategy, structure and rivalry of companies are last, but not the least, important link in the chain of this kind of competitive states. considering the fact that this concept is not given explicitly, quantify the impact of several groups of factors, one can reasonably expect that equal importance is granted for all. speaking about the strategy and structure which prevailing in the individual countries, which are caused by specific and different factors, but knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 113 relatively stable categories, it is pointed out that different countries are suitable, or unsuitable for the successful development of the various activities. on the other hand, the mutual rivalry of local companies is generally the most important factor in increasing the productivity and competitiveness of the one country. this is, of course, related to the size of an economy, and the prevailing economic system. reputable international organizations are dealing with regular monitoring of competitiveness and business conditions in different countries. the regular annual reports are the most valuable, which include smaller or larger number of indicators relating to the state of the economy in the surveyed countries. we would here pay attention only to the literature that has global scope and ambition of the regular annual reporting. in the first place we will point out the world economic forum and its regular annual report on competitiveness in the world which covers more than 140 economies in terms of comprehensive measurement of competitiveness of individual countries. afterwards we will highlight the world bank, whose annual “doing business” report includes even more of the 180 countries where the regulatory framework is evaluated in terms of ease of doing business. transparency international, publishes every year a list of countries according to the index of corruption in which is also achieved a great coverage of nearly 180 countries. subject of research is limited exclusively to corruption in the public sector. the world bank monitors the level of economic knowledge to over 140 countries worldwide. it the ability of selected countries it is estimated in the generating and adoption of the economic knowledges (peter sanfey and simone zeh, 2012). we also should mention the regular annual report of heritage foundation which now includes nearly 170 countries, and refers to the assessment of economic freedom for each of them (the heritage foundation, 2014). when all from the above is taken into consideration, for the purposes of this paper we are choosing "report on the global competitiveness" of world economic forum and the "doing business" of world bank as the most appropriate. it is because the both reports include a number of indicators, and by elaborated methodology provide the most complete picture of the majority of the competitiveness of the national economy. although these documents are valuable to the all investors in the world, as well as for officials involved in improving the competitiveness of their national economies, we should be aware of some of their limitations. usability of competitiveness report of the world in the mentioned sense, especially its reliability may be limited for small economies due to the extremely small sample available when determining the number of parameter values. similarly, the objectivity can be problematic considering the fact that about 60% of the score is based on surveys, rather than on the exact parameters. regarding the business, in addition to the lack of reliable data for individual countries, the methodological problem is that the final score is based mainly on existing regulations, not in their factual implementation in practice, which is certainly more important for the potential users of the report. despite these objections which relate primarily to the useable value of the two, in our opinion, most comprehensive reports, which relate primarily to their practical utility value to potential investors and government officials in the national economy, they are the the most relevant research links between competitiveness and the development of the national economy in global. economic analysis (2014, vol. 47, no. 1-2, 111-126) 114 the world bank report regular annual report "doing business" issued by the international bank for reconstruction and development is mainly engaged in administrative, legal and financial conditions. it is relatively dynamic and could be changed in a relatively short period of time, unlike the competitiveness factors in porter's theoretical propositions. the approach is based on private business (entrepreneurship) as the main propelling force of the economy and liberal conception that stands for active, but a neutral role in the economy of the state bureaucracy. the philosophy is based on the fact that, first, the role of the state in the economy is very significant in terms of establishing the so-called legal state, which means the rule of law, to be precise, appropriate and stable legal norms which will be effectively implemented in practice, which means, expeditious and non-discriminatory. in this way, the state would guarantee a stable and orderly economic milieu in which it could develop free competition of business. action of the state is appreciated by its efforts to result a strong focus in that direction and, thus, actively promotes the economic growth and development. on the other hand, its activity should be as neutral as possible in the sense that the action set out above is not privileged in any way. in fact, in the general approach, and in the methodology of the report, "doing business" starts implication of this neutral role of the state. framework for assessing the competitiveness of this aspect includes 10 indicators: 1. incorporation; 2. permissions (time and complexity); 3. hiring (and firing) employees; 4. registering property; 5. getting credit; 6. protection of investors; 7. payment of taxes; 8. the possibility of trade with foreign countries; 9. contract compliance; 10. closing a business. each of these criteria is treated in triple ways. specifically, each item is considered in terms of how long it takes, on average, from the beginning to the end of the administrative procedures, then, how the procedure is complex, as the stage is made, and at the end, what is the amount of total taxes and general expenses to complete one of the following procedures. the value of research is large as it is based on facts that are collected on a standardized methodology in all countries, and the comparability of the results is credible. the research is usually based on a hypothetical example of a small company with a pre-defined legal status, size, location and type of activity. all 10 indicators are considered, by all three mentiond parameters, and are evaluated by means of standardized parametres. the work done by 7000 local experts in the field which are experts in the listed 10 areas (lawyers, accountants, architects, government officials, consultants, etc.), which provide specific factual information for each area of the study. knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 115 thus, the entire approach of the world bank in a study of competitiveness "doing business" is based, as it is already mentioned, on the analysis of relationships and institutions in one country which are relevant to business firms in it. if the number of administrative procedures is smaller, their duration shorter and costs lower, the more competitive is the industry. global competitiveness index – gci reports of the world economic forum with their comprehensiveness, both in number of countries, and the number of indicators, provide a complete analysis of the competitiveness of the economy, both in absolute terms, the value of the indicators themselves, as well as relative, enabling comparison with the other countries. according to the global competitiveness index and the individual elements of competitiveness, provide detailed analysis and draw conclusions that should be the basis for corrective action. in addition, the following values of these indicators from one year to another, it coul be, in general, as well as, by individual indicators, monitored the development trend of competitiveness of countries in absolute and relative terms. in this way it can be concluded about the state and prospects of the economy of a country and to identify basic deficiencies of the system, and the development and economic policies that should be corrected. professor sala-i-martin at the beginning of this century constructed gci (global competetiveness index) that connects the micro-and macro-economic factors of competition, and it was adopted and used by the world economic forum since 2005 in its report on global competitiveness (global competetiveness report). in this report, national competitiveness is defined as "... a set of institutions, policies and factors that determine the productivity of a country." (schwab, 2010.p 4). competitiveness is assessed by considering the 12 pillars of competitiveness. sustainable competitiveness index– sci three decades ago, the term sustainable development appeared in the economy. this theory has been developed since the 80s decade of the last century and is widely accepted by the world's most distinguished institutions in monitoring the global economy. and in the global competitiveness report 2011-2012 we also can find the treatment of the problem by the world economic forum. it is concluded that the gci does not respect the long-term perspective of competitiveness, but only measure the current performance of each national economy. next step is designing the index of sustainable (long-term) competitiveness sci (sustainable competitiveness index). it includes factors that determine competitiveness in long term, even if some of them are not covered by gci. this, so to say, a broader concept of competitiveness is preliminarily defined "... as the set of institutions, policies and factors that determine the level of productivity of a country, while ensuring the ability of future generations to meet their own needs." (schwab, 2011. pp 51) in the next global competitiveness report 2012-2013 by the world economic forum has continued to work on further development of this indicator. the basic idea in designing the sci is to show the relationship between economic development, environmental management and social sustainability. it means that the long-term competitiveness is considered as a kind economic analysis (2014, vol. 47, no. 1-2, 111-126) 116 of correction gci indicators related to the management of environmental and social sustainability. since this correction is a maximum of 20%, we can conclude that gci is the basic determinant of the sustainablity and competitiveness. pilot study was carried out in 79 countries, in accordance with the available data. in any case, we have to wait a while before using this interesting and useful competitiveness index come in practical use. if this is implemented, it might be worth in the future in its domain, as much as it is today in its most authoritative gci. problems of economic development defining the level of development of an economy is complex, mainly because of the definition of the term and answer of the question: what exactly is the economic development? obviously the answer to this question is very complex, and there is no one generally accepted and answers that would be given once and for all. surely that this definition could include the provision of material conditions of life for all citizens above the subsistence level, the realization of self-worth and independence of the nation, as well as allowing individual freedom of choice (dragutinović et all., 2005) as we can see, all of this is not only difficult to quantify in a theoretical sense, but, perhaps more importantly, ensuring that the process of globalization of the world economy, especially the other determinant. however, no matter how it may sound idealistic, "economic development can be defined as a process of long-term sustainable growth in output and income with structural improvements in its creation and distribution, and which results in the long term in a general increase in living standards, financial independence and political freedoms of population." (dragutinović, 2005. pp 255). without a detailed justification of this, for the purposes of our study satisfactory definition, it should be emphasized as an important element of its economic structure changes. in fact, as national economy is more developed, the dominance of the sector in employment and creation of domestic product gross moves from the primary sector, through secondary to tertiary. this is particularly important because that guidelines and statistics are more accessible for verification from, for example, political freedoms. methodology data competitiveness measuring if we want to look at the relation between competitiveness and development of the national economy, we will allocate to our starting point the world economic forum reports that deals with the global competitiveness of the global economy. as a basic methodological approach to assess competitiveness we will select global competitiveness index (gci). our selection is based on the fact that many of the competitive assessment contained in the second most important tracking of competitiveness in the world, “doing business”, published by the world bank methodology incorporated into the global competitiveness index. the base for the preparation of the report is standardized survey, which each year includes increasing number of representative companies in every national economy. knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 117 executive managers, according to the majority of indicators, assess economic conditions ranging from 1 (worst) to 7 (best). this approach is very important because when calculating the global competitiveness index (gci), survey data participate in approximately 60%. in calculating the gci, according to the above mentioned primary sources, the secondary sources also must be used, meaning, the official sources of information which can not be collected in the manner described-by interviewing the managers of the economy. these are various statistics such as, for example, the number of installed computers and internet connections, phone lines, data on education and health, monetary and fiscal data, gdp, demographics, etc. combining these data 12 columns of competitiveness were constructed, which can be grouped in three sections, and all together they make a synthetic gci. figure 1. factors and columns of competitiveness source: schwab, k. (eds.). (2010). global competetiveness report 2010-2011 geneva: world economic forum, (pp 9). this methodology is based on basic division stages of development of any economy, the beginning, intermediate and advanced. according to the initial setting, which can certainly be accept by the fact that in practice is verified in most cases, developing countries base their chance to escape from poverty on exploiting the basic factors such are natural resources, economic analysis (2014, vol. 47, no. 1-2, 111-126) 118 labor and capital. for the countries at this stage of development, the competitiveness of the economy depends mainly on improving the following columns: institutions, infrastructure, macroeconomic stability, health and primary education. at the second stage of the development, economic growth must be based on increased efficiency, considering the fact that in this situation, economic growth can no longer be based on the increased quantum of engagement of basic factors of production, but on their more efficient use. it is important to set out that the share of these columns of competitiveness is estimated on 50% in the designing of the overall competitiveness of the national economy in the central stage of development, and what is particularly important is identical share for the developed countries. competitiveness of developed countries, according to this methodology, is based mostly on business sophistication and innovation. 1. institutions are the first, and therefore probably the most important pillar of the global competitiveness of each national economy. this term means legal and administrative environment in which private firm operates in cooperation with the state achieving a certain level of welfare in society. 2. infrastructure this column represents the basic material precondition of economic development and business conditions similar as previous column represents in the "immaterial" effect. high-quality and extensive network of all forms of transport and communications in the country, and its relationships with other countries, are indispensable convenience in locating economic activities and significant impact on the cost of investment and operation. 3. macroeconomic environment it is a very important pillar of competitiveness that can often undermine economic growth in developed countries, not only of the poor, who are certainly more vulnerable in practice and more exposed to this type of risk. a stable macroeconomic environment is the healthiest condition for doing business, especially in terms of interest rates. also, inflation has to be tightly controlled if we want a competitive economy. especially in modern conditions, for almost all states very important problem of public debt, which oversizing threatens the posibilities of anti-cyclical economic policies of each country. 4. health and primary education both elements concerning the most important factor of production-labor. health is the basis of the productivity of employees, and if it is bad, there are frequent absences from work and efficiency of the work involved people is reduced. in addition to health, the quality and quantity of basic education which covers the population of a country is the basis for each individual worker productivity, and global competitiveness of the economy as a whole. 5. higher education and training modern economy requires a workforce capable of adapting quickly to dynamic technical progress, which is impossible without quality education and appropriate specialized training. 6. goods market efficiency countries which own effective market of goods are in a position to produce goods and services in quantity and quality that is maximally aligned with the needs of local customers, so they could be easily implemented in the market. healthy market competition in the domestic and international markets is important to the knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 119 growth of market efficiency and business productivity, to increase microproductivity, producing goods for the market and growth of prosperity. 7. the efficiency of the labor market labor market through its efficiency and elasticity should ensure the optimal allocation of labor and to encourage the workers to actively participate in finding their optimal work engagement, and effective use of working time. labor market provides an ideal turnover of staff, but without socially unacceptable consequences. a particular problem is the high youth unemployment, which can lead to serious social unrest, and the current challenge to the labor market in most countries of the world. it is particularly important in this area, to provide gender equality in the field of labor relations, as well as opportunities for the realization of extremely talented individuals all of which enhance the global competitiveness of any economy, and it is especially important for the medium and high levels of development. 8. the development of financial markets last depression of the world economy that started actually in the banking sector in the most developed countries of the world shows the importance of this particular market segment for global competitiveness. only an efficient financial sector allows rational allocation and efficient use of economic resources. efficient financial market provides an entrepreneurial, non political investments and direct equity in projects where the highest rate of return, returning deadline is the shortest. 9. technological readiness – in the era of globalization, technology is the basis of the progress of each company. this column reflects the openness and competitiveness of the economy's willingness to quickly adopt and implement new technological solutions to increase productivity, meaning competitiveness. this is particularly important in the field of information and communication technologies (ict), which have unlimited use in all cells of economy and society, which represent the current technological revolution. 10. market size this column of competitiveness allows companies lower costs per unit due to the use of economies of scale, and therefore they price-competitive. despite the increase in the international trade and the globalization of the world market, most companies have made their first steps at domestic level, and often under the auspices of their government, so that the market size of one country has a significant impact on global competitiveness. therefore, the small countries are quite limited in terms of the competitiveness and they try to make up for foreign trade, but regardless, there are much more favorable conditions for business development in the countries that have a large domestic market. eu-type economic integrations are suitable for small countries because they allow them to strengthen the pillars of competitiveness through the institution of a common market. 11. business sophistication this column includes business practice that enables the efficient production of goods and services. it includes features of the economic environment in the country and the activity of the companies themselves. this aspect, which is very important for national productivity, is reflected in the quality of their business networks, supporting industries, the number of domestic companies and their business partnership. it includes a highly desirable cluster formation which involves cooperation between companies on a common geographical location in order to encourage innovation. in addition, the sophistication of business in a country reflects the activities of individual companies, economic analysis (2014, vol. 47, no. 1-2, 111-126) 120 through their branding, marketing, distribution channels, business process sophistication, uniqueness and perfection of products and services offered in the market. 12. innovation technological innovations are the last pillar of competitiveness, which, together with the previous, are the most important factor of competitiveness in developed countries and are certainly basis for global domination of the economy. the value of all the listed pillars of competitiveness in the long term can be valorized only with constant technological advances. technical progress is the ultimate goal of improving competitiveness, but also the basic condition for the maintenance of a high level. innovation means that the business knowledge and technology in society are adaptable to thenological changes, and quickly integrated into the economy. however, countries which want to reach the highest level of productivity, in addition to the monitoring of technical progress, must trough the development policy to force the more technologically advanced activities, and, in accordance with their capabilities, to contribute to the technological progress. measuring of development on the other hand, we need an indicator of development suitable for the study of the economy, whose competitiveness follow the way described above. of course, the economic development is one multi-dimensional problem and it could be traced through complex series of indicators. methodology used to measure it here is not going to be treated widely because the topic is old, and that there is an extensive literature about it. emphasis is placed on the methodology of measuring the competitiveness of the national economy as a contemporary phenomenon. however, regardless of the all said above, for the purpose of analysis we need a representative indicator of development. it is certainly hard to find it, especially since it must meet some requirements of methodological correctness as the availability in the first line for all countries included in the ranking of competitiveness by the world economic forum. so if we want just one indicator of economic development, which would result in connection with the gci individual national economies the best is, especially because of the availability of data, and analytical value, since we choose only one indicator, to opt for the traditional gross domestic product per capita (gdp per capita). we are aware of its shortcomings from which the most important are the following: it is about nominal, not actual sizes, it reflects statistic, not dynamic, it is not showing the distribution, etc. regarding the methodological correctness, we decided that the selected indicator should be used from same reports on competitiveness by the world economic forum in which we use the information on gci. we are going on this way, not only because of the availability of data, but also because many above mentioned shortcomings of this indicator in our approach does not come into play, that does not affect the accuracy of conclusions. for example, we track the ranking of several successive reports which completely eliminates the need for a more realistic indicator of the dynamics of economic development. in this way we will, in the most objective and methodologically correct way, try to discern the relationship between development and competitiveness at the global level as it was presented in the last five reports. so, we start the analysis of the report on the global competitiveness 2008-2009, and finish with the report of 2012-2013. please note that in any report data on gdp per capita at current prices in u.s. $, are related to the previous year. knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 121 however, this can not affect the objectivity in research, considering the fact that the study takes a five-year period. also, results can be considered quite reliable considering the fact that the report covers more than one hundred major economies, and that the coverage is approximately the same in all reports, with no major fluctuations. correlation analysis in studying the relationship between competitiveness and development of the world economy we will use correlation analysis. since the countries are ranked according to both traits, and the rank is more important than the feature value, we decided for the rank correlation. since we consider the two characteristics, it is common to use spearmen correlation coefficient (kvrgić, 2013) here d denotes the difference between the rank order of the i element in relation to the characteristics of x and y, and n is the number of elements. data analysis the global competitiveness report 2008-2009 includes 134 countries. so, in each of these reports we will calculate the correlation rank of countries by development and competitiveness, because these markers are more important than the value of gci and gdp per capita. this, because the essence of these macroeconomic indicators is reflected precisely in their relative comparability. they do not show much, but they do so in the context of comparisons with the other economies. so simply, we want to show how big is correlation of the development rank and competitiveness of the national economies towards the last five reports on world competitiveness published by the world economic forum. in the other words, to answer the question of whether more developed economy also means more competitive economy. in the case of the first report of the considered rank correlation is very high, the ratio is as high as 0.880. in the following report from 2009-2010, number of the countries is almost identical, one economy less is covered, but the rank correlation is only slightly lower and amounted to 0.869. in the 2010-2011 report, the number of economies surveyed increased to 139, but the rank correlation remains insignificantly less, is 0.853. in the report 2011-2012, there are almost no major changes. number of countries that are still analized gradually grows, so here reaches 142, the ratio is almost identical to the previous one 0.854. nothing has changed dramatically even in the next case analyzed. the global competitiveness report 2012-2013, the research included an even larger number of countries (144), but rank coefficient between the competitiveness and development is the smallest, but still very high at 0.766. in the report for 2013-2014, rank correlation for 148 countries is 0,843. economic analysis (2014, vol. 47, no. 1-2, 111-126) 122 figure 2. correlation between competitiveness and development in 2008 the world economy has experienced a series of quackes. the mortgage crisis upgraded the credit, followed by the inflationary pressures which the suppression of a drop in demand, slowdown and uncertainty. the crisis began in the previous year, aroused a great loss in the financial sector where it originated, but it shook the developed countries considering the fact that there has been a general loss of confidence in the financial sector as a whole, which is one of the most important elements of competitiveness. underdeveloped countries were in a especially difficult position because of the growth of world energy and food prices. at the same time, attempts inflationary stimulating economic growth in some developing countries only increased the poverty of the population. although the crisis initially emerged in the united states, it is expanded both to other developed countries, and on the whole world because of the great influence of this powerful economy. this year, the bearers of national economic policies were in particularly difficult position because of high instability and unpredictability of the international economic environment, which could also jeopardize the competitiveness of most economies. however, regardless the start of the global financial crisis, globally, we can see strong positive correlation between competitiveness and development. this confirms that institutional reforms and economic policies significantly affect the performance of most economies in the world. in the coming year, there was a deepening of global economic crisis. it started as a financial crisis in developed countries, but in the 2009 it was definitely spilled into the real sector of the world economy. in addition to rising unemployment in the world, it is especially worrisome decline in consumer installment demand and growth of protectionism that threatened competitiveness, and is consequently disposed to overcome the crisis. developing countries are particularly affected by the fall in demand for their exports, reduced remittances and decline in fdi. “specifically, the capital that cannot be characterized as speculative is attracted by the conditions that are conducive to long-term knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 123 profit maximization, and that conditions are favourable business climate, competitive free market, simple bureaucratic procedures, legal certainty, and macroeconomic and political stability.”(knežević 2013, pp 10). the globalization of the world economy has made the consequences of the crisis to be felt in all countries of the world. in terms of general uncertainty it is very difficult to devise economic policies to create competitive conditions for economic growth and development. although it is still globally strong and positive correlation between competitiveness and development, in terms of strengthening protectionism in world trade, as well as threats of action even in the most liberal market economies, there is, as expected, a slight weakening of the correlation. the main characteristic of the global economic crisis in 2010 whas economic activity in less developed parts of the world inhabited by those in developed countries. government in developed countries have tried to mitigate the recession by encouraging spending, but that yielded tangible results, mainly due to high and rising unemployment. special problem with euro-zone countries was budget deficit and foreign debt. now europe is in the earthquake financial crisis. most countries do not have an exit strategy from the crisis because of the limited political and social situation in which they find themselves. this year, only briks countries achieved satisfactory economic growth and development. in this way, as leaders of the world economy are promoted the countries whose competitiveness is not significant, which is all set to further decline in the influence of the correlation coefficient between competitiveness and development of the national economy, regardless of the relationship remains strong and positive. this year 2011, after several years of crisis can be called stagnant in global terms as a significant encouragement. halted of the decline in economic activity, and slight signs of the recovery at the global level are encouraging, however they are not equally represented in all national economies. still with this aspect we have a better situation in the developing countries than in developed, regardless of the presence of certain inflationary pressures. developed economies still have a problem with unemployment, low purchasing power and sensitivity of the financial sector. the crisis in the euro zone, caused external debt of some major economies undermines the confidence of foreign investors and makes it difficult to overcome the crisis. most developed countries have tried to create an environment for economic growth, but it is an aggravating circumstance, as a rule, the budget deficit. similar to the stagnation of the world economy in this year is recorded a fall arrest coefficient of correlation between competitiveness and development. and the wef by itself, as it considers it necessary to expand the concept of the competitiveness of the national economy in order to facilitate political and business leaders around the world to bring their economies out of the crisis to long-term sustainable development. in the year 2012 economic uncertainty in the world is renewed, unlike last year when it seemed that the crisis has stopped. the difficulties of the financial sector in developed countries have not been overcome, as well as the crisis in the euro zone. the debt crisis in europe and fiscal uncertainty in the u.s. definitely worried all businessmen. slowed is even the economic growth of briks, so it could not been seen the region's economic dynamism which would have beneficial effect on the faltering world economy. there is a general concern about possible significant drop in global trade, which would definitely mean a deepening and prolonging the crisis. to make the economy out of crisis and to open to itself economic analysis (2014, vol. 47, no. 1-2, 111-126) 124 good long-term perspectives, it is essential that the public come out of depression and to develop the concept of sustainable competitiveness, which will take into account not only economic factors but also social and environmental issues. this period due to the decline of optimism in public, and the lack of vision of the leaders of the world economy led to the first significant weakening of the links between competitiveness and development. achieved coefficient is positive medium, but it is a warning that we should move decisively in reviewing the ruling neo-liberal conception of the development of the world economy. next, 2013 year is giving, for first time since the outbreak of the global economic crisis, cause for optimism. in addition to further strengthening the role of the less developed countries, revivives economic growth and reduce poverty at the global level. progress has been slow and minimal, and it is absolutely difficult to make long-term forecasts, but it certainly has, after many years, the reason for guarded optimism in the global economy. structural reforms and investments remain priority in order to reduce unemployment by almost all countries of the world. the road to the lasting prosperity of the world economy is back on innovation. new technologies and new products are the key to economic progress of any country in the long run. it seems that once again comes to the fore the idea that lasting economic growth and development can only be based on innovation, and that means improving education. so this is the way to revitalize the idea of the responsibility of the national leaders in actual creating of the conditions for the creation of conditions for the verification of the social equity. this also explains the re-growth of the coefficient of correlation between competitiveness and development on a global scale for the first time since the outbreak of the crisis. a strong positive relationship between these two phenomena was rerecorded. conclusion in this review, we gave an overview of development of the concept of competitiveness of national economies in a theoretical sense. also mentioned are the world's most authoritative researchs in this area. we opted for a more detailed overview of the methodology of the world economic forum and explained why we think is the most complete. analysis of the medium term based on the global competitiveness report published regularly by the institution, we found a high correlation between ranking of global competitiveness of individual economies and their development. what we can conclude from all? can we confirm the implicit assumption by the whole concept that increased competition leads to an economic development? it is definitely difficult based on such a brief overview. limitations to make definitive conclusions are serious. even if we include the review and the first three reports, the series are small, and the period of time is short that so to could be observed regularities in the economic development of such a numerous very different economies. however, it is true that the correlation of these phenomena is extremely high, and the correlation coefficient has an average value of up to 0,844 for the period, showing the global level, it is evident a strong link between these two phenomena. as higher is an economy ranked in terms of competitiveness, the development it is better ranked. or maybe, opposite is the case: the more developed is an economy, it is more competitive. it remains eternally knežević, v., et al., development of national economy, ea (2014, vol. 47, no, 1-2, 111-126) 125 opened as the question of what is cause and what effect. at this level of analysis it is very difficult to give a definitive answer because both, the development and the competitiveness are two extremely complex phenomenons, and each specific industry is specific. considering such a high correlation between competitiveness and development, and the fact that many elements of competitiveness can be improved without significant investment, the creators of economic systems and economic policy actors should definitely work on improving the competitiveness of their economies. there is opportunity that they will, with no limitations, contribute to economic development. in any case, this inspiring subject is expecting further investigations. it would be very interesting to analyze the relationship between competition and development for different groups of countries classified according to the level of economic development. references dragutinović lj., filipović, m.,cvetanović, s. (2005). teorija privrednog rasta i razvoja. centar za izdavačku delatnost ekonomskog fakulteta u beogradu, beograd knežević v., kvrgić, g., ivković, d. (2013). “serbian modern economy-regoinal comparative analysis”, international review, 1-2, faculty of business economics and entrepreneurship, belgrade. kvrgić, g. (2013). ekonomska statistika. visoka škola za poslovnu ekonomiju i preduzetništvo, beograd peter sanfey and simone zeh. (2012). making sense of competitiveness indicators in southeastern europe, ebrd working paper no. 145, http: //www. ebrd. com/ downloads/ research/ economics/ workingpapers/ wp 0145. pdf). rakić, b. (2003). međunarodni marketing. megatrend univerzitet, beograd. schwab, k. ed. (2008). the global competetiveness report 2008-2009 geneva: world economic forum. schwab, k. ed. (2009). the global competetiveness report 2009-2010 geneva: world economic forum. schwab, k. ed. (2010). the global competetiveness report 2010-2011 geneva: world economic forum. schwab, k. ed. (2011). the global competetiveness report 2011-2012 geneva: world economic forum schwab, k. ed. (2012). the global competetiveness report 2012-2013 geneva: world economic forum. schwab, k. ed. (2013). the global competetiveness report 2013-2014 geneva: world economic forum. the heritage foundation, 2014. index of economic freedom, country rankings, www.heritage/index/ranking economic analysis (2014, vol. 47, no. 1-2, 111-126) 126 konkurentnost i razvijenost nacionalnih privreda rezime – ovaj rad se bavi vezom između možda dva najaktuelnija fenomena svetske ekonomije: konkurentnosti i razvijenosti. naravno da se oba mogu tumačiti na više načina, ali najoperativnije je konkurntnost razmatrati po metodologiji svetskog ekonomskog foruma kroz globalni indeks konkurentnosti, a razvijenost preko bruto domaćeg proizvoda po glavi stanovnika. namera nam je da utvrdimo kakva je i kolika veza između ova dva pokazatelja u globalu, i na taj način otvorimo pitanje, i uspostavimo metodologiju za dalje analize kod pojedinih grupa zemalja razmatranih u izveštajima svetskog ekonomskog foruma o globalnoj konkurentnosti u svetu. zato ćemo koristiti korelacionu analizu između ovih pokazatelja za posmatrane privrede nakon 2005 godine od kada se i sprovode pomenuta istraživanja konkurentnosti, sa akcentom na poslednjem srednjoročnom periodu zbog aktuelnosti. očekujemo odgovor na pitanje kakva je veza između ovih pokazatelja u vremenskom sledu za sve posmatrane zemlje. to je značajno i za zemlje bivše jugoslavije kao orijentacija u naporima za popravljanje pozicije u svetskoj privredi. ključne reči: konkurentnost, razvijenost, korelacija, kriza article history: received: 23 january 2014 accepted: 2 march 2014 doi: 10.28934/ea.21.54.2.pp30-40 original scientific paper economic impact of the covid-19 pandemic on western balkan countries duško bodroža1* | milena lazić1 1 institute of economic sciences, belgrade, serbia abstract the covid-19 pandemic has caused major economic imbalances and impeded economic activity in all western balkan (wb) countries. this paper analyzes the strength of economic impact of the ongoing health crisis on key macroeconomic variables (gdp, public debt, fiscal balance, and unemployment) in the wb countries. in addition, the paper points out the main challenges that the economies of these countries will face in the years to come. the analysis has shown that the crisis slowed down the wb economies, but its intensity differed among the observed countries. the main economic challenges in the coming period relate to the further course and duration of the pandemic. due to the great level of uncertainty, more detailed analysis of the crisis’ impact on the economic potential will be possible only after the end of the pandemic. key words: covid-19, gdp, fiscal balance, public debt, unemployment, western balkans jel classification: e60, f40, g01 introduction the global pandemic triggered by the contagious coronavirus outbreak represents an acute global health and economic shock. unlike previous economic crises, this crisis is not caused by an economic factor, which makes it very difficult to compare to something similar from the past (pavlović et al., 2020, erić et al., 2021). the crisis caused by the covid-19 pandemic differs significantly from previous recessions due to the fact that directly affects the real economy when it comes to both aggregate supply and demand (carletti et al., 2020). the initial decline of the aggregate supply due to disruption of the global production and supply chain as well as reduced labor engagement on one hand, and a drastic decline in aggregate demand due to imposed social distancing measures, declining employment, and reduced wages (firano and fatine, 2020) on other, led to a sudden and symmetrical shock to a large number of economies worldwide resulting in a dramatic slowdown of the global economic activity (imf, 2020). results of resent analysis indicate that “the covid-19 pandemic has generated the worst world economic recession since the great depression” (bortz et al., 2020). according to data published by the international monetary fund, the global economy shrank by 3.3 percent last year (imf, 2021). the subject of this paper is the analysis of the impact of the covid-19 pandemic on the countries of the western balkans (albania, bosnia and herzegovina, montenegro, north macedonia and serbia). the covid-19 pandemic has caused huge disruptions in the economic activity of the observed wb countries, which were already lagging behind in terms of economic conversions to * corresponding author, e-mail: dusko.bodroza@ien.bg.ac.rs duško bodroža, milena lazić 31 union (wb, 2021). the aim of this paper is to evaluate the economic impact of the crisis on key macroeconomic variables (gdp, public debt, fiscal balance and unemployment) in wb countries. in addition, the paper points out the main challenges that the economies of these countries will face in the years to come. given that the covid-19 pandemic is still present and that its future course is very unforeseen, authors believe that at this point of time it is still early to apply a quantitative approach in the analysis primarily due to the fact that implementation of such a model requires the inclusion of a large number of assumptions which at this point of time, unfortunately, cannot be fully comprehended. for this reason, in this paper authors opted for empirical analysis using a descriptive method when evaluating the impact of the covid-19 pandemic on the economies of the wb countries. with that regard, the paper aims to answer the following questions: • what are the economic effects of covid-19 in wb countries? • what are the main risks facing the wb economy? the paper is divided into 5 parts. in addition to the introduction, part 2 provides an overview of the scientific literature that analyzes the impact of the covid-19 pandemic on the global economy. in part 3, the impact of covid-19 virus on basic macroeconomic variables in wb countries was analyzed using different data sources. subsequently, part 4 contains a discussion emphasizing the main challenges that the economies of the wb countries will face during the following years. finally, section 5 presents our conclusions. literature review the covid-19 pandemic has resulted in unprecedented, unforeseen, and most abrupt economic downfall in modern economic history (european commission, 2021). the ongoing health crisis has had devastating impacts on all aspects of the society, some of which are predicted to have high scope and long-term effects. by the end of april 2020, there were more than 3 million confirmed cases of the covid-19 disease distributed among more than 180 world economies (world bank group, 2020). the lingering health crisis has profoundly affected aggregate supply and demand both on national, and global level (stanceva gigov, 2020). according to the oecd’s march 2021 economic outlook (oecd, 2021) the global gdp expressed in real terms shrank by 3.4 percent in 2020 but is projected to rise by 5.6 and 4.0 percent in 2021 and 2022, respectively. it has been widely accepted that the covid-19 pandemic has been overshadowing other developments while at the same time has accelerated existing trends (balkans in europe policy advisory group, 2020). the measures taken to suppress the spread of the contagious coronavirus have put the world into the state of “forced hibernation”. the crisis has severely hit external demand, prices of export commodities, and flow of international remittances (world bank, 2020a) on one hand, as well as financial outflows, fx rates, foreign reserves, and interest rates (hofmann et al., 2020), on other. the pandemic’s influence on global inflation and volatility of the financial instruments has already been profound (baker et al., 2020a), but its overall economic effects are yet to be evaluated (zaremba et al. 2021). with that regard, results of mckinsey's global survey imply that global sentiment remains high in january 2021, even though it has tempered since december 2020 (mckinsey, 2021). furthermore, bnp paribas' report indicates that major impacts of the covid-19 pandemic on the global production and trade are expected to be: accelerated deglobalization, reduced scope of trade and level of foreign direct investments (fdi), as well as lower productivity (bnp paribas, 2020). in domain of consumer behavior, new normal which will include structurally higher savings, less leisure travel, and greater remote working is foreseen to establish. apart from that, increased burden of public debt is predicted to become one of the major legacies of the covid-19 pandemic (morron salmeron and garcia arenas, 2021). in addition, sectoral impact of the covid-19 crisis defers substantially from normal recessions (european commission, 2021). the most affected sectors are contact-intensive services (lazić et al., 2021). it is estimated that at the peak of the first wave in q2 2020 economic activity in these 32 economic analysis (21, vol. 54, no. 2, 30-40) sectors was 25 percent lower compared to the pre-covid-19 levels. activities in pro-cyclical sectors (like industry and construction) are estimated to decrease somewhat modestly – 19 percent and 15 percent, respectively. finally, remote-work intensive services with high-skilled employees such as ict, finance, and real estate are estimated to contract less than 10 percent. furthermore, the regional and local impacts of the covid-19 pandemic are highly heterogeneous. by november 2020, it became clear that the impacts of the global pandemic differ substantially not only across countries, but also across lower political and administrative divisions within the countries, both in terms of declared cases and related deaths (oecd, 2020). according to a brief study published by kpmg countries and regions across the globe are expected to experience divergent recovery paths which will mostly be influenced by their experience in mitigating the spread of the coronavirus, on the one hand, and the underlying socio-economic characteristics of each country or region, on the other (kpmg, 2020). it is also projected that more trade-exposed economies are going to take proportionally longer period to recover. finally, the countries with the lowest income were those affected the most. during the pandemic emerging market economies (emes) have faced the largest capital outflows (bis, 2020) that were consequently followed by the negative spillovers of the economic downfalls in developed economies (bortz et al., 2020). moreover, less developed countries compared to developed ones have at their disposal less space to mitigate crisis’ negative effects (aizenman et al., 2019). when it comes to western balkans, the region has registered the main waves of covid-19 infections later than the vast majority of european union countries. nevertheless, contingency strategies were implemented at the same time and with equal force as in the rest of europe (emcdda, 2021). by the end of october 2021 (table 1), the total number of registered cases in the western balkans was 3,0 percent of the total number of cases registered in europe, while the total number of deaths, the total number of people recovered, and the total number of active cases represented 2.6 percent, 2.9 percent, and 3.9 percent of the same categories recorded for europe, respectively. table 1. the covid-19 reported cases by october 28, 2021 – world, europe, and western balkans 28-oct-21 total cases deaths recovered active cases mortality ratio world 246,165,934 4,994,011 223,052,026 18,119,897 2.03% europe 63,845,667 1,293,402 57,631,960 4,920,305 2.03% albania 183,873 2,902 173,443 7,528 1.58% bosnia and herzegovina 252,083 11,477 192,218 48,388 4.55% montenegro 142,807 2,087 136,212 4,508 1.46% north macedonia 201,292 7,098 187,695 6,499 3.53% serbia 1,125,602 9,761 990,667 125,174 0.87% western balkans 1,905,657 33,325 1,680,235 192,097 1.75% source: who coronavirus (covid-19) dashboard, retrieved from: worldometers.info, accessed 10/28/2021 the region is expected to enter a recession whose magnitude will be mostly affected by the duration of the covid-19 outbreak in developed european countries (world bank group, 2020). the current pandemic is expected to have lasting social, political, and economic repercussions in the western balkan countries (cep, 2020). to make economic recovery sustainable over the medium term, some of the western balkan countries would have to implement higher-resilienceto-shocks mechanisms into their economic systems. at the same time, it is advisable that all of the duško bodroža, milena lazić 33 western balkan countries should continue to conduct structural reforms to boost productivity in the years to come (world bank group, 2020). impact of covid-19 crisis on wb economy the crisis caused by the covid-19 pandemic has caused major economic disruptions and impeded economic activity in all wb countries. as the countries officially declared the epidemic, various epidemiological measures were imposed i.e., the ban on movement, social distancing, and suspension of certain activities, which resulted in the deterioration of almost all economic indicators. the extent to which these measures had an impact on individual countries depended primarily on the part of the economy that was affected by them and the time in which they were applied. from the following graph, we can see that the covid-19 crisis hit montenegro the hardest, where the gdp decline in 2020 was 15.2%. the main reason for such a large decline is the high dependence of this country's economy on service activities, primarily tourism (ivanović et al., 2021). therefore, these macroeconomic shocks affected montenegro to a greater extent compared to other countries (imf, 2020). other observed countries did relatively well in the crisis, primarily serbia, which in 2020 recorded a decline in gdp of 1%. common to all countries that recorded lower gdp in this crisis is the fact that the structures of their economies had a small share of service activities (prentice et al., 2021). graph 1. gdp growth in wb countries, 2019-2021*, % source: world bank *forecast in response to the covid-19 pandemic, the governments of the observed countries implemented strong monetary and fiscal support to limit the negative impact of the crisis on economic growth. such support, together with a decline in the collection of fiscal revenues as a result of the economic activity slowdown, has led to an increase in the fiscal deficit and public debt in all observed countries. the largest fiscal deficits in 2020 were recorded in montenegro (-11.0% of gdp), north macedonia (-8.2% of gdp) and serbia (-8.1% of gdp). -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 2019 2020 2021* 2.2 -3.5 5.0 2.8 -5.5 3.54.1 -15.2 9.0 3.2 -4.5 3.84.2 -1.0 5.0 albania bosnia and herzegovina montenegro north macedonia serbia 34 economic analysis (21, vol. 54, no. 2, 30-40) graph 2. fiscal balance in wb countries, 2019-2021*, % of gdp source: world bank *forecast with the growth of the fiscal deficit, the need for falling into greater debt grew sharply as the covid-19 disease spread. all observed wb countries in 2020 recorded an increase in the share of public debt in gdp. montenegro (28.6%), albania (11.4%) and north macedonia (11.4%) recorded the highest growth of debt-to-gdp ratio. considering the other wb countries, the share of public debt in gdp in serbia increased by 4.0% while in bosnia and herzegovina grew by 4.6%. if we look at the debt-to-gdp ratio in relation to the set maastricht criteria (60% of gdp), we can see that the level of debt in bosnia and herzegovina, north macedonia and serbia is below the prescribed level. on the other hand, in montenegro, the debt-to-gdp ratio at the end of 2020 was 105.1%, which is an indicator of high risk. in the same period, albania recorded a debt-to-gdp ratio of 75.1%. graph 3. public debt in wb countries, 2019-2021*, % of gdp source: world bank *forecast -12.0 -10.0 -8.0 -6.0 -4.0 -2.0 0.0 2.0 2019 2020 2021* -2.0 -6.7 -5.4 1.9 -5.4 -2.3-2.7 -11.0 -5.1 -2.2 -8.2 -5.3 -0.2 -8.1 -5.0 albania bosnia and herzegovina montenegro north macedonia serbia 0.0 20.0 40.0 60.0 80.0 100.0 120.0 2019 2020 2021* 63.7 75.1 75.4 32.8 37.4 38.2 76.5 105.1 90.1 40.7 51.4 56.549.7 53.7 54.0 albania bosnia and herzegovina montenegro north macedonia serbia duško bodroža, milena lazić 35 with the exception of montenegro and albania, we can conclude that public debt in the other observed wb countries is sustainable and far from the level that could lead to a crisis. however, one should keep in mind the fact that interest rates are currently at an all-time low and that their growth in the future could lead to problems in servicing debts. graph 4. discretionary fiscal response to the covid-19 crises in wb countries, cumulative spending in 2020 and the first four months of 2021. source: international monetary fond observed by country, different fiscal and monetary policy measures were taken. their shaping was influenced primarily by the fiscal space that the governments of the countries had at their disposal and the possibilities of using monetary policy instruments. the economic assistance package in the wb countries consisted of a combination of short-term crisis mitigation measures, the provision of subsidized loans to firms, the introduction of tax reductions or deferrals or loan repayments, or the subsidization of wages for affected firms. in addition to these measures, trade ones were created with the aim of banning the export of medical equipment or food products (wb, 2020, pavlović et al., 2020, đuričin and beraha, 2020). regardless of the type of measures chosen, all wb countries exceeded their planned fiscal results and projected pre-pandemic public debt levels. montenegro and serbia were in the lead. the slowdown in economic activity also affected the labor market, as can be seen from the graph below. 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 albania bosnia and herzegovina montenegro north macedonia serbia 2.3 4.3 7.6 4.3 8.3 1.6 0.0 5.6 3.1 2.4 additional spending and forgone revenue equity, loans, and guarantees 36 economic analysis (21, vol. 54, no. 2, 30-40) graph 5. unemployment rate in wb countries, 2019-2020*, % source: international monetary fund, montenegro see – 6 economic outlook *forecast of the observed countries, only north macedonia in 2020 recorded a decrease in the unemployment rate from 17.3% to 16.4%. all other wb countries had an increase in the unemployment rate in the observed period: bosnia and herzegovina (3.3%), montenegro (2.8%), serbia (2.4%) and albania (1.0%). unemployment rates indicate that the labor market has remained relatively stable given the severity of the crisis. strong fiscal and monetary stimulus certainly contributed the most to this. discussion the economic measures taken to alleviate the crisis have stimulated economic growth, reduced unemployment, but also the growth of public and budget deficits in all observed wb countries. we can conclude that the measures have given a positive short-term result, but it should be borne in mind that the covid-19 virus is still present and that from a macroeconomic point of view, these measures are not sustainable in the long run. given the high degree of unpredictability about the further development of the pandemic, we believe that decision-makers in the observed wb countries should be very careful in choosing future measures, especially given the fact that now the scope for counter-cyclical fiscal policy in many countries is narrowed. also, the measure of direct assistance to citizens and the economy through the provision of grants has proven to be quite ineffective in developed countries. in the united states, on average, less than 40% of transferred funds were spent, which means that the effects on aggregate demand were relatively small (coibion et al., and baker et al., 2020b). the main challenges for the future growth and development of wb economies lie primarily in the duration of the covid-19 pandemic. although these trends show that the current effects of the pandemic are smaller than during the first wave (imf, 2021), the situation is still very uncertain. in such circumstances, investors are still quite cautious, which may lead to a continued decrease in foreign capital inflows, especially foreign direct investment (fdi), on which wb countries are highly dependent (marijanović and đukić, 2020). during 2021, according to the uncdte, global capital flows decreased by 42%, while in the countries of southeast europe, to which the wb countries belong, the decline was 28% (uncdte, 2021). a drop in capital inflows would also have negative effects on interest rates, which would increase fiscal costs for wb 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0 2019 2020 2021* 11.5 12.5 14.0 15.7 19.0 17.5 15.1 17.9 14.3 17.3 16.4 16.3 10.9 13.3 13.0 albania bosnia and herzegovina montenegro north macedonia serbia duško bodroža, milena lazić 37 countries, especially those with a high debt-to-gdp ratio such as montenegro and albania, due to rising interest rates. in addition to fdi, inflows from remittances are a very important factor for all wb countries (russell and oruc, 2019). a slowdown in economic activity in western european countries, where most wb nationals are temporarily or permanently employed, would have a negative impact on the balance of payments and economic growth. also, western europe countries are the largest trading partners for wb countries (bonomi and uvalic, 2019). a slowdown in growth in these countries would reduce the exports of the entire wb, which would have a negative impact on the dynamics of their economic growth. finally, the long-term sustainability of economic recovery requires the implementation of structural reforms aimed at boosting productivity growth. in order for the economies of the wb countries to be more resistant to external shocks, it is necessary to diversify their economic structure. future diversification should be based on green technologies and smart specialization, which would achieve a synergetic effect with the current economic structure. in a broader context, it is a simultaneous attempt to respond to the challenges of the global covid-19 pandemic by using various instruments to increase resource efficiency through sector-specific improvements (montresor and quatraro, 2020, santoalha and boschma 2021). conslusion the crisis caused by the spread of the covid-19 disease has had a strong impact on the economies of the wb countries. according to conducting analysis, covid-19 crisis hit montenegro the hardest, where the gdp decline in 2020 was 15.2%, while other observed countries did relatively well in the crisis, primarily serbia, which in 2020 recorded a decline in gdp of 1%. due to the simultaneous shock which occurred to both aggregate supply and demand, there was a drop in gdp and an increase in unemployment in all observed wb countries. strong fiscal and monetary stimuli have mitigated these negative effects but also burdened public debt and the budget. shortterm measures to mitigate the negative effects of the crisis are very expensive and unsustainable in the long run. it would be economically justified to focus the new anti-crisis measures selectively on those economic activities that are most affected by the crisis. future recovery is unlikely to be equally quick and easy for all countries. the duration of the crisis will depend primarily on the further course of the pandemic. in addition, we see the slowdown in the inflow of foreign capital, especially fdi, as well as remittances from abroad, as the main challenges of the economic recovery. also, the speed of the eu's recovery as our largest foreign trade partner will significantly affect the speed of the wb's recovery. the conclusions and analyzes presented in this paper cannot be considered final given that the covid-19 virus is rapidly spreading in all observed wb countries at the time of writing this paper (october 2021). also, the 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https://www.worldbank.org/en/publication/global-economic-prospects. accessed: 10/2/2021. world bank, 2021. “western balkans regular economic report no.19 subdued recovery”. https://doi.org/10.1596/35509. world bank group. 2020. “the economic and social impact of covid-19 – western balkans outlook”. western balkans regular economic report no.17. retrieved from: https://euagenda.eu/upload/publications/the-economic-and-social-impact-of-covid-19western-balkans-outlook.pdf. accessed: 10/2/2021. article history: received: october 5, 2021 accepted: november 1, 2021 https://www.worldbank.org/en/publication/global-economic-prospects https://doi.org/10.1596/35509 https://euagenda.eu/upload/publications/the-economic-and-social-impact-of-covid-19-western-balkans-outlook.pdf https://euagenda.eu/upload/publications/the-economic-and-social-impact-of-covid-19-western-balkans-outlook.pdf economic impact of the covid-19 pandemic on western balkan countries duško bodroža10f* | milena lazić1 introduction literature review impact of covid-19 crisis on wb economy discussion conslusion references ea_2017_1-2 udc: 364.35 jel: h4, j3, j1 cobiss.sr-id: 240665612 scientific review the macroeconomic framework of the functioning of public compulsory pension insurance gordana đukić, university of belgrade, economic faculty, serbia1 mladenka balaban, institute of economic science, belgrade and independent university banja luka, faculty of economic, bih2 goran radisavljević, municipality od sokobanja, serbia 3 abstract – unfavorable demographic trends, economic and political crisis created the need to analyze the current situation in the pension system and created the concept of the modern system. existing public and private poles are the main causes of the crisis, especially the pension system based on intergenerational solidarity that has become unsustainable. the main problem is that the rate of the elderly population increases, the birth rate decrease, and revenues decreasing number of employees is not sufficient to support consumption ie. pension benefits a large number of pensioners. the sustainability of the system is reflected in the fact that the net income of pension funds should be increased to the same extent as net expenses, in order to maintain a constant net power. maintaining living standards requires expenditure to finance the deficit of pension funds, which is achieved by budget transfers. maintaining the balance of revenues and expenditures of pension funds, and the three pension pillars and the state budget is a priority to maintain economic stability, because the lack of purchasing power of pensioners causing social insecurity and unfavorable situation in public finances and the financial markets. key words: social insurance, pension system, pension benefits, pension system reform, pension plans, pension models introduction pension systems in the period of globalization and transition are the priority national goal, which is standardized in international agreements and directives and action plans. the system is specific to each country in terms of models, strategies and plans. a comparative analysis of pension systems of more countries can find solutions to existing problems. for directions successful reforms, useful experience to the same extent, developed, developing and transition countries. pension costs, pension fund deficits, an aging population, the decline in fertility, increase in average age, unemployment, and increased number of 1 research associate, university of belgrade, economic faculty, serbia 2 professor, institute of economic science, belgrade and independent university banja luka, faculty of economic, bih 3 adviser for finance, municipality od sokobanja, serbia đukuč, g. et al., the macroeconomic framework, ea (2017, vol. 50, no. 1-2, 26-37) 27 pensioners are the main causes of unsustainable pension systems. in this respect, the effects of changes depend primarily from the makers of macroeconomic and social policies in terms of taking urgent measures for the development and implementation of the national strategy of the pension system. this is confirmed by the fact that in times of economic crisis is expected increase in pension costs and economists around the world interested in the promotion and creation of a new pension system. in addition to the existing state payg system, it is necessary to create other capitalized private pension systems. realization of pension welfare would affect macroeconomic stability, to increase savings, economic growth, and productivity. the paper will show successful models of reform in certain countries of the capitalized pension system that contributed to the development of capital markets and individual and common welfare. the public "pay as go" pension system is largely represented in all countries and is implemented with the additional "fully funded" forms of pension insurance, because in this way increase pension benefits. the capitalization of the pension system becomes more and more important due to insufficient government funding. reform and differentiation of pension systems in the european union is a central question in terms of structural reforms. in the process of the reform serbia is obliged to, based on the experiences of other countries, the implementation of the most appropriate model for reform of pension system in line with international norms and standards, as well as the norms and standards of the european union. the main risks of mandatory pension system proper functioning of the compulsory pension insurance is carried out in the macroeconomic framework, including macroeconomic stability. will the pension system operate without the risk depends on the degree to which are present political, financial or social pressures on the mandatory pension system? the pension crisis caused by negative demographic, economic and political factors requires reform of the pension system. adequate pension reform will effect on the macroeconomic performance such as employment, economic growth, lower inflation, and efficiency of the financial markets. table 1. the main demographic risks of mandatory pension system source: holzmann, r. a ,world bank persepctive on pension reform, http://pensionreform.ru/files/24691/eng11.pdf 28 economic analysis (2016, vol. 50, no. 1-24, 26-37) in the first case, the assumption is that the real productivity unchanged, despite the negative demographic trend. it is assumed that t is the generation of two times greater compared to the next-generation t + 1, but the level of productivity is not changed despite the fact that the real earnings per capita were twice greater: ���� = 2�� . based on the well-known payg system formula, it appears that the ��� �� � = �� � � respectively, despite the reduction replacement ratios ��� real pension �� remains the same. in this case, capitalized (fully funded) systems do not have any risks in a situation where a higher level of productivity per capita and when the higher real wages, which requires that the demand of existing employees is the same in financial assets balance of social product, and consequently the existing pensioners have a realistic anticipated retirement.4 in the second case, the problem occurs when there is productivity growth, which does not offset the negative demographic trend. the assumption is that the n� = 2n� + 1 and productivity remains unchanged wt = wt+1. on the basis of the above payg system formulas can be noted that every future retiree has a halved retirement p��� = �� , or the contribution rate is twice as high ��� = 2 � to maintain pension at the same level p���a = p�. neither option is not viable in the long term. the problem can not be solved using transition payg (in fully funded) system, because then there would not be sufficient funding for the older generation demand, due to the much smaller working population. future real pensions in the capitalized system are lower than expected, due to higher prices and lower interest rates and due to the size of the workforce. on this basis, it is concluded that the problem is not demographic but the fiscal. to what extent a country is economically stable, may be determined based on a number of indicators such as real gdp growth, inflation, fiscal deficit, public debt and the share of state financial support for economic development, as a percentage of the state budget. without a real gdp, compulsory pension systems are influenced by multiple macroeconomic shocks (and risks). one of the most important factors to mitigate macroeconomic shocks is employment. uncertainty about the level of employment in the future and creates dissatisfaction among employees with retirees, because changing the level of their income. according to barr, n. (2000), the main determinant of macroeconomic stability, the effect of productivity at the national level, is a positive balance in the state budget (gdp). dealing with macroeconomic shocks implies political activities such as: first, an increase in labor productivity of each worker, and secondly, increasing the number of employees. in order to increase productivity it is necessary to provide: investment capital, improve the work quality and corresponding investment and using the appropriate human capital. 4 barr, n. (2000). „reforming pensions: myths, truths and policy choices“, imf working pepers, 139, imf, fiscal affairs department, p. 33. đukuč, g. et al., the macroeconomic framework, ea (2017, vol. 50, no. 1-2, 26-37) 29 in order to increase productivity it is necessary to provide: the capital investment, increase the quality of the work with the appropriate investments and using the appropriate human capital. in order to increase the number of employees policy measures are required to increase labor force: favorable conditions for child care, tax policy which does not preclude employment with limited hours, raising the retirement age, the direct import of labor force. achieving macro stability is possible by the strengthening economic growth, in the same extent and to enhance long-term sustainability and financing pay system (barr, n., 2000). another factor affecting economic stability and uncertainty of income of employees and pensioners is inflation. uncertainty of income of employees and pensioners increases due to inflation and unstable prices. inflation risk is defined as the risk that can affect the accumulated pension assets and the purchasing power of pensioners in the conditions of unstable price. private mandatory pension funds are at greater risk of payg system, because they use the accumulated capital for granting a pension. payg systems financed by the working population are protected to some extent from inflation risks, because the state guarantees for pension indexation. when funded funds, individuals can protect themselves from risk if they buy a certain guaranteed state funds, and inflation-indexed annuities. longevity risk is not represented in payg systems, as opposed to funded systems. in funded systems, individuals pay annuities, on the other hand there are certain disadvantages related to increased life of the elderly population. insurance companies have information, when nude anuitet individuals, about the average age of the previous and current generations, but do not take into account the possibility of longevity. the second risk relates to the individuals with forecast the lower life expectancy than the average age, so that they are not interested in annuities that are based on the average age. insurance companies are forced, because of the expected longevity projected for the projected period, to raise the price of annuities. for individuals who have the probability for high life expectancy, compared to the projected longevity, insurance companies adjust and raise once again the cost of annuities, which creates additional risk willingness of individuals to accept that offer of insurance companies. under the political risks are implied political action that substantially alters the amount of future pension benefits. the assumption is that the in payg systems are higher risks, due to frequent changes of government and political goals and decisions about frequent changes in legal regulations. these risks are less represented in the funded ("fully funded") systems, as in developed countries pensioners have guaranteed property rights. the state or political authority directs mandatory pension systems. the government has realized the parametric reforms by political measures (political measures are implemented parametric reforms) to eliminate the risks and mitigate the burden on the state budget pension costs, such as: 30 economic analysis (2016, vol. 50, no. 1-24, 26-37) • an increase incontribution rates, which falls on the employer and employees. this causes uncertainty for employees, because it affects the reduction of their salaries and for the employer creates uncertainty regarding the cost of production and profitability; • decrease of the net replacement rates, so reducing the share of average pension benefits in the average net earnings employees. reducing pension benefits creates uncertainty for current employees and future retirees; • a combination of the options listed by the state that leads policy mitigating the effects of demographic aging. in this situation, despite the applied policy choices of different combinations of parameters, in order to reduce the cost of the state budget and pension fund, adverse effects related to revenues still have employees and retirees. (börsch-supan and reilheld, 1998). regarding funded system barr, n. (2013) argues that in the "pure form" of this system, there are annuity risks due to fluctuations in the financial market. the risks are allocated to the individual, but can be extended distribution of risk on the government, which is the guarantor of the insured. in this system, employees set aside a certain amount of their earnings to accumulate financial resources and based on them receiving certain annuities. in addition, the risk borne by the individual at the time when he retired, because faced with different prices when purchasing an annuity. risks are expanded and because of return future rates on accumulated funds and due to demographic risks such as projecting mortality rates. at the moment when an individual buys an annuity from an annuity seller, the risk falls on the seller, ie. annuity provider (barr, n., 2013). barr, n. (2013) examined the distribution of risk in different pension systems. in "pure" payg system, which is financed from the social insurance fund, the allocation of funding is intergenerational. the risk is distributed between generations of employees, with height adjustment contributions. present and future contributions vary depending on the amount of expenditures of the pension system, ie. the height of the debt. risk refers to the employee’s income which may vary, and this result in a change in the amount of contribution. it relieves successful if there is a capital that has accumulated in the past. in systems that are funded partly from social insurance funds and partly from general state taxes, the risks are distributed to taxpayers, borrowing from government funds, distribution of risk to current and future generations. payg system in practice is not entirely clear, because in different countries at the same time are combined the distribution of risk in the form of contributions and pension benefits of the employees and retirees (barr, n., 2013). the responsibility of public payg system has the state, because of inability to pay appropriate pension benefits, due to the deficit of public budget in the short term perspective. another political risk is when the amount of a pension benefits depends đukuč, g. et al., the macroeconomic framework, ea (2017, vol. 50, no. 1-2, 26-37) 31 on the behavior of the government. state increases public taxes and reduce pensioners income to reduce the deficit of the state budget. the behavior of the government can cause long-term risks, when for personal use in order to gain votes in political elections, promises to retirees a pension increase, which in reality do not have long-term character. recommended by the world bank, certain elements of risk management in the process of reforming the pension system, such as: credibility, partnership, knowledge transfer, building and strengthening of appropriate reform capacity, flexibility, respect for property rights, implementation experiences and criteria of reforms in other countries, but with adaptation to the specifics of the pension systems. world bank approach is that it is necessary to engage in constructive dialogue in order to be accepted without confrontation guidelines of various international institutions and donors of bilateral agreements. dialogues should take into account the guidelines of the international labor organization (ilo), which has traditionally had opposing views on strengthening funded at the expense of underfunded mandatory pension systems. exchange of opinions includes the implementation of the most recent consensus in the field of social security. risk management and reform pension systems, entail certain financial means, and the necessity of foreign partnerships with corresponding international bank in the financial market. the world has largely focus attention on the pension system, because of the increasing need to cover pension benefits of socially excluded groups and provide all conditions to enable older population, economic independence and the necessary conditions for living standards. worldwide, 25% of the population covered by adequate social protection, and half has no social protection. the level of social protection depends on the level of gdp, employment rates in the relevant sectors of the economy, the share of self-employed in the labor market. in order to overcome the problem of social protection recommended modification of the contribution rate to social security, to be available to many socially disadvantaged, ie. pension insurance are recommended and structural reforms in the macroeconomic environment in order to create conditions for the functioning of the pension system. risk management has two moments before and after the occurrence of the risk. efficiency of management is in the functioning of a risk, to prevent the occurrence of social risk. preferred is a variant remove risk ex ante than ex post mitigate the negative effects of the formation of social risk. preventive strategy reduces the possibility of undesirable effects of risk and increases the expected income of the individual and reduces its incongruity i.e. uncertainty. this strategy is applied in the context of social security, macroeconomic policy, employment policy, fiscal, investment policy, and others. 32 economic analysis (2016, vol. 50, no. 1-24, 26-37) table 2. the main macroeconomic risks of mandatory pension system macroeconomic risks public unfunded payg private funded – ff the negative consequences of negative shocks lower individual income (but the effects can be mitigated)) possible negative effects on financing (which cannot be mitigated) unemployment lower individual income (but the effects can be mitigated) no effects on financing, but certain individual income in the future will have less profit low wage growth lower individual income, but that can be mitigated no effects on financing or lower benefits the financial crisis (depression, war, high inflation, natural disasters) possible lower revenues, but the effects can be mitigated accumulated funds (share capital) is reduced or eliminated low rate of return no direct effects on the financing and individual income (benefits) no effects on financing or lower benefits source: holzmann, r. a ,world bank persepctive on pension reform, http://pensionreform.ru/files/24691/eng11.pdf social policy measures are mainly related to the reduction of risks in the labor market due to the high level of unemployment, low salaries, and pensions. management of various risks is possible by using different strategies: • migration strategy is applied preventive and for mitigating the demographic risks. • the appropriate population policy has a preventive action to prevent risks and consequently the actions to reduce migration trends. • protective strategies are formulated in order to mitigate the effects of risk: when individuals do not save, do not have sufficient income to repay the loan, when borrow money, or when they rely only on the income from the state. spending most minimal revenue has resulted in poverty and the inability to cover basic needs. • interventions in the labor market. probably one of the most important instruments of preventive risk prevention and economic and social polarization is the labor market management. interventions in the labor market provide access to useful work and support age population. stable consumption, as a rule, provides savings and formal social (pension, health insurance for, etc.) and informal security (family, marriage). interventions in the labor market imply the possibility of the existence of private savings and health insurance, an active policy for retraining the unemployed and for social benefits for the unemployed work force, defining minimal earnings. đukuč, g. et al., the macroeconomic framework, ea (2017, vol. 50, no. 1-2, 26-37) 33 the concept of the world bank (2005) proposed the pension system with the five pillars. zero pillar is designed with the goal that social pensions provide social security to the poor and pensioners who did not participate with their work in the formal sector. multipillar system protects individuals from a variety of demographic, economic, social and political risks. the sustainability of macroeconomic stability in the context of the sustainability of the pension system largely depends on the political actors, because the government needs to provide effective regulatory measures to control pension systems, financial and annuity market with the implementation of certain legal regulations and "rules that are uniform, fair, swift and predictable". characteristics of the pension system in serbia effects of insurance on economic growth is reflected in: 1. increasing the financial security of individuals, companies and countries, 2. stimulating trade, exchange and entrepreneurship, such as economic and trade companies from providing risk 3. what financial relieves the public and state funds, 4. accumulation of capital, and increase the channeling of savings to investment and economic development, 5. creating conditions for a quality standard of living and social security. the inflow of foreign direct investment depends on the business environment, market conditions and institutional environment that is very unfavorable in serbia. there are numerous barriers to business entrepreneurs and attracting foreign investment. they are manifested in the following areas: obtaining non-specific permits for land, lack of employment of workers, registration of property, enforcement of contracts in court, paying taxes, and other conditions of business, based on the report "doing business 2016" shows that serbia did not meet the criteria of business which refers to the transfer of ownership, due to the complicated and lengthy procedures in 2015. world bank (2016) has published in its report that serbia is on the 139th place for the issuance of building permits to foreign investors, in respect of which it takes 18 procedures and 272 days. serbia is, as far as international trade and the fulfillment of the contract, is on the 96th, regarding starting a business on the 65th and obtaining a loan on the 55th place.5 the report concluded that it is necessary that the republic of serbia improve regulatory practices, particularly in terms of cost for the building permit, as the highest in europe and central asia (26% of the value of the object that is being built). for business and foreign investments, the situation is very unfavorable. the problem for foreign investors, paying taxes, 39.7% of the total profit, where investors need to pay 61.87 per year. no fewer than 635 days of entry into force of foreign investors, 5a world bank group flagship report. (2016). „doing business 2016: measuring regulatory quality and efficiency“, the world bank, p. 231. 34 economic analysis (2016, vol. 50, no. 1-24, 26-37) legal certainty for investors is listed with 11 (0-18). serbia is ranked 81st in respect of investors, out of 189 countries in the world, which is the highest and worst ranking compared to other countries in europe. indicators of business conditions show characteristics of the business environment. they are based on the measurement and analysis indicates the necessary reforms, to be held regular jobs and all investment activities, licensing, property registration. this would enable business conditions, necessary to start a new trade, especially export contracts, in order to create a suitable business environment for economic growth, financial market development, increasing national income. table 3. global age index (global index agewatch) for the observed countries (2015) country rate in the world index environmental ability health pension income (the social pensions) united kingdom 10 79,2 76,78 65,68 70,06 76,29 germany 4 84,31 78,64 68,45 75,59 80,93 chile 21 66,27 66,02 49,52 74,37 70,82 mexico 33 56,26 66,67 28,67 64,55 73,38 hungary 39 52,18 63,15 35,83 47,45 73,17 croatia 61 43,97 58,88 29,98 55,28 50,5 serbia 66 41,7 60,2 21,2 45,32 65,83 source: http://countryeconomy.com the main role and responsibility in the creation of favorable conditions for attracting greenfield and brownfield investments a country, the host country government. at the macro, national level this implies: macroeconomic stability, the quality of laws, regulation of foreign debt, cooperation with the european union and other international partners, the low level of potential risk and implementation of promotional policies and strategies at the micro (local) level: developed infrastructure, a wider offer of building land, efficient administration, the reliability of the local government, good location and financial benefits. it should also be greater cooperation and greater inflow from russia, especially because of the current political and economic relations. in addition to russia, which has a "strong investment and economic power," countries that do not invest in serbia are switzerland, japan and china. the right choice of sdi and related economic structures, are necessary conditions to achieve the positive impact of investments. economic growth could be achieved by attracting greenfield investments, and to change their structure in favor of the industry, ie. production and exports. the only thing would be to "achieve a level of positive impact of fdi to gdp, exports, employment, and the economy as a whole." in contrast to countries where there has been a dynamic and stimulating growth, đukuč, g. et al., the macroeconomic framework, ea (2017, vol. 50, no. 1-2, 26-37) 35 serbia has had negative tendencies in the process of transition and privatization, in terms of attracting fdi, which had an adverse impact on the increase in unemployment and a reduction of gdp. empirical evidence suggests that there is a positive relationship between financial sector development, economic growth, sustainability of the pension system and reducing poverty. improving the performance of the financial sector, such as, for example, increased savings by individuals, and insured employed in pension funds, have a positive effect on the national saving, increase of gdp, increasing growth, and consequently to reduce poverty. and vice versa poverty reduction has a beneficial effect on the financial activities and economic growth, while "virtuous cycle" closes.6 it is estimated that in serbia there are currently no conditions for the introduction of the second pillar, as the financial market is underdeveloped and there are no developed companies. within the first pillar of changes were made in how the indexing of pensions, expanded the base for payment of contributions, extended retirement age. however, because pensioners are vulnerable and disadvantaged groups, in 2014 7.9% of the poor in the age group of 46-64 years, and 7.4% of the poor in the group of 65 years and more, it is necessary to introduce new reforms to order to improve their position. it is necessary to: • increase the contribution rate for the pension and disability insurance (pio fund) • paid from the state budget expenditures for health insurance pensioners for care and assistance and physical damage (instead of the pension fund), and • changing the way pension indexation and the indexation of previous earnings with the indicator "net replacement rate" because pensioners unfairly denied the benefits of economic progress in the future.7 the reform of the pension system, economic development and financial restructuring is impossible without the development of incentives. these incentives can provide development banks. in the world there are more models of development banks, and one of them could be applied in serbia depends on the assessment of experts. national development bank would be in their work: to follow the successful examples from europe and the world; which does not represent the interests of the group, already has the motive "to create equal opportunities for all"; which includes financial democracy. 6 tejerina,l.,bouillon, c. demaestri, e.g. (2006). „access to financial services and poverty reduction in latin america and caribbean, u: tejerina, l., bouillon, c., demaestri, e.g., eds., financial services and poverty reduction in latin america and caribbean, inter-american development bank (idb),washington, p. 9-10. 7 mijatović, b. (2015). „siromaštvo u srbiji u 2014“, tim za socijalno uključivanje i smanjenje siromaštvavlade rs, beograd, str. 11. 36 economic analysis (2016, vol. 50, no. 1-24, 26-37) conlusion interconnection security and economic growth has been demonstrated, as through private pension funds encourages savings and loans for economic investments. pension funds pay out benefits only after many years, so use long-term investments insured until the time of their retirement. in this way, the accumulated capital is used for investment capital investments, encouraging exports and economic growth, which has a positive impact on national competitiveness. theoretically and empirically it was shown that countries with developed financial markets, long speaking, have a stable economy and dynamic growth. in developed countries, the insurance had a impact on economic growth. in contrast, countries that are in transition and less developed countries, should encourage non-life insurance to a greater extent, because it has shown that it affects economic growth alike, and in developed and developing countries. in countries in transition, such as the republic of serbia, there is an economic crisis, the collapse of a large number of companies in the privatization process and the process of integration and the european union. member states and the candidate countries have an obligation to respect the directives and programs of the european union in terms of economic restructuring, reforms of pension systems and social inclusion. in serbia, there was a crisis in the pension system due to the rich of factors such as the high mortality rate, aging population, the decline in fertility and birth rates, unemployment, inadequate economic structure, lack of competitiveness of the economy, foreign trade deficit, the deficit in the gross domestic product, as well as public debt. appropriate economic policies, the choice of suitable foreign partners, the correct choice of greenfield foreign direct investment, would create the conditions for industrial development, increase exports, employment, and an increase in gdp, which would have a positive impact on the rate increase in net earnings, adequacy of pension compensation and sustainability of the pension system. acknowledgements this work is part of research projects by codes 47009 (european integration and socio economic changes of the eu economy) and 179015 (challenges and prospects of structural changesin serbia: strategic directions for economic development and harmonization with eu requirements), financial long learning by the ministry of science and technological development of republic of serbia references a world bank group flagship report. 2016. „doing business 2016: measuring regulatory quality and efficiency.“ the world bank. barr, n. 2000. „reforming pensions: myths, truths and policy choices.“ imf working pepers, 139, imf, fiscal affairs department. đukuč, g. et al., the macroeconomic framework, ea (2017, vol. 50, no. 1-2, 26-37) 37 holzmann, r. a. world bank persepctive on pension reform, http://pensionreform.ru/files/24691/eng11.pdf. mijatović, b. 2015. siromaštvo u srbiji u 2014. beograd: tim za socijalno uključivanje i smanjenje siromaštvavlade rs. tejerina, l., bouillon, c. demaestri, e.g. 2006. „access to financial services and poverty reduction in latin america and caribbean.“ in financial services and poverty reduction in latin america and caribbean, eds. tejerina, l., bouillon, c. demaestri, e. g. washington: inter-american development bank (idb). article history: received: 1 june, 2017 accepted: 9 july, 2017 ea_2016_1-2 udc: 330.341.1 330.322.3:37.043.1-051.81 jel: o31, j21, j4 cobiss.sr-id: 224801036 scientific review competitiveness index analysis: is investing in young people important for achieving national competitiveness? pavlović dejana1, institute of economic sciences, belgrade, serbia ljumović isidora, institute of economic sciences, belgrade, serbia abstract – the aim of the paper is to analyse how investing in young people affects the overall national competitiveness. according to the global competitiveness report the top 15 countries hold the same position during couple years while some developing countries are changing ranks from the year to the year. there is no doubt that the financial crisis has the biggest impact on the macroeconomics factors and competitiveness in the most of countries. in past 6 years, some eu member countries are facing with the series challenges of the percentage of decline of the gdp, unemployment rate, world trade etc. the paper pays special attention to the labour market and higher education. the focus is on scores for the top 15 competitive countries and balkan countries from the global competitiveness report, which was presented at the world economic forum annual meeting in davos. in order to be competitive scores of national competitiveness it’s useful and the main of interest for policy makers and politicians who wants to improve the position of the country on the world level key words: global competitiveness index, youth, innovation introduction competitiveness is a phenomenon that is equally interesting and important for policy makers, managers and businessman who are focused on the position of their country and their company on the current and future market. their priority is to achieve leading position in the market. there are different approaches about global analysis of competitiveness. for example, at the macroeconomic level positive trade balance, standard of living in the country, employment rate and gdp growth have the biggest impact on the competitiveness index. competiveness and its factors are an issue that has been discussed ever since. buckley et al. (1988) concluded that the company is competitive if it can produce products with better quality and lower costs than its rivals and that can sell goods on the international markets. on the other hand, porter (1985) claims that competitiveness of a firm is its ability to employ resources with a good quality and in that way that is superior to rivals. 1 dejana.pavlovic@ien.bg.ac.rs pavlović, d., et al., competitiveness index analysis, ea (2016, vol. 49, no. 1-2, 24-35) 25 the aim of the paper is to analyse how investing in young people affects the overall national competitiveness. the paper is concentrated on two pillars important for youth: labour market efficiency and higher education and training. the paper is organized as follows: first part begins with introduction and literature review, followed by review of current state of gci and its pillars regarding employment and education. the concussion points out to the importance of inclusion young people in the decision-making process, getting them to reconsider strategies and be a part of their implemented in order to gain advantage on the global market. literature review the level of competiveness is usually determined among similar companies in the market, but in the same manner we can determine why a country is more competitive than the other. bearing in mind the increasing competition among national economies, during the eighties the interest for this subject increased. scott and lodge (1985) came to conclusion that the primary subject of national competitiveness are firms who bear the burden of competition with foreign rivals. shortly after during the 1987, artto defined the concept of competitiveness at the national level and described it as “the degree to which a nation can, under free and fair market conditions, produce goods and services that meet the test of international markets while simultaneously expanding the real incomes of its citizens.” the european commission (2001) defined competitiveness of a nation to be synonymous with its ability to provide citizens with high and rising standards of living and high rates of employment on a sustainable basis. consequently, europe union member states are trying to hold position in the world competing with big rivals such as china, india, usa and japan. the financial crisis has a big impact on the competitiveness on the national level. since the beginning of the world economic crisis, eu is facing with the series challenges regarding the decline of the participation in the world’s trade. the biggest decline of eu28 participation in the world’s trade happened during the 2009, when the share fell down to 23.62 % (eurostat, 2015). ever since this influence in exacerbated in the low to moderate gdp growth (often fall) of eu28 countries. there is an opinion that country is more competitive if it has a high value of the gross domestic product (gdp). following researchers argue that if the growth of the country is based on natural recourses the gdp can increase but economy will not improve. high level of the gdp means a high living standard in the country. aiginger (2006) believes that a high level of living standard is essential for the competitiveness of the county. over the past years, it is not defined what the kind of factors have the biggest impact on the national competiveness. according to porter (1985) in the 80s “low-cost unskilled labour” had a big influence on the competitiveness. hence, other scholars thought that the high level of productivity and living standard are essential for the national competitiveness. scores of the national competitiveness are useful for strategy makers who are trying to find better solution for achieving sustainable economic growth and to improve the global position of the country. currently, two reports are used for measuring and ranging national competitiveness: global competitiveness index (created by world economic forum) and doing business index. global competitiveness index which we use in this paper undergone 26 economic analysis (2016, vol. 49, no. 1-2, 24-25) through series of changes. it was first criticized by lall (2001) who analysed competitiveness index contained in the global competitiveness report 2000 of the world economic forum. she found some shortcomings in methodology. for example, the data has not been collected rigorously. about 90% responders came from the private sector. she emphasized that used qualitative measures are vague, redundant and wrong (lall, 2001). having this critiques and shortcomings in mind the global competitiveness index was redesigned in 2004 and new global competitiveness index was created. global competitiveness index a commonly accepted measure of competitiveness is the global competitiveness index, which as a result of global competitiveness report by world economic forum in davos. this event has been traditionally organized for 35 years. for the first time the global competitiveness index (gci) was introduced by the world economic forum in 2004, in order to measure national competitiveness using the twelve pillars and about 90 sub-groups. all pillars are related with each other’s. for example, labor market efficiency is not possible (7th pillar) without higher education and training (5th pillar). each of the pillars show different weight for different stage of development. the goal of gci is to provide an overview of competitiveness performance and give better insight of the economies of more than 140 countries, grouped into 12 pillars that determine the level of the productivity of a country. the world economic forum aims to explore reasons why one country is more developed and competitive than the other. according to the results from this report, policy makers are trying to define better strategy to achieve sustainable economic growth and long-term prosperity. report applies specific methodology and uses statistical data obtained from internationally recognized agencies, such as the united nations educational, scientific and cultural organization (unesco), the international monetary fund (imf), and the world health organization (who) (global competitiveness report, 2015-2016). the report measures the counties competitiveness and classifies counties using two criteria. the first is a level of gdp per capita at market exchange rates. stage 1 includes countries with the value of gross domestic product less than 2000 usd while "in transition" countries have gdp from of 2 000 to 3 000 usd. the stage 2 consists countries from 3 000 to 9 000 usd of the gdp and on the stage 3 are countries with the value of the gdp more than 17 000 usd. national economies can move from one stage to the next one. the second criterion is based on income. but some countries have natural resources and their prosperity is based on the extraction of resources (measured by the share of exports of mineral goods in total exports). for example, countries with a large extent factor driven have more than 70 percent of their export made up of mineral products (world economic forum, 2005). there are three specific stages: factor-driven, efficiency-driven, and innovation-driven. first stage, a factor-driven stage occurs when companies compete on price and take advantage of cheap labour or unprocessed natural resources. at this stage score of the country depends of the stability of institutions (pillar 1), infrastructure (pillar 2), macroeconomics factors (pillar 3), and health and primary education (pillar 4). according to the latest report from 2014, 37 countries such as cameron, chan, mali, and ghana are on the pavlović, d., et al., competitiveness index analysis, ea (2016, vol. 49, no. 1-2, 24-35) 27 first stage of development. as a country becomes more competitive it will move from the first stage into the efficiency-driven stage of development. during this stage, efficient production becomes the main source of competitiveness. it is driven by the higher education and training (pillar 5), efficient goods markets (pillar 6), well-functioning labour markets (pillar 7), developed financial markets (pillar 8), the ability to harness the benefits of existing technologies (pillar 9) and a large domestic or foreign market (pillar 10). balkan countries such serbian, bulgaria, romania, macedonia and montenegro are at this stage. countries such as croatia and turkey are in phase of transition between stages. developed economies create the innovation-driven stage. countries such as germany, finland, hong kong, austria and etc. are at this stage of development. based on the responses in the survey of global report, which is used for creating a database for making gci (global competitiveness index), more than 14 000 business leaders from 144 countries gave their opinion and answered the questions, with the score from 1 to 7. however, there are some exceptions where indicators are not derived from the survey, such as subgroup 7.4 for example. this indicator estimates the cost of advance notice requirements, severance payments, and penalties when terminating a redundant worker, expressed in weekly wages (global competitiveness report, 2015-2016). table 1 shows the top 15 competitive countries in the world and the position of chosen countries from the region. in the top 15 there have been certain changes related to last period analysed. switzerland holds the first position for 6 years in a row, with the highest scores in eight pillars. singapore follows and is the only economy to feature in the top 3 in seven out of the 12 pillars. qatar entered the top 14 in the latest report. netherland made a significant progress from eighth to fifth place, while on the other hand its neighbour finland fell from forth to eight place according to the latest data (global competitiveness report, 2015-2016). turkey is best positioned among balkan countries with the score of 4.37 and ranks 51. romania, bulgaria, slovenia, macedonia fyr and montenegro have relatively similar rank and position, while the other countries are lagging behind. table 1. score and rank in the global competitiveness report 2015-2016 current rank 2015/2016 country score (1-7) 2015/2016 gci 2014-2015 rank 1 switzerland 5,76 1 2 singapore 5,68 2 3 united states 5,61 3 4 germany 5,53 5 5 netherlands 5.50 8 6 japan 5,47 6 7 hong kong sar 5,46 7 8 finland 5,45 4 9 sweden 5,43 10 10 united kingdom 5,43 9 11 norway 5,41 11 12 denmark 5,33 13 13 canada 5,31 15 28 economic analysis (2016, vol. 49, no. 1-2, 24-25) current rank 2015/2016 country score (1-7) 2015/2016 gci 2014-2015 rank 14 qatar 5,30 16 15 taiwan, china 5,28 14 51 turkey 4,37 45 53 romania 4,32 59 54 bulgaria 4,32 54 59 slovenia 4,28 70 60 macedonia fyr 4,28 63 70 montenegro 4,23 67 77 croatia 4,07 77 81 greece 4,02 81 94 serbia 3,98 94 98 albania 3,93 97 source: global competitiveness report, 2015-2016. investing in youth fifth pillar of the global competitiveness report is higher education and training that highlights importance of human capital. investing in human capital is considered as one of the important business strategies. the strategic management of human resources has become a prominent field in the last thirty years and recorded a growing number of studies on this topic (ganon, roper, doherty, 2015; marler, 2012; leonard-barton, 1995). according to the human development report (hdr) (undp, 1990) “human development is a process of enlarging people’s choices. in principle, these choices can be infinite and change over time. but at all levels of development, the three essential ones are for people to lead a long and healthy life, to acquire knowledge and to have access to resources needed for a decent standard of living. if these essential choices are not available, many other opportunities remain inaccessible.” many empirical studies have showed that a group of economic and social factors have influence on the position of youth on the labor market. for example, high rate of minimum wages (gorry, 2013; cahus et al., 2013), professional experience (gorry, 2013), educational system in the country (parey, 2009), financial crisis (kelly, mc guennes, 2015) have a big impact to the unemployment rate among young people. young people are more educated, but after finishing their school they remain in the labour market as unemployed or inactive personnel. to focus of investing in human potential is on young people. low educated young people and the high youth unemployment rate are the biggest issues not only in developing countries but also in some eu member countries. factors, such as work experience, low wages, migration, regional differences, etc., make the labour market difficult to access. several authors and organizations identified the problem of low-educated unemployed youth. the research carried out in oecd countries shows that unemployment rate is the highest for low-educated workers in germany (oecd, 2006). another study shows, that although youth unemployment rate is low in germany, low-educated people without any academic or vocational training may be disadvantaged (gebel, 2008). in the netherlands, pavlović, d., et al., competitiveness index analysis, ea (2016, vol. 49, no. 1-2, 24-35) 29 training programs are adjusted to young people so that they can enter the job market in the easiest way in the shortest period of time (refrigeri and aleandri, 2013). according to the global employment trends for youth (ilo, 2013a) it is not easy to be young in the labour market today. data from this report show that: • every third young unemployed person has been looking for job longer than one year (35.5%); • more than one-third of employed young people in the developing world are living on less than us $2 per day (37.8%); • working poverty affects as many as 169 million young people in the world. high general and youth unemployment rates are great challenge across europe. the average of the youth unemployment rate in eu member countries is about 21%. contrary to that, west balkan countries are facing with extremely high unemployment rate among young people, ranging around 45% in 2014 (ilo, 2015). according to the statistical office of the republic of serbia in 2014 no significant rise in the unemployment rate happened (about 0.1%) and it was at average 48%. in the first half of 2015, the unemployment rate has decreased for 0.2% (statistical office of the republic of serbia., 2015). among west balkan countries, montenegro had the lowest unemployment rate among young people from 2000 to 2013. the average unemployment rate in montenegro is 19.45%, while average unemployment rate for young people aged 15 to 24 is 38.26%. the lowest rate of young unemployed was before financial crisis in 2008, when youth unemployment rate was 30.8%. however, youth employment rate escalated during the crisis. the highest unemployment rate of 46% was recorded in 2010 (ilo, 2015). these data are illustrated in figure 1. figure 1. unemployment rate, ages 15-64, from 2008-2014 source: ilo statistics, 2015. macedonia fyr and bosnia and herzegovina are facing with extremely high youth unemployment rate ranging above 55%. in macedonia, unemployment rate among young 0 10 20 30 40 2008 2009 2010 2011 2012 2013 2014 unemployment rate, ages 15-64 bosnia and herzegovina macedonia, the former yugoslav republic of montenegro serbia 30 economic analysis (2016, vol. 49, no. 1-2, 24-25) people, aged 15 to 24 was high even before the crisis (in 2000 it was 53.7%), while it escalated to 65.7% during the 2014. the positive aspect of the youth unemployment in macedonia is the slow but steady trend of reduction. bosnia and herzegovina is characterized by high youth unemployment rate that reached its peak of 60.4% in 2013. the problem that manifests in bosnian labour market are large fluctuations in the rate of unemployment among young people during the analysed period. rates have significant variation, which indicates the inconsistency of labour market policies and to a fairly chaotic and disorderly situation had on this market (ilo, 2015). the youth unemployment rates are presented in figure 2. balkan countries are facing with a high unemployment rate among youth for several reasons. firstly, regardless the high number of educated people older than 30, young people can’t find a job after finishing their education. usually they remain in the labour market as unemployed or inactive personnel. secondly, the difference in the number of employed people by regions influence on the number of unemployment people (regional outlook, 2015). a good practical example are strategies implemented by countries are austria, switzerland and germany, where the unemployment rate among young people is on average around 8-10% (ilo, 2015). according to the late statistical data from 2014, young people have the best position on the labour market in germany, where the youth unemployment rate is 7.7%. the highest unemployment rate among young people is recorded in spain and greece in 2014. figure 2. youth unemployment rate, ages 15-24, from 2008-2014 source: ilo statistics, 2015. in the paper we will focus on the two pillars of gci: labour market efficiency and higher education and training. we will try to determine the influence of these pillars on national competitiveness. every pillar in gci is divided into subgroups. labour market efficiency consists of 10 sub-groups: 1. cooperation in labour-employer relations; 2. flexibility of wage 0 20 40 60 80 2008 2009 2010 2011 2012 2013 2014 youth unemployment rate, ages 15-24 bosnia and herzegovina macedonia, the former yugoslav republic of montenegro serbia pavlović, d., et al., competitiveness index analysis, ea (2016, vol. 49, no. 1-2, 24-35) 31 determination; 3. hiring and firing practices; 4. redundancy costs, weeks and salary; 5. effect of taxation on incentives to work; 6. pay and productivity; 7. reliance on professional management; 8. country capacity to retain talent; 9. country capacity to attract talent; 10. women in labour force, ratio to men. higher education and training consists of 8 sub-groups: 1. secondary education enrolment, gross %; 2. tertiary education enrolment, gross%; 3. quality of the education system; 4. quality of math and science education; 5. quality of management school; 6. internet access in schools; 7. availability of research and training services; 8. extend of staff training. countries with high score of the labour market efficiency are aware that workers are allocated to their most effective use in the economy and provided with incentive to give the best efforts in their jobs. according to the global competitiveness report 2015, the best ranking countries for the labour market efficiency are switzerland (score 5,8 of 7), singapore (5, 71 of 7), hong kong (5, 56 of 7), u.s.a. (5, 4 of 7), u.k. (5, 31 of 7) and the netherlands (4, 9 of 7) as shown in table 2 (global competitiveness report 2015-2016). on the other hand, according to the international labour organization countries such as netherlands and switzerland have the lowest unemployment rate among young people, about 10% (ilo, 2015). the competitiveness of higher education and training and labour market is important for economic growth. quality of higher education and satisfied young people are crucial for economies of the world. according to the global competitiveness report 2015-2016, the best rank in higher education have countries such as finland, singapore, the netherlands, switzerland, belgium and norway. table 2. the youth unemployment rate in developed countries country 2010 2011 2012 2013 2014 austria 9.5 8.9 9.4 9.7 10.3 belgium 22.4 18.7 19.8 23.7 23.2 bulgaria 23.2 25 28.1 28.4 23.8 croatia 32.4 36.7 42.1 50 45.5 cyprus 16.6 22.4 27.7 38.9 35.9 czech republic 18.3 18.1 19.5 19 15.9 denmark 14 14.2 14.1 13.1 12.6 estonia 32.9 22.4 20.9 18.7 15 finland 21.4 20.1 19 19.9 20.5 france 22.9 22.1 23.9 23.9 23.2 germany 9.9 8.5 8 7.8 7.7 greece 33 44.7 55.3 58.3 52.4 hungary 26.4 26 28.2 26.6 20.4 ireland 27.6 29.1 30.4 26.8 23.9 italy 27.9 29.2 35.3 40 42.7 latvia 36.2 31 28.5 23.2 19.6 lithuania 35.7 32.6 26.7 21.9 19.3 luxembourg 14.2 16.8 18.8 15.5 22.6 malta 13.2 13.3 14.1 13 11.8 netherlands 8.7 7.6 9.5 11 10.5 poland 23.7 25.8 26.5 27.3 23.9 32 economic analysis (2016, vol. 49, no. 1-2, 24-25) portugal 22.8 30.3 37.9 38.1 34.8 romania 22.1 23.9 22.6 23.7 24 slovakia 33.6 33.4 34 33.7 29.7 slovenia 14.7 15.7 20.6 21.6 20.2 spain 41.5 46.2 52.9 55.5 53.2 sweden 24.8 22.8 23.6 23.5 22.9 united kingdom 19.9 21.3 21.2 20.7 16.9 source: international labour organization, 2015 the best rank in higher education among balkan countries has greece with 4, 84 score of 7, while bulgaria has 4, 48, croatia 4, 62, serbia 4, 28 and a high score has montenegro (4, 80). while in labour market efficiency romania has the best rank in redundancy costs, weeks of salary (7 of 144), bulgaria 21 and serbia is on the 22 place. figure 3 presents scatter graph of countries according to labour market efficiency and higher education and training pillars. the number in brackets after the name of the country point out to the latest gci total rank. as could be seen the countries are grouped similar regarding the two analysed pillars and total rank. in the upper right corner, the developed countries are grouped, while all countries from the region (with the exception of slovenia) are in the lower left corner. even though the values of the labour market efficiency and higher education and training pillars can vary a lot in the group of developed countries they exceed 5 for higher education and training and 4.5 for labour market efficiency. on the other hand, there is much more similarities in the values of pillars for developing countries, but they do not reach the lowest values of developed countries. figure 3. labour market efficiency and higher education and training pillars for 25 countries source: world economic forum, 2016 switzerland (1) singapore (2) united states (3) germany (4) netherlands (5) japan (6) hong kong sar (7) finland (8) sweden (9) united kingdom (10) norway (11)denmark (12) canada (13) quatar (14) taiwan, china (14) turkey (51) romania (53) bulgaria (54) slovenia (59) macedonia fyr (60) montenegro (70) croatia (77) greece (81)serbia (94) albania (98) 3 3.5 4 4.5 5 5.5 6 4 4.5 5 5.5 6 6.5 l ab ou r m ar k et e ff ic ie n cy higher education and training pavlović, d., et al., competitiveness index analysis, ea (2016, vol. 49, no. 1-2, 24-35) 33 conclusion experience is often one of the means to achieved competitiveness in companies. experienced managers and employees are one of the competitive advantages and there is no doubt. to the other hand, if we observe national competitiveness, young people, their needs and desires are an essential item in this analysis. youth unemployment is one of the most acute social problems which solution is of great importance. taking into account a number of factors that contributed to high unemployment among young people, it is clear that social apathy brought about by the global economic crisis has also had an impact on young people in search of work. high unemployment rate in the developing countries is the product of the difficult economic situation, the relatively underdeveloped private sector and underdeveloped business skills in young people. there is no doubt that the labour market for youth is threaten by many economic indicators and additional issues, such as the lack of entrepreneurial spirit in young people (in universities and secondary schools), insufficiently developed entrepreneurial skills, lack of self-employment programs and national incentives for youth. in order to solve these problems many countries are implementing labour market policies with the primary aim of reducing the period of unemployment and inactivity of young people. young people need to include in two levels in order to get advantage in the national competitiveness market. there is a need to involve them in the decision-making process, getting them to understand the process, why the policies are implemented and to make them contributors to solving social problems especially in the sphere of youth unemployment. applying strategies implemented together can be a way for gaining advantage on the market. the second level is encouraging them to gain new skills and knowledge or to actively involve in the process of entrepreneurship and creating new jobs. the implication of this research is applicable to all policy makers, business managers and others who want to improve economic growth. references aiginger, k. 2006. “competitiveness: from a dangerous obsession to a welfare creating ability with positive externalities.” journal of industry, competition and trade, 6 (2): 161177. artto, ew. 1987. 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(eds.). 1985. us competitiveness and the world economy. boston: harvard business school press. statistical office of the republic of serbia, labor force survey. 2015. retrieved from www.stat.org.rs undp (united nations development program). 1990. human development report. new york: oxford university press. world economic forum, the global competitiveness report. 2005. retrieved from www.weforum.org/reports?filter[type]=competitiveness world economic forum, the global competitiveness report 2015 – 2016. retrieved from www.weforum.org/reports?filter[type]=competitiveness pavlović, d., et al., competitiveness index analysis, ea (2016, vol. 49, no. 1-2, 24-35) 35 analiza indeksa konkurentnosti: da li je ulaganje u mlade važno za rast nacionalne konkurentnosti? rezime – cilj rada je da se analizira kako ulaganje u mlade ljude utiče na ukupnu nacionalnu konkurentnost. prema “the global competitiveness report” prvih 15 zemalja drži istu poziciju već nekoliko godina, dok neke zemlje u razvoju se menjaju pozicije iz godine u godinu. nema sumnje da je finansijska kriza imala najveći uticaj na makroekonomske faktore i konkurentnost u većini zemalja. u proteklih 6 godina, neke zemlje članice eu se suočavaju sa nizom problema u vidu procenta pada bdp-a, stopa nezaposlenosti, međunarodne trgovine itd. u radu je posebna pažnja data tržištu rada i visokog obrazovanja. fokus je na rezultatima za prvih 15 najkonkurentnijh zemalja i zemalja balkana iz “the global competitiveness report”, koji je predstavljen na godišnjem sastanku svetskog ekonomskog foruma u davosu. on je koristan i zbog nadmetanja nacionalnih ekonomija kojima je u interesu što bolji rang, kao i za kreatore politike i političare koji žele da poboljšaju položaj zemlje na svetskom nivou. ključne reči: indeks globalne konkurentnosti, mladi, inovacije article history: received: 18 june, 2016 accepted: 22 june, 2016 doi: 10.28934/ea.20.53.1.pp14-27 original scientific paper the impact of covid-19 crisis on medium-sized enterprises in serbia isidora beraha1* | sonja đuričin1 1 institute of economic sciences, belgrade, serbia abstract the research objective is to empirically assess the impact of the covid-19 crisis on the operation of medium-sized enterprises in serbia. the main research question is how the covid-19 crisis has affected the operation of medium-sized enterprises in serbia with focus on major problems faced by these enterprises in times of the state of emergency over the epidemic. also, considerable research attention is on policy measures to alleviate the negative impact of the covid-19 outbreak with comparison of measures between serbia and selected countries. to empirically assess the impact of the covid-19 crisis on medium-sized enterprises in serbia, an online survey research was conducted during the period of march and april 2020. the survey results show that the covid-19 crisis has affected the daily business of medium-sized enterprises in different ways and with varying intensity. due to the covid-19 outbreak, 20% of the surveyed enterprises have moved their employees to work from home, while a decline in liquidity and in business capacity utilization, as well as supply chain disruptions have occurred in 16% of enterprises each. less than 10% of enterprises expressed other problems such as payment of wages, insufficient workforce utilization, reduction in business hours, production disruptions, limited access to resources etc. key words: sme, medium-sized enterprises, covid-19 crisis, major problems, survey research, policy responses jel classification: m10, m21 introduction the first registered cases of sars-cov-2 (the virus that causes covid-19) appeared in wuhan, china in december 2019. between january and february 2020, the spread of the disease occurred in 31 provinces of mainland china with wuhan being the epicenter of the epidemic. the chinese government declared an emergency situation of the highest-level enforcing measures to prevent the further spread of the virus such as self-quarantine, public events cancellation, crowd gatherings prohibition, closure of all businesses and sport facilities except for food stores, as well as closure of highways, railroads, and flights across the country. the chinese government restriction measures were soon followed by other countries’ restrictions on travel to and from china. by the end of january, the chinese economy (particularly sectors such as transportation, tourism, hospitality, entertainment, and financial industry) was already strongly affected by the outbreak of the epidemic. early evidence of a survey of 761 business owners mostly smes conducted by the university of international business and economics in * corresponding author, e-mail: isidora.beraha@ien.bg.ac.rs isidora beraha, sonja đuričin 15 february reported the impact of the covid-19 outbreak, lockdowns and travel ban on the confidence of both domestic and international companies, expected loss of revenues and challenges related to cash flow (he wen long & wu jian feng, 2020). given that smes account for 99.6% of china’s companies, 80% of national employment, and more than 60% of gdp they were expected to suffer most during the epidemic (bouey, 2020, p.7). on march 11, 2020, the world health organization declared the outbreak of the covid-19 as a global pandemic. to prevent the spread of the disease, many governments across the world imposed national lockdown measures that have led to a dramatic decline in global economic activity. a significant reduction of production, falling demand and job losses occurred across many sectors of national industries worldwide. small businesses are characterized by exceptional flexibility, a propensity for entrepreneurial ventures, smaller production volumes, simple organizational structure, and informal internal communication (lazarevic-moravcevic, 2019, p.106). however, they are generally more vulnerable in times of economic crisis. the early evidence indicates that the impact of the covid-19 pandemic on smes is worse than the 2008 financial crisis. given that smes are the engines of economies around the world, their collapse could significantly impact the growth of national economies. a survey conducted by researchers from tsinghua university in beijing, china of 995 smes in february showed that 30% of the companies have seen their income drop by more than 50%; another 28% reported a 20% to 50% drop; more than one-third of the companies reported that they could stay open for only one month with their current cash flow, 33% could sustain two months, and less than 10% could stay open for more than six months, while most of the financial pressure (62.8%) is from paying salaries and employee insurance and social security; rent and loan payments were the second and third causes for stress (bouey, 2020, p.7). oecd (2020) presents the outcome of 31 sme surveys identified worldwide on the impact of covid-19 on smes showing that more than half of smes now already face severe losses in revenues, one third of smes fear to be out of business without further support within one month, and up to 50% within three months. an early evidence from a survey on how small businesses are adjusting to covid-19 conducted by bartik et. al (2020) from the us national bureau of economic research, that included more than 5.800 small businesses across the united states, suggests that the pandemic has already caused mass layoffs and closures with 43% of businesses being temporarily closed, that businesses have on average reduced their employee counts by 40% relative to january, many small businesses are financially fragile, they have widely varying beliefs about the likely duration of covid-19 related disruptions and the majority of businesses planned to seek funding through the coronavirus aid, relief, and economic security (cares) act. smes have been affected by the current crisis more severely than the large enterprises because of their sensitivity to the supply and demand shocks. according to narjoko & hill (2007), the effects of economic crisis on firms are profound, however they are uneven between firms. smes are in general more vulnerable to the crisis for many factors. their greater dependence on (fewer) customers and suppliers (nugent & yhee, 2002) may lead to increased difficulties in maintaining their activity in the face of the crisis (bourletidis & triantafyllopoulos, 2014). according to oecd (2009, p.6), it is more difficult for them to downsize as they are already small; they are individually less diversified in their economic activities; they have a weaker financial structure (i.e. lower capitalization); they have a lower or no credit rating; they are heavily dependent on credit and they have fewer financing options. smes are usually associated with risk-taking and findings show (soininen et. al, 2012, p.14) that risk-taking firms tend to be in more trouble especially in operations related both to short and long-term financing since they may already be highly-leveraged before the recession and when the recession begins, rising interest rates along with decreasing sales can cause them financial distress. chowdhury (2011, p.379) points out that smes are in general more vulnerable during crisis because of (a) 16 economic analysis (2020, vol. 53, no. 1, 14-27) demand shock: drop in sales, export decline backed by contraction of external demand as well as rising input costs; and (b) credit crunch: shrinking credit supply. the covid-19 virus has been present in serbia since the beginning of march 2020. the state of emergency was declared by the serbian government on march 15, followed by the strict measures to prevent the spread of the disease including closure of borders, school closure, public transportation suspension, restrictions on the movement of people and closure of businesses in the service sector such as restaurants, cafes, shopping malls, beauty salons, gambling facilities and casinos, sports related facilities etc. available evidence on the economic impact of the covid-19 outbreak provided by the oecd (oecd, 2020) reports that by the end of march 67.000 employees were working from home, 168 manufacturing companies stopped, damages in infrastructure and transport amounted to over eur 110 million, the damage to the tourism sector amounted eur 2.7 million between march and the first half of april, and round 85% of smes are expected to be negatively affected. governments across the world have issued policy responses to mitigate the impact of the covid-19 pandemic on humans and economies. the type and timing of policy measures vary in different countries depending on the intensity of the disease and level of economic development. however, the measures are particularly focused on supporting smes through the crisis. in serbia, the government adopted a set of measures including financial support to private sector activity and employment. the research objective is to empirically assess the impact of covid-19 crisis on the operation of medium-sized enterprises in serbia. the subject of the research are medium-sized enterprises in serbia. the main research question is how the covid-19 crisis has affected the operation of medium-sized enterprises in serbia with focus on major problems faced by these enterprises in times of pandemic. also, considerable research attention is on policy measures to alleviate the negative impact of the covid-19 outbreak with comparison of measures in serbia and selected countries. the assessment is restricted to medium-sized enterprises as they are the driving force behind growth in many oecd countries (oecd, 2017). medium-sized enterprises are less represented in the total number of business entities, but they provide greater contribution to employment and value added (đuričin& beraha, 2018a). because for years now medium-sized enterprises have made the greatest contribution to increasing employment, gross value added, turnover and foreign trade activities, they are considered the backbone of growth and development of the serbian economy. the empirical assessment of the impact of the covid-19 crisis on the operation of mediumsized enterprises is serbia is based on the evidence of an online survey of 18 enterprises conducted during march and april 2020. the article is structured as follows: after introductory remarks, section 2 describes the data and methodology, section 3 presents the research results and discussion. finally, conclusion summarizes the scientific results of the research, raises open questions, and provides recommendations for further research. data and methodology to empirically assess the impact of the covid-19 crisis on medium-sized enterprises in serbia an online survey research was conducted during the period of march and april 2020. the questionnaire combined close-ended and multiple-choice questions with predefined answers providing the respondents the possibility to choose among a set of options or rate the answer options on a 7-point likert scale (đuričin&beraha, 2018b). the questionnaire contained 19 questions and was designed to provide an insight on the major impacts of the covid-19 crisis on the operation of medium-sized enterprises in serbia. the questions were organized along three thematic blocks. the first block refers to general data about an enterprise such as size, number of years in operation, the function of responder within isidora beraha, sonja đuričin 17 an enterprise, primary industry classification, geographic district, whether an enterprise owns or leases an operation space, and the amount of monthly operating expenses. the second block includes questions about major concerns, reactions regarding the number of employees and impacts of the outbreak of covid-19 on an enterprise daily operation. finally, the third block contains questions about the type of support an enterprise needs to overcome the negative effects of the crisis, desired duration of the support measures and familiarity and understanding of government measures in response to covid-19. the questionnaire was sent to the addresses of 50 medium-sized enterprises that have been monitored and analyzed since 2016 within the publication "national network of medium-sized enterprises" published by the institute of economic sciences. the database used for the classification and selection of medium-sized enterprises is provided by the business registers agency of the republic of serbia. the sample of 50 most representative enterprises is made considering the distribution of medium-sized enterprises by activity classification and regional distribution. the primary criterion for the selection of 50 representative entities that form the network of medium-sized enterprises in the republic of serbia was the amount of total revenue generated. additionally, the criteria of the share of individual activities, geographical location, organizational form, and number of employees were also considered. concerning the geographical distribution, 56% of the total number of surveyed medium-sized enterprises is registered on the territory of the city of belgrade, 22% in the macva district, 11% in the central banat district and 11% in the north banat district. concerning the number of years in operation, 78% have been in business for more than 10 years, while 22% have been in business between 5 and 10 years. concerning the number of employees, 78% of the surveyed enterprises employ between 50 and 250, 11% employ between 10 and 50 and 11% employ more than 250 employees. the largest percentage of surveyed enterprises is in the field of professional, scientific, innovation and technical activities (33%), while those from other activities participate with 11% each. other activities include wholesale and retail of motor oil and tire batteries; agriculture, forestry and fisheries; information and communication; traffic and storage; it and production of construction material production. 56% of the total number of surveyed enterprises lease and 33% own business space, while it is partially owned and leased by 11% of enterprises. monthly expenses in 88% of surveyed enterprises are higher than eur 10.000, while in 12% they amount to between eur 5.000 and 10.000. table 1. sample structure in % district business space ownership north backa district 11 ownership 33 macva district 22 leasing 56 city of belgrade 56 ownership/leasing 11 central banat district 11 total 100 total 100 activity number of years in business wholesale and retail of motor oil and tire batteries 11 5 to 10 years 22 agriculture, forestry and fisheries 11 longer than 10 years 78 professional, scientific, innovation and technical activities 33 total 100 information and communication 11 number of employees traffic and storage 11 10 to 50 11 it 11 50 to 250 78 construction material production 11 over 250 11 total 100 total 100 source: authors’ survey 18 economic analysis (2020, vol. 53, no. 1, 14-27) results and discussion during the state of emergency, the medium-sized enterprises operated in difficult circumstances, expressing different degrees of concern about certain aspects of business. the research results indicate that 44% of enterprises expressed extreme concern about the health of employees during and after the epidemic. however, 22% are not at all concerned, 22% are unconcerned and 11% are moderately concerned about the health issues of employees. extreme concern about decreased demand and loss of market share was reported by 33% of the surveyed enterprises, while 22% expressed no concern for this aspect of business. 34% and 22% of enterprises respectively are concerned and moderately concerned about the lack of funds to smoothly operate business. unconcerned, somewhat concerned, and neither concerned nor unconcerned is stated by 11% of respondents each. 45% of enterprises are worried about unpaid receivables and lack of cash flow to cover operating expenses, moderately and extremely are worried 22% each, while 11% stated that they are somewhat unconcerned. moderate concern about minimum number of employees at workplace is expressed by 34% of the surveyed enterprises, while 22% stated that they are neither concerned nor unconcerned, the same percentage is unconcerned and 11% is somewhat unconcerne. table 2. structure of responses to the question: "what concerns you most about your business during and after the epidemic? please rate the given answer options." in % aspects of business evaluation not at all concerned un concerned somewhat unconcerned neither concerned nor unconcerned moderately concerned concerned extremely concerned concerns about employee health 22 22 0 0 11 0 44 decreased demand and loss of market share 22 11 11 0 11 11 33 decrease in turnover and revenue 0 11 0 0 22 33 34 lack of funds to smoothly operate business 0 11 11 11 22 34 11 unpaid receivables and lack of cash flow to cover operating expenses 0 0 11 0 22 45 22 minimum number of employees at the workplace 0 22 11 22 34 11 0 source: authors’ survey during the state of emergency, half of enterprises (56%) reported negative impact of epidemic on their business. however, 22% expressed that their business is not yet affected, but are expecting negative impacts in the following 2-5 months. that their business will not be affected, or that it has not been affected yet, but negative impacts are expected in the following 2 months is reported by 11% of responders each. isidora beraha, sonja đuričin 19 figure 1. structure of responses to the question: “has covid-19 affected your business?” source: authors’ survey the ways and intensity of the impact of the covid-19 crisis on the daily operation of mediumsized enterprises in serbia vary. 20% of enterprises reported that their employees are working from home due to the epidemic, while a decline in liquidity, decline in business capacity utilization and supply chain disruptions were reported by 16% of respondents each. 8% of enterprises faced difficulties with payment of wages and insufficient workforce utilization. the epidemic caused reduction in business hours in 4% of enterprises, and the same percentage experienced occasional production interruptions due to supply chain delays as well as restrictions on access to necessary resources and capital. figure 2. frequency answers to the question: "how has covid-19 affected your daily operation? (choose all relevant answers)" source: authors’ survey 22% 11% 56% 11% not as of yet, but i expect it to be affected in the next 2-5 months not as of yet, but i expect it to be affected in the next 2 months yes no 4% 20% 16% 16% 12% 16% 8% 4% 4% 0% 5% 10% 15% 20% 25% reduction in business hours employees working from home improved personal safety and… business capacity utilization decline decline in liquidity supply chain disruptions difficulties with payment of wages limited resources production disruptions 20 economic analysis (2020, vol. 53, no. 1, 14-27) the number of employees was not reduced because of the outbreak of covid-19 in 67% of serbian medium-sized enterprises, while 33% did not reduce nor expect to be forced to reduce the number of employees. evidence from surveys in other countries shows that the number of employees and level of wages in the sme sector has been affected by the epidemic. the results of the pan-asian research conducted between march 31 and april 6, 2020 indicate that almost 30% of smes expect to lay off 50% or more of its employees (oecd, 2020). according to the oecd data, 31% of smes in belgium were under the risk of stopping business operation due to the epidemic. enterprises need various types of support to continue to function smoothly and overcome the negative effects of the covid-19 crisis. some 45% expressed the need for an extension of income, property, and flat tax payments during the epidemic. most enterprises (89%) believe that this type of support would be efficient if implemented by the end of the fiscal year, while 11% reported that it would be efficient if implemented for more than one year. 33% of enterprises need fiscal policy responses to relieve employers of payroll tax liabilities, and 22% need preferential short-term loans i.e. lower interest rates and lower collateral. some 78% of respondents believe that fiscal measures to relieve employers of employment taxes would be efficient if implemented until the end of the fiscal year, while 22% suppose they should be implemented only during the state of emergency. figure 3. structure of responses to the question: "what type of business support is most needed by your enterprise during the covid-19 epidemic? source: authors’ survey more than half of the surveyed enterprises (56%) are completely familiar with the economic stimulus package adopted by the government of the republic of serbia to mitigate the negative impact of the covid-19 outbreak on businesses. 33% of enterprises stated that they are partially familiar, while 11% stated that they are mostly unfamiliar with the regulation. 45% 22% 33% tax payment extensions preferential short-term loans fiscal policy responses to relieve employers isidora beraha, sonja đuričin 21 table 3. structure of responses to the question: "please rate on a given scale each of the economic stimulus package adopted by the serbian government. (1completely dissatisfied; 4 – neither satisfied nor dissatisfied, 7completely satisfied)". in % measures evaluation completely dissatisfied dissatisfied moderately dissatisfied neither satisfied nor dissatisfied moderately satisfied satisfied completely satisfied moratorium on repayment of all loans granted to commercial entities and citizens 0 0 0 23 44 33 0 reduction of the key policy rate to 1.50% 0 11 0 34 44 11 0 salary increase for medical workers 0 0 23 11 33 33 0 one-time aid to pensioners of 4.000 rsd 11 11 23 11 11 33 0 tax relief measures for the economy 0 0 0 11 22 67 0 direct aid to private sector 0 11 0 0 45 33 11 measures for the maintenance of liquidity of the economy 0 0 11 11 56 22 0 direct oneoff cash grant in the amount of 100 euro for every adult citizen 67 11 0 22 0 0 0 source: authors’ survey during the state of emergency, a stimulus package consisting of fiscal measures, direct aid to the private sector, measures for the maintenance of liquidity of the economy, and a direct oneoff cash grant for every adult citizen was adopted by the government of the republic of serbia to alleviate the economic impact of the covid-19 outbreak. the measures within the package were rated by the surveyed enterprises as follows: 22 economic analysis (2020, vol. 53, no. 1, 14-27) • concerning the moratorium on repayment of all loans granted to commercial entities and citizens, 44% of enterprises is moderately satisfied, 33% is satisfied and 23% is neither satisfied nor dissatisfied. • concerning the reduction of the key policy rate to 1,50%, 44% of enterprises is moderately satisfied, 34% is neither satisfied nor dissatisfied, while satisfied and unsatisfied is 11% each. • regarding the salary increase for medical workers, satisfied and moderately satisfied is 33% of enterprises each, 23% is moderately dissatisfied and 11% is neither satisfied nor dissatisfied. • concerning the one-time aid to pensioners of 4.000 rsd, 33% of enterprises is satisfied, 23% is moderately dissatisfied, 11% is neither satisfied nor dissatisfied, while completely dissatisfied, dissatisfied, and moderately satisfied is 11% each. • tax relief measures for the economy consist of deferral of payment of payroll tax and social security contributions for the private sector, deferral of payment of monthly advances on corporate income tax due in the second quarter, and vat exemption on donation contributors. these measures provoked the most positive reactions with 67% of enterprises being satisfied, 22% being moderately satisfied, and 11% being neither satisfied nor dissatisfied. • direct aid to private entities is a measure consisting of direct financial aid for entrepreneurs, micro, small and medium-sized enterprises in the amount of three minimum salaries per each employee. concerning this measure, 45% of enterprises are moderately satisfied, 33% is satisfied, while completely satisfied and dissatisfied is 11% each. • measures for the maintenance of liquidity of the economy consist of: (a) program for granting loans and working capital to entrepreneurs, micro, small and medium-sized enterprises through the development fund of the republic of serbia and (b) guarantee schemes to support the liquidity of private entities through commercial banks operating in the republic of serbia. 56% and 22% of enterprises respectively is moderately satisfied and satisfied with these measures, while 11% is moderately dissatisfied and 11% is neither satisfied nor dissatisfied. • concerning the direct one-off cash grant in the amount of 100 euro for every adult citizen, 67% of enterprises is completely dissatisfied, 11% is dissatisfied and 22% is neither satisfied nor dissatisfied. many governments have already introduced policy measures to mitigate the economic impact of the covid-19 outbreak. the overview of the sme policy responses is provided by oecd (2020) based on analysis of 31 sme surveys conducted worldwide on the impact of covid-19 on smes. all measure packages are divided into four groups: labour, deferral, financial instruments and structural polices. generally, most adopted measures are related to labour and financial instruments, while the smallest number is in the field of structural policies. the measures related to labour include measures to reduce working hours of employees and their temporary redundancy, wage support schemes and measures to support self-employed ranging from sick leave payments and unemployment benefits, to lump sum subsidies. deferral refers to measures that enable smes to postpone payments such as income/corporate tax, value added tax, social security and pension contributions, rent/utilities/local tax, and debt moratorium. financial instruments measures include loan guarantees, direct lending to smes, and grants and subsidies, while structural policies include new markets, teleworking/digitalization, innovation and training and redeployment. all countries except for russia have adopted wage subsidy related measures. deferral of income/corporate tax was introduced by all observed countries except for israel. only croatia, russia and the usa did not adopt the loan guarantees, while portugal is the only country to introduce training and redeployment measures. isidora beraha, sonja đuričin 23 labour related measures in the republic of serbia include the 10% salary increase for medical workers, tax relief measures for the economy consisting of deferral of payment of payroll tax and social security contributions, and direct financial aid amounting to three minimal wages for each employee. direct and indirect labour related measures have been introduced in other countries as well. according to oecd data, belgium created new options for partial unemployment, while employment legislation has been relaxed in denmark and hungary to allow smes to temporarily reduce employees' hours. similarly, measures to enable short-term work arrangements and temporary layoffs have been adopted in germany and france. the survey was conducted in the united kingdom to identify the groups of workers who are most exposed to aggregate risk of salary reduction, and the results show that young workers employed in small enterprises are most at risk of 8-9% salary reduction (bell et al., 2020). also, the survey results indicate that older women employed in large companies face very little or no risk of salary reduction. an intervention law for co-financing temporary layoffs was introduced by the slovenian government, three quarters of costs when employee working hours are reduced and one third of costs for short-term workers are covered by the government in sweden, in poland all companies whose turnover drop by at least 15% can receive support from the guaranteed employee benefits fund, while in romania the government covers 75% of salaries for all workers who became technically unemployed due to the civid-19 epidemic. the policy measures related to deferral in the republic of serbia include moratorium on repayment of loans, reduction of the key policy rate to 1.50%, and tax relief measures for the economy consisting of deferral of payment of payroll tax and social security contributions, monthly advances on corporate income tax, and vat exemption on donation contributors. debt payment moratorium is adopted by many countries, however in some countries it is adopted by governments, while in others by commercial banks. for example, croatia introduced a threemonth moratorium on liabilities to the croatian bank for reconstruction and development and commercial banks. in belgium, a deferral of debt payments until 30 september is granted by the financial sector along with the governmental opening of a eur 50 billion new guarantee for all new credits up to 12 months. hungary introduced a moratorium until the end of 2020 on all loans taken by private individuals and businesses before 18 march. the italian banking association with support of the government adopted a debt moratorium on debt repayments, including mortgages and repayments of small loans and revolving credit lines on loans subscribed by companies until 31 january 2020. also, a six-month moratorium on repayments of sme loans worth less than eur 2.5 million is introduced by the netherlands banking association. tax relief for the economy is also the best rated package of measures by medium-sized enterprises in the republic of serbia. policy responses related to the deferral vary across different countries, and they are often designed to meet the needs of specific sectors. in norway, a nationwide vat is lowered from 12% to 8% until 31 october along with first-quarter payments being extended until 14 june. the united kingdom has introduced a 100% business rates tax holiday for the next 12 months. a 75% rates relief for retail, hospitality and leisure sectors has been introduced in scotland. in turkey, special tax relief measures are designed for the tourism sector and accommodation tax is cancelled until november. greece has adopted a 4month vat payment extension. some countries such as belgium, japan and israel have introduced relaxation in local tax payments and property taxes to alleviate the liquidity risk. furthermore, some countries provided the possibility of deferring the payment of rental costs (france) and utility costs (belgium) with special benefits for the sme sector. hungary suspended the payment of lease costs for smes facing difficulties in servicing this type of obligation, while slovenia temporarily released smes from paying electricity from renewable sources. 24 economic analysis (2020, vol. 53, no. 1, 14-27) table 3. overview of policy responses selected countries country labour deferral financial instruments structural policies r e d u n d a n ci es w a ge s u b si d ie s s e lf -e m p lo y e d in co m e/ co rp o ra te t a x v a lu e a d d e d t a x (v a t ) s o ci a l s ec u ri ty a n d p e n si o n co n tr ib u ti o n s r e n t/ u ti li ti es / lo ca l ta x d e b t m o ra to ri u m l o a n g u a ra n te e s d ir ec t le n d in g t o s m e g ra n ts a n d su b si d ie s n e w m a rk e ts t e le w o rk in g / d ig it a li za ti o n in n o v at io n t ra in in g a n d re d e p lo y m e n t belgium            croatia      czech republic         denmark        france              germany         greece        hungary         israel         italy           poland        portugal          romania      russia      slovak republic      slovenia          spain           sweden          switzerland      turkey           united kingdom         united states      source: oecd. 2020. ″tackling coronavirus (covid-19) contributing to a global effort: sme policy responses″. organisation for economic co-operation and development isidora beraha, sonja đuričin 25 policy responses related to the financial instruments in the republic of serbia include program for granting 1% interest rate loans to maintain the liquidity and working capital, and guarantee schemes to support the liquidity of private entities in times of covid-19 crisis. in some countries, central banks have abolished the reserve requirement on commercial banks to divert these funds to loans for smes. guarantee schemes for banks to strengthen loan financing of smes have been introduced by governments of many countries such as belgium, denmark, france, germany, poland, portugal, romania, spain, switzerland, the uk, etc. for example, the danish government guarantees 70% of the value of new bank loans of smes whose operating profits decreased by more than 50%. in italy, the central guarantee fund provided eur 1.5 billion for smes, germany provided eur 2.5 billion, and the united kingdom provided gbp 330 billion of loan guarantees for businesses. in some countries, administrative procedures have been simplified to provide easier access to loan guarantees. for example, in israel, loan approval at banks is shortened to up to 9 working days. along with guarantees, direct financial aid to smes is provided by some countries such as austria, croatia, czech republic, portugal, slovenia, spain, switzerland, uk, etc. direct financial aid in the republic of serbia is introduced only in the field of labour in the amount of three minimum salaries per each employee. ireland has introduced eur 200 million working capital scheme for businesses considered to have significant impact on economic development, while the united kingdom introduced a "coronavirus business interruption loan" for smes affected by covid-19 crisis in the amount of gbp 1.2 million. austria has directed the direct financial aid amounting to eur 100 million to the tourism sector, e.g. hotels whose sales declined by more than 15%. in some countries, the amount of funding allocated to the sme sector under existing lending schemes has been increased along with simplification of administrative procedures of getting loans. furthermore, some countries have decided to implement grants and subsidies to smes with different amounts and conditions for application (belgium, czech republic, denmark, france, germany, italy, slovak republic, spain, turkey, united kingdom, and united states). no structural policies have been adopted in the republic of serbia except for the distance learning for elementary and high school students. in all other cases, enterprises individually developed ways to adjust their working conditions to the new circumstances in times of epidemic and state of emergency. structural policies refer to the adoption of new working processes, retraining of workforce, digitalization, and finding new or alternative markets. these policies tend to tackle the new challenges of work through the covid-19 crisis aiming to strengthen the resilience of smes and support their growth and development. countries such as belgium, czech republic, france, italy, portugal, slovenia, and switzerland have adopted structural policy measures aiming to support smes in finding new markets. the danish export fund has introduced a support system for 250 smes, while germany established the economy stabilization fund to support businesses of crucial importance for the economy. to diversify sme export markets, italy has announced a eur 4 billion package, switzerland provided chf 4.5 billion for export promotion and spain provided eur 2 billion for the same purpose. in the republic of serbia, many enterprises have implemented the teleworking/digitalization measure thus enabling working from home during the covid-19 epidemic and state of emergency. teleworking/digitalization measures within structural policies have been adopted in many countries such as france, greece, italy, slovenia, spain etc. for example, the italian ministry of innovation and digitalization has launched an initiative called "digital solidarity" includes a portal for smes to register and access digital services of large enterprises without costs. countries such as the czech republic, france, germany, poland, etc. have adopted measures to support innovation and competitiveness of smes and start-ups. the chez republic has set czk 300 million for new technological equipment and facilities to subsidize projects to fight against the spread of the covid-19 disease. the european institute for technology has launched a call to innovative smes and start-ups to support testing, treating, monitoring and other aspects of covid-19 epidemics. for this purpose, france has set up an initial fund amounting to eur 4 billion to respond to the covid-19 crisis. measures to support training and redeployment have 26 economic analysis (2020, vol. 53, no. 1, 14-27) been adopted only in portugal where a special budget is set to provide training to people who are laid off because of covid-19. conclusion during the state of emergency declared due to the covid-19 epidemic, the medium-sized enterprises in serbia expressed varying degrees of concern for different aspects of doing business. concerns about employee health are mostly present along with strong concern about lack of funds to smoothly operate business and potential loss of market share. almost half of the surveyed enterprises expressed concern about unpaid receivables and lack of cash flow to cover operating expenses. early effects of the covid-19 crisis show that aspects of business that enterprises were most concerned about are not affected with the expected intensity. while 45% of the surveyed enterprises expressed concern about unpaid receivables and lack of cash flow to cover operating expenses, only 16% reported liquidity problems. 34% of enterprises reported concern about lack of funds to smoothly operate business, however only 4% reported difficulties accessing resources and capital. also, 67% of enterprises have not reduced the number of employees due to the early negative impacts of the covid-19 crisis, and 33% have not reduced and neither they expect to be forced to reduce the number of employees in the following months. research results show that concerns expressed by enterprises have been bigger than the real consequences that have occurred because of the covid-19 crisis. however, as the survey was conducted during the state of emergency, it represents a snapshot at one point in time thus leaving the possibility for negative effects to occur in the future. during the state of emergency, 56% of medium-sized enterprises stated that epidemics has affected their business activity, 22% reported that their business activity has not yet been affected by the epidemics but that they expect negative impacts in the following 2-5 months, 11% stated that their business will not be affected, and the same percentage of respondents reported that their business has not yet been affected but they expect the negative effects in the next 2 months. also, policy responses implemented in different countries to alleviate the economic impacts of the covid-19 outbreak were analyzed to identify problems faced by their smes. generally, the sme sector is facing similar problems in all countries. the research conducted on a sample of medium-sized enterprises in serbia indicates that this segment of the sme sector has shown brier resilience to the negative impacts of the covid-19 crisis comparing to entrepreneurs, micro and small enterprises. in line with identified problems, most countries have adopted similar measures to mitigate the negative impact of the covid-19 disease. measures and resources for their implementation vary across countries depending on the level of development and capacity to help the economy. accordingly, most measures introduced by the republic of serbia are related to labour and deferral. also, measures related to financial instruments have not been left out either, however they are less intensive comparing to other countries. what remains as an open question for future research is the assessment of efficiency of the adopted measures and the re-examination of possibilities for the adoption of new ones. acknowledgements this paper is a result of research financed by the ministry of education, science and technological development of the republic of serbia. isidora beraha, sonja đuričin 27 references bartik, a. w., bertrand, m., cullen, z. b., glaeser, e. l., luca, m., stanton, c. t. (2020). "how are small businesses adjusting to covid-19? early evidence from a survey." nber working paper no. 26989 bell, b., bloom, n., blundell, j., and pistaferr, l. (2020). ″prepare for large wage cuts if you are younger and work in a small firm″. cepr policy portal. https://voxeu.org/article/preparelarge-wage-cuts-if-you-are-younger-and-work-small-firm bouey, j. (2020). "assessment of covid-19's impact on small and medium-sized enterprises: implications from china", santa monica, ca: rand corporation, available at: https://www.rand.org/pubs/testimonies/ct524.html bourletidis, k., triantafyllopoulos, y. (2014). "smes survival in time of crisis: strategies, tactics and commercial success stories", procedia social and behavioural sciences, 148: 639 – 644. chowdhury, s. r. (2011). "impact of global crisis on small and medium enterprises". global business review, 12(3), 377–399. đuričin, s., beraha i. (2018a). „promoting the intensity of innovative activities of smes in the republic of serbia: „western balkans economies in eu integration”. cemafi international association, nica, france, 188-201 đuričin, s., beraha, i. (2018b). „financial power and development potential of environmentally responsible medium sized enterprises in the serbian industrial sector: sustainable growth and development in small open economies”. budapest: institute of world economics; centre for economic and regional studies of the hungarian academy of sciences, 124-142 he, w. l., wu, j.f. (2020). "research report on companies’ survival and development strategy during a novel coronavirus epidemic", beijing: uibe press. lazarevic-moravcevic, m. (2019). "characteristics of marketing communication strategy of a small enterprise". economic analysis, 52(2), 104-112. narjoko, d., hill, h. (2007). “winners and losers during a deep economic crisis: firm-level evidence from indonesian manufacturing”, asian economic journal, 21(4): 343-68. oecd. (2009). "the impact of the global crisis on sme and entrepreneurship financing and policy responses", available at: https://www.oecd.org/industry/smes/43183090.pdf oecd. (2017). "enhancing the contributions of smes in a global and digitalised economy". meeting of the oecd council at ministerial level paris, available at: https://www.oecd.org/industry/c-min-2017-8-en.pdf oecd. (2020). "tackling corona virus (covid-19), contributing to a global effort, sme policy responses", available at: www.oecd.org/coronavirus. soininen, j., puumalainen, k., sjögrén, h., syrja, p. (2012). "the impact of global economic crisis on smes". management research review, 35(10), 927–944 article history: received: may 15, 2020 accepted: june 2, 2020 https://voxeu.org/article/prepare-large-wage-cuts-if-you-are-younger-and-work-small-firm https://voxeu.org/article/prepare-large-wage-cuts-if-you-are-younger-and-work-small-firm https://www.oecd.org/industry/smes/43183090.pdf https://www.oecd.org/industry/c-min-2017-8-en.pdf the impact of covid-19 crisis on medium-sized enterprises in serbia isidora beraha11f* | sonja đuričin1 introduction data and methodology results and discussion conclusion acknowledgements references ea_2012_3-4 scientific review the evolution of serbian forex through nbs fx swaps živanović branko *, university union, belgrade banking academy, belgrade, serbia jolović ana**, maximaconsulting, belgrade, serbia udc: 336.761 ; 336.711(497.11) ; 338.23:336.74(497.11) jel: g28; d53 id: 195851276 abstract – this paper emphasizes the main goals of using derivatives as a monetary tool, increasing the foreign currency liquidity of commercial banks and controlling the volatility of the national currency. over the past few years, fx swaps, very often mistaken for currency swaps, became a popular monetary instrument among central banks. since 2007, inter-central bank swap credit lines have become a role model for supporting the foreign currency liquidity of national commercial banks. the national bank of serbia introduced fx swap transactions as part of a special facility for supporting the country’s financial stability. our research indicates that the nbs is not part of a swap credit line, but rather uses fx swaps internally and in a very fragmented manner. the trading volume of the newly-introduced instrument has been quite modest. the quiet introduction of fx swaps has failed to make any insignificant impact on the stabilization of the national currency, and has caused a fairly minor increase in eur liquidity. at the very end it is worth mentioning that, regardless of the first results, nbs swaps mean that the serbian forex derivative market has “crossed the rubicon”. key words: fx swap, monetary policy, central bank, fx currency liquidity, rsd volatility, national bank of serbia introduction the foreign exchange (fx) swap market has grown strongly over the years, reaching a notional amount outstanding of more than 30,000 billion usd in 2009. this rising popularity of fx swaps as an instrument for hedging or acquiring fx funding, combined with the role of central banks in the fx swap market, has raised questions about the nature of this instrument, as well as of its role in macro-financial stability. this question was given additional weight by the financial crisis and currency and liquidity shortages. one of the main roles of the fx swap at the macro level is to play the role of crucial instrument for the smooth functioning of financial markets and monetary intervention. since 2007, central banks have increasingly recognized the impact of fx swaps on financial and economic stability. the statement above is further borne out by their special exemption from us regulatory oversight. in august 2009, the us treasury department released the over-the-counter * branko živanović, phd, belgrade banking academy, belgrade ** ana jolović, phd, maximaconsulting, belgrade živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 15 derivatives market act of 2009 (ocdma) in order to prevent some of the causes that led to the financial crisis. the regulation moved all over-the-counter (otc) derivatives trading onto regulated exchanges, except for fx swaps and forwards. these instruments were excluded as they were not considered otc derivatives under general market conventions because of the short-term nature of the contracts, high turnover and real physical exchange of principal. following the introduction of ocdma, in july 2010, the senate passed financial markets, considered the most comprehensive set of such laws since the 1930s, aiming to significantly modify the otc markets. under this legislation, fx swaps and forwards are regulated as derivatives, but it is left to the secretary of treasury to write to relevant congressional committees asking for an exemption. in 2011, the us treasury department issued a notice of proposed determination, stipulating that central clearing and exchange trading requirements would not apply to fx swaps and forwards. in addition, the treasury confirmed that fx swaps and forwards market operated at high levels of transparency, with these instruments already traded in a highly transparent, liquid, and efficient market. they also pointed out that there was a number of unique factors limiting risk in the fx swaps and forwards market, such as fixed terms and physical exchange of currency, well-functioning settlement process and shorter duration contracts (68 % of the market matures in one week or less, and 98% in one year or less). in april 2009 the national bank of serbia (nbs) introduced fx swaps as part of a special package of facilities for supporting the country’s financial stability. the main goal was to improve the liquidity of national commercial banks (both in euros and dinars, the local currency) through swap auctions or as a bilateral agreement between commercial bank and the nbs (decision on special facilities supporting the country’s financial stability, article 5). bearing in mind that serbia has an underdeveloped otc market and a non-existent organized derivatives market, it is very important to address this newly introduced instrument, its function, the often overlooked difference between fx and currency swaps, market structure, and fx swap influence on financial stability. it should be emphasizes that this paper has no intention of addressing the current dispute over additional regulation of fx swaps. it focuses on fx swaps as a newly-introduced instrument in an underdeveloped financial market (in this case, the serbian financial market), as well as on the first results achieved. this paper is organized as follows: the background and key aspects of fx swaps, their functioning, valuation and differences in comparison to currency swaps are presented in section 2. section 3 discusses central banks and fx swaps as a monetary tool used to help achieve financial stability. fx swaps introduced by the nbs are comprehensively presented in section 4. section 5 presents the first findings on the usage of fx swaps by the central bank as a monetary tool in an underdeveloped financial market. fx swaps the reuters financial glossary defines an fx swap as “simultaneous borrowing and lending of one currency for another with two different value dates.” the different value economic analysis (2012, vol. 45, no. 3-4, 14-30) 16 dates usually refer to spot and forward date. fx swaps were introduced into the market at the beginning of the 1980s and are extensively used today (table 1).1 dealing with fx swaps has certain advantages. firstly, they are an interbank instrument which usually excludes clients. because of counterparties included, it is perceived as an instrument with minimal counterparty risk. secondly, an fx swap does not assume that banks are buying or selling deposits – they are exchanging them. and finally, in some cases, it is an off-balance-sheet item, so it does not influence assets and liabilities. table 1. amounts outstanding of otc foreign exchange derivatives (in billions of usd) source: bis statistics there are three common types of fx swaps: spot against forward, forward against forward and short dates forward. in the first case, the first exchange of money takes place on a spot date (2 business days) and the reverse exchange of money takes place on the future date. the second type of fx swap, forward against forward, assumes that the first exchange takes place on a forward date and the reverse exchange is on a later forward date. short date fx swaps are swaps which run for less than a month. in case of fx swaps, counterparties can agree on having a clearinghouse involved. in that case, the counterparties initially trade up to an agreed threshold of exposure (margin threshold) based on each counterparty’s credit rating. a margin call is made by a counterparty when its fx swap position is “in the money,” i.e., when the position of the other party is “out of the money.” cash or securities deposited in a margin account can be used as collateral (barkbu and ong: 2010). international accounting standard ias 39 applies to fx swap accounting. as there is no initial cost in case of financial derivatives, they would usually be presented in financial statements in the form of a note to the accounts. however, ias 39 brings derivatives onto financial statements to increase the transparency of risk exposures. fx swaps are carried on the balance sheet at their fair value which is zero on the day the fx swap is transacted. on the balance sheet the value of an fx swap may be positive (if the swap is in-the-money and an asset), negative (if the swap is out-of-the-money and a liability) or zero (barkbu and ong: 1 some authors, like hooyman (1993), argue that fx swaps were used even decades before. živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 17 2010). at this juncture we need to emphasize that not all countries follow ias 39, which implies that in some cases fx swaps remain off-balance-sheet. banks quote fx swaps by using swap or forward points instead of outright forward quotes. by doing this, risk associated with interest rate differentials is separated from spot exchange rate movements. fx swaps are easy to price based on available forward quotations and by satisfying the covered interest parity condition. by trading fx swaps, traders are basically trading interest rate differentials risks. the fx swap is mainly used for swapping surplus currencies; creating deposit borrowings in another currency; as an alternative to nonliquid money markets; speculation; and roll-over of spot fx position and cash management. these swaps are standard otc instruments that make it possible institutions to fund their foreign exchange balances in a more liquid way in comparison to forwards, and are used by banks and financial institutions for managing liquidity and shifting delivery dates (barkbu and ong: 2010). the mechanism of the fx swap can be explained by introducing a contractual equation to start with (neftici: 2008). let us assume there is a forward contract to buy usd against eur. this contract can be replicated with a portfolio made up of a loan denominated in eur, spot purchase of usd against eur, and a deposit in usd. if we exclude transaction costs, bid-ask spread, credit risk and market liquidity, the position can be presented as in figure 1. 2 figure 1. contractual equation source: neftici (2008:60) in comparison to the contractual equation, the construction of an fx swap includes only one bid-ask spread (figure 2). the fx swap is combination of money market deposits and money market loans in different currencies written on the same underlying “ticket”. it can be seen as an instance of two counterparties spot purchasing and forward selling two currencies against each other. interest rates play a crucial role in this instrument, since not both currencies will have equal interest rates between t0 and t1. the difference will be included in the amount exchanged at t1 as compensation for one side’s loss. 2 the left and right side generate the same cash flow, although it does not mean that the monetary value is the same. in many cases some of the right-hand side contracts may not even exist in a particular economy. = + + fx forward buy usd against eur loan borrow eur at t0 for maturity t1 spot operation using the proceeded buy usd against eur deposit deposit usd at t0 for maturity t1 economic analysis (2012, vol. 45, no. 3-4, 14-30) 18 figure 2. fx swap source: neftici (2008:67) the fx swap is not to be confused with the currency swap, which is a different instrument. a currency swap is like an exchange of two frns (floating rate notes) with different currencies. it has two principals in different currencies, which exchange equal values at t0. during the period between t0 and t1, the interest in different currencies will be received / paid at the agreed interest rate. at the end the principals from t0 will be reexchanged. let us assume that there is an agreement to pay 10% on a gbp principal of gbp10,000,000 and receive 10% on a usd principal of $15,000,000 every year for 5 years. the cash flow is presented in table 2. the typical usage of a currency swap is conversion from a liability in one currency to a liability in another currency or conversion from an investment in one currency to an investment in another currency. table 2. currency swap cash flow year usd in millions gbp in millions 0 15 + 10 1 + 1.5 1 2 + 1.5 1 3 + 1.5 1 4 + 1.5 1 5 + 16.5 11 at t1, money is re-exchanged in the event that either of these instruments is used, but in an fx swap it is exchanged at a different exchange rate in comparison to a currency swap, where the exchange rate from t0 is used. this is because in an fx swap there are no interim interest payments. two parties exchange currencies for a certain period of time, after which t0 t0 t0 + eur + eur usd t1 eurwith interest t1 t1 + usd with + usd with interest eurwith interest by adding these, we obtain the following fx swap… živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 19 they get their original currencies back. at the same time, the interest rates on those two currencies are not the same, so they need to be compensated for by using the exchange rate. in case 100,000,000 eur is received and against these 100,000,000 et0 usd are paid, where et0 is the eur/usd exchange rate at t0, the new exchange rate at t1 is (neftici:2008): ft0 = et0 1+ lt 0 usdδ 1+ lt 0 eurδ where usdtl 0 is the interest rate for usd at t0, eur tl 0 is the interest rate for eur at t0,and δ is the period of time. the comparison of an fx swap and a currency swap is presented in figure 3. figure 3. comparison of currency and fx swap source: neftici (2008:149) central banks and fx swaps although not originally designed by central banks, fx swaps have become part of the monetary policy intervention toolkit. in a survey conducted by the bank for international settlements more than thirteen years ago (bis 1997:332), seven out of fourteen industrialcountry central banks surveyed said they used fx swaps. they were used against either the receive 100m eur pay (100m et0) usd receive (100m et0) usd pay 100m eur (½ usd-libor) 100m e (½ eur-libor) 100m eur exchange at et0 again currency swap fx swap exchan ge at et0 receive 100m eur excha nge at pay (100m et0) usd receive 100m fet0 usd pay 100m eur no interim t0 t1 exchange at ft0 again economic analysis (2012, vol. 45, no. 3-4, 14-30) 20 us dollar or the deutschmark (or both), among other tools used to intervene in the open market. since then, central banks have discovered that the fx swap could be used for achieving other goals as well. in cases where the initiating agent is a central bank, the basic motivations for introducing fx swaps are to affect domestic liquidity, to manage foreign exchange reserves and to support further development of financial markets. on the odd occasion central banks have been known to use it for the main purpose of hedging and asset liability management (bartolini, 2002). central banks like to use fx swaps mainly because this instrument offers flexibility. from the viewpoint of central banks’ risk management, fx swaps are generally no riskier than standard repo operations. it is also important to notice that, in case of combining fx swaps with spot fx interventions, it can lead to significant risk-bearing by the central bank. if the central bank uses the foreign currency obtained as collateral in the swap transaction to defend exchange parity under pressure, it will incur losses if the defense fails before the forward leg of the swap transaction is unwound. fx swaps can be used by the central banks as an instrument for reducing volatility of foreign exchange, as well as liquidity. at the same time it is important to stress that fx swaps can behave as a magnifying glass in case of nonliquid markets and during stressful periods by creating more foreign exchange volatility instead of reducing it (barkbu and ong, 2010). the new era for fx swaps started in december 2007, when the fed introduced an fx swap system dubbed “swap lines”. these swap lines were also introduced by other central banks (table 3), as part of sets of measures designed to boost market stability. the program enhanced the ability of central banks to provide us dollar funding to financial institutions in their jurisdictions. it relieved pressures in usd funding markets and reduced incentives for foreign financial institutions to sell dollar assets at fire-sale prices. the swap lines system works as follows. in the first step, a foreign central bank draws a swap line by selling a specific amount of its national currency for usd at the market exchange rate. at the same time the fed and the foreign central bank agree that the foreign central bank will repurchase its currency at the same exchange rate in the future (fleming and klagge, 2010). looking only at the first part, this swap seems more like a currency swap than an fx swap. the difference appears at the time of maturity of the swap. at the time the swap is concluded, the foreign central bank pays the fed an amount of interest on the dollars borrowed equal to the amount that the central bank earned on dollar lending to institutions. on the other hand, the fed does not lend foreign currency and therefore does not pay any interest to the foreign central bank. the foreign currency that the fed acquires is an asset on its balance sheet. in classical fx or currency swap there is no third contributor. however, in case of swap lines created by the fed, the third contributors are institutions under the jurisdiction of foreign central banks, determined by the foreign central bank as eligible. the foreign central bank lends dollars to the eligible commercial banks, and has a right to decide on the required collateral. after introducing it, the fed rapidly increased the swap credit line, both in terms of including more central banks and in terms of dollars committed (table 3 and chart 1). živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 21 table 3. swap lines opened by the fed with central banks date central bank december 12, 2007 european cb, swiss national bank september 18, 2008 bank of japan, bank of england, bank of canada september 24, 2008 reserve bank of australia, sveriges riksbank, norges bank, danmarks nationalbank october 28, 2008 reserve bank of new zealand october 29, 2008 banco central do brasil, banco de mexico, bank of korea, monetary authority of singapore source: fleming and klagge (2010:3) during the financial crisis, the fed introduced the fx swap as a temporary swap line. these temporary arrangements expired in february 2010, but in may 2010 they were reestablished with some central banks (bank of canada, bank of england, european central bank, bank of japan, and swiss national bank), in response to the re-emergence of strains in short-term usd funding markets. the use of swap lines has been minimal since may 2010, reaching a peak of usd 9.2 billion compared with a previous peak of usd 586 billion. the fed’s swap lines with the european central bank (ecb) played a critical role alongside the ecb’s direct efforts to avoid a more rapid reduction in credit in the european union by making it possible for europe’s banks to borrow usd from the ecb. chart 1. usd fx swap facility usage since inception source: federal reserve system in addition to re-establishing swap lines, in april 2009 the fed introduced “foreigncurrency liquidity swap lines” which are a mirror image of the previously described fx swap line. the idea was to provide capacity to offer liquidity to us institutions in foreign currency. these lines were created with the ecb, the bank of england, the bank of japan, and the swiss national bank. moreover, in november 2011 these central banks started coordinated action to enhance their capacity to provide liquidity support to the financial system. they reduced fees applied to draws on usd from the fed’s foreign-currency economic analysis (2012, vol. 45, no. 3-4, 14-30) 22 liquidity swap lines and extended the terms of those facilities. the main goal was to mitigate the effects of the strains in financial markets to the supply of credit to businesses and households. the measures improved the financial conditions in the euro area and narrow euro-dollar fx swap basis spreads. determinants of nbs fx swaps the national bank of serbia introduced fx swaps with the aim of stabilizing the domestic fx market and minimizing rsd volatility. in direct trading with domestic commercial banks the nbs can swap sales of eur for rsd or swap purchases of eur for rsd. as part of fx swap transactions, the nbs performs spot and forward transaction at the same time. it simultaneously sells/purchases eur on the spot date and purchases/sells the same amount on the forward date. swap transactions can be organized as auctions or as direct transactions called “bilateral swaps” (based on a commercial bank’s3 request or as requested by the nbs). all transactions carried out to date were conducted as auctions. swap auctions are conducted via the web platform dubbed “monetary operations of the national bank of serbia – application for foreign exchange trading”. in practice, foreign currency is sold/purchased by using spot exchange rate and swap points defined by the nbs in advance auctions at fixed swap points. the swap points are calculated by using the following formula: swap points = spot exchange rate * 000,10*1 360 * 100 1 360 * 100 1 1 2             −      +      + dk dk forward exchange rate = spot exchange rate + (swap points/10,000) where: k1 annual interest rate for the eur, with two decimal places k2 annual interest rate for the rsd, with two decimal places d transaction maturity however, the nbs bylaw allows variable swap points auctions, i.e. swap points can be bid by banks. auctions at variable swap points can result in the nbs purchase/sell foreign exchange at swap points bid by the bank whose bid was accepted at the auction (auction at variable swap points), or the nbs can purchase/sell foreign exchange at the same swap points from each bank whose bid was accepted at the auction (auction at single swap points). the key elements of a swap contract are: type of a swap; type of auction; eur/rsd spot rate; swap points (in case they are fixed); transaction maturity; spot and forward date; and minimal amount that a bank can bid for. banks, previously notified about the auction and provided with key information from the decision on organization of auction, submit bids to 3in further text banks/bank živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 23 the nbs. fixed swap points auction allows only one bid per bank, in which the bank indicates the amount of foreign exchange to be swap purchased/sold within the swap points announced by the nbs in advance. where commercial banks’ total bids are higher than the central bank’s auction offer, the nbs assigns currency to each bank in proportion to its bid. variable swap points auction allows commercial banks to send not only one, but several purchase/sell bids. the nbs ranks bids depending on the level of swap points specified, ranking them from the lowest to highest. the governor, or a person authorized by him/her, decides on the lowest and/or highest swap points that a bid may contain to be accepted (marginal swap points), and on the total amount of funds that the nbs swap purchases/sells. in a multiple swap points auction, the nbs will make transactions with banks whose bids are accepted. in a single swap points auction, the transactions will be conducted with all banks whose bids are accepted, at the same swap points, i.e. marginal swap points. in bilateral swap trading between the nbs and banks, each bank submits a single swap bid that states the amount requested. the nbs responds by sending a bid which includes data about the spot fx rate and the level of swap points at which it is ready to make the transaction. finally, the bank takes into account the nbs’s bid and replies to it on the same day. alternatively, the nbs can refuse the bid and notify the commercial bank of its refusal on the same day. chart 2. nbs fx swaps source: national bank of serbia beginning in may 2009, the nbs held regular fx swap auctions with an average maturity of two weeks. banks did not show much interest as the swap rates were uncompetitive. in 2010 the nbs continued to organize two-week foreign exchange swaps, but without any real success. between april and july 2010, the nbs made changes and organized auctions of three-month fx swaps. the goal was to use fx swaps as a regular instrument of eur/rsd liquidity supply, as well as to encourage interbank swap trading and the development of the fx hedging market, sorely needed in serbia. a total of 28 swap auctions were held during that year, with the nbs selling eur 109.2mn and buying eur 152.5mn. in early march 2011, the nbs once more introduced auction of three-month fx swaps, and organized 88 of them in total. the balance for 2011 was: the nbs sold eur 179.5mn to banks and bought eur 0 50 100 150 200 2010 2011 2012 q2 109,2 179,5 116 152,5 185 123 fx swaps (in eur mln) nbs sold nbs bought economic analysis (2012, vol. 45, no. 3-4, 14-30) 24 185.0mn from them. at year-end, the total amount of receivables swapped by the nbs stood at eur 111.0mn, while the amount of payables stood at eur 49.0mn. in 2012, the nbs continued holding weekly auctions, organized under market conditions and offering limited quantities. during the first half of the year, until june 30, the nbs organized 52 auctions of three-month fx swaps resulting in the sale of 116mn eur and the purchase of 123mn eur. on that day, the balance of receivables swapped by the nbs stood at eur 16.0mn and that of payables at eur 36.0mn. impact of fx swaps as a monetary tool of the nbs without any doubt, the nbs introduced fx swaps with the intention to use it as a monetary tool to control significant rsd volatility and improve the liquidity of banks. this has been a concerted effort aimed at changing the classical model of monetary policy by introducing derivatives, previously not used in the serbian underdeveloped market. the current rsd fx regime, a so-called “managed float”, is fundamentally unstable. it is directly dependent on the level and structure of the central bank’s reserves, which are recovering with great difficulty, sustained only by significant nbs interventions on the interbank fx market, and determined by fdi inflows and the level of liquid commercial banks’ foreign currency reserves. domestic currency fx rates are highly sensitive and easy influenced by lobbying groups able to speculatively destabilize them. the serbian dinar used to be additionally supported by an effectively positive and significantly high key monetary policy rate (repo rate). the consequences of the above exchange rate regime are: 1. frequent nbs interventions; 2. decrease in net foreign assets; 3. significant depreciation of rsd. nbs interventions were the only tool used to control the stability of the national currency; moreover, during the 2000s, they were insignificant. rare interventions and occasional appreciation of the dinar were the result of net capital inflows as the result of privatization, net foreign borrowing, a significantly high key policy rate, and acceptably high foreign exchange and rsd reserve requirements for commercial banks. the high level of foreign currency reserves provided the capacity for defending the national currency even during the global financial slump. therefore, during 2008 and 2009, the nbs intervened to protect the rsd within a reasonable bracket. the first major attacks on the serbian dinar started in the last quarter of 2009 and continued until late 2010. in the last quarter of 2009, the nbs intervened by using large amounts, on average eur 50 million per month, with the aim of keeping the targeted exchange rate. at some point the nbs had to intervene with up to eur 100 million per day, in order to prevent the psychological margin of 100 rsd/eur from being exceeded, as this would have been considered as a definite sign of a wrong monetary policy and the end of the contended rsd managed float. živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 25 chart 3. monthly nbs interventions, 2008-2011, in millions of eur source: national bank of serbia the psychological threshold was crossed on 17 may 2010, and the nbs became less enthusiastic about defending the national currency but kept up the high volume of monthly interventions (chart 2 and chart 3). if nbs continues with this trend, it is certain that the foreign reserves – hardly a renewable source – will see a sharp fall. chart 4. annual interventions by the nbs for period 2008-2011 in millions of eur source: national bank of serbia the research shows that despite enormous interventions in 2010, there has been no noticeable decrease in the amount of foreign currency reserves: conversely, they even grew 5 4 ,0 1 2 5 ,0 1 0 5 ,0 7 4 ,0 3 8 ,0 0 ,0 0 ,0 3 ,0 0 ,0 2 3 9 ,0 3 7 2 ,0 1 1 7 ,5 4 4 2 ,9 2 1 9 ,8 0 ,0 0 ,0 1 ,0 1 ,0 0 ,0 0 ,0 0 ,0 0 ,0 0 ,0 4 2 ,0 2 4 5 ,5 1 9 6 ,0 1 9 0 ,0 5 ,0 3 5 9 ,0 4 2 1 ,0 2 3 1 ,0 2 0 2 ,0 1 5 1 ,7 1 7 3 ,0 1 5 8 ,0 1 9 0 ,0 0 ,0 0 ,0 0 ,0 0 ,0 0 ,0 3 0 ,0 2 0 ,0 1 0 ,0 0 ,0 0 ,0 0 ,0 3 0 ,0 0,0 50,0 100,0 150,0 200,0 250,0 300,0 350,0 400,0 450,0 500,0 2 0 0 8 -ј a n 2 0 0 8 -m a r . 2 0 0 8 -m a y 2 0 0 8 -j u l 2 0 0 8 -s e p 2 0 0 8 -n o v 2 0 0 9 -ј а n 2 0 0 9 -m a r 2 0 0 9 -м а y 2 0 0 9 -ј u l 2 0 0 9 -s e p 2 0 0 9 -n o v 2 0 1 0 -ј а n 2 0 1 0 -m a r 2 0 1 0 -м а y 2 0 1 0 -ј u l 2 0 1 0 -s e p 2 0 1 0 -n o v 2 0 1 1 -j a n 2 0 1 1 -m a r 2 0 1 1 -m a y 2 0 1 1 -j u l 2 0 1 1 -s e p 2 0 1 1 -n o v 0 500 1000 1500 2000 2500 3000 2008 2009 2010 2011 1127,5 706,6 2549,7 90.0 economic analysis (2012, vol. 45, no. 3-4, 14-30) 26 by eur 180 million in april. although one hopes that the increase was the result of economic growth or greater exports, in fact it was a consequence of the inflow of funds drawn under a stand-by arrangement with the imf. at first sight, the national foreign reserves might seem reasonably high and stable, at times providing cover for the money supply (m1) of over 400 per cent (for example in january 2010 the cover stood at 442%). however, the essence of the problem is the structure of the foreign reserves, which are very fragile and are mostly the result of national monetary policy measures, primarily the level of foreign currency reserve requirements. chart 5. structure of nbs foreign reserves source: national bank of serbia according to our research, net foreign assets, the key part of foreign exchange reserves, amount to some eur 6 billion (chart 4). the remaining amount is the direct result of the already mentioned drawing of funds under the imf standby arrangement and reserve requirements for banks. as we have shown, 2010 saw dips in foreign reserves as a result of periodical and aggressive nbs interventions, but, on the other hand, their permanent renewal was rooted in foreign borrowing and reserve requirements. therefore, the structure of foreign reserves has been changing, yet without any significant change in their total amount. any further analysis of the impact of fx on monetary stability and the likelihood of the nbs using different monetary tools, we need to point out that net foreign assets are a cornerstone of negotiations between the nbs and the imf. the quantitative requirement, according to the stand-by arrangement, means that the minimal level of net foreign assets had to be eur 4.8 billion in september and eur 4.6 billion in december 2010. as the monetary policy outlined above includes continuous and regular nbs interventions, the bottom level of required net foreign currency assets will be reached quickly, leaving the nbs in a position to change the policy or tools used to date. živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 27 chart 6. net foreign assets, 2008-2010, in billions of eur source: national bank of serbia the third consequence of using a “managed float” exchange rate regime has been the significant depreciation of rsd. although fx swaps and many other monetary tools are used to stabilize the national currency, distinct exchange rate volatility emerged in the last quarter of 2008 (table 4). constant depreciation to date may seem like modest decline, but, on the contrary, it is a significant drop when one bears in mind the amount of interventions recently made by the nbs. average annual depreciation for the seven-year period equals 6.90%. if we exclude 2006, when the rsd appreciated against the eur by 7.60%, we can conclude that the average annual depreciation equalled 8.97%. total depreciation since the introduction of the euro stands at 67.65%. table 4. depreciation of rsd for period 2003 until 2011 date rsd middle exchange rate depreciation of rsd (%) 01.01.2003 68.5845 31.12.2003 68.3129 -0.40 appreciation 31.12.2004 78.8850 15.48 depreciation 31.12.2005 85.5000 8.39 depreciation 31.12.2006 79.0000 -7.60 appreciation 31.12.2007 79.2362 0.30 depreciation 31.12.2008 88.6010 11.82 depreciation 31.12.2009 95.8888 8.23 depreciation 31.12.2010 105.4962 10.01 depreciation 31.12.2011 104.6409 -0.81 appreciation source: national bank of serbia 480171,0 570504,0 507330,0 473564,0480916,0 488003,0 549997,0 638358,0 670091,0 ,0 100000,0 200000,0 300000,0 400000,0 500000,0 600000,0 700000,0 800000,0 economic analysis (2012, vol. 45, no. 3-4, 14-30) 28 in the first six months of 2010, the dinar depreciated against the euro by 7.67%. a detailed examination of the depreciation at the monthly level is given in table 5. the impact on the dinar first became apparent at the beginning of the year and grew until may, when the nbs was forced to intervene in the foreign exchange market with eur 359 million, bringing the total amount expended since the beginning of the year to eur 1,118.5 million. despite the aggressive interventions not much was achieved, and the dinar lost more ground to the euro. the volatility of the rsd exchange rate is not the embodiment of banking and economic dogma. it is permanently reduced by ex post facto interventions. table 5. depreciation of rsd in 2010 and 2011 date rsd middle exchange rate depreciation of rsd (%) 31.12.2009 95.8888 8.23 depreciation 31.01.2010 98.4620 2.63 depreciation 28.02.2010 99.6337 1.19 depreciation 31.03.2010 99.7604 0.13 depreciation 30.04.2010 99.2683 -0.49 appreciation 31.05.2010 102.7303 3.46 depreciation 30.06.2010 104.3704 7.67 depreciation 31.07.2010 106.2256 1.78 depreciation 31.08.2010 105.1032 -0,56 appreciation 30.09.2010 106.1748 1.02 depreciation 31.10.2010 107.4270 1.18 depreciation 30.11.2010 107.1945 -0.20 appreciation 31.12.2010 105.4982 -1.59 appreciation 31.01.2011 104.6051 -0.58 appreciation 28.02.2011 103.2237 -1.32 appreciation 31.03.2011 103.5951 0.35 depreciation 30.04.2011 99.6292 -3.84 appreciation 31.05.2011 96.9802 -2.64 appreciation 30.06.2011 102.4631 5.66 depreciation 31.07.2011 102.1251 -0.34 appreciation 31.08.2011 101.5836 -0.53 appreciation 30.09.2011 101.1732 -0.41 appreciation 31.10.2011 100.4852 -0.69 appreciation 30.11.2011 103.9741 3.48 depreciation 31.12.2011 104.6409 0.65 depreciation source: national bank of serbia conclusion unlike most other derivatives, fx swaps and forwards have fixed payment obligations, are physically settled, and are predominantly short-term instruments. since the time they appeared in the intervention toolkits of many central banks around the world, many have thought that the popularity of this instrument was not going to last. however, the last crises proved them wrong, and the fx forward became a powerful tool for managing the liquidity and stability of the financial system. živanvić, b., et al., the evolution of serbian forex, ea (2012, vol. 45, no, 3-4, 14-30) 29 swap arrangements, allowing central banks to lend each other currencies, become contingency measures for crises, such as europe’s debt problems. the leaders of the brics countries, brazil, russia, india, china and south africa, announced in the fall of 2012 that they would study fx swaps as part of a broader effort to move away from reliance on the dollar and the euro. the introduction of nbs fx swaps is a positive move in the development of the serbian fx market. however, this instrument – originally intended to stabilize the daily volatility of the rsd currency rate – has not had the expected effects. the critically small number of auctions and volumes led to corresponding effects on the level of national fx reserves, level of net foreign assets, volume of nbs interventions and appreciation/depreciation of national currency. furthermore, the nbs has failed to join any currency swap line, as expected. the nbs’s main role was predominantly to mediate between banks that bid/offered foreign currencies through fx swaps; the nbs did not use much of its reserves for fx transactions. references 2012 annual report. the financial stability oversight board. allen, w. a., moessner r. 2010. “central bank co-operation and international liquidity in the financial crisis of 2008-9”, working paper, bank for international settlements. annual report on activities and results 2009..the national bank of serbia. annual report on activities and results 2010. the national bank of serbia. annual report on activities and results 2011. the national bank of serbia. barkbu, b. b., ong, l.l. “fx swap: implications for financial and economic stability”, imf working paper, 10/55. bartolini, l. “foreign exchange swaps”, new england economic review, second quarter 2002. bech, m. 2012. “fx volume during the financial crisis and now.” bis quarterly review, march. decision on performance of financial derivative transactions. rs official gazette, no. 85/2011. decision on special facilities supporting the country’s financial stability. rs official gazette, nos. 34/2009 and 36/2009. decision on terms and conditions of foreign exchange swap purchase/sale between the national bank of serbia and banks. rs official gazette, (10/2011) and (18/2012). decision on terms and conditions of foreign exchange swap trading between the national bank of serbia and banks.“ rs official gazette, (34/2009). determination of foreign exchange swaps and foreign exchange forwards under the commodity exchange act. u.s. department of the treasury, 2011. fleming, m.j., klagge, n. j. 2010. “the federal reserve’s foreign exchange swap lines.” federal reserve bank of ny current issues in economics and finance, 16 (4). goldberg linda s., kennedy craig and jason miu. 2011. “central bank dollar swap lines and overseas dollar funding costs.” frbny economic policy review. hooyman, k. 1993. „the use of foreign exchange swaps by central banks: a survey.“ imf working paper. neftici, s.n. 2008. principlesof financial engineering. london: academic press. report on otc derivatives data reporting and aggregation requirements. committee on payment and settlement systems and technical committee of the international organization of securities commissions, bis, january 2012. economic analysis (2012, vol. 45, no. 3-4, 14-30) 30 report to congress on international economic and exchange rate policies. u.s. department of the treasury, office of international affairs, may 25, 2012. semi-annual monetary policy report – january–june 2012. the national bank of serbia. triennial central bank survey report on global foreign exchange market activity in 2010. bis, december 2010. zubord, l., peterson, s. congress ready to pass historical legislation – highlights from the derivatives title, http://www.chathamfinancial.com/congress-ready-to-pass-historiclegislation-highlights-from-the-derivatives-title/ razvoj srpskog forexa preko svop transakcija narodne banke srbije rezime – ovaj rad ističe glavne ciljeve korišćenja derivata kao monetarnih instrumenata, povećanje devizne likvidnosti poslovnih banaka i kontrolisanje volatilnosti nacionalne valute. tokom proteklih nekoliko godina devizni svopovi, koji se vrlo često mešaju sa valutnim svopovima, postali su popularan monetarni instrument centralnih banaka. od 2007. svop kreditne linije među centralnim bankama postale su primer za podršku devizne likvidnosti domaćih poslovnih banaka. narodna banka srbije uvela je devizne svop transakcije, kao deo podrške finansijskoj stabilnosti zemlje. naše istraživanje pokazuje da nbs nije deo svop kreditne linije, već interno koristi devizni svop na vrlo fragmentiran način. obim trgovanja na novim instrumentima je prilično skroman. neprimetno uvođenje deviznih svopova nije uspelo da dobije značajniji uticaj na stabilizaciju domaće valute, i izazvalo je prilično mali porast likvidnosti evra. na samom kraju vredi pomenuti da je, bez obzira na prve rezultate, samo pojavljivanje svopova narodne banke srbije znači da je srpsko tržište derivata "prešlo rubikon". ključne reči: devizni svop, monetarna politika, centralna banka, devizna likvidnost, volatilnost dinara, narodna banka srbije article history: received: 4 octoper 2012 accepted: 25 october 2012 ea_2017_1-2 notes from of editor-in-chief it has been an enjoyable experience and i have been lucky to have worked with such good colleagues and members of the editorial board since 2009. looking back, as the editor in chief of economic analysis, i realized just how many changes there have been over the last eight years. in the meantime, the journal has progressed twice and it is now referred as m52 by ministry of education, science and technological development of republic of serbia. my effort, energy and motivation of previous years will be for sure maintained throughout the coming years by new editor in chief. in line with this, i wish him a lot of success. finally, thank you for all your help and trust in me over the years! 10th of june, 2017. editor-in-chief acad. prof.mirjana radovic-markovic, phd ea_2013_3-4 finalna ver scientific review reforms of the imf in the context of the global financial crisis1 plchová božena, university of economics, prague, czech republic baranenko elena2, institute of economic sciences, belgrade, serbia udc: 339.732.4 ; 338.124.2(100) jel: f33; g01 id: 203722764 abstract – the imf during its existence has undergone numerous changes. from the institution established for international monetary cooperation and oversight over fixed exchange rate regimes, the imf has turned into an institution whose main goal is the maintenance of the global economic and financial stability. in order to achieve this goal, the imf in the modern era focuses its activities primarily on the prevention of emergence of economic crisis and minimising of their negative effects. however, at the end of the xx and the beginning of the xxi century, due to inefficient activities and poor results, especially when it comes to solving the crisis in south east asia and argentina, the fund began to lose its credibility and found itself in a deep crisis. the imf has tried to take steps that would lead to the improvement of the situation, but it did not manage to achieve tangible progress. the global economic crisis has further highlighted the existing drawbacks and omissions, which the fund has been faced with. however, the growing demand for financial support from member states, as well as the need for the organization that would succeed in preventing the emerging of crisis and facilitate the fight with its consequences, were providing serious support to the fund. the imf's new effort has been focused on reforming its structure and the way of functioning. this paper analyzes the progress achieved by the imf in the implementation of reforms related to resolving the difficulties caused by the crisis and discusses possible directions for future activities of the fund including an overview of vulnerabilities and the possibility of their elimination. key words: imf, reforms, financial crisis introduction over the last few years we have been witnesses of one of the biggest financial crisis, which significantly influenced the development of the global economy and placed it into a recession. the global character of the crisis, the severity of the impact and the number of 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. 2 elena baranenko, ma, research associate, institute of economic sciences, belgrade, phd student at the faculty of international relations, department international trade, the university of economics in prague, e-mail: elena.baranenko@ien.bg.ac.rs economic analysis (2013, vol. 46, no. 3-4, 1-13) 2 affected countries, industries, companies and people indicated that it was necessary at the international level to conduct qualitative research of this phenomenon and deepen cooperation in order to avoid or prevent the proliferation of new financial crises of similar range and consequences. in this context, international financial organizations could actually play a significant role. one of the most important players in the international financial arena, whose main objective is to support financial stability, is the international monetary fund. for many years, the imf among other things has been trying by its activities to prevent the emergence and spreading of financial crisis, but despite all efforts it did not manage to achieve significant results in this area. lack of effective action, numerous internal problems as well as failures in solving the economic crises that erupted in the last two decades of the last century have influenced the imf to become a frequent target of criticism from the governments of various countries, large financial companies and professional public and in that way eventually began to speculate about the justification of the existence of this international economic organization. „in the last 60 years, the imf has promoted economic stability and socio-economic development. this organization, despite specific expectations, however, it did not achieve so much, so some observers consider that, in general, is not qualified to deal with the needs of countries that have certain problems. although it has the organizational capacity, the imf as well as other international financial / economic organizations must play a more coherent and effective role in the world. in the past, however its role was quite inefficient and discouraging“(paunovic, 2011, p.108). criticism is greatly tightened after the occurrence of the global financial crisis in 2007, when we could again notice that there are serious shortcomings when it comes to efficiency of the prediction and prevention of the emergence of crises, as well as the impact of the imf on the reduction of its consequences. also, the existing problems and weaknesses in the functioning of the fund have come to the fore. all this emphasized the necessity of reforming the imf as soon as possible and adaptation of its activities to modern turbulent period. the current financial crisis and imf activities in the framework of dealing with the crisis, the fund during the last 5 years has intensified activities in many areas and carried out a series of reformist steps in order to meet the needs of member countries and also contribute to the stabilization of the world economy. basic steps could be summarized in three points: perfecting the loan process and increasing permanent financial resources of the imf; improving projections and evaluations in order to strengthen the regulation of the world economy; regulation of international private capital flows. 1. perfecting the loan process and increasing permanent financial resources of the imf • process of lending one of the main goals in the first point was the formulation of such conditions for getting the loan, which would „enable the fund to respond with more flexibility to the diverse pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 3 liquidity needs of members with sound policies and fundamentals“(imf, 2012). necessity of the improvement of financing mechanism stemmed primarily from the fact that since the beginning of the crisis the demand for loans by the member countries has increased dramatically. for example, in the pre crisis period in 2007, the fund has lent approximately sdr 10 billion, while in may 2013 this amount increased significantly and accounted for more than sdr 93 billion (see the figure 1.). figure 1. imf credit outstanding for all members from 2003-2013 (in billion sdrs) source: imf it is interesting to mention that prior to the crisis, there were a lot of speculations that the fund most of its activities in the framework of financing had focused exclusively on developing countries (mostly low-income countries), while on the other side industrialized countries had begun to lose interest in the offer coming from the imf. this has contributed to the deepening of the crisis the fund has been facing with over several years, because it was unclear what exactly is the purpose of this organization and what type of work it is actually doing. however, after the emergence of the global economic crisis, the situation has significantly changed. in fact, by the end of 2008, the amount of borrowed funds in developed countries is almost equal to the amount of funds allocated to developing countries, and since 2009, the share of developed countries compared to developing countries has become considerably larger. it can be said that the global economic crisis „saved“ imf or, in other words, it gave him a second chance to achieve its basic goals and ultimately contribute to the stabilization of finance and economy in the world. • new lending instruments by implementing its intentions for improving credit processes in the framework of reforms, as a response to the challenges of the crisis, the imf starting from 2009, created several new instruments, which will be analyzed in the next section of the publication. economic analysis (2013, vol. 46, no. 3-4, 1-13) 4 the first two instruments, flexible credit line (fcl) and precautionary and liquidity line (pll), are intended for countries with a strong economy, and for countries having a healthy macroeconomic environment, strong institutional framework and follows the recommendations of the imf. the essence of fcl is about providing member countries with opportunities to apply for a loan before plunging into a serious crisis. countries can apply for a loan if they meet the qualifying criteria, or have a sound macroeconomic environment, strong institutional framework and follow the recommendations of the imf. for these countries then there is no conditionality or additional conditions nor limited access to financial resources. in addition, countries can withdraw the loan at any time. financial resources are available during 6 to 12 months with a maturity of 3.25 to 5 years. until now, fcl has been approved for poland, mexico and colombia. in 2010, the imf expanded its offer by introducing precautionary and liquidity line (pll). pll also applies to countries with a strong economy, which for some reason (usually due to certain weaknesses or moderate vulnerabilities that negatively affect the ability to meet the qualification criteria of fcl) are unable to use flexible credit line. pll allows the applicant to withdraw financial resources up to 1000% of quota in period from 12 to 24 months. table 1. some of the imf lending arrangements (in thousands of sdrs) member date of arrangement total amount agreed undrawn balance imf credit outstanding under gra stand-by arrangement (sba) antigua and barbuda june 07, 2010 67,5 16,875 50,625 bosnia and herzegovina september 26, 2012 338,2 202,92 404,994 georgia april 11, 2012 125 125 363,163 jordan august 03, 2012 1,364,000 852,5 511,5 kosovo april 27, 2012 90,968 12,752 96,976 romania march 31, 2011 3,090,600 3,090,600 7,682,625 st. kitts and nevis july 27, 2011 52,51 9,407 44,216 total 5,128,778 4,310,054 9,154,098 flexible credit line (fcl) mexico november 30, 2012 47,292,000 47,292,000 0 poland, republic of january 18, 2013 22,000,000 22,000,000 0 total 69,292,000 69,292,000 0 precautionary and liquidity line (pll) 1/ morocco august 03, 2012 4,117,400 4,117,400 0 total 4,117,400 4,117,400 0 source: imf pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 5 it should be mentioned that there was also a change, when it comes to the stand-by arrangement. in fact, since 2009 the sba is more flexible, and the conditions of its approving are significantly easier. among other things, within the sba there has been an increase in the supply of funds as well as borrowing limits.3 the next group of instruments is related to low-income countries. namely, within the „helping the world’s poorest“ imf offers more flexible programs and higher volume of loans (financial resources allocated for the period 2009-2014, whose mission is to reduce poverty and promote economic growth reached 17 mld.usd). aiming to provide a coordinated funding of low-income countries, the imf in 2010 formed a fund to promote economic growth and poverty reduction (prgt) and defined three lending instruments, which in april 2013 were advanced again in order to improve flexibility of the financial support. lending instruments or windows are the following: the extended credit facility (ecf), the standby credit facility (scf) and the rapid credit facility (rcf). ecf (succeeds the poverty reduction and growth facility) is the basic tool for providing medium-term financial support for low-income countries facing the balance of payments problems. the arrangement is intended for 3 to 5 years and gives the possibility to withdraw funds in the amount of up to 100% of its quota per year or 300% of its quota in total. in order to be able to obtain assistance, a country must provide a letter of intent which should contain the planned measures and policy actions to improve macroeconomic stability and a country's poverty reduction. the scf (replaced the high-access component of the exogenous shocks facility (esf)) is intended for low-income countries that have a strong and sustainable macroeconomic position, but faced with short-term balance of payments problems caused by political shocks or omissions. the period of the arrangement is 1 2 years, while the level of funding can be 100% of quota per year or 300% of quota in total. funding under the scf carries an interest rate of 0.25%, so that by the end of 2014 is acquitted of all interest. the rcf (streamlines the imf’s emergency assistance for low-income countries) provides rapid financial assistance to low-income countries facing an urgent balance of payments need and also in a wide variety of circumstances, including internal and external shocks, natural disasters, and other fragile situations. fund support under the rcf is provided without conditionality or reviews, in the form of direct payments, whereby access to financial resources is limited to 25% per annum or 75% cumulatively. financing under the rcf currently carries a zero interest rate, has a grace period of 5½ years, and a final maturity of 10 years. 3 http://www.imf.org/external/about/lending.htm economic analysis (2013, vol. 46, no. 3-4, 1-13) 6 table 2. some of the imf lending arrangements (in thousands of sdrs) poverty reduction and growth trust (prgt) extended credit facility (ecf) 2/ afghanistan, islamic republic of november 14, 2011 85 61 93,32 armenia, republic of june 28, 2010 133,4 26,6 132,478 bangladesh april 11, 2012 639,96 457,114 310,123 benin june 14, 2010 74,28 21,22 77,126 burkina faso june 14, 2010 82,274 6,45 136,038 burundi january 27, 2012 30 20 90,096 central african republic june 25, 2012 41,775 34,812 65,331 comoros september 21, 2009 13,573 3,115 9,715 cote d'ivoire november 04, 2011 390,24 178,86 512,277 gambia, the may 25, 2012 18,66 7,775 32,833 guinea february 24, 2012 128,52 73,44 55,585 haiti july 21, 2010 40,95 4,914 36,036 kenya january 31, 2011 488,52 71,921 641,049 kyrgyz republic june 20, 2011 66,6 28,544 118,215 lesotho june 02, 2010 50,605 5,68 47,025 liberia november 19, 2012 51,68 44,298 49,52 malawi july 23, 2012 104,1 65,05 128,717 mauritania march 15, 2010 77,28 11,04 75,067 niger march 16, 2012 78,96 56,4 52,946 sao tome & principe july 20, 2012 2,59 2,22 3,436 sierra leone july 01, 2010 31,11 8,91 78,318 solomon islands december 07, 2012 1,04 891 12,629 total 2,631,117 1,190,254 2,757,877 source: imf • financial recourses in order to provide a sufficient level of funding primarily to support the development in developing countries and emerging countries affected by the crisis, the imf has focussed on increasing the lending capacity. in april 2009, at the summit of the g-20, in the framework of the so-called „creating crisis firewall“ process, the increased lending capacity was approved by imf and amounted up to usd 500 billion in the size of the nab, while in 2010, the board of governors of imf approved an unprecedented doubling of quotas to approximately usd 733,9 billion (sdr 476,8 billion) (imf, 2013). according to (weiss a. martin, 2013), increase of financial resources through the nab instead an increase in quotas, was long-standing frustration among emerging market economies that, after years of sustained economic growth, their representation at the imf did not reflect their current economic position in the world economy. in april 2010, the volume of funds under the new arrangements to borrow (nab) was extended to nearly 560 billions usd (sdr 367.5 billion) and further 13 countries and several new institutions entered into the mechanism. in december 2011, the euro area pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 7 countries were committed to providing additional funding for the imf worth around 200 billion usd. 2. improving projections and evaluations in order to strengthen the regulation of the world economy • financial surveillance the second point, which imf defines as sharpening imf analysis and policy advice, is related primarily to prevent a new outbreak of the financial crisis. the global financial crisis revealed that there were serious failures when it comes to the fund's surveillance system that did not adequately react to the basic signs of the arrival of the crisis, primarily in build up of systemic risk (xafa, 2010). in an attempt to eliminate the major drawbacks and to strengthen financial surveillance, the imf has conducted a series of activities in the past three years. one of the first steps was directed to improving risk analysis and also the analysis of the linkages between the real economy, the financial sector and external stability, namely integration the analysis of financial stability with the macroeconomic analysis of the member countries4 (wickmanparak, 2012, p.3). the next important step is related to the financial sector assessment programmes (fsaps). in september 2010, the imf’s executive board decided to make fsap mandatory for 25 „systemically important“ member countries in this group had entered 15 of the g20 countries and the majority of members of the financial stability board (smyslov, 2012). in order to achieve improvement of quality assessment considerable attention has been devoted to improving the methodology and the fund's „stress testing tools“, as well as other factors like crisis management frameworks, institutional cooperation etc. (imf, 2013). among other things, there was an increase in flexibility, improved integration fsaps with the imf survelliance framework, as well as „clearer delineation of institutional responsibilities for stability and development, with greater institutional accountability.“ (imf, 2013) aiming to improve the practice of surveillance, particularly in relation to deepen the analysis of economic, financial and fiscal risks, as well as cross-sector and cross-border spillovers, the imf in cooperation with the financial stability board (fsb) on the proposal of the g20 in 2008 also focused on refining the effectiveness of the early warning exercise (ewe). despite the fact that the ewe is not intended to forecast crises, its „analytical techniques, practical experience, seasoned judgment and unique databases“ could significantly contribute to the prevention of crises or mitigation of potential consequences caused by crisis (lipsky, j, 2010). the imf will focus its activities on the major weak points of the ewe, which are primarily considered as unclearly defined goals, limited coordination and insufficient organizational capacity (brooks, s. et.al, 2013). the collaboration of the fund and the fsb is of fundamental importance towards removing obstacles, namely the 4 according to the latest of triennial surveillance reviews from 2011 compared to previous tsr from 2008, there was an improvement of the surveillance system. as an example of successful implementation of the goals, the executive board stated that there was a useful contribution between fund surveillance and analysis of external spillovers, which was conducted for five biggest systemic economics. economic analysis (2013, vol. 46, no. 3-4, 1-13) 8 integration of fund's macro-analysis financial with perspectives of fsb on regulatory and supervisory system. efficient communication is also very important, which means that all the results and recommendations of the ewe will be adopted by policymakers of the member states, while, on the other hand, the imf will be able to provide precise warnings and consistent policy advices. in july 2012, in response to the all above mentioned factors necessary for the improvement of surveillance framework, the executive board approved integrated surveillance decision and introduced new pilot external sector support. integrated surveillance decision imf is focused on enhancing of legal framework. in line with establishment of strengthened legal framework it was defined that the new framework would be based on the following postulates: • concentrating on the key issues of global economic and financial stability within multilateral surveillance • deepening of integration between bilateral and multilateral surveillance • providing sufficient coverage for a member country’s exchange rate as well as domestic economic and financial policies • providing effective coverage of significant spillovers from member countries’ policies onto global financial stability. when it comes to the pilot external sector report, its main purpose is fostering the assessment of external imbalances effectiveness. combining bilateral and multilateral perspectives in a single report, the pilot report provides a systematical analysis of financial indicators (exchange rates, current accounts, capital flows, reserves adequacy), which determines the external position of the largest economies.5 the report assesses, among other things, the potential policy responses. in order to assess external imbalances the new external balance assessment approach is being used. that approach allows identifying impact of a range of structural factors, respectively policy distortions in fiscal policy, capital controls etc. on a country’s current account. the approach also focuses on identifying weaknesses in the country’s policies and assessments whether the some changes in that context should be realized or measures should be taken. to further strengthen surveillance, the executive board recently developed a new financial surveillance strategy presenting major priorities and concrete steps of conducting surveillance in the coming years. „the aims of the strategy are for the imf to improve its understanding of macro-financial relations, to become better at identifying contagion risks across national borders and to increase its cooperation with other organisations. this is no easy task and the work involved is far from complete. this is something that the imf will need to develop on an ongoing basis” (wickman-parak, 2012). • governance reform although not directly related to the global economic crisis, reform of the management structure is essential for the future admirable position of the imf in the global financial system, so anyway we should analyze what significant changes have occurred in the past few years. 5 for now the analysis covers 28 of the largest economies plus the euro area pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 9 management reforms are primarily a consequence of the growing importance of developing countries and new emerging markets. the variable position of many countries from the above groups directly influenced the need to adapt management structures of the imf to new rules in order to ensure equal treatment for all member states. the first step on the road to reform was the adoption of the package of measures in the 2008, that should strengthen the position and at the same time increase the impact of dynamic economies through quota increases for 54 member countries and through increasing voting power of low-income countries by almost tripling their basic votes. in 2010, the executive board approved another reform packages focused primarily on a doubling of imf quotas that would lead to a shift of 6 percent of quota shares6 to the developing countries and dynamic emerging economies. that rebalancing of quotas, for example, opened the door in top 10 shareholders of the fund for two new member countries, india and brazil (imf, 2011). in order to improve position of the dynamic emerging economies and developing countries in a decision making process, the further reform steps refer to a restructuring of the executive board’s composition. as a result, board members from advanced european economies will be decreased by two members; and all executive directors will no longer be appointed, but elected. in addition, it was also agreed that the size of the board will remain the same (24 members) and will be reviewed every eight years. figure 2. progress with the acceptance of the board reform amendment source: imf 6 the quota shift was enabled thanks to reducing of shares of some developed countries economic analysis (2013, vol. 46, no. 3-4, 1-13) 10 the proposed quota increases, as well as an amendment to the imf’s articles of agreement initially, should be accepted by the membership in late 2012. however, the process of adoption of new measures has not been completed yet. according to the executive board’s last revision of progress toward implementation of the reform package, „as of april 10, 2013, 148 members having 77.4 percent of fund quotas had consented to their proposed quota increases under the 14th general review of quotas. as of the same date, 136 members having 71.3 percent of the total voting power had accepted the proposed amendment to reform the fund’s executive board” (imf, 2013, p1.). the main reason why the process of reforming the imf governance structure had not been completed yet, was the primarily position of the usa and the fact that the us congress refused to approve reallocation of $65 billion of the us loan to the imf into a permanent increase in shareholding. although we hope that participants of the g20 summit can find acceptable solution, which will be held in september in st. petersburg, russia, according to opinion of many analysts, it is unlikely that the reform will be implemented by the end of the year. concluding remarks despite justified criticism which the imf has been facing with over the last few decades, it is obvious that this organization has a huge impact and plays an important role in the global financial system. imf potentials are enormous, however, because of numerous problems and disagreements, their effective implementation could be hardly reached. the imf has already tried to make some steps that could eliminate drawbacks and change his reputation of inefficient organization. but the most important reforms were defined only after the outbreak of the global economic crisis, when all the weaknesses and failures came to the fore and it was necessary to take precautions in order to strengthen the legitimacy of the imf and the restoration of confidence in the fund as an organization that promotes global economic and financial stability. these reforms have to some extent contributed to the improvement of the situation. however, there are still a lot of unresolved problems and weaknesses where the imf should focus its activities in order to eliminate them. first of all, it is necessary to put more effort in reforming the governance structure and quotas. despite the fact that there has been a shift in the redistribution of votes among the member states, this change is not yet sufficient to be able to reflect the real position of countries in the world economy. the imf has already been criticized because it lacks legitimacy and that represents the interests of developed countries at the expense of developing countries. disposal of ratification of major measures defined by reform will have a negative impact on the reputation of the fund. among other things, imf should strengthen its role in preventing the emergence of crises. so far, the fund did not manage to successfully perform this role because its analysis is very dependent on the economic data that come from different countries, which very often affect the competency and objectivity of the results of the analysis in the sense that they do not reflect the real economic situation. to be able to perform better forecasts, the imf should focus on gathering more precise information and providing more comprehensive estimates and analysis. pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 11 the next step that would lead to more efficient coordination of the fund activities in the framework of providing global economic and financial stability should refer to further strengthen of surveillance over the economic and financial policies of member countries (truman, 2010). in this regard, truman proposed revision and reconstruction of the obligations of imf membership based on amendments to the imf articles of agreement and governance changes. reconstruction of the obligations should be maintained in order to achieve directing of financial and economic policies of the member states towards establishing price stability (internal stability), eliminating manipulation of exchange rates and stimulating economic growth. therefore, in order to improve monitoring over the fulfilment of obligations, it would be necessary to elaborate „norms for members’ policies and performance” (truman, 2010). these norms are supposed to represent the steps and procedures that member states had to implement in order to meet its own obligations. also, truman suggests creating a special independent committee-international monetary and financial committee-composed of independent experts from different countries. committee in the framework of bilateral surveillance would consult the member states concerning economic policy and performance. in addition, monitored country should explain shortfalls (deviations) in fulfilling standards. committee should be discussing all the details with employees of the fund and only after that it would hand a report to the executive commission. the next step should be related to the strengthening of the role of the fund in the macroeconomic adjustment and stabilization of the international monetary system, because the imf is often criticized for lack of paying attention to this very serious problem. in 2011, the executive board of the imf held a meeting where it was analysed the progress made in recent years in the context of strengthening the international monetary system. also, the main directions of future activities have been defined. although the imf made an important step forward, in the opinion of many experts, there are numerous shortcomings of the imf new „institutional view”. as the main weak points primarily considered are the possibility of implementing the institutional view ((truman , e, 2013; galagher, k and ocampo, a., 2013), as well as absence of a robust framework for analysing „the influence of policies and conditions in recipient and source countries on capital flows”. this was an overview of some of the most fundamental problems that must be solved. as can be seen, in the coming period the imf will be faced with a very hard and serious work. depending on the efficiency and speed of implementation of reform steps and measures will be clear whether the fund will finally become stable and effective institution capable of contributing to the financial stability and prosperity in the world. references brooks, s., et. al. 2013. „coordination critical to ensuring the early warning exercise is effective”, policy brief. no.4, http://www.balsillieschool.ca/sites/default/files/no4_1.pdf. gallagher, k., and ocampo, j.a. 2013. imf’s new view on capital controls, http://www.ase.tufts.edu/gdae/pubs/rp/gallagher_epw_capital_controls_2013.pdf. international monetary fund. 2011. important milestone reached to reinforce imf legitimacy, http://www.imf.org/external/pubs/ft/survey/so/2011/new030411a.htm. economic analysis (2013, vol. 46, no. 3-4, 1-13) 12 international monetary fund. 2012. annual report 2012: working together to support global recovery, http://www.imf.org/external/pubs/ft/ar/2012/eng/pdf/ar12_eng.pdf. international monetary fund. 2012. imf reboots framework for economic monitoring, http://www.imf.org/external/pubs/ft/survey/so/2012/pol071912a.htm. international monetary fund. 2013. financial sector assessment program: frequently asked questions, http://www.imf.org/external/np/fsap/faq/#q2. international monetary fund. 2013. imf’s response to the global economic crisis, http://www.imf.org/external/np/exr/facts/changing.htm. international monetary fund. 2013. proposed amendment on the reform of the imf executive board and fourteenth general review of quotas status of acceptances and consents. finance, legal, and secretary’s departments, http://www.imf.org/external/np/pp/eng/2013/041013.pdf. lipsky, jh. 2010. forewarned is forearmed: how the early warning exercise expands the imf’s surveillance toolkit, http://blog-imfdirect.imf.org/2010/09/23/forewarned-is-forearmedhow-the-early-warning-exercise-expands-the-imf%e2%80%99s-surveillance-toolkit/ paunović, s. 2011. uloga međunarodnog monetarnog fonda u savremenoj ekonomskoj krizi. beograd: savez samostalnih sindikata srbije. smyslov, d. 2012. „реформирование международного валютного фонда: проблемы и решения. регулятивные аспекты”. деньги и кредит, no. 1. http://www.cbr.ru/publ/moneyandcredit/smyslov_01_12.pdf. truman, e. 2010. „strengthening imf surveillance: a comprehensive proposal”, policy brief, 10-29, http://www.iie.com/publications/pb/pb10-29.pdf. truman, e. 2013. „managing international capital flows: the imf’s „institutional view” falls short”, realtime economic issues watch, http://www.piie.com/blogs/realtime/?p=3595 weiss, m. 2013. international monetary fund: background and issues for congress, http://www.fas.org/sgp/crs/misc/r42019.pdf. wickman-parak, b. 2012. the imf’s role-new thinking in the wake of the financial crisis, http://www.bis.org/review/r121009i.pdf. xafa, m. 2010. „role of the imf in the global financial crisis.” cato journal, 30(3), http://www.cato.org/sites/cato.org/files/serials/files/cato-journal/2010/11/cj30n3-5.pdf. reforme mmf-a u kontekstu globalne finansijske krize rezime –.međunarodni monetarni fond je tokom godina svog postojanja pretrpeo brojne promene. iz institucije osnovane u svrhu promovisanja međunarodne monetarne saradnje i nadzora nad fiksnim režimima deviznog kursa, pretvorio se u instituciju čiji je glavni cilj održavanje globalne ekonomske i finansijske stabilnosti. da bi se ovaj cilj postigao mmf u modernom dobu svoje aktivnosti fokusira prevashodno na prevenciju ekonomskih kriza, kao i na minimiziranje njihovih negativnih efekata. krajem xx i početkom xxi veka, zbog neefikasnog delovanja i slabih rezultata, posebno kada je reč o rešavanju krize u jugoistočnoj aziji i argentini, fond je počeo da gubi kredibilitet i na kraju se sam našao u dubokoj krizi. mmf je pokušao da preduzme određene korake koji bi vodili poboljšanju situacije, ali nije uspeo da ostvari značajniji napredak. globalna ekonomsko kriza pichovć, b., et al., reforms of the imf, ea (2013, vol. 46, no, 3-4, 1-13) 13 je dodatno naglasila postojeće nedostatke i propuste sa kojima se fond suočavao. međutim, rastuća potražnja država članica za finansijskim sredstvima, kao i potreba za jakom organizacijom koja bi mogla uspeti da spreči širenje krize i olakša borbu sa njenim posledicama, su pružili snažnu podršku fondu. stoga je novi napor mmfusmeren prvenstveno na reformu sopstvene strukture i načina funkcionisanja. u radu se analizira napredak postignut od strane mmf u sprovođenju reformi vezanih za rešavanje poteškoća izazvanih krizom i razmatraju se mogući pravci budućih aktivnosti fonda, uključujući pregled ključnih nedostataka i mogućnosti njihovog eliminisanja. ključne reči:. međunarodni monetarni fond, reforme, finansijska kriza article history: received: 9 september 2013 accepted: 9 december 2013 ea_2015_1-2 udc: 330.322.3:37 338.1 jel: h52, j24, i21, i22 cobiss.sr-id: 216162828 original scientific paper analysis of the impact of public education expenditure on economic growth of european union and brics tomić zoran, faculty of economics, university of niš, serbia12 abstract – knowledge is one of the key factors for the development and progress of each of the world economies. starting with the industrial revolution, more attention and resources are invested in the development of the education system. economies need to invest effort and resources in the education system that would allow for population to prepare for participation in the economic life of their country. this means that investing in youth education and training for work in the economy and development of young people in research, development and science would contribute to the development of new technologies and knowledge. development of new technologies and knowledge contributes to increased competitiveness of country in the global market. this paper presents a comparative analysis of investment funds in the education systems of the european union and brics, and it is shown that there is a positive correlation between public expenditure on education and the value of gdp of the country. key words: education, economic growth, regression analysis, european union, brics introduction education is the process of personality change in the desired direction by adopting different content depending on the age and needs of individuals. education includes teaching, in addition to educational facilities, depending on the age and needs of individuals. education is the process by which society transmits accumulated knowledge, skills and values from generation to generation. in the old societies, only a small number of people, especially those who had the money or the time, were educated. then the religious dignitaries were often the only literate group, who used the knowledge to read and interpret religious texts. education in its modern form involves teaching in specially constructed buildings. this form of teaching began to grow gradually, especially after the industrial revolution. the process of industrialization and urban expansion has caused the need for special education. people today are working in many professions and use a variety of expertise, so it is not possible to transfer knowledge from parent to child, as it was in old times. 1kralja petra prvog num.3, 37000 kruševac, zoranzoca@gmail.com 2scholarship holder from the ministry of education, science and technological development of serbia 20 economic analysis (2015, vol. 48, no. 1-2, 19-38) knowledge is now the main source of long-term economic growth of each of the world economies. modern tendencies of development in market economies show that education and investment in human resources are among the priorities of the national strategy and national policy, economic and technological progress. trends in investment in human capital and knowledge lead to a revision of economic theory and models. economists are still looking for the basics of economic growth. the traditional "production function" focused on labor, material, capital and energy as the main factors. knowledge and technology are external factors that impact on production. now analytical approaches have been developed so that knowledge can be included directly in the production function. investment in knowledge may increase the production capacity more than any other factor of production and to transform them into new products and processes. because these investments in knowledge characterized by an increase (rather than decrease) in rate of return on investment, they are the key to long-term economic growth. the state plays a very important role in the field of education. education is a big item in the expenditure budget of modern states. jadranka đurović-todorović and marina đorđević (2010) note that in some countries even though the state is able to provide funds for educational institutions, most of the education is provided by private schools, especially those belonging to churches. education is subject to permanent change. the sudden change of paradigm leaves little time to adjust. however, there are a few problems in education changes, mostly relating to how to preserve the good values from the previous education system and how to align the education system with the needs of the modern economy and society. today in serbian education system a major challenge by đurović-todorović and đorđević (2010) is harmonizing the educational profiles curricula with labor market needs. the aim of this paper is to find an empirical relationship between the values of gdp and public expenditure on education and to what extent public spending on education to economic growth in the example of the european union and brics and to compare. education as an important factor for economic growth and development of countries the importance of education for economic development was first spotted by father of economics, adam smith. adam smith represented the idea of specialization of labor. according to smith, the amount of annual products of a nation depends on two factors: the amount of labor employed in the production and productivity of labor. according to smith, the first factor is of lesser importance than the other factors, as can be seen from the fact that people in earlier times lived much poorer than modern people, even though the percentage of the employed labor was much higher. smith primarily indicates the importance of the division of labor, as well as first-rate factor increase in national wealth. obrad blagojević and marko sekulić (1990) note that many economists believe that the idea of division of labor is one of his greatest contributions to economic science. from the above it can be concluded that it is necessary to invest resources to people who are employed to train and educate to work in certain professions. therefore, it is very important to invest in education. even in some texts, lectures or videos on the internet we tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 21 can hear that the modern school was specifically made for the needs of industrialization. in fact, if you compare schools have classrooms that are like production facilities in the factories, the bell that marks the beginning and end of classes, such as in factories that marks the beginning and end of the work shift, the students are divided by grade, as in factories for the production facilities, and students in schools are doing exactly what their task is, as in factories where each plant has a specific role in the production process. adolph wagner was probably the first economist to recognize the positive correlation between economic growth and the growth of government activity. as magnus henrekson (1993) pointed out, wagner saw three major reasons for the increasing role of the state. first, industrialization and modernization would lead to an increase in private activity. expenditures for law and order, as well as contractual enforcement should be increased. second, the increase in real income will lead to the expansion of income elastic of "cultural and social welfare" expenses. wagner said that the education and culture are two areas in which the government is a better controller and executor than the private sector. dipendra sinha (1998) note that natural monopolies like railroads must be controlled by the government, because private companies are not able to run these monopolies effectively. for private companies it is impossible to raise huge finances that are necessary for the development of natural monopolies. problem of the impact of public expenditure in education many theorists have dealt with, and this topic now occupies one of the main topics in economic research. a lot of empirical studies have attempted to examine the relationship between human capital investment and economic growth. sayantan ghosh dastidar, sushil mohan and monojit chatterji (2013) in their work present that relationship is tested in countries such as the united states (jorgenson and fraumeni), and pakistan (aziz khan and aziz), tanzania and zambia (jung and thorbecke), nigeria (ogujiuba and adeniii) and india (chandra) and that results from these papers suggest that expenditure on education affects economy growth positively. fiszbein and psacharopoulos conducted a study to assess the effects of educational investment in venezuela and found that investments in primary education had the largest impact on growth and investment in higher education yields the lowest among the three levels of education. distidar,mohan and chatterji (2013) found in india that investing in education is a necessary but not a significant condition for achieving economic growth. other factors have a significant impact on economic growth in addition to education. oluwatobi stephen and ogunrinola oluranti (2011) for nigeria found that there is a positive relationship between the growth of expenditures for education and economic growth using an expanded model of economic reproduction, where they add to the analysis impact of costs of education and health care. dipendra sinha (1998) found in malaysia that there is a long-term relationship between the cost of education and economic growth, but that there is no mutual relationship between the increase in the cost of education and economic growth. avina sabah idrees and muhammad wasif siddiqi (2013) based on panel analysis found that there is a positive relationship between the rising cost of education and economic growth, and there is the effect of reaching the developed economies based on the investment in education. in their analysis they observed countries uk, usa, canada, germany, france, italy and japan, on the one hand, and pakistan, india, china, turkey, russia, poland and south africa, on the other hand. abhijeet chandra (2010) found that india’s boom in software industry experienced probably due to the huge investments in the 1950s and 1960s 22 economic analysis (2015, vol. 48, no. 1-2, 19-38) in education, particularly in technical sciences. there are also works like and nurudeen usman and belgrave and craigvell, which found that the impact of education expenditures on growth is negative. in addition to studying the impact of the increase in public expenditure of education to economic growth, there are works such as michel beine et.al. (2001) dealing with the problem of brain drain and its impact on economic growth. this is one of the big problems for the growth of the economy of countries like serbia. theories of economic growth and lucas' model dragan kitanović and nataša golubović (2006) define economic growth as the increase of the potential products of an economy, and moving to the right of its production possibilities curve. economic growth can be quantified, primarily by calculating the growth rate of gross domestic product, growth rate of gdp per capita, national income per capita and etc. the theory of economic growth has occupied an important place in classical economic theory. within the classical aproach there are three main factors of economic growth: labor, land and capital. economists of classical school did not take in account technological progress, as well as the development of human capital, which is one of the main objections to their theory. according to marxist school on economic growth was influenced by a number of variables, but chief among them was the rate of profit. for marx it was the constant tendency of capital accumulation and a steady increase in the organic composition of capital, which is not accompanied by a corresponding increase of workers income. neoclassical growth model is based on the model of the economy in which production is carried out with the use of capital and labor. also taking into account the progress of technology, but which has been conditioned by exogenously. this theory has experienced criticism primarily by post-keynesians, but the biggest criticism was the observation of technological progress as exogenous factors of economic growth. schumpeter was particularly emphasized the importance of investments to improve the quality of capital goods, ie. innovation. the implementation of "new combinations" of resources is the primary force that encourages economic growth. keynes represented the view that public expenditure as an exogenous factor can be used as a policy tool to promote economic growth. public expenditure can positively contribute to economic growth. thus, the increase in government spending is likely to lead to increased employment, profitability and investment through multiple effects on aggregate demand. as a result, government spending increases aggregate demand, which causes increased production depending on the expenditure multiplier. the new theory is "endogenous growth theory" which differs from the neoclassical theory, because assuming that the technological change endogenously conditioned, able to explain the continued growth of per capita income in some countries, on the one hand, and persistent survival disparity in the level of pre capita income among countries, on the other hand. the basic model of "endogenous growth" according to kitanović and golubović (2006) includes human capital as a separate factor in the production function. investment in education by the state, participating in the creation of an adequate educational program surely is a key factor for improving human capital, which leads to increased productivity and getting the necessary technological innovation to further economic growth. tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 23 lucas, along with romero, is one of the creators of the theory of endogenous growth. in lucas' model, human capital is seen as a factor of production and knowledge is central to accelerating economic growth. according to lucas' model engine of economic growth is human capital. people can use their time for work and training (i.e., research and practice). the relationship between these activities to individuals in an economy to make depends on the institutional structure and characteristics of the labor market and the economy. in this paper we performed a quantitative analysis of the impact of public spending on education in the economic growth of the economy in the example of the european union, usa and japan, as the largest economies in the world. model in research is used a model that is derived from the classical production function. in this case, the movement of the value of production in the economy depending on the cost of public education is observed. f(edu) =y (1) where y is a production function of one of the country, and edu represents public expenditure on education in the country. when this model is transformed into logarithmic from (1): µββ ++= )log( )log( 10 edugdp (2) where 0β is constant intercept term, 1β slope coefficient and µ is error. slope coefficient tells us how much it will increase the value of gdp if we increase the value of public spending on education. this paper uses costs of the public sector, because the private sector costs difficult to measure and obtain the necessary data, and because in most countries the greatest interest in investing in education is the state, and it bears most of the costs. in this paper, the analysis is performed on the european union and 28 member states, for brics countries and serbia. it also provides an overview of information on investing countries in different levels of education. the regression analysis was applied, which was made in the program origin 9. analysis of the model the analysis of public expenditure on education in the eu member states and the european union as a whole in the countries of the european union knowledge-based economy is a strategic task. the bologna declaration on higher education from june 1999 marked the beginning of a new enhanced european cooperation. đurović-todorović and đorđević (2010) say that educational system of each country can be divided into three main sectors: 24 economic analysis (2015, vol. 48, no. 1-2, 19-38) • public education • private education in which the state participates with 50% and • private education (independent schools) in the european union education is the responsibility of the member states. eu institutions have importance in supporting of education. according to article 165 of the treaty on the functioning of the european union, the community will contribute to the development of quality education by encouraging cooperation between member states, through activities such as promoting the mobility of citizens, designing joint study programs, establishing networks, exchanging information or teaching languages of the european union. the contract includes a commitment to promote lifelong learning for all citizens of eu. the eu funds educational, professional and public construction programs that encourage eu citizens to seize the opportunities offered by the eu to its residents to live, learn and work in other countries. the most famous of these is the erasmus program, under which more than two million students have participated in the inter-university exchanges and mobility in the last 20 years. since 2000, awareness of the importance of education and training in order to exercise economic and social objectives, the eu member states have started to work together to achieve a series of 13 specific objectives in the field of education. this is called the education and training 2010 program. sharing good practices by participating in peer education activities, by setting benchmarks and monitoring progress of key indicators, the 28 member countries aim to respond to coherent common challenges, while retaining their individual sovereignty in the area of educational policy. the european union is also a partner in a variety of intergovernmental projects, including the bologna process which aims to create a european higher education area by harmonizing academic degree standards and structures, as well as academic quality assurance standards across the eu member states and in other european countries3. main education priorities of the eu countries are: • strengthening vocational education and training, • increase transparency of professional education and training through the implementation and rationalization of information networks, • improving policies, systems and practices in the approach to learning, the professional education and training, • promote cooperation in assurance of quality in education, • supporting the professional development of staff, etc. for the analysis of the european union we used the data obtained from euro stat of the gdp values for the period from 2002 to 2011, as well as the amount of public expenditure on education for the period 2002 2011 expressed as a percentage of gdp. the used data are shown in table 1. 3 tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 25 table 1.gdp and public expenditure on education for eu, 2002 2011 year gdp (in mil €) public expenditure on education (% gdp) public expenditure on primary education (% gdp) public expenditure on secondary education (% gdp) public expenditure on higher education (% gdp) 2002 9,983,702.30 5.00 1.13 2.27 1.12 2003 10,151,451.90 5.03 1.15 2.29 1.11 2004 10,658,018.60 4.95 1.14 2.23 1.10 2005 11,128,703.00 4.92 1.13 2.20 1.12 2006 11,764,657.30 4.91 1.15 2.17 1.10 2007 12,473,648.90 4.92 1.15 2.17 1.11 2008 12,548,545.70 5.04 1.17 2.22 1.14 2009 11,815,746.60 5.38 1.24 2.39 1.21 2010 12,337,150.70 5.41 1.23 2.37 1.25 2011 12,711,206.20 5.25 1.19 2.23 1.27 source: euro stat http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/, data processed by author (accessed october 1, 2014) based on the obtained data it can be concluded that by 2008 the average of 5% of gdp for education was used to finance in 28 countries members of the european union. since 2009, after the economic crisis, eu has increased the allocation of funds for education, which may be related to the importance of education to obtain the competitive advantage of the eu member states in relation to the rest of the world economy to recover from the economic crisis. in addition that is the period when there was an increase in the unemployment rate in all eu member states. most of the funds were allocated for secondary education (2.17 to 2.39%), which indicates the importance of this level of education. at the secondary level of education young people gain expertise in areas that will be in their professional career to deal with, but also in that period they become capable of working. for basic and higher education almost the same amount of fund is used. the largest expenditure on secondary education can be explained by the fact that the present system of private financing of education of young people and that higher education is not compulsory. eu aims to reach by 2020 40% of the population are higher educated, and therefore should not be surprising that there is a growing trend when it comes to public funding of higher education. 26 economic analysis (2015, vol. 48, no. 1-2, 19-38) figure 1. graphic of gdp amount and cost of education in the eu 28 per year 2002 2004 2006 2008 2010 2012 0 140000 280000 420000 560000 10000000 12000000 14000000 16000000 18000000 20000000 gdp public education expenses public primary education expenses public secondary education expenses public higher education expenses m ill io n € year application of the model in case of the european union and the member states of the european union the analysis starts from the null hypothesis, which states that the total value of public education spending does not significantly affect the value of the observed gdp of the country. the analysis used the logarithmic values of the gdp of the european union and the logarithm of the absolute value of the principal amount of expenditure for the period 2002 2011. by applying multiple regression analysis of the model (2) we obtained the following values of the parameters: table 2. the parameter values of the regression analysis for eu 28 parameter value error t-statistics probability 0β 2.58353 0.52380 4.93232 0.0012 1β 0.77645 0.09082 8.54894 0.0000 r 0.94939 source:data processed by author from eurostathttp://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/, (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of investments in education significantly affects the value of gdp for the eu28. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country; in this case we reject the null hypothesis. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of the eu 28 to 0.77%. the coefficient of determination further confirms the high correlation between the observed size and degree of correlation observed data. the following table gives a presentation of the obtained values of parameters for each member country of the european union observed individually. we apply the same method tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 27 and logarithmic values for the amount of the gdp of the public expenditure on education. analysis was carried out in the program origin 9. table 3. the values of the parameters of the regression analysis for the member states of the european union country/period parameter value error t-statistics probability austria (1995-2011) 0β 2.42007 0.59208 4.08741 0.0001 1β 1.04697 0.06244 16.76707 0.0000 r 0.97260 belgium (2001 2011) 0β 5.17062 0.48839 10.58709 0.0000 1β 0.75814 0.04947 15.32444 0.0000 r 0.95899 bulgaria (1992 2011) 0β 3.81162 0.38295 9.9532 0.0000 1β 0.91115 0.05495 16.58232 0.0000 r 0.98403 czech republic (1996 2011) 0β 3.41425 0.31093 10.98091 0.0000 1β 0.97075 0.03766 25.77397 0.0000 r 0.98963 denmark (1995 2011) 0β 3.60350 0.44676 8.06584 0.0000 1β 0.88539 0.04627 19.13432 0.0000 r 0.98012 estonia (1993 2011) 0β 2.57688 0.18457 13.96168 0.0000 1β 1.05423 0.03076 34.27395 0.0000 r 0.99284 finland (1991 2011) 0β 2.02215 0.49168 4.11274 0.0006 1β 1.07870 0.05435 19.84583 0.0000 r 0.97672 france (1991 2011) 0β 2.63329 0.39265 6.70644 0.0000 1β 1.01830 0.03456 29.46617 0.0000 r 0.98923 greece (1995 2005) 0β 5.53809 0.28939 19.1369 0.0000 1β 0.74186 0.03426 21.65679 0.0000 r 0.99054 netherland (1991 2011) 0β 4.41575 0.29019 15.21652 0.0000 1β 0.85233 0.02900 29.38867 0.0000 r 0.98918 croatia (2002 2011) 0β 4.83044 0.21221 22.76285 0.0000 1β 0.77851 0.02882 27.01407 0.0000 r 0.99456 28 economic analysis (2015, vol. 48, no. 1-2, 19-38) country/period parameter value error t-statistics probability ireland (1995 2011) 0β 4.67164 0.66186 7.05836 0.0000 1β 0.80914 0.07614 10.62638 0.0000 r 0.93954 italy (1991 2011) 0β 0.91832 0.90234 1.01771 0.3216 1β 1.19519 0.08236 14.51145 0.0000 r 0.95773 cyprus (1995 2011) 0β 5.05524 0.13218 38.24534 0.0000 1β 0.65173 0.01991 32.72912 0.0000 r 0.99307 latvia (1992 2011) 0β 2.90361 0.19899 14.59143 0.0000 1β 0.99763 0.03223 30.95326 0.0000 r 0.99074 lithuania (1993 2011) 0β 2.95616 0.18844 15.68783 0.0000 1β 0.99680 0.02856 34.90756 0.0000 r 0.99310 luxembourg (1995 2011) 0β 0.99767 0.46843 2.12981 0.0546 1β 1.33602 0.06783 19.69685 0.0000 r 0.98488 hungary (1992 2011) 0β 2.70274 0.42606 6.34349 0.0000 1β 1.02995 0.05301 19.42903 0.0000 r 0.97698 malta (1998 2011) 0β 5.83850 0.30448 19.17522 0.0000 1β 0.47900 0.05441 8.80325 0.0000 r 0.93055 germany (1999 2011) 0β 6.89314 0.86364 7.98151 0.0000 1β 0.66907 0.07465 8.96261 0.0000 r 0.93785 poland (1995 2011) 0β 3.42800 0.27239 12.58510 0.0000 1β 0.95149 0.02926 32.51554 0.0000 r 0.99298 portugal (1995 2011) 0β 2.29273 0.42223 6.93282 0.0000 1β 1.00085 0.04746 21.08611 0.0000 r 0.98355 romania (1999 2011) 0β 4.40787 0.39950 11.03346 0.0000 1β 0.86593 0.05117 16.92169 0.0000 r 0.98465 slovakia (1993 2011) 0β 2.57600 0.25723 10.01422 0.0000 1β 1.08452 0.03613 30.01596 0.0000 tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 29 country/period parameter value error t-statistics probability r 0.99070 slovenia (2001 2011) 0β 1.94547 0.63310 3.07294 0.0133 1β 1.12505 0.08501 13.23465 0.0000 r 0.97526 spain (1992 2011) 0β 3.21737 0.41869 7.68433 0.0000 1β 0.98837 0.04041 24.46054 0.0000 r 0.96917 sweden (1991 2011) 0β 1.56319 0.42933 3.64099 0.0017 1β 1.10939 0.04369 25.38963 0.0000 r 0.98558 united kingdom (1991 2011) 0β 3.80688 0.57116 6.66518 0.0000 1β 0.92427 0.05102 18.11455 0.0000 r 0.97225 source: data processed by author from eurostathttp://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ (accessed october 1, 2014) based on the analysis, it can be concluded that the conclusions that are valid for the european union apply to the eu's member states. the correlation coefficients (r) range in values of 0.95 to finding indicating a high correlation observed data and the positive value of correlation suggests that changes in the value of public expenditure on education has a positive impact on the change in gdp observed countries. the values for all the countries under consideration are statistically significant because the probability of t-value is less than 0.05.for countries such as italy, luxembourg probability value of t-value for the parameter βo is greater than 0.05. analysis of public spending on education and model in the brics countries brics is the english abbreviation and economic term that refers to the growing development of the economic potential of brazil, russia, india, china and south africa. implicitly, concerns the economic alliance of these complementary economies. the term was introduced by jim o'neill of the corporation for the global financial research goldman sachs, and was quickly accepted by the public, especially the media, to the extent that the majority of news sources from global finance used without much explanation. the meeting of officials of these countries, held in the summer of 2008 in yekaterinburg, called the bric summit. the group originally consisted of brazil, russia, india and china. south africa is a member of this group of 13 april 2011. below will be analyzed for each country individually. in the analysis of the contribution of public expenditure in the case of brazil was observed period from 2004 2011. 30 economic analysis (2015, vol. 48, no. 1-2, 19-38) table 4. gdp and public expenditure on education in brazil, 2004 2011 year gdp (in mill. $) public expenditure on education (% gdp) 2004 663,760.34 4.0 2005 882,185.70 4.5 2006 1,088,916.82 5.0 2007 1,366,824.00 5.1 2008 1,653,508.56 5.4 2009 1,620,188.06 5.6 2010 2,143,067.87 5.8 source: the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure 2. graphic of gdp amount and cost of education in brazil by year 2004 2005 2006 2007 2008 2009 2010 0 20000 40000 60000 80000 100000 120000 500000 1000000 1500000 2000000 2500000 m ill io n $ year gdp public education expenses in percentage terms, brazil set aside 5.06% of gdp for education, which is the average of the european union. in the reporting period it can be observed upward trend in expenditures for education, both in absolute terms and in percentage values of the gdp of brazil. it can be said that investment in education is certainly one of the key factors that led brazil to the sixth position in the development of economy in the world. the analysis used the logarithmic values of the gdp of brazil and the logarithmic values of absolute principal amount of expenditure for the period 1995 2010. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. table 5. the values of the parameters of the regression analysis for brazil parameter value error t-statistics probability 0β 5.61954 0.15202 36.96493 0.0000 1β 0.76147 0.01425 53.46357 0.0000 r 0.99808 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 31 the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for brazil. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of brazil by 0.76%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of india was observed period from 2003 2006. table 6. gdp and public expenditure on education in india, 2003 2006 year gdp (in mill. $) public expenditure on education (% gdp) 2003 618,356.47 3.6 2004 721,585.61 3.3 2005 834,215.01 3.1 2006 949,116.77 3.1 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure 3. graphic of gdp amount and cost of education in india by year 2003 2004 2005 2006 0 10000 20000 30000 600000 700000 800000 900000 1000000 m ill io n $ year gdp public education expenses in percentage terms, india set aside of 3.3% of gdp for education, which is below the average of the european union and brazil. in the reporting period it can be observed upward trend in the expenditures for education in absolute terms. in the analysis of the applicability of the model were used logarithmic values of gdp india and logarithmic values of absolute principal amount of expenditure for the period 1997 2011. by applying multiple regression analysis and the model is presented by (2) in the above examples are obtained the following values of the parameters. 32 economic analysis (2015, vol. 48, no. 1-2, 19-38) table 6. the values of the parameters of the regression analysis for india parameter value error t-statistics probability 0β 3.18113 0.85151 3.73588 0.0047 1β 1.01915 0.08348 12.20772 0.0000 r 0.97111 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of the gdp of india. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of india for 1.02%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of south africa was observed period from 1999 2011. table 7. gdp and public expenditure on education in south africa, 1999-2011 year gdp (in mill. $) public expenditure on education (% gdp) 1999 133,183.58 6.0 2000 132,877.64 5.6 2000 118,478.99 5.3 2001 111,100.86 5.2 2002 168,219.32 5.1 2003 219,092.94 5.3 2004 247,051.56 5.3 2005 261,007.04 5.3 2006 286,171.83 5.2 2007 273,141.75 5.1 2008 284,183.10 5.5 2009 365,208.43 6.0 2010 403,894.32 6.2 2011 133,183.58 6.0 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 33 figure 4. graphic of gdp amount and cost of education in south africa by years 1998 2000 2002 2004 2006 2008 2010 2012 0 5000 10000 15000 20000 25000 100000 150000 200000 250000 300000 350000 400000 450000 m ill io n $ year gdp public education expenses in percentage terms, south africa invests 5.5% of gdp for education, which is the average of the european union. in the reporting period it can be observed upward trend in the expenditures for education in absolute terms. in the analysis of the applicability of the model were used logarithmic values of the gdp of south africa and the logarithmic values of absolute principal amount of expenditure for the period 1991 2011. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. table 8. the values of the parameters of the regression analysis for south africa parameter value error t-statistics probability 0β 3.04033 0.25257 12.03774 0.0000 1β 0.98389 0.02680 36.70966 0.0000 r 0.99448 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for south africa. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of south africa by 0.98%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of russia was observed period from 2000 2006. 34 economic analysis (2015, vol. 48, no. 1-2, 19-38) table 9. gdp and public expenditure on education in russia, 2000 2006 year gdp (in mill. $) public expenditure on education (% gdp) 2000 259.708,50 2.9 2000 306,602.67 3.3 2001 345,110.44 3.5 2002 430,347.77 3.4 2003 591,016.69 3.5 2004 764,000.90 3.8 2005 989,930.54 3.9 2006 259,708.50 2.9 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure 5. graphic of gdp amount and cost of education in russia by years 2000 2001 2002 2003 2004 2005 2006 0 5000 10000 15000 20000 25000 30000 35000 200000 400000 600000 800000 1000000 m ill io n $ year gdp public education expenses in percentage terms in russia 3.4% of gdp is allocated for education, which is well below the eu average. in the observed period upward trend in the allocation of funds for education in absolute terms can be seen. in the analysis of the applicability of the model were used logarithmic values of gdp of russia and the logarithmic values of absolute principal amount of expenditure for the period 2000 2008. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. table 10. the values of the parameters of the regression analysis for russia parameter value error t-statistics probability 0β 4.70764 0.19903 23.65263 0.0000 1β 0.86191 0.02010 42.89189 0.0000 r 0.99837 source:data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 35 the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for russia. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of russia by 0.86%. the coefficient of determination confirms that there is a positive correlation between the observed data. in the analysis of the contribution of public expenditure in the case of china was observed period from 1992 1996. table 11.gdp and public expenditure on education in china, 1992 1996 year gdp (in mill. $) public expenditure on education (% gdp) 1992 422,660.55 1.7 1993 440,501.21 1.7 1994 559,224.20 2.0 1995 728,007.55 1.9 1996 856,084.63 1.9 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) figure6.graphic of gdp amount and cost of education in china by years 1992 1993 1994 1995 1996 0 2000 4000 6000 8000 10000 12000 14000 16000 300000 400000 500000 600000 700000 800000 900000 m ill io n $ year gdp public education expenses in percentage terms in china allocates an average of 1.84% of gdp for education. in the observed period can be observed upward trend in the allocation of funds for education in absolute terms. in the analysis of the applicability of the model were used logarithmic values of the gdp of china and the logarithmic values of absolute principal amount of expenditure for the period 1992 1999. by applying multiple regression analysis and the model (2) in the above examples are obtained the following values of the parameters. 36 economic analysis (2015, vol. 48, no. 1-2, 19-38) table12. the values of the parameters of the regression analysis for china parameter value error t-statistics probability 0β 4.98414 0.42257 11.79476 0.0000 1β 0.89458 0.04467 20.02555 0.0000 r 0.99382 source: data processed by author from the world bank http://data.worldbank.org/indicator/ny.gdp.mktp.cd/countries?display=default (accessed october 1, 2014) the obtained values tell us that there is a positive correlation between the observed value and the value of his investments in education significantly affects the value of gdp for china. the probability of t-value of the regression coefficient is 0.0000, which is less than the significance level of 0.05, which confirms that the costs of education significantly affect the value of the observed gdp of the country. the value of the parameter tells us that if there is an increase in expenditure on education by 1% would be an increase in log (gdp) of russia by 0.89%. the coefficient of determination confirms that there is a positive correlation between the observed data. it is necessary to get to the more recent data and do further analysis to confirm the existing result. in a previous paper zoran tomic (2014) found for usa and japan that null hypothesis is rejected, i.e. there is a positive correlation between public expenditure on education and gdp growth. in the case of the us 1% increase in the cost of education is achieved gdp growth of 0.78% and japan with increasing the amount of expenditures of 1% leads to an increase in gdp by 0.81%. based on this, we can see that the highest growth has india (1.02%). if we take into account the individual eu member luxembourg has the highest growth of 1.33% to 1% of the additional costs in education. brazil has the smallest growth with 0.77%, and from the eu is malta with 0.47% growth. conclusion knowledge is a key factor for the improvement and development of each of the world economy. the significance of knowledge and education was spoken by adam smith, who represented need to divide the work among the people. today, an important question arises about all these activities, education and the education system to economic growth and development of each country. education and the education system helps and contributes to empower people to work in the economy, but also with the knowledge that they have and the resources contribute to the technological development that will allow the country's economy to develop and to have competitive an advantage. also a big problem today is the problem of brain drain which is also a challenge for new research in this area. based on the analysis for european union, usa, japan and briks, it was found that there is a positive correlation between the amount of public expenditure on education and economic growth in these countries. it was found that among india in briks group, italy, luxembourg and slovenia within the eu, achieved the highest economic growth, because a 1% increase in public expenditure on education comes up more than 1% growth in the value tomić, z., analysis of the impact of public education, ea (2015, vol. 48, no. 1-2, 19-38) 37 of log (gdp). observed between groups of the european union, usa and japan, the largest growth is achieved in japan with 0.87% growth in log (gdp), while the lowest growth is achieved in eu (as a group), where the increase in expenditure on education by 1%, the growth of log (gdp) for the 0.77%. in subsequent research should expand the number of countries that will be covered by the panel and perform analysis among the countries themselves on the contribution of public expenditure on education to economic growth. it was also found that most funds allocated for secondary education, which can be explained by the fact that post-secondary education young people are trained to work in the economy or for further education. among the surveyed countries malta achieved the lowest growth which can be best explained by the very size of economy, the structure of the economy, population size and so on. to further confirm the above results it is necessary to include additional information in the analysis (the period after 2011 and the period before 1991), which will provide direction for further research into this issue, as well as the inclusion of other factors that lead to economic growth of countries (health care costs, the costs of science, etc.) and thus further develop the model. references beine, michel, docoquier frederic and rapoport hillel. 2001.“brain drain and economic growth: theory and evidence.”journal of development economics, 64, 275-289. blagojević, obrad and sekulović marko.1990. ekonomske doktrine. beograd: privredni pregled. chandra,abhijeet. 2010.does government expenditure on education promote economic growth? an econometric analysis, munich personal repec archive, http://mpra.ub.unimuenchen.de/25480/ (accessed december 23, 2014). đurović-todorović, jadranka and đorđević marina. 2010. javne finansije.niš: ekonomski fakultet u nišu. idrees, alvina, sabah and siddiiqi muhammad wasif. 2013.“does public education expenditure cause economic growth? comparison of developed and developing countries.”pakistan journal of commerce and social sciences, 7(1): 174-183. henrekson, magnus.1993.“wagner’s law a spurious relationship.” public finance, 48(2): 406-415. oluwatobi, stephen and ogunrinola oluranti. 2011.“government expenditure on human capital development: implications for economic growth in nigeria.”journal of sustainable development, 4(3): 72-80. sinha, dipendra. 1998.“government expenditure and economic growth in malaysia.”journal of economic development, 23(2): 71-80. sayantan, ghosh, dastidar et. al. 2013. relationship between public education expenditures and economic growth: the case of india, http://repo.sire.ac.uk/bitstream/10943/435/1/sire-dp2013_07.pdf (accessed december 23, 2014) kitanović, dragan and golubović nataša. 2006.osnovi ekonomije.niš: ekonomski fakultet u nišu. tomić, zoran. 2014.analysis of the impact of public education expenditure on economic growth of european union, usa and japan, proceedings from 7th international 38 economic analysis (2015, vol. 48, no. 1-2, 19-38) conference science and higher education in function of sustainable development, business and technical college of vocation studies, užice, serbia. analiza uticaja javnih troškova obrazovanja na privredni rast u evropske unije i briks zemalja rezime – znanje je jedan od ključnih faktora za razvoj i napredak svake odsvetskih ekonomija. počevši sa industrijskom revolucijom, više pažnje i sredstava ulaže se u razvoj obrazovnog sistema. ekonomije trebaju da ulože napor i sredstva u obrazovni sistemu koji bi omogućio stanovništvu da se što bolje pripremi za učešće u ekonomskom životu svoje zemlje. to znači da će ulaganje u obrazovanje i obuku za rad u privredi i razvoj mladih ljudiza istraživanja, razvoj i bavljenje naukom doprineti razvoju novih tehnologija i znanja. razvoj novih tehnologija i znanja doprinosi povećanju konkurentnosti zemlje na globalnom tržištu. ovaj rad predstavlja uporednu analizu ulaganja u obrazovnim sistemima evropske unije i briks-a, i takođe je pokazano da postoji pozitivna korelacija između javne potrošnje za obrazovanje i vrednost bdp-a zemlje primenom regresione analize. ključne reči: obrazovanje, ekonomski rast, regresiona analiza, evropska unija, briks article history: received: 26 march, 2015 accepted: 3 april, 2015 microsoft word 2010_1_2.doc original scientific paper business relations in reverse logistics outsourcing grabara janusz*, kot sebastian, czestochowa university of technology, the management faculty, poland udc: 65.011.1 jel: m1; m2 abstract – nowadays cost reduction is a fundamental strategy used in companies during fighting for survival, keeping or increase in sales levels and profits. more and more often observed tendency to concentrate commercial and production companies leads to rise of demand for outsourcing in a reverse logistics chain. in the paper authors present concept of outsourcing in logistics processes, advantages of outsourcing in reverse logistics and types of relations between outsourcing partners as well as areas and stages of collaboration: engagement, improvement and communication. key words: business relations, outsourcing, logistics processes, commercial companies, production companies outsourcing idea in logistics services a strategy commonly termed ‘outsourcing’ is nothing more than a subcontracting, to a specialized companies, a part of functions and processes previously performed on your own. the scope of operations encompassed by outsourcing is becoming wider and wider. the subcontracting concerns e.g.: transport and forwarding (organizing of transport by the shipper), advertising, market survey, security services, social facilities (holiday and sport facilities), health care, legal services, training, financing of transactions, banking services and contract insurance. outsourcing concerns exclusively services. another words henry ford characterized very appositely phenomenon which is specified today with name of outsourcing. ʺif there is something we cannot do more efficiently, more inexpensively and better than our competitors, so there is no sense we do it. we should employ somebody for executing this work who will do it betterʺ (michałek 2005). he didnʹt foresee at the same time probably that the assertion just even often unwittingly is a base for todayʹs entrepreneursʹ wondering reflections above applying outsourcing to oneʹs companies. outsourcing describes the deliberate movement of a series of connected business processes to a which manages them on behalf of the company. the classic processes were it, warehousing and distribution, facilities management, and payroll – and to these can now be added call centers, manufacturing, web development, home shopping, credit cards, and even merchandising and design. in these movements the commercial risk and assets are usually passed to the outsourcing company (waters 2007). no doubt that outsourcing has become big business. from early beginnings in the midto late 1970s, many companies have traveled the outsourcing road, and as technology and * address: armii krajowej 19b, 42-200 czestochowa, poland, e-mail: grabara@zim.pcz.pl economic analysis (2010, vol. 43, no. 1-2, 99-107) 100 accessibility to shared electronic data have increased so has the range of services offered by outsourcing companies. the global logistics market has an estimated value of 972 billion us dollars (transport intelligence 2006). the asia pacific market was the largest with the share of 412 billion usd spent on logistics. europe, middle east and africa regions spent about 290 billion usd, while americas accounts for the balance of 270 billion usd. it is estimated that 265 billion usd (27%) was spent for outsourced logistics activities. western european firms are more likely to outsource logistics and supply chain activity. capgemini study (capgemini and langley 2004) showed that western european businesses spent 61% of their logistics spend on their third-party provider services against 44% in north america and 49% in asia pacific. globalization and increase in world trade has made the fast growth in the outsourcing market. as more products are sourced across borders, the complexity of the supply chain increases, driving many companies to outsource to third-party providers. this is particularly true as companies move manufacturing and operations to regions such as asia, eastern europe or south america, where they seek to mitigate risk by outsourcing their logistics and supply chain operations. outsourcing of logistics services may take a variety of sizes and shapes. in its most extreme form it leads to total liquidation of own logistics system and taking on responsibility for logistics management by external operator. in logistics outsourcing the lead is taken by international operators with necessary competence in terms of logistics strategic consulting and the execution potential connected with the branch experience. the operator must ensure their customers as best services as possible at the competitive price. in polish market two following groups of logistics services can be characterized: • transport services, which should be treated as fundamental services resulting from the necessity to move things and persons from one place to another, between the source and the goal, with the limited scope of consulting, which might concern, in case of e.g. international deliveries, the most favourable supply base. relocationtransport is an activity performed in order to satisfy particular needs, which requires to cover the distances either by a person or by goods in order to satisfy such needs. (szczepaniak 2002) • forwarding services, which, in its fundamental form consist in organization of the transport processes, insurance, preparation of necessary documentation and customs services. more advanced shipping services, which bring great cost benefits in case of general cargo or pallet cargo (as opposed to full truck load), include services provided by the consolidated shippers on the basis of the network of several or more than ten terminals, which consists in consolidation or deconsolidation of a particular cargo, custom packaging, with warehousing option and in more modern version of cross docking and thus in transition of cargo through terminal (without warehousing) and stopping their movement only for the time necessary for order picking, changes in cargo shape and changes in means of transport. grabara, j., et al., business relations in reverse logistics, ea (2010, vol. 43, no. 1-2, 99-107) 101 • logistics services, which, apart from transport and forwarding activities, encompasses terminal services, starting from cross-docking, through warehousing to order picking (including picking and packaging) and additional activities: labelling, re-packing, foil packing, minor repairs, creation of promotional sets etc. (sometimes referred to as co-packing). moreover, logistics companies often control their clients’ inventory, undertake complex servicing of distribution or logistic consulting – reaching far more than a selection of the route for deliveries or a supply base. the basis for creation of logistics services is to own a wide area computer network which might be connected with a client’s network in a variety of configurations. a company, which intends to subcontract logistics services to another external company should realize that they will partially or totally lose control over some processes connected with logistics. a considerable role is played by successful cooperation based on partnership of both companies and mutual trust (rydzkowski 2004). in order for this goal to be achieved, companies often abandon performance of various traditional activities e.g. legal services, research, pay policy, accounting services through transfer of these service to specialized external companies. such a policy enables company to focus their assets and efforts on what they can do best, e.g. on production, commercial activity or providing the services. many companies which need to reduce its organizational structure finds logistics to be an activity, which can be disposed of in order to reduce costs and to improve the customer service. while highlighting the concept of outsourcing one should consider what makes the companies order logistics activities from specialized external services. the reasons for such activities are numerous, however, the most important include the need for having logistics activities performed in best way as possible, which is possible in case of these activities being performed by a specialized entities with appropriate infrastructure and capacity which enable logistics services to be provided on possibly highest level. thus it seems that the argument for such a cooperation is lack of workload within the company which can focus on its core activities as well as easiness of flexible response to any changes within its environment. the advantages concern also economical aspect, through reduction in costs and service area both inside the company as well as services for customers. obviously, such a solution has particular disadvantages due to the possibility to be dependent on external service provider as well as loss of own know-how in terms of technology and logistics knowledge. therefore, a company which makes a decision on outsourcing should consider arguments both for and against it. main factors for outsourcing include (duck and schotz 1998): • the costs related to logistics activity are clearer, mainly through easiness of their recording, • cost reduction is possible through selection of most competitive offer in the market, which enable more flexible use of the owned resources, • levelling of internal problems which make performance of tasks difficult. economic analysis (2010, vol. 43, no. 1-2, 99-107) 102 the arguments against implementation of outsourcing include: • probability of being dependent on service provider, • risk of deterioration in quality of own products (e.g. improperly transported), • necessity of exact calculations in terms of costs, especially in the aspect of cost reduction, • lack of possibility to use experience in logistics obtained during operation in the market. the companies who decide to subcontract logistics activities outside focus more on coordination of operation within the area of cooperation with service provider and they can organize their logistics system so that it functions more efficiently within the chain. the solutions for organization of logistics processes enable formation of such structures which will enable using of all advantages of the described solutions. it should be considered if the companies are able to form their logistics chains so that all logistic activities and processes connected with their coordination are performed in a way that enables formation of an efficient structure adapted to the needs so that the achievement of the predefined goal of logistically managed organization is possible, i.e. finding right customers and ensuring them availability of the offered goods. from the company’s point of view the processes should be efficient both organizationally and economically. the processes which occur in contemporary economy indicate evolution, leading to the situation in which traditional divisions which separated production, commerce and service companies are fading away. more and more often logistics systems of separated companies are being replaced by whole logistics systems of logistics chains. the definition of the essence of logistics activities is becoming more and more difficult, mainly due to the fact of faded borders between companies. evolution of outsourcing leads to the situation where instead of normal subcontracting of services such as transport or warehousing a so called third party, and even the fourth-party logistics, is implemented for virtually total acquisition of the logistics area. the concerns may arise if employing external service provider, particularly a close cooperation with them, do not lead to losing control over the processes, which is very important as the companies which provide outsourcing services are on the supplier-customer interface. thus, they should organize the processes, to the benefit of the client, so that the customers are satisfied and buy goods from our company. on the other hand, the fact that logistics services providers are actually only an intermediaries, who not necessarily identify themselves with the company’s goals, might cause that they are not intent on satisfying the customer. this situation is dangerous and might lead to losing positive image by the company, which, in consequence, negatively impacts on the sales. on the other hand, despite some threats of using outsourcing, proper operation of companies (especially those operating in global markets) without using logistics services is actually not possible. this happens because one company is not able to specialize so much as to become a leader in production, marketing and logistics and other areas of operation. the competition between supply chains has become so strong that it is necessary to look for new solutions which enable to gain competitive advantage (schary, skjott-larsen 2002). one of them is outsourcing in reverse logistics. grabara, j., et al., business relations in reverse logistics, ea (2010, vol. 43, no. 1-2, 99-107) 103 typical activities of reverse logistics include processes which the company uses to collect worn out, damaged, unwanted or outdated products and the processes of packaging or sending materials from final user to manufacturer. if the products are returned to the company, the company has a variety of possibilities to handle them. if there is possibility to return a product to supplier at the full cost reimbursement, the company might choose this option as first. if the product has not been used yet, it can be re-sold to another customer or might be re-sold in the manufacturer’s shop. if the product is not of full value to be sold, it is passed to the repair services company, which, after appropriate repairs and improvements will export this product to the market. if a product can not be sold in current condition or if the company can considerably increase its price through renovation, recovery or processing of the product, the company can perform such activities before the product is sold. if the company does not perform such activities in its location, the intermediary companies, cooperating on the basis of contract or through outsourcing, can be involved in this procedure or the product might be sold immediately to the company which renovates, recovers or processes products. after performing these activities, the product might be sold as a renovated product or a processed product but not as a new one. if the product can not be renovated due to its bad condition or the environmental law does not permit to do this, the company can try to use this product at the lowest possible cost of production. the reverse logistics might involve a wide variety of activities. these activities might be performed in the following way: goods, materials, product or package in reverse flow return from end user or other user in distribution channel such as retailer or distribution centre. independently of its final designation, all products in the reverse flow must be stored and sorted before despatch to the final destination locations. if a product gets to reverse logistics flow from the customer, this might be a damaged product. the customer might also only think that the product is damaged while it is actually in good repair. this might result from customer’s lack of knowledge on using a particular product. if a product has not reached the final stage of its life, the customer may return the product to the service shop or directly to manufacturer. if the product has reached its final stage of usability, the customer may, in some cases, return product to manufacturer and a producer might use it in an appropriate way or to recover materials. if a product is returned by the partner in supply chain, this occurs because the product has not been sold or the partner wanted to get rid of it. the product might also reach its final stage of life or final stage of regular sales season. the product might also be damaged or destroyed. reverse logistics is strategically used mainly to enable users of a traditional channel – such as retailers and wholesalers – to take opportunity of reduction of risk of buying products which might not sell perfectly. for example, a company might create a software which controls the number of returns for various products depending on different elements which characterize particular groups of products. strategy which involves possibilities of reverse logistics considerably impacts on company’s cost. the goal of almost each business is to attach its customers to the company so as the customer do not change the supplier. there are many methods to build relationships economic analysis (2010, vol. 43, no. 1-2, 99-107) 104 which make it difficult to the customer and which put customers at risk of losing the benefits in case they change suppliers. an important services which supplier can offer to the customer is to give opportunity to return not sold or damaged products immediately, which credits customers on a temporary basis. initiation of reverse logistics might be a strategic response to a situation of growth in competitive environment. most of sellers and manufacturers have in recent years liberalized its policy of returns, due to the pressure from competitors. the companies still believe that the satisfied customer and ensuring possibilities of returns of unwanted products (which, according to the customers do not match their needs) are essential. cooperation in reverse logistics might concern its all aspects and activities such as collective planning, forecasting, design or marketing. this is essential due to the following benefits resulting from cooperation: • possibility of integrated information; • possibility of tracking and monitoring of events in supply chain; • improvement in clarity in supply chain; • possibility of managing the processes through corrective actions. advantages of reverse logistics outsourcing reduction of costs connected with logistics is justified in case when it leads to increase in profits. currently the most popular form of saving in logistics departments is outsourcing of supply chain (skowron-grabowska 2008). such a decision might impact on flows and financial results. first remarkable advantage is cumulating of commitments in the moment of the whole process of delivery. the settlements between individual suppliers are transferred to a logistics companies. the ordering entity gets the elongated deadline for payments and better opportunities to negotiate the price. the financial sources released in such a way increase its current assets. in order to execute the logistics processes it is necessary to involve fixed assets with a considerable value. they are mainly used for maintenance of distribution systems. in such systems, the resources of enormous value are employed – warehouses, distribution centres, local storage areas. the physical flow of goods between points of sale is realized also by the fleets which usually belong to the companies themselves and not to the specialized service providers. more and more often a tendency appears to rationalize distribution systems, e.g. through using specialized services of suppliers of complex logistics solutions. this tendency arose from the popular belief that actual cost of financing of investments with fixed assets is sometimes much higher than the cost generated by the investment. another element which makes companies to abandon the attempts to extend fixed assets connected with logistics is the efficiency of their use. the logistics companies show higher flexibility in terms of warehousing facilities and fleet. another advantage of subcontracting the supply chain maintenance to a specialized logistics company is a fact of savings, which appears as a result of liquidation of the transport/warehousing departments. such units, apart form labour costs, absorb a lot of expenditures connected with purchase of software (kot and slusarczyk 2009). a drawback of most of these systems is the price and lack of grabara, j., et al., business relations in reverse logistics, ea (2010, vol. 43, no. 1-2, 99-107) 105 possibilities to be used in other departments. logistics companies also make use of advanced systems, however, the cost of their purchase might be spread among a few clients. among numerous benefits connected with a supply chain outsourcing, having influence on financial standing of the company, the most important include: 1. increase in current assets through more profitable form of liabilities and opportunity to achieve time compression. 2. better use of fixed assets. 3. reduction in costs not connected with core activities in the company. relationship in outsourcing activity the 3pl/customer relationship is one where “partnership” can provide the basis for the business relationship and outsourcing success. the confirmation of this can be words of j. rodriguez: “if you understand the customer’s business model, the markets and geographies it wants to penetrate, the verticals it wants to target, its different manufacturing options and so on, you can continue to find low-hanging fruit. but if your relationship is just as a vendor of logistics services, you hit a brick wall.” (murphy 2005) continuing, partnership has to be on both fronts. the customer has to allow the service provider to become an intricate part of its business and look beyond the service it currently is providing. good partnerships share joint development, benefits and common strategic vision. collaboration with high degree of trust is next step of engagement in relation between outsourcing partners. j. grubic (grubic 2006) writes that the degree of trust in a relationship determines the level of flexibility a customer will allow the 3pl in operating the best of its capability. he also argues that this flexibility is necessary to deliver best-in-class process and solutions and in turn achieve the required performance and cost objectives. good collaboration will support business change and challenges, allowing both parties to review continually the current state against the vision and to agree actions to be taken to stay on course. sometimes outsourcing partners went to a business trap when thinking that all problems with logistics and supply chain processes have gone away to the 3pl. in fact some problems may now be a responsibility of the 3pl, others still remain firmly the responsibility of customers, and moreover there are some new issues to do how to manage the relationship. outsourcing will not work unless the customer stays deeply involved (bowman 2006). it is really important that customers stay involved but they should focus on managing the 3pls on strategic level, not to be involved in every decision taken by the 3pl. however, a good customer will want to collaborate around those activities that directly impact on service and where is a touch-point with their business. we can point on following stages of collaboration between outsourcing partners: engagement where it system integration, account management and implants are most important. part of the engagement between 3pl and its customer is the way of data interchange. it is extremely important to tightly integrate the 3pl system with the client’s erp system. high level of integration allows for fast flow of high volume data. the process economic analysis (2010, vol. 43, no. 1-2, 99-107) 106 is extremely reliable, with leading integration platforms having audit techniques that can signal an alert if message leave one system but are not received or processed in the other. the 3pl providers have also seen the opportunity for embedding implants into their customers operation for some time now. there is no better way to meet the customer requirement and understand its aims than to provide an implant working side by side in a planning or other supply chain role. account management is also important, because of it can help in the retention of customers, lead to more business with clients, potentially leading to improved profits for the 3pl and customers as well. by helping the customer to improve its operations, costs or sales, the 3pl is adding value. in continuous improvement stage, we can point on the sector expertise, process improvement and innovation as a main elements. one of the factors that 3pl offers their customers is expertise in the industry sector concerned. this provides the opportunity to help clients understand industry best practices and to provide benchmarking data. moreover, many times 3pls provide customers ideas they had learned in other industries. the continuous improvement contains also process improvement. resulting in cost and service benefits. also, it is clear that innovation brought from 3pls can be an element of outsourcing collaboration influencing on whole supply chain market position. innovations such as rfid, picking by voice are the sort of solutions that customers are looking for to enhance their operations. at last, communication should be pointed as a key ingredient for ensuing a good relationship between provider and customer. communication is the responsibility of both parties in the relationship, and to ensure good level of communication they both need to provide channels for this to happen. regular meetings provide a forum to discuss business changes and its impact on needs and priorities, it is also the best time to understand customer vision. summary to achieve a success in outsourcing relationships in every logistics functions including reverse logistics, the customer expectation should be properly aligned with the 3pl business model and relationships structure. the customer expectations focuses mainly on: superior service and execution, trust, openness and information sharing, solution innovation, ongoing executive level support. the capgemni study (langley and capgemini 2005) showed that, although relations between outsourcing partners are satisfactory, there is still much to be done and that both parties desire a more collaborative and strategic relationship. one of the reason this has not happened is that customers see the issue as the 3pls’ responsibility, and vice versa. in truth of course it takes two parties to really work hard to make any form of relationship work. references bowman r. j.: in managing outsourced relationships, there are no simple solution. global logistics and supply chain strategies, july 2006 capgemini and langley c.: logistics outsourcing is an important driver of topline growth and corporate strategy, according to new global study. fedex, philadelphia 2004 grabara, j., et al., business relations in reverse logistics, ea (2010, vol. 43, no. 1-2, 99-107) 107 duck o., schotz s., gospodarka materiałowa. poradnik praktyczny, wyd. alfa-weka, warsaw 1998 grubic j.: leveraging logistics outsourcing relationships. http://logistics.about.com/library/uc040303a.htm kot s., slusarczyk b., , process simulation in supply chain using logware software, annales universitatis apulensis series oeconomica, 2009, vol. 2, issue 11 langley j., and capgemini: 2005 third-party logistics, results and findings of the 10 annual study, capgemini 2005 michałek m.: nie tylko koszty, czyli co trzeba wziąć pod uwagę przy podejmowaniu decyzji o outsourcingu, [in:] gospodarka materiałowa i logistyka no. 11/2005 murphy j.v.: finding value in mature outsourcing relationships, global logistics and supply chain strategies, june 2005 rydzkowski w., usługi logistyczne, instytut logistyki i magazynowania, poznań 2004. schary, t.skjott-larsen p.b., zarządzanie globalnym łańcuchem podaż, wyd. pwn warsaw 2002 skowron-grabowska b.: position of logistics centers in reverse supply chains. [in:] enterprise, logistics and innovations in knowledge based economy. ed.by maria nowicka-skowron & ralph lescroart, haute ecole “blaise pascal”, arlon 2008 szczepaniak t., transport i spedycja w handlu zagranicznym, pwe, warsaw 2002. transport intelligence 2006. global supply chain intelligence portal. www.transportintelligence.com waters d.(ed.): global logistics. new directions in supply chain management. kogan page, london and philadelphia 2007 received: 6 january 2010 article history: accepted: 25 february 2010 microsoft word 2011_3_4_finalna ver.doc proffesional paper    tax incentives as a stimulant of r&d activities in  enterprises with the special review on their accounting  framework in b&h  vukmirović nikola, university of banja luka, faculty of economics,   udc:  336(497.63)   jel: o1; h25     poreski podsticaji kao stimulansi r&d aktivnosti   u preduzećima sa posebnim osvrtom na   računovodstveni okvir u bih        abstract – in the centre of attention of recovery plan of the eu for period 2010‐14 are, so  called, “smart investments” which, during long‐term, should ensure higher growth and sustainable  prosperity.  ʺsmart  investmentsʺ  mean  investments  in  research  and  development  (r&d)  and  investments in education from both public and private sources of funding. in order to stimulate higher  investments in r&d activities by private sector it is recommended to use public – private innovation  partnerships (direct way) as well as wider usage of r&d tax incentives (indirect way). as r&d tax  approach has a strong policy impact, this paper will deal with different r&d tax (accounting) schemes  and their impacts on financial performances of enterprises.   as  bosnia  and  herzegovina  admitted  international  accounting  standards  (ias)  and  international financial reporting standards  (ifrs)  for  its accounting  framework,  this paper will  examine relevant ias and ifrs in order to find out “positive” or “negative” effects of each r&d tax  accounting scheme for proper financial treatment of r&d activities in enterprises.   the overall aim of this paper is to answer the question: which r&d tax subsidy model would be  the most appropriate one for b&h, respecting the present legal and accounting framework, as well  as cost and benefits of each recommended model?    key words: accounting treatment of r&d activities, accounting analysis, r&d tax plans and  incentives,  volume  and  increment  based  r&d  subsidies,  corporate  tax  as  a  stimulant  of  r&d  activities.  the principles of the r&d tax incentives design   the basic question that arises when designing fiscal mechanisms friendly to research and  development  (r&d)  activities  is  to  which  companies,  sector(s)  or  technology(ies)  will  be  addressed  these  stimulants.  in  this  sense,  it  is  possible  to  develop  general  approach  to  stimulating, or such tax environment that would not make any differences among companies  according  to  their  size  (micro,  small,  middle  and  large  enterprises),  innovation  history  (innovation active or innovation inactive), sector’s affiliation or technology that is used or     economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   60 developed.  this  approach  has  a  number  of  benefits  which  mainly  come  from  a  wide  coverage of enterprises (greatest potential for the growth of total investment activity in r&d)  as well as minimal negative effects on market mechanisms and doing business conditions.  nowadays, about half of current tax schemes for encouraging r&d activities are general. [1]  on the other hand, certain countries within the general tax system, or as a single part, can  be encouraged on extra development of certain group of companies ‐ e.g. small and medium  enterprises (sme) and/or development of particularly technologies, through permanent or  temporary  programs,  which  usage  depends  on  whether  they  are  defined  by  national  strategic goals or even by the regional aims. by using this approach, greater focus on specific  sector  or  territory  can  be  achieved,  and  thus,  faster  development  of  the  specific  area.  however, these so‐called selective tax schemes cause significantly higher costs in terms of  operating and administration of such schemes, additional harmonization efforts and analysis  of its impacts, in order to avoid undue preference of certain groups of enterprises.   although in the literature can be found information on coverage and goals of different  r&d  tax schemes across  the eu and oecd countries, over time, a number of modalities  were  developed  within  tax  systems,  either  through  the  creation  of  temporary  funds  and  programs (e.g. for development of small innovative enterprises, enhancement of cooperation  between universities and private sector, overcoming the negative effects of the global crisis  etc.) or throughout the systematic  legal changes, and as a result  it  is hard to asses which  approach is better nowadays1. actually, the current practices of developed countries as well  as evolution of their systems show us  that r&d  tax system needs to be aligned with  the  strategic aims and fully and exclusively used to accomplish those goals.   when  designing  r&d  tax  incentives  is  extremely  important  to  take  into  account  the  simplicity  (the  level  of  administrative  and  operational  costs  for  private  enterprises),  consistency (the equal rights for all enterprises, the same interpretation of law by the officers  as well as inspectors, etc.) and system’s stability (so that enterprises can plan benefits that  will be reaped). therefore, these principles are necessary to bear in mind when choosing any  of  the  tax alternatives,  in order  to ensure efficiency and effectiveness of established r&d  friendly  tax  environment.  in  the  following  chapters,  already  used  r&d  tax  schemes  –  throughout  mechanisms  of  corporate  tax  and  wage  tax  and  contributions  (as  the  most  commonly  used  indirect  instruments  for  stimulating  innovative  activities  in  the  private  sector) will be presented.   corporate tax as a stimulant of r&d activities    through the institute of corporate tax, member states of oecd and eu have developed  the several incentives which may be divided into several groups: a) tax deferral ‐incentive in  the form of delayed tax payments, b) tax credits ‐ reduce tax liabilities and c) tax allowances ‐  on the amount of the current r&d costs before taxation. [2]                                                         1 for example, italy and uk stimulated the development of these activities only in smes until 2002.  after  that  the  scheme  was  extended  to  large  companies  but  with  a  lower  preferential  rate.  also  norway in 2002 introduced a tax scheme for smes for r&d which included the purchase of r&d  services from universities and public research institutes. japan, spain, denmark and the uk did the  same.       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   61 tax deferral means delay  in  the payment of corporate  tax based on  the  level of r&d  costs, which typically takes the form of accelerated depreciation of internally generated fixed  assets  (material  and  immaterial).  at  this  place  it  is  necessary  to  make  a  difference  in  accounting treatment of r&d activities. expenditures incurred in the research stage (research  activities) are treated as costs in period when they incurred while expenditures incurred in  the  development  stage  (if  they  fulfil  conditions  for  recognition  under  ias  38)  they  are  recognized  as  an  asset  (material  or  immaterial)2.  therefore,  these  subsidies  can  be  implemented through the accelerated depreciation method of internally generated assets3 (at  a higher rate than for externally generated assets) or even by 100% (and higher) write‐off in  the  first year of use of qualified asset4. through  this method of depreciation,  innovation‐ active companies will have higher depreciation costs, and thus a lower liability for corporate  tax (in the amount of the value of the asset ‐ for 100% write off in the first year x corporate  tax  rate  or  the  amount  of  depreciation  x  corporate  tax  rate).  in  this  way  government  ʺrewardsʺ innovative effort of a given company by reducing its corporate tax liability in the  first year of exploitation of internally generated innovation. if the government requires the  payment of corporate tax in the following years, previously deducted from the tax liability  (in the first year of exploitation), then such a tax incentive has the character of the tax credit  or  tax  asset  (because  the  amount  of  the  costs  in  the  income  statement  is  lower  than  the  amount of the liability for corporate tax). afterwards, the previously calculated tax asset will  be  “consumed”  as  a  result  of  lower  costs  reported  in  the  income  statement  and  higher  calculated  liabilities for corporate tax in the tax statement. it is important to note that the  listed benefits result primarily from the accounting policy ‐ under international accounting  standards (ias) and international financial reporting standards (ifrs), which usage and  ʺstrongerʺ positive effects release on r&d activities are stimulated through the tax system.   tax credits allow direct reduction of tax liability while the tax allowances are deduction,  above normal  ‐ 100% of r&d costs of the amount of taxable  income. therefore, the basic  difference between these two mechanisms  is that tax allowances reduce the gross  income  while the tax credits directly reduce the amount of liabilities for corporate tax. common is  that both reduce the real amount of r&d costs5. [3]                                                         2at this point is important to emphasize the major difference between the accounting regulations in  the eu (ias and ifrs) and accounting regulations in the u.s. (gaap) which is essential to bear in  mind when analysing r&d  tax schemes across  the oecd member states.  in  the usa  there  is no  capitalisation of any r&d costs, either for the cost incurred in the research or development phase.  3 belgium and greece allow depreciation of fixed assets (r&d property, plant and equipment) in 3  years, portugal in 4 years and the netherlands in 5 years.  4 this is case in canada, denmark, ireland, spain and united kingdom.  5 by  investing  in research, a company creates a positive tax savings  in the amount of: the costs of  research (r) x corporate tax rate (1), which lead to the fact that the real amount of research costs is: r x  (1-corporate  tax rate)  (2).  if we  treat expenditures  inccured  in  the stage of development as capital  expenditures  that will affect  the balance statement – will  increase  the value of  total assets.  in  the  depreciation  period  of  given  assets,  amount  of  gross  and  net  income  will  be  reducted  and  consequently the amount of corporate tax paid. if the company at the same time has active research  projects, gross profit for the period will be additionally burdened. total amount of tax savings in that  case will be: (depreciation costs + r) x corporate tax rate (3). this makes an open space for ʺinternally     economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   62 in countries that use the mechanisms of tax allowances, about ¾ of these countries set the  limits or caps on the annual amount of costs deductable for the tax purposes. through the  analysis we found the existence of two types of limits: upper limit on the amount of r&d  cost that can be recognized for tax purposes and the maximum amount of tax deduction that  can be approved. [4]  in the tax credit systems, some countries (e.g. australia and canada6) allow transfer of  credits  (reduction  of  liabilities  for  corporate  taxes)  in  the  next  tax  period.  in  this  way,  especially in small businesses, it is possible, for the periods when their taxable income is not  high  ‐  not  to  take  a  tax  credit  and  than  in  periods  when  they  are  more  profitable  ‐  implementation of a patent, new technology etc. to use it.    another innovation in the r&d tax schemes, in the eu and the oecd countries, is the  use of so‐called volume and increment tax schemes, which differ in the way that r&d costs  are recognised for tax purpose. in the first (volume) or scheme based on volume, all incurred  r&d costs are recognized  in  the tax statement while  in  the other (increment scheme)  the  amount  of  r&d  costs  above  a  certain  (base  level)  are  recognized  as  a  tax  deductable.  therefore, schemes based on the level of r&d costs are useful to stimulate r&d activities in  economies where stable market demand  for  innovation and r&d activities exist either  in  certain  sectors  or  generally.  schemes  based  on  the  increase,  which  are  obviously  more  difficult  to  administer,  are  used  in  cases  where  the  strategic  aim  is  to  support  (only  or  especially)  innovation‐intensive  enterprises  or  certain  sectors  or  specific  technologies.  among countries a  tendency of more  frequent use of volume based r&d  tax schemes  is  present because of lower administrative costs. the disadvantage of this scheme lies in the  fact that it does not only stimulate new r&d activities but also those that would be done  anyway. incremental incentives on the other hand reward extra effort and investment, but  the problem to define the base for comparison occurs [5]. having in mind the structure of eu  economies  and  their  innovation  policies,  both  mechanisms  meet  their  needs  and  are  therefore often combined. however, combined option of volume and increment based r&d  tax schemes is possible and we will call it a hybrid option7.  therefore,  tax credits and  tax allowances occur  in  three  forms depending on whether  they are based on a) the level of r&d costs, b) incremental change in r&d costs or c) the  combination of volume and incremental change in r&d costs. in the volume based r&d tax                                                                                                                                                                         generated sources of financeʺ for r&d activities. in other words, the actual cost of investment in r&d  is: the cost of r ‐ (3). [4]  6 in 2001 australia introduced a system allowing (only) small businesses to transfer a tax discount to  the periods when they have greater corporate tax  liabilities instead in the periods when they have  very litle or none tax liabilities. canada also refund unused tax credits and back to a period of three  years or forward to 10 years.  7 for  example,  in  2001,  australia  introduced  175%  tax  allowance  for  the  amount  of  incremental  increase in r&d costs versus a rate of 125% on the all r&d costs. companies can use this “extraʺ rate  for additional investments in the r&d if increases the volume of r&d investments above the average  amount of r&d investment over the past three years. austria also made some changes and now has  both types of incentives so that companies can reduce their liabilities to 25% on r&d investment and  an additional 10% (35%) if the investment is higher than the average amount of investments in the last  3 years. hungary increased the rate from 8% to 20% of the level of r&d costs and from 30% to 50% of  the incremental increase in investment.       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   63 scheme, companies that spend a monetary unit on r&d will be able to reduce the amount of  taxable income (1+w) (where w is greater than 0). in the case of incremental incentive, the  company can reduce a certain percentage ‐ w on the amount of increase to the base level of  r&d  costs.  in  the  tax  credit  system,  if  certain  scheme  is  volume  based  we  have  direct  deduction  of  tax  liability  in  given  percentage  of  the  annual  investments  on  r&d.  in  incremental form of r&d tax scheme, reduced amount of tax liability will depend on the  nominal change in the cost of r&d, in comparison to the base level of costs in a base period.  income tax and contributions on wages as stimulants of r&d activities   having  in  mind  the  typical  structure  of  the  research  costs8,  significant  effects  can  be  achieved decreasing the amount of gross wages for r&d staff that employers pay. although  the amounts of taxes and contributions on r&d wages have the character of costs and thus  already reduce the amount of liabilities for corporate tax, their reduction will have positive  impact on company’s cash flow which is extremely important for small innovation intensive  enterprises,  especially  in  the  initial  stages  of  research  when  revenues  are  low  and  investments in intellectual and human capital high. additionally, subsidies on r&d staff will  have positive effect on the employment in general, in the first line of highly skilled workforce  and  will  create  an  additional  positive  pressure  on  the  education  system  consequently.  however, the amount of net wages does not need to be reduced. that  is actually a fiscal  relief of employer by reduction of the amount of tax and contributions on r&d wages. from  the aspect of government, these tax incentives are much easier to administer and control as  opportunities for possible accounting manipulations are minimal.  it is interesting to point out that experience has shown that if the number of scientists and  engineers is stable over time (or the labour supply is inelastic), increased volume of r&d  activities (as a result of incentives through the tax system) will result in the increase of r&d  wages instead of raise in innovative activities [7]. this effect is known as ʺearnings effectʺ  which can be and enlarged if the only qualified costs of research activities are r&d wages, as  it was the case in traditional systems of tax subsidies. furthermore, it would be interesting to  determine does the “earnings effect” have the positive effect on the quality of r&d activities  (in  terms  of  better  scientists’  education,  a  higher  degree  of  commercialization,  quality  of  work experience, etc.). however, the results of these studies are not known yet.   also,  the  design  of  tax  incentives  through  taxation  of  r&d  wages,  like  corporate  tax  subsidies, arise the question of the level (volume) and selectivity (in all sectors and/or e.g.  newly employed in r&d) in the application of these tax incentives. the decision will depend  on the objectives and the balance and of the cost/benefit analysis of proposed tax subsidies.   examples of the practices used in eu and oecd countries  the most commonly used scheme in the eu and the oecd countries is volume based tax  scheme (the united kingdom, czech republic, norway and denmark) or schemes which in  addition  to  volume  based  recognise  and  capitalised  expenditures  (asset)  invested  in  the  purchase of r&d fixed assets (e.g. canada, australia, austria, france and italy). generally,                                                         8 it is estimated that 90% of each r&d cost relates to the cost of r&d wages. [6]     economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   64 these  countries  provide  greater  support  to  smes  through  the  system  of  higher  rate  of  deduction for the qualified research costs and capitalised expenditures. based on a display  (figure 1 and figure 2) we can see that e.g. a small company in the uk can reduce its liability  for corporate tax from 0.169 for each eligible r&d cost, while in canada, a tax credit of 35%  will reduce the sme’s corporate tax liabilities by 0.35 for each corresponding r&d cost and  so to a level of 3 million cad after which companies have a right of reduction of 0.2 per unit  r&d cost.     figure 1. examples of simple tax schemes, united kingdom (left), and canada (right) [8]          countries like the usa or e.g. ireland prefer a increment based system while countries  such as portugal, japan and spain use some kind of mixed ‐ hybrid system.  also  there  are  different  practices  regarding  the  consideration  of  qualified  r&d  costs,  eligible for recognition as a deductable in the tax statement. for example, belgium and the  netherlands as qualified r&d costs consider only r&d wages (gross amount). in addition,  belgium through the institute of corporate tax stimulates and capital investments in scientific  research  and  innovative  assets,  while  the  netherlands  additionally  stimulate  self‐ employment in s&t sector – for those who have at least 500 working hours per year spent in  r&d work.                                                           9 in the uk, in the system of “extra” reduction, regular corporate tax rate must be kept in mind. a  small company in the uk, with a corporate tax of 21%, will reduce its corporate tax liability for (175% ‐ 100% ‐ which is a normal deduction) x 21% = 0.1575 per each unit of the corporate tax liability.       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   65 figure 2. examples of common modifications of r&d tax schemes, portugal (left) and the netherlands  (right) [9].      financial analysis of the existing system of corporate and income taxation in b&h  from the aspect of r&d activities  according  to  the law  on corporate  tax  in rs corporate  tax rate  is set at 10%. by  the  regulations on the implementation of this law is determined which revenues and the costs,  in  what  amount,  are  deductable10.  r&d  costs  are  fully  recognized  as  corporate  tax  deductable if they meet the criteria listed in the regulations. also, it is noticeable that the  criteria  in  defining  and  determining  the  qualified  r&d  costs  match  definition  and  accounting treatment of r&d costs under ias 38 ‐ intangible assets, what is desirable from  the  point  of  consistency  in  applying  the  accounting  regulation  given  by  ias  and   harmonization  with  eu  legislation.  also,  the  regulations  require  documenting  the  r&d  activities and corresponding costs either  in  the  form of annual operating or project plan,  analysis, reviews, results of research projects, etc.  in order to avoid any possible abuse  in  terms  of  tax  evasion.  however,  according  to  the  pre‐exposed  practices  of  developed  countries, we can conclude that these activities are not sufficiently stimulated, but that there  is a good foundation for further development and stimulation.  under the law on corporate tax in federation of b&h (fbh), corporate tax rate is also  10% and r&d costs are fully recognized as deductable in the tax balance. unlike the law in  rs,  in  addition  to  expenditure  in  the  research  stage,  total  development  expenditures  (immaterial) are recognized as tax deductable in the period when such expenditure incurred.  at this place we need to have in mind that the already used tax allowances for the amount of  depreciation,  impairment  and  write‐off  costs  in  the  following  years  will  increase  the  tax  liabilities. so, we see that the fbh has established the stimulation that corresponds to a.m.  tax deferrals, and in that sense, the relevant law in fbh is more competitive than one in rs.  but, neither by the law nor by the regulations in fbh is further defined the coverage of  r&d activities and  it  is  leaved  to  the  ias and  ifrs. also, law  in fbh do not explicitly  require documentation of r&d costs. due to, abuse or subjective interpretation of ias and  ifrs might occur either by accountants or inspectors.                                                         10 b&h  is  a  complex  state  ‐  consist  of  two  entities,  where  each  entity  independently  create  and  implement taxation policy, in the domain of corporate and income tax.      economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   66 analysing  the  tax  system  in  the  domain  of  wage’s  taxation,  there  are  no  explicit  incentives for staff working on r&d activities, according to applicable regulations  in  this  area. we say explicit because the relevant laws in rs and the fbh do not provide possibility  for  reduction  of  income  tax  for  the  regular  work  (full‐time  contract  or  as  extra  work  contract). however, the personal income without contract of employment, specifically in the  case of authorship, provides  the possibility  for exemption of contributions on wages  (for  health,  pension,  unemployment  and  other)  if  the  author  of  such  services  is  previously  insured (has an employment contract in other company or on other types of services). in this  way, contractor of those services is required to pay (only) the amount of income tax on the  gross compensation of  the author’s service. those benefits can be used only  if  they meet  criteria set up by the law on copyrights and related rights in b&h. however, if we take a  look  from  the  other  perspective,  permanent  employment  in  r&d  is  conditionally  discouraged and/or companies whose main activity is r&d are not stimulated to deal (only)  with  those activities, and we note there is an additional space for further improvement in  this field.  instead of a conclusion ‐ recommendations for b&h and other western balkans  countries  having in mind current doing business conditions in b&h and administrative and tax  burden of companies, when designing a r&d tax friendly environment is essential focus on  the principles of simplicity, consistency and safety, which were discussed in the first part of  this paper. also, given the current level of total spending (public and private sector) in b&h  for the innovative activities (the estimation for the rs is 0.1% of gdp, the level of b&h about  0.07% of gdp) and a condition for joining eu (1% of gdp), the trends of other countries in  eu (3%of gdp by 2020.with the respect to the countries that already achieved that level), the  structure of b&h export and current level of industrial development, it is necessary to ʺrise  upʺ the general level of investments in the activities of r&d and by the example of ʺgood  practiceʺ to show and prove to businessmen and policy makers the importance of innovation  for society as a whole. this leads to conclusion that a general, volume based approach would  respond to b&h case. regarding to the possibility for 100% write‐off of internally developed  assets and innovations, we would recommend the implementation of the practice of fbh in  rs  with  the  possibility  for  the  extension  for  externally  generated  intangible  assets  (as  opposed to the current estimated depreciable life of 15 years). also, given that the existing  legal  regulations  in  fbh  and  rs  have  included  but  ʺhiddenʺ  r&d  incentives,  stronger  promotion of existing (hidden) r&d tax incentives is necessary. therefore, in short term we  would suggest the implementation of previously given recommendations which due to the  low  corporate  tax  rate  of  10%  in  this  post‐crisis  period  will  not  significantly  affect  the  diminish of the public revenues but may attract ʺcritical massʺ.  for the medium term, the suggestions would be related to the institutes of corporate and  income tax. in this regard, we would recommend the increase in recognition of current r&d  costs for the tax purpose and exemption of the contributions on r&d wages (at least partial,  either for authorships or for full/part‐time contracts) in order to encourage employment of  highly skilled workers and as a result a better education of youth. the above measures can  be initially implemented through a fund system ‐ as a temporary programme(s) and thus no       vukmirović, n., tax incentives, ea (2011, vol. 45, no, 3‐4, 59‐68)   67 system and  legal changes will be required. at  the same  time,  this would have a positive  impact on the supervisory authorities and inspectors, because they will have an open space  for preparation and professional  improvement. after a pilot period, based on cost‐benefit  analysis of those measures, a permanent introduction may be discussed.   in  the  long  run,  in  line  with  the  development  of  innovation  sector  in  b&h  the  introduction of the special incentives for highly innovative enterprises based on the principle  of incremental increases would be reasonable. additionally, difference between ʺrewardʺ on  externally and internally generated innovative products and services may be reduced, but  only  for  innovations  purchased  from  local  companies.  in  this  way,  bigger  innovative  company  would  make  a  significant  positive  push  to  small,  resourceful  and  flexible  enterprises and may stimulate the set up of new enterprises and businesses. in this sense, by  acquiring  the  experience  of  public  administration  and  enterprises,  it  may  be  discussed  creation of such tax environment that would stimulate r&d activities of innovation active  enterprises at the expense of those ʺinactiveʺ through the all elements of tax environment  (taxation of corporate  profit,  personal  income  tax,  the contributions on  wages,  vat,  real  estate taxation, a system of tariffs, taxes, etc.). in this way we would create a significantly  more  objective,  fairer  and  more  transparent  means  of  motivating  (because  it  is  based  on  market mechanisms),  instead of grants, subsidies and donations of  local and  international  institutions, which are very limited, especially after the great economic crisis.  references   details: bloom, n., griffith, r., klem, a., ʺissues in the design and implementation of an r & d tax  credit for uk firmsʺ(2001). briefing note no.15, institute for fiscal studies, london  goolsbee,  a.  “does  government  r  &  d  policy  mainly  benefit  scientists  and  engineers?”,  (1999),  american economic review 88 (2). pp. 298‐302.  hall, b. (1995), ʺfiscal policy towards r&d in the united states: recent experienceʺ, oecd  r&d tax incentives: rationale, design, evaluation (2010),oecd  supporting  growth  in  innovation:  enhancing  the  r  &  d  tax  credit,  (2005),  hm  treasury,  united  kingdom  tax incentives for research and development: trends and issues, science and technology industry,  (2002). oecd  towards  a  more  effective  use  of  tax  incentives  in  favour  of  r  &  d,  (2006),  commission  of  the  european communitiescommission staff working document, brussels.  vukmirovic,  n.,  turkanovic,  d.  “the  impact  of  intangible  assets  investments  on  the  financial  stability and profitability of enterprises”,(2010). ii international scientific conference: technology  innovations a generator of economic growth, association of inventors of republic of srpska         economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   68 apstrakt  ‐  u  centru  pažnje  plana  oporavka  eu  za  period  2010.‐2014.  su,  takozvane,  ʺpametne  investicijeʺ,  koje  treba  dugoročno  da  obezbede  veći  rast  i  održivi  razvoj.  ʺpametna  investicijaʺ znači ulaganja u istraživanje i razvoj (r&d), kao i ulaganja u obrazovanje iz javnih i  privatnih  izvora  finansiranja. u cilju podsticanja  investicija u aktivnosti  istraživanja  i razvoja od  strane  privatnog  sektora,  preporučuje  se  korišćenje  javno‐privatnog  inovativnog  partnerstva   (direktan način), kao  i šire upotrebe poreskih podsticaja za  istraživanje  i razvoj (indirektan način).  kako poreski pristup istraživanju i razvoju ima jak uticaj na donošenje odluka, ovaj rad će se baviti  različitim  r&d  poreskim  (računovodstvenim)  modelima  i  njihovom  uticaju  na  finansijske  performanse preduzeća.  kako  je  bosna  i  hercegovina  prihvatila  međunarodne  računovodstvene  standarde  (mrs)  i  međunarodne standarde finansijskog izveštavanja (msfi) kao svoj računovodstveni okvir, ovaj rad  će ispitati adekvatne mrs i msfi u cilju identifikovanja ʺpozitivnihʺ ili ʺnegativnihʺ efekata svakog  r&d poreskog modela, radi pravilnog finansijskog tretmana ovih aktivnosti u preduzećima.  opšti cilj ovog rada  je da odgovori na pitanje: koja model poreskih subvencija za  istraživanje  i  razvoju bi bio najprikladniji za bih, poštujući sadašnji pravni i računovodstveni okvir, kao i troškove i  koristi svakog preporučenog modela?    ključne reči – računovodstveni tretman aktivnosti r&d, računovodstvena analiza, r&d  poresko planiranje i stimulansi, obim i porast r&d baziran na subvencijama, korporacijski porez kao  stimulans r&d aktivnosti.        article history:  received:  15 july 2011 accepted:  21 september 2011          ea_2015_3-4 udc: 005.22:[005.35:336.581 cobiss.sr-id: 220031500 original scientific paper methodological proposal to measure social performance in microfinance institutions avolio alecchi beatrice1, calderón agüero nathalie, rojas villafuerte francisco, tokashiki matsuy manuel, centrum católica graduate business school, lima, peru abstract – in the last decades, the microfinance sector has globally grown. microfinance institutions (mfis) were created to fight and reduce poverty; however, many mfis seem to no longer achieve their social missions because they act as conventional financial institutions. this slows down the financial support that most low-income families need in order to improve their quality of life. this paper presents a methodological proposal to measures social performance in mfis. thus, mfis and other institutions with a social mission may benefit from an efficient tool used for a transparent and actual control of their social performance key words: management, social responsibility, microfinance, social performance introduction microfinance is the provision of financial services to low-income families. in the last years, it has become a useful tool to help the most vulnerable people, since it contributes to the improvement of the income and social empowerment. in this context, microfinance institutions (mfis) were created to fulfill a social function aimed to reduce poverty through the financing of poor customers who couldn’t have access to traditional financial services. nevertheless, these objectives have been distorted in some cases and many mfis are beginning to resemble traditional financial institutions, disregarding the initial objective that was to help people to overcome poverty and to achieve a verifiable social inclusion. this paper proposes a methodology to measure the social performance in mfis; it seeks to improve the management and the balance of financial and social objectives in mfis. the proposed methodology aims to be considered as a new approach to measure social performance, which seeks a more transparent achievement of mfis’ social mission. social performance measurement allows mfis to manage and balance their financial and social objectives, thus reducing their own operating costs. when improving their services, mfis are able to retain more customers and demonstrate their social performance to the stakeholders. additionally, the proposed methodology is also applicable to organizations of several industries interested in achieving not only financial objectives, but also social objectives. 1 corresponding author. jirón daniel alomía robles 125, urbanización los alamos, lima 33, peru. bavolio@pucp.pe 82 economic analysis (2015, vol. 48, no. 3-4, 81-100) evolution of the social performance concept within the mfis organizations are currently interested in the need to promote the creation of a sustainable society. however, the initiatives for this objective differ in the approach and needs of each organization, even though there are several similarities among them. in the last decades, the company and the community have been socially interacting by means of the concept of corporate social responsibility (csr). the definition of csr given by future foundation and bt (grimshaw & wilmott, 1998) states that it is an agreement that takes into consideration the opinions and interests of individuals, organizations, and other parties with whom the company deal on a regular basis. furthermore, csr incorporates economic, legal, ethical, and discretionary categories; hence, society creates an expectation with regard to the company’s operation, which must meet these four categories. the aim is to create a good relationship between businesses and the society, because if the company achieves to develop the concept of social sensitivity, it can meet the expectations of the society according to its business sector. social performance in the context of mfis becomes a peculiarity of the corporate social performance (csp) concept. the latter is the measurement of csr complied by companies. in other words, the csp is how an institution respects and achieves its social mission, measuring it by means of the principles, actions and the implemented corrective measures, i.e., the effective translation of the organization’s mission into practical actions that lead to the achievement of social objectives. hence, social performance assessment (spa) should be as systematic as the financial performance assessment. with regard to the performance of mfis, they have interrelated social and financial objectives since their creation. for this reason, the need to find the tools to measure social performance arises. mfis shall manage this double parameter, in which a strong financial performance will facilitate the achievement of the social mission. similarly, the social objectives of mfis shall be included in their own social mission, which should be based on the following principles: i) provide services to a growing number of vulnerable and excluded target groups; ii) improve the quality and adequacy of services; iii) increase the customers’ social capital and political capital; and iv) mfis shall involve their employees, customers, and the community in social responsibility activities (social performance task force, june 2009). moreover, according woller (2007), social performance is not only defined in terms related to poverty, as it may or may not include them since it does not only measures the final outcomes, but also the actions and corrective measures that are continuously taken in order to achieve this outcome. in practice, it is feasible for mfis to have a different social mission than to serve the poor. however, crompton (2007) stated that most mfis follow a double bottom line: financial outcomes, in terms of financial sustainability, and social outcomes in terms of socio-economic impact. nevertheless, it might be difficult to find the right balance between these two objectives. nowadays, mfis seek to achieve their social objectives as part of a change in industry practices, which has financial performance approach almost exclusively to a more active interest in their customers. this change is influenced by a growing interest in various types of impact assessments, market research, and in the development of new products, which avolio alecchi, b., et al., microfinance institutions, ea (2015, vol. 48, no. 3-4, 81-100) 83 enables a better understanding of their customers and a better service according to their needs. in summary, the continuous process of collecting customer information, changing mfis’ products and processes to improve their operations, and the achievement of the social objectives is exactly what social performance measurement intends to reflect. in addition, the translation of mfis’ social mission shall cover a wider range than the reduction of poverty. social performance management the most used scheme for the implementation of social performance management (spm) is a scheme that involves mfis with national networks and international cooperation organizations interested in establishing positive impact initiatives for the poor. social performance is not the casual result of mfis operation, on the contrary, it is the result obtained thanks to the planning and measurement of institutional decisions. this encompasses more than the impact of microcredit on the daily life of a poor person, considering the impact of financial services in terms of vulnerability decrease, methodologies of customers’ social participation, the creation of social ties, and the promotion of social capital. in order to achieve a high spm, it is important to organize administration processes, to define the mission, the strategic planning, and the information system design, but especially the governance and the focus on the poor shall determine the design of financial products, as well as the methodology of decentralization and social participation. spm helps mfis to translate their mission and values into clear, measurable objectives liable to capture intentional social benefits. mfis that are clear about their objectives are more likely to have a deliberate strategy to achieve them. microfinance has, indeed, a great potential to help customers; however, it also has the potential to be detrimental, especially through overindebtedness. mfis integrating a social approach in performance management processes will not only benefit from more loyal and satisfied customers, but also will able to demonstrate social outcomes to external stakeholders, including investors and donors. impact refers to the effects that the proposed intervention has on the overall community. in general, spm is a broad process that comprehensively examines the entire mfi: (a) management indicators, (b) social objectives, (c) target groups (d) operative processes, (e) reports, and (f) assessment reports (social performance task force, june 2009). social performance indicators social performance indicators (spi) is defined in four dimensions: (a) focus on the poor and the excluded, (b) adapt the services and products to the target population, (c) improve share and political capital of clients, and (d) social responsibility of the institution. the main indicators used to measure social performance in mfis are the following: a) poverty index: it measures poverty levels of clients in mfis. b) unemployment index: it evaluates job opportunities created by the companies supported by the mfi. 84 economic analysis (2015, vol. 48, no. 3-4, 81-100) c) human development index (hdi): it is a social indicator based on three factors: (i) a long and healthy life; (ii) education; and (iii) a decent standard of living measured by the gross domestic product per capita. d) social capital index: this is the result from an interaction among the individuals, institutions, and structures created to learn these, about their shared values. e) social policy index: it evaluates the preservation or increase of social welfare through a set of existing criteria and political guidelines. social performance measuring tools during the last years, isolated attempts to measure social performance have been made using different tools based on several definitions of social performance. these tools can be grouped into three groups, considering the main objective and the proposed dimensions: social audit tools, social indices tools, and poverty assessment tools. all these models and measurement tools have the disadvantage of having very extensive questionnaires, which implies that the interviewer or the survey taker has to spend a lot of time explaining the tool and, specially, obtaining the needed information. the comparison of these tools is shown in table 1, which is based on the following dimensions: (i) clarity in the social mission, objectives and organizational values; (ii) alignment of the organizational systems such as strategic marketing, product methodology, human resource incentives, the objectives, values and mission in the imf; (iii) the use of standardized indicators to measure the performance of the mfi with regard to the achievement of the objectives based on their values, strengthening the focus on the mission and on the targeted customers; (iv) the responsibility to the customers measured as the transparency and fairness of the services or products costs, effective communication, customer training in financial education, inclusion of illiterate clients, monitoring clients with overindebtedness, ethical behavior of the staff, including the appropriate practices of debt repayment; (v) gender considerations in relation to operational policies and practices; the number of members and the percentage of women on the organization board, the management, and staff; (vi) administration by the members with regard to the ease of board elections, regular meetings of all partners and the attendance level, and effective strategies for communicating the senior management’s decisions to the ordinary members; (vii) nonfinancial services such as literacy; (viii) responsibility to the community with regard to job creation and enhance the development of new businesses; (ix) responsibility to the staff with regard to the transparent recruitment and equal treatment; (x) responsibility to the conservation of the local environment; (xi) scope of social objectives; (xii) financial services aimed to achieve social objectives; (xiii) changes due to social objectives. t ab le 1 . c om p ar is on o f so ci al p er fo rm an ce t oo ls t o o ls / d im en si o n s clearness of the mission alignment of the systems decision making responsibility to clients gender considerations members’ governance non-financial services responsibility to the community responsibility to the staff responsibility in the local environment social objectives scope services to achieve social objectives changes due to social objectives w ea k n es se s so ci al p er fo rm an ce in d ic at or ( sp i) � � � � � � � � � � � • t h e tr an sl at io n g u id e is a v ai la b le i n f re n ch a n d e n g li sh , w h ic h m ea n s th at i t w ou ld b e d if fi cu lt t o ap p ly th e to ol w it h ot h er fo re ig n la n g u ag e sp ea k er s. • l im it ed i n te ra ct io n w it h t h e cl ie n t. t h er e ar e n o fi el d s tu d ie s. • l im it ed e v al u at io n o f sy st em s al ig n m en t. q u al it y a u d it t o ol ( q a t ) � � � � � � � � � • l im it ed i n te ra ct io n w it h t h e cl ie n t si n ce t h er e ar e n o fi el d s tu d ie s. • t h er e is n o co m p ar at iv e as se ss m en t of t h e so ci al p er fo rm an ce w it h o th er in st it u ti on s or ot h er in d u st ry s ec to rs . • l im it ed e v al u at io n o f n on -f in an ci al s er v ic es . g lo b al r ep or ti n g in it ia ti v e (g r i) • l ac k of sp ec if ic in d ic at or s fo r th e m ic ro fi n an ce s se ct or b ec au se m f is u se in d ic at or s d es ig n ed fo r ot h er f in an ci al i n st it u ti on s. • f in an ci al c os ts c an b e si g n if ic an t if a m f i m u st b e m od er n iz ed i n o rd er t o ap p ly t h e g r i to ol . so ci al � � � � � � � � so ci al p er fo rm an ce r at in g � � � � � � � � • a s h or t p er io d o f ti m e an d a s m al l te am d o n ot al lo w a th or ou g h v er if ic at io n , es p ec ia ll y d u ri n g fi el d w or k . • in cl u si on of th e cu st om er s’ su p er fi ci al p oi n ts of v ie w . m ic ro r at e so ci al r at in g � � � � � � � � � � • sh or t p er io d o f ti m e at t h e w or k si te . • l im it ed m ee ti n g s w it h t h e cu st o m er s an d l im it ed v er if ic at io n o f in s it u p ra ct ic es . • t h e ev al u at or s d on ’t h av e a v as t k n ow le d g e of so ci al p er fo rm an ce . t o o ls / d im en si o n s clearness of the mission alignment of the systems decision making responsibility to clients gender considerations members’ governance non-financial services responsibility to the community responsibility to the staff responsibility in the local environment social objectives scope services to achieve social objectives changes due to social objectives w ea k n es se s m ic ro fi n an ce r at in g t oo l � � � � � � � � • t h e re p or t h as f ew c om p ar is on s w it h o th er m f is . • v al u at io n p ro ce ss i s ex p en si v e an d i n te n se . m -c r il r at in g � � � � � � � � p ro g re ss o u t of p ov er ty in d ex ( p p i) � � • l im it ed a p p ro ac h r es tr ic te d t o d ev el op a ss es sm en ts b as ed o n p ov er ty l ev el s. u sa id i r is p a t � • t h er e ar e li m it at io n s w h en i n u se . f in c a � � � � � • t h er e ar e li m it at io n s w h en i n u se . n ot e. r et ri ev ed f ro m s t p f ( n .d .) avolio alecchi, b., et al., microfinance institutions, ea (2015, vol. 48, no. 3-4, 81-100) 87 among the main tools of the social audit are: a) the social performance indicator (spi)—designed by the committee of exchange, reflection and information on the saving-credit systems (cerise, by its french initials)—is mostly used on mfis thanks to its simplicity and accessibility. this tool focuses on process management and how their systems effectively comply with them. according to the social performance task force (sptf, 2009), this tool is appropriate for the internal review of systems and processes with the purpose of implementing the social mission in a mfi. b) the quality audit tool (qat), developed by the microfinance centre (mfc), is known for its accurate results in internal audits and for its practical diagnosis. it specifically focuses on examining management processes, assessing the status and effectiveness of the internal systems that support the achievement of social objectives. it identifies the strengths and weaknesses so as to have an improvement plan in the mfi. according to sptf (2009), the qat is appropriate for a mfi that requires an internal review of the process management and the internal system that helps to achieve its social mission, as well as an action plan to improve processes and systems. c) the global reporting initiative (gri) has developed a tool of the same name. it is globally known as the most used sustainable report tool. its main objective is to submit sustainable reports regularly, such as financial reports. according to the sptf (2009), the gri tool is ideal for an mfi that seeks to include social performance reports in their routine information systems. d) the social tool developed by accion internacional (sptf, 2009) stands out because it allows presenting a clear report to shareholders or potential investors, so that financial outcomes are not the only thing considered when making decisions. accion international believes that this tool helps to improve the effectiveness of the organization by highlighting the strengths and weaknesses of their social performance and by determining the image that the clients, staff and the community have of the mfi. among the social indices tools, we have: a) the social performance rating is designed by planet rating agency, which belongs to a department of “planet finance” international ngo. its main objective is to give an opinion about the capability of a mfi to achieve its social objectives. the sptf (2009) recommends the tool for institutions seeking an independent assessment about the achievement of their social objectives, as well as the risks, outcomes, and the ability to manage their social performance. b) the microrate social rating, developed by microrate agency, is the only tool that quickly allows a direct comparison of mfis’ social benefits in several regions with different mission statements. according to sptf (2009), the social value of the tool is suitable for mfis that want a gradual, summarized, and independent review of the benefits and social performance. c) the microfinance rating, created by the spin-off of microfinance company, stands out because it provides an objective opinion about the social performance of the institution and it allows to compare it with other mfis in the same 88 economic analysis (2015, vol. 48, no. 3-4, 81-100) geographical area and internationally. the sptf (2009) recommends the tool for mfis requiring a complete and independent social assessment, including field studies to inform and confirm the outcomes. d) the microcredit ratings international limited is a rating agency based in india. it experimentally applies its social performance rating tool to measure the likelihood of a mfi achieving its social mission, in line with the accepted social values. its scope is much broader than the other tools, since it covers all dimensions of social performance. the main tools to assess poverty are: a) the progress out of poverty index, developed by grameen foundation, is a tool that measures poverty levels of clients and how these poverty levels change over time. its main objective is to meet the customers’ needs, evaluating the change of the poverty likelihood status over time, throughout different programs. b) the usaid poverty tools, designed by the united states agency for international development (usaid), are designed to measure poverty levels of the client groups of microenterprises service providers, in comparison with the national or international poverty line. this tool is not intended to measure individual poverty, select new customers, or to measure the impact of microfinance services on the lives of the current clients. proposal to measure social performance in mfis this article proposes a methodology to measure social performance in mfis taking into consideration a framework to develop the indicators. indicators can be classified as simple or complex, since these are commonly used in project management. they might be classified according to their measurement object as: (a) impact; (b) effect; and (c) compliance indicators (bobadilla, del aguila, & de la luz, 1998). the proposal corresponds to a complex social indicator and an impact index because it requires a theoretical framework; therefore, there isn’t a simple way to confirm the outcomes. social investigations approach phenomena with different complexity and abstraction levels. measuring social performance can be classified as an abstract concept that, empirically, is not feasible to observe; therefore, it is not feasible to measure. for the latter, it is required to carry out a decomposition and transformation process called operationalization (lazarsfeld, 1958), which converts the social performance notion and concept into a set of indicators that enable empirical observation. for blalock (1970), the following items shall be considered in the operationalization process: (a) the conceptualization derives from theoretical reflections based on the bibliography review and on the author’s own thinking; (b) measurement enables to assign values to social phenomena according to certain rules. for lazarsfeld (1958), operationalization process makes it possible to express concepts empirically. the process includes the following stages: descriptive representation of the concept; specification of the concept identifying the dimensions of its components or semantic subdivisions; and the choice indicators for each dimension. once the dimensional indicators have been chosen, they are synthesized by constructing indices. avolio alecchi, b., et al., microfinance institutions, ea (2015, vol. 48, no. 3-4, 81-100) 89 the conceivable concepts are determined by social performance dimensions factors in order to measure the social performance. indicators used to measure social performance through quantification and weighting are obtained from these factors. figure 1 shows the operationalization process of social performance. it illustrates the measuring components used in several dimensions. it was developed taking lazarsfeld’s (1958) scheme as a starting point. since there is no consensus on a definition of social performance, the process starts with the proposed definition, which disaggregates the initial components, which are the dimensions. these shape the pillars that form the definition of social performance. finally, factors variables included in the pillars are weighted and the possible combinations are determined. weighting involves assigning weights in an attempt to express the relative importance in the measurement methodology. social performance determinants in mfis the methodological proposal considers the social performance as “the translation of mission into practice in line with accepted goals" (sen, 2008). these social objectives may relate to, for example, (a) sustainably help an increasing numbers of poor and excluded people; (b) improve the quality and adequacy of financial services available to target clients through a systematic assessment of their specific needs; (c) create benefits for mfi’s clients, their families, and communities in terms of increasing social capital, equity, income, access to services, reducing vulnerability and fulfillment of basic needs; (d) improve the social responsibility of the mfis towards its customers, employees, and the community. social performance determinants—which will be referred as pillars for the purpose of this study—have been established based on the previous literature of social performance. as described in the previous section, there is no consensus among mfis on a set of social performance determinants. conversely, social performance pillars are different in several existing methodologies. for the identification process of social performance pillars, the model developed by sen (2008) has been taken into account (see figure 2). it defines the social performance of mfis as the translation of mission into practice, in line with accepted goals. according to this proposal, social performance is not only the final outcome but also the process of achieving the outcome. therefore, to assess social performance, mfis should not focus only on trying to demonstrate a final outcome, but also on the different processes that can lead to positive social outcome. these steps follow a logical organizational path considering the intention expressed in its mission, the design of systems aimed to achieve this mission, the outcomes, the experience, and the impact that this social mission might have on the community. the pillars defined in this model are: intent and design, (b) internal systems and operations, (c) output, (d) outcomes, and (e) impact (figure 2). 90 economic analysis (2015, vol. 48, no. 3-4, 81-100) figure 1. pillars of social performance intent and design what is the mission of the institution? does it have clear social objectives based on its mission? do its objectives include formulation of principles of social responsibility? internal systems and operations are systems designed and in place to achieve those objectives? does the institution have information to trap performance towards those objectives? output who does the institution serve? is it reaching intended clients? is it serving poor people? are the financial services catering to their needs and capacities? outcomes have clients and their households experienced social and economic improvements? or impact can these improvements be attributed to institutional activities? note. retrieved from sen (2008). the pillars, factors and variables of the model are presented and explained in table 2 and figure 3. the factors correspond to the elements forming the pillars. they give a specific meaning to the pillar, derived from variables and weights. avolio alecchi, b., et al., microfinance institutions, ea (2015, vol. 48, no. 3-4, 81-100) 91 figure 2. indicators operationalization process note. retrieved from lazarsfeld (1958). dimension 1 dimension 2 dimension 3 dimension n pillar 1 pillar 2 pillar 3 pillar n performance concept operationalization notion social performance model factor factor factor factor factor factor factor weight weight weight factor weight weight t ab le 2 . p il la rs , v ar ia b le s, a n d i n d ic at or s of t h e p ro p os ed m od el p il la rs f ac to rs v ar ia b le s w ei g h t s u rv ey q u es ti o n s w ei g h t in te n t an d d es ig n m is si on a n d s oc ia l ob je ct iv es a ch ie v em en t of t h e m is si on an d s oc ia l ob je ct iv es o f th e m f i. 13 % 1. w h at i s th e m is si on o f th e m f i? 2. i s th e m f i or ie n te d t o th e p o or es t se ct or s? 3. h ow o ft en d o y ou r ev ie w t h e m is si on o f th e m f i? 6% 4% 3% g o v er n an ce it a ss es se s th e w ay t o es ta b li sh t h e b oa rd o f d ir ec to rs ’ r ol es a n d re sp on si b il it ie s is a ss es se d . it m ea su re s th e b oa rd o f d ir ec to rs ’ k n ow le d g e ab ou t so ci al p er fo rm an ce . 7% 1. i s th e b oa rd o f d ir ec to rs a n d p ar tn er s li st p u b li sh ed ? 2. a re t h e d ir ec to rs t ra in ed o n s oc ia l m an ag em en t? 3. d o th e d ir ec to rs i n te rf er e on r eg io n al g ov er n an ce , c om m u n it y o r m u n ic ip al m at te rs w it h r eg ar d t o su st ai n ab le s oc ia l d ev el op m en t p ro g ra m s? 4. d oe s th e g ov er n m en t p ro v id e so ci al w el fa re p ro d u ct s or s er v ic es th ro u g h y ou r in st it u ti on ? 0. 5% 2. 5% 2. 5% 1. 5% in te rn al sy st em s / o p er at io n s c u st om er s m ar k et re se ar ch t h e p or tf ol io i s cl as si fi ed b as ed o n a c ri te ri on . 6% 1. d o y ou p er fo rm m ar k et r es ea rc h t o id en ti fy t h e n ee d s of p ot en ti al cu st om er s? 2. h ow o ft en i s it d on e? 3. d o y ou s om eh ow c la ss if y y ou r p or tf ol io c on si d er in g a n y c ri te ri a? 4. i f th e an sw er is y es , w h ic h c ri te ri on i s u se d t o g ro u p t h e p or tf ol io ? 2% 1% 2% 1% m et h od s to r et ai n cu st om er s u se s to ol s to m ea su re t h e re te n ti on o f cl ie n ts . 8% 1. d o y ou u se a n y t oo l to m ea su re t h e re te n ti on o f cu st om er s? 2. i f th e an sw er is y es , p le as e d ef in e th e to ol . 8% so ci al p er fo rm an ce tr ai n in g f or t h e st af f so ci al p er fo rm an ce t ra in in g h ou rs . 7% 1. i s th er e st af f d ed ic at ed t o en su re t h e ac h ie v em en t of t h e in st it u ti on ’s so ci al m is si on ? 2. h ow o ft en i s th e st af f tr ai n ed o n s oc ia l p er fo rm an ce ? 3. h ow m an y h ou rs o f tr ai n in g r el at ed t o so ci al i ss u es a re a ss ig n ed f or e ac h w or k er a y ea r? 4. a re t es ts t ak en a ft er e ac h t ra in in g s es si on ? 5. a ft er a t ra in in g p er io d , a re t h e to p ic s le ar n ed d u ri n g t h e tr ai n in g p u t in to p ra ct ic e? 2% 1% 1% 1% 2% a ss es sm en t an d in ce n ti v es f or t h e st af f in ce n ti v es s y st em f or t h e st af f. 4% 1. i s th er e an i n ce n ti v es p ol ic y f or t h e st af f w it h r eg ar d t o so ci al p er fo rm an ce ? 2. w h at t y p es o f in ce n ti v es a re g ra n te d t o th e st af f on i ss u es r el at ed t o so ci al p er fo rm an ce ? 3. h ow o ft en i s th e st af f in ce n ti v es r ev ie w ed ? 1. 5% 1. 5% 1% p il la rs f ac to rs v ar ia b le s w ei g h t s u rv ey q u es ti o n s w ei g h t o u tp u t p ro d u ct s an d se rv ic es r an g e it c on si d er s an d in te g ra l ap p ro ac h f or m ic ro fi n an ce . it e v al u at es f in an ci al a n d n on -f in an ci al p ro d u ct s an d th e of fe re d s er v ic es . 4% 1. w h at k in d o f fi n an ci al a n d n on -f in an ci al s er v ic es d o y ou p ro v id e to cu st om er s? 2. w h at i s th e m os t in n ov at iv e fi n an ci al s er v ic e of fe re d ? 3. a re m or e b en ef it s p ro v id ed t o fo rm er c li en ts i n c om p ar is on t o n ew cl ie n ts ? 4. h ow o ft en a re n ew p ro d u ct s cr ea te d ? 1% 1% 1% 1% p o v er ty as se ss m en t m ea su re t h e cl ie n ts ’ p ov er ty l ev el . 6% 1. w h ic h t o ol s ar e u se d t o m ea su re p ov er ty ? 2. w h at i s th e p er ce n ta g e of p o or c u st om er s w it h in y ou r p or tf ol io ? 3. w h ic h a re t h e p ov er ty i n d ic at or s? o r d o y ou u se o th er m et h od ? 4. h av e y ou r ed u ce d y ou r cu st om er s’ p o v er ty l ev el ? 5. w h at i s th e p ov er ty r ed u ct io n p er ce n ta g e of p o or c u st om er s? 1% 1. 5% 1% 1. 5% 1% so ci al re sp on si b il it y to w ar d s th e cl ie n ts a v oi d o v er in d eb te d n es s, m on it or t ra n sp ar en t p ri ce s, ad eq u at e co ll ec ti on p ra ct ic es , b u si n es s et h ic s, th er e ar e m ec h an is m s to m an ag e co m p la in ts , t h e p ri v ac y o f cl ie n t’ s in fo rm at io n i s re sp ec te d . 5% 1. w h at p ol ic ie s d o y ou u se t o av oi d c li en t ov er in d eb te d n es s? 2. b y w h at m ea n s d o cu st o m er s g et n ot ic e ab ou t p ri ce s, a n d t er m s an d co n d it io n s of f in an ci al s er v ic es ? 3. i s th er e a m an u al t h at r eg u la te s th e p ro p er c ol le ct io n o f th e se rv ic es of fe re d ? 4. d o y ou h av e an in st it u ti on al c od e of e th ic s? 5. h ow d o y ou m ak e su re t h at t h e st af f is f am il ia r w it h t h is c od e? 6. d oe s th e in st it u ti on g u ar an te e th e p ri v ac y o f cu st om er i n fo rm at io n ? 1% 1% 0. 75 % 0. 75 % 0. 75 % 0. 75 % o u tc om e c os t of s er v ic es fo r th e cl ie n t t ra n sp ar en t ra te s an d c os ts of s er v ic es . 4% 1. a re t h e co st s, f re ig h t an d r at es f or e ac h t y p e of p ro d u ct p u b li sh ed o n t h e w eb si te o r at t h e of fi ce s? 2. h ow i s th e in te re st r at ech ar g ed b y t h e m f i fo r fi n an ci al s er v ic es ob ta in ed ? 1% 3% so ci al re sp on si b il it y to w ar d s th e st af f st af f is s om eh ow h el p ed ou t. 3% 1. i s th er e an y t y p e of o u tr ea ch f or t h e st af f w or k in g f or t h e m f i? 2. a re lo an s an d c re d it t er m s av ai la b le f or m f i w or k er s? 1. 5% 1. 5% so ci al re sp on si b il it y to w ar d s th e co m m u n it y so ci al r es p on si b il it y ac ti v it ie s ar e ca rr ie d o u t in th e co m m u n it y . 3% 1. i n w h ic h c om m u n it y w el fa re a ct iv it ie s d oe s th e m f i p ar ti ci p at e? 3% p ro d u ct s an d se rv ic es o u tc om es p er ce n ta g e of c u st o m er s sa ti sf ie d w it h t h e se rv ic e. 3% 1. w h at p er ce n ta g e of c li en ts is s at is fi ed w it h t h e se rv ic e? 3% c li en tor ie n te d ou tc om es c li en t’ s co m p la in ts a re m ea su re d . c li en t’ s su g g es ti on s ar e ac ce p te d . 3% 1. i s th er e a cu st om er s er v ic e ar ea m an ag in g t h e co m p la in ts ? 2. a re c li en ts ’ s u g g es ti on s ta k en i n to a cc ou n t? 1. 5% 1. 5% p il la rs f ac to rs v ar ia b le s w ei g h t s u rv ey q u es ti o n s w ei g h t f in an ci al a n d m ar k et o u tc om es in cr ea se o f p ro fi ta b il it y 4% 1. w h at w as t h e ou tc om e of s o ci al r es p on si b il it y f u lf il lm en t in t h e fi n an ci al re tu rn ? 2. w h at w as t h e ou tc om e of s o ci al p er fo rm an ce f u lf il lm en t in f in an ci al in co m e? 3. w h at w as t h e ou tc om e of s o ci al r es p on si b il it y f u lf il lm en t in m ar k et s h ar e in f in an ci al t er m s? 4. w h at w as t h e ou tc om e of s o ci al r es p on si b il it y f u lf il lm en t in m ar k et s h ar e w it h r eg ar d t o cu st om er s? 1. 25 % 0. 75 % 0. 75 % 1. 25 % p eo p le -o ri en te d ou tc om es c li en ts ’ f ee d b ac k 3% 1. d o y ou t ak e in to a cc o u n t y o u r cl ie n ts ’ f ee d b ac k ? 3% o rg an iz at io n al ef fi ci en cy ou tc om es p ro ce ss es r ev ie w 3% 1. h ow o ft en a re p ro ce ss es a n d p ro ce d u re s re v ie w ed ? 3% l ea d er sh ip a n d so ci al re sp on si b il it y ou tc om es so ci al p er fo rm an ce m ea su re m en t 3% 1. d id p eo p le f ee l co m p ro m is ed d u ri n g w or k e n v ir on m en t su rv ey s? 2. i s co rp or at e so ci al r es p on si b il it y f u lf il le d ? 3. h av e y ou e v er m ea su re d s oc ia l p er fo rm an ce in t h e p as t? 1% 1% 1% im p ac t p o v er ty r ed u ct io n 15 % 1. h as t h e cl ie n ts ’ p ov er ty l ev el b ee n r ed u ce d t h an k s to t h e p ro v id ed se rv ic es ? 2. i f th e an sw er is y es , w h at p er ce n ta g e of c li en ts h av e ob ta in ed t h is b en ef it ? 3. w h at p er ce n ta g e of c li en ts r en ew s se rv ic es w it h t h e in st it u ti on ? 8% 3. 5% 3. 5% n ot e. a u th o r’ s co m p il at io n f ig u re 3 . s oc ia l p er fo rm an ce o p er at io n al iz at io n n ot e. a u th o r’ s co m p il at io n . 96 economic analysis (2015, vol. 48, no. 3-4, 81-100) elements of social performance measurement (spm) in mfis in the methodological proposal, social performance measurement in mfis shall consider three elements: (a) review of the social mission, (b) social audits and improvement plans, and (c) social performance measurement survey. review of the social mission the first element includes the institutional review of the mission; it analyzes if the mfi has established its social objectives. this review is intended to verify whether the mission is aimed to promote changes in the customers’ lives, not only to achieve financial gain. hence, this establishes the starting point of the proposed methodology in order to achieve a measurement based on effectiveness and social performance value. the review of the social mission consists of answering the following questions: (a) what kind of target customers will be benefited from mfi services?; (b) will the services actually reach the vulnerable sector of the population?; (c) how can mfi services meet the specific needs of its customers?; and (d) what are the outcomes of mfis services in the customers’ lives?, is there any impact on them? similarly, it is important to develop an analysis of the social objectives and verify if they meet the basic characteristics of a properly established objective: (a) specific, (b) measurable, (c) attainable, (d) relevant, and (e) time-specific. these characteristics help mfis to manage their social objectives. social audits and improvement plans the purpose of social audits is to involve external organizations with mfis to broaden the perspective of social performance measurement. recommendations for the implementation of an improvement plan in the different evaluated aspects will thus be proposed. participants of social audits must be members of a committee from the various levels of mfis, such as: (a) members of the board of directors, (b) central level managers, (c) branch office managers, (d) loan officers, and (e) customers. therefore, the audit and the recommendations will be enriched by the different viewpoints of those involved. moreover, the recommendations should focus on improving social performance measurement in the institution in a sustainable way. this element enables to go in depth with regard to social performance elements, with a wider stakeholders’ spectrum, including customers. tools and sustainability in social performance management the proposed tool is presented in table 3, which is structured according to the pillars of social performance measurement. t ab le 3 . t oo ls a n d s u st ai n ab il it y o f so ci al p er fo rm an ce m an ag em en t p il la rs s o ci al p er fo rm an ce m ea su re m en t an d a ss es sm en t q u es ti o n n ai re in te n t an d d es ig n 1. d o a d m in is tr at io n m em be rs u se s o ci al p er fo rm an ce d at a fo r st ra te g ic p la n n in g a n d d ec is io n m ak in g ? if s o , h o w ? 2. t h e bo ar d u se s so ci al p er fo rm an ce d at a to a ss es s an d e n co u ra g e h ig h er l ev el s o f th e ad m in is tr at io n ? if s o , h ow ? 3. t h e fo ll o w in g g o al s: a cc es s to t h e p o o r, v er y p o o r o r lo w i n co m e fa m il ie s, t o s m al l b u si n es se s, t o u n d er d ev el op ed a re as , w o m en , so ci al ly m ar g in al iz ed p eo p le o r ex cl u d ed g ro u p s; s u p p o rt t o e m p lo y m en t (a s an e m p lo y ee a n d s el fem p lo y ed ), o bs er v at io n o f ch an g es i n t h e cl ie n ts ’ l iv es o r in t h ei r h o m es , c h an g es i n t h e lo ca l co m m u n it y ; c u st o m er s at is fa ct io n w it h t h e p ro d u ct s; a n d o th er so ci al o bj ec ti v es . a re t h es e so ci al o bj ec ti v es i n cl u d ed in y o u r in st it u ti o n ? 4. is t h er e an y w ri tt en f o rm al s o ci al r es p o n si bi li ty p o li cy o r a w ri tt en c o d e of c o n d u ct i n y o u r in st it u ti o n ? 5. d o es y o u r co d e of c o n d u ct o r so ci al r es p o n si bi li ty p ol ic y g o v er n t h e ac ti o n s o f th e m f is w it h r eg ar d t o t h e st af f, c u st o m er s, co m m u n it y a n d t h e en v ir o n m en t? in te rn al sy st em s / o p er at io n s 1. d o es t h e in st it u ti o n h av e in ce n ti v es f o r st af f p er fo rm an ce ? 2. d o es t h e in st it u ti o n h av e in ce n ti v es f o r th e st af f th at s p ec if ic al ly a d d re ss g o al s re la te d t o s o ci al p er fo rm an ce ? if s o , p le as e ex p la in th em . 3. d o es t h e in st it u ti o n h av e a se p ar at e m o d u le t o t ra in s ta ff o n s o ci al p er fo rm an ce ? is i t av ai la bl e fo r n ew e m p lo y ee s? i s it p er m an en t? o u tp u t 1. h o w d o y o u p u t in to p ra ct ic e th e co d e o f co n d u ct a n d s o ci al r es p o n si bi li ty p o li cy t h at g o v er n s th e ac ti o n s o f th e m f is w it h r eg ar d to t h e st af f, c u st o m er s, c o m m u n it y a n d t h e en v ir o n m en t? h o w d o y o u m ak e su re o f it s co m p li an ce ? 2. d o es t h e in st it u ti o n m ea su re s p o v er ty l ev el s o f n ew c u st o m er s? 3. h o w a re p o v er ty l ev el s o f n ew c u st o m er s m ea su re d ? 4. p er ce n ta g e o f n ew c u st o m er s w h o a re p o o r, v er y p o o r o r lo w -i n co m e. 5. w it h r eg ar d t o t h e n ew c li en ts f ro m l as t y ea r, w h at p er ce n ta g e is u n d er t h e n at io n al li n e o f p o v er ty ? 6. w it h r eg ar d t o t h e n ew c li en ts f ro m l as t y ea r, w h at p er ce n ta g e is b el o w t h e 50 % o f th e n at io n al li n e o f p o v er ty ? 7. w it h r eg ar d t o t h e n ew c li en ts f ro m l as t y ea r, w h at p er ce n ta g e h as a d ai ly i n co m e o f le ss t h an u sd 1 p er h o u se h o ld m em be r? 8. w it h r eg ar d t o t h e n ew c li en ts f ro m l as t y ea r, w h at p er ce n ta g e h as a d ai ly i n co m e o f le ss t h an u sd 2 p er h o u se h o ld m em be r? 9. w it h r eg ar d t o t h e n ew c li en ts f ro m l as t y ea r, i f th e in st it u ti o n u se d o th er t oo l o r m et h o d , w h at p er ce n ta g e w as p o o r, v er y p o o r o r lo w -i n co m e? 10 . w h ic h i s th e g eo g ra p h ic al d is tr ib u ti o n o f yo u r cl ie n ts ? (p er ce n ta g e o f cl ie n ts i n u rb an a re as , s em i u rb an , a n d r u ra l) . 11 . sp ec if y t h e p er ce n ta g e o f w o m en i n r el at io n t o th e g ra n d t o ta l o f cl ie n ts . 12 . sp ec if y t h e p er ce n ta g e o f cl ie n ts b el o n g in g t o s o ci al ly m ar g in al iz ed o r ex cl u d ed g ro u p s. 13 . d o es t h e in st it u ti o n s tu d y t h e ch an g es i n t h e cu st o m er s’ f in an ci al s it u at io n ? 14 . h o w a re t h e ch an g es i n t h e cu st o m er s’ f in an ci al s it u at io n s tu d ie d ? 9 8 e co n om ic a n al y si s (2 0 1 5 , v ol . 4 8 , n o. 3 -4 , 8 1 -1 0 0 ) p il la rs s o ci al p er fo rm an ce m ea su re m en t an d a ss es sm en t q u es ti o n n ai re 15 . sp ec if y t h e p er ce n ta g e o f cl ie n ts t h at e xc ee d ed t h e li n e o f p o v er ty . 16 . sp ec if y t h e p er ce n ta g e o f sc h o o l ch il d re n a tt en d in g s ch o ol ( cl ie n ts ’ c h il d re n ) 17 . d id t h e in st it u ti o n c ar ry o u t an y c li en t sa ti sf ac ti o n s u rv ey o r fo rm a g ro u p s tu d y d u ri n g t h e la st t w o y ea rs ? 18 . d o es t h e in st it u ti o n c ar ry o u t su rv ey s to l o st c u st o m er s? a re t h es e lo ss es m ea su re d ? o u tc o m e 1. w h at i s th e p er ce n ta g e o f cl ie n ts s at is fi ed w it h t h e p ro v id ed s er v ic es ? 2. d o y o u t ak e in to c o n si d er at io n t h e cl ie n ts ’ s u g g es ti o n s? 3. w h at i m p ac t d id s o ci al p er fo rm an ce h av e o n f in an ci al p ro fi ta bi li ty ? 4. w h at i m p ac t d id s o ci al p er fo rm an ce h av e o n m ar k et s h ar e (m o n et ar il y )? 5. w h at i m p ac t d id s o ci al p er fo rm an ce h av e o n m ar k et s h ar e (c li en ts )? 6. d o y o u t ak e in to c o n si d er at io n y o u r cl ie n ts ’ f ee d b ac k ? 7. h o w o ft en d o p ro ce d u re s an d p ro ce ss es a re r ev ie w ed in t h e in st it u ti o n ? 8. d o p eo p le f ee l o bl ig ed d u ri n g t h e w o rk e n v ir o n m en t su rv ey s? 9. is c o rp o ra te s o ci al r es p o n si bi li ty c o m p li ed ? im p ac t 1. h as t h e cu st o m er ’s p o v er ty b ee n r ed u ce d w it h t h e p ro v id ed s er v ic es ? 2. if p o v er ty l ev el w as r ed u ce d , w h at p er ce n ta g es o f cu st o m er s h av e be en b en ef it ed f ro m t h is ? 3. w h at p er ce n ta g e o f cu st o m er s re n ew s se rv ic es w it h t h e in st it u ti o n ? n ot e. a u th or ’s c om p il at io n . avolio alecchi, b., et al., microfinance institutions, ea (2015, vol. 48, no. 3-4, 81-100) 99 references blalock, hubert. 1970. introducción a la investigación social. buenos aires, argentina: edit. amorrortu. bobadilla, percy, del águila, luis, and de la luz, maria. 1998. diseño y evaluación de proyectos de desarrollo. lima, peru: pact-usaid. cerise. 2014. indicadores de desempeño social. http://www.cerisemicrofinance.org/homesp.htm (accessed june 7th, 2014). crompton, patrick. 2007. “double bottom line growth.” esr review, 9(1):10-4. global reporting initiative. 2014. gri index. https://www.globalreporting.org/pages/default.aspx (accessed on june 7th, 2014). grameen foundation product. 2014. progress out of poverty. http://www.progressoutofpoverty.org/ (accessed on june 7th, 2014). lazarsfeld, paul f. 1958. “evidence and inference in social research.” american academy of arts & sciences, 87(4): 99-130. microcredit ratings international limited. 2014. microfinanza institutional rating. http://www.m-cril.com/ (accessed on june 7th, 2014). microfinance center. 2014. quality audit tool. http://www.mfc.org.pl/en/content/qatprocess (accessed on june 7th, 2014). microfinanza rating. 2014. http://www.microfinanzarating.com/ (accessed on june 7th, 2014.) microrate. 2014. microrate social rating. http://www.microrate.com/es (accessed on june 7th, 2014.) planet finance. 2014. social performance rating. http://www.planetrating.com/en/socialperformance-ratings-23.html (accessed on june 7th, 2014). sen, mitali. 2008. “assessing social performance of microfinance institutions.” the icfai journal of applied finance, 14(7): 78-86. social performance task force. 2009. social performance task force tools. http://www.sptf.info/page/june-23-2009-sptf (accessed on june 29th, 2009). social performance task force. 2014. social performance task force tools. http://www.sptf.info/sp-tools (accessed on june 6th, 2014). unites states agency. 2014. poverty tools. http://www.m-cril.com/ (accessed on june 7th, 2014). woller, gary. 2007. “trade-offs between social & financial performance.” esr review, 9(2): 14-19. 100 economic analysis (2015, vol. 48, no. 3-4, 81-100) metodološki predlog mera za postizanje socijalne uspešnosti institucija za mikrofinansiranje rezime – tokom poslednje decenije, mikrofinansirajući sektor raste na globalnom nivou. mikrofinansijske institucije (mfi) stvorene su da se bore za smanjenje siromaštva; međutim, mnogi mfi ne postižu svoju društvenu misiju, jer one deluju kao konvencionalne finansijske institucije. to usporava njihovu finansijsku potporu porodicama sa niskim primanjima, kako bi poboljšalale njihov kvalitet života. ovaj rad predstavlja metodološki predlog mera postizanju socijalne uspešnosti mfi. dakle, mfi i druge institucije s društvenom misijom mogu imati koristi od upotrebe alata koji se koriste za transparentnu i stvarnu kontrolu njihovog društvenog učinka. ključne reči: upravljanje, društvena odgovornost, mikrofinansiranje, društveni učinak article history: received: 2 september, 2015 accepted: 30 november, 2015 microsoft word 2009_3_4-korigovano.doc professional paper employee development and knowledge-based organization kolaković kristijan*, institute of economic sciences, belgrade marinković vladimir, megatrend univerzitet, belgrade stefanović saša, institute of economic sciences, belgrade udc: 005.966.5 jel: d21, l20, m14, m20, m21, m50 abstract – in the conditions of constant market changes, fast development and spread of technology, multiply competition and „over night” product superannuation, successful companies became those who create new knowledge, spread it out trough the entire company and implement it rapidly in the new technologies and products. these activities define company as knowledge – creating organization which only and principal task is ongoing innovation. those are the companies that understood that the learning and new knowledge are the key to success, and that the development is crucial for future survival. the notion of education, development and knowledge creating company, or in other words an organization that develops and learns, in the most pragmatic way expresses the attitude of modern, successful companies versus the development and knowledge of employees. another name for this kind of organization is knowledge – based organization. the aim of this paper is to show that the employee development is a key procedure in implementing human resource politics. in order to create learning organization it is a necessity for the employees to have formal and informal education and to acquire it throughout entire professional career. life-long learning politics is the basic premise of the company’s market competiveness considering the fact that the knowledge is the only resource that grows with use and not disburse. the main conclusion of the paper states that the most successful companies and national economies are those based on knowledge, or in other words highly educated and trained human resources. high level of inventiveness and innovations, without which a modern market cannot be imagined, can be achieved only in following the path of permanent employee development, which also represents one of the main motivators in accomplishing efficiency and effectiveness of the companies. key words: employee development, learning organization, knowledge based organization introduction the changes, quotidianly dictated by the new technologies and the occurrences on the global market, established new relations among the companies at all levels. the new economy, based on knowledge, recognizes human knowledge and its usage in its full capacity as the basic factor of the market competiveness. this is also supported by the fact that the knowledge is the only resource that grows with use and that the subject of a main contest on the global market is precisely human knowledge and the unlimited possibilities of its growth. alongside new era in global economy, new game rules and new trends regarding * address: zmaj jovina 12, 11000 beograd, republika srbija, e-mail: kristijan.kolakovic@ien.bg.ac.rs economic analysis (2009, vol. 42, no. 3-4, 69-77) 70 employee development in the companies came also. new flexible labor markets, more and more flexible employment models, accentuation of the human resource management in organizations are set to rights and represent the base for the creation of a flexible and competitive organization. the dynamic growth of new technologies and science established completely new relations at the global market and raised standards of employees’ growth and education in organizations. new technologies and business automation definitely have large impact on the cut back of the administrative employees and they reduce the need for manual labor but in the same time they create the need for the new employees that implies human resources highly educated in the fields of creation of new products and services as well as creation of new consumer needs at the market. as far as for the companies doing business in conditions created by the transition process, it is of the essential importance to harmonize their business with the every-day changes that happen on the market and that, in this sense, they position themselves as highest as possible in comparison to the competition coming from the countries whose economy started its dynamical growth ten years ago. the employee development model in modern companies and its competitive advantages is presented in this paper. also, the main accent is put on the education and its importance as the base of the growth, both in micro and macro level. employee development in a modern company employee development implies a set of measures and activities within a company directed towards adjustments of knowledge, capabilities and skills of the employees to the future business requirements. this process has for its goal to assure the qualifications of the employees needed to overcome the demands caused by the changes but also synchronizing them with the entrepreneurial and individual goals. employee development is a process in which the main agents are the company and the employees (individuals). these agents have each its own interests. the interest of a company is the augmentation of the working capabilities and motivation of the employees, to the end to reassure competitive advantages in the long run and future development of the company. the interest of employees could be summed up in increasing job security, better chances for promotion, recognitions and professional affirmation, as well as the better earnings. in the human resource development it is necessary to respect the interests of each of the suggested agents and to assure that the process goes in the way that it connects the foregoing interests and pleases the both sides. the goals of the employee development in the company should be the following: 1. permanent adjustments of the employee qualifications to the changes of the job requests; 2. safeguard and increase the company’s competitive advantages; 3. marketing effects on the extern labor market; 4. higher possibilities to fulfill the needs for new knowledge and skills using the internal sources; kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 71 5. motivation of the employees; 6. investments in future success with a low level of material investing; 7. encouragement of the mobility and multifunctional work within the company; 8. assure and use the high quality potentials coming from the internal sources. the summery of the employee development arises from the comparison of the job requests and the existing capabilities of the employees. that is why it is necessary for the managers to have a clear vision about the goals, strategic and operational plans and requirements of the future business, as well as the assessment of the future directions regarding technology, market and environment that could influence concrete demands regarding the level and the caliber of the adequate knowledge, skills and behavior. in the same time, it is also necessary to follow up personal aspirations, interests and particularly the results of the employees. this has strong motivational effects considering the natural human needs for consideration and self-actualization. the employee development understood as the factor of company’s success and strategic advantage in market conditions, cannot be took for granted nor left to the personal assessments and interests of the employees than it should be well imagined and goal driven process by the direct superiors. education as the key aspect of employee development increased dynamic of the development of new technologies had extremely positively influenced the education growth process. more precisely, the new technologies and the demand for constant improvement determinatively influenced shaping the content and the forms of the educational system organization in each country. in the same time, increased creative power of the human labor, based on new technologies, has produced large material base for the educational system development and the accessibility of the education to the members of every social status. the introduction of new, more productive machines has contributed largely to the democratization of education and by which to the democratization of the entire society. exactly the growing dynamics of the technological development, which also signifies the necessity for constant improvement of professional and skilled knowledge of the employees, was the one who stipulated the two basic directions of the educational process development in all countries, or in other words built simultaneously two foundations of the education: • formal educational system – spreading from elementary school to university, including master and doctoral studies, which is legally recognized and implies certain procedures put in function of the systematical acquisition of general and professional knowledge; • informal educational system – which is essentially just the follow up of the education obtained in the schooling process within the formal educational system and which nowadays takes place throughout the entire working life, which is largely part or functionally attached to the working process and whose bearers are in large amount the companies themselves, most certainly in cooperation with the appropriate professional institutions involved in education, scientific and professional work. economic analysis (2009, vol. 42, no. 3-4, 69-77) 72 this division is getting more and more conditional, especially these days, so the titles should be also tentatively interpreted. so-called “informal educational system” is also being developed within a certain methodological, pedagogical and andragogical norms as the formal educational system, and has more or less stabile, but flexible, adjustable organization, formal tasks and procedures. in other words, formal and informal educational systems are not separated, independent systems but the parts of one unique functional ensemble to which the most appropriate name could be “life long learning process”. the fine line of separation between these two subsystems – formal and informal educational system, consists also of their different timelines. the formal educational system – or as often called “schooling”, normally takes place in early life – childhood or youth. this refers to the part of a life when, not only from the educational aspect but seen also from the aspect of a human life in its wholesome, the basic life experiences, moral and social values foundations, roots of all of that that represents perspective of the world are acquired, the time when the motivation to obtain knowledge, and this considers education, is the biggest. informal education starts with the partial or full endings of the formal education and represents its logical sequence. in modern era this part of education, with different intensity, lasts for entire working life. the best attestations on this subject are the information from the research according to which employees in economically and technologically developed countries change their jobs, or even a career, five to seven times during their working life. there is a difference between operating modes of the formal and the informal educational processes. the participants of the formal educational system are exclusively or mostly focused on the activity of schooling process. informal education is, above all, part of working process and is being held in most of the cases as a part of technological and organizational processes, or in other words it represents continual activity in order to adjust labor structure by its professional characteristics to changes in technology and organization. also, the essence of formal and informal education differs. the formal education is focused on the basic knowledge, which is providing general information about the world and time, trough historical and contemporary dimensions, about the basic laws of natural and social environments, about the reaches of the modern-age civilization. the informal education, using formal education as a logical stronghold, offers above all practical knowledge related to a certain domain of production or services, to the ways of using existing or new technologies, to the improvement of the individual professional skills and knowledge in order to increase productivity and quality of work as well as the encouragement of each individual to take part in the process of organizational and technological innovation. finally, the protagonists of formal and informal educational systems are different. the protagonist of the formal educational system is a scholar system, from elementary school to university, whose business is mostly financed from the budget – with the money of the taxpayers, which enables the actualization of the principle of equal accessibility to all levels and kinds of formal education to the members of different social layers. however, for the sake of true, it must be said that the principle of equal accessibility to education, or in other words the permanent professional improvement and development is also established and respected within the companies. thereby, while with the state this is influenced by political motives, within the companies this is one of the important components of a successful kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 73 participation in the global market game. the protagonists of the informal education are essentially companies that, trough creation and realization of the educational programs put in function of increasing professional and expert knowledge of the employees, use logical and expert support of the scientific and educational institutions, or if they are larger, economically and technologically stronger enterprises, they create its own educational, scientific research and educational subsystems. however, real interdependence between formal and informal educational system also stipulates the establishment of the permanent functional connection between their agents – formal educational system, companies and other agents of informal education. constant fortification of the functional connections between formal and informal educational system implied that these two systems become the subject of attention of politics, owners, capital, entrepreneurs and employees. each of foregoing agents has a need and interest to influence the definition and realization of the concepts of these two subsystems. there for, it could be said that the education, as the formal so as the informal, stopped being just a matter of an individual and became large strategic question, responsibility and interest of all social agents and one of the basic tests of the success in the fight against the discrimination. of course, the education still rests in part a question of each individual, but above all in the context of actual fulfillment of the right to be educated and the possibility to choose a profession, educational profile that is most acceptable to an individual. this choice, the one of the most important ones in the life of each human, so called the “destiny choice”, represents the crossroad where the personal freedom and the employee’s dignity openly face. the role of the employees in the creation of a learning organization a simple definition of a learning organization is that it is an organization in which the employees constantly learn new things and apply what has been learned in improving the quality or the services. that is a place where the employees perpetually broad their potentials in order to create results that they really want, where new and expansive models of thinking are developed, where the collective aspiration is set to free and where the employees learn how to learn together all the time. that is an organization that constantly broads its capacity in order to create its future. it is of the great importance for a learning organization that the innovation of new knowledge is not a special activity – it is a behavior mode, that is the way of existence in which each employee is an entrepreneurial. in simple words, a learning organization is an organization capable to create, absorb, develop and pass on the knowledge and modify its behavior in the way that it reflects its knowledge. an important difference between traditional and learning organization is the problem solving. while the first one is shaped to achieve efficiency, and is directed toward it, the second one is shaped on the idea of problem solving. learning organization is the one in which each employee is included in identifying and solving problems allowing organization continuous experiments, changes, improvements and enlargement of its capacities, to grow, learn and fulfill its purpose. the basic characteristics of a learning organization are: economic analysis (2009, vol. 42, no. 3-4, 69-77) 74 • it develops and learns constantly, increases the level of overall organizational development and knowledge; • constant learning and development became mandatory and part of a job description of each member of the organization; • transferring learned and produced knowledge also became obligatory for everybody. in a learning organization everyone is a teacher and a student in the same time; • the dedication to the development and learning, to acquiring and transferring the knowledge became an important factor of the individual performance assessment; • learning and development are not separated, isolated and specialized activities but the important parts of the organizational culture, behavior mode and of the upraise of an organization; • the essence of a continuous development is a creation of new ways of thinking, changes in behavior and application of what has been learned and acquired trough practice – while creating and changing products and services and continuous problem solving; • the development programs and knowledge are the basic assets as well as the biggest competitive advantages of a learning organization; • the learning organization is not determined by neither its technology, structure nor any other “hardware” but by its culture oriented towards development and knowledge, which produces and recognizes knowledge and innovations; that is a culture of continuous learning, innovations and constant changes. those organizations learn from its own experience, but also from the experience and the best practice of the others; • a learning organization assesses its competitive potentials and strategic advantages trough the quantity of knowledge, skills and capabilities in comparison to the competitions’; • the activities and the attitude toward learning in this kind of organization are strongly determined by the information regarding whether the organization’s overall knowledge, and also its competitive advantage, increases or decreases on daily basis in comparison to the competition. as it is often stressed, one of the important competitive advantages is a life-long learning and broadening of knowledge, as the principal assignment of the employees in order to reassure personal competitive strength in internal and external surroundings. a constant learning became the only path toward continuous changes, innovations and development, as for the organization so as for the employees. an important advantage of what is happening in an organization oriented towards learning is also the growth and application of a long-run development, learning and proficiency model. the important dimensions of this approach are: • the development and learning became parts of each assignment, which implies the defacement of the differences between the job execution and learning; • the employees should acquire skills related to other jobs and executors from its organizational unit and should understand the relation between its own job and kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 75 the activities in their organizational unit as well as the goals of the entire organization. in fact, the “flexible employee” concept is being developed trough cross training and continuous learning; • an active, informal interaction between employees, teams, trainers and supervisors is strengthen and institutionally supported all the time; • the employees should constantly transmit their knowledge to the other colleagues but also they should learn from the others; • learning became one continuous process of intensive interaction in which the knowledge circulates and spreads in all directions and everyone is simultaneously teachers and students. the supervisors, managers they become more and more trainers, or in other words teachers, substituting professional trainers and the development and learning are more and more executed within the company. conclusion during the last five decades, the human resource development has grown into one of the most significant modern strategic components in all levels. almost every organization approaches human resource development strategically which leads to the incensement in efficiency, productivity and profitability. besides that, in most of the cases both the employees and the organizations reflect to the matter of human resources more as to a certain challenge, investment in need than as to a burden, unnecessary waste of time and money. the education became the most important segment of the employee development. successful organizations are dedicating more and more time, effort and resources to the education and proficiency of the employees. the knowledge economy is the new reality. it changes the concept of values and signifies the beginning of the end of the conventional economy. the influence of the new technologies on a society, philosophy, politics, religion, culture and all the other human activities directs to a system of knowledge management. knowledge is the only category that grows with use. it is an impalpably good, immaterial product which is manifesting in the forms of information, scientific, literal, amusing and artistic creations. the knowledge is getting more and more imposed as a driving force of the new economy whose development is based on learning organization. knowledge, as an abstract assets and the new most important basic business resource has to be carefully managed. the management understands that only education and deepening the knowledge of the employees can create a competitive advantage in comparison to the other organizations. the insufficient investments in human resources means for the company lost of the market share and decrease of the profits. it is assessed that the most successful companies invest annually around 5% of its profits in the employees’ education. also, they consider that five to ten percent of the working hours should be spent on the employees’ education, depending on a job type and the education level. it is consider that the highly educated employees, engineers for instance, should spend at least 10% of their working hours on expanding their knowledge in order to rest in the same level as the freshly graduated, and 20 to 25% if they want to maintain the equal value for the employer and for the society. regarding the managers, it is economic analysis (2009, vol. 42, no. 3-4, 69-77) 76 assessed that they should spare 20% of the working hours annually to their own education in order to prevent “superannuation”. certain organizations spend more money on education than the all higher-schooling institutions in a country. for example, in 1987 ibm spent 750 millions of dollars on the education which is more than the budget of harvard university. the american organizations spent 4.1% of its profits averagely on training and development of the employees and averagely 62 hours of training for each employee in 2002. the money investment in human resource education increases on daily basis and it is quite logical that this trend will continue in the future. this can be supported with the statement of alan greenspan, the former president of the usa federal reserves’ board, dated from february 2004 where he said that “the key aspect of creation of the wealth in the usa, and no doubt in entire world, is the level of the knowledge and skills of the population. nowadays, to manage one economy, which is fur more complex than it used to be, deeper and wider knowledge is required more than ever. our education in the usa has to provide skills that are adequate for effective functioning of our economy”. how much the employee development is important for quality and profitable business these days also illustrates the example of “microsoft” and its owner bill gates who insists that the key of success does not lie in size but in the faith in company’s employees and their development. he is convinced that the key to a modern company’s success is to hire suited labor and than provide them with the possibility to work in small groups and give them large-scale proxies. gates still finds time to meet his employees and chat about their ideas. in this way he motivates employees to invest bigger effort and to be more loyal to the company. bearing in mind the goals, adjusted to the development strategies, that the market oriented companies should fulfill in future, and regarding the necessity to achieve consensus about these goals, forms and ways to achieve them among all of the agents in a modern company, as well as regarding the experiences from the practice of the modern states with developed market economies, it is necessary to focus on achieving the following priorities: • motivation of every employee, unions and management in order to obtain the largest possible business and working results; • encouraging all agents – employees, employers, unions, to initiate and develop new inter-relations in accordance to the market economy, based on tolerance, mutual trust and awareness of common company’s interests; • contribution to easier and better observation of potential and actual conflict sources within the company and rebuilding efficient, peaceful mechanisms to solve them; • affirmation and encouragement of the development of a new concept and practice regarding corporate culture and management; • contribution to the livelong, stable growth and to the full usage of the available human resources; • permanent point out of the advantages of the participation, enrollment and influence of wider spread of people in the process of definition and realization of the company’s development strategies; • inducting livelong, systematical educational process and especially the common educational programs for all of the agents of industrial relations in the companies. kolaković, k., et al., employee development, ea (2009, vol. 42, no. 3-4, 69-77) 77 in order to increase their competitive capabilities, or in other words in order to be able to confront the demands coming from the environment and to become more productive and competitive, the companies invest large amounts of money. they are dedicating their attention more and more to the human resource development because, in this way, they increase their productivity, employees’ motivation, bearing in mind in the same time that exactly the people, and not the expensive technology, are its most valuable resource. the expensive and modern technology is almost equally available to everybody, but the competitive advantage to one company over the others resides in human resources, in their knowledge and competences as well as in the ways of they are using it. if the capitalism so far mainly relied on the exploitation of natural resources and physical labor of human resources, the upcoming decades will show that in the future it will be exclusively founded on the grounds of the exploitation of the intellectual potentials of the employees which will be the core of the learning organization. references alexander, j.a., lyons, m. c. (1995) the knowledge based organization, irwin, chichago bjornavold, j. (2000), making learning visible, european center for development of vocational tarining, luxembourg bratton, j., gold, j. (2007), human resources management, palgrave macmillan, new york daft, r.l. (1997), management, the dryden press, forth worth drucker, p. (1993), post-capitalist society, new york, harper collins garvin, d. (1993), building learning organization, harvard business review handy, c. 1995), the age of paradox, boston, ma, harvard business press marinkovic, d. (2005), industrijski odnosi, megatrend univerzitet, beograd nanoko, j., takeuchi h. (2006), the knowledge – creating company: how japanese companies create the dynamics of innovation, oxford university press noe, r.a. (1994), human resources management, gaining a competitive advantage, irwin, burr ridge pržulj, ž. (2007), menadzment ljudskih resursa, fakultet za trgovinu i bankarstvo, beograd rollinson, d. (2008), organisational behaviour and analysis, pearson education limited, essex senge, p. m. (1990), the fifth discipline, new york, doubleday ćamilović, s., vujić, v. (2007), osnove menadzmenta ljudskih resursa, tecon, beograd watkins, k. e. (1990), business and industry, handbook of adalt and continuing education, san francisko received: 5 august, 2009 article history: accepted: 9 september 2009 ea_2015_3-4 udc: 005.52:005.33 005.71 cobiss.sr-id: 220024076 conference paper implications of business and economic environment and strategic management and performance management in selected countries of central and eastern europe (cee) balcar petr1, taušer jozef, university of economics, faculty of international relations, prague, czech republic abstract – this paper focuses on main characteristics of the recent development of the business environment, business education and management procedures in selected countries of central and eastern europe (cee), the baltic and balkan countries, and emphasizes important aspects influencing business performance. our conclusions are based on analyses of 30 international business companies, nonprofit, and public organizations, academic and business sources, and on our personal hands on business experience. we have observed differences especially in long-term development of entities, strategic management, controlling, performance management, employee appraisal, as well as other areas related to performance management. due to space limitations we do not include a comparative analyses of procedures based on identical aspects for selected countries but rather emphasize the most important elements. key words: strategic management, process management, performance management, financial management, cee countries and managerial performance introduction the goal of this article is to assess the business environment and governance procedures in selected countries of central and eastern europe (cee), and the baltic and balkan countries. the research is based on a sample of 30 international business companies, nonprofit, and public organizations. key strategic and performance-related issues that help business firms and other organizations cope will be our focus and we will investigate the details of managerial approaches in respective countries in order highlight both the weaknesses and strengths within the cee region. this will provide the foundation for systematic highlighting of the main challenges that the region faces to keep up with advanced western capitalist economies. more specifically, we focus on strategic management and performance management characteristics and specific needs for improvement to catch up and compete successfully in the international business arena. this research topic is part of a broader goal for our work. 1 university of economics, faculty of international relations, w. churchill square 4, 130 67 prague 3, czech republic, balcar.petr86@gmail.com 10 economic analysis (2015, vol. 48, no. 3-4, -9-28) we also include information from on our hands-on experience working with firms, and indepth interviews with their top management. the anticipated outcome of this paper is to develop to the extent to which it is important to use effectively standard strategic procedures and management processes to achieve a competitive level of performance in production, sales and service provision in international business. gaining and maintaining a competitive advantage are key conditions of success in current business dynamics. this paper emphasizes key steps for success in selected world regions influencing international business cooperation. from the authors’ experience in working with a wide variety of smaller, especially start up firms; they quite often do not emphasize quality of governance. both the shareholders and the management primarily focus on core business operations that support a fast launch of products and services into the market. their primary goal is the growth of output and revenue. investments in management systems and governance improvement, especially supporting improvement of effectiveness and competitiveness have lower priority. we have observed the lack of attention to this goal also among several large international business players. the public sector especially has much room for improvement of governance procedures. we also aim to provide general conclusions on the extent to which it is important to improve governance, the managerial processes of organizations and professional corebusinessrelated development. tracking all up-to-date development trends, especially in information systems and information technology (isit), is difficult. in the past two decades many organizations have decided to outsource key processes and activities, including parts of isit functions. the “profile”, i. e. strategically important activities, however, usually remained with the know-how “owners”, within a core business. because isit has not only an infrastructure supporting function, but it is integral to all company business processes, this paper focuses on how effectively isit is used by our sample entities. finally, we include a full comparative analysis for the most important elements of procedures, based on the same characteristics for selected countries. worldwide management system trends business procedures vary substantially in many aspects across geographical areas. these differences can be ascribed to specific fundamental values, cultural traditions, working habits, and by economic and overall level of progress. one would expect, however, that governance of companies and institutions worldwide should be rather similar in principle. nevertheless, differences in governance internationally occur not only among various industries but also within the same sector. such differences also exist within geographically and culturally similar regions. in general, there is almost never only one best management solution, especially in a combination with an isit solution. it is always important to consider “best practices” experience relevant to the nature, size and other specifics of an organization in question. for doing business internationally it is crucial to align optimally best practices within a particular sector, with circumstances of the respective geopolitical region, expectations and preferences of shareholders and thus the management. balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 11 high quality governance is closely linked with core business competences. it is the key precondition for a long term conceptual strategic approach to the organization’s development. business process areas are usually grouped as outlined below with selected typical processes falling into these groups: • management processes as primarily strategic management, risk management, research and development, legal services, process and organization structure maintenance, internal audit, pr and communications; • core processes as the ones that represent the primary specialization of an organization; and • infrastructural processes as finance, isit (penetrating into all company processes), human resources, security and safety. company processes need to be aligned and effectively managed in a coordinated way throughout the entire value chain. it is crucial primarily to use available theoretical sources on management, ideally in relevant sectors, to set a rational balance in designing and executing all processes that are supporting achieving and keeping a company’s competitive advantage. another important step is to analyze the degree of success in implementing the theory into practice, i. e. an ability to suggest and adopt, based on an up to date theory, steps towards entity’s performance improvement. we need gradually to analyze results, consider needs for ongoing corrections and take actions towards strategy improvements. it is necessary to utilize effectively a potential for implementation of new information. an anticipated outcome of this task would be to balance the status among learning new skills, speed of their implementation, quality of work and the final organization’s outcome. unlike as claimed in former communist countries we do not recognize two separate types of economic theories and thus business categories, domestic versus international. there is only one “business world”, even if operations are not international. due to a gradual opening of many economies towards international trade of goods, services, information, knowledge, science and values we only need to consider specifics of various geopolitical regions. an impact of international aspects of doing business on the importance of using a strategic approach and, consequently, structured financial and performance management in international business, is another focus of this article. analysis of current situation – key issues this analysis includes the managerial environment of companies operating in various countries, in connection with their existing local political, economic, and business environment. the sample entities operate both domestically internationally. the key research areas are strategic management and performance management, and their connection to financial management and controlling. an initial analysis will be a starting point for stating hypotheses and a consequent testing in a dissertation that will follow. the main theoretical bases used for the analyses portion are standard frameworks and procedures of strategic management such as strategic management framework by fred david (2013): 12 economic analysis (2015, vol. 48, no. 3-4, -9-28) diagram 1. a comprehensive strategic-management model source: david (2013), p. 47 the above strategic-management model outlines particular phases and components of strategic management, which can be linked to a controlling framework, comprehensive performance management framework models such as the balanced scorecard, to modern financial management concepts such as cfo framework, and to other current governance practices. due to its logical structure this comprehensive strategic model is compatible with process based management approaches and can be used in a process based organization. the following scheme shows how a balanced scorecard performance management framework that includes evaluation and feedback is linked with a strategy. balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 13 picture 2. performance measurement and management cycle framework source: drawn by the authors on the basis of the balanced scorecard concept by robert kaplan and david norton (1996) professional education, improvement of qualification education level, knowledge and skill sets of individuals are the first area of this analysis. to successfully conduct business processes in a particular function, role, resp. the employees are required to achieve a certain level of relevant professional education. right after the communist takeover of the former socialist bloc countries of the cee, very few managers had a formal management education and possessed management skills. most of them in the nationalized enterprises were workers by profession. their primary “qualification” was their loyalty to the communist regime. that changed in a positive way over years. if we abstract from the fact that upper level positions were directed by nomenclature rules, it was rather usual up to the 80s of last century that higher management positions would be held by people with a sector related degree. with the overall development of management education an interdisciplinary approach has become more common. this approach was introduced in other advanced capitalist countries earlier than in the cee countries. today, employees are expected to acquire new skills consistent with their evolving managerial roles. this can be seen especially in smes where individuals have to assume a wider range of roles. it can, however, also be seen at big international corporations or public institutions where there may be a need to replace an old way of thinking with a best-practices mind set. 14 economic analysis (2015, vol. 48, no. 3-4, -9-28) another way of upgrading education is earning advanced degrees from reputable internationally recognized universities, as mba, ms, or other specific programs as acca, cfa, cfba, cia, cima, cma, cpa, frm, various specific certifications in isit, etc. there are various ways of assessing and evaluating of education achieved. an academic value of a program studied matters. still, the individuals’ qualities are always crucial. overall considering, the above and similar programs are more valued in the western developed countries. for instance, when comparing starting salaries of employees in business an academic degree plays a significant role: table 1. source: starting salaries in business completed academic degree starting salary in thousand $ associate in business administration 30 – 50 bachelor in business administration 51 – 88 masters in business administration 73 – 103 source: http: //www.businessschooledge.com/starting-salaries-for-business-school-graduates, july 11, 2013 furthermore, due to competition for mba graduates in the usa sign-on bonuses are a common part of the compensation package for mbas. according to joop hartog and hessel oosterbeek (1998) “almost half of all companies offer a signing bonus, and the median bonus is $15,000”. a degree from a prestigious master program itself plays a significant role in the starting salary. a number of economic and other social science studies on the subjective utility of working have shown that higher levels of education are unambiguously associated with higher levels of satisfaction, e.g. hartog and oosterbeek (1988) or catherine ross & marieke van willingen (1997). however, there are several investigations that support the negative effects of perceived over-qualification on dimensions of job satisfaction (joop hartog, 2000) and that over-schooling negatively affects job satisfaction. a high quality education from advanced countries is also very well remunerated in most of countries in asia, africa and latin america. many organizations in the czech republic do not consider additional education in the determination of employees’ salaries. on the other hand, there are companies and institutions that compensate for specific education and training as part of a gradual professional growth of their employees. investment of this kind in the czech republic and other cee countries has grown since the 1990s of last century due to a high demand for new modern management education and stills. the 2007 economic crisis that hit this region caused dramatic cuts in financial abilities of companies to pay for such courses. investment for isit education and training is to some extent a separate factor that not entirely follows economic cycles. special training is needed to implement new software solutions or upgrades. in recent years there was a considerable slow down in spending for both new it systems and the respective training programs, as part of overall cost cutting. with the overall improvement of specialized management knowledge and skills managers tend to use their own organization’s more qualified employees, often newly hired professional, as training lecturers. for example, utility companies and banks build their own balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 15 in-house consulting and training departments that often recruit skilled advisors and auditors from reputable firms. experience of employees sector-specific knowledge is only part of what one needs to conduct effective management. such knowledge has to be instantly supported by acquiring new, primarily management, skills. this also holds for lower management levels and to some extent for all staff at most levels. therefore, we can observe that the best dynamic professional managers, who in some cases do not know in detail all specifics of the, for them relatively new, sector, are recruited into high or top position as a ceo, cfo, cso, cro. high profile business people with experience in dynamic business environments as consulting, audit and tax firms, but from another sector, also take such top positions as independent professionals. a very important trend is sharing international experience acquired during studies as well as during the working period. while it is maybe difficult to transfer experience internationally into a local environment, a wider international perspective enables assessment of work tasks from a broader viewpoint. this amplified perspective may suggest new alternative solutions in contrast to merely routine existing ones. readiness to work in a modern management environment strategic management framework, importance of strategy for a company or institution, design, implementation and evaluation of strategy and its further utilization for an effective governance are still today unknown in many organizations. on the one hand, the importance of a strategy must not be overstated. time devoted to strategy alone should not detract from the core business. strategy is a standard integral part of daily activities and is the spine that connects all management, core and infrastructural activities in a harmonized way. managements of many companies, including important international corporations and state institutions, quite often do not properly use the potential of their strategy. if it exists at all it is then only a formal static document. the typical format for a strategy includes formulation of strategic goals and strategic initiatives for particular processes and the organization units of an entity. it is possible to accomplish once the management team has identified and organized business processes that exist in the entity even without being properly designed according to usual formal definitions and procedures. following a clearly designed process structure allows forming a process-based organization structure. in connection with the above the organizations need to manage their revenue and cost structures and flows. simultaneously they need to track efficiency of all economic centers to enable transparent planning, reporting and evaluation of results. for this purpose it is important to establish a controlling system. “controlling” as a term has been historically more widely used in european business environment. the same process is commonly called “management accounting” in the us. this is the key platform for effective financial, operational, and project management. it is impossible to exercise modern financial management without a structured controlling, statutory accounting and thorough knowledge of tax agenda. 16 economic analysis (2015, vol. 48, no. 3-4, -9-28) controlling systems are often too robust to allow for flexible governance of a company. for a successful management of a company at all levels it is therefore important to introduce a performance management system linked to a strategy. it should be designed as a common platform for shareholders, all levels of management, and all employees. one very effective method for performance management is the balanced scorecard approach. also used are separate management information systems (mis) which compile management results in a more condensed form. complexity and a way to support strategy, financial management and performance management by appropriate isit sw solutions are the key tasks for most organizations in business, and nonprofits, including the public sector. the first obstacle for a decision on isit support is the perception of key decision makers towards an entity strategy. many managers with a long-term experience with a particular sector have adopted routine procedures and it is difficult, or, for various rational reasons inappropriate to change them. most of old-fashioned governance procedures, especially in the cee region, were not been based on a process-based management. organization structure would then often be designed, and along with general set of rules, used without any major changes for many years. on the one hand the rules were often conforming to a central plan. also, tasks would often be solved on an ad hoc basis, without any link to a rational strategy. after the fall of communism many firms and companies experienced a dynamic growth. a remarkable portion of them failed to focus on proper and efficient management. it was for capacity reasons or because of a rapidly developing demand which was by the management considered more important than improvement of management procedures. such companies concentrated primarily on growth of production, imports, exports, and sales. strategy and performance management were not their initial focus. in addition, up to date complex isit solutions were not sometimes seriously considered. currently, the level of experience of employees using an advanced strategic approach to financial management, controlling, and performance management differs considerably among organizations. growing competition among new management candidates motivates especially young people towards a higher interest in increasing their qualifications for this field. simultaneously, many older managers are adverse to the use management information from mis and other sources that could be introduced and implemented. specifics of business environment in selected economies this section identifies the main political, economic and business environment characteristics of selected countries of cee, the baltic and balkan countries. visegrad group countries – czech republic, hungary, poland, slovakia the economies of visegrad group (v4) countries, the czech republic (cz), hungary (hu), poland (pl), and slovakia (sk) can be considered as relatively economically advanced. they have gradually recovered from the communist system. all joined the oecd between 1995 and 2000, and became eu members in 2004. balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 17 gdp in purchasing power standards (pps) in 2013 reached in these emerging economies between 66 and 82 percent of the eu28 average index (cz 82, hu 66, pl 67, sk 75).2 real gdp growth of the visegrad group countries in 2007, i.e. before the last economic crisis, with the exception of hu (0.5), was relatively high – cz (5.5), pl (7.2), and sk (10.7). growth in 2014 was relatively balanced – cz (2), hu (3.6), pl (3.3), and sk (2.4).3 the v4 unemployment rate in 2013 was with the exception of cz (7.0) above the eu28 average of 9.5 percent – hu (10.2), pl (10.3), and sk (14.2).4 since then, except for cz, there has been a strong trend to leave one’s own country and work abroad, primarily in the west. this typically, but not exclusively, has held for younger generation. v4 countries have been relatively politically stable. they have moved from center-right governments to centeror even rather center-left ones but are still adopting western capitalist business models. all four countries do actively cooperate for the most part within the eu. further, we see evidence of openness to international cooperation, often accompanied by much inefficiency due to lack of experience and language skills. knowledge of foreign business languages has improved considerably, especially among younger people. local v4 university education is approaching western standards, including an exchange of students within the eu as well as with universities from overseas. academic degrees from international, primarily western universities are mostly well respected in the v4 countries. overall, there is an advanced knowledge of business management procedures in major and middle size companies. foreign language business skills are improving in the state sector but have room for much improvement. all v4 transportation infrastructure is far behind world standards. for example comparing prices per km of new highways among countries is disheartening. the czech republic has a sad reputation of paying much higher prices than germany or the usa. yet, the road infrastructure in v4 countries, with the exception of major highways in hungary and croatia, is poor to very poor. v4 railways are functioning and slowly but gradually improving. however, there are still roadbed quality limitations for operating high-speed trains. state institutions are still inefficient but the trend is for slowly improving professionalism and competencies. the banking sector in the v4 countries experienced a rather conservative risk management, especially for mortgage loans, which turned out to be a positive factor during the 2008 financial crisis. several major bad-debt cases occurred that cost many local bank clients and tax payers dearly. nowadays the banking sector, overall, has been rather favorable to local and international investors for loan approval. a vast majority of financial institutions were privatized by international, primarily west european banks. foreign banks have realized the highest return on investment from the region. local clients have suffered from record high fees imposed in the cee overall. many companies face financial problems related to foreign currency loans (in dm, eur) due to exchange rate fluctuations. 2 gdp per capita in pps, index (eu28 = 100), data from 1st of december 2014, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00114&plugin=1 3 real gdp growth rate – volume, percentage change on previous year, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00115&plugin=1 4 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 18 economic analysis (2015, vol. 48, no. 3-4, -9-28) globally, in the ranking of 189 economies, compared to the regional average oecd rank of 40, hungary stands at 20, czech republic at 37, poland at 52, and slovakia at 55 on the ease of enforcing contracts.5 business relationships in v4 countries are often based on strong lobbying, especially by politicians. a considerable part of business has been moved to off-shore companies. the countries have suffered from huge state budget losses due to in many cases sophisticated intentional fraud, especially linked to privatization. many politicians benefited from that. as a result of that, there is a lower degree of transparency and safety in doing business in v4 countries. there is a relatively high openness to corruption in v4. there are many serious cases under investigation and in court, especially in the czech republic. the courts often appear not to be independent and are under the influence of excessive and improper lobbying. belarus belarus is one of the remaining few communist dictatorships in the world and the last in europe. its heavy political heritage is strictly from the former ussr and still maintains very close ties with russia. several top politicians there are subject to eu and us sanctions due to severe human rights violations. political stability in the police state is forced and any active opposition is unfortunately still heavily opposed. comparatively, belarus had been a relatively economically advanced region of the ussr with “relatively well-developed industrial base which is now outdated, energy inefficient, and dependent on subsidized russian energy and preferential access to russian markets following the breakup of the ussr.”6 it experienced a capitalist “reform” between 1991-94, which included “privatization of state enterprises, creation of institutions of private property, and development of entrepreneurship. about 80% of all industry remains in state hands. a few banks, which had been privatized after independence from the ussr, were renationalized. state banks account for 75% of the banking sector”.7 overall, the business climate does not favor of foreign investment. within the socialist system limits, belarus had a traditionally high standard of technical education that allowed industrial development. the citizens have had only very limited access to current modern international education and international business, as well as international travel. the infrastructure barely functions with extremely rigid state institutions. despite the fact that the country political system includes a bicameral parliament and a government, the power of the president is very strong. socialist-style economic central planning is de facto under control of the dictator. professionalism and competencies are often questionable. preparedness for and openness to international cooperation in institutions and firms is limited, also due to limited foreign business language experience. there is large potential for improvement due to limited level of modern business and management skills. 5 doing business 2015, comparing business regulations for domestic firms, world bank group, 2015, http://www.doingbusiness.org/data/exploreeconomies/~/media/giawb/doing%20business/documents/ profiles/country/cze.pdf 6 www.cia.gov/library/publications/the-world-factbook/geos/bo.html 7 https://www.cia.gov/library/publications/the-world-factbook/geos/bo.html balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 19 involvement of international companies in the country, other than the russian investors, is rare with only a few projects in major industries co-funded by the eu. support of the president and his cronies is required for any successful business cooperation. bulgaria the country is overall relatively less advanced within the eu, having joined in 2007. the country is slowly but successfully recovering from communism. it joined the eu in 2007. gdp in purchasing power standards (pps) in 2014 reached bulgaria at 45% of the eu28 average index.8 real gdp % growth in 2007, i.e. before the last economic crisis, was relatively high 6.9, and 1.7 in 2014. 9 due to a relatively high unemployment rate – 13% overall in 2013, youth unemployment rate for people between 15 and 24 years of age between 2000 and 2013 was between 25 and 28.4%.10 the trend is to leave one’s own country and work abroad, especially, however, not exclusively among the young generation.“ 11… in the period 1990-93, 458,000 bulgarians left the country, of these 330,000 emigrated to turkey and the rest mainly to the united states, canada, south africa, and western europe (germany and austria) (yulian konstantinov, 1996).12 politically, the country tends to adopt western business models. the government is driving opening of the country economy to international cooperation and foreign investment. there is, however slow dissemination of this process, i.e. a low preparedness and openness to do international business at the company level. bulgaria recently has had the lowest corporate profit tax and corporate income tax in europe – 10% in 2015. the banking sector is following the government trend and is favorable to both local and foreign investors. bulgaria is also a popular place for real western estate investment. on the other hand there is a relatively high risk for investors due to low enforcement of contracts, including a low institutional protection against organized unofficial crime groups. as a result transparency of doing business is lower. also, pos-contract negotiations of already settled matters can be reopened. there is a high respect for education from international, primarily western, universities including those in central europe and international business education is improving. knowledge of foreign business languages is gradually increasing for new graduates. there is a limited level of modern business and management skills, and thus a big potential for improvement. transportation infrastructure in bulgaria has much room for improvement. roads are in very severe disrepair hindering development of all business, including tourism. the country 8 gdp per capita in pps, index (eu28 = 100), data from 1st of december 2014, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00114&plugin=1 9 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 10 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 11 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 12 patterns of reinterpretation: trader-tourism in the balkans (bulgaria) as a picaresque metaphorical enactment of post-totalitarianism; yulian konstantinov; source: american ethnologist, vol. 23, no. 4 (nov., 1996), pp. 762-782 20 economic analysis (2015, vol. 48, no. 3-4, -9-28) has excellent access to the black sea and good climate. tourism business at the coastline and sea freight transportation plays an important role in the country economy. also, on the minus side state institutions are rather rigid and ineffective. response time to matters already agreed in meetings, including eu funded projects may take several months. professionalism and competencies have been sometimes questionable. there is a higher resistance to change in bulgaria related to adopting and implementing eu regulations. according to transparency international ranking from 2014 bulgaria with a rank 69 is among the european countries that are most vulnerable to corruption.13 croatia croatia has been severely affected by yugoslavian civil war in 1991-1999. the economy of croatia is relatively less advanced. the country is slowly but successfully recovering from communism. it joined the eu in july, 2013. gdp in purchasing power standards (pps) in 2014 reached croatia 61% of the eu28 average index. 14 real gdp % growth in 2007, i.e. before the last economic crisis, was relatively high, 5.2, and -0.4 in 2014.15 due to a relatively high unemployment rate – overall in 2013, 17.2% youth unemployment rate for people between 15 and 24 years of age between 2000 and 2013 was between 25 and 49.7%.16 there is a trend to leave one’s own country and work abroad, especially, however, not exclusively among the young generation.“ a typical feature in croatia is that people have multiple jobs to cover their living costs. politically, the public opinion is split between sympathy for russia and the eu prosperity. the government tends to adopt western business models and support opening of the country economy to some international cooperation and foreign investment. by the world bank doing business 2014 report the process of getting credit in croatia has only begun. in 2012 the “ … private credit bureau started to collect and distribute information on firms, improving the credit information system.” 17 there is a high respect for education from international, primarily western universities including those in central europe and international business education is improving. croatia has new business schools that partner with good international universities and lure students from other former countries. knowledge of foreign business languages is gradually improving with new graduates. there is a limited level of modern business and management skills, and thus a big potential for improvement. 13 corruption perceptions index, 2014, http://www.transparency.org/cpi2014/results 14 gdp per capita in pps, index (eu28 = 100), data from 1st of december 2014, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00114&plugin=1 15 real gdp growth rate – volume, percentage change on previous year, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00115&plugin=1 16 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 17 http://wwwwds.worldbank.org/external/default/wdscontentserver/wdsp/ib/2014/04/29/000260600_2014042915 5911/rendered/pdf/828170croatia0hrv0box0382097b00public0.pdf balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 21 transportation infrastructure in croatia has improved considerably. a new highway connects central europe with mediterranean tourist resorts. sea ports also play an important role in the croatian economy. state institutions are gradually changing as part of the eu legislation harmonization process. close personal relationships are often crucial for successful business cooperation. compared to the regional average oecd rank of 40, croatia’s ranking of 49 of 189 economies globally on the ease of enforcing contracts is relatively good. however, there is still a lower transparency of doing business. according to transparency international ranking from 2014 croatia with a rank 61 is among the european countries that are vulnerable to corruption.18 slovenia slovenia was not severely affected by yugoslavian civil war in 1991-1999, and is one of the most advanced emerging economies. the country is successfully recovering after splitting from yugoslavia, joining the eu in may, 2004. gdp in purchasing power standards (pps) in 2013 reached in slovenia 82% of the eu28 average index19. real gdp % growth of slovenia in 2007, i.e. before the last economic crisis, was relatively high, 6.9, and 2.6 in 2014.20 the unemployment rate in 2013 was 10,1%, slightly above eu28 average of 9.5%, youth unemployment rate for people between 15 and 24 years of age was in 2013 21.6%.21 unlike in other former yugoslavia countries there are considerably more business opportunities in slovenia and the workforce is not fleeing the country. slovenia is a relatively political stable country and promotes western orientation. it is open to international cooperation with the slovenian government protecting the economy by primarily encouraging domestic investment into local business. positive political and business influence comes from italy. slovenia has a good level of education including foreign business languages with advanced level of modern business and management skills in the country. road infrastructure is well connected to italy and austria, as well as to the east. the country has a limited access to the mediterranean sea because of its short coastline remaining after yugoslavia split. compared to regional average oecd rank of 40, slovenia’s ranking at 122 of 189 economies globally on the ease of enforcing contracts is relatively very high. recently, contract enforcement takes on average 1270.0 days, costs are 12.7% of the value of the claim, and it requires 32.0 procedures.22 18 corruption perceptions index, 2014, http://www.transparency.org/cpi2014/results 19 gdp per capita in pps, index (eu28 = 100), data from 1st of december 2014, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00114&plugin=1 20 real gdp growth rate – volume, percentage change on previous year, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00115&plugin=1 21 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 22 doing business in slovenia, world bank, 2015, http://www.doingbusiness.org/~/media/giawb/doing%20business/documents/profiles/country/sv n.pdf 22 economic analysis (2015, vol. 48, no. 3-4, -9-28) according to transparency international ranking from 2014 slovenia with a rank 39, the same as lithuania is among the countries less vulnerable to corruption.23 baltic countries – estonia, latvia, lithuania compared to the emerging economies of the former communist bloc, all three baltic countries, estonia (ee), latvia (lv), and lithuania (lt) are relatively advanced. they are successfully recovering after freeing themselves from the ussr in 1991. all joined the eu in 2004 and became part of the euro zone (in 2011 ee, 2014 lv, 2015 lt). gdp in purchasing power standards (pps) in 2013 reached in these economies on average around 70% of the eu28 average index (ee 73, lt 73, lv 64).24 real gdp % growth of these countries in 2007, i.e. before the last economic crisis, was relatively high – ee 7.9, lt 11.1, and lv 9.8. the same category was in 2014 relatively balanced – ee 2.1, lt 2.9, and lv 2.4.25 compared to the eu28 average of 10.8% the unemployment rate in 2013 theirs was as follows: es – 8.6, lv 11.9, lt 11.8.26 unlike some other emerging economies, brain-drain has not been a typical problem for these countries. the population portion of russian origin before the split from the ussr as of 1989 was in ee 30%27; lt 10%28, and lv 34%29. currently, the countries are politically stable internally. with their international political orientation is towards the west. they have, however, a very high external political risk from the current russian expansion policy. the baltic countries are successful with the eu harmonization and have progressive market-based pro-business economic policies with clear openness to overall international cooperation. estonia itself has “one of the most liberal trade and investment policies in europe.”30 it was the first country to introduce a flat tax which was then followed by several other countries. the banking system in all baltic countries is favorable to local and international investors. globally, lt stands at 14, lv at 16, and ee at 32 in the ranking of 189 economies on the ease of enforcing contracts. “efficient and transparent courts encourage new business relationships because businesses know they can rely on the courts if a new 23 corruption perceptions index, 2014, http://www.transparency.org/cpi2014/results 24 gdp per capita in pps, index (eu28 = 100), data from 1st of december 2014, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00114&plugin=1 25 real gdp growth rate – volume, percentage change on previous year, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00115&plugin=1 26 http://ec.europa.eu/eurostat/statistics-explained/index.php/unemployment_statistics 27 http://estonia.eu/about-estonia/country/population-by-nationality.html, 28 http://euromaidanpress.com/2015/01/06/ethnic-russians-in-baltic-countries-love-russia-but-dontconsider-it-their-home/ 29 http://euromaidanpress.com/2015/01/06/ethnic-russians-in-baltic-countries-love-russia-but-dontconsider-it-their-home/ 30 investment in the baltic states, a comparative guide to investment in estonia, latvia, and estonia, kpmg, 2011, https://www.kpmg.de/docs/investmentbalticseas.pdf balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 23 customer fails to pay.”31 also, lowering of court fees played an important role in enforcing contracts. there is a very good level of local education and a high respect for education from international western universities. the countries have historically close contacts with scandinavia in both education and business. there is a good level of knowledge of foreign business languages as well as an advanced level of use of modern business management procedures. due to progressive and dynamic improvements the state administration of the baltic countries has earned a good reputation internationally. all three countries have an access to the sea which supports freight transportation and tourism. the baltic area is becoming very interesting for tourism. as far as corruption is concerned, estonia’s rank 26 is the highest of all emerging countries, followed by lithuania (39), and latvia (43).32 lessons learned from management procedures in selected transition economies from a group of 30 international entities, based on interviews from business companies, nonprofit organizations and public institutions, and our personal business experience the following findings have been determined: pitfalls, room for improvement it is very difficult to generalize accurately the commitment to work in transition economies. commitment of employees to work effectively always depends on the individuals, but often also depends on the industry, the shareholders’ requirements and quality of management in companies. the baltic countries, slovenia and to some extent visegrad group economies can be considered as the ones with a high commitment to work. managing the same company in the same sector in various countries likely requires a country-specific approach and understanding the environment. the differences in commitment to work and understanding management goals by the employees may differ considerably. this characteristic still cannot be broadly used for the entire countries. there are areas that got hit by downsizing of activities in particular sectors. it then becomes difficult to manage restructuring of employment and thus achieving a satisfactory performance. some geographic areas in the countries are, however traditionally more advanced as far as commitment to work than others. organizations in some of these emerging countries do not use modern management procedures. apart from some very well-managed international but also local companies we often see a missing or an unclear structured strategic management approach. if companies have any strategy it may not be well-elaborated. formulations of vision and mission statements may be missing or unclear. the same holds for strategic objectives, also called strategic goals, strategic initiatives, and key success factors. 31 doing business in estonia, world bank, 2015, http://www.doingbusiness.org/data/exploreeconomies/estonia/~/media/giawb/doing%20business/doc uments/profiles/country/est.pdf 32 corruption perceptions index, 2014, http://www.transparency.org/cpi2014/results 24 economic analysis (2015, vol. 48, no. 3-4, -9-28) strategy evaluation criteria are often missing, unclear, and / or inconsistent. if a strategy is already formulated and accepted, its implementation throughout an organization is ineffective, communication of strategy goals is missing or insufficient. assigning of responsibilities for strategic goals and initiatives is often unclear. often we realize that strategy evaluation and recommendations for improvement are missing. process management is often missing, which can then reflect a lack of knowledge of an entity process structure. the process approach is often understood as an additional structure to an existing organizational structure. in such a case there is danger of duplicate or multiple solutions of the same processes caused by an overlap or repeating of activities. as a result of that an organization structure is ineffective without a link to business processes. quite often too-rigid management structures are found with missing logical links and work flow understanding. in such cases company controlling, or management accounting, if any actually exists in a satisfactory form, is ineffective and a transparent way of doing business is uncertain. then, logically a transparent link between controlling and statutory financial accounting is insufficient and non transparent, and thus questionable. another pitfall found is an ineffective performance management that is based on non existing effective structured process based performance management framework. such organizations are then missing or have unclear performance metrics that are not well linked to the strategy. another insufficient approach is ineffective use of project management for solving individual, one-time tasks. a well-performed project management can support regularly repeating processes and many of project outcomes, which then become integral parts of business processes. if both approaches are missing, the company management becomes less effective and is less under control. isit management, i.e. set-up of management information systems activities, in several entities that were part of our research, also has a room for improvement. in several cases sw systems were not effectively consolidated into a compact enterprise resource planning (erp) solution. we found too many sw solutions that were incompatible with each other. acquiring and coordinating information for planning, reporting and analyses for an ongoing tracking and managing of performance is then ineffective. an mis reporting system, as a condensed system of reports for middleand top-management, is often non-existing or insufficient, or existing but only partially used by management, especially by top managers. another pitfall found is non-conceptually based employee training and education by organizations. with this we have also occasionally observed insufficient hr management by line managers, which leads to low motivation of employees and a higher employee turnover. apart from willingness of individuals to move into another country for work there has been traditionally a relatively lower preparedness of employees in central and eastern europe (cee) to relocate with their family to obtain a better job possibility within a country. therefore, even though bigger cities may offer more lucrative jobs, many families decide to stay at their original home place and risk of a lower salary or being unemployed. balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 25 suggestions for steps towards performance improvement and achievement of competitiveness following the above analyses we recommend that management define and implement a proper strategy to the degree as needed by an entity. on the one hand it is always good to keep in mind a simple and understandable solution that will cover all needs for an effective management focused on achieving and retaining competitive advantage. on the other hand, a superficial strategy formulation that will not be used for actually managing an organization and that does not address all stakeholders is useless. it is always necessary to review the organization’s existing set of processes and suggest a functioning process structure. ideally, it is useful to do a process mapping and design a feasible process structure that becomes part of the management documentation. it is also necessary to review an organization structure that reflects the existing process structure. following that entities need to review the controlling process – planning, reporting, analyzing results, and adopt decisions for performance improvement. selected items of controlling should become an essential part of performance management criteria. then, the next step is to review the existing performance management system and suggest updates of performance as needed. this should be done periodically, at least once in a fiscal period. once the performance management model is set, the management needs to conduct regular appraisals of employees and acquire a two-way feedback among employees and management. active participation on the performance evaluation is ideal for gaining a natural contribution of a wide portfolio of company staff in strategy fulfillment. these steps should be naturally linked to improvement of business processes and activities, improvement of process workflow, improvement of cooperation at all levels to increase performance. thus, it is necessary to consider an effective project management to solve new one-time tasks, such as innovations, launching new products or services, multiple internal improvement solutions, changes, etc. several such projects may become strategic goals and later an integral part of the existing entity’s process structure. simultaneously, it is permanently necessary to review and rationalize the isit process, optimize investment in isit, select a rational degree of outsourcing, and provide appropriate training to user teams. the above tasks need to be considered in connection with the political and economic specifics of the particular international environment. conclusion and recommendations this paper has introduced main characteristics of current business environment and management procedures in eleven post-communist emerging countries. this portfolio includes economies of cee, from the baltics through the visegrad group to the balkan countries. the only exception is belarus which still has not yet been able to get itself rid of the communist dictatorship. the main emphasis of our work has been to investigate selected aspects that influence performance of individual organizations and thus a specific country economy. 26 economic analysis (2015, vol. 48, no. 3-4, -9-28) our findings and conclusions have been based on structured research interviews in 30 international business companies, non-for-profit organizations, and public institutions, academic and business sources, and on personal hands on business experience. the main problem found in general with entities’ business activities is a non-systematic approach to conduct processes needed for effective functioning. to improve this it is necessary to set a strategic direction consistent with a long-term vision. simultaneously, the role of strategy should not be overstated. strategy should not be an extremely intricate selfstanding document. it should include only realistically achievable, yet always ambitious, tasks that will be well-understood and thus fulfilled. a practical use of a strategy then requires an effective and efficient tracking of entity costs, based on transparent controlling and a functional performance management system. an inevitable integral part of “effective use” of discussed structures is then high quality support by integrated isit. rational investment into this field is the key for good strategic management and performance management, all of which should lead to achieving and keeping strategic advantage in the current dynamic business and economic environment. based on our research there is still plenty of room for improvement of the strategic approach in business companies and other organizations in the cee region. western performance-based management procedures are becoming a standard in advanced entities. due to considerable differences in education, especially in the management area, we can experience rigidity of many organizations and institutions, resistance to change and overall inefficiencies. only a structured approach can improve performance of companies and thus contribute to the overall economic growth. research on poland and russia testing correlations between a performance management and two behavioral measures trustworthy behavior and energized take-action behavior of employees can be generalized for all post-communist transition countries: “companies in transition economies should feel encouraged when introducing a performance management process.” (robert d. costigan, richard c. insinga, jason j. berman et al., 2005). the selected characteristics, recommendations and conclusions in this article are aimed to be considered by managements of entities in international business, i.e. in production, distribution and consumption of goods and services. references costigan d. robert, insinga c. richard, berman j. jason et al. 2005. “an examination of the relationship of a western performance-management process to key workplace behaviours in transition economies.” canadian journal of administrative sciences, 22.3: 255-267. david, r., fred 2009. strategic management: concepts and cases. 13th ed.. pearson prentice hall, isbn-13: 978-0-13-601570-3. hartog, joop. 2000. “overeducation and earnings: where are we, where should we go?” economics of education review, 19: 131-147. hartog joop and oosterbeek hessel. 1998. “health, wealth and happiness, why pursue a higher education?” economics of education review, 17(3): 245-256 balcar, p., et al., selected countries of cee, ea (2015, vol. 48, no. 3-4, 9-28) 27 kaplan s. robert and norton p. david. 1996 the balanced scorecard: translating strategy into action. harvard business school press, isbn-13: 9780875846514. konstantinov, yulian. 1996. “patterns of reinterpretation: trader-tourism in the balkans (bulgaria) as a picaresque metaphorical enactment of post-totalitarianism.” american ethnologist, 23(4 nov., 1996): 762-782 ross, catherine and willigen, marieke. 1997. “education and the subjective quality of life.” journal of health and social behavior, 38: 275-297. internet sources www.ec.europa.eu/eurostat www.doingbusiness.org www.cia.gov/library/publications/the-world-factbook/geos/bo.html www.transparency.org www.estonia.eu/about-estonia/country/population-by-nationality.html www.euromaidanpress.com www.kpmg.de appendix abbreviations used: acca associate chartered certified accountant cfa chartered financial analyst cfab certification in finance accounting and business cia certified internal auditor cima chartered institute of management accountants cma certified management accountant cpa certified public accountant erp enterprise resource planning, i.e. integrated business management software system frm financial risk manager isit information systems and information technologies mba master of business administration mis management information system ms master of science (in various fields) oecd organization for economic co-operation and development smes small and medium enterprises r&d research and development pr public relations 28 economic analysis (2015, vol. 48, no. 3-4, -9-28) problemi poslovnog i privrednog ambijenta i strategijski menadžment i upravljanje performansama u odabranim zemljama centralne i istočne evrope (cee) rezime – rad se fokusira na glavne karakteristike razvoja poslovnog okruženja, poslovnog obrazovanja i procedura upravljanja u odabranim zemljama centralne i istočne evrope (cee), baltika i balkanskih zemalja, i naglašava važne aspekte koji utiču na poslovne performanse. zaključci su doneti na osnovu analize 30 međunarodnih kompanija, neprofitnih i javnih organizacija, akademskih i poslovnih institucija, a na osnovnu ličnog poslovnog iskustva. primećene su razlike, posebno u dugoročnom razvoju kompanije, strateškom upravljanju, kontroli, upravljanju performansama, procenama zaposlenih, kao i drugim oblastima koje se odnose na upravljanje performansama. zbog ograničenog prostora rad ne uključuje komparativne analize bazirane na identičnim aspektima za odabrane zemlje, već ističe najvažnije elemente. ključne reči: strategijski menadžment, upravljanje performansama, poslovni ambijent article history: received: 18 may, 2015 accepted: 20 july, 2015 ea_2018_1-2 notes from of new editor-in-chief as of september 2017 i am privileged and honored to take over the position of editor-in-chief of the economic analysis. on behalf of all the members of our new editorial board (ivana domazet, vladimir simović, jelena minović, sonja đuričin, duško bodroža), i would like to point out that we want that this change will mark the beginning of a new stage of journal development as we seek to position economic analysis among leading journals in the field economic analysis with special focus on emerging countries. as part of our future strategy the mission of the journal has been created: the economic analysis mission is to introduce the scientific and professional public with the original research results in the field of economic sciences, as well as with public policies proposals that are aimed at overcoming the identified challenges. the main thematic areas, which will be in the focus of the journal, are: sustainable economic development and resilience, business economy and management, labor economics and human capital and the international economy. accordingly, we invite academicians, professors, researchers, phd and master students which are connected to these topics to publish their work in our journal. the new editorial board decided that the quality of the editorial processes should be improved and that our publications should follow the international standards. therefore, starting from the end of 2017 open journal system (ojs) has been introduced to facilitate the development of entire editorial management workflow, including: article submission, multiple rounds of peer-review, and indexing. the new editorial board took the steps in indexing economic analysis in international databases such as central and eastern european online library (ceeol), central & eastern european academic source (ceeas), research papers in economics (repec), erih plus, doaj... last but not least, all the members of the international and local editorial board are entirely aware of upcoming challenges and high-level goals related to further improving the quality of the journal. however, over the next few years we shall work hard to build up a journal with a successful international reputation, publishing high quality research data, which will be abstracted and indexed in the main journal databases. in order to obtain this, i look forward to receiving your high quality submissions, general feedback and suggestions or criticisms for improving the journal. editor-in-chief ivan stošić, phd ea_2017_1-2 udc: 377.3:352.08 jel: l26, b52 cobiss.sr-id: 240675084 scientific review attitudes of the employees on education in local-selfgovernment olja arsenijević18, faculty of business studies and law, university „union_nikola tesla“, belgrade, serbia edita kastratović, faculty for business economics and entrepreneurship, belgrade, serbia sandra nešić, fefa, university “singidunum”, belgrade, serbia abstract – the aim of this research is to study the nature of connections between independent and dependent variables as relations between status features and general life orientations and attitudes on the efficiency of the existing professional training of staff in the sector of public government. the sample of respondents consists of 553 aldermen and employees in the local administration. the instruments for data collection: questionnaire for examination of special attitudes on the value of the education program for aldermen and employees in local administration. the greatest participation within distrust have the statements that the manner of work in the municipalities is the same before and after and that education will not lead to the changes in this generation of employees – r = 0,70 i r = 0,71. the connections between the affective and value component of the attitude on the efficiency of education is rather intensive, chi-square is 111,31. there are four times more of those respondents with a positive evaluation than those with an extreme negative statement “in municipalities, the attention is systematically paid to the education of the staff in the sector of public government and self-government“ chi – square = 155,15. key words: attitudes, local government, education, employees introduction education is a process that lasts whole life, but that also enables the achievement and development of a potential individual. olja arsenijevic (2015) in serbia, the provision of elementary education is a legal obligation, unlike the secondary and higher education. according to the studies of the world bank, about 98% of children enroll the elementary school, but 28% of them never finish it. according to the records of the national employment service, only 40% of the young have graduated from secondary school. the total of 25% of graduates chooses to enroll the university, but the data from 2014 show that 70% of students give up on the studies. these data clearly show that education system is hardly passable and that only a small number of those who enroll the elementary school 18 staro sajmište, 29, beograd, olja.arsenijevic@fpsp.edu.rs 78 economic analysis (2017, vol. 50, no. 1-2, 77-96) manage to acquire higher education in the end. in addition, it is evaluated that even 95% of graduates cannot get a job without an additional training. having in mind the situation in serbian economy where a very small number of organizations have defined the obligatory time for advanced training of the employees and the fact is that 6% of work-active population has high or higher qualifications, such data point to the need for the creation of long-term strategy of education, retraining of labor, obligatory promotion of knowledge with the introduction of mechanisms for the verification (different licenses). concept of lifelong learning can be our shortcut for overcoming the gap between us and the developed world and it can also be the reason for even more deeper gap. arsenijevic (2012) all of this points to the need of changing the educational institutions as well as erasing the borders between education and economy because today the usable knowledge is the best product, i.e. the greatest possible value created. in the very organization, it is required firstly to transform the personnel function into the function of human resource management and start to observe the employees as a factor crucial for the success. when making business decisions, it is required to include all the relevant facts and factors that can affect the results of business. making business decisions implies a serious segment of performing activities after which the consequences will reflect directly to the business results in the future. therefore, it is important while making decisions to observe the problem, activities or offer from several aspects. precisely this is enabled by the technique of parallel thinking. by this, it is enabled that the decision made is the right one and for the future results to bring positive consequences. vesna stojanovic aleksic (2011) the paper will be based on the observation of lifelong learning in an organization and promotion of employees. this part of business will be observed from different angles and based on that, all opinions will be considered. lifelong learning represents the promotion of knowledge and skills of the individuals. whether this individual is an employee or the education is advanced, individual lifelong learning implies the improvement of personality. lifelong learning at the level of organization implies the advancement of knowledge and skills of the employees. the advancement of employees who are a part of an organization implies that better and more significant results will be achieved in the future. if the employees are educated and additionally trained, it must certainly contribute to better results in the future. therefore, it can be observed the fact that lifelong learning is an investment that is certainly effective because it will contribute to the achievement of greater gain than costs that are spent for the education. education is started in the childhood and each form of learning is a part of education. whether the education refers to the theoretical segment or it is some form of learning through practical elements, it is important to conclude that this form of investments always gives positive effects. vojin milic (1996) in order for an organization to decide for the certain funds that it disposes with to be used for investments in learning and education of its employees, it is important to observe certain facts and to get informed in a proper manner. primarily, an organization needs to observe its position in the market. before it gets engaged in a certain project or a form of investment, it is required to observe the position in relation to the others. the organization must be aware of its current results and possibilities in order to be sure for the future arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 79 investments. when the organization observes its position and determines that the education of employees would be an adequate activity, it is required to observe whether it is required to invest in this where the results can be expected in the future. whether it is about this project or another form of investment, it is required to observe the facts and possibilities offered by this project. if some of the projects are not profitable, the organization will not make the decision on setting aside certain funds for this project. having in mind that education is an inexhaustible source and that its effects can be achieved in the long run, investments in education will certainly not be unprofitable. after observing these facts, the organization must consider its options. education of employees implies the additional amount of the costs. cost management represents one of the important strategies for successful business and achievement of competitive position. the managers who make such decisions should observe financial aspect and determine whether there is a certain amount of funds that can be set aside for this type of activities. for this investment, it is implied to set aside a sufficient amount of money that will bring the positive results. after all new elements, it is required to find the adequate “teachers”, i.e. lecturers. it is required to find experienced experts from the field where business of an organization takes place. education is transferred and it is required for the person who implements the training or lecture to be professional, competent and adequate for such a type of an activity. it is not sufficient only to be familiar with certain field or to have only the teaching skills. it is required to observe whether the lecturer possesses all those elements and whether he/she will properly transfer the knowledge and skills to the employees in an organization. an important segment of education of employees in an organization is the employees themselves. it is required that there are employees who have the will and ability to participate in education project. employees in an organization have different character and commitments. there are the employees who want to progress and improve their knowledge and skills. opposed to them, in an organizational structure there are the employees who are not willing to advance their knowledge and skills but they are already satisfied with their position and they want to achieve the progress in it. for that reason, it is required to adequately observe the structure of employees and whether they want to keep promoting their knowledge and skills. in relation to them, it is required to determine intentions and plans for the future of employees who should participate in education process. observing the facts and collecting the information regarding all the relevant segments of an organization represent a complex process. it is not sufficient to observe only one or a part of these facts. if there are workers who don’t want to promote their knowledge and skills, then the organization has needlessly set aside certain funds for that project. in addition, if an organization finds the lecturer who will successfully perform his job and adequately improve both knowledge and skills of the employees, there will not be any positive results in the future. for that reason, it is required to observe all these facts and consider them together as a whole. 80 economic analysis (2017, vol. 50, no. 1-2, 77-96) theoretical part education and knowledge management from the aspect of ikujiro nonaka and hirotakatakeuchi whose knowledge is not only a datum or information that can be placed on a computer, but it implies much more and includes emotions, intuition, attitudes and skills. in order to understand the real nature of knowledge, it is important to observe that both components of knowledge, tacit and explicit, are important for knowledge creation. ikujiro nonaka, toyama ryokoto, noboru konno (2000) although it was previously mentioned, explicit knowledge can be expressed in words and numbers and distributed as a datum, report, in a form of a manual, etc, tacit knowledge is directly related to the ideas, attitudes, perception, emotions and experience. characteristic of subjectiveness and intuitiveness of tacit knowledge makes it difficult for discovering and transfer in a logical and systematic manner. therefore, explicit knowledge refers to knowledge corpus «know what» (objective knowledge), while tacit knowledge can be presented as knowledge:know how» (subjective knowledge). while the first knowledge type can be adopted by reading the books, listening to lectures or access to knowledge bases, the second type is primarily rooted in practical application and experience that results from that application including different forms of social interaction. success of an individual or organization directly depends on the required knowledge and skills that they possess. the institutions of higher education have the greatest significance in formation of knowledge and skills of the individuals and in recognition and identification of knowledge and skills that are required. through education process, the profiles of workers in organizations are created that should meet the needs for knowledge and skills in organizations. on the other hand, faculties possess different disciplines and knowledge that can help the organizations to articulate their own needs and in that manner become aware of what they know, i.e. what they are missing, so that through the process of creation and usage of new knowledge they could improve their business. in this manner, high school institutions get a clear image of a profile that an oragnization needs, and therefore they also have the opportunity to improve traditional education in a positive direction. the most negative characteristic of traditional education is the focus on explicit knowledge that are most frequently, through the form of oral lectures, presented to students and then they are asked to reproduce the same explicit knowledge from the books and other different forms of materials, where they get the subjective grade of the person who grades them for the quality of their reproduction. the negativities that characterize this practice are reflected in the lack of constructing any kind of tacit knowledge with the students and particularly their skills and attitudes, a complete omission of creativity development in order to create and use new knowledge, motivation reduced to the level of meeting the condition of passing the exams and the fact that graduated students have knowledge corpus whose usable value is reduced or equal to zero, having in mind the trend of discovering and acquisition of new knowledge. traditional education should be replaced with new model that supports and implements the education concept during entire life. improvements that are brought by this concept are reflected in flexibility, diversity and availability in time and space with the aim for the arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 81 education to turn into permanent development of man’s personality, knowledge and skills, abilities of presenting their attitudes and undertaking different activities. the aim of this concept should be that not a single talent that a man has must’t be left unused. the talent includes : memory, ability to think, imagination, physical skills, aesthetic sense, ability to communicate with the others in other words, such a concept should get closer to the „learning society“ i.e. creation of of educational society based on acquisition, activation and application of knowledge. main terms knowledge acquisition – learning the acquisition of knowledge in organizations can be achieved in different ways, including the following : purchase of knowledge (through the purchase of organizations, individuals, licenses, procedures,…), merging i.e. fusion (gathering the workers with the same knowledge and experience with the aim to create new knowledge), target separation of resources (target formation of the departments for research and development, planned education of the employees,…), adaptation (adjustment through the creation of crisis before it appears and finding the solutions to resolve it,…), networking (finding the manner to connect the carriers of knowledge in order to communicate as better as possible), and in many different ways. in education sector, i.e. in the process of education, the most frequent form of knowledge acquisition is through learning. learning is, as psychologists say, main psychological process and it represents the process that includes everything than a man observes, discovers and evaluates. the manner in which he verbally expressed himself, how he solves the problems, man’s skills and knowledge, his feelings, motives and attitudes and all his habits in communication with the other people represent the result of the learning process. ratko dundjerovic (2004) main drivers of learning can be external or internal. external drivers of learning in school practice most frequently refer to the activities and means of external motivation (praises, awards, grades ). internal motivators represent those motivators that give the individuals the desire to learn his whole life. the most significant internal motivator for learning is certainly the curiosity. creative curiosity expresses each search for the new facts and ideas. main indicators of curiosity of the students with an expressed research orientation are primarily: continuous search for new and original answers; frequent repeating of the question: why?, how?; desire to find out more than it is heard during the class and more than it can be read in a textbook; desire to take part in experiments by which the set hypotheses are verified; the tendency to independently set different problems and to solve in new ways and many others. of course, there are also other internal motivators, but for this paper it is not required to further analyze them. there are different forms of learning which appear in the process of the change of an individual. classification of forms (manners) of learning can be made into the three main: 1. mechanical-associative learning 2. reproductive-creational learning 3. heuristic-creative learning 82 economic analysis (2017, vol. 50, no. 1-2, 77-96) skills skills can be defined as experience, ability to practically apply and easiness in performance of an activity, skillfulness and tacit. the skills include the combination of experience and practice and improvement of skills leads to the automatization and unconscious performance of certain activities. skills are much more than a mere following of routines that actions are based on. however, on the other hand, lack of knowledge and developed attitudes, a person who only possesses the developed skills does not have the ability to react to situations that exceed the frame of normal conditions. without knowledge and developed attitudes that support the competence development, only the skills, for themselves, can be represented as causal factor of the appearance of human error. ian glendon, eugene mckenna (1995) knowledge and attitudes should support the development of skills and improve competence. attitudes attitudes can be defined as «learned tendency to reacting in a consistent manner to a special situation or object». glendon, mckenna (1995) in addition to motives, man is also driven by his attitudes to take action. „by the very fact that they represent a relatively permanent tendency of emotional, value and action relationship towards people and occurrences, the attitudes have a dynamic effect, i.e. they act as motivators and affect our behaviour.“ dundjerovic (2004) the attitudes provide standard behaviour and easier coping with different situations in life. there are many reasons for which the attitudes are important in many fields of human activities, but the most significant are: attitude represents the tendency towards action (people are ready to fight for the things that are in accordance with their attitudes), attitudes include a cognitive component (attitudes include not only the things that are perceived, but also the manner in which some behaviour aspects of people towards an occurrence are valued), emotional component (attitudes include human feelings) and willingness component (include the readiness to be engaged, i.e. reaction), than the attitudes can extremely easy be measured (through the attitudes towards work it can be measured the dedication to work). milanbubulj, olja arsenijevic, jelena simic(2011) empirical study the city of leskovac – description of government and local self-government the highest legislative act of the city if the statute which closely defines the manner, conditions and forms of performing rights and duties that are under the jurisdiction of the city. the statute is adopted by the assembly with the majority of votes of the total number of aldermen. in executing its jurisdiction, the city adopts the regulations independently, in accordance with its rights and duties determined by the constitution, law, other regulations and the statute. the bodies of the city are: city assembly, mayor, city council and city administration. arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 83 city assembly is the highest body of the city that performs main function of local government defined by the constitution, law and statut. the assembly has 75 aldermen who are selected by the citizens in direct elections, by secret ballot, in accordance with the law and this statute. city assembly has the president of city assembly. research subject in the sphere of local self-government, as it can be seen from the description of local selfgovernment of leskovac, it is about a very great number of jobs that require experts, different managers (lawyers, economists, engineers, professors…). the concept of a good personnel development strategy in this field also assumes the familiarity with the requirements of the jobs and familiarity with relevant characteristics of their executors. if there is a good evaluation of relevant characteristics (abilities, personality traits, motivation,…) of the individuals who perform that job, then it can be reliably enough determined what they must be trained for, in what time, what are their development ranges, etc. both practice and science show that training and acquisition of experience in some job will not remove all the differences between the candidates regardless of the harmonization between the job requirements and characteristics of the candidates available it is about. this practically means that not a single municipality can pretend that all the candidates, regardless of the programs of training and development they are included in, will be trained to achieve an equal level of success. there is a difference in skills, there are differences in motivation, personal traits (self-confidence, domination, aggressivity…), attitudes etc. which contributes for the differences to appear in the very process of education. dundjerovic (2004) all of that proves that it is not sufficient to possess the potential possibilities for performing certain jobs that are pointed out to the individual in professional orientation or determined in professional selection. in order for those potential possibilities to be developed and used adequately, it is required that he goes through systematic training, to be aimed towards the acquisition of the required knowledge and skills and acceptance of duties and responsibilities for the proper performance of those jobs. therefore, development and application of new technologies in performance of those jobs impose that individual a request to go through the additional education. main starting subject of this empirical study represents the observation of nature, direction and intensity of attitudes on education of the aldermen and employees in local administration. the focus of study includes three main groups of attitudes. the first group includes those special attitudes (opinions, beliefs, evaluations) who talk about general cognitive and value relationship of respondents towards professional training they were included in.it is about the evaluation of overall attention that is paid to the education of staff in public government and self-government sector, evaluation of educational programs, efficiency of organization and conditions in which educational seminars are implemented, evaluations of the quality of attendants; participation, practical applicability of acquired knowledge, etc. this group also includes all those evaluations that the respondents have given for numerous characteristics of lecturers and moderators, such as: expertise, creativity, motivation, social openness, tollerance, etc. 84 economic analysis (2017, vol. 50, no. 1-2, 77-96) the second group of the attitudes observed includes all those through which the respondents could express the affective/emotional relationship towards the things and occurrences in relation to education: to what extent they are satisfied with general attention that is in their municipality attributed to the development and motivation of staff in the sector of public government and self-government, to what extent they are satisfied with the possibility for the acquired knowledge and skills to provide them some real professional improvement, to what extent they are satisfied with lecturers, behavior of colleagues in educational group, etc. the third group of special attitudes includes all those opinions of respondents that point to the cognitive/willingness component of their general attitude towards education: what are the most important areas for which professional training should be organized, in which area and to what extent they have the need for further education and from which professional groups it would be the best to choose lecturers in the future. the aim of the research the aim of the research is to study the nature of relationship between independent and dependent variables, as relations between status features and general life orientations, on one hand, and attitudes on efficiency of the existing professional training of staff in the sector of public government and self-government, on the other hand, as well as that the findings obtained should serve for the suggestion of the improvement of professional training in the sphere of local government and self-government. research questions and hypotheses research questions set on the basis of previously expressed theoretical consideration will aim the execution of hypotheses and provide their definition. several questions are formulated: what kind of attitudes towards current practice of education have the elected aldermen and employees in local administration who have passed some of the forms of professional training and what percent of variance of the attitudes examined can be explained with the help of the first three set latent factors? h1 two thirds of respondents are characterized by a positive general value relationship towards professional training they have participated in. h2 more than a half of aldermen and officials’ majority have a positive affective relationship towards important things and events related to the current education practice. h3 more than a half of respondents’ majority express their personal needs for additional education. h4 with the help of the factors set, it can be explained more than 60% of the variance of examined attitudes. arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 85 research methodology sample of respondents consists of 553 aldermen and employees in the bodies of local government (officials, assistants of the mayor, deputy heads). table 1. sample of respondents – demographic characteristics function frequency aldermen 75 deputies and assistants 5 officials 473 gender female 23 male 57 education level elementary and secondary 182 high school 128 faculty 243 work experience up to 10 years 158 11 to 20 years 162 more than 20 years 233 methods and instruments of research in this research, two fundamental methods for data collection were applied: method of theoretical analysis and survey method. method of theoretical analysis is used for the study of secondary material. in this research more instruments for data collection have been used: 1. questionnaire for examination of a series of special attitudes on the value of the education program for aldermen and employees in local administration, then collection of data on their social and experiential characteristics. 2. the scale for examination of a general attitude towards current practice of professional training in the field of local government and self-government. procedures for data processing in data processing, the statistical procedures that suited best to the nature of the distribution of data obtained are used: mean values measures and deviations from those measures; measures of statistical significances of differences between segments of crossed variables; measures that point to the level of relatedness between variables; measures of latent structure of attitudes towards the education. the overview and analysis of research results attitudes towards education satisfaction with the occurrences related to education 86 economic analysis (2017, vol. 50, no. 1-2, 77-96) based on overall data given in the table 1, it can be firstly determined that the respondents are more often dissatisfied than satisfied by things and occurrences that unquestionably represent an important precondition of efficient realization of education in the sector of local self-government. it can be seen that officials and aldermen are most frequently dissatisfied with general attention that is attributed to development and motivation of the staff in the sector of public government and self-government, then the possibility for the existing educational programs to offer them those skills and knowledge that will provide them with both real professional and expert improvement. in both cases it is about a critically high number of dissatisfied persons – more than 50% of those who are explicit and more than 25% of those who both “are and are not”. on the other hand, municipal officials and aldermen are rarely dissatisfied with the level of overall participation of the attendants in educational programs (each third) and particularly with the behavior of lecturers, i.e. moderators of educational programs (only each tenth).overall data on satisfaction, i.e. dissatisfaction provide us the execution of the two statements: level at which the alderman and employees in local administration are dissatisfied by important aspects of previous practice in the sphere of their expert training unequivocally point to the need of starting big changes, particularly those in the line of reconceptualization of the very education system of the staff in bodies of local government and self-government. if the things are observed from the standpoint of the guidelines of education’s success, the finding that the staff in municipal bodies are more frequently dissatisfied with wider social environment (general state in local government and self-government, general relationship towards professional development of staff, then general value of educational programs for professional improvement) than they are dissatisfied with narror social environment (lecturers, engagement of attendants, relationship that the people in a direct work environment have towards participation in education) is practically indicative. table 2. the extent to which you are satisfied with the following things and occurrences occurrences (evaluations for occurrences:1completely satisfied, 2mainly satisfied, 3partially, 4mainly dissatisfied, 5) –completely dissatisfied 1 cs 2 ms 3 par 4 md 5 cd general state on local government and self-government 4,2 18 36,6 26,5 14,7 attention that is in your municipality paid to development and motivatin of staff in the sector of public government and self-government 3,7 16,4 26,2 33,1 20,6 possibility to acquire new knowledge and skills through different educational programs and provide yourself a real professional improvement 7,2 16,9 25,6 30,19 19,9 lecturers who have taken part in educational programs you attended 13,6 45,7 26,7 8 3,7 level of overall participation of attendants in different educational programs. 6,5 29,5 31,7 20,4 11,9 attitude that the environment you work in has towards your participation in different education programs 6,3 33,7 29,8 16,9 13,2 arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 87 from the standpoint of the initiation of changes, the data obtained on the affective component of the attitude towards education show that the defining the very scope of dissatisfaction is not much of a problem, as well as the things by which and to what extent are certain groups of people dissatisfied. it is more of a problem how to use the data obtained in this manner in a practical way: what should be changed, where to begin, how should the people be engaged, etc. general attitude towards educational practice table 3. general attitudes towards education claims 1 2 3 4 5 positive experiences of other countries are not used to a sufficient level 39,7 39,6 14,9 4 1,8 educational programs are bad and they should be changed 7 15,7 35,7 30,5 11,2 organization of education is good and it should be continued the same way 15,8 34,8 31,6 12,4 5,3 lecturers in educational projects are bad 3,2 7,9 29 40,6 19,3 i felt comfortable during entire participation in education 25,4 43,5 21,2 6,2 3,6 i would like to be included in all future educational programs for professional training 51,8 31,7 11,4 3,1 2 all the time of the education i have managed to keep a high level of concentration 30,9 44,5 17,1 5,3 2,2 the greatest number of participants had a passive relationship towards the things presented by the lecturers 8,4 21,3 30,6 29,7 10 education is insufficiently aimed to practical issues, not much things can be used in practice 14,3 27,7 28,5 20,8 8,7 in the end of education, our evaluations on the quality of the program offered can be given 36,6 33,6 14,6 10,5 4,7 after the education, i perform my job much better 15,6 40 31,2 8,6 4,6 before and during the education process, with the appropriate literature were provided to us 29,8 35,5 17,1 10,7 6,9 it is clear that those who prepare education programs are not familiar with our interests and needs 13,4 21,8 32,1 22,8 10 implemented education programs contribute to better communication with the citizens 28,9 41,4 20,4 7,3 1,6 during the education, i have acquired important new knowledge and skills 25 42,2 23,9 5,7 3,2 as it can be clearly seen from the table, in case of aldermen and officials in local government there prevail positive attitudes on different aspects of existing practice in education sphere. most frequently, there are positive attitudes which show that they highly 88 economic analysis (2017, vol. 50, no. 1-2, 77-96) evaluate the need for professional training, more precisely, that they willingly take part in education. the data show that in case of respondents there significantly rarely exists a positive value relationship towards those most direct factors of successful education. it is about a relationship towards the engagement of the attendants themselves, organization of education, education programs, provision of reference books, and attitude towards educators. the opinions of respondents that even more expressive point to the critical evaluation of this practice are their attitudes about practical use of the existing system of professional training in the sector of local self-government. it is difficult to see that system as efficient if 42% of respondents believe that this education is poorely aimed to practical problems and that it cannot be applied in practice. the analysis is continued through the answers to some special questions, firstly those regarding the organization that implements the education and those that refer to the treatment of the acquired knowledge (table 3) and then, brief analysis of the data on educational needs of the respondents. table 4. special attitudes on organizations and human factors of a successful education statement true mostly true false mostly false difficult to evaluate organizations that deal with education have a good social treatment 23,8 39 6,1 25,8 5,3 organizations that deal with education have contemporary, pedagogically suitable and highly motivated lecturers 19,2 49,9 6,6 7,8 16,5 spatial and other conditions in which numerous organizations perform the education are rather good 20,8 45,4 11,5 8,6 13,7 knowledge is not evaluated and that is the main reason for which the employees or elected aldermen are not prone to education 41 37,8 10 9,1 2,1 after the education, its attendants have significantly greater chances for greater earnings and faster advancement at work 9,6 20,4 26,1 21,1 22,8 when there would exist the standards for the advancement at work that would involve quality in performance of the jobs and services offered to the citizens, everyone would have a different attitude towards education. 55,2 37,8 3,3 2,7 1 with the exception of the respondents who choose the answer “difficult to evaluate”, it can be seen that participants of educational seminars in a very big percentage have a positive attitude towards the organizations that implement the education: they think that they have a good social treatment, that they have professionally competent and motivated lecturers and arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 89 that they provide spatial and other conditions for content implementation at a rather satisfactory level. answers to the items regarding the treatment of knowledge unequivocally point out that in our environment the knowledge is still not seen, not even close, as a precondition for the success at work. it appears that in our organizational culture still strongly exists the tendency to underestimate the significance of a genuine education. the data on expressed needs for professional improvement in different thematic fields are given in table 4. it is obvious that it is about the data that are in accordance with previously presented finding on the stressed orientation on inclusion into education programs – more than 60% of respondents think it is significant to have additional education in the fields mentioned. it is interesting that personal needs for professional improvement as rather significant mostly appear in the following fields: information technologies, management, strategic planning and public relations. table 5. importance of additional education in the mentioned thematic fields field name it isn’t important at all not important both is and isn’t important important very important menagement 11,7 7,8 20 17,8 42,8 leadership 33,6 17,3 24 13,9 11,3 administration 8,2 10,5 24,6 22,4 34,3 strategic planning 6,8 6,8 19 25,1 42,2 budget 9 8,8 20,1 22,8 39,2 financial management 10,9 9,5 18,5 23,8 37,3 information technologies 4,9 5,8 18,5 27,6 43,2 public relations 5,1 7,1 20,3 27,5 40,1 decision-making process 5,4 8,2 20,3 26,7 39,4 communication with community members 7,9 7,6 18,9 27,7 38 negotiation skills 6,8 8,2 17,9 28,7 38,4 human resource management 7,6 8,9 21,9 26,9 34,7 partnership creation in community 6,8 8 20,7 28 36,5 when they have given them the possibility to mention within open answers of the main field the desired education, there were four main fields set aside: 1. strategic planning in the community, 2. economy, economy and finances, 3. information technologies and 4. efficiency of administration. factor analysis of attitudes on education value by factor analysis in latent space eight relatively independent factors that explain 54,65% of the total system variance are set aside. factor 1 education as a factor of success in work 90 economic analysis (2017, vol. 50, no. 1-2, 77-96) this factor explains 18,53% of the total variance and it consists of the following variables – attitudes: table 6.factor 1 statement r organization of education is good and it should be kept in the same way 0,37 i felt comfortable during the entire participation in education 0,45 i wish to be included in all future education programs for professional training 0,39 all the time during education, i managed to maintain high level of concentration 0,37 in the end of education, our evaluations on the quality of the program offered can be given 0,36 after the education, i perform my job significantly better 1,79 implemented education programs contribute to better communication with citizens 0,74 during the education i have acquired important new knowledge and skills 0,82 implemented education programs truly help the attendants of education in better and more efficient performance of jobs 0,46 this factor also includes the greatest number of the items observed and explains the greatest percentage of system variance. it is interesting that all the items express a positive value attitude towards education. it tells us that latent in the basis of numerous viewpoints that respondents have on education, they largely stand in belief that within the education observed new knowledge and skills are acquired, that implemented education programs contribute to better communication with citizens and better performance of the job, that it would be pleasant to participate in education, etc. factor 2 disbelief in practical use of education this factor explains 9,65% of variance and it consists of the following variables: table 7. factor 2 statement r knowledge is not evaluated and that is the main reason for which the employees or selected aldermen are not prone to education 0,57 education? everyone talks about it but we know that everything is the same in municipalities before and after each education. 0,7 education is important, but the reform of administration and local self-government, which will primarily promote professionalism and efficiency, is more important to us. 0,5 integration processes significantly affect the changes, as well as changes in municipalities, but it will mot affect this generation of employees and that is one of the reasons why the education is not attributed any special significance. 0,71 beliefs that express the lack of confidence in practical use, in relation to previously observed positive beliefs, significantly less participate in latent structure of overall attitudes on the value of implemented education programs in local self-government. however, it is practically indicative that the highest share within distrust have the claims that the work in municipalities is the same before and after the education and that education will not bring to the changes of this generation of employees – r = 0,70 andr = 0,71. arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 91 factor 3 education as a factor of professional promotion this factor explains 6,54% of the total variance and it is built by the following variables: table 8. factor 3 statement r in municipalities, the attention is systemically paid to the education of staff in the sector of public government and self-government 0,61 after the education, its attendants have significantly greater chances for higher eranings and more rapid progress in service and professional career 0,58 although it includes only two claims and has a relatively small share in explaining latent structure of the observed attitudes, this factor points out that the people who have gone through some forms of education positively evaluate the practice in those municipalities that systematically pay attention to education and that provide professional promotion to the attendants after the education. factor 4 competence and status of organizations that deal with education this factor explains 5,17% of the total variance and it consists of the following variables: table 9. factor 4 statement r organizations that deal with education have a good social treatment 0,68 spatial and other conditions where numerous organizations execute education are quite good 0,65 participants of educational seminars show an exceptional personal interest and engagement 0,42 organizations that deal with education have contemporary educated, pedagogical and highly motivated lecturers 0,6 the claims structured within this factor show that the following factors of successful education are mutually significantly related: 1. qualifications of the lecturer, 2. social treatment of organizations that deal with education, 3. conditions in which education takes place and 4. interest and engagement of attendants. factor 5 need for changes this factor explains 3,99% of the total variance and contains the following variables: 92 economic analysis (2017, vol. 50, no. 1-2, 77-96) table 10. factor 5 statement r education that is organized in our municipality has had the most direct positive effect on performance of the jobs in municipality -0,39 education affects the changes in attendance, but that is not enough. it takes changes that will affect the evaluation of the acquired knowledge and experiences in the workplace or municipal council -0,78 when there were standards for the progress in service that would respect the quality in performance of the jobs and provided services to the citizens, everyone would have a different attitude towards the education. -0,58 this factor points to the need for changes, primarily in the aspect of belief that it has come to a more positive relationship towards the education if there would be created the standards for the evaluation of jobs and progress in service. factor 6 lack of motivation of participants in education this factor explains 3,72% of the total variance and it consists of the following variables: table 11. factor 6 statement r educational programs are bad and they should be changed 0,55 lecturers in educational projects are bad 0,60 the greatest number of participants had the passive relationship towards the things that lecturers have said 0,71 education is not sufficiently oriented on the practical problem solving, there are very few things that can be transformed to practice 0,72 before and after the education process, we were provided with the appropriate reference books -0,35 it is clear that those who prepare education programs are not familiar about our interests and needs 0,72 here, as it can be seen from the table, it is about those negative statements that latently determine the overall given system of attitudes regarding the value of education – when the programs are evaluated as inappropriate, lecturers as bad, attendants as uninterested, references provided as inappropriate. factor 7 orientation on the experience of other countries the factor explains 3,58% of the total variance and includes only one variable: table 12. factor 7 statements r positive experiences of other countries are not used to the sufficient extent -0,78 arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 93 here it is about the negative claim and it negatively high correlates with the system, which tells us that positive evaluation of using experience of other people is a required and relatively important latent factor of attitudes on the value of education. factor 8 incomprehension of education as factor of changes this factor explains 3,44% of total variance and consists of one variable: table 13. factor 8 statement r people usually think that education does not affect the change in behavior of participants at the workplace or performance of election function of the aldermen 0,47 perceived characteristics of lecturers table 14. attitudes on lecturers characteristics less present moderately present extremely present interested 18,4 25,9 55,7 professional 15,4 20,2 64,3 creative 17,6 22,7 59,7 tolerant 14,1 21,2 64,7 motivated 12,3 16,2 71,5 real perception of the problems in local selfgovernment 25,1 22,3 52,6 conscientious 13,4 18,1 68,5 open towards each other 14 18,6 67,5 encourage participants to activity 17,2 13,96 68,8 agree with participants on the operation pace 18,3 16,9 64,8 apply modern methods of education 17,3 19 63,8 respondents have a positive attitude towards the lecturers in a very high percentage. four characteristics are however set aside as the most intensive: motivation for work, initiative, conscientiousness and extraversion. when the group were asked from which group it is best to choose the lecturers, they most frequently believe (35,7%) that they should be chosen from the group of the staff in public administration that have gone through a special training for lecturers. there comes the criterion for the education for management in public administration (23,7%) and criterion of experience in public administration (21,6%). it is clear that the majority thinks that the solution is not in the very level of education of lecturers, if they do not have the experiences and specific knowledge in this field, even if they are university teachers or exceptional experts. this says that there is a need for special education profile, for education of staff that will deal with management in local administration and self-government. 94 economic analysis (2017, vol. 50, no. 1-2, 77-96) mutual correlation between components of the attitudes on education in this part, it can be considered in what aspect are the value, affective and conative component of attitudes on education harmonized, whether and to what extent they are positive or negative, whether positive opinions are related to positive feelings and expressed disposition for action. firstly, attention will be paied to the nature of correlation between general attitude on efficiency of educational programs and general image that respondents have on moderators of those programs. from the data given in table 15 it is seen that between these two dimensions exists statistically significant and symmetrically positive correlation, in the aspect that more positive attitude is followed by a more negative perception of lecturers. table 15. general attitude on education and image on personality of lecturers general attitude image on personality of lecturers total % less positive positive more positive extremely positive 21 26,7 52,3 100 positive 28,6 40,1 31,3 100 negative 45,6 37,8 16,6 100 chi-square = 111,31; c coeff = 31. df = 4, p = .000 the totality of the observed characteristics of lecturers is extremely positively evaluated by every second person and negatively only each fifth from the group of those who have an extremely positive general attitude towards on education. on the other hand, within those characterized by a negative general attitude, positive image on lecturers have only 16,6% of respondents and 45,6% of them have the negative. as it can be seen from the table 16, correlation between the affective and value component of the attitude on education efficiency goes in the same direction, with even more intensive chi-square, for 4 levels of freedom that is 111,31). among the respondents with extremely positive attitude, there is the majority (54,9%) of those who are extremely satisfied, while 16,9% are dissatisfied, among the respondents with negative attitudes, extremely satisfied are only 18,4%, while the half are dissatisfied. general level of satisfaction with significant factors of efficient education is even more strongly related with one number of rather relative value judges on the existing practice. for example, within the group of extremely satisfied respondents there is four times more those who are extremely positively than those who are extremely negatively evaluating the statement “in municipalities the attention is systematically piad to education of the staff in the sector of public government and self-government” – for 4 levels of freedom, chi-square = 155,15. the same direction of correlation with a general level of satisfaction is in question also when it is talked about: 1. „organizations that deal with education have contemporary educated, pedagogical and highly motivated staff” and 2. „after the education, their attendants have significantly higher chances for greater earnings and faster progress in service and professional career“. arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 95 table 16. relationship between affective and value component of the attitude on education general attitude satisfaction total % less positive positive extremely positive extremely positive 54,9 28,2 16,9 100 positive 33,4 37,5 29,1 100 negative 18,4 31,8 49,7 100 chi-square = 155,15; c coeff = 31. df = 4, p = .000 unlike the previous type of correlation, relationship between affective and conative component between satisfaction and action orientation to additional professional training is negative. table 17. relationship between affective and conative component of the attitude on education general attitude educational needs total % less positive positive extremely positive extremely positive 39,3 25,8 35 100 positive 20,5 38,5 41 100 negative 19,7 35,6 44,8 100 chi-square = 51,80; c coeff = 20. df = 4, p = .000 the mentioned standpoint is confirmed by the findings, that dissatisfaction is the most secure indicator of the need for changes. it appears the the employees in the sector of public government realize that through education, through changing themselves, they can advance their job, change the things they are not satisfied with. conclusion within the consideration of the problem of this empirical study, it can be started from the fact that development of local self-government and self-government also depends on both social and personal factors. within social factors there were all those international integration activities on the plan of establishing the unique standards of behavior in this field, then those most general social circumstances of ours that enable this activity and those social circumstances that at the municipality level have a more direct impact on state of things in local government and self-government. the starting point was the fact that a good education system is one of the most secure paths of efficient development of local government and self-government. in order for individuals and groups to be developed and used for the possession of potentials of certain jobs, it is required that they go through systematic training in order to be aimed towards the acquisition of special knowledge and skills, which means in order to be prepared to assume the duties and responsibilities for the application of new technologies in job execution. the identification of the needs for studying certain aspects of activities and actions in this field from the aspect of the two main views of its value: firstly, when the education was observed primarily as an instrument of development and meeting of the needs of society, etc, 96 economic analysis (2017, vol. 50, no. 1-2, 77-96) when the education was primarily observed as an instrument of development and satisfaction of the needs of the attendants, i.e. those who are educated have been accessed. the level to which the aldermen and employees in local administration are dissatisfied with important aspects of previous practice in the sphere of their professional training unequivocally points to the need of starting big changes, particularly those on the line of reconceptualization of the very educational system of staff in the bodies of local government and self-government. all set of hypotheses at the beginning of the research have been confirmed. from the aspect of initiation of changes, the data obtained on affective component of the attitude towards education show that it is not much of a problem to determine the very range of dissatisfaction: by which and to what extent are certain people dissatisfied. it is a greater problem to practically use the data obtained in this way. the first step which was taken – it was examined, shown and interpreted all the attitudes of the aldermen and employees in municipal administration regarding the efficiency of the existing education programs. the second step should include the feedback information on relevant phenomena and problems that the research pointed to. therefore, the data obtained should serve as an incentive to all those people who are within this occurrence on daily basis, to observe that it only seems to them that they are sufficiently familiar with everything that goes on around them every day, to perceive how they can in a different manner observe the occurrences in the sphere of education, to point to many other things that were not included in the research during the discussion. the third step would be the introduction of changes by the exchange of information and it could be performed through three stages of the prevention of the resistance to specific changes. the first stage should create the awareness of the respondents on the existing dissatisfaction by things and occurrences important for the implementation of professional training, the fields within which the individuals and groups mostly want to be educated. then, there would come to the introduction of change. in the first stage it is required to patiently talk to the employees, obtain the support of the most influential individuals, observe the moments that could lead to conflicts, etc. in the end, within the third phase it should be worked on the implementation of new solutions, to make the newly established attitudes and way of thinking becomes a permanent aspect of behavior in public administration. references arsenijevic, olja, bulatovic, lj. ljiljana, bulatovic, goran. 2012. „lifelong education – paradigm of the age of knowledge.“ in proceedings 6th international technology, education and development conference, inted2012, 5-7 march, 1269-1275., valencia, spain: iated. arsenijevic, olja, lilic, vladana, zdravkovic, bojan. 2015. „impact of e-mentoring on inventivity in companies.” international journal of economics and law, 5(14): 7-17. arsenijević, o., et al., education in local-self-government, ea (2017, vol. 50, no. 1-2, 77-96) 97 bubulj, milan, arsenijević, olja, simić, jelena. 2011. „the impact of organizational culture on the development of the achievement motive among university" students.“ educational research and reviews.” academic journals, 6(6): 481-488. dundjerović, ratko. 2004. osnovi psihologije menadžmenta. novi sad: cekom, p. 42-47. glendon, ian. mckenna, eugene. 1995. human safety and risk management. new york: chapman & hall. milić, vojin. 1996. ka samosvesti u savremenom društvu. beograd: praxis. p. 54. nonaka, ikujiro, toyama ryokoto, konno, noboru. 2000. „seci, ba and leadership: a unified model of dynamic knowledge creation“. in lond range planning, 33(1): 5–34. stojanović aleksić, vesna. 2011. organizacija preduzeća. kragujevac: ekonomiski fakultet, p. 15. article history: received: 10 may, 2017 accepted: 17 june, 2017 doi: 10.28934/ea.21.54.2.pp104-117 preliminary report do labour and political will affect agricultural output?: evidence from sub-saharan africa kareem abidemi arikewuyo1* | lateef adewale yunusa2 | babatunde o. oke3 | babatunde adekunle okuneye4 1 southwestern university, nigeria, okun-owa, ogun state 2 olabisi onabanjo university, departmen of banking and finance, ago-iwoye, nigeria 3 university of lagos, department of finance, akoka, nigeria 3 olabisi onabanjo university, department of economics, ago-iwoye, nigeria abstract agriculture has been at the forefront in employment creation and revenue generation in africa until there was a shift from the sector to the non-farm or service industry which threatens the economic sustenance despite the growing population of youth in the region. the neglect of the agricultural sector resulted from labour migration and lack of political will in sub-saharan africa (ssa), which has severe implications on agricultural output. this study, however, investigated the nexus among labour, political will and agricultural production in ssa from 1998 – 2018 using the dynamic system – gmm estimation technique. the study found employment in the agricultural sector, agricultural raw material, exchange rate, political will, and agricultural material and exchange rate interaction significantly influenced agricultural output in ssa. therefore, it is recommended that for ssa future to be sustained, the governments should discourage labour migration from the agricultural sector through government supports to boost employment and poverty reduction. key words: labour, political will, agriculture output, ssa jel classification: j43, o38, o13, n47 introduction african countries are naturally endowed with mineral resources, and this led to europeans’ search for raw materials in which agricultural outputs played a crucial role in this respect. agricultural results have contributed to the gross domestic product (gdp) of most developing economies across the globe and africa. agriculture served as a source of foreign exchange earnings, creating investment outlets both locally and internationally, employment opportunities, and providing the material needed for further productions. some of the developing economies diversified their income sourced from crop exportation into crude oil exportation, which led to the reduction in crop exportation and gross domestic product of the economy (adeola & ikpesu, 2016). the decrease in crop exportation and other agricultural outputs led to divestment by some african nations from agricultural produce into the oil sector, which now reversed the earlier role played by developing countries as major suppliers of raw materials the world over. the demand for agricultural produce on a large scale became apparent due to an upsurge in the world population. therefore, it requires massive capital to meet its demand; finance becomes a * corresponding author, e-mail: kareem.arikewuyo@yahoo.com kareem arikewuyo, lateef yunusa, babatunde oke, babatunde okuneye 105 significant problem. shortage of funds has restricted the progression of the agricultural sector, leading to a decline in the sector’s output. that is why osinubi and akinleye (2006) opined that the government could promote agricultural sector output in developing economies by providing credit facilities to the sector to facilitate the procurement of modern farm implements and other necessary inputs needed to transform the farm product from subsistence to mechanised farming. this is expected to translate into a reduction in unemployment and poverty across africa, which have been adjudged to be hindering african development over time. this sector happens to be one of the largest employers of labour in africa (ajuwon & ogwumike, 2013). according to africa agriculture status report (2016), over sixty per cent of the african’s population under the age of 25 (roughly 220 million young people) will be entering the labour force by 2035. even under the most optimistic projections, wage jobs in ssa will absorb only 25 per cent of these 220 million prospective new workers. farming and self-employment will remain to salvage this situation for gainful employment of at least seventy per cent of young africans entering the labour force (aasr, 2016). the record has it that people in ssa have their means of livelihood from the agricultural sector, and their sustenance is tied directly to earnings realised from the industry. promoting this sector would improve the income of farmers; industrial raw materials, reduce unemployment, poverty and foreign exchange problem; boost food availability and lower the cost of foods which will transform into the economic development of the region (united states department of agriculture, 2013). there is no doubt that agriculture predominantly employs more than two-thirds of people in the area and contributes to regional gross national product (gnp) (yu & nin-prat, 2011). in recent times, employment in agriculture has continued to decline in the ssa economi,es, which portends great danger for the region in the foreseeable future. the shift in the labour force towards non-farm employment would breed unemployment level by the year 2035 as the non-farm or service industry may not be able to accommodate the growing population of youth in africa (africa agriculture status report, 2016). unemployment and poverty have been the bane of african nations as sub-saharan african, can mitigate this syndrome by improving human capital development and political will. labour which forms a more significant part in human capital development in developing economies due to its labour-intensive nature, has continued to decrease as evidence revealed job migration from the agricultural industry to service industry on a large scale (united states department of agriculture, 2013; food and agriculture organisation, 2019) and this has greatly affected investment in the sector over time thereby affecting agricultural growth. it is noted that empirical evidence from literature failed to investigate the nexus among labour, political will and agricultural output in ssa, which is very important to the investors, government and regulators. more so, it was discovered that only the study of ikpesu and okpe (2019) carried out a single-country research to investigate the relationship between capital inflow, exchange rate and agricultural output in nigeria. no cross-country study has, to the best of our knowledge, investigated the relationship between/among labour, political will and agricultural output in sub-saharan african countries, this backdrop informs this study. literature review several factors ranging from capital inflow to human capital, evidenced from the empirical and theoretical literature, have been found to influence agricultural output. recently in africa, a hike in the prices of agricultural products alongside increasing population, reducing disposable income, unbalanced political and economic situation has awakened not only the national policymakers but scholars across the globe. the hike in agricultural productivity has mostly not been given attention by scholars from the perspective of the political will of the government in conjunction with the fluctuating exchange rates. nmadu and akinola, (2015) investigated the factors affecting the availability of food crop production in nigeria. data for the study was obtained from 180 farmers in niger state via a 106 economic analysis (21, vol. 54, no. 2, 104-117) structured interview. the empirical result shows that the main source of supply of labour are family and hired labour. the regression result further revealed that total farm labour supply, age, household size, non-farm income, farm size, gender, education, health status, agro-chemical, capital and equity investment are positively related to agricultural crop output in nigeria while wage rate, migrated family, seed and fertilizer are inversely related to agricultural output in nigeria. however, the labour input model shows that age, household size, wage rate, non-farm income, farm size, gender, farm income, migrated family, health status, seed, capital and equity investment are positively related to labour input while education, agro-chemical and fertilizer are inversely related to labour input. dorward (2013) investigated the effect of agricultural productivity and food price on development and poverty reduction. this paper found that recent policymakers usually ignore the role of agricultural productivity sustainability and real food price changes across the globe. this is evidenced by the absence of relevant and accessible indicators for monitoring agricultural productivity sustainability and real food prices across the globe. rеy et al. (2016) classified the factors affecting agricultural sector negatively as a movement of the youth from village to cities, hostile ecological nature impacting both individual and nature, variation in weather condition. they further identified the factors inversely impact on the effectiveness of labour as technical, natural and technological factors. the study concluded that it is important to generate new jobs and develop the agricultural sector to increase labour effectiveness in the agricultural industry. polyzos and arabatzis (2006) investigated the variation in productivity of labour across 51 the greek regions. the paper further ascertains the factors that impact the productivity of the agricultural industry. the result shows that employment in the agricultural sector, cultivated agricultural areas., number of tractors, irrigated agricultural areas, degree of divisibility of the cultivated agricultural areas, the level of training and education of the population are positively related to agricultural sector productivity while investments in the agricultural sector and population potential are negatively related to agricultural sector productivity. agwu et al. (2013) examined the type of farm labour engaged by farmers in abia state and also identified the determinants of youths in agricultural sector in abia. the result shows that the coefficients of occupation of the parents, age, occupation of the parents and farm size are positively related to participation of youths in agricultural sector while education of the respondents, income from nonagricultural sources, education of the father and the rate of mechanization are inversely related to to participation of youths in agricultural sector. kimenyi et al. (2014) evaluate the role of the violence in nigeria and mali on the agricultural output and investment. the result from survey carried out shows that sustaining investments in conflict-affected areas could be achieved by engaging in small animal production, kitchen gardens and fishery production. the survey result also shows that organizing of trainings and workshops for farmers in safe locations in order to acquaint them with the recent development in farm mechanization. olayemi et al. (2021) investigated the political economy of agricultural development in northern nigeria. the study investigation revealed that the agricultural sector in nigeria has been neglected by the government in the past, giving greater attention to the oil sector which has recently recorded reduction in price. the investigation further revealed the factors that impacted on the agricultural development inversely in nigeria as follows; land tenure systems; rising populations and reducing land for farming; insufficient funding for procurement of farm machines and tools; insurgency in the north; migration of youths from rural area to the cities; low level of education; dishonest government officials; over reliant on oil sector; harsh government policies unfavorable to the agricultural sector and poor infrastructure development. naluwairo (2011) compared and analysed the manifestos of the political parties that partook in the presidential elections in uganda. the paper highlighted some of the areas omitted by the kareem arikewuyo, lateef yunusa, babatunde oke, babatunde okuneye 107 political parties in their manifestoes which will contribute to the success of the agricultural sector in uganda. the identified areas are good governance and institutional planning the agric industry; new innovation in the agricultural sector apart from the research and technology development; and the preservation and non-jeopardy usage of plant genetic resources for food and agriculture rightly. briones and felipe (2013) examined the variance in agricultural employment and agricultural output in asia. the study however noted that the successful asian countries gave investment in agriculture greater attention which led to the agricultural sectors being the largest employer of labour in the asian economy. the result of the study shows that for the developing asian countries to experience growth in their agricultural product, they need to key into recent development in the agricultural sector which will in the long-run help to increase the agricultural employment in relation to its output share. to take advantage of the transformation, the asian countries need to have a long-term productivity growth objective in agriculture and carry out an upgrade of their farm inputs. mukasa et al. (2017) investigated the agricultural transformation process in africa, identifies the regions that needs to be prioritized in the transformation process, as well as identification of the challenges facing african countries in their efforts to overcome structural impediments to agricultural development. the study however concluded that to achieve an increasing productivity in the agricultural sector, financial instrument that will solve the financial needs of the farmers need to be created. accessibility of modern farm implements by the farmers is also germane in the quest for increasing agricultural output. organizing of training and workshops for youths and women in agricultural is also important in developing the skills of the farmers. encouragement of free trade within the region will also help promote the marketing of agricultural output which is part of the political will of the government of the region, this will promote intra-african trade and ensure ease transformation process. methodology model specification this study is hinged on the endogenous growth theory of solow (1950). the theory opines that output in an economy is a function of capital, labour and technology. the solow model is expressed as: 𝑦𝑦 = 𝑓𝑓(𝐾𝐾, 𝐿𝐿, 𝐴𝐴) (1) based on the theory, agricultural output depends on material inputs/farm implements which serve as inputs. these inputs represent technology in our model because farm activities are being executed with the use of modernized technological inputs. more so, procurement of farm input is often affected by appreciation and depreciation of the exchange rate of a nation in relation to its trading partners currency (yunusa, 2020) which necessitate the incorporation of exchange rate into our model. in order to attain the effect of labour and political will on agricultural output, the model is modified and expressed as: 𝑦𝑦 = 𝑓𝑓(𝐾𝐾, 𝐿𝐿, 𝐴𝐴, 𝐸𝐸𝐸𝐸𝐸𝐸ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑅𝑅𝑎𝑎𝑅𝑅𝑎𝑎) (2) the solow model is premised on the assumption of cobb–douglas production function, the modified solow model in equation (1) is thus expressed in cobb–douglas form and expressed as: 𝑦𝑦𝑡𝑡 = 𝑓𝑓(𝐾𝐾𝑡𝑡𝛼𝛼, 𝐿𝐿𝑡𝑡 𝛽𝛽, 𝐴𝐴𝑡𝑡, 𝐸𝐸𝐸𝐸𝐸𝐸ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑅𝑅𝑎𝑎𝑅𝑅𝑎𝑎𝑡𝑡) (3) 108 economic analysis (21, vol. 54, no. 2, 104-117) where 𝑦𝑦𝑡𝑡 is the output at time 𝑅𝑅, 𝐾𝐾𝑡𝑡𝛼𝛼 is the political will at time 𝑅𝑅, 𝐿𝐿𝑡𝑡 𝛽𝛽 is the labour at time 𝑅𝑅, 𝐴𝐴𝑡𝑡 is the agricultural input, 𝐸𝐸𝐸𝐸𝐸𝐸ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑅𝑅𝑎𝑎𝑅𝑅𝑎𝑎𝑡𝑡 is the exchange rate at time 𝑅𝑅. the model is restated in panel forms and expressed as: 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝛽𝛽0 + 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽2𝐴𝐴𝐸𝐸𝐴𝐴𝑖𝑖,𝑡𝑡 + 𝛽𝛽3𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽4𝐺𝐺𝐺𝐺𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝜇𝜇𝑖𝑖,𝑡𝑡 (4) 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝛽𝛽0 + 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽2𝐴𝐴𝐸𝐸𝐴𝐴𝑖𝑖,𝑡𝑡 + 𝛽𝛽3𝐸𝐸𝑃𝑃𝐿𝐿𝑖𝑖,𝑡𝑡 + 𝛽𝛽4𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽5𝐺𝐺𝐺𝐺𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝜇𝜇𝑖𝑖,𝑡𝑡 (5) 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝛽𝛽0 + 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽2𝐺𝐺𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽3𝐴𝐴𝐸𝐸𝐴𝐴𝑖𝑖,𝑡𝑡 + 𝛽𝛽4𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽5𝐺𝐺𝐺𝐺𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝜇𝜇𝑖𝑖,𝑡𝑡 (6) 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝛽𝛽0 + 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽2𝐺𝐺𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽3𝐴𝐴𝐸𝐸𝐴𝐴𝑖𝑖,𝑡𝑡 + 𝛽𝛽4𝐸𝐸𝑃𝑃𝐿𝐿𝑖𝑖,𝑡𝑡 + 𝛽𝛽5𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽6𝐺𝐺𝐺𝐺𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝜇𝜇𝑖𝑖,𝑡𝑡 (7) 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝛽𝛽0 + 𝛽𝛽1𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽2𝐸𝐸𝑃𝑃𝐿𝐿𝑖𝑖,𝑡𝑡 + 𝛽𝛽3𝐴𝐴𝐸𝐸𝐴𝐴𝑖𝑖,𝑡𝑡 + 𝛽𝛽4𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽5𝐴𝐴𝐸𝐸𝐴𝐴 ∗ 𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽6𝐺𝐺𝐺𝐺𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝜇𝜇𝑖𝑖,𝑡𝑡 …(8) where 𝑦𝑦 is the agricultural output,𝐸𝐸𝐸𝐸𝐸𝐸 is the employment of labour, 𝐴𝐴𝐸𝐸𝐴𝐴 is the agricultural raw materials, 𝐸𝐸𝑃𝑃𝐿𝐿 is the political will, 𝐸𝐸𝐸𝐸𝐸𝐸 is the exchange rate, 𝐺𝐺𝐺𝐺𝐸𝐸 is the gross fixed capital formation and 𝜇𝜇 is the error term. data and estimation techniques this study used annual panel data covering 29 sub-saharan african countries from 1990 to 2018, namely, benin, burkina faso, burundi, cameroon, congo republic, cabo verde, ethiopia, gabon, ghana, guinea, gambia, kenya, liberia, lesotho, madagascar, mauritania, mauritius, malawi, namibia, nigeria, rwanda, senegal, sierra leone, togo, tanzania, uganda, south africa, zambia and zimbabwe. the data used for this study were obtained from the international financial statistics and world development indicator (wdi). data on exchange rate was obtained from international financial statistics while data on agricultural output, political will, employment of labour in agriculture, agricultural raw materials, male employment in agriculture and female employment in agriculture were obtained from wdi. this study employed the panel estimation technique in order to estimate the impact of the independent variables on the dependent variable. it is to be noted that it is imperative to carry out unit root test in order to ascertain the order of integration of the variables. this study estimated the dynamic panel data system generalised method of moment (gmm) (arellano & bover, 1995; blundell & bond 1998) which was based on the prior model developed by (arellano and bond 1991) where differencing of all the regressors was introduced and called difference gmm. the model of arellano and bond was based on the following assumptions; that the observation is greater than the time (n>t), linearity in relationship, inclusion of lagged value of the dependent variable as independent variable, regressors are not strictly exogeneous, fixed individual effects and problem of autocorrelation & heteroskedasticity within a variable (roodman, 2009). imposing the strict exogeneity assumption leading to violations and discrepancy in our fixed-effect model which leads to generation of a single-equation dynamic gmm estimator by using a common factor representation (blundell & bond, 1998). the dynamic panel output model is expressed as: 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝜌𝜌 + 𝜔𝜔𝑦𝑦𝑖𝑖,𝑡𝑡−1 + 𝜃𝜃1𝐴𝐴𝑖𝑖,𝑡𝑡 + 𝜃𝜃2𝐾𝐾𝑖𝑖,𝑡𝑡 + 𝜃𝜃3𝐿𝐿𝑖𝑖,𝑡𝑡 + 𝜃𝜃4𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝜃𝜃5𝐺𝐺𝐸𝐸𝐺𝐺𝑖𝑖,𝑡𝑡 + 𝜇𝜇𝑖𝑖,𝑡𝑡 (9) 𝑖𝑖 = 1 … … . 𝑎𝑎, 𝑅𝑅 = 1 … … . 𝑇𝑇 𝜌𝜌 is the constatnt parameter, 𝜔𝜔 and 𝜃𝜃 are the output elasticities the violation of the assumption of strict orthogonality led to the introduction of varying parameters by taking the semi-derivatives of the variables to account for variances in units and measurements. kareem arikewuyo, lateef yunusa, babatunde oke, babatunde okuneye 109 𝜀𝜀𝑖𝑖,𝑡𝑡 = 𝜇𝜇𝑖𝑖,𝑡𝑡 + 𝜐𝜐𝑖𝑖,𝑡𝑡 (10) the disturbance term 𝜀𝜀𝑖𝑖,𝑡𝑡 comprise of two orthogonal components; the fixed effects that is timeinvariant which is 𝜇𝜇𝑖𝑖,𝑡𝑡 and the idiosyncratic shocks which is represented by 𝜐𝜐𝑖𝑖,𝑡𝑡 which is assumed to be independent and normally distributed with zero (0) mean and constant variance. adjustment of the agricultural output is expected to be affected by factors such as political will, employment of labour in agriculture, agricultural raw materials, male employment in agriculture, female employment in agriculture, gross capital formation and exchange rate. agricultural output adjustment to changes in these factors is dependent on two basic conditions, first is the passage of time which give rise to the introduction of the lagged values of the factors as independent variables, and second is the equilibrium of agricultural output and the previous year actual output which led to the introduction of the dynamic gmm in which lag of the dependent variable is also included as independent variable in the model. application of ols in our estimation could lead to “dynamic panel bias” which occurs due to correlation between the lagged value of the dependent variable and the fixed effects in the error term which leads to the violation ols assumption which is necessary for attaining an unbiased estimate, leading to endogeneity problem. introduction of lagged variable as an instrument in the strict orthogonal assumption helps in solving this problem which is incorporated in the system gmm (blundell and bond, 1998; roodman, 2009). this study therefore estimated the impact of political will and labour on agricultural output in sub-saharan african countries using the system gmm based on the satisfaction of some assumptions. the dynamic gmm model is expressed as: 𝑦𝑦𝑖𝑖,𝑡𝑡 = 𝛼𝛼 + 𝛽𝛽3𝑌𝑌𝑖𝑖,𝑡𝑡−1 + 𝛽𝛽1𝐸𝐸𝑖𝑖,𝑡𝑡 + 𝛽𝛽2𝑍𝑍𝑖𝑖,𝑡𝑡 + 𝜀𝜀 (11) 𝑦𝑦𝑖𝑖,𝑡𝑡 represents agricultural output 𝛽𝛽3𝑌𝑌𝑖𝑖,𝑡𝑡−1 represents the lagged value of the agricultural output 𝛽𝛽1𝐸𝐸𝑖𝑖,𝑡𝑡 represents the independent variables which are political will, employment of labour in agriculture, agricultural raw materials, male employment in agriculture, female employment in agriculture 𝛽𝛽2𝑍𝑍𝑖𝑖,𝑡𝑡 represents the control variables which are gross capital formation and exchange rate. results and discussion this section comprises of the descriptive statistics, correlation matrix, the unit root test and the gmm result. the descriptive statistics is revealed in table 1. table 1. descriptive statistics of parameters 𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽𝑽 𝑶𝑶𝑽𝑽𝑶𝑶 𝑴𝑴𝑽𝑽𝑽𝑽𝑴𝑴 𝑺𝑺𝑺𝑺𝑺𝑺. 𝑫𝑫𝑽𝑽𝑫𝑫. 𝑴𝑴𝑽𝑽𝑴𝑴 𝑴𝑴𝑽𝑽𝑴𝑴 𝑽𝑽𝒂𝒂𝒂𝒂 597 9.21549 0.6006536 7.809687 11.06718 𝒑𝒑𝒑𝒑𝑽𝑽 607 1.259814 0.3359039 0.3198867 1.89786 𝑽𝑽𝒆𝒆𝒑𝒑 609 1.630976 0.2840179 0.6627578 1.965216 𝒆𝒆𝑽𝑽𝒑𝒑 609 1.634259 0.2576385 0.7371131 1.943208 𝒇𝒇𝑽𝑽𝒑𝒑 609 1.608421 0.3559388 0.4821587 1.985718 𝑽𝑽𝒆𝒆𝑽𝑽 528 0.0607285 0.2974615 -0.833841 1.266762 𝑽𝑽𝑴𝑴𝒆𝒆 598 2.136938 0.7692887 -1.625142 9.827566 𝒂𝒂𝒇𝒇𝒆𝒆 515 9.321027 0.6282011 7.639185 10.95196 source: authors computation. 110 economic analysis (21, vol. 54, no. 2, 104-117) table 1 reveals the descriptive statistics of the datasets, a wide difference exists between the mean and standard deviation of all the variables used in the study. the average value also falls between maximum and minimum values. the correlation coefficients of the variables are shown in table 2. table 2. correlation matrix variable 𝑽𝑽𝒂𝒂𝒂𝒂 𝒑𝒑𝒑𝒑𝑽𝑽 𝑽𝑽𝒆𝒆𝒑𝒑 𝒆𝒆𝑽𝑽𝒑𝒑 𝒇𝒇𝑽𝑽𝒑𝒑 𝑽𝑽𝒆𝒆𝑽𝑽 𝑽𝑽𝑴𝑴𝒆𝒆 𝒂𝒂𝒇𝒇𝒆𝒆 𝑽𝑽𝒂𝒂𝒂𝒂 1.0000 𝒑𝒑𝒑𝒑𝑽𝑽 0.2433 1.0000 𝑽𝑽𝒆𝒆𝒑𝒑 0.2487 0.8697 1.0000 𝒆𝒆𝑽𝑽𝒑𝒑 0.2599 0.8828 0.9844 1.0000 𝒇𝒇𝑽𝑽𝒑𝒑 0.2551 0.8250 0.9759 0.9253 1.0000 𝑽𝑽𝒆𝒆𝑽𝑽 -0.0145 0.0421 -0.0564 -0.0394 0.0835 1.0000 𝑽𝑽𝑴𝑴𝒆𝒆 0.2001 0.3785 0.4072 0.4363 0.3545 0.0522 1.0000 𝒂𝒂𝒇𝒇𝒆𝒆 0.7372 -0.3876 0.3024 -0.2988 -0.2669 -0.1245 0.0403 1.0000 source: authors computation. the correlation coefficients in table 2 revealed that there is no likelihood of occurrence of multicollinearity among the variables used in this study as showed by the correlation coefficients. the test in table 3 reveals the traits of the dataset used in the study order to ascertain the level of stationarity of the variables which helps to avoid a spurious result. the fisher unit root was preferred because the study used an unbalanced panel. the null hypothesis of the fisher test is that “all panels contain a unit root” while the alternate hypothesis is that “at least one panel is stationary”. the unit root result is presented in table three. table 3. fischer unit root variables adffischer im-pesaran-shin order of integration 𝑽𝑽𝒂𝒂𝒂𝒂 109.2393 (0.0001) -4.2640 (0.0000) i(0) 𝑽𝑽𝑴𝑴𝒆𝒆 90.6557 (0.0039) -2.3655 (0.0090) i(0) 𝒂𝒂𝒇𝒇𝒆𝒆 39.4662 (0.9309) 0.1709 (0.5678) i(1) 𝒑𝒑𝒑𝒑𝑽𝑽 207.9351 (0.0000) -3.9728 (0.0000) i(0) 𝑽𝑽𝒆𝒆𝒑𝒑 39.0078 (0.9738) 0.9723 (0.8346) i(1) 𝒆𝒆𝑽𝑽𝒑𝒑 38.4457 (0.9777) 0.1473 (0.5586) i(1) 𝒇𝒇𝑽𝑽𝒑𝒑 62.4172 (0.3221) 1.2685 (0.8977) i(1) 𝑽𝑽𝒆𝒆𝑽𝑽 130.4109 (0.0000) -4.3556 (0.0000) i(0) source: authors computation. table three (3) shows the adffischer and im-pesaran-shin unit root test results. the two test results shows that variable 𝑎𝑎𝑎𝑎𝑎𝑎, 𝑎𝑎𝐸𝐸𝐸𝐸, 𝑝𝑝𝑝𝑝𝑝𝑝 and 𝑎𝑎𝑎𝑎𝑖𝑖 are stationary at level i(0) while variable 𝑎𝑎𝑔𝑔𝑖𝑖, 𝑎𝑎𝑎𝑎𝑝𝑝, 𝑎𝑎𝑎𝑎𝑝𝑝 and 𝑓𝑓𝑎𝑎𝑝𝑝 are non-stationary at level but after first differencing, they became stationary at first difference i(1). the unit root test result further helps to reveal the covariance nature of the data set in a study (adekunle, 2020). the study further estimated the two-step dynamic system generalized method of moment (gmm) because of its ability to capture the uniqueness of the traits of these data and relying on the empirical works of adekunle (2020) and roodman (2009) for further consultations. gmm results for the models are presented in the table 4. kareem arikewuyo, lateef yunusa, babatunde oke, babatunde okuneye 111 table 4. gmm result variable model 1 model 2 model 3 model 4 model 5 ago i,t−1 0.8830225 (0.0731397) 0.9426038 * (0.0485049) 0.900545 * (0.0247166) 0.9187858 (0.0525472) 0.958088 * (0.0173555) emp i,t 0.0166305 (0.0139171) -0.0477362 (0.0525969) -0.0346398 (0.0389692) ami i,t -0.0223713 (0.0208141) 0.0096478 (0.0066705) 0.0130232 (0.0085888) 0.0204369 ** (0.0104496) 0.0024863 (0.0193576) pwl i,t 0.0837539 * (0.0292334) 0.1375857 (0.0820593) 0.0388306 (0.0333753) mep i,t 0.1071533 (0.1480049) -0.0290735 (0.098888) fep i,t -0.0562225 (0.0980601) 0.0242645 (0.0756916) ami ∗ exc i,t 0.0032957 (0.0047626) exc i,t 0.0805739 (0.0541607) -0.0002586 (0.0245654) -0.0186452 (0.0223099) 0.0209094 (0.0260658) 0.0617634 (0.0429736) gfc i,t 0.0356914 * (0.0148287) 0.0408081 (0.0210307) 0.0216388 (0.0120304) 0.0709811 ** (0.0318943) 0.0296399 ** (0.0135081) α i,t 0.5559287 (0.4414577) 0.1343522 (0.3029615) -0.2403711 (0.1520994) -0.1150769 (0.3119662) 0.1304668 (0.2075649) observation 414 414 414 414 494 number of countries 29 29 29 29 29 number of instruments 231 231 231 231 232 wald chi2 800865.54 * 46624.79 * 702457.65 * 22461.46 * 20323.44 * ar (1) 0.007 0.023 0.016 0.033 0.005 ar (2) 0.643 0.587 0.616 0.557 0.703 sargan test chi (2) 0.560 0.510 0.538 0.483 0.392 note: the dependent variable is the agricultural output, natural logarithm of all the variables were used. standard errors are reported in brackets. level of significance was reported as * and ** representing 1 and 5 percent respectively. the coefficients of the lagged dependent variable 𝑎𝑎𝑎𝑎𝑎𝑎 across the models are positively and statistically significant indicating that the agricultural output has been consistence. an increase in the lagged value of agricultural output increases the present agricultural output in ssa region. contrarily, a reduction the in the lagged agricultural output worsen the present agricultural output in ssa region which is not good for the region. furthermore, the first model shows that employment in the agricultural sector (𝑎𝑎𝑎𝑎𝑝𝑝) is positively related to agricultural output thereby increasing the volume of agricultural produce available for consumption in the region. an increase in the level of employment in the agricultural sector increases the agricultural output by 0.0166 in the ssa region. the coefficient of agricultural raw material (𝑎𝑎𝑎𝑎𝑖𝑖) shows an inverse relationship with agricultural output, thus, decreasing the agricultural produce available for consumption in the sector. this means a percentage increase in the agricultural raw material reduce the agricultural output in the ssa region by 0.0224. the coefficient of exchange rate (𝑎𝑎𝐸𝐸𝐸𝐸) shows a direct relationship with agricultural output, thus, a rise in the exchange rate increases the agricultural output in ssa region. the implication of this is that depreciation of exchange rate appears to increase the agricultural productivity in ssa region. gross capital formation(𝑎𝑎𝐸𝐸𝑓𝑓) exhibit a significant positive relationship with agricultural output in the region, promoting productivity in the agricultural sector in the ssa region. 112 economic analysis (21, vol. 54, no. 2, 104-117) additionally, in the second model, we introduced the political will (𝑝𝑝𝑝𝑝𝑝𝑝) into our model which shows the willingness of the government to support the agricultural sector or not. the coefficient of labour employment and agricultural raw materials are negatively and positively related to agricultural output respectively, thus, decreasing and increasing agricultural output by 0.0477 and 0.0096 respectively. the finding of negative effect of labour employment in agricultural sector contradicts the submission of polyzos and arabatzis (2006) whose study found positive impact on agricultural sector productivity. this contradiction may be due to difference in area of studies as well as period of coverage. also, the coefficient of political will is positively related to agricultural output in the region, thus, increasing the agricultural produce available for consumption in the region as a result of the government support directed towards the agricultural sector. this means a percentage increase in the political will increase the agricultural output in the ssa region by 0.0838. inclusion of the political will reduced the labour employment but increased the agricultural raw material which represents the level of technology introduced into the agricultural sector. also, in the third model was the decomposition of employment in agricultural sector into male employment in agriculture (𝑎𝑎𝑎𝑎𝑝𝑝) and female employment in agriculture (f𝑎𝑎𝑝𝑝) but isolated the labour employment, the coefficient of the male employment in agriculture is positively related to agricultural output while the coefficient of female employment is negatively related to agricultural output in ssa region. a unit increase in the male employment increase agricultural output by 0.1072 while an increase in the female employment in agricultural sector decreases agricultural output by 0.0562 in the ssa region. the implication of this is that, without government support (political will), male employment in agricultural sector promotes productivity while female engagement decreases the agricultural output in the ssa region. what could be deduced is that the self-effort of male employment promotes agricultural productivity in ssa when compared to female employment. however, introduction of political will into model three (3) which gives rise to model four (4) shows that female employment in agricultural sector promotes agricultural output compared with their male counterpart which exert a negative influence, though insignificant, leading to a reduction in the output of the sector. the implication of this is that government support (i.e. political will) in agricultural sector increased the female contribution in the agricultural sector, possibly encouraged more female participation in the sector. the coefficient of the male employment in agriculture is negatively related to agricultural output while the coefficient of female employment is positively related to agricultural output in ssa region. a unit increase in the male employment decrease agricultural output by 0.0291 while an increase in the female employment in agricultural sector increases agricultural output by 0.0243 in the ssa region. the economic intuition of negative influence of male employment on agricultural output revealed the migration of african male youths into non-farm or service industry due to lack of political will towards male counterpart which is a pointer to the fact that the future prospects of agriculture in ssa may become a myth in the year 2035 and this would exacerbate unemployment and poverty in ssa. this is partially in consonance with the submission of rey et al. (2016). furthermore, the coefficient of political will is positively related to agricultural output, thus, an increase in political will increases the agricultural output by 0.1375 in the ssa region. government support in agricultural sector has afforded the female farmers more opportunity which resulted in increased agricultural output in the ssa region. the fifth model which shows the interactive role of agricultural raw material and exchange rate on agricultural output indicates the interaction of these variables has increased the agricultural productivity in ssa region. a unit increase in labour employment in agricultural sector decreased the agricultural output by 0.0347 while increase political will increased agricultural output in ssa by 0.0388. the negative effect of labour employment on agricultural output has a serious economic implication in ssa as this showed the danger looming in the region which may breed high unemployment rate since natural resources in ssa would remain untapped in the foreseeable kareem arikewuyo, lateef yunusa, babatunde oke, babatunde okuneye 113 future. more so, the coefficient of interaction of agricultural raw material and exchange rate increase the agricultural output by 0.0033 in ssa region. the implication of this is that purchase of agricultural input for enhancing the farmers productivity which are mostly imported from developed countries are highly dependent on fluctuation of exchange rate, appreciation of domestic currency is expected to increase the purchasing power of the local farmers while depreciation of the exchange rate limits the number of farms implements that can be imported from the developed nations. thus, the interaction has enhanced the productivity in the agricultural sector in ssa region. the reliability of the instruments used in the study are shown in 𝐴𝐴𝑅𝑅(1), 𝐴𝐴𝑅𝑅(2) and sargan test. the serial correlation test 𝐴𝐴𝑅𝑅(1) indicate the existence of serial correlation at first order while the 𝐴𝐴𝑅𝑅(2) shows absence of serial correlation at second order in the three models which informs the acceptance of the null hypothesis of no serial correlation in the second order 𝐴𝐴𝑅𝑅(2). the sargan test revealed that all the instruments are exogenous which informs the acceptance of the null hypothesis which implies that the instruments used in the study are independent of one and others across the models. the pooled ordinary least square (pols) and fixed effect regression (fer) were further estimated in order to ascertain the validity of the dynamic system gmm leaning on the empirical credence of (adekunle, 2020; blundel et al., 2001) they asserted that another way of detecting the validity of dynamic system gmm is by ensuring that the lagged values of the dependent variable in the gmm model falls between estimates of pols and fer. however, our dynamic gmm result estimates in table 4 lies between the pols and fer in table 5 and 6 respectively (𝐺𝐺𝐸𝐸𝑅𝑅=0.7431<𝐺𝐺𝐸𝐸𝐸𝐸=0.8830<𝐸𝐸𝑃𝑃𝐿𝐿𝑃𝑃=0.9878). pooled ordinary least square (pols) result variable model 1 model 2 model 3 model 4 model 5 𝐚𝐚𝐚𝐚𝐚𝐚 𝐢𝐢,𝐭𝐭−𝟏𝟏 0.9878187* (0.0070345) 0.9640292 * (0.0088824) 0.9860334 * (0.0072066) 0.9638923 * (0.0088908) 0.9642284 * (0.0080784) 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0203721** (.0102896) -0.0088468 (0.0122064) 0.0078961 (0.010577) 𝐚𝐚𝐞𝐞𝐢𝐢 𝐢𝐢,𝐭𝐭 0.0120657 (0.0066645) 0.0140009 ** (0.0065456) 0.0119372 * (0.0066886) 0.0421673 ** (0.0081349) 𝐞𝐞𝐩𝐩𝐩𝐩 𝐢𝐢,𝐭𝐭 0.0643489 * (0.0151562) 0.063671 * (0.0155406) 0.0461194 * (0.0123285) 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0367449 * (0.0200362) 0.0062738 (0.020964) 𝐟𝐟𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 -0.0079077 (0.0129036) -0.0111398 (0.0126481) 𝐚𝐚𝐞𝐞𝐢𝐢 ∗ 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0054065*** (0.0028483) 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0030956 (0.0035217) -0.0007751 (0.0035688) 0.0019042 (0.0036496) -0.0012506 (0.0036513) 0.0276185 (0.0059356) 𝐚𝐚𝐟𝐟𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0184875 ** (0.0071664) 0.0447401 * (0.0093559) 0.0204132 * (0.0073203) 0.045062 * (0.0093599) 0.0440693 * (0.0082499) α 𝐢𝐢,𝐭𝐭 -0.0884827 (0.0350557) -0.1390194 (0.0363505) -0.1015023 (0.0365876) -0.1456302 (0.0373721) -0.1396294 (0.0361624) wald chi2(5) 106744.47* 111216.99 * 106211.05 * 111083.99 * 99523.40 * adjusted r2 0.9962 0.9964 0.9962 0.9964 0.9956 observations 414 414 414 414 494 countries 29 29 29 29 29 source: authors computation, 2020. nb: the dependent variable is the agricultural output, natural logarithm of all the variables were used. standard errors are reported in brackets. level of significance was reported as *, ** and *** representing 1, 5 and 10 percent respectively. 114 economic analysis (21, vol. 54, no. 2, 104-117) fixed effect regression (fer) variable model 1 model 2 model 3 model 4 model 5 𝐚𝐚𝐚𝐚𝐚𝐚 𝐢𝐢,𝐭𝐭−𝟏𝟏 0.7431222 * (0.0330419) 0.7169137 * (0.0321341) 0.7352188 (0.0342829) 0.7132711 * (.0332599) 0.7505996 * (0.0291562) 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 -0.0919474 ** (0.035551) -0.1676292 * (0.0367595) -0.1242996 * (0.0363744) 𝐚𝐚𝐞𝐞𝐢𝐢 𝐢𝐢,𝐭𝐭 0.0017882 (.0100725) 0.0093519 (0.0097851) 0.0006918 (0.0101586) 0.0087522 (0.0098929) 0.0075912 (0.0052057) 𝐞𝐞𝐩𝐩𝐩𝐩 𝐢𝐢,𝐭𝐭 0.189204 * (0.0336353) 0.1867616 (0.0337076) 0.1544507 * (0.0293837) 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.025671 (0.0912496) -0.0513294 (0.0889886) 𝐟𝐟𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 -0.0977443 (0.0703091) -0.1007528 (0.0677279) 𝐚𝐚𝐞𝐞𝐢𝐢 ∗ 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0034327 (.0036284) 𝐞𝐞𝐞𝐞𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0374154 (0.0243881) 0.0319035 (0.0234878) .0405391 .0246711 0.0334185 (0.0237993) 0.0312976 (0.0024389) 𝐚𝐚𝐟𝐟𝐞𝐞 𝐢𝐢,𝐭𝐭 0.0589008 (0.0137736) 0.0807868 (0.0138129) 0.0601983 * (0.013839) 0.0814295 (0.0138704) 0.0959967 * (0.0129259) α 𝐢𝐢,𝐭𝐭 1.89948 (0.2863766) 1.83629 (0.2757941) 1.918594 (0.2865883) 1.836181 (0.2764585) 1.419592 * (0.2504996) f-stat 357.04 * 326.61 * 297.47 * 279.18 * 492.82 * adjusted r2 0.9869 0.9918 0.9857 0.9911 0.9918 observations 414 414 414 414 494 countries 29 29 29 29 29 note: the dependent variable is the agricultural output, natural logarithm of all the variables were used. standard errors are reported in brackets. level of significance was reported as * and ** representing 1 and 5 percent respectively. summary and conclusion in spite of empirical works on agricultural output, little or no attention has been given to ascertaining the effect of political will and labour on agricultural output in ssa region, making this issue unaccounted for. scarcity of empirical works on this line of thought makes it crucial to dig deep. this identified lacuna helped to shape our thought and makes forecasting for the stakeholders a seamless task. in this light, this paper investigates the effect of labour and political will on agricultural output in in sub-saharan african nations from 1998-2018 using dynamic system-gmm estimation technique consisting of twenty-nine (29) cross-sections with a view of estimating the robustness check and short-run dynamics of the model. the result shows that employment in the agricultural sector is positively related to agricultural output but after inclusion of political will, employment in agricultural sector reduced the agricultural output. political will which shows the government willingness to support the agricultural sector is positively related to agricultural output. agricultural raw material exhibits a positive relation with agricultural output in all the models except model one. the result of the study also showed that male employment in agriculture increases the agricultural output while female employment decreased the agricultural output in ssa region. however, inclusion of political will i.e., government support promotes the contribution of female employment in agriculture, leading to increase in agricultural productivity while the male employment in agriculture reduced the agricultural output in ssa region. the result further revealed that the interaction between agricultural raw material and exchange rate promotes agricultural kareem arikewuyo, lateef yunusa, babatunde oke, babatunde okuneye 115 productivity in ssa region. from the result, it is glaring that the way forward to attain an increasing agricultural output is to engage more people in agriculture and ensure a policy that encourage higher female participation in agriculture in order to achieve continuous increase in the agricultural productivity in ssa. government support also contributed positively to the agricultural output in the region. this therefore portends a great deal for employment generation that would transform into poverty reduction through large scale supply of agricultural produce in ssa. importation of farm implements enhances higher agricultural productivity in the region. our study recommends that more people should be encouraged to participate, particularly, the female in order to harness the female impact on the economy. the government should also support the farmers in acquisition of new farm inputs in order to secure the future of african youthful population through agricultural productivity in ssa. references adekunle, i. a. 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"exchange rate volatility and nigeria crude oil export market." scientific african, 9, e00538. https://doi.org/10.1016/j.sciaf.2020.e00538 article history: received: december 11, 2021 accepted: december 28, 2021 do labour and political will affect agricultural output?: evidence from sub-saharan africa kareem abidemi arikewuyo10f* | lateef adewale yunusa2 | babatunde o. oke3 | babatunde adekunle okuneye4 introduction literature review methodology model specification data and estimation techniques results and discussion summary and conclusion references ea_2015_1-2 notes from of editor-in-chief the economic analysis appears to be growing in stature as the number of manuscripts submitted has been steadily increasing. it comes out twice a year and it is published by institute of economic sciences, belgrade. we appreciate the efforts of all the authors who have sent us quality papers, which passed the peer reviews and were published in our journal. we also expect that in the future we will 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spelling errors are encouraged to obtain such services prior to submission. at last, we want to remind you to follow the author's guide and to send your papers to the e-mail eaoffice@ien.bg.ac.rs. best wishes and thank you in advance for your contribution! editor-in-chief prof.mirjana radović-marković, phd, academician ea_2016_3-4 udc: 330.15:368 620.9 jel: q4, q42 cobiss.sr-id: 228332044 scientific review renewable energy sources and the possibility of their insurance vojinović željko1, university of novi sad, faculty of economics subotica, department of finance, banking, accounting and auditing,, subotica, serbia abstract – with the increase of population in the world is growing and demand for energy. since non-renewable sources has fewer mankind in the future must turn to renewable energy sources. identification, management and risk transfer are key components for projects related to renewable energy. in most situations, the funds for project will not be available except it's included component of insurance. the fundamental prerequsite for guiding and sustainable financial project is very effective identifcation and management of risk. increasing knowledge and understanding of this area insurance companies will begin to respond to the challenges faced by professionals and this will enable the growth of the industry. enough major role in financing and developing projects related to renewable energy sources, as well as in other areas of life, have insurance companies, which are more fully set out in the sequel. key words: energy, resources, risk, security, natural, premium introduction renewable energy sources are energy sources that come from nature and can be renewed. today it is increasingly used because of its harmlessness to the environment. renewable energy, excluding hydropower, give less than 1% of total energy demand. in future, share of the renewable sources should be notably increased because damaging influence of non-renewable sources has racily increased. renewable energy renewable energy sources are energy sources that come from nature and can be renewed. today it is increasingly used because of its harmlessness to the environment. it's important emphasis that renewable energy sources can be classified by biomass and large hydropower known as traditional sources and solar energy, wind energy, geothermal energy 1 professor, university of novi sad, faculty of economics subotica, department of finance, banking, accounting and auditing, segedinski put 9-11, 24000 subotica, serbia, phone: +381 24 628 000, fax: +381 24 546 486, e-mail: zeljko.vojinovic@ef.uns.ac vojnović, ž., renewable energy sources, ea (2016, vol. 49, no. 3-4, 40-47) 41 known as new renewables. renewable energy sources, excluding hydropower, gives less than 1% of total energy demand. with population growth in the world, demand for energy is growing. since a non-renewable source has less humanity in the future must turn to renewable energy sources. figure 1. gross domestic consumption of renewable energy sources in europe member states at 2000 and 2012. source: www.foeeurope.org, (11.10.2016) positive feature of renewable energy sources is reduction emission of carbon dioxide (co2) under an atmosphere and causing decrease of the greenhouse effect. also, increase the participation of renewable energy resources helping to improve energy security supply and decrease import dependance of raw materials and electricity. negative characteristics of renewable energy sources are: • exploitation of renewable energy is more expensive and technologically demanding from non-renewable sources of energy, • the amount of energy is much obtained using non-renewable energy sources. • it' impossible to transport the natural shape unless you transform them into el. energy. the target of 10% for the share of renewable energy sources in the transport sector represents a common goal for all countries for 2020 year. directive 2009/28/ec determines that only biofuels and bioliquids should be included because of their sustainable characters. in some countries their consumptions weren't be certified as compliant especially in period 2011-2013 because implementation of this directive was late. it's relevant to say that share of renewable energy sources increased since 2004 but it's share in transport declined between 2010 and 2011. this can be attributed to the total abscence of compliant biofuels reported by several countries member of eu. respecting accounting rules of this directive, the share of energy renewable sources in transport reached 5.4% in 2013.2 if all compliant and non 2 http://ec.europa.eu/eurostat/statistics-explained/index.php/energy_from_renewable_sources,(21.05.2015.) 42 economic analysis (2016, vol. 49, no. 3-4, 40-47) compliant biofuels consumed in the eu28 are taken into the account, their shares in transport will be above 5,8% in 2013.3 the central role of insurance identification, management and transfer risk are key components for projects related to renewable energy. in most situations, the funds for project will not be available except it's included component of insurance. that is why a potential risk will be less and ensure smooth and favorable outcome of the project. finding a suitable quality assurance isn't always easy for owners and workers of projects and without that risk profile can be considered insufficient. many entrepreneurs need to understand the complexity of risk factors faced, as well as the belief that insurers will seek to ensure coverage at viable rates. risks related to renewable energy and their priorities are higher than before. in addition, beginners can have a problem with complexity and innovation of this projects but with the ability to move much more "upside down". prototype technology may be involved in these projects, but it is incredibly difficult to assess and secure. moreover, despite all new technologies for renewable energy sources, standards and practices in industry should be more developed which makes it difficult risk benchmarking. this standards are related to the safety and risk in operational activities. owners of projects, often late in dilagoue with insurers, thereby be deprived of a significant contribution, which may seem a key challenges for success of their companies in the future. the role of expertise and services insurers risks of renewable energy sources of all types of insurers require experience in risk management in many relevant sectors. in fact, only a small part of the insurer has the necessary experience and skills in the sector. customers insurance, in this relatively new industry, should strive to learn the expertise of insurers, as well as the certainty that they will be able to honor its part of the contract when the insured event occurs. given that the purpose of insurance that pays a fee to sudden, unforeseen event, leading insurers and reinsurers has an aversion to risk so want to avoid the same. the analyses showed groups fo risk factors jointed with any kind of technology for renewable energy sources. it's assumed that this factors can jointly classified which leads to their relevance and this is important for level risk and it's construction. insurance policy is one of the complex area of the insurance. insurers can predict the probability so there lawsuits may be contrary with determining policies and evaluate their products accordingly and after the introduction of new products, the costs are much higher for insurers. 3 scarlat, n., j.f. dallemand, v. motola, and f. monforti-ferrario. "bioenergy production and use in italy: recent developments, perspectives and potential", renewable energy, 2013. vojnović, ž., renewable energy sources, ea (2016, vol. 49, no. 3-4, 40-47) 43 in order to make these decisions, insurers use actuarial science. actuaries analyzes risk factors in technology and economy responsible for evolvent by statistics. without using actuarial details, this factors can create a conceptual model available in insurance industry. "a number of insurers had a bad experience with wind power in the 1980s and early 90s, and although the industry has experienced tremendous growth since then and science technology has matured considerably, many insurers are still reluctant to provide projects with wind power. however, there are some that will do it and fully fund the project and will cover today. coverage of biomass energy is available for larger projects, but what is needed is a study project risk factors renewable energy affecting the insurance industry product to cover the security of supply of fuel. funders want to secure the supply of fuel, but still there is a product that does it. the flows of rivers supplying hydro facilities, however, smaller size, and for the development of mini-hydro facilities sometimes find it difficult to cover”4 insurance and renovated energy because of the relatively young nature of renewable energy sources, various experts working on the development of projects and continue to secure their financial support and safety. financial markets have a permanent problem with the difficulties in providing adequate management instruments for risk and new technology with renewable sources. one of primary conditions of accurate assessment are availability of historical actuarial data on risk factors, severity and frequency of key risk points.5 increasing knowledge and understanding of insurance companies, insurance companies and insurance brokerage will begin to respond to the challenges faced by professionals in the insurance and thus will enable the growth of the industry. this model can subsequently be developed by the actuary, which includes statistical probability and making estimates of the corresponding premium. it can use often and become very powerful model if choice of insurance products and package will be increased. therefore, insurance companies have an increasing role in financing and investment in ecology and economically sustainable energy and infrastructure projects in europe. boredom is allianz, europe's biggest insurer, has invested about 1.5 billion euros in solar and wind power, while the reinsurer munich re separated 2.5 billion for investment in renewable energy by 2016. and domestic insurance companies are slowly joining their foreign counterparts in financing environmental projects. however, a number of insurance companies in a range of its products have added security and renewable energy sources, because they possess the technical expertise and services to prevent losses in these projects. some of these companies are ace insurance in the usa, bruce stevenson leading insurance broker in scotland as well as rsa one of the leading international insurance groups and others. 4 bratt g.,”factors influencing the insurance industry”, 2010, str. 95. 5 www.esru.strath.ac.uk,(11.10.2016) 44 economic analysis (2016, vol. 49, no. 3-4, 40-47) the sun's energy solar energy is obtained from light and warmth of natural rays of sun. it's good to underline enormous potential for energy production. as a matter of fact, it;s estimated that enough energy from the sun reached earth at only 70 minutes to come the dmeands of global energy. instantly, there are two kind of technology that can transmute solar rays into electricity and solar collectors and photovoltaic cells. solar collectors transform energy into thermal energy or water and process warming of water systems can be opened which water be heated and goes directly across a roof collector where it is filled antifreeze. photovoltaic cells are semiconductor elements which directly transmute solar energy into electricity and they can be used as one of singular source of energy. by providing the unlimited power, solar energy obviously has enormous potential for reduction to using fossil fuels. one of the fact is solar energy contributes only 0.02% of global energy but her increase is rapidly. countries that lead in the introduction of photovoltaic power plants are spain, italy and germany, where demand increased due to favorable feed-in tariffs and subsidies. table 1. production of electricity from renewable sources per eu states (res-e) source: http://ec.europa.eu/eurostat/statistics-explained/index.php/energy_from_renewable_sources, (12.05.2015.) further in 2013, renewable energy accounted for 16.5% of total energy use for heating and cooling in the eu 28. this is significant growth from 9.9% in 2004. and the biggest increase is in industrial sectors, services and building sectors. aerothermal, geothermal and vojnović, ž., renewable energy sources, ea (2016, vol. 49, no. 3-4, 40-47) 45 hydrothermal heat energy taken by heat pumps is analyzed and reported by member states of eu.6 the share of renewable energy sources in gross final consumption is increased from 8.3% to 15% for ten years 2004-2013. this is proof of a stable progress towards the target of 20% by europe 2020. some countries haven't yet fully implemented all provisions of the renewable energy directive and some biofuels and bioliquids aren't counted as sustainable in the reporting period. the increased share between 2010 and 2011 isn't due to increased use of renewables but rather because of a decline in using of fossil energies, especially oil products and natural gas.7 wind farms are attractive from the perspective of security. homeowners insurance provides coverage damage and loss caused by fire, storm, theft, vandalism, earthquakes, landslides, eruptions, floods, tornadoes, typhoons and hurricanes. hydropower the power plant is the production of electricity from hydroelectric facility water. a movement requires reliable flow of water and reasonable amounts falling water. in typical installations, water is stored from the tank across canal or tube in the turbo. the pressure of liquid water on the blades causes rotating shaft which is linked to electric generator and it's providesthis movement of that shaft. the world's largest renewable energy source is water power where providing almost 0,2 of the entire world's electricity. large hydropower facility or a group of some plants could be create serious impact to environment and society. however, small hydro power plants can be developed using existing dam or creating new water gates whose are focused to control the level of rivers and lakes-water or irrigation. many projects mini-hydro power plants are based on downstream river flows and do not include the construction of dams. mini-hydro plants will have less influence to the environment if they are normally created and designed. mini-hydropower is a technology for future with simple application and adequate equipment and design and it's expected her using for over 100 years. if we look from the perspective of security, there are physical damage of property and loss of income as a result and injury to third parties are one of the major scenarios which can lead complaints. the major risks in building of mini-hydropower plants are fire, food, earthquake, landslide, collapse damage to equipment in transit. biomass energy biogas produced bacteria which crash organic waste and that includes sludge, botanical waste and food waste. anaerobic digestion and landfill gas represent two types of biogas power plants. first type reflects a form of interference which takes places in carefully controlled and constructed environment. on the other hand, landfill gas is similar with the main exception that initially takes place with oxygen. in this way the treated waste causes 6 http://ec.europa.eu/eurostat/statistics-explained/index.php/energy_from_renewable_sources, (11.03.2015) 7 isto, 46 economic analysis (2016, vol. 49, no. 3-4, 40-47) mehtane rich biogas and the rest of nutrient-rich liquid and solid materials suitable for usiung as fertilizer at agricultural land. re-acquired energy from waste has been important ecologically because it enables reduction amount of material and generates relatively inexpensive and sustainable source of fuel. likewise, we have point biodiesel and bioethanol as two form of biofuels. biodiesel is made from vegetable oils or tallow obtained from animal's fats while bioethanol is derived in the process of fermentation of crops such as corn, maize and wheat together. in its report, the wwf predicts that we will need for production of bioenergy about 250 million hectares of crops or 0,16 of global land until 2050. in addition, some crops offered little benefit for reducing emissions and in order to wwf wants to see compulsory criteria of sustainability. biogas has many risks mild violence bioenergy. due to the nature of raw material involved in biomass, fire risk tends to be bigger than biogas. property coverage provides protection from explosions, fires, floods, theft, etc. many countries require liability coverage because employees and other visitors have adequate protection and it's very significant for commercial production of bioenergy plants. conclusion mankind will soon have to find more environmentally friendly energy sources which will cover its energy needs. currently, as an environmentally friendly solution offering renewable sources of energy, but it is not realistic to expect that these energy sources are sufficiently developed to a greater extent meet the growing energy needs of mankind. solar energy is not enough exploitable and is very expensive, wind energy is not available in sufficient quantities and energetic potentials of water are already heavily exploited. bioenergy or biofuels are imposed as a substitute for traditional fossil fuels, but these fuels also causes the release of a variety of harmful gases and they are not completely ecologically acceptable. in addition to the biofuel is also one ethical problem. since biofuels are produced from sugar cane, corn, soybean, canola and other plants that serve as food. thus richer countries produce biofuels in ways that convert food into fuel, while the other side is extremely a lot of people on earth die of starvation and the same food would save their lives. environmental security, decrease emissions of greenhouse gas are the main reasons for the using renewable energy sources. also, improving protection of energy, increase economic competitiveness and less dependence of imported energy are very important and their significance shouldn't be ignored. financial markets have a permanent problem with risk and their providing using adequate management instruments by new technology for renewable energy sources. that's why insurance plays a major role in these projects, which, regardless of their financial value, is of great importance for the preservation of the environment. using the examples of many international insurance companies, and domestic security should be to incorporate environmental projects in their portfolios, which would divert public attention from those problems, and to attract new investment. of course, as long as they are legally within their states allow. vojnović, ž., renewable energy sources, ea (2016, vol. 49, no. 3-4, 40-47) 47 european commission has established a global framework for promotion of renewable energy determining by directive 2009/28/ec. this document settings required national targets of renewable energy for achievement a 20% a share in final energy consumption and a 10% share in transport by 2020. these goals are one of the main targets in european strategy for growth 2020. they contribute to europe’s industrial innovation and technological leadership, reduce greenhouse gas emissions, improve the security of our energy supply and reduce our energy import dependency.8 references bratt g. 2010 study of renewable energy project risk – factors influencing the insurance industry. university of strathclyde engineering shields c. 2010. renewable energy – facts and fantasies, green energy, usa. renewable energy: the insurance challenge an ace european group white internet site http://ec.europa.eu/clima/policies/brief/eu/package_en.htm http://www.esru.strath.ac.uk/ bruce stevenson insurance brokers – renewable energy http://www.brucestevenson.co.uk/ http:// www.biobasedeconomy.nl/ http://www.foeeurope.org/ rsa – insurance and renewable energy – emerging risks briefing http://www.rsagroup.com/rsagroup/en/home http://www.obnovljivi.com/index.php http://www.izvorienergije.com/ https://www.google.rs/search?q=tesla.pmf.ni.ac.rs/ http://www.worldwildlife.org/ article history: received: 25 march, 2016 accepted: 16 october, 2016 8 www.biobasedeconomy.nl, (11.10.2016.) doi: 10.28934/ea.22.55.2.pp49-65 first online: december 6, 2022 original scientific paper does the increase in the number of registered patents affect economic growth? evidence from romania and bulgaria ivana domazet16f* | darko marjanović1 | deniz ahmetagić2 | marija antonijević1 1 institute of economic sciences, belgrade, serbia 2 faculty of economics in subotica, serbia abstract the goal of this paper is to determine whether the increase in the number of registered patents per million inhabitants, as a measure of market verification of the results of r&d activities, affects economic growth and the increase in the country's innovation index. the empirical research covered two countries romania and bulgaria. given that the main task of the research was to accurately measure the investigated phenomena and discover the connection between them, the analysis was based on a quantitative research design. the analysis used secondary data from the international databases of the world bank and world intellectual property organization, covering the period from 2008 to 2018. the results of the empirical research showed that no correlations were found, which means that in the cases of romania and bulgaria, there is no dependence between the increase in the number of registered patents per million inhabitants and the growth of the innovation index and gdp per capita. key words: innovation, patents, innovation index, gdp per capita, development jel classification: o3 introduction economic growth is a key element for improving living standards, reducing poverty and achieving common progress (world bank, 2022). countries that generate new technologies and encourage their adoption, as well as those that create innovations, grow faster than those countries that do not promote these activities (domazet et al., 2021). the same authors state that patenting in certain industries is recognized as an important tool for protecting intellectual property and creating a sustainable competitive advantage. according to oecd (2004), patents have an important role in achieving innovation and economic performance. the changes that occurred in the last two decades regarding the patent policy of the oecd member countries encouraged the creation of patents to initiate investments in innovation and improve wedge. the oecd publication also points out that patents are intended to boost innovation in the private sector by enabling their inventors to profit from the invention. moser (2013) argues that policies aimed at spreading ideas and modifying patent rights to stimulation could be an adequate way to encourage innovation. the important role of patents in stimulating innovation and economic growth was emphasized in 2012 by the then-president of the european patent * corresponding author, e-mail: ivana.domazet@ien.bg.ac.rs 50 economic analysis (2022, vol. 55, no. 2, 49-65) organization (epo), benoît battistelli, during his speech at the bulgarian inventors of the year event (epo, 2022). it is important to understand that for patents to have a positive impact on economic growth, it is necessary to apply them in practice (atun et al., 2007). since the goal of every country is to achieve economic progress, numerous authors have examined the nature of the relationship between patents and economic growth. in this regard, some researchers have determined the existence of a positive relationship (wurster, 2021; maradana et al., 2017; pelinescu, 2017; nae & grigore, 2014; hasan & tucci, 2010; akçomak & ter weel, 2009; sinha, 2008; blind & jungmittag, 2008; crosby, 2000), while others identified the existence of a negative relationship between the mentioned variables (silaghi & medeşfălean, 2014; domazet et al., 2022). on the other hand, myszczyszyn (2020) and blind et al. (2021) argue that there is no relationship between patents and economic growth in the long run. bearing in mind that bulgaria and romania are countries that acceded to the eu at the same time (2007) and that they are characterized by similar issues concerning patents – long-term process, high costs, as well a lack of incentives (silaghi & medeşfălean, 2014; world bank, 2010), it is important to determine the nature of the relationship between patents and (a) economic growth and (b) innovation. in accordance with all the above, this paper aims to examine the relationship between the number of registered patents and economic growth and innovation in bulgaria and romania. the paper is structured as follows: the results of relevant studies concerning the relationship between patents, economic growth and innovation are presented in the literature review section. the methodology and results section describes the sample and applied statistical tests used to examine the nature of the relationship between patents, economic growth and innovation, and then presents the research results and their explanation. the last part of the paper deals with the conclusions of the conducted study. literature review analyzing the nonlinear effect of r&d, patents and exports of high-tech products on economic growth in 35 oecd countries for the period 1992-2006, ersin et al. (2022) have determined that there are significant marginal effects of economic growth rates, which are followed by threshold effects dominated by the participation of research and development in gdp. according to the research results of pelinescu et al. (2019) there is a positive and significant impact of growth in r&d expenditure on gdp growth per capita. however, the authors point out that each country should adjust patent rights according to the country's development, as well as the development of the respective industry. in addition, they determined that stronger patent protection is not desirable in underdeveloped countries. depending on the development of the economy, the contribution of patents to economic growth can differ (eliasson et al., 2004). pradhan et al. (2020) point to the role of intellectual property as one of the key drivers of economic growth. bearing in mind that developed countries are characterized by a significant fund of technological knowledge and human capital (alnuaimi et al., 2012), as well as appropriate institutional frameworks related to the protection of patents, that is, intellectual property rights (candelinpalmqvist et al., 2012), it can be concluded that developed countries may have better abilities to maximize utility from patents. based on the analysis of data from 99 countries in the period 1996-2018, rubilar-torrealba et al. (2022) claim that the more developed a country is, the more patents it tends to have. the increase in the number of patents can contribute to the development of innovations that can have a positive impact on economic growth (marjanović et al., 2019; caseiro & simões, 2019; pradhan et al., 2019). the number of patents is considered to be an adequate indicator for evaluating the success of innovative activities (dang & motohashi, 2015). patents can be used as a proxy for innovation crosby (2000) or as an indicator of innovation (blind et al., 2021). patent data are more closely related to innovation than research ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 51 and development data. in addition, patent data are more widely available since they cover a longer period and can be used in time series analysis crosby (2000). the research results, which in 1998-2016 included 43 countries (26 developed economies and 17 developing countries), showed that the number of new patents in the field of information and communication technologies (ict patents) has a positive one-way impact on economic growth. it is important to note that this type of patent has a positive long-term impact. also, the authors of the study identified a significant positive impact of patents on economic growth in developed countries. in contrast to developing countries, the impact of patents on economic growth is negative (nguyen & doytch, 2022). analyzing 4 european countries and 12 sectors, blind & jungmittag (2008) found that patents contribute to economic growth. likewise, the study points to the conclusion that patents are more important for growth in r&d-intensive industries. a positive impact of the number of patents on economic growth in the long term was identified in the study of josheski & koteski (2011), which covered the g7 countries in the period 1963–1993, while a negative impact was found in the short term. sinha (2008) examined the relationship between the number of patents and economic growth in japan and south korea over the period 1963-2005. in the case of japan, a two-way causal relationship was identified between the number of patents and real economic growth. in contrast to south korea, there is a one-way relationship between real gdp growth to the growth in the number of patents. the results of the regression analysis showed that a 1% increase in key technological patents leads to an average increase in gdp per capita by 0.108% (wurster, 2021). maradana et al. (2017) determined the existence of a significant connection between patents and economic growth per capita in the long term based on data for 19 european countries in the period 1989–2014. in romania, portugal, belgium, italy, germany, finland, greece, the netherlands and the uk, it was found that there is unidirectional causality from the number of resident patents to gdp growth. additionally, the results point to the conclusion that there is unidirectional causality from economic growth per capita to the number of patents of residents in hungary, norway, the czech republic, denmark and ireland. in addition, a two-way causality was established between the number of resident patents and economic growth per capita. in the case of the number of non-resident patents in romania, belgium, the czech republic, france, the netherlands, spain and sweden, there is unidirectional causality from the number of non-resident patents to economic growth per capita. unidirectional causality from economic growth to the number of non-resident patents was identified in norway, greece, finland and germany. bidirectional causality was found in portugal, the uk, denmark, ireland and hungary. the results of the research conducted by crosby (2000) based on the data on the number of patent applications in australia in the period 1901-1997 showed that the increase in patents leads to the economic growth of the country. crosby (2000) established the existence of a positive relationship between patents and economic growth in the short term; however, schmookler (2013) claims that this relationship should be negative in the short term, while it should be positive in the long term. akçomak & ter weel (2009) claim that there is a positive impact of the number of patent applications per population on the growth of gdp per capita based on the analysis of data from european countries in the period 1990 2002. hasan & tucci (2010), based on data for 58 states in the period 1980 2003, revealed a positive influence of the ratio patents / r&d expenses on the growth of gdp per capita. the existence of a positive relationship between patents and economic growth was established in romania (nae & grigore, 2014). similar conclusions were obtained in a study conducted by (pelinescu, 2017) based on data from unesco and eurostat databases for the period 2000-2015. a negative correlation between the number of patent applications and the gdp growth rate was identified in malaysia, china and indonesia based on the data from the period 2000-2009 (saini & jain, 2011). a study conducted by silaghi & medeşfălean (2014) based on the data for the period 1990-2010 in romania shows that patents have a statistically significant negative impact on economic growth. in addition, it was determined that an increase in the number of 52 economic analysis (2022, vol. 55, no. 2, 49-65) patents by 1% leads to a decrease in gdp by 0.089%. the authors claim that technologies in romania are most often imitated from abroad. it is also worth mentioning that companies that carry out r&d activities patent their products where they will sell them, which is usually outside the country. the biggest issues are considered to be the time required to obtain a patent, high costs and an underdeveloped market for trading the patented product. iwaisako & futagami (2013) explain the negative impact as a result of a high level of patent protection that significantly reduces the demand for capital, which consequently has a negative impact on output. myszczyszyn (2020) claims that in the long run, there is no relationship between the number of patents and economic growth in germany based on data from 1872–1913. similar are the conclusions of blind et al. (2021), who analyzed data related to the period 1981 2014 for 15 eu countries and found that there is no significant impact of patents on economic growth in the long term. data analysis and findings patents represent the product of innovative knowledge and facilitate the spread of technology, thereby stimulating economic growth. the main goal of the work was to determine whether the increase in the number of registered patents per million inhabitants affects economic growth, measured by gdp per capita, and the growth of innovation, measured by the innovation index of a country. the analysis was based on a quantitative research design (comparative approach). the empirical research covered two countries (romania and bulgaria) in the period from 2008 to 2018. the analysis used secondary data from internationally recognized databases on the phenomena that were the subject of research in this paper: 1. world bank and 2. world intellectual property organization. the secondary data used in the paper were based on several advantages that these data contain, and for that reason, were taken as relevant. the main reasons for choosing these databases are the ability to access identical data, their immediate availability, and the mutual comparability of data for romania and bulgaria. keeping in mind the aspiration to avoid the possible existence of different measuring instruments for the same phenomena in the national statistics of the countries included in the analysis, the data of international organizations were chosen (table 1) rather than the data of national statistics. table 1. number of patents, innovation index and gdp per capita country romania variable / year total patents total population number of patents* gii** gdp *** 2008 20,537,875 2.44 6,730 2009 1,150 20,367,487 56.46 2.92 6,410 2010 1,501 20,246,871 74.13 3.22 6,190 2011 1,599 20,147,528 79.36 36.83 6,350 2012 1,244 20,058,035 62.02 37.80 6,510 2013 1,241 19,983,693 62.10 40.33 6,760 2014 1,252 19,908,979 62.88 38.08 7,020 2015 1,235 19,815,481 62.32 38.20 7,330 2016 1,255 19,702,332 63.70 37.90 7,720 2017 1,452 19,587,491 74.13 39.16 8,320 2018 1,501 19,473,936 77.08 37.59 8,700 country bulgaria 2008 7,492,561 2.12 5,140 2009 397 7,444,443 53.32 2.85 4,990 2010 391 7,395,599 52.87 3.26 5,050 2011 395 7,348,328 53.75 38.42 5,300 ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 53 2012 371 7,305,888 50.78 40.70 5,350 2013 500 7,265,115 68.82 41.33 5,400 2014 467 7,223,938 64.65 40.74 5,530 2015 512 7,177,991 71.33 42.16 5,790 2016 427 7,127,822 59.91 41.42 6,050 2017 425 7,075,947 60.06 42.84 6,310 2018 459 7,024,216 65.34 42.65 6,550 notes: *number of patents per million inhabitants; **gii = global innovation index; ***gdp per capita source: wipo (2019), country profile – romania, bulgaria, available at: https://www.wipo.int/ipstats/en/statistics/country_profile/; world bank (2019), total population by country romania, bulgaria, available at: https://data.worldbank.org/indicator/sp.pop.totl since the secondary data available in international databases had the character of time series, appropriate econometric models for time series were used in the analysis. statistical testing of correlations between the variables shown in table 1 was performed through simple linear regression for each pair of independent and dependent variables individually. this was performed because the small sample size (n < 30) and the nature of the formulated hypothesis (only one independent and two dependent variables) did not allow the application of a more complex regression technique such as multiple regression or multivariate multiple regression, which require the existence of at least two independent variables and significantly a larger number of observations (hair et al., 2014). given that no data were available on the total number of registered patents for romania and bulgaria for 2008, it was not possible to calculate the number of patents per capita. if you look at the data on the innovation index from table 1, you can see that the data for the first three years (2008, 2009 and 2010) were presented using a different methodology compared to the other observation periods. for the results of the statistical analysis to be precise and clear, the research used data for the period from 2011 to 2018. statistical testing of relationships between variables was performed through simple linear regression for each pair of independent and dependent variables individually for romania and bulgaria. in the first case, in the example of romania, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (the dependent variable is the innovation index; the independent variable is the number of patents per million inhabitants). the results of the simple linear regression are presented in table 2. table 2. verification of fulfillment of assumptions case i (romania) variable / assumption number of patents per million inhabitants (n = 8) innovation index (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 2.558 d = 1.539 54 economic analysis (2022, vol. 55, no. 2, 49-65) variable / assumption number of patents per million inhabitants (n = 8) innovation index (n = 8) histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 2). the assumptions are not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 2, it was determined that there is no independence of observations when it comes to the number of patents per million inhabitants (d=2.558). the assumption is not met. ass. 4b. based on the conducted durbin watson statistic and the obtained results shown in table 2, it was determined that observations are independent when it comes to the country's innovation index (d=1.539). the assumption is fulfilled. ass. 5. and ass. 6. based on the performed analysis and obtained results shown in table 2 (histograms and p-p diagrams of normality), it was determined that there is no absence of heteroskedasticity and normal distribution of residual errors. assumptions are not made. in the second case, in the example of romania, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (dependent variable = gdp per capita; independent variable = number of patents per million inhabitants). the results of the simple linear regression are presented in table 3. ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 55 table 3. verification of fulfillment of assumptions case ii (romania) variable / assumption number of patents per million inhabitants (n = 8) gdp per capita (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 0.258 d = 1.140 histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 3). assumptions are not met. ass. 4. based on the conducted durbin watson statistic, it was determined that (a) there is no independence of observations when it comes to the number of patents per million inhabitants (d=0.971), (b) there is no independence of observations when it comes to gdp per capita (d=1.052). the assumption is not met. ass. 5. and ass. 6. based on the performed analysis and the obtained results shown in table 3. (histograms and p-p diagrams of normality), it was determined that in the case of the independent variable (number of patents per million inhabitants) there is an absence of heteroscedasticity and normal distribution of residual errors. in contrast, in the case of the dependent variable (gdp per capita), this was not the case. the assumptions are partially fulfilled. given that the obtained results showed that these assumptions were not met or only partially met, the next task was to transform the data based on the logarithm (table 4). 56 economic analysis (2022, vol. 55, no. 2, 49-65) table 4. results of linear regression model summaryb variables the number of patents per million inhabitants and the country's innovation index r r square adjusted r square se of the estimate 0.417a 0.174 0.036 0.01177 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita r r square adjusted r square se of the estimate 0.329a 0.108 -0.041 0.05052 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf anovab variables the number of patents per million inhabitants and the country's innovation index sum of squares df mean square f p regression 0.000 1 0.000 1.260 0.305a residual 0.001 6 0.000 total 0.001 7 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita sum of squares df mean square f p regression 0.002 1 0.002 0.726 0.427a residual 0.015 6 0.003 total 0.017 7 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf coefficientsa variables the number of patents per million inhabitants and the country's innovation index unstandardized coefficients standardized coefficients t p b std. error beta (constant) 1.777 0.174 -0.417 10.225 0.000 patent_transf -0.107 0.095 -1.122 0.305 a. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita unstandardized coefficients standardized coefficients t p b std. error beta (constant) 3.228 0.746 0.329 4.326 0.005 patent_transf 0.347 0.408 0.852 0.427 a. dependent variable: bdp_i_transf source: authors' research in the simple linear regression model for the variables number of patents per million inhabitants and the country's innovation index, a correlation coefficient of r = 0.417 was determined, which, according to cohen's criteria, can be considered a medium. based on the ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 57 obtained results, r2 = 0.174 (coefficient of determination) and adj.r2 = 0.036 (corrected coefficient of determination), it is concluded that a total of 17.4% and 3.6% of changes in the dependent variable, the country's innovation index, can be explained by changes in the independent variable, the number of patents per million inhabitants. based on the results of the anova test (f (1,6) = 1.260 and p = 0.305), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for changes in the country's innovation index. the obtained results showed that the value of the ordinary regression coefficient is b = 1.777 (se b = 0.174), while the value of the standardized regression coefficient is β = -0.417. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the country's innovation index in the case of romania. in the simple linear regression model for the variables number of patents per million inhabitants and gdp per capita, a correlation coefficient of r = 0.329 was determined, which according to cohen's criteria, can be considered as large (significant). based on the obtained results r2 = 0.108 (coefficient of determination) and adj.r2 = -0.041 (corrected coefficient of determination), the conclusion is that a total of 10.8% of changes in the dependent variable gdp per capita can be explained by changes in the independent variable number of patents per million inhabitants. however, this result should be taken with a grain of salt, while the entire explanatory power of the regression model should be assessed as insignificant. based on the results of the anova test (f (1,6) = 0.726, p = 0.427), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for changes in the gdp per capita. the obtained results showed that the value of the ordinary regression coefficient is b = 3.228 (se b = 0.746), while the value of the standardized regression coefficient is β = 0.329. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the gdp per capita in the case of romania. in the first case, using the example of bulgaria, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (dependent variable = innovation index; independent variable = number of patents per million inhabitants). the results of the simple linear regression are presented in table 5. 58 economic analysis (2022, vol. 55, no. 2, 49-65) table 5. verification of fulfillment of assumptions case i (bulgaria) variable / assumption number of patents per million inhabitants (n = 8) innovation index (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 1.220 d = 2.029 histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 5). the assumptions are not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 5, it was determined that there is no independence of observations when it comes to the number of patents per million inhabitants (d=1.220). the assumption is not met. ass. 4b. based on the conducted durbin watson statistic and the obtained results shown in table 5, it was determined that observations are independent when it comes to the country's innovation index (d=2.029). the assumption is fulfilled. ass. 5. and ass. 6. the results shown in table 5 (histograms and p-p diagrams of normality) were intended to show the absence of heteroskedasticity and the normal distribution of residual errors in the dependent and independent variables. the assumptions are partially fulfilled. in another case, using the example of bulgaria, the task was to determine whether all six assumptions (ass.1 ass.6) were fulfilled for both observed variables (dependent variable = gdp per capita; independent variable = number of patents per million inhabitants). the results of the simple linear regression are presented in table 6. ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 59 table 6. verification of fulfillment of assumptions case ii (bulgaria) variable / assumption number of patents per million inhabitants (n = 8) gdp per capita (n = 8) the nature of the variable metric metric distribution diagram value of indicators of durbin-watson statistics d = 0.322 d = 1.711 histogram p-p normality diagram source: authors' research ass. 1. the task was to determine whether the variables have a continuous nature. the analysis showed that both observed variables have a metric measurement and are therefore treated as metric variables measured on a ratio scale. the assumption is fulfilled. ass. 2. and ass. 3. in the conducted analysis, it was not established that there is a linear relationship between the dependent and independent variables. also, the absence of atypical points was not determined (distribution diagram, table 6). assumptions are not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 6, it was determined that there is no independence of observations when it comes to the number of patents per million inhabitants (d=0.322). the assumption is not met. ass. 4a. based on the conducted durbin watson statistic and the obtained results shown in table 6, it was determined that observations are independent when it comes to gdp per capita (d=1.711). the assumption is fulfilled. ass. 5. and ass. 6. the results shown in table 6 (histograms and p-p diagrams of normality) were intended to show the absence of heteroscedasticity and the normal distribution of residual errors in the dependent and independent variables. the assumptions are partially fulfilled. given that the obtained results showed that these assumptions were not met or only partially met, the next task was to transform the data based on the logarithm (table 7). 60 economic analysis (2022, vol. 55, no. 2, 49-65) table 7. results of linear regression model summaryb variables the number of patents per million inhabitants and the country's innovation index r r square adjusted r square se of the estimate 0.560a 0.313 0.199 0.01349 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita r r square adjusted r square se of the estimate 0.319a 0.102 -0.048 0.03583 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf anovab variables the number of patents per million inhabitants and the country's innovation index sum of squares df mean square f p regression 0.000 1 0.000 2.739 0.149a residual 0.001 6 0.000 total 0.002 7 a. predictors: (constant), patent_transf b. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita sum of squares df mean square f p regression 0.001 1 0.001 0.680 0.441a residual 0.008 6 0.001 total 0.009 7 a. predictors: (constant), patent_transf b. dependent variable: bdp_i_transf coefficientsa variables the number of patents per million inhabitants and the country's innovation index unstandardized coefficients standardized coefficients t p b std. error beta (constant) 1.320 0.179 0.560 7.395 0.000 patent_transf 0.165 0.100 1.655 0.149 a. dependent variable: indeks_i_transf variables the number of patents per million inhabitants and gdp per capita unstandardized coefficients standardized coefficients t p b std. error beta (constant) 3.370 0.474 0.319 7.106 0.000 patent_transf 0.219 0.265 0.825 0.441 a. dependent variable: bdp_i_transf source: authors' research in the simple linear regression model for the variables number of patents per million inhabitants and the country's innovation index, a correlation coefficient of r = 0.560 was ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 61 determined, which according to cohen's criteria, can be considered large (significant). based on the obtained results r2 = 0.313 (coefficient of determination) and adj.r2 = 0.199 (corrected coefficient of determination), it is concluded that a total of 31.3% and 19.9% of changes in the dependent variable, the country's innovation index, can be explained by changes in the independent variable, the number of patents per million inhabitants. based on the results of the anova test (f (1,6) = 2.739 and p = 0.149), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for the changes in the country's innovation index. the obtained results showed that the value of the ordinary regression coefficient is b = 1.320 (se b = 0.179), while the value of the standardized regression coefficient is β = 0.560. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the country's innovation index in the case of bulgaria. in the simple linear regression model for the variables number of patents per million inhabitants and gdp per capita, a correlation coefficient of r = 0.319 was determined. according to cohen's criteria, it can be considered a medium. based on the obtained results r2 = 0.102 (coefficient of determination) and adj.r2 = -0.048 (corrected coefficient of determination), the conclusion is that a total of 10.2% of changes in the dependent variable gdp per capita can be explained by changes in the independent variable number of patents per million inhabitants. however, this result should be taken with a grain of salt, while the entire explanatory power of the regression model should be assessed as insignificant. based on the results of the anova test (f (1,6) = 0.680, p = 0.441), it can be concluded that the regression model at the p < 0.050 level was not statistically significant. that result provides additional information about the relationship between the independent and dependent variables included in the regression model and shows that the change in the number of patents per million inhabitants does not provide a statistically significant explanation for changes in the gdp per capita. the obtained results showed that the value of the ordinary regression coefficient is b = 3.370 (se b = 0.474), while the value of the standardized regression coefficient is β = 0.319. given that the coefficients of correlation and determination had a small value, with the absence of statistical significance of the regression model, it can be concluded that there is no statistically significant relationship between the number of patents per million inhabitants and the gdp per capita in the case of bulgaria. conclusion the national innovation system of romania includes numerous institutions, organizations and agencies that have a highly developed organizational structure. however, the developed organizational structure in the case of the national innovation system of romania does not imply its efficiency because the system is excessively fragmented and needs to provide equal access to all actors in terms of financial support. financial investments in the field of research, development and innovation in romania in the analyzed period (2008-2018) are very low, the results of the policy in this area are modest, the demand for innovation is low while the supply of human resources is inadequate. in 2014, a new law on innovations was adopted with the task of interpreting private property rights and improving the development of patents, which was supposed to have a direct impact on the economy. nevertheless, there was still a low interest of companies in activities in the field of research, development and innovation, and the majority of companies justified their attitude with large allocations, the riskiness of the venture and the uncertainty of the results. a small number of innovations derive from the structure of the romanian economy itself, in which low and medium technologies prevail. 62 economic analysis (2022, vol. 55, no. 2, 49-65) on the other hand, during the analyzed period, bulgaria's innovation system, although institutionally developed, suffered from two pressing challenges inefficiency and the absence of significant financial resources that would ensure its development. in addition, the main problems faced by bulgaria in the field of research, development and innovation are their small application in the business sphere, weak demand for innovations, and poor cooperation between the academic community and the economy. however, despite all the developments that have taken place in the previous 10 years or so, bulgaria's innovation system is still facing major challenges, among which are the basic ones: how to ensure the continuity of a satisfactory intensity of investment in research and development, how to improve cooperation with the business sector; and how to create a climate and framework for the introduction of publicprivate partnership in the research and development system. of all the forms of intellectual property and technological innovation, patents are most often associated with them since they protect the essence of technological innovation. to create innovations to introduce new and improved products or services to the market, or to introduce new and improved production processes, companies must invest in research and development. therefore, the conducted research aimed to determine whether the increase in the number of patents per million inhabitants affects economic growth and the increase in the innovation index of romania and bulgaria. based on the obtained coefficients of correlation and determination and the absence of statistical significance of the regression model, the obtained results of the empirical research showed that in the case of romania and bulgaria, the following applies: (a) there is no statistically significant correlation between the number of patents per million inhabitants and the innovation index (b) there is no statistically significant correlation between the number of patents per million inhabitants and gdp per capita. if the national innovation systems of romania and bulgaria were to be compared, it could be concluded that there is an evident lack of cooperation between the business sector and the academic community. in addition, innovation in the economy is at a very low level. this is reflected in the entire system, which is inefficient and underfunded. all this supports the fact that the results obtained through this research are not a big surprise. in the analyzed countries, there are still many open dilemmas regarding cooperation between science and business. thereupon, there is little demand for innovation, but also an open question of the success of applying for patents in the business sector. based on all of the above, it is highly debatable whether romania and bulgaria would have more significant results if: • there was an increase in the number of patents per capita, • they invested more funds in the area of research and development, and • they hired a significantly larger number of better-quality researchers. the results of the conducted research, to a certain extent, can be of importance to decisionmakers in romania and bulgaria through certain recommendations, which refer to the efficiency of national innovation systems and the level of demand for innovation within each national economy. therefore, it is very important that policymakers in the field of innovation adequately present the impact that innovation has on the country's economy. an increase in the number of patents per million inhabitants does not guarantee that in these countries, there will be an increase in the innovativeness of the economy and an increase in well-being. for this to happen, it will be necessary for patents to have their application and for all actors in that process to understand that only the application of patents can enable significantly better results in business. the conducted research also has several limitations. the first drawback is the relatively small sample, considering that the analysis was performed only for two countries romania and bulgaria. for subsequent research, it is proposed to increase the sample to four or more countries, with the recommendation that they are countries of the european union or countries ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 63 of one region. the small number of indicators analyzed is another limitation of this research. given that the focus of this paper was on determining the impact of the number of patents on innovation and economic growth of the country, the recommendation for future research is to expand the list of indicators to be analyzed (e.g., production growth, employment growth, competitiveness). in this research, the analysis was performed for the period 2008-2018, which represents the third limitation of this work. in some future research, it is recommended to use data from as long a time series as possible (e.g. 30 years). acknowledgements this paper is financed by the ministry of education, science and technological development of the republic of serbia. references akçomak, s., & ter weel, b. 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(2014). some insights about determinants of economic growth in romania. an empirical exercise. theoretical & applied economics, 21(6), 23-36. sinha, d. (2008). patents, innovations and economic growth in japan and south korea: evidence from individual country and panel data. applied econometrics and international development, 8(1), 1-23. word bank. (2010). bulgaria's hidden growth potential lies in research, innovation and technology. https://www.worldbank.org/en/news/press-release/2010/06/21/bulgariashidden-growth-potential-lies-research-innovation-technology world bank. (2022). charting a path to future prosperity with the long term growth model. https://www.worldbank.org/en/news/feature/2022/02/15/charting-a-path-to-futureprosperity-with-the-long-term-growth-model/ https://mpra.ub.uni-muenchen.d/ http://ebooks.ien.bg.ac.rs/1402/ http://ebooks.ien.bg.ac.rs/1402/ https://www.worldbank.org/en/news/press-release/2010/06/21/bulgarias-hidden-growth-potential-lies-research-innovation-technology https://www.worldbank.org/en/news/press-release/2010/06/21/bulgarias-hidden-growth-potential-lies-research-innovation-technology https://www.worldbank.org/en/news/feature/2022/02/15/charting-a-path-to-future-prosperity-with-the-long-term-growth-model/ https://www.worldbank.org/en/news/feature/2022/02/15/charting-a-path-to-future-prosperity-with-the-long-term-growth-model/ ivana domazet, darko marjanović, deniz ahmetagić, marija antonijević 65 wurster, m. (2021). intellectual property – how key technology patents stimulate economic growth. https://globaleurope.eu/globalization/intellectual-property-how-key-technologypatents-stimulate-economic-growth/ article history: received: 26.9.2022. revised: 28.11.2022. accepted: 5.12.2022. https://globaleurope.eu/globalization/intellectual-property-how-key-technology-patents-stimulate-economic-growth/ https://globaleurope.eu/globalization/intellectual-property-how-key-technology-patents-stimulate-economic-growth/ ea_2013_3-4 finalna ver scientific review strengthening the competitiveness of serbian economy and the corporate market restructuring1 domazet ivana2, stošić ivan, institute of economic sciences, belgrade, serbia udc: 338:339.137.2(497.11) ; 005.591.4:334.7 jel: f23, g34 id: 203727628 abstract – chronically poor competitiveness of serbian market during the global economic crisis has become a basic weakness of serbian economy. therefore, the negative effects of the crisis in serbia felt widely, exposing the deep structural problems of serbian economy, but also imposed new challenges to be out passed. accordingly, the authors of this paper aims to diagnose and analyze the basic economic indicators, business conditions and the competitiveness of the serbian economy, and, on the strength of the study results, provide recommendations on how to speed up the recovery of the economy. namely, the base for competitiveness stature relies on sustainable growth and development, that should be based on the implementation of the reindustrialization strategy while intensifying the process of business and market restructuring, bringing the new agricultural policy, including the implementation of modern irrigation systems, implementation of the adopted system framework for solving the problem of illiquidity and adjusting the level of public spending with real economy potentials. key words: competitiveness, restructuring, growth and development sources introduction entering into recession phase has underscored many weaknesses of the serbian economy, especially poor competitiveness. serbia failed to make a good hand of global vantage and develop adequate institutional and evolutional performances that should provide a climate in which the adverse effects of the global crises were less perceptible. the negative effects of the global financial and economic crises deepened the economy burning questions – unemployment, double digit inflation, followed by a jump in food prices and weakening of dinar, while inflows of foreign direct investments declined. hence, the main objective of this paper is to analyze the situation, business conditions and competitiveness of the serbian economy in the period of the global economic crises. on the basis of that analysis, this research tends to reveal key weaknesses, but also to appoint potential growth and development sources of the serbian economy in the upcoming period, and thus provide the basic guidelines for the development of the economy after the crisis. 1 this paper is a part of research projects numbers iii47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and oi179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia. 2 institute of economic sciences, zmaj jovina 12, 11000 belgrade, serbia, ivana.domazet@ien.bg.ac.rs domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 109 competitiveness is one of the most analyzed economic phenomena and the development of the concept of competitiveness starts with the classical economists (smith, 1776; ricardo, 1817) who have identified the availability of production factors, such as land, capital, natural resources and labor as the primary determinants of competitive advantages. weber (weber, 1905) explains the differences in the economic performance of individual countries with certain socioeconomic factors, such as the composition of the value and religion, while schumpeter (schumpeter, 1942) emphasizes the role of entrepreneurship, innovation and technology. drucker (drucker, 1969) develops the concept of management as a key factor of competitiveness and solov (solow, 1957) emphasizes the role of education and technological innovation for long-term economic growth. at the macroeconomic level, national competitiveness – namely the competitiveness of countries, is defined as the capability of certain country to achieve more rapid economic growth then others and to increase the public wealth so that its economic structure converts more efficiently and adapts to changing conditions of international trade (bienkowski, 2006). trabold (trabold, 1995) analyzes four important aspects of national competitiveness: the ability to sell on the global market (export), the ability to attract investments (location), the ability to adapt the economy and the ability to create and increase disposable income. while the „porter's diamond of competitiveness“ (porter, 1990, 1998) analyzes four primary components that affect the level of competitiveness at the macro level: the quality of factor conditions, the context in which the company's strategy and rivalry is carried out, the quality of demand conditions and the existence of related and supporting activity (in the presence of developed clusters). this analysis became the basis of a new global index of competitiveness ngci (new global competitiveness index), which focuses on the determinants of the level of productivity that the economy can sustain, where the level of productivity is the ultimate carrier of national prosperity (porter, delgado, ketels and stern, 2008). mitrović b. and stefanović z. (2007) indicate that the factors that affect competitiveness can be considered as macro (state and its measures to stimulate competitiveness) and microeconomic (the very competitiveness of companies, which is partly a result of these state measures). in addition, low competitiveness of the serbian economy is to a large extent caused by the delayed transition, long-term isolation from the world market, long-term disinvestment and technological gap compared with developed economies. unlike the macro approach, methodology for measuring competitiveness at the micro level is based on the analysis of specific indicators related to the market position of the analyzed company (porter, 2005; thompson and strickland, 2011). with the market share of the company, as an indicator of competitiveness various financial ratios related to profitability indicators, assessment of product quality, market image, technological and marketing capabilities, production capabilities, financial strength, relative costs of production, human resource potential, and the like are used (for more details: domazet, stošić, zubović, 2011, page 79-88). in this study we analyzed the competitiveness of the serbian economy during the world economic crisis, based on research findings by the wef (world economic forum) (international competitiveness index), world bank (doing business), and „multi-country“ comparations with other western balkan countries. in addition, special attention is paid to the critical review of the results of the historical analysis, comparative analysis and economic analysis (2013, vol. 46, no. 3-4, 108-124) 110 benchmarking, but primarily on the analysis of secondary data obtained from empirical and quantitative research of prominent international institutions such as the wef and wb. such a methodological approach represents explorative and descriptive research in respect to competitiveness issues of countries in transition, with a focus on serbia during the global economic crisis. the research was conducted with the aim to provide guidance for increasing the competitiveness of the serbian economy, namely its economy real growth and competitiveness potential. the starting hypothesis of our study is that the competitiveness of serbia lags behind other transition countries of the western balkans. the fact is that serbia has made significant system adaptations and changes, being aware of its obligations towards the eu, but in comparison with other countries of the western balkans, serbia is lagging behind in substantial changes in economic policy and basic competitiveness indicators (primarily institutional factors, goods market efficiency, the complexity of operating conditions and infrastructure) since it requires a proactive economic policy based on job creation, investments, improving infrastructure and predictable business environment. consequently, the work is designed in accordance with the scope and objectives of the research. after the introduction, the second part presents an analysis of key indicators of the serbian economy and business conditions analysis conducted by the world bank. the third section presents the results of the analysis of the competitiveness of the serbian economy, while in the fourth part of the paper the authors propose a potential source of growth and development, which could contribute to improved competitiveness of serbia, with a particular focus on the process of market restructuring. at the end, concluding remarks and recommendations of the authors, with accompanying literature are presented. analysis of current situation and business conditions in serbian economy the basic prerequisite for the effective recovery of the serbian economy is the diagnosis of the actual problems. this part of the paper analyzes basic economic indicators of the serbian economy, of which the following are indicated as essential: • after modest economic growth over the period 2009-2011, during the year 2012 there was a decline in economic activity of about 2%. the most recent macroeconomic forecasts are announcing a slight growth rate of gross domestic product (gdp) in 2013, and this projection is primarily based on exports of fiat vehicles and better agriculture season. • industrial production in 2012 declined by about 4% compared to 2011. adverse trends in industrial production, particularly pronounced in the first months of 2012, have continued, indeed with less intensity, in the second half of the year. industrial production in the coming months in 2013 highly depends on the „fate“ of two capital projects: addressing issues in smederevo iron works and the production of the fiat factory in the city of kragujevac. • despite the negative trends in the area of manufacturing, exports in 2012 rose by 4.6%. domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 111 • budgetary funds assigned for subsidizing agriculture in 2012 amounted to about 49.5 billion dinars. according to the announcements of the line ministry, most of the agriculture budget in 2013 will be directed towards the development of animal husbandry, as well as on enabling of existing and construction of new irrigation systems, so that we can conclude that policymakers positioned agriculture as a development priority for serbia (ies, 2013). • in the monetary area, the practice of keeping the restrictive monetary and credit policy, which was aimed at nbs attempting to control the pressure on the national currency exchange rate depression, as well as to keep inflation within the targeted limits for 2012 (4% ± 1.5%) and financial stability in the country. however, inflation went far through the targeted framework in 2012, and amounted to just over 12% (nbs, 2012). the most important factors that caused such inflation trend lie in increased cost pressures on food prices, the rise in import prices and the depreciation of the national currency in the period behind. • the budget for 2013 anticipates total revenues amounted to 956.4 billion dinars, which is 15.3% more than those provided for in the budget rebalance for 2012. on the expenditure side, total expenditures in 2013 were 4.3% higher than the total expenditures anticipated in the budget revision for 2012. consequently, the deficit is planned to be significantly reduced from 203.6 billion dinars in 2012 to 121.9 billion in 2013. • a special issue of the serbian economy is the level of foreign direct investment (fdi), which in 2012 amounted to just over 1 billion euros of fdi. as a comparison, 1.827 billion euros investments in 2011, speaks volumes about the preferences of investors to develop their businesses in a stable and predictable business environment. here we must note the fact that significantly affected the reduction in fdi in 2012, which has, as an election year, resulted inmore than a half of the year to be lost in waiting for the government to be established. • serbia's total foreign debt at the end of september amounted to 24.8 billion euros and thus exceeded the high level of debt of 80% of gdp in 2012. this is very alarming fact, but not the final, because the borrowing continued in the last quarter of 2012, wherefore during 2013 we can expect more negative balance when it comes to serbia's foreign debt. • foreign exchange rate after significant depreciation in the first quarter of this year, the dinar continued to devaluate. in the first three quarters, serbian currency dropped by 13.2%, which was followed by an action of the monetary authorities. this caused the strengthening and stabilization of the currency in early 2013 (nbs, 2012). • employment is the burning issue of the serbian economy. employment in serbia, during the period of crisis that started in 2008, dropped by more than 300 thousand (approximately 15%), or on average for about 2% per year. analysis of activity and employment rates in the crisis period 2008-2012 indicates a worrying tendency of increased unemployment rate from 14.4% in 2008 to over 26% in late 2012, as well as the increasing rate of inactivity of the population from 37.3% to 40.3% over the same period. it must be noted that a distinct increase in the unemployment rate was economic analysis (2013, vol. 46, no. 3-4, 108-124) 112 recorded during the period 2009-2011, while in 2012 the labor market was partially stabilized. observation of the author is that employment will not significantly increase even during 2013, due to the predicted low growth of the serbian economy (rzs, 2013). table 1. general indices of economic trends in serbia, 2008-2012 (previous year = 100) 2008 2009 2010 2011 2012 gdp at constant prices 103,8 96,5 101,0 101,6 98,0 physical volume of production industry 101,1 87,9 102,5 102,1 96,6 agriculture 108,5 101,0 99,4 100,8 82,5 construction 104,2 80,1 93,7 121,0 103,7 domestic retail trade constant prices 106,7 85,1 100,5 82,0 97,5 external trade export, mill. eur 115,5 80,2 124,0 114,2 107,4 import, mill. eur 118,1 69,8 109,7 114,7 106,2 employees 99,9 94,5 95,1 97,2 98,9 consumer prices 111,7 108,4 106,5 111,0 107,8 average net salaries real 103,9 100,2 100,7 100,3 101,4 source: rzs statistical office of the republic of serbia (multiple sources from 2008-2013) with this, not at all bright economic indicators, hereafter is the analysis of business conditions in serbia. namely, the existing economic and market environment in serbia is negative and insufficiently competitive compared to the other countries in the region. particularly, the world bank study, presented in the report „doing business 2013“ in which the business conditions were analyzed based on 10 parameters in terms of ease of doing business (starting from the business startup, securing permits, employment, possibilities of crediting, through the protection of investors, contracts, up to the closure of business) indicate that the business environment in serbia is quite negative ranked on the 86th place in the global list of 185 countries. existing serbia's ranking in terms of business conditions is caused by numerous factors, among which are the following (stošić, i. and erić, d., 2012): • for establishing a company in serbia, it takes 6 different procedures, and on average 12 days. • to obtain different types of licenses, such as for construction, electricity or telephone connections, permissions of various inspections or other authorities to start a business, entities are faced with 18 procedures, for the fulfillment of which they have to spend approximately 269 days. in this regard, serbia significantly lags behind an average which is valid for the countries of the central and eastern europe, holding the infamous 179 place among 185 countries in the world. domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 113 • registration of property requires 6 procedures and takes an average of 11 days. thanks to reforms in 2011, the time for registration is shortened, which helped serbia to improve its ranking, and now holds the 41st place in the world. • when it comes to getting loans, serbia has a very solid position in terms of this indicator and occupies 40th place. • in terms of investor protection, serbia ranks 82nd place, and in this respect no reforms was observed during the last years. • the republic of serbia is among the countries with a complex system of taxes and fees the number of annual payments is 66 and for the preparation, calculation and payment of taxes and other mandatory benefits companies spend even 279 hours, while the overall system is not transparent enough. no major changes have been registered in that respect for the past five years, and in this regard, serbia holds the unenviable 149th position. • in terms of foreign trade liberalization serbia occupies 94th place, but since 2007, no major reforms were recorded in this area. • the efficiency of the legal system is unsatisfactory. to collect disputed claims under commercial contracts in the republic of serbia, it took an average of 635 days and 36 procedures, and the cost of collection of receivables from insolvent companies is very high (an average of 31.3%), and in terms of this indicator serbia is ranked as 103rd in the world. despite significant progress achieved since 2000, serbia lags behind many countries in the western balkans region. pursuant to the analysts of the world bank in the report „doing business 2013“, all the other countries of the western balkans (except for bosnia and herzegovina) are better positioned than serbia fyr macedonia (23), slovenia (35), montenegro (51) croatia (84 ), albania (85), while bosnia and herzegovina is at position 126. however, according to the report „doing business 2013“, serbia has improved its ranking by nine places (in the report „doing business 2012“ it was located at the 95 position). last year, serbia has made progress primarily in three areas (addressing issues of insolvency, enforcement of contracts and establishing an enterprise) and thanks to this belongs to the ten economies that have implemented most of the reforms in the past year. this positive step encourages that serbia will continue towards the economic policy reform, which will be based on realistic potential of competitiveness growth, rather than on the nice wishes of its creators. analysis of serbian economy competitiveness for many years, serbian is lacking in competitiveness in the global market, which is confirmed by the report of the world economic forum for 2011-2012. in other words, serbia is ranked at 95th position of the 142 countries covered, and is located at the rear of the group of 28 countries that, through increased efficiency, strive to achieve economic growth and improve their overall competitive position. true, in 2011, serbia has improved its ranking by one position, but it is still one of the most uncompetitive countries on the european continent. among the countries of the western balkans, bosnia and herzegovina is the only that has a lower value of global competitiveness index (gci). in addition, some countries, economic analysis (2013, vol. 46, no. 3-4, 108-124) 114 such as for example macedonia and albania, are listed ahead of serbia, and bosnia and herzegovina has significantly narrowed the gap, threatening to overtake serbia as well. table 2. gci index for serbia and other western balkan countries (2008-2012) gci 2008-09 2009-10 2010-11 2011-12 rank score rank score rank score rank score albania 108 3.5 96 3.7 88 3.9 78 4.1 bosnia and herzegovina 107 3.6 109 3.5 102 3.7 100 3.8 croatia 61 4.2 72 4.0 77 4.0 76 4.1 fyrom 89 3.9 84 4.0 79 4.0 79 4.1 montenegro 65 4.1 62 4.2 49 4.4 60 4.3 serbia 85 3.9 93 3.8 96 3.8 95 3.9 source: world economic forum, 2011-12. according to the world economic forum, the main bottlenecks for improving the competitiveness of serbia are institutional factors, market efficiency, the complexity of business conditions and infrastructure. ranks and scores of basic twelve groups’ competitiveness factors (pillars) for serbia are the following: table 3. serbian gci by groups of competitiveness factors pillar groups of factors 2009-10 2010-11 2011-12 rank score rank score rank score 1. institutions 108 3.4 120 3.2 121 3.2 2. infrastructure 102 2.7 93 3.4 84 3.7 3. macroeconomic environment 86 4.7 109 4.0 91 4.5 4. health and primary education 46 5.8 50 5.95 52 5.8 5. higher education and training 70 3.9 74 4.0 81 4.0 6. goods market efficiency 115 3.7 125 3.6 132 3.5 7. labor market efficiency 66 4.4 102 4.1 112 3.9 8. financial market development 89 3.9 94 3.8 96 3.7 9. technological readiness 61 3.5 80 3.4 71 3.6 10. market size 65 3.6 72 3.6 70 3.6 11. business sophistication 100 3.5 125 3.1 130 3.1 12. innovation 70 3.1 88 2.9 97 2.9 total 93 3.8 96 3.8 95 3.9 source: world economic forum, 2011-2012. domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 115 the institutional framework in serbia is still not good enough for the investment, and this arises from inefficient state regulation, the existence of corruption, problems in securing financing, low efficiency of courts and inadequate legal system, as well as inopportune application of antimonopoly legislation and underdeveloped infrastructure. rankings and reviews the basic twelve groups (pillars) of competitiveness factors in serbia is presented in table 3. the indicators presented do not point out the progress and the ability of the serbian economy to improve its competitiveness and evolve into more advanced stage of development. on the contrary, according to a total of 105 indicators, grouped into 12 pillars, competitive advantages (range of 0-50) are identified only in 13 indicators (or 12% of the total), while the weaknesses (ranking over 50) were found in the remaining 92 indicators (88% of the total number of indicators). of particular concern is the fact that, observed pursuant to the groups of competitiveness factors in the period 2008-2011, the competitiveness was either worsened, or simply not improved, concerning the majority of the factors other than infrastructure, and knowledge and use of technology. thereby, it should be clearly underlined that the progress in infrastructure is entirely linked with the change of the methodology made by the world economic forum, which has included the number of mobile phone users (according to this factor serbia ranks relatively well in the world with 28th place) in this group of competitiveness factors – which has significantly raised the average score for this group of factors in general. naturally, this is not enough, particularly while having in mind that the other countries have made significant improvements – for example, for example, with significant public investments in last three years, increased the assessment of the road infrastructure from 2.4 to 3.5. table 4. the best and the worst competitiveness factors of the serbian economy worst best* factor rank factor rank protection of minority shareholders, interests 140 legal rights index 20 extent of market dominance 139 number of fixed telephony lines 26 „brain drain“ 139 number of mobile phones 29 efficiency of legal framework in settling disputes 137 internet bandwidth 34 effectiveness of anti-monopoly policy 137 number of diseased with tuberculosis 34 cooperation in labor-employer relations 136 new-born mortality rate 40 nature of competitive advantage 136 redundancy costs, weeks of salary 50 firm-level technology absorption 136 willingness to delegate authority 136 economic analysis (2013, vol. 46, no. 3-4, 108-124) 116 worst best* factor rank factor rank burden of government regulation 134 reliance on professional management 133 quality of port infrastructure 133 quality of airport infrastructure 132 extent of staff training 132 quality of roads 131 degree of customer orientation 131 source: world economic forum, 2011-12 since 2008, in serbia, the most deteriorated are the efficiency of labor market, the efficiency of goods market, institutions and business conditions. particularly significant decrease was noted in terms of the labor market (down from 66th to 112th position), as well as in terms of the complexity of business conditions (down from 100th to 130th position). serbia has the lowest ranking in terms of protection of minority shareholders, the degree of dominance in the brain drain market, the efficiency in resolving jurisdictional disputes, the efficiency of antimonopoly policy, cooperation of employers and workers, natural comparative advantages, the use of technology in companies, corporate management efficiency, quality of harbor and airport infrastructure, training of employees, company investment in research and development, the efficiency of government investments, and business ethics in the company. namely, in respect to above stated indicators, serbia is ranked 130 of 142 world countries. on the other hand, serbia is ranked favorably when it comes to the protection of rights index, the number of fixed telephone lines, mobile phones, the use of broadband internet, a series of health indicators, and firing costs. bearing all this in mind, it must be said that serbia is in a very unfavorable competitive position. according to most of the indicators, serbian competitiveness is ranked below the average of the countries in the second stage of development, which means that it is far from the average of the of the eu member states. sources of serbian economy competitiveness improvement sustainable growth and development of serbian economy that will lead to increase of economy competitiveness, must rely on the implementation of reindustrialization strategy (djukić, 2012:1-18), while intensifying the process of business and market restructuring, bringing the new agricultural policy, including the implementation of modern irrigation systems, implementation of the adopted system framework for solving the problem of illiquidity and adjusting the level of public spending with real economy potentials. the process of industrialization in developed market economies is related to the change in the economic structure and development based on modern technologies and innovations, educated workforce and more efficient operations of companies (dess, 2007). in this way special attention should be routed on two aspects: first, it is necessary to increase the investments in human capital and to strengthen the connections of economy and scientific domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 117 research institutions; second, it is important to focus on recuperating the technological capacity (de wit, meyer, 2004). it is necessary, in this regard, to be focused on the areas of high technology with respect to the so far dominant, low-tech industries (stojanović-aleksić, erić, šapić, 2010: 563-574). this involves a high level of priority and specialization of exports, which means mastering the production and sale of some basic products, the product of small groups or just some branches. products, whose development should be supported, are those who are using the available factors in the most efficient and most productive way, as well as those that correspond to the structure of import demand of foreign trade partners of serbia. in the short term, it requires rehabilitation of some existing, but reindustrialization, and installation of new enterprises (kovačević, 2010). building a competitive industrial structure, among other things, requires sophisticated and technologically innovative products, medium and high technological content, i.e. of higher added value. it is clear that all these changes will take time and investment (ies, 2013). in this regard, in order to increase the competitiveness and efficiency of industrial development in the future, the leaders of the development and export of serbian industry should be: manufacture of motor vehicles and components, manufacture of machinery and electronic equipment, manufacture of information technologies, and food production. at the same time, certain products, particularly by small and mid-sized enterprises, must be developed for personal demand, but may also have significant export potential (textile products, leather products and footwear, ferrous and non-ferrous metallurgy, as well as products of chemical, pharmaceutical and defense industry). industrial policy, above all, must deal with (mićić, zeremski, 2011): strengthening of international competitiveness and growth in industrial exports, productivity growth, industrial restructuring and the establishment of an economy based on knowledge and innovation. these goals and priorities require true application of appropriate measures, as well as the other policies to be in operation or to be a part of the industrial policy. in respect to improvement of productivity and competitiveness, as the preconditions for effective development of serbian industry, the development of industrial framework in terms of macro-economic conditions, infrastructure and institutions, is of significant importance. in addition, serbia has to open up the market and to work up the competition that contributes to the development of intellectual capital, innovation and improved efficiency and flexibility of the labor market. furthermore, it is necessary to have closer cooperation between business and science, as well as a greater investment in the training of personnel who are really needed in the economy. moreover, it is necessary to give a concrete incentive for the development and strengthening of small and mid-sized enterprises, entrepreneurship and the development of industrial clusters. regulation of the business conditions and provision of a competitive environment is the basis of economic competitiveness. in this sense, the state needs to ensure macroeconomic stability, continued economic reforms, improving the efficiency of antimonopoly policy, reducing political risk, attracting of foreign investments and continued policy towards the european union. also, our economy needs a reduced and more efficient state administration, which should be fully oriented towards consumers. it involves the introduction of management systems and responsibility principles in all government systems, as the basis of the regulated business environment (fabris, 2010). however, the state economic analysis (2013, vol. 46, no. 3-4, 108-124) 118 cannot be solely responsible for the improvement of competitiveness and economic growth. neither the entrepreneurs cannot stand idly by, but it is important for them to be proactive in the process of increasing the competitiveness of their companies. the passive role of the economy and the expectation that the state will be responsible for improving competitiveness and increasing exports is a mistake that is often repeated in the past and that has to be avoided in the future. one of the competitiveness potentials in the foreign market is the introduction of international quality standards, as in a number of industries, such as construction, food and similar, operating in foreign markets is not possible without the implementation of these norms. in addition, linking businesses to export clusters has proved a successful strategy to increase competitiveness in the international practice, and in rare clustering examples in the serbian economy. such way of connecting provides a number of benefits, ranging from a safe source of supply, better strategic positioning, higher quality products, and providing more resources for penetrating foreign markets. in addition, most serbian companies are not paying heed to design and are lacking of funds for education of employees. only a small number of companies have set aside funds for their own researches, and innovations are extremely rare. one of the most important generators of economic growth and competitiveness lies in the entrepreneurship within the family. the concept of family enterprises is particularly important in respect to the current situation in the serbian economy, which is characterized by extremely high unemployment rate on the one hand, and by the lack of financial resources and absence of business climate that stimulates the uptake of risky and profitable business ventures, lack of competition, poor quality of products and a chronic illiquidity on the other. serbian family businesses could take a significant role in creating a competitive market and reducing unemployment, which are currently the greatest economic and social problems of serbia. the highest concentration of family enterprises in developed countries, is in the traditional economic sectors such as services and textile industry, small manufacturing and construction, while its share in the high technology sectors is extremely low due to the fact that in most cases they are not willing to take the risk and do not have the capital for necessary investments (golubović, 2009:471-491). in the serbian economy there are certain sectors and industries that have comparative advantages on which the economic growth and development of the country should rely on. in these sectors there is potential for the formation of a critical mass of family enterprises, primarily related to the agricultural sector, the food and textile industries. the competitive advantages of the domestic economy are reflected in the available natural resources, low-cost and skilled workforce and a favorable geographical position (close to the eu and corridor 10). key obstacles to the development of dynamic family businesses in serbia are tied to specific mentality and lack of preference for entrepreneurial activities, inadequately segregated enterprise capital from the money used for personal needs of family members, limited access to affordable financing, expressed suspicion in the banking sector and the lack of knowledge in respect to budgeting, business planning and production scheduling. in addition, the crucial economic problems of serbia lie primarily in the actual economy, inadequate structural changes and insufficient corporate restructuring and modernization of domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 119 production capacities during the first decade of the 21st century. a particular problem lies in the fact that in the period of intense transition changes (after 2000) the development of tradable products has been neglected. many companies have continued manufacturing their traditional, at best „cosmetically“ innovated, products that are, as seen from the global point of view, in many cases of obsolete technology, non-adjusted to changing market requirements, and the like. this kind of offering structure provides no real chance for greater success even in the „normal“ market conditions, and especially not in the conditions of extremely sharpened market relations that are gradually, but inevitably, becoming more important in case of extreme market circumstances. lingering restructuring of companies is the main reason for slow intensification of industrial production, and very limited changes in the volume and structure of serbian exports. a potential solution could be initiated with a process of market restructuring, since the company in the market economy is valid only if the market exists and if it is able to make a profit in a given business environment. therefore, it is desirable to provide the new strategic leverage by market restructuring, i.e. through the innovation of the business portfolio, the structure of the target market and marketing mix instruments, in order to improve market position and value of the company. consequently, market restructuring has to be an integral and indispensable part of a wider process of enterprise response to the negative effects of the global financial crisis. in addition, as part of the implementation of large-scale structural changes in the company, market restructuring must take the starting place. the method to overcome the problems and implement necessary changes in market restructuring, largely depends on the processes of carrying out the controlling, organizational, production and financial restructuring (slatter, 2000). this attitude is primarily determined by the fact that the process of market restructuring directly expresses the role of marketing and establishes a business based on the integrated marketing concept. market restructuring as the competitiveness potential market restructuring is aimed at redefining the market, business lines, reorganization of the offering, changes in the marketing strategy, and varied role of marketing in the mix of business functions (domazet, stošić, zubović, 2011:79-88). this is primarily directed at radical improvement of business efficiency, satisfaction of market demands and gaining the competitive advantage. through a series of structural changes in the market orientation and marketing activities, market restructuring strategy involves defining of the basic methods to enable the company to flexibly meet the needs of the environment and acquire competitive advantage in the redefined the market, business area and/or modified program portfolio. the formulation, selection and implementation of these changes are the core of the successful implementation of the market restructuring process. this is a very complex set of issues and problems, especially if one takes into account the negative effects of the global financial crisis and economic situation in neighboring markets, but also the actual situation in the enterprises, which were not adequately prepared, neither in concern with the management nor with the technologies, for new, disadvantageous, business conditions. a complex process such as market restructuring should be carried out systematically in order to minimize the adverse impact of the business environment, emphasizing the internal economic analysis (2013, vol. 46, no. 3-4, 108-124) 120 strengths of domestic companies. changing market orientation can be conditioned by (todorović, stošić, milosavljević, 2000): • stagnation or disappearance of existing focus markets • trespassing the limits of critical success factors • erosion of competitive advantages • changing of certain technology and inputs procurement factors • emerging of new competitors • development of new markets and the like. the structure of the competitive environment has a direct impact on the choice of the course, the methods and pace of restructuring, therefore it is necessary to anticipate and analyze the strengths that determine the current and future characteristics of the business environment within the particular industry. competition in particular industry depends on five main of competitiveness factors (porter, 1996), namely: the intensity of competition, the possibility of substitute products, conditions for entering the market, negotiating power of the buyers and providers. the cumulative strength of these powers determines the profit potential of the industry in question. it ranges from the intensive, for example in the software industry, telecommunications, recycling, through the medium intensive industries, such as field services and equipment, or beverages industry, up to the textile industry, where there is no room for high-refundable. in a competitive market, maneuvering for a better position is unlimited and the entrance to the particular industry is straightforward. however, this type of industrial structure offers poor chance for long-term profitability. the weaker the collective strengths are the prevalent is the possibility for superior individual characteristics. knowledge of the fundamental sources of competitive pressure provides the preparatory practice for the company management, which will define the strategic agenda in the situation of adverse market conditions. strategic program shall highlight the critical strengths and weaknesses of the company, initiates the company positioning within the industry, reveal areas where strategic changes may be the most lucrative, and emphasize the points where the economic trends are most promising, whether as the possibility or as the threat. the manager creates a plan of action which may include: • the company positioning in order to obtain the best defense line from the competitors; and/or • the impact on the balance of power by the strategic moves, which aim to improve the company position in the market; and/or • anticipation of changes in the business environment, with the hope that this will, by choosing an appropriate strategy for the new competitive balance, surprise the competition. the first approach takes the structure of the particular industry as given, and aligns it with the strengths and weaknesses of the company. the strategy can be considered as the organization of the defense line against the competition, and seeking for the position within the industry where these powers are the weakest. knowledge in regard to the company domazet, i., et al., strengthening the competitiveness, ea (2013, vol. 46, no, 3-4, 108-124) 121 potentials and the impact of competitive factors will „light up“ the areas where the company should confront its competition, and where it should avoid it. if the company is a manufacturer with low production costs, it can choose to deal with powerful buyers, but it should not sell the products that are subject to competition, or in other words it should reduce the threat of product substitutes. when mastering the forces that are driving the competition, the company may consider an offensive strategy. innovations in marketing can improve brand identification or otherwise, can make the product differentiate. capital investments in large-scale facilities or vertical integration are affecting the entry barriers. the balance of powers is partly the result of external factors and partly under the control of the company. industrial evolution is strategically important since it brings changes in competition sources. the pattern of the product life cycle, for example, changing the rate of growth, product differentiation is in decline when the business becomes more mature and the company tends to be vertically integrated. products and technologies that have been considered as „the hit“ in the world of innovation are now becoming the subject of interpretation and replication by the competitors, thus ensuring that they are widespread. the period of time that was required to imitate the product is now shortened, so the standardization of high technology products has become conventional. for this reason, in developed information technology industry a vertical integration is inherent, both in respect to production and software development. this very significant trend considerably improved the size of the economy and the amount of capital required to be competitive in the branch, which has increased the entry barriers and can influence on expelling some smaller competitors out of the industry. the process of defining the new strategic orientation should not be rigid, and the strategic orientation must be distinguished with adaptability, since it is a prerequisite for creating competitive advantage in the long run. obviously, the trends that are carrying the label of the highest strategic priorities are those that affect all important sources of competitiveness. conclusions the global crisis is not, as some experts believed, bypassed serbia, but it has dramatically demonstrated all the weaknesses of its economy. namely, according to the most macroeconomic indicators serbian economy is positioned on the european bottom. heavy duty working conditions and fragile competitiveness were manifested even more due to recession. the main problems for improvement of the competitiveness of serbian economy are institutional factors, goods market efficiency, the complexity of operating conditions and poor infrastructure. the institutional framework in serbia is still not good enough for the investment, by virtue of inefficient state regulation, the existence of corruption, problems in securing financing, low efficiency of the judiciary and inadequate legal system, as well as of the inappropriate application of antimonopoly legislation and underdeveloped infrastructure. with all these problems, potential growth and competitiveness of the serbian economy should be sought in the development of institutions and business infrastructure that are harmonized with the eu regulations, the implementation of proactive economic policy that will provide predictable and internationally competitive macroeconomic business conditions, adjusting the level of public spending with the real potential of the economy, economic analysis (2013, vol. 46, no. 3-4, 108-124) 122 restructuring of the serbian economy that is focused on more intense industrial and agricultural growth, developing and strengthening of small and mid-sized enterprises, stimulating of foreign direct investments by transparent business conditions, establishing a knowledge economy and innovation as the dominant criteria for a potential market success, the development of competition, intellectual capital and other intangible factors, efficiency and flexibility of the labor market and greater investment in education, development of leadership, management and cluster approach to foreign markets, as well as the improvement in efficiency of the antimonopoly policy. export-oriented industry, led by agribusiness, automotive and software industry (it communication in general) is the priority for serbian industrialization. this model should play a fundamental role in the creation of serbian strategy and planning, with regard to high and positive correlation between long-term, dynamic and sustainable economic growth and export industries. this especially refers to small and open transition economies. this should provide the improvement of basic development indicators and implementation of most socio-economic objectives, defined as macroeconomic stability, growth in employment and reducing the number of citizens living below the poverty line, reducing the deficit in external transactions, growth of labor productivity and international competitiveness, as well as the dynamic development of other economic activities, which would create the necessary conditions for a stable, balanced and sustainable economic development on the long-run. in addition, it is required to undertake a series of structural adjustments and significant changes of the economy that will bring it closer towards the pure market orientation. this aims to secure competitive advantage on the one hand, and satisfaction of demanding customers on the other, since the reconditioned market (concerning declination in aggregate demand), strengthens 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(accessed may 5-10, 2013). world economic forum. 2011-2012. (accessed may 5-15, 2013). izvori konkurentnosti privrede srbije i tržišno restrukturiranje kompanija rezime – dugogodišnja slaba konkurentnost srbije je, tokom perioda svetske ekonomske krize, postala bazična slabost privrede, te su se negativni efekti krize u srbiji osetili u velikoj meri, razotkrivajući duboke strukturne probleme privrede, ali i nametnuli nove izazove u pogledu njihovog prevazilaženja. shodno tome, cilj autora ovog rada je da dijagnozira i analizira osnovne ekonomske indikatore, uslove poslovanja i konkurentnost privrede srbije i da, shodno rezultatima, da predloge kako ubrzati oporavak privrede nakon kriznog perioda. naime, osnova povećanja konkurentnosti privrede je održiv rast i razvoj koji se treba zasnivati na realizaciji strategije reindustrijalizacije uz intenziviranje procesa poslovnog i tržišnog restrukturiranja, donošenju nove agrarne politike uključujući i implementaciju savremenih sistema za navodnjavanje, sprovođenje donetog sistemskog okvira za rešavanje problema nelikvidnosti, kao i prilagođavanje nivoa javne potrošnje realnim mogućnostima privrede. ključne reči: konkurentnost, restrukturiranje, izvori rasta i razvoja article history: received: 11 july 2013 accepted: 18 november 2013 doi: 10.28934/ea.20.53.1.pp179-186 article review creating monetary measurement unit (mmu) as the global universal measure for hedging against inflation and currency risk1 aleksandar manić1* | zoran grubišić2 1 independent researcher 2 union university belgrade, belgrade banking academy faculty for banking, insurance and finance, department for banking, insurance and finance, belgrade, serbia abstract the paper presents an indicator created to reflect the long-term stability in the trend of real growth of the global economy, based on the current market data through a basket of currencies with a government bond yields based premium. the results suggest that the indicator is adequate to be considered as a benchmark for widespread indexation, with a potential hedging for diverse types of contracts and assets against price level volatility and currency risk on an international scale. key words: indexation, hedging, inflation, currency risk, international financial markets jel classification: e31, e32, e44, f31 introduction the topic of indexation has been attracting attention of academics as well as the participants on the international financial markets especially since the rise of free market economics in the 1970s (backhouse, 2005), in the wide scope spreading from wage indexation to the creation of capitalization-weighted indexes used predominantly for investing-in or benchmarking-to in the trillion-dollar industry of modern stock markets. since creating and validating an index appropriate for mass utilization is a complex, and moreover, highly responsible endeavour, the demand for such a benchmark is yet to be satisfied. in the present world, it is widely believed that openness in financial systems can create more international financial linkages and enhance direct relationship between different categories of markets and assets. this phenomenon implies that it is more difficult to utilize the contribution of the modern portfolio theory with the general aim of implementing internationally diversified portfolio and reduce market risk defined by markowitz (1952, 1959) and developed by many other authors (among others, mangram (2013)). in practice, the effects of diversification arise where there are incentives to invest in international markets (grubel (1968), levy & sarnat (1970)), from lower correlations coefficients between markets and assets. in the contemporary markets, it is essential to acknowledge the effects of information spillovers, as a result of 1 the research presented in this paper is part of “the mmu algorithm“ project financed by anchor ag, switzerland, as stated in the acknowledgments section of the paper. * corresponding author, e-mail: aleksandar_manic@yahoo.com 180 economic analysis (2020, vol. 53, no. 1, 179-186) globalization shocks experienced in one financial market are transmitted to other markets, regardless of the linkage between the economies the markets are situated in (aragό-manzana and fernandez-izquierdo (2007)). moreover, it is not an easy endeavour to find even a weak safe haven in order to effectively execute the hedging strategy. it is widely believed that gold as a “store of value” has that characteristic, but it is questionable from the dynamic point of view is there a one and only safe haven for all times? analysis of chen and weng (2019) supported the view that safe haven characteristic of gold depends on the time frame. in addition, it differs across different sectors. it is, in this sense, of great importance to design an appropriate global measurement unit in order to use it in numerous different hedging strategies. in the process of developing a very current business concept, an indicator that seems to be an adequate candidate for the mentioned necessity has been created and is presented in this paper: it is the mmu – monetary measurement unit. the very origins of the mmu are connected to an idea to reflect a highly stable variable with a scope large enough not to be disrupted by short-term and local, even regional political and other shocks. in this sense, the trend of real growth of the global economy has been looked upon as an almost ideal candidate, since it empirically shows a stable and slight increase, if the years of global crisis are not taken into account. literature review humphrey (1974) explores the concept of indexation in economic history, presenting an elaborate overview of the evolution of means to protect the real value of time contracts from fluctuations in the value of money. starting in the eighteenth century, where he traces the origin of a price index, i.e. a weighted average of many prices, more specifically, the origin of the concept of a cost-of-living index as a measure of changes in the purchasing power of money, going over classical (xix century) and neo-classical (roughly 1870-1930) views on indexation, the author concludes with a comparison of earlier with contemporary views. he elaborates the advantages that proponents of indexation, led by milton friedman, propose, describing the mechanisms through which indexation would augment the effectiveness of existing antiinflationary monetary and fiscal policies. the paper by caiani, godin, caverzasi, gallegati, kinsella, and stiglitz (2016) moves from a discussion of the challenges posed by the crisis to standard macroeconomics, specifically focusing on the solutions adopted within the dsge2 community. the authors argue that major drawbacks still undermine the reliability of standard models, although several recent improvements have contributed to their realism. in particular, dsge models still fail to recognize the complex adaptive nature of economic systems, and the implications of money endogeneity. the paper argues that a coherent and exhaustive representation of the interlinkages between the real and financial sides of the economy should be a pivotal feature of every macroeconomic model and proposes a macroeconomic framework based on the combination of the agent based and stock flow consistent approaches. concept and methodology innitial adjustments of the imported macroeconomic data the imf and the world bank have been recognized as highly reputable international institutions that collect, analyze and publish reliable data on a regular basis. by looking more 2 dynamic stochastic general equilibrium modeling (abbreviated as dsge, or dge, or sometimes sdge) is a method in macroeconomics that attempts to explain economic phenomena, such as economic growth and business cycles, and the effects of economic policy, through econometric models based on applied general equilibrium theory and microeconomic principles. aleksandar manić, zoran grubišić 181 closely into the methodology of the presented figures for real growth of global gdp, however, it has been established that the published growth rates are based on annual gdps of 194 countries worldwide expressed with the respect to ppp (purchasing power parity). this implies equal purchasing power for all countries (for the sake of comparison and additon, the ppp gdps have been expressed in us dollars), namely the the united states of america have been selected as the base country for the purchasing power equalization. the expression of all other countries’ realized annual gdps as if their purchasing power is equal to the purchasing power of the us further implies that the emerging and developing economies’ gdps become larger than their market realized gdps expressed in constant prices, which as a result increases the total, that is, the real growth of the global economy, as well as the participation i.e. importance of their individual growth rates in the total. this was the main reason for opting for a different methodological approach and recalculation of the variables of interest. for the sake of the result that would be more plausible, i.e. that would rely on data which reflect the quantites of production realized in the international markets, instead of ppp based real gdps, the real gdps have been expressed in constant 2010 us dollars and with constant 2010 exchange rates for each country with respect to us dollars (base year 2010 is the imf standard). the elaborated methodological adjustment is presented in the following charts: graph 1. global gdp growth compared to previous year (%) source: imf data (world economic outlook, oct. 2018) graph 2. adjusted real growth (%) source: authors’ data the adjusted real growth of global gdp therefore served as a benchmark for a variable closely related to the global economy which enables direct and simple verification. since the real growth 182 economic analysis (2020, vol. 53, no. 1, 179-186) of global gdp takes into account constant prices and exchange rates, i.e. negates monetary variables such as inflation and the exchange rate volatility, the natural next step in the process of creating a monetary benchmark was finding a way to preserve the main desirable traits of the real variables – the stability and the steady increase – when developing a model that would have nominal variables in its core. the problem of the representation of the inter-linkages between the real and financial sides of the economy is a constant in the contemporary academic research (caiani et al. 2016), which is why realizing the way to solve this issue was a crucial point in the development of the mmu model. fundament for the model: adjusted participations of the basket countries as a monetary indicator, the mmu is designed to reflect the real growth of global gdp and express it in a nominal sense by including the current market data with adjustments for the key underlying factors of the global gdp. preserving the most important features of the real global economy and its growth has been realized in terms of relying on each country’s participation in the total adjusted global gdp. moreover, the distribution of countries and their respective participations has been concentrated; namely, at first the idea was to include 20 countries with the largest contribution to the annual global gdp (this conveniently corresponds to the trait of their participation in the global gdp being 1% or larger). the real global gdps of these 20 countries, which combine both the advanced and the emerging economies situated worldwide, in total represent over 80% of the total real global gdp, which is a more than satisfactory scope having in mind the improvements it provides, being a simplified base for calculation which contributes to having adequate data faster, with a decreased probability of error, thus enabling and enhancing the verification process.3 the countries that have been selected in the stated manner are included in the mmu model in two crucial manners. first and foremost, the exchange rates of these countries are included in a currency basket weighted by the appropriate participation of their respective countries, which results with an average global currency, as an authentic indicator of the average world economy.4 as expected, its value is between the relative5 values of currencies of the advanced economies, and the economies of the emerging and developing countries, as it will be further discussed in the results section of this paper. the currency based indicator constructed in the described manner is the base for the mmu calculation. it includes actual market data, imported as the final or closing values for each currency pair on a selected day. during the mmu creation process, the predictability and sustainability of the world’s overall real economic growth always should be regarded as the most important benchmark. that is why, in order not to let short-term shocks impact the mmu value, an average of 365 days has been established as the most appropriate for the sake of an adequate average value that will both buffer temporary volatility and also preserve the feature of relying on the current market data. finally, this 365-day average has been established as the base for the final mmu calculation. the second manner of inclusion of the selected countries’ participation in the final mmu value is through a premium that will ensure slight and steady increase over time, to reflect the corresponding property of the growth of real global economy. this premium is based on the risk-free interest rates of government bond yields which also reflect the strength and the stability of the observed country’s economy through country risk premiums. 3 this is especially important having in mind that the first utilization of the mmu is planned for business purposes, and efficiency is an important trait in this process. 4 on this point, a comparison to the existing concept of the sdr (special drawing rights) is to be expected. however, the sdr are considered to be more politically fashioned in terms of the quantities of the currencies included in the basket, so the comparison is reasonable only in the terms of very general properties. 5 expressed in a chosen currency unit from the ones included in the basket; for the sake of this paper, all such data are presented in us dollars. aleksandar manić, zoran grubišić 183 the amount of data for the model established in this way was rather substantial. several issues came up during the calculations, such as year-to-year change in the list of top 20 countries in terms of real gdp and the availability of specific data (especially for government bond yields), among others. therefore, eventually the number of included countries was reduced to 106, and this decision was supported by various significant advantages. the top 10 countries with largest real gdp are highly constant over time7, with slight changes in participation; potential change of a country in the list would still result in including a large production economy with participation relatively smaller than the rest of the countries’ in the basket. moreover, the proportion of advanced and emerging economies is preserved, with all of them having participation over 2% in the real global gdp. in addition, the total participation of the top 10 economies’ gdps is stably around 70% of the real global gdp, which is another confirmation that the essence of the global economy is preserved in an extent significant enough, given the conveniences this alteration provides not only in the sense of more efficient data processing, but also in the terms of analyses and monitoring. construction of mmu the base for the mmu model is, as is mentioned, the currency based indicator (also referred to as the fx indicator) which is constructed as the average weighted value of the basket of currencies, representing the average global currency, and reflecting the relations between the major world economies included in the basket. in order to maintain the proportions of countries’ participations, the exchange rates are weighted with quantities, calculated on the basis of elaborated adjusted participations of the included countries. this happens simultaneously with the automatic update of the real gdp data when the latest imf database update becomes available. the adjustment of currency quantities is performed in the following manner: 𝑄𝑄𝛥𝛥𝐻𝐻𝑟𝑟 = 𝑝𝑝𝑎𝑎𝐺𝐺𝐺𝐺 / 𝑓𝑓𝑓𝑓𝑈𝑈𝑈𝑈𝐷𝐷/𝛥𝛥𝐻𝐻𝑟𝑟 r (1) in the equation, 𝑄𝑄𝛥𝛥𝐻𝐻𝑟𝑟 is the calculated quantity of the specific currency, part the adjusted participation of the corresponding country in the global real gdp and 𝑓𝑓𝑓𝑓𝑈𝑈𝑈𝑈𝐷𝐷/𝛥𝛥𝐻𝐻𝑟𝑟 the exchange rate of the specific currency with respect to usd on the first day of the update (implemented on each 1st of january). the quantities are then constant until the following yearly update and as such included in the model. currency quantities adjusted as described above are then included as weights for corresponding currencies’ values for determining the average basket level, i.e. the value of the currency based indicator. the final daily value of the indicator is determined as a moving average value of basket weighted averages for the current day and 364 previous days (a 365-day moving average). this time scope was selected as the most adequate for both preserving the property of data being current and achieving the required stability over time. the historical data for the indicator constructed in this manner resulted with a stable trend with the property of slow increase over time. however, it still reacted to intrinsic volatility deriving from the fluctuations of currencies’ relative strengths, and had significant short-term decreases within the overall trend of increase. at this point, government bond yields based premium was introduced to the model. 6 for illustratory purposes, the 10 countries with the largest realized real gdp (constant 2010 prices) in 2019 are: canada, china, france, germany, india, italy, japan, russia, united kingdom and the united states of america. since three of the selected 10 countries are in the eu, thus using euro as their currency, there are 8 currencies in total in the mmu currency basket. 7 constant in the calculations period decided by data availability, since 2010. 184 economic analysis (2020, vol. 53, no. 1, 179-186) the premium is developed as an average weighted average of the 10 year government bond yields of the countries in the basket. the data for the yields is updated daily, and the daily values for the basket daily average are stabilized through another implementation of a 365-day moving average. this 365-day moving average value of the average basket yield is calculated on a monthly basis. the application of the premium is devised as an alternative manner for development of the trend for the currency based indicator. it takes the starting historical value of the indicator and applies the premium gradually (on a daily basis), in order to result in an almost perfectly linear trend with highly stable incremental increase whose yearly rate corresponds to the average yearly value of the basket government bond yields premium. the final value of the mmu indicator represents a daily average of the currency basket indicator value and the value devised from the premium-included indicator. results and discussions the following illustration presents the long-term trend of the currency basket based indicator: graph 3. currency basket indicator source: authors’ data the value of the indicator represents the average number of currency units in the basket required for converting one currency to another. the trend is stable with the property of slow increase in the long-term perspective. however, the short-term decreases due to intrinsic volatility deriving from the fluctuations of currencies’ relative strength, have a significant effect within the overall trend of increase. the historical trend of the mmu, for which the development was elaborated in the methodology section of this paper, is presented in the following illustration: aleksandar manić, zoran grubišić 185 graph 4. mmu historical trend source: authors’ data a conclusion can be derived that the model dynamics strongly correlates to the currency basket indicator’s, keeping its fundamental properties with an intrinsic mechanism that ensures that the impact of the short-term market fluctuations is minimized and that the value of the mmu preserves the expected stability at any given moment as well as in the long term. fundamentally being a measurement unit, the mmu provides a solid base for numerous applications in the sense of indexation for the purpose of hedging. conclusion the monetary measurement unit, an indicator that reflects the stable growth of the real global gdp and is based on monetary variables relying on current market data, whose creation and development have been presented in this paper along with the results, represents a sound candidate for a global measurement unit that could be used for hedging against price level volatility and currency risk, which is an intrinsic characteristic of the global financial markets. the research required a rather substantial amount of data, both macroeconomic and marketbased, that was processed and adjusted in the elaborated manner and included in the automated calculations that provided a long-term trend of the value of the indicator. in the process of creation of this paper emerged a certain limitation. so far, to the best of our knowledge, there has been insufficient research on the topic of a global measurement unit. hedging strategies were based on exploring options for a safe haven, strong hedge, weak hedge or at least diversifier. in this sense, this paper offers a valuable insight and suggestion and affirms the opportunity for future research. acknowledgements this paper is a result of a research conducted for the project “the mmu algorithm“ financed by anchor ag, switzerland. references aragό-manzana, v., and fernandez-izquidero, m. a. (2007). "influence of structural changes in transmission of information between stock markets: a european empirical study." journal of multinational financial management, 17(2): 112-124. backhouse, r. e. (2005). "the rise of free marketeconomics: economists and the role of the state since 1970." history of political economy, 37(1): 355-392. 186 economic analysis (2020, vol. 53, no. 1, 179-186) caiani, a., godin, a., caverzasi, e., gallegati, m., kinsella, s., joseph stiglitz, j. (2016). "agent based-stock flow consistent macroeconomics: towards a benchmark model." journal of economic dynamics and control, 69(1); 375-408. grubel, h. (1968). "internationally diversified portfolios: welfare gains and capital flows." the american economic review. 58 (5): 1299-1314. humphrey, t. m. (1974). "the concept of indexation in the history of economic thought." frb richmond economic review, 60: 3-16. ke, c., wang, m. (2019). "is gold a hedge and safe haven for stock market?" applied economics letter, 26(13): 1080-1086. levy, h., m. sarnat. (1970). "international diversification of investment portfolios." the american economic review, 60(4): 668-675. mangram, m.e. (2013). "a simplified perspective of the markowitz portfolio theory." global journal of business research, 7(1): 59-70. markowitz, h. (1952). "portfolio selection." the journal of finance, 7(1): 77-91. markowitz, h. (1959). "portfolio selection: efficient diversification of investments." new haven, connecticut: yale university press. article history: received: may 31, 2020 accepted: june 10, 2020 creating monetary measurement unit (mmu) as the global universal measure for hedging against inflation and currency risk28f aleksandar manić129f* | zoran grubišić2 introduction literature review concept and methodology innitial adjustments of the imported macroeconomic data fundament for the model: adjusted participations of the basket countries acknowledgements references ea_2016_3-4 notes from of editor-in-chief dear readers, we appreciate the efforts of all the authors who have sent us quality papers, which passed the peer reviews and were published in our journal. besides the original papers we welcome the papers from other scientific categories position papers, letters to editors, research papers, reviews, and syntheses as well as book and conference reviews. the responsibility for plagiarism is solely of the author. this is why we are introducing one new procedure this year – all authors, whose papers are being considered to be published, will fill in one form concerning the originality of the paper. all publications in the economic analysis are in english language. authors whose first language is not english should make sure their manuscript is written in idiomatic english before submission. please write your text in good english (american or british usage is accepted, but not a mixture of these). no language and copy-editing services are provided by the economic analysis; hence, authors who feel their article may require editing to eliminate possible grammatical or spelling errors are encouraged to obtain such services prior to submission. at last, we want to remind you to follow the author's guide and to send your papers to the e-mail eaoffice@ien.bg.ac.rs. editor-in-chief acad. prof. mirjana radovic-markovic, phd ea_2013_3-4 finalna ver preliminary reports possibility of applying regional diversification in capital markets of bosnia and herzegovina and republic of serbia alihodžic almir1, university of zenica – faculty of economics, bosnia and herzegovina udc: 336.76 ; 338.33(497.11+497.6) jel: g1, g11, g15 id: 203726092 abstract – generally, risk is an uncertainty associated with future outcomes or events. in economic terms, risk is an expected deviation from the planned return of real, financial and intangible assets, of loss or cash flows associated with the uncertain event. the most famous way of reducing the overall risk is diversification of assets. thus, diversification is a process of investment in a number of unrelated or partially related assets or activities in order to achieve stable business operation, and it shows that portfolios are poor to the extent that they should be avoided in order to increase yields and reduce risk. the portfolio diversification works because prices of different shares do not move in the entirely same direction. statisticians generally mean the same thing when they say that share price changes are nothing less than perfectly correlated. the main objective of this paper is to discuss the impact of the global financial crisis on the movement tendency of the stock exchange index in the western balkans, developed countries and individual eu member states, and determine the feasibility of implementing regional diversification in order to further reduce risk and establish the portfolio of share with the lowest coefficients of correlation keywords: absorption capacity of financial assistance, eu pre-accession programs, municipalities, multilevel governance introduction international portfolio investment has long been a tradition in many european countries, but it is a more recent practice in north america. there is now a strong trend toward international diversification in all countries, especially among u.s. institutional investors, such as corporate and public pension funds. in the early 1970 u.s. pension funds basically held no foreign assets, the percentage of foreign assets approached 20 percent of total assets by 2006. british institutional investors hold more than 25 percent of their asset in non british securities. some dutch pension funds have more than half of their assets invested abroad. indeed, the more size of foreign markets justifies international diversification, even for u.s. investors. at the end of 2006, the world stock market capitalization was around $ 25 trillion. the u.s. stock market accounted for roughly half of the world market. the growth of the world stock market since the early 1970, has been remarkable. in 1974, the new york 1 university of zenica – faculty of economics, email: almir.dr2@gmail.com, almir_alihodzi@yahoo.com alihodžić, a., regional diversification, ea (2013, vol. 46, no, 3-4, 52-71) 53 stock exchange was the only significant market in the world, representing 60 percent of a world capitalization of less than $1 trillion (solnik and mcleavey, 2009, pp. 386). the argument that diversification reduces an investor's exposure to risk is both intuitively and statistically clear, but risk and return models in finance go a step further. the models treat risk from the point of view of investors, which are likely to trade at any time horizon. for the investor who is well diversified, a market risk is the only investment risk. the question is whether this is a realistic assumption. taking into account the fact that border investors must have many shares that they trade, it is highly likely that they are institutional investors who are generally diversified, although a diversification level varies among different investors. the fact that the border investor is well diversified becomes insignificant if we take into account small companies whose securities are traded less and companies with more than 90 percent ownership in the hands of a small group of shareholders. in the long-run, diversified investors tend to get non-diversified investors out of the market. thus, the investment risk will always be regarded higher for a non-diversified than for diversified investor, since the diversified investor is not subject to company specific risks as non-diversified (damodaran, 2010, pp. 31). this paper will analyse the possibility to implement the regional diversification and find an index with the lowest coefficients of correlation with market indexes on the sarajevo stock exchange (sasx 10 and sasx 30), banja luka stock exchange (birs), bse (belex15 and belexline) with the aim to further reduce the risk of investment. the main hypothesis tested in this paper is: the inclusion of additional shares of stock indexes in developed countries in an optimal risk portfolio of the western balkan countries affects the increase of return and decrease of risk. this hypothesis will be tested in the research section of the paper. the paper is structured in three parts. the first part describes the theoretical concept and importance of diversification. the second part elaborates a statistical apparatus for measuring return and risk when investing. the last part analyses the possibility of using regional diversification by finding share indexes for the lowest correlation coefficients. finally, conclusions are given as the results of the study. theoretical concept of diversification the modern portfolio theory is the most important innovation of the twentieth century in the field of investment and portfolio management. before the modern portfolio theory, it was thought that each share should be analysed through fundamental analysis and include in the portfolio those that have the potential for growth. the modern portfolio theory is the first to provide general access to portfolio management. it has provided a unique platform for the observation and evaluation of investments. the markowitz portfolio optimization model, also known as (mean variance model mv model) is highly valued due to the fact that h.m. markowitz received the nobel prize in 1990 for his achievements in the development of the modern portfolio theory. markowitz’s basic idea was to find a balance between risk and income, and in this regard select a portfolio of shares that would bring maximum profit with minimum risk. therefore, his idea was to form a mathematical model for the selection of a portfolio that delivers the highest rate of income, but with a certain degree of risk. economic analysis (2013, vol. 46, no. 3-4, 52-71) 54 according to markowitz (1952), a much more interesting book is portfolio selection: efficient diversification of investments, where markowitz developed a theory according to which a risk and reward can be brought into balance in a well-selected combination of securities in a portfolio. therefore, the objective of the modern portfolio management is not maximization of expected revenues, but optimization of expected revenues and associated risks (aljinović et al., 2011, pp. 136-137). according to caso (1992), benefits from international diversification indicate that low diversifications can be overestimated for investors with long-term investment horizons if equity markets move together (dobardžić, 2013, pp. 124). many investors do not truly understand effective diversification, often believing they are fully diversified after spreading their investment across large caps, mid or small caps, energy, financial, healthcare or technology stocks, or even investing in emerging markets. in reality, however, they have merely invested in multiple sectors of the equities asset class and are prone to rise and fall with that market. if we were to look at the morningstar style indexes or their sector indexes, we would see that despite slightly varying returns, they generally track together. however, when one compares the indexes as a group or individually to the commodities indexes, we do not tend to see this simultaneous directional movement. therefore, only when positions are held across multiple uncorrelated asset classes is a portfolio genuinely diversified and better able to handle market volatility as the high-performing asset classes can balance out the under performing classes (http://finance.yahoo.com). it is not always easy to find securities with low mutual correlation coefficients. one way to reduce the overall risk of a portfolio is to increase the number of securities in it, i.e. increase its diversification. the traditional approach is known as a simple diversification and it includes investing in a number of different securities (shares, bonds, etc.). guided by this approach, at a first glance it may seem that the investment in for example hundreds of different securities had four times lower risk than investments in twenty-five such securities. banks, pension funds, insurance companies and other financial institutions are even legally obliged to form a diversified portfolio. individual investors are also guided by diversification. at the national financial market, diversification of risk can be reduced below the level of systematic, i.e. market risk, only with the assistance of the so called markowitz diversification and finding securities with lower levels of mutual correlation, when the rule is that the lower the correlation coefficient between the yield on the securities in the portfolio, the higher are the effects of diversification. however, very few securities have low levels of mutual correlation and the markowitz diversification requires a computer database of financial statistics on a large number of securities. the computer application of this method of diversification is called the markowitz portfolio analysis and it is the foundation of modern portfolio theory. a step further in the analysis of diversification is international diversification. it offers investors an even better opportunity to increase yield and reduce risk at the same time. on the other hand, the international diversification implies an exposure to foreign currency risk and country risk. the international diversification provides a special opportunity. investors have traditionally invested primarily in their national financial markets. in order to diversify their investments, they turned to investing in different economic sectors and various alihodžić, a., regional diversification, ea (2013, vol. 46, no, 3-4, 52-71) 55 securities. today, primarily due to the development of telecommunications, the prevailing commitment is to attempt and increase diversification of investments by investing in the international financial markets and the globalization of financial markets has become a worldwide trend. a systematic or market risk is the lowest limit to which a portfolio risk can be reduced by diversification in the domestic financial market. by investing in a number of shares, the impact of specific factors is reduced and portfolio volatility should be reduced as well. if there is a large number of risky securities in the portfolio, risk cannot be avoided, because in principle all securities are subject to the impact of general macroeconomic factors. the risk which can be eliminated by diversification is called unique, specific or unsystematic risk (bodie et al., 2009, pp. 162 163). additional diversification can have effects in terms of further reduction of portfolio risk, below the level of market risk, only if it is aimed at foreign financial markets (zivkovic et al., 2005, pp. 427). there are two motivations for global investment. all else being equal, a low international correlation allows reduction of the volatility, or total risk, of a global portfolio. a low international correlation also provides profit opportunities for an active investor: because market do not move up or down together, an expert investor can hope to adjust the international asset allocation of the global portfolio toward market with superior expected returns. this should lead to a superior risk adjusted performance. on the other hand, barriers to international investments also exist (solnik and mcleavey, 2009, pp. 388). according to some traditional estimates, internationally diversified portfolio should have half the risk of a diversified portfolio in the national u.s. financial market (figure 1). although globalization of the financial system in the world contributes to higher mutual dependence of national financial markets, there is no perfect correlation among them and this allows for a further risk decrease of internationally diversified portfolios. however, this has limits too. the limits are so called global factors, i.e. circumstances affecting the volatility of global financial markets as a whole and can be regarded a global systematic or market risk (lower interrupted line in the figure). a global market risk, according to some new estimates is 56% of the national market risk (hunter and coggin, 1990, pp. 303). an additional factor in minimizing risk through international portfolio diversification can be obtained also by hedging transactions, although their effectiveness may be under significant impact of foreign currency exchange rates (madura and tucker, 1992, pp. 2-3). the expansion of potential international investment opportunities with shares to bonds further contributes to raising the performance of so constructed portfolios. although further risk reduction through international diversification is limited, it does provide significant benefits to investors. a risk reduction is only one side of the international diversification of portfolio. other, often more important side, is potentially higher yields. the potentially higher yields can result from two factors. first, the global financial market provides a greater choice of investment, i.e. it allows investors to invest in companies which are not available through the national financial markets. economic analysis (2013, vol. 46, no. 3-4, 52-71) 56 figure 1. risk of internationally diversified portfolio and diversified portfolio in u.s. national market source: solnik, b. (1974) why not diversity internationally rather than domestically?, financial analysts journal, pp. 119 – 138. second, it allows for speculative gains relying on fluctuations in exchange rates, which can significantly increase yield on investments abroad if investors' domestic currency depreciates against the currency in which it is invested, and it can reduce if the domestic currency appreciates. the choice of countries in which to invest is based on the stability of national currency, capital appreciation of their financial markets and achievable average of dividend yield. market return and risk measurement from the point of view of investors, it is not that important whether prices of some securities rise or fall. what is important is the contribution of their portfolio and the portfolio risk. thus, the yield and risk of specific securities should not be analysed under conditions in which they affect the yield and risk of the portfolio in which they are. an investor's portfolio may hold shares of company that is not well known, whose shares are not liquid, whose earnings fluctuated in the past and which did not pay dividends. all of this indicates shares with high risk, which should correspond to high yield. however, in practice such shares may have a low yield. this means that investors regarded the company as low-risk, despite the low earnings. the reason for this lies in diversification and its impact on the risk. the earnings of the company and the price of securities grow during the recession, while the prices of most other shares fall. therefore, keeping these securities in the portfolio yield stabilizes the entire portfolio. the level of diversification depends on: (1) the scope of securities offer in the market, (2) volume of investments, (3) access to markets, and (4) investors being informed. when investing in a particular security, the portfolio risk is a possibility that planned yields will not be achieved, and that funds invested make less profit than expected or even a alihodžić, a., regional diversification, ea (2013, vol. 46, no, 3-4, 52-71) 57 loss. value deviations around its expected mean value can be measured by the variance and standard deviation. the variance is a sum of weighted squared deviations of possible returns around the expected mean (soskic and serdar, 1994, pp. 61). the weights are the probability of appearance of each contribution. the higher the possible deviation around the expected means value and the higher the probability, the higher is the variance. the standard deviation is expressed by the same units in which the arithmetic mean is expressed, so the standard deviation is an absolute measure of dispersion. for the calculation of the variance , the following formula is used: where: variance, possible variations (oscillations) around the mean value, expected mean value, probability of performing a certain value. the standard deviation σ is the square root of the variance: the standard deviation as an absolute measure of dispersion is not appropriate for the comparison of the dispersion size of two distributions with two different numerical evaluative features. a relative measure of dispersion should be used for such a comparison, eliminating the impact of various numerical values of the first and second sample units. the relative dispersion measure based on the standard deviation is the coefficient of variation: the expected yield of portfolio is calculated as the weighted sum of returns of individual securities that make up the portfolio. the share of individual securities in a portfolio serves as a weight: where: expected return on portfolio, percentage share of securities (i) in the portfolio, expected yield securities (i). the variance of the portfolio is calculated as follows: where: variance of the i-th securities, standard deviation of the i-th securities, the correlation coefficient between yield securities (i) and (j). the last part of the equation (5) can be replaced by the statistical term (covariance) in order to simplify the equation, since it is: economic analysis (2013, vol. 46, no. 3-4, 52-71) 58 covariance is obtained from the following formula (berenson and levine, 1996, pp. 733): a measure expressing a joint motion of two series is called the correlation coefficient, indicated by the greek letter . the correlation coefficient always takes a value between -1 (perfect negative correlation) and +1 (perfect positive correlation), indicating the accuracy of the description of the mutual movement between two sets of returns. the correlation coefficient between -1 and +1 describes that two sets of returns vary together in an imperfect way. the correlation coefficient is expressed as follows: the higher the correlation coefficient, the more two series are moving together, so that if the correlation coefficient was -1 or +1, then the two series would be in no correlation or in perfect correlation. thus, the positive correlation coefficient indicates the proportionality of variables, i.e. that the increase of one variable causes the growth of the other and vice versa. the negative indicates an inverse variable proportionality, i.e. that the increase of one variable causes the decrease of the other variable and vice versa. if is closer to zero, the correlation is weaker, and the closer it is to one, the relationship is stronger (vukicevic et al., 2010, pp. 294). table 1. correlation between variables depending on absolute values of correlation coefficients absolute value of correlation coefficient strength of association between variables complete correlation strong correlation medium correlation relatively weak correlation insignificant correlation complete absence of correlation source: vukičević, m., gregurek, m., odobašić, s., grgić, j. (2010). financial management in ms excel, golden marketing technical books, zagreb, pp. 294 the table above describes a rough interpretation of correlation coefficient values. the significance of correlation coefficients primarily depends on particular characteristics of observed variables determined by additional statistical methods. generally, the pearson's alihodžić, a., regional diversification, ea (2013, vol. 46, no, 3-4, 52-71) 59 linear correlation coefficient is used as a measure of association between two variables (x and y) in a risk analysis. it is indicated by r and expressed as follows:2 an investor who diversified an investment does not take into account the individual risk of an asset, but its effect on the risk of the overall portfolio (bawa et al., 1979, pp. 1042). as the standard deviation and variance measure the risk of an asset when it is viewed in isolation, it is necessary to use measures that bind one property to another when assessing a corporate risk. the determination of an expected return and standard deviation of return allows the formation of a yield probability distribution curve. by the yield probability distribution curve, a probability of deviations from the expected return is observed. thereby, the most widely used is the gaussian curve normal distribution curve (figure 2). figure 2. gaussian curve normal distribution curve source: brigham, e., daves, p., gapenski, l. (2004) intermediate financial management, mason oh: thomson south–western, pp. 35. the gaussian curve takes into account positive and negative deviations from the expected size. the yield is interpreted by the rule 3σ, i.e. 68% of the yield is in the range r ± 1σ, 95% of the yield is in the range r ± 2σ and 99.7% of the yield is in the range r ± 3σ. by the comparison of the curves of normal distribution, the investor chooses among possible investment alternatives. if the range of possible yields is higher, the curve will be flatter in shape and such investment will be riskier than investments with a lower range of possible 2 the assessment of significance of the correlation coefficients is very important in the application of the correlation analysis. the analysis of the importance of the correlation coefficients on the basis of their value often leads to erroneous conclusions, so that in examples of small samples the correlation analysis may be questionable. economic analysis (2013, vol. 46, no. 3-4, 52-71) 60 yields. by the optimisation of the portfolio structure and risk reduction, investors can increase positive deviations from the expected return or reduce negative bias. tendency of movement in capital markets of the western balkans and data analysis an uneven movement of share exchange indexes in the world and the region, as the result of global economic factors in the previous period, continued in 2012. main indexes experienced a decline in value in the world markets during the mid-year and in the third quarter there was growth, which continued until the end of the year as a sign of recovery of the world economy. chart 1. movement of share indexes in developed markets for the period: 23 december 2011 to 23 december 2012 source: www.dep.gov.ba, annual report 2012, economic trends, pp. 36 in 2012, the neighbouring countries, as well as the sarajevo and banja luka stock exchange, registered a slight decline in market capitalization, and by the end of the year they began making gradual growth. the total market capitalization3 of sarajevo and banja luka stock exchange (sase and blse) at the end 2012 amounted to eur 4.26 billion, which is a relative increase by approximately 1.52% in comparison to the same period the year before. unlike the market capitalization, indexes in bh capital market recorded a decline in value. in the period from 30 december 2011 to 29 december 2012, the value of the sasx 10 share indexes decreased by 31 index points, which is a relative decline by 3.86%. also, the index of banja luka stock exchange (birs) in the same period declined by 69 index points, i.e. in the relative value of 7.9% (dep, 2012). on the final day of 2012, on the belgrade stock exchange a regulated market capitalization of the share market amounted to 2.8 billion eur, whereby the prime listing capitalization was eur 1.34 billion and the standard listing around eur 131 million. after two consecutive years of negative returns, in 2012 the bse indexes had 3 market capitalization is the sum of share price and volume of shares traded on the stock exchanges. alihodžić, a., regional diversification, ea (2013, vol. 46, no, 3-4, 52-71) 61 positive values. the index of the most liquid shares (belex15) ended the year with a growth by 523.89 index points, i.e. with a relative increase by 4.98%, while the other general index (belexline) reported somewhat lower growth by 2.9% (bse, 2012). in this paper, we analyse the possibility of broader diversification using data on the movement of share indexes divided into three groups, namely: (1) indexes of developed countries, such as the indexes of usa (s&p 500 and djia), france (cac 40), great britain (the ftse all share), germany (dax), (2) indexes of the western balkans: bosnia and herzegovina (sasx 10 and sasx 30 and birs), serbia (belex15 and belexline), (3) indexes of eu countries: blue chip index eurozone (euro stoxx 50), hungary (bux and bumix), slovenia (sbitop) and croatia (crobex). we will observe the correlation coefficients in two different time intervals and for the period from 31 march 2009 to 28 december 2012 and from 31 march 2009 to 28 march 2013.4 the table below illustrates a correlation matrix between the share indexes in developed countries, western balkan countries and individual eu member states for the first period observed. 4 correlation coefficients were calculated based on monthly price movements of the observed indexes in the mathematical program matlab 7.1. economic analysis (2013, vol. 46, no. 3-4, 52-71) 62 table 2. correlation coefficient matrix for indexes of developed countries of western balkans and some eu member states for the period: 31 march 2009 – 28 december 2012 source: calculation by author sasx10 sasx30 birs belex15 belexline crobex bux bumix sbitop dax eurostoxx 50 ftse all share cac 40 s&p 500 djia sasx 10 1,000 0,836 0,463 0,659 0,656 0,633 0,331 0,393 0,544 0,211 0,272 0,208 0,269 0,188 0,126 sasx 30 0,836 1,000 0,463 0,573 0,571 0,626 0,369 0,404 0,466 0,222 0,335 0,224 0,310 0,209 0,155 birs 0,463 0,463 1,000 0,423 0,466 0,465 0,263 0,325 0,333 0,204 0,241 0,301 0,261 0,341 0,298 belex 15 0,659 0,573 0,423 1,000 0,987 0,739 0,537 0,581 0,452 0,312 0,383 0,422 0,440 0,382 0,296 belexline 0,656 0,571 0,446 0,987 1,000 0,717 0,501 0,569 0,497 0,267 0,337 0,374 0,391 0,342 0,252 crobex 0,633 0,626 0,465 0,739 0,717 1,000 0,569 0,558 0,481 0,288 0,379 0,460 0,429 0,448 0,386 bux 0.331 0.369 0.263 0.537 0.501 0.569 1.000 0.879 0.495 0.735 0.795 0.797 0.784 0.764 0.762 bumix 0.393 0.404 0.325 0.581 0.569 0.558 0.879 1.000 0.499 0.612 0.700 0.725 0.678 0.683 0.656 sbitop 0.544 0.466 0.333 0.452 0.497 0.481 0.495 0.499 1.000 0.334 0.281 0.270 0.243 0.351 0.296 dax 0.211 0.222 0.204 0.312 0.267 0.288 0.735 0.612 0.334 1.000 0.899 0.819 0.866 0.799 0.754 eurostock 50 0.272 0.335 0.241 0.383 0.337 0.379 0.795 0.700 0.281 0.899 1.000 0.897 0.978 0.835 0.804 ftse all share 0.208 0.224 0.301 0.422 0.374 0.460 0.797 0.725 0.270 0.819 0.897 1.000 0.914 0.910 0.887 cac 40 0.269 0.310 0.261 0.440 0.391 0.429 0.784 0.678 0.243 0.866 0.978 0.914 1.000 0.852 0.813 s&p 500 0.188 0.209 0.341 0.382 0.342 0.448 0.764 0.683 0.351 0.799 0.835 0.910 0.852 1.000 0.975 djia 0.126 0.155 0.298 0.296 0.252 0.386 0.762 0.656 0.296 0.754 0.804 0.887 0.813 0.975 1.000 alihodžić, a., regional diversification, ea (2013, vol. 46, no, 3-4, 52-71) 63 it is clear from the above table that most of the observed share indexes are positively correlated, while certain indexes have a correlation coefficient below one. if we observe indexes of the western balkan countries, what we first notice is that they have the highest positive correlation with indexes of some eu member states as well as between themselves, while they correlate the least with indexes of developed countries. if we take a look at the sasx – 10 index, it is evident that the strongest positive relationship is expressed with the other sarajevo stock exchange sasx – 30 index (0.836), which is logical given that they belong to the same segment of the financial market, then with the belex15 (0,659), belexline (0.656) and the zagreb stock exchange index crobex (0,633). the strongest negative correlation is present with the market indexes djia (0,126), s&p 500 (0,188) and dax (0,211). likewise, almost the same tendencies in the movement of correlation coefficients is between the banja luka stock exchange and belgrade stock exchange indexes. thus, the strongest positive relationship between the share indexes of banja luka stock exchange index was observed with indexes of the belgrade stock exchange belexline (0.466) and zagreb stock exchange (0,739). on the other hand, the strongest negative correlation was achieved with market indexes of developed countries, such as the dax (0,204), djia (0,298) and s&p 500 (0,341). a similar trend of movement is also with other indexes of the western balkan countries. to test the hypothesis about the variability of correlation coefficients between the observed share indexes, the correlation coefficient matrix is calculated below for the period from 31 march 2009 to 28 march 2013. economic analysis (2013, vol. 46, no. 3-4, 52-71) 64 table 3. correlation coefficient matrix for indexes of developed countries, western balkans countries and some eu member states for the period: 31 march 2009 – 28 march 2013 source: calculation by author sasx10 sasx30 birs belex15 belexline crobex bux bumix sbitop dax eurostoxx 50 ftse all share cac 40 s&p 500 djia sasx 10 1.000 0.826 0.442 0.662 0.657 0.636 0.337 0.389 0.541 0.209 0.273 0.223 0.273 0.195 0.143 sasx 30 0.826 1.000 0.464 0.558 0.552 0.612 0.355 0.393 0.457 0.214 0.319 0.221 0.303 0.196 0.142 birs 0.442 0.464 1.000 0.396 0.417 0.436 0.237 0.316 0.320 0.196 0.223 0.274 0.247 0.315 0.258 belex 15 0.662 0.558 0.396 1.000 0.986 0.742 0.539 0.575 0.449 0.312 0.387 0.434 0.445 0.391 0.314 belexline 0.657 0.552 0.417 0.986 1.000 0.721 0.498 0.561 0.488 0.266 0.341 0.385 0.395 0.354 0.273 crobex 0.636 0.612 0.436 0.742 0.721 1.000 0.557 0.542 0.466 0.282 0.375 0.473 0.430 0.459 0.407 bux 0.337 0.355 0.237 0.539 0.498 0.557 1.000 0.874 0.505 0.730 0.794 0.788 0.780 0.748 0.740 bumix 0.389 0.393 0.316 0.575 0.561 0.542 0.874 1.000 0.503 0.613 0.701 0.711 0.677 0.670 0.631 sbitop 0.541 0.457 0.320 0.449 0.488 0.466 0.505 0.503 1.000 0.336 0.286 0.268 0.245 0.340 0.280 dax 0.209 0.214 0.196 0.312 0.266 0.282 0.730 0.613 0.336 1.000 0.898 0.807 0.865 0.791 0.734 eurostock 50 0.273 0.319 0.223 0.387 0.341 0.375 0.794 0.701 0.286 0.898 1.000 0.887 0.976 0.829 0.788 ftse all share 0.223 0.221 0.274 0.434 0.385 0.473 0.788 0.711 0.268 0.807 0.887 1.000 0.909 0.907 0.886 cac 40 0.273 0.303 0.247 0.445 0.395 0.430 0.780 0.677 0.245 0.865 0.976 0.909 1.000 0.848 0.802 s&p 500 0.195 0.196 0.315 0.391 0.354 0.459 0.748 0.670 0.340 0.791 0.829 0.907 0.848 1.000 0.972 djia 0.143 0.142 0.258 0.314 0.273 0.407 0.740 0.631 0.280 0.734 0.788 0.886 0.802 0.972 1.000 alhodžić, a., possibility of applying, ea (2013, vol. 46, no, 3-4, 52-71) 65 table 3 shows that the correlation coefficients in the second analysed period for the share market indexes in the western balkans and the eu countries slightly changed the intensity and direction with respect to the increase of values with respect to the first analysed period, while the correlation coefficient of indexes of developed countries recorded a tendency of a slight decrease in value. the strongest positive correlation with the index of the sarajevo stock sasx – 10 index was made by the following indexes: sasx 30 (0.826) belex 15 (0.662), belexline (0.657) and crobex (0.636). as in the first analysed period, the strongest negative relationship with the share index of sasx 10 was made by the following indexes of developed countries: djia (0,143), s&p 500 (0,195) and dax (0,209), which provides a good opportunity for diversification. based on the data on the movement of share indexes in the western balkans and on the theoretical basis elaborated in the second part of the paper, we will initially make the selection of shares from sarajevo, banja luka and belgrade stock exchange, which we will combine into a certain optimal risk portfolio. the second step of the analysis is to include a certain number of shares from the new york stock exchange and germany stock exchange in our initial portfolio in order to further reduce investment risks because the correlation coefficients between the share indexes of western balkan countries and the developed countries are with the lowest correlation coefficients (table 3). based on the collected data on monthly price changes of selected securities share indexes of the western balkans for the period from 31 august 2010 to 28 march 2013, which amount to the total of 944 days or 677 working days, by the calculation by a software used for the optimisation, we came up with the following values of return and risk, as illustrated by the table below. table 4. average yield and standard deviation of individual shares within the share market indexes: sasx – 10, birs and belex15 for the period from 31 august 2010 to 28 march 2013 s h ar e s y m b o ls b h t s r b s n l r h t k m r jp e m r jp e s r b o k s -r -a h e d r -r -a n o v b -r -e r n a f -r -a t l k m -r -a a ik b e n h l k m b n n ii s average yield 0,19 0,06 -0,54 -0,58 -0,18 2,59 0,90 -0,35 1,24 1,13 -1,36 -0,28 -1,22 2,57 standard deviation 5,50 7,48 7,44 9,70 8,07 11,43 7,92 8,50 24,48 5,14 9,04 9,65 10,66 12,79 source: calculation by author the table above clearly shows that the highest average (monthly) rate of return was achieved by the shares of the company of boksit, milici by 2.59%, and the risk is expressed by a standard deviation of 11.43%, whereby it could be concluded that the yield and risk are positively correlated. the second highest average positive yield is achieved by the shares of the serbian oil company1 of 2.57% and a standard deviation of 12.79%. the highest prices of the oil industry of serbia shares in 52 weeks of trading amounted to rsd 1.020, while the lowest price was rsd 585 ( www.belex.rs). unlike the positive values of average (monthly) 1 the public joint stock company of oil industries of serbia is an enterprise for research, processing, distribution and sale of oil and exploration and production of natural gas. economic analysis (2013, vol. 46, no. 3-4, 52-72) 66 yields, the lowest negative value during the observed period was recorded by the shares of the agro-industrial commercial bank, nis (-1.36%), and a standard deviation of 9.04%, followed by the shares of the belgrade commercial bank with a negative average yield of 1.22% and a standard deviation of 10.66%, and the shares of jp ep hzhb mostar are in the third place with an average yield (-0.58%) and a standard deviation (9.70%). by the comparison of the average rate of return of the observed share indexes of the western balkan countries it can be noted that there is a slight deviation from the value of zero, except for the shares of the oil industries of serbia, telekom of srpska, boksit company milici and oil refinery brod, which is consistent with the theoretical assumption of many approaches and models for measuring market risks, which include the premise that a long-term average (monthly) return equals zero. likewise, along with the data collected on the monthly price movements of selected shares, a process of the optimisation of initial venture portfolio of 14 shares observed was carried out, as illustrated in the table below. table 5. features of first nine optimal portfolios of shares observed in the composition of the share indexes: sasx – 10, birs and belex15 on 28 march 2013 portfolio 1. 2. 3. 4. 5. 6. 7. 8. 9. yield (%) 0.50 0.76 1.02 1.29 1.55 1.81 2.07 2.33 2.60 risk – σ (%) 3.36 3.42 3.60 3.87 4.23 4.74 5.47 6.38 11.43 share (%) bhtsr 0.136 0.140 0.130 0.113 0.052 -0.000 -0.000 -0.000 -0.000 bsnlr 0.107 0.077 0.037 0.001 -0.000 -0.000 -0.000 -0.000 -0.000 htkmr 0.065 0.011 -0.000 -0.000 -0.000 0.000 0.000 -0.000 0.000 jpemr 0.017 0.027 0.016 0.001 0.000 0.000 -0.000 -0.000 0.000 jpesr 0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 boks –r-a 0.000 0.015 0.064 0.116 0.164 0.244 0.345 0.447 1.000 hedr-r-a 0.132 0.141 0.141 0.141 0.143 0.105 0.040 -0.000 -0.000 novb-r-e 0.130 0.101 0.073 0.043 -0.000 0.000 -0.000 -0.000 0.000 rnaf-r-a 0.009 0.015 0.017 0.018 0.019 0.019 0.019 0.013 -0.000 tlkm-r-a 0.381 0.424 0.431 0.434 0.444 0.393 0.288 0.160 -0.000 aikb-2 -0.000 -0.000 -0.000 0.000 0.000 -0.000 -0.000 -0.000 -0.000 enhl -0.000 0.000 0.000 0.000 0.000 0.000 -0.000 -0.000 0.000 kmbn 0.015 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 niis 4 0.008 0.049 0.048 0.133 0.178 0.239 0.308 0.380 -0.000 source: calculation by author as it can be seen, the second out of nine portfolios has a slightly higher risk measured by standard deviation compared to the first, but a significantly higher rate of return, so we opted for the second portfolio as the optimal solution. the selected initial (risk) optimal portfolio has an overall yield of 0.76%, the variance of 11.70% and standard deviation of 3.42%. the yield of the second selected optimal portfolio presents a relative increase by 52% compared to the yield of the first portfolio. since the selected shares present a structural share of the stock indexes of sasx-10, birs and belex15, if we compare the yield and risk of share index with the optimal portfolio we come to the following data. the benchmark alhodžić, a., possibility of applying, ea (2013, vol. 46, no, 3-4, 52-71) 67 index of the sarajevo stock exchange sasx 102 in the period from 31 september 2009 to 28 march 2013 reached a negative average (monthly) return of 0.08%, the variance of 29.05 and a standard deviation of 5.39%. in the same period observed, the index of banja luka stock exchange birs also generated negative average (monthly) return of 0.22% , the variance of 13.76% and a standard deviation of 3.71%. unlike the index of sarajevo and banja luka stock exchanges, the share index of the belgrade stock exchange belex15 in the same period registered a positive average (monthly) return of 1.25%, variance of 81,90% and standard deviation of 9.05%. if a potential investor is in a dilemma whether to invest in shares of initially formed optimal portfolio or the shares of sasx 10 and birs share indexes, they should certainly give advantage to the optimal portfolio for the simple reason that the average return is positive (0.76%) compared to the yield of the share index sasx – 10, which is negative (-0.08%) and the yield of birs share index (-0.22). also, in terms of risk measured by a standard deviation, the advantage is with the optimal portfolio, which achieved a standard deviation of 3.42%. unlike the optimal portfolios, the sasx-10 share index achieved a standard deviation of 5.39% over the observed period, which represents a relative increase compared to the optimal portfolio by approximately 58%. similarly, the index of banja luka stock exchange birs in this period was riskier than the optimal portfolio, where it achieved a standard deviation of 3.71%, which represents a relative increase by 8%. on the other hand, if a potential investor has the option to invest in shares of the belgrade stock exchange index belex15 or in shares of initial optimal portfolio, then in terms of return they should invest in the belex15 share index because it yielded by 1.25%, which is a relative increase by 64%. if we look at the risk, then priority should certainly be given to the optimal portfolio which had a standard deviation by 3.42% in this period, which is a relative decrease compared to the share index of belex15 by approximately 63%. if certain shares from the structure of the german stock exchange index (dax) and new york stock exchange indexes (s & p 500 and djia) are included into the initially formed (risk) portfolio, we come to the newly formed optimal portfolio, as illustrated by following table. table 6. features of the first nine optimal portfolios of observed shares in composition of share indexes: sasx – 10, birs and belex15, dax, s&p 500 i djia on 28 march 2013 portfolio 1. 2. 3. 4. 5. 6. 7. 8. 9. yield (%) 0.88 1.09 1.31 1.52 1.74 1.95 2.17 2.38 2.60 risk – σ (%) 2.12 2.14 2.24 2.42 2.67 2.99 3.36 3.78 11.43 share (%) bhtsr 0.015 0.025 0.038 0.031 0.000 0.000 0.000 -0.000 -0.000 bsnlr 0.000 -0.000 -0.000 -0.000 -0.000 -0.000 0.000 0.000 -0.000 htkmr 0.103 0.101 0.089 0.073 0.058 0.027 0.000 -0.000 0.000 jpemr -0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 jpesr 0.089 0.059 0.021 0.000 0.000 -0.000 -0.000 0.000 -0.000 2 index of sasx 10 follows price movements among top ten companies on the market, excluding investment funds as measured by market capitalization of trading. economic analysis (2013, vol. 46, no. 3-4, 52-72) 68 boks –r-a 0.052 0.074 0.094 0.117 0.142 0.165 0.188 0.000 1.000 hedr-r-a -0.000 0.002 0.013 0.015 0.011 0.003 0.000 0.216 -0.000 novb-r-e 0.011 0.000 -0.000 -0.000 0.000 0.000 0.000 -0.000 0.000 rnaf-r-a -0.000 0.000 0.000 -0.000 -0.000 -0.000 -0.000 0.000 0.000 tlkm-r-a 0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 0.000 -0.000 aikb -0.000 -0.000 0.000 -0.000 0.000 -0.000 -0.000 -0.000 0.000 enhl -0.000 0.000 -0.000 -0.000 0.000 0.000 0.000 -0.000 -0.000 kmbn 0.004 -0.000 -0.000 -0.000 0.000 0.000 0.000 -0.000 0.000 niis 0.007 0.018 0.029 0.043 0.058 0.074 0.090 0.103 0.000 ads 0.032 0.074 0.124 0.177 0.235 0.297 0.352 0.430 -0.000 bayn 0.063 0.057 0.051 0.039 0.022 -0.000 -0.000 -0.000 -0.000 dai 0.000 -0.000 0.000 0.000 -0.000 -0.000 -0.000 0.000 0.000 aapl 0.117 0.108 0.098 0.091 0.088 0.084 0.079 0.066 -0.000 goog 0.006 0.030 0.054 0.077 0.098 0.118 0.131 0.149 0.000 pep 0.456 0.437 0.390 0.337 0.288 0.231 0.159 0.036 -0.000 chrw 0.045 0.016 -0.000 -0.000 0.000 0.000 0.000 -0.000 -0.000 phh -0.000 0.000 -0.000 -0.000 0.000 0.000 0.000 -0.000 -0.000 source: calculation by author from the table above, it is clear that the rates of return of almost all of the nine observed portfolios were increased and risks measured by the standard deviation were reduced by including shares of companies from different sectors in germany and the new york stock exchange, which confirms the main hypothesis tested in the paper, that further inclusion of shares stock indexes in developed countries in the optimal risk portfolio of the western balkan countries directly affects the increase of return and decrease of risk. since here the second portfolio from the efficient threshold (table 6) also has a slightly higher risk than the safest portfolio and a higher rate of return, it presents an optimal solution. the selected optimal portfolio in the period observed has a total average yield of 1.09%, variance of 4.58 and a standard deviation of 2.14%. since we compared the initial (risk) optimal portfolio to the market indexes in the western balkans, i.e. the market performance of their business, we will compare the market performance of the second obtained optimal portfolio to the performances of the share index dax, s& p 500 and djia. the index of german stock exchange dax in this period achieved an average (monthly yield) of 1.52%, the variance of 31,92 and standard deviation of 5.65%. if a potential investor considers whether to invest in the shares of the german stock exchange index dax or the shares of another optimal portfolio, from the point of view of return they should invest into the share index dax because it yielded 1.52%, which represents a relative increase by 39% compared to other established optimal portfolio. if we analyse the risks, then a priority should definitely be given to the optimal portfolio, which in this period had a standard deviation of 2.14%, which is a relative decrease compared to the dax share index by approximately 63%. unlike the german stock market index, the index of new york stock exchange s&p 500 achieved an average (monthly) return of 1.69%, variance of 18,40% and standard deviation of 4.29% over the observed period. in this case, a potential investor from the yield point should invest in the s&p 500 share exchange index because they guarantee higher profit compared to the other established optimal portfolio, while in terms of risks the advantage is once again given to the optimal portfolio. the other analysed index on the new york stock exchange alhodžić, a., possibility of applying, ea (2013, vol. 46, no, 3-4, 52-71) 69 djia in this period also made a positive average (monthly) return of 1.44%, variance of 15.44% and standard deviation of 3.93%. it is safe to conclude that in this case priority is given to investments in shares of the djia share index because they guarantee the yield of 1.44%, which in comparison with the optimal portfolio yield represents a relative increase of 32%. on the other hand, in terms of a risk measured by the standard deviation, advantage is given to the optimal portfolio because for the period observed it has a standard deviation of 2.14% and, as opposed to the djia share market index, it is a relative reduction by approximately 46%. conclusion the basic argument in favor of international diversification is that foreign investments allow investors to reduce the total risk of the portfolio, while offering additional profit potential. by expanding the investment opportunity set, international diversification helps to improve the risk adjusted performance of a portfolio. domestic securities tend to move up and down together because they are similarly affected by domestic conditions, such as monetary announcements, movements in interes rates, budget deficits, and national growth. a portfolio diversification works because prices of different shares do not move in a completely same direction. statisticians generally mean the same thing when they say that share price changes are nothing less than perfectly correlated. correlation coefficients between securities in the capital markets in the western balkans should be taken with some reserve because of their proven variability, since in financial crises correlation coefficients converge to the unit, benefits of diversification disappear and portfolio risk becomes simply equal to the weighted sum of individual risks of securities of which it is composed. the logic of diversification has very solid theoretical assumptions and it is well known in the popular proverb: „do not put all your eggs in one basket“. it is equally easy to demonstrate logical benefits of inclusion of securities from different industries and markets into the portfolio, which is reflected in lower risk and stable returns. reasons for positive effects of international diversification can be found in the fact that economic cycles of countries do not move synchronously. the above analysis clearly shows that the investment of available funds for a given optimization model and active management of a portfolio can provide significant rates of return because, as it can be observed from the second formed optimal portfolio, yield rate of about 30% increased compared to the risk portfolio formed first. also, the risk of almost all of the nine formed portfolios decreased owing to the inclusion of shares from different share markets and different sectors of activity. a chronic lack of large institutional investors, whose participation in the capital markets, in addition to providing liquidity also reduce volatility, again brings to the forefront the issue of establishing cooperation and finding adequate forms of association of market organisers. connection in the capital market is a very topical issue, because it brings forth all the positive effects, such as the formation of an optimal portfolio, increase of the attractiveness of a market and a wider range of market materials for potential investors. also, the trend of connectivity brings with it the possibility of a direct trade to a broker over the stock market, which is a model that should meet the highest standards of broker share economic analysis (2013, vol. 46, no. 3-4, 52-72) 70 market business. observed on the other hand, it is true that smaller share markets face problems of economic self-sufficiency, which is particularly evident in times of recession to be successfully overcome, where the connectivity between stock markets and capital markets becomes inevitable. references alihodžić, a., and plakalović, n. 2013. savremeno upravljanje finansijama sa primjenom u ms excelu. beograd: institut ekonomskih nauka. bawa, s. v., elton, j. e. and gruber, j. m. 1979. „simple rules for optimal portfolio selection in stable paretion market“. the journal of finance, (34):4. bodie, z., kane, a., and marcus, j. a. 2009. osnovi investicija. beograd: datastatus. belgrade stock exchange (bse). 2012. godišnji izveštaj o poslovanju u 2012. godini. http://www.belex.rs/files/proizvodi_i_usluge/gi_2012.pdf. 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finance diversification. http://finance.yahoo.com (accessed, october 30, 2013). hunter, j. r., and coggin, t. d. 1990. „an analysis of the diversification benefit from international equity investment”. the journal of portfolio management, 17(1). madura, j., and tucker, a. l. 1992. „hedging international stock portfolios: lessons from the 1987 crash”. the journal of portfolio management, 18(3). richard, a. b., myers, s., and marcus, j. a. 2007. osnovi korporativnih finansija. beograd: mate. solnik, b., mcleavey, d. 2009. global investments. sixth edition. boston: pearson international edition. solnik, b. 1974. „why not diversity internationally rather than domestically“?. financial analysts journal. šoškić, i., and serdar, v. 1994. uvod u statistiku. zagreb: školska knjiga. vukičević, m., gregurek, m., odobašić, s., and grgić, j. 2010. finansijski menadžment u ms excelu, zagreb: golden marketing tehnička knjiga. http://www.belex.rs http://www.sase.ba http://www.blberza.com http://www.zse.hr http://www.bse.hu alhodžić, a., possibility of applying, ea (2013, vol. 46, no, 3-4, 52-71) 71 http:// deutsche-boerse.com http://www.londonstockexchange.com http://www. nyse.com http://www.investing.com/equities/apple-computer-inc-historical-data mogućnost primene regionalne diversifikacije na tržištima kapitala bosne i hercegovine i r. srbije rezime – generalno rizik predstavlja nesigurnost povezanu s budućim ishodom ili događajem. u ekonomskom smislu rizik predstavlja očekivano odstupanje od planiranih prinosa realne, finansijske i neopipljive imovine, ostvarivanje gubitka, ili novčanih tokova povezanih s nesigurnim događajem. najpoznatiji način umanjivanja ukupnog rizika je diversifikacija imovine. dakle, diversifikacija je proces investiranja u brojne nepovezane ili djelimično povezane imovine ili aktivnosti u cilju postizanja stabilnog poslovanja, odnosno ona pokazuje koji su portfoliji u toj mjeri loši da ih treba izbjegavati kako bi se uticalo na povećanje prinosa i smanjenje rizika. diversifikacija portfolija funkcioniše jer se cene različitih akcija ne kreću u potpunosti u istom smeru. statističari u principu misle na istu stvar kada kažu da promene cena akcija nisu ništa manje nego u savršenoj korelaciji. osnovni cilj u ovom radu je razmatranje uticaja globalne finansijske krize na tendenciju kretanja berzanskih indeksa zemalja zapadnog balkana, razvijenih zemalja i pojedinih zemalja članica eu, te utvrđivanje mogućnosti sprovođenja regionalne diversifikacije u cilju dodatnog smanjivanja rizika, odnosno formirnja portfolija akcija s najnižim koeficijentima korelacije. ključne reči: sistematski rizik, nesistematski rizik, gausova kriva, efikasna granica, optimalni portfolio article history: received: 26 june 2013 accepted: 10 october 2013 microsoft word 2008_01_02.doc original paper    the attractiveness of the western balkans for the fdi    srđan redžepagić, institute of economic sciences    xavier richet, université de la sorbonne nouvelle, paris cemafi    key words: fdi, ceec, european union, investments, economy    udc: 327.39:061.1          jel: e22, 018  abstract ‐ as the eu expands, the focus is on the western balkans region1, which is rich with  opportunity and potential. it is experiencing significant improvements in terms of reforms, economic growth  and foreign direct investment (fdi). developing economies such as those in the western balkans are par‐ ticularly dynamic, which can mean rapidly changing costs and conditions for investors. the region has made  strong progress, outpacing central europe  in economic growth with an average gross domestic product  (gdp) increase, these latest years. for the next several years, the markedly strong economic development is  expected to continue in western balkans. inflation has largely been kept under control, and is expected to  decline further in the near future. the western balkans are improving risk profile and economic outlook are  also validated by the international credit ratings. as unemployment (in almost all western balkans coun‐ tries) is still high, sustainable economic growth (redzepagic and llorca 2007) and job creation are the major  challenges the region faces. it is important to mention, for example, that the fdi into the region was 3.4 bil‐ lion of euros in 2005, but also the cumulative fdi inflow in the region was near 15 billion of euros for the  five‐year period of 2001‐2005 (redžepagić and richet 2008). as the countries of the region rarely invested  abroad, net fdi inflows also played a key role in financing foreign trade imbalances that stem from ongoing  structural reforms and significant investment demand in the transition to free markets.  introduction  as the eu expands to the east and south, the western balkans are considered by many cur‐ rent and prospective investors to offer opportunities as europe’s next high‐growth business loca‐ tion. croatia and macedonia are candidates for eu membership, and stabilization and association  agreements are in force or under negotiations for the other countries of the region. generally ana‐ lyzing, the characteristics driving investment in this region include:  o access to a growing market of over 150 million consumers  o a competitive business environment, with labor costs under the levels of the czech  republic and hungary in parts of the region  o abundant availability of a highly skilled and well‐educated workforce  o economic reforms delivering an enhanced investment climate  o first‐mover advantage  to  those entering  the market at  the  front end of a growing  wave of investment  the fdi in the new market economies in eastern europe (now for new member states of the  eu) is interesting to be analyzed from the several points of view (redžepagić 2006):  o the motivations of the foreign firms – mainly european (the share of the fdi except  europe are lower than 20% of the total) are divided between the access to new mar‐ kets, on the one hand and with a regional integration by the means of a vertical seg‐ mentation from the other side. this contributes to redraw the industrial landscape of  1 albania, bosnia and herzegovina, croatia, fyr of macedonia, montenegro and serbia    volume 40 • spring 2008 • 49  these  economies  by  specializing  them  around  activities  mainly  with  high  added  value. the analysis of flows and the contents  in value added of the exchanges be‐ tween these countries and the countries of the eu‐15 emphasize well this phenome‐ non: intra‐branch, mainly, are initially characterized by inter‐branches exchanges  o the transformation of these economies into market economies could not have taken  place without the assistance of the foreign capital. the companies with foreign capital  contribute in a very significant way to employment, the investment, exports and the  new specialization of these economies  o the effect of proximity, the ʺnearshoringʺ2, of the fdi: the delocalization of activities is  required for well‐known advantages (cost of work, growth of new markets, etc). it  appears  that  the  effect of  proximity plays  such  a  significant  role,  because of con‐ straints related to the production of products or services integrated in the production  of the goods and the services in the country of origin.   some evidences from western balkans countries   the operation of the multinational firms shows, on the contrary, that the step which animates  them is rather an operation in network, at the same time in terms of division of competences, of  entry on the markets, of research and development. the opening of the western balkans and cen‐ tral and east european countries (ceec) more than ten years ago has fundamentally altered the  political and economic landscape of the european continent. the region has been transformed into  a marketplace with dynamic growth, attracting a significant amount of fdi. much of this success  can be attributed to the efforts of local governments, international organizations, and other non‐ governmental institutions. foreign investors have shared information on their experiences and on  best practices within countries in which they have invested. this direct approach with authorities  and cooperation with several international organizations has helped to create a more accurate pic‐ ture of the investment landscape within various countries in the region. the western balkans re‐ gion, along with some of the other ceecs, lags in many ways behind the central european transi‐ tion economies. the private sector is not as well developed in the western balkans; the public sec‐ tor is only partially reformed, and the informal economy is more evident than in the ceecs.  in albania, with most state‐owned small and medium‐sized enterprises (smes) already pri‐ vatized the inflow of fdi into albania has been moderate since 1999. fdi peaked in 2004 at 275  million of american dollars, helped by albania’s  largest‐ever privatization deal. specifically,  in  april 2004, the austrian raiffeisen zentralbank (rzb) acquired full ownership in the savings bank,  albania’s  largest commercial  bank,  in  exchange  for  126  million of american  dollars.  italy  and  greece are the predominant sources of fdi in albania, with roughly 48% originating in italy and  34% in greece. these two countries are also albania’s major trading partners for both import and  export. foreign investments are mainly concentrated in the key commercial districts of the country.  approximately two‐thirds of all fdi is targeted toward either the capital, tirana, or the main cargo  port, durres. since the beginning of 2003, key foreign direct investments in albania include: multi‐ ple flour mills, including one in tirana with a daily production capacity of 300 tons of wheat and  10,000 tons of grain, by flour mills loulis of greece; from aprider of israel, six greenhouses in dif‐ 2 « nearshoring » means sourcing service activities to a foreign, lower‐wage country that is relatively close in distance or  time zone (or both). the customer expects to benefit from one or more of the following constructs of proximity: geo‐ graphic, temporal, cultural, linguistic, economic, political, or historical linkages. similar terms include nearsourcing and  nearshore outsourcing. the service work that is being sourced may be a business process or software development. as  with offshore, the term ʺnearshoreʺ was originally used in the context of fishing and other ocean‐based activities and  later adapted by the business world.  2007 ‐ 50  •  economic analysis®  ferent regions of the country; a 2.5 million of american dollars investment by the japanese gov‐ ernment in a vegetable oil plant in fier; and, as announced in 2005, a planned investment of 1.9  million of american dollars by berlinwasser international, a german water company, to increase the  supply of drinking water in durres.  the fdi inflow, in bosnia and herzegovina, in 2003 amounted to 338 million of american  dollars, more than 20% higher than in 2002. progress has been achieved in foreign investment law  and promotion, although there remain duplicating government structures at the state, entity, and  cantonal levels. the federal government of bosnia and herzegovina has selected lnm holding to  purchase bh steel, zenica. in addition, some food processing plants in banja luka were recently  privatized. in june 2003, the swiss company kreis‐industriehandel ag (a majority shareholder  in  vitaminka) purchased 51% of fruktona. the company also announced further investment plans in  both entities. this kind of privatization is considered vital for former yugoslav companies to re‐ structure and regain their domestic and regional markets. several domestically owned companies  report that they have had discussions with foreign investors. incoming investors intending to serve  the domestic market in addition to pursuing exports may require reassurance with respect to pur‐ chasing power growth locally and in the regional economy, as well as continued macro political‐ economic stability. it is expected that the effective functioning of designated free zone areas will  increase bosnia and herzegovina’s attractiveness to foreign investors.  since 1999, the inflow of fdi into croatia has exceeded 1 billion of american dollars each  year. the fdi inflow reached its peak of us$1.8 billion in 2003, largely due to the sale of oil com‐ pany ina to hungarian mol. in 2004, a year with no large privatization deals, fdi inflows slid to  1.08 billion of american dollars. greenfield investments are not yet common in croatia, particu‐ larly in the export oriented manufacturing sector. nevertheless, croatia ranks first among ceecs  in fdi stock per capita and is competitive in this area with the new eu member states. at year‐end  2004, croatia (with fdi inward stock of 13 billion of american dollars) ranked ahead of slovakia  and poland, trailing only hungary, estonia, the czech republic, and slovenia in south east and  central europe. in croatia 30‐40% of the inflow takes the form of equity investment, with the bal‐ ance consisting mainly of loans from the mother company and, since 2003, reinvested earnings.  equity investment (the only form of fdi for which a sector breakdown is available) amounted to  888 million of american dollars in 2003 and 319 million of american dollars in 2004. the main eco‐ nomic activities attracting fdi in 1993‐2004 were financial intermediation (21% of equity invest‐ ment), telecommunications (16%), pharmaceuticals (11%), petroleum (8%), and cement manufac‐ turing (3%). while the manufacture of machinery and transport equipment together accounts for  30% of exports (a figure trending upward), they attracted only 3% of fdi. rapid export increases  and high export revenues in 2002‐2004 were registered in the sector of other transport equipment,  as well as for electrical and other machinery. these data3 indicate that medium high‐tech manufac‐ turing is booming, but that the role of fdi is still small. locally owned companies are increasingly  competitive in certain industries. the croatian national bank registered 77 greenfield investments  in the manufacturing sector through the end of 2000, mainly in small enterprises in the textile and  clothing sectors (accounting for 5,600 employees at year‐end 2002). the bank identified 76 foreign  affiliates established by takeover through the end of 2000, accounting for 17,000 employees at year‐ end 2002, constituting a far greater impact than the greenfield projects. fdi companies in 2002  accounted for 15% of registered capital, 16% of revenue, 24% of exports, and 9% of employment –  much smaller shares than for central european countries, where foreign penetration typically ex‐ ceeds 50%. greenfield investment in croatia, as in slovenia, has been hindered by a lack of indus‐ trial real estate outside the former socially owned companies. the general attitude toward fdi in  3 for more details see ebrd transition report (2007).  volume 40 • spring 2008 • 51  croatia  is positive. government and most business representatives recognize  that a  transfer of  technical and managerial know‐how is required for many croatian companies to survive over time  and that this will most likely arrive through fdi. however, the study elicited comments by some  firms on the need for the croatian government to take a proactive stance in removing barriers and  in truly understanding the concerns and interests of business.  macedonia has historically attracted higher fdi per capita than most other countries in the  region, but has experienced a downturn in recent years. about 40 foreign investments entered the  country via privatization between 1995 and 2001, accounting for a substantial portion of the total  fdi.  subsequently,  however,  unstable civil conditions  and  the subsequent halt of privatization  have resulted in minimal fdi inflows. macedonia’s inclusion in the eu stabilization and associa‐ tion process, as well as its official application for eu membership in 2004, may encourage inves‐ tors. furthermore, a new government program for stimulating fdi was launched in august 2003,  with privatization re‐started in 2004, raising expectations of higher inflows by year‐end 2005. the  majority of foreign investment comes from hungary, since its german‐owned telecom provider  purchased the privatized maktel in 2001. the next largest amount of fdi flows from greece. tele‐ com is the most significant recipient of fdi, while manufacturing has a share of only 25%. the  most  important manufacturing fdi target  is the food and beverage processing  industry, which  serves the local market and exports to neighboring territories, such as kosovo.  in serbia, net fdi inflows increased more than twofold between 2002 and 2003, to 1.2 billion  of american dollars, reflecting progress in privatization. the net inflow was us$149 million for the  first quarter of 2004. tenders generated privatization revenues of about 245 million of american  dollars in 2002 and 740 million of american dollars (roughly 5% of gdp) in the first ten months of  2003. transactions in 2003 include the acquisition of steel producer sartid by u.s. steel, the pur‐ chase of specialty tire producer ruma guma by galaxy tire, and the acquisition by uniworld of ser‐ bia’s largest travel and tour company. developments in 2004 include the announcements of serbia’s  largest greenfield investment since its political transition in october 2000, a new plant to produce  aluminum cans by ball (a u.s. packaging company) of up to us$75 million, and a 10 million of  american dollars investment by henkel (germany)  in its existing factory. in addition, kikinda’s  foundry livnica has accepted the sole bid placed by slovenian automotive firm cimos. an impor‐ tant segment of the corporate sector, constituting 41 large enterprises that require restructuring,  has not yet been placed on the agenda for privatization. their restructuring and privatization will  likely take several years, and some must first undergo bankruptcy procedures based on a recently  created legal framework. bank privatization is proceeding step by step, starting with the closure of  non‐viable banks at the end of 2001. authorities anticipated that the jubanka privatization would  generate proceeds of 138 million of american dollars. furthermore, an  institutional framework  was started in 2003 for the privatization of public utilities.   despite the relatively small size of its economy, montenegro has managed to attract solid in‐ terest from foreign investors, especially through  its privatization program. investors from more  than 40 countries have vested interests in montenegro. the primary sources of investment have  been greece, slovenia, and russia, and to a somewhat lesser extent italy, china, and croatia. re‐ cent examples of investments in montenegro include the following:  o hellenic petroleum acquired a majority stake in montenegroʹs oil refinery, jugopetrol  kotor, for 65 million of euros, plus an additional 36.5 million of euros for capital in‐ vestment and social programs.  o daido metal, a japanese‐owned bearings producer, acquired the kotor baring plant,  with total investment around 1 million euros.  2007 ‐ 52  •  economic analysis®  o slovene investors have invested in a variety of important sectors, such as agriculture,  tourism (including the purchase of multiple hotel assets on montenegro’s coast), in‐ dustry, and banking (e.g., the sale in 2003 of montenegro banka to a slovene strategic  partner, nova ljubljanska banka).  table 1: fdi inflows, 1998‐2004  (million of euros)    source: national banks of respective countries, based on balance of payments statistics and world investment report  2003 for asian cis; ebrd transition report (2007)    volume 40 • spring 2008 • 53     table 2: fdi inflows per capita, 1998‐2004  (million of euros)    source: national banks of respective countries, based on balance of payments statistics and world investment report  2003 for asian cis; ebrd transition report (2007)  movement of the capital: the case of eastern europe  the question of the compared attractivity of the ceecs already was discussed several among  some authors (redžepagić and richet 2008) who agree to recognize that the fdi in this area of  europe have creates a strong effect of ousting, engaged quite front in programs of adjustment even  if relatively, flows which were directed in this area, on the beginning were modest and still remain  it with respect to other destinations (intra developed countries, china). they also recognize that  the nature of specializations is different: intrabranche in the case of the eu‐ceecs exchanges. it is  not necessary to reconsider here the history of the transformation of the countries from the region  which is well‐known (drouet and richet, 2007). we can focus, on the other side, to know why the  foreign capital moved in the one area and not worms of others, or more exactly, why for the euro‐ pean firms  it is necessary  to be at  the same time present  in eastern europe and china4 factors  played, even if they appeared contradictory. the first factor is related to the level of economic de‐ velopment  and  with  the  emergence  of  new  needs  for  consumption  which  were  strongly  con‐ strained in the old system by a rigid or non‐existent offer. the second factor is related to the nature  4 one of the reasons of the strong competitiveness of german industry in spite of the recession, the strong euro comes  owing to the fact that mainly german industries assemble products whose components are manufactured at low cost in  the ceecs. a considered german economist, w. sinn goes even until qualifying the german saving in ʺsaving in bazaarʺ  2007 ‐ 54  •  economic analysis®  of the ʺnational system of innovationʺ of these economies. in spite of a ʺbad industrializationʺ (i.e.  an industrialization around an economic development, within an autarkical framework privileging  heavy industries), on the one side, and of a not very effective industrial engineering (autonomy of  the firms, quality of management, signal and intermediary, information system) of the other side,  the national system of innovation (nsi) was able to create a scientific and technical environment  with relatively high standards, with a qualification of the labor close to those of the countries of the  eu.   the differential of cost of work was also a significant factor: to equal qualification and for a  level of productivity are equivalent (in the firms which were restructured by the foreign investors,  the differential is still significant, between a fifth and a quarter of the german average wages. the  narrowness of the labor markets, the competition of the low costs induce also a delocalization of  the investments carried out in the production of goods with low value added in the area towards  other regions (china, for example).   as the last frontier amid a rapidly integrating continent, the western balkans have emerged  as europe’s next high‐growth destination for fdi. the region, now directly adjacent to the eu’s  expanding border, has attracted the focus of the leadership of the european commission. it is ex‐ pected that countries of the western balkans will enjoy membership in the eu within few years. as  has been demonstrated in the economic booms of recently acceded eu member countries, the pe‐ riod leading up to full eu integration is a strategic time for forward‐looking investors to maximize  their opportunity. to confirm  this opinion, we can precise some  important and significant ele‐ ments:  o in a comparison of the largest operating costs (i.e., labor, land and utilities), western  balkans countries rank well ahead of new member states of  the eu  (such as  the  czech republic and hungary).  o the workforce, in the western balkans countries, is well educated and experienced in  production processes; so this is the reason why current investors cite local technical  expertise and the strong work ethic as competitive advantages of this region.  o geographically,  uniquely  situated  with  adriatic  port  access  and  adjacent  to  both  western and central european major country markets, the region is well positioned  for serving the eu, russia and beyond.  o in the western balkans countries, inputs increasingly can be locally sourced in key  sectors, and an existing supply network is based in the region’s longstanding history  as a production center.  o the governments of the western balkans region are committed to the attraction of  fdi, as evidenced on several fronts, including progress on regulatory, fiscal and tax  reforms and investor incentives.  fdi in the western balkans are mostly concentrated in the service sector (banks, telecommu‐ nications,  insurance)  in  non‐tradable  inward  oriented  sectors  (constructions,  real‐estate).  some  preliminary analysis indicated  that  there was an underlying problem with competitiveness and  productivity level:  o labor flexibility and skills shortages and gaps  o infrastructure (energy, transport, telecommunication)  o access to land (cadastre, registration, permits)  o complex regulatory environment    volume 40 • spring 2008 • 55  graph 1: investment related obstacles across the region: evidence from western balkans (2005)    source: world bank, beeps (2005)    some analyzes are pursuing two approaches:  o “macro approach” exploring the links between trade liberalization and fdi, in par‐ ticular  the  impact of  regional  liberalization  through  central  european  free  trade  agreement (cefta) and external liberalization on fdi inflows  o “sectoral analysis” looking at competitiveness factors in selected industry sectors.  the model of privatization of the companies contributed, in certain countries (hungary, for  example) to attract the ide quickly, leading, then, with the fast reorganization of the economies of  the countries hosts (calf & richet, 2004). the fast creation of a legal environment protecting the  investments made the remainder.  the adjustment of the firms to the new environment of market  was  facilitated  by  the  implementation of  macroeconomic  policies  and stabilization  continuous,  supported by the assistances structural provided by the eu within the framework of the future  integration of these economies which intervened in 2004 and in 2007.   lastly, it is necessary to mention the effect of proximity which, associated the costs and the  human capital accentuated the process of delocalization of the large firms of the eu in direction of  these market. a great number of fdi concern vertical integration5. these fdi contribute to create a  true industrial crown in the region with the integration of the existing manufacturing units in the  strategy of the great european groups, on the one side, that is to say by the creation of investments  “ex‐nihilo” in the region, on the other side.   the following graph measure the impact of the fdi, the countries hosts of the region at the  same time in terms of specialization of the sectors, of export of goods and services in direction of  the industrialized countries (mainly european, in terms of contents in value added of exports. the  graph shows the growth of exports of the countries of the area in direction of the developed indus‐ trialized countries which were carried out during these last years in particular around the three  countries which received the most fdi (poland, the czech republic and hungary).     5 ernst&young, european investment monitor, 2006  2007 ‐ 56  •  economic analysis®  graph 2: exports of goods and services towards the industrialized countries     source: the economist (2005)     table 3 shows the contents in value added of exports in direction of the countries developed  during these last years. it translates at the same time the importance of vertical integration (“re‐ exportation” of products which will enter the final assembly), the contents in qualified work and  capital intensive intensity.     table 3: exports in terms of intensity of factors in 1996, 2000 and 2003   leaves intensive qualified work and intensive  products in capital in  country classes in  terms of stock of ide  in the manufacturing  sector per capita in  2003  exports  exports minus exports  intensive in natural  products  value of exports  in qualified  work and capital index, 2003    1996  2000  2003  1996  2000  2003  1996=100  hungary    46%  73%  76%  65%  84%  87%  535  czech republic    61%  68%  73%  77%  80%  83%  267  slovenia    61%  65%  67%  73%  76%  79%  169  slovakia   49%  66%  70%  59%  76%  83%  353  estonia    38%  50%  47%  59%  71%  71%  336  poland    41%  52%  54%  59%  68%  68%  286  lithuania    37%  30%  31%  64%  54%  52%  183  bulgaria    41%  31%  32%  63%  44%  47%  120  romania    35%  34%  37%  45%  43%  47%  225  latvia    30%  24%  26%  53%  49%  54%  176           source: b. kaminski (2004)     the figure below  illustrates  the paradox of the delocalization in the sense that the recent  movements of delocalization go today on sites close at the same time to the sources of knowledge  (economy of knowledge, organizational complexity, “just in time”, etc.) and of the final markets  with more or less strong purchasing power.     volume 40 • spring 2008 • 57  table 4: the paradox of the outsourcing: proximity vs. costs/quality   proximity (“nearshoring”):   complex final market: small series, speed of  the quasi‐integration production on the level of  the final assembly    sources of knowledge    to answer a double request in the country host  and the country of origin     relatively high costs but with one   interesting differential:    labor more qualified and powerful in sectors  with high added value   distance   control, costs of coordination, outdistances,  large volume     weak costs   can become a secondary advantage if   integration quality   interest: growth of the local markets   possibility of  correction, but mass productions  conclusion   the western balkans prospects have looked mixed for some time, as have general appraisals  of the situation in the region. the overall assessment has tended to vary according to the primary  focus (economic, political, security) or even temperament of the observer‐summed up by the pro‐ verbial question of whether the glass is “half empty or half‐full”. the importance of fdi for the  region, and the need for the recent trend to be sustained, cannot be overstated. despite the strong  theoretical case for the advantages of free capital flows, many private capital flows pose “counter‐ vailing risks”. in contrast, fdi is both less volatile than other flows and has a series of additional  benefits. fdi is a key factor for upgrading physical and human capital; for increasing export capac‐ ity; for reducing external vulnerability; and for boosting the structural reform momentum. fdi  inflows are more likely than other forms of capital flows to translate into increases in domestic  investment.  fdi  is  a  vehicle  for  the  transfer of  technology  and  managerial  and  organizational  know how, and it can promote competition in the domestic market. profits generated by fdi con‐ tribute to host country tax revenues. it has been shown that for fdi to have a significant positive  impact on a host country’s performance and growth the host has to already have a certain level of  skills, which the western balkans countries generally possess. finally, and crucially, the reliance on  fdi is far preferable to dependence on official aid flows – this general proposition is likely to be  especially important in the western balkans.  generally analyzed, trade liberalization and fdi inflows in the western balkans countries,  show us the following:  o the western balkans countries are characterized by advanced trade liberalization and  open non‐discriminatory regime to fdi.  o proximity to the eu market and significant lower labor costs than in the eu‐15, and  very competitive tax rates.  o these elements should contribute to generate high fdi inflows into the region repli‐ cating the same dynamic central european countries experienced in the late nineties  and early 2000. however, so far this has not been the case.    2007 ‐ 58  •  economic analysis®  table 5: advantages and disadvantages of the fdi in the western balkans  advantages  disadvantages  growth  macroeconomic stability  reform speed  foreign investment and tax incentives  trade cooperation  eu aspirations  unhappiness  external imbalances  slow implementation  problems of corruption and business climate  trade barriers  stalled eu progress    literature  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marked by several events which were extremely important to portugal. the consequences of these events would later be responsible for the fall of the monarchy and, thus, for the birth of the republic. the first republic was officially proclaimed on the 5th october 1910, and had a relatively short lifetime. this regime was later abolished by a military dictatorship. during most of its duration, the first republic was marked by economic, financial, political and social instability. however, the portuguese economic scenario started to change and improved by the end of this regime and, consequently, before the beginning of the military dictatorship, which ended up taking advantage of the ‘new’ and more favourable economic situation of the country. additionally we find evidence that in the first two civil years of the military dictatorship, the real gdp grew sharply and above our prediction, and the public debt as percentage of gdp, had a more significant reduction then predicted. key words: economic growth, first republic, public finance, portugal introduction at the end of the 19th century, the portuguese economy was one of the most backward in europe, with low standards of living, so portugal began a ‘new’ century with aspiring meaningful changes, but nothing changed in the first years. on 5th october 1910, monarchy was replaced by a new regime known as the first portuguese republic (1910-1926) with new ideas for the country3. but this new regime lasted only sixteen years, giving way to a military dictatorship (1926-1933). the aim of this work is to analyse the performance of public finance and the growth of the portuguese economy during the period of the first portuguese republic. additionally, we will try to find if in the first two civil years of the portuguese military dictatorship, the economic growth, and the public debt as percentage of gdp, stayed below or above the expected performance. to make this possible, we will use statistical analysis and econometric prediction models, more precisely arima models, in order to validate the study and draw objective conclusions. 1 economic advisor at portuguese parliament, lisboa, portugal. phd student at lisboa school of economics & management (iseg), lisboa, portugal. email: ricardoferraz1984@hotmail.com 2 phd in economics, assistant professor, faculty of economics, university of coimbra, portugal and research fellow, gemf – grupo de estudos monetários e financeiros, faculty of economics, university of coimbra, portugal. email: portugal@fe.uc.pt 3 see marques (2010) and telo (2011). economic analysis (2014, vol. 47, no. 1-2, 59-75) 60 hence, this study can represent a real contribution for all those interested, not only in the historical dimension of this topic, but at the same time want to appreciate the economic dimension of the period being studied. the contribution is noticeable namely when we take into consideration a distant period of analysis in respect of the set of variables which are object of the study (resulting from a great effort to conciliate several time series), but also when we call on econometric methods of analysis. the paper is organised in four sections. after the introduction, section 2 analyses the evolution of the portuguese gdp and the behaviour of the portuguese public finance, since the end of the 19th century up to the fall of the first republic in the 20th century. section 3 is dedicated to the applied study. finally, section 4 concludes. from the end of the 19th century to the fall of the first republic in the 20th century the end of the 19th century was a time when several extremely significant political, economic and social events happened in portugal (see chronology of events in appendix). the consequences of these events were later responsible (even if indirectly) for the fall of the monarchy and, therefore, for the birth of the ‘new’ form of government called republic, thereby effecting a new period for the portuguese nation. the end of the 19th century, the first republic, and the world war i the portuguese economy was one of the most backward in europe, with extremely low of living even when compared to the countries on the periphery of europe (see table 1), such as spain and italy (rosas, 1987; gonçalves, 1998; mateus, 1998; lains, 2003; mata and valério 2003). table 1. gdp per capita at 1990 prices (percentage regarding the 15 ec) country 1820 1870 1900 1913 belgium 105 134 127 121 denmark 100 98 101 110 germany 91 97 109 112 greece 62 50 51 47 spain 87 70 71 66 france 99 94 99 101 ireland 78 90 87 80 italy 89 74 61 73 luxembourg 105 134 127 121 netherlands 127 134 123 116 austria 105 95 101 102 portugal 64 55 49 40 finland 62 56 56 60 sweden 98 84 89 91 united kingdom 143 165 159 147 15-ce 100 100 100 100 source: mateus (1998). ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 61 as shown in table 1, by the end of the 19th century, portugal had a gdp per capita very inferior to the average value of the current european community with 15 countries (15 ec), and at the beginning of the new century that situation became even worse. in what concerns public finance, we can say that portugal was placed in a high level of indebtedness, having abandoned the gold standard system and declared a moratorium regarding the external debt in 1891 (duarte and andrade, 2012). a year later, in 1892, the portuguese state’s bankruptcy (a partial one) was declared. however, as is pointed out by santos (2001), this crisis was not only a financial one; it was also economic, since it caused a stagnation of economic growth and richness. rosas (1987) goes even further, arguing that both this event and the british ultimatum in 1890, would later lead to the fall of the monarchy and, therefore, to the republican revolution on 5th october 1910. in table 2 is documented the evolution of the portuguese public debt as percentage of gdp, from which it is seen that at the beginning of the ‘new’ century the ratio reduced4. table 2. evolution of the public debt as percentage of gdp date debt-to-gdp ratio 1890 105,7 1895 111,3 1900 104,1 1905 99,5 1910 91,5 source: authors calculation based on the valério (2001 and 2008). on the other hand, table 3 clarifies that in respect of public revenues and expenses, while countries such as romania and bulgaria recorded a surplus throughout most of the last quarter of the 19th century, other countries such as portugal and greece, recorded a significant deficit in the same period. the first years of the portuguese first republic were, however, marked by a relative improvement in the budgetary situation of the country, despite portugal’s continued struggle with a situation of government deficit. 4 our calculation for public debt as percentage of gdp differs from the international monetary fund (imf) historical debt database. it happens because imf used other sources, such as flandreau and zumer (2004). for more detail see imf (2012) and abbas et al. (2010). economic analysis (2014, vol. 47, no. 1-2, 59-75) 62 table 3. public revenue and expense in the european periphery (revenue in percentage of the expense) countries 18801884 18851889 18901894 18951899 19001904 19051909 19101912 bulgaria 102,9 109,4 99,7 91,6 95,0 101,2 96,7 greece 93,5 95,8 97,5 67,8 116,7 101,6 126,4 romania 99,0 101,7 103,7 96,1 105,3 114,4 117,0 serbia 86,0 78,5 92,3 86,7 92,2 98,1 105,1 portugal 79,5 80,6 81,9 93,2 94,6 98,1 99,5 source: for bulgaria, greece, romania and serbia, the source is lains (2003). for portugal, the source is authors calculation based on the valério (2001). only four years after the beginning of the first portuguese republic, world war i began5 (1914-1918). as shown in table 4, on the beginning of this conflict, portugal had one of the major public national debts. however, only 31,4% consisted of external debt, a fact that illustrates the external financing difficulties faced by portugal. table 4. national public debt in 1914 (millions of french francs) country total internal external external/amount (%) united kingdom 17257 17257 0 0,0 denmark 498 123 375 75,3 finland 164 0 164 100,0 norway 493 31 462 93,8 sweden 955 169 785 82,3 spain 9347 8346 1001 10,7 italy 15661 15661 0 0,0 bulgaria 986 123 862 87,5 greece 1345 339 1006 74,8 portugal 3265 2238 1027 31,4 romania 1714 180 1535 89,5 serbia 888 765 123 13,9 source: lains (2003). 5 see again chronology of events in appendix. ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 63 portugal’s participation in this conflict had financial and economic consequences. as we can see on figure 1, the gdp, in real terms, decreased sharply during the world war (between 1914 and 1918, reduced by approximately 23%). figure 1. portuguese gdp, 1914 prices, thousands of ‘contos’, 1885-1920 source: valério (2008). the participation in this war led to a very significant raise in the portuguese public expenses, which were more than quintupled in the period from 1914 to 1920. these public expenses were financed through an increase in the debt demanded by the bank of portugal, leading to the consequent growth of the portuguese public debt, in thousands of ‘contos’, which increased by approximately 93% between 1916 and 1920. also gonçalves (1998), lains (2003) and mateus (2013) points out that the financing of the war effort was at the expense of the public debt, which according to mata and valério (2003), reached its highest point with the consecutive loans to the bank of portugal, leading also to enormous amounts of money creation. as can been seen in table 5, this way of financing war led to an increase in inflation levels. the public expense and public debt continued to rise after de war, so as the inflation. between 1914 and 1920, the price index (pi) raised from 100 to 580, which can also be explained by the strong increase in money supply, from 165 to 840 thousand ‘contos’6. however the debt as percentage of gdp reduced substantially because of the strong growth of gdp at current prices. 6 1 conto = 1000 portuguese escudos. economic analysis (2014, vol. 47, no. 1-2, 59-75) 64 table 5. portugal’s monetary and financial indicators, 1914-1920 (pi: 1914=100) 1914 pi: 100 1916 pi: 137 1920 pi: 580 exchange rate ($/£) 5$8 7$0 18$3 public expense (thousands of ‘contos’) 62 134 347 public revenue (thousands of ‘contos’) 69 86 159 public budget balance (thousands of ‘contos’) +7 -48 -188 public budget balance (% of the gdp) +1,0 -4,2 -4,8 public debt (thousands of ‘contos’) 648 806 1.553 public debt (% of the gdp) 91,1 70,6 40,0 money supply (m1) (thousands of ‘contos’) 165 213 840 source: authors calculation based on the valério (2001 and 2008). the revenues also increased, but not enough to avoid the consecutive and growing government budgetary deficit, which were also financed by the public debt (as mention, this form of financing war obviously caused the increase in inflation levels). in addition to the inflation crisis, during the first republic, portugal also face a serious crisis, concerning a cereals shortage (mainly wheat), and the energy supply (coal). the world war i disturbed the supply of these goods, because the usual suppliers decided to reduce their exports and because there were not available means of transport. these goods were essential to the war effort of the countries involved in the armed conflict. furthermore, portuguese external commerce traditionally depended on british vessels, which were then being used for military purposes. thus, it is not surprising that the shortage of essential products significantly reduced portugal’s economic activity. the food supply to lisboa and porto, and the supply of fuel and raw material to the main industries were seriously affected. together with portugal’s hard economic and financial situation, there was also an unstable political situation, considered an additional cause of the lack of control of portuguese public finance. in fact, during the portuguese first republic’s relatively short life (it lasted only 16 years), there were several governments, some lasting only a few months. hence, it is easy to understand the many social confrontations between workers, state, lower and higher bourgeoisie, and employers which occurred in 1920. in that year, there were strikes, demonstrations, rallies, bomb attacks and several assassinations (some of important state personalities) throughout the country. all these events seriously affected the political regime’s credibility, which had to deal with, not only an economic and financial crisis, but also a serious social one7. it is also important to mention that, at the time, the portuguese population was mostly illiterate (before world war i, the illiteracy rate was around 70%, and in 1920 it was still above 65%). 7 we should not forget that following the world war i, 10 thousand portuguese died. ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 65 the fall of the first republic contrary to expectations, and in spite of the undoubted catastrophic situation at the start of the 1920’s, portugal began to show signs of revitalisation in this decade. from figure 2, it is apparent that an economic growth, in real terms, was evident from 1922 (even though the real output decreased again between 1923 and 1924). this conjunctural change followed the positive developments in the international financial markets, being also aided by a series of measures concerning taxation and financial reform implemented by the republicans. lains (1998) emphasises the fact that in 1922 the state decreed a taxation reform which made the increase of the revenue and the public deficit reduction possible. figure 2. portuguese gdp, 1914 prices, thousands of ‘contos’, 1910-1926 source: valério (2008). on the other hand, in 1924, a foreign exchange reserve fund financed by the compulsory delivery of part of the exportations revenue was created. this was a system which relieved the pressure on the bank of portugal regarding the external deficit financing. thus, the bank of portugal was also able to administer the monetary policy again, which was itself reinforced by the bank law reform in 1925. this reform allowed greater government control over the banking sector, and assigned the bank of portugal the role of market regulator. table 6 illustrates the republican leaders’ attempt to stabilise the portuguese public finance. economic analysis (2014, vol. 47, no. 1-2, 59-75) 66 table 6. portugal’s monetary and financial indicators, 1922-1926 (pi: 1914 = 100) 1922 pi: 1099 1923 pi: 1726 1924 pi: 2399 1925 pi: 2306 1926 pi: 2208 exchange rate ($/£) 65$1 109$7 133$9 99$2 94$8 public expense (thousands of ‘contos’) 550 1187 1171 1428 1508 public revenue (thousands of ‘contos’) 320 537 770 1162 1099 public budget balance (thousands of ‘contos’) -230 -650 -401 -266 -409 public budget balance (% of the gdp) -2,9 -5,0 -2,4 -1,6 -2,4 public debt (thousands of ‘contos’) 4.002 6.963 8.048 8.041 8.900 public debt (% of the gdp) 49,7 54 47,5 47,1 51,9 money supply (m1) (thousands of ‘contos’) 1.555 1.986 2.438 2.438 2.499 source: authors calculation based on the valério (2001 and 2008). mata and valério (2003) note that the taxation reform in 1922 brought an increase in public revenues, even though some items of public expenditure increased, namely education expenses, through their strategic priority in the republican programme. also, the problems related to high inflation that marked most of the portuguese first republic period started to being resolved, and in 1925 the results was evident. according to the data, the portuguese fiscal consolidation strategy consisted on reducing the budget deficit essentially by increasing public revenue. thus, the revolution in may 1926, which led to the military dictatorship, occurred in a very favourable context (recovery). besides experiencing real economic growth, portugal was also in a process of stabilising its public accounts (however, it should be mentioned that, in spite of the obvious efforts on fiscal consolidation, the portuguese public debt in thousands of ‘contos’, continued to rise). mateus (1998) and lains (2003) argue that the military dictatorship was caused mainly by the political instability (there were nine governments during a single year) and social restlessness (strikes, attacks and assassinations), and not by the economic and financial situation experienced within the country. it was just starting to be favourable to the republicans. to summarise, in figure 3, the historical course of public revenue and expenditure during the period 1885 to 1926 is presented, thereby indicating the events during the period which is the focus of this study. from this figure, it is possible to conclude that during most of the first republic, there were high budgetary deficits as a percentage of gdp. ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 67 figure 3. portuguese public revenues and expenses as a percentage of gdp, 1885-1926 source: authors calculation based on the valério (2001 and 2008). by the opposite, as we can see in figure 4, in the same period, the public debt (as percentage of gdp) continued to decline since the beginning of xx century, with a substantially decrease in the period of the war. this substantially decrease in debt-to-gdp was because of the strong growth of gdp at current prices. figure 4. portuguese public debt, as a percentage of gdp, 1885-1926 source: authors calculation based on the valério (2001 and 2008). however in respect of the economic growth, in real terms, as we can see on figure 5, on the first republic, there was a strong decrease in the portuguese real gdp during, and after, the world war, especially between 1917-1921, which it only started to recover in 1922, when the negative tendency was inverted. economic analysis (2014, vol. 47, no. 1-2, 59-75) 68 figure 5. portuguese gdp, 1914 prices, thousands of ‘contos’, 1885-1926 source: valério (2008). in this context, and because the series evolution does not show any behaviour change, it is important to determine whether, after the end of the first republic, the economic growth, and the public debt, stayed below or above the expected performance. more precisely we will try to find if the economic growth in real terms, and public debt, as percentage of gdp in the first two civil years (1927 and 1928) of the portuguese military dictatorship (1926-1933), stayed below or above the expected performance. this exploration is made in the following section of this paper. applied study the brief econometrical discussion that follows is, in fact, a prediction exercise, so it is important to start with a brief explanation of some of the available options regarding prediction models; thereafter, the study of the portuguese economy will be considered. prediction models prediction models analyse stochastic features of the time series based on previous values (lags) of the variables and of the stochastic term (error term). these models are known as univariate time series models, and they are used to make predictions about the evolution of a meaningful variable, studying the characteristics of the past and analysing the dynamic inter-relation in a single time series. these models can have several specifications, namely i) auto-regressive process (ar); ii) moving average process (ma); iii) auto-regressive and moving average process (arma) and iv) auto-regressive integrated and moving average process (arima), among others (pindyck and rubinfeld, 1997; gujarati, 2003; stock and watson, 2007). ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 69 the arima is the most usual one, once it includes all the ar and ma situations. this models are applied exclusively to stationary time series. for example, an arima process (p,d,q) means that it has p auto-regressive terms, it is integrated (stationary series) of order d, and it has q moving average error terms. analysis of ‘stationarity’ of variables before conducting the econometric estimation, we performed the augmented dickeyfuller test, known as adf test (dickey and fuller, 1979), in order to analyse the stationarity characteristics of our variables: gdp at constant prices and public debt as a gdp percentage. with this test, we can only conclude that a given series is stationary and, therefore, make a given prediction by rejecting the null hypothesis of presence of unity root in. the results obtained in adf test in respect of both variables are shown in table 7, from which it can be concluded that the gdp (1914 prices) and public debt as percentage of gdp are stationary in the first differences. table 7. augmented dickey-fuller unit root test8 test with no constant variables lags statistic of test p-value conclusion of the test gdp 2 0,376573 0,793 non stationary d_gdp 1 -7,81143 1,476e-013*** stationary: i(1) debt 4 -1,14998 0,2286 non stationary d_debt 3 -2,42246 0,01492** stationary: i(1) test with constant variables lags statistic of test p-value conclusion of the test gdp 2 -1,91761 0,3244 non stationary d_gdp 1 -7,74723 2,711e-012*** stationary: i(1) debt 4 -0,565163 0,8673 non stationary d_debt 3 -2,70013 0,07394* stationary: i(1) test with constant and trend variables lags statistic of test p-value conclusion of the test gdp 2 -2,75113 0,2158 non stationary debt 4 -3,09227 0,108 non stationary source: estimated by the authors. after analysing the order of integration (d) of the variables, we can proceed to the selection of the arima model to predict the behaviour of each one. 8 as usual, on adf test the notation (*), (**) and (***) represents the rejection of the null hypothesis at a significance level of 10%, 5% and 1%, respectively. h0= null hypothesis of presence of unit root. the number of lags was chosen automatically by gretl software. economic analysis (2014, vol. 47, no. 1-2, 59-75) 70 arima model selection according to pindyck and rubinfeld (1997), the selection of the p auto-regressive terms and q moving average terms should be made through the minimisation of the schwarz information criterion (bic). the prediction model chosen for each of the variables is documented in table 8. for the gdp at constant prices and for the public debt (as a percentage of gdp), the arima model (1,1,1) was chosen. table 8. arima models variable type of arima model schwarz criterion d_gdp (1,1,1) 462,4 d_debt (1,1,1) 295,1 source: estimated by the authors. we are now able to present our predictions. we begin by the expected performance of the gdp at constant prices, as can be seen in figure 6. figure 6. portuguese gdp, 1914 prices, thousands of ‘contos’, and arima (1,1,1) prediction, 1885-1928 source: for gdp, valério (2008). for gdp_pred, estimated by the authors. from figure 6, it is possible to conclude, within a confidence interval of 95%, that there was real economic growth in actual terms above the level predicted by our model. consequently, in 1927 and 1928, the real output grew sharply (gdp) instead of a contraction like the prediction indicated (gdp_pred). in other words, the first two civil years of militar dictatorship corresponded to a real economic growth instead of a contraction. on the other hand, the expected tendency to the public debt in percentage of gdp (debt _pred) can be observed in figure 7. ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 71 figure 7. public debt in percentage of gdp, and arima prediction (1,1,1), 1885-1928 source: for debt, valério (2001 and 2008). for debt_pred, estimated by the authors. from figure 7, it is possible to conclude that it was expected that portuguese public debt should be around 46% of the gdp in 1928 (debt_pred), but instead there was a more significant reduction (debt)9. as we can easily conclude, the first two civil years of military dictatorship represented real growth and a reduction of public debt as percentage of gdp. in reality, in 1927 and in 1928, portugal grew sharply and above our prediction, and it public debt as percentage of gdp, had a more significant reduction then predicted. conclusion through this study it has been possible to arrive at some important conclusions. in the very beginning of this ‘new’ century, a new political regime called the first republic emerges; precipitating a wave of new aspirations in portugal. however, this regime was characterised by instability at different levels. during the most of his period, there were economic and financial (and also political and social) instability. more precisely, there were simultaneously high budgetary deficits and a growing public debt. although public debt as percentage of gdp continued to decline since the beginning of xx century because of the strong growth of gdp at current prices. and about the prices, we can state that there were high inflation problems too, more precisely from 1916. this problems started to being resolved and in 1925 the results were evident. in terms of real economic growth the first republic was characterised by a sharp decline in real gdp, especially in 1917-1921, but it started to recover in 1922, when the negative tendency was finally inverted. 9 one must bear in mind that antónio de oliveira salazar took over the ministry of finance again in april 1928 (he had already taken on that position in 1926 for six days only); the main goal of this ‘new minister’ of finance was to balance public finance. economic analysis (2014, vol. 47, no. 1-2, 59-75) 72 so the portuguese economic scenario started to change and improve by the end of the first republic and, consequently, before the beginning of the military dictatorship (19261933), which ended up taking advantage of the ‘new’ and more favourable economic situation of the country. on the other hand, the econometrical trial showed that in the first two civil years of military dictatorship, portugal grew sharply and above our prediction, and the public debt as percentage of gdp, had a more significant reduction then predicted. this military dictatorship was later replaced by another regime in 1933, which from the perspective of the analysis of the macroeconomic indicators used in this study would be interesting to explore. the present reality, about 100 years away from the first republic, is such that we are forced to say that some problems in that period sounded familiar. it is certain that the portuguese economy has democratised itself and made great progress in the last years in the context of its european integration process, such that it has become part of the restrictive group of countries which are part of the euro area nowadays. however, the truth is that portugal faces great challenges nowadays regarding the sustainability of its public finance and serious growth problems. acknowledgments the authors thank joão oliveira and participants in the xxx encontro da associação portuguesa de história económica e social (aphes), held in lisboa, for their helpful comments and suggestions. the gemf is financially supported by the foundation for science and technology. the usual disclaimer applies. references abbas, a. nazim, b. asmaa, e. and mark, h. (2010). "a historical public debt database", imf working paper wp/10/245, washington, dc. dickey, d. fuller, w. (1979). “distribution of the estimators for time series regression with a unit root”, journal of the american statistical association, vol. 74, pp. 427-31. duarte, a. p. and andrade, j. s. (2012). “how the gold standard functioned in portugal: an analysis of some macroeconomic aspects”, applied economics, vol. 44, no. 5, taylor & francis, routledge, pp. 617-629. flandreau, m. and zumer. f. (2004). the making of global finance 1880–1913, development centre studies. paris: oecd. gonçalves, o. f. (1998). “convergência real no longo prazo da economia portuguesa. notas económicas”. feuc, pp. 82-100. gujarati, d. (2003). basic econometrics. 4ª edição, mcgraw-hill, cap. 22. imf. (2012). historical public debt database. international monetary fund fiscal affairs department. lains, p. (2003). os progressos do atraso: uma nova história económica de portugal. lisboa: ics. marques, a. (2010). a primeira república – do sonho à realidade. lisboa: texto editores. ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 73 mata, e., valério, n. (2003). história económica de portugal: uma perspectiva global. lisboa: editorial presença. mateus, a. (1998). economia portuguesa: desde 1910. lisboa: verbo. mateus, a. (2013). economia portuguesa: evolução no contexto internacional (1910-2013). cascais: principia. pindyck, r. s.; rubinfeld, d. l. (1997). econometric models and economic forecasts. 4ª edição, mcgraw-hill, cap. 17 e 18. rosas, f. (1987). a crise do liberalismo e as origens do «autoritarismo moderno» e do estado novo em portugal. comunicação ao colóquio entre el liberalismo y la democracia: estudio comparativo em sociedades meridionales. oviedo. santos, l. a. (2001). “a crise financeira de 1891: uma tentativa de explicação”. análise social, pp. 185-207. stock, j., watson, m. (2007). introduction to econometrics, 2ª edição, pearson. telo, a. (2011). primeira república i – do sonho à realidade. oeiras: editorial presença. valério, n. (2001). estatísticas históricas portuguesas. lisboa: ine. valério, n. (2008). “avaliação do produto interno bruto de portugal”. working paper no 34: grupo de história económica e social do instituto superior de economia e gestão. vitorino, d. f. (1996). história comparatada portugal europa e o mundo. navarra, espanha: círculo de leitores. appendix: chronology of events 15/11/1884: beginning of the international conference in berlin. 26/02/1885: the principle of the effective occupation of the african territories is laid down. 1886: portugal claims the regions of angola and moçambique in the “pink map”, a project which collided for a long time with the british claims of connecting “cairo to cape”. 11/01/1890: the english government gives the ultimatum to portugal. 14/01/1890: the new monarchic government takes office and soon faces protests and hatred feelings regarding england, feelings that are soon transmitted to the state, personified in the king and in the government, considered the main responsible for the overseas politics by the public opinion. 20/08/1890: portugal and spain sign a treaty which is considered a humiliation to portugal (the following year it would sign a more humiliating one). 07/05/1891: a serious financial and banking crisis starts in portugal. 13/05/1892: the portuguese state announces bankruptcy (even if a partial one). 08/08/1901: the last monarchy’s electoral law is published; it was one of the most restrictive electoral laws. from this moment on, centralisation and repression progressively take over. 23/05/1906: a decree ordering the end of the enrolments in the universidade de coimbra is published. the strikes in the schools go on and the atmosphere of dictatorship condemnation, together with social unrest, intensifies every day. economic analysis (2014, vol. 47, no. 1-2, 59-75) 74 01/02/1908: king carlos and prince luís filipe are murdered. 05/10/1910: proclamation of the republic in lisboa; a provisional government is formed. 20/04/1911: the law separating state and church is published; all the cults are declared to be free, teaching christianity in the schools is forbidden and the church’s assets are nationalized. the vatican reacts, cutting off diplomatic reactions with portugal. 22/05/1911: the ‘escudo’ is made portugal’s official currency. such measures aimed at changing the main state’s symbols, making an eventual restoration harder. 21/08/1911: the first constitution of the republican regime is promulgated. 1913: serious financial crisis which led to the disappearance of important banks. besides a contraction of the external markets, the stronger social groups showed a great distrust regarding the radicalism demonstrated by the republic. the intensification of the protest movement led to a capital flight to foreign countries (a usual practice from the end of the monarchy on) and to a big investment reduction. 28/07/1914: the archduke fernando from austria is murdered. this event marks the beginning of world war i. 23/11/1914: the portuguese entities approve portugal’s participation in world war i besides england. the reasons for this are related with defending the african colonies and also with an attempt of assertion and recognition of the “young” portuguese republic. 03/03/1915: the rise of the essential goods prices in portugal causes robbery and uproars. 09/03/1916: germany declares war on portugal. 30/01/1917: the ‘corpo expedicionário português’ second contingent leaves a month later. 19/05/1917: during several days, there was a set of strikes, riots and burglary in grocery stores and warehouses in lisboa and porto. the war effort and the international context bring disastrous internal consequences. the lack of goods and the repression lead to the degradation of the state’s image and to the growing social unrest. 12/07/1917: in face of the serious social situation, the state of siege is declared in lisboa. 1918: world war i comes to an end, with the signature of armistices by the countries defeated (triple alliance). 28/05/1926: under the leadership of general gomes da costa, hero of the world war i, the military coup which founded the military dictatorship started in braga. 03/06/1926: antónio de oliveira salazar, professor at the universidade de coimbra, is appointed minister of finance, having resigned shortly after. 27/04/1928: the new military dictatorship government takes office. antónio de oliveira salazar accepts, under certain conditions, to be the minister of finance again. his first aim was clearly achieving as fast as possible the “budgetary balance”, so he becomes responsible for the action of all the other ministries. ferraz, m. n., et al., the first portuguese republic, ea (2014, vol. 47, no, 1-2, 59-75) 75 javne finansije i ekonomski rast u prvoj portugalskoj republici rezime – kraj 19. veka obeležilo je nekoliko događaja koji su izuzetno važni za portugal. posledice ovih događaja biće kasnije odgovorne za pad monarhije i , samim tim, za rođenje repubilke. prva republika je zvanično proglašena 5. oktobra 1910 i relativno je kratko trajala. ovaj režim je kasnije ukinut od strane vojne diktature. tokom većeg dela trajanja, prvu republiku obeležila je ekonomska, finansijska, politička i socijalna nestabilnost. ipak, portugalski ekonomski scenario počeo je da se menja i poboljšava do kraja ovog režima, i posledično, pre početka vojne diktature, koja je okončana uz prednosti i koristi od “novog” i povoljnije ekonomske situacije u zemlji. pored toga smo pronašli dokaze da je u prve dve civilne godine vojne diktature realni bdp rastao naglo iznad naših predviđanja, a javni dug kao procenat bdp-a, imao je više značajno smanjenje ključne reči: ekonomski rast, prva republika, javne finansije, portugal article history: received: 26 january 2014 accepted: 9 april 2014 ea_2014_1-2 udc: 004.738.5:339 ; 366.12(497-15) jel: l81 id: 207712780 professional paper determinants of customers behavior in online group buying markets of the western balkans countries zahirović suhonjić anida1, university of tuzla, tuzla, bosnia and herzegovina abstract – the field of this research is a specific part of electronic commerce called group buying on the internet or online group buying in terms of theoretical assumptions and key determinants of customers behavior in online group buying. the basic theoretical concepts of customers decision making in online group buying are analyzed: social exchange theory, equity theory and heuristic model. the basic characteristics of competitive environment are established and customer behavior in online group buying is analyzed in terms of website performance and heuristic factors of customer decision making within national markets of selected countries of the western balkans. key words: online group buying, customer behavior, heuristic model, western balkans introduction given that the group buying on the internet or online group buying (ogb for short) is primarily a sales and marketing business model, for its success are especially important determinants of the market, such as customer behavior in group buying and market performances of suppliers and online group buying services in the context of a specific terms of competitive environment. ogb is a specific form of electronic commerce where the products or services can be purchased with a significant discounts in the case that the offer reached a sufficient number of interested buyers. although it seems like a simple business model, the nature, content and processes in the online group buying require a complex analysis of the competitive environment and the different aspects and relations between participants in online group buying. every business model produces a variety of specific customer behavior. the model of ogb uses different factors to influence customer behavior on the website, which offers services and products. the successful offers on the website must reach the required minimum number of customers. ogb business model designers should understand the factors that determine the decision to purchase and use it to influence social intelligence about position of their offers. social buying (and ogb) uses social intelligence (the ability to understand and manage the buyers) in order to create profitable opportunities for business (erik eliason, yohanes frezgi and fatima khan, 2010). 1 inžinjerijske brigade 3 5/10, tuzla, bosna and herzegovina, e-mail: zahirovic.suhonjic@gmail.com economic analysis (2014, vol. 47, no. 1-2, 175-192) 176 in a significant number of cases, it is a first time that customers are confronted with a certain company (supplier, vendor) on the website of ogb service. values and discounts determine the attraction level to consumers, although it affects the perception of the supplier’s product/service. usually, consumers will first collect information about the supplier before they decide to buy, therefore it is crucial to have satisfied consumers that give positive feedback and comments. with better grades and comments about supplier's product/service, the brand of the supplier becomes stronger, and the ogb service becomes less needed. goal of each offer on the online group buying website is to attract the customer, who will eventually come back and purchase the product/service at full price in official market. (alex cohen, 2012) for research on consumer behavior in ogb the most important questions are: • what theoretical concept of customer decision making can be applied to ogb? • how the customer accepts this form of shopping? • why does the customer accepts this form of shopping? • what are the main reasons for making a decision to purchase? • besides economic, what psychological determinants are important (group effect, motives, expectations, security of transactions, etc.)? • how competitive environment influences the behavior of customers? • how much does the seller and online service impact the purchase? • is the ogb business model compliant to theoretical models? etc. therefore, the subject of the study relates to the role, structure and intensity of the key determinants of customer behavior in a business model of ogb in the context of competitive environment and ogb service management in order to achieve long-term profitability to suppliers and ogb service, and to satisfy customers’ needs and desires. the purpose of the research is to identify and explain the competitive environment and key determinants of customer behavior in a business model of ogb. the purpose is also to determine the characteristics of the applied business model of group buying in terms of website performances and decision making factors of the customers within the national markets of selected countries of western balkans: serbia, croatia and bosnia and herzegovina. basic theoretical concepts of customers decision making applied to online group buying taking into account the specifics of e-commerce and ogb business model, customer behavior in group buying has characteristics of individual and group behavior in shopping. due to this interaction, research and identification of patterns in customer behavior in ogb is more complex compared to traditional shopping. main motive for customers to participate in ogb is usually intent to save money, however, the studies have shown, motives tend to change and develop into more dimensions over time. those changes were influenced by the development of online social networks and competition among online group buying services as well. with development of social networks the perception of information exchange, interaction and knowledge sharing among customers has changed. customers have a feeling that they benefit from sharing and zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 177 exchanging the information (wen-lung shiau and margaret m. luo, 2012). therefore, customer satisfaction can be managed through ogb business model, so it is necessary to present different theoretical approaches and empirical results on decision making and customer behavior in group buying. in the literature, we can find three dominant theoretical concepts, as analyzed below. theory of a social exchange in the research (shiau and luo, 2012) the factors that impact the intention of the customers to participate in group buying were studied. the level of reciprocity and reputation of social exchange, trust and creativity of a supplier that impact on customer satisfaction and intent to shop online were studied as well. the concept of the research was based on the theory of social exchange in terms of online group buying by applying factors such as reciprocity, reputation, trust and satisfaction. these factors were identified as very important in online and offline shopping. theory of the social exchange is a concept based on: expectations (prize, contribution and social association) and anticipation (unpredicted prizes and reciprocal relation). motives for knowledge exchange were identified as egoistic and altruistic. egoistic motives imply that certain behavior is a result of the economical reward, while altruistic motives imply that one is willing to increase the welfare of all, not expecting anything in return. this research used knowledge exchange factors (reciprocity, reputation and trust) in order to define factors that influence the intention of individual to participate in online group buying, but altruistic motives were omitted with assumption that participation in online group buying does not include motives to increase welfare of other customers, and it only includes motives for personal gain. however, online group buying participants share their knowledge and expect feedback from other participants, because of mutual benefits. reciprocity, reputation and trust affect the perception of social prize. results of the study show that intention of a customer to enroll into ogb can be predicted based on their satisfaction, trust and creativity of the ogb service. satisfaction of the customer in the online group buying inicialy is predicted by the trust customer is showing, then by the customer reciprocity. theory of equity by the use of theory of equity as conceptual basis in the research (tracy l. tuten & christy ashley, 2011), it is studied how the customers evaluate the offers and how this value exceeds into future positive outcomes for suppliers, including the intention to purchase again and positive “word-of-mouth” marketing. the subject of the research is also how small companies can make the most of ogb market. the theory of equity suggests measuring costs of participation of customer compared to achieved benefits which results in estimated value. in the context of group buying, perception of the transaction value is connected to three benefits: • practical perception of monetary benefit • hedonistic perception of research benefit economic analysis (2014, vol. 47, no. 1-2, 175-192) 178 • symbolic perception of social benefit. this research has shown that small companies have to find a way to increase the perception of the transaction value. that can be achieved by noticeable price difference (discounts), by increasing the perception of research and social aspects of the offer. other recommendations for small businesses that want to exploit the benefits of online group buying, to increase the transactions, and to build awareness about their offers and brand are following: • make sure that group buying market at particular geographical region matches the target market; • create product/service offer that assures brand promotion regardless of the customer demand; • plan the initial offer so the costs of attracting new customers does not exceed the revenue from the offer or has negative impact on transactions with current customers; • encourage satisfied customers to share their positive experience with friends, family etc.; • measure the success rate of the offer by counting sold offers and return of customers attracted by the offer on group buying website, and based on that, crate future offers; • collect information about customer satisfaction and accept their suggestions in order to create better offers (emphasize that customer privacy is assured). heuristic model of customer decision making this customer decision making model has six dimensions: popularity, authority, reciprocity, affiliation, consistency and scarcity. this model is used in case study (eliason, frezgi and khan, 2010) of group buying and all six dimensions were taken into account. this approach provides useful frame to influence positive decision making of the customers under the psychological pressure. in the context of ogb the each of these six dimensions is explained. popularity: popularity is powerful tactic that impacts customer behavior. the popularity principle implies that group affects the individual. traditional e-commerce websites do not show how many products have been sold or the popularity of certain offer, while ogb websites transparently give these information and use them to attract even more customers. group buying websites also allow comments and questions from the customers relevant to the offer or supplier. usually, comments are positive. another successful tactic that increases popularity of the offer or supplier is sharing information on facebook, twitter or some other social network. authority: when it comes to decision making people often ask experts for their opinion. experts with their knowledge reduce the users’ time needed for decision making. these decisions are affected by news reports, politicians or comments on social networks. online group buying services apply relevance tactic by showing articles and news reports published by relevant media. they publish users’ comments from other websites, like yelp and opentable (in usa) where these users were given a title of “local experts”. actually, group zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 179 buying services create their own relevance through branding and claim that they are experts for offers, local businesses and things that people should visit or try out. reciprocity: reciprocity principle is applied to group buying through different methods, such as exclusive approach. reciprocity represents certain procedure of individual or company, believing that other side will compensate their initiative. customers usually believe that supplier rewarded them with discounts through online group buying. scarcity: online group buying services apply the principle of scarcity in order to encourage certain customer behavior. it is well known that products become even more attractive when they are less available. in practice this principle is constructed so it seems to customers that products or services are exclusive. compared to popularity principle where it is what people gain by shopping, scarcity principle is based on what people lose by not buying. on group buying websites this principle is applied by creating time and quantity limitations on the offers. affiliation: affiliation principle shows the behavior where customers follow other customers, brands or products they like. this principle represents believe that customers like people, brands and products they are familiar with or similar to. group buying services use this principle in order to increase quaintness and mutual interest among customers in same cities. consistency: when customers find their position, usually they tend to keep it. offer published on group buying website contains information about the offer, terms, supplier, and about the customer as well. customers want to be identified by the content of the offer and supplier activities. for example, fitness, sauna and gym offers usually attract trendy customers who live healthy life. customers behave consistent and stay consistent to their actions from the past. key determinants of customers behavior in online group buying because group buying happens online, it has to be mentioned that the internet has made major changes in customers behavior. in ogb model customers behavior factors are: (1) individual factors of customers behavior in ogb, (2) group behavior factors, (3) social factors and (4) e-commerce factors. individual factors of customers behavior in ogb individual factors of customer behavior in group buying, besides the usual factors in theory of customer behavior, are ability to use the internet, sensitivity to price and discount perception, and trust in the supplier and online service. most common factors used in research of customer behavior are: consumer resources and economic status, gender, age, education, profession, life style, psychological characteristics such as: motives, emotions, character, memory, knowledge, attitudes, preferences, habits, loyalty, shopping flow, impulsive shopping tendency etc. examples are groupon and livingsocial, leading online group buying services in usa with over a million customers and subscribers. research has shown that average user of ogb service is a woman at age of 28, with college degree and household revenue over $100k a year (eliason, frezgi and khan, 2010). economic analysis (2014, vol. 47, no. 1-2, 175-192) 180 in 2012. there was a research in croatian gfk (gfk croatia market research center, 2012) on subject of online group buying. research showed that 64% of online users are members of group buying and that they receive newsletter from 2-3 ogb services. more women (73%) than men (54%) receive newsletter. around 50% of online users (80% members) have made at least one purchase through a group buying service. although women are more often to be members of a group buying service, research has shown that men are more often to realize the purchase (88%:75%). these purchases were usually related to cosmetic services (haircuts, pedicure, manicure, and other treatments around 24%). purchases related to specific products and travel bookings come second (around 20% each), then gastronomic offers (around 20%), followed by purchases related to clothes, footwear and accessories (around 10%) (gfk croatia market research center, 2012). buying “invisible” goods, payment terms, shipping cost and time or service execution, and after sale services (complaint, service and maintenance) are important factors in making an attitude about online transaction. although online group buying service communicates with customer and is considered as mediator, supplier is usually responsible for product/service quality and other terms of transaction in online group buying. ogb is based on discounts (at least 50% off) and according to the author (dragutin gutić, 2006) customers perceive those discounts as shown in the following table 1. theoretically, discounts can cause positive and negative reactions among customers. in the group buying the effects are similar, so discount perception can be a very important factor in purchase decision making. table 1. customer product/service discount perception negative perception positive perception • if the product was any good, it would be sold by now. • obviously they have sales problems. • probably product's expiration date is closing up, so they want to get rid of it as soon as possible. • probably there is a brand new similar product. • suppliers made their commissions too high and now they are lowering them. • supplier is facing bankruptcy, so he made stock clearance. • it was about time they lower the prices. • obviously they want to increase transactions. • that is my chance to buy that product. • it is expected since it is seasonal product. other elements can also cause a negative perception of the customer, such as the time limit of the offer. offers on the ogb websites usually have time limit, and sometimes the offer is active only for one day. this practice is good because otherwise it could lead to counter effect and questions from customers like (robert j. kauffman, hsiangchu lai & chao-tsung ho, 2010): zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 181 • what is the real price of a product or a service if it is offered for a long time with a significant discount? • why is it so hard to sell a specific product or a service, and why can it only be sold on the ogb market? the decision to purchase products and services, in general, can occur in two ways: (1) mostly planned, especially if it is a product for daily use or products with brand, where customers behave routinely, and (2) impulsive or unplanned. given the specifics of the ogb model and mostly unsegmented approach to the customers, their behavior in this model is very similar to the characteristics of customers who purchase in impulsively rationally manner. impulsively rationally purchase is based on rational criteria. it means that the subject of purchase is not currently needed, but it is purchased because it is on sale and it is a special offer. ogb model exactly meets the characteristics of this way of purchasing. of course with this type of purchase the other factors must also be taken in consideration, such as tendency to e-commerce, experimentation and innovation in purchasing, satisfaction of participating in group buying, satisfaction with the award (lower price and other benefits), the impact of the group, etc. the study (irem eren erdogmus and mesut cicek, 2011) based on the survey results explained the motives, behavior and perceptions of customers in online group buying in turkey. although the ogb expects customer satisfaction, loyalty and „word-of-mouth“ marketing, this study has shown that it often leads to a disappointment of customers due to price sensitivity and transactional orientation. this study showed that discount rates are the main motive for participating in online group buying. however, searching for news, exploring and learning have also proved to be important factors for participation in ogb. customers mostly perceive ogb as a way to enrich their experience and discounts enable them to buy something they wouldn't otherwise buy. in addition to the discount rates, the decision to purchase is usually affected by the location of provider of products or services, and the perceived value of the product/service. the influence of groups and social factors on the behavior of customers in online group buying group factors of customer behavior in ogb are specific compared to the traditional approach to influences of group factors on behavior. in addition to groups, group status, group interaction, group norms, the role of leaders and followers is a little more specific in this purchasing model. in the ogb model the relevant and reference group have important influence on customer behavior (the principle of popularity), as well as aspects of social acceptability of some purchases. the relevant or reference group includes a set of individuals who contact each other in a given period and who have common needs and goals (stevan vasiljev and ljubomir trufunović, 2006). the group in the ogb business model is a set of individuals gathered in order to buy a particular product or service at a discounted price, which have indirect contact with each other through the ogb service. these individuals don't need to know each other. among these individuals there are some who are committed to promoting and economic analysis (2014, vol. 47, no. 1-2, 175-192) 182 attracting new customers because they are expecting additional bonuses. this principle where customers follow other customers in ogb is called the principle od similarity. customers generally value opinions of other people, friends, family and other formal and informal groups, and that is usually based on the principle of popularity and similarity. the presence of groups in the purchasing situation encourages customers to behave in a way that benefits ogb. social factors that are important for e-business, and thus for online group buying include legal and political environment, the state of the economy, demographics, but the most important for ogb are the it culture of the population and technical infrastructure. the following factors are crucial for the development of e-business market: computer literacy, adequate telecommunication networks, hardware and software support, the regulations for the use of internet services and economic status of the participants as a prerequisite for the purchase of necessary equipment. e-marketing and customer behavior in online group buying e-marketing factors are used to directly impact and effect customer behavior. those factors include the basic elements of the marketing mix 4p and 7p, online infrastructure, platforms and websites of ogb services. different tactics and techniques of e-marketing and social media can be used for the implementation of business strategies. tactics are generally associated with a marketing mix, while e-marketing techniques used in the ogb business model are (božidar radenković, marijana despotović-zrakić and zorica bogdanović, 2011b): e-mail marketing, permission marketing, viral marketing, affiliate marketing, referral marketing, one-to-one marketing, etc. social media are online media for social interaction and they include social networks, online communities, creating groups, internet forums, message boards, blogs, and every kind of sharing photos, audio and video clips. for example, the power of social applications in groupon's business model consists of the following (vinny wu, 2010): integration with the facebook account, so there is no need for additional registration, location-based business, every city has an independent twitter or facebook account, $10 bonus for a recommendation to a friend, subscription to a newsletter, rss, and api. as the additional marketing methods groupon uses: blog (one of the ways to communicate with customers and suppliers), groupon says/ live off, reward system for referrals and personalized service in order to increase trust and reduce the emotional distance and barriers. „word-of-mouth“ marketing is especially important in online group buying, the key purpose of marketing is to manage demand, level of demand and timing (philip kotler, 2003). ogb marketing usually integrates all the factors that influence the decision to buy on the group buying website. in the study (erdogmus and cicek, 2011) that analyzed turkish market of online group buying, it is established that ogb is suited for companies that offer products or services and whose buyers are reluctant in traditional shopping. this study has shown that buyers are more interested in different services, like recreational activities, than products. when ogb service is posting a new offer, they should make sure that their target market, who lives nearby, hears about the offer, goes to a website and makes a purchase. the offer should also zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 183 contain the information about the supplier of products/services and it should be presented as a reliable, reputable and high quality so that buyers reduce perceived risks. ogb service should publish guarantee and compensation schemes for the buyers. as such, ogb service can gain the trust and loyalty of customers and competitive advantage on the market. personalization and creating a consumer value in online group buying personalization allows customers to personalize the content that is presented to them on the website based on their preferences (božidar radenković, marijana despotović-zrakić and zorica bogdanović, 2011a). in online group buying it means that two users can be on the same website at the same time and see completely different offers. personalization is implemented by using different technologies that enable web server to collect information about buyers and based on that to present relevant offers to a particular buyer. there are three key elements in the process of personalization: 1. the mechanism responsible for personalization 2. the criteria for personalization 3. what exactly adjusts to user – content, design, functionality of a website, etc. personalization is usually realized by forming groups of users. groups are formed based on different criteria, such as common demographic, geographic and other characteristics. modern web technologies enable automatic collection of data on each web user. the users can voluntarily leave information about themselves by filling out different questionnaires and forms on the website. once the web server collects enough information about the user, it puts user in a particular group and displays the content intended for that particular group of users. it is necessary to clearly define which requirements a user must meet to be classified into the group. depending on the size of a group, there may be different levels of personalization. once the groups of buyers are identified, it must be defined what exactly on the website will adjust to what group of users. ogb service collects information about customers that can be divided into: • information that customer voluntarily submits during registration or by filling out the form or questionnaire • buyer evaluates and ranks different offers, and based on that ogb service understands buyers preferences • information on previous purchases (type of offer, how often they buy, how much they spend, etc.) • information about buyers behavior on the website (clickstream, which offers they watch, etc.) group buying services use personalization to create a suitable situation for all participants in online group buying. customers are satisfied because they have a personalized shopping experience, and they can see the offers they are most interested in. suppliers are satisfied because they have the opportunity to approach the most relevant customers, while ogb service benefits when it effectively and efficiently meets the needs of customers. by doing this, ogb service builds a better relationship with customers and it encourages them to return to the website. economic analysis (2014, vol. 47, no. 1-2, 175-192) 184 in the framework of personalization in online group buying it is important to give the customers the option to review offers, suppliers, products and services offered on the group buying website. empirical research of the competitive environment and customers decision making model in online group buying market of the western balkans competitive environment of the ogb business model represents the segment of the external environment (industry), which includes all ogb services that offer products or services by the principles of online group buying and the market where ogb services sell these products or services. the industry of ogb is characterized by products and services sold by the ogb service and customers who purchase these products or services. in addition to technical characteristics, the content of a website can have a positive impact on customer decision making about participating in online group buying. ogb services create and present content on the website in the way that customers are often under psychological pressure to buy and social media is used for the same reason on ogb websites. therefore, the adequacy of information presented on a website influences the intention of customers to participate in ogb, to say „yes“ under psychological pressure and social media are all crucial factors of the ogb website. these factors can be considered in the context of a theory, such as the theory of social exchange or theory of six heuristic factors. this second theory provides a suitable framework for determining the adequacy of the information presented on a website. compliance of the information that influence customers decision making can be explained based on the indicators of a website content on the premise of six heuristic factors. theoretical concept of empirical research the theoretical concept of empirical research is based on the premise that the characteristics of the competitive environment are important for understanding the customers behavior in ogb model. important characteristics of the competitive environment in the ogb market are as follows: number of significant ogb services, ogb website rank, the dynamics of change in rank, market structure, spatial aspect of the market, strategic groups, etc. in addition to the competitive environment and the characteristics of the offer, the content of websites is an important factor in customers decision making about participating in ogb. the adequacy of information can be examined based on the website content and how it influences the intention of customers to participate in online group buying, which is the goal of heuristic model of ogb customer behavior. heuristic factors (variables) of customers decision making are identified based on the indicators of website content and related social media, including: • popularity: information on the number of sold offers, the popularity of a particular offer, the option to comment and ask questions about the offer or supplier, the option to share offer on facebook, twitter and other social networks, review of products or services; zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 185 • authority: displaying articles or reports published by authoritative media, user reviews from other websites (e.g. in usa yelp or opentable), branding, claiming they are experts for offers, local activities and things to do and see in the city; • reciprocity: exclusive access, the belief that customers are already awarder in the form of discount; • scarcity: it is not about what customers gain if they make a purchase, it is about what they lose if they don't buy a particular offer, offers on the ogb websites can be limited by time and sometimes quantity; • affiliation: interest among buyers in the same geographical area, offering products or services to a large groups of customers; • consistency: personalization, information about suppliers and products/services from the buyers' perspective. performances of the ogb websites are identified in the context of heuristic model and they are divided into four groups of indicators, which is presented in table 2. table 2. performances of the ogb websites indicators of the market and offers e-metrics social media indicators mobile application indicators • number of cities • rewards for buyers • prize games • payment methods • reviews • personalization • average website load time • average time spent on a website • google pagerank • facebook likes • google +1 • twitter followers • youtube views • rss • blog • android • ios methodology of empirical research the research covered the industry of online group buying in selected countries of the western balkans: serbia, croatia and bosnia and herzegovina. the time coverage referred to the second half of the year 2012. there are no registers of ogb services on the observed markets, rather the data on the basic set (the list of ogb service on the selected market), their presence and performance were obtained from various sources. significant presence on the market of group buying was found for the following services: in serbia 37, in croatia 31 and in bosnia and herzegovina 5 services of ogb. on the selected market a sample of five best rated sites of online group buying for each country were taken from the site (alexa.com) and the sites of services (for bosnia and herzegovina). gathering the data was made by primary and secondary research. the primary data were gathered by the method of observation applying the analysis of the content from web pages, while the secondary data on research units were taken from their websites and the site economic analysis (2014, vol. 47, no. 1-2, 175-192) 186 (alexa.com) about buyers. groupon – a website and business model of the most successful online service was used as a benchmark for websites in the sample. the instrument for gathering primary data was a form for observation of websites of the selected ogb services which was used to gather the data on the presence or absence of various types of website performances, such as: system of rewards, prize games, comments on the offer and seller, personalization, review and so on. the rest of the data from websites are secondary ascertainments and they refer to: features of the offer (category, discount, savings, duration, efficacy), amount of sold offers, sharing information on social media, opinions and reviews of the media and buyers, savings for buyers, restrictions of the offer and offer category. analysis of competitive environment on the markets of group buying in the western balkans countries analysis of competitive situation in the branch of group buying in the countries of the western balkans was conducted by determining the key features of competitive environment, which is presented in table 2. table 3. key features of competitive environment of the observed countries features of competitive environment bosnia and herzegovina croatia serbia number of more significant services of ogb 5 31 37 services of ogb according to the rank of the site 1 to the rank of 300 4 above the rank of 500 1 to the rank of 100 5 to the rank of 500 1 to the rank of 100 7 to the rank of 500 dynamics of changes growth with undeveloped market participants growth stagnation of fall market structure monopoly to oligopoly oligopoly oligopoly spatial aspect of the market mostly national markets number of cities from 1 to 6 mostly national markets families of services regionally present number of cities from 6 to 23 mostly national markets families of the services regionally present number of cities from 2 do 20 strategic groups identified market leader and lower group identified market leader, corporative innovators and corporative followers identified market leader, corporative followers and low group to differentiation dreamers zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 187 development of competitive environment in a branch of group buying may be evaluated on the basis of the number of ogb services. it is obvious that the branch of ogb in croatia and serbia is on a such institutional level that it enables the development of this branch (in croatia 31 significant service was identified, and in serbia 37), while this branch in bosnia and herzegovina is undeveloped (identified 5 significant services). if we take into account the criterion of positioning the ogb service according to the rank of a site it can be noted that all three markets are not the most popular with respect to electronic markets. in serbia and croatia only 1 service is among the first 100, while in bosnia and herzegovina the most popular service is of the rank 201-300. also a small number of ogb sites is among the first 500 sites, so that in serbia there are 7 of those, in croatia 5, and in bosnia and herzegovina merely 1. if we observe the dynamics of changing the sites of ogb service it can be noted that both in croatia and serbia the market leaders strengthened their market position and improved their rank, while in croatia the rest of the sites improved their rank, and in serbia the sites of services mainly stagnated or considerably worsened their rank. in bosnia and herzegovina, which has an undeveloped market structure, the market leader has significantly improved his rank, and the follower has also improved his rank, however, other sites have significantly decreased their ranks. the markets of group buying in the selected countries converge to approximately oligopoly structure (five competitors together have at least 75% of market participation), which is acceptable taking into consideration the level of development of these countries and development of the market of e-commerce. oligopoly structure is characterized by the branch of ogb of croatia and serbia, while in bosnia and herzegovina prevails monopoly to oligopoly structure of the group buying market on the internet. on the market of group buying in croatia and serbia this process is currently ongoing, while in bosnia and herzegovina the existing and new online services that will create stable oligopoly structure are yet to be recognized. services of ogb are mainly oriented towards national markets in all three countries. it has been noticed that certain families of services of ogb are present on the regional market. when it comes to strategic groups a classification was made for services in the following five groups: market leader (have many or enough resources and a large market participation), corporative innovators/differentiators (have enough resources and despite the low market participation, they try to differentiate, which puts them on a promising position), corporative followers (have enough resources, but low market participation and low level of differentiation), differentiation dreamers (have very restricted resources, low market participation, but an average or high level of differentiation) and low group (low level of differentiation and focus, low market participation, as well as resources and possibilities). seven significant competitors of group buying were identified in serbia (by the popularity of website), which can be classified in the following strategic groups: market leader, four corporative followers and two services in low group to differentiation dreamers. five significant competitors were identified on croatian ogb market, which can be classified in the following strategic groups: market leader, three corporative innovators/differentiators and one corporative follower. economic analysis (2014, vol. 47, no. 1-2, 175-192) 188 bosnian and herzegovinian ogb market is undeveloped, so that the leader on the market does not have the features of a true market leader, but is closer to the features of corporative follower in the sense of following the basic business model of group buying. implementation of heuristic model of decision making of web users on the participation in group buying under the application of heuristic model for identification of factors of decision making of web users for group buying that refer to website ogb service features, an analysis was conducted for the content of websites of all services from the aspect of heuristic factors and indicators they are measured by. tables 4 to 9 show the similarities and differences between the ogb services in the context of heuristic models in the selected countries of the western balkans: serbia, croatia and bosnia and herzegovina. table 4. similarities and differences of ogb sites with respect to popularity variable similarities differences • all sites have prominent number of offers • presence on social networks (facebook and twitter) • they have the ability of sharing information on social networks • they have the ability of commenting offers and asking questions • most of the services do not have android and ios applications • smaller number of services in serbia do not have the ability of commenting • larger number of services in croatia do not have the ability of commenting • smaller number of services in croatia do not have the possibility of sharing offers on social networks when it comes to popularity only a small number of services do not satisfy the criteria defined by the indicators. mainly all sites have prominent number of offers and possibility of sharing offers on social networks. the sites also have the possibility of commenting offers and asking questions. average time spent on the site in serbia is from 2:52 minutes to 11:15 minutes, while all the sites have below-average value of google page rank, on the level 4, with respect to the most popular sites with the value 10. in croatia the average time spent on an ogb site is from 3:05 minutes to 6:30 minutes. in croatia one site has an average value of google page rank 5, while the rest of the sites have below-average value. for bosnian and herzegovinian ogb market it is in effect that the average time spent on a site is from 2:05 minutes, to 3:32 minutes. all sites of group buying in bosnia and herzegovina have low value of google page rank (from 1 to 3). all of the services on the observed markets are present on facebook and twitter with different number of likes and followers. zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 189 table 5. similarities and differences of ogb sites with respect to the variable of authority similarities differences • mainly do not show articles and reviews published by competent media • mainly do not show reviews of the users on concrete offers, sellers, products and services • services mainly do not give the possibility of review • in croatia and serbia strong branding of ogb services and suppliers • in bosnia and herzegovina branding is inadequate since there are unsuccessful offers • in serbia there are services that give the possibility of review the criterion of authority is not met by the vast majority of services. a small number of ogb services contain a link to reviews of diverse media related to that service. the users are partially enabled to value and write their opinion on concrete offers, sellers and services. table 6. similarities and differences of ogb sites with respect to the variable of reciprocity similarities differences • savings are mainly emphasized • only participation in group buying means a prize in the form of discount • system of prizes and prize games is present but not dominant • in croatia and bosnia and herzegovina the savings are mainly shown monetarily or in percentage • in serbia there are services which only show the savings in percentage reciprocity as a factor of decision making is on a satisfactory level with all services. some services practice expressing savings for buyers in money and percentage, while some have decided for expressing only the percentage. table 7. similarities and differences of ogb sites with respect to the variable of scarcity similarities differences • offers mainly have temporal and/or quantitative restrictions • products or services look like exclusive (mainly successful offers) • in serbia offers are present without temporal or quantitative restrictions • in croatia and bosnia and herzegovina most of the services restricted the offers temporally and quantitatively by coupons per person (buyer) • in bosnia and herzegovina nonexclusivity is present due to unsuccessful offers even though scarcity is one of more important factors effecting the behavior of buyers on a site of online buying, ogb services have not fully used the influence of this factor. some of the services have not clearly restricted the offers neither temporally, nor quantitatively, while some also restrict offers by total amount and amount of coupons per person. economic analysis (2014, vol. 47, no. 1-2, 175-192) 190 table 8. similarities and differences of ogb sites with respect to the variable of affiliation similarities differences • most of the services do not build mutual interest between buyers in same cities • for the success of offer mostly needed small number of coupons • most of the services have offers that succeed only with one sold coupon • in serbia an average affiliation (more than 5 sold coupons) • in croatia there is no, or it is a weak feature of affiliation (up to 4 sold coupons) • in bosnia and herzegovina mainly weak affiliation (up to 2 sold coupons) services in the region have not used the influences the factor of affiliation has on buyers in the best way, so that there are considerable lags in implementation of this criterion. with respect to the system of reward and prize games, ogb services that apply them have similar approaches, most frequently a prize of a buyer when a friend to whom the buyer recommended the offer makes the purchase. table 9. similarities and differences of ogb sites with respect to the variable of consistency similarities differences • all have presented content on seller and offer from the aspect of buyer • personalization is present, but not dominant • same means of payment (cards, ebanking and deposit slips) • in croatia with smaller number of services the detailed content on the seller and offer is not present from the above stated it can be concluded that consistency as a factor of decision making with buyers is on a satisfactory level with all ogb services in the observed countries, except from personalization as a form of personalized offers that are shown on a site and personalized offers in newsletters, which is not adequately present on websites of services in the region. conclusive considerations behavior of a buyer in group buying is an important market determinant of business model in group buying. this market determinant is important both for supplier, and for the ogb service. systematization and analysis of factors in behavior with buyers by the system of group buying have determined various aspects, structure and intensity of governing determinants of their behavior. theoretical concepts for analysis of buyers decision in the system of ogb are identified and clearly given. theories of social exchange, theory of equity and heuristic model of buyers decision making are specially analyzed. zahirović suhonjić, a., online group, ea (2014, vol. 47, no, 1-2, 172-192) 191 particular factors of buyers behavior in group buying are analyzed in the context of perception of price reduction, behavior in a group and under the influence of e-marketing factors and personalization. in the empirical part of the work it has been affirmed that market structure of group buying in serbia and croatia has oligopoly features, while in bosnia and herzegovina it is monopoly to oligopoly. the market of group buying in the period of observation in serbia had stagnation or a fall, in croatia growth, while in bosnia and herzegovina the growth of market was emphasized, but with undeveloped market participants both on the side of offers and the side of demand. markets of group buying in the selected countries converge to approximately oligopoly structure that is acceptable concerning the level of development of these countries and the development of e-commerce. the market of group buying in bosnia and herzegovina is on a low level of development, with respect to the number of present ogb services, observed needs of sellers for group buying, as well as education of buyers and encouragement of satisfaction of their needs with participation in group buying. structure of heuristic model buyers decision making implemented in group buying was analyzed. indicators were identified that can measure each of these dimensions. heuristic model is implemented in the ogb market of the countries of the western balkans. it has been determined that ogb services in the region have not used the influences that some of the factors from heuristic model have in adjusting their sites to the principle of their implementation, so that there is a lot of space for enhancement of functions and design of websites in the context of this model. references alexa – the web information company, www.alexa.com cohen, a. 2012. “the ultimate guide to group buying sites” http://searchenginewatch.com/article/2206458/the-ultimate-guide-to-group-buyingsites (last visited 11.10.2013.). eliason, e., frezgi, y. and khan, f. (2010). “daily deals white paper: understanding the industry dynamics of daily deals and implications for merchants and consumers” harvard business school http://www.slideshare.net/hackstartups/group-buying-whitepaper (last visited 09.10.2013.). erdogmus, irem & cicek, mesut. (2011). “online group buying: what is there for the consumers?” procedia social and behavioral sciences, 24: 308-316. gfk croatia. 2012. “servisi za grupnu kupnju – oblik zarade za ponuđače, a ušteda za krajnje kupce!” http://www.gfk.hr/public_relations/press/press_articles/010370/index.hr.html (last visited 01.11.2013.) gutić, dragutin. (2006). ponašanje potrošača, široki brijeg: hercegtisak, split: hercegtisak. kauffman, j. r., lai, h., and ho, c. t. (2010). “incentive mechanisms, fairness and participation in online group-buying auctions” electronic commerce research and applications, 9: 249-262. kotler, philip. (2003). kako kreirati, ovladati i dominirati tržištem, novi sad: translation, adizes. economic analysis (2014, vol. 47, no. 1-2, 175-192) 192 radenković, b., despotović-zrakić, m., and bogdanović, z. (2011a). “elektronsko poslovanje: stanje i perspektive” teaching material, www.myelab.net. radenković, b., despotović-zrakić, m., bogdanović, z. (2011b). “internet marketing: strategije, taktike i tehnike internet marketinga” teaching material, www.myelab.net. shiau, w. l. and luo, m. (2012). “factors affecting online group buying intention and satisfaction: a social exchange theory perspective” computers in human behavior, 28: 24312444. tuten l. t. and ashley c. (2011). “promotional strategies for small businesses: group buying deals” small business institute journal, 7(2): 15-29. vasiljev, stevan, and trufunović ljubomir. (2006). marketing. bijeljina: fakultet spoljne trgovine. wu, v. (2010). “groupon – collective buying & social marketing,” http://www.slideshare.net/vnnw/groupon-2nd#btnnext (last visited: 02.10.2013.). determinante ponašanja grupe internet kupaca na tržištima zemalja zapadnog balkana rezime – područje istraživanja u radu je specifičan dio elektronske trgovine nazvan grupna kupovina na internetu ili onlajn grupna kupovina s aspekta teorijskih postavki i ključnih determinanti ponašanja kupaca grupne kupovine. analizirani su osnovni teorijski koncepti odlučivanja kupaca primenjeni na onlajn grupnu kupovinu: teorija društvene razmene, teorija pravičnosti i heuristički model. utvrđene su osnovne karakteristike konkurentskog okruženja i ponašanje kupaca u grupnoj kupovini s aspekta performansi veb sajtova servisa i heurističkih faktora odlučivanja kupaca grupne kupovine unutar nacionalnih tržišta odabranih zemalja zapadnog balkana. ključne reči: onlajn grupna kupovina, ponašanje kupaca, heuristički model, zapadni balkan article history: received: 13 november 2013 accepted: 20 november 2013 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp133-144 scientific review serbia‐china bilateral trade relations: major challenges and opportunities elena jovičić1* | slavica stevanović1 | isidora beraha1 1 institute of economic sciences, belgrade, serbia abstract considering the growing presence of china in serbia and deepening the overall bilateral relations, the main objective of the paper is to analyze the major trends and changes in the bilateral merchandise trade between both countries. the paper also focuses on exploring the main challenges as well as determinants for enhancement of trade relationships in the upcoming period. the total trade between serbia and china has been steadily growing over the last decade. the value of total trade in 2019 compared to 2010 is increased twice, the value of imported and exported goods grew twice and almost 45 times, respectively. despite the rapid growth, the trade intensity index shows that trade between serbia and china is under-represented, implying there is a space for improvement. some obstacles hinder trade relations between serbia and china. one of the main challenges stems from the fact that china shares its influence in serbia using investments rather than trade. on the other side, serbia does not have enough capacity to meet chines market demand, which is among other things a result of the domination of low value-added products in the total serbian exports. in order to overcome the obstacles, serbia should focus on its comparative advantage as well as attracting the chinese investment in the strategically important sectors. furthermore, it is essential for serbia to develop a strategic approach to trade policy towards china, which implies better promoting of export growth, relevant support of serbian exporters as well as more active engagement around trade matters during official negotiations with china. key words: bilateral trade, exports, imports, serbia, china, trade intensity index jel classification: f1, f14 introduction over the past decade, serbia has committed itself to the development of relations with china. belgrade has become open to many types of cooperation with beijing, especially after the establishment of a strategic partnership in 2009. the strategic partnership was strengthened and expanded in 2013 through involvement in bri initiative, respectively 17+1 mechanism (formerly 16+1). with a particular focus on the transport sector at the beginning, the partnership was deepened by the extensive government to government funding from a variety of state-owned chinese banks (bastian, 2017). namely, the strategic partnership contributed to the conclusion of a series of investment and framework agreements and the implementation of joint projects in the serbian energy, transport, agricultural and other sectors, as well as in the field of scientific and cultural exchange and cooperation (dimitrijević, 2016). in * corresponding author, e-mail: elena.jovicic@ien.bg.ac.rs 134 economic analysis (2020, vol. 53, no. 2, 133-144) addition to existing projects, in 2019 serbia signed several agreements with china, i.e. memorandums of understanding, on future cooperation in the field of innovation and infrastructure, such as co-operation projects in the construction of the belgrade subway, the establishment of a joint industrial park, the construction and modernization of railway sections near to the border with northern macedonia, etc. (the government of republic of serbia, 2019). deepening cooperation between serbia and china also led to the enhancement of bilateral trade relations. the volume of trade has increased significantly, more than twice over the past ten years. but, despite the rapid growth, the economic cooperation between serbia and china has been a small part of the economic exchanges with the world of both countries (babić, 2016). moreover, there were certain obstacles hampering bilateral trade relations. one of the main challenges stems from the fact that china is strategically oriented to the longlasting expansion of exports of domestic products and imports of energy and mineral resources. so that serbia, due to the weak capacities as well as significant differences in economic power, has no possibilities to impact substantially to the development of trade flows. as a result, the trade relationship between the two countries appears to be running in one direction only. furthermore, it is hindered by the lack of any formal legal basis, including the absence of free trade agreements and similar arrangements (hartwell and sidlo, 2017). finally, the fact that china shares its influence in serbia using investments rather than trade can be highlighted as an important challenge. considering the growing presence of china in serbia and deepening the overall bilateral relations, as well as the fact that trade, in general, has a positive and significant impact on economic growth and could enhance economic cooperation between countries, we decided to focus on the analysis of the major trends and changes in the bilateral trade of goods between serbia and china. also, the aim of the research was to investigate the main obstacles and opportunities for enhancement of trade relations between the two countries. the research, based on the conducting of comprehensive analysis of bilateral trade flows, would enable a better understanding of the development of the trade relations between serbia and china and more appropriate planning of the future steps towards improving the current situation and eliminating main obstacles. literature review literature review regarding trade relations between both countries is relatively scarce. this is not surprising bearing in mind the fact that chinese investments (both fdi and loans) have attracted much more attention during the last decade. series of research studies was focused primarily on the issues of investments as well as implementation of the different infrastructural and energetic projects. a great deal of research is devoted to the deepening economic collaboration between china and cee countries especially in the context of the bri initiative or 17+1 platform (turcsányi, 2014; vangeli, 2017; musabelliu, 2017; šteinbuka, muravska and kuznieks, 2018; tianping, 2015; jakóbowsk, 2016). some authors (liu, 2013, song, 2018) focus on the basic characteristics of china-cee cooperation and problems china and cee countries face in this regard, highlighting non-homogeneous conditions in the region following by diversified demands and pressure from eu as main challenges which should be tackled. however, the majority authors have been investigating the deepening cooperation between china and cee countries through the prism of chinese investment projects, mapping the chinese investment flows and types of involvement, as well as analysis of motivations of the chinese companies’ penetration to the cee region, etc. (mccaleb and szunomár, 2017; éltető and szunomár, 2016; jacoby, 2014). when it comes to bilateral relations between serbia and china, many authors indicate that in terms of project implementation, serbia became beijing’s key partner in the region of western elena jovičić, slavica stevanović, isidora beraha 135 balkans (tonchev, 2017; vladisavljev, 2019; yan, 2019; hackaj, 2018; song, 2018). under holzner and schwarzhappel (2018) serbia is the prime target of chinese construction contracts, i.e. almost half of the projected amounts are earmarked for construction there. more than half of the projected construction costs are budgeted for transport and slightly less for energy projects, while a minor contract is dedicated to a (communication) technology project (holzner and schwarzhappel, 2018). trade aspects with regard to cee countries and china bilateral relations are investigated by xin, (2012); jacimovic, et al. (2018); matura, (2019); szunomár, liisi and leonte (2020), and others. the authors generally came to the conclusion that despite deepening bilateral cooperation, trade relations remain relatively low, leading to the increasing trade deficit. only a few authors conducted a comprehensive analysis of bilateral trade relations between serbia and china with deeper insight in challenges and opportunities for its development (jelisavac trošić, stojanović-višić and petrović, 2018; jacimovic, et al., 2018). bearing in mind that there is relatively scarce research on this topic, the paper could contribute to the literature by widening the existing knowledge. methodology the conducted analysis is descriptive and based on secondary data. the period from 2010 to 2019 is observed, although on several occasions references to the first half of 2020 are made. data on merchandise trade by the standard international trade classification (sitc) are collected from the statistical office of the republic of serbia and from the un comtrade database. data are in current u.s. dollars. trade intensity index (tii), the simple technique developed by brown (1948) and kojima (1964), was used in the research as well. indices of trade intensity are calculated using un comtrade data. the tii approach evaluates bilateral trade status based on both a country’s global trade status and its trade partner’s economy size tii, helping identify how intensively the countries are trading with each other (chen and li, 2014). besides the analysis of statistical data, the review of relevant literature was conducted, and information on various actors and issues related to the foreign trade of the republic of serbia and china was examined. trends in bilateral trade according to official data of the statistical office of the republic of serbia, in 2019, the total trade between serbia and china reached 2.8 billion dollars, with an increase of 25.6% compared to 2018. the volume of imports grew by 16%, while the volume of exports increased by 259%. the trade deficit amounted to almost 2.2 billion dollars (a rose by 5%), and china was the country serbia had the largest deficit with. during the period from 2010 to 2019, trade exchange between serbia and china has been steadily growing, the trade deficit also significantly rose over the same period in some regards obscuring the fact that serbia has been increasing its trade with china. although the value of goods imported from china grew two times, exports increased almost 45 times in the same period. the coverage ratio of imports by exports rose to 13.2% in 2019, compared to 0.6% in 2010, but still remains at a very low level. 136 economic analysis (2020, vol. 53, no. 2, 133-144) figure 1. the trend of serbia’s trade with china (2010-2019, in mil. usd) source: authors’ calculations based on the statistical office of the republic of serbia in the first half of 2020, exports increased by 36.1%, while imports grew by 24.4%. it is noteworthy that china was one of the few countries with which trade growth was recorded. moreover, the trade growth rate with china was the most significant compared to other countries. an explanation could be the fact that china, after coronavirus pandemic shutdowns relatively fast returned to full production, taking the advantage of manufacturing re-openings and consumer demand. as a result, after the turbulence in the first three months, trade showed a slight recovery in the second quarter, and the exports have risen during three straight months (the state office of china, 2020). following the latest data, this trend continued in september and october 2020. being one of our major tared partners, china has become an engine of bilateral trade with serbia. an improving of mutual relations (mostly given to china's assistance to serbia over coronavirus) has consequently contributed to fostering trade between both countries. when it comes to serbia’s main trading partners, china has a leading position that has been improving over the past decade. however, this is the case primarily in terms of imports. in 2020, china ranked second (just behind germany) with a share of 12.5 % in serbia’s total imports, which is an improvement by one place compared to its position a year before. china was the fourth most important trade partner in 2010, accounting for 7.2% of serbia's total imports. ‐2200.0 ‐1200.0 ‐200.0 800.0 1800.0 2800.0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 exports imports trade balance total elena jovičić, slavica stevanović, isidora beraha 137 figure 2. serbia’s major trading partners (share in total imports, 2020, %) source: authors’ calculations based on the statistical office of the republic of serbia in terms of exports, china is not yet among serbia's top 10 trading partners. namely, china ranked 20th in 2020, while in 2010 it occupied 29th position. it is not surprising taking into account a huge trade deficit serbia has with china. however, the improvement of the position instils a dose of optimism. composition of exports and imports according to the standard international trade classification, during the last decade, serbian import from china referred primarily to computers, broadcasting equipment, polyacetals, and raw aluminium. on the import side, the leading product group in 2019 was telecommunication equipment, followed by automatic data processing machines, apparatus for electrical circuits etc. (figure3). it is evident that the import structure has remarkably changed during the last ten years. apart from automatic data processing machines, which remained one of the main patterns of imports, lower value-added goods like footwear, baby’s carriages and toys, etc. were imported in 2010. figure 3. commodity structure of imports (per cent of total, 2010, 2019) source: authors’ calculations based on the statistical office of the republic of serbia germany, 13.3 china, 12.5 italy, 8.3 russian federation, 7 hungary, 4.7 turkey, 4.2poland, 3.2 other, 46.8 138 economic analysis (2020, vol. 53, no. 2, 133-144) it is essential to mention that despite its minor share in total imports compared to the main groups of products, the volume of imports of some products has grown significantly compared to 2010: road motor vehicles, n.e.s. (by 205 times); rails and railway tracks construction material, of iron and steel (by 42 times); stone, sand and gravel (increase by 30 times); civil engineering and contractors' plant and equipment (by 17 times); other machinery and equipment for particular industries and parts thereof n.e.s. (by 10.5 times); rotating electric plant and parts thereof, n.e.s. (9.3 times); rubber tyres, tyre treads or flaps & inner tubes (by almost six times); articles of rubber, n.e.s. (by 6.5 times); pig iron, spiegeleisen, sponge iron, iron or steel granules and ponders and ferro-alloys (by 6.3 times). serbia’s exports during the period from 2010 to 2019 have been overwhelmingly in commodities, including iron and lead ore and sawn and rough wood. in 2018 exports of copper increased dramatically (in previous years the value of copper exports was negligible), and large quantities of copper were exported in 2019 as well. precisely, the share of copper reached a remarkable 80% of total exports to china, definitely taking the lead in the export structure. this enormous growth was a consequence of the conclusion in july 2018 of the agreement on the acquisition of rtb property in bor with the chinese company "zijin mining group". besides copper, there are some groups of products which have also recorded significant growth in terms of exports volume in the period 2010-2019: meat of bovine animals, fresh, chilled or frozen (2000! times compared to 20111); fixed vegetable fats and oils, 'soft', crude, refined or fractionated (1300 times); polymers of ethylene in primary forms and polymers of styrene in primary forms (both more than 1000 times); wood manufactures, n.e.s. (1000 times); wood, simply worked, and railway sleepers of wood (447 times); stone, sand and gravel (427 times); parts and accessories of the motor vehicles (72 times). figure 4. commodity structure of exports (per cent of total, 2010, 2019) source: authors’ calculations based on the statistical office of the republic of serbia despite the absence of the official data related to the product groups or products imported from and exported to china in the first half of 2020, it could be assumed based on information from the news and media, that serbia has been imported epidemic prevention supplies, medical and telecommunication equipment (these groups of products have generally had the major share in chinese exports in first six months of 2020). on the export side, copper and agricultural 1 data for 2010 is not available elena jovičić, slavica stevanović, isidora beraha 139 products have most probably had the largest share. such a conclusion stems from the fact that, based on the latest information of ministry of finance (mfin, 2020), zijin bor copper was second-largest exporter in 2020. when it comes to the agricultural products, as director of the division for strategic analyses, services and internationalization at the pks, mihailo vesovic, declared, despite the challenges occurred due to the covid-19 pandemic, serbia managed to increase the export of food products to china by 50 per cent (xinhua news agency, 2020). trade intensity index since with the help of an analysis of trends in trade, one cannot get the full idea about the intensity of trade between the two countries, trade intensity index (tti) was used in the research as well. the tii approach evaluates bilateral trade status based on both a country’s global trade status and its trade partner’s economy size tii, helping identify how intensively the countries are trading with each other (chen and li, 2014). the index can be defined as a certain quantity share exports of a country to its partner divided by the quantity share exports of the world to its partner (world bank, 2010). the mathematical definition of tii is: tij = (xij/xit)/(xwj/xwt) (1) where xij and xwj are the values of country i’s exports and of world exports to country j and where xit and xwt are country’s total exports and total world exports respectively. if the index is equal to one, it means that there is a higher degree of trade intensity between two given nations. hence, if the index close to zero, it indicates that there is a lower intensity of trade relations. the index numerically greater than on implies over-representation of one nation in the other nation's exports/imports. vice-versa, if estimation of the index is less than one, then it infers under-representation.   table 1. trade intensity index between serbia and china, 2010-2019 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 tti 0.008 0.014 0.018 0.005 0.009 0.015 0.017 0.035 0.043 0.152 source: authors’ calculations based on un comtrade database it could be concluded based on the data in the table 1 that, despite the trade intensity index has been increasing during last five years reflecting that serbia has strengthened the trade relation with china, trade intensity index value is still low and close to zero. it implies that trade between serbia and china is under-represented, and there is a space for improvement. discussion concerning previous analysis, authors tried to identify main challenges facing trade relations between serbia and china. the ways of addressing these challenges as well as opportunities for the enhancement of bilateral trade were also examined. main challenges in trade between serbia and china as it has been already mentioned, one of major obstacles is huge trade deficit, which has been constantly growing in last ten years. the explanation lies in the fact that given its small size and lack capacity to meet the chinese market demand serbia can hardly conduct reciprocal trade 140 economic analysis (2020, vol. 53, no. 2, 133-144) cooperation with china. the lack capacity is reflected, for instance, in domination of low value added products in the total serbian exports, as well as low technology-intensive products in the structure of industry exports by technology intensity (which is presented almost half of total industry exports of serbia). although bilateral relations between serbia and china hit the highest level in recent years in many areas, including politics, economy, culture, security, etc., the economic relations resulted primarily in the conclusion of different investment projects (which were mostly loans). in other words, trade relations were to some extent neglected, while investments attracted much more attention. bilateral trade has been developing almost spontaneously (as a result of deepening collaboration), with no substantial government interventions. hence, the serbian government should develop a more appropriate strategic approach to the fostering of bilateral trade relations, primarily focusing on promoting export growth. serbia would also use a politically driven warming up of bilateral relations and apart from the attracting of chinese investment, should make efforts to initiate negotiations on the trade enhancement matters as well. market access barriers and unfair competition are often indicated as problematic issues not only for serbian, but for exporting companies all over the world entering the chinese market. barriers means existence of the subsidies, equity restrictions on foreign investments, lack of transparency and unfair treatment, lack of uniformity of regulations. government procurement practices are also one of the main trade barriers, since china's procurement system is characterized by unconsolidated procurement-related laws (i.e. the existence of two laws the tendering and bidding law and the government procurement law) and shortcoming in implementing regulations. although, it is important to mention that china proposed major revisions of its tendering and bidding law (tbl) in december 2019. “the proposed revision would improve the transparency, conduct and fairness of tendering activities and move the law closer to gpa requirements in certain areas and less so in others. the revision would establish public bidding (bidding is open to all) as the main tendering method, rather than invitation to bid (the entity undertaking the tendering process invites certain persons to submit a tender) and imposes more requirements on use of the latter” (grier, 2020). serbian companies might be impacted by the delay in the implementation of agreements, which is primarily related to the obtaining of the permissions for exports of goods to china. it takes usually several months before permissions, certificates and all related documents are obtained and the implementation of the agreement starts. for instance, the several agreements on exports of dairy products and pork meat were signed in 20192. but only two companies “mlekoprodukt” from zrenjanin and “mlekara ub” received certificates for the export of milk to china in august 2020, while other three companies imlek, meggle serbia and somboled received the chinese government's approval for the export of their products in the end of october 2020 (seenews, 2020). an initial plan to start export pork meat to china at the beginning of november 2019 was also several times postponed due to the delay in the chinese inspection visit and in signing of the agreement on phytosanitary protection. namely, as branislav nedimovic, minister of agriculture of serbia, declared in june 2019, the two sides still need to sign an agreement on phytosanitary protection, adding that the first chinese inspectors are expected to arrive in serbia (xinhua, 2019). so far, the authors have not been able to find information that would confirm that this agreement was eventually signed, or any updated information related to the situation with export of pork meat. in a broader context, situation on a global market may also greatly influence the economic cooperation. since countries are becoming increasingly interconnected and interdependent, some changes or distortions in the global market can hinder trade of any of them. the good 2 agreements enabling the export of pork and dairy products to the chinese market were signed by serbian agriculture minister branislav nedimovic and the deputy minister of the general administration of customs of china, zhang jiwen in june 2019, in belgrade (serbian monitor, 2019). elena jovičić, slavica stevanović, isidora beraha 141 example could be the covid-19 pandemic which has gravely wounded the world economy, including global trade (under the wto (2020), the 14.3% quarter-on-quarter decline in world merchandise trade was recorded in the second quarter of 2020), as well as trade flows between china and other countries. the opportunities for the enhancement of bilateral trade when it comes to the opportunities for fostering bilateral trade, the market size and demand of the chinese consumers should be primarily considered as an essential issue. in this regard, there is definitely space for improvement, especially in terms of diversification of serbian exports. the growing chinese investment could be very helpful in this regard. serbia should attract investment in the strategically important sectors, which could stimulate the improvement the technology content of export products and producing of goods with higher value-added (halilbašić, muamer, snježana brkić, and vedrana bosić, 2015), which in addition to other benefits, is also of great importance for export growth (baranenko and đukić, 2012). hence, investments in machinery, automotive, it, and chemical sectors should be promoted. key sectors could potentially be those with a comparative advantage. based on the comparative advantage index and using un comtrade data chen and chengyu (2016) revealed, that serbia, for instance, in terms of industry sectors is more competitive in the following industries: tobacco, paper and paper products, beverage, food processing, non-ferrous metal smelting and rolling processing, printing, record media and replication and transportation equipment. furthermore, investments in agriculture and food industry also have a growth potential, occupying a significant place in serbian exports (jelisavac trošić, stojanović-višić and petrović, 2018). it is worth taking into account that cooperation with china could enable serbia for easier involvement in international production through "global value chains" (global supply chains) led by chinese companies, which would contribute to increased productivity, more intensive international trade and economic growth. in addition, this could further boost the expansion of mutual economic cooperation, but also cooperation with other countries (dimitrijević, 2017). conclusion economic relations between serbia and china, including bilateral trade, have been steadily growing over the last decade. the value of total trade in 2019 compared to 2010 significantly increased, the value of imported and exported goods also grew by several times. this trend has continued in the first half of 2020 as well. however, there are a number of challenges which prevent faster and more effective development of bilateral trade relations. main obstacles are the huge trade deficit and low capacity of serbian market following by considerable share of products with low value-added in total export. focusing on investments rather than trade, the absence of a strategic approach in trade policy, delay in the implementation of agreements, etc., also prevented the faster development of bilateral trade relations. concerning the main challenges as well as the fact that trade between the two countries is continuously under-represented, authors have tried to identify the opportunities towards improving the current situation and enabling fostering of the bilateral trade in the upcoming period. namely, the size of the chinese market, as well as rising chinese demand, leave plenty of room for improvement. by attracting investments in the industries and sectors where serbia has a comparative advantage or export growth potential, serbia could diversify and consequently increase its exports to china. furthermore, it is essential for serbia to develop a strategic approach to trade policy towards china, which implies better promoting of export growth, 142 economic analysis (2020, vol. 53, no. 2, 133-144) relevant support of serbian exporters as well as more active engagement around trade matters during official negotiations with china. acknowledgements this paper is financed by the ministry of education, science and technological development of the republic of serbia. this paper is also based upon work from cost action ca18215 chern, supported by cost (european cooperation in science and technology). references babić, blagoje. 2016, "new silk road – china’s new 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"the pragmatic cooperation between china and cee: characteristics, problems and policy suggestions." institute of european studies chinese academy of social sciences 7, no. 6: 1-9. article history: received: november 24, 2020 accepted: december 3, 2020 ea_2015_1-2 udc: 005.332.3:005.7 jel: l22, m10 cobiss.sr-id: 216168716 professional paper organizational change and improvement performance of companies župljanin slobodan1, independent university banja luka, faculty of economic, bih balaban mladenka2, institute of economic science, belgrade and independent university banja luka, faculty of economic, bih abstract – changes are now a reality faced by all organizations, wherever they were, and no matter which activity dealt with. changes are only a certain constant in all business activities of today's enterprises. modern organizations must be empowered to develop specific competencies for quality change management, because only in this way, organizations can improve their business performance and stay "in the game" at all on a turbulent global market. the main research objective of this paper is to demonstrate how change management process can affect the performance improvement of business operations and thus make the company competitive. competitive advantage is the most important competitive advantage of each company, and its achievement, in terms of global change significantly conditioned by creating appropriate models of change management. this work is, in essence, and deals with issues of organizational change, in response to the changes that come from the environment, or by creating an appropriate model of change management as an important prerequisite to improve the business performance of enterprises, which are the guarantee of the survival of the company in a dynamic and turbulent global market. key words: organization, change, performance, enterprise introduction organizational behavior is a new approach to the human factor in the organization, which consists in shaping the behavior of employees, whereby a man is seen as an active factor in the company comes with its own personal traits and experience. the organizational environment in which it includes is an environment in which an individual reacts to her interactions established in accordance with previously adopted patterns of behavior. access to organizational behavior, as part of management, is based on the knowledge that it is very important that the management of the company understands well the behavior of people and to have the ability and skills to influence the behavior of form or shape in a way that will contribute to achieving the objectives of the company, with management as well as the 1 professor, independent university banja luka, faculty of economic, bih 2 professor, institute of economic science, belgrade and independent university banja luka, faculty of economic, bih župljanin, s., et al., organizational change, ea (2015, vol. 48, no. 1-2, 98-107) 99 ability to perform tasks over people, receives its full meaning, as suggested situational approach and understanding of the many concepts that will help to understand human nature and behavior of people in a given situation. the behavior of people in enterprises must be a constant concern of management, because people are key potential through which to introduce changes in the business, as the surest way to improve the performance of business. today companies live and work in a very dynamic and changing environment in which the changes become everyday business. how and how many people will be able and willing to introduce changes in business largely depends on the company's management, and the ability and willingness of these depends on the ability to improve the performance of business. the main task of the research in this paper is to determine what is and what the impact of the changes that are coming from the turbulent environment and how their anticipation and proper implementation of affecting change or improve enterprise performance. modern managers must be able to timely detect impending changes and to recognize them as a new opportunity for the elimination of perceived weaknesses, ie, as a new opportunity to improve enterprise performance. organizational changing in today's world, characterized by the speed of information exchange and the globalization of business, management must provide organizational flexibility and react to creating favorable conditions for learning and self-organization. the changes include the ability to identify opportunities, missed opportunities, upcoming needs and creating a need on the one hand, and a willingness to respond creatively to the same regardless of the level of existing blockade, possibly, expected or outright resistance to change, on the other hand.3 previous findings show that social order there is no perfect organization so that there are always conditions and opportunities for better and more perfect organization and for the achievement of better results in the organization. in terms of turbulent change, the company is no longer enough to make minor changes to create value for customers, shareholders and other stakeholders but requires the implementation of major transformational change that insist on a new approach to management, a different strategy, structure, culture and so on. basically an organization can have two concepts in relation to their own environment. first, a passive approach to environmental influences, the company accepts the same as something that cannot be influenced. in this approach behavior, the company is basically a relative, is in standby mode, the passive observer of events and not takes measures that would serve to adapt to changes in the environment. second, active approach to enterprise seeks to influence the environment for the purpose of adjustment and alignment with their own interests or adapts resulting changes. in short, the company is an open system that affects the entire network of power in an environment that affect the company. how are the relations with the environment more complex and relations within organizations become more complex internally and the key to success is in better use of 3zivkovic, m. (2004) organizational adaptation and redesign of our company, proceedings: improving the performance of companies a condition of doing business in the european environment, megatrend of the university of applied sciences, begrad, p. 70s. 100 economic analysis (2015, vol. 48, no. 1-2, 98-107) resources, assets and activities through the creation of better organizational structure and process connections that enable the realization of synergies, stronger market impact and lower costs. successful change management is becoming increasingly important managerial responsibility and managers react to new threats and opportunities, initiate changes in anticipation of the expected opportunities and provide interpretation of rapid, dynamic changes in the environment. for any organization and any organizational change, the main goal is to create a prosperous and successful organizational configuration that will enable the achievement of organizational goals with minimum cost and effort, satisfying the interests of all stakeholders. under the organizational change involves the process of changing or modifying an existing organization, the process of accepting new ideas or behavior in order to meet the new requirements of the environment in which changes in the organization, regardless of which level of conduct, chained affect every part of the organization and include: changing technology and manufacturing processes, change the organizational structure and change of structure. types of organizational changes organizational system, by definition, a unit which operates in a given environment and the company represents a subsystem with its environment which needs to establish certain relationships. the modern environment is characterized by a large interaction, instability and changes that often turbulent character, and the changes taking place both in the area of technology and the field of socio economic and political relations. technological, economic and social factors influence the speed of change, and the creation of new management theory and practice. in this sense, in the search for answers to new management challenges have been developed and new concepts and approaches in management. starting from the basic characteristics of the environment in which the organization operates, theory and practice management were differentiated into three basic models of strategic and organizational changes:4 • model of incremental (evolutionary) change, • disrupted equilibrium model, • revolutionary model (entrepreneurial) changes. model incremental (evolutionary) strategic changes aimed at minimizing deviations from the traditional behavior, both inside and outside the organization, and is based on small (incremental, step-by-step) changes. incremental changes are called first order changes or alpha changes, the basic characteristic of gradual adjustment of strategic changes and changes in the organization, through partial change of low intensity. in most organizations the changes are not greeted with enthusiasm. employees, in general, do not like change and generally oppose their introduction. this opposition can be of varying intensity, but is, in fact, always present, especially in the initial stages of awareness of the need for these changes. managers at all levels of the organization must take this into account and duly 4 mašić, b. (2001) strategic management, university "braca karic", belgrade, p. 303. župljanin, s., et al., organizational change, ea (2015, vol. 48, no. 1-2, 98-107) 101 employed to prepare for the process. companies that are not prone to making changes in the business, i can count on long-term and efficient operations. managers reach the planned objectives by bringing logically related decisions step by step so that employees gradually adapt because the changes mid slow, predictable based on past trends, and are within acceptable levels and volume. as shown in the figure below, the model of incremental change includes adaptive learning or in one round (single loop learning), which is based on the knowledge and understanding of changes in the environment and adapting to these changes. in addition to adaptive, there is a generative learning or in a double circle (double loop learning) which is the creation and exploration of new strategic areas for the expansion of the organization. generative learning does not improve the existing knowledge, practices and activities, but also create entirely new competences and this learning, unlike adaptive, including another round of referring to a review of the premises on which they based their existing knowledge and creating new knowledge, competencies and strategy. figure 1. relationship of strategic change and learning in a single and a double circle source: creating author according to armstrong, sa, fukami, cv (2009) management learning, education and development, sag model disrupted balance is based on the assumption that changes in the environment according to its frequency, scope and level of turbulence, beyond the framework that can be filled by permanent adaptation of incremental changes. organizations adapt to changes in the environment by using the alternation of long periods of incremental short periods of radical changes that need to break the existing, old frame work, thinking and behavior, and to create a new framework of strategic change. the essence of the model of change lies in the fact that every system that is intended to be changed, it must first be "unfreeze" or prepare for change, then that change, and finally to "freeze" (stabilization system), and all in accordance with the movement of organizations 102 economic analysis (2015, vol. 48, no. 1-2, 98-107) from current to future, who are looking for performance. increasing the frequency and rate of change of diffusion leads to the fact that the company cannot adapt to the requirements of the environment is not even an occasional incremental to radical changes but it is necessary to incorporate into its own structure model of change management that includes a permanent, continuous revolutionary change.5 the causes of organizational changes causes organizational changes lie in the imbalance or disruption of the balance between organization and environment and within the organization itself, i.e. between its subsystems. external or internal imbalance leads to a drop in performance and crisis companies so that organizational change is a way to avoid the company anticipated or eliminate imbalances already caused, or degradation of performance. thus, the main causes of organizational changes, changes in the environment and changes in the company which organizations must adapt. top management companies can anticipate or at least very quickly noticed the changes in the external and internal environment and to adapt the organization of enterprises these changes before a potential imbalance actually disappears. in this case changes occur without the appearance of a real crisis and the organization continuously adapts to changes in the environment and the company itself. external causes of organizational changes unlike internal factors, external external factors have a much stronger impact on the company, changing the nature and characteristics of the conditions with which it is faced. computerization, electronic revolution and the internet, then globalization and liberalization of business, demographic, social and educational change, migrations, the democratization of society and the transition of non-market economies in the 21st century are generic forces that are changing companies and organizations. external causes of organizational changes consist of changes in the environment that results or may result in external imbalances organization, or its non-compliance with the requirements of the environment. for example, the intensification of changes in the environment requires that companies become more flexible organization which raises decentralization, team grouping, lateral communication and reducing the number of hierarchical levels in the organization.6 if inevitable break with old practices, the traditional organization, the organizational culture that supported hierarchy, centralization of power and business formula accumulation of resources. new time imposed the necessity of redefining everything, enterprises transition as a comprehensive and fundamental change in its structure, culture and processes. 5cochran, c. (2006) breaking down the walls, http://www.saferpak.com/process_management_art4.htm 6 milisavljević, m. (2000) strategic management, čigoja press, belgrade župljanin, s., et al., organizational change, ea (2015, vol. 48, no. 1-2, 98-107) 103 one of the strongest factors influencing the necessity of implementing organizational changes is the market and competition. market creates a dynamic and environment generates changes in the company in order to adapt to the company through the change in strategy and structure. information technology has generated a radical change of strategy, structure, processes and company culture in a way that created the prerequisites for their redefinition, enabling easier access to world markets, access to information, knowledge and innovative achievements. management of the company is forced to global searches for opportunities and resources to maximize returns on invested assets that concentrate the activities in which the company is the best or the ones that can adequately developed to relocate all the other activities that can be performed faster, etc. demographic changes, globalization, migration and social trends are also significant external forces organizational changes whose influence is reflected in the fact that many companies from developed countries moved their production to areas with cheap and flexible workforce. when it comes to religion and national culture, management needs and the external factor organizations to devote particular attention, and modern managers must know not only the national culture and religion rather than individual people, because people's behavior specific ethical elements, which are transmitted from religion in national culture, and the culture of the organization.7 internal causes of changes analysis of the interior internal causes of organizational changes indicates that the strongest internal causes changes contained in the change and development of business strategies, changes in the age and size of the company, changing leaders and organizational culture. changing the objectives and strategies of the company are to a high degree of correlation with the organization of enterprises because each strategy implies a certain organizational structure so that the change in strategy will inevitably require a change in organizational structure. furthermore, the life cycle model company explains that the changes caused by the growth and aging of the company so that the company changing the size and orientation of the market operation leads to the redistribution of power in the company. the decentralization of decision-making, with which the delegating authority from higher levels to lower organizational levels, a general trend and the biggest innovation in organization and management in the 20th century. distribution of power, which has resulted in the decentralization of decision-making, shows that the top management decided to change leadership style, rather than autocratic to democratic leadership. by changing the leaders in the organization comes to changes in the way the company employees understand the world around them and the way they behave in the world. the new leader of the company carries the new assumptions and beliefs and imposes them to others in the company who accept them. the wide acceptance of new views, ideas, attitudes and values creates a need for organizational change because the company organization adapts to the new reality that has brought a new leader. 7 weihrich, h., koontz, h. (1994) management, mate, zagreb. 104 economic analysis (2015, vol. 48, no. 1-2, 98-107) a change in ownership structure of companies also implies a change of organizational structure. the company as a corporate form of organization of economic activity is subject to constant changes in ownership structure, which occurs thanks to the marketability of shares and companies that are bought and sold on the stock exchange. also, the integration process of mergers and acquisitions is amended as size and ownership structure of the company. human resources influence the design of organizations with their knowledge and ability; shape the action set a formal organization, but also shape and informal organization. both staff and organizational culture affect change within enterprises, in particular, their quality, their professional and working abilities. wealth is less cost per ownership of the means of production, and more in knowledge, skills, abilities and creativity of staff. only a talented and highly trained staff can create and apply new technology to reformat and streamline operations, improve and rationalize production, enhance and promote the organization of work. we can see that they are just internal factors of the enterprise, to a greater or lesser extent, influence or control them but they do not act in isolation but are interconnected and have always unidirectional effect on the organization, so they should be analyzed in their mutual influence. target of change management the main goal of change management is to ensure a positive reaction to the changes of the unemployed in terms of their implementation in accordance with the objectives set. what will be the response and reaction to changes depends on four key elements:8 • flexibility is the ability of accepting changes with minimal loss of quality or productivity. flexible individuals are able to remain calm in a hectic environment and can be quickly restored from stress. • communication-related changes must be started from the top, and serve the formal and informal communication channels, to be constantly monitored and developed, based on openness and should not be burdened with irrelevant details. • education about the consequences of changes reduces unproductive behavior is unpredictable, the risk of non-acceptance of change and provides orientation employed real problems. solid knowledge of the changes have a significant impact on the success of the implementation of changes. • preparation of the planned changes by estimating the potential value, impact and required resources. the methodology of implementation of change represents a structural plan for achieving the desired objectives through the implementation of the accepted solution thus reducing errors and omissions. therefore, we developed a model implementation of changes in the organizations that we briefly introduce. 8 djuric, z. (2001) adapting to change for success of enterprises, the institute of economic sciences. belgrade. župljanin, s., et al., organizational change, ea (2015, vol. 48, no. 1-2, 98-107) 105 figure 2. the phases of organizational change source;http://changemanagementsuccess.com/2012/12/first-mckinsey-change-management-model/ mckinsey consultants peters & waterman were the most popular in the 80s and 90s because they coauthored the book in search of excellence. the methodology of implementation of change represents a structural plan for achieving the desired objectives through the implementation of the accepted solution thus reducing errors and omissions. therefore, we developed a model implementation of changes in the organizations that we briefly introduce. as shown in the figure, the first phase, ie. an indicator of the need to restructure the state of stagnation which is manifested as a general slowness of the system, the difficulty or impossibility of making decisions, lack of motivation and energy. this is followed by the preparation phase, which involves communication with employees for recognition and acceptance of change implementation. at this stage it is necessary to set clear goals, define new roles and responsibilities, but is performed and the diagnosis of risk in the event of failure to implement the changes. planning is the next step which involves making changes in strategy implementation and establishment of a system to measure progress. this is followed by the implementation of changes, i.e. involvement of the entire organization to implement changes. special attention is paid to the identification of potential problems in the implementation of changes, monitoring organizational climate and attitudes of employees about the new circumstances. incubation is the stage where conflicts arise and takes adaptation to new circumstances, because it is not yet appear first results of the changes so that they can be anticipated and doubts about the correctness of any changes made. if at this stage clearly predict and explain the problems, there is a risk that the organization is once again backing in the phase of stagnation. the final phase of expansion is easier place, and the staff has more confidence. now is the time to build a new system of compensation, measuring performance and rewarding but also establish a process of continuous improvement of the system and learning, transfer of experience and lessons learned. 106 economic analysis (2015, vol. 48, no. 1-2, 98-107) based on the development of new models of change management, designed and created entirely new models of reforms in transition countries. depending on the authors, they are called radical (bing bang) approach and a gradual approach or the "shock therapy" and the model of gradual change. for the purposes of this paper we elaborate beyond the aforementioned models, but only highlight the importance of developing new models of management changes and consequences that are produced in the transition economies. conclusion research conducted and presented elaboration unambiguously shows that globalization and development of technology, key determinants of contemporary business conditions post-transition period. a holder of globalization changes the transnational companies, which new markets createsnew business standards. on the wings of transnational companies are numerous and dynamic changes, which exert a strong influence on the business of domestic enterprises. domestic companies are now faced with numerous, new challenges, which require local management of new behaviors, new knowledge, new policies and business strategies. the changes are so powerful and so dynamic, it does not leave enough room for action in the new business environment. the management of domestic companies is now faced with a strong need to develop new models of change management to sustain the company in the fierce market competition. by creating new models of change management, it is possible to harmonize the organizational changes with changes in the environment, and thus improve the performance of existing business enterprises and provide long-term survival of the company in the market. note: this work is part of research projects by codes 47009 (european integration and socio economic changes of the eu economy) and 179015 (challenges and prospects of structural changesin serbia: strategic directions for economic development and harmonization with eu requirements), financial long learning by the ministry of science and technological development of republic of serbia references armstrong, s. a., fukami, c. v. 2009.management learning, education and development. sag. cochran, c. (2006) management art, breaking down the walls. cochran, c. (2006) management pack, breaking down the walls. dulanović, ž., jaško, o. 2002.the organizational structure and change.belgrade: faculty of organizational sciences. djuric, z. 2001 adapting to change for success of enterprises.belgrade: institute of economic sciences. masic, b. 2001 strategic management.belgrade: university "braca karic". milisavljević, m. 2000.strategic management.belgrade: čigoja press. weihrich, h. koontz, h. 1994.management.zagreb: mate. župljanin, s., et al., organizational change, ea (2015, vol. 48, no. 1-2, 98-107) 107 zivkovic, m. 2004.organizational adaptation and redesign of our company, proceedings: improving the performance of companies a condition of doing business in the european environment.beograd: megatrend of the university of applied sciences. parishioner, s. 2010.modern trade, independent. banja luka: university of banja luka. internet izvori: www.efos.unios.hr/arhiva/…/a10%20-%20novo… www.efsa.unsa.ba/.../sesija_2... www.efzg.hr/.../upravljanje%20promjenama%20... www.perkov_savjetovanje.hr/.../upr_prom... www.tasco.civilnodrustvo-istra.hr/...upravljanje promjenama… www.zzjzfbih.ba/.../modeliupravljanja-promjenama... organizacione promene i upravljačke performanse kompanija rezime – promjene su danas realnost sa kojom se suočavaju sve organizacije, ma gdje bile i ma kojom se djelatnošću bavile. promjene su jedina izvjesna konstanta u svim poslovnim aktivnostima današnjih preduzeća. savremene organizacije moraju biti osposobljene da razvijaju posebne kompetencije za kvalitetno upravljanje promjenama, jer, jedino na taj način organizacija može poboljšati svoje performanse poslovanja i ostati „u igri“, na sve trurbulentnijem globalnom tržištu. osnovni cilj istraživanja u ovom radu je dokazati kako proces upravljanja promjenama može uticati na poboljšanje performansi poslovanja preduzeća i na taj način učiniti preduzeće konkurentnim. konkurentska prednost je najznačajnija kompetitivna prednost svakog preduzeća, a njeno dostizanje, u uslovima globalnih promjena, značajno je uslovljeno kreiranjem odgovarajućeg modela upravljanja promjenama. ovaj rad se, u suštini, i bavi pitanjima organizacionih promjena, kao odgovora na promjene koje dolaze iz okruženja, odnosno, kreiranjem odgovarajućeg modela upravljanja promjenama, kao značajnog preduslova poboljšanja poslovnih performansi preduzeća, a koje su garancija opstanka preduzeća na dinamičnom i turbulentnom globalnom tržištu ključne reči: organizacije, promjene, performanse, preduzeće article history: received: 25 march, 2015 accepted: 5 may, 2015 udc: 332.122(470) 502.131.1:332.155 cobiss.sr-id: 252602124 scientific review economic efficiency of implementation of the concept of sustainable development of the urbanized territories in russia kseniia lapshina1* | natalia bakaeva2 | olga sotnikova3 1 voronezh state technical university, voronezh, russia 2 southwest federal university, kursk, russia 3 voronezh state technical university, voronezh, russia abstract the necessity of transition to sustainable development of the urban territories is proved. the concept of the natural-socio-technical model of urban territories is offered. green building as one of the aspects of unity in urbanized areas and the natural environment is presented. the basic principles of the paradigm of safe and comfortable urban environment that is compatible with the biosphere are formulated. the structure of the humanitarian balance and the methodology for quantifying them are described. the model of sustainable development of the environment through the comparison of human capacities and parameters of the environment is simulated. the criteria for the compatibility of urbanized territories with the biosphere were formulated as a measure of the sustainability of their development. the example of calculation of an indicator of biospheric compatibility of urbanized areas in relation to transport construction and road infrastructure of the city is given. it shows the economic efficiency of realization of the concept of sustainable development and the creation biospherically of the urban environment on the example of road infrastructure of the city. key words: economic efficiency, city infrastructure, transport system, ecological safety, urban ecology jel classification: q56, q01 introduction the last decades have shown that the terrestrial biosphere in general and her separate components – ecosystems of various levels – have limited potential for ensuring the normal functioning and reproduction in the conditions of excessive impact of human activity. therefore among global problems which solution is badly checked in the existing development models the important place is taken by such problems as exhaustion of available natural and resource capacity of earth and pollution of the environment of the planet. therefore the concept "sustainable development of the urbanized territories" is so widely used and discussed by the scientific world community, including russia. as ideologists of transition to sustainable development the most advanced and progressive organizations of both the world community and the certain countries act. * e-mail: kseniia_lapshina@mail.ru 10 economic analysis (2017, vol. 50, no. 3-4, 9-19) today the concept of sustainable development is considered as means of an exit from the ecological deadlock of development of a modern civilization. the cities which have become the leading form of the human settlement and the urban environment created by the person are centers of a modern technogenic civilization. but development of a civilization at insufficient accounting of laws of interaction between society and the nature accompanied by essential impact on components natural environment. it conducts to catastrophically consequences for the biosphere and the person as one of parts of the biosphere. the world famous scientists involved in new concept of compatibility of the urbanized territories are barber, brown, clemens, daniel, dasgupta, goldman, hamilton, heal, korowitz, meadows, mozes, randers, stievers, tadani, wagner a. and others. in russia in academy of architecture and construction sciences the founders of this new concept of compatibility of the urbanized territories with the biosphere are academicians ilyichev and kolchunov and others. the russian higher education institutions in the cities: kursk, oryol, voronezh, are actively engaged in the decision of problems of a numerical experiment of assessment of compatibility of the urbanized territories with the biosphere. as a result the modern cities gradually turn from the centers of development of a civilization into sources of destruction of the surrounding nature and degradation of the population. the widespread point of view that the market model of economic development and the concept of a possibility of his self-regulation will automatically solve all arising environmental problems is insolvent. it was shown by the analysis of trajectories of economic development and an ecological condition of those countries which in the last decades have passed to market economy. the economy and the market badly adapt to the actions having perspective focus concerning the interests of future generations. profit today and at any cost – such is the motto of today's economy of the majority of the countries. the basic principles of the conceptual approach we will state the basic principles of transformation of the city in compatible with biosphere and developing the person. principle 1. the unification of the city and the surrounding nature, respect for earth, unity of consciousness because the person is generated by the nature, he is her part, without her he can't exist and has to serve a maternal organism. the solution of the problem of sustainable development initially means interaction with the nature, preservation of her self-sustaining state. anthropogenic loading shouldn't exceed the limit providing such state. the following principle helps to understand that it hinders the achievement of unity with the nature in activity of the city. principle 2. connection of two contrasts (external and internal activities of the city). external withdrawal of resources from the biosphere: air, water, fossil minerals and energy resources (gas, oil, etc.) and throw-in of waste in her: msw, sewer drains, production wastes, gaseous products of burning at combined heat and power plant, state district power plant, in propulsion systems and many other things. internal is a living environment and indicators of impact on the population: quality of the urban environment, health and life expectancy, education level, income, human potential, etc. both activities of the city are interdependent and deterioration or improvement of one of them in the same way influences another. kseniia lapshina, natalia bakaeva, olga sotnikova 11 initially activity of the cities has to be directed to reduction of external and internal negative impacts, promote restoration of capacity of the biosphere and, finally, lead to the graded beginning reproduction of the clean biosphere. indicators of realization of this principle are, on the one hand, quantitative assessment of consumption of resources and formation of pollution, on the other hand, quantitative characteristics of a condition of quality of life and level of human potential in the urbanized territory. it is necessary to use existing or to create the new criteria allowing quantitatively (on the basis of correlation dependences) to estimate results of external and internal activity of the city. for example, in a qualitative sense it is such characteristics as: extent of renovation of the territory from waste and her involvement in economic circulation; volume of investment into "green" industries and creation of new jobs; availability of housing; depression of consumption of energy resources on ensuring vital activity of the cities; decrease of emissions of a carbon dioxide and so forth. principle 3. drawing up and calculation of triple (humanitarian) balances of biotechnosphere construction and the solution of the system of the equations establishing quantitative standard ratios between: a) biosphere life potential; b) population and number of places of satisfaction of needs of the population for the cities; c) needs of people and technospheres in resources of the biosphere and a possibility of the biosphere to satisfy these requirements. triple (humanitarian) balances of biotechnosphere establish harmonious proportions between various parts of the biosphere, including the population and also the list and quantity of the withdrawn resources in unit of time with a binding to the territory of the city. if the given ratios of triple (humanitarian) balance of biotechnosphere aren't kept, then in the city (further on hierarchy: the region, the country) it is necessary: 1) to reorientate productions, to enter innovations into a technosphere to reduce pressure upon the biosphere and to reduce negative impact on the population; 2) to limit population in this city at the existing technologies in a technosphere. in case the humanitarian balance of biotechnosphere isn't reached, then development of the city will degrade, if it is reached it will progress, grade. progressive development of the cities promotes conservation, restoration of the biosphere and the person, improves quality of life in general. as the person himself is a part of the biosphere, he influences it through the vital activity and can reduce or enlarge the biosphere sizes. as calculated components of the equations of triple balances of biotechnosphere it is offered to apply [15]: • technosphere unit: one place of satisfaction of needs of the person framed by people (for example, a workplace, the educational place, the medical place, the vacation spot and others); • biosphere unit: the site of the biosphere which potential on norms symbiotic corresponds to technosphere unit, i.e. one place of satisfaction of rational needs of the person; • biotechnosphere's unit: the site of the biosphere including technosphere unit, i.e. one place of satisfaction of needs of the person which is in standard symbiotic ratios with the biosphere. principle 4. legislative and standard fixing of humanitarian balance of biotechnosphere of the city, or phased transition to it. 12 economic analysis (2017, vol. 50, no. 3-4, 9-19) for each city it is necessary to set legislatively the triple (humanitarian) balance of biotechnosphere determining the extreme sizes of a technosphere at the available capacity of the biosphere or to carry out phased transition to it (acceptance of organizational and technical actions, updating and development of normative legal acts, etc.). legislative and normative documents have to be based on the principle of prophylaxis and anticipation of possible dangerous situations in the cities, and not just on the facts of their detection and elimination of consequences. the control system of the city has to provide daily regulation of its activity; to establish degree of admissible risks of emergency situations on the basis of introduction new the biosferosovmestimykh of technologies; to bring to the level of the main priority: preservation of life and human health, development of the person and so forth. indicators (indicators) of realization of this principle will be: quality of the legislative initiatives, normative documents and legal acts guaranteeing humanitarian balance of biotechnosphere or phased transition to him. it is necessary to regulate the rational criteria, standard functions concerning: 1) and use sites under building, streets, green zones, etc., 2) water supply and water disposal, 3) power engineering specialists, 4) the air basin according to climatic seasons. for each factor all stages of his use from withdrawal from the biosphere before formation of waste and their processing consistently are considered. it is especially important that concerning social criteria it is necessary to develop normative documents and legislatively to approve them. principle 5. knowledge as necessary condition of existence of the city strategic development of the city is based on knowledge and includes the following elements: professionalism (vocational higher education, preparation and retraining of highly skilled managing directors of shots, improvement of knowledge in the system of continuous education); intelligence (use for preparation and implementation of programs of development of experts from the universities, scientific research institute, the academic and professional communities); reliable information; preparation of new actions and development of programs for improvement of biotechnosphere; recommendations about elimination of negative factors and offer on human development. within strategic city map on the basis of the analysis of the available information (the general, survey, special, statistical, analytical, etc.) the purposes of management coordinate with resources by means of the innovative programs of development which are result of creative, business activity of scientists, engineers, businessmen, authorities. important result is participation of scientists specialists of the relevant branches in reorientation of the existing productions to the new resource-saving directions and low-waste technologies that is extremely important for the cities with an intense ecological situation. innovative projects and programs have to be directed not to creation of the new equipment, technologies and goods and to the coordinated progressive development of technologies, the organizations and goods in their unity and interrelation with the biosphere feeding them. innovative programs have to include the actions and economic expenses providing transformation of the saved-up wastes, i.e. pathologies of economy and society, into a development resource. at the same time not used members of society (the unemployed, criminals) are involved in a useful social and economic turn as waste of harmful productions. we suggest, that the technologies compatible to biosphere are considered to be the actions providing an economic opportunity to use industrial and household wastes, low-quality raw kseniia lapshina, natalia bakaeva, olga sotnikova 13 materials and renewable resources for creation of the high-quality products competing with the traditional items received from originally taken natural resources. in such technologies the price of the used natural resources has to correspond to costs of their reproduction. the compatible to biosphere technologies in construction the innovative offers developed and collected by the russian academy of architecture and construction sciences [16], and which have proved the economic efficiency and investment attractiveness can be examples of that. the offers illustrate, for example: transformation of solid household (organic) waste (msw) to the gaseous products used for development of energy or for additives in fuel; application of waste of logging production, fight of glass-container raw materials in production heat-insulating the crystalline materials of foam and glass. rather small volume of use of innovations in construction branch and the limited list of objects of “green” construction in russia is explained by legal lack of regulation of process of their realization or immunity of economy to innovations now. the problem of not demand of innovations again is well confirmed by the main motto of real market economy "profit at any cost". the major factors influencing resource-saving, for example, at design and construction of buildings as a part of program actions, are: rational choice space planning of decisions, survivability of constructive systems of buildings, term of their service; decrease in resource intensity, ecologically safe construction materials. as result decrease in use of non-renewable natural resources. quantitative indices of effectiveness of programs of development can be criteria of their selection at competitions, and the projects containing the technologies reducing the biosphere could not be allowed to participation in a competition in general. in germany, japan and some other countries the applicant who has submitted the proposal containing innovations concerning biotechnosphere on a competition receives essential preferences in points at assessment of the competitive offer. in russia, unfortunately, there is no such practice yet; even directive introduction of innovations practically doesn't work as in the country there is no economical and legal system stimulating innovative development of branches and municipal economy. finally, indicators of realization of the principle of "knowledge" will be: quality of target programs of regional development, effectiveness of actions for improvement of biotechnosphere and recommendations about elimination of the factors interfering symbiotic progressive development. all programs have to contain quantitative indices of implementation of innovative projects by means of program and target or share mechanisms of management. principle 6. creation of harmonious social climate on the basis of this principle it is expedient to estimate internal stability and wellbeing of the city, progress in development of the person and in restoration of the nature. for similar assessment it is necessary to use indicators: social tension, moral atmosphere, the fact that "terrestrial happiness" the family wellbeing, the birth of children and other indicators characterized by data of the statistical reporting on a social status on regions is called (birth rate and mortality, prevalence of deviant behavior owing to alcohol and drugs, life expectancy), quality of labor, the actual assessment of human potential and another. principle 7. satisfaction of rational needs of the person through functions of the city for harmonious development of the person rational requirements of him as person (vital, emotions, will, geniality and kindness, aspiration to knowledge, the need for creativity, sense of beauty) have to be satisfied with functions of the city: life support, entertainments and emotions, power, mercy, knowledge acquisition, knowledge of the world and creativity, communication with the nature. any of needs of the personality isn't main, all of them are necessary, and without satisfaction of any of them people won't be harmonious. 14 economic analysis (2017, vol. 50, no. 3-4, 9-19) as the principles of biospheric compatibility are implemented through the functions of the city designed to provide satisfaction of rational needs of the person and, respectively, through his infrastructure, we will address the analysis of these functions in practice of a urban planning. life support ─ this existence of worthy housing, jobs and their transport availability, providing with food, objects of life and life, available medical care. all life support system is rather difficult, and it is difficult to overestimate its importance. the problems connected with life support take 90% of working hours of the city administration today. entertainments and emotions ─ this is the creation of recreational zones in the cities, theme parks, squares, sports constructions and playgrounds, bars, restaurants, dance halls and so forth, convenient for use by the population of the city. in the city, as a rule, there are these or those opportunities for satisfaction of these needs of the person parks and attractions, cafe, bars and restaurants, dance halls and discos, game zones, the disneyland and many other things. saturation of the city by these objects depends on many factors, including on the number of inhabitants, on the level of income of the population, fashion and other. the power ─ is the mission personifying functions of management of the city (respect for discipline, control, the choice of the purposes and priorities at their achievement, etc.). the person in the course of the development is forced to operate himself self-discipline, control of emotions, the choice of the purposes and priorities at their achievement, etc. in a bigger measure these functions are necessary for community of people. in the city elements of the power have to have the corresponding architectural expression and placement on the master plan of the city: buildings of governing structures (administrations of areas, cities, areas and so forth), legislative, law enforcement agencies (police, prosecutor's office, courts, etc.), representation of the state participation (mails, banks, pension funds, etc.). the mercy ─ is the central point of needs of the person. the geniality and kindness which are received by the child under normal conditions the developed harmonious personality cause the reciprocal need to make something similar in the matured person. in the city – there are the objects representing and performing functions of the help to persons in need: to large families, aged, to disabled people, families with adopted children, etc. day nursery, gardens, educational, educational and specialized schools, out-of-school clubs on interests and other institutions; for physically weak, needy and socially unprotected groups of the population a nursing home and aged, doss houses, buildings of salvation armies and many other things. knowledge ─ that means the establishment of relationships of cause and effect in the world that always was need of the person. the understanding of the events which are taking place both around the person and in him, are extremely important for individual needs of the person and for city life. in the social plan traditionally this need of the person is satisfied with an education system kindergartens, schools, higher educational institutions, advanced training courses, retrainings, the systems of continuous professional retraining, etc. knowledge makes the person independent, and the education system and its personnel structure make the country intelligently independent. therefore the universities, higher education institutions, schools were always significant objects in the city and their importance can't be neglected. these objects in many respects define also its architectural appearance, form the place of the city in hierarchy of the cities including on the level of development of human potential. knowledge of the world and creativity ─ is the need for creativity which is the integral line of the person (to understand an essence of the observed phenomena and the taking place events, to create something new) and is implemented in the form of various creative organizations divided into two segments: kseniia lapshina, natalia bakaeva, olga sotnikova 15 • the scientific creativity (fundamental science, i.e. science as creativity) which is carried out by the russian state academies of sciences, the educational organizations: universities, academies, institutes); • the art creativity shown in the form of arts (architecture, a sculpture, painting, music, literature, theater, etc.). respectively in the city there always existed and have to be buildings and constructions in which these high needs of the person as however, and requirements of society, are satisfied. theatrical buildings, conservatories, concert halls, the museums, temples usually are architectural monuments, define architectural appearance of the city and though in a quantitative sense it is only several objects, they create in many respects the unique image and internal relevancy of the city, determine his creative potential for further development of the person. communication with the nature ─ is important function of the city as the person as a species, has indissoluble interrelation with the nature, actually he uses the goods granted to him by earth, the nature and the biosphere. during evolution human has created the life support system. however the need of communication with space, earth, the nature remained in the form of requirement of contemplation of fine, inspiration with images of natural harmony. the person needs to feel an initial natural basis and as a psychological support and as an esthetic factor. from these positions in the city there have to exist wildlife "impregnations" in the form of parks, natural monuments, certain reserved places with picturesque landscapes, a harmonious combination of a landscape and architectural objects. ancient architects paid attention to importance of this party of existence of the city, architects stand up for it and inhabitants rejoice to it. the charm of many old cities is defined by indissoluble communication with the surrounding nature which is shown in many respects a sufficient aeration, good illuminating intensity, existence of healthy reservoirs, but also picturesque landscapes, a harmonious combination of a landscape and architectural objects, etc. in the modern cities there is a danger of not only reductions of natural landscapes, but also their transformations to aloof territories and also in this context there is a problem of video pollution and light pollution. residential areas of the modern cities as "the stone jungle", aggressive in the impact on the central nervous system of the person, promote not only to depression of health of the people living in them but also turn them into socially dangerous persons. all functions of the city are closely interconnected among themselves. realization of these functions, together with other principles of transformation of the city in compatible with biosphere and developing the person, provides achievement of a condition of favorable medium for life and development of the person. excellent feature of the offered approach of measurability of functions of the city is that it allows to give a quantitative assessment to such concepts as quality of life, safety, favorable environment, comfort. quantitative estimates of representation to the inhabitant of functions of the city on time spent for their satisfaction form the basis of a technique of feasibility of these functions. the following step is an opportunity to survey advantages of the cities, plans of strategic planning and perspective versions of the master plan, to estimate as far as they correspond to needs of the person and as the person and balance of its time can change as a result of realization of this or that option. principle 8. reliability it is necessary to create "constitution" of the city according to which the city has to play the role in the constellation of other cities adequately: capital (of country, of region, of district), monoprofile or industrial city, resort, military base, city university, shopping center and many other things. it is necessary to maintain the traditions of ethnos which have developed in the 16 economic analysis (2017, vol. 50, no. 3-4, 9-19) cities, culture, to bring up the relations of respect and preservation of the nature, to involve the councils of elders in management process. to promote a unification of the cities, development of friendly communications between them in the field of economic and cultural cooperation, education, medicine, environment protection, etc. joint holidays, friendly visits, exchange of experience and so forth. communication and information transfer between people, ability to collaboration (exchange of the ideas, thoughts, intentions, feelings, information, etc.) necessary living conditions and development of the person in the city and society. observance of diverse conditions of public life, the system of behavior, norm, value, professional knowledge and another unite people in various social communities (group of people): labor unions, creative public organizations, clubs on interests, association. the purpose of such association simplification of communications between representatives of various cultures, ethnoses, decrease in conflict potential in the city, society, the state. communications between social communities have to be based on the principles of biospheric compatibility. if cooperation between people and groups of people is the basis for interaction, then development of the personality and society will be friendly and harmonious. otherwise there are unorganized mass of people (crowd and other their versions) that generate rumors, panic and fear in society, which is less controllable or uncontrollable by the city and the country in general. if the previous clauses and this point are implemented, then it is possible to speak about the comfortable environment for life and development of the person. principle 9. knowledge = force ─ this is the knowledge of the truth, objective reality allowing to pursue the correct policy is reasonable to apply law enforcement agencies, to make interaction between various layers in the city and a boundary by the cities. the cities have to develop the style, have memorials, city holidays. the ability to dispose by force assumes knowledge of functions of the city, his political, economic, social, ecological situation, relationship of groups and certain people, their interests, understanding of strategy and tactics by means of which force is got and being kept. knowledge promotes establishment of multilevel communications inside and between regions, development of the national idea, and strategy as bases for application of internal law enforcement agencies, planning of defense of the country, image of the country, etc. the greatest efficiency to "force" is given by "knowledge" allowing achieving the required objectives minimum spending resources; to convince people of their personal interest for this purpose; to turn opponents into allies. the principle "knowledge=force" ensures safety of residents. the indicators of safety of medium of vital activity are: counteraction of crime and anti-terrorist activity; information security; fire safety; mitigation of consequences and depression of level of impact of natural and technogenic catastrophes, ecological safety; sanitary and epidemiologic safety; safety of infrastructure facilities and transport. if all previous clauses are implemented, then it is possible to speak not only about comfortable (favorable), but also safe medium in the city for development of the person. thus, stated above represents the sequence, hierarchy of points, positions, actions for transfer of the city in biosferosovmestimy and developing the person. today, according to official data [1, 2], the major factors of destabilization of the urban environment and regressive development of the cities are: 1. the ingredient pollution of the air basin and its implication as in the form of the local phenomena a photochemical smog, acid deposits, and on a global scale formation of greenhouse effect, destruction of an ozone layer in a stratosphere. formation of climatic conditions of the city, meso and the microclimatic features of the urban environment, meteorological factors influencing processes of dispersion of emissions and localization of contaminants are bound to a condition of the atmosphere; kseniia lapshina, natalia bakaeva, olga sotnikova 17 2. pollution of water medium and formation of a significant amount of the crude sewage, including due to the lack of treatment facilities and a shabby condition of water supply systems. difficulties of providing urban population with drinking water are experienced practically by all regions of the country, and its sanitary state doesn't meet the existing requirements of norms and rules (40% of superficial and 17% of underground sources) [3, 4]. the problem of incidental developing of infectious diseases as which reason serves the low-quality water medium is also acute; 3. erosion and deflation of the soil in the cities and in adjacent territories, formation on the anthropogenic broken or anthropogenic transformed territories of artificial structures and specific educations different from natural structures by their properties. the factors blasting natural structure of a soil integument in the cities, that have the "sealed" day surface, reinspissation and the raised loads on the soil, its salinization and poisoning. a special problem for the modern cities is the modification of geological medium in a litosphere which is shown in the form of various dislocations: failures, sags, karst phenomena, landslides and gullying; 4. parametrical (thermal, mechanical, sound, vibratory, optical, electromagnetic) and radioactive pollution; development of new types of energy carriers with negative ecological consequences; 5. territorial offensive ("expansion") of the city at the environment through direct contact transport networks, utilities etc., leading to reduction of the sizes and violation of integrity of natural complexes and also decrease in their stability and efficiency of favorable impact on the urban environment. so, annual reduction of the area of forests results from activity of the person with a speed about 7,3 million hectares a year; 6. the adverse effect of the city on a plant and animal life leading, as a rule, to violation of natural processes of activity both separate species of plants and animals, and all biocenosis. by estimates of experts, daily and forever from 100 to 200 types of live organisms and plants disappear. loss of the habitat, its pollution and overexploitation of biological resources by the person are the reasons of it; 7. accumulation of dumps, tailings dams, waste heaps and other results of long-term economic activity, problem of their utilization and elimination. only in russia there are more than 500 million m3 of radioactive wastes and about 20 thousand tons of the fulfilled nuclear fuel; 8. global distribution of super toxic substances through trophic chains that leads to violation of endocrine and reproductive systems of the person, manifestation of disintegration of genetic programs of the person that can lead to degeneration of the nation; 9. low level of ecological consciousness and culture of the population, is a consequence of what the insufficient efficiency of administrative and, first of all, control functions in the field of environmental management and environmental protection take place; low level of ecological regulation of town-planning activity, including lack of rent payments for use of natural resources, for the territories polluted by dumps, etc. finally, the cities as civilization carriers, get the prevailing function destroyers as they destroy the nature, and together with her and own population. 1) the urban environment represents dynamic system which condition is caused by: 2) external influences (for example, climatic factors, change of requirements of the standard-right base, social standards and qualities of life, change of education level and culture of society and others, defining a possibility of cooperation with the biosphere); 3) internal interactions between components (for example, rendering services, social tasks, environmental protection, etc.; 18 economic analysis (2017, vol. 50, no. 3-4, 9-19) 4) the intra making processes (for example, the intra production and economic relations). thus, the urban environment is the system open for external managing directors of influences, i.e. the influences transferring system to a new state. on the basis of the above-stated principles of transformation of the city in compatible to biosphere and developing the person the conceptual model of the safe urban environment as natural socio technical structure is constructed [24]. in conceptual model natural socio-technical structure of the urban environment we have allocated the following components: • the natural component as the part of the external environment containing resources for the person, interacting with objects of city infrastructure and which is exposed to negative technogenic impact; • the social component as the part of the external environment which is also interacting with objects of city infrastructure and expecting satisfaction of the requirements at certain risks. besides, the person as the representative of society, being a part of the environment, indirectly is influenced by negative technogenic impact; • the technological component making power impact on natural and social environments, and defining first of all, a possibility of formation of an adverse ecological situation in a certain territory. the basic novelty in creation of conceptual model of the safe urban environment in the form of open dynamic system in this case is that her state is defined by other specific laws which are based on mutual influence of parts of model which make her, as a part of uniform natural socio technical structure with external influences. conclusion for an example we have executed calculation of an indicator of biospheric compatibility of the territory of the motor transportation enterprise on the example of one of the cities of the central part of russia with the population about 400 thousand people. on the basis of the analysis of the received indicative values of factors conclusions on development of normative documents or concepts of program documents, for example, of target programs of innovative development for motor transportation infrastructure and other life support systems of municipal economy functioning in close interrelation with motor transportation system are drawn. the general recommendations about development of programs of development of objects of motor transportation infrastructure contain the following stages. at the initial stage conceptual installation and the general purpose of innovative development of the city transport system according to the fundamental principle of paradigm 1 by the biosphere of compatibility are formed. on the basis of the formulated general purpose tactical targets as which, for example, there can be following are developed: 1) realization of purposes of strategy of ecological reconstruction and safe development of motor transportation infrastructure of municipal economy; 2) development of new regional criteria for evaluation of quality of ecological safety of objects of motor transportation infrastructure of municipal economy; 3) development and legislative fixing of branch humanitarian balances of a biotechnosphere or phased transition to them; 4) realization of the program actions which are based on the principles of program goals management and share mechanisms of managing; 5) introduction to economic circulation the compatible to biosphere technologies eliminating imbalance of objects of motor transportation infrastructure and providing kseniia lapshina, natalia bakaeva, olga sotnikova 19 realization of functions i am proud for the maximum satisfaction of public benefits in the conditions of market economy; 6) establishment of target standards of the socio-economic indexes characterizing quality and technical capabilities of motor transportation system and objects of motor transportation infrastructure, for example, of costs of transport availability, etc. it should be noted separately that application of a program and target method of management of realization of program actions is based on share mechanisms of management by means of which participants of programs of development are called to work for the end result with "personal" responsibility of everyone. references brand ulrich. 2012. “green economy – the next oxymoron? no lessons learned from failures of implementing sustainable development”, gaia 21(1): pp. 28-35. ilyichev v. a., emelyanov s.g., kolchunov v.i., eds. 2015. "principles for the transformation of the city into biosferosovmestimyj and developing people." a scientific monograph. 184 pp. jeremy rifkin. 2013. “the third industrial revolution”, vii, 233-242. kennet m. and felton j. 2012. “the green built environment: a handbook.” the green economics institute. kennet m. and courea e, pepinyte 2011. “handbook of green economics.” the green economics institute. kennet m. 2012. “the green economics reader. the green economics institute.” shmelev s. 2017. “green economy reader. lectures in ecological economics and sustainability.” springer, 463 pp. https://www.springer.com/gb/book/9783319389172. shmelev s. 2012. “ecological economics: sustainability in practice.” springer, 248 pp. https://www.springer.com/gb/book/9789400719712. shmelev s., shmeleva i.a., eds. 2012. “sustainability analysis: an interdisciplinary approach.” palgrave, 335 pp. https://www.springer.com/gb/book/9780230355248. united nations division for sustainable development (undesa). 2012. “a guidebook to the green economy”. united nations environment programme. 2010. “green economy report: a preview.” http://www.unep.org/greeneconomy/linkclick.aspx?fileticket=jvdftjopxsa%3d&tabid=135 0&language=en-us. united nations environment programme. 2010. “developing countries success stories.” http://www.unep.org/pdf/greeneconomy_successstories.pdf. united nations environment programme. 2010. “a brief for policymakers on the green economy and millennium development goals.” http://www.unep.org/greeneconomy/portals/30/docs/policymakers_brief_gei&mdg.pdf. article history: received: october 6, 2017 accepted: october 25, 2017 microsoft word 2007_01_02.doc globalisation, global business and transnational corporations  besim ćulahović, university of sarajevo, faculty of economics, sarajevo  key words: globalisation, transnational corporations, localisation, clusters  udc: 005.44           jel : f02, f2  original paper  abstract ‐ the process of globalization should be conceptualized as a complex interaction between  transnational corporations (tncs) and the state that occurs in the context of the dynamic technological en‐ vironment. although tncs have an extremely  important role  in globalization, they have not superseded  other traditional economic institutions, especially the state. the localization of economic activities remains  fundamental, because every economic activity must be grounded in specific locations.  introduction  the phenomenon of globalization, whose  impact on modern political and socio‐economic  world is more than fascinating, has been present on the world political and economic scene for  over 30 years. the majority of people associate the word globalization with positive movements  which bring progress. at the same time, the increasingly aggressive minority sees globalization as  the root of all evil that has engulfed mankind. such oppositions create the demand to define the  concept of globalization more precisely, to locate the forces which generate and drive it, as well as  its important social, economic and geographical consequences.  the ideas of globalization initiate globalized processes that are drawing a new geoeconomi‐ cal map. there are much more driving forces on the global scene than we can imagine. globaliza‐ tion is a tendencies which are geographically and organizationally unbalanced. although tncs  have an extremely important role in globalization, they have not yet superseded other traditional  economic institutions, especially the state. the process of globalization should therefore be concep‐ tualized as a highly complex interaction between tncs and the state that occurs in the context of  the rapidly changing, dynamic technological environment.  this conceptual framework requests that the matter discussed in this paper is organized into  three parts. section 2 defines the concept of globalization, historical processes and levels of global‐ ization. section 3 analyses  the forces of globalization and  the nature of changes  in  the modern  economy. section 4 discusses the analytical frameworks and the localization of economic activities.  section 5 has concluding remarks.  what is globalization?  the globalization debate  people have undoubtedly become aware that something fundamental  is happening  in the  world economy, something that is irreversibly drawing the outline of a new economic and social  order. but precisely what that ‘something’ in the global world might be has been the subject of  many fierce and controversial debates. advocates of globalization claim that the processes of glob‐ alization show universal potentials for economic growth and productivity, that they enable better  and equitable division of labour between individual countries and economic blocs, which makes it  possible  for  developing  countries  to  specialize  in  work‐intensive  activities,  and  for  developed  countries to use their highly paid labour force in a more productive way. besides, through global‐ ization processes, capital flows are being transferred from developed to undeveloped countries,  which enable bigger benefits for investors (tax concessions, profit reparation, subventions for the  2007 ‐ 48  •  economic analysis®  construction of plants and installation of equipment in certain development zones, cheaper labour  force  for  the operations of material assembly etc.). this word  is sometimes used  to denote  the  processes of protection of  intellectual property and  trademarks which  to buyers all around  the  world represent a certain quality guarantee. as long as the quality of a brand remains unchanged,  consumers do not really care where a certain product with a certain design was manufactured,  providing, of course, they can afford to buy it.  the opponents of globalization display a much gloomier picture of these processes. they  usually claim that the increasing competition of the countries where salaries are low takes toll on  working places in developed countries, reduces salaries and the level of social protection, lower  the high standards of the environment protection and erode the capacities of national governments  to pursue their own economic policies. their concern is also the fact that the growing force of glob‐ alized financial markets can result in a huge economic chaos, as it has happened several times be‐ fore.  the nature of globalization debates held in economic circles become transparent when we  carefully analyze the most frequent questions addressed in globalization debates, as well as the  questions referring to mutual integration of three dimensions of the global market: a) – market of  goods and services, b) – labour market and c) – capital market.  debates about the market of goods and services usually refer to the causes of trade growth,  the impact of trade on globalization and political determinants of trade policies. typical questions  which attempt to illuminate the causes of trade growth are following: how extensive is the trade  volume between partners? which are the political, geographical, linguistic and institutional obsta‐ cles that are slowing down the process and growth of trade? to what extent do more liberal trade  policies and  technological revolution contribute  to removing  the obstacles of  trade growth? to  what extent is the current trade boom responsible for world’s economic growth, especially after  1950? the questions that are raised in order to find answers on the impact of markets of goods and  services on the processes of globalization are mostly the questions from the fields of specialization,  structural  adjustment  and  distribution.  for  instance:  which  industries  are  “progressive”  and  which are subject to the influence of foreign competition? how do economies adapt to supply‐side  changes? what happens to resources when domestic industries collapse due to the incompetence  to deal with foreign competition, when they are “on the street”? is it possible to find some alterna‐ tive ways  to put  them back  to work? do  institutions of authority and  their policies attempt  to  minimize the emerging losses in certain sectors and companies by transferring a part of revenues  from “winning” sectors and companies into “losing” sectors and companies? and, finally, what  happens with political determinants of trade policies? how do constituents of those policies com‐ municate with political authorities, how do politicians interpret and respond to that information?  at which point do political aversions towards globalization start to develop?  debates referring to labour markets open up other types of questions. for example, if there  exists a possibility of an open and free migration, who will migrate and why? what are economic  and demographic conditions that cause the source of migration and its destinations? what is the  impact of migratory flows on the economies of states‐emitters and states‐receptors of migrants?  what happens with migratory flows when they are limited by suitable policies? how do integra‐ tions of markets of goods and services influence migrations and integrations of labour markets?  has trade become the replacement of migration or just its supplement?  as far as the analysis of capital market flows is concerned, we can apply basically the same  questions as with the  labour market. in addition, the  integration of capital market gives rise to  many new questions. for instance, what is the cause of global crises in the capital market? does  integration provide grounds  for easier or “epidemic” spread of  irresponsible policies  from one  volume 40 • spring 2007 • 49  country to another? does the globally integrated world economy facilitate capital flows towards  poor countries as well? do debtor countries lose the ability to control their own economies? do  strategies of attracting the capital by tax benefits reduce the social security programs for poor lay‐ ers of population? do foreign investors collect the entire profit, or do they leave the host country a  fair share?  academic debates are much more complex and fierce. they are polarized around two clearly  differentiated lines (dicken, 2001, pp. 3‐4). cohen, zysman, drucker, reich and ohmae, authors of  currently  prevailing  theories,  believe  that  fundamental,  possibly  irreversible  changes  have  oc‐ curred, resulting in a deep‐seated shift in the structure of the world economy. people are already  living in a world where there are no borders, where globalization has become the new economic  (as well as political and cultural) order. in a new, globalized world, nation‐states are no longer  significant actors or meaningful economic units. consumer tastes and cultures are homogenized  and satisfied through the provision of standardized global products, created by global corpora‐ tions with no allegiance to place or community. in today’s technologically driven world, in which  time and space have been compressed and where the ‘end of geography’ has arrived, the global  has become the natural order of affairs.  the authors from the second line (gordon, glyn, sutcliffe, hirst and thompson) claim that  globalization is nothing but a mirage and an obsession. according to this view, the world economy  was much more open and more integrated in the half century prior to world war one, in which  there was, under the influence of the industrial revolution, unprecedented international integra‐ tion. this means that we live in an internationalized (rather than globalized) economy in which  national economies remain dominant.  all previous questions define globalization mostly from its economic aspect. however, the  globalization phenomenon is much broader – it refers to much more other things as well. global‐ ization is also an accelerated transmission of diseases between countries; such is the epidemics of  aids that struck africa and asia at the beginning of the 21st century in almost the same way as  plague, which was brought to europe in the 14th century by trade ships from asia, devastated a  great part of the “old lady”, or that measles, syphilis and other european diseases wiped away  native american population in the 15th and the 16th centuries. globalization does not pay enough  attention  to  the  transmission of  technology as  the most  important determinant of modern eco‐ nomic growth. in addition, globalization ignores huge environmental damages that are caused by  it, as well as avoids evaluating the consequences of disappearance of many natural languages and  ancient cultures. claims that these events are completely irrelevant for the future of mankind have  less and less sense. economy is not and cannot be a universal medicine for all dilemmas and dis‐ eases of modern society.  flows of globalization  globalization is not a completely new phenomenon. fifty years prior to world war i, the in‐ dustrial revolution triggered massive flows of goods, capital and people across national borders  and continents. back then, as it is still the case today, the processes of globalization accelerated the  lowering of trade barriers and development of cheaper transportation technologies (railways and  steamships). are current trends only a repetition of something that happened a hundred years ago  (economist 1997), or are there any substantial differences between the two major waves of global‐ ization?  2007 ‐ 50  •  economic analysis®  figure 1‐ waves of globalization  immigrants to the united states by decade, millions (right axis) 12 10 8 6 4 2 0 millionspercent 40 30 20 10 0 1870 1914 1950 1980 2000 wave 1 wave 2 merchandise exports/world gdp (left axis) foreign capital stock/developing country gdp (left axis) wave 3 ?retreat   source: world bank (2002), page 23  data on the number of immigrants in the usa, the share of global export of goods in the  global gdp, as well as the relation between stocks of foreign capital and gdp since 1870 to 2000, as  shown on figure 1  (world bank 2002), can prove  that  theories on  the similarity of  two major  waves of globalization do have empirical background. one does not need any serious analyses to  see that, in both waves of globalization, the trade and investment barriers have lowered, technolo‐ gies have caused distances to shrunk, and material cultures started to look alike.  the most important directions of the development of the world economy in the last two cen‐ turies were related to the internationalization of economic activities. however, internationalization  is not a completely new trend. certain goods have had international character for centuries. inter‐ nationalization was set  in motion by  the  industrialization  in  the 18th century  in  europe,  from  where it is spreading around the world.  early industrialization initiated a new global division of labour, which brought about some  changes in global geographical models of specialization. at the beginning, the division of labour  referred to the specialization of workers in certain parts of the production process, without any  geographical connotations. however, with the expansion of industry, the division of labour started  to gain geographical dimensions as well. certain regions and countries started to specialize in cer‐ tain types of economic activities. on the global plan, there has been a broad division of labour into  industrialized  countries  that  produced  manufactured  goods,  and  unindustrialized  countries,  whose major  international functions were reduced to supplying the  industrialized nations with  raw material and agricultural products and to being a market of manufactured goods. such geo‐ graphical  specialization,  structured  around  industrial  core,  semi‐periphery  and  raw  material‐ producing periphery, had formed a model of international trade that remained active for a number  of years. besides, production processes were organized within national economies, whereas inter‐ national  trade developed more or  less as an exchange of raw materials and  finished products,  manufactured and completed in national economies.  the nature of the world economy has changed dramatically in the second wave of globaliza‐ tion since the 1950s. national boundaries no longer act as hermetically sealed containers of pro‐ duction processes and trade flows. many leakages have started to emerge on them, through which  the world has become more and more integrated.  during the past few decades, trade flows have become far more complex. the old model of  direct exchange between core and peripheral areas, based upon mutual division of labour, is being  transformed into a new, highly complex, kaleidoscopic structure involving the fragmentation of  many production processes and their relocation beyond national boundaries. new centers of in‐ dustrial production in the newly industrialized economies started to emerge. with the develop‐ ment of new technologies, cheaper transport and communication technologies, corporate organiza‐ volume 40 • spring 2007 • 51  tion and new production processes, both old and new industries got involved in resorting of the  global jigsaw puzzle. two major components of the new wave of globalization – globalization of  market and globalization of production – made a new division of labour in production possible,  together with a new international financial system, based on the twenty‐four hour global transac‐ tions concentrated in the three major financial centers of new york, london and tokyo. today, a  huge number of new economic activities can be imagined only in the global context, since many  products (or their parts) can be manufactured anywhere in the world.  the levels of globalization  globalization processes never occur on  just one, global  level. globalization goes on verti‐ cally, horizontally and simultaneously on many different levels – starting from the entire world, a  certain country, a specific industry, a specific company, to the level of production lines within a  single company. essentially, globalization is a complex set of processes of the transformation of  activities, very uneven in time and space. globalization can be defined depending on the level we  choose to observe.   at a worldwide level, globalization refers to a growing economic interdependence between  countries, as reflected in increasing cross‐border flows of goods, services, capital and know‐how.  clear evidence of this is offered by the following trends:  o in the last two decades of the 20th century, cross‐border trade in goods and services  grew at an average annual rate of 8%, which is twice as fast as the growth rate in the  world’s gdp during the same period (unctad 2002)  o from 1987 to 2000, foreign direct investment (fdi) grew from 57$ billion to 1271$ bil‐ lion. during the same period, foreign affiliations increased their sales from 2465$ bil‐ lion to 15680$ billion, the employment grew from 17,4 million to 45,6 million, total as‐ sets from 1888$ billion to 21102$ billion, and the export and import from  637$ billion  to 3572$ billion (unctad 2001)  o in 1970, transactions in bonds and equities as a ratio of gdp stood at under 5% in the  us, germany and japan. by 1996, the respective figures had soared to 152%, 197%  and 83% (ft 1999, p. 5).  at the level of a specific country, globalization refers to the extent of the interlinkages be‐ tween a country’s economy and the rest of the world. not all countries are equally integrated into  the global economy. some key indicators to measure the level of global integration of a country’s  economy are: exports and imports as a ration of gdp, inward and outward flows of fdi and port‐ folio investment, as well as inward and outward flows of royalty payments associated with tech‐ nology transfer.  at the level of a specific industry, globalization refers to the degree to which a company’s  competitive position within that industry in one country is interdependent with that same indus‐ try in another country. the more global an industry, the greater is the competitive advantage that a  company  can  obtain  from  its  technology,  manufacturing  process,  brand  names  and/or  capital.  globalized industries tend to be dominated in every market by several global companies, which  coordinate their strategic actions. key indicators of the globalization of an industry are the extent  of cross‐border trade within the industry as a ratio of total worldwide production, the extent of  cross‐border investment as a ratio of total capital invested in the industry, and the proportion of  industry revenue and the revenue of global companies.  at the level of a specific company, globalization refers to the extent to which a company has  expanded its revenue and asset base across other countries and engages in cross‐border flows of  2007 ‐ 52  •  economic analysis®  capital, goods and know‐how. key indicators of the globalization of a company are international  dispersion of sales revenues and asset base, intra‐firm trade in intermediate and finished goods,  and the intra‐firm flows of technology.  recent globalization processes  the forces of globalization  which are the major forces that are modeling recent globalization processes? do they differ  from the forces that initiated the first wave of globalization? what are their consequences? these  are fundamental questions that arise from the globalization debate, and which require a convinc‐ ing answer.  what is obvious both on the global economic field and on different geographical areas today,  results from interactions between two major groups of institutions:  (tncs) and states, operating  in a changeable and dynamic technological environment. through complex and dynamic interac‐ tions, these three forces (tncs, states and technological changes) shape primary generators of the  world’s global economic transformation. tncs, through their geographically dispersed operations,  and states, through their trade,  investment and  industry policies, shape and reshape the global  economic map of the world, whereas the dynamic technological changes in transport and commu‐ nication technologies and production processes accelerate the industrialization and globalization  of the production of goods and services.  however, those processes are not even in terms of geography, sectors or time, nor are those  simple processes that expand from global to local levels. there are many geographical, political  and socio‐cultural conditions that act as active moderators of global forces and trends. some of  major trends lie at the core of globalization:  o an increasing number of countries are embracing the free‐market ideology. the shift  from a ‘planning’ to ‘market’ mentality, often referred to as ‘transition’, is well known  and has been well documented in literature.  o the  economic  center  of  gravity  is  shifting  from  the  developed  to  the  developing  countries. economic liberalization promotes competition, efficiency, innovation, new  capital  investment and faster economic growth. virtually any company  today  that  wants to grow has no other choice than to pursue its operations where the economic  growth takes place.  o technological advances are constantly improving the quality and speed of communi‐ cations between firms and countries. integral container transport, invention of quick  trains,  motorways,  airports  and  wide‐body  airplanes  continuously  increased  the  transfer of goods capacities, thus shrinking the shipping costs per unit of the product.  in past 70 years, telephone costs have decreased 300 times, whereas the costs of elec‐ tronic  information  processing  kept  decreasing  at  an  average  annual  rate  of  30%  (economist, 1998). new internet technologies are changing the settled models of sup‐ ply and demand from the roots.  o general  liberalization  of  trade,  which  was  performed  within  gatt’s,  tokyo  and  uruguay rounds and numerous unilateral decisions, as well as the liberation of capi‐ tal  flows,  opened  the  national  boundaries  to  trade,  investment  and  technological  transfers. not only does this create new market possibilities for local companies, but  also enables foreign investors to enter domestic markets. the intensification of com‐ volume 40 • spring 2007 • 53  petition creates a race to fulfill the needs of globalizing buyers, strengthens the econ‐ omy of scope, exploits the potentials of optimal locations to reduce costs and improve  quality, and encompass the benefits of technological improvements where they actu‐ ally  happen.  the  result:  the  phenomenon  of  globalization  has  become  a  self‐ accelerating frenzy.   the nature of new changes  although in quantitative terms the world economy seems at least as integrated economically  before 1913 as it is today, the nature of that integration was qualitatively very different:  o international economic integration before 1913 – and until the second half of the 20th  century – was shallow integration manifested through trade in goods and services be‐ tween independent firms and through cross‐border movements of portfolio capital.  o since 1980s, deep integration starts to gain ground, organized primarily by tncs. this  type of integration soon extended from trade to the level of the production of goods  and services, which increased both ‘visible’ and ‘invisible’ trade. links between na‐ tional economies are  therefore significantly strengthened and expanded, and some  tncs established extensive global networks.  however, although there are undoubtedly strong globalizing forces at work, it is not true  that today’s world economy is fully globalized. the forces of globalization can be at work without  this resulting in the end‐state – the globalized economy – in which all unevenness and difference  are  ironed out, market forces are rampant and uncontrollable, and the nation‐state passive and  supine. therefore, it is important to distinguish between processes of internalization and processes  of globalization. namely, globalization is a momentary complex of inter‐related processes, highly  uneven in time and space, rather than an end‐state.  o internationalization processes involve the simple extension of economic activities across  national boundaries. these are essentially quantitative processes  leading to a more  extensive geographical pattern of economic activity.  o globalization processes are qualitatively different from internationalization processes.  they involve not merely the geographical extension of economic activity across na‐ tional boundaries but, more  importantly, also the functional  integration of  interna‐ tionally dispersed activities.  in today’s world economy, both processes (internationalization and globalization) coexist. in  some cases, it is the continuation of long‐established international dispersion of business activities,  whereas in others there is an increasing dispersion and integration of business activities of tncs  across national boundaries. the pervasive internationalization and growing globalization ensure  that changes originating in one part of the world are rapidly diffused to others.  global vs local geoeconomy   analytical framework  although contemporary developments often make us believe that the world is becoming in‐ creasingly homogenized economically, and perhaps even culturally, we need to be extremely cau‐ tious with the use of such labels as “global village”, “global marketplace” or “global factory”. the  “globalization” tag is too often applies very loosely for all countries, regions and localities in the  same way and at the same rate. although the forces of globalization are very powerful, we still  2007 ‐ 54  •  economic analysis®  need to pay attention to the particular character of individual countries, regions, local interests,  cultural, language and other factors. reality is far more complex and chaotic.  as figure 2 shows, the economy of a country is made up of different types of business or‐ ganizations – transnational and domestic, large and small, public and private – in different combi‐ nations  and  inter‐relationships.  besides,  in  each  of  those  segments,  the  firms  can  operate  over  widely varying geographical ranges and perform different roles in their economic systems. they  can  also  be  in  different  phases  of  internationalization  and  globalization,  as  well  as  in  the  co‐ existence of shallow and deep phases of integration. all of that happens in a way that is uneven in  both  time and space, as well as within  individual economic sectors. besides, only a very small  number of industries is completely global; however, many industries are showing a tendency to‐ wards globalization. the question is how to disentangle this extremely dynamic complexity, and  how to define the major elements of globalization?  figure 2 ‐: major organizational segments within an economic system  source: dicken (2001), page 8  the literature abounds with analytical concepts that are trying to provide an answer to those  questions. in his analysis of the geographical organization of production systems, walker (1988)  uses the concept of filière (‘the connecting filament among technologically related activities’); stor‐ per (1992) uses the concept of the ‘commodity chain’ as the basis for his analysis of technology dis‐ tricts in a global context; porter (1988) uses the term ‘value chain’ in his analysis of performance of  corporations, whereas the term used by johnson and lawrence (1988) is ‘value‐added chain’.  the concept of production chains illustrated on figure 3 can be defined as a transactionally  linked sequence of functions, in which each stage adds value to the entire process of production of  goods and services. basic elements of this production chain (materials, procurement, transforma‐ tion, marketing and sales, distribution, service) process the  inputs  into outputs through mutual  transactional links. each of the individual elements in the production chain and their transactional  links depend upon various kinds of technological inputs, including transport and communication  processes. each production chain is both embedded within a financial system, which provides the  necessary investment and operating capital, and also has to be regulated, coordinated and con‐ trolled. in the cases of internationalization and globalization, many production chains are being  globalized in such way that they either spread to other countries or perform certain operations of  some elements in other countries as well. two aspects of production chains are especially impor‐ tant: a) – their coordination and regulation and b) – their geographical configuration (figure 4.,  porter 1986).  state-owned enterprices strategic alliances transnacional corporations public sector private sector national firms small usually single plant global corporations large usually multiplant smaller tncs joint ventures, induastrial cooperation agreements, licensing, subcontracting “arm’s length” transactions licensing subcontracting subcontracting “arm’s length” transactions “arm’s length” transactions “arm’s length” transactions subcontracting strategic alliances subcontracting volume 40 • spring 2007 • 55  figure 3 ‐ the basic production chain  source: dicken (2001), page 6  production chains can be coordinated and regulated at two levels. first, they are coordinated  (through various forms of intra and inter organizational relationships) by a business firm. tncs  play the key role in coordinating production chains. this new, broader role of tncs creates a de‐ mand to redefine the conventional definition of the tnc based upon levels of ownership of inter‐ nationally based assets, in order to capture the diversity and complexity of transnational business  networks. thus, tncs are firms which have the power to coordinate and control business operations in  more than one country, even if they do not own them.  this definition implies that it is not essential for a tnc to own productive assets of their own  in order to be able to control how such assets are used in some countries and industries. however,  tncs generally do own such assets but they are typically involved in a global spider’s web of col‐ laborative relationships with other.  at one extreme, each individual function in specific production chain may be performed by  individual independent firms, which means the links in the chain consist of a series of externalized  transactions, which are organized through the market. at the other extreme, the whole chain may  geografical location of functions dispersed concentrated loose tight global ..... national ..... regional ..... local figure 4 the two dimensions of production chains source: porter (1986) financial system technology / research and development (product design, process technology, logistics of procurement / distribution) materials procurement transformation marketingand sales distribution service transport and communications processes (movement of materials, products, people, information) regulation, coordination, control note: labour inputs are involved in each elem ent and are not shown 2007 ‐ 56  •  economic analysis®  function within a single firm as a vertically integrated system, in which case the links in the chain  consist  of  a  series  of  internalized  transactions,  which  are  organized  hierarchically  through  the  firm’s organizational structure. this dichotomy simplifies the richness of the regulatory mecha‐ nisms  that  exist  in  the  economy.  the  boundary  between  internalization  and  externalization  of  transactions is highly flexible and is constantly shifting as firms make decisions about which func‐ tions to perform “in‐house” and which to “out‐source” to other firms.  however, there are no extremes in reality; what we have is a spectrum of different forms of  coordination which consist of networks of  interrelationships, structured by different degrees of  power and influence. these networks are very dynamic and are continuously changing, which is  why it is necessary to have a coordinator driving a particular production chain or network. in this  regard, gereffi (1994, p. 97) makes a distinction between two types of ‘driver’:  o producer‐driven chains refer  to  those  industries  in which  tncs or other  large  inte‐ grated industrial enterprises play the central role in controlling the production sys‐ tem (automobiles, computers, aircraft, electrical machinery etc.).  o buyer‐driven  chains  refer  to  those  industries  in  which  large  retailers,  brand‐name  merchandisers and trading companies play the central role in organizing decentral‐ ized production networks  in a variety of exporting countries  (garments,  footwear,  toys and houseware industries).  the  second  level  at  which  production  chains  can  be  regulated  is  that  of  the  state.  even  though many authors argue that the state is either dead or dying as a viable force in the contempo‐ rary global economy, it still has a significant influence. namely, all the elements in the production  chain are regulated within some kind of political structure whose basic unit  is the nation‐state.  these structures also include such supranational institutions as well as regional economic group‐ ings such as the european union. all markets are socially constructed; so even supposedly deregu‐ lated markets are still subject to some kind of political regulation. all states introduce and carry  out a number of economic policies and measures, whose global goals are to enhance national wel‐ fare. types and orientations of those policies or policy mix varies according to the political, social  and cultural complexion of the individual state.  subsequently, all business organizations, even the most global tncs, have to operate within  national  and  international  regulatory  systems  and  to  conform  to  national  business  legislation.  tncs attempt to take advantage of national differences in regulatory regimes while states try to  minimize such regulatory arbitrage. the result  is a very complex situation  in which  firms and  states are engaged in various kinds of power play; what stopford and strange (1991) call a “trian‐ gular nexus of interactions comprising firm‐firm, state‐state and firm‐state relationships”.   the second fundamental dimension of figure 4 answers the question where a certain ele‐ ment in a production/value chain is located geographically and how the geographical structure of  the different parts of the firm are physically linked. namely, production functions may be local‐ ized anywhere along a geographical continuum from the global, dispersed scale to the local, con‐ centrated scale. one obvious influence on the geographical configuration of production chains is  technological – primarily the technologies of transport and communications which transform the  conventional meaning of geographical distance. however, even though there has been a tendency  for the geographical dispersion of production chains, different types of production chain can still  be configured geographically in very different ways.  volume 40 • spring 2007 • 57  localization of economic activities  two phrases are commonly used in much of the globalization literature: “the end of geogra‐ phy” and “the death of distance”. these phrases imply that dramatic developments in the tech‐ nologies of transport and communication have made capital hyper‐mobile. the forces of globaliza‐ tion are replacing this ‘space of places’ with a ‘space of flows’ (dicken 2001, p. 10). however, the  problem of localization remains fundamental, because every component in the production chain,  every  firm,  every  economic  activity,  is  grounded  in  specific  locations.  such  grounding  is  both  physical and less tangible in the form of localized social relationships.  not only does every economic activity needs to be localized somewhere; there is also a very  strong tendency to form localized geographical clusters or agglomerations. in fact, the geographi‐ cal concentration of economic activities, at a local or subnational scale, is the rule rather than the  exception. their significance has been recognized by many leading economists and management  theorists, notably paul krugman, michael porter and kenichi ohmae. however, at the end of the  nineteenth century, alfred marshall explained in his principles of economics (1890) the advantages  of the concentration of specialized industries in particular localities. his characterization of these  local concentrations of specialized activity was cast in terms of a simple triad of external econo‐ mies: the availability of skilled labour, the growth of supporting and ancillary trades, and the spe‐ cialization of different firms in different stages and branches of production (see figure 5), which he  named “industrial districts”. a century later, porter’s neo‐marshallian cluster concept argued that  leading export firms from newly industrialized countries are not isolated success stories, but be‐ long to successful groups of rivals within sets of industries related by various kinds of horizontal  and vertical links. according to porter, the significance of these industrial clusters rests in the in‐ teractions between four sets of factors that constitute a ‘competitive diamond’: a) – firm strategy  and rivalry, b) – demand conditions, c) – factor input conditions and d) – related and supporting  industries. the more developed and intense the interactions between these four sets, the greater  will be the productivity of the firms in a cluster.  figure 5 ‐ marchalʹs and porterʹs concepts of localization of economic activities  source: martin (2001) pp 7‐8  the geographic concentration of firms in the same industry in a  ‘competitive diamond’ is  common all around the world. the ‘competitive diamond’ is the driving force of cluster develop‐ ment, and at the same time the cluster is the spatial manifestation of the ‘competitive diamond’.  porter’s works have encouraged many authors to pursue the study of local industrial specializa‐ tion, spatial economic agglomeration and regional development, in order to more precisely iden‐ tify the economic, social and institutional processes involved. the literature is full of neologisms  local pool of specialised labour accumulated skills local market for special workers local supporting and ancillary trades supply of inputs organisation of trade local inter-firm division of labour specialisation in different branches of production use of specialised machinery ‘local industrial atmosphere’ localised knowledge accumulation creation of new ideas and business methods a) -marshall’s triad of external economies of industrial localisation b) porter’s competitive diamond of local industrial clustering demand conditions sophisticated and demanding local customers specialised local demand customer needs that anticipate those elsewhere firm strategy and rivalry vigorous competition among locally-based rivals related and supporting industries presence of capable locally based suppliers and competitive related industries factor input conditions local labour, capital and natural resources; physical, administrative, information and technological infrastructures; specialised inputs local context local environment that encourages appropriate forms of investment and sustained upgrading 2007 ‐ 58  •  economic analysis®  invented in order to describe the nature of local business concentration, such as: ‘industrial dis‐ tricts’,  ‘new  industrial  spaces’,  ‘territorial  production  complexes’,  ‘neo‐marshallian  nodes’,  ‘re‐ gional innovation milieux’, ‘network regions’ and ‘learning regions’ (martin, sunley 2001) .  the initiation, growth and development of specific industrial clusters tend to be based upon  two sets of agglomerative forces:  o traded interdependencies. geographical proximity between firms performing different,  but  linked,  functions  in  the production chain may reduce  the  transaction costs  in‐ volved and intensify interfirm transactions between neighboring firms.  o untraded  interdependencies. these  less  tangible benefits can be economic (the devel‐ opment of an appropriate pool of labour) and sociocultural (personal contacts, social  and cultural interaction, enhancement of knowledge and innovation).  once established a localized economic cluster or agglomeration will tend to grow through a  process  of  cumulative,  self‐reinforcing  development  (figure  6).  such  cumulative  nature  of  the  processes emphasizes the significance of historical trajectory. this means that a region’s (or na‐ tion’s) economy becomes “locked in” to a pattern which is strongly influenced by its history. this  may be either a source of continued strength or  if it embodies too much organizational rigidity, a  source of weakness.    figure 6 ‐ strategic and organizational change in district  source: alberti (2001)  concluding remarks  within  modern  globalization  processes  territorialization  of  economic  activities  remains  a  highly significant component in the organization of economic activity. the new geo‐economy can  be described as a geographically uneven, highly complex and dynamic web of production chains,  economic spaces and places connected together through threads of flows. different places have  different actors which compete within the global economic system. firms, states and local commu‐ nities are each faced with a problem of resolving the global‐local tension.  it is a mistake to focus only on the two extremes on the scale (the global and the local) at  which economic activities take place. it is much more realistic to think in terms of inter‐related  scales of activity: the  local, the national, the regional (supranational) and the global, bearing  in  mind  that  neither  of  the  scales  is  an  independent  entity.  individual  industries  (produc‐ tion/commodity chains) can be regarded as vertically organized structures which  interact with  horizontal geographical political‐economic scales. it  is at the points of  intersection of these two  large and leading firm (locomotive) clasical distrikt firm subcontracting firm (wagon) specializired firm homogeneity of the industrial district work-force supplier (stuck) heterogeneity of the industrial district volume 40 • spring 2007 • 59  dimensions in ‘real’ geographical space where specific outcomes occur and where the problems of  existing within the globalizing economy occur, the problems that need to be resolved by firms,  governments, local communities or individuals.   references  alberti, f. (2001), strategic and organizational change in industrial districts’ firms, the world bank course for regional com‐ petitiveness and industrial cluster development, milan  dicken, p. (2001), global shift: transforming the world economy, paul chapman publishing, london  economist (1997), the century the earth stood still, london, 29.12.1997  economist (1998), delivering the goods, london, 18.01.1998  financial times (1999), mastering global business, financial times and prentice hall, london  gereffi, g. (1994), the organization of buyer‐driven global commodity chains: how us retailers shape overseas production net‐ works, in g. gereffi and m. korzeniewitz (eds), commodity chains and global capitalism, praeger, westport, ct, chap‐ ter 5.  humbert, m. (1994), strategic industrial policies in a global industrial system, review of international political economy,  vol. 1, pp. 445‐64  johnson, r. and lawrence, p.r. (1988), beyond vertical integration ‐ the rise of the value‐adding partnership, harvard  business review, july‐august, pp. 94‐101  marshall (1890), principles of economics, london: macmillan.  martin, r. and sunley, p. (2001), deconstructing clusters: chaotic concept or policy panacea?, the regional studies associa‐ tion conference on regionalizing the knowledge economy, london  porter, m. (1986), competition in global industries, harvard business school press, boston, ma  porter, m. (1988), competitive advantage, the free press, new york  porter, m. (2000), locations, clusters and company strategy, in clark, g.l., feldman, m. and gertler, m. (eds) handbook of  economic geography, oxford: oxford university press, pp 253‐274.  storper, m. (1992), the limits to globalization: technology districts and international trade, economic geography, vol. 68,  pp 60‐93.  stopford, j.m. and strange, s. (1991), rival states, rival firms: competition for world market shares, cambridge university  press, cambridge  walker, r. (1988), the geographical organization of production systems, environment and planning a, vol. 6, pp. 257‐71  unctad (2001),world investment report 2001, geneva  unctad (2002), trade and development report 2002, new york and geneva  world bank (2002), globalization, growth, and poverty: building an inclusive world economy, oxford university press, new  york  ea_2016_1-2 udc: 005.331 005.311.11:303.62 jel: l29, o31 cobiss.sr-id: 224802316 original scientific paper employees' perceptions of their leaders golubović-stojanović aleksandra1, belgrade university, faculty of organizational sciences, belgrade. serbia radović-marković mirjana2, institute of economic sciences, belgrade, serbia vujičić slađana, faculty of business economics and entrepreneurship, belgrade, serbia stevanović mirjana, faculty of business economics and entrepreneurship, belgrade, serbia abstract – this paper presents the research about employees and the leaders who are included in leading the organization, as an important segment of the modern business. the aim of this research is to show the real picture about presence new strategies of leaders in the organizations, as well as the analysis of the perception of employees about their leaders. the research in business organizations conducted on the sample of leaders and employees. the construction of high-quality questionnaire represents the important segment of modern statistical and business researches. the issues in questionnaire construction are very complex and they are in the focus of all statistical and research methodologies. it was conducted on the sample of at least 250 examinees (employees) in bigger companies in serbia. research results showed that understanding communication satisfaction, with its link to job satisfaction, should provide an ability to better target resources to improve communication satisfaction issues. key words: leader’s strategies, employees, communication introduction some of the greatest researchers of these fields highlight that creativity and innovation are the key of development and success of modern organizations, business systems, governments as well as non-profit organizations (mumford et al. 2012:3). while earlier researchers focused on scientists and their organizations to survive in the highly competitive environment (jung, chow & wu, 2003), researchers have made an effort in understanding the factors and mechanisms which improve or inhibit creativity in the organizations (shalley, zhou & oldham, 2004). based on relevant literature, steier and sundgren (2005:68) determined five major organizational factors which affect creativity in the business environment based: organizational climate, organizational culture, leadership styles, resources, skills, structure and organizational systems. 1 aleksandragolubovicstojanovic@gmail.com 2 this paper is an unpublished part of ph.d. thesis of aleksandra golubović-stojanović written under supervision of her mentor prof. dr mirjana radović-marković golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 37 one of basic issues in the research of organizational creativity is defining and measuring of dependent variables. this paper contributes to actual literature by researching the relationship of leaders and employees, including applications of some new leadership strategies and innovations and expanding the understanding of the manner which supports leaders’ creativity and includes them in discovering of new possibilities for organizational innovations, as creativity and innovation are very important parts of development processes. new leadership strategies and their influence of employees’ communication are explored relatively poorly, which leads us to an evident need for systematic, detailed, qualitative case studies that should give answers to this question. therefore, the idea of creativity and leadership practice remain an important part of scientific programs whose aim is to improve creativity as the key process. this research is based on the need to determine how some leaders manage to incite employees' creativity. literature overview the leaders are the key of the modern organizations efficiency. since the second part of the xx century great attention is focused on the researching of the leadership. hunt (1991) claimed that exist more than 10 000 empirical studies which have been done under the subject of leadership. yukl (1998) broadly defines leadership as influence processes affecting the interpretation of events for followers, the choice of objectives for the group or organization, the organization of work activities to accomplish the objectives, the motivation of followers to achieve the objectives, the maintenance of cooperative relationships and teamwork, and the enlistment of support and cooperation from people outside the group or organization. education and training have a large role in human development by teaching people to improve themselves and actively participate in building a nation (radović marković et al., 2012) kirkpatrick and locke (1991) emphasize following leaders’ characteristics as the most important for the achieving of success: • energy as a desire for prove, ambitiousness, endurance, initiative, • honesty and integrity, as reliability, trust, extroversion. • leaders’ motivation, as a desire for the domination to realize common goals, • self-confidence as a faith in your own capabilities, • the ability to perceive, as intelligence; ability to summarize and interpretation of large number of information, • understanding of job as understanding of complete sector, reliable technical support. • creativity as originality, • flexibility as ability to adapt to the needs of followers and the requests of certain situation (p. 48-60). the best leaders need to be attentive, motivational, and supportive (radović-marković, 2007). also, leaders must be conscious of what is perceived by others and develop • strategies that are proactive in building success (radović-marković, et al. 2013). 38 economic analysis (2016, vol. 49, no. 1-2, 36-47) subject and issue of the research the subject of the research in this paper is managers’/leaders’ creativity which implies creative approaches to management that are expressed through their leadership strategies as well as their effect on the employees’ creativity and organizational innovations of organizations themselves. the starting point of this paper is a creative leader who has the crucial role in encouraging and strengthening employees’ creativity and creative thinking and this is one of the basic conditions of good acceptance and implementation of new leadership strategies, as well as changes and innovations in the organizations, which is the subject of the research of this doctoral thesis at the same time. the main question, this is issue of this research is whether leaders apply some new strategies or not and, if they apply them, how they affect communication and employees’ creativity in the organizations/companies through two levels of observation – individual and group, by means of defined variables and mechanisms. research method in this chapter, we will describe methodology used in this paper, including research contest, data collection, analysis techniques as well as results. while defining the research plan, it was decided to base the research on collection of primary data by means of a questionnaire (communication satisfaction questionnaire) composed of closed questions. summing up the results should give us a real picture of existence or absence of leadership, employee creativity, marketing and organizational innovations… in business organizations, the research was conducted on the sample of leaders and employees. minimum 256 examinees (employees) participated in the research in larger cities of serbia, namely belgrade, nis, novi sad, cacak and kragujevac. employees and leaders were interviewed by the method of a standard questionnaire which requested from the employees (examinees) to evaluate the importance of and satisfaction with certain activities of the organization in order to determine the relation (communication) between employees and leaders as a key of success of each organization. some researchers claim that leaders increase the employees’ creativity by supporting their creativity and motivating them to participate in the creative process (amabile et al. 1996; tierney, 2009), while studies on a leader’s influence on creation of psychological conditions which lead to creativity are rare. therefore, one of the goals of this paper is to expand the existing understanding on how leaders, using their strategies, affect the employees’ communication and their creativity through processes and mechanisms and which processes bridge leaders’ behavior on all levels within the organization. total number of examinees was 256, including 49 leaders of the chosen organizations and 207 employees who cooperate with a leader directly. questionnaire in order to examine hypothesis, we created two questionnaires – one for the leaders of the researched organizations and one for the employees. all questionnaires are confidential, golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 39 for the sake of general security and protection of the employees. the data about gender, age, level of education, working experience in the cultural institution as well as total years of service were common for both questionnaires. the questionnaire intended for leaders consists of 12 variables and each of these variables contains 5 questions – 60 questions in total. the answers to the questions are in the form of a likert scale: 1 – i completely disagree 2 – i mostly disagree 3 – undecided 4 – i mostly agree 5 – i completely agree variables examined in this questionnaire are: guiding vision, relationship with employees, motivating the employees, inspiring the employees, open communication, power, coercion, manipulation, directive management, transparency of communication, monitoring, control, “leads by example” and focus on interpersonal relations in the team. besides this, leaders had an additional question in which they had to evaluate their own leadership style based on the offered descriptions – coaching style, cross-cultural, situational, transformational or autocratic. socio-demographic variables were examined as well: gender, age, education, type of organization (production or service providing), sector – private or public, salary, years of service, years of service on a particular position, how many times they changed current position, if they have a partner and kids. the employees filled 3 questionnaires: 1. questionnaire about satisfaction with communication (communication satisfaction questionnaire (csq), (c. w. downs and hazen (1977)) it has 37 questions in total – 7 variables of which each variable contains 5 questions and 2 additional questions on general satisfaction with communication and productivity. the answers to the questions are in the form of a lakert scale: variables examined in this questionnaire are: communication climate, relationship to superiors, organizational integration, media quality, horizontal and informal communication, organizational perspective and personal feedback 2. the questionnaire contains 10 variables in 3 categories of variables, 50 questions in total: this questionnaire examined variables of communication: type of communication (written, oral, in person, by phone, by e-mail…), problems in communication, non-verbal communication, communication channels … variables of a leader were examined by means of this questionnaire as well: relationship with a leader, freedom at work , to what extent the employees feel that a leader uses their potentials to the maximum. this questionnaire examined variables of the employees, too: motivation, loyalty to the organization, identification with organization. questions about dominant types of communication contain different offered answers, while the answers to other questions are in the form of a likert scale: 40 economic analysis (2016, vol. 49, no. 1-2, 36-47) public leadership questionnaire it contains 29 questions in total, distributed on 5 variables, with the answers in the form of a likert scale. in theoretical research, we used the data collected by the analysis of relevant scientific, professional and modern literature in the field of management, leadership, psychology and organizational innovations. inductive and deductive methods of conclusion have been used for creation of questionnaires and data analysis. quantitative statistical methods have been used, namely: • correlation method • analysis of variance research procedure the research was conducted by means of online questionnaire on the website: www.kwiksurveys.com. leaders and employees who belong to the teams lead by the leaders filled these questionnaires. questionnaires for leaders were electronically connected with the questionnaires for the employees from their team. questionnaires were filled anonymously. in this doctoral thesis it was planned to examine managers/leaders in 49 chosen organizations as well as their closest, direct cooperatives. total number of examinees in this research was 256, including 49 leaders from the chosen organizations and 207 employees who cooperated directly with the leaders. among them, there were marketing managers, commercial managers, public relations managers, production managers, lawyers. all of them were permanently employed. a) structure of examinees (age, gender, education) table 1. structure of the total number of examinees number of leaders percent of leaders leaders 49 19.1 employees 207 80.9 total 256 100.0 chart 1. total number of examinees the ratio of female and male examinees, the leaders, is 49% to 44.9% golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 41 table 2. ratio of female and male examinees (leaders) gender number of leaders percent of leaders men 22 44.9 women 24 49.0 total 49 100.0 table 3. gender structure of examinees (employees) gender number of employees percent of employees men 92 44.4 women 98 47.3 table 4. employees’ education education number of employees percent of employees secondary education 34 16.4 faculty/college 40 19.3 bachelor’s degree 48 23.2 master’s degree 39 18.8 magister’s degree 6 2.9 specialization 3 1.4 total 207 100.0 table 5. average age of employees average age standard deviation minimum maximum 36.7529 10.20257 23.00 71.00 table 6. leaders’ education education number of leaders percent of leadesr secondary school 3 6.1 faculty/college 5 10.2 bachelor’s degree 11 22.4 master’s degree 18 36,7 magister’s degree 7 1,3 specialization 2 4,1 table 7. the average age of leaders average age standard deviation minimum maximum 39.8043 7.90673 28.00 65.00 as for the age of employees, all examined leaders are 40 or more. in order to check theoretical aspects of leadership, communication, motivation in the function of improving organizational success which were mentioned above, we checked the sample of 50 chosen business companies. 42 economic analysis (2016, vol. 49, no. 1-2, 36-47) speaking of the level of examinees’ education, the results are very encouraging. none of the examinees stopped his/her education after primary school, but they continued their education. the lowest level of examinees’ education is finished secondary school – 34 (16.4%) of the examinees from the employees’ group and only 3 (6.1%) from the leaders’ group. 40 (19.3%) examinees from the category of employees have graduated from the faculty/college, 48 (23.2%) have bachelor’s degree, 39 (18.8%) have master’s degree, 6 (2.9% of the examinees) are magisters and 3 (1.4%) examinees have finished specialization. the leaders in the organizations in which the research was conducted also have master’s degree (18 leaders or 36.7%), 7 leaders (1.3%) are magisters, while 2 examinees (4.1%) have specialization. these very positive results can testify to education of the people employed on key positions in the examined organizations, in relation with their expertise and knowledge, which have been previously identified as important segments of individual creativity b) organizational sector table 8. organizational sector sector number of organizations percent of organizations private 43 87.8 public 3 6.1 total 49 100.0 some authors (oldham & cummings, 1996; tierney & farmer, 2004) showed in their researches that expertise was proportional to the years of service and it could explain variations in the employees’ creativity and communication and therefore we examined the employees’ years of service in the chosen organizations (table 9), as well as leaders’ total years of service (table 10). based on this research, we came to the conclusion that leaders were averagely 14 years employed in the examined organizations. the years of service in certain company may imply identification with the institution as well as knowing of its organizational climate, building of positive and deeper relationships with the employees, including also knowing of formal and informal forms of communication which exist in the organization. leaders were averagely about 4,5 years on that position and they changed the company in which they work at least once. as for the employed in the examined institutions, their average years of service were about 9 years and they were on the same position for about 3 years. just like their leaders, they also changed the company in which they worked at least once. table 9. total years of service of the examinees (employees) average standard deviation minimum maximum years of service 9.2294 7.52670 0.00 40.00 years of service on the current position 3.2941 3.98317 0.00 20.00 how many times they changed position 1.2412 2.00755 0.00 14.00 golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 43 table 10. total years of service of the examinees (leaders) speaking of monthly salaries, 75.5% leaders have above average salary and 16.3% have average salary (table 11). table 11. total monthly salary of the examinees (leaders) salary number of leaders percent of leaders below average 0 0 average 8 16,3 above average 37 75,5 speaking of monthly salaries of the employees, 39.1% has above average salary, 25.6% have average salary and 15.9% have below average salary. (table 12). table 12. total monthly salary of the examinees (employees) salary number of employees percent of employees below average 33 15,9 average 53 25,6 above average 81 39,1 key results and their explanation the main goal of this research was to perceive the influence of leadership (leadership style) as well as new leadership strategies which a leader applies to motivate and award the employees in order to improve organizational success. the examinees’ attitudes show that leadership style has a significant effect on their everyday work and environment in which they work, which is confirmed by the examinees’ answers in which better relationship with the leader is pointed out as one of important elements. personal responsibility and participation in decision-making are significant regulator of relationships between the employees, as they are mandatory and undisputed for achieving of general organizational goals, which is confirmed by the employees’ answers. average standard deviation minimum maximum years of service 14.8478 7.63025 3.00 42.00 years of service on the current position 4.1739 3.83727 .00 19.00 how many times they changed position 1.5000 1.64317 .00 6.00 44 economic analysis (2016, vol. 49, no. 1-2, 36-47) table 13. leadership strategies strategies average (maximum is 5) standard deviation guiding vision 4,01 ,52 relationship with employees 4,48 ,41 motivating 4,37 ,38 inspiring 4,34 ,53 open communication 4,53 ,40 power, coercion 2,16 ,72 manipulation 2,65 ,91 directive management 2,32 ,91 transparency of communication 4,04 ,66 monitoring, control 3,57 ,80 “leads by example” 4,20 ,73 focus on interpersonal relations 4,40 ,46 one of possible interpretations of such results is that employees are mostly satisfied with communication and relationship to their superiors, as the average of their answers to satisfaction with communication is 3,60, while standard deviation is 0,71. standard deviation is a measure which shows average variation of the values from arithmetic mean, i.e. in this case average satisfaction with communication. it is the average deviation from arithmetic mean. if it is lower, this means that the values are close to average, and if it is higher, the values vary more. all desirable strategies are above 4 of 5 and all undesirable values are low. as we can conlude based on the data from the table, the employees are not very satisfied with organizational perspective (3,36), which is indicated by standard deviation amounting to 0,99. the higher standard deviation, the bigger dissatisfaction of the employees. this is one possible interpretation. another possible interpretation is that the sample we used was not random, but occasional, so that we may have included similar employees in the research, while a part of the reason may be that the majority of employees worked in the organizations from private sector, which could cause their similar behavior. table 14. employees’ satisfaction with communication satisfaction with communication average (maximum is 5) standard deviation communication climate 3,60 ,92 relationship to superiors 3,97 ,81 organizational integration 3,53 ,87 media quality 3,57 ,86 horizontal and informal communication 3,77 ,79 organizational perspective 3,36 ,99 perfonal feedback 3,43 ,97 satisfied with communication 3,60 1,12 evaluation of their own productivity 4,16 ,74 total satisfaction with communication 3,60 ,71 golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 45 table 15. employees’ satisfaction with communication with their leader average (maximum is 5) standard deviation relationship with a leader 4,04 ,88 freedom at work 3,91 ,70 leader exploits their potentials 3,69 ,76 motivation 4,04 ,70 loyalty 3,78 ,89 identification with organization 3,64 ,80 based on the obtained results, it can be seen that the employees mostly have good relationship with their leader (average is 4,04 and standard deviation is 0,88). as we can conclude based on the data given in the table, the employees do not have strong identification with the organization in which they work, which implies that they are not loyal to the organization itself, but they are strongly motivated to stay and work in that organization. we cannot be 100% sure about this, but in the organizations in which there are no possibilities for advancement, loyalty is on the lower level as well as motivation of the employees to stay in that organization. conclusion this research contributes to the literature theoretically and methodologically. it examines leadership strategies and their influence on the employees’ communication at all levels in the organization. the obtained results show that good communication has the effect on the organizational success itself. they also show that the employees are mostly satisfied with communication and relationship with their superiors, which results in their higher motivation and loyalty to the organization in which they work. our research has provided the findings which suggest that new leadership strategies have an effect on the employees’ communication at all levels in the organization. furthermore, we have explained the methods and mechanism through which leaders encourage creativity of their employees on individual, group and organizational level. the results of this research highlighted the importance of communication climate as the characteristic which explains the organizational perception supporting innovations. leadership strategies and styles shape organizational climate which results in a positive relation between good communication of a leader with his/her employees and organizational success. according to the obtained results, we can conclude that the employees are mostly satisfied with communication and relationship with their superiors. from the obtained results it can be seen that the employees mostly have good relationship with their leader, but their identification with the organization in which they work is not strong, which brings us to a conclusion that they are not loyal to the organization itself, but they are strongly motivated to stay and work in that organization. we cannot be 100% sure about this, but in the organizations in which there are no possibilities for promotion loyalty is smaller as well as the employees’ motivation to stay in it. 46 economic analysis (2016, vol. 49, no. 1-2, 36-47) based on this research, we think that creative approaches in management are necessary, not only in private organizations but also in public, governmental and non-governmental agencies. references andrews, p. h., & herschel, r. 1996. organizational communication: empowerment in a technological society. boston: houghton mifflin. amabile, t. m. 1996. creativity in context. boulder, co: westview frone, m., & major, b. 1988. “communication quality and job satisfaction among managerial nurses.“ group & organization studies, 13(3): 332-347. goldhaber, g. 1983. organizational communication. dubuque, ia: william c. brown. hunt, j. g. 1991. leadership: a new synthesis. beverly hills, ca: sage. jung, d. d., chow, c., & wu, a. 2003. “the role of transformational leadership in enhancing organizational innovation: hypotheses and some preliminary findings.” the leadership quarterly, 14(4): 525-544. kirkpatrick, s., a. & locke, e.a. 2001. leadership: do traits matter? academy of management executive. mumford, m. d. (ed.). (2012). handbook of organizational creativity. academic press. 569 -582. oldham, g. r., & cummings, a. 1996. “employee creativity: personal and contextual factors at work.” academy of management journal, 39(3): 607-634 pincus, j. d. (1986). “communication satisfaction, job satisfaction, and job performance.” human communication research, 12(3): 395-419 radović marković, m. 2007. “women leaders: case study of serbia.” in the perspective of women’s entrepreneurship in the age of globalization, ed. mirjana radović marković, 87-95. iap, charlotte. radović marković, m., grozdanić, r. kvrgić, g., marković, d.,vujičić, s. 2012. “new educational strategies versus the traditional methods.” international review, 1-2. radović marković, m., salamzadeh, a., razavi, mostafa. 2013. „women in business and leadership: critiques and discussions.“ the second international scientific conference on employment, education and entrepreneurship, belgrade, serbia, pp. 19-31. available at ssrn: http://ssrn.com/abstract=2349488 rou, alan, dž. (2008.) kreativna inteligencija. beograd: clio shalley, c. e., zhou, j., & oldman, g. r. 2004. “the effects of personal and contextual characteristics on creativity: where should we go from here?” journal of management, 30: 933–958. tierney, p., & farmer, s. m. 2002. “creative self-efficacy: its potential antecedents and relationship to creative performance.” academy of management journal, 45(6): 1137-1148. yukl, g. (1989). “managerial leadership: a review of theory and research.“ journal of management, 15. golubović-stojanović, a., et al., employee’s perceptions, ea (2016, vol. 49, no. 1-2, 36-47) 47 kako zaposleni percipiraju svoje lidere? rezime – ovaj rad predstavlja istraživanje o zaposlenima i liderima koji su uključeni u vođenje organizacije, kao važan segment savremenog poslovanja. cilj ovog istraživanja je da pokaže pravu sliku o prisustvu novih strategija lidera u organizacijama, kao i analizu percepcije zaposlenih o njihovim liderima. istraživanje u poslovnim organizacijama sprovedeno je na uzorku lidera i zaposlenih. izrada visokokvalitetnog upitnika predstavlja važan segment modernih statističkih i poslovnih istraživanja. pitanja u upitniku su veoma kompleksna i u fokusiraju se na sve statističke i istraživačke metodologije. istraživanje je sprovedeno na uzorku od najmanje 250 ispitanika, zaposlenih u većim kompanijama u srbiji. rezultati istraživanja su pokazali da zadovoljstvo komunikacijom, koje je povezano sa zadovoljstvom samim poslom, treba da obezbedi mogućnost da se bolje usmere resursi za poboljšanje pitanja zadovoljstva komunikacija ključne reči: liderske strategije, zaposleni, komunikacija article history: received: 28 june, 2016 accepted: 29 june, 2016 microsoft word 2011_1-2 original scientific paper    precision cotton agriculture and strategic commercial  policies: an analysis in terms of duopoly by quality   baldin claire*, université de nice‐ sophia antipolis, france   udc: 338.44, 339.5    jel: f13, f18, h22, q00, q55, q17, q18        abstract – we study a hotelling’s duopoly in world cotton market to examine the effects of  precision agriculture’s (pa) adoption  in term of strategic  international trade between the united‐ states and central and west africa (cwa). we prove that us producers should be well advised to  adopt  pa  to  offer  “environmental  quality”  cotton  whereas  cwa  producers  have  a  natural  comparative advantage that allows them to offer a “product quality” cotton. we also argue that if the  usa subsidizes pa in order to protect environment, this measure can be considered as a strategic  international policy. we determine a critical subsidy  level, which ousts cwa producers  from  the  cotton market. at this subsidy level, us policy can be thought of unfair even if this policy enables  them to improve the environment    key  words:  strategic  commercial  policy, precision  farming,  hotelling’s  duopoly,  quality’s  differentiation, environment, welfare, cournot, nash equilibrium, subsidies  introduction  the adoption of precision agriculture (pa) is now considered an essential objective for  sustainable  agriculture,  as  has  been  shown  by  the  many  programs  implemented  by  governments.  in  fact,  pa  decreases  pollution  (lambert  and  lowenberg‐deboer  2000,  schumacher  et  al.,  2000,  whitley  et  al.,  2000,  lowenberg‐deboer,  2004)  while  increasing  productivity gains (bronson et al., 2003, yu et al., 2000, and yu et al., 1999).  moreover,  pa  is  an  issue  for  international  trade  because  it  enables  the  countries  that  adopt it to differentiate their products qualitatively as is the case for the cotton sector. pa  enables the production of cotton that  is of a better environmental quality than traditional  cotton. however, the impact of pa on the quality of the cotton fibres remains uncertain so it  may  be  beneficial  for  countries  with  a  natural  advantage  in  terms  of  fibre  quality  to  differentiate their product without necessarily adopting it (yu et al. 1999).  in  this context, pa may be a support  to  the  implementation of strategic  international  trade policies based on granting subsidies for its adoption. recent studies show that, in the  united states, pa has caused a double impact on international cotton exchanges (pan et al.,  2004; world cotton model from pan, malaga and kulkarni, 2008). first of all, we have seen a  decrease  in  world  cotton  prices  and  secondly,  an  increase  in  american  exports  and  in  decrease in exports from central and western african countries (cwa) that are unable to                                                         * université de nice sophia‐antipolis, gredeg‐demos unité mixte de recherche du cnrs n°6227,  e‐mail: claire.baldin@gredeg.cnrs.fr     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     79 adopt pa (oberthür et al. 2006). such policies are even more easily justifiable since, from an  environmental  point  of  view,  pa  enables  a  decrease  in  pollution.  with  respect  to  international trade,  it  looks as  if certain states should switch traditional trade policies for  strategic environmental policies which cannot easily be condemned by the wto although  they have exactly the same effects. in fact, restrictions imposed by the gatt or the wto on  traditional  trade policies have  led many governments  to  increase strategic environmental  policies  to  promote  their  exports  and  protect  their  agricultural sectors  from  international  competition (bureau and mougeot, 2004, bouët, 1992, 1998, 1999, 2001, ulph, 1996, barrett,  1992) without any risk of being condemned for these actions.  the purpose of this article is to evaluate international trade issues of pa in the cotton  sector by analyzing united states (us) policies as opposed to cwa1 countries. two reasons  justify this problem. the first resides in the united states’, the world’s main cotton producer,  role of “price‐maker” on the market (parmentier, 2006). the second involves cwa countries  for which the cotton sector in the main source of agricultural riches (perrin and lagandre,  2005) while there is very little chance that pa will be developed in these countries because of  its cost and the technical knowledge necessary for its implementation (oberthür et al., 2006).  therefore, the states that are unable to adopt pa are at risk of losing their natural advantage.  in order to answer this question, we will develop a horizontal differentiation model “à la  hotelling” between us cotton and cwa cotton, in order to evaluate the strategic effects on  international  trade  that  result  from  the  adoption  of  pa.  we  will  show  under  which  conditions cwa countries can or cannot retain a portion of their revenues from international  trade if the us agent produce cotton of a high environmental quality by using pa. we will  considerer the fact that american and african cottons possess both qualities: environmental  and fibre. the us produces cotton that is of a high environmental quality, because they use  pa, and low fibre quality while the cwa countries offer cotton with high fibre quality that  results from their natural advantage.  our analysis is based around three sections. the first describes the model by explaining  the  demand  for  cotton  (1.1),  the  behaviour  of  growers  (1.2)  and  the  architecture  of  the  proposed issues between the us and the cwa countries (1.3). the second part shows how  cotton consumers are spread over the international market according to whether they prefer  “environmental”  quality  or  “fibre”  quality  (2.1).  we  will  determine  the  nash‐hotelling  balance for “environmental quality” (2.2) and  for “fibre quality” (2.3) which allows cwa  countries to remain competitive when us cotton producers develop pa. we will evaluate the  level of welfare on the international cotton market (2.4). in the third part, we infer that the  us  implements  a  commercial  subsidy  policy  for  pa  so  that  their  growers  will  produce  “environmental quality” cotton. we will determine the levels of “environmental quality” and  “fibre quality” of the cotton that results from this type of policy (3.1). the results show an  improvement in “fibre quality” in us cotton with relation to “fibre quality” of cotton from  cwa countries so that cotton fibre consumers do not care if they use cotton fibre from the  us  or  cotton  fibre  from  cwa.  the  competitive  advantage  of  cwa  countries  is  thus  decreased. we will  then demonstrate  that  this policy  improves  the welfare of  the united  states and cwa countries, but, over a certain level of subsidy, the us trade policy is unfair                                                         1 the main countries involved here are benin, burkina faso, mali and tchad.    economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   80 because  the  cwa  countries  are  at  risk  of  being  crowded  out  of  the  international  cotton  market (3.2).  the model    we  look  at  two  countries,  the  us  and  cwa  countries,  as  a  duopoly  on  the  international cotton market that competes for quality on the third market. we look at the fact  that the competition  is supported by the qualities of the cottons offered knowing that the  cotton has two characteristics: one “environmental” and the other “fibre”. the us produces  cotton  with  high  “environmental  quality”,  noted  as  qe,e ,  due  to  pa.  this  qualitative  characteristic is justified by the fact that pa induces strong environmental benefits. us cotton  also has “fibre quality” of lower quality than the cotton produced in cwa countries. manual  cotton production allows them to produce cotton with a high “fibre quality”, noted as  qa, p .  cwa cotton fibre is qualitatively superior to american cotton.   • hypothesis 1: pa  is adopted  by all of  the american cotton growers but not by  cwa countries.  • hypothesis 2: since the “environmental quality” of cwa cotton is stable because  they  do  not  possess  adapted  technology,  it  is  not  considered  as  an  exogenous  variable noted as  qa,e = q .  demand for cotton  we  infer a heterogeneous demand composed of  two categories of consumers. on one  hand, consumers who are concerned with preserving the environment and who maximise a  utility  function,  noted  as μe ,  and  who  only  use  cotton  characterized  by  a  high  “environmental quality” qe . on the other hand, consumers who maximise a utility function,  noted as μa , who only use “fibre quality” cotton qp .  there  is a continuum of mass  l consumers distributed according  to a  linear hotelling  model on a segment representing the possible cotton qualities where us growers are situated  in  0  and  cwa  growers  are  situated  in  1.  consumers  go  to  american  or  african  cotton  growers  depending  on  whether  they  prefer  cotton  with  high  “fibre  quality”  or  high  “environment quality”. “environmental quality” and “fibre quality” cotton consumers are  noted  as  ne and  na   respectively,  with ne + na = 1.  we  admit  that  american  and  african  growers sell at world cotton prices, supposedly fixed and noted as p = p. we use an  x  to  indicate the location of an agent according to his preferences for one or the other quality of  cotton such as: x ∈ 0;1[ ]. we define the mass of consumers who prefer high “environmental  quality” cotton as  ne ∈ 0; x[ [  and the mass of consumers who prefer cotton with high “fibre  quality” as  na ∈ x;1] ]. the utility functions are noted as follows:  ux = μe = r + qe,e + qe, p − tx − p μa = r + q + qa, p − t 1− x( ) − p ⎧ ⎨ ⎪ ⎩⎪               (1)  in the previous expression,  r  (r > 0) represents the utility of each consumer no matter  what the quality of the cotton. the consumers choose one quality or the other so that the     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     81 entire market  is covered,  in order that  in the balance, all the consumers obtain a positive  utility no matter what type of cotton they buy. the expression  tx  (resp.  t 1− x( )) represents  the disutility of consumers when they want to acquire the cotton  qe  (resp. qp ). the term  x   (resp. 1− x( )  represents the market segment covered by “environmental quality” us cotton  qe   (resp.  cwa  “fibre  quality”  cotton qp ).  the  parameter  t  represents  the  cost  of  transportation traditionally used to formalise the differentiation between the two types of  product.  it  is  linear  and  represents  the  cost  for  a  consumer  to  purchase  environmental  quality or fibre quality cotton.  profit functions    the term  qe,e (resp. qe, p ) represents the “environmental quality” (resp. “fibre quality) of  american cotton with:  qe,e > qe, p > 01. the term  qa, p  represents the “fibre quality” level of  african  cotton  with  qa, p > q > 0 2.  american  growers  (resp.  africans)  determine  the  “environmental quality” of cotton  (resp.  the “fibre quality”) which maximises their profit  function.  we  note  as  ce   and  ca   the  cost  functions,  which  are  supposedly  quadratic,  of  american and african cotton as:   ce = 1 2 qe, p 2 + ne × qe,e   and ca = 1 2 q 2 + na × qa, p   the profit functions of us and cwa growers are then noted as follows:  πqe ,qp = π e = ne ⋅ p − 1 2 qe, p 2 − ne ⋅qe,e = ne p − qe,e( ) − 12 qe, p 2 π a = na ⋅ p − 1 2 q 2 − na ⋅qa, p = na qa, p − p( ) − 12 q 2 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪         (2)  eπ represents the profit function of the us while the adoption of pa allows them to produce  “high  environmental  quality”  cotton,  and  aπ represents  the  profit  function  of  cwa  countries that, being unable to adopt pa, produce “high fibre quality” cotton.  in order to evaluate how pa modifies the terms of competition between american and  african growers, and determine under what conditions the african growers maintain their  competitive advantage despite the diffusion of pa, we will resolve the following issue using  backwards induction.  the architecture of the issue  the  objective  of  the  model  is  to  explain  how  the  adoption  of  pa  by  the  us  can  be  profitable  from  the  point  of  view  of  international  trade  to  both  american  growers  and  growers  in cwa countries,  therefore resulting  in qualitative environmental gains. this  is  how  we  justify  optimal  quality  research  strategies  when  growers  maximize  their  profits.  their objective is to corner the demand of consumers who are concerned with one quality of  cotton or the other. the issue includes four steps:                                                         1, 2 this relation is justified by the specialization in the cotton quality.    economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   82 figure 1. sequence of issue          • in t0 the price of cotton is fixed by the world market as  p = pa = pe . american  and african growers decide whether or not to produce.  • in t1 american and african growers fix the “fibre quality” qp .  • in  t2  american  growers  fix  their  “environmental  quality” qe,e .  the  “environmental quality” of supposedly exogenous cwa cotton  is noted as q   such as  q ≤ p  • in t3 us producers adopt pa. american and african producers determine their  profits and market shares.  resolution of the issue: determine the balances in optimal qualities  the issue is resolved using fait par backward induction. we successively determine the  market shares for growers, the “fibre quality” and “environmental quality” of the american  cotton and the “fibre quality” of the cwa cotton.  determining narket shares between the united states and the cwa countries  in t3 we determine how the two categories of consumers are divided along the  0;1[ ] axis.  we infer that a representative consumer, indifferent as to  qe  cotton and qp cotton situated at  point x̂ verifying μe = μa  such as:  r + qe, p + qe,e − tx̂ − p = r + qa, p + q − t 1− x̂( ) − p  after resolving the previous expression with relation to  x̂ , we obtain:  x̂ = t + δe + δ p 2t   (3)  where  δe = qe,e − q and δ p = qe, p − qa, p  if 0 < x̂ < 1, there is a consumer who is indifferent to the two qualities of cotton available.  consumers belonging to the  0 < x < x̂  range want  qe cotton grown by the us. consumers  belonging to the  x̂ < 1− x( ) < 1 range prefer  qp cotton grown by the cwa countries.  condition 1a: the cotton market is totally covered if r is big enough. in this case, consumers  have  the  choice  between  one  or  the  other  qualities  of  cotton  which  implies  that:  r + qe,e + qe, p − tx̂ − p > 0 and/or that: r + q + qa, p − t 1− x̂( ) − p > 0 .   condition 1b: the model which supposes a configuration of the market such as x̂ ∈ 0;1] [,  t  must  satisfy the following necessary and sufficient condition: t > δe + δ p. this condition ensures a balance  in which us and cwa growers are faced with positive demands.  t0  t1  t2 t3 tstep 1  step 2 step 3 step 4 us and cwa  growers decide to  us and cwa  growers determine qp us and cw  growers determine repartition of the  cotton market    baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     83 condition 1c: the previous condition implies that the degree of horizontal differentiation between  the two types of cotton is high enough for us and cwa cotton growers to coexist on the market. in  other words, it is necessary for:  qe,e > q and  qa, p > qe, p  by  hypothesis,  condition  (1b)  is  satisfactory  because  consumer  preferences  are  evenly  distributed on the market. consumers situated to the left of  x̂ prefer “high environmental  quality” while consumers situated to the right of  x̂ prefer “high fibre quality”. condition (1c)  is  equally  satisfactory  because  cotton  growers  are  differentiated  by  the  competitive  advantage that they possess.       from (3), we can write the functions of demand that are addressed to each grower:  ne = x̂ = t + δe + δ p 2t na = 1− x̂ = t − δe − δ p 2t ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                   (4)  by replacing (4) in (2), we obtain the following us and cwa profits:  πqe ,qa = π e = p − qe,e( ) 2t δe + δ p( ) + p − qe,e( ) 2 − 1 2 qe, p 2 π a = qa, p − p( ) 2t δe + δ p( ) + qa, p − p( ) 2 − 1 2 qe, p 2 + p − 1 2 q 2 − qa, p ⎧ ⎨ ⎪ ⎪ ⎩ ⎪ ⎪ (5)  determination of the “environmental quality” balance  by t2, us cotton growers define the optimal “high environmental quality” of their cotton  by maximising their profit function (first rate conditions)2:  max qe ,e π e = ∂π e ∂qe,e = 0 ⇔ p 2t − qe,e t + q 2t − δ p 2t − 1 2 = 0           (6)  after  resolving  equation  (6),  we  obtain  the  level  of  “high  environmental  quality” qe,e *   produced by the us:  qe,e * = 1 2 p + q + qa, p − qe, p − t( )            (7)  the  “environmental  quality”  level  proposed  to  the  us  depends  negatively  on  t.  therefore, when t decreases, the differentiation with cwa cotton is accentuated. the reverse  observation  can  be  proposed  if  t  increases.  likewise,  if  t  increases,  * ,eeq decreases,  with  induced a decrease in us profits. the effect on the profits is reversed with t decreases.  for cwa growers, the “environmental quality” of their cotton was exogenous qa,e * = q .   the  balance  noted  (ee)  in  terms  of  “environmental  quality”  on  the  cotton  market  is  determined by the following expression:  ee = qe,e * = 1 2 p + q + qa, p − qe, p − t( ); qa,e* = q⎧⎨ ⎩ ⎫ ⎬ ⎭    (8)                                                         2 we verified that at the balance the second order conditions are verified: ∂ 2π e ∂2qe,e = − 1 t < 0 .    economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   84 determining the optimal “fibre qualities” on the cotton market  in  t1,  the  african  and  american  producers  define  the  level  of  “fibre  quality”  of  their  cotton  which  maximizes  their  profits.  the  derivatives  of  the  profit  function  (first  order  condition)3 are expressed in the following way:  max qe , p ,qa, p π = max qe , p π e = ∂π e ∂qe, p = 0 max qa, p π a = ∂π a ∂qa, p = 0 ⎧ ⎨ ⎪ ⎪ ⎩ ⎪ ⎪ ⇔ p 2t − qe,e 2t − qe, p = 0 p 2t + qe,e 2t + qe, p 2t − qa, p 2t − q 2t − 1 2 = 0 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪      (9)  the reaction functions in terms of “fibre quality” of us and cwa growers are written  respectively:  qe, p = 1 2t p − qe,e( ) qa, p = 1 2 p + qe,e + qe, p − q − t( ) ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                 (10)  after the resolution of the equation system (10), we obtain a balance of us and cwa  “fibre qualities” which are noted respectively * , peq and qa, p * such as:  qe, p * = 1 2t p − qe,e( ) qa, p * = 1 2 p 1+ 1 2t ⎛ ⎝⎜ ⎞ ⎠⎟ + qe,e 1− 1 2t ⎛ ⎝⎜ ⎞ ⎠⎟ − q − t ⎡ ⎣ ⎢ ⎤ ⎦ ⎥ ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪ 11.a 11.b            (11)  we notice, as previously  for relation  (7),  that  the “fibre quality”  level of cwa cotton  depends negatively on  t. the utility of  the consumer  preferring “fibre quality”  improves  particularly as t decreases like cwa profits which depend positively on  qa, p * . the effects are  reversed if t increases.   determining “environment” and “fibre” qualities on the cotton narket  in t0, the growers must decide of they grow, in view of the balance qualities determined  in (8) and (11) at the world price p . by replacing (11) in (7), we obtain the “environmental  quality” level that us growers propose:  qe,e ** = p + 2tq − 6t 2 6t −1                   (12)  likewise, by replacing (12) in (11.b) we obtain the optimal “fibre quality” level for cwa  cotton produced in the balance:                                                         3 by considering 1.b the second order conditions are respected if: ∂ 2π e ∂2qe, p = −1 < 0 and ∂2π a ∂2qa, p = − 1 t < 0.    baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     85 qa, p ** = p + t 2 − 2q( ) − 6t 2 6t −1                  (13)  finally,  by replacing  (12)  in  (11.a), we obtain  the optimal “fibre quality”  level  for us  cotton:  qe, p ** = 3t − q 6t −1                     (14)   the optimal level of demand ne ** (resp. na **), for us growers (resp. cwa) is obtained by  replacing (12), (13) and (14) in (4). or after calculation:  ne ** = x̂** = 3t − q 6t −1 na ** = 1− x̂** = 3t − q −1 6t −1 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                   (15)   proposition 1: the growers undertake their production if the level of qualities (environment and  fibre) is positive or nul.     this proposition is verified if the following conditions are realized:  • qe,e ** = p + 1 6t −1 2tq − 6t 2( ) ≥ 0 which implies that: p ≥ 2tq − 6t 2( ) 6t −1 . since p > 0 we verify that: 2tq − 6t 2 > 0 . we deduct that: ** ,eeq if and only if ⎥⎦ ⎤ ⎢⎣ ⎡∈> qtp 3 1 ;0 • qa, p ∗∗ = p + 2t − 2tq − 6t 2 6t −1 ≥ 0implies that: p > 2t − 2tq − 6t 2 6t −1 . since p > 0 we verify that: t 2 − 2q( ) − 6t 2 > 0 . we deduce that: qe, p** ≥ 0 if and only if p > t ∈ 0; q ≤ 1⎡⎣ ⎤⎦. • qe, p ∗∗ = 3t − q 6t +1 ≥ 0 which implies that: 3t − q ≥ 0 . we deduce that: qe, p ** ≥ 0 if and only if t ≥ 1 3 q . (16) according to condition 1.b and proposition 1, if we want the combined levels of quality  to  be  positive,  we  must  restrict  our  study  to  the  case  where  t  respects  the  following  condition: t ≥ 1 3 q with q < 1 (17.a). proposition 1 also highlights the fact that the world price  verifies the following condition:  p > t  (17.b).  by replacing the optimal demand defined by (15) and the balance qualities defined by the  relations (12), (13) and (14) in the profit functions (4), we obtain, in t0, the following profit  balances:         economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   86 π e ∗∗ = ne ∗∗( p − qe,e ∗∗ ) − 1 2 qe, p ∗∗2 = x̂** p − qe,e **( ) − 1 2 qe, p ∗∗2 π a ** = na ** ( p − qa, p ** ) − 1 2 q 2 = x̂** (qa, p ** − p) − 1 2 q 2 + p − qa, p ** ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪         (18)  the growing decision is not undertaken unless the t0 profits are positive.  proposition 2: according to (18), in order for the profits to be positive, we must be able to verify  that:  p − qe,e ** > 0 and p − qa, p ** > 0   this proposition implies that  p is sufficiently large. therefore:  p ∈ qe,e ** , qa, p **( );+∞⎤⎦ ⎡⎣   (19).  when conditions (17.a), (17.b) and (19) are satisfied, the profits of us and cwa growers  are positive so that both countries share the cotton market.                   in other terms, the previous developments show that if american growers adopt pa and  opt  for  an  “environmental  quality”  strategy  of  cotton  production,  cwa  cotton  growers  remain competitive if they adopt a “fibre quality” cotton development strategy.   it is now necessary to assess the impact of the previous strategies in terms of welfare by  determining, first of all, at what level the welfare is set when all the growers adopt pa and,  secondly, show  that public  intervention,  to ensure the distribution of pa  to all of  the us  growers, can impact quality levels to the detriment of cwa countries.   subsidies for the adoption of pa: a study in terms of welfare  two  scenarios  are  considered.  the  first  consists  in  determining  welfare  when  pa  is  distributed to the us (hypothesis 1). the goal of the second is to determine welfare when pa  is used as a support for an international trade policy of subsidies to assist the adoption of pa  for the us who want to acquire a competitive advantage. two arguments are brought forth  to justify such a policy: the first concerns environmental protection and the second concerns  assistance for innovation. in this case, we show how, first of all, the us obtain international  trade revenue by improving their two cotton qualities, and secondly, how such a policy can  be unfair if it continues to crowd cwa countries out of the cotton market since they have no  way to retaliate.  first scenario: evaluation of the welfare without a strategic subsidy  we note as ase ** the surplus of consumers concerned with environmental protection and  as  asp ** the surplus of  the consumer who prefers “fibre quality”. the surplus of growers  corresponds to the level of profits π e ** andπ a ** previously calculated. we note as  w1 ** welfare  on  the  cotton  market  such  as:w1 ** = ase ** +π e ** + asp ** +π a **.  the  following  expression  determines the level of welfare on the cotton market as t0:  w1 ** = r + qe,e ** + qe, p ** − tx̂ − p( )∂x + r + qa, p** + q − t 1− x̂( ) − p( )∂x +x=x̂** 1 ∫ π e** +π a**x=0 x̂** ∫      baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     87 or,  %x** = 3t − q 6t −1   after calculations we obtain the following expression:  w1 ** = −18t 3 + t 2 10q 2 − 36q +15( ) + t 2q −1( ) − q2 2(6t −1)2 + r + q − 1 2 q 2    (20)  proposition 3: cotton production  is undertaken only  if  the welfare  is positive or nil. for all  values of  t > δe + δ p(1.c), and knowing  that r  is sufficiently  large, we verify  that  w1 **is always  positive for  t ∈ δe + δ p;+∞⎤⎦ ⎡⎣  (21).  if condition (21) is satisfactory the welfare is positive. this expression implies that all the  american cotton growers must adopt pa. it this is not the case, the entire american cotton  production  will  not  benefit  from  the  “high  environmental  quality”  characteristic  which  implies that certain consumers μe will not be satisfied and will see no difference between us  and cwa cotton. in this case, the surplus of consumers  ase ** and the welfare  w1 **decrease  and  a  regulator  is  necessary,  in  this  case  the  american  government,  to  ensure  that  all  american growers adopt pa in order to respect the result (20).   second scenario: the implications in terms of welfare of a public policy for  assistance to the adoption of pa  in this paragraph, we abandon the hypothesis in which all of the us growers adopt pa,  which implies that some growers are unable to produce “high environmental quality” cotton  so that their cotton’s level of “environmental quality” may be noted as qe,e ≤ q . because pa  is a “green”  technology, we  infer  that  the american state decides  to subsidise  it without  running the risk of being liable of illegal subsidy policies. we note as “s” the marginal public  subsidy such as:  ∂ qe,e − s( ) ∂s < 0                 (22)  the  impact  of  such  a  policy  can  be  measured  by  evaluating  its  effect  on  the  level  of  american cotton qualities ** ,eeq  and  ** , peq and on the level of profits. from an economic point  of view, taking into consideration pa subsidies is done at the level of “environmental quality  cotton production costs which can be expressed as follows: )( , sqn eee −× .    in sub‐section 3.2.1, we will evaluate  the  impact of such a policy on  the  levels of  “environmental quality” and “fibre quality” of us and cwa  cotton. we will deduct  the  impact of the levels obtained on the level of profits made. sub‐section 3.2.2 will evaluate the  effects of subsidies on welfare.  subsidy policies to assist the adoption of pa in the us: a study in terms of  competitiveness  we  note  as q( s ) e,e ** , q( s ) e, p ** , q( s ) a, p ** ,π( s ) e **   and  π( s ) a ** respectively,  the  optimal  level  of  “environment” and “fibre” qualities produced by us growers when they are subsidised; the  “fibre” quality offered by cwa growers when us growers are subsidised, and the us and     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   88 cwa  profits  with  subsidies.  after  calculating,  and  applying  the  method  of  backward  induction as was used previously, we obtain the following values:  q( s ) e,e ** = p + 1 6t −1 2tq + s 4t −1( ) − 6t 2⎡⎣ ⎤⎦               (a)  q( s ) e, p ** = 3t + s − q 6t −1                            (b)  q( s ) a, p ** = p + 1 6t −1 −6t 2 − 2tq + 2t + 2st⎡⎣ ⎤⎦             (c)  the  levels of “quality” balance obtained depend differently on the parameter t, which  brings us to make several comments.         comment 1: the balance represented by  the relation showed  that the variation  in the  level of “environmental quality” in us cotton, when the growers are subsidised, depends on  t. the quality also depending on s, both cases can be distinguished to appreciate the impact  of a variation of t on (a).  ‐ case 1:  if   s > 3 2 t  and  t decreases,  then  the  level of “environmental quality” balance  decreases towards q , so that the differentiation with “environmental quality” cwa cotton  decreases and disappears. the disutility related to using cwa cotton decreases.   ‐ case 2: if s < 3 2 t , the scenario is reversed. a decrease of t induces an improvement of  “environmental quality” for us cotton which accentuates the differentiation of the cottons.  the disutility related to using cwa cotton increases.  comment  2:  we  can  compare  the  effects  of  a  t  variation  between  levels  of  quality  between     (b) and (c).  ‐ case 1 bis: if  s > 3t  an increase of t, if q < 1, induces an increase in the level of “fibre  quality” of us and cwa cotton. the improvement is greater for us cotton.  ‐ case 2 bis:  if  s < 3t  an  increase  of  t  improves  the  “fibre  quality”  of  us  cotton  and  decreases that of cwa cotton. the differentiation between the two cottons decreases so that  growers in the cwa countries no longer have as much of their natural advantage. if, to the  contrary, t decreases, the induced effect is reversed to the previous to that the improvement  of “fibre quality” in us cotton induced by pa is lower.  comments 1 and 2 show that a variation of t can cancel the positive effects that subsidies produce on us and cwa cotton’s level of balance qualities. we can also see that a variation of t can minimise the anticipated effects on the qualities of us cotton that result from the adoption of pa. at the balance, the repartition of the demand for each cotton quality of given by: x̂s ** = ns,e ** = 3t + s − q 6t −1 1− x̂s ** = ns, a ** = 3t + q − s −1 6t −1 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪                 (23)     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     89 likewise with regards to the profits we obtain:  π( s ),qe ,qa ** = π( s ),e ** = x̂s ** p − 1 2 q( s ) e, p **( )2 − x̂s** q( s )e,e** − s( ) π( s ), a ** = x̂s ** q( s) a, p ** − p( ) − 1 2 q 2 + p − q( s ) a, p ** ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪           (24)  proposition 4: according to expression (24) public policy induced an increase in profits if the  level of subsidies verifies the following condition: q( s ), e,e ** − s ≥ 0 . or if:  0 ≤ s ≤ q + 3p − 3t − p 2t                   (25)  the effects of subsidies for the adoption of pa on optimal “environment” and “fibre”  qualities for us and cwa growers can be expressed as follows:  ∂q( s ) e,e ** ∂s = 4t −1 6t −1 > 0 ;  ∂q( s ) e, p ** ∂s = 1 6t −1( ) > 0 ; ∂q( s ) a, p ** ∂s = 2t 6t −1( ) > 0   proposition  5:  subsidies  to  assist  the  adoption  of  pa  induce  a  positive  effect  on  the  “environmental quality” and “fibre quality” levels of american cotton with a greater positive effect on  “environmental quality”.  the previous results show that when subsidies allow american producers to improve the  “fibre quality” of their cotton, they can compete with the growers in cwa countries, who  then see their market share decrease because consumers of “fibre quality” cotton are may  buy american “fibre quality” cotton which meets, or closely meets, their demand.  the  effects  of  public  policy  on  the  demand  for  american  and  african  cotton  can  be  expressed as follows:  ∂ns,e ** ∂s = 1 6t −1 > 0 ∂ns, a ** ∂s = −1 6t −1 < 0 ⎧ ⎨ ⎪⎪ ⎩ ⎪ ⎪   proposition  6:  subsidies  paid  to  us  growers  for  the  adoption  of  pa  cause  an  increase  in  american demand and a decrease in african demand.  the results stated in proposition 4 confirm those of proposition 5. profits resulting from  pa on the “fibre quality” of american cotton, which can be confirmed by certain empirical  works that explain that pa can induce positive effects on the intrinsic quality of the product,  result in the fact that some consumers who are concerned with this will meet their needs by  buying “fibre quality” cotton from the us and not from cwa countries. the closer the level  of american “fibre quality” cotton is to cwa cotton, the more indifferent consumers are as  to the origin of the cotton.  the profit functions can now be expressed in the following way:     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   90 π e,s ** = 36t 3 + t 2 24s − 24q − 9( )+ t 4s2 − 6s − 8sq + 6q + 4q2( )+ 2qs − s2 − q2 2 6t −1( )2 π a,s ** = 18t 3 + t 2 12q −12s −12( )+ t 2s2 + 4s + 2 + 2q2 − 4q − 4sq( ) 6t −1( )2 + p − 1 2 q 2 ⎧ ⎨ ⎪ ⎪⎪ ⎩ ⎪ ⎪ ⎪   from numerical values that respect the hypotheses defined in the model (r sufficiently  large; p > t ;  t ≥ 1 3 q   ;  q ≤ 1   ; and  0 < s < 3t + q −1, we verify that  π e,s ** > 0 andπ a,s ** > 0 1. the  study on the impact of public policy on profits verifies that:  ∂π e,s ** ∂s = 24t 2 + t 8s − 8q − 6( ) + 2q − 2s 2 6t −1( )2 > 0 ∂π a,s ** ∂s = −12t 2 + 4st + 4t − 4tq 6t −1( )2 > 0 ⎧ ⎨ ⎪ ⎪ ⎩ ⎪ ⎪ 26.a( ) 26.b( ) (26)  the expression (26) shows that, no matter what the level of the subsidy, growers’ profits  increase. the following graphic illustrates our results:    graphic 1. evolution of us and cwa profits according to levels of subsidies        proposition 7: american subsidies have a positive impact of the profits of cotton growers in this  country and those in cwa countries, although the  impact  is greater on american profits. it  is an  optimal subsidy level sm when us profits are greater than cwa profits. this level optimal level of  profits is determined after profit maximisation with regard to s. we obtain it by equalizing equations  (26.a) and (26.b). or:  −12t 2 + 4st + 4t − 4tq 6t −1( )2 = 24t 2 + t(8s − 8q − 6) + 2q − 2s 2 6t −1( )2 ⇔ 2s = 48t 2 − 4tq − 7t + q                                                          1 we verify, using numerical values ( ) that the profits are positive.     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     91 ⇔ sm = 24t 2 + t −4q − 7( )+ q       (27)  therefore,  on  a  profit  level,  for  any  amount  of s ≥ 0 ,us  and  cwa  profits  increase.  however, according to proposition 6, subsidies induce an increase in the us market and a  decrease in cwa market shares. this means that there is a critical level of subsidy, noted  as sc from  where  cwa  growers  are  crowded  out  of  the  market.  this  level  is  defined  as:  na ** = 0 ⇔ 3t + q − s −1 = 0  ⇔ sc = 3t + q −1  for a subsidy amount  that  is greater or equal  to cs we can consider  that  the us  trade  policy becomes unfair, without necessarily being condemnable, in the sense that, under the  pretext of protecting the environment, they contribute to crowding cwa growers out of the  cotton market. graphic 2 explains this eventuality:    graphic 2. evolution of cotton market shares with relation to subsidies in place        what  effects  do  public  subsidies  have  on  overall  “environmental  quality”   qe ** = q( s ) e,e ** + q(s ) a,e ** = q( s ) e,e ** + q and overall “fibre quality” quality” qp ** = q( s ) e, p ** + q( s ) a, p **   ?  these impacts can be evaluated from the following derivatives:  ∂qe ** ∂s = 4t −1 6t −1 > 0   ∂qp ** ∂s = 2t +1 6t −1 > 0   proposition  8:  subsidies  to  assist  with  the  adoption  of  pa  increase  the  total  levels  of  “environmental” and “fibre” qualities. this implies that subsidies to assist the adoption of pa induce  an increase in benefits to all consumers.   in this paragraph we were able to show that the implementation of the american public  policy  of  subsidies  to  assist  the  adoption  of  pa  induces  positive  effects  for  growers  and  consumers. although african growers lose market shares, subsidies induce and increase in  their profits. the results also highlight the fact that such a policy can exclude cwa cotton  growers from the market even though they have a comparative advantage.     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   92 it is now time to evaluate the level of welfare that results from subsidies for the adoption of  pa.  the impact of a subsidy for the adoption of pa in terms of welfare  the objective of this section is to identify the level of subsidy that ensures the complete  circulation of pa. to do so, we will establish under what conditions the profits, qualities and  welfare are at least equal to those obtained in the first scenario.  we  note  as  s = s × ne ** the  amount  of  the  subsidies  paid  by  the  us  government.  total  welfare  is defined as  the surplus amount  from consumers and profits minus  the  level of  subsidies.  the public authorities decide to allocate subsidies so that:  (i) the subsidies have a positive impact for us and cwa growers and for cotton  consumers, which we have highlighted in section 3.2.1.  (ii) the amount of the subsidies s is compensated by the increase in the level of  consumers purchasing us cotton and profits made by us growers. in this case  the new level of welfare be at least equal to the previous level.  we will determine the amount of the subsidies that is necessary to maximize us profits  so that welfare in not inferior to that which was obtained without subsidies.  the  level  of  welfare  with  subsidies  noted  as  **2w is  determined  by  the  following  expression: w2 ** = ase,s ** + asp,s ** +π e,s ** +π a,s ** − s**  ⇔ w2 ** = r + q( s ) e,e ** + q( s ) e, p ** − tx̂ − p( )∂x + r + q(s ) a, p** + q − t(1− x̂( )∂x +x=x̂s** 1 ∫ π e,s** +π a,s** − s ⋅ x̂s**x=0 x̂s ** ∫   with: %xs ** = 3t + s − q 6t −1 ;   π es ** = 3t − q 6t −1 −12t 2 + t 4q − 3( ) + q 2 6t −1( ) ⎡ ⎣ ⎢ ⎢ ⎤ ⎦ ⎥ ⎥ + s;   π a ** = 18t 3 + t 2 12q −12( ) + t 4q2 − 4q + 2( ) 6t −1( )2 − 1 2 q 2 .  after calculation, the value of welfare is given by:  w2 ** = 18t 3 + t 2 36s − 36q + 3( ) + t 10s2 + 2q +10q2 +1− 20sq − 2s( ) + 2qs − s2 − q2 2 6t −1( )2 − 1 2 q 2 + r + q  we verify, by taking relevant numerical values1 that respect our hypotheses (r sufficiently  large;  p > t;  t ∈ 0; 1 3 q⎤ ⎦⎥ ⎡ ⎣⎢ ;  q ≤ 1   ; and  0 < s < 3t + q −1 as the welfare  w2 ** > 0. we also verify                                                         1 for  the profits are positive.     baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     93 that **1 ** 2 ww ≥ .  the  impact  of  public  subsidies  for  the  adoption  of  pa  on  the  welfare  is  expressed as follows:  ∂w2 ** ∂s = 36t 2 − 2t + s 20t − 2( ) − 20qt + 2q 2 6t −1( )2   proposition 9: an increase in the value of the marginal subsidy ʺsʺ has a positive impact on the  collective welfare. it this case we verify that:∂w2 ** ∂s > 0   in  this  situation,  the  us  public  authorities  optimize  the  welfare  by  determining  the  optimal level of subsidies such as:  ∂2w2 ** ∂2s = 20t − 2 2 6t −1( )2 > 0   the previous expression signifies that, no matter what the level of subsidy, the welfare is  improved.  the  following  graphic  illustrates  this  conjecture  that  welfare  increases  in  fine:  w2 ** (s) ∈ 0;+∞] [, for all values of  s > 0 .    graphic 3. evolution of welfare according to level of subsidies        in the first case, the policy for subsidies to assist the adoption of pa allows american  growers to decrease their production cost for “environmental quality”. the goal of the public  authorities is to evaluate the optimal subsidy that will be beneficial to all of the us actors.  several conditions must be respected in order to make it so.      ‐ condition (25) must be respected: s** ≤ q + 3p − 3t − p 2t   ‐  the  public  authorities  must  take  into  consideration  the  gains  of  african  growers  because, according to the hypotheses retained, they must not be crowded out of the market  (i).   graphic 2 highlights the fact that there is a level of subsidy where african growers are  crowded out of the market. nevertheless, as by hypothesis, r is large enough so that no actor     economic analysis (2011, vol. 44, no. 1‐2, 78‐97)   94 is crowded out of the market, the level of subsidies that are granted must meet the following  condition: q − 1 2 < s** < 3t + q −1                 (28)    there  is a  level of subsidy  that  is optimal and profitable  for all  the actors on  the  market.  its  value,  in  t0,  when  condition  (25)  is  respected,  is  given  by  the  following  expression: s** = q − 1 2 .  for this subsidy amount, the welfare is positive and superior to the welfare when pa  is not subsidised. the strategic policy undertaken by the american government enables an  increase  in american market shares and an  improvement in the qualities of cotton that  is  produced. the american and african growers also remain competitive (proposition 7). in  this  case,  the  public  policy  is  justified  economically  because  the  welfare  is  positive  and  superior  to  w1 **(graphic  4),  and  also  because  it  induces  an  increase  in  american  market  shares.    graphic 4. evolution of welfare according to t with and without pa subsidies        we have shown that public policy to distribute pa to the cotton sector enables in increase  in  welfare  and  an  increase  in  market  shares  for  american  growers.  this  policy  can  be  considered to be a strategic commercial policy combined with an environmental policy for  the  reduction  of  pollutants  caused  by  agriculture.  the  american  cotton  sector  becomes  profitable  without  harming  cwa  growers  who  have  a  natural  advantage  in  this  sector.  however, we have shown that there is a critical subsidy level that causes cwa countries to  be crowded out of the cotton market. this situation would obviously be contrary to the us  commitment regard ding policies to aid development in countries such as those in cwa. we  have finally highlighted the fact that subsidies improve both cotton qualities, which would  place cwa countries at a disadvantage because their natural competitive advantage would  be blurred.       baldin, c., precision cotton agriculture, ea (2011, vol. 44, no. 1‐2, 78‐97)     95 conclusion  although the quality of the cotton produced by cwa countries is undeniably superior to  cotton from other countries, distributing pa could reverse this state of affairs. many studies  recognize that pa enables optimal soil management, positively influences cotton quality and  induces a positive impact on the environment (bradow et al., 1999a. and 1999b., johnson et  al.,  2002,  ping  et  al.,  2004).  if  pa  should,  in  the  future,  become  a  support  for  the  implementation of strategic trade policy combined with environmental policies, it would be  clear  that  cwa  countries  would  be  faced  with  a  new  challenge  because  their  competitiveness would be jeopardized (gergely, 2005).  the  previous  model  shows  that  such  a  situation  could  be  considered  under  certain  conditions. the balances obtained (section 3), the result of a subsidy policy for the adoption  of pa, are higher to those determined when the hypothesis is made that us growers have  access to pa but are not subsidized (section 2). in other terms, aid for the adoption of pa  implemented by the us would result in an improvement of welfare of the us and welfare of  cwa  countries.  they  also  analytically  confirm  studies  by  yu  et  al.,  (1999),  yu,  2000,  bongiovanni and lowenberg‐deboer, (2000), whitley et al., (2000), schumacher et al., (2000)  bronson et al.  (2003,) regarding  the use of pa, which confirms an  increase  in yields and  profitability and a decrease in pollutants. they also agree with the studies that highlight the  fact that pa enables the quality of cultivated products to be  improved. (long et al., 1998,  bradow et al., 2000, johnson et al., 2000, ping et al., 2004a). however, we have shown that  there  is  a  critical  level  of  subsidy  that  crowds  out  cwa  countries  from  the  market.  for  subsidy amounts that are greater or equal to this level, a strategic commercial policy can be  considered unfair because cwa countries are unable to react by a trade war.  finally, in as much as american profits and welfare are not susceptible to variations in  cotton  prices,  strategic  trade  policies  implemented  by  the  us  to  support  pa  have  every  reason to be initiated at the risk of harming cwa countries.  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economics  of  precision  agricultural  practices  in  cotton  production”,  beltwide  cotton  conferences proceedings, national cotton counicil, memphis.  yu, m. segarra, e. et nesmith, d. (1999), « spatial utilization of phosphorus : implication for precision  agriculture practices », proceedings of beltwide cotton conferences, pp. 299‐302.        article history:  received:  15 march 2011 accepted:  16 april 2011                  microsoft word 2011_3_4_finalna ver.doc original scientific paper    bridging the learning gap in the market for higher education:   e‐learning and public subsidies  ben youssef adel*, letexier thomas, ragni ludovic,   university of nice sophiaantipolis, france   udc: 37.014  jel:i20; i28; l13; l35     premošćavanje jaza učenja na tržištu visokog obrazovanja:   e‐learning i državna subvencija      abstract – this article aims at analyzing the adoption patterns which apply on the market for  higher  education when  two  types of  learning organizations – namely,  traditional  learning and  e‐ learning organizations – provide educational programs. we focus on the impact of public subsidies to  e‐learning providers in order to evaluate the conditions under which the learning gap is bridged. a  welfare analysis is introduced to estimate the relevance of such ‘pro e‐learning’ public policies. our  first results show that public subsidies enable the e‐learning organization to provide quality‐based and  pricing strategies that tend to be similar to those of the brick’n mortar organization. besides, we find  that such short‐term policies positively impact on the global level of quality which is provided by both  providers. nevertheless, our welfare analysis underlines contrasted results about the relevance of such  short‐term public policies.    key words: adoption patterns, costs, e‐learning, public subsidies, quality, welfare  introduction  information and communication  technologies have deeply changed  the scope and  the  nature of  the market  for  higher  education  (bates, 2005).  indeed, virtual campuses and e‐ learning  programs  have  emerged  as  relevant  alternatives  to  traditional  ‘brick’n  mortar’  learning  organizations,  thus  providing  somehow  distant  learning  features.  following  the  developing of such new types of learning providers, it has been suggested that it is possible  to consider a market for higher education learning services in which academic institutions  and  virtual  campuses  are  key  actors  (allen  and  shen,  1999;  belfield  and  levin,  2002;  brasington, 2003; sosin et al., 2004). the advent of virtual campuses and e‐learning programs  leads to two major changes  in the market for higher education. a first significant change  affects the scope, the boundaries and the nature of competition in such a market. a second  major change is related to the provision of quality for programs in this market inasmuch as  e‐learning programs tend to stimulate the developing of new – ict‐related – uses.   the quality of the learning services each channel is likely to provide represents one key  issue  following  the  appearing  of  new  competition  dynamics  on  the  market  for  higher                                                         * université de nice sophia‐antipolis gredeg umr 6226 crns     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   2 education.  icts  have  been  shown  to  enable  teachers  and  learning  staff  to  develop  pedagogical innovations (becker and watts, 2001; rivkin et al., 2005; cukusic et al., 2010).  friedman  (1962),  hoxby  (1994;  2000),  west  (1997),  dee  (1998)  and  jaag  (2006)  find  that  educational mobility leads learning organizations to provide higher‐leveled quality for their  programs whereas lesser optimistic results are obtained by epple and romano (1998), hoyt  and lee (1998), jepsen (2002) and mcmillan (2004). although the impact of the competition  effect on learning quality remains unclear, such contributions have opened alternative paths  to  study  the  delivering  of  educational  services.  the  european  union  has  taken  various  initiatives  so  as  to  promote  e‐learning  programs  and  to  overcome  the  so‐called  ‘learning  gaps’. some countries of its members states (i.e., france and spain) have hugely subsidized  these  programs.  although  the  impact  of  government  subsidy  on  performance  and  social  outcomes  in  the  traditional  market  for  higher  education  has  largely  been  explored  by  scholars  (schneider,  2010;  yamauchi,  2011),  the  whole  impact  of  such  policies  remains  unclear in the case of e‐learning and deeper analyses have to be carried out.  the aim of this article is to analyze the impact of public subsidies to e‐learning providers  in  order  to  evaluate  the  conditions  under  which  the  learning  gap  is  bridged.  a  welfare  analysis is introduced to estimate the relevance of such ‘pro e‐learning’ public policies in a  framework in which traditional learning and e‐learning organizations compete by providing  educational  programs.  our  first  results  show  that  public  subsidies  enable  the  e‐learning  organization to provide quality‐based and pricing strategies that tend to be similar to those  of the brick’n mortar organization. besides, we find that such short‐term policies positively  impact on the global level of quality which is provided by both providers. nevertheless, our  welfare analysis underlines contrasted results about the relevance of such short‐term public  policies.  the paper  is organized as  follows. section  two presents  the settings of  the model  (2).  section  three  identifies  optimal  quality‐based  and  pricing  strategies  when  the  market  for  higher  education  partially  and  shared  (3).  section  four  analyzes  the  impact  of  public  subsidies on both competition outcomes and welfare (4). section five concludes (5).  the model  we  present  a  market  in  which  two  commercial  organizations  act  as  duopolists  when  providing learning services. we introduce two types of learning providers, namely brick’n  mortar campuses and virtual campuses. these traditional organizations are more likely to  provide mass‐oriented services whereas virtual ones rather provide customized services to  better  match  the  needs  of  the  students.  they  also  differ  in  the  nature  of  the  constraints  students have to face when adopting one of the two services. we develop a model in a ‘à la’  hotelling framework in which providers sell differentiated services, the traditional campus  (resp. the virtual campus) being located at 0 (resp. 1). adopters are uniformly distributed on  the hotelling  line and their total mass  n   is equal to 1. they adopt at most one  learning  service that  is provided by either the traditional campus or the virtual campus. be  x  the  location of each product on the line ( [ ]0;1x ∈ ). utility functions are defined as follows:       ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   3 ( ) 1 1 2 2 if adopts from the traditional campus 1 if adopts from the virtual campus 0 if does not adopt x r q tx p u r q t x p + − −⎧ ⎪ = + − − −⎨ ⎪ ⎩       ( )1   r  ( 0r > ) is the gross utility adopters derive from learning services.  tx  (resp.  ( )1t x− ) is  the transportation disutility adopters get from adopting the learning program provided by  the traditional campus (resp. the virtual campus). transportation cost  t  captures the nature  of the constraints which lead students to adopt at most one of the two educational services.  such constraints are related to both technical features (e.g., equipments) and abilities (e.g.,  competences) to use one of the two types of service.  x  (resp.  ( )1 x− ) represents the distance  between any adopter’s ideal product and that provided by the traditional campus (resp. the  virtual  campus).  1p ( 1 0p > )  is  the  price  the  brick’n  mortar  provider  charges  to  students  when adopting learning programs and  2p ( 2 0p > ) represents the price students have to pay  to adopt e‐learning programs.  1q   ( 1 0q > )  (resp.  2q ,  2 0q > )  is  the  level of quality  that  is  provided by the traditional provider (resp. the virtual provider). we here interpret learning  qualities as the efforts carried out by the organizations to hire high‐leveled learning staff and  to  contribute  to  the  provision  of  high‐leveled  diploma.  we  suppose  that  the  content  of  learning programs provided by the two types of learning organizations is the same. product  differentiation can only be measured by the way educational services are released.   both  learning  providers  are  driven  by  pure  for‐profit  motives  to  develop  learning  programs. we define their objective functions as follows:  ( ) ( ) 2 1 1 1 1 1 2 2 2 2 2 2 2 2 2 n p f q n p n f q π π ⎧ = − −⎪ ⎨ = − −⎪⎩                      ( )2   1π  (resp.  2π ) is the profit function of the traditional learning provider (resp. the virtual  learning provider) when supplying her programs. we define  1n  ( ] [1 0;1n ∈ ) as the mass of  the students who adopt the programs provided by the brick’n mortar campus whereas  2n   ( ] [2 0;1n ∈ )  represents  the  mass  of  the  students  who  adopt  e‐learning  services.  both  organizations  face  costs  whose  cost  structures  are  not  the  same.  the  traditional  learning  provider  has  to  support  fixed  costs  f1  to  carry  out  the  provision  of  learning  services  inasmuch as the setting out of brick’n mortar activities requires buildings to be allocated and  both teaching and administrative staffs to be paid. nevertheless, the mass of the students  who adopt traditional learning services is not likely to strongly affect the levels of costs of the  learning  supplier  since  her  activity  is  based  on  a  mass‐consumption  scheme.  for  simplification purposes, we set the level of marginal costs to zero. the provider of e‐learning  programs has to face marginal costs when carrying out her activity inasmuch as it is based  on a customization‐based approach. indeed, since each student is likely to be individually  provided  a  specific  learning  program  and  teachers  are  likely  to  be  more  involved  in  participating to personal trainings, marginal costs  2f  have to be taking into account when  providing learning services. we however suggest that fixed costs are much lower‐leveled in  the case of commercial e‐learning activities. again, for simplification purposes, we set the     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   4 level  of  fixed  costs  to  zero.  as  generally  assumed,  we  eventually  suppose  that  both  producers face innovation production costs whose shapes are quadratic. such costs lead both  learning providers to design suitable pricing and quality strategies to maximize their profits.  we define the adoption decision process as a four‐step game:  • at  step  0t = ,  both  the  traditional  organization  and  the  virtual  organization   decide whether to provide or not to provide learning programs;  • at step  1t = , both organizations simultaneously set qualities  1q  and  2q ;   • at step  2t = , both organizations set prices  1p  and  2p ;  • at step  3t = , students decide to adopt or not to adopt the product released by  either the brick’n mortar organization or the virtual campus.  providers and potential adopters have full and common knowledge of the production  outcomes, whether  they concern  prices and qualities. we suppose  that  their expectations  about the way prices and qualities are defined do apply.  we consider the specific case in which the market is partially served and shared. indeed,  the gross utility adopters derive from getting access to learning services (i.e.,  r ) is low so  that access to learning services is limited. therefore, we here focus on the case in which both  the cultural and political landscapes of the countries are likely to generate learning gaps.  optimal strategies and competition outcomes  potential adopters have a low intrinsic valuation for learning services and/or constraints  to access educational services that are high so that no‐adoption patterns are introduced. the  two learning providers consequently act as ‘local’ monopolists.     figure 1. adoption patterns when the market is partially served        our analysis holds for specific values for t  and  2f .   assumption 1a. transportation costs t  are large so that  1t > .   mobility is limited so that there exist adoption constraints which do not allow potential  adopters to easily switch from one learning provider to the other one.  assumption 1b. marginal costs  2f  are lower‐bounded so that 2f t< .   assumption 1b is introduced to restrict our analysis to a framework in which marginal  costs are low‐leveled enough so that the e‐learning provider may generate a positive profit  from her commercial activity.        ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   5 in addition, we restrict our analysis to ‘reasonable’ values of  r , namely  r .1  assumption 2. the intrinsic valuation for learning services  r  is defined so that  ( )2 20 2 1 2f r t f< < < − + .  assumption 2 presents the conditions for values of  r  we have to consider for the market  for higher education to be partially‐served. let us stress that assumption 2 can be extended  and expressed so that  ( )2 2 20 2 1 2 2 1 2 1f r t f t t f< < < − + < − < − + .  solving backward, we identify optimal levels for quality, prices and adoption patterns:  * 1 * 2 2 2 1 2 1 r q t r f q t ⎧ =⎪⎪ − ⎨ −⎪ = ⎪ −⎩ * 1 * 2 2 2 1 ( 1) 2 1 tr p t tr f t p t ⎧ =⎪⎪ − ⎨ + −⎪ = ⎪ −⎩ * 1 * 2 2 2 1 2 1 r n t r f n t ⎧ =⎪⎪ − ⎨ −⎪ = ⎪ −⎩        ( )3a , ( )3b  and ( )3c   marginal costs  2f  only affect the optimal level for quality, price and adoption of the e‐ learning provider. this results from the partially‐served nature of the market. one can easily  see from assumptions 1a, 1b and 2 that levels for  *1p ,  * 2p ,  * 1q ,  * 2q ,  * 1n  and  * 2n  are all positive.    proposition 1. both learning providers reach out positive profits and partially serve the market  when potential adopters have a ‘low’ intrinsic valuation for learning services.  proof of proposition 1. one can easily observe from assumption 1a that the traditional  learning provider generates a positive profit from her activity provided that fixed costs  1f   are sufficiently small. it is straightforward to show that the profit of the e‐learning provider  is positive at the optimal state for any value of  2f  ( 20 f t< < ).   traditional  learning  and  e‐learning  activities  are  thus  both  found  to  be  sustainable  inasmuch as their respective optimal levels of profit are always shown to be positive.  proposition 2. when the market for higher education is partially served, the traditional learning  organization sets out higher (resp. lower) quality (resp. price) levels for their learning programs than  the ones which are provided by the e‐learning organization.  proof of proposition 2. from assumptions 1a and 1b, one can easily find that   ( ) ( )* *1 2 2 1 2 2 0p p f t t− = − − <⎡ ⎤⎣ ⎦  and  ( ) * * 1 2 2 2 1 0q q f t− = − > .  the  traditional  learning  provider  appears  more  likely  to  attract  a  higher  scope  of  potential adopters. nevertheless, let us remind that no‐adoption patterns apply due to the  structure of the market for higher education.  learning divides’ and public policies  no‐adoption patterns are represented by the optimal mass of non‐adopters, which is    [ ] ( )* * *1 2 21 ( ) 2( ) 1 2 1n n n t r f t∅ = − + = − + − −           ( )4                                                          1 if  r   is shown  to be  ‘too’  low, global no‐adoption patterns are  likely  to apply on  the market  for  education. we do not analyze such a case in this article.      economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   6 we obviously find that  *n∅  is positive for any value of t ,  2f  and  r  under assumptions 1a,  1b and 2. moreover,  ( )* * 2 ,n n f r∅ ∅=  is unsurprisingly found to be an increasing function for  2f  and a decreasing function for  r . consequently, one may see appropriate to set up public  policies which tend to make levels for marginal costs  2f  lower and levels for valuation for  educational programs  r  higher. although such policies are both shown to reduce the gap for  learning access, they differ in the amount of time which is needed for positive outcomes to be  reached out. the setting up of information campaigns which are led to develop the intrinsic  valuation for educational programs are somehow likely to be efficient in the long run. we  therefore restrict  our public analysis  to  the  example of  public subsidies  to  the  e‐learning  provider  (e.g.,  public  support  to  purchase  it  terminals  or  computers).  the  total  amount  allocated by the public authorities thus depends on the number of adopters of e‐learning  services. marginal public subsidy is noted  s  ( 0s > ) and is defined so that  ( )2 0f s s∂ − ∂ <                     ( )5   s  refers to the amount which is allocated by public players to the virtual campus to enhance  the  providing  of  e‐learning  programs  and  to  reduce  the  so‐called  ‘learning  divides’.  the  impact  of  such  a  type  of  public  policies  can  be  measured  by  analyzing  the  effect  that  marginal costs  2f  have on optimal price and quality levels, as well as on profits. the level of  marginal subsidy  s  is of course assumed to be lower to that of marginal cost  2f  (i.e.,  2s f≤ ).    we first analyze the effect of public subsidies on the optimal levels we previously pointed  out (4.1.). a welfare study is then carried out to see to what extent public subsidies may be  socially‐improving (4.2).   public subsidies and competition outcomes  we define  * * *1 2q q q= +  as the quality effort which is jointly provided by the two learning  organizations. as we have supposed that educational programs are homogeneous products,  one can interpret  *q  as a – yet preliminary – measure of social outcome. we show that  ( ) ( )* 22 2 1q r f t= − −                   ( )6   the  effect  of  public  subsidies  on  the  optimal  quality  and  pricing  strategies  of  both  learning providers, as well as that on their profits, are expressed as follows:  * 1 2 * 2 2 0 1 0 2 1 q f q f t ⎧∂ =⎪ ∂⎪ ⎨ ∂⎪ = − < ⎪ ∂ −⎩ * 1 2 * 2 2 0 1 0 2 1 p f p t f t ⎧∂ =⎪ ∂⎪ ⎨ ∂ −⎪ = > ⎪ ∂ −⎩ * 1 2 * 2 2 2 0 0 2 1 f r f f t π π ⎧∂ =⎪ ∂⎪ ⎨ ∂ −⎪ = − < ⎪ ∂ −⎩            ( )7a , ( )7b  and ( )7c   lemma 1. when potential adopters have a low intrinsic valuation for learning services, public  subsidies have a positive  (resp. negative)  impact on  the quality  (resp. pricing)  strategy of  the  e‐ learning provider whereas they have no effect on that of the brick’n mortar learning provider. public  subsidies enable the e‐learning provider to increase her profits whereas such subsidies do not affect  that of the traditional organization.        ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   7 the effect of public subsidies on the global quality effort is given by  * 2 1 0 2 1 q f t ∂ = − < ∂ −                    ( )8   lemma 2. public subsidies improve the level of global quality effort.  lemma  2  provides  first  social  insights  about  the  providing  of  public  subsidies.  it  somehow stresses that the providing of marginal subsidies does negatively  impact on the  joint level of quality delivered by both types of learning organizations. as such, exclusive  public support  to  the e‐learning provider  is  likely  to  lead both providers  to offer higher‐ leveled services.   public subsidies and welfare  we  discuss  welfare  outcomes  to  identify  the  impact  of  public  subsidies  on  welfare.  aggregate  adopters  surplus  is  equal  to  * * *1 2as as as= + .  the  surpluses  of  both  learning  organizations are equal to the sum of the profit of the brick’n mortar provider  *1π  and that of  the e‐learning provider  *2π . welfare is defined by the sum of both adopters and providers’  surpluses, as well as of the level of total public subsidy (i.e., public deficit)  ( )* *2 2s s n s n= = × .  indeed,  we  here  consider  that  public  authorities  take  rational  decisions  when  designing  public policies  inasmuch as subsidies are allocated  if and only  if two conditions are met.  these conditions state  that  (i)  the  impact of public subsidies on both  the producers’ and  consumers’ surpluses is shown to be positive, and (ii) public deficit  s  is overcome by the  increase of the level of total surplus which results from the setting up of such a public policy.   when  public  subsidies  are  provided  to  the  e‐learning  organization,  its  marginal  cost  decreases to a level that is equal to  2f s− . we define the optimal level of welfare  *w  as   ( ) ( )( ) ( ) * 1 * 2 1 ** * * * * * * 1 1 2 2 1 2 2 0 d 1 d 1 x x x x w r q tx p x r q t x p x s xπ π = = = + − − + + − − − + + − −∫ ∫   we find that   ( ) ( )( ) ( ) ( ) 2 22 2* 1 2 1 1 3 1 2 2 1 2 1 r f s w f t r r f s s t t − −⎡ ⎤⎛ ⎞ ⎡ ⎤= − + − + − − − ⎢ ⎥⎜ ⎟ ⎣ ⎦− −⎝ ⎠ ⎣ ⎦      ( )9   one  can  find  that  levels  for  welfare  are  positive,  provided  that  fixed  costs  1f   are  sufficiently small (see proof  in appendix a). the  impact of public subsidies on welfare  is  expressed as follows:  ( )( ) ( )( ) 2* 2 1 1 2 1 w r f t s t s t ∂ ⎛ ⎞ = − + −⎡ ⎤⎜ ⎟ ⎣ ⎦∂ −⎝ ⎠                    ( )10   proposition 3. when the market is partially‐served, public subsidies are beneficial to welfare for  ‘low’ values for marginal public subsidy  s , and detrimental otherwise.     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   8 proof of proposition 3. we  find  that  * 0w s∂ ∂ > for values  for  s   that are set out by  public authorities so that  ( )( )21s t t r f< − −  and that  * 0w s∂ ∂ <  for values for  s  that are  defined so that  ( )( )21s t t r f> − − . �  we  find  that  public  subsidies  may  be  relevant  to  reach  out  welfare‐improving  states  provided  that  the  level  of  marginal  subsidy  does  not  exceed  a  maximal  value.  upper‐ bounded  public  support  is  likely  to  be  welfare‐improving  for  areas  in  which  access  to  learning programs is limited.    the optimal decision‐making of public authorities can be seen as the result of a welfare‐ maximizing program of which  ( )( )* 21s t t r f= − −  is the result.2 let us note that such an  optimal  level for  s   is higher (resp.  lower) than marginal cost  2f   if  ( )2 2 1f t t r> −  (resp.  ( )2 2 1f t t r< − ). when public authorities define levels for public subsidies so that  20 s f≤ ≤ ,  *s  is set out at a level which is equal to  ( )( )21t t r f− −  if values for  2f  and  r  are so that  ( )( )2 2 1f t t r≥ − , and  * 2s f=  if values for  2f  and  r  are so that  ( )( )2 2 1f t t r≤ − .  it  is  needed  to  see  if  the  setting  out  of  public  subsidies  whose  marginal  amount  is  ( )( )* 21s t t r f= − −  or  * 2s f=  eventually leads to the disappearing of ‘learning divides’ or if  they only attenuate them.  proposition 4. although public subsidies eventually foster the adoption of educational services,  they may not lead to the disappearing of the ‘learning gap’.  proof of proposition 4. see appendix b.   proposition 4 suggests that short‐term oriented public policies may not be sufficient for  ‘learning divides’ to disappear. indeed, one can see that a – yet narrower – ‘learning gap’  may apply, depending on the values of both  r  and 2f . short‐termed public support to e‐ learning organizations cannot thus be seen as a great  ‘equalizer’ which would lead to the  developing of universal access to educational services.   conclusion  the  aim  of  this  article  has  been  to  analyze  to  what  extent  the  setting  out  of  public  subsiding may affect the bridging of ‘learning divides’ while stimulating the providing of  high  levels of quality for educational programs. following the  increasing popularity of e‐ learning  services,  we  have  built  a  model  in  which  a  traditional  learning  organization  competes  with  a  virtual  one  while  having  to  deal  with  differing  cost  structures  so  as  to  measure the relevancy of ‘pro’ e‐learning support policies from a social point of view. one of  our major research directions has been to identify how public policies should be designed to  eventually  facilitating  access  to  learning  services  while  not  levelling  down  overall  educational quality.                                                         2 as  ( ) ( )22 * 2 1 2 1 1 0w s t t∂ ∂ = − − < , the value  *s  for  s  which is defined so that  * 0w s∂ ∂ =  depicts a  maximum state.        ben youssef, a., et al., bridging the learning gap, ea (2011, vol. 45, no, 3‐4, 1‐11)   9 the impact of public subsidies has been analyzed, notably to measure to what extent they  are  likely  to  reduce  the  ‘learning  divides’  one  may  observe  in  areas  in  which  intrinsic  valuation  for  educational  services  is  low.  our  welfare  analysis  has  evidenced  that  the  providing of public subsidies that level is too high is detrimental from a social viewpoint. it  has also revealed that – under some specific circumstances – public subsidies may not be  efficient  enough  to  fully‐cover  the  ‘learning  gap’.  this  last  result  can  lead  to  several  interpretations.  a  somehow  pessimistic  interpretation  is  that  it  may  not  be  possible  to  provide  universal  access  to  educational  services  through  the  designing  of  short‐termed  public  policies.  although  the  setting  out  of  public  policies  is  found  to  ‘equalize’  the  competitive game between the two types of learning organizations from both a pricing and  quality‐based point of view, detrimental effects to welfare levels may appear. we suggest  that  the  mixing  of  short‐term  (e.g.,  public  subsidies)  and  long‐term  (e.g.,  educational  campaigns)  public  policies  may  be  appropriate  to  lead  to  the  disappearing  of  ‘learning  divides’. yet, such a practice is likely to generate coordination failures and seems to provide  efficient results only when political contexts are found to be stable. nevertheless, we would  like to address another – rather optimistic – interpretation. indeed, our findings pinpoint that  it  may  be  possible  for  public  authorities  to  widen  access  to  educational  services  while  preserving  their  ‘cultural’  learning‐provision  model.  put  it  differently,  they  may  allow  a  larger scope of people to get access to educational services while avoiding the emerging of a  mass‐consumption model for such higher services.  the analysis of  adoption  patterns  for  educational  services raises major concerns  from  both  market‐based  and  public  viewpoints.  we  strongly  believe  that  both  empirical  and  model‐based  further  contributions  will  lead  to  the  better  understanding  of  adoption  dynamics  within  the  market  for  higher  education  and  to  the  shaping  of  suitable  public  policies.     appendixes  appendix a. positive welfare levels   the level of welfare that applies when the market for higher education is partially served  is given by  ( ) ( ) 2 2* 2 1 2 2 2 2 1 1 2 1 2 ( )( ) ( ( ) ) 2 2 1 w f t r r f f s f s t r r f s t ⎡ ⎤ ⎡ ⎤⎡ ⎤= − + − − + − + + + − +⎡ ⎤⎣ ⎦⎢ ⎥ ⎣ ⎦⎣ ⎦−⎣ ⎦   from assumptions 1a and 2, it is straightforward to find that  * 0w >  for sufficiently small  values of  1f . �  appendix b. proof of proposition 2   as we previously pointed out, two cases have to be taken into account: (i)   ( )( )* 2 2; 2 1s f f t r t= ≤ −  and (ii)  ( )( ) ( )( )* 2 21 ; 2 1s t t r f f t r t= − − ≥ − .  let  us  first  focus  on  the  ( )( )* 2 2; 2 1s f f t r t= ≤ −   case.  we  show  that  ** 0n∅ >   if  the  following conditions are simultaneously met:     economic analysis (2011, vol. 45, no. 3‐4, 1‐11)   10 ( )( ) ( ) ( ) 2 2 2 2 1 2 2 1 2 1 0 1 2 (2 1 ) 2 1 2 1 r t f t r t f r t f t t f < −⎧ ⎪ ≤ −⎨ ⎪ < < < − + < − < − +⎩   such conditions can be summarized as follows:  ( )( ) ( )( ) ( )2 2 2 20 2 1 1 2 2 1 1 2 (2 1 ) 2 1 2 1f t f t r t t f t t f< < − < < − < − + < − < − +   in a similar fashion, we show that  ** 0n∅ <  if the following conditions are simultaneously  met:  ( )( ) ( ) ( ) 2 2 2 2 1 2 2 1 2 1 0 1 2 (2 1 ) 2 1 2 1 r t f t r t f r t f t t f > −⎧ ⎪ ≤ −⎨ ⎪ < < < − + < − < − +⎩   such conditions can be summarized as follows:  ( )( ){ } ( )2 2 20 max 1 2 2 1 ; 1 2 (2 1 ) 2 1 2 1t f r t f t t f< − < < − + < − < − +   we  thus  identify possible conditions under  which public subsidies are  found  to  fully  bridge the ‘learning gap’ and other conditions under which such policies are not found to be  efficient enough to fully cover this gap.   similar results are found when the  ( )( ) ( )( )* 2 21 ; 2 1s t t r f f t r t= − − ≥ −  case is dealt. �   references  allen,  r.f.,  &  shen,  j.  (1999).  some  new  evidence  of  the  character  of  competition  among  higher  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visokog  obrazovanja  posmatrajući  dva  tipa  edukativnih  organizacija  ‐  one  koje  pružaju  klasične  edukativne programe i one koji pružaju e‐learning obrazovne programe. posebno je posmatran uticaj  državnih  subvencija na  e‐learning organizacije u  cilju procene uslova pod kojima premošćuje  jaz  učenja. predstavljena  je analiza blagostanja u cilju procene relevantnosti ovakvih državnih politika  koje  favorizuju  e‐learning.  naši  prvi  rezultati  pokazuju  da  državne  subvencije  omogućavaju  e‐ learning organizacijama da primenjuju cenovne, i strategije bazirane na kvalitetu koje teže da budu  slične  onima  kod  brick’n  mortar  organizacija.  pored  toga,  utvrdili  smo  da  kratkoročne  politike  pozitivno utiču na nivo ukupnog  kvaliteta  koji pružaju  oba  tipa  organizacija.  ipak, naša  analiza  blagostanja ističe različitost rezultata u vezi sa relevantnošću ovakvih kratkoročnih državnih politika.        article history:  received:  5 november 2011  accepted:  14 december 2011          economic analysis (2011, vol. 45, no. 3‐4, 59‐68)   68 apstrakt  ‐  u  centru  pažnje  plana  oporavka  eu  za  period  2010.‐2014.  su,  takozvane,  ʺpametne  investicijeʺ,  koje  treba  dugoročno  da  obezbede  veći  rast  i  održivi  razvoj.  ʺpametna  investicijaʺ znači ulaganja u istraživanje i razvoj (r&d), kao i ulaganja u obrazovanje iz javnih i  privatnih  izvora  finansiranja. u cilju podsticanja  investicija u aktivnosti  istraživanja  i razvoja od  strane  privatnog  sektora,  preporučuje  se  korišćenje  javno‐privatnog  inovativnog  partnerstva   (direktan način), kao  i šire upotrebe poreskih podsticaja za  istraživanje  i razvoj (indirektan način).  kako poreski pristup istraživanju i razvoju ima jak uticaj na donošenje odluka, ovaj rad će se baviti  različitim  r&d  poreskim  (računovodstvenim)  modelima  i  njihovom  uticaju  na  finansijske  performanse preduzeća.  kako  je  bosna  i  hercegovina  prihvatila  međunarodne  računovodstvene  standarde  (mrs)  i  međunarodne standarde finansijskog izveštavanja (msfi) kao svoj računovodstveni okvir, ovaj rad  će ispitati adekvatne mrs i msfi u cilju identifikovanja ʺpozitivnihʺ ili ʺnegativnihʺ efekata svakog  r&d poreskog modela, radi pravilnog finansijskog tretmana ovih aktivnosti u preduzećima.  opšti cilj ovog rada  je da odgovori na pitanje: koja model poreskih subvencija za  istraživanje  i  razvoju bi bio najprikladniji za bih, poštujući sadašnji pravni i računovodstveni okvir, kao i troškove i  koristi svakog preporučenog modela?    ključne reči – računovodstveni tretman aktivnosti r&d, računovodstvena analiza, r&d  poresko planiranje i stimulansi, obim i porast r&d baziran na subvencijama, korporacijski porez kao  stimulans r&d aktivnosti.        article history:  received:  15 july 2011 accepted:  21 september 2011          professional paper    general characteristics, role and importance of international  marketing information system  stanetić vedran*, institute of economics ad banja luka  bosnia and herzegovina   udc:  339.138   jel: m31; l22; f23  osnovne karakteristike, uloga i značaj međunarodnog  marketinga informacionih sistema abstract –  information  flow  from  the company  to  the market, and contrary also, enables  effective communication of the subject with the environment. formalizing and directing that kind of  flows emanates information systems. the task of such systems is constantly refreshing the content of  the information flow. this ensures that company`s decisions, which would be undertaken, are adequate  and in the right time. information systems find their application in almost all areas of business. maybe  the most  interesting of them are marketing  information systems. however, such systems are often  considered a substitute for marketing (market) research, or if there are undertook marketing (market)  research,  then  there  is no need  for marketing  information  system. this  paper  seeks  to prove  the  opposite, that these two concepts are not identical, and therefore not mutually exclusive but rather  complementary and compatible. since the operations of business entities are  increasingly becoming  regional  or  global,  that  makes  sense  to  talk  primarily  about  international  marketing  information  systems. local business levels should be regarded only as a fragment of the total portfolio of markets.  the  last statement  is valid especially  if  the domicile market  is not sufficiently  large  for profitable  production or if it is under‐developed    key  words:  information  systems,  market,  marketing,  information,  marketing  research,  international environment  characteristics of international marketing information system  definition of international marketing information system  it is not an easy task to give a comprehensive and complete definition of international  marketing information system (imis), which would be easily understood at the same time.  defining difficulties arise  from  the complexity of  the aforementioned system,  interwoven  elements  that  make  up  the  imis,  their  entanglement  and  complementarity  with  other  activities in the enterprise, as well as understanding the role and importance of the imis. in  order to understand properly the meaning of the imis it is recommended to start with the  etymological  analysis  of  the  imis  concept.  the  compound  ʺinternational  marketing  information  systemʺ  will  be  briefly  analyzed  word  by  word  ʺsystemʺ,  ʺinformational,ʺ                                                         * address: krfska 94, 78000 banja luka, republika srpska, bih; e‐mail: vedranstanetic@ekinst.org,  staneticv@yahoo.com     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   70 ʺmarketing,ʺ  while  the  adjective  ʺinternationalʺ  is  in  brief  content  analyzed  through  the  entire text.   it is important to understand correctly the meaning of the word ʺsystemʺ because it is the  basis  for  not  only  a  imis,  but  also  any  other  form  of  organization.  according  to  efraim  turban, ephraim mclean, and james wetherbe (1999, pg. 40, 41) a system is a collection of  elements,  such  as:  people,  resources,  concepts  and  procedures,  intended  to  perform  an  identifiable  function  or  serve  a  goal.  a  system  is  separate  from  its  environment  by  a  boundary.  the  system  is  inside  the  boundary,  whereas  the  environment  lies  outside.  in  short, the system is determined by elements, its tasks and purpose, as well as the limits that  can be very abstract. especially interesting are the systems that collect and process various  kind of information. information system (is) of enterprise is defined as a set of human and  technical means that, with a certain organization and methodology, perform the collection,  storage, processing and disseminating to the use of data and information (lazo roljić, 1997,  pg. 23). is can be represented graphically by the diagram as follows:    figure 1. schematic view of the information system    inputs    processing outputs  business  problems:  data  information  instructions  opportunities  programs  people  equipment  storage    solutions:  reports  graphics  calculations  voices  tactics                control     feedback decision makers  auto‐control                     source: turban, mclean, and wetherbe (1999, pg. 18)  in  the  previous  figure  is  shown  that  the  tasks  of  the  is  are  to  collect  and  process  information,  which  goal  is  to  create  information  reports  for  different  purposes.  the  information system is a system that is oriented to decision making information.  classification of is in companies can be done in various ways. is can be classified taking  into account four main aspects: the organizational level, functional area, provided support,  system architecture, etc. however, regardless of classification, the structure of is is the same  and  consists  of  the  previously  mentioned  elements.  for  this  paper,  the  most  interesting  classification of is is based on the division of functional areas in the companies. besides to  marketing is, there are also: accounting is, financial is, manufacturing is, human recourses  is and the like. also, for purpose of this paper it is important only formal is, as opposed to  informal whose study is more in the field of operating management, or sociology.  in order to understand properly the marketing information system, it is needed to start  with  the  concept  of  the  marketing  system.  the  essence  of  the  marketing  system  is  the     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   71 information flow between producers and consumers. the flow of these data is twofold. data  from consumers go  to  the manufacturer. the content of  this data  include: needs, desires,  preferences and problems, and it is defined as the purchasing power demand. on the other  hand, information circulate from the manufacturer to the consumers and the content of this  data is about its mission, goals and tasks, in other words information about marketing plan  and program  ‐ defined as an offer. the process of communication between company and  customers  is  needed  to  ensure  that  market  exchange  would  be  performed  without  complications and to mutual satisfaction. this means that the consumers will satisfy their  needs, meet  their desires, solve  their problems and remove  the  tension; and, at  the same  time, the company will make a profit with lasting affection by consumers. as could be seen,  the marketing system is very complex, and when it is added to the information system leads  to more complex systems.  to generate a continuous flow of appropriate information is an essential task of imis. the  environment of the company is subject of constant change. these changes are particularly  evident  in  the  international environment. imis goal  is  to create an optimal database as a  basis for effective marketing management. there are two basic tips to keep in mind when  observing the imis that are continuous flow of data collection and international environment  as inevitable element in a globalized business world.   the  main  task  of  imis  is  an  ”intelligenceʺ.  intelligence  refers  to  the  gathering  of  information from decision‐making system`s environment and exploring that information in  an  effort  to  recognize  the  existence  of  problems  (gilbert  a.  churchill,  1991,  pg.  28).  therefore, the tasks of the imis are to continually survey the widest surrounding, to collect  general data that is even few suspected that might be of importance for the system, further  processing of these data, then thoroughly explore, and try to determine whether these data  represent or suggest changes in the environment that could be a threat or an opportunity for  the reference system. when it is concluded on the basis of such ʺgeneral informationʺ and  using ʺinsightʺ that there are threats or chances in environment, such information is further  transferred to a higher level of decision making.   when it comes to comparison between marketing information system (mis ‐ referring to  the information system oriented toward the domestic market only) and imis, the conclusion  is  the  same  as  the  comparison  between  domestic  and  international  marketing  research.  looking evolution through time first have came mis. however, the issue of performance is  not a matter of chronology rather than rationality. the broad framework of observation, or  more  statistical  populations,  theoretically  creates  a  greater  chance  of  optimal  choice.  the  practical significance of imis, in a liberalized and the changing business world, is increasing.  the need for a systematic approach to information collection and dissemination in the field  of  international  marketing  is  conditioned  by  the  weaknesses  that  are  typical  for  most  companies. according to boris tihi (2003, pg. 320) those weaknesses can be summarized as  follows:  • there are many information, concerning various aspects of market problems, but  the lack of a system that would select and direct that information force decision‐ makers  to  take  unsystematic  “information  hunt”  in  making  any  specific  marketing decisions;     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   72 • above mentioned “hunting” takes place in the business environment and within  an  entity,  and  a  result  of  unsystematic  work  is  the  fact  that  many  valuable  information are losing within the organizational structure of a subject;  • what  makes  situation  more  difficult  is  that  a  lot  of  information  are  often  not  formally recorded, information are kept in minds of individuals who sometimes  jealously keep information for themselves believing that it could ‘’increase their  authority’’ in some situations;  • late arrived information at the decision making place are practically worthless;  • due to unsystematic data collection and use of different sources of information, it  is difficult to assess the degree of reliability, which is an essential precondition for  the quality of decisions.  the only applicable way to solve the mentioned to solve the mentioned problems is a  systematic approach. one of the possible systematic approaches to the problem mentioned is  by  imis. the emphasis  in  these systems must be on determining  the precise  information  needs  of  each  marketing  decision  makers.  this  ensures  that  they  have  exactly  the  information they need, when they need them, to make the decisions that they have to. it is  not  easy,  but  it  is  possible  knowing  what  characterize  quality  and  developed  imis.  for  indicators of the quality and development of information activities miodrag jovićević (2001,  pg. 161) takes the following:  • the  time  between  the  moment  of  emerging  and  the  moment  of  noticing  a  problem;  • sources of data and information – to be known in advance and to provide data  and information of current, future and historical character;  • quality of data and information – reliability, accuracy and authenticity;  • procedures and programs of data and information processing – to be known and  provided  in  advance,  that  we  know  what  the  relationships  and  the  degree  of  abstraction of the past and the future projection;  • knowledge – a  fundamental prerequisite  for solving problems and conducting  informational activities.  content of an international marketing information system  within  a  imis  comes  to  generating  information  necessary  for  strategic  and  tactical  decision‐making in an international environment. for a better insight into complex structure,  and for the completeness and clarity, content of imis will be shown as a picture. this ensures  a complete overview of the elements and relationships between elements of a imis.  on  the  next  figure  is  shown  the  content  and  structure  of  elements,  and  a  connection  between  them  in  imis.  the  system  consists  of  three  essential  parts:  the  information  component,  processing  of  collected  data  and  the  application  of  the  imis.  information  components are included in the imis in the form of internal, external and other data. based  on the data collected, it is necessary to apply the methods of sorting, processing, analysis and  synthesis.  the  resulting  information  are  input  in  the  subsystemʹs  tasks  of  imis.  what  is  important to emphasize and what is not shown in the previous figure, is a feedback. data  and  information  regarding  the  purpose  and  quality  of  the  imis  application,  or  decisions     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   73 made  on  the  basis  of  information  obtained  through  imis,  have  to  become  one  of  the  components of information or re‐entry to miss.    figure 2. international marketing information system    information  components    issues in the data  aggregation process  applying the  international  information system    external data              macroenvironmental  information      data      scaning the global  environment                comparability        infrastructure  data               allocating resources                         synthesizing and      market size and  structure                            data input               interpreting data    monitoring company  performance    internal data        updating and  maintaining        company sales and  market performance    system      transfer of ideas and  experience           source: samule c. craig, and susan p. douglas (2005, pg.423)     the functioning of the international marketing information system  for successful operation of a imis is necessary to exist three sub‐systems shown in the  second  figure.  in  the  following  text  will  be  briefly  analyzed  each  of  the  subsystems  and  connections between them.  information components – source of the required data is the basis of the work of any of  information system. all data sources, from the point of origin can be divided into external,  internal and other sources.  external data are: macroeconomic indicators, data on infrastructure, as well as data on  market  size.  data  about  macro‐economic  situation  in  individual  countries,  regions  or  globally, could be only the secondary. the most complete such information can be found in  the database of: un, world bank, oecd economic indicators, eurostat and the like, as well  as  on  the  websites  of  other  institutions  that  monitor  such  indicators.  data  on  market  infrastructure  can  also  be  geographically  structured,  for  example:  globally,  regionally,  nationally, and locally in the cities, depending on which the target market is. these are data  about  the  media  infrastructure,  for  example:  electronic  media,  print  media,  outdoor  advertising  media  (billboards,  posters,  etc.),  and  retail  infrastructure,  e.g.:  type  of  organization and structure of retail organizations and wholesale  legislation,  the nature of  competition  and  the  like.  data  about  company`s  products,  about  market  size  and  it`s  structure, as well as alternative and complementary products can be found in databases. it is     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   74 important that the product`s market would not be too narrowly defined. therefore there is  the need to collect and analyze data on complementary and substitute products.  internal data are contained within the company itself. these data are relating to: financial  indicators (for example roa, roe, etc.); market indicators (for example market share, sales  costs,  increased  sales  by  individual  product  lines  and  the  like);  data  about  employees  (example fluctuations, the emergence of new professions of interest to the company, etc.);  data obtained through the marketing research studies (for example research centralized or  organized for particular target markets and the like).   other  data  sources  can  be  divided  into  two  groups:  people  as  a  source  of  data  and  observation  of  physical  stimuli  as  another  data  source.  people  could  create  and  transfer  ideas,  experiences  and  knowledge  within  the  organization,  or  between  world  or  region  markets. they create and transmit information to each other. such communication occurs in  the  oral  and  written  form,  staff  meetings,  teleconferencing  and  so  on.  also,  this  communication can be separated to the internal, within the same enterprise, and external,  communication  with  sales  representatives,  managers  from  other  countries,  promotion  agencies, distributors and so on. a complete picture about same market could be obtained  only by visiting that market, observing it and talking with customers and business partners,  looking  at  shopping  habits  and  the  type  of  retail  outlets,  monitoring  advertisements  on  electronic and print media,  looking at weather conditions, geographical terrain, quality of  transport infrastructure and the like.   issues in the data aggregation process – imis could not function  ideally  just on the  basis of data collected. there are also some technical problems, for example: quality of data  collected, data entry, constantly update the content of the data collected and the like. the  quality of data collected depends on the possibility to make comparisons with data collected  in other countries. this problem is usually related to the existence of different data collection  procedures, as well as different accounting practices between countries and regions of the  world.  data  are  presented  in  units  of  measure  that  can  be  quantitative,  qualitative  and  monetary  indicators  (e.g.  goodwill).  quantitative  measures  generally  are  not  a  problem.  however, monetary measures are subject to strong and rapid changes due to: changes  in  exchange  rates,  price  fluctuation  on  stock  exchanges  or  other  markets,  changes  in  fiscal  policy of the observed countries, or due to changes in the ways of their calculation. entering  data procedures define the degree of similarity and type of data to be collected to be useful  for  the  system.  there  have  to  be  defined  by  whom  and  how  to  enter  data  within  the  enterprise,  in  order  to  make  collection  procedures  more  successful.  also,  it  have  to  be  defined  how  to  change  data  presentation  to  make  them  comparable.  this  is  particularly  important  for data coming  from external sources. data  issued by  the un or world bank  generally  do  not  have  mentioned  problems  because  those  data  usually  cover  the  entire  world, and their parameters are either global or highly standardized for certain regions or  countries. the problem is with a regional or national data. these problems are reflected in  different ways of: collecting, sampling, systematization, generalization of data and the like,  to  the  language  of  presentation.  it  is  necessary  to  ensure  that  the  system  continuously  collects new data and to processes them. the processed data are synthesized, in other words  those  processed  data  are  the  basis  for  drawing  conclusions.  new  information  should  be     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   75 compared with previous ones and, in the case of difference, investigate the difference and  inform management. the system should be constantly maintained and serviced.  application (tasks) of imis – by roche (as cited in craig and douglas, 2005, pg. 434),  imis  is used  in performing  the  following  four  tasks: scanning  the global environment  to  monitor trends and pinpoint those with specific implications for the geographical areas and  product markets  in which the company  is  involved, assessing how to reallocate resources  and efforts across different countries, products markets and target segments so as to achieve  desired rates of growth and profitability, monitoring performance in different countries and  product markets through  the world, and transferring  ideas and experience from different  countries and areas of the world throughout the organization.  feedback – even  if  it  is not shown  in the previous figure, the  importance of feedback  should be particularly emphasized. through the previous analysis of imis it is mentioned  the  importance  of  re‐entry  of  data  into  the  system.  the  information  flow  in  imis  is  continuous. this is a fundamental feature of the marketing information system that ensures  the  quality  of  marketing  decisions  (momčilo  milisavljević,  1999,  pg.  62).  based  on  the  information collected and create through the imis, the company affects its environment. the  environment  reaction  creates  a  new  situation.  new  data  from  changed  environment  represents a new entrance into the system. in that way a company gets a feeling about the  success of implemented decisions, and the effectiveness of an imis, which in turn should be  constantly creating new, more favorable business conditions for the company.  the process of international marketing research in the absence of an international  marketing information system  the  relationship  between  international  marketing  research  and  imis  has  to  be  understood  as  a  relationship  of  complementarity  rather  than  equality  or  competition.  although  they have  the same goals and similar  tasks, ways of achieving  these goals and  tasks  are  based  on  different  grounds.  this  reflects  theirs  complementarity.  international  marketing  research  project  usually  occurs  when  a  company  finds  the  problem  that  often  needs to be urgently solved. that leads to an emphasis on data collection and analysis rather  than on the development of the formal and regular collection of information. therefore, the  main  difference  between  the  research  project  and  the  system  is  in  time  and  speed  of  execution. the research project appears in times of crisis, so from time to time and as rarely  as possible. on the other hand, the data collection process is ongoing, or the keyword in the  definition  of  marketing  information  system  is  ʺregularʺ,  since  the  emphasis  in  marketing  information system  is  the establishment of systems  that produces  information needed  for  decision making on a recurring basis (churchill, 1991, pg. 24). however, the project must be  completed as soon as possible due to the fact that the duration of the crisis only exacerbates  the situation of the entity which drives the research project. the system of data collection,  since it is a continuous process, has enough time to conduct quality research and make the  necessary analysis.  another important difference relates to the scope of research. considering that the study  (project) of research is conducted in a relatively short period of time, it is very often that so  called preliminary (investigative or orientation) research is neglected. according to the tihi     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   76 (2003,  pg.  83)  preliminary  research  is  a  way  to  get  an  information  that  is  not  strictly  formalized, as is the case with detailed research based on the plan drawn up in advance, and  therefore this type of study is called investigative. the ultimate goal of investigative research  is obtaining the necessary prior knowledge of the specific problem in a rational manner. it is  a  preceding  surveys  and  it  is  based  only  on  secondary  data.  in  preliminary  studies  are  commonly used four methods shown in the following figures:    figure 3. the four methods of preliminary research        research of existing literature            studies of previous experience  preliminary research          analysis of selected cases            pilot studies          sources: tihi (2003, pg. 84)    the figure shows a structured review of methods of preliminary research. the first and  basic  method  of  search  is  to  use  available  literature:  books,  magazines,  newspapers,  databases  accessible  through  the  internet,  libraries,  statistical  publications,  regular  information services for marketing research and the like. also, the use of othersʹ experiences  much  simplifies  and  cheapens  investigation.  therefore,  it  is  necessary  to  collect  other  experiences: field vendors, consultants, engineers and specialists, consumers and customers,  competitors and so on. the third method is based on learning through case studies. it is a  realistic analysis of some past or current problems and opportunities facing a company. the  last  method  of  preliminary  research  is  a  pilot  studies.  these  are  informal  methods  of  communication with customers through which could be know the motives and opinions of  consumers. preliminary research is especially important to a large international marketing  research projects. many of the facts, opinions and attitudes, which are already well known in  the domestic market, we have to find out when we come to another market. therefore, the  phase of preliminary research is almost obligatory in these cases and requires the collection  and analysis of numerous and diverse data (tihi, 2003, pg. 397).  the  third  difference  between  the  market  research  in  general,  and  therefore  the  international marketing research and imis is contained in the following assertion: the task of  marketing  research  is  to  provide  information,  while  the  marketing  information  system  focuses on the routing of information flow  in the direction to those who make marketing  decisions.  this  distinction  is  important  because  the  information  is  completely  worthless  unless  it  is  relevant  and  is  effectively  communicated  (geoff  lancaster  and  lester  massingham, 1997, pg. 333). previous  thesis  is based on  the kotler`s model of marketing  information  system,  where  marketing  research  is  treated  as  a  subsystem  of  marketing  information system (philip kotler, 1999). in this system, marketing research is conducted on  behalf  of  marketing  information  system.  all  obtained  information  are  analyzed  and  compared  with  information  gathered  from  internal  sources  of  the  company,  as  well  as     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   77 scanning the environment. thus the final information has high value and reliability because  it has been checked and confirmed many times. from the prior discussion could be seen how  the international marketing research methodology would be quite poor and the less reliable  if it is not combined with imis. their combination is a superior way of gathering reliable  information.  this  is  a  sure  path  to  successful  decision‐making  and  management  in  international marketing.  compatibility of international marketing information system with international  marketing research  compatibility analysis  according to jovićević (2001, pg. 129)29 compatibility could be determined as a situation  in which two or more objects (procedures, methods, goals, programs, ideas, etc.) can coexist  within one, as a part of the same system, so that the existence of one does not preclude the  other. some studies have shown that managers do not know what information to request for  researchers  and  analysts.  they  know  only  what  is  available.  experience  from  local  and  international business practice show that many companies do not have established market  research systems or the systems are reduced only to routine predictions based on empirical  cognitions or to analyzing of historical data (hasan hanić and čivić beriz, 2009, pg. 43). this  problem could be overcome by efficient functioning of imis. it provides, among other things,  the survey of the international environment and general information in form of intelligence.  on  the  basis  of  such  general  information,  managers  can  identify  important  threats  and  opportunities  in the environment, and how it fits  into the strategy and other plans of the  company. thus they are able to know exactly what information they need, and such, in this  case, detailed  information should be required of analysts and researchers of  international  marketing.  such  detailed  information  could  be  provided  by  comprehensive  international  marketing research. above mentioned is most easily represented graphically as follows:    figure 4. relationship between marketing research and marketing information system                                      sources: tull, hawkins, 1987, (as cited in tihi, 2003, pg. 325)                                                           29 similar milan vujaklija. (2002).; grupa autora, (1994, pg. 638)   environment    internal data  external data     marketing  research      decisions                       requests      information     instruction      marketing  managers    periodic information  monitoring  information  requested  information    mis        feedback         economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   78 figure 4 shows the relationship between marketing information system and marketing  research,  as  well  as  their  relationship  with  marketing  managers  and  the  environment.  previous  paragraph  depicted  an  explanation  of  such  relations  in  the  international  environment.  a slightly different relationship between marketing information system and marketing  research  is  shown  in  the  third  kotler`s  model  (philip  kotler,  1999).  in  that  model,  a  marketing research system, as a subsystem of marketing information system, is integrated  into the whole system together with the other three subsystems. according to the mentioned  model,  a  system  of  marketing  research,  in  union  with  the  system  of  internal  reports,  marketing information system and system‐analytical marketing, is working on collecting and  converting  data  from  the  internal  and  external  environment  into  information  useful  in  making decisions.  according  to  that model,  international marketing  research  is  part  of  a  larger system – marketing information system. this is clear evidence that those two systems  do not overlap. if it is provided that they are integrated into a higher system and the system  is properly organized, than there is no overlapping goals and responsibilities in their mutual  existence, as well as excessive spending organizational resources.  all of these on the relationship between imis and international marketing research could  be circled by the following heinzelbercker`s (1977) statement (as cited in hasan hanić, 2003,  pg.  599):  in  the  last  two  or  three  decades  market  research  is  developed  in  three  complementary  directions  which  represent  paths  from  traditional  marketing  research  till  marketing information system. they are characterized by:  • orientation to the method,  • orientation to the decision‐making,  • orientation to the system.  it  is  expected  that  the  integration  gap  between  marketing  research  and  marketing  management will soon be eliminated thanks to the system orientation of marketing research.  affirmation of systematic approach in marketing has led that a trends in marketing research,  method and decision making oriented, connect with each other, simultaneously providing  the missing link ‐ organization of the whole range of marketing information in relation to the  needs of marketing managers for information. this attitude becomes clear by following bellʹs  (as cited in hanić, 2003) stating: although the market research continually modernize and  make it more relevant for management problems solving, because of the narrowness of its  functions it is, unfortunately, inadequate to fully satisfy the information needs of marketing  staff. due to concerns about implementation of marketing research techniques, researchers  were unable to resolve a number of information problems in a company. as marketing has  become more complex, there was a need to expand its functions in order to provide greater  quantity and higher quality of information. application of marketing approach has led to the  development of marketing information systems. systematic orientation in marketing has led,  therefore,  to  the  knowledge  that  traditional  market  research  should  be  seen  as  part  of  a  larger marketing  information system. according  to hanić  (2003, pg. 602) development of  marketing research toward marketing information systems enabled:  • marketing  research  orientation  to  the  needs  for  information  of  marketing  management.     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   79 • continuously collecting of external information – marketing information system  contributes to the elimination of the situation in which are the most continuously  collected only internal information, while the collection of external information is  made by ad‐hoc marketing research with a defined beginning and end, concerning  a particular project. marketing managers need a marketing  intelligence system,  which would be ʺtailoredʺ to suit their needs.  • to organize total it activities in the marketing – marketing information system  should be structured so that decision‐making processes is supported by organized  flow of relevant information from sources that are in the company and outside it.  based on the presented analysis, it can be said that international marketing research and  imis  not  only  compatible  but  also  complementary,  i.e.  they  complement  each  other  to  achieve the common goals at a higher level.  identified savings due to the compatibility  from  the  analysis  above  it  is  clear  that  by  combining  and  complementing  imis  and  international marketing research are generating a new quality, which in itself contributes to  the  efficiency  and  savings  for  business  enterprises.  effective,  i.e.  well  structured  and  rationally organized international marketing information system, according to hanić (2003,  pg. 598), provides multiple benefits:  • provide more information in the time unit.  • allows to achieve the same  level of satisfaction for  information needs at  lower  cost.  • helps to large and decentralized companies to integrate information scattered in  smaller organizational units into a meaningful whole.  • provide a basis for effective application of the marketing concept – contributes to  enlargement of the overall marketing productivity of companies.  • enables faster identification of trends in the marketing environment.  • it enriches the analysis.  • provides  optimal  decision‐making  –  developed  and  cultivated  marketing  information system contains a bank of models which help marketing managers in  making optimal decisions.  • provides better control of marketing plans and actions implementation.  • provides data protection.  to the previous list it could be added the removal of redundancy as one more benefit.  avoid redundancy means saving time and unnecessary costs in obtaining information. in the  case of international marketing research, the imis should be considered a benefit gained by  its existence and costs arising from its organization and operation. although there are some  general  indication  about  usefulness  of  the  existence  and  functioning  of  the  imis  and  international  marketing  research,  in  each  case  it  should  be  re‐checked  their  opportunity.  only in a case of their synergetic effect their combination justifies their purpose. therefore,  to determine  the exact savings  in  the coexistence of  international marketing research and  imis depend upon the situation, or a planned project.     economic analysis (2011, vol. 45, no. 3‐4, 69‐81)   80 conclusion  international  marketing  information  system  is  a  complex  system,  within  the  organizational  structure,  focused  on  information  flow  from  a  company  towards  the  environment and vice versa. imis should integrate, lead and organize all communications  between company and the environment. this communication should not be limited to data  and information on supply of enterprise and demand from customers, but it should include  all  forms  of  information  that  could  be  used  in  company  decision  making,  and  better  informing  consumers  before  the  act  of  buying.  in  that  case,  the  company`s  environment  should  be  widely  seen,  that  takes  information  from  all  or  most  of  the  world  market  by  various market segments, other industries, various centers of decision‐making and the like.  collecting and processing data and information, and submission of processed information in  decision‐making must be timely. this provides rationality in business decisions making. the  tasks  of  the  imis,  in  addition  to  the  above,  are  monitoring  of  business  performance  of  organizational units of enterprises in various markets, as well as the transmission of ideas  and  experiences  from  other  countries  and  regions  of  the  world  to  the  organization.  relationship  between  marketing  research  and  imis  are  characterized  by  mutual  complementarity  and  compatibility.  their  complementarity  is  reflected  in  the  fact  that  marketing research is detailed and targeted at solving specific problems. unlike marketing  research, which takes place periodically and with limited duration, the information flow in  the imis is permanent and without a defined time period. from the mutual complementarity  and compatibility between imis and international marketing research, derives cost savings  for a company that strives to constantly observe its environment, thoroughly research and  identify  potential  problems,  timely  decisions  making  and  monitor  the  results  of  those  decisions. timely response to identified and explored, existing and potential problems, that  the company meets, creates a greater benefit than the cost of implementation and operation  of a imis. on the other hand, the elimination of consequences of bad or overdue decisions of  the  company,  in  terms  where  do  not  exist  a  imis,  creates  more  costs  than  the  costs  of  implementation and operation of a imis. because of all this it could be concluded that the  imis should take a more important position in the organizational structure of companies that  are proactive and market‐oriented.  references   cateora,  philip  r.,  and  graham,  john  l.  (2007).  international marketing.  13th  edition,  mcgraw‐hill  irwing, new york  churchill, gilbert a. (1991). marketing research – metodological foundations. fifth edition, the dryden  press  craig, samule c., and douglas, susan p. (2005). international marketing research. john wiley & sons  ltd. england  galogaža, milan. (1998). principi marketinga, knjiga prva i druga. copyright by milan galogaža, novi  sad  grupa autora. (1994). ekonomska i poslovna enciklopedija. savremena administracija, beograd  hanić,  hasan.  (2003).  istraživanje  tržišta  i  marketing  informacioni  sistem.  ekonomski  fakultet  beograd, beograd     stanetić, v., general characteristics, ea (2011, vol. 45, no. 3‐4, 69‐81)   81 hanić, hasan and beriz, čivić. (2009). “specificities of online concept in comparision with a classic  concept of marketing research.“ economic analysis, vol. 42, no. 2009/1‐2s: 43‐52.  harvard business review. (1991). “marketing research – the right way”, harvard business review  paperback no. 90061  jovićević miodrag. (2001). informacija i odlučivanje. univerzitet crne gore podgorica  kotler, philip. (1999). upravljenje marketingom, informator zagreb  kumar, v. (2000). international marketing research. prentice‐hall inc. new jersey  lancaster geoff i massingham lester. (1997). menadžment u marketingu. ps grmeč, beograd  macura, perica. (2000). sistem informacija promocije. glas srpski, banja luka  milisavljević, momčilo. (1999). marketing. univerzitet u beogradu, ekonomski fakultet  rakita, branko. (2003). međunarodni marketing. ekonomski fakultet beograd  roljić, lazo. (1997). osnove informatike. univerzitet u banjoj luci, poljoprivredni fakultet banja luka  tihi, boris. (2003). istraživanje marketinga – peto izmjenjeno i dopunjeno izdanje sarajevo. «dom štampe»  zenica  turban,  efraim,  mclean,  ephraim,  and  wetherbe,  james.  (1999).  information  technology  for  management. john wiley & sons inc.  vujaklija, milan. (2002). leksikon stranih reči i izraza. izdavačko preduzeće prosveta, beograd        apstrakt – protok informacija od kompanije prema tržištu, i obrnuto, omogućava efektivnu  komunikaciju  subjekata  sa  okuženjem.  formalizaciju  i  usmeravanje  informacija  omogućava  informacijoni  sistem. suština  funkionisanja  sistema  se odnosi na neprekidno osvežavanje  sadržaja  informacionog  toka,  što  pruža  mogućnost  preduzećima  za  pravovremeno  donošenje  odluka.  informacioni sistemi nalaze primenu u gotovo svim oblastima poslovanja. između ostalih,  jedan od  najinteresantnijih je marketinški informacioni sistem, koji se često smatra substitutom marketinškog  istraživanja (tržišta). njegova upotreba se često percipira nepotrebnom ukoliko se aktivno učestvuje u  istraživanju  tržišta.  cilj  rada  je  da  dokaže  suprotno,  tj.  da  ova  dva  koncepta  nisu  identična  i  međusobno  isključiva,  već  komplementarna  i  kompatibilna.  kako  poslovanje  sve  više  teži  regionalizaciji  i  globalizaciji,  aktuelnost  međunarodnih  informacionih  sistema  dobija  na  značaju.  poslovanje na lokalnom nivou treba posmatrati isključivo kao fragment ukupnog tržišnog portfolia,  naročito  ako  domaće  tržište  nema  potrebne  kapacitete  za  profitabilnu  proizvodnju  ili  ako  je  nerazvijeno.     ključne reči: informacioni sistemi, tržište, marketing, informacije, marketinško istraživanje,  međunarodno okruženje        article history:  received:  27 july 2011 accepted: 25 october 2011        review    book review  organizational behaviour and culture:   globalization and the changing environment  of organizations    edited by  professor mirjana radovic‐markovic      in  this  review  we  introduced  a  book  „organizational  behaviour  and  culture:  globalization  and  the  changing  environment  of  organizations“,  published  by  vdm  verlag  dr.  müller e.k ,germany, in july 2011.   the book represents a unique responses on a very actual and  generally  known  issues.  radovic‐markovic,  m.  in  forward  pointed out that this book focuses on a body of knowledge that  balances  and  requires  that  many  disciplines  should  be  brought  together  to  create  a  contemporary  approach  to  organization  behavior  and  transformation  (of  both  organization  and  the  individual) in a changeable business environment. her intention  as a book editor was  to explore the organization behavior, culture  and strategies relating to effective organizational and managerial performance.  at  the  micro  level,  it  covers  topics  such  as  organizational  behaviour,  organizational  changes  and  restructuring  of  entities.  on  the  other  hand,  the  book  deals  with  terms  of  organizational culture and behaviour examining their impact on economic development and  sustainable growth, when concerning macro level of investigation. these issues, due to the  financial crisis and rapid changes in global economic environment, became very important  for every economic entity.    the book consists of five parts. the first part, entitled globalization, organization behavior  and culture, deals with the issues of organizational behaviour, gender gaps and the influences  of  organizational  culture  on  enterprises  organizational  structure.  in  the  first  chapter,  organizational behaviour in a global context: gender issues, professor radovic‐markovic  stresses  two  most  important  issues  that  are  essential  for  all  modern  companies.  first  is  changes management, that requires from the company to frequently change its strategy and  structure in order to stay competitive in global economy. the second one, cultural diversity,  became  one  of  ordinary  problems  that  companies  in  transition  economies  face  in  recent  years. managing cultural diversity is one of the most important factors of competitiveness  nowadays. gender gap problems, radovic‐markovic addresses, still exist in modern times.  women in eu, earns on the average, 15% less than men (page 18). their participation in top     đukić, m., et al., book review, ea (2011, vol. 45, no. 3‐4, 82‐85)   83 management levels is also significantly lower. therefore, it is on economic policy creators to  find mechanisms for women equal access to economic and financial resources. as radovic‐ markovic  suggest,  female  entrepreneurship  is  one  of  the  major  factors  that  contribute  economic growth  in many developing countries. in the second chapter, ondrej jaško and  ana  jaško examined  the  influence of organizational culture on enterprises organizational  structure.  organizational  model  creation  is  highly  dependent  on  different  cultures  by  determining  business  strategy,  leadership  style,  motivation  etc.  when  evaluating  work  performances  it  is  necessary  to  consider  whether  corporate  culture  is  well  designed.  however, as the authors mentioned, this field is still not enough explored in modern papers  and there is lot of space for further investigations.   second  part  of  the  book  focuses  on  individual  organizational  aspects  such  as  communication  and  motivation  problems  in  modern  companies.  in  the  third  chapter,  managing  communication  in  changeable  business  environment,  authors  present  theoretical  approaches and importance of good communication for companies as well as for managers.  it is intuitive that good communication is vital part of every successful business. but, it is not  always easy to provide efficient communication to achieve coordination and integration of  organizational units on different levels. it is up to managers to provide good communication  using  proper  communication  techniques  of  oral,  or  nowadays  electronic  communication.  when considering environment, things become more complicated since we can do almost  nothing to control it. communication is very related to other management and organization  concepts.  chapter  four  observes  connection  between  communication  and  motivation.  professor  chambers  explores  how  communication  and  motivation  work  together  and  provides tactics as a some kind of guide for managers how to motivate their employees. she  suggests managers to be enthusiastic and friendly oriented toward their employees. people  included  in  projects  need  to  be  well  informed  about  project  progress  and  know  exactly  predicted  rewards  system.  creating  clear  short  term  and  long  term  goals  as  well  as  reasonable deadlines are also considered as tremendously important. considering all these  advices  good  communication  figures  as  a  key.  all  mentioned  concepts  are  developed  in  order to provide formula of business success. professor simandan developed theories that  explain success from completely different point of view. he investigated correlation between  geographical and  interindividual differences and outstanding entrepreneurial success. his  conclusion is that intelligence as well as place one grew up are from exceptional importance  for business success. however, he underlined, only by exploring one’s potentialities, one can  learn  the  things  one  is  good  at.  this  uncertainty  is  pure  wealth  for  him.  conclusions  obtained,  by  simandan,  should  be  motive  for  engaging  more  people  on  the  path  of  entrepreneurship.   in  the  third  part,  the  organizational  context,  readers  will  discover  a  lot  of  interesting  concepts and empirical findings that can be very helpful for understanding nature of modern  organizations.  cvijanovic  and  lazic  considered  importance  of  adequate  macro  organizational  restructuring.  once  created  organizational  entities  have  vertical  and  horizontal  connections.  linking,  dynamisation  and  coordination  within  macro  organizational entities represents a necessary macro organizational structure and it is often  called „harmonization“. the authors stress that modern company is doubtless in need for  performing periodical harmonization through soft structural modalities. as examples they     economic analysis (2011, vol. 45, no. 3‐4, 82‐85)   84 address  work  groups,  collegiate  boards,  commissions  etc.  this  means  need  for  behavior  harmonization too, both direct (through the chosen form), and indirect (through the chosen  model).  in  this  context,  stress  is  also  considered  as  one  of  the  objective  conditions  in  everyday business. in order to improve efficiency as much as it is possible, leaders sometime  increase stress level of their employees. respecting this issue, krumov, larsen and hristova  formulated several hypotheses to test impact of leadership styles on stress experienced by  employees. obtained results indicate the following:   • that demographic characteristics (gender, age, education, family status, number  of children in the family and total length of service in the organization) influences  strategies for coping with chronic stress.  • there are significant correlations between leadership style and perceived stress of  the employees in organizations.  • there are correlations between the leadership style and the strategies for coping  with the stress of the employees.  • the  respondents  perceived  stress  and  the  leadership  style  of  their  leaders  determine the desirable strategies for coping with professional stress.  authors summed up that, especially in time of crisis such as recent global financial crisis,  companies not led by ego‐based charismatic leaders do better than the average on the stock  market.  as  well  as  knowing  itself,  modern  and  competitive  company  need  to  be  future  oriented trying to predict future events and moves of their competitors. recognizing that  managers are often myopic concerning competitors and competitors moves are not always  rationally predictable, drossos and fouskas tried to develop conceptual model that will help  analyzing  competition  and  making  strategic  decisions.  by  their  findings,  successful  competition  analysis  should  include  w1  (sufficient  identification  of  competitors),  w2  (organizational  learning  from  competitor’s  strategies),  w3  (effective  prediction  of  competitor’s behavior) and w4 (successful implementation of competition analysis process  outcomes in firm’s competitive strategy formulation). sum of variables should be equal to 1.  model they developed can be very useful both for new and mature companies. economically  educated auditorium certainly recognize balance scorecard (bsc) concept as one of the well  known concept of strategic planning originated by robert kaplan. globa and gavurova in  chapter  9  examined  learning  and  growth  perspective  of  balanced  scorecard  system  and  focused  their  research  on  slovakia.  they  systematized,  examined  and  evaluated  chosen  attributes  of  the  bsc  system  within  the  process  of  its  implementation  in  the  slovak  organizations,  in  order  to  identify  potential  problems  and  to  propose  possible  solutions.  obtained results made them able to propose two implementation techniques of the morality  profile  into  the bsc strategy maps,  through  incorporation of ethics  into  the existing bsc  perspective or extension of the bsc system by the business ethics perspective. relationship  of  business  ethics  with  the  knowledge  management  is  underreported  in  the  relevant  literature.  however, sometimes management  that respect principles of good organization  restructuring, communication, motivation and proper leadership styles do not meet targets.  reasons for that could be various and sometimes not so evident. product design is one of the  factors that have to be taken into account. malikova performed an empirical investigation in  order to find out consumers criteria for buying products. research is focused on slovakian  and french market. her starting hypothesis was that consumer nationality determines the     đukić, m., et al., book review, ea (2011, vol. 45, no. 3‐4, 82‐85)   85 importance of the same packaging criteria. results she obtained approved that nationality  matters. consumer preferences in france, country with long experience strongly differ from  slovaks. implications of this finding are very useful. packaging designers should be aware  that  nationality  should  not  be  forgotten  when  targeting  foreign  markets,  creating  new  design, redesigning packaging etc.        the fourth part of the book is considering organizational culture and economic development,  and consists of two papers which observe organizational culture from aspects of economic  development and as competitive  advantage. lucian and silviu gave sum up  of  the  most  valuable  definitions  and  functions  of  organizational  culture  concept,  also  trade  off  in  orientation of organizational culture dimensions between various factors, as results towards  processes,  opened  towards  closed  system,  level  and  type  of  control  etc.  types  of  organizational cultures are important part of this paper because it includes classification of  organizational cultures and give analyses based on different features. they suppose that it is  nowadays absolutely necessary to understand functions of organizational culture in modern  enterprises, and to recognize factors that influence on it, both internal and external. the most  important are the national culture and the vision or mission of the organizationʹs founders.  the outline is concerning manifestation and types of organizational culture and it is a great  prelude for the next paper which is observing culture and cultural diversity from an aspect  of  competitive  advantage  for  economic  development.  after  the  cultural  development  process,  there  is  an  interesting  point  of  view,  presenting  culture  as  an  iceberg.  certain  elements of culture are visible to the bare eye and easily noticeable, while most of it is hidden  “under water” – deeply rooted in the value system of the organization.  redzepagic, eric and  stosic concluded that those organizations where there is harmony between the elements of  organizational  culture  and  the  formulation  of  a  strategy,  may  lead  to  better  business  performance, and may have a positive impact on the national economy as a whole.  the final part of this book is kind of mixture composed of three very important issues,  such as social psychology, entrepreneurship development and sustainable economic growth in eu. in  this chapter authors gave their opinion on a body of knowledge that balances and requires  that  many  disciplines  should  be  used  together  to  create  a  contemporary  approach  to  organizational  behavior  and  transformation  in  a  changeable  business  environment.  first  chapter recognizes problem of youth migration and distinctive reasons as economical and  psychological,  also  as  socio‐economic  inequalities  in  eu  countries.  last  paper  includes  information and analysis of support of woman entrepreneurship by european commission,  its aims and projects on promoting this issue.   after reading this book, we were delighted to share the impressions with the auditorium  and all interested readers from different economic areas as well as the authors whose field of  research cover psychology and sociology. due  to  its multidisciplinary approach  it can be  very useful  for  politicians,  engineers and all people  from practice  that run companies or  some company departments. we warmly recommend this book to students, researchers and  everyone interested in organizational behaviour, human resources and entrepreneurship.   mihajlo đukić, saša milivojević  institute of economic sciences    author guidelines    general outline  authors submitting to the economic analysis are requested to email full paper in english. pictures, if  imported, should be placed separately in the zip file in tiff, jpg, gif or cdr format in resolution of  300 dpi.  manuscripts are blind reviewed with the understanding that they are substantially new and have not  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manuscript. economic analysis use aea rules for references.  12. abstracts would be sent to editor‐in‐chief by email                                            cip ‐ каталогизација у публикацији  народна библиотека србије, београд    33        economic analysis / editor‐in‐chief  mirjana radović‐marković. ‐ vol. 42, no. 1  (2009)‐           . ‐ belgrade (zmaj jovina 12) :  institute of economic sciences, 2009‐ (novi  sad : sp print). ‐ 30 cm    polugodišnje. ‐ je nastavak: economic  analysis and workersʹ management = issn  0351‐286x  issn 1821‐2573 = economic analysis (belgrade)  cobiss.sr‐id 169576460        ea_2015_3-4 udc: 005.1:005.342 cobiss.sr-id: 220032268 scientific review new venture creation: controversial perspectives and theories salamzadeh aidin1, university of tehran, faculty of entrepreneurship, tehran, iran abstract – new venture creation is a hot topic and different scholars tried to shed light on this fascinating research subject. despite the vast body of existing literature, there is little consensus about which theoretical perspectives and theories are best suited for describing and explaining the phenomenon. one of the most controversial topics is that “whether this phenomenon could be considered as a process or not?” this paper presents the existing views and theories on new venture creation, and tries to answer the mentioned question. to do so, moroz and hindle’s (2012) distinguished views are used. finally, the paper concludes with some suggestions and remarks. the main contribution of this paper is to criticize the existing perspectives and theories, to categorize them, and to present a more comprehensible view of the phenomenon. key words: new venture creation, perspectives, theories, process introduction the history of new venture creation is as old as the history of organizations (salamzadeh, 2015). however, in the early stages of this domain, i.e. organization sciences, less emphasis were placed on the “new venture creation” phenomenon. as one could see, the earliest notions of new venture creation came from distinguished theories of schumpeter in 1912 and 1934 (schumpeter, 1912, 1934). schumpeter (1937), in “the theory of economic development”, considers new ventures as one of the factors affecting economic development. he sees new venture creation as dependent on entrepreneur’s opportunity recognition process, and leads to technological change. he believes that innovation and creative destruction are the most important elements of creating new ventures, and new venture creation could be the engine for economic development. later, in 1970s, hannan and freeman (1977), in their theory of population ecology, highlight the importance of external environment in determining the lifestyle of companies in the same industry. this theory provides insights into the birth of a new type of company in a typical industry. however, the insights are less prone to be used at the meso and micro levels. these works of followed by other authors for several years, until in 1984, van de ven et al (1984) draw the attention of researchers in this field to consider the phenomenon in different levels, i.e. individual, organizational, and ecological levels. however, it did not take 1 faculty of entrepreneurship, university of tehran, 16th street, north kargar avenue, tehran, 1439813141, iran, e-mail: salamzadeh@ut.ac.ir 102 economic analysis (2015, vol. 48, no. 3-4, 101-109) so long. just one year later, gartner (1985) proposed his challenging view, which dominated the literature, and focused on too narrow a range of determinants to explain new venture creation. these works are followed by others such as, katz and gartner (1988), vesper (1990), aldrich (1990), larson and starr (1993), bhaves (1994), carter et al. (1996), veciana (1988), aldrich, (2000), deakins and whittam (2000), sarasvathy (2001), delmar and shane (2004), grimaldi and grandi (2005), lichtenstein et al. (2006), serarols (2008), lim et al. (2008), samuelsson and davidsson (2009), campbell and de nardi(2009), dimov (2010), davidsson and gordon (2012), brush et al. (2014), and becker et al. (2015). yet, there is a lack of consensus on how to describe and explain this phenomenon. in this paper, the author tries to elaborate the axioms and presumptions used in the existing literature on new venture creation to elaborate what could be the best choice. thus, it answers to the question: “whether new venture creation could be considered as a process or not?” to do so, first the existing literature is briefly reviewed. then, the axioms and presumptions behind each study are discussed, and finally, the paper concludes with some remarks and suggestions for future directions. literature review: controversial perspectives and theories recently, kuratko et al. (2015) investigated the existing approaches, one of which was new venture creation view. they consider eight major themes which characterize recent research about entrepreneurs and new venture creation: (i) venture financing, (ii) corporate entrepreneurship, (iii) social entrepreneurship and sustainability, (iv) entrepreneurial cognition, (v) women and minority entrepreneurs, (vi) the global entrepreneurship movement, (vii) family business, and (viii) entrepreneurial education. on the other hand, proposing a “universal model” for “new venture creation” is not easy, and some scholars believe that it is not promising or reasonable. while some authors agree to the process view, some disagree. the rationale behind these arguments is the source of challenges in this domain. this dilemma, initiated by gartner (1985), is followed by others and no consensus is reached yet. some argue that this process is complex and varies among different entrepreneurs in different environments (haugh, 2007), and some argue that transition between stages is not done automatically (bhave, 1994). similar to gartner (1985), storey (1994) also criticizes the stage models. he personally adheres to this belief that understanding the factors which have influence on growth is important, compared to considering the stages. albeit this view is initiated by gartner (1985) and followed by many others, some process models show that considering a process model in which the environment and environmental factors are included could alleviate this dilemma. some studies on new venture creation approve this argument (e.g. see, parker, 2006). by the way, despite gartner’s (1985) critiques on process models, just one year after publishing his famous views, katz and gartner (1988) presented a model which implicitly follows a process view. they suggested four factors, i.e. intentionality, resources, boundaries, and exchange of resources in boundaries which show the creation of a typical new venture. these indicators convey a logical sequence behind the famous story of new venture creation. that means, once an intended entrepreneur starts its new venture creation activities, he or salauzadeh, a., new venture creation, ea (2015, vol. 48, no. 3-4, 101-109) 103 she searches for resources, shapes the boundaries, and exchanges his/her resources, and enters into a market. this view is similar to larson and starr’s (1993) conceptualization, which used network theories to explain new venture creation, and bhave’s (1994) view which considers the opportunity stage, the technology set-up, the organization-creation stage, and the exchange stage. however, larson and starr (1993) and bhave (1994) explicitly make arguments following process model views, some scholars like vesper (1990), lichtenstein et al. (2006), lim et al. (2008), campbell and de nardi (2009), dimov (2010), brush et al. (2014) try to be more conservative and not enter into this controversial debate. again, haugh (2007) points out that different management styles are considered contingent to each stage in new venture creation. although, this might be true, one could propose that high rates of failure might be a direct result of mismanagement of entrepreneurs/founders in different stages (cardon et al., 2011). for instance, charismatic leadership might be an integral part of managing a new venture in the very early stages, such as recruiting new experts, dealing with angel investors, etc., however, it might not be appropriate in the next stages, such as resource mobilization which requires a more pragmatic that charismatic management style. moreover, haugh (2007) argues that these stage models assume that movement between stages is triggered by a specific crisis. this is a challenging argument to make, which needs to be explored in another studies. remember the notion made by bhave (1994) which tells that there is a transition between stages, and compare it to the haugh’s (2007) argument. even if haugh (2007) disagrees with the process view, she accepts it implicitly. veciana (1988) follows a timeline view. in her view, there are several stages in a lifecycle of an organization, i.e. gestation, creation, launching, and consolidation. she tries to be more specific, and makes clear arguments. later, núñez (2007) elaborates this model in more details, and adds practical comments to this work. deakins and whittam (2000) also make a similar argument. despite the views that disagree with the process model, deakins and whittam (2000) consider formation of an idea, opportunity recognition, pre-start planning and preparation, entry into entrepreneurship launch, and post entry development, as the stages to new venture creation. serarols (2008) agrees with veciana (1988), núñez (2007), and deakins and whittam (2000). he explicitly breaks down the new venture creation process into some stages, i.e. concept (or gestation) stage, planning stage, and implementation stage. samuelsson and davidsson (2009) investigate the venture creation process, and mention that katz and gartner (1988) categorize gestation activities under three groups, i.e. legitimacy building activities, relationship building activities, and resource acquisition activities, which were considered by scholars such as delmar and shane (2004). recently, davidsson and gordon (2012) conducted a panel study of new venture creation, and considered three main areas, i.e. characteristics of nascent entrepreneurs (person), antecedents and characteristics of new venture creation (process), and explaining new venture creation process outcomes (outcomes). in this study, they highlighted the existing approaches on new venture creation, and mentioned that the process view is dominated in last five years. more recently, becker et al. (2015) presented a model, an integrative view of a dynamic multi-stage new venture emergence, that they considered it as a first step towards an integrative discussion of new venture emergence. they used entrepreneurship theories in the 104 economic analysis (2015, vol. 48, no. 3-4, 101-109) field of opportunity discovery and creation. also, they mentioned that there should be a new venture creation process. to elaborate their meaning, they used moroz and hindle’s (2012) distinguished work which considers entrepreneurship as a process. moroz and hindle (2012) differentiated between four types of entrepreneurial process models, which are: static frameworks, stage models, process dynamic models, and quantification sequence models. these theories and perspectives are among the most important new venture creation studies which have numerous proponents and opponents. cons and pros to these views challenged the ideas in their works, but as mentioned earlier there should be some starting points to reach consensus. in the next section we use moroz and hindle’s (2012) categorization of entrepreneurial process models to elaborate the status in this domain. discussion: new venture creation models on the one hand, it is axiomatic that new venture creation is an integral part of entrepreneurship (timmons and spinelli, 1994). in fact, entrepreneurship deals with new venture ideas or opportunities to be discovered, created, evaluated, and exploited in order to create value (shane and venkataraman, 2000). on the other hand, like any other being, organizations or ventures have their lifecycles (lester et al., 2003). they pass through a lifecycle: embryos, birth, growing, and death. as mentioned earlier, organization science, entrepreneurship, and some other fields have focused on different aspects of these entities. yet, the research on new venture creation is still young and in its embryonic stages. considering that new venture creation is a process, and using moroz and hindle’s (2012) distinguished views, the studies could be classified into the following categories: (i) static frameworks: these frameworks capture the overall process. these models divide into a priori stages major tasks or phases. one major weakness of these models is that “they tend to narrow the scope of investigation and that temporal orders of events do not fit the proposed stages and/or often overlap” (moroz and hindle, 2012) (type 1). for instance, see van de ven et al. (1984), gartner (1985), vesper (1990), lim et al. (2008), campbell and de nardi (2009), etc. (ii) stage models: these models add sequences to static frameworks and make sequential processes. these models “characterize the overall process of venture creation without examining the sequence of activities, consists of a limited set of variables connected by speculative causal links; process oriented but do not capture sequence of dynamics” (moroz and hindle, 2012) (type 2). for instance, see katz and gartner (1988), bhave (1994), etc. (iii) process dynamic models: these models show the influence of context and process variations on outcomes. these models “employ qualitative methods to examine how and why variations in context and process shape outcomes; often interpretive, temporal, and change oriented” (moroz and hindle, 2012) (type 3). for instance, see larson and starr (1993), lichtenstein et al. (2006), sarasvathy (2006), etc. (iv) quantification sequence models: these models explain new venture creation based on a historical sequence. these models are “historical sequence-based approaches of the new venture creation process; this approach does not allow salauzadeh, a., new venture creation, ea (2015, vol. 48, no. 3-4, 101-109) 105 researchers to understand the dynamics of how antecedent conditions shape the present and the emergent future within the process (moroz and hindle, 2012) (type 4). for instance, see veciana (1988), carter et al. (1996), deakins and whittam (2000), grimaldi and grandi (2005), serarols (2008), becker et al. (2015), salamzadeh and kawamorita (2016). (v) other models: any other model which do not fit the four mentioned models. for instance, see aldrich (1990, 2000), sarasvathy (2001), delmar and shane (2004), etc. table 1 presents an overview of extant models of new venture creation and their key components, events, stages, or domains. as it is shown in the table, the literature lacks coherence and a clear set of models, and it is too narrowly focused and limited in scope. table 1. an overview of extant models of new venture creation model class author(s) year key components/events/stages/domains static frameworks van de ven et al. 1984 individual, organizational, ecological gartner 1985 individual, organizational, environment, process vesper 1990 technical know-how, product or service idea, personal contacts, physical resources, customer orders lim et al. 2008 acquiring financial resources, developing products, developing a market and acquiring customers, acquiring human and production resources, delivering products, developing production systems, developing other systems campbell and de nardi 2009 “who are you?”, “what are you trying to accomplish?”, “what have you and others put into the business?”, “what have you accomplished?”, “what remains to be done?” stage models katz and gartner 1988 intentionality, resources, boundaries, exchange of resources in boundaries. bhave 1994 opportunity; technology set up/organizing; exchange stage; separate opportunity process: external and/or internal process dynamic models larson and starr 1993 focus on essential dyads, converting dyadic ties to socio-economic exchanges, layering the exchanges lichtenstein et al. 2006 measure the emergence in the dynamics of new venture creation sarasvathy 2006 inputs, effectual strategy, outputs quantification sequence models veciana 1988 gestation, creation, launching, consolidation carter et al. 1996 up and running, still trying; given up deakins and whittam 2000 formation of an idea, opportunity recognition, pre-start planning and preparation, entry into entrepreneurship launch, post entry development grimaldi and grandi 2005 the incubation models serarols 2008 concept (or gestation) stage, planning stage, implementation 106 economic analysis (2015, vol. 48, no. 3-4, 101-109) model class author(s) year key components/events/stages/domains becker et al. 2015 a dynamic multi-stage new venture emergence model salamzadeh and kawamorita 2016 formation stage, challenges, exit stage other aldrich 2000 opportunity identification based on expertise, prior experience, and education sarasvathy 2001 effectuation delmar and shane 2004 legitimacy building activities, relationship building activities, resource acquisition activities source: self-elaborated conclusion “organizational genesis does not mean virgin birth” (padgett and powell, 2012). it is “a journey from conception to birth” (evers, 2003). the process of new venture creation is a journey in which an entrepreneur or a group of entrepreneurs engage in entrepreneurial activities, to turn a new venture idea or an opportunity into value. to do so, like any other entrepreneurial activity, they should follow a process. although the literature on new venture creation lacks consensus about a universal model, this research showed that there should be a process view toward this phenomenon to increase the rate of success and to make a better understanding of it. to do so, the author reviewed the literature to find the nuances and differences in diverse views. next, the author used moroz and hindle’s (2012) outstanding view to categorize the main existing new venture creation models. but, the difference between this research and their approach is that the author considered all the relevant theories and frameworks, and not only the selected one. although one could easily marginalize the ideas in this domain as “merely” addressing entrepreneurship as a process, the range and perspicacity of topics examined demonstrated that new venture creation is a more focused area of research. future researchers might study the main axioms of studies in this domain, categorize them into homogenous groups, and make clearer axioms. also, still there are some dark points which need to shed light on, like investigating the levels of analyses, which is referred to in moroz and hindle (2012), to conduct panel studies like the one done by davidsson and gordon (2012) focusing on process views. using other theories might add fruitful insights to the existing literature as well, such as activities proposed by delmar and shane (2004), which could be integrated into a process view. however, there are some limitations such as considering the industry type, entrepreneurial styles, type of new venture ideas, and last but not least the context. references aldrich. howard e. 1990. “using an ecological perspective to study organizational founding rates.” entrepreneurship theory and practice, 14(3): 7-24. aldrich. howard e. 2000. organisations evolving. 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business sector. london: routledge. timmons, jeffry a., and stephen spinelli. 1994. new venture creation: entrepreneurship for the 21st century (vol. 4). burr ridge, il: irwin. van de ven, andrew h., roger hudson, and dean m. schroeder. 1984. “designing new business startups: entrepreneurial, organisational and ecological considerations.” journal of management, 10: 87-107. veciana, josé maria. 1988. “empresari i process de creacio d’empreses.” revista economica de catalunya, num.8. may-august. vesper, karl. h. 1990. new venture strategies, 2nd ed. englewood cliffs, nj: prentice hall. salauzadeh, a., new venture creation, ea (2015, vol. 48, no. 3-4, 101-109) 109 kreiranje novih poslova: kontroverzne perspektive i teorije rezime – otvaranje novih poslova je vruća tema i stoga su različiti naučnici pokušali da je rasvetle u svojim istraživanjima . uprkos obimnoj postojećoj literaturi, gotovo da ne postoji konsenzus o tome koje perspektive i teorije su najprikladnije za opisivanje i objašnjavanje ovog fenomena. jedna od najkontroverznijih tema je "da li se ovaj fenomen može smatrati procesom ili ne?" ovaj rad prikazuje postojeće stavove i teorije o novom stvaranju firmi, i pokušava da odgovori na spomenuto pitanje. da bi to učinili, moroz i hindle (2012.) su pokušali da naprave razlike izmedju različitih stavova . konačno, u radu se daje zaključak sa nekim priedlozima i primedbama. glavni doprinos ovog rada je kritika postojećih teorija, kako bi se izvršila njihova sistematizacija i predstavio razumljiviji pogled na fenomen. ključne reči: razvoj novih poslova, perspektive, teorije, proces article history: received: 12 june, 2015 accepted: 5 december, 2015 ea_2014_3-4 udc: 005.332:005.322 005.51 jel: l29, o31 cobiss.sr-id 211782924 original scientific paper a leaders’s influence on the definition and implementation of strategy in organizations vujičić slađana1, faculty of business economics and entrepreneurship, belgrade, serbia radović marković mirjana, institute of economic sciences, belgrade, serbia faculty of business economics and entrepreneurship, belgrade, serbia ivković dragan, nikitović zorana, faculty of business economics and entrepreneurship, belgrade, serbia abstract – in modern business conditions, the success of an organization is connected to the leader skills and abilities. leadership becomes more important every day due to the requests of a turbulent and variable environment which can be satisfied only by organizations led by leaders able to harmonize the leading of the organization with the real situation within it. thus leaders, through their behavior and skills influence, define and implement organization strategy to a large extent. key words: leaders, leading process, strategy, organizational changes, transformation. introduction the business activities of modern organizations are trailed by great changes and dynamics. these changes bring difficulties to the large number of organizations, as on a daily basis, the market becomes more unpredictable, with more demanding customers. organizations know that they must gain an understanding of the presence and way of changing in order to succeed in the future (mcmillian, 2012). the survival of organizations in these business conditions is possible only if the leaders of the organizations are ready to face the occurring changes, as they are the basis and key of the success of modern organizations because their role is to create organizations which are flexible enough not only to adapt to changes but also to their executors. aware of the need to strategically plan the future of their organization and the process of implementing the chosen strategies, leaders today tend to lead their organizations in a better and more effective way and to accomplish the given goals. achieving goals is the characteristic of efficient leadership. leader effectiveness is perhaps most obvious when the organization changes its strategy. to implement a new strategic initiative, leaders at subordinate levels must reinforce it; that is, they must allocate resources for it, deal effectively with resistance, and convince employees that the new initiative is important and in their interest (cannella, monroe, 1997; rotemberg, saloner, 1993) 1 corresponding author: sladjana vujičić, email: sladjanakonto@gmail.com vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 91 review of literature the strategy used during the last years can be defined as the main concept of management. due to constant and rapid changes, strategies must be planned and implemented in the right way. xenophon (cummings, 1993), an ancient greek writer, defined strategy as ‘knowledge about the business which is supposed to be done’. from this definition, it can be concluded that knowledge is necessary for implementing strategy and here there is a connection between leadership and strategy formulation. chandler (1962) observed strategy as ‘a defining of the basic long term goals and tasks of the company and defining the course of action and allocation of resources necessary for accomplishing these goals’. asnof (1987) gave the following definition: ‘strategy is the rule of decision-making’. coulter (2010) defines strategy as the cluster of decisions and activities directed toward accomplishing the goals of the organization. the strategy of a certain company is as a rule a mix of the following effects: 1) the proactive actions of managers for improving market position and the financial results of the company, and 2) the reactions to unpredictable happenings and new market conditions (figure 1) (thompson et al., 2008). figure 1 shows the external and internal factors which impact the defining of an organization’s strategy. figure 1. the external and internal factors which impact the strategy of an organization. source: adapted from thompson, a. strickland a. j. iii, gamble j.e. “strategic management – in searching for competitive advantage – theory and practice cases”, complete 14th chapter, zagreb economy and management school, mate, zagreb, 2008, pp. 5-7. today leaders are the key elements for defining and implementing strategy. the leader is to decide what to do and how to do it (hornsby, 2000). the attempt of a leader to change the economic analysis (2014, vol. 47, no. 3-4, 90-103) 92 way of thinking can be considered as the strategy forming process. leaders should adopt a realistic approach to identify the strategic gaps so that proper strategies can be formulated (fairholm, 2009). in fact, leaders are those which influence the behavior of their followers within organizations. they have key role in the decision-making process in order to provide an efficiency and effectiveness of modern organizations. the best leaders need to be attentive, motivational, and supportive (radović-marković, 2007). however, which role they would play and to what extent they will succeed in the realization of the given goals depends on multiple factors, which includes factors from the environment in which an individual was raised, his or her family situation, and his or her personality traits (radovićmarković, 2007a). rauch and bealing (1984) see leadership as ‘the process of influence on the activities of an organized group for accomplishing goals’. howard (2005) defines leadership as the process of communication (verbal and nonverbal) which includes teaching, motivating, leading and supporting others. figure 2 can help us understand leaders and the leading process. the leading process can be envisioned as a dynamic and complex process of exchange. figure 2. the leadership process source: dunham r.b., pierce j. l. (1989) management, glenview, il: scott, foresman, p. 556. figure 2 shows five crucial components and their connections (leader, followers, context, leading process and the results). leadership is a dynamic process which includes a constant exchange between the leader and the followers. leadership in modern organizations brings great responsibility. according to covey (1996), there are three major leader roles: finding a goal, influencing and training. kouzes, posner (1997) promote the attitude that leaders hold the following roles: 1) initiating the process – leaders are capable of noticing good quality ideas, supporting them and accepting the challenge to implement the ideas. leaders are ready to make vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 93 steps into unknown territory and they initiate the innovation processes and are ready to accept innovations. 2) they inspire others with a vision – namely, their associates, as leaders do not motivate by command but with enthusiasm and vision, due to the fact that leadership assumes following without coercion. 3) they provide the possibility for others to act – one of the major leader roles is to give support and help all those which must accomplish a certain business goal. due to rapid changes in the business environment, today’s leaders mostly try to create more flexible organizations and to respond to changes with a good strategy. leader influence on the decision-making process is the core of the strategic management process. figure 3 shows us the influence of certain components which characterize strategic leadership and have a positive influence on the implementation of strategy in organizations: determining a strategic direction, establishing balanced organizational controls, effectively managing the organization’s resource portfolio, sustaining an effective organizational culture, emphasizing ethical practices. figure 3. the role of selected strategic leadership actions in strategy implementation. source: adapted from hitt et al. ,2007 each of these strategic leadership actions positively contributes to effective strategy implementation (hitt et al., 2007). the leader’s role in implementing strategy in organizations leaders and the leading process are key factors for formulating and implementing strategy because they represent the core of strategic management. leaders influence decision-making processes because effective decision-making impacts the implementing of the strategy. also, leaders must be conscious of what is perceived by others and develop strategies that are proactive in building success (radović-marković, et al. 2013). to ease the economic analysis (2014, vol. 47, no. 3-4, 90-103) 94 development of certain strategies and to implement them easily is a very important job of the leaders. in figure 4 we can see strategic leadership and the strategic management process. strategic leader skills culminate in strategic competitiveness and above-average returns. figure 4. strategic leadership and the strategic management process source: hitt et al.,2007 basically, leaders in organizations influence three areas of organization. on the first place, they influence vision, strategies and values. these three components together create the culture of the organization. before strategy formulation, leaders have to identify the need for change by proper care and a full scanning of the environment within which organizations exist (jon, 2008). strategy formulation is all about planning for the future (chatman, 2010). to implement a formulated strategy, all the employees of one organization must take part. each employee should understand the need for change and give his or her own contribution to an effective implementation of the strategy. the leaders must motivate the employees to accept changes because it is known that people always reject them. thus, successful strategy implementation depends on leadership skills of working through others, organizing, motivating, culture building, and creating strong links between a strategy and how the organization does things (thompson et al., 2008). vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 95 the challenge of leadership is the commitment to people within an organization and to embrace change and implement strategies intended to position the organization for this. leaders incite commitment to embrace changes and an effective implementation of strategy through various interrelated strategic leadership roles which include clarifying strategic intent, building an organization, and shaping organizational culture, to mention only a few (pearce, robinson, 2005, 2008). research methodology the aim of the research in this paper is to verify a leader’s role in defining and implementing strategy in organizations. empirical research was conducted by a testing method in which a questionnaire is the chosen instrument. the research was conducted in a random sample of 40 organizations from the territory of the republic of serbia at the beginning of 2014 in a direct interview. the research included 480 employees from the mentioned organizations of different genders and education levels. 0 5 10 15 20 25 shops small enterprises medium enterprises large enterprises number 15 22 2 1 figure 5: structure of the surveyed organizations male 58% female 42% figure 6:surveyed by gender 13% 34% 36% 15% 2% 0% 10% 20% 30% 40% 50% <31 31-40 41-50 51-60 >60 figure 7: surveyed by age economic analysis (2014, vol. 47, no. 3-4, 90-103) 96 for the purpose of the questionnaire, the leader was defined as ‘a person who influences the behavior of employees or a group of people, or an organization as a whole in the aim of carrying out the strategy of an organization’. the strategy of an organization was defined as a cluster of goals, policies and plans for accomplishing an organization’s set targets. the questions in the questionnaire were formulated in such a way that an analysis of the leader’s influence on strategy implementation in organizations could be carried out based on the given answers. the questionnaire was made from three different parts: 1. data about the organization. in this part of the questionnaire, the questions referred to the type of business system, the name of the organization, the address of the organization, business activities and the total number of employees. 2. data about the respondent. this part of the questionnaire contained provided answers, and referred to information about the respondent. 3. the third part of the questionnaire referred to the role of strategy in organizations and to the role of the leader in its conducting. 4. considering all the mentioned, the general hypothesis in the research was the following: h0: leaders in organizations have a key role in defining and implementing the organization’s strategy. based on this general hypothesis we developed separate hypotheses: h1: defining and implementing of strategy are key factors which influence the results achieved by an organization. h2: the business results of an organization depend on the strategy with which an organization responds to external and internal changes in their wish to accomplish results. for each question in the questionnaire, there was an offered answer by which the respondents estimated how much they agree with the given assertion in the form of a fivepoint likert scale (1-very small, 2-small, 3-average, 4-significantly, 5-very significantly). 0.80% 5.20% 13.20% 19.80% 35.40% 25.60% 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% phd ma university degree bachelor's degree graduated other figure 8: surveyed by education level vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 97 the key results of the research and discussion after the collecting of data, we began data processing. below are the results of the empirical research based on the survey conducted in organizations on the territory of the republic of serbia. the respondents have answered eight questions which are significant in determining the leader’s influence on organization strategy (annex). table 1. statistical indicators the arithmetic mean the standard deviation coefficient of variation how much is the organization strategically oriented? 3.9792 1.099045 0.276200 how much does organization strategy influence its success? 4.1292 0.851459 0.206206 how much are employees in an organization aware of the vision and mission of the organization? 4.0438 0.950966 0.235169 how much does a leader influence an organization’s strategy? 4.0583 0.915568 0.225602 how much do leader characteristics influence the defining of an organization’s strategy? 4.0563 0.925879 0.228260 how much does a leader influence strategy implementation? 4.0896 0.874581 0.213856 how much does a leader use modern concepts in defining and implementing a strategy? 4.2667 0.846398 0.198374 how much does applied strategy influence the improvement of the performances of the organization? 4.0167 0.983051 0.244743 the given answers give results which produce reliable conclusions. the survey has shown that leaders influence on the successful implementation of strategy in organization is very large. conclusion leaders are the key for accomplishing the given business targets and carrying out organizational changes, and thereby, conduct strategy in organizations. the research conducted on a random sample of 40 organizations from the territory of the republic of serbia at the beginning of 2014 by direct interview included 480 workers from various organizations has shown that a leader’s influence on defining and implementing strategy is very large. the conducted survey confirmed major and separate hypotheses. for example, to the question ‘how much does a leader influence an organization’s strategy?’ 37.08% respondents replied with a very significant influence, and 38.54% said significant. to the question, ‘how much does a leader influence strategy implementation?’ 38.33% respondents answered very significantly, and 37.8% significantly. economic analysis (2014, vol. 47, no. 3-4, 90-103) 98 the main hypotheses in the paper ‘leaders in organizations have a key role in defining and implementing organization strategy’ is confirmed by the series of positive answers. among the questions used for checking the major hypothesis, the answers given which vary from ‘significant’ and ‘very significant’ are between 30% and 100%. it is especially significant to know that the largest number of respondents recognizes that leaders in organizations have a clear vision about defining and implementing the strategy in the right way. with this paper we tried to show the role of the leader in defining and implementing strategy in organizations and to give a basis for further research. references asnof, h.i. 1987. corporate strategy rev. ed. london: penguin. cannella, a.a., & monroe, m.j. 1997. „contrasting perspectives on strategic leaders: toward a more realistic view of top managers.“ journal of management, 23: 213−237. coulter, m. 2010. strategijski menadzment na delu, prevod sa engleskog. beograd: data status. covey, s.r. 1996. three roles of the leader in the new paradigm, in: hesselbein, f., goldsmith, m., bechard. chandler, a.d. 1962. strategy and structure. cambridge, mass: mit press. cummings, s. 1993. the first strategy, long range planning. davis, r.c. 1942. the fundamentals of top management. new york, harper. dunham, r.b., pierce, j.l. 1989. management. glenview, il: scott, foresman, p. 556. fairholm, m.r. 2004. “different perspectives on the practice of leadership”. public administration review 64(5): 577-590. hitt, m.a., ireland, r.d., and hoskisson, r.e. 2007. strategic management: competitiveness and globalization. 8th edition. new york: west publishing company. hornsby 2000: new roles of leaders: a step by step guide to competitive advantage hillsboro press. howard, w.c. 2005. „leadership: four styles.“ education, 126(2): 384-391. jon minerich. 2008. strategy and leadership, published in a series of articles about leadership. kouzes, j.m., posner, b.z. 1997. the leadership challenge. san francisco, jossey-bass, pp. 8-14. mcmillian, l.a. 2012. „gender, organizational behavior & organizational culture: what studies tell us about how women lead in business?“ international review, 1-2/2012. belgrade: faculty of business economics and entrepreneurship. pearce, j.a., robinson, r.b. 2005. strategic management: formulation, implementation, and control. 9th edition. new dehli: mcgraw hill. radović marković, m. 2007. “women leaders: case study of serbia.” in the perspective of women’s entrepreneurship in the age of globalization, ed. mirjana radović marković, 87-95. iap, charlotte. radović marković, m., salamzadeh, a., razavi, mostafa. (2013). „women in business and leadership: critiques and discussions.“ the second international scientific conference on employment, education and entrepreneurship, belgrade, serbia, pp. 19-31. available at ssrn: http://ssrn.com/abstract=2349488 radović marković, m. 2007a. entrepreneurship for women. belgrade: magnus, pp.157. rauch, c.f., behling, o. 1984. functionalism: basis for an alternate approach to the study of leadership. in leaders and managers: international perspectives on managerial behavior and leadership, ed. j. g. hunt, d. m. hosking, c.a. schriesheim, and r. stewart, 45-62. new york: pergamon press. rotemberg, j.j., & saloner, g. 1993. „leadership styles and incentives.“ management science, 39: 1299−1318. thompson, a., strickland a.j.iii, gamble, j.e. 2008. strateški menadžment – u potrazi za konkurentskom prednošću – teorija i slučajevi iz prakse. četrnaesto cjelovito izdanje. zagreb: mate, 5-7. vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 99 annex to the question ‘how much is the organization which you are working for strategically oriented?’ 20 respondents answered very little, 35 little, 70 average, 165 significantly and 190 very significantly. figure 9: the strategic orientation of organization 4.17% 7.29% 14.58% 34.38% 39.58% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does an organization’s strategy influence its success?’ 2 respondents answered very little, 15 little, 90 average, 185 significantly and 188 very significantly. figure 10: influence of strategy on success 0.42% 3.13% 18.75% 38.54% 39.17% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much do you think employees are aware of the vision and mission of the organization?’ 12 respondents answered very little, 19 little, 78 average, 198 significantly and 173 very significantly. economic analysis (2014, vol. 47, no. 3-4, 90-103) 100 figure 11: vision and mission of the organization 2.50% 3.96% 16.25% 41.25% 36.04% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much do you consider leaders influence an organization’s strategy?’ 5 respondents answered very little, 23 little, 89 average, 15 significantly and 178 very significantly. figure 12: leader’s influence on organization strategy 1.40% 4.79% 18.54% 38.54% 37.08% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much do leader characteristic influence the defining of organization strategy?’ 4 respondents answered very little, 24 little, 97 average, 171 significantly and 184 very significantly. vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 101 figure 13: leader characteristics and organization strategy 0.83% 5.00% 20.21% 35.63% 38.33% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does a leader influence the implementation of a strategy?’ 0 respondents answered very little, 23 little, 95 average, 178 significantly and 184 respondents answered very significantly. figure 14: leader influence on strategy implementation 0.00% 4.79% 19.79% 37.08% 38.33% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does a leader use modern concepts in defining and implementing a strategy?’ 7 respondents answered very little, 9 little, 56 average, 185 significantly and 223 respondents answered very significantly. economic analysis (2014, vol. 47, no. 3-4, 90-103) 102 figure 15: leader and modern concepts 1.46% 1.88% 11.67% 38.54% 46.46% 0% 10% 20% 30% 40% 50% very small small average significant very significant to the question ‘how much does a strategy influence the improvement of an organization’s performances?’ 6 respondents answered very little, 30 little, 102 average, 154 significantly, and 188 respondents answered very significantly. figure 16: strategy and organization performances 1.25% 6.25% 21.25% 32.08% 39.17% 0% 10% 20% 30% 40% 50% very small small average significant very significant uticaj lidera na definisanje i implementaciju strategije u organizacijama rezime – u današnjim uslovima poslovanja uspeh organizacija je usko povezan sa liderskim sposobnostima. liderstvo svakim danom sve više dobija na značaju jer zahteve promenljivog i turbulentnog okruženja mogu da zadovolje samo organizacije koje na svom čelu imaju lidere koji mogu da usklade način vođenja organizacije sa realnom situacijom u njoj. lideri svojim ponašanjem i osobinama u velikoj meri utiču na definisanje, ali i na implementaciju strategije organizacije. vujičić, s, et al., a leader's influence, ea (2014, vol. 47, no. 3-4, 90-103) 103 ključne reči: lideri, liderski proces, strategija, organizacione promene, transformacija article history: received: 7 june 2014 accepted: 23 november 2014 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp92-102 scientific review social responsibility of banks in the function of comparative advantage on the market milica raičević1* | dijana medenica mitrović 2 1 faculty of business studies “montenegro business school”, mediterranean university, podgorica, montenegro 2 faculty for business management bar, bar, montenegro abstract the business operation of companies is not neutral and is not perceived any more in terms of profitable operations, but also in terms of whether it is beneficial for the society. social responsibility contributes to improving relationships with key stakeholders, thus contributing to the long-term sustainability of the company. the paper points out to the positive link between corporate social responsibility (csr) and the reputation of the bank. without csr, neither the improvement nor the expansion of banking operations is possible. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a strong comparative advantage on the market. the paper gives a theoretical and practical overview of the concept of corporate social responsibility (csr), with a focus on the banking sector. in the theoretical part, the term csr is defined, as well as its significance and special features regarding the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its characteristics in terms of csr. the empirical part includes the qualitative analysis, based on the data available on the official sites of banks operating in montenegro. based on the collected internet data, an analysis of the factual situation was carried out, conclusions were given and recommendations have been made for the implementation of the csr concept with a view of improving the competitive position of banks on the market. through qualitative analysis of the available data, the advantages and disadvantages of corporate social responsibility of banks in montenegro were considered, as well as which csr activities are most represented and which still have the capacity to be improved and involved in the marketing strategies of the banks in montenegro. key words: social corporate responsibility, banks, reputation, marketing jel classification: n20, g20 introduction the turbulence of the environment, market changes that represent the process today, not just the business event as they once did, have led to the need for companies to re-examine themselves and to supplement their business strategy in order to gain competitive advantage in the market. in order to gain a competitive advantage they should focus on the people, that is, the need to increase the number of people who use their products and services or more simply believe in them. in order to be successful in a dynamic services market companies must delivered superior value to target customers who become more demanding, and choose products/services rationally, analysing relation between price and quality. the competitiveness of companies in the financial sector is largely based on fostering customer loyalty, integrating * e-mail: milica.raicevic@unimediteran.net milica raičević, dijana medenica mitrović 93 various communication channels, reducing operating costs and good risk management (domazet, stošić and hanić, 2016). in the last ten years, in the literature, as well as in the practice, the concept of social responsibility has started to develop, which focuses on the support to the community in which the business operations are carried out, and in return, these companies are recognized by the community as the companies which should be trusted, which is one of the ways in which the companies can contribute to their growth and their competitive advantage. banks, as a specific phenomenon by itself which has a specific way of generating profit, have realized that they have to incorporate the concept of social responsibility into their business strategy, in order to differentiate and gain a competitive advantage in the banking sector, which is characterized by an increasing number of banks and tougher competition in the financial market. the paper views the concept of social responsibility, the banks in montenegro, as well as the implementation or introduction of this concept in their operations. moreover, a positive correlation between corporate social responsibility (csr) reputation of the bank has been pointed out. the without the social responsibility of banks, it is not possible to improve or extend the banking operations. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a serious comparative advantage on the market. the initial hypothesis: the application of the concept of social responsibility is an important factor for achieving competitive advantage and strengthening the position of banks in the financial market, all through the creation of services that will improve and expand banking activities, to create satisfied consumers who are loyal. auxiliary hypotheses are: 1. the willingness of banks to invest in csr activities will increase the confidence in banks by customers and the community 2. developing awareness of the importance of csr for company business and training and inclusion of employees in csr activities provides for a higher level of business and better reputation 3. socially responsible activities address the problem for which the state does not have sufficient financial resources, which also affects the strengthening of the reputation of the bank 4. improving the business environment creates the conditions for developing the competitiveness of banks and strengthening their position in the financial market, and therefore profit. the paper gives a theoretical and practical overview of the concept of csr and its application in the banking sector. in the theoretical part, the term csr is defined, its significance and specific qualities related to the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its features in terms of csr. the empirical part covers qualitative analysis, on the basis of the data available from the official websites of the banks operating in montenegro. on the basis of the data collected from the internet, an analysis of the factual situation has been conducted, conclusions have been drawn and recommendations have been made for the application of the csr concept in order to improve the competitive position of banks on the market. through the qualitative analysis of the available data, the advantages and disadvantages of social responsibility of banks in montenegro have been studied. it has been analysed which csr activities are the most prominent, and for which there is still the space to be improved and involved in the marketing strategies of banks operating in this area. in the end, it has been pointed out that the awareness of the benefits the csr brings to the company has not still been developed in montenegro. the socially responsible practice is often perceived as an unprofitable and impractical activity. in recent years, in the banking sector, socially responsible activities are growing in importance and have a tendency towards growth. 94 economic analysis (2018, vol. 51, no. 1-2, 92-102) the social responsibility of banks is significant for the montenegrin economy and society, because socially responsible banking activities contribute to the improvement and advancement of the existing situation in certain segments which the country has insufficient resources to support. banks carry out their socially responsible activities through activities in the fields of education, health care, culture, sports, environment protection, and work with people with disabilities. in conclusion, the banks have a dual role, they are both promoters of socially responsible behaviour and institutions investing in those areas of vital importance, for which the state does not have enough resources. the csr of banks represents a serious comparative advantage in the market, because the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro and actively engage in solving problems at both the local and the national level. theoretical aspects of social responsibility of banks in montenegro defining the concept of corporate social responsibility social responsibility is now perceived as an inevitable part of the company's operations and one of the market differentiation options. in this context, social responsibility or corporate social responsibility (according to the world business council for sustainable development) can be seen as "the commitment of business units to contribute to sustainable economic development, cooperation with employees, their families, the local community and society as a whole aimed at improvement of the quality of their lives”(saraiva and serrasqueiro, 2007). this would mean that the concept of social responsibility does not perceive as the opposing sides, on the one hand, the people, the community and the environment, and on the other hand, the economic goals of the company. the concept of social responsibility would mean that the company assumes responsibility for the impact of its own activities on all the stakeholders of the company, as well as on the environment (zelenović, 2015). moreover, it should be emphasized that csr is not the same for every company, but that the business operations according to this principle depends on the size of the company, the economic region, the market and the actual operations of the company. as noted, the operations based on the corporate social responsibility principle connect and enhance the relationships between the company, stakeholders and the environment, and combines them into a single whole that generates benefits both for the company itself and for the meeting of the current needs of future generations. so the most famous model regarding the csr is the model of the pyramid presented by caroll (1996), according to which if the company is to be socially responsible, then it needs to be financially stable (to be profitable), then legally responsible (to respect the laws of the state and markets), then ethically responsible (to operate in accordance with the moral and ethical norms of the society, community and the market) and ultimately to have a philanthropic responsibility (to be a good citizen). when we talk about when the concept of social responsibility dates back, we could say that, from a historical point of view, it dates back to the thirties of the last century, and as the subject of research of experts and interested individuals, somewhat later, sometime to the nineties, when companies accept the contemporary concept of social responsibility and implement it into their business strategy so that the activities they carry out create value for the company's owners, on the one hand, and for a wider community, on the other. significance and characteristics of corporate social responsibility numerous questions are raised regarding the concept and implementation of corporate social responsibility. some of them are related to the actual implementation of this concept in the company's operations and they relate to whether social responsibility is cost-effective or not and whether it should be considered as a cost or as an investment (stojanovi-aleksić and allies milica raičević, dijana medenica mitrović 95 2016). the given questions cannot be answered either with yes or no, but the answers require perceiving the things from different angles. the concept of social responsibility can be viewed from the aspect of the impact that the company operating in accordance with the given concept has on the enterprise and the society. this would mean that the responsible behaviour earns praise, that is, produces positive effects with the public which can be seen in the long run and can create a positive image or improve the existing one. thus, the sense of security and confidence is created among the interested individuals and groups, which creates a positive effect on the actual operations of the company. this means that the concept of social responsibility creates a positive effect on the company through the activities that contribute to the positive image, and the image creates confidence among the stakeholders, which contributes to the increase of the value of company’s shares, greater market share, competitive advantage etc. the study carried out in the usa has shown that the factors related to the social responsibility have almost the same effect on the company's reputation as some traditional factors such as quality, price, usage etc. (stojanovi-aleksić and allies 2016) it should also be taken into account that there is another aspect that reflects the importance of social responsibility, and that is the reporting on corporate social responsibility which should be included in the results and reporting on the company's overall business operations. when we talk about the activities, that is, the areas that the concept of social responsibility entails, we would say that it is the promotion of social goals (humanitarian work), the interconnection between marketing activities and social goals (part of the revenue is allocated for solving the problems of vulnerable groups), volunteer work (voluntary work aimed at supporting and actively participating in a community-run activity) and corporate philanthropy (the company's contribution through humanitarian activities) (stojanovi-aleksić and allies 2016). specific phenomenon of social responsibility in the banking sector the above mentioned prompted us, when talking about social responsibility, to think first about the relationship between csr and profit-making companies, which perceive this concept as a way of contributing to the community, on the one hand, and of gaining greater competitive advantage, on the other hand. the banks generally did not have a need for such a concept. this is due to the fact that they are independent financial institutions that take care of their finances independently, as well as the fact that they are intermediaries in the economy and have no need to care about the profit. however, due to the development of the market, increase in the number of participants in the banking market and increase and creation of new banking services, banks had to find a way to improve their reputation, develop trust among customers, restore the trust through various activities that would be receptive to people's eyes and ears. the assets of the company are not worth without customers, the task of managing services marketing is not only to attract new, but also to retain existing customers. new customers can be attracted only by delivering superior service, the role of marketing is to create a superior offer and ensure customer satisfaction, but also to anticipate the future needs of its clients, only satisfied customers can be loyal to a given organisation (hanic, domazet, 2012).thus the banks have realized that the concept of social responsibility provides an opportunity for expansion and improvement of their business operations. they can incorporate this concept into their defined strategy and thus, through the csr activities, gain competitive advantage in the banking market. by implementing socially responsible activities, the banks become an active part of the community in which they operate (zelenović, 2015) through the following: • promotion of social goals through a financial contribution or other types of contribution to develop or solve a particular social goal, • general well-being marketing when a certain amount of revenue is allocated for the achievement of a social goal 96 economic analysis (2018, vol. 51, no. 1-2, 92-102) • corporate social marketing assistance in development, implementation of campaigns which contribute to raising the awareness of the health, the sick, environmental protection ..., • corporate philanthropy – making direct contributions to a charitable or social activity, • community volunteer work voluntary work of employees and partners, • socially responsible business practice adopting and implementing the business practice that supports a social goal which should improve the life of the community (both the people and the environment) (kotler, li, 2009). based on the above, market changes and behaviour in the banking sector have led to the situation where the banks behave in the following way (vunjak, kovačević, 2006): • customer orientation because he/she is the most important person • the client is the purpose of the banking business • respecting the wishes and demands of the clients • a higher marketing concept • customer service quality. the motive for introducing the concept of social responsibility appears at different levels (zelenović, 2015): • internal ethics processes in banks and • external ethics consequences of banking actions. practice of social responsibility of the banks in montenegro the empirical framework of social responsibility of the banks in montenegro banks, as independent financial institutions, have focused on the care about their finances until recently. the bank is perceived solely as a recipient and provider of banking services, whose employees dominate the clients, without the adequate system of rewards and without paying a particular attention to the competition and customer requirements. the turbulent environment, the saturation of consumers by marketing advertising of various forms, has imposed the need for incorporating the socially responsible operations in the strategies of banks, as the necessary prerequisite for acquiring and maintaining the competitive advantage. they must not be focused solely on profit, but must be socially responsible, and take care of the environment. this raises the question of whether company can be both environmentally and socially responsible and profitable at the same time (domazet, kovačević, 2018). the whole community benefits through the activities of corporate social responsibility and the clients are becoming aware of this. by associating their products and services with the solving of a particular social problem, the banks do their promotion and encourage customers to buy their products or services. banks can demonstrate corporate social responsibility by providing the financial resources for raising awareness of a social problem, encouraging campaigns for behavioural change, engaging in local initiatives, humanitarian actions, financing and implementing the business practice for environmental protection or improvement of community life. all of these activities can be carried out by the bank itself and in cooperation with public sector partners, profit and non-profit organizations. moreover, the bank encourages and supports both its employees and partners to help local organizations and actions through voluntary work. implementation of csr activities is increasingly under pressure, both internal and external, to apply a strategic approach. the bank needs to choose what it will focus on and how to link its philanthropic and other initiatives to its business goals and tasks. the goal of milica raičević, dijana medenica mitrović 97 investing in various forms of socially responsible strategies is the strengthening of the bank’s reputation. through its reputation, the bank creates barriers to its competitors, sends a message that its services are of high quality, improves its market position, which contributes to profit increase. at the level of the economy, such operations encourage increased competitiveness and transparency in business, encourages trust and partnerships with the target public. the goal of reputation is not that a bank is liked but to create its value through business success and the solving of community problem which the state cannot solve alone. changes in the way of thinking and behaviour have led to more customer-orientated banks today, respect for customers' wishes and demands, introduction of a higher marketing concept and an increase in service quality. today, even conventional banks are participating in the actions that are of general welfare to the community. some of these activities are as follows: local scholarships and sponsorships, financing in the field of sports, health care, culture, more affordable housing loans, financing of some traditional events in the community, etc. although the positive effect of applying the csr concept in the banking operations has already been recognized, this concept is still inadequately implemented in a wider scope in montenegro, although the trend towards the growth of csr activities has been present in recent years. the reason for this can be found in the still underdeveloped awareness of the benefits of socially responsible practice, since such practice is often perceived as unprofitable and impractical experience. the common approach to corporate social responsibility is usually limited, defensive and unrelated to the actual strategy of the bank. the csr activities should be aimed at enhancing the relationship between employees and customers (as key stakeholders) so that they do not abandon the bank. according to the official data of the central bank of montenegro, 15 licensed banks operate in montenegro. the data on corporate social responsibility of banks is available on the official websites of seven montenegrin banks, which suggest that a little less than half of the banks have recognized the importance of informing the stakeholders of this aspect of bank operations. the csr data is available for the following banks: 1. societe generale bank montenegro ad 2. prva banka crne gore ad podgorica 3. nlb banka ad podgorica 4. addiko bank ad podgorica 5. erste bank ad podgorica 6. crnogorska komercijalna banka ad podgorica member of otp group 7. hipotekarna banka ad podgorica on the basis of available data on the official websites of montenegrin banks, it can be concluded that socially responsible activities are mainly focused on the fields of health care, education, sports, culture and the promotion of environmental protection. analysis of the state of corporate social responsibility of the banks in montenegro analysis of the state of corporate social responsibility of the banks in montenegro was made on the basis of secondary data, available on the official websites of the banks operating in our territory. below is an overview of the key objectives and activities of the seven banks, which publish the information on their csr activities on their websites. societe generale montenegro bank indicates, as the objective of its csr activities, the support for projects in the field of health care, education and culture which are useful for citizens and society over a longer period of time. the social community has acknowledged the efforts of this bank and in 2011, 2012 and 2015 societe generale montenegro, as a socially 98 economic analysis (2018, vol. 51, no. 1-2, 92-102) responsible company, was given the iskra award for philanthropy for the overall contribution of the bank to the montenegrin society and for its contribution to inclusive education. the bank is also the winner of the naturally equal award received for the best practice in achieving gender equality in montenegro (http://www.societegenerale.me/mne/o-nama/o-societegenerale-banci-montenegro, accessed on 17.03.2018.). the activities of the bank focused on healthcare activities included cash donations for the purchase of necessary resources for the montenegro clinical centre and the institute for children's diseases, as well as for procurement of medical and sanitary equipment for healthcare institutions, primarily for health care centres and general hospitals in the territory of montenegro. in this way, the bank contributes to the creation of better conditions for the strengthening of health care and the care about the public health. the bank is also active when it comes to monetary donations and cooperation with nongovernmental organizations dealing with the problems of children with developmental disturbances, people with disabilities, children suffering from cancer, as well as women victims of violence and juvenile mothers. with these donations, the bank draws attention to this group of women and children and actively participates in an effort to improve the position of women and children in the montenegrin society. societe generale bank also directs its socially responsible activities towards the support for inclusive education (donations to the stimulation room in elementary schools, financing instruction manuals for improvement of the teaching process within the inclusive education). through donations for educational tools in kindergartens, the construction of children's playgrounds, presents for pupils who walk to school from rural areas, the concern is shown for young people and improvement of conditions in educational institutions. the bank also organized a student competition on the topic of corporate social responsibility, which contributes to the development of awareness of the importance of corporate social responsibility among this target group. within the activities aimed at environmental protection, the bank supported the activities of greening of certain parts of the capital. another action with the same goal was the purchase of electric bicycles for employees and clients. numerous activities include humanitarian aid for the most deprived families, donations for the library of the blind, as well as numerous sponsorships for art exhibitions of montenegrin artists. prva banka crne gore has actively participated in the realization of socially beneficial projects since the very beginning of its existence. it is recognized by its support for projects of national significance in the field of health care, culture, sports, as well as support for humanitarian and other projects that have an impact on raising the quality of life of the citizens in montenegro (http://www.prvabankacg.com/o-nama/drustvena-odgovornost/, accessed on 17.03.2018.). some of these projects by which prva banka crne gore confirms its strategic commitment to corporate social responsibility include: the ulcinj's greening project, sponsorship of the women's handball team of montenegro at the world championship in denmark, a donation for the internal ward of the bar hospital. nlb montenegro bank promotes its socially responsible operations through sponsorships or donations to cultural, sports and entertainment events as well as environmental protection projects. the largest and most significant sponsorship projects of nlb banka are: sponsorship of the budućnost basketball club, the as tennis club, the main sponsor of the national parks of montenegro, which has been its partner since november 2010 within the project 'obradujmo prirodu' (make the nature happy), which contributes to raising awareness of the importance of environmental protection and conservation of protected natural areas for future generations (https://www.nlb.me/me/nlb-banka/opste/sponzorstva-i-donacije, accessed on 17.03.2018.). milica raičević, dijana medenica mitrović 99 for several years, addiko bank ad podgorica has been allocating funds in a planned manner, within its budget, to support the local community, where it carries out its activities, through the support for the work of educational and healthcare institutions, and events aimed at promoting and preserving social values through the fields of culture, arts, non-commercial sports activities (https://www.addiko.me/o-nama/drustvena-odgovornost/sponzorstva-idonacije/, accessed on 17.03.2018.). the most significant activities include: donations to children and adolescents with developmental disturbances; cooperation with non-governmental organizations and primary schools to support children with autism spectrum disorders; donations to children suffering from cancer; donation to the institute for children's diseases for the supply of equipment for the orl ward. in cooperation with the red cross, it participates in humanitarian actions for socially vulnerable citizens and in voluntary blood donation activities. among numerous activities the following are also worth mentioning: donations to the fire department in tivat; assistance for the purchase of equipment for the national team of the special olympic games of montenegro; baskets for the school gym in žabljak; equipment for primary and secondary schools in kotor and tivat; procurement of exercise equipment in the gym of the junior team of the "jadran" water polo club; a donation aimed at improving the social inclusion of children and youth with developmental disturbances and people with disabilities; donations of children's books to libraries in podgorica and kindergartens in kotor and tivat; sponsorship of the sea dance festival. as a modern and practical bank focused on customers and their needs, addiko has also provided the festival's visitors with various opportunities to make simple financial transactions on-site. the sea dance festival payment card and the addico bank card was the official payment instrument at the sea dance festival, and addiko bank has also provided an atm for cash withdrawals for all visitors (https://www.addiko.me/onama/drustvena-odgovornost/sponzorstva-i-donacije/, accessed on 17.03.2018.). what seems interesting is the fact that all the activities listed on the website of addiko bank were conducted in the period from november 2016 to december 2017. erste banka actively and consistently contributes to the re-building of the value system, the development of society and culture in the country by initiating, acknowledging and providing organizational and financial support to the activities, projects, organizations and institutions acting in the same direction. erste banka gives its contribution to: the culture and arts, education, sports, social inclusion and environmental protection (https://www.erstebank.me/sr_me/footer-stanovnistvo/o-banci/sponzorstva-i-donacije accessed on 17.03.2018.). one of the ongoing programmes listed on the website refers to the best of south east programme: study in graz –development and further education programme, as well as international work experience for talented and dedicated graduates and students from montenegro, bosnia and herzegovina, croatia , macedonia, slovenia and serbia. crnogorska komercijalna banka bases its corporate social responsibility on supporting independently or as a partner the realization of projects in the field of culture, arts, science and sports. aware of the importance of entrepreneurial initiative in culture, ckb has supported the representative editions of the cid publishing house (economic, literary, legal, anthropological, historical) which has published important studies from the history, culture, nature of montenegro, as well as numerous capital translations (http://www.ckb.me/marketing-ipr/marketing-i-pr.69.html accessed on 17.03.2018.). ckb sponsors or participates in the organization of various events (concerts, mimosa festival, world savings day), gives donations in the field of health care, education and science, paying special attention to children and young people, through the scholarships to the best, but also through the ckb donations to the unicef projects. the support for sports clubs in football, basketball, handball, karate, and cooperation with the montenegrin water-polo national team are some of the csr activities of crnogorska komercijalna banka. ckb has recognized the importance of financing in the field of cinematography (film festival hercegfest) and arts. 100 economic analysis (2018, vol. 51, no. 1-2, 92-102) moreover, for the first time in montenegro ckb ensures the financing of renewable energy sources aimed at continuous improvement of efficient and sustainable economic, social and ecological environment (http://www.ckb.me/marketing-i-pr/marketing-i-pr.69.html accessed on 17.03.2018.). hipotekarna banka ad podgorica is the winner of the special award "iskra" for corporate philanthropy in 2016. the award has recognized the contribution and importance of corporate social responsibility of hipotekarna banka ad podgorica, which has several directions: investment in health care improvement, investment in culture, care for the elderly, investment in youth education and general contribution to the community. some of the csr activities of hipotekarna banka are: donations of books to educational institutions in montenegro; scholarships and the provision of international practice to the best students; procurement of reanimation vehicle for the needs of the institute for emergency medical assistance; together with the partners, the donations of vehicles for the transportation of patients on dialysis of the montenegrin clinical centre; participation in the donation to the clinic for gynecology and obstetrics; in cooperation with the non-governmental sector, the donations to the nursery home in bijelo polje; the general sponsorship of the montenegrin national theatre; donations of funds for the construction of a swimming pool in nikšić; sponsorship of the made in ny jazz festival; organization of panel discussions "live globally, work locally”(http://hipotekarnabanka.com/o-banci/vijesti accessed on 17.03.2018.). results of empirical research the overall goal of sustainable development is the long-term sustainability of economy and the environment, which will be achived by integrating economic, environmental and social aspects of the decision-making process (domazet, kovačević, 2018). adequate socially responsible activity of banks contributes significantly to the improvement and advancement of the existing situation in those segments of society and the local community which the state has either insufficient interest or resources to support. from the previous analysis of the state of corporate social responsibility of banks in montenegro, it can be seen that some banks are aware of their social responsibility, which is demonstrated through financial investments in certain activities. some of the most prominent activities include: inclusive education, work with people with disabilities, health care, education, sports, culture, environmental protection, work with the youngest, which are all segments of our society, for which insufficient funds are allocated from the state budget. table 1. csr activities of the banks in montenegro bank csr activity societe generale banka mne prva banka crne gore nlb bank mne addiko bank erste bank crnogorska komercijalna banka hipotekarna banka health care x x x x education and science x x x x x inclusive education x x social inclusion x x x x culture x x x x x x x sports x x x x x x arts x x x x environmental protection x x x x source: authors' analysis 18.03.2018. milica raičević, dijana medenica mitrović 101 banks have a dual role: the role of promoters of socially responsible behaviour and institutions investing in those areas of vital importance for community development, for which the state does not have enough resources. in this way, the banks are directly involved and become a partner to the country in solving strategic social issues, both at the local and the national level. banks also have some benefits from csr initiatives, namely: building a strong corporate reputation, contributing to overall business goals, attracting and retaining motivated workforce, supporting marketing goals, establishing strong relationships in the community, etc., which contributes to the comparative advantage of certain banks in the market. given that these activities are just some of those available to the banks in the area of corporate social responsibility, we hope that corporate social responsibility will develop in montenegro in the forthcoming period, and that the banks will also be in a position, through the appropriate selective credit and interest rate policy, as well as the establishment of special funds, to have a direct impact on the companies to behave in a more responsible manner. given that montenegrin banks are predominantly in foreign ownership and that the csr represents a serious comparative advantage on the market, the foreign banks which implement the csr send their customers a clear message that they are ready to stay in montenegro and actively engage in solving problems both at the local and the national level. conclusion as the conclusion of the paper and the conducted research, it is suggested that the concept of social responsibility and supplementing the bank's business strategy with it, can have multiple benefits for the bank itself, i.e. its competitive advantage in the banking sector, as well as for the improvement of the community and hence greater customer satisfaction. by introducing this concept, a positive image is built in the market, and thus a greater degree of trust is created in the operations of the bank by all interested individuals and groups. the paper analyses the concept of corporate social responsibility, its positive effect on the above-mentioned entities, the introduction of this concept into the strategy and business policy, the specific phenomenon of the bank and its operations, and the contributions that the introduction of this concept makes both for the bank and for all stakeholders of the bank. the results obtained by empirical research in montenegro indicate that banks carry out their socially responsible activities through the activities in the fields of education, healthcare, culture, sports, environmental protection, and work with people with disabilities. the conclusion is that banks have a dual role, they are both promoters of socially responsible behaviour and institutions that invest in those areas of vital importance, for which the state does not have enough resources. it was then concluded that the csr of banks constitutes a serious comparative advantage in the market, since the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro, and actively engage in solving problems both at the local and the national level. the contribution of this paper is reflected in the fact that through a qualitative analysis a breakdown has been given of the activities and areas in which the csr of banks in montenegro is present. an analysis of csr activities can be helpful to decision-makers in the marketing sector of banks in deciding how to use csr as one of the leverages for gaining the comparative advantage in the market. we have also defined in the paper what characterizes the csr of the banks in montenegro, what are the advantages and what are the shortcomings in the past csr practice of banks, and in which direction the csr of banks should be improved. the contribution of the paper is also reflected in the analysis of what is the extent of the impact of csr activities on the generation of a higher profit of banks. moreover, new opportunities for future research have been opened, and one of them concerns the strategies that banks use in the implementation of corporate social responsibility. 102 economic analysis (2018, vol. 51, no. 1-2, 92-102) references carroll, archie. 1996. business and society: ethics, sustainability and stakeholder management, cincinatti ohaio: south-western collage publishing domazet, ivana, đokić ines and milovanov olja. 2018. “the influence of advertising media on brand awareness”, management: journal of sustainable business and management solutions in emerging economies, 23(1):13-22. domazet, ivana, and kovačević milica. 2018. “the role of green marketing in achieving 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http://www.ckb.me/marketing-i-pr/marketing-i-pr.69.html, (accessed march 17, 2018). erste bank ad podgorica, 2018. https://www.erstebank.me/sr_me/footer-stanovnistvo/obanci/sponzorstva-i-donacije, (accessed march 17, 2018).ž hipotekarna banka ad podgorica, 2018. http://hipotekarnabanka.com/o-banci/vijesti, (accessed march 17, 2018). nlb banka ad podgorica, 2018. https://www.nlb.me/me/nlb-banka/opste/drustvenaodgovornost, (accessed march 17, 2018). prva banka crne gore ad podgorica osnovana 1901. godine, 2018. http://www.prvabankacg.com/o-nama/drustvena-odgovornost/, (accessed march 17, 2018). societe generale banka montenegro ad, 2018. http://www.societegenerale.me/mne/bankau-javnosti/banka-kao-drustveno-odgovorna-kompanija, (accessed march 17, 2018). article history: received: april 2, 2018 accepted: june 6, 2018 udc: 336.774.3 005.334:336.77 cobiss.sr-id 252606476 scientific review methodology of credit analysis development slađana neogradi1* 1 addiko bank, belgrade, serbia abstract the subject of research presented in this paper refers to the definition of methodology for the development of credit analysis in companies and its application in lending operations in the republic of serbia. with the developing credit market, there is a growing need for a well-developed risk and loss prevention system. in the introduction the process of bank analysis of the loan applicant is presented in order to minimize and manage the credit risk. by examining the subject matter, the process of processing the credit application is described, the procedure of analyzing the financial statements in order to get an insight into the borrower's creditworthiness. in the second part of the paper, the theoretical and methodological framework is presented applied in the concrete company. in the third part, models are presented which banks should use to protect against exposure to risks, i.e. their goal is to reduce losses on loan operations in our country, as well as to adjust to market conditions in an optimal way. key words: loan, credit analysis, credit risk, credit process, assessment of creditworthiness jel classification: j21, e0 introduction credit policy is the one that directs credit placements into priority economic branches and sectors, ensuring the stability of an individual bank as a lender. a good credit policy implies a well-designed credit analysis and a selection of credit placements. (hanić a., žunić e., dželinhondžić, 2017). adequately defined credit policy means respecting strict principles and standards for formulating loan applications, financial analysis, credit analysis, credit classification and structure, implementation of internal control of approved loans, and determination of methods and ways of credit obligations (domazet, marjanović, 2017). approving loans to clients is the core business of banks. loans are the basic component of assets of most banks. they are the main source of income, but also the main source of risk exposure. banks must constantly monitor their overall loan coefficient in relation to total assets, being aware that the increase in the loan-to-asset ratio is promising higher revenues, but also a higher risk (ćirović, 2002). the coefficient method is most common in banks. its basic function is to closely monitor the ability of the borrower to repay the credit obligations, the degree of efficiency of the business and the use of resources as well as the levels of potential risk (vuković, domazet, 2014). one of these criteria is the company's liquidity, its profitability, its indebtedness, equity, interest rate coverage, operational efficiency of assets and its business integrity (ranković, 2005). * e-mail: s.neogradi@gmail.com 76 economic analysis (2017, vol. 50, no. 3-4, 75-85) loan granting is also a risky activity, as apart from the internal factors, there are external factors which also influence the quality of the loans, such as changes in the economy, natural disasters, as well as the regulations adopted by the state. the estimation of the probability of the debtor's default is the main component of any rating category (anderson, 2007). among the existing approaches to measuring credit risk, the key input for each of them is the existence and use of the borrower's credit rating (carey & hrycay, 2001). despite innovations in the field of financial services, credit risk is still the most significant single cause of bank bankruptcy (vuković, domazet, 2015). in its broader sense, credit risk also signifies the risk from a decrease in the credit rating of the debtor or the issuer of securities, thereby increasing the probability of default and/or loss of money invested (domazet, stošić, 2013). the exposure to credit risk in modern banking business is measured by estimating the expected loss on a certain investment based on quantitative analysis, whereby the expected loss for this type of risk depends on three components (bcbs, 2004). credit and interest rate risk are the two most important risks which commercial banks may encounter. this article provides a comprehensive framework for measuring the integrated impact of both types of risk. taking into account the changes in the prices of characteristics of assets, liabilities and off-balance sheet items, the integrated impact of loans and interest rates on banks' economic value and capital adequacy is estimated. the stress test, which is applied on banks, is fundamental to measuring credit and interest rates (drehmann m., sorensen s, and stringa m., 2010). altmant's z-score model was a logical upgrade of the current development of credit analysis. the financial indicators that measure profitability, liquidity and solvency of the company were considered irreplaceable and priceless performance indicators of the company. it is only recently that, with the development of new credit risk models, the potential of using financial indicators in assessing the creditworthiness in anticipating bankruptcy of the company is put to question (altman, edward i., g. haldeman, and p. nurajanan, 2001). loans are granted on the basis of a direct request by the client, who contacts the credit institution. when discussing with a client, the loan officer assesses his character and the real purpose of the necessity for additional monetary funds. a loan officer also contacts other creditors who have previously approved loans to this client to assess their experience in dealing with this client. records of an earlier loan can be seen in the credit bureau. when all the necessary documentation is collected, the loan officer undertakes preparation of the financial analysis of the loan applicant in order to determine the client's creditworthiness. the credit analysis department then makes a proposal and gives their recommendation, i.e. their opinion, which is further forwarded to the credit committee for approval. if the credit committee approves the request, contracts are drafted, signed by both parties. the evaluation of the borrower's creditworthiness is defined as a financial analysis in which the information collected is systematically examined and interpreted in order to evaluate the past and present performance of the borrower, as well as its future prospects. the analytical techniques used in the financial analysis are numerous. the financial analysis is based on a critical examination of the balance sheet, the profit and loss account, the cash flow statement and the ratio of numbers. balance sheets and profit and loss accounts provide a static picture of the borrower's creditworthiness, while the cash flow statement brings about the required dynamism into the analysis (ranković, 2005). the most complex method of determining the creditworthiness of a loan applicant is the degree of business efficiency and utilization of resources, the level of operating funds used, the efficient use of credit resources and the level of potential credit risk. the analysis becomes a very suitable approach to continuous monitoring and checking the borrower's creditworthiness, early detection of deformations in the rating of financial strength of companies and signaling the process of correcting the business strategy. the determination of creditworthiness through the coefficient method is applied widely. the method consists of the analytical transformation of raw balance data and company reports and the comparison of the obtained credit rates with slađana neogradi 77 standard, theoretical, empirical and sectoral rates. by analyzing all indicators, the creditworthiness of the company is evaluated, which represents its ability to repay the debt. the aim of the research is the analysis of the credit analysis methodology and application of the model to reduce the credit risk in banks in the republic of serbia. risk management becomes very important under the conditions of constant changes in the banking environment today and in the organization of banking operations which bear a very high risk. the basic hypothesis is the application of more rational components for making the improvement in credit analysis. banks can use empirical models that can help to determine the financial difficulties of the borrower. our banks cannot remain immune to this trend of development, and the need to control the risks that this development brings about. it emphasizes the process of deregulation of the economy and the banking system, but also points out the instability of the conditions in which this process is implemented. in the banking sector this need is best illustrated by the data on the growing number of non-performing loans in many countries, which further motivated the national bank to develop a set of procedures and to introduce regulations governing the control and protection against credit, interest, currency and other risks, and also encouraged many banks to seriously direct the actions forecasting and managing risk, and develop functions of risk management. the oldest and most popular empirical model is called the z-score model. the origin of all empirical models is the z-score model, designed by edvard altmant. the model was a logical upgrade in the evolution of the development of credit analysis. financial indicators which are measured are the following: profitability, liquidity and solvency of companies were considered indispensable and invaluable indicators of company performance. yet recently, with the development of new credit risk models, the potential use of financial indicators to assess the creditworthiness of companies and bankruptcy forecasts are put on question. the essence of the method is to bridge the gap between traditional credit analysis and exact parameters obtained based on statistical multivariate methods of analysis of the creditworthiness of the loan applicant. zeta method is considered a second generation of z indicators and consists in using current data, a larger number of variables (a total of seven) and the inclusion of a very wide range of companies from industry, trade, services etc. it is considered to be particularly reliable for long-term predictions. it is based on the methodology of discrimination analysis and formulation of synthetic indicators of financial and credit quality of the borrower. this method is very important in taking decisions on the (non) approval of the loan to a company. based on the results of the bank will determine the level of interest rates, compensatory share of borrower, collateral structure and coverage of credit. zeta method determines the solvency of the borrower and the level of potential risk in case of placing the loan. companies that do not meet the established framework of the financial profiles cannot get a loan. methods for early detection of financial difficulties of enterprises by banks have a wider application in relation to the allocation of bank resources. credit analysis in the company z-group based on the parameters used in banks in the republic of serbia credit analysis of the company z-group is presented in the paper. 78 economic analysis (2017, vol. 50, no. 3-4, 75-85) table 1. balance sheet z-group (in 000 eur) assets 31/12/2016 31/12/2015 31/12/2014 cash and cash equivalents 3,258 2,499 1,435 receivables from sales 8,929 7,035 5,994 other receivables 4,994 4,167 2,455 inventories 35,950 32,111 19,203 current assets 53,080 45,811 29,078 land and premises 31,044 21,385 18,856 plant and equipment 14,144 13,268 9,789 current payments and construction 1,838 118 9 tangible fixed assets 47,025 34,771 28,655 shares, related parties 0 0 0 receivables from sales (mid-term/long-term) 0 0 0 other assets (mid-term/long-term) 590 566 100 various assets (mid-term/long-term) 590 566 100 accrued taxes 1.470 347 185 other receivables 626 3,161 65 goodwill 3,131 0 0 total goodwill, z-group receivables 5,228 3,508 250 total assets 105,923 84,658 58,083 liabilities and capital 31/12/2011 31/12/2010 31/12/2009 liabilities to banks 34,762 15,461 13,758 liabilities from sales (short-term) 25,759 23,323 16,369 other liabilities, deferred income (short-term) 3,757 3,192 2,477 current mid-term/long-term liabilities 7,360 7,330 4,145 provisions – without pensions (short-term) 122 266 750 total short-term liabilities 71,760 49,572 37,499 liabilities to banks 13,451 7,216 7,880 liabilities from sales (mid-term/long-term) 472 0 0 liabilities for pensions 0 0 0 other mid-term/long-term provisions 0 0 0 other liabilities, deferred income (mid-term/longterm) 1.395 151 127 liabilities (mid-term/long-term) 15,318 7,367 8,007 minority interest and fixed assets 6,653 6,653 5,892 extra assets, capital surplus 16,461 16,187 287 retained earnings/ accrued loss -11,142 3,033 3,638 own shares -734 -387 -736 other changes on equity 7,607 2,233 3,496 equity 18,845 27,719 12,577 total liabilities and equity 105,923 84,658 58,083 source: serbian business registers agency slađana neogradi 79 table 2. profit and loss account of z-group (in 000 eur) revenues, expenses and result 31/12/2016 31/12/2015 31/12/2014 net sales 135,285 110,761 90,671 costs for goods sold -74,417 -59,548 -47,161 gross profit (loss) from business operation 60,868 51,214 43,510 sales, general and administrative costs -29,492 -21,739 -17,116 other business expenses -39,076 -27,829 -17,116 writing-off/appreciation of receivables -241 -41 -7 currency difference -14 358 463 earnings before interest and tax (ebit) -7,305 4,061 7,189 interest and other expenses -6,024 2,190 5,419 interest receivable and other financial revenues 90 205 42 earnings before tax/group/extraordinary -13,239 2,190 5,419 revenues from participation of related parties 0 0 0 earnings before tax and extraordinary revenue -13,239 2,190 5,419 other/writing-off/appreciations/provisions 0 0 0 extraordinary writing-off of tangible and intangible fixed assets 0 0 0 extraordinary expenses 0 0 0 profit/loss from sales of assets 0 0 0 addition/ascribing/with provisions before tax 0 0 0 extraordinary revenues 0 0 0 other ascribing and revalorization 0 0 0 profit (loss) before tax on income -13,239 2,190 5,419 deferred tax income/loss 1,122 -113 -18 income tax -144 -1,149 -1,311 net income -12,261 927 4,089 source: serbian business registers agency negative and available cash flows in 2015 and in the first half of 2016 are the result of negative flows from business and investment activities. the group has an increase in inventories, a reduction in liabilities to related companies, and a significant investment in equipment. cash flow statement of z-group is shown in table 3. table 3. cash flow statement of z-group (in 000 eur) position 31/12/2011 31/12/2010 31/12/2009 earnings before tax (profit/loss before income tax) -13,239 2,190 5,419 depreciation of intangible fixed assets 6,253 4,192 3,047 writing-off/appreciation of receivables 241 41 7 loss/profit from sales of fixed assets 0 0 0 other extraordinary expenses/revenues 0 0 0 loss/profit from capital investments/related parties 0 0 0 interest and financial expenses/revenues 5,934 1,871 1,770 earnings before interest, taxes, depreciation and amortization/ebitda -811 8,294 10,243 income tax -144 -1,149 -1,311 changes in tax/provisions -1,055 -581 0 earnings before interest, depreciation and amortization/ebida -2,010 6,563 0 interest and financial expenses/revenues -5,934 -1,871 0 current long-term liabilities from the previous year -7,330 -4,145 0 80 economic analysis (2017, vol. 50, no. 3-4, 75-85) position 31/12/2011 31/12/2010 31/12/2009 increase/decrease of provisions for pensions 0 0 0 increase/decrease of other non-cash items 0 0 0 cash flow for capital expenses, working capital -15,273 547 0 working capital -2,597 -7,907 0 cash flow for capital expenses -17,871 -7,357 0 inflow of tangible fixed assets -14,668 -12,680 0 revenues from sales of fixed assets 640 2,229 0 capital investments/related parties/ financial assets -6 0 0 goodwill (non-tangible fixed assets) -3,131 0 0 other assets/liabilities 455 -465 0 adjusting conversion/revaluation/other writing-off 501 -1,357 0 cash flow of the group -34,080 -19,633 0 assets/liabilities of the group 2,535 -3,097 cash flow before dividend -31,545 -22,730 0 dividends -1,310 -745 0 own shares -347 0 0 stake in loss/profit in minority interest 0 0 0 financial needs/surplus -33,203 -23,484 0 cash, cash equivalents, marketable securities -758 -1,064 0 liabilities to banks (short-term) 19,300 1,704 0 new liabilities to banks (mid-term/long-term) 13,595 6,666 0 adjusting non-realized changes (realized general revenues) 1,066 -476 0 cash after debt financing 0 -16,655 0 absorption of increase/decrease of share capital 0 0 0 cash after financing 0 0 0 source: authors calculation based on serbian business registers agency data after analyzing the balance sheet, the profit and loss account and the cash flow statement all financial indicators which are applied in the development of credit analysis by domestic banks with foreign capital are shown in the appendix part (table a). based on the data used in the proposed model, the financial analysis of z-group was made and the following conclusions were drawn: 1. return on equity (roa) is negative in 2016, telling investors that the group does not earn any money, despite making investments. 2. return on assets (roe) in 2016 is negative. the fall in this indicator shows the competitive weaknesses of the company. 3. the net margin is the ratio of profit after taxation and net sales. it shows how much net profit the group has generated from the total realized business at the market. in the presented examples it is negative. 4. return on investment was negative in 2016 and amounted to -12.5%, while in the previous year it amounted to 5. 2,6%. the company's revenues began to decline, according to which the loan officer concludes that the group will hardly repay the existing loan. 6. the return on the engaged capital represents the ratio of the net profit with total assets. it amounted to -11.1% in 2016. 7. the group's equity ratio in 2016 was 17.79%. the share of borrowed sources of financing is significant and is above their own capital: also, business assets are predominantly (82.3%) financed with borrowed capital. slađana neogradi 81 8. the ratio of distribution of dividends was negative in 2016 and indicates a weak development perspective of the company. 9. ebit/interest expense in 2016 was negative and indicates the possibility of bankruptcy. it also shows the company's inability to fulfill its obligations to creditors. 10. debt / ebitda is negative and poses a problem for the group to settle its debts to banks because there is no cash available. 11. tangible fixed assets/sales fixed assets in 2016 were provided by sale in the amount of 64.7%. 12. the total liabilities ratio shows that the level of indebtedness increases from year to year. 13. the gross profit margin amounted to 45% in 2016 and shows how much the group has on its disposal to cover current expenses on financial and other expenditures. gross profit margin is a measure of market demand for group's products or services and market competitiveness. 14. the z-group sales ratio in 2016 was decreasing and indicates that the company does not have the capacity to grow in the local economy and does not use its capacity sufficiently. 15. the debt-to-sales ratio increased from year to year, as equity and net assets declined faster than the company's liabilities. most of the financial liabilities represent short-term liabilities. it is necessary to make the conversion of short-term liabilities to long-term in agreement with the bank. 16. business loss in 2016 and negative net result are caused by the large costs of moving the warehouse and administrative buildings of the company into a new distribution center, as well as due to the increase in the price of energy products, which resulted in increased production and distribution costs. credit risk mitigation at international level actions are taken and methods of risk assessment are standardized. the leading financial institutions were involved in the development of internal models for measuring market and credit risk. the agreement on international capital, now known as basel ii, has been adopted. the foundations of the second basel accord are the following (sinhal, 2012): 1. the minimum capital requirements of each bank are based on their own assessments of risk exposure. 2. supervisory review for determining the risk assessment procedure of each bank and adequate level of capital. 3. increased public informing on the actual financial position of the bank so that market discipline can become a decisive factor that would force too risky banks to reduce risk exposure. one of the key novelties proposed in the second basel accord is the requirement that banks hold capital to the level they can endure business risk in addition to already existing credit and market risks. for the assessment of credit risk, two main approaches have been proposed as follows: 1. standardized approach 2. approach based on internal ratings –irb a standardized approach includes credit risk weights which are multiplied by credit exposure in order to obtain weighted risk assets. ratings assigned to creditors by rating agencies are used as risk weights. rating agencies are independent institutions that perform an external credit assessment of the client. the advantage of this approach is the improvement of refined approaches in determining risk weights. the standardized approach does not recognize the time dimension of credit risk, i.e. the different placement maturities when determining risk ponders. 82 economic analysis (2017, vol. 50, no. 3-4, 75-85) it also does not recognize the maturity structure of interest rates that reflects the rise in credit risk with the flow of time. the irb refers to the fact that ratings internally assigned to borrowers play a major role in the determination of risk weightings. the practice has shown that most banks base their credit risk assessment methodology on one component of credit risk bankruptcy probability. an important feature of the irb approach is that it measures both unexpected and expected losses. the expected losses should be covered by reserves for losses on credit placements, which is why they are separated from the second level of regulatory capital. the level of expected losses is obtained as a multiplication of the probability of bankruptcy and bankruptcy loss. the conditional expected loss, which is the multiplication of the two previous explanations of the parameter, indicates the total capital that the bank must possess to cover the expected and unexpected loss. the risk weight function promoted in basel ii has the following form (http://www.addiko.com): figure 1. n –standard normal probability g –inverse standard normal distribution r –correlation coefficient b (pd) adjustment for maturity date which depends on the bankruptcy probability conditional probability of bankruptcy in the function of risk weight is presented by the following: ( ) ( ) ( ) ( )             − +− − 999,0 1 1 05 05 xg r r pdxgrn (1) in this expression, g (0.999) is interpreted as the inverse standard deviation from which the conservative value of the system factor for the confidence level of 99.9% is derived. another important element of the expression is g (pd), which denotes the inverse standard normal distribution from which the bankruptcy threshold is derived under normal business conditions, based on a certain probability of bankruptcy. similar to the conditional probability of bankruptcy is the average probability of bankruptcy pd. it is weighted by the loss caused by bankruptcy in conditions of an unfavorable environment in order to obtain the unexpected loss measure. it is the economic interpretation of the term (http://www.addiko.com): ( ) ( ) ( ) pdxlgdxg r r pdxgrlgdxn −            − +− − 999.0 1 )(1 05 05 (2) an important parameter in the above expression is the correlation coefficient r. the correlation coefficient r is characteristic for each class of credit exposure. changes in the value displayed by various classes of credit exposure are dependent to a various degree on the state of slađana neogradi 83 the general economic environment. the new agreement recognizes the basic and higher irb approach. (alexander, c. and e. sheedz, 2004). if the bank applies a higher irb approach, it independently determines the probability of bankruptcy, but it also has the ability to independently determine the value of some other risk factors, and potentially of all of them together. when estimating the probability of bankruptcy, banks have a lower limit of its value to 0.03%. also, it should be determined on the basis of the long-term average rate of bankruptcy of borrowers from a given class or subclass for the time period of one year. the quality of the irb approach derives from the following (alexander, c. and e. sheedz, 2004): • it is obligatory to evaluate the credit rating of each loan applicant. • obligatory risk assessment of any business transaction that should be subject to loan making. • a diversified scale of risk weight • the ability of banks to use their own internal risk models, as more sophisticated and more precise models in determining a risky portfolio of a particular bank. the basel committee decided to introduce the latest standards basel iii. the new set of rules implies an increase in operating capital in case of market instability. banks are required to keep ratio of capital and their total assets to 7%. for these reasons, banks will have to retain their profits, which they will not give to the shareholders or spend on bonuses. the reform package that basel iii brings about envisages that the minimum ratio of regular capital is increased from 2% to 4.5%. banks will be obliged to have stabilization reserve that will be used to protect capital in times of crisis. the stabilization reserve is allocated on the basis of a set of rules that limit the payment of dividends and rewards when the limit of stabilization reserve is exceeded. (bcbs, 2010). although banks in the region have mainly introduced a risk management framework which is in accordance with regulations, the issue of optimizing business processes remains unsolved. conclusion in this paper, the development of credit analysis is presented as well as the implementation of all ratio indicators. in the development of credit analysis, return on equity (roe) is a very important indicator, as its decline points to competitive weaknesses of the company. return on assets (roa) represents the ability of the company management to maximize profit in relation to invested capital. based on a net margin, a credit analyst concludes to what extent the management is able to maintain revenue growth by investing in relation to the increase in costs due to interest payments on the company's loans. in the analysis of debt ratios, banks apply another three coefficients as follows: ebit / interest expenses, ebitda / interest expenses and interest debt / ebitda. the indicator between interest debt and ebitda represents the ability of the company to settle its loan obligation which is required to be less than five where a credit officer can conclude that a company can settle its obligations in five years from its own funds. based on the value of net working capital, the credit analyst concludes that the company is funded by external sources of financing or by its own sources. if the company has a negative cash flow, the company relies more on external sources of financing, being a high-risk enterprise with low profitability. the european union has adopted a key directive introducing a mandatory requirement for all banks in the eu. as basel ii focuses on the conscious management of risks by the bank management, banks will have to archive data, primarily by shifting ratings and failing to fulfill obligations as well as by determining the distribution of these phenomena by rating classes. 84 economic analysis (2017, vol. 50, no. 3-4, 75-85) in this paper, models for the assessment and management of credit risk are defined. some of their basic characteristics have been examined. the conclusion can be drawn that all models can be applied in banks in serbia in order to reduce uncollectibles. references alexander, carol, and eds sheedy. 2004. “the professional risk managers handbook”, volume iii. wilmington: primia publications. altman, edward. 2000. „zeta analysis: a new model to identify the bankruptcy risk of corporation”. journal of banking and finance 1. basel committee on banking supervision. 2009. principles for sound stress testing practices and supervision, basel. bcbs [basel committee on banking supervision]. 2010. 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338.246.025.88 jel: j32, g34 id: 207711244 scientific review privatization and company restructurings impact on serbia1 stošić ivan2, institute of economic sciences, belgrade, serbia abstract – effects of privatization and company restructurings performed up to now in serbia, besides certain results, are unsatisfying generally observed. one of the key negative consequence of these processes is a severe downfall in number employed persons. however, the conducted analysis suggests that trends of employment (and unemployment) have been intensely influenced by the certain number of other factors, first and foremost by the negative effects of the global financial crisis. nevertheless, the research indicates that the process privatization and restructuring had undoubtedly a powerful negative impact on the level of employment in serbia. as though privatization and restructuring of a significant number state owned enterprises (which employ a large number of persons) are still to come, this processes could have a strong further negative impact on employment. consequently, the paper provides some lessons that can help the policy makers in conducting forthcoming privatization and enterprises restructurings. key words: employment, privatization, company restructurings, correlation analysis, serbia introduction the privatization and company restructurings initiated a modification of the company’s workforce that affect both the quantitative features (number of employed persons) and the qualitative (skills and qualifications required). these adaptations, which are the result of many factors, such as changes in the company’s structure, organisation or production processes introduced by privatization and company restructurings, but also fluctuations in demand, globalisation, new technologies and the arrival of new competitors, etc. are necessary if companies want to be competitive. the beginning of process of privatization and companies restructurings had strong effect on decrease of employment in all transition countries. like the other transition countries, serbia experienced similar trends. taking that in account, the aim of this paper is to examine the impact of privatization and company restructuring on the employment in serbia in the period after 2001. the goals of the paper are to analyse: a) the trends in privatization and company restructurings in serbia; b) 1 this paper is a part of research project: challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements (179015), financed by the ministry of education, science and technological development of the republic of serbia. 2 senior research associate, institute of economic sciences, belgrade, serbia; e mail: ivan.stosic@ien.bg.ac.rs economic analysis (2014, vol. 47, no. 1-2, 127-136) 128 the characteristic tendencies in employment; c) the impact of privatization and restructuring on the employment (through statistical analysis). the paper investigates a very important question of serbian society and provides to the general assessment of the privatization and company restructurings impact on employment. by the the systemic, comparative and logical analysis of the results published in scientific literature, as well as the methods of the data study, with the help of statistical analysis (software package spss), this paper is an effort to lay a ground work for future advocacy and development of adequate framework to mitigate possible negative effects of further transitional changes in serbia. literature overview the phenomena of privatization has been extensively analysed and different authors were focused various aspects: the theory of privatization, privatization models, the effects of privatization on the company’s business performances, economic growth as well as society, the efficiency gains, the agency problem, the issue of sequences in restructurings, the postprivatization performances… many of the authors stress the importance of privatization noting that privatization moved from novelty to global orthodoxy in the period of two decades and often arguing that the success of privatization is indisputable in the transition (i.e. megginson and netter, 2001). a number of studies have been focused on the impact of privatization on productivity and employment. most of these studies (i.e. megginson, 2005) show that privatization usually results in increased productivity, but also leads to a reduction or no change in employment. ebrd transition report (2011) indicates that the processes of privatization and restructuring had, especially in the initial stages of transition, a very negative effect on the labour market. the european restructuring monitor observed that in 11 000 cases of restructuring from 2002 to 2010 the ratio of job losses/job creations standing was 1.8:1. in the period 2008-2010, that ratio increased to 2.5:1. (restructuring in europe 2011, p. 3) there are some papers there are some papers focused on post-privatization effects, including effects on human capital. a 2006 survey of 28,000 individuals in 28 postcommunist countries (denisova, eller, frye and zhuravskaya, 2006) reveals overwhelming public support for the revision of privatization. authors find that human capital poorly suited for a market economy with private ownership and a lack of privately owned assets increase support for revising privatization with the primary reason being a preference for state over private property the various aspects of privatization have been also extensively analysed by serbian authors. some of them have been focused on theoretical aspects of privatization, arguing that private ownership is superior to the public and stress the importance of prompt and efficient completion of the privatization (i.e. begović, 2005). as time goes by the centre of analysis among serbian authors has been transferred on some effects of privatization (i.e. drašković, 2010, kovačević, 2010). the impact of privatization on employment was of particular interest. some authors (zubović and domazet, 2010; djukić, 2010) draw attention to the negative effects of privatization on the labour market in serbia. most of the studies, focused on data analysis and case studies, stošić, i., privatization and company restructuring, ea (2014, vol. 47, no, 1-2, 127-136) 129 pointing out that privatization in serbia had severe negative effects on total state economic performances and particularly employment (i.e. kosanović, paunović, žigmund, 2014). results the results of privatization and restructuring process in serbia process of privatization and restructuring companies in serbia was one of the priorities of intensive transitional changes. in the period 2002-2013, significant number of enterprises was privatized in the real sector of local economy. by various privatization methods (tenders and auctions, and the sale from portfolio of the auction fund on a capital market) 2,367 companies have been sold with some 334 thousands employees in them, and the revenue of € 2.6 billion has realized. table 1. results of privatization process in serbia in the period 2002–2013. period number of privatized companies sales price (in mil. €) tenders auctions capital market total tenders auctions capital market total 2002 11 151 48 210 200,7 34,9 83,0 319 2003 16 515 107 638 594,7 177,3 67,8 840 2004 6 183 45 234 11,2 90,3 52,2 154 2005 9 157 147 313 67,2 144,6 125,2 337 2006 14 155 102 271 62,4 97,2 70,1 230 2007 7 167 120 294 27,3 178,8 162,1 368 2008 12 133 105 250 33,5 98,2 91,7 223 2009 4 44 40 88 3,5 33,7 10,5 48 2010 2 18 13 33 0,5 6,6 11,6 19 2011 1 2 14 17 0,9 0,1 17,9 19 2012 0 2 10 12 0 2,2 13,3 16 2013 0 0 7 7 0 0 14,6 15 total 82 1.527 758 2.367 1.002 864 720 2.586 source: bulletin of public finance of the republic of serbia, 11/2013 the privatization process in serbia took place more slowly than expected and the accomplished results are not fully satisfactory. according to the ebrd transition report 2012 serbia realized solid results in privatization of small enterprises, while in the area of privatization of large enterprises, as well as in the company restructurings, the achieved results are still modest. these estimates indicate that the process of privatization and restructuring in serbia is still incomplete and a lot more have to be done. one specific feature of the serbian privatization process is the model company “in restructuring” as one of the alternatives. within this model of privatization, the privatization agency has been trying to prepare the certain number of once large and/or significant enterprises on local level for privatization and more successful business operating. basic strategic directions of restructuring were: a) financial restructuring (to restore the financial health through debts released, and even write-off, of debts by priority towards the economic analysis (2014, vol. 47, no. 1-2, 127-136) 130 state and public enterprises in state ownership); b) organizational restructuring (mostly fragmentation and individual sale of parts of enterprises or property together with employees, and spin-off of “non-core” activities) and c) labour force restructuring – downsizing the number of employees (mostly based formerly on so-called passive labour market policies, in which severances and monetary compensations financed by the state, were the main instrument of solving problems of redundant persons unfortunately, the restructuring process was completed with successful privatization in a very small number of these enterprises. the major part of companies “in restructuring” have been in this status for many years now. at the end of 2013. some 179 companies that employ more than 53 thousands workers are still in the process of restructuring. the financial losses of these companies are typically large, most of them are not able to pay their current business obligations, and the state through a variety of incentives provides significant financial resources for their day-to-day operating (mostly wages). unlike some transition countries, especially in the central europe that have realized relatively efficiently company restructurings, such tendencies have been not recorded in serbia. moreover, the restructurings of around 700 public owned enterprises (with more than 166 thousands employees) still is delaying. currently, there is no clear policy in relation to the issue of ownership restructuring of these companies. on one hand, there are some ideas to make massive privatization of most public owned enterprises at national and local level, but on the other hand, there is a lack of the real willingness to enter into these process. nevertheless, scrupulous restructuring of these companies has to be made in order to ensure that sector of serbian economy become effective and sustainable, without outside financial support in the years to come. the characteristic tendencies in employment in serbia in the period from 2002 to 2013 serbia experienced negative tendencies on its the labour market. table 2. key indicators of the serbian labour market year employment in 000 active population in 000 nonactive population in 000 unemployment in 000 rate of unemployment (ilo definition) in % 2002 2,066 3,459 2,709 904 15.2 2003 2,041 3,418 2,716 945 15.8 2004 2,050 3,596 2,888 970 22.9 2005 2,069 3,453 3,002 991 26.2 2006 2,026 3,323 3,188 1,011 24.7 2007 2,002 3,421 3,115 851 21.0 2008 1,999 3,267 3,083 794 15.8 2009 1,889 3,119 3,23 812 17.8 2010 1,796 2,965 3,352 803 20.2 2011 1,746 2,924 3,373 833 23.7 2012 1,727 2,929 3,348 869 22.4 2013 1,725 2,936 3,194 908 20.1 source: statistical office of the republic of serbia and national employment service stošić, i., privatization and company restructuring, ea (2014, vol. 47, no, 1-2, 127-136) 131 total employment3 decreased during the last ten years and reached its minimum in 2013 (1.725 million employees) or about 17% less than in 2002. at the same time the number of economically active population fell down for 16%, leading to the reduction in activity rate to 59.7% significantly lower than the average eu-28 – 72.2% (ec labour force survey, 2013). at the same time the employment rate of 44.2% recorded in april 2013 (labour force survey for serbia, 2013) was significantly lower than the average eu-28 64.5% and most of neighbouring countries (croatia, bulgaria, romania). the drop in employment has been affected by two broad groups of factors: first, the impact of transition changes (first and foremost privatization and company restructuring) and second, the negative effects of the global economic crisis. the decline in employment caused by the global economic crisis was more severe in serbia than in other countries and the reduction in the number of unemployed persons was more intensive than reduction in gdp (elasticity of employment in the period 2008-2012 is 0.76). the impact of privatization and company restructurings on employment statistical analysis it is difficult to determine the impact of privatization and company restructuring on employment (and unemployment) trends. we tried to perform statistical study through analysis correlation and covariance between privatization and restructuring (x measured by the revenues from privatization presented in table 1. of this paper) and the number of employed (and unemployed) persons (y), presented in table 2. of this paper. ∑ ∑ ∑ −− −− = 22 )()( ))(( ),( yyxx yyxx yxcorrel using correlation analysis, as well as covariance, is pursued to investigate and determine whether two variables have a tendency to move together. the results and the descriptive statistics of applied direct correlation analysis between privatization and employment and between privatization and unemployment, conducted in spss, are as following: table 3. results of correlation analysis between privatization and employment and unemployment and statistical significance test variable name pearson correlation covariance privatization / employment 0.697 23 827.903 privatization/ unemployment 0.390 7 105.644 3 there are two basic sources of information on key labour market indicators – labour force survey (the main source of internationally comparable data on labour market status of the population) and statistical office of the republic of serbia national employment service, based on formal registration of employees and unemployed with the corresponding institutions. due to difference methodology applied the data of these sources vary. for example number of employed persons in 2013 according to the labour force survey is 2,207 thousands and according to the nes 1,725 thousands, etc. economic analysis (2014, vol. 47, no. 1-2, 127-136) 132 table 4. descriptive statistics of correlation analysis between privatization and employment and unemployment mean std. deviation sum of squares and crossproducts sig. (2-tailed) privatization 220.8833 241.17872 639 838.92 employment 1 928.1667 141.71023 262 106.93 0.12 unemployment 890.9167 75.59276 78 162.083 0.210 conducted statistical analysis suggests that there is significant, unexpectedly positive, correlation between privatization and employment (correlation 0.697) and the certain correlation between privatization and unemployment (0.390). however, values of statistical significance testing among manifest variables are higher than 0.05 what leads to conclusion that there is no statistically very significant correlation between these analysed variables. that applies privatization had a statistically specific impact on the trends on labour market in serbia, but also applies that trends of employment and unemployment have been influenced by some other factors. discussion – what happens to workers numerous studies (i.e. analysis of privatization effects, 2011) indicate that privatization and company restructuring processes in serbia had strong depressing impact on the level of employment. the number of employees in privatized companies dropped down by 60% in period from 2002 to 2011. in the privatized companies, where the purchase contracts were cancelled, the reduction of number employees was even higher – 86% (analysis of privatization effects, 2011). furthermore, the share of unemployed people with prior work experience increased from 34% in 2001 to around 66% in 2012 (labour force survey for serbia, 2012). this indicates that lay-offs have become a significant factor since the early 2000s. part of laid off workers in companies undergoing privatization and restructuring went through so called social programs. the common characteristics of these programs were the following (based on empirical research (case study on labour force restructuring in serbia, 2008): • the state played significant role, both in creating the social programs and finance severance payments for redundants; • concept of the social programs was based on voluntary leave and mainly on passive labour market measures. within offered models, a share of redundancy who declared for severance payments was dominant. • redundant employees, and even trade union management as well, were in the first place interested in severance amount; • reasons for such attitude, besides insufficient information and not understanding active labour measures were: the qualification profile and average age of redundancy, then non-readiness for training/learning for new jobs, as well as incapability and weak motivation to develop own business, and unfavourable stošić, i., privatization and company restructuring, ea (2014, vol. 47, no, 1-2, 127-136) 133 ambient, lack of own capital for investment in business, insufficiently specific credit support to beginners in new business and others; • re-integration of redundant employees on labour market is impeded, both due to age and qualification profile of redundant employees, and due to unfavourable business ambient and insufficient demand for labour; • the amount of paid severances differs significantly from company to company and in payment time – in the range from € 100 to more then € 300 per year of employment; amount of paid severances was not enough for autonomous starting-up of new business and it that circumstances received severances were mainly spent on private consumption. namely, it has been shown that severances have been relatively quickly spent, and that employees have found themselves fast in difficult social situation. however, it has to be stated that severances have given well-mannered effects in a great number of cases, firstly persons of older age and with low wages; the concept mainly based on passive labour market measures, in which severances and pecuniary compensations were main instruments of “solving” problems of persons who lost their jobs in the process of privatization and company restructuring, has been lately partly altered and supplemented. in last 3-4 years the efforts of the government and national employment service are on active labour market measures, firstly through the dissemination of information, consulting and contacts with employees who left the enterprises as redundant (active job search), then through the realization of numerous training and education programmes, and through subsidies to entrepreneurs for employment of defined categories of unemployed persons (trainees, persons older than 55 or who perform jobs in activities of significance for regional development) and public works, as well as programs like „by severance to job“, "the first chance", etc. however, those changes did not help a lot and number of employed persons as well as active population continued to drop. the data analysis has shown that a large number of persons who lost the job went out of the labour market and became inactive. namely, the problem of redundant has been “solved” by the massive retirements of large number of older persons. as a result, the level of labour activity rate in serbia drop down and speeding for pension fund increased enormously. conclusions the performed analysis suggests that trends in employment have been influenced by the privatization and company restructurings, but as well as by the certain number of other factors, first and foremost in the last years by the negative effects of the global financial crisis. overview of economic tendencies and developments on the labour market in serbia indicates that the impact of global economic crisis been very serious in terms of loss job. as a matter of fact, the cut down of number employed in serbia was more significant in period after 2008, when privatizations had been practically stopped and when negative consequences of the global financial crisis were widely evident. economic analysis (2014, vol. 47, no. 1-2, 127-136) 134 but no matter the reason, the solving status of laid off workers is an important issue. in forthcoming years it will become even more important as an extensive restructurings are expected in publicly owned companies and not privatized companies ”in restructuring”. these companies will have to cope with high level of change in theirs way of operating, as well as in labour force. in that circumstances the solving status of laid off workers will be one of most challenging problems for the policy makers in the years to come. moreover, it should not be forgotten that, even in “normal” times, restructuring is a part of daily business life, and a process that is necessary in order to ensure that organisations keep pace with change and remain competitive. restructuring is therefore a vital and constant part of organisational life and can create as well as destroy jobs. the success of privatization and company restructurings can be measured, not only by the enhanced competitiveness and ability to innovate of the companies concerned and, but also by the number of the jobs safeguarded or created and the successful social management of adverse repercussions. unlike the attitudes prevailing in some areas of the world, the author of this paper believe that employed in the companies undergoing privatization and restructurings cannot be left to deal alone with the consequences of these processes. in order to limit the negative impact of restructuring as much as possible, it is vital that wide range of short term and long term actions of the state are put into place. countering the negative effects of privatization and company restructurings on employment it is necessary that certain state financial aid has to be provided. state aid should, at the first place, enable timely and targeted support to quickly reintegration of redundant persons into the labour market. in particular, the active labour market policy measures and reinforced matching of skills and jobs has to be supported. but most important is the creation a more dynamic business environment by unlocking the business potential, particularly of smes freeing up businesses, and helping the unemployed to start up a new business quickly and cheaply. references analysis of privatization effects (2011), agency for privatization begović boris, four years of transition in serbia (2005), centre for liberal and democratic studies, belgrade bulletin of public finance of the republic of serbia (2013), ministry of finance of republic of serbia case study on labour force restructuring in serbia (2008), ilo/conzit, belgrade cerović božidar (2009), serbia in transition and crisis, transition in serbia, ndej and economic faculty belgrade denisova irina, eller markus, frye timothy, zhuravskaya ekaterina (2006), who wants to revise privatization and why? evidence from 28 post-communist countries, the world bank's annual bank conference on development economics (abcde) "beyond transition," st. petersburg, russia stošić, i., privatization and company restructuring, ea (2014, vol. 47, no, 1-2, 127-136) 135 drašković božidar (2010), end of privatization and the consequences for development, research monograph: kraj privatizacije posledice na ekonomski razvoj i nezaposlenost u srbiji, institute of economic sciences, belgrade djukić petar (2010), završetak privatizacijeefekti na razvoj i zaposlenost, research monograph: kraj privatizacije posledice na ekonomski razvoj i nezaposlenost u srbiji, institute of economic sciences, belgrade erić dejan, stošić ivan, stefanović sasa (2009), privatization and restructuring process of serbian economy, monograph: economic integrations, competition and cooperation, faculty of economics rijeka, croatia ebrd transition report 2011. ec labour force survey, eurostat.www.ec. europa.eu.online labour and welfare impact study of rtb bor (2006), institute of economic sciences and conzit, belgrade kosanović rajko, paunović sanja, žigmund ljuban (2014), privatizacija i deindustrijalizacija u republici srbiji research monograph: kraj privatizacije posledice na ekonomski razvoj i nezaposlenost u srbiji, institute of economic sciences, belgrade kovačević mlađen (2010), privatizacija u začaranim krugovima, research monograph: „deindustrijalizacija u srbiji, mogućnost revitalizacije industrijskog sektora", institute of economic sciences, belgrade megginson william, the financial economics of privatization, new york: oxford university press, 2005. megginson william and netter jeffry (2001), from state to market: a survey of empirical studies on privatization, journal of economic literature, june 2001. paunovic blagoje, fabris nicola, phillips ray, fetsi anastasia and huitfeld henrik (2005), labour market review of serbia, working paper, etf restructuring in europe 2008, a review of eu action to anticipate and manage employment change (2008), commission staff working document, commission of the european communities, brussels, sec (2008)xxx restructuring in europe 2011, restructuring and anticipation of change, what lessons from the economic crisis? (2012), commission staff working document, commission of the european communities, brussels, sec(2012) 59 final stošić ivan, stefanović sasa, vukotić-cotič gordana (2009), privatization and restructuring of serbian economy real and banking sector, research monograph: challenges of economic sciences in the 21st century, institute of economic sciences, belgrade zubović jovan, domazet ivana (2010), transition and employees in serbia, research monograph: kraj privatizacije posledice na ekonomski razvoj i nezaposlenost u srbiji, institute of economic sciences, belgrade economic analysis (2014, vol. 47, no. 1-2, 127-136) 136 uticaj privatizacije i restrukturiranja reduzeća na kretanje zaposlenosti u srbiji rezime – efekti privatizacije i restrukturiranja preduzeća u srbiji, i pored određenih pozitivnih rezultata, su generalno posmatrano nezadovolјavajući. jedna od klјučnih negativnih posledica ovih procesa je značajan pad broja zaposlenih. ipak, sprovedena istraživanja ukazuju da su kretanja u oblasti zaposlenosti (i nezaposlenosti) snažno determinisana i uticajem određenog broja drugih faktora, a pre svega negativnim efektima globalne finansijske krize. međutim, istraživanja pokazuju da su privatizacija i restrukturiranje preduzeća nesumnjivo imala snažan negativan uticaj na nivo zaposlenost u srbiji. s obzirom da predstoji privatizacija i restrukturiranje značajnog broja javnih preduzeća i preduzeća „u restrukturiranju“ (koja zapošlјavaju veliki broj lica), ovi procesi mogu da imaju jak negativni uticaj dalјe kretanje zaposlenosti u našoj zemlji. imajući sve navedeno u vidu, analize izvršene u ovom radu mogu pomoći kreatorima ekonomske politike u sprovođenju predstojećih privatizaciji i restrukturiranja preduzeća. ključne reči: zaposlenost, privatizacija, restrukturiranje preduzeća, korelaciona analiza, srbija article history: received: 14 february 2014 accepted: 5 april 2014 udc: 336.221.4(4-12) 338:339.137.2(4-12) cobiss.sr-id 252605452 scientific paper economic and tax competitiveness in selected south east european countries branimir kalaš1* | vera mirović1 | miloš pjanić1 1 university of novi sad, faculty of economics, subotica, serbia abstract national competitiveness has become one of the central preoccupations of government in every nation. international capital flows affect diversification of business activities and intensifying competitive advantage. market liberalization, open economy, and economic integration have become a key principle of globalization and the disregard of them reduces the possibility of a certain economy to be competitive in global terms. this assertion is primarily directed towards small countries and countries which aren't economic strong enough to withstand the competitive pressure and they are forced to economic integrated. the aim of the paper is to draw the attention to the significance of competitiveness and tax rates in the economy. the subject of the paper is showing the competitive position of serbia with special emphasis on the wef indicators and tax rates. key words: competitiveness, gci, gdp, tax rates, south eastern european countries jel classification: e62, h20, h21 introduction theoretical background competitiveness is the primary goal of every economy and national competitiveness has become one of the central preoccupations of government in every nation. if the country is competitive, it's attractive to investors and inflow of foreign capital will be more intense. competitiveness means effective and efficient administration and predictable tax system and it isn't just an attractive business environment. when we say predictable tax system, it' reflects stable tax rates without frequent changes of their level and one segment of this paper properly emphasize the height of tax rates and how their differentiation is in the region. competition policy is a major instrument for building a modern and competitive market economy (unctad, 2011). to understand the competitiveness of the economy it is necessary to start from the crucial source of prosperity. the standard of living of a nation is the determinant of productivity of its economy, measured by the value of products and services produced per unit of human capital and natural resources (porter, schwab, sorrell and lopez-claros, 2004). according to the wef (klaus schwab, 2010) national economic competitiveness is defined as the set of institutions, policies, and factors which determine the productivity of countries. national competitiveness has become one of the central preoccupations of government in every nation. myles (2000) emphasizes that economic growth is the foundation of increased prosperity. matthews (2011) defines that competition is primarily determined by fundamental elements which determine productivity and economic progress. he means that political and economic * e-mail: branimir.kalas@ef.uns.ac.rs 56 economic analysis (2017, vol. 50, no. 3-4, 55-65) stability, efficient and impartial institutions and law enforcement are more important than the level of the tax burden. the significance of improving national competitiveness is a widely accepted and in order to determine this concept in a good way, it's necessary to proceed from the upgrading of the standard of living of citizens as the foundation of national prosperity (savić, 2012). lengyel (2004) defines competitiveness as the complex term that can be applied to all the basic units (company, sector, region, country, and macro-region) and it focuses on two measurable economic components: income and employment. krugman and obstfeld (2003) emphasize that countries have to specialize in those products that it can produce more efficiently than other economies. zeneli (2011) and his statistical research has proven that the quality and performance of the institutions and business environment free of corruption are the main factors that investors consider before entering this region. theoretical principles and methodology of competitiveness before we start to detailed talk about competition it's essential to define and emphasize the main principles without market economy can't operate. table 1. principles of world competition economic performance business efficiency prosperity of a country manifests past economic performance. competition governed by market forces improves the economic performance of a country. openness for international economic activities increases a country's economic performance. export -led competitiveness is related with growthorientation in the domestic economy. a well-developed internationally integrated financial sector in a country supports its international competitiveness. the attitude of the workforce affects the competitiveness of a country, efficiency and ability to changes in the competitive environment are managerial attributes crucial for enterprise competitiveness. maintaining a high standard of living requires integration with the international economy. government efficiency infrastructure state intervention in business activities should be minimized, apart from creating competitive conditions for enterprises. government should provide macroeconomic and social conditions which are predictable and thus minimize the external risks for economic enterprise. government should be flexible in adapting its economic policies to a changing international environment. government should provide a societal framework that promotes fairness, justice and equality while ensuring the security of the population. a well-developed infrastructure includes information technology and efficient protection of the environment, including efficient business systems support economic activity. adequate and accessible educational resources help develop a knowledge-driven economy. long term investment in rd is likely to increase the competitiveness of enterprises. competitive advantage can be built on the efficient and innovative application of existing technologies. source: garelli (2006) table 1. shows economic performance, business efficiency, infrastructure and government efficiency as major principles of world competition. it's necessary to realize these principles together and set the economy on a competitive basis to enable the countries to profile their place in the globalized market. garelli (2014) creates a list of golden rules of the competition: • create a stable and predictable legislative environment, • work on a flexible and resilient economic structure, branimir kalaš, vera mirović, miloš pjanić 57 • invest in traditional and technological infrastructure, • promote private savings and domestic investments, • develop aggressiveness on the international markets as well as attractiveness for foreign direct investment, • focus on quality, speed and transparency in government and administration, • maintain a relationship between wage levels, productivity and taxation, • preserve the social fabric by reducing wage disparity and strengthening the middle class, • invest heavily in education, especially at the secondary level and in the life-long training of the labour force, • balance the economies of proximity and globality to ensure substantial wealth creation while preserving the value systems that citizens desire. in line with the economic theory of stages of development, the gci assumes stages of an economy based on a factor, efficiency, and innovation. factor-driven economies are very sensitive to world economic cycles, exchange rate fluctuations and commodity prices and their main competitive advantage are low-cost labour and unprocessed natural resources. efficiencydriven economies are countries which have advanced products and services, heavy investment in infrastructure, strong investment incentives, improving skills and better access to investment capital, etc. at the end, economies driven by innovation are characterized by distinctive producers and a large share of services in the economy and they are quite resilient to external shocks. the main competitive advantage is innovative products and services at the global technology frontier using the most advanced methods. table 2. stage of development economy stage of development indicator stage 1: factordriven transition from stage 1 to stage 2 stage 2: efficiencydriven transition from stage 2 to stage 3 stage 3: innovationdriven gdp per capita (us$) < 2000 2000-2999 3000-8999 900017000 > 17000 weight for basic requirements 60% 40-60% 40% 20-40% 20% weight for efficiency enhancers 35% 35-50% 50% 50% 50% weight for innovation and sophistication factors 5% 5-10% 10% 10-30% 30% source: wef (2014) world economic forum (wef) analyses the productive potential of countries around the world more than 30 years and indicates which factors of competitiveness are the most important as well as why some countries are more successful and better ranked than others. since 2005, the wef is based on an analysis of the competitiveness of gci (global competitiveness index) which deals with macroeconomic and microeconomic fundament of competitiveness. all components are grouped into twelve factors: a) institutions, b) infrastructure, c) macroeconomic environment, d) health and primary education, e) higher education and training, f) goods market efficiency, f) labor market efficiency, g) financial market development, h) technological readiness, i) market size, j) business sophistication and innovation. 58 economic analysis (2017, vol. 50, no. 3-4, 55-65) competitiveness in south east european countries after 25 years of transition, the economies of the western balkans are in a risky state. unemployment has climbed to alarming levels and this is partly because to the fallout from the spillover effects of the crisis in eurozone, but structural unemployment were high in the preceding period (bartlett, 2013). contemporary world economic development takes place in the era of globalization and open market with emphasized liberalization and privatization of property as well as stabilization of macro and micro level. it's necessary to improve productivity and adapt production structure with a high level of finalization and technology. also, the permanent involvement of new technical content and innovation, as well as modern management is key prerequisites for potential growth of the economy. after 2000, the western balkan countries enjoyed sustained economic growth up until the global economic crisis. during pre-crisis period, real gdp per capita in the region increased by more than 40% on average, riding the tide of deeper financial and trade integration with the rest of europe, rapid credit expansion, high capital inflows and productivity growth. (murgasova et al., 2015). growth needs to be driven by competitiveness and economic integration, productivity and investment (zeneli, 2014) figure 1. gdp growth rates in western balkans (2007-2014) source: authors based on http://www.imf.org/ at the beginning of the observed period, countries recorded encouraging growth rates to the escalation of the crisis that there was a significant fall in gdp where slovenia dropped by 7.8%, which is the largest decrease with croatia whose gdp fell by 7.4%. at the end of 2014, countries in the region have achieved positive rates of a given indicator, in addition to croatian and serbian which recorded a negative result. in croatia, a slight drop of 0.8% in economic activity, while in serbia, the drop was particularly noticeable was 1.8%. the economy of macedonia has had a respectable growth of 3.4%, which represents the highest rate in the observed group of countries, while the economies of romania and montenegro had an increase of over 2% (kalaš, 2015). as can be seen, only albania had positive growth rates throughout the period to the end of 2014 amounted to 2.6%. 2007 2008 2009 2010 2011 2012 2013 2014 branimir kalaš, vera mirović, miloš pjanić 59 figure 2. gdp per capita by country source: authors based on http://www.worldbank.org/ figure 2. shows the trend in gdp per capita in countries in the region in the period from 2007 to 2014. as we can see slovenia has the highest gdp per capita exceeding 22,000 us with the largest value recorded in 2008 when it was at the level of 27,502 us. it should emphasize that only croatia still has a double digit value of this indicator while other countries are far below. serbia occupies a medium position in the observed group of countries where it's value increased by 33.37% during the period 2007-2014. it is notable that all countries in 2009 recorded a reduction of gdp per capita which is certainly attributable to the impact of the economic crisis and this decrease in serbia amounted to 13.13% compared to 2008. albania and bosnia and herzegovina are economies that have the lowest value of this indicator and it doesn't exceed the value of 5000 per capita. table 3. gci (global competitive index) by country gci 2007. 2008. 2009. 2010. 2011. 2012. 2013. 2014. albania 3.5 3.6 3.7 3.6 4.1 3.9 3.8 3.8 bosnia and herzegovina 3.6 3.6 3.5 3.6 3.7 3.8 3.9 bulgaria 3.9 3.9 4 4.1 4.2 4.3 4.3 4.4 montenegro 3.9 4.1 4.2 4.4 4.3 4.1 4.2 4.2 croatia 4.2 4.2 4 4.2 4.1 4 4.1 4.1 macedonia 3.7 3.9 3.9 4 4.1 4 4.1 4.3 romania 4 4.1 4.1 4.2 4.1 4.1 4.1 4.3 slovenia 4.5 4.5 4.6 4.4 4.3 4.3 4.3 4.2 serbia 3.8 3.9 3.8 3.9 3.9 3.9 3.8 3.9 source: authors based on global competitiveness report (2007-2014) table 3. reflects gci measured by wef in serbia and countries in the region in period 20072014. the reference value of this indicator is from 1 to 7 and as we can see, serbia has almost identical score in an observed group of countries like albania and bosnia and herzegovina which their value is not above 4. macedonia and montenegro are countries which are good placed and have similar value like eu countries regardless they aren't members of eu. if we just look 2014. bulgaria takes the first place with highest gci of 4.4 while albania has the smallest gci of 3.8 but it's important to say that data for bih is not available for a previous year. albania bih bulgaria montenegro croatia macedonia romania slovenia serbia 60 economic analysis (2017, vol. 50, no. 3-4, 55-65) table 4. rank and score of serbian economy by wef indicators parameters 2012. 2013. 2014. growth score rank score rank score rank score 2014/2013 2014/2012 basic requirements 95 4.1 106 4 101 4.1 2.5 0 institutions 130 3.2 126 3.2 122 3.2 0 0 infrastructure 77 3.8 90 3.5 77 3.9 11.7 2.6 macroeconomic environment 115 3.9 136 3.4 129 3.5 2.9 -10.3 health and primary education 66 5.7 69 5.7 68 5.8 1.75 1.75 efficiency enhancers 88 3.8 92 3.8 80 3.9 2.6 2.6 higher education and training 85 4 83 4 74 4.3 7.5 7.5 goods market efficiency 136 3.6 132 3.6 128 3.8 5.6 5.6 labor market efficiency 100 4 119 3.9 119 3.7 -5.1 -7.5 financial market development 100 3.7 115 3.5 109 3.5 0 -5.4 technological readiness 58 4.1 60 3.9 49 4.4 12.8 7.3 market size 67 3.6 69 3.7 71 3.7 0 2.8 innovation and sophistication factors 124 3 125 3 121 3.1 3.3 3.3 business sophistication 132 3.1 137 3.2 132 3.2 0 3.2 innovation 111 2.8 112 2.9 108 2.9 0 3.6 source: authors based on global competitiveness report (2012-2014) table 4. reflects the trend of wef competitive indicators in serbia in the reporting period 2012-2014 and growth of score looking 2014 as the current year. at the beginning, basic requirements are observed and we can see improvement rank of infrastructure which is essential for foreign capital but also worse position of serbia when it comes to the macroeconomic environment. regardless serbia increases her rank for 7 places it isn't good enough information for big investors. efficiency enhancers are the second main indicator and his value is growing from year to year where our economy climbed to 80 place. the greatest growth is presented in higher education and training and technological readiness which reflect encouraging data for competition but on the other hand, deterioration of labour market efficiency and financial market development is a serious problem for serbia economy. when it comes innovation and business sophistication factors, serbia didn't much improve this segment regardless our economy increase rank for four places of 112 to 108 for one year. based on figure 3. serbia has to upgrade state bureaucracy and facilitate access to funding, reduce the level of corruption and ensure policy and government stability. further, it’s necessary to pay attention to tax regulation and tax rates, because the favourable and flexible tax system is one of the main prerequisites for attractive investment environment. also, the business environment will need to improve significantly in order to boost private sector investment and improve competitiveness (world bank, 2014). branimir kalaš, vera mirović, miloš pjanić 61 figure 3. the most problematic factors for doing business source: wef (2014) tax policy and rates in south east european countries siyan and adebayo, (2005) defined fiscal policy is one of the most important tools used by the government to realize macroeconomic stability of the economy of most developing countries. the opening of the western balkans and other countries in south east europe more than a decade ago has fundamentally changed the political and economic landscape of the europe (miga, 2000). the political changes in western balkan countries were followed with a lot of institutional changes linked with the new system based on market economy and one of the most important changes was the fiscal reform (pere, hashorva, 2011). lawrence (1998) tried to econometric models relationship between tax policy and competitiveness and concluded that in short-term tax incentive policy can contribute to increased competitiveness. tax policy changes that are most likely to raise growth in any particular country will depend on its starting point, in terms of both its current tax system and the areas in which its economic performance is relatively weak (oecd, 2010). the tax policy and administration can contribute to a competitive economy in next way (matthews, 2011): 1) raising tax revenues in a way that is broadly accepted as fair is more likely to achieve high levels of voluntary compliance 2) good administration that is effective in deterring evasion reinforces social cohesion and ensures no unfair advantage accrues to business that evades tax 3) tax administration which isn't open to corruption and consistent tax laws with the predictable tax regime poor public health, 1.6 insufficient capacity to innovate, 2.7 inadequately educated worforce, 3.1 inflation, 3.3 poor work ethic in national labor force, 3.7 foreign currency regulations, 4 restrictive labor regulations, 4.1 inadequate supply of infrastructure, 5.1 crime and theft, 5.3 tax regulations, 6.1 tax rates, 6.8 government instability/coups, 6.9 policy instability, 8.3 corruption, 11.9 access to financing, 13.3 inefficient government bureaucracy, 13.7 62 economic analysis (2017, vol. 50, no. 3-4, 55-65) 4) efficiency in tax administration reduces the number of an economy's resources which have to be devoted to revenue collection 5) low compliance costs and burdens on business decrease the time that taxpayers have to spend on tax compliance 6) tax policy making that is evidence-based and transparent. high tax rates are more difficult to sustain in this new economic environment and as economic integration increases, individuals and business gain greater freedom to take advantage of foreign economic opportunities. that raises the sensitivity of decisions about investment and location to taxation (edward and rugy, 2002). today all countries in the region have set up a tax system similar to one of the developed countries in europe and these systems are based on the three major types of taxes: individual income tax (pit), corporate (cit) and value added tax (vat). figure 4. tax rates in western balkan and see countries 2014 source: authors based on http://www.kpmg.com/ figure 4 reflects the trend of tax rates in western balkans and see countries at the end 2014. first, montenegro economy has an only one figure corporate tax rate of 9% and this is the lowest rate in the region. on the other hand, companies pay the highest tax on profit in croatia and it's amounts 20% which is slightly less than slovenia and romania where the rate of this tax is 17% and 16%. serbia is a country where the tax rate is 15% and it is a medium tax burden for companies if we look other corporate tax rates in the environment. second, there is no large difference between countries when it comes vat rate. croatia and romania have vat 25% and 24% and this is the high level of this type of tax while bih has the lowest tax rate of 17%. as we can see, serbia takes again medium position in the observed group of countries and vat is 20% which is the same as in bulgaria. third, slovenia and croatia have the biggest individual tax rates where it goes to 40% and 50% which is much higher compared to other economies. five countries have individual tax rates around the level of 15%, including a serbia which is more less than in romania and albania. the doing business (db) database provides objective measures of business regulation and their enforcement, comparable across 180 countries. the dataset is attractive for the ranking of economies according to the number of procedures, time and costs borne by a typical firm to carry out activities. authors are focused on tax paying indicators in serbia and other countries in the region from 2014 to 2015. this indicator includes number and time payments per year, the percentage of profit tax, labour tax and contributions, total tax rate and other taxes. corporate tax vat individual income tax branimir kalaš, vera mirović, miloš pjanić 63 figure 5. paying taxes indicators of 189 countries (2014 2015) source: authors based on htp://www.doingbusiness.org/ observing the paying taxes indicator, serbia is located at the rear which represents alarming information, especially as there has been a further deterioration in 165 to 167 place compared to 2014. likewise, albania and bosnia and herzegovina are very bad ranked 131 and 151 of 189 analysed countries. romania and macedonia are the best examples how an economy can rapidly progress in the ranking db because of improving components of the tax system and appreciation of its relevance as part of the economic system. thus, romania recorded an impressive progress as much as 76 places compared to last year. figure 6. tax burden (% of gdp) in western balkan and see countries 2014 source: authors based on http://www.economywatch.com/ figure 6 represents the tax burden in countries in the region in 2014. the analysed indicator is expressed as the ratio of the fiscal burden and income as a percentage of gdp. as we can see, the biggest tax burden is presented in bosnia and herzegovina, slovenia and serbia, where it exceeds 35% which is far more than in other countries in the region. in order to analyse the position of serbia in europe in terms of this indicator, it’s included the average of member states of the european union that is 34.5% at the end of 2014 which is less for 1.7%. montenegro and albania are the countries where the tax burden is the lowest in an analysed group of economies, whose share in gdp doesn’t exceed 25% respecting 10% below the eu average. 2015 2014 bih, 38.8 slovenia, 37.4 serbia, 36.2 romania, 28.2 bulgaria, 26.5 macedonia, 25.6 montenegro, 24 albania, 22.9 64 economic analysis (2017, vol. 50, no. 3-4, 55-65) it' s very important points out key economic challenges in the western balkans (european commission, 2014): a) strengthening fiscal consolidation by reducing budget deficit and implementing credible public sector reforms, including reform of the public administration and pension system; b) restructuring and improving governance of state-owned enterprises; c) improving the business environment, supporting private sector development, reducing parafiscal charges, simplifying regulation and increasing research investment; d) establishing functioning and flexibility labour markets and improving the employability of workers by aligning education and skills with labour market needs. conclusion growth and development strategy following the european perspective of the region's future and innovation, skills, and trade integration should be primary drivers of growth. competitiveness of the serbian economy even after twelve years of the transition process is still very poor. serbia economy occupies an unacceptably low level of competition, especially when it's observed gdp per capita and this also indicates that there is a large space for improvement of competitiveness. in 2014, serbia was ranked 94th among 144 countries with the score of 3.89 and this data is an alarm for our economy to improve economic and institutional performances in future. bearing in mind that only albania and bosnia and herzegovina have the smallest score than serbia it speaks about the insufficient level of her competition especially on the european market. one of the competitive advantages could be a tax system which is stable, predictable and efficiency that means an optimal number of procedures, payments, tax incentives and exemptions as well as parafiscal charges. serbia needs to build modern material and information infrastructure with enhancing state companies. also, investments in contemporary equipment and production are a crucial prerequisite for improving competitiveness. to raise the rate of economic growth and creating a constant increase in gdp and employment standards, serbia has to reach the global level of competitiveness, especially with eu countries. economic policy must make and develop competitive advantage of the serbian economy, not just comparative advantages. the final goal of economic policy is to increase gdp growth rate and hold at the optimal level and also narrow the gap in gdp per capita between serbia and the eu countries as well as countries in transition. productivity and price stability represent one of the primary assumptions of the long-term development and only that can create a framework for growth of domestic and foreign investment. references bartlett, w. 2013. 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"the fundamentals and history of competitiveness". in imd world competitiveness yearbook, lausanne: imd world competitiveness center, pp. 488-503. imf. 2016. world economic outlook database, data and statistics, available at: https://www.imf.org/external/pubs/ft/weo/2015/01/weodata/index.aspx branimir kalaš, vera mirović, miloš pjanić 65 kalaš, b. 2015. "the importance of foreign direct investment in function of sustainable development", annals of the faculty of economics in subotica, 51(33): pp. 217-235. kpmg. 2016. tax rates, available at: http://www.kpmg.com/global/en/services/tax/pages/default.aspx krugman, p.r., & obstfeld, m. 2003. international economics: theory and policy, 4th edition, new york: harper collins. lengyel, i. 2004. "the pyramid model: enhancing regional competitiveness in hungary". acta oeconomica, 54(3): pp. 323-342. matthews, s. 2011. "what is a competitive tax system?". oecd taxation working papers no. 2 oecd publishing paris. miga. 2006. investment horizons: benchmarking fdi opportunities. washington, dc, the world bank, new york. munier, n. 2005. inclusive wealth report, 2012, introduction to sustainability road to a better future, springer, dordrecht. murgasova, z., ilahi, n., miniane, j., scot, a., & vladkova-hollar, i. 2015. "the western balkans 15 years of economic transition", washington dc, international monetary fund, regional economic issues, special report, imf. myles, g.d. 2000. "taxation and economic growth". fiscal studies, 21(1): pp. 141-168. oecd. 2010. "tax policy reform and economic growth: growth-oriented tax policy reform recommendation", available at: http://www.oecd.org/berlin/46391708.pdf pere, e., & hashorva, a. 2011. "tax systems in west balkans countries between simplicity and efficiency". romanian economic and business review, 6(2): pp. 80-94. porter, м., schwab, k., sorrell, m., & lopez-claros, a. 2004. "the global competitiveness report 2004 2005", palgrave mаcmillian, new york. regional cooperation council of eu. 2013. "south east europe 2020: jobs and prosperity in a european perspective". european union, available at: http://www.rcc.int/pages/86/southeast-europe-2020-strategy savić, n. 2012. "comparative analysis based on new competitiveness index", panoeconomicus, 59(1): 105-115. doi: 10.2298/pan1201105s. schwab, k. 2010."the global competitiveness report 2010-2011". world economic forum, geneva simons, k. 2003. "industrial growth and competition". the role of technology in firm success, industry evolution, and regional and national growth, essential course notes ec2212. siyan, p., & adebayo, f.o. 2005. "an empirical investigation of stability and money demand in nigeria (1970-1999)". nigerian journal of economics development matters: 4(1): pp. 87-102 unctad. 2011. "voluntary peer review of competition law and policy: serbia". united nations conference on trade and development, full report, new york. world bank. 2014. "rebalancing serbia's economy: improving competitiveness, strengthening the private sector and creating jobs", report no: acs8575. world bank. 2015. doing business available at: http://www.doingbusiness.org/rankings world economic forum. 2007-2014. global competitiveness report, available at: http://www3.weforum.org/docs/wef_globalcompetitivenessreport_2007-15.pdf zeneli, v. 2014. "economic development in the western balkans: on the road to competitive market economies". the quarterly journal, 8(4): pp. 53-64. zeneli, v. 2011. "the determinants for the attraction of fdi in southeast european countries: the role of institutions". doctoral dissertation, university of bari. article history: received: september 4, 2017 accepted: october 10, 2017 ea_2019_2 doi: 10.28934/ea.19.52.2.pp113-127 original scientific paper environmental and financial performance: review of selected studies slavica stevanović1* | olivera jovanović1 | aida hanić1 1 institute of economic sciences, belgrade, serbia abstract the main objective of this paper is to examine selected literature on the relationship between environmental performance and financial performance on firm-level. specific objectives are defined in accordance with the observed group of environmental performance measures. we decided to investigate environmental performance measured that refer to pollutant emissions, waste, and environmental disclosures. examined studies cover different periods, regions, and companies. in observed literature, we found mixed results. the results depend on many factors such as the used environmental measures, the financial performance measure, the control variables, the industry type, and the characteristics of companies. key words: environmental performance, financial performance, emissions, waste, environmental disclosure, companies jel classification: q51, q53, g32 introduction the relevant question in the literature that studies the relationship between environmental performance (ep) and financial performance (fp) of the companies is whether improving environmental performance is related to the financial success of the companies. nature of this relationship, but different measurements of environmental and financial performance is also examined in many studies. improved environmental performance of the companies that are the result of investments leads to an increase in expenditures, but the trust and reputation of companies can increase too. the companies that have poor environmental performance risk to pay higher environmental levies or fines, and more importantly, they can lose trust and reputation from companies' stakeholders. in order to avoid that possibility and to meet the stakeholder demands, companies need to express its responsibility towards society, especially when it comes to the environment. this is closely linked to the concept of environmental disclosure because the company is a public institution and an open system. this aspect is more emphasized in the case when the company does its business globally. in that context, the link between the disclosure of the environment activities and the company’s financial performances is an economic issue that needs to be analysed. the main objective of this paper is to examine studies on the relationship between environmental performance and financial performance on the level of companies. specific * corresponding author, e-mail: slavica.stevanovic@ien.bg.ac.rs 114 economic analysis (2019, vol. 52, no. 2, 113-127) objectives are defined in accordance with the observed group of environmental performance measures. the first specific objective is to investigate literature on the relationship between pollutant emissions and financial performance. the research on waste financial performance link is examined as the second objective. the third specific objective refers to analyse environmental disclosures-financial performance nexus. the motivation of this paper is to present studies that investigate the relationship between environmental performance and financial performance before starting to analyse this kind of relationship in the case of serbian companies. the studies examined in this paper cover the different periods, regions, and groups of the companies. in observed studies, we found mix results. the effects of environmental performance on financial performance depend on many factors such as the used methodologies, used environmental measures, the financial performance measure, the control variables, geographic areas considered, the industry type, and characteristics of companies. the contribution of this paper to economic literature is a comparative analysis of studies that examined the relationship between environmental and financial performances using companylevel data. this paper may have policy implications for companies' stakeholders that have to be conscious of corporate environmental management. solving environmental problems, companies can achieve financial success. the relationship between economic growth and environmental pollution on a macro level is researched by mitić et al. (2019) in their literature survey of the environmental kuznets curve. the paper has an introduction, three interrelated sections, conclusions, and literature list. in the first section, we review the literature on the relationship between pollutant emissions and financial performance. the relationship between waste and financial performance is reviewed in the second section. the special part included the analyses of the link between environmental disclosures and financial performances. the final section concludes the paper research. pollutant emissions and financial performances indicators for the evaluation of environmental quality can use a qualitative or quantitative environmental variable. the type of environmental performance indicator affects the environmental-financial performance relationship because of that, the choice of ep indicators is relevant (horvathova, 2010). while researchers consider different indicators as measures of environmental performance, in this part of the paper, we observe measures that refer to pollutant emissions. the ghg protocol developed by the world resources institute (wri) and the world business council for sustainable development (wbcsd) categorizes ghg emissions into three different scopes that are defined for accounting and reporting purposes. scopes emissions include direct ghg emissions occur from sources that are owned or controlled by the company (scope 1), ghg emissions from the generation of purchased electricity consumed by the company (scope 2) and emissions from the activities of the company that occur from sources not owned or controlled by the company (scope 3). some papers focus on a particular emission, but some studies mix various emissions and use indexes consisting of several pollutants. pollutants as greenhouse gases, acids, particles, and ozone precursors are used in telle's study (2006) for computing the index. wagner et al. (2002) construct an index aggregated of so2, nox, and chemical oxygen demand emissions. using the same emissions as telle, wagner (2005) computes the outputs-oriented index. for constructing the inputs-oriented index, wagner chooses total energy input and total water input. horvathova (2012) uses more than 90 types of emissions and propose to normalize different emissions according to their impact on the environment. as a measure of the impact of each pollutant on the environment, she chooses the reporting thresholds as set out by the european union. slavica stevanović, olivera jovanović, aida hanić 115 the comparative analyses of selected studies that investigate the relationship between emissions (e) and financial performance (fp) are presented in table 1. analysed studies are published in the period from 2011 (by iwata and okada) to 2017 (by trumpp and guenther). the five-year period is the most frequent research period. one study has emission data for just one year. the longest research period covers 20 years. some studies cover different research period for different emissions depending on data availability. table 1. comparative analyses of selected studies: pollutant emissions-financial performances link studies sample period ep measures fp measures methodology impact iwata and okada (2011) 268 japanese manufacturing firms 2004 – 2008 ghg emissions roe, roa, roi, roic, ros, tobin’s q panel data model win-win; no impact wang et al. (2014) 69 australian public companies 2010 ghg emissions tobin’s q multiple regression model win–lose delmas et al. (2015) 1,095 us publicly traded companies 20042008 ghg emissions roa, tobin’s q panel data model mixed trumpp and guenther (2017) 696 manufacturing companies part of the cdp global 500, s&p 500 or ftse 350 20082012 carbon perfor mance roa, tsr panel data model mixed misani and pogutz (2015) 127 companies from different countries 20072013 carbon emissions tobin’s q panel data model mixed qi et al. (2014) 39 chinese industrial sectors 19902010 so2 emission intensity roa panel data model win-win fujii et al. (2012) japanese manufacturing firms listed on tse; co2: 758; chemical emission: 2,498 20062008; 20012008 co2 chemical emissions roa regression models mixed lee et al. (2015) 362 japanese manufacturing firms 20032010 carbon emissions tobin’s q, roa panel data model win-win perezcalderon et al. (2012) 122 european companies listed on djsei 20072009 co2, nox and so2 emissions roa, roi, mbr cluster analysis and sfa based on panel data mixed horvathova (2012) 136 czech firms 2004 – 2008 emissions in eprtr roa, roe generic regression model mixed muhammad et al. (2015) australian publicly listed companies 2001 2010 emissions in australian prtr; toxicity weighting scores tobin’s q, roa panel data model win-win; no impact source: authors note: ep – environmental performance; fp – financial performance; ghg greenhouse gas; roe – return on equity; roa – return on assets; roi – return on investments; roic return on investing capital; ros return on sales; tsr total shareholder return; tse tokyo stock exchange; djsei dow jones sustainability europe index; mbr the market to book ratio; sfa stochastic frontier analysis; prtr pollutant release and transfer register. 116 economic analysis (2019, vol. 52, no. 2, 113-127) researchers in the mentioned studies use different types of emissions as a measure of environmental performance. the amount of greenhouse gas emissions as environmental performance is used by iwata and okada (2011), wang et al. (2014), delmas et al. (2015). wang et al. (2014) convert the average ghg emission in tonnes equivalent to co2. delmas et al. (2015) converted all six of the ghgs identified by the ghg protocol into co2-equivalent too. wang et al. (2014) and delmas et al. (2015) use the logarithm of total emission as a proxy for environmental performances. trumpp and guenther (2017) and misani and pogutz (2015) use ghg emissions to defined carbon performance. misani and pogutz (2015) calculate carbon performance as the ratio of the firm’s scope 1 and scope 2 emissions to sales. environmental emission intensity also can be used for measuring environmental performance. trumpp and guenther (2017) use carbon intensity calculated as total ghg emissions divided by sales. qi et al. (2014) use the so2 emission intensity, where the industry environmental emission intensity is measured as so2 emissions per unit of industry value-added. fujii et al. (2012) use co2 emissions and the amounts of emitted chemical substances to calculate the environmental efficiency indicator. they observe the ratio between sales and mentioned environmental pollution measures (co2 emissions and toxic release). lee et al. (2015) investigate ep-fp relationship focusing on the carbon emissions (co2 emissions) as an ep measure and focusing on the impact and environmental research and development investments on company performance. perez-calderon et al. (2012) use consumption of energy and water, and emissions-to-air of co2, nox, and so2 as variables representing environmental performance. some authors use ep measure based on the prtr (pollutant release and transfer register data (horvatova, 2012; muhammad et al., 2015). horvatova (2012) uses a comprehensive measure of ep based on e-prtr data, which includes 93 pollutants releases to air, water, land, off-site transfers of waste and pollutants in wastewater. an absolute amount of emission for each included pollutant is normalized according to their reporting threshold. muhammad et al. (2015) use australian prtr data as a proxy for environmental performance, but they include the toxicities of the chemical substances’ emissions using toxicity weighting scores. financial performance measures are more standardized then ep measures. in studies analyzed in this part of our paper, financial performance is measured only by roa in two studies (qi et al.,2014; fujii et al., 2012) and only by tobin’s q by wang et al. (2014) and misani and pogutz (2015). fujii et al. (2012) observe roa through both returns on sales and capital turnover. most of the analyzed papers use two and more financial performance measures. the majority of analyzed studies include among other things roa in fp measures (iwata and okada, 2011; horvathova, 2012; trumpp and guenther, 2017; lee et al., 2015; muhammad et al., 2015; delmas et al., 2015). few authors used two fp measures: roa and roe by horvathova (2012); roa and the total shareholder return by trumpp and guenther (2017); tobin’s q and roa by lee et al. (2015), muhammad et al. (2015) and delmas et al. (2015). except for roa and tobin’s q, iwata and okada (2011) use the natural log of tobin’s q roe, roi, roic and ros as measures of financial performance. perez-calderon et al. (2012) chose to use the roa, roi, and mbr as variables representing financial performance. the results in emissions financial performance studies are obtained mostly using regression models. some authors used regression models based on japanese manufacturing company's data (iwata and okada, 2011; fujii et al., 2012; lee et al., 2015). iwata and okada (2011) applied regression model based on five-year panel data on 268 japanese manufacturing firms, while lee et al. (2015) did ordinary least square analysis based on 362 japanese manufacturing firms. fujii et al. (2012) examined the relationships between environmental and financial performances on firms listed on tse that are assumed to be linear and quadratic in two models. several of the other observed studies were also conducted on the companies’ level in individual countries. wang et al. (2014) used least-square regression model that is applied by multiple regression slavica stevanović, olivera jovanović, aida hanić 117 analysis with data from 69 australian public companies, and muhammad et al. (2015) applied a generic regression model on australian publicly listed companies too. delmas et al. (2015) conducted panel data analysis on 1,095 us publicly traded companies using fixed effects model estimation. horvathova (2012) estimated a generic regression model on 136 czech companies, also running regressions for the restricted sample. misani and pogutz (2015) applied hierarchical ordinary least square regression on data 127 companies from different countries. trumpp and guenther (2017) used a non-linear regression model for 696 manufacturing companies that are part of the cdp global 500, s&p 500 or ftse 350. they addressed the company effects in a panel dataset using a one-way clustered ordinary least squares panel regression. qi et al. (2014) developed regression models to test the impact of independent on dependent variables on 39 chinese industrial sectors. perez-calderon et al. (2012) used the stochastic frontier analysis (sfa) and cluster analysis observing 122 european companies listed on djsei, where sfa is applied basing on a data panel. studies mentioned in table 1 include various sources of data to determine ep and fp measures. the source of data can be prtr data that contains quantitative environmental data. horvatova (2012) used the czech prtr, muhammad et al. (2015) used australian prtr data. fujii et al. (2012) use emissions data conducted by pollutant release and transfer register (prtr) system report published by the ministry of the environment in japan and mandatory greenhouse gas accounting and reporting system of the ministry of the environment. iwata and okada (2011) use the national corporate social responsibility (csr) database released by data services, more precisely the japanese csr database. some researchers use a comprehensive database that includes environmental emission and financial datasets (qi et al., 2014). the data are often obtained by organizations and companies that run data disclosure system for stakeholders (trumpp and guenther, 2017; wang et al., 2014; misani and pogutz, 2015) and provides environmental performance data for the socially responsible investment community (delmas et al., 2015). delmas et al. (2015) use kld analytics data for compiling environmental performance ratings. muhammad et al. (2015) obtain environmental data from the national pollutant inventory (npi) and firm performance data were collated from the asx database. lee et al. (2015) obtain firm-level data on carbon emissions from environmental report plaza, which is released by the japanese ministry of economy, trade, and industry. the researchers find the different effects of each environmental performance on financial performance, depending on used methodologies, periods, and geographic areas considered. environmental performance can enhance firm or industry financial performance. this is proved by iwata and okada (2011), qi et al. (2014) and lee et al. (2015). iwata and okada (2011) found that greenhouse gas emissions have significant negative impacts on roa, roi, roic, and tobin's q−1. lee et al. (2015) imply that carbon emissions decrease �irm value and report a consistently negative coefficient of carbon emissions on firm value. muhammad et al. (2015) found a strong win-win association between environmental performance and financial performance during the pre-financial crisis period, but during the financial crisis there is no relationship between environmental performance and financial performance. some studies found a positive relationship between financial performance and emissions. this kind of relation (win–lose) is explained in the literature that money spent on reduction of emissions could possibly negative affects company competitiveness. the finding of wang et al. (2014) shows that companies with high ghg emissions can generate more profit when a carbon tax is not enforced. majority analysed studies have mixed research results depending on used financial performance measures (delmas et al., 2015; iwata and okada, 2011), types of pollution (fujii et al., 2012). delmas et al. (2015) found that ghg emissions negatively affect tobin’s q and positively affect roa. they show that improved environmental performance reduce return on assets as a short-term financial performance measure, but enhanced environmental performance has the potential long-term value measured by tobin’s q . iwata and okada (2011) find that financial performances are different depending on different environmental issue. the 118 economic analysis (2019, vol. 52, no. 2, 113-127) fact is that roe reflects equity capital and does not include debt, therefore the effect of greenhouse gas emissions on roe is insignificant. the coefficient of greenhouse gas on the natural logarithm of tobin's q is not significant too. the greenhouse gas reduction does not have a significant effect on ros as the short-run financial performance, but increases the most longrun financial performance. fujii et al. (2012) find a significant, positive relationship between financial performance indexes and environmental performance measured by co2 emissions, and demonstrates that there is a significant, inverted u-shaped relationship between roa and environmental performance calculated by aggregated toxic risk. trumpp and guenther (2017) in their study show a negative ep – fp relationship for companies with low ep and a positive association for high ep. misani and pogutz (2015) confirmed that environmental processes positively moderate the relationship between carbon performance and tobin’s q. the carbon performance improves financial performance up to a certain point. after that point, the further reduction of carbon emissions do not offset the marginal cost. perez-calderon et al. (2012) found that the business groups which showed the greatest efficiency in energy and water consumption are also the ones who achieved the best economic and financial profitability indicators but cannot maintain the preceding for emissions efficiency. horvathova (2012) observes that increased company´s emissions reduce firm profitability in the two years lag period but improve in the one-year lag period. waste and financial performances waste management in the developed countries, as well as in the low and middle-income countries all over the world recognize several activities which are the same in all of them: waste prevention, reuse of used products, recycling activities and final disposal of the rest of municipal waste. depending on national and local conditions for their enforcement in developed and less developed countries, the effects of waste management activities on health and environment can be very different among them. environmental policy and government activities are intensively related with the degree of social and economic activities in the domain of waste reduction and ways for its treatment. the ways in which waste is generated and how it is treated are significant for all population, all enterprises (small and medium-sized), big companies and corporations as well as for all policymakers; so adequate activities in the field of waste management can contribute in the improvement of overall population health and conditions of living. analysis of literature in the field of environmental protection shows that waste is recognized as a serious economic and social problem. on the one hand, waste causes environmental pollution, but on the other hand waste can be a great potential as a resource of secondary raw material and energy. special attention in the literature is dedicated to agriculture waste because some kinds can be a great potential for agricultural production like an animal or biodegradable waste. no matter what type of waste is generated (municipal waste, industrial waste or agricultural waste), his treatment can be a significant challenge from technical aspects. waste management companies are continually improving their technical capacities as well as personnel with new skills and knowledge. in overall economic development in recent years, this sector contributing through the creation of new jobs and opportunities for new business development. in recent years, waste-related activities in business can be viewed from two different approaches. one approach sees waste as an opportunity for business because waste management is a socially desirable and socially beneficial activity that is profitable in most cases. another approach treats waste activities as a way of improving company business, but also improving living conditions for all populations. improving the core business of a company includes the environmental responsibility of managers who take care of all generated waste in one company – recycling is not only a business but also a way of everyday life. slavica stevanović, olivera jovanović, aida hanić 119 the link between waste and financial performances of companies is a newer topic in the field of environmental protection and sustainable development. studies that were conducted in the last decades trying to describe the causal relationship between these two variables. the subject of this segment in the paper is to present an overview of several significant studies that are different in many ways. on the one hand, the selected papers are very important in this scientific field because they represent a similar methodology, even if independent and control variables in models are different; sample size and sources also are not consistent as well as period of time and geographical region. on the other hand, analyzed studies are conducted and published in the last twenty years, which implies that this topic became very interesting for researchers. qualitative studies are not good enough to be the basis for public policy recommendations, so a quantitative approach is more appropriate because those results are quite reliable. table 2 shows comparative analyses of these selected studies. table 2. comparative analyses of selected studies: the link between waste and financial performances studies sample period ep measures fp measures methodology impact bartolacci f. et al. (2018) 45 italian companies in the field of msw collection 2012 2015 swc per capita; swc% roa regression analysis win-win and weak maleka t., nyirenda g., fakoya m.b. (2017) 30 firms listed on jse sri 20072016 waste reduction targets waste management expenditure, firms profitability panel data models mixed trumpp c., guenther t. (2017) 2361 companies 2008 2012 waste intensity roa, tsr panel data model mixed bartolacci f. et al (2016) 298 companies registered in aida database 20102013 municipality solid waste treated with sc/total msw produced in each province roi, ros, working capital turnover ratio panel data models mixed pintea m., stanca l., achim s., pop i. (2014) 81 companies registered on the bucharest stock exchange 20052010 waste pollution roa; roe panel data models no impact iwata h., okada k. (2011) 268 japanese manufacturing firms 2004 – 2008 waste emission roe, roa, roi, roic, ros, tobin’s q panel data model win-win; no impact king a., lenox m. (2002) 614 companies 19911996 waste generation, waste prevention roa; tobin’s q panel data models win-win source: authors note: ep – environmental performance; fp – financial performance; mswmunicipal solid waste; swc solid waste collection; msw – municipal solid waste; jse sri – south african johannesburg stock exchange’s (jse) socially responsible index (sri); aida bureau van dijk’s; roa – return on assets; roi – return on investments; ros return on sales. bartolaci et al. (2018) analysed the relationship between good environmental practice and financial performances in waste management companies. authors recognized waste management companies as very important in the domain of recycling and reusing products, so they decide to investigate the link between selected financial performances with selected environmental performances. the sample included 45 italian companies in the field of municipal 120 economic analysis (2019, vol. 52, no. 2, 113-127) solid waste collection. the selected companies do their business in the municipalities with more than 50,000 habitants. the sample is based on the green book survey of medium and large companies in 2013 and includes entities that only deal with municipal waste and have an obligation to follow italian accounting regulations. the primary financial performance used by bartolaci et al. (2018) is the return on assets because it depends on the revenues (based on recycling or reusing products) and operating costs. operating costs in italian public waste management companies can be slightly higher, taking into account their social and institutional goals, so it is important to consider them in the analysis of the overall financial performances. in empirical research conducted by mentioned authors, return on assets is an independent variable. environmental performances are dependent variables, so authors try to identify the most common variables for all companies in the survey. one of them is solid waste collection ratio measured as the ratio between the quantities of the collected waste and size of the population of the municipality. another one is ratio between the amount of the solid and total waste in the municipality (solid waste collection in %). the source for the environmental performance data was italian ministry of environment during period 2012 till 2015. the methodology used in this paper implies chi-square index and standard regression analysis to identify the type and direction of causation between financial and environmental performances. the results for the observed period showed that the relationship between selected dependent and independent variables is linear, positive and weak, which is in line with the results of the studies referred to in this paper. bartolaci et al. (2018) present findings useful for policymakers and managers of the waste companies. for policymakers, the results can be significant in the domain of institutional support to waste management activities. on the other hand, for managers the mentioned findings can suggest improving recycling and reusing waste activities. another study analyzed in this paper is conducted in south africa. maleka et al. (2017) researched the link between waste management expenditures on waste reduction targets and financial performances. the main objective in maleka et al. study is to present the first results about this type of relationship in south africa because other studies conducted in this region are more focused on disclosure activities. authors selected 30 companies listed on jse sri for a period of 10 years 2007 to 2016; selected companies were high pollutants. as in other research studies, financial performance variables are independent variables, so authors identify two important and comparable. waste management expenditure is one of the two selected variables. it represents the total costs of activities during the realization of the waste reduction targets (waste prevention, waste recycling, etc.). another independent variable is the firm’s profitability measured as difference between total expenditures and total revenues. also, authors used the two control variables – change in the turnover and financial leverage. environmental performance measured as waste reduction targets is dependent variable, so this study provides the answer about the influence of waste expenditure and firm’s profitability on waste reduction targets. the authors used panel data with fixedeffects model and the random-effects model. the results showed positive relationship between waste management expenditures and waste reduction targets, which means that increase in waste management expenditures will lead to increase in waste reduction targets. also, the relationship between financial leverage and waste reduction targets is negative indicating that growth in financial leverage will lead to a decrease in waste reduction targets. one of the studies which is also citaden in the field of environmental is written and conducted by trumpp and guenther (2017). according to the objective of the study, two measuers of environmental performances were used. one of them was waste intensity. the authors research the hypothesis that relationship between waste intensity and company′s profitability. sample size include 2361 firms which were part of the cdp global 500, s&p 500 or similar lists. the companies were separated in line with registered activities, so sample covered manufacturing industry and service industry. panel data methodology resulted in the mixed results, because the authors can not claim that both environmental performance measuers had significant positive impact on firm′s profitability. slavica stevanović, olivera jovanović, aida hanić 121 bartolaci et al. (2016) published an interesting study conducted on 298 italian companies. they tried to investigate the link between profitability and environmental performances in selected companies. this study is quite different than the survey published in 2018 for several reasons, but one of them certainly is sample size. the database used in this survey is aida (bureau van dijk’s), authors selected only companies registered for two main activities with waste – a collection of solid and treatment and disposal of other waste. as financial performance variables, authors decided to calculate return on investment, return on sales and working capital turnover ratio. as dependent environmental performance variable, authors have chosen to analyze solid waste collection. after they collected the relevant data via desk research, authors divide the country into a large number of municipalities (81) and rank them using the ranking technique in decreasing order. for every municipality, companies were listed according the value of variables. panel regression data for the period 2010 till 2013 showed inconsistent results; the relationship between financial selected performances can be either positive or negative. this research topic is entirely new in the south eastern europe (see) region, just several research studies were published during the last decade. one of the recent studies is published by pintea et al. (2014) and was conducted in romania. following the literature and similar researches for other developed countries in europe, authors try to test a starting hypothesis that better environmental performances lead to an increase in companies' revenues and decrease in companies’ costs. even authors analyze the period from 2005 up to 2010, they separated on period before and after financial crises during 2008. this methodology is specific; it gives a possibility to compare environmental and financial performances of companies before and after critical period of time. like other authors, pintea et al. decided to take into account return on assets, return on equity as independent variables, waste performances as carbon dioxide pollution, while including control variables such as firm size eliminate the effects of the different economic performances between companies. the data collected from two official and public databases: bucharest stock exchange and the national pollutant release and transfer register. the econometric analysis involves panel data models – models with fixed effects and models with random effects. the main conclusion of this study is the absence of the link between environmental and financial performances in romanian companies in overall period. in the first part of the paper, two authors were mentioned because they researched the different approaches in environmental performances – iwata and okada (2016). one of them was greenhouse gas and another was waste emission. in japan, waste emission was strictly regulated with government lows and control policies. so the research hypothesis that waste emission had significant effects on financial performances is very interesting for nacional economy, but also for other countries which is facing with increasing waste emissions. as other studies that we present in the paper, methodology is consis of using panel data and model with fixed effects. observed period was 2004 till 2008 and the results showed that research hypothesis is not true, authors did not have enough evidence to confirm that between waste emission and financial performanes exsist significant impact. king and lenox (2002) investigated two research hypotheses. the first research hypothesis argues that more waste prevention activities lead to higher financial performances of the company. the second research hypothesis argues that less onsite waste treatment leads to the higher financial performance of the company. their research covered the period from 1991 till 1996 while sample size includes 614 companies. it can be said that this is the largest sample size between selected studies presented in this paper. all companies were listed on the compustat database and had reported about waste activities. financial performances such as return on assets and tobin’s q were calculated based on balance sheet for all companies. based on similar researches, authors decide to calculate waste generation as the sum of total toxic outcome and waste prevention based on total production of the company. also, authors constructed new variables as the ratio between treated waste and the total waste generated. to control the effects 122 economic analysis (2019, vol. 52, no. 2, 113-127) of differences between selected companies, authors include control variables such as the firm’s size and financial leverage in regression model. the econometric framework in this paper is based on panel data and use of model with fixed – effects, where authors try to identify the best model specification. authors confirmed both hypotheses and find that between firm emission of waste and financial performances exists negative relationship. thus, waste prevention is very significant for company’s profitability. environmental and financial disclosures some authors, like milton friedman (1970) claimed that the company has just one responsibility: to make a profit. on the other hand, in the teachings of stakeholder theory (freeman, 1984), business organizations, as bearers of economic and social activities, exist not just for themselves, but to fulfil a specific social purpose and meet the particular need of society, community or individuals (drucker, 1986). in other words, they have a certain degree of responsibility towards society. fulfilling these responsibilities can be identified through the annual or another type of reports, which can be mandatory and voluntary. reports can also be financial and nonfinancial. in financial reports we can find information about the company's economic performance and conclude is the company profitable or not. there is nothing wrong with being profitable, but just like the drucker said, companies don’t exist just for themselves, which means that we need to consider not just the companies’ financial data but also the nonfinancial information about the companies social, environmental and human rights activities. in that aspect, our focus is on nonfinancial reporting which describes how the company communicates with its stakeholders by disclosing their nonfinancial data, more precisely on environmental disclosure because of increased public interest regarding ecological issues. regarding the fact that the companies became financially powerful as well as one of the pillars of economic development, environment protection became a global trend. in that aspect, the researches wanted to explore is there an empirical link between the company’s responsibility toward the society and its financial performance. this issue is critical because the classic economic equation tells us that the primary goal of a business subject is profit maximization. if in this equation we add the environment, the question is: does it pay to be green? in other words, is it possible for a company to be "green and competitive" (porter and van der linde, 1995) at the same time? in that aspect, we analyze the literature regarding the disclosure practice among companies, with a particular focus on environmental disclosure and its relationship with financial performance. it is essential to notice that a specific discussion regarding the specific industry, period or region, was not included in this review. in one of the early works dealing with disclosure, mobley (1970) uses the term social accounting, stating that it “refers to the ordering, measuring and analysis of the social and economic consequences of governmental and entrepreneurial behaviour”. generally, the history of nonfinancial reporting dates back to 18 century, as explained in the research done by guthrie and parker (1989) who examined social and environmental disclosure practices of an australian steel company, broken hill proprietary company ltd (bhp), for the period of 100 years (1885 – 1985). in practice, when disclosing the nonfinancial data company comes out of the classical reporting frame emphasizing their social engagement, which is essential for the stakeholder's decision-making process. regarding the link between social and financial performance, it started to gain interest during the 1970s (moskowitz, 1972; parket and eilbirt, 1975; vance, 1975; sturdivant and ginter, 1977; alexander and buchholz, 1978 and many others). what is important to notice is that not only one result is possible, but it depends on several factors such as the used measure of disclosure, the used financial performance measure, the used control variables, the industry type, specific characteristics of the firm, company size, etc. that means that the relationship between social slavica stevanović, olivera jovanović, aida hanić 123 and financial performance can be positive, negative and neutral or inclusive. this situation is also present in the case of environmental disclosure, which will be explained below. teoh et al. (1998) analyzed 60 singapore publicly listed companies identified as polluting the environment or potentially polluting the environment. authors used content analysis covering the period of seven years, from 1990 to 1996. they used accounting-based variables (roa, roe, cash basis return on assets, cash basis return on equity, operating roa, operating roe, net margin and net operating margin). the results of the study can be caregorized as followos: a) firms that disclose their environmental practice have, in general, better financial performance, b) firms that disclose more about their environmental practice have better performance than firms with less disclosure practice, c) firms with better prior financial performance make more significant subsequent environmental disclosures and d) rms that disclose more about their environmental practice will have a positive impact on subsequent financial performance. similar research was done by stanwick and stanwick (2000), who researched the current practice among relatively large corporations in the aspect of the relationship between environmental disclosure and financial performance. the analysis included 469 companies listed in the forbes 500 for the year 1994. the authors sent a letter with a question: does their organization has a formal environmental policy and environmental commitment? if the answer was affirmative, they were required to send back the information to the authors. financial paramaters used in the research were net income for the firm divided by their total assets. the results showed that there is a link between the environmental disclosure and financial performance in a way that firms that had higher financial perfromes also have a higher incidence of environmental policies and gave more detail about their commitment to the environment practice. at the same time, firms ranked as medium financial performers had the highest incidences of firm environmental policies and a description of their environmental commitment. to determine the relationship between environmental disclosure and financial performance in the case of europe companies, dragomir (2009) extracted data from the ftseurofirst 300 index for the 60 largest european industrial business groups. the author created an environmental disclosure index using gri guidelines based on content analysis. the results showed a significant association between contemporaneous environmental performance and disclosure but no association between environmental performance and financial performance. a similar result was found by rahman et al. (2009), who analyzed the relationship between environmental disclosure and financial performance in the case of malaysia, thailand, and singapore. in their study, the authors used the term “detailed environmental reporting” to describe company practice of environmental disclosure in the companiy’s annual report. the disclosure can be in the form of one paragraph or more. the resultt shows that in the analysed countries, the performance of the company has no relationship with the types of environmental disclosure. another country from asia was analysed by makori and jagongo (2013), who wanted to explore is there any significant relationship between environmental accounting and the profitability of selected firms listed in india. they selected 14 randomly companies listed in the bombay stock exchange in india and analysed their annual reports by using multiple regression models. results where mixed in terms that there is a significant negative relationship between environmental accounting and return on capital employed (roce) and earnings per share (eps) but at the same time a significant positive relationship between environmental accounting and net profit margin and dividend per share. mixed results were also found by akbas (2014), who analysed environmental disclosure and financial performance among 62 non-financial turkish firms listed on the bist-100 index. the study employed content analysis for the year of 2011. independent variables used in the research were size, leverage, profitability, industry membership and age. results showed that size and industry membership is positively related to the extent of environmental disclosure 124 economic analysis (2019, vol. 52, no. 2, 113-127) while in the case of the profitability the relationship is negative. on the other hand, leverage and age have no statistically significant association with the extent of disclosure. in order to determain the link between environmental disclosure and financial performance among different sectors, tasneem et al., (2016) carried out research based on the us manufacturing industry on companies listed on nasdaq with a total sample of 100 companies taking 20 companies from each sector (energy, health care, technology, public utilities, and capital goods). their result indicates that greenhouse gas emissions, water consumption and waste disposal) are key indicators of environmental reporting. another research done by using companies from the index was by qiu et al. (2016), who analyzed the ftse350 index companies covering the years 2005-2009. the aim of their research was to examine the link between a firm's environmental and social disclosures and its profitability and market value. the results indicate that there is no relation between environmental disclosure and profitability while in the case of social disclosure, firms that make higher social disclosure have higher market values. a similar result was showen by nor et al., (2016), who analyzed the relationship between environmental disclosure and financial performance among the top 100 companies of market capitalization in malaysia for the year 2011. the authors created the environmental index containing 20 units while roa, roe, eps, and profit margin were chosen as financial performances. the results showed a significant relationship between total environmental disclosure and profit margin but not a significant relationship between full environmental disclosures with roa, roe, and eps. fonseka et al., (2019) explored what is the effect of environmental information disclosure and energy product type on firms cost of debt on the example of companies from china. the analysis included the period 2008–2014. the authors found a significant negative association between the observed variables. results also indicate that there is a significant negative association between several energy product types (hydro power, oil, solar, and wind) and energy firms' cost of debt. conclusion this paper analysis studies that rely on researching the relationship between environmental and financial performance, and it makes a relevant contribution to the literature on environmental performance and financial performance, especially in domestic literature. authors of this paper chose to investigate studies that use pollutant emissions, waste emissions and prevention and environmental disclosure as main environmental measures, because pollutants and waste emissions are relevant aspects of environmental problems. the qualitative research studies are not enough for policymakers, their decisions can be improved with quantitative studies based on empirical research and reliable data sources. the lack of the adequate company level empirical research in the see region motivate authors of this paper to compare studies conducted in different areas all over the world and to identify adequate theoretical and econometric framework for future research. the results of selected analysed studies are mixed, suggesting that the evaluation of each pollutant emission measure is different among various financial performance, industries, regions and periods. in some circumstances, there is no impact of emissions on financial performances. a decrease in pollutant emissions can improve financial performance. the winwin situation is created when environmental improvement leads to financial advantage. these negative effects on financial performance can indicate that companies want to reduce emissions in order to build company legitimacy, mitigate future risks and improve their competitive advantage, corporate reputation, and image. stakeholders take the performance of these companies into account and evaluate them better. the win-lose situation is conducted when environmental improvement doesn’t lead to financial improvement, on the contrary, money slavica stevanović, olivera jovanović, aida hanić 125 spent on environmental improvement would possibly harm company competitiveness. some studies have shown mixed results because the relationship between environmental and financial performance depends on the time horizon. the mitigating emissions can be unprofitable in the short-term because the costs of reducing emissions were difficult to offset in the short term but profitable in long term. the selected studies in the field of waste management also indicate different results. while in several studies better environmental performance improves higher financial performances, in other studies results were opposite. even if the methodology were similar as well as the variables which measured both performances, the results are not unique. the main reason for the mixed results can be found in the overall characteristics of the national economy and business environment as well as in the degree of implementation of environmental measures. in the case of environmental disclosure, the results were also mixed regardless of the region or the the used financial measures. this indicates all the complexity of this research area. analysis of selected studies can be very valuable to authors to create a similar study. further research should investigate the environmental and financial performance relationship in serbian companies. environmental performance measures should be chosen depending on environmental data availability. acknowledgements this paper is a result of research projects under the code 179015 (challenges and prospects of structural changes in serbia: 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"do greenhouse gas emissions affect financial performance?– an empirical examination of australian public firms." business strategy and the environment, 23(8): 505-519. world business council for sustainable development, and world resources institute. the greenhouse gas protocol: a corporate accounting and reporting standard, https://ghgprotocol.org/sites/default/files/standards/ghg-protocol-revised.pdf article history: received: november 6, 2019 accepted: november 27, 2019 microsoft word 2007_01_02.doc agri‐environmental policy in poland:   challenges and evaluation approaches  jadwiga ziolkowska, humboldt university of berlin  key words agri‐environmental policy, agri‐environmental measures, transformation  udc: 338.43.02:719.502.2         jel: q1, q5  original paper  abstract ‐ the main objective of the paper is to investigate challenges for the agri‐environmental  policy in poland and to detect methodical approaches which can be used for the evaluation and design of agri‐ environmental measures to make them more effective. analysing the development of the agri‐environmental  policy in the transformation process in poland, before and after the accession to the european union, we  state that several changes are necessary to  improve the efficiency and effectiveness of agri‐environmental  measures in poland. the acknowledged methodical approaches can be helpful to evaluate agri‐environmental  measures and to specify problems to be solved in the following years.  introduction  before the transformation process in poland, the necessity of environmental protection in ru‐ ral areas has not been promoted very widely. the reason was the belief that environmental pollu‐ tion was caused by the industry. in the following years of the transition process and before the  accession to the european union, several measures have been undertaken in order to improve the  environmental protection in agriculture. thus, in the course of the structural change in the polish  economy, also changes in the agricultural and environmental policy have appeared.   since the accession of poland to the european union (eu) in may 2004 agri‐environmental  policy is obligatory for the policy of rural areas according to the eu regulation 1257/99 on support  for rural development from the european agricultural guidance and guarantee fund (eaggf)  (europäische kommission, 1999b). also agri‐environmental measures are realised in poland as regu‐ lar political instruments. as the agri‐environmental policy is new in poland, no empirical evalua‐ tion has been undertaken until now. the only available descriptive evaluation delivered by the  ministry of agriculture and development of rural areas is based on statistical data regarding the  number  of  participating  farmers  and  the  budget  amount  spent  on  supporting  the  agri‐ environmental measures.   according  to  the  eu  regulation  farmers  realising  agri‐environmental  measures  are  sup‐ ported with compensation payments  for  their services  for  the environment. thereby,  following  objectives should be promoted with agri‐environmental measures:  o ways of using agricultural  land which are compatible with the protection and  im‐ provement of the environment, the landscape and its features,  o natural resources, the soil and genetic diversity,   o an environmentally‐favourable extensification of farming and management of low‐ intensity pasture systems,  o the conservation of high nature‐value farmed environments which are under threat,  o the upkeep of the landscape and historical features on agricultural land,  o the use of environmental planning in farming practice.  according to the european commission (n.d.), the agri‐environmental measures are direct  instruments to protect the environment in rural areas apart from the direct stimulation measures  e.g.  land  set‐aside  scheme  or  the  „cross‐compliance“  (obligatory  environmental  requirements  which have to be fulfilled to be eligible for direct payments from the first pillar of the common  2007 ‐ 6  •  economic analysis®  agricultural policy – cap). agri‐environmental measures are interpreted as the most important  instruments of environmental protection in rural areas in the national policy after the accession to  the european union. therefore, we focus our investigation and discussion on these measures and  do not address the other instruments.   in this paper we discuss the development of the agri‐environmental policy in the transition  process of the polish economy. additionally, we analyse changes occurred in the regulation of the  agri‐environmental policy before and after the accession of poland to the european union. against  this background we analyse challenges resulting for poland  in  the following years and discuss  methodical approaches which can be used for the evaluation and design of agri‐environmental  measures to make them more effective and objective‐oriented.   the  paper  is  structured  as  follows.  first  we  present  the  development  of  the  agri‐ environmental  policy  in  the  transformation  process  and  continue  the  discussion  for  the  pre‐ accession phase to the european union. next, we present the implementation rules and the realisa‐ tion of agri‐environmental measures after the accession to the european union. in the following  chapter we analyse challenges for the agri‐environmental policy in poland. next, we compile and  discuss possible methodological approaches which can be used in the evaluation and design of the  agri‐environmental policy. according to the experience with these methods in other countries of  the european union, we discuss advantages, potentials and difficulties connected with the imple‐ mentation of the respective approaches.   agri‐environmental policy in poland in the transformation process  since may 2004 poland is a new eu member state. with the accession to the european union  poland  adopted  the “acquis  communautaire”  and  thereby  agri‐environmental  programmes  were  acquired as obligatory measures for the policy of rural areas. agri‐environmental measures are  realised within the national agri‐environmental programme which is a new paradigm in poland.   the very first political discussions on the necessity of environmental protection in poland  were initiated in the 70‐th, when the environmental protection was defined as a new political pur‐ pose. in 1976 the environmental protection has been established in the polish constitution (welfens,  1993). in the centrally planned economy, the economic progress had a priority against the envi‐ ronmental protection in rural areas.   after the economic changes and the transition from the centrally planned economy to the  free market economy, a heterogeneous picture of environment was stated in poland. on the one  hand, immense environmental pollution caused by the industrial sector was found; on the other a  lot of protected areas and natural resources were maintained. this phenomenon is called „post‐ communist paradox” these days (sandberg, 1999, p. 48). additionally, the low importance of the  environmental protection in agriculture was determined by the fact that the factual measured pol‐ lution of the air, ground and water was ascribed to the industrial development. due to the great  importance of market‐oriented agricultural activities, environmental problems such as ground and  water pollution, accumulation of chemical pollutions, emissions of fertilisers were not discussed  by political stakeholders. moreover, economic and social problems in rural areas e.g. smallholder  farming and missing information about the necessity of the environmental protection in agricul‐ ture or else missing political instruments were the main problematic issues in the transition proc‐ ess which inhibited the development of agri‐environmental policy in poland (sapek, 1998, p. 78).  the first concrete environmental measures in agriculture were defined in 1990 with the „na‐ tional environmental policy” (ministry of environmental protection, natural resources and forestry,  1991). following, new environmental organisations were established, e.g. inspection for environ‐ volume 40 • spring 2007 • 7  mental protection, polish ecological club, national fund for environmental protection and water  policy. environmental measures were, however, mostly supported by  international and private  foundations. the political comment from 1991 “environmental protection policy of the country”  had the aim to diminish the agricultural pollution. in 1992 on behalf of the national fund for envi‐ ronmental protection and nutrition policy  the study “the pro‐ecological orientation of polish  agricultural policy at the end of the 20th century” was published, which promoted a coherent  agri‐environmental  policy  (oecd, 1999, p. 31).  in  1994,  the  document  “the  outlines  of  socio‐ economic policies for the polish countryside, agriculture and food processing industry until the  year 2000” was published by the polish ministry of agriculture and nutrition policy in which po‐ tential disadvantages of  the agricultural production  for  the environment were presented. since  then, the environmental protection policy in rural areas was characterised by two targets: firstly –  the necessity to remove environmental pollution caused by the industrial sector from the time of  the centrally planned economy (oecd, 1995), secondly – the wish to access the european union.  in 1997 sixteen working groups for different sections of the common agricultural policy were es‐ tablished in the polish ministry of agriculture and nutrition policy such as e.g. “structural funds  and rural development” or “agriculture and protection of agricultural environment” (ministry of  economy and food agriculture, 1998). hence, the terms “environmental protection in agriculture”  and following “agri‐environmental policy” have been adopted very quickly. in march 1997 the  project “green lungs of poland” was initiated in the east‐northern part of poland with the aim to  create a basis for the future agri‐environmental programmes according to the eu regulations (ted‐ erko, 2000). also other measures were planned and partially realised in preparation for the eu ac‐ cession.   agri‐environmental measures in poland before the eu accession  before the accession of poland to the european union, no political regulations promoting  environment‐friendly  measures  in  agriculture  existed.  the  national  budget  expenditures  were  planned to a low extent also for environmental tasks such as:  o preservation of domestic farm animal species,  o support for ecological farming,  o advisory  services  for  farmers  with  regard  to  fertilisation  and  usage  of  pesticides  (klisowska, 2001, p. 79).  the first successful agri‐environmental measures supported by the european union were re‐ alised in 2000 and 2001 within the eu project phare99 in two regions of poland: subcarpathia and  warmia‐masuria. the responsibility  for  the  implementation of  the measures was by  the polish  agency for management development, whereas the realisation was coordinated and controlled by  the ministry of agriculture and development of rural areas. within the project, 277 farms in the  voivodship subcarpathia (from the 386 applications) and 131 farms in warmia‐masuria (from 213  applications) were supported (umwp, 2003; faber and duer, 2001; domagalska, n.d.). in the follow‐ ing, additional agri‐environmental measures were planned within the program sapard (special  accession programme for agriculture and rural development) for the period 2000‐2006. with this  programme,  the  adaptation  of  the  polish  regulations  to  the  european  “acquis  communautaire”  should  have  been  prepared  and  concrete  realisation  patterns  for  agri‐environmental  measures  should have been delivered. the measures were planned as continuation of the phare99 and as  complementary instruments for the phare2000 as well as phare2001 which supported ecological  farming with 2,5 million € (mrirw, 2004b, p. b2). the measures were planned in chosen regions in  2007 ‐ 8  •  economic analysis®  poland with immense problems of natural protection or else in regions with valuable natural re‐ sources such as: o warmia‐masuria (13 500 ha) – high erosion problems,  o subcarpathia (4 000 ha) – problems with fallow land,  o valley of warta‐river (1 500 ha) – natural protection area for different bird species,  o valley of narew and biebrza rivers (11 000 ha) – the biggest peat and bog areas in  europe, biotopes for bird species of international importance.  ecological farming was approved to be realised in each region of the country. the assess‐ ment of the regions was conducted on behalf of experts representing following institutions: minis‐ try of agriculture and development of rural areas, ministry of environment, institute for melio‐ ration and greenland, institute for farming, fertilisation and soil sciences, institute for agricul‐ tural economics and nutrition policy, and the national advisory centre for development of the  agriculture and rural areas. in general, the area of 30 000 ha and 3 500 farmers should have been  engaged in the realisation of the agri‐environmental measures under sapard 2000‐2006 with the  budget of 2 % of the total sapard‐expenditures. the programme should have been co‐financed  by  75 %  from  the  eu  budget  (faber  and  duer,  2001,  p.  66).  for  the  time  period  2000‐2006,  22,3 million € were planned for agri‐environmental measures and the annual payment rate was set  to 120 €/ ha (mrirw, 2002). due to changes in political strategies and missing legal rules for the  appropriate implementation of the agri‐environmental measures, the planning and realisation of  agri‐environmental measures was abandoned under the sapard in order not to hinder other po‐ litical instruments of the sapard‐programme (mrirw, 2002, p. 117‐121). apart from dissatisfac‐ tion of farmers, the ministry of agriculture and development of rural areas advised to more pre‐ cisely prepare agri‐environmental measures. according to the statement of the ministry, in the face  of the awaiting accession to the european union, the priorities should be placed on the prepara‐ tion  of  agri‐environmental  measures  under  the  national  agri‐environmental  programme  2004‐ 2006 (zysk, 2002).   agri‐environmental measures in poland after the eu accession  after the accession of poland to the european union and the implementation of the “acquis  communautaire” agri‐environmental measures became obligatory for the policy of rural areas. in  the first membership period 2004‐2006 the agri‐environmental measures were co‐financed from the  european agricultural guidance and guarantee fund (eaggf) and from the polish state budget.   the support for agri‐environmental activities is granted to farmers who are owners or ten‐ ants of farm land of more than 1 ha and who oblige themselves to meet all agri‐environmental  commitments for at least five years. the agri‐environmental measures exceed the requirements of  the  “good  agricultural  practice”.  therefore,  additional  realisation  costs  resulting  for  farmers  should be reimbursed with public funds in form of compensation payments. the support should  be calculated by responsible national or regional administration offices on  the basis of:  income  losses, additional costs resulting from the commitment given, and the need to provide an incentive  (stimulation premium). the compensation rates for agri‐environmental measures can be enlarged  by 20 %, provided one measure is realised on the natura‐2000 protection areas or in the case  when in organic farming system, plant production is balanced with animal production.  in  the  negotiation  process  seven  agri‐environmental  measures  (‘sustainable  agriculture’,  ‘organic farming’, ‘extensive meadow farming’, ‘extensive pasture farming’, ‘ground and water  protection’, ‘buffer zones’, and ‘domestic farm animal species’) were proposed by the polish min‐ volume 40 • spring 2007 • 9  istry of agriculture and development of rural areas and approved afterwards by the european  commission.  due  to  a  differentiated  system  of  cost  calculation  for  the  respective  agri‐environmental  measures  and  due  to  different  instructions  for  the  monitoring  process,  the  agri‐environmental  measures were divided in 40 realisation options. additionally, agri‐environmental measures can  be realised horizontally (in all regions in poland) as well as regionally (in specific priority zones).  while the measures ‘organic farming’, ‘ground and water protection’, ‘buffer zones’, and ‘domes‐ tic farm animal species’ are realised in all regions of the country, the ‘sustainable agriculture’, ‘ex‐ tensive meadow farming’, and ‘extensive pasture farming’ can be realised only in the 69 priority  zones in poland.   the agri‐environmental measures are realised within the national agri‐environmental pro‐ gramme. the national agri‐environmental programme is an integral part of the plan for devel‐ opment of rural areas (prow). the available budget for agri‐environmental measures amounted  to 348,9 million € for the time period 2004‐2006 and was stepwise extended in the following years:  70,5 million € in 2004, 116,2 million € in 2005 and 157,7 million € in 2006 (mrirw, 2004a, p. 129).  the co-financing rate for agri-environmental measures amounts to 80 % from the eaggf which results from the fact that all regions in poland were ascribed as “objective-1-regions” [1] (european commission, 2003, p. 20). the other 20 % are financed from the polish state budget. the budget expenditures can be utilised according to the “n+2” rule during two following years after the finish date of the programme. after this time, the budget not used for the approved objectives has to be repaid to the european union (europäische kommission, 2004). thus, due to a  low  interest of farmers  in the agri‐environmental measures  in  poland in the first membership period 2004‐2006, the committee for monitoring of the plan for development of rural areas decided on the 23.11.2006 to shorten the budget for the national agri-environmental programme by 37 % down to 218,9 million € (mrirw, 2007).   the national agri‐environmental programme  is defined, planned and coordinated by the  polish ministry of agriculture and development of rural areas. the competences regarding the  preparation,  realisation  and  control  processes  rest  on  the  national  and  regional  offices  of  the  agency  for  restructuring and modernisation of agriculture. however, regional experts, stake‐ holders or farmers have no impact on political decision‐making processes in agri‐environmental  policy.  challenges for the agri‐environmental policy in poland  agri‐environmental measures are regular political instruments which create chances both for  farmers which directly benefit from financial support and for the society due to an improvement of  environmental quality. however, the agri‐environmental measures create also a great challenge as  the idea of environmental protection in agriculture realised in the form of regular political instru‐ ments is relatively new in poland. therefore, little experience is given in this term and no practical  implementation  patterns  are  known,  especially  by  political  decision‐making  committees.  thus,  decision‐making with regard to environmental objectives is not familiar to political stakeholders,  farmers, or the society.   the first challenge is the fact that financial support from the first pillar of the cap for mar‐ ket‐oriented farms is strictly dependent on the implementation of “cross compliance” – environ‐ mental rules which have to be fulfilled to be eligible for direct payments. challenging for farmers  is to implement new requirements and to adopt farming systems to new regulations. for political  stakeholders the challenge is given by the necessity to undertake appropriate measures to make  agri‐environmental policy more effective and to alleviate the further evaluation process.   2007 ‐ 10  •  economic analysis®  according to the experience with agri‐environmental policy in the eu‐15 as well as to a case  study conducted  in poland  (ziolkowska, 2007) challenging  is  to  influence  farmers perception of  agri‐environmental measures and to show ways to understand the measures as not only supported  activities but also as  instruments which can directly  improve  the environmental quality. thus,  challenging is to sensitise farmers for the problems of the natural protection and to teach them to  be not only producers but also ‘nature guards’, which undoubtedly would strengthen their social  role.  several analyses on agri‐environmental measures proved  that  the compensation payment  rates in poland are assessed as insufficient to reimburse all costs resulting for farmers from the  implementation of the measures. indeed, the compensation payment rates were calculated by the  ministry of agriculture and development of rural areas on the basis of income losses and other  costs estimated within an economic survey of farms in the three following years 1999, 2000, and  2001 (rada ministrów, 2004). however, the calculation does not contain any stimulation premium.  this fact can have contra‐productive effects for farmers in a long term perspective. thus, the com‐ pensation payment calculation covering all costs of implementing the agri‐environmental meas‐ ures is an important challenge for poland. alternatively, other approaches can be recommended  such as bidding payments successfully used in the us. according to this system farmers partici‐ pating in the conservation reserve programme offer their environmental services to the state (rei‐ chelderfer and boggess, 1988). thus, prices are estimated for the respective environmental services of  the applying farmers and only the offers are accepted which can be realised by the minimal costs  and which simultaneously promise the highest environmental benefits (s.a. latacz‐lohmann, 1993;  lehmann, 2005, p. 4‐6). although this system is very successful in the us, it has not found any wide  acceptance in the european union until now.   additionally, in the first membership period of poland in the european union the invest‐ ment costs for agri‐environmental measures had to be covered by farmers, which was a serious  financial challenge. the recent evaluation of the national agri‐environmental programme in po‐ land helped to improve the implementation regulations and established the investment costs as an  integral measure (“non‐productive investments”) in the national agri‐environmental programme  2007‐2013 (mrirw, 2006a,b).   also the evaluation of agri‐environmental measures is challenging also due to the fact that  the effects of agri‐environmental policies can be estimated in a long‐term perspective. moreover,  the environmental effects can be influenced by other external effects of economic activities in other  sectors and can be measured only by means of concrete indicators. linckh et al. (1996, p. 22) and  bussmann et al. (1997) proved that environmental elements such as water, ground, air, biodiver‐ sity, and landscape can be influenced by different external factors. therefore, the extent and the  effect quality of agri‐environmental measures can not be assessed in the short perspective, which is  the state in poland nowadays.   agriculture is said to “produce” both positive and negative external effects. as difficult ap‐ plies  to  completely  cover  all  external  effects  and  evaluate  them  with  economic  monetary  ap‐ proaches. potential indicators can be helpful, however, in many cases, they can not reflect all as‐ pects of the complex agri‐environment. thus, economic evaluation approaches are in several cases  inappropriate  to  characterise  intangible  (immeasurable)  characteristics  or  effects  of  agri‐ environmental programmes. the evaluation of agri‐environmental measures is of a particular im‐ portance as usage of natural resources has a great influence on the social welfare, apart from the  externalities  (positive externalities – external economies or negative externalities – external dis‐ economies).  according  to  the  recommendations  of  the  european  commission,  the  externalities  should be analysed possibly on the lowest administrative level in order to consider typical envi‐ ronmental, political, and institutional conditions/ contexts of the regions (europäische kommission,  volume 40 • spring 2007 • 11  2000, p. 15). thus, the challenge resulting for the evaluation and realisation of agri‐environmental  measures in poland is to design and implement the measures on the regional level (in voivodships  – regional administrative units) which is opposite to the current conception in poland to design the  agri‐environmental measures on the national level. the positive results of regional responsibilities  for agri‐environmental measures were proved by several studies. the german agricultural asso‐ ciation and world wide fund for nature (wwf) proposed recommendations for the future de‐ sign of agri‐environmental programmes in the european union. according to it, the adaptation of  agri‐environmental measures to specific regional conditions and priorities can help to more effec‐ tively design and finance the programmes (dlg, 2002).   other challenges for the polish agri‐environmental policy are related to the cooperation be‐ tween regional and national entities and stakeholders in terms of design and evaluation of the na‐ tional agri‐environmental programme. in poland, this cooperation is given between the ministry  of  agriculture  and  development  of  rural  areas  and  the  national  and  regional  offices  of  the  agency for restructuring and modernisation of agriculture. however, the plans to develop and  finance the national agri‐environmental programme are taken on the national level without any  participation of regional stakeholders or farmers. the practitioners are, however, the persons who  best know regional necessity and priorities with regard to environmental protection. in this term,  the integration and tighter cooperation between national and regional stakeholders and decision‐ makers would be beneficial both for farmers and the environment (dlg, 2002).   moreover, dlg recommends replacing the current activity‐oriented measures (payments for  the realisation of the measures) by the result‐oriented measures (compensation for the actual envi‐ ronmental outputs). thereby, higher efficiency can be achieved and potential negative external  effects (spillover effects or farmers’ income losses) can be minimised (latacz‐lohmann, 1995). from  the  other  point  of  view,  the  result‐oriented  realisation  pattern  of  agri‐environmental  measures  would discourage many farmers and bring the question if all investment costs met nowadays can  be reimbursed on the base of the achieved outputs in the future. the proposition of the dlg seems  to be effective and efficient to improve budgeting of the agri‐environmental policy. however, at  the current development stage of agri‐environmental measures  in poland  its adaptation would  result in a decreasing participation in the national agri‐environmental programme.   other difficulties and challenges for the evaluation of agri‐environmental programmes result  from different environmental conditions and different usage of natural resources in different re‐ gions in poland. the fragmented structure of the polish farms (the average farm size in poland  amounts to 8,6 ha (dmochowska, 2003)), the diversification of the agricultural production, simple  farming systems with a huge variety of biotopes are characteristics which require to define differ‐ ent objectives in each region. however, in each voivodship the same agri‐environmental measures  with the same objectives are realised. thus, a risk exists that the compensation payments for the  realisation of agri‐environmental measures will be used by farmers in region, in which no prob‐ lems  occur  or  else  the  problems  are  very  minor.  thereby,  aside‐effects  of  agri‐environmental  measures can be stated (spillover effects). in order to minimise such negative effects, regional con‐ ditions should be considered in political strategies.   other problems connected with  the evaluation processes are missing methodological and  conceptual evaluation tools. also missing reference data, limited data access or high evaluation  costs inhibit evaluation processes of the agri‐environmental policy. these problems can be already  stated in poland. due to the complex character of the programmes, the named difficulties can not  be abolished. they create, however, a challenge  to diminish negative or  limiting  factors  in  the  evaluation processes.   2007 ‐ 12  •  economic analysis®  the evaluation and design of the agri‐environmental policy with the aim to achieve possible  maximal environmental effects  is very complex. the discussion shows, however,  that  the envi‐ ronmental effects can be maximised while planning the agri‐environmental measures on regional  levels considering concrete environmental, economic and social conditions.  evaluation approaches for agri‐environmental policy in poland  due to a short experience with agri‐environmental policy in poland the methodical evalua‐ tion approaches have not been implemented to a wide extent until now and little experience  is  given in the evaluation and design of agri‐environmental measures. before the implementation of  the national agri‐environmental programme, an ex‐ante analysis was conducted by the ministry  of agriculture and development of rural areas (mrirw, 2004a) and output, effect, and result in‐ dicators were defined (mrirw, 2004b, p. p4‐p8). by means of these indicators solely qualitative  analysis can be done basing on statistical data regarding the number of participating farmers or the  support amount for the respective measures in the country or else in the voivodships. the evalua‐ tion of agri‐environmental measures is complex due to the fact that no market for environmental  goods exists and no marginal prices are set for the usage of natural resources. in this context a  question arises which evaluation methods are most appropriate to directly capture ecological ef‐ fects of agri‐environmental programmes? the evaluation theory of the agri‐environmental policy  delivers several approaches which were already proved in practice. as an example, by means of  the “willingness to pay” (in the case of positive external effects) or the “willingness to accept” (in  the case of negative external effects), ecological outcomes can be indirectly measured. the imple‐ mentation of a certain approach is, however, combined with several risks, especially with regard to  indirect assessments (bartmann and busch, 1998, p. 24).   other problems can be related to the incommensurability and the subjectivity of evaluation  approaches on regional and the eu‐level. thus, positive effects in terms of environmental objec‐ tives assessed in one eu member country by means of a certain evaluation approach and com‐ pared to the status‐quo of this country can differ from the effects in other countries after similarly  positive evaluation conducted by means of the same method (hilfenhaus, 1991). thus, using differ‐ ent approaches, more significant distortions should be taken into account.  according to the oecd (1994, p. 31‐33, 1997), environmental indicators could be used in po‐ land for the evaluation of agri‐environmental measures to estimate the influence of agriculture on  the environment. the indicators are related to the soil erosion, water quality, grade of the envi‐ ronmental  protection,  greenhouse  gases,  biodiversity,  habitats,  and  agricultural  landscape.  the  aim of these  indicators  is to reflect the current situation compared to a reference situation. the  oecd indicators as well as other indicators developed by the european commission (“indicators  for integration of environmental issues in the common agricultural policy” (keg, 1999, 2000) and  the european environment agency (eea, 1993, 2005) create an extension of the implemented out‐ put, effect, and result indicators in poland and could help to more effectively evaluate and design  the agri‐environmental policy in the long‐term perspective.  the evaluation methodology provides several direct and indirect approaches (primary and  secondary analysis) to state about the agri‐environmental programmes. the most used are multi‐ criteria‐decisionmaking‐method (mcdm) which can be used in political decision‐making proc‐ esses for design of the environmental policies. best known are cost‐benefit and cost‐effectiveness  analysis.   as new approaches count ‘agri‐environmental panels’ as a form of “round tables” and ‘me‐ diation practices’ which have the aim to get together political stakeholders and practitioners  in  volume 40 • spring 2007 • 13  order to find best possible solutions for agri‐environmental problems (wwf, 2001, p. 44‐50; endres,  et al, 1991, p. 94‐95). for a sectoral and regional analysis „regionalised agri‐ and environmental  information  system  for  germany“  (regionalisiertes  agrar‐  und  umweltinformationssystem  für  deutschland“ (raumis) has been approved (weingarten and schleef, 2000; gömann, et al, 2005).  according  to  pruckner  (2003)  for  the  evaluation  of  environmental  problems,  approaches  should be chosen which can help to better create political decision‐making processes. for practical  evaluation and policy design mathematically founded interactive decision‐support methods were  developed. kirschke and jechlitschka (2002) propose linear programming for evaluation and de‐ sign of agri‐environmental measures. a successful evaluation of the agri‐environmental policy in  an interactive process with political stakeholders is provided with a case study for saxony‐anhalt  in germany (kirschke, et al, 2004, 2007). the suitability of this method was also proved for evalua‐ tion and design of agri‐environmental measures in poland (ziolkowska, 2007). landscape model‐ ling, which also covers the field in agri‐environmental policy, is an innovative evaluation tool in  the last years (dabbert, et al, 1999).  due to the complexity of agri‐environmental aspects, no unique and homogenous methodol‐ ogy is given to be implemented for the evaluation of all environmental problems/ programmes.  the european commission has not accurately specified which approaches should be used for the  evaluation  of  agri‐environmental  measures  (europäischer  rechnungshof,  1998).  principally,  ap‐ proved methods should be used in the evaluation process (europäische kommission, 1999a, p. 21).   conclusions  with this study several challenges for the agri‐environmental policy in poland have been re‐ vealed. additionally, the importance of an extended evaluation of agri‐environmental measures  was  confirmed.  the  deliberation  presents  outlooks  for  the  future  development  of  the  agri‐ environmental policy, and especially the agri‐environmental measures to make them more effec‐ tive  and  efficient.  the  question  is  the  more  important  as  no  empirical  evaluation  of  agri‐ environmental measures in the first membership of poland in the european union has been con‐ ducted by the ministry of agriculture and development of rural areas in poland until now. in the  course of the transition process and before the accession of poland to the european union several  changes in terms of the environmental protection in rural areas have been undertaken. beginning  with pilot projects before the accession to the eu, agri‐environmental measures became regular  instruments of the environmental protection in agriculture (obligatory for the policy of rural ar‐ eas). with the implementation of the agri‐environmental measures new challenges revealed.   according  to  the  presented  discussion,  several  challenges  have  been  revealed  for  agri‐ environmental measures such as the necessity to sensitise farmers for the problems of the natural  protection,  the  necessity  of  a  more  precise  calculation  of  compensation  payments  for  agri‐ environmental measures, the necessity to improve financing of the agri‐environmental measures  and  to consider regional preferences  in  the decision‐making process,  the necessity  to minimise  negative aside‐effects of the agri‐environmental measures such as spillover effects or income losses  resulting for farmers, the necessity to extend evaluation of agri‐environmental measures, the ne‐ cessity to improve access to statistical data and diminish other disturbing evaluation factors, and  the choice of an appropriate evaluation method.   by means of qualitative and quantitative evaluation approaches, existing difficulties in the  realisation and financing the agri‐environmental measures can be found and solved. the most ap‐ proved  methods  are  cost‐benefit  and  cost‐effectiveness  analysis  as  well  as  multi‐criteria‐ decisionmaking‐methods. new methods such as  ‘agri‐environmental panels’ and mathematical  2007 ‐ 14  •  economic analysis®  approaches such as linear programming give a chance to evaluate and design agri‐environmental  measures interactively with political decision‐makers. these methods have been already success‐ fully proved in germany and poland. using these or other evaluation approaches, ways can be  found to more effectively design the agri‐environmental measures in the future.   [1] as „objective‐1‐regions“ are classified  those regions  in the european union which are  characterised by poor economic conditions. in order to improve the competitiveness of these re‐ gions, higher support rates from the european funds were adopted. according to the cap reform  on  the 26.  june 2003  in luxembourg,  the maximal eu co‐financing rate  for agri‐environmental  programmes was enlarged up to 85 % in objective‐1‐regions (from heretofore 75 %) and up to 60 %  (from heretofore 75 %) in the non‐objective‐1‐regions.  references  bartmann, h. and busch, a.a. (1998), ökonomische (monetäre) bewertung als basis für umweltpolitische maßnahmen.  beiträge zur forschung, mainz: johannes gutenberg‐universität mainz.  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abstract ‐ recent global, world occurrences (turbulence, volatility, risks, huge transaction costs,  the weakness of public and private banking, financial structures, instabilities in the international financial  activities and excessive international financial crises) made clearly, that the current international monetary  system canʹt insure global stability and prosperity, neither the system can adapt to a more modern economic  and social structure. instabilities and unbalances, which characterised the system in the past century and at  the beginning of the xxi  century, have been brought by the economic globalization, in other words financial  globalization. intensive widespread of these instabilities, between developing countries and even to the in‐ dustrialized world, have influenced on the international policymakers (called as the international financial  institution) to start the initiatives about possible reform of the international monetary system and its inter‐ national financial architecture.   introduction  recent global, world events (turbulence, volatility, risks, huge transaction costs, the weakness  of public and private banking, financial structures, instabilities in the international financial activi‐ ties and excessive international financial crises) on the international economic and financial stage,  made clearly that current international monetary system canʹt insure global stability and prosper‐ ity, neither the system can adapt to a more modern economic and social structure. namely, ad‐ verse, unfavourable and overload volatile global financial movements brought the international  monetary system and its structure (the international financial architecture) in the state of deep cri‐ sis and collapse, with expressive risks and instabilities from the actual international economic and  financial integration. suggestions for exceeding this negative situation become actually, a workable  and necessary initiative of the international financial and other institutions, for creating the fun‐ damental framework of agenda of the future reform of the international monetary system and the  international financial architecture. it was realized, that the international financial crises are very  «contagious and contaminate», and that they have a «strength» to spread  even to the industrial,  developed countries with sound economic structures and macroeconomic management. however,  the most unsuccessful and vulnerable are shown by developing countries and countries in transi‐ tion (emerging nations). this pattern has been aggravated by premature, previous and hasty liber‐ alization of the capital flows, fragile domestic financial structures and very weak financial regula‐ tion and supervision of the national and international financial institutions. thus, there is no need  for wondering, that the special place in reforming of the international monetary system take de‐ veloping countries and countries in transition. regardless of how is the reform of the monetary  system running, it is certain clear that there is need for better coordination and collaboration be‐ tween international economic policies of both, industrial developed and developing countries.        volume 40 • spring 2008 • 105  instabilities and crises of the current (actual) international monetary system and the  international financial architecture: necessity for reform  in last few decades, process of globalization had a big influence on the evolution and func‐ tioning of the international monetary system. although the system was changing and adopting to  new circumstances and environments, becoming aware of its disadvantages and lacks, that same  institutional  framework  of  international  economics  (the  international  monetary  system)  didnʹt  avoid cyclic movements, which emerged in the middle of the xx. century and at the beginning of  the xxi century. namely, the system has been agitated with the international financial crises, start‐ ing with erm crisis (european exchange rate mechanism, 1992./93), «tequila» crises 1994./95,  and  crises in asia, russia, brazil, argentina in the period from 1997. till 2001. excessive and foster lib‐ eralization  of  the  international  capital  flows,  frequent  speculative  strokes  on  the  international  monetary and national financial systems, evolution and appearance of the financial disturbances  and crises, (un)adequate established foreign exchange rate regimes etc., were  just some of a few  global financial problems spread in the last decades. besides, insufficient, slowly and unsuitable  activities of  the  international financial  institutions  in  the field of: maintaining  the  international  economic relations, solving the financial crises and supporting suitable developments and growth  of developing countries, were pointing that there were a serious problems in the system. such in‐ stabilities and economic unbalances are became more global and systematic, and trying to solve  this limits are not enough. additionally, the problems in the international financial architecture are  more strengthen with the existence of a huge volume of the international financial transactions and  insensitive transfer of financial instruments, also with the integration of the international financial  markets, with inconsistent of the exchange rate policy with macroeconomic performances, prob‐ lems in creating a stable currency configuration, a single global currency, increasing systematic  risks, a deep corruption in governments («crony capitalism») and also with problems of maintain‐ ing the international liquidity. all that, interrupted global financial stage and had influence on de‐ creasing the possibilities for keeping the international trade in balance. this aggravates the current  situation, because the high‐risk financial activities can deepen the unbalances in the future.   unfortunately, at the beginning of the xxi century, the diagnosis of instabilities and prob‐ lems in the international economic relations is still remaining. although, there was established an  actual coordination between macroeconomic politics on global level, the biggest monetary prob‐ lem, which global economy is facing with, specially developing countries, made an impression that  the current international monetary system is more unstable today, than in last decades. todayʹs  monetary system is threatened by collapse, but that shouldnʹt prevent the international and na‐ tional economic politics to learn about the structure of the system, about the arrangements, proce‐ dures, instruments and institutions, which are necessary for defining common standard of valuing  global currencies. hence, it is necessary to do something, in way that global economy becomes  more stable and resistant on sudden and unexpected gaps. a propos, there is an important ques‐ tion: can the current international monetary system resist of the challenges of economic or financial  globalization, so as the question: what kind of the international financial architecture would suit to  the current international monetary system?. all past and current instabilities were raison d’être for  forehand  (timely)  action  and  the  reform  which  realizes:  providing  the  international  liquidity,  global consistency of the macroeconomics policies and financial regulation in developed and de‐ veloping countries, crisis resolution, crisis prevention, solving debt problems, liberalization of the  capital flows, involving or bailing the private sector in solution of currency and debt crises. in this  respect,  in global academic economic  literature, more and more attractive, will become a crisis  management discipline (crisis resolution, crisis prevention) which might ex ante, with new tools  prevent financial disturbances. with predicted, anticipated reform of the international monetary  2007 ‐ 106  •  economic analysis®  system,  it should be only partly decreased  frequencies of  the  turbulences and bring  long‐term  monetary stability which will strength the international trade and keep the global economy more  resilience versus the erratic financial disturbances. no expectations to creating alias a «new inter‐ national monetary system». it must be emphasized that the present system is badly equipped to  prevent financial crises and only partly equipped to manage them and that is also one of the rea‐ sons of reforming it.  the recent crises (crises in usa, europe, 2007/08.) have demonstrated a serious problem in  global economy: the enormous, huge discrepancy that exists between an increasingly sophisticated  and dynamic international financial world, with intensive financial globalization, and the lack of a  adequate institutional framework to regulate it. in other words, existing institutions are inadequate  to deal with financial globalization. this is true of institutions at the international level, which have  manifested significant shortcomings in the consistency of macroeconomic policies, and in the man‐ agement of international liquidity, financial supervision and regulation, it is true, also of national  institutions in the face of globalization. these systemic deficiencies, above mentioned, and the as‐ sociated threat of recurring crises in the future have, thus, underscored the need for a comprehen‐ sive, immediate reform of the international monetary system, geared to prevent costly crises and to  manage them better if they occur. besides, these systematic shortages became the threats to global  system, even with the possibilities to appear in the near future. and, excessive liberalization of  international capital flows, (un)adaptable foreign exchange rate regimes, financial and technical‐ technological solutions and innovations did not effect  just on the increasing of the international  financial transactions, also on the increasing volatilities in the international economic relations. a  several times, repeatedly, on the conferences preceded by the international monetary fund (imf),  the world bank and the other international financial institutions, have been noticed the needs for  (possible) reform of the international monetary system in way to prevent the crises situations. the  expected results of the (possible) reform of the system and financial architecture will be based on  improvement of global economic prosperity and welfare, on forming global financial market, a  single currency and single monetary and fiscal policy.   this chaotic state in the international monetary system provoke numerous discussions, that  there is no the international monetary system, then the «no system» or even «clear‐cut» system.  because of existence of huge proposals for the reforming of the international monetary system, it is  hard to establish unique consensus about how the reform of the system should be realized. in‐ stance for,  r. mundell suggested the fixed exchange rate and a single currency, m. friedman free  floating exchange rate,  j. williamson    target zone, r. mckinnon coordination of  the macroeco‐ nomic politics, j. tobin foreign exchange tax proposal and capital control, etc. thus, there isnʹt an  optimism for creating the «clear‐equalize» international monetary system. it is impossible to estab‐ lish single currency and single exchange rate which will be appropriate for all countries. no single  currency regime is right for all countries at all time, and no single «rules of the game» for the de‐ veloping countries and developed countries.  the fundamental framework of agenda for future reform of the international monetary  system and the international financial architecture  the reform of the international monetary system and the international financial architecture,  for a long time, was metaphorical. however, in the last few decades of the xxi. st century has been  realized that for the long term global prosperity, stability and welfare is indispensable the reform  of the international monetary system and the international financial architecture. the first serious  move about this theme was noted in mexico on the conference called the united nations interna‐ tional conference on financing for development in march 2002. at the same time, that skip was  volume 40 • spring 2008 • 107  considerable as the main (key, basic) turning point in completing the agenda for possible reform of  the  international monetary system and the international financial architecture. even then, there  were established a composition of the reform (directives): minimizing the financial and market  risks (because these risks could bring back again the systematic, currency, debt crises), insure sta‐ bility and «calm» functioning of the system and insure the early warning system with so‐called  financial indicators for assessing financial system soundness (mpi). in other words, there is need  for starting new activities for correcting the basic weaknesses, which    the current international  monetary system revealed at the beginning of the xxi century.    the possible directions for reforming the international monetary system and international fi‐ nancial architecture became  the real challenges for policymakers, international financial institu‐ tions, as on its broad, as on its complexity. namely, the starting premise for reforming the system is  that, the significant economic growth, integration of the international financial markets of the one  part, and a new structure of  the monetary system and  financial architecture of  the other part,  would contribute to larger investments and development in global economy, especially in the de‐ veloping  countries.  the  main  goal,  is  actually,  to  enhance  the  international  integrated  system,  which will be establish on stabile economic policies, stabile national financial system, more open  international financial markets, bigger transparency, legitimacy and right social‐economic polities.  there is need for harmonization of the rules, rights and accountabilities of different constituents in  global economy staring with: governments, citizens, private corporations, special financial institu‐ tions and international financial organizations. the international monetary fund (imf) isnʹt only  responsible for performing already mentioned activities. it should be involve the other interna‐ tional financial organizations and institutions as: the world bank, oecd, bank for settlements and  the other special financial agencies, institutions and non‐profit organizations. with the regarding  to justification and indispensable reform of the monetary system, in meanwhile the number of di‐ rections has been increase (since 2002. up to 2008.). reforms in this area must be addressed with a  sense of urgency in several key areas:   o strengthening and reforming the international financial institutions, thereby improv‐ ing transparency, international standards and codes, international codes of conduct,  improved information, quota, voice reforms,  o involving the private sector in crisis resolution and crisis prevention,  o improving the «crisis management» discipline,  o enhancing social politics of developing countries,   o adopting adequately foreign exchange rate regimes,  o provisioning of adequate international liquidity in times of crisis,  o orderly debt workouts,  o capital account management,   o liberalization of the capital flows,   o strengthening  national  financial  systems  and  enhancing  financial  supervision  and  regulation, etc. [imf,(2007), 9‐15.]  proposals and suggestions for the reform go in two lines: the first one, is consideration of re‐ shaping the goals and models of the current international monetary system and the other one, is  establishing the different, but new tools, rules for system and new international financial institu‐ tions, with new missions and functions («new rules of the game»). still remain to see in which di‐ rection reform needs to run.  2007 ‐ 108  •  economic analysis®  as we can notice, there are many areas of potential or possible reforms, but it will be intro‐ duced just few of them.   the most controversial dilemma is reforming the international monetary fund (imf), as a  main holder (carrier) of the international monetary system. the arguments of the adherents of the  fund (proponents), understand that this central institution will gets out its members and staff with  weaker financial status from the economic difficulties, and enable them prosperity and progress.  the other side, the opponents of the fund think that the institution has the monopolistic position,  putting the developing countries in bigger economic and financial problems. no matter of, many  discussions put on the first place strengthening and reforming the international financial institu‐ tions. the main goal of this activities is mostly directed on improving efficiency of the institutions.  so, the international economic policy are agreed that, imf and world bank should have (and keep)  a central role  in the  international monetary system and strengthening the cooperation between  developed and developing countries. in that way, with supervision and regulation the monetary  system would be more robust. also a less radical reviewers and mostly of the members of the  fund, consider appropriate that institution need to stay «with us», and reform of that institution  should go towards the agency which will help in eliminating global misery and poverty. there are  many opinions how the reform of imf should go, but the main subjects are improving the activi‐ ties in the surveillance of global economy (imf surveillance over the policies of creditors as well  debtors, national financial systems) and finding balance between confidential advices and possible  escalation [salvatore d., (2007), 790]. fundamental directions is actual in the current year (2008)  and will be in the next two or three years. besides, the fundʹs surveillance is being influenced by  efforts to improve transparency and accountability of its members, to develop international stan‐ dards and financial sector assessments. simplify, it became clearly that the prevention and resolu‐ tion of the financial crises, require greater transparency and disclosure of information, regarding  the activities of the public sector, financial markets and institutions and international financial in‐ stitutions.   now, imf publish most of country documents and policy papers (from different countries),  and imfʹs goal is encouraging and promoting transparency in member countries. also, the fund  has to form an efficient and independent mechanism for its politics, programs and operations (ac‐ countability), which will help the institution to demonstrate the responsibility and to justify trusts  to its participants in the international financial markets. the action in the international institution  (imf, world bank) has so far concentrated on setting standards for improving the timeliness and  quality of information concerning key macroeconomic variables, and transparency of public sector  activities including fiscal, monetary and financial policies or data dissemination, transparency of  fiscal, monetary and financial policies and banking supervision. and of course, the transparency is  the «the gold rule» for the successful of reforming of the system. the governments, non‐financial  and international financial institution, have to subjugate to those standards and codes. however,  the special problem for developing countries, is that they arenʹt agreed, completely, with adoption  of these standards, because there are a lot of different standards and very often the institution put  on adoption the «one‐fits –all standards», which sometimes donʹt suit to the economic politics of  emerging markets. anyway, we emphasis the agenda of these standards and codes: code of good  practices on fiscal transparency, code of good practices on transparency in monetary and finan‐ cial policies, special data dissemination standard (sdds), data dissemination standards, basel  core principles, financial sector assessment programme etc.   there are some initiatives for reforming the activities of the world bank. two key principles  are guiding the bank’s work in support of the reform of global system: the bank’s primary focus is  to assist developing countries integrate with the global financial system based on demand‐driven  volume 40 • spring 2008 • 109  country assistance strategies, and the bank is well placed to bring developing country experience  and perspectives to the discussions that are underway on reform (trainings, consultation).   imf and the world bank need to work better together, in way of creating the stronger culture  of cooperation, creating a more equalize dialogue and monitoring process (voting methods). al‐ though, the fund and other international financial institutions work for usa (which possesses a  huge influence in decision‐making), those organizations shouldnʹt forget their mission: supporting  the sustainable development, long term reconstruction of economies, short term financial supports,  collaboration with its staff, human rights, environmental protecting, social care system and wel‐ fare. recent events in the world economy have underlined an important link between economic,  social issues and global system, and that economies depend, both, on stable relationships between  governments and their citizens and strong social cohesion. an efficient social system, by equipping  people for change, builds trust and encourages people to take the risks which are a necessary part  of a competitive modern market. this in turn helps to mitigate the risks and spread the benefits of  globalisation. effective social policy can help in building the support for necessary reforms and  ensuring that the burden of adjustment doesnʹt fall disproportionately on the poorest and most  vulnerable groups in society (still, there is a big problem‐a deep financial gap and improper distri‐ bution international liquidity in times of crisis between developed and developing countries). and,  if policy makers succeed to restore confidence and promote stable growth, parallel, they will re‐ duce poverty and supporting social welfare. therefore,  the  initiatives on social policy must be  taken forward together with the initiatives on debt relief and poverty reduction.  imf surveillance hasnʹt been successful in preventing international financial crises. because  of that, involving the private sector in crisis prevention and crisis resolution is very an important  direction. one of the most complex tasks is how could the private sector be involve in crisis pre‐ vention and resolution. in that way, the international financial institutions suggest to develop bet‐ ter cooperation between debtor and creditor, finding a new crisis prevention measures and new  institutions for crisis resolution. the role of the private sector in reforming of the system, should  help in promotion cooperative decisions between countries in debt and private sector, and improv‐ ing the activities which will decrease risks of investors. these framework, which relief cooperation  debtor/creditor, can minimize frequency and intensity of crises, but the crises canʹt be eliminate. in  view of the growing size and integration of the financial markets, every major financial crisis now  has global ramifications. consequently, preventing a crisis is a concern not only for the country  immediately affected, but also for other countries. with the increased frequency of crisis in emerg‐ ing markets, a consensus has emerged on the need to provide contingency financing to countries  experiencing payments difficulties. above (preliminary) direction is often supplement by the dis‐ ciplines which are called crisis prevention and resolution. and, imf has been working on the crea‐ tion  the  adequate,  supplemental  reserve  facility  (srf)  or  new  contingent  credit  line  (ccl)  which will improve the stability of the international monetary system and decrease the frequency  of the crises. the activities are still actual and will be the theme of discussions on the next interna‐ tional conferences.   the crucial question is adoption and choosing the adequate and properly exchange rate re‐ gime. so, the actual regime today  is hybrid foreign exchange rate system. the system  includes   three blocks: hard peg fixed exchange rate regime (monetary union, dollarisation, eurisation, cur‐ rency board),  intermediate regimes (adjustable peg, crawling peg, basket peg and target zone),  managed  and  clean  floating. also, countries could  decided    between  two solution:  to  use  free  course or to tide up  the currency to one of leading currencies like us dollar. there are suspicions   that this  solutions  couldnʹt stop instabilities and financial crises  in countries. neither of this sys‐ tem is favourable to terms of trade and competence. countries with flexible exchange rates are no  2007 ‐ 110  •  economic analysis®  less vulnerable to financial crises than those with pegged fixed exchange rates. this provoke dis‐ cussable questions: which exchange rate regime is best?, who is right?.[pilbeam k., (2006), 289].  is there progress or ...?  despite the general consensus, that the reform of the global monetary system is‐imperative,  by then no efforts are done towards reform. developed, industrial countries arenʹt ready for acti‐ vating developing countries in discussions about the mentioned theme. the biggest disappoint‐ ment was shown by  the international public financial institutions and their little  interesting for  reconstruction of the global finance. mostly economists can find the main reasons for the reform of  the international monetary system and international financial architecture, in excessive volatility  international capital mobility and foreign exchange rate regimes, in deepening gaps between de‐ veloped and developing countries, and in frequent appearance of the «virtual contagion and dis‐ ease» of monetary system (demonstrated by financial crises and large but extremely volatile and  highly concentrated private capital flows). the predictable reforms they called the «cure», which  should mitigate  instabilities and  frequency of  the  financial appearance and   bring a  long  term   monetary stability, specially in the developing countries. also, the reforms should have the same  echo in the national, as in the international economic policies, which means‐the effects of the pro‐ posed reforms should compose the long term period, so that the results of  renovating of the sys‐ tem could manifest also on developing countries.   the tasks, which global economy had established, are the challenges to all actors of the inter‐ national  monetary  system,  starting  with  industrial,  developed  countries,  developing  countries,  international financial institutions and actors on the international financial markets (banks, pen‐ sion funds, commercial institutions). so, if developing countries want to be involve in progress of  reforming and modernizing the monetary system and the financial architecture, they need to cre‐ ate the consistent strategy of negotiating with developed countries. from the start, countries with  difficulties should represent needs for a new  international financial architecture, providing  the  main directives for sustainable economic growth and development. instance for, providing a few  credit facilities, strengthening and regulations of national financial system, accepting and improv‐ ing the standards and good practice, codes, liberalization of capital account, decreasing the possi‐ bilities for beginning and spreading crises by cooperating with industrial countries, their investors,  exporters, and creditors, international banks and companies.  the progress for the reforming started, but insufficient. the current international financial  institutions and their arrangements are seem so inadequately, and the international financial crises  are still actual. from all that reasons, it is very necessary to, intensively, follow all «mini» progress  of reforms of the international monetary system. so, the developed countries, should strength as  their own individual financial system, macroeconomic politicises, so as the resistance on vulner‐ abilities and crises. however,  the progress on reforming  the  international financial system and  financial architecture doesnʹt go asymmetrical in developing and developed countries. one of the  reasons is, even if they know that the problem already exist, but there isnʹt defined the adequately  framework of the international monetary system, that should adapt to new environments and cir‐ cumstances. also, there is no consensus, which will support and realize the reform in the future.   given this support, why has more progress not been made? an important part of the answer  seems to be that while there is broad consensus on the need for reform, there is far less agreement  on specific measures needed to build a new financial architecture (table 1). all actors have a indi‐ vidual approach  to  the reform of the  international monetary system and international financial  architecture. analyzing the table 1., it is very hard to find common denominator of these direc‐ tions (improving and adoption the international standards and codes, improving the level of inter‐ volume 40 • spring 2008 • 111  national  liquidity,  developing  the  global  finance,  adoption  the  international  regulation, orderly  debt workouts, participations of the developing countries...), which will suit all actors, in the same  time and under different circumstances. also, there is no common attitude toward each one direc‐ tions. only that we can emphasise is, adopting of standards, codes, good practise and  transpar‐ ency.    table 1.: looking a progress of reform of the international monetary system  agreed/disagreed  yes/no  industrial,  developed  countries  developing  countries,  countries in  transition  international  financial  institutions  (imf, world bank...)  definitive  outcomes    adoption of codes and  standards  yes, for equal‐ ize adoption  yes, for equal‐ ize adoption  yes, for equalize adoption  changes occur  provision of sufficient  international liquidity  no large pro‐ vision for  developing  countries  yes, searching  for adequate  directives of  provision of  sufficient  international  liquidity  yes, searching for ade‐ quate directive of provi‐ sion of  sufficient  international liquidity  changes do  not  occur  increased development  finance  no, not  enough  no, not  enough  yes, but not enough  changes do  not  occur  provision of sufficient  and appropriate  international regulation  yes, but not  enough  yes, but not  enough  yes, but not enough  changes do  not  occur  increased participation  by developing  countries  not ready for  activating  developing  countries  yes, but not  enough   unclear  changes do  not  occur  adoption of standstill  and orderly debt work‐ outs  yes, some  quite keen,  but no pro‐ gress  varies,  not too keen,  but no pro‐ gress  quite keen, but no pro‐ gress  changes do  not  occur  conclusion  modernizing and redesigning the international monetary system and the international finan‐ cial architecture are very important for all world. it is very important to support these mutual‐ connected trends and activities of reforms in the future. debates about reforming the international  monetary system and international financial architecture, still will remain in the framework of the  theory and politics of the representatives (the international financial institutions, the international  monetary fund (imf) and world bank). the main factor which are stopping the realization of the  reform, is asymmetrical policy‐economic interests of developed, industrial countries and develop‐ ing countries. because of that, the global prosperity is not yet accomplish.   efforts  in creating  the new  international financial architecture are becoming «hostage» of  agreements between developed countries (g7)  and developing countries.  to decrease these prob‐ lems, mostly economists have to continue the discussions and to organize diverse debates about  exploring the factors which brought international monetary system in this situation. also, debates  should compose: detail problems of weak national financial systems, unreasonable way of lending,  2007 ‐ 112  •  economic analysis®  inconsistent macroeconomic politics and foreign exchange rate regimes, problem of confidence,  problem of international liquidity, etc.  reference  intenational monetary fund, (2007), annual report, imf, washington d.c.  pilbeam k., (2006), international finance, third edition, palgrave macmillan, new york.  salvatore d., (2007), international economics, ninth edition, john wiley & sons, inc., new york.    ea_2017_1-2 udc: 346.543(4-664) 330.322(4-664) jel: f21, d53, p2 cobiss.sr-id: 240648972 scientific review the role of investment funds in countries with transition economies marija đekić1, milan gavrilović, miloš roganović, faculty of business economics and entrepreneurship, belgrade, serbia ranka gojković, university of east sarajevo, east sarajevo abstract – investment funds, their foundation and development in serbia, as a country with transition economy, should be viewed in the context of overall economic reforms, which are necessary for these kind of countries, to enable them to emerge from decades of stagnation and poverty, and create conditions for establishing an open market economy. only within financial reforms, investment companies provide a significant contribution in the improvement of the national economies of the countries in transition. through knowledge of their managers and scope of resources they possess, they have greater opportunities than individuals from quality and professional market analysis, to the dispersion of risk by investing in various securities. this paper presents the impact of investment funds as institutional investors on financial market development, as well as their role in the privatization process and points out the problems and possibilities of development of investment funds in the countries in transition. key words: country risk, credit rating, macroeconomic indicators, spearman’s rank correlation coefficient, south-east european countries introduction investment funds have emerged as a result of the very fast development of the securities market in developed countries, as well as the inability of the classic banking sector to respond to the needs of investors and users. with the advent of these funds, the structure of the banking sector has been enriched, increased competition, deepened of capital markets and enabled the execution of transactions in a modern way. their rapid development has led to the explosive growth of, especially, the securities market. therefore, these funds are considered the best form of development and successful functioning of the securities market, in countries where this market is developed, as well as in countries in which there is not. 1 corresponding author: đekić marija, email: djekic.maja90@hotmail.com 2 economic analysis (2017, vol. 50, no. 1-2, 1-12) the starting point for pan-european history of investment funds has been the so-called ucits directive (undertaking for collective investment in a transferable securities), which came into force on 1. october 1985. and was later implemented into national law of the member states of the european union and the european economic community. the aim of ucits is the harmonization of laws, administrative regulations that relate to joint investment in transferable securities. in addition, a secondary aim of the directive was to simplify international marketing and to assist the creation of a european capital market. ucits are, by definition, only open-end investment funds, while the remaining (non-ucits) are closedend funds and other special funds. during its brief existence ucits directive has already become a globally recognized model of regulation of funds, which provides a high level of protection of investors. getting to know the investment funds is in the interest of the general public, and all those who will have the opportunity to acquire shares at privileged conditions. their permanent orientation to small investors, in our situation, only later will come to the fore. then they will exhibit the basic advantage of investment funds, as well as the best form of investment of small investors who do not know and cannot take advantage of investing in shares of companies and want to avoid the risks that arise from there. investment funds in developed countries have strengthened their positions in the financial market, evoking great interest of the holders of small savings. their expansion over the past decade was lightning and today it is in a diverse range of financial institutions, the indispensable institution. in modified form, funds have confirmed their expediency in countries in transition, realizing the tasks posed by these specific economic and social circumstances. in ambitious tasks of the privatization, investment funds are not provided only a mere infrastructure support, but they secured a substantial reform of ownership and management structures. it should be stated that the serbia, relatively late, legally regulated and enabled business of investment funds. other countries in transition have been done so a long time ago. the privatization process, the spread of shareholding and accelerated circulation of shares is necessary to assume the existence of investment funds. although in developed market countries, financial markets cannot be imagined without their existence, about this institution in our country very little is known. therefore, it was expected that their implementation in our country will follow a certain caution and fear of the new. this imposes the necessity to coordinate quality law on investment funds, from the start. investment funds in serbia have started with the founding in 2007. until the global economic crisis in october 2008., the funds achieved positive yield rate. investors in serbia are expecting similar yields accomplished in croatia after the arrival of funds, however, the effects of the global crisis reflected on the market of serbia, but also on the markets of all countries in the region. in this period, there was a decrease in demand and a decline of securities price on the stock market, which resulted in a decrease in investment units of funds and negative yields over the coming years. the paper, conceptually, is composed of two parts. the first part talks about investment funds in general, summarizing their characteristics in general, while the other is more focused on the experience and perspective of development of investment funds in the countries in transition, as well as the legal framework of the privatization process and investment funds in serbia. đekić, m., et al., the role of investments funds, ea (2017, vol. 50, no. 1-2, 1-12) 3 the role and significance of investment funds the role of investment funds is reflected in the intensification of circulation of securities through (lajović, 1998, p. 46): • portfolio diversification, • professional portfolio management, • increasing the level of marketability of securities. investment funds founded and managed by investment companies, brokerage houses and banks. it is usually part of the proper "family of funds". individual funds are relatively rare, created with the ambition to cover a wide range of securities of different types. so, in most cases, funds are specialized on the basis of securities which they manage or by the management style, as well as by sector or region in which they invest. investment objectives, which are the reason of the existence of investment funds can be classified into three categories (kidwell et al., 2016, p. 552): • realization of current income, • ensuring future growth / appreciation of capital, • combining the first two objectives. the advantages available to individual investors, if they invest in an investment fund could be: • does not require large funds to invest, • clearly defined investment objectives, • offering simple reinvestment opportunities, • provide liquidity. sociologically, investment funds had experienced an expansion in the world with the strengthening of the middle class, which saved up for: home purchase, education for children, pension reserves. the funds have enabled to the average citizen that, based on small stakes and regular savings, participating in the securities market, hitherto reserved for investors with significant capital. investment funds affect the development of capital markets through several roles: through the collection of domestic savings by providing investors higher yield rates and greater security than commercial banks, diversification in placements and reducing risk by ensuring adequate liquidity of investments, enabling reinvestment of dividends and accomplished capital profit, providing new sources of funding for corporations, small and medium-sized enterprises, through an increase in competition over the banks raise the quality of financial institutions, and finally, encouraging circulation on the financial market, as investment funds also appear as buyers and sellers of securities. today, the world is dominated by open-end investment funds. in almost all developed market economies, investment funds have become big players in the financial market, and the process of privatization in the former centrally-planned economies, enabled their presence in economies in transition. at the end of 2015, according to data from the investment company institute (2016), the world has 100,494 open-end investment funds, managed with net assets worth 37.2 trillion us dollars (usd), which represents an increase in net assets from 0.3% compared to 2014. in 4 economic analysis (2017, vol. 50, no. 1-2, 1-12) europe, at the end of 2015, it operated 45 427 open-end investment funds, which are managed by total net assets of 12.77 trillion usd. most open-end investment funds in europe, at the end of 2015, was registered in luxembourg, a total of 12,074 open investment funds, which are managed net assets of 3.57 trillion usd. according to the same data the investment company institute (2016), open-ended investment funds from the united states manage with almost half of the total assets of all open-end investment funds in the world, namely with around 48% of global assets. assets of open-end funds, which are registered in europe, make 34% of the total assets of all open-end funds in the world. participation of other continents is much less than in europe and the united states. by passing the institutional regulations for the operation of investment funds in serbia (the law on investment funds in 2006), have opened up perspective of development of a propulsive nonbank financial deal which is very important for the further development of banks. banks should, through its investment funds, keep under control and manage transfers of significant funds from their savings toward investment funds, as well as new net investments in shares of investment funds. table 1. number of investment funds and management companies in serbia in the period 2010-2015. types of investment funds 2010 2011 2012 2013 2014 2015 open-end 15 15 16 11 12 12 closed-end 2 2 1 1 2 1 private 3 3 3 2 2 number of companies for managing investment funds 9 8 6 5 5 4 source: commission for securities in serbia, annual report of the commission and market developments in the period 2010-2015. in the industry of fund, there is an open-end, closed-end and private funds. the largest part of the assets of these three types of funds is in the open-end investment funds, in which investors can every day buy and sell investment units, so that they have secured liquidity. during the crisis, despite the large decline in the value of shares, liquidity of investments is held on, and until now has not happened that the investor is not paid the value of assets within the legally prescribed period (5 days). a year before the advent of the crisis, and in 2007, the investment policies of many investment funds have been directed toward investments with high yields, which led to the creation of high-risk portfolio. the yields of these funds in serbia had a positive correlation with the movements of the index belex15. as the crisis continued, increasingly appeared funds with conservative investment portfolios. investors who had optimistic expectations about the recovery of the stock market, they chose the balanced open-end funds, which in its portfolio have government securities with fixed yield. (korenak et al., 2013) on the other hand, view of the fact that the stock market indexes experienced a record decline, property of funds also experienced a large decline and failed to fulfill expectations of investors, who have invested funds, hoping for high yields in the first years of business đekić, m., et al., the role of investments funds, ea (2017, vol. 50, no. 1-2, 1-12) 5 activities of funds. the decline was interrupted in 2010, when it re-established the confidence of investors and continuous growth trend in the number of investment units in the coming years. table 2. basic indicators of movements of sectors of open-end investment funds in serbia in the period from 2007 to 2015 year number of open-end fund number of investment units total net asset of all open-end fund (in dinars) 2007 6 3.644.829 4.012.075.402 2008 14 2.402.647 1.340.474.105 2009 15 2.156.867 1.035.981.297 2010 15 1.744.493 1.078.883.380 2011 15 1.947.097 1.607.044.353 2012 16 2.331.690 2.324.588.939 2013 11 4.416.264 5.277.371.251 2014 12 6.952.001 9.156.460.680 2015 12 11.003.640 16.986.007.038 source: commission for securities of the republic of serbia (2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016) transitional reversal in serbia the impact of geopolitical shocks and rigidity of the political system by the year 2000, as well as errors in the implementation of the transition and the inability of the coalition government to implement its plans, after the october changes, had an unambiguous impact on competitiveness and economic growth. the best indicator of the impotence of the serbian economy is trade deficit. consequently, the maintenance of macroeconomic stability implies permanent inflow of capital. however, inadequate entrepreneurial capacity and instability in the business environment, on the one hand, and the effects of the crisis, on the other hand, talk about the poor perspectives of investing in serbia. this kind of situation, combined with a constant increase in external debt in order to finance of the gap in resources, can lead to reduced inflow and the withdrawal of existing capital, primarily from financial institutions. consequently, this would lead to a negative domino effect (monetary crisis, devaluation and inflation) that would lead to macroeconomic instability. to avoid this scenario and ensure sustainability, current, shallow reforms, it is necessary to create conditions for (re) industrialization through the growth of institutional capacities and investment opportunities. in the period after the october changes, a lot has been done on the understanding of macroeconomic stability. however, macroeconomic stability is a necessary, but not a sufficient condition for the sustainability of reforms and development. the foundation of sustainable development is located in a special and original strategies and institutions, which form and create a business environment in which economic subjects can compete. however, 6 economic analysis (2017, vol. 50, no. 1-2, 1-12) the question arises: is the problem of development and growth of economies in transition formulating and implementation of the adopted strategies (and their continual improvement in a turbulent and changing environment)? by abandoning the path of pragmatic solutions and through transitional turn, and switching from macro to micro-economic reform, it is possible to achieve sustainable development of fragile and weak economy. consequently, it is necessary to create a new transitional strategy (pavicevic, albijanić, 2015), deeper market reform. the essence of the market economy, however, is that economic power is limited by competition. ownership over the large economic resources may not be directly related to economic power, if there is competition in the market. so, with deeper market reforms and by strengthening market mechanisms eliminates the concentration of economic and political power, which could have the most funds as majority owners of economic resources. the basic prerequisite for the increased volume of trading on the capital market is the existence of supply and demand. serbia has emitted a significant amount of securities, but still there is not enough of satisfactory offer, and not enough demand for the securities. there are plenty of reasons that cause the low demand for securities in serbia. lack of knowledge of local investors in the business with securities, as well as the lack of information about prices and transactions, discourages investment in securities. low living standards and the lack of a middle class are not good conditions for savings and investments. political instability, inflation, lack of tax incentives is another reason that contributes to this situation. until the establishment of domestic investment funds be postponed, foreign investment funds will become owners of the increasing number of best companies. this is corroborated by cases with companies: salford, midland, fpp balkan limited. (maksimovic, marčetić, 2014) problems and perspective of development of investment funds in the countries in transition guided by the experience of the most successful transition economies, that have joined the european union, it is concluded that the most important indicators of a successful completion of the transition process: the dominance of the private sector in the overall economy and the creation of gross domestic product, hard budget restrictions at the micro and macro level, the efficient functioning of financial markets and a high degree of economic freedom. (petraković, 2004) countries in the region substantially lag behind high-income countries when it comes to investment funds. the main reasons for this are as follows: 1. underdeveloped capital markets, 2. the dominance of banks, and credit as a source of funding, 3. the low level of investment culture poor awareness of population and insufficient knowledge of the operations of investment funds. (lekovic, 2014) european bank for reconstruction and development (ebrd) published a set of indicators of development of countries in transition (transition indicators) based on which estimates the reform process in these countries from planned to an open market economy. đekić, m., et al., the role of investments funds, ea (2017, vol. 50, no. 1-2, 1-12) 7 transitional indicators are ranging from 1 to 4+, where 1 represents little or no change compared to a rigid planned economy, and 4+ represents the standards of an industrialized market economy. table 3. transitional indicators for the financial sector of countries in the region for 2016-2017 financial sector banking insurance and other financial services private equty capital market albania 32 1 2 bosnia and herzegovina 32+ 22 bulgaria 3 3+ 33 macedonia 331 2 montenegro 32+ 1 2 serbia 33 2 2 romania 3 3+ 33 source: (ebrd, 2016) the competitiveness of serbia is not on enviable level. according to the global competitiveness report for 2015.-2016. serbia is one of 140 ranked countries, is on the 94th place. serbia was in 2014. and 2015., also occupied 94th place in terms of competitiveness, but of 144 ranked countries, with global competitiveness index of 3.9 in both periods. (world economic forum, 2015) this points to a very slow progress of the serbian economy and economic environment. according to the model of porter's diamond, business environment of serbia has many flaws: poor infrastructure, poor and slow state administration, the mass outflow of professionals and scientists, the emergence of market dominance, poor efficiency antitrust policy, bad regulation of property law, lack of investment in research and development, slow acceptance of modern technologies, not quality vendors, bad cluster development, poor development of research services and training. so, these are the deficiencies in the areas that are about to be a priority for the country. (mitrovic, mitrovic, 2015) when we talk about the capital market, the market capitalization on the belgrade stock exchange, at the end of 2016., amounted to 592.4 billion dinars, compared to the end of 2014 is lower by more than 15%. (bse, 2017) on the stock exchange is traded shares and bonds of the republic of serbia, and by now there were no initial public offering of shares of the company. overall, capital market is characterized by low liquidity and quality of investment options. before the advent of the global crisis, investment funds were focused on risky investments with high returns, and already in 2008. its investment policies directed towards more conservative portfolios. during 2008. there is a significant withdrawal of foreign investors from the stock markets of countries in transition. foreign investors are very important participants in the transition countries, which do not have a large market capitalization, have low liquidity and poor active domestic investors. in the period from 2005-2009. participation of foreign investors moved up 42.77%, and their withdrawal after this period had an impact on all stock market indicators, including the volume of circulation, 8 economic analysis (2017, vol. 50, no. 1-2, 1-12) the number of transactions, indexes and market capitalization. only in 2008. compared to 2007., the volume of total circulation dropped by 56.45%, in order to 2009. decreased by 41.86% more, in comparison to 2008. (pavlović, muminovic, 2010). moradi, mirzaeenejad and geraeenejad (2015) conducted a study on the level of developed countries and developing countries where the results show that the type of financial system affects the distribution of income in the sense that market-oriented financial system leads to a better distribution of income in developed countries, while bank-based reduces income inequality in developing countries. (moradi et al., 2016). the financial system of serbia belongs to the domain of bank-based market with the participation of banks over 90%. serbian financial market functions under the principle that credit is the most common financial instrument, because the market of corporate and municipal bonds in serbia is underdeveloped. as in other countries in transition, and in serbia, venture capital still plays a minor role in the financial market. besides the initial activities of the network of business angels of serbia, which was founded in 2010, investments through venture capital are just getting started. in serbia, there is still no effective law that regulates the establishment of investment funds, as well as venture capital funds, business angels and other forms of financing. besides some changes of law relating to these forms of funding, are not made significant steps to motivate and facilitate the business of venture capital funds. according to the index of attractiveness for the venture capital and investment in shares of companies, serbia in 2016. was in the 74th place among 125 countries, which is an improvement compared to 2015., when it was in 81st place of 120 countries observed. (iese) such a bad evaluation serbia could fix with the new laws concerning the capital market, which should provide greater protection to investors, to reduce the systemic risk of the country and create a more transparent market. transition economies can have many economic benefits from private investment funds that operate in their own territories, and these funds can greatly help the economic transition and recovery. the operations of private equity funds have greatly hampered by legal regulations, institutional, legal and political framework for business, but also the great distrust in the financial sector, due to fraud and malfeasance that occurred in the past. private investment funds will play an important role in investment companies and this trend will continue in accordance with the economic prosperity of the economy, especially for the reason that this type of financing has obvious advantages over the financing of loans and credits. they have a special role and importance for the economies of countries that are candidates for accession to the european union. the largest investor of private investment funds in central and eastern europe is the european bank for reconstruction and development. in forthcoming period, it is expected the entry of new private investment funds in the balkans and in countries in transition, which tend to institutionally regulate their markets in order to become members of the european union. changing the ownership of the company, beyond the opportunities, for private equity investment which furthers their development and create better conditions for their functioning. continuous improvement of economic conditions, intense economic reforms and radical institutional changes have led to the creation of a suitable environment for investment and development of the private equity industry in large parts of eastern europe and the balkan countries. đekić, m., et al., the role of investments funds, ea (2017, vol. 50, no. 1-2, 1-12) 9 developments in private equity investments and the capital market in the last year, gives hope that the situation on this issue fix it. in serbia, recently, government bonds are listed on the stock exchange, which provides institutional investors an adequate price benchmark. also, what is important for the business of institutional investors in the transition economies of the region is that the belgrade and zagreb stock exchange joined the see link platform, thereby improving access to capital markets in the serbia and croatia. this should expand the investor base of countries and improve the availability of funds. in the future, it can be expected that foreign management companies are increasingly establishing specialized funds for investing in the markets in countries in transition. in these countries, the banking sector has largely lost the public's trust, so that other forms of savings or financing may gain in significance. investment funds generally offer investors higher yields with high liquidity of assets, so that in the future may represent a more attractive form of investment. legal regulation of the privatization process and investment funds in order to accelerate the privatization process, the government of the republic of serbia in 2005 and 2006 proposed and the parliament subsequently adopted amendments and additions of relevant laws: the law on privatization, concerning the privatization agency and the share fund. the important amendments to the law on privatization related to the fact that the companies that went on sale, the state wrote off debts to funds and public companies and thus made them significantly more attractive for potential investors. the mentioned debts would be settled subsequently from the sale proceeds of these companies. adopted the law on investment funds (june 2006), which regulates the operation of investment funds in the privatization process, thereby achieving greater public in their business. other laws were adopted and with the aim of creating suitable environment for foreign investors. law on privatization stipulates that the privatization should be completed in 2007, with the exception of public enterprises, which expects the preparation of the organization and status for the privatization. namely, it was necessary that these companies strengthen and reduce the costs of their operations, and it was necessary that the government as soon as possible, adopt the strategy of restructuring of public enterprises, which would stipulate the general conditions of the privatization of these companies, reducing redundancy in them (by approximately 10 %), as well as specific social programs for workers, which would be financed from the so-called. transitional funding, while the additional funds provided for this purpose through a process of restructuring of public enterprises (companies selling those parts that are far away from the basic activities). according to the adopted amendments and additions to the law on privatization, from december of 2007, is scheduled to complete the privatization of public companies by the end of next year. it also stipulates that companies that do not find buyers by that deadline privatized through the bankruptcy and thus find strategic partners. particular problem in so far completed privatization are private investors who have in recent years purchased the company from the state, which in many cases do not respect their contractual obligations relating to social and investment programs. 10 economic analysis (2017, vol. 50, no. 1-2, 1-12) in the process of privatization of public enterprises is considered that there are two scenarios for the takeover of public companies. the first is that major parts of the company sale to strategic partners and the rest of the capital appeared on the market. the second scenario involves an investment by the investment fund. in the case of strategic takeover, the company is unlikely to expand beyond existing markets, while in the case of investment by the investment fund objective would be the faster growth of the company increasing its value to that extent, so that its value will increase as more. (kvrgić, 2013) besides the foreign investors, very significant investments are made by domestic investors and their level also needs to be raised. only 13% -16% of serbia's gdp goes to investment. it is difficult to count on an increase in foreign investment, before the domestic investment does not significantly raise, because the domestic entrepreneurs first test the quality of the business environment in the country. (roskić, 2007) private funds are not subject to the general provisions of the law on investment funds concerning the issuance of permits for the investment fund, investing assets of the fund the investment restrictions of the fund assets, restriction of disposal of the fund's assets, determining the income of the fund, issuing prospectus, marketing and intermediary. on the private fund, do not apply the provisions of this law, except the submission of annual financial statements. private investment fund may be indebted without restrictions, in accordance with its policy and rules of operation. managing private investment fund exclusively provided by the management company, in accordance with the contract on management concluded with the private fund. the management company submits to the commission a contract on management and business rules. the commission registered private investment fund in the investment funds registry. on the private funds, accordingly, apply the provision rights which regulate business companies. however, there is still no harmonization of the legal framework for the "private equity" on the territory of europe. on the eu level a large number of regulations govern only indirectly operations of these investors. some of the relevant regulations are: mifid, ucits, the directive on pension funds (pension funds directive) and directives which are loosely linked to capital requirements (capital requirements directive). prior to defining the legislation is desirable to spot potential unwanted activity of funds in terms of the impact on global economic trends in the country. it happens often, cases where the legislation passed before the identification of potential situations that should be allowed and those that should be controlled and prevented. it is especially important to consider these aspects, for the reason that in our country there is still no clear regulations for these investors, although for years there are institutions that operate in this region. (erić et al., 2012) conclusion the privatization process, the spread of shareholding and accelerated circulation of shares necessarily assume the existence of investment funds. this is especially evident in the fact that they were one of the key pillars of the privatization programs of many countries in transition. this type of privatization was usually accompanied by the establishment of đekić, m., et al., the role of investments funds, ea (2017, vol. 50, no. 1-2, 1-12) 11 privatization investment funds, which had a key role of financial intermediaries during the privatization and in post-privatization period. however, due to a series of problems in their functioning, investment funds did not achieve the expected role in countries in transition, primarily in terms of enterprise restructuring and improvement of corporate governance. there are different roles that investment funds have in developed countries, countries in transition and finally in serbia. in developed countries, they are the biggest investors in shares and work over management companies and thus influence on the competitiveness of the economy and the diversification of risk. in countries in transition, they appeared at the beginning of the transition, were the favorites, but did not lead to the expected development of the financial markets. financial experts see the primary advantage of investment funds in the fact that they reduce the investment risk, because they invest in shares of several companies. enables easy transport, because the small investor has no need to register and participate in the public offering of shares. all this, for him, makes an investment fund. their work is regulated and monitored by the commission for securities, and we must not neglect the fact that investment funds managed by professional people. for further development of the financial market in serbia are important institutional investors, because institutional investors in international financial markets, especially in oecd countries over the last ten years, had a very high growth and played a key role in the financial market. about this institution in our country do not know much, which applies to entrepreneurs, although in developed market countries the system of financing cannot be imagined without their existence. advantages of investment funds are well known the diversification of the portfolio, portfolio management and corporate governance are particularly current, at the present time, in our economy, so should not miss their expression through the activities of these institutional investors. it would be extremely important, not only the presence of foreign investment funds, but also the formation of domestic, because it would fill noticeable cracks in the capital market. we need someone to offer the market the new securities which would be safe enough and sufficiently attractive to ordinary depositor. law regulations would, of course, be necessary to define a number of issues related to the establishment and operations of investment funds, starting from the required capital, qualification of personnel, types of investment fund, the restrictions regarding allowed percentage of investments in certain securities, preventing manipulation, etc. also, the state should, through tax incentives, stimulate investment in investment fund. references beogradska berza. 2017. http://www.belex.rs/files/bilteni/254.pdf (accesse march 15, 2017) ebrd. 2016. transition report 2016-2017. erić, d., behara, i., đuričin, s., kecman, n., jakšić, b. 2012. finansiranje malih i srednjih preduzeća u srbiji. beograd: privredna komora srbije. iese. (n.d.). the venture capital and private equity country attractiveness index 2015 annual. retrieved march 20, 2017 from http://blog.iese.edu/vcpeindex/ranking/ 12 economic analysis (2017, vol. 50, no. 1-2, 1-12) kidwell, d. s., blackwell, d. w., sias, r. w., whidbee, d. a. 2016. financial institutions, markets, and money. john wiley & sons. komisija za hartije od vrednosti. republika srbija, godišnji izveštaj o radu komisije i kretanjima na tržištu, u periodu od 2008-2016. godine. korenak, b., miletić, s., ivaniš, i. 2013. performances of different investment policies of open-end funds in republic of serbia. the second international scientific conference employment, education and entrepreneurship (eee 2013). belgrade: faculty of business economics and entrepreneurship, pp. 520-534. kvrgić, g. 2013. upravljanje investicionim fondovima. treće izdanje. beograd: visoka škola za poslovnu ekonomiju i preduzetništvo . lajović d. 1998. "investicione kompanije-institucije koje nedostaju našoj ekonomiji". berza, 78: 43-61. beograd. leković, m. 2014. “regionalne razlike u razvoju industrije investicionih fondova srbije i hrvatske.” bankarstvo, 5: 70-85. maksimović, d., marčetić, m. 2014. the investment funds as an insentive for economic activity in republic of serbia. employment, education and entrepreneurship (eee 2014). belgrade: faculty of business economics and entrepreneurship. pp. 123-132. mitrović, v., & mitrović, i. 2015. “uloga ljudskog kapitala u povećanju konkurentnosti privrede srbije.” international scientific conference of it and business-related research, 699705). beograd: univerzitet singidunum. moradi, z. s., mirzaeenejad, m., geraeenejad, g. 2016. “effect of bank-based or marketbased financial systems on income distribution in selected countries.” procedia economics and finance, 36: 510-521. pavićević, ž., albijanić, l. 2015. “intelligent investments management; transition u-turn.” international conference on accomplishmants in electrical and mechanical engineering and information technology. banja luka, 787-795. pavlović, v., muminović, s. 2010. “značaj razvoja finansijskih trţišta za srpsku privredu.” industrija, 38(4): 41-67. petraković, d. 2004. “rizici uspešnog završetka tranzicije u srbiji.” industrija, 32(1-2): 119129. roskić, j. 2007. “pravni i institucionalni okvir za podsticanje i zaštitu inostranih ulaganja u srbiji.” finansije, časopis za teoriju i praksu finansija, 28-43. the investment company institute 2016. investment company fact book: a review of trends and activity in the investment company industry. 56th edition. the investment company institute. world economic forum. 2015. geneva. article history: received: 15 may, 2017 accepted: 10 july, 2017 ea_2018_3-4 24 economic analysis (2018, vol. 51, no. 3-4, 24-32) doi: 10.28934/ea.18.51.34.pp24-32 scientific paper inflation, unemployment and nairu estimate in indonesia: phillips curve approach nurul hafnati1* | sofyan syahnur2 1 university of syiah kuala, faculty of economic and business, department for economic, banda aceh, aceh, indonesia 2 university of syiah kuala, faculty of economic and business, banda aceh, aceh, indonesia abstract the present study was carried out to analyze the relationship between inflation and unemployment in nairu estimate in indonesia through phillips curve approach during 25 years data from 1991-2016. the analysis model used in this research was vector error correction model (vecm) as attempts to determine the long run and short run relationships between inflation and unemployment matters in indonesia. the results of granger causality test indicated two-way relationship between inflation and unemployment in indonesia. the formulated resultsonlong run estimate pointed out that unemployment delivered negative and significant effects on inflation. nonetheless, wald test designated that there was a short run relationship between inflation and unemployment key words: inflation, unemployment, phillips curve, nairu, vector error correction model jel classification: e24, e31, f41 introduction inflation and unemployment are two economic mattersfacing each country in the world. the relationship between inflation rate and unemployment refers to the theory of an economist, a.w. phillips (1958), was investigating wage inflation and unemployment in england from 1861 to 1957. phillips discovereda consistent inverse relationship that if the unemployment rate is high, then wage will increase slowly, and if the unemployment rate is low, then wage will increase rapidly. an empirical study on inflation and unemployment rate were then developed by samuelson and solow (1960) who found a trade-off between inflation rate and unemployment rate in the united states. further development on phillips curve phenomenon was proposed by friedman (1968) and phelps (1968) stating that trade off between inflation rate and unemployment rate will occur only in the short run. while in the long run, it will not occur because in the long run, monetary policy makers will face a vertical phillips curve, where the unemployment rate tends to be at its natural rate, so that the prevailing monetary policy will not only affect inflation rate. friedman (1968) and phelp (1967) were the first economists to introduce the term natural employment rate or so-called non-accelerating inflation rate of unemployment (nairu) which is a component in the phillips curve. nairu is a modern inflation theory where if the unemployment rate is low, then it is not followed by high inflation. this corresponds to the unemployment rate of sources where workers and market products are in a state of inflation balance. inflation balance occurs when there is no excess in demand and no supply shocks. in nairu theory, it is explained that there is no negative relationship between inflation and unemployment, and phillips curve in * corresponding author, e-mail: nurulhafni@mhs.unsyiah.ac.id nurul hafnati, sofyan syahnur 25 the long run is vertical. if policy makers use phillips curve by selecting the higher inflation in order to reduce unemployment, then the reduction in the number of unemployments is not permanent. in nairu hypothesis, there is a condition that unemployment will eventually return to its normal and natural level, regardless of the inflation rate. nairu may cause 3 conditions that inflation will increase if unemployment rate is below nairu, inflation will decrease if unemployment rate is above nairu, and inflation will be stable or balance if unemployment rate is equal to nairu. thus, if the government seeks to reduce unemployment below nairu, it will lead to increasing inflation, so that workers and companies will expect inflation to be higher. higher inflation expectation leads to an increase in inflation expectation. rising inflation expectation for a long time will make the economy to be slower, so that contraction in economic activity will make output to return to its original potential, and the unemployment rate returns to a reasonable level. therefore, in nairu theory, the reduction of number of unemployments can be carried out without the increase in inflation by maintaining the unemployment to be equal to nairu. according to helali (2018) the nairu model is a standard inflation model based on the anticipation of the augmented phillips curve. in this study the time-path of the nairu is extracted from the information contained in the measurement equations by employing the kalman filter recursions. as the true values of the unobserved components – including the unemployment gap and the nairu – are unknown, the kalman filter provides an algorithm to finding estimates for the unobservables (heimberger (2017)). in indonesia, unemployment is a problem in the economy due to its increasing number every year. in indonesian economic development, job opportunities are the main problem because the gap in getting jobs, which is the gap between the growth of labor force and the limited job field directly leads to high unemployment rate. this research used time series data from 1991-2016 with the objective to determine the presence of phillips curve in indonesia. in accordance with this objective, testing is needed to analyze the relationship between inflation and unemployment in short and long runs for 25 years. in addition, it is necessary to conduct a causality test between unemployment rate and inflation rate. this research consists of 5 sections. section 1 presents an introduction. section 2 presents a literature review. section 3 describes the analysis of theoretical methodology. section 4 describes data source and methodological framework used in this research. section 5 describes the the research results and section 6 concludes the results of this research. previous research samuelson and solow examined the relationship between inflation and unemployment in the united states. the result was in accordance with phillips’s showing that there was a negative relationship between inflation and unemployment and the result was the first result supporting the phillips theory. friedman (1968) and phelps (1967) analysis indicated the difference between short and long run phillips curves. as long as the average inflation rate remains constant as in 1960’s, inflation and unemployment will be inversely proportional. but if the average inflation rate changes when policy makers seek to suppress unemployment rate below the natural rate, the unemployment rate will return to its natural rate after the adjustment period. the research has finally concluded that there is no trade-off between inflation and unemployment in the long run. the research hypothesis of friedman (1968) and phelps (1967) was supported by lucas (1976) stating that there was no trade-off between inflation and unemployment in the long run. differences of opinion about whether there is a trade-off or not make the researchers interested in conducting a research on inflation and unemployment. alogoskoufis and smith (1991) indicated the result supporting lucas’s theory that there was no trade-off between inflation and unemployment. in contrast, king and watson (1994) examined the presence of phillips curve using the us data. the finding provided empirical support for the presence of a trade-off relationship between unemployment and inflation in the united states during the research period. 26 economic analysis (2018, vol. 51, no. 3-4, 24-32) islam et al. (2003) examined the presence of phillips curve in the united states from 1950 to 1999. the result found that there was a long run cointegration and long run causality between unemployment and inflation. hart (2003) examined the phillips hypothesis in england using hourly wage over the period (1926-1966). the result did find any presence of phillips curve in england during the period. singh et al. (2011) analyzed the presence of phillips curve in india. the research used inflation and output gap variables and the result provided evidence of the presence of phillips curve in india in 2004 in the first quarter and in 2009 in the first quarter. dritsaki (2012) also examined the presence of phillips curve in greece using nairu. the result found that there was a long run relationship between inflation and unemployment and the presence of phillips curve in greece. this study differs from research conducted by other researchers related to the relationship of inflation and unemployment in the estimation of nairu data, but has the same method as dritsaki (2012) using the vecm model. the difference in this study is that nairu data was obtained by researchers by estimating nairu's time varying from multiple linear regression with the ballmankiw (2002) approach. ball-mankiw (2002) assumed that expected inflation equals the previous year's inflation and extracts nairu using hodrick prescott filters. theoretical methodology the research method with the analysis of short run supply function in phillips curve in the recent research employs lucas approach theory used by dritsaki (2012). the derivation of aggregate supply equation can be seen in the equation (1) by dritsaki (2012). 2 = 2ᵉ + (4 + 5)(7 − 7∗) (1) where p is actual price, 2ᵉ is expected price, y is actual output, 7∗is natural output and α is constant.inflation expectation should be kept stable so as not to be high so that the economy does not experience a decrease. in the initial step, add the right side of equation (1) with world supply shock (wss) to indicate exogenouse events (such as changes in world oil prices). the supply shock will change the price level and shift the short run aggregate supply curve, so the equation becomes: 2 = 2ᵉ + (4 + 5)(7 − 7∗) + :;; (2) to change the price level into inflation rate, it is conducted by reducing last year’s price level p1 from both sides of equation (2), so that it becomes: 2 − 2(−4) = 2ᵉ − 2ᵉ(−4) + (4 + 5)(7 − 7∗) + :;; (3) the symbol on the left side, p-p(-1) represents the difference between the curent price level and last year’s price level, which is inflation (infl). the symbol on the right side, pᵉ-pᵉ(-1) represents the difference between the expected price level and last year’s price level, which is the expected inflation(inflᵉ), so equation 3 becomes: <=>? = <=>?ᵉ + (4 + 5)(7 − 7∗) + :;; (4) to shift from output to unemployment, it can include okun’s law providing a relationship between these two variables. okun’s law states that the output of the natural rate is inversely proportional to unemployment from the natural rate. if the output is higher from the natural rate of output, then unemployment is lower than the natural rate of unemployment. the equation can be written as follows: (4 + 5)(7 − 7∗) = −a(b − bᵘ) (5) nurul hafnati, sofyan syahnur 27 where: u is unemployment rate, uᵘ is natural rate of unemployment and β is the constant. by using okun’s law relationship, -β(u–uᵘ) can be substituted for (1+α)(y-y*) in the previous equation to obtain: <=>? = <=>?∗ − a(b − bᵘ) + :;; (6) equation 6 is a short run equation on phillips curve indicating a negative slope between inflation rate (infl) and unemployment rate (u).in this research, phillips curve is modified by adding expected inflation, but expected inflation can not be observed directly, thus it is used adaptive expectation assumption so that πᵉt = πt-1 (ball and mankiw, 2002 andbarsky, 1987): cd = cd − 1 − �('d – 'ᵘ) + hiid (7) cd − cd − 1 = �'ᵘ − �'d + hiid (8) cd − cd − 1 = � − �'d + hiid (9) equation (8) can be estimated with least square to obtain nairu estimate, so that in equation (8), it can be formed the following equation: (cd – cd − 1) + �'d = �'ᵘ + hiid (10) �'ᵘ + hiid = �'d + �cd (11) 'ᵘ + (jd /�) = 'd + (�cd /�) (12) from equation (11), it can be seen that the component uᵘ is a smooth component estimated using hp filter from the component wt = ud + (δπd /α) because component uᵘ varies, then it can be written to u du from constant α, it is obtained slope at ut from regression(π ! − π!"#) on u!. component wt is the total of nairu(uᵘ! ) and supply shocks adjusted (v! /α). component (uᵘ! ) represents longer term trend and component (wss! /α)represents shorter term supply shocks. to extract nairu (uᵘ! )from wt, the author used hodrick-prescott filter with λ=100. after obtaining nairu, then the equation can be written as follows: <=>?q = 5(?)<=>?q"4 + a(?)(r=stq − =u<vrq ) + wd (13) where α(l) and β(l) represent lag polynomial, unemt is a term for actual unemployment in year t and nairut is natural employment in year t. equation (13) is modified to: <=>?d = 5(?)<=>?q"4 + a(?)r=xuyd + wd (14) where infl is a term for inflation rate and ungap is a term for actual unemployment rate minus natural unemployment rate. datasource and framework methodology the recent study uses annual data in the period of 1991-2016. the data is obtained from world bank. this research examines the effect of unemployment on inflation with phillips curve approach performed with the following stages: 1. unit root test with augmented dickey-fuller (adf) and phillips-perron (pp). 2. cointegration test to find long run relationship between variables. 3. if the variables are cointegrated, then it is proceed with granger causality test using vector error correction method (vecm) to find long run causality. 4. wald test is carried out to determine short run causality relationship. 28 economic analysis (2018, vol. 51, no. 3-4, 24-32) in this line of study, data stationarity test is performed using augmented dickey-fuller (adf) and phillips perron (pp) on the same degree (level or difference) to obtain a stationary data, which is the data whose variant is not too large and having a tendency to approach the average value. cointegration test in this research is used to determine whether there is a long run balance of variable in the model or not. this research uses johansen test by comparing between the value of trace statistic andthe critical value at a confidence level of 10%, 5% and 1%. the data analysis model used in this research is quantitative by testing vector error correction model (vecm) which is a derivative of var. prior to model testing, cointegration test is required by performing johansen method. if the variables are not cointegrated and is stationary in the same order, then var can be applied. however, if the test proves that the variables are cointegrated, then vecm can be applied. in predicting the effect of inflation and unemployment over the next several periods, impulse response function (irf) and forecast error variance decomposition (fevd) are used. irf is a method used to determine the response of an endogeneous variable to a particular shock. irf can also measure the effect of a shock at a time to the innovation of endogeneous variable at that time and in the future. irf aims to isolate a shock to be more specific, meaning that a variable can be affected by a certain shock. in fevd, it can be seen the strengths and weaknesses of each variable in affecting other variable in a long period of time. fevd characterizes forecast error variance into components that can be correlated with each endogenous variable in the model. this study differs from research conducted by other researchers related to the relationship of inflation and unemployment in the estimation of nairu data, but has the same method as dritsaki (2012) using the vecm model. the difference in this study is that nairu data was obtained by researchers by estimating nairu's time varying from multiple linear regression with the ballmankiw (2002) approach. ball-mankiw (2002) assumed that expected inflation equals the previous year's inflation and extracts nairu using hodrick prescott filters. results in this research, unit root test is performed by using augmented dickey fuller (adf) popularized by dickey and fuller (1979) and phillips-perron (pp) by phillips and peron (1998). both indicate the presence of unit root as the null hypothesis. phillips-perron uses non-parametric statistical method, so that it does not require lag in solving the problem of serial correlation (breitung and pesaran, 2005). the result of unit root test can be seen in table 1. table 1. result of unit root test with adf and pp variable adf pp at level 1 st different at level 1 st different infl -4.0914*** -5.8731*** -4.0602*** -14.89325 *** ungap -1.4723 -4.9786*** -1.4624 -4.9786*** description: based on the test result of adf and pp. ***, ** and * indicate significance at level of 1 percent, 5 percent and 10 percent, respectively. based on table 1, infl variable is stationary at level either with adf or pp, but ungap variable is non stationary at level, either with adf or pp. this can be seen from the value of t-statistics greater than the critical value at level of 1 percent, 5 percent, and 10 percent, respectively. therefore, since the data is non stationary at level of 0 percent, then data stationarity test is proceeded at the first difference. before performing an analysis with vecm, cointegration test is required. in cointegration test, johansen lag used is the selected lag minus 1 because the variable is stationary at first difference. nurul hafnati, sofyan syahnur 29 table 2. result of johansen cointegration test model hypothesized trace statistic prob. max-eigen statistic prob variable lag length=3 none* 37.04 0.0000 25.36 0.0006 inf at most 1 * 11.68 0.0006 11.68 0.0006 ungap source: result of johansen cointegration test processed using eviews (2018). *1% to figure out the causality relationship between the research variables, it can be performed by using granger causality test. the result of granger causality test can be seen in table 3. table 3. granger causality test source: result of granger causality test processed using eviews (2018). *1% the result in table 3 shows that inflation variable (inf) statistically has a significant effect on ungap value with the probability of 0.0011 or smaller than α=0.05 while ungap statistically has a significant effect on inflation variable (inf) as evidenced by the probability value smaller than 0.05, that is 0.0007. after johansen cointegration test is performed, then it is proceeded at the stage of vecm model. the use of vecm estimation is in accordance with problem formulation in this research, that is to identify long run relationship of the effect of independent variable on dependent variable. table 4. result of short runvecm (vector error correction model) estimate variable coefficient t-statistic dinfl(-1) 1.000000 dependent dungap(-1) -3.5932 [-3.0089] source: test result processed using eviews 9 (2018). long run vecm estimate indicates that ungap variable has a negative and significant effect on inflation. it indicates if inflation rises then unemployment will fall. to analyze the short run causality relationship between independent variable to dependent variable, it can be performed with wald test. if the probability value of chi-square < 0.05, then there is short run causality relationship between variables. the lag coefficient of ungap is shown by c(6), c(7), c(8) and c(9). the result of wald test can be seen in the table 5. table 5. estimation result of wald test test statistic value df probability f-statistic 10.81238 (3, 10) 0.0018 chi-square 32.43714 3 0.0000 null hypothesis: c(6)=c(7)=0 and c(8)=c(9)=0 source: test result processed using eviews (2018). null hypothesis: obs f-statistic prob . ungap does not granger cause inflasi 22 8.90284 0.0011 inflasi does not granger cause ungap 9.74327 0.0007 30 economic analysis (2018, vol. 51, no. 3-4, 24-32) based on wald test in the table 5, it can be seen the probability value of chi-square is 0.0000 or smaller than 0.05. from the result, it can be concluded that there is a short run relationship between inflation variable and ungap variable in this research. figure 1. impulse response function source: test result processed using eviews (2018). the response of inflation variable to ungap as can be seen in figure 1 describes that if there is an increase of shock from ungap variable it will have an effect on inflation with fluctuating magnitude. beginning with an increase in inflation in the 2nd period, then creeps down in the 4th period and then fluctuates back to the 10th period. table 6. result of vdc inflation analysis variance decomposition of (infl): period s.e infl ungap 1 6.871090 100.0000 0.000000 2 8.325344 72.15293 27.84707 3 9.090228 62.52320 37.47680 4 9.205061 61.18396 38.81604 5 9.673164 55.90552 44.09448 6 10.28092 50.29660 49.70340 7 10.52415 48.15083 51.84917 8 10.68234 46.98074 53.01926 9 10.94083 45.92024 54.07976 10 11.34817 43.78633 56.21367 source: data processed by eviews 9 (2018) the result of vdc analysis of the inflation variable shows that the variable that is expected to have the greatest contribution to inflation in the next ten years is inflation itself with an average -2 0 2 4 6 8 1 2 3 4 5 6 7 8 9 10 response of inflasi to inflasi -2 0 2 4 6 8 1 2 3 4 5 6 7 8 9 10 response of inflasi to ungap -.4 -.2 .0 .2 .4 .6 .8 1 2 3 4 5 6 7 8 9 10 response of ungap to inflasi -.4 -.2 .0 .2 .4 .6 .8 1 2 3 4 5 6 7 8 9 10 response of ungap to ungap nurul hafnati, sofyan syahnur 31 contribution of 58.69 percent per year. this is in accordance with the theory of inflation expectations, where the rate of inflation that will come is influenced by the rate of inflation itself in the past. table 7. result of vdc ungap analysis variance decomposition of (ungap): period s.e infl ungap 1 0.687043 1.096442 98.90356 2 0.972628 2.216098 97.78390 3 1.221930 9.644483 90.35552 4 1.329548 8.384698 91.61530 5 1.488157 7.435771 92.56423 6 1.686562 7.709181 92.29082 7 1.809969 8.698308 91.30169 8 1.929529 10.29297 89.70703 9 2.055021 12.45201 87.54799 10 2.173996 13.55728 86.44272 source: data processed by eviews 9 (2018). the result of vdc analysis of the inflation variable shows that the variable that is expected to have the greatest contribution to ungap in the next ten years is ungap itself with an average annual contribution of 91.85 percent. conclusion this paper was carried out to analyze the long run relationship between inflation and unemployment in nairu estimate in indonesia and to determine the form of causality relationship among variables during 1991-2016 years period. the findings disclosed that phillips curve theory could be applied in indonesia from 1991 to 2016. the empirical obvious issue could be figured out from the results of regression model indicating that coefficient of inflation was negative and especially significant. based on the results of cointegration test using granger causality test based on vecm, it indicated that there was long run causality relationship between unemployment rate and inflation rate. the findings of granger causality test demonstrated that inflation and unemployment showed a two-way relationship and statistically significant. the obvious phenomenon devoted that inflation prompted a significant effect on unemployment, and in turn, it has a significant effect on inflation. the result of this research suggested that ungap variable provided a negative and significant effect on inflation. based on the result of wald test, short run relationship between inflation and unemployment was simply obtained. in the forecasting error variance decomposition analysis, inflation was the emerging variable with highest contribution to inflation. this research provided an empirical evidence that there was a significantly negative relationship between inflation and unemployment in indonesia. a country’s economy might be stated as keen if at the some point, the inflation and unemployment rates are lower than the rate of economic growth achieved. the main purpose of macroeconomic policy,after all, is to overcome the inflation matters as the cause of price volatility and to solve terribly unemployment complication. by way of conclusion, macroeconomic policy shall be able to achieve its objectives, to create price stability and at the same time contribute to employment opportunities. 32 economic analysis (2018, vol. 51, no. 3-4, 24-32) in further research so that the determination of smoothing parameters in the hodrick-prescott filter uses criteria such as cross validation and generalized cross validation. then because the ballmankiw approach assumes that expected inflation this year is the same as the previous year's inflation, so further research is expected not to use these assumptions but at the same time be estimated simultaneously with nairu using the kalman filter or unobserved component method. references alogoskoufis, g. and smith, r. (1991). “the phillips curve: the persistence of inflation and the lucas critique: evidence from exchange-rate regime.” american economic review, 81, pp.1254-1275. ball, l.m., & mankiw, g.n. (2002). “the nairu in theory and practice.” journal of economic perspectives, 16, no. 4: 115-136. breitung, j. and pesaran, m. (2005), “unit roots and cointegration in panels”, discussion paper series 1, economic studies no. 42, deutsche bundsbank, frankfurt. dickey d.a. and fuller w.a. (1979). “distributions of the estimators for autore-gressive time series with a unit root.” journal of american statistical association, 74, 427431. dritsaki, chaidodan melina dritsaki. (2012). ”inflation, unemployment and nairu in greece.” procedia economics and finance, 118-127. friedman, m. (1968). “the role of monetary policy.” american economic review, 58, 1-17. helali, kamel. (2018).” a new assessment of the non-accelerating inflation rate of unemployment and capacity utilization in tunisia.” the romanian economic journal, 68, 54-77. heimberger, p., kapeller, j. and schutz, bernhard. (2017). “the nairu determinants: what’s structural about unemployment in europe?” journal of policy modeling, 39, 883-908. islam, f., hassan, k., mustafa, m. and rahman, m. (2003). “the empirics of u.s. phillips curve: a revisit.” american business review, 20(1), pp.107-112. king, r.g. and watson, m.w. (1994). “the post-war u.s. phillips curve: a revisionist econometric history.” carnegie-rochester conference series on public policy, 41, pp.157-219. lucas, r.e. (1976). “econometric policy evaluation: a critique.” carnegie-rochester conference series on public policy, 1, pp.19-46. phelps, e. (1967). “phillips curve, expectation of inflation, and optimal inflation over time.”economica, 34, 254-281. phillips, a.w. (1958). ”the relationship between unemployment and the rate of change of money wage rates in the united kingdom.“ economica, 25, pp.258-299. phillips, p.c., and perron, p. (1988). “testing for a unit root in time series regression”, biometrika, 75, 335-346. samuelson, p.a. and solow, r.m. (1960). “analytical aspect of anti-inflation policy.” american economic review, 50, 177-194. singh, b. karan, kanakaraj, sridevi, t.o. (2011). “revisiting the empirical existence of the phillips curve for india.” journal of asian economics, 22, 247–258. article history: received: august 6, 2018 accepted: november 30, 2018 ea_2018_3-4 miroslav milojević 105 doi: 10.28934/ea.18.51.34.pp105-114 original scientific paper the state of public enterprise financial reporting in serbia miroslav milojević1* 1 rsm serbia d.o.o. belgrade, serbia abstract serbian public enterprises bear a strong general pressure initiated on the account of unsatisfactory quality of services they provide and difficulties related to their ability to service the costs. a discrepancy between general public expectations and actual performances of these entities is transformed into a systematic search for conditions that would enable their reform and further development. however, this issue is very complex and it is based on important qualities of organisational structure and functioning of public enterprises. moreover, it to an extent merges with another issue that of the quality of financial reporting. in that respect, this paper presents financial statements in the context of characteristics of public enterprises and their environment, and outlines the directions of changes aimed at their improvement key words: reforms, institutions, public enterprises, financial reporting, financial reporting oversight jel classification: l26, g32 introduction financial reporting is a specific outcome of the total economic and social circumstances of a society in which is prepared and presented. it is a phenomenon of a particular subtlety whose establishing, maintaining and enhancing necessitate meeting numerous conditions and whose high quality is sustained only if numerous harmonised forms of influence are exerted. it reflects all circumstances under which it emerges and functions and requires a constant and undivided attention. a state of financial reporting has been marked as a significant supporting factor to economic growth; for that purpose, the world bank created a special programme (rosc) and formed a special institution for monitoring the state of financial reporting in individual countries. all these efforts are aimed at strengthening the quality of financial information. only permanent monitoring and reporting on the state of financial reporting, along with adequate responsive actions on financial statements, contributes to its sustaining and improving. in the absence of these conditions, benefits derived from financial reporting are easily lost. this paper focuses on the factors determining the state of financial reporting of public enterprises in serbia and presents general economic circumstances under which financial reporting is performed; weaknesses of financial reporting; and, lastly, the prospects for its further development. general conditions financial reporting is always considered having in mind the general conditions that determine it. financial reporting is a complex meta-phenomenon in the economy, which incorporates the * e-mail: miroslav.milojevic@rsm.rs 106 economic analysis (2018, vol. 51, no. 3-4, 105-114) conditions that determine it and the state of all protagonists in the reporting chain, who are both producers/presenters and supervisors of those who maintain financial reporting discipline. general conditions of financial reporting encompass all major characteristics of a society in which they are formed as an outcome of all historically acquired circumstances and views pervading the reality of financial reporting. it that sense, it can be argued that circumstances of financial reporting are the reflection of the circumstances existing in a society and its economy. serbia has been undergoing transition towards the market economy for only less than two decades and it still deeply feels the consequences of its recent traumatic past. these less than two decades were preceded by a decade of bloody wars and general negligence. while the world was improving and constantly enhancing its standards, all standards in serbia were destroyed and, as a result, building foundations of market economy started only at the beginning of the first decade of this century. from a historical perspective, this is a very short period, since institutionalisation of a society requires a several-decades long establishing in practice. that period in serbia was marked by a provision of significant aid from the mentors from the west, who have been building their own institutionalised market societies for centuries. needless to say, there are considerable difficulties concerning adoption of a new manner of economic and social life, but also there are difficulties concerning adaptation of the existing models, which are not a product of the serbian experience, but come from the west. serbia started accepting the new orientation and institutionalisation without relying on its own experience and without a predisposition for their acceptance and application. political and economic aims as the framework of financial reporting serbia has set its main aims, which can be defined as catching up with the world and, particularly, integration into the eu. within this orientation, important factors are political and economic frameworks serbia establishes for the purpose of organisation of its society. the political direction of serbia’s course was established at the very beginning of this century, after casting off the socialist method of organisation and severe frustrations caused by dissolution of yugoslavia and a decade-long agony characterised by disorientation and wars in former yugoslavia. immediately after the change of government in 2000, a declarative policy change towards the building of a market economy society took place, and after that, towards an actual institutionalisation and practicing life based on new foundations. the efforts in the new direction were supported by advice and material aid provided by the eu and other countries. the economic direction of building a new system was marked as a free market economy, which involves discarding the old concepts of economy and founding entirely new ones. the economic values were set in a reverse direction in comparison to the previous period: instead of focusing on people, the system was focused on economic contribution; instead of a system of settling things by mutual agreement and negotiations, free-market competition was introduced; instead of collectivism, individualism was instituted; instead of self-management administrative framework, a voluminous market society regulations came into force; economic sustainability gained primacy over the social one. the results of these efforts are building and implementation of a completely new institutional system, one that channels the behaviour of economic protagonists in a completely new way. political and economic frameworks became a sign of everything that was wanted as a new reality. at the same time, they set a new touchstone by which every step in the society and economy is measured. these aims represent a considerable challenge, one that is overcome with great difficulties, since it is necessary to give up deeply entrenched habits and adopt new ones that yet need to be understood, adopted and practised and whose benefits yet need to be recognised. miroslav milojević 107 real economic circumstances a real economic basis considerably determines all occurrences in a society. the assessment of the impact of the economic reality in the previous decade, never before completely presented, indicates the following: the serbian economy is very weak and not even in 2018 did it attain its 1989 state. its recovery is the slowest in the region. in 2017, the gross domestic product (gdp) amounted to eur 31,184 million. in the period between 2006 and 2016, the growth rate peaked in 2007, when it amounted to nearly 5.9%. with the emergence of the world economic crises, the serbian economy began to deteriorate significantly. the highest gdp drop was recorded in 2009 when it amounted to 3.1%, while the negative rate was also recorded in 2012 and 2014 when the downslide amounted to – 1% and -1.8% respectively (10, https://www.nbs.rs/internet/cirilica/80/index.html). gdp per capita is very low, it is clearly seen from the national bank of serbia’s data for the period 2006 – 2007 that it dropped significantly in 2009 and 2010, recovered in 2011, then dropped again twice – in 2012 and 2014. to illustrate the above, in 2006 gdp per capita amounted to eur 4,586, while in 2017 reached the amount of eur 4,998 (10). the causes of such state of things are: firstly, a long hesitance to undergo transition, which started in 2000, after the overthrow of a long-maintained socialist system. during 1990’s, when most countries recorded high growth rates, serbia experienced a colossal drop, since it completely turned its back to progress. the losses suffered as a result of rejecting to accept the necessary reorientation were immense. secondly, the devastating consequences of the nato-imposed war, when the country’s available economic resources were demolished, making it impossible in most cases to restart production. serbia had a quite strong industrial sector, which represented an important factor of economic security. thirdly, the large number of young people left the country during 1990’s, a trend that continued in the following period, resulting in the fact that serbia lost a significant development potential. the trend of young people leaving the country in search for better conditions also continued in the liberalisation period. fourthly, serbia has an aged population. according to the 2011 census, the average age of population is 42.2 years, while 20% of the population is older than 65, which ranks serbia on the list of 10 countries with the oldest population in the world. fifthly, as a non-institutionalised country, serbia suffers additional losses. lack of order that is constantly supressed is deeply rooted, while its protagonists slowly and with difficulties discard the habits that support such state of affairs. sixthly, corruption is deeply rooted and generally affects the society at all levels. this takes its toll in form of significant gdp losses. economic circumstances determine the totality of occurrences in the entire society, above all social consciousness of its political and economic protagonists. undeveloped economy is reflected in undeveloped representations of economic concepts, which as a result has a weak stimulus coming for the sphere of mind. this inadequate social consciousness should be understood in two ways, as a product of circumstances and as a brake that halts the desperately needed faster progress. institutional circumstances during the last decade, a complete institutional re-arrangement has been accomplished. new institutions have been conformed to the eu standards, created according to the eu models and introduced with a strong assistance by the world bank and the eu. all institutional circumstances have an impact on the quality of financial reporting in a society. given below are the main characteristics of institutionalisation in the light of corporate financial reporting with an emphasis on public enterprises. 108 economic analysis (2018, vol. 51, no. 3-4, 105-114) the starting point for regulations in corporate financial reporting is the legal framework. all economic regulations affect public enterprises, some fundamentally, some marginally, some of them generally, some specifically. listed below are cardinal laws and, in outlines, their relevance for corporate financial reporting of public enterprises. the primary law in this sense is the law on economic entities, which stipulates a group of the most important determinants for constitution and functioning of economic entities. this law was last amended in 2018. those amendments introduced many innovations; however, financial reporting was not subject to any significant changes. the amended provisions of the law demonstrated the adherence of serbia to further changes, testifying to a genuine convergence with the eu framework. the 2016 law on public enterprises introduced a number of novelties that affect constitution and management of public enterprises. among many novelties, two are of central importance. the first one was introduced in the management sector. it brought about corporatisation and institutionalisation of internal audit and the audit committee. the other one is an introduction of significant reporting novelties. both groups of measures imply a considerable improvement of the quality of reporting content, as well as of the institutions functioning in the framework of public enterprises. the real changes were effected in the field of financial reporting, implemented by the ministry of economy and encompassing a number of new forms. the accounting law and the audit law have the most immediate impact on financial reporting. introduced in 2013, they are based on no longer effective eu acts. these acts treat public enterprises as any other economic entity, which they really are. public enterprises must conform to the above regulations, while the provisions of the law on public enterprises represent special forms applicable only to public enterprises. public enterprises are categorised as entities of public interest, therefore the provisions of the audit law stipulate that all public enterprises, regardless of their size, must engage an auditor for the purpose of issuing an opinion on financial information presented in their financial statements. public enterprises in serbia are legally obliged to submit annual financial statements, along with statistical financial reports, to the business registers agency, while special long-term and short-term plans should be submitted to the ministry of economy. the state of public enterprises and the quality of financial reporting the real state of affairs is shaped by both legal means and practical actions. the aims direct the reality, and the reality has its capacity to adopt what is imposed by those aims, but also to resist it, as a result of inconsonance between interested parties and officially defined interests. the following pages interpret the state of reality in the light of several most important characteristics. inadequate structural organisation structural organisation of public enterprises is predetermined by legal solutions. these solutions are adopted as a part of general efforts to conduct an organisation of public enterprises introduced an actual corporate structure, that is, a truly modern solution. that solution represents a formal compliance with the law, while essentially nothing incessant reform, in which it is recognised that the structural organisation of public enterprises must be continuously improved and solutions that are the best prerequisites for a desired efficiency must be found. although public enterprises are mostly associated with massive property, infrastructure, they are primarily intangible creation in which management structure plays an important role. new solutions for the structural have changed. those enterprises remained a field in which the will of a ruling party is demonstrated. their envoys are those who actually govern, while evading all the requirements of the law and failing to meet expectations of the public. miroslav milojević 109 corporatisation of public enterprises means introduction of a new dimension which is capable of producing results only if adequately treated. it means a group of measures by which such values are set, directions given, conditions organised that enable acting towards the chosen directions and aims and, lastly, by which actions towards attaining goals are controlled. corporate governance is above management; hence, a serious problem occurs related to interference of the former into the activities of the latter. in normal circumstances, this is not tolerable and it produces not only derogation of the management motivation and limits its operating scopes, but also represents an attack on responsible behaviour and efficiency of work of public enterprises. corporate governance is an agent of public interest and it is under ever-increasing public scrutiny, which shall certainly not subside (2,90). all issues related to insufficiently profiled structure of public enterprises are reflected in financial reporting. corporate governance and corporatisation are directly related. more powerful corporate governance bodies are necessary prerequisite for strengthening the quality of public enterprise financial reporting. firstly, corporate bodies are based on transparency, which is attained by transparent reporting. a more agile role of corporate governance would mean more pressure on management that its information becomes more transparent. in the absence of the above, a lower level of transparency occurs as an important characteristic of financial reports. secondly, in large majority of cases the internal audit function is not established in those enterprises. internal audit is a key element in that respect. without this function, there is no supervision over internal control systems of public enterprises and, consequently, no supervision of financial reporting in its entirety. a lower level of control means a higher possibility of existence of deficiencies in financial statements, that is, lower level of reliability of financial information. insufficient market orientation public enterprises are associated with public life, providing conditions for life and sustainability and development of quality of life. they are defined as enterprises, as market entities that are subject to general economic principles of doing business, on the one hand, but also as factors of the quality of life in a society, on the other. a dual nature of their aims leaves space for alternative placement of emphasis on their being a market and general social instrument. the former function becomes dominant when the ownership is undergoing privatisation and the latter when the ownership belongs to the state. serbian public enterprises are exposed to pressure to become organised in form of an economic entity, believing that it will bring betterment. the powers of mistrust towards the private ownership base their opinion on the fact that private ownership will marginalise public interest; the powers in favour of privatisation derive their arguments from the insufficient efficiency and low quality of public enterprises held by the state. it is an undeniable fact that serbian public enterprises operate with abnormally low prices and that in present conditions citizens with low purchasing power are not capable of bearing higher price of services. in any case, the market aspect here symbolises a request to organise production of public sector goods and services in a more rational manner, the request to rationalise all production factors, to cut high payroll costs which are the result of unproductive hiring, and to apply optimisation rules on all assets with respect to their aims and tasks. in addition, it is also an undeniable fact that management in public enterprises is not making a sufficient effort to increase productivity and general efficiency, because, among other things, conditions that would lead them into that direction, control them and stimulate economically, have not been met yet. in any case, the law on public enterprises includes a provision on their aims which states that public enterprises operate, among other things, in order to generate profit. in the countries in the region, public enterprises have a status of an economic entity in its true sense, as it is the case with 110 economic analysis (2018, vol. 51, no. 3-4, 105-114) any other economic entity. it is certain that in this respect we must harmonise ourselves with the requirements of eu regulations. financial reporting suffers consequences from an insufficient market orientation of public enterprises. the elements of negative impact on the quality of financial reporting are not only the mere fact that these enterprises have not enhanced the market criteria of evaluation of all items in financial statements, but also the fact that they are not sufficiently supervised by those who define the success criteria. the authorities that supervise financial reporting (local selfgovernment units, the ministry of economy and the ministry of finance) do not have capacities (they do not have established clear control instruments, while in cases where such instruments exist relevant procedures are not applied; they do not have a well-qualified staff or resources) to perform its expected and legally stipulated function; hence, they become direct causes of lowquality financial and non-financial reporting of public enterprises. insufficient efficiency public enterprises are driven by capital. capital employed in public sector is a part of the total capital of a society and there is no reason why (with specific restrictions) it should not function based on principle of maximising yield on capital. yield on capital in the economy and yield on capital in public enterprises are considered important elements of any comparison made between public and commercial sector. and the records state that public sector attains far lower results in comparison to those achieved by the commercial sector. the causes of inefficiency are looked for in the input. in this area, many facts can be observed: inappropriately high number of employees in comparison to what is actually required; inadequate structure with respect to long-term and short-term assets, excessive equipment, irrational use of materials and many others. under the condition of controlled service prices, cost-effectiveness is attained by means of rationalisation of input. the perception of the public is that public enterprises are not trying to keep the costs down. studies support this opinion. inadequate efficiency produces unsatisfactory results and their joint effect impairs the integrity of financial statements. low efficiency is a phenomenon manifested in many respects and accompanied by low salaries of public enterprise employees and general dissatisfaction. an inefficient company will hardly be able to attract highly-qualified professionals, who represent a necessary precondition for quality financial reporting. poor financial standing poor financial standing most clearly manifests itself in insolvency. it is a well-known fact that public enterprises are heavily indebted, borrowed money both excessively and without any criteria, and, as a result of burden of debts and inability to repay them, entered a deeper and deeper crisis. the situation is the gravest in large state enterprises (srbija gas, rtb bor, železnice srbije), which place a heavy burden to a serbian budget. such a difficult burden that the world bank placed it under its scrutiny, analysed and determined the ways how to organise and remove them as generators of state indebtedness, but also as driving forces of insolvency chain, as a result of their own inability to service debts in due time. a similar situation, although a far less severe, exists in many public utility enterprises. there is a complex of causes of insolvency, starting from structural factors to daily behaviour concerning disposal of liquid assets. sometimes it happens that in the beginning public enterprises do not have sufficient liquid assets, that is, not enough current assets. it is an initial handicapping factor. in other cases, inobservance of financing rules (in particular, financing investments from current assets) devastates operating financial ability of an enterprise. whatever miroslav milojević 111 the cause is, it is an undeniable fact that public enterprises in serbia suffer from a chronic lack of current assets, that is, they are chronically insolvent. poor financial standing in itself represents a threat to integrity of financial reporting, which is clearly stated in several financial reporting and audit standards. those threats have such longreaching implications that endanger the going concern assumption. other consequences are that such enterprises, for the purpose of improving unfavourable picture, are brought under pressure to apply fraudulent accounting practices, which means falsifying financial statements. management, whose reputation depends on financial constitution and financial success of public enterprises they run, is under pressure to search for and find all possible ways to avoid presentation of a real situation. furthermore, this pressure represents a threat to accounting professionals to find illegal solutions and in such manner deviate from the standards of presentation of financial information. another fact related to such state is that well-qualified accounting professionals leave public enterprises, as a result of both jeopardizing their professional integrity and poor working conditions. poor reputation all problems related to economic weaknesses of public enterprises create a precondition for their poor reputation. enterprises that do not enjoy good reputation in public can hardly attract management and professionals with high aspirations. the rule is: the higher the reputation is, the higher the power to attract is. insufficient human resource attracting power has a reversal effect on weakening the position in economic organisation and efficiency. poor reputation is a meta-phenomenon, based on all tangible and intangible circumstances of functioning of public enterprises. poor reputation in the mind of people is immediately linked with dubious financial statements. poor reputation is a synonym for general weaknesses, hence the weakness of accounting and finance function. if this function is deficient, it is immediately assumed that its products – financial statements – are poor. poorly-coordinated financial reporting institutions there is a number of factors that are above public enterprises, whose activities, if complied with regulations, would significantly contribute to accomplishing functions of public enterprises and, consequently, financial reporting. those factors are the following: the state audit institution, the ministry of economy, the ministry of finance, the property management directorate, investigating bodies and legal authorities. it is a generally-known fact that they suffer from significant weakness, which leaves an ample space for their improvement. the exception to the above is the state audit institution, which acts according to standards, undergoes constant coordination with european institutions and produces its findings, which are worth only to the extent they are applied. for financial statements of public enterprises, the condition of organisation of publicly-owned assets is important, which means functioning of all factors responsible for their management and control. the state audit institution, in its document ‘disposal of immovable property owned by the republic of serbia’, stated on the first page of its report: ‘the republic of serbia does not have accurate data on the number and value of its immovable property, as a result of lack of action by the competent authorities and users and shortcomings of regulations. the republic of serbia’s property directorate has not established uniform records of immovable property owned by the republic of serbia…’ (5.3). the report did not produce a strong impact in reality, as no one acted according to its findings and recommendations. to describe conditions in all institutions mentioned in this report is futile. not only had the state audit institution drawn attention to these institutions. a glance at the 2018 european commission report for serbia (4) can give clear signals with respect to who is resisting the calls for improvement. 112 economic analysis (2018, vol. 51, no. 3-4, 105-114) in public sector an action is taken only if willingness from the top echelons exists (and usually it does not) and in case of prosecution of those who do not observe the law (which hardly ever happens). the consequences of non-existence of the records on capital assets, such is immovable property, are immense. absence of established records and adequate valuation represent a heavy blow to the integrity of financial statements of owners and users of publicly owned property. impending changes ‘most politics have market implications. as money is getting short, the manoeuvre space for holders of political decisions is getting smaller’ claims bovaird and loeffler and continue saying that with the crisis ‘imperatives for reforms in public sector become more sluggish, while the fact remains that reforms of public services must be governed in a cost-effective and efficient manner (1.16). as a country that strives towards integration in the eu system, serbia will be under relentless pressure to reform public sector and public enterprises in particular. this is also emphasised in all documents of the world bank, international monetary fund and the eu which addressed these issues in serbia. when considering what is to be done in order to improve the quality of financial reporting, the answer leads to two paths: the first is strengthening the economic position of public enterprises, while the other concerns measures aimed at strengthening the conditions for quality financial reporting. the former is the primary field of action, whereas the latter is to a large extent conditioned by the results in the primary field of action. let us call the first group of measures strengthening the capacity of public enterprises, while the second can be named strengthening financial reporting. strengthening the capacities of public enterprises the key issue is what the structural organisation of public enterprises is, that is, what are the aims and strategies of their use. structural organisation is based on strategies and aims, stipulated by laws that regulate them. these laws are the assumption on which these enterprises are based. in many respects, legal requirements are met and public enterprises are converged with eu requirements. the issues related to the implementation of legal provisions, addressed in this paper, remain to be resolved. strengthening the capacities of public enterprises through reforms reforms and reforms. that means constant introduction of novelties into structural organisation and behaviour of public enterprises. the aim of all these activities is to improve their performances. remedies for inefficiency of public enterprises are extensively discussed and solutions are searched for. as a possible solution, privatisation is frequently mentioned. to privatise public enterprises or not? it is a question that has been lingering for decades among public, expert circles and in governments’ agendas. impression is created that they are the only two solutions available, whereas this is not the case. d. detter and s. foelster in their book, which was a planetary bestseller last year, clearly claims that the above discussions fail to mention and oversee – the right option. it concerns ‘the quality of public property management’ (1.12) as a strangely overlooked factor, a factor with a decisive role on whether the use of public property will produce the effects that it is able to produce. only effectively structured management of public property can reduce to a minimum impact of corruption, dysfunctionality and miserable results of its use. strengthening the capacities is related to all conditions which can become, by means of better management, a factor of improving the quality of services and more efficient and effective use of resources which it has at disposal. the 2016 european commission report for serbia emphasises the unfinished process of reforming public enterprises (6.41), but also high susceptibility of privatisation processes to corruption. serbian public enterprises are awaiting many reforms, miroslav milojević 113 many of which were previously marked but not implemented. the list of impending reforms includes: • consolidation of publicly-owned property consolidation of publicly-owned property has not been finished. there are many deficiencies in this respect and many losses which are not presented to public (7.21). despite substantial donations and institutionalisation, there are a number of deficiencies and problems observed in the special report prepared after performed assessments. • strengthening the market nature of public enterprises. this is a problem that still remains and resolving of which is constantly insisted on. the model for its solution can be found in the countries in the region. • introduction of corporate governance. in this area, much has been done and much has been defined by the law. what creates the problem is the fact that legislation is only formally adopted, while in fact everything remained as it was. much additional initiative and the more active role of the competent minister are required, as well as by-law regulation and supervision. • strengthening the founder’s function. the founders of public enterprises are mainly active when they insist on receiving a half of a profit payment. the founder does not possess a capacity to run public enterprises. it has no built-up bodies, no management and control instruments, it is not structured for that function. pressures aimed at bringing about a reform are expected in this area. reforms are not focused only on internal changes in public enterprises, but also on all external bodies which are a significant factor of guiding, controlling and restraint. • professionalization of management. a problem of management professionalization is still of current relevance, and concerns the issue of the status of political parties and corporate governance. • depoliticization has not been accomplished. public enterprises are in the hands of political parties and there is no decisive power in sight which would be able to break the bond between the political parties and public enterprises. as long as there are no new mechanisms for separation between political parties and public enterprises, there will be many problems. management must have a status that is dependent on economic results and not on loyalty to political parties. • activation of potential of public-private partnership. no legal conditions have been created for this activation; there is no clear and transparent way for initiating this partnership, potential protagonists are insecure; therefore no improvement in this area. strengthening of the financial reporting factor the 2018 european commission report for serbia emphasises the non-conformity between the serbian financial reporting system and eu legislation and the need for a further compliance with the requirements of aquis communaitaire (6.58). the rosc report examines in detail (3.122-130) circumstances of financial reporting in serbia and outlines the directions for further reforming of financial reporting (3.52). according to the national strategy of corporate reporting and audit 2011-2018 (9), the year 2018 has been marked as a year in which domestic financial reporting legislation is to be conformed with the eu legislation. it is the end of the year, the conformation process is in progress, but the results are still lacking. the following changes in the field of strengthening financial reporting are to be effected: • compliance with the eu legislation. new accounting and audit eu directives adopted in 2013 were not introduced into domestic legislation, this issue is on the agenda and legal 114 economic analysis (2018, vol. 51, no. 3-4, 105-114) compliance is to be performed, which will be followed by institutional changes and coordination of practical protagonists performed on new foundations. • strengthening the reporting capacities of public enterprises. poor effectiveness and low salaries and incentives for accounting professionals cannot be an attracting power for well-qualified accounting staff. financially strong enterprises can also be attractive for accountants. • stricter supervision of financial reporting. poor supervision over financial reporting of public enterprises. there is no supervising body which would focus attention on the quality of financial information of public enterprises; hence, a poor discipline of financial reporting. • stricter inspection of financial statements. financial statements of public enterprises have many irregularities, no one is addressing these issues; irregularities are not found out and the perpetrators are not indicated. • stricter prosecution of those who present irregular financial statements. legal authorities are not involved in this field, they have neither capacities nor willingness to address these issues; therefore, far more agility is expected in future from legal authorities, which requires creating proper conditions. • stronger awareness of importance of financial statements. all previously emphasised circumstances related to public enterprise financial reporting indicate that this field is much neglected, and in such conditions protagonists have neither the awareness nor understanding of importance of financial information. the world bank noticed this fact and formed a special programme for raising awareness on financial reporting. however, raising awareness depends on all the above-mentioned factors, and their activation is a significant driving force leading into this direction. to sum up, the quality of public enterprises’ financial statements is a very complex issue, which means that it is necessary to work at all levels and in a coordinated manner. only when completion of measures and their coordination are attained, a progress in this field can be expected. references bovaird, t., loefler, e. (2009). public management and governance, routledge, london busarac, r. (2018). nova rešenja u zakonu o privrednim društvima i korporativno upravljanje u javnim preduzećima, revizor vol 21 no 83/2018 cfrr, report on the observance of standards and codes on accounting and auditing, republic of serbia 2015 detter, d., s. foelster. (2015). the public wealth of nations: how management of public assets can boost or bust economic growth, palgrave macmillan, london, 2015 dri, godišnji izveštaj o radu državne revizorske institucije (http://www.dri.rs/документи/годишњи-извештаји-о-раду.43.html) europian commision, serbia 2018 report https://ec.europa.eu/neighbourhoodenlargement/sites/near/files/20180417-serbia-report.pdf milojević, m. (2018). finansijsko izveštajne promene u srbiji 2018, revizor, vol 21 no 83/2018 milojević, m. (2017). sređivanje imovine u javnoj svojini, revizor, vol 20 no 78/2017 nacionalna strategija za unapređenje korporativnog finansijskog izveštavanja i revizije 2011 – 2010, ministarstvo finansija srbije statistika nbs / https://www.nbs.rs/internet/cirilica/80/index.html article history: received: november 25, 2018 accepted: december 19, 2018 ea_2018_3-4 đuro kutlača 1 doi: 10.28934/ea.18.51.34.pp1-9 original scientifi paper in search for ris3 for the republic of serbia: challenges between theory and reality đuro kutlača1* 1 institute “mihailo pupin” belgrade, serbia abstract objectives of this paper are exploration of the challenges of use of methodology for creation of smart specialization strategy (s3) in serbia. s3 is focused on use of knowledge for economic development. major challenges of implementation of s3 in serbia are weak links between r&d sector and economy, and undeveloped culture of dialogue for adoption and realization of s3 priorities. in this paper are presented key challenges authors of s3 in serbia are faced with in very first trial of introduction of s3 methodology in country. paper is organized in four main parts. first part is (critical) description of the main concepts of methodology for creation of s3. the concept of s3 is a tool for realization of the strategy of the european development through "integrated industrial policy for the globalization era" and "innovation union". second part will present implication of implementation of s3 in serbia, i.e. conditions for use of one theoretical concept in reality of economy and society in serbia. third part is discussion of results of implementation of s3 in serbia achieved so far (process is not finished at the moment of writing of this article, mid 2018), analysing challenges between proposed methodology and real situation in country. fourth part is addressed to further steps in implementation of s3 in serbia, with particular attention to the aspects of dialogue which should be organized between involved stakeholders in order to achieve consensus for adoption and realization of s3 priorities in serbia. key words: smart specialization; s3 strategy; mcdm methods; priority sectors; edp; dialogue jel classification: a0, o33 introduction in the beginning of the year 2017 the government of the republic of serbia has decided to launch activities addressed to creation of a research and innovation strategy for smart specialization (ris3). first steps in this direction were creation of three working groups: first, an interministerial working body (iwb) for coordination of the activities between different ministries and governmental institutions; second and third working groups are established by iwb: the iwb has decided to establish an analytical team (at) and an operational team (ot). the european commission's (ec) joint research centre (jrc) has supported these processes in partnership with the governments of ukraine, moldova and serbia in developing ris3 (government of montenegro has joined activities six month later). the operational team consists of representatives of the republican secretariat for public policy, the ministry of education, science and technology development, the ministry of economy, the statistical office, the serbian chamber of commerce and the national employment service. their major tasks are operationalisation of activities for creation of ris3 and communication between major stakeholders: government, research and innovation (r&i) stakeholders, private sector, civil society, and jrc. the analytical team consists of representatives of the institute mihajlo pupin * e-mail: djuro.kutlaca@pupin.rs 2 economic analysis (2018, vol. 51, no. 3-4, 1-9) (imp), republic statistical office (rso), and republic secretariat for public policy (rspp) as well as some independent experts when needed. their key activities are quantitative and qualitative analyses necessary for building a strong evidence-base for of ris3. this article is organized in four main parts. first part is (critical) description of the main concepts of methodology for creation of smart specialization strategy (s3). second part will present implication of implementation of s3 in serbia, i.e. conditions for use of one theoretical concept in reality of economy and society in serbia. third part will discuss results of implementation of s3 in serbia achieved so far (process is not finished yet), analysing challenges between proposed methodology and real situation in country. fourth part will be addressed further steps in implementation of s3 in serbia, with particular attention to the aspects of dialogue which should be organized between involved stakeholders in order to achieve consensus for adoption and realization of s3 priorities in serbia. important note for readers is fact that in the moment of writing of this article (mid 2018), process of creation of ris3 is in the beginning of mentioned dialogue, which is named by the authors of s3 methodology as entrepreneurial discovery process (edp). s3 methodology the concept of “smart specialisation” is a tool for realization of the strategy of the european development through "integrated industrial policy for the globalization era" and "innovation union". s3 methodology is focused on use of knowledge for economic development, primarily is based on work of the expert group knowledge for growth (foray, david & hall, 2009), and has rapidly been implemented in eu policy as precondition for use of structural funds. elaborated by a group of academics in 2008, it very quickly made a significant impact on the policy audience, particularly in eu, as part of the preparation of the new cohesion policy for 2014–2020. major presumption is that smart specialisation strategies can ensure a more effective use of public funds and can stimulate private investment. it is mainly addressed to regions (rather than country level) to concentrate resources to a few key priorities rather than spreading investments across all business sectors. they can also be a key element in developing multi-level governance for integrated innovation policies because of use of knowledge and creativity rather than manual work. moreover, they have to be closely linked with other policy domains and require an understanding of regional strengths relative to other regions and the possible gains for interregional and transnational cooperation (european commission, 2010). the european commission has established the s3 platform in seville, in order to support national and regional actors in the process of developing research and innovation strategies for smart specialisation (ris3), providing various forms of support, e.g. in terms of information, seminars, peer reviews and guidelines. methodologically, process of development of s3 is organised in six practical steps for designing national or regional ris3 (s3 platform, 2012): step 1 – analysis of the national or regional context and potential, in relation to other nations and regions; step 2 – governance: ensuring participation and ownership – set up an inclusive structure and incentives for securing broad stakeholder involvement; step 3 – vision – produce a shared vision among stakeholders – elaboration of an overall vision for the region; step 4 – prioritisation – identification of priorities – selection of a limited number of priorities for regional development; step 5 – policy mix – definition of a coherent policy mix, road maps and action plans – combination of a mixture of policy measures and support them with road maps or action plans to secure implementation; đuro kutlača 3 step 6 – evaluation and monitoring – integration of monitoring and evaluation mechanisms – developing of systems for continuous and evidence-based monitoring of the process and follow up on results and effects, in order to learn and revise the policy mix. implementation of s3 methodology in serbia serbia as candidate country for membership in eu is in permanent transition of economy and society since 1991, facing serious problems of unemployment, brain drain, ageing, and political instability (semencenko & kutlaca, 2018). major challenges of implementation of s3 methodology in serbia are: weak links between r&d sector and economy; moderate level of innovation activities; undeveloped culture of dialogue between stakeholders involved in realization of s3 (kutlača, semenčenko and nedović, 2016). therefore, crucial support of jrc and foreign experts from fhg institute isi (karlsruhe, germany), engaged (financed) by jrc is to overcome organisational weaknesses linking stakeholders and support process of selection of priority sectors of economy which development should be realised with use of knowledge, rather than manual work, or fdi. external support has resulted firstly with roadmap for development of ris3 in serbia in 2017-18. this roadmap is adaptation of originally proposed six steps into five phases (jrc and iwb, 2017): preparatory stage: organisation of process of development of ris3 in serbia – resources necessary for effective cooperation between jrc and domestic institutions; mapping of economic, innovative and scientific potential: multi-dimensional quantitative analysis showing strongest sectors and areas of science at regional level; entrepreneurial discovery process: qualitative analysis and organized dialogue with all engaged stakeholders – edp should be organized for all selected areas of smart specialisation; establish a monitoring and evaluation system: development of indicators for monitoring of implementation and ex-post impact evaluation of ris3 in serbia; develop an implementation system: organisation and financing of implementation of ris3 in serbia. during the year 2017, and according to road map, major activities belong to phase 2 (or step 1), i.e. both external experts and domestic analytical teams were engaged in quantitative analysis of available statistical data with aim to identified priority sectors in economy of serbia which development should be relied on r&i activities. external experts (jrc and fhg) have developed procedure with two presumptions, based on already proved reach statistical bases with data available on regional level for nace 3-digit categories of economic activities in serbia1: (1) quantitative analysis could and should be organised for four statistical regions in serbia: region rs11: belgrade, region rs12: vojvodina, region rs21: šumadija and western serbia, region rs22: southern and eastern serbia (region rs23: kosovo – data are not available); (2) prioritisation of the sectors of economy within the regions should be based on their specialisation proper, i.e. an in relative terms higher importance of the sector in the regional economy than is calculated for the economy in serbia. measure for specialisation proper is the location quotient (lq) which compares the share of a sector in the regional economy with the share of a sector in the national economy. condition for selection of priority sectors is value of a location quotient of more than 1.5 i.e. only sectors that are at least 1.5 times the share in a regional economy than they do in the national economy! for 1 nace is the acronym for “nomenclature statistique des activités économiques dans la communauté européenne”; nace rev. 2 statistical classification of economic activities in the european community; isbn 978-92-79-04741-1, issn 1977-0375, ec, 2009 4 economic analysis (2018, vol. 51, no. 3-4, 1-9) example, lq for employment is given in formula 1, with e = (sectoral) employment in region and e = (sectoral) employment in nation, for nace sector x: �� = ���� ���� � ��� ��� � (1) two more characteristics must be considered for selected priority sectors: absolute size: this characteristic will exclude sectors which are employing to small number of people: and growth: with this characteristics it is possible to differentiate sectors whether they are emerging or mature sectors which should be restructured first. with these two characteristics, additional thresholds were defined, particularly minimum size of absolute value for each indicator. analysing data for period of 5-6 years only those nace 3-digit level sectors are kept as relevant if they show as stable specialisations for at least 3 times for single years across the entire economy. external experts have defined three sets of indicators that should best describe positions of the regions in terms of specialisation (kroll, schnabl & horvat, 2017): (1) indicators of economic potential of the region: − employment, according to 2011-2016 labour force survey data, − exports, according to 2012-2016 national export statistics; (2) indicators of innovative potential of the region: − innovating firms, according to the 2010-2014 national innovation survey, − patents, according to indicators developed by the mihajlo pupin institute, based on data provided by the intellectual property office; (3) indicators of scientific potential of the region: − publications, according to indicators developed by the faculty of physics and m. pupin institute, based on data collected by the faculty of physics, using web of science/frascati classifications of fields of sciences. all data, necessary for calculation of proposed indicators were provided to external experts and analytical team by the republic statistical office, with requested levels of details and accuracy. integration of all three analysed potentials (economic, innovative and scientific) is done by external experts in two steps: step 1: identifying potential priority domains based on overall thresholds; step 2: matching of results with further information on "smartness" – several more indicators are used in order to assess the relevance and potential promise of the identified economic priority domains: total employment, wages, value added, labour productivity, growth in employment. steps 1 and 2 have resulted with identification of potentially priority areas of specialisation by regions based on quantitative analysis, and should be basis for edp process between all interested stakeholders. integration of all indicators used for quantitative analysis presented within these two steps is done using excel table with calculated values, selecting nace 3-digit sectors they fulfil conditions – predefined thresholds (kroll et al., 2017): • region rs11 belgrade: − priority sectors: computer programming and ict; r&d and technical consultancy; creative economy; monetary intermediation, − potentially emerging innovative sectors: beverages, pharmaceuticals, electrical components, transport equipment, đuro kutlača 5 − science based sectors: various; • region rs12 vojvodina: − priority sectors: automotive; agricultural economy (including processing industries); petrochemical industry; plastics industry; − potentially emerging innovative sectors: agricultural machinery, measurement instruments − science based sectors: computer science, telecommunications • region rs21 šumadija and western serbia: − priority sectors: agri-/horti-/silvicultural economy (including processing industries); automotive; textile industry; plastics industry; metal industry; − potentially emerging innovative sectors: special purpose machinery − science based sectors: mechanical engineering, pharmacy • region rs22 southern and eastern serbia: − priority sectors: agri-/horticultural economy (including processing industries); textile industry; rubber industry; electrical engineering; − potentially emerging innovative sectors: food products, medical and dental − science based sectors: electrical engineering implementation of s3 in serbia: challenges between proposed methodology and real situation in country rigidity of the proposed method of selection with threshold of lq>1.5 and even with reduced threshold of lq>1.25 should be welcomed by the wider public as ability to make priorities without compromise. still, question on use of complete available data, considering all indicators of economic, innovation and scientific potentials, remain unanswered, although steps 1 and 2 presents sort of mixture of quantitative with qualitative analysis with aim to make more adequate decisions – selections. exhaustive analysis of statistical data finalised with analytical tool is result of quantitative analysis provided by external experts (fhg institute isi, karlsruhe, germany). excel table listing all nace 3-digit sectors they fulfil conditions for selection of potentially priority areas of specialisation by regions should be basis for edp process between all interested stakeholders; still 0-1 type of table could be source of numerous questions, doubts and mistrust, particularly from stakeholders they represent sectors which are not selected among potentially priority areas of specialisation. therefore, additional quantitative analysis is recommended by the analytical team – associates of “mihajlo pupin” institute (mpi) and accepted by the interministerial working body (iwb): use of single criterion as aggregate value of all proposed indicators provides rationale for extension of basic s3 approach with implementation of multiple criteria aggregation in mapping exercise. therefore, mpi associates have applied the ideal point method (ipm) compromise programming (zeleny, 1976). the ipm is implemented as follows: a set a of n sectors is compared with respect to m indicators. all sectors are compared with a sector that has ideal values for all m indicators, a so-called ideal (a reference sector). a point in mdimensional space represents each sector from the set a. the point representing the ideal sector is referred to as the ideal sector (ideal point, as name of the method suggested). the distance d (the author of ipm has recommended geometrical distance) of each point from the ideal one is calculated using formula 2. the sector, whose distance from ideal is the shortest, is the best sector. the calculated distance d is value which could be used for a ranking list of objects: 6 economic analysis (2018, vol. 51, no. 3-4, 1-9) ( ) n1,...,i ; m1,...,j ; c c ic kd p p l 1 l j maxij ijj ji ==        ×= ∑ (2) where: icj a j-th single indicator for ‘reference sector’, ci,j a j-th single indicator of an i-th observed sector, kj a weighting factor of a j-th single indicator; j – number of single indicators; i – number of observed sectors; lp used metrics, di – calculated distance for i-th sector from reference sector. with lp=2, the formula is a calculation of euclidean distance, and this case is used by analytical team. the extension of the quantitative analysis with, recommended by the analytical team, use of mcdm ideal point method compromise programming has provided one more geographical area of analysis – entire country! therefore, results of this amendment to basic s3 procedure are five ranking lists of nace 3-digit level sectors-groups: one ranking list for serbia total and four ranking lists for statistical regions (table 2; data for year 2016, excerption – only first ten nace 3-digit sectors-groups are presented and for serbia total only). table 2. ranking list of nace sectors-groups in serbia total – excerption, first ten nace 3-digit level sectors-groups, year 2016 rank nace 3-digit sectors – groups – first ten presented – serbia total 1. j62.0 computer programming 2. m73.1 advertising 3. m71.1 architectural and engineering activities 4. a1.1 growing of non-perennial crops 5. g46.9 non-spec. wholesale trade 6. m71.2 technical testing and analysis 7. c28.2 manufacture of other general-purpose machinery 8. c26.5 manufacture of instruments and appliances for measuring, testing and navigation; watches and clocks 9. c10.8 manufacture of other food products 10. m72.1 r & d natural science source: analytical team, internal working documents, 2017-2018 quantitative analysis of economic, scientific and innovative potentials of serbia in total and in all statistical regions using the basic s3 process of selection of nace 3-digit potentially priority sectors-groups in four regions and with amendment of ranking list of all nace 3-digit sectorsgroups created with aggregate criteria (mcdm aggregation and ranking) both for serbia total and for four regions, all together this information should be a basis for meaningful edp dialogue! s3 – challenges between theory and reality in serbia development and implementation of smart specialisation strategy in serbia is adventure faced with numerous challenges, some of them will be clarified as follows: 1. responsibility: which ministry should be in charge of development and implementation of the ris3 in serbia? eu member countries were firstly obliged to develop s3 in order to be eligible for use of structural funds: “this communication complements the one on the innovation union by calling on policymakers in member states at all levels to act without delay to invest more of the resources still available from the european regional development fund (erdf) in the present programming period on smart growth” (european commission, 2010). seven years later, s3 became new industrial policy for eu – the smart specialisation is, in fact, đuro kutlača 7 development of sectors of economy based on knowledge, i.e. new industrial policy relying on integration of r&d and innovation with business: “investing in a smart, innovative and sustainable industry – a renewed eu industrial policy strategy” (european commission, 2017). unlike already established mind-set in eu with orientation of s3 as main policy instrument for development of economy, situation in both western balkan countries which are in process of development of ris3 is rather puzzled. in the republic of serbia (rs) and in the montenegro (mne), ministries which are responsible for development of ris3 are ministries in charge for science: ministry of education, science and technological development in rs and ministry of science in mne. having in mind fact that development of ris3 in both countries is supported by the joint research centre of eu ipts (seville, spain), it is reasonable to expect that implementation of the ris3 will be realised through activities of (and financed by) ministries in charge of economy and other related ministries, with, eventually, coordinating role of ministries in charge of science for better allocation of research and innovation resources in countries; 2. organisation – motivation i: although development of the ris3 has all elements of project activity (institution involved, activities and responsibilities with mailstones, results, deliverables, etc. pre-defined and agreed; therefore management, financing, monitoring, etc. are clearly defined) in the republic of serbia is, primarily, voluntary based activity. there are no contracts, obligations, and consequently, there is no financing of development of ris3!? there is budget, with clearly defined roles and obligations, for jrc as supporting institution, but jrc has no obligation for creation of ris3 in rs. therefore, development of ris3 in rs relies on good will and voluntary based engagement of members of operational and analytical teams, together with involved associates of the “mihajlo pupin” institute, republic statistical office, intellectual property office, faculty of physics, and some others; 3. financing – motivation ii: having no project organisation, there is no financing of the development of ris3 in rs! this challenge, although already mentioned within previous challenge, must be stressed as serious issue which could increase risk for successful realisation of ris3 to the unacceptable level; 4. mobilisation of stakeholders – motivation iii: stakeholders, particularly representatives from companies, but also from all other relevant institutions, can be mobilised if they could find interest for this engagement. adoption of the ris3 in rs has no direct consequences in terms of launching of new programme with specific (and already allocated) funds, primarily addressed to companies which should develop new products/services in cooperation with r&d sector. such situation hardly could motivate stakeholders for active involvement in development of ris3, particularly during edp process which should serve as dialogue for (re)definition and adoption of proposed priority areas (nace 3-digit sectors/groups); 5. legal framework: because of un-clear position of involved institutions (“who is responsible for what”), there is no laws and by-laws with precise definition of the role of ris3, as well as procedures for financing (budgeting), monitoring, reporting, etc. for the process of implementation of ris3 in rs; 6. quantitative vs. qualitative analysis – selection of priority sectors: fact based decision making is regular procedure for businesses; surprisingly “believing” could be preferable approach for other sorts of decision, as this is explored in previous article, using wrong figure for gerd and number of researchers in main policy document for scientific community, official s&t strategy adopted in 2010, ignoring available official statistics (stefanovic-sestic & kutlaca, 2014). this is a reason for precaution rather than enthusiasm having such exhaustive quantitative analysis provided by external experts (fhg, jrc) and complemented by the analytical team. prejudices, hidden interest and political preferences could be stronger argument than data and information based on 8 economic analysis (2018, vol. 51, no. 3-4, 1-9) quantification of the available statistics. this challenge could be major obstacle for wider dialogue of involved stakeholders and could lead to wrong decisions; 7. culture of dialogue: entrepreneurial discovery process (edp) is one of the key phases in creation of the ris3, and should be sort of dialogue between involved stakeholders in order to reach consensus in selection of priority areas for smart development. it is necessary to consider findings related to ability and readiness for dialogue: the results of gert hofstede's research on the impact of certain components of national cultures showed that people in serbia are characterised by the disrespect of institutions and tendency towards short-term orientation rather than strategic long-term thinking (hofstede & hofstede, 2005). combining these findings with inherited legacy from socialist period of autocratic decision making it is reasonable to assume that organisation of wider democratic dialogue could be serious challenge. s3 – further steps first year of development of the ris3 in serbia has ended with quantitative analysis and mapping of economic, innovative and scientific potential in serbia (kroll et al., 2017), complemented with ranking lists of nace 3-digit level sectors-groups in serbia total and for all four regions using mcdm ideal point method compromise programming, developed by the imp associates within the analytical team. following road map, in the second year (2018) should be realised third phase, i.e. entrepreneurial discovery process (edp), or dialogue between all stakeholders and qualitative analysis of proposed priority nace sectors-groups and ranking lists of nace sectors in regions and for serbia in total. following original s3 methodology and advices from external experts (jrc), edp should be organized for all selected areas of smart specialisation, therefore, imp associates within the analytical team has proposed generalisation of ranking list of nace 3-digit level sectors-groups in serbia total. this generalisation has led to the following proposal: 1. priority areas – vertical: • digitalisation of the economy and society • smart agriculture – food and health • smart industry 4.0 and smart materials • cultural heritage and cultural industries 2. priority areas – horizontal: ket; ict; environmental protection; energy efficiency 3. with key emerging technologies (ket): micro and nano-electronics; nano-technologies; industrial biotechnology; advanced materials; photonics; advanced technologies in manufacturing. preparation of conditions for organisation of edp is ongoing activity in the time of writing this article, and results of this phase together with creation of final ris3 document together with plan for implementation of ris3 in serbia are the future steps, and possible subject for future writing about ris3 in serbia. main outcome of all mentioned activities should be consensus about identified priorities, as well as wider understanding of necessity of creation of national innovation system in serbia (edquist & johnson, 1997). acknowledgement research presented in this paper was supported by the ministry of education, science and technological development of the republic of serbia, under the project: "research and development of the platform for science based management of the scientific and technological development of the republic of serbia", reg. no. iii 47005. đuro kutlača 9 references edquist, c., and johnson, b., (1997). 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(2005). cultures and organizations. mcgraw-hill s3 platform (2012). guide to research and innovation strategies for smart specialisation (ris3). retrieved from: http://ec.europa.eu/regional_policy/sources/docgener/presenta/smart_specialisation/smart_ri s3_2012.pdf semencenko, d., kutlaca, dj., (2018). shaping national innovation system in small, transitional economy – case of serbia. publisher: university of belgrade, institute "mihajlo pupin" science and technology policy research centre. pages: 186. belgrade stefanovic-sestic s. & kutlaca dj. (2014). harmonization of the sti statistics in serbia with eu standards, proceedings of the xxi scientific conference ''technology, culture, development', tivat, montenegro, pp. 212-219. zeleny, m. (1976). the theory of the displaced ideal. in zeleny, m., (ed), multiple criteria decision making, berlin-kyoto, springer-verlag, pp.153-206 article history: received: october 30, 2018 accepted: december 14, 2018 microsoft word 2011_1-2 original scientific paper    peer‐to‐peer networks and complementary goods:   the impact of openness and innovation on profitable piracy   le texier thomas *, université de rennes 1, france   gordah maher, université de nice – sophia antipolis, france   udc: 339.188.4    jel: f1        abstract – file‐sharing  is often depicted as detrimental to traditional commercial activities  and tends to dissuade official digital goods’ producers from innovating. meanwhile, evidence shows  that producers are likely to provide complementary hardware goods that are compatible with digital  goods available both offline and online. this article  investigates to what extent the  introduction of  peer‐to‐peer networks has a positive impact on the level of profits reached by producers.   our model shows that the file‐sharing activity does not crowd the official digital goods producers  and hardware goods producers out of the market. moreover, we find that there exists suitable quality‐ based strategies so that both types of producers benefit from the file‐sharing activity. the utility that  peer‐to‐peer networks provide to file‐sharers has to be considered cautiously for commercial firms to  gain positive outcomes from the file‐sharing activity.    key words: peer‐to‐peer networks, piracy, complementary goods, communities  introduction  the emergence of the internet as a new transactional space has deeply changed the way  consumers, producers and distributors  interact and has  therefore  led  to several economic  research tracks over the last decade. the development of new compression standards marks  a  significant  step  in  the  development  of  economic  analyses  related  to  the  internet,  thus  highlighting the transition to the ‘dematerialization era’ which leads to the widespreading of  digital files online and to new technological adoption issues (shapiro and varian, 1999; peitz  and  waelbroeck,  2006a).  the  consumption  of  such  digital  goods  is  more  particularly  facilitated by the emergence of new electronic platforms relying on specific organizational  models,  namely  peer‐to‐peer  networks  (krishnan  et  al.,  2003,  2004,  2007),  as  well  as  the  increasing abilities of users to participate in productive activities (toffler, 1980; von hippel,  1988;  von  hippel,  2005;  flowers,  2008).  the  increasing  use  of  computers  and  the  democratization of high‐speed broadband help internet users to get access to digital files,  thus  contributing  to  the  increasing  popularity  of  such  file‐sharing  networks.  as  an  illustration, the peer‐to‐peer activity nowadays represents 37% of the internet global traffic,  and  gradually  leads  to  the  emergence  of  new  networks,  like  fasttrack,  edonkey2k  or  bittorrent which have superseded the late napster.                                                         * université de rennes 1, crem – umr 6211 cnrs, 7, place hoche, 35065 rennes cedex, france, e-mail: thomas.letexier@univ-rennes1.fr      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   16 the popularity of the file‐sharing activity, as far as it is widely adopted online, is in many  cases perceived by commercial entities – producers and vendors – as a direct threat for their  own activities  which  would affect  their  perenniality on  markets  they historically used  to  control  (bourreau  and  labarthe‐piol,  2004).  as  such,  the  introduction  of  peer‐to‐peer  networks would represent a convenient way for users to get access to and acquire digital  goods without having to pay pecuniar fees. these considerations tend to define peer‐to‐peer  networks as intermediaries improving the consumption of digital goods by enhancing piracy  online and by altering the level of profits reached by commercial digital goods’ stakeholders.  in other terms, such arguments tend to state that the activity of commercial‐based networks  and peer‐to‐peer networks are substituable and that there does not exist any complementary  relationship beneficial that is for both of them. as a consequence, facing the popularity of the  file‐sharing activity, the technological  innovation efforts made by digital goods producers  would appear to be vain and costly.   yet, this point of view may have to be qualified, since recent research topics dealing with  internet activities have on the contrary revealed positive external effects between traditional  and  new  consumption  models  and  have  proved  that  the  emergence  of  new  distribution  channels may improve their profitability. for instance, evidence and economic analyses have  shown  that  offline  and  online  commercial  activities  are  likely  to  be  both  preserved  and  valuated  through  the  setting  up  of  specific  strategies  for  each  of  them  (brynjolfsson  and  smith, 2000; bakos, 2001; curien and moreau, 2004). economic studies dealing with open  source  software  research  tracks  have  also  underlined  the  existence  of  such  beneficial  relationships.  whereas  open  source  software  projects  were  previously  considered  as  competitors by software firms, the evidence of recent hybrid software development models  today exhibits new potential benefits  in a  framework  in which open source software and  commercial actors cooperate (dahlander and magnusson, 2005; bonaccorsi et al., 2006; shah,  2006).  the impact of piracy on the valuation of the traditional commercial‐based activities the  file‐sharing activity naturally  implies has yielded several major contributions, underlining  the importance of network effects in the outcome of producers (liebowitz, 1985; besen and  kirby, 1989; conner and rumelt, 1991; takeyama, 1994; king and lampe, 2003). focusing on  digital  goods  (peitz  and  waelbroeck,  2005;  liebowitz,  2006),  empirical  studies  reveal  contrasted results, as some scholars exhibit a detrimental effect on commercial actors’ profits  (peitz and waelbroeck, 2004; liebowitz, 2005; zentner, 2006) while others on the contrary  underline  a  beneficial  one  (oberholzer  and  strumpf,  2004).  the  piracy‐related  literature  usually  links  piracy  to  the  widespread  online  diffusion  of  digital  files,  thus  presenting  “sampling” as a way of enhancing the popularity of commercial digital goods (bounie et al.,  2005; peitz and waelbroeck, 2006b) as well as that of the artists concerned (gayer and shy,  2006; gopal et al., 2006). finally, some authors show that enhancing piracy and digital goods’  diffusion online have to be considered with the ensuing externalities resulting from the sales  of  complementary  goods.  more  particularly,  even  though  piracy  may  be  detrimental  for  digital goods’ producers, the diffusion and the unauthorized consumption of digital files are  likely  to  increase  the  level  of  profit  of  the  producers  providing  the  hardware  products  needed to use any digital goods (i.e., original or pirate ones) (gayer and shy, 2006). as such,  piracy‐related  studies  highlight  that  piracy  does  not  necessarily  represent  a  source  of       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     17 disutility but can also be used as a strategic tool for producers to increase their surplus (shy  and thisse, 1999; poddar, 2005). we actually do find evidence of such complementary goods  strategies through the actual provision of physical hardware terminals aiming at exploiting  both original and pirate digital goods. several well‐known companies (e.g., sony, philips or  pioneer) offer hardware products compatible with both official and ‘less official’ standards,  thus potentially casting on piracy to sell complementary and impossible‐to‐reproduce goods.  one may hence think, notably on account of the current popularity of apple and its ipod  players’ offer,  that using piracy  to enhance complementary sales  is a pertinent  industrial  strategy.     although  the  literature associating general  information economics  topics  (e.g., dealing  with network effects) with piracy ones has already led to a large number of contributions,  few  studies  have  dealt  with  the  impact  of  peer‐to‐peer  networks  on  the  diffusion  of  unauthorized digital goods and its market‐based consequences on traditional producers. it is  generally shown that the activity of peer‐to‐peer networks can improve the level of sales of  the products generally sold in stores under specific conditions (gayer and shy, 2003a; gopal  et al., 2004, rochelandet and le guel, 2005). the popularity of such file‐sharing networks  and the increasing interest these are currently arousing nevertheless require further analyses  to be carried out. studies related to the activity of peer‐to‐peer networks  in a managerial  framework notably stress that file‐sharing networks differ in their degree of openness, that is  the community‐based – non‐financial – benefits users derive from the file‐sharing activity.  the acquisition of unauthorized digital goods is therefore not as easy as it is often described,  since  access  and  participation  appear  to  be  regulated  by  somewhat  internal  policies  (asvanund et al., 2001; cunningham et al., 2004), thus impacting on the level of the goods  distributed online (domon and yamazaki, 2004). one key issue would therefore be to take  into account the organizational specificities on which file‐sharing networks are based so as to  see to what extent their activity may be profitable for producers.    we identify to what extent the level of openness of peer‐to‐peer networks may have a  positive impact on the level of profits reached by traditional producers. we notably develop  a  model  in  which  we  consider  two  types  of  producers,  each  evolving  in  a  monopoly  framework: digital goods producers and hardware producers. digital goods are available for  consumption in official or pirate form. such two types of digital goods differ in their quality,  as  pirate  digital  goods  are  likely  to  be  less  qualitative  than  official  ones  usually  are.  customers differ in their levels of preference for quality and have three adoption strategies:  official digital goods’ adoption and complementary hardware purchase, pirate digital goods’  adoption and complementary hardware purchase, or non‐adoption.  our  results  stenghten  the  ‘beneficial  complementary‐based  activity’  hypothesis  previously  highlighted  in  the  literature.  in  a  context  in  which  the  file‐sharing  activity  is  introduced,  we  point  out  that  the  official  digital  goods  firm  is  always  able  to  sell  their  products, and that the hardware goods firm  is not motivated to crowd the official digital  goods producer out of the market. moreover, the hardware goods producer intends to deter  non‐adoption  patterns  while  the  digital  goods  producer  –  fully  or  partially  –  serves  the  market. as such,  the existence of  peer‐to‐peer networks  is not  likely  to evict commercial  players from the market. moreover, our qualitative analysis aiming at measuring the impact  of the file‐sharing activity on both types of commercial activities reveals positive effects. as     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   18 such, we suggest  that  the  losses perceived by  the official digital goods  firm are  likely  to  result from the setting up of inappropriate quality‐based strategies according to the degree of  openness that file‐sharing networks may deliver. we thus underline that commercial‐driven  innovative efforts should cautiously be considered, according to the degree of openness file‐ sharing  communities  exhibit.  our  model  therefore  shows  that  the  diffusion  of  non‐ authorized digital goods may be enhance the outcomes of commercial producers, provided  that firms set up appropriate strategies to gain from a so‐called ‘outlaw’ activity (flowers,  2008). our findings tend to qualify the relevancy of the recent local policies that have been  initiated  by  the  recording  industry  association  of  america  targeting  the  file‐sharing  networks whose degree of openness is too high.  the  organization  of  this  paper  is  as  follows.  we  first  present  the  model.  second,  we  analyze the levels of price, quantity and profit that are obtained by the two producers when  the  file‐sharing activity does not apply. third, we analyze  the market structures  that are  likely to emerge when the file‐sharing activity is introduced, as well as the levels of profit  that  commercial  players  obtain  from  it.  fourth,  we  study  the  impact  of  the  file‐sharing  activity  on  commercial  ones  and  identify  potential  commercial  opportunities.  fifth,  we  conclude and provide directions for further research.  the model  we first present the properties of the market we consider, as well as the nature of the  goods  (i.e.,  digital  goods  and  hardware  goods)  on  which  we  focus.  we  then  present  the  demand side and the supply side that we take into account in the model.  digital goods, hardware goods and the market  we present a market in which technological users may adopt a digital good available in  two versions: official digital goods and pirate digital goods. users have to pay a fee ( 0 0p > )  if they adopt official digital goods while they do not have to incur any pecuniar cost if they  adopt pirate digital ones. in addition, technological adopters need to purchase a hardware  good so as to use the digital goods previously acquired. as such, digital goods and hardware  goods appear as complementary goods. moreover, as opposed to digital goods, which have  immaterial properties  that  facilitate piracy and unauthorized distribution on  the  internet,  hardware goods provide material characteristics that disable any copying schemes.  as opposed to some studies (e.g., gayer and shy, 2003b), we do not restrict our analysis  to the case of software and do not consider software‐related compatibility network effects.  we consider digital goods  in the forms these are usually  likely to appear on peer‐to‐peer  networks  online,  such  as  music  files,  video  files,  text  files,  etc.  our  model  applies  in  an  extreme  framework  in which peer‐to‐peer networks only provide  pirate digital goods,  in  respect with the argumentation of the majors who consider that digital goods available on  file‐sharing networks are unauthorized ones.       technological adopters  we set the size of the population of potential adopters as equal to n . we describe the  choices made by potential technological adopters by defining three utility functions. due to       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     19 the heterogeneity of  the users’ preference, adopters differ  in  their  intrinsic willingness  to  adopt or not adopt digital goods, depicted by [ ]0;1x ∈ . users with a high valuation for digital  goods exhibit a low value for  x , while users with a low valuation for digital goods present a  high value for x . potential adopters for whom  x  is close to 0 acquire official digital goods  and those for whom  x  tends to 1 do not adopt digital goods. users for whom the value of  x   is  intermediate  adopt  pirate  digital  goods  in.  adoption  choices  are  set  by  the  quality  provided by digital goods. in addition, we suppose that each potential user presents a level  of utility which is uniformly distributed, that yields to  i in xδ=  for adopter i .   as generally assumed (takeyama, 1994; shy, 1996; shy, 2001), we state that official and  pirate digital goods are vertically differentiated, i.e.,  0α β> > , where α  (resp. β ) represents  the  quality  of  the official  (resp.  pirate)  digital  goods  considered.  our  model  applies  in  a  framework in which the use of digital goods (whether official or pirate ones) requires the  purchase of a complementary hardware good. the cost of such a hardware good is  0hp >   and applies to each digital goods adopter.  we thus define three utility functions corresponding with the three adoption strategies  users are given: (i) official digital goods’ adoption and complementary hardware purchase,  (ii)  pirate  digital  goods’  adoption  and  complementary  hardware  purchase,  or  (iii)  non‐ adoption.   the utility of each adopter, according to her level of preference for digital goods, is given  by:   (1 ) (1 ) ( ) 0 ho h o hp h l u x p p u x p c u α β γ ∅ = − − − = − − − − = ⎧ ⎪ ⎨ ⎪ ⎩            ,  [ ]0;1x ∈                                                            (1)   the  use  of  peer‐to‐peer  networks  to  reach  pirate  digital  files  requires  learning  costs  ( 0lc > ). for  instance,  learning costs refer to the time needed for an adopter to be able to  efficiently use file‐sharing access software or to distinguish relevant digital files from those  that are not. such learning costs are likely to be lowered by the thematic orientations and the  scope  of  the  monitoring  policies  of  the  file‐sharing  networks’  moderators,  aiming  at  regulating  participation  within  peer‐to‐peer  networks.  as  a  consequence,  peer‐to‐peer  networks differ in their level of community‐based dynamics, openness thus relying on the  nature of the moderating policies applied within such networks. we therefore define  0γ >   as the degree of openness of the peer‐to‐peer network considered in our model. here, the  openness of peer‐to‐peer networks  is  likely  to generate a  twin‐effect on  the users of  file‐ sharing  networks.  firstly,  it  enables  file‐sharers  to  easily  get  access  to  suitable  files  and  overcome  their  learning  constraints  related  to  the  use  of  peer‐to‐peer  networks.  we  particularly state that openness is likely to outweigh the learning costs required to access and  efficiently use peer‐to‐peer networks providing pirate digital goods. secondly, the openness  of  peer‐to‐peer  networks  generates  both  social  and  economic  benefits  from  community‐ based interaction. as such, file‐sharers may derive positive outcomes from belonging to a  community whose scope is compatible with their own interests and expectations.       economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   20 producers  we consider two producers in the model. the digital goods producer provides official  digital goods to potential customers and the hardware goods’ producer provides physical  terminals aiming at using both official and pirate digital goods. as such, hardware producers  are  likely  to  benefit  from  piracy  and  the  ensuing  diffusion  of  pirate  digital  goods,  since  complementary hardware terminals tend to be needed for digital goods’ exploitation while  not being duplicable at no cost. these considerations highlight a potential conflict of interest  between the two types of producers that our model is aiming at estimating.  we  assume  that  official  digital  goods  are  sold  by  a  monopoly  firm.  the  firm  sets  a  price *op  that maximizes its profit defined by:  ( )o o o on p kπ = −                                   ( )2   0on >  represents the number of individuals adopting official digital goods and 0ok >  the  amount  invested  by  the  firm  to  produce  official  digital  goods.  due  to  the  informational  nature of digital goods and their reproduction facilities, we assume that production costs do  not depend on the level of production.   we also assume that hardware goods are sold by a monopoly firm. such an assumption  holds in a realistic framework in which the price convergence of complementary hardware  goods is observed. this representative firm sets a price *hp  which maximizes its profit defined  by:  ( ) ( )h h h h hn p k anπ = − +                                            ( )3   0hn >  represents the number of individuals purchasing hardware goods and 0hk >  the  amount invested by the firm to produce hardware goods. besides, as hardware production  relies  on  material  production  and  assembling,  0a >   represents  the  cost  needed  by  the  hardware firm to produce a single quantity of hardware goods.  the next section analyzes the levels of price, quantity and profit that are obtained by both  digital  goods  and  hardware  goods  producers  in  a  framework  in  which  the  file‐sharing  activity does not exist.  adoption and optimal strategies when file‐sharing does not apply  in a framework in which access to peer‐to‐peer networks is not possible, there are two  categories of users: individuals that purchase both official digital and complementary goods,  and individuals that do not.    figure 1. adoption patterns when file‐sharing does not apply           le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     21 the utility of each adopter in this case is given by:  (1 ) 0 ho h ou x p p u α ∅ = − − − = ⎧ ⎨ ⎩            ,  [ ]0;1x ∈                                                               ( )1'   1x   defines  the  level  of  intrinsic  preference  for  digital  goods  for  which  adopters  indifferently  choose  between  technological  adoption  ( ' 'o h+ )  or  non‐adoption  (∅ );  individuals exhibiting a level of  x  under  1x  thus adopt both the official digital good and the  complementary hardware one, while others do not adopt both of them. we find that:  ( )1 h ox p pα α= − −                                 ( )4   the official digital goods producer sets op  which solves  ( )max ( ) o o o o o o o p h on p k p kp pπ δ α α= − = −− −⎡ ⎤⎣ ⎦                                    ( )5   from( )5 , we find that the price of the hardware goods’ producer which maximizes her  profit is given by:  ( ) 2o hp pα= −                                   ( )6   the hardware goods producer sets hp that solves  ( ) ( )max ( ) ( ) h h h h h h h h p h on p k an p a kp pπ δ α α= − + = − −− −⎡ ⎤⎣ ⎦                                            (7)   from( )7 , we find that the price of the hardware goods’ producer which maximizes her  profit is given by:  ( ) 2h op a pα= + −                                                       ( )8   from( )6 and( )8 ,  we  find  values  for  price  equilibria  in  a  framework  in  which  both  producers maximize their profits when the file‐sharing activity does not prevail.  ( ) ( ) * * 3 2 3 o h p a p a α α = − = + ⎧⎪ ⎨ ⎪⎩                                    ( )9   assumption 1. when the  file‐sharing activity does not prevail, both producers provide prices  with positive levels, implying that:  aα >                                   ( )a1   this assumption stresses that digital goods producers have to provide a level of quality  high enough for digital goods to be adopted. assumption 1 implies that the price of official  digital  goods  is  always  higher  than  the  price  of  hardware  goods  when  the  file‐sharing  activity does not apply.  from( )4 and( )9 , we find the optimal quantity of both digital goods and hardware goods  sold by the two firms:  ( ) ( )*1 3 0x aα α= − >                                          ( )10      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   22 ( )10 shows that there is always a proportion of users that adopt both goods when peer‐ to‐peer networks do not exist. besides, as  ( ) ( )3 1 0 2a aα α α− ≤ ⇔ − ≤ ≤ , we find that there  is always a part of non‐adopters (i.e., both hardware and digital goods non‐adopters) on the  market.  from( )2 ,( )9 and( )10 , and from( )3 ,( )9 and( )10 , we find the optimal  levels of profits  that are reached by each firm at equilibrium:  ( ) ( )( ) ( ) ( )( ) 2* 2* 9 9 o o h h a k a k π δ α α π δ α α = − − = − − ⎧ ⎪ ⎨ ⎪⎩                             ( )11   proposition 1. both digital goods and hardware goods are produced if and only if a high enough  level of digital goods quality is provided by digital goods producers, i.e.,   ( ) ( ) ( ) ( ){ }2 2max 2 9 36 81 2 ; 2 9 36 81 2 ;h h h h o oa k a k k a k a k kα δ δ δ δ δ δ∈ + + + + + + +∞⎡ ⎡⎢ ⎢⎣ ⎣   proof of proposition 1. see appendix  proposition 1 suggests that the activity of hardware goods producers are linked to that of  digital goods producers.  i) there exists a  level of digital goods quality that provides a positive profit for both  hardware and digital goods producers;  ii) when  h ok k> , there exists a level of digital goods quality that may be detrimental to  the profitability of hardware producers;  iii) there exists a level of quality below which the profits of both producers are negative;  such a level has to be avoided by the digital goods producer.   proposition 1 evidences complementarities – or at least dependencies – between the activity  of hardware goods producers and that of digital goods producers. we find that the level of  quality  chosen  by  the  digital  goods  producer  may,  in  some  cases,  incitate  the  hardware  producer not to produce.  adoption and optimal strategies when file‐sharing applies  in a framework in which peer‐to‐peer networks are introduced, we stress the existence of  several scenarii  in  technological adoption schemes, depending on  the set of values of  the  parameters of  the model. we  first present  the general case and we  then analyze  the  five  scenarii that are likely to prevail when the file‐sharing activity is introduced. primary results  are eventually summarized.  assumption 2. when the file‐sharing activity applies, the level of satisfaction reached by users  whose valuation for pirate digital goods is high exceeds the cost required by the hardware producer to  produce one unit of hardware good.  aβ >                                            ( )a2   assumption 2 implies that adopters presenting a high level of valuation for pirate digital  goods are likely to adopt complementary hardware digital goods to use such digital goods in  a convenient and enjoyable way.       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     23 general case  when peer‐to‐peer networks are introduced and enhance the diffusion of unauthorized  digital  goods,  there  are  three  categories  of  users:  individuals  that  purchase  both  official  digital  goods  and  complementary  hardware  goods,  individuals  that  adopt  pirate  digital  goods and purchase hardware goods, and individuals that do not adopt either digital goods  or hardware goods.    figure 2. adoption patterns when file‐sharing applies: general case        the utility of each adopter in the general case is given by:  (1 ) (1 ) ( ) 0 ho h o hp h l u x p p u x p c u α β γ ∅ = − − − = − − − − = ⎧ ⎪ ⎨ ⎪ ⎩        ,  [ ]0;1x ∈                                       ( )1   2x   defines  the  level  of  intrinsic  preference  for  digital  goods  for  which  adopters  indifferently choose between official technological adoption ( ' 'o h+ ) or pirate technological  adoption ( '' p h+ ).  3x  defines the  level of  intrinsic preference for digital goods for which  adopters  indifferently  choose  between  pirate  technological  adoption  ( '' p h+ )  or  non‐ adoption (∅ ). thus, users do not purchase complementary hardware goods if their level of  intrinsic preference for digital goods is above 3x . in addition, users whose level of intrinsic  preference for digital goods is above 2x do not purchase official digital goods. we find that:  [ ] ( ) [ ] 2 3 ( ) ( ) ( ) ( ) l o h l x c p x p c α β γ α β β γ β = − + − − − = − − − ⎧ ⎨ ⎩                                      ( )12   the official digital goods producer sets *op  which solves  ( ) ( )[ ], 2max ( ) ( ) o o p p l o o o p c p p kπ δ α β γ α β= − + − − − −                                                         ( )13   from( )13 , we find that the price of the official digital goods’ producer which maximizes  her profit is given by:  [ ]* ( ) ( ) 2o lp cα β γ= − + −                                                     ( )14   the hardware goods producer sets *hp  which solves  ( )( )( ), 2max ( ) ( ) h h p p h l h h p p c p a kπ δ β β γ= − − − − −                                                        ( )15      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   24 from( )15 we find that the price of the hardware goods producer which maximizes her  profit is given by:  [ ]* ( ) ( ) 2h lp a cβ γ= + − −                                                     ( )16   from( )12 ,( )14 and( )16  we find the  level of  intrinsic preference for digital goods. we  easily deduce the ensuing optimal value of the quantity of both digital goods and hardware  goods sold by the two firms:  [ ] [ ] ( ) ( )[ ] ( ) * * * 2 2 * * * 3 3 ( ) ( ) 2( ) ; 2 ; l o l h x c n x x a c n x α β γ α β δ β γ β δ = − + − − = = − − − = ⎧⎪ ⎨ ⎪⎩              ( )17   assumption 3. we assume that preferences for digital goods are transitive according to the type  of adopters, i.e.,  * *3 2x x> , implying that:  ( ) [ ]( )lc aγ α β α− − > −                                         ( )a3   proposition 2. pirate digital goods’ adoption requires learning costs ( lc ) to be outweighted by  the level of openness of the peer‐to‐peer networks (γ ) to prevail.  proof of proposition 2. from ( )a3  and as ( )( ) 0a α α β− ≥ ,  ( ) 0l lc cγ γ− − ≥ ⇔ ≥ .    evidence  highlights  the  realistic  nature  of  proposition  2,  as  peer‐to‐peer  networks  provide to their users with numerous services and tools aimed at stimulating interaction and  mutual help, for example through the setting up of message boards, chatrooms or faqs. the  degree  of  openness  selected  by  the  moderators  of  file‐sharing  networks  and  its  ensuing  positive external effect all the more rapidly offsets the learning costs required by users to  access relevant pirate digital goods available online.  file‐sharing and technological adoption: case 1  case 1 refers to a situation in which the adoption of official digital goods is maintained  and in which potential adopters may either adopt or not adopt digital goods, whether they  are official or pirate ones.    figure 3. adoption patterns when file‐sharing applies: case 1        such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                                         ( )c1    ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                                   ( )c2        le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     25 ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                                                            ( )c3   ( )*2 0 lx cα β γ> ⇔ − > − −                                        ( )c4   ( )*3 0 lx c aγ β> ⇔ − − > −                                         ( )c5   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                        ( )c6   ( )*3 1 lx c aγ β< ⇔ − − < +                                         ( )c7   from( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c4 ,( )c5 ,( )c6 and( )c7 ,  we  find  that  case  1  applies when :  ( ) ( )( )[ ] ( ) ( )( )[ ] ; if 2 ; if 2 l l c a a a c a a γ α α β β α β γ α α β α β α β − − ∈ − + − > − − ∈ − − − < ⎧⎪ ⎨ ⎪⎩                                                                   ( )18   from( )13 ,( )14 ,( )15 ,( )16 and( )17 ,  in  a  context  in  which  case  1  applies,  the  profits  obtained by both firms are:  ( )[ ] ( )[ ]( ) ( )[ ] ( )( ) 2* , 2 2* , 2 ( ) 4 ( ) 4 o p p l o h p p l h c k a c k π δ α β γ α β π δ β γ β = − + − − − = − − − − ⎧ ⎪ ⎨ ⎪⎩                                                                   ( )19   file‐sharing and technological adoption: case 2  case 2 refers  to a situation  in which  the  firm which produces official digital goods  is  crowded out. in this context, official digital goods are not purchased and users adopt or do  not adopt pirate digital goods.    figure 4. adoption patterns when file‐sharing applies: case 2      such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                              ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                                                 ( )c3   ( )*2 0 lx cα β γ< ⇔ − < − −                                        ( )c8   ( )*3 0 lx c aγ β> ⇔ − − > −                                                               ( )c5   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                                   ( )c6   ( )*3 1 lx c aγ β< ⇔ − − < +                                                                         ( )c7      economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   26 proposition 3. the firm which produces digital goods is never evicted from the market.   proof of proposition 3. ( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c5 ,( )c6 ,( )c7 and( )c8  can not  be simultaneously satisfied.    here, proposition 3 stresses that the file‐sharing activity cannot been depicted as the key  factor to explain why digital goods producers may be crowded out of the market.   file‐sharing and technological adoption: case 3  case 3 refers to a situation in which both firms (i.e., official digital goods and hardware  producers)  are  evicted.  in  this  context,  non‐adoption  patterns  prevail  and  threaten  the  perenniality of the cultural goods market.    figure 5. adoption patterns when file‐sharing applies: case 3      such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                                         ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                                                            ( )c3   ( )*2 0 lx cα β γ< ⇔ − < − −                             ( )c8   ( )*3 0 lx c aγ β< ⇔ − − < −                                         ( )c9   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                                   ( )c6   ( )*3 1 lx c aγ β< ⇔ − − < +                                         ( )c7     proposition 4. non‐adoption patterns do not prevail on the cultural goods market. when file‐ sharing applies, there does not exist settings in which digital goods (whether they be official or pirate)  are not purchased/adopted.  proof of proposition 4.  ( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c6 ,( )c7 ,( )c8 and( )c9  cannot  be simultaneously satisfied (e.g., ( )a2 and( )c9 are not compatible).    here,  proposition  4  reveals  that  the  file‐sharing  activity  is  not  likely  to  threaten  the  perenniality  of  the  cultural  goods  market.  at  least,  it  suggests  that  there  exist  other  key  reasons  to  explain  why  the  cultural  goods  market  may  vanish.  proposition  4  partially  explains the actual popularity of piracy and peer‐to‐peer networks. such a result also points  out that productive efforts made to enhance the quality of official digital goods enable the  hardware goods producer to maintain her activity. consequently, the official digital goods       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     27 producer  is not  incited to evict the hardware goods producer, since such an eviction also  naturally implies that of the official digital goods producer.  file‐sharing and technological adoption: case 4  case  4  refers  to  a  situation  in  which  the  hardware  goods  producer  fully  serves  the  market, while the digital goods producer is not evicted. in this case, non‐adoption patterns  do not apply.    figure 6. adoption patterns when file‐sharing applies: case 4        such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                              ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )[ ]* *3 2 lx x c aγ α β α> ⇔ − − > −                           ( )c3   ( )*2 0 lx cα β γ> ⇔ − > − −                             ( )c4   ( )*3 0 lx c aγ β> ⇔ − − > −                                         ( )c5   ( ) ( )*2 1 lx cα β γ< ⇔ − − < − −                                        ( )c6   ( )*3 1 lx c aγ β> ⇔ − − < +                                       ( )c10   from( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c4 ,( )c5 ,( )c6 and( )c10 ,  we  find  that  case  4  applies when :  ( ) [ ]; if 2lc a aγ β α β α β− − ∈ + − − >                                     ( )20   from( )13 ,( )14 ,( )15 ,( )16 and( )17 ,  in  a  context  in  which  case  4  applies,  the  profits  obtained by both firms are:  ( )[ ] ( )[ ]( ) ( ) ( )[ ] ( )( ) 2* , 2 2* , 2 ( ) 4 4 o p p l o h p p l h c k a c k π δ α β γ α β π δ β γ β = − + − − − = − − − − ⎧ ⎪ ⎨ ⎪⎩                        ( )19   file‐sharing and technological adoption: case 5  case 5 refers to a situation in which the market is fully served by both hardware goods  and digital goods firms. this case reflects a situation in which the file‐sharing activity has not  a detrimental effect on the sales of both digital goods and hardware goods.     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   28 figure 7. adoption patterns when file‐sharing applies: case 5        such settings require seven conditions to be simultaneously satisfied:  ( ) ( )* 0o lp cα β γ> ⇔ − > − −                              ( )c1   ( ) ( )* 0h lp c aγ β> ⇔ − − > − +                                        ( )c2   ( ) ( )* *3 2 lx x c aγ α β α> ⇔ − − > −⎡ ⎤⎣ ⎦                                      ( )c3   ( )*2 0 lx cα β γ> ⇔ − > − −                             ( )c4   ( )*3 0 lx c aγ β> ⇔ − − > −                             ( )c5   ( ) ( )*2 1 lx cα β γ> ⇔ − − < − −                                      ( )c11   ( )*3 1 lx c aγ β> ⇔ − − < +                           ( )c10   proposition 5. the  cultural  goods market  cannot be  fully  served by both  digital  goods  and  hardware goods producers.  proof of proposition 5.  ( )a1 ,( )a2 ,( )a3 ,( )c1 ,( )c2 ,( )c3 ,( )c4 ,( )c5 ,( )c10 and( )c11  can  not be simultaneously satisfied.    as we have found in the case in which peer‐to‐peer networks are not introduced, we find  that digital goods producers do not fully serve the market. however, proposition 5 suggests  that non‐adoption patterns are downplayed by patterns of pirate digital goods adoption.  market structures    the  following  table  (table  1)  summarizes  the  main  results  we  have  previously  found  when the file‐sharing activity is introduced. moreover, we underline that two cases are likely  to appear in such a framework.    table 1. market structures when file‐sharing is introduced    case  details  results  case  1  the market is partially served by both producers  no‐adoption patterns partially apply  applies when  ( ) ( ) ( ) ( ) ; if 2 ; if 2 l l a c a a a c a γ α β β α β α γ α β α β α β α − − ∈ − + − > − − ∈ − − − < ⎧ ⎡ ⎤ ⎪ ⎢ ⎥⎪ ⎣ ⎦ ⎨ ⎡ ⎤⎪ ⎢ ⎥⎪⎩ ⎣ ⎦        le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     29 case  2  the digital goods producer is crowded out  the market is partially served by the hardware  firm  no‐adoption patterns partially applies  does not apply  case  3  both producers are crowded out  no‐adoption patterns prevail  does not apply  case  4  the market is fully served by the hardware firm  the market is partially served by the digital firm  no‐adoption patterns do not apply  applies when  ( ) [ ]; if 2 l c a aγ β α β α β− − ∈ + − − >   case  5  the market is fully served by both producers  no‐adoption patterns do not apply  does not apply    as cases 2, 3 and 5 do not apply, our primary results stress that digital goods producers  are always likely to sell their products. such results reveal that the perenniality of the digital  goods  producer  on  the  market  can  be  guaranteed.  the  hardware  goods  producer  is  not  motivated to crowd the digital goods producer out of the market so as to fully serve the  market. in other words, one of the main goal of the hardware goods producer is to deter non‐ adoption patterns, while the digital goods producer – partially or fully – serves the market.  all  the ensuing adoption  issues of course depend of  the  level of quality of digital goods  provided by the digital goods firm.   such settings reveal strong dependencies of hardware producers on digital goods’ that  are all the higher‐leveled as most pirate digital goods are generally issued from official ones  (e.g., through media copying, media ripping or miscellaneous files conversions).  our primary results are compatible with both short  term and  long  term perspectives,  since  the  crowding  out  of  official  digital  goods’  suppliers  would  in  the  long  term  permanently lead to the disappearance or the strong contraction of the pirate digital goods’  offer. as such, our findings primilarly suggest that the eviction of the official digital goods  supplier  should  not  to  be  targeted  by  the  hardware  goods’  firm  if  it  is  to  maintain  profitability in the long run.   for cases 1 and 4, the profits of both producers are as follows:  ( )[ ] ( )[ ]( ) ( ) ( )[ ] ( )( ) 2* , 2 2* , 2 ( ) 4 4 o p p l o h p p l h c k a c k π δ α β γ α β π δ β γ β = − + − − − = − − − − ⎧ ⎪ ⎨ ⎪⎩                        ( )19   lemma 1. the profit reached by the official digital goods producer depends on both the quality  gap (i.e., α β− ) and the degree of openness of the peer‐to‐peer community (i.e.,  ( )lc γ− − ).  more precisely, we find that the official digital goods producer reaches a positive profit in  two different frameworks:  • when  the  degree  of  openness  of  the  peer‐to‐peer  community  is  high  (i.e.,  ( ) ( ) ( )( ) ( )2 16 2 ;l oc kγ δ α β δ α β δ− − ∈ − + − +∞⎡ ⎡⎣ ⎣ ),  whatever  the  quality  gap  is;     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   30 • both when the quality gap is high (i.e.,  ( )4 okα β δ− > ) and when the degree of  openness  of  the  peer‐to‐peer  community  is  low  (i.e.,  ( ) ( ) ( )( ) ( )0; 2 16 2l oc kγ δ α β δ α β δ− − ∈ − − −⎡ ⎡⎣ ⎣ ).  lemma 1 suggests that the degree of openness is critical for the digital goods’ producer to  get  a  positive  profit.  in  a  specific  case,  a  lower  degree  of  openness  of  the  peer‐to‐peer  community can generate a positive profit when the quality gap is high. this result stresses  that qualitative efforts are likely to generate positive profits for the digital goods firm, by  taking into account the level of its fixed costs (i.e.,  ok ).  lemma 2. the profit reached by the hardware goods producer depends on both the quality of the  pirate digital goods available on file‐sharing platforms (i.e.,  β ) and the degree of openness of the peer‐ to‐peer community (i.e.,  ( )lc γ− − ).  similarly  to  the case of  the digital goods producer, we  find  that  the hardware goods’  producer obtains a positive profit in two different frameworks:  • when  the  quality  of  the  pirate  digital  goods  is  very  low  or  very  high  (i.e.,  ( ) ( ) ( ) ( )2 20; 2 4 4 2 2 4 4 2 ;h h h h h ha k ak k a k ak kβ δ δ δ δ δ δ∈ + − + + + + +∞⎡ ⎡ ⎤ ⎡⎣ ⎣ ⎦ ⎣u ), whatever the degree of openness of the peer‐to‐peer community is;  • when  the  quality  of  the  pirate  digital  goods  is  intermediary‐leveled  (i.e.,  ( ) ( ) ( ) ( )2 22 4 4 2 ; 2 4 4 2h h h h h ha k ak k a k ak kβ δ δ δ δ δ δ∈ + − + + + +⎤ ⎡⎦ ⎣ ),  and  when  the  degree  of  openness  of  the  peer‐to‐peer  community  is  high  (i.e.,  ( ) ( )( ) ( )2 4 2 ;l hc a kγ δ β δβ δ− − ∈ − − + +∞⎡ ⎡⎣ ⎣ ).   lemma  2  suggests  the  hardware  goods  producer  has  to  consider  both  the  quality  of  pirate  digital  goods  and  the  degree  of  openness  of  the  peer‐to‐peer  community  to  get  a  positive profit. moreover,  the hardware goods’ producer has  to set  its both costs  (i.e.,  a   and hk ) to reach such a valuable issue.   in this section, we have pointed out that, contrary to the conventional wisdom, the file‐ sharing  activity  does  not  evict  the  official  digital  goods  producer  and/or  the  hardware  producer from the market. following such a result, one key research question would be to  measure the nature of the impact (i.e., positive or negative) that the introduction of peer‐to‐ peer networks has on commercial activities (i.e., digital goods firm and hardware terminals  firm). the next section is devoted to this study.   comparative statics  in a framework in which digital goods were previously available in their official form, the  file‐sharing  activity  is  likely  to  have  an  impact  on  the  level  of  profits  reached  by  the  producers of official digital goods and hardware goods.  this section aims at seeing  if the  introduction of peer‐to‐peer networks  in the cultural  goods industrial landscape may deliver beneficial outcomes for both producers. to do so,  our approach is merely qualitative, inasmuch as we identify to what extent the file‐sharing  activity generates gains for the firm providing official digital goods and the firm providing       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     31 hardware  terminals.  qualitative  results  are  summarized  and  coordination  strategies  are  discussed.  the impact of file‐sharing on the profitability of official digital goods  producers  from  ( )11 and( )19 , we  find  that  the effect on  the  file‐sharing activity on  the  level of  profit of the producer of official digital goods is as follows:  ( ) ( ) ( )[ ] ( )( )2 2* 9 4 36o l c a δ π α α β γ α β α α α β δ = − + − − − − − ⎡ ⎤ ⎣ ⎦                                           ( )21   from( )21 , our mathematical analysis aiming at identifying the – positive or negative –  nature of the expression of  *oπδ provides the following results.     lemma 3. the file‐sharing activity may positively or negatively influences the profitability of the  official digital goods firm. the nature of such an influence depends on the qualitative effort (i.e.,α )  that is provided by the official digital goods firm – facing the production of pirate digital goods (i.e.,  β ) – as well as the degree of openness of the peer‐to‐peer community (i.e.,  ( )lc γ− − ).    more precisely, we find that the introduction of peer‐to‐peer networks enhances the level  of profit of the producer of official digital goods:  • when the digital goods firm sets a low level of quality for its official digital good  (i.e.,  ( )( )2 20; 324 288 186624 186624 104976 373248a a aα β β β∈ − + − +⎤ ⎡⎦ ⎣),  whatever the degree of openness of the peer‐to‐peer community is;  • when the digital goods firm sets a high level of quality for its official digital good  (i.e.,  ( )( )2 2 373248 ;324 288 186624 186624 104976a a aα β β β∈ +∞⎤ ⎡− + − +⎥ ⎢⎦ ⎣ ),  and  when  the  degree  of  openness  of  the  peer‐to‐peer  community  is  high  (i.e.,  ( ) ( ) ( )( )( ) ( )218 144 18 ;lc aγ α α β α α β α α− − ∈ − − + − − +∞⎤ ⎡⎥ ⎢⎦ ⎣ ).  however, we find that there exist settings in which the file‐sharing activity is detrimental  to that of the digital goods firm. indeed, negative externalities are likely to appear both when  the digital goods firm sets a high level of quality (i.e., α ) for its product and when the degree  of  openness  of  the  peer‐to‐peer  community  is  low  (i.e.,  ( ) ( ) ( )( )( ) ( )20; 18 144 18lc aγ α α β α α β α α− − ∈ − − + − −⎡ ⎡⎢ ⎢⎣ ⎣).  our  results  show  that  firms  producing  official  digital  goods  may  benefit  from  the  existence of peer‐to‐peer networks. moreover, suitable quality‐based strategies have to be set  up,  by  taking  into  account  the  degree  of  openness  that  peer‐to‐peer  communities  may  exhibit. in the case of the digital goods firm, the commercial losses the file‐sharing activity  may generate result from the setting up of quality‐based strategies that do not cope with the  level of community‐based utility that file‐sharers may get from peer‐to‐peer networks. thus,  we point out that commercial benefits may be generated from surrounded activities (e.g., the  file‐sharing activity) provided that appropriate strategies are delivered.       economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   32 the impact of file‐sharing on the profitability of hardware goods producers  from  ( )11  and  ( )19 , we find that the effect on the file‐sharing activity on the level of  profit of the producer of hardware goods is as follows:    ( )[ ] ( ) ( )[ ] ( )2 2* * *, 2 36 9 4h h p p h la c aπ π π δ αβ α β γ β αδ = − = − − − − −⎡ ⎤⎣ ⎦                   ( )22   from( )22 , our mathematical analysis aiming at identifying the – positive or negative –  nature of the expression of  *hπδ  provides the following results.    lemma 4. the file‐sharing activity may positively or negatively influences the profitability of the  hardware goods firm. the nature of such an influence depends on the quality of both official and pirate  digital goods (i.e., α  and β ), as well as the degree of openness of the peer‐to‐peer community.  more precisely, we find that the introduction of peer‐to‐peer networks enhances the level  of profit of the producer of hardware goods:  • both when  the quality provided by  the official digital goods producer  is high‐ leveled  compared  to  that  of  pirate  digital  goods  (i.e.,  ( ) ( )( )2 29 4a aα α β β− > − ) and when the degree of openness of the peer‐to‐ peer  community  is  high‐leveled  (i.e.,  ( ) ( ) ( )( ) ( )218 144 18 ;lc a aγ α β αβ α α− − ∈ − − + − +∞⎤ ⎡⎥ ⎢⎦ ⎣ );  • when the quality provided by the official digital goods producer is low‐leveled  compared  to  that  of  pirate  digital  goods  (i.e.,  ( ) ( )( )2 24 9a aβ β α α− > − ),   whatever the degree of openness of the peer‐to‐peer community is high‐leveled is.  nevertheless, we also find that there exist settings  in which the file‐sharing activity  is  detrimental to that of the hardware goods firm. indeed, negative externalities are likely to  appear both when the quality provided by the official digital goods producer is high‐leveled  compared to that of pirate digital goods (i.e.,  ( ) ( )( )2 29 4a aα α β β− > − ) and when the  degree  of  openness  of  the  peer‐to‐peer  community  is  low‐leveled  (i.e.,  ( ) ( ) ( )( ) ( )20; 18 144 18lc a aγ α β αβ α α− − ∈ − − + −⎡ ⎡⎢ ⎢⎣ ⎣).  similarly  to  the  case  of  the  official  digital  goods  firm,  our  results  show  that  firms  producing  hardware  goods  may  benefit  from  the  file‐sharing  activity.  we  find  that  such  beneficial outcomes depend on the levels of quality of both official and pirate digital goods,  as well as the community‐based benefits that peer‐to‐peer networks provide to their users.  qualitative results and coordination insights  the  following  table  (table  2)  summarizes  the  main  results  we  have  obtained  when  qualitatively  analyzing  the  impact  of  the  file‐sharing  activity  on  the  profitability  of  both  types of producers (i.e., official digital goods firm and hardware terminals firm).             le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     33 table 2. file‐sharing and commercial opportunities        ‘low’ degree of  openness  ‘high’ degree of  openness  ‘low’ official quality   (compared to pirate quality)  * 0oπδ >   * 0hπδ >   * 0oπδ >   * 0hπδ >   ‘high’ official quality   (compared to pirate quality)  * 0oπδ <   * 0hπδ <   * 0oπδ >   * 0hπδ >     from table 2, we find that the strategies led by the official digital goods firm for the file‐ sharing activity to be beneficial for its own activity are somewhat the same that are required  for the producers of hardware goods to  increase their profits. from a qualitative point of  view, we stress that conflicts of interest are not likely to prevail in this framework. moreover,  commercial players, whether they are digital goods producers or hardware goods producers,  have similar interests vis‐a‐vis the file‐sharing activity. indeed, we find that both producers  are likely to apprehend in the same way the ‘official quality’ (i.e., α ) variable and the ‘degree  of openness’ (i.e.,  ( )lc γ− − ) parameter.      discussion and further research  in this paper we have developed a model to analyze the impact of the introduction of  peer‐to‐peer  networks  on  commercial  activities,  by  distinguishing  official  digital  goods  producers  on  the  one  hand  and  hardware  goods  producers  on  the  other  hand.  in  this  framework, we have whether investigated if the diffusion of pirate digital goods is always  detrimental for both producers or if it might improve the level of profit of at least one of  them. when hardware goods are compatible with both official and pirate digital goods, we  have  shown  that  the  degree  of  openness  of  peer‐to‐peer  networks  (i.e.,  the  value  of  the  switching  costs  required  by  users  to  access  peer‐to‐peer  networks  and  use  pirate  digital  goods, as well as the benefits that file‐sharers may derive from community‐based interaction)  has a significant impact on the variation of the level of profits obtained by producers when  the file‐sharing activity is introduced.  starting from a framework in which peer‐to‐peer networks do not exist, we have firstly  stressed that the activity of hardware goods producers are linked to that of official digital  goods producers. moreover, we have pointed out that there exist complementarities – or at  least dependencies – between the activity of the hardware goods firm and the activity of the  official  digital  goods  firm.  in  some  cases,  the  level  of  quality  chosen  by  the  producer  of  official digital goods may incitate the hardware goods firm not to produce.  in a framework in which the file‐sharing activity exists, we have secondly stressed that  several  scenarii  depicting  technological  adoption  schemes  and  shaping  ensuing  market  structures are likely to prevail. yet, a deeper analysis has revealed that only two of these may  occur. in particular, we have pointed out that the official digital goods firm is always able to  sell their products, and that the hardware goods firm is not motivated to crowd the official  digital goods producer  out  of  the market.  in other words,  the hardware goods producer     economic analysis (2011, vol. 44, no. 1‐2, 15‐37)   34 intends to deter non‐adoption patterns while the digital goods producer – fully or partially –  serves the market. as such, contrary to somewhat common beliefs, the file‐sharing activity  does not appear to evict the official digital goods firm and/or the hardware goods firm from  the market.  we have thirdly intended to qualitatively measure the impact of the file‐sharing activity  on  both  types  of  commercial  activities.  we  have  found  that  the  file‐sharing  activity  may  positively  influence the  level of profits of both official digital goods and hardware goods  producers. hence, we have suggested that the losses perceived by the official digital goods  firm  are  likely  to  result  from  the  setting  up  of  inappropriate  quality‐based  strategies  according to the degree of openness that file‐sharing networks may deliver. interestingly, we  have  underlined  that  conflicts  of  interest  between  official  digital  goods  producers  and  hardware terminals producers are not likely to prevail. this result all the more stresses that  the file‐sharing activity may be beneficial for commercial activities, provided that firms set  up suitable strategies to generate gains from such a so‐called ‘outlaw’ activity.  our  results  support  the  setting  up  of  commercial  strategies  that  are  similar  to  those  recently observed, since many producers who used to fight against piracy nowadays exploit  both official and ‘less official’ technological standards to sell complementary material goods.  as such, the diffusion of pirate digital goods has led to the setting up of new commercial  strategies in which piracy is likely to be tolerated as it may enhance complementary sales.  we  have  found  that  innovative  strategies  may  be  considered  by  official  digital  goods  producers  provided  that  file‐sharing  communities  are  likely  to  provide  a  high  level  of  community‐based  benefits  (i.e.,  what  we  have  called  degree  of  openness)  to  their  users.   innovative strategies may be then considered, since the improvement of the quality of official  digital  goods  over  pirate  ones  may  increase  the  level  of  profits  obtained  by  commercial  producers. although  it may seem a priori paradoxal, the file‐sharing activity appears as a  factor stimulating commercial efforts to innovate. in this context, we have pointed out that  the existence of peer‐to‐peer communities which exhibit  low degrees of openness may be  detrimental  to  the  activities  of  commercial  players.  as  a  consequence,  the  setting  up  of  policies  aiming  at  shutting  file‐sharing  platforms  down  should  be  cautiously  considered,  since inappropriate quality‐based strategies led by official digital goods firms may lead to  the decrease of both producers (i.e., official digital goods firm and hardware terminals firm).  peer‐to‐peer networks and commercial producers exhibit  transversal relationships  that  reveal  retroaction  and  interdependence  between  their  activities.  contemporary  business‐ models  should  thus  take  into  account  the  existence  of  the  wide  range  of  digital  goods  available  online  and  their  diffusion  through  both  commercial  and  non‐commercial  distribution channels, notably through peer‐to‐peer networks. the compatibility prevailing  in both official and pirate digital goods is particularly likely to enhance the profitability of  commercial producers in the media industry and to allow the setting up of new commercial  strategies based upon the complementarity existing between immaterial and material goods.  the model we have presented represents – to our knowledge – one of the first attempts to  understand  the  influence of  the peer‐to‐peer networks on commercial activities. we have  intended  to  consider  the  file‐sharing  networks  not  only  as  simple  parallel  distribution  channels, but also as communities whose users derive community‐based utilities from their       le texier, t., et al., peer‐to‐peer networks, ea (2011, vol. 44, no, 1‐2, 15‐37)     35 participation. we have taken into account these two features of the file‐sharing activity to  analyze technological (i.e., digital goods and hardware goods) adoption issues.   the study we have held in this part however presents three limitations that we will deal  with in further contributions. first of all, we have assumed in our model that the users who  adopt pirate digital goods through file‐sharing platforms have the same learning constraints.  one  could  wonder  what  would  happen  if  users  were  heterogeneous  in  their  learning  abilities. although our model provides results aiming at measuring the impact of the file‐ sharing  activity  on  commercial  ones,  our  findings  are  qualitative.  quantitative  analyses  would deliver stronger insights to identify the optimal strategies that official digital goods  firms may set up to increase their profits. such a quantitative approach may evidence the  potential conflicts of  interest between official digital goods  firms and hardware  terminals  firms  that  our  qualitative  results  are  not  able  to  reveal.  by  considering  an  oligopolistic  framework in which several official digital goods producers and hardware goods’ producers  would  evolve,  it  would  be  possible  to  firstly  more  precisely  study  the  role  of  the  compatibility  between  technological  standards  on  commercial  actors’  profitability  and  to  secondly  stress  the  nature  of  the  optimal  industrial  strategies  that  should  be  considered.  such results would enable us to estimate the relevancy of the new strategies that have been  recently implemented by digital goods’ producers, such as the setting up of commercial file‐ sharing  networks  whose  offers  are  limited  to  the  content  of  the  catalog  held  by  each  producer, or the several merging attempts nowadays commonly observed between various  digital goods producers.   we think that the file‐sharing activity and its ensuing industrial economics applications  open relevant  fields  for  future research. one might  investigate  into  these research  tracks,  while others – we hope – will be interested in pondering over this vast and fruitful topic.    appendix: proof of proposition 1  digital goods are produced if the profit of the digital goods producer is positive, that is to  say ( )[ ]( )2* 9 0o oa kπ δ α α= − − ≥ .   such a conditions holds when ( ) ( )22 9 36 81 2 ;o o oa k a k kα δ δ δ∈ + + + +∞⎡ ⎡⎣ ⎣ .     in  a  similar  fashion,  hardware  goods  are  produced  if  the  profit  of  the  hardware  goods  producer is positive, that is to say ( )[ ]( )2* 9 0h ha kπ δ α α= − − ≥   such a conditions holds when ( ) ( )22 9 36 81 2 ;h h ha k a k kα δ δ δ∈ + + + +∞⎡ ⎡⎣ ⎣ .  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zentner, a. (2006) “measuring the effect of music downloads on music purchases”, journal of law and  economics, 49(1): 63–90.        article history:  received:  17 february 2011 accepted:  17 march 2011          ea_2015_1-2 udc: 005:336.761.5(4)"2010/2013 jel: c10, c14, g10, g35 cobiss.sr-id: 216163596 original scientific paper towards and effective financial management: relevance of dividend discount model in stock price valuation mugoša ana1, university of montenegro, school of economics, podgorica popović saša2, university of montenegro, school of economics, podgorica abstract – the aim of this paper is to analyze the relevance of dividend discount model, i.e. its specific form in stock price estimation known as gordon growth model. the expected dividends can be a measure of cash flows returned to the stockholder. in this context, the model is useful for assessment of how risk factors, such as interest rates and changing inflation rates, affect stock returns. this is especially important in case when investors are value oriented, i.e. when expected dividends are their main investing drivers. we compared the estimated with the actual stock price values and tested the statistical significance of price differences in 199 publicly traded european companies for the period 2010-2013. statistical difference between pairs of price series (actual and estimated) was tested using wilcoxon and kruskal-wallis tests of median and distribution equality. the hypothesis that gordon growth model cannot be reliable measure of stock price valuation on european equity market over period of 2010-2013 due to influence of the global financial crisis was rejected with 95% confidence. gordon growth model has proven to be reliable measure of stock price valuation even over period of strong global financial crisis influence. key words: dividend discount model, gordon growth model, stock valuation, european equity market introduction valuation as a strategy is especially crucial in corporate finance whether it is the study of market efficiency, analysis of stock returns, or evaluation of different investments in process of capital budgeting. it is very important to assess current and future company’s profitability in order to estimate its real market value. once the stock value is determined, the investors will be able to decide whether the stock is overvalued or undervalued, which will consequently affect their investment choices and profit opportunities. knowing how to estimate the value of a company and understanding its determinants seem to be prerequisites for making prudent investment decisions. 1 teaching assistant, university of montenegro, school of economics, j. tomasevica 37, suite 415, 81000 podgorica, montenegro, e-mail: ana.mugosa@ac.me (corresponding author) 2 associate professor, university of montenegro, school of economics, j. tomasevica 37, suite 211, 81000 podgorica, montenegro, e-mail: sasap@ac.me 40 economic analysis (2015, vol. 48, no. 1-2, 39-53) company valuation incorporates different goals, such as increasing value by changing financial and dividend policies, investment strategies or creating profitable portfolio that will generate high returns and therefore increase value of money invested. as noticed by damodaran (damodaran, 2006: 3) there are four approaches to valuation: 1. discounted cash flow valuation analysis of asset present value, calculated by discounting its expected future cash flows, at the rate that reflects the risk of future cash flows. 2. liquidation and accounting valuation – valuation of existing assets or business of a firm based on accounting estimates and book values. 3. relative valuation valuation of comparable assets price relative to a common variable, such as earnings, sales and etc. 4. option pricing model an alternative or choice that becomes available with a business investment opportunity. real options can include opportunities to expand and terminate projects if certain conditions arise amongst other options. this paper focuses on discounted cash flows analysis at european equity markets applied on stock price valuation. when considering stock investment, investors can, in general, expect two types of cash flows: dividends and the price at the end of holding period. based on the assumption that stock will be held indefinitely or that the expected price of stock is determined by future dividends, the easiest way to estimate the present value of stock is to discount its expected cash flows or dividends. dividend discount models (ddm) are widely used in practice even though their reliability is often tested. the common application of ddm has been caused particularly by the fact that the investors’ received return was the most incoming form of dividends in the past century. on the other hand, recent studies point out the importance of capital gains on investors’ total returns and the need for method’s combination in valuation process. however, our goal is to analyze whether stable ddm, i.e. this specific form of the gordon growth model (ggm), is reliable in stock valuation of the publicly traded european companies, using the year 2009 as a referent year for stock price estimation. therefore, we posit as follows: ggm cannot be used as a reliable measure of stock price valuation in european equity market over the period of 2010-2013 due to influence of the global financial crisis. the prices are estimated over period of four years, from 2010-2013, and, then, compared to the actual values in that period. computing differences between estimated and actual prices and testing their statistical significance, we will observe whether ggm gives accurate estimates for future value of stocks. the paper is structured as follows: section ii reviews the literature of previous empirical analyses. section iii describes the theoretical approach. section iv explains the data and methodology employed. section v presents empirical results while section vi offers concluding remarks. literature review mid past century, lintner (lintner, 1956) has discovered the importance of dividend interviewing managers from 28 companies and observing that long-term payout ratio was targeted. this means that companies tried to maintain a stable pattern in future cash-flows mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 41 toward shareholder or dividends. brav et al. (brav et al., 2005) widen the study and find that managers do focus on a steady growth rate of dividends rather than a consistent payout ratio. analyzing the bank of montreal over a period of more than 120 year, foerster and sapp (foerster and sapp, 2005) compare the actual share price to the expected price using several of the most commonly used fundamental valuation methods. the results showed that dividend discount model (ddm) and gordon growth or constant growth model (ggm) both perform well at explaining the observed price for one firm that has a long history of paying dividends. these models perform better than commonly used earnings based models. apparently, fundamental analysis can be applied and results in accurate estimates of future stock price or expected returns. the relationship between volatility of earning and abnormal return was widely studied and analyzed in the past century (ou and penman, 1989; lev and thiagarajan, 1993). these studies demonstrated that the analysis of certain fundamental financial signals is very useful in stock price evaluation. abarbanell and bushee (abarbanell and bushee, 1997) find that risky portfolio that is created based on company’s ranking using fundamental information can generate average cumulative abnormal return of 13%. the announcement of future earnings and dividend growth positively affects the present value of stock. shiller (shiller, 1981) and famma and french (famma and french, 1988) argue that the volatility of stock prices is excessive and difficult to be explained by dividends. they state that variations in prices are much more expressed than variations in dividends. even dividend yields are much more prone to volatility than absolute dividends. so the evident problem is that there exists a significant difference between potential dividends and actual dividends, which additionally undermines and challenges the dividend discount models. the first to point out this problem are fama and french (fama and french, 2001). they demonstrate the significant gap between payout ratios at the end of the seventies and at the end of the nineties of the the xxth century (from 67% to 21% on average). these declines were only in a small part affected by company’s characteristics. the scholars explain that possible reasons could be investors will to reinvest earnings or increase in idiosyncratic risk. in the context of dividends payout decline, baker and wurgler (baker and wurgler, 2004) provide an explanation based on behavioral finance. during periods of high dividends fads, the payout ratios are high, whilst in periods of low dividend fads, payer valuations decline. these scholars argue that companies’ dividend policies are synchronized with the periods of fads, and that dividend proxies explain on average 30% of changes in propensity to pay variable. this means that behavioral fads are the first-order determinants of disappearing dividends. deangelo, deangelo and skinner (deangelo, deangelo and skinner, 2004) argue that dividends on aggregate level have not decreased. the dollar supply of dividends does not mimic the trend of the disappearing dividends. the cause of disappearing dividends can be found among smaller companies which represent fewer payers on the market and are not interested in paying dividends. grullon and michaely (grullon and michaely, 2002) reach same results, meaning that payouts to shareholders in the form of repurchases and 42 economic analysis (2015, vol. 48, no. 1-2, 39-53) dividends have not declined. the results are supported by evident growth of repurchases since low changes (us sec, rule 10b-18) for firm repurchasing shares. nevertheless, dividend discount models are widely used as there are variations of basic model. the gap between the potential and actually paid dividends could be narrowed by redefinition of the cash flow paid as dividends including stock buybacks or, even, including earnings as proxies to dividends (damodaran, 2006). theoretical consideration dividend discount model (ddm) the basic principle of dividend discount model is simple stocks trade from which investors expect future cash flows or dividends and expected price in case the stock is being sold. in order to compare the profit and cost of investment, this model uses time value of money to determine the present value of stock (based on discounted value of future cash flows). this generated value is called intrinsic value of stock as it is determined through fundamental analysis without including external factors such as its market value. if an investor buys a stock and holds it for one year, than the value of stock could be calculated as follows: ek pd p + + = 1 11 0 (1) where, d1 – expected dividend at the end of first year, p1 – value of stock at the end of first year, ke – cost of equity. because we do not have infinite required information on expected dividends, the stock is valued in two stages. the first stage determines the value of expected dividends based on available information over analyzed period, and the second stage determines terminal value or the last price. considering both stages, the model can capture the effects of dividends as well as capital gain on stock price (foerster and sapp, 2005). in general, for the period of n years, the value of stock represents the sum of the present value of discounted expected dividends over n years and selling price at end of the nth year: n e n n e n ee k p k d k d k d p )1()1( ... )1()1( 2 21 0 + + + ++ + + + = (2) since the assumption that the expected price is determined by future expected dividends, the present value of stock held by an investor through infinity is: ∑ ∞ = + = 1 0 )1(n n e n k d p (3) mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 43 where, dn – expected dividend per share in period n, ke – cost of equity. as already noticed, the model calculates in a simple manner the present value of stock by using two variables – expected dividends and cost of equity. in order to calculate expected dividends, it is necessary to estimate future growth rates, by which the dividend will increase in the future. the cost of equity can be measured in various ways, but in majority of cases it is derived from capital asset pricing model (capm). different assumptions on dividend future growth caused the formulation of various dividend discount models: • ddm with zero growth • ggm • two and three stage ddm brief explanation of those models follows. dividend discount model with zero-growth basic assumption of zero-growth ddm is that dividends are constant forever with no growth. present value of stock, whose dividends are constant over time, will be equal to the present value of dividends, in perpetuity. if d1 is the constant dividend which is expected to be paid through infinity (d1=d2=….=dn), and if ke is cost of equity, then the present value of stock p0 can be expressed as: ek d p 10 = (4) zero growth model represents the simplest ddm and assumes no inflation, no variation in cash flows, and no change in other external factors influencing future cash flows. dividend discount model with stable growth – the gordon growth model (ggm) assuming that dividends grow at stable rate (rate that can be sustained indefinitely), gordon (gordon, 1959; gordon and shapiro, 1956) formulated the model known as gordon growth model, which can be used to value a firm that is in a stable state. this model evaluates stock prices by using the constant growth of dividends in perpetuity. this means that the stock will be held by the investor indefinitely. therefore, stock price can be valued as follows: gk d p e − = 10 (5) where, d1 – expected dividend one year from now (next period) 44 economic analysis (2015, vol. 48, no. 1-2, 39-53) g – infinite future constant growth rate in dividends ke – cost of equity, where ke > g since the dividend growth rate is constant, it is expected that earnings grow at the same rate as dividends. additionally, a growth rate which is stable has to be less or equal to the growth of gnp. the model implies that the stable infinite growth rate cannot be more than 1% or 2% greater than the growth rate of economy (damodaran, 2004). in case when dividends grow at variable rate or when companies do not pay dividend, then other models must be applied, such as the valuation of free cash flow or residual income as well as twostage or a three-stage model (foerster and sapp, 2006). damodaran (stern nyu 2014) estimates the upper and lower end of stable growth rate by following: upper end: long term inflation rate + growth rate in real gnp lower end: long term inflation rate + growth rate in real gnp damodaran estimates that the lower and upper end for stable dividend growth rate in the us is from 5%-8%, and, if the company is multinational, the real growth rate will be the growth rate of the world economy, which is about one percent higher. the limitation of the model is obvious in that it relies on the basic assumption of stable dividend growth. its assumption is difficult to prove, especially considering cyclical companies with high earnings deviations and volatility. nevertheless, in specific cases when earnings are volatile but dividends on average have a constant growth rate, the gordon’s model could be applied. to summarize, gordon growth model can be reliable in price valuation of companies whose growth rate is less or equal to nominal growth of economy, as well as for companies which have strategically defined future long-term stable dividend policies. two-stage and three-stage dividend discount model when companies are unable to meet the assumption of stable dividend growth, stock can be valued using techniques of two or three-stage dividend growth (damodaran, 2004). these models can be applied on companies that grow by certain, in most cases, higher rate in initial phase and have a stable growth rate in subsequent long-term period. two-stage dividend discount model can be defined as follows: value of the stock = pv of dividends during extraordinary phase + pv of terminal price, or n hge n s t s hge s k p k d p )1()1( ,1 , 0 + + + = ∑ = , where n nsge n n gk d p )( , 1 − = + (6) where, ds = expected dividends per share in year s, ke = cost of equity (hg: high growth period; st: stable growth period), pn = price (terminal value) at the end of year n, mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 45 g = extraordinary growth rate for the first n years, gn = steady state growth rate forever after year n. unlike classical two-stage growth model, the h-model was derived by fuller and hsia (fuller and hsia, 1984), where the initial period is characterized by decline in growth rate and than follows a stable pattern in a steady state over the long-term period. the three-stage dividend discount model represents a combination of two-stage and h-model, providing that company has high growth in initial phase, decline in rate in transition period and, afterward, a stable rate in the last phase (infinity). the limitations of these models are determined by the question of how to define the length of initial growth phase; by the sudden transformation of initial growth rate to stable rate; and by cases of companies retaining profit and paying lower dividend in certain phases. in that context, these models can be suitable for companies that have modest growth rates that can be easily transformed to stable rates; companies that pay the majority of free cash flow to equity (fcfe) to shareholders; or companies that are specific and expected to grow higher in initial phase and be moderately stable afterwards. data and methodology we analyzed firm-level data of 4,788 publicly traded companies on the european equity market off of the new york stern university website (stern nyu 2014). due to the lack of data on dividend per share paid, 2009 was used as referent year for price estimation. the prices were estimated starting from year 2010 up to year 2013. the aim of this paper is to analyze whether gordon growth model (ggm) is reliable in stock valuation, comparing the estimated with the actual stock price values and testing the statistical significance of price differences. statistical difference between the two price series (estimated and actual) is tested using the tests of equality (equality of average value and variance). in order to apply ggm, total available number of companies was reduced by excluding companies following the criteria: • bank, financial, insurance, reinsurance and real estate companies, due to global financial crisis, • where ke< g, • with dividend yield = 0% , and • with g < 0 (payout ratio > 100%). after following these criteria, we end up with the sample of 199 companies. cost of equity is estimated using capm – the required return equals risk free rate increased by the product of company’s beta and market premium. risk free rate of 3.68% represents ecb 10 year aaa-rated euro area central government bonds issued in 2009, whilst the market premium risk in 2009 amounted 5.2% (european central bank, 2014). using companies’ individual betas from the damodaran’s database, we generated ke for each single company from the sample. in gordon’s model, payout ratios of dividend paying companies tend to be stable, which means that growth rate of dividend g equals growth rate of earnings. earnings will increase when a portion of net earnings is retained and when companies invest. this results in 46 economic analysis (2015, vol. 48, no. 1-2, 39-53) conclusion that growth rate of earnings, and therefore dividends, is a function of retention ratio (1 – payout ratio) and return on retained earnings (rore). because the details of future investment projects are not publicly available, it is difficult to estimate the ratio of return on retained earnings. therefore, it is often assumed that the future projects will have the same expected rate as those from previous years. in that case, the expected project rate can be estimated using historical data of return on equity (ross, westerfiled and jaffe, 2002). dividend growth rate is estimated as product of return on equity (roe) and retention ratio: g = roe * retention ratio (7) again, using companies’ individual roe rates and retention ratios from the damodaran’s database, we generated gfor each single company from the sample. calculating the corresponding cost of equity ke and dividend growth rate g, and discounting the initial dividend from the year 2009, the gordon growth model was applied in price estimation for the period of 2010-2013. table 1 reports the descriptive statistics of estimated firms’ prices from the sample. from the results, it is evident that the data time series does not have normal distribution, which, consequently, implies the use of nonparametric tests of time series equality – wilcoxon signed-rank test and kruskal–wallis tests. table 1. descriptive statistics of estimated an actual prices in observation period 2010-2013 p1e p2e p3e p4e p1a p2a p3a p4a mean 93.07947 99.73328 106.9354 114.7341 42.39884 31.15342 36.90675 45.23538 median 9.963856 10.40862 11.07812 11.79068 13.01000 9.800000 10.44000 13.40000 maximum 4183.969 4619.661 5100.722 5631.878 1814.500 1080.560 1423.490 1387.260 minimum 0.002846 0.003006 0.003175 0.003354 0.043000 0.047000 0.037000 0.090000 std. dev. 382.4551 415.7875 452.4644 492.8274 141.2007 87.77031 110.2661 115.2178 skewness 7.968668 8.138462 8.311607 8.487132 10.45366 9.283313 10.33518 8.543701 kurtosis 76.12060 79.49674 82.96460 86.50087 127.5103 106.2840 127.6493 95.17107 jarque-bera 46438.48 50717.55 55310.96 60201.82 132168.5 91310.29 132374.2 72862.90 probability 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000 sum 18522.81 19846.92 21280.15 22832.08 8437.369 6199.530 7344.444 9001.840 sum sq. dev. 28961832 34230091 40535361 48090019 3947653. 1525318. 2407405. 2628477. observations 199 199 199 199 199 199 199 199 wilcoxon two-tailed signed-rank test is applied when comparing two series or populations with paired observations. this test is an alternative to paired t-test in cases when mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 47 data time series and the differences between observations are not normally distributed. wilcoxon test does not only incorporate the sign differences analysis, but also tests their magnitude. this process is done by considering the ranks of these differences. the null and alternative hypotheses of wilcoxon signed-rank test are defined as follows: h0: µa-µe = 0, or the median difference between populations is zero h1: µa-µe ≠ 0, or the median difference between populations is not zero suppose we have independent and identically distributed data x1, x2, . . .,xn from some symmetric continuous distribution. then, the assumptions of wilcoxon non-parametric test are (taheri and hesamina, 2013): • independence of differences (i.e., changes in prices are mutually independent) • identical distribution (the data are paired and come from the same population) • continuity (the continuity assumption assures that ties are impossible, and is • necessary for the point estimate and confidence interval) • symmetry. in order to calculate the wilcoxon t statistic, the difference d is calculated for each pair of data (d=x1-x2). the second step involves the rank of differences absolute values. in the next step, the ranks of the positive and negative differences are summed. the wilcoxon t statistic is defined as the smaller of the two sums of ranks (aczel, 1999: 689): (8) where, ∑(+) is the sum of the ranks of the positive differences and ∑(-) is the sum of the ranks of the negative differences decision rule: if the test statistics t is less than the critical point from the table, for a given level of significance, the null hypothesis is rejected. the kruskal-wallistest represents a non-parametric alternative to one-way anova in cases when the data time series and the differences between observations are not normally distributed. this test is an analysis of variance, using ranks of the observations rather than the data themselves. it is possible to conduct it under the assumption that the measurement scale is an interval and that populations are continuous (meyer and seaman, 2011). the null and alternative hypotheses for k population of the kruskal-wallis test are defined as follows: h0: µa-µe = 0, all k populations have the same distribution h1: µa-µe ≠ 0, not all k populations have the same distribution the kruskal-wallis h statistics is given by the following formula (aczel, 1999: 696): 48 economic analysis (2015, vol. 48, no. 1-2, 39-53) (9) decision rule: if the h statistics is too large, exceeding the critical point for a given level of significance, the null hypothesis is rejected. empirical results in order to test the reliability of ggm, the research hypothesis was defined as follows: gordon growth model cannot be reliable measure of stock price valuation in european equity market over period of 2010-2013 due to influence of the global financial crisis. our expectations are negative, taking into consideration that the global financial crises (gfc) started in 2008 and that our referent estimation year was one year after the crisis. the effects of gfc were the highest one year after. when we consider the effects of gfc, we assume several changes: • decline in free cash flow to equity value, • decline in dividends value, • decline in payout ratios, • decline in dividend and earnings growth rate, • decline in market capitalization, • increase in risk premium of securities, • increase in market premium of securities. the summary of empirical results, with probabilities assigned to each test by the observation period 2010-2013, is given in the next table. table 2. summary of empirical results, 2010-2013 method probability (p-values) 2010 2011 2012 2013 wilcoxon/mann-whitney 0.4167 0.4162 0.7657 0.5646 wilcoxon/mann-whitney (tie-adj.) 0.4167 0.4162 0.7657 0.5646 med. chi-square 0.2701 0.9201 0.9201 0.6162 adj. med. chi-square 0.3161 1.0000 1.0000 0.6884 kruskal-wallis 0.4164 0.4159 0.7653 0.5643 kruskal-wallis (tie-adj.) 0.4164 0.4159 0.7653 0.5643 according to the assessed probabilities, shown in table 2, and corresponding t and h statistic of the wilcoxon signed-rank and kruskal-wallis test (see appendice, a-1, a-4), we accept the null hypothesis with 95% confidence (α=5%) and conclude that there is no statistically significant difference between the estimated and actual prices medians and distribution over observation period 2010-2013. mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 49 concluding remarks reliability of gordon growth model in stock price valuation is confirmed on the sample of 199 publicly traded eu companies. referent year 2009 was chosen due to the lack of data on dividend per share paid. gordon growth model showed to be reliable measure of stock price valuation even over period of strong global financial crisis influence. our confirmation of these results relies on two assumptions: • first, only 11.5% of the companies from the sample have the growth rate greater than 8%. this means that the growth rate of the majority of the companies is inside the interval of damodaran’s lower and upper end for stable growth (5%-8%). the first assumption may make us conclude that the majority of companies from our sample represent mature companies with stable growth and high payout ratio. • second, as discussed in literature review, dividends were representing major cash flow and return to shareholders in the xxth century and these models performed better than commonly used earnings based models. we assume that this trend continues in the xxist century and, therefore, it is reliable to measure stock prices using different types of dividend discount models. finally, as our focus on assessment of the model was the stable dividend growth rate, further research could involve analysis of the reliability of gordon growth model by taking into account firms with stable leverage and beta over time; firms that pay out dividends that are high and come close to free cash flow to equity. references abarbanell, jeffrey and brian bushee. 1997. “fundamental analysis, future earnings, and stock prices”, journal of accounting research, 35(1): 1-24. aczel, amir. 1999.complete business statistics. mcgraw-hill international editions, fourth ed. baker, malcolm and jeffrey wurgler. 2004. “appearing and disappearing dividends: the link to catering incentives”, journal of financial economics, 73(2): 271–288. brav, alon, john r. graham, campbell r. harvey and roni michaely. 2005. “payout policy in the 21st century”, journal of financial economics, 77(3): 483-527. damodaran, aswath. 2004.damodaran on 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pp.1-49. foerster, stephen r. and stephen g. sapp. 2005. “the dividend discount model in the long-run: a clinical study”, journal of applied finance, 15(2): 55-75. fuller, russell j. and chi-cheng hsia. 1984. “a simplified common stock valuation model”, the financial analysts journal, 40(5): 49-56. gordon, myron j. 1959. “dividends, earnings and stock prices”, the review of economics and statistics, 41(2): 99-105. gordon, myron j. and eli shapiro. 1956. “capital equipment analysis: the required rate of profit”, management science, 3(1): 102–110. grullon, gustavo and roni michaely. 2002 “dividends, share repurchases, and the substitution hypothesis”, journal of finance, 57(4): 1649–1684. lev, baruch and ramu s. thiagarajan, s. r., 1993, “fundamental information analysis”, journal of accounting research, 31(2): 190-215. lintner, john. 1956. “distribution of incomes of corporations among dividends, retained earnings and taxes”, the american economic review, 46(2): 97-113. meyer, patrick j. and michael a. seaman. 2013. “a comparison of the exact kruskal-wallis distribution to asymptotic approximations for all sample sizes up to 105”, journal of experimental education, 81(2): 139-156. new york university stern, http://people.stern.nyu.edu/adamodar/new_home_page/data.html (accessed april 13, 2014) new york university stern, http://people.stern.nyu.edu/adamodar/pdfiles/ddm.pdf (accessed april 29, 2014) ou, jane a. and stephen h. penman. 1989. “accounting measurement, price-earnings ratio, and the information content of security prices”, journal of accounting research, 27(supplement): 111-144. ross, stephen a., randolph w. westerfield, r. and jeffrey jaffe. 2002.corporate finance, mcgraw-hill, 6th edition. shiller, robert j. 1981. “do stock prices move too much to be justified by subsequent changes in dividends?”, the american economic review, 71(3): 421-436. taheri, mohmoud s. and gholamreza hesamian. 2013. “a generalization of the wilcoxon signed-rank test and its applications”, statistical papers, 54(2): 457-470. mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 51 appendix: detailed empirical results, 2010-2013 table a-1. statistical tests of equality between actual and estimated stock prices, 2010 test for equality of medians between series date: 06/01/14 time: 12:40 included observations: 199 method df value probability wilcoxon/mann-whitney 0.812208 0.4167 wilcoxon/mann-whitney (tie-adj.) 0.812208 0.4167 med. chi-square 1 1.216080 0.2701 adj. med. chi-square 1 1.005025 0.3161 kruskal-wallis 1 0.660389 0.4164 kruskal-wallis (tie-adj.) 1 0.660389 0.4164 van der waerden 1 0.349390 0.5545 category statistics > overall variable count median median mean rank mean score p1e 199 9.963856 94 194.8141 -0.029281 p1a 199 13.01000 105 204.1859 0.029282 all 398 10.82336 199 199.5000 2.95e-08 table a-2. statistical tests of equality between actual and estimated stock prices, 2011 test for equality of medians between series date: 06/01/14 time: 12:43 included observations: 199 method df value probability wilcoxon/mann-whitney 0.813079 0.4162 wilcoxon/mann-whitney (tie-adj.) 0.813079 0.4162 med. chi-square 1 0.010050 0.9201 adj. med. chi-square 1 0.000000 1.0000 kruskal-wallis 1 0.661806 0.4159 kruskal-wallis (tie-adj.) 1 0.661807 0.4159 van der waerden 1 1.074622 0.2999 category statistics 52 economic analysis (2015, vol. 48, no. 1-2, 39-53) > overall variable count median median mean rank mean score p2e 199 10.40862 100 204.1910 0.051353 p2a. 199 9.800000 99 194.8090 -0.051353 all 398 10.10757 199 199.5000 5.03e-08 table a-3. statistical tests of equality between actual and estimated stock prices, 2012 test for equality of medians between series date: 06/01/14 time: 12:44 included observations: 199 method df value probability wilcoxon/mann-whitney 0.298042 0.7657 wilcoxon/mann-whitney (tie-adj.) 0.298042 0.7657 med. chi-square 1 0.010050 0.9201 adj. med. chi-square 1 0.000000 1.0000 kruskal-wallis 1 0.089089 0.7653 kruskal-wallis (tie-adj.) 1 0.089089 0.7653 van der waerden 1 0.211050 0.6459 category statistics > overall variable count median median mean rank mean score p3e 199 11.07812 100 201.2211 0.022758 p3a 199 10.44000 99 197.7789 -0.022758 all 398 11.01800 199 199.5000 2.98e-07 table a-4. statistical tests of equality between actual and estimated stock prices, 2013 test for equality of medians between series date: 06/01/14 time: 12:45 included observations: 199 method df value probability wilcoxon/mann-whitney 0.576040 0.5646 wilcoxon/mann-whitney (tie-adj.) 0.576040 0.5646 med. chi-square 1 0.251256 0.6162 adj. med. chi-square 1 0.160804 0.6884 kruskal-wallis 1 0.332324 0.5643 kruskal-wallis (tie-adj.) 1 0.332324 0.5643 van der waerden 1 0.160077 0.6891 category statistics mugoša, a., et al., towards an effective financial management, ea (2015, vol. 48, no. 1-2, 39-53) 53 > overall variable count median median mean rank mean score p4e 199 11.79068 97 196.1759 -0.019818 p4a 199 13.40000 102 202.8241 0.019822 all 398 12.03400 199 199.5000 1.82e-06 prema efektivnom finansijskom menadžmentu: relevantnost modela diskontovanja dividendi u vrednovanju akcija rezime – cilj rada je analiza relevantnosti modela diskontovanja dividendi, tj. njegove specifične forme u procjeni vrijednosti akcija poznate kao gordonov model rasta. očekivane dividende mogu predstavljati mjeru slobodnih novčanih tokova prema akcionarima. u tom kontekstu, model je koristan u ocjeni uticaja faktora rizika, kao što su kamatne stope i stope inflacije, na cijene akcija. procjena vrijednosti primjenom ovog modela je veoma važna za investitore orjentisane na vrijednost kompanije , tj. isplatu očekivanih dividendi. na uzorku od 199 javno trgovanih evropskih kompanija, u periodu od 2010.-2013. godine, upoređene su ocijenjene i stvarne cijene i testirana je statistička značajnost njihovih razlika. testiranje razlika parova cijena (stavrnih i ocijenjenih) je izvršeno primjenom wilcoxon i kruskal-wallis testova jednakosti srednjih vrijednosti. hipoteza da gordonov model rasta ne može biti pouzdan u procjeni vrijednosti akcija na evropskom tržištu kapitala, u periodu od 2010.-2013. godine, zbog uticaja globalne finansijske krize, je odbačena u intervalu povjerenja od 95%. rezultati su pokazali da je gordonov model rasta pouzdan u procjeni vrijednosti akcija, čak i u periodu jakog uticaja globalne finansijske krize. ključne reči: model diskontovanja dividendi, gordonov model rasta, vrednost akcija. evropsko tržište akcija article history: received: 12 may, 2015 accepted: 8 june, 2015 microsoft word ea_2020_2_final.docx doi: 10.28934/ea.20.53.2.pp109-120 scientific review western balkan countries as an attractive investment destination darko marjanović1* | mihajlo đukić1 1 institute of economic sciences, belgrade, serbia abstract foreign direct investments are potentially very important for each country as they could significantly contribute to its economic development. the importance of foreign direct investments reflects in their ability to contribute to development of comparative advantages and competitiveness. in the last 20 years, wb countries have tried to attract as many foreign investors as possible using various policy incentives. foreign direct investment inflows followed the pace of economic transformation and reforms towards a market economy, leading to economic growth. the aim of this paper is to analyse characteristics of the inflow of foreign direct investments in the western balkans (wb) countries, as well as the impact they might have on their economic growth and development. in order to determine the amount of foreign direct investments, but also the position, i.e. competitiveness of each of the observed countries, there have been used secondary data from the official unctad reports. the paper will also present an analysis of the greenfield investments for selected economies, as a very important type of foreign investments that probably have the largest positive spillovers. the time period covered by this research was from 2010 to 2019. the results of the conducted research indicate that serbia is the most attractive investment destination, considering that in the observed period, more than 60% of the total amount of foreign direct investments that were directed to the countries of the western balkans ended up on its territory. key words: foreign direct investments, western balkans, investors, economic development jel classification: f21, p33, p45 introduction in the single european union market, characterized by fierce competition and free movement of capital, labor, goods and services, member states and international organizations strive to create the most competitive economic environment. in that context, tax policy instruments are very important. the realization of comparative advantages by using tax policy instruments was especially obvious at the beginning of the 21st century, when the new members from eastern europe joined the european union, and the „race“ in attracting foreign investments additionally intensified. in line with the accession of these countries to the european union, the issue of tax competitiveness shifts to the countries of the western balkans (albania, bosnia and herzegovina, montenegro, north macedonia and serbia) that remained outside the european union. all these countries generally do not have sufficient domestic capital, and therefore not enough investments to stimulate economic activity. this is one of the main reasons to explain * corresponding author, e-mail: darko.marjanovic@ien.bg.ac.rs 110 economic analysis (2020, vol. 53, no. 2, 109-120) why these countries strived to be as much competitive as possible, since they will be in a position to attract foreign investors not only from europe, but from all over the world as well. the competitive economic environment of a country is a clear investment signal for multinational companies. favourable environment results with larger amount of investments and consequently leads to the opening of new production facilities as well as the employment of the local labor force. factors often present in transition and less developed countries and particularly beneficial for the foreign capital are, above all, the high unemployment rate as well as privatization which has led to the closure and restructuring of a large number of companies. high unemployment rate sometimes leads to lower labor costs, whereas destroyed local companies cannot be enough strong competition for large multinational businesses. all of the aforementioned favours foreign capital. countries that have gone through the transition towards market economies are in a position to attract foreign capital with low tax rates, trying at the same time to eliminate high unemployment rate, increase gdp, etc. (feld, 2005). the most important factors that guide multinational companies in deciding which country to invest in are lower income tax and income tax rates (donath & slavin, 2009). fdi accumulation in the western balkans has been associated with an increase in production given that multinational companies usually have better operational solutions and know-how that transfer to the targeted economies. in this case, multinational companies can benefit not only from the increased revenues but also from increased production and efficiency. fdi are often based on the new innovative technologies educating employees for the particular business, and bridging the gap between developed and developing countries. fdi contribution often results in the promotion of foreign trade, given that increased efficiency, economy of scale and product quality will contribute to greater export opportunities for domestic companies, previously unable to participate in foreign markets. a favorable investment climate is very important for all investors in these countries, given that the state, when creating an adequate investment climate for foreign investors, also provides domestic companies with additional opportunities and support. literature review foreign direct investments are very important form of international capital movements, significantly influencing national economic development (musabegović et al., 2015). the western balkans could be an attractive investment destination in the following period (sanfey et al., 2016). for that to happen, it is necessary for these countries to increase their production, export and achieve overall economic stability (domazet & marjanović, 2017a). foreign direct investments might significantly contribute to the economic growth, reduce unemployment and result in inflow of new technologies (zdravković et al., 2017). foreign direct investments are one of the factors of success of the national economy in the global market (marjanović & domazet, 2018). although decisions related to fdi inflows/outflows are primarily an economic consideration driven by market forces, they are also deeply shaped by the economic, political, and legal rules governing investment in the host country (meunier, 2017). one of the main tasks for the western balkans countries is to attract as much foreign direct investment as possible. it is very important that there is available, but not limitless capital on the world market, which lead to countries competing with each other for investors and their capital (marjanović, 2018; stošić et al., 2011). the country features such as size, openness, skill levels, and institutional stability not only set the pace of fdi, but that they also influence both the network structure and the power positions of each node (bolivar et al., 2019). the findings of research paul & jadhav (2019) indicate that infrastructure quality, trade cost measured by tariff and non-tariff barriers, institutional quality measured by effective rule of law, political stability, regulatory quality and control on corruption are significant determinants of fdi in emerging markets. darko marjanović, mihajlo đukić 111 if state aims to be an attractive destination for foreign investors, it is necessary for tax policy makers to pay special attention to tax rules. precisely these rules and the adopted measures in the field of tax policy will significantly influence the decision of investors to invest capital (domazet & marjanović, 2018). tax incentives tend to attract efficiency-seeking fdi motivated by lowering production costs than other types of investment. developing country governments can take unilateral steps to use tax incentives in a more targeted and cost-efficient manner by (1) targeting incentives at those investors whose decision to invest is most likely swayed by incentives and (2) improving the design, transparency, and administration of incentives to reduce indirect costs and avoid unintended consequences (andersen et al., 2018). in the process of globalization, states are trying to reduce tax rates and / or expand tax bases with an aim to attract foreign capital. this is also called a "race to the bottom", which is based on two predictions: (a) multinational companies invest in countries that do not have high standards and grant additional benefits to investors, (b) countries undermine each other's standards to achieve the main goal and that is attracting foreign capital (olney, 2013). according to cazzavillan & olszewski (2012), non-financial fdi is positively affected by financial services fdi and by market potential and fdi crowds out domestic investment in the manufacturing sector. according to li & tanna (2019) fdi has a strong and positive impact on tfp (total factor productivity) growth after accounting for the roles of human capital and institutions. institutions are found to be more important than human capital in realizing productivity gains from fdi. if the western balkans countries succeed in attracting foreign investors, it will automatically mean that the state has provided a safer and more favorable economic environment in the country compared to competitors (domazet & marjanović, 2017b). however, it does not necessarily mean that the fdi will result in economic development. western balkan countries generally have a certain level of skills and knowledge, which might contribute to a higher inflow of foreign direct investment in these countries. this could also lead to the growth and development of the host countries and result in increase of the country's competitiveness as well (redžepagić & richet, 2008). corruption is one of the major issues the western balkans is facing, challenging both domestic and foreign companies in doing business. according to zeneli (2015), high levels of corruption negatively affect the economic development of the western balkans countries. corruption is negatively correlated with the level of income, given that a higher level of corruption affects the reduction of per capita income. it also negatively affects the current account balance, stimulate tax evasion, reduce competitiveness, also discouraging innovation activities. analyzing the inflow of foreign direct investments, đukić and bodroža (2011) come to the conclusion that all western balkan countries should invest more efforts in solving potential problems that might negatively affect the attraction of greenfield investments, since these investments can significantly contribute to the development of these economies. data analysis and findings western balkan countries still lag behind developed eu economies in terms of their overall economic development. they cannot obtain sufficient capital from the internal sources of their own accumulation. therefore, fdi represent very important channel of capital accumulation for these countries. one of the main goals for these countries is to attract as much foreign capital as possible bridging the gap between available and desired amount of investments. inflow of the new investments is supposed to have significant impact on their economic growth. 112 economic analysis (2020, vol. 53, no. 2, 109-120) fdi in the western balkan countries over the last ten years, fdi in the western balkan economies has been mainly focused on the manufacturing sector, which recorded significant improvement in productivity and the profitability if compared to the previous period. this is one of the reasons behind the transfer of resources from the industrial sector with small comparative advantages, towards industrial sectors that may have comparative advantages comparing to more competitive regions, primarily neighbouring balkan countries. there are numerous reasons why companies seek to expand their business to other countries, with particular emphasis on (a) lower operating costs, (b) availability of raw materials, (c) cheaper labor, (d) avoidance of customs and other export costs when exporting to targeted markets, (e) lower transport costs, (f) takeovers of companies direct competitors operating in targeted markets, etc. fdi has had a significant impact on catch-up processes in developing countries. western balkan countries (albania, bosnia and herzegovina, montenegro, north macedonia and serbia) are also the ones that might experience economic benefits from the fdi inflow. the aim of this paper is to present recent trends in the fdi inflow, as well as to explore the impact of fdi on the development of selected economies. in addition, the paper will present an analysis of greenfield investments (amount and total number of implemented projects). the analysis covered the period from 2010 to 2019. data from the official united nations conference on trade and development (unctad) were used. table 1. fdi inflows in western balkan countries, 2010-2019. (millions of us dollars) country 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 albania 1 050 876 855 1 265 1 111 945 1 100 1 148 1 289 1 281 bosnia and herzegovina 406 496 394 276 550 361 349 449 472 528 montenegro 760 558 619 447 497 699 226 558 489 452 north macedonia 212 478 142 335 272 240 374 205 725 365 serbia 1 686 4 932 1 298 2 053 1 998 2 347 2 352 2 878 4 127 4 280 source: unctad (2020) over the period from 2010 to 2019, about $ 51,805 million of foreign direct investments entered the western balkan region. the main sources of the attracted investments are the eu countries, china, russia and the usa. table 1. shows that 2012 was extremely unfavorable in terms of attracted investments. as a result of the reduced fdi inflow, it was hard to achieve strong economic growth in the period after 2012. however, since 2013 it could be noticed relatively favorable trend in fdi, particularly in serbia and albania. by conducting stimulative fiscal policy towards foreign investments, serbian authorities have created a relatively competitive economic environment, which resulted in positive results measured in the amount of attracted foreign capital. if we consider the overall level of investments in the western balkans, it could be noted that serbia has significantly larger inflows of foreign direct investment if compared to other countries in the region. if per capita fdi are taken into account, montenegro takes the first position followed by serbia and albania. however, the western balkans region lags significantly behind eu countries in terms of fdi inflows per capita. average fdi stock per capita in the western balkans is around €2,600 while in the european union it is around €14,300 (sanfey et al., 2016). darko marjanović, mihajlo đukić 113 figure 1. fdi inflows in western balkan countries, 2010-2019. (millions of us dollars) source: authors based on the unctad (2020) the largest single recipient of the regional fdi is serbia, which received about $27,951m in the analysed period, which is 54% of the total amount of foreign direct investment that ended up in the western balkans. it is followed by albania with $10920m (21%), montenegro with $5305m (10%), bosnia and herzegovina with $4281m (8%) and north macedonia with $3348m (7%). at first glance, it can be concluded that in the observed period, out of the total amount of fdi attracted, more than half arrived in serbia. this is not surprising, since besides the fact that serbia is the largest economy in the region, serbian policy makers put special emphasis on creating conditions for attracting foreign investors. other countries received much less fdi in relative terms if compared to serbia. figure 2. share of fdi attracted by western balkan countries (2010-2019), in % source: authors based on the unctad (2020) in the first half of 2019, compared to the same period 2018, fdi fell by 1 percentage point. however, we inflow of fdi to the countries of the western balkans is still solid, mostly due to the favourable geographical location, relatively cheap and skilled labour as well as lower labour costs. the contributions of foreign direct investment (fdi) to the western balkan economies have been relatively important over the last years, providing support for economic growth, job creation, innovation and technological progress. eu companies are the biggest investors in the western balkans: over €10 billion of foreign direct investments in the past five years. 114 economic analysis (2020, vol. 53, no. 2, 109-120) western balkan countries are not yet members of the european union which, to a certain extent, can be a limiting factor for attracting foreign investors. if the total fdi inflow in the eu countries with the total fdi inflow in the western balkans is compared, we can derive conclusion that western balkan countries significantly lag behind in terms of fdi inflow compared to eu. table 2. fdi inflows, 2010-2019. (millions of us dollars) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 european union 394082 488712 397392 366738 312030 645445 591331 465076 415116 446896 wb countries 4114 7340 3308 4376 4428 4592 4401 5238 7102 6906 source: unctad (2020) although the share of fdi in the western balkans has increased significantly in the recent years, it is still insufficient compared to other eu countries. if the inflow of fdi in eu countries is compared over the same period, it could be noted that the western balkan countries receive between 0.7 and 1.8% of the total fdi recorded in the eu countries. figure 3. foreign direct investment in western balkan countries, net inflows (% of gdp) source: world bank data url: https://data.worldbank.org/indicator/bx.klt.dinv.cd.wd the contributions of foreign direct investment (fdi) to the western balkan economies have been relatively sizeable over the last years (figure 3), providing support for economic growth, job creation, innovation and technological progress. greenfield investments in the western balkan countries one of the most important sources of business development of multinational companies refers to investing in other regions, i.e. other countries. it is motivated by a legitimate interest aimed at ensuring economic benefits and increasing profits. by entering foreign markets, they have the opportunity to invest capital in one of the following ways: (a) greenfield investments, (b) m&a (merger and acquisition) and (c) joint ventures. the most common form of foreign investment is through greenfield investments. this form of investment is typical for companies that invest their own capital in a foreign country, where they do not have pre-built infrastructure, space or labor force for their business. therefore, to have the characteristics of a greenfield investment, the company has to build completely new plants and facilities, and agreed darko marjanović, mihajlo đukić 115 location in the specific market, to activate a new business as a new market player, to enrich the offer of products and services in the target market, as well as to hire new workers. table 3. number of announced greenfield fdi projects in western balkan countries, 2010-2019. country 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 albania 6 8 12 4 6 5 2 3 6 5 bosnia and herzegovina 23 30 29 31 21 25 16 26 29 28 montenegro 10 6 7 9 8 4 3 2 17 10 north macedonia 15 26 31 27 32 20 20 11 13 10 serbia 79 111 113 125 79 75 86 112 157 114 source: unctad (2020) over the period between 2010 and 2019, the largest share of greenfield investments arrived in serbia. other western balkan countries have recorded significantly lower share of greenfield investments. the reason for this lies in the fact that serbia has significantly improved its policy towards greenfield investments, which has been also recognized by foreign investors. figure 4. share of greenfield investments in western balkan countries (2010-2019), in % source: authors based on the unctad (2020) out of the total number of greenfield investments attracted by the western balkan economies, serbia leads with 64%, whereas in other countries there were significantly lower amount of this type investments. serbia is followed by bosnia and herzegovina (16%), and by north macedonia (12%), while the other two countries have a very small number of these investments (montenegro 5%, albania 3%). table 4. value of announced greenfield fdi projects, by destination, 2003-2019. (millions of us dollars) country 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 albania 58 431 302 62 51 139 36 12 188 183 bosnia and herzegovina 291 1 235 1 210 888 975 3 140 936 552 701 558 montenegro 510 388 343 850 1 136 44 615 47 1 988 582 north macedonia 414 811 966 555 854 342 291 111 855 237 serbia 3 710 3 785 4 387 4 006 1 977 4 470 2 068 3 842 6 699 4 172 source: unctad (2020) 116 economic analysis (2020, vol. 53, no. 2, 109-120) many companies have recognized the western balkans as an ideal place to invest their capital. hence, it is not surprising that a significant amount of greenfield investments in the last decade arrived in these countries, where serbia stands for the largest recipient. during 2018, the western balkans recorded the largest inflow of greenfield foreign direct investments over the observed period 2010-2019, amounting to approximately $ 9 billion. although western balkans have attracted significantly fewer greenfield fdi projects than other countries in central, eastern and western europe, the region's performance has been relatively solid if the share of global gdp is considered. serbia attracts almost 12 times more foreign investments compared to similar economies of its size. the main reasons for such a significant attraction of fdi lies in the economic incentives, solid labor force and relatively generous tax policy, but also trade agreements and other political agreements signed with other countries. discussion western balkan countries use different strategies aiming to attract fdi. it is very important to create a good investment climate, and one of the prerequisites for creating favorable business environment is the adequate tax policy. the establishment of investor support agencies as well as the conclusion of bilateral agreements related to capital investment can significantly contribute to the opening of the market for foreign investors resulting in capital inflows. therefore, fdi could be a significant source of economic development, modernization, growth of production, exports and employment. since the early 1990s, albania experienced a steady inflow of the fdi. choosing albania as an investment destination provides foreign investors with significant competitive advantages over the neighbouring balkan countries geographical location, low tax burden, very cheap labor as well as natural resources (oil, gas, copper, iron, chromium), including solid penetration of the regional market. in recent years, the albanian government has aimed to increase the inflow of fdi through tax reform. measures have also been taken to improve the overall business climate in the country by improving business procedures as well as undertaking comprehensive structural reforms, primarily in legislation while reducing the fiscal burdens. albania offers equal treatment to foreign and domestic investors, but has also signed bilateral agreements aiming to promote and protect investments. the focus of the policy makers in the future period should be to attract foreign direct investments in sectors where the potential of the albanian economy has not been exploited, particularly in exploitation of the natural resources, development of tourism and the agribusiness sectors. although bosnia and herzegovina has competitive tax rates compared to other western balkan countries, the level of foreign direct investment is still far from the expected level. the authorities aim to improve their competitive position by introducing numerous tax and other incentives for foreign investors. one of the problems for business development, being also a significant barrier for the fdi inflow, is the complex state administration and several levels of governance. inadequate and inefficient administration as well as the complex legal framework are coupled with non-transparency of the state policy. foreign investors are particularly concerned about of political instability, high levels of corruption, the gray economy and inadequate workforce skills. in order to attract fdi and improve competitiveness, it is important for bosnia and herzegovina to carry out the necessary political reforms, reduce corruption, improve administrative efficiency, and develop a strategy for attracting fdi. one of the steps towards creating a system for attracting fdi refers to the strategic decision about the country's development priorities that could result in advantages over neighboring countries. foreign direct investments are one of the important factors in achieving sustainable economic development and increasing the competitiveness of montenegro. the legal framework in montenegro is very liberal and favors the fdi attraction. however, it should be borne in mind that fierce competition in the world market and the presence of liberal regulations are typical darko marjanović, mihajlo đukić 117 for almost all countries worldwide that aspire to attract foreign investments. it is important to note that an attractive legal framework has been created in the country, i.e. foreign investors have the national treatment and there are no restrictions on profit repatriation. additionally, montenegro has very simple legal procedures for establishing a company. montenegro has an extremely high potential for attracting fdi, but in the following period, the implementation of major projects will largely depend on the economic situation at the global level. in the forthcoming period, the inflow of foreign direct investments could be negatively affected by lower interest of foreign investors in the implementation of large projects in the field of tourism, outflow of foreign capital, slow administrative procedures and delays in privatization. therefore, it is very important for montenegro to complete the privatization process in the coming period (through simplification of procedures and acceleration of the privatization process) and change the investment structure in terms of increasing the share of greenfield investments. it is also very important to increase investment in new production programs that will inevitably lead to job creation. one of the main goals of the macedonian government in the coming period is to attract as much as foreign direct investments as possible, which will contribute to the creation of a safer and more favorable economic situation in the country, resulting in creation of new jobs. in addition to low tax rates, northern macedonia has made efforts in other segments of the economic policy in order to be competitive with neighboring countries. this is reflected in various benefits for starting a business, reducing costs and time for a company registration, strengthening regulations and investors' protection, simplifying the process of obtaining building permits and electricity, etc. all these efforts have been rewarded by increasing foreign direct investment in macedonia over the last decade. after 2012 and the recorded sharp decline of fdi in serbia, the period that followed led to significant economic stability in the country, which resulted in an increase in fdi inflows from both eu countries and china. greenfield investments in serbia have grown over the past 6 years, where 2018 stands out, in which over 100 individual projects have been implemented. it should be particularly emphasized that serbia, according to the fdi intelligence list for 2019, is ranked first in the world as a country receiving greenfield investments, taking into consideration the level of gdp. with a score of 11.92 serbia attracts almost 12 times the amount of greenfield fdi compared to the amount that could be expected given the size of its economy. the implemented reforms have significantly contributed to the fact that foreign investors are increasingly interested in serbia as an investment destination, with eu countries (germany, italy, the netherlands and austria) leading the way. economic perspectives of serbia in the following period will dominantly depend on its readiness to deal with high level of corruption and strengthen rule of law which have been stressed as the main challenge in most of the reports of the international institutions and organizations (i.e. european commission report, 2020). to summarize, it is obvious that the western balkan countries are favourable investment locations for foreign investors. all these countries have implemented economic reforms and greatly simplified the criteria for attracting foreign investors. well-implemented tax reform is also crucial for attracting foreign direct investment, which primarily refers to tax incentives that will largely determine the future strategies of multinational companies and their choice to invest capital. however, it is important to note that fdi should not be considered only as a whole, since the structure of the attracted fdi is also important. fdi that bring new technologies, and result in producing higher added value products are particularly important for the sustainable economic development. conclusion size of the market and the market growth rate are the key parameters that investors are taking into consideration when entering the particular market. if the market is large and the 118 economic analysis (2020, vol. 53, no. 2, 109-120) growth rates are high, management will seriously consider diverting resources to the particular market, analysing possibilities to establish its own branch or acquire a majority stake in a joint firm. the decision about entering enter a new market also depends on other market conditions such as trade barriers (tariffs, quotas, customs duties). fdi are very important for those countries where there are underdeveloped regions, as they could significantly change the business conditions helping these regions to grow and develop much faster if compared to regions relying only on their own resources. the positive impact of fdi is often pronounced in industry, service development, trade, trade relations and the transfer of new technologies. industries in developing countries which succeeded in attracting foreign capital, often achieve good business results. foreign capital plays a stimulative role in the overall economic recovery of a country. western balkan countries have established investment agencies in charge of promotion of their economic potentials, so that the number of concluded bilateral agreements, agreements on avoiding double taxation as well as free trade agreements are increasing every day, aiming to improve the investment climate in these countries. bilateral agreements typically involve developed countries on the one hand and developing countries on the other, with the aim of protecting companies from developed countries from political risks while helping developing countries to attract fdi. double taxation agreements are essential to prevent a multinational company from being taxed twice on the basis of the same business activity. it is very important for investors to have adequate conditions for unlimited and equal participation in the market. when making a decision on investing in a certain country, special attention is paid to the index of economic freedoms, which serves to measure economic freedoms in world economies. according to the results for 2020, on a scale of 0 to 100, where the maximum value represents a perfectly free country, western balkans countries score 65.3 on average. according to the index of economic freedom, all the countries of the western balkans are classified in the third level moderately free. the effects of potential foreign investments on the western balkan economies are mainly positive, and the key evidence lies in their dynamic growth over the last 10-15 years. western balkans is experiencing an increase in fdi during the european union accession process. it is important for all the western balkan countries to ensure an adequate environment in the following period creating an appropriate investment policy framework and providing political stability and favourable business climate. the competitiveness of the western balkan economies has significantly improved in the previous period, since countries are competing to each other when applying specific measures offered to potential investors. macroeconomic stability, strategic geographical position, favorable tax regime as well as low labor costs are important determinants of the attractiveness of particular country for the fdi inflow. in order to attract investors, it is very important to provide investors with attractive fiscal incentives. one of the benefits is the establishment of economic zones, business parks, trade zones and other similar measures, through which countries offer tax exemptions as a significant benefit. in the following period, it is very important for the western balkan countries to design adequate investment and tax policies, so to be even more oriented to the attraction of free capital, which could significantly contribute to their economic 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attractiveness of east african community (eac) for foreign direct investment penev slavica1, institute of economic sciences, belgrade marušić andreja, the world bank group abstract – the paper identifies competitive advantages and disadvantages of east african community (eac) as fdi location, observing eac as a region, in spite of visible differences among the member countries. despite the eac’s progress towards the development of a common market still existing restrictions on free movement of capital, services, and goods inhibit or make fdi and entry into the market unduly expensive. the identified competitive advantages of eac as a location for fdi are the following: fast economic growth, relatively low general government debt, low cost of labor, geographical proximity to regional and international markets, and high share of young people involved in primary education. the most prominent weaknesses inhibiting more fdi inflows in eac are: small domestic market with low per capita income, low share of exports in gdp, high country risk, slow progress in structural and institutional reforms, underdeveloped infrastructure, high administrative barriers, inefficient government bureaucracy, low secondary and tertiary education enrolment, high level of corruption, and poor implementation of laws. the papaer concludes that the main policy message arising from theoretical findings and empirical evidence suggest that the best way for eac to attract more fdi in the future is to: to speed up their eac integration processes, to strengthen the structural and institutional reforms, to accelerate the legal and regulatory reforms, necesary for the improvement of the rule of law, reduction of corruption, and elimination of addministrative barriers. any specific fdi policies are only of a secondary importance. key words: fdi, location criteria, eac, regional integration, attractiveness introduction the east african community (eac) is a regional intergovernmental organization which comprises five eastern african countries, including republics of kenya, uganda, the united republic of tanzania, republic of burundi and republic of rwanda 2. the eac was originally established in 1967 but collapsed in 1977, the main reasons contributing to its collapse being lack of strong political will, the continued disproportionate sharing of benefits of the community among the partner states due to their differences in 1 zmaj jovina, 12, belgrade, slavica.penev@ien.bg.ac.rs 2 the countries included in this analysis: republics of kenya, uganda, the united republic of tanzania, republic of burundi and republic of rwanda will be referred to as east african community or eac. economic analysis (2014, vol. 47, no. 3-4, 35-49) 36 their levels of development and lack of adequate policies to address this situation. in addition, the private sector and civil society did not have adequate participation in the cooperation activities. upon the dissolution of the east african community the said countries signed in 1984 the east african community mediation agreement, for the division of the assets and liabilities of the former each. this agreement however contained the basis for further regional cooperation, as it provided for the establishment of a permanent tripartite commission for co-operation between kenya, uganda and tanzania to be responsible for the co-ordination of economic, social, cultural, security and political issues among the said countries, in addition a declaration was made by the heads of state of the said countries for closer east african co-operation. in 1997, the heads of state of the said countries after reviewing the progress made by the tripartite commission directed it to embark on negotiations for the upgrading of the agreement establishing the tripartite commission into a treaty (eac, 2009, and davoodi, 2012). these negotiations resulted in the signing of the treaty for establishment of the east african community in 1999 entering into force in 2000 following its ratification by the original three partner states – kenya, tanzania and uganda. rwanda and burundi acceded to the eac in 2007. according to the treaty, the community is established with the objective to develop policies and programmes aimed at widening and deepening co-operation among the partner states in political, economic, social and cultural fields, research and technology, defense, security and legal and judicial affairs. in implementing the treaty, the eac countries established a customs union in 2005 and a common market in 2010. the next phase of integration will see the establishment of a monetary union and ultimately a political federation of the east african states (world bank. 2014a). the eac has a population of 153, 1 million, and a relatively low level of development, with total gdp based on purchasing power parity (ppp) at usd 232.5 billion. the regional gdp per capita at ppp is usd 1516, or only 43.1% of the african average. size, population and level of economic development vary within these countries. with its 79.6 million inhabitants, kenya is the most populated country in the region, and the country with the highest gdp per capita at ppp in region, amounting to usd 1796 in 2013. it is followed by tanzania and uganda, which are the countries of a similar size and with slightly lower gdp per capita. the two smallest countries in the region, burundi and rwanda, of respectively 5.3 and 14.1 million inhabitants, are also the the poorest countries in the region, with gdp per capita at ppp of only usd 521 and usd 1201 (see table 1). however, eac countries witnessed relatively high growth rates in the period 2005-2013, averaging 6.1%, compared to african average of 5.4%. the region is expected to continue its growth in the next three years, as the regional gdp growth in that period (2014-2016) is projected at 6.6% (imf, 2014). penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 37 table 1. basic indicators, 2013 population gdp based on ppp valuation gdp per capita annual real gdp growth (thousands) (us $ million) ( ppp valuation, $) (average over 2005-2013) burundi 10 163 5 297 521 4.1 kenya 44 354 79 664 1 796 4.8 rwanda 11 777 14 142 1 201 8.2 tanzania 49 253 77 834 1 580 6.9 uganda 37 579 55 605 1 480 6.7 eac 153 126 232 543 1 516 6.1 africa 1108 966 3827 029 3 520 5.4 eac to africa ratio 13.8 6.1 43.1 114.0 source: african economic outlook 2014 in more than a decade now, there has been significant progress in the implementation of the eac treaty and the integration process. however, significant challenges remain, some of which were partly the cause of the collapse of the eac in 1977, which impacts on people’s skepticism about the success of political integration. the challenge is to ensure that all member states are clear about the benefits of regional integration and more importantly that they do benefit. the member states are still at a different level of development the ones with a rapid productivity growth (rwanda, tanzania and uganda) as opposed to burundi that shows a slower growth. kenya has also still to meet its full potential as a leader for regional growth. while the customs union and common market implementation have progressed, there is still a long way to go, in particular having in mind that nontariff trade barriers remain between eac member states. finally, the successful implementation of a monetary union will depend on how successfully the customs union and common market have been implemented as well as the level of harmonization of the financial policies of the member states (world bank, 2014a). economic theory suggests that economic integration increases fdi inflows in the region because: (i) size of the market increases what leads to the replacement of exports with fdi; (ii) mncs reorganize their investments in the region due to new configuration of location advantages (new structure of costs, benefits, economies of scale) among member countries; (iii) new investment opportunities arising from the restructuring of activities between countries, sectors and firms triggered by economic integration (dunning, 1993). due to this correlation, we will focus in this paper on the attractiveness of the eac for fdi. foreign direct investment (fdi) in the east african community (eac) developing countries have increasingly come to see foreign direct investment (fdi) as a source of economic development and modernization, income growth and employment. the size, structure and stability of flows of fdi, are generally recognised as a potentially important source of economic growth (see, for instance, billington, 1999; bevan and estrin, 2000; dunning and lundan, 2008). fdi represents an addition to domestic accumulation, economic analysis (2014, vol. 47, no. 3-4, 35-49) 38 meaning an increase of production capabilities and, consequently, of employment (buckley et al. 2002). fdi also results in the inflow of new knowledge and technology (buckley et al. 2002), with positive spillover effects on the rest of the economy (lucas, 1993; borensztein et al. 1998). foreign investors may also open new markets and transfer knowledge. the inflow of fdi in eac countries was almost negligible during the 1990s. their growth started in in the early 2000s, when their average annual inflows almost tripled, amounting to 623 million usd. in the last 10 years fdi inflows registred almost permanent growth, as impact of the world economic crisis on the fdi inflows to this region was minimal. the region reached a pre crisis level of fdi in 2010, continuing its growth, and culminating in 2013 with usd 3650 million. fdi in eac were growing faster that fdi in africa as a whole, increasing their share in africa's fdi stock from 3.1% in 2001 to 3.8% in 2013 (table 2). the vast mayority of fdi in eac region were in tanzania and uganda, amounting on average to 87% of total eac fdi inflows. kenya, the strongest economy in the region, is substantially lagging behind these two countries. only in 2007, as a result of the privatization of telecomunication sector, the fdi amountred to usd 729 million, a level which they have failed to achieve over the next few years (table 2). table 2. inflows of fdi inflows in eac countries in 1990-2013 (in million usd) 1990-99 2000-2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 burundi 1 2 1 0 1 4 0 1 3 1 7 rwanda 4 8 14 31 82 103 119 42 106 160 111 kenya 21 54 21 51 729 96 115 178 335 259 514 uganda 80 203 380 644 792 729 842 544 894 1205 1146 tanzania 121 355 936 403 582 1383 953 1813 1229 1706 1872 eac 226 623 1351 1129 2186 2315 2028 2578 2568 3330 3650 africa 6746 15920 31018 35720 51364 59276 56043 47034 48021 55180 57239 eac to africa ratio (%) 3.4 3.9 4.4 3.2 4.3 3.9 3.6 5.5 5.3 6.0 6.4 source: unctad database increased fdi inflows in eac countries since 2001 resulted in the increase of inward fdi stock to gdp ratio from average 12.9% in 2001, to 19.4% in 2013. comparison to fdi penetration in/to africa, however, shows that there is still a room to increase fdi in eac. namely, average inward fdi stock to gdp ratio in eac was 19.4% in 2013, compared to the african level of 33.2% (see figure 1). however, the fdi inward stock as a percentage of gross domestic product in 2013 in tanzania and uganda, the two eac countries, that attracted the vast majority of eac’s fdi, amounted respectively to 39.1 and 38.3%, exceeding the african average of 33.2%. increased fdi inflows to eac countries since 2001 resulted in the increase of inward fdi stock to gdp ratio from 12% in 2001 to 19.4% in 2013. in spite of eac’s faster growth of fdi stock as a percentage of gross domestic product than in africa, it is still lagging behind the african average. if we observe the individual countries in the region, the differences among them are huge, as the fdi stock to gdp ratio in kenya, the strongest economy in the region, penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 39 amounted to only 7.2% in 2001, retaining almost the same level until 2013. uganda and tanzania extensively exceed the regional average, while this ratio in the least developed burundi was only 0.6 in 2013 (figure 1). figure 1. fdi inward stock as a percentage of gross domestic product, 2001 and 2013 source: unctad database determinants of eac attractiveness as fdi location according to dunning (1993) host country determinants for attracting fdi are: (i) main economic (structural and market) determinants/factors, (ii) regulatory-policy framework determinants/factors and (iii) business facilitation. empirical analyses of foreign investors' motivation and of location specific factors of fdi show that main economic factors represent the basic reason/motive of foreign investors for investing in a particular country (i) market characteristics (market size and per capita income, market growth, access to regional and global markets etc.), and (ii) availability / quality / costs of factors of production (labor, raw materials and other inputs, technological, innovatory and other created assets, physical infrastructure etc.). general regulatory and policy framework determinants/factors, which define investment climate in its broadest sense, include elements such as: (i) economic, political and social stability, (ii) privatization policy, (iii) trade regime and policy, (iv) tax rates and tax structure, (v) labor market (vi) product markets regulations and policies, etc. only if these (the above mentioned) basic preconditions are in place, specific fdi regimes and policies can become relevant for attracting foreign investors (see, for instance, dunning, 1993; unctad, 1998; business international, creditanstalt, 1992; a.t. kearney, 1998; meyer, 1998; rojec, redek and kostevc, 2007 etc.). analyses of various international institutions, which assess countries’ attractiveness for inward fdi are more or less based on the above theoretical concept. • market access is by far the most important location determinant (50% of answers, see graph 1). “market size” (18%) favours large countries, while “market growth rate” (18%) gives priority to dynamically growing economies. criteria “access to international and regional markets” (14%) is in favour of small and medium sized countries offering access to large regional markets. 10.0 20.0 30.0 40.0 burundi rwanda kenya uganda tanzania eac africa 7.2 3.4 7.2 15.2 27.0 12.0 23.7 0.6 11.5 7.5 38.3 39.1 19.4 33.2 2001 2013 economic analysis (2014, vol. 47, no. 3-4, 35-49) 40 • availability and costs of labour ara also frequently mentioned by the surveyed mnes (16%). here, we have two aspects. the first is access to skilled labour (8%), and the other is low labour costs (8%). • technical quality of business environment relates to the quality of infrastructure (7% for world average), availability of suppliers (6%) and access to domestic capital markets (3%). all these criteria are in favour of more developed countries as fdi location. • as far as legal and administrative environment is concerned, the survey cleary shows that incentives play a more or less marginal role (3% in the case of world average). in general, foreign investors seem to be more sensitive to governmment efficiency (6% in world average). • acess to natural resources and following of the competitors seem to be less important determinants of fdi inflows (see figure 2). figure 2. location criteria for fdi; world average, 2008-2010 (% of answers of surveyed mnes) source: unctad wir wips 2008-2010. based on the above factors that determine a country’s attractiveness for fdi, in this section we provide empirical data for assessing eac as a region as well as individual countries’ attractiveness for fdi, i.e. advantages and disadvantages of eac countries as investment locations. in doing that, we use the following sources: unctad inward fdi potential index, wef global competitiveness report, world bank ease of doing business rankings, andworld bank worldwide governance indicators, which are relevant for the estimation of locational competitiveness for fdi. 0 2 4 6 8 10 12 14 16 18 access to international / regional markets access to local capital markets access to natural resources availability of incentives skilled labour availability of suppliers cheap labour following of competitors governmenteffectiveness quality of infrastructure rate of growth of market market size 14 3 5 3 8 6 8 4 6 7 18 18 penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 41 further on we provide a more detailed evaluation of fdi locational competitiveness of the eac as a region and individual eac countries as far as main economic determinats (figure 3, table 3,4 and 5), regulatory framework (table 6) and business climate and promotion of entrepreneurship (table 7) is concerned. figure 3. eac country rankings by inward fdi potential index3, 2011 source: unctad (www.unctad.org/fdistatistics). note 1: the inward fdi potential index 2011 rank is out of 177 countries. the lower the rank number, the better. in figure 3 and tables 3, 4 and 5, main economic (structural) determinants, which are relevant for a countriy's fdi locational attractiveness, are classified into three groups: • market size and market growth (market-seeking fdi), • availability of resource / factors of production (resource/asset-seeking fdi), and • costs of resources / factors of production and productivity (efficiency-seeking fdi). some of the conclusions that can be drawn from this data are: market size and standard of living (gdp p.c.) in eac are not attractive for foreign investors, due to low regional lewel of gdp p.c. however, the growth of eac market (gdp growth) is a potential advantage for attracting market-seeking fdi, due to the fast regional growth. access to regional and global markets may be attractive for foreign investors, as all the countries are members of eac and all of them except tanzania are members of comesa. in addition, an interim economic partnership agreement with the eu was signed 3 the inward fdi potential index is based on several quantifiable factors: this index is thus constructed as the unweighted average of the normalized values of 12 variables: gdp per capita, the rate of gdp growth over the previous 10 years, the share of exports in gdp, average number of telephone lines per 1,000 inhabitants, commercial energy use per capita, the share of r&d spending in gdp, the share of tertiary students in the population, country risk, the world market share in exports of natural resources, the world market share of imports of parts and components for automobiles and electronic products, the world market share of exports of services, and the share of world fdi inward stock. 50 100 150 200 market attractiveness availability of low-cost labour and skills enabling infrastructure presence of natural resources overall rank 113 43 153 108 127 burundi kenya rwanda tanzania uganda eac economic analysis (2014, vol. 47, no. 3-4, 35-49) 42 in 20074. the eu and the east african community are also committed to concluding a comprehensive economic partnership agreement. all the member states of the eac are part of the africal growth and opportunity act (agoa), a trade preference program enacted in 2000 that is at the center of u.s.-african engagement on trade and investment5. table 3. main economic (structural) determinants of fdi relevant for market-seeking fdi b u ru n d i k en y a r w an d a t an za n ia u g an d a e a c inward fdi potential index: market attractiveness (unctad, 2012) among 177 countries 166 104 111 86 98 113 rate of gdp growth (%, average 2005-2013) 4.1 4.8 7.7 6.9 6.7 6.0 gdp per capita (us$, average 2009-2013) 303 864 569 572 497 561 ppp gdp per capita (us$, average 20092013) 740 2104 1308 1580 1288 1404 share of exports in gdp (% , 2013) 9 28 17 28 23 21 [1] inward fdi potential index, source: unctad (www.unctad.org/fdistatistics). rank 2011: the lower the rank number the better. 177 countries have been included in 2011 ranking. [2] source: world bank database: http://data.worldbank.org eac countries can be considered as attractive for some types of resource/asset-seeking and efficiency-seeking fdi. potential advantages for resource/asset-seeking attracting this type of fdi is the availability of low-cost labour, and to some extent the presence of natural resources (espetially in tanzania, kenya and uganda) (table 4 and figure 3. there is a perspective of significant growth of fdi inflow in eac countries in the forthcoming years, influenced by the fdi in the energy sector due to recent ugandan and kenyan oil discoveries, and new gas finds off the coast of tanzania (pwc, 2014). underdeveloped infrastructure can be considered as one of the most problematic barriers for foreign investors to invest in the eac region. according to the wef gci, quality of overall infrastructure is poor, and ranks 97th among 144 countries. the only exception is well developed sector of mobile telecomunication. quality of electricity supply is the most problematic factor, as the eac as a region ranks 112th among 144 countries (table 4 and figure 3). only according to the wef gci data, scores and rankings for rwanda and kenya 4 an interim economic partnership agreement with the eu includes: (i) duty and quota-free access for east african community imports to the eu, (ii) a gradual removal of duties and quotas over a period of 25 years, (iii) special agreements on co-operation in the area of sustainable fishing, (iv) new and extended rules of origin for farming, fishing and clothing and (v) rules for settling trade disputes. 5 by providing duty-free entry into the united states for almost all african products, agoa has helped expand and diversify african exports to the united states, while at the same time fostering an improved business environment in many african countries through eligibility requirements. in august 2012, legislation was enacted to extend agoa’s important third country fabric provision to 2015. penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 43 are well above the regional average. according to the wef survey with foreign investors, infrastructure is aslo identified as one of the most problematic barriers to fdi in eac (figure 4). table 4. main economic (structural) determinants of fdi relevant for resource/asset-seeking fdi b u ru n d i k en y a r w an d a t an za n ia u g an d a e a c determinants of fdi relevant for resource/asset-seeking fdi 1. infrastructure enabling infrastructure, among 183 countries) inward fdi potential index, 2011 unctad 166 142 151 150 157 153 average number of telephone lines per 100 inhabitants (2004) 0.2 0.5 0.4 0.3 0.6 0.4 mobile telephone subscriptions per 100 inhabitants (2014) 25 71 57 56 44 51 wef gci: 2nd pillar: infrastructure ranks 2.01 quality of overall infrastructure (wef gci 2014-2015) ranks among 144 countries 131 65 68 117 104 97 2.02 quality of roads 101 59 46 112 105 85 2.03 quality of railroad infrastructure n.a. 71 n.a. 88 101 87 2.07 quality of electricity supply 132 95 92 125 114 112 2. labour and skills availability of low-cost labour and skills, inward fdi potential index, 2011 unctad n.a. 40 n.a. 45 n.a. 43 wef gci 5th pillar: higher education and training a. quantity of education, scores 5.01 secondary education enrollment rate 28.5 60.1 31.8 35 27.6 37 5.02 tertiary education enrollment rate 3.2 4 7.2 3.9 9.1 5 a. quantity of education ranks 5.01 secondary education enrollment rate 137 113 134 132 138 131 5.02 tertiary education enrollment rate 136 133 124 134 118 129 b. quality of education: ranks 5.03 quality of the educational system 133 30 50 109 78 80 5.04 quality of math and science education 100 76 71 137 117 100 5.05 quality of management schools 138 44 99 126 96 101 5.06 internet access in schools 142 79 70 124 116 106 c. training, ranks 5.07 local availability of specialized research and training services 138 32 96 109 98 95 5.08 extent of staff training 137 34 55 116 110 90 3. natural resources presence of natural resources, inward fdi potential index, 2011 unctad (among 177 countries) 151 82 139 63 107 108 [1] inward fdi potential index, source: unctad (www.unctad.org/fdistatistics). rank 2011: the lower the rank number the better. 177 countries have been included in 2011 ranking. economic analysis (2014, vol. 47, no. 3-4, 35-49) 44 [2] mobile telephone subscriptions per 100 inhabitants , average number of telephone lines per 100 inhabitants and tertiary education enrollment rate, source: world bank database: http://data.worldbank.org [3] wef gci, source: world economic forum (wef): the global competitiveness report 2014-2015,. among innovation and sophistication factors, the region as a whole can not be considered as competitive. however, there are huge diferences among the countries in the region. kenya and rwanda have higher scores compared to the regional average, almost in all the sub-indices (table 5). table 5. determinants of fdi relevant for efficiency-seeking fdi b u ru n d i k en y a r w an d a t an za n ia u g an d a e a c 9th pillar: technological readiness ranks 9.03 fdi and technology transfer 140 59 25 99 56 76 9.04 internet users 142 85 125 133 110 119 9.05 broadband internet subscriptions 142 124 137 128 126 131 9.06 internet bandwidth 95 53 103 111 121 97 11th pillar: business sophistication a. network and supporting industries 11.02 local supplier quality ranks 135 47 96 112 129 104 b. sophistication of enterprise operations and strategiesranks 11.04 nature of competitive advantage 122 51 65 108 121 93 11.05 value chain breadth 136 36 71 102 93 88 11.06 control of international distribution 135 40 67 119 100 92 11.07 production process sophistication 140 55 102 111 115 105 11.08 extent of marketing 142 59 125 117 119 112 12th pillar: innovation ranks 12.01 capacity for innovation 140 33 86 102 90 90 12.02 quality of scientific research institutions 134 42 72 80 78 81 12.03 company spending on r&d 137 28 94 86 97 88 12.04 university-industry collaboration in r&d 122 37 64 83 62 74 share of r&d spending in gdp (%, 2010) 0.14 0.98 n.a. 0.52 0.56 0.27 wef gci, source: world economic forum (wef): the global competitiveness report 2014-2015. main determinants of the regulatory and policy framework relevant for the locational competitiveness for fdi are given in table 6, which clearly shows that the region is poorly performing with respect to quality of laws and rule of law (world bank worldwide governance indicators). country risk can also be considered a disadvantage for investing in eac. ease of doing business according to the world bank doing business is a serious penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 45 disadvantage of eac as a region (with the exception of rwanda) as their average rank is 123 among 189 countries. (world bank ease of doing business 2015); table 6. regulatory and policy framework determinants of fdi relevant for the locational competitiveness for fdi b u ru n d i k en y a r w an d a t an za n ia u g an d a e a c country risk rank among 185 countries mar. 2011) euromoney 181 102 163 112 113 134 country risk score among 185 countries mar. 2011)(euromoney 8.4 38.7 18.4 36.4 35.8 27.5 wef global competitiveness index: 2014– 2015 1st pillar: institutions 1. property rights 1.02 intellectual property protection 131 65 32 91 124 89 2. ethics and corruption 1.03 diversion of public funds 129 83 19 91 134 91 4. state inefficiency 1.09 burden of government regulation 97 48 6 61 42 51 1.12 transparency of government policymaking 131 58 8 111 80 78 3rd pillar: macroeconomic stability 3.04 general government debt, % of gdp 40 88 34 65 49 55 6th pillar: goods market efficiency 2. foreign competition 6.09 prevalence of trade barriers 139 110 53 125 62 98 6.10 trade tariffs, % duty 95 98 96 104 99 98 6.13 burden of customs procedures 136 92 16 123 84 90 8th pillar: financial market development a. effectiveness 8.04 ease of access to loans 131 33 41 86 93 77 8.05 venture capital availability 129 43 39 81 106 80 8.06 investors protection b. reliability and trust 8.08 legal rights index 113 1 29 43 43 46 worldwide governance indicators 2013; world bank regulatory quality -0.87 -0.35 0.03 -0.34 -0.24 -0.35 rule of law -1.06 -0.74 -0.15 -0.5 -0.36 -0.56 control of corruption -1.39 -1.06 0.65 -0.82 -1.05 -0.73 [1] country risk, rank 2011: source: euromoney ecr. september 2010. http://www.euromoney.com , the lower the rank number the better. 185 countries have been included in 2011 ranking. [2] wef gci, source: world economic forum (wef): the global competitiveness report 2014-2015, rank 2015: the lower the ranks number the better. 143 countries have been included in 2015 ranking. economic analysis (2014, vol. 47, no. 3-4, 35-49) 46 [3] world bank worldwide governance indicators, source: world bank, worldwide governance indicators; http://info.worldbank.org/governance/wgi., score 20013: scores are on the scale from -2.5 (the worst) and +2.5 (the best). however, the advantages for investing in eac include: • macroeconomic stability, especially government debt, as one of macroeconomic stability's sub-indicators (wef global competitiveness index). • several sub-indicators related to the quality of institutions, including burden of government regulation and transparency of government policymaking (wef global competitiveness index), and • reliability and trust: legal rights index (wef global competitiveness index). selected factors of business environment/entrepreneurship promotion, which determine the attractiveness of a country for fdi are given in table 7. there are very few potential advantages of eac related to business environment/ entrepreneurship promotion, including primary education enrollment rate (wef global competitiveness index).. however, administrative barriers, including starting a business and closing a business (world bank ease of doing business rank), are serious impediments for investing in these countries. in addition, several sub indicators related to security, including business costs of terrorism, business costs of crime and violence and organized crime (wef global competitiveness index), are also seriously affecting the atractivenes of the region for fdi. table 7. business environment/promotion of entrepreneurship determinants from selected international assessments of competitiveness, relevant for the locational competitiveness for fdi b u ru n d i k en y a r w an d a t an za n ia u g an d a e a c ease of doing business rank (world bank 2015) starting a business 18 143 112 124 166 113 closing a business/resolving insolvency 144 134 101 105 98 116 wef global competitiveness index: 2014–2015 1st pillar: institions security 1.13 business costs of terrorism 106 135 37 99 131 102 1.14 business costs of crime and violence 115 129 6 88 118 91 1.15 organized crime 122 125 9 77 108 88 5th pillar: health and primary education 4.09 quality of primary education 131 79 82 132 115 108 4.10 primary education enrollment rate 70 125 16 38 100 70 [1] world bank doing business ranking, source: world bank doing business rankings; http://www.doingbusiness.org. , rank 2015: the lower the rank number the better. 189 countries have been included in 2015 ranking. penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 47 [2] wef gci, source: world economic forum (wef): the global competitiveness report 2014-2015. rank 2015: the lower the rank number the better. 143 countries have been included in 2015 ranking. conclusions and recommendations in this paper we observed eac as a region, in spite of visible diferences among the member countries, (with kenya as the most developed country in the region, uganda and tanzania as the countries which attracted the vast majority of fdi, and rwanda with the most attractive investment environment for fdi), as they all belong to the group of lowincome countries. the eac’s progress towards the development of a common market in capital, services, and goods is of crucial importance for the improvement of the region’s attractiveness for fdi. in spite of achieved progress in regional integration, still existing restrictions on free movement of capital, services, and goods inhibit or make fdi and entry into the market unduly expensive. barriers which particularly impede fdi are: (i) legal restrictions on fdi, (ii) existence of non-tariff barriers in all member states, (iii) discriminatory measures towards foreign investors (taxes, limitations on acquiring or disposing of shares), (iv) nonharmonized fdi and trade laws and regulations among the eac member states, which present barriers to cross-border trade and foreign direct investment into the region. establishment of a fully functional eac common market in capital, services, and goods is only one of the preconditions for the improvement of its attractiveness for fdi. the main strengths of eac relevant for attracting fdi are: (i) fast economic growth, (ii) relatively low general government debt (iii) relatively low cost of labor, (iv) geographical proximity to regional markets, and international markets (special agreements with eu, us, china and india), (vi) high share of young people involved in primary education. the most prominent weaknesses inhibiting more fdi inflows in eac are: (i) small domestic market, (even as a region), with low per capita income, (ii) relatively high country risk, (iii) slow progress in structural and institutional reforms (iv) low share of exports in gdp, (vi) poor supply of infrastructure, (vii) inefficient government bureaucracy, (viii) low secondary and tertiary education enrolment, (ix) low share of research and development in gdp, (x) high level of corruption, (xi) high administrative barriers, (xii) poor implementation of laws. the main policy message arising from theoretical findings and empirical evidence suggest that the best way for eac to attract more fdi in the future is to: (i) to speed up their eac integration processes, (ii) to strengthen the structural and institutional reforms, (iii) to accelerate the legal and regulatory reforms, which will positivly influence the rule of law, and will reduce the level of corruption, and will eliminate a huge number of addministrative barriers. any specific fdi policies are only of a secondary importance. acknowledgement: this paper is a part of research projects 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 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"domet in možni elementi politike aktivnega spodbujanja tujih neposrednih investicij v sloveniji". delovni zvezek, 5/2007, 16, urad za makroekonomske analize in razvoj, ljubljana. unctad. 1998. world investment report 1998. new york and geneva. unctad. 2004. world investment report 2004. new york and geneva. unctad. 2008. world investment prospects survey 2008-2010 (wips 2008-2010). new york and geneva. unctad. 2013. economic development in africa, report 2013, unctad. new york and geneva. penev, s., et al., attractiveness of eac for fdi, ea (2014, vol. 47, no. 3-4, 35-49) 49 unctad. 2014. world investment report 2010. new york and geneva. unctad. fdi/tnc database (www.unctad.org/fdistatistics). undp, afdb, oecd. 2014. african economic outlook, undp www.africaneconomicoutlook.org/en world bank. 2011. regulatory capacity review east african community, world bank. washington dc. world bank. 2013. doing business in the east african community 2013, world bank washington, dc. world bank. 2014. doing business in 2015, world bank washington, dc. world bank. 2014a. the east african common market scorecard tracking eac compliance in the movement of capital, services and goods. world bank. washington dc. atraktivnost istočno afričke zajednice (eaz) za strane direktne investicije rezime – ovaj rad identifikuje komparativne prednosti i nedostatke istočno afričke zajednice kao lokacije za strane direktne investicije (sdi), posmatrajući eaz kao region, uprkos činjenici da među zemljama članicama ovog regiona postoje značajne razlike. i pored ostvarenog napretka ka stvaranju zajedničkog tržišta, postojeća ograničenja slobodnom kretanju kapitala, usluga i robe, čine priliv sdi, kao i ulazak na ovo tržište, prekomerno skupim. identifikovane komparativne prednosti eaz kao lokacije za privlačenje sdi su sledeće: visoke stope ekonomskog rasta, relativno nizak javni dug, jeftina radna snaga, geografska pristupačnost regionalnim i medjunarodnim tržištima, kao i visok stepen uključenosti mladih u primarno obrazovanje. nasuprot tome, najveće prepreke za privlačenje sdi u eaz su: malo tržište sa niskim bdp-om po glavi stanovnika, nisko učešće izvoza u bdp-u, usporen napredak u sprovođenju strukturnih i institucionalnih reformni, nerazvijena infrastruktura, neefikasna administracija, nizak stepen uključenosti mladih u sekundarno i tercijerno obrazovanje, visok nivo korupcije, i nedovoljna primena zakona. rad zaključuje da je najvažnija preporuka koja proizilazi iz teoretskih i empirijskih osnova, da je najbolji način da eaz privuče više sdi u narednom periodu: da se ubrza intergacioni proces eaz regiona, da se intenziviraju strukturne i institucionalne reforme, neophodne za unapredjenje vladavine prava, smanjenje korupcije i uklanjanje administrativnih barijera. bilo koja vladina politika vezana za sdi je samo od sekundarnog značaja. ključne reči: sdi, lokacija, kriterijumi, eaz, regionalna integracija, atraktivnost article history: received: 8 july 2014 accepted: 10 november 2014 ea_2017_1-2 udc: 336.132(1-775) jel: h4, j3, j1 cobiss.sr-id: 240669964 original scientific paper analysis of public sector efficiency in developed countries ivan lovre, republic institute for court expert witnessing a.d., novi sad, serbia olja munitlak ivanović1, institute of economic sciences, belgrade, serbia petar mitić1,2, institute of economic sciences, belgrade, serbia abstract – the public sector in developed countries went through various forms of transformation in the twentieth century. the expansion of the public sector resulted in high levels of public spending in developed countries. the financial crisis of 2008 led to recessions in the economies of developed countries, the public debt growth, and actualized the issue of the public sector optimal size and efficiency. this study analysed the public sector efficiency in 19 developed countries. the analysis focuses on the relationship between the size of public expenditure and economic growth in the global financial crisis and the measures implemented. the aim of the research in this paper is a comparison of total and partial efficiency of the public sector in developed countries, in order to determine the characteristics of the public sector operations. the comparison covers the areas of the public sector operations in order to identify sources of inefficiency. partial and overall efficiency of countries are analysed with different size and concept of the public sector, to determine the relationship between the public sector size, efficiency and welfare of citizens. the research results clearly indicate (un)justified state intervention in developed countries key words: public sector, efficiency; developed countries, socio-economic indicators, public expenditures introduction developed market economies went through various forms of public sector transformation in the twentieth century. any economic and political crisis led to the expansion of the public sector and the development of theoretical concepts that justified state intervention. the concept of market inefficiencies resulted in the state’s growing role in the economic system and the development of the theory of public choice. the changes that affected the state’s role in developed market economies are: changes in the industrial sector towards the production of more sophisticated products, a greater role for the service sector, 1 munitlak ivanović and mitić express gratitude for the financial support of the ministry of education and science of r. serbia on the projects no. 47009 (european integration and socio-economic changes in serbian economy on the road towards eu) and no. 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements). 2 corresponding author: petar mitić, petar.mitic@ien.bg.ac.rs lovre, i., et al., analysis of public sector efficiency, ea (2017, vol. 50, no. 1-2, 38-49) 39 globalization, changes in international relations and the creation of supranational integration, acceptance of (neo)liberal doctrine in economic policy, the emergence of information society, economic stagnation in some countries, population migration, and new ways of movement of capital, knowledge and information. the public sector transformation was influenced by the increasing competition between the private and public sectors. today, the economic reality of the developed countries is characterized by sophisticated and developed markets and lower degree of economy autarky, allowing for quicker and cheaper procurement of goods from developing countries. public policy makers have become more sensitive to high levels of public spending, and they create inefficiencies in public revenue in the form of higher tax rates, and in public expenditure in the form of increased bureaucracy. from the aspect of individual users, government departments have a relatively low prices in relation to their effects (income redistribution, public health and education, etc.), which generates greater demand. analysis of the public sector efficiency was brought into focus due to fiscal difficulties faced by most european countries the growing deficits and high levels of public debt, which caused a crisis of public finances and the inability of some developed countries to put public expenditure under control. the level of public debt in 28 countries of the european union reached a level of over 85% of gdp, which significantly exceeds the allowable maastricht criteria of 60% of gdp, and classifies them as indebted countries under the world bank criteria (lovre, jotić, 2011). the crisis of state finances actualizes the issue of the public sector efficiency, since the inevitable fiscal consolidation implies reforms in the structure and functioning of the public sector, if its inefficiency is confirmed. the aim is to use structural and functional reforms to increase the public sector efficiency and the scope of public services while reducing fiscal expenditure. this concept of fiscal consolidation is more successful than the implementation of the fiscal consolidation as a package for reducing state expenditure. literature review analysis of the public sector efficiency and its international comparison is not easy due to the complexity of measuring, quality of data and different definitions of public sector (alfonso et al, 2006). additional difficulties that occur during the measurement and comparison of public sector are: lack of a single theoretical approach that would accurately and unambiguously determine the area of state actions, differences between public sectors as a result of the size, structure and scope of the public sector, political organization (unitary or federal state), as well as demographic and geographic characteristics of a country. different levels of government and forms of institutional and fiscal decentralization further complicate the measurement and comparison of public sectors (imf, 2001). any assessment that does not take into account national specificities can easily lead to erroneous conclusions. the public sector efficiency is measured as a relative term, i.e. whether a particular economic entity (company, sector, country) is more efficient compared to other economic entities (oecd, 2004). the efficiency of public sector is measured as the ratio between costs and results compared to the same variables in other countries. if the results (quality of public services or public goods produced) are better, with the same or lower costs (the level of fiscal contributions), it is considered that the public sector of that country is more efficient. in 40 economic analysis (2017, vol. 50, no. 1-2, 38-49) measuring the public sector efficiency, it is necessary to distinguish between products and results. the public sector product represents the scope of provided public services, while the result is the quality of provided public services (farell, 1957). results of the public sector do not have to be overlapping with the product of the public sector. results in the provision of education and health are the level of students’ knowledge (usually measured by their success on standardized international tests), the number of patients who were cured, while the product presents the number of students enrolled in school, the number of operations carried out or the number of patients cared for. results of the public sector are expressed qualitatively, while the product of the public sector is expressed quantitatively (wilson, 2005). in contemporary literature the emphasis is on measuring the indirect costs of public programs and investments, while the analysis includes opportunity costs of public investments. in measuring the efficiency of specific public policies, it is necessary to take into account the socio-economic environment and lifestyle. furthermore, implemented public policies do not achieve their effects in the short term and are partly influenced by policy makers. more than one political cycle is necessary to see the effects of implemented policies (health and education) (mandl, u., dierx, a., ilzovikz f., 2008). in addition to the methodology used in this study developed by vito tanzi, ludger schuknecht and antonio afonso, the efficiency of public policies are measured by parametric and non-parametric methods, such as stochastic frontier analysis and dea analysis (charnes, a., cooper, w. and rhodes, e., 1978). the efficiency of public sector and implemented public policies may not be measured only through monetary values (public spending), but the analysis can include non-monetary values, such as the number of employees in the public sector, the number of hours required for public activities (hindriks, j., myles, g., 2004).the global financial crisis of 2007 led to recession in the economies of developed countries. the global financial crisis was accompanied with a sharp increase in public debt in the developed countries and the crisis of over-indebtedness. the austerity and rationalization measures carried out in the public sectors of developed countries actualized the issue of efficiency in the public sector. the authors of this study compared the public sector efficiency of developed countries, in order to compare the overall efficiency of the public sector. the aim of the research was to compare specific areas of the public sector in order to identify sources of inefficiency. the study covers the period from 2003 to 2013. the structure of the paper comprises three parts. the first part explains the methodology of measurement, comparison and analysis of the public sector efficiency. the issues of measuring and international comparability of public sectors are elaborated. the second part provides the comparison of the public sector efficiency in developed countries. the performances of the public sector, the overall and partial efficiency of public sector were analysed. the third part of the paper provides conclusions based on the results obtained in the study. lovre, i., et al., analysis of public sector efficiency, ea (2017, vol. 50, no. 1-2, 38-49) 41 research methodology the growth of the public sector during the twentieth century led to the fact that most of the developed countries spend between a third and half of their income on services provided by the state. the public sector efficiency was the focus of researchers and experts since the economic crisis of the 1970s of the twentieth century and the rise of new public management. the methodology of macroeconomic analysis in the public sector was developed by vito tanzi, ludger schuknecht and antonio afonso, due to the need for comparing the efficiency of public sectors (alfonso, schuknetcht, tanzi, 2003:15). the method developed is of imperative character and analyses the relationship between the level and the growth of public expenditure and changes in socio-economic indicators. socioeconomic indicators in this model can be divided into seven separate areas (administration, education, health, infrastructure, income distribution, stability and economic performance) with 17 sub-indicators (figure 1). all indicators in the model are normalized to the average size, but the unit value indicates the average size of performance (simple arithmetic mean), based on which the overall average performance is calculated. most of the indicators and sub-indicators are expressed as the ten-year average, in order to analyse the structural changes. the growing impact of public spending on socio-economic indicators influences the increase of the public sector efficiency. this methodology was adopted by the european central bank. figure 1. socio-economic indicators and sub-indicators of the public sector performance source: afonso a., schuknecht l., tanzi v. (2003). “public sector efficiency: an international comparison”, european central bank, working paper, no. 242. (adapted by authors) process indicators include the largest systems in the public sector. administrative indicator consists of four sub-indicators that are measured by the assessment of the world economic forum in the index of global competitiveness. education indicator is composed of two sub-indicators the enrolment rate in secondary schools and educational achievements 42 economic analysis (2017, vol. 50, no. 1-2, 38-49) of students. given that primary school attendance is compulsory and that many countries included in this study reached the level of development where the coverage of children regarding primary education is extremely wide, the rate of enrolment in secondary schools provides better information on the public education. data were taken from the index of global competitiveness by the world economic forum. education outcomes were measured by students’ achievement on standardized pisa tests in the field of mathematics. mathematics is taken as an indicator of performance more often than natural sciences or reading and comprehension (the other two components of the pisa tests), because it more frequently influences the creation of formal logic, which is necessary for the acquisition of knowledge and making independent judgments. indicator of health is composed of three indicators. infant mortality was measured by the number of stillborn babies per 1,000 births. data were taken from the index of global competitiveness by the world economic forum and national statistics. for life expectancy measured by the average number of years of life, the data were taken from the index of global competitiveness by the world economic forum. the quality of the health care system is analysed by health system efficiency by the grade from the index of global competitiveness of the world economic forum. quality of infrastructure is measured by data from the index of global competitiveness by the world economic forum. the second group of indicators corresponds to the most important functions of the state the allocation of resources, stability and distribution). this division of economic functions of the state was introduced by richard musgrave in 1939 in his paper titled “voluntary exchange theory of public economy”. this group of indicators is also called musgrave’s indicators (afonso a., schuknecht l., tanzi v., 2003). each of the indicators is trying to express the results of interaction between state and market. in this study, all economic categories are expressed in the ten-year period, in order to improve the observation of changes in economic performances and structural changes in the public sector. the distribution of income is measured by first indicator, which is composed of two sub-indicators. the level of relative poverty is measured by the percentage of the population living below the national poverty line. the data were taken from the world development indicators of the world bank. the second sub-indicator is the gini coefficient. second indicator measures how successful a country is in achieving the stabilization goal of economic policy. economic stability is measured by the coefficient of variation of gdp growth and the average ten-year inflation rate. data were taken from the database of the world economic outlook of the international monetary fund. economic performances of the economic system consist of three sub-indicators: economic growth is measured by the tenyear average growth in gross domestic product. data were taken from the database of the world economic outlook of the international monetary fund. the unemployment rate is measured by the ten-year average, and the data are taken from the database of the world economic outlook of the international monetary fund. amount of public debt is measured by the participation in the gross domestic product, and data are taken from the database of the world economic outlook of the international monetary fund. based on these 7 indicators of the same weights and 17 sub-indicators, the overall public sector performance (psp) is obtained. all indicators are normalized to the average value, so the value of the average performance of the sample is 1. unit value means the average lovre, i., et al., analysis of public sector efficiency, ea (2017, vol. 50, no. 1-2, 38-49) 43 performance value (simple arithmetic mean), and overall average performances are calculated based on the average values. it is a relative indicator, since deviations from the average of the sample are measured. economic indicators and sub-indicators are analysed as a ten-year average, as the analysis covers structural changes in the public sector but not changes on an annual basis. to get the overall efficiency of the public sector it is necessary to weigh the performances of the public sector efficiency by the corresponding public expenditure. in order to calculate indicators of the public sector efficiency, it is necessary to normalize each of the seven categories of public expenditure to the average value: 1. total public expenditure (indicator of administration), 2. public expenditure on health (indicator of health), 3. public expenditure on education (indicator of education), 4. public investment (indicator of public infrastructure), 5. transfers and subsidies (indicator of distribution), 6. total public expenditure, since it is considered that the larger public sector leads to stabilization of the economy, as an indicator of stability), and 7. total public spending (indicator of economic efficiency). the model defines the public sector performance (psp), of i countries and j fields of government as the results of public policies that depend on the values of certain indicators (ik) (alfonso, schuknetcht, tanzi, 2003:17): ����� = �� ! " �1" improving socio-economic indicators leads to the growth of public sector performance: ∆����� = $ %� % ! ∆ ! �2" public sector efficiency (pse) of a country is measured as the ratio between public sector performance (psp) and public expenditure (pex) (alfonso, schuknetcht, tanzi, 2003:17): ��&� = ���� �&'� �3" each performance indicator is weighted by the relevant category of public expenditure: ���� �&'� = $ ������&'�� ) �*� �4" in applying this analysis, it is not easy to identify the effects of public spending on the results of the public sector and differentiate the impact of public spending from others, exogenous impacts. measurement in this analysis should be interpreted with caution, since the public sector and public finance system differ from country to country. in some countries, the transfer payments are taxed, and public expenditures are higher than in the countries in which these forms of public spending are not taxed. correlation analysis in this paper was done in microsoft excel 2013, with the certainty of 95%. t ab le 1 . p u bl ic s ec to r pe rf or m an ce ( p s p ) in d ev el op ed c ou n tr ie s c o u n tr y a d m in is tr at io n e d u ca ti o n h ea lt h p u b li c in fr as tr u ct u re d is tr ib u ti o n s ta b il it y e co n o m ic p er fo rm an ce t o ta l p er fo rm an ce a u st ra li a 1. 10 50 5 1. 17 69 7 1. 12 72 6 1. 01 65 1 1. 08 30 5 0. 97 41 4 1. 09 76 52 1. 06 46 8 a u st ri a 1. 34 75 6 0. 97 48 3 1. 20 32 6 1. 23 57 6 1. 70 05 7 1. 33 03 9 1. 39 56 68 1. 31 92 2 b el g iu m 1. 11 08 9 1. 05 22 9 1. 06 99 7 1. 15 60 3 1. 02 82 4 1. 32 88 5 1. 12 45 36 1. 13 60 3 d en m ar k 1. 19 20 4 1. 17 28 2 1. 15 42 0 1. 15 60 3 1. 00 24 2 1. 57 51 0 1. 20 46 59 1. 21 81 5 f in la n d 1. 29 67 3 1. 06 80 3 1. 42 88 4 1. 27 56 2 1. 02 99 6 1. 51 22 9 1. 25 26 96 1. 27 12 9 f ra n ce 1. 29 32 7 1. 04 31 2 1. 19 69 3 1. 21 58 3 1. 48 26 7 1. 57 66 4 1. 32 53 92 1. 32 97 5 g re ec e 1. 28 14 3 0. 99 08 5 1. 11 55 9 0. 91 68 5 0. 93 23 7 1. 82 20 5 1. 33 67 10 1. 17 11 7 n et h er la n d s 1. 23 17 8 1. 16 96 7 1. 13 01 8 1. 25 56 9 1. 30 91 4 1. 51 11 7 1. 26 56 56 1. 29 08 6 ir el an d 1. 36 88 5 1. 09 47 1 1. 23 01 4 1. 01 65 1 1. 92 12 3 1. 40 71 9 1. 41 50 95 1. 35 88 4 it al y 1. 28 17 4 0. 98 93 1 1. 23 55 9 0. 91 68 5 0. 81 50 9 1. 84 05 2 1. 29 71 27 1. 17 00 3 ja p an 1. 37 47 1 1. 04 75 4 1. 43 86 8 1. 23 57 6 0. 98 91 1 1. 95 48 7 1. 35 33 88 1. 35 19 7 c an ad a 1. 15 23 2 1. 03 65 8 0. 91 36 6 1. 11 61 7 1. 36 01 2 1. 33 89 2 1. 23 18 75 1. 17 42 0 g er m an y 1. 19 28 3 1. 00 25 8 1. 15 66 7 1. 19 59 0 1. 00 05 1 1. 59 76 2 1. 20 48 86 1. 20 79 5 n ew z ea la n d 0. 96 28 8 1. 09 56 0 0. 99 22 6 1. 01 65 1 0. 96 07 5 1. 10 12 3 0. 95 30 85 1. 03 00 3 p or tu g al 1. 26 04 3 1. 05 02 6 1. 13 73 1 1. 19 59 0 1. 33 14 4 1. 81 55 8 1. 30 14 76 1. 33 54 5 sp ai n 0. 96 26 4 1. 13 40 2 1. 00 09 4 1. 17 59 6 0. 92 77 3 1. 26 41 4 0. 94 98 77 1. 10 25 2 sw ed en 1. 42 15 5 0. 97 09 4 1. 41 37 6 1. 13 61 0 1. 43 52 3 1. 68 11 6 1. 42 41 47 1. 35 30 4 u sa 0. 99 96 5 0. 95 13 7 0. 92 72 7 1. 15 60 3 1. 18 00 9 1. 13 38 5 1. 02 37 85 1. 08 63 74 g . b ri ta in 1. 08 70 4 0. 97 30 7 1. 11 60 8 1. 05 63 7 0. 92 98 9 1. 24 58 1 1. 07 73 59 1. 06 93 7 s ou rc e: a u th or s lovre, i., et al., analysis of public sector efficiency, ea (2017, vol. 50, no. 1-2, 38-49) 45 public sector efficiency research of efficiency phenomenon in the public sector was carried out on a sample of 19 countries. in all countries, a high negative correlation (r = -0.74) is observed between the share of public expenditure in gdp and rate of economic growth in the ten-year period (2003-2013), i.e. there is a tendency that economic growth is accompanied with the reduction of the share of public expenditure in gdp. in a sample of developed countries1 (table 1) we can see that the countries that adopted the concept of new public management2 (n. zealand, g. britain and usa) have lower estimated performance than other developed countries. table 2. size of the public sector, psp and pse developed countries3 country public sector size overall performance overall efficiency australia 35.8 1.064681 1.050160 austria 50.5 1.319225 1.519899 belgium 53.5 1.136032 1.380953 denmark 57.6 1.218151 1.321588 finland 55.1 1.271296 1.401854 france 56.1 1.329754 1.573040 greece 51.9 1.171175 1.313467 the netherlands 49.8 1.290869 1.532231 ireland 48.1 1.358842 1.343016 italy 49.8 1.170031 1.250109 japan 42.0 1.351977 0.989559 canada 41.9 1.174203 1.002264 germany 45.4 1.207951 1.201807 new zealand 47.5 1.030034 1.140064 portugal 49.4 1.335458 1.387175 spain 45.2 1.102520 0.986911 sweden 51.2 1.353041 1.425285 usa 22.0 1.086374 1.289343 g.britan 41.6 1.069377 0.898541 source: authors 1 indicators of performance and efficiency of the public sector of greece should be taken literally, since greece is providing unrealistic statistical data to international organizations. during the research, federal expenditures were used in the analysis of the public sector size of the united states. 2 new public management is the common name for a series of public sector reforms, which were carried out since the beginning of the eighties in most oecd countries. new public management aims to transform the rigid, hierarchical, bureaucratic, traditional model of public administration into a more flexible and more market-oriented public sector. the emphasis is on privatization and cooperation between the public and private sectors. in the concept of new public management that is based on the supremacy of the neoliberal market mechanism and criticism of the welfare state, a citizen is reduced to a customer or service client. 3 the table presents data on the size of the public sectors (measured as the share of public expenditure in gdp in%) of developed countries, the overall performance of the public sectors and their overall efficiency. the values of overall performance and efficiency were normalized to the average value (the average of the sample is 1) for their comparability. 46 economic analysis (2017, vol. 50, no. 1-2, 38-49) correlation analysis between the public sector performance and the public sector size measured as a share of public expenditure in gdp (figure 2), leads to the conclusion that there is a weak positive correlation (r = 0.42). the analysis of indicators of administration of developed countries below average values appear in all anglo-saxon countries except australia. anglo-saxon countries have below-average or average values for indicators of public infrastructure, distribution and economic performance. spain indicates low performance and is the lowest ranked country, which is mostly influenced by indicators of unemployment, relative poverty, public infrastructure, stability of gdp growth and the public debt, resulting from the lag in economic growth. if we compare countries with small public sectors (public sector < 40% of gdp) and medium-sized public sectors (public sector < 45% of gdp) with countries with large public sectors (public sector > 45% of gdp), we can observe the following trends: 1. countries with large public sector show above-average performance in most indicators compared to countries with small and medium-sized public sector. 2. countries with small and medium-sized public sectors show above-average performance in the indicator of stability and economic performance and belowaverage value of the indicator of distribution, which indicates greater income inequality and a higher level of relative poverty. 3. countries with large public sectors show better performance in the indicator of distribution, which indicates a lower income inequality, poverty and unemployment. indicators of scandinavian countries are slightly above-average and average values, indicating that they have the best public sector. analysis of the indicators points to a better performance of welfare countries than countries that adopted the concept of new public management. countries that introduced new public management show better economic performance, greater stability of economic growth, while the welfare states have better indicators in education, health, public infrastructure and distribution indicating that the emphasis in the countries of neoliberal capitalism is on efficiency and stability of the economic system, while in welfare states greater emphasis is on the income equality, quality of public services and quality of life in general. in a sample of 19 developed countries, we can see that the greater efficiency of the public sector is achieved by the welfare stated in comparison to the countries of neoliberal capitalism that generate above-average levels of total public sector efficiency (table 2). correlation analysis between the size of the public sector (measured by the share of public expenditure in gdp) and overall efficiency of the public sector leads to the conclusion that there is a medium-high positive correlation (r = 0.74). lovre, i., et al., analysis of public sector efficiency, ea (2017, vol. 50, no. 1-2, 38-49) 47 table 3. public sector efficiency (pse) in developed countries country public sector size overall performance overall efficiency australia 0.80766 1.16826 1.19509 austria 1.50960 1.18264 1.44508 belgium 1.38236 1.16056 1.45117 denmark 1.30833 1.32582 1.86654 finland 1.39498 0.97177 2.00003 france 1.72944 1.29425 1.40774 greece 1.77150 1.09279 0.89397 the netherlands 1.49863 1.51576 1.38774 ireland 1.59551 1.08661 1.56652 italy 1.49397 0.98198 1.15130 japan 0.68071 1.03978 1.12605 canada 0.58579 1.20039 1.02160 germany 1.02727 1.27159 1.21668 new zealand 1.10241 1.08749 1.51631 portugal 1.51430 1.18727 0.93704 spain 0.77543 1.21942 0.63991 sweden 1.32496 0.99052 2.04331 usa 1.21581 1.88866 1.00802 g. britan 0.71631 1.01952 1.27568 source: authors the results lead to conclusion that countries with large public sectors have higher total and partial efficiency of the public sector. indicators of economic performance and stability are higher in countries with large public sectors, which clearly indicate that a large public sector stabilizes the economy and justifies state intervention in the economy of developed countries. quality of life and welfare of citizens is higher in countries with large public sectors, which have a more efficient administration, the health system and education. countries with large public sectors have a better management of public investment. distribution is the only indicator where countries with large public sectors achieve belowaverage efficiency, which clearly points to inefficient spending and lack of selectivity in spending funds from the program for poverty reduction. conclusions comparing the public sector performance of developed countries, we can conclude that countries with large public sectors achieve better performance than countries with small public sector. countries that introduced the concept of new public management showed better performance only in the stability of economic growth and economic performance, while other indicators are lagging behind. the welfare states have higher quality of public sector with lower income inequality, higher quality of public services and greater welfare of their citizens. the best performance of the public sector is delivered by the scandinavian countries that adopted the concept of the welfare state and have large public sectors. 48 economic analysis (2017, vol. 50, no. 1-2, 38-49) comparing the efficiency of countries with small public sectors (public sector < 40% of gdp) and medium-sized public sectors (public sector < 45% of gdp) with countries with large public sectors (public sector > 45% of gdp), we can observe the following trends: • countries with small public sectors show below-average efficiency of the public sector in relation to the countries with medium and large public sector. • countries with large public sectors have above-average values of the overall efficiency of the public sector in comparison with countries with small and medium-sized public sector. • countries with large public sectors have above-average values of the indicator of administration in comparison with countries with small and medium-sized public sector. • countries that adopted the concept of new public management have lower efficiency of health than other countries. • countries with large public sectors showed greater efficiency of public infrastructure in comparison with countries with small and medium-sized public sector. • greater efficiency in distribution is indicated by countries with small and mediumsized public sector, which implies the inefficiency of redistribution programs for countries with higher allocations. • higher values of indicator of stability are showed by countries with large public sectors in comparison with countries with small and medium-sized public sector. • higher values of indicator of economic performance are showed by countries with large public sectors in comparison with countries with small and medium-sized public sector. the analysis of indicators of the overall efficiency of the public sector indicates that countries that accepted the concept of new public management are less efficient than other models of the public sector. countries with traditionally large sectors (france, germany) achieve greater efficiency than the anglo-saxon countries that adopted the concept of new public management (gb, new zealand, usa, canada, australia). the highest efficiency of the public sector is achieved by the scandinavian countries. the only indicator in which the countries of new public management are more efficient as compared to other countries is distribution, which indicates the inefficiency and lack of selectivity in the fight against poverty. this research clearly shows that developed countries should not accept the concept of new public management imposed by international financial institutions (imf, world bank). from the aspect of the public sector efficiency, state intervention is justified in developed countries. references afonso a., romero, a., monslave, e. 2013. “public sector efficiency: evidence for latin america.” inter-american development bank discussion paper idb-dp-279. afonso a., schuknecht l., tanzi v. 2003. “public sector efficiency: an international comparison.” european central bank, working paper, 242. lovre, i., et al., analysis of public sector efficiency, ea (2017, vol. 50, no. 1-2, 38-49) 49 afonso a., schuknecht l., tanzi v. 2006. “public sector efficiency: evidence for new eu member states and emerging markets.” european central bank working paper, no. 581. afonso, a., gaspar, v. 2007. 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"the measurement of productive efficiency." journal of the royal statistical society, part iii vol. 120. global competitiveness report data retrieved from http://reports.weforum.org/ government finance statistics manual. 2001. imf, washington. hindriks, j., myles, g. 2004. intermediate public economics. cambridge: the mit press. lovre, i., jotić j. 2012. “uticaj svetske ekonomske krize na javni dug srbije”, zbornik radova sa trećeg naučnog skupa sa međunarodnim učešćem univerzitet educons, sremska kamenica. mandl, u., dierx a., ilzovikz f. 2008 “the effectiveness and efficiency of public spending.” european economic papers 301, european commission: brussels. oecd. 2004. ”enhancing the effectiveness of public spending: experience in oecd countries.” economic department working papers no 380. sigma. 2009. “sustainability of civil service reforms in central and eastern europe five years after eu accession.” sigma paper no.44, oecd, paris. stiglic, e. dž. 2008. ekonomija javnog sektora. beograd: ekonomski fakultet. tanzi, v. 2005. “the economic role of the state in xxi century.” cato journals, no. 3. walker, r., boyne, g., brewer. 2010 public management and performance. cambridge: cambridge university press. wilson, p.w. 2005. "efficiency in education production among pisa countries, with emphasis on transitioning economies", department of economics, university of texas. world economic outlook. databases data retrieved from http://www.imf.org/ article history: received: 25 may, 2017 accepted: 4 july, 2017 doi: 10.28934/ea.21.54.2.pp1-19 original scientific paper beyond the returns the u.s. mutual funds value and growth style weighted sector portfolios investment performance attribution boris korenak10 f* | nikola stakić2 1 investometrix group, lakeshore m8v 1e7, toronto, on, canada 2 singidunum university, danijelova 32, belgrade, serbia abstract the aim of this study is to provide insight into the portfolios constructed out of sector mutual funds, based on value and growth investment styles. moreover, this study does not exclusively consider the returns, but it looks beyond them by incorporating the holdings data into portfolio performance attribution. we use two different sector mutual funds across the us sectors, over the observed decade. the findings show that smart money was not able to produce the value on the cumulative basis. we show that growth style was favourable over the observed decade. in addition, by implementing the growth style based on shiller price-to-earnings in the portfolio construction and assigning sector weights the tested portfolio offset partially and fully the negative effect by managers’ stock selection. overall, the holdings-based relative portfolios attribution in relation to appropriate benchmarks gave additional insight into dynamics of the alpha creation and the loss of alpha. brinson-fackler and brinson-hood-beebower attribution models are used including distinct model versions. in addition, the geometric attribution model is used to provide analytical consistency for multi-period attribution. key words: brinson models, geometric attribution, mutual funds’ performance, allocation effect, selection effect jel classification: g110 introduction in an effort to examine investment performance it is quite common to focus solely on the returns. based on the return track record different risk metrics can be calculated. they can be based solely on portfolio return (such as value-at-risk) or in relation to the benchmark (such as tracking error). together with the benchmark return data they are used to present risk-adjusted measures (such as information ratio). there are plenty of regression based multi-factor models that are used to examine investment performance of the institutional investors. usually used factors can be related to investment style, macroeconomic or microeconomic attributes. however, commonly overlooked data by researchers are holdings data, for both portfolio and benchmark. to get a deeper level of insight, it is necessary to understand the sources of the * corresponding author, e-mail: korenak.boris@investometrixgroup.com 2 economic analysis (2021, vol. 54, no. 2, 1-19) investment active performance, thus there is a necessity to look beyond the return-based approach and include holdings data into analysis. the aim of this study is to closely examine the investment performance of portfolios that are composed out of the us sector mutual funds in relation to the broad market index s&p500. weights for portfolios sectors exposure were assigned according to the investment style. furthermore, we broke down the sector allocation and security decisions across 11 sectors, for each of the 10 observed years, using two-set of returns and holdings data, for both value and growth style investment style, with the annual rebalancing frequency. also, the multi-period issue was addressed in the appropriate way and the cumulative results were presented. to achieve that we deployed asset-grouping attribution models. two different arithmetic attribution models were used including different model versions. in addition, geometric attribution model was used to provide analytical consistency for multi-period attribution. the assumptions are that an investor assigns the weights to sector in the us, based on shiller price-to-earnings ratio, and to achieve that exposure he/she uses sector mutual funds. this can be observed from the perspective of the fund-of-funds as well, that portfolio is composed out of mutual funds units. the rest of study provides theoretical background, data source, reasoning for the used methodology, as well as presented results and discussions, followed by conclusions. literature review various regression models have been used to explain the source of the return and risk. these models are known in investment performance attribution as factor-based models. one of the most prominent example of multi-factor model is fama and french (2015) five-factor model. the five-factor model extends the three-factor model by adding two factors: robust-minusweak profitability (rmw) and low-minus-high (conservative-minus-aggressive) investment (cma). previously commonly used fama and french (1993) three-factor model in academia for empirical research, uses the market beta, small minus big (smb), and high-minus-low book-tomarket ratio (hml). another extension to the model is carhart (1997) four-factor model, that uses momentum as additional factor. lastly, the most used model due to its simplicity is capital asset pricing model (capm), despite that it failed many empirical tests (eugene f. fama and kenneth r. french, 2004). there is also a special sub-group within factor models, that are non-linear models. traditional non-linear models are treynor-mazuy (1966) model and henriksson-merton (1981) model. abergel and thomas (2021) introduced a different approach to the performance analysis of multifactor investment strategies. characteristic of this methodology is a cross-sectional projection of asset returns onto the factors to form approximate portfolio returns. also, it shows nonlinear interaction terms between factors that produce the investment portfolio construction, as well as a natural and intuitive decomposition of the portfolio performance as the sum of factor contributions. lastly, this study offers practical applications to multi-factor equity strategies. as an alternative to return-based attribution, there is an asset-based approach. this approach requires, in addition to returns, beginning period holdings data for the portfolio and benchmark. this approach is not only return-based, like the factor-based approach. asset-based approach can be holdings-based (including different frequency of holdings data) and transaction-based. to avoid unexplained residuals, that are especially prominent in the portfolios that deploy strategies with high turnover and whose underlying exhibits high volatility, transaction-based approach is preferred over holdings-based approach (spaulding, 2018). spaulding (2018) performed empirical comparison between transaction and holdings-based attribution. former can be less precise especially if the lower frequency is used. also, if the turnover of the observed portfolio is high then it can lead to unexplained residual. in addition, the boris korenak, nikola stakić 3 author finds that the residuals caused by holdings-based analysis can be extensive and are not always necessarily correlated with turnover, as might be anticipated. within asset-based approach the most used models are brinson models, such as brinsonfackler (1985) and brinson-hood-beebower models (1986). however, since the introduction of these models both standard terminology and the interpretation have slightly changed. the terminology that is almost universally accepted now is asset (segment) allocation (term that was used by brinson and fachler was market selection), security selection and interaction effect (term that was used by brinson and fachler was cross-product). vashisht and gupta (2014) study underlines the concept of performance attribution, the methodology used by two of the most important performance attribution models namely brinsonhood-beebower model and brinson-fachler model. the study also discusses different approaches used for performance attribution, like arithmetic or geometric and the periodicity effects in carrying out attribution for multi-periods. peng (2020) used holding-based approach to analyze actively managed mutual funds in china. his research suggests that there is a positive correlation between holding-based model and regression model, fama-french three-factor model that he used for the comparison. during the observed period he found that most of the chinese mutual funds were able to deliver positive stock selection effect. however, most of the funds fail to deliver positive asset allocation effect due to inability to predict policy changes. interestingly when it comes to the interaction effect, contrary to the original authors that perceived interaction effect (cross-product) as residual value, spaulding (2003/2004), campisi (2004) and bacon (2008) perceive it as a direct result of the combined allocation and selection effects. latter two authors proposed that interaction effect should be included within selection effect, since it is not an inherent part of the investment decision process. arithmetic attribution has a disadvantage over geometric attribution when it comes to multiperiod attribution. arithmetic return for the multi-period fails to include the compound effect over time. to overcome this issue different algorithms have been used for smoothing and linking returns. initially, they were introduced by grap (1997) and carino (1999) and additional solutions have been offered by menchero (2000), frongello (2002) and bonafede and others (2002). reztsov (2011) offers detailed comparison between arithmetic and geometric approach. also, this study offers linking algorithm that is order independent. on another side, geometric excess return for the full observed period can be calculated from the compounded total allocation and selection effects, without residual. for multi-period attribution geometric approach is preferable (bacon, carl r., 2002). when it comes to investment style, pettengill et. al. (2014) performed mutual funds investment style performance analysis that included period of 1979 to 2012. their findings go in favor of value over growth mutual funds. they showed that value funds outperform growth funds especially in terms of lower realized risk and higher realized terminal wealth. when it comes to allocation, selection and interaction effect for the individual segments, their total geometric values for the whole period do not compound to the total excess return. this is the reason why weber and arno (2018) address them as semi-geometric models. also, menchero (2000/2001) presented a model that could be perceived as fully geometric, since individual allocation and selection effects compound through time. when it comes to multicurrency attribution, traditional brinson model was adjusted initially by ankrim and hensel (1992) followed by karonsky and singer (1994). 4 economic analysis (2021, vol. 54, no. 2, 1-19) data and methodology data data that were used for the calculations includes the following inputs portfolio sector weights (𝑤𝑤𝑖𝑖), portfolio sector returns (𝑅𝑅𝑖𝑖), benchmark sector weights (𝑊𝑊𝑖𝑖) and benchmark sector returns (𝐵𝐵𝑖𝑖), for the period 2011 to 2020. holdings-based approach with the annual frequency was deployed. portfolios sector weightings were based on value and growth investment styles. to distinguish between investment styles, we used historical sector price-to-earnings ratio adjusted according to professor shiller. that means that earnings were calculated as a 10-year average at any given point. data was obtained from s&p global, and fidelity and morning star mutual funds data bases. total sector returns were used. manager sector peers’ groups returns were used and obtained from the morning star mutual funds data base. they cover all 11 sectors that are classified by global industry classification standard (gics): information technology, health care, financials, consumer discretionary, communication services, industrials, consumer staples, energy, utilities, real estate, and materials. also as a represented group, mutual funds that were used to construct the fidelity portfolios are the following ones: fidelity select communication services portfolio (fbmpx), fidelity select consumer discretionary portfolio (fscpx), fidelity select consumer staples portfolio (fdfax), fidelity select energy portfolio (fsenx), fidelity select financial services portfolio (fidsx), fidelity select health care portfolio (fsphx), fidelity select industrials portfolio (fcyix), fidelity select technology portfolio (fsptx), fidelity select materials portfolio (fsdpx), fidelity real estate investment portfolio (fresx), and fidelity select utilities portfolio (fsutx). during the observed period s&p 500 index composite sectors have changed. real estate was spun off from the financial sector post september 16, 2016. due to that we decided to include allocation towards real estate sector post-2016, to make it more comparable to the s&p 500 benchmark. telecommunication services sector was renamed to communication services, with issues added from other sectors post september 20, 2018. we use the latter name throughout the whole observed period. methodology four different portfolios made up of the sector mutual funds were used. first portfolio is value weighted peers sector mutual funds portfolio. where, as the name suggests sector weights allocation was based towards sectors with the relatively low shiller price-to-earnings ratios. here we have used managers’ average returns for the given sectors from the whole database of morning star mutual funds. the same approach was used to construct the value weighted fidelity mutual funds portfolio, using only the returns for fidelity sector mutual funds. portfolio sector weights were assigned proportional to sectors with relatively higher shiller price-to-earnings ratio and was used to implement the growth strategy for two different series. thus, we constructed the following portfolios growth weighted morning star peers sector mutual funds portfolio and growth weighted fidelity sector portfolio. for performance attribution asset-grouping models used in research are two brinson models, as well as the geometric approach. brinson-hood-beebower model the first one is brinson-hood-beebower model, where total allocation effect is calculated in the following way. boris korenak, nikola stakić 5 benchmark return (b) is the weighted sum of the individual segment returns. b = ∑𝑊𝑊𝑖𝑖𝐵𝐵𝑖𝑖 (1) semi-benchmark return (bs) is a hybrid measure, that uses portfolio weights and benchmark segment returns. 𝐵𝐵𝑠𝑠 = ∑𝑤𝑤𝑖𝑖𝐵𝐵𝑖𝑖 (2) allocation effect for the individual segment (ai): 𝐴𝐴𝑖𝑖 = (𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖)𝐵𝐵𝑖𝑖 (3) total allocation effect can be expressed as: 𝐵𝐵𝑠𝑠 – b = ∑𝑤𝑤𝑖𝑖𝐵𝐵𝑖𝑖 − ∑𝑊𝑊𝑖𝑖𝐵𝐵𝑖𝑖 = ∑(𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖) 𝐵𝐵𝑖𝑖 = ∑𝐴𝐴𝑖𝑖 (4) it represents the value that is added/lost by having different segment weights in portfolio than the segment weights in the benchmark. as long the portfolio has overweighted the sector in which benchmark has delivered positive results the allocation effect will be positive. next, for securities selection within the sector we need to take in consideration the selection effect, that is calculated in the following way. in addition to previously used benchmark return (b), another hybrid metrics needs to be used, and that is semi-portfolio return (rs). it uses the benchmark sector weights and portfolio sector returns. 𝑅𝑅𝑠𝑠= ∑𝑊𝑊𝑖𝑖𝑅𝑅𝑖𝑖 (5) selection effect for the individual sector (si) 𝑆𝑆𝑖𝑖 =𝑊𝑊𝑖𝑖(𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) (6) when it comes to total selection effect, it is expressed as following: 𝑅𝑅𝑠𝑠 – b = ∑𝑊𝑊𝑖𝑖𝑅𝑅𝑖𝑖 − ∑𝑊𝑊𝑖𝑖 𝐵𝐵𝑖𝑖 = ∑𝑊𝑊𝑖𝑖(𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) = ∑𝑆𝑆𝑖𝑖 (7) it represents the value that is added/lost by having different securities weights in the portfolio segment than the securities weights in the benchmark segment. this version of the model has a residual, when compared to the total excess return. the residual can be explained by interaction effect, and when included it fully explains the excess return. the excess return can be obtained in the following way. 𝐵𝐵𝑠𝑠 − b + 𝑅𝑅𝑠𝑠 − b + r − 𝑅𝑅𝑠𝑠 − 𝐵𝐵𝑠𝑠 + b = r − b (8) brinson-fachler model where the agency supported the research, authors should have a funding acknowledgement in the form of a sentence as follows: we used two different versions of brinson-fachler model. 6 economic analysis (2021, vol. 54, no. 2, 1-19) allocation in both versions is the same. however, it is different than in brinson-hood-beebower model because it takes in account not only individual sector benchmark return but also total benchmark return. 𝐵𝐵𝑠𝑠 – b = ∑(𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖) (𝐵𝐵𝑖𝑖 − 𝐵𝐵) = ∑𝐴𝐴𝑖𝑖 (9) on another hand, selection effect can be shown in two different versions (with and without interaction effect). version with the self-standing interaction effect. pure selection is expressed as: 𝑅𝑅𝑠𝑠 – b = ∑𝑊𝑊𝑖𝑖 (𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) (10) interaction effect is the following: r – 𝑅𝑅𝑠𝑠 – 𝐵𝐵𝑠𝑠 + b = ∑(𝑤𝑤𝑖𝑖 − 𝑊𝑊𝑖𝑖) (𝑅𝑅𝑖𝑖 −𝐵𝐵𝑖𝑖) (11) version with the combined selection and interaction effects. in this version of the model, the selection is expressed as following: r – 𝐵𝐵𝑠𝑠= ∑𝑤𝑤𝑖𝑖(𝑅𝑅𝑖𝑖 − 𝐵𝐵𝑖𝑖) = ∑𝑆𝑆𝑖𝑖 (12) to summarize, bhb and bf models’ attribution results difference is due to individual segment allocation effect. however, the total allocation effect results are the same. selection effect is the same based on these two models and is presented in that manner. geometric model in addition, we used geometric attribution approach, where: individual sector geometric allocation effect is the following: a𝑖𝑖 𝐺𝐺= (𝑤𝑤𝑖𝑖 – 𝑊𝑊𝑖𝑖) ( (1 + 𝐵𝐵𝑖𝑖) (1 + 𝐵𝐵) 1) (13) total geometric allocation effect is: 𝐴𝐴𝐺𝐺 = (1 + 𝐵𝐵𝑠𝑠) (1 + 𝐵𝐵) 1 = ∑ a𝑖𝑖 𝐺𝐺 (14) individual sector geometric selection effect is: s 𝑖𝑖 𝐺𝐺= 𝑤𝑤𝑖𝑖 ( (1 + 𝑅𝑅𝑖𝑖) (1 + 𝐵𝐵𝑖𝑖) 1) (1 + 𝐵𝐵𝑖𝑖) (1 + 𝐵𝐵𝑠𝑠) (15) total geometric selection effect is: 𝑆𝑆𝐺𝐺= (1 + 𝑅𝑅) (1 + 𝐵𝐵𝑠𝑠) 1 = ∑ s𝑖𝑖 𝐺𝐺 (16) boris korenak, nikola stakić 7 lastly, geometric excess return is expressed as: r𝑒𝑒𝑒𝑒𝑒𝑒𝐺𝐺 = (1 + 𝑅𝑅) (1 + 𝐵𝐵) 1 (17) important property, for the multi-period attribution of the geometric approach is the following: 𝑅𝑅𝑒𝑒𝑒𝑒𝑒𝑒𝐺𝐺 = ( 1 + 𝑆𝑆𝐺𝐺)(1 + 𝐴𝐴𝐺𝐺) − 1 = (1 + 𝑅𝑅) (1 + 𝐵𝐵) – 1 (18) results and discussion in this section we present our findings of performance attribution for the analyzed portfolios. first, we answered the question did the mutual fund investment managers add or lose value for investors by making security selection decisions in comparison to s&p500 sector returns. in other words, we discuss the stock selection effect within sectors, for both morning star mutual funds sector peers and fidelity mutual sector funds. actually, this gives us the answer to the question “how smart is the smart money” for the observed period. then we dive into each of the four portfolios and try to understand the source of alpha (or negative alpha). more precisely, portfolio performance attribution, is based on brinson-fachler and brinson-hood-beebower model, as well as the geometric model that addresses the multiperiod performance. how smart is the smart money? in order to get the insight into managers’ stock picking skills, it is necessary to consider the selection effect. we would like to point out that the selection effects are the same no matter which version of the brinson’s models we use for performance attribution. used version of the brinson model will play a role only later when we discuss the allocation effect, but for the stock selection it is irrelevant. this is the reason why we present selection effect only based on two different data series, and not at the portfolio level. when we analyze the morning star database sector mutual funds (figure 1) for most of the observed years majority of sector mutual funds have underperformed in relation to the average stock performance for the given sector. that shows that managers, on average, were not able to beat their appropriate sector benchmarks. cumulative combined selection effect for the whole 10-year period is negative and it was 18.22%. however, relative performance in relation to the sector benchmark is quite heterogenous across the sectors. results suggest that there is a certain level of consistency in alpha that managers were able to produce for the certain sectors. one of the rare examples of positive alpha consistency is health care sector. however, majority of the sector mutual funds from the morning star database exhibit negative alpha with a relative high level of consistency year-over-year. 8 economic analysis (2021, vol. 54, no. 2, 1-19) figure 1. morning star peers sector mutual funds portfolio combined selection effect source: authors when we analyze the stock selection effect of the fidelity sector mutual funds, our finding show that fidelity managers did overall better in relation to the morning star sector peers (figure 2). the majority of differences in returns in relation to morning star peers can be assigned to the period of 2014 until 2019. where, fidelity managers for certain sectors managed to add value to stock selection whereas their peers almost universally underperformed in relation to the benchmark for the mentioned period. also, our findings suggest that managers for the given funds were able to beat their peers on consistent base. this is especially prominent for information technology, communication services and health care. however overall, on cumulative bases total selection effect is still negative and it was -4.40%. however, what is common for both series is that the year 2020 is an outlier for both. that suggests that the managers’ stock selection decisions were superb in relation to s&p500 sector benchmarks almost for all sectors. this might suggest that there are certain biases in managers’ stock selection in general such as the company size or investment style that are widely spread throughout their investment philosophy and strategy. furthermore, this can be an explanation through the relative high level of correlation of stock selection effect between fidelity and morning star peers. -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% 8,00% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 energy materials industrials consumer discretionary consumer staples health care financials* information technology communication services** utilities real estate* boris korenak, nikola stakić 9 figure 2. fidelity sector mutual funds portfolio combined selection effect source: authors value weighted morning star peers sector mutual funds portfolio it is important to stress out that when it comes to sector allocation effect brinson-fachler and brinson-hood-beebower models they produced the same total allocation effect for any given period, in our case a year. on another hand, allocation effect is differently allocated across the sectors. figure 3 is an example of comparison of allocation effect of brinson-fachler and brinsonhood-beebower models. for example, according to the brinson-fachler model the highest negative allocation effect for the year 2020 is the energy sector -1.79% and according to the brinson-hood-beebower model it is for the information technology sector -1.28%. however, total allocation effect for year 2020 is the same based on both brinson’s models and it is -3.33% -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% 8,00% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 energy materials industrials consumer discretionary consumer staples health care financials* information technology communication services** utilities real estate* 10 economic analysis (2021, vol. 54, no. 2, 1-19) figure 3. value weighted morning star peers sector mutual funds portfolio – allocation effect bf vs. bhb model comparison source: authors figure 4 shows arithmetic attribution results for each of the analyzed years. it can be observed that value weighted morning star peers sector mutual funds underperformed in relation to the s&p500 sector benchmarks for eight of ten years that can be noticed based on excess return. moreover, sector allocation based on value investment style and higher assigned weights towards the sector with the lower price-to-averaged-earnings. sector allocation effect is positive for two periods and security selection effect is positive for only one period. clearly, value investment style was not in favour for the observed decade. moreover, negative alpha produced by sector mutual funds managers made even worse results. as a result, only two years of positive total excess return for value weighted morning star peers sector mutual funds portfolio. figure 4. value weighted ms peers sector mutual funds total portfolio allocation and selection annual effects – arithmetic approach source: authors -4,00% -3,50% -3,00% -2,50% -2,00% -1,50% -1,00% -0,50% 0,00% 0,50% allocation (bf) 2020y allocation (bhb) 2020y -6 ,2 8% -0 ,5 0% 1, 16 % -6 ,3 5% -2 ,8 1% -2 ,1 0% -1 ,5 8% -3 ,9 5% -4 ,3 0% 6, 20 % -0 ,3 3% -0 ,0 7% -0 ,2 6% -0 ,9 8% -2 ,0 1% 1, 95 % -1 ,1 2% -0 ,7 3% -0 ,9 7% -3 ,3 3% -6 ,6 1% -0 ,5 7% 0, 91 % -7 ,3 3% -4 ,8 2% -0 ,1 5% -2 ,7 0% -4 ,6 8% -5 ,2 7% 2, 87 % 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 11 multiperiod attribution and geometric approach for the cumulative 10-year period arithmetic attribution approach is not appropriate. it can be only used by implementing different types of algorithms. geometric approach does not leave residual, and it is not order dependent. therefore, it is a preferable approach. also, excess returns for single periods cannot be linked geometrically together to get the excess return for multiperiod. figure 5 shows annual geometric excess return. however, as stated linked annual geometric excess returns to get the geometric return for the 10-year period would be a mistake. table 1 summarizes the geometric attribution results for the 10-year period. geometrical excess return is negative, and it is -23.77%. it was obtained as geometrical excess return between portfolio geometrical multiperiod return and benchmark geometrical multiperiod return. another way how the excess geometric return for the multiperiod can be obtained is to calculate total multiperiod effect. because geometric attribution does not leave residual, they must be equal. sector allocation geometric effect for the 10-year period is negative, as a result of underweighting the sectors that had high shiller price-to-earning ratio and overweighting the ones that had lower than average s&p500 shiller price-to-earning ratio. stock selection for the value weighted morning star peers sector mutual funds portfolio is even more negative and the value for investors is lost for the observed period. allocation and selection effects are geometrically linked, and the result is in the line with the previously calculated 10-year excess return. figure 5. value weighted ms peers sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors 12 economic analysis (2021, vol. 54, no. 2, 1-19) table 1. value weighted ms peers sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 180.43% 267.89% -23.77% -6.79% -18.22% -23.77% source: authors value weighted fidelity sector mutual funds portfolio here we have another portfolio which was constructed based on value investment style. however, this time fidelity sector mutual funds were used to assign portfolio weights. stock selection effect was positive half of the observed time period. in all of the observed years when selection effect was positive it was significant enough to offset negative allocation effect and produce total positive excess return for the given year. such as in the 2020, 2019, 2017, 2013 and 2012 years (figure 6). on another side, unfavourable value investment style resulted in only one year of positive sector allocation effect out of the whole decade. it was the main factor why overall excess returns are negative and they only added to the negative stock selection effect. overall, negative excess returns are present in half of the observed years, and they were more significant than the positive ones. figure 6. value weighted fidelity sector mutual funds total portfolio allocation and selection annual effects – arithmetic approach source: authors -6 ,0 9% 2, 28 % 1, 98 % -3 ,1 3% -1 ,3 9% -2 ,3 3% 1, 94 % 0, 00 % 1, 38 % 7, 10 % -0 ,3 3% -0 ,0 7% -0 ,2 6% -0 ,9 8% -2 ,0 1% 1, 95 % -1 ,1 2% -0 ,7 3% -0 ,9 7% -3 ,3 3% -6 ,4 2% 2, 21 % 1, 72 % -4 ,1 1% -3 ,3 9% -0 ,3 8% 0, 82 % -0 ,7 3% 0, 41 % 3, 76 % 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 13 multiperiod attribution and geometric approach when we observe a decade as a whole, we use once again, the geometric approach. (figure 7). because of the previously explained known properties of the excess return for the multi period, negative total geometric sector allocation effect and negative combined geometric security selection effect were used to calculate the total effect for the whole period. total effect is also negative, as expected and it is -10.72% (table 2). these results are in line with the geometric difference between the value weighted fidelity sector mutual funds portfolio return and s&p500 benchmark return. for the observed decade, portfolio produced 228.46% and the benchmark produced 267.89% which resulted in excess return of -10.72% which is by definition the same as the total effect for the whole multiperiod. figure 7. value weighted fidelity sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors table 2. value weighted fidelity sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 228.46% 267.89% -10.72% -6.79% -4.22% -10.72% source: authors 14 economic analysis (2021, vol. 54, no. 2, 1-19) growth weighted morning star peers sector mutual funds portfolio moving to the growth style portfolios, we are starting with the portfolio that is constructed by sector peers. sector allocation effect, this time, is drastically different than the one that we obtained using the value style investment strategy. by assigning higher portfolio weights to the sectors with lower shiller price-to-earnings ratio we ended with the nine out ten years positive sector allocation effects. this as a result did not have a major impact on annual total excess returns that one might expect. this is because the stock selection effect for morning star peers is strong enough to offset the positive allocation effect as a result of the growth style. overall, only three out of ten observed years ended with the positive excess return (figure 8). figure 8. growth weighted ms peers sector mutual funds total portfolio allocation and selection annual effects – geometric approach source: authors multiperiod attribution and geometric approach by observing the whole decade for growth weighted morning star peers sector mutual funds portfolio, it can be seen that portfolio return of 218.89% was still below the benchmark return and it produced negative excess return of -13.32% (figure 9) (table 3). this is despite the positive sector allocation effect of 5.87% because managers from the morning star database made many suboptimal stock selection decisions in comparison to the benchmark and they fully offset all the positive effect of the growth investment style that was implemented in the portfolio construction. -6 ,6 2% -0 ,6 1% 1, 12 % -5 ,5 2% -2 ,4 3% -3 ,1 0% 1, 49 % -3 ,7 7% -4 ,3 8% 6, 34 % 0, 50 % 0, 69 % 0, 42 % 0, 53 % 1, 39 % -1 ,4 1% 0, 75 % 0, 63 % 0, 88 % 2, 14 % -6 ,1 2% 0, 07 % 1, 53 % -4 ,9 9% -1 ,0 4% -4 ,5 1% -0 ,7 4% -3 ,1 4% -3 ,4 9% 8, 49 %2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 15 figure 9. growth weighted ms peers sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors table 3. growth weighted ms peers sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 218.89% 267.89% -13.32% 5.87% -18.12% -13.32% source: authors growth weighted fidelity sector portfolio moving to the growth investment style portfolio that was constructed using only fidelity sector mutual funds our findings are very different than for the other portfolios. positive sector allocation effect for nine years this time together with the lower negative sector selection effect resulted in six out of ten periods of positive excess return (figure 9). for individual years positive allocation effect, in certain years it partially offset negative security selection effect and in other years they were working in synergy with one another. the most prominent example of synergy is the year 2020. 16 economic analysis (2021, vol. 54, no. 2, 1-19) figure 10. growth weighted fidelity sector mutual funds total portfolio allocation and selection annual effects – geometric approach source: authors multiperiod attribution and geometric approach as with other portfolios we performed multiperiod attribution. however, this time our results are different in a sense that total excess return was slightly positive. this means that portfolio outperformed the benchmark on the cumulative basis for the observed ten-year period. despite the negative selection effect as a result of fidelity managers’ suboptimal stock selection decisions on average growth weighted fidelity sector portfolio was able to beat the benchmark by implementing growth investment style (figure 11). moreover, for the whole period sector allocation effect was 5.87% and selection effect together with interaction effect negative -4.40%. that led to the slightly positive total effect of 1.21% which can be also obtained by portfolio compound return of 272.33% in relation to the benchmark (table 4). important note is that combined selection effect includes the interaction effect. that is the reason why the combined selection is not the same between value and growth portfolio using the same data series. -7 ,3 1% 2, 02 % 2, 70 % -2 ,5 0% -1 ,3 5% -3 ,6 8% 2, 61 % -3 ,9 0% 1, 56 % 8, 63 % 0, 50 % 0, 69 % 0, 42 % 0, 53 % 1, 39 % -1 ,4 1% 0, 75 % 0, 63 % 0, 88 % 2, 14 % -6 ,8 1% 2, 71 % 3, 11 % -1 ,9 6% 0, 04 % -5 ,0 9% 3, 36 % -3 ,2 7% 2, 44 % 10 ,7 8%2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7 2 0 1 8 2 0 1 9 2 0 2 0 combined selection allocation excess return boris korenak, nikola stakić 17 figure 11. growth weighted fidelity sector mutual funds total portfolio – annual and total cumulative geometric excess returns source: authors table 4. growth weighted fidelity sector mutual funds total portfolio multiperiod geometric attribution portfolio compound return benchmark compound return 10y excess return allocation effect compound combined selection effect compound 10y total effect 272.33% 267.89% 1.21% 5.87% -4.40% 1.21% source: authors conclusion by incorporating holdings data into performance attribution, we were able to get a closer insight in the portfolios investment performance that are composed out of the us sector mutual funds in relation to the benchmarks. especially valuable was to analyze sector mutual funds performance using different models and approaches, as well as to construct investable portfolios and implement the performance attribution of the same ones. this gave us opportunity to draw certain conclusions. growth style overperformed value style based on the sector allocation effect. portfolio sector weighting was based on shiller price-to-earnings ratio. reason why growth style was favourable over value style is because sectors where investors were ready to pay the highest earning multiplier were the ones that had the highest price appreciation, over the observed decade. expectations for the high growth rate of earnings in the future created a price momentum. this is especially prominent in the information technology sector. smart money underperformed when it comes to stock selection within sector mutual funds. this was true for average sector mutual fund from the morgan star database, as well as selected fidelity sector funds. 18 economic analysis (2021, vol. 54, no. 2, 1-19) in addition, both sector selection and sector allocation effects are quite heterogenous across the sectors. that means that managers in different sectors were not equally successful to beat their appropriate benchmarks. there is a strong correlation of stock selection effect between morning star and fidelity sector mutual funds year-over-year. reason for this might be related to certain fundamental biases in investment philosophy and strategy of sector mutual funds managers. finally, total excess return for multiperiod was only slightly positive for one out of four analyzed portfolios. after finding out that the stock selection effect is negative, it was clear that the positive total excess return must be driven by significant enough sector selection effect that would be able to offset the average suboptimal stock selection decisions of managers. value style underperformed the benchmark so there was no chance for value portfolios to beat the benchmark. growth portfolios had the mixed success in regard to delivering alpha. growth weighted morning star peers sector mutual funds portfolio did not produce a positive alpha. even in relation to the value weighted fidelity sector mutual funds portfolio, it slightly underperformed. the reason for this is the difference in stock selection skills between average sector mutual funds manager and selected fidelity sector mutual funds managers. the growth weighted fidelity sector portfolio had small enough negative stock selection effect, that it was possible to be fully offset by value that was produced with the growth style sector weighting on annual basis. this study was limited on equity only sector mutual funds that had only exposure to domestic market. because the mutual funds have exposure to usd we did not have to incorporate the fx market attribution. also having mutual funds that are equity only made performance attribution comparable. in addition, the attribution for self-standing years is more intuitive for users using arithmetic models. however, when it comes to multiperiod, the whole ten-year period was more adequate to be analyzed by geometric attribution. hence, we presented the multi-period excess return in relation to total effect, without residual. in addition, we used holdings-based approach that works fine with our assumptions of buyand-hold mutual funds units for 1-year period. however, with the portfolios that have high turnover, transaction-based approach would be more appropriate. also, we used total returns to calculate portfolio return. from the perspective of an investor, he/she would inquire mutual funds fees, as well as tax burden. in summary, the study shows that the sector mutual funds did not add value on average, based on negative stock selection effect. however, the negative selection effect could have been offset, in some cases partially in others fully, by assigning sector portfolio weights based on growth investment style. references abergel, frederic and heckel, thomas. 2021. “performance attribution for factor investing.” http://dx.doi.org/10.2139/ssrn.3450392 ankrim, ernest m., and chris r. hensel. 1992. “multi-currency performance attribution.” russell research commentary bacon, carl r. 2002. “excess returns—arithmetic or geometric?” journal of performance measurement 6 (3): 23–31, http://dx.doi.org/10.2139/ssrn.1858937 bacon, carl r. 2008. “practical portfolio performance measurement and attribution.” john wiley & sons. bonafede, julia k., steven j. foresti, and peter matheos. 2002. “a multiperiod linking algorithm that has stood the test of time.” journal of performance measurement 7 (1): 15– 26. brinson, g. p., & fachler, n. 1985. “measuring non-us. equity portfolio performance.” the journal of portfolio management, 11(3). https://doi.org/10.3905/jpm.1985.409005 http://dx.doi.org/10.2139/ssrn.3450392 https://dx.doi.org/10.2139/ssrn.1858937 https://doi.org/10.3905/jpm.1985.409005 boris korenak, nikola stakić 19 brinson, g. p., hood, l. r., & beebower, g. l. 1986. “determinants of portfolio performance.” financial analysts journal, 42(4). https://doi.org/10.2469/faj.v42.n4.39 campisi, stephen. 2004. “debunking the interaction myth.” journal of performance measurement 8 (4): 63–70 carhart, mark m. 1997. “on persistence in mutual fund performance.” journal of finance 52 (1): 57–82. carino, david r. 1999. “combining attribution effects over time.” journal of performance measurement 3 (4): 5–14. fama, eugene f., and kenneth r. french. 1993. “common risk factors in stock and bond returns.” journal of financial economics 33: 3–56. fama, eugene f., and kenneth r. french. 2015. “a five-factor asset pricing model.” journal of financial economics 116 (1): 1–22, https://doi.org/10.1016/j.jfineco.2014.10.010 fama, eugene, f., and kenneth r. french. 2004. "the capital asset pricing model: theory and evidence." journal of economic perspectives, 18 (3): 25-46., http://dx.doi.org/10.2139/ssrn.440920 frongello, andrew s.b. 2002. “attribution linking: proofed and clarified.” journal of performance measurement 7 (1): 54–67. grap. 1997. “synthèse des modèles d’attribution de performance.” paris: groupe de recherche en attribution de performance henriksson, r. d., and r. c. merton. 1981. “on market timing and investment performance ii. statistical procedures for evaluating forecasting skills.” journal of business 54: 513—33 karnosky, denis s., and brian d. singer. 1994. “global asset management and performance attribution.” charlottesville, va: research foundation of the institute of chartered financial analysts. menchero, jose g. 2000. “an optimized approach to linking attribution effects over time.” journal of performance measurement 5 (1): 36–42 mirabelli, andre. 2000/2001. “the structure and visualization of performance attribution.” journal of performance measurement 5 (2): 55–80 peng, huimin 2020 “holding-based evaluation upon actively managed stock mutual funds in china” papers, arxiv.org, post-doctor research at pbcsf, tsinghua university. https://arxiv.org/abs/2004.05322 pettengill, g.n., chang, g.t., & hueng, c. 2014. “choosing between value and growth in mutual fund investing.” financial services review, 23, 341. reztsov, andrei. 2011. “excess returns – arithmetic and geometric?” available at ssrn: https://ssrn.com/abstract=1858937 spaulding, david. 2003/2004. “demystifying the interaction effect.” journal of performance measurement 8 (2): 49–54 spaulding, david. 2018. “transactionvs. holdings-based attribution: the differences are not so clear but quite important.” journal of performance measurement 22 (3): 49–76 treynor, j., and mazuy, k., 1966. “can mutual funds outguess the market?” harvard business review 44 (july—august):131—136. vashisht, c., & gupta, m. 2014. “asset allocation, stock selection and interaction effects: study of concept of performance attribution in equity mutual funds.” international journal of business management weber, arno. 2018. “geometric attribution and the interaction effect.” journal of performance measurement 22 (4): 6–19, http://dx.doi.org/10.2139/ssrn.3282191 article history: received: october 12, 2021 accepted: october 21, 2021 https://doi.org/10.2469/faj.v42.n4.39 https://doi.org/10.1016/j.jfineco.2014.10.010 https://dx.doi.org/10.2139/ssrn.440920 https://arxiv.org/abs/2004.05322 https://ssrn.com/abstract=1858937 http://dx.doi.org/10.2139/ssrn.3282191 beyond the returns the u.s. mutual funds value and growth style weighted sector portfolios investment performance attribution boris korenak10f* | nikola stakić2 introduction literature review data and methodology data methodology brinson-hood-beebower model brinson-fachler model geometric model results and discussion how smart is the smart money? value weighted morning star peers sector mutual funds portfolio multiperiod attribution and geometric approach value weighted fidelity sector mutual funds portfolio multiperiod attribution and geometric approach growth weighted morning star peers sector mutual funds portfolio growth weighted fidelity sector portfolio multiperiod attribution and geometric approach references ea_2015_3-4 udc: 336.774.3(497.11) 005.24:657.631.6 cobiss.sr-id: 220026380 scientific review the accuracy of the information presented in credit bureau reports: research and comparative analysis simović vladimir1, institute of economic sciences, belgrade, serbia abstract – this paper presents research results regarding information accuracy in the serbian credit bureau reports and tries to identify the reasons which affect the accuracy of the information presented in credit bureau reports, in global terms. the research was conducted by interviewing respondents. comparative analysis was used in order to formulate proposal of factors which determine information accuracy in the credit bureau reports. the results show that the materially significant errors in information presented in serbian credit bureau reports make 0.5% of the sample. this implies that creditors in serbia base their credit decisions on reliable information. the results of this study were compared to results of the studies conducted in usa and germany in order to formulate proposal of factors which influence the information accuracy in the credit bureau reports. in order to improve information accuracy in credit bureau reports, in global terms, special attention should be paid to formulation of international standards of credit reporting and identification systems of natural persons and legal entities. key words: credit information exchange, information quality, decision support systems, information management introduction main task of a credit bureau is to provide an exchange of information that will eliminate information asymmetry and enable creditors to make decisions that will minimize credit risk. luoto et al.(2004) identify three possible levels of exchanging information between credit institutions. the lowest level means there is no exchange of information. in these circumstances, financial institutions exclusively possess information on activity of users of their services. the next level means the exchange of negative information between creditors. they share information about the unsettled payments and debts of their clients. the most sophisticated level of information exchange between financial institutions is the exchange of both positive and negative information on the credit activity of their users. 1 zmaj jovina 12, belgrade, serbia, e-mail: vladimir.simovic@ien.bg.ac.rs 1 this paper is a part of research projects numbers 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) and 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), financed by the ministry of science and technological development of the republic of serbia 30 economic analysis (2015, vol. 48, no. 1-2, 29-53) the international finance corporation (2006) cites research in argentina and brazil showing that exchanging both positive and negative information between creditors on debtors' credit activities leads to a reduction in loan default rates by 22% (in the case of argentina) and by 45% (in the case of brazil) in comparison to the situation when lenders only share negative information. the credibility of a credit bureau, viewed from the perspective of its users, as well as the overall effect it has on macroeconomic atmosphere of an economy, is dominantly affected by the quality of information in its database. the presence of a significant share of errors in the reports generated by this institution at creditors’ requests undermines the very sense of its existence. credit bureaus around the world tend to officially promote their dedication to providing the users with the accurate information. unfortunately, there are very few researches on the accuracy of information in credit reports that could support this thesis. the aim of our research is to determine the real degree of accuracy of information in credit reports of the serbian credit bureau. thus, we will determine weather creditors in serbia base their decisions on reliable credit information. moreover, we tend to identify the reasons for differences in results produced by this study and comparative studies published in the usa and germany. the motivation for this study is to empirically confirm or deny the hypothesis that the credit bureau in serbia which, based on the world bank’s methodology, has a high performance level (simovic et al. 2011) can provide serbian creditors with accurate, highquality information that would serve as a base for decision making. literature review academic literature gives very little information on the credit report accuracy. however, in the usa, several studies were conducted on the consistency and accuracy of information in credit reports of the major national credit bureaus (experian, equifax and transunion). in the year 2002, a study of consistency was conducted, sponsored by the consumer federation of america (2002). this study compared the data on mortgage applicants that were registered by all three national credit bureaus. the study was conducted on a sample of 1.700 respondents and it showed a level of inconsistency that could bring about an inadequate credit risk evaluation. avery et al. (2003) examined the contents of 249,000 credit reports from a single credit bureau and highlighted problems associated with data that was missing from a file (e.g., credit limits on revolving accounts; non-reporting of minor delinquencies), out-of-date (e.g., old balance information that had not been updated), and sometimes ambiguous (e.g., multiple collection entries but no clear reference as to the number of incidents; accounts listed as open but with no recent activity). a research conducted by the national association of state pirgs (2004) in the usa. in 2004, showed that 78% of credit reports of the largest national credit bureaus contained errors. the results of the sample analysis also showed that 25% of the reports contained errors that could significantly affect applicant’s chances of getting a credit line (materially significant errors). the study in question was conducted on a sample of 154 respondents. simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 31 in 2006, a research on the credit report accuracy was conducted by the federal trade commission (2006) on a sample of 30 respondents. the research showed that 53.33% of the reports contained at least one data error. in 2009, an independent study conducted in germany (korczak and wilken 2009), showed that 45% of credit reports from the largest credit bureau schufa contained errors. 35% of the sample results contained materially significant errors. the research was conducted on a sample of 100 respondents. apart from the mentioned economies, academic literature has no information on the credit report accuracy of other national bureaus. research on the accuracy of data in the reports of serbian credit bureau methodology and analysed sample the research that provided us with the results presented in this paper was conducted on a sample of 100 respondents, in the period february-may 2011. it included 48 female and 52 male respondents. the sample included citizens from belgrade (89 respondents) and kragujevac (11 respondents). association of serbian banks, an institution that monitors the operations of the only private credit bureau in serbia, supported this research. the 100 respondents were allowed to receive their credit reports free of charge on the premises of this institution in belgrade, serbia. serbian credit bureau’s database contains information about individuals, provided by banks and leasing companies. having this in mind, the structure of the analysed sample can be presented in terms of financial services used. table1. the structure of the analysed sample in terms of financial services used number of financial services in use number of respondents 1-3 18 4-7 52 8-10 15 11-15 11 16 or more 4 total: 100 source: author the research included 100 respondents, and the credit bureau’s database provided 782 data lines and 4.761 individual items of data on their financial activity. the methodology used for determining credit report accuracy in serbia, was based on interviewing the respondents. after receiving their personal reports from the credit bureau, each respondent analysed the data contained, under the guidance of a researcher trained for this project. the researchers used a protocol for interpreting individual report data, designed for the research and approved by association of serbian banks. the errors observed and confirmed during the interview, were entered into a research diary. the entries were made by the trained researchers, into separate diaries made for each respondent. 32 economic analysis (2015, vol. 48, no. 1-2, 29-53) results credit report errors identified during the research, can be divided into two categories: • materially significant. errors that can directly affect applicant’s chances of getting a credit line they applied for. • materially insignificant. errors related to personal data that do not affect an applicant’s chances of getting a credit line. the total sample showed that 38% of the credit reports in serbia contained errors, which means, out of the 100 analysed reports, 38 had at least one error. out of the number mentioned, 5 reports contained materially significant errors and 33 reports had errors which were not materially significant. we presented the total number of errors in relation to the number of services used in table 2. table 2. the number of errors in relation to the number of financial services used number of financial services in use number of respondents number of credit reports containing errors 1-3 18 3 4-7 52 22 7-10 15 7 11-15 11 6 16 or more 4 0 total 100 38 source: author if the respondents are categorized according to the number of financial services used, the highest portion of reports containing errors belongs to the group that has between 11 and 15 financial services in use. table 3. the percent of reports containing errors in relation to financial services used number of financial services in use number of respondents percent of reports with errors for each category 1-3 18 16.67% 4-7 52 42.31% 7-10 15 46.67% 11-15 11 54.55% 16 or more 4 0% source: author on the basis of the data shown in table 3, it can be seen that with an increase in the number of services used, there is an increase in the number of credit reports containing errors. this observatoin is expected due to the fact that users with a higher number of simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 33 financial services, have more data entries in the database and consequently, more data in their reports. the only exception to this observation is seen in the category of users with 16 or more financial services in use. as mentioned above, out of the total sample, 5% of the respondents had errors that could affect the future chance of getting a credit line (materially significant errors). below, we present the structure of the analysed sample in terms of materially significant errors. table 4. the structure of the analysed sample in terms of materially significant errors data number of respondents percent of the total sample missing active current account 1 1% incorrect overdraft amount 1 1% incorrect installment amount 1 1% missing active credit card 2 2% total number of errors: 5 5% source: author out of the total sample, 33% of credit report errors could be described as materially insignificant. in regard to this number, we should point out that out of the 33, 19 reports contained errors due to the missing information on the consumers' debit cards in use. this was the only error identified in the mentioned 19 reports. this situation results from the fact that banks, according to the bureau’s operating rules, are not required to provide the information on debit cards in use. in our research, we marked all the debit card information that was not listed in the reports as missing, and therefore, as materially insignificant. table 5. shows the structure of materially insignificant errors identified in during the research. table 5. the structure of materially insignificant errors data number of errors incorrect personal data 5 incorrect address 7 missing debit card information 26 incorrect status of the current account / payment cards 4 historical data over 3 years old still present 4 incorrect date of credit approval 1 total number of errors: 47 source: author the total number of materially insignificant errors (47) is higher than the number of reports with materially insignificant errors (33). this is due to the fact that some of the reports contained more than one materially insignificant error. 34 economic analysis (2015, vol. 48, no. 1-2, 29-53) the errors in the credit bureau reports can also be analysed according to the number of individual data lines listed on the reports. table 6. shows the error statistics according to this criterion, for serbian credit bureau. teble 6. total number of erroneous data lines in the sample of credit reports title of data line number of data lines in the sample total number of erroneous data lines in the sample personal identifying data 100 12 loans 105 2 loan default 22 2 gaurantee provider 5 / gaurantee default / / cancelled gaurantee / / current accounts 218 4 disputed claims (current account) 26 2 debit cards 179 27 disputed claims (debit cards) 8 / credit cards 96 3 credit card default 19 / leasing contract 1 / leasing contract default 3 / total: 782 52 source: author table 6. shows that of the 782 data lines in the research sample, 52 contained an error. this is the 6.65% of the sample. it is noticable that the highest number of errors was identified in data lines reffering to the debit card information (26), and then personal idendifying information (12). out of the total number of erroneous data lines, there is 5 materially significant (table 4.) and 47 materially insignificant errors (table 5.). apart from the ctriteria metioned above, credit report errors can further be analysed by looking at the individual items of data contained in the bureau's database. namely, every data line is made up of numerous individual items of data. for instance, the data line on loans, consists of 9 individual items of data (name of the bank, type of loan, installment amount, unsetteled debt...). with the 100 respondents included into the research, and 782 data lines, the total number of individual data items amounts to 4.761. simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 35 table 7. the total number of erroneus individual items of data in the research sample type of data number of data number of data errors personal identifying data 700 12 loans 945 2 loan default 132 12* gaurantee provider 45 / gaurantee default / / cancelled gaurantee / / current accounts 872 7** disputed claims (current account) 130 10*** debit cards 895 131**** disputed claims (debit cards) 40 / credit cards 864 19***** credit card default 114 / leasing contract 6 / leasing contract default 18 / total: 4.761 193 source: author *12 individual data items are erroneous due to the fact that historical data wasn't deleted 3 years following the repayment of the loan **4 erroneous individual items of data reffer to an active current account that wasn't listed in the credit report ***10 individual data items are erroneous due to the fact that historical data wasn't deleted 3 years following the closure of the current account. ****130 erroneous individual items of data reffer to the missing debit card information, and 1 idividual data item reffers to the incorrect debit card status *****18 erroneous individual items of data reffer to the missing crdit card information, and 1 idividual data item reffers to the incorrect crdit card status analyzing of the data in table 7, leads us to the conclusion that the percentage of erroneus individual items of data in the total data sample is 4.05%. the portion of materially significant errors in the total sample is 0.5%. discussion the research on the accuracy of information in the reports of serbian credit bureau, was conducted on a suitable sample of 100 respondents, and so far, it represents the only one of this kind ever conducted in serbia. as a final result, this study gave a more realistic insight into the quality of information used by serbian creditors in the process of credit decision making. the number of errors identified in the total sample, as shown in table 2, can lead to the conclusion that serbian credit bureau has a relatively high portion of erroneous reports. the reason for this lies in the fact that every report that contained even one erroneous data item, was categorized as completely inaccurate, during the research. however, the data shown in 36 economic analysis (2015, vol. 48, no. 1-2, 29-53) table 7. makes a more realistic insight of the quality of information in serbian credit bureau database, and consequently in credit reports. summerizing all the results, we can conclude that there is 38% of the reports marked as completely inaccurate. on the other hand, considering the total number of data lines analysed, the portion of errors is.6.65%, while considering the total number of individual data items, it is 4.05%. if we add the fact that there is only 0.5% of materially significant errors in the total number of individual data items, it will leads us to the conclusion that serbian creditors base their decisions on high-qaulity, relaible information coming from the credit bureau. this fact enables creditors to make more realistic credit risk evaluation for each applicant. it aslo provides a better resource allocation and minimizes default risk. (simovic, 2009) point out the fact that the category of non-performing loans in serbia dropped from 23.8% in 2005, to 4.1% in 2006. this resulted directly from the fact that the first serbian credit bureau started its business operations in 2004, and that it provided the information creditors needed in order to allocate their resources with less risk. reasons for inconsistency of credit report information analysed in the usa, germany and serbia the question that rises after summerizing the results of information accuracy research of serbian credit bureau, is why these results are far more favourable than the ones obtained from similar studies in the usa and germany. this observation particularly refers to the portion of materially significant errors, which directly determines the quality and realiability of information used for decision making. considering the fact that the studies conducted in the usa and germany show only the number of the reports marked as completely inaccurate, further analysis will be made according to this criterion. research results show that the portion of materially significant errors in serbia is 5%, while in the usa and germany it is 25% and 35% respectively (we refer to the national association of state pirgs research conducted in 2004. in the usa). the 2004. research in the usa was conduted on a larger sample of respondents than the one conducted in 2006. due to this fact, we used the 2004 research results as relevant. the degree of accuracy of credit report information is determined by a number of different factors. we consider the following factors the most dominant: • the number of national credit bureaus • the number of creditors forwarding credit information to the bureaus • the technique of matching different information on individual credit line consumers table 8 shows the number of credit bureaus in relation to the total portion of errors in their reports, for the economies where empirical researches on the accuracy of credit report information have been conducted. simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 37 table 8.the number of national credit bureaus in relation to the total percent of credit report errors (and materially significant errors) in analyzed economies country number of credit bureaus percent of reports with errors total/materially significant errors usa 3+* 78% (25%) germany 3+** 45% (35%) serbia 1 38% (5%) source: author * in the usa apart from the three largest information exchange systems, there is a large number of smaller ones ** in germany, apart from the largest credit bureau schufa, there are smaller ones such as creditinform and infoscore, as well as bureaus that primarily deal with economic entity information and public credit register from the perspective of an individual credit bureau, the degree of information accuracy should not depend on the number of competitors in the market. however, when there is more than one national credit bureau, creditors are obliged to forward them the information in different formats. they aslo need to follow different instructions given by each bureau which increases the incidence of erroneous reports. among the analyzed conuntries, serbia is the only country with a single operating credit bureau. this circumstance provides the bureau with the possibility to gather all the leading creditors (banks and leasing companies) and apply its unique credit information matching.technology. it also enables prescribing and enforcing a set of standards for credit infomation forwardnig which eliminates task and data duplication. the second important factor that, in our opinion, determines the degree of credit report accuracy is the number of sources of credit information. it is logical to assume that an increase in number of institutions forwarding credit information means a higher incidence of credit report errors. table 9. the number of credit information sources in realtion to the total percent of credit report errors (and materially significant errors) in analyzed economies country number of credit information sources percent of reports with errors total/materially significnt errors usa 30.000+ 78% (25%) germany 5.000+ 45% (35%) serbia 72 38% (5%) source: author simple analysis of the information in table 9. shows that the percent of errors increases with the increase of the number of credit information sources. however, in our opinion, if the three basic conditions are met, the impact of the number of credit information sources on credit information accuracy, would lose its relevance: 38 economic analysis (2015, vol. 48, no. 1-2, 29-53) 1. if there are standards of credit reporting, that prescribe the format to be used for information forwarding (for all the creditors and other institutions) 2. if there is a set of clear data validation rules that are being implemented in order to discard faulty, incomplete and illogical credit data before importing it into bureau's database 3. if there is a developed, nationally used system of unique identifiers used for individuals and economic entities. this system should serve as an efficient information matching technique for all the credit line consumers. an alternative to this system, which has obvious disadvantages, is formation of parallel identification systems for individuals and economic entities, whoose format should be defined by the international standards of credit reporting. with these conditons being met, the number of credit bureau's information sources, weather it be 10 or 100.000, would lose its relevance, regarding credit report accuracy. we also need to point out the significance of information matching techniques used by the bureaus in order to gather credit activity information. in this regard, table 10 shows information matching techniques in realtion to the percent of credit report errors in analyzed economies. table 10. information matching techniques used by credit bureaus in relation to the percent of credit report errors in analyzed economies country information matching technique percent of reports with errors total/materially significant errors usa single credit file 78% (25%) germany single credit file 45% (35%) serbia information matching in the moment of assembling a credit report 38% (5%) source: author in the usa and germany, credit bureaus use unique identifiers to integrate users' credit information into a single credit file. a problem related to this kind of information management, occurs in the event of unique identifier being incorrect or stored in a wrong format by the creditor. this leads to the problem of duplication or incompleteness of individual users' credit files, and subsequently to the occurrence of errors. other problem in this regard, is the fact that once the credit bureau has received credit information from the creditors, it takes the resoponsibility for information accuracy. this means that, in the case of credit report dispute, the bureau has to identify the reason for information inaccuracy and confirm the adequacy of user's request to change the information. the whole process is not only time consuming but it also creates additional costs (more people are engaged, takes more physical locations where people can address the bureau). moreover, credit bureau is responsible for integrating the information received from the creditors into one credit file, which increases the possibility of errors. simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 39 another information matching issue that can have an indirect influence on credit report accuracy, is a difficult or even impossible credit information exchange in a case of several national credit bureaus. this problem occurs when a credit file exchange is needed among them. in the analyzed countries, it's a common practice for creditors to overcome this type of a problem by withdrawing credit reports on the applicant from all the national bureas. however, this kind of credit risk evaluation creates additional costs (withdrawal costs for a larger number of credit reports) and information incosistency. namely, different credit bureaus can give reports with different information on the same applicant which creates inconsistency within the same credit line data. the entire process is characterized as unreliable, as confirmed by consumer federation of america's study conducted in the usa (2002). general conclusion is that the accuracy of information shown in credit reports, when integrated into a single credti file, depends on a number of different factors. serbian credit bureau applies a different technology of credit information matching.this technology implies that all the credtiors import users' credit information into a private database (rented private space) within the bureaus information system. while importing data into the private database, the system filters it by means of syntax and logic rules of data validation. the aim of these rules is to send back all the illogical and inadequately formated data to the creditors for correction on the other hand, data that satisfies syntax and logic rules of validation is being written into the creditor's private database within the bureau's system. when a creditor sends a request for credit report, along with written consent of the natural person or legal entity in question, the credit bureau generates a query. the query enables collection of the information on this particular user from all the private databases, by means of unique identifier. this information is afterwards imported into a reporting database and transformed into a single credit report. therefore, different pieces of credit information on a single credite line user are being matched only in the moment of assembling a credit report. the adventage of this kind of information matching technique is a very simple way of detecting errors and detrmining their cause and source. this reduces operating costs (the need for employees and physical locations where people can address the credit bureau) and makes operating procedures of the bureau much more simple. considering the fact that creditors are the only responsible for the accuracy of credit information, credit report errors can not occur as a result of the bureau's operations which is not the case with credit bureaus which use the technology of creating a unique credit file. with this kind of information management, the only possible sources of errors are unique identifiers and creditors themselves. one way to solve this problem is to apply rules of syntax and logic validation onto the data that is imported into the creditors' private databeses. the research on the credit report accuracy of serbian credit bureau, showed that the majority of the errors that occurud were materially insignificant. according to this, we can conclude that creditors take their obligation to forward reliable credit information very seriously. the research also confirmed the efficiency of data validation rules used by the 40 economic analysis (2015, vol. 48, no. 1-2, 29-53) bureau. on the other hand, the statistics mentioned, indicate that data validation rules applied for materially insignificant errors, need further improvement. the greatest potential of this kind of data collection and matching technology, lies in the fact that it could enable a rather simple credit information exchange, on the level of a national economy and in global terms, if few conditions are met. • if other credit bureaus use this technology of information management (data importing and information matching) • if creditors are obliged to participate in operations of a national credit bureau • if there are standards of credit reporting set in place • if the reliable system of unique identifiers is used worldwide if those conditions are met, the only thing that needs to be done in order to ensure efficient exchange of credit information in global terms (currently this is not an option) is the establishment of regional interlinking systems. the purpose of the interlinking systems would be to enable matching of credit information on every user from different national credit bureaus i.e. from private databases of all creditors which are in the regional interlinking system. the number of regional interlinking systems in global terms should be 5 to 6. one regional interlinking system could communicate with others in order to collect data which are possibly stored on users in private databases of their creditors by menas of it technology the whole process of generating credit report upon creditor request (meaning that literally all credit information on particular person or legal entitiy are collected) should not last more than 5 to 10 seconds. the advantages of this system of credit information exchange for the creditors are numerous. this system would reduce their costs. they would not be forced to withdraw credit reports from several different sources and compare information in order to make the right credit decision. also, they would have all existing credit information on credit line applicant in their possesion, while making credit decision.. finally, the information collected and presented in this way are much more reliable and accurate which is very important issue for the creditors. recommandations for improvement of the credt report accuracy in serbia the research on the credit report accuracy of serbian credit bureau showes that creditors in this country base their decisions on high-quality, accurate information (in terms of materially significant errors). this entirely justifies the purpose of this institution. however, this system is still being developed, which leaves a significant space for further improvement. in our opinion, the degree of information accuracy in serbian credit bureau reports can be improved in two ways: 1. the percent of materially insignificant errors in the reports of this institution is relatively high, which points out the need for improvement. the research confirmed that there is a significant number of errors in personal information of credit line users (name, surname, address). the fact that there is a rather high percent of this kind of errors, leads us to the conslusion that data validation rules simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 41 in this area are not developed enough and need further improvement. therefore, the first recommandation refers to the improvement of data validation rules in the area of materially insignificant errors. 2. the degree of accuracy of credit information could be improved by allowing indviduals and economic entities to obtain a free annual credit report. this would give users an oppurtunity to review their reports and react promptly in case of errors. subsequently, the degree of information accuracy would be raised to a higher level. this measure has already been applied in the practice of developed countries. an alternative to this could be, allowing individuals to review their credit reports when applying for a credit line. at the moment, serbian banks do not provide this option to the applicants. conclusion the research results presented in this paper, show a high degree of accuracy of information in the reports of serbian credit bureau (especially information that are crucial to the risk evaluation process). this confirms the hypothesis of a high quality of service and overall performance level of this institution. for the first time in academic literature, an analysis was performed to discover the causes of credit report errors. empirical studies on the credit report accuracy of the usa, german and serbian credit bureaus, served as a basis for this analysis. based on the available information, we suggested a set of factors that have an influence on the accuracy of information in credit reports. it was concluded that unique identifiers used for private individuals and economic entities, significantly determine the credit report accuracy. however, we also pointed out the possibility of developing alternative identification systems. in addition to this, we suggested the introduction of credit reporting standards that would raise the degree of credit information accuracy to a higher level, and improve credit information exchange in global terms. with the aim to improve the degree of information accuracy in credit reports of serbian credit bureau, we proposed the measures for the decrease of the percent of erroneous data in the database of this institution. one of the major limitations of the presented research is its sample. the sample used to analyze and determine the accuracy of data, can not be qualified as representative. the second limitation refers to the proposal of factors that determine credit data accuracy. this proposal was based on a sample consisting of only 3 countries. in our opinion, future research on the accuracy of credit information should be directed towards a larger number of national credit bureaus. this would provide the researchers with a representative research sample and enable them to conduct comaprative analyses with more reliable results. it would also give a better insight into the factors that have dominant influence on the credit report accuracy. this would provide an oppurtunity to empiricaly confirm or deny conceptual suggestions defined in this paper. 42 economic analysis (2015, vol. 48, no. 1-2, 29-53) references avery, r. b calem, p, canner, g., bostic, r. 2003. “an overview of consumer data and credit reporting.” federal reserve bulletin, 47-73. consumer federation of america. 2002. 'credit score accuracy and implications for consumers', december 17, 2002. federal trade commission. 2006. “processes for determining accuracy of credit bureau information.” pilot study, september 12, 2006. international finance corporation. 2006. “credit bureau knowledge guide.“ washington dc: world bank group. korczak, k & wilken, m. 2009. „verbraucherinformation scoring', gp forschungsgruppe, institut für grundlagen-und programmforschung.“ munchen, juni 2009. luoto, j mcintosh, c wydick b. 2004. »credit information systems in less-developed countries recent history and a test'.“ economic development and cultural change 55: 313334. national association of state pirgs. 2004. “mistakes do happen: a look at errors in consumer credit reports.” june, 2004. simovic, v vaskovic, v poznanovic, d. 2009. ”a model of credit bureau in serbia: instrument for preserving stability of the banking sector in conditions of the global economic crisis.” journal of applied quantitative methods, 4(4): 429-439. simovic, v vaskovic, v rankovic, m malinic, s. 2011. 'the impact of the functional characteristics of a credit bureau on the level of indebtedness per capita: evidence from east european countries.” baltic journal of economics 11(2): 101-130. tačnost podataka u izveštajima kreditnog biroa: istraživanje i komparativna analiza rezime – u ovom radu su predstavljeni rezultati istraživanja tačnosti podataka u izveštajima kreditnog biroa u srbiji i ukazano je na razloge koji utiču na tačnost podataka predstavljenih u izveštajima kreditnih biroa širom sveta. istraživanje je obavljeno korišćenjem metode intervjuisanja ispitanika. sa ciljem formulisanja predloga faktora koji opredeljuju tačnost podataka u izveštajima kreditnog biroa korišćena je komparativna analiza. rezultati istraživanja pokazuju da materijalno značajne greške u izveštajima kreditnog biroa u srbiji čine 0,5% ukupnog uzorka. ova činjenica ukazuje na to da kreditori u srbiji baziraju svoje kreditne odluke na pouzdanim informacijama. rezultati ovog istraživanja su upoređeni sa rezultatima sličnih istraživanja koja su sprovedena u sad i nemačkoj sa ciljem identifikovanja faktora koji utiču na tačnost podataka u kreditnim izveštajima. sa ciljem unapređenja tačnosti podataka u izveštajima kreditnih biroa širom sveta, posebna pažnja mora da bude posvećena formiranju međunarodnih standarda kreditnog izveštavanja i unapređenju sistema jedinstvenih identifikatora za fizička lica i privredne subjekte. simović, v., the accuracy of the information presented, ea (2015, vol. 48, no. 3-4, 29-43) 43 ključne reči: razmena kreditnih informacija, kvalitet informacija, sistemi za podršku odlučivanju, menadžment informacija article history: received: 13 november, 2015 accepted: 16 november, 2015 doi: 10.28934/ea.21.54.2.pp82-93 preliminary report design and packaging an important factor in consumer behavior when buying juices merima činjarević1 | emir agić2 | enisa dizdarević3 | adi alić2 muamer halilbašić40f* 1 university of sarajevo, school of economics and business, department of microeconomics, sarajevo, bosnia and herzegovina 2 university of sarajevo, school of economics and business, department of marketing, sarajevo, bosnia and herzegovina 3 university of sarajevo, school of economics and business sarajevo, sarajevo, bosnia and herzegovina 4 university of sarajevo, school of economics and business, department of economics, sarajevo, bosnia and herzegovina abstract the primary purpose of this research is to investigate the consumers’ implicit taste associations (sweetness. freshness, and naturalness) towards the color of product packaging in the context of the non-alcoholic beverage product category – orange juice. moreover, the current research aims to assess how incongruity, as opposed to congruity, between the color package and product color-code/norm may shape a consumer's evaluation (liking/disliking) of a product. the findings indicate that green appears to be the color that would lead to the highest perception of freshness and naturalness. in contrast, grey is the color implicitly associated with artificial flavors and perceived to be stale. the results of this study do not provide evidence for the existence of color/taste correspondences in terms of perceived sweetness. also, findings suggest that incongruent (atypical) color package – white, might lead to more favorable consumer attitudinal responses than the product’s color-code package – orange. the current research offers relevant insights for both researchers and practitioners. key words: package color, taste, cross-modal correspondences, orange juice jel classification: m31 introduction in the modern market, consumers are faced with a mélange of products and advertising messages, making the entire buying process highly complex. even though many factors have a bearing on what and why consumers buy, when consumers purchase day-to-day products such as snacks, candies, or soft drinks, they tend to make quick choices among available product alternatives based on visual cues (spence & velasco, 2018). although consumers can rely on other sensory cues (e.g., auditory cues, haptic cues) to make their product judgments, the use of visual cues seems to dominate over other single-sensory signals. bearing this in mind, marketers and product designers are trying to create compelling visual cues to lure the consumers' attention and influence consumers' evaluation of products or brands (kauppinen-räisänen & jauffret, 2018). considering that the color is the first visible feature of a product noticed by the consumer, the * coressponding author, muamer.halilbasic@efsa.unsa.ba merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 83 color of a product packing is regarded as the vital visual cue (e.g., piqueras-fiszman & spence, 2011; spence & velasco, 2018). hence, the choice of color of product packing plays a significant role at every stage of the buying process and drives the consumer along the marketing funnel, i.e., attention-interest-desire-action (beneke et al., 2015). the fundamental premise is that the color package almost instantly creates the sensory and high-order expectations of the product (e.g., freshness, sweetness, crispiness). this is particularly true for low-involvement and low-cost products such as food and beverages (beneke et al., 2015; lyons & wien, 2018). however, it is necessary to highlight that using the color package in evoking the favorable first impression of the product and eliciting positive consumers’ responses at different stages of the buying process is a challenging task. in some cases, by changing the color package, the company may succeed at the first stage of the buying process, i.e., grabbing consumers' attention and encouraging them to buy on impulse (spence & velasco, 2018). however, the same company may experience failure at the second moment of truth by discovering that the consumers are experiencing post-purchase dissonance or buyer's remorse (garber et al., 2000; spence & velasco, 2018). the story of crystal pepsi shows what happens when the change in the color of a product package does not meet consumers’ expectations about the product’s sensory attributes (e.g., taste). pepsi co. introduced crystal pepsi in 1992 as a caffeine-free version of traditional pepsi cola. to underline the characteristics of the new soda drink and as well as to attract consumer's attention, pepsi co. replaced the typical color (dark brown) with an atypical one (transparent color). crystal pepsi was advertised with the slogan "you've never seen a taste like this", pointing out the change of color packing and introducing the new taste. however, when crystal pepsi was released, the consumer reaction was less than enthusiastic. one year after the launch, pepsi co. discontinued the production and sale of crystal pepsi. it has been argued that the drastic change in color package (transparent color) has contributed to the failure of crystal pepsi. more precisely, based on the transparent-colored package of crystal pepsi, consumers had created expectations that new soda drinks would have different tastes compared to regular coke. they were displeased when the new product tasted almost the same (krishna et al., 2017). the case of crystal pepsi demonstrates that a color package can induce consumers' sensory expectations (taste/flavor) and affect the consumers’ positive or negative evaluation (liking/disliking) of a product or a brand. the phenomenon of cross-modal correspondences can explain the color-induced expectations of the sensory properties of a product. previous research has shown that consumers express consistent cross-modal correspondences across the different types of sensory stimuli (e.g., spence & deroy, 2014; velasco et al., 2016). several studies demonstrated that consumers tend to match specific tastes with product package's particular visual attributes, including the color, shape, and graphics (e.g., velsco et al. 2016; piquerasfiszman et al., 2012). one of these cross-modal correspondences that have particularly attracted the attention of both scholars and practitioners is the color-taste/flavor correspondences (e.g., barnett & spence, 2016; carvalho et al., 2017). cross-modal correspondences of the color package and taste can be explained by the fact that people are inclined to associate basic tastes (e.g., bitter, sweet, sour, salty) with a particular color of product/brand packaging (spence et al., 2015). for instance, black and brown packages are associated with bitter tastes, yellow packages with sour flavors, and red and orange packages with sweet tastes (spence et al., 2015). moreover, extant literature implies that consumers are also prone to associate a specific package color with a particular product category. for instance, consumers usually expect to find different milk brands in white boxes, water in blue containers, and dark chocolate in red packages. these specific expectations regarding the match (congruency) between the color of a particular product and the typical package color traditionally associated with its product category are known as color codes/norms (garaus & halkias, 2019). previous research reveals that consumer's perception of congruity/incongruity of the color package with color code/norm can influence consumer responses. 84 economic analysis (21, vol. 54, no. 2, 82-93) although the color-taste correspondences have been explored across a range of food and beverage products, the associations between the color package and expectations about the taste of orange juice remain unexplored. orange juice is an appealing product choice for this research since it is the most popular fruit juice flavor, well-known for its health benefits (kim et al., 2013). albeit the study's findings published by deliza et al. (2003) suggest that orange juice is very likely to be a product where color/taste correspondences exist, additional research is required to validate this claim. in terms of congruity/incongruity of product package with product category color norm, extant research suggests that orange is a typical color associated with orange juice (garaus & halkias, 2019). however, there is a lack of research exploring the effect of the atypical color of orange juice package on consumer responses (liking/disliking). given that schema incongruity theory postulates that moderate deviations from consumers' expectations may lead to positive responses, it is lucrative to investigate the consumers' preferences toward typical color packages of orange juice. the present study aims to: (1) examine consumers' implicit taste associations (sweetness, freshness, and naturalness) toward the color packages of orange juice; (2) assess consumer evaluation (liking/disliking) toward the color of orange juice package by including both typical and atypical product category colors. theory and hypotheses color-taste correspondences the fundamental premise of crossmodal correspondences is that individuals tend to match a " consistently sensory feature, or attribute, in one modality—either physically present or merely imagined—with a sensory feature in another modality” (deroy & spence, 2013, p. 644). according to spence (2011), three different mechanisms can trigger crossmodal correspondences: structural, statistical, and semantic. structural correspondence refers to the innate tendency of the human brain to assign more profound meaning to the stimulus using the neural mapping of sensory stimuli. statistical correspondence is the result of perceptual learning, and it reflects the learned correlation between attributes of different sensory stimuli. semantic correspondence occurs when standard linguistic terms are used to describe different stimuli. although the theory of crossmodal correspondences is deeply rooted in cognitive psychology, it has also been applied in packing design research. in terms of food and beverage packing design, most researchers have focused on how visual stimuli (e.g., shape, color) can influence basic tastes. regarding the shape, it has been established that angular package shape is associated with bitter, sour, and salty tastes while rounded package shape is related to sweet and rich/creamy tastes (chen et al., 2018; spence & ngo 2012). moreover, previous research suggests that manipulating the package shape itself may influence the intensity of taste. for instance, becker et al. (2011) examined how the shape of the lemon yogurt package (angular vs. rounded) affects the taste intensity. they found that an angular, as opposed to a rounded, package shape is related to the higher level of taste intensity. also, it has been demonstrated that glass/cup shape may influence the taste/aroma of wine, beer, and coffee (delwiche & pelchat, 2002; mirabito et al., 2017; van doorne et al., 2017). for instance, van doorne et al. (2017) confirmed the existence of shape-taste symbolism in the case of milk-based coffee drinks (cappuccino). more precisely, their study revealed that shape influences the expected liking, bitterness, and the rated quality of the cappuccino. also, they found that angular shape, compared with a rounded shape, is associated with a higher level of likeability, bitterness, and the drink's quality. previous research has also confirmed the existence of color-taste symbolism. koch and koch (2003) explored the associations between ten colors (red, green, yellow, blue, brown, orange, purple, black, grey, and white) and eight tastes (sweet, sour, bitter, salty, citrusy, syrupy, fruity, and bubbly) in the context of soft drinks. they found that five out of ten colors are associated with basic tastes, namely red and orange, related to sweet tastes, green and yellow to sour tastes, and merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 85 white to bitter and salty tastes. the colour/taste correspondences have been also validated in other studies (e.g., ares & deliza, 2010; piqueras-fiszman & spence, 2011; piqueras-fiszman et al., 2012; rebollar et al., 2012). moreover, it has been suggested that color saturation, i.e., the intensity of color, may affect the intensity of the product taste. for instance, becker et al. (2011) found that highly saturated color is associated with more intense taste sensations by manipulating the saturation level of lemon-greenish-colored yogurt package. tijssen et al. (2017) showed how the manipulation of color attributes (hue, brightness, and saturation) affects the consumer's expectations about the taste of a product as well as the evaluation of a product. by using the implicit association tests (iats), they demonstrated that red package is associated with the highest expectations for sweetness, creaminess (dairy milk), fattiness (sausage), and flavor intensity (dairy milk and sausage). also, the study's findings of tijssen et al. (2017) confirmed that the expected intensity of taste could be manipulated by changing two attributes of color, namely the brightness and the saturation. overall, previous research indicates that color package attributes (hue, brightness, saturation) are likely to be transferred to the consumer's evaluation of the product itself (see table 1. for a review of selected studies published in this area). table 1. review of studies that have investigated the association between the color package and sensory properties of a product author(s) (year) product package color studied main findings ares and deliza (2010) milk dessert yellow black white milk dessert in the yellow package was perceived to be sweet, delicious, vanilla flavor, and dulce de leche. milk dessert in the black package was perceived to be bitter with chocolate flavor. milk dessert in the white package was perceived to be sour and tasteless. becker et al. (2011) yogurt yellowgreenish yogurt from the high saturated yellow-greenish package was perceived to have more intense taste than yogurt from the low saturated yellowgreenish package. rebollar et al. (2012) chewing gum warm colors cold colors grey chewing gums from warm-colored packages were judged to be fruity, sweet, and acidic. chewing gums from cold and grey-colored packages were judged to be spicey and with menthol flavor. piquerasfiszman et al. (2012) strawberry mousse white black mousse served at a white plate, compared to the same mouse served at a black plate, was perceived to be more intense and sweeter. piquerasfiszman and spence (2012) hot chocolate white cream red reddish orange hot chocolate served in orange (with a white interior), and dark-cream colored cups increased the chocolate flavor of the drink and, thereby, improved acceptance of the beverage. hot chocolate served in the dark-cream cup was perceived as sweeter and with a more intense aroma. beneke et al. (2015) bottled water warm colors neutral colors cold colors consumers preferred the neutral-colored package as opposed to neutral and cold-colored packages. 86 economic analysis (21, vol. 54, no. 2, 82-93) author(s) (year) product package color studied main findings huang and lu (2015) breakfast cereal ice-cream iced tea yogurt red blue green the majority of respondents associated the red packaged products with a sweet taste, whereas the green and blue-colored packaged products are associated with healthiness. tijssen et al. (2017) dairy drink sausage blue (both products) purple (dairy milk) red (both products) green (sausage) dairy milk from the red-colored package was perceived to be more taste intense and sweeter. sausage milk from the red-colored package was perceived to taste more intense and high-fat. the relationship between color brightness expected the intensity of taste depends on the product category (positive relationship of dairy brink but negative for sausage). the relationship between color saturation and the intensity of taste was found to e positive for both products (dairy milk and sausage). da rosa et al. (2019) cookies (buttery vs. cereal) grey blue-to-green red-to-yellow cookies from red-to-yellow and blue-to-green colored packages were preferred over the cookies from the grey-colored package. ares and deliza (2010) milk dessert yellow black white milk dessert in the yellow package was perceived to be sweet, delicious, vanilla flavor, and dulce de leche. milk dessert in the black package was perceived to be bitter with chocolate flavor. milk dessert in the white package was perceived to be sour and tasteless. based on this backdrop, we formulated the following hypotheses: h1: orange juice from the warm-colored package is perceived to be sweeter than orange juice from cold-colored and neutral-colored packages (white and grey). h2: orange juice from cold-colored packages is perceived to be fresher than orange juice from warm-colored and neutral-colored packages. h3: orange juice from cold-colored packages is perceived to be more natural than orange juice from warm-colored and neutral-colored packages. typicality in color packing marketing scholars argue that consumers tend to organize products within their corresponding product category based on the level of perceived typicality (celhay & trinquecoste, 2014). in the case of the color package, the typicity refers to the degree to which the color of the product package conforms the generic color code/norm of its category (van ooijen et al., 2016; garaus & halkias, 2019). for instance, a color code typically used for ketchup is red, mayonnaise yellow, and organic food green. the rationale behind the choice of color codes in packing is that such stimuli are processed more fluently than other stimuli (winkielman et al., 2006). also, they are positively related to the consumer emotional and attitudinal responses (garaus & halkias, 2019). however, incongruity theory suggests that using an atypical color package may attract consumer attention and lead to more positive responses (van ooijen et al., 2016; schoormans & robben, 1997). spence and velasco (2018) pointed out how nabisco' breakfast cereal brand alpen moved merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 87 away from predominantly bright color code and embraced the black product packing to stand out from other breakfast cereal brands. against this backdrop, we formulate the following hypothesis: h4: atypical package color, compared to the typical package color, will lead to a more favorable attitude (liking) toward a product. methodology stimulus development considering that color associations differ among cultures, a pre-study was conducted to identify a standard package design for a selected product (orange juice) in the country where research was performed bosnia and herzegovina. the findings of the pre-study were used as a framework for developing mock packages for a fictional brand of orange juice named orange splash. we created mock packages and a fictional brand to avoid potential bias in consumer responses (e.g., familiarity with existing brands and consumers' habits). also, the findings of our pre-study allowed us to select realistic typical and atypical package colors for orange juice. using google's image search, we found that orange is a typical package color for orange juice, while white can be qualified as potential atypical color. to examine the presence of color-taste symbolism, we selected five colors, namely orange (corresponding to the warm-colored package), black and green (corresponding to the cold-colored packages), and grey and white (corresponding to the neutral-colored packages). in line with previous studies, we manipulated only the hue, holding other attributes of color (value and saturation) constant. furthermore, we did not include other visual and verbal packing elements (shape, size, graphics, country of origin, etc.) in mock packages to avoid potential interaction effects between the package color and other package attributes. the visual design of the mock package was created in adobe photoshop by a professional designer. participants and procedure two hundred fifty-five undergraduate students from the largest university in bosnia and herzegovina participated in the experiment. participants were randomly assigned to five experimental groups, and each group was exposed to a different stimulus. considering the treatment design, each participant had the opportunity to see and rate only one out of five images of mock packages. participants were asked to evaluate taste properties of orange juice using the three semantic differential scales, namely sweet/sour, fresh//stale, and natural/artificial. each of these scales had seven categories, represented by numbers ranging from -3 to +3. for instance, sweetness scale had 7 categories, namely “very sweet” (-3), “sweet” (-2), “slightly sweet” (-1), “neither sweet nor sour” (0), “slightly sour” (+1), “sour” (+2), and “very sour” (+3). at the end of the experiment, respondents were exposed to all stimuli (five different mock packages), and they were asked to rate the liking of each package, using the 5-point likert scale (1 – “most preferred” to 5 – ‘’the least preferred”). analysis and research findings table 2. describes the respondents’ demographic characteristics. out of 255 respondents, 63.5 percent were female and 36.5 percent male. all respondents were young consumers, and the majority of them were 18-20 years old. in terms of frequency of purchase, 13 percent of respondents have purchased orange juice daily. more than one third of respondents (37.2 percent) are heavy buyers of orange juice since they are buying orange juice on daily or weekly basis. one-third of the respondents (27.8 percent) are light buyers as they have purchased orange juice at least once in a month. the most preferred orange juice brands are cappy, juicy, and fructal. 88 economic analysis (21, vol. 54, no. 2, 82-93) table 2. demographic profile of respondent variables categories frequency (%) gender female 63.5 male 36.5 age 18 – 20 years old 69.9 21 – 24 years old 30.1 frequency of orange juice purchase on daily basis 13.3 at least once per week 23.9 2 – 3 times per month 34.9 at least once per month 27.8 type of favorite orange juice brand juicy 35.7 cappy 44.3 fructal 15.3 others (rauch, takovo, to) 4.7 source: author’s own research an anova analysis was used to test potential differences in consumers' evaluation of orange juice taste (sweetness, freshness, naturalness) among five different colors of orange juice package. when those differences were significant, genuinely significant differences were determined by employing the post-hoc for pairwise comparison. observed differences were regarded as significant if the p-value was 0.05 or lower. statistical analyses were carried out using spss. to assess the reliability and validity of anova statistics, levene's test of homogeneity of variances was carried out. for two variables (“sweetness” and "naturalness"), the f values of levene's test were greater than 0.05, indicating that null hypothesis (no difference) for the assumption of homogeneity of variance is met. on the other hand, f-value of levene’s test for the variable “freshness” was less than 0.05, suggesting that null hypotheses (no differences) for the assumption of homogeneity of variance can be rejected. given that the assumption of homogeneity of variance is violated for two variables (“sweetness” and “naturalness), we employed games-howell’s post hoc test for pairwise comparison instead of tukey post hoc test. table 3. means and differences with tukey's test and games-howell's post hoc test for color/taste cross-modal correspondences taste attributes warm color cold colors neutral colors f statistic s p-value orange (a) green (b) blue (c) white (d) grey (e) sweetness 1.34 1.38 1.74 1.30 1.12 1.322 0.262 freshness -1.48 -1.78c,e 1.00b 1.40 1.19 2.184 0.071* naturalnes s 0.10 0.69e -0.08 0.53e -0.22 2.268 0.062* note: values with different superscripts in the mean are significantly different (p < .05) according to tukey’s test and games-howell’s post hoc test means in a column based on the 7-point likert scale ranging from -3 (sweet/fresh/natural) to +3 (sour/ stale/artificial) source: author’s own research an anova analysis showed no significant differences in perception of sweetness between the five experimental groups ((f(1.322); p>0.05). therefore, hypothesis h1: orange juice from warmcolored package is perceived to be sweeter than orange juice from cold-colour packages and neutral-colored packages, is not supported. surprisingly, findings revealed that all five selected merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 89 colors are associated more with sour tastes than with sweet tastes. regarding the general premise that cold-colored packages are perceived as fresher than warmand neutralcolored packages, results of anova confirmed this assumption ((f(2.184), p<0.05). the pairwise comparisons test indicates that a significant difference in the perception of freshness exists between cold-colored and natural-colored packages. tukey’s post hoc test revealed that orange juice in the greencolored package was perceived as fresher than that in the grey-colored package. furthermore, a significant difference was observed in the perception of freshness between green-colored and blue-colored packages, indicating that green color is associated more with freshness than blue. however, it should be noted that no significant differences in the perceived freshness of orange juice were found between green and orange packages and green and white packages. this result suggests that green, orange, and white packages are closely associated with the perceived freshness of orange juice. since significant differences in the perception of freshness were observed between green (cold color) and grey (neutral color) packages, hypothesis 2: orange juice from cold-colored packages is perceived to be fresher than orange juice from warm-colored and neutral-colored packages, is partially supported. in terms of perceived naturalness, significant differences were found between five experimental groups (f (2.268), p<0.05). gameshowell’s post hoc test for pairwise comparisons showed a significant difference in the perceived naturalness of orange juice among green and grey packages and white and grey packages. no significant differences were observed between the other pairs of color packages. this result indicates that green and white packages are closely associated with the perception of naturalness. bearing this in mind, hypothesis h3: orange juice from cold-colored packages is perceived to be more natural than orange juice from warm-colored and neutral-colored packages, is partially supported. in line with our expectations, the atypical color of the orange juice package – white (mean rank = 2.54), led to a more favorable attitude (liking) than the typical color – orange (mean rank = 2.80). moreover, the friedman rank sum test shows that consumer preferences toward a product differ among different package colors (χ=52.97; p<0.01). thereby, hypothesis h4: atypical package color, compared to the typical package color, will lead to a more favorable attitude (liking) toward a product, is supported. however, we should note that incongruity with the product category color norm in some cases (grey-colored package) resulted in a less favorable attitude /liking) than typical color-orange. discussion and conclusion the present study was designed to explore the degree to which consumers implicitly associate particular tastes (sweetness, freshness, and naturalness) to specific product packaging colors. against this backdrop, this study provides compelling empirical evidence to support the existence of cross-modal correspondences between color and taste (color/taste correspondences) in product packaging. more precisely, the current study investigates how cold-, warm-, and neutralcolored packages are tied to the perceived sweetness, freshness, and naturalness of a product (i.e., orange juice). the overall results indicate that green seems to be the color that would lead to the highest perception of freshness and naturalness. in contrast, grey is the color that is implicitly associated with artificial flavors and perceived to be very stale. contrary to our expectations, we did not confirm the effect of package color on the perception of sweetness. this finding contradicts extant research arguing that warm colors (e.g., orange, red) are likely to stimulate the taste of sweetness (e.g., rebollar et al., 2012; spence et al., 2015; tijssen et al., 2017). one way to explain why warm color (orange) did not evoke the highest level of perceived sweetness in our study is that the color/taste correspondences vary across cultures (carvalho & spence, 2019). another possible explanation is that sweetness is not a taste attribute that is primarily associated with the chosen beverage (orange juice). grounded in the schema incongruity theory, the present study was carried out to investigate how the use of typical and atypical package colors influences consumer's attitudes 90 economic analysis (21, vol. 54, no. 2, 82-93) (liking/disliking) toward a product. our findings suggest that the deviation from the generic color code/norm of product category might trigger a more favorable attitude (liking) toward a product. more specifically, findings suggest that consumer attitude toward a product (orange juice) differs among different product packaging colors. in terms of typicity, results reveal that a whitecolored-package is likely to lead to a more favorable attitude (liking) toward a product (orange juice) than orange, confirming the product's color code/norm. however, it should be noted that previous research have showed that some consumer segments (e.g., young consumers, consumers with higher level of innovativeness, consumers who are 'expert' in product category) are more prone toward atypical packaging (celhay & trinquecoste, 2015). considering that our sample includes only young consumers (18-24 years old), the reported propensity toward the atypical color of a package, opposite to the typical color of a package, is not particularly surprising. the present study contributes to the extant literature in marketing and food science by exploring the applicability of color/taste correspondences in the context of non-alcoholic beverages, namely orange juice. the findings extend our knowledge about the phenomenon called ‘sensation transference' in the area of product packing design by providing empirical support to the idea that people are inclined to transfer sensations and perceptions derived from product packing elements to the product itself. more precisely, the present study suggests that green is the color that is most related to the perception of sweetness and freshness of orange juice. furthermore, the current research contributes to the schema incongruity theory by demonstrating that incongruity, opposed to congruity, between the color package and product color-code/norm may generate more positive attitudinal responses toward the product. the current research provides managerial implications for orange juice manufacturers and packing designers. since consumers tend to associate a specific color of orange juice packing to certain taste attributes, orange juice manufacturers should concentrate not only on the taste properties of orange juice itself but also on the visual elements of product packing. by changing the color of product packaging, the marketers may shape consumers' expectations/perceptions regarding the taste of the orange juice stored in such packing. if marketers want to trigger expectations/perceptions of freshness and naturalness, they should opt for green-colored packages. moreover, marketers should use trial experiments to assess consumers' attitudinal and emotional responses toward the typical (orange) and atypical (white) orange juice package. although our study suggests that white-colored package is likely to lead to favorable consumers' responses, marketers should be cautious about using atypical package colors. any deviation from the typical package color may generate confusion about the product and lead to negative feelings and attitudes (garaus & halkias, 2019). the present study has some limitations that offer pathways for further research. first, in the current research, only the package color is manipulated to avoid any potential interaction between the package color and other visual and verbal elements of packing (e.g., shape, graphics, nutritional claims, etc.). although this decision enabled us to assess the isolated effect of color packages on consumers' evaluation of a product, it does not reflect the real-life correspondences among multiple stimuli. thus, future research should emphasize the possible cross-modal correspondences between color, shape, and taste attributes. moreover, our research focuses on only one product category – orange juice, which makes the results merely applicable to this product category. thereby, future studies are encouraged to deepen our knowledge about color/taste correspondences in the context of other food and beverages. moreover, in this study, the selection of package colors was based on the pre-study carried out using the google picture search engine. thereby, qualitative research addressing the issue of correspondence between package colors and taste attributes would be welcomed in the future. such research may contribute to identifying taste attributes and package colors that are relevant for the chosen product category and, thereby, provide more reliable findings regarding the color/shape symbolism. lastly, the present study focuses only on younger consumers (18 – 24 years old). since color/shape symbolism and reactions to (a)typicity of color packages may vary across different merima 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“on tasty colours and colourful tastes? assessing, explaining, and utilizing crossmodal correspondences between colours and basic tastes.” flavour, 4: 23. doi: https://doi.org/10.1186/s13411-015-0033-1 tijssen, irene, cees de graff, elizabeth h. zandstra, and gerry jager. 2017. “why a 'light' product should not be light blue: effects of package color on perceived healthiness and attractiveness of sugar-and fat reduced products.” food quality and preference, 59: 46-58. van doorn, george, andy woods, carmel a. levitan, xiaoang wan, carlos velasco, cesar bernal-torres, and charles spence. 2017. “does the shape of a cup influence coffee taste expectations? a cross-cultural online study.” food quality and preference, 56: 201–211. van ooijen, iris, marieke l. fransen, peeter w.j. verlegh, and edith g. smit. 2016. “atypical food packaging affects the persuasive impact of product claims”. food quality and preference, 48: 33-40. velasco, carlos, andy t. woods, olivia petit, adrian d. cheok, and charles spence. 2016. “crossmodal correspondences between taste and shape, and their implications for product packaging: a review.” food quality and preference, 52: 17–26. merima činjarević, emir agić, enisa dizdarević, adi alić, muamer halilbašić 93 winkielman, piotr, jamin halberstadt, tedra fazendeiro, and stave catty. 2006. “prototypes are attractive because they are easy on the mind.” psychological science, 17: 799–806. article history: received: september 9, 2021 accepted: october 18, 2021 design and packaging an important factor in consumer behavior when buying juices merima činjarević1 | emir agić2 | enisa dizdarević3 | adi alić2 muamer halilbašić40f* introduction theory and hypotheses color-taste correspondences methodology stimulus development participants and procedure analysis and research findings discussion and conclusion references microsoft word 2007 3 4.doc volume 40 • autumn 2007 • 41    abstract: the paper refers to the development of corporate governance phenomenon in the fed‐ eral republic of yugoslavia (fry) during the 1990s of the twentieth century. it is about the country estab‐ lished by disintegration of the former socialist yugoslavia, which was in the immediate war zone, under the  united nationsʹ sanctions a full eight years and had one of the most undemocratic regimes in the world. in  those circumstances, under the influence of factors from external environment, but also in a situation of un‐ finished privatization and transition processes and almost complete centralization of entire social and eco‐ nomic life, the specific forms of corporate governance developed, that did not bear much resemblance to the  practice in other countries. many ex‐socialist countries of the central and eastern europe which at that time  were in the initial phases of transition also faced certain ʺchildhood illnessesʺ characteristic of the corporate  governance development. that was a logical consequence of the long‐standing existence of socialist systems,  absence of private ownership, the real corporations and market economy institutions. meanwhile, however, it  became possible to find adequate solutions too many problems and deviations. in yugoslaviaʹs case, the oppo‐ site trends and one strange kind of corporate governance have appeared, due to the rise of unusual forms of  corporations, uncharacteristic ownership, and specific mechanisms of control and governance. in that situa‐ tion, ʺchildhood illnessesʺ were not adequately cured, but soon began to take on some degenerative forms.  since eventually the necessary political changes were effected in yugoslavia in 2000, the bases for radical  departures from the past and correction of many mistakes and misconceptions were formed. one of them has  certainly referred to the departure from the strange kind of corporate governance.   introduction  welcome to the story about one utterly strange kind of corporate governance. it will be ana‐ lyzed on the example of a country that in the era of increasing internationalization and globaliza‐ tion processes during the last decade of the twentieth century tried to live isolated from the rest of  the world. under the undemocratic regime of one man and his politics, some strange economic  processes and phenomena developed those were relatively unknown to contemporary economic  theory and practice.  hence, this story could be similar to travelling to some attractive and exotic  destinations. or, perhaps, to one of the episodes of the space tracks series when captain spock with  his crew landed on some new planet. they soon noticed that certain forms of life existed there, but  not the ones known to the rest of the world or the ones they were used to.   the country we are going to talk about is the federal republic of yugoslavia (fry), that at  the beginning of 2003, officially changed its name into serbia and montenegro. it is located at al‐ most the very heart of the south‐east region of europe, in the balkan peninsula, bordered by hun‐ gary to the north, romania and bulgaria to the east, albania and macedonia to the south and bos‐ nia and herzegovina and croatia to the west. it was established after disintegration of the former  socialist federal republic of yugoslavia (sfry) and constituted of the two then remaining repub‐ lics – serbia and montenegro. the time frame we are interested in is the period between 1992 and  2000, when the civil war raged in that region, while the fry was almost all that time under the  regime of severe sanctions imposed by the united nations.  one could ask himself – why the title of the paper is exactly the strange kind of corporate  governance? the reason lies in the fact that in the federal republic of yugoslavia during the men‐ tioned period certain elements of corporate governance have existed but not in the form known to  the strange kind of corporate governance dejan erić, institute of economic sciences, belgrade, serbia  key words : corporate governance, management, control, state  jel : o16, g30 original paper  2007 ‐ 42  •  economic analysis®  economically developed, or as we shall refer to it in this paper, ‐ ʺnormalʺ world. in order to ex‐ plain the strange kind of corporate governance an analysis will be focused on four basic elements:  o corporation  ‐ as a business organization with  its ownership divided  into common  stocks.  o ownership rights and property relations – which are considered to be protected and  completely clearly defined.  o corporate management – who is expected to show a high level of responsibility, effi‐ ciency and effectiveness; and  o appropriate institutional environment – which encompasses the whole set of factors,  such  as  a  reliable  legal  system,  developed  stock  market  or  stock  exchange,  larger  number of financial institutions, precise accounting standards, independent experts,  the existence of appropriate know‐how and system of information, etc.    if we were just a bit more critical of what happened in serbia and montenegro during the  1990s we could already assume that little of what we have just mentioned actually existed at that  time! namely, there were no true corporations, almost non‐existent property right protection, no  efficient and effective management, or appropriate infrastructure to support that. all resembled  the situation when captain spock landed on almost desert planet, with seemingly no visible traces  of life. we now come to one very crucial moment regarding this paper, when we could simply  conclude it by stating that the practice of corporate governance did not exist in the fry. however,  if we give up a further analysis we would commit at least two mistakes. first, we would unrea‐ sonably waste your precious time by reading the previous part of the paper and second, we would  miss the chance to learn about one extremely strange form of corporate governance in the world  context. therefore, since captain spock is still a very determined man, he finally managed to find  something that showed some signs of life on seemingly dead planet. so did we. and we stay in  this story, so if we scratch little further under the surface we shall see that in essence there are cer‐ tain elements of corporate governance, but ʺprettyʺ malformed and extremely peculiar.  finally, why would someone write about corporate governance in the fry, that is, serbia  and montenegro anyway? there are several possible answers. first of all, this region has not been  researched so far, either in the country itself, or abroad. after dethroning of slobodan milosevic  from the position of authority and power, both republics are in the process of accelerated transi‐ tion towards market economy, which should imply a fast break with the past. the country still has  big economic problems, relatively low level of gross domestic product and extremely low living  standards of its citizens. this is why the mistakes from the past should be identified and many  accumulated problems solved. it is necessary to find the ways how to finish the already begun  process of privatization in as short time as possible and raise the entire efficiency and effectiveness  of management and business operations of economic subjects. in that sense, an issue of corporate  governance is gaining so much in importance. eventually, there is one more important reason –  the author himself lives and works in that country. maybe he would prefer to write about corpo‐ rate governance in italy, france or nebraska, but he happens not to be from these regions.  the paper, that analyzes the strange kind of corporate governance, will be divided into four  parts.  in  the  first part, we shall emphasize some of  the most  important characteristics  that  the  ʺnormalʺ types, that is, the usual kinds of the world corporate governance excel at. the second part  points out a certain manifestations of deformed corporate governance in the fry. the third part  deals with some specific issues of the former socialist countries and characteristic environment of  the fry that contributed to emergence of the strange kind of corporate governance. finally, in the  fourth part we shall focus on certain specific features of the strange kind of corporate governance  in serbia and montenegro during the 1990s.   volume 40 • autumn 2007 • 43  the most important features of the ʺnormalʺ corporate governance  there are many possible approaches to researching the field of corporate governance. no  matter what and which approach or method we choose to analyze, it is practically impossible not  to mention the three indispensable elements (robert monks & neil minow, 1995):  o corporation  o ownership and  o management.  this approach implies, first of all, that in the economic structure of a national economy there  must  exist  public  corporations  with  certain  tradition  which  is  quite  disparate  from  country  to  country. although certain elements of financing by way of selling shares in the specific business  ventures can be traced back to the ancient greece (in regard to commercial travelling of ships) and  rome (building of roads and waterworks), the roots of modern corporations can be found with  emergence of joint‐stock companies during the sixteenth and at the beginning of the seventeenth  century. among the first mentioned there were muscovy company of the london trader sebastian  cabot founded in 1553, and more famous and renowned united east india company, established on  march 20, 1602 in holland (robert sharp, 1989, pp. 7‐16). some companies such as for example hud‐ son bay company, set up in 1670 in england still exists today. adolf berle and gardiner means (1932),  professors at columbia university, pointed out that the origins of corporate system in the usa  dated back to the beginning of the nineteenth century, when there were about ʺ335 profit‐seeking  corporations, 219 turnpikes, bridges and canal companiesʺ. the development of industry, trans‐ portation, trade, and later banking contributed to their foundation and strength. modern corpora‐ tions that appeared in the usa and the uk at the beginning of the nineteenth century have con‐ tinuously been developing for more than 200 years. there were times of great rises, but also occa‐ sional falls, and scandals. still, what is most important the development has proceeded without  violent interruptions. thus, we can claim that the tradition of corporation development is some‐ thing that presents the exceptional value and wealth of the west world!   the second major element which if left out would make corporate governance analysis prac‐ tically  impossible to perform  is the property right protection and clearly defined property rela‐ tions. all this is hard to exist without an efficient system, in the first place legal system! in the case  of ʺnormalʺ systems the things are crystal clear – a corporation issues stocks, stockholders have  voting rights they use at the stockholderʹs assembly in order to choose board of directors, whose  main role is to protect the interests of stockholders. this means that the third, unavoidable element  of corporate governance analysis must be efficient management who is responsible to owners for  corporation performance, primarily with regard to the creation of shareholdersʹ values (alfred rap‐ paport, 1986). the ownerʹs welfare is being created by dividend payments or capital gains, which  presents the basis for a managerʹs assessment. in the west, especially in the usa and uk, there is a  built  sense  of  responsibility  and  a  high  level  of  awareness  regarding  the  interests  of  owners  handed down from generation to generation!   sometimes in relations between the owners and managers some agency problems and costs  could arise  (m. jensen & w. meckling 1976, e. fama 1980). these occurrences are primarily the con‐ sequence  of  spreading  the  corporate  ownership  to  a  great  number  of  individual  stockholders.  these  situations  demand  a  separation  of  ownership  from  control  what  the  already  mentioned  adolf berle and gardiner means (1932) wrote about back in the 1930s. they differentiated between  the five basic types of control:  1. control through almost complete ownership  2. majority control  2007 ‐ 44  •  economic analysis®  3. control through a legal device without majority ownership  4. minority control   5. management control.  in  developed  countries  these  five  types  of  control  are  present  even  today  to  a  lesser  or  greater extent. each of them has certain specific characteristics, but no matter the type, the rules are  absolutely clear. it is very hard to talk about the above mentioned types of control in the case of  socialist countries, as yugoslavia essentially was. private ownership did not exist until the end of  the 1980s, so none of these types of control could completely and independently develop.   many researchers  in the field of corporate governance have  identified different types and  approaches. thus marco becht,  for example, a german economist and executive director of  the  european corporate governance institute in brussels pointed out that there are multiple models of  corporate governance developing around the globe (business week, 2002). david o. beim & charles  calomiris (2001, pp. 213) went one step further in order to be more specific and identified four pri‐ mary models of corporate governance around the world:  1. state ownership and control  2. family ownership and control  3. bank‐centered control systems  4. control by dispersed shareholders.  we shall return to this classification somewhat later. since our intention is not to go deeper  into the problems of corporate governance in ʺnormalʺ systems, we shall now point to some of the  current questions that are of professional interests of the west researchers. those are:  o how to pay executives and members of the board of directors;  o how to compose the board – with regard to proportion between insiders and outsid‐ ers;   o more efficient regulatory system in order to prevent manipulation, fraud and other il‐ legal matters, better system of information and prevention of information asymmetry;  o creation of new disclosure standards;  o how to create more democratic forms of corporate governance and corporate moni‐ toring;  o the role of institutional investors;  o accounting practice – how to improve it in order to inform the owners and the gen‐ eral public as objectively as possible;  o improvement of business operations of financial analysts and other experts  in this  field;  o leadership development.  a few notes in favour of the strange kind of corporate governance  in order to fully understand the story about the strange kind of corporate governance we  shall ask you one very simple question – what would you think of if you learned about the follow‐ ing situations:  1. a minister of the government is a member of several boards of directors simultaneously,  even in those companies that belong to the same industry.  volume 40 • autumn 2007 • 45  2. a company owes money to employees for 18 unpaid wages. in explanation of unsettled  debts, the company says that they are in crisis and deep financial problems. on the other  hand, the director is putting pressure on his employees to sell him or give him over their  stocks they got through privatization process. those who refuse to do that – receive notice  of dismissal and dismissal wage.   3. a director is purchasing equipment from a foreign partner. to partnerʹs big surprise the  director demands invoice increase by almost 50% provided that the difference between the  effective and invoice price the company is going to pay should be transferred to his private  account in a foreign bank.   4. a director of partly privatized company keeps  the stock certificates  locked  in  the com‐ panyʹs safe and does not want to share them to the owners, but demands from them in‐ stead to give him a three‐year proxy.  5. the director and the members of the board of directors invite workers who are at the same  time stockholders to give them over blank stock certificates, without any explanation or  compensation.  6. the minister of the police is at the same time the president of the board of directors of the  same company that exports weapons to the country under the un embargo on those activi‐ ties. when the scandal breaks, he does not accept any responsibility, arguing that ʺhe has  not been informed about itʺ.  believe it or not, these are some of the typical situations of economic life in serbia and mon‐ tenegro during the 1990s. we hope you will understand that for objective reasons we did not give  the names of the firms or individuals, but you can be sure that the events, of course with a certain  degree of simplification, have been realistically depicted. can you sense even now that on the basis  of six aforementioned situations there is room for analysis of the strange kind of corporate govern‐ ance?  different researches have been conducted in the world regarding the models of corporate  structure and governance. one of them refers to rafael la porta, florencia lopez‐de‐salinas and an‐ drei shleifer (1999). they conducted studies of control structure of the 10 largest firms in each of 27  different countries. they used ownership of 20% or more as a definition of control and reported  that 36% companies are controlled by dispersed shareholders, 30% are family controlled, 18% are  state controlled, 5% are bank controlled and about 10% are in the hands of different categories. a  huge problem in our case is that this kind of research does not exist in yugoslavia. hence, all our  evaluation will be based on observation and the use of case study methods. applying the classifi‐ cation of the four basic models of corporate governance we can claim now that during the 1990s  the situation in yugoslavia was as follows:  1. state ownership and control ‐ the state‐owned companies in the fry did not exist until  1992, when milosevic nationalized many big enterprises in the field of power production  and  distribution,  manufacturing,  oil  industry,  mining  industry  (e.g.  gold  mines),  postal  services, rail transportation, etc. this form of corporate governance has certainly existed  since then, but with specific mechanisms of control that we shall write about somewhat  later. at this point,  it should be stressed that those were most often natural monopolies  without any competition, controlling already limited resources.   2. family ownership and control ‐ this type of corporate governance does not exist until the  middle 1990s. since then it has begun to develop only in its rudimentary forms. the reason  is very simple. the first private companies in yugoslavia could be set up as late as 1990. a  period of couple of years was too short to enable this form of corporate governance to de‐ 2007 ‐ 46  •  economic analysis®  velop in its full swing.   3. bank‐centered control systems –this type existed only partially and in a very specific form.  it was a strange mixture of the bank investments and their ownership structure that can be  seen in case number 1. namely, the bank stocks were extremely unattractive financial in‐ struments to many investors. in order to solve the problem many banks offered their stocks  in return for obtaining credits, which was probably the unique example in the history of  banking! as a consequence, we had a structure  in which  the biggest bank stockholders  were the biggest debtors as well, which created many problems in the functioning of the  boards of directors and operational management.      4. control by dispersed shareholders ‐ this type of corporate governance in the fry certainly  did not exist, not even in the slightest possible form. one should not disregard the fact that  the first corporations were established only at the beginning of the 1990s, alongside the ini‐ tial stage of privatization process. nevertheless,  those processes were not entirely com‐ pleted in the next 10 years, so that even nowadays it is very hard to talk about the existence  of true anglo‐saxon type corporations in serbia and montenegro.  in addition, many institutions of market economy did not exist as well. even when they did  case no. 1. – who is the owner of whom?  according  to  legal provision  in force, at  the beginning of 1990s all banks  in  the  federal republic of yugoslavia were transformed into corporations. they began to issue  stocks, but it soon turned out that there was a weak interest of general public and almost  nonexistent demand on the part of investors. to make the issue of their stocks more at‐ tractive some banks started to stipulate that their clients ‐ depositors – should first buy  their stocks – and then the banks would allow them credit, give guarantee, open a letter  of credit or perform some other bank transaction.   that the matters started to be very serious the best evidence was the fact that when  making decisions to issue a new series of stocks the banks included a right to open a  credit, obtain a guarantee and open a letter of credit, together with voting rights, divi‐ dend rights and others. in that way, serbia (in which there were more cases like these  though) has become an extremely innovative country in the areas of banking and stock  ownership, which were then and are still unknown to the modern world.  to raise a credit, the yugoslav firms had to buy stocks from their banks. however,  since there were no severe legal sanctions for those who defaulted, many big, especially  socially‐owned and state‐owned enterprises ever returned the credits they raised. in that  way the banks became big creditors for many companies, which gave rise to a strange  mixture of ownership and debtor structure – where the biggest stockholders were at the  same time the biggest debtors. it was a paradox that almost the same people who were  the members of the board of directors were also the members of the credit boards. you  can only imagine what the line of decision‐making about many important matters looked  like! on the other hand, the banksʹ accounts receivable due but not yet paid were con‐ verted into ownersʹ shares, and there goes another paradox – the bank was one of the  owners of the same company that was one of the bankʹs stockholders. very often in those  circumstances it was hard to tell who was the owner of whom!   epilogue – at the end of 2001 four biggest serbian banks that were most involved in  those business transactions went bankrupt.  volume 40 • autumn 2007 • 47  exist, they were weak and undeveloped. legal system was incomplete, corrupted and extremely  inefficient. accounting standards were obsolete, auditing practice was not used for such a long  time, and the public was uninformed, uninterested and preoccupied with other, more important  problems such as war, sanctions, or the mere survival.   specific features of socialist self‐management system and factors that affected the crea‐ tion of the strange kind of corporate governance  in the beginning, we have to point out a couple of general factors related to corporate gov‐ ernance analysis which are important not only to the fry, but also to many other ex‐socialist coun‐ tries in the region of central and eastern europe. these are:  o a lack of corporate governance tradition – in developed countries the tradition of corporate  governance is remarkably long, as for instance in the uk where the first joint stock companies  appeared in the middle of the sixteenth and at the beginning of the seventeenth century. serbia  and montenegro, as well as many republics of the former yugoslavia did not even exist at that  time as independent states. they were under the rule of either austrian or turkish empire. the  whole region stayed undeveloped for long time. the first traces of industrial development can  be found in serbia only at the end of the nineteenth century. the origins of the belgrade stock  exchange can also be traced back to that period. it was founded in 1895 as one of the oldest  stock exchanges in the balkans. however, frequent wars were the cause of interruptions in its  development. in serbiaʹs case, there were a lot of these periods – from 1914 to 1918, when ser‐ bia was occupied, and then from 1941‐1989 – formally, but basically up to 1997. in other words,  out of 120 years of possible development we have a discontinuity of almost 60 years. we are of  the opinion that it is such a long period.  o political terror of socialism on economy – hereby we imply in the first place the dominance of  planned approaches to economy that inhibited the market functioning. managers of socialist  enterprises are not used to keen competition such as the one that exists on the world market.  the  capital  officially  does  not  exist  in  socialism,  since  all  assets  are  either  state  or  socially  owned. therefore, there is no capital market as a vital ingredient of financial market. there is  also no need for any financial instruments such as bonds or stocks. in those conditions, market  mechanisms become suppressed while politics has absolute control over economy.  o state and social ownership – brought about a specific form of economy and business organiza‐ tion governance. state ownership led to centrally planned management, which was the case in  the ussr and other countries of the warsaw pact. in the former sfry the situation was some‐ what different – it was characterized by distinct elements of workersʹ self‐management and so‐ called ʺassociated laborʺ, that gave rise to appearance of specific approaches to management –  so‐called self‐management. since private ownership did not exist and self‐management was so  dominant that practically meant that the ownership function was not separated from manage‐ ment.   o the practice of ʺsoft budget constraintʺ – which means that in certain situations the state was  ready  to cover  the part of  the companyʹs  losses. consequently,  the socialist companies and  managers did not face a high level of responsibility and risk of bankruptcy.    o special environment of serbia and montenegro – refers to a set of factors that contributed to  the appearance of specific corporate governance during the 1990s. those factors are first of all:  war  in  immediate environment, war psychosis, sanctions  imposed by  international commu‐ nity, isolation, scarcity of most important resources, a fall in the gross domestic product, a de‐ cline  in  industrial  production,  a  fall  in  foreign  trade  (exports  and  imports),  hyperinflation,  2007 ‐ 48  •  economic analysis®  monetary chaos, increase in unemployment (more than 20%), a drastic fall in the living stan‐ dard and disappearance of the middle class, moral degradation and a strong desire of one man  for absolute control and power.  the socialist federal republic of yugoslavia (sfry) was seemingly perfect example of ideal  system for theorists of socialism. social ownership made possible that the means of production  were really controlled by those who worked with them. since the employees formally own all the  means of production, those who work make decisions as well, and consequently should take the  responsibility. so where the problems came form? they were not theoretical problems, but they  existed in practice. just look at the case number 2 ‐ seven wonders of communism – which colour‐ fully depicts the way of thinking of people in socialist socio‐economic systems.    one of the basic problems of socialism was a chronic inefficiency of business operations. it  was manifested in an array of irrationalities that on the other hand led to other problems such as  an  increase  in costs, exclusive orientation of employees to get wages with neglecting  long‐term  objectives and investments, growth and development; that all contributed to a decline in competi‐ tiveness of economy, both on domestic and international level. for increasing economic failures  nobody was held responsible, which in the first place put an emphasis on (ir)responsibility. on the  other side, there were no market economy institutions, no financial markets, stock exchanges, fi‐ nancial instruments and efficient mechanisms of creditorsʹ protection. in that way, there were no  external  factors  and  pressures  that  could  restrain  and  punish  management  inefficiency,  either  through bankruptcy or takeovers, that is, by way of functioning of market for corporate control  (henry manne, 1965).  the specific system of corporate governance  in serbia and montenegro during  the 1990s  originated  exactly  from  the  socialist  yugoslavia,  where  a unique  system  of  ownership  existed,  which except partly in israel (kibuci) has not been recorded anywhere in the world. this is – social  ownership – which implied that the owners of certain means of production are those who in fact  perform business with them (encyclopaedia of economics, 1994, pp 233). ownership in the sfry pre‐ sented rather political, philosophical and social issue than economic or legal one. social ownership  was not essentially state ownership similar to other socialist countries of the central and eastern  europe. it was the property of ʺall working people and citizensʺ, what according to theoreticians of  self‐management socialism in the sfry was one step forward to a communist ideal that assumed a  complete control over means of production by the workers themselves. those phrases were very  frequently quoted and used as proofs of great humanity of socialist systems and superiority of self‐ management and social ownership. however, there was still one unresolved question in practice –  case no. 2 – seven wonders of communism  1. everybody had a job.  2. although everybody had a job, nobody worked anything.  3. although nobody worked anything, we realized all our plans at least 100%.  4. although the plan was more than 100% realized, the stores were empty.  5. although the stores were empty, everybody had everything.  6. although everybody had everything, all (of them) were stealing  7. although all (of them) were stealing, nobody ever lacked anything.   (ʺblicʺ, a daily newspaper, belgrade, december 14, 2002) volume 40 • autumn 2007 • 49  if all the workers are owners, who has the real power, that is, who takes the real control?  looking for an answer to the above question, we can trace the origins of specific features of  the corporate governance system in the fry during the 1990s. in all socialist countries, the sfry  being no exception, the communist party and its structures had the real power. the communist  parties in many countries were the most powerful and the best organized structures. through their  bodies, political party cells and secretaries they were in a position to control not only all economic  organizations, but also all the activities in the society. the managerial positions were allowed only  to those who were members of the communist party. the similar situation was in the sfry as well  as later in the fry!  slobodan milosevic until his dethroning on october 5, 2000 was undoubtedly the most influ‐ ential and the most powerful man in the fry. officially a socialist (he was the president of the so‐ cialist party of serbia), deep in his soul a communist (he had an enviable political career in the  communist league of yugoslavia, the only and leading party in the former sfry), he proved him‐ self in the real political life as dictator and tyrant. at the beginning of his rule, he proclaimed him‐ self a reformer and protector of the national interests. however, it soon became evident that using  the old party model of economic governance he only wanted to strengthen his power. in his at‐ tempt  to accomplish  this goal, he  took advantage of  the external environment  and  its circum‐ stances, for which he was also personally very responsible (he  is currently standing trial at the  war‐crimes tribunal in the hague). first of all, there was a disintegration of the sfry, followed by  an outbreak of very cruel civil war, first in croatia, then in bosnia and herzegovina. starting from  1992, the fry was under the united nationsʹ sanctions, which apart from smaller easing off were  effective the following eight years. having been in constant isolation, the country inside suffered  from suppression of democracy and democratic freedoms; the atmosphere of fear and general in‐ security was being spread;  the different phobias were being developed culminating  in national  frustration. the economy also experienced  the  infringement and suppression of economic  free‐ doms, the state of complete centralization and the whole country resembled more than ever the  communist systems of the soviet type. these are just a few characteristics of the general social en‐ vironment in the fry during the 1990s.  economically speaking, some of the major factors that should be mentioned are:  o economic structure dominated by social and newly established state companies ranked  in order of strength.  o the emergence of the first private companies which were still very economically weak.  a more serious growth and development of the private business could only be made  possible by huge back up of the political elite.  o the already started privatization process (in 1990) but soon brought to a halt (during  1993‐1994) and the existence of extremely indefinite property relations in one part of  economic subjects.  o suspension  of  workersʹ  rights  and  the  formal  suppression  of  the  workersʹ  self‐ management. this was a direct consequence of a high level of general social insecurity  that milosevic skilfully took advantage of in 1992 by amending the company act, where  he informally abolished self‐management, giving extremely great authority to company  directors.  o a developed political party structure inherited from the communist league of yugo‐ slavia (ex‐communist party).  under these conditions, the first corporations and the first elements of corporate governance  were created, followed by a series of ʺchildhood illnessesʺ. were it not for the fact that the country  2007 ‐ 50  •  economic analysis®  was isolated and under the sanctions and the political scene dominated by undemocratic system,  serbia and montenegro would have probably been cured of many of those illnesses after only a  couple of years as many other countries in transition. nevertheless, the above mentioned condi‐ tions gave rise to a degenerative development of corporate governance we  label as the strange  kind.   the specific features of the strange kind of corporate governance  the basic specific features of the corporate governance in the federal republic of yugoslavia  during the 1990s can be analyzed by specific characteristics of the four basic elements we formu‐ lated at the beginning of this paper. therefore, in the fry we had:  1. the strange kind of corporation  2. the strange kind of ownership  3. the strange kind of management and control  4. undeveloped institutional environment  regarding the fact that all the elements were specific, it logically follows that they have re‐ sulted in the strange kind of corporate governance.  1. the strange kind of corporation –we can freely claim that in the fry during the 1990s  there were no true corporations of the western type, especially not of the anglo‐saxon type. the  corporations officially did not exist from the beginning of the second world war in 1941 up to  1989 when the company act laid the foundations of re‐establishing privately owned enterprises.  the first corporations were officially set up at the beginning of the 1990s. they originated as a con‐ sequence of privatization trends, where the social capital was first evaluated, then shared into cer‐ tain number of parts, that is, stocks, which were later granted to the employees depending on their  years of employment. however, since those processes were not fully completed we had therefore  the emergence of the strange kind of corporations!  yugoslavia is probably holding the world record in number of trials to complete the privati‐ zation process. this process has been started many times though, but just as the entire process of  transition too, it has never been fully conducted, because in the first place it lacked both the true  political readiness and support. only in serbia in the period of 10 years five different privatization  acts have been passed (1990, 1992, 1994, 1997, 2001). if we do not take into account the last one,  passed after milosevicʹs fall – then we are talking about four different acts that put an emphasis on  the different privatization models. however, privatization effects were extremely poor. the eco‐ nomic structure was still dominated by social and state companies ranked in order of strength and  size. what presented a particular feature of the development of corporations in the fry was the  existence of corporations of mixed ownership, that is, a combination between private (stock own‐ ership) and social ownership. until the end of 2000, out of 6,000 social corporations in serbia only  1,000 were partly privatized. a typical structure of those corporations was as follows: 40‐80% of  ownership was in the hands of individual stockholders (the number ranged from a couple of hun‐ dreds to a couple of thousands, mostly individual persons, often the employees, former employees  and retired workers); the remaining part of ownership that amounted to 60‐20% was still a social  capital. of course, many problems occurred in practice, in the first place concerning the election of  the members of the boards of directors. some more distinctive features of corporations in serbia  and montenegro can be found in more detail in case number 3.   volume 40 • autumn 2007 • 51  a special problem regarding the strange corporations referred to their relationship to stock‐ holders. in the fry until the end of the twentieth century there were no generally accepted ac‐ counting  principles  (gaap);  the  iasc  standards  (international accounting standards committee)  were also disregarded; there was hyperinflation, great monetary instability, a practice of ʺprofit  smoothingʺ that is, fixed financial reports; auditing did not come into existence for a long time;  independent financial analysts also did not exist; the system of public information was very low  because there were no obligation of public announcement of information; and there was a huge  information asymmetry. all these are arguments in favor of our thesis that during the 1990s in  yugoslavia we had a strange kind of corporation, where on the one side there were individual  petty stockholders pretty much unprotected, and on the other side there was still very powerful  social capital, that increasingly took on the features of classical state capital.  2. the strange kind of ownership – an issue of ownership and property relations has al‐ ready been dealt with in this paper. we wish to emphasize again that no legal regulations existed  in yugoslavia that treated the private ownership as inviolable. the reform of property relations  was carried out very slowly. it was considered that a huge contribution to ownership reform was  adoption of pluralism of property relations. it practically meant the co‐existence of several forms of  ownership, in the first place, private, social and the state ownership. these principles enabled the  changes of legal regulations that were effected as early as 1989, which gave rise to a legal basis for  establishment of private companies. only in serbia, in the period of couple of years, starting from  1989 until 1994, a number of business organizations increased from 10,000 to 200,000. as much as  95% of that number were privately owned companies. although it could be said at first glance that  the ownership structure of economy had radically changed, the practice showed that considering  the strength and importance the socially and state‐owned companies still dominated the economic  scene.   simultaneously with changes of ownership structure, the process of privatization started to  develop. however, it has never been entirely effected. in that way one type of business organiza‐ tions was created which was a mixture of property structure – partly social and partly privatized.  these organizations started to take the shape of modern corporations, but also retained elements  of social enterprises. the stakeholders were mainly internal stakeholders – from managerial struc‐ tures and among the employees. that caused some confusion, since efficient mechanisms for the  protection of their interests did not exist. in addition, many other financial instruments were not  case no. 3 – the strange kind of corporation  the following cases can best illustrate to what extent the strange kinds of corporate  governance did exist in the fry:  o according  to  legal  provision  in  force,  it  was  possible  to  establish  a corporation  in  which there was only one owner!  o according  to yugoslav acts, corporation as a  form of ownership was  termed a.d.  (akcionarsko društvo – when translated ‐ company with the shares or stocks). many  firms, in order to stress their importance put after their names ‐ corporation a.d. –  which presented a real pleonasm. particularly surprising was the fact that hardly any  one in the public did really notice it was a pleonasm.   o all that time during the 1990s no corporation publicly made known financial informa‐ tion and business reports. the balance sheet and the income statement were treated as  a top business secret.  2007 ‐ 52  •  economic analysis®  fully developed as well.  thus, only common stocks existed, but due to a high level of ignorance  and absence of tradition, they did not have the characteristics of those in the developed countries.  there were no preferred stocks or multiple classes of stocks. what is even worse, the issues of debt  finance and use of corporate bonds was also not regulated. this all contributes to the fact that there  was a very strange kind of ownership in the fry.       3. the strange kind of management and control – one of distinctive features of socialism re‐ ferred to the fact that the directors and members of the manager teams had to be members of the  communist party. the problem of political party membership of management constituted a part of  their responsibility. for example, what if some good party ʺcadreʺ makes wrong business decisions  and the company they run makes a loss? this was otherwise a very frequent occurrence in the  sfry. the question of responsibility was solved by so‐called collective responsibility, which actu‐ ally presented a way of avoiding individual blame. these things and practice did not change a bit  in the federal republic of yugoslavia during the 1990s. it was just enough to look at the structure  of directors of the biggest enterprises in serbia for instance. one would soon conclude that almost  every one of them, without exception was at the same time a member of some ruling party. more  interesting though was the fact that many of them did not have much faith in ideals or programs of  those parties, but realized that it was the only and the safest way to help themselves and their  companies.   at the beginning of this paper we mentioned the famous work of adolf berle and gardiner  means  (1932)  in  which  they  made a  difference  between  the  five  basic  types  of  control:  control  through almost complete ownership, majority control, control through legal devices without ma‐ jority ownership, minority control and management control. many of these types of control simply  could not exist in the federal republic of yugoslavia since there was no private ownership. the  control was manifested in some other ways. nevertheless, during and especially at the end of the  case no. 4 – ʺpositive zero?!ʺ  a zero in mathematics is always a zero. it does not have either positive or negative  sign. however, accountants and managers in yugoslavia introduced one innovation un‐ heard‐of in mathematics. it is a positive zero.   a positive zero  is a very frequent expression exploited  in the business  jargon by  managers, not only in serbia and montenegro, but also in other former yugoslav repub‐ lics. it was figuratively used to describe two kinds of conditions:  1) acknowledgement that the firm had certain financial problems that they (manag‐ ers) somehow managed to solve at the end of the year. in other words, the firm did not  make a loss (because certain legal consequences should follow then, in the first place filing  a petition in bankruptcy), but the balance sheet and income statement recorded neither  losses, nor profits. in this case, the accountants would post‐date many liabilities and costs  for the next year, so simply there were no losses – according to financial results profits  and losses were equal, that is, the bottom line would indicate zero profit or loss.   2)  looking  for  ways  to  evade  profit  tax  payments.  the  concept  of  positive  zero  would be applied when the company was successful and made a certain level of profit. in  this case the opposite procedures were affected, namely the profits were deliberately di‐ minished  and  losses  inflated  so  that  the  profit  would  somehow  ʺmeltʺ  and  soon  be  showed that the companyʹs financial results were close to zero, which did not draw much  attention of the public, tax authorities and political structures. volume 40 • autumn 2007 • 53  1990s these questions increasingly gained in importance. this assertion especially refers to man‐ agement type of control, that started to be very prominent but in some rather specific forms. we  can now ask ourselves – what was in fact the real control of corporations in bigger part of the ob‐ served period?   one of the basic criteria for selection of managers (either directors or members of the boards  of directors) of the state, social and mixed companies was not professional qualifications, educa‐ tion, capability or results, but loyalty and obedience! that means that there were actually no clear  standards. often the term ʺselectionʺ meant ʺappointmentʺ as in the good old communist times.  during the 1990s, the federal republic of yugoslavia was a country isolated from the international  community. due to exclusion, the state itself started to lose many of its legal attributes and increas‐ ingly become party‐state. the political parties (in the beginning – only one, somewhat later ‐ many  of  them but with  the same program) pervaded all  layers of social and economic  life. the real  power was in their hands. since social ownership still existed, while the society was controlled by  the state and the state was the party itself, party structures began to take over a central role in the  control of economy. the party bodies appointed managers, members of the board of directors and  the supervisory board of the social companies and mixed capital corporations (where social capital  still existed in not completely privatized companies). in that way, the party had control over the  most important economic trends. there were no independent directors or members of the board of  directors, because it was ʺimportant to have their own men in the key positionsʺ. the issues con‐ cerning manager compensation, their professional orientation or continuous education and profes‐ sional training were completely pointless. political parties were simply not interested.  loyal and obedient managers got a certain degree of authority, which was validated by the  1992 company act. however, a high degree of authority was not followed by the high level of nec‐ essary responsibility. many yugoslav managers did not have to respect efficiency and effective‐ ness criteria, since these were not the most  important parameters of their work assessment. in‐ stead, they were trying so hard at any cost to keep the social peace and hierarchical system, having  an opportunity to finish their ʺownʺ deals in return. thus many managers of that time concluded  business deals that were damaging for their companies, set up private firms through which they  could ʺpump outʺ the assets of the social companies, employed their favorites and dismissed those  they disagreed with without any responsibility, etc. there was no sense of responsibility to own‐ ers, since  they were small and disunited. besides,  the owners were actually employees,  former  employees and retired ones who ʺmust not refuse to obeyʺ anyway and who were not even pro‐ tected by appropriate legal regulations. furthermore, they were smaller owners, since the biggest  share of the capital was still socially owned. if there were no responsibility to owners then the ba‐ sic goal of contemporary business organizations could not be achieved as well, i.e. creating share‐ holder value. there was also no true responsibility towards the society because it was in the state  of fear and chaos. there was only responsibility to those who had a real power and control – i.e.  political party structures. therefore, in yugoslavia we had the strange kind of control in action.  what happens to governance in those conditions? the great influence of the party on eco‐ nomic life created a high level of manager dependency. if you make a loss – it is not a serious prob‐ lem – ʺthe societyʺ will make up for the losses, in other words, there must be a way to help loyal  and obedient ʺcomradesʺ in trouble. if, by any chance, managers make a profit – then ʺit is only  right  to share  it with  the comrades.ʺ domestic managers could never be sure what part of  the  profit they would really have at their disposal. once more we stress that profit and success were  not criteria for business performance evaluation. only loyalty, obedience, and capability to finish  certain jobs counted. therefore, we have now the strange kind of governance as well.  2007 ‐ 54  •  economic analysis®  4. undeveloped institutional environment (undeveloped market economy infrastructure)  – in order to speak of ʺnormalʺ kind of corporate governance in one country it is necessary that at  least a minimum of market economy institutions and corresponding legal framework should exist.  that did not exist in the federal republic of yugoslavia sufficiently enough. first of all, there was  no necessary political support  to reforms. many  laws and acts were  inherited  from  the  former  sfry, legal system was slow and inefficient, and many state institutions corrupted. the state due  to sanctions, isolation and the wars in immediate environment controls the most important flows  of goods, money and capital. monetary power is not at all independent. the crucial way of the  state budget financing is by monetary expansion, which in turn brings about extreme rise in infla‐ tion and the general economic instability. the fiscal system is on the primitive level of develop‐ ment. the stock exchange exists only formally, but it does not function as a capital market. the  broker‐dealer organizations exist, but there is no financial instruments quality enough that could  be traded with.  accounting standards are obsolete, incompatible with international standards and  utterly unreliable. there is no adequate system of financial reporting and analysis. there are no  clear obligations of disclosure. there  is a  lack of qualified and trained cadre. the public  is not  enough motivated or interested. besides, stock ownership development simply does not suit po‐ litical structures. stock ownership essentially assumes the embodiment of economic democracy,  case no. 5 – how to help unsuccessful ones  the ruling parties have worked out a whole set of ways in order to help loyal man‐ agers who would get into troubles from time to time. the typical ways were:  o transport of cash money in bags – which was particularly popular during 1993 when  the biggest hyperinflation in the history of mankind raged in yugoslavia. one of the  participants in those activities told later that on one occasion there was a real panic  when a truck full of money had broken down on the road. the whole city of krusevac  (about 150 miles away from belgrade) got the salary not on friday afternoon as previ‐ ously planned, but on saturday morning. instead of buying 10 dm (about 5$) with  their average salary on friday afternoon, the unfortunate citizens of krusevac could  barely buy 1 dm (0,5$) on saturday around noon  o mechanism called ʺnight smoothingʺ – referred to the way of temporarily covering the  losses and negative balance on accounts. it actually implied transfer of financial means  from  accounts  of  economic  subjects  who  had  excess  money  into  accounts  of  those  companies that at the end of working day had negative balance. this was being ef‐ fected during the night, when money was fictively transferred from account of one  subject into somebody elseʹs account, so that at least in the morning all would have  seemingly positive balance and business operations of some of the companies would  run uninterruptedly. during the day, everything would be the same as before, just ʺtill  the  night  comesʺ  and  there  went  ʺsmoothingʺ  again.  everything  for  ʺcomradesʺ  in  trouble!  o primary issue of credits – the central bank of yugoslavia many times uncontrollably  issued money and granted credits to many selected companies, most often to those  that were the regime favorites. thus those companies either covered their  losses or  bought foreign currencies in the street from citizens, did some questionable jobs, made  profits and after a couple of months returned given credits, which by that time were  already devalued by hyperinflation.  volume 40 • autumn 2007 • 55  but to slobodan milosevicʹs regime any form of democracy was absolutely unknown.    since  corporations  did  develop  in  serbia  and  montenegro,  but  not  the  real  ones,  private  ownership existed alongside vague social ownership. there was also a specific system of control,  and the governance itself was rather political than economic concept – no wonder we write about  the strange kind of corporate governance in this paper. some of its main characteristics are:  o specific conditions of  its development – on the one side the absence of true political  willingness for reforms and privatization, and on the other side, unfavorable influences  of  international environment that made the federal republic of yugoslavia the most  isolated country in the world during the 1990s.  o non‐existence of corporate development tradition – a discontinuity of almost half of  century in stock ownership development.  o existence of mixed ownership that implied a combination of outmoded social owner‐ ship that slowly disappeared and private ownership that slowly became stronger.  o legal restrictions – a lack of adequate protection of both property rights and property  relations.  o insufficiently developed awareness of managers to respect ownersʹ interests and insuf‐ ficient level of responsibility.  o underdevelopment  of  necessary  market  economy  institutions  and  financial  instru‐ ments.  o almost nonexistent protection of shareholdersʹ rights.  case no. 6 – ʺbelieve it or notʺ column: the relationship to stockholders  the following examples can best illustrate what the relationship to stockholders in  the federal republic of yugoslavia really was:  in the spring of 1999, immediately before the nato air strikes, a joint meeting of  representatives of securities commission and a score of broker‐dealer firms was held in  belgrade. the author of this paper was also present at that meeting as a director of one  broker firm. the commission was obliged to do the following three things:  o to let broker‐dealer companies to do business operations with physical subjects. they  were not allowed to do that before, in other words they could do business only with  economic subjects.  o to re‐examine the belgrade stock exchange commission on stock trade that accounted  for 0,50% since the brokerage according to commission decision was fixed at 0,40%.  the brokers complained that on each realized transaction in stock trade they made at  least a loss of 0,10%.  o to reconsider the possibility of cancelling pre‐emptive right in secondary stock trade.  namely,  this  right  was  instituted  in  serbia  according  to  1997  privatization  act  by  which the stockholders were prevented to freely dispose of their stocks.  although all the three demands seem perfectly logical or suitable for some ʺbelieve  it or notʺ column – they were neglected without any justifiable reasons!   epilogue – all three anomalies were removed soon after the political changes at the  end of 2000.  2007 ‐ 56  •  economic analysis®  o dominant influence of politics on the composition of the boards of directors and selec‐ tion of managers.  o disregard for efficiency and effectiveness criteria.  o insufficient system of information of potential investors and the general public.  o non‐existence of developed accounting standards and auditing systems.  o a lack of professional personnel.  in the end, we can conclude that the problems of corporate governance development in ser‐ bia and montenegro are completely different from those that existed not only in developed coun‐ tries, but also in other countries in transition. as to developed countries, it is perfectly logical ‐ one  should just take into consideration the differences regarding the economic development. we also  particularly lay stress on discontinuation of market economy development and corporate owner‐ ship forms of business organizations. socialism has been deeply engraved in the peopleʹs mind.  economic democracy, as well as political one takes time to develop. this is what both serbia and  montenegro most  lacked, so  that certain  initial problems of  transition and so‐called  ʺchildhood  illnessesʺ have not been treated on time. what essentially distinguished the federal republic of  yugoslavia from other counties in transition was degenerative form of economic undemocracy that  undemocratic political regime has introduced and created. still, everything comes to its end, so  does this kind of tyranny. in the reform processes that lie ahead of serbia and montenegro, it is  extremely important to survey the initial state. we hope that this paper at least help a little in that  regard – i.e. in identifying some of the problems of corporate governance development that need  to be resolved.  moral and conclusions  at the beginning of the twenty‐first century serbia and montenegro are strongly determined  to radically depart from the past. consequently, the name of the new state community has been  changed and the federal republic of yugoslavia does not exist any more, even formally. both re‐ publics strongly advocate integration into international political and economic trends. they expect  an influx of fresh capital and foreign investments necessary for acceleration of economic growth  and development. their ultimate aim is to become full members of the european union. however,  they will have many problems and obstacles on that road. what should be borne in mind is the  fact that without efficient economic subjects there is no efficient economy as well. in that sense, the  experience of other countries lasting several centuries has proved that corporations represent one  of the most efficient forms of business organizations.  corporate governance began to develop in the federal republic of yugoslavia during the  last decade of the twentieth century, but in rather irregular conditions. in that way, besides ʺchild‐ hood illnessesʺ many other countries in transition have faced, here we also had some very specific  conditions caused by the factors of external environment on the one side and undemocratic regime  on the other side. their activity gave rise to one degenerative and deformed practice and form of  corporate governance on which political structures had far too great influence. this is as if you  took a big dose of a medicine so that many side effects would result. in that regard we can freely  conclude that both in serbia and montenegro we had one ill form of corporate governance that  tolerated inefficiency, ineffectiveness and irresponsibility, so it could naturally not contribute to  economic growth and development, or democratic tendencies either. the political changes effected  in 2000 have  finally provided  the  foundations  for  the nationʹs economic revival and departure  from old practice.  volume 40 • autumn 2007 • 57  hence, one of the basic tasks of the new government authorities is to face the problems and  find the ways to solve them. to accomplish these objectives, serbia and montenegro must make  many efforts, starting from the protection of owners ʹ interests, transformation of judicial system  and institutions, raising of the general level of responsibility, improvement of morale and business  ethics, to development and education of effective and efficient managers. all this is of course im‐ possible without appropriate willingness of political structures. we deeply believe that there  is  such willingness this time and that serbia and montenegro will become very attractive investment  destinations for investors from all over the world.  literature  1. adolf a. berle and gardiner c. means (1932) »the modern corporation and private property«, harcourt, brace &  world inc., new york  2. david o. beim and charles w. calomiris (2001) »emerging financial markets«, mcgraw‐hill, irwin, boston  3. »blic«, yugoslav newspaper, belgrade, december 14th, 2002.  4. »how to fix corporate governance« (2002), business week – special report, may 6, pp. 69‐79  5. »corporate governance rule proposals«, reflecting recommendations from the nyse corporate accountabillity  and listing standards committee as approved by the nyse board of directors august 1, 2002, www.nyse.com   6. »encyclopaedia of economics and business« (1994), savremena administracija, belgrade  7. eugene fama (1980) »agency problems and the theory of the firm«, journal of political economy 88, pp. 288‐307  8. mark grinblatt and sheridan titman (2002) »financial markets and corporate strategy«, 2nd edition, mcgraw‐ hill, irwin, boston  9. michael jensen and william meckling (1976) »the theory of the firm: managerial behavior, agency costs and own‐ ership structure«, the journal of financial economics 3, pp. 305‐60  10. rafael laporta, florencia lopez‐de‐silanes and andrei shleifer (1999) »corporate ownership around the world«,  journal of finance 54, pp. 471‐517  11. henry manne (1965) »merger and the market for corporate control«, journal of political economy 73, pp. 110‐20  12. robert a.g. monks and nell minow (1995) »corporate governance«, blackwell, cambridge, ma  13. alfred rappaport  (1986) »creating shareholder value –  the new standards  for business performance«, the free  press, new york  14. robert m. sharp (1989) »the lore and legends of wall street«, dow jones – irwin, homewood, il  15. »company act« (1992), official gazette of fry, belgrade    ea_2018_3-4 10 economic analysis (2018, vol. 51, no. 3-4, 10-23) doi: 10.28934/ea.18.51.34.pp10-23 original scientific paper productive specialisation and growth in the eu15: exploring an education based sectoral taxonomy andrea araujo1 | marta simoes2* 1 faculty of economics, university of coimbra, coimbra, portugal 2 ceber and faculty of economics, university of coimbra, coimbra, portugal abstract this paper analyses the relationship between productive specialisation and economic growth in the 15 older european union member states between 1970 and 2005. the sectoral taxonomy proposed by (peneder, 2007) is used to classify the different sectors of activity according to the educational levels of the respective workforce and establish a comparison between the manufacturing and the services sector, based on their potential contribution to productivity improvements. the empirical model corresponds to a growth regression where the employment share of the different sectors is the main explanatory variable taken alongside other control variables identified in the empirical growth literature as robust growth determinants and is estimated with the fixed effects method. the results indicate that a higher weight of manufacturing activities that use mostly very low and low educated workers presents a negative association with growth. services activities that require low educated workers make a negative growth contribution. manufacturing activities with high and medium-high educational requirements have a positive growth influence, while in the case of services only activities that require highly-educated workers show a positive correlation with growth. the policy advice that can be extrapolated from this study contemplates the design of industrial policies that promote manufacturing activities such as chemicals, telecommunications and transports equipment, and services such as financial intermediation, audit, tax consulting, engineering and legal activities, to promote growth key words: productive specialisation,; economic growth; sectoral taxonomy; education; european union jel classification: j24; l60; l80; o14; o47 introduction in recent decades, the productive specialisation pattern of many countries has changed, characterized by what is known as deindustrialisation. the typical development pattern corresponding to a reduction of the importance of the agricultural sector and the associated increase in the weight of manufacturing has been followed by a reduction in the weight of manufacturing and an increase in the weight of services. this change in the productive specialisation pattern can have important consequences for the growth path of countries since different sectors present different potential for productivity improvements, the main driver of growth in modern knowledge based economies ((baumol, 1967); (silva & teixeira, 2008)). industrialisation has been associated with a sustained increase in economic growth due to its innovative nature, resulting in an increase in aggregate productivity. on the contrary, the services sector was considered as a low productivity sector and so a structural change pattern based on * corresponding author, e-mail: mcsimoes@fe.uc.pt andrea araujo, marta simoes 11 the increase of the relative weight of services could lead to a growth slowdown. more recently, several authors highlight that services activities are quite diversified in terms of their potential for productivity improvements, with some services sub-sectors rivalling with manufacturing (eichengreen & gupta, 2013). from a growth enhancing industrial policy perspective it is thus important to assess the contribution of the different sectors for economic growth. the specific characteristics of each sector of activity, such as the associated physical and/or human capital intensities, participation in world markets, market size, etc., imply different potential for productivity improvements in each sector, and so it is important to distinguish the sectors according to a certain number of features to make the design of industrial policy more effective. (peneder, 2007) proposes a taxonomy that classifies industries according to the educational composition of their workforce given that in knowledge-based economies human capital is a fundamental input of innovation activities and thus a major contributor to increases in productivity ((romer, 1990); (jones, 2005); (teixeira & fortuna, 2011)). the taxonomy proposed by (peneder, 2007) distinguishes between seven types of industries according to the respective educational requirements, very high, high, medium-high, medium, medium-low, low, very low, confirming a tendency towards ‘education-biased structural change’ between industries. this study analyses the relationship between productive specialisation and economic growth in the 15 older european union member states between 1970 and 2005. the main objective is to examine the impact of structural change towards sectors with higher educational intensity on economic growth. in particular, we want to assess the growth impact (positive/negative/nonexistent) of different manufacturing and service industries classified according to the educational composition of their workforce under the assumption that activities with higher educational requirements should promote growth due to their role as sources of aggregate productivity growth, while the opposite applies to activities that require less educated workers. the sectoral taxonomy proposed by (peneder, 2007) is used to classify the different sectors of activity according to the educational levels of the respective workforce and establish a comparison between the manufacturing and the services sector, based on their potential contribution to productivity improvements. the empirical model corresponds to a growth regression where the employment share of the different sectors is the main explanatory variable taken alongside other control variables identified in the empirical growth literature as robust growth determinants. this model is estimated with the fixed effects method. the remainder of this paper is organized as follows: the section after the introduction contains a brief review of the related theoretical and empirical literature. afterwards we present the sectoral taxonomy used. the next section presents the empirical model and estimation methodology, as well as the results obtained. in the final section we include the main conclusions. productive specialisation and economic growth: an overview of the literature with a focus on sectoral disaggregation in recent decades, the study of structural change, understood as a change in sectoral composition and thus resulting in a change in the productive specialisation pattern of a country, has regained interest within the growth literature given the potential growth impact of these changes and in particular on the ability of a country to sustain its long run growth rate of output. this resurgence of interest is particularly related to the importance of technological change and innovation, considered the main engines of economic growth ((romer, 1990); (jones, 2005)). the sectors of activity that make up an economy have very different characteristics with respect to technological features, the relative intensity of physical and human capital and economies of scale ((marelli, 2004)). as a result of these differences, the contribution of each sector to aggregate economic growth can be quite different. the modern economy we live in is the result of the industrialization process that occurred in many countries over the last couple of centuries 12 economic analysis (2018, vol. 51, no. 3-4, 10-23) ((rodrik, 2013)). the industrial revolution ignited economic growth in europe and other western countries, but more recently the weight of manufacturing has declined and it is being replaced by the services sector as the dominant sector of activity. this process of structural change raises concerns for the sustainability of economic growth, since manufacturing generally records higher productivity levels as it is a technologically more dynamic sector and produces tradable goods, among others. the growing importance of the services sector has thus been regarded with concern. (baumol, 1967) argued that this sector suffers from the cost disease since the productivity of the services sector is limited when compared to that manufacturing. this results from the fact that the potential for replacing labour by capital is more limited and so productivity improvements are less likely to occur in certain activities of the services sector such as education, health or art. these activities were thus called "stagnant services". however, later baumol recognized that it is necessary to distinguish between various types of services in terms of their potential for productivity gains due to the importance of innovation and technology in some services subsectors. thus, the services sector as a whole should be subdivided into traditional and modern services. within the traditional services are included activities such as housing, barber shops, beauty salons, that is, labour intensive activities that make a small contribution to productivity growth. at the same time, modern services include activities such as banking, insurance and communications, which require a higher level of human capital and make a strong contribution to productivity growth ((baumol, blakman, & wolff, 1985); (maroto-sánchez & cuadrado-roura, 2009)). in any case, according to some authors (pugno, 2006), even the traditional (stagnant) personal services can make a positive growth contribution since services such as education, health or culture may contribute to human capital formation and in this way offset the negative contribution to overall growth due to its low productivity2. recent empirical studies investigate how structural change has contributed to economic growth through increases in aggregate productivity using different sectoral taxonomies. (peneder, 2003a) estimates how the share of manufacturing activities classified according to three different taxonomies affects either the level of real gdp per capita or its growth rate in a sample of 28 oecd countries over the period 1990-1998. taxonomy i distinguishes activities according to factor input combinations resulting in five categories (mainstream; labour intensive; capital intensive; marketing driven; technology driven). taxonomy ii distinguishes among four categories according to skills requirements (low-skill; medium-skill blue-collar; medium-skill white-collar; high-skill). taxonomy iii is based on the use of external service inputs including also four categories (high inputs from transport services; high inputs from retail and advertising services; high inputs from information and knowledge based services). the results obtained indicate that technology driven and high skill manufacturing activities have a quantitatively important positive and statistically significant influence on the level and growth rate of real gdp per capita. the findings point also to a negative influence of an increasing share of services on the aggregate growth of gdp per capita, as well as on its level, and are thus consistent with baumol’s predictions. however, the impact is weak and the author stresses that it might be the case that opposite signs effects are netting out, and that in any case there might be a positive contribution from certain types of services industries that systematically achieve higher rates of productivity growth. following up on this idea, (maroto-sánchez & cuadrado-roura, 2009) assess the impact of tertiarisation on overall productivity growth for a sample of 37 oecd countries over the period 1980-2005. the heterogeneity of the services sector is taken into account by differentiating the structural variables for market services and non-market services. the estimated coefficients are positive in both cases but the productivity growth impact of market services is quite stronger. 2 several authors also highlight the possibility that tertiarisation is a consequence not a cause of economic growth due to higher demand as income grows or more investment in r&d and education as a country develops. see (peneder, 2003a). andrea araujo, marta simoes 13 adopting two different classifications of industries, one that takes into account the industries’ skill requirements, and a classification based on technological characteristics, (e.g. silva & teixeira, 2011) assess the importance of structural change for productivity growth in a sample of 10 countries described by the authors as ‘relatively less developed’ in the late 1970s but that exhibited different paths of structural change from then onwards with some promoting more skilled and technology-intensive activities. the main idea is to test whether these differing paths can explain the different growth performances registered over the period 1980-2003. the evidence suggests that a change towards the high-skill industries and science-based industries shares influences positively labour productivity growth. in contrast, an increase in the value added share of supplier-dominated industries results in a decline in labour productivity growth. using data for 28 manufacturing industries from 44 countries over the period 1980-1999, (ciccone & papaioannou, 2009) provide evidence of the importance of human capital availability for structural change. the authors find a positive and statistically significant correlation between initial schooling levels and value added and employment growth in schooling-intensive industries, stronger for more open economies. faster educational attainment growth also seems to lead to faster shifts in production towards human capital-intensive industries. it is thus also likely that the availability of high levels of human capital, by facilitating technology adoption in educationintensive sectors, leads to faster growth. (peneder, 2007) also presents evidence that the activities with a very high educational intensity, and also most industries with a high or intermediate level, were the ones that registered the highest growth rates in terms of value added and employment in a sample of 24 oecd countries over the period 1992-2000. the studies reviewed indicate that it is possible to gain additional insights on the role of structural change for economic growth by disaggregating the main sectors activity. in this study we apply the sectoral taxonomy proposed by (peneder, 2007) in order to distinguish the growth impact of different manufacturing and services activities divided according to the educational composition of the respective workforce. sectoral taxonomies and productivity gains: the taxonomy of peneder (2007) the impact of structural change and thus productive specialisation on economic growth has been mainly analysed taking into account the sectors of activity at a very aggregated level, in some cases considering only the three main groups of activities: the primary sector, which includes activities that extract raw materials such as agriculture, livestock and fishing, the secondary sector, which transforms raw materials provided by the primary sector into tangible goods/products and includes activities such as manufacturing, construction and utilities, and the tertiary or services sector, which includes activities that produce intangible goods, that is services instead of products. it comprises a wide range of activities going from warehousing and transportation services, information services, financial intermediation, professional, technical and scientific services, education, health care and social assistance and arts, entertainment, and recreation services. this taxonomy does not, however, take into account the characteristics of the different activities that can contribute to greater productivity gains, namely the educational composition of the workforce and the innovation potential of the different subsectors, measured according to different features. nevertheless, modern growth theory identifies productivity gains as the main driver of long run output growth and human capital and innovation as its primary sources ((romer, 1990); (hall & jones, 1999); (jones, 2005)). thus, the consideration of sectoral taxonomies that accommodate these characteristics allows us to identify, in a more consistent way with the predictions of economic growth models, the impact of structural change on the behaviour of output in the long run. the diversity of the characteristics of each sector, such as the intensity / quality of the factors used, technological regimes, economies of scale, inter-sectoral linkages or type of competition 14 economic analysis (2018, vol. 51, no. 3-4, 10-23) ((peneder, 2003b); (marelli, 2004)) imply different sectoral innovation potential and require a more disaggregated classification in order to achieve results that are more useful for policy makers. in what follows, we briefly present the sectoral taxonomy adopted in this study that will allow us to distinguish different activities according to their potential for productivity improvements assuming that higher human capital requirements lead to higher productivity gains. (peneder, 2003b) reviews the existing (to date) major industry classifications used in empirical research in terms of their aim, scope and methods of identification, highlighting their advantages and limitations, so that researchers can make an educated selection of the most appropriate classification for the purposes of their studies. according to the author, a taxonomy differs from a typology in that it is an empirical classification produced from quantitative identification undergirded in adequate statistical tools, such as cluster analysis, instead of the simpler but more subjective cut-off approach in which a differentiating threshold is defined exogenously by the researcher. a useful taxonomy must guarantee stability between countries and over time, “(…) reflecting systematic relationships for data which otherwise are difficult to compare.” ((peneder, 2003b); p. 126) obeying the general principles for the construction of a good taxonomy identified in (peneder, 2003b), the taxonomy proposed by (peneder, 2007) classifies 49 manufacturing and service industries according to the educational intensity required from the respective workforce3, distinguishing between seven categories, on a scale that starts with activities with very high educational requirements and ends with activities with very low educational requirements (very high, high, medium-high, medium/intermediate, medium-low, low, very low). according to the author, “it provides an empirical tool that allows the researcher to add analytic structure to microlevel studies of firm behaviour, as well as aggregate international and comparative studies— applicable whenever sector dependent characteristics of educational intensity, or its according productive capabilities in the human resource base, are thought to be of importance.” (p. 207). since education data at the firm/sectoral level is not easily available in a comparable format across countries, the author first applies the statistical cluster analysis to each country for which there is detailed education data separately (the usa, germany, france, the uk, and austria) in order to identify the activities that belong to each of the seven educational categories that resulted from the identification method used. statistical cluster analysis is a statistical identification method that classifies observations based on their relative similarities according to a multidimensional array of variables and produces different segments/categories of data (seven in this case) by allowing for maximum homogeneity within and maximum distance between segments ((peneder, 2003b)). the five separate national taxonomies were then synthesized into one common consensus classification to be used in cross-country analysis, which would otherwise not be possible due to lack of comparable sectoral data on educational intensity (see table 1, pp. 198-99, in (peneder, 2007)). the subsequent quantitative validation of the taxonomy by means of anova type regressions revealed considerable robustness to variations over time and between countries. in this study, we group, for each eu15 member state, manufacturing and services activities according to the former seven categories, distinguishing between manufacturing and services in order to compare the results for these two main sectors of economic activity. table a.1 in the appendix describes the manufacturing activities according to the isic rev. 3 classification at the two digit level that belong to each of the categories in the sectoral taxonomy proposed by 3 other popular sectoral taxonomies that distinguish sectors according to their potential for productivity improvements include (pavitt, 1984) perfected by (tidd, bessant, & pavitt, 2005), which is based on the innovative intensity of each sector and the use of inter-sectoral knowledge, and (robinson, stokes, stuivenwold, & ark, 2003), based on the production and use of icts by each activity. see also (peneder, 2003a,b). andrea araujo, marta simoes 15 (peneder, 2007). table a.2 in the appendix does the same for services activities. notice that there are no manufacturing activities in the very high educational intensity category. empirical model and results for the analysis of the relationship between productive specialisation and economic growth we use data on real gdp per capita growth, computed with data on real gdp and population taken from the penn world table (pwt) 9.0, while productive specialisation is measured as the share of different activities in total value added, computed with data from the eu klems. the period covered starts in 1970 and ends in 2005 for econometric and data availability reasons. recently, eu klems has released data for a more recent period that goes up to 2015, but it only starts in 1995. using this more recent data would thus involve the loss of a considerable number of degree of freedom in the econometric analysis that follows, making the results less robust. additionally, this more recent data is not directly comparable to the data used in the paper since it uses isic rev. 4 (nace 2) classification of economic activities while the data in the paper refers to the isic rev. 3 (nace 1) the one used by (peneder, 2007) as the basis for his sectoral taxonomy, making the more recent eu klems sectoral data based on isic rev. 4 more difficult to translate into the original taxonomy. we estimate what is known as a growth regression since the dependent variable in our empirical model is the growth rate of real gdp per capita and the main explanatory variable refers to productive specialisation defined according to the sectoral taxonomy of (peneder, 2007), included alongside a set of control variables identified as relevant growth determinants in the theoretical and empirical growth literature ((peneder, 2003a); (moral-benito, 2012)). the data used refers to a 35 years period (1970-2005) and were taken from the eu klems (jäger, 2017) and the pwt (feenstra, inklaar, & timmer, 2015) databases and the barro and lee education data set ((barro & lee, 2013)). the estimations were carried out with the econometric package gretl. the empirical model is given by equation (1): ����������,� = � + ���� �,!"# + $���������,!"# + %�&'��,!"# + (�) )�,! + *+��,�,! +-�+.�,! + /�,! (1) where δlngdp���0,1 is the annual average growth rate of real gdp per capita measured for each 5year (τ) sub-period from 1970-2005, with gdprpc corresponding to real gdp per capita, � is a constant; i= 1,2,…, n (with n = 15, the fifteen eu member states in our sample); 1 = 1,2,…,7 (with 1 = 7) are the 5-year sub-periods (1970-75; 1975-80;…; 2000-05); spec is the value added share of each sectoral category defined by (peneder, 2007), included each at a time; lngdprpci,t-1 is the log of the initial value of real gdp per capita for each 5-year sub-period; educ i,t-1 is average years of total schooling of the population aged 25 and above measured at the beginning of each 5-year sub-period taken from (barro & lee, 2013); gfcf is the investment rate – gross fixed capital formation as a percentage of gdp measured as the average value for each 5-year sub-period; open refers to openness measured as the gdp ratio of imports plus exports corresponding to the average value for each 5-year sub-period; gov is public consumption as a percentage of gdp measured as the average value for each 5-year sub-period; and ε is the error term. all the control variables except for educ were computed with data taken from the pwt. the initial value of gdp per capita is included in the regression to capture the convergence hypothesis from exogenous and technological diffusion growth models according to which initially poorer countries/more distant from the technological frontier are expected to grow faster and so the respective coefficient is expected to be negative ((islam 1995; 2003). according to (solow, 1956), higher investment rates lead to higher physical capital accumulation and the increased availability of this input fosters growth, at least in the medium run. the estimated coefficient for the variable gfcf is thus expected to be positive. models in the tradition of solow (1957) that include additionally human capital ((mankiw, romer, & weil, 1992)) but also 16 economic analysis (2018, vol. 51, no. 3-4, 10-23) endogenous growth models ((lucas, 1988); (romer, 1990); (jones, 2005)) attribute a fundamental role to education, either as an input into final goods production, allowing workers to produce more, but also as an input into innovation and imitation activities allowing for productivity improvements and thus faster growth. the estimated coefficient for the variable educ is thus expected to be positive. more open economies have access to larger markets and new technologies and thus become more efficient and productive, so the coefficient of open is expected to be positive ((gries & redlin, 2012)). according to (barro, 1990), public consumption (gov) is expected to hamper growth since it deviates resources from more efficient/productive activities (θ is expected to be negative). table a.3 in the appendix contains descriptive statistics for the variables in the model. overall it is possible to see that there is considerable variation across countries and over time for the variables under analysis. as far as our dependent variable is concerned, the growth rate of real gdp per capita, a more in depth inspection of the data (available from the authors) revealed that there is some evidence of convergence among the eu15, with the initially poorer countries (greece, portugal, spain, ireland) recording higher than average growth rates. as for the main explanatory variables, the value added shares of the different manufacturing and services activities classified according to (peneder, 2007), overall the activities that increased the respective value added share are those that need more human capital. this is true for both manufacturing and services, although the relative weight of these categories is higher for services. additionally, the countries with the higher levels of real gdp per capita are also the ones that recorded a higher weight of activities that require more educated workers. the countries with lower initial levels of real gdp per capita also recorded a higher weight of manufacturing and services activities classified as very low and low by (peneder, 2007). the empirical model described in equation (1) is a static panel data model that will be estimated using the fixed effects method. fixed effects is more adequate when, although there are common variables that affect the behaviour of the countries under analysis, there are also characteristics intrinsic to each country that influence the respective behaviour that are different across countries, while remaining constant over time ((adkins, 2010); (rodríguez-pose & tselios, 2009)). table 1 contains the results obtained with the fixed effects method considering as the main explanatory variable the value added share of each category in (peneder, 2007) for the manufacturing sector4 5. the findings confirm the expected influence of initial income, with the estimated coefficient of lngdprpc statistically significant and negative, supporting in this way the convergence hypothesis: initially poorer countries such as greece, portugal and spain are approaching the income levels of the richer countries in the sample, such as germany, sweden or denmark. regarding educational attainment levels, the results confirm the importance of human capital for growth with the estimated coefficient always positive as expected and statistically significant. the control variables gfcf, gov and open present more varied results. the estimated coefficient for the investment rate is always positive as expected but only statistically significant (at 10%) when considering manufacturing activities with high educational requirements. the variable public consumption presents a negative and statistically significant influence on the growth rate of real gdp per capita, indicating that it is probably the source of inefficiencies in the group of countries under analysis. as for openness, although the estimated coefficient is also always positive as expected it is never statistically significant. the results for the value added shares of the different sectors defined by (peneder, 2007), confirm the expected negative influence of specialisation in manufacturing activities with rather 4 as described in section 3, for the manufacturing sector there are no activities in the very high educational requirements category, which is why we only consider six categories. 5 the model was also estimated using the employment shares of the different categories as the main explanatory variables. the results are identical to the ones obtained when using the value added shares. andrea araujo, marta simoes 17 low educational requirements, in particular very low and medium-low, and positive for the remaining categories. the estimated coefficients are statistically significant at the 10% level for the categories medium-low and medium-high, at the 5% level for the category very low and at 1% for the category high, and are not significant for the categories low and medium. overall, these findings indicate that the countries in our sample stand to gain in terms of economic growth from moving their productive specialisation pattern away from manufacturing activities with low educational requirements. table 1. estimation results with the manufacturing sector divided according to peneder (2007) notes: ***, **, * indicate statistical significance at the 1%, 5% and 10% levels, respectively. standard errors in parenthesis. source: authors’ computations using gretl table 2 contains the results of the estimation of equation (1) considering the value added shares of the different services activities grouped according to the seven categories in (peneder, 2007). in any of the estimated models, initial gdp presents a negative coefficient that is statistically significant at the 1% level. the variable educ presents a positive coefficient as expected and is statistically significant at the 5% level. the estimated coefficient for public consumption is negative and presents statistical significance at the 1% level for all equations. on the other hand, the estimated coefficients for gfcf and open are not statistically significant for any of the categories in the peneder taxonomy. the variable spec, measured as the value added share of the services activities corresponding to each of the seven categories in (peneder, 2007), shows a negative sign for the categories very low, low and medium-low and a positive sign for the medium, medium-high, high and very high categories. these results are in line with the theoretical predictions since the latter three categories are the ones that require a more educated workforce, which may indicate that when countries are specialized in activities in the services sector that require skilled labour the growth rate of the country will be higher, and the opposite applies to the low educational requirements categories. however, the variable is only statistically significant (at 1%) in the very low category and in the high category. very low low medium-low medium mediumhigh high constant 0.2907*** (0.0780) 0.2460*** (0.0774) 0.2508*** (0.0766) 0.2521*** (0.0769) 0.2566*** (0.0016) 0.2653*** (0.0718) lngdprpc 0.0269*** (0.0085) 0.0233*** (0.0087) −0.0226*** (0.0085) −0.0234*** (0.0085) −0.0240*** (0.0085) −0.0267*** (0.0080) spec 0.2969** (0.1169) 0.0288 (0.0370) −0.3580* (0.2140) 0.0619 (0.0417) 0.1224* (0.0712) 1.2467*** (0.2754) educ 0.0035** (0.0015) 0.0037** (0.0016) 0.0035** (0.0015) 0.0027* (0.0016) 0.0027* (0.0016) 0.0027* (0.0014) gfcf 0.0136 (0.0320) 0.0187 (0.0335) 0.0163 (0.0327) 0.0147 (0.0328) 0.0229 (0.0330) 0.0549* (0.0298) gov −0.1863*** (0.0499) −0.1653*** (0.0510) −0.1841*** (0.0511) −0.1493*** (0.0521) -0.1479*** (0.0516) −0.0723 (0.0483) open 0.0017 (0.0038) 0.0024 (0.0039) 0.0035 (0.0039) 0.0020 (0.0038) 0.0016 (0.0038) -0.0033 (0.0038) r2 0.2463 0.2009 0.2194 0.2145 0.2207 0.3801 aic -603.7688 -59.6269 -600.0875 -599.4232 -600.2586 −585.7840 hq -589.7881 -583.6463 -586.0107 -585.4425 -586.2780 −572.1917 no. obs. 105 105 105 105 105 105 18 economic analysis (2018, vol. 51, no. 3-4, 10-23) combining the analysis of the different results in tables 1 and 2, we find that both in the manufacturing and services sectors the activities included in the very low category that includes the activities that require the less educated workers present a negative and statistically significant correlation with real gdp per capita growth. on the other hand, the activities included in the high category present a positive correlation with real gdp per capita growth, a category that includes activities with high levels of human capital. besides these common results, manufacturing activities included in the low category present a negative correlation with growth while those included in the medium high category present a positive correlation. additionally, as far as comparing manufacturing and services activities is concerned, the results indicate that a productive specialisation pattern towards manufacturing activities classified as very low and low is more harmful for growth than specialisation in the equivalent categories but in services activities. on the other hand, there are also more categories requiring more skilled workers in the manufacturing industry that positively influence growth, relative to services activities. finally, a somewhat unexpected result refers to the finding that services activities classified in the very high category do not show a statistical significant relationship with growth. table 2. estimation results with the services sector divided according to peneder (2007) notes: ***, **, * indicate statistical significance at the 1%, 5% and 10% levels, respectively. standard errors in parenthesis. source: authors’ computations using gretl from an industrial policy perspective, the main policy advice that can be extrapolated from this study contemplates the design of industrial policies that promote manufacturing activities such as chemicals, telecommunications and transports equipment, and services such as financial intermediation, audit, tax consulting, engineering and legal activities, in order to promote growth. this industrial policy orientation involves also coordination with educational policy, promoting higher educational attainment levels in the eu, in order to guarantee that the expansion of the former sectors is not constrained by a lack of supply of skilled/more educated workers. very low low mediumlow medium mediumhigh high very high constant 0.2627*** (0.0771) 0.2433*** (0.0774) 0.2618*** (0.0781) 0.2667*** (0.0867) 0.2523*** (0.0778) 0.2670 (0.1070) 0.257*** 0.0783) lngdprpc -0.0237*** (0.0085) 0.0225*** (0.0086) −0.0234*** (0.0086) −0.0253*** (0.0099) −0.024*** (0.0087) −0.025*** (0.0115) 0.024*** (0.0087) spec 0.0940* (0.0534) -0.0493 (0.06230) −0.1356 (0.0970) 0.0257 (0.0448) 0.0342 (0.0382) 0.0784*** (0.0508) 0.06566 (0.0670) educ 0.0032** (0.0015) 0.0032** (0.0016) 0.0036** (0.0016) 0.0037** (0.0017) 0.0034** (0.0016) 0.0046* (0.0021) 0.0036** (0.0016) gfcf 0.0099 (0.0327) 0.0152 (0.0330) 0.0152 (0.0329) 0.0160 (0.0332) 0.0157 (0.0330) 0.0430 (0.0443) 0.0152 (0.0330) gov −0.1729*** (0.0502) −0.1570*** (0.0529) −0.1743*** (0.0541) −0.1776*** (0.0533) -0.180*** (0.0524) −0.2227*** (0.0587) 0.181*** (0.0524) open 0.0039 (0.0039) 0.0034 (0.0042) 0.0021 (0.0042) 0.0021 (0.0039) 0.0040 (0.0044) -0.0075 (0.0058) 0.0014 (0.0039) r2 0.2218 0.2011 0.2179 0.1985 0.2026 0.2757 0.2040 aic −600.4149 -597.6532 -597.8808 -597.3178 -597.852 -470.3560 598.033 hq −586.4342 -583.6726 -582.8247 -583.3371 -583.872 -457.7947 584.052 no. obs. 105 105 105 105 105 105 105 andrea araujo, marta simoes 19 conclusion this study analyses the relationship between productive structure and economic growth for a sample composed of the fifteen older eu member states over the period 1970-2005 taking into account the innovation potential of different groups of activities. to identify these groups we use the sectoral taxonomy proposed by (peneder, 2007) based on the educational requirements of the respective workforce. when analysing real gdp per capita levels in the eu15, we concluded that countries such as portugal, greece, spain, ireland and finland with lower than average levels are also the countries that recorded a higher relative weight of activities classified as very low and low in terms of educational requirements, both in the manufacturing and services sectors. from 1970 until 2005, the period covered in this study, the eu15 has experienced changes in its productive structure, with the activities that need more educated workers gaining importance. this is true for both manufacturing and services activities, although in the latter the activities that require more human capital have a higher weight relative to the services activities classified as very low and low. we thus investigated the relationship between productive structure and economic growth for the eu15 countries by estimating a growth regression in a panel data context using the fixed effects method. the results support the idea that countries with a productive specialisation pattern based on activities that require mainly low skilled labour tend to record lower growth rates. in particular, manufacturing and services activities classified as very low according to the sectoral taxonomy of (peneder, 2007) present a negative and statistically significant correlation with the growth rate of real gdp per capita, while manufacturing and services activities classified as high present a positive correlation. for the remaining categories the estimated coefficients present the expected signs but are not statistically significant. the exceptions are manufacturing activities classified as medium-low, with a negative and statistically significant coefficient, and as medium-high with a positive and statistically significant coefficient. the implications of these key findings for the design of a growth enhancing industrial policy are the support of activities that require more educated workers, in particular manufacturing activities corresponding to chemical, telecommunications and transports, classified as mediumhigh and high according to (peneder, 2007), and services activities corresponding to financial intermediation and computers, classified as high in terms of education requirements. this industrial policy orientation involves also coordination with educational policy, promoting higher educational attainment levels in the eu, in order to guarantee that the expansion of the former sectors is not constrained by a lack of supply of skilled/more educated workers. the robustness of the previous conclusions needs in any case to be further checked in future studies that address issues related to the use of econometric methodologies for panel data that control in other ways for endogeneity issues or non-linearities, for instance. additionally, the economic policy implications derived would benefit from the analysis of the situation in specific countries as the results obtained apply to the representative/average country, not taking into account potential heterogeneity among the fifteen eu countries analysed coming from sources other than the fixed effects considered. finally, a comparison with the results obtained through the use of alternative sectoral taxonomies could also bring additional insights. acknowledgements we would like to thank an anonymous referee for the helpful comments and suggestions to the version submitted to the 10th international scientific conference theoretical and empirical aspects of economic science – 60 years of challenges and opportunities organized by the institute of economic sciences, belgrade, november 1, 2018. 20 economic analysis (2018, vol. 51, no. 3-4, 10-23) references adkins, l. c. 2010. using gretl for principles of econometrics. oklahoma state university. barro, robert. 1990. 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and apparatus, nec insulated wire motor vehicles, trailers and semi-trailers medium 24 321 322 323 33-331 351 353 352þ359 chemicals and chemical products electronic valves and tubes telecommunication equipment radio and television receivers medical, precision and optical instruments scientific instruments other transport equipment building and repairing of ships and boats aircraft and spacecraft railroad equipment and transport equipment nec medium-high 30 office, accounting and computing machinery high source: authors based on peneder (2007), table 1, pp. 198-99. table a.2. services activities divided according to the taxonomy of peneder (2007) isic revision 3 subsectors classification of peneder (2007) 55 95 hotels and restaurants; private households with employed persons; very low 50 sale, maintenance and repair of motor vehicles and motorcycles; retail sale of fuel; low 52 60 61 retail trade, except of motor vehicles and motorcycles; repair of household goods; inland transport; water transport; medium-low 51 63 64 70 71 wholesale trade and commission trade, except of motor vehicles and motorcycles; supporting and auxiliary transport activities; activities of travel agencies; post and telecommunications; real estate activities; renting of machinery and equipment; medium andrea araujo, marta simoes 23 isic revision 3 subsectors classification of peneder (2007) 66 67 75 85 90-93 insurance and pension funding, except compulsory social security; activities related to financial intermediation; public administration and defense; compulsory social security; health and social work; other community, social and personal services; medium-high 65 741-3 49 financial intermediation, except insurance and pension funding; legal, technical and advertising; other business activities; high 72 73 80 99 computer and related activities; research and development; education: extra-territorial organizations and bodies. very high source: authors based on peneder (2007), table 1, pp. 198-99. table a.3. descriptive statistics for the variables in the empirical model variable mean median std. dev. min. max. δlngdprpc 2.36% 2.30% 1.40% -0.93% 8.54% gdprpc (usd) 24900 24100 7400 9960 48100 educ (years) 8.43 8.49 1.87 2.72 11.9 gfcf 27.50% 26.80% 4.49% 19.10% 46.00% open 73.80% 60.90% 42.90% 15.30% 202.00% gov 16.90% 16.70% 3.20% 9.05% 25.90% spec_very_low_manuf 1.99% 1.72% 1.27% 0.06% 6.49% spec_low_manuf 7.04% 6.60% 3.88% 2.81% 32.3% spec_medium_low_manuf 1.40% 1.34% 0.66% 0.32% 3.38% spec_medium_manuf 6.86% 6.05% 3.94% 2.28% 29.9% spec_medium_high_manuf 2.70% 2.20% 2.38% 0.48% 16.9% spec_high_manuf 0.22% 0.07% 0.56% 0.00% 3.85% spec_very_low_serv 4.17% 3.36% 2.99% 1.30% 20.5% spec_low_serv 2.61% 1.88% 2.73% 1.15% 20.1% spec_medium_low_serv 7.67% 7.67% 2.23% 2.03% 21.4% spec_medium_serv 17.40% 18.20% 3.96% 1.94% 23.8% spec_medium_high_serv 17.50% 17.80% 4.51% 1.63% 36.9% spec_high_serv 6.79% 6.72% 4.19% 1.06% 23.9% spec_very_high_serv 6.58% 6.54% 2.26% 1.35% 20.0% source: authors’ computations article history: received: october 12, 2018 accepted: december 10, 2018 microsoft word ea_2021_1_final.docx doi: 10.28934/ea.21.54.1.pp41-59 original scientific paper housing quality and human capital formation in developing countries guilherme shirazawa1 | marta simões2* 1 university of coimbra, faculty of economics, coimbra, portugal 2 university of coimbra, ceber, coimbra, portugal abstract the main objective of this work is to analyse the relationship between the quality of housing and human capital formation in the context of developing countries. the analysis attempts to fill a gap in the current literature regarding the lack of empirical studies that address the impact that living conditions can have on human capital. the study was performed using cross-sectional data, mostly taken from the unesco database, for 52 low and middle-income countries. the estimated empirical models consider average years of schooling as the dependent variable and as the explanatory variable of interest the proportion of the population living in houses with below minimum quality standards. the ols results obtained suggest a negative association between housing quality and average years of schooling, but with little or no statistical significance, making the empirical analysis inconclusive. we pose that this result might relate to the comparability of the housing quality data provided by unesco, highlighting the need to gather more data and produce new, more reliable indicators on the topic. key words: human capital, housing, developing countries, cross-sectional analysis, economic growth, economic development jel classification: i25, o18, o15, o50, r20 introduction the economic impact of housing investment has gone through several debates over the last few decades. housing has mainly been treated as a factor that influences short-run macroeconomic performance through its (wealth) effect on consumption and investment (harris & arku. 2006). in this study we take a different perspective focusing on the potential long-run economic impact of housing investment through education improvements, an important source of human capital accumulation, in turn a key driver of economic growth and development (mankiw, romer and weil (1992); lucas (1988), benhabib & spiegel (1994); hanushek & woessmann (2011)). our main hypothesis is that housing quality can play an important role in the explanation of human capital availability differences. having adequate dwellings has been recognized by the literature as a basic requirement for individuals to develop and become more prosperous (e.g., healy (1971); bradley and putnick (2012)). the main argument is that housing provides basic facilities, such as having access to a good shelter that protects from the elements, to electricity, clean water and a proper * corresponding author, e-mail: mcsimoes@fe.uc.pt 42 economic analysis (2021, vol. 54, no. 1, 41-59) environment for cooking. access to these factors would in turn have a positive effect on productivity and overall personal health, as well as on the performance of children at school. however, the analysis of this relationship has seldom been pursued from an empirical perspective and has never considered the specific impact on human capital. given the present gap in the literature, this study aims to empirically investigate the relationship between housing quality and human capital formation in the context of developing countries through the estimation of an empirical model where human capital is the dependent variable and an indicator of the lack of housing quality is our explanatory variable of interest, alongside a set of control variables selected from previous empirical studies on the determinants of human capital. the majority of the data used comes from the unesco institute for statistics. the remainder of this study consists of four sections. in the first section we provide an overview of the literature concerning the relationship between housing, human capital formation and macroeconomic performance. in the second section, we present the empirical model and data used. the third section contains the discussion of the results obtained and, finally, the fourth section concludes. literature overview in this section we start by giving an overview of the literature on human capital and economic growth in order to motivate our analysis of the relationship between housing and human capital formation and better identify the gap in the literature that the present study tries to address. we next review the scarce (at least at the macro level) literature on the relationship between access to housing and human capital formation. human capital and economic growth after the initial methodological and empirical foundations laid in the 1960s, economic growth models began to incorporate the concept human capital in the 1980s and 1990s. a pioneer work is the model proposed by mankiw, romer and weil (1992) where the authors extend the solow (1956) exogenous neoclassical growth model to include human capital as another input into final goods production and subject to diminishing returns just like physical capital. the model shows that this augmented version of the solow model provides a better explanation of the differences in income per-capita across countries although it is not able to explain the growth rate of output in the long run. in the empirical validation of their model, the authors considered annual data (1960-1985) for a sample of 98 countries and found that the inclusion of human capital made possible to explain about 80 per cent of the variation in income across countries. a different approach is that proposed by lucas (1988), which lies within the category of ak growth models. in this model, human capital accumulation creates positive externalities due to “learning-by-studying”. in the final goods sector the increase in human capital at the individual level raises the average human capital in the economy by making workers that are in contact with the more educated individuals more productive. in this way, the economy is able to continue growing as a whole even if there are diminishing returns to individual human capital accumulation. another important landmark in the analysis of the relationship between human capital and economic growth is the work of romer (1990) in which the growth of output in the long run is the result of intentional decisions made by economic agents in terms of the allocation of resources to an r&d sector that produces new knowledge (non-rival) usable in final goods production. human capital is viewed as the main input in this r&d sector and thus a major driver of growth. at the empirical level, benhabib & spiegel (1994) benchmark study analyses the relative importance of human capital for economic growth through the different channels discussed above, i.e. distinguishing between the role of human capital in final goods production and as an input into innovation and imitation activities. the empirical model uses time series crosscountry data for 78 countries with annual observations from 1965 to 1985, with the proxy for guilherme shirazawa, marta simões 43 human capital corresponding to average years of schooling retrieved from the barro-lee and kyriacou datasets. the results obtained indicate that human capital plays a major role in the adoption and implementation of new technologies. additionally, human capital seems to be more relevant to absorb technology from the leading countries than it is to internally develop new technologies, supporting the idea that the cost of imitation activities is lower than that of innovation activities for follower countries. the empirical identification of the role human capital plays in economic growth has also revolved around measurement issues, in particular in what concerns quality vs. quantity of human capital. an example is the work by hanushek & woessmann (2011). the authors developed an empirical analysis that focus on the role of human capital, as measured by cognitive skills, in explaining the differences in income per capita across oecd countries, from 1980 to 2000. they use microdata from international achievements tests (pisa– programme for international student assessment scores) for measuring, separately, basic and top skills. this is a more sophisticated approach than considering just measures of the quantity of human capital such as average years of schooling, literacy rates or educational attainment rates, which the authors consider to be a potentially incomplete and misleading measures for human capital as they implicitly assume that learning outcomes from additional years of education are the same across countries. the results from the regressions indicate that cognitive skills are a better predictor of economic growth than average years of schooling, confirming that the quality of human capital is more important for growth than its quantity. in any case, the results obtained still point to average years of schooling as able to explain an important part of long-run growth, which is in line with the empirical findings from mankiw, romer and weil (1992). even though human capital quality plays a more important role than its quantity in the explanation of economic growth, the two previous studies show that human capital in general is crucial if countries are in pursuit of long-term prosperity. in a more recent study, égert, botev and turner (2020) investigate the impact of different educational policies on economic growth. for this purpose, the authors analyse the influence that different educational policies have on human capital formation and, as a consequence, on economic growth. the study found that increasing spending in educational policies such as lowering teacher-to-pupil ratios, providing greater autonomy to schools and universities, reduced barriers for university funding, increasing the age of first education tracking (separating students in different education programmes according to performance) and more primary schooling all had a positive and statistically significant impact on aggregate human capital. the results were next used to estimate the gains in terms of economic growth from the implementation of the best practices in terms of educational policies, and meaningful gains in terms of economic growth in the long run were found. housing and human capital despite some theoretical and empirical analyses on the relationship between housing and economic growth (e.g. green (1997); hongyu et al. (2002); terzi and bolen (2008)), to the best of our knowledge there are no studies that try to analyse its mediating role through human capital formation7f1. given the importance of the latter for economic growth, we identified some studies on the relationship between housing and human capital formation at the micro level that provide some arguments on what to expect in terms of the sign of the relationship at the aggregate level. 1 a related recent study is that by manzoli, duarte & simões (2020). similarly to our study, the authors investigate the role of housing for macroeconomic performance, proxied by the growth rate of real gdp per capita, although the focus is not on the quality of housing but on the housing deficit in the particular situation of brazil. they find evidence of a negative association between the housing deficit and economic growth, which supports the promotion of policies that facilitate access to housing as a means to promote social inclusion and economic growth. 44 economic analysis (2021, vol. 54, no. 1, 41-59) an earlier study on the topic is healy (1971). the author analyses the impact of a rehousing program for a group of workers in a mexican factory on the respective productivity, starting from the hypothesis that improvements in housing conditions can raise either the capacity to work or the desire to work, resulting in greater output per hour worked and lower absenteeism. the empirical analysis considered two groups of workers, those that were rehoused and those that remained in their original low-quality homes, over a period of four years, two years before the rehousing of the first group and two after. in addition to productivity, the study also investigated the effects of the program on worker’s absenteeism and health. the author found that one year after the rehousing programme workers’ productivity increased and housingrelated health problems decreased. overall, the improvement in the worker’s living conditions had a positive effect on the health component of the worker’s human capital and may have impacted positively their ability to concentrate and become more productive. these positive relationships leave room to ask whether these positive outcomes could also have an effect on and individual’s educational path. in bradley and putnick (2012) the authors analyse the relationship between the home environmental conditions that are associated with child development, e.g., housing quality, material resources, formal and informal learning resources, and the human development index (hdi) for 28 developing countries. the study found that the quality of housing and material resources were positively associated with the hdi. looking at the issue in the context of low-income households, the study from the citizens housing and planning council (housing, c., & council, p. ,2001) analysed a sample of diverse low-income young adults in new york and found that crowded homes, among other factors such as ethnicity, have a negative impact on the probability of a teenager to finish high school. one aspect of housing that has been known to affect educational outcomes is tenure. bramley & karley (2007), for selected areas in both england and scotland, found that children living in a household where the parents are the homeowners record higher school attainment and better test scores. the authors attribute these results to better housing conditions that provide higher quality and a more stable environment so that children are able to advance in their educational path. the higher quality of homes in which the owners reside is attributed to the propensity of these owners to take better care of the internal facilities when compared to renting. mohanty and raut (2009) find no direct impact of home ownership on educational achievement but conclude that it creates a better home environment, which has a positive effect on children school outcomes. these conclusions are based on data from the panel study of income dynamics (psid) child development supplement for the usa. using data from the national longitudinal survey of youth, usa, blau et al. (2019) also find a positive association between owner-occupied home during childhood and young adults’ educational attainment. furthermore, the positive effects of homeownership are found to go beyond education, being positively associated with employment and negatively associated with teen pregnancy, criminal convictions and the likelihood of being on welfare. leviten-reid & matthew (2018) also confirm the importance of homeownership for bonding social capital availability in canada, although other factors such as residential stability exert a bigger effect on all forms of social capital. closer to the goals of our analysis, simson & umblijs (2020) investigate the relationship between home and neighbourhood environment and the educational performance of pupils. using microdata from norway, the authors found that factors such as noise pollution, overcrowded homes, lack of homeownership and housing stability (moving frequently) are related to lower test scores. in summary, housing conditions have been portrayed as exerting a positive influence on health and educational outcomes in single country studies (the exception is bradley & putnick (2012)), but the literature lacks a comprehensive empirical analysis covering a wider sample of countries considering human capital measured in a way that may be more useful for economic growth analyses. this approach also adds to the housing literature, allowing it to expand from its usual focus on the impact of housing on short-run economic performance and providing insights on its potential role for economic growth. guilherme shirazawa, marta simões 45 empirical strategy and data the empirical analysis considers a sample composed of lowand middle-income countries, based on the world bank income classification groups. we exclude high-income countries from the analysis due to the small variation in housing quality in this group of countries. the final sample comprises 52 low and middle-income countries for which data on housing quality was available (for the complete list of countries included in the analysis see table a.1 in the appendix). all the estimations were carried out with the econometric package gretl (gnu regression econometrics and time-series library) version 2019b. the baseline empirical model estimated is given by equation (1): 𝑙𝑛𝐻 = 𝛼 + 𝛽𝑙𝑛𝑄 + 𝜆′𝑙𝑛𝑋 + 𝑢 (1) where the dependent variable, h, is human capital for country 𝑖 and the explanatory variable of interest is q, (lack of) housing quality in country 𝑖. the model additionally includes a vector x of control variables with other determinants of human capital formation selected based on previous empirical literature (baldacci et al., 2008). α is the constant term and u the error term. the variables included in vector x are gdp that corresponds to real income per capita, gov_edu, that represents state intervention at the educational level, mortality that corresponds to the health status of the population and internet, the proportion of the population with access to the internet. these control variables were selected based on the work of baldacci et al. (2008) who estimate a regression to predict educational outcomes in 118 developing countries over the period 1971-2000 based on a set of explanatory variables (e.g., population’s health, expenditure in education, urbanization and gender equality). our choice of explanatory variables was also dictated by data availability issues and the need to define a parsimonious empirical model due to the limited number of observations available. we first had to guarantee that we had data for our explanatory variable of interest, housing quality, and the dependent variable, human capital, and the choice of the remaining control variables implied that they had to be available for the sample defined by the previous variables. table a.2 in the appendix identifies the variables used, describes how they are measured and identifies the sources of the data. we measure human capital, h; as average years of schooling of the population aged between 25 and 74 years old taken from the unesco institute for statistics. this proxy is widely used as a measure of human capital in empirical growth studies8f2 and one of the main purposes of our analysis is to investigate the relationship between housing quality and human capital availability to reflect on the role of the former as a potential determinant of economic growth, with human capital as the mechanism of transmission. other often used proxies for educational human capital include enrolment rates, for measuring quantity of schooling, and internationally comparable test scores, for measuring the quality of schooling as in hanushek & woessmann (2011). the choice of average years of schooling was based on its wider availability for developing countries and is in line with applied economic growth studies such as benhabib & spiegel (1994). one problem we encountered was the matching of the cross-sectional data for the human capital stock and housing quality for some countries and years. to address this problem, we used the barro-lee dataset to fill the gaps for countries for which there was no data in the unesco database. although the barro-lee dataset computes average years of schooling based on the highest education level attained by individuals aged 15-64 years old (not 25-74), we believe that this approach does not meaningfully influence the results. in fact, when we 2 for some very recent examples of the vast number of studies that consider the relationship between human capital, measured as average years of schooling, and economic growth see e.g. cornell, knutsen, & teorell (2020), gutiérrez-romero (2021), köppe malanski & póvoa (2021), matousek & tzeremes (2021), osei & kim (2020), ouedraogo, sourouema & sawadogo (2021), sturn & epstein (2021), woo (2020) and zergawu, walle & giménez-gómez (2020). 46 economic analysis (2021, vol. 54, no. 1, 41-59) compared the two datasets for the countries for which we have data in both datasets, for the same year, we concluded that the values were quite similar. of the 52 countries considered, we used the barro-lee data to fill the gaps for 8 countries, or 15,38% of our sample (see table a.3 in the appendix). our explanatory variable of interest, q, is the proportion of the population that lives in substandard housing. the use of this variable dictated the structure of the data used in the empirical analysis. in fact, the cross-section approach was chosen due to data limitations associated with the housing quality indicators, where for each country only one data point was available, corresponding to a single year. the year to which each observation refers to was also usually different across a large number of countries. to measure the lack of housing quality (substandard housing) we consider the number of occupants of housing units, according to different housing types, retrieved from the unesco institute for statistics. we chose this indicator due to its comparability across countries, covering ten standardized types of housing. this homogenous international classification allows us to compare different countries despite the large variability in housing standards between different countries, usually dictated by the availability of building materials among other factors. the housing data is divided into several categories corresponding to different housing quality types. table a.4 and figure a.1 in the appendix summarize the different housing quality classifications used by the united nations and present the respective definitions. good quality housing according to the description in the database corresponds to a common dwelling with all the basic facilities. according to the un’s principles and recommendations for population and housing censuses, a common dwelling has four essential features: it is composed by a room or suite of rooms, it is located in a permanent building, it has a separate access to a street or common space and was intended for occupation by a single household (un, 2017, p.249). furthermore, the un also defines basic facilities for decent living: piped water, a toilet, fixed bath or shower, a kitchen or other space for cooking, with all four located within the same dwelling. all other categories of housing fail to meet the former criteria and so we dub them sub-standard housing. due to some inconsistency in the observations for different housing categories we cannot include each separately in the regressions. to overcome this problem, we computed a new variable that considers the population living in any of the housing categories considered to be sub-standard divided by the total population to take into consideration different population sizes, as can be seen in equation (2). q = ∗ 100 (2) as far as the expected sign of the different estimated coefficients is concerned, we expect a negative relationship between lack of housing quality and human capital, with higher shares of the population living in sub-standard housing (higher q) associated with lower human capital formation because lower housing quality may act as a disincentive for individuals to pursuit more education due to the lack of a study enhancing environment at home or negative health effects caused by low housing quality. income per capita is expected to have a positive influence on human capital since higher income raises the ability of individuals to afford more education since its relative cost becomes lower as income increases (baldacci et al. 2008). the same positive influence applies to state intervention at the educational level that gives broader access to the education system and probably allows for poorer, but talented, individuals to acquire skills and competences that would otherwise be unattainable. a less healthy population, proxied by the infant mortality rate, is expected to have a negative influence on human capital because it may act as a barrier for individuals to be able to afford investing in education since the individual’s poor health status can act as a disincentivise for school attendance, can lower learning ability or even induce dropping out of school altogether. finally, the percentage of the population with access to the internet is expected to have a positive influence on human capital guilherme shirazawa, marta simões 47 formation as it is a tool that helps individuals in the education process through online materials, useful when doing homework and studying, see e.g. lei & zhao (2007) and sanchis-guarner, montalbán & weinhardt (2021). table 1 contains some descriptive statistics for the variables of interest, lack of housing quality and human capital (see table a.5 in the appendix for the descriptive statistics for the control variables). at first glance, it seems the data for both variables shows enough variation across countries in order to allow for the identification of a relationship between the two variables. indeed, the minimum and maximum values are located apart from each other, indicating a high variation in the dataset. this characteristic is also supported by the high standard deviation, in particular for the lack of housing quality variable. for human capital, the standard deviation is not very high, but this is to be expected since the sample is comprised of low and middle-income countries only, which tend to be associated with similar low levels of education. the high variability of the lack of housing quality variable holds true also when comparing directly to human capital, with the standard deviation of the former being higher than that of the latter. looking at the median and the mean, neither of the variables follows a normal distribution, with housing quality having a positive skew and human capital with a negative skew. the positive skew in the lack of housing quality variable is especially worrying as its skewness value is very high (5.2486). furthermore, the coefficient of correlation between the two variables is negative (-0.1179) but not statistically significant. this negative correlation indicates that the relationship we expect to find is confirmed by the data. however, the correlation coefficient for the same variables in logs changes in sign (+0.1052), although it remains insignificant. table 1. descriptive statistics for the lack of housing quality and human capital variables notes: q is the share of the population that lives in substandard quality housing. h is average years of schooling. source: authors’ own calculations using the econometric package gretl results the results from the ols estimation of the baseline equation (1) are presented in table 2. we present the results for four distinct regressions corresponding to different model specifications depending on the set of control variables considered in order to check the robustness of the results to different combinations of the control variables. we eliminated the control variables according to its importance to the explanation of differences in educational attainment based on the findings of previous empirical literature (e.g. baldacci et al. (2008)) or due to its lack of statistical significance. we first leave out the variables that are less consensual as determinants of human capital formation, such as access to the internet, up to the most parsimonious model that considers only gdp per capita as a control variable, according to the relevance attributed to these variables by baldacci et al. (2008). column (1), table 2, contains the results considering all control variables; column (2) leaves out internet access; column (3) additionally leaves out mortality; and, finally, column (4) also does not consider government spending on education. variable mean median min max std dev c.v q 4.8489 2.1928 0.1912 73.07 10.950 2.2583 h 8.4023 8.7687 1.9193 12.632 2.6627 0.3169 ln_q 0.8615 0.7851 -1.6540 4.2915 1.0226 1.1869 ln_h 2.0587 2.1706 0.6519 2.5362 0.4188 0.2034 48 economic analysis (2021, vol. 54, no. 1, 41-59) table 2. results with ols (1) (2) (3) (4) const 1.4773* (0.8470) 0.9789 (0.7937) −1.0653** (0.4323) −0.9320** (0.3918) ln_q 0.0806** (0.0379) 0.0885** (0.0381) 0.0821* (0.0411) 0.0743* (0.0396) ln_gdp 0.1211 (0.0749) 0.1848*** (0.0633) 0.3306*** (0.0435) 0.3288*** (0.0432) ln_gov_edu −0.0219 (0.0982) 0.0036 (0.0982) 0.0765 (0.1026) ln_mortality −0.2039*** (0.0664) −0.2010*** (0.0673) ln_internet 0.0523 (0.0340) countries 52 52 52 52 adjusted r-squared 0.6025 0.5910 0.5237 0.5280 p-value(f-stats) 2.71e-09 1.72e-09 1.84e-08 3.85e-09 akaike criterion 14.7156 15.3191 22.3365 20.9351 p-value (breusch-pagan) 0.0010 0.0003 0.0010 0.0002 notes: standard error in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. heteroskedasticity-robust standard errors, variant hc1. source: authors’ own calculation using the econometric package gretl according to the results presented in table 2, in all of the estimated models we obtain a positive and statistically significant relationship between lack of housing quality and human capital, at either 5 or 10% significance levels (but never at the 1% level). from model (1) to model (4) the coefficient for lack of housing quality remains basically unchanged, ranging from 0.07 and 0.08, indicating that if this variable increases by 10% the human capital stock will increase by 0.7-0.8 percentage points, depending on the model. this positive relationship implies that a country that has a larger share of its population living in sub-standard housing also has available higher levels of human capital, a result that goes against our initial expectations. as for the control variables, the estimated coefficient for gdp per capita has the expected positive sign in all models, with statistical significance at the 1% level for models (2) to (4), confirming the prediction that countries with higher levels of income per capita are also the ones with higher average years of schooling. the coefficient for public spending in education appears with a negative sign in model (1), contrary to our expectations when considering the results from the work of baldacci et al. (2008), implying that the more governments spend on education, the less human capital stock is available. this could indicate that higher public spending on education results in less efficiency in terms of resource allocation. however, the former coefficient is not statistically significant and turns positive in models (2) and (3), when the variables for the health status and access to the internet are removed from the regression. again, none of the coefficients is statistically significant and the estimated coefficient is relatively low. it thus seems that state intervention in the education system has not had a significant impact on human capital formation in developing countries. the result for the health status of the population is in line with initial predictions, presenting a large negative estimated coefficient, corresponding to a negative elasticity of 2 percentage points for models (1) and (2), and statistically significant at the 1% level. this is in line with baldacci et al. (2008), which concluded that countries that have a population with better health have a higher amount of human capital available. the estimated impact of internet access on human capital is positive in sign but not statistically significant, which might indicate that having access to information does not provide enough aid in the personal educational process, as oppose to income for example. guilherme shirazawa, marta simões 49 overall, when looking at the adjusted r-squared for model (1), we can see that the model explains 60.2% of the change in the dependent variable. considering the relatively small number of explanatory variables and observations, we can say that the model provides a satisfactory prediction ability. for the f-test’s p-value, it is possible to reject the null hypothesis of the test for all the models which means that the coefficients obtained have more explanatory power than if the model had no explanatory variables, i.e., an intercept-only model. comparing the performance of the models by the akaike-information-criteria, in which lower values indicates a higher predictive ability of the model, we observe that the best model, with the lowest value for the akaike criteria, is model (1). however, when we apply the breusch-pagan test, for which the null hypothesis is that of homoscedastic errors, the p-value is always lower than 0.01, indicating that all the models suffer from heteroskedasticity. this indicates that the regression results can be biased, which is caused by the omission of an unknown variable, and so the results we obtained are not robust. table 3. results with ols and robust standard errors (1) (2) (3) (4) const 1.4773* (0.7909) 0.9789 (0.7681) −1.0653* (0.5358) −0.9320* (0.5118) ln_q 0.0806 (0.0501) 0.0885* (0.0483) 0.0821 (0.0543) 0.0743 (0.0493) ln_gdp 0.1211 (0.07220) 0.1848*** (0.0657) 0.3306*** (0.0522) 0.3288*** (0.0524) ln_gov_edu −0.0219 (0.1032) 0.0036 (0.1053) 0.0765 (0.1120) ln_mortality −0.2039*** (0.0533) −0.2010*** (0.0540) ln_internet 0.0523* (0.0299) countries 52 52 52 52 r-squared 0.6415 0.6230 0.5517 0.5465 adjusted r-squared 0.6025 0.5910 0.5237 0.5280 p-value(f) 1.15e-08 4.26e-09 7.44e-07 3.96e-07 akaike criterion 14.7156 15.3191 22.3365 20.9351 p-value (breusch-pagan) 0.0010 0.0003 0.0010 0.0002 notes: standard error in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. heteroskedasticity-robust standard errors, variant hc1. source: authors’ own calculations using the econometric package gretl to address the problem of heteroskedasticity we estimated equation (1) correcting for this problem. the results can be found in table 3 where we ran the same models but now considering robust standard errors, in which heteroskedasticity is eliminated from the calculation of the matrix of variances-covariances. it is important to notice that this procedure does not eliminate the problem of heteroskedasticity from the regressions, but considers robust standard errors, making statistical inference possible while maintaining the same value and sign of the coefficients as in the former estimations but potentially changing its statistical significance, i.e., standard errors and t-statistics. as can be seen in table 3 from the p-value of the breusch-pagan test, the heteroskedasticity problem remains after the inclusion of robust standard errors specification and, thus, we continue to have the problem of omitted variable bias. as for the estimated coefficients, although the estimated coefficient for lack of housing quality is still positive, the respective statistical significance changed considerably, since it is only significant in model (2) and only at the 10% level. overall, these results suggest that housing quality is not an important determinant of human capital availability in developing 50 economic analysis (2021, vol. 54, no. 1, 41-59) countries, contrary to our initial expectations. the results for the control variables indicate now that the relevant determinants of human capital availability are the mortality rate and gdp per capita. according to the adjusted r-squared and the akaike criterion, model (1) in table 3 outperforms the other models. also, all the models still managed to reject the null hypothesis of the f-test. notice one interesting change in the results for the control variables relative to the ones in table 2: now access of the population to the internet presents the positive expected sign and is also statistically significant, in line with our expectations that the ability to access the large pool of useful information online, such as educational materials, can affect positively the accumulation of human capital. given the poor performance of the coefficient for the housing quality variable, we moved on to test for different hypothesis always considering robust standard errors. in the previous estimations we considered the whole sample of countries corresponding to low and middleincome countries according to the world bank classification. this implies considering a set of countries still with quite distinct realities, since the sample includes low income, lower-middle income and upper-middle income countries. therefore, it is important to consider the possibility of a difference in the behaviour of human capital in relation to housing quality for these distinct levels of income. to address this possibility, we estimated the model with interactions terms between dummies for each of the three levels of income interacted with the lack of housing quality variable, where the dummy variables are defined as: 𝑑𝑢𝑚𝑚𝑦 = 1, 𝑓𝑜𝑟 𝑖 = 𝑙𝑜𝑤 𝑖𝑛𝑐𝑜𝑚𝑒 𝑐𝑜𝑢𝑛𝑡𝑟𝑦, 𝑎𝑛𝑑 0 𝑜𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒; 𝑑𝑢𝑚𝑚𝑦 = 1, 𝑓𝑜𝑟 𝑖 = 𝑙𝑜𝑤𝑒𝑟 − 𝑚𝑖𝑑𝑑𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 𝑐𝑜𝑢𝑛𝑡𝑟𝑦, 𝑎𝑛𝑑 0 𝑜𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒; 𝑑𝑢𝑚𝑚𝑦 = 1, 𝑓𝑜𝑟 𝑖 = 𝑢𝑝𝑝𝑒𝑟 − 𝑚𝑖𝑑𝑑𝑙𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 𝑐𝑜𝑢𝑛𝑡𝑟𝑦, 𝑎𝑛𝑑 0 𝑜𝑡ℎ𝑒𝑟𝑤𝑖𝑠𝑒, this specification allows us to investigate if the relationship between lack of housing quality and human capital availability differs according to income levels. the former difference would correspond to different estimated coefficients for each of the interaction terms where we could have also different signs and statistically significance. the results of the regressions with interaction terms can be seen in table 4. the number of countries included in each country group is discriminated in the notes to the table. table 4. ols regressions with interaction terms for income groups (1) (2) (3) (4) const 1.1363 (0.8975) 0.5835 (0.8307) −1.3747** (0.6198) −1.2629** (0.6058) lnq*dummy_low 0.1551 (0.1026) 0.1525 (0.1008) 0.1742 (0.1097) 0.1719 (0.1097) lnq*dummy_middle_l 0.0552 (0.0595) 0.0751 (0.0584) 0.0600 (0.0680) 0.0504 (0.0561) lnq*dummy_middle_h 0.0364 (0.0400) 0.0371 (0.0393) 0.0169 (0.0428) 0.0135 (0.0408) ln_gdp 0.1549* (0.0851) 0.2259*** (0.0739) 0.3701*** (0.0642) 0.3681*** (0.0649) ln_gov_edu −0.0337 (0.1088) 0.0002 (0.1098) 0.0615 (0.1190) ln_mortality −0.1857*** (0.0545) −0.1855*** (0.0533) ln_internet 0.0585* (0.0305) total countries 52 52 52 52 r-squared 0.6573 0.6353 0.5768 0.5735 guilherme shirazawa, marta simões 51 (1) (2) (3) (4) adjusted r-squared 0.6028 0.5867 0.5308 0.5373 p-value(f) 1.08e-07 1.88e-08 1.12e-06 2.47e-06 akaike criterion 16.3651 17.5961 23.3398 21.7360 notes: standard error in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. heteroskedasticity-robust standard errors, variant hc1. for the dummy variables, we have in dummy_low 12 countries, in dummy_middle_l 15 countries and in dummy_middle_h 27 countries. source: authors’ own calculations using the econometric package gretl as can be seen in table 4, all four models reveal again a positive association between lack of housing quality and human capital in the three country groups under analysis based on the estimated coefficients of the three interaction terms, although none is statistically significant. for the control variables, we left them out of the regression in the same order as used in tables 2 and 3. public expenditure on education still presents no statistical significance, indicating that this variable is not a relevant determinant of in human capital formation. infant mortality maintains its statistical significance at the 1% level as in the previous tables. the sign of the estimated coefficients for gdp per capita and access to the internet remain basically the same. concerning the overall performance of the regressions, all models reject the null hypothesis of the f-test. model (1) records the best performance based on the results of the akaike criterion and the adjusted r-squared. finally, we also tested in a different way for the possibility of non-linearities in the relationship between housing quality and human capital formation by considering that the response of human capital to housing quality might correspond to an inverted u: for small levels of q an increase in the former variable leads to an increase in human capital but, beyond a certain threshold, the relationship becomes negative. in line with the regressions in table 4 that assume a different response of human capital to housing quality depending on the level of income of countries, we also believe that the influence of housing quality on human capital can have different responses depending on the intensity of the former, according to a quadratic function. in practical terms, an inverted u would mean that, beyond the maximum point of the function, the ratio of the population living in sub-standard housing would become too detrimental to the well-being of the population, impacting negatively the ability to attend school. however, this inverted u also implies that for lower values in the housing quality ratio, the relationship is positive, meaning that, until the maximum is reached, having a portion of the population living in sub-standard housing is actually positively correlated with human capital. this could apply if lower housing quality functioned as an incentive for individuals to search for more education to access better paying jobs and later improve their housing quality. to test this hypothesis, we ran the regressions including additionally the square of the housing quality variable. table 5. results with a quadratic term for lack of housing quality (1) (2) (3) (4) const 1.7311* (0.8684) 1.1181 (0.8168) −0.7736 (0.5283) −0.7375 (0.5292) ln_q 0.1618* (0.0894) 0.1563* (0.0919) 0.1661* (0.0987) 0.1677 (0.0985) (𝐿𝑛_𝑄) −0.0362 (0.0272) −0.0297 (0.0280) −0.0366 (0.0987) −0.0379 (0.0293) ln_gdp 0.0951 (0.0811) 0.1723** (0.0715) 0.3067*** (0.0561) 0.3055 (0.0570) ln_gov_edu −0.0811 (0.1072) −0.0413 (0.1066) 0.0167 (0.1084) 52 economic analysis (2021, vol. 54, no. 1, 41-59) (1) (2) (3) (4) ln_mortality −0.1927*** (0.0496) −0.1914*** (0.0504) ln_internet 0.0612* (0.0321) countries 52 52 52 52 r-squared 0.6613 0.6368 0.5728 0.5726 adjusted r-squared 0.6162 0.5973 0.5365 0.5459 p-value(f) 3.65e-08 1.10e-08 1.43e-06 4.87e-07 akaike criterion 13.7499 15.3844 21.8217 19.8480 notes: standard error in parenthesis. ***; **; * indicate statistical significance at the 1%, 5% and 10% level, respectively. heteroskedasticity-robust standard errors, variant hc1. source: authors’ own calculations using the econometric package gretl the results considering a quadratic relationship are presented in table 5. each column considers different sets of control variables selected according to the strategy described for table 2. overall, the results do not support the existence of a non-linear relationship in any of the four models estimated since the estimated coefficient for the square of housing quality, although negative, is never statistically significant. in any case, the estimated coefficient for the linear term of housing quality is positive and statistically significant at the 10% level in all models except model 4 and, based on the p-value for the f statistic, we confirm the joint significance of the variables in the models. model (1) presents the highest adjusted r-squared and the lowest value for the akaike information criterion and so is our preferred model. by deriving human capital relative to housing quality in model (1) and equalizing it to zero (see equation (3)) we can compute the maximum of the function, i.e., the value of q beyond which the relationship becomes negative: = 0 ≤=> 𝛽 + 2𝛽 𝐿𝑛_𝑄 = 0 (3) the maximum is located at 𝐿𝑛_𝑄 = 2.667. this turning point implies that countries with values of lnq higher than this maximum record a negative relationship between q and h, as expected. the maximum for lnq implies a value for q of 14.39%. however, there is a small number of countries in our dataset that record housing quality ratios higher than the threshold and so are located in the part of the curve where the relationship is positive. this means that, for the majority of countries under analysis, the positive relationship that the previous linear models in tables 2 to 4 indicated still holds true. as for the control variables, the results remain basically unchanged when compared to the results in table 2. discussion in this section we will discuss some issues that might explain the inability of our results to confirm our initial hypothesis, that lack of housing quality hinders human capital formation, and the potential implications of the results found for structural policies that promote economic growth in developing countries. regarding the presence of heteroskedasticity in all the estimated models, we believe that this problem might be due omitted variables in the model specification, a consequence of limited data availability for our sample of developing countries. it is possible to find in the previous literature some potential candidates for these missing explanatory variables. for instance, hanushek & woessmann (2011) propose a production function approach for the estimation of the quality of human capital that includes other variables not considered in the present study. the empirical model proposed by the authors is given by equation (5): guilherme shirazawa, marta simões 53 𝐻𝑢𝑚𝑎𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 𝛽 𝑓𝑎𝑚𝑖𝑙𝑦 𝑖𝑛𝑝𝑢𝑡𝑠 + 𝛽 𝑠𝑐ℎ𝑜𝑜𝑙𝑖𝑛𝑔 𝑖𝑛𝑝𝑢𝑡𝑠 + 𝛽 𝑖𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙 𝑎𝑏𝑖𝑙𝑖𝑡𝑦 + 𝛽 𝑜𝑡ℎ𝑒𝑟 𝑓𝑎𝑐𝑡𝑜𝑟𝑠 + 𝜖 (5)9f3 as it is possible to see in equation (5), this model differs from ours mainly because it considers factors that impact the human capital of individuals at the micro level where family inputs and individual abilities define the context in which an individual develops its cognitive abilities to absorb the knowledge provided by the educational system. however, in the present study we are not able to access data on the quality of human capital for our sample of countries. lee & barro (2001) carry out an empirical analysis of schooling quality in a cross-section of countries considering a similar production function, summarized in equation (6): 𝑄 = 𝛼 + 𝛽 𝐹 + 𝛽 𝑅 + 𝜀 (6) where q stands for individual tests scores, f includes family factors, such as parents’ income and educational attainment, which affects the probability that children enrol in, attend and complete school, but also the ability of a child to learn. r stands for school resources, such as pupil-teacher ratios, average teacher salary, educational expenditure per pupil and school duration, with all these factors influencing the ability of the schooling system to provide a good quality environment for learning. the authors found that family background and school resources have a strong positive association with student performance. this positive association is also supported by the results found in égert, botev and turner (2020). the inputs of the human capital production function in lee & barro (2001) gives us a clue for one of the reasons why our analysis probably does not allow us to reach robust results. even though we included inputs such as public expenditure in education and gdp per capita, which lee & barro (2001) considered as a proxy for parental income, we left out other potentially important determinants of human capital, which explains our need to perform the breuschpagan heteroskedasticity test in our original models (table 2). the test results indicate that the variance of the error term is not white-noise, indicating that the models suffer from misspecification, thus limiting the ability of the control variables to isolate the effect of our explanatory variable and limiting its predicting ability. as much as we would like to fill this gap in the model’s specification, the unavailability of data for the countries under analysis, given that, being developing countries, most suffer from limited data collection at the national level and data processing by the national statistical agencies, did not enable us to define comprehensive model specifications. moreover, in lee & barro (2001) the authors analyse the quality of human capital and not the quantity, as we do in our study. this difference in measurement might also give a clue for the lack of meaningful results in our regressions, as housing quality probably impacts more human capital quality than quantity. however, we were not able incorporate human capital quality in our analysis as internationally comparable data on student’s performance is not available for most of the countries in our sample. other limitations that might influence the performance of the models can be found in the housing quality data. housing quality data is scarce in the un’s database, resulting in a maximum of 52 developing countries with which we could work with since we also had to guarantee that we had human capital data for those same countries. additionally, the data collected in the un’s database lacks a periodic time frame and so most of the countries in upper middle income to low middle income groups have only one-time observation. this lack of observations over time limits the estimations methodologies that can be applied to correct certain issues, which would become possible with a panel data structure. the lack of observations is not only due to lack of time coverage. the number of countries for which data is available is higher than 52, but we had to reduce this number due to lack of data for average years of schooling for some countries. 3 hanushek & woessmann (2011, p.433) 54 economic analysis (2021, vol. 54, no. 1, 41-59) besides the small number of observations, we also encountered other problems with the housing quality variable which had to be computed as an aggregate of different classifications/categories of housing quality. this was done to overcome the problem of having different coverage of housing quality categories across countries and enabled us to reach a comprehensive measure that represents the overall problems in access to decent housing for each country. however, as we saw during the construction of the variable, it appears that the lack of information in various categories, which was represented as a zero in the spreadsheet provided in the unesco dataset, is improbable, leading us to believe that the dataset suffered from a problem of poor data collection. if this applies then the indicator that we constructed does not accurately represent the proportion of individuals living in sub-standard housing, making it harder to find a robust relationship with human capital. although this problem might seem to impede an econometric analysis, we went ahead with the study due to the possibility that the inclusion of control variables that are known to be measured with a good degree of precision might help to isolate the housing indicator effects even if its accuracy is not as high as that of the remaining variables. additionally, we can also be in the presence of endogeneity with human capital availability influencing access to quality housing. this problem could in principle be solved using instrumental variables estimators, but we could not find good instruments and even if we had it would be unlikely the respective availability would match our limited dataset. the previously discussed shortcomings thus represent hurdles to the interpretation of our findings leading us to doubt the positive relationship between the lack of housing quality and human capital obtained. this conclusion is further supported by the lack of statistical significance of the estimated coefficient for the variable of interest in the models considering robust standard errors and the fact that even when the coefficient was statistically significant this happened only at a 10% level and in a very small subset of the regressions using robust standard errors. overall, if new datasets emerge in the future, both for housing quality and human capital quality in the context of developing economies, a new version of this analysis can be done which could not only answer our initial question, but also enable a research on the impact that housing quality has on economic growth. this could be done much in the same ways as in the study by égert, botev and turner (2020), in which the authors estimate the impact of educational policies on human capital and, consequently, on economic growth. conclusion the main objective of this work was to empirically investigate the relationship between housing quality and human capital formation in the context of developing countries. for this purpose, we performed a cross-sectional analysis estimating different model specifications, considering different control variables, robust standard errors and the possibility of nonlinearities in the relationship, according to countries’ income levels or described by a quadratic relationship. our findings suggest that, overall, there is no statistically significant association between the lack of housing quality and human capital although the respective estimated coefficient is positive, contrary to theoretical prediction. however, we believe that this is likely due to the quality of the housing data that results in measurement error. additionally, the small number of observations for developing countries under analysis leads to inconclusive results. from a policy design perspective, our results do not endorse investing in access to better quality housing as a means to increase human capital formation in developing countries. as we were not able to obtain conclusive results for the relationship under analysis, the study also could not support access to better housing quality as a factor that impacts long-run economic growth through its interaction with higher levels of human capital, along with other factors, such guilherme shirazawa, marta simões 55 as investment in physical capital and technology, or even the health status of a country, that has consistently been shown to impact human capital negatively. although the inconclusive nature of the results did not allow us to bridge the gap identified in the literature concerning empirical analysis of the relationship between housing and human capital, we believe that a major contribution of this work lies in raising awareness to the need for better data for housing quality and human capital to enable for future empirical analyses that e.g. consider also human capital quality not just quantity. considering the rapid rate of urbanization that has been taking place since the end of the 20th century in developing countries, future research on this topic can help produce helpful guidelines for the design of effective and efficient policies directed at housing that can additionally promote growth and development. acknowledgments we are grateful to the anonymous reviewers for their time and effort reading our manuscript and for the constructive input on an earlier version of the text. references baldacci, e., clements, b., gupta, s., & cui, q. 2008. “social spending, human capital, and growth in developing countries.” world development, 36(8): 1317-1341. barro, robert and jong-wha lee. 2013. “a new data set of educational attainment in the world, 1950-2010.” journal of development 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2020. “the joint impact of infrastructure and institutions on economic growth.” journal of institutional economics, 16(4): 481-502. guilherme shirazawa, marta simões 57 appendix figure a.1. classification of housing units source: un (2017), p. 250 58 economic analysis (2021, vol. 54, no. 1, 41-59) table a.1. list of the 52 countries included in the econometric analysis country year of the data used income classification country year of the data used income classification albania 2011 m_l latvia 2011 m_h argentina 2010 m_h lesotho 2006 m_l armenia 2011 m_l liberia 2008 l azerbaijan 2009 m_h malawi 2008 l belarus 2009 m_h malta 1995 m_h bolivia 2012 m_l malaysia 2010 m_h brazil 2010 m_h mexico 2010 m_h bulgaria 2011 m_h morocco 2004 m_l chile 2002 m_h myanmar 2014 m_l costa rica 2011 m_h nicaragua 2005 m_l croatia 2001 m_h peru 2007 m_l cuba 2002 m_l philippines 2000 m_h dominican republic 2002 m_l poland 2002 m_h ecuador 2010 m_h republic of moldova 2004 l ethiopia 2007 l romania 2011 m_h egypt 2006 m_l russian federation 2010 m_h georgia 2002 l rwanda 2012 l ghana 2010 m_l saint lucia 2010 m_h guinea 2014 l serbia 2011 m_h hungary 2001 m_h slovakia 2001 m_h india 2001 l south africa 2011 m_h iran (islamic republic of) 2011 m_h thailand 2000 m_l jamaica 2011 m_h tonga 2006 m_l kazakhstan 2009 m_h turkey 2011 m_h kyrgyzstan 2009 l uganda 2002 l uruguay 1996 m_h zambia 2010 m_l notes: according to the income classification group of the world bank “l” refers to low-income countries, “m_l” refers to lower-middle income countries and “m_h” refers to upper-middle income countries. source: authors. guilherme shirazawa, marta simões 59 table a.2. variables and sources variable definition source h average years of schooling of the population aged between 25 and 74 years old unesco institute for statistics (2019) and barro-leee educational attainment dataset (barro & lee, 2013) available at http://barrolee.com/ q proportion of the total population living in sub-standard housing (%) own computations based on data from the unesco institute for statistics (2019). available at http://data.un.org/data.aspx?d=pop&f=tablecode%3 a309 gdp gross domestic product per capita (in 2011 usd purchasing power parities) unesco institute for statistics (2019) gov_edu government expenditure in education as a percentage of gdp unesco institute for statistics (2019) mortality mortality rate of children under 5 (per 1000 live births) unesco institute for statistics (2019) internet percentage of the population with access to the internet unesco institute for statistics (2019) source: authors. table a.3. list of countries with human capital data taken from the barro-lee dataset country year of reference in the barro-lee dataset morocco 2000 myanmar 2010 nicaragua 2005 thailand 2000 zambia 2010 malawi 2005 liberia 2005 india 2000 source: authors. article history: received: february 10, 2021 accepted: may 5, 2021 microsoft word 2007_01_02.doc exchange rate regimes and monetary policies in emerging   markets: a showdown for few theoretical misconceptions  marko malović, belgrade banking academy   key words: «two‐corner solution», crawling/monitoring bands, «dirty float», flexible inflation tar‐ geting, (un)sterilized interventions, small open economy, emerging markets, «bbc» plus.  udc: 338.23:336.74          jel : e52, e61, f31, f41. original paper      abstract:  the purpose of this paper is to challenge couple of dangerous theoretical misconceptions  in open‐economy macro, namely, in respect to desirability or sustainability of available exchange rate re‐ gimes and inflation targeting framework and their mutual compatibility in small open economies with in‐ complete (emerging) markets.   first of all, we dismiss the ruling »two corner solution« as dogma in scientific disguise. furthermore,  all the benefits of more flexible intermediate regimes (sliding currency bands) as well as empirical support of  their wellbeing have been put forward.   as to the monetary policies, majority of transition countries recognised superiority of inflation target‐ ing over alternative monetary concepts. however, until very  recently  some  emerging market  economies  failed to realize the benefits of full‐fledged ‐let alone flexible‐ inflation targeting. in what follows, the article  counters another theoretical dogma: that inflation targeting in emerging market economies must go hand in  hand with fully flexible exchange rate regime.   having said that, and again contrary to the mainstream literature in the field, paper exposes some se‐ rious weaknesses of the so‐called dirty (or managed) floating as an intermediate regime: in particular, its  potential  sub  optimality  in  practice  and  its  hidden  incompatibility  with  widespread  inflation  targeting  strategies.  paper concludes by reiterating the inevitability of close relationship between inflation targeting and  exchange rate targeting and hence suggests several possible reaction functions for the monetary authorities  in emerging markets among those already laid out in the related literature.  introduction  this is a theoretical, yet policy‐oriented essay which tries to isolate and address several is‐ sues that have plagued the quest for optimal monetary and exchange rate policy in the emerging  market countries for too long. voices, opinions and paper‐titles akin to the view taken in this dis‐ cussion  are  thankfully  gaining  in  strength  and  professional  appreciation,  while  still  remaining  outnumbered and being considered quite a bit unorthodox. hence, the flickering point in joining  the band wagon of numerous papers written or being written on monetary and exchange rate pol‐ icy issues.  the rest of the paper1 is organised as follows: section 2 depicts the still ruling dogmatism of  the «two corner‐solution», nonetheless confronted with the criticism of bipolar view and a look  into reality, eventually reinforced by dismantling of the too rigid understanding of impossible trin‐ ity theorem. section 3 (re)examines the potential, the rationale and empirical tests for relatively  flexible currency bands of the so‐called bbc breed. section 4 brings in the notion of  inflation tar‐ geting as a monetary strategy  in emerging market countries, while stressing specificities and some  of the intellectual wanderings that it regimes have exhibited/undergone in small open economies.  1 this paper partly draws on research carried at and the hospitality of the centre for the study of global governance of  the lse, where the author was a visiting fellow under the auspices of the fco/osi/lse faculty development in south  east europe programme.  2007 ‐ 18  •  economic analysis®  section 5 looks more carefully into the shortcomings and imminent incompatibility of the popular  dirty floats in the presence of  inflation targeting practices  in emerging markets thus far. subse‐ quently, section 5 extends  to overall appraisal of rationale and  feasibility  for simultaneous ex‐ change rate and inflation targeting.  rejection of «two‐corner solution»  in modern open‐economy macro,  there  is a  famous  theoretical paradigm of  the so‐called  «impossible trinity», which reminds us that a country cannot simultaneously keep complete liber‐ alisation of international capital transactions, independence of monetary policy making and fixed  value of national currency.  ignorance or  inability  to  fully appreciate  this  theorem has recently  placed many economies with fixed but adjustable exchange rate regimes in the epicentre of devas‐ tating  international  financial  crises  [fischer,  2001].  mexico,  thailand,  indonesia,  south  korea,  czech republic, former yugoslavia, argentina, india and turkey are some examples of financial  fiascos caused by unsustainable fixed (but adjustable) exchange rates. after the turbulent experi‐ ence of 1990´s, leading theoreticians followed by emerging market policymakers forcefully rejected  the wide spectrum of intermediate exchange rate arrangements between rigidly fixed and freely  floating extremes. this bipolar view2, preached by several leading macroeconomists in the world3  was  further acknowledged by  the  famous metzler commission. bipolar view, alias  two‐corner  solution, suggests that developing and transition countries, faced with fast and furious traits of  financial globalisation, have only two feasible options when  it comes to exchange rate manage‐ ment, if they are to shelter themselves from devastating effects of currency crises. namely, either  superfixed regimes like ‐for instance‐ very hard pegs, currency boards and dollarisation, or fully  flexible exchange rates [fisher, 2001], [reinhart‐reinhart, 2003].  closely related to bipolar view is hausmann´s concept of «original sin», which claims that  instability of emerging market currencies and low credibility (high sovereign and political risks)  are  eternal road‐block  to  stabilisation  and  development  efforts  of  their  economies  [hausmann,  2002]. their inabilities to borrow in domestic currency or clear the reputation of budget deficit‐ monetisers have been seen by calvo as principal causes of  the «fear of floating» in emerging mar‐ kets, which also happens to be a rather superficial reason for apparent popularity of dirty floats in  these countries  lately [calvo‐reinhart, 2000, 2000*]. in other words, although freely floating ex‐ change rates are making extreme balance of payments crises and severe currency crashes next‐to‐ impossible events (if we abstract from somewhat intrinsic fx volatility), despite the fact that they  enable monetary autonomy and preservation of foreign exchange reserves, every more sizeable  depreciation inevitably brings about a drop in living standard (since the wages/salaries are often  sticky in local currency) and tightens the dollar‐denominated debt noose. that, of course, retro‐ spectively points towards the fixed corner of bipolar extremes. moreover, international finance in  the real world soon enough came out with the holy grail: managed or dirty float, currency regime  that seems acceptable and sufficiently resemblant to fully flexible regime. this «revelation» fed the  bipolar view even more voraciously, thereby epitomising the notion of the non‐existing, or «the  missing middle» [goldstein, 2002]. in theory, however, managed or dirty floating assumes that the  2 as a result, number of imf members who positioned themselves in one of the corners along the exchange rate regimes  axis grew in period 1991‐1999 from 39% to 66% [goldstein, 2002].   3 larry summers, being primus inter pares, then more nuanced stan fisher, as well as  jeff frankel and sergio schmukler  (although  the  last  two oddly enough changed  their mind somewhere along  the road)  [see reinhart‐reinhart, 2003].  nonetheless, the first who forged the term »two‐corner solution« were in fact barry eichengreen, maurice obstfeld and  ken rogoff in the mid 1990´s, yet from the view point of ems members, not emerging markets [frankel et al., 2001, page  354].  volume 40 • spring 2007 • 19  value of national currency is being constantly determined in the forex market, only sporadically  accompanied by central bank interventions in accordance with other urgently pressing legitimate  objectives of macroeconomic policy making. nevertheless,  after scrutinising dirty floats through  empirical tests of actual floating (with a  null hypothesis that floating currency regimes arguably  need neither gigantic foreign exchange reserves nor too often interventions in the forex market),  practice has revealed that they are much more akin to dirty (camuflaged) fix than a managed float;  see for instance [hausmann‐panizza‐stein, 1999], [detken‐gaspar, 2003]. and indeed, it has to be  said that (super)fixed exchange rate regimes do display certain  indisputable advantages. in the  case of both currency board and dollarisation, inflation expectations are minimised, exchange rate  ‐and overall macro‐ stability is initially achievable whereas currency risk related costs are almost  non‐existing (if reserves under board are big enough to support broad money rather than m1 or  monetary base only).  on the other hand, both dollarisation and as currency boards completely tie  down  hands  of  monetary  authorities  and  expose  the  economy  to  often  asymmetric  exogenous  shocks of the business cycle. furthermore, sooner or later they entail overvaluation risk and immi‐ nent wages‐productivity conflict (for currency boards), or loss of seignorage, legal problems with  outright  introduction of foreign currency and    inflation typically higher than  in the euro/dollar  area as contradictio in adjecto sui generis (for dollarisation).   in a nutshell, there are minimum three crucial reasons why emerging market countries ide‐ ally should adopt neither of the extreme corner solutions, but rather opt for limited flexibily re‐ gimes of the «bbc» type:  • even a partial autonomy in anticyclical monetary policy making always means a lot for  fragile economies in transition.  • modern forex and financial markets (and especially emerging ones) are ages away from  stylised  arrow‐debreu  world,  therefore  much  of  speculative  trading  is  not  stabilising  as  ones  claimed by m. friedman, but random at its very best!  • in presence of more serious import dependency and/or significant foreign indebtedness, it  is neither credible nor feasible to expect from monetary authorities to completely give up exchange  rate targeting.      in the context of «impossible trinity» dogma, the argument goes that although we cannot  simultaneously fully liberalise capital flows and retain absolutely fixed exchange rate as well as  absolutely  independent  monetary  policy,  nobody  have  ever  said  one  couldn’t  partially  control  capital flows, and retain reasonably flexible currency rate and relative independence in formulat‐ ing monetary policy  [williamson, 1999],  [frenkel et alia, 2001]! this  impression  is amplified by  findings of several recent studies which have confronted de facto exercised with de iure adopted  exchange rate regimes among  the  imf members  [reinhart‐rogoff, 2004],  [frankel et alia, 2001],  [hausmann‐panizza‐stein, 1999]. results of the mentioned studies show beyond any doubt that  «the missing middle» is actually pretty densely populated by still practiced intermediate exchange  rate regimes [see also reinhart‐reinhart, 2003].  «bbc» intermediate regimes reconsidered  «bbc» exchange rates are as close as one gets to relative flexibility of the currency under  evaluation. the main proponent of crawling/monitoring bands and alike regimes has been john  williamson (1996, 1999, 2000, 2000*). its name «bbc» owes to the late rudi dornbusch, who hu‐ morously summarized regimeʹs main ingredients: a basket (of currencies our currency is pegged  against), a band within which itsʹ floating is limited, and a crawl according to inflation differentials  or other prespecified fundamentals. there are a number of advantages of such a regime. first of  2007 ‐ 20  •  economic analysis®  all, exchange rate is not tied down but rather able to operate as a proper macroeconomic weather  vane. nevertheless, a publicly disclosed band could guide market expectations, thereby discourag‐ ing too excessive «noise trading». as opposed to the krugman‐ian well‐known target zone con‐ cepts, «bbc» exchange rate regimes are much more akin to jacob frankel´s crawling band, which  underlines the fact that, need be, the whole corridor should slide as frequent as possible in order to  close the gap between the central parity and updated value of fundamental variables and/or algo‐ rithm chosen to be responsible for equilibrium exchange rate determination. on a top of it, in an  exchange rate regime like this, intramarginal interventions should be prohibited, otherwise poli‐ cymakers would tend to reduce it to de facto crawling peg while the market participants would not  be able to differentiate «noise trading» from persistent «order flows» propped up by ever changing  fundamentals.4  in  fact, all of  the  famous empirical studies which dismissed  the mean‐reverting  trait  of  the  exchange  rate  corridors,  for  instance  [flood‐rose‐mathieson,  1990],  [svensson  1991,1991*] and neely [1994], dealt with detected «honeymoon effect» although it was a theoretical  violation, whereas majority of existing studies  further proposed  full price  flexibility as an odd  marriage with sticky price reality of contemporary macro.  moreover, bekaert and gray (1998) and  slightly  later andersen (2000), by modelling target zones  in a discrete time, and by using non‐ parametric techniques and monte carlo simulations have clearly showed that exchange rate trajec‐ tory in absence of intramarginal interventions does display mild but nontrivial stabilisation effect  (or s‐shaped recovery in krugmanʹs own words)! finally, perhaps the most convincing argument  for mean‐reverting character of crawling/monitoring bands was raised by williamson (1999), who  verifies that within a currency band (in comparison with free floats) spot rate movements are fol‐ lowed by much less volatile reactions of forward rates.  inflation targeting in emerging markets  after considerable success which inflation targeting achieved in oecd countries (primarily  in terms of price stability), it is swiftly becoming the holy bible of monetary policy making in de‐ veloping countries and emerging markets, too. nonetheless, lagging behind the contagious fash‐ ion, there is still barely a handful of serious studies that examine the compatibility of textbook it  design with  transitional peculiarities of emerging markets. in  terms of voluminous mainstream  literature, however, supremacy of inflation targeting over thus far identified alternative monetary  strategies  is strikingly obvious. instead of  irrelevant or  ineffective targeting of monetary aggre‐ gates on one hand, and virtually  impossible  targeting of nominal output on  the other  [eichen‐ green, 2002], inflation targeting concentrates directly on price stability and, if not too rigidly aimed  at, under certain well known preconditions simultaneously stabilises output gap around its natu‐ ral level [blanchard, 2003]. moreover, since «we are all dead in the long run», inflation targeting  also has understandable advantage over price level targeting, advocated by svensson (1997), de‐ hejia and rowe (2000), and ball, mankiw and reis (2003), since it regimes tolerate so‐called base‐ drift  which  enables  additional  anticyclical  flexibility  and  keeps  the  focus  on  price  differences  rather than prices themselves.5 on a top of proclaiming mid‐term numerical  inflation target for  4 the idea is that honeymoon-free (no marginal interventions), wide enough currency bands leave reasonably sufficient space and time to identify more robust/durable exchange rate movements and hence distinguish them from temporary “noise” at fx market. however, it is true that even under such a regime we cannot always be 100% sure regarding the exact nature of exchange rate dynamics at hand.   5 it is in order to say that, if one ignores the concern about time inconsistency and credibility of central bank’s commit‐ ment to price‐level targeting, superiority of price‐level targeting over  inflation targeting could indeed materialize in the  long‐run, yet at the short‐run expense in terms of gdp and inflation volatility, brought about by rectifying the base‐drift  intolerance.  volume 40 • spring 2007 • 21  monetary authorities, full‐fledged  inflation targeting strategy assumes  institutional support and  informational intensity as well as maximum transparency in explaining the concept and operative  policy of the central bank [mishkin, 2000].    as prerequisites for successful implementation of inflation targeting in transition countries,  we choose to stress the following from the latest (and scarce) literature [fraga‐goldfajn‐minella,  2003], [jonas‐mishkin, 2003], [przystupa, 2002]:  1. well understood transmition mechanism from exchange rate into inflation as well as  feed‐back influence of instrument rule on inflation.  2. balanced budget and absence of the so‐called fiscal dominance  3. reasonably well developed financial system  4. institutional and actual independence and transparency of central bank  5. freely floating exchange rate, i.e. absence of any other nominal anchor apart from in‐ flation target.  however, in our opinion, already an academic consensus stated under 5), represents a dog‐ matic misconception and should be ruled out, at least for small open economies in transition with  fragile and emerging markets. without properly developed hedging instruments coupled with the  lack of domestic savings, speculative attacks on official reserves and, broadly speaking, exogenous  shocks for capital flows cause significant volatility of exchange rate and economic activity if ex‐ change rate  is totally neglected by monetary authorities. moreover, even  if exchange rate pass‐ through in emerging markets appears to be dramatically lower than a priori expected,6 many au‐ thors claim that in economies with rich and recent history of monetary instability, exchange rate  stubbornly remains to be the focal point of inflation expectations. at last, but not least, exchange  rate oscillations apparently exhibit strong impact on profitability of firms and sectors of emerging  markets, even when aggregate indicators give reason for self‐confidence [røisland‐torvik, 2000],  [ball, 2001].  as a matter of fact, empirical evidence on exchange rate policies effectively exercised in such  economies shows that monetary authorities knew all too good the dangers of completely giving up  the exchange rate, yet potential or actual malfunctioning of it regime often came about for com‐ pletely opposite reasons – namely too little floating disguised under politically correct fad: man‐ aged or dirty float [malovic, 2006].  be that as it may, a handful of serious studies of inflation targeting in emerging markets de‐ tected several more problems or potential limitations of it regimes in transition reality [eichen‐ green, 2002], [fraga‐goldfajn‐minella, 2003], [ho‐mccauley, 2003], [jonas‐mishkin, 2003]: a) credi‐ bility, especially under strict (point) targets and lack of communication and reporting; b) appropri‐ ateness of inflation measure chosen to be targeted; c) too high partial dollarisation of economy; d)  inherent imprecision of inflation forecasting; d) feasibility of softening the edges of inflation band  targeted if the need arises, and specifically e) too rigid –implicit or explicit exchange rate targeting.    regarding the credibility of inflation targeting strategy, this short experience of emerging  market economies seemingly shows that strict inflation targeting, i.e. taking responsibility for hit‐ ting the point announced might not be very credible after all. since statistical base and experience  may typically be  lacking, whereas administrative control of quite a few prices and ongoing tax  reforms in emerging market countries are evidently still deployed [jonas‐mishkin, 2003], it is cer‐ tainly much safer and more credible to commit to targeting inflation within a range than its par‐ 6 indeed, in many transition countries exchange rate pass‐through, initially believed to be close to 1, turned out to be  significantly lower than 1, in some cases even less than 0.5. see [ho‐mccauley, 2003], [hausman‐panizza‐stein, 1999].   2007 ‐ 22  •  economic analysis®  ticular  level. even more so should politically motivated conflicts between  fiscal expansion and  monetary commitments arise.    in respect to inflation measure one should stick to, we agree with the thin minority of opin‐ ions that –unless any other index has been previously used for sufficiently long time prior to in‐ troduction of inflation targeting ‐ cpi dynamics is the most appropriate measure of inflation that a  bloke in the street really cares about. having said that, one cannot be unaware of the difficulties to  control some of the components of cpi inflation that seem to be out of direct and immediate reach  of central banksʹ policies, as pointed out by advocates of core  inflation concept. however,  it  is  common knowledge that core inflation concept excludes several important prices with systemic  secondary consequences for the overall inflation. hence, even if one rules out the possibility that  obscurity is the exact reason for the weapon of choice, core inflation is often at the verge of missing  the point as far as general public is concerned: namely, if you are targeting something that´s not  completely relevant for the behaviour of the market you strive to control, that might easily pinch  some rhyme or reason out of the whole business.    nonetheless, perhaps principal cause of problems with it in emerging market countries is  proverbially massive dollarisation of economy and specifically of its external as well as domestic  liabilities.  notorious  volatility  of  international  capital  flows  and  «pillow  nature»  of  savings  in  emerging markets exacerbate monetary policy challenges further still. according to fraga, gold‐ fajn and minella (2003), typical sequence of events in such a constellation goes like this: «sudden  stop» phenomenon a la calvo heavily influences nominal (and real) exchange rate, which in turn  via pass‐through effect fuels the inflation, so that consequently restrictive monetary policy cata‐ pults interest rates and thereby inflicts third generation financial crises onto fragile banking cum  corporate sector (both burdened with hard‐currency‐indexed liabilities), instead of bringing about  stabilisation. one way of dealing with the volatility of capital flows is unavoidably a krugman‐ian  (2000) version of the tobin tax, i.e. pecuniary check‐point installed on the way in rather than on the  way out. severe dollarisation problem  in many emerging markets, as a flip‐side of the bad old  greshamʹs law, alas, is likely to consume much more time and credibility effort. however, dollari‐ sation (as a phenomenon, not as an exchange rate regime) is to the extent endogenous to a lagged  observations of the adopted monetary policy regime [batini et alia, 2006], so that establishing disin‐ flation together with rising export performance through credible policy rules is likely to eventually  crowd out dollarisation to acceptable levels. probably the key ingredient for success in the afore  mentioned ball‐game rests once again with the ability to reassure market participants that currency  stability and exchange rate fixing are not one and the same thing...     in addition,  inherent  imprecision of  inflation forecasting apparently did not restrain few  emerging market countries from flirting with incomplete yet narrow inflation targeting in the early  days of their it experience. nowadays virtually all inflation targeters in emerging markets realise  the benefits of flexible inflation targeting, since targeting a band instead of a point doesnʹt make  central banker less of a sharp shooter, but makes him a wiser one. the latest empirical evidence  implies that hitting the often impossibly strict inflation target may be less crucial for regimeʹs suc‐ cess than the sustained pursuit of improvements and publicly released revision of reasons for vio‐ lating the forecast once the framework has been adopted [batini et alia, 2006]. moreover, leaving a  bit more room for targeted inflation enables monetary authorities to acknowledge (if not pursue)  other legitimate goals of macroeconomic policy, economic growth and employment being the first  two coming to economistʹs mind. goals that, mind you, tend to be even more pressing in emerging  market reality. therefore, flexible inflation targeting implies a trade‐off between stabilising infla‐ tion around and within the precommitted inflation target and minimising output gap defined as  departure of current output from its natural level or otherwise defined potential.   volume 40 • spring 2007 • 23  however, as previously stated, most studies on inflation targeting have tended to ignore the  emerging market reality and open economy issues. woodford (2003), for instance, in his seminal  book on monetary policy and inflation targeting in particular practically does not deal with open  economy issues and exchange rates at all. in the meanwhile, apart from eight industrial countries  which exercise full‐fledged inflation targeting, there are more than 15 emerging market economies  that opted for either informal or full‐fledged inflation targeting. majority of those latter ones in  reality opted for –often strict at onset‐ inflation targets coupled with managed floats. therefore, the  last section examines the feasibility, rationale as well as potential pitfalls of simultaneous exchange  rate and inflation targeting.  «bbc plus» ‐ simultaneous exchange rate and inflation targeting  «bbc plus», catch‐phrase from the title of this section, is actually paroding goldsteinʹs (2002)  famous «dirty floating plus», which posits the latest professional fad, that managed floating en‐ dures all identified challenges of it in small open economies and that these two are an item. the  argument goes that since emerging markets countries cannot abstain from exchange rate targeting   even under it regime, then they should manage exchange rate «under the table», intervene and  manage «silently», «in the dark», without precommitment to any last ditch that would have to be  defended. thereby we would still be able to avoid speculative attacks, keep central bankʹs reserves  safe while successfully controlling inflation.   but, is there something fishy with the matrimony of dirty float and an inflation targeting re‐ gime? in theory, managed floating plus represents an it package which should indeed retain all  the desirable features of relatively flexible exchange rate regime while still being able to address  nominal anchor and balance‐sheet  issues critical for emerging market economies. however, too  aggressive and fearful interventions in practice fall far from correcting currency mismatches, as a  matter of fact, they often turn into conservation of fragile macroeconomic stability via tying down  interest rates and exchange rate itself, thereby threatening with recessionary consequences the very  (and alas often unrealistically low) inflation target they aim to preserve. in addition to that, espe‐ cially when coupled with too narrow inflation targets,7 dirty floats become, ironically, rather prone  to speculative attacks of the first generation type as explained by kumhof [2001]. finally, our prin‐ cipal critique of «managed floating plus» has to do with the efficiency (and effectiveness for that  matter) of sterilised foreign exchange interventions, that are so persistently carried out in emerging  markets on an ever growing scale. bofinger and wollmershaeuser (2003), as the most famous ad‐ vocates of managed floating, by dedicating almost a third of their managed floating study to ster‐ ilisation issues, implicitly admit that utility and usefulness of dirty floats depend on the ability to  effectively  and  efficiently  sterilise  foreign  capital  inflows.  moreover,  bofinger  and  wollmer‐ shaeuser  (2003)  recognise  that  if  we  care  about  monetary  concept  broader  than  high‐powered  money, as most central banks nowadays do, successful sterilisation of foreign capital  inflows  is  identically equivalent to interest rate targeting. now, if we are severely limiting the motion of ref‐ erence interest rate (typically 2w to 3m repo), then we are losing degrees of freedom in trying to  implicitly target exchange rate by targeting interest rate which is by definition a principal instru‐ ment in controlling inflation target!? let alone the steeply rising quasi‐fiscal costs of any prolonged  sterilisation [kumhof, 2000], [kletzer‐spiegel, 2002]...  7 in essence, strict inflation targets are almost equivalent to hard effective exchange rate pegs, with all the dangers of  committing to such a numerical target in the case of speculative attack on foreign reserves [calvo, 2000], [kumhof‐li‐ yan, 2001]. if  the ricardian equivalence  is violated, while  the currency  is  too heavily “managed”, speculative attack  tends to simply relocate from one nominal anchor and forex market to another (inflation target) and government securi‐ ties market as in [kumhof, 2001] and [corsseti‐mackowiak, 2003].  2007 ‐ 24  •  economic analysis®    be that as it may, does that mean that we could abandon exchange rate targeting all to‐ gether in small open economies once the inflation targeting regime is in place? or is there still a  role for auxiliary anchor, especially having in mind conveniently soft edges of sufficiently wide  monitoring bands designed by tarapore committee of the indian central bank, which allow resort‐ ing to stretching clause in the event of temporary but massive non fundamental shocks [william‐ son, 2000*]? moreover, until the dirty float come‐back, economists seemed to agree upon the su‐ premacy of well‐designed transparent rules over under the table non‐committed discretion. by not  having the opinion on whereabouts of central parity (nominal and/or real effective exchange rate)  or by hiding that  information from the public, do central banks of managed floaters add up to  transparency of it regime and their interest rules as well as reaction functions? after all, whom are  proponents of dirty floating plus trying to fool, by claiming that ‐in high pass‐through and highly  indebted environment‐ once authorities choose the inflation target and its «maturity», speculators  cannot feel the trend of exchange rate puls even if «maginot lines» are not formally announced,  since dirty pegged exchange rate is the main worn‐out instrument for controlling reflation?  for  ought we care, all the answers to previous rethoric are bound to be negative.   in as much as non‐zero pass‐through from exchange rate affects inflation as well as to the ex‐ tent that any more serious exchange rate misalignment affects output gap, it is painfully obvious  that every emerging market central bank would have to keep a close eye on relationship between  inflation targeting and national currency movements and react through some kind of taylor rules,  even if there is no publicly announced exchange rate targeting [clarida, 2001], [eichengreen, 2002],  [flamini, 2003]. on a top of it, all prospective candidates for sooner or later e(m)u membership,  including those which have already  introduced  inflation targeting,8 will have to  introduce very  formal and irrevocable exchange rate target zones within the erm ii: target zones for which much  more flexible yet similar «bbc» regimes appear to be a good starting point and an excellent itera‐ tive interim solution.9    nevertheless,  the question of whether exchange rate  targeting should be an  independent,  explicitly modelled particle of central bank´s reaction function remains a bitterly debated puzzle in  contemporary open economy macroeconomics. batini et alia (2006)  in general, bufman and lei‐ derman (1999) and brenner and sokoler (2001) in the case of israel, jonas and mishkin (2003) for  hungary, morande (2001) and schmidt‐hebbel and tapia (2003) in the case of chile, to name only  the few, express poorly‐documented concern for possible dynamic inconsistency between (or even  reason for existence of) two nominal anchors. as far as potential conflicts between simultaneous  achievement of inflation target and exchange rate target are concerned, after thorough examination  of chilean, israeli and hungarian case,  our conclusion is that eventual conflict between inflation  and exchange rate target can (yet by no means must) happen either when the level and/or width of  target zones  is  ill‐chosen (often set unrealistically  low and narrow), or as a consequence of too  steeply predetermined rate of currency crawl. as a residue, equally serious pitfall for «bbc plus»  and alike policy mix opens up out of controversial ambition of monetary authorities in emerging  markets  to overly  exploit  sterilised  intervention  in  order  to  simultaneously  accomplish  several  mutually excluding goals [malovic, 2006].10 otherwise, direction if not magnitude of nominal ex‐ 8 for example romania, turkey and serbia.  9 it goes without saying that within fixed, non sliding currency band preconceived under erm ii all of the perils of pre‐ committed pegging are once again threatening countries’ exchange rate targets, even more so since the ecb in practice  insists upon much thinner corridors than officially proclaimed, yet one should not forget that responsibility for defend‐ ing such a target zone rests not only with the national central bank in question, but with the ecb itself too.  10 political leaders often utter the pressing need to attract as much fdi as possible and provide growth while simultane‐ ously urging for decreasing or even overthrowing balance of payments deficits. similarly, emerging markets frequently  strive to obtain massive capital inflows in prolonged periods yet to avoid either premature debt repayment, their curren‐ cies’ appreciation or increase in inflation as a corollary of abandoning sterilization policy.  volume 40 • spring 2007 • 25  change rate movements within the band and inflation dynamics within the targeted corridor ought  to be fairly compatible. regarding the rationale for their simultaneous existence, one of the best  explanations so far as to why this may be a good idea and in fact may enhance the social welfare  (further minimise central bank’s loss function) is the one given by edwards (2006, pages 22‐23),  who rightfully realises that when there is a lag in reaction of both inflation and output gap to ex‐ change rate changes, «(...) the central bank may want to pre‐empt their effect by adjusting the pol‐ icy stance when the exchange rate change occurs, rather then when its effects on inflation and out‐ put are manifested».     therefore, for small open economies with fragile emerging markets central bankʹs loss func‐ tion (that we are trying to minimise) obviously cannot be of the simplest flexible inflation targeting  form:  ( )[ ]2121 )(2 1 t t tt t yy −+−=λ ++ οππ   eichengreenʹs (2002) and woodfordʹs (2003) specification which includes a concern for limit‐ ing variability of interest rates observable in many transition countries is perhaps acceptable, but  probably suffers from the same instrumental and operational pitfalls already assigned to managed  floating plus:11  2 1 2 1 2 1 )()( t t tt t t yt iiyy −+−+=λ +++ εοοπ     hence,  it  is advisable for emerging market central bankers to explicitly adopt  logarithmic  version of flexible nominal effective exchange rate target following svensson (2004):12  ( ) ( ) +−+−=λ ++ 2 1 2 1 t t tt tt yyoππ (€t+1 ‐ €t)2     naturally, this kind of objective function must not degenerate into manipulating the real ex‐ change rate. moreover, even (wide enough) sliding currency corridor let alone monitoring band  would enable “bbc plus” enough flexibility to tolerate transitional nonfundamental exchange rate  fluctuations. at the same time, transparency of exchange rate regime and its stabilisation proper‐ ties would be preserved [forbes‐kofman, 1998], without confusion in regard to the primacy of in‐ flation target over auxiliary nominal anchor.   to the extent that nature of exchange rate fluctuations is not readily verifiable, ball (1998)  suggests another way to avoid the “exchange rate whiplashing”, namely, central bankers could  choose to target longer run inflation, which again depends upon lagged value of currency rate,  although in the instrument rule one gets only the output channel utilized to control inflation.13  however, ball (2001) implicitly admits that, unlike market participants in australia, emerg‐ ing markets share the keynesian view of the  long run, by advocating his monetary conditions  index as an optimal instrument rule for small open economies. mci rule appoints simultaneous  fine‐tuned interest rate and exchange rate management in order to achieve inflation target, with  real exchange rate target on the left side if we assign it primarily the role of instrument (operating  11 for the purpose of  sketching several convenient ways of including some other variables (exchange rate being primus  inter pares) into central banks objective function in emerging small open economy version of inflation targeting, we ab‐ stract from legitimate need to refine formulae with precise definition and/or calibration of weights, as well as acknowl‐ edge often autoregressive nature of  inflation. for more on those  issues consult for example svensson and woodford  (2003).   12 indeed, one could also target real (rather than nominal) exchange rate. svensson proposes that as an alternative too in the same presentation. 13 surely the best yet only theoretical option (out of statistical reach) for most emerging markets would be the ability to  break down output gap  into  its  tradable and nontradable component. following svensson  (2004), one would mini‐ mize ( ) ( ) ( )2)1(2)1(21 ttnttttttt yyyyo ν+ντ+ττ+ −+−+−=λ οππ ,  with  more  than  obvious  implicit  presence  of  real exchange rate concern once again.  2007 ‐ 26  •  economic analysis®  target) or on the right side if its limited floating is simply an indicator to be taken into considera‐ tion [ball, 2001]:  φ ir +(1‐φ )εr = tϑ ( ) ( )tttytt ννοππ −+− −1               ir= ( ) ( )tt t y tt t νν φ ο ππ φ ϑ −+− −1  ‐  ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ − φ φ1 εr    in those two mathematically identical formulae, ν represents the output gap while φ  indi‐ cates the weight given to real interest rate in the policy mix. faced with repeatedly occurring calvo  shocks, simultaneous exchange rate and inflation targeting policy fares better than simple infla‐ tion‐centred interest rate rule: in such a setting, sudden capital flight provokes interest rate hike  which compensates for real exchange rate depreciation caused by the balance of payments disequi‐ librium.  in  fact,  keeping  mci  in  check  lowers  domestic  spending  (via  interest  rate  channel)  whereas increases net export (via real exchange rate channel) and thereby restores balance of pay‐ ments and stabilises output. nevertheless, it is fair to say that this conventional interpretation of  mci might reveal inferior stabilisation properties as opposed to taylor rule in the face of prebisch‐ adversity (net export revenue shock) [ball, 2001]. however,  more careful alternative specifications,  such as taking care of policy makerʹs preferences and direct exchange rate‐domestic inflation link  as in guender (2005), as well as rethinking the role of relative prices in effectiveness of exchange  rate as a shock absorber as demonstrated in edwards (2006),  could rule out such deficiencies.    conclusion  this paper has tried to argue that contrary to taylor (2001) and officially preached stance of  many central banks in small open economies, exchange rate targeting does play an important role  in the conduct of optimal monetary policy. after acknowledging the supremacy of somewhat for‐ gotten sliding currency bands vis‐à‐vis the still ruling bipolar view, on one hand, as well as vis‐à‐ vis the latest dirty floating fad, on the other, paper turns to specificities of inflation targeting in  emerging markets as well as rationale for versus potential pitfalls of simultaneous exchange rate  and inflation targeting.   discussion has been closed by reiterating the inevitability of close relationship between infla‐ tion targeting and exchange rate targeting. hence, several possible reaction functions for the mone‐ tary authorities in emerging markets were suggested, among those already laid out in the related  literature.  references  andersen, a. (2000), »was the honeymoon effect effective? an analysis of the ems target zone«, the arhuus school of  business, mimeo.  ball, l. (1998), «policy rules for open economies», research discussion paper 9806, reserve bank of australia.  ball, l. (2001), «policy rules and external shocks», norges bank, arbeidsnotat 3.  ball, l.‐mankiw, g.‐reis, r. (2003), «monetary policy for inattentive economies», nber working paper 9491.  batini, n. et alia (2006), «inflation targeting and the imf», international monetary fund, washington, (march).  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university, department of economics, lubbock, united states 2 texas tech university, rawls business school, department of management, lubbock, united states abstract this paper investigates the causal relationship between income shocks during the first years of life and adulthood mortality due to specific causes of death. using all death records in the united states during 1968-2004 for individuals who were born in the first half of the 20th century, we document a sizable and statistically significant association between income shocks early in life, proxied by gdp per capita fluctuations, and old age cause-specific mortality. conditional on individual characteristics and controlling for a broad array of current and early-life conditions, we find that a 1 percent decrease in the aggregate business cycle in the year of birth is associated with 2.2, 2.3, 3.1, 3.7, 0.9, and 2.1 percent increase in the likelihood of mortality in old ages due to malignant neoplasms, diabetes mellitus, cardiovascular diseases, influenza, chronic respiratory diseases, and all other diseases, respectively. key words: recession, public health, mortality jel classification: i18, i10, h51 introduction the disturbances in the accumulation of health endowments during the early-life period could alter the trajectory of individuals' outcomes later in life. several strands of empirical economic research have documented the mechanisms through which initial health endowments can explain, partly, the variations of short, medium, and long term individual outcomes including infant mortality, toddler mortality, cognitive development, test scores, completed education, employment, earnings, mortality rates during adulthood, and hazards of old-age cause-specific death (for a recent review, refer to costa (2015)). according to the fetal origin hypothesis, a nutritional shock during pregnancy can be compensated by an adjustment in vital organs and generally human system development with the main purpose of embryo's survival (barker, 1990). the lower quality of health endowment of the survived infants provides a channel to later-life outcomes. another possible explanation for this long-term link is that lower quality early-life conditions may posit individuals in inimical life trajectories (yeung et al., 2014). being born in a poor family might leave individuals with adverse health endowments but also could lead to lower education, lower likelihood of employment, and lower earnings. the lower earnings during adulthood could cause lower access to health care and so an increase in mortality. this effect reinforces the negative relationship between early-life conditions and adult * corresponding author, e-mail: hamid.noghanibehambari@ttu.edu 2 economic analysis (2020, vol. 53, no. 2, 1-19) mortality. another channel is families' selection for educational investment in their healthier/unhealthier children. as stated in costa (2015), since the marginal benefit of education rises at higher levels of schooling, householdds tend to sort their healthier children into high human capital development. therefore, healthier children benefit from higher educations and so higher earnings during adulthood. the higher earnings mean higher current nutrition and health-care access and so lower likelihood of mortality. exploring the long-term health effects of early-life conditions can have important policy implications. it could help policymakers identify the most vulnerable groups in the society, design more accurate healthcare policies to increase the health of the society, and decrease the mortality gap among different cohorts and gender-race groups. more importantly, health, as one of the fundamental components of human capital, has been shown to have sizable and statistically significant effects on aggregate output (bloom et al., 2004; fogel, 1994; grimm, 2011). therefore, a well-designed policy could not only lessen inequality but also contribute to long-term economic growth. this paper explores the effect of a negative income shock during the early-life period on old-age adult mortality due to specific causes of death. the main challenge to build a causal relationship is to find an exogenous shock that had an effect on families' income but is not correlated with their characteristics. moreover, such shocks should not directly affect individuals' outcomes later in life. a small branch of the literature uses booms and busts in aggregate output as the exogenous source (den berg et al., 2006, 2011; yeung et al., 2014). following this literature, we use business cycle fluctuations at the year of birth and first year of life as the source of shock to households' income. we use cause-specific mortality data, which covers all death records in the united states. for individuals born between 1910 till 1950, and who died between 1968-2004, we find a sizable, statistically, and economically significant effect of early-life fluctuations in real gross domestic product per capita on the risks of mortality due to different causes of death. a 1 percent reduction in gdp per capita at the year of birth is associated with an increase in the likelihood of death due to malignant neoplasms, diabetes mellitus, cardiovascular diseases, influenza, chronic respiratory diseases, and all other diseases by 2.2, 2.3, 3.1, 3.7, 0.9, and 2.1 percent, respectively. the marginal effects are still significant and in some cases larger using business fluctuations in the first year of childhood. in order to explore the potentially different effects of macroeconomic conditions across cohorts, we split the sample into four cohorts based on their year of birth. each subsample contains at least one severe recession. the negative effect of the recessions has mitigated over time and became even positive for cohorts born between the years 1943-1950. the main reason behind this sign reversion could be the large government anti-poverty policies such as the emergency relief act of 1933, aid to families with dependent children act of 1940, and social security act of 1935. note that this fact is consistent with the literature that mortality in wealthy countries like the us is procyclical (g. miller and urdinola, 2010; ruhm, 2000, 2015). however, these analyses work with datasets that cover the years after the start of these social programs. in the main results, we include dummies to capture the effect of these policies. the negative and statistically significant coefficients confirm the fact that this sign reversion for recent cohorts is, possibly, due to governmental policies to provide a minimum level of welfare (like nutritional sufficiency) for american families. although there is no established causal effect of government policies on later-life health outcomes, the cohort analysis points to a plausible avenue for future research. next, we stratify the sample based on race and gender. in all cases, the negative effects of recessions on cause-specific mortality are confirmed. the gender difference varies across models and depends on race and cause of death. however, comparing the marginal effects of whites and blacks, an income shock during childhood is more effective among whites. higher rates of infant mortality among blacks could partly explain this gap since they let fitter and healthier black individuals survive into adulthood, which shows lower cause-specific mortality later in life. even after controlling for education, occupation, and marital status, this gap prevails. however, all marginal effects are statistically significant at conventional levels. this paper makes a number of contributions to the current literature. first, while there is limited literature that explores the economic conditions early in hamid noghanibehambari, farzaneh noghani, nahid tavassoli 3 life and old-age mortality, no study has investigated this link for us data. more noticeably, no study has investigated early-life conditions and cause-specific death using us data. therefore, the main contribution of this paper to the literature is that it is the first study to fill this gap in the literature. second, it contributes to the literature that explores the latent outcomes of earlylife negative shocks by exploring the different causes of death among cohorts born in different economic circumstances. third, by presenting separate sets of marginal effects for different cohorts, this paper offers a plausible mechanism through which recessions started to be a healthy period in the us, which is the starting point of mass government aids and social security programs. third, using all death records in the us, which provides millions of observations, makes the results of this study more reliable compared to previous studies. the rest of the paper is organized as follows: in section 2, we provide a brief literature review. section 3 describes the core dataset, sample selection strategy, and gives a brief summary statistics of the final dataset. the identification strategy and main results are discussed in section 4. in section 5, we go over some robustness checks and show the heterogeneity of the coefficients in different sub-samples. possible issues and drawbacks of the analysis, some concluding remarks, and suggestions for future research are presented in section 6. a brief literature review recessions could affect the health endowment of individuals through different channels. as the main channel, it affects the wealth and earnings of households. lower earnings could be translated into lower nutritional access or health care affordability. this link between economic status early in life and short and long-term health outcomes is well established in the literature. ferrie and rolf (2011) use longitudinal data which covers the years 1895-2005 and show that us-born male who lived in a low socioeconomic household before age 5 are more likely to die younger, conditional on survivor until age 70, and more likely to die from heart diseases than those individuals who were in high-ses households before age 5. using panel study of income dynamics (psid), hoynes et al. (2016)investigate the long-run impacts of participation in the food stamp program. access to food stamps during early childhood is associated with lower odds of metabolic syndrome and raises the economic self-sufficiency of women in adulthood. the important implication of their paper is the causal effect of a direct policy-driven channel, namely nutrition, during childhood on health outcomes later in life. a small strand of literature uses fasting during the islamic holy month of ramadan as a plausibly exogenous nutritional shock in utero and investigates its impacts later in life. being exposed to ramadan during prenatal development is associated with lower birth weight, reduces the number of male births, increases the likelihood of disability during adulthood (almond and mazumder, 2011), lowers the test scores at age 7 (almond et al., 2014), intensifies the symptoms indicative of coronary heart problems and type 2 diabetes during old ages (van ewijk, 2011), diminishes cognitive and math test scores at school and decreases working hours during adulthood (majid, 2015). based on these studies, we expect that a negative income shock caused by a fall in gdp has adverse health effects on children in utero or in their early years of life by reducing nutritional stock available to households. another possible mechanism through which a recession could influence health outcomes is the reduction in pollution. recession comoves strongly with pollution and pollutant industries including the manufacturing sector (eaton et al., 2016; tavassoli et al., 2020). it is now well established that exposure to pollution during the antenatal development period has adverse health impacts for newborns. isen et al. (2017) use us administrative data to evaluate the long-term effects of the 1970 clean air amendment act. they exploit the variation of differential exposures of counties that were affected by the caaa and find that higher exposure in the year of birth is associated with lower earnings and labor force participation at the age of 30. chay and greenstone (2003) use variation in pollution exposure in us counties caused by 1981-1982 recession to estimate the effects of pollution on infant mortality rates and find that 1 percent reduction in total suspended particulates (tsp) will cause a 0.35 percent 4 economic analysis (2020, vol. 53, no. 2, 1-19) decline in infant mortality. through this channel, a positive relationship is expected between recession and health. following the influential paper of ruhm (2000), this theory was supported by empirical evidence of procyclical fluctuations in total mortality and several cause-specific death (coile et al., 2014; janet currie et al., 2015; mcinerney and mellor, 2012; d. l. miller et al., 2009; ruhm, 2015). in addition, an economic collapse during a severe recession could force mental pressure on pregnant mothers and cause more stressful pregnancies. this pathway, although not widely explored, has been shown to increase the probability of a low birth weight child and reduce the sex ratio (olafsson, 2016). the effect of these shocks could be deteriorated by parental overor under-investment in children. the parental investment could reduce the health endowment gap between their offspring or reinforce this gap if they decide to invest more in their healthier children (janet currie, 2011; frijters et al., 2010, 2013; yi et al., 2015). restrepo (2016) finds evidence that low educated parents allocate more resources to their offspring who had initially normal birth weight compared to their low birth weight children while high-educated mothers compensate this health gap among their children. mortality rates during adulthood and old-age could be partly explained by early-life nutritional and economic conditions. yeung et al. (2014) explore this path and find that an adverse income shock caused by a recession during pregnancy and the first year of life will increase the risks of old-age causespecific mortality. it increases the probability of death due to cancer among males and females by about 8 and 6 percent, respectively. in addition, it increases female mortality due to cardiovascular diseases by roughly 5 percent. den berg et al. (2006) use a longitudinal dataset covering the years 1812-2000 for individuals born in the period 1812-1912 in netherlands and document that household economic conditions early in life can explain adult mortality rates. they exploit booms and busts during childhood as an instrument for individual economic conditions. applying a hazard analysis, they find that being exposed to a boom early in life is associated with a 9 percent reduction in adult mortality rates. using the same instrument, van den berg et al. (2011) show that being born under a recession increases the probability of cardiovascular mortality later in life. den berg and gupta (2015) introduce a causal pathway for this effect. they show that marital status, as a determinant of adult mortality, is itself affected by economic conditions early in life. among women, longevity is reduced upon marriage in case they are born under adverse economic conditions. however, marriage has a protective effect for men. married men enjoy longevity and the marital status does not depend on economic conditions in early-life. on the other hand, male mortality rates comove, negatively, with business fluctuations in their early childhood. other relevant papers confirm the influence of economic conditions during early-life and later outcomes including health, mortality rates, and old-age cause-specific mortality rates (banerjee et al., 2010; case et al., 2005; d. m. cutler et al., 2007; flores and kalwij, 2014; frijters et al., 2010; myrskylä, 2010a, 2010b; myrskylä et al., 2013; noghanibehambari et al., 2020; rao, 2016; strand and kunst, 2006). data and sample selection strategy the main source of data is the multiple cause of death data files from us vital statistics. since there are multiple interactions between early-life circumstances and individuals' state of birth, we restrict the sample to the years 1979-2004, which contain the information on the state of birth. all individuals who were not born in the us excluding its territories are eliminated. the main filter for the final dataset is to choose a time-window for individuals' year of birth. going further back in time has the advantage of larger sample sizes and including more cohorts. the problem is the selection bias due to earlier mortality rates. for instance, cohorts born between 1900-1910 who died between the years 1979-2004 have a minimum and maximum age range of 69 and 104. old-age death due to different causes could have started earlier during their 50s or 60s. thus, the estimations will probably suffer from sample selection. to alleviate this problem, we let the maximum age at the beginning of the observation-window to be 69. this means that the year of birth is restricted to be above 1910. moreover, since the focus of this study is old-age hamid noghanibehambari, farzaneh noghani, nahid tavassoli 5 mortality, individuals below age 55 are excluded. therefore, all death records in the final dataset have occurred to persons who were born between 1910-1950, a period with several severe recessions and significant booms in the us economy. ultimately, in order to overcome the processing power limitation due to the large sample size, we use a 20 percent random sample withdrawn from the final dataset in all analyses. since the sample size still contains millions of observations, we expect to see similar results. indeed, when we use a 1 percent, 5 percent, and even 30 percent random sample, the marginal effects and their standard errors are quite similar to the current level of random sampling. we do not restrict this random sampling to be from a specific subpopulation or overor under-representing some subsamples. the random sample is drawn from the full sample. this random sampling has been done in the previous literature (j. currie and moretti, 2003). table 1 depicts a cross-tabulation of causes of death records by year of birth by gender. cardiovascular diseases are the main causes of death for both genders and malignant neoplasm diseases are the second. in most cells, male death rates are higher than that of females. historical estimates of us gdp per capita are extracted from jordà et al. (2017). the increasing trend in gdp per capita during 20th century comoves with other social and noneconomic outcomes like provision of public health, health care availability, progress in sewage systems, water cleaning, persistent increase in the number of schools and universities, and more noticeably improvements in governmental welfare policies. these secular trends make the use of gdp per capita as the instrument of economic conditions inappropriate. therefore, following yeung et al. (2014), we decompose the time series into a time trend and a cyclical component using the hodrick-prescott (hp) filter with a smoothing parameter of 200 (hodrick and prescott, 1997). figure 3 illustrates the trend and fluctuations for real gdp per capita between the years 1910-1950. starting around 1914, there are several recessions during this period (including the big recession) and several considerable boom periods (including world war ii years). note that a positive deviation from the trend refers to a boom in the economy and a downturn from the trend points to a recession. figure 4 shows a descriptive effect of being born during a recession (boom) on the average age of death from cardiovascular diseases. visually, except for individuals who died in their late 70s, being born during a recession increases the rates of death from cardiovascular diseases at each given age. one possible drawback in assessing the latent effects is the selection of most fit individuals to reach maturity. fetal deaths and infant mortality in periods of hardship can let stronger newborns survive. this fact causes the real effects of early-life conditions on adult outcomes to be underestimated. to alleviate this issue we use two other variables that can partly control for secular trends in the health of infants and other macro conditions. first, we use historical average grain prices interacted with state of birth. using historical meat prices reveals very similar estimates. this dataset is extracted from jacks (2013) which covers real prices (1900=100) of barley, corn, rice, rye, wheat, beef, hides, lamb, and pork among other commodities in the years 1850-2017. to proxy for the health environment during childhood, we use childhood mortality rates at the year of birth. the time series of childhood mortality rates for children 1-4 years old (interacted with state of birth in all specifications) are extracted from the national centre for health statistics. table 2 provides summary statistics of the final dataset. only over a few years, vital statistics asked about education and occupation. over the years 1989-1999, information on both variables is available. this table covers the selected years in order to provide information on education, too. for all causes of death, the median age at death is higher if individuals are born during a boom compared to those born during a bust. born during either a recession or a boom, females occupy a lower portion of each cause-specific death. as expected, log average grain prices are lower during busts and higher during booms. additional variables during this period, the main inflection point in american households' welfare, especially during recessions, was the start of a series of government social welfare programs. we define 6 economic analysis (2020, vol. 53, no. 2, 1-19) three indicators to account for the three most important of these acts: emergency relief act commencement (1933), aid to families with dependent children (afdc) that was enacted in 1940, and social security act (1935). moreover, we include in all formulations a dummy to control for the 1918 influenza pandemic which has been shown to have large health impacts among other outcomes during adulthood and old age (almond, 2006; almond and mazumder, 2005). dustbowl in the great plains during the 1930s was another possible channel to affect health since it damaged topsoils and agricultural products in certain ecological places. we include dummies to capture this phenomenon for states (states of birth) that were mostly affected: texas, new mexico, oklahoma, kansas, and colorado. in addition, we use 5-year dummies to account for all other secular trends in health improvements and other macro influences that changed over time but affected all individuals uniformly. methodology we take two approaches to reveal the causal relationship between early-life conditions and cause-specific mortality: nonparametric analysis in which we draw kaplan-meier survival curves to explore an illustrative relationship, and parametric analysis in which we apply extended cox model for hazard analysis. two periods in early-life are the main interest in this study: year of birth and first year of life. vital statistics does not ask about the month of birth. therefore, year of birth could attribute only to the period in utero or only the first year of life or both. this fact should be considered while interpreting the coefficients of the year of birth (yob) as the variable of interest. hence, (yob+1) refers to either the first or second year of life. however, we report all coefficients separately in all specifications. non‐parametric analysis figure 1 and figure 2 depict the kaplan-meier survival curves for different causes of death in different stages of life for cohorts born during an expansion versus cohorts born during a recession. the sample is stratified based on gender. it is well established that there is a gender difference in mortality and cause-specific mortality. figure 1 shows the survival curves of males and figure 2 depicts that of females. we selected two subsequent periods of expansion and recession during 1912-1913 (boom) and 1914-1915 (bust period) for three reasons. first, there are no government interventions during this period to deteriorate the income shock to households. second, neither the boom nor the bust is as severe as other recessions in the years 1910-1950. obtaining the latent effects of early-life conditions during a mild boom-bust period suggests similar results for more severe business fluctuations. third, public health improvements increased over time and so act at the benefit of later cohorts who were born during recessions. this will cause an underestimation of true effects if we compare two subsequent cohorts born during expansion-recession while leads to an overestimate if we compare cohorts born during succeeding recession-expansion periods. the latent effects of born in a recession are more informative at older ages. for any level of mortality rate, being born in an expansion is associated with higher age at death. cohorts who were born during a recession are more probable to die younger considering each cause of death. referring to the upper left panel of figure 1 and figure 2, the differential effect begins at age 70 for deaths due to malignant neoplasm diseases. there is no obvious difference between the start of this divergence among males and females. the middle left panel of both figures shows the survival curves for death due to cardiovascular diseases. the survival of both cohorts starts to diverge considerably around age 80, for both males and females. this fact reveals that, at least descriptively, the effects of adverse conditions in childhood can remain passive until much older ages. hamid noghanibehambari, farzaneh noghani, nahid tavassoli 7 parametric analysis following the literature (myrskylä et al., 2013; strand and kunst, 2006; yeung et al., 2014), we assume that conditional on individual characteristics the causes of death are independent from each other. we apply extended cox model which allows for time dependent variables (therneau and grambsch, 2013). a simple cox model can be written in the following form: h t, x t h0 t e ∑ (1) where t is the survival time, h is a hazard function, x represents covariates, and h_0 is the baseline hazard. the main results are presented in table 3. each column represents a separate regression. individual characteristics include age dummies, fixed effects for the current state of residence, gender, and race. however, the literature has documented a differential path for mortality among different races and genders. including a dummy for the race in these models will shift the survival trajectory vertically. however, stratifying the data will allow each stratum to form its own trajectory, which provides flexibility in survival paths and increases the precision of the estimates. therefore, instead of adding a set of dummies for the state of birth, state of death, race, and gender as control variables, we stratify the model by these variables. other control variables are explained in section 3.1. as shown in the first column of each panel in table 3, a 1 percent reduction in the cyclical component of gdp per capita during the year of birth is associated with 3.2, 2.8, 2.6, 1.9, and 3.7 percent increase in the likelihood of mortality due to malignant neoplasm diseases, diabetes mellitus, cardiovascular diseases, influenza and pneumonia diseases, and chronic respiratory diseases, respectively. the effects are larger for exposure to business fluctuation in the first year of life. next, to account for the secular increase in health conditions during childhood, we add an interaction of state of birth with rates of childhood mortality. to account for other macro conditions, we add the log of average grain prices interacted with the state of birth. the results are reported in table 4. the magnitude of the estimates falls but remains significant at 1 percent level. in the next stage, we add education, marital status, and a set of dummies for occupation. due to data limitations explained in section 3, the observations fall in the years 1989-1999 only. the results of full specification models for different causes of death are reported in table 5. a 1 percent decrease in the cyclical component of real gdp per capita during the year of birth is associated with 2.2, 2.3, 3.1, 3.7, and 0.9 percent rise in the probability of death due to malignant neoplasm diseases, diabetes mellitus, cardiovascular diseases, influenza and pneumonia diseases, and chronic respiratory diseases, respectively. the estimates are quite similar to the results of table 4 which implies that education and type of occupation do not mitigate the latent effects of adverse conditions in the early-life. the marginal effects of the first year in life are larger than coefficients of the year at birth for most causes of death in all three tables. among the causes that we explore here, cardiovascular diseases and chronic respiratory diseases are among the main mortality causes that are linked to adverse conditions during pregnancy and early years of life. for example, lawlor et al. (2006) investigate the socioeconomic conditions during childhood and causespecific death at older ages in sweden and find a positive association between economic conditions early in life and higher risks of death due to respiratory diseases. using data of the netherlands, yeung et al. (2014) find a positive association between economic conditions early in life and hazard of death due to respiratory and cardiovascular diseases. 8 economic analysis (2020, vol. 53, no. 2, 1-19) robustness checks race‐gender decomposition there is evidence on racial and gender gap in mortality (montez et al., 2011; satcher et al., 2005). if cause-specific mortality can be partly explained by childhood conditions then the racial and gender gap could provide different pathways from childhood condition into adult mortality and morbidity. to check for this differential effect, we split the sample into four groups: white males, white females, black males, and black females. the full specification models of the group decomposition are reported in table 6 through table 8 for different causes of death, separately. the gender difference depends on race and cause of death. childhood conditions are more effective on while males rather than white females for death due to malignant neoplasm diseases while for diabetes mellitus the impacts are more pronounced for females. black females are less affected by childhood conditions based on death due to chronic respiratory diseases compared to black males while in other causes of death their respective coefficients are larger. in general, cause-specific deaths in white people are more influenced by their childhood conditions compared to their black counterparts. the latter findings could be partly explained by higher fetal death and infant mortality among black people (elder et al., 2016). during hardships, infant mortality and fetal death increase among blacks more than whites. therefore, those black newborns who survive their infancy are the fittest and healthiest and have higher initial endowments. this higher level of initial health increases their life expectancy and reduces the mortality rates at older ages. thus, the lower coefficients are only a reflection of initial selection rather than the lower susceptibility of blacks to income shocks. cohort decomposition secular improvements in the health environment, changes in the provision of public health, the introduction of new vaccines, eradicating many formerly deadly diseases, and more noticeably the change in governmental policies to neutralize the adverse economic shocks lead to substantial variations in cohorts' health quality (costa, 2015; d. cutler and miller, 2005; noghanibehambari et al., 2020; noghanibehambari et al., 2020; noghanibehambari and salari, 2020). to account for this possible heterogeneity, we apply the baseline model separately for different cohorts. the results are depicted in table 9 through table 11 for six causes of death and four cohorts. two criteria are used to make cohort boundaries. first, a range should have at least one major recession and one major boom so that the model can compare different cohorts within our cohort-groups. second, it should reflect, partly, the medical time-line in the first half of 20th century. considering these facts, four cohorts based on year of birth are defined, as follows: 1910-1918, 1919-1928, 1929-1942, and 1943-1950. as shown in table 9, a 1 percent reduction in aggregate business fluctuation is associated with 1.5 and 0.8 percent increase in the likelihood of death due to malignant neoplasm and cardiovascular diseases for cohorts born between the years 1910-1918. surprisingly, the marginal effects increase to approximately 15 percent for cohorts born in 1919-1928. the signs reverse for cohorts born in the period 1943150 which implies that recessions are good for the health of newborns and reduces the probability of cause-specific mortality in old ages. this fact is confirmed for other causes of death shown in table 10 and table 11. for chronic respiratory diseases, the positive effect of recessions starts at the cohorts born in 1929-1942. this finding is consistent with the literature that recessions could improve the health of newborns (chay and greenstone, 2003; miller et al., 2009; page et al., 2017; tapia granados and ionides, 2017). however, these studies use the most recent data for the us and more specifically in the second half of the 20th century. in a similar analysis, cutler et al. (2007) use the dust bowl in great plains during the 1930s as the exogenous shock to income in utero and investigates its effects later in life. it finds no evidence on such effects on chronic diseases, disability, and infant mortality. one possible explanation for hamid noghanibehambari, farzaneh noghani, nahid tavassoli 9 these findings is the effectiveness of welfare programs. recall that a series of government policies started during the 1930s. these policies, like the social security act, could have provided pregnant mothers with sufficient nutrition. meanwhile, a recession could lower pollution and supply a cleaner environment. as suggested by ruhm (2000), recessions could lower obesity, increase physical activity, and decrease habits like smoking and drinking. therefore, an effective welfare program can offset the effect of recession by extending the access of households to nutritional resources that is the main channel through which adverse economic conditions can affect health. thus, the positive effects dominate the negative ones. discussion and conclusion the long term relationship between early-life economic conditions and old-age cause-specific mortality has been investigated in several studies using european data (bhalotra et al., 2017; den berg et al., 2006, 2011; yeung et al., 2014). virtually no study explored this topic using us data mostly due to lack of historical longitudinal data (costa, 2015; ferrie and rolf, 2011). this paper attempted to investigate this question using all death records in us vital statistics. it uses the fluctuations in the business cycle at birth as the instrument for economic conditions during infancy and finds that being born during a recession has a significant and substantive effect on the probability of cause-specific mortality. this negative relationship is stronger for older cohorts. in the nonparametric analysis, we showed that the effects on death due to cardiovascular diseases remain latent roughly until age 80. in a full specification of cox models, we find that 1 percent decrease in the cyclical component of gdp per capita is associated with 2.2, 2.3, 3.1, 3.7, 0.9, and 2.1 percent increase in the likelihood of mortality in old ages due to malignant neoplasms, diabetes mellitus, cardiovascular, influenza, chronic respiratory diseases, and all other diseases. cohorts born during a recession in earlier periods, e.g. 1910-1930, are more prone to be affected by the economic conditions early in life while the sign of the marginal effects reverses for recent cohorts, e.g. 1940-1950. this cohort analysis suggests that government welfare programs could neutralize the effect of income shock by granting american families a minimum level of nutritional requirements. this could let other positive effects of recessions to dominate the negative effect of an income shock (d. l. miller et al., 2009). this study has some drawbacks resolving which could point to future research avenues. first, the path from childhood economic conditions to old-age mortality passes through some mediatory channels. although we tried to proxy contemporaneous socioeconomic status by education, marital status, and occupation, no data is available to control for earnings, retirement age, years of labor force participation, wealth, insurance, and access to health care. all these variables can explain a significant portion of variation in mortality (gerdtham and johannesson, 2004). second, income shocks can adversely affect health during early-life in several ways including lack of sufficient nutrition, stressful pregnancies, lowering access to health care, and decreasing prenatal visits. disentangling the different mechanisms requires a different strategy. third, assuming that the main channel is nutritional deficiency, not all households are affected by a recession to the same extent. more educated mothers with higher socioeconomic status are less affected compared to families with lower socioeconomic status. this heterogeneity among individuals from different families is not captured in the current study. fourth, male embryos are more susceptible to external stressors and so during times of hardships sex ratio decreases. this will also lead to higher fetal death for males. thus, those male newborns that are born during harsh periods have been fitter, stronger, and healthier in the first place. hence, male cohorts born during a recession could be, on average, healthier than their female counterparts and possibly healthier than males born during a proceeding expansion. this fact will attenuate the estimation of the impact of childhood conditions on old-age cause-specific mortality 10 economic analysis (2020, vol. 53, no. 2, 1-19) references almond, d. 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(2015). early health shocks, intra-household resource allocation and child outcomes. the economic journal, 125(588), f347--f371. h am id n o gh an ib eh am b ar i, f ar za n eh n og h an i, n ah id t av as so li 1 3 t a b l e s t a b le 1 . t ab u la ti o n o f c au se s o f d ea th b y y ea r o f b ir th a n d g en d er y e a r o f b ir th : 1 9 1 0 ‐1 9 2 0 y e a r o f b ir th : 1 9 2 0 ‐1 9 3 0 y e a r o f b ir th : 1 9 3 0 ‐1 9 4 0 y e a r o f b ir th : 1 9 4 0 ‐1 9 5 0 m a le f e m a le t o ta l m a le f e m a le t o ta l m a le f e m a le t o ta l m a le f e m a le t o ta l m al ig n an t n eo p la sm 2 6 .2 2 4 .1 2 5 .2 3 1 .4 3 4 .5 3 2 .8 3 4 .1 4 2 .2 3 7 .5 3 0 .6 4 4 .7 3 6 .2 d ia b et es m el li tu s 2 .0 3 .0 2 .5 2 .5 3 .6 3 .0 2 .9 3 .9 3 .3 3 .3 3 .8 3 .5 c ar d io va sc u la r d is ea se 4 9 .5 4 8 .1 4 8 .8 4 4 .1 3 7 .4 4 1 .2 4 0 .5 2 9 .9 3 6 .1 3 6 .8 2 4 .9 3 2 .1 in fl u en za a n d p n eu m o n ia 2 .5 2 .2 2 .4 1 .6 1 .3 1 .5 1 .2 1 .1 1 .2 1 .3 1 .2 1 .3 c h ro n ic l o w er r es p ir at o ry 4 .4 3 .2 3 .8 3 .3 3 .3 3 .3 2 .0 2 .5 2 .2 0 .9 1 .4 1 .1 a ll o th er d is ea se s 1 5 .4 1 9 .3 1 7 .3 1 7 .1 1 9 .9 1 8 .3 1 9 .2 2 0 .3 1 9 .7 2 7 .1 2 3 .9 2 5 .9 t o ta l 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 1 0 0 .0 (4 ,3 9 9 ,0 3 9 ) (4 ,0 7 8 ,2 4 1 ) (8 ,4 7 7 ,2 8 0 ) (3 ,4 7 4 ,8 1 0 ) (2 ,6 5 3 ,6 0 6 ) (6 ,1 2 8 ,4 1 6 ) (1 ,6 7 4 ,6 6 7 ) (1 ,1 6 5 ,3 8 4 ) (2 ,8 4 0 ,0 5 1 ) (9 0 4 ,7 0 4 ) (5 9 6 ,5 5 4 ) (1 ,5 0 1 ,2 5 8 ) n u m b er o f c as es 7 ,4 7 7 ,2 8 0 6 ,1 2 8 ,4 1 6 2 ,8 4 0 ,0 5 1 1 ,5 0 1 ,2 5 8 n ot es . d at a a re e xt ra ct ed fr om v it al s ta ti st ic s d at a fi le s. 5 0 % r an do m s am pl e is u se d. t a b le 2 . s am p le c h ar ac te ri st ic s b y c au se o f d ea th b y r ec es si o n i n d ic at o r at y ea r o f b ir th m a li gn a n t n e o p la sm d ia b e te s m e ll it u s c a rd io v a sc u la r in fl u e n za a n d p n e u m o n ia c h ro n ic r e sp ir a to ry a ll o th e r d is e a se s b o o m b u st b o o m b u st b o o m b u st b o o m b u st b o o m b u st b o o m b u st m ed ia n a ge a t d ea th 7 0 .3 7 6 7 .7 7 7 1 .6 5 6 9 .3 1 7 3 .3 3 7 1 .5 0 7 5 .6 0 7 4 .2 6 7 3 .3 3 7 2 .3 3 7 2 .6 0 6 9 .3 8 % (8 .8 7 9 ) (1 0 .6 2 ) (8 .8 7 7 ) (1 0 .6 7 ) (8 .8 5 1 ) (1 0 .6 2 ) (8 .3 7 7 ) (1 0 .1 9 ) (7 .5 9 9 ) (9 .1 4 1 ) (1 0 .2 5 ) (1 2 .5 4 ) e d u : h ig h s ch o o l 4 9 .4 1 4 9 .5 7 4 8 .5 6 4 9 .2 8 4 7 .9 0 4 8 .0 9 4 6 .1 6 4 6 .3 7 5 0 .5 4 5 0 .8 6 4 7 .6 5 4 7 .5 5 % (5 0 .0 0 ) (5 0 .0 0 ) (4 9 .9 8 ) (5 0 .0 0 ) (4 9 .9 6 ) (4 9 .9 6 ) (4 9 .8 5 ) (4 9 .8 7 ) (5 0 .0 0 ) (4 9 .9 9 ) (4 9 .9 4 ) (4 9 .9 4 ) e d u : < h ig h s ch o o l 1 6 .4 8 1 5 .3 6 2 3 .1 8 2 1 .8 0 2 0 .4 9 1 9 .5 7 2 2 .1 9 2 1 .7 1 2 0 .5 2 2 0 .1 1 1 9 .1 1 1 7 .7 3 % (3 7 .1 0 ) (3 6 .0 6 ) (4 2 .2 0 ) (4 1 .2 9 ) (4 0 .3 6 ) (3 9 .6 7 ) (4 1 .5 5 ) (4 1 .2 3 ) (4 0 .3 8 ) (4 0 .0 8 ) (3 9 .3 2 ) (3 8 .2 0 ) m ar ri ed 5 7 .5 4 5 8 .5 7 4 7 .8 3 4 9 .0 0 4 9 .1 9 4 9 .9 2 4 2 .0 6 4 1 .6 4 4 6 .3 3 4 6 .0 2 4 5 .3 0 4 4 .5 6 % (4 9 .4 3 ) (4 9 .2 6 ) (4 9 .9 5 ) (4 9 .9 9 ) (4 9 .9 9 ) (5 0 .0 0 ) (4 9 .3 7 ) (4 9 .3 0 ) (4 9 .8 7 ) (4 9 .8 4 ) (4 9 .8 7 ) (4 9 .7 0 ) w h it e 8 7 .6 8 8 7 .5 2 8 0 .0 0 7 9 .0 0 8 6 .8 3 8 5 .7 9 8 7 .6 8 8 6 .6 2 9 2 .9 3 9 2 .2 4 8 6 .7 0 8 4 .6 5 % (3 2 .8 7 ) (3 4 .1 5 ) (4 0 .0 0 ) (4 0 .7 3 ) (3 3 .8 2 ) (3 4 .9 1 ) (3 2 .8 6 ) (3 4 .0 5 ) (2 5 .6 4 ) (2 6 .7 5 ) (3 3 .9 6 ) (3 6 .0 5 ) f em al e 4 5 .8 1 4 6 .3 1 5 4 .3 2 5 2 .8 8 4 5 .5 0 4 4 .2 5 4 6 .8 1 4 6 .5 1 4 5 .8 3 4 6 .4 9 4 8 .6 7 4 6 .3 2 % (4 9 .8 2 ) (4 9 .8 6 ) (4 9 .8 1 ) (4 9 .9 2 ) (4 9 .8 0 ) (4 9 .6 7 ) (4 9 .9 0 ) (4 9 .8 8 ) (4 9 .8 3 ) (4 9 .8 8 ) (4 9 .9 8 ) (4 9 .8 6 ) c h il d m o rt al it y 8 1 .7 1 7 0 .1 6 8 4 .8 5 7 3 .7 7 9 1 .3 0 8 1 .6 4 9 8 .1 1 8 9 .9 9 9 0 .6 8 8 2 .5 6 8 6 .7 5 7 3 .9 8 (3 4 .0 5 ) (3 2 .3 7 ) (3 4 .1 1 ) (3 2 .9 4 ) (3 3 .4 4 ) (3 3 .5 7 ) (3 1 .4 5 ) (3 2 .8 8 ) (3 2 .0 8 ) (2 9 .9 2 ) (3 5 .8 4 ) (3 6 .4 3 ) l o g( a vg g ra in p ri ce ) 0 .0 5 6 7 -0 .0 5 0 6 0 .0 5 7 5 -0 .0 4 3 9 0 .0 5 9 1 -0 .0 2 6 7 0 .0 6 0 2 -0 .0 0 6 2 5 0 .0 6 2 9 -0 .0 4 0 9 0 .0 5 8 5 -0 .0 1 6 3 (0 .1 2 9 ) (0 .2 7 4 ) (0 .1 3 0 ) (0 .2 6 9 ) (0 .1 2 9 ) (0 .2 5 9 ) (0 .1 2 9 ) (0 .2 4 4 ) (0 .1 3 2 ) (0 .2 6 7 ) (0 .1 2 8 ) (0 .2 6 3 ) c as es 1 ,2 8 5 ,1 7 5 1 ,1 4 3 ,7 1 0 1 2 9 ,0 5 0 1 1 3 ,7 7 1 1 ,8 0 8 ,7 9 2 1 ,5 5 1 ,9 7 4 1 2 3 ,8 4 8 1 0 4 ,3 5 6 2 4 7 ,9 4 7 2 0 0 ,4 4 9 5 9 3 ,0 1 6 5 4 5 ,4 4 2 1 4 e co n o m ic a n al ys is ( 2 0 2 0 , v o l. 5 3 , n o . 2 , 1 -1 9 ) t a b le 3 . r eg re ss io n a n al ys is fo r th e e ff ec ts o f e ar ly -l if e r ec es si o n o n a d u lt s’ c au se -s p ec if ic m o rt al it y w it h o u t in d iv id u al c o n tr o ls a n d in te ra ct io n s m a li gn a n t n e o p la sm d ia b e te s m el li tu s c a rd io v a sc u la r in fl u e n za a n d p n eu m o n ia c h ro n ic r es p ir a to ry a ll o th er d is e as es h az ar d : (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , -3 .1 5 8 ** * -2 .8 3 5 ** * -2 .5 8 6 ** * -1 .9 4 1 ** * -3 .7 2 2 ** * -2 .4 6 5 ** * y ea r of b ir th (0 .0 1 3 ) (0 .0 4 2 ) (0 .0 0 9 ) (0 .0 4 0 ) (0 .0 3 3 ) (0 .0 1 5 ) b u si n es s c yc le , -3 .4 9 3 ** * -3 .2 5 8 ** * -2 .6 0 7 ** * -1 .9 1 0 ** * -3 .7 2 6 ** * -3 .1 0 1 ** * y ea r of b ir th + 1 (0 .0 1 6 ) (0 .0 5 3 ) (0 .0 1 1 ) (0 .0 5 0 ) (0 .0 3 9 ) (0 .0 1 9 ) a ge d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es d ec ad e d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es d u st b o w l p er io d ( t x , n m , o k , k s, c o ) y es y es y es y es y es y es y es y es y es y es y es y es 1 9 1 8 s p an is h f lu y es y es y es y es y es y es y es y es y es y es y es y es so ci al s ec u ri ty a ct s ta rt s y es y es y es y es y es y es y es y es y es y es y es y es e m er ge n cy r el ie f a ct s ta rt s y es y es y es y es y es y es y es y es y es y es y es y es a f d c a ct s ta rt s y es y es y es y es y es y es y es y es y es y es y es y es w o rl d w ar i i p er io d y es y es y es y es y es y es y es y es y es y es y es y es c as es 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 1 1 ,0 0 7 ,7 5 5 n ot es . s tr a ti fi ed b y se x, s ta te o f de a th , a n d ra ce . s ta n da rd e rr or s ar e cl u st er ed a t st at e of b ir th . d at a sp an s th e ye ar s 1 96 8 ‐2 00 4. 2 0 p er ce n t ra n d om s am p le i s u se d . ( * p< 0. 1 , * * p< 0 .0 5 , * ** p < 0. 01 ) t a b le 4 . r eg re ss io n a n al ys is fo r th e e ff ec ts o f e ar ly -l if e r ec es si o n o n a d u lt s’ c au se -s p ec if ic m o rt al it y w it h o u t in d iv id u al c o n tr o ls m a li gn a n t n e o p la sm d ia b e te s m e ll it u s c a rd io v a sc u la r in fl u e n za a n d p n e u m o n ia c h ro n ic r e sp ir a to ry a ll o th e r d is e a se s h az ar d : (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -2 .4 5 1 ** * (0 .0 5 4 ) -2 .5 6 8 ** * (0 .1 0 3 ) -3 .5 5 3 ** * (0 .0 6 9 ) -4 .0 9 6 ** * (0 .1 0 7 ) -0 .5 4 1 ** * (0 .0 4 4 ) -2 .3 5 4 ** * (0 .0 7 7 ) b u si n es s c yc le , y ea r o f b ir th + 1 -4 .3 3 9 ** * (0 .0 5 5 ) -4 .3 0 9 ** * (0 .0 9 3 ) -4 .5 3 1 ** * (0 .0 8 1 ) -4 .2 1 2 ** * (0 .1 0 5 ) -4 .5 6 2 ** * (0 .0 5 9 ) -4 .0 7 9 ** * (0 .0 6 4 ) in d iv id u al a ge a n d m ar it al s ta tu s d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es p o li cy , i n ci d en t, a n d d ec ad e d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es g ra in p ri ce s b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c h il d m o rt al it y b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c as es 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 6 ,9 9 5 ,3 5 1 n ot es . s tr a ti fi ed b y se x, s ta te o f de a th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st at e of b ir th . p ol ic y va ri ab le s in cl u d e: e m er ge n cy r el ie f a ct o f 19 33 , a fd c a ct o f 19 4 0, s oc ia l se cu ri ty a ct o f 19 35 i n ci de n t d u m m ie s in cl u d e: w or ld w ar i i p er io d , 1 91 8 sp an is h f lu , a n d d u st b ow l p er io d fo r st a te s t x , n m , o k , k s, c o d at a s p an s th e ye a rs 1 97 9 ‐ 20 0 4. 2 0 pe rc en t ra n do m s a m pl e is u se d. ( * p <0 .1 , * * p< 0 .0 5 , * ** p <0 .0 1 ) h am id n o gh an ib eh am b ar i, f ar za n eh n og h an i, n ah id t av as so li 1 5 t a b le 5 . r eg re ss io n a n al ys is fo r th e e ff ec ts o f e ar ly -l if e r ec es si o n o n a d u lt s’ c au se -s p ec if ic m o rt al it y, f u ll s p ec if ic at io n m a li gn a n t n e o p la sm d ia b e te s m e ll it u s c a rd io v a sc u la r in fl u e n za a n d p n e u m o n ia c h ro n ic r e sp ir a to ry a ll o th e r d is e a se s h az ar d : (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) (y o b ) (y o b + 1 ) c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -2 .1 6 5 ** * (0 .0 4 6 ) -2 .3 4 6 ** * (0 .0 8 6 ) -3 .0 8 6 ** * (0 .0 5 9 ) -3 .7 0 1 ** * (0 .0 8 9 ) -0 .9 1 2 ** * (0 .0 6 8 ) -2 .0 8 2 ** * (0 .0 7 7 ) b u si n es s c yc le , y ea r o f b ir th + 1 -2 .8 3 4 ** * (0 .0 5 6 ) -2 .8 0 8 ** * (0 .1 2 4 ) -2 .4 9 6 ** * (0 .0 4 2 ) -2 .2 5 9 ** * (0 .0 9 1 ) -3 .3 0 8 ** * (0 .0 8 1 ) -2 .3 3 8 ** * (0 .0 5 9 ) in d iv id u al d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es p o li cy , i n ci d en t, a n d d ec ad e d u m m ie s y es y es y es y es y es y es y es y es y es y es y es y es g ra in p ri ce s b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c h il d m o rt al it y b ir th s ta te y es y es y es y es y es y es y es y es y es y es y es y es c as es 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 2 ,1 0 0 ,6 5 5 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 9 18 s p an is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) t a b le 6 . h et er o ge n ei ty b y d if fe re n t g en d er -r ac e g ro u p s fo r m al ig n an t n eo p la sm s an d c ar d io va sc u la r d is ea se s m a li gn a n t n e o p la sm c a rd io v a sc u la r g ro u p s b as ed o n : w h it e m al e w h it e f em al e b la ck m al e b la ck f em al e w h it e m al e w h it e f em al e b la ck m al e b la ck f em al e g en d er -r ac e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , -2 .9 7 3 ** * -2 .6 7 8 ** * -2 .3 4 4 ** * -2 .0 1 0 ** * -3 .1 6 0 ** * -3 .1 0 9 ** * -2 .1 5 6 ** * -2 .6 5 9 ** * y ea r of b ir th (0 .0 6 4 ) (0 .0 7 3 ) (0 .1 0 9 ) (0 .1 4 9 ) (0 .0 6 5 ) (0 .0 6 8 ) (0 .1 0 2 ) (0 .1 2 6 ) c as es 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 9 18 s p an is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) 1 6 e co n o m ic a n al ys is ( 2 0 2 0 , v o l. 5 3 , n o . 2 , 1 -1 9 ) t a b le 7 . h et er o ge n ei ty b y d if fe re n t g en d er -r ac e g ro u p s fo r d ia b et es m el li tu s an d i n fl u en za p n eu m o n ia d ia b e te s m e ll it u s in fl u e n za p n e u m o n ia g ro u p s b as ed o n w h it e m a le w h it e f e m a le b la ck m a le b la ck f e m a le w h it e m a le w h it e f e m a le b la ck m a le b la ck f e m a le g en d er -r ac e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -2 .7 7 2 ** * (0 .1 5 8 ) -3 .2 1 5 ** * (0 .1 4 7 ) -1 .7 4 1 ** * (0 .2 6 0 ) -2 .2 1 4 ** * (0 .2 4 4 ) -3 .2 9 7 ** * (0 .1 4 8 ) -2 .7 2 6 ** * (0 .1 2 5 ) -1 .9 9 7 ** * (0 .3 3 2 ) -2 .3 8 0 ** * (0 .2 4 8 ) c as es 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 91 8 s pa n is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) t a b le 8 . h et er o ge n ei ty b y d if fe re n t g en d er -r ac e g ro u p s fo r c h ro n ic r es p ir at o ry a n d a ll o th er d is ea se s c h ro n ic r e sp ir a to ry d is e a se s a ll o th e r d is e a se s g ro u p s b as ed o n : w h it e m a le w h it e f e m a le b la ck m a le b la ck f e m a le w h it e m a le w h it e f e m a le b la ck m a le b la ck f em a le g en d er -r ac e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -3 .9 9 9 ** * (0 .0 7 6 ) -3 .7 3 2 ** * (0 .0 9 2 ) -3 .2 0 6 ** * (0 .3 0 2 ) -1 .9 1 2 ** * (0 .3 1 2 ) -1 .9 0 8 ** * (0 .1 1 3 ) -2 .3 3 6 ** * (0 .0 8 2 ) -0 .7 2 6 ** * (0 .1 8 4 ) -1 .3 3 6 ** * (0 .1 3 5 ) c as es 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 1 ,5 5 1 ,5 5 3 1 ,2 9 5 ,8 2 2 2 0 9 ,8 7 1 1 8 3 ,2 5 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n d ar d er ro rs a re c lu st er ed a t st at e of b ir th . i n di vi du a l c h a ra ct er is ti cs i n cl u de : m ar it al s ta tu s (2 d u m m ie s) , e du ca ti on ( 3 d u m m ie s) , a ge ( 16 d u m m ie s) , a n d o cc u pa ti on ( 10 d u m m ie s) . p ol ic y va ri a bl es i n cl u de : e m er ge n cy r el ie f a ct o f 1 9 3 3, a fd c a ct o f 1 9 4 0 , so ci a l se cu ri ty a ct o f 19 3 5 i n ci de n t du m m ie s in cl u de : w or ld w a r ii p er io d , 1 9 18 s p an is h f lu , a nd d u st b ow l p er io d f or s ta te s t x , n m , o k , k s, c o d at a sp a n s th e ye ar s 19 8 9 ‐1 99 9 . 2 0 p er ce n t ra n do m s am pl e is u se d. ( * p< 0 .1 , * * p< 0. 0 5 , * ** p < 0 .0 1) t a b le 9 . h et er o ge n ei ty b y c o h o rt s fo r m al ig n an t n eo p la sm s an d c ar d io va sc u la r d is ea se s m a li gn a n t n e o p la sm c a rd io v a sc u la r h az ar d : 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , -1 .5 5 3 ** * -1 5 .1 3 6 ** * -1 .5 3 0 ** * 5 .3 0 2 ** * -0 .8 4 1 ** * -1 5 .3 2 2 ** * -1 .3 6 3 ** * 5 .4 4 5 ** * y ea r of b ir th (0 .0 9 3 ) (0 .0 3 8 ) (0 .0 4 0 ) (0 .0 2 6 ) (0 .0 9 2 ) (0 .0 3 7 ) (0 .0 4 4 ) (0 .0 2 7 ) c as es 2 ,6 6 7 ,6 0 0 2 ,3 8 0 ,6 7 6 1 ,5 0 9 ,6 1 3 4 3 7 ,4 6 2 2 ,6 6 7 ,6 0 0 2 ,3 8 0 ,6 7 6 1 ,5 0 9 ,6 1 3 4 3 7 ,4 6 2 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st a te o f bi rt h . i nd iv id u a l c h ar ac te ri st ic s ar e re st ri ct ed t o ag e an d m a ri ta l s ta tu s du m m ie s. d a ta s pa n s th e ye a rs 1 9 79 ‐2 0 04 . 2 0 p er ce n t ra n do m s am pl e is u se d . ( * p< 0 .1 , * * p< 0. 05 , * ** p < 0. 0 1 ) h am id n o gh an ib eh am b ar i, f ar za n eh n og h an i, n ah id t av as so li 1 7 t a b le 1 0 . h et er o ge n ei ty b y c o h o rt s fo r d ia b et es m el li tu s an d i n fl u en za p n eu m o n ia d ia b e te s m a ll it u s in fl u e n za p n e u m o n ia h az ar d : 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -0 .7 3 0 ** * (0 .1 2 5 ) -1 2 .6 3 2 ** * (0 .1 2 9 ) -0 .6 5 8 ** * (0 .0 7 0 ) 4 .7 0 1 ** * (0 .1 0 8 ) 0 .2 8 9 ** * (0 .1 0 4 ) -1 3 .9 9 0 ** * (0 .1 0 2 ) -0 .6 4 8 ** * (0 .0 9 0 ) 5 .1 8 8 ** * (0 .1 6 2 ) c as es 1 ,5 6 0 ,6 6 7 1 ,3 3 8 ,8 3 1 8 2 8 ,3 5 3 2 3 3 ,1 8 7 1 ,5 6 0 ,6 6 7 1 ,3 3 8 ,8 3 1 8 2 8 ,3 5 3 2 3 3 ,1 8 7 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st a te o f bi rt h . i nd iv id u a l c h ar ac te ri st ic s ar e re st ri ct ed t o ag e an d m a ri ta l s ta tu s du m m ie s. d a ta s pa n s th e ye a rs 1 9 79 ‐2 0 04 . 2 0 p er ce n t ra n do m s am pl e is u se d . ( * p< 0 .1 , * * p< 0. 05 , * ** p < 0. 0 1 ) t a b le 1 1 . h et er o ge n ei ty b y c o h o rt s fo r c h ro n ic r es p ir at o ry a n d a ll o th er d is ea se s c h ro n ic r e sp ir a to ry d is e as e s a ll o th e r d is e a se s h az ar d : 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 1 9 1 0 ‐1 9 1 8 1 9 1 9 ‐1 9 2 8 1 9 2 9 ‐1 9 4 2 1 9 4 3 ‐1 9 5 0 c au se -s p ec if ic d ea th b /s e b /s e b /s e b /s e b /s e b /s e b /s e b /s e b u si n es s c yc le , y ea r o f b ir th -0 .7 7 0 ** * (0 .1 2 0 ) -1 2 .3 8 8 ** * (0 .0 7 8 ) 0 .4 3 3 ** * (0 .0 7 7 ) 5 .0 5 3 ** * (0 .1 3 8 ) -0 .2 4 1 ** * (0 .0 8 4 ) -1 1 .3 2 2 ** * (0 .0 4 7 ) -1 .0 5 1 ** * (0 .0 6 1 ) 4 .3 4 6 ** * (0 .0 3 9 ) c as es 1 ,2 6 4 ,9 2 7 1 ,1 1 8 ,6 5 7 7 0 9 ,2 7 8 2 0 1 ,0 4 7 1 ,2 6 4 ,9 2 7 1 ,1 1 8 ,6 5 7 7 0 9 ,2 7 8 2 0 1 ,0 4 7 n ot es . s tr at if ie d b y se x, s ta te o f d ea th , s ta te o f bi rt h , a n d r ac e. s ta n da rd e rr or s ar e cl u st er ed a t st a te o f bi rt h . i nd iv id u a l c h ar ac te ri st ic s ar e re st ri ct ed t o ag e an d m a ri ta l s ta tu s du m m ie s. d a ta s pa n s th e ye a rs 1 9 79 ‐2 0 04 . 2 0 p er ce n t ra n do m s am pl e is u se d . ( * p< 0 .1 , * * p< 0. 05 , * ** p < 0. 0 1 ) 18 economic analysis (2020, vol. 53, no. 2, 1-19) figures figure 1. mortality risks are constrained to males who died in period 1968-2004 and was born in the years 1912-13 (expansion) or 1914-15 (recession). figure 2. mortality risks are constrained to females who died in period 1968-2004 and was born in the years 1912-13 (expansion) or 1914-15 (recession). 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 malignant neoplasm 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 diabetes mellituse 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 cardoivascular disease 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 influenza and pneumonia 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 chronic lower respiratory 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 other diseases kaplan-meier survival curves 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 malignant neoplasm 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 diabetes mellituse 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 cardoivascular disease 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 influenza and pneumonia 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 chronic lower respiratory 0 .1 0 0 .5 0 0 .9 0 50 60 70 80 90 stock market boom 1912-13 stock market bust 1914-15 other diseases kaplan-meier survival curves hamid noghanibehambari, farzaneh noghani, nahid tavassoli 19 figure 3. log of gdp per capita (ppp) in united states during 1910-1950. the trend extracted using a hodrick-prescott filter with smoothing factor of 200. figure 4. likelihood of death from cvd for cohorts born during recession and expansions in different stages of life. article history: received: july 3, 2020 accepted: december 8, 2020 ea_2013_3-4 finalna ver preliminary reports competitiveness of croatian destinations through online marketing indicators gržinić jasmina, university jurja dobrile in pula, faculty of economics and tourism „dr. mijo mirković”, croatia1 sučić čevra mirela, net travel service, zagreb, croatia udc: 338.487:659.13/.16(497.5) ; 659.131.7:004.738.5 jel: f29, g34 id: 203728908 abstract – the purpose of this paper is to determine whether destinations in croatia follow the trend of the modern market by ensuring first impression quality through an online campaign. the world tourist organisation (unwto: 2008) takes into consideration categories of web page quality evaluation such as: information level of the destination web site, level of accuracy, level of consistency, type and quality of interaction with visitors, value of visual identity. web site development requires a user centered design process with permanent evaluation of the evolving design. the aim of this research is to explore web site design quality factors in order to adopt web page quality to a profile of destination visitors. this paper analyses online marketing concepts as new tools and processes that enable customer relation systems and ensure an interactive approach to potential customers. the fundamental empirical research was based on 11 croatian destinations, both inland and coastal types, in order to analyse and identify levels of standardisation in online marketing quality. the focus was on the official local tourist board sites as destination tourism organisations. destinations included in the research were: zagreb, split, dubrovnik, opatija, osijek, zadar, šibenik, varaždin, plitvice, hvar and rijeka. it is confirmed that the web structure did not meet the requirements of modern tourists according to the selected categories. for example, the šibenik official page is written only in the croatian language. furthermore, it is found that in addition to a non-existent domain policy, there is no commonly accepted visual identity that would be followed. the platforms of the web sites do not have a common system or tool. the evaluation indicates that only zagreb's site offers a direct booking engine which proves that the destination is in line with the modern trends of online marketing. there is a strong, positive and statistically significant connection between the quality of internet pages of chosen tourist destinations and the number of tourist arrivals in that destination. from the web designers perspective, this research should help in the future web site development process in order to define the business objectives, context and key scenarios of use. key words: tourism market, new technologies, online marketing, destinations, quality, standardisation introduction tourist and hotel companies need to present themselves in modern business as „smart organisations” which mobilise resources (open information flow, disciplined decision 1preradovićeva 1/1, email: jasminagrzinic@efpu.hr economic analysis (2013, vol. 46, no. 3-4, 125-140) 126 making, alignment & empowerment), understand the environment (systems thinking, embracing uncertainty, outside-in strategic perspective), achieve purpose (continual learning, value creation culture, creating alternatives). these nine „smart organisation” factors form a base for the making of high quality strategic decisions. (matheson & matheson, 2001). marketing and promotion form is an important part of the quality of a tourist product. a company whose services fulfil fundamental tasks associated to users, consumers or clients will be perceived by a website visitor as a company which provides quality services. (ozretić, 2002). there is a need for different financial mechanisms in order to fit market requirements. besides their own investments in marketing and promotion, tourism participants should be supported at a local level by investment by local authorities in order to gain coordinated marketing activities. activities should not be individual and unbalanced, but they should be a part of an organised and coordinated overall destination market performance. it is crucial to create transparent marketing as well as a system of return of marketing investment through continuous evaluation and monitoring in order to enable the optimal balance of marketing activities. tourism provides a unique set of circumstances in which firms have an incentive to cooperate to promote the destination but compete to promote them. (richie, 2002). the modern tourism market concept has consequently been facing a rather dynamic and continuously changing organisational and conceptual background which is mostly recognised through: (european commission, 2002). • change of system towards market economy, • change of market from mass to experience, • change of product – ever greater adjustment to demand, • new sales and distribution channels and systems, • new technologies and operating standards. destinations seen through the market category should follow market changes in order to ensure a stable market position as well as a solid platform for the complete travel experience to clients. today’s tourists are prepared to use new services for the reasons of practicality of travel booking from their own homes, cost reduction, lack of time and formal planning, as well as the impalpability of services in tourism (goh, et al., 2010, dimanche & jolly, 2009, davidson & burgess, 2006, buhalis & jun, 2011). research shows that a modern traveller visits almost 26 destination web sites before they commit to purchase of a holiday. furthermore, almost 2/3 of travellers tend to get very detailed information on the product (such as location, service level or specific points of interest) before a travel decision is taken and almost 71% of the potential clients follow a tv or press advertisement by an online search of product details. this information significantly emphasises the importance of the new sales and promotion tools and involves very indicative information on a modern traveller. (cf. trittschuh: 2012, international conference future hotels). the travel process is rather complex and begins not with the purchase of a tourist product or travel itself, but with getting information about the destination and ensuring the quality of the first phase of the process (avelini holjevac, 2002). destination management organisation (dmo) is an organisation which enables tourism bodies, coming from both the public and private sectors, to coordinate cooperation with local gržinić, j. et al., competitiveness of croatian destinations, ea (2013, vol. 46, no, 3-4, 125-140) 127 authorities in order to provide the best possible result for destination’s visitors. the aim of the dmo includes better usage of the destination’s existing resources though the involvement and cooperation of different stakeholders in order to achieve possibilities for long term competitiveness. the local destination management organisation is therefore responsible for management and/or marketing of a limited area or destination. the marketing concept should be thoroughly planned, using appropriate promotional channels in line with the necessary investment criteria as well as the best possible market result. additionally, the marketing concept should be followed by an adjusted and coordinated destination offer as well as communication with the visitor before and after the visit, but especially during the visit to the destination. a lack of quality in any of the mentioned travel process stages will result in lack of quality in the entire tourism product chain. marketing investments should be directed to those markets that can generate visitors with medium and higher purchasing power as well as shorter and more frequent visits with a focus on the special interest segment. that means that the tourist traffic can be spread across a longer period of the year with the content adapted to a very specific type of visitor. the focus of the entire destination offer should be placed on the content, animation and event organisation which gives a new dimension to a destination product and generates an economic and wider aspect of other benefits to a wide variety of stakeholders. the destination’s marketing message must be creative and clear and should reflect the idea which needs to be conveyed. the internet, as a marketing tool, has ensured new distribution possibilities, reduction in personnel costs and penetration into new markets. (chaffey, 2009b). it is predictable that the number of services available online will continue to grow every year, not only in order to provide clients with more services, but also to keep up with the competition. (bevanda, gržinić, & červar, 2008). it is noted that, on web pages, higher priority is given to informing the visitors rather than to the entertainment content, with the aim to accelerate the decision making process, i.e. channel communication towards the sales (costa, 2001). the largest part of the funds within the it application in tourism business is placed in advertising. (dore & crouch, 2003), while often neglecting the quality (frew, 2000). a quality chain is complex and creating a first image of the destination is the first element in ensuring the integrated quality of a travel process. in a modern technology era there are several points to be taken into consideration while trying to ensure quality in all aspects, from promotion to delivery of a tourism product and post communication. in short, the intellectual component of destination management now rivals the action component in significance. (richie, 2002). there is a need to support the marketing process with increasingly sophisticated destination marketing information systems (dmiss) (sheldon, 1997, sussman, 1994). online marketing and promotion represent a growing element of influence of purchase theory. marketing goals begin to be fulfilled by implementation of digital technologies. (chaffey, 2009a). some of the website selection criteria are: server and web technical characteristics, usability and accessibility, content quality and presence on the internet (ružić, biloš, turkalj, 2009). several authors (park & gretzel, 2007, gonzales & palacios, 2004) indicated the existence of the different relative importance of each web site quality factor across e-business economic analysis (2013, vol. 46, no. 3-4, 125-140) 128 domains and between stakeholders. they also found the correlation between web site quality and e-business performance. a web site with the highest quality produced the highest business performance. therefore there is a need to constantly monitor users’ behaviour and their requirements in different e-business sectors towards better web site design (lee & koza, 2006). vrkić (2003) suggests that tourist destinations should be connected with the market by means of the internet and quotes the following methods: internet marketing applications, audience, information sources and internet pages. web page design guidelines often offer the same advice for all types of web sites, regardless of their purpose (susser & ariga, 2006). tourism companies and hotel structures tend to follow the market trend carefully and adjust their sales and promotion activities to the demands of a modern market. there is a continuous introduction of new tools and processes which facilitate customer relation systems and ensure an interactive approach to potential customers. destinations, seen through market categories, should follow as the model of consumer behaviour changes: • new entrance points such as modern tablet technologies, smart phones and pc’s, • social media tools (twitter, facebook etc.), • online magazines. the development of icts and particularly the internet has empowered the „new” tourist who is becoming knowledgeable and is seeking exceptional value for money and quality time. they are less interested in following the crowds on packaged tours and much more keen to pursue their own preferences and schedules. (buhalis & law, 2008). web offers as opposed to traditional information distribution channels increase purchasing power and decrease the power of business internet subjects. the research conducted by the internet company for design and development genex among american consumers points to clients’ impressions related to the design of web pages of the search requirements. upon the arrival of surfers on the pages, the first impressions pertinent to the design of those pages are the most important; low prices and/or famous product brand names do not mean anything if the design and usefulness are missing and 30 percent of the surveyees believed that the page design is more important than the products offered for sale. (peters, 2003, beuchert & malek, 2011, cho & youn-kyung, 2012). according to plenković et al (2006), what web pages should (or should not) look like, the most important recommendations being: • content should be placed on each page, • individual web pages should contain 25-50 percent less information than corresponding paper pages, because reading from a screen is 25 percent slower than reading from paper, • web pages should use larger letters than paper pages. the web design quality research on specific tourism industry issues have not reached a consensus on what makes a tourism site effective (susser & ariga, 2006). web designers, especially in the tourism field, have a difficult job which requires a lot of effort, creativity, originality and which, above all, has to result in a „catchy” page that will attract the user of tourist services more than a page from the competition. the importance of a simple but attractive look of a web page is one of the key factors to a successful tourist organisation business (yuan, et al., 2003, kaplanidou & vogt, 2006). a survey of previous research in this field has shown that web site evaluation studies tend to rely on expert assessments or gržinić, j. et al., competitiveness of croatian destinations, ea (2013, vol. 46, no, 3-4, 125-140) 129 predetermined benchmarks and on the tangible aspects of a web site rather than on consumer’s options. perceived usefulness was a key predictor of users’ attitudes towards using hotel-owned web sites, while perceived ease of use was a key predictor of users’ attitudes towards using third-party web sites. (park & gretzel, 2007, dulčić, petrić, 2008, morosan & jeong, 2008). research hypothesis destination internet pages, strategy marketing and destination tourism strategy must be closely linked. the main hypothesis of the article is that the information structure on internet pages and their mutual connection are a dominant activity of dmo internet page creation. web designers especially in a tourism field, have a difficult job to conceive a web page that will attract the user of tourist services more than a page from competition. there is the lack of effort, originality and creativity in croatian web tourism presentation. the most pages are not user friendly, they are both confusing and outdated. the destinations of osijek and šibenik are not only not being updated, but all the subpages are technically inactive. on the other side, stronger, positive and statistically significant connection exists between the quality of the internet pages of chosen tourist destinations and the number of realised overnights in that destination. in croatia, we distinguish six types of tourist internet pages, namely: (ružić, biloš, turkalj, 2009): • company internet pages, • reservation internet pages, • destination tourism pages, • tourist mega internet pages, • tourist search pages and information catalogues, • tourist information services. zeithaml, parasuraman and malhotra (2002) have developed a conceptual model for evaluation and improvement of electronic service quality, which now consists of the listed criteria: information and content accessibility, simplicity of use, security/privacy, site aesthetics/graphic design, efficiency and reliability, assurance/trust, price knowledge, personalisation. the world tourist organisation takes into consideration 5 categories of web page quality evaluation (table 1). (unwto, 2008). table 1. evaluation factors key factors description information level of the destination web site shows balance of quantity and quality of information about the destination as well as how well organised and presented the information is level of accuracy shows accuracy of information provided, i.e. whether they are true and valid (updated) level of consistency shows compliance of subpages to a home page economic analysis (2013, vol. 46, no. 3-4, 125-140) 130 key factors description in terms of information, visual identity and accuracy type and quality of interaction with visitors shows the level of interaction tools for visitors: interactive maps, booking platforms, applications etc. value of visual identity visual attractiveness of the web site research was conducted in the period from march to may 2012 and the results are indicative for a subject of this paper in order to ascertain if destinations utilise modern technology tools as innovation to secure the integrated quality of their products in all phases. the focus was on the official local tourist board sites as the tourism carriers of a destination. destinations included in the research were: zagreb, split, dubrovnik, opatija, osijek, zadar, šibenik, varaždin, plitvice, hvar and rijeka. in order to estimate the mentioned quality the likert five-point scale was applied, with point 1 being the lowest and point 5 being the highest evaluation point. even though the period of the research was relatively short, it can represent an indicative result from which significant conclusions can be made. methodology in this paper, five evaluators, tourism experts, graded the web page quality. the grades ranged between 1 and 5, where 1 was the lowest grade and 5 the highest grade. each evaluator awarded a grade for a specific quality aspect of each of 11 destinations (category evaluation). the evaluated categories were as follows: • web level grade, • change/upgrade frequency grade, • web page accuracy grade, • subpage consistency grade, • interaction quality grade and • visual identity grade. all the sites were evaluated with the same procedure, with the same order of subpage evaluation and an equal period of time for each web page in order to ensure objective conclusions. evaluation of the site was complete only after every subpage was surfed through. descriptive data analysis of internet page quality the grading results are expressed in descriptive indicators in tables 2 and 3. the web page quality of 11 evaluated destinations in croatia varies between the lowest average of 2.84 (varaždin) and the highest average of 4.20 (zagreb). if we designate the grade 3 as the quality minimum, then two destinations (varaždin and osijek) did not satisfy that minimum, while the remaining nine destinations, did. the average grade of all the 11 destinations for all six evaluated categories is 3.43. gržinić, j. et al., competitiveness of croatian destinations, ea (2013, vol. 46, no, 3-4, 125-140) 131 table 2. average grades of web page quality of evaluated destinations no. destination average grade 1. zagreb 4.20 2. split 3.07 3. dubrovnik 3.92 4. opatija 3.81 5. osijek 2.95 6. zadar 3.90 7. šibenik 3.01 8. varaždin 2.84 9. plitvice 3.40 10. hvar 3.43 11. rijeka 3.19 total 3.43 by the kolmogorov-smirnov test, it was determined that the grades in specific evaluated categories were not distributed normally (p<0.001). therefore, the arithmetic means (averages) are not adequate mean values, they are median and mode. however, in order to more precisely express the mean value and for the purposes of further analyses, the arithmetic mean has indisputable advantage. certain destinations’ achieved average grades (arithmetic means) are illustrated graphically, by simple columns (graph 1), while the destinations in the graph are listed according to the height of the average, from the highest to the lowest. in the first evaluated categories, the median is 4 and, in the last evaluated categories, it equals 3. this means that half of the destinations were awarded the grade 4 and less and the second half of the destinations, grade 4 and higher in the following categories: • web level grade, • change/update frequency grade, • web page accuracy grade and • subpage consistency grade. it can also be said that half of the destinations were awarded the grade 3 and less and the other half of the destinations were awarded the grade 3 and higher in the following categories: • interaction quality grade • visual identity grade. economic analysis (2013, vol. 46, no. 3-4, 125-140) 132 graph 1. rank list of web page quality average grades of evaluated tourist destinations in croatia in may 2012 the modal (the most frequent) values are similar to the medial values. these two types of mean values coincide in all categories, except in the category of interaction quality grade. when considering average grades by specific categories, then all the evaluated categories, apart from the interaction quality grade, have satisfied the aforementioned minimum of 3. in table 3, all the three types of mean values are stated in order to compare them according to specific evaluated categories. table 3. web page quality average grades by evaluated categories destination web level change upgrade page accuracy consistency interactive quality visual identity average zagreb 4.6 5.0 4.6 3.4 4.2 3.4 4.20 split 3.4 4.0 3.0 2.8 2.2 3.0 3.07 dubrovnik 4.4 4.5 4.6 3.4 3.6 3.0 3.92 opatija 3.4 4.25 4.4 3.8 3.4 3.6 3.81 osijek 3.0 3.5 3.2 2.6 2.0 2.4 2.95 zadar 4.0 4.0 4.2 3.8 3.4 4.0 3.90 šibenik 3.0 3.25 3.0 3.0 2.6 3.2 3.01 varaždin 2.6 3.25 3.2 3.0 2.2 2.8 2.84 plitvice 3.8 3.0 4.2 4.0 2.8 2.6 3.40 hvar 3.2 3.75 4.0 3.8 3.0 2.8 3.43 rijeka 3.2 3.75 3.2 3.2 3.0 2.8 3.19 average grade 3.51 3.84 3.87 3.35 2.95 3.05 3.43 median 4 4 4 4 3 3 1 1.2 1.4 1.6 1.8 2 2.2 2.4 2.6 2.8 3 3.2 3.4 3.6 3.8 4 4.2 4.4 zagreb dubrovnik zadar opatija hvar plitvice rijeka split šibenik osijek gržinić, j. et al., competitiveness of croatian destinations, ea (2013, vol. 46, no, 3-4, 125-140) 133 destination web level change upgrade page accuracy consistency interactive quality visual identity average mode 4 4 4 4 4 3 standard deviation 0.979 0.939 0.982 1.058 1.268 0.989 1.036 variation coefficient 28 24 25 32 43 32 30 the grade variability is average in all evaluated categories, given that the variation coefficient ranges between 24% and 43% (on average it is 30%). in the category of interaction quality grade, the evaluators were the least united (the variation coefficient is 43%). correlation analysis of data on quality of internet pages of chosen tourist destinations it is expected that there is a correlation between the quality of the internet pages of 11 chosen destinations as an independent variable (x) and the number of tourist arrivals in that destination, as well as the number of tourist overnights in that destination (y). table 4. internet page quality grades, number of tourists and number of overnights in chosen tourist destinations destination average grade number of tourists (in 000) number of overnights (in 000) zagreb 4.20 603.8 969.5 split 3.07 234.0 749.1 dubrovnik 3.92 568.0 2098.1 opatija 3.81 285.2 920.8 osijek 2.95 31.5 66.3 zadar 3.90 250.7 967.4 šibenik 3.01 195.5 1076.4 varaždin 2.84 19.3 42.9 plitvice 3.40 162.8 216.7 hvar 3.43 100.2 457.2 rijeka 3.19 210.0 265.6 source: prepared by the author according to croatian bureau of statistics, http://www.dzs.hr for this, average quality grades obtained in this research can be of use, as well as official data on the number of tourists and number of overnights in the quoted destinations in the year 2012 (table 4). the stated connections are graphically shown (graph 2 and graph 3). economic analysis (2013, vol. 46, no. 3-4, 125-140) 134 graph 2. graphic illustration of the correlation between average grades of web page quality and the number of tourist arrivals for the 11 chosen destinations graph 3. graphic illustration of the correlation between average grades of web page quality and the number of tourist overnights for the 11 chosen destinations there is a strong, positive and statistically significant connection between the quality of internet pages of chosen tourist destinations and the number of tourist arrivals in that 0 200 400 600 800 1000 1200 1400 1600 1800 2000 2200 2400 2.7 2.9 3.1 3.3 3,.5 3.7 3.9 4.1 4.3 web page quality average grade number of tourist overnights in thousands 0 100 200 300 400 500 600 700 2.7 2.9 3.1 3.3 3.5 3.7 3.9 4.1 4.3 web page quality average grade number of tourist arrivals in thousands gržinić, j. et al., competitiveness of croatian destinations, ea (2013, vol. 46, no, 3-4, 125-140) 135 destination. the proof lies in the spearman’s correlation coefficient of 0.84, which is statistically highly significant (p = 0.001). a stronger, positive and statistically significant connection exists between the quality of the internet pages of chosen tourist destinations and the number of realised overnights in that destination. the proof for this is spearman’s correlation coefficient of 0.66, which is statistically significant (p = 0.026). discussion summary of findings it is found that in addition to a non-existent domain policy, there is no commonly accepted visual identity that would be followed. the platforms of the web sites do not have a common system or tool. detailed research results are analysed in the following text. information level of the destinations' website it is found that the tourist boards of zagreb, zadar and dubrovnik keep a high level of information on their web sites, providing clear indications of the most important information that potential visitors should receive. on the other side, research shows that the site of the destination of rijeka does not contain any useful information a modern visitor would expect and the site content is not inviting to the potential audience. it is important to further note that the šibenik official page is written in the croatian language only which, if we compare this fact to the main emissive markets, indicates a lack of market focus. osijek's site provides a choice of only 2 languages – croatian and english. this fact indicates the need to define the top emissive markets for the destination in order to adjust online content to the specific segments. level of accuracy the evaluation indicates the most common mistakes such as grammar mistakes, misspelling, translation errors; e.g. the destination of osijek does not have the same home page in both offered languages, or the destination of split has an updated site version only in the english language, despite the presence of other languages, which leaves the impression of negligence and unprofessionalism. level of consistency the evaluation shows that there is a significant lack of quality in this segment. the destinations of osijek and šibenik are not only not being updated, but all the subpages are technically inactive. the pages are not user friendly, they are both confusing and outdated. even though the average grade for the destination of zagreb is relatively high, translation of daily updates of sites is done only in the english language. considering the new and growing emissive markets that tend to visit this destination, it is widely recommended to have a continuous translating service for all subpages. economic analysis (2013, vol. 46, no. 3-4, 125-140) 136 type and quality of interaction research shows that only a few destinations hold modern interacting tools such as interactive maps, social network connections or a main tool such as a booking platform for example, only zagreb's site offers a direct booking engine which proves that the destination is in line with the modern trends of online marketing offering a client a direct connection to suppliers. further, dubrovnik offers a booking platform only for its hotels and camps. value of visual identity the results represent the realistic value level of visual identity with a few destinations which hold extremely low grades in this category such as osijek, šibenik and rijeka. it is important to note that the destination of plitvice is graded as a very informative web site, yet the visual identity is recognized at a very low level. it is important to balance and standardise the quality level with all the categories of the research. limitations and future research directions it was found that there is a need to further invest into visual identity along with securing a consistent quality level throughout the entire web page, but the most worrying value belongs to introducing modern interacting tools that are not widely accepted by the destinations examined. there is a high need for adjustment as well as coordination of online activities with local and national respective quality and development strategies. the model of consumer behaviour has been widely changed and only a systematic approach and complex overview of the problem can result in long term consistency. the travel process begins with an online search for a product, research of the key elements that can create a desire to travel and to motivate a consumer to make a purchase. the online presentation of a destination should be determined by simplified online content with a high level of consistency, accuracy and attraction. form and content count, therefore more elements are crucial: • images presenting the destination must be taken professionally, • layout should be functional, • design should be modern and fitting the «destination feel», • material should be informative, • web site engine should be solid, • atmosphere of the website should create desire, • materials should be updated regularly, • added value should be incorporated, • it should be adjusted to modern tools like smart phones, social media platforms, • memberships and affiliations, • booking engines, • website should have sales approach, • materials should be interactive, • attention to detail, gržinić, j. et al., competitiveness of croatian destinations, ea (2013, vol. 46, no, 3-4, 125-140) 137 • analytical side of the page (to find out about visitors, what they research, where they checkout and how to visit the page). visitors to croatian destinations are mostly very loyal visitors. they have been coming to croatia for generations and loyalty programmes should be implemented in agreement with the destination stakeholders. web site presentation should encourage a desire to visit, try local products, participate in local activities and to enter the destination. every detail should be planned and should come with a story. the web site should be adjusted to different market segments (business travellers, families, young couples, children, pensioners). the web page should be adapted to a profile of destination visitors. if the average stay is 7-10 days, programmes on the site should be created to match the criteria offering added value to clients. the page must be interactive and good practice examples should be encouraging new visitors and bad comments should be treated properly to minimise negative impacts. databases should be renewed and updated continuously. quick connection to skype and telephone contacts should be adopted to follow global online trends. visitors should be able to leave comments, post photos, connect to social networks and share information. certain destinations acknowledged that the personal approach is not to be underestimated, so they provide customer service at „happy hour” times with an online support and information service. this practice should be considered. all these facts imply that the gap between croatian destination presentations and european benchmark models is huge and a serious turn should be taken. destinations interact in the modern tourism market and perform as business units offering different tourism products to different market segments. to ensure their competitiveness in a continuously demanding environment, modern market rules should be applied. in order to ensure quality at each level of the tourism product, the quality of the destination's online presentation, as the first phase of travel, should not to be neglected. this paper represents the results of the survey on whether croatian destinations follow modern marketing trends and what quality level is achieved among croatian destinations in regard to online marketing. the results show that there is a big lack of quality in their online activity and that the average value is significantly low. tourist destinations with quality sites (eg dubrovnik and zagreb) have more visitors, as opposed to destination with lower quality sites (eg osijek and varaždin). the quality of a website is not a critical factor that determines the number of visitors, but it is (as evidenced by these correlation coefficients) indicative. that being said, there are fundamental changes which should be made at both organisational and political level. it is recommended that further authors' researches include some of the following points: • who should be the main carrier/leader of destination marketing and branding? • is there a need to standardise online marketing rules for croatian destinations? • does standardisation necessarily imply creativity limitations? • how to monitor whether the quality of the presented content corresponds to high quality delivery in the destination etc.? this research is indicative as an overall evaluation of the investment, creativity and update of the destinations, but it will be further analysed from the perspective of the background and organisational and political frame of the needed changes. economic analysis (2013, vol. 46, no. 3-4, 125-140) 138 references avelini holjevac, i. 2002. upravljanje kvalitetom u turizmu i hotelskoj industriji. opatija: fakultet za turistički i hotelski menadžment. bevanda, v., gržinić, j., and červar, e. 2008. „analysing the 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savremenom turističkom tržištu vezano za kvalitet online prezentacije. svetska turistička organizacija (unwto: 2008) sugeriše procene kategorije kvaliteta web stranica i to: nivo informiranosti, izmene, tačnost, doslednost, interakcija, identitet. razvoj zahteva dizajn procesa koji se orijentiše prema korisniku sa stalnom evaluacijom razvoja. cilj ovog istraživanja je istražiti kvalitet web stranica kako bi se ostvarilo prilagođavanje profilu gosta destinacije. u radu se analizira kvalitet web stranica kao novih alata koji obezbeđuju interaktivni pristup potencijalnim kupcima. istraživanje obuhvata 11 hrvatskih odredišta, obalnih i kontinentalnih, kako bi se analizirao i utvrdio nivo standardizacije kvaliteta online marketinga. fokus istraživanja su službene stranice turističkih zajednica zbog njihove funkcije destinacijskih menadžment kompanija. odredišta uključena u istraživanje su: zagreb, split, dubrovnik, opatija, osijek, zadar, šibenik, varaždin, plitvice, hvar i rijeka. potvrđeno je da web struktura ne ispunjava zahteve savremenih turista po izabranim kategorijama. primjerice, web stranica destinacije šibenik daje informacije samo na hrvatskom jeziku. osim toga, utvrđeno je da pored nepostojanja zajedničke domene ne postoji opšte prihvaćen vizualni identitet koji će se pratiti. platforome stranica nemaju zajednički sistem ili alat. procena ukazuje da samo web stranica zagreb nudi direktan buking, što dokazuje da je destinacija u skladu sa savremenim trendovima online marketinga. postoji jaka, pozitivna i statistički značajna veza između kvaliteta internet stranica odabranih turističkih destinacija i broja dolazaka turista u te destinacije. iz perspektive web dizajnera, ovo istraživanje bi trebalo da pomogne u budućem procesu razvoja, kako bi se definisali poslovni ciljevi, kontekst i bazni scenariji korišćenja. ključne reči: turističko tržište, nove tehnologije, online marketing, destinacija, kvalitet, standardizacija. article history: received: 3 july 2013 accepted: 29 september 2013 ea_2014_1-2 udc: 007:004]:336.71 jel: g21, o3 id: 207714060 scientific review the impact of it on the banking productivity jevtić boris1, raf, belgrade, serbia kovačević vladan, tehnicom, belgrade, serbia, vučeković miloš, singidunum university, belgrade, serbia abstract – there has been much debate on whether the investment in information technology provides improvements in productivity and business efficiency of banks and, weather the usage of the opportunities of digital technologies to better serve customers and achieve firm goals the proliferation of technologies offers vast new opportunities. this paper investigates the impact of ict capital on productivity in banks. for the analysis, data from various research reports, and reliable studies on banking efficiency and productivity and digitalization of their services are employed. the results obtained shed some light on the relative impact of ict capital, and provide new insights about the structural dynamics between these factor inputs. we find that the banks as financial service sectors in developed countries are quite similar in terms of efficiency, and that efficiency and productivity depends more and more on ict capital. although, the financial services industry and banks in particular increasingly invest in technologies to improve their online banking and more recently their mobile payment solutions, the serbian case, as banking sector in transition countries, shows slower implementation of new digital trends in operational activities of the banks. at the same time, banks use tools such as social networks, digital tools kits, online competitions, online advertising campaigns, mobile apps, location-based services and online market research to connect with customers. the paper also provides an overview of digital trends in general and the banking industry in particular and best practices how digital media tools are helpful to achieve marketing goals, and ultimately generate higher revenues at lower costs. the contribution of the paper can be seen also in: deeping the understanding of (stationary and mobile) digital technologies in the marketing tool box; further exploring the digital landscape and the types of digital customers in the banking industry, and in discussions the cases of the introduction of a mobile payment system key words: serbian banks, financial crisis, productivity, ict, digitalization introduction the banking industry world-wide is being transformed. the global forces for change include technological innovation; the deregulation of financial services at the national level and opening-up to international competition; and equally important changes in corporate behaviour, such as growing disintermediation and increased emphasis on shareholder value. in addition, recent banking crises have accentuated these pressures. the banking industries in central europe and south east europe have also been transformed as a result of 1 doctorial studies, tadeusa koscuska 86, belgrade, email: boris.jevtic10@gmail.com economic analysis (2014, vol. 47, no. 1-2, 193-204) 194 privatisations of state-owned banks that had dominated their banking systems in the past. with the increasing use of standardized products and services in the banking business that are based on electronic risk ratings of customers, the banking industry increasingly utilizes computers and telecommunication equipment connected via the internet as the ordinary distribution channel of their services. ranging from online brokerage and home banking to electronic insurance contracts, information and communications technologies (icts) have changed the financial service industry significantly over the past decade. banks that deploy technology more successfully to get more from the higher-quality knowledge employees they attract will gain large business model advantages—and drive substantial growth and productivity gains. in further table is showed executives weighting in on the major developments that will be important for business over the next five years, employing. information streams as the infinite by-product of a knowledge economy, and support the idea that the best companies will turn this free good into gold. table 1. the impact of global forces on business,( % of executives who mark the force), 2010 forces reshaping the global economy is important for business with the positive effect on profits is being actively addressed by their company the great rebalancing 85 48 72 the productivity imperative 57 40 58 the global grid 61 41 68 pricing the planet 48 23 51 the market state 57 39 29 source: source: mckinsey global forces survey of 1,400 executives, 2010 a final productivity driver will be something businesses are creating in digital bucket loads: information. although the volume of data created is expected to increase fivefold over the next five years, best-guess estimates suggest that less than 10 percent of the information created is meaningfully organized or deployed. to sustain wealth creation, developed nations must find ways to boost productivity; product and process innovation will be the key. the banking industry exhibits the highest proportion of it investment compared to all other industries after 1995 (for the us see e.g. council of economic advisors, 2001, for the eu see eito, various yearbooks 1996 until 2001). the financial service industry will only be able to grow steadily in the future by innovations in terms of new financial services. while automatic teller machines and credit cards were the early enablers to reduce the need for front-desk service workers, such as cashiers etc., the pervasiveness of the internet provides the opportunity to offer and use ubiquitous financial services from virtually everywhere. a particularly attractive option is the conduct of financial transactions via mobile communications devices. this transformation process has not been completed yet, so that one might expect that there is a still on-going labour-saving process that could last well into the nearand even mid-term future. jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 195 in this paper is investigated the impact of ict capital, and labour input at different skill levels, on aggregate productivity and employment in the financial intermediation sector. literature overview several studies over the years have been conducted at both the industry and firm-level to examine the impact of it on productivity. there has been much debate on whether or not the investment in information technology provides improvements in productivity and business efficiency. firm-level studies, primarily in the manufacturing sector, have shown that there are significant positive contributions from it investments toward productivity. using data collected through a study of retail banking institutions in the united states, it could be concluded that additional investment in it capital may have no real benefits and may be more of a strategic necessity to stay even with the competition. however, the results indicate that there are substantially high returns to increase in investment in it labor, and that retail banks need to shift their emphasis in it investment from capital to labor. brynjolfsson (1993) and wilson (1993) provide reviews of this literature on the business value of it. some studies have drawn on statistical correlation between it spending and performance measures such as profitability or stock value for their analyses (dos santos et al. 1993, strassman 1990), and have concluded that there is insignificant correlation between it spending and profitability measures, implying thereby that it spending is unproductive. brynjolfsson and hitt (1996), however, caution that these findings do not account for the economic theory of equilibrium which implies that increased it spending does not imply increased profitability. the researches which have been drawn upon the economic theory mostly use a technology or production function which relates the output of a firm to its inputs and contribute significantly to the establishment of the “it paradox” with the industry-level studies of the midand late 1980s; this “paradox” indicated a negative correlation between it investments and productivity. more recent firm-level studies, however, paint a more positive picture of it contributions to productivity. these findings raise several questions about miss-measurement of output by not accounting for improved variety and quality, and about whether it benefits are seen at the firm level or at the industry-level. such issues have been discussed in brynjolfsson (1993), and to a lesser extent in brynjolfsson and hitt (1996). one illustration of the industry-level studies is that of morrison and berndt (1991), which found that in the manufacturing industry, “estimated marginal benefits of investment in it are less than marginal costs, implying over investment”. of late, the increased availability of firm-level data has led to several other studies which report results different from those found in industry-level studies. loveman (1994), for example, using data from the management productivity and information technology database in a cobb-douglas production function framework, concludes that for the manufacturing firms included in his study, there is no significant contribution to output from it expenditure. lichtenberg (1995), on the other hand, concludes that there is significant benefit from investment in it. for his analysis, he draws data from annual surveys conducted between 1988 and 1991 by information week and computer world magazines. using a cobb-douglas production function, he estimates that there are “substantial excess returns to investment in computer capital” and further, that one information systems employee is equivalent to six non-is employees in terms of marginal economic analysis (2014, vol. 47, no. 1-2, 193-204) 196 productivity. the latest in this trend of research is brynjolfsson and hitt (1996) and hitt and brynjolfsson (1996). brynjolfsson and hitt (1996) use data from two sources: the dataset compiled by the international data group, and standard and poor’s compustat ii database. the idg data includes self-reported firm-level details of it expenditure collected annually. using this data in a cobb-douglas production function, brynjolfsson and hitt conclude that “computers contribute significantly to firm-level output.” in fact, they find that computer capital contributes an 81% marginal increase in output, whereas non-it capital contributes 6%. similarly, they show that is-labor is more than twice as productive as non-is labor. most of such studies relating to the contribution of it toward firm-level productivity have been restricted to the manufacturing industry, possibly owing both to a lack of data at the firmlevel in the service industry and perhaps, more significantly, the difficulty of unambiguously identifying the “output” of a service industry. the latter problem is particularly persistent in the banking industry, which is the focus of this study. as parsons, gotlieb, and denny (1993) argue in the banking industry, “the growth of output, and the measurement of productivity, is very sensitive to the choice of output. parsons, gotlieb, and denny (1993), in fact, is one of the very few studies that deal with the impact of it on banking productivity per se. they conclude from their estimation of data from five canadian banks using a trans log production function that, while there is a 1723% increase in productivity with the use of computers, the returns are very modest compared to the levels of investment in it. productivity of banks highlights the productivity and efficiency of banks critically impacts the productivity and efficiency of all economic activity and is a matter of concern for policy makers and economy watchers, while the banks form the core of a nation’s financial system, performing the vital function of financial intermediation through liquidity, maturity and risk transformation. the banking efficiency could be like highlighted as allocation and operational. allocational efficiency focuses on ensuring that the precious financial resources are allotted to the most productive activities as per development needs of society. it seeks to ensure that the broad national priorities are furthered through the process of resource allocation and that the interests of the most vulnerable sections are protected. operational efficiency means banks seek to provide financial services in a safe, secure, speedy and cost effective manner. the goal should be to ensure that the transformation function generates least friction in terms of time and cost overlays. these concepts of efficiencies have considerable inter-linkages and the challenge for banks is to ensure optimal performance on both fronts. technology in banking according to mckinsey institute (2013), as top retail banking trends could be seen further predictions: � drive-to-digital: impacting delivery, marketing and service usage � payment disruption: new players, technologies and innovations � increased competition: neo banks and non-traditional player pressures jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 197 � branch optimization: maybe not branchless, but certainly less branches � focus on customer 3.0: digitally astute, social and yearning for insight � breaking down silos: product and data silos begin to crumble � simplifying engagement: removal of friction and steps to engage � improving contextual experiences: leveraging data for improved service � differentiating brands: avoiding commoditization in a digital world � global innovation perspective: expanding view of tomorrow's innovations according to conventional wisdom, new information technology is not at present likely to impinge much on the development of the banking industry in the emerging economies, which remain technologically behind the industrial countries. for example, the low level of penetration in most emerging economies means that the internet is not seen as a threat to traditional banks. given the signs of a possible bursting of the e-banking .bubble. in the united states and europe, some have also argued that the issue of electronic banking may go away before the emerging markets need to worry about it. this conventional view can be challenged on several grounds. as noted above, the major issue about new it is its impact on the processing of information, which is the very essence of the banking business. perhaps the most significant innovation has been the development of financial instruments such as derivatives that enable risk to be reallocated to the parties most willing and able to bear that risk, thereby inducing more investment in real assets and fostering the development of banking and financial markets in general.4 the use of such instruments is not the preserve of industrial countries: � with their increasingly sophisticated it applications, banks in the emerging economies use new financial instruments daily in their transactions. their banking systems and financial markets are thus in a position to advance much more rapidly from a rudimentary to a fairly advanced stage of development of risk management and other commercial banking functions. such potential skipping of financial development stages would not have been possible in the past, when information processing technology was not readily available, and when the development of futures markets and other domestic financial institutions that enable unbundling and shifting of risks on a large scale was much more time-consuming and costly. � the potential for rapid development of commercial banking functions offered by alternative delivery channels such as atms, debit cards, telephone, internet and electronic banking should not be underestimated. despite the still low level of usage of such channels (with the exception of atms, which are now very widespread), the vast majority of banks in the emerging economies see such channels as a must for their industry. banks fighting for some important part of the retail market believe that they have to offer such services as an essential marketing tool, although the true demand for them has so far been limited. � in advanced economies, new technology is affecting the structure and performance of the banking industry in the emerging markets mainly through its impact on the costs and the determination of optimal scale. branch-based transactions are much more expensive than alternative delivery channels. this economic analysis (2014, vol. 47, no. 1-2, 193-204) 198 cost advantage would seem to favor smaller institutions, as investments needed to attract deposits or provide banking services via the internet are in principle lower than the costs of setting up a traditional branch network. at the same time, investments needed to develop adequate back office and risk assessment systems are very high, creating considerable cost advantages for larger institutions. moreover, branch networks are not expected to shrink as a result of the however, just because share prices of internet stocks fall, this does not mean that the impact of new technology on banking will disappear. table 2. costs of banking transactions (in us dollars) estimates by us department of commerce (1998) estimates by booz, allen & hamilton (1997) estimates by goldman sachs & boston consulting group physical branch 1.07 1.07 1.06 phone 0.52 0.54 0.55 atm 0.27 0.27 0.32 pc-based dial-up 0.11 0.02 0.14 internet 0.01 0.01 0.02 source: sato, hawkins and barentsen (2001) banks are increasingly losing their privileged access to information about investment opportunities, and are thus under pressure to merge or build alliances with domestic or foreign-owned banks and technology companies in order to share the costs and exploit the benefits of the development of new it applications. for retail banks, today’s markets are fraught with challenges: new digital competitors and digitally empowered customers prominent among them. yet most still pursue business as usual, striving to be all things to all customers. despite their best efforts to focus on the customer, many still don’t offer what their customers actually want. these banks also tend to manage their extensive channel networks—including digital—separately, and not as a holistic function impacting all aspects of their retail operation. according to the accenture report (2013, conducted online interviews with more than 2,000 us retail banking customers of the 15 most leading retail banks doing business in the us today. when asked how happy they are with the performance of their primary bank provider, 71 percent declared themselves “satisfied” and 68 percent said they would be “extremely likely” to recommend their primary bank to a friend, family member or colleague). this research, however, also reveals just how fragile this apparent customer loyalty really is. more than a quarter (26 percent) of bank customers who remain with their primary provider do so simply because they consider switching to be a hassle. among them, about half just haven’t seen competing offers compelling enough to make them move, and the other half believe the process of switching to another bank is just too difficult. this not only exposes the tenuous relationship banks have with their customers. it also confirms that the right offering and approach can induce them to switch. jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 199 industry newcomers have understood that in the post-financial crisis environment the most fundamental question in retail banking has changed from “how do you find your future customers?” to “how do new customers find you?” and they are leveraging their innate advantage as digital pure plays to deliver the speed, convenience and low-cost personalized service that today’s customers increasingly seek. traditional players, of course, also have an innate advantage—the extensive branch networks that customers still value, as our research confirms. but they cannot afford to ignore what the nimble new entrants are telling them: winning with digital in the future will be all about winning more satisfied and loyal customers with trusted, transparent and compelling offerings. and that means becoming an integral part of customers’ lives: an agile, ubiquitous presence, wherever those customers may be. in an era of industry consolidation, new entrants, expanding regulation, more onerous capital requirements, and continuing economic volatility, traditional retail banks urgently need a lower-cost operating model that can generate more predictable and sustainable revenues. indeed, if traditional providers don’t move swiftly and decisively to build such a model, they will lose more customers. the core challenge for traditional fullservice providers: how to build a seamless digital customer experience—and optimize its power with a better and more cost-effective complementary offering in the branches that customers still find so attractive. common characteristics of the emerging disruptors � emphasize social responsibility � focus on customer centricity and empowerment � present simpler fee structure to customers � provide personal financial management tools and access to other accounts � embedded with social media, especially facebook � leverage big data and analytics � offer mobile bill pay, p2p, remote-deposit, free atm access one source of concern related to new banking technology is the emergence of a digital divide in the access to banking services. according to this view, better educated and more affluent customers will be able to obtain improved service from banks through the internet over the medium term, while the services provided to poorer and older customers will deteriorate as branches are closed, particularly in remote areas. these concerns have led some policymakers to seek a continued role for the state owned commercial banks that maintain traditional, nationwide branch network. with the rapid expansion of ownership of smartphones and tablet devices, today's consumer wants to be able to research, purchase and manage their financial services on demand using the device(s) of their choice in virtually any location. reinventing the financial services purchase funnel, the way people conduct daily banking, the delivery of insight, and the interaction between channels, the drive-to-digital will provide both opportunities and challenges for financial institutions of all sizes. economic analysis (2014, vol. 47, no. 1-2, 193-204) 200 figure 1. emerging disruptors source: accenture report, 2013 in 2014, it is expected to be seen greater experimentation in new products and revenue build around mobile, web and social commerce, and the emergence of drive-to-digital competing with drive-to-branch. mobile and web have all been about brochure ware and transactional services to this point – finally we’ll start to see a concerted effort to revenue fulfillment digitally. there will be a realization that channels are owned by consumers, and not banks, and thus must meld into a digital experience that exists seamlessly regardless of channel or device. the silos of traditional retail delivery channels will begin to erode and a more holistic approach to a digital banking experience will take hold. in a mobile-first environment, banks will begin to support more complex types of functions and transactions on the small screen, new forms of authentication that better balance security and convenience, and more relevant, contextual information delivery via alerts, push notifications, and other forms of messaging. banks will also likely promote mobile banking to an older, more risk-averse cohort than in the past. the impact of ict on serbian banks productivity the efficiency of the serbian banks operations has an important bearing on overall economic health of the country. the serbian banking system which is 78 percent foreign owned in these where state capital is dominated has not succeeded in balancing allocation and operational efficiency focuses on ensuring that the precious financial resources are allotted to the most productive activities as per development needs of society. it seeks to ensure that the broad national priorities are furthered through the process of resource allocation and that the interests of the most vulnerable sections are protected. in the purpose jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 201 to support the usage of the it technologies in banks national bank of serbia has adopted the decision on minimum information system management standards for banks, (rs official gazette, 2013). for the purpose of this decision: • information system should be implemented as a comprehensive set of technological infrastructure (hardware and software assets), organization, people and procedures for the collection, processing, storage, transfer, presentation and use of data and information; information system resources would include software assets, hardware assets and information assets; software assets would adopt all types of system and application software, software development tools and other software and hardware assets would include computer equipment, communication equipment, data storage media, and other technical equipment supporting the functioning of the information system. • information assets in banks should be improved as data in files and databases, program code, configuration of hardware assets, technical and user documentation, internal regulations, procedures, with information system users authorized to use the information system (employees in a financial institution, employees in other entities accessing the information system of a financial institution, clients of a financial institution accessing the institution’s information system through electronic interactive communication channels). as information system risk is shown to be very high in state owned banks, the possibility of negative effects on the financial result and capital, achievement of business objectives, operation in accordance with regulations, and reputation of a financial institution due to inadequate information system management or other system weaknesses which negatively affect the system functionality or security, and/or jeopardize the business continuity of the financial institution, controls are proposed to design and monitor policies, procedures, practices, technologies and organizational structures relating to the information system and established to reasonably ensure that business objectives of a financial institution will be achieved and that undesired events will be prevented or detected. controls would differ by the implementation method (administrative, technical and physical) and purpose (preventive, detective and corrective). different type of controls in that process which would be provided mean; administrative controls means the adoption and implementation of policies, standards, plans, procedures and other internal acts, and the establishment of an adequate organizational structure, for the purpose of achieving and maintaining the adequate level of information system functionality and security; technical controls means controls implemented in hardware and software assets of the information system and physical controls are controls protecting the information system resources from unauthorized physical access, theft, physical damage or destruction; preventive controls means controls aimed at the prevention of problems and incidents; detective controls means controls aimed at the detection and recognition of problems and incidents, and the identification of problems and incidents which occurred; corrective controls means controls aimed at the limitation and elimination of problems and consequences of incidents. information system security would have to uphold the principles of confidentiality, integrity, availability, authenticity, accountability, non-repudiation and reliability as well as confidentiality of data and information not to be disclosed or made available to unauthorized economic analysis (2014, vol. 47, no. 1-2, 193-204) 202 persons. the integrity of data, information and processes would have to be better protected from unauthorized or unforeseen modifications, or that any such modifications do not remain undetected; availability of data, information and processes more available and usable on request of the authorized party; accountability would be upgraded so that each activity in the information system may be traced uniquely to its source. it has to support the faster electronic banking systems development which enable bank clients to use services offered by banks (access to financial information, electronic payment) from a remote location through electronic interactive communication channels (e.g. internet banking, mobile banking, telephone banking). greater efficiency in banking operations in serbian banks would have to ensure that the cost of financial intermediation is minimized. at a time when the global and serbian economy are facing challenges on multiple fronts, efficient financial intermediation would provide impetus to the process of economic recovery by channelizing funds to the most productive sectors at the improvement in productivity and efficiency, and the resultant decline in cost of providing financial services will help in furthering financial inclusion, although it seems to be very hard task, as banks don’t demonstrate the will to decrease the cost of their services very soon. more importantly, it will help in converting the improved access to financial services into improved usage. this improved usage will make the financial activities commercially viable for the banks and encourage them to scale up their initiatives. hence, banking productivity and efficiency has a direct impact on improving financial access and financial usage. the recent decline in economic growth has presented significant challenges to banks through rising impairment of assets, pressure on margins and volatility in noninterest income. in this demanding business environment, improved operational efficiency could help banks in standing up to the challenges and enable them to maintain their health and profitability. as banks form the core of the serbians financial system, the health and profitability of banks will help in ensuring stability and resilience of the entire financial system. thus, from a systemic stability perspective also, improved productivity and efficiency of the banking system is a definite positive. discussions and conclusion this paper has shown the importance of it capital in the overall productivity and profitability of the banking industry. the results of the research point to the need to continually invest in software and hardware capital in banks. this research can be extended in several directions. first, using data collected from us reports, eu reports and serbian banking system, analysis can be conducted as to what firm-level characteristics differentiate banks that use it better from those that do not. are there any business process-related parameters that make it use more productive in some cases, and not in some others? what can we say about human resource practices and work-organization, and how they affect the implementation and use of it? does the it capital budgeting process influence it contributions toward productivity and efficiency? how does the decision-making process about it investments affect the success of it implementation--do firms that employ “technology committees” to make it-investment decisions see better returns from it than jevtić, b., banking productivity, ea (2014, vol. 47, no, 1-2, 193-204) 203 those that rely on “pioneers” who promote it use in the firm? we will seek to explore these and other related questions in our future research. the serbian banking system, taken as an case in the paper, has seen important productivity improvements over the last two decades, bridging the gap with new private banks and foreign banks. however, the pace of progress has declined, largely due to lack of desired impetus. our banks have to strive towards closing this gap. banks’ gains in operational efficiency have, however, come at the cost of their allocation efficiency. the improved operational efficiency has been a result of technological progress and structural changes in balance sheet towards more wholesale business. the operational efficiency gains, though profitable for the banks, have not had the desired beneficial impact on the society as a whole, particularly the rural areas, individuals and small businesses. it can be concluded that the vulnerability of the banking system has increased on account of the imbalances arising from growth in operational efficiency without commensurate rise in allocation efficiency. references accenture report. (2013). banking 2020 thought leadership series benston, g.j., g.a. hanweck, and d.b. humphrey. (1982). “scale economies in banking: a restructuring and reassessment,” journal of money, credit and banking, 14:1 435-450. brynjolfsson, e.. (1993). “the productivity paradox of information technology,” communications of the acm, 35: 66-67. brynjolfsson, e. and l. hit. (1996). “paradox lost? firm-level evidence on the returns to information systems spending,” management science, 42: 541-558. dos santos, b.l., k.g. peffers, and d.c. mauer (1993). “the impact of information technology investment announcements on the market value of the firm,” information systems research, 4(1): 1-23. hitt, l. and e. brynjolfsson. (1996). "productivity, business profitability, and consumer surplus: three different measures of information technology value,” mis quarterly, june, 121-142. loveman, g.w. (1994). “an assessment of the productivity impact of information technologies,” in t.j. allen and m.s. scott morton (eds.), information technology and the corporation of the 1990s: research studies, mit press, cambridge, ma. morrison, c.j. and e. r. berndt. (1991). “assessing the productivity of information technology equipment in the u.s. manufacturing industries,” national bureau of economic research working paper 3582, january, parsons, d., c.c. gotlieb, and m. denny. (1993). “productivity and computers in canadian banking,” in z. griliches and j. mairesse (eds.) productivity issues in services at the micro level, kluwer, boston. sato, hawkins and berentsen. (2001) for an overview of developments in e-finance. bis papers no 4. economic analysis (2014, vol. 47, no. 1-2, 193-204) 204 uticaj it na bankarsku produktivnost rezime – aktualne su brojne diskusije o tome da li ulaganje u informacione tehnologije obezbeđuje poboljšanja u produktivnosti i efikasnosti poslovanja banaka, te da li korišćenje mogućnostii digitalnih tehnologija za u ciju boljih usluga klijentima i postizanja ciljeva banke, širenjem ovih tehnologija i pruža ogromne nove mogućnosti. ovaj rad ispituje uticaj ikt kapitala na produktivnost banaka. za potrebe analizu korišćeni su podaci iz raznih izvještaja, istraživanja i studija o bankarskoj efikasnosti i produktivnosti i digitalizacii usluga. dobijeni rezultati bacaju svetlo na relativan uticaj ikt kapitala, i pružaju nov uvid o strukturi dinamike između ovih faktora inputa . nalazimo, da su banke kao finansijski sector usluga u razvijenim zemljama veoma slične u pogledu efikasnosti, i da efikasnost i produktivnost zavise sve više ikt kapitala. iako industrija finansijskih usluga i banke povećavaju svoja ulaganja u tehnologije u cilju unapređenja elektronskog bankarstva i plaćanja, srpske banake, kao sektor zemalja u tranziciji, pokazuje sporiju primenu novih digitalnih trendova u operativnim aktivnostima banaka. istovremeno, banke koriste alate kao što su društvene mreže, digitalnih alata kompleti online takmičenja, online reklamnih kampanja, mobilne aplikacije usluge bazirane na lokaciji i onlajn tržištu istraživanja da se povežu sa kupcima. rad takođe daje pregled digitalnih trendova globalno ubankarskoj industriji, naglašva najboluu praksu i alate digitalnih medija u podršci marketinških ciljeva, većih prihoda sa nižim troškovima. doprinos rada može se videti takođe u: produbljavanju razumevanja (stacionarnih i mobilnih) digitalnih tehnologija u kao marketinških alata, upućivanju na dalja istraživanja digitalnih oblasti, vrstama digitalnih kupaca u bankarskoj industriji, i dalje diskusije dobrih primera uvođenja mobilnog sistema plaćanja. ključne reči: srpske banke, finasijska kriza, produktivnost, ikt, digitalizacija article history: received: 30 december 2013 accepted: 8 may 2014 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp36-47 original scientific paper development and implementation of the integrated marketing communications concept tatjana cvetkov čikošev1* 1 nis a.d., belgrade, serbia abstract understanding consumers’ needs implies creating an adequate offering, which leads to good and sustainable relations over time. consumers, under the influence of (new) technologies, change their habits, attitudes and behaviour in the usage of certain product or service as well as the way they communicate. analysis of the effects of created communication on the brand through developing imc model is the main objective of this paper. considering consumers’ demographic structure, not only the points at their path to purchase, usage or recommendation, the effects among different groups will be analyzed. questions that are important for this paper are about awareness of brands in the category, noticeability of certain ways of communication, and the influence of that communication on behaviour is measured. the goal of every communication is sales and repeated sales, but in that process potential users should be introduced to brand, create a need and want to use that brands, to be satisfied, loyal and be its ambassadors. beside usage of the results of primary research, desk method of collecting and analysing is also used, in order to have detailed insight of certain aspects that are related to the objective of this paper. the results of conducted research indicate that the implementation of integrated marketing communications leads to additional sale and better brand positioning, as well as company positioning in the market. additionally, effective integrated communications positively influence brand positioning and consumers ‘satisfaction is in positive relation with the repeated purchase of the brand. key words: integrated marketing communications, brands, positioning, customer experience, consumer behaviour jel classification: m31 introduction in today’s world, consumers, brands, and the media are changing, fundamentally some would say. those changes put marketers in front of many challenges. how we interact and how we communicate is directly under the influence of the technology and the internet and its development. with “epidemic” of new media, consumers change, and how they use and utilise different media sources, which consequently have influence on brand choice timing, place and way of choosing. consumers attention is divided, as they willingly (or not) multitask. consumers are not passive receivers of brand information, through so‐called traditional media, print or tv, which accumulate in their memory for usage once they need that information, as it was supposed before. they are now active seekers of information when in need – using all available * e‐mail: tatjana.cvetkov@nis.eu tatjana cvetkov čikošev 37 means ‐ different search engines, (mobile) browsers, blogs, forums, brand websites (porcu, del barrio‐garcia, kitchen, 2017). marketers are now, under the influence of these new ways of communicating, creating personalised content of the message, personalise time and location of conveying this message, and utilising more (as much as it is needed) media to achieve set communication objectives. the other side is more complex customer journeys and the focus on customer experience (domazet, stošić, lazić, 2018). customers may now have interactions with firms through multiple channels and media, almost countless number of touch points. the objective of this paper is to identify customer journey, critical touch points and adequate communication as an answer to it, that leads to profitable customer behaviour. the model of integrated marketing communication that is used as a base for this paper is presented as a conceptual framework. therefore the idea is to empirically test it on one brand, and try to answer some of the questions emerged in the original work. one of the issues are the effects of the communication, which option(s) is the best fit for achieving set goals on the customer journey (domazet, đokić, milovanov, 2018). or, how all the communication options may be integrated to maximise the effects. authors of the conceptual framework, batra and keller (2016), propose, among others, checking the role of brand web page, positive and negative sides, and if it works in growing trust and emotions. beside this, the paper is analyzing consumer behavior on the lubricant market, as well as outcomes of created communication. integrated marketing communication communication marketing communications are the means by which firms attempt to inform, persuade and remind consumers – directly or indirectly – about the products and brands they sell (kotler & keller, 2009). as shown in table 1, eight major modes of communication make the marketing communications mix: the first half of the table, advertising, sales promotion, events and pr, are considered as more mass media types of communications. the other half, direct marketing, interactive marketing, wom and personal selling are 1 on 1, more personal modes of communication (keller 2009). marketing communications is the narrator of the brand story, it tells or shows consumers the story about the product – where, when, how and why is used, as well as who is using it, the typical user. also, it tells a story about the company and their values. using the tools of marketing communications companies make relations of their brands and places, events, other brands, other people. experiences are created, feelings are provoked, and all other things attributed to the brand, company, product or service (domazet, 2012). beside aforementioned, marketing communications can build communities, both online and off‐line (faškova & kretikova, 2015). table 1. major communication types (1) advertising –promotion of ideas, goods or services by an identified sponsor in any form that is paid and is not personal (2) sales promotion – the objective is to encourage trial or purchase of product, service, brand, supported by diverse incentives, for limited (short) time (3) events and experiences – in order to create interactions on daily basis or for special occasion firms design programs or sponsor different events (4) public relations and publicity – the main goal is to promote or protect a company’s image or its products. services, brands 38 economic analysis (2019, vol. 52, no. 1, 36‐47) (5) direct marketing – using different means of communication (mainly digital – e‐mail, and other electronic means of communication, but also mail, telephone) to speak directly with customers and prospects. (6) interactive marketing – different to direct marketing, as main goal is to engage customers to interact, and raise awareness, improve image or elicit sales of products and services. also, these activities and programs are online (7) word‐of‐mouth marketing – any recommendation, information about user (buyer) experience, mouth ‐to‐mouth (thus it may be written, electronic, or really verbal) communications (8) personal selling – face‐to‐face interaction – presentation of product/service/brand, q&a, ordering – with potential buyer source: kotler & keller (2009) the communication environment changed and it not easy at all for marketing communications (domazet & neogradi, 2018). the media environment has changed dramatically ‐ new media, technology driven, grow, while on the other side traditional advertising media such as tv, radio, magazines and newspapers are losing their position(s) (chang & thorson, 2004). everything is changed – the time, the place, and how consumers process communications, and even their choice is to process them at all. in this new media environment, the consumer is the one who has control. consumers not only have more choices of media to use, they also have a choice about whether and how they want to receive commercial content (domazet, stošić & hanić, 2016). the broadband internet connections, ad‐skipping digital video recorders, multi‐purpose (smart) mobile phones and portable music and video players and all other changes in consumers lives, enforce marketers to rethink many of their traditional practices almost daily (kaplan & koval, 2003; kiley, 2005). put in its simplest form, integrated marketing communications (imc) is the bringing together of all marketing communications activities working towards the same goal. integrated marketing communications are the coordinated, consistent means by which firms attempt to inform, incent, persuade, and remind consumers, directly or indirectly, about the products and brands. (pickton & broderick, 2004). integrated marketing communications is a process which involves the management and organization of all individuals and organizations involved in the marketing communications process within and external to the organization, in the analysis, planning, implementation and control of all marketing communications contacts, media, messages and promotional tools focused at selected target audiences in such a way as to derive the greatest enhancement and coherence of marketing communications effort in achieving predetermined product and corporate marketing communications objectives (pickton & broderick, 2004). integration of marketing communications should be or lead to synergy, which is described as the 2 + 2 = 5 phenomenon. in terms of marketing communications, that means that bringing together the various types and forms of marketing communications in a mutually supportive and enhancing way then the resulting ‘whole’ is more than the simple sum of its parts (hanić, domazet & simeunović, 2012). on the other side, lack of integration of marketing communications elements must be acknowledged ‐ not only that various promotional tools have to perform independently of the other elements but also that, collectively, the total effort can be counter‐productive (mcgrath, 2010). integration is not an easy process and cannot be effortlessly be achieved, but when it is reached, the 4es and 4cs of imc create the synergistic benefits of integration (pickton & broderick, 2004). imc should be enhancing (improve; intensify), economical (least cost in the use of financial and other resources), efficient (doing things right), effective (doing the right things). the 4cs of integrated marketing communications are coherence (logically connected), consistency (not self‐contradictory), continuity (connected and consistent over time), complementary communications (producing a balanced whole). integration is not easily achieved, and while the problems of integration are not impossible, they are significant for a variety of reasons. imc is discouraged by mindset of individuals tatjana cvetkov čikošev 39 involved (fear of change and loss of control) and their abilities (esp. managers), classifications and language, the structure of organizations, sense of superiority, the scale of the task, adequacy of budgets, and dimensions of integration. the imc conceptual framework the marketing communications environment is transformed by technological advances and other factors and becomes a new challenge and/or opportunity to the ones that practice it. for example, great versatility and precision of digital media is huge potential, but on the other side, they are challenging for integration (domazet & stošić, 2013). marketers need new tools and ways of thinking that can provide structure to an increasingly complex communications environment if they want to use these new media opportunities. to better understand how to develop and deliver fully integrated communication programs in today’s changing marketing world, batra and keller (2016) reviewed academic research and proposed conceptual framework. result of their academic research review is following five main themes: 1. decision journey nowadays significantly differs to the one it was in the past ‐ imc programs need to be more carefully designed and implemented to maximize results, esp. having in mind media and messages, that should be stage appropriate 2. every communication option has its own strengths and weaknesses and generates specific (different to other types) of effects on consumer knowledge and behaviour along consumers’ decision journeys. additionally, marketers’ ability to aim for the specific outcome with greater precision increases by new media options 3. there is a myriad of interaction and synergy across communications. different types of information, different communications and all their combination and sequence, create relations that lead to change consumer knowledge and behaviour in meaningful ways. 4. once they identify changes in knowledge and behaviour (direct or indirect) caused by different communications, marketers can choose those communication options that are most likely to collectively achieve brand objectives. 5. digital communication options, hardly present in the past, influence consumers directly as well as indirectly and the way they interact with many other digital or nondigital communication options. a conceptual framework is presented in figure 1. it shows the combination of two conceptual models in order to assist in the development and delivery of imc programs. on one side there is consumer and communication outcomes – the knowledge and understanding of the consumer, the context, and the content – everything that “colors” the (desired) outcome (kerr & patti, 2015). the communications matching model should commend the best‐aligned media and messaging options, by bearing in mind the specific objectives and desired outcomes at different stages of the consumer’s journey on one side and the different media features (batra & keller, 2016). the communication optimisation model is about effectiveness and efficiency ‐ all proposed communication options are evaluated to ensure that maximal collective effects result (batra & keller, 2016). by considering communication matching and integration in detail, the two communications models offer a comprehensive top‐to‐bottom view of marketing communications. the framework offered can help guide managerial thinking and academic research in several specific areas. for example, it may help understanding online versus offline communication, which media/messages are controlled by marketers versus the ones that consumers create and influence, digital versus nondigital differences, as it is broad and neutral regarding media. when thinking about communication optimization model it is important to consider coverage (reach of the desired effectiveness of different communication options), contribution (is it affecting consumer positively, influencing each stage along their journey), communality 40 economic analysis (2019, vol. 52, no. 1, 36‐47) (common associations across communication options?), cross‐effect, conformability (is this appropriate answer to different consumers, their different characteristics and communication needs). well‐designed imc program should perform well on these criteria. however, there are more opportunities to match communications to one another if more modalities are employed (audio, images, video…), to appeal to different audiences. (batra & keller, 2016). figure 1. imc conceptual framework source: batra & keller (2016) the communication matching model studies the needs/gaps in consumer knowledge and behaviours, compares the current position of different targeted consumer segments to where they need to be, relative to the brand’s needs. afterwards, suggests the most appropriate media combinations that should best meet these needs/gaps at each stage along the journey (batra & keller, 2016). the journey consist of 12 steps – from having a need at a category level, knowing about (can recall and recognize), over active consideration, search for more information and building brand knowledge, liking and having trust, willing to pay (more) for it, having (high) desire to act, and consuming/using, to satisfaction, both attitudinal and behavioral loyalty, engagement and interaction, and advocating for this particular brand. an emerging and increasingly recognized best practice in the area of brand and customer management is that experiences are emotional and emotions are multi‐dimensional. there are two dimensions of primary interest – valence (was the experience good or bad? answer shows what we often get right) and arousal (was the experience memorable or forgettable? answer leads to what we often overlook). the more memorable and vivid an experience is, the stronger the emotional imprint it creates ‐ and the higher that person's advocacy and resistance to switching to competitors (robins, 2015). identifying those aspects of the experience that leave an emotional imprint, leads to customer‐centric insights on which attributes to promote, to drive loyalty and enhance customer lifetime value. according to robins (2015), direct experiences create more positive and memorable experiences than indirect experiences. owned and earned experiences (usage, wom, in store, sponsoring, etc.) create more positive and memorable experiences than paid experiences. tatjana cvetkov čikošev 41 the effects of created communication the industry of lubricants lubricant can be defined as a substance that reduces friction, not limited to that function, but also completing certain strict, specific demands. for example, modern motor oil has to lubricate surfaces, but at the same time has to have the cooling ability, corrosion protection, sealing, cleaning engine elements and it has to be thermally and oxidatively stable. without those traits, it wouldn't be able to please the complex demands of the modern engine. durability and reliability of a machines operation and of various mechanisms is greatly conditioned by the right selection and application of lubricant. namely, poor lubricant selection or its wrong application are the cause of premature and rapid contact surface wear, permanent deformation and damage. lubricants are chosen specifically for different parts of a machine. so for example in motor vehicles, the engine is lubricated with motor oil, the transmission mechanism with transmission oil, certain bearings with lubricating grease and similar. the task of motor oil in an engine is to:  lubricate the engine, reduce friction and wear of metal surfaces and moving parts when in contact  clean the internal engine parts from carbon black particles  seal the engine (cylinder ‐ piston assembly), blocks the penetration of combustion glasses into the engine crankcase and it raises the engine compression  protect internal engine parts from corrosion  provide the correct engine operation in low as well as in high temperatures  secure added cooling demand for lubricants in the balkan region has stabilised from 2015. in the period 2008‐2013 was a drop and stagnation due to the economic situation. by the year 2025, a 10 percent growth in demand is expected (mandakovic & novina, 2015). a significant qualitative structure change and a growth in demand of top of the line quality lubricants is expected in the region due to very strict environmental legislation and change and renewing the automobile transportation fleet. new industry technological solutions will also play a part on the qualitative change of the structure of lubricants. there are a total of 80 brands of small manufacturers. by the year 2030, a 46 thousand tons growth is forecasted in the serbian market. main market development growth factors are – macroeconomics, environmental protection and sustainable development. nisotec brand was presented to the serbian market in 2008. as a result of novolin rebranding, produced in the nis oil refinery in novi sad. after the completion of a detailed market analysis of the serbian and regional markets in 2010, a new market oriented strategy was adopted, a complete redesign of the label's visual identity and an advertising campaign was done under the "simply better" slogan. the same year, nisotec brand became the general sponsor of dusan borkovic, who ended that season as the runner up of the european rally championship and in the general standings. there was a formation of the nisotec racing team. nisotec gets the leading position in the serbian market in 2012. that same year cooperation with dusan borkovic continues, which quickly lead to the realisation of both parties vision: nisotec as a champion of quality, confirmed by a quality and good design champion trophy, with plenty of gold medals at the novi sad agriculture fair, thus becoming a leader on the domestic market and nisotec racing team becoming a european champion. with the goal of following modern market tendencies, in 2013 there was a nisotec packaging rebranding done. quality levels were differentiated based on the color of the packaging and oil types based on the label colors. an asortiman of nisotec lubricating grease was introduced. the distribution network and new sales channels was expanded in 2014 which led to an increase in market share of nisotec in the lubricant market, thus confirming the leading position in serbia. new 42 economic analysis (2019, vol. 52, no. 1, 36‐47) confirmation was received from engine and equipment manufacturers as well as ohsas 18001:2007 quality certificate. today, in this oil brand asortiman there is over 200 products in over 500 different packages, and all of them cover over 20 different range of application. created communication marketing support is an important component in a brand life, and in the case of lubricants and serbian market, consist of several activities that lead to increase of brand awareness and loyalty, and ultimately, sales. generally speaking, all major communication types are used in order to reach set targets by the company. pr and publicity support every event and every sales promotion organized at nis petrol and gazpromneft petrol station as well as other sales outlets covered by distributors. among events, brand takes presence at fairs. presence in digital media is through website (with information about promotions, trends... ), as well as an online program that help consumer choose the lubricants that are best suited for their vehicles. also, advertising through google (google search and google display) are part of the communication set for the brand. having loyalty program “sa vama na putu” makes usage of direct marketing possible – informing customers via e‐mail, viber messaging or sms. specifically, this year communication plan of activities, towards customers, had one new product launching and one new product packaging introduction, price promotion activities, presence at agronomical fair in novi sad, as well as a campaign „moj auto voli nisotec“. all activities are noted in table 2, together with both communication optimization and matching models, i.e. platforms and outcomes. the idea of integration of marketing communication for this brand was always present, thus breakthrough is made by considering consumer journey of several personas. one type of users consider themselves as experts regarding their vehicle, and therefore the best lubricant. they read magazines and websites regarding this topic, they may be those who recommend others what to buy/use, but may not be loyal to brands, but to types of lubricants. they know when they need to change lubricants, and when in need, they search the net (and other offline sources, like auto magazines), visit some stores and always petrol station. they may be price sensitive, thus they like to consider themselves as smart shoppers. the main answer to their need is quality, not overpriced lubricant, nourishing their smart shopper image. the other type is opposite to them, those who have no knowledge and don’t need to know ‐ they rely on recommendation, mechanics and car service people mostly. for them, easy to find – easy to use is most important. they either have to be able to buy the lubricant at the car service or somewhere where they usually go (supermarket, ps where they usually go, auto shop near car service...). third group are those who constantly have to be assured that they are making the right decision, that the quality, price and other features are the right ones. for them, a good image and brand presence is very important. forth group are the ones with the habit, who once made a decision what to buy and continue to follow the route. in a situation in which they buy a new car, with different engine and needs, they may change their habit, otherwise they are not easy to be reassured. fortunately, they are behaving the same with the petrol station choice, so nisotec has the opportunity to remind them of its presence and assure them of its quality and price. tatjana cvetkov čikošev 43 table 2. imc implementation for nisotec activity top down (communication optimization model) bottom up (communication matching model) new product launch ‐ nisotec antiled feb 2018 web campaign promotion at ps promotions with sampling direct marketing – messages (sms, viber) pr remind of need for the category, learn, active consideration trial and work on trust improve awareness of this specific product, as well as total brand awareness price discount for snnp and agro card users march 2018 pos posters website pr consideration and buying awareness growth 85. international agricultural fair in novi sad may 2018 event presence media conference pr and publicity digital sms awareness knowledge of brand trust satisfaction new packaging of nisotec adblue june 2018 pr pos promotion web site awareness of the new possibility buying satisfaction moj auto voli nisotec july 2018 radio campaign web campaign promotion an ps pr awareness (remind) buying satisfaction 50% discount for the second pack of nisotec testerol september 2018 pos brand web page company fb and instagram pr consideration and buying awareness growth with evro diesel get nisotec diesel lub (nis agro card users) october 2018 pos on target petrol stations sms not loose gas oil users, but turn them to euro diesel trust awareness source: nisotec communication plan, 2018 the effects on brand five years ago, nis gpn started with the brand tracking study, in order to unify and continuously track market dynamics ‐ usage and attitudes of consumers regarding fuels, petrol stations and lubricants, as well as brands (awareness, usage, image, communication…). the insights obtained are used for decision making, strategic and marketing plans to keep and grow the current position. the sample consists of weekly drivers, 18‐64 years old, who use a car as a main way of transportation. one of the important questions is the place of purchase of lubricants, and it shows that habits are not easily changed – the share of stores that sell car parts is the same from wave to wave. comforting is the fact that nis petrol station succeed in keeping lubricants’ buyers, i.e. those who buy lubricants at petrol station. 44 economic analysis (2019, vol. 52, no. 1, 36‐47) figure 2. purchase place ‐ where do you usually buy lubricants? source: brand tracker survey, 2013‐2018, nis, serbia regarding the brand awareness, nisotec reports an increase. one‐half of drivers are aware of this brand, compared to 35% in the previous wave. the results of this year activities are to be measured by the end of this year. figure 3. total brand awareness ‐ which brands from the list do you know? source: brand tracker survey, 2013‐2018, nis, serbia this study also tracks the reasons which are important for decision making and shows growth of importance of price, quality and recommendations of mechanics. users need to be assured that their choices are the best fit for their car for the budget they have. figure 4. decision making ‐ which source of information do you trust the most? source: brand tracker survey, 2013‐2018, nis, serbia 0% 20% 40% 60% 80% 100% wave 1 wave 2 wave 3 petrol station car parts stores service supermarkets other 0% 20% 40% 60% 80% 100% wave 1 wave 2 wave 3 store location price quality brand friend's recommendation mechanics' recommendation tatjana cvetkov čikošev 45 another, performed among the visitors of novosadski sajam in may 2018, shows which media platform has an influence on consumers, which one they have noticed nisotec used, as well as the difference among users. figure 5. influence on decision making source: nis survey at novosadski sajam, may 2018, nis this study shows that the highest influence on decision making has mechanics’ recommendation; even 80% says this communication has a high or highest influence on their decision. another trustworthy sources are friends and family, especially mentioned by females, who are much less (mentally) involved in choosing lubricants. they are also more susceptible to information received from people at petrol stations, and also actions and promotions. figure 6. nisotec communication noticed source: nis survey at novosadski sajam, may 2018, nis mechanics' recommendation friends' recommendation actions and promotion recommendation at ps web page presence at fairs tv advertisement fb page radio fb ads newspapers and magazines sposorship of races and drivers banners top 2 boxes top box recommendation at ps actions and promotion presence at fairs friends' recommendation newspapers and magazines sposorship of races and drivers tv advertisement radio mechanics' recommendation banners web page fb ads bilboards none 46 economic analysis (2019, vol. 52, no. 1, 36‐47) figure 6 shows that the majority has noticed communication at ps, i.e. recommendations, followed by actions and promotions. interestingly, even being at fair, only 40% report noticing this kind of communication, most probably thinking of some other fair or not considering presence at fair as a communication. some differences among subgroups are also noticed regarding this question – males more than females have the notion of seeing sponsorship of races and drivers, while females mention friends recommendations and seeing ads in print. the oldest group of respondents (older than 50 years) are less often mentioning seeing certain nisotec communication, compared to younger users. those aged 30‐50 years more often mention noticing radio and print, as if they more often listen and read those media. the effects can (and will be) measured by units sold, profit and profitability, but the results are collected once a year. immediate actions, like price promotions, show results in an increase of sales during the action, but it’s also important to know the yearly results. year to date data show ambiguous information, and it’s hard to tell what the yearly result will be. conclusion the model of integrated marketing communication that is used as a base for this paper is applied, thus integration is not easily achieved. the effects of communication are measured and appreciated. the selection of which option(s) is the best fit for achieving set goals on the customer journey is not an easy process and is not fully conveyed ‐ the customer journey way of thinking is one barrier, the budget constraints together with options available and acceptable for the company are another set of barriers. still, even this level of integration of marketing communication leads to an additional sale and better positioning. seams that it’s not enough to integrate activities for one brand, as the brand is part of a bigger system, and certain activities are not owned by the brand. that is, the structure of organization and adequacy of budget are barriers that slow down the process of integration. the customer journey way of thinking is not fully accepted and implemented, it seems it takes more time, and more trials (and errors). on the positive side, some critical touch points are observed and communication as an answer to it, which leads to profitable customer behaviour, was applied. references batra, r., keller, k.l. 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(2015). “customer lifetime value & loyalty in the new consumer economy”, total customer experience philadelphia 2015 article history: received: november 13, 2018 accepted: may 29, 2019 doi: 10.28934/ea.19.52.12.pp48‐55 original scientific paper assessing organisational maturity in predictive analytics of telecommunications companies in the republic of macedonia kalina trenevska blagoeva1 | marina mijoska1* 1 ss.cyril and methodius university, faculty of economics ‐ skopje, department for e‐business, republic of macedonia abstract data analytics and predictive analytics are among major trends companies are facing worldwide. in a highly digitalised environment, it is not only to question the usage of data analytics but how analytically mature organisations are. the goal of this paper is to assess organisational maturity in predictive analytics of telecommunications companies in the country. in order to assess the level of organisational maturity in predictive analytics, we use predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competence, deployment and governance). for each dimension, four maturity levels are defined: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony (capgemini, 2012). survey results confirmed that analysed companies fully understand the benefits of predictive analytics as a valuable source of gaining competitive advantage from data. the overall level of predictive analytics maturity is set between levels 2 or 3 for almost all dimensions. this research is the first attempt to analyse organisational maturity in predictive analytics in the country. its originality derives from the specific characteristics and development of the telecommunications sector. this sector is one of the most advanced service sectors in the country and hence represents a benchmark concerning digital transformation. results of this survey provide useful information needed to design a roadmap for migrating towards higher maturity levels key words: organisational maturity, predictive analytics, predictive analytics maturity framework, telecommunications sector, republic of macedonia jel classification: m19, l96 introduction companies in all industries worldwide are using and benefiting from data analytics. data analytics, especially big data analytics, advanced analytics, and predictive analytics, are among the major trends for 2017 companies worldwide are facing (gartner, 2017). but, in spite of how powerful data analytics is, almost every organisation of every size is currently struggling with the challenges associated with building a proper analytics team and becoming a data‐driven * corresponding author, e‐mail: mijoskam@yahoo.com kalina trenevska blagoeva, marina mijoska 49 organisation. in the literature, there are a variety of explanations about what a data‐driven company is and how an organisation can become one. an organisation where every individual can use data to improve decision‐making and has ubiquitous access to the needed data can be considered as a data‐driven company. there is no doubt that more companies will attempt to drive value and revenue from their data (forester, 2017). “predictive analytics is a branch of the advanced analytics which is used to make predictions about unknown future events and uses many techniques from data mining, statistics, modelling, machine learning, and artificial intelligence to analyse current data to make predictions about future” (www.predictiveanalyticstoday.com). predictive analytics provide analysing large amounts of data with different variables; it includes clustering, decision trees, market basket analysis, regression modelling, neural nets, genetic algorithms, text mining, hypothesis testing, and decision analytics (mishra and silakari, 2012). the goal is to go beyond knowing what has happened to providing a best assessment of what will happen in the future (https://www.forbes.com). data and analytics are also changing the nature of industry competition. the most significant changes are reported in high tech, media and telecom, and consumer and retail (mckinsey, 2016). the ability to derive new insights from data using analytics techniques can enhance the decision‐making process in companies. in today’s analytics economy, in which data science is increasingly adopted by companies across all industries, it is not only to question the usage of data analytics but how analytically mature organisations are since the higher levels of analytical maturity provides better perspectives. in this sense, analytical maturity refers to organisations being able to get their business to its optimal potential by using predictive analytics. using the maturity model can provide an understanding of the current state and help management form a strategy of what level of capability is desired in order to support the achievement of organisations objectives. the telecommunications sector has seen momentous growth over the past decades and continues to be a critical force for growth, innovation, and disruption across multiple industries/countries. as a whole, the telecommunications industry generates upwards of 1 trillion euro in service revenues each year (https://www.statista.com/). the 54 telecommunications companies on the 2018 forbes global 2000 list claim more than $3.4 trillion in assets and totalled nearly $1.5 trillion in revenue last year (www.forbs.com). while in the past revenue was essentially sourced from a traditional landline and wireless services, today the range of products and services available in this industry is persistently increasing, offering further opportunities for revenue creation. the telecommunications industry is competing on analytics and embracing the new science of winning by investing in data science capabilities within the enterprise. these companies use predictive analytics for analytical customer relationship management (acrm), fraud reduction, bad debt reduction, price optimisation, call center optimization, etc. in the study published by ernst & young “global telecommunications study: navigating the road to 2020“, participants scored “improving big data and analytics capabilities” as very important in order to boost their organisational agility, with nearly 40% of respondents selecting it as a priority. consumer behavior has changed significantly in the last five years. consumers are shifting to applications like whatsapp, facebook messenger, snapchat, and instagram rather than calling and texting. according to stephan gatien, general manager of telecommunications business, sap, the core services of telcos – text, voice, and data – are actually evaporating and the revenue associated with these services is evaporating as well. the big challenge in this industry is to determine how to offset the degradation of this revenue coming from text, voice, and data to a certain extent, by buying new services that will be relevant to subscribers. in the article. “turning data into insights: how digitization creates new opportunities for the telecommunications industry, julie stoughton, the head of telecommunications marketing and communications at sap, stated that telecommunications 50 economic analysis (2019, vol. 52, no. 1, 48‐55) companies are trying to reinvent themselves and stay relevant in the digital era. this has led to two major trends. first, companies are focused inward on their customer experience. they need to retain their most valuable customers and secondly, telcos are looking outward. they’re considering how they can monetize the enormous volume of iot data currently in their possession. there is no doubt that data analytics is not going to be neglected as a valuable tool for achieving that reinvention, not only for telecommunications companies but other service companies as well (stoughton, 2018) the telecommunications industry is area specific industry regarding predictive analytics use. this counts for the telecommunications sector in the republic of macedonia as well. this sector is one of the most advanced service sectors in the country and hence represent a benchmark concerning digital transformation. in line with global trends, the telecommunications market in the country is developing rapidly, particularly in the mobile segment. telecommunications in the republic of macedonia include radio, television, fixed and mobile telephones, and the internet. according to the latest report of agency of electronic communications of the republic of macedonia ‐aec, the telecommunications market in the country is fully dominated by two companies (makedonski telekom and one. vip) in all segments of the market (mobile, internet, fixed lines). according to the data of the same report, in 2017, the mobile operators' share in the mobile telephony market per number of active subscribers shows that makedonski telekom’s share was 47.97%, while one. vip operator’s share was 49.57%. the market share of mobile operators in the republic of macedonia by revenue generated from the provision of mobile communication services on the retail market is as follows: makedonski telekom has the largest market share at 52.56%, while one. vip operator has a market share of 47.21%, with a third operator having an insignificant share of 0.23%. the market shares were calculated for the total revenue, which represents the sum of revenues arising from call initiation service, monthly subscription, data transfer, terminal equipment, sms, mms, roaming (traffic, sms and data), and other revenues. the operators’ share in the total number of active subscribers to broadband and narrowband internet access via mobile network (2g/3g/4g) states that one.vip operator has a market share of 52.18%, makedonski telekom has a market share of 46.51%, while the third operator has an insignificant market share of 1.31% (www.aek.mk). methodology and results according to the latest data and analytics global executive study and research report (2018) prepared by mit sloan management review, organisations can outperform by making use of data from multiple sources. these organisations are considered innovative and analytically mature. data analytics in companies matures differently with regards to different aspects/dimensions and different parts of an organisation (departments). in practice, the maturity path of an analytical organisation is not linear in all dimensions and departments. it has a more complex trajectory which is not synchronised nor by dimension or sector/department. according to lismont (2017) “it is not unfamiliar that analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy”. (lismont, 2017). but, what analytically mature organisation means and how one organisation can become innovative and analytically mature. different authors and consulting groups propose different analytics maturity models/frameworks in order to reach a predefined analytical maturity level. in the literature, one of the latest research representing a summary of the existing analytics maturity models is one of chen and nath (2018). according to their research, numerous maturity models have emerged recently, following the proliferation of the predictive analytics tools development. chen and nath (2018) suggest that business analytics maturity models can kalina trenevska blagoeva, marina mijoska 51 be categorized by the following determinants: technology, organization, capability, and impact ‐ focused. one of the latest is the analytic processes maturity model (apmm) for evaluating the analytic maturity of an organisation (grossman, 2018). the apmm identifies analytic‐related processes in six key process areas, defined as: 1) building analytic models; 2) deploying analytic models; 3) managing and operating analytic infrastructure; 4) protecting analytic assets through appropriate policies and procedures; 5) operating an analytic governance structure; and 6) identifying analytic opportunities, making decisions, and allocating resources based upon an analytic strategy. based upon the maturity of these processes, the apmm framework of grossman (2018), organizations can differ i.e. reach five maturity levels defined as: level 1 ‐ organizations that can build reports level 2 ‐organizations that can build and deploy models; level 3 ‐ organizations that have repeatable processes for building and deploying analytics; level 4 ‐organizations that have consistent enterprise‐wide processes for analytics; and level 5 ‐ enterprises whose analytics is strategy driven. this model is based upon the capability maturity model ‐ cmm that is the basis for measuring the maturity of processes for developing software created by software engineering institute, carnegie mellon university. another approach which provides estimation of analytics maturity i.e. analytical maturity levels differs organizations in three major categories based on their relative level of sophistication in adopting analytics i.e. 1) the analytically challenged organizations display limited analytical capabilities; 2) analytical practitioners largely use analytics to track and support performance indicators; and 3) analytical innovators incorporate analytics into virtually every aspect of their strategic decision‐making, including gleaning data from a variety of sources such as direct measurement and sensors, industry data, and third parties (ransbotham and kiron, 2018, p.7). according to the defined methodology, in order to determine the relative analytics proficiency of an organization, it is suggested to calculate the analytics core index, based on the organization’s core analytics capabilities in three major areas like: (1) ingesting data (capturing, aggregating, and integrating data); (2) analyzing data (descriptive analytics, predictive analytics, and prescriptive analytics); and (3) applying insights (disseminating data insights and incorporating insights into automated processes). in detail. the analytics core index is calculated by assessing how effectively the organisation performs these seven analytics‐related tasks and activities defined like 1. capturing data, 2. aggregating/integrating data, 3. using descriptive analytics, 4. using predictive analytics, 5. using prescriptive analytics, 6. disseminating data insights and 7. incorporating analytics insights into automated processes (ransbotham and kiron, 2018, p.9). the measurement process is based on a five‐point scale ranging from very ineffective to very effective. the analytics core index score represents the sum of the responses to the seven questions, scaled to a range from 0 to 100. higher levels of analytical maturity are associated with higher levels of customer engagement, which in turn is associated with higher scores on the analytics core index, which in turn is associated with greater use of diverse data sources. this means that organizations that make effective use of a wide range of data sources — from different types of technologies and different types of entities, such as customers, vendors, competitors, and publicly available sources — are more likely to use analytics to generate higher levels of customer engagement and gain a competitive advantage than organisations that use fewer sources of data. (ransbotham and kiron, 2018, p.9). according to lismont et al., (2016), the application of analytics in organisations generally differs with regards to five different aspects like: data, enterprise or organisation, leadership, targets or techniques and applications, and the analysts who apply the techniques themselves. in their research, they found that the analytics organisation in companies matures with regards to these aspects. moreover, analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy (lismont et al., 2016). 52 economic analysis (2019, vol. 52, no. 1, 48‐55) in our survey in order to assess the level of organisational maturity in predictive analytics, we use the predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. in different business units within the same organisation, there are different maturity levels. for that reason, managers from different organisational sectors were approached and interviewed. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competency, deployment and governance). for each dimension, managers were asked to choose the appropriate level of usage out of four available maturity levels: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony. this framework can serve as a roadmap for moving the organisation towards achieving its predictive analytics goals. the suggested framework which defines analytics adoption level of an organisation and its environment is illustrated in figure 1. figure 1. the pamfa – dimensions and maturity levels source: capgemini. 2012. “measuring organisational maturity in predictive analytics: the first step to enabling the vision”, p.8. according to the defined methodology, the five different aspects/dimensions of predictive analytics maturity are assessed. the first dimension is vision and strategy. it is rare today for an organisation to develop software and information systems, without striving to use the data in best way. in this sense, having an analytics vision and strategy is very important, as the long term decisions an organisation makes about how it uses its data is needed. by defining maturity level of this dimension, the companies can write a broad “analytical map” in which the current level of the organisation will be stated, accompanied with the vision of the future wanted level. the roadmap can help in harmonising predictive analytics incentives with the organisation’s high‐level strategic goals. it demonstrates where legitimisation, or execution of extra activities, is required. pamfa looks at the current predictive analytics strategy, distinguishing any gaps and key enablers required for execution. having a vigorous methodology set up makes it conceivable to prioritise analytics initiatives based on enterprise level business imperatives, not departmental ones. the second measurement is called – enablers, and it alludes to discovering how prepared the company’s environment is to adopt or pursue predictive analytics. pamfa examines the data condition, legacy solutions, analytics process, and technology and support arrangements. it likewise survey the association's comprehension of predictive analytics and its impression of the advantages. among the empowering enablers considered in the framework are an information framework that suits predictive analytics needs and a justified portfolio of applications. kalina trenevska blagoeva, marina mijoska 53 the third dimension is competence. this implies that organisations ought to have a full understanding of all current predictive analytics projects, and of parts where analytics could be used further on. next is deployment. this measurement estimates the organisations capacity to convey predictive analytics and coordinate it into business processes which is a basic part of predictive analytics maturity. the central matter predictive analytics is to power is the decision making capability of the organisation. the last, fifth dimension in the pamfa is governance. governance is a regularly disregarded yet fundamental part of predictive analytics. therefore, it is essential to look at the organisation’s modelling lifecycle management and its administration of model precision and pertinence. for every one of these measurements, four maturity levels are characterized. level 1 is called impromptu. at this level, sporadic and secluded analytic capability results from impromptu undertakings done by a solitary administrator or speciality unit. the second dimension is named solo. level 2 is separated into two sub‐levels: amateur solo, implying that predictive analytics abilities and procedures exist for the most part at an individual dimension, and are not natural to the organisation, and professional solo which is a brilliance inside a silo. predictive analytics processes, capacities and environment meet up to address business issues adequately, yet just for individual tasks. level 3 is named ensemble. on this level, one can perceive predictive analytics activities crosswise over business functionalities, with certain procedures being made together. the last, most developed level is symphony level, where well‐organised, company’s wide activities apply analytics for achieving business advantage. this framework can fill in as a guide for moving the organisation towards accomplishing its predictive analytics objectives. pamfa is structured not exclusively to distinguish the present dimension of predictive analytics development, yet additionally to find the company's ideal analytics maturity level (iaml). the iaml is the dimension that would empower the firm both to capitalise on existing assets and furthermore to put ideally in extra assets, so as to accomplish key objectives and infer greatest business benefits. the results of the survey confirm that analysed companies fall somewhere around level 2 or 3 for almost all dimensions. more precise, results for each dimension are shown in the table below. table 1: survey results vision and strategy enablers competency deployment governance a b a b a b a b a b level 1 impromptu level 2 solo * * * * * level 3 ensemble * * * * * level 4 symphony regarding the first dimension, vision and strategy, analysed companies are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not formulated enterprise vision and strategy for using predictive analytics as a valuable asset for the company as a whole. although some employees in separate departments have an analytics vision, yet there is no single formulated analytics strategy, even for that department. the achieved level is relatively high and can be a boost for achieving higher level on other dimensions. the maturity of the analysed companies for the second dimension – enablers is on level 2 (solo). this implies that separate business departments may work together with innovation or business intelligence units, yet there is almost no data exchange. while discussing this 54 economic analysis (2019, vol. 52, no. 1, 48‐55) dimension with the managers‐respondents, it was obvious that they are not satisfied with the alignment of the processes. the third dimension is called competency. analysed companies in our research are on level 2 of maturity. this implies that some business units, individual competency may exist, but it is not used widely on a regular basis. the reported level is in correlation with the reported level of the dimension enablers, and the silo thinking is still an obstacle in this companies for performing predictive analytics and monetizing its results. for the fourth dimension ‐ deployment, the answers from the interview are more dispersed. this means that company a is on the second level of maturity and company b on the third. level 2 (solo) means that in company a integration with the business information systems is manual. for company b which is on level 3 (ensemble), this score shows that the analytics is integrated with decision‐making systems. for both companies, the predictive analytics model output is not yet integrated with business intelligence systems, decision‐making systems and business information systems. the last dimension (governance) for both companies shows level 3 of maturity. this level, ensemble, means that business unit level governance in both companies exist but, there is still a limited enterprise‐level governance. according to the results, the overall level of predictive analytics maturity is set between levels 2 and 3 for analysed companies. although both companies are doing well on maturity journey, there is an evident difference in the maturity of the fourth dimension – deployment. the pamfa can serve as a plan for guiding the organisation to achieving its predictive analytics objectives. this framework is designed not only to identify the current level of analytical maturity but also to discover the organisation’s ideal analytics maturity level (iaml) (capgemini, 2012). the limitation of the research methodology is the subjectivity that is expected in assigning the levels by the managers‐respondents. overestimating the levels of maturity is possible. however, this bias is present in every methodology of this type. with respect to initially measurement, vision and methodology, broke down organizations are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not characterised and verbalised a venture vision and technique for utilizing it on a big business level. increasingly exact, an investigation people in some speciality units have an examination vision, yet there is no enunciated examination methodology, notwithstanding for a solitary speciality unit yet. vision is explained by individual speciality units, alongside the it, who need to help the vision. the accomplished dimension is moderately high and can be a lift for accomplishing a more elevated amount on different measurements. conclusion organisations nowadays are focused on predictive analytics as a valuable tool to use data for achieving competitive advantage. the telecommunications sector in the country is one of the most advanced service sectors and hence represent a benchmark concerning the digital transformation. the results of our survey confirmed that telecommunications companies in the country understand the benefits of predictive analytics as a valuable source to gain a competitive advantage from data. the interview results confirm that organisations fall somewhere around level 2 or 3 for almost all dimensions. this survey results provide useful information needed to design a plan for migrating towards the higher levels of maturity. the road to achieve higher levels across all dimensions is hard, and it will take full management commitment in order to maintain competitive. this research is the first attempt to analyse organisational maturity in using predictive analytics in the country. its originality derives from the specific characteristics and development of telecommunications sector in the country and its importance. knowing where an organization is on this journey will help managers/strategists to kalina trenevska blagoeva, marina mijoska 55 adopt ideal analytics maturity level, i.e. the highest level that would enable organisations to derive maximum business benefits and achieve its strategic objectives. further research can include companies from other industries in the country (finance, health) since the pamfa can be used to measure and describe their predictive analytics efforts. references agency for electronic communications of the republic of macedonia. 2018. “report on the development of the electronic communications market in the republic of macedonia for 2017.“ https://www.aek.mk capgemini. (2012). „measuring organizational maturity in predictive analytics: the first step to enabling the vision.“ https://www.capgemini.com ernst & young. (2015). “global telecommunications study: navigating the road to 2020.“ https://www.ey.com grossman, robert l. (2018). “a framework for evaluating the analytic maturity of an organization.“ international journal of information management, 38: 45–51 chen, l. & nath, r. (2018). "business analytics maturity of firms: an examination of the relationships between managerial perception of it, business analytics maturity and success", information systems management,. 35(1): 62–77 lismont, j., et al. (2017). “defining analytics maturity indicators: a survey approach.“ international journal of information management, 37 (3): 114‐124 mckinsey global institute. (2016). “the age of analytics: competing in a data‐driven world.“ https://www.mckinsey.com mishra, n. & silakari, s. (2012). “predictive analytics: a survey, trends, applications, opportunities & challenges.” international journal of computer science and information technologies, 3 (3): 4434‐ 4438 morabito, v. (2015). “big data and analytics: strategic and organizational impacts.“ springer ransbotham, s. & kiro, d. (2018). “using analytics to improve customer engagement, findings from the 2018 data & analytics global executive study and research report.” mit sloan management review, https://www.sloanrieview.mit.edu stoughton, j. (2018). “turning data into insights: how digitization creates new opportunities for the telecommunications industry.” https://www.digitalistmag.com trenevska blagoeva, k., josimovski, s., mijoska, m. & jovevski, d. (2018). “determinants of analytics usage to improve customer engagement in chosen macedonian companies.“ knowledge ‐ international journal, 22(1): 187‐192. valdez‐de‐leon, o. (2016). “a digital maturity model for telecommunications service providers“, technology innovation management review, 6 (8): 19‐32 https://www.digitalistmag.com. https://www.forbs.com https://www.gartner.com https://www.infoworld.com https://www.predictiveanalyticstoday.com https://www.statista.com article history: received: may 16, 2019 accepted: june 21, 2019 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp23-35 original scientific paper comparative analysis of insurance premiums in serbia and bosnia and herzegovina ‐ multiple linear regression analysis model tijana kaličanin1* | sandra kamenković1 | ivana simeunović1 1 university union, belgrade banking academy ‐ faculty of banking, insurance and finance, belgrade, serbia abstract in the last few years, the global insurance market has shown a trend of concentration growth, which was conditioned by the processes of mergers and acquisitions in insurance. the aim of this paper is to make a comparative analysis of insurance premiums in serbia and bosnia and herzegovina. dynamic analysis of market concentration indicators calculated on the basis of absolute amounts of premiums indicates that the insurance market in bosnia and herzegovina is characterized by low concentrated supply, i.e. there is greater equality of market share in relation to high inequality and high concentration among market participants in the insurance sector of the republic of serbia. having applied the multi‐linear regression model in order to analyze the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐2017, it can be concluded that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had the average net salary, households and final consumption expenditure and gross domestic income. key words: insurance premiums, insurance sector, multiple linear regression analysis model jel classification: c30, g22, l19 introduction in the last two decades, countries of central and east europe have experienced tremendous changes in the political, cultural, social and economic environment. central and east european financial system has been rapidly developing during the last couple of years, contemporary regulations have been introduced and new financial institutions have been established contributing to the maintenance of macroeconomic stability in the region. nonetheless, the macroeconomic sector in the region, underdeveloped even before the recession took place, has been a highly risky place for investments and unstable in comparison with western europe (kaličanin & hanić 2016a). the insurance market in the western balkans is characterized by significant changes caused by different economic growth pace. countries preparing to become members of the european union are carrying out faster reforms, and there is also a significant inflow of foreign capital due to a reduction of financial and political risks (novović‐burić et al. 2017). in this paper, the insurance sectors were analyzed in the republic of serbia and bosnia and herzegovina. in addition to the transition process in both countries, these countries have * corresponding author, e‐mail: tijana.kalicanin@bba.edu.rs 24 economic analysis (2019, vol. 52, no. 1, 23‐35) undergone similar political and economic changes in the past decade. both insurance markets have passed through the process of integration and internationalisation. in addition to many similarities characteristic for these two markets, there are substantial differences that are reflected in the number of residents, the number of insurance companies, the market structure, the participation of the market leader, and the number of companies with foreign capital. the market of a country is as developed as its competition is able to function on it. competition has to be constantly stimulated and protected by mechanisms in line with the european integration processes and policy focused on market economy development. competition as such has been a particularly sensitive issue in transitional countries such as serbia and countries in the region. changing the number of insurance companies on the market influenced significantly the formation of a group of leaders in the insurance market as well as strengthening the position and increasing the individual market share of the leader (kaličanin & lazić, 2018). initial structural changes raised an issue and brought about the need for a higher competitiveness in serbia. every country aspiring to join the eu and integration processes ought to develop legal norms and apply the eu regulations (kaličanin & hanić 2016a). in recent years, the insurance sector has become a significant factor in the development of the overall financial and economic system. in the first part of the paper, insurance markets and level of competitiveness were analyzed. competitiveness in the market has led to changes in the balance sheet structure of the entire financial sector as well as the position of individual insurance companies in previous years. the insurance sector is extremely important for the economy of a country, not only from the point of view of security and protection from different types of risks but also from the point of view of the overall economic development and improvements in the functioning of the financial market. in the second part of the paper, the focus is on the analysis of insurance premiums and the impact of selected macroeconomic indicators on premiums using the multi‐linear regression model. literature review there are many analyses which deal with insurance premiums and economic growth. outreville (1990), zhi (1998), beck and webb (2003), webb et al. (2002) have shown a very strong interaction between insurance premiums and gdp despite different periods and country patterns. analyses mainly suggest that higher gdp growth rates have an impact on economic activity growth, which leads to assumptions about a positive correlation between gdp growth rate and demand for insurance. haiss and sumegi presented very extensive research in 2008, which led to the conclusion that there is a correlation between insurance and gdp growth in eu‐15 countries with developed financial markets as well as short‐term linkages between gdp and non‐life premiums on a sample of cee countries. serbia and bosnia and herzegovina are selected for this research because very few authors have analyzed this region from the insurance aspect. novovic‐buric et al. (2017) explored the influence of certain factors on the purchase of insurance products through a panel analysis. western balkan countries were analyzed in the period from 2005 to 2015, and the results show that most of the economic factors affect total life premiums. the demand for life insurance has a significant and positive impact on gdp and wages, while the influence of unemployment and interest rates is negative. dragos (2014) used the fixed and random effects model in the analysis, which entailed 17 countries in asia and central eastern europe. the aim was to compare emerging markets in europe characterised by market economies and emerging markets in asia, which are predominantly planned economies in terms of the impact of economic performance on life and non‐life insurance. it has been noted that the differences certainly exist. the results concerning the cee, taking into consideration the countries which are analyzed in this research have shown tijana kaličanin, sandra kamenković, ivana simeunović 25 that income and education have a positive impact on the insurance demand, while urbanisation has shown a significant impact on non‐life insurance. on the other hand, income distribution negatively influences the demand for insurance. kjosevski (2012) analysed the determinants of life insurance demand in central and southeastern europe by using fixed‐effect panel models in the period 1998‐2010. the results show that in terms of life insurance, the most significant predictors are the following: high gdp per capita, inflation, health expenditure, level of education and the rule of law. mitra (2017) analysed the impact of economic, demographic and cultural factors on life insurance consumption in 28 eu countries. the focus was on the emerging east european economies, given that in the analysed period 2009‐2014, there were significant reforms of the insurance sector in these countries. the results show that the higher gdp is an indicator of higher wages and higher levels of economic activity, the more positive impact on insurance demand. ward and zurbruegg (2002) analysed 37 countries in the period 1987 ‐ 1998 with the intention to point to the links between insurance premiums and various legal and political factors, as well as economic and social factors. the analysis has shown that the consumption of life insurance products is under stronger influence of gdp in asia than in oecd countries, which is an expected result given that in the oecd countries there is a considerably higher average income level and that ‘s curves’ suggest that at higher levels of income the demand for insurance is less susceptible to the revenue growth. bianchi et al. (2011) analysed the insurance market in central, eastern and southeastern europe and both countries which were analyzed in this research are contained in the sample. they used panel regression (a cross section with fixed effects) to examine the impact of gdp growth on insurance premium growth. the results suggest that economic development and catching‐up processes mainly condition premium growth, and that in unstable periods, it shows increased volatility. comparative analysis of the insurance market figure 1 shows the total number of insurance companies operating in the insurance market in serbia as well as in bosnia and herzegovina in the last ten years. the largest number of insurance companies in serbia was present in the period 2011‐2013 when there were 28 companies, followed by the decline in the number of insurance companies, ranging from 25 in 2014 to 21 at the end of 2017. figure 1. number of insurance companies, 2007‐2017 with the number of insurance companies in the market in bosnia and herzegovina, fewer oscillations can be noted in the observed period, ranging from 24 to 27. the largest number of 0 10 20 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 20 24 26 26 28 28 28 25 24 23 21 25 26 26 26 25 25 25 24 24 27 27 number of insurance companies ‐ serbia number of insurance companies ‐ bih 26 economic analysis (2019, vol. 52, no. 1, 23‐35) insurance companies at the b&h market operated in the last two years of the observed period, i.e. 2016‐2017 with a total of 27 companies. in addition to the banking sector with the largest share of the balance sheet total in the total financial sector ‐ about 90%, the balance sheets of the leasing companies, pension funds and insurance companies are included. figure 2 shows a fall in the share of the insurance sector's balance sheet total in the total financial sector, which is notable in both markets in the period 2005‐2008. after 2008, the share of the insurance sector balance sheet total in serbia rose from 4.2% in 2008 to 6.3% in 2017. the same trend is present in the insurance market of bosnia and herzegovina, where the growth of the balance sheet total in the total financial sector increased in the same period for the same percentage ‐ 2.1%, from 3.45% to 5.57% in 2017. figure 2. contribution of the balance sheet total of the insurance sector to the overall financial sector, 2005‐2017 figures 3 and 4 show the ratio of the total number of insurance companies and foreign companies in the period 2007‐2017. it can be concluded that the number of foreign insurance companies in serbia has changed proportionally with the total number of companies present in the market. the number of foreign companies in the insurance market of b&h did not change significantly in the observed period. there were 10 foreign insurance companies in the period 2008‐2014, after which this number increased to 11 and 12 in 2015, 2016 and 2017, respectively. figure 3. relationship between the total number of insurance companies and foreign companies, 2007‐2017, serbia 4,42 3,75 3,46 3,45 3,72 3,86 4,43 4,77 4,86 5,19 5,38 5,57 5,57 5,3 4,3 4,1 4,3 4,2 4,2 4,4 4,5 4,8 5,2 5,8 6,1 6,3 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih serbia 20 24 26 26 28 28 28 25 24 23 21 13 17 19 19 21 21 21 19 18 17 15 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign tijana kaličanin, sandra kamenković, ivana simeunović 27 figure 4. relationship between the total number of insurance companies and foreign companies, 2007‐2017, b&h given that the subject matter of the analysis is the amount of income earned by insurance companies, the companies’ market shares are calculated on the basis of the amount of total premiums at the end of the year taken from the balance sheet of insurance companies. figure 5 shows a comparative analysis of the concentration of the largest companies in b&h and serbia according to the criterion of the total balance sheet. dunav insurance company was the market leader in serbia according to the mentioned criterion and has absorbed about one‐quarter of the entire market in the observed period. by the end of 2015, sarajevo insurance was the market leader in b&h according to the criterion of the total premium. for the next two years of the observed period, uniqa insurance achieved the largest amount of total premiums. the concentration of leader ratio in b&h is much lower than in serbia, so the leader in this market has a share of about one‐tenth of the entire market. figure 5. cr1 according to the criterion of the total premium, 2007‐2017 the number of companies involved in the calculation of this indicator is determined by government agencies that are monitoring the degree of bid concentration in that particular country, provided that this coefficient is used as an official indicator (martin, 2002). cr 1, cr3 and cr5 are most frequently accrued in the reports of the responsible insurance institutions, according to the criterion of total premiums, total non‐life insurance premiums and total life 25 26 26 26 25 25 25 24 24 27 27 9 10 10 10 10 10 10 10 11 11 12 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign 013 012 012 012 013 013 012 011 010 009 008 031 025 028 026 027 029 027 025 027 026 027 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 28 economic analysis (2019, vol. 52, no. 1, 23‐35) assurance premiums. figure 6 shows the concentration ratio of the top five insurance companies with the highest total premium. although there is a mild tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. (as can be seen in lorenz curves 8 and 9). cr5 had fallen from 84.16% in 2007 to 77.19% in 2017. the mentioned concentration ratio in b&h dropped from 45.97% to 39.21%, from 2007 to 2017. figure 6. cr5 according to the criterion of the total premium, 2007‐2017 figure 7 shows the dynamic analysis of the herfindahl‐hirschman index in the period 2007‐ 2017 for both markets. the significance of the index is reflected in the fact that although it respects the individual market share of all companies in the branch it particularly responds to the presence of companies with large market participations, which significantly increase its value (lipczynski & wilson, 2001) given the above and taking into account the high cr5 concentration ratio on the insurance market of the republic of serbia, high values of the herfindahl‐hirschman index are not surprising. figure 7. herfindahl‐hirschman index according to the criterion of the total premium, 2007‐017 with the increase in the number of insurance companies in serbia, this index has declined, so the highly concentrated bid with the index of 2050 in 2007 reached the level of a medium concentrated bid (it is considered thin the market is medium concentrated if the hhi index value 046 045 045 046 046 045 046 045 042 041 039 084 082 079 077 077 077 076 077 076 075 077 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 2050 1820 1654 1520 1551 1595 1495 1496 1558 1495 1543 655 623 622 643 636 640 636 610 585 555 534 0 500 1000 1500 2000 2500 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 serbia bih tijana kaličanin, sandra kamenković, ivana simeunović 29 ranges from 1000 to 1800). it can be concluded that from 2008 until today, the insurance market in serbia is medium concentrated. herfindahl‐hirschman index according to the criterion of the total premium differs significantly in the market of bosnia and herzegovina, where the permanent low‐concentration bid is present in the observed period. although the hhi index fell from 655 to 534, from 2007 to 2017, it can be concluded that the insurance market in b&h is inconsistent, i.e. that there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. figure 8 shows lorenz curves based on the amount of total premiums for the initial and the last year of the observed period, i.e. 2007 and 2017. first, insurance market leaders have reduced their market share, i.e. the top 20% of insurance companies in 2007 had a cumulative 80% of the total market share measured by the total premium, while the same percentage of leaders in 2017 had less than 60%. with the exception of market leaders (the first four companies) of 18 companies in 2007, 14 companies shared 18.85% of the total market, while in the year 2017 some 15 companies shared 18.69%, which suggests that the number of companies increased in the market with smaller market share, primarily due to the appearance of new companies in the market. this finding contributes to the value of the herfindahl‐hirschman index as well as the value of cr5. figure 8. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, serbia constructing lorenz's curve in terms of the degree of concentration of supply in the relevant market, the distribution of the entire market between business entities can be clearly seen. (kaličanin & hanić 2016b). lorenz curves for the insurance market of bosnia and herzegovina constructed based on the premiums shown in figure 9 differ considerably from those presented in figure 8. the distribution of the market share of insurance companies in the stipulated market is characterised by greater equality, which can be inferred from the lorenz curve distance from the equal’s curves (in case of equal distribution of market share among all participants in the market). fewer companies have been able to increase their market share over the observed period, while market leaders reduced their cumulative market share. 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz 30 economic analysis (2019, vol. 52, no. 1, 23‐35) figure 9. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, b&h in 2017 in bosnia and herzegovina, there were 27 companies, i.e. 6 companies more than in the republic of serbia. in addition to the difference in the number of companies, there is greater inequality in the distribution of market shares in the serbian insurance market as well as greater concentration on the supply side compared to the low concentration of the insurance market of bosnia and herzegovina. methodology as emphasised before, the aim of this paper is to analyse the insurance market in serbia and bosnia and herzegovina with reference to certain macroeconomic indicators that play a key role in the development of insurance. in this respect, we investigated the mutual influence of individual variables on the movement of total premium income earned in these countries. in this analysis, a time series is used for the period 2000‐2017, i.e. for a period of 18 years. for the mentioned period, the following independent variables were analysed:  – average net salary (current, rsd/km)  – unemployment, total (% of tthe otal labor force)  – gross domestic income (constant lcu)  ‐ gdp per capita (current us$)  ‐ wage and salaried workers, total (% of total employment)  ‐ households and npishs final consumption expenditure (current us$) while the dependent variable was – total premium (current rsd/km). for this research, multiple regression analysis was carried out using the spss statistical software. the choice of independent variables is based on empirical fundaments that relate to the studied variable, as well as on the information contained in the relevant literature. six independent variables were included in the analysis to identify those that could explain the major part of the variability of the studied (dependent) variables. a model involving variables whose calculated regression coefficient is significant at 5% level is selected. empirical research and discussion usually, the first part of the study contains basic indicators of descriptive statistics. since all variables included in the analysis were measured on the ratio scale, the values of arithmetic mean and standard deviations are presented as indicators of a descriptive statistic (table 1 and table 2). 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz tijana kaličanin, sandra kamenković, ivana simeunović 31 table 1: descriptive statistics for different variables – serbia mean std. deviation n total premium 49372718.5000 24831359.35237 18 average net salary 345729.3333 183811.84680 18 unemployment, total (% of total labor force) 17.6239 3.61340 18 gross domestic income (constant lcu) 2855342777777.7780 458570337497.97485 18 gdp per capita (current us$) 4614.9873 1798.25314 18 wage and salaried workers, total (% of total employment) 69.4582 1.98410 18 households and npishs final consumption expenditure (current us$) 25301236558.1667 9670960437.31504 18 source: authors using spss table 2: descriptive statistics for different variables – bih mean std. deviation n total premium 430206288.0000 141434498.99548 18 average net salary 1035.7778 262.30260 18 unemployment, total (% of total labor force) 27.3079 2.00943 18 gross domestic income (constant lcu) 24073220032.1667 3036558289.97812 18 gdp per capita (current us$) 3848.6667 1366.86275 18 wage and salaried workers, total (% of total employment) 66.5221 6.48730 18 households and npishs final consumption expenditure (current us$) 12811176132.8333 2684992943.38614 18 source: authors using spss below is an output that refers to the multiple regression model which was implemented on the data obtained for both countries involved in the analysis. table 3: model summary along with the values of r and r square – serbia model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .962a .925 .920 7023512.91992 .925 196.491 1 16 .000 2 .981b .962 .957 5152189.94256 .037 14.733 1 15 .002 3 .992c .983 .980 3548389.97989 .021 17.624 1 14 .001 4 .996d .993 .990 2444365.32992 .009 16.502 1 13 .001 a. predictors: (constant), average net salary b. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$) c. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu) d. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu), unemployment, total (% of total labor force) source: authors using spss 32 economic analysis (2019, vol. 52, no. 1, 23‐35) in the case of variables describing the insurance market in the republic of serbia, four models were generated, where the last model was selected having the highest value of the coefficient . the value in this case shows that 99.3% variations in total premium can be explained by selected four variables and this model can be considered appropriate to develop the regression equation. the independent variables selected by the above mentioned model are as follows: average net salary, households and npishs final consumption expenditure, gross domestic income and unemployment, total (table 3). the following table shows the unstandardized and standardised regression coefficients for all models. in the last model, t‐values for all the two regression coefficients are significant as their significance values (p‐values) are less than 0.05. therefore, it can be concluded that the previously selected 4 independent variables significantly explain the variations in the total premium. table 4: regression coefficients of selected variables in different models along with their ‐ values and partial ccorrelations – serbia model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) 4460520.406 3606405.932 1.237 .234 average net salary 129.906 9.267 .962 14.018 .000 .962 .962 .962 2 (constant) 14150355.208 3656718.281 3.870 .002 average net salary 178.058 14.268 1.318 12.479 .000 .962 .955 .628 households and npishs final consumption expenditure ‐.001 .000 ‐.405 ‐3.838 .002 .753 ‐.704 ‐.193 3 (constant) ‐66019515.273 19262250.240 ‐3.427 .004 average net salary 102.779 20.448 .761 5.026 .000 .962 .802 .174 households and npishs final consumption expenditure ‐.002 .000 ‐.640 ‐6.977 .000 .753 ‐.881 ‐.242 gross domestic income 4.254e‐5 .000 .786 4.198 .001 .934 .747 .145 4 (constant) ‐49098413.472 13907538.352 ‐3.530 .004 average net salary 107.565 14.135 .796 7.610 .000 .962 .904 .182 households and npishs final consumption expenditure ‐.001 .000 ‐.550 ‐8.200 .000 .753 ‐.915 ‐.196 gross domestic income 3.880e‐5 .000 .717 5.512 .000 .934 .837 .132 unemployment, total (% of total labor force) ‐783350.327 192833.041 ‐.114 ‐4.062 .001 .250 ‐.748 ‐.097 a. dependent variable: total premium source: authors using spss using the values of the unstandardized regression coefficients of the last model presented in table 4, the following regression model can be shown: 49098413.472 107.565 0.001 0.0000388 783350.327 tijana kaličanin, sandra kamenković, ivana simeunović 33 concerning the same analysis carried out for the data from bosnia and herzegovina, two models were generated, where the second one was selected for which the value of 0.983 was assigned for the determination coefficient (table 5). in this way, a multiple hierarchy model was formulated which combines two independent variables as follows: gross domestic income and wage and salaried workers, total. since the f‐value for this model is highly significant, the model is reliable. also, the regression coefficients in the stipulated model are statistically significant, and it is considered that the selected variables have a great predictive significance in estimating the value of the total premium. table 5: model summary along with the values of r and r square ‐ bih model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .975a .951 .948 32128444.21790 .951 313.443 1 16 .000 2 .992b .983 .981 19491967.96979 .032 28.470 1 15 .000 a. predictors: (constant), gross domestic income (constant lcu) b. predictors: (constant), gross domestic income (constant lcu), wage and salaried workers, total (% of total employment) source: authors using spss the last table contains the values of the regression coefficients for the previously selected model. table 6: regression coefficients of selected variables in different models along with their ‐ values and partial correlations ‐ bih model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) ‐663490820.738 62238137.572 ‐10.661 .000 gross domestic income .045 .003 .975 17.704 .000 .975 .975 .975 2 (constant) ‐827546449.311 48694106.929 ‐16.995 .000 gross domestic income .035 .002 .759 14.452 .000 .975 .966 .483 wage and salaried workers, total (% of total employment) 6110923.803 1145287.155 .280 5.336 .000 .866 .809 .178 a. dependent variable: total premium source: authors using spss regression equation, which can explain the variability of the observed total premium variable analysing trends in selected independent variables goes as follows: 827546449.311 0.035 gross domestic income 6110923.803 wage and salaried workers 34 economic analysis (2019, vol. 52, no. 1, 23‐35) conclusion after 2008, the share of the insurance sector balance sheet total in serbia and bosnia and herzegovina increased in the same period for the same percentage – 2.1%. the number of insurance companies with foreign equity in serbia has changed proportionally with the total number of companies present in the market whereas the number of the foreign insurance companies in bosnia and herzegovina remained almost the same although the total number of the insurance companies increased. the concentration of leader ratio (cr1) in bosnia and herzegovina is much lower than in serbia, so the leader in this market has a share of about 10% of the entire market while in serbia it is about 27%. although there is a moderate tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. it can be concluded that in the last decade the insurance market in serbia is medium concentrated according to herfindahl‐hirschman index calculated by total premium and it differs significantly in the market of bosnia and herzegovina, where permanent low‐concentration bid is present in the observed period ‐ there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. in this paper, the multi‐linear regression model was applied in order to analyse the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐ 2017. we can conclude that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had average net salary, households and final consumption expenditure and gross domestic income. therefore, there is a positive correlation between household income (including salary and other income) and premiums. also, in the periods when household expenditure was higher, the amount of total insurance premium was also higher. both of the selected economies have undergone changes in the financial sector, particularly in terms of recent regulatory reforms. this paper provides information on the determinants of insurance demand in the republic of serbia and bosnia and herzegovina. this research is limited to a macro level analysis of the insurance demand. further, detailed analysis can be performed on individual life insurance products, 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(1998). die nachfrage nach lebensversicherungen: eine empirische analyse für china, mannheimer manuskripte zu risikotheorie, portfolio management und versicherungswirtschaft 112, universität mannheim. www.nbs.rs www.azobih.gov.ba www.data.worldbank.org article history: received: april 1, 2019 accepted: may 29, 2019 doi: 10.28934/ea.19.52.12.pp56-68 scientific review the impact of globalization on entrepreneurship mirjana radović-marković1 | zvonko brnjas1 | vladimir simović1* 1 institute of economic sciences, belgrade, serbia abstract this paper aims to explore the importance of globalisation for the development of entrepreneurship. changes in the global business environment require new business strategies. small business owners are expected to be able to develop the resiliency of their businesses so that they can face severe external conditions. their sustainability depends on resilience but also on the perspectives of longterm business operations. therefore, small and medium-sized enterprises must demonstrate their ability to anticipate changes in the market, react to them, and initiate them. this implies the improvement of basic processes, learning new skills and closer cooperation with external and internal partners. small enterprises need to redefine their goals and use their resources more effectively as a necessary condition for expanding maneuvering space for growth and for achieving sustainable development. finally, it is concluded that organisations must establish the right balance between the challenges and benefits of globalization and the four basic areas for achieving the right balance are adequate cost, human resources and risk management, as well as the formulation of a strategy that follows the requirements of the global market game. key words: globalization, entrepreneurship, global index of entrepreneurship, organization, competitiveness, resilience jel classification: m13, f690, m15 introduction the analysis of the implications of globalisation for the development of entrepreneurship is of particular importance, bearing in mind the overall significance of entrepreneurship. however, this impact varies depending on the level of economic development of a country and the degree of its integration into the global business environment. therefore, it has long been assumed that highly developed and globally integrated countries have a developed entrepreneurial sector, measured by the global index of entrepreneurship. it determines the impact of globalisation on the development of entrepreneurship at the level of individual countries. it is also an indicator of the quality of entrepreneurship, especially related to the effects of entrepreneurship and innovation, which are conditioned by individual and institutional factors. in addition to the differences in the global index of entrepreneurship, what is common to most countries is the fact that with the growth of globalisation, the number of start-up companies and new jobs are growing; there is an increase in innovation and effective and rapid absorption of technological progress. globalisation influences following the strategy of the company more than before, which in today's terms implies multifunctional teams. this is also an explanation of why globalisation can never be tied only to business with one region or market. accordingly, * corresponding author, e-mail: vladimir.simovic@ien.bg.ac.rs vladimir simović, mirjana radović-marković, zvonko brnjas 57 global companies differ in their ability to serve a large number of markets, but also in their possibility to take advantage of all market opportunities and increase their competitiveness. the method of analysis is primarily based on a review of the latest literature on this topic. the theoretical framework presented in this paper provides a starting point for the study and analysis of the relationship between the level of globalisation and the level of entrepreneurship. literature review literature abounds mainly with papers dealing with the effects of globalisation on the business and performance of large multinational corporations (drucker 2001; mazlish, 2012; haller, 2016; button, 2018), while there is a lack of equivalent studies that explore these effects on the example of small and medium-sized enterprises. drucker (2001) states that multinational companies are more knowledge-oriented, while hierarchies are less important within the organisation. they are particularly characterized by a high level of professionalism (employees are rather professionals than just executives), independence (employees have decision-making rights, flexibility in the activities they perform, access to continuous training and education) and they identify with company values. the last decade of the 20th century became a testament of the market power, benefits of integration processes and globalisation (pesakovic,2017). globalisation has also affected small and medium-sized enterprises in the fact that they have changed their role, first of all, in national economies. namely, globalisation represents new challenges for small and medium enterprises, leading them to integrate the idea of global changes into their business strategies. in this way, by changing their business strategy in global terms, they would become less sensitive to internal and external shocks and raise the index of resilience (radovic-markovic, 2019). to what extent the economies deal with shocks depends on various factors, including the political environment, the depth of economic and financial diversification, and especially the quality of institutions and the economic structure of the economy. in addition, countries that have well-developed business plans and action plans in case of disaster risk, as well as programs for assessing the resilience of enterprises, showed a higher index of resilience than those who did not have it (radovic-markovic, 2018). the study found that the index of resilience is highly correlated with gdp per capita, suggesting that economic resilience is associated with economic success. namely, despite the high exposure to external shocks, a large number of small countries manage to maintain economic growth and continue their development, given their relatively high gdp per capita (radovic-markovic, 2019). since the influence of many factors arising from globalisation is different for small and medium enterprises in relation to multinational companies, it is necessary to identify the most important factors and to determine their effect. one group of researchers identified the two most important factors of globalisation that directly affect small and medium enterprises (deo, 2013): 1. growth of cheap communications and transport (with the improvement of information technology and cheaper transport, new opportunities have opened up for many companies, especially for small and medium ones). 2. internationalisation of businesses depending on financial and economic integration. also, research has shown that there is no correlation between the big market and the success of large businesses. in other words, globalisation rewards companies that are innovative and competitive, regardless of the size of the organization and the country of origin (radovicmarkovic and tomas, 2019). in addition, employee competencies play a major role in achieving success in the global market (radovic-markovic, 2011). there is great agreement among researchers that e-skills are becoming increasingly important for improving competitiveness, productivity and innovation, as well as for hiring a workforce and its professionalism. in this sense, the need to provide the knowledge, skills and competencies of managers and it specialists in this field, as well as the users, is very evident in order to influence the fulfilment of 58 economic analysis (2019, vol. 52, no. 1, 56-68) the highest global standards, which are continuously improved through the process of effective lifelong learning. the researchers also put entrepreneurial orientations, behavior of entrepreneurs, their personality traits, leadership styles, the influence of entrepreneurial education on the success of entrepreneurial business, and the cultural aspects of entrepreneurship in the global context (lee, lim & pathak, 2009, lepoutre et al. al., 2010, ryan, tipu & zeffane, 2011, radovicmarkovic & tomas, 2019). it was found that various exogenous factors, such as cultural specifics and experience, had implications for the development and types of businesses, as well as the background of family businesses and emotional intelligence of entrepreneurs (pradhan & nath, 2012). namely, the conditions leading to entrepreneurial activities range from personal, cultural and institutional, and are influenced by the levels of business innovation, variety of offers (products and services) and individual entrepreneurial efforts (wennekers, thurik, 1999). having in mind the various approaches to the research of entrepreneurship, it can be concluded that entrepreneurship has become a point of interest among many researchers. in the first place, all the schools of entrepreneurship can be classified into special categories (radovicmarkovic, 2009): a. psychological schools those examining personal qualities of entrepreneurs and their psychological characteristics b. traditional schools those based on recognizing the new opportunities in entrepreneurship c. management-based schools those dealing with the management and leading of entrepreneurial activities in recent years, the schools that can also be added are those that focus on the development of entrepreneurship in the global business environment by examining its legal (parker, 2007; loza, 2011), socio-cultural (valdez & richardson, 2013; nagayya & tirumala 2013; ghiat, 2014; and economic aspects (kropp, lindsay, & shoham, a., 2008; singh, garg, & deshmukh, 2010; radovic-markovic & tomas, 2019). the two-sided impact of globalization on small and medium-sized enterprises (smes) the impact of the phenomenon of globalisation today has become comprehensible and has affected all areas of life. of particular importance is its impact on the economy, and here we are interested in the impact on one very important segment of the economy: small and mediumsized enterprises (smes), as one of the key agents of the development of entrepreneurship and innovation. the impact of globalisation on smes, like in other areas of life, is twofold. on the one hand, it opens up the unobserved opportunities for developing smes, primarily through the opening of new markets that were completely inaccessible to them in the past. by their nature and in accordance with their resources and general capacities, smes are targeted at local markets. the main drivers of globalization in today's conditions, primarily the development of information technology and traffic, annul the basic handicaps of small and medium-sized enterprises that are related to the inability to communicate effectively with the distant markets, how to get information about customers and suppliers, and how to send information about them in the other direction. thanks to the availability of the market in terms of simple and efficient communication and information exchange with its stakeholders, as well as increasingly easy and cheaper ways to overcome spatial and other geographical barriers, smes are becoming more and more able to become equal participants in economic activities in the most distant international markets. on the other hand, these same factors allow real and potential sme competitors from international markets to suddenly appear on local markets that are considered to be their safe "protected zone" until recently and dramatically threaten existing positions and relationships. vladimir simović, mirjana radović-marković, zvonko brnjas 59 the characteristics of smes competitive models in a global environment according to the namiki model (mckinnon, 2003); small and medium-sized enterprises in the competitive struggle on the global market have available four of the following strategic forms of competitiveness: • becoming competitive by pricing. this model or strategy implies that smes, due to their flexibility, lower administrative costs, knowledge of the local labour market and in general procurement, are able to offer their products at lower costs than large local companies and most international competitors; • competing by unique capabilities in production (reliance on a unique, innovative product, a wide range of products, and so on) .this model is based on the production capabilities that enable smes to offer products that will more fully meet the expectations and needs of customers compared to competitors. this type of sme can supply end-users, but also very often are contractually linked to large corporations that supply certain inputs on a long-term basis. • competing by technological superiority. this type of competitiveness model refers to smes that have emerged and are developed under the influence of factors such as genuine innovative-technological solutions, inventions or expertise, which give them a superior position in relation to existing standard technological solutions used by competitors. this advantage in technology gives companies possessing it a significant market advantage over competitors. • competing by high quality of services and/or products. finally, smes can differentiate themselves from competitors with the high quality of their services and products. in addition to the technology that is especially distinguished in the previous model, this type of competitive advantage can also be based on superior market knowledge, some specific segments of clients, and the ability to satisfy their needs in the best possible way. if a company can combine these models, i.e. to achieve a competitive advantage based on several factors, insofar as this will more favorably affect its market position. for example, if at the same time it can offer a technologically superior product at lower prices and to a greater degree adjusted to the needs of its clients, then it can count on a superior market position over the long term, with the expected continued stable financial results. essentially the described strategies are reduced to the differentiation strategy in specific market segments, which is achieved by the specialization and high quality of products and services. the limitation of resources as a general characteristic of smes necessarily directs them to strategies based on entrepreneurship and innovation, which means to specialization, i.e. focusing on narrower market segments where they can be imposed as superior competitors and thus differentiate in relation to their competitors. this strategy allows them to avoid direct conflicts with large corporations in which, due to limited resources in the long run, they have no chance. it also allows them to occupy specific niches in which they can satisfy the needs of clients, including large corporations with whom they can establish cooperative relationships, instead of entering, for them into a very uncertain relationship of competitive conflicts. competitiveness factors for smes in the global market the global environment is characterized by its growing complexity and uncertainty. the theorists of strategy and strategic behaviors believe that such an environment necessarily requires companies, both large and smes, to provide an entrepreneurial strategic response (covin, & lumpkin, 2011). when defining a strategy, it is no longer enough to merely make rational decisions that take into account the existing market situation, relations between competitors and similar; but rather it is necessary to make entrepreneurial decisions that create new relationships in the market and establish new "rules of the game" in a competitive bid. 60 economic analysis (2019, vol. 52, no. 1, 56-68) the key factor for adapting to the complex global environment and successful internationalisation of business is the ability of smes to develop new technologies and to be competitive in the launch of advanced technological solutions and procedures (gagnon, sicotte and posada, 2000). in this domain, certain limitations of smes have been observed, which are primarily reflected in their often insufficient administrative capacity and the establishment of robust operational procedures that are a prerequisite for the efficient management of complex production and technological systems necessary for the development and continuous production of new products. the importance of technological development for smes has been observed in both developed and developing areas (almubaraki & aruna, 2013). research has shown that market and site clustering can significantly improve the performance of smes and help them empower their strategic position (requier-desjardins, boucher, & cerdan, 2003). such groupings, due to their geographical proximity, significantly facilitate communication between these companies and lower transport costs, thus enabling synergetic effects in their operational functioning. these effects are manifested when there is direct production-business cooperation between these companies, but often in an indirect way, through the facilitated exchange of knowledge and experience. globalisation very often has a direct positive impact on the grouping of companies, including smes and their clustering. many countries, as well as regions and local governments, today bring a series of measures that encourage companies to be located on their territories. for this purpose pre-arranged and specially equipped locations are specially offered under very favourable conditions (industrial zones, business centres, innovative centres, etc.) so that they group the companies of similar or related activities. organizational forms of entrepreneurs in a global environment the global environment, as already mentioned, exposes standard business and entrepreneurial practices to many challenges that are multiplying and becoming more and more complex. on the other hand, it opens up many new opportunities and chances: in many activities, today there are completely new forms of doing business activities in general, especially entrepreneurial activities. further, some of the previously existing forms of activities are gaining new content and are becoming increasingly important. according to the global entrepreneurship monitor (gem, 2018/2019 global report), in the modern conditions at the global level, the following four forms of entrepreneurial activities are especially distinguished: • "solo" entrepreneur • entrepreneurial employee activity • family entrepreneurship • "gig" entrepreneurship or entrepreneurship based on internet platforms the "solo" entrepreneur. entrepreneurial activities usually relate to an individual who appears as a leader of a smaller or larger team. he is the driver of an entrepreneurial initiative, and often at later stages of company development, and organizer and manager of operational processes. the emerging phenomenon is that a growing number of entrepreneurs decide to start, but also to continue to perform all business and entrepreneurial activities on their own, that is, to act as a "soloist", without associates, partners and employees. the reasons for this phenomenon can be found first in technological changes that allow certain activities to be completely transferred to, in a word, machines. for this reason, in some situations, instead of employing associates, they can rely on technology, especially for the purpose of performing less complex, technical tasks. these possibilities are at the same time based on changes in work habits and preferences of individuals: there are more and more people who are unwilling to submit themselves to rigid corporate procedures, externally imposed discipline, specific value systems but prefer autonomy and independence in their work. vladimir simović, mirjana radović-marković, zvonko brnjas 61 the percentages of entrepreneurial activities carried out in this way are becoming more and more important. according to gem report from 2018 in the netherlands, about 23% of entrepreneurial firms are entrepreneurs "soloists"; in spain, great britain, italy, germany and sweden, over 15%. this trend is also very pronounced in less developed countries. brazil is one of the countries in which this form of entrepreneurship becomes dominant: according to the same report in this country, where the enterprise becomes characteristic of this phenomenon, as many as 53% of entrepreneurs operate alone. the next country in which solo entrepreneurs are highly represented is madagascar (over 30%). the entrepreneurial employee activity. entrepreneurship is most often viewed and studied as the activity of autonomous, independent individuals (owners and managers of newlylaunched and already existing entrepreneurial businesses, as well as already mentioned “solo” entrepreneurs). in recent years, more and more attention has been paid to entrepreneurial activities driven by people who are employed in already existing companies. this phenomenon denotes entrepreneurial behaviour within an existing company in which employees take the immediate responsibility to turn an innovative idea into a profitable business. it is often referred to in the literature as "entrepreneurial activity of employees"1, and also often the term intrapreneurship, which was first introduced at the end of the last century, is often used (pinchot, 1984). interestingly, the entrepreneurial employee activity (or eeas) in some countries viewed by the participation in overall entrepreneurial activities is equally important as independent entrepreneurship. this is the case in sweden, germany and cyprus, while in the netherlands and canada, this form of entrepreneurship has somewhat less participation, albeit with it, its movement closely correlates with the trends of independent entrepreneurship (gem, 2018/2019 global report). the research of these two forms of entrepreneurship has shown that, according to some key parameters between their bearers (the two types of entrepreneurs: independent and employed in companies), there are essentially no major differences (nyström, 2012). it turned out that both groups perceive in the same way, i.e. highly value entrepreneurship in terms of three indicators, namely as a good choice regarding the development of one's own career, according to the social status that they can have as successful entrepreneurs and the attention given to them by the media. however, the difference is seen in perceiving the opportunities for entrepreneurship and having the knowledge and skills to start a new business. employed entrepreneurs, namely, as well as those independent, consider that the chances of starting entrepreneurial activities are good, but unlike independent ones, they feel that they do not have enough knowledge and skills to start a new business on their own. family entrepreneurship family business, especially within smes, is a phenomenon whose significance has been observed for a long time, and as such has been the subject of numerous research, as well as specific measures of active economic policy. what is more specifically indicated to in recent times is family entrepreneurship. family entrepreneurship is defined as an entrepreneurial business involving more members of one family. a family entrepreneurial company is distinguished in which members of one family jointly own and/or actively participate in the management of a company from a company in which ownership and management is not shared among family members, but they are only part of the collective (family members are employed by the company without managerial and proprietary rights). according to the gem definition, the first form is said to be the complete form of family entrepreneurship, and the second the partial form of family entrepreneurship (gem, 2018/2019 global report). family entrepreneurship is particularly pronounced in start-ups. namely, entrepreneurs turn to the family most often during the first stages of starting their businesses. this phenomenon is 1 entrepreneurial employee activity (eea) 62 economic analysis (2019, vol. 52, no. 1, 56-68) particularly pronounced in asia; thus, for example, in china and thailand, every fourth started business involves more members of one family. in europe and north america, this trend ranges between medium and highly present: in switzerland and bulgaria, for example, about 30% of newly-established companies have characteristics of family entrepreneurship. countries with this characteristic are least visible in poland and the uk. in examining the development of family businesses in serbia, grozdanic and radovic-markovic (2015) emphasize that resource-limited family businesses must use internationalisation as a strategy to address current resource requirements. they also state that economic policymakers in the country need to improve general business parameters so that business internationalization can become faster, and resources can be easily transmitted across borders. "gig" entrepreneurship or entrepreneurship based on internet platforms. the development of information technology and the process of globalisation, which alongside it is causative, have initiated the development of a phenomenon that can in many respects be considered the beginning of some completely new forms of entrepreneurship and forms of work in general. they have the potential to make a real revolution in the organisation of work at the micro level (level of the individual workplace), but also at the macro level in terms of the way companies organize their operational processes. it is an economy based on internet platforms for which a completely new term is crafted: the "gig" the economy. "gig" economy denotes a situation in which individuals offer their services to small and large companies on the basis of individual contracts. the business operations are therefore not performed on the basis of employment of people with certain skills, qualifications, etc. but an agreement is being made to provide a specific service. this type of work is suitable for service providers (the so-called "freelancers") because it provides them with flexibility and autonomy; on the other hand, for companies, this form of human resources security is cheaper and gives them also considerable flexibility in conducting operational activities. the "gig" economy formally represents a form of work that has long been present in the practice of employment: technically, it is temporary work. what, however, in contemporary conditions of globalisation gives a completely different dimension to this form of work is the inclusion of it technology which opens to both sides (service providers and companies) unprecedented opportunities in terms of market capacities and potentials. special internet platforms have been developed (such as "99 designs", "airtasker", airbnb and others) that link service seekers (companies), on the one hand, and service providers ("freelancers"), on the other hand on a global level. thanks to information technology, locations of both companies and freelancers become irrelevant, so partners in these forms of work can be from completely different parts of the globe. due to the role of the internet in these processes, the "gig" -the economy is also called an economy based on internet platforms, a sharing economy or a network economy (frenken & schor, 2017). given that this is a new phenomenon, there is still no comprehensive statistics on the number and share of this type of economy in total economies. some individual assessments, however, indicate a high share of this kind of work in the total number of employees and a very dynamic trend of its further growth. thus, it is estimated that in south korea, every fifth adult resident participates in a "gig" economy; high participation of this phenomenon is also registered in israel, ireland and the united states (gem, 2018/2019 global report). the analysts of this phenomenon especially point to another potentially very positive effect of the "gig" of the economy. "freelancers" and all others engaged in the "gig" economy represent a significant reservoir of future entrepreneurs. namely, "gig" entrepreneurs are only a step away from the other forms of entrepreneurship described above, especially from soloentrepreneurship. the extent to which people that perform certain economic activity through individual contracts will be devoted to establishing a separate firm and starting their own entrepreneurial business depends on the environment. in this regard, economic policymakers vladimir simović, mirjana radović-marković, zvonko brnjas 63 are suggested to pay special attention to this (potential) entrepreneurial population by creating a special set of incentive measures for them. it should be pointed out, however, that in addition to all of the above mentioned positive effects, the "gig" economy also brings certain risks and controversies (kobie, 2018). they are mainly related to limiting the rights of employees: companies in these relationships often, in the effort to reduce costs, do not pay ordinary employment benefits (health and pension insurance, etc.). therefore, as part of the above-mentioned incentive measures for the "gig" economy and "gig" entrepreneurs, it is necessary to pay attention to ensuring fair working conditions in which employees in this form will have all forms of social protection, identical or similar to those obtained in other forms of employment. it is significant that countries will simultaneously provide fiscal support for this type of work, which has a growth trend in the future. gender aspects of entrepreneurship in the last two decades, there are first studies that focus on gender aspects of entrepreneurship. in many countries, their need to realize themselves in their work through the realization of their business ideas has not been properly understood and recognized for a long time (radovic-markovic, 2012). for these reasons, there was no longer a significant period of significant research. even in the late 1980s and early 1990s, literature was concerned only with male entrepreneurs (loza, 2011). therefore, only in the late 1990s papers appeared in the literature citing the importance of the special study of women as entrepreneurs (wortman, 1987, devine, 1994; coleman, 1998). they mostly deal with women in business only as an economic and social phenomenon. however, recent studies on women entrepreneurship expand the scope of their research, focusing on five thematic areas (radovic-markovic, 2007): 1. studies dealing with the motivation factors of women who decide to establish their businesses 2. studies dealing with the constraints faced by women who want to engage in entrepreneurial activities 3. studies dealing with models of female entrepreneurship 4. studies examining the "entrepreneurial culture" of entrepreneurial women 5. studies examining the types of businesses that women are dealing with also, there are more and more studies dealing with the economic potentials of women, which put their research into a global context (karnani, 2007; minniti, 2010; radovic-markovic, 2007, 2011, 2019). information technologies and entrepreneurship the development of information technology, the internationalization of businesses, globalization and other processes whose influence on the development of entrepreneurship is analyzed in the previous part of this paper are inextricably linked to the development of the internet as a global medium, which by its occurrence has drastically changed the way companies conduct their business operations, led to the emergence of new business models and the creation of a new, unique virtual market. according to data from relevant agencies (internet world stats, 2019) in march 2019, the number of internet users in the world was around 4.38 billion, or about 56.8% of the world's population. in developed regions of the world (north america and europe) penetration of internet users is between 86% and 89%, which is a huge, highly payable virtual market. this fact, together with all the other advantages of internet business, is one of the main reasons for the expansion of internet-based entrepreneurship in recent years. 64 economic analysis (2019, vol. 52, no. 1, 56-68) with its occurrence, the internet has led to the emergence of new business models, many of which could not even be imagined before the emergence of the internet. by using and combining different business models, contemporary entrepreneurs create new value by using their distinctive advantages and market dynamics (tallman et al., 2017). below are some of the most common business models of internet business systematized: 1. business models based on commission (commission based model). the essence of this model is in a business that provides a dedicated service for a fee (commission) (lumpkin, dess, 2004). an internet business that applies this business model in its business usually has the role of intermediary between, on the one hand, customers and, on the other hand, sellers. by facilitating transactions between buyers and sellers, the broker earns from the commission he charges, usually to the seller. there are many variations of this business model that have surfaced over time on the internet, such as services that connect consumers and sellers of fast food (donesi.com), services that connect buyers and sellers to auctions (limundo.com), services that link owners of apartments and travelers (booking.com) and the like. 2. business models based on advertising (advertisement based model). the essence of this business model is the free provision of content and services to visitors who are subsequently monetized through the payment of advertisements. the best-known example of a service that has monetized its popularity globally through the advertisingbased model is google. google has created two parallel services that monetize its enormous popularity. the first is called google adwords and is intended for business owners who in this way, want to advertise their service using google's platform. the second service is google adsense and is intended for owners of popular sites who, by connecting to this service, give google some part of the ad space to advertise advertisements from other advertisers. in addition to google, the second largest online platform that monetized its enormous popularity through a business-based advertising model is facebook. google and facebook are certainly gigantic internet entrepreneurs, but a large number of other, smaller service-providers offering different, usually free content to their users, later monetize their popularity through a business-based advertising model. 3. merchant business model. it is a business model that has its foundation in a real environment and classical trade, regardless of whether it is a wholesale or retail sale. this type of business model is equally represented in both the click and mortar companies and virtual companies, that is, with companies that normally operate in a real environment that use the internet to expand its market boundaries and reduce costs and companies operating exclusively on the internet. the essence of this business model is to obtain cheaper and sell more expensive, using the advantages that the internet carries with it in terms of significantly lower operating costs and greater geographic reach. examples of large and successful companies that apply this business model in their business are numerous and varied. some examples are amazon and aliexpress, but the internet market is full of many other successful internet businesses that apply this business model in their business. 4. manufacturing business model. as the title suggests, it is a business model in which the entrepreneurial idea is based on production based on the use of available raw materials and intermediate goods. two basic categories of advantages that the internet has contributed to by its appearance, and in the context of this business model, are considerably lower marketing costs and the ability to produce personalised product versions, which has a very beneficial impact on consumer loyalty (lumpkin, dess, 2004). a company that is a representative example of the successful implementation of this business model is dell. vladimir simović, mirjana radović-marković, zvonko brnjas 65 5. affiliate business model. the basic assumption of this business model is in rewarding business associates for traffic (visitors) who come from their websites to the merchant website that has launched an affiliate business model with the aim of undertaking some concrete action: purchasing, registering, application to mailing lists etc. for any action taken by the visitor who came from the affiliate's website on the merchant's site, the affiliate receives a certain fee. in this way, the market reach significantly increases and reduces the costs of marketing. an example of a company that owes its initial market success precisely to the business model of the associate is amazon. 6. subscription-based business model. the essence of this business model of modern entrepreneurs is to charge subscriptions at a monthly and/or annual level in the name of providing a kind of service or content that is made available to users. companies that provide hosting services to users are an example of this business model. content creators such as netflix are also examples of internet companies that base their business models on the subscription model. 7. software as a service business model (saas). progress in cloud computing has led to the emergence of a variation of this technology called software as a service. the essence of this technology is that software is placed on remote servers and thus made available to users instead of a traditional approach that involved purchasing a software license and installing software on a local machine. some providers, using this business model, do not charge any fees to users (for example, google's drive service). this business logic is conditioned by monetization through another business model, in the case of google's advertising. 8. the fee for service model. the essence of this model is that providers charge content or other types of resources that they make available to their users according to actual consumption or the degree of use that the client has in a given period. for example, eproject.com provides its clients with a virtual work environment equipped with collaboration tools and charges them with the degree of utilization of these resources during the month. these business models of modern entrepreneurs represent only a copy of those models that over time, have been clearly differentiated and demonstrated that they have significant potential for purposeful business use. in addition to the above, there are a number of other business models in the modern business practice, whose number practically has no limits, since the business model settings that will be applied in internet business are limited only by the imagination and the entrepreneurial imagination. one of the most important features of modern entrepreneurs is flexibility. in this regard, the selected business models of successful internet businesses often involve a combination of several different business models. competent managers, who are at the forefront of innovative entrepreneurial ventures, should use a wide range of new, technologically-supported options in formulating their strategies in order to respond to changes, rather than just reacting to them (radovic-markovic et al., 2018). the combination of innovative business models is one of the good examples of such a practice. educating entrepreneurs also plays a very important role in this process (simovic, radovic-markovic, 2018). as suggested by fjeldstad and snow (2018), the business model choice is directly related to organisational design and performance. the goal of combining different business models is to provide a competitive advantage and more potential revenue sources for the entrepreneurial enterprise (revenue streams). conclusion this paper presents a systematic effort to perceive, through the analysis of relevant literature in the field of entrepreneurship, processes that have a dominant influence on the development of entrepreneurship in the 21st century. although entrepreneurship as a practical activity appears 66 economic analysis (2019, vol. 52, no. 1, 56-68) in antiquity, the creation of a scientific-theoretical framework has been implemented only since the mid-18th century. given that each country has its history and vision regarding its integration into global business flows, it is necessary to take into account their size and their diversity; variations in their inclusion in international trade; their geographical, ethnic and cultural differences; and differences in the degree of their economic development. the opinions in regards to the effects of globalisation on the development of small and medium enterprises are different in scientific circles. on the one hand, it is claimed that the turnover of the global market would improve the access of smes to foreign inputs and international finance, while on the other hand it would be considered that globalisation could only intensify restrictions for smes and jeopardise their ability to survive in global business frameworks. despite the fact that many researchers believe that small and medium-sized enterprises are endangered in the global business environment due to limited size and resources, they play an important role in this type of internationalization (radovic-markovic & tomas, 2019). besides many differences, what is common to most entrepreneurship theorists is the fact that smes can succeed in global processes if they can increase economic competitiveness and innovation. consequently, this paper provides integrated insight into the models and factors of competitiveness of smes in the global business environment. the organisational forms of entrepreneurship in the global environment have been thoroughly analyzed, and the current views of the scientific community on this issue are presented. examples of leading smes around the world emphasise that specific information and communication technologies, then innovations and the implementation of strategic risk management and risk management in small businesses are becoming more and more important for their survival and development. therefore, a special segment of the paper deals with the analysis of the relationship between the internet and modern entrepreneurship. in this segment of the paper, business models of modern entrepreneurial ventures on the internet were analyzed, and the importance of combining business models was pointed out with which modern entrepreneurs resort to the goal of achieving competitive advantage. speaking about the future of the entrepreneurial sector, a large number of researchers in the world believe that 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(2016). progress-report pradhan mantri jan dhan yojana as on april 20, 2016, http://www.pmjdy.gov.in/account, retrieved on april 29, 2016. ea_2016_3-4 udc: 005:336 658.115:656.2(497.11)"2014/2015" jel: g30, g39 cobiss.sr-id: 228332556 scientific review problems of financial management in the public sector anđelić slavica1, gajić aleksandar2, ilić djordje3 high business school "prof. dr radomir bojković "kruševac, srbija abstract – the paper discusses the financial management in the enterprise serbian railways. the construction of the first railroads in our country began back in the mid of the last century, when a large part of our territory ruled by the austro-hungarian monarchy and the ottoman empire. the development of railway transport in the region saw the expansion of the late nineteenth and early twentieth century, twisting in the territory of the then country: serbia, montenegro, austriahungary and turkey. today serbian railways railway network is 4.347km, 1.387km of which electrified (32%). the main activity of eating the transport of passengers and goods, hauling the trains and maintenance of traction units, trains and rolling stock, track maintenance and control over them, control over other lines and station structures and installations, maintenance and construction of equipment and installations. the significance of this research is the promotion of modern methods of financial management and for pointing out the importance of the same for efficient business operations. using modern methods of financial management it is possible to identify and monitor the needs for financial resources and their sources. it is de facto one of the central category of financial management. the main objective of this study is to monitor and analyze the financial resources of the company "serbian railways", that they are optimal from the viewpoint of the situation and trends, and to the short and long term. financial management includes compliance tools and resources in the process of business where revenues are greater than expenses. it is therefore important that in addition to the scope, structure and resources to be covered by the method of determining the necessary financial resources. key words: finance, management, financial ratios, results, financial plan 1 slavica anđelic, high business school "prof. dr radomir bojković "krusevac, srbija, e-mail: slavica.andjelic@indmanager.edu.rs 2 aleksandar gajic, high business school "prof. dr radomir bojković "krusevac, srbija, e-mail: alaksandar.gajic@indmanager.edu.rs 3 djordje ilic, high business school "prof. dr radomir bojković "krusevac, srbija, e-mail: djordje.ilic@indmanager.edu.rs anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 49 introduction modern approach to financial management emphasizes the continuous earning ability of the company, ie the ability to make a profit through the implementation of strategic objectives (growth, development and market share). modern methods of financial management assume that the assessment of the financial situation must be based on the correlation of the balance sheet and income statement. the necessity of using both reports originating from their character as balance sheet and income statement are connected parts of one whole. these changes in the economy have contributed to the increasing responsibilities of financial managers, which includes: • determining the amount of funds that should be engaged, depending on the size of the company and growth rates, • raise funds on favorable terms and determining duties, • allocation of funds in the form of determination means, • management of working capital. (ljutic, 1995, pp. 308). the responsibility of managers for the contemporary theory is focused on internal and external stakeholders of enterprises (shareholders, creditors, state, employees, suppliers and customers). these responsibilities of managers imposed the application of modern scientific methods in making financial decisions, which contributed to the development of the theory of financial management as a scientific discipline. businesses initially used traditional methods in making financial decisions. however, the modern theory of financial management contains a systematic approach to making decisions about the optimal use of financial resources, aimed at achieving the goals of the company. it can be said that modern scientific conceptions emphasize the need to adapt ways of managing the implementation of the strategic and financial objectives of the company in accordance with the principles of productivity, profitability and competitiveness. this means that modern methods of financial management attach importance to the competitive position and competitive advantage of companies in the market. competitiveness indicators rooted in the different levels of customer satisfaction. inclusion of customer satisfaction is expanding the number of indicators of operating performance in the modern financial management. there are basically the following six performance indicators, strategic financial management companies: • the performance indicators in relation to competition, such as market share, participation in a particular segment of consumers, growth, etc., • the financial performance indicators, such as profitability, liquidity, capital structure, etc., • the quality of services, such as availability, reliability, acceptability by consumers, accessibility, etc., • the flexibility of the "package deal", such as flexibility of scale, flexibility in delivery of goods, flexibility in size range, price, etc., • the usefulness of the assets, such as productivity and efficiency and • the effects of the process of innovation in all areas of activity of the company. (lovreta, 2014, pp. 324). 50 economic analysis (2016, vol. 49, no. 3-4, 48-68) the exposed elements of business success boil down to competitive and financial indicators. between these elements there is a high degree of interdependence. financial indicators to measure the success factors that determine the success and competitive position of companies in the market. their interdependence is coming to the fore in the harmonization of short-term financial goals related to "yield" and long-term goals related to the competitive position of the company. in the "package deals" there is a link between productivity and efficient use of resources and quality of services. modern management is expanding the number of indicators of effectiveness and efficiency. special attention was given to indicators of productivity and profitability, which play a central role in the integrated management of the company. modern approach to financial operations, thus actualize the need for integrated management of productivity and profitability of the company. (lovreta, 2014, pp. 325). results financial management in the case of company "serbian railways" the scope of activities for 2014.: company "serbian railways" jsc in 2014. realized around 3.7 billion dinars, which is about 3.5% less than in the year 2013. and the gross income from the transport conveyor of about 10.9 billion dinars, which is about 2.8% more than in the year 2013. passenger transport: the suspension of traffic on many lines caused by snow drifts in february and floods in may, resulted in a significant reduction in the number of passengers carried. a large number of canceled trains caused the reduction of passengers in international traffic, while in beovoz fall transported passengers caused by the transition of some trains on the application of tariffs from local traffic, which is why passengers are recorded as travelers from local traffic. only in the domestic traffic recorded the carriage of passengers at last year's level. transport of goods: difficult traffic conditions on certain lines due to severe flooding in may, significantly affected the functioning of the transport of goods. in such conditions, increased transport of goods in domestic traffic, import and export turnover was mainly due to increased transport fiat cars and spare parts, then gravel and other aggregates, increasing the transport of oil and oil products, as well as the increase in production in "smederevo steelworks" etc. financial indicators for 2014.: according to balance sheet positions for 2014.., basic indicators of liquidity, or short-term financial balance are unsatisfactory, and amount to 0.21 (general liquidity ratio), followed by 0.14 (current ratio) and 0 03 (current liquidity ratio). "serbian railways" jsc in 2014.. realized a total income in the amount of about 26.3 billion. dinars (of which around 10.9 billion related to net transportation revenue with income from the use of foreign cars), total expenditures in the amount of about 34.5 billion and a net loss of about 8.1 billion. at the height of the most affected by the loss of accrual of expenses (amortization in the amount of about 5.7 billion and exchange rate differences in the amount of about 2.3, billion). in 2014. on account of the company, after all receipts and payments of cash, remains an amount of 1,223 million dinars, which is about 462 million dinars more than at the end of anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 51 2013. (mostly balance in the account referred to eurofima investment funds that are spent in 2014.). the scope of activities for the year 2015.: directorate for infrastructure: network railways of the republic of serbia is more than a century, and over 55% of all stripes have been built in the 19th century. regulation on categorization of railways made the categorization of the main, regional, local and handling lines. permanent lack of funds for maintenance caused a drastic reduction in the length of repaired lines, as well as the lack of capacity on the revitalization of electrical lines and increasing the difference between the actual average and the projected average speed. given the level of revenue in 2015. it is possible to provide for these purposes around 1,297 million. these funds are sufficient, especially for the already initiated procurement procedures, as well as for the rehabilitation of the flood-damaged sections of lines and plants for a minimum volume of new works. organization of transport timetable 2014/2015: according to the planned timetable for the 2014/2015., in traffic every day should be 500 trains to transport passengers. bearing in mind that the design of the railway timetable begins a year before the entry into force, due to the material support of rolling stock for its implementation, are set timetable will be adjusted depending on the availability of railway trains. transport capacity: in 2015. expressed the high rate of immobilization of certain series of towed vehicles (diesel locomotives and carriages dezelmotorni), as well as passenger cars. for 2015. average was 158 correct towing vehicles, 52 passenger and 4,000 freight cars. based on the average number of correct towing vehicles by series, asserts that for driving the execution of the order 2014/2015. lacking five electric locomotives, two electric trains, one diesel locomotives, while the towed trains lacked 20 passenger cars. according to estimates by the directorate for transport, the necessary funds to maintain capacity in 2015. amounted to 4.8 billion dinars. in assessing the funds needed have been taken into account the technical condition and capacity deadline for implementation of repair of vehicles, in accordance with the applicable rules on maintaining of railway vehicles. (rules 241 "sl. glasnik rs" no. 2/84, 2/88, 5/88, 7/88, 9/88 and 13/98) necessary financial resources for services amounted to about 3.33 billion pounds, with the following the structure: • to maintain traction vehicles 1,507 million dinars • to maintain the trucks 1,200 million dinars • to maintain passenger cars to 300 million dinars • for cleaning and car washing 136 million dinars • to maintain the other assets of 110 million dinars • to maintain warehouses and buildings 109 million dinars in addition, the necessary funds for the purchase of materials, spare parts and repair amount to 1.44 billion dinars. 52 economic analysis (2016, vol. 49, no. 3-4, 48-68) given the level of revenue in 2015, it is possible to provide for these purposes around 1.333 million. most of the funds spent on the already started procedures for procurement of services and spare parts for maintenance. volume of transportation: after the economic downturn caused by large floods in the future he felt a gradual economic recovery, so that the serbian railways ad in 2015. with an increase in the workload of approximately 15.6%. for 2015. achieved the transport of about 18.8 million passengers, compared to the execution in 2014. an increase of 8.7%. no bg trains for 2015. achieved the transport of about 7.9 million passengers, an increase of 23.6% of the number of passengers carried in 2014. the increase in transport volume is based, inter alia, the effects of the importation into service of new emus, as well as increased passenger transport operations to restore traffic on the belgrade-vrbnica-border. in 2015. increase revenue by about 22.1%. within the revenues from passenger transportation achieved revenues from bg train in the amount of 361 million dinars. these revenues are not correlated with the number of passengers carried, but depend on the actual driving kilometers. in 2015. to complete the delivery of all emus train "stadler" from the ebrd loan funds iii and the beginning of delivery dizelmotornih trains from the project loan of the government of the russian federation, while the funds secured from eurofima, carry out activities for the supply of used passenger cars, which allows successive replacement of old and nonperforming capacity for the transportation of passengers and contribute to significant improvement of quantitative and qualitative indicators, and thus income, the passenger rail transport and allows for more competitive performance on the transport market. in 2015. achieved the transport of about 12.5 million tons of cargo, which is in relation to the assessment of the implementation of transport in 2014, year, 14.7% more. the increase in transport volume is based on the recovery of economic activity after the may floods and the establishment of traffic on the damaged lines, the expected new transport services zelezarz smederevo, rtb bor, then, cosco transport trains from the port of piraeus to european destinations, as well as increased transport of stone, grain, concrete sleepers, iron and others. in order to reduce costs, take over the activities on the development of direct cooperation with other railway companies in the region, to the international commercial contracts for the transport of goods to avoid intermediaries in freight transport and thus reduce transport costs and increase the competitiveness of the railways, and thus the economy, etc. started investments in rolling stock for the transport of goods in the form of procurement of new multi-system electric locomotives from the ebrd loan funds iv in the coming years should contribute to increasing the quality and quantity of work in cargo traffic. estimated financial highlights for 2015 positions in the balance sheet are planned starting from the estimated states and the sources of funds at the end of 2014. as well as the investment plan. implementation of the investment plan or cip, depends, among other things, the level and dynamics of providing anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 53 necessary funds for financing and indirect variable costs, as well as the participation, for the realization of these projects. expected characteristics of the planned balance sheet as at 2015.years are: • the high share of fixed assets, primarily property, plant and equipment of 97.3%, conditional on the realization of investments, • there is still high share of stock from 28.5% in the total assets of the rotation, • the degree of self-financing, as seen through the share capital in liabilities, decreased from 72.5% to 65.6% due to the cumulative loss, • of the total liabilities, long-term liabilities relating to 45.7% maturities of the principal debt on long-term obligations and the creation of short-term liabilities arising from the repayment of part of credit commitments from the state budget, leading to an increase in short-term liabilities and the difficulty of improving the liquidity of the underlying indicators: table 3.1. liquidity ratio 31.12.2014. 31.12.2015. 1. the general liquidity ratio (the ratio of turns assets and current liabilities) 0.21 0.21 2. current ratio (ratio of working assets and current liabilities excluding inventories) 0.14 0.15 3. the ratio of current liquidity (coverage short-term cash commitments) 003 0.04 in the income statement for 2015. are planned for the following positions: within operating income, net transportation revenues (including revenues from the use of kola) refers to 12.8 billion dinars. although the planned increase in net transport revenues of over 17%, the projected income at the level estimated in 2014. due to a significant decrease in revenues from the budget, primarily, regular subsidies, as well as dedicated revenue of the ministry of finance to finance the cost of maintenance and modernization of railway vehicles, or on arrival by management largely can not be influenced. it is planned that its own operating income per unit of work (rtkm) in 2015. stay at the level of 2014., to a nominal operating expenses fell by over 11% (from 7.9 on the 7.0 pounds). table 3.2. structure of total income, expenses and loss (in millions of dinars) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 i total revenues 26.740 26.324 25.542 97,0 1. business income 24.954 24.331 24.373 100,2 1.1 revenues from sales 10.788 11.396 13.272 116,5 1.2 other operating income 14.166 12.935 11.101 85,8 2. financial income 582 486 447 91,9 3. other income 1.040 1.134 591 52,1 4. revenues from value 164 373 132 35,3 54 economic analysis (2016, vol. 49, no. 3-4, 48-68) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 adjustments of assets ii total expenditures 34.438 34.453 31.512 91,5 1. business expenses 29.199 28.816 29.457 102,2 2. financial expenses 1.966 3.594 1.157 32,2 3. other expenses 2.461 1.771 702 39,7 4. expenses from value adjustments of assets 608 41 55 132,5 5. net loss from discontinued operations 25 230 141 61,4 deferred tax expense 179 iii net profit / loss -7.698 -8.129 -5.970 73,4 the structure of operating revenues illustrates the following display: table 3.3. operating income (in millions of dinars) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 i business income 24.054 24.331 24.373 100,2 1. own income 11.215 11.813 13.679 115,8 1.1 transportation revenues 10.497 10.886 12.752 117,1 passenger transportation 1.823 1.726 2.049 118,7 transport of goods 8.674 9.160 10.703 116,8 2. income from commercialization 453 452 595 131,7 2.1. other income 265 475 332 70,0 2.2. subsidies 13.739 12.518 10.694 85,4 2.3. ordinary subsidies 13.065 12.221 10.376 84,9 2.4. the funds from the development fund 581 103 2.5. funding for projects 61 318 519,1 4. funds for construction 41 5. other 93 93 the structure of operating expenses illustrates the following display: table 3.4. structure of operating expenses (in millions of dinars) serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 i business expenses 29.199 28.816 29.457 102,2 1. cost of materials 4.135 4.327 4.441 102,6 1.1. spare parts 897 869 1.108 127,6 1.2. energy costs 3.022 3.179 3.001 94,4 anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 55 serial number description realization assessment of realizat. 2014. the program for 2015. index 1 2 3 4 5 6 1.3. protective clothing and footwear 61 140 180 128,4 1.4. the cost of oil and lubricants 61 58 60 104,4 1.5. other materials 94 81 92 112,6 2. wages 15.442 15.177 14.718 97,0 2.1. gross earnings 11.845 11.534 10.674 92,5 2.2. contributions 2.275 2.215 2.040 92,1 2.3. other fees 1.322 1.428 2.004 140,4 2.4. business travel costs 486 354 286 80,7 the costs of transport workers 597 582 582 100,0 impairment earnings 153 927 605,2 other fees 239 338 208 61,7 3. amortization 5.377 5.726 5.687 99,3 4. other operating costs 4.290 3.613 4.697 127,9 4.1. production services 2.641 2.289 3.468 151,5 4.1.1. maintenance services 946 566 1.833 323,8 from its own resources 467 419 1.521 362,8 4.1.2. costs of common use 788 742 747 100,6 4.1.3. research costs 12 111 106 95,8 4.1.4. communal services 321 223 232 104,2 4.1.5. fire protection 190 219 201 92,1 4.1.6. other production services 384 429 348 81,3 4.2. immaterial costs 1.650 1.384 1.229 88,8 4.2.1. non-production services 525 531 435 81,9 4.2.2 representation 14 15 6 40,0 4.2.3 insurance 102 96 94 98,6 4.2.4. payments 348 289 251 86,8 4.2.5. membership fee 37 47 49 106,3 4.2.6. tax expenses 545 317 305 96,2 4.2.7. other expense 79 89 88 98,9 4.2.7.1. fees 51 63 69 110,0 4.2.7.2. professional literature 11 12 13 110,0 4.2.7.3. other 18 15 6 42,2 5. revenues 46 86 86 100 in the context of the position 4.1.3. column 5 shows the costs of which are financed from earmarked funds of the ministry of construction, transport and infrastructure in the amount of about 5.8 million for the cost of services for the development of project documentation on relocation of capacities in the area of the railway station in belgrade, as well as funds for the development of spatial plan special purpose infrastructure corridor railway belgrade-stara pazova-novi sad-subotica-hungarian border, with two stripe track. serbian railways are already in the year 2013. took over and continued continue to implement actions to reduce costs, especially predominantly fixed expenses: cost of compensation (per diem), costs of production services, insurance, payments, taxes, costs, etc. 56 economic analysis (2016, vol. 49, no. 3-4, 48-68) plan profit / loss for 2015: the law on budget of the republic of serbia for 2015., subsidies for "serbian railways" jsc was reduced by about 2 billion dinars, which will neutralize the effects of the planned growth in transportation revenue and internal undertaken austerity measures. how to be to alleviate the shortage of funds for current operations in 2015. in terms of the cumulative increase in prices of production inputs railway services, numerous operating expenses in the program for 2015. the maximum planned restrictive. the consequences of the natural disaster in may 2014.., which caused major damage to the building and electrical engineering infrastructure of railways, will be continuously transmitted and in 2015. the final training for all parts of lines for railway traffic. also, the effects caused by the floods to infrastructure capacity will also be financed in 2015. exclusively from its own funds. company, which is one of the main reasons for the absence of the possibilities of providing adequate resources for the work of the new procurement of goods, services and works for the maintenance of railway capacities. the company will in 2015. to deal with the loss, but the loss will be generated primarily as accounting depreciation expense category. coverage of loss is possible after resolving the causes of unprofitable operations, of which the most important are: • the lack of compensation for ojp funding, • high level of transportation revenue, due, still present effects of the global economic crisis, as well as the consequences caused natural disasters (floods) • low level of resources to cover infrastructure costs (subsidy can cover 62% of the total expenditure of the directorate of infrastructure). cash flow statement: in 2015., as part of cash flows from operating activities is planned inflow collected transport and other operating income, plus prepayments received subsidies from the budget of the republic of serbia and other inflows. from operating activities are planned payments to suppliers, payments to employees, outflows from other public revenues, etc. in the area of investment is planned for the negative balance (net outflow). financing the investment will be carried out to the extent that funds are secured. in the area of financing planned inflows and outflows from financing activities. given that the net change in short-term and long-term loans (ie the amount of inflow of long-term and short-term loans, net of repayment of these loans) is positive, the amount is shown as part of the cash inflows from financing activities. subsidies: the most significant sources of funding current operations as its own operating revenues, which account for about 56% of the total projected operating revenues and subsidies from the state budget. the law on budget of republic of serbia for 2015. defined the budgetary funds or subsidies, "serbian railways" jsc in the amount of 10.4 billion dinars. until the establishment of a new way of funding infrastructure, and the full establishment of financing obligations of public transport, distribution and use of budget funds will be made pursuant to a special act of the government. starting from the year 2013. significantly reduced the amount of current subsidies, as well as a percentage share of gdp, so that the company in anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 57 all the difficult economic situation because despite the growth of transportation revenues is not able to replace the reduction of subsidies and to finance the costs necessary amount. in addition to subsidies for current operations, the budget of the republic of serbia are provided funds amounting to 1,419 million dinars earmarked for the participation of "serbian railways" ad in the project loan agreement, which serbia received from the government of the russian federation, which will be used to deliver the goods, performance of works and provision of services in the field of railways, in accordance with the law on ratification of the agreement between the government of the republic of serbia and the government of the russian federation on the approval of the national export credit to the government of the republic of serbia. revenues of railways exercise alone are sufficient to cover only one third of operating expenses. in the last five years of income without subsidies amount to about 10-11 billion, while operating expenses about 30 billion dinars. were it not for government subsidies amounting to about 14 billion pounds per year, net loss from operations amounted to about 20 billion. (rs, fiscal council, pp. 44) direct annual budget expenditures (subsidies and guaranteed loans paid) for railways amount to as much as 18 billion pounds. railways are the largest recipient of subsidies from the state budget, with about 13 billion pounds a year. the amount of subsidy is reaching a higher value (15.5 billion in 2011) and gradually reduced in the period 2012-2014. the nominal decline in subsidies to the gdp growth led to a decline in the relative importance of subsidies (in gdp), but it should be borne in mind that the goods resulting from the reduction of subsidies to budgetary problems and not from the restructuring and savings in salaries in the railways. in other words, there is a risk that the reduction of subsidies resulting in redirection of other expenditure on wages, less expenditure on maintenance and the like, which would further aggravate the situation in the railway transport. subsidies from the budget complement operating income, are used to cover part of the operating expenses (less than the annual wage bill) and can not be used for maintenance or new investment. in addition to subsidies, the state pays activated guaranteed loans instead railways. this amount is in the period 2014-2016 is projected at more than 5 billion pounds per year (about 6 billion of total credit commitments in 2014). (rs, fiscal council, p p. 44) earnings and employment policy total staff costs in 2015. amounted to 14.7 billion dinars, which is 3% less than the costs of employees in 2014.. and the same account for about 50% of operating expenses. as part of the cost of employees, the largest amount refers to the weight of earnings amounting to 12.7 billion dinars, which is 7.5 less than in 2014. within other employee benefits expenses and other personnel expenses, which amount to about 2 billion pounds, is the planned amount of funds to be paid into the budget of the republic of serbia on the basis of the law on the regulation of temporary base for the calculation and payment of salaries, wages and other regular income in public funds. total planned mass for earnings with contributions paid by the employer amounts to 12,714 million dinars from the stated amount of contributions paid by employers is planned to be directed to 2.040 million, while the remaining 10.674 million dinars includes the costs of 58 economic analysis (2016, vol. 49, no. 3-4, 48-68) gross earnings (10,650 million dinars) and cost per the basis of conduct or use of benefits, amounting to about 23.8 million dinars, around 3.8 million dinars for subsidies that have the character earnings (net amount, including taxes and contributions paid by employee) and 20 million dinars based on privileged driving employees and goods on international agreements (taxes and contributions paid by employee). operating revenues are not sufficient to cover the wages, since earnings amount to about 15 billion pounds annually. all sizes listed are fairly stable in the last five years, which shows that there is no change and progress in the business model and results. and in the program of operations for 2014 is estimated to be basically unchanged dynamics and structure of revenues, expenses and net results. in doing so, such as a stable revenue categories (own and subsidies), so they are stable and categories of expenditure salary costs, so make up between 15 and 16 billion dinars during the whole period. number of employees at the end of 2013 is approximately 18,000 and the five-year period was reduced by about 1,500 people (the largest decrease in the number of employees in 2010; in 2014 the reduction applies only to the number of employees who retire). (rs, fiscal council, p p. 44) the dynamics of employment, "serbian railways" jsc have extremely unfavorable structure of employees, dominated by old, with insufficient and outdated skills, with which they are unable to accept and implement the effects of modernization of railway capacities on the basis of current investment projects and market orientation that has to be built through restructuring "serbian railways" jsc employees have a need for specialized professions of all kinds, especially engineering, and certainly for the young and modern educated people. the reception staff in the "serbian railways" ad will be aligned with the arrangement of the "serbian railways" ad permanently reduced to 2018.god. the planned structure of employees: on 31.12.2014.god. structure of employees in the "serbian railways' ad shows the following characteristics: vice employees with secondary education (42.7%), while employees with higher education relations 10.2; the average age of employees is approximately 47.7 years and the largest number of employees by length of 3135 years, about 23%. wages paid in 2014 and the plan of payment of wages for 2015: funds for salaries have been planned in accordance with the law on the regulation of temporary base for the calculation and payment of salaries, wages or other income and other in public funds. mass of earnings for all employees (management and other employees) is planned starting from the average salary paid to this category of employees in november 2014.., estimated the number of employees at the end of 2014.. and in accordance with the planned schedule of employment. planned mass of salaries can be adjusted in accordance with the principles of fiscal management and policies of the government. the monthly value of food during the work and value of one twelfth of recourse for annual leave are contained in the value of a working hour. "serbian railways 2" ad is paid 13 salaries. planned charges union members: the amount of compensation for the chairman and members of the assembly of "serbian railways" jsc, which are paid monthly, determined on the basis of resolution of the government 05 no. 120-4780 / 2008 of 6.11.2008. in the amount of a single net average salary in the republic paid in october 2014., plus projected inflation anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 59 of 4.2%; compensation for the work of the president of the assembly has increased by 50 percent. assembly of the "serbian railways" jsc has 15 members. investments as a consequence of these results, the total investment is financed from the loan. country or issuing guarantees for borrowing railways or directly debited to the needs of railways. railways have received loans from the development fund. the state guaranteed the loans granted railways is about 300 million euros, while the approved (not revoked) a total of about 750 million euros. setting priorities for investment (and debt) stems from the fact that the budget will continue to finance these expenditures. (rs, fiscal council, pp. 44) in 2015. investment projects were funded primarily from loans and other arrangements of the international financial institutions. capital projects that were started in the past and whose financing will be continued in 2015. as well as new capital project of reconstruction and modernization of the railway line niš-dimitrovgrad-jredita phase i of the czech export bank, which has provided a guarantee of the republic of serbia, presented are attached to point 7.1., and include the following projects: 1. railway rehabilitation project ii a loan from the european investment bank (eib iv) in the amount of 80 million euros. the project includes three components, namely the reconstruction and modernization of batajnica-golubinci railroad belgrade-sid-state border, section gilje-cuprija-paracin railroad belgrade-nis and cele kula-section stanicenje of nisdimitrovgrad-bulgarian border (the last component will be financed from the credit of the czech export bank, with the approval of the eib. the modernization of batajnica-golubinci is completed. in 2015., on the section giljecuprija-paracin, expected completion of all contracted to build a new bridge across the velika morava river in the length of 322,5m, construction of new double-track line in the length of 10,2km and procurement of equipment and works the reconstruction and modernization of electrical installations (the work had begun 06.11.2013.god., and the deadline for completion of all work on completing the new electronic signaling and safety equipment for cuprija station is 730 days, ie november 2015.). after reviewing all the necessary papers, physical and financial implementation of reconstruction and modernization of the section ginje-cuprija-paracin, propose funding for new components from the remaining part of the loan and in cooperation with the bank take appropriate decisions 2. project rolling stock electromotive multipart sets a loan from the european bank for reconstruction and development (ebrd iii) in the amount of 100 million euros. the project includes the purchase of 30 electric multiple furniture. in 2014.. realized the delivery of trains 5 of the agreed procurement of 21 new emus with swiss company "stadler bussnang ag". in 2015. planned delivery of the remaining trains and completion of the project. 3. project corridor h a loan from the european bank for reconstruction and development (ebrd iv) in the amount of 100 million euros. the project includes three components: 1) the rehabilitation of railway lines along corridor h, including the purchase of machinery for track maintenance and 2) the purchase of approximately 15 multi-system 60 economic analysis (2016, vol. 49, no. 3-4, 48-68) electric locomotives. in 2015., as part of the rehabilitation component lines along corridor h, involved the delivery of new material for the permanent rehabilitation of six sections along the corridor h, whose works will be financed from the russian loan, and delivery of new machinery for the maintenance of the building infrastructure. 4. project rehabilitation of railway line a loan from the european bank for reconstruction and development (ebrd v) in the amount of 95 million euros. the project includes the reconstruction of sections of the belgrade-rakovica-resnik and rehabilitation sections along corridor h. at the beginning of the project "belgrade on water" 2014., there was a necessity of correction of the first component, or change the length of the section to be implemented under this component. ebrd officially informed that due to define new priorities of the republic of serbia in connection with the belgrade railway junction, railways rehabilitation project to be amended for the component beograd-rakovica-resnik (will be done the overhaul on a smaller scale than originally envisaged). serbian railways board of directors has made in december of 2013. the decision on the redefinition of the components to be financed from the loan in the ebrd, which is a bank and a list notified redefined komponemti submitted to the bank for information 2013. in accordance with the above, reference were developed for all planned components and the drafting of project documentation. after devastating floods, which occurred in late may 2014. the government of the republic of serbia has conducted a needs assessment in training and reconstruction of infrastructure affected and in september submitted to the ebrd to consider partial reallocation of the loans, which became effective and which implementation at the moment has not yet begun. the proposed components of the project are as follows: • program updates, due to the damage caused by the floods on the lines of serbian railways, • the reconstruction and modernization of facilities for the purposes of the system bg voz, • program updates on streaks along the corridor h and ebrd loan v (in accordance with the previously planned project). by the end of 2014. were not adopted appropriate decisions, which causes postponement of implementation of other components of the loan for 2016. 5. project railroad station belgrade center-stage i a loan from the kuwaiti fund for arab economic development in the amount of 10 million kuwaiti dinars. the project includes the construction of missing track, construction and equipping of the platform, the reconstruction of stable electric traction facility, contact network and telecommunications facilities with the installation of new pieces of equipment and construction of access roads. in 2014.. the contract was signed with a consortium led by "energoprojekt". with the works began on 3 december 2014., the deadline for completion of works is 420 calendar days, so during 2015. expected to be the largest part of the works. 6. project procurement of new multipart dizelmotornih furniture eurofima loan in the amount of chf 43 million. the project includes two components 1) the purchase of 12 multi anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 61 part dizelmotornih furniture (delivered to all 12) and procurement of major components, equipment and special tools necessary to equip the capacity to maintain as well as parts and components for the maintenance of diesel trains series 711 and 2) the purchase of additional equipment, tools, parts and components in the amount of unused part of the loan. 7. project procurement of used passenger cars eurofima loan in chf equivalent to the amount of 5 million euros. the purchase of used passenger cars will create conditions for improving the supply of passenger transport, both in quantitative (number of available passenger cars) and qualitatively (by types of car, car interior, etc.) and create conditions for realization of the planned arrival of the passenger traffic, ie, its increase. in december 2014.. launched a public procurement procedure ten rounds with five beds and sleeper. 8. the project of reconstruction and modernization of the railway line nis-dimitrovgradphase i czech export bank loan in the amount of 51 million euros. the loan is not agreed whether the guarantee provided by the budget law of the republic of serbia for 2015. 9. infrastructure projects and rolling stock project loan government of the russian federation, the republic of serbia in the amount of $ 800 million. with the participation of the republic of serbia of 15% of the total value of the project amounts to 941 million dollars. for the realization of the project is planned to conclude contracts annex 5 (annex 1 construction of the second track of the belgrade centre pancevo main, annex 2 reconstruction of 6 sections on corridor h, annex 3 reconstruction and modernization of the section stara pazova novi sad, annex 4 reconstruction of the belgrade-vrbnica (bar) and annex 5 delivery dizelmotornih trains. annex 1 covers the financing of the reconstruction and modernization of the section pancevo bridge pancevo main, 15km in length, on the line bg centar-pancevo-vrsac-main border. at this section, includes construction of the second track, as well as construction and reconstruction of existing track capacity and infrastructure in the cells krnjaca, ovca, pancevo bridge, and stop sebešs krnjaca bridge and a new bridge on the tamis in the length of 241,90m and the new lower bridges and engineering structures. the contractor is the russian company "rzd international" doo. earth-moving sub-contractor was selected domestic "energoprojekt engineering" sd belgrade. annex 2 for the reconstruction of 6 sections on koriddoru h concluded 03.2014.years between "serbian railways" jsc and "rzd international". in may 2014.. russian contractor "rzd international" doo has received from "serbian railways" ad proposal that a contract for annex 2 separated into two parts, "north" and "south" as it is only three so-called. "north" section of corridor h building permit and provided funds for the down payment, which is a prerequisite for the commencement of works. serbian railways and "rzd international" doo, signed in october 2014.. contract for the reconstruction of three "northern" sections of the trans-european railway corridor h: golubinci-ruma (oko17,9km), sopot kosmajski-kovacevac (about 18,4km) and mala krsnavelika plana (about 29,5km), and the total value of the contract is about 56 million dollars. "serbian railways" at the end of december 2014. paid the russian company "rzd international" amount of approximately $ 7.3 million on behalf of the serbian state participation of 15% in the project, thus creating conditions for the start of works. 62 economic analysis (2016, vol. 49, no. 3-4, 48-68) in 2015. work began on three 'n' shares and the completion of the preparation of project documentation for three "southern" section. annex no. 5 provides for the acquisition of dizelmotornih trains. "serbian railways" and "rzd international" doo, signed in october 2014.. contract for delivery of 27 new diesel trains, which will be manufactured in the russian company "metrovagonmaš". the value of this contract is $ 100 million. law on budget of the republic of serbia for 2015. are provided earmarked funds of the republic of serbia on behalf of the serbian state participation of 15% in the project in the amount of 1.4 billion dinars. at the end of 2015. it is expected that the first delivery of the new trains dizelmotornih. signing of other annex in 2015. (2.2, 3 and 4) will depend on the moment of providing funds for participation in the amount of 15% of the contract value, as well as the completion of the necessary project documentation and land expropriation. financing of capital projects in 2015. is planned in the amount of 29.2 billion dinars, and to 27.7 billion dinars (94.9%) from international funding sources 1.4 billion (4.8%) from the budget of the republic of serbia and 0.05 billion dinars (0.2%) of the company's assets. the condition for realization of the planned investments is to provide the means for financing and indirect variable costs. for the preparation of technical documentation, participation and other indirect costs and dependent plans funds in the amount of 1.5 billion dinars, of which the largest part relates to the funding of participation, and the participation of the russian loan. law on budget of the republic of serbia for 2015. provided 1.4 billion earmarked for the participation of jsc "serbian railways" the russian loan. part of the funds for these purposes, in accordance with the financial capabilities, the company financed, so as not to jeopardize further implementation of the project, while providing the necessary funds for the participation of countries expected to participate. in addition to the above, to finance the project documentation has been provided and donor funds ipa funds of the european union, for. the project of reconstruction and modernization of the railway novi sad subotica, the value of the donation is 3,95 million; project of the railway bypass around nis, the value of the donation is hinjada 900 euros and the project of reconstruction and modernization of the existing track and the construction of the rest track of the belgrade-nis, shares stalac-djunis the value of the donation is 1.5 million. the donation from the ipa funds of the european union, by means of ap vojvodina and the city of novi sad financed the project of building a new "zezel bridge" over the danube in novi sad. preojekta value is 45.4 million euros. in addition to resources for indirect and attributable costs that are provided from the budget of the republic of serbia or its own funds railways (provided funds are presented in the form 7.1., attached to the program of operations), have not yet been provided, or did not plan the necessary resources for indirect and associated costs the following projects: memorandum of understanding and cooperation on the project hungarian-serbian railways between the people's republic of china, hungary and the republic of serbia 2014. the realization of the project of reconstruction and construction of the belgrade-budapest, "serbian railways" jsc were called to the authorized organization of the republic of serbia on the preparation of the feasibility study of the project, with the task of joint action with the other two parties in the preparation of the study. since the decision of the government of the anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 63 republic of serbia on education working group to find a model of financing the project of reconstruction and construction of the belgrade-budapest in 2015. is defined by the model of financing, both for the preparation phase of the project (preparation of project documentation and expropriation), as well as for the implementation phase of the project, and the start of implementation of activities whose defining also expected. indebtedness capital projects are largely financed loans from international financial institutions. on the day 2014. total liabilities of "serbian railways" jsc amounted to 40.5 billion dinars, of which 40.4 billion to foreign creditors and 121 million dinars to domestic creditors. the total credit obligations are liabilities arising so far exploited or withdrawn, and the outstanding amount of foreign loans for which the republic of serbia has given guarantee (eib, ebrd, the kuwait fund for arab economic development), as well as loans contracted without guarantee (meinl bank). given that "serbian railways" ad are not able to service all obligations, expected assistance of the republic of serbia in the settlement of liabilities arising from loans that were given guarantees and loans eurofima while credit obligations to meinl bank and domestic creditors (bank intesa development fund and the rs fund of solidarity) "serbian railways" ad settled from its own funds. in 2015. matured for payment of total liabilities in the amount of 7.9 billion dinars, of which 7805.6 million dinars based on foreign loans and 104.4 million dinars on the basis of domestic credit. outstanding debts and unpaid claims: estimated-outstanding receivables as at 2014. amounted to 4.3 billion dinars (amount without value adjustment). estimated outstanding obligations as at 2014. amount to about 11 billion dinars. railways the main problems arise from the ordinary course of business, not of debt. the largest enterprises imbalances resulting from the loss from operations. operating loss determines the lack of funds for maintenance and investments and, consequently, the borrowing company. however, the standard indicators of indebtedness are still not alarming (for example, the debt to capital ratio to about one quarter). liquidity is not at a high level (current assets are about one-quarter of current liabilities), and it contributed to the small claims (about 2 billion), and moderately high short-term liabilities (primarily trade payables, about 11 billion dinars). it appears that the road to better results is based on solving the cause of the problem income and expenses. (rs, fiscal council, p p. 44) prices the last price increase in cargo traffic was realized in the first quarter of 2008. (25% in domestic traffic), and in passenger traffic in the first quarter of 2010. (16% in domestic traffic), where the railway is facing a constant increase in cumulative cost of inputs in the production of transport services. in domestic passenger traffic in the second half of 2015. possible activities are ashamed of initiating procedures for obtaining the approval of the government of the republic of serbia for the adjustment of prices only to the level of inflation according to the latest official data of 64 economic analysis (2016, vol. 49, no. 3-4, 48-68) the republic institute ua statistics of the republic of serbia. in domestic freight traffic for 2015. not provided price increase. the company will, if the need arises, the transport of passengers, certain measures of tariff policy (through possible correction commercial privilege or correction of the borders of tariff zone) affect the level of transportation revenue, present activities towards market orientation towards the business model. according to all users who have completed the interview credited carriage of goods in internal traffic, apply the same principle of price levels for the same, or similar transport conditions (quantity and type of goods, transport relations, etc.). the international freight traffic (implementation of agreements on the central billing of transport), the price level to be contracted will be in line with market is acceptable, what is needed to define the prices in accordance with the intensity of competition, seasonal fluctuations, quantities and types of goods offered the transport, the degree of capacity utilization, organization of transport (individual journeys, groups of circuits, block trains), in accordance with the mode of payment and other criteria. expected foreign share of revenues from the international traffic amounts to about 47.5 million. risk management in its normal course of business the company is exposed to a different extent certain financial risks, the risk of reduction in state benefits, changes in exchange rates of foreign currencies, the risk of changes in interest rates, the risk of price changes and liquidity risk. risk management in the company is aimed at minimizing the potential negative impact on the financial position of the company's operations. the risk reduction of state fees: in 2015. government subsidies for "serbian railways" jsc have been reduced by about 2 billion dinars. this reduction leads to the risk of payment to creditors, then the risk of technical readiness for the transport of goods and passengers because of the very difficulty of securing the necessary funds to maintain, and therefore leads to risks in the context of road safety. price risk: given that prices for domestic services controlled and subject to the approval of the government of the republic of serbia, in the circum exposure avoid the risk of disapproval price increases, an increase in transmission revenues in passenger traffic for 2015. not based on the increase in the price of transport. credit risk: a) the risk of changes in interest rates: interest calculation is carried out every six months and the interest rate is equal to six-month euribor-a + 1% fixed percentage. the main credit risk arises from the possible variations euribor and its changes. b) the risk of paying rates on the undrawn portion of the loan in accordance with the opposition on the loan, the borrower pays the fee on the undrawn portion of the loan, which is part of the standard procedures of the ebrd and calculated the total available amount of the loan as well as any amount of the loan which is subject to debt payment but has not yet been withdrawn and amounts to 0.5% of the 'year' level. this fee is calculated and paid twice a year. the main risk for the "serbian railways" ad on this basis, is untimely loan anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 65 disbursements, delays in project implementation, causing a large amount of commission payments, and therefore a longer period of payment of the same. c) the risk of repayment of loans: for loans to "serbian railways" ad repaid independently from its own resources, there is a risk of untimely repayment of the loan due to lack of funds. the risk of changes in foreign exchange rates: the company is exposed to risk from changes in foreign exchange rates arising out of future business transactions, as well as from significant foreign currency liabilities, primarily borrowings, but also to foreign railway administrations, as well as foreign suppliers. on the one hand, the change of course in terms of depreciation of the dinar, especially against the euro and the swiss franc, the cost increases through increased foreign exchange losses and higher credit and other commitments are translated into dinar amount. on the other hand, the change of course in terms of strengthening the dinar's value, especially against the euro, may affect the lower income denominated in dinars in the income statement than planned, given that the company realizes a significant amount of foreign currency earnings. liquidity risk: liquidity management aims to ensure that the company of its obligations on due dates. despite the fact that due to operating losses and long-term financial imbalance of liquidity risk management is difficult, the company regularly pay taxes and contribute to the state. risk management is more difficult when it comes to borrowings, foreign railway governments and foreign suppliers, due to the aforementioned credit risk and the risk of changes in exchange rates and foreign currencies. management reform program public finance 2016 – 2020 the government of the republic of serbia signed a memorandum of economic and financial policies (mefp) with the imf in early 2015, in which he presented the economic policy of the government of the republic of serbia intends to implement in the context of stand-by precautionary arrangement (sba) in the period from 2015 to 2017 in order to solve existing economic imbalances. mefp determined based and provides a framework in which to implement the reform of the management of public finances in the medium term as part of the overall reforms of public administration, while it contains some of the key themes and elements that occur in all the sub-systems of public finance management. (rs, ministry of finance, pp. 5) the program of reform of public finance management strongly relies on a number of previous analyzes undertaken by the european commission and carried out during the screening process in the accession negotiations in the period from 2013 to 2015 as part of a number of negotiation chapters which include, among others, chapter 5 public procurement, chapter 11 agriculture and rural development, chapter 16 taxation, chapter 17 economic and monetary policy, chapter 19 social policy and employment, chapter 22 regional policy and coordination of structural instruments, chapter 23 judiciary and fundamental rights chapter 29customs union chapter 32 financial control, and chapter 33 financial and budgetary issues. these estimates are further supplemented by an annual report on the progress of the republic of serbia, as well as the reports arising from the assessment conducted by sigma program in the period from 2012 to 2015, with special emphasis on the estimates of the management of public finances from 2014 to april 66 economic analysis (2016, vol. 49, no. 3-4, 48-68) 2015, in relation to the principles of public administration throughout the relevant horizontal level management system. (rs, ministry of finance, pp. 6) displaying the current situation in public finance management, report of sigma on the management of public finances for 2015 states a slight improvement over the 16 observed the principle of public finance management, pointing to a weak commitment to transparency in the state budget for 2015, the lack of new programming plan for the development internal financial controls in the public sector (ifkj) in the future, low level of awareness about the importance of internal audit in public funds, low percentage of implemented recommendations of the state audit institution in the published annual audit reports for 2013, certain inconsistencies in the regulatory framework for public procurement, although it is largely harmonized with the eu acquis, as well as the poor quality of the result 7 (rs, ministry of finance, pp. 6) further recommendations arising from the report of sigma on the assessment of the legal framework and organizational and institutional capacity building to consolidate the financial management and control and indirect management of eu funds under the ipa ii, which requested the ministry of finance in early 2014, are incorporated into the program of public administration reform finances in an effort to consolidate the management of all public funds in the republic of serbia, regardless of the source, the harmonization and integration of financial planning, control and execution of eu pre-accession assistance into the national budget system, to ensure the highest level of coordinated and effective planning and programming of public investment and establish a meaningful and unique system of financial control of public funds in the republic of serbia. imf report on the assessment of fiscal risks, reporting and budget preparation from 2015 is one of the cornerstones of the program of reform of public finance management. at the same time, it provides a vital link with the mefp by the government of the republic of serbia signed with the imf in early 2015 for economic reforms that it intends to apply under the sba as a precaution in the period from 2015 to 2017, and supports its implementation. the report of the imf from 2015 on the assessment of fiscal risks, reporting and budget preparation states that serbia made significant progress in the implementation of public finance reforms, while emphasizing that a large fiscal deficit and the need for fiscal consolidation in order to preserve fiscal sustainability increases the importance of continuing the reform of governance public finance. faults as indicated in this report include the limited credibility of the budget because of the focus on an annual budget in the budget process, limited includes the national budget due to the fact that significant parts remain outside the budget of the republic, the lack of reliable estimates of fiscal risks and liabilities, what is the answer spreads a work program to improve fiscal reporting and the expansion of the current cash to accrual accounting in the medium term. finally, the report repeated the assessment of public expenditure and financial accountability of the world bank provides the basis for the preparation of the current reform program of public finance management as it provides a comprehensive and detailed assessment of the current situation in all subsystems of public finance management with a comparison with the results of that assessment, which was carried out in 2010. therefore, the reform program of public finance management relies heavily on inputs obtained from the anđelić s., et al., problem of financial management, ea (2016, vol. 49, no. 3-4, 48-68) 67 pefa assessment of 2015 in order to eliminate deficiencies therein. (rs, ministry of finance, pp. 7) conclusion imf report on the assessment of fiscal risks, reporting and budget preparation from 2015 is one of the cornerstones of the program of reform of public finance management. at the same time, it provides a vital link with the mefp by the government of the republic of serbia signed with the imf in early 2015 for economic reforms that it intends to apply under the sba as a precaution in the period from 2015 to 2017, and supports its implementation. as an example of a public company, this paper presents the company railways of serbia, which is already in the year 2013. took over and continued continue to implement actions to reduce costs, especially fixed expenses: costs of fees (per diem), costs of production services, insurance, payments, taxes, costs, etc. revenues of railways exercise alone are sufficient to cover only one third of operating expenses. in the last five years of income without subsidies amount to about 10-11 billion, while operating expenses about 30 billion dinars. were it not for government subsidies amounting to about 14 billion pounds per year, net loss from operations amounted to about 20 billion. the government of the republic of serbia signed a memorandum of economic and financial policies (mefp) with the imf in early 2015, in which he presented the economic policy of the government of the republic of serbia intends to implement in the context of stand-by precautionary arrangement (sba) in the period from 2015 to 2017 in order to solve existing economic imbalances. mefp determined based and provides a framework in which to implement the reform of the management of public finances in the medium term as part of the overall reforms of public administration, while it contains some of the key themes and elements that occur in all the sub-systems of public finance management. references ljutić, b. 1995. financial management in agribusiness. belgrade lovreta, s. 2004. a shopping and management. faculty of economics, belgrade rules 241 ("sl. glasnik rs" no. 2/84, 2/88, 5/88, 7/88, 9/88 and 13/98) vidakovic, s. 1999. analysis of the operating companies. belgrade: megatrend university. vunjak, s. 2005. fundamentals of financial management. belgrade dedović, m., milačić, s. 2005. financial management. leposavic ćirović, m. 2000. foreign direct investment, trends and strategies. belgrade ivanisevic, m. 2008. business finance. belgrade cidef james c. van horne. 2006. fundamentals of financial management. belgrade: data status. karavidić, s. ivkovic, d., kvrgić, g. 2012. financial management. belgrade: faculty of business economics and entrepreneurship. kovačević, r. 2000. forms and mechanisms of investment. beograd ostojic, s. 2010. working capital in small business. belgrade: megatrend university. radosavljević, g., tomić, r. 2006. management in the modern business. novi sad. 68 economic analysis (2016, vol. 49, no. 3-4, 48-68) ristić, g., komazec, s. 2000. financial management. belgrade. stakic, b., stanković, m. 2003. financial leasing and leasing. belgrade: university singidunum – ffmo. www.zeleznicasrbije.com, access to the site 20.07.2015., access time 11:30:00 www.fiskalnisavet.rs/analiua preduzeca u drzavnom vlasnistvu, access to the site 04.09.2016., access time 17:30:00 www.mfin.gov.rs/program reforme upravljanja javnim finansijama, access to the site 06.09.2016., access time 08:45:00 article history: received: 17 november, 2016 accepted: 15 december, 2016 ea_2016_3-4 udc: 336.77/.78 336.76(4-12)"2007/2014" jel: f39, g24 cobiss.sr-id: 228330252 scientific review correlation between credit rating and macroeconomic indicators: case study of south-east european countries brkić snježana1, school of economics and business sarajevo, bosnia and herzegovina pijalović velma, school of economics and business sarajevo, bosnia and herzegovina pjanić elma, eurorisk systems, ltd. abstract – credit rating, as one of country risk indicators, plays an exceptionally important role in international capital markets – for creditors and investors as much as countries, industries and companies which require loans and investments. it is connected with a wide range of different factors, both of economic and non-economic nature. the goal of this paper is to provide insight in trends of credit ratings of south-east european countries and to compare their ratings, bringing them into relation with macroeconomic situation of given countries. the research takes into account ratings provided by three the most significant rating agencies – standard & poor's, moody's and fitch, as well as eight macroeconomic indicators, for albania, bosnia and herzegovina, montenegro, croatia, macedonia and serbia in period between 2007 and 2014. results of this research have shown that credit ratings of these countries ranged within the non-investment speculative grade. croatia has the highest credit rating, followed by macedonia, then serbia and montenegro, while b&h scores the lowest. trend of the credit rating often does not sufficiently match the macroeconomic situation of the countries observed through main macroeconomic indicators. by using scatter diagrams and spearman’s rank correlation coefficient, it has been discovered medium strong positive correlation between credit rating on one side and gross domestic product, external debt and exports, on the other side, while correlation with other analysed macroeconomic indicators has been extremely low. key words: country risk, credit rating, macroeconomic indicators, spearman’s rank correlation coefficient, south-east european countries introduction the problem of country risk has been one of the most significant research topics in the international business and finance field in the past several years. the impact which risk assessment can have on a country, especially in context of international business and investments, keeps the focus of many authors on this particular topic. most authors share the opinion that globalisation of the world financial market and financial crises in the 1980s and 1 e-mail: snjezana.brkic@efsa.unsa.ba address: snježana brkić, ekonomski fakultet u sarajevu, trg oslobođenja alija izetbegović br. 1, 71 000 sarajevo, bosna i hercegovina 2 economic analysis (2016, vol. 49, no. 3-4, 1-19) 1990s, from the collapse in chile in 1982 to the russian crisis in 1998, brought the analysis of country risk in focus of interest of not only banks and international financial institutions, but also governments and wider public. (pjanić, 2015) country risk analysis requires extensive and comprehensive knowledge of international economics and macroeconomics, socio-political institutions and history of the country which is being analysed. however, most market participants are not capable of carrying out their own deep analysis, so the number of specialized institutions doing country risk assessment is growing. among these institutions, credit rating agencies play an especially important role. rating agencies provide credit rating assessment, which symbolises the level of risk to which investors are exposed when purchasing bonds and other securities. in today’s financial world, it is almost impossible to borrow money without credit rating – credit rating scores serve as guidelines for investors indicating where and how much to invest, they are therefore of crucial importance for economies of countries which rely on external financing. since transition countries belong to the countries which have been relying on foreign financing sources for years, this paper will examine credit ratings of the group of south-east european transition countries – albania, bosnia and herzegovina, montenegro, croatia, macedonia and serbia in period between 2007 and 2014. this research covers the dynamics of credit ratings of the above listed countries, comparison of their credit rating scores, and review of major macroeconomic indicators of these countries in context of their correlation with credit rating. theoretical considerations for a long time, country risk belonged to the category of complex and incomprehensible topics, mainly because of lack of access to information as well as their incompleteness. due to the extraordinary complexity of this term, there are many different definitions. bouchet, clark and groslambert (2003) analysed the literature related to country risk in the past four decades, and they established that each country risk definition contains a wide range of different situations, but they always refer to specific risks which are caused by international business and which are not present in local business, regardless of the cause of the risk or nature of the given industry. some authors emphasize the economic character of this term. bhalla (2006) country risk from the point of view of creditors as exposure to cross-border credit loss caused by economic movements within a country. madura (2006) defines country risk as potentially negative influence of a country’s environment on the cash flow of multinational corporations. however, such observation of country risk can be considered incomplete, because it does not emphasize the wider context and multidimensional character of the term. the economic dimension of country risk, according to mondt and despontin (1986), reflects only the ability of a country to pay its debt, but not its willingness to fulfil its obligations. in their opinion, this indicates the necessity to examine the political environment as an inevitable factor in country risk analysis. a more comprehensive definition of country risk was provided by calvaerley (1990), who defined country risk as potential economic or financial loss caused by difficulties a country is facing on macroeconomic and/or political scene. country risk defined in this way brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 3 takes into account relevant factors such as economic, financial, social and political ones. shapiro (2006) provides a brief definition of country risk as general level of political and economic uncertainty which influences the value of loans and/or investments in a country. according to meldrum (2000), all business transactions involve a certain level of risk, but when they are carried outside of borders of one country, they include additional risk which arises due to different features of each country, be it economic structure, politics, sociopolitical institutions, geographic position or currency. the goal of country risk analysis is to identify the possibility of occurrence of such risks, as well as they impact on potential return of cross-border investment. berg and guisinger (2003) claim that country risk represents the most comprehensive category of international business risk, and that includes the overall risk of business environment of the host country. perry (2010) defines country risk as economic, political and business risks which are specific for a certain country, and which can result in unexpected loss for an investor. so, country risk includes all sources of potential difficulties, from political and social risk, to macroand microeconomic risk. two basic components of country risk are most frequently mentioned in literature: socio-political and economic-financial component. political risk occurs due to internal or external conflicts, disputes related to territorial division, revolutions aiming at change in power, terrorist attacks and so on. according to hoti and mcaleer (2005), political risk can also occur due to political instability or conflicts in the region to which a country belongs, although the country in question is not involved. social risks include collective actions launched and led by trade unions, non-governmental organizations and other informal groups which are trying to influence the local government and/or directly influence the business policies of foreign corporations (bouchet, clark and groslambert, 2003). scientist buckley (2004) links economic risk to events in national economy which might influence the outcome of international economic transactions, whereby the definition includes both present and potential economic situation in a country. economic risk is divided into macro risk which applies to all foreign corporations, and micro risk which applies only to certain sectors or individual corporations. macroeconomic risk entails shift in certain variables within economic system, such as economic activity growth rate, prices, interest rates, currency exchange rates and so on. microeconomic risk purports all negative events which take place at the level of an industry or corporation. sovereign risk is risk related to crediting of a state. it occurs when a government cannot or will not fulfil its obligations abroad, and/or when a government does not allow residents (corporations or individuals) to pay back their foreign debt. a. shapiro (2006) divides sovereign risk into direct and indirect risk. direct sovereign risk occurs in the situation when a government is not willing or not able to fulfil its international obligations. indirect risk occurs when measures undertaken by a government influence the ability of individual debtors to pay back their debt to foreign creditors and investors. (ghose,1988, as cited in hoti and mcaleer, 2002). in both cases, foreign investors and creditors are exposed to risk caused by decisions of the government in the country in which they are investing. the first attempts to define a unique system of country risk analysis were made by banking institutions. these were simple systems focusing only on economic variables (saini, krishnan and bates, philip, 1978, as cited in kosmido, doumpos and zopounidis, 2008). today, institutions which make country risk assessments use different methodologies, 4 economic analysis (2016, vol. 49, no. 3-4, 1-19) depending on type of investment and source of risk. these institutions are generally divided in two categories. the first category consists of institutions which take all possible kinds of risk into account. the second category focuses on credit rating of a country. these are credit rating agencies. based on a detailed analysis of information, and in line with predefined standards, rating agencies determine the credit rating, i.e. the score which symbolises the level of risk to which investors are exposed when purchasing bonds and other securities. credit rating can be described as an assessment of present situation in a country, based on which investors can predict the success of their potential investment in the country, or based on which investors can predict the credit ability of the country (bouchet et al, 2003). in order to enable a better understanding of risk, agencies analyse and interpret a large number of information about investors and debtors, market and changes in economic and political circumstances. also, they give opinion on credit ability of institutions and their financial obligations. in many cases, countries request rating not because they need to borrow, but because they want to show the international market their tendency for adequate, transparent and pro-market governance; in other words, governments insist on having a (positive) credit rating score so that the market can see their economic policy as acceptable and suitable (pjanić, 2015). due to intense development of the financial system, the role, significance and range of activities of rating agencies changed over time. today, renowned agencies do not only provide the service of credit rating assessment, but they also provide consulting service, manage important international indexes and engage in other highly profitable activities related to international borrowing and investments. there are more than 70 credit rating agencies in the world. the most famous ones are moody's, standard & poor's and fitch, which are recognized by all members of the basel committee and almost all non-member countries. the structure of the rating agency industry is extremely oligopolistic. from the very beginning, the industry has been dominated by the triumvirate of agencies – moody's, standard & poor's and fitch – which cover over 95% of the market. this triumvirate is further divided with “the big two” – moody’s and standard & poor’s, each holding market share of 40%, and fitch which holds 15% of market share and is specialized in distinctive niches which it dominates (begić, 2013) standard & poor's (s&p's) was established in 1941 through merger of standard statistics which was established in 1860 and poor's publishing. today, the agency operates in 26 countries throughout the world. s&p lists several key parameters which are used for assessment of credit risk: political risk, revenues and economic structure, economic growth perspective, fiscal flexibility, obligations of the state, external and potential obligations, monetary flexibility, external liquidity and foreign debt (bouchet, clark and groslambert, 2003). according to methodology applied by s&p's, huljev (2013) specifies the following key determinants: gdp growth rate, gdp per capita, currency stability, fiscal equilibrium, public debt and especially external debt, foreign reserves level, inflation and current account of balance of payments. moody's investor service, daughter company of moody's corporation, issued its first rating report in 1909. today, moody's investor service belongs to the most famous and most renowned world agencies specialized in credit ratings and risk analysis. it operates in 35 brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 5 countries. according to moody’s, the essence of credit rating assessment lies in analysis of three basic factors: structure of social interactions, social and political dynamics, and economic basis. experts also research foreign debt, calculate net debt, compare the burden of debt among countries and analyse short-term debts (bouchet, clark and groslambert, 2003). fitch publishing company was established in 1919. fitch did not play any significant role as a rating agency. however, in perod from 1997 to 2000, after a series of successful mergers with other companies, fitch ratings became recognisable as an agency specialised in risk management, financial “training” and data distribution. the criteria which support the risk assessment methodology defined by this agency can be grouped in following subgroups (bouchet, clark and groslambert, 2003): demographic, educational and structural factors, labour market analysis, production and trade structure, private sector dynamics, balance of payments, macroeconomic policy, trade and foreign investment policy, banking and finances, external property, foreign debt, international position and government policy. details of the methodology framework used by credit agencies are not fully known. if they were known, investors themselves would be able to calculate values of certain determinants and set the credit rating score, and decide based on that whether to invest or not. what is known is that the methodology used by agencies to assess credit rating is very complex. analysts do not only use publicly available information on issuers of financial instruments, they also use information not available to the public. this means that on top of the objective assessment of financial and economic indicators, analysts must also make a subjective assessment. all of this indicates that there is no single, universal formula to determine the credit rating score. methodology differs not only from agency to agency, but also from analyst to analyst. regarding macroeconomic factors connected to credit rating, research done by borenszstein and panizza, (2006) as cited in huljev (2013) indicated that credit rating was significantly correlated with gdp growth rate and gdp per capita. in the given research gdp per capita explained around 80% fluctuations in credit rating. some studies (bucur, andreea dragomirescu, simona, 2014) emphasize that unemployment rate should be part of credit rating analysis, as higher unemployment rate is in negative correlation with country risk assessment. huljev (2013) argues that foreign debt is also significantly and positively correlated with default risk. in that sense analysts consider relation between foreign debt and gdp especially relevant. however, rating agencies take into account the whole context of a country in analysis of the given variable, making it relevant for less developed countries only. methodology remarks this paper takes into account the credit rating scores of the three most significant rating agencies – standard & poor’s, moody’s and fitch, for selected countries of south-east europe in period 2007-2014. the south-east european countries selected for this analysis are albania, bosnia and herzegovina (bih), montenegro, croatia, macedonia and serbia. it is necessary to note that the three agencies did not rate all observed countries in the entire period. only croatia was rated by all three agencies in the entire observed period. bosnia and herzegovina and serbia were given credit rating scores for the first time in 2004, 6 economic analysis (2016, vol. 49, no. 3-4, 1-19) macedonia in 2005, albania in 2007 and montenegro in 2008. fitch does not rate bosnia and herzegovina, montenegro and albania at all, and the remaining countries are rated in some years only (serbia and macedonia starting with 2005). similarly, moody’s rated serbia for the first time only in 2013, and it is still not rating macedonia (table 1). these facts influenced the selection of the observed period, and this is why the period in which a comparative analysis of credit ratings of these countries is possible is limited to eight years, from 2007 to 2014. table 1. periods of assignment of credit rating, per country and agency country/agency moody's standard & poor's fitch albania 2007-2014 2010-2014 bosnia and herzegovina 2004-2014 2008-2014 montenegro 2008-2014 2010-2014 croatia 1997-2014 1997-2014 1997-2014 macedonia 2009-2014 2005-2014 serbia 2013 2004(2007)-2014 2005(2007)-2014 source: prepared by authors based on data published by credit rating agencies. a new derived numeric scale with score range from 1 to 20 was created for the purpose of comparative analysis. it is based on the existing rating scales used by agencies. (annex table 1) for each of the observed countries, we also provide and explain annual data on macroeconomic indicators. the analysis uses eight macroeconomic indicators which are, basing on existing literature about country risk analysis and methodology of rating agencies, assumed to have the greatest impact in the system of assessment by credit rating agencies: economic growth expressed through rate of real gross domestic product, gross domestic product (gdp) per capita, inflation (as consumer price index), savings as share of gdp, foreign debt as share of gdp, unemployment rate, export and import of goods and services in relation to gdp. the aim of this part of the research is to contribute to better understanding correlation between macroeconomic indicators and credit rating score. for that purpose, spearman’s rank correlation coefficient and scatter diagrams which indicate form, strength (degree) and direction of correlation between selected variables, are used. research results credit rating score and macroeconomic indicators by country albania moody’s is the only agency which published credit rating scores for albania throughout the entire observed period. s&p’s provided rating scores in the last five years. moody’s assigned albania the score of b1 with stable outlook (similar to the score assigned by s&p’s), which puts albania in the non-investment speculative category, with high credit risk. (table 2) brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 7 table 2. credit rating of albania (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s b1/ stable outlook b1/ stable outlook b1/ stable outlook b1/ stable outlook b1/ stable outlook b1/ stable outlook b1 / stable outlook b1 / stable outlook standard & poor’s n/a n/a n/a b+ / stable outlook b+ / stable outlook b+ / stable outlook b / negative outlook b / stable outlook fitch n/a n/a n/a n/a n/a n/a n/a n/a source: prepared by authors based on data published by credit rating agencies albania’s credit rating remained stable throughout the observed period – constantly at the level of score 7 on the derived numeric scale of credit rating (graphs 1 and 2). at the same time, the country experienced gradual worsening of macroeconomic situation. according to information published by websites of the global economy, world bank and national bank of albania, albania had the lowest gdp per capita of all the analysed countries (usd 4,564.39 in 2014). albania’s gdp grew throughout the observed period, but at a decreasing rate in recent years, significantly lower (as much as four times lower) than in the years before the global crisis. along with positive albeit slow economic growth, maintenance of monetary stability characterised by a relatively low and declining inflation rate (2.65% in average during the observed period and under 2% in recent years) and positive lek to euro exchange rate remains the only positive achievement. share of savings in gdp was in decline, while the share of external debt had a continuous strong growing trend, tripling during the observed period (57.7% of gdp). unemployment rate also grew from 13.5% to 16.10%. strong trade deficit was also maintained throughout the entire period bosnia and herzegovina as in case of albania, fitch does not assign credit rating to bosnia and herzegovina. moody’s has been assigning credit rating to bih since 2004, and standard and poor’s only since 2008. table 3. credit rating of bosnia and herzegovina (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s b2 / stable outlook b2 / stable outlook b2 / stable outlook b2 / stable outlook b2 / negative outlook b3 / stable outlook b3 / stable outlook b3 / stable outlook standard & poor’s n/a b+ / stable outlook b+ / stable outlook b+ / stable outlook b+/ negative outlook b / stable outlook b / stable outlook b / stable outlook fitch n/a n/a n/a n/a n/a n/a n/a n/a source: prepared by authors based on data published by credit rating agencies. 8 economic analysis (2016, vol. 49, no. 3-4, 1-19) moody’s and s&p’s credit rating score for bih remained within the non-investment speculative grade throughout the entire period. however, it is interesting that the score assigned by s&p’s, although in the same grade, was always slightly better than the score assigned by moody’s. the score assigned by the two agencies in period between 2007 and 2011 did not change (b2 with moody’s and b+ with s&p’s), but it went down in the last three years – it remained at the non-investment speculative level, but dropped down by one unit on the derived numeric scale, from 7 to 6 for s&p’s (from b+ to b), and from 6 to 5 for moody’s (from b2 to b3). (table 3, graphs 1 and 2) according to information published by websites of the global economy, world bank, b&h ministry of foreign trade and economic relations and central bank of b&h, the significant economic growth which b&h experienced in 2007 and 2008 (5.98% and 5.59% respectively) stopped in 2009, when growth rate became negative for the first time in the observed period, dropping to -2.72%. although growth rate has been positive since 2013, gdp per capita has not yet reached its value from 2008, and in 2014 gdp per capita was usd 4,790.05. inflation is low, around 1.92% in average. except in 2008 when foreign debt share in gdp dropped by one percentage point, bih’s foreign debt in post-war period has been constantly growing. still, with foreign debt share in gdp of 30.40%, bih is the least indebted among the analysed countries. unemployment rate is very high, the highest among the analysed countries except macedonia. the highest unemployment rate was registered in 2007 with 29.7%. the lowest rate was 23.9% in 2008. at the end of the observed period it was 27.9%. although export share in gdp has been growing from 27.11% in 2007 to 33.90% in 2014, significant trade deficit remain present due to growing import. there is a decreasing trend in savings-to-gdp ratio which went from 13.15% in 2007 to 9.6% in the last analysed year. trade deficit and chaotic public finances along with political instability and inefficient institutions are listed in reports of credit rating agencies as main problems in bih. montenegro of all three agencies, only moody’s assigned credit rating to montenegro in throughout the entire analysed period. s&p's published its first rating for montenegro in 2010. in 2010 and 2011, these two agencies assigned different rating scores to montenegro, although in the same category of credit ability with speculative elements and significant credit risk: moody’s assigned montenegro the score of ba3, and s&p’s the somewhat higher score of bb. the scores remained the same in the following years. (table 4) table 4. credit rating of montenegro (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s n/a ba2 / negative outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook ba3 / stable outlook standard & poor’s n/a n/a n/a bb / negative outlook bb / negative outlook bb/ stable outlook bb/ negative outlook bb/ negative outlook fitch n/a n/a n/a n/a n/a n/a n/a n/a source: prepared by authors based on data published by credit rating agencies. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 9 according to the derived numeric scale, the rating score was 9 in the first two years, after which it dropped by one unit, and remained at that level for the rest of the period (graphs 1 and 2). montenegro’s credit rating was quite stable throughout the entire period, according to moody’s. according to information published by websites of the global economy, world bank and ministry of finance of montenegro, the country, like other analysed countries except albania, experienced negative economic growth rate in 2009 and 2012 (-5.66% and -2.72% respectively), and there was also a decline in credit rating in these two years. full economic recovery after the crisis did not happen – gdp real growth rate was 10.7% in 2007, and only 1.78% in 2014. montenegro achieved gdp per capita usd 7,378.45 in 2014 that is only slightly higher than in 2008. the common characteristic of montenegro and other observed countries is the growing trend of foreign debt, as well as trade deficit. montenegro also experienced a growing trend of savings which grew from the negative -10.55% of gdp in 2008 to more than 5% of gdp in the most recent analysed years. unemployment rate was relatively stable at around 19%, except in 2008 when it dropped to 16.8%. average inflation rate was 2.86%, but in final year the inflation rate was negative with -0.7%. croatia croatia is the only one among the observed countries which in period between 2007 and 2011 was, according to all three agencies, in the investment category with medium credit ability and moderate credit risk. from 2011 to 2014, s&p’s agency reduced its credit rating score (the other two agencies followed the suit as of 2012) from lower medium grade (highest b level) to the highest grade in the speculative category which is described as “credit ability with speculative elements and substantial credit risk”. (table 5) table 5. credit rating of croatia (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s baa3 / positive outlook baa3 / positive outlook baa3 / stable outlook baa3 / stable outlook baa3 / stable outlook baa3 / negative outlook ba1 / stable outlook ba1 / negative outlook standard & poor’s bbb / stable outlook bbb / stable outlook bbb / stable outlook bbb-/ negative outlook bbb-/ negative outlook bb+ / stable outlook bb+/ negative outlook bb / stable outlook fitch bbb-/ stable outlook bbb-/ stable outlook bbb-/ negative outlook bbb-/ negative outlook bbb-/ negative outlook bbb-/ negative outlook bb+/ stable outlook bb / stable outlook source: prepared by authors based on data published by credit rating agencies. the derived numeric scale provides better insight into decrease of credit rating from 12 points in period 2007-2009 to 10 points (moody’s) and 9 points (s&p’s) in 2013 and 2014. (graphs 1 and 2) it is obvious that the 2008 economic crisis hit croatia most severely. according to information published by websites of the global economy, world bank and ministry of 10 economic analysis (2016, vol. 49, no. 3-4, 1-19) finance of republic of croatia, the country was in recession in the last 6 years – with continuously negative economic growth rates and decline in gdp per capita which dropped from usd 15,893.86 in 2008 to usd 13,475.26 in 2014. inflation was relatively low and stable in the post-crisis period, ranging from 1 to 3.4%, and even had negative value in the last analysed year (-0.2%). unemployment rate also displayed a constantly growing trend from 2008, when it was 8.4%, to 2013 when it was 17.3%. in the final analysed year, there was a slight decline in unemployment rate to 16.7%. unlike other countries, croatia mostly had relatively well-balanced import and export of goods and services. with foreign debt which exceeded debt-to-gdp ratio of 100% as of 2009 (108% of gdp in 2014), croatia is most indebted of all the analysed countries. macedonia macedonia had stable credit rating assigned by two agencies for almost the entire observed period (moody’s does not assign credit rating to this country), within the speculative grade, but mostly with score of bb+ by fitch and bb by s&p’s (table 6). on the derived numeric scale, macedonia had 10 points with fitch in all years except in 2007 when it had 9 points, which makes macedonia country with the second highest credit rating score among the observed countries. table 6. credit rating of macedonia (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s n/a n/a n/a n/a n/a n/a n/a n/a standard & poor’s n/a n/a bb / stable outlook bb / stable outlook bb / stable outlook bb / stable outlook bb / stable outlook bb-/ stable outlook fitch bb / positive outlook bb+/ stable outlook bb+/ negative outlook bb+ / stable outlook bb+/ stable outlook bb+/ stable outlook bb+/ stable outlook bb+/ stable outlook source: prepared by authors based on data published by credit rating agencies. the 2008 crisis had a negative impact on macedonia’s economic growth which was negative in 2009. according to information published by websites of the global economy, world bank and ministry of finance of republic of macedonia, growth rate has not managed to reach the pre-crisis level even today (in 2007, it was 6.47%, and in 2014 it was 3.77%). inflation was low throughout the observed period (it oscillated slightly between 1.5% and 3.9% with the exception of 2008 when it hit 8.3%), but in 2009 and 2014 it was negative. savings-to-gdp ratio was constantly growing, from 15.88% in 2007 to 29.46% in the final analysed year. on the other hand, unemployment rate is highest in the region (around 32% in average). foreign debt increased significantly from 47.60% of gdp in 2007 to 66.01% in 2014. similar to other analysed countries, macedonia experienced trade deficit in the observed period. despite the low economic growth rate, high unemployment and increase of foreign debt, its credit rating score remained unchanged for most of the observed period. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 11 serbia moody’s assigned credit rating score to serbia for the first time only in 2013, and it was b1. the other two agencies assessed serbia’s credit rating throughout the observed period. according to scores assigned by two agencies, serbia has stable outlook (table 7), but there is a possibility for change in economic environment and a high credit risk, mostly due to slow economic grow and high share of public and foreign debt in gdp. table 7. credit rating of serbia (2007-2014) year/agency 2007 2008 2009 2010 2011 2012 2013 2014 moody’s n/a n/a n/a n/a n/a n/a b1 / stable outlook b1 / stable outlook standard & poor’s bb/ stable outlook bb/ negative outlook bb/ stable outlook bb/ stable outlook bb / stable outlook bb/ negative outlook bb/ negative outlook bb/ negative outlook fitch bb/ stable outlook bb/ negative outlook bb/ negative outlook bb/ stable outlook bb / stable outlook bb/ negative outlook bb/ negative outlook b+ / stable outlook source: prepared by authors based on data published by credit rating agencies. as in most other observed countries, according to information published by websites of the global economy, world bank and national bank, serbia also experienced negative economic growth in 2009, 2012 and 2014, as well as modest economic growth after the economic crisis (2.57% in 2013). gdp per capita in 2014 still had not reached the level achieved in 2008. serbia had highest inflation of all the observed countries, and in all years of the observed period it showed significant oscillation in interval between 6.1% and 12.4%. savings-to-gdp ratio ranged between 10.58% and 13.66%. foreign debt grew and reached its peak in 2012 with 87.9% of gdp, but in 2014 it dropped to 77.1% of gdp. the unemployment rate in the observed period ranged between the lowest 13.6% in 2008 and 23.9% registered in 2012. unemployment rate in the final observed year was 22.2%. although we saw an increase in exports from 28.36% in the beginning to 44.34% of gdp at the end of the observed period, serbia is still experiencing trade deficit. comparative analysis of credit rating scores in order to conduct comparative analysis of credit rating scores of the countries, we used a derived numeric scale (annex table 1), as well as graphs which allow easier interpretation of the dynamics of credit rating. because some countries were assigned different credit rating scores by different agencies in some years, we use two approaches in the comparative analysis: (1) single rating is higher rating and (2) single rating is lower rating, as depicted in graphs 1 and 2. the numeric scale showed that credit ratings of sampled countries ranged between 5 and 12. the highest credit rating (12) was registered for croatia, followed by macedonia with one or two points less on the numeric scale. the lowest credit rating among the observed 12 economic analysis (2016, vol. 49, no. 3-4, 1-19) countries was registered for bih – in some years, bih’s rating dropped to 5 points. albania is in a somewhat better position, although in some years its credit rating matched the one of bih. compared to other countries, serbia and montenegro are in the middle, with credit rating between 8 and 9. graph 1. comparative analysis of credit rating of south-east europe countries (higher credit rating) 7 7 7 7 7 7 7 76 7 7 7 7 6 6 6 9 9 8 9 9 8 8 8 12 12 12 11 11 11 10 109 10 10 10 10 10 10 108 8 8 8 9 8 8 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 2007 2008 2009 2010 2011 2012 2013 2014 albania bosnia and herzegovina montenegro croatia macedonia serbia source: prepared by authors based on data published by credit rating agencies. the comparative analysis of higher credit rating shows a decline in credit rating scores for most of the observed countries after 2011, except for albania and macedonia. the scores of these two countries show most visible stability. croatia has the highest credit rating throughout the period, but at the same time it has the rating which changes most from the beginning to the end of the period. graph 2. comparative analysis of credit rating of south-east europe countries (lower credit rating) 7 7 7 7 7 7 6 66 6 6 6 6 5 5 5 9 9 8 8 8 8 8 8 11 11 11 11 11 11 10 99 10 9 9 9 9 8 88 8 8 8 8 8 7 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 2007 2008 2009 2010 2011 2012 2013 2014 albania bosnia and herzegovina montenegro croatia macedonia serbia source: prepared by authors based on data published by credit rating agencies. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 13 the comparative analysis of lower credit rating shows stability of scores for all sampled countries up to 2012. in that year, and all subsequent years, all countries except montenegro experienced lower credit rating. correlation between credit rating and macroeconomic indicators in order to test if there is a correlation between credit rating and macroeconomic indicators, we used the spearman’s rank correlation coefficient and scatter diagrams for each of the analysed macroeconomic indicators. credit rating is shown on a derived numeric scale from 0 to 20, based on higher credit rating scores presented in the previous chapter. table 8. values of rank correlation coefficient macroeconomic indicators coefficient values description gdp growth rate -0.078 very weak positive correlation gdp per capita 0.66 medium strong positive correlation inflation (consumer price index) 0.17 weak positive correlation savings-to-gdp ratio 0.44 weak positive correlation unemployment rate -0.17 weak negative correlation external debt-to-gdp ratio 0.63 medium strong positive correlation exports-to-gdp ratio 0.62 medium strong positive correlation imports-to-gdp ratio -0.07 very weak negative correlation source: authors’ own calculation spearman’s rank correlation coefficient between economic growth and derived numeric value of credit rating is negative, and is -0.078, which indicates a negligible negative correlation. scatter diagram shows that there is no unambiguous trend, which also indicates a weak correlation. weak correlation of negative sign also exists between credit rating on one side, and unemployment rate and share of import in gdp, on the other side, while weak correlation but of positive sign has been registered between credit rating, and inflation and savings-to-gdp ratio. medium strong correlation exists between credit rating and gdp per capita, exports-to-gdp ratio and external debt-to-gdp ratio. spearman’s rank correlation coefficient is highest in case of correlation between credit rating and gdp per capita with value of 0.66, which means that countries with higher gdp per capita also have a higher credit rating. (table 8 and graphs in annex) conclusion this research shows that credit rating scores for south-east europe countries in the observed eighth-year period oscillated within the non-investment, speculative b grade (except croatia in the first three years), the grade which is for most of these countries described as “credit ability with speculative elements and substantial credit risk”. according to moody’s, the credit rating scores range from baa2 to b3, and according to s&p’s and fitch from bbb to b-. this means that the countries are still able to pay their due liabilities, although there is a relatively high risk for investments. 14 economic analysis (2016, vol. 49, no. 3-4, 1-19) the numeric scale, created for purposes of comparative analysis, shows that the countries ranged between 5 (bih in recent years) and 12 (croatia in the beginning of the period). the highest credit rating was experienced by croatia – according to all three agencies, the rating of this country in the beginning of the period was classified in the investment grade (although at the lowest level). however, croatia’s credit rating changed the most during the observed period compared to ratings of other countries – from the lowest investment grade it dropped to the highest and medium level of b grade of speculative investment (from 12 to 10 on the numeric scale). macedonia had the second highest rating score, followed by serbia, montenegro and albania. bih had the lowest credit rating among the observed countries. in 2014, moody’s put bih at the lowest level of grade b which borders to grade c – extremely speculative grade. the analysis did not show any significant changes in scores or any major oscillations. a more apparent decreasing trend of credit rating is visible only in the example of croatia. in context of macroeconomic situation, it is obvious that the countries are slowly recovering from the global crisis. absence of any significant economic growth had an impact on increase of unemployment, maintenance of trade deficit and growing foreign debt, which generally indicates a growing country risk and therefore this does not represent a business environment which would be attractive for investors. decrease in credit rating of croatia is in line with changes in basic macroeconomic indicators of this country, especially with absence of gdp growth and enormous increase in foreign debt. however, the trends of credit ratings of other countries do not sufficiently match their macroeconomic situation observed through the selected macroeconomic indicators, and we can assume that some noneconomic factors, such as political and social ones, have a more significant influence on their credit rating scores. the strongest correlation between credit rating and analysed macroeconomic indicators has been discovered in case of gdp per capita, exports-to-gdp ratio and external debt-togdp ratio – medium strong correlation of positive sign, while correlation between credit rating and other macroeconomic indicators is almost negligible. finally, we must underline that although problems of these countries are well-known to the public, they are additionally increased by their dropping credit ratings. since most of these countries do not have a sufficiently developed capital market, or they do not issue bonds on the international market, they depend on other external sources of financing. lower credit rating will mean a more difficult access to foreign capital under favourable conditions, and it will even prevent foreign loans and cause less attractiveness of the countries for foreign investors. it will be increasingly difficult to break the vicious circle of insufficient availability of financing sources and weak economic growth under such circumstances. references bhalla, b. 2006. “how corporations should weigh up country risk.” euromoney publ. issn 0014-2433, pp. 66-72. brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 15 begić, j. 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& poor's; fitch short description of rating category investment grade 20 aaa aaa highest credit quality, the lowest credit risk 19 aa1 aa+ very high credit quality, very low credit risk 18 aa2 aa 17 aa3 aa 16 a1 a+ upper-medium credit quality, low credit risk 15 a2 a 14 a3 a 13 baa1 bbb+ medium credit quality, moderate credit risk 12 baa2 bbb 11 baa3 bbb speculative grade 10 ba1 bb+ low medium credit quality, with speculative characteristics, substantial credit risk 9 ba2 bb 8 ba3 bb 7 b1 b+ relatively low credit quality, high credit risk 6 b2 b 5 b3 b 4 caa1 ccc+ low credit quality, very high credit risk 3 caa2 ccc 2 caa3 ccc 1 cc very low and the lowest credit quality, with prospect of non-payment of financial obligations, selective bancruptcy, bankruptcy ca c c sd d source: prepared by authors based on data published by central bank of bih http://www.cbbh.ba/print.php?id=549 legend: a – with no risk or with low risk; b – with moderate credit risk; c i d – with medium or high credit risk; symbols + and – show trend of change of credit rating (outlook); 18 economic analysis (2016, vol. 49, no. 3-4, 1-19) graph 1. correlation between credit rating and economic growth graph 2. correlation between credit rating and gdp per capita source: authors' own calculation graph 3. correlation between credit rating rating and inflation rate graph 4. correlation between credit and unemployment rate source: authors' own calculation y = -0.079x + 8.6657 r² = 0.0273 0 2 4 6 8 10 12 14 -10 -5 0 5 10 15 derived numeric value of credit rating economic growth (gdp growth) y = 0.0004x + 6.0649 r² = 0.5575 0 2 4 6 8 10 12 14 0 5000 10000 15000 20000 derived numeric value of credit rating gdp per capita y = 0.0292x + 8.4203 r² = 0.0028 0 2 4 6 8 10 12 14 -5 0 5 10 15 derived numeric value of credit rating inflation rate (cpi) y = -0.0398x + 9.3379 r² = 0.0285 0 2 4 6 8 10 12 14 0 10 20 30 40 derived numeric value of credit rating unemployment rate brkić, s., et al., case study, ea (2016, vol. 49, no. 3-4, 1-19) 19 graph 5. correlation between credit rating rating and savings as % of gdp graph 6. correlation between credit and external debt as % of gdp source: authors' own calculation graph 7. correlation between credit rating rating and exports as % of gdp graph 8. correlation between credit and imports as % of gdp source: authors' own calculation article history: received: 15 september, 2016 accepted: 20 september, 2016 y = 0.0617x + 7.0089 r² = 0.2658 0 2 4 6 8 10 12 14 0 20 40 60 derived numeric value of credit rating savings-to-gdp ratio y = 0.0418x + 6.2002 r² = 0.4481 0 2 4 6 8 10 12 14 0 50 100 150 derived numeric value of credit rating external debt-to-gdp ratio y = 0.1559x + 2.8334 r² = 0.3511 0 2 4 6 8 10 12 14 0 20 40 60 derived numeric value of credit rating exports-to-gdp ratio y = -0.023x + 9.8033 r² = 0.0218 0 2 4 6 8 10 12 14 0 20 40 60 80 100 derived numeric value of credit rating imports-to-gdp ratio ea_2019_2_final doi: 10.28934/ea.19.52.2.pp28-42 original scientific paper post-merger performance in financial service industry: a case of the republic of serbia dejan erić1* | ivan stošić2 | vuk dapčević3 1 belgrade banking academy, faculty of banking, insurance and finance, belgrade, serbia 2 institute of economic sciences, belgrade, serbia 3 eurobank, belgrade, serbia abstract understanding consumers’ needs implies creating an adequate offering, which leads to good and institutions after mergers and acquisitions (m&a) with foreign organisations in the republic of serbia. the main actors in these m&a activities were banks. our research and analysis cover the period from 2002 when m&a processes were intensified by the end of 2017. the results obtained indicate that the arrival of foreign banks led to the consolidation of the serbian financial services market. numerous strategic advantages have been achieved, and a lot of weaknesses from the past have been eliminated. however, when analysing the most important profitability ratios (roa, roe, nim), a slightly different picture is obtained. compared with the banks that came through greenfield investments and a group of domestic banks, this group of banks made slightly lower performances. key words: mergers and acquisitions, post-merger performance, financial service industry, banks, serbia jel classification: g21, g23, g34 introduction the arrival of foreign banks on some national financial market is a form of cross-border mergers. over the past thirty years, the permanent growth of cross-border m&a has been noticed, especially in the banking sector, which can be seen from the data presented in graph 1. a more visible rise in the volume of m&a in the european banking sector began in the 1990s. especially in the period after 1999, with certain oscillations (primarily in the period between 2001-2004 and during the global financial crisis), there is a rapid growth of m&a banks when, european megabanks such as bnp paribas, bbva, intesa bci, unicredit… emerge as megamergers. at the same time, the m&a cross-border orientation are gaining momentum. namely, when banks were left without major development opportunities on the national level, they turned to cross-border m&a. within that, the eu banks have directed a significant part of their activities to the markets of central and eastern europe countries in transition. this trend, although with a certain delay comparing to other transition countries, did not overleap serbia in which many foreign banks became present precisely through various forms of m&a’s. * corresponding author, e-mail: dejan.eric@bba.edu.rs dejan erić, ivan stošić, vuk dapčević 29 graph 1. overview of m&a in the banking sector in the period 1986-2016 source: imaa, institute for merchants, acquisitions and alliances, www.imaa-institute.org in the beginning, we need to give a few introductory remarks on the changes that have taken place in the banking system of the republic of serbia in the last twenty years. in the period after 2000, the banking sector of serbia has undergone a series of fundamental changes, of which the most significant is related to major changes in the banking ownership structure. at one point, more than 100 banks operated at the banking market in serbia, and at the beginning of 2000, 84 banks had permission to operate. almost 90% of this number were banks with predominantly state-owned capital. only a few years later, after major transitional changes, the total number of banks almost halved. the banks with a majority share of foreign capital appeared, and the share of banks with state capital was dropping drastically. the mentioned major changes in the serbian banking structure were the result of two processes that took place in parallel. on the one hand, work permits were issued to interested foreign banks, and on the other hand, privatisation of existing state-owned banks was carried out (erić, stošić & dapčević, 2018). along with an increase in the number of m&a transactions and their total value, the scientific interest of a large number of researchers willing to devote themselves to research in this field has grown. namely, a number of open questions, regarding the motives and ways of foreign banks entering into the serbian market, the benefits they bring for clients, as well as the analysis of their business success degree, were raised before them. the motivation for this research was found in the fact that so far there are not too many researches that dealt with comparative analysis of the performance of certain categories of banks within the financial system of the republic of serbia. the key issues that we have tried to answer in this paper are the following: whether, and how successful they operated after being taken over by foreign banks? whether and to what extent did the method of entering reflect on the results of their operations in the later period? what are the comparative results of the operations of individual banking sectors (domestic db, "entered" into the banking sector through greenfield investments gb and those that came through the m&a process m&a)? ultimately, but not least, the post-merger performance of banks in the serbian financial market? the text is organized in several parts. in the first part, we presented a review of foreign and domestic literature in the field of m&a performance studies. the second part presents an overview of the research methodology and the sample used for analysis. the third part of the paper is devoted to a comparative statistical analysis of the basic business performance of 0 20 40 60 80 100 120 0 100 200 300 400 500 600 700 800 900 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 t ra n sa c ti o n s v a lu e (b n e u r ) n u m b e r o f tr a n sa c ti o n s global mergers and acquisitions in the banking sector 30 economic analysis (2019, vol. 52, no. 2, 28-42) certain segments of the banking sector in serbia. finally, in the fourth part of the paper, within the conclusions, the assessment of the performance of certain segments of the banking sector of serbia was presented, with a special emphasis on the analysis of the operations of banks created through the m&a process. literature review mergers and acquisitions (m&a) analysis in the financial sector attracts the attention of a large number of researchers. over the past twenty years, a significant number of researches were focused on the issue of these activities in the banking sector of transition countries. namely, during the period of intensification of the process of globalisation, especially from 1995-2006, about one-third of m&a’s of western european banks pertained to their transactions in european countries in transition (report on financial structures, 2016). this has led to an intensification of research into the motives, goals, and success of these m&a’s. on the banking market of the countries in transition, including the countries of south-eastern europe, reforms that were reflected in the privatisation of state banks and the opening of the domestic financial sector to foreign investors were implemented. consequently, in a relatively short period, foreign-owned banks became dominant in practically all central and southeast european countries. this trend has been present since the middle of the last decade of the last century to the present day, which can be seen in the following table: table 1. the trend of foreign banks ownership shares growth central europe southeast europe period/ rate % 1995 2000 2005 2010 period/ rate % 1995 2000 2005 2010 czech republic 15.5 65.4 84.4 84.8 bulgaria <1 75.3 74.5 84.0 hungary 36.8 67.4 82.6 81.3 croatia <1 84.1 91.3 91.0 poland 4.4 72.6 74.3 72.3 romania <1 46.7 59.2 84.3 slovakia 32.7 42.7 97.3 91.6 serbia <1 <1 66.0 72.5 slovenia 4.8 15.3 22.6 29.5 source: bonin et al. (2014) two basic groups of factors decisively influenced these two tendencies. on the one hand, it is a matter of extensive transitional changes in the poorly developed banking markets of the central and eastern europe countries, characterized by intense privatization and restructuring processes (bonin et al., 2005, estrin et al., 2009) and the ability of foreign "players" to enter these markets. on the other hand, there are "internal" factors that have determined the operation of banks in national markets. this was primarily related to the limited possibilities of achieving higher profits, the growth and expansion prospects through the conquest of new markets and the rapid increase in the placement of services, the implementation of economies of scale, risk diversification, customer tracking, etc. in addition to researching the motives and goals for m&a implementation, another attractive area for researchers was to analyse the effects of m&a transactions undertaken, and the assessment of their performance. namely, a large number of banking m&a in the developed countries has not yielded the expected results. the 2003 merrill lynch and the 2001 capgemini studies have shown that from 1990-2000, large bank deals have performed worse than smaller ones and that 50 per cent of financial services mergers eroded shareholder returns (moyer, 2009). dejan erić, ivan stošić, vuk dapčević 31 there are different ways to measure the performance of post-merger integration activity in the banking industry. very often, this is done by comparing the banks business performance before and after m&a. surprisingly, most studies that compared performance before and after the merger process did not reveal improved performance. in the study (ferrier et al., 2013), over two thousand m&a in the us were analyzed between 1988 and 2009, and it was empirically determined that the performance of banks after a status change, in many cases did not improve, but on the contrary deteriorated. other surveys (kama, 2007) pointed to opposite results in banks' business after m&a. two papers that proved that banks with majority foreign capital operated more effectively than domestic competitors are the best evidence that there are very contradictory opinions on the post-merger profitability of banks. thus, bonin et al. (2004) in their work on the sample of 67 banks in the economies of the six transition countries (bulgaria, czech republic, hungary, croatia, poland and romania) in the period from 1994 to 2002 show that foreign-owned banks are cost-efficient and provide a higher level of service than domestic banks. kraft et al. (2006) confirmed this thesis, indicating higher efficiency of banks in majority foreign ownership in croatia in relation to domestic banks. the analysis covers the period from 1994 to 2000 on the market where 43 banks operated. the mentioned authors conclude that the findings from work certainly support the justification of the process of selling state-owned banks to foreign strategic investors or the opening of the local market for the entry of foreign banks. fixer & zieschang (1993) stated that there are “three measurement methodologies on bank efficiency: the econometric frontier approach, the data envelopment approach and the thick frontier approach” (fixer & zieschang, 1993, p. 438). through these three approaches, the evaluation of the technical and allocative efficiency of banks is carried out. in order to improve and operationalise, they went a step ahead and developed the “index number approach” that takes into account all three approaches. unfortunately, this index is inapplicable in our conditions. the main reason lies in the lack of adequate data, especially ones from the financial market, which is still “shallow” and “narrow”. hence, the focus of the research in this paper is somewhat narrower than the area of application of the mentioned approach. according to altunbas & ibáñez (2004), the analysis of the post-merger performance of banks practices two types of empirical methods. the first relates to an analysis of the performance of newly created institutions by comparing the movement of their most important financial indicators in the financial statements. the second refers to the analysis of changes in the value of certain parameters in the financial markets. generally speaking, all m&a effects studies involve two sets of methodological approaches: event studies and comparisons of pre-merger and post-merger performance (erić, stošić & dapčević, 2018). event studies predominantly focus on the impact that the m&a announcement has on stock price movements. based on a sample of 1,320 european m&a conducted between 2003 and 2012, alsharairi et al. (2012) studied the different post-merger performance and process implementation effects. one of the newer papers in this group is the research by kyriazopoulos, drymbetas (2015), which includes a sample survey of 118 m&a transactions conducted in europe between 1996 and 2010. they compared the stock price movements on the day of the transaction announcement and after a certain period (3 and 10 days after the event). it was shown that the prices of the shares of the banks that were the target of the takeover had positive returns above the average, while the shares of the banks that initiated the m&a processes did not significantly respond. for the application of this methodology, a necessary precondition is an efficient capital market and a large number of publicly available information. this group of methods is hardly applicable in the domestic financial system, where the capital market is still in its initial phase of development, with low transparency and low liquidity. 32 economic analysis (2019, vol. 52, no. 2, 28-42) the second group of methods is related to the analysis of the financial performance of the combined banks before and after the realised transaction. hagendorff et al. (2008) in their study suggest that shareholders of the bank that undertakes acquisitions (or mergers), expect to be rewarded for taking the risk of entering into these operations, especially if these operations take place outside their home countries. huizinga, nilissen & vander (2001), on a sample of 52 horizontal european banking mergers, showed that these activities led to an increase in cost efficiency, but not a significant increase in profitability. the period in which m&a activities were analyzed was from 1994-1998. the results showed that the effects of economies of scale were achieved, which affected the reduction of total costs and increased operational efficiency. however, the vast majority did not lead to a significant improvement in financial performance, above all, profitability. most authors who were researching post-merger performance observed them based on profitability comparison a couple of years after the transaction was completed. according to vennet (1996), “the traditional measures of profitability are return on equity (roe) and return on assets (roa)”. according to this author, in the analysis of banking performances roe requires a special review, bearing in mind that “bank capital funds are subject to capital adequacy standards” (vennet, p. 1537). he points out that the level of costs and revenues strongly influence the profitability of banks. in his analysis, which covers the sample of 492 acquisitions realised in the last decade of the 20th century (of which 70 were cross-border), he uses certain ratio related to their movement (labour cost ratio and operating expense ratio). his analysis showed that in the short run, cross-border m&a does not bring a significant increase in profitability. this is explained by the need for larger investments, more aggressive appearance in new markets, which has implications on the level of interest rates, i.e. revenues and expenditures. kemal (2011) has a similar approach to measuring post-merger profitability. he uses public data from the financial statements by calculating the appropriate ratio on the royal bank of scotland case, following the takeover of a local bank in pakistan. this author compares a group of profitability ratios a few years before the m&a transaction and a few years after takes the following ratios roa, roe, gross profit margin, net profit margin, pre-tax profit margin and operating profit margin. the study covered only one bank, and the results unambiguously showed that the mentioned m&a did not lead to increased profitability. the process of mergers and acquisitions in the banking sector of serbia was the subject of research by a number of domestic authors (dinkić & jelašić 2001; kontić & kontić, 2009; janjić & lukić, 2009, marinković & ljumović, 2011; barjaktarević & paunović 2012; erić & đukić 2012, savović 2016, dimić & barjaktarević 2017, erić, stošić & dapčević 2018, etc.). a large number of these papers dealt with the mergers and acquisitions within the banking sector of serbia in the light of transition and privatisation, and they mainly point to numerous changes (and benefits) brought by the entry of foreign banks (e.g. eric & stošić, 2012; stošić & domazet 2014). a part of the papers focused on the analysis of the motive for the foreign bank's acquisitions on the local market. according to the research (marinković et al., 2011, pp. 527-528) the most important motives at the time of deciding on the entry of foreign banks into the serbian market, derived from the theory of profit growth and the use of market opportunities. that is a search for new clients, high competition on the market of the country of the capital origin, high-interest margin, as well as the unused borrowing potential of enterprises and the population on the capital market. the rank of the motive changed after entering the market, and at the time when the survey was carried out. as the most important individual factors, risk diversification, highinterest margin, unused borrowing potential of companies and population in the capital market, as well as the search for new clients, have arisen (domazet & stošić 2013). according to the authors' findings, the problems of comparative analysis of bank performance, depending on the model and origin of ownership, were not subject to studies that are more dejan erić, ivan stošić, vuk dapčević 33 detailed. this is precisely the focus of this paper, above all, with the aim of identifying the degree of success of the post-merger performance of the banking sector of serbia. methodology of research and sample for this work, the official balance sheet data of banks that operated in the banking sector of serbia in 2004 were used. the sectoral averages, according to the indicators, were calculated based on aggregate balance data published on the national bank of serbia (nbs) website. the survey sample represents 18 major banks, with an individual market share of more than 1% of the balance sheet assets of the banking sector at the end of the observed period. the sample excluded banks with negligible market share (less than 1% of the balance sheet assets of the banking sector), that is, banks that withdrew from the market or were shut down during the observed period. at the end of the observed period, 18 banks from the sample accounted for 95% of the total balance sheet assets of the serbian banking sector. for comparison, in 2012, they participated with 91%, in total assets; 2008 89%, 2005 80%, and in 2004 they accounted for 74% of the total balance sheet assets of the banking sector. by pointing to this data, we want to underline the fact that this is a representative sample. on the other hand, a tendency of concentration within the banking structure of serbia can be perceived at the very beginning. banks are divided into three groups based on the ownership structure and the way of creation. in particular, we took care to identify the group of banks that had significant m&a activities in the mentioned period. therefore, the subject of research in this paper consists of three groups of banks: • i group foreign banks that entered the serbian banking market through a greenfield or the purchase of an existing domestic small bank, which practically represents greenfield investment (gf). • ii group foreign banks that have entered the market by purchasing or merging with existing private or state banks, or essentially through the real mergers and acquisition (m&a), and • iii group domestic banks in state and private ownership (db). the first group includes all foreign banks that entered the serbian market through the gf or the purchase of an existing small bank to obtain a license for doing business and afterwards did not participate in significant m&a. this group consists of1: société générale bank (gf / 1977 – representative office/ 1991 corporate/ 2001 retail), raiffeisen bank (2001 gf), procredit bank (2001 gf), hvb/unicredit bank (2001 gf/ 2005 eksim bank), hypo /addiko bank (2002 deposit bank), volks/sber bank (2003 trust bank). the second group includes foreign banks that have entered the market by purchasing existing private or state-owned banks with a significant market share, or through massive privatisation of state-owned banks. this group includes2: banca intesa (2005 delta bank, 2007 panonska bank), eurobank (2003 post bank, 2006 national savings bank), alpha bank (2005 jubanka), vojvođanska bank (2006 nbg bank, 2017 otp bank), otp (2006 niška, zepter, kulska bank), 1 note: in 2001, two more gf licenses were issued to greek banks, namely alpha and nbg. these banks subsequently participated in large privatizations of state banks, and were in another group of foreign banks. 2 due to the fact that there is a limited availability of the available balance sheet data for the banks that merged, for the period before the m&a, the following available balance sheet data were used during the analysis: national savings bank for eurobank before 2006, kulska banka for otp before 2006, vojvođanska bank for nbg -vojvođanska before 2006, jubanka for alpha bank before 2005, continental bank for nlb bank before 2006. 34 economic analysis (2019, vol. 52, no. 2, 28-42) erste bank (2005 novosadska bank), credit agricole bank (2005 meridian bank), piraeus bank (2005 atlas), nlb/lhb bank (2003 lhb bank, 2006 continental bank). the third group includes domestic banks in state and private ownership (db). this group consists of only three domestic banks in the sample: 1. komercijalna bank, 2. aik bank and 3. poštanska štedionica bank. at the end of the observed period, they stand for a representative sample with over 95% of the assets of domestic banks, while the remaining domestic banks are not statistically significant (jubmes, mts bank, srpska banka, as well as direktna bank, which becomes significant only after the observed period and the takeover of piraeus bank). performance of the banking sector of serbia in the period 2004-2017 profitability indicators in the general assessment of profitability trends measured through asset yield (roa), there is high volatility during the analysed period. perhaps surprisingly, it is noticeable that at the very beginning of the observed period, domestic banks achieved high profitability rates, while both categories of foreign banks were below the average. the reason for lower profitability indicators for a group i gf banks is, among other things, the sharp rise in assets, while in the other group of banks m&a is characterised by high reserves and high operating costs, which also diverts the sector average into a negative zone. nevertheless, it should be noticed that the reason for a slightly higher profitability indicator with domestic banks lies partly in the fact that the sample of domestic banks was "purged" of bad banks that went into bankrupt during the period. graph 2. comparative overview of profitability indicators – return on assets (roa) in the period 2004-2017 note: roa return on assets=pbt*/avg. assets *pbt available instead net profit; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.html however, since 2006, gf banks have begun to achieve top-up profitability. in contrast, the m&a group of foreign banks had a profitability level that was below the market average throughout the analysed period. particularly unfavourable results of m&a groups of foreign banks were recorded in 2013, when the overall average of the entire banking sector was negative, due to the loss of m&a banks (primarily due to high reserves and operating costs). since the relationship between capital and assets for all banks is fairly stable and moving in the same ratio, the other important parameter of measuring the profitability of banks return on equity (roe) has moved in approximately the same range. namely, as well as the previously analysed profitability indicator roa, return on equity (roe) also shows volatility in the -8,00% -6,00% -4,00% -2,00% 0,00% 2,00% 4,00% 6,00% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 roa banking sector domestic greenfield&licence m&a dejan erić, ivan stošić, vuk dapčević 35 observed period. the average of the sector at the beginning of the period is in the negative zone on account of the loss of the m&a group of banks due to the high provisioning and operating costs, which was repeated in 2013. when it comes to returning on equity (roe) of the m&a group of banks, it is below the average of the total banking sector of serbia in the observed period. even when this group operated in a positive zone, there was a constant presence of high reservations and operating costs, which reduced profit. the presence of high reservations and operating costs, in particular, state-owned domestic bank, dropped the average of this category during 2006 and 2007 into a negative zone, which was repeated at the end of the observed period. during the period, foreign gf banks mainly showed higher profitability (except for 2005 due to high operating costs) because they were not burdened with high reserves and costs associated with m&a activities. in achieving this result, they were not hindered by the constant significant increase in capital compared to the other two groups, which was especially expressed in the first half of the observed period. graph 3. comparative overview of profitability indicators return on equity (roe) in the period 2004-2017 note: roe return on equity=pbt*/avg. equity *pbt available instead net profit; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.html www.nbs.rs similar to the previous two ratios, the third key profit indicator net interest margin (nim) has diverse values over the period observed. what is generally observable is that highly capitalised banks, as well as banks oriented to retail and entrepreneurial jobs, achieve better value for this indicator. the reason is that capital does not generate interest expense, and the retail sector on average has a higher interest income. the nim analysis for three groups of banks points to very different values. domestic banks, as already established on the market, with a large client base in the retail sector, earn high net interest income (except for 2007, when the lower net interest income of top performers in this segment pushes the indicator down to the average). on the other hand, the sharp rise in foreign banks' assets affects below the average results of gf and m&a banks in the period after the takeover of local banks. the reverse effect for these two groups of foreign banks has aforementioned the deleveraging process that took place in 2013. -40,0% -30,0% -20,0% -10,0% 0,0% 10,0% 20,0% 30,0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 roe banking sector domestic greenfield&licence m&a 36 economic analysis (2019, vol. 52, no. 2, 28-42) in the last third of the observed period, increased competition on the market, as well as historically low-interest rates, pushed this indicator downwards and make all three categories of banks correlate with the average. conducted analysis of key profitability ratios of the banking sector indicates the high profitability of the domestic banking sector until the outbreak of the global financial crisis. after that, there is a sharp decline in profitability for all three groups of banks observed. the profitability of banks after the crisis was not at a satisfactory level. this was also contributed by the high share of "bad" loans (npl in certain years ranged to more than 20%). as a rule, such placements demanded far larger reserves (provisions), which immediately affected the decline in profit (net income), which further affected the decline in return on assets. at the same time, interest income decreased, which unfavourably affected the overall profitability of the banking sector. graph 4. comparative overview of profitability indicators – net interest margin (nim) in the period 2004-2017 note: nim = net interest income/ avg. interest bearing assets; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs a comparative analysis of the performance of certain groups of banks points to different results in different periods. however, it can be noted that in the initial period, 2004-2007, domestic banks were the most successful, and this primacy was later taken over by the group of gf banks. a particularly surprising finding of our analysis is that the banks that have occurred through m&a activity, with a few exceptions in certain years, were generally the least profitable. in particular, we emphasise that in some years, their unfavourable results led to negative trends in profitability for the entire banking sector of serbia. performance indicators to analyse the efficiency, as illustrative, we have investigated the cost/income ratio for all three groups of banks. the second group of banks that participated in m&a activities had a higher cost/income (c/i) indicator over the entire observed period, which indicates lower efficiency. this finding corresponds fully with the previous one. namely, lower efficiency consequently leads to lower profitability. the reason for this is the fact that m&a activities generate significant operational costs during the m&a itself, but also in the post-merger period. these costs relate to consulting costs, information systems integration, a surplus of employees, re-branding, marketing costs, etc. 0,0% 2,0% 4,0% 6,0% 8,0% 10,0% 12,0% 14,0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 nim banking sector domestic greenfield&licence m&a dejan erić, ivan stošić, vuk dapčević 37 in contrast, domestic and gf banks showed better efficiency for most of the observed period. graph 5. comparative overview of efficiency indicators in the period 2004-2017 note: cost/income= operating expenses/ operating income; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs indebtedness/solvency indicators at the beginning of the observed period, one of the most important indicators of indebtedness d/e (debt to equity) is higher than the average for the gf group of banks. the main reason for this lies in the fact that these banks financed the rapid growth of the loan portfolio from borrowed funds while retaining the existing amount of capital, unlike m&a banks, which, due to acquisitions, reached high levels of capital. the prudential regulation of the central bank and the measures from 2007, which conditioned further credit expansion by the amount of mandatory capital, lead to the equalisation of this indicator for all three categories over the observed period. graph 6. comparative overview of indebtedness indicators (debt/equity) in the period 2004-2017 note: total debt to equity = debt/equity; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs 0% 20% 40% 60% 80% 100% 120% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 cost/income banking sector domestic greenfield&licence m&a 0,00 2,00 4,00 6,00 8,00 10,00 12,00 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 debt/equity banking sector domestic greenfield&licence m&a 38 economic analysis (2019, vol. 52, no. 2, 28-42) the solvency of banks is best reflected through the amount of the reserves for non-performing receivables. at the beginning of the observed period, domestic banks have the above-average cost of reservations, due to the burden of poor placements from previous years. the second category, m&a banks, due to the takeover of banks with a certain level of bad placements, had a higher indicator than the average, but due to more stringent credit policies and faster growth of assets relative to domestic banks, it quickly returned to the sector average. during 2013, the m&a group of banks saw remarkable changes in the balance sheet and growth in provisions for bad placements, and a similar rise in reserves is occurring in 2016 with domestic banks, especially those in state ownership. gf banks record the lowest indicator during the observed period, since they entered the market without varying load, or with "clean" balances. subsequently, more stringent credit policies and strong portfolio growth contributed to keeping this solvency indicator below the sector average. graph 7. comparative overview of solvency indicators (provisions/expenses) in the period 2004-2017 note: provisions expense=provisions/avg. loans; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs capital adequacy indicators the banking sector of serbia is well capitalised, first of all, keeping in mind the prudential requirements of the regulator. in almost the entire period of analysis, the prescribed minimum for the capital adequacy ratio, according to the provisions of the national bank of serbia was 12%, which was above the average comparing to the countries of the european union. the reform of the entire banking sector at the beginning of 2000 aimed at creating a stable financial sector, which over the period under review managed to resist external shocks caused at first the by the global economic crisis, 2008-2009, and subsequently by the greek external debt crisis since mid-2010. during the entire observed period, the capital adequacy indicator is significantly above the prescribed minimum, with the performance of domestic banks additionally above the average. as noted, a sample of domestic banks was purged of problematic and bad banks that went bankrupt during the period, which, if included in the sample, would correct the indicator downwards. in particular, we emphasise that too high capital adequacy has its implications in terms of profitability, which has already been elaborated before. 0,00% 5,00% 10,00% 15,00% 20,00% 25,00% 30,00% 35,00% 40,00% 45,00% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 provisions expenses ratio banking sector domestic greenfield&licence m&a dejan erić, ivan stošić, vuk dapčević 39 graph 8. comparative overview of capital adequacy indicators in the period 2004-2017 note: *data published by banks individually / prior to 2006, there was generally the practice to descriptively indicate in the bank's annual reports, that this ratio is above the prescribed rate of 12% without quotation ratio; source: calculation of the author based on official data from the nbs financial reports of banks: https://www.nbs.rs/internet/cirilica/50/50_5.htmlwww.nbs.rs finally, we will note that liquidity indicators are not counted, as there is no uniformity in the expression of the most important liquidity ratio. the second reason lies in the fact that this indicator is not available for the whole period since the nbs started publishing it only since 2008. conclusions one of the key areas of transit processes in almost every country on the path to establishing market economy mechanisms is related to reforms in the field of the financial services industry. in this respect, a particularly important area refers to structural changes in the banking system. almost all countries in central and eastern europe have undergone these processes. as a consequence, we had changes in the banking structure in which some domestic, especially inefficient and bad banks disappeared. on the other hand, the market share of the foreign banks, which have proven to be more efficient, more flexible as the bearers of technological development and other innovations, has increased. the banking sector of the republic of serbia experienced major changes after 2000. the total number of banks has diminished; some of the formerly large and well-known banks have been liquidated, foreign banks have emerged. the processes of foreign banks' entry took place in one of two ways through greenfield investments (gf) and buying, taking over, merging with domestic banks (m&a). the focus of our research in this paper is aimed precisely on the analysis of the post-merger performance of this segment of banks. entry through m&a activities allows foreign banks some advantages in local markets. they are primarily related to the collection of new deposits, the expansion of the client base and the built-in organisational network, which can enable them to grow rapidly (ljumović et al., 2015). the conducted research and analyses in this paper generally point to the fact that the operations of m&a banks were successful. this is the result of the effects that have been achieved on the scale, scope, rationalisation of organizational and transaction costs, and the efficiency of management and organization. however, on the other hand, when the profitability of this group 0 5 10 15 20 25 30 35 40 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 capital adequacy banking sector domestic greenfield&licence m&a 40 economic analysis (2019, vol. 52, no. 2, 28-42) of banks is compared with the other two categories of banks (gf and db), it is evident that m&a banks were slightly lower in performance. this is primarily reflected in a regular review of roe and roa ratio movement that is lower with the m&a group of banks. the reason lies in the fact that m&a activities generated more operational costs, as well as the takeovers of domestic banks with npl legacy, which consecutively increased the provisioning cost and influenced lower profitability. with the nim indicator, this difference is not so obvious, primarily because strong competition on the market has balanced the interest income of market participants, with partial rebounding of domestic banks. the reason for this is that domestic banks increased their interest-bearing assets at a much slower pace in relation to foreign banks, as well as previously stated that the sample of domestic banks was "purged" of bad banks that went bankrupt during the period. analysing the individual segments of efficiency, we noticed that banks that conquered the domestic market through m&a had poorer performance compared to the other two categories. namely, m&a banks had a higher c/i indicator over the entire observed period, because m&a activities generate significant operating costs both during the m&a process and in the postmerger period. only the process of integrating information systems can last for years, and by the way, generate quite high costs. in contrast to m&a banks, domestic and gf banks showed better efficiency because they were exempt from these costs. m&a banks lagged behind gf banks in the solvency segment, as with the domestic banks acquired, the burden of legacy npl from previous years also came along. in this segment, m&a banks were not the worst, since more flexible domestic banks credit policy, impacted their highest index of reservation costs in the observed period. due to the prudential requirements of the regulator, all categories of banks were well capitalised and displayed capital adequacy that is significantly above the prescribed minimum. to better understand the results of the analysis, it is important to take into account the particularities of the serbian market from the perspective of customer loyalty to banks. namely, due to developments in the sector during the 1990s, when the client's confidence in the banking sector in serbia was quite ruined, a lower level of customer loyalty to banks was noticed. this is reflected in the fact that foreign banks from the gf category were able to relatively quickly increase their clientele and placements without having to participate in expensive acquisitions, which directly affected their profitability. finally, it should not be forgotten that in the middle of the observed period, the global economic crisis, which spilt rapidly on the domestic economy, also suddenly stopped the credit expansion, reducing revenues and increasing the number of npls. here lies another reason for the poor performance of m&a banks, since in the post-merger period, m&a banks should, among other things, bring profit growth, their flight stopped because credit activity was almost frozen, and on the other hand, all operating costs related to the m&a transaction remained, now combined with the effect of increasing the provision for non-performing loans. with this kind of ballast, m&a banks were hardly able to do better. acknowledgements this paper is a part of research project no. 179015 (challenges and prospects of structural changes in serbia: 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(1996). the efect of mergers and acquisition on efficiencz and profitability of ec credit institutions, journal of banking and finance, 20, pp. 1531-1558 article history: received: april 22, 2019 accepted: november 25, 2019 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp138‐148 scientific review analysis of cooperation between science and business in the function of improving the effectiveness of the republic of serbia economic growth ivan stošić1* | duško bodroža1 | mihajlo đukić1 1 institute of economic sciences, belgrade, serbia abstract the subject of this paper is the analysis of cooperation between science and business in the republic of serbia. the main goal of the paper is to identify the level of cooperation, the achieved results and the scientific areas in which the cooperation is being carried out, through the analysis of the current state of cooperation between science and business. the paper should serve as the starting point for future research, where the effects of profitability of investments in science at macro and micro level will be evaluated. the analysis used the official data on the achieved results in scientific research activities from the statistical office of the republic of serbia, and data from the ministry of education, science and technological development. the obtained results showed that serbia has a potential in the science sector, but that it is not sufficiently used by the economy since researchers focus exclusively on the production of scientific work. key words: science, economy, business, cooperation, results, republic of serbia jel classification: o30, o32, i25 introduction topicality for making this paper immerges from ascertainment that cooperation between science and business in the republic of serbia is still dissatisfactory. until now, an efficient way of linking science and economy has not functioned, neither to ensure the mobilisation and capitalisation of knowledge and research, nor their coordination. economy does not use the results of scientific research sufficiently and does not encourage the development of research, which may have many benefits over a longer time horizon. on the other hand, the scientific community, due to the decades‐long absence of a market economy, often has no proactive approach in the context of promoting the results of its research to business entities, thus ensuring their practical application as well as verification of theoretical concepts. according to “the strategy of scientific and technological development of the republic of serbia for the period from 2016 to 2020 ‐ research for innovation” ("official gazette of rs", no. 55/05, 71/05 ‐ correction, 101/07, 65/08, 16 / 11, 68/12 ‐ us, 72 / 12,7 / 14 ‐ us and 44/14), the current relationship of science and economy in the republic of serbia is characterized by insufficient level of human resources, a small number of financial instruments, and the insufficiently developed institutional and legal framework for supporting research and innovation in the economy. in order for this cooperation to be successful, stronger links between * corresponding author, e‐mail: ivan.stosic@ien.bg.ac.rs ivan stošić, duško bodroža, mihajlo đukić 139 the educational and research system with the economy are needed in order to more efficiently utilise existing resources, as well as those which are created through higher education and research. the aim of this analysis is to determine the current state of cooperation between science and economy and identify the scientific areas and sectors where cooperation exists. the obtained results will be used as a starting point in future research, in which, using the worldly recognised methodology, the effects of an investment in science at macro and micro level will be measured. the paper consists of three parts. in the first part, we provide an overview of the basic forms of cooperation between science and business, as well as a review of relevant scientific literature in which the relationship between science and economy was analyzed. the second part is devoted to the analysis of the capacities of research and development organisations in the republic of serbia, their achieved results, and financial resources spent on research and development. in the third part, as part of the concluding observations, we indicate the main sectors in which cooperation between science and economy is being realized, as well as problems that make the successful realisation of this cooperation difficult. cooperation of science and business ‐ general information the most important resource that a society has at its disposal is knowledge. unlike other resources, such as natural (mineral and water resources, arable land, etc.), knowledge as a resource cannot be stored freely (babić, 2013), but it must always be renewed and always re‐ acquired otherwise it will disappear and perish. this renewal can be achieved by transferring knowledge, education and extending the scope of existing knowledge through research, which we call science (babić, 2013). in order to achieve this continuous renewal of knowledge, significant material resources, both in education and in science, are invested in the world. modern society requires a high level of knowledge and transfer of this knowledge into new products, processes and services. science, technological development and innovation play an important role in fostering economic development and are a key factor in competitiveness and sustainable development. in order to respond adequately to the rapid economic advancement of society, a stronger link between science and the economy is needed. cooperation of science and economy is realized in two directions: the science on precise requirements of the business corresponds to solve important problems and science offers the business something new, improved or more accessible in order for this cooperation to be successful, in addition to the necessary knowledge and competencies of science, it is very important that the economy recognises the importance of science in modern business conditions. according to the european commission report "the state of the european university‐business cooperation" (ek, 2011) a total of eight forms of two‐way cooperation between science and business are distinguished: 140 economic analysis (2019, vol. 52, no. 1, 138‐148) graph 1. forms of cooperation between science and business source: the european commission the most popular form of cooperation is in the field of r & d, and it covers a whole range of joint research and development activities, research projects contracts, joint publications of scientists/researchers with business entities employees, as well as joint mentorship in a master and doctoral thesis. another aspect of cooperation is the commercialisation of research and development results that requires establishing of support mechanisms and relevant legislation the following very important form of cooperation relates to cooperation between students and the economy. students perform joint projects and practice in companies, which in this way mobilise high‐quality staff. new developments in the market create a growing need for innovative culture and entrepreneurial behaviour, and it is very important that as a result of cooperation between science and economy, new spin‐off and start‐up companies will be established. the pressure of competition in all markets, including the labour market, imposes continuous education and acquisition of new knowledge and skills that meet the needs of present society. for this reason, lifelong learning programs provide skills and knowledge to employees and their managers in order to adapt to the demands of modern society. the flexibility of the labour market is important in the process of absorption of future graduates, so it is recommended that the representatives of the business participate in the creation of study programs. the last form of science and business cooperation is academic mobility with the economy. managers are members of the board of directors at faculties and institutes, while on the other hand, academic and scientific workers are involved in decision‐making in companies for the successful cooperation between science and economy, the following factors are important (rakovska n. et al, 2012):  common goals ‐ cooperation should be based on mutual benefits, needs and goals,  commitment ‐ a good partnership is in the hands of "right people", starting with leadership and involving all organisational levels, modes of cooperation among industry and academia 1) r&d collaboration / contract research projects,sc. / tech. services 2) commercialization of r&d results by patenting, licensing 3) student projects with businesses 4) entrepreneurship: spin‐outs from university, start‐ups 5) student mobility, career services 6) lifelong learning, training courses 7) involvement of businesses in curricula development 8) mobility of academics between science and businesses ivan stošić, duško bodroža, mihajlo đukić 141  communication ‐ establishing a current and open dialogue, mutual trust and good knowledge is an important factor for successful cooperation. career centres and specialised departments, such as industry liaison departments, technology transfer centres, technology parks, business incubators, etc., have a special role in linking science and the economy, and  context ‐ scientific and business cooperation should be considered as a priority and has to be supported by adequate legislation. in addition, it is necessary to provide financial support to the national and institutional levels. there is a large number of authors who have confirmed the importance of investments in research and development in order to strengthen the competitive position of individual economic entities and, consequently, the economy as a whole. in doing so, it is of particular importance that the synergetic effect is achieved by the state incentives for businesses to treat the research as one of the priority factors of long‐term development. in this regard, investments in research and development are considered as an investment rather than cost and are especially important in periods of recession when it is necessary to encourage the investment cycle, provide the basis for future growth and stimulate aggregate demand. in such situations, companies often hesitate or postpone this type of investment, which may have negative consequences for the entire economy. brautzsch et al. (2015) analysed the incentive program that germany created in the aftermath of the global crisis in 2009 to encourage research and development and investment in equipment. compared to the initial budget of € 626 million, germany provided an additional € 900 million from the budget to finance research and development activities of small and medium‐sized enterprises (up to 1000 employees). in their research, the authors confirmed the justification of investments both in the production phase and in the stage of consumption of the earned income, stating that the value of the multiplier of output, added value and employment was around 2. thanks to the initiated investment cycle, the total value of production increased by almost 900 million euros, ie there was an increase of added value by over 360 million euros and over 7000 newly created jobs. certainly, a large number of authors point to the needs of a detailed analysis of the best modalities of cooperation between the state and the economy and how the state, by stimulating research at the company level, achieves the best effects, both at the level of the economy as a whole, and at the level of the companies. in this regard, it is necessary to pay particular attention to possible crowding out and measurement of the effects of various incentives – financing of researches through specially developed programs and tax incentives. guellec and de la potterie (2003) state that the funding of research and development programs and tax incentives significantly stimulate private sector investments and in that sense have positive effects on the development of the economy. on the other hand, state researches lead to crowding out, while researches at the level of higher education institutions have neutral effects on business investments. the government's investment effects are in the form of a u‐ curve, with the largest effects reaching a 10% increase over the initial level of investment. an increase of more than 20% is a substitute for private sector investments. bearing in mind that the analysis encompassed 17 oecd countries in the period 1981‐1996, it should be noted that the effects in a particular country must take into account both the specificities of economic conditions and the local context, the current level of investment in r & d, as well as the level of economic development in certain sectors and in total. nevertheless, guellec and de la potterie point out that in any context, stable versus volatile and unpredictable investment policy yields better results and that incentive instruments have the character of substitutability, which means that increased use of one reduces the effectiveness of another instrument. petrović (2013) states that science is an important factor in the recovery of the industry and that a small country can also develop high technology. world experiences show those countries which have continuously invested in research and education more successful and resilient to the crisis. hodžić (2011) notes that the nature of science and technology is such that at a time when 142 economic analysis (2019, vol. 52, no. 1, 138‐148) the cost of s&t occurs is impossible to measure future economic benefits. then one can only assume that the long‐term economic benefits are just the result of research and development costs. however, according to the results presented by zubović et. al (2013), we may conclude that the republic of serbia should use its research and development capabilities in order to achieve a competitive position in the global market based on knowledge and innovation. monitoring the international position of countries in science and innovation has been a challenge for governments, their specialised bodies, international organisations and institutions for decades. the reason for this is found in the fact that the economic development of the country is directly influenced by the development of science and technology, that is, research and innovation activities. numerous domestic authors have dealt with various issues of improving the effectiveness and efficiency of science in serbia ‐ rašević et. al (2013), kutlača et. al (2016), šipka (2016) in all these works, it is common to point out that science and innovation are considered as key factors of competitiveness and sustainable development, especially knowledge‐based development. on the other hand, in all these works, there is a common indication of the numerous problems that burden the science in serbia, where insufficient cooperation between science and economy is found as the most prominent one. cooperation between science and business in the republic of serbia researches in serbia are exclusively concentrated in the public sector at universities and institutes. according to the data of the statistical office of the republic of serbia, a total of 280 organisations are engaged in research and development, out of which 111 are higher education institutions, 107 come from the non‐financial sector, 54 from the state sector and 8 from the non‐profit sector. observed by scientific fields, the largest number of organisations are engaged in research and development in the field of engineering and technology and social sciences, a total of 103 and 62 organisations respectively. table 1. r & d organisations by sectors and scientific fields, 2017 total non‐financial sector state sector higher education non‐profit sector republic of serbia 280 107 54 111 8 natural sciences 47 19 11 16 1 engineering and technology 103 68 9 23 3 medical and health sciences 19 9 3 7 ‐ agricultural sciences 26 9 11 6 ‐ social sciences 62 2 9 47 4 humanities 23 ‐ 11 12 ‐ source: statistical office of the republic of serbia in r & d organisations, 22,782 persons are employed in total, out of which the majority are researchers – 16,182. of the remaining number of employees, technical staff is 3,037, professional associates 1,533, management staff 559 persons and other staff 1,471 persons. the largest number of persons are employed in technical (6,729) and natural sciences (5,185 persons). social sciences employ a total of 3,765 persons, medical sciences and health sciences 2,804 persons, while in agricultural and humanistic sciences there are a total of 2,458 or 1,841 employees. ivan stošić, duško bodroža, mihajlo đukić 143 table 2. full‐time and part‐time employees on research and development activities, by sectors, science fields and gender, 2017 (number of persons) total researches professional associates technical staff management other staff total female total female total female total female total female total female republic of serbia 22,78211,41116,182 8,098 1,533 778 3,037 1,539 559 214 1,471 782 natural sciences 5,185 2,631 3,977 2,062 299 130 590 287 96 34 223 118 engineering and technology 6,729 2,649 4,352 1,704 603 236 1,138 434 226 63 410 212 medical and health sciences 2,804 1,715 2,419 1,454 75 55 143 94 59 41 108 71 agricultural sciences 2,458 1,235 1,134 568 191 118 531 287 65 23 537 239 social sciences 3,765 2,072 2,848 1,480 194 121 481 320 91 43 151 108 humanities 1,841 1,109 1,452 830 171 118 154 117 22 10 42 34 source: statistical office of the republic of serbia in the past few years, serbia has improved its scientific research potential and, according to scimago journal & country rank, serbia participated in 0.15% of the total worldwide scientific work and ranked 54th in the list of 239 countries in total. the total number of realised research projects and studies in 2017 was 10,093. of this, the largest number of research works are fundamental ‐ 4,694, there is 3,705 applied works, and 1,694 development works. observed by sectors, the largest number of research works were carried out in higher education institutions, that is 6,215 works. the state sector accomplished 2,678, the non‐financial sector 1,174 and the non‐profit sector 26 research projects and studies. the total value of all realised research projects and studies is 41,531 million rsd, out of which the research works were worth 15,521 million rsd, development 13,638 million rsd and fundamental 12,371 million rsd. table 3. research works (projects and studies) by sectors, 2017 number of scientific works value of scientific works, 000 rsd total fundamentalapplied development total fundamental applied development republic of serbia 10,093 4,694 3,705 1,69441,531,049 12,371,06715,521,581 13,638,401 non‐financial sector 1,174 195 468 511 15,230,986 342,908 7,079,232 7,808,846 state sector 2,678 1,389 881 408 11,228,148 5,117,088 3,380,352 2,730,708 higher education 6,215 3,089 2,351 775 15,040,402 6,908,199 5,033,356 3,098,847 non‐profit sector 26 21 5 ‐ 31,513 2,872 28,641 ‐ source: statistical office of the republic of serbia the largest number of research projects and studies is from technical and social sciences, a total of 3,537 or 2,687 works. it should be kept in mind that in social sciences, most research works were involved in fundamental research (2,018), while applied and development researches included 554 and 106 works. the table below gives an overview of the number and value of research works by scientific areas. 144 economic analysis (2019, vol. 52, no. 1, 138‐148) table 4. research works (projects and studies) by scientific areas, 2017 number of scientific works value of scientific works, 000 rsd total funda‐ mental applied develop‐ ment total funda‐ mental applied develop‐ ment republic of serbia 10,093 4,694 3,705 1,694 41,531,04912,371,06715,521,581 13,638,401 natural sciences 1,769 1,225 302 242 10,700,246 5,079,198 1,560,586 4,060,462 engineering and technology 3,537 464 2,096 977 16,090,769 1,095,436 8,328,903 6,666,430 medical and health sciences 558 406 121 31 2,069,398 827,760 957,743 283,895 agricultural sciences 537 34 319 184 4,307,166 316,294 2,250,370 1,740,502 social sciences 2,678 2,018 554 106 6,662,013 3,595,654 2,238,714 827,645 humanities 1,014 547 313 154 1,701,457 1,456,725 185,265 59,467 source: statistical office of the republic of serbia in 2017, out of the total number of research and development works, in 6,139 cases, the contracting parties were ministries, while the economy commissioned only 773 researches. the largest number of ordered researches in business is in technical, and natural sciences, 621 or 94 r & d works, and in most cases they were engaged in applied and developmental research. table 5. research and development works by contracting party, scientific areas and type of research, 2017 business associations ministries total funda‐ mental applied develop‐ ment total funda‐ mental applied develop‐ ment republic of serbia 773 110 398 265 6,139 3,157 2,130 852 natural sciences 94 16 33 45 1,368 1,035 206 127 engineering and technology 621 94 315 212 1,748 230 1,110 408 medical and health sciences ‐ ‐ ‐ ‐ 296 225 64 7 agricultural sciences 10 ‐ 10 ‐ 320 26 183 111 social sciences 48 ‐ 40 8 1,683 1,292 320 71 humanities ‐ ‐ ‐ ‐ 724 349 247 128 source: statistical office of the republic of serbia compared to developed countries, investment in science in serbia is considerably more modest. according to the statistical office of the republic of serbia, the share of total budget funds for research and development in 2017 amounted 0.40% of gdp. according to eurostat data in the eu28 countries, the total allocation for research and development participates with 2.06% of gdp. the largest amount of funds spent for research and development activities in 2017 was in technical and natural sciences that participated with 38.7% and 25.8% respectively in the total sources of funding for r & d activities. of the other sciences, social and agricultural sciences participate with 16.0% and 10.4% respectively, while the participation of medical and humanistic sciences is 5.1% and 4.1% respectively in the total sources of funding for research and development activities. ivan stošić, duško bodroža, mihajlo đukić 145 table 6. sources of funds spent on research and development activities, 2017 in 000 rsd total own funds state and local government private and public companies non‐profit institutions foreign investors republic of serbia 41,531,049 9,751,556 19,334,739 4,173,842 2,345 8,268,567 natural sciences 10,700,246 1,221,219 5,502,870 790,072 545 3,185,540 engineering and technology 16,090,769 3,206,739 6,094,963 3,184,316 ‐ 3,604,751 medical and health sciences 2,069,398 124,533 912,314 ‐ ‐ 1,032,551 agricultural sciences 4,307,166 2,266,369 1,552,936 155,433 ‐ 332,428 social sciences 6,662,013 2,594,973 3,942,323 44,021 1,800 78,896 humanities 1,701,457 337,723 1,329,333 ‐ ‐ 34,401 source: statistical office of the republic of serbia according to the statistical office of the republic of serbia data, the highest amount of funds for research and development activities is allocated by the state and its authorities, which is rsd 19,335 million in 2017. the system of financing from budget funds includes a total of 16 programs of general interest which are financed by the project after publicly conducted calls and selection according to predetermined criteria. the largest part of funds (68.4%) is intended for financing scientific projects that were accepted at the competition announced in 2011. of the 68.4% of funds, 56.9% goes to the costs of the work of the researchers, 8.3% to the overheads of the institution in which the survey is conducted, and the remaining 3.2% is for the material costs of the projects. these percentages clearly show the difficult position of science in serbia. low r&d budget influences the quality and scope of research. since a relatively large amount of funds is spent on salaries, there is a small amount of disposable budget which could be allocated for the purchase of the research material and core research activities (mpntr, 2017). in addition to the state funding, research and development activities are still financed from own funds (rsd 9,752 million) and foreign investors (rsd 4,173 million). private and public companies account for 4.174 million rsd, which is only 10.0% of the total funds spent on this purpose. graph 2. sources of funds spent on r&d activities, 2017 source: statistical office of the republic of serbia 0% 20% 40% 60% 80% 100% foreign ordering parties non‐profit institutions private and public enterprises government and local authorities own 146 economic analysis (2019, vol. 52, no. 1, 138‐148) if we observe r & d expenditures according to the activity, the largest percentage of spent funds is in scientific research and development 45.7%, education 36.2% and оther mining and quarrying 5.2%. these three groups of activities together account for 87.1% of total research and development expenditure. table 7. gross domestic expenditure on r & d in grouped activities, 2017 gross domestic expenditure republic of serbia 41 531 049 scientific r & d 45.7% education 36.2% other mining and quarrying 5.2% veterinarian activities 3.0% electricity, gas, steam and air conditioning supply 2.4% service activities in mining and geological exploration 2.3% other activities 5.2% source: statistical office of the republic of serbia conclusions the analysis of the presented results clearly shows that serbia has significant potential in the science and research sector that the economy is not sufficiently utilising. the problem also originates from the fact that a large part of the domestic economy is privatized, and the largest number of r & d departments of these companies is abroad in countries of the parent companies. in addition, due to the high costs of research and development, the domestic economy relies more on the purchase of license‐solutions from abroad than on its own development, as evidenced by the fact that the very small percentage of researchers in serbia is engaged in the private sector the highest institutional and personnel capacities for cooperation between science and economy currently have technical and natural sciences in which the highest number of research projects and studies are implemented at higher education institutions. unfortunately, the big issue arises from the fact that published works, except in technical sciences, have a fundamental character that is not applicable in the short term. in addition, the domestic education system is much lagging behind and is not in line with the needs of the domestic and global markets. research activities are focused exclusively on the production of scientific papers. the main contractors of research projects and studies are the ministries, while the economy in the total of ordered r & d projects and studies participates with only 11.2%. funds from the budget and own funds continue to be the main source of science funding, while private and public enterprises in the financing of science account for only 10.0%. the level of monetary investments in scientific and technological research and scientific infrastructure in the republic of serbia has been stable over the past five years, but in comparison with the countries of the region and especially the world, it is insufficient to provide technological development of the country. however, presented results clearly show that serbia has potential in the science and research sector, but that this potential is not being transferred to new products and services on the market. inside the research system, no appropriate steering mechanisms necessary to ensure that the results of the research find their way to a competitive product or service have been established. in addition to the aforementioned challenges, representatives of the scientific community, as the main obstacles to cooperation between science and economy, see the lack of financial resources and their incompatibility, as well as an insufficient number of prospective projects. on the other hand, the representatives of the business, as the main issues, indicate too high ivan stošić, duško bodroža, mihajlo đukić 147 research and development costs, mismatching the duration of scientific projects with the needs of the economic cycle, inefficient system of transfer of scientific knowledge and technologies, as well as inadequate state support. all this points to the numerous challenges that stand as an obstacle to the greater role of science in the function of improving the effectiveness of the economic growth of the republic of serbia, which should be overcome in the coming period. references babić, j. (2013). uloga i značaj nauke i znanja sa posebnim osvrtom na društvene nauke, istraživanje u oblasti društvenih nauka u srbiji: pregled stanja, karakteristični problemi i preporuke, regional research, promotion programme western balkans, beograd. brautzsch, h. u., günther, j., loose, b., ludwig, u., & nulsch, n. (2015). can r&d subsidies counteract the economic crisis?–macroeconomic effects in germany. research policy, 44(3), pp. 623‐633. european commision. (2011). the state of the european university‐business cooperation european commission, smart specialization platform (ssp). http://s3platform.jrc.ec.europa.eu/eye‐ris3. eurostat, https://ec.europa.eu/eurostat/web/science‐technology‐innovation/data/main‐ tables. guellec, d., & van pottelsberghe de la potterie, b. (2003). the impact of public r&d expenditure on business r&d. economics of innovation and new technology, 12(3), pp. 225‐ 243. hodžić, s. (2011). stimulacija poreznih olakšica za istraživanje i razvoj, working paper, institute for public finance, zagreb, croatia. kutlača, đ., semenčenko, d. & nedović, v. (2016). smart specialization in serbia – challenges for governance of research and innovation, 23th scientific conference technology, culture and development, proceedings, tivat, montenegro, association “technology and culture”, isbn 978‐86‐915151‐3‐7, cobiss.sr‐id 230384908, pp. 7‐21. oecd. (2010). science, technology and innovation indicators for policymaking in developing countries: an overview of experiences and lessons learned, http://innovacion.ricyt.org/files/unctad.pdf. oecd. 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(2013). ka unapređenju saradnje između naučne zajednice i kreatora politika u srbiji, u stošić, i., radovanović, b. i đukić, m. (ur.): istraživanja u oblasti društvenih nauka u srbiji: pregled stanja, karakteristični problemi i preporuke, beograd: institut ekonomskih nauka, pp. 135–146. statistical office of the republic of serbia, scientific research activity, 2017. science and engineering indicators (2016). national science board, https://www.nsf.gov/statistics/2016/nsb20161/uploads/1/nsb20161.pdf scimago journal & country rank, https://www.scimagojr.com/countryrank.php microsoft word 2007 3 4.doc volume 40 • autumn 2007 • 87  abstract: the trustees of funded defined benefit pension schemes must make two vital and inter‐ related decisions ‐ setting the asset allocation and the contribution rate. while these decisions are usually  taken separately, it is argued that they are intimately related and should be taken jointly. the objective of  funded pension schemes is taken to be the minimization of both the mean and the variance of the contribution  rate, where the asset allocation decision is designed to achieve this objective. this is done by splitting the  problem into two main steps. first, the markowitz mean‐variance model is generalised to include three types  of pension scheme liabilities (actives, deferreds and pensioners), and this model is used to generate the effi‐ cient set of asset allocations. second, for each point on the risk‐return efficient set of the asset‐liability portfo‐ lio model, the mathematical model of haberman (1992) is used to compute the corresponding mean and vari‐ ance of the contribution rate and funding ratio. since the haberman model assumes that the discount rate for  computing the present value of liabilities equals the investment return, it is generalised to avoid this restric‐ tion. this generalisation removes the trade‐off between contribution rate risk and funding ratio risk for a  fixed spread period. pension schemes need to choose a spread period, and it is shown how this can be set to  minimise the variance of the contribution rate. finally, using the result that the funding ratio follows an  inverted gamma distribution, shortfall risk and expected tail loss are computed for funding below the mini‐ mum funding requirement, and funding above the taxation limit. this model is then applied to one of the  largest uk pension schemes ‐ the universities superannuation scheme.   in a funded defined benefit scheme the employer and employees both make contributions to  a fund which is invested to provide the pension, and any other benefits due under the scheme. the  benefits received under such schemes are defined in advance, usually as a proportion of the em‐ ployee’s final salary. many uk companies have recently chosen to close their defined benefit pen‐ sion schemes. in the 5½ years up to february 2003, 63% of uk final salary schemes were closed to  new entrants, while an additional 9% of schemes were also closed to future accruals (association  of consulting actuaries, 2003). the reasons given for closure include the introduction of financial  reporting standard 17, the substantial deficits on final salary schemes (caused by the fall in inter‐ est rates, the major stock market decline after the peak in december 1999, the extended contribu‐ tion holidays and contribution reductions for employers, increases in benefits, the conversion of  discretionary benefits into non‐discretionary benefits, the use of pension schemes to finance early  retirement on very favourable terms, and the tax limit on scheme surpluses); the effective move  from limited price indexation to fully indexed pensions, with the fall in annual increases in rpi to  below 5% since july 1991; the regulatory burden of administering these schemes; the increased cost  due to rising life expectancy; the increased size of pension liabilities, relative to the size of the em‐ ployer; the increase in stock market volatility; the risks that such schemes impose on employers  (e.g. the risk that the fund will be insufficient to pay the pensions, the credit rating of the employer  may be reduced because of the possibility of pension shortfalls); the abolition of tax relief on divi‐ dends from uk companies  in 1997;  the changes  in actuarial  technique  leading to more volatile  surpluses; the risk that new legislation or decisions by the law courts will increase the liabilities;  joined‐up pensions policy in the uk:   an asset‐liability model for simultaneously determining  the asset allocation and contribution rate* john board, charles sutcliffe, the icma centre, university of reading  key words: pension scheme, portfolio theory, asset‐liability  modelling, contribution rate risk, solvency risk  jel: g11, g23  * previousy published in handbook of asset and liability management, edited by stavros a. zenios and william t. ziemba,  (north holland handbooks in finance, elsevier science b.v., volume 2, 2007, pp. 1029‐1067, isbn‐10: 0‐444‐52802‐4)  analysis  2007 ‐ 88  •  economic analysis®  the  lower  priority  given  to  retaining  staff;  the  opportunity  to  establish  defined  contribution  schemes with a lower cost to the employer, and the much greater portability of defined contribu‐ tion schemes.  this  paper  develops  an  approach  to  the  simultaneous  analysis  of  two  critical  and  inter‐ related decisions which must be made by any fund’s trustees: the fund’s asset allocation and its  contribution rate. the model developed  in  this paper  is applicable  to a wide range of pension  schemes, and is illustrated with reference to a particular very large pension scheme ‐ the universi‐ ties superannuation scheme.  some previous authors have used multi‐period stochastic programming (mpsp) to analyse  the  investment  and  contribution  rate  decisions  of  defined  benefit  pension  schemes,  bogentoft,  romeijn and uryasev (2001), dert (1998), drijver, klein haneveld and van der vlerk (2002, 2003),  gondzio and kouwenberg (2001), hilli, koivu, pennanen and ranne (forthcoming), kouwenberg  (1997, 2001) and mulvey, simsek and pauling (2003)1. while mpsp permits the relaxation of many  of the assumptions required by other methods,  it requires extensive model   building, has  large  data requirements and, until recently, has been difficult to solve. dynamic stochastic control the‐ ory was applied to a small swiss pension scheme by dondi, herzog, schuman & geering (2006),  while rudolf and ziemba (2004) applied stochastic control theory to a hypothetical us example.  however, stochastic control theory requires the solution of nonlinear problems, assumes that the  portfolio is constantly revised, can generate very large short and long positions, and may require  big changes in asset proportions from period to period, see ziemba (2003). a third approach that  has been applied to analyse the investment and contribution rate decisions of defined benefit pen‐ sion schemes is stochastic simulation, boender (1997), boender, van aalst and heemskerk (1998),  boender and vos (2000), boender, dert and hoek (2006), haberman et. al. (2003), kingsland (1982),  mulvey et al. (2005), mulvey, gould and morgan (2000), mulvey and thorlacius (1998) and wright  (1998). although simulation models are flexible, they do not generate optimal decisions and re‐ quire considerable effort  to  formulate. however,  they are useful  to check  the validity of more  complex models. fourth, frankfurter and hill  (1981) developed a multi‐period  linear program‐ ming asset‐liability model which minimizes the present value of the contributions. however,  it  approximates  the non‐linearity  introduced by risk, does not generate a risk‐return  frontier and  treats  the  liabilities as certain. finally, tepper  (1974) used stochastic dynamic programming  to  minimize the present value of the contributions, but did not include either asset or liability risk.  this  paper  proposes  a  different  methodology  based  on  mean‐variance  portfolio  theory,  which is well understood, has modest data requirements and is both general and simple to apply.  this makes the methods used  in this paper straightforward to operationalise, while still  jointly  optimising  the  asset  allocation  and  contribution  rate  decisions.  an  enhanced  portfolio  model,  which includes the scheme’s liabilities (sub‐divided into active members, deferred pensioners and  pensioners) as well as its chosen assets, is solved to generate efficient asset allocations.  for efficient portfolios, a generalisation of the mathematical model of haberman (1992) is used to  compute the implied mean and variance of the contribution rate and funding ratio (i.e. the ratio of  the fund value to its actuarial liabilities). the extension of the haberman model is critical as we are  able to relax a major inflexibility of the original model to allow the discount rate used in the actuar‐ 1 see ziemba (2003) for an introduction to the application of multi‐period stochastic programming to asset‐liability man‐ agement. geyer, herold, kontriner and ziemba (2005) developed a multi‐period stochastic programming model for both  defined benefit and defined contribution schemes, which was applied to the siemens ag österreich defined contribution  scheme. other papers in related areas include cariño, et al. (1994), cariño and ziemba (1998), cariño et al. and ziemba  (1998). fabozzi, focardi and jonas (2005) survey ed 28 pension schemes in the uk, usa, netherlands and switzerland  with average assets of $16 billion. one third of these schemes used mpsp.  volume 40 • autumn 2007 • 89  ial calculations to differ from the expected investment return, and thus to model contribution rates  in a way which conforms to finance theory. this generalization also removes any trade‐off be‐ tween contribution rate risk and funding ratio risk (for a fixed spread period), as one is simply a  linear function of the other. it also removes the need to recompute the actuarial valuation of the  liabilities as the asset allocation changes. we then further enhance the model to allow an investiga‐ tion of the choice of the spread period used to adjust the contribution rate. this mathematical  model is also used to estimate the distribution of the funding ratio, and to investigate the regula‐ tory and solvency risk implied by the asset allocation and contribution rate decisions.   section 1 discusses why the asset allocation and contribution rate decisions must be taken  jointly. section 2 presents the portfolio model of the asset‐liability problem, while section 3 shows  how  the  means  and  variances  of  efficient  asset‐liability  portfolios  can  be  transformed  into  the  means and variances of the contribution rate and funding ratio. section 4 sets out the assumptions  of the haberman model. section 5 investigates the issue of choosing the spread period, and section  6 considers regulatory and solvency risk. section 7 briefly describes the pension scheme studied ‐  the universities superannuation scheme; while section 8 contains the data. sections 9 and 10 con‐ tain the results for the portfolio model and the transformation of these results into contribution  rates and funding ratios. section 11 has the results for the optimal spread period, section 12 con‐ siders the effect of triennial valuations, and section 13 deals with regulatory and solvency risk.  section 14 concludes.   linkage between the asset allocation and the contribution rate  the initial point for the analysis is the calculation of the actuarial liability of the fund. this  calculation is divided into three parts, the value of the liability in respect of active members (those  currently  contributing  to  the  fund  before  retirement)  and  those  in  respect  of  non‐contributing  members (deferred pensioners and pensioners). equation (1) sets out a very simple calculation of  the actuarial liability for active members using the projected unit method.  the projected unit method “is now the natural method to use. ..... we see no strong reason to  use any other method than the projected unit method for funding large schemes expected to have  a continuing flow of new entrants”. a survey found “that the majority of actuaries are now using  the projected unit method”, thornton and wilson (1992). frs 17 requires the use of the projected  unit method, while it is prescribed by financial accounting statement 87 (employersʹ accounting  for  pensions)  issued  in  1985  by  the  us  financial  accounting  standards  board.  (however,  the  valuation method used for company accounts under frs 17 could differ from that used in setting  the contribution rate.) for the projected unit method, “the actuarial liability for active members  either as at the valuation date or as at the end of the control period is calculated taking into ac‐ count all types of decrement. in such calculations pensionable pay is projected from the relevant  date up to the assumed date of retirement, date of leaving service or date of death as appropriate.”  faculty and institute of actuaries (2003).   this paper uses a simple actuarial model. however, a very wide range of alternative actuar‐ ial models could be used without changing the main conclusions. in a fully specified model, addi‐ tional terms would be included to allow for withdrawals, transfers in and out, deferment, death in  service, early retirement, ill‐health retirement, the option for a lump sum payment on retirement,  etc. the formulae are based on actuarial education company (2002).   2007 ‐ 90  •  economic analysis®    (1)  where  ala is the actuarial liability for the active members of the scheme,  p is the average member’s past years of service as at the valuation date,   s is the average member’s annual salary at the valuation date,   a is the accrual rate,  e is the forecast nominal rate of salary growth per annum between the valuation date and retirement,  h is the nominal discount rate between now and retirement, and is assumed equal to the expected investment return on  the assets for this period,  r is the average member’s forecast retirement age,  g is the average age of the member at the valuation date,  w is the life expectancy of members at retirement,  p is the rate of growth of the price level, and  na is the current number of active members of the scheme.  the final term in equation (1) is the capital sum required at time r to purchase an index‐ linked annuity of £1 per year.  a simple model for the computation of the actuarial liability for pensioners is    (2) where    alp is the actuarial liability for pensioners,    np is the current number of pensioners,    pen is the average current pension;    and the final term is the capital sum required now to purchase an index‐linked annuity of £1  per year for the life expectancy, q, of pensioners. adjustments to this simple model are required for  dependents’ pensions, death lump sum, etc.   a similar expression for the liability of deferred pensioners is  (3) ald is the actuarial liability for the deferred pensioners of the scheme,  nd is the current number of deferred pensioners of the scheme,  sd is the average deferred pensioners’ leaving salary, compounded forwards to the valuation date at the inflation rate  (p), and  pd is the average deferred pensioner’s past years of service as at the valuation date.  the total actuarial liability (alt) is  alt = ala + alp + ald  (4)  which is the sum of the actuarial liabilities for every active member, pensioner and deferred  pensioner. the precise  form of  the actuarial computations  in equations 1‐3  is  irrelevant  for  the  volume 40 • autumn 2007 • 91  model developed below for setting the asset allocation and the contribution rate.  the trustees must invest the funds to ensure that the scheme is able to meet its liabilities. to  do this they make the asset allocation decision, which involves setting the proportions of the fund  invested in different classes of asset. classes of asset might include domestic equities, foreign equi‐ ties,  domestic  gilts,  domestic  index  linked  gilts,  foreign  bonds,  property,  cash,  private  equity,  commodities, etc. because it is generally accepted that asset classes with higher expected returns  also have higher risks (dimson, marsh and staunton, 2002; cornell, 1999; constantinides (2002);  and siegel, 2002), the asset allocation has an important effect on both the risk and return of the  fund. while the selection of specific stocks, bonds or properties may also be important in determin‐ ing the investment performance of the fund, it is not usually possible for the trustees to become  involved  in  this  level of detail, and so  the asset selection decision  is usually delegated  to fund  managers. this delegation can be further  justified by the evidence that the main determinant of  investment performance for uk and us pension funds is asset allocation, rather than asset selec‐ tion (blake, lehmann and timmermann, 1999; brinson, hood and beebower, 1986; brinson, singer  and beebower, 1991; and ibbotson and kaplan, 2000).   the trustees must also determine the employer’s and employees’ contribution rates. the em‐ ployees’ contribution rate (the percentage of their salary that each employee must pay to the pen‐ sion scheme),  is usually constant. in contrast, the employer’s contribution rate  is set (or recom‐ mended) by the pension scheme’s trustees, and is periodically reappraised. the modified (or rec‐ ommended) contribution rate is equal to the standard (or normal) contribution rate plus or minus  a contribution rate adjustment to correct for any difference between the actual and target funding  level of the scheme. the contribution rate adjustment can be computed in a variety of ways. in the  uk  the commonly used methods are  the spread  (or percentage of pay) method,  the mortgage  method and the straight line method. the us and canada use the amortization of losses method.  because the employees’ rate is usually constant, any change to the overall contribution rate made  by the trustees will result in a change to the employer’s rate. obviously, increasing the contribu‐ tion rate has a direct effect on  the fund’s value, while  increasing employment costs  to  the em‐ ployer.   using the projected unit method, the standard contribution rate is defined by the actuarial  education company (2002) as ʺthe present value of all benefits that will accrue in the year follow‐ ing the valuation date (by reference to service in that year and projected final earnings) divided by  the present value of all membersʹ earnings in that yearʺ. the standard contribution rate (scr) is  (5) where  a1┐ is an annuity to give the present value of earnings by the member over the next year, and  ae is the administrative expenses of the scheme, expressed as a proportion of the current salaries of the active members.  the asset allocation and contribution rate decisions are interrelated as both affect the level  and volatility of the contribution rate and the value of the fund. throughout this paper assets are  valued using current market prices. actuaries can use other methods of valuation (e.g. the divi‐ dend discount model) which tend to smooth out variations in the value of the fund and contribu‐ tion rate. but the actuarial profession is adopting market values, and smoothing the value of the  fund and the contribution rate by ignoring changes in market value is diminishing in importance.  if the scheme chooses an equity tilt in its asset allocation, in the expectation that this will increase  returns on the fund, the average contribution rate may be reduced. however, an equity tilt will  increase the volatility of the fund’s returns. the degree of over or under funding of the scheme will  2007 ‐ 92  •  economic analysis®  also tend to be volatile, and this will increase the volatility of the contribution rate. the extent to  which the volatility of an equity tilt feeds through to the contribution rate depends on the way in  which the contribution rate is adjusted. for these reasons, the asset allocation and contribution rate  strategies need to be considered jointly. haberman et. al (2003) have also argued that the funding  and investment strategies of a pension scheme should be considered jointly. in essence, the trus‐ tees choose the level and variance of the contribution rate which they prefer; and this then deter‐ mines the asset allocation.  a multi‐period portfolio model of the asset‐liability problem  when portfolio models are applied to assets, the conventional objective is to maximize the  return for a given level of risk; or minimize the risk for a given level of return. previous models of  pension schemes have used a range of objectives reflecting risk and return. the risk measures used  include the minimization of the variance of the contribution rate, the variance of fund value, the  variance of the funding ratio, and solvency risk (defined in a variety of ways). while the aim for an  asset portfolio is to maximize its returns, the objective of a pension scheme is to minimize its cost.  therefore  the “return” measures used by previous studies  include  the minimization of  the ex‐ pected contribution rate, the minimization of the present value of total future contributions, and  the maximization of expected utility. this study minimizes the contribution rate and its variance.  pension schemes have liabilities that may fall due up to sixty years (the life expectancy of a  young academic) in the future, and so face a multi‐period portfolio problem. although no general  solution to the multi‐period portfolio problem exists, it can be solved if some additional assump‐ tions are made. a number of authors including hakansson (1970, 1971), mossin (1968) and camp‐ bell and viceira (2002, pp. 33‐35) have noted that, if portfolio returns are expected to be stationary  over time (that is, returns are independently and identically distributed, or i.i.d.) and have a nor‐ mal distribution, the investor’s attitude to risk is wealth independent, and all dividends are imme‐ diately reinvested; then the problem is stationary, and the one‐period solution is also the multi‐ period solution. if some aspect of the problem changes, the model can easily be re‐solved. since the  contribution rate is usually fixed for three years, the asset allocation decisions in the second and  third years are constrained to generate portfolios with risks and returns that are similar to those of  the initial portfolio chosen in the first year of each triplet.  the strong assumption of normal i.i.d. returns is widely accepted and generally works rea‐ sonably well (it is, for example, made in the derivation of the black‐scholes option pricing model).  while asset returns can be approximated by a normal distribution, this is less clear for liabilities. if  the maturity of the scheme is changing over time, the correlation between the scheme’s liabilities  and the various asset classes will also change. however, since the liabilities will be disaggregated  into active members, pensioners and deferred pensioners; a change in scheme maturity need not  change the correlations used in the model. the assumption of wealth independence fits with the  evidence that the risk premium has not trended up or down over the last century as society has  become much richer, and with the fact that pension schemes are organisations with an infinite life  that do not  themselves consume goods and services. black  (1995) refers  to pension schemes as  “conduits”. finally, the immediate re‐investment of all dividends is common practice. therefore,  while the assumptions underlying myopia and the use of a one‐period model are simplifications,  they appear to offer a reasonable approximation to reality.   pension schemes have  liabilities to present and future pensioners, and the purpose of the  pension fund is to meet these liabilities. to allow for liability risks, the portfolio model used to  determine the asset allocation is modified by the inclusion of scheme liabilities (sharpe and tint,  volume 40 • autumn 2007 • 93  1990; sharpe, 1990; ezra, 1991)2. instead of viewing the pension scheme as a separate entity, it can  be treated as an integral part of the employer. in which case the portfolio problem includes not  only the assets and liabilities of the pension scheme, but also the assets and liabilities of the em‐ ployer (bagehot, 1972). chun, chiochetti and shilling (2000) and craft (2001, 2005) have applied  the sharpe‐tint model to us corporate pension funds. the returns on shares in some employers  may be highly correlated with those of a particular industrial sector. in which case the portfolio  allocation decision of the fund should make allowance for this situation. however the very large  public sector pension scheme studied below (uss) has no such problems, and so this feature is not  incorporated into the model.  since the value of the liabilities  is assumed to be unaffected by the asset allocation of the  fund, the portfolio problem can be stated in terms of the mean and variance of returns on the fund;  but with the addition of a term for the covariances of returns on each asset class with the liabilities.  there is no explicit consideration of matching the duration of the assets and liabilities. however, if  assets with a range of durations are included, the portfolio model implicitly takes duration match‐ ing into account.  the model of sharpe and tint (1990) is extended by disaggregating pension fund liabilities  into three components (active members, deferred pensioners and pensioners), where each of these  components has different correlations with the various asset classes. pensions in payment can take  the form of a fully index‐linked annuity when pension increases are linked to the retail price index  (rpi), while deferred pensions are usually based on final salary, indexed to the retirement date for  subsequent increases in the rpi. index‐linked gilts are likely to represent a good match for such  liabilities. full price indexation and an absence of deflation is assumed so that there are no limited  price indexation complications.   the size of the pension that will be received by active members depends on their final sala‐ ries; and other asset classes are likely to provide a better match for this salary risk than uk gov‐ ernment bonds (gilts). the model assumes, as does haberman’s (1992) model, which is discussed  below,  that  the  growth  rates  of  total  benefits  and  total  contributions  are  non‐stochastic.  if  the  growth rates of total benefits and contributions are stochastic, the variances of the portfolios pro‐ duced by the sharpe and tint model must be expanded to include the correlations between wages  and the assets, and between benefits and the assets, see yang (2003).  the expanded portfolio model, including different types of liability, is    (6a‐6e)  2 waring (2004) deflated by the liabilities, rather than the assets; and expressed the risk and return of the asset‐liability  portfolio in terms of the alphas and betas of the capital asset pricing model. nijman & swinkels (2003) applied the  sharpe‐tint model, but with the simplification that the importance of the liabilities (k) equals the initial funding ratio.  2007 ‐ 94  •  economic analysis®  where:  val is the variance of the asset‐liability portfolio,  i and j represent asset or liability classes,  n is the number of assets and b the number of liabilities,  vij are covariances of returns between asset or liability classes i and j,  ei and ea are the expected arithmetic returns on asset or liability class i and the chosen asset portfolio respectively,   wi are the initial portfolio proportions of the b types of scheme liability, which are assumed fixed. thus, for three types of  liability, w1 = −l01/a0, w2 = −l02/a0 and w3 = −l03/a0, where l01 represents the current liability to active members, l02 is the  current liability to deferred pensioners, l03 represents the current liability of pensions in payment, and a0 is the current  value of the fund’s assets, and  xi are the investment proportions in each of the n+b asset or liability classes.   an efficient frontier can be constructed by repeatedly solving this quadratic programming  problem for a range of required expected returns on the portfolio of assets held, ea. short selling is  excluded by (6d) because pension schemes choose not to engage in this activity. the exclusion of  short selling (and of borrowing money) has important implications for the optimal asset allocation  (sutcliffe, 2005). because the liability proportions are fixed, the returns on the liabilities and the  covariances between returns on different liabilities play no part in determining the asset propor‐ tions of the efficient frontier. the returns on the liabilities are the proportionate changes in value of  the  liabilities during  the period. liability returns may be due  to changes  in accrued years,  the  number of members and pensioners, the level of salaries and the rpi, variations from the actuary’s  demographic assumptions, and, most importantly, changes in the discount rate.  a  continuous  time  model  for  the  asset  allocation  decision  of  defined  benefit  pension  schemes, based on the sharpe & tint (1990) model and merton (1992), was derived by rudolf &  ziemba (2004). their model has four‐fund separation, with  investors determining  their optimal  weights across these four funds. the objective is to maximize the intertemporal scheme surplus,  and rudolf & ziemba show that the proportion of the scheme’s assets invested in securities pro‐ viding a hedge for its liabilities should be equal to a constant (which is a linear function of the asset  and liability covariances), divided by the funding ratio. therefore, the proportion of the fund in‐ vested in assets hedging the liabilities is independent of preferences; and becomes lower as the  funding ratio rises.  transformation of the portfolio returns to contribution rates and funding ratios  macbeth,  emanuel  and  heatter  (1994)  report  than  trustees  find  it  much  easier  to  make  judgements about contribution rates and funding ratios than about return distributions. since the  asset allocation decision should be taken simultaneously with the contribution rate decision, it is  helpful to respecify the objective from a mean‐variance analysis of returns to using the mean and  variance of the contribution rate and funding ratio as the criteria. haberman (1997a) observes that  there is a difference between the variance of the present value of all future contributions, and the  long‐run variance of contribution rates. the usual choice, which is followed in this paper, is the  long‐run variance of contribution rates.  beginning with the work of dufresne (1986, 1988, 1989, 1990a, 1990b), mathematical expres‐ sions have been derived for the first two moments of the contribution rate and the funding ratio.  these models provide formulae for the mean and variance of the total value of contributions and  the total value of the fund. however, if alt and q (the total value of annual salaries currently paid  to active members) are fixed, it is more convenient to work with the mean and variance of the con‐ tribution rate and the funding ratio. a series of papers have developed and elaborated this ap‐ volume 40 • autumn 2007 • 95  proach: bédard (1999), booth, chadburn, cooper, haberman & james (1999), cairns (1995, 1996a,  2000), cairns and parker (1997), chang and chen (2002), gerrard and haberman (1996), haberman  (1990b, 1992, 1993a, 1993b, 1994a, 1994b, 1995, 1997a, 1997b, 1998), haberman, butt and megaloudi  (2000), haberman and dufresne  (1991), haberman and owadally  (2001), haberman and wong  (1997),  mandl  and  mazurová  (1996),  owadally  and  haberman  (1999,  2000)  and  zimbidis  and  haberman (1993).   some studies have used stochastic control theory to investigate the effects of allowing the as‐ set proportions in the risky and riskless assets to be altered over time according to some assumed  rule (boulier, trussant and florens, 1995, boulier, michel and wisnia, 1996, cairns, 1996b, 1997,  bédard and dufresne, 2001, josa‐fombellida and rincón‐zapatero, 2001, and rudolf and ziemba,  2004). this usually involves modelling a hypothetical pension scheme with two classes of asset,  one risky and one risk‐free, and a riskless liability; to derive expressions for the mean and variance  of both the value of contributions and the value of the fund for combinations of the following as‐ pects of the problem:  o spread period –  the use of  the spread method or  the amortization of  losses method  when setting the number of years over which the over or under‐funding of the scheme  is to be eliminated.  o returns distribution – the assumption of i.i.d. returns, first or second order autoregres‐ sive returns, or first order or second order moving average returns on the investments  of the scheme.   o funding method – the use of individual or aggregate funding methods by the actuary  when valuing the liabilities of the scheme and setting the standard contribution rate.  o lagged adjustments – the presence of a lag of zero, one or more years in revising the  contribution rate.  o valuation timing – annual or triennial actuarial valuations of the scheme.  many different funding methods have been developed to compute the contribution rate and  funding ratio, among them are the attained age, entry age, projected unit and current unit meth‐ ods. the choice of funding method affects the level and stability of the contribution rate. for ex‐ ample, the entry age method produces a stable contribution rate over the life of each member, and  if the distribution of entry ages and sexes remains equal to those assumed, the contribution rate for  the scheme is constant over time. similarly, if the forecast return on investments exceeds the fore‐ cast rate of salary growth, then the contribution rate generated by the projected unit method is a  positive linear function of the member’s age. if the age, sex and salary distribution of members  remains constant, this method also produces a stable contribution rate for the scheme.  the model which is closest to the circumstances of many large uk pension schemes is that of  haberman (1992). among this model’s assumptions are that the scheme uses the spread method  for adjusting the contribution rate. the spread and the amortization of losses methods have been  compared by cairns (1995, 1996a), haberman (1998), haberman and owadally (2001) and owa‐ dally  and  haberman  (1999,  2000).  the  minimum  variance  of  the  contribution  rate  that  can  be  achieved  using  the  spread  method  is  below  that  achievable  using  the  amortization  of  losses  method. in addition, for a given variance of the funding ratio, the corresponding variance of the  contribution rate is lower for the spread method. therefore, the spread method is preferable on the  grounds of giving lower variances for both the contribution rate and the funding ratio.   it is also assumed that the valuation, or discount, rate is certain and equal to the expected  rate of return on investments. the use of the return on the assets as the discount rate is permitted  2007 ‐ 96  •  economic analysis®  by ssap 24 (asb, 1988), and has been in widespread use by actuaries for many years. recently  other discount rates have been suggested  ‐  long term bond yields, bond yields plus a risk pre‐ mium, and returns on a portfolio that replicates the liabilities, faculty and institute of actuaries  (2003) and exley, mehta and smith  (1997). frs 17  (asb, 2000) proposes  that  the return on  the  matching portfolio be proxied by the return on aa grade corporate bonds. if the return on the as‐ sets is higher than these alternatives, its use as the discount rate reduces the actuarial liability and  the  expected  contribution  rate.  therefore  the  contribution  rates  given  by  the  haberman  (1992)  model are usually lower than those produced by a model using the return on a liability matching  portfolio as the discount rate.  additional assumptions are  that returns are  i.i.d., an  individual funding method (e.g.  the  projected unit method) is in use, actuarial valuations are annual, there is a lag of one year in ad‐ justing  the  contribution  rate  after  each  actuarial  valuation,  there  are  no  benefit  improvements  (other than full price indexation), the target funding ratio is 100%, the demographic assumptions  of the actuary are realized, scheme membership is stationary in size and structure and the rate of  salary growth is constant and certain. the model shows that, in these circumstances, the actuarial  liability and the standard contribution rate are constant over time, and the average funding ratio is  100%.  although  the  haberman  (1992)  model  assumes  that  the  size  of  the  scheme  is  constant,  scheme growth need not affect the standard contribution rate computed using the projected unit  method  if  the  age,  sex  and  salary  distribution  of  members  remains  unchanged.  to  allow  for  growth in salaries and benefits, the haberman (1992) model uses the deflated investment return  (va)  (7) where the rate of salary growth between now and retirement is assumed to increase at the same rate as benefits. to en‐ sure stationarity, haberman also assumes that e = p, and that there is no promotional scale. these restrictions are not  imposed on the actuarial models in equations 1 to 5.     if expected returns are to be deflated by earnings growth, it follows that the variance of the  asset‐liability portfolio should also be deflated, and so σ2al is  (8) relaxing the assumptions of the haberman (1992) model  the  most  restrictive  assumption  of  the  haberman  (1992)  model  is  that  the  discount  rate  equals the rate of return on investments. this assumption, which is also widely used in other actu‐ arial models of pension schemes, has  the strange consequence  that, by  investing  in a high‐risk  high‐return portfolio of assets, the liabilities of the scheme get smaller. to avoid making this unde‐ sirable assumption, we generalise the haberman model to allow the discount rate to differ from  the investment return. full details of the generalisation are available from the authors, but it fol‐ lows the similar generalisation of the dufresne (1988) model presented by cairns (1995, 1996a). as  well as improving the economic realism of the model, this generalisation greatly simplifies its em‐ pirical application. this is because the actuarial liability is unaffected by the asset allocation deci‐ sion, obviating the need to re‐compute the actuarial liability for every asset allocation with a dif‐ ferent rate of return. when the investment rate of return is used to estimate h (as in haberman,  1992) the actuarial liabilities change as the asset allocation changes, and the actuarial formulae for  volume 40 • autumn 2007 • 97  the computation of the liabilities are necessary to operationalise this model. however, if the rate of  return on a portfolio that matches the liabilities is used to estimate h (as in the generalised haber‐ man model), the return on the matching portfolio is invariant with respect to changes in the asset  allocation, and the values of the actuarial liabilities are constant. in which case, the actuarial valua‐ tion of  the  liabilities  is simply a  fixed  input number  to  the model. the generalized haberman  model also drops the requirement that the funding ratio be 100%.  the models of haberman et al assume that the liabilities are riskless. this implies there is no  discount rate risk; and that the actuarial demographic assumptions such as longevity, withdrawals  and early retirement are satisfied. the discount rate for liabilities in this paper is the riskless rate.  however, when computing investment risk, the asset variance is replaced by the variance of the  asset‐liability portfolio. since the portfolio model allows the liabilities to be risky, both discount  rate risk and actuarial demographic risks are indirectly incorporated into the model.   the  haberman  (1992)  model  assumes  that  actuarial  valuations  are  annual,  while  most  schemes have triennial valuations. as a result, the model tends to understate the true variance of  the contribution rate and funding ratio. triennial valuation could have been allowed for using the  model of haberman (1993b), but at the expense of assuming that the contribution rate was ad‐ justed instantly on the date of the actuarial valuation. cairns (1996a) concludes that a one year lag  in adjusting the contribution rate has a much bigger effect on the variance of the contribution rate  than does allowance for triennial valuations. we investigate the size of this effect by comparing the  mean and variance of the contribution rate and funding ratio using the model of dufresne (1988),  which assumes annual valuations and instant revision of the contribution rate, with those obtained  using the model of haberman (1993b), which assumes instant revision of the contribution rate, but  triennial valuations. details of these models appear in the appendix.   the haberman model does not  incorporate benefit  improvements which may be granted  when the funding ratio becomes strongly favourable, nor does it include any defaults which may  occur when the funding ratio becomes very unfavourable. this is because the inclusion of such  effects would considerably complicate the model.  while the haberman model could be applied to determine the asset allocation of the pension  schemes of companies, there are tax arbitrage arguments for such schemes simply selecting the  asset allocation which minimises the risk of the asset‐liability portfolio (ralfe, 2001; ralfe, speed  and palin, 2003; sutcliffe, 2005). if these arguments are accepted, the haberman model only applies  to pension schemes whose employer does not pay tax. among examples of such schemes in the  uk are those run by local authorities, the british broadcasting corporation, the universities su‐ perannuation  scheme,  the  church  commissioners,  the  financial  services  authority,  the  civil  aviation authority, london transport, british coal, the post office and the merchant navy.  the following equations give the first two moments of contributions and the value of the  fund for a given investment return and variance of asset‐liability returns under the projected unit  method using both the haberman (1992) model and its generalised version, denoted respectively  by the subscripts h and g. the expected value of the fund (f) is  e[f]h = alt  (9h)  e[f]g = galt  (9g)    (10)      2007 ‐ 98  •  economic analysis®    (11)    where d’ is the discount rate for liabilities      (12)  i.e. k is the reciprocal of a compound interest rate annuity with a life of m years calculated at the rate d.  the expected modified level of contributions (c) is equal to the standard level of contribu‐ tions (sc, where sc = scr×q, where q is the total value of annual salaries currently paid to active  members) plus an additional term in the case of the generalised model  e[c]h = sc  (13h)  e[c]g = sc + kala(1−g).  (13g)  when g > 1, the term kala(1−g) becomes negative, and if |kala(1−g)| > sc, e[c] becomes  negative, and expected contributions are negative. a negative contribution rate is only possible if  permitted by the scheme rules and sanctioned by the trustees; and a contribution holiday, i.e. e[c]  = 0,  is much more  likely. the use of a contribution holiday, rather than negative contributions,  means that the funding level of the scheme will tend to grow over time, and this conflicts with the  assumption of  the haberman model  that  the scheme  is  in  long run equilibrium. therefore,  the  generalised haberman model excludes situations where e[c]g < 0.  the corresponding variances of f and c are  var[f]h = alt2b  (14h)  var[f]g = alt2bg2  (14g)  var[c]h = ala2k2b  (15h)  var[c]g = ala2k2bg2  (15g)  where     (16)  u = (1+va), and σ2 is the variance of va.   these equations give the first two moments of the total levels of the value of the fund and  annual contributions to the scheme. the equivalent numbers for the funding ratio (fr) and the  contribution rate (cr) for the haberman (1992) and the generalised haberman models are  e[fr]h = 1  (17h)  e[fr]g = e[f]g/alt = g  (17g)  e[cr]h = sc/q  (18h)  e[cr]g = e[c]g/q  (18g)    volume 40 • autumn 2007 • 99  var[fr]h = b  (19h)  var[fr]g = bg2   (19g)  var[cr]h = var[c]h/q2  (20h)3  var[cr]g = var[c]g/q2.  (20g)  it can be seen from equations (15), (19) and (20) that, for both the haberman (1992) and the  generalised haberman models, the variance of the contribution rate is equal to the variance of the  funding ratio multiplied by ala2k2/q2. for the haberman (1992) model, ala varies as the invest‐ ment return varies, and so the relationship between var[cr] and var[fr] is non‐linear. however,  for the generalised haberman model, ala is computed using a fixed discount rate, resulting in a  constant proportional relationship between var[cr] and var[fr], i.e. ala2k2/q2. therefore, for the  generalised haberman model with a  fixed spread period  (but not  the haberman, 1992, model)  there is no trade‐off between contribution rate risk and funding ratio risk.  in these equations, the values of va and σ2 relate to a particular efficient portfolio generated  by the quadratic programming model, alt, ala, q and sc are the result of actuarial calculations, d  is the deflated discount rate, and m is a policy variable.  the choice of the spread period  although uk accounting rules require m, the number of years used in the spread method to  be equal to the average future working life of the membership, actuaries are free to choose m. a  number of researchers have examined the choice of m for computing the contribution rate adjust‐ ment: bédard (1999), booth, chadburn, cooper, haberman & james (1999), cairns (1995, 1996a),  cairns and parker (1997), chang and chen (2002), dufresne (1986, 1988, 1989, 1990b), haberman  (1990a,  1993b,  1994a,  1994b,  1995,  1997a,  1997b,  1998),  haberman,  butt  and  megaloudi  (2000),  haberman and dufresne (1991), haberman and wong (1997) and owadally and haberman (1999,  2000). their models reveal that, as the spread period is lengthened, the variance of the contribution  rate first decreases, but then, after a critical value of m, denoted m*, begins to increase. in contrast,  because they use the return on investments as the discount rate, the variance of the funding ratio  increases monotonically with m.  for haberman (1992) the optimal spread period m*h is    m*h = −log(1−va/[(1+va)kh]) / log(1+va) for va > 0  (21h)  where kh = [−(2−y)+(y(5y−4))0.5] / 2u(1+y).   (22h)    similarly, the optimal spread period for the generalised haberman model, m*g, is      (21g)  where kg is one of the solutions to the quintic equation  3when making this adjustment for the haberman (1993b) model q is increased to 3q because this model deals with three year periods. 2007 ‐ 100  •  economic analysis®  kg5(vay−dy)u2  + kg4(2y{va−d}/u+y+va+d+vay+dy+dva+dvay+1)u2 +   kg3(2+y{va−d}/u−2uva+2va+2d−y−2udva−vay +2dva−dvay+2udvay−dy−2uvay)u +  kg2(1−4udva+uvay+dyu−vay+dva−dy−4uva−y+va+d−dvay+u2dva+2dvayu+u2dvay)   +   2kg(y−d+ud+dy−dyu/2−1)va +dva(1−y)  =  0  (22g) where  y = (1+va)2+σ2.   for regulatory and solvency reasons, the scheme may also be concerned about the variance  of the funding ratio, which is a positive function of m, so that the more slowly any over or under‐ funding is eliminated, the higher will be the variance of the funding ratio.   equations (21) and (22) reveal that m* decreases as higher risk and higher return asset port‐ folios are chosen, and so a one‐size‐fits‐all policy of determining the spread period separately from  the fund’s investment decision is inappropriate. the spread period used in adjusting the contribu‐ tion rate is endogenous and should be selected in the light of the risk and return on the chosen  portfolio. in the haberman (1992) model, m is the only available contribution rate policy variable.  however,  in reality contribution rate policy can be more complex  than always eliminating any  over or under  funding. while  there  is a  linear relationship between contribution rate risk and  funding ratio risk for the generalized haberman model with a fixed spread period, this ceases to  be the case when the spread period is endogenous.   regulatory and solvency risk   although the discussion in this section is couched in terms of uk legislation, the arguments  are  general  and  will  apply  in  most  regulatory  environments.  uk  legislation  places  upper  and  lower  limits on  the funding ratio of pension schemes. under  the pensions act 19954, a scheme  which  is  less than 90% funded on the minimum funding requirement, mfr, basis, must be re‐ turned to 90% funding within three years, and to 100% funding within ten years. under the fi‐ nance act 1986, schedule 13, part 2, schemes which are more that 105% funded, on the prescribed  valuation  basis5,  must  be  reduced  to  below  105%  over  the  next  five  years6.  the  likelihood  of  breaching these requirements must, therefore, be considered when making the asset allocation and  contribution rate decisions.  value at risk (var) is a popular risk measure for financial institutions. it gives the estimated  maximum loss that can occur over a stated time horizon for a chosen probability, λ; and so the  probability  that  the actual  loss exceeds  the specified var  is  (1−λ), which  is called  the shortfall  probability  (sp). however, although var  is useful,  it suffers from some serious  theoretical and  applied difficulties. for example,  it does not satisfy  the coherency axioms of artzner, delbaen,  eber, and heath (1999). some of these difficulties are overcome by using the expected tail loss,  etl, to quantify the effects of breaching the solvency and regulatory constraints. the etl is also  known as the conditional value at risk (cvar), the mean shortfall, the mean excess loss or tail var.  the etl has been applied to pension schemes by bogentoft, romeijn and uryasev (2001); while  there  is also a  literature on the use of shortfall risk  in the context of pension schemes (see lei‐ 4 the rules are specified in the occupational pension schemes (minimum funding requirement and actuarial valua‐ tions) regulations 1996; as amended by the occupational pension schemes (minimum funding requirement and mis‐ cellaneous amendments) regulations 2002.  5 the valuation basis is specified in the pension scheme surpluses (valuation) regulations 1987, statutory instrument no.  412.  6 this upper limit will shortly be abolished, as will the mfr.  volume 40 • autumn 2007 • 101  bowitz, bader and kogelman, 1996 and haberman et. al., 2003)7.  the etl computes the expected size of any breach of the funding requirements which ex‐ ceeds the specified var. in the present context, two var values, representing the regulatory restric‐ tions on the maximum and minimum funding ratio, are of interest. breaches of the upper regula‐ tory constraint can be analysed in the same way as breaches of the lower constraint, except that  breaches are greater, rather than smaller than the specified var. while the var is defined as a loss,  it is convenient in the present circumstances to treat the var as a specified funding ratio, rather  than a deviation from the specified upper or lower bound. such etls have been termed condi‐ tional tail expectations. as well as the etls, the probability of a particular funding ratio breaching  each of the regulatory limits (i.e.(1−λ), the shortfall probability, sp) is also computed.  the computation of the etls and sps requires a knowledge of the probability distribution of  the funding ratio, and this probability distribution has been studied by dufresne (1990b), cairns  (1995, 1996b, 1997, 2000) and cairns and parker (1997). cairns (1995) concludes that, in discrete  time, the inverted gamma distribution (also known as the reciprocal or inverse gamma distribu‐ tion, and the pearson type v distribution), provides a very good approximation to the distribution  of the fund value in a wide variety of cases, and so this distribution is used to compute cumulative  probabilities for the funding ratio. using the results in evans, hastings & peacock (1993) and john‐ son, kotz & balakrishnan (1994), it can be shown that the reciprocal of the funding ratio has a two  parameter gamma distribution with parameters α (shape) and β (scale), where  e[fr] = 1/β(α−1)   (23)  var(fr) = 1/[β2(α−1)2(α−2).  (24)  from this, the two parameters of the gamma (and inverted gamma) distribution can be ob‐ tained from the mean and variance of the funding ratio of the generalised haberman model  α = {(e[fr])2 / var(fr)}   +  2  (25)  β = var(fr) / {e[fr][(e[fr])2+var(fr)]}   (26)  the probability density function (pdf) of the inverted gamma distribution of t is equal to 1/t2  times the pdf of the gamma distribution of 1/t. the probability density function for the inverted  two parameter gamma distribution for the variable t is:   p(t) = t−(α+1)e−1/tβ / βαγ(α),   where α > 0 and β > 0   (27)  where the term γ(α) is the gamma function which acts as an adjustment factor to ensure that  the probabilities sum to one. the sp and the etl for over‐funding are computed by integrating the  probability density function from zero to the chosen value of 1/t; while the corresponding figure  for an under‐funding involves integration from the chosen value of 1/t to infinity. the cumulative  density function (cdf) of the inverted gamma distribution of t (i.e. inverted cdf(t, α, β)) is equal  to one minus the cdf for the gamma distribution of 1/t (i.e. 1−cdf(1/t, α, β)).  the etls can be approximated to any degree of accuracy by computing the average of the  var values throughout the tail (i.e. for all losses greater than the specified var). let λ represent the  chosen probability for the specified var, and divide the tail beyond this var into φ parts. let λi = λ  + i(1−λ)/φ where i = 0 ... (φ−1), and then, for each value of λi, the cumulative inverted gamma dis‐ tribution is used to find the corresponding value of the funding ratio. the etl is then the equally  7 for stochastic programming models, kusy & ziemba (1986), cariño et. al. (1994), cariño & ziemba (1998) and cariño,  myers & ziemba (1998) proposed the use of a convex tail risk measure which leads to a concave utility function that can  be modelled using a piecewise linear approximation. this convexity means that shortfalls from target levels are penal‐ ized more and more as the shortfall increases.  2007 ‐ 102  •  economic analysis®  weighted arithmetic average of these funding ratios. thus    (28)  where var(λi) is the var corresponding to a probability of λi. the accuracy of this method is  reported to be reasonably good for values of φ > 50 (dowd, 2002).  description of the universities superannuation scheme   the asset‐liability model described above was applied to  the universities superannuation  scheme (uss). uss was created in 1974 as the main pension scheme for academic and senior ad‐ ministrative staff in uk universities and other higher education and research institutions (logan,  1985).  from  10  december  1999,  the  rules  of  uss  were  changed  to  allow  any  employee,  non‐ academic or academic, at any higher education institution (or associated establishment) in the uk  to become a member. by 2002 there were over 300 institutional members (i.e. employers) partici‐ pating in uss, which was the third largest pension fund in the uk, with assets of £20 billion, and  180,000 members, pensioners and deferred pensioners. uss is a defined benefit scheme with an  80ths accrual rate and is managed by the trustee company, uss ltd. the employers’ contribution  rate  in 2002 was 14% of salary, while  the employee contribution rate was 6.35%. the principal  benefits are an index‐linked pension and a tax‐free lump sum on retirement, ill‐health retirement  with an index‐linked pension and tax‐free lump sum, and index‐linked pensions for spouses and  dependents on the death of the member or pensioner. uss is an immature scheme with a net cash  inflow of £550 million in 2002. while the maturity of the scheme will probably increase in the fu‐ ture, it is expected to have a positive cash flow for many years. the uss actuary uses the projected  unit method, which is an individual funding method, and triennial valuations.  data  the numerical results presented below relate to the application of the asset‐liability model  described in this paper to uss, using data for its 2002 actuarial valuation (uss, 2003). this actuar‐ ial  valuation  allows  the  calculation  of  the  values  of  the  initial  liability  proportions  as  w1  =  −0.5523121, w2 = −0.0642698 and w3 = −0.3788936. the valuation of the liabilities was approximately  equivalent to a buyout valuation. the trustees of the fund allocate its assets between five principal  asset classes: uk equities, overseas equities, property, fixed interest and uk index‐linked gilts. in  addition, three types of  liability are recognised  ‐ active members, deferred pensioners and pen‐ sioners. table 1 shows the modest data requirements of this model; with only 25 correlation fore‐ casts (of which 15 involve pension liabilities), 8 forecasts of the expected returns, and 8 forecasts of  the standard deviations of returns. the  forecasts used  in generating  the subsequent  illustrative  results are based on annual data for the period 1981‐2002 ‐ the ipd index of total returns on all uk  property, the msci world ex uk total returns index in £, the ftse all share index including divi‐ dends, yields on long term uk government bonds supplied by datastream, and uk index linked  gilt yields for a constant maturity. since the assets are proxied by indices, to the extent that the  fund engages in active management, as opposed to tracking the index, the risk is understated and  returns and correlations altered.   the liability data was constructed using the top point on the lecturer scale together with the  simple actuarial models in equations 1‐3. for each liability estimate, the discount rate used was the  current long term uk government bond yield. since salaries are subject to public sector pay pol‐ volume 40 • autumn 2007 • 103  icy, it is possible that salary increases are related to the macroeconomic situation in a way that dif‐ fers from the private sector. the numerical results from this empirical analysis were then adjusted  using estimates supplied by schroders and watson wyatt. craft (2005) used annual data on the  projected pension benefit obligation of 647 us firms for 1988‐2002 to construct a series of aggregate  liability returns. these returns included changes in liabilities due to additional benefits, etc, ad‐ justed for changes in the number of employees. the correlations of these liabilities with domestic  equity, bonds and property; as well as the returns and standard deviation of liabilities, were used  in adjusting the forecasts in table 1.   portfolio  theory  treats  the  means,  variances  and  co‐variances  as  free  of  estimation  error.  however, in reality, these parameters are subject to estimation risk. therefore, the computed risks  and returns of the portfolios are imprecise. since portfolio theory seeks out those portfolios with  low risk and high return, the presence of estimation risk tends to result in the choice of portfolios  where the return is overstated and the risk is understated, see michaud (1989). the size of this es‐ timation risk depends on the accuracy of the forecasting procedures adopted. board and sutcliffe  (1994) provide an example of the performance of different forecasting procedures in constructing  efficient portfolios. it is generally accepted that for large pension schemes, actuarial forecasts of the  demographic factors are reasonably accurate, and the key forecasts concern the  investment and  discount rates. chopra and ziemba (1993) demonstrate that for investors with high risk aversion  the accuracy of mean asset returns is about three times more important than the forecasts of the  variances; while the variance forecasts are about twice as important as the covariance forecasts. for  investors with low risk aversion they can be in the ratios 60:3:1. kallberg and ziemba (1984) found  that forecasts of mean returns are about ten times as important as forecasts of the covariance ma‐ trix. therefore the greatest effort should be focussed on obtaining accurate expected mean returns.  in the present paper, estimation risk is not explicitly considered, and allowance for this should be  made in interpreting the results presented below. decision makers can get some idea of the ro‐ bustness of the results of this model to estimation risk by conducting a sensitivity analysis and re‐ solving the problem using alternative estimates of asset and liability returns.    table 1: correlation matrix, expected returns and standard deviations     uk  equi‐ ties  over‐ seas  equities prop‐ erty  fixed inter‐ est  uk index‐ linked  gilts  active mem‐ bers  de‐ ferreds  pension‐ ers  uk equities  ‐  a12  a13  a14  a15  a16  a17  a18  overseas equities  ‐  ‐  a23  a24  a25  a26  a27  a28  property  ‐  ‐  ‐  a34  a35  a36  a37  a38  fixed interest  ‐  ‐  ‐  ‐  a45  a46  a47  a48  uk index‐linked  gilts  ‐  ‐  ‐  ‐  ‐  a56  a57  a58  active members  ‐  ‐  ‐  ‐  ‐  ‐  a67*  a68*  deferreds  ‐  ‐  ‐  ‐  ‐  ‐  ‐  a78*  expected return  e1  e2  e3  e4  e5  e6  e7  e8  standard deviation  s1  s2  s3  s4  s5  s6  s7  s8  * the covariances between returns on different liabilities play no part in determining the asset propor‐ tions of the efficient frontier.    uss does not hedge the currency risk of foreign securities, and so the returns and correla‐ tions are expressed in terms of the sterling‐equivalent returns. the returns are gross, since pension  schemes are exempt from paying taxation. prior to july 1997, uk pension schemes received a tax  refund equal to the value of the advance corporation tax (act) paid by the company on the divi‐ 2007 ‐ 104  •  economic analysis®  dends declared. therefore, before this date, the net dividend income of pension schemes exceeded  their gross dividend income by the amount of this tax refund. this is no longer the case and pen‐ sion schemes simply receive gross dividends. uss pensions are fully index linked, so that in the  absence of deflation, no adjustment is required to allow for limited price indexation.  solving the asset‐liability portfolio model  the data in table 1, together with the liability proportions (w1, w2 and w3) for the pension  scheme were used to solve the extended portfolio model set out in section 2. the results of this  asset‐liability pension model are sets of five asset proportions and three fixed, liability proportions.  this allows the calculation of two sets of portfolio risks and returns: for the asset component of the  portfolio only  (representing  the gross portfolio performance), or  for  the asset‐liability portfolio  (representing the net portfolio performance). results were also obtained for the portfolio model  using only assets, but these are not reported.   table 2: efficient portfolios ‐ returns, standard deviations and asset proportions  assets (%)  asset‐liability  (%)  efficient asset proportions (%)   exp   ret  std  dev.  exp ret  std  dev  effec‐ tiveness %  uk  equi‐ ties  overseas equities prop‐ erty  fixed  inter‐ est  index‐  linked  gilts  1  2.20  2.500  −1.03  2.454  15  0.0  0.0  0.0  0.0  100.0  2  2.88  2.335  −0.35  2.112  37  0.0  0.0  2.1  20.7  77.2  3  3.56  2.452    0.33  1.916  48  0.0  0.2  9.4  31.9  58.5  4  4.24  2.676    1.01  1.823  53  0.0  3.2  15.3  39.0  42.6  5  4.92  2.940    1.69  1.828  53  4.4  3.2  20.2  43.8  28.3  6  5.60  3.234    2.37  1.921  48  9.1  3.2  25.1  48.6  14.0  7  6.28  3.550    3.05  2.090  38  13.8  3.2  30.0  53.0  0.0  8  6.96  4.057    3.73  2.452  15  27.8  5.3  31.8  35.1  0.0  9  7.64  4.679    4.41  3.036  −30  41.7  7.5  33.6  17.2  0.0  10  8.32  5.367    5.09  3.742  −97  56.4  9.6  34.0  0.0  0.0  11  9.00  6.599    5.77  5.360  −305  88.9  11.1  0.0  0.0  0.0  uss  8.12  5.462   4.89  4.070  −133  53.1  21.0  11.4  11.8  2.7  table 2 shows the risk and return of both the asset and the asset‐liability portfolios, as well as  the investment proportions themselves, for a range of points on the efficient frontier. the asset‐ liability portfolios use the uss funding ratio of 101%. for low risk portfolios, the size of the opti‐ mal holding by uss of index linked gilts represents a substantial proportion of the market. this  can be overcome by using the index linked swaps market, or by placing constraints on the maxi‐ mum holding of index linked gilts. the last line of table 2 shows the actual uss asset allocation on  31 january 2002. this portfolio is plotted in figure 1 as ussa (uss assets only) and ussal (uss as‐ sets and liabilities). the efficient frontiers for these two alternative sets of portfolios are plotted in  figure 1. while the asset‐liability quadratic programming model must generate convex efficient  sets, the assets‐only frontier may not necessarily be convex. table 2 and figure 1 show that the  asset‐liability numbers have lower risk and lower return than the corresponding asset‐only num‐ bers, highlighting the fact that the model allows the pension scheme to hedge the liability risk.   the  uss  statement  of  investment principles  (sip)  supports  the  objective  of  “funding  the  volume 40 • autumn 2007 • 105  scheme’s benefits at the lowest cost over the long term, having regard to the minimum funding  requirement of the pensions act 1995 and having regard to the attitude of the committee of vice‐ chancellors and principals and of the management committee towards the risk of higher contri‐ butions at some time in the future”, uss (2002). given these objectives, the relevant values for de‐ cision taking by the pension scheme are those reflecting its net position, rather than the unhedged,  or gross, asset returns and risks. the scheme is taking positions on the spread between investment  returns and the rate of increase in retail prices and salaries. thus, while small changes in the dif‐ ference between these two returns may be important for the pension scheme, big changes in both  may not. the asset‐liability efficient frontier can be viewed as the outcome of a risk‐minimising  generalised hedge, subject to the constraints of a given rate of return and a hedge ratio of (w1+w2)  or −0.9918747.  figure 1: expected returns frontiers  table 2 also shows the ederington (1979) measure of hedging effectiveness, which gives the  reduction in the variance of the asset‐liability portfolio, relative to the variance of the fund’s liabili‐ ties. this shows that the best hedge occurs for portfolios 4 and 5, which offer a 50% reduction in  risk. it also shows that for portfolios 9 to 11 (and uss), the risk of the hedged portfolio exceeds that  of the liabilities alone, so that the fund faces additional asset risk in addition to the basic risk of its  liabilities.   the expected return for portfolios 1 and 2 for the assets and liabilities together is negative; a  fact obscured if only the asset returns are considered. the results also demonstrate the interaction  between assets and liabilities in the model, as the asset‐liability frontier is not simply a linear trans‐ formation of the assets‐only frontier (e.g. each point on the asset frontier shifted the same distance  to the south west). for example, the risk‐minimising portfolio for the asset‐liability model is port‐ folio 4, while for the assets‐only portfolio it is portfolio 2. the expected return on the assets in the  risk‐minimizing portfolio 4 is 4.24%, which compares with a discount rate of 5.5% used in comput‐ ing  the actuarial  liabilities. thus,  the asset‐liability results  reveal  that portfolios 1, 2 and 3 are  2007 ‐ 106  •  economic analysis®  dominated, while the assets‐only numbers incorrectly suggest that only portfolio 1 is dominated.  similarly, the slopes of the efficient frontiers differ, and the correct risk‐return trade‐off facing the  pension scheme for any specified rate of return (or risk) is that provided by the asset‐liability re‐ sults, not the assets‐only results. this confirms the view that any pension scheme should adopt an  asset‐liability based analysis of the asset allocation, rather than attempting to consider the asset  allocation separately from the liabilities.   transformation of the portfolio returns to contribution rates and funding ratios    as noted in section 3, pension scheme trustees usually prefer to judge the results from port‐ folio models in terms of the implied level and dispersion of the contribution rate and funding ratio,  rather than the risk and return of the asset or asset‐liability allocation. for example, the declared  objectives of uss can be summarised as simultaneously minimising the average contribution rate  and the variance of the contribution rate. the academic literature has considered three main objec‐ tives ‐ (a) minimise the expected contribution rate, (b) minimise the variance of the contribution  rate, and (c) minimise the variance of the funding ratio. uss takes the view that the first two objec‐ tives are the most important criteria for a well‐funded scheme where insolvency is very unlikely.  for the generalised haberman model with a fixed spread period, the variance of the contribution  rate is a linear function of the variance of the funding ratio, and so the choice between these two  measures of risk is of little consequence. however, for regulatory reasons, the distribution of the  funding ratio will also be considered, to ensure that the asset allocation decision is unlikely to lead  to any regulatory problems.  in 2002 uss had a funding ratio of 101% and set the employers’ contribution rate for the next  three years at 14%, the same rate as in the preceding six years. this suggests that uss was in a  fairly stable position, which is consistent with the haberman (1992) model’s requirement that the  pension scheme is in long run equilibrium.   equations (17–20) were used to calculate the mean and variance of the contribution rate and  funding ratio of each efficient portfolio for both the haberman (1992) and generalised haberman  models. for the generalised haberman model the only additional parameters are m and d, while  for the haberman (1992) model many more parameters are required to re‐compute the three actu‐ arial liabilities. these parameters were based on uss (2003). the uss actuary used one rate for  computing the standard contribution rate (i.e. a nominal yield of 6%) and a different rate for com‐ puting the funding ratio of the scheme, and hence the contribution rate adjustment (i.e. a current  yield of 5%). the values of m = 12 and d = 5.5% were used.  the results for the haberman (1992) model and the actual uss portfolio on 31 january 2002  are in table 3. the fund’s objective is assumed to be to minimise both the contribution rate and the  standard deviation of the contribution rate, so that for the haberman (1992) model portfolios to the  north east of the minimum contribution rate risk portfolio (i.e. portfolios 1 to 6  in table 2) are  mean‐variance dominated and need not be considered further. thus, the transformation from the  mean and variance of portfolio returns to the mean and variance of the contribution rate results in  the exclusion of portfolios 4 to 6 from further consideration. this is in addition to portfolios 1 to 3,  which were found to be dominated using asset‐liability returns, see table 5. the funding ratio for  the haberman (1992) model (fr) is constrained to be 100%, and the uss portfolios have been con‐ verted to the same basis. if the funding ratio is computed using a fixed discount rate of 5.5% (as in  the generalized haberman model), it ceases to be 100%.       volume 40 • autumn 2007 • 107  table 3: the first two moments of the contribution rate and funding ratio ‐ haberman (1992) model  with m = 12    e(ra)  (%)  σal  (%)  e(cr)  (%)  sd(cr)  (%)  e(fr)  (%)  sd(fr)  (%)  1  2.20  2.45  39.88  2.75  100.00  6.02  2  2.88  2.11  33.80  2.11  100.00  5.24  3  3.56  1.92  28.75  1.71  100.00  4.81  4  4.24  1.82  24.54  1.45  100.00  4.64  5  4.92  1.83  21.01  1.31  100.00  4.71  6  5.60  1.92  18.05  1.23  100.00  5.02  7  6.28  2.09  15.56  1.21  100.00  5.53  8  6.96  2.45  13.46  1.29  100.00  6.59  9  7.64  3.04  11.68  1.45  100.00  8.28  10  8.32  3.74  10.17  1.62  100  10.37  11  9.00  5.36  8.87  2.13  100.00  15.15  uss  8.12  4.07  10.59  1.82  100.00  11.24  table 5: mean‐variance dominance  model  dominated portfolios  assets only portfolios  1  asset‐liability portfolios  1, 2, 3  contribution rates for haberman (1992) with m = 12  1, 2, 3, 4, 5, 6  contribution rates for generalised haberman with m = 12  1  table 4 and figure 2 show that, for the generalised haberman model, the lowest contribution  rate risk occurs for portfolios 2 and 3, while portfolio 3 has the lowest funding ratio risk. so, in this  case, only portfolio 1 is dominated. table 5 indicates that, while portfolios 2 and 3 are dominated  when using asset‐liability returns, they are not dominated when the generalised haberman model  is used. the generalised haberman model allows fr to depart from 100%, as shown in table 4.  (the uss plots in figures 2 and 3 use the funding ratio of 101%.) for portfolios 1‐5, the funding  ratio is below 100% because, although the contribution rate is high, the expected return on assets is  low.    table 4: the first two moments of the contribution rate and funding ratio   ‐ generalised haberman model with m = 12    e(ra)  (%)  σal  (%)  e(cr)  (%)  sd(cr)  (%)  e(fr)  (%)  sd(fr)  (%)  1  2.20  2.45  25.95  0.99  70.09  3.96  2  2.88  2.11  24.76  0.93  74.82  3.72  3  3.56  1.92  23.43  0.93  80.16  3.70  4  4.24  1.82  21.91  0.97  86.23  3.88  5  4.92  1.83  20.16  1.08  93.19  4.33  6  5.60  1.92  18.14  1.28  101.27  5.09  7  6.28  2.09  15.77  1.57  110.74  6.27  8  6.96  2.45  12.95  2.11  122.01  8.43  9  7.64  3.04  9.53  3.04  135.63  12.12  10  8.32  3.74  5.32  4.42  152.45  17.66  11  9.00  5.36  0.00  7.69  173.71  30.69  uss  8.12  4.07  6.68  4.57  147.01  18.26    2007 ‐ 108  •  economic analysis®  figure 2: efficiency frontiers for cr and fr risk ‐ generalized haberman, m = 12  figure 3 shows the trade‐off between the contribution rate and the standard deviation of the  funding ratio. figure 3 reveals that, for the generalised haberman model with a fixed spread pe‐ riod, there is a positive linear relationship between the standard deviations of the contribution rate  and the funding ratio. this is in sharp contrast to the convex relationship for the haberman (1992)  model, which is also shown in figure 3. the efficient set for the haberman (1992) model in figure  3 is the curve ab (portfolios 7 to 11).    figure 3: sd(cr) and sd(fr) ‐ haberman (1992) and generalised haberman, m = 12  volume 40 • autumn 2007 • 109  choice of the spread period  in section 10, the spread period, m, was set to the value used by uss (12 years). however, it  is possible that a different choice of m would improve the risk‐return performance of the scheme.  section 5 described the estimation of m*, the spread period which minimises the contribution rate.  m* cannot be computed when the rate of salary growth exceeds the expected rate of return on the  assets (because va is then negative), which is the case for the low return portfolios 1, 2 and 3. as  table 6 shows, for the haberman (1992) model these are dominated portfolios, and so this is not a  significant issue. however, for the generalised haberman model table 7 shows that this condition  rules out portfolios 1 to 6, of which only the first is dominated.    table 6: the first two moments of the contribution rate and funding ratio   ‐ haberman (1992) model with m = m*h    e(ra)  (%)  σal  (%)  m*h  (years)  e(cr)  (%)  sd(cr)  (%)  e(fr)  (%)  sd(fr)  (%)  4  4.24  1.82  129  24.54  0.66  100.00  17.1  5  4.92  1.83  60  21.01  0.84  100.00  11.7  6  5.60  1.92  39  18.05  0.94  100.00  9.91  7  6.28  2.09  29  15.56  1.02  100.00  9.31  8  6.96  2.45  24  13.46  1.16  100.00  10.01  9  7.64  3.04  20  11.68  1.36  100.00  11.34  10  8.32  3.74  17  10.17  1.57  100.00  12.9  11  9.00  5.36  15  8.87  2.10  100.00  17.49  uss  8.12  4.07  18  10.59  1.75  100.00  14.5      note: m*h cannot be computed for portfolios 1–3  table 7: the first two moments of the contribution rate and funding ratio ‐ generalised haberman  model with m = m*g    e(ra)  (%)  σal  (%)  m*g  (years)  e(cr)  (%)  sd(cr)  (%)  e(fr)  (%)  sd(fr)  (%)  7  6.28  2.09  19  15.18  1.50  119.55  8.93  8  6.96  2.45  14  12.51  2.11  127.26  9.70  9  7.64  3.04  11  9.96  3.00  131.35  11.07  10  8.32  3.74  9  7.53  4.11  133.56  12.63  11  9.00  5.36  8  4.81  6.47  137.56  17.82  uss  8.12  4.07  10  7.98  4.37  135.47  14.79      note: m*g cannot be computed for portfolios 1–6  tables 6 and 7 show the optimal spread period for each portfolio (including the uss portfo‐ lio  on  31  january  2002)  for  the  haberman  (1992)  and  generalised  haberman  models.  for  the  haberman (1992) model the fund’s chosen spread period of 12 years is always less than the opti‐ mal spread period. as discussed in section 5, for the haberman (1992) model using a spread pe‐ riod shorter than m*h reduces sd(fr), but increases sd(cr). therefore, although sd(fr) can be  reduced by lowering the spread period, this comes at the expense of an increase in sd(cr). since  the two principal objectives used in this paper are to minimise both the mean and variance of the  contribution rate, the possibility of minimising sd(fr) is not pursued. for the generalised haber‐ man model, both sd(cr) and sd(fr) rose as m*g fell.  the transformation of the portfolio results into the mean and variance of the contribution  rate  and  funding  ratio  in  the  previous  section  was  repeated  using  the  relevant  value  of  m*  2007 ‐ 110  •  economic analysis®  (rounded to the nearest integer) from tables 6 and 7. as can be seen by comparing tables 3 and 6  for the haberman (1992) model, the use of m*h in place of the fund’s standard spread period of 12  years, increases sd(fr) in every case, sometimes by substantial amounts. however, as expected,  there were reductions in sd(cr). a comparison of tables 4 and 7 reveals that, for the generalised  haberman model, moving to m*g leads to a reduction in sd(cr), with the size of the reduction  depending on the size of the change in m. there is no reduction in sd(cr) for portfolio 8 due to  the rounding of the spread period and the insensitivity of sd(cr) to m. for portfolios 7 and 8 m*g  > 12, and the values of sd(fr) rise; while for portfolios 9 to 11 and uss, m*g < 12 and the values of  sd(fr) fall. this shows that, when the spread period is not fixed, the tradeoff between sd(cr) and  sd(fr) reappears.  the relationship between sd(cr) and m is illustrated in figure 4 for portfolios 7 and 11 us‐ ing the generalised haberman model. this shows that for portfolio 7, increasing m from 12 to 19  years reduces sd(cr) from 1.57% to 1.50%; while for portfolio 11, reducing m from 12 to 8 years  reduces this risk from 7.69% to 6.47%. figure 4 also reveals that, over the relevant range, sd(cr) is  not very sensitive to m.    figure 4: optimal spread periods ‐ generalised haberman  allowance for triennial valuations    both the haberman (1992) and the generalised haberman models assume annual actuarial  valuations.  however,  most  schemes  have  triennial  actuarial  valuations.  the  effects  of  triennial  valuations on the variances of the contribution rate and the funding ratio were  investigated by  comparing the dufresne (1988) and haberman (1993b) models, which are summarised in the ap‐ pendix. triennial valuations may  increase or decrease the variance of the contribution rate, see   haberman  (1993b)  and  cairns  (1996a).  the  dufresne  (1988)  model  is  similar  to  the  haberman  (1992) model, except that there is no lag in adjusting the contribution rate, and differs from the  haberman (1993b) only in that the latter assumes triennial actuarial valuations. therefore a com‐ parison of the results from these two models will reveal the increase in the variances caused by the  volume 40 • autumn 2007 • 111  introduction of triennial valuations. using the uss data described above, but with m set equal to  the value of m* for the model concerned, it was found that the understatement of the variances of  cr and fr due to the absence of a one year lag was only about 2.6% (or 2.7% when m = 12 years).  this suggests that a move to triennial valuations would make little difference to the variances of  cr and fr, or to the other results in this chapter.   even if there had been a material effect on the variances by switching to triennial valuations,  a model which assumes annual valuations may still be preferable. this is because many pension  schemes, including uss, make an annual actuarial check on the funding ratio, after which the con‐ tribution rate could be adjusted. this is effectively an annual review of the contribution rate, even  though a full actuarial valuation is performed only every three years.  regulatory and solvency risk  in order to investigate solvency risk, a knowledge of the probability distribution of the fund‐ ing ratio is required. the parameters of the distribution of the funding ratio were computed using  the equations in section 6 for the generalised haberman model with m = 12 and m = m*g. the in‐ verted gamma distribution was then used to compute the values of the shortfall probability (sp)  and the etl for the upper and lower regulatory restrictions. the values of sp and etl were for  one year. to obtain results for say a 3 year period, assuming that proportionate changes in the  funding ratio are independent over time, the mean and variance of the fr used in equations 23  and 24 must be multiplied by 3. if proportionate changes in the fr are correlated, a more compli‐ cated adjustment is required (jorion, 2000).   as a simple approximation to the lower solvency bound that will apply after the abolition of  the mfr, the specified var for the lower tail was set at 70%, which roughly approximates to 100%  mfr funding. while the mfr funding ratio is due to be replaced by scheme‐specific funding re‐ quirements (secretary of state for work and pensions, 2002), it was decided to use the current mfr  as the lower bound. because each of the regulatory restrictions requires the use of a valuation basis  that differs from that used to determine the contribution rate, the funding ratios of 90% and 105%  were adjusted to be comparable with those used elsewhere  in this paper. at the 2002 actuarial  valuation the mfr funding ratio for uss was 144%, as against a funding ratio of 101% using the  assumptions of the uss actuary. this implies a lower solvency bound of 101/144 = 70%. the upper  bound, imposed to prevent over‐funding, was set at 100/70 = 142.86%.  the results are in tables 8 and 9. the etls in tables 8 and 9 were computed by setting m, the  number of samples, to 100. when m = 12, sp1 drops to zero for portfolios 4 ‐ 11, while for portfolio  1 it is over 50%. this reflects the negative expected asset returns for portfolios 1 and 2, and the lar‐ ger expected returns for higher numbered portfolios. conversely, for portfolios 1 ‐ 7, sp2 = 0, but as  the expected asset return and risk rise, sp2 rises to over 85% for m = 12. even though portfolio 1  has a 50% chance of breaching the mfr when m = 12, the expected value of the funding ratio (etl)  is still 67%, i.e. a 3% breach. portfolio 11 has an 85% probability of breaching the upper bound  when m = 12, and  the expected  funding ratio  is 180%,  i.e. a breach of 37%. thus,  the average  breach of the upper bound tends to be much bigger than the average breach of the lower bound,  reflecting the strong positive skewness of the distribution of the funding ratio.      2007 ‐ 112  •  economic analysis®  table 8: solvency and regulatory risk: shortfall probabilities and etls:   generalised haberman model with m = 12                70%  142.8%    e(ra)  (%)  σal  (%)  e(fr)  (%)  sd(fr) (%)  alpha  beta  sp1  (%)  etl1  (%)  sp2  (%)  etl2  (%)  1  2.20  2.45  70.09  3.96  315  4.54  50.57  67.03  0.00  ‐  2  2.88  2.11  74.82  3.72  407  3.29  9.26  68.49  0.00  ‐  3  3.56  1.92  80.16  3.70  472  2.65  0.14  69.16  0.00  ‐  4  4.24  1.82  86.23  3.88  496  2.34  0.00  69.45  0.00  ‐  5  4.92  1.83  93.19  4.33  466  2.31  0.00  69.58  0.00  ‐  6  5.60  1.92  101.27  5.09  397  2.49  0.00  ‐  0.00  144.01  7  6.28  2.09  110.74  6.27  314  2.89  0.00  ‐  0.00  144.67  8  6.96  2.45  122.01  8.43  212  3.89  0.00  ‐  1.14  146.42  9  7.64  3.04  135.63  12.12  127  5.84  0.00  ‐  26.18  150.99  10  8.32  3.74  152.45  17.66  77  8.68  0.00  69.26  68.98  160.67  11  9.00  5.36  173.71  30.69  34  17.43  0.00  68.70  85.33  180.10  uss  8.12  4.07  147.01  18.26  67  10.34  0.00  69.11  56.05  159.17  when m = m*g, table 9 shows that the values of sp1 and etl1 are little changed, while for  sp2 and etl2 the values become more even across the range, with falls for high risk and high re‐ turn portfolios, and rises for lower risk and lower return portfolios. note that for m*g, the values  of sp2 and etl2 for portfolios 7 and 8 are larger than when m = 12; while for portfolios 9‐11, the  reverse is the case. this is because m*g > 12 for portfolios 7 and 8, and any surplus is removed  more slowly, permitting high funding ratios to be attained; while for portfolios 9‐11, m*g < 12, and  any surplus is eliminated more quickly.   table 9: solvency and regulatory risk: shortfall probabilities and etls:   generalised haberman model with m = m*g                70%  142.8%    e(ra)  (%)  σal  (%)  e(fr)  (%)  sd(fr) (%)  alpha  beta  sp1  (%)  etl1  (%)  sp2  (%)  etl2  (%)  7  6.28  2.09  119.55  8.93  181  4.64  0.00  ‐  0.88  146.64  8  6.96  2.45  127.26  9.70  174  4.54  0.00  ‐  6.13  147.79  9  7.64  3.04  131.35  11.07  143  5.37  0.00  ‐  14.86  149.40  10  8.32  3.74  133.56  12.63  114  6.63  0.00  69.36  22.03  151.05  11  9.00  5.36  137.56  17.82  62  12.00  0.00  68.91  35.25  156.35  uss  8.12  4.07  135.47  14.79  86  8.69  0.00  69.19  28.83  153.26    note: m*g cannot be computed for portfolios 1–6  conclusions  this paper had modelled a number of aspects of pension trustees’ decisions concerning the  asset allocation and contribution rate. a simple extension of the portfolio model permits the inclu‐ sion of different types of liability in the computation of the efficient asset proportions for various  levels of risk and return. pension schemes generally state that their asset allocation decision has  taken account of their liabilities. however, they have usually not explicitly incorporated the liabili‐ ties into the asset allocation decision. the asset allocations derived from this extended model are  different from those derived from an assets‐only formulation, and offer significant hedging of the  schemes’ liabilities. because of this, it is important that the results of the portfolio analysis are pre‐ sented to decision makers in terms of the risks and returns on the combination of the assets and  liabilities of the scheme, rather than just the assets alone.  volume 40 • autumn 2007 • 113  an analysis of the asset allocation decision in terms of its effects on the risks and returns of  the assets and liabilities of the scheme does not explicitly consider the effects on the contribution  rate  and  the  funding  ratio.  this  paper  shows  how  the  results  of  a  portfolio  model  can  be  re‐ expressed in terms of the first two moments of the contribution rate and funding ratio. by present‐ ing decision makers with the implications of alternative asset allocations for the mean and variance  of the contribution rate and funding ratio, the problem is translated into the variables which ulti‐ mately  concern  the  trustees.  this  transformation  can  also  reveal  additional  or  reduced  mean‐ variance dominance between alternative asset allocations.  computing the effects of the asset allocation decision on the contribution rate, enables the ac‐ tuary to calculate the spread period which minimises contribution rate risk for the chosen asset  allocation. this paper generalises the haberman (1992) model by dropping the requirement that  the discount rate equals the rate of return on the investments. as well as improving the economic  realism of the model, this greatly simplifies its empirical application because the actuarial valua‐ tion need not be repeated for a range of different discount rates. in addition, it removes the trade‐ off between contribution rate risk and funding ratio risk (for a fixed spread period). the haberman  (1992) model and the generalised haberman model were applied to data for the universities su‐ perannuation scheme, and the efficient frontiers plotted for both fixed and optimized spread peri‐ ods. the trustees then choose a particular combination of the contribution rate and contribution  rate risk, which determines the asset allocation.  finally, the distribution of the funding ratio was considered, in conjunction with the upper  and  lower statutory  limits. this allows trustees to  investigate the regulatory and solvency risks  associated with a particular asset allocation/contribution rate choice.  the application of the model proposed in this paper requires a change in the way pensions  schemes operate. currently, the contribution rate is usually recommended by the scheme actuary  on the basis of an assumed asset allocation; while the actual asset allocation is set separately on the  basis of  investment advice. the proposed model requires a  joint decision by a single person or  group, probably at the time the contribution rate is set. the results for uss suggest that this can  lead to superior decisions.  2007 ‐ 114  •  economic analysis®  references  1. accounting standards board (1988) statement of standard accounting practice 24  ‐ accounting for pension  costs, may, asb publications, london.  2. accounting standards board  (2000) financial reporting standard 17  ‐ retirement benefits, november, asb  publications, london.  3. actuarial education company (2002) acted study materials: 2002 examinations, subject 304, course notes, ac‐ tuarial education company, oxford.   4. artzner, p., delbaen, f., eber, j.m. and heath, d. (1999) coherent measures of risk, mathematical finance, vol.  9, no. 3, july, pp. 203‐228.  5. association  of  consulting  actuaries  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education, informal sector jel: j13, j24, j44 abstract this paper sheds light on the trade-off between child labour and education in developing countries. we show there are different strategies of education that parents can adopt to enhance children’s wellbeing. we distinguish four categories of education: formal education, vocational training, non-formal education and informal education, implying that child labour and education analysis is no more binary. hence, these educations are suitable for different categories of households (the richer of the poor and the poorer of the rich). these households make their decision about education and child labour according to the adult labour market and their income. in an environment characterised by a high level of youth unemployement these households prefer investing in informal education. we specify explicitly that we make a commitment to do not proceed to any kind of tests. our critical point of view is to assert that education, as such, could not be summed up to a simple binary arbitration. on the contrary, we defend a conceptual approach. introduction since the creation of the ipec (international programme for eliminating child labour), the focus of the ilo (1997) has been to eradicate child labour entirely but, progressively, this institution has recognised that the task would be hard to achieve (schlemmer 1997). hence, priority has been given to eradicate the worst forms of child labour with special attention paid to education to achieve this goal. the ilo (1997) and other institutions, like unicef and unesco, consider that school is a perfect substitute for child labour. the idea behind this is that a child enrolled at school is one child less in the labour market; so parents should be encouraged to provide children with an education. this hypothesis does not take into account the fact that in some countries child labour and education can be mutually reinforced as children combine schooling and work to support their education (grootaert and kanbur 1995; akabhayashi and pscharopoulos 1999; pscharopoulos and patrinos 1997; ray 2004). as education and child labour are seen as perfect substitutes, analytical frameworks on this issue tend to focus on the reasons why parents do not invest in their children’s education (baland and robinson 2000; ranjan 2001), while emprirical studies point to the reasons for drop-out from schooling (jensen and nielsen 1997). hence, education is not playing its role in keeping children out from the labour market. in the ilo’s analysis (1997), the different educational strategies of households are not taken into consideration. economic analysis 1-2 (2009) 7-18 8 indeed, all the households do not have the same strategy towards child labour and education. in this paper we present these different strategies and show in which context they are adopted in order to have a better understanding of the phenomenon and to facilitate decision makers to take actions against child labour and to implement proper policies regarding to different categories of households’ expectations. in the second section of this paper, we explore the binary trade-off between child labour and education by making the education a heterogenous variable. thus we present different forms of education possibilities available to parents for ensuring their children’s wellbeing. the third section describes the choices of households. the fourth section analyses the reason why parents choose informal education to ensure their children’s well-being, and finally we conclude with some policy recommendations. taking seriously diversity in forms of education child labour analysis: a binary approach according to baland and robinson (2000), in an economy where poverty exists alongside the imperfections of the credit market, the level of child labour is socially inefficient. this hypothesis is also supported by ranjan (1999, 2001) who argues that poor parents would like to invest in their children’s education but cannot afford to because they are excluded from the formal credit institutions. rammohan (2001) states that parents rely on child labour for security in their old age. baland and robinson argue that children and parents cannot come to a commitment engaging the former to reimburse the latter for the effort needed to educate them. altruistic parents care for their children’s wellbeing. thus, we argue that they want to endow their children with human capital but the notion of education is not the same as it is understood in the economic literature. the models of baland and robinson and of ranjan consist of describing a binary trade-off between child labour and education; we state that the problem of child labour and education is far from being binary. there exists different forms of educations (formal education, vocational training, non-formal education and informal education) and parents have all these alternatives of education to ensure their children’s future wellbeing. our analysis is based on the strategies parents adopt to ensure the household’s survival depending on the decision of child labour and education. dessy and pallage (2001) state that there is a co-ordination failure between a household’s decision to school and the decision of enterprises to invest in high technology. parents fail to invest in education because they are not sure that enterprises will invest in high technology, contrarily enterprises do not invest in high technology because they are not sure of parents’ investment in children’s education. we argue that this lack of co-ordination cannot be solved if parents don’t feel that they are gaining by investing in their children’s education. in an environment where the informal sector is expanding, poor parents consider that this sector is suitable to enhance their children’s future wellbeing, particularly when the formal sector is unable to absorb all the young educated people. according to mukherjee and sinha (2005) and ballet and bhukuth (2006), parents give a minimum level of education (primary education) to their children and put them into the informal sector to acquire informal skills. according to gormly and swinnerton (2003), returns to education in the adult labour market affect children’s school d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 9 enrolment. hence, child labour and schooling decisions are closely related to the adult labour market. basu (2000) states that the minimum wages in the labour market push parents into sending children onto the labour market. thus, in an environment where the formal labour market is fully integrated, parents whatever their financial situation would invest in children’s education because the returns of education are high. baland and robinson (2000) demonstrate that incertainty on the expected benefits of investment in children’s education leads to a non optimality situation because the choice of work is not required for assuring children’s well-being. therefore, the analysis of baland and robinson is based on a binary trade-off between education and child labour. the binary approach is not suffisient to understand the households choices of education and child labour. therefore, we go farther this analysis to show the existence of different forms of education and why parents do not invest in the formal education. distinguishing several forms of education “education” is a generic term covering different forms of learning. hence, households have several possibilities to ensure their children’s well-being. we distinguish between four types of educations: formal education, formal vocational education, non-formal education and informal education. formal education: schooling given by public or private schools that follow the curriculae defined by the ministry of education. the knowledge shared is general and theoretical. vocational training or formal apprenticeship: the prolongment of the formal education, oriented towards professional formation and technics. it is thus complimentary to formal education. the programme is both practical and theoretical; it is often considered to be more theoretical by entrepreneurs in the informal sector (charmes 1985a,b). the skill is destinated to the modern enterprises of the formal sector (liimatainen 2002). the courses are inflexible and standardised (liimatainen 2002). non-formal education: non-formal education1 works outside the formal education circuit. non-formal education is dispensed by non-governmental agencies, as well as government agencies and private institutions. non-formal education replaces formal education in rural areas where schooling is not available to a high number of people. indeed, non-formal education is for people in the informal sector and increases their capacity to work in the formal sector. this system of apprenticeship is not for children who are likely to enter the labour market, but for adults or confirmed apprentices of the informal sector. so it is very rare to find children who have finished their primary education or dropped out, or even children from vulnerable households, in this form of education. the ngos focus on teaching civic education, the apprenticeship of reading and writing. this type of programme is more oriented towards technical formation. the aim of non-formal education is to improve the skill of those in the informal sector so as to improve their wages and, so, their standard of living. informal education or traditional apprenticeship: informal education is technical and professional education dispensed in the informal sector by a master to young apprentices. 1 this kind of knowledge acquiring system has been developed by unesco in 1991 at the conference of jontien in thaïland for promoting education in developing countries facing a crisis of their formal educational system. economic analysis 1-2 (2009) 7-18 10 the informal sector is characterised by a lack of structures in terms of the organisation of apprenticeships (liimatainen 2002). the informal apprenticeship system distinguishes from the other forms of formations by its operationality. indeed, the informal apprenticeship forms the skill that the informal sector needs. the development of the informal sector: a factor of child labour the informal sector gives young apprentices the opportunity to become entrepreneurs who enjoy a high social position in society. so the idea that the informal sector does not permit the accumulation of capital is rejected by charmes (1992) who states that owning a business can provide a high income. this evidence is also supported by a study carried out in several sub-saharan countries (gasarian and maldonado 2001; gaufryau and maldonado 2001). some informal activities are more lucrative than others, such as repairing tvs, radios, cars and jewels. this sector welcomes not only the poor but also young, educated people. the wage in the informal sector depends on several factors: the qualification of the employees, the statuts (permanent workers, occasional workers, helpers and apprentices) and the activity. in sub-saharan africa, more than 70% of the active population works on the informal sector2. the dynamisn of the informal sector is related to the formal sector; both sectors are connected; the former plays the role of subcontracting for the latter. the parental choice about education or work affects a child’s future life. the choice to educate or send to work is a decision influenced by the socio-economic environment. poor households live in an environment where the informal sector is dynamic, absorbing the surplus of labour, whereas the formal sector appears to be in crisis3. the informal sector is no longer characterised by a lack of capital accumulation and, indeed, enables individuals to become rich (charmes 1992). hence, apprentices have an opportunity to become entrepreneurs, giving them social mobility. so parents choose the informal sector because they estimate that working in the informal sector gives their children a skill that might be informal, but is necessary for working in the sector. enlarging the household choices of education all the theoretical models (baland and robison, 2000; ranjan 2001; dessy and pallage 2001) on child labour that deal with the trade-off between work and education fail to consider the different forms of education available to households and the financial resources that dictate educational choices. households living in extreme poverty clearly lack the financial resources and choose the option of child labour. so, whatever the economic situation, if living standards are not improved, they do not invest in their children’s education. indeed, these households cannot live without child labour. we support the idea of basu and van (1998) who stipulate that a household puts its child into the labour market if and only if the adult members of the household cannot support the household. hence, income poverty is central in our analysis of trade-off against child labour and education. the 2 according to maldonado (1998), in benin 95.5% of the active population are wage employees in the informal sector. 3 this is particularly true in subsaharan africa. d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 11 luxuary axiome is supported by some empirical studies led by edmonds (2004) in vietnam and admassie (2002) in sub-saharan africa. differentiating categories of households we assume that rich households invest in formal education, knowing how important education is for assuring the household’s and its children’s continued wellbeing whereas the poorest of the poor take the decision of child labour because they cannot give up the opportunity cost of education. the most interesting cases lie within the circle of the graph below. households living near the poverty line are vulnerable households that can fall into extreme poverty (for the richest of the poor) and into poverty (for the poorest of the rich). the economic context and income fluctuations influence the choice of the household’s head (grootaert 1998). according to its economic situation, a household considered to be “the poorest of the rich” will make a different choice to a household living in “the richer of the poor” category. indeed, the populations considered the “richest of the poor” and the “poorest of the rich” have an interest in improving their economic situation and to do so by investing in their children’s formal education. hence, these categories of household (“the poorest of rich” and the “richest of the poor”) are sensitive to income fluctuations and to the overall economic situation. the graph below shows the possibilities of investment in children’s education for different types of households according to their levels of income. households inside the circle have four possibilities of investment. these households can invest either in formal education, vocational training, non-formal education and informal education. figure 1. possibilities of investment in education of children by different levels of income i riches = formal education the poorest of the poor = child labour poverty line the richest of the poor the poorest of the rich vocational training non formal education the poorest of the poor the richest of the rich formal education informal education the richest of the poor the poorest of the rich economic analysis 1-2 (2009) 7-18 12 in this figure, we do not have a binary choice households have four choices about educating children. we assume that formal education and formal vocational training can be assimilated as formal education, since they compliment each other using similars types of teaching and both give access to the formal labour market. also, non-formal education and traditional apprenticeship can be categorised as informal education, even if they appear to be distinct. by regrouping the different categories of education into two main categories, we make these household’s educational choice binary. hence, the household of the categories « the richest of the poor and the poorest of the rich » has to choose between child labour, formal education and informal education to ensure the wellbeing of children. we are going to discuss informal education that is seen as an alternative to child labour and to formal education. revising the trade-off between education and labour we assume that education is thought of as an asset by the households once the investment is realised. parents are investors and they want their investment to be fruitful at the end of the investing period. education is a long-term investment which makes it risky. the risk is the probability that you can still be unemployed. investment in education is a kind of asset that the investors themselves do not possess, but that benefits another person (alderman and king, 1998). the transfer of gains depends on the person benefitting from his investment. there are two kinds of educational cost: direct and indirect. the former is the cost of admission, buying uniforms, school materials (books, pens, etc) and travel costs. in some countries, educational fees are an obstacle for households too poor to educate their children. to overcome this, unesco has implemented the programme, education for all (efa), to provide compulsory education to every child in low developing countries. according to jensen and nielsen (1997), travel costs are also a factor affecting school enrolment. lack of transport means that children have to walk long distances to reach school, so that they are often late and too exhausted to follow classes. the children also suffer a high risk of being attacked on the way to school. the indirect cost is the opportunity cost of education. the poorest households cannot give up the financial resources that child labour contributes to the household’s survival. in the analysis of cost and benefit, the household compares the cost of its investment to its benefits. the cost of investment in education is short term (annual or monthly) until the end of schooling, whereas its benefits are long term. for a better understanding of the tradeoff between education and child labour, we make three assumptions: 1) we assume that households actualise their expenses realised annually at the term of the educational level (primary, secondary and tertiary education in relation with the strategies adopted): ( ) ( ) ( )∑∑∑ === + + + + + = o i o ot m i m ms n i n np a r c r c r c c 1 , 1 , 1 , 111 . therefore, we state that the actualised cost4 of primary education is cheaper than secondary education: 4 r is the rate of interest and the n=m=o=6 are the period of schooling. the whole period of schooling is then n+m+o=18 years which is relatively a long term for poor households. d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 13 ( ) ( )∑∑ == + < + m m ms n i n np r c r c 11 , 1 , 11 , and the actualised cost of the secondary education is less than tertiary education: ( ) ( )∑∑ == + < + o i o ot m i m ms r c r c 1 , 1 , 11 . hence, poor households can afford to invest in primary education, but cannot afford to go beyond this level as cost increases with higher levels of education. 2) the long-term benefits of education are effective when the child becomes an adult salaried worker in the formal sector. the household needs to anticipate these future benefits, but this is difficult to do so in an uncertain environment without access to information. indeed, the household is not at all certain that the child will find stable employment to repay the parents. in such an environment, the household compares the actualised expenses to the income prevailing in the formal labour market. hence, in the short term, the actualised expenses5 (ca) is compared to the wage the child could earn in the informal market, i.e. the opportunity cost of education wc and in the long term they will be compared to the profitability of the investment in education. the actualised expenses (ca) include the direct costs of education. distinguishing between the short and long term the short-term trade-off when ca wc = , the parent is indifferent to the choice between education and child labour, and will enroll the child in education out of concern about the child’s wellbeing. in the case where ca wc < and ca wc > , the choice about whether or not to educate is difficult. when ca wc < , a household living in extreme poverty has the child work as it needs the child’s wage to survive. since the household’s decision is made according to its economic status and the child’s wellbeing, the household compares ca with the future wage of the child. however, the child’s opportunity of future gain depends on the economy and the likelihood of finding a job in the modern sector. this hypothesis is shared by alderman and king (1998), and quisumbing and otsuka (2001), showing that girls in developing countries have a lower rate of enrolment as the opportunity to find a well-paid job in the formal sector is small. we assume that what is true for girls can be extended to all children regardless of gender. the long-term trade-off the parents need to anticipate the future wage of the children by putting a value on their investment which corresponds to the current adult wage waf applied in the formal labour market. this means that parents compare an adult wage to the actualised expenses of education. so we have three possibilities: 5 the household compares ( )∑= + n i n np r c 1 , 1 the cost of the primary education to the child labour wage, wc. economic analysis 1-2 (2009) 7-18 14 (i) afa wc = where the household is indifferent to choosing between education and child labour. the preference is given to education if parents are altruists and are not living in extreme poverty. (ii) afa wc > where educational expenses are higher than the wage of adults in the formal labour market, so poor households don’t consider it worthwhile to invest in children’s education. in this case, accessing the credit market would allow parents to finance their investment (ranjan 2001). (iii) afa wc < where education is a profitable asset, so parents do invest in their children’s education. however, when adult salaries in the labour market are high – higher than the anticipated expenses – poor parents will not invest in education if there is a high rate of unemployment among young educated people. the economic context is crucial for the parents’ decision about child labour and education (“hypothesis of coordination failure”, dessy and pallage (2001)). in the context of growth with creation of employment, parents invest in education. in low developing economies there is a high rate of unemployment among young educated people and a crisis of the formal sector; so parents lose confidence in school institutions that they don’t think are adapting to the demands of the labour market. factors explaining parental choice of informal education when households have several possibilities of investment, why don’t they choose the formal education? the crisis of formal education the education system in developing countries, particularly in sub-saharan africa, is in profond crisis with a high drop-out rate from schools. at the beginning of the 1980s, all the developing countries were submitted to the structural adjustment programme which consisted of improving the economic performances of economies facing a crisis of their balance of payment. institutions, such as the world bank and the international monetary fund, gave financial help in exchange for demands to reduce the public deficit; open public market to private investors; liberalise the capital and labour markets, all of which had some drastic consequences for these economies. the restructuring of public enterprises has meant redundancy for inefficient workers. their unemployment has an immediate effect: a decrease in family income. indeed, these people were unable to find a job in the formal sector and had to work in the informal sector where wages are lower. the loss of income is compensated by sending other household members – children and women – out to work (grootaert 1998). the consequence of which was an increase in children dropping out of school. the school drop-out rate has not been immediate; it accelerated with the reduction of the public deficit, accompanied with smaller amounts of state budgets going into primary education (cornia et al. 1987). this has been disastrous for educational systems. teachers have not been paid and infrastructures broke down. parents have financed the maintenance d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 15 of schools6. according to canagarajah and colombes (1996), teachers in ghana have asked their students’ families for domestic or farm work to compensate for their unpaid salaries. parents have also let their children drop out of school to go and work in the labour market to improve the household income. in keyna classes are overcrowded, with some 50 pupils in each classes, making it difficult for teachers and with pupils often having to repeat classes. in the macro-economical context of developing countries characterised by unemployment of young, skilled people within a formal sector in crisis, the long-term benefits of education appear to be nil. parents feel they are investing in a non-profitable asset. to encourage investment in education, the economic environment must be favorable. school is not seen as a vehicle that enables social mobility. parents (mostly the poor) judge the institution as ill adapted to the wider socio-economic context (gérard 1992) that fails to create employment for young, skilled people. the failure of the education system is also explained by a fast increase in africa’s population. in turn, the education system is unable to meet the demands of the extra number of enrolled children. this problem can also be related to what we have described above. the hypothesis of substitution between formal and informal education education in the informal sector is a different way of acquiring skills than education in the formal system. charmes and oudin (1994) and oudin (1990) have stated that formal education and traditional apprenticeships are complementary within the formal sector. vocational training is a prolongment of formal education as the teaching is theoretical and practical. these two forms of education give access to jobs in the formal sector. formal and informal education gives access to two different labour markets, even if individuals employed in the formal sector can work in the informal sector7. a person with formal skills can work in both sectors; the contrary is less likely8. the formal and informal labour markets are thus dichotomous. the choice of education for children altruistic parents will always invest in education for enhancing the wellbeing of their children. according to the economic theory of child labour, children’s wellbeing cannot be ensured outside of formal education because it gives access to formal employment distinct to the informal employment (ranjan 2001). wages in the formal sector should be higher than those in the informal sector. parents invest in education according to their financial resources and of the overall economic situation. households living in extreme poverty have little choice but to put their children into the labour market as non-qualified, occasional workers or helpers. the choice of these households is restricted by the need to survive. children change several jobs without learning any specific skills, ending up with incomplete skills across different activities. they 6 according to cornia et al. (1987) in africa, schools being in worst states parents have made enough efforts for maintaining them in state, they were paying teachers in nature (hen, vegetables and so on) for encouraging them keeping on teaching their children. 7 examples of pluriactivities illustrate the interactivity between these two different sectors. 8 taillors from the informal sector can work in the formal enterprises of textiles as it was the case in mauritius island. economic analysis 1-2 (2009) 7-18 16 learn to manage in the informal sector. their limited social network means that they do not have access to the most demanded informal education (ballet and bhukuth 2006) for which they need to be recommended by someone known to the master (charmes 1985a,b). the indigent households aren’t properly trusted by apprenticeship masters, which only reinforces their marginalisation. in the figure above, there is a move from the left to the right in the parents’ choice of education. the preference for work is high among the indigent households and the tendency changes by moving towards the right. in other words, the better the potential for the household income, the more parents prefer to invest in formal education9. therefore, poor households prefer investing in informal education rather than in formal education. rich households know the importance of education; they prefer putting their children into formal education which permits them to be different from the poor population. as bourdieu (1986) points out in another context, those of developed countries, educational strategies are also a significant means to maintaining differences between social classes. conclusion and policy recommendation we have studied the difficulties faced by households when weighing up the benefits of child labour versus education. this trade-off is more difficult for households facing financial constraints. poor households cannot give up the opportunity cost of education. to ensure their children’s wellbeing, therefore, they provide their children with an informal education that is different to formal education. hence, the trade-off is no more binary because there are different types of education for different categories of households. parents base their decision about formal schooling on the formal adult labour market. if such a market is characterised by unemployment of young, educated people while the informal sector is expanding, parents prefer to give their children an informal education. analysing the tradeoff between child labour and education in terms of costs and benefits, gives a new insight to the issue of child labour. formal education must appear to enable social mobility in order to encourage parents to invest in formal education. in developing countries, parents are not convinced that schools play a role in forming the type of skilled labour market that society wants (in the formal sector, bhukuth and bennani, 2006). so, in such an environment, (poorer) parents tend to choose informal education that prepares their children for the informal sector and contributes to its development. according to the sociologist schlemmer (1999), school is not “the norm” in most developing countries of sub-saharan africa; it is their colonial heritage. people are not aware of the importance of educating children. in most developing countries, primary level school requires less financial resources than other levels of education, and more resources should be allocated to it. more modern schools must be built both in urban and rural areas and more effort must be made to improve the training of teachers. states also need to encourage private initiatives in order to reduce unemployment among young educated person to inspire confidence in the long-term benefits of education. 9 parent’s income is high enough to offer children’s an education. d. bazin, a. bhukuth / ea 1-2 (2009) 7-18 17 references admassie a. 2002. explaining the high incidence of child labour in sub-saharan africa. 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(1999), l’ecole ou le travail. cahier ares 1: 155-167. ea_2016_1-2 udc: 005.961:005.914.3 658.14 jel: l26, l21 cobiss.sr-id: 224804108 professional paper sources of finance for entrepreneurship development balaban mladenka1, institute of economic science, belgrade and independent university banja luka, faculty of economic, bih župljanin slobodan, independent university banja luka, faculty of economic, bih ivanović periša, belgrade banking academy, faculty of banking, finance and insurance, belgrade, serbia abstract – entrepreneurship is one of the most important categories that are now associated with small and medium-sized enterprises, employment and the creation of new jobs and new business category. entrepreneurial behavior in finance implies a readiness to take risk and a taste for independence and self-fulfillment. it can develop in any sector of the economy and in any type of business. through entrepreneurship strengthen personal resources not only the material but also the motives of self-realization, freedom, independence, challenge. large number of small and medium enterprises provide a huge range of products, and the customers or service users increased choice and lower prices. considering that entrepreneurship represents the futurethis work is aimed to highlight the role the financial sector plays in its development. the authors suggest that the financial sector has very important role for the development of entrepreneurship, pointing to the different possibilities of cheaper funding development of guidelines for small and medium enterprises, but in other hand in some cases financial sector has negativ impact for growing through expensive sources of financing of development. key words: enterpreneurship, financial sector, credit, interest rate, debt introduction every year in the only in usa generate between 3 and 4.5 million new small and medium enterprises, ie, a new company is formed every 12 seconds. the level of interest in entrepreneurship in finance, from year to year is very high in all age groups. from people who start a business, 84% to work for the first time in his life. everywhere in the world, these new economic heroes, changing business environment and play a very important role in the economies of their countries. much better than the big companies, these "small giants" and innovate in finance products and services, pushing boundaries, creating new jobs. each of them uses a development strategy which in addition to the increase of gross domestic product, aimed at raising the standard of living, improved health services, increasing literacy, reducing crime, poverty reduction, etc. according to a recent survey, conducted by 1 professor balaban, m., et al., source of finance, ea (2016, vol. 49, no. 1-2, 48-58) 49 the company ernst & young (ernst & young), 78% of influential people in the business world believes that entrepreneurship and its development will be the most important trend of the 21st century.there are different opinions when, how and in what form began to use the terms entrepreneur and entrepreneurship in finance. trends and characteristics of entrepreneurship economy in which encourages entrepreneurial business orientation and stimulate the development of enterprises is entrepreneurial economy. modern economies are increasingly transformed into entrepreneurship because the path of entrepreneurship realized production growth, profits and employment. a society that fosters the development environment for enterprises is entrepreneurial society. entrepreneurship as an indispensable segment of development and progress of any modern region creates jobs and driving force of the economy, entrepreneurship and the development of a strong supporting social development. for successful entrepreneurs is crucial to understanding the legislative regulations and administrative requirements, a wide range of business disciplines and the adoption of practical entrepreneurial experience. entrepreneurship is a process in which almost nothing is building something. entrepreneurship represents the willingness of individual or multiple partners that, with certain capital investment and underwriting uncertainty due to partial starts a business venture with the objective of making a profit. this is the way the business operation in which an entrepreneur decides what, how and for whom something is created (product, service) all through entrepreneurial venture, at their own expense and with a certain amount of risk, with the aim of earning profit. the essence of entrepreneurship is in action, the constant search for new ideas, and imagination in finding new business opportunities, a reliable assessment of the intuition and skill and determination. entrepreneurship is a way of thinking is not only closely related to the job. entrepreneurial thinking is very important is linked to creativity, systematic approach to the problem. "entrepreneurship is the mindset and process to create and develop economic activity by combining risk, creativity and / or innovation with sound management, within a new or existing organization". business process changes through history as well as the way of thinking, human understanding of what the term entrepreneur and entrepreneurship really means and what we should mean by these terms. both theoreticians and practitioners of classical economics like richard cantillon and adam smith's notion of the entrepreneur tied to the notions speculator and innovator, coordinator of business activities, the coordinator of markets for goods, services and capital. theorists and practitioners of neoclassical economics like marshall and schumpeter term entrepreneur tied to notions coordinator, innovator, broker, responsible decision-maker under uncertainty, while the modern economy places emphasis on the fact that an individual is considered to be an entrepreneur until the findings, create and exploit opportunities for well-being its promotion and the environment in which it is located. this primarily means that the terms leader and manager does not refer exclusively to business owners or managerial functions, but also to all employees in their workplace with their activities take on the characteristics of the leader and / or manager. 50 economic analysis (2016, vol. 49, no. 1-2, 48-58) it is no coincidence that the concept of entrepreneurship in the narrow sense, usually associated with small businesses. studies have shown that, by its characteristics, small businesses more entrepreneurial than large: the more creative, more innovative, more willing to experiment, take a larger dose of the relative risk (compared to its size and strength) of the large etc. why is it so? the main reason is that they are usually small and medium-sized enterprises "forced" (the situation and circumstances) be entrepreneurial-oriented. this, according to adizes methodology, the basic characteristics of enterprises in the development and / or companies which are in a balanced development phase (the so-called. "top form"). the limitations of the resources that small businesses have and what causes them to navigate, creativity, and finding the ideal combination of resources at their disposal to maximize the result is the main reason why small companies are more entrepreneurial than large ones. another reason is that small companies, too, thanks to the lack of resources, cannot afford the deployment of of quality people at the market, but they are forced to "nurture them in your own garden." in this way employees grow with the company, and often emotionally tied to the goals and ideas. the owner of a small company is exposed to stressful situations and problems in relations with the environment (there is no deep hierarchical structure that would protect him from personal exposure to problems in relationships with customers, suppliers, distributors, etc.), which encourages to him greater personal responsibility and entrepreneurial behavior. entrepreneurs are people who take the initiative and make changes in the environment. the entrepreneur is the driving force behind the entrepreneurial process a person / individual, which creates new value, and in the process takes the risk of losing money, time, or any other form of value of the product or service. an entrepreneur is a person who is creative, ambitious, persistent, committed to what he does, results-oriented, safe and wellnetworked knows people and people know him. it is obvious that an entrepreneur must have certain skills and personal qualities that should be developed and perfected in the external environment. starting their own business as the most common activity that is related to the concept of entrepreneurship has its own characteristics, strengths and weaknesses, problems and ways of solving them. there are a lot of needs and resources, especially small country are limited, so it is necessary to set priorities. you must determine which priority must be the order of execution. the main element of successful strategy development is ownership and participation. in some cases, it is necessary that new companies replace traditional, but in others, the new company will develop the elements of the old, but it will be necessary to evolve and adapt. the current growth of economic development and entrepreneurship is based on the concept of comparative advantage. to highlight the importance of resources for economic development: economic development depends on the quality of resources and the country's ability to perform as much specialization of production and services in these sectors, commitment to sectorial development priorities. state declares branch-priorities and measures of economic policy encourage their development, to the detriment of other branches (from other taken to invested in priority sectors). however, in an open and global economy productivity does not depend on which branch of priorities, but on how each balaban, m., et al., source of finance, ea (2016, vol. 49, no. 1-2, 48-58) 51 company works, how it operates, what people and has a strategy. the emphasis is on companies, not the branches. if the company is investing in you, in modern technology, in the organization, then it can be productive in any branch. modern technologies open up great opportunities for improvement in all areas. from this it follows that it does not matter in which branch of the company. it is important to operate productively and successfully. the state should not provide incentives to companies (via priority treatment) is more general conditions that companies help to get information, to new technologies, to professional people. vision of the company is trying to focus its future trends on the avoidance of incorrect actions and reduce failure in the region, as well as the uncontrolled behavior within the company. the vision does not include making future decisions, but rather refers to the current decision making on the realization of their future goals. the main problem of planning is not what the company should do in the future, but what should now take to ensure the desired development in the future. the impact of globalization on the development of entrepreneurship globalization is a dynamic process where the increasing competitive pressures, new technologies create new opportunities, fall's international barriers to trade and investment, increase transparency thanks to the development of information technology, which means that firms competitors are no longer just local rivals, but could be with anyone globe city, the capital market provides incentives for companies to improve performance, enormous advances in communication technology support globalization. the realization of high performance in business results in maintaining the harmony of three elements: company strategy, organizational design and the environment in which the company exists. attractiveness strategies defined only in terms of how it functions well in an appropriate environment to the organization. recognizing the contribution of smes to economic growth, job creation, innovation, technology transfer and achievements in social and economic harmonization, as well as the basis of the existing restrictions on the development of small and medium enterprises, low level of business knowledge, regulatory and administrative barriers, restricted access to available sources of funding in the medium and longer term, inadequate access to sources of business and market information and limited availability of specialized business services and taking into account the best international experience in the field of development of smes and regulations of the un declaration on cooperation in development of small and mediumsized companies in the north-eastern europe. the objectives of the strategy of development of entrepreneurship are: • increase the number of small and medium-sized enterprises registered in the private sector. • significantly increase the participation of small and medium-sized enterprises compared to micro-enterprises. • increase the competitive activities of small and medium enterprises in economic sectors where certain countries depend on import of goods and services; and increase the participation of small and medium-sized enterprises in export revenues. 52 economic analysis (2016, vol. 49, no. 1-2, 48-58) • increasing the participation of small and medium enterprises in foreign strategic alliances and arrangements of joint ventures (joint ventures). • to increase the participation of small and medium enterprises in the gross domestic product. • increase the share of smes in total employment. figure 1. entrepreneurial development and organization source: http://www.slideshare.net/tangypreeti213/entrepreneurial-development the key demands placed upon managers of the highest level in the innovative economy and may refer to entrepreneurship in finance are: • forecasting and observation of global change on all levels of society, as well as the design and instinct for innovation that will enable them to create and test a completely new business approaches that are based on these principles. • co-creative way of thinking in order to facilitate changes to the business environment, ecosystem processes and practices, along with business partners (not only the mindset to adapt to more active participation) • innovation in all aspects of the business not just in products or department of research and development, • the ability to produce changes in the culture and release energy in the company in order to act in a certain paradox: the requirements for creating a climate of continuous innovation, with a simultaneous focus on efficiency and effectiveness confirmed the business model. but one of the most important issues that arise is: what means to finance the development of new projects. the economic crisis has made the closure of the banking sector for financing small and medium enterprises entrepreneurship, a parallel to the financial conditions in the banking sector seemed totally unattractive or unachievable for most of the sector. there are virtually no mechanisms for financing start new business, regardless of the quality of business ideas. guarantee schemes are scarce and unavailable the largest number of balaban, m., et al., source of finance, ea (2016, vol. 49, no. 1-2, 48-58) 53 companies. there is strong enough corporate and entrepreneurial sector, which would be interested for the financing of entrepreneurship and innovation. finance sources there are alternative ways of financing the business and they are based on ownership of capital company. essentially, this financing is the process of raising funds by selling stocks or shares of a company in order to provide investors position for further growth and business development, during which investors acquire control the interests and rights in the company. these models are not adequate funding for all legal forms of business organization, but only for companies. various types of institutional or non-institutional investors the professional and / or from their own entrepreneurial ambitions deal with such financing and the development trend of the industry is very visible, so that is becoming more and more numerous. some statistics and research shows that one of the most used resource for finance small companies is bank loan or overdraft, which presented in next figure. figure 2. the use of bank loans as a source of financing entrepreneurial in 2014 and 2015 source: analytical report 2015, european commission, p. 15, research of european commission presented in annual report for 2015 shows that „use of bank loans is most prevalent among large enterprises (with at least 250 employees) and smallest among micro enterprises (1 to 9 employees). between april and september 2015, 14% of gazelles used a bank loan compared to 19% of smes in the total eu28. the proportion 54 economic analysis (2016, vol. 49, no. 1-2, 48-58) of use for high-growth smes is on par with that of smes in the eu28. compared to nonexporting smes, exporting smes are more likely to use bank loans. furthermore, the use of this type of financing is more prevalent among innovative smes.“ figure 3. use of credit line, bank overdraft or credit overdraft to finance entrepreneurial in 2014 and 2015 source: analytical report 2015, european commission, p. 18, „among the four sectors distinguished, smes in industry most often used credit line and overdraft and smes in services use this type of financing least often. the proportion of enterprises that used credit line or overdraft increases with enterprise size. the use of credit line or overdraft is most prevalent among large enterprises (with at least 250 employees) and smallest among micro enterprises (1 to 9 employees). the use of credit line or overdraft occurs the least among gazelles: 27% of smes in this category compared to 37% of smes in the total eu28. the use of credit line or overdraft for high-growth smes is on par with eu28. exporting smes are more likely to use credit line or overdraft than their non-exporting counterparts. furthermore, the use of this type of financing is more prevalent among innovative smes.“ nevertheless, investors unlike banks that all risks are transferred to the entrepreneur, part of the risk undertake. it is logical that not every entrepreneurial venture succeed, but it is also logical that these investors are relatively often run out of funds invested in a business. it does not need to worry, because in this industry there are rules of the game that can do this kind of financing profitable. these investors are very care about the team and the people in which they invest, business model, means for generating revenue, the potential business ideas to meet the needs of large market or a large number of consumers, the potential of the business to rapidly expand and grow rapidly. therefore, these investors are much more involved in the business, often part of management rights and / or control over certain balaban, m., et al., source of finance, ea (2016, vol. 49, no. 1-2, 48-58) 55 business functions in the company. all of this means that they essentially share the risk with entrepreneurs (take on much more risk than banks). investing in this way is usually termed as investors professionally engaged, through investments, so that they have an interest to come out after a certain time from a certain business by selling the purchased share, but at a price that is several times higher than that in the purchase of the stake. getting out of business and sold shares at a much higher price is the main goal of these investors and the basic rule of this industry. it is possible to finance a business combination of debt and equity ownership. these are the situations when funding started granting loans, after which after a certain time and under certain conditions, the remaining debt is converted into ownership. from time to time, the state or any of its institutions to create programs in which, under certain conditions, share grants for business development. these situations are relatively rare and certainly they should be used when the opportunity arose, but these funds are usually not large not enough, but it is not recommended development plans based on such programs. following the availability of such programs is leading the european union, which in its budget cycle allocated tens of billions of euros to finance operations. most of the funds is aimed at companies that come from the eu, but many programs allow the participation of local entrepreneurs, especially in the areas of new technologies. the procedures which lead to these funds are quite complex, so it takes a company to devote a lot of work and time in order to qualify for these options. finance decision in entrepreneurship, usually carries with it certain risks. an entrepreneur in finance knowingly enters into entrepreneurial risks, which are themselves the most common material, financial, then the risk of his career; family / social risk; psychological / health risk. any business venture requires some investment. waiting for the ideal moment to collect the optimal level of financial resources to get the job started, leading to a situation leakage of business opportunities and risk avoidance, which is not peculiar entrepreneurial. hence the entrepreneur primarily (by starting their own business) enters the financial risk. investing requires a personal investment funds (savings), lending (friends, relatives) or taking bank loans. an entrepreneur in finance should build its reputation on quality, be persistent and plan their own activities; specialize their knowledge and above all, choose a profitable business, which has its own market and its customers (the entrepreneur must be reasonable unreasonable people). in front of the entire economy of the country, and therefore the financial entrepreneurial sector put a difficult task of joining the international trends and the adoption of rules, regulations, practices and experiences that are valid in the global financial market. this includes the existing segmentation of financial markets in the money market, which is now in the domain of banks, the institution where they are liquid and available funds on the capital market, as well as the segment where the free capital, as well as finding the best options for safe placement of that capital. an important role in this play instruments on the financial market, as they are the subject of purchase and sale between the participants in the financial market. 56 economic analysis (2016, vol. 49, no. 1-2, 48-58) the instruments must be legally protected and defined, and must be minimized risk investments, and the possibility of fraud. in the area of stock exchange business is done a lot, bring the relevant laws governing the stock exchange as an institution and defining ways of doing business on it. these same laws stipulate when and in what form can occur as a participant on the stock exchange, or in what capacity occurs, either on the supply side were on the demand side. it also prescribes the way trade is conducted, and thus a participant can trade, or which instruments are subject to trade on the stock exchange. every transaction is recorded in a central registry. therefore, any change in ownership of securities by the moment of the change of ownership are entered in the central register and be issued a certificate. the law also specifies how to perform settlement, clearing and recording of changes in the central register. in this way it is achieved equality of participants at the stock exchange, with a view to minimizing the risk of corruption or possible influence of privileged information. this way of operating on the market, or on the entire financial market, investor protection is the maximum, in order to create the appropriate economic environment to increase turnover on the stock exchange and financial markets, with the ultimate aim of involving the financial markets in the current world and the global financial market as an equal partner. responding entrepreneurial environment in finance involves the application of all regulations in force and applicable to the global financial market, as well as marketing moves that aim at attracting foreign investors. also, in this way takes place, and power exchanges as a mediator in the inflow of investments in international financial flows. conlusion the strategy of development of entrepreneurship should have the main objective of the transformation of entrepreneurship. first of all, it is a broad vision of the future enterprise: where the company should be in 10 years. in essence, it is a "folder" of this enterprise to a defined objective. modern development process is complex and difficult, and the process of creating a strategy often requires more knowledge and information than is available now. therefore, the development strategy is a living document. it is necessary to set up a way to create, revise, and implement. sure, no successful development strategy without learning about entrepreneurship. entrepreneurship in finance is a dynamic process of vision, change and creation. this requires energy and passion for creation and implementation of new ideas and creative solutions. the main elements of this process include the willingness to take certain risks in terms of time career or status, creativity necessary to take advantage of the necessary resources and the vision and the ability to recognize the financial opportunities where others see only chaos, contradictions and ambiguities. these new policies should be multi-sectorial and eclectic and should include the area of the entire tax system, labor law, state aid, innovation policy, programs and ways of using foreign funds (eu, bilateral relations) support policies for smes, the financial sector, the creation of social initiatives and initiatives of interested communities. only a part, but not exclusively, the policy should be directed towards the establishment of the new regulation, which specifically. balaban, m., et al., source of finance, ea (2016, vol. 49, no. 1-2, 48-58) 57 the region has in recent years done a lot in the area of the opening of its economic and financial system and to the world, and the global economic and financial flows. all this resulted in the creation of an adequate economic environment, which is interesting for foreign and domestic investors. however, in today's modern economy is very dynamic, as evidenced by the current global financial crisis must not be stopped, but the economy and the financial markets must constantly adapt to challenges. only in this way the region can take its position in the global entrepreneurial financial system and participate in the world's financial flows, on the one hand and to preserve that position, that is the time to strengthen, on the other hand. alternative financing models (eng. equity based models seed, startup, business angel, venture capital and private equity) based on the ownership of capital, were not developed. these models, which represent the backbone of financing sme sector in most developed countries, are not legally recognized, nor are they visible enough efforts to these regulations and the establishment of mechanisms. it is necessary to create and introduce a set of policies that would be related to market development, models and mechanisms of alternative investment. this investment is based on the ownership of capital companies (based equity investment). these policies need to be based on contemporary legal and economic achievements and reputation in the markets where these models have achieved great success and where they are a driving force of economic growth and private sector financing. references adižes, i. 2005. upravljanje životnim cilkusom preduzeća. novi sad: adižes. daft, l. r. 2003. management. new york: thompson south-western sixth edition. drucker, p. 1991. inovacije i preduzetništvo, praksa i principi. beograd: privredni pregled. erić d, beraha i., đuričin s. i drugi. 2012. finansiranje malih i srednjih preduzeća u srbiji. beograd: institut ekonomskih nauka. stefanović, ž. 2004. menadžment. ekonomski fakultet, univerzitet u kragujevcu, doove s., kwaak t. and span t. 2015. „survey on the access to finance of enterprises (safe).“ analytical report 2015, european commission internet sites http://www.slideshare.net/tangypreeti213/entrepreneurial-development 17.06.2016. http://www.pks.rs/sadrzaj/files/finansiranje%20msp%20u%20srbiji.pdf 16.06.2016. http://www.rpksombor.co.rs/vesti/dodaci/finansiranje%20rasta%20msp%20knjiga%2 0preporuka.pdf 20.06.2016. note: this work is part of research projects by codes 47009 (european integration and socio economic changes of the eu economy) and 179015 (challenges and prospects of structural changesin serbia: strategic directions for economic development and harmonization with eu requirements), financial long learning by the ministry of science and technological development of republic of serbia 58 economic analysis (2016, vol. 49, no. 1-2, 48-58) izvori finansiranja za razvoj preduzetništva rezime – preduzetništvo je jedan od najvažnijih kategorijakoje su u vezi sa malim i srednjim preduzećima, zapošljavanjem i otvaranjem novih radnih mesta i novih poslovihe kategorija. preduzetničko ponašanje u finansijama podrazumeva spremnost da se preuzme rizik i osećaj za nezavisnost i lično ostvarenje . ono može da se razvije u bilo kojem sektoru privrede i u bilo kojoj vrsti posla. kroz preduzetništvo jačaju lični resursi ne samo materijalni nego i motivi samospoznaje, sloboa, nezavisnost, izazov. veliki broj malih i srednjih preduzeća pružaju veliki asortiman proizvoda, a kupci ili korisnici usluga imaju povećan izbor i niže cene. obzirom da preduzetnistvo predstavlja buducnost, ovaj rad ima za cilj da ukaže na ulogu koju finansijski sektor ima u njegovom razvoju. autori ukazuju da finansijski sektor ima veoma važnu ulogu za razvoj preduzetništva, ukazujući na različite mogućnosti jeftinije finansiranje razvojnih smjernica za mala i srednja preduzeća, ali sa druge strane, u nekim slučajevima finansijski sektor ima negativ uticaj na rast kroz skupe izvore finansiranja razvoja. ključne reči: preduzetništvo, finansijski sektor, kredit, kamatna stopa, dug article history: received: 23 june, 2016 accepted: 29 june, 2016 microsoft word 2007 3 4.doc volume 40 • autumn 2007 • 1  abstract: on the global market competitiveness of serbian companies is at a very low level. ac‐ cording  to  global  competitiveness  report  2007‐2008  serbia  was  ranked  91.  leading  country  is  usa,  whereas the uk had lost the second and fell to ninth position. the criteria on which global competitiveness  report ranks 131 world countries are creation of business strategies and a quality of business environment1.  competitiveness increase of local companies’ should be assessed through holistic concept which targets on  core micro and macro environment indicators improvement, as well as by adopting a new business philoso‐ phy ‐ strategic management and innovation. development of crm (customer relationship management)  concept is one of the tools which significantly influence raise of competitiveness and more effective creation of  business strategies.    introduction  in modern market economies, along with development of information technology, internet  and data base software, the priority of business activities is becoming a two‐way communication  between companies and product/service consumers. customer relationship management is one rela‐ tively new concept which, as a result of change in management, strategic business planning and  personalised customer service, is being constantly developed.  development of new information technologies shifts business operations from “push” prod‐ uct strategy to “pull” customer strategy. this change will result in change of customer position in  the value chain. customers as the company main asset are becoming more sophisticated and de‐ manding in their buying behavior. for that reason it is important to analyze main factors of crm,  as they can significantly increase company competitiveness:  o customer selection   o customer acquisition   o customer retention   o customer growth   transaction marketing is based on pushing customer so as to make transactions faster and  easier. unlike that, the new marketing and management relationship concept insists on establish‐ ing communication with every single customer even when the transaction is completed. use of the  crm concept helps the company in gaining on competitive advantage.   according to research made in eu during 2006, companies without crm concept:  o in average lose 50% of their customers in five years  o have 65% of lost customers leaving because of unsatisfactory service and communica‐ tion  1 world economic forum  customer relationship management ‐ competitiveness improvement tool* jovan zubović, ivana domazet, institute of economic sciences, belgrade, serbia  key words : crm, competitiveness, customer, strategy, companies  jel : l21, d91, m11  * original paper was previously published on international scientific conference contemporary challenges of theory and practice in economics “management and marketing under globalization”, under title “crm (customer relationship management): a factor of global competitiveness improvement”, cobiss.sr-id 512030562 editorial  2007 ‐ 2  •  economic analysis®  o have the cost of acquiring a new customer five times higher than the cost of retaining  the old one  companies that have a developed crm concept:  o grow almost 60% faster than their competitors without crm  o increase their market share by 6% yearly  o charge their product 10% higher  o have roi (return on investment) at the level of 12%  o by 5% increase of customer loyalty grow profits by 25%‐85%.  crm concept  customer relationship management (crm) is a new management strategy which focuses on  long‐term relationship with customers. this concept has some similarities to relationship market‐ ing concept, but with significant differences. unlike relationship marketing crm analyzes more in  depth the relationship with customers. it covers all activities starting with creation of organiza‐ tional structure and other development tools (business culture, etc) up to specific programs for set‐ up of long term relationship. in relationship marketing focus is more on finalization and specific  programs of setting long term relationship (communication channels, offer adapting, loyalty pro‐ grams, etc).  crm concept defines capability, methodology and technology which can enable company  adopt the process of improving customer relationship. the purpose of crm is to enable more ef‐ fective and efficient fulfillment of company goals, through more analytical review of customer real  needs.  crm  is  focused  on  creating  and  retaining  long  term  relationship  with  customers.  even  though market offers some commercial crm program packages supporting crm strategy, it is not  technology on its own. crm is rather a strategic change in the organization philosophy towards  emphasis on customer. these program packages  include software and hardware  that will help  automate crm system. in such a system output of crm is not only information, but it is rather  complete support for decision making and market analysis. successful crm strategy cannot be  installed in a company overnight and integrated with other software packages. the changes are  necessary at all levels, including company policy, employees training, marketing systems, informa‐ tion management etc. this means that all company activities must comply with principles of crm.  the efficiency of crm process, which has to be integrated through marketing, sale and rela‐ tionship with customers assumes:   o identifying factors which contribute successful relationship with customers,  o development of customer relationship policies,  o development of a process which satisfies customers,  o defining key factors that in most adequate way help solve potential customer prob‐ lems,  o suggesting solutions for customer complaints about product/service,  o sales follow‐up and customer support.  in establishing crm concept in a company, it is very important to precisely analyze: key as‐ pects of business operations; information we offer to customers; customer financial background;  effects of crm segments.  important  task  is also  to gain detailed  information about company’s  volume 40 • autumn 2007 • 3  prime (loyal) customers. nevertheless very  important aspect  in crm system  implementation  is  identifying and eliminating unnecessary information. in such a concept, we can define crm as a  business strategy aiming to balance income and profit on the one side with customer satisfaction  and value added on the other side, where some tasks need to be measured: customer behavior,  processes and technologies.   basic structure of crm comprises three segments:  o operational – core business processes (marketing, sales, services)  o analytical – support for customer satisfaction analysis and  implementing business  policies and technologies  o cooperative – keep contact with customers using phone, fax,  internet, mail, direct,  etc.  for successful development of customer relationship company has to combine certain tasks:  o knowledge (understanding markets and customers)  o targeting (direction and adaptation of product/service)  o sales (gaining customers)  o service (maintaining customers)  planning and development of strategy, organization,  implementation and control of crm  process is very important. for that reason we can review crm concept as:   o strategy development  o information analysis  o identifying needs (understanding customers, their needs and wants)  o defining change (corporate revolution – from reactive to proactive approach)  o future building (creating of business and technical company structure which     o will deliver expected value to customers)  o measuring results and upgrade of crm system.  customer relationship management combines business strategy and technique in order to  identify and gain customers, and retain long term relationship with them – by creation of added  value, which comes as a result of  interaction between company and customers. it also  includes  knowledge of strategic management and internet technologies. the purpose of this concept is to  identify opportunities for creation and retaining of profitable relationship with customers.  the crm as a strategic set of activities begins with a detailed analysis of company organiza‐ tional strategy, and it ends with measuring of shareholders value. competitive advantage is a key  success factor of crm, which at the same time generates value both for customer and for the com‐ pany. competitive advantage is generated by using crm principles of creation, development and  retention of relationship with precisely targeted groups of customers. once set, this relationship  has been optimized for customers, corporate profitability and stakeholders’ value. all these make  crm highly positioned on the priority list of today’s corporate agenda and it is closely linked with  use of it that are needed for implementation of strategic marketing relationship with customers.  objectives and methods of crm concept implementation  the  acronym  crm  is  often  regarded  as  customer  relationship  marketing,  since  in  both  cases the emphasis is made on relationship between the company and customers. the crm con‐ 2007 ‐ 4  •  economic analysis®  cept is among most important segments of strategic planning, which has to be regarded as market‐ ing and promotional mix, but it has to include  integrated marketing communication. in case of  marketing, the experts very often use only 4p concept (product, place, price, promotion), and di‐ minish the role of the strategy which has to help general manager lead the company in strategic  and functional manner using crm concept.2  the success of synergy effect of crm concept in a company depends on fulfillment of 2 crite‐ ria:  1. conceptual – company strategy is based on e‐business and customization, and it has  individual approach to every customer   2. technical – use of  ict, standardization, marketing automation, data management,  company management and analysis   the crm method assumes combination of:  o strategic vision  o corporate understanding of customer values using multichannel environment  o use of appropriate managerial information and crm software  o high level of operations, high level of expectation fulfillment and the effect of satis‐ faction3  when introducing crm concept, company goals are: manage customer life cycle, increase of  income and profit, as well as satisfaction of customer needs, hence achieving highest level of loy‐ alty. the analysis of gathered information in every single transaction and interaction (purchase,  support and other activities) by using this multidimensional vertical and horizontal approach en‐ able company to gather widespread information about the customer, out of which the company  will  create  a database  for  future  customer strategy and  individual approach. nevertheless we  cannot regard crm from technology aspect as it solution which will help us created unique cus‐ tomer  database  and  develop  it.  the  technology  influences  communication  and  communication  influences relationship with customers. knowing the goals, which are not only to satisfy custom‐ ers, but as well the stakeholders, we can view the crm as the integrator of marketing communi‐ cation (especially in pr).  e‐commerce, e‐trade and e‐government are the fields of electronic business application. they  use resources from economic science about fundamental knowledge from different areas of mar‐ keting and sales management, whereas internet economics has significant influence on change in  internet marketing environment. transition from traditional to electronic business bears certain  level of risk in market adaptation.  e‐business and crm strategic approach  e‐business includes online communication and business transactions, e‐trade, financial and  other services over internet, as well as all other activities in business that require computer net‐ work. e‐business is exchange of information over electronic media in the market. prefix e became a  communication channel.  throughout the web there are tens of millions of potential customers that companies can  reach (in serbia, potential number of customers is tens of thousands of customers, since develop‐ ment of it is slower, and there is significant resistance for new technologies). those companies  2 salls (2003), p. 156.   3 payne (2004), p.56.  volume 40 • autumn 2007 • 5  using the web are more powerful, competitive and profitable than the ones not using advantages  of the web. in all areas of e‐business new services are to be offered, among which are the software  packages, created for customer relationship management – e‐crm. to make successful relation‐ ship with customers, companies need databases which collect, connect and integrate information  about the customers, and make two way communications with them. such a database enables a  company to create specific set of marketing activities for targeted customer.   reason why a company needs to understand a customer is to have the ability to meet their  needs. to know what their preferences are, we need to establish two way communications with  them. we have to understand all their specific wants regarding the product/service quality, design,  color, shape and other preferences, so as to be able adapt our offer to those preferences. all infor‐ mation about the customer are  integrated  into database which facilitate  individual approach  to  customers. database offers data about every customer which are the basis for marketing planning  and direct marketing ‐ database marketing.4  introduction of crm software in a company creates competitive advantage, wins over com‐ petition and opens foreign markets. this is not all what crm may offer. today we have to antici‐ pate what  is necessary to change and apply  in a company,  in order to become a system which  “walks together” with the needs of more demanding global market. the key step is to persuade all  stakeholders in the company to accept crm and regard it as investment into future.  strategic framework of crm is interaction of 4 related and functionally connected business  processes:  1. formulate company strategy  2. create value/offer – percept your customer and understand values   3. integrate by multichannel – sales  force, pr, phone, direct marketing, e‐commerce,  mobile sales etc.  4. evaluate campaign success – results analysis  integrated crm processes have the synergy effect – global success is greater than the sum of  singe processes effects. it is important to view crm as integrated set of activities which enables  improvement of company operations through:  o identifying, understanding and successful communication with customers  o targeted sales of product/service to new and existing customers  o development of new attractive offers, price discounts and marketing programs cre‐ ated for customers  o retention and share of value with most profitable customers, since satisfied customer  becomes a loyal customer  customer satisfaction is not easy to measure by “yes” or “no”. we have to offer customers  scale from 1‐10. the ones which rate you average (5‐6) are not loyal, and your competition may  attract them. but the ones which rate you 10, are not only satisfied customers, they will recom‐ mend you to others, if you ask them so. different levels of relationship intensity between company  and customer may be shown like:5  o suspect – latent buyer is the person who may be your potential buyer (we have only  his/her name or cookie left on internet site)   o prospect – potential buyer is the person you have registered as someone who may need  4 filipović and  kostić (1999), p. 112.  5 cottle (2000), p. 98.  2007 ‐ 6  •  economic analysis®  your product/service, and who is able to pay for it (unfortunately, not everyone who  needs you may afford you)   o customer – buyer is the weakest on relationship scale. registered user is a buyer, since  he/she has used some of your services, like free downloads, but is still not regular  buyer. on satisfaction scale is 5‐6, and is actively searching for replacement. loyalty  is very low, close to zero  o client – is normal on relationship scale. clients use your service and according to it  they give feedback, looking for advice and help. clients have the buying habit. their  satisfaction is 7‐8 on scale. this means that you may afford to lose contact or not to  satisfy them once, and they will give you another chance. even though relationship  with client depends on marketing activities of competitors  o cheerleaders – advocates are highest on relationship scale. they will not only help you,  they will sell for you. they will talk about you to their friends and business partners  and send you’re their clients if you ask them so.  we have identified four types of strategically significant customers (ssc)6:  o high life‐time value customer,  o benchmarks ‐  the other customers copy him/her,  o inspirations – buyers that cause changes in the company, find new usages,   o come with new ideas   o cost magnets – the customers who absorb disproportional high level of fix cost and  in that way enable other customers to be more profitable for the company  the best buyers deserve the best treatment. if you treat your best customers the same way  like all others, they will soon behave the same way, which is not good business manner. the task  for marketers is to identify significant customers and to retain continuous individual communica‐ tion with them. in order to get appropriate and measurable response marketing manager has to be  trained to create “customer knowledge” out of hundreds of non‐related data collected from differ‐ ent company divisions.  conclusion  the crm solutions are designed in that way as to offer knowledge needed for development  and implementation of “smart” customer profit maximization strategies, and at the same time to  create company competitive advantage. by analyzing crm technologies we can understand our  clients in order not to react when the problem appears, but to proactively find hidden opportuni‐ ties for growing customer wants.  the key success factor of crm concept is for the company to anticipate customer expecta‐ tions. to reach that goal, the platform for communication with customers, gathering and analysis  of data has to be made. within web‐sites, specialized statistical software packages enable overview  and storage of data collected from answers on many different questions. in that way, company  may keep track on customer behavior and their specific interest fields.  company goal is to persuade potential customers to buy, prepay, register, answer the ques‐ tionnaires and generate recommendations, which all together create competitive position for the  company. potential customers, more like the company, have their goals – needs satisfaction and  6  maričić (2002), s. 212.  volume 40 • autumn 2007 • 7  understanding, as well as the strategies of reaching those goals. company ability to persuade po‐ tential customers to realize planned action is the result of effectiveness of crm strategy. the proc‐ ess  in which customer becomes and remains real buyer, who  improves company operations by  his/her loyalty, is based on assured principles which include analysis, art of communication, crm  concept and fundamental knowledge of economics.  literature  1. cottle, w. (2000), professionals guide to target marketing, harcourt professional publishing, san diego.  2. domazet, i. (2007) , operativni menadžment‐faktor unapredjenja konkurentske poyicije preduzeća, zbornik ”ekonomsko‐ finansijski odnosi sa inostranstvom”, nde i ekonomski fakultet, beograd.  3. filipović, v. and kostić, m. (1999), marketing menadžment, institut za menadžment, beograd.  4. maričić, b. (2002), ponašanje potrošača, savremena administracija, beograd.   5. milićević, v. (2002), internet ekonomija, fakultet organizacionih nauka, beograd.  6. payne, a. (2004), developing a strategic approach to crm, harvard business school, boston.  7. pickton, d. and broderick, a. (2005), integrated marketing communications, prentice hall, new jersey.  8. salls, m. (2003),  strategic role of marketing, harvard business school, boston.    9. varagić, d. (2000), vodič kroz raj i pakao internet m@rketinga, prometej, novi sad.  10. word economic forum (2007) the global competitiveness report 2007‐2008:   http://www.weforum.org/en/initiatives/gcp/global%20competitiveness%20report/index.htm   microsoft word 2008_01_02.doc original paper    job stability and gender perspectives:     application of a logistic regression model    j. antonio ariza montes, mariano carbonero ruz,    mª del carmen lópez martín, belén gutiérrez villar     faculty of business – etea – affiliated to the university of cordoba    key words: gender discrimination, temporary employment, logistic regression models    udc: 331.564:316.647.82          jel: b41, c51, j16    abstract ‐ several changes have been taking place in the labour market since the 1970s that have  created the right climate to spur organisations and workers to demand greater flexibility in employment. in  this context, temporary employment has been the focus of many research papers and temporary contracts  have been used as a tool to achieve  labour  flexibility. in order to understand the situation  in andalusia  (spain), this paper aims to identify the decisive factors in permanent employment. to this end, starting hy‐ potheses will be defined about the decisive  factors in permanent employment and the positive or negative  significance of their influence; the starting hypotheses will then be tested empirically using a logistic regres‐ sion model on a sample population of wage earners in andalusia. in the second stage, given that the ratio of  temporary contracts is much higher among women, the variable ‘gender’ is likely to be decisive in the con‐ struction of the regression model, therefore the decisive factors for permanent employment in andalusia will  be evaluated separately for men and women, in order to calibrate the impact of gender on job stability. fi‐ nally, based on the estimated probabilities of having a permanent job depending on gender, the degree of la‐ bour discrimination faced by women in the andalusian labour market will be analysed.  introduction  many researchers have examined the decline of standard labour relations, in other words,  the model of employment in which the worker has a clearly defined employer, works full time  throughout the financial year under the supervision and premises defined by the employer, enjoys  certain legal and social benefits, and finally, expects this working situation to continue indefinitely  (muckenberger, 1989; schellenberg and clark, 1996; vosko, 1997).  the changes that have been taking place in the labour market since the 1970s have created  the right climate in many countries to spur organisations and workers to demand greater flexibility  in employment. researchers in this area define nonpermanent employment as contingent work, in  other words, jobs in which the worker does not have an indefinite contract, either implicit or ex‐ plicit, or in which the minimum limit of two hours’ work could vary at any time (connelly and  gallagher, 2004).   temporary employment is possibly the most common form of contingent work in the labour  market, which is why it has been the focus of many research papers in the field of labour relations.  temporary contracts have been used as a tool to achieve labour flexibility, which is why they are  more commonly found in countries with strict labour relations ‐ such as spain, france or italy ‐ in  comparison with labour markets that are less tightly regulated, such as the united kingdom or the  united states (brown and sessions, 2003; brown and sessions, 2005).  in order to understand the current  labour market situation  in spain, we have to go back  around three decades. at the end of the 70s and early 80s, the situation was extremely worrying,  with unemployment rates reaching over 20% of the working population. this sparked the need to  implement flexibility measures when hiring workers in order to promote job creation. as a result  2007 ‐ 60  •  economic analysis®  of  the new  legislative framework provided by  the  labour reforms  introduced  in  the 1980s, the  presence of temporary contracts increased from 8% of all contracts in 1984 to 33% in 1994, and in a  short space of time spain had one of the highest rates of temporary employment in europe.  subsequent reforms introduced between 1994 and 2002 attempted to change this trend, by  applying measures aimed at increasing job stability, mainly by restricting the facilities granted to  employers previously in terms of temporary contracts and reducing certain methods of dismissal.  in spite of these policies, currently, the ratio of temporary contracts in spain is still one of the high‐ est in the european union1. in an attempt to remedy this situation, on the 9th june 2006, a royal  decree reform act was passed for the labour market, which chiefly aimed to reduce temporary  contracts and promote stable employment. to this end, certain measures were established that pro‐ mote the application of permanent contracts and reduce certain business contributions. the effects  of these latest reforms will only become clear over the next few years.  certain authors specify that there is no rational reason to prefer a temporary contract, since a  permanent contract offers all the advantages of a temporary one with the added bonus that the  worker is able to prolong the working relationship for as long as she or he wishes (brown and ses‐ sions, 2005). however, this argument is not shared by the scientific community as a whole. garcía  and rebollo (2005) suggest two basic points of view in relation to temporary contracts. on the one  hand,  they can be viewed as a previous step before moving onto other more stable situations  (booth, francesconi and frank, 2002; varejao and portugal, 2002), especially among younger job‐ seekers, who are looking to gain experience. on the other hand, the temporary link with a com‐ pany does not always have to be imposed and in some cases it can be the free choice of the indi‐ vidual. however, the latter alternative is fairly improbable in the case of spain, given that tempo‐ rary contracts are somewhat detrimental from an economic point of view in this country (jimeno  and toharia, 1993; de la rica, 2004; garcía and rebollo, 2005).  whatever  the case may be,  the segregation between employees with stable contracts and  those  with  temporary  contracts creates  a significant  dualism  in  the  spanish  labour  market,  as  pointed out by several authors (bentolila and dolado, 1994; saint paul, 1996; toharia, 2002). as if  they were two different models, according to garcía and rebollo (2005), there are two clearly sec‐ tors in the labour market. on the one hand, a primary sector characterised by workers with per‐ manent contracts who have a strong influence on collective bargaining processes. this group en‐ joys job stability, high salaries and opportunities for internal promotion. and on the other hand,  there is a secondary sector, made up of workers with temporary contracts, limited salaries, low  internal mobility and who are excluded from bargaining processes.  another characteristic feature of the spanish labour market is that the ratio of temporary to  permanent contracts varies a great deal from region to region. hence, in the fourth quarter of 2006,  regions such as andalusia, extremadura and murcia recorded figures of over 40% temporary em‐ ployment, whereas in catalonia and la rioja, three out of every four wage earners had a perma‐ nent contract. this regional variation could be the result of several factors: heterogeneity in the  composition of  the workforce, production specialisation, different  levels of productivity,  labour  costs, etc.   given the impact of temporary work in the spanish and andalusian labour markets (anda‐ lusia ‐ 46.4% temporary contracts ‐ has the highest ratio of any of spain’s autonomous regions), this  paper aims to identify the decisive factors in permanent employment. to this end, firstly, a review  will be provided of previous research in this area; starting hypotheses will be defined about the  decisive factors in permanent employment and the positive or negative significance of their influ‐ 1 hence, in q4 2006, 33.8% of salaried workers had temporary contracts, although these figures conceal a marked gender  inequality, since this percentage drops to 32.0% among men and increases to 36.2% among women  volume 40 • spring 2008 • 61  ence; the starting hypotheses will then be tested empirically using a logistic regression model on a  sample population of wage earners in andalusia taken from the national institute of statistics ac‐ tive population survey. in the second stage, given that the ratio of temporary contracts is much  higher among women (36.2% in spain and 49.2% in andalusia) than among men (32.0% and 44.6%,  respectively),  the variable  ‘gender’  is  likely to be decisive  in  the construction of  the regression  model2, therefore the decisive factors for permanent employment in andalusia will be evaluated  separately for men and women, in order to calibrate the impact of gender on job stability. finally,  based on the estimated probabilities of having a permanent job depending on gender, the degree  of labour discrimination faced by women in the andalusian labour market will be analysed.  temporary vs. permanent contracts: empirical background  the pairing temporary/permanent employment has been studied from various angles. many  authors have focused on analysing the harmful effects of temporary employment: lack of stability  and  opportunities  for  professional  development  (farber,  1999; arulampalam  and  booth,  1998),  demotivation and staff turnover (purcell et al., 1999), dissatisfaction, fewer opportunities for train‐ ing and  lower wages  (booth, francesconi and frank, 2002; aronsson et al., 2002, nollen, 1996;  segal and sullivan, 1997)3, less job security, lower health and safety standards (quinlan, mayhew  and bohle, 2001), insecurity and concern about the future (purcell, 2000; sengenberger, 1995).  more in keeping with the objectives of this paper, another area of research has focused on de‐ termining the variables associated with temporary or permanent employment. dolado et al. (2002)  performed regression analysis for spain, confirming that age is negatively associated with tempo‐ rary employment. these conclusions are coherent with the trinomial logistic model (in which the  reference category, being unemployed, is compared with the situation of temporary and perma‐ nent wage earners) created by morris and vekker (2001), who concluded that individuals between  the age of 16 to 24 are less likely to sign a permanent contract and more likely to have temporary  employment. furthermore,  the probit analysis performed by dolado et al.  (2002) confirms  that  there is a lower incidence of temporary employment among older wage earners. similar results  were obtained in studies performed by nollen (1996), farber (1997, 1999), segura et al. (1991) and  álvarez aledo (1996).  training is also negatively associated with temporary employment, as confirmed by dolado  et al. (2002) in a study comparing wage earners who gained a secondary education and those with  a lower level of education. brown and sessions (2005) arrived at similar conclusions using perma‐ nent employment as the point of reference. they applied probit analysis to a sample of close to  9000 wage earners and concluded that every year an individual remains within the education sys‐ tem  increases his/her chances of gaining permanent employment. other authors have obtained  empirical  evidence  in  this  respect,  including  nollen  (1996),  farber  (1997,  1999),  álvarez aledo  (1996)  and  segura  et  al.  (1991),  confirming  that  temporary  contracts  are  much  more  frequent  among uneducated workers in comparison to other educational categories.  2 according to a group of gender researchers, new non‐standard working methods merely contribute to the perpetuation  of gender inequalities, since historically atypical labour relations (outside the regulations of full‐time permanent em‐ ployment) have always been linked (and continue to be so) with women (fudge, 1991; armstrong, 1996; spatler‐roth  and hartmann, 1998; vosko, 2000; fudge and vosko, 2001)  3 the study carried out by brown and sessions (2003) quantifies the difference between the salaries earned by permanent  and temporary employees, giving a figure of 13%. some researchers in spain have obtained similar results (jimeno and  toharia, 1993; alba‐ramírez, 1994). furthermore, brown and sessions (2003) point out that salary discrimination affects  women more than men regardless of whether the contract is permanent or temporary  2007 ‐ 62  •  economic analysis®  marital status is another variable that certain researchers had attempted to link with the type  of contract signed by the wage earner. segura et al. (1991) claim that temporary contracts are more  common among single people than the married population, in line with the results obtained by  morris and vekker (2001) for a sample of women. according to these authors, being married in‐ creases an individual’s chances of having a permanent contract and reduces the chances of having  a temporary contract.  however the link between marital status and contract type does not always manifest itself as  expected, since laird and williams (1996) and golden (1996) found that the proportion of married  women in the labour market is positively linked to levels of temporary employment.  cranford et al. (2003) state that the role taken on by women, taking care of the everyday and  generational needs of their families, causes them to choose part‐time or temporary employment of  their own free will. consequently, it can be expected that the presence of children in the home,  especially little children, or another dependent relative, will increase the frequency of temporary  contracts among the female population. this hypothesis was tested by morris and vekker (2001)  on a sample of women with children under the age of 18 still living at home, concluding that this  variable  reduces  the  probability of having  a permanent  contract,  increasing  the possibilities of  temporary employment.  the  type of work undertaken  is  also  linked  to  the  type of  contract  signed  by  the  wage  earner, in the sense that  jobs that require a higher degree of skill, and which are therefore more  difficult to fill with qualified staff, must be duly compensated, among other things with greater job  stability, in other words the offer of a permanent contract. the probit model developed by brown  and sessions (2005) confirms this link among professionals, and with even greater intensity among  management positions.4 dolado et al. (2002) examined at this same area and noted that temporary  contracts are less frequent in qualified positions.  another interesting variable when studying this issue is the sector or industry. the probit  model created by dolado et al. (2002) reveals that temporary contracts are negatively associated  with employment in the public sector, a similar conclusion to the findings obtained previously by  segura et al. (1991). furthermore, the study performed by dolado et al. (2002) concludes that there  are fewer temporary contracts in the industrial sector and the services industry, and a higher per‐ centage in the construction industry. breaking it down even further, segura et al. (1991) found a  higher incidence of temporary employment in construction, agriculture, commerce and financial  institutions.  research has also been conducted into the influence of nationality and parttime work, al‐ though not to the same extent as for other variables. in relation to the first variable, morris and  vekker (2001) demonstrated that non‐us wage earners were less likely to have a permanent con‐ tract and more likely to have a temporary one. in relation to the second variable, the analysis con‐ ducted by brown and sessions (2005) concluded that permanent employment is negatively linked  with part‐time work.   and finally, one of the fundamental variables in this research project, which has purposefully  been left until last, is the gender of the wage owners. the increasing integration of women into the  workforce in recent decades is irrefutable, although this situation masks considerable diversity that  exists at different levels and in different forms (bradley et al., 2000). certain authors such as stand‐ ing (1989) believe that there is no such thing as fairness in the labour market, and that women tend  to cluster at the very lowest levels, occupying positions with the lowest salaries, which are the least  4 the authors already confirmed this hypothesis in a previous study together with the positive association between tem‐ porary contracts and smaller companies (25‐100 employees) and the inverse relationship between the variable studied  and the presence of trade union representation (brown and sessions,2003)  volume 40 • spring 2008 • 63  secure and with the worst professional expectations5. this fact is borne out by official statistics: as  indicated previously, at the end of 2006 the rate of temporary employment among women in spain  was more  than  four percentage points higher  than among men; furthermore, 11.9% of women  work part‐time in comparison to just 4.1% of men; or to cite another example, one out of every five  women works in unskilled employment (as opposed to 11.9% of men), whereas only five out of  every one hundred women occupy management positions (8.4% among men). studies that have  analysed the relationship between gender and labour relationships have concluded that women  are more likely to have a temporary contract than men. the probit analysis conducted by brown  and sessions (2005) confirms that permanent employment is positively linked with the male gen‐ der. these results are coherent with the findings of dolado et al. (2002), who confirm that being a  female wage earner in the private sector increases the probability of having a temporary contract.  this effect is even more marked in the case of public employment.  the research of booth et al. (2001) is particularly relevant for the purposes of this paper, since  these authors performed separate multinomial logistic regression studies for men and women. the  conclusions of this research showed that women who occupy skilled positions (professionals, spe‐ cialists and teachers) are more open to the idea of having a temporary contract than men. further‐ more,  in  comparison  with  the  male  population,  these  authors  noticed  that  the  probability  of  women having a temporary contract is higher in public administration and charity organisations.  finally, having young children is also a discriminatory factor, since the regression models obtained  confirm that in such a family context the chance that a woman will have a temporary contract is  higher than for men.  research hypotheses  the above bibliographic review shows which variables are linked, in different markets, with  the type of contract signed by wage earners, as well as the foreseeable influence (positive or nega‐ tive) of each relationship. taking these previous studies as a point of reference, the main working  hypotheses to be tested in relation to temporary contracts in the andalusian labour market are as  follows:  o hypothesis 1. gender, age, level of education, family structure, nationality and la‐ bour‐related aspects are decisive factors when determining the probability of gaining  permanent employment.  o hypothesis 2. the above‐mentioned factors have a different  impact depending on  gender.  o hypothesis 3. all things being equal regarding the other variables, women in anda‐ lusia have fewer chances of gaining permanent employment than men.  empirical study  methodology: binary logistic regression model  the methodology used to achieve our research objectives is based on the binary logistic re‐ gression model, a specific type of dichotomous response regression model6. this statistical tech‐ 5 krahn (1995) claims that the probability that women will remain in non‐standard employment (including self em‐ ployed, part‐time and temporary work) is higher in comparison with men    2007 ‐ 64  •  economic analysis®  nique determines the probability of the occurrence of an event ‐ having a permanent contract in  this case ‐ compared to the probability of the occurrence of the opposite event.  sample  in order to analyse which factors determine permanent employment in andalusia, a sample  population was obtained from  the microdata file of the active population survey (epa) for q4  2006. in order to avoid the problem of oversensitivity of the model, which can occur when an ex‐ cessively high number of observations are considered, 1628 records were selected: 929 andalusian  men and 699 andalusian women7.  the sample was then divided in two. the first part, comprising 80% of the observations, was  used to train the model, and the second part, containing the remaining 20% of observations, was  used for model validation. the comparison between the percentages of success in both stages indi‐ cates the general validity of the model and detects possible overtraining. the division of the sam‐ ple into two sub‐samples was conducted in a random manner, although the initial structure re‐ garding contract duration and gender was maintained.  the variables included in the model were taken from the epaʹs anonymised microdata file.  in some cases, new variables had to be created in order to reflect the most important aspects of  each subject’s family structure, and in other cases, a certain degree of recoding had to be applied in  order to simplify the study or adapt the content of the original data to the objectives pursued in  this paper. the coding and frequency of the variables included in the regression model are shown  in table 1.  as a prelude to regression analysis, the degree of association was measured between each  pair of independent variables, chosen by a coefficient in each case, depending on the nature of the  6 the most common way of presenting this model is:     the first member of this equation is called the odds ratio (or) and represents the relative probability of the researched  event as opposed to non‐occurrence. hence, an or with a value of x would indicate that it is x times more likely that an  individual will have a permanent contract as opposed to a temporary one. from this point of view, the interpretation of  the model coefficients is simple. once the variable xj has been chosen along with the other independent variables, in the  event of any unitary increase in this predictor, relationship between the odds ratios will be calculated as follows:     hence, if βj>0, the increase in the odds ratio will be greater than 1, which indicates an increase in the probability of oc‐ currence of the researched event. just as in any statistical model, logistic regression can test several hypotheses in order  to determine its validity both in global and individual terms. global analysis evaluates as a whole the possibility that the  investigated phenomenon really can be modelled using the chosen type of expression, whereas individual analysis ‐ in  which validity is subject to the global analysis performed ‐ examines the appropriateness of including each of the vari‐ ables in the model considered. in this paper, the hosmer‐lemeshow goodness‐of‐fit index was used as a global meas‐ urement, and the wald test was applied for individual analyses.  7 these amounts were chosen by configuring the gender composition of the epa sample on the one hand and the num‐ ber of independent variables of each of the estimated models on the other, taking a ratio of about 85 observations per  variable in the case of women and 115 in the case of men, which are sufficient values to be able to maintain the freedom  of the model at a reasonable level. the selection of these observations was made by sampling the original epa file , re‐ stricting the sample to andalusian individuals over the age of 16 engaged in salaried employment during the reference  period, and by sampling proportionally by gender and contract duration  volume 40 • spring 2008 • 65  variables (nominal or ordinal). the maximum value has been found to be between occup1 and  leduc (0.669). these values do not seem to indicate significant evidence of colinearity.    table 1 ‐ explanatory variables: coding and frequency  variable and coding  name  frequency        value 0  value 1 value 2  value 3  value 4   age (0: 16‐25; 1: 26‐40; 2:41‐55; 3: 56 or over)  age5  419  704  448  57  ‐‐‐‐  gender (1: male; 0: female)  gend1  699  929  ‐‐‐‐  ‐‐‐‐  ‐‐‐‐  nationality (1: spanish; 0: foreign)  nat1  56  1572  ‐‐‐‐  ‐‐‐‐  ‐‐‐‐  lives with partner (1: yes; 0: no)  livp  600  1028  ‐‐‐‐  ‐‐‐‐  ‐‐‐‐  level of education (0: primary educa‐ tion; 1:secondary education; 2: higher educa‐ tion)  leduc  255  993  380  ‐‐‐‐  ‐‐‐‐  occupation (1: unskilled; 2: skilled, opera‐ tional work; 3: skilled, administrative work; 4 :  highly skilled)   occup1  ‐‐‐‐  302  717  350  259  sector/industry (0: agriculture; 1: indus‐ try; 2: construction; 3: services)  sect1  90  192  213  1133  ‐‐‐‐  number of children in the home (0:  none; 1: one; 2: two; 3: three; 4: four)  chil  998  337  263  29  1  working day (1: full‐time; 0: part‐time)  fpar1  182  1446  ‐‐‐‐  ‐‐‐‐  ‐‐‐‐  source: authors’ own calculations.  nb: the variable chil indicates the number of children under the age of 15 living with the person interviewed.  results analysis  the analysis was conducted in two stages: in the first stage, considering both sub‐samples  (men and women) as a single sample, the aim was to analyse which variables or factors determine  job stability among andalusian wage earners, with particular emphasis on gender, since  if this  factor is significant, the separate estimation of probabilities for men and women is justified, which  is the second objective of this research paper.  general model  table 2 shows the results of the estimation using logistic regression of the factors that deter‐ mine the chances of gaining permanent employment in andalusia. firstly, it should be pointed out  that the comparison statistic applied to evaluate the validity of the model as a whole indicates that  there are sufficient reasons to accept the validity of the model8, in other words, to confirm that the  fact of whether a wage‐earner has a permanent contract or not can be satisfactorily explained by  the set of variables considered in this paper. this general model shows that the regression coeffi‐ cients for age, the level of skill required for the occupation, working full time and the number of  children under 15 living in the home, provide positive results, thereby contributing to permanent  employment. hence, the older the individual, the higher the skill level required for the  job per‐ formed, the number of children living in the home and the fact that the individual works full time,  8 the hosmer‐lemeshow test, used for this purpose, presents the following results: chi‐squared: 9.230; sig. 0.323  2007 ‐ 66  •  economic analysis®  the greater the probabilities of having a permanent job. however, the coefficients for the variables  gender, nationality and the agriculture and construction industries are negative, which suggests  that being a woman, foreign, or working in these two economic sectors decreases the individual’s  possibilities of finding permanent employment, increasing the probability of having a temporary  contract9.  table 2 ‐ logistic regression: factors that determine permanent employment   in andalusia and the odds ratio confidence intervals  variables in the model  odds ratios95% c.i. for or    b  s.d.  wald  p  or  lower  upper  age5  0.0595  0.0063  88.9376  0.0000  1.0613  1.0483  1.0745  gend1(1)  ‐0.3840  0.1528  6.3182  0.0120  0.6812  0.5049  0.9189  nat1(1)  ‐0.7761  0.3535  4.8214  0.0281  0.4602  0.2302  0.9200  occup1  0.4005  0.0790  25.6737  0.0000  1.4925  1.2783  1.7426  fpar1  1.3679  0.2099  42.4576  0.0000  3.9269  2.6024  5.9257  chil  0.1674  0.0833  4.0379  0.0445  1.1823  1.0041  1.3920  sect1      59.1200  0.0000        sect1(1)  ‐1.5949  0.3454  21.3167  0.0000  0.2029  0.1031  0.3994  sect1(2)  ‐0.0489  0.2246  0.0474  0.8276  0.9523  0.6132  1.4788  sect1(3)  ‐1.3271  0.2642  25.2359  0.0000  0.2653  0.1581  0.4452  constant  ‐2.7344  0.3606  57.5015  0.0000        source: author’s own calculations.  nb: the variable sector/industry is linked to the industrial sector, therefore the coding would be as follows: sect1(1),  agriculture; sect1(2), construction; sect1(3), services.  in spite of everything, the impact of each of the significant variables on the probability of  gaining permanent employment differs substantially from one variable to another, as indicated in  the confidence intervals analysis for the corresponding odds ratios (see table 2). hence, each year  that passes in relation to the variable age only slightly increases the odds ratios (approximately 6%  of the value of the previous year), which is a minimal increase in the probability of gaining perma‐ nent employment. the effect is much more intense in relation to the variable gender. in this case,  the or for women is 68.12% compared with the or recorded for men, which reveals the difficulty  women have accessing jobs with greater stability10. furthermore, being foreign is also a major ob‐ stacle to accessing a permanent contract: 46.02% relative probability in comparison to spanish‐born  citizens. the or for the variable occupation (1.4925 with a confidence interval of between 1.2783  and 1.7426) suggests that jobs that require a greater degree of skill also offer greater job stability. as  expected, the most intense effect is observed when comparing part‐time workers with people who  work full time, with an increase of almost four points in the or. a similar occurrence, although  with  less  intensity, is observed when analysing the  influence of the presence of children  in the  home: for every child under the age of 15 in the home, the relative probability of having permanent  employment increases by 18%. finally, the sector or industry in which the individual works also  plays an important role in the type of contracts signed: taking industry, agriculture and construc‐ tion as the points of reference, the ratios are much lower (20.29% in the first case and 26.53% in the  9 all these results are significant at 1%. for this level of significance, the logistic regression model indicates that there is a  series of variables that are neither positively or negatively associated with job stability: having or not having a spouse,  the educational level of the wage earner, and the fact that the individual works in the services industry in comparison  with the industrial sector  10 even in terms of confidence intervals, even though the upper limit for the ratio evaluated is slightly above 90%, the fact  that the lower boundary of this same ratio is around 50% cannot be ignored in other words, the probability of a woman  having a permanent contract, in comparison with a man, is 91.89% in the best case scenario, dropping to 50.49% in the  worst case scenario  volume 40 • spring 2008 • 67  second), which shows that the probability of having stable work in these sectors is much lower  than in the industrial sector. this situation ‐ when compared to the services sector, which has a  ratio of 95% ‐ shows that the chances of having permanent employment in this sector are practi‐ cally the same as in the industrial sector11.  the  final step  in  this  first research stage analyses  the model’s generalisation capacity, by  comparing  the  correctly  classified  observations  in  both  the  training  and  generalisation  stages.  hence, in the training stage, corresponding to the construction of the model, 73.37% of the indi‐ viduals cons idered were classified correctly, knowing their real situation beforehand. there were,  however, considerable differences between the percentages corresponding to permanent (48.03%)  and temporary contracts (87.01%), which suggests that the latter are easier to identify. in the gener‐ alisation stage, once the model coefficients were estimated, individuals were presented for classifi‐ cation with previous information about their real situation. the results obtained were better than  expected in the training stage (77.23% of the global model, 50.88% for permanent contracts and  91.47% for temporary contracts) both in global terms and for each of the groups, which reveals the  general validity of the estimated model.   gender model  given that the variable gender proved to be decisive in the construction of the general model,  the second research objective was to compare the regressions corresponding to the male and fe‐ male population, thereby calibrating the impact of gender on job stability. the results of the hos‐ mer‐lemeshow test (chi squared: 8.930; sig. 0.348), in relation to the model corresponding to the  male population once again confirmed that the variables considered were sufficient  in order to  explain the type of contract, at least in terms of determining the characteristics that affect it.   table 3 presents the results obtained from the logistic regression model for the male popula‐ tion sample. the main difference from the general situation relates to the presence of children in  the home. this variable, which showed a positive association in the global model, has no influence  when considering just the male population.   furthermore, analysis of the odds ratios shows that the effect of the significant variables on  permanent employment differs in certain cases from the global model. firstly, the type of working  day has more of an influence on job stability among men in comparison to the collective as a whole  (4.76 in comparison to 3.92). secondly, and in the opposite direction, the importance of nationality  as a decisive factor of job stability is considerably lower among men: an odds ratio of 0.2186 com‐ pared to 0.4602 for the general model. for the other variables, differences are insignificant, indicat‐ ing that age, the level of skill required for the job and the economic sector do not display specifi‐ cally different behaviour for  the male collective in the determination of the type of contract to  which they have access.  just as with the global analysis, the modelʹs generalisation capacity for the male population  is adequate, obtaining similar classification percentages to the general model12, with only exception  of a small decrease in the number of correctly classified individuals in the generalisation stage re‐ garding the total number of individuals with a permanent contract13.  11 it should be noted that the logistic regression model explains the relationship between variables, which does not neces‐ sarily have to be causal. for example, the positive association between the presence of children in the home and perma‐ nent employment does not imply that the former is a source of job stability and the relationship might even be present in  the opposite direction  12 training stage: 74.97% for the male population as the whole; 49.19% for men with a permanent contract and 87.88% for  temporary contracts. generalisation stage: 76.88%, 45.16% and 92.74%, respectively   13 at any rate, the figures in themselves and the scant differences between the training and generalisation stages indicate  that the evaluated model is sufficiently valid in general and is not predetermined by the specific observations used in its  2007 ‐ 68  •  economic analysis®  table 3 ‐ logistic regression: factors that determine permanent employment in the andalusian male popula‐ tion and odds ratios confidence intervals  variables in the model  odds ratios 95% c.i. for or    b  s.d.  wald  p  or  lower  upper  age5  0.0562  0.0085  44.0292  0.0000  1.0578  1.0404  1.0755  occup1  0.5219  0.1269  16.9292  0.0000  1.6853  1.3143  2.1610  fpar1  1.5603  0.4362  12.7915  0.0003  4.7600  2.0243  11.1930  sect1      50.3354  0.0000        sect1(1)  ‐1.3314  0.3939  11.4251  0.0007  0.2641  0.1220  0.5716  sect1(2)  0.0256  0.2703  0.0090  0.9244  1.0260  0.6040  1.7428  sect1(3)  ‐1.3774  0.2908  22.4338  0.0000  0.2522  0.1427  0.4460  nat1(1)  ‐1.5206  0.5243  8.4102  0.0037  0.2186  0.0782  0.6108  constant  ‐2.8537  0.5500  26.9170  0.0000        source: authorsʹ own calculations.  nb: the variable sector/industry is linked to the industrial sector, therefore the coding would be as follows: sect1(1),  agriculture; sect1(2), construction; sect1(3), services.  focusing now on the group of women studied, the hosmer‐lemeshow test confirms the va‐ lidity of the model (chi squared: 5.475; sig. 0.706). the variables that are really associated with  permanent contracts are summarised in table 4, which reveals that the main difference as regards  to the situation of men focuses on two variables14: on the one hand, the presence of children in the  home is related in this case with having or not having a permanent job; on the other hand, nation‐ ality, which was a relevant factor when determining job stability among men, does not influence  this aspect among the female population.  as in the previous analyses, in order to determine the effect of each explanatory variable on  the dependent variable, the estimated odds ratios and their associated confidence intervals were  considered (see table 4). firstly, of particular importance is the fact that the presence of children in  the home is directly associated with the probability of having a permanent contract. furthermore,  comparison of the odds ratios for the common variables between the logistic regression models for  men and women reveals, in general, fairly similar values; therefore, from variable to variable, there  are no significant differences in the way in which the different circumstances affect the type of con‐ tract. the only exception, apart from the aforementioned presence of children in the home, can be  observed in terms of the sector or industry in which the individual works, since the probability of  having permanent employment in agriculture (always in relative terms in comparison to industry)  is substantially lower among women than men (or=0.2641 for men and or=0.0802 for women)  and slightly lower in the services industry (1.03 as opposed to 0.8218).  to bring this section to a close, it should be pointed out that the classification percentages of  the training and generalisation stages are slightly different to those obtained in the other two mod‐ els analysed15. furthermore, significant improvements were observed in the generalisation stage in  comparison to the training stage, both for permanent and temporary employment. moreover, sub‐ stantial differences were observed in the number of correctly classified individuals according to  the type of contract in favour of temporary contracts, just as with the model applied to the male  population, which indicates that the profile of a temporary female worker is easier to predict than  construction  14 it should be emphasised that the construction industry was excluded from this analysis, given that the number of  women employed in this sector is very low and that all those present in the sample had a permanent contract, which  would significantly distort the coefficient estimation associated with this level  15 training stage: 71.92% for the female population as a whole; 54.81% for women with a  permanent contract and 82.27% for temporary contracts. generalisation stage: 80.15%, 68.00% and 87.21%, respectively  volume 40 • spring 2008 • 69  that of a woman with a permanent job. just as with the other two logistic regression models, these  results confirm that the model evaluated is sufficiently valid in general and is not predetermined  by the specific observations used in its construction.  table 4 ‐ logistic regression: factors that determine permanent employment among the   andalusian female population and odds ratios confidence intervals  variables in the model  odds ratios 95% c.i. for or    b  s.d.  wald  p  or  lower  upper  age5  0.0666  0.0098  46.5539  0.0000  1.0689  1.0486  1.0896  occup1  0.2817  0.1063  7.0196  0.0081  1.3254  1.0761  1.6325  fpar1  1.4364  0.2521  32.4603  0.0000  4.2055  2.5658  6.8932  chil  0.3439  0.1313  6.8585  0.0088  1.4104  1.0904  1.8244  sect1      11.3621  0.0034        sect1(1)  ‐2.5234  0.8056  9.8109  0.0017  0.0802  0.0165  0.3889  sect1(2)  ‐0.1963  0.4201  0.2183  0.6403  0.8218  0.3607  1.8721  constant  ‐3.2485  0.5708  32.3951  0.0000        source: authors’ own calculations.  nb: the variable sector/industry is linked to the industrial sector, therefore the coding would be as follows: sect1(1),  agriculture; sect1(2), construction; sect1(3), services.    gender discrimination in the andalusian labour market  the previous analyses evaluated the influence of the variables studied in this research paper  on the type of contract signed by wage earners in andalusia, placing specific emphasis on the vari‐ able  gender.  this  last  section  makes  a  graphic  comparison  between  the  situation  of  men  and  women. for  this purpose,  for each of  the  individuals surveyed, regardless of  their gender,  the  probability of having  a  permanent contract  was  calculated  according  to  the  logistic  regression  models obtained (see graph 1).   graph 1. probability of having permanent employment according to a gender    source: authors’ own.  2007 ‐ 70  •  economic analysis®    if the employability of men was similar to that of women, each and every one of the points  should be located on the diagonal, where both probabilities are equal. when this does not occur,  the location of each point indicates which gender offers greater opportunities for permanent em‐ ployment: men when the point is lower than the diagonal or women when it is higher. this graph  clearly shows that when the other variables are constant, being a man offers greater expectations  for stable employment than being a woman. furthermore even in cases in which being a woman is  a competitive advantage in terms of job stability, the probability of having permanent employment  is very high for both sexes (top right‐hand corner of the graph), so in actual fact this advantage is  relative.  in order to quantify the content of the graph, the observations were classified into two crite‐ ria: the real gender of each individual and that which, in terms of probability, would offer greater  prospects of having permanent  employment. for  this  second criterion,  three possibilities  were  taken  into account: man, woman, or irrelevant. here, the term  irrelevant refers to situations  in  which the difference in the probability of accessing permanent employment is less than 0.05. the  results shown  in table 5 confirm  that  the possibilities of finding permanent employment are in  general much higher for men. in fact, only 49 (7.1%) of the 688 women interviewed and 26 (3.5%)  of  the 727 men  interviewed would have a better chance of  finding permanent employment as  women. however, 412 of the women interviewed, representing 59.9% of the total, would have a  much greater chance as men.    table 5 ‐ probabilistic comparison of employability in terms of the real gender of the individual interviewed  and the preferable gender to access permanent employment  real  preferable    irrelevant  male  female  total  male  307  394  26  727  female  227  412  49  688  total  534  806  75  1415  source: authors’ own.  discussion  the research aims of this paper are: on the one hand, to determine which factors affect the  probability of having a permanent job contract among wage earners in andalusia, which had the  highest rate of temporary employment of any autonomous region in spain at the end of 2006; and  on the other hand, to evaluate the impact of gender on job stability.  in order to achieve these objectives, firstly a logistic regression model was applied, indicating  that the probability that a wage earner has of getting a permanent contract increases with age, the  level of skill required for the position, full‐time employment and the number of children living at  home. it was also confirmed that being a woman, being foreign and working in agriculture or con‐ struction reduces the possibilities of finding permanent employment. our results practically con‐ firm the approach of the first hypothesis: gender, age, some characteristics of family structure, na‐ tionality and labour‐related aspects are as being decisive factors in determining the probabilities  for  permanent  employment.  our  conclusions  are  similar  to  previous  results  in  the  field  back‐ ground.  given that gender is a decisive variable in the logistic regression model, the model coeffi‐ cients were then estimated for the male and female populations. the most significant results were:  volume 40 • spring 2008 • 71  on the one hand, that having or not having children living at home does not alter the possibilities  of finding permanent employment among andalusian men, whereas it does influence job stability  for women; and, on the other hand, that being a spanish national ‐ a factor that contributed to  permanent employment among the male population ‐ does not show any influence among the fe‐ male population. this result confirms our second hypothesis.   finally, from the perspective of gender, a graphic estimation was generated of the probability  of each individual interviewed having a permanent job contract, regardless of gender and main‐ taining all the other variables constant. the evidence obtained confirms the expectations in the  hypothesis 3: being a man in andalusia offers greater prospects for permanent employment; hence  any legislative measures taken to promote equality among men and women will be welcome in  order to redress this situation.  there are two limitations for this study. firstly, we focus on only one region; therefore our re‐ 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countries' export performance (bosnia and herzegovina, croatia, macedonia, montenegro, serbia and slovenia) over the period 2006-2013. the paper is aimed at assessing these countries’ export competitiveness and determining its dynamics in trade with the world. the analysis included the research into and comparison of export characteristics – the volume and dynamics of export flows, geographic and product export structure and concentration, technological export sophistication, export specialization expressed through revealed comparative advantage, intensity and direction of change in export structure. in order to gain a comprehensive insight into export competitiveness, a few indicators were used: balassa rca index, michaely index, herfindahl-hirschman concentration indices, etc. the indices were calculated based on the information from relevant databases of the world bank and international trade centre, aggregated at the second and sixth hs2002 level, for the eight-year period and/or for the first and the last year. the research revealed that ex-yu countries’ export performance is generally unsatisfactory, despite the progress that individual countries registered in the observed period. most countries have comparative advantage in the products of traditional, declining industries, a high share of semiproducts and primary products, and a negligible share of high-technology products in their export portfolio, a stagnating export structure, and a low degree of geographic and product export diversification. mutual comparisons showed that the group is not homogenous and that, besides the described common characteristics, there are significant differences within the group in certain aspects of export competitiveness. the eu member–states, croatia and particularly slovenia, have a series of advantages compared to countries that are candidates and potential candidate. the greatest progress toward the improved export competitiveness was achieved by serbia, while montenegro got the poorest rating for export competitiveness key words: ex-yu countries, export competitiveness, export structure, revealed comparative advantages (rca), export diversification, export concentration 1 school of economics and business university of sarajevo; e-mail: muamer.halilbasic@efsa.unsa.ba halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 109 introduction the significance of exports as a given economy's growth factor depends on their volume, structure and trend, which is related to the issue of studying a country's export performance and competitiveness. export competitiveness is primarily understood as a country’s ability to sell commodities in foreign markets at the price and quality that can be compared to competition, while achieving the foreign-trade balance. export competitiveness comprises different aspects of export performances including trend, structure, diversification and quality of exports. the paper is aimed at assessing export competitiveness of the countries of former yugoslavia (ex-yu countries) and determining its dynamics in the trade with the world. the research focuses on export characteristics of six ex-yu countries – bosnia and herzegovina (bih), montenegro, croatia, macedonia, serbia and slovenia in the period 2006-2013. the research included a comparative analysis of export dynamics and structure (production, geographic and technological one), of changes in export portfolio, geographic and product export concentration and revealed comparative advantage of the observed countries. the research results should provide for the identification of advantages and shortages of analyzed countries regarding export competitiveness that would serve as a basis for definition of appropriate recommendations aimed at improving their export positions. in order to obtain a comprehensive insight into export competitiveness, a few different indicators were used: indicators of export composition and revealed comparative advantage (balassa rca index, michaely index), indicators of export diversification (share of top five export products and top five export markets, the number of export products, herfindahlhirschman indices of geographic and sectoral export concentration), and export quality indicators (export product classification by technology content). the data gathered from relevant databases of the world bank2 and international trade centre3 were analyzed at the second level of harmonized commodity description and coding system classification(hs 2002). the indicators were calculated, compared and interpreted at the annual export level for the period 2006-2013, and/or the first and last year of the period (2006 and 2013 respectively). theoretical background the concept of competitiveness is extremely broad and comprehends a few different aspects. what everybody agrees about is the complexity of concept and of its theoretical basis. in the same time, there is no consensus about the definition of competitiveness, regardless of the fact that the issue has been the topic of a number of theoretical and empirical studies for years. this leaves space for different definitions, which define this term at the macro, mezzo or micro level, while some try to integrate all the three levels. mlađen kovačević (2002) believes that all the described dimensions of competitiveness are essentially mutually conditioned. janno reiljan and dorel tamm (s.a.) also consider competitiveness 2world bank.world integrated trade solutions (wits).database. (available at: http://wits.worldbank.org/wits/) 3international trade centar (itc).trade map. (available at: http://www.trademap.org/index.aspx) 110 economic analysis (2015, vol. 48, no. 1-2, 108-129) multidimensional concept (i.e. four-dimensional concept); they created a scheme including as follows: extent of competitiveness (broader and narrower concept), area of competitiveness (economic, political, social etc. concept of competitiveness), “location” of competitiveness (concepts of internal, regional or international, i.e. global competitiveness), and management of competitiveness (international agreements, government policies, company strategies, etc.). in the context of this scheme our paper focuses on the international economic competitiveness at the macro level. the most significant contribution to the development of the broader concept of international competitiveness was provided by michael porter (1991). before the emergence of porter’s concept, which was a distinctive revolution in the theory of international trade and was therefore labeled as a “new paradigm”, the development of thought on international trade and, tentatively, on international competitiveness, was long dominated by the concept of comparative advantages founded on david ricardo’s theory of the 19th century. based on the premises of perfect competition, free trade, constant costs, immobility of production factors and the “world” without technological and other changes, the concept offered an incomplete and static explanation of reasons for international trade and the structure of the trade, which was adopted by neo-classic theories that followed, the most notable one being the hekscher-ohlin’s theory. as opposed to the concept of comparative advantages elaborated in the traditional theories of international trade, and partly in individual more recent theories, the concept of competitive advantages developed by porter is not limited to countries with the favorable factor endowments (natural resources, population), nor is static – a country can create the new so-called reinforcement factors, and the focus of explaining the international trade shifts from a country to an industry or product. porter’s understanding of international competitiveness is related to the development of competitiveness first in the national market. in order to answer the question as to why some countries are more successful in certain industries compared to some others, porter develops his famous “diamond” as a system with four basic determinants of competitive advantages, with strong interaction: production factor conditions, demand conditions, related and supporting industries, firm strategy, structure and rivalry. porter added two new factors, government policy and chance, which support the described system. (michael porter, 1991). one of the definitions that attracted some attention at a time and that highlights the macro-dimension of international competitiveness in a narrower sense is the definition by bruce r. scotta and george c. lodgea (1985) who understand a country’s competitiveness as its ability to most rationally employ the national resources in accordance with international specialization and trade, so that this ultimately leads to the growth of real income and the standard of living. scott (1985) also defines the international macro-competitiveness as a country’s ability to produce, distribute and service products in international framework in the competition with goods and services from other countries, though in a way that secures the increase in the standard of living. jan fagerberg (1988) believes that “international competitiveness of a country’s economy is its ability to realize central economic policy goals, especially growth in income and employment, without running into balance of payment difficulties”. a number of authors also relate the concept of international competitiveness to the national economy’s ability to ensure economic growth without trade imbalance, i.e. to halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 111 produce goods and services which will ensure the growing real income both in the domestic and in the international market. (lorena škuflić, 1999). according to some narrower definitions, international competitiveness is completely equaled to a country’s exporting ability. experts of the united nations’ conference on trade and development claim that a country’s global ability to export reflects the successfulness of state enterprises and their competing ability, which in turn depends on factors from their business environment (unctad, 1987). this leads us to the narrower understanding of international competitiveness, which boils down to the export competitiveness. export competitiveness is defined as a country’s ability to sell commodities in foreign markets, at the price and quality that can be compared to competitors (us international trade commission, 2010). christian h.m. ketels (2010) defines export competitiveness as “… an increase in ability to sell domestic goods and services in the world market.” applied methodology same as there is no consensus about the definition of international competitiveness, there is no universally accepted way of its empirical measurement. international competitiveness can be analyzed using a number of quantitative and/or qualitative indicators, most of which are related to the conditions and trends in the foreign trade sector (lorena škuflić, 1999), primarily to export characteristics and dynamics. the volume, structure and dynamics of exports, as well as the attitude toward imports affect its significance for economic growth and development. there are a few dozens of different export competitiveness indicators, which can be classified according to different criteria. according to the world bank’s classification (world bank, 2011), from the viewpoint of their purpose, i.e. the export characteristic that should be “measured”, one can distinguish three groups of export competitiveness indicators: a) indicators of export composition and revealed comparative advantages; b) export diversification indicators, and c) export quality indicators. indicators of export composition and revealed comparative advantages are balassa revealed comparative advantages index (balassa rca), michaely index (mi), trade performance index (tpi). use of these indicators is primarily aimed at establishing sectoral specialization. export diversification indicators, which mostly indicate the degree of production or geographical concentration, consist of herfindahl-hirschman index (hhi), total entropy index (tpei) and index of export market penetration (iemp). export quality indicators include export technology content and sophistication, which in turn indicate the technological structure. there are a few classifications of export technology content, the four most significant ones being: the classification proposed by the organization for economic cooperation and development (oecd, 2002), classification proposed by joe tidd and john bessant (2009), classification by the international trade department of the world bank (2011), and classification of the international trade centre (international trade centre, n.d.). in order to analyze export competitiveness as comprehensively as possible, and to get a full picture of export competitiveness, it is necessary to use a few indicators. for the actual research, a shortlist of indicators from the described classification was made, which includes those that were assessed as the most suitable from the aspect of their purpose and the 112 economic analysis (2015, vol. 48, no. 1-2, 108-129) availability of data for their calculation. the selected indicators include balassa index of revealed comparative advantage, michaely index in its modified expression, herfindahlhirschman index, itc classification of products by technology content etc. balassa rca index (bi) in his paper „trade liberalization and 'revealed' comparative advantage“ of 1965, bella balassa first used the index of 'revealed comparative advantage' which is based on exports as the only variable. since that time original balassa index has become the most frequently used index of revealed comparative advantage the index of revealed comparative advantage is a measure of a country’s relative advantage or disadvantage in a certain industry represented by trade flows (world integrated trade solutions, 2014). bi uses the trade pattern to identify the sectors in which an economy has a comparative advantage, by comparing the country of interests’ trade profile with the world average. (mia mikić and john gilbert, 2009). the original balassa rca index reflects the relative export structure, and is calculated as the ratio between a given product’s export share in the country’s overall exports and the share of the product’s global exports in the overall world’s export (balassa, 1989): (1) c –given country; w– all countries (world) or a group of countries; s – given sector; s – all the sectors included in the analysis; t – time period; bi reveals that a country has a comparative disadvantage in sector s, if 0 < bi < 1, while it has a relative advantage in sector s, if 1 < bi < . balassa index allows estimates of export capability of a country’s individual industries by ranking and comparing relative shares of different industries’ exports within the country (cross-sector comparison), by ranking and comparing relative shares of different countries’ exports at a sectoral level (cross-country comparison), and by revealing changes in the relative shares over time. (elias sanidas and yousun shin, 2010) michaely index (mi) michael michaely (1962, 1967) construed the so-called index of dissimilarity for a country, with the aim of measuring the total dissimilarity in the commodity composition of trade. the index value ranges within the 0-1 interval; the higher the index value, the less similar are commodity compositions of exports and imports of the observed country.4 4 mi reaches the maximum value in the case when there is total dissimilarity, which means that all products are only exported or only imported. the minimum index value (mi=0) occurs in the case of halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 113 michaely index (mi) has a broad range of applications. its use is recommended when measuring the degree of similarity between trade patterns. it is used for the comparison of trade patterns, e.g. the comparison of a country’s import and export patterns, export (import) patterns of two countries or a group of countries, etc. (pablo coto-millán, 2004). it is also used as a measure of international trade specialization at a sector level (keld laursen, 1998). mi is an excellent indicator of the dynamics of a country’s export structure, i.e. the dynamics of revealed comparative advantage. however, it indicates the intensity of change, rather than its direction (coto-millán, 2004; halilbašić, 2012). the formula for calculating the dynamics of a country’s export structure using mi, a synthetic indicator of dissimilarity, is given below: (2) t – years being compared; – exports of sector s of country c over time t=2; – total exports of country c over time t=2; mi advantage is the simplicity of result interpretation, since it takes value from 0 (perfect stability of specialization patterns) to 2 (absolute mobility of specialization patterns). herfindahl-hirschmanov index (hhi) although it was first used as a measure of asymmetry, in the 1940s, herfindahlhirschman index was related to the economic theory only in 1976 (keith cowling and michael waterson, 1976).5hhi can be used as a measure of the degree of a country’s export concentration, when it is calculated using the following formula (juan felipe mejía, 2011): = (3) value of exports of sector s of country c; – value of total exports of country c. the lower hhi value indicates the higher export (production) dispersion and a lower degree on export concentration and specialization. a lower value of hhi is also a sign of a higher degree of export diversification. we distinguish between hhi production concentrations, which measure export dispersion from the aspect of export products, and hhi geographical concentrations, which total, perfect similarity, when each product is both exported and imported, proportional to its share in total exports and imports. (snježana brkić, 2010) 5 since 1984, regulatory institutions in the usa started using hhi as a measure of concentration in judicature, banking, in the area of electric power and aviation (mark g. lijesen, 2004). 114 economic analysis (2015, vol. 48, no. 1-2, 108-129) measure the same but from the export partners’ aspect (world integrated trade solutions, 2013). technology content of exports the paper uses itc classification, which provides an insight into the percentage share of five types of products of different levels of processing in a country’s exports. these are: primary products, semi-finished products, capital equipment, consumer goods and hightechnology products (international trade centre, s.a.). research results exports dynamics and performances over the observed period (2006-2013), all former-yugoslav countries registered an increase in their trade. compared to the beginning of the period, almost all the countries registered an increase in exports (except for montenegro) and an increase in imports (except for croatia). in this respect, the highest value of commodity exports and imports was achieved by slovenia6, and the lowest by montenegro. bih ranked fourth by the amount of exports, and fifth by the amount of imports both in the beginning and at the end of the period7. eeach country of former yugoslavia imported more products than it exported over the observed period, which resulted in the continuous trade deficit. in 2013, the highest trade deficit in absolute terms was registered by croatia – 9.03 billion usd, although, when compared to 2006, the deficit actually decreased (from 11.13 billion usd). with the deficit of 4.60 billion usd in 2013, bih retained the fourth position. a decrease in the value of deficit in 2013 compared to 2006 was registered by slovenia8, serbia and croatia.9 trends in the observed countries’ exports significantly coincide. after growth in 2007 and 2008, commodity exports decreased in the year of economic and financial crisis (2009), while in the following four years (2010-2013) exports of all the observed countries continued to increase, though of different intensities. all ex-yu countries, except for montenegro, registered an increase of commodity exports in the observed period. serbia experienced the evident increase and doubled its exports compared to 2006. (figure 1) 6 with the recorded value of commodity exports of 28.73 billion usd and commodity imports of 29.38 billion usd in 2013, slovenia maintained the top position it had in 2006 as well. 7 the volume of bih trade for 2013 amounted to 15.98 billion usd, which is by 5 billion usd or 45.46% higher compared to its trade in 2006. in the period 2006-2013, the volume of bih trade was significantly determined by imports, which was twice as high as exports over the entire period (10.29 billion usd of imports versus 5.69 billion usd of exports in 2013). 8 from 2 billion usd in 2006 to 640 million usd deficit in 2013. 9 the table with all the data is available in the appendix to the paper. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 115 figure 1. exports dynamics of ex-yu countries, in 000 usd, 2006-2013 source: authors on the basis of data from itc, trade map and state statistical office of republic of macedonia export increase by a greater rate than imports also resulted in an increase of the degree in export-import coverage in all the countries in 2013 compared to 2006, except in montenegro, which registered a decrease. montenegro has the lowest level of export-import coverage in both observed years 30.22% in 2006 and 21.05% in 2013. the highest value of coverage was registered by slovenia 91.18 and 97.82% respectively. slovenia’s export revenues almost fully cover payments due to commodity imports. the greatest increase of export-import coverage, of over 20 percent, was registered by serbia (from 48.80 to 71.11%), which allowed it to move from the third to the second position, while bih, croatia and macedonia managed to raise the coverage by 9 to 10 percent and mostly maintained previous positions.10 exports structure over the observed period, exports of most ex-yu countries were dominated by manufactures of metal (particularly aluminum and products of aluminum, iron and steel), machinery manufactures (nuclear reactors, electrical machinery), manufactures of mineral fuel industry, and wood manufactures. (table 2) ex-yugoslav countries’ export portfolios are dominated by products characteristic of the world export markets that are growing below the average world rate of 10%, which coincides with the results obtained by lucia orszaghova et al. (2013) through the analysis of export portfolios of four ex-yugoslav countries11 for the period 1999-2010. bih and serbia export products which increased their respective shares in the world export markets, i.e. products that are included in the “winners in declining sectors”12. montenegro, croatia, macedonia 10 authors’ own calculation on the basis of data from itc, trade map and state statistical office of republic of macedonia. 11 the analyzed countries included: montenegro, croatia, macedonia and serbia. 12 in order to present a country's export performance compared to trends in world demand and estimate the potenttial of long-term export growth, itc uses the so-called „bubble“ graphs. the 116 economic analysis (2015, vol. 48, no. 1-2, 108-129) and slovenia export products which decreased their share in the world export markets that grow below the rate of 10%, and their export portfolios are thus dominated by “losers in declining sectors”. (itc, 2014) all the ex-yugoslav countries mostly focus their export on semi-products and least on the high-technology products. in their commodity export structure, the share of semi-products ranged from about 55-56% in the case of slovenia, croatia and macedonia to 61% in bosnia and serbia, while it was the highest in montenegro, where it amounted to 74% (in 2013). they are followed by consumer goods, with the market share that varied from 15 to 22% in all the countries except for montenegro (only 5.2%). share of primary products is significant in most countries as well except for slovenia (only 4.1%.) slovenia and croatia registered a higher share of capital equipment than of primary products. the lowest share of capital equipment was registered in montenegro and bih. no significant share of high-technology products was registered in the observed years. in 2013, high-technology products had a very low share in all the countries’ commodity exports. bih13 and montenegro registered the lowest shares of these products in commodity exports, and they are followed by macedonia and serbia. (table 1) table 1. technological export structure of ex-yu countries, 2013 products14 country bih montenegro croatia macedonia slovenia serbia primary products 10.6 16.3 10.1 13.6 4.1 12 semi-products 60.6 73.6 54.8 54.4 56.6 61.1 capital equipment 7.8 4.7 17.5 10.1 18.4 10.6 consumer goods 18,3 5.2 15.7 21.9 20.4 15.4 high-technology products 1.4 1.3 6.6 2.8 5.1 2.6 source: authors on the basis of data from itc, trade competitiveness map with respect to geographic orientation of ex-yu countries’ exports in the observed period, they registered the greatest share of their exports and imports with the european union as a whole. to illustrate this point, in 2013 almost all the countries, except for montenegro achieved an average of 60% of their exports in the eu27 market – montenegro 28.3%, bih 57.8%, serbia 58.1%, croatia 58.2%, macedonia 62.8%, and the highest share was achieved by slovenia – 68.5%. (wto, 2013) presented data lead to the conclusion on significantly high export dependence of these countries from the eu market. particular relations each of them with the eu in terms of their membership status or status in the process of association to the graphs provide information on the value of product exports and compare the annual growth of the country's share in world exports to the annual increase in world demand over a five-year period (international trade centre, 2014), and are divided into four segments, where products are classified as: winners in growing sectors (champions), losers in growing sectors, winners in declining sectors or losers in declining sectors. 13 these products' share in croatia's commodity exports was almost five times higher compared to the same products' share in bih commodity exports. 14note: there are share of 1-2% of unclassified products for every country. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 117 union15 create possibilities forfurther growth of export to the eu market and even higher export dependence in the next future. revealed comparative advantages ex-yu countries export specialization compared to the world was analyzed based on the revealed comparative advantages, founded on the calculation of balassa index. the highest values of bi index for bih both in the beginning and in the end of the period were measured in the production of wood and articles of wood, footwear, explosives, aluminum and articles thereof, furniture, raw hides and skins and leather, etc. six out of ten sectors with the highest bi’s registered an increase in specialization, while the others registered a decrease. in montenegro, the highest bi’s were identified in the production of aluminum and articles thereof, raw hides and skins and leather, beverages, explosives, wood and articles of wood, tobacco and manufactured tobacco substitutes, etc. most sectors registered an increase in specialization, some even twofold (raw hides and skins, vegetables); however, bi for aluminum production decreased twofold. the highest bi values for croatia were found in the production of arms and ammunition, wood and articles of wood, fertilizers, salt, sulphur, earths and stone, miscellaneous edible preparations, live animals, etc. an increase in specialization was registered by seven out of ten product groups, and was the greatest in the production of arms and ammunition (three times) and live animals (four times)16. macedonia registered the greatest comparative advantage in the production of tobacco and manufactured tobacco substitutes, miscellaneous chemical products, articles of apparel, iron and steel, vegetables, etc. specialization decreased in six out of ten products, but bi for chemical products increased almost seven times. with respect to serbia, comparative advantage was revealed in the production of arms and ammunition, fruits, products of the milling industry, cereals, sugars and sugar confectionery, etc. all the products registered a decrease in comparative advantage. slovenia revealed the greatest comparative advantage in the production of aluminum and articles thereof, wood and articles of wood, pharmaceutical products, tanning or dyeing extracts, man-made filaments etc. an increase in comparative advantage was observed in almost all top ten products, but values of bi’s of top 5 industries are much lower than for top 5 of other countries.17while top ten product groups where bih, montenegro and macedonia revealed comparative advantage had a significant total share in these countries’ exports (37%, 39% and 59% respectively), the total export share of serbian, croatian and slovenian product groups with the greatest comparative advantages was relatively low (19%, 20% and 26% respectively). however, the fact remains that the total export share of ten products with highest bi decreased in all the countries, most in montenegro (almost twofold). there are no major similarities in the comparative advantage patterns’ among the observed countries if analyses top 10 lists there are only three products that are the same on 15 slovenia (2004) and croatia (2013) are the eu member – states, macedonia (2005), montenegro (2010) and serbia have a status of candidate countries, and only bih has the status of a potential candidate (2008). 16 the greatest decrease of bi – more than four times – was registered in the production of ships, boats and floating structures. 17 the table with top ten industries by bi index for each country is provided in the appendix. 118 economic analysis (2015, vol. 48, no. 1-2, 108-129) the lists18). all the countries have comparative advantage in the production of aluminium and articles thereof, and four of them (except for macedonia and serbia) also in the production of wood and articles thereof. the intensity of change in export structure was measured using michaely index (mi). mi was used as an indicator of the dynamics of a country’s export structure, or the dynamics of revealed comparative advantage. according to mi, ex-yugoslav countries mostly experienced the perfect stability in the 2006-2013 period, and in some cases a very low intensity of change in their most significant industries’ exports. accordingly, mi reveals that ex-yugoslav countries are not export competitive in the world with their most significant industries’ products. table 2. top 5 export industries of ex-yu countries and michaely index, 2006-2013 bosnia and herzegovina croatia industry mi industry mi 27 mineral fuels, mineral oils etc. 0.02 27 – mineral fuels, mineral oils etc. 0.00 94 furniture 0.01 84 – nuclear reactors, boilers, 0.01 76 aluminium and articles thereof 0.02 85 – electrical machinery and 0.00 44 wood and articles of wood 0.01 44 – wood and articles of wood 0.01 84 – nuclear reactors, boilers, 0.02 30 – pharmaceutical products 0.01 macedonia montenegro industry mi industry mi 72 iron and steel 0.04 27 – mineral fuels, mineral oils etc. 0.14 38 miscellaneous chemical products 0.07 76 – aluminum and articles thereof 0.18 62 articles of apparel, not knitted 0.03 72 – iron and steel 0.03 84 – nuclear reactors, boilers, 0.03 22 – beverages, spirits and vinegar 0.00 85 – electrical machinery and 0.01 44 – wood and articles of wood 0.00 serbia slovenia industry mi industry mi 87 – vehicles other than railway or 0.07 85 – electrical machinery and 0.01 85 – electrical machinery and 0.03 87 – vehicles other than railway or 0.01 84 – nuclear reactors, boilers, 0.01 84 – nuclear reactors, boilers, 0.01 39 – plastics and articles thereof 0.00 30 – pharmaceutical products 0.02 27 – mineral fuels, mineral oils etc. 0.01 27 – mineral fuels, mineral oils etc. 0.02 source: authors on the basis of data from itc trade map mi value for bih shows that in the period 2006-2013 there was no change in the intensity of exports of mineral fuels, furniture, aluminium and manufactures thereof, wood manufactures and nuclear reactors. in the same period, croatia and slovenia registered the perfectly steady exports of their top five industries. montenegro registered a very low intensity of change in the exports of aluminum and manufactures thereof and mineral fuels. a low intensity of change was also registered by macedonia in the exports of various manufactures of chemical industry, and by serbia in the exports of vehicles. other 18 only on lists for top ten products with highest bi for serbia and montenegro four products are the same. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 119 montenegrin, macedonian and serbian industries registered the perfect stability of exports in the same period. (table 2) exports concentration by the number of ex-yu countries’ export markets whose individual values were higher than 100,000 usd in 2013, slovenia is ranked highest, with 96 larger export markets, and montenegro is ranked lowest, with 42 larger export markets. an increase in the number of export markets in the period 2006-2013 was registered by bih, montenegro and macedonia, while the number of export markets decreased for slovenia, croatia and serbia. regardless of the decrease in the number of export markets, these three countries maintained their top three rankings among ex-yu countries. bih is the only country that improved its ranking (from five to four), montenegro remained at the bottom (although the number of its export markets increased threefold), while macedonia moved from the fourth to the fifth position. (table 3) table 3.number of export markets of ex-yu countries, 2006 and 2013 country number of markets > 100.000 usd 2006 2013 growth/fall bosnia and herzegovina 61 76 ↑ croatia 95 82 ↓ macedonia 62 66 ↑ montenegro 16 42 ↑ slovenia 103 96 ↓ serbia 81 78 ↓ source: authors on the basis of data from wits, trade outcome indicators according to the values of herfindahl-hirschmann index of geographic export concentration (hhi) in 2013, serbia and croatia registered the highest, and macedonia and montenegro the lowest export dispersion of all ex-yu countries (hhi=0.06 versus hhi=0.1619) in the period 2006-2013, most countries, except for macedonia and serbia, increased the degree of their geographic export diversification. although the degree of its geographic concentration remained the same, serbia retained the first position with the most dispersed exports of all ex-yu countries, while croatia joined it at this position, and followed by slovenia. bih decreased the degree of export concentration (from 0.10 to 0.80), and thus moved from the fourth to the third position. macedonia is the only ex-yugoslav country which registered the increase in geographic exports concentration in the observed period.20 (table 4) 19 the lower value of hhi index is a sign of greater export dispersion – a higher degree of geographic diversification, i.e. a lower degree of export geographic concentration and specialization. 20 compared to the exports of fast-growing economies (bric countries), ex-yu countries’ exports were twice less geographically dispersed. (vedrana bosić, 2015.) 120 economic analysis (2015, vol. 48, no. 1-2, 108-129) compared to the exports of fast-growing economies (bric countries), ex-yu countries’ exports were twice less geographically dispersed. (vedrana bosić, 2015.) table 4. geographic export concentration of ex-yu and bric countries, 2006 and 2013 country hhi geographic exports concentration 2006 2013 change bosnia and herzegovina 0.10 0.08 ↑diversification croatia 0.09 0.06 ↑diversification macedonia 0.11 0.16 ↑concentration montenegro 0.24 0.16 ↑diversification slovenia 0.08 0.07 ↑diversification serbia 0.06 0.06 no change ex-yu average 0.11 0.10 ↑diversification brazil 0.05 0.06 ↑concentration china 0.08 0.07 ↑diversification india 0.05 0.04 ↑diversification russia 0.04 0.05 ↑concentration bric average 0.06 0.05 ↑diversification source: authors on the basis of data from wits, trade outcome indicators sectoral export concentration was analyzed by determining the number of exported products of the observed countries, and by calculating and comparing hhi of sectoral export concentration for 2006 and 2013. by the number of exported products with the export values higher than 100,000 usd, slovenia is ranked highest, with 2,417 products, while montenegro is ranked lowest among ex-yugoslav countries, with 198 products. in the 2006-2013 period, most ex-yu countries, except for montenegro and croatia, increased the number of their products of higher export value. the greatest increase (of some 300 new products) was registered by serbia, which thus improved its ranking from third to second. slovenia retained the first position. croatia moved from the second to the third position. (table 5) table 5. number of exports products of ex-yu countries, 2006 and 2013 country number of products > 100.000 usd 2006 2013 growth/fall bosnia and herzegovina 805 1,022 ↑ croatia 1,676 1,534 ↓ macedonia 607 668 ↑ montenegro 201 198 ↓ serbia 1,400 1,701 ↑ slovenia 2,161 2,417 ↑ source: authors on the basis of data from wits, trade outcome indicators halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 121 hhi of sectoral export concentration for 2006 and 2013 revealed a high degree of concentration for all the observed countries21, which indicates a low diversity in export supply. (table 6) table 6.sectoral export concentration of ex-yu countries, 2006 and 201322 country hhi of product concentration 2006 2013 change bosnia and herzegovina 0.02 0.01 ↑ diversification croatia 0.01 0.01 no change macedonia 0.02 0.04 ↑ concentration montenegro 0.34 0.12 ↑ diversification slovenia 0.01 0.01 no change serbia 0.01 0.01 no change average ex-yu countries 0.07 0.03 ↑ diversification brazil 0.01 0.03 ↑ concentration china 0.01 0.01 no change india 0.02 0.03 ↑ concentration russia 0.17 0.17 no change bric average 0.05 0.06 ↑ concentration source: authors on the basis of data from wits, trade outcome indicators most countries (four out of six in the observed sample) registered the same degree of export concentration in 2013. croatia, slovenia and serbia retained the same value of hhi of sectoral export concentration of 0.01 as in the beginning of the observed period and were, in 2013, joined by bih. compared to 2006, only bih and particularly montenegro registered an increase in export dispersion. montenegro decreased the degree of concentration almost three times (from hhi=0.34 to hhi=0.12), though it was not enough to push it from the last position by export dispersion compared to the other countries. only macedonia registered deterioration, in terms of an increase in the degree of export product concentration and specialization. over the observed period, ex-yu countries registered a decrease (from 0.07 to 0.03) while fast-growing countries experienced an increase (from 0.05 to 0.06) in the average value of hhi of product concentration, whereby china is the country with the highest export product diversification in the observed period. concluding remarks the analysis of ex-yu countries’ export competitiveness in the period 2006-2013 generally indicated their unsatisfactory export performance, despite the progress that some of them registered over the observed period. the weaknesses are primarily related to the product export structure, patterns of comparative advantages, export quality in terms of its 21 a lower value of hhi of export product concentration is a sign of greater export dispersion (sectoral diversification), i.e. a lower level of sectoral concentration and specialization, and vice versa. 22 data were analysed at 6th aggregation level of hs 2002 classification. 122 economic analysis (2015, vol. 48, no. 1-2, 108-129) technological sophistication, and the degree of geographic and product export diversification. all the discussed countries (except for montenegro) increased their exports over the observed period; however, their role in the world markets remained minor. although all the countries still reveal the trade deficit, they managed to achieve higher export-import coverage due to faster export growth. these countries’ exports are dominated by the products of traditional, declining industries, with an extremely high share of semi-products, primary products and consumer goods, while the share of high-technology products is negligible. such an inadequate export structure in terms of the level of processing and technology contents was retained throughout the observed period. despite a certain increase in export dispersion (in most countries except for macedonia and serbia), increase in the number of export products (except for montenegro and croatia), and a decreased share of main export industries, ex-yu countries’ exports still show a high level of geographic and product concentration, which means a great export dependence on a smaller number of markets and a smaller number of products. the highest revealed comparative advantage of these countries are mostly observed in the traditional sectors, such as production of metals and articles thereof, wood and articles thereof, apparel, etc. in this respect, the comparative advantage patterns reveal perfect stability in the observed period, almost without emergence of comparative advantages in new sectors. some changes in comparative advantages patterns only refer to an increase in the level of specialization in export sectors and decrease in total export share of product groups with most revealed comparative advantages. based on a few analyzed indicators, the best export performance was registered by ex-yu countries which are eu members – primarily slovenia and then croatia, compared to the countries that have the status of candidate or potential candidate. over the observed period, both countries registered an increase in exports, increase in export-import coverage and a decrease in trade deficit, with slovenia in the lead, since it almost achieved the foreign-trade balance. compared to the other countries in the sample, eu members increased the degree of specialization in the sectors with revealed comparative advantages, registered a higher level of export dispersion in terms of increasing the number of export products and the number of export markets, and of increasing the degree of product export diversification; in the same time they also register a more favorable technology export structure by the level of product processing. the greatest progress in the observed period was registered by serbia, with respect to various aspects of export competitiveness, except for the fact that the number of export markets and the degree of specialization in all the sectors with comparative advantages decreased. despite the progress in some segments, bih and macedonia’s export competitiveness can be assessed as relatively stagnant and less favorable compared to the three previously described countries. the poorest rating of export competitiveness was achieved by montenegro, due to deterioration in trends of a few indices. research results point to the need both for a further increase in exports and the improvement of its structure in terms of increasing the diversity of export supply and improving the technology content of export products, which in turn requires modernization of industries, as well as support by 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washington dc: usitc. world bankworld integrated trade solutions. database. http://wits.worldbank.org/wits/ world bank world integrated trade solutions. 2013. online trade outcomes indicators, user's manual. washington dc: world bank. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 125 world bank – world integrated trade solutions. 2014. online trade outcomes indicators, user's manual. washington dc: world bank. world bank international trade department. 2011. trade competitiveness diagnostic toolkit. geneva: international trade department of the world bank. world trade organization. 2014. trade profiles 2013. https://www.wto.org/english/res_e/booksp_e/trade_profiles13_e.pdf(accessed march 25, 2015). 126 economic analysis (2015, vol. 48, no. 1-2, 108-129) appendices table 1. merchandise exchange of ex-yu countries, 2006 and 2013 in 000 usd country import export deficit 2006 2013 2006 2013 2006 2013 bih 7,559,256 10,294,930 3,427,782 5,687,314 -4,131,474 -4,607,616 croatia 21,502,494 20,953,444 10,376,964 11,927,531 -11,125,530 -9,025,913 macedonia 3,762,715 6,599,824 2,041,265 4,266,855 -1,721,450 -2,332,969 montenegro 1,841,505 2,348,873 556,459 494,376 -1,285,046 -1,854,497 serbia 13,172,330 20,550,990 6,427,892 14,613,752 -6,744,438 -5,937,238 slovenia 23,013,428 29,375,441 20,982,713 28,734,599 -2,030,715 -640,842 source: authors on the basis of data from itc, trade map and state statistical office of republic of macedonia table 2. top 10 industries of ex-yu countries, by bi and export share, 2006 and 2013 bosnia and herzegovina 2006 2013 industry bi share bi share 44 wood and articles of wood 9.9 8.9 9.6 6.7 64 footwear 9.3 5.7 9.3 6.5 36 explosives 4.1 0.1 8.5 0.2 76 aluminum and articles thereof 9.9 11.4 8.4 7.1 94 furniture 6.5 7.6 8.2 10.3 41 raw hides and skins and leather 8.1 2.0 7.6 1.5 28 inorganic chemicals 7.4 5.0 6.6 4.0 66 umbrellas 1.8 0.0 5.0 0.1 46 manufactures of straw, of esparto 4.3 0.1 4.4 0.1 17 sugars and sugar confectionery 2.0 0.5 3.4 0.9 total share in exports of bih 41.3 37.4 montenegro 2006 2013 industry bi share bi share 76 aluminum and articles thereof 50.3 57.7 26.3 22.2 41 raw hides and skins and leather 3.5 0.9 8.6 1.7 22 beverages, spirits and vinegar 9.3 5.4 8.1 5.0 36 explosives 5.0 0.1 7.3 0.2 44 wood and articles of wood 5.0 4.5 7.1 4.9 24 tobacco and manufactured tobacco substitutes 0.5 0.1 6.7 1.5 11 products of the milling industry 0.2 0.0 5.1 0.5 68 articles of stone, plaster, cement 0.6 0.2 3.8 1.0 18 cocoa and cocoa preparations 0.2 0.0 3.7 0.9 7 edible vegetables, certain roots, tubers 1.7 0.6 3.7 1.3 total share in exports of montenegro 69.5 39.3 halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 127 croatia 2006 2013 industry bi share bi share 93 arms and ammunition 4.9 0.3 18.9 1.1 44 wood and articles of wood 4.5 4.0 8.0 5.6 31 fertilisers 6.6 1.6 7.1 2.4 25 salt, sulphur, earths and stone 7.8 1.9 7.0 1.7 21 miscellaneous edible preparations 5.2 1.5 4.5 1.5 1 live animals 0.4 0.0 4.1 0.5 89 ships, boats and floating structures 15.6 11.4 3.6 2.8 41 raw hides and skins and leather 3.8 0.9 3.5 0.7 68 articles of stone, plaster, cement 2.0 0.6 3.3 0.9 76 aluminum and articles thereof 2.5 2.8 3.2 2.7 total share in exports of croatia 25.1 19.9 macedonia 2006 2013 industry bi share bi share 24 tobacco and manufactured tobacco substitutes 20.7 4.7 18.7 4.3 38 miscellaneous chemical products 0.2 0.2 14.9 15.1 62 articles of apparel, not knitted 13.7 18.0 10.7 11.5 72 iron and steel 9.4 25.2 7.7 16.5 7 edible vegetables, certain roots, tubers 6.8 2.2 4.8 1.7 19 preparations of cereals, flour 2.8 0.8 4.0 1.4 25 salt, sulphur, earths and stone 7.9 1.9 3.9 0.9 20 preparations of vegetables, fruit, nuts 3.2 1.0 3.4 1.2 22 beverages, spirits and vinegar 5.9 3.4 3.4 2.1 26 ores, slag and ash 1.7 1.3 3.3 4.2 total share in exports of macedonia 58.6 58.9 serbia 2006 2013 industry bi share bi share 93 arms and ammunition 10.8 0.7 8.1 0.5 8 edible fruit and nuts 7.0 3.1 6.2 3.3 11 products of the milling industry 7.0 0.5 5.5 0.6 10 cereals 7.2 3.0 4.9 3.3 17 sugars and sugar confectionery 10.6 2.6 4.9 1.3 36 explosives 3.9 0.1 4.1 0.1 74 copper and articles thereof 6.0 6.7 3.6 3.1 76 aluminum and articles thereof 3.6 4.2 3.2 2.7 24 tobacco and manufactured tobacco substitutes 0.9 0.2 3.2 0.7 40 rubber and articles thereof 4.4 4.3 3.0 3.4 total share in exports of serbia 25.3 19.0 128 economic analysis (2015, vol. 48, no. 1-2, 108-129) slovenia 2006 2013 industry bi share bi share 76 aluminum and articles thereof 4.3 4.9 4.3 3.6 44 wood and articles of wood 2.6 2.4 4.1 2.9 30 pharmaceutical products 2.8 6.9 4.0 10.6 32 tanning or dyeing extracts 3.1 1.5 3.7 1.6 54 man-made filaments 2.7 0.9 3.6 0.9 68 articles of stone, plaster, cement 3.2 0.9 3.3 0.9 56 wadding, felt and nonwovens 3.0 0.4 3.2 0.4 82 tools, implements, cutlery,spoons 3.1 1.1 2.6 0.9 83 miscellaneous articles of base metal 2.6 1.0 2.6 0.9 94 furniture 5.2 6.0 2.6 3.2 total share in exports of slovenia 26.0 26.0 source: authors on the basis of data from wits, trade outcome indicators komparativna analiza konkurentnosti izvoza zemalja bivše jugoslavije rezime – rad se bavi analizom izvoznih performansi zemalja bivše jugoslavije (bosna i hercegovina, crna gora, hrvatska, makedonija, slovenija i srbija) u periodu 2006-2013. godine. cilj rada je ocjena izvozne konkurentnosti navedenih zemalja i utvrđivanje njene dinamike u robnoj razmjeni sa svijetom. analiza je obuhvatila istraživanje i upoređivanje karakteristika izvoza – obima i dinamike izvoznih tokova, geografske i proizvodne strukture i koncentracije izvoza, tehnološke sofisticiranosti izvoza, izvozne specijalizacije izražene otkrivenim komparativnim prednostima, intenziteta i smjera promjene u izvoznoj strukturi. u cilju potpunijeg sagledavanja izvozne konkurentnosti korišteno je više indikatora: balassin rca indeks, michaelyjev indeks, herfindahlhirschmanovi indeksi koncentracije i dr. indeksi su računati na podacima relevantnih baza svjetske banke i međunarodnog trgovinskog centra, agregiranim na drugoj i šestoj razini hs2002, za osmogodišnji period i/ili za prvu i posljednju godinu. istraživanje je pokazalo da su izvozne performanse ex-yu zemalja općenito nezadovoljavajuće, uprkos napretku koji su pojedine od njih ostvarile u posmatranom periodu. većina zemalja ima komparativne prednosti u proizvodima tradicionalnih, opadajućih industrija, visok udio poluproizvoda i primarnih proizvoda, a zanemariv udio visokotehnoloških proizvoda u svom izvoznom portfoliju, stagnantnu izvoznu strukturu, te nizak stepen geografske i proizvodne diverzifikacije izvoza.međusobno poređenje pokazalo je da grupa nije homogena, te da, pored navedenih zajedničkih karakteristika, unutar grupe postoje i značajne razlike u pojedinim aspektima izvozne konkurentnosti. članice eu – hrvatska i posebno slovenija imaju niz prednosti u odnosu na zemlje u statusu kandidata i potencijalnog kandidata. najveći napredak u pravcu poboljšanja izvozne konkurentnosti ostvarila je srbija, dok je ocjena izvozne konkurentnosti za crnu goru najnepovoljnija. halilbašić, m., et al., comparative analysis of export, ea (2015, vol. 48, no. 1-2, 108-129) 129 ključne reči: zemlje bivše jugoslavije, izvozna konkurentnost, izvozna struktura, otkrivene komparativne prednosti (rca), izvozna diverzifikacija, izvozna koncentracija article history: received: 14 april, 2015 accepted: 19 april, 2015 ea_2016_1-2 note of the editor-in-chief peer journal economic analysis (ea) belongs to that rare group of scientific journals, which encourage multidisciplinary approach on various research topics on economics. that makes this scientific journal interesting and useful reading material for scientists, experts and other readers, which are interested in different disciplines of economics. the journal ea is published twice a year as a double issue in english language by the institute of economic sciences from belgrade, serbia. we welcome manuscripts from academics, independent scholars, practitioners and students. feel free to reach out directly with comments and proposals. send your papers and proposals to ea address: eaoffice@ien.bg.ac.rs with warmest regards, academician mirjana radovic-markovic editor in chief microsoft word 2008_01_02.doc   original paper    development of small and medium enterprises:     b&h compared to other western balkans countries    zijad džafić, faculty of economics, university of tuzla    adnan rovčanin, faculty of economics, university of sarajevo    nermin klopić, indirect taxation authority b&h    key words: governmental policies, smes, transition process, unemployment, entrepreneurship    udc: 334.012.64:338.24.021.8(497.6)         jel: o18, r11, e65    abstract  ‐ experiences of many countries that were very successful in transition process like slo‐ venia, czech republic, hungary and poland show that special attention has been given to the development  of a powerful smes sector in order to change the economic structure and initiate economic development.  small and medium enterprises make 99,8% of the total number of enterprises and they create 60% of the  gdp and 50% of all investments in eu. smes were the main source for increasing employment in last ten  years. the eu has a goal that it will be the most competitive region in the world before the end of 2010, and  for achieving that goal it will count on the development of small and medium enterprises. if we look at smes  and their development in that regard, in light of making the whole region of the western balkans closer to the  european union, it is clear that smes in this part of europe must develop faster and become a dominant  form of income for the region. smes contribute significantly to decreasing unemployment, but only with the  presence of a powerful government and a consistent industrial policy in which a business environment for  entrepreneurships can develop. the significance of this research is in the need of selection of decisions on:  essential elements of entrepreneurial environment in western balkans; identification of main obstacles for  the development of smes  in these countries, and analysis of  institutional support to the development of  smes and entrepreneurship in these countries  small and medium enterprises (smes) and   entrepreneurship in bosnia and herzegovina  bosnia and herzegovina is one of the countries in the region that experienced such extensive  war destruction in the least decade of the 20th century that has been seen in the area since the sec‐ ond world war. before the war conflict in former yugoslavia started,  bosnia and herzegovina was  more developed by its economic performances than some transition countries that are now full eu  members. presently, bh gdpp/c is only 60% of the pre‐war level.  the starting economic position of bosnia and herzegovina in the environment shifted a few  decades back consequent to the war, and the forthcoming processes and phenomenon characteriz‐ ing the present time – transition, liberalization, globalization, trans‐nationalization – have taken on  a special dimension in such an environment. this is the reality that cannot be ignored. neverthe‐ less, one thing is certain: the new priority mission in bosnia and herzegovina is full membership  in european union.   development of smes and entrepreneurship in b&h is in its initial stage, even though this  sector of economy could become the initial force of development of the country. the government  still has no strategy of the development of entrepreneurship and smes, and furthermore, there are  even government‐imposed barriers for the development of smes and entrepreneurship.   volume 40 • spring 2008 • 89  there is no policy and there are no specific objectives of the development of smes in b&h.  there is also lack of specific legislation, which leads to a lack of measures, instruments, and har‐ monized organization for the support of smes development.   the structure of b&h economy by the number of employees is given in the following table:      table 1 structure of b&h economy by the number of employees  federation b&h (fb&h)  republic of srpska (rs)  up to 10 employees  84%  up to 50 employees  85.5%  11‐50 employees  11%  51‐250 employees  12.8%   51 ‐ 250 employees  4%      smes sector   99%  smes sector   98.3%  large companies  1%  large companies   1.7%     source: dafić. z., preduzetnička ekonomija, denfas, tuzla, str. 45.      b&h devoted itself to strategic development of sme sector in order to reduce the rate of unemployment. there is over half a million people without jobs, and 90,000 young people have already left b&h because of lack of perspective. high unemployment rate stresses the need to encourage, activate and direct the population to business start ups and the development of entrepreneurship as a means of employing family members and other people. an entrepreneurship continually finds himself between the goal to maximize profits and minimize losses, which requires innovativeness and rationality in decision making. looking at entrepreneurship from the human resources perspective, it is cruvial to approach it in an organized fashion, i.e. to encourage and redirect entrepreneurial practives, increase the efficacy and effectiveness of managers and entrepreneurs. finally, the results should be implemented, which would then lead to economical revitalization and strengthening of entrepreneurial and sme sectors in post-war b&h. research on the given topic is in accordance with mid‐term development strategy of b&h  (prsp), 2004‐2007. in this strategy, clear‐cut goals have been defined, and they are: to encourage  the development and growth of micro and small business, to encourage companies to move from  the gray economy into the formal sector and to create new jobs in the private sector.   the economy of bosnia and herzegovina, as well as that of other developed countries and  those  in  transition,  has  turned  to  strategic  development  of  the  small  and  medium  enterprises  (smes) sector in order to decrease the rate of unemployment, which is the highest in europe (43%).  an  increased number of  the unemployed  imposes  the need for encouragement, activation and  guiding people  to start  their own businesses and entrepreneurships  in order  to stimulate self‐ employment and employment of family members and others.  economy of the 20th and 21st century has different rules than smith’s economy of the 19th cen‐ tury. the new ideology of neoliberalism apostrophes the role of smes as promoters of a “healthy”  business climate, economic efficiency and power for economic growth, especially in small, devel‐ oped countries, and even more so for countries in transition.   these statements and theories contribute to increasing the awareness of governments and  businessmen  that smes are crucial for economic development  in  the region. large  interest  for  smes was aroused in countries of the western balkans in the last decade when it was realized that  smes could play a key role in the process of transition.   2007 ‐ 90  •  economic analysis®  western balkans – key economic indicators   the term western balkans is a political one. it expresses the strategy (ie. a clearly set external  policy) of the eu towards the region of ex‐yugoslavia minus slovenia plus albania1. even in the  document the process of stabilization and accession of south‐east european countries (brussels, 26 may  1999) in the context of issues of regional accession, there is a mentioning of „joint strategy“ for  western balkans. in the joint report of the eu titled the role of the union in the world, in the 7th sec‐ tion, countries of western balkans are precisely determined: „croatia, bosnia and herzegovina,  albania, fyr macedonia and serbia and montenegro“.  the  region  of  western  balkans  consists  of  relatively  small  economies.  while  the  biggest  country, population‐wise, is fry (now serbia and montenegro) with 8,6 million people, croatia is  the biggest, economy‐wise, with over 22 billion euros. the total population of the region is 25 mil‐ lion people, which is equal to 6,5% of the eu population, or a third of the ten countries which  joined the eu in may 2004. the total gni of the region is 50 billion euros, which is about 0,6% of  gni of eu or 40% of gni of portugal. gni per capita, according to current nominal rates of ex‐ change in the region is about 1800 euros, with significant difference between gni in croatia (5100  euros) and other countries of western balkans, which is below 1,90o euros. according to criteria of  the world bank, b&h, together with serbia and montenegro, macedonia and albania, is in the  group of 54 countries with  lower‐medium  income per capita  ($736‐$2,935). of all  the analyzed  countries, only croatia belongs to those in the higher‐medium income ($2,936‐$9,075). the follow‐ ing table represents the comparison of economies of western balkans:  table 2. compare economies by income p/c, informal sector, and population.    countries:    b&h    albania    croatia    macedonia    serbia and  montenegro  income cate‐ gory:  lower mid‐ dle income  lower  middle  income  upper mid‐ dle income  lower middle  income  lower middle  income  population:  4,1 million  3,2 million   4,4 million    2.1 million    8.1 million  gni per capita  (us$):  2,040    2,080     6,590    2,350  2,620    informal econ.  estimate (%  gnp):  34,1  33.4  33.4  not available  29.1  source: http://doingbusiness‐org/ 2006  the directorate for western balkans is set up by the european commission for the negotia‐ tions for accession of western balkans countries2. even though the eu has started the negotiations  on stabilization and accession with other countries much earlier, the negotiations with b&h have  started just recently, on 25/01/2006.  the main challenges of transition facing the countries of western balkans in the following  period are3:  o privatization and restructuring of companies and removing of barriers for businesses,  in order to strengthen the flows of private capital and decrease the donation support,  1 milardović, a., zapadni balkan – pojam, ideje i dokumenti o rekonstrukciji balkana u procesu globalizacije, pan liber, osijek –  zagreb – split, 2000., pg.26  2  the agreement of stabilization and accession, www.dei.gov.ba  3 ebrd document, strategy for bosnia and herzegovina, 2005., pg. 2  volume 40 • spring 2008 • 91  o decrease the size of public sector, bureaucracy and administration  o structural and institutional reforms in key infrastructural sectors, such as: transport,  energy, telecommunications and communal infrastructure, as well as financial sector,  o strengthening of state institutions and creation of unifies economic territory in b&h.  the following table (transition report, 2004) shows the realized transitional indicators in the  mentioned segments of economy. this index is between 1 (showing little or no progress) and 4+  (4.33 – showing the standards which are similar to advanced economies of the industrial market)    table 3. indicators of transition for western balkans countries    albania  bosnia and  herzegovina  fyr of mace‐ donia  serbia and  montenegro  liberalization of prices  4,33  4,00  4,00  4,00  liberalization of trade and  currency  4,33  3,67  4,33  3,33  small‐scale privatization  4,00  3,00  4,00  3,33  large‐scale privatization  2,33  2,33  3,33  2,33  company reforms  2,00  2,00  2,33  2,00  competition policy  2,00  1,00  2,00  1,00  infrastructure  2,00  2,33  2,00  2,00  banking sector  2,33  2,67  2,67  2,33  non‐banking financial institu‐ tions  1,67  1,67  2,00  2,00  source: ebrd transition report, 2004.god.  defining smes in eu and countries of western balkans4  the european commission has adopted a recommendation (commission recommendation of  3 april 1996 concerning the definition of small and medium‐sized enterprises (smes), oj l 107 of  30.4.1996, p. 4.) concerning the definition of smes which now provides a clear global framework  for all the measures directed towards micro‐, small and medium‐sized enterprises. it will be ap‐ plied to all new community programmes, whereas existing programmes which use different crite‐ ria will continue to be implemented to the benefit of the enterprises which were considered smes  when these programmes were adopted.         table 4. newly adopted eu definition of smes  criteria  micro enter‐ prises  small‐ sized  enterprises medium‐sized   enterprises  max. number of employees  < 10  < 50  < 250  max. turnover in million ecus  ‐  7  40  max. balance sheet total in million euro   ‐  5  27    to be classed as an sme or a micro‐enterprise, an enterprise has to satisfy the criteria for the  number of employees and one of the two financial criteria, i.e. either the turnover total or the bal‐ ance sheet total. in addition, it must be independent, which means less than 25% owned by one  4 according to: united nations economic commission for europe, small and medium‐sized enterprises in  countriesin transition, united nations, new york and geneva, 2003  2007 ‐ 92  •  economic analysis®  enterprise (or  jointly by several enterprises) falling outside the definition of an sme or a micro‐ enterprise, whichever may apply. the thresholds for the turnover and the balance sheet total will  be adjusted regularly, to take account of changing economic circumstances in europe (normally  every four years).   comparative analysis of level of development   of smes in countries of western balkans  in all transition countries, among which we certainly include countries of western balkans,  the process of political and economic transformation is based on the development of the private  sector and entrepreneurship, as well as the creation of favourable business environment for the  development of smes. some countries have gained a significant progress in these activities, while  others are less successful. as a result, in almost all economic analyses, all transition countries are  divided into two groups.  picture 1. index of development of smes in transition countries    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2005.    the first group consists of the advance transition countries, and the second group includes  the less advanced transition countries. all the countries that belonged to the first group, except  croatia, became members of eu in 2004. other countries of western balkans belong to the second  group. the data that follows relates to the period before this eu expansion. the following picture  volume 40 • spring 2008 • 93  shows the share of private sector in the economy, the share of sme sector in gdp and employment,  the amount of gdp, and finally, the index of smes development in the analyzed countries.   the previous picture shows that b&h has a very low share of private sector in the overall  economy, which is only 45% of gdp. the share of private sector in overall economy which is lower  than this one is characteristic only for the following countries: belarus 25%, turkmenistan 25%,  uzbekistan 35%.  index of development of sme sector  index of development of sme sector in advanced and less advanced transition countries is  shown  in  the  two following pictures. all  the countries of western balkans belong  to  the  latter  group.  picture 2. index of development of smes (advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003.    picture.3. index of development of smes (less advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003   2007 ‐ 94  •  economic analysis®  in b&h, index of development of smes is very low – only 118,2, while in slovenia, which has  the greatest index of all the former and current transition countries it is amazing 2534,9. index of  development of smes, lower than the one of b&h, have only the former members of ussr and  serbia and montenegro. it is indicative that albania has a significantly higher index of develop‐ ment of smes than the most of less advanced transition countries.  sme sector share in gdp  the following pictures show the share of sme sector in gdp, in both advanced and less ad‐ vanced transition countries. countries of western balkans are shown in picture 3.5. with a rela‐ tively low share of smes in the total gdp.    picture 4. share of smes in gdp (advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003    picture 5. share of smes in gdp (less advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003.  volume 40 • spring 2008 • 95  thus, it is evident that the share of sme sector in gdp is low, and it amounts to only 36% in  b&h, which confirms the fact that our economy is still dominated by large companies, which are  mostly state owned.  share of employment in sme sector    the following pictures 6 and 7 show the share of employment in sme sector in advanced  and less advanced transition countries.    picture 6. share of employment in sme sector (advanced transition countries)    source: unece, ibidem    picture 7. share of employment in sme sector (less advanced transition countries)    source: unece, small and medium size enterprises in countries in transition, new york and geneva, 2003    the share of employment in sme sector is the highest in the check republic, which is now a  member of eu, while in b&h it is very low, even lower than the total unemployment. this data  confirms the existence of informal economy in our country in a great percent. only serbia and  montenegro are in a more alarming state. in all other less advanced transition countries the share  of employment in sme sector is greater than that of the overall unemployment, and in armenia  this percentage is the greatest.  2007 ‐ 96  •  economic analysis®  comparison of index of development of smes in western balkans countries  based on the previous charts, we can calculate the index of development of smes in these  countries and perform benchmarking of countries of western balkans in relation to croatia, as the  most successful country in the region.     table .4. benchmarking ‐ index of smes development in western balkans countries5  country    share of the  private sector in  total economy  (%)  share of the  sme sector in  total gdp  (%)  share of number  in employees in  all smes  gdp/  (usd/capita)  index of smes  development  albania  75  40  58,4  1.565  274,2  bosnia and  herzegovina  45  36  53  1.376  118,2  croatia  99  56  65  5.053  1.820  the fyr of  macedonia  60  42  65,1  1.866  306,1  serbia and mon‐ tenegro  55  46,6  32,4  1.879  156,0    we can conclude that only serbia and montenegro have a lower index of development of  smes than b&h, while all other members of western balkans have a higher index. in comparison  to the countries of the region it is evident that b&h is lagging behind, in regards to the institu‐ tional support to the development of smes. also, the share of private sector in gdp is quite low  (40%) which confirms the thesis that the process of privatization of state‐owned sector is very slow,  but also it confirms the fact that the rate of establishment of new smes in b&h is on a very low  level.   comparison of the development of institutions for support of sme sector  the unsatisfactory institutional support in relation to the region is shown in the following  table as well:    table 5. a comparison with the surrounding countries – institutions for the support of smes     minist.  for  smes  law  on  smes  agency  fund sme  strategy  internat.  organiz. chamber  agencies  for smes  centres  and incu‐ bators  education spec. instit. albania  +  +  +  +  +  +  ‐  +  +  +  croatia  +  +  +  +  +  +  +  +  +  +  macedonia  +  +  +  +  +  +  ‐  +  +  +  scg  +  +  +  +  +  +  +  +  +  +  b&h  ‐  ‐  ‐  ‐  ‐  +  +  +  +  ‐  b&h is the only country that has no ministry for smes on a state level, it has no law on  smes, it has no sme agency, no sme funds, no strategy for the development of the smes sector,  5 this document is prepared on the basis of the unece questionnaire on small and medium ‐ sized enterprises in economies in  transition and emerging market economies in 2001. printed at united nations, geneva (switzerland), 2003.      volume 40 • spring 2008 • 97  no specialized institutions that exist in other countries. the previous statements and a very com‐ plicated business environment for the development od the smes and entrepreneurship are con‐ firmed and according to the research of the world bank, conducted in 155 countries.   table 6.  benchmarking – doing business on each of the  ten topics (out of 155 countries)    b&h  albania  croatia  macedonia  smn  best  per‐ former  worst per‐ former  simplicity of  doing business  87  117  118  81  92  new  zealand  congo,  dem. rep.  business start  up  123  108  103  114  35  canada  angola  licence acquir‐ ing  141  131  148  64  130  palau  tanzania  worker em‐ ployment  95  127  109  123  61  palau  burkina  faso  registration of  property  132  66  99  73  103  new  zealand  nigeria  credit acquir‐ ing  9  41  131  53  99  united  kingdom  cambodia  investor protec‐ tion  77  136  135  30  45  new  zealand  afghanistan  tax payment  46  132  85  58  74  maldives  belarus  foreign busi‐ ness operation  122  100  109  96  123  denmark  iraq  contract obedi‐ ence  72  113  43  111  110  norway  timor‐leste  business shut  down  58  73  66  109  90  japan  west bank  and gaza  source: doing business, the world bank, 2006    based on table 6 we can conclude that b&h is in 87th place out of 155 countries, which is,  compared to other countries of western balkans, a weaker position than that of fyr of macedonia,  but better than that of albania, croatia and serbia and montenegro. however, as far as conditions  required to start up business in bosnia and herzegovina are concerned, our country is in the low  123rd place, and serbia and montenegro is in the 35th. property registration places b&h in the  132nd place, and albania in 66th. conditions needed for getting credit in b&h place it in the high‐ ranking 9th palce, which is a significantly better position than other countries in western balkans.  it can be concluded here that obstacles for the quicker development of sme sector come mostly  from government, because the market and its mechanisms function well enough.  based on the data from the table 7 it can be concluded that entreoreneurs go through 10 dif‐ ferent procedures when starting up a business in serbia and montenegro, 11 procedures in alba‐ nia, 12 in b&h, 13 in fyr macedonia, which takes about 15 days in serbia and montenegro, 41  days in albania,  48 days in fyr macedonia, and 54 days in b&h. during registration, entrepre‐ neurs face costs of 6% gni per capita i serbia and montenegro up to amazing 40,9% in b&h. as a  consequence of a complicated procedure during business registration in b&h, our registration has  a total of 7 smes/1000 inhabitants, which is significantly below all other countries in the region.  number of smes per capita is shown in the following picture.    2007 ‐ 98  •  economic analysis®  table 7. time required for business registration in western balkans countries  company registration  2005.  number of  steps  days  costs  (% gdp p/c)  alb  b&h  mkd  sim  11  12  13  10  41  54  48  15  31,1  40,9  11,3  6,0  see‐4  oecd  11,8  6,0  39,5  19,0  22,3  6,5    the key obstacles of faster development of smes in bosnia and herzegovina  the most visible obstacles have been elaborated in the following nine bullets. in some cases  we give some recommendations and possible solutions, based on results of our exploring, and on  our own experience. i hope that our suggestions will be of use to the creators of economic policy of  bosnia and herzegovina, because in the worse case, obstacles to the development of the smes can  also slow down the process of transition and to block the transfer to the market economy.  although the current situation of the smes in bosnia and herzegovina we can not character‐ ized as satisfied for many reasons, as  inadequate financial support, non‐supporting tax system,  complex  and  long  lasting  process  of  registration  of  entrepreneurship,  insufficient  institutional  support, smes are the only economic structure that worked with positive results in the past pe‐ riod. with relatively small initial capital, sme sector achieves over 40% of gdp of the country and  it gives needed job to over 250 000 employees, or in the other words, around 654%.  the structure  of smes by economy activity is not satisfied because out of total number of smes, 45 % of them are  involved in trade, 18 % in the production, and 9%, in building projects, 12 % in service and 16% in  other activities. that is the reason why smes are involved export only with 39%. based on stated  data, we can conclude that sme sector could give a job to a larger number of people in this coun‐ try, in the case of decreasing of tax load on them, establishing of stable business environment, mak‐ ing deregulation of certain regulations, liberalization in the field of foreign‐market economy, and  in the case of easier access to the initial capital with better conditions.     research that we made showed us that smes in bosnia and herzegovina are facing many  obstacles, on daily basis but the major one is lack of finances. considering that the system of finan‐ cial support is inadequate in bosnia and herzegovina, majority of companies is financed by its  own capital and with loans from the customers and suppliers. the biggest number of companies  (apx. 93% out of total number of smes) is defined as micro‐companies (up to 10 employees) and  the amount of capital is limited. if we are talking about economic effects of working of smes, the  majority of them is on the edge of surviving – they achieve economic sustainability very hardly  (approx. 50%), while approx.. 20% of them do not want to increase number of employees and ca‐ pacity of business because of fear of failure. cases of complete ruin of companies are often and not  because of market circumstances but because of high obligations toward the state. newly estab‐ lished smes have the largest problems with lack of capital, and banks see them as very risky cate‐ gory of applicants for loans, and often banks insist on very high measures of risk‐protection (mort‐ gage is approximately 200‐300% of measure). beside that, rates are mainly very high and they are  between 11% and 13%, and in a case of micro‐credit organizations they are between 20% and 25%.  volume 40 • spring 2008 • 99  these mentioned loans are strictly oriented, short lasting (up to 12 months) and with the grace  period 6 to 12 months. this is the reason why financing externally is still inadequate for smes.   the next obstacle to the faster development of smes in bosnia and herzegovina is tax system  that  is  primarily  in  the  function  of  covering  high  public  expenses.  with  a  current  high  ratio  tax/gdp,  the economy of bosnia and herzegovina  is one with  the highest  taxes  in  the central  europe, where the taxes are one of the reasons of slow development of private sector and smes  and leads to transition to the grey economy and induces avoiding of tax payment. besides that,  valid tax regulations are often complicated and complexity is additionally increased by their often  changing. luckily, current inefficient tax regulations will be changed with new and more efficient  laws. following measures that would lead to the faster development of smes are:  o abolition of income‐tax in total amount or up to certain amount in the first year of  work   o abolition of taxes on newly employed personnel of specific type of profession and  age, tax credits for research and development  the procedure for registration of company is really complicated in the administrative way.  there are no regulations in the legal system of the bosnia and herzegovina that strictly define spe‐ cially for smes, and their state and business could be seen only as companies in general. one of  the key institutional measures has to be simplifying of registration procedure. this procedure at  this moment is really complicated, complex and long lasting, and costs are very high. for the start  up of new business in bosnia and herzegovina, a person will need 12 steps and 54 days, and costs  are double than in the countries in transition, and around four times higher than in the countries of  oecd. in bulgaria, businessmen for the start up need only 11 steps and 20 days.   smes in bosnia and herzegovina in the past period did not have support of the leaders in  the economic development. similar to the other countries that have been in the transition period,  smes in b&h have shown a constant growth in the last decade. at the same time the environment  is also in the process of transformation through the bringing up new regulations, finalizing the  process of privatization but also starting with the first planned activities by the state toward devel‐ opment of smes and business. however, this is only the beginning and a lot of time will be needed  for creating good conditions for the faster development of this sector. the owners of smes should  hope that the support to this sector will be less declarative, and more concrete, and also that the  atmosphere for the development of internationally oriented sector. to achieve this it is necessary  that the state make influence on more positive environment for the smes by measures of direct  and indirect policy. the government has to provide political, legal and economic stability of the  country in order to develop smes. until now, there is no one institution for the monitoring and  support of the smes on the state level in bosnia and herzegovina, there is no regulations, nor pro‐ grams of support of the development of smes, neither on state nor entity, cantonal, regional nor  municipality  level.  besides  this,  on  economic  faculties,  departments  for  entrepreneurship  and  management have been opening  just recently. professionals should be educated in these depart‐ ments, and they would later on direct the development of smes, but there are still no sme centres,  that would function in universities, and that would be connected with sme agencies. in regards to  them the centres would be in the expert’s role. also, the universities still have not established even  a single incubators, as we can see in other countries. there is not even a joint definition of smes.  therefore, making a comparison of the level of development of institutions crucial for the devel‐ opment of smes in b&h with highly developed countries, and with the transition countries, we  have pointed at our distance from those countries clearly and unambiguously.   2007 ‐ 100  •  economic analysis®  having in mind the importance of smes in the market structure of the developed countries  and the advanced transition countries, b&h should secure support and help to the development of  smes, by using the legal system and setting up the appropriate institutions to:  o establish a stable policy of support to the development of smes on all levels of terri‐ torial organization in b&h, which would not oscillate depending on the changes in  power on all levels;  o making programs of support for smes.  o supporting the creation of centres in non‐governmental institutions that would give  special and immediate support to smes in all stages of their development  o the local authorities should support the development of technological parks, clusters,  incubators etc.   o the local authorities should improve legislation, and especially practices, of registra‐ tion of companies based on principle: „everything in one place – faster, easier and  cheaper“.  o establishing funds for the development of smes, which would stimulate activities of  companies on:  improving current and creating new products and services,  developing competitive advantages of smes in domestic and foreign markets,  securing the level of quality in accordance with the requirements of iso stan‐ dard,  faster implementation of modern technologies,  introducing information systems and e‐commerce,  preparation and execution of ecological projects, etc.  o establishing euro‐info centre state‐wide and including it in the european network of  euro‐info centres. these centres today have the status of official it network of the eu  and besides the member countries they also include over 20 countries of central and  eastern europe, as well as the mediterranean. these centres give answers to all the  questions regarding the operations of smes in the european union. this computer  network would provide employment for a large number of young experts of various  profiles.  o leasing has been proven as an effective tool of supporting smes in many countries  and, therefore, legislation in this area could be a priority for the authorities in bosnia  and herzegovina. the government can influence the leasing market as it is very sen‐ sitive to tax treatment and the protection of rights of retailers in order to be able to ex‐ tract money in case that the customer does not pay.   one of the basic results of the analysis conducted in this paper is that the creation of a spe‐ cific model of a  successful transition in b&h is a task with no alternative. this is not surprising,  because under the influence of events that are gaining speed ever so quickly (and these event are  mostly external – globalization) there is no possibility of a stationary condition; either there is eco‐ nomic growth, or there is recession, with all the consequences of such a process. this is especially  true for b&h, which, as a late participant in the process of globalization, which is caused by war,  must put in additional effort. the economy of bosnia and herzegovina must get institutional sup‐ port on national  (and more and more even on the  international)  level,  in order not  to  lose  its  chance in regards to those countries that have gone quite far down that road. besides this, the pro‐ gram of restructuring of the economy and the development of the sme sector is unimaginable  volume 40 • spring 2008 • 101  without the necessary infrastructure. first of all this relates to: highways, railroads, telecommuni‐ cation systems, securing cheap and safe sources of electric power, creation of industrial zones, etc.  only such a modern infrastructure, ready for investments of commercial investment capital can be  the answer (the countermeasure) for opportunity attractiveness of investing in other, mainly transi‐ tion countries in which there is a low price of workforce. if these things do not happen, investment  capital will not come to b&h.  although the sme sector was expected to expand and grow so that it creates enough jobs, to  absorb the fired workers in the process of restructuring and privatization of large companies, and  to create jobs for those that are new in the labour market, this has not happened in many transition  economies, especially in south‐east europe. in our country too, the sme sector neither grew fast  enough to prevent the growth of unemployment, nor it realized its potential as the initiator force.  even though a large number of new smes entered the market, because of market liberalization  those smes did not grow as fast as it was expected based on the experiences of the developed  market economies. a possible reason might be in the obstacles to development that we listed ear‐ lier on. such obstacles to development stunt a quicker transfer of workforce from the old, non‐ productive large companies to the newly formed private sector. as a consequence, this can result  in less‐than‐possible growth of a given economy, as well as a significantly greater unemployment  that the one that is necessary.   in the end we can conclude that the most evident obstacles to the development of smes in b&h  are the following:  o the divided economic space,  o insufficient legislation,  o lack of financial support,  o high tax rates and a complicated tax system  o non‐existence of a central registry of a bank account holder in banks in b&h,  o non‐existence of a financial market and non‐banking credit institutions,  o non‐existence of advisory and financial support for start‐ups,  o no possibility for securing the requested collaterals,  o big technological backwardness,  o non‐sufficient present on foreign markets,  o non‐sufficient education of the management,  o lack of managerial skills,  o big share of informal economy  o no networks between the existent smes,  o a very long period of time is required to register a firm, also a lot of documentation is  required etc..  conclusions  more than a decade after the end of war in b&h, when it comes to the private sector, three  things can be concluded:  first – there are still numerous obstacles for its development.    2007 ‐ 102  •  economic analysis®  second –  that development  is still a crucial precondition  for  the progress of economy  in  b&h.  third – the economic space in b&h is still divided in two parts.  in order for the sme sector to develop faster, and thus decrease unemployment, it is neces‐ sary to crate a unified economic space and than conduct a significant deregulation, as this area is  regulated with too much legislation. then, it is necessary to make access to financing easier for  smes, to pass a leasing law, to privatize state firms and to increase the share of sector in gdp. sim‐ ply, the number of smes must be significantly greater in the following period, because without the  new companies there will be neither new employment  nor the reduction of the huge deficit. there  is no positive trend while the growth of new firms in b&h is 30‐40%. it is thus needed to crate the  presumptions for the increase in number of start‐ups. also, it is necessary to increase the number  of medium sized enterprises because the share of micro smes with less than five employees is cur‐ rently too big.   the situation is somewhat better in serbia. in this country there is around 50 thousand active  private smes, and their number has not increased significantly in the last ten years. there are 600  medium enterprises and only 83 large enterprises. in comparison with hungary, which has around  the same population, the number of smes is too small. namely, hungary has got over 500 thou‐ sand smes. the basic obstacle to faster development of smes in this country is, similarly to other  countries of western balkans „undercapitalization“. on the average, smes in serbia have 20,000  euros at their disposal, and under current conditions they can be in credit of up to 6,000 euros.   finally we can conclude, that in comparison to other countries of western balkans, b&h is  lagging behind both in institutions and in lack of support for smes. the ground laws for smes in  bosnia and herzegovina have not been passed yet, there is no state‐wide sme strategy, there is no  agency for smes, which is a unique case in the whole region. the government not only does not  have the strategy for the development of smes, but many obstacles, as we have seen, also come  from government. however, we consider that the philosophy on which the market structure in  bosnia and herzegovina should be established is the following:  5 firms with 200 employees is  safer than  1 firm with 1000 employees,  and  100 firms with 10 employees are  more flexible than  10 firms with 100 employees.    one of the primary results of the analysis undertaken in this paper is that the sme sector  has not created enough jobs, that it absorbs the fired workers in the process of restructuring and  privatization of large companies, and that it has not created  jobs for new workers in the labour  market. the possible reason is in obstacles that we have mentioned earlier on, which can result in  growth under possibilities, and a significant unemployment. in the worst case, the obstacles to the  development of smes can block the transition of bosnian economy to market economy. besides  this, the set goals and tasks of research have been realized.  literature  blanchard, o.: the economics of post‐communist transition, clarendon, 1997.  volume 40 • spring 2008 • 103  milardović, a., zapadni balkan – pojam, ideje i dokumenti o rekonstrukciji balkana u procesu globalizacije, pan liber, osijek –  zagreb – split, 2000., pg.26  strategy for bosnia and herzegovina, ebrd document, 2005., pg. 2  united nations economic commission for europe, small and medium‐sized enterprises in countriesin  transition, united nations, new york and geneva, 2003  bašić, m.: ekonomija b&h, ekonomski fakultet univerziteta u sarajevu, sarajevo, 2005.   unece,  small and medium ‐ sized enterprises in economies in transition and emerging market economies in 2001.  printed at united nations, geneva (switzerland), 2003.  džafić z.: pretpostavke razvoja malih i srednjih preduzeća u b&h, tempus projekti u funkciji razvoja malog biznisa, faculty  of economics, sarajevo, sarajevo, 2004.  džafić z.: značaj i uloga malih i srednjih preduzeća u razvoju zemalja centralne i istočne evrope, legal advisor, center for  promotion of civil society, sarajevo, number 4, may 2004.   džafić z.: mala i srednja preduzeća u funkciji restrukturiranja tranzicionih privreda sa posebnim osvrtom na b&h, doktorska  disertacija, ekonomski fakultet, tuzla,  2005.   džafić z.: ruolo ed importanza delle piccole e medie imprese nella fase di ristrutturazione e sviluppo dell economia di  bosnia ed herzegovina, specialist paper, bologna university, italy, 1997.    rovčanin, a., džafić z.:  franšizing – partnerstvo uz sinergetske efekte, collection of papers of faculty of economics in sara‐ jevo, number 24, september 2004  rovčanin, a., džafić, z.: institutional changes ‐ assumption for development of small and medium‐sized enterprises in bosnia  and herzegovina”, international conference of university of rijeka, entrepreneurship and macroeconomic  management, april, 28‐30. 2005. pula, croatia,   www.eppu.ba/pdf/unapredjenje poslovnog okruzenja/pdf.  www.unece/indust/sme/smepub/2003/  www.www.dei.gov.ba‐ the agreement on stabilization and accession          udc: 005.96 005.53:334.7(497.11) cobiss.sr-id 252606732 scientific review the impact of human resource management of the work design concept in serbia dejana pavlović1* 1 institute of economic sciences, belgrade, serbia abstract human recourse management (hrm) has an important role in every organization. in addition, investment in human capital is not represented only in developed countries but also in non eu countries, such as serbia. hence, in the last two decades, a large number of eu countries started to analyze the role of hrm in companies. one of the studies conducted in this field is cranet, which represents the academic network for conducting hrm research in practice worldwide. the first results of cranet survey were presented in 1999 and at the beginning only 24 countries were a part of this network and now the number doubled. in the paper, the role of hrm will be analyzed in serbian organizations by using the cranet 2015 research results. according to the cranet 2015 survey results, the role of hrm in serbia is present but not to the extent that it is present in developed countries. key words: human recourse management, cranet, serbia jel classification: j53, m54 introduction human recourse management is essential for the development of individuals but also for the company's prosperity. investment in human capital is no longer represented only in developed countries, but also in developing countries, such as serbia. however, the impact of hrm practice in different segments varies from country to country (lekovic, stangl-susnjar, 2010). according to the research that used cranet survey from 1999 to 2000, ignjatović and svetlik (2003) determined four european hrm clusters such as nordic cluster (employee-focused hrm of medium intensity), central southern cluster (hrm is of low intensity and mainly gives administrative support to managers), western cluster (hrm activities are intensive and professional and hrm is a strategic partner of management), peripheral cluster (hrm has a low status and management focus). in the past few decades significant changes in the work design among organizations worldwide have occurred as a result of technological innovations, the processes of liberalizations and privatizations, but also of the problems caused by financial crises. the shift from traditional job design strategies best described more than a century ago by the early works of the author taylor (1911) to high-performance work practice (hpwp) including part-time * e-mail: dejana.pavlovic@ien.bg.ac.rs dejana pavlović 87 work, job sharing, shift and weekend work, overtime, annual hours, flextime, temporary work, fixed-term contracts, subcontracting, home-based work, tele-working etc. has been made. regarding above mentioned, author oldham (2012) defined work design at its most basic level as the actual structure of jobs that employees perform in their organizations on a daily basis. in other words, work design focuses on the work itself and the tasks or activities that individuals complete daily in their organizations. furthermore, in support of that author osteman (2010) considered work design as a part of a larger package of employment practices that consequently has a significant influence on employees’ work outcomes and different benefits related with the workplace. in other words, the main purpose of the job design is to create the adequate structure which best fits the requirements of the strategy that needs to be implemented. taking into account the significance of the work design concept within the organizations, it is not surprising that nowadays it plays central role in human resource management (hrm). hrm has gained a prominent role in the business and scientific world. monitoring of the impact of hrm and the collection of comparable data on human resource management policy and practice in the business world in specific countries appeared for the first time in 1989. cranet, which represents the academic network for conducting hrm research in practice worldwide, has a current picture of the status of practice in the member countries. coordination of activities is carried out by the centre of european hrm at cranfield school of management in the uk. the first study was conducted in the period from 1999 to 2000, when a total of 24 countries took part. however, the latest studies include even 40 member countries of the cranet network. the paper will show the influence of hrm in serbia based on the results of cranet research. based on the presentation of individual hrm indicators and comparisons with eu countries, it is possible to determine how much the role of human resource management is present in companies in serbia. literature review looking back in the past, taylor's basic idea was to increase employees work efficiency by designing jobs that were simplified and standardized, so that any unnecessary work could be eliminated and employees could be just as interchangeable as standardized machine parts (oldham, 2012, p. 652). on the other hand, within the contemporary economic literature it is widely accepted that acquiring, developing and keeping talented individuals play central role at the management of human resources (pittino et al., 2016). regarding previously mentioned, hpwp present the set of specific human resources practices developed during the last decade of 20th century (combs et al., 2006). often labelled as innovative hrm practices, hpws have been extensively linked to organisational benefits expressed through higher levels of labour productivity, organisational competitive advantages, and profitability (mackenzie et al., 2015). from the organisations' point of view, the usage of hpwp and non-traditional work arrangements is considered to be a good strategy to improve the organization's position in the competitive business environment (roberts, 1996) having influence on the increase of motivation of the employees and consequently on company's productivity level. it symbolizes a new approach towards organization of work that promotes teamwork and flexibility, responds to complexity and variability of work assignments, and enhances employee’s motivation and skill development (hernaus et al., 2012) having the impact on both, employees’ satisfaction as well as motivation and on company’s performances. authors rappapor, bancroft and okum (2003) argued that those organizations that can not retain the high performing workforce lose their ability to remain competitive. in particular, 88 economic analysis (2017, vol. 50, no. 3-4, 86-92) empirical evidence indicates that the higher the number of hpwps employed, the more positive the employee responses (pittino et al., 2016). according to the results presented in their study, authors (gittleman et al., 1998) showed that the large organizations are more likely to use high-performance work practices. furthermore, myers (1999) considered implementing flexible working arrangements (fwa) one of the main factors to increase productivity and substantial reductions in absenteeism and turnover. on the other hand, authors pittino, visintin, lenger and sternad (2016) indicated that in family firms compared to non-family firms relational mechanisms originating from the family social capital may act as substitutes of formal high-performance work practices aimed at increasing employee involvement and commitment. as a form of hpwp, flexible working arrangements (fwa) in firms have been identified as one important means of balancing work and other commitments (evans 2001). according to ilo (2000a), fwas consist of working patterns involving modifications to the regular week, work at nights and at weekends, as well as work schedules where the starting and finishing times are at different hours of the day, the week or a longer reference period. flexibility in the workplace allows employees to make arrangements about working conditions that best fit them. this helps employees maintain work/life balance and can help employers improve the productivity and efficiency of their business. moreover, author barker (barker, 1995) in his paper argued than when employees work at their best hours they are more loyal to their employer, reducing absenteeism and turnover as a result. in some empirical research, though, the contextuality of fwa used across the countries and industries that have been the subject of analysis has been noticed. hara (2014) examined frequency and density of firm-provided training for workers in fwa. the author also analyzed the impacts on this kind of training on skills, productivity, and wage growth in japan. the results showed that participation in firm provided training improved job skills and productivity, but did not appear to impact the wage growth of non-regular workers. however, participation in training program raised possibilities of transition from non-regular to regular workers, enhancing the probability of future wage increases. although, the vast majority of the mainstream hrm literature in its focus has had the pragmatic aspects of hpwp, the impact of labour unions on the adoption on hpwp seems to be neglected. furthermore, there is no consensus in the literature regarding the impact of trade unions on the hpwp adoption. nevertheless, author verma (2005) examine and summarize the different impacts (positive, negative, neutral or indirect) that labour unions have on hrm practices. the group of authors (liu et al., 2009) in their study has noticed negative correlation between the level of unionization in the organizations and the usage of hpwps. on the other hand, rolfsen (2013) as well as gill and meyer (2013) in their papers concluded otherwise. with that regard, author (mackenzie, 2015) has also demonstrated that strong trade unions facilitate the adoption of hpwp whereas trade union militancy negatively affects hpwp. in their research cristiani and mari a peiro (2015) find that organizations with the hr function strategically involved and with higher degree of union presence have more personcentred hrm practices, while performance-centred hrm practices were positively influenced by hr function strategic role. however, the findings do not support the moderating role of trade union presence on the relationship between the hr function strategic role and hrm practices. in his study galang (1999) argued that hpwp could be considered substitute to labour unions as those practices encourage employee individual voice instead of collective employee voice. gill and mayer (2013, pp. 512-515) summarized the ways in which unions may contribute to the adoption of hpwp in an organization. in their study, authors argued that unions promote a long-term and organisation wide perspective and enhance collective and individual voice. furthermore, they highlighted that union networks provide an effective communication dejana pavlović 89 infrastructure. authors also considered that in the organization, unions increase employee trust and commitment and reduce employee withdrawal, as well. methodology based on the results of the cranet study conducted in the first half of 2015, the impact of hrm activities is presented in more than 150 organizations in serbia. cranet study involves company surveys with more than 50 employees. the survey consists of 70 questions, and the survey is done by post or through a personal interview, where the questionnaire is filled out by experts in the field of human resources. the questionnaire contains questions for all the basic activities of human resources management, within six parts of the questionnaire: a) human resource management activities in the organization b) the practice of obtaining and selecting candidates in the organization c) development of employees in the organization d) system of compensations and benefits of employees in the organization e) relations between employees and employers and communication in the organization f) information about the organization. processing of collected data is done by teams of top experts of the cranet organization and on the basis of results, they analyse trends from certain hrm activities. data can be used for scientific and teaching purposes, while adhering to the basic academic principles of citations. in the survey in 2015, 158 organizations participated, 104 of them from the private sector and 54 from the public sector. the companies’ activity is mostly in the field of food, beverage, textile, wood and paper production, oil derivatives and similar products (share of 13.6% of the total number of companies surveyed); agriculture, hunting, forestry, fishing, mining and exploitation of stone (7.6%) as well as in the field of wholesale and retail (9.5%). more details about the surveyed subjects are listed in the table below (table 1). table 1. general data of analysed organizations frequency share private sector 104 66 public sector 54 34 total 158 100 number of employees in organizations total number share less than 100 27 17 100-249 68 43 250-1000 42 27 1001-2000 15 9 2001-5000 4 3 more than 5000 2 1 total 158 100 source: cranet 2015 study the paper will provide the analysis of the impact of hrm as well as the impact of trade unions in organizations. 90 economic analysis (2017, vol. 50, no. 3-4, 86-92) human resources departments out of the total number of organizations surveyed, about 72% confirmed that there is a special department responsible for human resources management. this share is about 64% and 76% in the public and private sector, respectively. table 2. special department for human resources average private sector public sector frequency share (%) frequency share (%) frequency share (%) exists 113 72 79 76 34 64 does not exist 44 28 25 24 19 36 total 157 100 104 100 53 100 source: cranet 2015 study one of the signs of the strategic importance of human resources management is the existence of a general hr strategy, as well as specific hr strategies related to the most important activities of human resources. table 3. share of organizations that have a strategic approach to human resources management total private sector public sector mission statement 76 77 73 business/service strategy 87 88 87 hrm/personnel strategy 59 60 57 hr recruitment strategy 45 51 32 hr strategy for training and development 53 56 47 statement on corporate social responsibility 49 54 40 statement on respecting the diversity of employees 58 60 55 source: cranet 2015 study from the table above, we can conclude that most organizations in serbia have a business strategy (about 90%) and mission statements (about 75%). the share of companies with written general and special strategies is higher in the private sector than in the public sector. in addition, in more than half of the observed organizations, the hrm department has been involved in drafting a strategy from the outset, i.e., there is a full connection between the top management that brings the business strategy and hr department. table 4. share of union members (%) share total private sector public sector 0 31 43 6 1-10 6 9 0 11-25 6 6 8 26-50 8 6 11 51-75 22 18 28 76-100 28 18 47 total 100 100 100 source: cranet 2015 study in most of the analysed organizations (about 80%), the importance of hr department is not at the highest level because decision-making and implementation of activities still involve line managers. the share of such serbian organizations in which the decision on the most important human resource management activities is made by the hr department itself or in consultation dejana pavlović 91 with the line manager is about 20%. the results show that the hr managers' influence is more present in the private sector than in the public sector, but there is also the influence of line managers in the public sector. out of the 100 observed business entities, about 30% of organizations have no trade unions. a larger number of trade union organizations is present in the public sector. in 75% of public organizations, more than half of employees are members of trade unions. in the private sector this number is significantly lower, for example, more than half of the employees are union members in 22 companies. in 65% of organizations observed, trade unions have a role in negotiating. this number is higher in the public sector. table 5. impact of trade unions on business in the organization total private sector public sector no impact 32 45 5 low impact 8 8 8 medium impact 10 10 9 significant impact 5 5 6 very significant impact 45 32 72 total 100 100 100 source: cranet 2015 study in 45% of the total number of organizations observed, the influence of trade unions on the company's operations is very significant. conclusion cranet study enabled the monitoring of hrm's role in the business world. based on previous results, we can certainly say that the role of hrm in serbia is present but not to the extent that it is present in developed countries. based on the answers obtained from 158 organizations, most companies and institutions do not perform outsourcing of basic hr activities, but about half of the respondents occasionally hire external consultants for training, recruitment and selection of employees. about 60% of the surveyed organizations have hr information system, but various self-service systems work only in about 20% of organizations. the research results showed that the written mission, vision and strategy are present in almost all companies, both in the private and public sector. from the very beginning, human resource managers are involved in their drafting but with the help of liner messengers. however, in most organizations, especially in the private sector, important decisions regarding hr activities are made by line managers themselves. in about 1/3 of the observed organizations, there are no trade union organizations. in the private sector, this share is over 40%, while in the public sector; over 90% of organizations still have some form of union activity of employees. acknowledgements this paper is a part of research project number 179001 financed by the ministry of education, science and technological development of the republic of serbia. references barker, john. 1995. “family ties: family-friendly policies are no longer a luxury, they are a competitive advantage“. sales and marketing management, vol 147: pp. 18–24. 92 economic analysis (2017, vol. 50, no. 3-4, 86-92) combs, james, liu youngmei, hall angela, & ketchen david. 2006. „how much do highperformance 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„work design practices: do trade unions make a difference?“. feb working paper series, no. 12-04. ignjatovic, miroljub, and svetlik ivan. 2003. “european hrm clusters”. ebs review, no 17: pp. 25-39. liu, wenchuan, guthrie james, flood patrick, and maccurtain sarah. 2009. „unions and the adoption of high performance work systems: does employment security play a role?“. industrial and labor relations review, 63(1): pp. 109-128. mackenzie, robert, cook hugh, forde christopher, and valizade danat. 2015. „the effect of trade unions on high performance work systems (hpws): does industrial relations climate matter?“. internet source, available at: https://www.ilera2015.com/dynamic/full/il253.pdf, accessed: 4.7.2017. myers, sarah. 1999. „flextime catches on in business, but size matters“. providence business news,14: pp. 16–19. oldham, greg. 2012. „the strategy for enhancing the positive outcomes of individuals at work“. ed. by cameron k.s., spritzer g.m. published in: the oxford handbook of 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november 23, 2017 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp37-46 scientific paper common assessment framework – improving organizational performance of municipalities in bosnia and herzegovina daut bajramovic1* | manfred gram1 1 american university in bosnia and herzegovina, faculty of economics, sarajevo, bosnia and herzegovina abstract common assessment framework (caf), a european total quality management (tqm) methodology, has been applied by municipalities across bosnia and herzegovina (bih) for a number of years. municipalities have used caf as a self-assessment tool to identify and meet their own development needs and improve organizational performance. along with international organization for standardization (iso) and business friendly certificate (bfc) standards, caf has been promoted by domestic non-governmental and international organizations as a tqm tool for public sector. this article provides an insight into experience of municipalities in bih with implementation of caf by focusing on their thematic priorities, organizational efficiency, output, outcome and citizens’ satisfaction. key words: caf, tqm, organizational performance, outputs, outcomes and citizen’s satisfaction jel classification: l38 introduction caf is inspired by the excellence model of the european foundation for quality management and the model of german university of administrative sciences in speyer. it is based on the premise that excellent results in organizational performance in the public sector are achieved through effective leadership, planning, human resource management, partnerships and processes (the common assessment framework manual, osce, 2009). the pilot model was introduced in 2000, which was succeeded by revised versions in 2002, 2006 and 2013 (https://www.eipa.eu/portfolio/european-caf-resource-centre/) at the end of 2016, around 4,000 public sector organizations have applied the model in 52 countries in and outside of europe. also, caf resource centre of the european institute of public administration has issued 185 caf effective user labels. the caf 2013 model has been translated in more than 25 languages (caf newsletter, 2017/1). the caf aims to be a catalyst for a full improvement process within the organization and has five main purposes (the common assessment framework, 2013): 1. to introduce public administrations into the culture of excellence and the principles of tqm; 2. to guide them progressively to a fully-fledged pdca (plan, do, check, act) cycle; 3. to facilitate the self-assessment of a public organization in order to obtain a diagnosis and a definition of improvement actions; * e-mail: dtbc1155@aubih.edu 38 economic analysis (2018, vol. 51, no. 1-2, 37-46) 4. to act as a bridge across the various models used in quality management, both in public and private sectors; 5. to facilitate bench learning between public sector organizations. figure 1. the caf model source: http://www.eipa.eu/en/topic/show/&tid=191 under the caf model (figure 1.) assessment of public organization is measured against nine assessment criteria, five enablers and four results criteria. in bih initiation of application of caf in public sector commenced around mid-2000s. municipalities were then transitioning from the period of direct post-war recovery to a period of consolidation of administrative framework with more focus on their actual development needs. in this regard, municipalities saw caf, which was promoted by major international organizations in bih, as an opportunity for assessment of level of their development and identification of programmatic and administrative areas where improvements are needed. it was also seen as a tool that helps strengthening of good practices and development of new and innovative approaches. since caf is used by most eu countries municipalities also welcomed caf as a tool for strengthening eu integration processes and taking ownership of the reform process. literature review nowadays quality in public sector has been recognized as a critical strategic issue, which contributes to increase in performance efficiency and citizens’ satisfaction, (wisniewski, 1996; montesinos & brusca, 2009; and chiarini, 2016). total quality management (tqm) is a customer driven philosophy of quality, which focuses on building quality into the process and reflects the entire organization. it is built around seven concepts: 1) customer focus, 2) continuous improvement, 3) employee empowerment, 4) use of quality tools, 5) product design, 6) process management, and 7) managing supplier quality, barnes (2008). application of concept of tqm, in public sector, started in late 1980s and early 1990s when us governmental agencies saw it as an agent for change and a mean to address citizens-related issues (loomba & spencer, 1997). milakovich (1991) notes that application of tqm techniques by federal, state, and local agencies responds to citizens’ demands for better service quality, improves government’s ability to effectively solve public problems, and provides a promising model for altering future public management practices. despite this, it has been challenging to obtain positive effects of application of tqm in reaching certain quality standards in service and particularly in public sector. donelly (1999) daut bajramovic, manfred gran 39 problematizes quality in public sector by recognizing that increase in number of customer’s results in higher demand for the offered services, while at the same time resources are kept constant. in this sense improvement in quality in public sector is limited to improvement of internal organization's operations instead of improving the final services in order to offer better, new, and more services. quality in public sector is characterized by three main features (karyotakis, moustakis, 2014): 1. quality in sense of respect for rules and procedures 2. quality in sense of achieving efficiency 3. quality in sense of achieving citizens' satisfaction swiss (2014) underlines that adapted tqm, for public administration purpose, retains principles such as: employee empowerment, continuous improvement and quantities tracking of product quality and of client reactions. according to loomba and spencer (1997) the greatest barrier to successful tqm implementation rests in the agency culture, organizational structure, and management policies. for good application of tqm methods in public sector they stress a need for employees at all levels to be trained, empowered and rewarded for teamwork. furthermore, environment in the organization needs to foster open communication, teamwork and learning. when compared to other tqm models, caf is distinguished by two features: 1) it is a model developed specifically for the public sector, unlike several others which came and were adapted from the private sector and 2) it is a bottom-up approach with special focus on the crossdepartmental element in the composition of the self-assessment groups (thijs, 2013). studying motives for use of caf by belgian public agencies van doren & van de walle (2002) found that internal motivations (quality improvement) are of much greater importance than external motivations (use of caf for budget maximization, promoting oneself or one's organization). since inception of caf in year 2000, european institute of public administration (www.eipa.eu) has been regularly collecting information from the member states on use of caf model, analyzing a need to improve the model, measure its impact and look for new opportunities for further spread. in 2011, after five years of implementing caf 2006, eipa surveyed 407 organizations from 27 countries. survey showed that 60% of the organizations declared that the improvement actions, because of application of caf have a large or very large impact on the functioning and results of the organization (staes et al, 2011). in 2016, eipa provided an overview of 20 good practices of application of caf. in most case descriptions, clear data illustrated a link between better results of an organization and the undertaken improvement actions (staes et al. 2016). interpreting numbers of caf users from caf resource centre in 2012 in comparison to size of individual eu countries vrabkova (2013) finds that the highest implementation rate of caf is in poland, denmark, belgium and portugal. the largest countries of eu germany, spain, france and including uk at that time reported very low implementation rate. vrabkova (2013) further breaks down individual caf users and their spheres of action and concludes that the highest percentage of organizations implement caf in public administration (57%), education sector (17%), and defense, public policy and security (9%). implementation of caf in bosnia and herzegovina implementation of common assessment framework in municipalities was initially promoted by eda – agency for development of companies from banja luka and the organization for security and cooperation in europe, mission to bih. eda introduced caf methodology, in period of 2004 – 2007, to seven partner municipalities: doboj, doboj istok, doboj jug, maglaj, usora, petrovo and gracanica. introduction of caf 40 economic analysis (2018, vol. 51, no. 1-2, 37-46) methodology aimed to provide municipalities with the tool for monitoring of the processes at level of local self-government unit and tool for improving quality of administrative services (draganic, 2006). draganic (2006) summarizes the major factors that contribute to sustainable implementation of the methodology, and those are the following: a) expression of interest and support from the municipal leadership; b) correct selection of members of caf teams in terms of diversity and quality of their working experience; c) good level of relationship between the leadership and members of caf teams; d) regular information sharing to all employees of the administration on implementation of caf; e) well planned time for process of self-assessment; f) integration of projects from the improvement plan into strategic planning at municipal level; g) correct adaptation of the methodology, especially self-assessment forms into specific context of local self-governance units. osce mission to bih worked on introduction of caf methodology through a local governance project named local first initiative (inter-municipal learning and support component), which was implemented in period of 2009 – 2012. the purpose of the inter-municipal learning and support component was to encourage municipalities to identify and meet their own development needs (local first “empowering citizens – building communities”, 2009). according to “guide for better access to management of property at local level” from 2012 there were 36 municipalities in bih that participated in inter-municipal learning and support component and used caf self-assessment methodology. those are the following: zenica, kakanj, maglaj, travnik, novo sarajevo, banja luka, bijeljina, trebinje, tomislavgrad, vogošća, tešanj, rogatica, višegrad, bileća, nevesinje, ugljevik, donji vakuf, bihać, bileća, cazin, centar sarajevo, foča, gacko, goražde, tuzla, gračanica, konjic, jablanica, kozarska dubica, modriča, mrkonjić grad, lukavac, novi grad sarajevo, sanski most, ugljevik and visoko. in addition to municipal level higher levels of government in bih also included caf in their tqm aspirations. since 2010 german economic development and employment (giz) introduced caf and other quality management techniques to the state and entity levels of government in bih through public administration reform coordinator’s office of bih (parco), state civil service agency and institute for standardization of bih. in february 2017 council of ministers of bih recommended to the bih state institutions to consider introduction of caf and iso standard. it also approved parco to be the contact point for caf on behalf of bih institutions. government of republika srpska (rs) in strategy for development of local self-governance from 2009 (http://www.vladars.net/sr-spcyrl/vlada/ministarstva/muls/omin/documents/strategija%20razvoja%20lokalne%20samou prave.pdf) defined a goal to stimulate and promote appropriate systems of quality management, caf or iso 9001:2000 in public services. strategy for development of local self-governance in rs for period of 2017-2021 (http://www.vladars.net/sr-spcyrl/vlada/ministarstva/muls/pages/default.aspx#collapsible3) does not specifically refer to caf; however it defines an objective “ensure availability and quality of public services for all citizens”. in 2016 government of federation of bih (fbih) adopted information on commencement of introduction of caf methodology in agency for civil service of fbih. the agency was tasked to prepare actions on introduction of caf as a tool for assistance to organizations in public sector (http://www.fbihvlada.gov.ba/bosanski/sjednica_v2.php?sjed_id=560&col=sjed_saopcenje). daut bajramovic, manfred gran 41 surveying municipalities in bih on implementation of caf in bosnia and herzegovina there has been little public information available on municipal experience in implementing caf methodology. several organizations and institutions do recommend and provide technical support on caf; however, at the same time we lack an insight on actual impact of implementation of caf to municipal organizational performances. in this regard, author of this article has designed a questionnaire to measure perception of civil servants, which were directly involved in implementation of caf, on success rate of application of the methodology. it is to be noted that municipalities involved different departments and sectors as focal points for implementation of caf i.e. heads of departments of general affairs, economy, information officers, ict administrators, quality assurance officers and members of mayors’ cabinets. the questionnaire contained nine questions and was focused to measure the following variables: 1) years of implementation of caf, 2) success of implementation of the methodology, 3) methodological focus of implementation of caf, 4) citizens satisfaction, 5) organizational efficiency, 6) social accountability, 7) outputs, and 8) outcomes (see appendix). the questionnaire was sent out, via survey monkey service, to 36 municipalities that implemented caf as part of the inter-municipal learning and support component of the local first initiative of the osce mission to bih. as a result, 10 complete questionnaires have been filled out. additional ten municipalities stated via direct contacts that they did not have enough institutional memory on results of implementation of caf in period 2009-2011. the remaining 16 municipalities did not respond to the call for participation in the survey. results of the survey ten surveyed municipalities stated they had implemented caf in different time frames from 1 to 5 years and more. nowadays one municipality keeps applying caf, while others shifted to implementation of iso 9001 and business friendly certificate (bfc). business friendly certification south east europe (www.bfc-see.org) is a unique program for improving the quality of services and information that municipalities in the see region offer to companies. most of municipalities that participated in the survey stated that their goal in implementing caf was to improve citizens’ satisfaction and management of processes and facts. in addition to this, municipalities also aimed at improving development of capacities and empowerment of employees and continuous innovation and improvements. no municipality answered that their goal in implementing caf was to improve social responsibility. municipalities generally had positive experience with implementation of caf methodology. two of ten surveyed municipalities expressed negative opinion, figure 2. figure 2. municipal view on rate of success of caf implementation 42 economic analysis (2018, vol. 51, no. 1-2, 37-46) assessing success of implementation of caf relating to increase of citizens’ satisfaction, seven municipalities stated it had positive impact, while three claimed the impact was indifferent. internal efficiency of work got improved according to eight municipalities while two stated that impact was average. in terms of effects of implementation of caf on socially responsible performance, responses of municipalities differed. seven of them however reported positive impact. one on contrary noted no effect. surveyed municipalities indicated positive impact of caf on municipal outputs i.e. management of budget, property, capital investments and projects, figure 3. figure 3. impact of caf on municipal outputs assessing outcome results or impact on indicators of development of communities, municipalities expressed more caution than with output, five reported positive impact, two indifferent, while three in the end saw no impact of caf, figure 4. figure 4. impact of caf on municipal outcomes, development of municipality conclusions this research indicated that success of implementation of caf at municipal level in bih has been modest. ten municipalities responded to the survey, ten did not have adequate institutional memory to respond to the survey, while sixteen of them did not participate in the survey for unknown reason. it is also indicative that one municipality out of ten surveyed continues to apply caf. at the same time, municipalities that responded to the survey view caf as a methodology worth applying and find support of the leadership being critical success factor. responses of the municipalities also show that they achieved the best results in improving efficiency of work of their administrations and increasing citizens’ satisfaction. as expected, daut bajramovic, manfred gran 43 municipal respondents found it most difficult to associate implementation of caf to indicators of development of local community. considering that functional and result oriented municipality is needed but at the same time also insufficient condition for ensuring development of the community, this latest conclusion does seem sensible. observing the trend of application of caf in different levels of government in bih it is noticeable that through parco and entities’ civil service agencies higher levels get the deserved attention. moreover, caf and iso are regularly jointly recommended as tqm standards. municipalities on the other hand, which had focus on caf earlier, are now being “left” on their own due to lack of institutional support. entities associations of cities and municipalities in bih do not actively promote implementation of caf at municipal level. it is also noted that municipalities now more favor introduction of iso 9001 quality standard. lack of institutional support for caf and presence of different professional agencies that promote iso in bih can be seen as one of the reasons for this increased application of iso by municipalities in bih. nevertheless, caf remains to be the tqm standard developed by the public sector for public sector, which is free of charge. institutional support for caf at higher levels of government in bih is encouraging and welcomed. for the municipal level, entities associations of cities and municipalities should consider developing special program of institutional support for introduction and implementation of caf. relatively positive experience in implementing caf and provision of institutional support will be a good reason for municipalities to introduce or revisit the tqm standard in way public institutions should do. acknowledgments hereby i wish to thank all municipalities for their participation in the survey. references barnes, david. 2008. “operations management: an international perspective.” south-western cengage learning. chiarini, andrea. 2016. "strategies for improving performance in the italian local government organizations. can iso 9001 really help?" international journal of quality & reliability management, vol. 33 iss 3 pp. draganic, aleksandar. 2006. “kako da usavršimo lokalnu upravu po caf metodologiji.” eda 2006. https://edabl.org/pub/edasr/ drucker, peter f. (1980). “the deadly sins in public administration”. public administration review, vol. 40, no. 2 (mar. apr., 1980), pp. 103-106 european institute for public administration. 2017. “the common assessment framework (caf) improving public organisations through self-assessment.”. caf resource centre. eipa. european public administration network. https://www.eipa.eu/portfolio/european-cafresource-centre/ (accessed january 2018) karyotakis, konstantinos and moustakis, vassills. 2014. “total quality management and change management in public organizations.” sinteza, međunarodna naučna konferencija univerziteta singidurum. loomba, arvinder and spencer, michael. 1997. “a model for institutionalizing tqm in a state government agency.” international journal of quality and reliability management, vol. 14 no. 8, 1997, pp 753-767 milakovich, michael e. 1991. “total quality management in the public sector.” national productivity review 1991. montesinos and isabel brusca. 2009. “towards performance, quality and environmental management in local government: the case of spain.” local government studies, 35:2, 197212 44 economic analysis (2018, vol. 51, no. 1-2, 37-46) osce mission to bih. 2017. “local first “empowering citizens – building communities.” http://www.osce.org/bih/110194?download=true (accessed september 2017) savez općina i gradova federacije bosne i hercegovine. 2017. “vodič za bolji pristup upravljanju imovinom na lokalnom nivou.” mreža općina/opština partnerstvo i resursi “pares” (accessed august 2017). staes, thijs and dorina claessens. 2016. “caf improvement, identification, prioritization and implementation.” european institute of public administration, caf resource centre staes, thijs, soffels and sven geldof. 2011. “five years of caf 2006: from adolescence to maturity – what next?.” european institute of public administration, caf resource centre swiss, james e. 1992. “adapting total quality management (tqm) to government.” public administration review, vol. 52, no. 4 (jul. aug., 1992), pp. 356-362 thijs, nick. 2013. “how the caf model strengthens staff participation.” european institute of public administration, caf resource centre van dooren, w. & van de walle, s. 2004. “why do belgian public agencies use the common assessment framework (caf)?” in: löffler, e. & vintar, m. (eds.). improving the quality of east and western european public services, hampshire: ashgate, pp. 157-71. vlada fbih. 2017. “saopćenje. ”http://www.fbihvlada.gov.ba/bosanski/sjednica_v2.php?sjed_id=560&col=sjed_saopcenje (accessed september 2017) vlada rs. 2017. “draft strategy on development of local self-government of rs.” http://www.vladars.net/sr-sp-cyrl/vlada/ministarstva/muls/omin/documents/. vlada rs. 2017. “strategy on development of local self-government of rs for period of 20172021”. http://www.vladars.net/sr-spcyrl/vlada/ministarstva/muls/pages/default.aspx#collapsible2 (accessed september 2017) vrabkova i. 2013. “quality management in public sector: perspectives of common assessment framework model in the european union”. acta všfs, 2/2013, vol. 7 wisniewski, mik. 1996. “measuring service quality in the public sector: the potential for servqual,” total quality management, 7:4, 357-366 daut bajramovic, manfred gran 45 appendix improving organizational performances of units of local self-governance by implementing common assessment framework methodology questionnaire 1. how many years have you implemented/been implementing caf methodology? a. 1 b. 2 c. 3 d. 4 e. 5 and more 2. how would you assess the rate of sucess of implemntation of caf methodology in your local self-governance? a. unsatisfactory b. satisfactory c. good d. very good e. excelent 3. does your local self-governance currently apply a methodology of total quality management? a. caf b. iso c. other 4. what was / is your focus in applying caf methodology? (please rank your answeres) a. results b. citizens' satisfaction c. management and constancy of fulfilling the purpose d. management of processes and facts e. development of capacities and inclusion of employees f. continuous inovation and improvements g. development and maintaing of partnerships h. social accountability 5. has your measurements, during implementaiton of caf, showed an increase of the degree of citizens's satisfaction with overall work of the local self-governance? a. yes b. mostly yes c. neither yes or no d. mostly no e. no 6. has your measurement, during implementation of caf, showed improvements regarding internal indicators of efficiency of local sef-governance? a. yes b. mostly yes c. neither yes or no d. mostly no e. no 46 economic analysis (2018, vol. 51, no. 1-2, 37-46) 7. has your measurement, during implementation of caf, showed improvements regarding socially responsible actions of local self-governance (i.e. environment protection, support to minorities and persons with special needs, philantropic activities, social engagement etc)? a. yes b. mostly yes c. neither yes or no d. mostly no e. no 8. has your measurement, during implementation of caf, showed improvements regarding outputs of perfomance of local self-government unit (budget management, management of property, management of capital investments, management of projects)? a. yes b. mostly yes c. neither yes or no d. mostly no e. no 9. has your measurement, during implementation of caf, showed improvements against indicators of development of local community (number of employed, number of unemployed, number of registered businesses, improvements in infrastructure etc)? a. yes b. mostly yes c. neither yes or no d. mostly no e. no article history: received: january 6, 2018 accepted: june 7, 2018 microsoft word 2009_1_2.doc business operation and technology strategy besim ćulahović, university of sarajevo faculty of economics and business administration, sarajevo, b&h zvonko brnjas, belgrade banking academy, belgrade, serbia jel: l2, 032 technology strategy: some key elements defining technology strategy: key foundation and questions conventionally, the broad objective of technology strategy is to guide a firm in acquiring, developing and applying technology for competitive advantage. a firmʹs technology strategy is also expected to serve its overall strategy in developing and exploiting firm specific advantage. in this sense, it is contingent on the firm to ensure a consistency between technology and business strategies. the economics literature has emphasized the role of technological capabilities in acquiring and sustaining firm level competitive advantage. these capabilities broadly relate to the ability of firms to handle technologies and cope with technological change; the ability to absorb and build on technologies. in this context, building such capabilities should be the focus of strategic technology management endeavors. figure 1. three foundation of technology strategy at the firm level these strategic choices get translated into a variety of decisions which cut across functional boundaries. need assessment, make-buy choices, identification of the technology and its source, selection of the collaborator if joint development is involved, levels and timing of r&d and associated investments etc. are all part of this complex decision process. studies have shown that formulation and implementation of technology strategy are constrained/determined by a variety of features which distinguish technological economic analysis 1-2 (2009) 19-31 20 activities from other activities and one industry/firm from the other. following a recent analytical review of these issues, we summarize some of these features here. figure 2. three key questions of technology strategy effective technology strategy rest on three foundations: a) value creation, b) value capture and c) value delivery, i.e. on answers to these three key questions (see figures 1 and 2). the foundations and questions build capability to maximize value and profits. more formally, a technology strategy as a choice of capabilities to maximize profits given that: • profit is a function of value delivered and competitive offerings, • value delivered is a function of product attributes (in the broader sense), • product attributes are a function of technical capabilities and value chain, • technical capabilities are in house capabilities and partner skills, in an environment in which many of these relationships are not fully characterized and in which they will probably all change over time. so, a central part of effective technology strategy is to use of effective tools to understanding evolution: • the s curve and dominant design • the evolution of markets • understanding competition • who will make the money? • appropriability and complementary assets • exploring organizational competence • no one best way: organizational competence as a key strategic choice • putting the pieces together: the evolution of competition and competence over the life cycle. b. ćulahović, z. brnjas / ea 1-2 (2009) 19-31 21 formulation of technology strategy technology is at the core of systems designed to satisfy societal or customer needs. companies are formed to provide a structure and a mechanism that facilitate the spinning out of technology to satisfy those needs. when a company has a vision and develops its mission statement, it is stating the reasons the company exists and the inherent values of the company. when the company develops a strategy and its associated plans of action, it creates the vehicle that moves it toward the fulfillment of its mission and the attainment of its vision. the purpose of business strategy is to gain a sustainable economic advantage. the purpose of technology strategy is to gain a sustainable technological advantage that provides a competitive edge. the two strategies must be closely intertwined and highly integrated. this requires extensive forethought about the firmʹs distinctive technologies, the products or services it can provide, the potential customers, and where the organization wants to be in the future. the companyʹs technologies must be harnessed and exploited according to a welldesigned plan. effective technology management is based on successfully linking business and technology strategies. technology strategy is concerned with exploiting, developing, and maintaining the sum total of the companyʹs knowledge and abilities. many organizations still seem to underestimate technologyʹs importance. there are many factors that determine business success; although technology is a very important one, it is not in itself sufficient to ensure business success. good business is about integrating technological innovation with production, marketing, finance, and personnel to achieve established goals. two commonalities among companies that use technology as a competitive weapon are: 1. management views technology as a major competitive weapon but does not emphasize it at the expense of other areas. 2. the criteria used to support any project consist of (a) whether the project supports the business goal, (b) whether the project protects and/or establishes technological leadership, and (c) whether the project solves customer problems. technology gives a company a competitive edge. corporations with inferior technology cannot compete with corporations utilizing superior technology. however, to use technology as a competitive weapon, managers must manage it as part of the business system. michael porter advocates that technology strategy be formulated within the larger context of business planning. porterʹs approach to formulating a competitive strategy is to concentrate on optimizing the efficiency of the value chain. this implies developing and maintaining a competitive advantage by finding the most effective means of carrying out all the activities of the business process so as to offer the customer long-term value. porter proposes that a technology strategy be formulated using the following steps: 1. identify all the distinct technologies and sub-technologies in a value chain. 2. identify potentially relevant technologies in other industries or under scientific development. 3. determine the likely path of change of key technologies. 4. determine which technologies and potential technological changes are most significant for competitive advantage and industry structure. economic analysis 1-2 (2009) 19-31 22 5. assess a firmʹs relative capabilities in important technologies and the cost of making improvements. 6. select a technology strategy, encompassing all-important technologies that reinforce the firmʹs overall competitive strategy. 7. reinforce business-unit technology strategies at the corporate level. linking technology and business strategies business success depends on the products or services brought to the market. as previously indicated, these have their base in technology. organizations that know how to link their technology strategy with their business strategy will be more competitive in the global marketplace. the first step toward integrating business and technology strategies is to get the business and technical sides of corporate management to agree on a common usually the business and technology strategies side perceives technology as a subset of business, while technologists perceive business as a subset of the general technological ascent of human beings, as shown in figure 3. on one side, technology is a subset of a business enterprise. market demographics influence the success of the business. here, businesses tend to identify technologies relevant to creating business opportunities that satisfy market demands. on the other side, technology, through its role in the ascent of human beings, is the influencing factor in creating business. business becomes a subset of technological advances that create significant opportunities for companies. for optimal results both sides must be integrated into one organizational strategy. metaphorically speaking, integrating technology strategy and business strategy can be thought of as two sides of a coin: either side is worthless without the other. figure 3. framework for formulation of business set of priorities companies that have a one-eye view toward business-oriented functions, such as finance, accounting, marketing, and sales, may face technical obsolescence or miss out on potential growth and profitability. similarly, companies that focus entirely on technological development without effective strategy for exploiting the technology in a timely manner may not be able to sustain profitability. management must be able to align its technology and business strategies to focus on achieving its goals and objectives. an interesting illustration of this concept is shown in figure 4. b. ćulahović, z. brnjas / ea 1-2 (2009) 19-31 23 figure 4. integration of technology and business strategies the technical community tends to hold the view that technical achievements by peers around the world often provide a more reliable guide to the future than do formally documented business forecasts. by contrast, the business-planning community usually looks at markets and other external trends as a more obvious and direct source of business opportunity. these two perspectives need to be reconciled. the linkage between the goals and objectives of the corporation and its technological strategy is very important. broad consensus and understanding must exist between business and technical managers throughout a company. a number of generic questions that should be addressed by strategic planners on both the business and the technical sides of the house: what new strategic options will technologies provide? in responding to these questions, a company can develop relationships among its highlevel strategies, its lines of business, and the technologies that are needed to achieve business goals. a company can then proceed to develop the product-technology-business connection. technology strategy features nature of technology and innovative activities few of many inter-related features of technology, technological change and innovative activities identified in the literature, which can impinge on firmsʹ technology strategies are discussed here. tacitness: a significant part of knowledge developed by enterprises is tacit; it is difficult if not impossible to codify. this is particularly the case in the early phases of technology development and where circumstantial specificity is high. while it is difficult to make a general statement, among the three ps, practice is likely to most tacit in nature. tacitness has significant implications for the transfer and appropriability of technology. broadly, as tacitness of a technology increases, appropriability goes up but transfer becomes increasingly difficult, requiring significant efforts on the part of the buyers and sellers of technology. economic analysis 1-2 (2009) 19-31 24 differentiated and cumulative nature of learning: innovation related activities are highly differentiated. specific technological skills in one field (e.g., developing pharmaceutical products) may be applicable in closely related fields (e.g., pesticides), but they are of little use in other fields (e.g., designing automobiles). besides, technological change is often incremental in nature based on continuous cumulative learning; discrete/ quantum changes in technology are few and far between. however, the degree of specificity and cumulativeness may differ across the three ps and firms may consciously need to ascertain if learning on any one of the ps could be generalized across technologies within the organization. cumulativeness like tacitness adds to appropriability of technology. technology supply chain: technological inter-relatedness plays a crucial role in technological development. linkages with upstream and downstream technologies (users) may hinder or induce technological change in a segment (see below). such a network of “linked” innovators or the technology supply chain may also be important in another way. often, the full benefits of new technologies are not reaped because all elements associated with the technology are not adequately implemented within the organization; product, processes and practices linked to a technology need to be embodied in the organization for good results. traditionally, technology development has been analyzed within the boundaries of a firm. the role of input-output linkages the firm has with other entities is usually ignored. suppliers of products and processes are, at best, seen as ʺborrowed blueprint makersʺ who would fabricate only on the basis of given designs. the problem with this approach is that innovation is viewed as a compartmentalized and discrete activity. however, empirical evidence suggests that successful development of technology, either in the form of products, processes or practices, has often involved interaction of firms across industrial sectors. technology development in these supply chains takes advantage of the synergies of technological capabilities in their respective sectors. for example, improvements in weaving processes in a textile mill may call for a close interaction with a textile machinery firm which in turn may have to depend on the assistance of firms in machine tool and microelectronics sectors. technology supply chains form natural clusters for continuous improvement of products processes and practices. in economic terms, these technology supply chains can be seen to form the core incentive structures for technological activity. it is the joint interest of the suppliers and users of technology which induces continuous innovation. appropriability: despite various legal provisions for protecting intellectual property, appropriability of an innovation is never complete. how far the results of the r&d activity be internalized and how far will they constitute a public good depends on a large variety of factors including tacitness, cumulativeness and complexity of technology, market structure and access to complementary assets. what is not appropriated by the innovating enterprise spills over? technology spillovers in a sector determine the potential for imitation in that sector. we have already referred to the links between appropriability and technology specific features. it is the discussion of complementary assets that we now turn. b. ćulahović, z. brnjas / ea 1-2 (2009) 19-31 25 complementary assets and technology strategy-manufacturing strategy interface in all these decisions, which are expected to develop firm specific competitive advantages, the issue of complementary assets will have to be tackled. in the absence of such assets, which include manufacturing and distribution capabilities, appropriation of new technologies may be rather limited. the earlier literature analyzed the role of complementary assets in the context of the technology life cycle: in the initial phases of new technology commercialization, competition is among designs. uncertainties are about which design will emerge as dominant. it is of strategic relevance in this phase to make efforts to create the dominant (standardized) design closer to firmʹs specification. after the emergence of the dominant design, price (and delivery) competition becomes more relevant. consequently, reduction in costs through process innovation, scale economies and learning becomes crucial. these processes get reflected in the empirical observation that when new technologies are commercialized, process innovation often follows product innovation. with the slowing of the rate of product innovation, designs tend to become more standardized, providing the opportunity for large scale production and the deployment of specialized assets. while this perspective on the technology life cycle is instructive, it implicitly assumes that a breakthrough innovation underlies this transition. recent developments and the success of the japanese firms, especially in the auto sector, have challenged this linear-dichotomous (product versus process innovation; design versus price competition) characterization of the processes at work. even during the phase of process innovation, significant product innovations may take place; firms compete on new variations of the old designs with significant reductions in lead times. within the broad technology life cycle, product life cycles are increasingly becoming shorter with high rates of product obsolescence. besides, both product and process innovations may require simultaneous attention for reaping full benefits of product innovations as an exclusive focus on product innovations may delay. complementary assets can be generic, specialized or co-specialized. generic assets are general purpose assets that do not need to be tailored to the innovation. specialized assets are tailor-made for the innovation, and are necessary for the implementation of the innovation. co-specialized assets are those for which there is bilateral dependence. in any case most developing country firms are usually not dealing with breakthrough innovations. therefore the role of complementary assets needs to be analyzed in a different context. in almost all cases, the successful commercialization of an innovation requires that the know-how embodied in the innovation be utilized in conjunction with such complementary assets as competitive manufacturing, marketing and after sales support. whether the assets required for least cost production and distribution are specialized is important for strategic decisions regarding integration and collaboration. it has been suggested that when managers make r&d and commercialization decisions, they must identify, preferably ahead of time, the complementary assets that the innovation will need for success full commercialization. contractual or collaboration alternatives will make strategic sense if the complementary assets are not specialized, or if the appropriability of the innovation is ironclad. economic analysis 1-2 (2009) 19-31 26 collaboration/contract modes can also be acceptable if (i) the required complementary assets are not critical; or (ii) for assets which cannot be procured by the innovating firm due to lack of financial resources; or (iii) for assets in which imitators are already irrevocably better positioned. otherwise, the integration (in-house availability of complementary assets) alternative ought to be preferred to capture the value of the innovation. given limited appropriability of technology, strategies that employ co-specialized assets and other interdependencies are advocated to generate and protect the economic rents from innovation. manufacturing capability is often seen as one such asset. empirical evidence has shown that competitive manufacturing provides significant learning potential and the associated cost, quality, delivery and flexibility advantages. just like successful commercialization of certain innovations is dependent on access to good manufacturing facilities, nature of existing manufacturing facilities can condition nature of innovation activities (even technology strategy) undertaken by the firm. competitive manufacturing is also likely to be critical in many circumstances because technology and product (and industry) life cycles are not co-terminus; a given embodied technology may be able to provide various generations of new products. as the technology moves from early design to the stable stage, manufacturing ought to move through job shop, batch and continuous process modes. depending on product variants and volumes, the focus of the manufacturing facility, capacity levels, and manufacturing infrastructure changes to meet the strategic technology needs. this, in essence, characterizes the manufacturing strategy of a firm. sometimes, production capabilities provide strategic choices for in-house innovation for new product and process introduction. industry characteristics observed sectoral patterns of technical change are often seen as a result of the interplay between various kinds of market inducement, and opportunity and appropriability combinations. structural and technological characteristics of industrial sectors affect opportunity and appropriability conditions and therefore, impinge on technological strategies of firms in these sectors. structural features: competition involves rapid imitation with innovations continuously superseding each other. therefore, there is incentive to innovate only if one feels confident of being able to exploit that innovation rapidly. monopoly or imperfect competition provides a better setting in which to exploit innovation. the schumpeterian view is that monopoly power and large size of the firm facilitate/induce technological advance. this is so because the large oligopolistic firms are better able to internalize the benefits of innovation and are generally more certain of their environment. such firms have the wherewithal to exploit new technology quickly largely due to better access to finance and complementary assets like manufacturing facility and capacity and marketing infrastructure. therefore, oligopolistic industries are expected to be more innovative. empirical studies, however, have not been able to discern any neat pattern of linkages between market structure and technological activity. while the importance of complementary assets cannot be denied for any innovation, the schumpeterian logic is probably more apt for breakthrough innovations rather than continuous improvements of the kaizen variety. it is not clear if the empirical investigations b. ćulahović, z. brnjas / ea 1-2 (2009) 19-31 27 are able to make a clear distinction between these two types of innovations. furthermore, differences across and within industries in terms of product/industry life cycles, can complicate empirical investigations. in any case, the implications of market structure may differ for the three ps of technology: oligopolistic power may not be required for changes in practices and many incremental process (even product) innovations. the firms, especially in the developing countries, need to recognize such opportunities and benefit from them. technological features: many studies have emphasized the existence of significant intersectoral differences in the nature, sources, determinants and objectives of innovative activities and resulting innovations. on the basis of sectoral specificities observed in developed countries, pavitt has identified five categories of these sectors: supplier dominated, specialized suppliers, scale intensive, science based and information intensive. broadly, as compared to other sectors, technological opportunities are higher in science based firms (given munificence in underlying technologies) and in specialized suppliers (given continuous pressures to improve production efficiency in user sectors). the information intensity of many sectors is on the rise. it should be emphasized that these are not watertight categories and a firm may show features of more than one category. besides, the characterization of these sectors can change over time. while the importance of product and process innovations may differ across sectors, the relevance of practice innovations is likely to be high in all the sectors. firm characteristics a large variety of firm characteristics, impinging on technology strategies have been highlighted. it is not our purpose required to cover all these features; only a few points are made. the role of firm size has already been highlighted above. we only wish to reemphasize that large firms are often able to internalize the benefits of innovation because of the access to complementary assets which include competitive manufacturing facilities, distribution and service networks and complementary technologies. a multi-product firm has opportunities for economies of scope based on transferring technologies across product lines and blending them to create new products. despite the path dependent nature of technological change, the diversity of application areas for a given technology is often quite large, and it is often feasible and sometimes efficient to apply the firmʹs capabilities to different market opportunities. a multi-product firm, therefore, may have the opportunity to widely diffuse the innovations in the three ps, especially practices. firms commonly need to form external linkages, vertical (both upstream and downstream), lateral, and sometimes horizontal in order to produce and market their products. for example, linkages are extremely important when there is vast consumption in supplier-dominated sectors, innovation is exogenous to the sector and is embodied in purchased inputs. r&d is low and mainly adaptive due to limited technological opportunities. firms in the specialized suppliers sector focus on product innovations that enter other sectors as capital goods. formal r&d is low but abundant innovation opportunities are exploited through tacit design and engineering capabilities. innovation is endogenous to the scale-intensive sector as part of production activities in large complex production systems. production engineering and learning-by-doing are major sources of technology. r&d expenditure is high as these forms generate their own process technology economic analysis 1-2 (2009) 19-31 28 in many cases and integrate vertically to make their own equipment. innovation activity is endogenous to the science-based sectors also but is located in labs and based on rapid developments in underlying sciences. technological opportunities are high resulting in high r&d expenditures. product innovations from this sector enter a wide range of sectors as capital or intermediate inputs. technological accumulation in information intensive firms comprises the design, building operation and improvement of complex systems for the storage and processing of information. improvements are incremental and experience based and emanate from operating experience in large user firms and suppliers of systems and application software. technology policy and its links with technology management technology policy in transition most advanced countries have established sets of policies which are directed towards the national capacity to produce and utilize technology in the interests of social and economic development. these include, most notably, incentives such as subsidies and/or tax concessions for firms investing in r&d or hiring research and engineering personnel. although their roots can clearly be traced to science policies and they still share some of the same types of instruments, technology policies are now considered to fall into a specific and separate policy area. they tend to embody distinctive objectives (most notably the advancement of industrial competitiveness) and address particular problems (such as the uptake and utilization of technology by industrial firms). they reflect a perception that the world of technology, which is mainly the province of firms searching for profits, follows rules which are rather different from that of science, despite the fact that the two worlds are intimately associated and mutually dependent on one another. technology management: the emergence of the concept the concept of technology management draws on the same roots as contemporary technology policies. reflecting the principles, technology policy into the private sphere, technology management sees technology as a core strategic resource, with many systemic characteristics, which must therefore be considered from an integrated perspective. on the part of firms, technology management serves to ensure that the synergies between different technological capabilities and applications are fully exploited, and that the organization, skills, and other associated factors are in place to optimize the value of these resources. this obviously requires a sophisticated understanding of the nature of technology and the determinants of technological change. like business strategy more generally, technology management can be seen as a function at the interface between a series of bottom-up and top-down processes of organizational development, both of which serve to emphasize the growing importance of technology as a component of the way business is done. technology management is the point at which longterm visions of research at short-term (continuous) improvements in products and process meet (see figure 5). b. ćulahović, z. brnjas / ea 1-2 (2009) 19-31 29 figure 5. technology management: where long-term visions and short-term improvements meet the search for improved performance of existing business processes has, on the one hand, brought together methods at technologies that were previously separate: total quality management, just-in-time logistics, electronic data interchange, cad-cam, management information systems, etc. these partial improvements are being increasingly integrated into more comprehensive approaches requiring a strategic orientation over the enterprise as a whole: lean production, computer-integrated business, business re-engineering. on the other hand, there is growing appreciation of the need to link research and development more closely to the long-term needs of the enterprise. this has led to a number of management approaches which link the firm's overall business strategy with its technological capabilities. the concepts of 'core competence' and 'core technology’ are illustrative of this trend. firms are increasingly thinking of technology not just as an internal factor which forms a major element of their specific competitive strengths, but as a means to leverage external capabilities, via strategic alliances and joint ventures. an important impetus towards the technology-management approach comes from the lessons of failure in accommodating to technological change. heavy investments in new production technology were made by firms in the 1980s with little understanding of their operational and strategic implications. they were driven by the perception that easy gains in productivity could be captured by introducing high technology automation such as robotics, and supported by various government initiatives. the widespread failure to realize the anticipated benefits has been well documented, and the lessons learnt have been a determining factor in developing the more sophisticated approach to technology associated with the notion of technology management. technology management implies a movement economic analysis 1-2 (2009) 19-31 30 from considering technology in functional terms or in relation to individual business processes, towards an overall appreciation of technology from a corporate perspective. it also reflects an appreciation that the fundamental and distinctive competences of firms are not static features which relate only to their present products and processes, but that they have important dynamic characteristics, at the same time allowing an accumulating innovative capability, but also constraining the direction of their future competitive development. the rationale for technology management the essential factors which make technology management so important for firms are fourfold: first, the widespread and diversified impact of technology on competitive performance in practically all areas of business, technology has become a dimension on which firms are able to differentiate themselves from their competitors, whether their strategies relate to price, quality, speed to market, or other aspects of competition. this is no less true of service than manufacturing sectors: the information revolution has ensured that sectors like telecommunications and financial services are amongst the most technologically dynamic. neither is the phenomenon restricted to high-tech industries; the sectors just cited, for example, carry out relatively little research of their own, and there are innumerable examples of where astute introduction of new process technologies has rejuvenated industries once regarded as mature. technology management fills the need for a much broader concept than research management, which is relevant to the complete range of processes within the firm and practically all types of firm. second, the interdependence between technology, knowledge and skills. what the failures of the 1980s demonstrated above all was that the level of performance of complex technological systems is not an attribute of the hardware alone. understanding and making use of the full potential of investments in technology depends upon complementary investments in the knowledge and skill of the people making use of the technology. this goes well beyond the workforce directly associated with the technology in question, and may affect all levels of management. the specific knowledge necessary to master complex technologies in a specific business context is rarely widely available, and accumulates only slowly. this means that firms are closely bound to the development paths that their previous history has prepared them for, and their business strategies need to be based on an understanding of the limitations of their own technological capabilities in the face of radical changes in the technological basis of their industries. third, the organizational implications of technological change exploiting in-house technological resources in the development of new products and processes depends upon an organizational capacity to transcend functional and divisional boundaries and thus bring together research activities from different product areas and put them in close contact with development and marketing activities, etc. exploiting external sources of technology, on the other hand, can demand a capability to transform production processes to take advantage of the new possibilities opened up by the technology. emerging management paradigms such as ‘lean enterprise’, ʹcore competence’, ʹbusiness process re-engineering’, and so on, can be seen to involve both organizational and technological components, closely linked. b. ćulahović, z. brnjas / ea 1-2 (2009) 19-31 31 fourth, the limits to technological autonomy enjoyed by firms the complexity of modern technologies and their intrusion into all aspects of business mean that even the largest and most technologically advanced firms depend quite extensively on technology sourced from outside. all firms face the need to monitor technological developments undergone by their suppliers, customers, and competitors. increasingly, firms are thinking of leveraging their own technological capabilities by combination with those of other firms, through strategic alliances, joint ventures, and more informal networking arrangements. this brings additional organizational and skill-related problems internally, to manage a variety of external interfaces and assimilate the knowledge arising from them, whilst protecting against leakage of the firmʹs own intellectual property. bibliography a social history of american technology, oxford university press, new york, 1997. bassala g.: the evolution of technology, cambridge university press, new york, 1993 j. bradford de long, estimating world gdp, one million b.c.-present, http://ec-oni6i.berkeley.edu) cardwell d.: turning points in western technology, new york, 1975; cowan r.s.: a social history of american technology, oxford university press, new york, 1997; david p.: technical choice, innovation and economic growth, london 1975 freeman c.: the economics of industrial innovation, baltimore, 1974; gilfillan s.c.: the sociology of invention, cambridge, mass. gobac s.: tehnologija proizvodnih procesa, informator, zagreb, 1987; hughes t.p.: american genesis: a century of invention and technological enthusiasm, 1870-1970, viking, new york, 1989; mansfield e.: microeconomics, new york, 1975; jones l.j.: history of technology, rupert hall and norman smith, london, 1979. schumpeter j.a.: the theory of economic development, cambridge, mass, 1934 ea_2015_3-4 udc: 005.412:332.122 cobiss.sr-id: 220029708 scientific review region as a basic territorial unit of regional development (concepts and types) radulović dejan1, faculty for economics and management engineering, novi sad, serbia pindžo renata, singidunum university, faculty for economics, finance and administration, belgrade, serbia radulović sofija, faculty for economics and management engineering, novi sad, serbia vuković darko, belgrade banking academy, belgrade, serbia abstract – the authors analyze and summarize the history of the development of the region, meaning of the term region and types. the paper analyzes the regions as basic territorial units which are important for regional development, the area in which establishes and implements regional development policy. the concept of the region is seen dynamically, in a historical context. the subject of the work is focused on the study of the phenomenon of the region as a territorial unit for the preparation and implementation of regional development policy for the purpose of equitable development. the authors analyzed different concepts and underlined the most important characteristics of the idea region and its types. based on the analysis, definitively that the region is starting and basic territorial unit for planning and implementation of sustainable policies for regional development. key words: region, types of regions, regional development, regional policy, regional state introduction historical development there are different definitions of the region, which is derived from the latin word „regio” which means the area, zone, region, area, space, city, region, and district. this indicates that the ancient romans used this name indicating some space within the country without any legal impact. historically, the regions and the regional concept of the organization of human communities are much older than modern national states and states of nation (lilic, s., 2009, 7-21; komsic, j., 2009, 81-94). by nature and character, the regions are the first forms of connecting people and the human community, which identifies the space which the best expresses and realizes the interest of a community (pavlovic, v., 1994, 52). region as a form of physical connection, besides the territorial proximity, represents functionally and interest 1 docеnt phd, faculty for economics and management engineering in novi sad (femec), former assistant minister in the government of the republic of serbia in the period 2010-2014, in charge for the sustainable regional development as well as for the development of smes and business infrastructure. correspondence: radulovic@notarvozdovac.rs 70 economic analysis (2015, vol. 48, no. 3-4, 69-80) organization, which define phenomena such as culture, language, traditions, the spirit of life, the economy. the emergence of "praregion" is caused by political factors (todorovic, m. tošić, b. stojanovic, b., 2004, 24). among these the first forms of the regions we have two different groups: • territories that were under the rule of the powerful feudal • territories that were totally free i.e. city-states that existed in ancient greece (polis athens, sparta) or rome (res publica). the emergence of the region is not linked to spatial-functional development. it’s a result of the independence process of some urban centers, which are the result of either weak central government or even of its non-existence. the first forms of the region like we have today, appear very early, between the fourteenth and nineteenth centuries in the south mediterranean and central parts of the continental area (vasic, n., 2007, 52). in mid-nineteenth century, when we had a big socio-political changes, abolition of feudalism in the central european countries, political unification and forming of germany and italy, the role of the regions also changes his meaning. the political factor loses its significance and increasingly coming a functional meaning. in the countries which had traditionally strong central government and which were typical of a unitary state (france), there is a real and less formal regionalization in which the dominant role is urbanization and expansive development of large cities, which have become centers and the main initiators of physical functional transformation in the entire territory. on the other hand, in countries with newly created central authority (germany and italy), in which the political-territorial structure existed for centuries "praregions", with the impact of urbanization (rapid industrial development and the development of transport infrastructure), inherited transition autonomous operation of individual territorial units (regions ) influenced on the internal political-territorial and spatial-functional organization, which will since today, lead to the new forms of regional differences and connections. in the eastern and southeastern europe, until the modern era was not pronounced processes of regional differences. the reason for this is the centuries-long hegemony and domination of the ottoman empire in eastern europe and organization of the state as a national and strictly centralized. and in the period of socialism states remain centralized because their ideology and command economy requires a strong central government and the state. this led to the creation of political and psychological barriers to the process of regionalization. the contribution to this is the lack of the basic prerequisites of a functional character (dominant urbanization, poor transport infrastructure, the government is entirely at the central level). meaning of the term "region" region (vujaklija, m 1991, 2 .; markovic, j., pavlovic, m., 1995, 3-4) means: • region geographical meaning: region, landscape, city, area, region or layer; • region social, political (administrative) meanings: area, province, territory, social order; radulović, d., et al., region (concepts and types), ea (2015, vol. 48, no. 3-4, 69-80) 71 • region medical significance: part of the body or the layer of air. in a broader sense it can be a territory, province, prefecture, district or administrative area. for smaller areas in geography used the term "micro-region". regions can be conditionally divided into: • physiognomic regions (ie. a homogenous which have its own distinctive appearance and physiognomy, thanks to the homogeneity of the environment and social processes); • functional regions (an important feature given the elements of spatial organization, ie. the consequences of men working); • nodal regions (based on territorial entity with its own center around which gravitates to its environment; latin “nodus” node). the region (geographical meaning) is territorial entity with its own geographic structure which is framed in space and time, and that is difference from other units. the regional geography studying and describing the regions. her work is to allocate a regional entity, limit, describe and establish the causal link between the natural and social factors that have influenced education. on that occasion, regional geography serves methods of study, such as analysis, synthesis, mapping and fieldwork. in determination of the region it is necessary to establish its borders because of delimitation and for more precise determination of geographic content. it is best when the boundaries are natural, but also we often have borders of states which are unnatural and non-ethnic. to extract of the neighboring region is sufficient and less, especially pronounced differences in their geographical inventory (for example, banat and bačka separates the tisza, but with all the similarities of these two vojvodina region show large differences). the border of region is often broad, imprecise zone of permeation. but, for determination of quantity of some geographical region, it is necessary to define the boundary in the form of lines. without that, would not know the surface of region, number of people and villages, fields and forests fund, membership of a factory or length of roads. the limits are necessary, but that are often disputed. the borders of the pannonian area towards the mountain-valley basin area is determined by the contour line of 800 m, because the north side of the dinaric watershed, stepped down to the lowlands, whose altitude is greater for some in coastal lowlands. limit of the adriatic area for the mountain-valley-basin macro-region is conditionally determined by the contour line of 500 m, with respect to the zero point of the sea level and the fact that the 500 m height of some low mountains. the ambiguous, vague and undefined border regions, changes their name and frame, make it difficult or impossible comparative views of the region and analyzing information about them. it is difficult even for recognized (traditional, natural, economic, ethnic, and historical) geographical units. in the serbian geographical terminology have been adopted and international generally accepted names for the regions micro-region, sub region, mesoregion and macro-region. each region consists of two main factors regions and areas. the region is spatially individual natural entity which concludes geomorphological, climatic, hydrological and pedological factors, while the area is the space with prominent socio-economic and anthropological characteristics (population, economy and settlements). the region is therefore an integrated region and area, ie. the complex heterogeneous space with comprehensive geographic content (ink, n, 2005, 87). 72 economic analysis (2015, vol. 48, no. 3-4, 69-80) in political-territorial sense, there are interpretations that the region represents determination and hedge part of the country as a separate entities with established institutions. the broader meaning would be that this non-institutional hedge certain space which with some of its properties represent the region (jovicic, m., 1993, 964), which represents the optimal rounded complex, which is characterized by uniqueness: economic, geographical and transport nature, the interconnection of parts region and similar conditions for independent existence and development (jovicic, m., 1996, 87). in political sciences, the interpretation of the region is based on social and political criteria which defining the region as a unit large enough to be within its framework organized by various forms of social life and can politically be strong enough to be a kind of counterbalance to the central government, and not to endanger the territorial integrity of the state. central authorities tend to have authority over more areas of life, people and especially, of resources, and the regional government prevents them to do that (stanovčić, v. 1999, 40). in sociological sense the region represents the interaction of different political, economic, ecological, cultural, mentality factors, which allows different interpretations of the concept of regions in the modern state. the region may be considered as: air-geographical area, supranational political economy as a whole and etc. (avramovic, z. 2001, 194). in cultural sense in determination of the essence of the region a major role has social, i.e. collective psychology, since he is not only a physical fact and with time starts to becomes the collective consciousness. people live in a particular area and develop a sense of self, gain awareness of the interconnectedness and belonging, identified themselves with the interests of the region and allocate more material and spiritual symbols that express those interests and the sense of belonging together (veljanovski, r, 1998, 50-51). economically, the region is defined as a part of the territory of a country, which is characterized by geographical entity and economic homogeneity, inter-regional division of labor and product orientation, and generates around one or more industrial centers. the region should be by sufficient size to available natural resources and human potential in the given socio-economic conditions, facilitate the creation of economic development, and specialization with the simultaneous development of production complex on the territory (group of authors, 2001, 589). we could say that it is territorially rounded part of a state regardless of its size. the region contains the common features of the entire economy and therefore exhibit the following general principles of development and follow common goals that connect the parts into a whole system. with regard to the specifics of the area as well as the diversity of interests of the population, appear some regional goals which do not match at all with the interests of the economy as a whole. development’s factors of the region are: population, area, natural resources, infrastructure, manufacturing, etc. (group of authors, 1984, 695). in the process of defining the concept of a region, we can say that on the one hand, it contains features that connect him with the whole country, and on the other hand, contains features that make it specific and can give him dimensions more than have the state. the western balkans, eastern and central europe, include parts of several countries: the pannonian region, the danube region. radulović, d., et al., region (concepts and types), ea (2015, vol. 48, no. 3-4, 69-80) 73 in terms of the europe, the region represents the basic economic-territorial unit for planning and implementing development policies. we could say that "the european concept of the region" was created in order to implement the regional policy of the european union in all its member states. the institution of the region in some legal systems and institutions of the state is not present, while others are trying to introduce the concept of the region in its constitutional and legal system. we could define region as a community in which the boundaries are not drawn, but they recognize and respect each other. it represents a form of organization of people who are halfway between the local community and the state, which can be determined by a number of criteria such as: geographical and territorial, cultural, traditional, ethnic-linguistic, topographic, climatic, industrial and urban, administrative, political, statistical, economic and others. we can conclude that this term is not clearly defined, and there is no one definition and one only meaning of that. often in the literature, we can find the interpretation that the region represents the highest level of the local government (đorđević, s. 2002, 60). if we look at the german federal unit we will see that they are referred to the regions even though they have a government which with her own nature and authority does not represent the level of local government (đorđević, s. 2002, 81). also, often we can hear that the parts of the territory of a country called regions even though they do not represent the level of government. when we talk about regional policy of the european union, the region can be considered as only one city but sometimes the whole country. types of regions in the literature we have to concepts of the regions: a. broader (wider) concept the region is bounded by non-institutional space in some properties (cultural, historical, geographic, demographic, language and so on.) is a special region (matić, m. podunavac, m, 1993, 65) (territorial unit), which has a specific regional identity in order to preserve these specifics as special interest (matić, m. podunavac, m, 1993, 67). this broader definition of the concept of a region can be understood as a simple division of the country into territorial units in some ways, where the division does not necessarily have to do with the system of government or with the political system of the country. this can be: a geographic location (aland islands, greenland); common historical, cultural and economic characteristics; specific cultural identity shaped multi-ethnic composition of the population (spain, italy); distinctive ethnic composition of the population (scotland, wales). in international terms the region is determined by the space that bind some similar characteristics, which is different from the environment and makes it more countries that share common characteristics or interests, such as for example the western balkans. this concept is based on the natural and social facts. 74 economic analysis (2015, vol. 48, no. 3-4, 69-80) b. narrower concept the region is bounded by space specific for some properties, except that it is an element regularly existing political-territorial division. he is a political element with a clearly defined status in law or constitution. in the narrower concept we have some different types: 1) administrative statistical regioninstitutional bounded territory which is the level of government. division into regions with their regional government (political) and those who do not (administrative and statistical).the regions which do not have power can differ on administrative (administrative) and statistical-planning regions. in the administrative regions at the level of the defined area, there are state bodies, i.e. administration which are local office of the central authorities which are necessary for the operation and enforcement authorities. these regions represent devolution. in serbia there name is district. these subdivisions are often the basis for the establishment of statistical regions in accordance with the nuts classification. in some countries this type of regions coincides with statistical regions. in countries where these administrative regions smaller, usually statistical regions formed by merging several administrative regions. statistical region can, but need not, be both administrative (administrative), which for him in this case says that the region is non-administrative territorial unit. statistical regions are also known as: economic, analytical and functional development. the states have defined territory for the policy or for the collection of certain statistical data. at the end of the 50s, france has created administrative and planning regions and regionalization carried out in order to facilitate governance and management. due to modern changes in economic and political fields, regions receive a number of new functions, naturally retaining old ones. in this type of regions include those from which it implements eu regional policy. earlier traditional unitary state (ireland, greece), create administrative bodies at the level of those regions in order to harmonize with european union criteria for the realization of regional policy and achieving regional development and use of dedicated funds (đorđević, s. 2004, 5). these processes of strengthen of the region may lead to the formation of political regions. 2) administrative (governing) region serves as a territory within the state in which they operate distraction central authorities. they are formed as a form of dispersion. they have a hallmark of sub-state level of state authority organization. this form is characteristic of a unitary state. it is a form of administrative decentralization. the affairs of state i.e. of public administration does not perform only one organizational unit, but a higher number. for this reason, we have definition of administrative territories that represent the area in which operates one organizational unit of the central authorities which means administrative region which has not its own legal personality, political power i.e. has not government, powers, autonomous regional finance and cannot be constitute like a separate level of autonomous public authorities. in such units they do not make any policy, but is implemented regional policy of the government. these administrative regions radulović, d., et al., region (concepts and types), ea (2015, vol. 48, no. 3-4, 69-80) 75 over time and often served as a basis for future political or statistical regionalization. as an example of these administrative regions in our country can make parallels with districts that exactly and only serve the purpose of the administration (they coincide with nuts3 in our country). 3) political region specific for the existence of democratically elected and fully rounded authorities. they enjoy political self-government and autonomy. they are formed as a form of territorial decentralization of power. this means that for the performance of tasks assigned to the region formed by the regional authorities, which are directly elected by the citizens of the region. in this way, the region, with its system of government and administration, with the powers allocated to it and a certain degree of autonomy that belongs to it, is the decentralization of power and middle level management. depending on the powers and the status he has, the region may represent a level of local government, federal unit, and some combination of these two cases (regions in italy and spain). it is important that political region includes the legal personality, a certain set of competencies and public finance, i.e. a certain degree of freedom and autonomy in governance. they can be only in certain parts of the national territory (asymmetrical regionalismexamples are our autonomous provinces (vojvodina and kosovo and metohija), northern ireland, scotland, wales) or on the entire territory of the state (a symmetrical regionalism-essential precondition for european regional policy). the assembly of european regions (the pan-european organization founded in 1985, which promotes regional level management and ensures the possibility of participation of the region at the international level) adopted a "declaration on regionalism in europe", in which the region is recognized as a territory which is the subject of public law established at the level below central government and who has been given political self-government and as such is recognized by the constitution or by law. the declaration means that the region should be established by the constitution or by law under which he is guaranteed autonomy, authority and organizational structure. political regionalization (stačetić, v, 2009, 10-11), is the process of forming a political regions and giving some kind of power and responsibilities from the central government to regional authorities. in depend of that powers and responsibilities we can recognize different types of regionalization. according to the degree of autonomy from the central government, political regions can be: • regions with characteristics of regional governments; • regions incurred in devolution as a territorial autonomous units; • regions which the state provide form of regional state. according to the method of generation: • regions which are generated through the expression of administrative-territorial division of the unitary state as a special form of local government (greece, portugal); 76 economic analysis (2015, vol. 48, no. 3-4, 69-80) • regions which arise in the process of adapting existing forms of territorial organization, with the principles of the regional organization of the state (sweden, germany, the netherlands); • regions (spain, italy), which represent a form of "institutional regionalization, which involves introducing regions in the structure of government as a political entity that contain the feature of decentralized authorities but the main quality of political autonomy" (radovic, z, 2000, 33-40; radovic z, 2000, 57). important political characteristics of the region are: legal status, the definition of regional, finance and competencies. based on the legal status of act which include definition and determined region, regionalization, can be: • constitutional category – for example italy, in which constitution is a number of the region and the name of the region and are partly regulated by regional competences, rights and obligations. in article 114 of the constitution of the italian republic states that the italian republic consists of municipalities, provinces, metropolitan cities, regions and countries. article 117 specifies the responsibilities of the state, and everything else belongs to the competence of the region. • legal category which is the case in france, poland, the czech republic, slovakia. the french regions are weaker than the italian because they have no legislative power, the greater is degree of control of the central government. this regional power vary from country to country, and we can say that we distinguish five models in the european union: • constitutional regions with state powers (germany, austria, belgium, switzerland); • regions with wide political and administrative autonomy (spain, italy); • regions in decentralized countries (france, the netherlands, poland, czech republic); • regions whose authority is formed indirectly through districts (ireland); • small states whose size corresponds to the size of the region. allow for the practice of european countries, the council of europe has tried to make a kind of classification models and is so identified several types of regions, building on the types of authorization, the degree of representative democracy and the legal basis for regionalization (report on european practice and recent developments in the field of regional self-government, the cdlr, 2006): • regions with powers to adopt acts of the original legislation, which the existence is not guaranteed by the constitution or federal legislation (spain, scotland in the uk); • regions which have the right to adopt acts of primary legislation, whose existence is guaranteed by the constitution or federal arrangement (belgium, italy); • regions with powers to legislate within the framework of national legislation, which the existence is not guaranteed by the constitution (wales in the uk, poland); radulović, d., et al., region (concepts and types), ea (2015, vol. 48, no. 3-4, 69-80) 77 • regions which have the power to make decisions, but they have no legislative powers, with the assemblies which they are directly elected (denmark, sweden, france, turkey and the metropolitan area of london in the uk); • regions that have the power to make decisions, but not the laws, which the assembly is not elected directly and local governments make them (finland, latvia). • there are different regional systems of government, but for all we can identify some common features; • regions are part of the territorial structures (federation, regional or unitary state); • they have the highest level of organization of local self-government, and on the other hand have some other states duties; • regions can be the basis of the movement for national independence and in the field conflicts arise to the central government for fear of possible secession (scotland and wales in the uk, catalonia and the basque country in spain, quebec, canada, brittany in france, etc.). the existence of political regions within a country is its internal affair. although this form of state organization and decentralization recommended by the region, though there is no obligation to actually implement this. when we talk about economic regions, all eu members must be regionalized to be able to use the funds from the eu funds. the statistical division of the country on this regions is also called regionalization, but it is not regionalization in terms of decentralization when introduced regions in establishing the regional authority and gives a certain autonomy. this statistical or economic regionalization of the country should be carried out with respect for the principles laid down as a standard for the whole of the european union. it is the formation of a hierarchical structure of territorial units that are supposed to represent an effective instrument to balance all of the units within the state. based on this classification collecting some dates, analyzing the situation and propose measures regional policy of the european union. the introduction of these regions will be based on so-called. nuts classification established as the standard for all members of the european union. various forms of the region in the practice of some states exist in the same time: in spain, there are 26 statistics (nuts level 1 and 2) regions and 16 territorial-political region; in the uk has 49 statistics (nuts level 1 and 2) in the region, during the process of creation (i.e. devolution), three territorial and political regions (wales, scotland and northern ireland); in france there are only administrative regions and that 27 of them, and in some states of the european union exist only statistical regions. we can conclude that for spain the regions are question (attempts) for survival, and for france the only term is unacceptable when we talk about corsica, which is called a "territorial collectivity", while all other territories in france are administrative regions. in the french law exist an exception, it is accepted that one part of the territory and the population lives, has a special treatment because of its historical and geographical linguistic-cultural characteristics, and is officially (1991) established a special status for corsica (the "territorial collectivity of corsica"). status of corsica represents an entirely original solution and has enabled france to more clearly perceive the specific requirements of the population of a 78 economic analysis (2015, vol. 48, no. 3-4, 69-80) particular region, which will have an impact on the attitude of the state towards other minority communities. for the institutionally strengthening of the region the state is responsible, and state defines the regions and their functions constitution or law, which they will have the right but also the responsibility to manage an important part of the economic, political and cultural development of society, which beyond the capabilities of local communities and complicated central government institutions. conclusion for the european concept of the region in the context of the implementation of regional policy and regional development of the european union, it is not necessary that the state party is organized on the principles of regional states, such as for example spain and italy. regional orderly state, are peculiar form of institutional organization of the state characterized by the division of powers between different levels of government organizations. the division of responsibilities among different levels of government organization is also the specific form of restricting government because under the equivalent functions of state government establishes more of those in authority, including the competence conferred and differ in content, scope and quality. regionally organized state is a specific form of complex state characterized by a diversity of shapes and specific relations between the state (central government) and the autonomous communities (regions). we could conclude that the region with the european concept only has significance as an economic, statistical functional territorial integrity, which can be classified in the developed or the underdeveloped region, for implementation of regional policies. this is particularly important for the development of backward regions which have very small attention. as can be seen by the percentage of the eu budget that is spent on starting and acceleration in economic growth of lagging regions. for new members in which are poorest regions, this should be an excellent opportunity for a much faster development than would be the case if the poorer countries are developing with own resources. a big responsibility is on the member states when we talk about products and expected results. that includes the creation of conditions and organizational structure like as funds that the region has or some available resources, be use on the best way. in the end, we could perform a unique conclusion that regional development policy is a policy with clearly articulated objectives in relation to the regions, with the establishment of which regions qualify for that purpose or how the region can receive money depending on the degree of development. this means that when we talk about regional development policy of the european union, it should be borne in mind that that is not only about regional development in the narrow sense, but rather an effort to achieve connectivity in the european union by reducing the existing differences in levels of development between its regions. references lilić, s. 2009. „regionalizam evropske unije i pravni okvir regionalizacije srbije“. in izazovi regionalizacije. izazovi evropskih integracija. belgrade, official gazette no. 6. radulović, d., et al., region (concepts and types), ea (2015, vol. 48, no. 3-4, 69-80) 79 komšić, j. 2009. „političko-institucionalni aspekti regionalnog razvoja srbije u svetlu evropskih standarda“. in izazovi evropskih integracija, belgrade, official gazette no. 6. pavlović, v. 1994. „o pojmu regiona i regionalizma“, in: „regioni i građani“. subotica, subotičke novine. todorović, m, tošić, b, stojanović, b. 2004. srbija, evroregioni i evropska integracija. belgrade: serbian academy for science and arts, geographical institute, „jovan cvijić“. vasić, n. 2007. „dominantne regionalne inicijative u jugoistočnoj evropi“collection of papers, „duhovnost pisane kulture srba u kontekstu kultura balkanskih slovena“. institute for serbian culture, leposavić. vujaklija, m. 1991. leksikon stranih reči i izraza. belgrade: prosveta. marković, j, pavlović, m. 1995. geografska regija jugoslavije. belgrade: savremena administracija. mastilo, n. 2005. rečnik savremene srpske geografske terminologije. belgrade: geografski fakultete. jovićič, m. 1993. regionalizam, lexicon of political culture. belgrade: savremena administracija. jovičić, m. 1996. „regionalna država“, ustavno pravna studija, chapter „podela na regione“. vajat, belgrade. stanovčić, v. 1999. „lokalna i regionalna samouprava u demokratskoj teoriji“, chapter „regionalizam i ideje regionalne države“. collection of papers of matica srpska (department for social science), no. 106-107. novi sad. avramović, z. 2001. „regionalizam i demokratija (regionalizam kao ideološko sredstvo desuverenizacije)“, chapter: „globalizacija, desuverenizacija, regionalizacija“. sociološki pregled, vol. xxxvi, january-june 2001, belgrade veljanovski, r. 1998. „alternativa postoji“, peace and crises management foundation, chapter „region-forma i sadržaj“. belgrade. group of authors. .2001. ekonomski rečnik. belgrade: faculty of economics. group of authors. .1984. ekonomska enciklopedija 1. belgrade: savremena administracija. đorđević, s. 2002. renesansa lokalne samouprave. belgrade: faculty of political science matić, m, podunavac, m. 1993. enciklopedija politička kultura. belgrade: savremena administracija. đorđević, s. 2004. „regioni kao najviši nivo organizaovanja lokalne vlasti i značaj regionalne integracije“. in: evropski standardi u lokalnoj samoupravi. belgrade: palgo centar. stačetić, v. 2009. „region kao razvojna perspektiva u evropskoj uniji.“ official gazette no. 8. belgrade. radović, z. 2000. principi ustavne deklaracije. belgrade: forum for ethnic relations. radović, z. 2003. regionalizacija srbije. belgrade: clds. skupština evropskih regiona. www.a-e-r.org report on european practice and recent developments in the field of regional selfgovernment, cdrl. 2006. 80 economic analysis (2015, vol. 48, no. 3-4, 69-80) region kao osnovna teritorijalna jedinica regionalnog razvoja (koncept i vrste) rezime – autori analiziraju i daju pregled istorije razvoja regiona, značenja pojma regiona, vrste regiona. rad se bavi analizom regiona kao osnovne teritorijalne jedinice značajne za regionalni razvoj, teritorije na kojoj se utvrđuje и primenjuje politika regionalnog razvoja. koncept regiona sagledan je dinamički, u istorijskom kontekstu. predmet rada usmeren je na proučavanje fenomena regiona kao teritorijalne jedinice za pripremu i primenu politike regionalnog razvoja u svrhu ravnomernijeg razvoja. analizirani su različiti koncepti i podvučene najznačajnije karakteristike pojma regiona i njegovih vrsta. na osnovu analize zaključeno je da je region polazna i osnovna teritorijalna jedinica za planiranje i sprovođenje održive politike regionalnog razvoja. ključne reči: region,održiv razvoj,politika regionalnog razvoja article history: received: 18 november, 2015 accepted: 21 november, 2015 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp1-17 original scientific paper demographic changes and sustainable demographic development in the western balkans verica janeska1* | aleksandra lozanoska1 | elizabeta djambaska1 1 ss. cyril and methodius university in skopje, institute of economics-skopje, skopje, republic of macedonia abstract the main goal of this paper is to identify the challenges of the sustainable demographic development in terms of the changes and current demographic situation in the western balkan countries and to detect the importance of population policies. the analysis is based on the relevant indicators for demographic changes identified in the sustainable development strategy of the eu. the comparative analysis is made for the following countries: albania, bosnia and herzegovina, croatia, montenegro, republic of macedonia and serbia. the available data from the eurostat statistics and other relevant data sources and studies for the last decade are used. the added value of this research is in the comparison of the demographic indicators and recognizing their importance for the sustainable demographic development of this region as one of the key preconditions for the future sustainable development. the results of the analysis show that the demographic changes are big challenge for the sustainable development in all western balkan countries. they have implications in many domains and should be in the focus of the demographers, researchers and policy makers in different fields of the macroeconomics. the lack of data for old-age income adequacy and public finance sustainability imposes the need for comprehensive database in each country as a precondition for continuous monitoring of the demographic changes and for creating appropriate policies regarding the sustainable development. based on the results of this research, the common areas where the population policies of these countries should be directed are identified. key words: demographic changes, sustainable demographic development, western balkan, employment rate of older workers jel classification: j1, j21, q01, h5 introduction the sustainable development means improvement of the quality of life and the welfare of the existing and future generations through making relations between the economic development, protection of the environment and social justice. in these terms the changes in the population development are very important because they have significant influence on all aspects of the sustainable development. in contemporary conditions, worldwide they are manifested in certain misbalance between the working-age population and older population, which has implications on the economic and social development, especially on the social transfers. having on mind the importance of the human resources, particularly human capital, as a one of the key factors for sustainable economic development, many studies are observing the * e-mail: verica@ek-inst.ukim.edu.mk 2 economic analysis (2018, vol. 51, no. 1-2, 1-17) demographic changes and trends. intensified demographic changes are a global phenomenon resulting from two almost universal trends: declining fertility and increasing life expectancy. most countries in the world experience declining fertility or have stagnating fertility. in most developed countries fertility is below replacement level, and the majority of countries report increasing life expectancies. as a consequence, most parts of the world will witness demographic aging – defined as a rise in median age of populations and a growing share of people above age 65 – during this 21st century. large discrepancies, however, will remain (muenz, 2007). his assumptions, today become real and has happened sooner than expected. the western balkan countries in the last decade are facing major demographic changes, due to low birth rates, changing family structures and intensified emigration abroad. it results with accelerated demographic ageing that implicates serious challenges for the economic and social development and is expected to become even more important in the future. therefore, the sustainable demographic development is one of the key aspects of the western balkan countries’ sustainable development. this paper is considering the demographic changes and the sustainable demographic development in the western balkan countries: albania, bosnia and herzegovina, croatia, montenegro, republic of macedonia and serbia. the comparative analysis is based on the set of sustainable development indicators agreed upon for monitoring the sustainable development strategy of the european union (eu sds). the demographic changes can be followed through one key indicator which refers to the employment rate of the older workers, as well as through several others divided in three groups: demography (life expectancy, population growth, total fertility rate, migration and old-age dependency); old-age income adequacy (income level of over-65s compared to before); public finance sustainability (government debt, retirement, the impact of aging on public expenditure, pension expenditure projections). the analysis refers to the period 2006-2016 and the eurostat database (and world bank database for one indicator) as comprehensive source of comparable data is used. almost all previously mentioned indicators, except: the impact of aging on public expenditure and pension expenditure projections, for which there isn’t any data in the eurostat and world bank databases, are analyzed. although for some of the indicators there isn’t data or the data is incomplete for some of the western balkan countries, the paper gives certain knowledge for the changes and current conditions regarding the sustainable demographic development in these countries. overview of the demographic indicators employment rate of older workers the employment rate of older workers (55-64 years) is important indicator for the sustainable development because it shows the ageing of the population, the adaptability of the labour force market, the sustainability of the pension and social system. also, higher employment rate of older workers is guaranteeing strong public finances. the available data for this indicator for the period 2007-2016, despite some oscillations, show that it has a tendency of increase in all western balkan countries (table 1). it is highest in the republic of macedonia (almost 12 percentage points) and in serbia (nearly 11 percentage points), and lowest in croatia (for 1.5 percentage points). comparable data1 for 2015 shows that the numerical value of this indicator is in the range from 28.2% (bosnia and herzegovina) to 53.6% (albania). concerning the employment rates of older workers by sex, the differences between the employed men and women were and remain emphasized. regardless of the more highlighted 1 because for bosnia and herzegovina the employment rate of older workers for 2007, 2008, 2009 and 2016 is calculated for the age group 50-64 years, the comparison between the western balkan countries is made for 2015. verica janeska, aleksandra lozanoska, elizabeta djambaska 3 dynamics of the women’ employment increase, the employment rate of men is significantly higher in all analysed western balkan countries. for example, in 2015 the employment rates of older men were in range from 37.3% (bosnia and herzegovina) to 66.9% (albania), while of women from 19.8% to 39.2% in the same countries (figure 1). table 1. employment rate of older workers (55-64 years) in the western balkans, 2007-2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania : : : 48.3 54.7 56.3 51.1 51.2 53.6 : bosnia and herzegovina 31.9 34.4 34.0 26.8 27.0 27.2 27.7 28.5 28.2 36.8 croatia 36.6 37.1 39.4 39.1 38.2 37.5 37.8 36.2 39.2 38.1 montenegro 37.7 34.2 35.6 35.6 34.1 37.0 38.7 39.3 40.0 41.2 republic of macedonia 28.8 31.7 34.6 34.2 35.4 35.4 37.9 38.6 40.1 40.7 serbia 33.5 40.6 39.3 32.9 31.4 31.6 34.3 36.7 37.3 44.2 * the employment rate for 2007, 2008, 2009 and 2016 are for the age group 50-64 years source: eurostat database, employment rates by sex, age and citizenship (%), last accessed: 12.4.2018 if we compare this indicator in eu28 with the western balkan countries, the situation was and remains unfavourable for the second ones. in 2015, the employment rate of the older workers is 53.3% (for men 60.1%, while for women 46.9%). in the observed period the increase of the employment rates of older women in eu28 is also more emphasized and significantly higher than in western balkan countries. figure 1. employment rate of older workers (55-64 years) in the western balkans and eu28, by sex, 2015 source: eurostat database, employment rates by sex, age and citizenship (%), last accessed: 12.4.2018 the lower employment rates of older workers, as well as the discrepancies between western balkan countries are result of a several factors, such as: the different employment sectors, retirement ages, and opportunities for early and partial retirement, retention of older workers, employment policy incentives and incentives to work longer. furthermore, the sectorial distribution has an impact on the employment rates by providing more or fewer opportunities to find a job or to remain employed. considering the intensity of the population ageing in each country, the values of this indicator can be assessed as unfavourable in terms of the social transfers’ sustainability. 4 economic analysis (2018, vol. 51, no. 1-2, 1-17) until 2011, the employment rate of older workers has been evaluated against the target set out in the lisbon strategy and the eu sds, which was to increase the average eu employment rate among older men and women (55 to 64) to 50% by 2010. based on the available data, on eu level the target is met, while none of the western balkan countries (except albania), until 2016 didn’t reach that goal. in the publication titled: employment and social developments in europe 2012 (european commission, directorate-general for employment, social affairs and inclusion directorate a, 2012) is stated that increasing the employment rates of older workers has become a focus of policy actions because it is considered a promising answer to the demographic challenge of structural longevity. a longer working life can both support the sustainability and adequacy of pensions, as well as bring growth and general welfare gains to an economy. with employment rate of older workers of 55.2%, eu is concerned and aware of the importance to increase it. the western balkan countries with lower values of this indicator and intensified demographic ageing have to pay more attention to increase the employment of older workers in order to expect sustainability of the pension systems as one of the key aspects of sustainable development. demography life expectancy the increase of the life expectancy implicates greater and longer demand for pensions, health care and social protections, as well as long term care for the elderly. in terms of identifying the influence of the life expectancy on the sustainable development of a country, it is important to perceive the life expectancy and the healthy life years at age 65 in which one person is capable to have a good and quality life. however, due to the lack of complete and comparable data for the analysed western balkan countries, this analysis refers only to the life expectancy at age 65. therefore, one should have in mind that we are observing the expected years of life, but without knowing how long the people will be in good and healthy condition. the available data on this indicator are from the eurostat database and is referring to the period 2006-2016 for croatia, montenegro, republic of macedonia, serbia and albania for 20142016 (there is no data for bosnia and herzegovina). the expected number of years left to live at age 65 for the total population at this age, in the period 2006-2016 has a tendency of slow, but constant increase in four out of the five analysed countries. it amounts as follows: in serbia for 1.4 years, in croatia 1.3, in montenegro for 1.0 and in the republic of macedonia for 0.9 years. albania in 2016 is characterized with a nearly the same life expectancy at age 65 as it was in 2014 (table 2). having on mind the differences between men and women regarding their health, physical and psychical conditions, it is important to identify the life expectancy at age 65 by sex. this indicator, for men, as well as for women has continuous increase, although, the expected number of years left to live is higher for women. the gap between men and women’s life expectancy in 2016 remains around 3.6 years in croatia, 2.7 in montenegro, 2.5 in serbia, 2.0 in republic of macedonia and 1.5 years in albania. when it comes to the life expectancy of men, in 2016 albania is distinguished with the highest (16.8 years), while macedonia with the lowest life expectancy at age 65 (14.5 years). as for the women, croatia has the highest (19.2 years) and macedonia, again, has the lowest value of this indicator (16.5 years). in 2016 the life expectancy at age 65 in eu28 amounts 20.0 years for the total population, 18.2 for men and 21.6 years for women. life expectancies in the balkan countries (albania, montenegro, republic of macedonia and serbia) are comparable to the life expectancies in the lowest ranked eu member states. verica janeska, aleksandra lozanoska, elizabeta djambaska 5 table 2. life expectancy at age 65, by sex, in the western balkan countries, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 total albania : : : : : : : : 17.6 17.0 17.5 bosnia and herzegovina : : : : : : : : : : : croatia 16.3 16.1 16.4 16.5 16.7 17.0 17.0 17.4 17.5 17.1 17.6 montenegro 15.1 15.2 15.7 15.7 16.3 16.2 16.2 16.3 16.4 16.2 16.1 republic of macedonia 14.6 14.3 14.6 14.9 15.0 15.0 14.9 15.5 15.4 15.3 15.5 serbia 14.6 14.8 15.0 15.0 15.2 15.2 15.4 15.7 15.8 15.7 16.0 males albania : : : : : : : : 16.6 16.2 16.8 bosnia and herzegovina : : : : : : : : : : : croatia 14.2 14.1 14.4 14.5 14.7 15.1 15.0 15.3 15.5 15.2 15.6 montenegro 14.0 14.1 14.5 14.7 15.2 14.9 15.1 15.0 15.1 15.0 14.6 republic of macedonia 13.6 13.3 13.6 13.9 13.9 14.0 13.9 14.4 14.5 14.3 14.5 serbia 13.5 13.6 13.8 13.8 14.0 13.9 14.0 14.3 14.4 14.4 14.6 females albania : : : : : : : : 18.5 17.8 18.3 bosnia and herzegovina : : : : : : : : : : : croatia 17.8 17.8 18.0 18.0 18.2 18.6 18.7 19.1 19.1 18.7 19.2 montenegro 16.0 16.0 16.7 16.7 17.3 17.4 17.2 17.5 17.5 17.2 17.3 republic of macedonia 15.5 15.2 15.6 15.8 16.0 15.9 15.9 16.4 16.2 16.2 16.5 serbia 15.6 15.8 16.0 16.0 16.2 16.3 16.5 16.9 16.9 16.8 17.1 source: eurostat database, life expectancy by age and sex], last accessed: 12.4.2018 the population ageing process and longer life expectancies at age 65 in almost all analysed western balkan countries, may lead to higher public spending on older people. however, elderly people are not just recipients of pensions or long-term health care, rather the public health-care costs for older people depend on their health status. because elderly people are often the ones who provide care for other elderly people, improvements in their health status may mean they are able to provide more care to others (for example, to a spouse or a parent). furthermore, elderly people often engage in volunteer work or help look after grandchildren, thus providing important services to society that would otherwise have to be purchased in the marketplace (doyle, mckee, rechel, grundy, 2009). population growth one of the indicators important for the sustainable demographic development is the population growth, measured through the crude rate of total population change. the data in table 3 shows that in the last decade western balkan countries were faced with unfavourable changes, because majority of them noticed certain population decrease. concerning these data, we should have on mind that maybe they aren’t reflecting the real situation due to the intensified emigration abroad in all these countries and lack of relevant data for its scope. in this terms, striking is the example of republic of macedonia, which according this data have a positive population growth, but in the population estimations the real scope of the emigration abroad is not considered. the available eurostat data shows that in the last decade only in the eu receiving countries the number of macedonian citizens is increased for about 140.000 6 economic analysis (2018, vol. 51, no. 1-2, 1-17) persons. also, significant is their rise in overseas and other receiving countries all over the world. so, there isn’t any doubt that in the analysed period the republic of macedonia has faced negative population growth rates. considering the available data for the crude rates of total population change for the western balkan countries, one can conclude that croatia is distinguished with very unfavourable change due to the most intensive total population decrease (table 3). in the observed period the value of the crude rate of total population change is in range from 0.2% (2006) to -8.7% (2016). similar is the situation in serbia where the value of this indicator is also negative, but the decrease has constant and significant intensity (from -3.8% to -5.1%, respectively). in bosnia and herzegovina, the changes in the population growth are negative since 2010, but less intensified and in 2016 the crude rate of total population change amounts -1.8%. for albania there is a lack of data for some of the years, but in the period 2013-2015 it is also faced with the decrease of the total population. table 3. crude rate of total population change in the western balkan countries, 2008-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 1.1 5.5 4.6 : : : : -1.0 -1.3 -2.2 -3.3 bosnia and herzegovina 0.4 0.0 0.0 0.0 -0.3 -1.0 -0.9 -1.2 -1.5 : -1.8 croatia 0.2 -0.4 -0.5 -1.6 -3.0 -3.2 -3.2 -3.6 -5.1 -8.2 -8.7 montenegro 2.5 1.5 2.6 4.4 1.4 0.7 0.9 1.0 0.9 0.2 0.3 republic of macedonia 1.7 1.6 1.7 2.0 2.2 1.2 1.2 1.7 1.6 1.0 1.2 serbia -3.8 -4.4 -4.2 -3.9 -4.2 -4.8 -4.9 -4.8 -4.5 -5.4 -5.1 source: eurostat database, http://appsso.eurostat.ec.europa.eu/nui/submitviewtableaction.do, last accessed: 24.4.2018 the crude rate of total population change in eu28 despite the oscillations has positive values. the population growth is mainly driven by positive net migration (indicating that immigration is exceeding emigration). since the demographic ageing is accelerating, and under the assumption that fertility will rise but still will remain at a relatively low level, negative natural change (more deaths than live births) would be inevitable in the future. therefore, positive net migration is expected to be only factor contributing to long-term population growth in eu28. quite opposite is the situation in the western balkan countries which are faced with an intensified emigration abroad of young population, which is narrowing the population reproductive base, which implies significantly decreased or negative natural population increase. at the same time, they are challenged with accelerated demographic ageing. so, in near future these countries will face even higher negative crude rates of total population change and very unfavourable demographic situation. total fertility rate the total fertility rate (tfr) is an indicator which shows whether there is a simple reproduction of the population in a country. when the tfr is smaller than 2.1, once all other conditions are unchanged, there is an assumption that the total and working-age population are decreasing. according the available data from eurostat, the western balkan countries are facing with below-replacement fertility, despite the manifested oscillations of the tfr indicator values (table 4). so, there are small changes in the tfr values in the period 2006-2016 and in the position of the separate western balkan countries. in 2006 the numerical values of this indicator are in range from 1.38 (albania) to 1.73 (montenegro), while in 2016 from 1.42 (croatia) to 1.79 verica janeska, aleksandra lozanoska, elizabeta djambaska 7 (montenegro). although with below-replacement fertility montenegro is separated with relatively better position among western balkan countries. the eu28 is also characterized with below replacement fertility, although in the analysed period the value of tfr is increasing (from 1.54 in 2006 to 1.60 in 2016) and is slightly better compared to majority of the western balkan countries (european commission and eurostat, 2011). these changes in the tfr, more or less, are result of the changes in the family structures, influenced by fewer marriages, more divorces and increasing share of children born outside marriage. the possibility of a flexible and less traditional family life seems to have a positive impact on individual child-bearing decisions. also, fertility tends to rise when the welfare of the country is increasing. table 4. total fertility rate in the western balkan countries, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 1.38 : : : : : : : 1.79 1.67 1.56 bosnia and herzegovina : : : : : 1.27 1.24 1.25 1.26 1.31 1.33 croatia 1.47 1.48 1.55 1.58 1.55 1.48 1.51 1.46 1.46 1.40 1.42 montenegro 1.73 1.80 1.89 1.98 1.70 1.65 1.72 1.73 1.75 1.74 1.79 republic of macedonia 1.46 1.46 1.47 1.52 1.56 1.46 1.51 1.49 1.52 1.50 1.50 serbia 1.43 1.38 1.40 1.44 1.40 1.40 1.45 1.43 1.46 1.46 1.46 source: eusrostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tps00199&plugin=1, last accessed: 12.4.2018 *source for bosnia and herzegovina for 2011-2014 http://mecometer.com/whats/bosnia-andherzegovina/total-fertility-rate/, for 2015-2016: http://www.worldometers.info/world-population/bosniaand-herzegovina-population/ the changes in the total fertility rates in the western balkan countries are accompanied by a significant change in the fertility features and determinants. the majority of life births in the western balkan countries were within wedlock. it means that, mainly, fertility decline in the last decades was under the influence of marriages and divorce changes (fewer marriages and more divorces). although, an increase in the number of life births outside marriage is a common feature of the western balkan countries (except bosnia and herzegovina), its share in the total live births is considerably lower than in eu28 (about 40.0% in 2015) and have no significant influence on the fertility increase. concerning the timing of childbearing in western balkan countries evident is the postponement of the first births. changes of the mean age of childbearing are relatively small or insignificant, while mean age of women at the birth of the first child indicates significant increase in all observed countries. regarding this indicators, the panel regression results show that mean age of women at the birth of a first child have statistically a significant impact on the tfr for all western balkan countries (janeska, lozanoska, 2017). migration in analysing the migration in terms of the sustainable development, the crude rate of net migration plus adjustment should be calculated. the available eurostat data for the western balkan countries show that the value of this indicator has been fluctuating over time. so, in three out of six countries it has a negative value over the whole analysed period (2006-2016). they are: montenegro, republic of macedonia and albania. it means that the emigration in these countries is higher than immigration. based on the data from table 5 in montenegro the crude 8 economic analysis (2018, vol. 51, no. 1-2, 1-17) rate of net migration has raised from -0.1 per 1000 persons (2006) to -1.5 per 1000 persons (2016). in republic of macedonia there is a slight decrease of the value of this indicator (from 0.3 to -0.1). the crude rate of net migration has the highest value in albania, where in the period 2013-2015 (for which there is available data) this indicator has decreased (from -6.3 per 1000 persons to -5.7 per 1000 persons). croatia is characterized with positive value of the crude rate of net migration until 2009. after this year the indicator started to fall and in 2016 has reached value of -5.4 per 1000 persons. serbia and bosnia and herzegovina are the only two countries that have positive net migration, but in 2016 it was 0.0 per 1000 persons. having in mind these changes, it can be noted that majority of the western balkan countries have greater emigration than immigration, although not with high scope. but, different studies and data sources show that almost all western balkan countries are facing intensive emigration abroad, which imposes doubt about the relevance of the available data, or possibility that countries doesn’t have complete registration of the people who are emigrating. table 5. crude rate of net migration plus adjustment in the western balkan countries, 20062016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania -4.4 -0.4 -1.7 : : : : -6.3 -6.5 -5.7 : bosnia and herzegovina 0.1 0.3 0.0 0.1 0.1 -0.1 0.0 0.1 0.0 : 0.0 croatia 2.3 2.1 1.4 0.2 -1.0 -0.9 -0.9 -1.1 -2.4 -4.3 -5.4 montenegro -0.1 -1.5 -1.5 0.0 -1.5 -1.5 -1.5 -1.5 -1.5 -1.5 -1.5 republic of macedonia -0.3 0.1 -0.3 -0.3 -0.3 -0.4 -0.5 -0.2 -0.2 -0.2 -0.1 serbia 0.5 0.3 0.4 0.7 0.6 0.3 0.0 0.0 0.3 0.0 0.0 source: eurostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tps00019&plugin=1, last accessed: 12.4.2018 when it comes to the situation in eu28 there is a positive crude rate of net migration, meaning that the number of immigrants is higher than of emigrants, and in 2016 it amounts 3.0%. although, the migrant workers have positive influence on the economies of the receiving countries, the analyses are showing that the sustainability of the public finances can’t rely on the migrations. nevertheless, the strategy of sustainable development of eu recognizes the favourable contribution of the positive net-migration in terms of the challenges imposed by the demographic changes (janeska, 2012). migration affects demographic changes in various ways (postponing population decline, have positive influence on the population ageing, since the migrants usually are younger and have higher fertility rates, increasing the labour market supply, solving specific labour market shortages etc.) (european commission, 2007). since the western balkan countries are facing intensive emigration abroad, it is obvious that they have the opposite situation concerning the consequences of the migration on the sustainable demographic development. these consequences can be seen in the population growth, natural population increase and population ageing. so, as it was mentioned above, migrations have significant influence on the population growth due to a large proportion of children, young working-age population and population of fertile age lives abroad. regarding the consequences to the natural population increase, inevitable is the fact that the share of live births abroad in the total live births is continuously increasing. for illustration, in one research for the republic of macedonia, for the purpose of identifying the factors which influence the natural population increase of the migration contingent in germany, switzerland and italy, the correlated component regression is used. the results from the calculations are implying that the share of the macedonian live births in these three countries in the total verica janeska, aleksandra lozanoska, elizabeta djambaska 9 number of live births in the country, is significantly correlated with the increase of the share of total number of migrants in the total population of the republic of macedonia, as well as with the participation of women in these countries in the total women population in the republic of macedonia (janeska, lozanoska, djambaska, 2016). the consequences on the demographic ageing process in the western balkan countries are also very concerning. in situation, when the emigration of the young population is significantly intensified, the ageing process in these countries is accelerating. demographic ageing has numerous implications, and one of them is the increase of the old age dependency ratio. old age dependency ratio the old age dependency ratio is an indicator of the balance between the older population and the working-age population. it gives information about the potential pressure of the population aging on the public finances. it is determined by the age limit for retirement, by the level at what the pension system depends on the paid contributions or the public financing. the high value the old age dependency ratio implies great burden on the pension system which is based on the paid contributions, especially in terms of lower age limit for retirement. this indicator also gives information about the sustainability of the pension system in terms of the current demographic changes and the expected increase of the public consumption in the future decades. the available data on the old age dependency ratio in the western balkan countries shows that in all of them the value of this indicator is increasing (table 6). the highest increase is characteristic for albania, where from 13.1% (2006) it rose to 18.5% (2016). relatively higher increase is noticed in the republic of macedonia, from 16.0% to 18.5%, respectively. in the rest of the analysed countries the increase is around 10%. it is very important to notify that croatia and serbia are differentiating from other western balkan countries with the highest old age dependency ratio during the whole observed period. it is in range from 26.3% (2006) to 29.0% (2016) in croatia and from 25.1% (2010) to 28.5% (2016) in serbia. in the eu28 the old-age dependency ratio in the period 2006-2016 is significantly increasing from 25.0% to 29.3%. population projections point towards even stronger dependency of older people on persons of working age, as the ratio is expected to increase up to 50% in 2060. the trend towards a growing share of older people (aged 65 and over) in the total population and shrinking working-age population (15-64 years) has been observed for a long time. population ageing is a major driver of the expected increase in pension expenditure in the eu (eurostat, 2015). table 6. old-age-dependency ratio (per 100 persons) in the western balkan countries, 20062016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 13.1 13.3 : : : : : : 17.5 18.0 18.5 bosnia and herzegovina : : : : : : : : : : : croatia 26.3 26.5 26.7 26.8 26.7 26.5 26.7 27.1 27.6 28.3 29.0 montenegro 19.1 19.2 19.3 19.2 19.1 18.9 19.0 19.2 19.6 20.2 20.8 republic of macedonia 16.0 16.0 16.2 16.3 16.4 16.5 16.6 16.9 17.5 18.0 18.5 serbia 25.7 25.6 25.6 25.4 25.1 25.1 25.3 25.9 26.7 27.5 28.5 source: eurostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tps00198&plugin=1, last accessed: 12.4.2018 the high values, as well as the increase of the old age dependency ratio, in all western balkan countries implies heavier burden on the working-age population to provide social expenditure 10 economic analysis (2018, vol. 51, no. 1-2, 1-17) to support the ageing population. therefore, the countries should (if they didn’t) undertake reforms to limit the increasing effect of a population ageing on public pension expenditure. these reforms should include cancelation or restriction of the early retirement schemes, increasing the statutory ages or providing incentives to stay in the labour market beyond the legal retirement age on a voluntary basis. old-age income adequacy the old-age income adequacy measured through the aggregate replacement ratio is gross median individual pension income of the population aged 65-74 relative to gross median individual earnings from work of the population aged 50-59, excluding other social benefits. considering the available data on this indicator for the western balkan countries, i.e. the lack of data for all countries and for the complete analysed period, the comparison is difficult to be made. therefore, the analysis is focused only on identifying the changes and current situation in the countries for which there is available data. according the data in table 7, among the three countries for which there is a comparable data on this indicator, republic of macedonia has the highest aggregate replacement ratio, which increased from 55% (2012) to 72% (2016). it means that in 2016 the pensioners aged 65-74 had on average incomes equal to 72% of the average earnings of people close to retirement (aged 50-59). in serbia the value of this indicator in the period 2013-2016 is around 47%. for croatia there is data for longer period (2010-2016) and according it, the aggregate replacement ratio had a continuous increase until 2015 (from 0.32% to 0.40%), in 2016 the pensioners aged 65-74 had on average incomes equal to 39% of the average earnings of people close to retirement (aged 50-59). table 7. aggregate replacement ratio (in %) in the western balkan countries, 2010-2016 2010 2011 2012 2013 2014 2015 2016 albania : : : : : : : bosnia and herzegovina : : : : : : : croatia 0.32 0.36 0.36 0.37 0.40 0.40 0.39 montenegro : : : : : : : republic of macedonia : : 0.55 0.60 0.65 0.70 0.72 serbia : : : 0.49 0.47 0.47 0.47 source: eurostat database, http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tespn070&plugin=1, last accessed: 12.4.2018 the average income of people aged 65 and over in the eu28 relative to the earnings of people in their 50s has increased by six percentage points in the period 2010-2016. this increase, as well as the increase of the value of this indicator in the western balkan countries is a result of the same changes in the demographic structure of the population by age. given the pressure on pension funds due to the effects of demographic ageing, it is very unlikely that pensions of elderly people would actually increase. the increase in the replacement ratio might rather be a result of decreasing incomes of the working-age population. besides addressing poverty, pension systems play a role in allowing retirees to maintain adequate living standards comparable with those achieved during their working lives (eurostat, 2015). over the past decade most of the western balkan countries have reformed their pension systems to improve their medium and longer term sustainability as a precondition for delivering on adequacy objectives. however, the countries have to face trade-offs and difficult choices when trying to reconcile and optimize sustainability and adequacy concerns. achieving the goal verica janeska, aleksandra lozanoska, elizabeta djambaska 11 of cost-effective and safe delivery of adequate benefits that are sustainable is quite challenging (european commission, 2012). public finance sustainability government debt when it comes to the public finance sustainability in terms of the sustainable demographic development, the government debt as a percentage of gdp is an important indicator to be considered. based on the available and comparable data for the period 2006-2016 in all western balkan countries, the general government gross debt as a percentage of gdp, although with some oscillations, has a tendency of increase (table 8). the highest increase of 45.5 percentage points is characteristic for croatia, while the lowest for macedonia 8.1 percentage points. in the rest of the western balkan countries it is as follows: montenegro for 35.0 percentage points, serbia for 33.8, bosnia and herzegovina for 23.2 and albania for 14.8 percentage points. it is very important to point out that there is an eu reference value for the government debt of 60% of gdp.2 considering the available data on the western balkan countries, only in bosnia and herzegovina and in the republic of macedonia the value of this indicator didn’t reach that threshold. in the other countries, although in different year, the reference value of the government debt is exceeded. the general government gross debt in the eu28 has also increased sharply from 60.1 % in 2006 to 86.7 % in 2014. in 2016 it reached 83.5%. the big changes with this indicator happened after 2009, and were result of the economic crisis. unfortunately, there have been no signs of recovery since the onset of this crisis. in eu28 the government debt is exceeding the eu reference value starting from 2006 (except in 2007) (eurostat database, 2018). table 8. general government gross debt as a % of gdp in western balkan countries and eu28, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania 56.7 53.6 55.1 59.7 57.7 59.4 62.1 70.4 72.0 73.7 71.5 bosnia and herzegovina 21.2 18.7 30.9 35.1 42.8 43.1 43.4 44.5 45.0 45.4 44.4 croatia 38.9 37.7 39.6 49.0 58.3 65.2 70.7 82.2 86.6 86.7 84.4 montenegro 36.3 31.0 32.1 41.4 43.7 48.6 56.9 58.7 63.4 69.3 71.3 republic of macedonia 30.6 23.5 20.6 23.6 24.1 27.7 33.7 34.0 38.1 38.2 38.7 serbia 40.3 33.4 32.4 36.0 43.7 46.6 57.9 61.1 71.9 76.0 74.1 source: the world bank data, https://data.worldbank.org/indicator/gc.dod.totl.gd.zs?locations=al, last accessed: 10.4.2018 the increase of the government debt as a percentage of gdp is a consequence of several factors: revenue shortfalls due to the decline in the economic activity, measures to support the economy, including large-scale interventions to support the financial sector, as well as the effect of negative or very low economic growth (eurostat, 2015). recognizing that high levels of government debt are not sustainable in the long-term, the western balkan countries should put greater emphasis on reviving their economic growth. 2 the current provisions are defined in the 2012 consolidated version of the treaty on the functioning of the european union (http://eur-lex.europa.eu/legal-content/en/txt/?uri=celex:12012e/txt). 12 economic analysis (2018, vol. 51, no. 1-2, 1-17) retirement regarding the sustainable demographic development one of the key aspects is the retirement. it can be explained with the duration of working life (in years). in the eurostat database there are available data on this indicator only for three out of six western balkan countries. so, according to this data, the duration of working life is increasing (table 9). it is highest in croatia and lowest in the republic of macedonia. however, the differences among these three analysed countries aren’t very big, since this indicator is between 30-32 years in croatia and macedonia, and a little bit lower in montenegro (28-30 years). when it comes to the duration of working life it is important to see the differences by sex. in the western balkan countries, the number of years a person could be expected to be active in the labour market throughout his or her life, in the analysed period, was always higher for men. for illustration, in 2016 in croatia the duration of working life for men was 33.9 and for women 30.2 years, while for macedonia 37.2 and 24.4 years, respectively. a slight convergence between the two sexes is visible over time, meaning that the gap is narrowing. in eu28 the changes in this indicator are relatively similar. it means that the number of years a person could be expected to be active in the labour market is increasing. for example, from 33.8 (2006) to 35.6 years (2016). the duration of working life is higher for men than for women. also, the differences according this indicator between men and women are tightening, because this number for men has increased from 36.9 (2006) to 38.0 years (2016), while for women from 30.6 to 33.1 years, respectively. table 9. duration of working life (in years) in western balkan countries and eu28, 2006-2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 albania : : : : : : : : : : : bosnia and herzegovina : : : : : : : : : : : croatia 31.2 31.5 31.7 31.8 31.6 31.4 31.2 31.1 32.3 32.6 32.2 montenegro 27.8 28.7 28.7 30.1 30.8 31.2 republic of macedonia 30.0 30.2 30.6 30.9 31.1 31.1 30.9 31.3 31.3 31.2 31.0 serbia : : : : : : : : : : : source: eurostat database, http://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=lfsi_dwl_a&lang=en, last accessed: 23.4.2018 the world has largely focus attention on the pension system, because of the increasing need to cover pension benefits of socially excluded groups and provide all conditions to enable older population, economic independence and the necessary conditions for living standards. worldwide, 25% of the population covered by adequate social protection, and half has no social protection. the level of social protection depends on the level of gdp, employment rates in the relevant sectors of the economy, the share of self-employed in the labor market. in order to overcome the problem of social protection recommended modification of the contribution rate to social security, to be available to many socially disadvantaged, i.e. pension insurance are recommended and structural reforms in the macroeconomic environment in order to create conditions for the functioning of the pension system (đukić, balaban, radisavljević, 2017). challenges and policies of the sustainable demographic development the small population growth and the intensive demographic aging, which assumes decrease of the working-age population, as well as the increase of the life expectancy, accompanied with low fertility rates, undoubtedly will have unfavourable influence on the economic growth and sustainable demographic development of the western balkan countries. it is real to expect that verica janeska, aleksandra lozanoska, elizabeta djambaska 13 these changes will significantly influence the sustainability of the pension systems and the provision of the health and social protection for the older population, on middle and long-term. the need to anticipate these changes is especially emphasized in the terms when they can’t be compensated by postponed retirement and labour force immigration, which can jeopardy the sustainable development and the welfare of the population. the analysis of the available indicators important for the sustainable demographic development gives relevant knowledge for the current conditions and expected changes. in these terms, the main challenges of the sustainable demographic development can be identified. these challenges are as follows. it is necessary to apply more implicit measures of the population policy which can provide higher and sustainable increase of the fertility rates. also a set of policies and measures directed towards decrease of the emigration abroad of highly educated young population, especially in terms when there is a large number of unemployed with high educational level, should be adopted. it is very important to increase the employment rates, including those of the older workers, which is the key assumption to provide sustainability of the social transfers in the future. no less significant is the restructure of the social protection system, since it is expected the contingent of elderly to be significantly increased. the demographic changes in the western balkan countries in the last decades are being watched in absence of appropriate population policy which can direct them, regardless of the manifested unfavourable changes in the natural and migration movements of the population. the need for comprehensive population policy in the western balkan countries was identified in the sixties and seventies of the last century, anticipating the possible consequences of the demographic changes on the economic and social development. unfortunately, the creators of the population policy didn’t recognize the significance of this question, neglecting the long-term consequences and implications of the population development. the insights in the population policies show that in most of the balkan countries the "major" concern about population ageing appears earlier than the concern for "too low" fertility. the western balkan countries have policies related to fertility: with the purpose to "raise" it, and one (albania) to "maintain" its level. only bosnia and herzegovina government preferred "no intervention" (un, world population policies database, 2018) the current demographic situation indicates delayed fertility policies, measures and activities with relatively small effects on fertility "raise". experiences show that policies designed to increase fertility have only had limited success. so, the western balkan countries should design fertility policies to their specific pathways to low fertility and the social, economic and institutional environment in which fertility behaviour occurs. in circumstances when the importance of the biological factors is declining, they should pay more attention on the socioeconomic determinants of the fertility decrease and its complexity. in this respect recommendations in four areas of intervention are pointed out. related to pro-natalist policies measures should be more complex and focused on the socio-economic factors that determine childbearing postponement to older ages. financial incentives should be better targeted and focused on reduction of the opportunity cost of having children. because marriages are still an important determinant of fertility increase, the western balkan countries must pay more attention on family friendly policies with consistent measures and activities. also, the western balkan countries should implement proper policies concerning work-life balance, because the compatibility between childbearing and labour force participation of women is one of the key determinants influencing fertility (janeska, lozanoska, 2017). ageing will pose a challenge for government finances and social programmes. on the one hand, as the proportion of individuals of working age declines, so will government revenues from employment taxes and the growing number of elderly will need health care. in many advanced economies, pension systems risk bankruptcy. these problems can be tackled by policy reforms, such as changing employment, pension and tax policies. the decline in working-age populations could slow economic growth. indeed, the economist intelligence unit's economic 14 economic analysis (2018, vol. 51, no. 1-2, 1-17) projections for croatia and serbia to 2030 take this factor into account, and on this basis predict a decline in the rate of economic growth in these countries (european environment agency. 2010). in the present conditions, when the working-age population is under the continuous pressure to provide the social expenditures for support of the ageing population, it is necessary to take policies and actions for the elderly. this means to provide incentives the elderly to work longer, to increase the retirement age and continuous to develop their skills and lifelong learning. healthy public finances, reflected by general government gross debt, are essential to meet the needs of ageing populations and to promote economic growth while preventing debt from being handed down to future generations. in addition to pensions, which make up a big part of public expenditure, other expenditure might be needed to provide adequate old-age care and social protection. with an ageing population, the western balkan countries are facing trade-offs between pensions that are sustainable, on the one hand, and adequate, on the other. besides addressing poverty, pension systems play a role in allowing retirees to maintain living standards comparable to those achieved during their working lives, thus preventing social exclusion of the elderly. the shift towards longer working lives (later retirement) in the western balkan is essential to support the sustainability and adequacy of pension systems. conclusion the western balkan countries are facing major demographic changes, including decreasing of the population growth rate due to the below replacement fertility rates, an ageing population accompanied with increase of the life expectancy at age 65 and old-age dependency ratio, changing family structures and intensified emigration abroad. since 1990, western balkan countries have lost around a tenth of their populations. they could lose another 14 percent of their current populations by 2050, not least because of emigration, especially of young people. the low fertility rates of around 1.3 children per woman are another contributor to the rapid shrinkage of the populations of the west balkan states. at the same time, those populations are aging rapidly: while today around 15 percent of inhabitants are at least 65, this figure will probably rise to 26 percent by mid-century. in future, providing adequately for the growing number of old people is likely to pose a major challenge for the comparatively poor countries of the western balkans (sievert, s. at al. 2017). these changes have imposed serious challenges for the economic, social and sustainable demographic development. based on the analysis on the available demographic indicators in terms of the sustainable demographic development, several relevant conclusions can be made. the demographic changes in the western balkan countries can be assessed as unfavourable due to the negative changes which are characteristic for the majority of these indicators. although is characterized with increase, the employment rate of older workers is still relatively low, which imposes the question of the social transfers’ sustainability on medium and long term. the population ageing process and longer life expectancy at age 65 in almost all western balkan countries, mean that the public expenditures for pensions and for health and social protection will increase. however, one should consider that although the elderly are recipients of the previously mentioned public spending, significant amount of these costs depends on their health and social status. according the available data on the population growth seen through the crude rate of total population change, most of the western balkan countries are facing negative trend of this indicator, i.e. a decrease. this changes are expected since most of them are facing intensive emigration abroad, especially of young population, which is shrinking the population reproductive base and consequently results in decrease or negative natural population increase. verica janeska, aleksandra lozanoska, elizabeta djambaska 15 that is implicating very concerning demographic situation in the future demographic development of these countries. the total fertility rate (tfr) although has a tendency of increase, shows that in all western balkan countries there isn’t a simple reproduction of the population, i.e. that they are facing below replacement fertility. this implicates further decrease of the total population. the most important determinants of low tfr in these countries are the changes in the marriages and divorces, the postponed timing of childbearing, and the mean age of women at the birth of first child which is significantly rising. recent studies show that the western balkan countries are characterized with significant intensification of the emigration abroad. the emigration abroad implicates large proportion of children, young working-age population and population of fertile age to live abroad. it causes the population growth of the western balkan countries to decrease, their natural population increase to be negative and the demographic aging to accelerate. the shrinking proportion of the working-age population combined with the rising number of retirees puts pressure on public finances. this is reflected by the old-age dependency ratio, which has been continuously increasing over the last decade in all western balkan countries. these changes impose heavier problem for the working-age population to provide social expenditures to support the elderly. in these terms, the old-age income adequacy, measured through the aggregate replacement ratio is important indicator for the sustainable demographic development, but moreover for sustainability of the pension systems. the average income of people aged 65 and over relative to the earnings of the people in their 50s has increased in almost all western balkan countries. since, these countries are facing great pressure on their pension systems and it is very unlikely that the pensions will actually increase, it is necessary for the western balkan countries to start or to continue reforming their pension systems in order to provide their medium and long term sustainability. the government debt as a percentage of gdp is increasing in all western balkan countries. the available data shows that only in bosnia and herzegovina and in the republic of macedonia the value of this indicator didn’t reach the eu reference value (the government debt of 60% of gdp), while in the other countries, although in different years, it is exceeded. the high levels of government debt are not sustainable in the long-term, and the western balkan countries should put greater emphasis on intensifying their economic growth. but, due to the demographic changes, particularly the intensified emigration abroad, the growth should be achieved in terms of reduced human capital, which is one of the most important factors for economic development of these countries. all above mentioned demographic changes have more or less significant impact on the sustainable demographic development of the western balkan countries. since, all these countries are facing the increased impact of population aging on the public expenditures and on the pension system sustainability, it is an imperative for them to take consistent and comprehensive population and fertility policies, with particular attention on the emigration abroad. main challenges of the sustainable demographic development in the western balkan countries are the following: application of more implicit measures of the population policy to stimulate the fertility rates increase; decrease of the emigration abroad, especially of the highly educated and young persons; increase of the employment rates, including those of older workers; restructure of the social protection system, particularly for the older population, in context of its expected increase. development has been equated with the economic growth for decades, where the increase in the gross national product (gnp) per capita has been an indicator of the increase in the quality of people’s life. although economic growth is certainly a necessary condition for increase in personal well-being, it however does not necessarily correspond with the improvement of people’s life conditions. for example, it is noticed that, in some countries, relatively high level of gross national product gnp per capita is not followed by the high quality of life as expressed in 16 economic analysis (2018, vol. 51, no. 1-2, 1-17) terms of life expectancy, adult literacy, and infant mortality (radovanović, 2017). it implies the need for different approach to the demographic issues and more resources for implementation of the demographic policies, considering the importance of the sustainable demographic development for the economic development. having in mind the current demographic situation in the western balkan countries it is even more emphasized. references doyle, y., mckee, m., rechel, b., grundy, e. 2009. “meeting the challenge of population ageing”. bmj (clinical research ed.), 339. b3926. issn 0959-8138 doi: 10.1136/bmj.b3926 đukić, g., balaban, m., radisavljević, g. 2017. “the macroeconomic framework of the functioning of public compulsory pension insurance”. economic analysis, [s.l.], v. 50, n. 1-2, p. 26-37, oct. 2017. issn 2560-3949. available at: <http://www.library.ien.bg.ac.rs/index.php/ea/article/view/342>. date accessed: 31 may 2018. european commission. directorate-general for employment, social affairs and inclusion directorate a. 2012. “employment and social developments in europe 2012”, brussels. european commission. 2012. “pension adequacy in the european union 2010-2050”. report prepared jointly by the directorate-general for employment, social affairs and inclusion of the european commission and the social protection committee. european commission and eurostat. 2011. “demography report 2010 older, more numerous and diverse europeans”, commission staff working document. european commission directorate-general for employment, social affairs and equal opportunities unit e.1. 2007. “europe's demographic future: facts and figures on challenges and opportunities”. luxembourg: office for official publications of the european communities. european environment agency. 2010. “environmental trends and perspectives in the western balkans: future production and consumption patterns. part 2: driving forces that shape environmental futures in the western balkans“. no.1/2010 eurostat. 2015. “sustainable development-demographic changes”. http://ec.europa.eu/eurostat/statisticsexplained/index.php/archive:sustainable_development_-_demographic_changes, last accessed: 25.4.2018 eurostat database. 2018. http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tsdde41 0&plugin=1 last accessed: 25.4.2018 janeska, v., lozanoska a. 2017. “fertility changes in the balkan countries main features and challenges of the below-replacement fertility”. proceedings from the fifth international conference of balkans demography: the population of the balkans at the dawn of the 21st century. demobalk. ss. cyril and methodius university in skopje. institute of economics – skopje. skopje. p. 7-30. janeska, v., lozanoska. a., djambaska. e. 2016. “demographic consequences of the emigration from the republic of macedonia”. economic development. journal of the institute of economics-skopje. year. 18 no. 1-2/2016. skopje. p. 157-178 janeska, v. 2012. “demographic changes and sustainable development of the republic of macedonia”. proceedings of the scientific symposium in honour of the 100th birth anniversary of academician kiril miljovski (1912-1983). macedonian academy of sciences and arts. ss. cyril and methodius university in skopje. faculty of economics-skopje. skopje. p. 171-190 verica janeska, aleksandra lozanoska, elizabeta djambaska 17 muenz, r. 2007. “aging and demographic change in european societies: main trends and alternative policy options”. sp discussion paper no.0703. hamburg institute for international economics. p. 1 radovanović, bojana. 2017. “well-being – resources, happiness and capabilities: theoretical discussions and the evidence from the western balkans”. economic analysis, [s.l.], v. 46, n. 34, p. 152-163, oct. 2017. issn 2560-3949. available at: <http://www.library.ien.bg.ac.rs/index.php/ea/article/view/265>. date accessed: 31 may 2018 sievert, s. at al. 2017. “europe’s demographic future-where the regions are heading after a decade of crises”. berlin institute for population and development. p.138 un world population policies database. 2018. http://www.un.org/en/development/desa/population/publications/policy/worldpopulation-policies-2013.shtml last accessed: 28.4.2018 article history: received: april 30, 2018 accepted: june 1, 2018 ea_2017_1-2 udc: 658.8 339.138 jel: o29 cobiss.sr-id: 240671500 original scientific paper the use of semantic differential in function of measuring image of the company ines đokić1 university of novi sad, faculty of economics in subotica, subotica, serbia abstract – in order to influence consumers to buy products, company has to figure out how and where to present them, i.e., it is necessary to make decisions about which marketing communication instruments to use to refer them. what is needed is to provide consumers sufficient information to identify the brand in a given product category at the moment of purchase decision, because consumers, before opting for a particular product, go through various stages. company can apply different marketing communication instruments, but needs to co-ordinate them to send consumers a clear and consistent promotional message. whether company has implemented marketing communications successfully can be seen from different indicators, from economic to communication, that is, from increasing sales to a positive image. it is very important for a company to measure the effects of implemented marketing communication, because it helps in making the right decisions in the future and obtaining as many regular customers. one of the main goals of the company is positive and clear image that can be achieved through the instruments of marketing communication. company can measure its image by applying semantic differential, which can help in obtaining a picture that consumers have about the company and its products. its usage can be of the great importance for entrepreneurs, as well key words: marketing communications, measuring the effects of communication, the indicators of communication success, image, semantic differential introduction in modern conditions of conducting business and severe market competition, each company strives to be recognized and fights for its products to be the first choice of consumers. to achieve this goal company needs to implement marketing communications and to promote its products. also, one of the reasons for implementation of marketing communication is to establish and maintain long-term relationships with customers. before deciding to purchase a particular product, consumers pass through cognitive and affective stage of the purchase process. while going through these stages consumers have different levels of awareness, knowledge, beliefs, preferences and actions i.e. willingness to purchase 1 msc., segedinski put 9-11, subotica, email: mines@ef.uns.ac.rs đokić, i., the use of semantic differential, ea (2017, vol. 50, no. 1-2, 50-61) 51 and therefore they need different information based on which they form beliefs and attitudes about the product and the company. information can be obtained from different marketing communication instruments which company implements. company is interested in the success of marketing communications, and promotional messages and campaigns. since consumers form an image of company on the basis of gained messages, effects of marketing communication instruments should be approached from consumer’s perspective and their understanding, viewing and integrating individual instruments in a comprehensive conception of the brand (weilbacher, 2001). therefore, it is very important for a company to measure the effects of the implemented marketing communication. measuring the effects of communication is related to finding out whether the target audience knows and remembers promotional messages, recalls certain details from it, has feelings about the message and attitudes in regard to the product and the company, purchases products and the like. in this paper is presented an example of how the company could measure image, as an indicator of the success of marketing communication, through the use of semantic differential. the implementation of this technique does not have to be related only to large companies implementing numerous marketing communications instruments and having expensive campaigns, but can also be connected to entrepreneurs that use less promotion instruments but strive to communicate consistent message with its target audience. the essence of marketing communication for the company’s achievement of the desired success in the market, it is not enough to produce a good product with an acceptable price and with an effective distribution system, but is also necessary to set up an effective system of communication with the market, especially consumers. if consumer does not recognize product or is not informed about its characteristics and advantages compared to competing products, she/he will not buy it. therefore, it is very important that company implements marketing communication, i.e. to make decisions what to say, how and when to communicate, who to contact and how often in order to inform consumers about the existence and characteristics of its products. in developing marketing communications strategy, company combines different instruments of promotional mix: advertising, sales promotion, marketing public relations, economic publicity, personal selling and direct marketing (e.g. de pelsmacker, geuens, bergh, 2007; ognjanov, 2009; salai, grubor, 2011; stanković, đukić, 2014). company integrates these instruments taking into account the balance of advantages and disadvantages of each. in fact, the company strives to achieve consistency in communicating and providing unique promotional messages directed to consumers (belch, belch, http://imc.sdsu.edu/articles-abstracts/ae_effect-imc.htm). by performing integrations at various levels, synergetic effects appear through an appropriate combination of instruments of promotion and media (naik, raman, 2003; domazet 2015). creators of communication programs can have a number of challenges because each marketing situation is different and each marketing campaign requires a different creative approaches and a basic question is what message to send to consumers. the problem is further complicated by the fact that consumers are actually the subjects who integrate in their minds all the messages and contents received from different media they are exposed to, 52 economic analysis (2017, vol. 50, no. 1-2, 50-61) and at the same time, determine what types of media they want to be exposed to, as well as the amount of time they want to devote to each medium. the effectiveness of promotional messages depends on its content, creativity, structure, form and origin (salai, grubor, 2011). the content of promotional message is related to brand concept, idea or association, and all other values, or the perception that marketers are transferring to consumers, and should be relevant, creative, consistent, engaging, persuasive, to cause behavior, that is, action of the target audience which is the core principle of integrated marketing communication (kliatchko, 2008). also, for the message content is very important its interaction with communication channels, because it is communication channels that enable customers to know how to get to brand, while the message content assures and convinces them to the purchase (domazet 2016). promotional message has a strategic and creative component (shash, d'souza, 2009). the strategic component refers to the question of what to say, that is. what is the idea, while the creative component consists of questions how message communicates and includes words, images, music, location, layout, logo, colors (domazet, 2015). one of the segments of creative marketing communication strategy is the selection of an adequate appeal. the aim of appeal is to provoke a reaction to promotional message content, where appeals influence the intellect, decision making, feelings, imagination, image, which means the psychological side of the consumers mind (salai, grubor, 2011; domazet 2016). structure of the promotional message answers to the question how to say something logically, primarily in the context of whether the communicator needs to carry out definitive conclusions or leave them to the audience, as well as whether to use arguments that are oneway or two-way, and in what order to present the strongest arguments (salai, grubor, 2011). there is no single answer to the question of whether to carry out definitive conclusions or to leave them to the target audience. the form of promotional message gives the answer to the question of how symbolically to express the message and is conditioned by the media that sends promotional messages. the source of promotional messages or communicator is the initial component of marketing communication process, because it broadcasts a promotional message and therefore must know the message coding system, the media through which it is to be sent, and how the target audience will decode the message (domazet 2016). the success of the communicator depends on his knowledge and expertise, reliability, objectivity and attractiveness for a given audience. indicators of marketing communication success communication indicators of marketing communications success are related to researching whether consumers recognize or remember the promotional message, how many times they saw it, which parts they remember, how they feel about the message, and their previous and current attitudes toward a company and a brand (keller, 2001). also, as indicators of marketing communication success, there can be mentioned attracting consumers attention, easily memorable promotional messages, message persuasion, the content of useful information, interest for promotional messages and the level in which providing the entertainment, consumer response, positive image, brand popularity, as well đokić, i., the use of semantic differential, ea (2017, vol. 50, no. 1-2, 50-61) 53 as the extent to which promotional messages justifies the cost as measured by an increase in sales. what kind of effects marketing communications have in relation to consumers, can be seen through the so-called. "pyramid of communication effects" – illustration 1. illustration 1. pyramid of communication effects of marketing communication source: belch, belch (2009, 218) based on the illustration it can be concluded that the company first needs to achieve goals that are at the lower level of the pyramid, awareness and knowledge and understanding of the message and the brand. the next task is to move upward consumers who are aware of and have knowledge about the product. if most of the target audience is not aware of the brand, then marketing communications should build that awareness. the target audience can be aware of brand, but without knowing anything about the brand, whereas marketing communications goal is to inform them. if the target audience has knowledge about the brand, the task of marketing communication is to find out what are their feelings about brand, and if they are negative, to find out why, in order to eliminate mistakes. the target audience can like the product, but does not need be to prefer it in comparison to others. in this case, the goal of marketing communications is to build consumer brand preference by comparison of quality, value, performance and other factors with competing brands. if the target audience prefers a particular brand, but it is not convinced to buy it, marketing communication goal is to convince them to buy it. some members of the target audience can be convinced that product is high-quality, but still do not decide to purchase. in that case, a company has to encourage consumers to purchase, for example by lowering the price of the product, offering a discount, or allowing consumers to have experience with the product. marketers use the instruments of marketing communication to achieve different objectives, including creating awareness about a company or a brand, meeting consumers with attributes, characteristics and advantages of the brand, designing, maintaining and possible changing attitudes about the brand, creating brand preference and purchase intent. kotler (2003) found that marketing communication contributes to increasing brand regular brand purchases trial preference liking knowledge, understanding conscience 54 economic analysis (2017, vol. 50, no. 1-2, 50-61) awareness and positive brand image. consequently, all described phases can be seen as indicators of marketing communications success. measuring communication effects in order to measure the success of marketing communications by the company, it is necessary to perceive its effects. "given the fact that some companies are investing significant resources in marketing communications and especially in advertising, measuring and analyzing the efficiency of marketing communications has great practical significance" (domazet, hanić, simeunović, 2012). companies are trying to measure communication impact of advertising, i.e., the impact on awareness, knowledge or preference (kotler, keller, 2006). however, elements of marketing communications that should also be explored are (ewing, 2009): • consumer reaction to the activities of marketing communications, • interactions within marketing communication instruments, • the impact of technology on the "empowerment" of consumers and planning and evaluation of marketing communications, • understanding relationships between the activities of integrated marketing communications and potential of marketing in general, • more successful understanding of when, why and how to implement the concept of integrated marketing communications. consideration of marketing communications effects is also important for the following reasons (shah, d'souza, 2009): • allows determining how much investment in market communication contributes refunds through greater sales, • presents the basis of managerial evaluation of communication alternatives (potential messages, instruments and media), whereas by selection of their most effective combination is allowed to determine what are the effects of different communication strategies, • presents the basis for future planning, • increases the effectiveness of marketing communications, by elimination of unproductive alternatives and by implementation of productive elements of the communication program. having in mind all mentioned above, there can be identified consequences in regard to possibility to manage marketing by companies, which could view the results of researches from the aspect of internal information that are in relation to investments in certain promotional activities and revenues earned by the realization of offers at the market. measuring the marketing communication effects is very useful but not easy to implement, due to undefined measurement criteria, the reliability of the used methods and the validity of the results. namely, the authors have different opinions on what actually presents an indicator of the success of marketing communications. although there are different indicators of marketing communication success, it can be concluded that marketing communication is successful if attracting attention, informing consumers about the product, đokić, i., the use of semantic differential, ea (2017, vol. 50, no. 1-2, 50-61) 55 being easy to remember, and if helping the company to achieve its objectives, such as growth in sales, profits, market share, brand popularity, as well as improving the image of the product and the company. additional relevance to the above question suggests the contribution of marketing communication to building brand value (schultz, 2004) in the context of forming brand awareness and brand image (madhavaram, bandrinarayanan, mcdonald, 2005). analysis of image as a communication impact of marketing communications by applying different marketing communication instruments company has aim to transmit the unique promotional message and to create a positive image. communication effect of marketing communication is reflected in the image of the product and the company. the image is actually the picture that consumer has about product and company, obtained on the basis of experience, feelings, information and knowledge about the company and products. the company aim is to have a positive and clear image (salai, grubor, 2011). one of the methods which can be used for measuring image is osgood semantic differential (osgood, 1964). osgood semantic differential is a bipolar scale and assumes that some conflicting concepts include different levels of positive, or negative emotional meanings. subjects evaluate the term on the scale. the scale commonly has 7 levels, medium is neutral, three to the left are negative and three to the right are positive. the advantage of this method is that it provides the spontaneity of the subject's response and is suitable for testing attitudes. the implementation of this technique will be shown on an example. company "a" has conducted marketing research, after conducting a promotional campaign, on sample of 60 respondents. after developing a set of relevant dimensions and their reduction, surveys with the content shown in the table below were given to respondents. the task was to circle the number that most closely matches their attitude on a given product attribute. table. 1. the scale of product attribute value -3 -2 -1 0 1 2 3 bad ο ο ο ο ο ο ο good expensive ο ο ο ο ο ο ο inexpensive ugly ο ο ο ο ο ο ο nice not useful ο ο ο ο ο ο ο useful not healthy ο ο ο ο ο ο ο healthy unreliable ο ο ο ο ο ο ο reliable old fashioned ο ο ο ο ο ο ο modern ineffective ο ο ο ο ο ο ο effective complicated ο ο ο ο ο ο ο simple respondents were given nine product attributes that they had to evaluate on scale of seven possible answers. the obtained results are as follows: 56 economic analysis (2017, vol. 50, no. 1-2, 50-61) table. 2. the attribute bad / good x f xf -3 0 0 -2 2 -4 -1 1 -1 0 3 0 1 9 9 2 18 36 3 27 81 σ 60 121 the first attribute of product was related to whether respondents consider product as bad or good. results show that the average value of x is 121/60, i.e. 2.02. table. 3. the attribute expensive / inexpensive x f xf -3 15 -45 -2 18 -36 -1 13 -13 0 10 0 1 2 2 2 1 2 3 1 3 σ 60 -87 the second attribute of product was related to whether respondents think that product is expensive or cheap. results show that the average value of − x is -87 / 60, i.e. -1.45. table. 4. the attribute ugly / nice x f xf -3 2 -6 -2 1 -2 -1 0 0 0 3 0 1 17 17 2 15 30 3 22 66 σ 60 105 the third attribute of product was related to whether respondents think that the product is ugly or nice. results show that the average value of − x is 105/60, i.e. 1.75. đokić, i., the use of semantic differential, ea (2017, vol. 50, no. 1-2, 50-61) 57 table. 5. the attribute unuseful /useful x f xf -3 0 0 -2 0 0 -1 2 -2 0 2 0 1 8 8 2 20 40 3 28 84 σ 60 130 the fourth attribute of product was related to whether respondents think that product is not useful or is useful. results show that the average value of − x is 130/60, i.e. 2.16. table. 6. the attribute not healthy / healthy x f xf -3 0 0 -2 1 -2 -1 2 -2 0 6 0 1 11 11 2 19 38 3 21 63 σ 60 108 the fifth product attribute was related to whether respondents consider product healthy or unhealthy. results show that the average value of − x is 108/60, i.e. 1.8. table. 7. the attribute unreliable / reliable x f xf -3 1 -3 -2 0 0 -1 2 -2 0 5 0 1 16 16 2 13 26 3 23 69 σ 60 105 the sixth attribute of product was related to whether respondents think that product is unreliable or reliable. results show that the average value of − x is 105/60, i.e. 1.75. 58 economic analysis (2017, vol. 50, no. 1-2, 50-61) table. 8. the attribute old-fashioned / modern x f xf -3 2 -6 -2 3 -6 -1 0 0 0 5 0 1 16 16 2 18 36 3 16 48 σ 60 88 the seventh attribute of products was related to whether respondents consider that product is old-fashioned or modern. results show that the average value of − x is 88/60, i.e. 1.46. table. 9. the attribute ineffective / effective x f xf -3 2 -6 -2 1 -2 -1 1 -1 0 9 0 1 15 15 2 12 24 3 20 60 σ 60 90 the eighth product attribute was related to whether respondents think that product is ineffective or effective. results show that the average value of − x is 90/60, i.e. 1.5. table. 10. the attribute complicated / simple x f xf -3 1 -3 -2 2 -4 -1 2 -2 0 5 0 1 9 9 2 22 44 3 19 57 σ 60 101 đokić, i., the use of semantic differential, ea (2017, vol. 50, no. 1-2, 50-61) 59 the ninth attribute of products was related to whether respondents think that product is difficult or easy. results show that the average value of − x is 101/60, i.e. 1.63 graph. 1. the semantic differential for the image of the product of company "a" based on semantic differential obtained after entering the average value of individual product attributes, it can be concluded that after a six-month campaign, product image of "a" company is positive, because the average value of almost all the attributes is on the positive side of graph. in fact, the product of company "a" is considered expensive, but on the other hand, healthy, of good quality, nice. therefore, consumers can rely on the product because they trust it "solves the problem", i.e. achieves effects that are listed and contributes to satisfaction of needs. in order to obtain clearer picture of communication effects of implemented marketing communications campaign, company "a" has to compare results with the image research related to the previous promotional campaign, or to compare them with the results of other methods of measuring the effects of marketing communication. conclusion in modern business conditions priority for marketers is requirement of finding an adequate marketing communication mix instruments, defining their roles and the extent to which they should be implemented, as well as their mutual coordination and obtaining synergetic effects. this is especially important because consumers create an image of the company and its products on the basis of all information obtained from the company, i.e. based upon all the manners in which company establishes contacts with them. for the company, it is important to measure effects of implemented marketing communication, especially communication effects i.e. image. by measuring communication effects, a company gets information about effects of promotional messages in regard to interest, clarity, perception, memory, thinking and attitudes of consumers when it comes to promotional messages, products and the company itself. measuring the effects of marketing -3 -2 0 1 2 3 -1 60 economic analysis (2017, vol. 50, no. 1-2, 50-61) communication can be realized by various methods and techniques, and one of the methods for measuring the image is semantic differential that shows how consumers perceive and experience the company and its products. this technique, described in details within this paper, has potential to be implemented by entrepreneurs as well, no matter if they use only few promotion instruments as long as they attempt to communicate consistent message with their target audience. references belch, g. e., & belch, m. a. “evaluating the effectiveness of elements of integrated marketing communications: a review of research” (http://imc.sdsu.edu/articlesabstracts/ae_effect-imc.htm) belch, g. e., & belch, m. a. 2009. advertising and promotion: an integrated marketing communications perspective. new york: mcgraw-hill education. de pelsmacker, p., geuens, m., & van den bergh, j. 2007. marketing communications-a european perspective. harlow: 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2014. marketing komuniciranje. niš: ekonomski fakultet. đokić, i., the use of semantic differential, ea (2017, vol. 50, no. 1-2, 50-61) 61 weilbacher, w. m. 2001. “point of view: does advertising cause a „hierarchy of effects?“” journal of advertising research, 41(16): 19-26. article history: received: 27 october, 2016 accepted: 15 december, 2016. microsoft word 2009_1_2.doc letter from the editor-in-chief welcome to the first issue of the economic analysis in 2009. at the same time it is the first issue that i edited. after a long period of time starting from the year 2009 the journal will be published except for the eand in printed version, too. our goal is to be available to as big number of the scientific public as possible. our aim for this journal is to bring it onto the working desk of our current and future colleagues all over the world. it is our wish to get to isi list among the world’s most prestigious scientific journals with its quality of works and articles and with the variety of its contents. what the editorial politics is concerned, i will work diligently with all my heart and might on the realization of this aim as one of my top priorities accompanied with all the other members of the editorial board as well. in the end, i ask all the future authors to send us their works and articles as much as they can all the year around, so that we can make a selection of works and to be able to publish them yearly in two planned issues. all of them will be objectively examined by independent, nonpartial language experts as i planned to include periodically a foreign guest editor or to publish thematic issues of the journal. i wish you the best of luck in your work and a good cooperation in the future. sincerely, prof. dr mirjana radović-marković ea_2017_1-2 udc: 005.334:368 551.583 jel: g15, g22 cobiss.sr-id: 240652044 professional paper insurance sector and climate changes in serbia tatjana piljan1, business college of vocational studies “prof. dr radomir bojkovic”, krusevac, serbia ivan piljan, dušan cogoljević, faculty of business economics and entrepreneurship, belgrade, serbia abstract – climate changes have a strong negative impact on the insurance sector, which is reflected in the slow development of the insurance sector and in the transfer of the greater part of risk on the state and individuals. the difference between collected and paid premiums on the basis of incurred losses is rapidly decreasing, which leads to the fact that insurance market is less and less capable of absorbing the losses associated with climate changes, which then has negative repercussions on the availability of insurance services at an affordable premium. the question of establishing potential long and short-term effects of climate changes on business activities of insurance and reinsurance companies represents a priority and its ultimate objective is to find ways to minimize risks and losses. the problem of climate changes represents an important social problem in today’s civilization. at the same time, it is also an ecological problem, but also economic, political, social, cultural, health, etc. it is a global ecological problem, hence we can speak about global climate changes which affect states, nations, continents regardless of where they are and how responsible they are for creating and sustaining these changes key words: insurance sector, effects of climate changes, risk and loss minimization, social problem, ecological problem, adaptation climate changes the problem of climate changes represents a topical social problem in today’s civilization. at the same time, it is an ecological problem, but also economic, political, social, cultural, health, etc. today, in modern scientific thought, both in humanitarian and in natural sciences, there is not one important scientific paper, article or a book, in which they deny the existence of climate changes. even more, there is not one inconsistency when it comes to the fact that what we have is a global ecological problem, hence we can talk about global climate changes which affect states, nations, continents regardless of where they are and to what extent they are to blame for creating and sustaining these changes. it is about 1 e-mail: tanja.piljan@gmail.com 14 economic analysis (2017, vol. 50, no. 1-2, 13-25) dramatic climate changes in which the altered nature does not choose its victims. it is evident that there is a certain inconsistency in sciences and it refers to the influence of anthropogenic factors on the occurrence of climate changes. regardless of these inconsistencies, the future of modern civilization, human race, nations, but also flora and fauna, is to a great extent determined by how climate changes will further develop and if the human race, which has directly or indirectly caused them, can reverse the situation from being directly beneficial for them into being beneficial for the nature and natural world. there is a simple solution for the problem of climate changes, but the consequences of that solution in its idealistic meaning, the crash of industries, is not the solution that can bring welfare to our civilization, but rather it can create economic and political global catastrophe. on the other hand, catastrophic scenario, where high atmospheric temperatures are destroying everything around us, is very close to the previous idealistic meaning. destroyed climate causes destruction of economy, agriculture, hence it creates the ambience of political instability. wherever we look, a catastrophe is inevitable if we approach the problem of climate changes from the point of exclusiveness and stubbornness. to alter traditional understanding of politics, even the economy, towards ecology and ecological problems, i.e. to break from traditional, rigid and narrow-minded understanding of climate problems and its influence on social and natural development is the solution that can represent a winning combination. that winning combination is in fact the creation of two ways, two strategies, for solving climate changes, where both paths are each other’s alternative but also backup. the word is about mitigation (reducing climate changes) and adaptation (adjustment to changed climate conditions). the objective of mitigation is to restrict climate changes by reducing emissions of greenhouse gases. on the other hand, adaptation refers to adjustment of ecological, social and economic systems as a response to real or expected climate changes and their effects and processes. it refers to changes in processes, practices and structures made to mitigate potential losses or benefits brought by climate changes. strategy of adaptation to climate changes is the one which is understood as a necessary response of the international community to the existing problems brought by climate changes. adaptation strategies are of great importance for the states that are particularly vulnerable to the consequences of climate changes because if they don’t manage to adapt it can lead to “significant losses, social disturbances and population transfer, and even to sicknesses and mortality rate”. the matter of adaptation is mostly the subject of scientific researches which rely solely on the theoretical concept without trying out those theories in practice, or the concept of adapting to climate changes is observed as totally separated from adaptation which is the research subject in other disciplines. in that sense, adaptation consists of three unities: theoretical part, as a response to risks and vulnerability assessment; political response to the problem of adaptation to climate changes (policy), and practice, i.e. involvement of relevant actors in the process of adaptation to climate changes. every research of the problem of adaptation to climate changes brings a question if the adaptation to climate changes, which is today dominantly led through certain solution policies concerning influences climate changes have, especially on developing countries, by analyzing relevant political instruments and approaches in the framework of the convention and theoretical approaches which are related to the adaptation to climate changes. piljan, t., et al., insurance sector, ea (2017, vol. 50, no. 1-2, 13-25) 15 in the last ten years, beside the fact that a large number of theoretical approaches and policies in the area of climate changes have been developed, the majority of them referred to only one approach defined by the convention, i.e. mitigation. adaptation, i.e. adjustment to changed climate conditions has become the subject of an increased interest only since the beginning of the 21st century. even in the majority of those papers, the matter of adaptation is approached to from the perspective of natural or social sciences, while multidisciplinary and interdisciplinary approaches are lacking. even though developing countries are most affected by climate changes, the matter of adaptation has mostly been the subject of developed countries’ interest. we should also bear in mind that the matter of and the approach to adaptation and sustainable development is not the same for developed and developing countries. on western balkan territory, the matter of climate changes has been the subject of interest of decision makers and interested parties in the last few years, while in papers this problem has mostly been researched from the perspective of natural sciences. sociologists and political scientists, when they address the matter of climate changes, they usually do that in the context of negotiation process and new global regime on climate changes. the question of adaptation in general is the subject of research papers in many disciplines, but is rarely observed from the perspective of adapting to climate changes. the concept of adaptation is yet to be researched in serbia. adaptation to climate changes as a concept which exists on the international level is at the same time an integral part of the concept of sustainable development in developing countries. there has been a word about economic, political and financial possibilities of including the project of adaptation to climate changes in developing policies of developing countries. what is possible are certain controversies in accepting and incorporating adaptation to climate changes in traditional understanding about the final domains and efficiency of the sustainable development concept as a global response to ecological, political, social and economic challenges of the modern era. the problem of climate changes cannot be easily defined in the framework of only one science, be that natural or social sciences. bearing in mind causes and consequences of this social and natural problem, as well as the survival of the natural world and civilization, we have to think about the context and basis in which this problem can be scientifically thought through. political and economic causes of climate changes expressed in traditional, materialistic and quantitative indicators most definitely implicate that social sciences, like sociology, political sciences, economics, social and political ecology, take their own part in researching the phenomenon of climate changes and their future social consequences, but we shouldn’t put aside possible contribution of natural sciences which, unlike social sciences, can exactly determine and even predict the dynamics of climate changes and changes affecting our flora and fauna. influence of climate changes risks brought upon by climate changes are real and their influences have been more and more present. oun estimates say that all its urgent appeals in the last few years have 16 economic analysis (2017, vol. 50, no. 1-2, 13-25) concerned climate. in 2007, un security council held its first debate on climate changes and how they affect the international security. science on climate changes is now better understood. intergovernmental panel on climate changes shows that, even if by 2050 the emissions would have decreases to half of the 1990 level, we could hardly avoid a temperature increase of 20 c above the pre-industrial level. that kind of temperature increase will represent a serious security risk which will only get worse if the temperature increase continues. effects of these climate changes are that icebergs and glaciers are melting down and extreme weather catastrophes are becoming more frequent and intense. investments in mitigating climate changes, as well as methods of adaptation to what is inevitable, should keep up with responses to international security threats brought upon by climate changes. there are estimates that the recovery of climate changes could cost the world economy up to 20% of the world gdp per year, while expenses of efficient joint action could be limited to 1%. climate changes are best understood as a multiplier of threats that worsens the existing trends, tensions and instabilities. key source is that climate changes threaten to burden the states and regions which are already weak and conflict prone. it is important to admit that those risks are not only of humanitarian nature, rather they include political and security risks that directly affect european interests. moreover, in accordance with the concept of human security, it is clear that many questions referring to the influence of climate changes on international security are mutually connected and that they seeks comprehensive political answers (grozdanic et al, 2013). eu is now found in a unique position to give answers to the influence of climate changes on international security, bearing in mind its leading role in development, global climate policy and a wide range of tools and instruments it has got. security challenge makes europe stronger due to its comprehensive approach to conflict prevention, crisis management and post-conflict renewal, but also because of the fact it is the chief advocate of effective multilateralism. eu climate strategies on january 10th 2007, the european commission introduced new energy policy and climate change policy. this package of measures unites different prepositions given to the eu council in order to establish the objectives of future energy and climate change policies. key elements of this package are: establishing the objective of reducing emission of greenhouse gases, strengthening the emission trading scheme, increasing energy efficiency, greater use of renewable energies and greater support to new technologies. as one of the leading greenhouse gases emitters, but also one of the creators of the agenda of global climate policy, eu has taken a specific obligation to reach the agreement on new global climate regime for the period after 2012. if it is necessary to reach a solution under the contract on the international level for decades to come, the bases must be set as soon as possible. in a debate on climate policy, we still haven’t reached an international consensus, we haven’t even managed to form a strong coalition capable of taking on a unique action on a global scale. this is causing serious concerns bearing in mind the reports piljan, t., et al., insurance sector, ea (2017, vol. 50, no. 1-2, 13-25) 17 of the international panel on climate changes, whose estimates of global climate remove any doubt in regards to the seriousness of the situation and the assessment of possible risks and possible harmful consequences (droge, 2010). eu member states’ governments have pledged to reduce the emission of greenhouse gases for at least 20%. when assessing eu climate strategy, it is important to differentiate between its effects inside eu and outside eu. eu council has emphasized that the set objective of 20% is a minimal level which will be increased to 30% during international negotiations as soon as other industrialized countries have reached a consensus on having the same objective. intensifying the objective concerning reduction of the emission of carbon dioxide is an imperative, especially because it will strengthen the credibility of eu climate policy. one important objective is also the reduction of global warming to an average level of 20 c. to fulfil these tasks won’t be an easy job because based on the so-far indicators and bearing in mind the differences in economic development in the world, by the end of 2050 industrialized countries should have reduced their emissions of carbon dioxide by up to 80%. eu is currently responsible for 1/6 of global emissions of carbon dioxide and 1/5 of greenhouse gases in industrialized countries (annex i to the kyoto protocol). the eu emissions trading system is the basic managerial mechanism in eu, and it is used to ensure compliance with the objectives to reduce emission of carbon dioxide. this system demands companies to abide to emission levels they have planned. increase in energy security (by increasing the share of renewable energies) and increase in competitiveness on the international markets (strengthening efficiency and innovations) are the desired side effects. taking part in this emission trading system does not only offer reliability in planning, but it also sends an important message to other countries. giving certificates for fulfilling eu’s task can have an important role on the international level if the countries individually accept these biding objectives. eu could be the leader in this and like that encourage other states to follow. the system of allocating and trading emission certificates should be transparent in order to prevent distortion of competition and endangering the safety of fuel distribution (ganter, 2010). it is possible to establish increased energy efficiency by determining sectorial levels – strengthening the development of new technologies and developing consumer standards for electrical appliances and vehicles. great potential for energy savings is the improvement of existing facilities isolation of buildings. international cooperation in this area is very important both on the technological level and for formulating innovation policies. in order to increase energy efficiency, eu council believes that it is essential that the suggested measures be introduced not only by the eu states, but also by other countries. in such a way, developing countries and industrialized states would be offered the possibility of a planned cooperation in traffic, construction and energy sectors, and development of common standards in the reduction of energy consumption could also be promoted. in the field of supporting technological strategies, eu has to support renewable energy, wherein there are clear differences in certain technologies. while the costs of hydro energy and wind energy, as well as some aspects of biomass production, are almost competitive, others, such as solar, geothermal and ocean energy are lagging far behind. those who create policies should here estimate whether to spend available resources on promising but expensive technologies with an open date (like solar) or on alternative technologies with a 18 economic analysis (2017, vol. 50, no. 1-2, 13-25) potential to be launched on the market in near future. the european commission does not have a mandate to intervene in making national decisions on energy mix: member states have a sovereign jurisdiction over their energy supplies. this doesn’t include council’s approval on binding objectives of the share of renewable energy in energy mix and it indirectly affects energy mix at the level of the member state. increasing the share of renewable energies and promoting the development of technologies based on them will help european companies sustain their competitiveness on the constantly growing market. in the long run, tendency to achieve these objectives will stabilize or even reduce dependency on fuel imports. eu is an important player in the arena of global climate policy. the basis of its climate strategy is offering exceptional incentives to other states to participate in emission trade and technological cooperation. it is necessary to immediately take measures in order to increase the emission of greenhouse gases and mitigate the influence of climate changes. nevertheless, even if we would take the necessary measures to reduce emission, it seems that the increase of average global temperature of 20 c is inevitable, which will result in the rise of sea level, increase of natural catastrophes, desert increase. one more probable consequence will be a greater number of conflicts concerning insufficient natural resources, like food and water in many parts of the world. most of the developing countries don’t have financial resources and alternative ways of making money to adjust to these changes. even though they are the least responsible for climate changes, countries of the global south are the most vulnerable to their influence, and western balkan countries fall under that category. therefore, developing countries are asking the industrialized world to face the historical responsibility and to give suggestions for mitigating consequences of climate changes. adjustment is identified as one of the key elements for strengthening the future answer to climate changes. deliberation on adaptation policies is in fact a conversation on who pays for what financial mechanisms and who can keep up with the expected costs, but also on how financing is distributed. new political possibilities for collecting resources for adaptation are being imposed as further elements for reducing consequences of climate changes, and those are: carbon tax, auction of emission allowances, taxing international air traffic and initiative for climate insurance. policy of climate changes and challenges in serbia due to the region’s climate, agriculture—in particular the production of crops, fruits and vegetables has traditionally been a crucial contributor to the national economies, providing the income basis for a high proportion of the population and employment for many, being also the second highest contributor, after the energy sector, to national greenhouse gas (ghg) emissions. (radovic markovic ,et.al. 2013,p.1). serbia stands out in terms of progress in climate change policy as it was stated in the ec report on progress. serbia ratified unfccc in march 2001, as non-annex and party and kyoto protocol in january 2008. ministry of energy, development and environment protection (medep) is the focus on the point for uncfccc and kyoto protocol. since the ratification of unfccc, serbia has made significant efforts to fulfil requests of the piljan, t., et al., insurance sector, ea (2017, vol. 50, no. 1-2, 13-25) 19 convention. preparation of the two-year update report has started, an obligation towards unfccc, and developmental guidelines for the nationally appropriate mitigation action plan (nama) are ready. first national communication with unfccc was carried out in 2010 and the government is currently working on the second communication. preparation of the climate change strategy and action plan predicts the inclusion and examination of the basic needs in terms of adaptation to climate changes and with the aim to define a sustainable path towards the reduction of ghg emission by 2020 and 2030. regulations in certain sectors, including energetics, waste, air, transport and industry, are making contributions in terms of mitigating climate changes, while policies in the forestry sector cover certain adaptation measures. when it comes to traffic and with the aim to once again establish an efficient international railway system, serbia has worked on road repairs, on the increase of quality and efficiency of the river transport and it stopped producing leaded petrol. the country is ready to invest in waste technology, while in agriculture the use of biogas for the production of heat and energy for local consumption in large cattle activities is the key step towards the reduction of agricultural emissions. in terms of forestry and land usage, the optimum strategy is afforestation. national program for environmental protection (2010) and sustainable development strategy (2008) believe climate changes are an important challenge in the battle to protect our environment. energetics development strategy until 2015, strategy for scientific and technological development and strategy for the forestry development are also developed and refer to the importance of mitigating and adapting activities of economic development in energetics and forestry. in 2010, serbia adopted the first action plan for energy efficiency (locsee – rs 2013). as a contracting party of the energy community, serbia has ambitious plans until year 2020 including the 27% share in renewable energy resources, as well as 10% share in bio flues in the transport sector. objectives for energy efficiency are similar to those of other contracting parties (9% until 2018). insurance sector and climate changes in serbia climate changes have a really strong impact on insurance sector and it is reflected through a slowing development of insurance sector and in transferring a greater portion of risk on the state and individuals. the difference between the premiums collected and premiums paid on the basis of incurred losses has been decreasing which leads to the fact that insurance sector is becoming less capable of absorbing damages regarding climate changes and which then has negative repercussions on the availability of insurance services under an affordable premium. according to one scenario (unepfi, 2006, pp. 15) which takes into consideration previous scientific findings on the influence of climate changes, the influence of climate changes on insurance companies could be catastrophic. namely, if we don’t take any measures regarding the reduction of the emission of greenhouse gases, insurance industry will be faced with the problem of inadequacy to determine insurance premiums, by 2025 certain markets will have been non-insurable (like it is occasionally happening in coastal areas of the usa), by 2035 property insurance will have become extremely limited and by 2045, when it is estimated that at least once a year there would be losses whose total costs would surpass one trillion dollars, many insurance companies 20 economic analysis (2017, vol. 50, no. 1-2, 13-25) would have become insolvent. climate changes are no longer just a mere theoretical question, they represent a factual state which is already making a significant impact on the business activities of the global insurance sector, and based on the study by ernest & young (strategic business risk, 2008) climate changes represent the most important risk insurance companies will be faced with in the years to come (njegomir et al, 2009). according to all indicators, parallel to the process of global warming came a significant increase in the value of damages conditioned by the achievement of catastrophic occurrences, especially those caused by weather conditions. according to a definition, risk in insurance depends on possible danger of harmful events actually happening, on the exposure and susceptibility of the insured property and individuals to adverse events and on insured values. changes in any of these three components can cause risk increase or decrease. increase in the amount of losses for insurance is conditioned to a great extent by socio-economic changes such as increasing concentration of values as well as increase in concentration of population in areas affected by catastrophic events, increase in insured values as a consequence of growing population, values of insured assets, liberalization of insurance market and greater presence of insurance, changes in insurance coverage as well as an increased probability of occurrence and intensity of adverse consequences of catastrophic events. by analysing all the parameters in the previous period we can come to a conclusion that the increase in the amount of damages for the insurance company is not caused exclusively by climate changes, but they have an important influence because trends of catastrophic events caused by natural forces are keeping up with trends of global warming. it is evident that natural catastrophes caused by weather extremes (such as floods, droughts, storms) have been more intense, while if we observe in the long run, realization of natural catastrophes caused by geophysical factors (such as earthquakes, tsunamis, volcano eruptions) is constant. even though it is hard to precisely quantify the existing and future effects of climate changes on damages caused by natural catastrophes, it is evident that the trend of extreme catastrophic events, as well as their more frequent occurrence, which is caused by climate changes, is conditioning greater damages for insurance market. in terms of the influence of climate changes on insurance sector, one of the biggest problems is the occurrence of hurricanes that hit the coastal region of the usa. what supports the reality of climate change influence on the occurrence of hurricanes is the data that 10 most devastating hurricanes, both for the human race and the insurance sector, have happened in the last 10 years. for example, year 2005, which was the year of hurricanes in the us, which is characterized by the highest number of named hurricanes ever, caused damages estimated at around 87 billion dollars, and it was a burden insurance market had to bear. wherein, the catastrophic hurricane katrina caused economic damages in the amount of 125 billion dollars, out of which 62 billion dollars were covered by insurance (schadenspiegel, 2007). this hurricane season led to a change in the paradigm for insurance companies and was reflected in numerous factors, including record hurricane damages, changed perceptions in terms of hurricane activities, change in the domain of modelling risks and changes in estimating the necessary capital by rating agencies, which consequently led to a changed approach to strategies for capital management and the way of determining premiums. scientific assumptions are that the probability oh hurricanes happening is related piljan, t., et al., insurance sector, ea (2017, vol. 50, no. 1-2, 13-25) 21 to long-term changes in sea surface temperature which normally appears in cycles with the duration from 20 to 50 years. sector of property insurance is the most susceptible to climate changes, especially in terms of influence on generating natural catastrophes, and it has so far suffered the most severe consequences of these changes. climate changes do not only affect property insurance, but also other types of insurances, and one might say all business operations of insurance companies. after catastrophic events, people can initiate compensation claims against architects, engineers, designers and other individuals working in construction industry if they didn’t, when designing and constructing building facilities, take into consideration new weather conditions caused by climate changes, and were noted in europe and had a direct influence on people’s health and lives. floods, droughts, storms, heat waves and rainfalls followed by hailstone caused by climate changes have a strong impact on the insurance of agriculture and forest households. thanks to more intense winter storms in the last few years that caused the implementation of more restrictive terms and tariffs of insurance premiums, a limited offer of insurance coverage for forest households already exists in europe. climate changes also have an impact on the insurance of motor vehicles, both on compulsory and car insurance. it’s been established that there is a direct link between the number of traffic accidents and weather conditions, because 18% more accidents happen in warmer days (topics geo, 2004). extreme weather conditions are causing damages to vehicles due to tree falls, roof parts falling, hailstone rainfalls, floods. climate changes, beside their influence on insurance business, have a large impact on the change of investment climate. influence on investment strategies of insurance companies is very important, and it in reverse has influence on their long-term financial profitability and solvency. it affects not only both sides of insurance companies’ balance sheet, assets and liabilities, by generating adverse events, but they also affect the value of the property through the reaction of financial markets. share and real estate markets, as well as corporate bonds, are under the greatest influence of climate changes. value of the company whose business activities or products are susceptible to climate changes can be threatened, which can cause sudden market shocks because climate factors are not integrated into market prices. due to this, performances of investment portfolios of insurance companies can be threatened. by applying creative risk protection strategies as well as by investing in sectors and companies which in a responsible manner react to climate changes, insurance companies can not only protect and improve performances of their investment portfolios, but they can also improve their market reputation and encourage companies to limit negative influences on environment, which in the end is in the interest of insurance companies. that is why many insurance companies, such as aig, swiss re and allianz are placing their resources into projects concerning the development of the use of renewable energy resources, into the improvement of energy efficiency, in waste management projects, recycling and afforestation (njegomir et al, 2009). influence of climate changes on insurance companies is reflected in the risk they take from their policy holders and in their investment activities and they represent risk only for the insurance sector. on the other hand, climate changes, if adequate adaptation steps are applied, will bring numerous possibilities for the promotion of insurance companies’ business. 22 economic analysis (2017, vol. 50, no. 1-2, 13-25) examples of innovative solutions applied in insurance companies are: insurance policies for hybrid drive motor vehicles alternative fuel vehicles (sompo japan insurance), insurance policies for motor vehicles that have a lower emission of harmful gases (tokyo marine & nicshode), development of insurance policies for motor vehicles on the principle pay-as-yougo that imply premium payments depending on how much we use the motor vehicle in question (insurance company agf, member of the allianz group), insurance policies for windmill fields (in 2006, axa group collected premiums in the amount of 14 million dollars thanks to these insurance policies) (mills, 2007). climate changes cause fundamental changes in the domain of the probability of adverse events realization as well as the change of insurability conditions of certain risks and they also have the potential to affect how we determine insurance premiums (bigger insurance premium in areas exposed to catastrophic events but also stimulatory insurance premiums for policy holders who achieve positive effects on the reduction of global warming), funds and solvency provision policy (vujovic, 2009). we can say with certainty that climate changes affect business activities of reinsurance companies in a similar way they affect insurance companies. bearing in mind that the role of reinsurance mostly boils down to taking over the liability for covering rare but extreme events, climate changes have a more emphasized impact on the business of reinsurance companies. that is why reinsurance companies were the first to point out to global warming and they gave support to researchers who dealt with gaining statistically reliable mediumterm and long-term weather forecasts. in today’s conditions, reinsurance companies are faced with two alternatives: to eliminate certain risks from the reinsurance coverage, which is unacceptable considering that in those conditions the insurance coverage would also be omitted or to increase reinsurance premiums which would lead to impracticability in the realization of insurance. scarcity in reinsurance capacity that inevitably goes along the effects of climate changes demands the finding of new solutions in insurance risk management. that is why reinsurance companies are striving to apply more sophisticated risk modelling and more disciplined risk taking but on the basis of supporting research on climate changes phenomenon and adaptive measures such as seasonal hurricane predictions, understanding of new industries’ sensitivity, research in the aim of using possibilities of new markets. one of the innovative solutions is the application of an alternative transfer of insurance risk to the capital market as well as the role of the state in ensuring insurance and reinsurance coverage. public attention has recently been directed towards finding adequate forms of partnerships between the public and private sectors wherein the state should be the partner and not a substitute for the private insurance sector. conclusion strengthening of institutions, capacities and policies in the field of climate changes are very important in western balkan countries. analyses of institutional structures and political and economic sectors should be integrated in the evaluation of potential climate change strategies in order to mitigate or adapt. it is also of crucial importance to improve the participation of civil society through activities of raising awareness because this area is currently incomplete. even though efforts to get in harmony with the standards and acquits piljan, t., et al., insurance sector, ea (2017, vol. 50, no. 1-2, 13-25) 23 of eu concerning climate changes are constantly made, there is a heightened focus within public institutions on applying climate activities in the international arena. the problem is that some of these activities are not directed in a unique way or are incomplete, hence they demand further coordination, cooperation and financing as well as a long-term vision. many projects (e.g. locsee) are giving significant contributions and benefits to the region in terms of progress towards integration and in trying to coordinate low-carbon strategies with intersectorial focus in eu. key question in the period to come will be how to manage effects of climate changes. this question shall primarily have to be solved by insurance and reinsurance companies that are directly threatened by the consequences of global warming and which will have to deal with the challenges of developing and implementing strategies and business solutions in the context of managing risks caused by climate changes as well as with the need to continually seek solutions for the problem of increasing capital to cover all risks. climate changes, that most definitely bring changes in terms of risk insurability, don’t only affect insurance companies that deal with the problematic of insuring catastrophic risks, mostly property, but they also affect insurance companies that offer services of life, health and liability insurance. in the long run, investments of insurance companies are threatened by negative consequences of global warming. insurance business is a specific business and by its nature it is a cyclic one. given the fact that in the last few years of the 20th century there was a decline in premiums, and frequency and intensity of losses were growing, it became inevitable that insurance companies would have to consolidate, integrate or to increase premium rates depending on the risks given. globalization impact makes the world closer and closer and as the events in one country extremely affect the events in another country, it has become clear that today we have the need for more versatile insurance policies. insurance liberalization is today visible in many countries. since the concentration of greenhouse gasses is constantly increasing, also thanks to the globalization, it is evident that we should no longer ask the question if the climate changes will occur or not, but at what speed the consequences of these changes will be materialized and how severe they will be. even if the emission of greenhouse gasses would stop at today’s value, some consequences would still be inevitable. we cannot predict with certainty what kind of climate to expect in the future. for those reasons, smart risk management tells us that we have to take actions that enable mitigation and adjustment to global warming because not taking any actions is a lot more expensive than taking some kind of actions. based on long-term analyses of large natural catastrophes it’s been confirmed that the damage trend has been increasing. this is a consequence of a large socio-economic development that covers the increase of value concentration, population increase and industrialization of areas exposed to bad weather conditions. insurance industry has to actively start with the adaptation process if it wishes to survive and start the following activities: • there have to be more scientific research papers related to climate changes and larger investments of time and money, such as, for example, considering the 24 economic analysis (2017, vol. 50, no. 1-2, 13-25) questions of climate changes and extreme weather conditions from the perspective of insurance, predicting how climate changes will affect finances etc. • insurance and reinsurance companies have to take a different stand in issuing insurance policies by looking forward into the future and not only relying on the existing statistical data, like it’s been so far. price lists and models for allocation of capital have to be updated regularly so that they be the reflection of the most modern scientific proofs, and not only of extreme ones, like it was the tendency in the past. • in the period to come, insurance and reinsurance companies have to consider risks they agree to insure more objectively. risks being products of probability and intensity. and they have to do that by applying more developed scientific methods when identifying, analyzing, measuring and controlling those risks. • society has to place bigger pressure on governments in order to ensure more restrictive laws related to construction, where that is necessary, and also to make these conditions as related as possible with the terms and regulations of the insurance policy. insurance companies should cooperate with governments and agencies for help in case of accidents because that is the only way to reach proper solutions. • in the long run, people dealing with strategies will want to consider future insurability of risks related to bad weather conditions. if insurance companies are prevented from collecting the risk (e.g. due to some regulations) or if insurance companies are in any other way prevented from doing so, such as the market pressure, it can happen that risks from weather conditions that are insurable today become un-insurable tomorrow. references adaptation and vurnerability to climate change, 2006. the role of the finance 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munich, germany. piljan, t., et al., insurance sector, ea (2017, vol. 50, no. 1-2, 13-25) 25 strategic business risk. 2008. insurance. new york: ernst & young in corporation with oxford analytica. topics geo. 2004. annual review : natural catasrophes 2003. vujović, r. 2009. “uticaj globalizacije i klimatskih promena na stanje rizika i tržišta osiguranja.” istraživanja i projektovanja za privredu, pp. 23/24. beograd. article history: received: 18 april, 2017 accepted: 21 june, 2017 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp97‐108 scientific review organizational culture in serbian companies according to the denison model snežana kirin1 | gordana gavrić2* | sandra kirin3 1 university of belgrade, innovative center of faculty of mechanical engineering 2 faculty of business economics and entrepreneurship, department for management 3 statistical office of the republic of serbia abstract the phenomenon of organisational culture is an important source of competitiveness of today's organisations, and therefore, organisational culture is an important research topic of modern management science. finding the balance between diametrically opposite requirements, for stability and flexibility, is a challenge in managing organisations in a modern business environment. these requirements are incorporated into denison's model of organisational culture, applied in this research on companies in serbia. according to the denison model, organisational stability factors are its mission and consistency, while factors that characterise its flexibility are the organisation's adaptability and the involvement of employees. a well‐formulated mission with which all employees are familiar makes the organisation unique on the path to achieving the desired goal. consistence that relates to a well‐defined system of values and rules facilitates resolving conflicts and other problems in the day‐to‐day functioning of the organisation. on the other hand, organisations with high participation of employees are more efficient and more likely to implement changes, while the ability to quickly and adequately adapt to challenges from the environment allows organisations to preserve their competitiveness on the market. the obtained results of the research showed that there is a balance of the factors of stability and flexibility, which according to the model is a welcomed result, but also that there is a significant place for improvements in the organisational culture. the results presented in this paper may serve as useful information for policymakers to plan changes that improve business efficiency. key words: organisation culture, denison model, mission, the involvement of employees, consistency, adaptability, serbian companies jel classification: m14 introduction today's business environment is marked by the fourth industrial revolution characterised by the growing demand for connectivity, communication and networking, automation, digitisation, flexibility, “smart” management, ecology, and social responsibility. complex business conditions increase business risk and the importance of organisational culture, which permeates all the activities of organisations, becomes more and more prominent. “due to the complexity of the human factor in the company, it takes a lot of expertise and relevant skills to successfully guide people's behaviour in accordance with the strategy and goals of the company” (kirin, mitrovic, borovic & sedmak, 2016, p. 825). * corresponding author, e‐mail: gordana.gavric@vspep.edu.rs 98 economic analysis (2019, vol. 52, no. 1, 97‐108) despite a number of works dealing with the organisational culture, there is no unique definition and tools for its measurement. according to edgar h. schein, organisational culture means “a pattern of shared basic assumptions learned by a group as it solved its problems of external adaptation and internal integration (…), and it is a product of joint learning”(schein, 2013). janicijevic states that “organizational culture is defined as a system of assumptions, values, norms, and attitudes, manifested through symbols which the members of an organization have developed and adopted through mutual experience and which help them determine the meaning of the world around them and how to behave in it” (janicijevic, 2012, p. 25). in short, organisational culture is a powerful force that holds together members of an organisation (janicijevic & milovanovic, 2015) giving it uniqueness, and the fact that it is invisible and intangible makes it a real puzzle for imitators and competitors. “organizational culture like “operating system” leads an organisation and its activities, shaping the way its employees think, work, and how they feel”(vukotic, sukovic, rasevic, maksimovic & goati, 2014, p. 406). organisational culture establishes value systems. if we want a “culture to be a “tailwind” to business success, there has to be compliance between organisation’s management principles and its organisational culture”(gavric, sormaz & ilic, 2016, p. 28). stone d.l. and all considered “the impact that values may have on (a) the establishment of performance criteria, (b) the methods used to measure” (stone, stone‐romero & lukaszewski, 2007, p. 160). according to j. chatman and c. o’reill, to make progress “future research should focus on conceptualizing and assessing organizational culture as the norms that characterize a group or organization that if widely shared and strongly held, act as a social control system to shape members’ attitudes and behaviours”(chatman & o’reill, 2016, p.199). “alvesson & sveningsson, 2015; katzenbach, steffen, & kronley, 2012; lorsch & mctague and others stated that managers have also recognised the importance of culture because of the presumed relationship between certain types of organisational cultures and effective organisational performance” (chatman & o’reill, 2016, p.202). an example of this is the company chrysler which, after struggling for survival, accepted the change of culture, involving employees in the entire process, focusing on learning and “put emphasis on quality and they once again, became a successful and profitable company” (krouse, 2012, p. 28). “today, it is clear to almost all managers that the key to long‐term success lies not in individual strategies and effective management of resources, but in, so far largely neglected dimension of governance, the cultural dimension” (cardona & ray, 2009, p. 32). in other words, “in order to understand the source of competitive advantage of a company, one must understand its organisational culture” (janicijevic, 1997, p. 23). according to korn ferry survey in july 2014, with more than 500 global respondents, “72 per cent said they feel culture is extremely important to organisational performance, but only 32 per cent said their organisational culture aligns to a great extent with their business strategy. the survey also showed that despite the high ranking in importance, only 25 per cent believe they have identified and communicated their culture to a great extent, and only 35 per cent believe their employees are able to articulate their culture to a great extent” (eaton & kilby, 2015, p. 5). recognising the importance of organisational culture problem in serbia, the authors did extensive research using the denison model based on following factors of organisational culture: mission, employee involvement, consistency and adaptability (denison & mishra, 1995), which also allows displaying a degree of each dimension appliance. this model is chosen because it is generally applicable and it balances the need for stability of a company, represented by its mission dimensions and consistency as well as the need for flexibility, represented by employee involvement and adaptability. the aim of the conducted research is to point out critical aspects of the organisational culture whose improvement will improve the efficiency and competitive advantage of the serbian companies, and the conclusions will serve as useful information for decision makers to make better decisions. snežana kirin, gordana gavrić, sandra kirin 99 factors of organization culture according to denison model “a mission is an important aspect of organisational culture. unclear missions, as an image or label, or its absence results in the company being left at the mercy of market forces”(gavric, sormaz & ilic. 2016, p. 28). mission differentiates the company in relation to its competitors, fueling sharing of values that brings business success and competitive advantage to an organisation. the behaviour produced by the mission should lead an organisation to significant financial results, not to its exerting of a mission formulation. consistency is reflected by the presence of stability, which implies well‐defined value and a system as the foundation of a strong organisational culture. sharing key values and expectations among employees will facilitate the resolution of disputes and other efforts in an organisation functioning. lamberg j. a. states that, although “flexibility and speed are considered sources of competitive advantage in a dynamic environment, researches of development strategies see consistency as a necessary condition for company survival (e.g. barnett & hansen, 1996; sheth & sisodia, 2002)(lamberg, tikkanen, nokelainen & suur‐inkeroinen, 2005)”(gavric & stankovic, 2015, p. 132). “using established business practices, a company develops efficient processes and routines that support its long‐term goals and strategies through knowledge that the organisation remains independent of the departure of individual” (gavric & stankovic, 2015, p.132). unlike traditional hierarchical organisations, which tend to have standard policies and procedures when dealing with certain issues, organisations with high employee involvement can make more effective decisions on specific environmental problems or special customers’ requirements, but also have a chance to be more flexible and faster in their decision making (lawler, 1993). also, changes will be easier to introduce if the power of attorney concept and employee involvement is already developed. jovanovic states that “failures in organisational learning also limit organisational adoption and ability to change” (jovanovic, 2015, p. 147). he examined “one of the most important organisational learning issues, the distinction between lower‐level learning and higher‐level learning. lower‐level learning is characterized by improvements or refinements of existing beliefs, understandings, and organisational processes. higher‐level learning involves developing completely new beliefs, understandings and organisational processes” (jovanovic, 2015, p. 147). a perceived need for continuous development of employees is in accordance with the research in which cvjetkovic stated that “it is necessary to raise employees’ awareness on quality achievement as the factor of business operations improvement. it is of exceptional importance for serbian companies to realize that it is necessary to change the way and the philosophy of business operations in the future” (cvjetkovic, 2015, p. 69). a danger for the survival of modern companies is their rigidity and a possible decrease in organisational flexibility and resilience. nowadays, a company’s flexibility is the most important factor for its survival, presented by its ability to meet new habits, tastes and needs of consumers and customers, as well as to change the way of treating employees because they want to become important subjects of business by engaging in more decision‐making. companies that fail to rapidly adjust to the new demands of the global market, would stay behind or taken over by stronger and more successful entrepreneurial players. by compression of space and time, the process of globalisation exposes workers, companies and states to increasing pressure, imposing fast and efficient adjustment to all stakeholders (jaksic, 2009). companies face the challenge to learn and move through this wave of transition as easily and as creatively as possible (radovic markovic, 2008). adequate and timely response in unpredictable business conditions is essential, and a prerequisite for such response of 100 economic analysis (2019, vol. 52, no. 1, 97‐108) management is that employees have a habit of learning, skills and knowledge as well as a desire to learn' (torrington, hall & taylor, 2004). “organizational culture should be cultivated, set in the function of a company's success, but its negative impacts should be avoided” (gavric, sormaz & ilic, 2016, p.27). researching of organizational culture in serbia using the denison model the questionnaire that was distributed in 2015 was used as the research instrument. the questionnaire was distributed in two ways: personally and via facebook. it was designed in the form of a likert scale as that is the most suitable method for evaluating opinions and attitudes. the scale was created in the following way: 1 – completely disagree with the given statement, 2 – partly disagree with the given statement, 3 – neither agree nor disagree with the given statement, 4 – partly agree with the given statement, 5 – completely agree with the given statement. the entire questionnaire was based upon the denison model (denison & neale, 1999) with the slightest of alternations of the researched statements. the following programs were used for the analysis of the obtained data: ibm spss statistics 21 and ms excel. this paper presents a descriptive statistical data analysis. a total of 1000 respondents, i.e. employees who came from various companies from twenty‐ nine serbian cities, took part in this research. tables 1 and 2 describe the personal characteristics of respondents and the companies in which they work. table 1. description of the personal characteristics of the sample frequency percentage gender мale 520 52 female 460 46 missing 20 2 total 1000 100 age 18–30 340 34 31–40 380 38 41–50 190 19 41–60 80 8 over 60 10 1 level of education high school / highly skilled workers 420 42 college 270 27 faculty 200 20 master 90 9 phd 20 2 years of service to 5 350 35 6–15 390 39 16–25 160 16 26–35 90 9 over 35 10 1 work position worker 640 64 low‐level manager 190 19 middle‐level manager 90 9 top‐level manager 80 8 source: ibm spss statistics 21 snežana kirin, gordana gavrić, sandra kirin 101 table 2. description of the companies frequency percentage company size micro 200 20 small 171 17.1 medium 338 33.8 large 291 29.1 company activity services 204 20.4 public administration and mandatory social security 178 17.8 production 140 14 education 116 11.6 finance and insurance 84 8.4 transportation and storage 66 6.6 lodging and meals 47 4.7 health and social care 43 4.3 information and communication 39 3.9 administrative and support service activities 36 3.6 professional, scientific and technical activities 26 2.6 arts, entertainment and recreation 19 1.9 real estate services 2 0.2 company ownership domestic 860 86 foreign 140 14 ownership structure private 520 52 state‐owned 440 44 public 40 4 source: ibm spss statistics 21  exploring the mission dimension for the mission testing, the following statements were observed:  “there is a long‐term purpose of the company existence as well as its development direction”,  “our strategy leads other organisations to change the way they compete in the industry”,  “there is a clear mission that gives meaning and direction to our work”,  “there is a clear strategy for the future”,  “our strategic direction is clear to me",  “leaders set goals that are ambitious, but realistic”,  “there is widespread agreement about goals”,  “the leadership has "gone on record" about the objectives we are trying to meet”,  “we continuously track our progress against our stated goals”,  “people understand what needs to be done for us to succeed in the long run”,  “we have a common vision of what the organisation will be like in the future”,  “short‐term thinking seldom compromises our long‐term vision”,  “leaders have long‐term thinking”,  “our vision creates excitement and motivation for our employees”, 102 economic analysis (2019, vol. 52, no. 1, 97‐108)  “we are able to meet short‐term demands without compromising our long‐term vision“(denison & neale, 1999, p. 2‐14‐2‐15) mean values for compliance with the preceding paragraphs are shown in figure 1. the  figures will show only key words of the statements.  figure 1. results on the mission source: ms excel the results showed that the mean value of the compliance with the individual positions varied between grades 3 and 4, i.e. between the neither agree nor disagree and the partially agree scale measures concerning the researched statements. the overall mean is 3.56. a minimum value of the mean compliance is reported in relation to the following statements:  “our vision creates excitement and motivation for our employees” (3.14)  “we have a common vision of what the organisation will be like in the future” (3.28)  “short‐term thinking seldom compromises our long‐term vision” (3.32) the greatest values of the mean compliance are reported related to the following statements:  “there is a long‐term purpose of the company existence as well as its development direction” (3.99)  “there is a clear mission that gives meaning and direction to our work” (3.88)  “our strategic direction is clear to me” (3.76) the strongest factors related to the dimension of mission defined in the denison model are strategy, goals, and vision. in addition to these factors, the experience of employees, company size and position in it, ownership of the company (and the fact whether it is domestic or foreign), level of education, employee activity as well as social environment also influence mission understanding of enterprises in serbia. snežana kirin, gordana gavrić, sandra kirin 103 exploring consistency dimension the following statements are considered:  “the leaders and managers do what they say”,  “there is a characteristic management style and a distinct set of management practices”,  “there is a clear and consistent set of values that governs the way we do business”,  “ignoring core values will get you in trouble”,  “there is an ethical code that guides our behaviour and tells us right from wrong”,  “when disagreements occur, we work hard to achieve "win‐win" solutions”,  “there is a "strong" culture”,  “it is easy to reach consensus, even on difficult issues and key issues”,  “there is a clear agreement about the right way and the wrong way to do things”,  “our approach to doing business is very consistent and predictable”,  “people from different parts of the organisation share a common perspective”,  “it is easy to coordinate projects across different parts of the organisation”,  “working with someone from another part of this organisation is not like working with someone from a different organisation”,  “there is good alignment of goals across levels” (denison & neale, 1999, p. 2‐10‐2‐11) mean values for compliance with the previous statements are shown in figure 2. figure 2. results of consistency source: ms excel the results of the analysis of compliance with the views of the consistency show that all the answers are in the interval between 3 and 4, i.e. between the neither agree nor disagree and the 104 economic analysis (2019, vol. 52, no. 1, 97‐108) partially agree scale measures concerning the researched statements. the minimum obtained value is related to the statement that all employees have equal chances and opportunities for promotion (“people from different parts of the organization share a common perspective” (denison & neale, 1999, p. 2‐10)) – it is the closest to the value: neither agree nor disagree, while the closest value 4– partly agree (3.85) is related to the statement: “ignoring core values will get you in trouble”(denison & neale, 1999, p. 2‐10). lower values are related to the following statements: • “people from different parts of the organisation share a common perspective” (3.08) • “the leaders and managers do as they say” (3.23) • “it is easy to reach consensus, even on difficult issues and key issues” (3.24) • “it is easy to coordinate projects across different parts of the organisation” (3.39) the main factors of consistency by the denison model are defining core values and business ethics in an organisation and their implementation in dealing with co‐workers, clients and all interested parties in order to reach agreements and management coordination. in organisations with strong consistency, employees understand a ʼbig pictureʼ without creating obstacles to goal achievement. an experience, organisation size, an employee's position in it, the culture of an organisation, i.e. domestic or foreign ownership, gender, company activity and social environment where a company is located also influence attitudes towards consistency. exploring dimensions of employee involvement aspects of employee involvement have been seen through empowerment, personal development and team orientation. in terms of transitional changes, employee involvement contributes to a faster and more successful acceptance and implementation of the necessary modifications. the following statements were observed:  “most employees are highly involved in their work”,  “decisions are usually made at the level where the best information is available”,  “information is widely shared so that everyone can get the information he or she needs when it's needed”,  “everyone believes that he or she can have a positive impact”,  “business planning is ongoing and involves everyone in the process to some degree”,  “cooperation across different parts of the organisation is actively encouraged”,  “people work like they are part of a team”,  “teamwork is used to get work done, rather than hierarchy”,  “teams are our primary building blocks”,  “work is organised so that each person can see the relationship between his or her job and the goals of the organisation”,  “authority is delegated so that people can act on their own”,  “there is a continuous investment in the skills of employees”,  “the capabilities of people are viewed as an important source of competitive advantage”,  “problems seldom arise because we have the skills necessary to do the job”(denison & neale, 1999, p. 2‐8‐2.9) mean values for compliance with the previous statements are shown in figure 3. snežana kirin, gordana gavrić, sandra kirin 105 figure 3. results for employee involvement source: ms excel the result shows that employees are the least involved in the planning process (mean = 2.95) and they disagree with the statement that they rarely face problems because they have all the skills needed for the job (mean = 3). values of approvals given by the respondents along with the other statement vary between 3 and 3.5, i. e. around the neutral position. the results show that there is no value close to 4 in any statement describing employee involvement, which is in correspondence with the statement. the maximum value is obtained in the statement that decisions are made where the best information are obtained so that it can be interpreted by the importance of the decision‐making process. it can be said that the following was observed:  small influence of employees on business policy creating and  a need for continuous development of employees. the study of employee involvement showed that obtained factors were identical to involvement factors in the denison model: teamwork, professional development and empowerment (through access to information and decision‐making where the information are available). exploring the adaptability dimension the following statements were examined:  “the way things are done is very flexible and easy to change”,  “we respond well to competitors and other changes in the business environment”,  “new and improved ways to do work are continually adopted”,  “attempts to create change seldom meet with resistance”, 106 economic analysis (2019, vol. 52, no. 1, 97‐108)  “different parts of the organisation often cooperate to create change”,  “customer wants, and needs are being mentioned and have directly influence on decisions and business”,  “we encourage direct contact with customers by our people”,  “we view failure as an opportunity for learning and improvement”,  “innovation and risk‐taking are encouraged and rewarded”,  “learning is an important objective in our day‐to‐day work”,  ‘we are familiar with the work of other sectors at all times”(denison & neale, 1999, p. 2‐ 12‐2‐13) mean values for compliance with the previous statements are shown in figure 4. figure 4. results on adaptability source: ms excel it may be noted that the minimum value of the compliance degree is related to the following statements:  “the way things are done is very flexible and easy to change” (3.23)  “innovation and risk‐taking are encouraged and rewarded” (3.25)  “attempts to create change seldom meet with resistance” (3.29). conclusion in order to highlight the values of organisational culture in serbia, the research has been conducted and presented, using the denison model of organisational culture. the research included a sample of 1,000 respondents in enterprises in serbia, during 2015. values for all four dimensions of the model have been obtained – mission, consistency, the involvement of snežana kirin, gordana gavrić, sandra kirin 107 employees and ability – that vary in the interval from neutral attitude to the attitude "partly agree”. this means that the awareness level of the mission is foggy among the staff, consistency dimension is between values “it is both existent and non‐existent,” employee involvement in the business planning is on a low level, and when it comes to adaptability dimension, there are no concrete measures to stimulate innovation. by the analysis of organizational culture, we have concluded that the aspects of this culture, the improvement of which will improve the efficiency and competitive advantage of enterprises in serbia, are: innovation rewarding, investment in continuous employee development, greater influence of employees on the policy and planning of future activities, short‐term interests that jeopardize the long‐term mission of the company, opportunities and advancement opportunities to all employees, defining a common vision that stimulates and motivates employees with leaders and managers who act in accordance with what they saying and creating a climate in which changes that lead to progress encounter less resistance of employees. this means that in all dimensions of the observed model, there is room for improvement of the organisational culture in concretised areas, which can serve to policy‐makers as useful information for making better decisions. the need for long‐term planning that balances short‐ term and long‐term goals is noted. the results obtained in 2011 by nikolic, savic & markoski, regarding organizational culture in companies in serbia indicated that certain "strategic issues should be improved, such as: quality making strategic decisions, the attitude of the company towards change and innovation, the vision and mission of the company, teamwork, encouraging the creativity of individuals, etc. (nikolic, savic & markoski, 2011, pp. 649). from this, it can be concluded that the situation in the companies in serbia has not changed drastically in relation to 2011 and that the critical points are innovation, the vision and the mission and the involvement of employees. the significance of the research lays in the fact that it has covered a large sample and therefore, it brings an important contribution to the perception of the state of organisational culture in serbia. the study complements findings reached 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(anti)liberalizam i ekonomija. belgrade: center for economic research of institute of social sciences article history: received: november 29, 2018 accepted: may 26, 2019 ea_2015_1-2 udc: 336.761-027.13(4-12) jel: g11, g14 cobiss.sr-id: 216164108 original scientific paper the identification of blue chip stocks in underdeveloped stock markets of south-eastern europe okičić jasmina1, university of tuzla, faculty of economics, bosnia and herzegovina remetic horvath sonja2, university of vienna,institut für betriebswirtschaftslehre, austria abstract – the main goal of this paper is to explain the discriminatory variables between the blue chip and second-grade stocks in the underdeveloped stock markets of the south eastern european (see) region. since there is relatively less empirical research on the stock selection in underdeveloped markets, with even less studies on the markets in the transition economies of the see region, this paper is designed to shed some light on the identification of blue chip stocks from this region. results presented in this paper provide confirmatory evidence that the blue chip stocks from the selected underdeveloped stock markets of the see region can be identified by examining their dividend yields, price to cash flow and eps. therefore, both institutional and individual investors need to focus on these variables when selecting stocks from these markets in order to reduce the risk associated with investing in equities. key words: blue chip stocks, discriminant analysis, see region introduction according to graham and dodd (2009) the functions of security analysis may be described under three headings: descriptive, selective and critical. here, descriptive analysis consists of marshalling the important facts relating to a security and presenting them in a coherent manner. in its selective function, security analysis goes further and seeks to determine whether a given security should be bought, sold or retained. while there is a substantial body of literature on stock selection in developed markets (markowitz, 1952; merton, 1969; samuleson, 1969; treynor and black, 1973, etc.), there is relatively little research on underdeveloped markets. in stock selection process various methodologies so far were used, i.e. from simple technical trading rules (dannet al., 1977; brock et al.,1992; mills, 1997; gencay and stengos, 1997; allen and karjalainen, 1999, etc.), classification and regression tree (sorensen et al., 2000), multiple criteria decision making (lee et al., 2009) to more complex neural network approach (kaastra and boyd, 1996; quah and srinivasan, 1999; linet al., 2006; fernándezand 1 univerzitetska 8, 75000 tuzla, bih, e-mail: jasmina.okicic@untz.ba 2 oskar-morgenstern-platz, a-1090 vienna, austria, e-mail: sonja.remetic@gmail.com okičić, j., et al., the identification of blue chip stocks, ea (2015, vol. 48, no. 1-2, 54-68) 55 gómez, 2007; yuet al., 2008; şenolet al., 2012, etc.). discriminant analysis, as one of the possible methodologies for stock selection has, since the pioneering work of altman (1968), been predominantly used to predict corporate failure. however, in the recent literature, there is evidence of using discriminant analysis in case of predicting stock price performance (yoonet al., 1993; aono and iwaisako, 2010; ionescu et al., 2008; kheradyar et al., 2011; oz et al., 2011; khan et al., 2012; siqueira et al., 2012; vu, 2013, etc.). the purpose of this research is to provide potential investors with useful information on basic criteria for selecting stocks in underdeveloped stock markets. investors rely on different allocation strategies when planning to invest. depending on their investment styles and horizons, they seek out stocks that have met the criteria they look for. in order to do this, stocks need to be categorized according to their certain characteristics. although there are different kinds of such categories, in this research we will use only two, i.e. first-grade (blue chip) and second-grade stocks, where, according to the graham and dodd (2009), the blue chip is, generally respected and widely owned stock. although there has been extensive research into the empirical and theoretical aspects of stock selection process, most of these studies have focused almost exclusively on the well-developed financial markets. motivational grounds for this paper lies in the fact that to our best knowledge, very few publications can be found in the literature that discuss this issue in case of underdeveloped capital markets. hence, as achour et al. (1998) have already pointed out, these markets present an ideal testing ground for the efficiency of asset allocation approaches that are common place in developed markets. therefore, the main goal of this paper is to explain the discriminatory variables between the blue chip and second-grade stocks in the underdeveloped stock markets. in the research we will try to give answer to the following question: which variables are the best predictors of two types of stocks, blue chip and second-grade, in the selected underdeveloped stock markets? having in mind the above said, the central research hypothesis shall be as follows: discriminatory variables between blue chip and second-grade stocks in the selected underdeveloped stock markets predominantly refer to dividends, cash flows and earnings per stock. the main limitations of this study are to be found in the missing data for selected issuers from the see region. the remainder of this paper is organized as follows. after introduction, part two brings description of the research methodology and data. subsequently, part three discusses the empirical results. finally, conclusions are drawn in the last part of the paper. data and research methodology data the research is focused on the underdeveloped stock markets of south eastern european region (see). as a representative of this region we will use following countries: slovenia, croatia, serbia, bulgaria and romania. the issuers from these countries are included in the 56 economic analysis (2015, vol. 48, no. 1-2, 54-68) south-eastern europe traded index3 (setx) that is a tradable benchmark for the see region. structure of the setx is given in appendix a. according to the msci inc. (2014) all capital markets can be classified as developed, emerging, frontier or standalone. this classification is done as the results of an evaluation of the four criteria, which are: (1) openness to foreign ownership, (2) ease of capital inflows/outflows, (3) efficiency of the operational framework and (4) stability of the institutional framework (msci inc., 2014).in order to be classified in a given instrument universe, a country must meet the requirements of all three criteria as described in the table below. table 1.the msci market classification framework criteria type of the capital market frontier emerging developed a economic development no requirement no requirement country gni per capita 25% above the world bank high income threshold for 3 consecutive years. a.1 sustainability of economic development b. size and liquidity requirements b.1 number of companies meeting the following standard index criteria: 2 3 5 company size (full market cap) usd 630 mm usd 1260 mm usd 2519 mm security size (float market cap) usd 49 mm usd 630 mm usd 1260 mm security liquidity 2,5% atvr 15% atvr 20% atvr c market accessibility criteria c.1 openness to foreign ownership at least some significant very high c.2 ease of capital inflows/outflows at least partial significant very high c.3 efficiency of the operational framework modest good and tested very high c.4 stability of the institutional framework modest modest very high source: msci inc. (2014) according to previously mentioned criteria selected capital markets from slovenia, croatia, serbia, bulgaria and romania are classified as frontier markets. assessment results for these capital markets are given in appendix b. furthermore, specificities of the selected markets are (msci inc., 2014): • in bulgaria there is no offshore currency market. in this country, the process to set up an account is lengthy due to the requirement to provide several documents in notarized form. in bulgaria, stock market information is occasionally not disclosed in a timely manner and there is no formal segregation between custody and trading accounts. finally, there is a lack of efficiency in terms of communication between the central registry/central depository and the custodians/brokers. 3 the setx is one of the cee and cis indices of the vienna stock exchange. okičić, j., et al., the identification of blue chip stocks, ea (2015, vol. 48, no. 1-2, 54-68) 57 • when it comes to croatia, investor registration is mandatory and the process can take up to five days. additionally, investors are required to open segregated accounts for trading and for taxation. here the central depository acts as a central registry, and registration of few securities is executed at the issuer level. limited level of competition between brokers can lead to relatively higher trading costs. • in romania, and when it comes to equal rights to foreign investors, relevant information for investors is not always readily available in english. the same goes for market regulations and detailed stock market information. on the bucharest stock exchange, there is an absence of a real delivery versus payment system. also, there is no formal segregation between custody and trading accounts, and there is a lack of efficiency in terms of communication between the central depository and the custodians/brokers. limited level of competition between brokers can lead to relatively higher trading costs. in-kind transfers and off-exchange transactions are prohibited. • in serbia, relevant information for investors is not always readily available in english. the same goes for market regulations and detailed stock market information. due to some administrative requirements, repatriation of funds can take up to two weeks. registration is mandatory and all foreign investors need to a point a legal and tax representative and documents must be filed in serbian language. overdraft facilities are restricted to foreign banks. limited level of competition between brokers can lead to relatively higher trading costs. off-exchange transactions are allowed but they require approval from the authorities. • when it comes to slovenia, limited level of competition between brokers can lead to relatively higher trading costs. exchange transactions are now settled on a linked delivery versus payment system with a gross settlement of securities followed by a multilateral netting of funds. in this research all data on the selected companies from the see region were obtained from the investing.com portal in july 2014. investing.com is a global financial portal that provides news, analysis, streaming quotes and charts, technical data and financial tools about the global financial markets, i.e. a broad variety of financial vehicles including stocks, bonds, commodities, currencies, interest rates, futures and options (fusion media ltd., 2014). sample, variables and indicators our sample consists of two groups of stocks, i.e. blue chip and second – grade stocks. as mentioned earlier, the setx is made up of the most actively traded and highest capitalized stocks from the see region. therefore, these stocks can be classified as first-grade or simply blue chip stocks. the second group consists of all of those stocks that are included in one of the equity indices from the analyzed capital markets (sofix from bulgaria, crobex from croatia, rotex from romania and sbitop from slovenia) but are not included in the setx. due to missing data, stocks included in belex15 (serbia) were excluded from the further analysis. the structure of the entire sample which consists of 56 stocks is given in appendix c. 58 economic analysis (2015, vol. 48, no. 1-2, 54-68) as a dependent variable in this research we used type of the stock, i.e. blue chip or second-grade stocks. it is a dichotomous nominal variable. we used following 35 independent variable with a possible discriminatory power: p/e ratio, p/e ratio ttm4, beta, price to sales ttm, price to cash flow mrq, price to free cash flow ttm, price to book mrq, price to tangible book mrq, revenue/stock ttm, basic eps, diluted eps, book value/stock mrq, tangible book value/stock mrq, cash/stock mrq, cash flow/stock ttm, dividend yield, return on equity ttm, return on equity 5ya, return on assets ttm, return on assets 5ya, return on investment ttm, return on investment 5ya, eps(mrq) vs. qtr. 1 yr. ago, eps(ttm) vs. ttm 1 yr. ago, 5 year eps growth, sales (mrq) vs. qtr. 1 yr. ago, sales (ttm) vs. ttm 1 yr. ago, 5 year sales growth, 5 year capital spending growth, quick ratio mrq, current ratio mrq, lt debt to equity mrq, total debt to equity mrq, asset turnover ttm, inventory turnover ttm and receivable turnover ttm. based on the selected variables we will use discriminant analysis to explain whether selected variables will discriminate between two groups of stocks, i.e. blue chip and second – grade stocks. discriminant analysis: a short methodological overview in this paper, discriminant function analysis is used to determine which of the 35 independent variables best discriminate between two groups: blue chip and second-grade stocks from the see region. discriminant analysis is a multivariate statistical method designed to set up a model to predict group memberships. it results with the discriminant function, i.e. a variate of the independent variables selected for their discriminatory power used in the prediction of group membership (hair et al., 1998, p. 241). the main objectives of discriminant analysis are as follows (malhotra, 2004, p. 534): • development of discriminant function which will best discriminate between the categories of the criterion or dependent variable (groups). • examination of whether significant differences exist among the groups, in terms of the predictor variables. • disrimination of which predictor variables contribute to most of the intergroup differences. • classification of cases to one of the groups on the values of the predictor variables. • evaluation of the accuracy of classification. discrimination is achieved by setting the variate’s weights for each variable to maximize the between – group variance relative to the within – group variance (hair et al., 1998, p. 244). each discriminant function has the general form (brown and wicker, 2000, p. 219): (1) 4 here, ttm refers to trailing twelve months, 5ya refers to 5-year average and mrq refers tomost recent quarter. okičić, j., et al., the identification of blue chip stocks, ea (2015, vol. 48, no. 1-2, 54-68) 59 where d is the discriminant score, a is the y – intercept of the regression line, b is the discriminant function coefficient, x is the discriminator variable raw score, and p is the number of discriminator variables. discriminant analysis multiplies each independent variable by its weight and adds these products together. as a result, discriminant score for each independent variable in the analysis is calculated. by averaging these scores we get the group mean, which is referred to as centroid that indicate the most typical location of any independent variable from a particular group, and comparison of the group centroids shows how far apart groups are along the dimension being tested (hairet al., 1998, p. 245). empirical results and discussion first step in discriminant analysis is to examine whether there are any significant differences between groups on each of the independent variables. if there are no significant group differences it is not worthwhile proceeding any further with the analysis. in this research, by using tests of equality of group means we found statistical evidence of significant differences between means of blue chip and second-grade stocks from the see region, particularly in case of dividend yield (p-value =,008) and 5 year capital spending growth (p-value =,024). we used stepwise method that basically removes independent variables that are not significant. in our case, out of initial 35 independent variables, we are left with only three of them: dividend yield , price to cash flow mrq and eps(mrq) vs. qtr. 1 year ago . summary of relevant results is presented in the following section. first, we will briefly discuss the eigenvalues presented in table 2. table 2. eigenvalues function eigenvalue % of variance cumulative % canonical correlation 1 6.461 100.0 100.0 .931 source: authors' calculations the larger the eigenvalue, the more of the variance in the dependent variable is explained by the particular function. one more result presented in the previous table is the canonical correlation that represents the measure of association between the discriminant function and the dependent variable. this measure is important because its square represents the percentage of variance explained in the dependent variable. in our case, that means that this model accounts for 86,68% (,931²) of the between group variance. results of wilks' lambda are presented in table 3. wilks's lambda, is an inverse measure of the importance of the functions where values close to 1 indicate that almost all of the variability in the discriminator variables is due to within-group differences and values close to 0 indicate that almost all of the variability in the discriminator variables is due to group differences (brown and wicker, 2000, p. 223). the smaller the value of wilks' lambda refers to greater discriminatory ability of the function. 60 economic analysis (2015, vol. 48, no. 1-2, 54-68) table 3. wilks' lambda test of function(s) wilks' lambda chi-square df sig. 1 .134 17.082 3 .001 source: authors' calculations results presented in table 3 indicate a highly significant function (p < .005). here, the null hypothesis (h0: the function has no discriminating ability) is tested by using the chisquare statistic. since there are only two groups, we will have only one discriminant function, as follows: . coefficients in discriminant function indicate the partial contribution of each independent variable to the discriminate function. good predictors tend to have large weights. in our case, dividend yield score was the strongest predictor while price to cash flow mrq and eps(mrq) vs.qtr. 1 yr. ago with negative sign were next in importance as a predictors. these variables stand out as those that strongly predict allocation to the blue chip or second-grade stocks. others variables were less successful as predictors. another way to interpret these results is to describe each group in terms of its profile, using the centroids, i. e. group means of the predictor variables. centroids are displayed in table 4. in our example, blue chip stocks have a mean of 2.475 while second-grade stocks produce a mean of –1.961. table 4.functions at group centroids groups function 1 blue chip stocks 2.745 second-grade stocks -1.961 source: authors' calculations so, if stock’s score on the discriminant function is closer to 2.745, then this stock is probably blue chip. if stock’s score on the discriminant function is closer to -1.961, then this stock is probably second grade. the final phase is classification presented in table 5. okičić, j., et al., the identification of blue chip stocks, ea (2015, vol. 48, no. 1-2, 54-68) 61 table 5.classification results groups predicted group membership total blue chip stocks second-grade stocks original count blue chip stocks 10 5 15 second-grade stocks 6 33 39 % blue chip stocks 66.7 33.3 100.0 second-grade stocks 15.4 84.6 100.0 source: authors' calculations the overall predictive accuracy of the discriminant function is called the ‘hit ratio’. according to the results presented in table 5, the hit ratio is 0.7963 which means that 79.63% of original grouped cases were correctly classified into blue chip or second-grade group. what is an acceptable hit ratio? as burns and burns (2008) have already pointed out, one must compare the calculated hit ratio with what could be achieved by chance, meaning that if two samples are equal in size then there is a 50/50 chance anyway. let us now examine the practical implications of these results. out of 35 selected variables, only three of them (dividend yield, price to cash flow mrq and eps(mrq) vs. qtr. 1 yr. ago) stood out as those that strongly predict allocation to the blue chip or second-grade stocks in the selected stock markets. contrary to the findings of previous research of lee et al. (2009) and siqueira et al. (2012) beta coefficient didn’t have discriminatory capabilities in stock selection. also, contrary to the findings of vu (2013) p/e ratio didn’t empirically discriminate between those stocks of high-value (blue chip) and those not (second-grade). all of the identified discriminatory variables are very important in creating investment strategy. dividend yield, as the strongest predictor, shows to investor how much a particular company pays out in dividends each year relative to its stock price. as second best predictor in this analysis, price to cash flow mrq, as an indicator of a stock’s valuation, is nothing else but the ratio of a stock’s price to its cash flow per stock. next important predictor, eps(mrq) vs. qtr. 1 yr. ago, is calculated as the most recent quarterly (mrq) earnings per share (eps) minus the eps for the quarter one year ago divided by the eps for the quarter one year ago and multiplied by 100. this is consistent with the findings of kheradyar et al. (2011) who have also confirmed that dividend and earning yield have the predictive power of stock returns in developed stock markets. the practical implications of this study are that blue chip stocks from the selected underdeveloped stock markets of the see region can be identified by examining their dividend yields, price to cash flow and eps. therefore, both institutional and individual investors need to focus on these variables when selecting stocks from these markets in order to reduce the risk associated with investing in equities. although further work is required to gain a more complete understanding of the discriminatory variables between blue chip and second-grade stocks in the selected underdeveloped stock markets from the see region, results presented in this paper provide confirmatory evidence that the blue chip stocks from the selected underdeveloped stock 62 economic analysis (2015, vol. 48, no. 1-2, 54-68) markets of the see region can be identified by examining their dividend yields, price to cash flow and eps. conclusion providing solid measures that can help foreign and domestic investors to reliably identify investable companies in less developed, less transparent and less liquid stock markets is of crucial importance for the entire economic region. on the basis of theoretical inferences and empirical evidence presented in this paper, it seems fair to suggest that discriminatory variablesbetweenblue chip and second-grade stocks in the selected underdeveloped stock markets predominantly refer todividends,price to cash flow and earnings per stock. alam et al. (2008) find that in the period between 2002 and 2008 central, eastern and southeastern european economies significantly surpassed growth rates experienced in other western european countries. in the era of historically low interest rates and stock markets following the expansion of balance sheets of major national banks, many investors are looking for sources of solid growth and turning to less developed economies where low labor costs, highly skilled work force and diversified consumer profile are driving the organic growth. the companies listed on see stock markets, growing organicallly will have to look to diversify their investor base and constantly seek compliance with improved capital market regulation as well as corporate governance practices in order to do so. informational efficiency and transparency are fundamental issues in the design and regulation of markets. transparency helps to link dispersed markets and improve the price discovery, fairness, competitiveness and attractiveness of markets. especially in underdeveloped stock markets, where informational efficiency and transparency do not always meet the strict rules of more developed and regulated exchanges, investors need much more solid parameters in order to perform equity analysis and allocation. the results presented in this paper provide confirmatory evidence that the blue chip stocks from selected underdeveloped stock markets of the see region can be identified by examining their dividend yields, price to cash flow and eps. when determining the price of shares eps is one of the most important variables. using solely this determinant investors are often mislead as it ignores the capital required to generate the earnings. two companies having the same eps measure would wrongly be compared when one of them would be using less equuity to generate the same earnings. in the time of earnings manipulations and speculations it is important to say that eps should not be used alone, but always in conjuction with other measures. one of these measures is cash flow. cash flow as a measure is widely used in the investment to value stocks as it measures the health of a company to manage its debt, revenues and pay its taxes. this measure too is not purely free from manipulation, although companies do have a much harder time to deceit on their cash flows, but the decision process should be aided by others measures mentioned in this paper. dividend paying stocks are an attractive alternative for a risk neutral investor requiring a minimum stream of free cash flow from their investment portfolio. such stocks allow the okičić, j., et al., the identification of blue chip stocks, ea (2015, vol. 48, no. 1-2, 54-68) 63 investor to take part in the company profits and reinvest the dividends what has resulted in higher yields over longer periods of time. usually, companies paying high dividends are utillities, experiencing stable, forseeble but lower growth rates and lower stock price 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republic of serbia 9,045,756 49,683,011 0.70% banca transilvania romania 2,559,179,315 436,893,930 6.19% brd-groupe sg romania 696,901,518 262,611,002 3.72% ericsson nikola tesla croatia 1,331,650 145,780,043 2.07% fondul proprietatea romania 13,778,392,208 1,148,503,276 16.28% hrvatski telekom croatia 81,888,535 811,597,579 11.50% krka slovenia 35,426,120 1,265,456,433 17.93% mercator slovenia 3,765,361 128,022,274 1.81% nis republic of serbia 163,060,400 250,010,941 3.54% omv petrom romania 56,644,108,335 872,107,903 12.36% petrol slovenia 2,086,301 421,839,631 5.98% sopharma bulgaria 132,000,000 114,159,973 1.62% telekom slovenije slovenia 6,535,478 337,230,665 4.78% transelectrica romania 73,856,084 90,982,736 1.29% transgaz romania 11,773,844 136,931,246 1.94% triglav slovenia 22,735,148 216,438,609 3.07% valamar adria holding croatia 7,467,235 105,172,324 1.49% source: wiener börse ag (2014) 66 economic analysis (2015, vol. 48, no. 1-2, 54-68) appendix b table ii assessment results for the selected capital markets criteria countries bulgaria croatia romania serbia slovenia openness to foreign ownership investor qualification requirement ++ ++ ++ ++ ++ foreign ownership limit (fol) level ++ ++ ++ ++ ++ foreign room level ++ ++ ++ ++ ++ equal rights to foreign investors ++ ++ + + ++ ease of capital inflows / outflows capital flow restriction level ++ ++ ++ + ++ foreign exchange market liberalization level + ++ ++ + ++ efficiency of the operational framework market entry investor registration & account set up + -/? ++ -/? ++ market organization market regulations ++ ++ + + ++ competitive landscape ++ ++ ++ information flow + ++ + -/? ++ market infrastructure clearing and settlement ++ -/? + + ++ custody -/? ++ -/? ++ ++ registry / depository + + + ++ ++ trading ++ + -/? + + transferability ++ ++ -/? + ++ stock lending -/? -/+ -/? -/? -/? short selling -/? -/? -/? -/? -/? stability of institutional framework + + + + + ++: no issues; +: no major issues, improvements possible; -/?: improvements needed / extent to be assessed. competitive landscape for some frontier market countries is still being assessed. source: msci inc. (2014) okičić, j., et al., the identification of blue chip stocks, ea (2015, vol. 48, no. 1-2, 54-68) 67 appendix c table iii sample country/index code issuer ticker bulgaria/sofix 1 sopharma 3jr 2 central cooperative bank ad 4cf 2 chimimport ad 6c4 2 corporate commercial bank ad 6c9 2 eurohold bulgaria ad 4eh 2 first investment bank ad 5f4 2 industrial holding bulgaria plc 4id 2 m+s hydraulic ad 5mh 2 monbat ad 5mb 2 neohim ad 3nb 2 staraplanina hold ad 5sr 2 advance terrafund reit 6a6 2 bulgarian real estate investment fund 5bu 2 bulgartabac holding ad 57b croatia/crobex 1 adrisgrupad.d. adrs-p-a 1 ericsson nikola tesla ernt-r-a 1 hrvatski telekom ht-r-a 1 valamaradria holding korf-r-a 2 arenaturistd.d. arnt-r-a 2 atlantskaplovidbad.d. atpl-r-a 2 krašd.d. kras-r-a 2 podravkad.d. podr-r-a 2 zagrebačkabankad.d. zaba-r-a 2 dalekovodd.d. dlkv-r-a 2 atlantic grupad.d. atgr-r-a 2 petrokemijad.d. ptkm-r-a 2 ad plastikd.d. adpl-r-a 2 viaduktd.d. vdkt-r-a 2 luka rijeka d.d. lkri-r-a 2 hup zagreb d.d. hupz-r-a 2 ledod.d. ledo-r-a 2 uljanikplovidbad.d. ulpl-r-a 2 luka pločed.d. lkpc-r-a 2 ingra d.d. ingr-r-a 2 vupikd.d. vpik-r-a 2 virotvornicašećerad.d. viro-r-a 2 ina d.d. ina-r-a 2 beljed.d. darda blje-r-a 2 đurođaković holding d.d. ddjh-r-a romania/rotex 1 bancatransilvania tlv 68 economic analysis (2015, vol. 48, no. 1-2, 54-68) country/index code issuer ticker 1 fondulproprietatea fp 1 omvpetrom snp 1 transgaz tgn 1 brd-groupesg brd 2 romgaz 0qhq 1 transelectrica tel 2 bursa de valor bvb 2 erste group bank ag ebs 2 biofarm s.a. bio slovenia/sbitop 1 krka krkg 1 mercator melr 1 telekom slovenije tlsg 1 petrol petg 1 triglav zvtg 2 pozavarovalnica sava posr 2 gorenje grvg note: 1 denotes ‘blue chip stocks’ (the ones included in the setx), while 2 denotes second-grade stocks identifikacija prvorazrednih deonica na nerazvijenim tržištima kapitala jugoistočne evrope rezime – osnovni cilj ovog rada je da se objasne diskriminirajuće varijable između prvorazrednih i drugorazrednih deonica koje kotiraju na nerazvijenim tržištima kapitala jugoistočne evrope (jie). s obzirom da su emprijska istraživanja selekcije deonica sa nerazvijenih tržišta kapitala uopšte, a posebno tržišta kapitala tranzicijskih zemalja sa prostora jie, retka, ovaj rad je koncipiran tako da se pokuša rasvetliti identifikacija prvorazrednih deonica kojima se trguje na predmetnim tržištima. na osnovu rezultata sprovednog istraživanja potvrđeno je da se prvorazredne deonice sa nerazvijenih tržišta kapitala jie mogu identifikovati na osnovu dividendnog prinosa, gotovinskih tokova i zarade po deonici. stoga bi se institucionalni i individualni investitori, u cilju redukcije investicionog rizika, prilikom selekcije deonica sa jie regiona trebali fokusirati upravo na prethodno pomenute varijable. ključne reči: prvorazredne deonice, diskriminaciona analiza, jie region article history: received: 2 march, 2015 accepted: 28 april, 2015 microsoft word 2020_ea1_final.docx doi: 10.28934/ea.20.53.1.pp149-162 original scientific paper fiscal adjustments in the european union versus west balkans economies: evidence from heterogeneous panels olgica glavaški1* | emilija beker pucar1 1 university of novi sad, faculty of economics subotica, department of international and european economics and business, subotica, serbia abstract this paper empirically assesses heterogeneity of fiscal adjustments in the european union and west balkans economies, in the circumstances when debt crisis renewed the questions when and how governments adjust their public expenditure. the research covers sample of 28 european union economies and 5 west balkans economies over the period 1995-2018. the results based on pmg panel model point to weak fiscal sustainability with significant fiscal adjustments, in average 28.18 % of deviations from equilibrium relationship are corrected in one year. moreover, the research provides heterogeneous evidence of public expenditure adjustments to long-run equilibrium relationship in european union and west balkans economies. according to the results, candidates and potential candidates for european union membership have improved their public finances, however, accession process does not lead to automatic convergence of these economies and fiscal sustainability assessment key words: fiscal adjustments, european union economies, west balkans economies, heterogeneous panels jel classification: c33, h50, h62 introduction the essence of fiscal sustainability framework is the question of time and way to undertake fiscal adjustments. the question of time is related to the phases of business cycle, whether to adjust in expansion or recession phase, while the way is connected to the question whether to cut public expenditure or to raise the taxes, and finally the effects of fiscal adjustments on gdp growth. recent papers in this theme showed that there are fewer costs of fiscal adjustments based on public expenditure in comparison to fiscal adjustments based on austerity measures, and that way of fiscal adjustment is more important in comparison to state of the cycle (alesina at al. 2016). therefore, the research question in this paper is related to the problem how governments of european economies adjust their public expenditures in circumstances of limited capacities of economies, and in some cases overindebtness. focus is on european union economies which are faced with unique monetary and heterogeneous fiscal policies, due to lack of supranational fiscal rules. defined fiscal policy framework with maastricht treaty (1992), stability and growth pact (1997), and fiscal compact (2012), still leave room for heterogeneous fiscal adjustments and fiscal (ir)responsibility in european union economies. special attention in this paper is dedicated as well to west balkans economies which are in the accession phase to * corresponding author: olgicai@ef.uns.ac.rs glavaski.olgica@gmail.com 150 economic analysis (2020, vol. 53, no. 1, 149-162) european union and fiscal adjustments that those economies undertake in order to fulfill defined goal for membership. heterogeneity in the sample is important as well due to eu accession dynamic, namely, each west balkans economy movement forward eu membership is dependent on own results achieved. therefore, fiscal sustainability and heterogeneous fiscal adjustments based on flow model are estimated in this paper using westerlund cointegration test, mean group (mg), pooled mean group (pmg) estimators. the results point to weak fiscal sustainability in european union and west balkans economies and provide heterogeneous evidence of fiscal adjustment of public expenditure to long-run equilibrium relationship. purposed fiscal adjustments in order to assess fiscal sustainability are distinguished from ad hock changes in public expenditure that have reduced efforts for sound fiscal policy. the organization of the paper is as follows. after the introduction, next section briefly shows literature review related to the question of fiscal sustainability and fiscal adjustment. in the next section are defined hypotheses, methods and data. the following, comparative analysis of fiscal variables in the european union and west balkans economies are represented. in the next section, the estimation results for fiscal adjustments using panel cointegration analysis with heterogeneous parameters are given. the last section contains of the main conclusions and policy recommendations. literature review fiscal sustainability and fiscal adjustments have been issued to the debate in european economies and worldwide, especially in the last three decades. the most often are the studies with the aim to estimate fiscal (un)sustainability using time-series analysis, or panel data models with the focus on different groups of economies, while some studies are oriented toward estimation of fiscal reaction function. in the pioneer papers of modern fiscal sustainability concept, the analysis is often based on usa fiscal sustainability and fiscal adjustment. two traditional approaches of fiscal sustainability are identified. first is based on papers from hamilton and flavin (1986) and wilcox (1989), and it is related to the empirical analysis of public debt and primary deficit stationarity. namely, intertemporal budget constraint could be satisfied when the value of public debt corresponds to the sum of future primary surpluses and when present value of public debt approaches zero in infinity. that could be analysed using stationarity test, so when primary deficit is stationary process, fiscal sustainability is achieved and the condition for intertemporal budget constraint is fulfilled. second approach is based on papers from hakkio and rush (1991) and quintos (1995) the cointegration analysis between public expenditure and public revenues. hakkio and rush (1991) showed that if public expenditure and public revenues are integrated of order 1, these two variables could be cointegrated. if the cointegration parameter b is 1, fiscal sustainability is assessed, otherwise, is unsustainable. however, quintos (1995) relaxed previous assumptions, distinguishing strong sustainability condition (when cointegration parameter is b=1, and first difference of fiscal debt is stationary process), from weak sustainability condition (when cointegration parameter is in the range from 0 to 1, and second difference of fiscal debt is stationary process). among the first papers which have analysed fiscal sustainability and fiscal adjustment using these concepts in european economies in the frame of time-series analysis are caporale (1995), vanhorebeek and van rompuy (1995), and further papadopoulos and sidiropoulos (1999), santos bravo and silvestre (2002), afonso (2004), greiner, koeller, and semmler (2004), krejdl (2006), neaime (2015). however, due to relatively lower power of tests proposed for timeseries, in comparison to tests defined for panel data, and due to availability of longer panel datasets in the recent years, panel analysis is more frequently used. rault and alfonso (2007) analysed sample of 15 eu economies for the period 1970-2006 using unit root tests of first and second generation, banerjee and carrion-i-silvestre test (2006), westerlund and edgerton olgica glavaški, emilija beker pucar 151 (2007) cointegration test. the results showed that fiscal policy is sustainable for the eu-15, as well as in the two separated sub-periods 1970-1991 and 1992-2006, and that public expenditure adjusts to long-run equilibrium relationship. in the paper from the year 2015, afonso and rault showed that fiscal sustainability is questionable in some eu countries in the period 1960-2012. in this paper, analysis are undertaken using seemingly unrelated regression sur method, suradf test for level of integration, westerlund (2007) test for cointegration, polled mean group pmg method and common correlated effects cce method. however, we have remarked that bohn (2007) harsh critique the way of fiscal sustainability analysis – based on unit roots and cointegration, pointing out that any finite order of integration of public expenditure, public revenues and public debt leads also to intertemporal budget constraint fulfilment, namely “absurdly weak” sustainability (when the order of integration is m). bohn emphasises that the best option for fiscal sustainability testing is error-correction model, namely, analysis whether fiscal reaction function are determined by level of indebtedness. moreover, fiscal sustainability concept based on flow models (between public revenues and public expenditure) is implemented for different groups of countries and period of time. beside european economies, fiscal sustainability in oecd economies is often subject of investigation. alfonso and jalles (2012) analysed fiscal sustainability in oecd countries in the period 19702010, taking into account structural breaks parallel with cointegration analysis in time-series and in the panel. results show that fiscal sustainability is questionable in majority of countries, and that weak sustainability exists in some countries. in the paper from 2015, afonso and jalles using sample of 18 oecd economies in the period 1970-2010, analysed fiscal sustainability by modern econometric techniques, pesaran cips test, pedroni cointegration tests, fmols method, identifying that accumulation of public debt is the main disturbing factor of fiscal sustainability in this group of countries. westerlund and prohl (2007) undertook dols and fmols methods to estimate non-stationary panels, taking into a consideration structural breaks for 8 oecd countries in the period 1977-2005. chow (2013) as well used fmols and dols methods for heterogeneous panels to estimate fiscal sustainability in 28 countries in the period 1981-2011. author concluded that weak sustainability exists in the analyzed sample and emphasised advantages of methods for heterogeneous panel estimation. josifidis et al. (2018) as well emphasise the importance of heterogeneity in the sample of european union economies, namely, the study provides evidence of heterogeneous effects of different public policies on fiscal sustainability in eu-28. on the other hand, ehrhart and llorca (2008) showed fiscal sustainability in six south-mediterranean countries, while campeanu and andreea (2010) analyzed fiscal sustainability and fiscal reactions in central and eastern european countries, distinguishing economies which fiscal adjustments could improve the ability to run a primary surplus, from economies with opposite responses. kumar, leigh, and plekhanov (2007) focused on fiscal consolidation in oecd economies, identifying short-run and long-run effects of fiscal adjustments on economic activity; short-run effects could be contractionary, while long-run could be expansionary. yang, fidrmuc, and ghosh (2015) confirmed contractionary effects of fiscal adjustment in oecd economies in the short-run, and in line with the results of alesina (2016), authors show that spending-based fiscal adjustments lead to smaller output losses in comparison to tax-based fiscal adjustments. summing up all the findings in the literature, there are two main concepts of fiscal sustainability analysis (stationarity analysis and cointegration analysis) and relatively novel methodology based on multicointegration analysis (engsted, gonzalo, and haldrup, 1997, and camarero, carrion-i-slvestre and tamarit, 2013). there also different econometric techniques for estimation, different groups of countries and length of time dimension in studies, and therefore, there is no common conclusion related to fiscal adjustments and strong/weak fiscal sustainability versus fiscal unsustainability in analysed groups of countries. 152 economic analysis (2020, vol. 53, no. 1, 149-162) hypotheses, methodology and data taking into a consideration conclusions from the literature review, especially critiques of stationarity and residual-based cointegration tests in paper of bohn (2007), in this paper we estimated error-correction model and heterogeneous short-run adjustments in the sample of 28 european union economies and 5 west balkans economies in the period 1995-2018. following research hypotheses are tested: h1: cointegration relationship between flow variables exists in homogeneous parameters ‐ fiscal sustainability exists in the sample of european union and west balkans economies. h2: short‐run fiscal adjustments to equilibrium long‐run relationship are heterogeneous in the sample of european union and west balkans. the research methodology in this paper is based on heterogeneous, nonstationary panel data framework, which allows the analysis on fiscal adjustments across west balkans and european union economies and differences over the time. the sample contains the data on 33 economies, namely 28 european union members and 5 west balkans economies (albania, bosnia and herzegovina, montenegro, north macedonia, and serbia) over the period 1995-2018. an important goal in this paper to estimate heterogeneous fiscal adjustments to long-run cointegration relationship (hypotheses 2), and therefore, preferable models are proposed by pesaran, shin, and smith (1999) mean group (mg) or pooled mean group (pmg) estimator. panel error-correction model is described as: ∆𝑙𝑡 𝛷 𝑡 𝜃 𝑙𝑔 ∑ 𝜆∗ ∆𝑙𝑡 , ∑ 𝛿 ∗ ∆𝑙𝑔 , 𝜇 𝑢 (1) where, 𝛷 is error-correction parameter, indicating speed of adjustment to long-run equilibrium relationship, 𝜃 is long run relationship, 𝜆∗ is coefficient of lagged dependent variable, 𝛿∗ is short-run parameters for each panel unit, 𝜇 represents individual effects. mg is based on estimation of n time-series regressions and averages coefficients, while pmg is based on equal long-run relationship across all panel units and averaging of coefficients (short-run adjustments). in order to find out whether the restriction related to homogeneous long-run relationship in pmg model is true, hausman test is used. if long-run relationship is homogeneous, namely, if the restriction in pmg model is true, the estimates are efficient and consistent. in opposite, pmg method provides inconsistent estimates. mg model assumes heterogeneous long-run equilibrium relationships, and provides consistent estimates in both cases. short-run adjustments are heterogeneous in both models. the source of data is world economic outlook (april 2019), namely, international monetary fund. used software is stata 13. comparative analysis of fiscal variables in the european union economies versus west balkans economies there is no doubt relating the diversity of fiscal behavior in group of european union economies and west balkans economies through the period of 1995-2018. although the west balkans economies are geographically surrounded by european union member states, european perspective of these economies are determined by overall economic, structural and political reforms. west balkans economies have passed the long way since the end of the 1990s till today and managed to make significant progress (about financial structure, see in janković, 2019). according to the strategy to strengthen the european union by 2025, serbia and montenegro could complete the accession process in a 2025 perspective, for albania and north macedonia the commission is ready to prepare recommendations to open accession negotiations, while for bosnia and herzegovina, the commission will give the opinion (european commission 2018). moreover, european commission defined six flagship initiatives related to specific actions which olgica glavaški, emilija beker pucar 153 could improve their position in accession process. the specific interest in this paper is related to fiscal adjustments in west balkans economies in comparison to european union economies, and their progress in this field is estimated as follows by the european commission for the year 2019: for albania still remains essential to ensure effective, efficient and transparent functioning of public finance management; bosnia and herzegovina should adopt strategy for public administration and public finance management, and establish monitoring framework in order to ensure financial sustainability; in montenegro is undertaken public financial management reform in 2018, however, budget transparency have to be ensured; north macedonia improved public finance and transparency, however, composition of public expenditure worsened which threatens fiscal sustainability; related to serbia, it is emphasized weakness in public finance management and in defined fiscal rules, together with the need to improve competitiveness (domazet, zubovic and lazic, 2018) . differences do not exist only between european union economies and west balkans economies. the fiscal balance could be used in order to measure differences among economies in the context of fiscal sustainability, and the range is from −32.5 % of gdp in the year 2010 in ireland to 6 % of gdp in luxemburg in the year 2006. it turns out that important differences already exist in the sample of eu members, and certainly between eu members vs. (potential) candidates’ economies. average fiscal balance per annum for all analyzed economies shows two years as extremes: 2007 the lowest fiscal deficit was achieved (−0.2 % of gdp), and 2009 the highest fiscal deficit was achieved due to influence of global instability (−6.3 % of gdp). according to this, it is assumed heterogeneity within the sample and differences during the analyzed period. using data related to public expenditure and public revenues, the situation is as follow. in european union members, public revenues share in gdp on average were stabile during analyzed period of time, while public expenditure share in gdp fluctuated (figure 1). namely, in the period before global instability, public expenditure in average decreased, and achieved fiscal balance in average in the year 2007. global crisis caused higher indebtedness in the period 2008-2010, which accompanied with decrease of gdp in the years of global crisis determined sharp increase of public expenditure (7.7 p.p. in average of european union members). in the period 2011-2018, fiscal balance positions of european union member economies were improved. on the other hand, during analyzed period of time, west balkans economies on average have experienced lower public revenues and public expenditure in comparison to european union economies. public expenditure share in gdp in west balkans economies had similar path as in member states, while public revenues fluctuated more. this could be related to the fiscal reform in west balkans economies. 154 economic analysis (2020, vol. 53, no. 1, 149-162) figure 1. public expenditure and public revenues in the group of european union and west balkans economies source: authors. beside observed distinctions between european union and west balkans economies, profound analysis could indicate individual differences within each group. in european union economies during the period 1995-2018, public revenues varied from 25.77 % of gdp in ireland in 2018 to 57.341 % of gdp in sweden in 1996, while average public expenditure fluctuated from 25.73 % of gdp in 2018 to maximum value of 65.046 % gdp in 2010 both in ireland. therefore, ireland was the economy with the highest fluctuations of public expenditure in analyzed period of time. in the west balkans economies fiscal revenues varied from 19.393 % of gdp in albania in 1997 to 54.721 % of gdp in bosnia and herzegovina in 1999, and public expenditure from 28.229 % of gdp in albania in 2012 to 57.503 % of gdp in bosnia and herzegovina in the year 1999. this indicates important differences between two groups of economies and within two groups, emphasizing that although all analyzed economies belong to european continent and all economies are member or in the accession phase to european union, it is necessary to analyze specificities of each country’s fiscal adjustments, namely, it is important to use heterogeneous coefficient in panel estimations. testing fiscal adjustments in the european union versus west balkans economies econometric framework for fiscal sustainability and fiscal adjustment estimation is selected taking into account potential problems of heterogeneity, nonstationarity, and cross-sectional dependency in the panel. in the beginning, anova f-test and welch f-test are used to test the variability for each economy for key variables. the results showed heterogeneity in analyzed sample in the most important fiscal sustainability variables (results are shown in table 1). next, cross-sectional dependency is tested using pesaran cd test in the pre-estimation phase for all variables (table 1), and results indicated that in all cases null hypothesis of cross-section independency has to be rejected. detected dependency is expected due to the fact that all 20 25 30 35 40 45 50 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 16 20 17 20 18 public revenues eu28 public expenditure eu28 public revenues wb public expenditure wb olgica glavaški, emilija beker pucar 155 economies in the sample are members of european union or in the accession phase, and certainly linked by strong institutional framework (customs union, common market, common agricultural policy, tax harmonization, and finally, monetary union). although a large degree of the competencies are directly related to the level of european union, fiscal policy is not unified. therefore, mechanisms of fiscal deficit reduction could not be the same, but given that it is directed by the same framework, the similarities must exist. this could explain the existence of cross-sectional dependency and heterogeneity in the model. table 1. variability testing in countries and pesaran cd test variables anova f‐test welch f‐test cross‐sectional dependency test teststat. pvalue teststat. pvalue cdtest pvalue correlation aps. (corr.) fiscal deficit 7.22 0.000 13.1202 0.000 25.80 0.00 0.297 0.370 public revenues 234.5 0.000 424.055 0.000 5.79 0.00 0.051 0.346 public expenditure 95.82 0.000 165.78 0.000 24.02 0.00 0.213 0.342 public debt 54.96 0.000 224.897 0.000 6.2 0.00 0.77 0.507 source: authors’ calculation. cross-sectional dependency in the sample, conditioned the use of second generation panel unit root test – pesaran cips test (2007). westerlund and prohl (2007) showed that inclusion of trend in the model when all variables are represented in the form of gdp share is redundant, so decisions are made on the basis of models with constant, and according to akaike information criteria to determine optimal lag in model. results of pesaran cips test (table 2) indicated that variables are nonstationary. next, the stationarity of variables first differences is tested, and results of pesaran cips test showed stationary of variables in first differences, namely, all variables in the model are integrated of order 1. results of pesaran’s unit root test indicate assessment of fiscal sustainability, due to difference stationarity of fiscal deficit, while first order of integration of public revenues and public expenditure is the base for cointegration analysis. table 2. pesaran unit root test cips test ho: i(1); h1:i(0) l a gs model with constant a level of variables first difference of variables 𝑍 𝑡̅ -statistika (cips) p-value 𝑍 𝑡̅ -statistika (cips) p-value public revenues 0 -1.527 0.063 -22.596 0.000 1 -2.546 0.050 -14.264 0.000 2 1.355 0.912 -7.525 0.000 public expenditure 0 -1.920 0.027 -20.617 0.000 1 -0.824 0.205 -11.768 0.000 2 -0.530 0.702 -7.098 0.000 public debt 0 3.039 0.999 -15.115 0.000 1 -0.154 0.288 -8.025 0.000 2 2.956 0.987 -3.565 0.005 source: authors’ calculation. 156 economic analysis (2020, vol. 53, no. 1, 149-162) results based on heterogeneous panel coefficients according to the results of possible heterogeneity in the model, as well as cross-sectional dependency, the analysis is continued using westerlund (2007) cointegration test, between variables integrated of order 1, public expenditure and public revenues. in application of westerlund (2007) cointegration test an important assumption is related to the causality of variables. in the equation proposed in section related to hypothesis and methodology, causality is defined from public expenditure to public revenue, indicating uncompleted control of public expenditure, namely hypothesis “spend and tax”. in order to check causality nexus, granger causality test, and dumitrescu-hurlin (2012) test for heterogeneous causality in panels are undertaken (table 3). table 3. causality testing granger test public expenditure doe not granger cause public revenues fstat. p-value 4.39461 0.0127 dumitrescu and hurlin causality test in heterogeneous panels public expenditure does not homogeneously cause public revenues w-stat. �̅�stat. p-value 3.72899 2.97950 0.0029 source: authors’ calculation. results of granger-lee and dumitrescu-hurlin (2012) tests for heterogeneous causality in panels are presented in table 3, indicating that causality goes from public expenditure to public revenues, and that heterogeneous causality exists. therefore, westerlund (2007) test is a good solution for cointegration testing, due to the fact that one of the assumptions of westerlund test is existence of heterogeneous panels, and in this case, causality is heterogeneous and goes from public expenditure to public revenues. table 4. westerlund (2007) cointegration test test values z‐values p‐values bootstraped p‐values h0: no cointegration h1: at least one panel unit is cointegrated gt -1.989 -5.594 0.000 0.023 ga -7.214 -4.309 0.000 0.013 h0: no cointegration h1: all panel units are cointegrated pt -10.417 -6.412 0.000 0.010 pa -6.008 -9.885 0.000 0.005 aic selected lag length: 1; aic selected lead length: 2. source: authors’ estimation. the results in table 4 are for the assumption “spend and tax”, while the lead and lag lengths structure are chosen using aic criteria, for the model with constant. due to the fact that crosssectional dependency exists in panel, westerlund (2007) test could provide relevant conclusion only after bootstrap procedure. robust p-values are calculated using bootstrap procedure in 400 steps. conclusion related to westerlund test using group mean tests (gt and ga) and pooled panel tests (pt and pa) is that at least one panel unit is cointegrated or all panel units, and therefore is necessary to estimate heterogeneous coefficients with the intention to find out in which panel units (countries) exist cointegration, and in which countries not. mean group and pooled mean group methods are furthermore used to estimate long-run equilibrium relationship between public expenditure and public revenues, as well as short-run olgica glavaški, emilija beker pucar 157 fiscal adjustment to long-run relationship, according to empirical instructions proposed by blackburne and frank (2007). table 5 represents only homogeneous coefficients in model. according to the results of homogeneous coefficients in both cases cointegration vector is significant and between 0 and 1: 0.496 in mg model and 0.475 in pmg model. using quintos (1995) terminology, these results indicate weak fiscal sustainability in european union and west balkans economies. in comparison of two methods, higher long-run coefficient is estimated for mean group method, as well as fiscal adjustment. namely, fiscal adjustment in mg model is 0.3473, indicating that 34.73% of deviations are corrected in one year, while short-run fiscal adjustment in pmg model is -0.2818, showing that 28.18% of deviations are in average corrected in one year. however, hausman test for long-run relationship homogeneity showed that pmg method provides optimal specification, with consistent and efficient estimates. table 5. homogeneous coefficients of mg and pmg estimators for european union economies and west balkans economies in the period 1995-2018 dependent variable: log public revenues homogeneous long‐ run relationship (𝜽) ∆𝒍𝑬 𝝁𝒊 error correction (𝜱𝒊) coef. p‐value coef. p‐ value coef. p‐ value coef. p‐ value mg 0.496121 0.000 0.07643 0.163 1.1432 0.000 -0.3473 0.000 weak fiscal sustainability pmg 0.475849 0.000 0.09007 0.009 0.83392 0.000 -0.2818 0.000 weak fiscal sustainability hausman test for long‐run relationship homogeneity hausman test statistics 0.04 p-value 0.8381 ardl (1,1) source: authors’ estimations. tabela 6. heterogeneous coefficients of pmg estimator for european union and west balkans economies in the period 1995-2018 dependent variable: log public revenues error‐correction (𝜱𝒊) ∆𝒍𝑬 𝝁𝒊 countries coeff. p-value coeff. p-value coeff. p-value european union economies austria -0.632 0.001 0.119 0.334 2.1402 0.002 belgium -0.345 0.000 -0.046 0.459 1.1779 0.001 cyprus -0.244 0.085 -0.427 0.009 0.7525 0.001 estonia -0.878 0.000 0.010 0.939 2.7521 0.000 finland -0.143 0.154 -0.012 0.847 0.5002 0.168 france -0.247 0.020 -0.163 0.264 0.8461 0.022 germany -0.012 0.908 0.016 0.830 0.4448 0.906 greece -0.181 0.044 -0.089 0.770 0.6126 0.032 ireland -0.137 0.243 0.264 0.002 0.2931 0.367 italy -0.422 0.002 -0.009 0.936 1.4018 0.003 latvia -0.252 0.098 0.1853 0.100 0.6817 0.092 lithuania -0.164 0.225 0.1797 0.086 0.4190 0.173 luxemburg -0.101 0.307 0.1496 0.004 0.3542 0.312 malta -0.202 0.040 -0.240 0.196 0.5840 0.041 netherlands -0.174 0.141 -0.059 0.473 0.5715 0.151 portugal -0.312 0.001 -0.304 0.040 0.9839 0.001 slovak republic -0.256 0.044 0.3095 0.012 0.7167 0.050 158 economic analysis (2020, vol. 53, no. 1, 149-162) slovenia -0.459 0.017 -0.0681 0.521 1.4587 0.025 spain -0.228 0.024 -0.547 0.008 0.648 0.034 bulgaria -0.286 0.046 0.1345 0.251 0.8122 0.046 uk -0.076 0.491 -0.278 0.045 0.2322 0.406 croatia -0.406 0.017 0.7084 0.001 1.2804 0.021 hungary -0.237 0.037 -0.1668 0.277 0.7651 0.043 poland -0.403 0.023 0.3739 0.123 1.2206 0.025 romania -0.361 0.023 0.255 0.039 0.7091 0.032 czech republic -0.184 0.087 0.2534 0.048 0.5811 0.176 denmark -0.194 0.050 -0.410 0.594 0.6744 0.061 sweden -0.218 0.048 -0.011 0.901 0.7521 0.052 west balkans economies albania -0.451 0.010 0.775 0.001 0.5200 0.034 bosnia and herzegovina -0.157 0.276 0.224 0.040 0.5268 0.284 montenegro -0.381 0.007 0.643 0.000 1.2177 0.008 north macedonia -0.438 0.003 0.203 0.115 0.9835 0.006 serbia -0.193 0.412 0.630 0.000 0.3020 0.402 source: authors’ estimation. pmg estimates show that exist significant long-run equilibrium relationship in the sample (european union and west balkans economies in period 1995-2018), and weak fiscal sustainability (table 5). according to error-correction in the model, 28.18 % of deviation from equilibrium is in average corrected in one year. table 6 shows heterogeneous fiscal adjustments estimated by pmg method. based on results, fiscal adjustments are the highest in estonia and austria, while the most weak but significant fiscal adjustment is estimated for greece. although with expected sign, fiscal adjustments are not significant in some economies in the sample, which could be interpreted differently. for instance, in germany and luxemburg, fiscal adjustment in terms of public expenditure adjustments to long-run equilibrium relationship, is not significant because of existence of opposite hypothesis in this economies, “tax and spend”, and higher average public revenues in comparison to average public expenditure. in other economies it could be due different fiscal policy framework (welfare state such as finland), or because of the influence of global instability (ireland). for west balkans economies individual fiscal adjustments are more intensive than average fiscal adjustment, namely, 45.1% in albania, 38.1% in montenegro, 43.8% in north macedonia, showing that west balkans economies have some progress in the period 1995-2018 related to fiscal adjustments and stabilization of public finances. results indicated that fiscal adjustments for serbia and bosnia and herzegovina are not significant. this result for serbia is in line with the paper of andrić, arsić, and nojković (2016) which showed that corrective actions of government in serbia were insufficient before and after global crisis, and provided empirical support to the fiscal fatigue hypothesis. for the bosnia and herzegovina, in the report for 2019, european commission estimated fiscal policy as vulnerable to inefficiency and waste, and emphasized need for fiscal adjustments, especially in building-up sufficient fiscal buffers. the relevance of the results is analysed by robustness check in time dimension by reduction in the analysed period. years 1995 and 1996 are excluded from the model, in order to test robustness and whether introduction of stability and growth pact in 1997, significantly changed results. estimated model is presented in appendix (tables 1a and 2a) and confirms validity of the results heterogeneous fiscal adjustments and weak fiscal sustainability in european union and west balkans economies. average fiscal adjustment is higher in comparison to the baseline model, namely, 30.34% of deviations are corrected in one year, meaning convergence after the adoption of stability and growth pact in 1997. finally, it is concluded that hypothesis 1 and 2 are confirmed: weak fiscal sustainability exists in the panel of european union and west balkans economies according to homogeneous olgica glavaški, emilija beker pucar 159 coefficients, while fiscal adjustments to long-run equilibrium relationship are heterogeneous in the sample; namely in some economies fiscal adjustments are negatively and significant with different magnitude of influence, while in others is defined ad hock. conclusion this paper empirically assesses heterogeneity of fiscal adjustments in european union and west balkans economies, in the circumstances when debt crisis renewed questions when and how governments adjust their public expenditure. the research covers panel of 28 european union economies and 5 west balkans economies over the period 1995-2018. the paper operates within non-stationary, heterogeneous panels using flow relationship. the results based on pmg model point to weak fiscal sustainability and that in average 28.18 % of deviation from equilibrium relationship is corrected in one year. moreover, the results provide heterogeneous evidence of public expenditure adjustments to long-run equilibrium relationship in european union and west balkans economies. the highest significant values are estimated in austria and estonia, and the lowest significant value in greece, while fiscal adjustments are insignificant in some economies, due to influence of global instability or fiscal policy framework. results showed that accession process for west balkans economies does not lead to automatic convergence of countries and fiscal sustainability assessment, although significant fiscal adjustments are noted in albania, 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(2015). “macroeconomic effects of fiscal adjustment: a tale of two approaches.” journal of interntional money and finance, 57 (october2015): 31-60. olgica glavaški, emilija beker pucar 161 appendix table 1a. robustness check: pmg estimator for european union and west balkans economies in period 1997-2018 dependent variable: log public revenues homogeneous long‐ run relationship (𝜽) ∆𝒍𝑬 𝝁𝒊 error correction (𝜱𝒊) coef. p‐value coef. p‐value coef. p‐value coef. p‐value mg 0.46855 0.000 0.0485 0.347 1.2827 0.000 -0.3672 0.000 pmg 0.28402 0.000 0.10185 0.059 1.3888 0.000 -0.3034 0.000 hausman test for long‐run relationship homogeneity hausman test statistics 0.27 p-value 0.3120 ardl (1,1) source: authors’ estimations. tabela 2a. robustness check: heterogeneous coefficients of pmg estimator for european union and west balkans economies in the period 1997-2018 dependent variable: log public revenues error‐correction (𝜱𝒊) ∆𝒍𝑬 𝝁𝒊 countries coeff. p-value coeff. p-value coeff. p-value european union economies austria -0.6080 0.001 0.248 0.025 3.1661 0.001 belgium -0.225 0.099 0.0311 0.444 1.1865 0.097 cyprus -0.227 0.005 -0.479 0.079 1.0475 0.002 estonia -0.460 0.011 0.298 0.018 2.1045 0.011 finland -0.703 0.000 -0.083 0.166 3.7644 0.001 france -0.059 0.558 -0.417 0.796 0.3147 0.554 germany -0.135 0.349 0.0235 0.755 0.6911 0.348 greece -0.201 0.091 -0.149 0.693 0.6126 0.032 ireland -0.076 0.526 0.295 0.000 0.2109 0.656 italy -0.197 0.137 0.1522 0.161 1.1011 0.136 latvia -0.168 0.170 0.232 0.026 0.6762 0.170 lithuania -0.157 0.248 0.1191 0.117 0.5995 0.220 luxemburg -0.294 0.050 0.1281 0.006 1.5122 0.051 malta -0.285 0.010 -0.062 0.722 1.3007 0.009 netherlands -0.288 0.072 -0.067 0.458 1.4340 0.071 portugal -0.268 0.013 -0.266 0.097 1.3196 0.012 slovak republic -0.214 0.083 0.3711 0.003 0.9347 0.084 slovenia -0.909 0.000 -0.0542 0.460 4.3751 0.000 spain -0.350 0.008 -0.572 0.006 1.5689 0.009 bulgaria -0.245 0.086 0.1936 0.104 0.9923 0.087 uk -0.400 0.002 -0.416 0.001 1.6591 0.001 croatia -0.371 0.032 0.779 0.000 1.8821 0.033 hungary -0.205 0.088 -0.175 0.224 1.0348 0.089 poland -0.548 0.005 0.2833 0.264 2.5643 0.006 romania -0.401 0.017 0.260 0.015 1.2981 0.016 czech republic -0.190 0.311 0.234 0.181 0.9165 0.299 denmark -0.282 0.077 -0.405 0.606 1.5071 0.079 sweden -0.153 0.104 -0.028 0.763 0.8064 0.107 west balkans economies albania -0.488 0.005 0.376 0.046 0.999 0.002 bosnia and herzegovina -0.279 0.288 0.244 0.007 1.4301 0.008 162 economic analysis (2020, vol. 53, no. 1, 149-162) montenegro -0.318 0.011 0.722 0.000 1.5587 0.012 north macedonia -0.264 0.085 0.580 0.643 0.860 0.101 serbia -0.030 0.751 0.686 0.000 0.1528 0.738 source: authors’ estimation. article history: received: august 6, 2019 accepted: september 27, 2019 ea_2016_3-4 udc: 005.334:336.71(497.11) jel: g15, g32 cobiss.sr-id: 228331276 scientific review stress testing tool in banking risk management – an evidence from serbia džodžo miodrag1 abstract – in the paper, the basic types of bank stress tests will be showed as examples from the practice of a relatively small bank in serbia with assets of less than a hundred millions euro’s. the tool is shown in two types of stress test (scenario of analysis and sensitivity test) with examples. subject of the article is relevant to the problems that global economic crisis deeply affected and still affecting the serbian banking sector. crisis is prolonged and emphasizes the importance of more sophisticated tools and methods for risk management in financial institutions, especially those tools and methods dealing with the elaboration of sudden negative circumstances that could dangerously affect banks. according to extent of the crisis, bank management should envision possible situations and early signals to indicate any possible losses in future period. special attention should be focused on actions of regulatory bodies in the forms of obligatory executions of complex and comprehensive stress tests. stress tests are performed for banks individually and on level of national financial system. this article shows how relatively small changes in business environment can deeply affect a financial institution. key words: banking, risk management, stress test, scenario of analysis, sensitivity test introduction the global economic crisis inevitably led to the use and development of new tools for risk management in banking sector. stress tests again stood out and gained importance compared to other risk tools because they are beginning to be used for risk management not only within the individual banks but also within the financial system at the state level (bis, 2000). the main objective of these tests is to detect future problems if we apply certain criteria on current data. the theme of this study is the use of stress tests for risk management in financial institutions within banking system of serbia. national bank of serbia uses the macro-prudential stress test of the financial system. the results of these tests are published as a part of annual report about stability of the financial system of serbia (nbs, 2016). 1 corresponding author, phd studies with the fakultet za poslovne studije i pravo, belgrade, serbia, beograd, email miodrag22@gmail.com džodžo, m., stress testing tool, ea (2016, vol. 49, no. 3-4, 20-24) 21 stress tests considering that the risk management is increasingly important in banking business, stress tests are used for successful management of the bank. stress test is a tool that is used to determine bank ability to resist unexpected adverse events and continue with regular work. using stress tests it can be assessed whether the bank can continue to meet its obligations if something unexpected occurs or it is necessary to apply certain measures in advance. measures to be applied are depending on conclusions from stress tests results, for example what could have happen to capital profits and cash flows, as a result of testing. stress test analysis uses different methodologies, form simplest as sensitivity analysis of risk factors, to more complex as scenario analysis. both types of stress tests should be performed regularly in order to evaluate the influence of multiple risk factors on the operations of the bank. these tests are necessary for effective management of the risks and bank leadership is able to timely make right decision and prepare for exceptional circumstances. stress testing is widely accepted form basle accord in 1996, and became standard part of bank business. practice has shown that stress testing is usable and the results are good element for making decisions. also, tools are important supplement for the risk management in banks, in addition to other standard methods such as ''value-at-risk'', where stress testing should be seen in broader context, not only as a statistical method. (mirkovic, 2014). stress tests are carried out as projections’ of potential negative effects and future problems. the main objectives of stress tests by drehmann (drehmann, 2008:56) are evaluating risk level, determination of the portfolio weaknesses, assisting the planning and decision-making process which makes clearer picture in financial institutions. after the global economic crisis, stress tests have greater significance and they are used in banks, international financial institutions and by regulators. tests are used as an additional tool that provides information about bank's tolerance level, and how one can proceed in crisis situations. within imagined conditions in future, considering stress tests, one can check the level of capital, cash flow, deposits as well as credit facilities. the most important goal of the stress tests is applicable way to point potential problems in banks and markets. analysis may include one or more variables. stress testing can be, for example, conducted through sensitivity analysis and scenario (simulation) analysis (bis, 2009). stress tests entail projections of potential negative market trend, and the impact on the bank's results. stress test, in general, belongs to the static group of model for evaluating risks, and the simplest stress test is the sensitivity analysis. this way, the estimation of results of possible scenario is done, and represents the easiest method is to assess the bank vulnerability. with the sensitivity analysis one can monitor only individual parameter of stress. it is about data connected with potentially real events and their consequences in the real environment. what's good about sensitivity analysis is offer of fast assessment of these harmful possibilities and level of sensitivity of the bank to many factors. the weakness of the sensitivity analysis is that it doesn't analyze multiple factors simultaneously. more complex scenario analysis monitors multiple parameters simultaneously in some given unforeseen circumstances in the future. this analysis monitors correlation between multiple measured risks, too. the results of both models depend on the quality of imagined scenarios. if a lot of variables in reality differ from ones assumed. after defining the types of stress test to use, 22 economic analysis (2016, vol. 49, no. 3-4, 20-24) the selection steps must be undertaken to identify data and indicators which will be analyzed. two different types of approaches are used to select indicators: historical and hypothetical. historical scenarios are based on historical data. it should be considered the time frame of measuring. short-term time frames are those up to one year, and longer terms are up to five years and they provide less reliable results. in practice, after determining the scenario, identifying risk factors and time frame next step is the stress test. team of risk specialists collaborates with other organizational units of the bank. testing phases includes collection of the data, determining risk factors, construction and launching stress test, calculation of potential losses, reporting results and undertaking corrective actions as well as re-evaluations of the stress test. when results are presented to the management, results and proposal should be examined to recognize problems and prevent potential losses that may appear if conditions of the stress test occur. in order to successfully manage the risks, it is necessary to conduct and improve stress tests on regular basis. sensitivity analysis each bank must maintain the appropriate level of liquidity in a way that the ratio between the total liquidity of the bank claims on the one hand, and the sum of liabilities of the bank deposits or without contractual maturity and deposits of the bank, with fixed maturity within the next month, following the date of calculation of the liquidity ration, on the other hand. the liquidity ratio is maintained so that at least 1.0 as the average for all working days in a month, not to be less than 0,9 for more than three consecutive working days and at the end of each work day, at least 0,8. in presented sensitivity analysis of the bank from serbia it is anticipated simultaneous withdrawal of a part of domestic and foreign currency deposits, which are deposited for a period of one month and longer. in table 1 it is shown the liquidity ratio, analyzed hypothetical withdrawal of total 20% of the local currency term deposits and 20% of term deposits in euro’s. table 1: stress test of liquidity risk at the date of 31st december 2015 indicator actual data after the stress test effects daily liquidity ratio 4,35 1,72 +6,23 in the event that we have shown, it can be seen that the bank showed resistance to this hypothetical case of withdrawal of deposits and that is an indicator of liquidity remained above the prescribed limit. scenario analysis in the above example unknown are the other consequences of such massive withdrawal of deposits on other important indicators of the bank. for example such event could indicate high reputational risk which in turn could trigger other losses. a hypothetical event shown džodžo, m., stress testing tool, ea (2016, vol. 49, no. 3-4, 20-24) 23 in the following scenario analysis also presents stress test of the bank's liquidity. displayed scenario analysis belongs to combination of systemic and specific events. the scenario includes potential deterioration of quality of the bank's portfolio due to reduced economic stability of the domestic market. simultaneously bank must extraordinary repay the full amount of taken long-term loan from abroad, due to breaches of contractual clauses concerning the quality of the portfolio of that bank. the bank develops scenario and observe development in this hypothetical scenario, as the worsening of the economic situation in the country develops. austerity measures anticipated are abolishing government subsidies to milk producers who are very significant segment of customers for the bank, and a further increase in import of pig’s because, due to high inflation and high prices farmers have no profit from growing pigs. the example also shows increase in unemployment, the decline in average earnings, and the increasing price of fuel which consequently leads to additional increasing of problematic loans in all sectors. after detailed analysis and calculation of the effects of the hypothetical bank, in following table are the results: table 2. results of scenario analysis on the date 31st december 2015 indicator the actual data scenario analysis effect capital in million eur 15,1 13,9 -1,8 the share of problematic loans 2,87% 10,01% +7,14% return on equity indicator (roe) 14,97% -3,30% -18,27% the daily liquidity ratio 4,35 1,34 -3,01 in the proposed situation, all business and personal clients and most of the agricultural segment of the portfolio are late with payments, and consequently the bank has worsening portfolio quality. this situation quickly causes the creditor from abroad to clam all the longterm borrowed funds immediately. the latter automatically adversely affects the liquidity of the bank. furthermore, there are additional negative effects on liquidity due to that clients massively cease to pay obligations to the bank and thus reduce the expected inflows. also, the reduced quality of the portfolio the bank required increased provisions for loan losses in the income statement and reduction of capital, which added burdens profitability and capital and also, reduced capital adequacy ratio. particular heaviness of this scenario is the fact that everything happens simultaneously. this is a complex scenario that is possible in extreme circumstances, but it deserves to be closely examined by the bank. scenario analysis assesses the impact of variables related to each other, and then as the sum of all the negative impacts there is the further deterioration of portfolio quality, than, probably further crisis of profitability, and after that, at the end we have again deeper liquidity crisis. bank leadership after the scenario analysis examines possible options to implement in the near future, an advance plan for a case described in scenario, in order to possibly reduce or neutralize negative effects. 24 economic analysis (2016, vol. 49, no. 3-4, 20-24) conclusion it is important to note that for reality of stress test is necessary to have a team that has experience and team which is inventive while choosing parameters and develop scenario analysis. in elaboration of the assumptions, participants must know causes and consequences of events that have occurred in the country and abroad historically. stress testing is a standard tool in risk management, and is always the result of teamwork. sensitivity test is a simple and fast method, but it can also be insufficiently precise. scenario analysis requires a lot more time and participants. it can provide a more precise picture of the effects of larger number of indicators. there is always a real danger that during the development of stress tests it could go to extremes where the assumptions are too conservative or optimistic, or that the tests are either too simple, or too complex. when elaborating scenario, it is very important to apply well known historical shocks i.e. it is important to elaborate repetition of familiar events. references drehman, m. 2008. stress tests: objectives, challenges and modeling choices.” economic review, 2: 60-92. basel committee on banking supervision. 2009. principles for sound stress testing practices and supervision, consultative document, bank for international settlements, switzerland. bis, 2000. http://www.bis.org, stress testing by large financial institutions: current practice and aggregation issues, bank for international settlements, cgfs publications no 14, switzerland. lindgren m., bandhold h. 2003. scenario planning the link between future and strategy. palgrave macmillan, new york mirković, v. 2014. “stres testovi u finansijskim institucijama.” bankarstvo, 1/2014: 88-117, beograd. nbs. 2016. annual financial stability report http://www.nbs.rs/internet/english/90/90_2/fsr_2015.pdf, narodna banka srbije, beograd. article history: received: 11 september, 2016 accepted: 14 september, 2016 ea_2018_3-4 jovan rabrenović 67 doi: 10.28934/ea.18.51.34.pp67-80 case report comparative analysis of tourist brand of montenegro and croatia – perspectives of the impact on the economy of the state jovan rabrenović1* 1 faculty for economy and business, mediterranean universit abstract the importance of tourism for the economy of a country, from the beginning of the 21st century, is significantly increased in relation to its traditional role as one of the segments of the economy. the speed through which tourism in the world, and therefore in the region, develops and the amount of revenues generated through it makes it the generator of the economic development of a large number of countries. examples of montenegro and croatia, as two comparable systems for the way tourism was experienced and developed in the period of the former yugoslavia, ie the time when the foundations of the tourism economy of the then republics, and today's sovereign states, as well as strategic approach and target markets, were set up is a comparison of the tourist brands of both countries, with the possibility of precisely determining the revenues realized by the two countries through the tourism sector and their two tourist brands as research purposes. the aim of the research is to determine the differences and similarity of tourist brands of montenegro and croatia, through analysis of several indicators, starting from those related to tourism and travel revenues and their impact on gdp, to the effects of the economies of these countries from capital investment and employment. finally, the main result of the analysis is the confirmation that there is a significant impact of the country's tourist brand on the level of revenue generated by the economies of the analyzed countries. the research has also shown the necessity of further development of the tourist brand montenegro in the direction of croatia. which means an active approach to solving infrastructure problems, greater application of marketing management, synchronization of campaigns with the strategies of developing the national brand of the state and building hotel capacities that meet the standards of the most developed tourism economies in europe. key words: marketing in tourism, national brand, country tourist brand, gross domestic product jel classification: m31, a10 introduction montenegro has opted for tourism as one of the three strategic directions for the development of the economy. however, the legacies of the former social and economic order are still present in this country, which is significantly contributed to by the transition period and the environment in which it was located. the nineties of the last century was characterized by the collapse of one and the transition in another way to the development of the economy and tourism as its significant segment. only in the period after the re-establishment of autonomy, montenegro is moving towards direction of noticable investment in tourism and the re-establishment of fallen tourism economy. croatia has moved to this process significantly earlier,, hence its tourist brand is better * e-mail: jovanrabrenovic@gmail.com 68 economic analysis (2018, vol. 51, no. 3-4, 67-80) positioned, and therefore the benefit to the economy is much more larger.1 from the above mentioned, we can see the need for analysis of tourist brands of montenegro and croatia, two neighboring countries with high tourist potential. the study compares tourism promotion campaigns conducted by these two countries. it analyzes the destination markets of both countries and changes in tourism revenues acomplished by these countries in the years that were taken as comparable. the economy of each country that has tourist potential has the possibility of faster development and increase in revenues, which will provide long term economic stability. the tourism economy and the fallowing activities will have a significant share in gdp if, as a support, they have favorable natural, cultural and historical heritage. through increased interest of investors, it will also enable bigger investments in tourism infrastructure, in the first place in hotel facilities, road infrastructure and air transport. over the last fifteen years, some countries in the region have given long-term lease of some of their largest airports.the croatia has done this by giving its largest airport in zagreb and montenegro is also preparing to do the same. some of the countries of the western balkans, like montenegro, have entrusted the construction of highways to foreign companies with great international experience. with the condition that at least 30% of the companies engaged in the construction of the highway are from montenegro. in croatia, as well as in montenegro, the government entrusted the construction of the largest tourist complexes to international investors. in montenegro, the amount of these investments exceeds one billion euros. all this significantly increases the value of the country's tourist brand. montenegro can use the experience of croatia to reduce possible wanderings in the selection of strategies and policies for the development, or strengthening of its tourist brand. methodology of research in order to determine the position of tourist brands of montenegro and croatia, financial and economic benefits of tourism achieved by their respective economies, the parallel comparison had to be done by all relevant and available indicators. therefore, the research method based on data from secondary sources was used, with the emphasis on the strategies for development of tourism in montenegro and croatia, the documents of ministries responsible for the tourism of the two countries, national tourist organizations, specialized journals and publications, press, internet and professional literature. important sources of information for the research were the institutions responsible for official statistics in montenegro, croatia and the european union. analysis of tourist brands of montenegro and croatia key elements of strategies for development of tourism of montenegro and croatia at this moment when the global trend of building strong tourist brands is noticeable in the countries that have tourist or complementary potentials, there are challenges of developing their own models of tourist brands in the countries of western balkan that would be competitive in the target markets. countries of this part of europe are particularly aimed at developing, or exploiting an existing, competitive advantage and assuming the role of a primary tourist destination in relation to other regional actors. the building of tourist brands should include building the image of the country and destinations, positioning at desired markets and target markets, respetively. the image of the country or national image should unite all the usable potentials that the country possesses and build a positive picture in the consumer's mind, since this can attract more interest not only to tourists but also to investors. according to that, it is crucial that the offer that certain country creates to tourists should be based on: credible arguments, promises that can be fulfilled and objective presentation of the country. on the other hand, the common mistake that the 1 internet:http://iztzg.hr/userfiles/pdf/izvjestaj-10-strategija-razvoja-turizma-rh.pdf, (accessed:21.05/18) jovan rabrenović 69 country and its institutions can make is to develop its tourism brand by hiding or denying negative aspects, which are inevitable and present in most countries. the negative image should be changed by changing the behavior of one's own administrative and business system and creating an offer that is based on superior performance that we own or develop. it is wrong approach to try with media campaigns to change the image of the country on long terms, and gain the effection and sympathy of other nations and consumer segments. tourism development strategy of montenegro and croatia are the key documents issued by the governments of both countries. they have through strategic and operational goals routed directions of tourism development and targeted emitting markets.2 it is noticeable that although, both strategies have been developed for the period until 2020, croatia has significantly processed more thoroughly and more analitically some of the key segments of the strategy. table1. presents these elements of the strategy and their comparison have been done by parallel view. table 1. key terms of strategies for tourism development of montenegro and croatia criteria montenegro croatia slogan and promotion title „montenegro wild beauty” crna gora, divlja ljepota) “croatia, full of life” (hrvatska, puna života) logo of tourist brand source: https://www.montenegro.travel source:https://htz.hr period related to strategies strategy for tourism development in montenegro for period until 2020. strategy for tourism development of republic of croatia for period until 2020. strategic goals applying the principle and goals of sustainable development, montenegro will create strong position of global high quality tourist destination; for citizens of montenegro tourism will provide enough working positions and growth of standard of living and the country will generate revenues at stable and confident manner. the main goal of the development of croatian tourism for the period untill 2020. is an increase in its atracttiveness and competitiveness , which will result in enetering into the leading 20 tourist destinations in the world according to the criterion of competitiveness. operational goals • creating the necessary tourist and supporting infrastructure into direction of achieving strategic goal • montenegro forms a particular unique sale offer • marketing marketing activities trace the transformation of croatia into a destination that offers more than a family vacation, more than summer and more than the sun and the sea. • development of tourism offer apart 2 the result of author's research with the use of strategy for tourism development in montenegro until 2020 and strategy for tourism development of republic croatia until 2020. http://www.go.me/files/1228912294.pdf, and https://mint.go.hr/strategija-razvoja-turizma11411/11411 (accessed:21.05/18) 70 economic analysis (2018, vol. 51, no. 3-4, 67-80) • montenegro is known and accepted as "all-year" tourist destination • the institutional and legal framework corresponds to the requirement of a successful and sustainable development of tourism • the local population is significantly involved in the tourism industry ("internal marketing") from the development of important products for croatian tourism, the development of a tourist offer implies completion of the privatization process, activation of tourist interesting, unused state property and improvement of accommodation and other tourist offer. • investments due to numerous limitations and barriers, the level of investment activity in croatian tourism in the past period was not satisfactory. • human resources development suitability of human resources quality, or possession of modern knowledge and practical skills, is a basic element of delivering quality tourism services and promoting the competitiveness of croatian tourism. • process management effective implementation of the conclusions of the tourism development strategy of the republic of croatia until 2020 assumes organizational adaptation at the level of the ministry of tourism, functioning of the system of tourist communities, as well as the ongoing interdepartmental cooperation of the ministry related to tourism activity. target emitting markets until 2020. • west european and north european markets, russia and more of eastern european countries (eu members). these markets are a priority. • markets of neighboring countries of serbia, bosnia and herzegovina, albania, and the local market. tourists from both the largest emitting regions do not differ very much in terms of what they want to experience on vacation, as far as financial opportunities are concerned. • leading ( germany, austria, slovenia) • promt to (czech, poland, slovakia) • challenging (russia, netherlands, • france) • neighboring (hungary, bosnia and herzegovina, serbia) • remote (usa, canada, australia) source: the result of author's research with use of strategy for tourism development in montenegro for the period until 2020. and strategy for tourism development of republic of croatia for period until 2020. the logo of the tourist brand of montenegro is in application significantly longer than the logo of croatia.3 although both designs have suffered public criticism, they are still in use, although it is noticeable that the logo of montenegro tourism has needed a long time ago to be refreshed or approached to create a new logo. 3 https://croatia.hr/documents/3583/izbor-vizualnog-identiteta-brenda-hrvatska-za-htz-hrv-.pdf i https://www.montenegro.travel/en/ [pristupljeno: 03.06/18] jovan rabrenović 71 comparison of economic indicators of montenegro and croatia with upcoming analysis of the economic indicators, the mutual relations of the economies of montenegro and croatia will be compared and changes in their value incurred during period covered by research will be presented. total accommodation capacities (hotels, tourist resorts, campsites, hostels, etc.) in montenegro in 2016 are contained in 348 facilities that have a total number of 166.842 beds. the total number of tourist facilities, as well as the total number of beds in montenegro in relation to 2010, did not change significantly. in 2010, montenegro had in total 308 facilities that had 166.288 beds. in 2016, croatia had 4.567 accommodation facilities (hotels, tourist resorts, campsites, hostels, etc.) with a total of 1.33.751 beds. compared to 2016, croatia had 909.951 beds in 2010, which were deployed in 2.117 facilities.4 the number of international tourists in 2016 in montenegro were 1.662.000. the number of arrivals in montenegro increased from 136.000 in 2002 to 1.66 million in 2016, which means that the number of arrivals is growing at an average annual rate of 23,96%. the total number of tourists who visited montenegro in 2017 increased to around 2.00.000. in the same period, croatia had 13.809.000 international tourists. their number increased from 4.18 million in 1997 to 13.8 million in 2016 and grew at an average annual rate of 7.11%. in 2017, the total number of tourists who stayed in croatia was additionally increased to 17.430.580 tourists.5 expenditures for tourism as a share in total imports in 2016 in montenegro amounted to 3.3%. these costs have significantly changed over the past few years, so in the period from 2007 they increased from 1.8% in 2016 to 3.3%. expenditures for tourism as a share in total imports in the same year for croatia amounted to 4%. this category of costs in croatia has oscillated over the past few years with a tendency of a slight increase in the period from 2005 (3.8%) to 4% in 2016.6 table 2 presents revenues from tourism in the period 2007-2016 for montenegro and croatia year montenegro croatia value in millions of dollars change% value in millions of dollars change% 2016 978,000,000 3.27% 9,820,000,000 8.89% 2015 947,000,000 -1.25% 9,018,000,000 -10.53% 2014 959,000,000 3.23% 10,079,000,000 3,75% 2013 929,000,000 8.02% 9,715,000,000 9.01% 2012 860,000,000 -7.13% 8.912.000.000 -7.15% 2011 926,000,000 21.05% 9,598,000,000 15.65% 2010 765,000,000 -3.41% 8.299.000.000 -10.76% 2009 792,000,000 -7.80% 9,300,000,000 -19.93% 2008 859,000,000 30.15% 11,615,000,000 20.78% 2007 660,000,000 9,617,000,000 15.92% montenegrin tourism revenues in 2016 amounted to 978 million dollars. it is noticeable that the revenues from tourism in montenegro, in addition to the fluctuations present in the last few 4 internet: https://tradingeconomics.com/indicators, [pristupljeno: 11.05/18] 5 the author's research based on data from eurostat, knoema.com, montstat i central bureau of statistics of croatia 6 the author's research based on data from eurostat, knoema.com, montstat i central bureau of statistics of croatia 72 economic analysis (2018, vol. 51, no. 3-4, 67-80) years, increased in the period from 2007 to 2016. tourist revenues in 2016 amounted to 9.820 million dollars for croatia.7 revenues from tourism of montenegro as a share in total exports in 2016 amounted to 55%. croatian revenues on the same basis in 2016 were 38.8%.8 table 3 presents a comparative overview of the share of tourism in total exports of montenegro and croatia in the period 20112016 table 3. revenues from tourism as a share in total exports of montenegro and croatia year montenegro croatia value in % change % value in % change in % 2016 55.0 -0.84% 38.8 5.00% 2015 55.5 6.53% 37.0 -2.61% 2014 52.1 3.28% 38.0 -2.81% 2013 50.4 -0.26% 39.1 2.55% 2012 50.5 5.07% 38.1 0.67% 2011 48.1 -5.83% 37.8 1.89% 2010 51.1 -7.34% 37.1 -12.95% 2009 55.1 16.56% 42.7 0.96% 2008 47.3 13.37% 42.3 3.38% source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia expenditures for tourist travel abroad to citizens of montenegro in 2016 amounted to 91 million dollars. montenegro's travel expenses have significantly changed over the past few years, but have generally increased in the period from 2007 to 2016. the croats spent 954 millions of dollars on travel expenses abroad in 2016. these costs have fluctuated considerably over the past few years, however, they have mostly increased in the period from 2002 to 2016.9 the direct contribution of travel and tourism to montenegro's gdp amounted to 1.1 billions of dollars in 2017. the contribution of travel and tourism to montenegro's gdp has changed over the last ten years with an alternate increase and a decrease in the share of total gdp. croatian gdp in 2013 amounted to 13.7 billions of dollars from travel and tourism. in croatia, the share of travel and tourism revenues in gdp oscillated in a comparable period.10 in table 4. presents revenue generated from travel and tourism in montenegro and croatia in the period 2007 2017. 7 ibid 8 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 9 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 10 ibid jovan rabrenović 73 table 4. contribution of travel and tourism to gdp in montenegro and croatia year montenegro croatia $ change in % $ change % 2017 1.1 8.55% 13.7 11.21% 2016 1.0 8.25% 12.4 7.05% 2015 0.9 2.08% 11.5 -11.81% 2014 0.9 2.70% 13.1 2.14% 2013 0.9 15.92% 12.8 9.36% 2012 0.8 -2.45% 11.7 -13.30% 2011 0.8 5,81% 13.5 11.19% 2010 0.8 -2,37% 12.2 -13.82% 2009 0.8 -45.62% 14.1 -19.79% 2008 1.4 53.18% 17.6 20.20% 2007 0.9 69.19% 14.6 16.78% source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia in the period from 2006 to 2017, the direct contribution of revenues generated from travel and tourism in montenegro and croatia generally had a growth trend.11 data for both countries are presented in table 5. table 5. direct contribution to the growth rate of gdp from travel and tourism in montenegro and croatia year montenegro croatia change in % change in % 2017 6.21 8.14 2016 0.67 6.09 2015 10.96 5.69 2014 0.48 3.79 2013 7.05 6.81 2012 5.05 -5.85 2011 7.31 8.36 2010 0.13 -9.63 2009 -33.81 -15.40 2008 13.91 6.61 2007 40.12 4.71 2006 58.96 3.82 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia contribution of travel and tourism to gdp (% of gdp) for montenegro in 2017 was 23.7%. the impact of this segment of the economy has not changed significantly since 2006. in the same period, the contribution of travel and tourism to gdp (% of gdp) for croatia was 25%. the contribution of travel and tourism to gdp (% of gdp) in croatia also increased in the period from 1998 to 2017.12 the following table (table 6) presents the percentage participation of travel and tourism in the gdp of montenegro and croatia. 11 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 12 the author's reseaarch based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 74 economic analysis (2018, vol. 51, no. 3-4, 67-80) table 6. contribution of travel and tourism gdp to participation in gdp in montenegro and croatia year montenegro croatia value of percentage participation change in% value of percentage participation change in% 2017 23.7 4,69% 25.0 3,84% 2016 22.6 2.44% 24.1 3.04% 2015 22.1 9.25% 23.4 2.86% 2014 20.2 -0.23% 22.7 2.98% 2013 20.3 6.14% 22.1 6.46% 2012 19.1 8.31% 20.7 -4.45% 2011 17.6 -3.50% 21.7 6,69% 2010 18.3 -1.90% 20.3 -9.83% 2009 18.6 -40.56% 22.5 -9.83% 2008 31.3 24.02% 25.0 2.57% 2007 25.3 25.12% 24.4 -1.91% 2006 20.2 24.9 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia in 2017, the direct contribution of travel and tourism to employment in montenegro amounted to 14.4 thousand persons. in croatia, this industry branch has created jobs for 138.000 people.13 table 7 presents a comparative overview of the number of employees engaged in tourism and travel business in montenegro and croatia. table 7. the direct contribution of travel and tourism to employment in montenegro and croatia year montenegro croatia number of employees in tourism change in% number of employees in tourism change in% 2017 14.4 0.72% 138.0 2.88% 2016 14.3 -1.70% 134.2 0.92% 2015 14.5 -4.33% 132.9 3.56% 2014 15.2 1.07% 128.4 1.02% 2013 15.0 18.09% 127.1 4.60% 2012 12.7 0,35% 121.5 -6.74% 2011 12.7 12.90% 130.3 7.02% 2010 11.2 -18,42% 121.7 -14.49% 2009 13.8 -23.03% 142.3 -11.36% 2008 17.9 12.13% 160.6 7.04% 2007 16.0 31.87% 150.0 2.15% 2006 12.1 146.9 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 13 the author's reseaarch based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia jovan rabrenović 75 capital investments in montenegro were at the level of 0.4 billion euros in 2017, which is higher by 18.71%. compared to 0.3 billions of euros invested in the previous year. in 2017, they reached 7.9 billions of euros in croatia, which is 3.89% more than in 2016.14 changes in capital investments for montenegro and croatia in the period 2006 2017 are presented in table 8. table 8. capital investments in montenegro and croatia in the period 2006 2017 year montenegro croatia capital investments in billions of euros change in%* capital investments in billions of euros change in% 2017 0.4 18.71% 7.9 3,86% 2016 0.3 29.81% 7.6 6.55% 2015 0.2 21.49% 7.1 9.27% 2014 0.2 8.17% 6.5 -2.46% 2013 0.2 17.09% 6.7 0.73% 2012 0.2 4.21% 6.7 -4.49% 2011 0.1 -23.20% 7.0 -3.28% 2010 0.2 3.93% 7.2 -16.32% 2009 0.2 -47.35% 8.6 -27.00% 2008 0.4 94.56% 11.8 -4.09% 2007 0.2 26.34% 12.3 -2.69% 2006 0.1 12.6 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia the share of capital investments in export of montenegro in 2017 was 35.1%. this indicator also significantly fluctuated in the period from 2009 2017. croatian capital investments as a share in exports amounted to 10.9%. the share of capital investments in croatia (%) in exports in the period 2009 2017 ranged from 10 to 12 percent.15 the next table (table 8) brings comparative data on the share of capital investments in exports of the economies of montenegro and croatia table 8. the share of capital investments in exports of montenegro and croatia montenegro croatia year share of capital investments in exports (%) change%* share of capital investments in exports (%) change in% 2017 35.1 3,22% 10.9 -0.26% 2016 34.0 4,26% 11.0 1.81% 2015 32.6 8.43% 10.8 5.00% 2014 30.1 11.62% 10.2 -0.23% 2013 26.9 8.50% 10.3 0.04% 2012 24.8 5,64% 10.3 -0.62% 2011 23.5 -18.46% 10.3 -0.02% 14 the author's reseaarch based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 15 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 76 economic analysis (2018, vol. 51, no. 3-4, 67-80) 2010 28.8 25.81% 10.3 0.02% 2009 22.9 -21.74% 10.3 -14.50% 2008 29.3 41.35% 12.1 -15.22% 2007 20.7 -29.26% 14.3 -11.84% 2006 29.3 16.2 source: the author's estimation based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia in the period from 2006 to 2017, montenegro's gdp continued to increase, so in 2006 it amounted to 35% of the european union's gdp (28 countries) and in 2017 it increased to 46% of european union's gdp. in the comparative period, croatia had present gdp fluctuations in relation to the eu, and in 2006 it amounted to 58% of european union's gdp, to be at the level of 61% in 2017.16 table 9 presents the gdp of montenegro and croatia in the period 2006 2017. table 9. montenegro's and croatia's gdp (percentages) relative to gdp of eu member states (28 countries) year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 country % % % % % % % % % % % % european union 100 100 100 100 100 100 100 100 100 100 100 100 croatia 58 61 63 62 59 60 60 60 59 59 60 61 montenegro 35 39 41 40 41 42 39 41 41 42 45 46 source: result of the author 's research using the data of the eurostat website the last indicator that was analyzed was the purchasing power parity of montenegro and croatia in relation to the european union and it is presented in table 10. table 10. purchasing power parity price level indices and real costs for aggregates year 2005 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 country % % % % % % % % % % % % european union 100 100 100 100 100 100 100 100 100 100 100 100 croatia 65.1 64.6 67.8 68.8 69.5 66.9 64.5 64.2 63.0 61.7 63.7 64.2 montenegro 41.8 40.8 46.1 48.9 48.4 48.2 48.9 49.6 49.1 47.8 49.0 49.9 source: result of the author 's research using the data of the eurostat website analysis of tourist brands of montenegro and croatia according to bloom consulting bloom consulting has developed one of the most reliable methods for measuring tourist brands in the countries. therefore, it follows from the view that the economic impact of the tourism sector in the country is a crucial variable in determining its place on the list of tourist brands.17 the brand of the country's tourism industry can not be strong if the country does not generate profit from tourism and travel. at bloom consulting, they are of the opinion that when choosing a destination, tourists will prefer to travel to the country with a stronger attraction and greater attractiveness 16 the author's research based on the data of eurostat, knoema.com, montstat and the central bureau of statistics of croatia 17internet:https://www.bloomconsulting.com/en/pdf/rankings/bloom_consulting_country_brand_ranki ng_tourism.pdf , pg. 6 [accessed: 07.06/18] jovan rabrenović 77 of the tourist destination.18 bloom consulting's methodology consists of four variables that together provide a methodology for ranking the country's tourist brand. the first variable consists of revenues from tourism and growth of tourism revenues. therefore, the average annual tourist revenues of international tourists visiting a country for a period of five years is taken. this eliminates possible deviations that may arise from economic or political instability. the second variable measures the attractiveness of the country's brand through market research using software that measures the total amount of search when choosing a destination for a trip. the more searches are related to tourism and the tourist offer of a country, it is the tourist brand of that country more stronger. the third variable of bloom consulting's ranking of the country evaluates the accuracy of the strategic positioning of national tourism organizations (ntos), hence consistency in the application of the strategic documents of all 193 countries included in the ranking. the fourth variable analyzes the visibility and position of the national tourism organization through the search of the official nto website. therefore, data are collected on the number of unique visits and the average total time spent per visitor on a web site. the algorithm further analyzes social media and evaluates the presence of facebook, twitter and instagram.19 according to bloom consulting, montenegro is ranked on 35th place in europe in 2017/18, which is 2 places better position in in the previous research for 2016/17. in this survey, montenegro is ranked on 99th place in the world, when it comes to the tourist brand of the country. in the comparative period of 2017/18 in europe, according to strengh of its tourist brand, croatia is ranked on 13th place and this place is for one position weaker in relation to the previous measurement. however, croatia's position on the global list of tourist brands is significantly better than montenegro, which is ranked on 27th place.20 table 11 presents the tourist brands of montenegro and croatia at the level of europe in the period 2013-2018. table 11. position of the tourist brand of montenegro and croatia at the level of europe name of the country rank 2013/14 rank 2014/15 rank 2016/17 rank 2017/18 montenegro 33 37 37 35 croatia 11 12 12 13 source: result of the author's research using the data of bloom consulting's country brand ranking tourism edition analysis of the world economic forum for 2017 index of tourism competitiveness 2017 world economic forum continuously evaluates the competitiveness of tourism of all world economies. in its report for 2017, montenegro is ranked on 72th place and croatia on 32th place, according to the index of tourist competitiveness.21 table 12 presents the detailed relation between the two countries in the period 2015 2017. 18 ibid 19 ibid 20 ibid. pg. 9 21 internet: https://www.weforum.org/reports/the-travel-tourism-competitiveness-report-2017, pg. 9 11 [accessed: 07.06/18] 78 economic analysis (2018, vol. 51, no. 3-4, 67-80) table 12. index of tourist competitiveness of montenegro and croatia name of the country rank 2017 rating change since 2015. montenegro 72 3.68 -5 croatia 32 4.42 1 source: result of author research using data from the travel & tourism competitiveness report 2015 2017 conclusion an analysis of some of the key indicators of the economy of montenegro and croatia has led to the findings confirming the views expressed in the work and the conclusion that the economies of both countries are directly related to the strength of their tourist brands and that it is necessary to permanently work on innovations in the sphere of marketing in order to make these markets more interesting to international and domestic tourists. it is evident that both countries are recognized as the dominant summer destinations and that tourists visit them mostly during this season. although tourism development strategies in montenegro and croatia have strongly anticipated the activities in order to develop the perceptions of both countries as the destination of the sun and the sea, in the reality of the economy, most of the revenues generates precisely from this offer. on the other hand, montenegro by improving its infrastructure by introducing more favorable conditions for investment, introduces international hotel chains, increases tourism revenues as well as the number of tourists, and encourages local businessmen to become more actively involved in this branch of economy through the construction of a four and five star hotel. croatia is committed to the new concept of marketing activities that provide certain results, while montenegro still does not have visible activities, although the increase in the number of tourists in the past year is a good signal to continuously improve the performance of the tourism industry. if we compare the degree of application of marketing management in the tourism of these two countries, we will note that montenegrin tourist managers are using less of marketing management in their activities. croatian managers pay more attention to the practical application of marketing in their work, which is evident in the campaigns of tourist organizations and hotels. the recommendation for montenegro would be to actively start campaigning for the branding of the montenegrin tourist destination in order to coordinate these activities with state institutions that are working on the construction and promotion of the national brand of montenegro. the development of the tourist brand, as one of the elements of the national brand of the state, should be harmonized with the strategies for the development of the national brand of montenegro, and in particular should be dedicated to modern forms of campaigns in the promotion of tourism. in the end, we can conclude that the hypothesis of the work paper is confirmed, and that the tourist brand of the state is directly related to the level of revenues that the country's economy generates. tourist brands of montenegro and croatia with smaller oscillations, increased tourist revenues and therefore strengthened their position among the tourist brands of other countries. all tested indicators give us the right to conclude that without a strong tourist brand, as part of the national brand, there will be no slightly increase in revenues and benefits for both economies. creating the preconditions for strengthening the tourist brand, the economy of the state also strengthens, and the indirect benefit, through greater engagement and employment have all branches of the economy. therefore, connecting tourism with other complementary and related business activities (agriculture, gastronomy, etc.) is a necessary step in strengthening the tourism brand and the brand of countries. literature bloom consulting and digital demand. 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http://ec.europa.eu [accessed: 03.05/18] https://www.bloomconsulting.com/en/pdf/rankings/bloom_consulting_country_brand_ranki ng_tourism.pdf, [accessed: 07.06/18] https://www.weforum.org/reports/the-travel-tourism-competitiveness-report-2017, pg. 9 11 [accessed: 07.06/18] 80 economic analysis (2018, vol. 51, no. 3-4, 67-80) http://iztzg.hr/userfiles/pdf/izvjestaj-10-strategija-razvoja-turizma-rh.pdf, [accessed: 21.05/18] article history: received: october 18, 2018 accepted: december 3, 2018 ea_2018_3-4 martin kiselicki, saso josimovski 57 doi: 10.28934/ea.18.51.34.pp57-66 original scientific paper implementation of gamification in heis in the republic of macedonia martin kiselicki1* | saso josimovski2 1 integrated business faculty, skopje, macedonia 2 faculty of economics – skopje, university „ss cyril and methodius“, skopje, macedonia abstract the focus of the paper is gamification, which has been researched typically through its’ implementation in the business sector. our research follows the implementation of gamification in higher educational institutions, since the same concepts and benefits that function in the workplace, should function with similar effect or yield even better results with students. the topic of gamification in education is a relatively novel one, with only a few papers addressing it in detail, especially on the balkan region. the contribution of the paper is two-sided, i.e., through primary and secondary research, recommendations for optimal ways of implementing gamified systems in higher education is given, and according to the obtained data, present statistics and implications for implementing gamification in heis in the republic of macedonia. the core elements and mechanics of gamification are researched and adjusted in the context of education, as well as improving existing implementations of gamification in heis through the introduction of cycles of interest (rewards for encouraging a certain type of behavior of students) and cycles of progression (a stepwise increase in the weight of the activities). the results of the primary research demonstrate that the concept of gamification offers great potential advantages for students and teaching staff, primarily by increasing the level of intrinsic motivation and the degree of completion of subjects. the paper uncovers the gamification mechanics and elements that would work best for heis in macedonia, as well as outline the biggest motivational problems students have when navigating through the educational process. through the primary research conducted, the first public available information on the introduction of gamification in higher education in the republic of macedonia is made available. key words: gamification, higher education, intrinsic motivation, extrinsic motivation, motivators, barriers jel classification: i21, i23 introduction gamification as a concept has been explored mainly in the business sector, to motivate employees outside of the traditional reward systems. gamification is the use of elements, mechanics and way of thinking from video games in an environment that has no connections with video games (detering, 2011; van der boer, 2011). since the introduction of the term in modern day business in 2008, gamification has been the focus of companies and researchers, due to the potential it offers regarding the motivation of employees, without depending on a financial reward system. gamification exploits video game elements and mechanics to connect with employees on a deeper level, transforming work tasks to be more interactive and fun. the authors have already * corresponding author, e-mail: artin.kiselicki@fbe.edu.mk 58 economic analysis (2018, vol. 51, no. 3-4, 57-66) researched the concept and its implementation in smes in macedonia, and this paper represents a continuation of the research in the higher education sector. the main goal of gamification is to increase participant/employee motivation, which can be either intrinsic or extrinsic motivation (benabou & tirole, 2003). extrinsic motivation comes from external sources, such as financial rewards (such as salary increase, bonuses), recognition, future promotions etc. intrinsic motivation is defined as coming from the individual himself, meaning he is not motivated by any specific rewards system, but instead get enjoyment from performing the task itself. the main objective of the paper is to research the current state of gamification in heis in the republic of macedonia, as well as analyze the potential for implementing it in the future. methodology the paper examines the correlation between the implementation of gamification in higher education and the increase in students’ motivation in heis to participate and complete activities related to the subjects/courses they enroll, through primary and secondary research. additional focus is provided on researching the prerequisites for introducing gamification in education through secondary data. student motivation is analyzed through secondary research, which covers the available data by analyzing the types of motivation (intrinsic and extrinsic), as well as methods for increasing it, while the primary research is conducted through a questionnaire on students from heis on the territory of the republic of macedonia. the questionnaire is composed of both open and closed questions, to better examine and understand various aspects of gamification and motivational techniques, as well as to give accurate predictions for implementation of gamified systems in heis. literature review the authors’ previous research shows that video games, as a medium, are attractive because they generate intrinsic motivation. gamers continue to perform trivial tasks because of the mechanics set up in the video game, and the inclusion of these types of mechanics in the workplace can create intrinsic motivation in employees (kiselicki et al., 2018). according to ryan and deci (2000), there are five specific intrinsic motivators: autonomy, skills, purpose, progress and social interaction. recent statistics show that there are more than 2.5 billion gamers1, while men and women are almost equally represented (59% male and 41% female)2. the largest percentage of gamers are between the ages of 21-35 (35%), which is an age group current students are mostly a part of. the second largest groups is 10-20 year olds (22%), which represent current and future students3. there are specific models (yousef adel et al., 2011) concerned with the learning divide and providing educational services in digital form (e-learning), which can increase the reach of heis, as well as provide as basis for implementing gamification. since current and future higher education students are composed of the so-called “generation z”, there could be great benefits in introducing the concept of gamification in the classroom. generations born between 1995 and 2014 with immediate contact with new technology such as the internet, cellphones/smartphones and digital media are considered a part of generation z (singh & dangmei, 2016). this generation has been born and raised in a digital world, including access to video games at a very young age, so they are well aware of the mechanics and elements of video games, meaning that implementing a gamification system in their educational process can be easily recognized and connected with. according to statistics in the united states and the eu, only 56% of students complete their four-year studies within the predicted six-year period, indicating that there could be some 1 https://www.wepc.com/news/video-game-statistics/ 2 https://www.bigfishgames.com/blog/2017-video-game-trends-and-statistics-whos-playing-what-andwhy/ 3 https://www.statista.com/statistics/722259/world-gamers-by-age-and-gender/ martin kiselicki, saso josimovski 59 systematic shortcomings in the design of the educational process itself (symonds et al., 2011). it is evident that once students go out of the loop and start being late with exams, it begins a downward spiral that could result in finishing their studies late (7-10 years) or even not graduating at all. the rationality behind the benefits of gamifying the study process in heis is the creation of higher levels of interaction, immersion and motivation among students when participating in activities during and outside the classroom. the use of game mechanics can boost learning skills by 40%, leading to higher level of commitment and task completion (kiryakova et al., 2014). difference with game-based learning the closest implementations of gamification in the classroom are game-based learning (gbl) initiatives. gbl is defined as the type of gameplay with defined learning outcomes, with the objective being to prioritize gameplay to cover the subject matter (plass et al., 2015). gbl initiatives could include digital games (such as “call of duty: world at war”) to introduce concepts around world war ii, with the goal being to interest students in identifying historically accurate events and areas. another example would be to utilize a driving game to challenge students to text and drive, with the goal being to measure reaction time, speed and other variables. utilizing video game hardware is also part of gbl, such as microsoft “xbox kinect” and specific compatible video games in physical education classes and sports training to engage students in an active way (hill e., 2015). although this over lapses with concepts of implanting gamification in education (such as including digital games), it is not the same as a gamified educational system. gamification is not the inclusion of an entire video game in the learning process, instead focusing on the mechanics implemented in various video games which motivate players to continue performing tasks and playing. these mechanics can include virtual experience points, player levels, player badges earned through performing specific tasks, leader boards and ranking systems, specific skills earned through performing tasks etc. in the context of the example with “call of duty”, a gamified system would implement certain elements of the video game, such as mimicking the progression system and connecting it with specific class-related tasks, giving players (students) the ability to earn new skills based on their class performance and having a daily/weekly/monthly leader board system that is easily viewable for everyone. these are certain mechanics which motivate players to come back to the specific video game and therefore have the potential to create intrinsic motivation in students as well. existing research on gamification in higher education lee sheldon (2012) has documented one of the first successful implementations of gamification in education. in 2009, he began modeling his course as a massively multiplayer online role playing game (mmorpg), transforming class activities in the process. students created their own avatars, they formed guilds (an alternative term to groups in mmorpg) and they completed tasks/quests to gain experience points and gain new levels. if the student reached level 12 by the end of the semester, they would receive an a. the average student grade was improved from “c” to “b” (in ects system of evaluation), while also attendance records rose drastically. gamification in education in recent years has been increasingly implemented through digitalization and smartphone applications as well. for example, if teachers want to implement gamification in a simple manner, they can utilize applications such as superfunner, which gives students experience points, badges and levels for various classroom activities (nicholson, 2013). 60 economic analysis (2018, vol. 51, no. 3-4, 57-66) graph 1. average grade for students source: laskowski m., badurowicz m., 2014 graph 1 demonstrates the results of the classroom experiments on gamification from laskowski and badurowicz (2014). they performed testing on 62 students from master studies and divided them into two groups, with one being given a gamified learning experience. their research shows that students from the gamified group had an average grade of 4.5, while students from the non-gamified group had an average grade of 3.8. gamified groups also had higher attendance records over regular students and higher homework completion rate. graph 2. student engagement levels source: nicholson, s., 2013 graph 2 shows the participation of students in classes via the application superfunner, performed on two courses by scott nicholson (2013). after the initial positive reactions and involvement by students in weeks 1 through 3, participation fell through in latter weeks (4-6). this means that gamification has to be implemented in courses in a meaningful and consistent way, as well as ensure that points and activities are spread equally throughout the semester to ensure constant student involvement and interaction. another problem that appeared was students being demotivated if they fall behind classmates, especially on the leaderboard rankings. their demotivation was even higher knowing that there is no way to catch up in the following martin kiselicki, saso josimovski 61 weeks to the leader, making them feel that it is futile to even attempt it and ultimately becoming disinterested in class. an interesting take on gamification can be found in the work of nina frischmann (2014), who designed her course as a fantasy multiplayer game, where students create their own avatars and join guilds in the continent of “educopia”. the players (students) begin with zero experience points (just as in role-playing video games) and they gain experience points by performing various tasks (named quests) and other specific actions. by acquiring experience points, players level up (with 9 levels in total), where each level bring specific skills to the player, for example “skip 1 tasks and still get experience points” or “add 15 experience points to any assignment”. the final level gives the player the ultimate skill – earn an “a” in the course. in terms of gamification, this is the most accurate implementation of the process and has the potential to make classroom tasks and homework entertaining by themselves. one of the problems faced in this particular implementation was the lack of real-time feedback, because students can only view their level and progress while in class and when they request it from the teacher. system for implementing gamification in the educational process there are various implementations of gamification in education, each bringing its own set of benefits and drawbacks. in our previous research for implementing gamification systems in the workplace, we concluded that it is paramount to follow specific steps when gamifying tasks, which can also hold true in education. gamification is implemented in the educational sector through a system of elements, mechanisms and rewards and the four steps should also be followed in the educational sector as well (aparicio, 2012): 1. identification of the main tasks the classroom tasks that needs to be gamified 2. identification of transversal objectives other objectives besides the main objective that would be interesting and attractive for students to perform the activity 3. selection of gamification mechanisms depending on the main goal, related to the elements of intrinsic motivation 4. analysis and control through tests with specific metrics, questionnaires, or evaluation of experts on gamified processes and mechanisms applied, in order to compare the results before and after implementing gamification in activities another important aspect seen in previous attempts at implementing gamification in courses is students becoming disinterested in latter weeks, either because they are well behind class-mates or because tasks and rewards are repetitive. to minimize these types of problems, the system should be evaluated in two aspects: 1. cycles of interest – important for encouraging students to engage in the initial phase and start performing tasks, by following a three-step infrastructure: 1.motivation; 2. action 3. feedback 2. progression cycles – important to ensure that earlier levels in the beginning are easy enough for players to get engaged, while later levels from the gamified system are challenging enough for players to continue be engaged. gamified systems in education should also include four different dynamics to boost learning and engage students (stott & neustaedter, 2013): 1. freedom to fail – game design should encourage students to experiment without fear, by giving them multiple chances to tackle a certain task 2. rapid feedback – students should get real-time and continuous feedback whenever possible, such as visual cues or a progression bar 62 economic analysis (2018, vol. 51, no. 3-4, 57-66) 3. progression – gamified courses should include the most interesting elements at the beginning, to gain the attention of students. however, the difficulty should be increased as the course progresses, to maintain student interest throughout the semester 4. storytelling – since most games include some type of story, gamified courses should be no different. including a story can be an enticing experience for the students and should increase their engagement and motivation levels. research the primary research for this paper is done through a questionnaire (structured of 11 questions, 10 closed questions and 1 open-ended question). the survey was conducted on students from public and private heis in the republic of macedonia. since there were no further restrictions on demographic characteristics or type of studies, students were selected at random, with the questionnaire being sent to them in a digital form, through the digital platform google docs. students were also encouraged to share the questionnaire with their peers, in an effort to get a larger sample. a total of 238 responses were received in the period of 03.05.2018 through 10.10.2018, of which 18 of them were ruled as invalid or incomplete, leaving 220 valid responses. the questionnaire in its original form is contained in the annex of the paper. through extensive inquiry on student motivation, class satisfaction and connection with video games/mobile games, we can evaluate the potential for implementing gamification in the curriculums of heis in the republic of macedonia. most of the students are enrolled social sciences (44%), followed by natural sciences (29%), applied sciences (16%) and humanities and arts (11%). from the respondents, 66.4% are male students, while 33.6% are female students. graph 3. student age distribution source: own researh graph 3 shows the age distribution between respondents. the most prominent group are students aged between 18-20, followed by 20-22 year olds and 22-25 year old, which comprise 95% of all respondents. 48% 29% 18% 3%2% 18-20 20-22 22-25 25-30 30+ martin kiselicki, saso josimovski 63 graph 4. student view towards classes source: own source graph 4 demonstrates students’ feelings during classes. since gamification focuses on intrinsic motivation, it is important to understand whether students are currently engaged in classes and draw positive feelings towards their respective faculties. the answers were based on a 5-point likert scale, with 1 being the lowest and 5 being the highest grade. students’ answers were averaged, where the best average grade was students feeling successful in their studies with 3.2 (out of 5), followed by being interested in classes (2.8 out of 5) and motivated (2.8 out of 5). generally, average grades are low, most of them being below an average grade of 3, thus there could be potential for gamification to be introduced and yield positive results. graph 5. views towards the learning process source: own source graph 5 illustrates students’ views towards the learning purpose, as well as their intent and goal. over three quarters of students like working in groups (75.4%), while a large number of students feel that they learn just to pass an exam (55.9%). specific answers that are connected to the potential for implementing gamification are doing additional tasks for a higher grade (46.3%), 2.9 2.4 2.8 2.4 3.2 interested inspired motivated fullfilled successful 21.8% 55.9% 40.4% 75.4% 43.1% 46.3% learning for personal satisfaction learning just to pass an exam likes to see progress during tasks likes working in groups likes public recognition does additional activities for higher grade 64 economic analysis (2018, vol. 51, no. 3-4, 57-66) public recognition (43.1%), seeing progress during tasks (40.4%) and learning for personal satisfaction (21.8%). we further researched the reasons behind student participation in class activities, with rewards/points being the main motivator (60.9%), followed by improving personal skills (42%) and getting recognition (30.9%). students rarely respond to negative motivation (punishment) with 14% or because of other students (10%), while a fairly large percentage of students (28%) do not participate in class or do homework activities. classroom interested depends on the course itself for some students (39%). graph 6 addresses these cases. graph 6. student motivation for participating more in certain classes source: own source as shown in graph 6, most of the students that are more invested in certain courses list the reward systems (80%), work in groups (74%) and practical work during class (48%) as the main motivators. this is in line with gamification principles and its’ focus on intrinsic motivation. the final two questions were focused specifically on video games. the largest group of students (74%) plays video games or mobile games (smartphone games) either every day or a few days a week, followed by rarely playing games (14%) and never playing games (13%). most of the students do not know whether introducing elements of video games would make the classroom experience better (66.8%), while 21.8% disagree with introducing these types of elements. concluding remarks the primary and secondary research clearly demonstrate the benefits of introducing gamification in the educational process. attempts have been made to create a fusion between fun and learning in the past through gamification in certain heis, although problems and barriers have always been present. the stated principles and steps for implementing gamification in this paper can be followed to minimize potential problems and help teachers to get a better understanding of this concept and its’ correct utilization. in short, gamification in macedonian heis offers great potential because of several factors: • current and future students are comprised from generation z, which has grown up with internet technologies and smartphone/video games. this generation has already been in touch with certain elements and mechanics from gamification, so they are more susceptible to them. the research show that most of the students are in contact with video 48% 25% 80% 74% practical work during class examples and case studies rewards based on performance work in groups martin kiselicki, saso josimovski 65 games or smartphone games on a regular basis (74%) with only a small percentage stating that they never play video games (13%). • gamification focuses on the intrinsic motivation, which is more difficult to achieve, but also longer lasting than extrinsic motivation. various case studies show that gamification can yield positive results, from higher attendance, higher engagement rates and ultimately higher average grades for the students. • our research shows that most of the students are disinterested (2.9), uninspired (2.4), unfulfilled (2.4) and unmotivated (2.8) during classes. these are all intrinsic motivational factors, which can be engaged with gamification in the learning process. this notion is strengthened by the fact that students would do additional activities to pass an exam (46.3%), like working in groups (75.4%) and like public recognition (43.1%). • gamification requires doing tasks for rewards and recognition, and students currently participate in class because of the reward system in place (60.9%), to improve personal skills (42%) and to get recognition (30.9%). there is also a large percentage of students which do not participate in class activities (28%), which could be engaged through gamified systems for learning. students are more interested in classes with rewards based on performance (80%) and with practical work during class (48%), which is also in line with gamification principles. • the paper defines the process of designing a gamified system for specific courses by introducing four steps to be followed, specifying the importance of the cycle of interests and progressive cycles and including four different types of dynamics for gamification in the learning process. tracking these steps is necessary because gamification focuses directly on intrinsic motivators for students, who, although powerful, are also extremely difficult to activate. an improperly designed gamified system could damage the implementation itself, so it is important that teachers pay enough time and attention to it since the initial phase. implementation can be managed easily via third-party application which can be freely used, such as superfunner which is discussed in this paper. these types of application already contain finished elements and mechanics which can be used by teachers in their classes in a digital form. the research can be continued by evaluating the necessary administrative precursors and changes that have to be made to implement gamification in the courses, which can also include changing the syllabus and curriculums, as well as evaluate administrative and teaching staff on their readiness to implement such a system. to fully analyze the potential of gamification in heis in the republic of macedonia, a case study can be conducted and implement a gamified system in a certain course, through close monitoring and evaluation of the process throughout the semester. references aparicio, a.f. et al., 2012. analysis and application of gamification. proceedings of the 13th international conference on interacción persona-ordenador interaccion ’12, pp.1–2. benabou r., tirole j., 2003, intrinsic and extrinsic motivation, review of economic studies, 2003 70, pp. 489–520 detering s., dixon d., khaled r., nacke l., 2011, from game design elements to gamefulness: defining “gamification”, mindtrek’11, september 28-30, 2011, tampere, finland frischmann n., 2014, gaming the system: using game elements in reacting and non-reacting classes, whitepaper available at https://reacting.barnard.edu/sites/default/files/gamification_saturday_handout.pdf (accessed on 10.08.2018) hill e., 2015, level up: using games and gaming to improve teaching and learning, adolescent literacy in perspective, 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(2015). foundations of game-based learning.educational psychologist,50(4), 258-283. doi:10.1080/00461520.2015.1122533 ryan r., deci e., 2000, intrinsic and extrinsic motivations: classic definitions and new directions, contemporary educational psychology 25, 54–67 sheldon l., 2012. the multiplayer classroom: designing coursework as a game. boston, ma: cengage learning. singh a., dangmei j., 2016, understanding the generation z: the future workforce, south-asian journal of multidisciplinary studies (sajms) issn:2349-7858:sjif:2.246:volume 3 issue 3 stott, a., neustaedter, c., 2013. analysis of gamification in education. surrey, bc, canada symonds, william c., robert schwartz, and ronald f. ferguson., 2011. pathways to prosperity: meeting the challenge of preparing young americans for the 21st century. cambridge, ma: pathways to prosperity project, harvard university graduate school of education. youssef adel, b., thomas, l., & ragni, l., 2011, bridging the learning gap in the market for higher education: e-learning and public subsidies. economic analysis, 44(3-4), 1-11. van der boer, p. 2011, introduction to gamification, whitepaper, available at https://www.cdu.edu.au/olt/ltresources/downloads/whitepaperintroductiontogamification-130726103056-phpapp02.pdf (accessed on 20.03.2018) web-sources: https://www.wepc.com/news/video-game-statistics/ (accessed on 10.05.2018) https://www.bigfishgames.com/blog/2017-video-game-trends-and-statistics-whos-playingwhat-and-why/ (accessed on 10.05.2018) https://www.statista.com/statistics/722259/world-gamers-by-age-and-gender/ (accessed on 11.05.2018) article history: received: november 14, 2018 accepted: december 9, 2018 microsoft word 2007 3 4.doc 2007 ‐ 58  •  economic analysis®  abstract: after the collapse of communism in 1990, the european union (eu) has immediately  sustained  in  the process of democratization  in  the ex‐communists countries, and has provided necessary  technical and financial assistance in order to place a market economy.  the enlargement was (and always is)  the most significant and the most ambitious european project since the signature of the treaty of rome1: it  reconciles one of the economic projects of the united europe with geo‐strategic vision of the european conti‐ nent, which will allow the important position of the eu in the world. the 1st may 2004 the eu has passed to  the  twenty‐five  member  countries2,  with  accession  of  ten  new  member  states  (nms).  the  process  of  enlargement has continued on january the 1st, 2007 by accessing to the eu of bulgaria and romania. the  “single market”, economic and monetary union (emu) and the process of integration are the major points  of the europe of twenty‐seven member countries. the process of preparation of accession to the eu, has an‐ nounced the preparation in the central and east european countries (ceec) from the 1989, and it marked  some difficulties for the ceec – on the level of political integration but also economic and social. the present  article show us, also, the importance of the introduction of the euro – which present the very important phase  in the evolution of the eu, and the biggest monetary changement in the history of europe…we consider  euro as the concretization of the eu. it represents the success of the “single market” and contributes to the  economic stability of the eu. also, it is important to know that the euros play his important role to the poli‐ tic and economic fields. the new member states (nms) are engaged to enter to the emu in his future3. for  the success of their entrance to the emu, the nms have to align their economies with these of the old mem‐ ber states of  the eu.   this economic alignment, so called “convergence”, constitutes  the supplementary  phase on their aim toward european  integration.   the  latest enlargements represent the most  important  moments in the history of the european continent.  today, the question is also the integration of the balkan  countries to the eu and their future toward european integration.  introduction    the enlargement policy of the european union (eu) is noted in the article 49 of the treaty4 of  the eu5, which dispose that “any european state which respects the principles set out in article  6(1) may apply to become a member of the union…”. the eu is defined the political and economic  1 the treaty of rome, signed by belgium, france, germany, italy, luxembourg and the netherlands on march 25, 1957,  established the european economic community (eec) and came into force on 1 january 1958.  2 cyprus, czech republic, estonia, hungary, latvia, lithuania, malta, poland, slovak republic and slovenia  3 slovenia as the nms has entered the emu the 1st january 2007.  4 the maastricht treaty (formally, the treaty on european union, teu) was signed on february 7th, 1992 in maastricht,  the netherlands after final negotiations on december 9th, 1991 between the members of the european community and  entered into force on november 1st, 1993 during the “delors” commission. it led to the creation of the european union  and was the result of separate negotiations on monetary union and on political union. the maastricht treaty has been  amended to a degree by later treaties.  5 “any european state which respects the principles set out in article 6(1) may apply to become a member of the union.  it shall address its application to the council, which shall act unanimously after consulting the commission and after  receiving the assent of the european parliament, which shall act by an absolute majority of its component members. the  conditions of admission and the adjustments to the treaties on which the union is founded, which such admission en‐ tails, shall be the subject of an agreement between the member states and the applicant state. this agreement shall be  submitted for ratification by all the contracting states in accordance with their respective constitutional requirements.”  the future of the european economy srđan redžepagić, institute of economic sciences, belgrade, serbia  key words: eu, emu, ceec, enlargement, euro, european economy jel : f15, f31 original paper volume 40 • autumn 2007 • 59  criteria for accession. before the accession to the eu, some phases are necessary to be established  for  all  the  central  and  east  european  countries  (ceec).  the  following  phases  are  necessary  (obliged) for each european country which would like to become the member of the eu:  o to candidate: each european country can depose candidature for the membership to the  eu.  o to become candidate: the treaty of the eu precise two conditions, before the country ob‐ tain candidate status: to be european and democratic country. after this condition com‐ pleted, the european commission recognise the statute of the candidate country. it isn’t  the only criteria the one european country obtain the full membership to the eu.  o the strategy of pre‐accession: when the county has become the candidate, the strategy of  pre‐accession is necessary. this strategy has the objective to “familiarise” the candidate  country with the procedure and policy of the eu – giving the possibility to the candidate  country to participate to the programmes “communautaires” and accordant the financial  aid. the opening processes of the negotiations for the accession: to join the eu, each new  member state (nms) must fulfill three criteria:  • political: stability of institutions guaranteeing democracy, the rule of law, human  rights and respect for and protection of minorities;  • economic: existence of a functioning market economy and the capacity to cope  with competitive pressure and market forces within the union;  • acceptance  of  the  community  “acquis”:  ability  to  take  on  the  obligations  of  membership, including adherence to the aims of political, economic and mone‐ tary union.  o signature of the treaty of accession: the results of the negotiations included in the treaty  of the eu are transferred to the european council for confirmation by it and to the euro‐ pean parliament for his agreement.  o accession to the eu: after the signature, the treaty is transferred to the member countries  and to the candidate(s) country(ies) for the ratification,  in some cases, by referendum.  the treaty takes place, and the candidate country becomes the eu member state.   the eight ceec6, and also cyprus end malta, has entered to the eu on the 1st may 2004. bul‐ garia and romania has joined the eu on the 1st january 2007. these two enlargements have had  the biggest effect in the history of the enlargements of the eu. in this article we will pointed to the  economic criteria for the nms of the eu, but also to the effects (after the enlargements) that have  been produced in (and for) the nms and the eu old member states. it is necessary to know that  the latest enlargements have had very positive effects, but also “some negative effects” (less than  positive effects) for the new and old member states of the eu.   the introduction of the euro represents the essential phase in the evolution of the eu, and  the biggest monetary changement in the history of europe7. euro is the concretization of the eco‐ nomic and monetary union (emu). the emu consists of three stages coordinating economic pol‐ icy and culminating with the adoption of the euro, the euʹs single currency. under the copenha‐ gen criteria, it is a condition of entry for states acceding to the eu that they be able to fulfil the re‐ quirements for monetary union within a given period of time. the twelve nms that acceded to the  6 czech republic, estonia, hungary, latvia, lithuania, poland, slovakia and slovenia  7 cf. redžepagić, s. (2006), l’analyse de l’évolution de l’union européenne – les effets économiques d’élargissement, issn 1453‐ 8202, editor: university valahia targoviste, the 17th international conference organized by cedimes, faculty of eco‐ nomics ‐ university of targoviste (xviième colloque fédérateur cedimes), university of valahia, targoviste, romania,  november 2006, pp. 122 – 133  2007 ‐ 60  •  economic analysis®  eu in 2004 and 2007 all intend to join third stage of the emu in the next ten years, though the pre‐ cise timing depends on various economic factors. similarly, those countries who are currently ne‐ gotiating for entry will also take the euro as their currency in the years following their accession  (slovenia has entered to the euro zone the 1st january 2007).  enlargements  the enlargement of the eu represented (and i hope represent also today and for the future)  one of the most important chances for the eu for the 21st century. the enlargements represented  (and probably will represent) the advantages  in the field of stability and the prosperity for the  nms but also for the old members of the eu. the eu summit8 was scheduled to invite ten (twelve)  more countries to join the eu. this enlargement brought the number of eu member states up from  15 to 27. in the past the eu was limited to western europe, but following the impending expan‐ sion it included the whole of eastern europe up to the former soviet border and, in addition, the  two mediterranean island nations of malta and cyprus. in western europe, norway and switzer‐ land are the only countries not to have joined the eu. in the east, only the balkan nations of ex‐ yugoslavia9 (with the exception of slovenia) and albania remain outside the eu. with the latest  enlargements, the population of the eu has grown by 75 million, brought it up to half a billion  people.  with  9,200  billion  euros,  the  eu’s  gross  domestic  product  (gdp)  is  equal  that  of  the  united states of america.   it is important to know, the full timeline of past enlargements (and treaties) were10:  o 23 july 1952 – the treaty of paris entered into force, establishing the european coal  and steel community (ecsc). founding members were the benelux countries (bel‐ gium, the netherlands, and luxembourg), france, italy and west germany.  o 1 january 1958 – the treaty of rome entered into force, establishing the european  economic community (eec), which later becomes the european community (ec).  o 1 january 1973 – (first enlargement); denmark, ireland, and the united kingdom ac‐ cede to the ec (norway signed the treaty but failed to ratify due to a negative opin‐ ion in a national referendum on accession).  o 1 january 1981 – (second enlargement); greece accedes to the ec.  o 1985 – granted home rule by denmark six years earlier, greenland decides to leave  the ec following a referendum. (see member state territories).  o 1 january 1986 – (third enlargement); portugal and spain accede to the ec.  o 1  november  1993  –  the  maastricht  treaty  takes  effect,  formally  establishing  the  european union.  o 1 january 1995 – (fourth enlargement); austria, finland, and sweden, accede to the  eu.  o 1 may 2004 – (fifth enlargement, part i); comprising the largest number of countries  ever admitted at one  time, cyprus,  the czech republic, estonia, hungary, latvia,  lithuania, malta, poland, slovakia and slovenia accede to the eu.  o 1 january 2007 – (fifth enlargement, part ii); bulgaria and romania joined eu.  in june 1993, eu leaders meeting in copenhagen set three criteria that any candidate country  8 being held december 12th and 13th in copenhagen.  9 bosnia and herzegovina, croatia, macedonia, montenegro and serbia  10 for the full explanation see the site official of the european commission.  volume 40 • autumn 2007 • 61  must meet before it can join the eu. in order to become a candidate for entry to the eu, countries  need to fulfil the economic and political conditions known as the “copenhagen criteria”, according  to which a prospective member must:  o have stable institutions guaranteeing democracy, the rule of law, human rights and  respect for and protection of minorities  o have a functioning market economy as well as the capacity to cope with competitive  pressure and market forces within the eu  o take on board all the “acquis” and support the various aims of the eu (especially, the  ability to take on the obligations of membership including adherence to the aims of  political, economic and monetary union).   these three criteria have been fulfilled by all nms. in addition, each nms must have a pub‐ lic administration capable of applying and managing eu laws in practice11. the eu reserves the  right to decide when a candidate country has met these criteria and when the eu is ready to accept  the new member, as this was the cases for each nms before her enter to the eu.  economy in the enlarged eu   according to the international monetary fund, the eu has a large economy, greater than that  of the united states of america with a 2005 gdp of 12,865,602 usd million vs. 11,734,300 usd  million (usd figures). the enlargements have always some significant economic consequences on  the economy of the eu12. so the reason is because the bigger market which stimulate the economic  growth in the nms. the euʹs member states account for 30.3% of the worldʹs total gdp in 200513.  after the signature of the treaty of rome14, one of the most important objectives for the eu  consists to maintain the economic and social progress in order to assure the health, prosperity and  better future for the europeans. economic performance varies from state to state, as presented in  the table 1.  table 1: eu member states economic indicators  member states  gdp (ppp*)  2006  millions of  euros  gdp (ppp*) per capita  2006  euros  % of eu27  average gdp (ppp*) per  capita  gdp (ppp*)  2007  millions of  euros  gdp (ppp*)  per capita  2007  euros  percentage of  eu27  average gdp  (ppp*) per capita european union  11,557,853  23,500  100%  12,172,536  24,600  100%  austria  250,247  30,200  129%  264,472  31,900  130%  belgium  302,570  28,700  122%  319,867  30,200  123%  bulgaria  66,799  8,700  37%  71,714  9,500  39%  cyprus  16,849  21,900  93%  17,773  22,900  93%  czech republic  191,080  18,600  79%  207,174  20,100  82%  denmark  161,613  29,700  126%  171,298  31,200  127%  estonia  21,170  15,900  68%  23,919  17,900  73%  finland  143,818  27,300  116%  153,595  28,900  117%  france  1,673,128  26,500  113%  1,744,444  27,800  113%  11 for more precisely explanations see the official web site of the european commission.  12 gauthier a. (2005), “la construction européenne : étapes et enjeux”, forth edition, bréal, paris.  13 source: world bank  14 the treaty of rome, signed by france, west germany, italy and benelux (belgium, the netherlands and luxembourg)  on march 25, 1957, established the european economic community (eec) and came into force on 1 january 1958.  2007 ‐ 62  •  economic analysis®  germany  2,184,612  26,700  114%  2,340,372  28,200  115%  greece  230,659  20,800  89%  246,671  22,100  90%  hungary  154,358  15,300  65%  166,031  16,200  66%  ireland  143,475  33,700  143%  157,070  35,700  147%  italy  1,432,261  24,300  103%  1,500,475  25,500  104%  latvia  29,971  13,100  56%  33,630  14,900  61%  lithuania  46,015  13,600  58%  50,241  15,000  61%  luxembourg  30,183  65,300  278%  31,376  69,900  284%  malta  7,289  17,700  75%  7,824  18,600  76%  netherlands  500,762  31,000  132%  530,564  32,800  133%  poland  473,774  12,400  53%  525,277  13,600  55%  portugal  185,083  17,500  74%  190,882  18,200  74%  romania  190,657  8,800  37%  208,220  9,700  39%  slovakia  79,339  14,700  63%  88,602  16,400  67%  slovenia  40,867  20,400  87%  44,040  21,800  89%  spain  1,053,600  24,000  102%  1,121,961  25,400  103%  sweden  256,327  28,200  120%  274,499  30,000  122%  united kingdom  1,688,660  27,900  119%  1,847,105  29,400  120%  *purchasing power parity  source: eurostat – 21 april 2007, percentages recalculated manually to eu‐27  according to the literature15, and analyzing economic situation of the eu, the enlargement  has provoked the supplementary economic growth of 1% per year in the nms16. the supplemen‐ tary economic growth registered by other member states is less, but always significant.  table 2:  gdp per capita: distribution of the richness    country  %    luxembourg  189    ireland  125    denmark  115    netherlands  113    austria  110    belgium  108    finland  104    france  103    united kingdom  103    germany  103    italy  103    sweden  102    average of the eu‐15  100    spain  84    slovenia  74    cyprus  72    portugal  69    15 farvaque e. et g. lagadec (2002), “l’élargissement à l’est : risques, coûts et bénéfices, intégration economique  européenne : problèmes et analyses”, edition : de boeck university, 2002.  giuliani j‐d. (2003), “quinze plus dix : le grand élargissement”, foundation robert schuman, paris : albin michel,  2003.  16 and by previsions, will continue to present during the first ten years after the accession of the nms!  volume 40 • autumn 2007 • 63  greece  66    czech of republic  60    hungary  57    malta  55    slovakia  47    estonia  42    poland  39    lithuania  39    latvia  35            source: eurostat; european commission   euro and economic and monetary union    on the march 13th 1979, the european monetary system (ems) was created. the ems has  created a zone of monetary stability in europe, encouraging growth and investment. it was based  on the “ecu”17, on the exchange rate and intervention mechanism18 and the credit mechanism19. in  order to remove the non‐tariff barriers to the free movements of good, capital, services and per‐ sons, the ems wasnʹt anymore enough and so the single currency became a necessity. the euro‐ pean monetary union was established during the treaty of maastricht which entered into force in  1993. its formation spanned three stages:  1. stage one: 1 july 1990 to 31 december 1993 – at this initial the member states drew up  convergence program designed to promote improvements in the convergence of eco‐ nomic performance, thereby making it possible to establish fixed exchange rates.  2. stage two: 1 january 1994 to 31 december 1998 – this was a transitional period during  which a determined effort was made to achieve economic convergence. the european  monetary institution (emi) was set up in frankfurt to strengthen the coordination of  member statesʹ monetary policies, promote  the creation of a european central bank  (ecb) in stage three.  3. stage three: 1 january 1999 and continuing – at the beginning of this third stage a ecb  was set up and the exchange rates among the participating currencies were fixed once  and for all. the bank was made independent of the national governments and would  manage the monetary policies of all the participating countries.  during the madrid european council the member states decided to call the single currency  ʺeuroʺ. to be able to join, every member state had to accomplish the following criteria:  o deficits – national budget deficits must be close to or below 3% of gross national prod‐ uct (gnp).  o debt – public debt may exceed the 60% of gnp only if the trend is declining towards  this level.  o price stability – the rate of inflation may not exceed the average rates of inflation of the  three member states with the lowest inflation by more than 1.5%.  o interest rates – long‐term interest rates shall not vary by more than 2% in relation to the  average interest rates of the 3 member states with the lowest interest rates.  17 a basket of the currencies of the member states  18 based on that each national currency had a central exchange rate linked to “ecu” and bilateral rate exchanges were  allowed to fluctuate within a band of 2.25%, or up to 6%, increased finally at 15%  19 when the bilateral exchange rates are approaching the 15% limit, the banks have unlimited liability to intervene to not  pass the limit of 15%  2007 ‐ 64  •  economic analysis®  o exchange rate stability – a national currency shall not have been devalued during the  two previous years and must have remained within the ems 2.25% margin of fluctua‐ tion.  on may 3rd, 1998, the member states decided which of the 15 nations achieved the five crite‐ ria to join the single currency:  o austria, belgium, finland, france, germany, ireland, italy, luxembourg, netherlands,  portugal and spain all qualified.  o greece and sweden did not achieve all the five criteria.  o denmark and the united kingdom took the “opt‐out” choice but could join it anytime  when the inner political conditions would allow it.  on january 1, 1999, the third stage of emu began. the euro became a currency on its own  right and the exchange rates were definitely fixed. until january 1st, 2002, the national currencies  were used with the banks with businesses completely transferring to euro and the euro coins and  notes were introduced and are circulating beside the national currencies.  the european exchange rate mechanism (erm)20 is based on the concept of fixed currency  exchange rate margins, but with exchange rates variable within those margins. before the intro‐ duction of the euro, exchange rates were based on the ecu, the european unit of account, whose  value was determined as a weighted average of the participating currencies.        source: european commission (2007)    20 the erm was a system introduced by the european community in march 1979, as part of the ems, to reduce ex‐ change rate variability and achieve monetary stability in europe, in preparation for emu and the introduction of a single  currency, the euro, which took place on january 1, 1999.  volume 40 • autumn 2007 • 65  table 3: respect the criteria of convergence in the ceec – “maastricht criteria”  measured crite‐ rion    price stability    public fi‐ nances  results for  public fi‐ nances   durability of  convergence    stability of con‐ vergence    how this criterion  is measured  inflation rate  (consumption  prices)  budget defi‐ cit (% of  gdp)   public debt  (% of gdp)  interest rate  (long term)   stability of ex‐ change rate  criteria of conver‐ gence    < 1.5 % three  member states  which have the  lowest rate  not more  than 3 %    not more  than 60 %   < 2 % three  member states  which have the  lowest rate  participation to  the erm ii dur‐ ing two years   czech republic     1.8 %     12.6 %     37.8 %     4.7 %     during accession  to the erm ii   estonia     2.0 %     – 3.1 %     5.3 %     4.6 %     accession  28.6.2004     latvia     4.9 %     1.5 %     14.4 %     5.0 %     accession  2.5.2005     lithuania     – 0.2 %     1.9 %     21.4 %     4.7 %     accession  28.6.2004     hungary     6.5 %     6.2 %     59.1 %     8.1 %     during accession  to the erm ii    poland     2.5 %     3.9 %     45.4 %     6.9 %     during accession  to the erm ii   slovenia21     4.1 %     2.0 %     29.4 %     5.2 %     accession  28.6.2004     slovakia     8.4 %     3.7 %     42.6 %     5.1 %     accession 28.11.   2005    reference values for  the euro zone  < 2.4 %     < 3.0 %     < 60 %     < 6.4 %         source: european commission (2006), calculated by author  as of 1 may 2004, the ten national central banks of the nms became party to the erm ii  central bank agreement. the national currencies themselves will become part of the erm ii at  different dates, as mutually agreed.  table 4: declarations of the member states concerning their entrance to the emu   country  declaration 2004  declaration  2006  entry to  erm ii  czech republic  2009  2010  2007  estonia  2007  2008  june 28, 2004  lithuania  2007  2010  june 28, 2004  latvia  2008  2010  may 2, 2005  hungary  2009  2014  without declaration  poland  2009  2013  without declaration  slovenia  2007  2007  june 28, 2004  slovakia  2009  2009  november 28, 2005  cyprus  2008  2008  may 2, 2005  malta  2008  2008  may 2, 2005      source: the world bank  21 slovenia has become the member of the euro zone the 1st january 2007.  2007 ‐ 66  •  economic analysis®  the estonian kroon, lithuanian litas, and slovenian tolar were included in the erm ii on 28  june 2004; the cypriot pound, the latvian  lats and the maltese  lira on 2 may 2005; the slovak  koruna on 28 november 2005. the currencies of the three largest countries which joined the eu on  1 may 2004 (the polish zloty, the czech koruna, and the hungarian forint) are expected to follow  eventually. plans for bulgaria are to apply for erm ii membership in 2007 and to commit to its  rules regardless of the european commission decision, while romania plans to join erm in 2010‐ 2012. eu countries that have not adopted the euro are expected to participate for at least two years  in the erm ii before joining the euro zone. as slovenia adopted the euro in 2007, the slovenian  tolar was removed from the erm ii and from circulation. the same will happen to the maltese lira  and the cypriot pound on 1 january 2008. sweden is expected to participate in erm ii in order to  meet the convergence criteria required for switching currency, but has deliberately chosen to stay  out of  the mechanism,  thus maintaining  their currency swedish krona. this choice  is currently  tolerated by the ecb, but it has been warned it wonʹt be tolerated for newer union members.  conclusion   this study22 makes use of the recent analyse for the eu new member states. “enlargement is  both a political necessity and a historic opportunity for europe. it will ensure the stability and se‐ curity of the continent and will thus offer both the applicant states and the current members of the  union new prospects  for economic growth and general well‐being. enlargement must serve  to  strengthen the building of europe in observance of the acquis communautaire which includes the  common policies.” this is declared to the european summit of madrid from december 199523. eco‐ nomic integration in general and enlargement of the eu to the east of europe in particular created  a wider european single market, thereby stimulating structural adjustment and economic speciali‐ zation. this study analyzed economic situation in the enlarged eu with a special focus on the new  eu member states and the monetary union. finally, it is important to know that the policy (eco‐ nomic, social, political, etc.) options for the new eu member states played (and still play) the im‐ portant role for the nms but also for the eu‐15 states (old member states).   literature  1. aristovnik, a. and berčič, b. (2007), fiscal sustainability in selected transition countries, munich personal repec  archive paper no. 122, posted 9th january 2007, university of ljubljana, faculty of administration, slovenia, 17  p.  2. budina, n. and van wijnbergen, s. (1996), inflation stabilization, fiscal deficits and public debt management in poland,  tinbergen institute discussion paper, ti 96‐179/4  3. chauveau s. (2004), élargissement de l’union européenne : les dix nouveaux entrants – opportunités dans la filière,  edition : fédération de la maille, 2004.  4. european central bank (2002), review of the international role of the euro, december 2002  5. farvaque e. et g. lagadec (2002), l’élargissement à l’est : risques, coûts et bénéfices, intégration economique eu‐ ropéenne : problèmes et analyses, edition : de boeck university, 2002.  6. gauthier a. (2005), la construction européenne : étapes et enjeux, forth edition, bréal, paris, 2005.  7. giuliani j‐d. (2003), quinze plus dix : le grand élargissement, foundation robert schuman, paris : albin michel,  2003.  22 for more precisely study, cf. redžepagić, s. (2007), les politiques économiques comparées et les coûts d’intégration pour les  pays de l’est candidats à l’adhésion à l’union européenne, doctoral dissertation under direction of professor j.‐p. guichard,  university of nice sophia‐antipolis, cemafi (centre d’etudes en macroéconomie et finance internationale), march  2007  23 this summit held on 15 and 16 december 1995 in madrid.  volume 40 • autumn 2007 • 67  8. green, c. j. et al. (2000), poland: a successful transition to budget sustainability?, economic research paper no.  00/5, loughborough university  9. redžepagić, s. (2006), l’analyse de l’évolution de l’union européenne – les effets économiques d’élargissement, issn  1453‐8202, editor: university valahia targoviste, the 17th international conference organized by cedimes,  faculty of economics ‐ university of targoviste (xviième colloque fédérateur cedimes), university of vala‐ hia, targoviste, romania, november 2006, pp. 122 – 133  10. redžepagić, s. (2007), les politiques économiques comparées et les coûts d’intégration pour les pays de l’est candidats à  l’adhésion à l’union européenne, doctoral dissertation under direction of professor j.‐p. guichard, university of  nice sophia‐antipolis, cemafi (centre d’etudes en macroéconomie et finance internationale), march 2007  11. rinaldi‐larribe m‐j. (2004), l’élargissement de  l’union économique et monétaire européenne à  l’est et  l’euro, paris,  edition : harmattan, l’esprit économique : le monde en questions, 2004.      microsoft word 2007_01_02.doc the role of tourism in the development of employment in istria  jasmina gržinić, aljoša vitasović, university jurja dobrile in pula  key words: employment, tourism, fluctuation, istria  udc: 338.48 (497.5)          jel : r58, l83  original paper  abstract  ‐  in comparison  to other mediterranean countries,  the croatian  tourist sector  is of  greatest importance to the economy in general, and to exports in particular. however, analyses have shown  that in spite of its successes, croatian tourism has not yet reached the level of activity it had before the war.  good results can be seen in a significant growth of income from tourism, a decrease in the unit‐based cost of  labor, a growth of productivity and employment and a gross added value in the activity of hotels and restau‐ rants. the problems in croatian tourism are mainly to be found in insufficient investments in hotels and  restaurants, a marked seasonality, insufficient occupancy of capacities, negative business results, overpriced  products and services connected  to  tourism  in comparison with  the competition  (italy, austria, greece,  czech republic, hungary, italy and switzerland). this paper is trying to present the state of employment in  tourism in croatia and istria in the after‐war period and research some concrete measures undertaken to  educate the personnel.  1. introduction  according to the world travel and tourism council, the tourism industry is the biggest in‐ dustry in the terms of investment, employment and gdp. tourism is significant export product  and employment generator. the characteristics of employment and the effects of tourism devel‐ opment vary according to the type of tourist activity, some types of tourism being more labour‐ intensive than others.( ratz, t. & l. puczko: 1998).    tourism economies have remarkable differences with respect to the economy as a whole.  tourism significantly contributes to the republic of croatiaʹs economic growth. the needs of em‐ ployment position  in  the hotel and catering business  is directly connected with  the seasonality  character of the croatian tourism destination. the paper analyze the difference in the tourism la‐ bor market of the economy highly specialized in tourism.   the division of the analysis of tourism in different fields can cause the abandonment of some  relevant areas. (kinnard & hill: 1994). most of the existing research deals with a higher labor in‐ stability, less remunerations, and occupational segregation. (breathnach et al: 1994), (purcell: 1997).  the most commonly used definition is the following: ʺtourism is the temporary movement of per‐ sons to destinations outside their normal home and workplace for leisure, business and other pur‐ poses, the activities undertaken during the stay and the facilities created to cater for the needs of  tourists.ʺ (wto, 1989).  ʺthe travel and tourism  industry  is defined by  the economic activities  (personal, investment, government, business and net export) associated with travel as measured  by the wide variety of current and capital expenditures made by or for the benefit of a traveller  before, during and after a tripʺ (wttc, 1995).  under a social point of view, higher standards of living may be observed, as well as an in‐ crease of employment opportunities and productivity. (santos, c. & almeida, a: 2004). it is neces‐ sary to encourage the tourism industry to always strive for a better education of stuff in tourism  industry. most of the existing research deals with a higher labor instability, less remunerations,  and occupational segregation. (breathnach et al: 1994), (purcell: 1997).  in croatia every region must be focused on the development of the tourism offerings which  will have the greatest influence on the on employment. however, economic analysis in the tourism  2007 ‐ 30  •  economic analysis®  system must embrace  those forces which protect  life, as well as  the  traditional supply‐demand  equation which focuses on maximizing profit to the shareholder. (reid, d.g.: 2003).   most services provided to the tourists have to be delivered at the time and place at which  they are produced (hansen & jensen: 1996). in this analysis authors tried to consider the fact that   financial resources are required  to generate employment. the same vary with  the size of hotel  companies,  the  types of working skills,  the economic development of  the destination region as  croatian istria, etc.  2. the role of tourism in the development of employment  after the right to life and freedom, the right to work has become the basic principle of hu‐ man interrelationship in the modern world, contained in all the relevant international declarations,  conventions and systems of government. besides, work is at the base of the philosophy and gen‐ eral culture of modern humanity, which makes it not only a right but also an obligation, so much  that it is today identified with a strict rule of life – man lives by his work.    tourism and national employment policy are in complete correlation in the world. it is the  same on both the emitting and receptive tourist poles in the world. otherwise, such an important  tourist logistics would not exist. it is clearly visible, whether we observe germany (where the an‐ nual unemployment rate is about 8% of the fit for work population), as a predominantly emitting  tourist power employing 1.800.000 people in tourism (data from 1995), or italy (where the north‐ western part of the country has an unemployment rate around 8‐10% and more than 20% in the  south), where around 2.000.000 people is employed in the receptive sphere of tourism.  according to the croatian employment office, in september 2006 there were 50.000 unem‐ ployed in the sector of tourism and catering. on the other hand, the croatian trend does not enter  in the developing countries. the importance of tourism in the overall economy of croatia is still  smaller than in other mediterranean countries, while salaries in that activity are 15 to 20% lower  than the national average14.    table 1 ‐ seasonal employment in tourism and catering (in 000)  2005  month  no. of employed in  croatia  employed in tourism  and catering  ratio of tourism and catering in the  total employment (%)  i  1.317  70  5,3  ii  1.332  71  5,3  iii  1.333  72  5,4  iv  1.341  74  5,5  v  1.354  80  5,9  vi  1.368  88  6,4  vii  1.379  93  6,7  vii  1.381  94  6,8  source: central bureau of statistics  under direct employment, we mean work inside a structure of a direct tourist activity, like  catering, travel agencies, transport, trade and national tourist administration. indirect employment  comprises all those economic activities which service the direct tourist activities like the produc‐ tion of food, catering equipment and other consumer goods in tourism. realistically, it is very dif‐ ficult to track these activities statistically. not only because of a non standardized statistics but also  because of problems around original data.  14 vizek, m. i lj. lončar (2007), tourism in croatia, study, economic institute in zagreb.  volume 40 • spring 2007 • 31  graph 1 ‐ development trends of accommodation capacities (beds) and employment in hospitality in the  republic of croatia from 1976 to 2000 in % (1976 = 100)  50 60 70 80 90 100 110 120 130 140 150 160 19 76 19 77 19 78 19 79 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 capacities employment source: processing of data made available by the croatian tourist yearbook and the croatian em‐ ployment office.  it is especially problematic in the developing countries where there a countless activities re‐ volving around tourism, (un)officially tolerated in order to employ as many people as possible.  in the developing countries the role of tourism in employment is even more visible. not (al‐ ways) because of the low cost for a workplace but most of all because of security and advantage in  placement – sale of tourist services requiring only a limited knowledge for their “production”, in  relation to technologically even more modest material products made in conditions of a low level  technological progress, which cannot be placed on the international market.    table 2 ‐ indicators in the croatian tourist sector    2006.  2007.  2008.  2011.  net salary (in kn)  4602  4858  5128  6032  employed  86.000  88.000  90.000  96.700  the tourist and hospitality activity has a huge seasonal fluctuation of workforce. there are  significant  differences  in  the  regional  analysis  of  unemployment  in  croatia.  croatian  tourism  points out the issues of those employed in the tourist sector, before all the underpayment of work‐ ers, a lack of educational programs but also the import of workforce which additionally lowers the  price of an already underpaid work.  in december 2005 the average unemployment rate on the national level was 17,1%, lower in  eight regions and higher than the national average in thirteen regions (croatian employment of‐ fice, 2006). young people do not want to get an education in the tourist occupations because of low  salaries and seasonal work of only four to five months. in the region of istria there are virtually no  foreign workers in tourism. a reason for a possible entrance of foreigners is the building of new  capacities but also scarce interests of young people for occupations in tourism. 15  15 vermezović ivanović, m., interview with palma f.,  «neće u turizam», glas istre, 03.04.2007.  2007 ‐ 32  •  economic analysis®  table 3 ‐ seasonal employment in hospitality and tourism  most wanted occupations in 2006  people employed  share in the structure (%)  salespeople*  1.807  12  waiters  1.688  11  chambermaids  1.584  11  cooks  1.272  9  workers in kitchen  968  7  cleaning  951  6  assistant cooks  598  4  hotel‐tourist employee  537  4  assistant waiter  388  3  receptionist  201  1  laundry women  201  1  other occupations  4.634  31  total  14.949  100  *increased need for work in commercial activities in the tourist season  source: croatian employment office  3. employment vs. unemployment in croatia  a regional analysis of unemployment in croatia shows considerable differences. in decem‐ ber 2005 the average unemployment rate on the national level was 17,1%, lower in eight regions  and higher than the national average in thirteen regions (croatian employment office, 2006). the  lowest rate was in the city of zagreb (7,8%) and the region of istria (8,0%), while the highest rate  of unemployment was recorded in the region vukovarsko‐srijemska (32,1%).    compared to the previous year the rate of unemployment was lowered in 12 regions, the  most  in  the  region  sibensko‐kninska  (2,6%),  vukovarsko‐srijemska  (1,9%)  and  the  region  of  zadar  (1,9%). at  the same  time,  the rate  increased  in only  two regions, bjelovarsko‐bilogorska  (0,5%) and viroviticko‐podravska (0,1%) (croatian employment office, 2006). 16  the employed are people who have been permanently or temporarily employed by an em‐ ployer, regardless of working hours and the property of the legal person. 17 in the republic of croa‐ tia, the region of istria makes for 5% of the total area, 4% of population, 5% of employed people,  2% of unemployed and 7% of the gross domestic product. according to the branch in pula of the  croatian employment office, the unemployment trend in the region of istria is going down – to a  lesser extent as a consequence of changes  in  the unemployment observation methodology, and  mainly as a result of positive economic trends. characteristics of increased seasonal employment  are especially evident. unemployment is the highest in january and the lowest in august. table 1.  shows the structure of unemployment in the region of istria on march 31, 2005. we can see that  the majority is employed in the processing industry with 20,90%, followed by trade and services  with 18,27%, hotels and restaurants are on third place with 11,55%. construction is on fourth place  with 9%, real estate sale, rental and business services are fifth with 6,47%. the region of istria has  a lower employment in activities like education; public administration, defence; compulsory social  security;  transport, storage, communications; health  insurance and social welfare; pother social  activities and services; financial mediation; power, gas and water supply; agriculture, hunting and  forestry. the lowest employment is recorded in activities like fishing, mining and others. the dif‐ 16 dragičević, m. i a. obadić, (2006), regional clusters and new employment in croatia, university in za‐ greb.  17  www.dzs.hr  volume 40 • spring 2007 • 33  ference between the processing industry, which has a leading position for employment in the re‐ gion of istria, and mining, which has the lowest employment, is 20,60%.   table 5 represents the active population in the republic of croatia according to administra‐ tive sources and sex for july and august 2006. in august 2006 the number of people employed  with legal persons in croatia was 1.138.175, of which 514.785 were women. compared to july 2006  the number of people employed with legal persons and the ration of women employed grew by  0,1%.     table 4 ‐ employment structure in the region of istria (on march 31, 2005)  employed   activity  legal per‐ sons  crafts and  similar profess.  total  share in %  agriculture, hunting and forestry  747  207  954  1,20  fishing  103  661  764  0,96  mining  220  20  240  0,30  processing industry  14.332  2.218  16.550  20,90  power, gas and water supply  1.559  ‐  1.559  1,97  construction  4.110  3.022  7.132  9,00  trade and services   10.644  3.827  14.471  18,27  hotels and restaurants  5.319  3.831  9.150  11,55  transport, storage and communica‐ tions  3.070  1.261  4.331  5,47  financial mediation  1.742  210  1.952  2,46  real estate sale, rental and business  services  3.754  1.367  5.121  6,47  public administration and defence,  compulsory social security  4.573  1  4.574  5,78  education  4.647  8  4.655  5,88  health insurance and social welfare  2.916  786  3.702  4,67  other social activities and services  2.547  819  3.366  4,25  other  ‐  681  681  0,86  total  60.283  18.919  79.202  100  source: statement of the national bureau of statistics no. 9.2.2/1 dated may 9, 2005.    table 5 ‐ active population of the republic of croatia according to administrative sources and sex  july 2006 august 2006  indices  aug 2006 / jul 2006.    total women total women total women active population 1 726 268   823 673  1 727 241   823 841  100,1  100,0  total of employed  1 455 515   659 936  1 456 190   659 745  100,0  100,0      employed with legal persons1)  1 137 033   514 464  1 138 175   514 785  100,1  100,1      employed in crafts and free profes‐ sions2)   273 725   124 371   273 553   124 051  99,9  99,7      ensured in agriculture2)   44 757   21 101   44 462   20 909  99,3  99,1  unemployed3)   270 753   163 737   271 051   164 096  100,1  100,2  registered unemployment rate, %4)  15,7  19,9  15,7  19,9        source: www.dzs.hr  2007 ‐ 34  •  economic analysis®  the total number of the employed and the number of employed women in august 2006 re‐ mained the same compared to the previous month. the number of employed in crafts and free  professions recorded a decrease by 0.1% and the number of women by 0.3%. the number of en‐ sured people employed in agriculture is generally decreasing by 0.7%, and 0.9% for women.   the registered unemployment rate in august 2006 was 15,7%, 19,9% for women. the highest  unemployment in 2005 was in february when 330.000 unemployed people were registered, while  the highest unemployment in 2006 was in january when 315.000 unemployed people were regis‐ tered. the lowest unemployment is registered during the tourist season, in particular in august  2005. when the number of unemployed people was 290.000. in 2006 the lowest unemployment was  registered in july with the number of 270.000.  the number of the unemployed in august 2006 has grown by 0.1%, while the number of un‐ employed women has grown by 0.2% compared to july 2006. towards the end of september 2006  the croatian employment office registered 279.017 unemployed people, precisely 7.966 people or  2,9% more than the previous month, and 15.293 people or 5.2% less than the same month in 2005.  september saw a greater number of people becoming unemployed (27.096 people) than the num‐ ber of those becoming employed (19.130 people), which resulted in a monthly increase of the re‐ corded number of unemployed people. it is a usual phenomenon this time of year because of peo‐ ple who were working during the tourist season and also because of new people recorded after  they graduate and apply to the employment office in order to get a  job. according to age, the  largest portion of recorded unemployment is held by people over 50 (25,4%), while the share of  young people aged 15 to 24 is 20,0%.  according to various activities, most people are employed in the processing industry (2.565  or 23,1% of the total number of employed), commercial activities (2.253 or 20,3%) and education  (2.070 or 18,6%), while according to the regions the number of people employed was the highest in  the city of zagreb (1.720 or 15,5%), followed by the regions osjecko‐baranjska (1.101 or 9,9%) and  splitsko‐dalmatinska (1.091 or 9,8%).     graph 2 ‐ unemployment ratio in republic of croatia and in istrian county for period 1991.‐ 2005.  index unemployment ratio in republic of croatia unemployment ratio in istrian county years source: region of istria, department for economy, 2006.  prevailing in the unemployment records are people with three‐year secondary education, i.e.  schools for skilled or highly skilled workers, with a share of 36,0% in september 2006. people with  a four‐year secondary education and grammar schools follow with 26,0%, and people with only  elementary school are last with 23,9%. the smallest number of the unemployed is among those  volume 40 • spring 2007 • 35  with a higher education or a professional degree (3,2%) and a university degree, academy degree,  ma or phd (4,1%). 18  seasonal employment in tourism has again had a significant impact of regional employment  in croatia, as has already been pointed out in this paper. considering individual regions the most  seasonal workers were employed as follows: splitsko‐dalmatinska (2791 or 18,2%), istria (1996 or  13,0%), dubrovačko‐neretvanska (1784 or 11,6%), primorsko‐goranska (1574 or 10,3%), šibensko‐ kninska (1141 or 7,4%) and zadarska region (941 or 16,1%) (croatian employment office, 2006)19.  if we disregard (or  ignore)  the fact that  the owners  ‐ foreign  investors  in national  tourist  economy know exactly what to do and that is return the invested capital as soon as possible, we  can also expect some positive byproducts. for example, there may be a balancing between domes‐ tic and foreign (european) prices of new or rebuilt accommodation units (beds) since they will  refuse to pay for the unproductivity of our work at our prices. on the other hand, we can expect a  positive change concerning the protection of prices of our national tourist offer, raising them by  obtaining a parity of price and quality of our products with the quality of the country of origin of  the capital, thus reaching prices dominant on the international tourist demand market.  4. the role of tourism in the development of employment in istria  the decrease of the share of tourist economy in the overall employment in istria points to the  fact that tourism suffered more than other sectors of economy during the years of crisis in the last  decade (graph 2). therefore, the role of tourism in regional employment has become questionable  due to a trend of decrease in the number of employees in large hotel enterprises. the situation is  that more serious since the growth of unemployment is extenuated by the growth of investments.  in the current conditions, tourism in istria cannot keep its function of economic development  for the area without a conflict of interests between the two parties. one party, the tourist economy,  is  defending  itself  with  the  “free  market”,  while  the  other,  the  regional  and  local  self‐ administration, tries to do the same with the available interventionist mechanism set in motion to  sustain tourism in the function of a general development of istria. the balance of interests of the  two parties can be reached only through stability and clear zoning plans and communal infrastruc‐ ture. this way the market interests, which are as usual without limits, would be reduced to stable  and clear long‐term plans of the economic development of istria, finding room for the develop‐ ment of the so‐called “green tourism”.  the region needs to go into the sphere of regional economic policy which has to develop ru‐ ral regions in istria so that tourism becomes a complementary activity to be used in order to sell its  surplus of production.  4.1. education programs  “man – the key to success” is a national program organized by the head office of the croa‐ tian tourist association directed towards raising the level of hospitality and creating a climate of  welcome to the destination. the aim of the program is to support a hospitable and friendly attitude  to tourists, raise the service quality through education, increase the level of satisfaction of tourists,  make them come back and promote the destination by word of mouth, thus spreading a positive  image. what is considered of extreme importance for workers in tourism is the understanding of  18 www.hzz.hr  19 dragičević, m. and a. obadić, (2006), regional clusters and new employment in croatia, university in zagreb.    2007 ‐ 36  •  economic analysis®  modern trends and new products in european tourism. an increase in the number and quality of  tourist services is planned through a program of education of the local population.   on  the  other  hand,  the  rural  tourism  of  istria,  through  the  consortium  of  rural  tourism  “ruralis”, has aims to create educational processes in order to improve the hospitality and tourist  services in rural tourism, and precisely with20:  o compulsory education for owners and future owners of rural tourist households  o education of educators  o formation of a system of trainers of rural tourism  o start of educational processes in educational institutions (vocational schools, higher edu‐ cation) in order to preserve and revitalize the traditional building heritage and an ap‐ propriate construction of new structures in the rural areas and carry out other programs  and projects. with that in mind, the office for cultural tourism of the croatian tourist  association will organize educative seminars for cultural tourism in 2008, with the aim  to support and raise the standard of  interpretation and quality of such programs. all  these programs are an incentive to the development of employment in tourism and are  intensely worked on in croatia, before all, in order to create a positive business envi‐ ronment.  5. conclusion    it  is  the aim of  the european union  to obtain a balanced regional development.  in  that  sense the union supports the creation of regional operative plans whose aim is to prepare croatia  for the acceptance and successful usage of structural funds when it becomes member of the euro‐ pean union. clusters enable the realization of a wide range of local development goals, creation of  new work places, new skills and generally positive gains in the development of welfare on a na‐ tional level. the istrian ragion is the only region where the activity of hotels and restaurants has  continually recorded a net profit since 2000. the key of istrian success is in a controlled growth of  expenditure, a maintaining of employment and a realization of higher profits by using mainly ex‐ isting resources.    the future activities of other croatian regions have to be directed towards the education of  employees in tourism in order to raise the level of joint creation of new tourist programs and offer.  literature  babić, z. (2004), tržište rada u rh i mjere za poticanje zapošljavanja, magistarski rad, ekonomski fakultet, zagreb   bejaković,  p.  i  gotovac,  v.  (2003),  (ne)zaposlenost  u  republici  hrvatskoj,  [online],  http://www.ijf.hr/eu/bejakovic‐ gotovac.pdf  bejaković, p. smanjivanje dugotrajne nezaposlenosti u hrvatskoj. // financijska teorija i praksa. 27(2003), 4 ; str. 581‐607.  breathnach, p. et al. (2004), gender in irish tourism employment in tourism: a gender analysis. kinnard, v., hall, d.  eds. chichester: wiley.  santos, c. & almeida, a.  (2004), comparative analysis of  tourism contribution  to  the gdp of madeira and azores,  economia del turismo, international conference, aecit, university of balearic island. p. 277‐287.  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paolo de mas,jan mansvelt beck: geography, enviroment and development in the mediterranean, sussex academic  press, portland, oregon  rutkowski,  j.  (2003)  analiza  i  prijedlozi  poboljšanja  tržišta  rada  u  hrvatskoj,  [online],  http://www.ijf.hr/financijska_praksa/pdf‐2003/4‐03/rutkowsky.pdf  šošić, v. (2002), unemployment, human development report – croatia, undp (raspoloživo u ekonomskom institutu).  woods, r.h. (2006), managing hospitality human resources, 4 edition, educational inst of the amer hotel.  www.hzz.hr  www.istra‐istria.hr  www.dzs.hr  microsoft word 2008_01_02.doc   editorial    personality model in human resources management    jovan zubović, institute of economic sciences belgrade    key words: personality, hrm, manages, executives, advisory    udc: 005/.96         jel: j21, j24    abstract ‐ this paper presents the new „personality model” of managing human resources in an  organisation. the model analyses administrative personnel (usually called management) in an organisation  and divides them into three core categories: managers, executives and advisors. unlike traditional models  which do not recognise advisors as part of an organisation, this model gives to advisors the same ranking as  managers and executives.  model traces 11 categories of personality traits for every employee, rates them  accordingly and gives the average rate for the position the employee occupies in the organisation. the model  is tested in three empirical cases and results offer the additional value which may be created by proper man‐ agement of human resources in an organisation.  traditional models  every organisation’s most valuable resources are employees. organisation structure is a re‐ sult of the process of human resource management. according to traditional models all organisa‐ tional activities are divided to managerial and executive. managers are those employees who or‐ ganise business operations as long the others are executives. graph 1 shows a simple theoretical  model which may be applied in every corporation.  graph 1 – corporate executive and managerial activities                                      relationship between managers and executives in every company and on every position in  an organisation may be allocated on graph 1. the structure and the volume of either activity define  the position one occupies in the company.   typical corporate macro organisational structure is shown in graph 2. company president  should perform 100% of his activities as a manager. in many corporations because of the improper  president general manager  and top level direc‐ tors  executive  directors  ceo executive activities managerial activities  executives  2007 ‐ 4  •  economic analysis®  delegation of work and operational activities this is not the case. many presidents move down‐ ward along the curve in graph 1 and so their real occupation is ceo or even general manager.  similarly top level directors have much more of executive activities than their position requires. in  that way they do not have sufficient time for research and development of new jobs, markets and  customers. on the other hand executive directors and executives usually have more managerial  activities than their position requires. their position is often unclear and they are not certain to  which category they belong.     graph 2 – typical managerial corporate macro‐organizational structure     role of advisors  according to traditional models administration in a corporation is divided to managers and  executives. the “personality model” includes advisors as third type of administrative activity in  an organisation.  in order to simplify the analysis of personnel, we give the role of managers in an organisa‐ tion to (as on graph 2):  o president– the leader and strategy maker in an organization.   o ceo – chief executive officer, unlike president is more oriented to organization, goals  and control  o top level directors– whose competence, authority and responsibility are directed to  their sectors as profit centres. they are key managers of autonomous business units.  o subsidiaries’ directors – independent in their work. they have high level of compe‐ tence, authority and are responsible directly to head office.  o financial director – responsible for expenses control and business planning, project‐ ing and budgeting.  all other directors and chiefs as middle and lower management in company most of their ac‐ tivities perform as executives who perform tasks set by “managers” and should be treated as „ex‐ ecutives“.  president managerial   board  ceo subsidiaries  directors  top level  directors  financial  director  volume 40 • spring 2008 • 5  improper allocation of executives in corporations created a problem of what role they really  perform. are they managers or they are executives depends on different points of view.   the role of advisors in an organisation is permanently increasing in the last decade. admin‐ istrative personnel occupying positions like deputy general manger, gm assistants and advisors,  internal auditor, quality control manager and similar are traditionally misallocated either to mana‐ gerial or executive positions. usually advisors should be employees with huge experience in com‐ pany but with no promotional potential left. in practice most of their activities is advising manag‐ ers. for that reason in personality model they are observed as “advisors”.  modelling   „personality  model”  gives  value  to  quality  of  administrative  personnel  by  giving  them  grades 1 to 10 for the following eleven categories of personality traits (skills):  1. authority and hierarchy obedience  2. resourcefulness  3. frankness and fulfilling obligations  4. work quality and responsibility  5. promptness and organizational skills  6. initiative and proactive  7. promotion potential   8. adaptability and learning   9. loyalty  10. team work  11. accuracy  grading has to be performed by at least 4 independent interviewers. for each employee it is  possible to analyze all 11 categories and in such way to get general overview of one’s abilities. in  order to get maximum of the model, according to what position one occupies in an organization  most relevant skills for that position have to be analyzed. that would enable review of how effi‐ ciently have administrative personnel been allocated in an organization.  skills relevant for “managers” are:  o work quality and responsibility  o initiative and proactive  o adaptability and learning   o loyalty  o team work  skills relevant for “executives” are:  o authority and hierarchy obedience  o frankness and fulfilling obligations  o promptness and organizational skills  o promotion potential   o team work  2007 ‐ 6  •  economic analysis®  o accuracy  skills relevant for “advisors” are:  o resourcefulness  o work quality and responsibility  o promptness and organizational skills  o team work  o accuracy  it has to be mentioned that team work is the only category relevant for all administrative  personnel observed by this model. in every analysis of human resources one company has, team  work has to be trait that must be valued at most.  empirical analysis – three cases  personality model has been tested in three corporations. two of them are privately owned  companies and one is state owned. since the testing was confidential the names of organizations  and grades for single persons will not be given. organizations will be called company a, com‐ pany b and company c, and for personnel the average grades will be used.  companies’ details  company a is large privately owned corporation with 600 employees. it has 3 divisions and  2 subsidiaries. managers in the company according to delegation of authority in personality model  are: general manager, divisions’ directors and one subsidiary director. executives are: financial  director, chiefs of finance, legal and logistics department and second subsidiary director. finally,  the advisors in company a are: chief of quality management systems, internal auditor and dep‐ uty general manager.  average grades in company a for all fifteen interviewed administrative personnel ranges  from 5.9 to 8.0 in different categories (see table 1). average grade in team work is 6.5 and it is the  third lowest of all eleven categories.   company b is large state owned company with 1200 employees divided in 5 divisions. man‐ agers in the company according to delegation of authority in personality model are: general man‐ ager, deputy general manager, marketing director and on division director. executives are: four  division directors, deputy chief of finance, chief and deputy of legal department, two chiefs of  production and chief of logistics department. finally, the advisors in company b are: director of  finance, director of legal department and chief engineer.  average grades in company b for all seventeen interviewed administrative personnel ranges  from 3.5 to 8.8 in different categories (see table 1). average grade in team work is 7.1 and it is  higher than average of all eleven categories.   company c is recently privatized company with 400 employees divided in one production  division and several support sectors. managers in the company according to delegation of author‐ ity in personality model are: general manager, and technical director. executives are: financial  and commercial director. finally, the advisors in company c are: it manager and chief of pro‐ duction.  average grades in company c for all six interviewed administrative personnel ranges from  3.5 to 8.8 in different categories (see table 1). average grade in team work is 7.8 and it is higher  than average of all eleven categories.   volume 40 • spring 2008 • 7  skills rating  in table 1 there is a cross analysis of three companies administrative personnel with average  grades by skills.  table 1 – companies a, b and c average grades of administrative personnel  skills  company  a  company  b  company  c  number of persons  13  17  6  authority and hierarchy obedience  7,5  7,0  8,8  resourcefulness  6,2  6,7  7,2  frankness and fulfilling obligations  8,0  6,9  7,4  work quality and responsibility  7,9  8,2  8,5  promptness and organizational skills  7,2  5,6  7,6  initiative and proactive  5,9  3,5  6,1  promotion potential   6,5  5,8  6,9  adaptability and learning   7,2  5,8  7,6  loyalty  7,4  8,8  8,1  team work  6,5  7,1  7,8  accuracy  7,8  6,4  6,8  average  7,1  6,5  7,5  managerial  7,0  6,7  7,6  executive  7,2  6,5  7,5  advisory  7,1  6,8  7,6  note that for all 13 persons in company a average managerial skills are rated 7.0, executive  7.2 and advisory 7.1; in company b for 17 persons average managerial skills are rated 6.7, execu‐ tive 6.5 and advisory 6.8.; and in company c for 6 persons average managerial skills are 7.6, ex‐ ecutive 7.5 and advisory 7.6.  if grades are calculated for skills relevant to position administratives occupy in companies  the results are shown in tables 2 through 4.   table 2 – companies a, b and c average grades for managers  table 3 ‐ companies a, b and c average grades for executives  skills  company  a  company  b  company  c  number of persons  5  10  2  authority and hierarchy obedience  7,5  7,2  9,0  frankness and fulfilling obligations  8,5  7,1  7,0  promptness and organizational skills  6,8  5,5  8,5  promotion potential   6,5  4,9  7,8  team work  7,3  6,8  8,3  accuracy  8,2  6,1  7,0  executive  7,5  6,3  7,9    skills  company  a  company  b  company  c  number of persons  5  4  2  work quality and responsibility  8,4  7,7  6,9  initiative and proactive  8,0  6,0  4,8  adaptability and learning   7,0  3,7  5,3  loyalty  7,4  9,0  6,9  team work  7,0  6,0  6,3  managerial  7,6  6,5  6,0  2007 ‐ 8  •  economic analysis®  table 4 ‐ companies a, b and c average grades for advisors  skills  company  a  company  b  company  c  number of persons  3  10  2  resourcefulness  5,0  4,3  7,9  work quality and responsibility  7,0  8,0  9,5  promptness and organizational skills  6,8  6,0  8,8  team work  5,0  9,0  9,0  accuracy  7,8  7,0  7,5  advisory  6,3  6,9  8,6    if we compare results from table 1 to tables 2‐4 it is obvious that allocation of personnel in  company a is efficient regarding managers and executives, since their average grades are 7.6 and  7.5 respectively in tables 2 and 3 are higher than grades 7.0 and 7.2 from table 1. even if we com‐ pare single grades by skills it is notable that managers and executives have higher grades than all  13 persons in average, like for example “initiative and proactive” which in company a have given  lowest average of 5.9, for managers who require that skill in performing their activities, the grade  is 8.0.  problem of company a are the advisors. grades from table 4 are by every category lower  than  in table 1.   categories “resourcefulness” and “team work” for three advisors have been  rated as low as 5.0 which is much below it is expected for persons occupying those positions.   in company  b  unlike  company a,  the  best  allocated personnel  are advisors.  they have  slightly higher average grades for their required skills than all 17 persons interviewed. looking on  personal data, which is confidential and not shown in this paper it is more than notable that per‐ sonnel in company b could have been reallocated differently so as to reach average in managers to  8.0,  executives  to  8.5  and  advisors  to  7.7.  main  problem  of  company  b  is  skill  of  managers  “adaptability and learning” which is rated by only 3.7.   finally in company c executives and advisors have been perfectly allocated, but with man‐ agers there is a significant problem. average grade of 6.0 is much lower than 7.6 from table 1.   further research in company a has shown that three advisors have been given improper or‐ ders by managers. two of them were advised to change their position and become executives and  one to been sent to training for improving some of the skills.  in company b analysis of personal data shown that there is a need for several repositioning  and specifically change in systematization and organization of the company.  in company c there is a need for change of positions between advisors and managers, or  possibly recruiting new technical director.  additional value in managing human resources by personality  several skills analyzed  in  this model are subject to change in time. persons may  learn in  many of them either by experience, in specific courses or in the process of self learning. these are:  o authority and hierarchy obedience  o frankness and fulfilling obligations  o work quality and responsibility  o promptness and organizational skills  volume 40 • spring 2008 • 9  o team work  o accuracy  other skills (traits) are given by birth and are very difficult to change:  o resourcefulness  o initiative and proactive  o adaptability and learning  o promotion potential  o loyalty  loyalty is the only trait which is given but possible to change by different types of benefits,  which may be called “bribing”.  knowing all this and having analysis of personnel done properly enable the company stake‐ holders to reorganize their human resources and improve company operations. as seen in three  empirical cases no company has hr manager. it is highly advisable for every company to employ  experienced manager on that position who will be able to use several existing models to analyze  what changes in organization may be made without high costs. hrm should set the employment  standards which would differ from the one which has been in practice in last decades that values  candidates according to elementary skills (education, foreign languages, computer skills etc) and  no analysis of personality traits.      ea_2016_3-4 udc: 005.311.121:005.591.6 005.521:334.7(497.11) jel: o33, m1 cobiss.sr-id: 228332812 preliminary report statistical monitoring of innovation capacities of the serbian firms as decisionmaking tool mosurović ružičić marija1, kutlača đuro, belgrade university, institute “mihajlo pupin”, belgrade, serbia abstract – the subject of this paper is to underline the importance of using data obtained via the official statistical reports that is based on oslo manual methodology manual (community innovation survey) for strategic decision making both at the national level as well as at the level of the company. these data enable monitoring and evaluating the innovation capacity of the firms with the aim of improving it. the paper, also, points out the importance of the firm's innovation capacity assessment as an impeller of economic development based on knowledge. by the data obtained by presented methodology, national decision makers can clearly comprehend and improve the direction of innovation policy and its integration into the wider policy framework that encourage economic development based on innovation. at the firm level, the use of data implies development of professional management of the innovative firm that will be able to respond to problem situations of the modern economy through the formulation of appropriate strategies. the paper analyzed data from three statistical periods during which the oslo manual methodology had been applied in serbia. analysis has shown that the data obtained in this way are not sufficiently used by decision-makers an occasion rating innovation capacity of enterprises. key words: innovation capacity of the firms, innovation activities, oslo manual, community innovation survey, strategic decision. introduction the importance of innovation is not possible to ignore. they are incorporated into everyday life. innovation could not be seen only in a narrow sense as a driver for increasing the wealth of the nation and prosperity, but also in a more fundamental senseas a tool that enables individuals to do things that they had never done. innovation is not only significant in terms of sustainable economic growth, but also in terms of changes of direction of economic progress and ultimately increases the quality of life (freeman, 1988). 1 marija.mosurovic@pupin.rs 70 economic analysis (2016, vol. 49, no. 3-4, 69-80) observation of the firms innovation capacity in a certain period may provide insight into the dynamics of the inventiveness of a certain economic activity which provides a space for comparing the development of certain sectors and determine the technological leader (suarezvilla , 1990). some of them are based on developed practices of cooperation between the various innovation stakeholders, knowledge capital development, and some are related to organization design and human resources management. in accordance with that, various databases can represent a source of information which can be used for determining the innovation capacity of the firms. this work particularly emphasized the importance of the data obtained using the methodology oslo manual, which represents the methodological framework for the creation of community innovation survey (cis) a questionnaire that investigates innovation activities within the firms. this methodology provides a better understanding of the innovative behavior of firms through the definition of indicators of firms’ innovation capacity. in that way, the influence of innovation on employment, competitiveness, economic growth, trade, etc ., could be determined. also, the obtained data can be used, by applying appropriate statistical programs and techniques, for constructing different models for further investigating of specified dimensions of firms’ innovation capacity. analysis and assessment of the impact of the firms’ innovation capacity on the firms’ competitiveness are equally important for the macro and the micro level of decision making. at the macro level, a competitive advantage based on the technology development has been influenced by the development of system variables of the national economy, i.e. the elements of the national innovation system. the level of development of infrastructure, political and other institution which determine the function of creation of transfer technology and diffusion indicate the development of national innovation system (author). at the company level, the importance of technology is analyzed functionally: exploring how technology can influence the business activities that lead to increasing market share of the company, both on domestic and foreign markets. besides, the company can gain a competitive advantage in innovation, through efficient use of technology developed within the company or the market (aralica & račić, 2007). understanding of the firm’s innovation capacity at the national level can provide insights into how the innovation of the nation has been changed over the time, besides that, the relationship between national innovation stakeholders can be monitored. firm’s innovation capacity the importance of innovation for improving the functioning of national economies has been recognized in the literature. many authors believe that the innovation capacity could be seen as the driving force for economic growth and development and competitive advantage. in the literature, there is a consensus that innovation has significant implications on the performance of national economies, the region and beyond (arrow, 1962; freeman, 1988; romer, 1990, van tunzelmann, 1995; mervar, 1999; radošević, 2004; oecd, 2005; knell, 2006; lentz&mortensen, 2006; courvisans & mackenzie, 2014; melinkas, 2014;), etc. mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 71 national innovation capacity in the narrowest sense is the "country's ability to produce, commercialize and enable the smooth flow of innovation over a longer period of time" (furman et al., 2002). the success of innovative companies can be measured not only through the consideration of innovation and/or the economic performance of the firms but also includes activities which are related to the performance evaluation during the implementation of the innovation process. these activities, beside evaluation of a technological aspect of innovation, include the evaluation of non-technological dimension of the innovation process such as the mechanisms for diffusion and transfer of technology, the strength of interaction between all national innovation stakeholders as well as organizational design components. through measuring of innovation capacity of the firms over some period, it is possible to gain insight not only of the economic activity of the firms, but also in the economic activity of the nation, and even the region. the decline in innovation capacity in some sectors certainly can identify the future problems and can be used as an indicator for taking corrective actions (lukjanska, 2014). the firm’s innovation capacity assessment reinforces and improves the competence of all relevant individuals and institutions, including the complete system environment. at the national level through the improvement of the innovation capacities, the competitiveness of the firms, specific industries, as well as the national economy at the whole, can be enhanced. thus increased competitiveness is based on better utilization of knowledge. at the regional level, increasing innovation capacity improves the potential for innovative cooperation, clustering, and regional development. at the firm level, assessment of innovation capacity is important for the management of the firms and includes the identification of the current situation, through the assessment of innovation performance, and to the anticipation of the desired state. through defining action plans with the aim to overcome the identified variations, the strategic management at the firm level can be improved. innovation management at national level is a complicated and complex process that includes mechanisms for the establishment of the effective fitting of innovation capacity with needs of the economy. successful innovators can be determined by their capacity for fitting research and development with knowledge of market demands (freeman, 1982). peter drucker (2003) believes that the success of innovation is in close connection with the specific systematic approach in analyzing all sources of innovation. he also underlined that for successful innovation, it is necessary that there is a recognized need for it. its findings also indicate that innovation is not linked only to companies with high technology, but also for the companies with lower technological level. for a successful understanding of the firm’s innovation capacity, the indicators of innovation input and innovation output should be explored which is possible by using various databases. statistical sources for innovation capacity indicators for investigating of innovation activities of the firms with the intention of assessing their innovation capacity, there is no precisely defined set of indicators. the number and type of indicators varies according to the objectives and tasks of the analysis. basic statistical sources 72 economic analysis (2016, vol. 49, no. 3-4, 69-80) for indicators of innovation capacity of firms can be different databases (maroulis & tsipouro, 2011): • eurostat provides data for all european union member states, as well as certain which are not yet. using this database comparison between the countries and region make easier. • oecd provides data for quality analysis and between countries that are not members of the european union. • national statistical offices provide statistical data at national level. data obtained from these sources can be internationally comparable if the common methodology is used. these institutions provide data to the international statistical organizations. • innovation union scoreboard provides data that enable assessment of innovation performance of european union member states and beyond to identify the strengths and weaknesses of their systems of research, development and innovation. • different specialized databases of patent activities (european patent officeepo; world intellectual property organizationwipo, etc.); bibliometric data (web of science, scopus, kobson), etc. • periodic and/or one-time researchcollection and processing of qualitative and quantitative data. in recent years, the great efforts have been made to develop indicators for monitoring the performance of innovative firms. there are various initiatives related to the development of innovation indicators that originated from different areas: education, based on developed practices of cooperation between the various innovation stakeholders of data relating to the organization and management of human resources. however, the most prominent source of information for measuring innovation performance of enterprises is the community innovation survey. information about research and development costs, patents and bibliometric data can be obtained from periodic reports relating to the research and development of citation indexes and other sources. but, the information obtained in this manner, observe only certain aspects of the innovation capacity of the firms. this paper points out the importance of using data gathered using the oslo manual methodology for decision makers. firms continually develop their products and processes and establish new knowledge. it can be seen as a dynamic process rather than static. only adequate use of knowledge could improve competitiveness at the firm level. oslo manual is a comprehensive guide for collection, processing and analysis of data that can describe the innovation process (eg. innovation activities, expenditures for the performance of innovation activity, as well as the connection of the company with other actors of the national innovation system), the implementation of significant improvements in products and processes in the company (different types of innovation), and to obtain information about the factors that affect the performance of innovation activities and their effects. all this information is very important for researching firm’s innovation capacity. the distinguishing of four types of innovation: innovation of products/services, innovation mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 73 process, innovation in organization and innovation in marketing makes this approach useful for the understanding of innovation from various aspects. data, which are obtained from community innovation survey, are used for the creation of indicators that describe firm's innovation capacity. the specific indicator may refer to only one question from the questionnaire, although often it is an analytical framework for few questions (oecd, 2005). based on the study of indicators it is possible to make a different kind of comparison regarding innovation performance of the firms in other to assess and follow the dynamics of changing their innovation capacity at all levels of observation. data obtained by using this methodological framework can be used further for creating the different analytical models depending on the aim and users of the analysis. the oslo manuel methodology has evolved over time so its development could be followed through several periods (oecd, 2005): • the first stage covers the period of the eighties and nineties of the last century when different models for monitoring innovation activities in the firms have been developed; • at the beginning of the nineties, exactly in 1992, when the first edition of oslo manual was published, stared the new stage of methodology development for firm’s innovation capacity assessment. by this manual, it is enabled tracking of innovation activities in the manufacturing sector with the main focus on technological innovation; • disadvantages of the first edition of the oslo manual were overcome with the second edition, which was published in 1997. this edition was included some methodological improvements. the service sector was also covered; • the last, the third edition of the oslo manual is improved in accordance with the recommendations of users and represents a major step forward compared with previous editions. improvements can be seen primarily through the complex approach of monitoring firms innovation capacity, which includes beside technological dimensions , the non-technological dimension of the innovative behavior of firms. the main advantage of this edition is the comprehensive methodological framework of analysis. statistical monitoring of innovation activities of the firms were conducted in serbia during the four three-year cycle using oslo manuel methodology. this paper presents a comparative analysis of some indicators of innovation capacity of serbian firms in the last three cycles. information obtained by using this methodology which is applied through community innovation survey are input for a design of a framework for analyzing the innovation capacity of enterprises that were investigated. this information enables the creation of a large number of indicators that make up the national innovation capacity internationally comparable. indicators of innovation capacity in the serbian firms assessment of the innovation capacity of the serbian firms in a narrow sense means the mechanism for an understanding of creating and development of product innovation, process innovation, innovation in marketing and organizational innovations. this 74 economic analysis (2016, vol. 49, no. 3-4, 69-80) information is available on the basis of the community innovation survey, by which is possible to collect a lot of different information for creating a large number of indicators that could describe innovation inputs and innovation outputs (mohnen et al., 2006; knell, 2006; aralica et. al., 2008). in this part of the paper indicators that could describe some dimension of the innovation capacity of the serbian firms will be presented: investment in innovation activities, sources of financing innovation activities, the share of revenues from the implementation of innovation activities in the total income of the company. for the analysis, official statistical data of the statistical office of the republic of serbia will be used. the data are collected by applying the methodological tool of oslo manual. in this way, it will be possible to follow the dynamics of individual indicators of innovation capacity of firms in serbia during three three-year periods during which the official community innovation survey was conducted in serbia. investing in innovation activities is one of the most important indicators of innovation capacity of the firms. as soon as the company realizes the importance of these kinds of expenses, its chances for success are greater. figure 1 shows the dynamics of expenditure on innovation activities during the observed periods. figure 1. expenditure for innovation activities in serbian firms (%) during the periods 2008-2010, 2010-2012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. during the observed three-year statistical period, the companies in serbia invested in their own research capacity the most, through the provision of necessary equipment and the implementation of internal research and development activities without any significant variations during the period that was considered. beside the mentioned types of innovation activities, the firms may implement and other types such as preparation of feasibility studies, testing, routine software development and industrial engineering. innovation activities cannot be observed separated because conducting the one doesn't exclude the others. they are almost always carried out 13.6 5.2 75.1 6.1 0 7 2.3 80.3 7.1 3.3 12.3 2.6 64.3 9.5 11.3 in-house r&d purchase of external r&d acquisition of machinery, equipment, and software acquisition of external knowledge other 2012-2014 2010-2012 2008-2010 mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 75 simultaneously. for example, internal research and development activities often involve the purchase of new machinery and equipment and/or purchase of certain forms of intellectual property rights as well as providing education and acquiring new knowledge and skills. companies recognize the need to undertake research and development activities in order to survive in business. most of the companies, especially in less developed economies play a less risky role of imitators (contrary to technology leaders) or technology followers. this means that most innovation expenditures will be connected with purchasing equipment, software and rights to use someone else's intellectual property rights (patents and nonpatented inventions, licenses, trademarks). there is increasing tendency in these expenditures in serbia within observed periods: (9.5%) in the period 2012-2014 compared to the previous periods observed (figure 1. 7.1% and 6.1%). external financial support for conducting innovation activities is mainly provided from government funds in serbia, but there is decreasing tendency in funding from this kind of sources in the last reporting period (63.2%) compared to the previous two periods (70.8% and 63.2%). it is encouraging that the importance of investment in innovation activities is recognized at the local level. however, in order to establish a functional link between results of innovation activities and the economy needs, firms should turn out to market in order to find additional financial sources. figure 2 shows that the firms in serbia identified the importance of applying for the framework programs (fp) of the european union. these programs are with the aim to establish the better efficiency of research and development in order to improve the economy of the european union as the most dynamic, competitive global economy based on knowledge. figure 2. the structure of public financial support for innovation activities in serbian firms (%) during the periods 2008-2010, 2010-2012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. technological innovation can occur through the introduction of new products and processes (radical innovation), which substantially change the dynamics of the sector, or as a 28.6 82.3 10.5 1.9 29.2 70.8 13.1 2.4 36.8 63.2 11.4 2.8 local or regional authorities central government the european union (eu) fp7 2012-2014 20102012 2008-2010. 76 economic analysis (2016, vol. 49, no. 3-4, 69-80) small improvement in existing products and processes (incremental innovation). in the public, the term innovation is mainly related to radical innovation, but, one should have in mind that the higher profits could be achieved through conducting less risky, incremental innovation. it is especially important for countries that do not have the large financial capacity. according to schumpeter, "radical" innovations shaping the great economic changes, while incremental enable this process to take place continuously. the structure of the percentage of firm’s total turnover over observed periods is shown in figure 3. innovative enterprises in serbia mostly obtain the income from products that have undergone minor changes or were only new for the company (oecd, 2005). figure 3. the structure of total turnover of innovative activity in serbian firms (%) during the periods 2008-2010, 2010-2012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. the results of performing innovation activities usually can be seen as a number of generated innovation. the firm could also be considered as innovative if during underperforming period conduct innovation activities regardless of whether scientific results achieved during the period or not. inclusion and abandoned and innovation in progress are covered by definition (oecd, 2005). on the basis of the oslo manual methodologies results of performing innovation activities can be expressed as the product/ service innovation, innovation in organization and marketing innovation (figure 4). 4.4 3.8 3 7.3 9.1 5 35.2 37 35 53.1 50.1 57 20082010 2010-2012 2012-2014 products new to market products new to firm changed or only marginally modified product non innovators mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 77 figure 4. innovation activities by type in serbian firms (%) during the periods 2008-2010, 20102012; 2012-2014 source: statistical office of the republic of serbia, authors' calculations. the data presented in table 4. shows that the highest number of innovative firms were identified within the period 20082010. a slight decreasing tendency in the number of innovative firms in serbia is also presented especially in the last period of observation. this fact influences the results of innovation activities. perhaps the topics of some research in the future should be an investigation of the causes that led to a decline in the number of companies that have performed innovation activities in the last three-year period under review. conclusion firms’ innovation capacity assessment is very important for making strategic decisions at the firm’s level, but also in decision-making at the national level through the creation of different policies. there is the unquestionable role of assessment of the innovation capacity of firms for their management. strengthening the innovation capacity of enterprises leads to improving the competence of all relevant individuals and institutions, including the complete system environment. innovation management and building innovation capacity implies a strong and complex interaction between the national research base, decisionmakers in this field. developing capacities, skills, and innovation management skills, as well as the creation of a friendly environment for innovation, are the key things that could be advised to decision makers at all levels for improving the innovation capacity of firms in serbia. changes in technology and market requirements, "force" the innovative firms in their effort in the implementation of different strategies, depending on available resources, the general attitude of management and ultimately "lucky" circumstances (freeman, 1982). 27.4 28.2 32.5 29.3 15.5 52.1 21 19.1 31.4 29.7 7.9 55.4 20.4 20.2 24.9 23.8 10.9 59.5 0 20 40 60 80 product innovations process innovation organisational innovation marketing innovation ongoing or abandoned innovation non-innovators 2012-2014 2010-2012 2008-2010 78 economic analysis (2016, vol. 49, no. 3-4, 69-80) innovation strategy of the firm should be an integral part of the general strategy of every company that conducts research and development activities. strategic management of the company should continuously monitor and investigate the relationship of innovation input and innovation output of firms in contexts of overall firm s performance. there is the need for the existence of highly skilled management of innovative firms that can respond to problem situations of the modern economy through the formulation of appropriate business strategies. the role of government in fostering innovation of enterprises is seen through the creation and implementation of a set of interrelated measures and incentive mechanisms, which include the provision of a large amount of financial resources (from the budget and allocations within the framework of encouraging the business sector), as well as the creation of an adequate economic environment for efficient function of national innovation system. in order to ensure efficiency funding, there is a need for focusing research and development efforts on a certain set of priority areas. determining the strategic priorities should be a systematic by applying bottom-up rather than top-down approach (smart specialization, foresight, etc.). innovation policy should be addressed towards the problems of practitioners and synchronize the activities of all actors of the national innovation system. this can be achieved in best way through a horizontal approach to the innovation policy that overcome the scope of work of one ministrycoordination of innovation policy with the policy of economic development. only in that way, it will be possible to develop a model of economic growth that will lay on the effective use of innovation as well as the transfer of innovation in the economy. the main characteristics of the model should be (fabris, 2014): increase in export demand, import substitution, more emphasis on the manufacturing sector as a generator of economic growth, competitiveness based onknowledge-transfer technology. the work presented here points out the importance of innovation capacity of firms assessment by using the methodological framework developed by the oecd, oslo manual, which is widely recognized as the strategic decision-making tool in developed countries. data obtained through community innovation survey are very descriptive for analysis, monitoring assessment of innovation capacity of firms, in spite of the survey limits, which are listed below: (oecd, 2005; knell& nas & 2006): • detailed analysis of the innovation capacity of firms in some cases requires data that that are not covered by community innovation survey; • it is very hard to understand innovation expenditures from the classical financial report. in order to interpret these data in the proper way, it is necessary to analyze the data from other various business-related reports, particularly financial; • it is difficult to determine the timeframe of the analysis. period covered by the questionnaire refers to three years, but the results of innovation activities are often known only in a future period; • do not provide enough information about the general institutional environment, such as the education system, labor market, and financial system. this paper presents that the assessment of the innovation capacities of companies providing quality information to improve the innovative performance in the future, both at mosurović ružičić, m., et al., statistical monitoring, ea (2016, vol. 49, no. 3-4, 69-80) 79 the level of individual companies, and the level of national 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the innovation capacities of central and east european countries in the enlarged eu.“ jcms, 42 (3): 641-666. renate, l. 2014. “regional innovation policy and systemcase of latvia.“ the annals of the university of oradea. romer, m.p. 1990. „endogenous technological change.“ journal of political economy, 98 (5): 71-102. suarez-villa, l. 1990. „invention, innovative learning, and innovative capacity.“ behavioral science, volume 35 (4): 290-310.s von tunzelmann, n.g. 1995. technology and industrial progress. edward elgar publishing limited, england. article history: received: 10 november, 2016 accepted: 25 november, 2016 ea_2019_2 doi: 10.28934/ea.19.52.2.pp43-63 original scientific paper the offer of financial derivatives in the banking sector of the republic of serbia mina kobilarev1* | branko živanović2 1 glasgow caledonian university 2 union university belgrade, belgrade banking academy faculty for banking, insurance and finance, department for economic and finance, belgrade, serbia abstract the paper examines the results of the research conducted in the serbian banking sector considered the only counterparty to companies in the derivative otc market given that serbia’s financial system is bank-based. the primary objective is to assess the total level of derivative instruments demand in serbia and types of derivatives offered by banks. besides, we also aim to determine the reasons that limit the most the development of the domestic derivatives market and that impact bank activities aimed at attracting derivative business and its development phases. in addition, we explored the expertise of banking sector employees in the financial derivatives field, most often in the treasury department. we endeavoured to ascertain the number of staff working in departments in charge of derivatives trading, their professional skills and expertise, qualifications, training and certificates. we have analysed the reasons that most severely restrict the development of the domestic derivatives market and possibilities and limitations of introducing the derivatives market as an unregulated segment on the belgrade stock exchange. this paper also gives a comparative overview of the use of derivatives from the banks’ viewpoint between the banking sectors in serbia and bosnia and herzegovina (bih) so as to determine the level of derivative instruments demand, types of derivatives offered by the banking sector and possibilities and limitations of introducing the derivatives market as a market segment on stock exchanges in serbia and bosnia and herzegovina. key words: risk management, banking sector, financial derivatives, corporate finance, hedging jel classification: g21, g32 introduction serbia is an economy in transition which records elevated instability as to its exchange rate, inflation and other main macroeconomic indicators. in addition, financial derivatives as hedging instruments are not frequently used in the country (djenić et al. 2012). the main precondition for the use of financial derivatives are developed financial markets. the degree of development is seen in the level of financial infrastructure, the range of financial instruments and human know-how. in view of the poor profitability of the economy, inappropriate savings habits, soaring interest rates, dented confidence in the financial system, unclear ownership rules, no expert human resources and high inflation, the degree of development of serbia’s stock exchange is inappropriate. grubišić, kamenković and duran (2013) analysed the weakness of * corresponding author, e-mail: minakobilarev@gmail.com 44 economic analysis (2019, vol. 52, no. 2, 43-63) the financial market of serbia, when an attempt was made to apply the concept of a contemporary portfolio theory to the serbian capital market, but there were a number of restrictions. the market of financial derivatives in serbia is in the initial phases of development. the concept of a stock exchange emerged in serbia as early as 1830, but the belgrade stock exchange (bse) was established in 1894. shares, bonds, commodities and foreign currency were traded on this combined stock exchange. it was suspended in 1941, and officially wound down in 1953. it was set up again in december 1989 as the yugoslav capital market – belgrade. since 1992, it has been working as the belgrade stock exchange. it trades mainly in short-term securities. the initiative to establish the stock exchange came from government authorities which wanted to have as an institution with the main role in the transition process. still, the former reputation of the bse was not renewed. the first financial derivative is about to be admitted to the organised market (marinković and skakavac, 2010). the currency forward agreement was the first derivative traded in modern serbia (djenić et al., 2012). a forward is in fact an otc contract. the first cash market that carried a forward component was the foreign exchange market. currency derivatives, e.g. currency forwards in serbia are carried out in the financial market via banks. thus, serbia’s fx market is the only market where financial derivatives are truly traded. for instance, as suggested by shiu, moles and shin (2010), in the case of taiwan, interest rate and foreign exchange derivatives were launched only in 1998 on the taiwan futures exchange. the serbian legal framework allowing the use of financial derivatives was established in 2006 pursuant to the foreign exchange law (the fx law), and the law on securities market and other financial instruments, which envisaged for the first time the concept of financial derivatives. by-laws were adopted in mid-2007, though the practice began only in 2009–2010. even then, these instruments were used highly infrequently. users were usually large multinationals companies already working with these instruments. smes were either not interested or did not have expertise concerning currency hedging. they were hesitant mainly due to the lack of knowledge. generally, all financial derivatives are carried out through banks given that serbia’s financial sector is bank-based – the share of banks in its total assets equals 92.6 per cent. on 1 december 2011, the nbs adopted the decision on performance on financial derivative transactions (rs official gazette, no. 85/2011), which superseded the decision on the terms of performing financial derivative transactions by banks, residents and nonresidents (rs official gazette, no. 80/2007). this decision prescribes the conditions under which and the manner in which banks, residents and non-residents may make payments, collections and transfer in respect of trading in financial derivatives. this decision also defines netting and reporting obligations on transactions in regard to financial derivatives trading. the valid legal framework defines only derivative products. secondary legislation governing this field has still not been adopted. such steps must be taken so that the forward market can be established, and in order to define the limits of what is permitted. also, the above decisions of the national bank enable residents to trade in derivative products on foreign stock exchanges and have contractual relations with foreign clearing houses, but such trading in the territory of serbia is not stipulated. in april 2009 the national bank of serbia (nbs) introduced fx swaps as part of a special package of facilities for supporting the country’s financial stability. the main goal was to improve the liquidity of national commercial banks (both in euros and dinars, the local currency) through swap auctions or as a bilateral agreement between commercial bank and the nbs according to živanović b. and a jolović (2012). barjaktarović m. et al., (2017) concluded that commercial banks and monetary regulators should continue in the direction of creating a good climate for further development of financial derivatives market. potential corporate users of the derivatives, on the other hand, are to recognize their interest in these instruments and expend their knowledge of them. emerging economies, including serbia, introduced financial derivatives as entirely new instruments, with many companies still not recognising the importance of their use and methods mina kobilarev, branko živanović 45 of financial risk exposure management. this paper analyses the development of financial derivatives markets in serbia, with a focus on the use of financial derivatives for risk management objectives of non-financial firms from banks’ viewpoint given that the serbian banking sector is considered the only counterparty to companies in the derivative otc market, bearing in mind the bank-based position of serbia’s financial system. in order to achieve the research objectives, authors gathered data on the derivatives market structure, usage and types of derivative instrument traded, with a focus on commercial banks. given the above, in order to conduct relevant analyses, two scientific hypothesis have been formulated, i.e. h1: types of the derivatives offer by the banking sector is sufficient in regard to the derivatives usage by non-financial companies in serbia. h2: knowledge about and focus on the effect of derivatives use. according to literature, limited knowledge affects companies’ use of derivatives (bodnar et al. 1998; børsum and ødegaard 2005). it is suggested that companies’ focus on derivatives, their importance and the extent of use. this paper explores whether knowledge affects the derivative usage from banks’ perspective given that banks are considered the only counterparty to companies in the derivative otc market bearing in mind the bank-centric nature of serbia’s financial system, as already mentioned. literature review travica (2010) explored the use of currency derivatives, namely forward derivatives as a possible solution for currency-induced credit risk. she also identified non-performing loans on the basis of foreign exchange rate regression model, using the sample of 123 serbian nonfinancial companies. she investigated the most important factors which affect hedging and the relationship between non-performing loans and the exchange rate. she claims that managers perceive currency-induced credit risk, but are not aware of the potential of forwards as hedging instruments. she ascertained that variables which affect the currency-induced credit risk (nonperforming loans npls) are statistically significant at a pretty high confidence level and are economically important for the prediction of further trends in non-performing loans. besides, research has shown that managers are not familiar with the protection offered by forwards in case of a volatile exchange rate. the research found several key conclusions and observations: • there is currency-induced credit risk and forwards as hedging instruments are not recognised as instruments which hedge against foreign exchange risk. as a result, it is not used to the degree possible because of the lack of understanding of such financial instrument and its benefits. • besides, the lack of corporate management in domestic companies is a serious gap. it enables managers to pursue unhedging policy and thus avoid responsibility for foreign exchange losses. there is also the fear of job loss because foreign exchange losses arising from hedging may lead to a change in financial managers. the research also showed that most of the management failed to employ forwards as hedging instruments for repaying of foreign currency-denominated loans, while the majority of companies carry that kind of liability in their balance sheets. managers in the sample observed do not frequently involve in use of derivatives (fx forwards) because of possible regret due to loss, lack of understanding of determinants of foreign exchange rate and lack of corporate governance and fear. • the research also identified the new cause of negligible hedging presence in the serbian market, this being the interest rate differential. forward thus becomes too expensive. namely, if the number of companies (forward users) increases, banks would be able to 46 economic analysis (2019, vol. 52, no. 2, 43-63) offer better pricing of forward which may increase hedging. also, if the dinarisation takes hold, there would be less need for hedging loans. still, successful de-euroisation may last many years. • thus, the relationship between npls and the exchange rate should be closely followed. the research shows the basic model and also explains npls and foreign exchange relationship. this confirmed the second hypothesis that “there was strong correlation between non-performing loans and foreign exchange rate on serbian market in the period december, 2008 – august 2011” • also, hedging a loan at the time of dinar’s depreciation could save money to the company’s owners and ensure a more predictable business environment. besides, a company would have the same level of predictability provided the dinar appreciates, but in that case foreign currency loss would be recorded. in either way, this would affect the company’s profitability and its repayment capacity, which corresponds to the third hypothesis. • additionally, this research opened new avenues for future research. one point would be to establish a model so as to hedge companies against foreign exchange risk. furthermore, future research should explore the difference between spot and forward rates as an important factor against hedging, and should encompass a larger number of observations of npls, available over a longer period. travica (2010) finally argued that the recommendation for all market participants such as the serbian banking association, the national bank of serbia and commercial banks is to act jointly in promoting hedging instruments and in educating stakeholders about benefits and cost of hedging instruments. the degree of development of the serbian forward market in serbia was explored by djenic, popovic-avric and bajraktarović (2012), who also analysed the presence and use of forward contracts. despite volatility, this hedging instrument is not frequently used. the research began from the legal framework analysis regarding forward contracts, including the analysis of the degree of forward market development. the aim was to determine why local companies still do not understand their benefits deriving from this instrument in their everyday operations. another aim was to assess the use of forward contracts in serbia, including the main economic and legal issues pertaining to their successful implementation. the findings show that even though currency forward contracts do hedge against fx risk, they do not increase with greater exchange rate volatility. the principal reason is the fact that forward contracts are implemented by big companies, i.e. companies which have high risk management awareness. such companies implement forward contracts constantly, regardless of trends in the exchange rate. they implement these contracts in accordance with their foreign currency ins and outs (i.e. liabilities). as a result, for bigger companies, the most important determinant for the use of financial derivatives is the business cycle. other companies still complain about foreign exchange flexibility and expect from national bank of serbia to eliminate the risk of foreign exchange rate changes, instead to hedge it through forward contracts. thus, greater exchange rate volatility is not an important determinant of demand for forward contracts for the majority of serbian companies. the unclear regulatory framework and the ensuing restrictions only to hedging transactions because of limited legal regulations, including inadequately developed companies` awareness of the necessity to hedge against risks, are the main reasons for the lack of use of forward contracts and other financial derivatives in serbia. other reasons include the neglecting of exchange rate volatility, as well as ignoring risks and expecting from the government and the central bank to stabilise the exchange rate. namely, the government and central bank are responsible for ensuring a macroeconomic environment that will create stable conditions for doing business and, therefore, they are responsible for systemic risk factors, including currency risk. mina kobilarev, branko živanović 47 nonetheless, according to the current monetary policy, the main objective of the national bank of serbia is price stability (low and predictable inflation), and not exchange rate targeting. thus, it unjustified for local companies to rely on the central bank and the state, in regard to foreign exchange rate and risk elimination. besides, the poorly developed entrepreneurial spirit and no understanding of business risks, including improper education, are only some of the reasons why local companies do not use forwards. in addition, there is no disputing that many entrepreneurs already hedge – not by sophisticated instruments, but only by building their selling prices at the exchange rate. a probable reason is also reflected in the impossibility to agree forward contracts with long maturities which would serve as hedging of long-term liabilities denominated in foreign currency in a company’s balance sheet liabilities. in conclusion, the paper presents many upsides of financial derivatives as modern financial instruments. but, given the potential risks of financial derivatives because of undefined legal norms and at the time of the world economic crisis, they offer scope for abuse. future research will analyse the use of other financial derivatives in the serbian market. marinković and skakavac (2010) analysed the evolution of derivatives trading in the serbian financial market and its prospects. the first part of their paper includes some of their analytical observations of the current situation in the domestic economy, as well as the questionnairebased survey, conducted in the banking industry. they concluded that most banks try to answer to the increasing need for derivatives. banks with the highest market shares recently began to offer less sophisticated risk management products to clients. those were, at the first place, currency forward agreements. as the matter of fact, the core of the banking industry aimed to respond to the increasing need for derivatives. some banks already offered risk management products, primarily currency forwards and swaps. besides, there is a forecast of future trends, prepared based on observed facts. the authors identified the factors constraining the development of derivatives markets. namely, banks considered market leaders did not show a clear interest. the competition from other financial institutions which break the monopoly of customary intermediaries (banks) is rather fruitless. the domestic financial industry is underpinned by financial conglomerates which leave little space for independent financial service providers. although some banks offer currency-risk related products, this takes place only on an ad hoc basis, and there are no efforts to make twosided continuous trade at a fair price, without discriminatory terms and conditions. those seriously affected by currency and interest rate risk (households and corporates) are not knowledgeable about the derivatives business. the third main stakeholder is the local financial exchange. there is no initiative in the financial exchange field to diversify business by offering a new range of products, which can be partly put down to the bad timing. cash trading also loses its momentum. therefore, it will probably take a lot of time for the first derivatives to be traded on the exchange. the paper by kozarević, kesetović, kokorović and čivić (2012) analyses the derivatives use in financial risk management by companies in bosnia and herzegovina (bih) on two samples: banks and companies. in general and based on information provided by banks, financial derivative users and export/import companies, the authors concluded that the main reasons for the weak use of derivative instruments are the lack of information about procedures of the derivatives usage and the lack of knowledge about possible benefits of these instruments when it comes to risk management. this is true not only for company employees, but for bank employees as well. moreover, a significant restriction to a greater derivatives usage is the small number of business operations implemented by bih companies in the foreign market, and no major trends on the bih currency market given the central bank’s currency board (i.e. fixed exchange rate of the bosnian convertible mark against the euro and, in turn, a low degree of currency risk that companies face, excluding bam/usd). risk factors against which bih 48 economic analysis (2019, vol. 52, no. 2, 43-63) companies hedge by means of financial derivatives are revenue and cash flow volatility, and the safeguarding of balance sheet positions. the reasons why bih companies do not use derivatives in order to hedge relate to the company size (in terms of annual turnover), and the intention to restrict cash flow or revenue volatility or to safeguard financial ratios. bih companies decide against derivatives is the lack of knowledge and higher costs of derivatives portfolio maintenance; costs associated with financial risks are not a likely reason. however, the derivative products offer in bih is substantial, and bih companies plan to introduce additional products such as interest rate swaps. besides, a lot of companies decide to use current and new financial derivatives instruments in their future business. however, if they wish to improve their financial risk management practices, given higher costs (arising mainly from banks’ provisions and targeted profit rates) and irrespective of their positive experience, bih companies should apply exchange-traded derivatives of developed countries rather than derivatives on the local otc market. conversely, f. sajjad, u. noreen and zaman k. (2013) analysed risk concerning the financial services sector (fss) and the adequacy of risk management derivatives in pakistan. with the aim of developing the derivatives market in pakistan, the financial derivatives business regulations (fdbr) have been designed in the implementation of power by the state bank of pakistan pursuant to the banking companies ordinance 1962 and foreign exchange regulations act 1947, to allow, regulate and supervise financial institutions that conclude derivative transactions. relying on literature and sbp/fdbr publications, the study arrives at the conclusion that derivatives products are appropriate for managing fss risk exposures. the development of the pakistani derivatives market is needed to improve liquidity and employ the necessary capital for economic growth. f. sajjad, u. noreen and zaman k. (2013) gave the following recommendations to encourage vibrant growth of the derivatives market in pakistan: • there are several causes of concern concerning exchange-traded equity derivatives in pakistan. namely, there are major gaps in the scope of actively traded derivative products. when it comes to equity derivatives, merely a single stock of deliverable futures is transacted, making up close to 100% of the overall volume of derivatives traded on the stock exchange. depleted market liquidity may be ascribed to poor derivatives trading. the key challenge to sbp is to facilitate proper trading and prudent supervision of derivatives transactions. therefore, sbp should regulate and conduct monitoring of participants in the pakistani derivatives market so that market guidelines are complied with. • it is advisable that the exchange should initiate new programmes for the education of dealers, traders, brokers and market staff. competent institutions must dedicate more resources to enhance operational processes and improve the derivatives-trading technology. • reforms aimed at market development will step up the growth of these markets. public institutions such as the old age benefit fund and national investment trust should be supported to take part in the operational derivatives market. this will, in turn, enhance liquidity volumes. metodology data about serbian commercial banks were collected from two main sources: the survey and interview. we relied on questionnaire data more than on the interview given that the survey data were supported by interviews results. mina kobilarev, branko živanović 49 questionnaire in order to assess the overall level of derivative instruments demand in serbia and types of derivatives offered by the banking sector, kobilarev (2014) conducted a research amongst commercial banks operating in serbia in early june 2013. for this purpose, a particular questionnaire was designed and delivered to all banks in serbia that offer hedging instruments. the sample included 17 commercial banks, according to the data from the national bank of serbia (nbs). the methodological framework of the questionnaire was primarily based on elaborative and simultaneous development of research questions, theory and analysis, which aim to explore the types of derivatives offered in the serbian banking sector in order to hedge fx, ir and pr exposures. another aim was to assess the level of usage by serbian companies as the banking counterparty, and to provide proposals and outline the limitations for the development of the derivatives markets in serbia. the questionnaire was structured into six major parts. research questions were addressed to explore: 1. the first section aims to evaluate the source of information that the banking sector uses in regard to the financial derivatives use. 2. the second section aims to assess the overall level of the financial derivatives demand in serbia, to explore the types of derivatives offered by the banking sector, and to assess their importance. 3. the third section analyses banking activities taken to attract derivative business. it also analyses whether banks intend to establish a special department for financial derivatives management in the near future, to introduce or have already introduced new derivatives lines. 4. the fourth section steams from the third section but with more emphasis on bank staff in the financial derivatives field, usually in the treasury department – the intention is to understand how many staff were employed in the department in charge of derivatives trading, including their professional skills and expertise, qualifications gained, adequate training and certificates obtained. 5. the fourth section explores the reasons that most severely constrain the development of the domestic derivatives market and possibilities and limitations of introducing the derivatives market as an organised segment on the belgrade stock exchange. 6. the last section aims to collect the company profile details, the field of industry, when the company was founded, the number of employees, respondents’ personal data, including their gender, age group, years of professional experience, profession, academic and professional qualifications, position and the department where they work. judging by the data collected from official websites of the nbs and association of serbian banks and questionnaire, out of 31 commercial banks, 17 of them offer derivatives products. the remaining 14 banks do not offer derivative instruments. thus, these 14 banks were not included in further research. out of 17 banks with derivative instruments, 11 banks returned the questionnaire, which was 65 per cent of all responses. additionally, a part of the questionnaire concerned those banks that do not offer derivatives instruments at all so as to determine if they tend to introduce them in a near future. three banks returned the questionnaire, which resulted in the total response rate of 82 per cent – this is considered an adequate response rate compared to other studies (e.g. the response rate in the 2012 bih survey called “the usage of derivatives in financial risk management by companies in bosnia and herzegovina, from the banks perspective”, as reported in kozarević et al. (2012) was 80 per cent). the questionnaire consisted of 28 questions. out of 11 respondent banks that offer derivative products, only one is state-owned, while ten are foreign-owned. therefore, it may be concluded that foreign-owned banks will probably offer derivatives products. 50 economic analysis (2019, vol. 52, no. 2, 43-63) a similar response rate was observed in the neighbouring country. according to kozarević, kesetović, kokorović and čivić (2012), in bih out of 29 commercial banks, ten of them offer derivatives. the remaining 19 do not offer derivative instruments. therefore, these 19 banks were not taken out from further research. out of ten banks offering derivative instruments, eight banks returned the questionnaire, which was 80 per cent of all responses. the primary data in the serbian banking sector were collected through the questionnaire – a semi-structured questionnaire was delivered to the bank’s deputy executive director or if there is no such position, to the deputy head or head of sales of the banks’ treasury departments. it was implicitly assumed that these persons would most probably have the relevant information. the methodological framework of the questionnaire implied primarily the elaborative and concurrent development of research questions, theory and analysis, with a view to analysing the types of derivatives offered in the serbian banking sector for the purpose of hedging fx, ir and pr exposures. another objective was to assess the degree of usage by serbian companies as the banking counterparty, and to give proposals and define the constraints for the development of the derivatives markets in serbia. in order to evaluate the degree of derivative instruments demand in serbia and types of derivatives offered by the banking sector we used a descriptive statistical analysis excel. the main limitation of the present study lies in the fact that only one research has been carried out in the region. it concerns bosnia and herzegovina, which is why we compared our results with this country only. in this context, the present article contains the first empirical evidence of the derivatives offer in the serbian banking sector, which is particularly significant for the corporate sector given that it contains all necessary information concerning this field. the survey also contains considerable evidence enabling international comparison, which is certainly an advantage. the study can also be carried out in other see countries. the findings presented in this article may be used as the starting point for further research of the derivatives use in financial risk management from the perspective of banks. interviews for this concrete research, the semi-structured interview was applied as the suitable method to elicit subjective answers from respondents. therefore, semi-structured interviews were carried out with serbian directors of treasury departments of the banking sector. according to bernard (1998), a semi-structured interview is more suitable as the interviewer oversees the process of obtaining information from the interviewee but is free to explore new ideas as they appear. besides, primary data in the banking sector were gathered not only through the semistructured questionnaire, but also through the semi-structured interview with serbian experts from treasury departments. as soon as the directors or heads of sales from treasury departments filled out the questionnaire, they were invited to an interview. the response rate was high – 82 per cent, the same rate as in the questionnaire; 82 per cent of contacted treasury directors spoke of their willingness to participate. we obtained information from 14 treasury directors and managers from the serbian banking sector. the main aim of the interview was to supplement and reinforce the qualitative semistructured questionnaire earlier conducted among the banking sector. the interview contains several main questions concerning the areas covered by the research. the interview contains 38 open-ended and probing questions. seven semi-structured interviews were carried out with banks’ treasures. each interview spanned for around 40–60 minutes. the interviews were recorded in order to ensure accurate information for the research and to ensure a careful analysis of respondents’ answers. most respondents agreed to audio recording. we took notes in the case of those interviewees who refused the recording. mina kobilarev, branko živanović 51 the following stage of the study implied the analysis of collected data. each interview question is to ascertain a particular issue not fully explained by the answers in the questionnaire. thus, to examine interview data, the interpretive analysis approach was introduced. data interpretation implies explicating insights, making deductions, giving appropriate relevance, enabling understanding, and arriving at appropriate conclusions. the application of the same principles in other places in different circumstances is reasonable as well (patton, 2002). results and discussions the serbian banking sector has 31 banks (nbs, 2013). foreign-owned banks are dominant in the market – they account for 75 per cent of total assets, 74 per cent of total capital and 72 per cent of total banking sector employment and record a profit of around rsd 17 bn (nbs, 2012). foreign-owned banks operating in serbia are members of banking groups from 11 countries. when it comes to their share in total banking sector assets, the most important are italian banks (23 per cent), followed by austrian (15 per cent), greek (15 per cent) and french (10 per cent) banks. banks from other countries accounted for a 12 per cent share in total banking sector assets (nbs, 2012).1 based on banks’ answers, kobilarev (2014) concluded that, besides a poor supply of derivatives in the banking sector (54.8 per cent), the otc derivatives market in serbia is relatively “young” and it has been operation for the last six years only. there is no formally organised derivatives market as a derivatives exchange. respondent 1 noted the following: “we are still a bank-based financial market, we have no alternative financial market, banks are the main markets for capital movements. banks in serbia are traditionally dominant financial mediators, so it is understandable to say that the serbian financial sector is bank-based. this is confirmed even by the data that banks indirectly manage more than 90 per cent of financial sector’s assets. except this, banks are majority owners of non-bank financial institutions. banks are certainly major players on such a financially focused market from the demand and supply sides. the importance of banks for the serbian financial markets is confirmed by the fact that the two biggest markets – foreign exchange market and money market – are organised as standard interbank markets. on the capital market, banks are also leading investors, as the largest government bonds buyers.” respondent 2 said the following: “the capital market does not exist. serbia’s capital market is banks. the capital market is when you, as a firm, think about how to obtain money, to finance something. you have the option to issue shares, bonds, to take a loan. and then you weigh up the pros and cons. in serbia, all that is more expensive by 3-4 per cent, and you take a loan. cash flow is clear for a bond. you pay a coupon, or you do not have a coupon and you pay the bill of exchange. in case of a share, you pay nothing apart from the dividend. there is a return to the investor of the share the price of your share perhaps goes up, and he sells it at a higher price than he bought your share, or through the dividend payment he periodically recovers a part of his money. only nis in serbia and a few other companies pay out dividends; rising shares are a dream and it doesn’t happen, those are mostly some speculators. based on banks’ answers, kozarević et al. (2012) came to the conclusion that, besides a weak supply of derivatives in the banking sector (34.48 per cent), the otc derivatives market in bih is still nascent given that it has operated for merely six years already. there is official derivatives market as a derivative exchange, which is also the case with the serbian banking sector. still, despite the weak derivatives supply in both countries, it is possible to conclude that the supply of derivatives in the serbian banking sector is by 20.32 per cent (total 54.8 per cent) higher than in the bih banking sector, even though both derivatives markets are still young and nascent. 1 banking sector in serbia – first quarter report 2013. 52 economic analysis (2019, vol. 52, no. 2, 43-63) sources of information of derivative usage in banking sector we first analysed the source of information that the banking sector relies on in terms of the financial derivatives usage. the survey shows that 64 per cent of respondents have a very positive attitude and that 36 per cent of respondents have a positive attitude towards derivative instruments. graph 1. attitude towards derivative instruments source: author’s data in addition, 82 per cent of respondents are fully informed about the role and characteristics of derivatives instruments, while only 18 per cent are merely informed. no respondent stated that he/she is not informed or merely uniformed or gave no answer. in general, it is possible to conclude that most bankers from treasury departments have a very positive attitude in regard to derivatives and the majority are fully informed about their usage. judging by to survey results, the dominant source of information about financial derivatives is literature with 100 per cent, followed by seminars and courses with 73 per cent and the internet with 64 per cent. bankers infrequently attend conferences for the purpose of informing themselves about derivatives (36 per cent) and are not used to being informed through regulatory authorities such as the nbs and sec (36 per cent). besides these sources of information, one bank stated its head office as the source of information about derivatives. as a part of a large international network, this bank puts significant effort in educating and training its employees in serbia in the field of derivatives trading. graph 2. source of information about financial derivative instruments source: author’s data mina kobilarev, branko živanović 53 in the interviews, kobilarev (2014) ascertained the main reason why subsidiaries often do not inform themselves through their parent banks. “our head office provides us with all the necessary information about the use of financial derivatives since it is in their interest that we sell more financial derivatives. but i do not think that all head offices are doing so. nor are they always ideally organised, and do not have time to deal with the education of their daughter banks. but generally it is a good backup”, said respondent 3. the response of this particular interviewee mirrors the general feeling stated by most interviewed banks. it can therefore be said that the link between the parent bank and its branches in terms of information is good, but banks generally try not to burden their parent banks and therefore rely more on information available, mainly literature and the internet. they also educate themselves by attending seminars, courses and trainings about the use of derivatives. in case of dilemmas, they often contact their parent banks. the second section of the questionnaire analyses the overall level of the financial derivatives demand in serbia, examines the types of derivatives offered by the banking sector, and ascertains their importance. the research showed that the offer of derivative instruments in serbia is insufficient. commercial banks usually offer only five types of derivatives, which are used predominantly for foreign exchange risk, interest-rate risk and price risk hedging: the most frequent are currency forwards with 100 per cent, followed by currency swaps with 73 per cent, and interest rate swaps. on the other hand, currency options (18.2 per cent), otc commodity options (18.2 per cent) and otc interest rate options (9.1 per cent) are the least present in the banks’ offer. the structure of derivatives offered in the otc market in serbia is presented in graph 3. six banks in serbia (54.5 per cent) offer financial instruments for hedging against currency risk only (see figure 5.4). all of them offer currency forwards (100 per cent) and only three of them currency swaps (27.3 per cent). merely three out of 11 banks covered by the survey (27.7 per cent) offer derivative instruments for hedging both against currency and interest rate risk. they offer currency forwards, currency swaps and interest rate swaps (27.3 per cent for each). graph 2. source of information about financial derivative instruments source: author’s data the two biggest surveyed banks offer a broader range of financial derivatives. they offered financial instruments for hedging against all three types of financial risks: currency, interest and price risk (see table 1). conversely, banks in bih have in their offer only three types of derivatives, generally used for foreign exchange risk and credit risk hedging: currency forwards, currency swaps, and interest rate swaps. according to the research, all three types of derivatives are contained in the offer of 54 economic analysis (2019, vol. 52, no. 2, 43-63) 12.5% of the surveyed banks, currency forward and currency swaps are in the offer of 50% of the banks, and 37.5% of the banks have only currency forwards (kozarević et al. (2012)). table 1. overview of derivatives by the type of financial risks in the otc market in serbia types of derivative number and % of banks offering only fx derivatives 6 (54.5%) number and % of banks offering fx and ir risk derivatives 3 (27.3%) number and % of banks offering fx, ir and commodities derivatives 2 (18.2%) currency forward (%) 6 (54.55%) 3 (27.3%) 2 (18.2%) currency swap (%) 3 (27.3%) 3 (27.3%) 2 (18.2%) interest rate swap (%) 3 (27.3%) 2 (18.2%) otc interest rate option (%) 1 (9.1%) otc commodity option (%) 2 (18.2%) otc currency option (0%) 2 (18.2%) source: author’s data according to the interviews conducted in the serbian banking sector, derivative instruments, notably commodities and interest derivatives, are transacted with clients through parent banks. the primarily reason why transactions do not take place in the domestic market is insufficient knowledge among banking professionals about these products. fx derivatives, namely fx forwards and fx swaps are still the most prevalently traded derivatives in serbia, while ir and price risk derivatives are underdeveloped. as suggested by the questionnaire results, banks which offer financial instruments to hedge against price risk do not publish such information on their websites. respondent 4 said the following: “the demand for derivatives is very small, which is why we do need to inform our clients of them on our website. commodities derivatives are highly costly and the corporate sector’s demand for them is extremely low. all treasury directors interviewed concurred that “there are around 40–50 companies in our market at most which use financial derivatives for hedging, usually against currency risk: 99 per cent are currency forwards, of which 80 per cent are covered or quasi forwards. in terms of interest rate hedging, mere two interest rate swaps are traded in serbia, according to their knowledge. there is no knowledge about interest and price risk, while the knowledge of fx risk is low. there are no options because they are expensive. in general, we can offer all instruments envisaged by law, but no one will use them except for the said three types of instruments. options are costly. of course, a bank must have a small margin and when it gives an option to a client, it is much costlier than a forward agreement, which is the reason these options are not used. a bank can calculate an option, this poses no problem, but it will also deliver a price, which will be rather high. companies are not inclined to paying anything in advance. banks offer options at expensive terms, which is why companies use them infrequently.” the demand for derivative instruments in serbian and bih banks is also very weak. in the questionnaire serbian banks graded the demand for financial derivatives on the one to five scale (from very low to highest intensity). it transpired that 36.4 per cent of the respondent banks assessed demand for financial derivatives with very low intensity of one, while 45.45 per cent of banks scored demand with the low intensity grade of two. only 18.2 per cent (two surveyed banks) graded the derivatives demand with a medium intensity grade of three (see graph 4). mina kobilarev, branko živanović 55 when it comes to the demand of bank corporate clients for financial derivatives, it can be noted that it did not increase compared to last year in the case of 72.72 per cent of surveyed banks. only in three banks (27.3 per cent of the surveyed banks), the demand for financial instruments went up compared to 2012. graph 4. assessment of derivatives demand in the banking sector source: author’s data in addition, information obtained in interviews with deputy heads of sales in treasury divisions showed that the major reasons for the weak usage of derivative instruments are the absence of information about the procedure of the derivatives use and no knowledge about potential benefits of these instruments in the field of risk management. information given by derivatives users (via informal communication) in the bih banking sector showed that the main reasons for weak usage of these instruments are the same as those in serbian banks. besides, the key limiting factor of a stronger derivatives use both in serbia and bih can be put down to the small number of business operations of the companies on the foreign market. judging by the interviews in serbian banking sector, it can be concluded that the main derivatives users are companies producing and distributing oil and oil derivatives, including wholesale and retail companies, gas trading and supplying companies, construction companies, communication and it companies. rather similar results are found in bih where the main users of derivatives, in addition to the above mentioned, are also furniture production and trade companies (especially trade companies importing from china), including gas trading and supplying companies. serbian banks were asked questions about the practical use of derivatives by the corporate sector, with a view to exploring the practical usage of derivatives in the banking sector. asked if they ever concluded forward contracts with the corporate sector, 100 per cent of banks gave a positive answer. in terms of the contracts category, 100 per cent of banks stated that they use forwards, while 36.36 per cent of them concluded swap contracts. the underlining asset for derivative contracts is currency with 100 per cent, and interest sensitive assets with merely 18.18 per cent. all institutional agreements are concluded in the otc market. according to the survey results of kozarevic and al. (2012), the clients of bih banks show the strongest interest in currency forwards, with the average grade of 2.33, currency swaps (2.20) and finally interest rate swaps (2.00)2. currency risk derivatives the questionnaire also examines the banking sector’s offer of derivative instruments as a currency risk management tool (see table 2). 2 the surveyed banks were asked to assess demand for derivative instruments through the grading system, where 1 meant “there is no demand”, 2 “low demand”, 3 “moderate demand”, 4 “high demand”, and 5 “very high demand”. 56 economic analysis (2019, vol. 52, no. 2, 43-63) table 2. banks’ offer of financial derivatives as a currency risk management tool instrument percent of banks that offer the instrument importance 1-3 (1 less important, 2 important, 3 very important) 1= less important 2= important 3= very important 1. currency forward 100 9 2 2. covered or “quasi” forward 91 1 7 2 3. currency futures 0 4. currency swap 72.73 3 3 2 5. stock-exchange currency option 0 6. otc (over-the-counter) currency option 18.18 2 7. structured derivatives (e.g. currency swaption) 0 source: author’s data the table shows that currency forwards are the most dominant and are offered by all surveyed banks. nine out of 11 surveyed banks consider them an important currency risk management tool, while two of them give them the highest score (of three), i.e. consider them very important. currency swaps with 72.73 per cent are the second most common currency hedging instrument. in contrast to currency forwards with high importance, only two banks assessed currency swaps as very important, three banks as important and three as less important. in line with the interview, otc currency options are the least commonplace in the offer and were graded as less important by two out of 11 surveyed banks. as the matter of fact, options are still rather costly financial instruments for the corporate sector. banks were also asked to state the total number and the type of currency forward contracts that they entered into with their corporate clients for hedging purposes, in 2011 and 2012, and the average value of contracts in the national currency. six banks considered this question a business secret, which is why we did not obtain these data. for the reasons already mentioned, the following data were prepared on the sample of five banks. data about three banks are contained in table below, while two other banks will be examined further in the text. the data in table 3 show that three banks concluded only 115 currency forward contracts in 2011 with an average value of eur 310,000 and 106 currency forward contracts in 2012 with an average value of eur 316,666. the most commonly used were the so-called “quasi” forwards. there were 801 of them in 2011, with the average value of eur 550,000. table 3. total number of fx derivatives contracted with the serbian companies 2012 total number of contracts 2012 average value of contracts in din or eur 2011 total number of contracts 2011 average value of contract din or eur currency forward 106 eur 316,666 115 eur 310,000 covered or “quasi” forward 880 eur 550,000 810 eur 550,000 currency swap 40 eur 750,000 30 eur 750,000 currency option 3 eur 225,000 5 eur 225,000 source: author’s data since the start of their derivatives trading in 2009, two banks entered in only six currency forwards with the average value of eur 790,000, and only had a forward agreement with the average value of eur 120,000. according to research results, the derivatives market in serbia is mina kobilarev, branko živanović 57 in its early stages of development, which indicates a low derivatives market potential in serbia. furthermore, živanović et al. (2018) concluded that 65.9 per cent of slovenian companies covered by the sample employ financial derivatives, vs. 43 per cent in croatia, and in serbia only 40.32 per cent of companies use financial derivatives, implying that the serbian corporate sector has the lowest percentage of derivatives usage in the region. kozarević et al. (2012) assessed the demand for derivatives in bih as extremely low. according to data, one bank which is the largest supplier of derivatives, closed merely 10 contracts for derivatives with an average value of bam 750,000.00 (cc. eur 383,600.00) since august 2008. all other banks together concluded only four contracts for derivatives. a suggested by research results, the derivatives market in bih is in the early stage of development, which indicates a low derivatives market potential in bih. the research results suggest that serbian banks concluded 106 currency forwards in only one year (2012) with an average value of 316,666 eur, which implies 98 more closed currency forwards than the bih sector has ever contracted. for the sake of comparison, the serbian banking sector concluded more types of derivative contracts than the bih banking sector. it is possible to conclude that the serbian derivatives market has a higher potential than the bih derivatives market though both markets are still in development phases. the situation is similar in montenegro, although the montenegrin economy is to an extent better developed. the main reason for the low visibility of forwards in the local financial market is the absence of currency risk exposure, as the legal tender of montenegro is the euro, in all transactions since march 2002. (živanovic et al., 2012). interest rate derivatives foreign exchange derivatives are the most frequently traded of all risk categories in serbia, whereas interest rate derivatives remain underdeveloped according to the survey results. when the question was asked about the types of interest rate derivatives on offer and their importance (1 = less important; 2 = important; 3 = very important), five surveyed banks (45.45 per cent) said that they offer interest rate swaps, while only two banks offer otc interest-rate options (see table 4.). in terms of interest rate swaps, three out of five surveyed banks assessed them as a less important interest-rate risk management tool, giving them the lowest score of 1, while two banks consider them an important ir tool (the score of 2). the overall activity in interest rate derivatives in serbia, however, remains extremely low. otc interest rate options were assessed by two banks as less important, with the score of 1. on the sample of five surveyed banks, the questionnaire results suggest that since ir derivatives were introduced to the serbian market only four contracts have been entered into with the average notional amount of eur 10 million, while otc interest rate options are not traded. table 4. banks’ offer of interest rate hedging products instrument percent of banks that offer the instrument importance 1-3 (1 less important, 2 important, 3 very important) 1= less important 2= important 3= very important 1. interest rate forward 0 2. interest rate futures 0 3. interest rate swap 45.45 3 2 0 4. stock-exchange interest rate option 0 5. otc (over-the-counter) interest rate option 18.18 2 0 0 6. structured derivatives (e.g. cap, floor, collar, corridor or swaption) 0 source: author’s data 58 economic analysis (2019, vol. 52, no. 2, 43-63) with the aim of assessing, on the one hand, the opinion of serbian deputy heads of treasury divisions about this matter, as well as to increase the reliability of the results obtained from the questionnaire, the following question was asked at the interviews: what are the instruments that the banking sector offers to corporate clients to hedge them against interest rate risk and what is the perspective of the further development of ir derivatives. a general opinion of heads of treasury divisions can be summed up in the following answer given by respondent 5: “i can assure you that among interest derivatives, only the interest rate swap is used in serbia. interest rate swaps are at a disposal, but i believe that the advantage of an interest rate swap is that at the beginning there is no payment, i.e. no exchange of cash, while in case of interest options the premium must be paid in the start. it is the same as an insurance policy. this doesn’t exist with swaps. interest swaps will be popular now because euribor is expected to rise. this will certainly happen as interest rates have hit the bottom. you already see the information that the european economy is recovering and exiting from recession. as the economy is recovering, there is fear of inflation, key interest rates are rising, everyone is raising interest rates, euribor is soaring. i therefore believe that companies will start to use more interest rate swaps in hedging their risks. interest rate options imply advance premium payment. very few clients are ready to give you cash in advance. commodity options would be more popular. i believe they are more liquid, especially oil and wheat; commodity derivatives will be generally more popular here than interest rate ones.” as confirmed by survey results, interest rate derivatives are not used by the corporate sector to a significant extent in the serbian otc market. in terms of ir derivatives, only ir swaps are traded, but have a very low importance. nevertheless, it is expected that the interest in ir derivatives, i.e. swaps, will go up in the future given the high variability of interest rates (e.g. euribor) and in parallel with the increase in economic activity of the serbian corporate sector, primarily growth in exports and imports, and the development of the domestic financial market. commodity derivatives when it comes to price risk management solutions, banks’ offer of commodity derivatives is very poor according to the survey results. merely two out of 11 surveyed banks offer otc commodity options (18.18 per cent), rating them with the score of 1 as less important (1 = less important; 2 = important; 3 = very important). judging by information obtained from the interviews, all bankers believe that commodity derivatives in serbia are still in their infancy. respondent 6 noted: “regulations were recently amended. the nbs allowed what was recently forbidden by the decision on performance of financial derivative transactions – the contracting between a domestic legal person and a foreign bank of a commodity non-deliverable derivative (ndf). a domestic company can now conclude with a foreign bank a derivative which is not executed in goods, but in the difference, and now they are launching first commodity derivatives, then they will analyse the situation and will see what are possible impacts on the financial systems, they will be letting interest rates go up etc. by changing the provision, it is possible to deliver nondeliverable derivatives between residents and non-residents. we expect higher interest in this instrument in the future, but it should be emphasised that the lack of corporate culture of serbian enterprises is what generally impedes the development of derivative instruments in general.” in view of the above research results (see table 2; 3; 4), it is possible to accept our research hypothesis that types of derivative offer by banking sector are sufficient relative to the derivative usage by non-financial companies in serbia. mina kobilarev, branko živanović 59 prospects for the further development of derivatives usage when asked about the activities they undertake to attract derivative business, all 11 banks stated that they are working all the time to improve staff education in derivatives trading, while six surveyed banks carry out strategic planning activities so as to attract their corporate clients. a downside is reflected in the fact that all surveyed banks do not have the intention to establish separate departments for financial derivatives management in the near future. at the time of data collection, no bank surveyed was planning to set up departments for derivatives trading in the near future, which is understandable given the lack of substantial demand for derivatives. this will, ceteris paribus, hinder further development of financial and derivatives markets in serbia. the same research results were observed in the bih banking sector, as suggested by kozarevic et al. (2012), with a positive fact that the surveyed banks pay considerable attention to basic financial instruments that are available and have therefore organized separate departments (such as trading and asset departments), with staff trained for this type of transactions. a positive aspect relating to operations in the otc derivatives market is that 54.5 per cent of the surveyed banks engage employees with appropriate knowledge and international certificates for financial instruments trading (e.g. aci dealing certificate, cfa), while other banks engage staff with relevant brokerage certificates (27.27 per cent) and investment advisor certificates (9.1 per cent) issued by the republic of serbia securities commission. as indicated by the survey, there are on average three employees in charge of financial derivatives. when interviewed about the type of necessary education, most respondents referred to the aci dealing certificate exam, as well as basic education and training in all fields of business operations with derivatives. education is indispensable not only for staff employed in the front desk, but also for those engaged in other departments and dealing with derivative transactions, such as the financial department, trading department, credit department, etc. a downside of operations on the bih otc derivatives market is that merely 25% of the surveyed banks engaged specialized persons with now-how and international certificates for financial instruments trading (e.g. aci dealing certificate), while other banks meet legal requirements and take on staff with adequate brokerage certificates and investment advisors certificates issued by the securities commissions in the federation bih and republic of srpska. when surveyed the type of education needed in the serbian banking sector, the majority of the surveyed subjects referred to the aci dealing certificate exam, and the need for basic education and trainings in all aspects of derivatives operations. education is indispensable not only for those engaged in a front desk, but also for those working in other departments and dealing with derivative transactions, such as financial department, trading department, credit department, etc. it is noteworthy that all banks, both in serbia and bih, express the need for further education of their staff in the area of derivatives trading as the tool for managing (i.e. hedging) risks. this made us conclude that the main reason for the weak level of derivatives supply and demand is the lack of information and education of banking staff in derivatives contracting, as well as banks’ caution in terms of legal risk. nine banks or 81.82 per cent of banks in the serbian banking sector did not introduce any new derivative product recently, with only two banks introducing them. when it comes to widening the derivatives offer, 54.5 per cent (six) of the surveyed banks intend to offer new derivative instruments, 27.27 per cent (three) do not have such plan, while 18.18 per cent (two) did not give a clear answer to this question. as for the broadening of types of derivative products, 75% of the banks surveyed in bih intend to offer new derivative instruments, 12.5% do not have such plans, while 12.5% did not provide a clear answer to this question. the banks that gave a positive answer to the question concerning the broadening of their derivative offer, they intend to offer non-deliverable forward, currency swap, interest rate swap 60 economic analysis (2019, vol. 52, no. 2, 43-63) and otc commodity options. a thorough structure of the derivative offer development in serbia is presented in graph 5.5. in bih, the banks that gave a positive answer to the questions concerning the broadening of their derivatives offer, stated they will offer interest rate swaps, currency swaps, and credit options. in regard to the need to set up a regulated derivatives market, the situation with the surveyed banks is as follows: 36 per cent state that establishing the derivatives market will contribute to the development of the financial market in serbia in general, while 64 per cent think that there is no need for that yet. those stating there is no need for an organised derivatives market believe that bilateral cooperation among banks would suffice. as stated by respondent 7: “financial markets demand volume and market participants. in our country, bilateral cooperation between banks would be sufficient. first you need to regulate the interbank (otc) market properly because it has many disadvantages and should be regulated in the first place. in our banking system, there is still no spot market or forward rate quotations. our financial market is still in infancy, while the corresponding volume and demand for financial derivatives are at a very low level. where there is no market environment there cannot be a real financial market. where there are no basic financial instruments, derivatives cannot be contracted and traded. the prerequisite for this is the existence of an adequate market depth.” when it comes to the need to organise a derivatives market as a segment within the sarajevo stock exchange (sase) or banja luka stock exchange (blse), the situation among the surveyed banks is the following: 50% of them believe the establishing of the derivatives market will incite the development of the financial market in bih in general, while 50 per cent believe there is still no such need. graph 5. the (intended) structure of derivative offer development in serbia source: author’s data when surveyed about the reasons that most seriously constrain the development of the domestic derivatives market, all 11 surveyed banks (100 per cent) stated that this is due to the uninformed client base and valid legislation regulating derivatives. in addition, the absence of interest in banks (36.36 per cent) and no experienced staff in banks (18.18 per cent) are less important reasons. as banks were also provided the possibility to state another reason which we may not have specified in the question, 80 per cent of them said the main reason hindering the development of the domestic derivatives market is our shallow financial market. we also asked banks to provide the most important reasons/limitations for the derivatives use by the corporate sector (companies). as suggested by the survey, the most significant conditions and/or obstacles to derivatives purchases by companies the following: • the absence of corporate culture in the corporate non-financial sector, as highlighted by all eleven surveyed banks (clients are still not informed of how hedging instruments can improve the security of their financial operation) mina kobilarev, branko živanović 61 • costly derivative instruments and still insufficiently elaborate legal regulations regulating derivatives in serbia • need to have deposits on a special bank account to cover forward transactions • high level of required collateral (depending on clients’ creditworthiness) and • substantial need to purchase different currencies. kobilarev (2014) asked the same question in the interview, aiming to obtain a more elaborate explanation of the expression “the lack of corporate culture”, stated by serbian bankers as the primarily reason hindering the use of derivatives by the corporate sector. respondent 8 stated that “one of the obstacles to the use of hedging instruments is the lack of corporate culture because of the unwillingness of entrepreneurs, especially smes, to inform, educate and engage in new transactions. the trend of using hedging in the future will depend on the willingness and desire of banks to refer clients to these possibilities and to assist them in understanding the rules of the financial derivatives usage.” we learned the following from the interview: “in the corporate sector there are generally financial directors who do not want to hedge against financial risks; if the dinar strengthens, the director is a bigwig, if the dinar weakens he will ascribe it to force majeure, no one will tell him that he is a bad financial director. this is the main reason – poor corporate governance. unfortunately, this is the hardest factor for investigation, but this will not be settled until the economy is transformed, before the governance structure in enterprises is established under a western model. not all is the best in the west, this financial crisis showed that everything was not in order”, claimed respondent 8. it is therefore possible to accept our research hypothesis according to which knowledge and focus on derivatives impact their use. according to research results of kozarević et al (2012) in bih, as evident from the information provided by derivatives users (via informal communication), the principal reasons for the low usage of derivative instruments are the lack of information about the derivatives use procedure and the absence of knowledge about possible benefits of these instruments for risk management purposes. besides, the main factor constraining a more substantial derivatives usage can be put down to a relatively low number of business operations of bih companies on the international market. the most important conditions and/or constraints for derivatives purchases by bih companies are as follows: • need to have a deposit on a special bank account to cover forward transactions (usually 10% of transaction value), • value of turnover of the client with the bank, • substantial need to buy different currencies, and • degree of collateral (depending on clients’ credit worthiness). conclusion based on the research carried out in the serbian banking sector, currently 17 out of 33 banks in serbia offer different hedging instruments. banks are considered the only counterparty to companies in the derivatives otc market given that serbia’s financial system is bank-based. as suggested by research results in the banking sector, in addition to a weak supply of derivatives in the banking sector (54.8 per cent), serbia’s otc derivatives market is nascent given that it has existed over the past seven years only (m. kobilarev, 2014). in terms the types of derivatives used, serbian companies generally employ otc derivatives, which are more expensive compared to exchange-traded derivatives, since there is no regional market for exchange-traded derivatives. as suggested by survey results, foreign exchange derivatives are the most traded of 62 economic analysis (2019, vol. 52, no. 2, 43-63) all risk categories in serbia, whereas interest and commodity rate derivatives are still underdeveloped. the research showed that currency forwards are the most commonplace and are contained in the offer of all surveyed banks, with currency swaps being the second most dominant currency hedging instrument. the research results confirm that interest rate derivatives are not employed by the corporate sector to a high degree in the serbian otc market. in terms of ir derivatives, only trading in ir swaps takes place, but their importance is very low. as stated by all the banks, the reasons that most seriously hinder the development of the serbian derivatives market are the lack of information in the corporate sector and the absence of appropriate legislation governing derivatives transactions. as banks could also state other reasons, most of them referred to serbia’s shallow financial market. as indicated by the survey, the most important restrictions for the derivatives purchase by companies are the lack of corporate culture in the company sector and costly derivative instruments, including the still insufficient regulations regulating derivatives operation in serbia. taking into account the above, both of our research hypotheses can be accepted. the first hypothesis suggests that types of the derivative offer by the banking sector are sufficient in regard to the derivatives usage by non-financial companies in serbia. furthermore, we concluded that knowledge and focus on derivatives influence 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10.28934/ea.21.54.1.pp139-156 scientific review international acquisitions and labor productivity in serbian cement industry slađana savović1* | dušan marković2 1 the university of kragujevac, faculty of economics, department for management and business economics, kragujevac, serbia 2 the university of belgrade, faculty of economics, department for business economics, belgrade, serbia abstract this paper investigates the impact of international acquisitions on the productivity of acquired companies in the cement industry of the republic of serbia. we analyze the productivity of companies in the cement industry during the twenty-year period from 2000 to 2019. acquisitions in the cement industry are one of the first international acquisitions realized in the republic of serbia. the multinational companies that took over the cement plants are from switzerland, france and greece. the paper analyzes the effects of international acquisitions on the productivity of acquired companies in the short and long term. the research results show that the productivity of all acquired companies improved both in the short term and in the long term after the acquisitions, with the largest productivity improvements being achieved in the short term. in addition, the research results show that lafarge serbia recorded the largest improvement in labor productivity, which, compared to other companies, optimized the number of employees and increased production volume. key words: international acquisitions, labor productivity, cement industry jel classification: e24, g34, l61 introduction the processes of liberalization, deregulation and privatization in emerging markets contribute to the development of a market economy, improving the business investment climate and creating conditions for more intense international acquisitions. international acquisitions are the preferred way for multinational companies to enter emerging market economies (lebedev, peng, xie & stevens, 2015). motives for multinational companies to acquire companies in emerging economies include entering new markets, improving the acquired companies’ operations, achieving various synergies, i.e. access to natural resources and an abundance of relatively cheap labor (meyer, 2002; dikova & van witteloostuijn, 2007; uhlenbruck, 2004; khanna & palepu, 2010). the specificity of the institutional environment in emerging market limits multinational companies to achieve synergy effects by simply transferring intangible assets to the acquired company (peng, wang & jiang, 2008), so they need to adapt the competitive strategy to the business environment. the positive effects resulting from multinational companies’ operations increase the interest of emerging markets in the realization * corresponding author, e-mail: ssladjana@kg.ac.rs 140 economic analysis (2021, vol. 54, no. 1, 139-156) of cooperation with them, because the inflow of capital, knowledge and modern technology contributes to economic growth and development (stošić, 2014). although numerous studies analyze the effects of international acquisitions on productivity in developed economies (modén, 1997; gima & gorg, 2002; harris & robinson, 2002; gioia & thomsen, 2004; olford & otchere, 2016), few studies have focused on studying the impact of international acquisitions in emerging markets (lui & qiu, 2013; azdejković & marković, 2016; savović & mimović, 2020). hence, this study seeks to fill the research gap by analyzing the impact of international acquisitions on the acquired companies’ productivity, focusing on international acquisitions made in the cement industry of serbia. we focus our research on cement industry because the industry is asset-heavy and technology intensive, so large multinational companies control lion – share of global market. additionally, cement products are characterized by low value to weight ratio, so export as an internationalization strategy frequently is not profitable. due to that, multinationals from cement industry establish foreign production subsidiaries aiming to serve demand in local markets. tremendous economic development, considerable investment in transportation infrastructure and strong growth of real estate market, motivate multinational companies from developed countries to realize cross-border acquisitions in emerging markets. the acquirers transfer cutting-edge technology and marketing and management knowledge to the targets. the transfers and access to new customers result in improved the targets’ business performance (erić, stošić & dapčević, 2019). three companies make up serbian cement industry and all of them were acquired by multinational companies from developed markets, so the main aim of this paper is to find out how cross-border acquisitions have affected productivity of this strategic important industry. the paper is structured as follows. first, the paper gives a review of literature on the effects of international acquisitions on productivity, thus creating a basis for formulating research hypotheses. second, we describe the research methodology. third, research results and discussion of results are presented. finally, concluding remarks are given, with limitations and directions of future research, as well as the theoretical and practical implications of the paper. review of literature motives of international acquisitions in emerging markets one of the motives for starting the processes of international acquisitions is faster entry into the new market. a firm may find that there is an untapped opportunity on a foreign market, but that it cannot take advantage of it through internal expansion, which is slow, especially given the rapid reaction of competitors (gaughan, 2002). a large number of authors emphasize that international acquisitions allow faster entry into new markets compared to greenfield investment (datta & puia, 1995; shimizu, hitt, vaidyanatah & vincenzo, 2004). exploring the motives of international acquisitions made by british companies in europe and the usa during the 2000-2004 period, ahammad, tarba, glaister, kwan, sarala & montanheiro (2017) point out that the key motive for international acquisitions is the presence on new markets. by changing the way of doing business, changing inefficient management, transferring technology, as well as transferring management and marketing know-how, foreign companies can improve acquired companies’ operations (deng & yang 2015). the motive of international acquisitions in emerging markets is to transfer and further exploit intangible assets from the domestic market (dunning & lundan, 2008), and thus raise efficiency of the existing business model. in the specific context of international acquisitions in emerging markets, there are different ways of achieving synergetic effects. in the short term, it is possible to achieve business synergy effects due to the elimination of duplicate functions, division of business functions, thus achieving economies of scale, and division of production facilities, while slađana savović, dušan marković 141 in the long run it is possible to achieve synergetic effects due to placement of existing products into new sales channels and joint creation of new products and new sales channels (cullinan, le roux & weddigen, 2004). in addition, the possibility of achieving financial synergies appears, when the superior credit rating of the investor can bring the acquired company loans under more favorable conditions (fanlkner & cambell, 2003). in a large number of cases, multinational companies seek to increase business efficiency due to lower labor costs in emerging markets (meyer, 2002; dikova & van witteloostuijn, 2007). analyzing the motives of more than a thousand international acquisitions realized in the period 2000-2013, cogman, jaslowitzer & rapp (2015) show that one third of international acquisitions realized by companies in emerging markets are made in order to access new markets, gain access to natural resources or improve efficiency. acquisitions are in themselves one of the riskiest competitive strategies, often leading to the destruction of value for owners (kpmg, 1999; lodorfs & boateng, 2006). an additional problem for companies realizing takeovers in emerging markets is facing a relatively inefficient institutional environment, a larger number of stakeholders and their greater impact on business than is the case on the markets of developed countries. in order to minimize the risks on this basis, foreign investors must carefully identify stakeholders, their interests and strengths, and try to form a partnership with them (rondinell & black sloan, 2000), while in the long run it is necessary to actively work with stakeholders to improve efficiency of the institutional environment (iankova & katz, 2003). the impact of international acquisitions on productivity there are no consistent findings about the impact of international acquisitions on productivity, as studies have come to different conclusions. while a number of studies reveal a positive impact (modén, 1997; karpaty, 2007; modén, norbäck & persson, 2007; liu & qiu , 2013; olford & otchere, 2016; azdejković & marković, 2016; savović & mimović, 2020), there are studies in which this impact is not fully clear (bandick, 2008; girma & görg, 2002; schiffbauer, siedschalg & ruane, 2017), and a small number of studies find a negative impact of international acquisitions on productivity (ataullah, hang & sahota, 2014; harris & robinson, 2002; gioia & thomsen, 2004). some studies find a positive impact of international acquisitions on productivity. analyzing acquisitions in sweden during the 1980-1994 period, modén (1997) investigates the impact of domestic and international acquisitions on labor productivity and overall factor productivity. the research results show that the productivity of companies taken over in the processes of international acquisitions increases compared to the industrial average, while the productivity of companies taken over in the processes of domestic acquisitions remains at the same level or decreases. analyzing the difference in the change in total productivity in international acquisitions of manufacturing companies in sweden in the period from 1986 to 2002, karpaty (2007) finds that international acquisitions contribute to productivity growth, but that productivity growth does not occur immediately but in a period of up to 5 years. analyzing the effects of foreign ownership in poland during the 1990s, modén, norbäck & persson (2007) show that companies owned by foreign investors have on average higher labor productivity compared to companies taken over by domestic investors, as well as compared to state-owned companies. the authors point out that by investing resources and knowledge, foreign investors improve business efficiency of the acquired companies. liu & qiu (2013) investigate the impact of domestic and international acquisitions on the productivity and profitability of acquired and acquiring companies. the research covers american companies that made international acquisitions in developed and transition economies during the period 1991-2007. the research results show that the productivity of acquiring companies is better in international acquisitions in emerging markets, compared to international acquisitions made in developed economies. 142 economic analysis (2021, vol. 54, no. 1, 139-156) following international acquisitions in canada during the period 1980-2010, olford & otchere (2016) analyze their impact on labor productivity. the research results show that international acquisitions have a positive impact on labor productivity. analyzing the impact of international acquisitions on labor productivity, employment and employee wages in acquired companies in the republic of serbia during the period 2003-2009, azdejković & marković (2016) show that international acquisitions have had a positive impact on labor productivity and real wages, while the number of employees in the acquired companies has decreased. savović & mimović (2020) analyze the effects of international acquisitions in the cement industry of serbia on the partial productivity of labor, materials and capital, as well as the total productivity of factors using the dea (data envelopment analysis) approach. the research results show that international acquisitions increase the partial productivity of labor, materials and capital, as well as the total factor productivity. some studies fail to find clear relationship between international acquisitions and productivity, emphasizing that the impact of international acquisitions can be both positive and negative depending on the level of analysis and criteria used (labor productivity vs. total factor productivity). bandick (2008) analyzes changes in total productivity of international acquisitions in sweden in the period from 1993 to 2002 and comes to the conclusion of international acquisitions contributing to productivity growth only in vertical, but not in horizontal acquisitions. girma & gorg (2002) investigate the effects of international acquisitions on productivity in different sectors in the uk and find positive effects in the food sector as well as negative effects in the electronics sector. schiffbauer, siedschalg & ruane (2017) investigate the impact of international acquisitions on the productivity of companies in the short and long term, focusing on acquisitions in the uk realized during 1999-2007. the research results show that international acquisitions improve labor productivity, while there is significant heterogeneity in the effects of international acquisitions on the total factor productivity at the sector level. on the other hand, the results of several studies show that international acquisitions have a negative effect on productivity. exploring international acquisitions in developed and less developed economies realized during the period 1997-2008, ataullah, hang & sahota (2014) investigate the impact of international acquisitions made by companies from emerging markets on labor productivity and employment growth. the research results show that international acquisitions in developed economies do not have a statistically significant impact on labor productivity, while in less developed countries and culturally different countries they have a negative impact on labor productivity. similarly, certain studies of international acquisitions in developed economies, such as the united kingdom (harris & robinson, 2002) and denmark (gioia & thomsen, 2004), reveal a negative impact of international acquisitions on labor productivity. most previous empirical research in this area (table a1 is given in the appendix) show that labor productivity improves in the period after the realization of international acquisitions. our study seeks to see how international acquisitions realized in the serbian cement industry have affected the productivity of the acquired companies. one of the ways in which international acquisitions can improve the productivity of acquired companies in this industry is the transfer of modern technology (deng & yang 2015). in the period before the liberalization of the cement industry of serbia, cement plants had outdated technology, so there was a need for significant modernization. the implementation of modern cost-effective technology provides an opportunity for the acquired companies to increase the volume of production, thus contributing to increased productivity. in addition, the implementation of the necessary restructuring measures in the post-acquisition period, which include, among other things, rationalization of the number of employees, brings savings and a lower degree of labor engagement as input, which contributes to increased productivity. the rationalization of the number of employees is much higher among production workers, due to the introduction of new technological solutions, slađana savović, dušan marković 143 than among administrative workers (lehto & bockerman, 2008). labor productivity in the acquired companies could be increased by developing a new system of employee values, i.e. by changing the existing organizational culture and adopting a new one based on greater employee commitment and motivation (savović, 2017). the introduction of a new remuneration system in accordance with the achieved results encourages employees to engage more, contributing to increased productivity. additionally, an increase in labor productivity can be achieved by knowledge transfer, which increases the ability of employees and allows them to perform tasks more efficiently (meyer, 2002). based on the above, the following research hypotheses are formulated: hypothesis 1: international acquisitions in the cement industry of serbia lead to an increase in the productivity of the acquired companies in the long and short term. hypothesis 2: the growth of labor productivity in the short run is predominantly a consequence of the decline in employment, while in the long run it is a consequence of the increase in the volume of production. methodology and data this study analyzes the impact of international acquisitions on the productivity of acquired companies in the cement industry of the republic of serbia in the short and long term. the cement industry of serbia is characterized by an oligopolistic market structure, in which only three companies are present (commission for protection of competition, republic of serbia, 2018), both in the period before privatization and in the period after the realization of international acquisitions. the privatization of the cement industry in the republic of serbia was carried out in 2002, when three cement plants: popovac cement plant, beočin cement plant and kosjerić cement plant were taken over by multinational companies: holcim (switzerland), lafarge (france) and titan (greece). in 2015, the multinational holcim and lafarge merged globally. due to the threat to competition on a large number of markets on which these companies operate, regulatory bodies required disinvestment, i.e. the sale of a certain number of cement plants. in the cement industry of serbia, the integration of these companies would lead to the transformation of the oligopolistic market structure into a duopoly market structure, with one dominant competitor. in order to prevent the creation of a duopoly, holcim was forced to sell its branch in serbia to the irish crh in 2015. despite these sales, the cement market is still characterized by a high degree of concentration measured by the harfindal-hirschman index. theoretical values of this index range from 0 to 10,000, and values greater than 2,500 indicate a high degree of concentration in the sector. in the cement industry of serbia, the value of this index is 3,576 (commission for protection of competition, republic of serbia), based on which we can conclude that the degree of concentration is very high. table 1 presents the companies in the cement industry of serbia. table 1. analyzed companies in the serbian cement industry acquired company acquiring company country of acquiring company year of acquisitions company after acquisition cementara popovac holcim swiss 2002 holcim serbia* cementara beočin lafarge french 2002 lafarge serbia cementara kosjerić titan greek 2002 titan serbia note: holcim serbia was taken over in 2005 by the irish company crh the paper analyzes labor productivity in the twenty-year period (2000-2019). relying on the existing literature in this field and studies that analyze the effects of acquisitions on labor productivity (conyon, girma, thompson & wright, 2002; schiffbauer, siedschalg & ruane, 2017; 144 economic analysis (2021, vol. 54, no. 1, 139-156) bertrand & capron, 2015), we measure labor productivity as the ratio of sales revenue and number of employees. sales revenue represents the total value of products sold and is one way of expressing products in terms of productivity. in order to eliminate the effect of the change in current market prices on the change in income and enable the change in income to mean a change in the quantity of products, and thus a real change in labor productivity, we deflate sales revenue by using the constant price index of 2000. data on inflation rates is taken from the imf database. to analyze the short-term effects of international acquisitions on labor productivity, we compare the average labor productivity two years after the acquisitions with the average labor productivity two years before the acquisitions. to find out the long-term effects of international acquisitions on labor productivity, the average labor productivity in the entire post-acquisition period is compared with the average labor productivity in the pre-acquisition period. to deepen our research, we analyze dynamics of the labor productivity. to analyze the labor productivity dynamics, we construct base and chain indices. base index is an index number in which the value of every period in a time series is directly related to the same value of one fixed base period. data from 2000 is used to construct base indices. we calculated the base indices by dividing the real productivity of acquired companies in each year by the realized productivity of the base year. chain index is an index number in which the value of any given period is related to the value of its immediately preceding period. we calculated chain indices by dividing the real productivity of acquired companies in each year by the real productivity of the previous year. this approach enables us to create wider picture about influence of the cross – border acquisitions on the targets’ labor productivity. the data required for the research is collected from the official financial reports of the analyzed companies. income statements, as well as data on the number of employees for the last three years of the analyzed period are available on the website of the business registers agency, while income statements and data on the number of employees for all other years were received from the business registers agency after an official request. results and discussion in order to adequately interpret short-term and long-term productivity, the motives for foreign companies in the cement industry to enter the serbian market should be considered. cement is a product where the ratio of value and weight is relatively low, which is why transportation costs have a significant share in the selling price. given the above, companies strive to locate their facilities relatively close to customers, in order to minimize transportation costs, so that investment strategies are imposed as the expected way of internationalization. this is a capital-intensive activity and it is very important to achieve economies of scale, which is why acquisitions in this activity are frequent, and new plants are being raised relatively cautiously. also, after the political changes and the change of the economic model in serbia after 2000, strong growth was expected in the field of construction, which would affect the growth of demand for cement products (chart 1). these factors have encouraged foreign cement plants to implement takeovers in the privatization process, although the business environment has been characterized by a relatively high degree of political and economic risk. slađana savović, dušan marković 145 figure 1. quantity of installed construction material source: statistical office of republic of serbia, https://www.stat.gov.rs/, (accessed january 22, 2021) figure 1 shows that the demand for cement products grew rapidly until the beginning of the great recession in 2008, after which there was a large drop in demand for portland and other types of cement, while the demand for cement mortar grew steadily. the recovery of demand for the first two types of products was gradual and irregular, so that in 2019 the aggregate demand was slightly higher than in the year of privatization of cement plants. on the other hand, the demand for cement mortar is more than 13 times higher than the demand in the year of privatization. the natural growth of demand and the change in customer preferences for new, better quality, and higher-priced products had a positive effect on the growth of revenues from the sale of cement plants in the period after privatization. figure 2. real sales revenue in millions of rsd note: revenues are deflated and reduced to the value from 2000; source: calculation of the authors based on data obtained from the business register agency and the imf 146 economic analysis (2021, vol. 54, no. 1, 139-156) figure 2 shows that revenues from the sale of cement plants expressed in constant rsd in 2019 were 3.3 times higher than in the year of cement plant privatization, and that sales grew strongly until the great recession in 2008. during the recession, the market lost 20% of its value, and it took 10 years after the recession for real revenues from cement sales to reach pre-crisis levels. in the last year of the analysis, the market was only 15% higher than before the crisis maximum, which confirms the great damage that the cement industry suffered due to the global economic crisis and the slow economic recovery after it. international acquisitions often result in radical restructuring of acquired companies, which is especially pronounced in acquisitions in transition countries and emerging markets (meyer & estrin, 2001; meyer & estrin, 2011), so that in these countries, due to the degree of restructuring, acquisitions often have brownfield investment characteristics. specifically, in these countries, companies, due to state ownership and lack of the cutting-edge technology, have more workers than comparable companies in developed countries. after the takeover, foreign investors lay off workers who do not have full employment, (santalainen, baliga & leiman, 2003), transfer new technological solutions to the target (uhlenbruck & de castro, 2000), but also provide additional training to employees (meyer, 2002). the first measure will contribute to the decline in employment in the short term, while the other measures in the long run will contribute to further optimization of employment and growth of production. when it comes to the cement industry in serbia, it employed over 5,000 workers in the year of takeover, and at the end of 2019, the number of hired workers was around 730 (figure 3). the chart shows that the largest decline in the number of employees occurred in the first year after privatization, due to the reduction of the number of employees to the optimal level, and then in accordance with the introduction of new technologies, organizational solutions and employee training, the number of employees further decreased. figure 3. comparative overview of number of employees during the period 2000-2019. source: the business register agency based on data on the number of employees and real sales revenues, we calculate real productivity at the level of companies in the cement industry. figure 4 shows the real productivity of the acquired companies during the period 2000-2019. slađana savović, dušan marković 147 figure 4. comparative overview of real labor productivity during the period 2000-2019 (in 000 rsd/employee) source: calculation of the authors based on data obtained from the business register agency and the imf figure 4 shows that all three analyzed companies had different dynamics of labor productivity growth. prior to the cement privatization process, titan had the highest labor productivity, which increased sharply in the first two years after privatization. after that, productivity was relatively stable with minor oscillations, ending in 2015, after which productivity it rose sharply, as a result of which the company reached maximum labor productivity in 2019, and became the second most productive in the industry. prior to privatization, holcim had the lowest productivity, but after the change of ownership, productivity grew rapidly until 2011, when there was a decline and a slow recovery in productivity. problems with productivity in the second decade of the 21st century are a consequence of the decline in real incomes as of 2011, and a slight increase in the number of employees, due to the change in management and ownership in 2015. lafarge is the absolute industry leader in terms of productivity. at the same time, lafarge aggressively reduced the number of employees and increased production, during the entire analyzed period, so that in 2019, the company productivity was slightly lower than the combined productivity of the other two competitors. to deepen our findings about cross-border acquisitions’ impact on labor productivity we analyze base and chain indices for all companies in the sample. table 2 shows the companies’ real labor productivity and base and chain indices during the period 2000-2019. according to base indices holcim (crh) had the largest labor productivity in 2011, when the real labor productivity was 850% larger compare to 2000 year. titan and lafarge had the largest labor productivity in the last analyzed year. the real labor productivity in that year was larger 200% and 1,344%, respectively, compared to the base year 2000. increase of the companies’ labor productivity was not linear. after the privatization the companies’ productivity was growing constantly until 2009. in that year the companies’ productivity decreased, due to effects of global financial crisis. the second drop of the productivity was in 2013. in this year holcim’s (crh) productivity decreased by 15%, lafarge’s productivity decreased by 11% and titan’s productivity plunged by 21%. the productivity decrease in this year was result of fiscal consolidation, postpone of public investments in infrastructure projects and decreasing private investments in real estates. in 2014 serbia has been severely hit by floods. the floods cause significant damage of transport infrastructure and 148 economic analysis (2021, vol. 54, no. 1, 139-156) houses. serbian government organized repairment of damaged infrastructure and real estates which positively affected the sales income and labor productivity in cement industry. when public investments in infrastructure and real estates recovery decreased in 2015, the industry productivity dropped sharply due to lower sales incomes. since 2016 serbian government has been increasing investment in hard infrastructure and real estate market has been booming, which has resulted in the productivity increase for all analyzed companies. table 2. real productivity (000 rsd/employee), base and chain indices in the period 20002019 source: calculation of the authors based on data obtained from the business register agency figure 5 shows short-term and long-term changes in average productivity compared to the two-year average before the takeover. in the short term, all three companies improved productivity compared to the two-year average before the takeover. short-term productivity at the industry level increased 2.73 times, in just two years after the change of ownership. such a radical change in productivity is predominantly a consequence of the reduction in the number of employees, and to a much lesser extent of the increase in production volume. looking at individual companies in the industry, it can be seen that short-term productivity improved the most at holcim (crh), by 3.26 times, followed by lafarge 2.75 times and titan 1.75 times. titan had the lowest short-term productivity improvement, as it had an average productivity in the pre-acquisition period higher than holcim (crh) by 2.5 times, or 2.1 times compared to lafarge, so it can be concluded that this company before the takeover had the best ratio of production and number of employees. holcim (crh) lafarge titan holcim (crh) lafarge titan holcim (crh) lafarge titan 2000 472 563 1,600 100 100 100 2001 663 811 1,281 140 144 80 140 144 80 2002 513 791 1,240 109 140 78 77 98 97 2003 1,704 2,010 2,323 361 357 145 332 254 187 2004 1,993 1,763 2,707 422 313 169 117 88 117 2005 1,997 2,464 2,774 423 437 173 100 140 102 2006 2,491 2,948 2,867 528 523 179 125 120 103 2007 2,658 3,451 2,585 563 612 162 107 117 90 2008 4,008 4,943 3,348 849 877 209 151 143 129 2009 3,899 4,828 3,050 826 857 191 97 98 91 2010 4,312 5,287 3,558 914 938 222 111 110 117 2011 4,485 5,360 2,990 950 951 187 104 101 84 2012 4,453 5,549 3,303 944 985 206 99 104 110 2013 3,805 4,949 2,577 806 878 161 85 89 78 2014 4,043 6,396 3,166 857 1,135 198 106 129 123 2015 3,490 6,187 3,077 740 1,098 192 86 97 97 2016 3,809 7,028 3,462 807 1,247 216 109 114 112 2017 3,673 6,902 4,057 778 1,225 254 96 98 117 2018 4,054 7,497 4,580 859 1,330 286 110 109 113 2019 4,188 8,137 4,804 887 1,444 300 103 109 105 base indices chain indicesreal productivity slađana savović, dušan marković 149 figure 5. comparative overview of the average real labor productivity in the pre-acquisition period and post-acquisition period (short and long term) (in 000 rsd/employee) source: calculation of the authors based on data obtained from the business register agency and the imf when looking at the change in productivity in the long run, the situation is somewhat different than in the short-term change in productivity. specifically, at the industry level, productivity increased 5.39 times, which is primarily a consequence of the increase in production volume, but also partly the introduction of new technological and organizational solutions that lead to further optimization of the number of employees. when the change in long-term productivity at the company level is observed, the situation has changed, so that the largest productivity improvement was recorded at lafarge, 7.34 times. on the other hand, with holcim (crh), which improved productivity the fastest in the short term after the change of ownership, long-term productivity improved on average 6.12 times. by far the slowest growth in long-term productivity was recorded at titan, only 2.26 times. based on the results, we see that when productivity growth opportunities were exhausted by reducing the number of employees, titan and holcim did not sufficiently use productivity growth opportunities by introducing new technological solutions and better work organization, which strengthened lafarge's leadership position and competitive advantage. the analysis of productivity in the cement industry opens space for further discussion, at the level of companies, but also at the level of the national economy. the obtained results are in line with previous studies that suggest that international acquisitions contribute to productivity growth in emerging markets (savović & mimović, 2020; azdejković & marković, 2016). at the micro level, it is evident that the privatized cement plants were burdened with redundancy and relatively old technology. therefore, productivity growth in the short run was predominantly a consequence of optimizing the number of employees, and to a lesser extent, of increasing production volume. in the long run, when productivity growth opportunities have been exhausted by optimizing the number of employees, companies have sought to increase productivity by introducing new technologies and better work organization. this approach resulted in slower growth in average productivity between 2005 and 2019, which is partly due to declining sales during the global financial crisis, and a slow recovery thereafter in serbia. on the other hand, it has been observed in international takeovers that there is a relatively stable number of employees, especially non-productive workers, who must be hired independently of the fluctuation of production and sales (lehto & bockerman, 2008). 150 economic analysis (2021, vol. 54, no. 1, 139-156) the results also show that in the cement industry, as a capital-intensive one, there was an increase in employee productivity, which further raised the already high barriers to entry into the industry. with this in mind, there is little chance that late followers will appear on the market that would intensify competition, and reduce the level of concentration in the industry. given the above, state authorities must carefully monitor developments in the industry, which is of strategic importance for the development of construction and road infrastructure, in order to prevent collusion between companies at the expense of customers. at the level of the national economy, the benefits of these takeovers are relatively limited. revitalization of acquired companies and growth of sales revenues have a positive effect on tax revenue collection, while this industry, due to the nature of products, is primarily focused on the domestic market, so there was no greater contribution to reducing the current account deficit. the negative consequence of these takeovers is a decline in employment. specifically, in 2019, only 15% of the number of employees were engaged in all three companies in relation to the year of takeover. an additional problem is that the production facilities are located in municipalities that are poorly developed and devastated, and in which in the past cement plants were a significant, and, we can say, a dominant employer. conclusion intensive globalization and liberalization of economic policies have created conditions for the growth of foreign direct investment inflows in the form of international acquisitions in emerging markets. foreign investors’ motives to make acquisitions in these countries are: access to large and growing markets, abundance of relatively cheap and skilled labor, the ability to transfer and further exploit intangible assets from the domestic market (technology, brands, management know-how, etc.) and achieving financial synergy. the acquired companies were mainly characterized by outdated technology, redundancy and inadequate management and marketing knowledge. given the current situation, foreign investors have embarked on radical restructuring of the acquired companies, which contributes to improving business performance. the cement industry is characterized by a low ratio of value and product weight, a high share of distribution costs in the selling price and capital intensity, which is why acquisitions are a common way of internationalizing business. with this in mind, lafarge, holcim and titan have taken over three cement plants in serbia, in order to be closer to customers. the paper sought to determine whether the new owners succeeded in improving the productivity of the acquired companies in the long and short term. data on real (deflated) sales revenues and the number of employees in the period from 2000 to 2019 was used for the research. the research results confirm the first hypothesis in the paper that international acquisitions lead to an increase in labor productivity in the short and long term. the results are in line with previous studies indicating that international acquisitions in emerging markets contribute to productivity growth. a deeper analysis showed that in the short run, productivity growth was predominantly due to optimization of the number of employees, while in the long run productivity grew more slowly and was predominantly a consequence of increased production, i.e. introduction of new technologies, better organization and higher employee motivation. the results also showed that foreign companies, which based the restructuring of the acquired companies largely on the reduction of employment, and not on the transfer of technology and knowledge, did not succeed in achieving the same dynamics of productivity growth in the long run as in the short run. in this way, the second hypothesis in the paper is proved. the main limitation of the paper is that the number of analyzed international acquisitions, although covering the entire cement industry, is very small. also, no domestic acquisitions were made in this industry, so it was not possible to determine whether foreign owners were more successful than domestic ones. upgraded work and further research on this topic are abundant. specifically, it is possible to analyze and compare post-acquisition productivity in the cement slađana savović, dušan marković 151 industry of serbia and other transition or emerging markets, as well as post-acquisition productivity in the cement industry and other industries in serbia. the theoretical implications of the paper are reflected in expanding the knowledge base on the effects of international acquisitions on productivity in emerging markets. this creates a basis for comparison with the research results in developed economies and allows the perception of certain specifics. in addition, by analyzing all acquisitions realized in the cement industry of serbia, it expands the knowledge 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"foreign acquisitions in central and eastern europe: outcomes of privatization in transitional economies." academy of management journal, 43(3): 381 – 402. 154 economic analysis (2021, vol. 54, no. 1, 139-156) appendix: table a1. a review of empirical studies on the impact of international acquisitions on productivity studies sample period productivity measures research results effect modén (1997) companies in sweden 1980-1994 labor productivity, total factor productivity after the realization of international acquisitions, there was an improvement in the productivity of the acquired companies compared to the industrial average. positive girma & gorg (2002) uk companies 1980-1994 after the international acquisitions there was increase in productivity in food industry, while productivity in electronic sector decreased positive/ negative (depending on the sector) harris & robinson (2002) uk companies 1987-1992 labor productivity after international acquisitions realized a slight decrease in labor productivity negative gioia & thomsen (2004) international acquisitions in denmark 1990-1997 international acquisitions had negative effect on productivity negative modén, norbäck & persson (2007) companies in poland 1995-2000 labor productivity companies owned by foreign investors have, on average, higher labor productivity compared to companies taken over by domestic investors, as well as compared to state-owned companies. positive karpaty (2007) international acquisitions in sweden 1986-2002 productivity growth is achieved in a period of up to 5 years positive bandick (2008) international acquisitions in sweden 1993-2002 total factor productivity international acquisitions has positive effect on total factor productivity (this is the case for vertical acquisitions but not horizontal acquisitions) positive/ negative (depending on the type of acquisition) liu, & qiu, (2013). us companies that have realized acquisitions in developed and transitional economies 1991-2007 productivity and profitability performance acquired companies is better when they have participated in acquisitions in transitional economies, compared to acquisitions in developed economies positive ataullah, hang & sahota, (2014) international acquisitions in developed and developing economies carried out by companies from developing economies 1997-2008 labor productivity, employment growth international acquisitions in developed economies do not have a statistically significant impact on labor productivity, while in developing economies they have a negative impact on labor productivity negative olford & international 1980-2010 labor international acquisitions improve positive slađana savović, dušan marković 155 studies sample period productivity measures research results effect otchere (2016) acquisitions in canada productivity the productivity of acquired companies azdejković & marković (2016) 79 international acquisitions in serbia 2003-2008 productivity, employment and wages international acquisitions have a positive impact on labor productivity and real wages, and a negative effect on the number of employees positive schiffbauer, siedschalg & ruane, 2017 labor productivity, total factor productivity positive/ne gative (depending on measures) savović & mimović (2020) international acquisitions in cement industry in serbia 2000-2018 application of the dea approach in monitoring the partial productivity of labor, material and capital, as well as the total factor productivity international acquisitions have a positive impact on the partial productivity of labor, material and capital, as well as total factor productivity in the long term. positive sources: authors according to the literature review article history: received: february 18, 2021 accepted: may 24, 2021 ea_2019_2 doi: 10.28934/ea.19.52.2.pp137-151 scientific review concentration measuring techniques in banking sectorlorenz curve and gini coefficient maja dimić1* | svetislav paunović2 1 university union nikola tesla, faculty for business stadies and law, belgrade, serbia 2 university union, belgrade banking academy, belgrade, serbia abstract the paper presents the indicators of market concentration in the banking sector with a focus on the lorenz curve and the gini coefficient. the authors present the results of the empirical research of concentration levels in the banking sector in selected countries in the cee region (serbia, croatia, montenegro, bosnia and herzegovina, macedonia, bulgaria, romania and albania) in the period 2007-2012. the level of market concentration can be exploited and operationalized by using different concentration indicators. the contribution of this research is reflected in the comparative empirical analysis of the results of our previous research that was focused on quantification of the most frequently used indicators of concentration (concentration ratio 4 and herfindal-hirshman index), and the results obtained using the lorenz curve and the gini coefficient. the paper analyzes the level as well as variability of these indicators and tests the degree of their correlation. individually observed, concentration indicators have relatively low capacity to present the real nature of competition in the banking sector in the analyzed countries as well as to provide a good estimate of possible future trends. the results of our analysis indicate that, for the purpose of a more precise and better understanding of the relevant issues of market concentration in the financial sector, several indicators of concentration need to be analyzed simultaneously. additionally, improvement of methodology should provide a more reliable basis for a precise definition of adequate policies and legislation in this area. key words: level of concentration, gini coefficient, lorenz curve, banking sector, cee region, economic crisis jel classification: g21, g01 introduction concentration is a measure of market power, whereby market power can be defined as a company's ability to increase the price of a product / service without reducing total sales. in this context, competitive business in the industry is distorted in uncontrolled economic systems. this market position can lead to monopoly behavior, which is reflected in unjustified price increases (and extra profit), lower product / service quality, the lack of innovativeness, the use of cheaper and low-quality raw materials in the production process (barjaktarović, filipović & dimić, 2013). the concept of concentration in the financial sector defines the form of interconnection of institutions whereby they come under common control thus creating a certain level of economic * corresponding author, e-mail: maja.dimic@fpsp.edu.rs 138 economic analysis (2019, vol. 52, no. 2, 137-151) unity which, by the time of association, did not exist (šubić, 2009). larger part of the theory of industrial organization can be applied in the financial system. however, the banking sector is part of a group of specific business branches where oligopoly structure can be found in the market. the reason for this kind of market structure lies in the fact that banks aim at achieving profit margins justifying shareholder investments, thus attracting a higher level of capital. perfect competition in the financial sector is not market-sustainable, because of the following: • endangering the profit margins of financial institutions. under the conditions of perfect competition in the market, financial institutions would achieve minimum profits, which would prevent the accumulation of capital necessary to protect against potential losses. • the problem of asymmetry of information is raised and the moral hazard increases. financial institutions operate under "too big to fail" principles, take on greater business risk because they are certain that in the event of an emergency, the state will stand in their defense. • increasing the level of passive rates in the banking sector with the aim of attracting as many customers as possible. the increase in passive interest rates would have an effect on an increase in active interest rates. the scientific literature adopts several reasons which can lead to the increased concentration in the financial system. hawkins & mihaljek (2001) cite the following groups of motives which encourage institutions to consolidate in the financial sector: • benefits (economy of scale, organizational activity, diversification of risks); • economic reasons (motives for checking the level of concentration that emerge after the crisis or during the increase in the business cycle); • other motives (defending against the takeover and managerial motivation to capitalize). the objective of the paper is to elaborate characteristics of gini coefficient as a measure of the concentration, to quantify gini coefficient in the banking sector in selected cee countries as well as to compare the results with findings of our previous research (barjaktarović, filipović & dimić, 2013; dimić, 2015; dimić, 2018; dimić, paunović & tešanović, 2019) which was based on most frequently used indicators of concentration (concentration ratio 4 and herfindal-hirshman index). in this context, we also test the degree of their correlation. the main hypothesis of the paper is that there is a high average value of gini coefficient, indicating the relatively high level of concentration in the banking sector of analyzed countries during the period 2007-2012. the auxiliary hypotheses are: h1: there are significant differences in the degree of correlation between individual concentration indicators (cr4, hhi and g). h2: degree of concentration in the banking sector is poorly correlated with the level of economic development. the paper will be structured as follows: within the first section previous research that relates to indicators of concentration will be elaborated followed by the methodology of research and data collecting. within the third section the results of our survey will be presented. finally, the conclusion and recommendations will be given. previous research the turbulence of the environment and market changes have led to the need for business entities re-examine themselves and to design their business strategy in order to gain competitive advantage in the market (raičević & medenica-mitrović, 2018). in this context, the degree of concentration represents an important structural variable in any business area. various levels of concentration of individual industries or companies in the economic branches maja dimić, svetislav paunović 139 are the first indicator of the market structure (dimić, 2015). in this context, the significance of the indicator of concentration is found in the interpretation of structural changes in the market. concentration indicators reflect changes in the level of market concentration, which are the consequence of entering or leaving of the companies from the branch, as well as merging of companies in the industry. concentration indices are therefore considered as the starting point for conducting anti-monopoly policy, whereby the value of concentration indicators can be used in the decision-making process on whether to approve the uniting of companies. concentration indices belong to a group of indicators of structural approach, as they describe the state and changes in the market structure (dimić, paunović & tešanović, 2019). different authors have indicated certain characteristics that the indicators of concentration need to possess. hall & tideman (1967) cited the following characteristics of the concentration index in their research: • they should be one-dimensional, which practically means that they should be unambiguous in order to be comparable between different branches and different times. • they should be independent of the size of the branch indicating their intercomparability. practically speaking, for measuring of concentration the absolute value of the variables is not important, but their distribution among the participants in the market • concentration indices affect the changes in market share of the corporation. thus, the shift of market share from small to larger companies increases, and the shift from bigger to smaller reduces the value of the concentration index. • concentration index should range from 0 to 1. this characteristic is not ultimate, but it is desirable because the indices in such a state are more useful for analysis. depending on the purpose of the research, market concentration can be measured by numerous indicators. in their scientific paper bikker & haaf (2000) presented theoretical explanations of concentration indicators: concentration ratio, herfindal-hirshman index, entropy measure, the lorenz curve, the gini coefficient, the comprehensive industrial concentration index cci, hannah and kay (hki), hall-tideman index (hti), hause index (ha). table 1. indicators of market concentration index title tag and interval value index value interpretation concentration ratio 1/n≤ cr≤1 the value of the index is approaching 0 when a larger number of identical entities are present on the market, and value 1 takes the situation when the sum of "r" entities make the entire industry. herfindahl-hirschman index 1/n≤hhi≤1 the higher value of the index indicates the higher concentration. in case of a monopoly, it is worth 10,000. entropy measure 0≤e≤logn greater entropy value indicates lower concentration. in case of a monopoly, the value of the index is equal to 0. lorenz curve indicates the distribution of population in population. the larger the concentration the further the curve from the direction of even distribution. gini coefficient 0≤g≤1 the bigger the coefficient the larger the conentration. in case of total uneven distribution it amounts to 1 comprehensive industrial concentration index 0≤cci≤1 the value of the index ranges from 0 to 1. value 1 occurs in case of a pure monopoly. hannah and kay index hki; α>0; α ≠1 the lowest values of α parameter emphasize the influence of small companies, while the highest values of α parameter point out the influence of big companies on concentration. 140 economic analysis (2019, vol. 52, no. 2, 137-151) index title tag and interval value index value interpretation hall-tideman index 0≤hti≤1 value close to 0 means the presence of a larger number of banks of the same size, while the index value of 1 signals the presence of a monopoly. hause index 0≤h≤1 index is equal to the value of 1 in case of a monopoly, while the value 0 occurs in the presence of an infinite number of identical banks in the market. source: dumićić et al. (2012), ljubaj (2005) the most commonly used concentration measurement techniques are the concentration ratio 4 (cr4) and herfindahl-hirschman index (hhi). these techniques are widely accepted and used by referent institutions that analyze, monitor and make decisions regarding the control of the degree of concentration. in this context, one of our previous surveys could be a good basis for a broad comparative analysis of concentration indicators. in the analysis that is the subject of this paper, the aforementioned commonly used techniques are added a theoretical and methodological review of the lorenz curve and the gini coefficients as well as the empirical analysis of the level of concentration in the banking sector in cee countries during the world economic crisis based on these techniques. comparative analysis of the obtained results and practical implications are also the subject of our research. theory and methodology lorenz curve and gini coefficient the lorenz curve is a graphical instrument through which it is possible to monitor the uniformity of the distribution of selected variables, and can therefore successfully be used for analyzes of concentration of various industrial sectors or markets (marinković, 2007). the lorenz curve shows the distribution of the cumulative numerical sequence on its parts. it is constructed in the first quadrant of the coordinate system and consists of the points whose coordinates are determined by the members of cumulative sequences (tipurić, kolaković & dumičić, 2002). thus, using the lorenz curve it is possible to show the link between the cumulative number of companies and their cumulative market share. the x-axis shows the number of firms (f) grouped by size, from the smallest to the largest, while the y-axis shows the percentage of the offer (from 0% to 100%). the first step in constructing a graph with the lorenz curve is defining the curve of 45°: the first point will have coordinates [0,0] and the last one [1,1]. as data is compared by size, x-axes are counted as the values of the empirical functions of distribution, according to the following formula: (1) i= 1, 2, … n the y-axes are the members of cumulative sequence of proportions of subsum and are calculated according to the following formula: (2) j=1, 2, ...n maja dimić, svetislav paunović 141 the curve of 45°, is interpreted as a line of perfect equality, i.e. an even distribution of offers among companies. the equilibrium of distribution is observed on the basis of deviation of the lorenz curve from the curve of 45 °, which shows the absolutely equal distribution of market share among all participants (kostić, 2009). as the lorenz curve moves away from the ideal distribution, the concentration of the sector is becoming more pronounced. an absolutely uneven distribution means that one company provides 100% offer in the sector. figure 1. lorenz curve the main deficiency of the lorenz curve is the unevenness of the distribution of market share between individual companies. in determining the degree of concentration, the number of companies will not play a significant role, so one company with 100% market share and ten companies with 10% of market share will be at 45 ° (kostić, 2008). also, the lorenz curve does not show an easily comparable numeric data. in order to overcome the deficiency, this instrument of concentration is supplemented by the gini coefficient (g). the gini coefficient is a parameter that follows the logic of the lorenz curve. the value of the gini coefficient is determined by the deviation of the lorenz curve from the line of perfect equality. this measure of concentration is based on the assumption that companies' participation in the industry is split between the lowest and the highest. the gini coefficient gives us a unique numeric indicator that describes the position of the lorenz curve by determining the ratio between the area of the line of perfectly even distribution and the lorenz curve (a) with the area below (or above) the line of perfectly even distribution, which by definition, mathematically, amounts to a half of the quadrant in which the lorenz curve is drawn (marinković, 2007). the coefficient can be calculated in two ways: (3) where the interval represents the area below the lorenz curve. another way for calulating the gini coefficient is according to the following formula: , i= 1,2, ... n (4) where: n stands for the number of companies; μ stands for the average size of the company's sales on the given market 142 economic analysis (2019, vol. 52, no. 2, 137-151) ri the ranking which the ith company occupies (companies are ranked according to the size of sale or their market share, ranging from the smallest to the biggest); qi scope of sale of the ith company. the value of the gini coefficient can range from 0 to 1. if the gini coefficient has a value of 0, all firms are of the same size and there is no concentration on the market. in this case, the lorenz curve lies on the line of a perfectly equal distribution and the area between them cannot be mathematically expressed. when the obtained value approaches 1, there is a huge disproportion in the size of the offer among companies, i.e. one company dominates the industry. the main disadvantage of this indicator is that it ignores the number of firms and solely observes the inequality in the offer between them. the industrial branch with two companies identical in size has the same value of the gini coefficient as the industry with 100 firms of the same size, although the competitive structure of these two industries is completely different (lipczynski & wilson, 2001). datasource and framework methodology in this part of the paper, an empirical study of concentration levels in the banking sector was carried out in selected cee countries in the period 2007-2012, using the lorenz curve technique and the gini coefficient. the territorial starting points for empirical research are the countries which the international monetary fund classified and defined as cee countries.1. our research includes the following countries of the cee region: serbia, croatia, bosnia and herzegovina, montenegro, macedonia, romania, bulgaria and albania. the analysis of the level of concentration in the banking sector is based on the following development criteria: assets (total balance sheet) of the banking sector, loans granted to the non-financial sector and deposits of the non-financial sector (dimić, 2018). data used in the research were collected on the websites of relevant financial institutions responsible for the control and supervision of banking sector operations as well as other available sources and publications of institutions responsible for the financial sector. table 2. data sources for the banking sector country data sources for the banking sector serbia national bank of serbia (banking sector – analyses and reports, bank web sites, auditors’ reports, annual reports) croatia croatian national bank (bulletin on banks) bosnia and herzegovina banking agency of the federation b&h (concise report of external auditors on banks’ financial statements in fb&h) montenegro central bank of montenegro (journal of central banking, banks’ balance sheets and profit and loss accounts) macedonia national bank of the republic of macedonia (report on banking system of the republic of north macedonia) romania national bank of romania (monthly bulletin of nbr) bulgaria central bank of bulgaria (banks in bulgaria) albania albanian association of banks (banking system monthly bulletin) source: national banks of the analyzed countries 1 according to the classification methodology used by the international monetary fund in its reports (world economic outlook), the following countries are listed in the group of central and eastern european countries (cee region): albania, bosnia and herzegovina, bulgaria, montenegro, croatia, lithuania, latvia, hungary, macedonia, poland, romania, serbia, kosovo and turkey. maja dimić, svetislav paunović 143 data processing was aimed at identifying the levels of concentration in the banking sector in the analyzed countries and their dispersion in the period 2007-2012, using the lorenz curve and the gini coefficient. the analysis was carried out in several steps: • calculation of concentration indicators in the analyzed countries using the three development indicators of the banking sector (assets, loans granted to the non-financial sector and deposits of the non-financial sector). • determining the average values of concentration indicators for each particular country in the analyzed period as well as the average weighted concentration indicators for the analyzed region in each individual year. bearing in mind that different levels of realized balance sheet totals, loans granted to non-financial sector and non-financial sector deposits are reported in the group of analyzed countries in the region of central and eastern europe, shares of individual countries are taken as the weights in the total amount of individual indicators of the analyzed region; • determining the statistical measure of variability using coefficient of variation (expressed as a ratio of standard deviation and mean value of concentration indicator, i.e. average weighted concentration indicator value). in this context, the following are analyzed: dynamic changes (variability) of the level of concentration by countries in the period 2007-2012, as well as the changes (variability) of the level of concentration between the countries analyzed for each year. • comparative analysis of the previously obtained results based on the use of cr4 and hhi and the results obtained using the gini coefficient was made. also, the correlation analysis of the obtained results was done. • the survey also included establishing the intensity of the ratio of the individual concentration indicators and the gdp per capita. in this context, the spearman’s correlation coefficient (5) where ρ – stands for spearman’s correlation coefficient; d – stands for the difference between the ranks x and y; n – stands for the number of pairs of ranks of the x and y variables; is used, which is suitable for data that can be ranked, especially for smaller series of data. correlation coefficients range from -1 to 1, with the sign indicating the negative or positive correlation or the absence of correlation (0). research results – lorenz curve and gini coefficient the lorenz curve allows for a clear understanding of the distribution of the banking market (according to analyzed criteria) in cee countries in the observed period. based on our research, the following key points and characteristics of the banking sector can be stressed. level of concentration (based on total assets ) serbia the first 50% of banks in the domicile market have a share of 13% of total banking sector assets, while the remaining 50% of banks account for 87% of the market. 90% of banks have a share of 67% of total assets croatia 50% of banks have a share of 4% of total assets. 90% of banks have a share of 45%, the remaining group of participants (10%) possesses about 55% of banking sector assets. 144 economic analysis (2019, vol. 52, no. 2, 137-151) level of concentration (based on total assets ) bosnia and herzegovina 1/3 of banks have a share of only 3.5%. montenegro 90% of the participants in the banking market have a share of 75% of total assets macedonia 50% of banks have a share of only 10% of total banking sector assets romania about 30% of the market participants have a share of only 1%, while 90% of the bank has a slightly more than 50%. bulgaria 90% of banks have a share of 65% of total assets. albania 50% of the market participants participate in the market with 12%, while 95% have a share of 75%. figure 2. lorenz curve for the banking market according to the criteria of total assets source: based on authors' calculations maja dimić, svetislav paunović 145 regarding the criterion of the loans granted to the non-financial sector as well as collected deposits, the following results were obtained2: level of concentration based on loans granted to non-financial sector level of concentration based on collected deposits from nonfinancial sector croatia 2/3 of banks have a share of 6.6%, while 96% of the market participants have a share of 75% 50% of banks have a share of 4.5%. bosnia and herzegovina 50% of banks have a share of 5%, while 90% of banks have a share of little more than 50%. 2/3 of banks have a share of 12%. montenegro 50% of banks participate with 20% in total loans granted to the nonfinancial sector. 2/3 of banks have a share of 25%. macedonia 95% of market players have a share of 75%. 2/3 of banks have a share of 17%. bulgaria 50% of banks participate with 8%. 2/3 of banks have a share of 20%. albania 2/3 of banks have a share of 25% 95% of banks have a share of 70%. as far as gini coefficient in the banking sector in the group of analyzed countries is concerned, it can be stated that the average values of the gini coefficient show relatively similar values of the concentration according to the total loans granted to the nonfinancial sector (0.68), the deposits collected from the nonfinancial sector (0.67) and the total balance sheet (0.66). generally, average values are in the medium to high concentration zone. values of the gini coefficient, according to the total assets of the banking sector, show that serbia, bulgaria, albania and partially montenegro have values of 0.5. other countries in the analyzed region recorded values ranging from 0.6 to 0.8, with the highest degree of market share inequality in croatia in the observed period. according to the criterion of loans granted to the nonfinancial sector, the level of concentration measured by the gini coefficient gives similar results as in the previous case. thus, in the four of the six analyzed countries in the region there is a high value of the gini coefficient ranging from 0.6 to 0.8. obtained values of the gini coefficient for deposits collected from the non-financial sector show that croatia and bosnia and herzegovina, with values above 0.7, may be ranked as markets with a high degree of inequality of market share distribution. 2 serbia and romania are excluded from the average values according to the criterion of loans granted to the non-financial sector and collected deposits of the non-financial sector due to the lack of data. 146 economic analysis (2019, vol. 52, no. 2, 137-151) based on total assets of banking sector based on loans granted to non-financial sector based on collected deposits from non-financial sector figure 3. gini coefficient in banking sector source: based on authors' calculations our previous research, in which the indicators cr4 and hhi were calculated, showed that the degree of concentration and inequality in the banking sector in the region stagnates in the observed period. on the basis of the calculated average values of the cr4 indicator, the banking maja dimić, svetislav paunović 147 market, measured by all three criteria of development, belongs to a group of highly concentrated markets (above the 50% limit value). contrary to the share indices of the four largest banks', the average values of hhi in the banking sector in the region, according to all three analyzed development criteria, show the values which indicate a mid-concentrated market (from 1,000 to 1,800 points). the following table presents data that relate to the variability (expressed by coefficient of variation) of the gini indicator on the banking market according to countries in the period 20072012 as well as data related to the variability of the gini indicator among countries per years. the obtained results show that values of coefficients of variation among countries, according to all three criteria of development, are greater than the variation that occurred in individual countries. coefficients of variation of the gini indicator show that the biggest changes occurred on the banking market of montenegro (loans granted to the non-financial sector 15.3%), while on the other hand, the least oscillation was present on the banking market in croatia. regarding the coefficients of variation between countries, the maximum values (all three indicators of the banking sector's development) were recorded in 2012. table 3. coefficients of variation of the gini coefficient (in %) in banking sector coefficient of variation in countries in the period 2007-2012 coefficients of variation among the countries per years country balance sheet total granted loans collected deposits year balance sheet total granted loans collected deposits serbia 1.6 n.a. n.a. 2007 11.3 10.7 10.6 croatia 1.0 1.1 1.3 2008 11.1 11.0 10.7 bosnia and herzegovina 5.5 6.1 6.4 2009 11.4 12.9 12.0 montenegro 13.1 15.3 12.4 2010 12.8 13.8 12.5 macedonia 4.5 3.4 5.5 2011 12.8 14.3 13.0 romania 2.4 n.a. n.a. 2012 13.1 14.8 13.7 bulgaria 2.0 0.6 1.1 albania 1.6 2.7 3.2 source: authors' calculations the following table summarizes the ranking of countries according to analyzed indicators of concentration in the banking sector based on the criterion of the balance sheet total in 2007 and 2012 (the rank 1 represents the highest level of concentration, while the rank 8 represents the lowest level of concentration). according to the largest number of analyzed indicators of concentration, the banking market in serbia was the least concentrated market in the group of analyzed countries in the observed period. also, an overview of country rankings changes according to the concentration indicators in the banking sector (regarding the criterion of balance sheet total) was prepared. the results obtained show that there were no significant changes in the ranking of countries according to certain concentration indicators in the analyzed period. thus, the ranking of countries according to the indicator cr4 remained unchanged in 2012 compared to 2007 in all analyzed countries. the highest oscillations were recorded in the ranking of countries according to the hh index (in five out of eight countries). analyzed by countries, the banking market in romania and serbia did not record changes in country ranking according to none of the analyzed concentration indicators in the observed period. 148 economic analysis (2019, vol. 52, no. 2, 137-151) table 4. country ranking and change in ranking (according to concentration indicators based on total assets) 2007 2012 change in country ranking cr4 hhi g cr4 hhi g cr4 hhi g serbia 8 8 7 8 8 7 = = = croatia 3 5 1 3 4 1 = -1 = bosnia and herzegovina 2 4 3 2 1 3 = -3 = montenegro 5 1 8 5 5 8 = +4 = macedonia 1 2 4 1 3 6 = +1 +2 romania 6 6 2 6 6 2 = = = bulgaria 7 7 5 7 7 4 = = -1 albania 4 3 6 4 2 5 = -1 -1 source: authors' calculation our research has shown that there are differences in the degree of correlation among the analyzed concentration indicators. because of that, in terms of statistics, it is difficult to talk about the capacity of only one indicator, if analyzed independently, to show the real nature of competition in the banking sector in the analyzed countries and to provide quality estimates of possible future movements. a statistically significant positive correlation between the indicators cr4 and hhi (0.911) was found with the significance threshold of 0.01, as well as the relative weak correlation of the gini coefficient with the indicators of cr4 and hhi. in this context, in order to have a more accurate insight into the concentration level, it is necessary to include a greater number of concentration indicators as well as their integral understanding. table 5. pearson correlation coefficient between concentration indicators (according to the criterion of total assets) cr4 hhi g cr4 pearson correlation 1 .911** .209 sig. (2-tailed) .000 .154 n 48 48 48 hhi pearson correlation .911** 1 -.023 sig. (2-tailed) .000 .876 n 48 48 48 g pearson correlation .209 -.023 1 sig. (2-tailed) .154 .876 n 48 48 48 **. correlation is significant at the 0.01 level (2-tailed). *. correlation is significant at the 0.05 level (2-tailed). source: authors' calculation additionally, a qualitative assessment of common and specific elements characteristic for the sector (nature of the market and the relationship between competitors on it) is needed (lipczynski & wilson, 2001). these elements have greatly influenced or will affect the development of banking in the analyzed countries. starting from the research in which deidda & fattouch (2005) analyzed the relationship between economic growth and bank concentration, concluding that in relatively underdeveloped countries the concentration in the banking sector was negatively correlated with economic growth, we tried to test the strength of the relation between the concentration level (expressed by cr4, hhi and g concentration indicators) and the gross domestic product per capita (gdp per capita) indicator, using the correlation of ranking, on the example of analyzed countries in 2007 and 2012. maja dimić, svetislav paunović 149 table 6. spearman's correlation coefficient between the concentration indicators (according to the criterium of total assets) and gross domestic product per capita 2007 2012 gdp per capita gdp per capita cr4 correlation coefficient -.310 cr4 correlation coefficient -.333 sig. (2-tailed) .456 sig. (2-tailed) .420 n 8 n 8 hhi correlation coefficient -.286 hhi correlation coefficient -.571 sig. (2-tailed) .493 sig. (2-tailed) .139 n 8 n 8 g correlation coefficient .381 g correlation coefficient .452 sig. (2-tailed) .352 sig. (2-tailed) .260 n 8 n 8 source: authors' calculation obtained spearman’s coefficient values argue that the level of concentration in the banking sector is poorly correlated with the level of economic development, since in all observed parameters the correlation value is moving to the zone of very low values. this, on the one hand, points to the fact that the analyzed countries at relatively similar levels of development had significantly different levels of concentration, but also the fact that some countries, although at different levels of development, had similar levels of concentration of the banking sector. in the first case, a group of countries that have almost equal gdp per capita (serbia, bosnia and herzegovina and macedonia) had large differences in the level of concentration. on the other hand, although croatia and albania vary significantly according to the level of economic development (three times higher gdp per capita in croatia than in albania in 2012), they have similar levels of concentration in the banking sector (according to total assets). having in mind the analyzed development criteria (balance sheet, granted loans and collected deposits), it can be stated that the banking sector in the region lags behind the banking sector in the eu countries, primarily due to the low and underdeveloped market, political, economic and credit risks, but also insufficient innovativeness and high poverty rates. most of the reform reflected in the privatization of state-owned banks and the opening of the domestic financial market for foreign investments. at the beginning of the restructuring process, the domination of state-owned banks was noted. several years after, the market share of foreign investors was higher. regarding the number of participants in the banking market, in the number of banks in the region was stagnant. the lack of interest of foreign banking groups can be explained by the fact that fewer banks have been attractive for takeover, that the banking market in the region is oversaturated, that the banking profit margins have fallen (due to which many investors left the market in the region), but also the negative effects of the world economic crisis, which have led to the increase in the venture investments and the fall in liquid assets available to foreign investors. conclusion the results obtained by empirical research in analyzed countries in the period 2007-2012 indicated high average level of concentration in the banking sector measured by gini coefficient. regarding the hypothesis 1, the results of the correlation analysis of the cr4, hhi and the gini coefficient indicated significant differences in the degree of correlation between individual concentration indicators. from the findings of the conducted research we can conclude that relatively different conclusions can be drawn about the level of concentration on the banking market in the analyzed countries in the region while using different techniques and indicators of concentration. if analyzed individually, the indicators have relatively low capacity to present the real nature of competition in the banking sector in the observed countries as well as to provide a 150 economic analysis (2019, vol. 52, no. 2, 137-151) good estimation of possible future trends. therefore, simultaneous analysis of several concentration indicators is needed. regarding the hypothesis 2, our research indicated that the degree of concentration in the banking sector is poorly correlated with the level of economic development. in order to obtain clearer images of market concentration in the financial sector, recommendation to decision-makers in referent institutions and regulatory bodies is to include a greater number of concentration indicators in their reporting on the level of concentration in the banking sector, which can contribute to a more precise definition of adequate policies and legal regulations in this area. in addition to the quantitative analysis of the level of concentration, it is also necessary to qualitatively assess the common as well as the specific elements of the banking sector in the countries of the region. in this context, it is necessary to take into account the specificities of individual countries (institutional barriers, geographic barriers to entry, macroeconomic indicators and historical aspects) as well as the characteristics of the banking sector. the referent regulatory bodies are expected to establish appropriate mechanisms and instruments of economic and financial policy and controlling as well as to define legal regulation in this area that will encourage the enlargement of the market scene in the analyzed sectors (which should contribute to further business efficiency), but also to prevent the creation of undesirable and over-concentrated markets and market structures. in this context, the approach and methodology used in this research can contribute to a better and more accurate understanding of all 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''role of foreign banks in integration of banking industry’’ economic journal, 22(2):296-313. article history: received: may 29, 2019 accepted: september 27, 2019 ea_2019_2 doi: 10.28934/ea.19.52.2.pp152-162 scientific review theoretical and practical foundations of inflation targeting with special emphasis on the experience of serbia milena lazić1* | ivana domazet2 1 belgrade banking academy faculty of banking, insurance and finance, university union, belgrade, serbia 2 institute of economic sciences, belgrade, serbia abstract compared to the 1970s when the inflation rate in most countries reached double digits, nowadays we are facing low inflation rates globally. inflation targeting, as a monetary policy strategy, appeared in late 1980s in the period when other strategies proved to be insufficiently effective. the first country to apply inflation targeting in 1989 was new zealand. since then, 64 countries have implemented the inflation targeting as a monetary policy regime. the concept of inflation targeting as a strategy for conducting monetary policy in serbia was introduced in august 2006. when choosing the appropriate strategy to ensure price stability, the nbs relies on the experiences of other countries, especially central and eastern european countries. accordingly, the paper aims to present the genesis of the development of the inflation targeting, as well as the impact of applying this strategy on reducing global inflation. a special segment of this paper is devoted to the analysis of the experiences of serbia in terms of applying the inflation targeting. key words: inflation targeting, small open economy, transmission mechanism of monetary policy, pass-through effect, dollarized economy, serbia jel classification: e4, e5, e6, n1 introduction contemporary central banking faces numerous challenges. in this regard, the authors kozaric and fabris (kozaric & fabris, 2012) stated in their paper that the key problems that central banks are facing today are the followings: • choosing monetary policy goal; • choosing monetary policy regime and • selecting the key monetary policy instruments. as far as the goals are concerned, friedman (friedman, 1968) states that there is a consensus among the general public regarding the basic objectives of economic policy in terms of high employment, low inflation (price stability) and economic growth. the author, however, considers that there is no such consensus to their mutual consent. however, the findings of numerous empirical studies have confirmed the existence of a positive link between price stability (stable economic environment) and economic growth. it is therefore not surprising that the large number of modern central banks as the main goal (or one of the basic goals) of * corresponding author, e-mail: milena.lazic@bba.edu.rs milena lazić, ivana domazet 153 monetary policy management emphasize the establishment and maintenance of price stability, i.e. the preservation of the purchasing power of the national currency. in addition, most contemporary central banks implement their monetary policy within the framework of some of the current regimes. generally, monetary policy regimes provide a framework for the decision-making process implemented by monetary authorities in the country (in the form of a set of more or less rigid rules and procedures). in this regard, the authors bordo and schwartz (1997) in their paper made a distinction between monetary regimes and monetary standards. according to these authors the monetary policy regimes imply ".... a set of monetary arrangements and institutions accompanied by a set of expectations expectations by the public with respect to policymakers’ actions and expectations by policymakers about the public’s reaction to their actions.... ". contrary to that, and according to these authors, monetary standards refer only to institutions and arrangements which are in the function of managing money supply. historically, over time, two basic categories of monetary policy regimes have been singled out. the first category includes regimes that have implied convertibility of currency into goods (usually gold). the second category includes contemporary regimes that function within the framework of the so-called fiat money. these are as follows: • exchange rate targeting; • monetary aggregates targeting (monetary targeting); • monetary policy regime with an implicit nominal anchor and • inflation targeting. as with homogeneity of the perception of the basic goals of monetary policy, there is a certain consensus regarding the trend of the application of different monetary policy regimes. eugenio domingo solans, the member of the executive board of the european central bank1, believes that in recent years the tendency towards the "standardization of the monetary policy regimes" has become more prominent at the global level. namely, in the last few decades, there has been a shift in the way monetary policy is conducted. in other words, many countries have abandoned various forms of fixed exchange rate regimes that they applied until then, adopted a free (or managed) floating of their currencies, or implemented a strategy of inflation targeting. with that regard, one of the key findings presented in the work of the author pesakovic (2017) was the importance of historical perspective when conducting a policy which was often ignored in past. the first country which applied inflation targeting in 1989 was new zealand. since then, 64 countries2 have implemented the inflation targeting as a monetary policy regime. the concept of inflation targeting as a monetary policy regime in serbia was introduced in august 2006. when choosing the appropriate regime/strategy to ensure price stability, the nbs relies on the experiences of other countries, especially central and eastern european countries. with that regard, the subject of this paper is the analysis of our country's experience regarding the implementation of inflation targeting regime. the paper aims to illustrate the basic effects of inflation targeting implementation in the case of serbia as a small open emerging market economy with recent hyperinflation past. the paper consists of four parts. after the introductory remarks, the second part provides an overview of the literature which deals with the inflation targeting strategy and points to the main advantages and disadvantages of this monetary policy regime. in the third part the experience of serbia regarding the application of inflation targeting strategy was analyzed. within the fourth, i.e. final part, concluding observations and recommendations for further research in this area have been provided. 1 more on: https://www.ecb.europa.eu/press/key/date/2000/html/sp001201_1.en.html 2including the european union, usa and south african countries, see more on: http://www.centralbanknews.info/p/inflation-targets.html 154 economic analysis (2019, vol. 52, no. 2, 152-162) literature review compared to the 1970s when the inflation rate in most countries reached double digits, today we are facing low inflation rates globally (with the exception of underdeveloped countries in south america, africa and asia). inflation targeting, as a monetary policy strategy, appeared in late 1980s in the period when other strategies proved to be insufficiently effective. bernanke, laubach, mishkin and posen (bernanke et al., 2001) in their paper defined inflation targeting as the monetary policy framework whose main characteristics are public announcement of numeric target (or fluctuation zone) for the selected inflation rate for one or more time periods, as well as a clear determination of monetary authorities that stable and predictive inflation rate is the main goal of the monetary policy. inflation target is mostly connected with the consumer price index, i.e. some variances of this index which occur by exclusion of some price categories (food price, energy, mortgage loans interest rates, etc.). heenan, peter and roger (heenan, peter & roger, 2006) selected the four pillars which they consider to be the basis of inflation targeting: • explicite determination of the central bank to proclaim price stability the main goal of the monetary policy, as well as a high degree of central bank independence in its everyday operational procedures; • defining explicite numeric target for the selected rate of inflation; • responsibility of central bank for implementation of the proclaimed goal which is reflected through a high level of transparency in conducting monetary policy; • implementing policy based on pro-active approach, i.e. anticipation of factors which can contribute to the growth of inflationary pressures and accordingly undertaking appropriate measures. complementary to the above mentioned, in his paper svensson (2010) emphasized the following basic characteristics of the inflation targeting: • the public announcement of the numerical target or the fluctuation zone of the targeted inflation rate measured mainly by the consumer price index (it is also important to note that the inflation rate is previously defined for the midterm goal); • high level of transparency and responsibility of monetary authorities which is accomplished through continuous communication with the public regarding plans and goals along with making public reports on inflation and its determinants; • goals regarding stabilization of economic activity are not ignored, although these goals are considered in the long run; • a certain (justified) deviation from a defined target is tolerated in order to prevent sudden shocks in the short run. inflation targeting should be considered primarily as a framework for conducting monetary policy, rather than as a set of rigid rules that the monetary authorities in the country must adhere to (hammond, 2012). implementation of the inflation targeting implies that the central bank sets an explicit target in terms of the level of inflation rate, which necessarily affects the increase in the level of transparency, i.e. the establishment of the credibility of the monetary policy process. generally, central banks usually opt for a "more flexible" form of inflation targeting strategy, that is, instead of explicit numerical value for the target rate they determine the fluctuation zone and the probability of realization of each scenario. in this way, the emphasis is placed on the medium-term (most often two to three years) the fulfillment of the set goal, i.e. justifiable deviations are allowed in the short run. according to some authors (gürkaynak et al., 2006), this allows monetary authorities to manage inflationary expectations more easily, while at the same time it represents an efficient method for controlling the level of inflation in the long run. in fact inflation targeting is a milena lazić, ivana domazet 155 strategy based on two contradictory elements: defining a precise numerical value for the targeted inflation rate in the medium term and responding to sudden and unforeseen shocks in the short run (king, 2005). the inflation targeting defines a framework for conducting monetary policy which is based on the rule which speaks in favor of the potential rigidity of the regime itself. the regime basically consists of defining the operational target for the nominal short-term interest rate of the central bank that functions in the inflation targeting framework. in his book, woodford (2003) states that decision made by monetary authorities almost always involves determination of the level of the short-term interest rate that is in the function of an operational target, as well as increased transparency in decision-making and reaching the ultimate goal. in this context, it is not surprising that dedication to achieving the ultimate goal implies the definition of a specific procedure when deciding on the amount of the short-term interest rate. however, what gives some flexibility to the regime is the fact that the central bank never actually fixes the interest rate completely. in addition, within the defined framework, the central bank has discretion to respond to sudden shocks. regarding the aforementioned stipulations, in practice there are two basic ways in which the central banks achieve defined operational target in terms of the numerical value of the selected nominal short-term interest rate. the first way involves conducting open market operations in the form of regulating the amount of money in circulation. the other way represents the corridor system and is applied, among other things, in our country. the corridor system involves determining the amount of the selected key interest rate and the basic money market interest rates deposit facilities interest rate and lending facilities interest rate. the interest rate corridor system has proven to be highly efficient in countries such as canada, australia and new zealand. the most famous practical example of the rule for determining the level of the short-term nominal interest rate was defined by john taylor in 1993 (taylor rule). in its basic form, taylor rule was defined by the following equation: it = 2 + πt + 0,5 (πt – 2) + 0,5 (yt yt p) where πt stands for the current inflation rate and yt and yt p represent gross domestic product and potential gross domestic product, respectively. taylor’s rule is defined according to the available empirical data for the american economy. as the optimal inflation rate, the rate of 2% has been selected. compared to other strategies, the inflation targeting strategy provides the wider public with the clearest explicit goal, places more emphasis on the transparency of central bank operations and the growth of their credibility (obradović, dinić, & pivašević, 2014). in addition, some authors (arestis & sawyer, 2008) believe that the application of the inflation targeting as a monetary policy regime reduces the importance of fiscal policy, due to the reduction of the possibility of deficit budget financing from the primary emission. svensson (2002) stated that the strategy of inflation targeting proved more efficient in the domain of reducing the growth rate of the general level of prices compared to the strategy of monetary aggregates targeting. apart from that, in addition to reducing the inflation rate, it has been proved empirically that the huge number of countries managed to increase credibility and transparency in conducting monetary policy by applying the inflation targeting as a monetary policy strategy (obradović, dinić, & pivašević, 2014). the first country which applied inflation targeting in 1989 was new zealand. inflation targeting was most often applied in situations where another monetary policy regime gave a bad results. thus, a large number of european countries accepted the concept of inflation targeting 156 economic analysis (2019, vol. 52, no. 2, 152-162) after a sudden collapse of the erm system in 1992 (fabris & galić, 2016). today, almost all central banks in the world are legally required to declare price stability as one of their primary goals (laurens et al., 2015). the panel of countries that implement inflation targeting is very heterogeneous. analyzing figure 1, it can be noted that the average level of inflation in developing countries has drastically decreased as the number of developing countries which started to apply this strategy increased (from the initial 60% in 1995 to less than 10% in 2014). when it comes to developed countries, the growth in the number of developed countries that implemented inflation targeting has also contributed to lowering the average inflation rate of developed economies, though to a far lesser extent. figure 1. the level of the world inflation (for developed countries and developing countries) and the begining of implementation of the inflation targering strategy source: (hale & philippov, 2015, p.2) the imf study supports the aforementioned (international monetary fund, 2005), showing that in the period 1990-2004 in the countries that implemented the inflation targeting, the inflation rate was 4.8 pp lower on average in comparison with the inflation rate of countries that applied some of the alternative monetary policy strategies. in addition, the implementation of the inflation targeting also contributed to lowering the inflation rate variability (declining variability by 3.6 pp versus countries that used alternative monetary policy strategies). advantages and disadvantages of the inflation targeting strategy are shown in table 1. table 1. advantages and disadvantages of implementation of inflation targeting strategy advantages disadvantages central bank focused on domestic shocks rigid regime with too much discretion it is not necessary to have stable and predictable link between inflation and monetary aggregates. controlled prices make implementation of the regime more difficult the strategy is comprehensible to general public underdeveloped financial markets make implementation of the regime more difficult milena lazić, ivana domazet 157 advantages disadvantages high level of transparency and communication with the general public interest rates growth increases the burden of debt servicing responsibility of the central bank in case of long time delays it is difficult to reach annual targets the central bank is focused on things it can influence – price stability risk of huge oscilations of the exchange rate lower costs in case of failure in conditions of informal dollarization it is difficult to implement the regime source: (fabris & galić, 2016, p. 345) although it has many advantages, the inflation targeting regime has some drawbacks as well. in the last few years, the question of the applicability of this regime in the presence of informal dollarization has been increasingly raised in the professional public. informal dollarization implies a situation where the economy and the population choose to use a foreign currency as a value keeper (which implies the high share of deposits denominated in foreign currency in total deposits). this resulted in a significant weakening of the key policy instrument (domestic short-term interest rates) to the achievement of the final target (targeted inflation rate / fluctuation zone). in their paper, fabris and galic (2016) state that countries with two currency systems which are characterized by a high level of fluctuations in the exchange rate cannot apply the conventional inflation targeting regime. namely, the high level of fluctuations in the exchange rate in the conditions of high dollarization significantly determines the level of prices in the country. regarding that, there is a consensus in the literature that the pass-through effect is higher in highly dollarized countries compared to those in which dollarization is not present (reinhart, rogoff, & savastano, 2014). experience of serbia in implementing inflation targeting over the past two decades serbian economy has been characterized by price volatility and high inflation rates, inadequate monetary policy and a very weak and underdeveloped financial system (vilaret, pješčić, & đukić, 2009). in order to increase the credibility of the central bank, for the last two decades domestic monetary authorities have been trying to build an environment with low and stable inflation rates. with that regard, numerous empirical studies have found that a low, stable and predictable inflation rate is positively correlated with the economic growth. currently and according to scores assigned by the two most prominent rating agencies, serbia has stable outlook, but there is a possibility for change in economic environment and a high credit risk, mostly due to slow economic grow and high share of public and foreign debt in gdp (brkić and pijalović). the problem of price instability, which culminated in hyperinflation in the first half of the 1990s, with the existence of high degree of pass-through of the exchange rate on prices, was the main reason why foreign exchange rate was used as a nominal anchor for a long time in the suppression of inflationary pressures (tasić, 2008). consequently, the inflation rate was reduced from 111.9% in 2000 to 15% in 2002. after the official exchange rate became equal to the market rate, the national bank of serbia abandoned the fixed exchange rate regime and introduced the managed floating as the exchange rate regime. all that resulted in decline of inflationary expectations in the forthcoming period. the concept of inflation targeting as a monetary policy regime in serbia was introduced in august 2006, although formal implementation of the regime did not start before january 2009. 158 economic analysis (2019, vol. 52, no. 2, 152-162) when choosing appropriate strategy to ensure price stability, the nbs relies on the experiences of other countries, especially central and eastern european countries. as a measure of inflation, the annual percentage change in the consumer price index is taken, which at the same time represents the most reliable numerical indicator of the direction of monetary policy conduct in the country. however, the inflation projection cannot be made without assuming direction of monetary policy conducting during the period covered by planning. the assumption of direction of monetary policy conducting is a critical aspect of the inflation projection because it can be interpreted as a statement of the intention of the central bank in the medium term (đurđević, 2007). the basic instrument that the nbs uses to achieve its goal is the key policy rate. other monetary policy measures are an auxiliary instruments whose main goal is to make the monetary transmission process more efficient. inflation projections are based on the assumptions about the movement of the interest rate on which they are based. with that regard, the literature provides three basic models for the projection of the inflation rate in the following period (đurđević, 2007): • constant key policy rate; • the key policy rate based on market expectations; • the key policy rate which central bank intends to follow. table 2 shows the monetary policy regime conducted by the national bank of serbia since the year 2000. apart from that, the main characteristics of these regimes are explained. table 2. monetary policy regimes implemented by the nbs in the period 2000 2015 monetary policy regime operation target exchange rate regime monetary policy instruments control of capital monetary targeting (20002006) net domestic assets (top); net foreign assets (bottom) managed fluctuation interventions on the foreign exchange market; the rate of mandatory reserve; open market operations yes (short term) inflation targeting (september 2006) short-term interest rates managed fluctuation with a tendency towards free fluctuation two-week (one week) repo rate as the main instruments; auxiliary instruments: interventions on foreign exchange market; prudential measures; mandatory reserve rate yes (short term) source: (vilaret, pješčić & đukić, 2009), p. 60 in the new monetary policy framework, the target for inflation is determined as a unique value with the allowed deviation for several years in advance. for the period from january 2018 to december 2019, the memorandum on targeted inflation rates of the national bank of serbia foresees a targeted rate of total inflation of 3% with a tolerance of +/1.5 p.p (see figure 2). milena lazić, ivana domazet 159 figure 2. realized inflation rate and its deviation from the predicted target for the period 2009 q1– 2019 q2 (year-on-year rates), % source: national bank of serbia official website taking into account that serbia is highly euro-oriented economy, in the conditions of applying the inflation targeting, the fact that the monetary policy in our country is far less effective and precise in comparison with other countries in which foreign currency is not dominant should be taken into consideration. the change in the key policy rate by the central bank should theoretically influence the cost of the loan and, consequently, the aggregate demand in such a way that any increase in that rate also increases the cost of borrowing, reduces the aggregate demand and lowers the inflation rate. in addition, the growth of interest rates simultaneously discourages consumption (aggregate demand), i.e. has a stimulating effect on the economy and savings. however, in highly dollarized economies operating in the inflation targeting regime, the change in the key policy rate only affects the cost of loans and deposits denominated in domestic currency, which implies higher volatility and far more significant changes in this instrument in absolute terms in order to achieve the desired effect. in support of the above mentioned, the results of the research conducted by rajkovic and urosevic (rajkovic & urosevic, 2016) point out that when faced with a negative external shock (under which the mentioned authors imply an increase in foreign interest rates), central banks operating in two-currency monetary systems tend to be more restrictive compared to central banks that do not function in dollarized economies. besides that, on the global level the global economic crisis led to the use and development of new tools for risk management in banking sector (abdesslem, pascal, 2014). in the case of our country, the fact that the dominant part of the loan is denominated or indexed in euro makes the direction of the ecb's monetary policy more likely to affect the cost of the loan (and therefore the aggregate demand) than the change in the key policy rate of the nbs. moreover, the success of the inflation targeting in serbia depends on comprehension and assessment of the impact of pass-through of the exchange rate on prices. numerous researches have shown that the classical channels of monetary transmission do not work in the financial system of our country which is highly euro oriented, that is, that the exchange rate channel becomes dominant channel of influence on the level of inflation and even 160 economic analysis (2019, vol. 52, no. 2, 152-162) the goal itself (šoškić, 2016). in his study šoškić noticed that for a more efficient monetary policy, i.e. a lower and more stable inflation rate, which is also within the defined inflation target, it is necessary to influence the reduction in level of dollarization (euroization), which would contribute to the smooth functioning of the traditional monetary transmission channel. conclusion experience of a great number of countries has shown that ensuring price stability, in the medium term, is a prerequisite for achieving other important macroeconomic goals stable and sustainable economic growth, employment growth and improvement in the living standards. it is therefore not surprising that a large number of modern central banks emphasize the establishment and maintenance of price stability as one of the basic goals of monetary policy implementation, i.e. the preservation of the purchasing power of the national currency. central banks of many countries around the world function in some of the contemporary monetary policy regimes. depending on the specificity of the particular economy, the chosen regime may prove to be adequate or inadequate. compared to other strategies, inflation targeting provides the wider public with the clearest explicit goal, and places more emphasis on the transparency of central bank operations, the improvement of their credibility and accountability in monetary policy management. the strategy proved to be more efficient in lowering the rate of inflation compared to the strategy of targeting monetary aggregates. moreover, apart from lowering the inflation rate, it has been empirically confirmed that a large number of countries have managed to increase the credibility and transparency of monetary policy in general through the implementation of inflation targeting. taking into account that serbia is an import dependent highly dollarized economy characterized by recent inflationary past and, in general, public mistrust in domestic currency, in addition to choosing the appropriate monetary policy regime the monetary authorities in our country have to pay special attention to the foreign exchange rate mechanism. consequently, comprehension and assessment of the impact of pass-through of the exchange rate on prices is crucially important for the success of inflation targeting in serbia. this is supported by the fact that, immediately prior to the implementation of the new monetary policy regime, the exchange rate was used as a nominal anchor in our country. in this regard, future research in this field should focus on the impact of the pass-through of the exchange rate on prices in the serbian economy. acknowledgments this paper is written as a part of the research projects oi179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements) and iii47009 (european integrations and social and economic changes in serbian economy on the way to the eu), financed by the ministry of education, science, and technological development of the republic of serbia. references arestis, philip, & sawyer, malcolm. 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(2003). interest and prices foundations of a theory of monetary policy. new jersey: princeton university press. article history: received: july 18, 2019 accepted: august 19, 2019 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp79-91 scientific review solving the problems of rural development as environmentally desirable segment of sustainable development vladan joldžić1* | ana batrićević1 | vera stanković1 | nikola paunović1 1 institute of criminological and sociological research, belgrade, serbia abstract the paper highlights key problems of rural development in the context of economic and environmental crisis, with focus on rural areas in serbia. it emphasizes the link between sustainable rural development and environmental protection, particularly in the fields of organic agriculture, small organic farming and agro-eco tourism. it analyses legislative and strategic documents regulating this issue on universal, european and national level, making suggestions to improve their application. obstacles for sustainable rural development include: uncultivated agricultural lands, soil pollution, insufficient irrigation or draining, agricultural lands fragmentation, poor infrastructure, inadequate tax policy, uncompleted restitutions, long probate proceedings and financially uncertain position of land-owners. some of them have environmental impacts and can be resolved by suitable policy and legislation, strategic planning, environmental education and financial stimuli for green agriculture. the paper suggests legislators and policy makers in the areas of: sustainable development, taxes, agriculture, green economy and environment protection to analyse more profoundly key problems of rural development and their linkage to nature conservation. when it comes to practice, it suggests which legal documents should be applied in order to achieve successful, sustainable and environmentally acceptable development of rural areas. the paper contributes to a better understanding of the relationship between sustainable rural development and environment protection, emphasizing the possibility to preserve nature and increase incomes of rural communities through green agriculture, small farm production and eco-tourism. it also states that current legislative framework provides preconditions for resolving the issues that might appear within, suggesting key steps for its future implementation. key words: sustainable development, rural development, agriculture, eco-tourism, environment protection, ecology, green economy jel classification: q01, q57 introduction the most widely accepted definition of sustainable development is the one from the report of the world commission on environment and development: our common future, also known as the brundtland report. it describes sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs” (world commission on environment and development, 1987). national sustainable development strategy of the republic of serbia defines sustainable development as targetsoriented, long-term (continuous), comprehensive and synergetic process with impacts on all * e-mail: vladanj@eunet.rs 80 economic analysis (2019, vol. 51, no. 1-2, 79-91) aspects of life (economic, social, environmental and institutional) at all levels (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). in its paragraph 54, the united nations’ resolution “transforming our world: the 2030 agenda for sustainable development”, adopted in 2015, proclaims 17 “global goals” of sustainable development with 169 targets between them. they include the following: 1) end poverty in all its forms everywhere; 2) end hunger, achieve food security and improved nutrition and promote sustainable agriculture; 3) ensure healthy lives and promote well-being for all at all ages; 4) ensure inclusive and equitable quality education and promote lifelong learning opportunities for all; 5) achieve gender equality and empower all women and girls; 6) ensure availability and sustainable management of water and sanitation for all; 7) ensure access to affordable, reliable, sustainable and modern energy for all; 8) promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all; 9) build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation; 10) reduce inequality within and among countries; 11) make cities and human settlements inclusive, safe, resilient and sustainable; 12) ensure sustainable consumption and production patterns; 13) take urgent action to combat climate change and its impacts; 14) conserve and sustainably use the oceans, seas and marine resources for sustainable development; 15) protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss; 16) promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels and 17) strengthen the means of implementation and revitalize the global partnership for sustainable development. as stated in paragraph 55 of the agenda, “the sustainable development goals and targets are integrated and indivisible, global in nature and universally applicable, taking into account different national realities, capacities and levels of development and respecting national policies and priorities”. however, each state is free to decide how the global targets should be implemented into their national planning processes, policies and strategies. it is also emphasized that the link between sustainable development and other relevant ongoing processes in the economic, social and environmental areas should be recognised. by insisting on the correlation between economic, social and environmental fields in the process of sustainable development, paragraph 55 of the agenda implies that sustainable development comprises three interrelated components or aspects that should not be perceived as independent one from another. national sustainable development strategy of the republic of serbia highlights that sustainable development involves the need to harmonize the different aspects of development and the contradictory ideas included in each individual sectoral program. accordingly, the strategy’s key objective is to establish a balance between the three key factors, or three pillars, of sustainable development: 1) sustainable economic growth, economic and technological progress, 2) sustainable social development, based on social balance, and 3) environmental protection accompanied by reasonable use of natural resources. the strategy attempts to join these three pillars within an adequate institutional framework. sustainable rural development the term “rural” appears to be rather vague. although there is no exact definition of that term, rural areas can be clearly recognised. they form the space where human settlements and infrastructure occupy only small parts of landscape, whereas fields, pastures, woods, forests, waters, mountains and deserts tend to be predominant. in rural areas, people usually live in farmsteads or settlements of not more than 10.000 persons. however, the differences between urban and rural settlements vary from one country to another (ashley & maxwell, 2001). vladan joldžić, ana batrićević, vera stanković, nikola paunović 81 rural development represents "a multi-level process rooted in historical traditions" (van der ploeg et al., 2000: 391-392). today, it is related to a general restructuring of the economy at the global level and can be in part perceived as a response of the farm enterprises to new, more flexible trends in firms’ organisation. furthermore, modern rural development implies a new developmental model for the agricultural sector and a cohesion at farm level but also between different farms or farms and other rural activities as well as between local and regional ecosystems, specific farm-styles, goods, services etc. (van der ploeg et al., 2000). rural development can be observed either as a development policy managed by the state or as a broader concept of rural society change with or without state interventions. this implies that rural development refers to interventions of much more extensive character than agricultural development as well as to the process of rural society change that is not always directly influenced by the state (bogdanov, 2007). rural development should be perceived as a multi-actor process, involving a complex institutional setting. it is also multi-faceted process since it comprises a wide range of different practices, some of which are interconnected. these practices include: landscape management, natural values conservation, agro-tourism, organic farming and the production of high-quality and region-specific products (van der ploeg et al., 2000: 394). rural development also comprises nature conservation and landscape management and the development of short supply chains. all these activities are rather new and their number and variety actually seems to be much larger (knickel & renting, 2000). environmental sustainability is considered an important component of rural development is also given a significant amount of attention, especially in the european union. (ristić, 2013). the link between rural development and environmental protection was recognised for the first time in the 1980s, when agro-ecology emerged as an attempt to establish a scientific basis for alternatives to industrialized agriculture. the agro-ecological framework is based upon different intellectual traditions and disciplines, such as: peasant studies, ecology and environmentalism and development theory. it implies an alternative definition of sustainability from which an ecologically oriented discourse is shaped. its central concept is co-evolution of society and natural factors, i.e. humans and nature. (marsden et al, 2001). there are many aspects of rural development that are related to environmental protection: rural or agro tourism, agriculture and organic farming and food production are some of the most important ones. in accordance with the modern concept of rural development, agriculture is supposed to be multifunctional, which means that it includes some other activities that are not directed only towards the increase of production but comprise other benefits of rural environment. multifunctional agriculture has several aspects and one of them is environmental protection, i.e. conservation of biodiversity, preservation of natural landscapes and protection from floods, and erosion. namely, it has been converted from agriculture of production to agriculture of protection (pejanović & vujović, 2008). being socially, economically and ecologically acceptable, organic agriculture can significantly contribute to sustainable development of rural areas (ristić, 2013). due to declining economic activity, agricultural reforms, restructuring of the agricultural sector, deteriorating rural industrialisation and out-migration of educated young people from rural to urban areas, many rural communities have adopted tourism as an alternative development strategy. rural tourism is seen as a means for the economic and social regeneration of rural areas, particularly in eastern europe, and less developed countries of subsaharan africa, affected by rural poverty (briedenhann & wickens, 2004). rural, as a specific type of eco-tourism is already developing in some parts of serbia and should be strongly supported, in particular as a means to promote and enhance the conservation of environment. eco-tourism is considered environmentally responsible, it includes a low visitor 82 economic analysis (2019, vol. 51, no. 1-2, 79-91) impact, and contributes to socioeconomic participation of local populations (scheyvens, 1999). this type of tourism is also addressed to as agro-tourism and is also important for rural development. it is a type of tourism focused on healthy nutrition of tourists and spending time in healthy environment that is accomplished through the development of agriculture with respect to different aspects of sustainability (pejanović & vujović, 2008). tourism development has the potential to generate new jobs, improve community infrastructure and assist in revitalising the weakening economies of rural areas. that is the reason why governments often tend to see it as a solution to the problems of rural areas. but, it has to be developed wisely in order to avoid lack of incomes, the unfairness of profit distribution and the social costs to resident communities (briedenhann & wickens, 2004). therefore, it is important that local communities have some control over it and share the benefits it provides, which can only be provided if conservation and development at the local level are promoted (scheyvens, 1999). problems affecting rural areas in the past couple of decades, the state of rural development has been rather troubled, primarily due to rural poverty, decline in funding to the agricultural sector and inappropriate policy created by international funding agencies and developing country governments (ashley & maxwell, 2001). in spite of the fact that the importance of agriculture varies significantly from one european country to another, its general significance seemed to be decreasing in the past decade (van der ploeg et al., 2000). in the eyes of public and policy-makers, the agricultural sector has been considered detached, over-subsidized and unattractive because of crisis in food production, growing health risks, environmental loss, overproduction of low-quality products and the decline in number of producers and farm workers (marsden et al, 2001). poverty, marginalization, depopulation and low quality of life in rural areas causing village decay are now identified as a global problem (vasilevska, 2010). in developed countries, rural poverty is observed in the context of lower incomes per capita in rural areas in comparison to average national incomes and incomes in urban areas. poverty of some rural areas leads to their social exclusion, causes lower education and diminishes their developmental possibilities, similar to ghettos in urban areas. poverty in both rural as well as urban areas also results in the degradation of natural environment and has negative implications in social and economic sphere (bogdanov, 2007). the link between poverty and environment is often mentioned in the context of sustainable development. this refers to rural poverty as well, since rural development is particularly dependent on natural resources. researches show that high level of rural poverty and unemployment is most commonly closely related to the fact that rural areas predominantly depend on agriculture. the experiences of developed countries in resolving the problems of economic and demographic devastation of rural areas have confirmed that the policy of sustainable rural development should not support only agriculture but non-agricultural economic activities (ristić, 2013). the aforementioned is particularly important for environmentally fragile and poor rural areas, where incomes from agriculture are faced with the high risk and should be replaced with non-agricultural activities such as gathering (local flora and fauna, farming and livestock husbandry (reardon & vosti, 1995). problems of rural development in serbia rural areas comprise around 85% of serbia’s territory and are the home of one half of its population. there are altogether 5.965 rural settlements in serbia, whereas 6.158 are considered urban. demographic trends in rural areas are increasingly negative, primarily due to migration and negative birth rate. due to that, rural population comprises 40.6% of serbia’s vladan joldžić, ana batrićević, vera stanković, nikola paunović 83 population (strategy of agriculture and rural development of the republic of serbia for the period between 2014 and 2024, official gazette of the republic of serbia, no. 85/2014). natural resources (including agricultural lands, forests, waters, flora, fauna and cultural heritage) represent important components of rural areas in serbia. despite their natural potentials, rural areas in serbia are facing an array of persistent problems such as: negative demographic trends, undeveloped infrastructure, fragmented agricultural households that are not market-oriented, inadequate structure of production, low productivity rate, minimal household incomes, large share of agriculture in rural economy, low rate of diversification of rural economy, high unemployment rate, insufficient trading capacities, poor organisation, inability to compete with foreign producers, lack of state support etc. (pejanović, 2009; ristić, 2013). the crisis of serbian agriculture has been lasting for a long time and long-term problems that emerged as the consequences of lack of systematic and continuous economic policy measures caused a permanently inconvenient situation in agriculture (pejanović, 2009). as stated in national sustainable development strategy, intensive urbanization and industrialization in serbia have caused intensive migrations from rural to urban areas, massive loss of large fertile agricultural lands and decelerated socio-economic and cultural development of rural areas. the lack of systematic state support to integral rural development also contributed to the neglect and abandonment of households, agricultural lands and other natural resources in rural areas. nowadays, natural, infrastructural and other conditions relevant to agricultural production differ from one rural area to another. these differences affect social development, demographic characteristics, cultural features, attitudes towards tradition, views on modernization and environmental awareness of individual rural areas (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). numerous problems related to rural development also affect components of the environment such as: soil, water and forests. the main threats for soil quality include: soil acidification, minimisation of organic particles’ level in the soil, soil pollution and erosion. for example, more than one quarter of agricultural lands in serbia are acidified, as the result of uncontrolled use of chemical substances and some areas in the province of vojvodina (around 14%) are salted. irrigation of soil is also not conducted in an appropriate manner. a small share of agricultural land is irrigated legally, some are irrigated only partially and the number of parcels irrigated without necessary permission is much larger. one of the most delicate issues regarding future development of agricultural sector in serbia is a very inconvenient age and educational structure of population involved with this type of production. this problem might affect social structure of rural areas as well as the capacities of human resources to adopt and implement new technologies, changes in production structure etc. (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). rural households are not equipped with modern technologies, their production is not enough specialised and the motivation of employees is not very high due to low incomes (pejanović, 2009). in spite of efforts of relevant institutions directed towards the conservation of biodiversity including the ratification of international treaties, adoption of national legislative framework and establishing of numerous protected areas, serbia is still facing obstacles when it comes to the implementation of policies and strategies in this field. insufficient financial resources, missing of appropriate institutional framework, lack of monitoring and information systems are some of the reasons causing such situation. closely related to the issues regarding biodiversity are the problems in the area of forestry. around 29% of forests are devastated, natural forests are rather old and their natural renewing is missing, some of the forests are dry and there are not enough forest roads. all these problems lead to insufficient use of forests’ potentials. serbia has made significant improvements when it comes to legislative framework dedicated to animal welfare. however, the condition in this field, especially when farm animals and animals in traffic are concerned, is still not in accordance with international standards. this affects livestock 84 economic analysis (2019, vol. 51, no. 1-2, 79-91) production and has a negative impact on the trust of foreign consumers (national sustainable development strategy, official gazette of the republic of serbia, no. 57/2008). legislative and strategic measures for resolving the problems of rural development united nations the un sustainable development agenda incorporates rural development in the goals of sustainable development, with special focus on developing and least developed countries. according to its paragraph 24, the states have made commitment to devote their resources to developing rural areas and sustainable agriculture and fisheries, supporting smallholder farmers, especially women farmers, herders and fishers in developing and least developed countries. in its second goal (end hunger, achieve food security and improved nutrition and promote sustainable agriculture), the agenda mentions rural development in the context of investment in rural infrastructure, agricultural research and extension services, technology development and plant and livestock gene banks in order to enhance agricultural productive capacity in developing countries, in particular least developed countries. within its eleventh goal, dedicated to making human settlements inclusive, safe, resilient and sustainable, the agenda promotes supporting of positive economic, social and environmental links between urban, peri-urban and rural areas by strengthening national and regional development planning. the economic and social council of the united nations plays an important role in the promotion of sustainable rural development on a global level. for example, ministerial declaration on promoting an integrated approach to rural development in developing countries for poverty eradication and sustainable development(http://www.un.org/esa/coordination/alliance/documents/website/ministerial% 20declaration.pdf) adopted in 2003 among other issues, states that the eradication of rural poverty and hunger is critical to the achievement of the internationally agreed development goals, including the millennium development goals. it suggests that rural development should be an integral part of national and international development policies, including bilateral donor response strategies and the activities and programmes of the united nations system. the declaration emphasizes that rural development should be pursued through an integrated approach, encompassing the economic, social and environmental dimensions. it should also take into account the gender perspective and consisting of mutually reinforcing policies and plans. such approach to rural development is supposed to be balanced, targeted, situation specific and locally owned. it must include local synergies and initiatives and be responsive to the needs of rural populations. although the declaration considers rural development the responsibility of each country it claims that enabling international economic environment is significant to support effective national development efforts, including rural development efforts. empowerment of population living in poor rural areas is strongly supported by the declaration. it is particularly pointed out that poor people living in rural areas should play a full and effective role in their development by participating in the decision-making processes, relevant to: resource allocation; promoting mechanisms. they are encouraged to influence the market and public policies as well as to participate fully in the design, development and implementation of rural development strategies and programmes. environmental protection is also mentioned in the declaration. the declaration reaffirms that sustainable agriculture and rural development are vital to the implementation of an integrated approach to food security and safety in an environmentally sustainable way. it states that rural populations play an important role in sustainably managing natural resources, including biodiversity and in combating desertification and land degradation. accordingly, the declaration supports the promotion of environmentally sound and sustainable natural resources vladan joldžić, ana batrićević, vera stanković, nikola paunović 85 management, including the implementation of integrated land management, sustainable forest management programmes and water-use plans. the declaration invites states and international organisations to target rural areas and households more systematically in their poverty reduction policies by integrating poverty eradication and food security as well as environmental objectives more firmly in poverty reduction strategies. european union third the european union has been insisting on coordination between agriculture, rural economy and sustainable rural development for decades and has adopted several documents regulating these issues and setting basic principles of their future development and management. rural development is a part of common agricultural policy and is included in the targets set by europe 2020: a strategy for smart, sustainable and inclusive growth. the so-called “neo-ruralism” emerged in the european union during the 1960s as a reaction to inconvenient position of agriculture and rural regions in industrially developed countries. it is based on the multifunctional concept of agriculture and presumption that agriculture is not the only activity rural areas can benefit from, but that it should also comprise: environment and natural landscapes conservation, food supply safety, increase of employment in rural areas, social and economic benefits, preservation of tradition and cultural heritage of rural areas etc. (pejanović & vujović, 2008). common agricultural policy (cap) of the european union represents a legal framework for agricultural and rural development of its member states (veselinović, 2009). it contains several documents pertinent to the issue of sustainable rural development and its environmental aspect. it was created in 1962, and reformed in 1992, 2003 and 2013, adapting the policy to a changing world. moreover, the commission's agenda 2000, adopted in 1999, established economic, social, and environmental goals within the objectives of the cap. today, four main regulations govern the common agricultural policy (https://ec.europa.eu/agriculture/cap-overview_en). they were introduced by a reform in 2013 to simplify legislation and have been applied since 2014. cap has always been taking into consideration the improvement of the environment and landscapes, and this issue represents an important strategic goal that member states are supposed to implement in their national strategies of rural development (veselinović, 2009: 61). when it comes to sustainable rural development and its environmental aspect, the most important of them is regulation (eu) no 1305/2013 of the european parliament and of the council of 17 december 2013 on support for rural development by the european agricultural fund for rural development (eafrd) and repealing council regulation (ec) no 1698/2005 (http://data.europa.eu/eli/reg/2013/1305/oj). the regulation invites eu member states to focus on priorities such as: knowledge transfer and innovation in agriculture, forestry and rural areas, farm viability, the competitiveness of all types of agriculture in all regions, promoting innovative farm technologies, sustainable management of forests, the organisation of the food chain, animal welfare, risk management in agriculture etc. it also asks them to focus on: restoring, preserving and enhancing ecosystems that are related to agriculture and forestry, the promotion of resource efficiency and the shift towards a low carbon economy in the agricultural, food and forestry sectors, and to promoting social inclusion, poverty reduction in and the economic development of rural areas (article 4). the regulation’s objectives also include environmental protection and climate change mitigation and adaptation. it invites member states to limit emissions in agriculture and forestry from key activities such as livestock production, fertilizer use and to preserve carbon sinks and enhance carbon sequestration with regard to land use, land use change and the forestry sector (article 4). furthermore, the regulation emphasizes that priorities for rural development in the eu should be pursued within the framework of sustainable development and environmental protection. it is also very explicit about the application of the polluter pays principle. among 86 economic analysis (2019, vol. 51, no. 1-2, 79-91) other goals of knowledge and information sharing between farmers, rural small or medium enterprises and forest holders, is the enhancement of their abilities to increase resource efficiency and improve their environmental performance while contributing to the sustainability of the rural economy (article 12). when improvement of rural areas’ development is concerned, the regulation suggests the following approaches: the creation and development of new economic activity in the form of new farms, the diversification into non-agricultural activities including the provision of services to agriculture and forestry, activities related to health care, social integration and tourist activities (article 17). the regulation points out forestry as a particularly important part of rural development, claiming that support for sustainable and climate friendly land use should include forest area development and sustainable management of forests (article 20). in that context, the regulation insists on granting payments to forest holders who provide environment-friendly or climate-friendly forest conservation services by enhancing biodiversity, preserving high-value forest ecosystems, improving their climate change mitigation and adaptation potential. the measures of particular importance include the reinforcement of the protective value of forests when it comes to soil erosion, maintenance of water resources and natural hazards (article 28). the targets set by europe 2020: a strategy for smart, sustainable and inclusive growth (european commission, 2010) represent an overall assessment of where the eu should be on key parameters by 2020. they are interrelated, mutually reinforcing and include: employment, research and development, climate change and energy, education and poverty and social exclusion. europe 2020 highlights three priorities: 1) smart growth: developing an economy based on knowledge and innovation, 2) sustainable growth: promoting a more resource efficient, greener and more competitive economy and 3) inclusive growth: fostering a highemployment economy delivering social and territorial cohesion. sustainable growth includes, among other, building a resource efficient, sustainable and competitive economy, developing new processes and technologies, including green technologies. the aim of this approach is to help the eu to prosper in a low-carbon, resource constrained world as well as to prevent environmental degradation, biodiversity loss and unsustainable use of resources. according to europe 2020, the european commission is therefore expected to establish a vision of structural and technological changes required to move to a low carbon, resource efficient and climate resilient economy by 2050. one of the measures to achieve this goal includes the changes of agricultural, rural development, and maritime policies so that they address climate change. the adaptation measures these policies are supposed to introduce are based on more efficient use of resources, which would also contribute to improving global food security. the european commission is obliged to mobilise eu financial instruments including rural development funds, as part of a consistent funding strategy that pulls together eu and national public and private funding. all these goals and guidelines confirm that there is a close and complex relationship between sustainable rural development and environmental protection, which should be taken into consideration when creating national policies and legislation. it is also worth mentioning that the european union has been supporting rural development in other states that are not its members for decades. since 2007, candidate countries and potential candidates are receiving eu funding and support through the instrument for preaccession assistance, or ipa. this mechanism provides help for other countries, depending on their needs and status in the process of european integrations (janković, 2009). ipa has replaced the former pre-accession assistance instruments, i.e. the phare, ispa and sapard programmes, the specific pre-accession instrument for turkey and the cards programme. one of ipa’s components refers to agriculture and rural development. current beneficiaries are: albania, bosnia and herzegovina, the former yugoslav republic of macedonia, kosovo, montenegro, serbia, and turkey (https://ec.europa.eu/neighbourhoodenlargement/instruments/overview_en). vladan joldžić, ana batrićević, vera stanković, nikola paunović 87 legal framework relevant to rural development in serbia legislative framework and strategic documents regulating the area of agriculture and rural development were not fully developed in serbia, which caused the lack of clearly defined agricultural policy and a set of long-term enhancement measures (veselinović, 2009). on the other side, the countries that have a developed policy of regional and rural development, rural development is considered a development priority and occurs in almost all national and regional development programs (vasilevska, 2010). in the past couple of years, the republic of serbia has adopted a large number of laws, strategies and other documents that regulate key issues related to agriculture and rural areas, including the following: 1) law on agriculture and rural development (official gazette of the republic of serbia, no. 41/2009, 10/2013 and 101/2016), 2) law on incentives for agriculture production and rural development (official gazette of the republic of serbia, no. 10/2013, 142/2014, 103/2015 and 101/2016), 3) law on agricultural land (official gazette of the republic of serbia, no. 62/2006, 65/2008, 41/2009 and 112/2015), 4) animal husbandry law (official gazette of the republic of serbia, no. 41/2009, 93/2012 and 14/2016), 5) strategy of agriculture and rural development of the republic of serbia for the period between 2014 and 2024 (official gazette of the republic of serbia, no. 85/2014), 6) national program for agriculture and rural development (ministry of agriculture and environmental protection of the republic of serbia, 2014: 167), 7) forestry development strategy of the republic of serbia (official gazette of the republic of serbia, no. 59/2006), 8) biodiversity strategy of the republic of serbia (official gazette of the republic of serbia, no. 13/2011) and 9) national strategy for sustainable use of natural resources and goods (official gazette of the republic of serbia, no. 33/2012). the adoption of legal documents regulating agriculture and rural development was one of the obligations serbia had to fulfil on its road towards the european integrations in order to harmonize its legislation with the standards of the european union. also, the world trade organisation requires its members to harmonise their legislative measures in the area of agriculture and their agricultural policies (veselinović, 2009). having in mind the fact that rural development cannot be observed separated from environmental protection and sustainable use of natural resources, the following legislative and strategic documents should also be taken into consideration: 1) law on nature protection (official gazette of the republic of serbia, no. 36/2009, 88/2010, 91/2010 and 14/2016), 2) law on environmental protection (official gazette of the republic of serbia, no. 135/2004, 36/2009, 36/2009, 72/2009, 43/2011 and 14/2016), 3) law on strategic estimation of environmental impact (law on strategic estimation of environmental impact, official gazette of the republic of serbia, no. 135/2004 and 88/2010), 4) law on estimation of environmental impact (official gazette of the republic of serbia, no. 135/2004 and 36/2009), 5) law on integrated prevention and control of environment pollution (official gazette of the republic of serbia, no. 135/2004 and 25/2015), 6) law on air protection (official gazette of the republic of serbia, no. 36/2009 and 10/2013), 7) law on waters (official gazette of the republic of serbia, no. 30/2010, 93/2012 and 101/2016), 8) law on forests (official gazette of the republic of serbia, no. 30/2010, 93/2012 and 89/2015), 9) law on spatial plan of the republic of serbia between 2010 and 2020 (official gazette of the republic of serbia, no. 88/2010) and 10) law on planning and construction (official gazette of the republic of serbia, no. 72/2009, 81/2009, 64/2010, 24/2011, 121/2012, 42/2013, 50/2013, 98/2013, 132/2014 and 145/2014). finally, the fact that rural development in accordance with the principles of environmental protection has the potential to be improved via popularisation and promotion of eco-tourism, the provisions of law on tourism (official gazette of the republic of serbia, no. 36/2009, 88/2010, 99/2011, 93/2012 and 84/2015) should also be concerned in that context. 88 economic analysis (2019, vol. 51, no. 1-2, 79-91) conclusion it is assumed that the problems of rural development can be adequately treated within the regional development framework. this is supposed to be done through an integrated planning approach in accordance with sustainable development paradigm. such political willingness is based on the harmonization of two traditional approaches: regional or physical planning and environmental protection. problems of rural development require an integral approach depending on the characteristics of each individual rural area, local developmental potentials and socio-economic background. integral approach to sustainable rural development is focused on the population, economy, environment and institutions. rural development has to take into consideration various components such as: economic, ecological, social, energetic, cultural, religious, infrastructural and. new forms of farm-based rural development activities are emerging and different participants compete for opportunities and resources in rural areas. for example, the interests of farmers and owners of agricultural lands might sometimes be in conflict with the interests of wildlife conservationists, eco-tourists, hobby-farmers or high quality food producers. namely, enhancing the natural resource base could contribute to the reduction of rural poverty in cases where soil degradation is reducing yields on the farms of the poor. on the other hand, conserving natural resources might increase poverty. this refers to cases where poor rural households earn their incomes from activities such as gathering of wild flora and fauna or even depend on these as their key survival strategy. therefore, it is essential to recognise the interests that these subjects share and try to incorporate them into national rural development policies. multifaceted nature of rural development requires the synergy between different fields of activity and between different levels and actors. synergy may occur between local and regional eco-systems, specific farm styles, specific goods and services, localized food chains and specific social carriers and movements, but it also refers to the correlation between ecology and economy. this means that modern concepts of sustainable rural development demand the change of traditional organisation and management structures and relationships and the division of responsibilities, tasks, activities and funds between the state and the private sector as its important partner and their joint efforts aimed to improve local development. in this, “new paradigm of rural development”, agriculture cannot be viewed as the only solution to rural poverty. on the contrary, it should be developed along with other actual and potential rural activities that are suitable to enhance the capacities of rural households and increase their incomes. just like other developing countries, serbia is also facing numerous problems in the area of rural development. some of them are present in other countries as well, whereas others represent the results of specific historical, political, economic, social and cultural circumstances. rural areas in serbia still seem to have certain resources for successful implementation of sustainable development concept. nowadays, especially in the times of economic crises, agriculture, agro-industry and the potentials of rural areas play a significant role in the overall economic development of our country. however, the presence of several limiting development factors require profound structural changes and significant investment in this field. sustainable development of agriculture should be recognised as one of priorities of overall economic development. such approach is in accordance with european standards, includes a multi-functional agriculture and high-quality food production as key argument for competency. for example, organic agriculture has been spreading in serbia since 1990, but the number of agricultural lands for this type of production has been increasing in the past couple of years, thanks to support of several state and civil organisations. another environmentally desirable potential of rural areas lays in their renewable sources of energy that can be used for the production of biomass and biodiesel. this refers to various organic materials that appear as the vladan joldžić, ana batrićević, vera stanković, nikola paunović 89 results of agricultural production. unfortunately, it appears that this potential has not yet been fully used in serbia and it deserves a much stronger financial and educational state support. education of rural population in the fields of environmental protection and sustainable use of natural resources, as well as about the application of modern technologies and approaches is also very important. however, local peasant or indigenous knowledge also has to be recognised as significantly different from standard scientific knowledge, embedded in local ecology and encoded in culture rather than theory. it is relies on the interdependent accumulation of local, natural and social resources, practices and knowledge. they are not only important for maintaining “old cultures”, but also contribute to a constant renewal of knowledge systems. finally, normative regulation of rural development and other issues related to it is one of key preconditions for a more active role of the state in this area. it could be said that lack of adequate legislative framework contributed to the inconvenient position of rural areas in serbia. therefore, the adoption of allows and strategic documents harmonised with european standards represents a positive step. however, the laws and strategic documents must be implemented properly, with a more intensive monitoring, larger long-term investments in the rural areas, and multi-sectoral support. this is not possible without financial support from the budget, 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"report: our common future." http://www.un-documents.net/our-common-future.pdf article history: received: january 13, 2018 accepted: june 7, 2018 doi: 10.28934/ea.18.51.12.pp92-102 scientific review social responsibility of banks in the function of comparative advantage on the market milica raičević1* | dijana medenica mitrović 2 1 faculty of business studies “montenegro business school”, mediterranean university, podgorica, montenegro 2 faculty for business management bar, bar, montenegro abstract the business operation of companies is not neutral and is not perceived any more in terms of profitable operations, but also in terms of whether it is beneficial for the society. social responsibility contributes to improving relationships with key stakeholders, thus contributing to the long-term sustainability of the company. the paper points out to the positive link between corporate social responsibility (csr) and the reputation of the bank. without csr, neither the improvement nor the expansion of banking operations is possible. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a strong comparative advantage on the market. the paper gives a theoretical and practical overview of the concept of corporate social responsibility (csr), with a focus on the banking sector. in the theoretical part, the term csr is defined, as well as its significance and special features regarding the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its characteristics in terms of csr. the empirical part includes the qualitative analysis, based on the data available on the official sites of banks operating in montenegro. based on the collected internet data, an analysis of the factual situation was carried out, conclusions were given and recommendations have been made for the implementation of the csr concept with a view of improving the competitive position of banks on the market. through qualitative analysis of the available data, the advantages and disadvantages of corporate social responsibility of banks in montenegro were considered, as well as which csr activities are most represented and which still have the capacity to be improved and involved in the marketing strategies of the banks in montenegro. key words: social corporate responsibility, banks, reputation, marketing jel classification: n20, g20 introduction the turbulence of the environment, market changes that represent the process today, not just the business event as they once did, have led to the need for companies to re-examine themselves and to supplement their business strategy in order to gain competitive advantage in the market. in order to gain a competitive advantage they should focus on the people, that is, the need to increase the number of people who use their products and services or more simply believe in them. in order to be successful in a dynamic services market companies must delivered superior value to target customers who become more demanding, and choose products/services rationally, analysing relation between price and quality. the competitiveness of companies in the financial sector is largely based on fostering customer loyalty, integrating * e-mail: milica.raicevic@unimediteran.net milica raičević, dijana medenica mitrović 93 various communication channels, reducing operating costs and good risk management (domazet, stošić and hanić, 2016). in the last ten years, in the literature, as well as in the practice, the concept of social responsibility has started to develop, which focuses on the support to the community in which the business operations are carried out, and in return, these companies are recognized by the community as the companies which should be trusted, which is one of the ways in which the companies can contribute to their growth and their competitive advantage. banks, as a specific phenomenon by itself which has a specific way of generating profit, have realized that they have to incorporate the concept of social responsibility into their business strategy, in order to differentiate and gain a competitive advantage in the banking sector, which is characterized by an increasing number of banks and tougher competition in the financial market. the paper views the concept of social responsibility, the banks in montenegro, as well as the implementation or introduction of this concept in their operations. moreover, a positive correlation between corporate social responsibility (csr) reputation of the bank has been pointed out. the without the social responsibility of banks, it is not possible to improve or extend the banking operations. the aim is to point out that profit and csr are not opposed categories and that the csr of banks represents a serious comparative advantage on the market. the initial hypothesis: the application of the concept of social responsibility is an important factor for achieving competitive advantage and strengthening the position of banks in the financial market, all through the creation of services that will improve and expand banking activities, to create satisfied consumers who are loyal. auxiliary hypotheses are: 1. the willingness of banks to invest in csr activities will increase the confidence in banks by customers and the community 2. developing awareness of the importance of csr for company business and training and inclusion of employees in csr activities provides for a higher level of business and better reputation 3. socially responsible activities address the problem for which the state does not have sufficient financial resources, which also affects the strengthening of the reputation of the bank 4. improving the business environment creates the conditions for developing the competitiveness of banks and strengthening their position in the financial market, and therefore profit. the paper gives a theoretical and practical overview of the concept of csr and its application in the banking sector. in the theoretical part, the term csr is defined, its significance and specific qualities related to the application in the banking sector. the empirical part deals with the study of the characteristics of the montenegrin banking sector, its features in terms of csr. the empirical part covers qualitative analysis, on the basis of the data available from the official websites of the banks operating in montenegro. on the basis of the data collected from the internet, an analysis of the factual situation has been conducted, conclusions have been drawn and recommendations have been made for the application of the csr concept in order to improve the competitive position of banks on the market. through the qualitative analysis of the available data, the advantages and disadvantages of social responsibility of banks in montenegro have been studied. it has been analysed which csr activities are the most prominent, and for which there is still the space to be improved and involved in the marketing strategies of banks operating in this area. in the end, it has been pointed out that the awareness of the benefits the csr brings to the company has not still been developed in montenegro. the socially responsible practice is often perceived as an unprofitable and impractical activity. in recent years, in the banking sector, socially responsible activities are growing in importance and have a tendency towards growth. 94 economic analysis (2018, vol. 51, no. 1-2, 92-102) the social responsibility of banks is significant for the montenegrin economy and society, because socially responsible banking activities contribute to the improvement and advancement of the existing situation in certain segments which the country has insufficient resources to support. banks carry out their socially responsible activities through activities in the fields of education, health care, culture, sports, environment protection, and work with people with disabilities. in conclusion, the banks have a dual role, they are both promoters of socially responsible behaviour and institutions investing in those areas of vital importance, for which the state does not have enough resources. the csr of banks represents a serious comparative advantage in the market, because the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro and actively engage in solving problems at both the local and the national level. theoretical aspects of social responsibility of banks in montenegro defining the concept of corporate social responsibility social responsibility is now perceived as an inevitable part of the company's operations and one of the market differentiation options. in this context, social responsibility or corporate social responsibility (according to the world business council for sustainable development) can be seen as "the commitment of business units to contribute to sustainable economic development, cooperation with employees, their families, the local community and society as a whole aimed at improvement of the quality of their lives”(saraiva and serrasqueiro, 2007). this would mean that the concept of social responsibility does not perceive as the opposing sides, on the one hand, the people, the community and the environment, and on the other hand, the economic goals of the company. the concept of social responsibility would mean that the company assumes responsibility for the impact of its own activities on all the stakeholders of the company, as well as on the environment (zelenović, 2015). moreover, it should be emphasized that csr is not the same for every company, but that the business operations according to this principle depends on the size of the company, the economic region, the market and the actual operations of the company. as noted, the operations based on the corporate social responsibility principle connect and enhance the relationships between the company, stakeholders and the environment, and combines them into a single whole that generates benefits both for the company itself and for the meeting of the current needs of future generations. so the most famous model regarding the csr is the model of the pyramid presented by caroll (1996), according to which if the company is to be socially responsible, then it needs to be financially stable (to be profitable), then legally responsible (to respect the laws of the state and markets), then ethically responsible (to operate in accordance with the moral and ethical norms of the society, community and the market) and ultimately to have a philanthropic responsibility (to be a good citizen). when we talk about when the concept of social responsibility dates back, we could say that, from a historical point of view, it dates back to the thirties of the last century, and as the subject of research of experts and interested individuals, somewhat later, sometime to the nineties, when companies accept the contemporary concept of social responsibility and implement it into their business strategy so that the activities they carry out create value for the company's owners, on the one hand, and for a wider community, on the other. significance and characteristics of corporate social responsibility numerous questions are raised regarding the concept and implementation of corporate social responsibility. some of them are related to the actual implementation of this concept in the company's operations and they relate to whether social responsibility is cost-effective or not and whether it should be considered as a cost or as an investment (stojanovi-aleksić and allies milica raičević, dijana medenica mitrović 95 2016). the given questions cannot be answered either with yes or no, but the answers require perceiving the things from different angles. the concept of social responsibility can be viewed from the aspect of the impact that the company operating in accordance with the given concept has on the enterprise and the society. this would mean that the responsible behaviour earns praise, that is, produces positive effects with the public which can be seen in the long run and can create a positive image or improve the existing one. thus, the sense of security and confidence is created among the interested individuals and groups, which creates a positive effect on the actual operations of the company. this means that the concept of social responsibility creates a positive effect on the company through the activities that contribute to the positive image, and the image creates confidence among the stakeholders, which contributes to the increase of the value of company’s shares, greater market share, competitive advantage etc. the study carried out in the usa has shown that the factors related to the social responsibility have almost the same effect on the company's reputation as some traditional factors such as quality, price, usage etc. (stojanovi-aleksić and allies 2016) it should also be taken into account that there is another aspect that reflects the importance of social responsibility, and that is the reporting on corporate social responsibility which should be included in the results and reporting on the company's overall business operations. when we talk about the activities, that is, the areas that the concept of social responsibility entails, we would say that it is the promotion of social goals (humanitarian work), the interconnection between marketing activities and social goals (part of the revenue is allocated for solving the problems of vulnerable groups), volunteer work (voluntary work aimed at supporting and actively participating in a community-run activity) and corporate philanthropy (the company's contribution through humanitarian activities) (stojanovi-aleksić and allies 2016). specific phenomenon of social responsibility in the banking sector the above mentioned prompted us, when talking about social responsibility, to think first about the relationship between csr and profit-making companies, which perceive this concept as a way of contributing to the community, on the one hand, and of gaining greater competitive advantage, on the other hand. the banks generally did not have a need for such a concept. this is due to the fact that they are independent financial institutions that take care of their finances independently, as well as the fact that they are intermediaries in the economy and have no need to care about the profit. however, due to the development of the market, increase in the number of participants in the banking market and increase and creation of new banking services, banks had to find a way to improve their reputation, develop trust among customers, restore the trust through various activities that would be receptive to people's eyes and ears. the assets of the company are not worth without customers, the task of managing services marketing is not only to attract new, but also to retain existing customers. new customers can be attracted only by delivering superior service, the role of marketing is to create a superior offer and ensure customer satisfaction, but also to anticipate the future needs of its clients, only satisfied customers can be loyal to a given organisation (hanic, domazet, 2012).thus the banks have realized that the concept of social responsibility provides an opportunity for expansion and improvement of their business operations. they can incorporate this concept into their defined strategy and thus, through the csr activities, gain competitive advantage in the banking market. by implementing socially responsible activities, the banks become an active part of the community in which they operate (zelenović, 2015) through the following: • promotion of social goals through a financial contribution or other types of contribution to develop or solve a particular social goal, • general well-being marketing when a certain amount of revenue is allocated for the achievement of a social goal 96 economic analysis (2018, vol. 51, no. 1-2, 92-102) • corporate social marketing assistance in development, implementation of campaigns which contribute to raising the awareness of the health, the sick, environmental protection ..., • corporate philanthropy – making direct contributions to a charitable or social activity, • community volunteer work voluntary work of employees and partners, • socially responsible business practice adopting and implementing the business practice that supports a social goal which should improve the life of the community (both the people and the environment) (kotler, li, 2009). based on the above, market changes and behaviour in the banking sector have led to the situation where the banks behave in the following way (vunjak, kovačević, 2006): • customer orientation because he/she is the most important person • the client is the purpose of the banking business • respecting the wishes and demands of the clients • a higher marketing concept • customer service quality. the motive for introducing the concept of social responsibility appears at different levels (zelenović, 2015): • internal ethics processes in banks and • external ethics consequences of banking actions. practice of social responsibility of the banks in montenegro the empirical framework of social responsibility of the banks in montenegro banks, as independent financial institutions, have focused on the care about their finances until recently. the bank is perceived solely as a recipient and provider of banking services, whose employees dominate the clients, without the adequate system of rewards and without paying a particular attention to the competition and customer requirements. the turbulent environment, the saturation of consumers by marketing advertising of various forms, has imposed the need for incorporating the socially responsible operations in the strategies of banks, as the necessary prerequisite for acquiring and maintaining the competitive advantage. they must not be focused solely on profit, but must be socially responsible, and take care of the environment. this raises the question of whether company can be both environmentally and socially responsible and profitable at the same time (domazet, kovačević, 2018). the whole community benefits through the activities of corporate social responsibility and the clients are becoming aware of this. by associating their products and services with the solving of a particular social problem, the banks do their promotion and encourage customers to buy their products or services. banks can demonstrate corporate social responsibility by providing the financial resources for raising awareness of a social problem, encouraging campaigns for behavioural change, engaging in local initiatives, humanitarian actions, financing and implementing the business practice for environmental protection or improvement of community life. all of these activities can be carried out by the bank itself and in cooperation with public sector partners, profit and non-profit organizations. moreover, the bank encourages and supports both its employees and partners to help local organizations and actions through voluntary work. implementation of csr activities is increasingly under pressure, both internal and external, to apply a strategic approach. the bank needs to choose what it will focus on and how to link its philanthropic and other initiatives to its business goals and tasks. the goal of milica raičević, dijana medenica mitrović 97 investing in various forms of socially responsible strategies is the strengthening of the bank’s reputation. through its reputation, the bank creates barriers to its competitors, sends a message that its services are of high quality, improves its market position, which contributes to profit increase. at the level of the economy, such operations encourage increased competitiveness and transparency in business, encourages trust and partnerships with the target public. the goal of reputation is not that a bank is liked but to create its value through business success and the solving of community problem which the state cannot solve alone. changes in the way of thinking and behaviour have led to more customer-orientated banks today, respect for customers' wishes and demands, introduction of a higher marketing concept and an increase in service quality. today, even conventional banks are participating in the actions that are of general welfare to the community. some of these activities are as follows: local scholarships and sponsorships, financing in the field of sports, health care, culture, more affordable housing loans, financing of some traditional events in the community, etc. although the positive effect of applying the csr concept in the banking operations has already been recognized, this concept is still inadequately implemented in a wider scope in montenegro, although the trend towards the growth of csr activities has been present in recent years. the reason for this can be found in the still underdeveloped awareness of the benefits of socially responsible practice, since such practice is often perceived as unprofitable and impractical experience. the common approach to corporate social responsibility is usually limited, defensive and unrelated to the actual strategy of the bank. the csr activities should be aimed at enhancing the relationship between employees and customers (as key stakeholders) so that they do not abandon the bank. according to the official data of the central bank of montenegro, 15 licensed banks operate in montenegro. the data on corporate social responsibility of banks is available on the official websites of seven montenegrin banks, which suggest that a little less than half of the banks have recognized the importance of informing the stakeholders of this aspect of bank operations. the csr data is available for the following banks: 1. societe generale bank montenegro ad 2. prva banka crne gore ad podgorica 3. nlb banka ad podgorica 4. addiko bank ad podgorica 5. erste bank ad podgorica 6. crnogorska komercijalna banka ad podgorica member of otp group 7. hipotekarna banka ad podgorica on the basis of available data on the official websites of montenegrin banks, it can be concluded that socially responsible activities are mainly focused on the fields of health care, education, sports, culture and the promotion of environmental protection. analysis of the state of corporate social responsibility of the banks in montenegro analysis of the state of corporate social responsibility of the banks in montenegro was made on the basis of secondary data, available on the official websites of the banks operating in our territory. below is an overview of the key objectives and activities of the seven banks, which publish the information on their csr activities on their websites. societe generale montenegro bank indicates, as the objective of its csr activities, the support for projects in the field of health care, education and culture which are useful for citizens and society over a longer period of time. the social community has acknowledged the efforts of this bank and in 2011, 2012 and 2015 societe generale montenegro, as a socially 98 economic analysis (2018, vol. 51, no. 1-2, 92-102) responsible company, was given the iskra award for philanthropy for the overall contribution of the bank to the montenegrin society and for its contribution to inclusive education. the bank is also the winner of the naturally equal award received for the best practice in achieving gender equality in montenegro (http://www.societegenerale.me/mne/o-nama/o-societegenerale-banci-montenegro, accessed on 17.03.2018.). the activities of the bank focused on healthcare activities included cash donations for the purchase of necessary resources for the montenegro clinical centre and the institute for children's diseases, as well as for procurement of medical and sanitary equipment for healthcare institutions, primarily for health care centres and general hospitals in the territory of montenegro. in this way, the bank contributes to the creation of better conditions for the strengthening of health care and the care about the public health. the bank is also active when it comes to monetary donations and cooperation with nongovernmental organizations dealing with the problems of children with developmental disturbances, people with disabilities, children suffering from cancer, as well as women victims of violence and juvenile mothers. with these donations, the bank draws attention to this group of women and children and actively participates in an effort to improve the position of women and children in the montenegrin society. societe generale bank also directs its socially responsible activities towards the support for inclusive education (donations to the stimulation room in elementary schools, financing instruction manuals for improvement of the teaching process within the inclusive education). through donations for educational tools in kindergartens, the construction of children's playgrounds, presents for pupils who walk to school from rural areas, the concern is shown for young people and improvement of conditions in educational institutions. the bank also organized a student competition on the topic of corporate social responsibility, which contributes to the development of awareness of the importance of corporate social responsibility among this target group. within the activities aimed at environmental protection, the bank supported the activities of greening of certain parts of the capital. another action with the same goal was the purchase of electric bicycles for employees and clients. numerous activities include humanitarian aid for the most deprived families, donations for the library of the blind, as well as numerous sponsorships for art exhibitions of montenegrin artists. prva banka crne gore has actively participated in the realization of socially beneficial projects since the very beginning of its existence. it is recognized by its support for projects of national significance in the field of health care, culture, sports, as well as support for humanitarian and other projects that have an impact on raising the quality of life of the citizens in montenegro (http://www.prvabankacg.com/o-nama/drustvena-odgovornost/, accessed on 17.03.2018.). some of these projects by which prva banka crne gore confirms its strategic commitment to corporate social responsibility include: the ulcinj's greening project, sponsorship of the women's handball team of montenegro at the world championship in denmark, a donation for the internal ward of the bar hospital. nlb montenegro bank promotes its socially responsible operations through sponsorships or donations to cultural, sports and entertainment events as well as environmental protection projects. the largest and most significant sponsorship projects of nlb banka are: sponsorship of the budućnost basketball club, the as tennis club, the main sponsor of the national parks of montenegro, which has been its partner since november 2010 within the project 'obradujmo prirodu' (make the nature happy), which contributes to raising awareness of the importance of environmental protection and conservation of protected natural areas for future generations (https://www.nlb.me/me/nlb-banka/opste/sponzorstva-i-donacije, accessed on 17.03.2018.). milica raičević, dijana medenica mitrović 99 for several years, addiko bank ad podgorica has been allocating funds in a planned manner, within its budget, to support the local community, where it carries out its activities, through the support for the work of educational and healthcare institutions, and events aimed at promoting and preserving social values through the fields of culture, arts, non-commercial sports activities (https://www.addiko.me/o-nama/drustvena-odgovornost/sponzorstva-idonacije/, accessed on 17.03.2018.). the most significant activities include: donations to children and adolescents with developmental disturbances; cooperation with non-governmental organizations and primary schools to support children with autism spectrum disorders; donations to children suffering from cancer; donation to the institute for children's diseases for the supply of equipment for the orl ward. in cooperation with the red cross, it participates in humanitarian actions for socially vulnerable citizens and in voluntary blood donation activities. among numerous activities the following are also worth mentioning: donations to the fire department in tivat; assistance for the purchase of equipment for the national team of the special olympic games of montenegro; baskets for the school gym in žabljak; equipment for primary and secondary schools in kotor and tivat; procurement of exercise equipment in the gym of the junior team of the "jadran" water polo club; a donation aimed at improving the social inclusion of children and youth with developmental disturbances and people with disabilities; donations of children's books to libraries in podgorica and kindergartens in kotor and tivat; sponsorship of the sea dance festival. as a modern and practical bank focused on customers and their needs, addiko has also provided the festival's visitors with various opportunities to make simple financial transactions on-site. the sea dance festival payment card and the addico bank card was the official payment instrument at the sea dance festival, and addiko bank has also provided an atm for cash withdrawals for all visitors (https://www.addiko.me/onama/drustvena-odgovornost/sponzorstva-i-donacije/, accessed on 17.03.2018.). what seems interesting is the fact that all the activities listed on the website of addiko bank were conducted in the period from november 2016 to december 2017. erste banka actively and consistently contributes to the re-building of the value system, the development of society and culture in the country by initiating, acknowledging and providing organizational and financial support to the activities, projects, organizations and institutions acting in the same direction. erste banka gives its contribution to: the culture and arts, education, sports, social inclusion and environmental protection (https://www.erstebank.me/sr_me/footer-stanovnistvo/o-banci/sponzorstva-i-donacije accessed on 17.03.2018.). one of the ongoing programmes listed on the website refers to the best of south east programme: study in graz –development and further education programme, as well as international work experience for talented and dedicated graduates and students from montenegro, bosnia and herzegovina, croatia , macedonia, slovenia and serbia. crnogorska komercijalna banka bases its corporate social responsibility on supporting independently or as a partner the realization of projects in the field of culture, arts, science and sports. aware of the importance of entrepreneurial initiative in culture, ckb has supported the representative editions of the cid publishing house (economic, literary, legal, anthropological, historical) which has published important studies from the history, culture, nature of montenegro, as well as numerous capital translations (http://www.ckb.me/marketing-ipr/marketing-i-pr.69.html accessed on 17.03.2018.). ckb sponsors or participates in the organization of various events (concerts, mimosa festival, world savings day), gives donations in the field of health care, education and science, paying special attention to children and young people, through the scholarships to the best, but also through the ckb donations to the unicef projects. the support for sports clubs in football, basketball, handball, karate, and cooperation with the montenegrin water-polo national team are some of the csr activities of crnogorska komercijalna banka. ckb has recognized the importance of financing in the field of cinematography (film festival hercegfest) and arts. 100 economic analysis (2018, vol. 51, no. 1-2, 92-102) moreover, for the first time in montenegro ckb ensures the financing of renewable energy sources aimed at continuous improvement of efficient and sustainable economic, social and ecological environment (http://www.ckb.me/marketing-i-pr/marketing-i-pr.69.html accessed on 17.03.2018.). hipotekarna banka ad podgorica is the winner of the special award "iskra" for corporate philanthropy in 2016. the award has recognized the contribution and importance of corporate social responsibility of hipotekarna banka ad podgorica, which has several directions: investment in health care improvement, investment in culture, care for the elderly, investment in youth education and general contribution to the community. some of the csr activities of hipotekarna banka are: donations of books to educational institutions in montenegro; scholarships and the provision of international practice to the best students; procurement of reanimation vehicle for the needs of the institute for emergency medical assistance; together with the partners, the donations of vehicles for the transportation of patients on dialysis of the montenegrin clinical centre; participation in the donation to the clinic for gynecology and obstetrics; in cooperation with the non-governmental sector, the donations to the nursery home in bijelo polje; the general sponsorship of the montenegrin national theatre; donations of funds for the construction of a swimming pool in nikšić; sponsorship of the made in ny jazz festival; organization of panel discussions "live globally, work locally”(http://hipotekarnabanka.com/o-banci/vijesti accessed on 17.03.2018.). results of empirical research the overall goal of sustainable development is the long-term sustainability of economy and the environment, which will be achived by integrating economic, environmental and social aspects of the decision-making process (domazet, kovačević, 2018). adequate socially responsible activity of banks contributes significantly to the improvement and advancement of the existing situation in those segments of society and the local community which the state has either insufficient interest or resources to support. from the previous analysis of the state of corporate social responsibility of banks in montenegro, it can be seen that some banks are aware of their social responsibility, which is demonstrated through financial investments in certain activities. some of the most prominent activities include: inclusive education, work with people with disabilities, health care, education, sports, culture, environmental protection, work with the youngest, which are all segments of our society, for which insufficient funds are allocated from the state budget. table 1. csr activities of the banks in montenegro bank csr activity societe generale banka mne prva banka crne gore nlb bank mne addiko bank erste bank crnogorska komercijalna banka hipotekarna banka health care x x x x education and science x x x x x inclusive education x x social inclusion x x x x culture x x x x x x x sports x x x x x x arts x x x x environmental protection x x x x source: authors' analysis 18.03.2018. milica raičević, dijana medenica mitrović 101 banks have a dual role: the role of promoters of socially responsible behaviour and institutions investing in those areas of vital importance for community development, for which the state does not have enough resources. in this way, the banks are directly involved and become a partner to the country in solving strategic social issues, both at the local and the national level. banks also have some benefits from csr initiatives, namely: building a strong corporate reputation, contributing to overall business goals, attracting and retaining motivated workforce, supporting marketing goals, establishing strong relationships in the community, etc., which contributes to the comparative advantage of certain banks in the market. given that these activities are just some of those available to the banks in the area of corporate social responsibility, we hope that corporate social responsibility will develop in montenegro in the forthcoming period, and that the banks will also be in a position, through the appropriate selective credit and interest rate policy, as well as the establishment of special funds, to have a direct impact on the companies to behave in a more responsible manner. given that montenegrin banks are predominantly in foreign ownership and that the csr represents a serious comparative advantage on the market, the foreign banks which implement the csr send their customers a clear message that they are ready to stay in montenegro and actively engage in solving problems both at the local and the national level. conclusion as the conclusion of the paper and the conducted research, it is suggested that the concept of social responsibility and supplementing the bank's business strategy with it, can have multiple benefits for the bank itself, i.e. its competitive advantage in the banking sector, as well as for the improvement of the community and hence greater customer satisfaction. by introducing this concept, a positive image is built in the market, and thus a greater degree of trust is created in the operations of the bank by all interested individuals and groups. the paper analyses the concept of corporate social responsibility, its positive effect on the above-mentioned entities, the introduction of this concept into the strategy and business policy, the specific phenomenon of the bank and its operations, and the contributions that the introduction of this concept makes both for the bank and for all stakeholders of the bank. the results obtained by empirical research in montenegro indicate that banks carry out their socially responsible activities through the activities in the fields of education, healthcare, culture, sports, environmental protection, and work with people with disabilities. the conclusion is that banks have a dual role, they are both promoters of socially responsible behaviour and institutions that invest in those areas of vital importance, for which the state does not have enough resources. it was then concluded that the csr of banks constitutes a serious comparative advantage in the market, since the banks that implement it (especially foreign banks) send their clients a clear message that they are ready to stay in montenegro, and actively engage in solving problems both at the local and the national level. the contribution of this paper is reflected in the fact that through a qualitative analysis a breakdown has been given of the activities and areas in which the csr of banks in montenegro is present. an analysis of csr activities can be helpful to decision-makers in the marketing sector of banks in deciding how to use csr as one of the leverages for gaining the comparative advantage in the market. we have also defined in the paper what characterizes the csr of the banks in montenegro, what are the advantages and what are the shortcomings in the past csr practice of banks, and in which direction the csr of banks should be improved. the contribution of the paper is also reflected in the analysis of what is the extent of the impact of csr activities on the generation of a higher profit of banks. moreover, new opportunities for future research have been opened, and one of them concerns the strategies that banks use in the implementation of corporate social responsibility. 102 economic analysis (2018, vol. 51, no. 1-2, 92-102) references carroll, archie. 1996. business and society: ethics, sustainability and stakeholder management, cincinatti ohaio: south-western collage publishing domazet, ivana, đokić ines and milovanov olja. 2018. “the influence of advertising media on brand awareness”, management: journal of sustainable 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4.docx doi: 10.28934/ea.19.52.12.pp128‐137 scientific review the impact of accounting harmonization on financial statements quality in serbia danijela anđelković1* | danijela zubac2 1 university “union union ‐ nikola tesla“, belgrade, faculty of entrepreneurial business, belgrade, serbia 2 higher technical professional school zvecan, serbia abstract the general process of the world market globalisation and the great influence of international financial organisations, especially the imf and the world bank, caused the need for standardisation and harmonisation of financial statements of the participants involved in international economics and trade. in this process, in the republic of serbia, the international accounting standards board (iasb) and the iasb.s project for ias/ifrs implementation have a crucial role. by adopting the international financial reporting standards ‐ ifrss (including international accounting standards ‐ iass), financial statements prepared in serbia may be comparable with financial statements in other countries. starting from this, the main goal of the research is to indicate whether the financial statements in serbia based on the iasb project can be comparable with financial statements in other countries, and on this basis can they satisfy the needs of external users of information (investors, creditors and others). in doing so, it points to the experience in the republic of serbia, the accounting practice and experiences of other countries, above all members of the european union. the results of the research show that, in addition to the ias/ifrs, the us generally accepted accounting principles (gaaps) and the directive 34 of the european union represent the key segments of professional regulation contributing to greater accounting harmonisation, and on this basis, the higher quality of financial reporting. most countries that have national accounting regulations align the accounting rules in the most important issues with those regulations. key words: accounting standards, harmonisation, ifrs, iasb jel classification: м41, м48, g15 introduction financial statements represent an important and reliable basis for the management, and in particular for the external users, to acquire information about enterprises from the business environment, both by branches and by the areas to which they belong, which is fundamental for making strategic decisions. the information power of the statement is the most important given that based on it, by applying the relevant analysis, conclusions on the enterprise's yield, assets and financial position are made. comparable and transparent financial statements represent a basis for deeper and more liquid financial markets, for strengthening investors’ confidence, and thus to overall financial stability. all this, in turn, contributes to the construction of a modern market structure in the function of ensuring greater competitiveness among enterprises. several countries, including the republic of serbia, has accepted the international accounting standards/international financial reporting standards (ias/ifrs) as the single financial * corresponding author, e‐mail: andjelkodani@gmail.com danijela anđelković, danijela zubić 129 reporting framework for all enterprises, taking into account, to a certain extent, formal specificities applicable to small and medium‐sized enterprises. unlike serbia, most other countries that have their national accounting regulations align their accounting rules with their accounting practices, with the ias/ifrs, but also with other standards, such as the directive 34 of the european union. in the context of the quality and interest of users, the international federation of accountants (ifac) has established specific accounting rules and principles, and thus greatly harmonised the accounting, i.e. the system of preparation and presentation of financial statements (fletcher, 2002). "factors determining the development of accounting at the national level also contribute to accounting diversity at the international level (saudagaran, 2004)." this is confirmed by the generally accepted conclusion of adhikari and tondkar: "accounting and reporting standards and practices are not developed in a vacuum, but reflect the specific environment in which they are developing (haskins, ferris, & selling, 2000)." starting from the above statements, the research objective in this paper is to indicate to the iasb.s project of ias/ifrs review, highlighting the problems faced by national enterprises in their implementation, especially when it comes to small and medium‐sized enterprises. in doing so, it highlights the accounting practice and experience in certain countries, especially from the neighbouring and comparable environment of serbia. this is particularly related to those countries that also had an obligation to implement the ifrss, prescribed by domestic legislation, and in which the general content of the financial statements was under the significant influence of the ias 1 and eec directive iv (1978) and now the eu directive 34 (2013). the iasb‐s project of the international financial reporting standards making economic decisions by enterprises in different markets of goods, services and capital, as well as many others, is not possible without reliable, transparent and comparable accounting information, expressed through certain financial statements. the international financial reporting standards, i.e., the international accounting standards and related documents creation and approval, such as the framework for financial statements and other documents preparation and presentation, are under the jurisdiction of the international accounting standards board (iasb) in great britain. according to the iasb, the purpose of financial statements is to offer the information on the financial results and the financial position of an entity useful to a wide range of users so that they could evaluate management quality shown by the entity management, and enable them to make economic decisions. the purpose of financial statement submission can usually be met through attention directly to the needs of the existing and potential investors and other external information users. such external users need the information to evaluate the entity’s ability to increase revenue and on that basis, to evaluate positive financial results. according to anđelković & vujić (2019), “the process of value creation is not based on the traditional formula where it begins with input and ends with output”. however, although financial statements lack all the information necessary for the users, they still provide the framework within which information users can compare specific information gained from other sources (kothari & barone, 2012). the international federation of accountants (ifac) has an important role in this process, determining certain accounting principles through standards in the information quality and user interest contexts, thus harmonising accounting to a large extent, i.e., financial statement preparation and presentation system. when it comes to professional regulation activities definition, we should also state, according to barth, landsman, lang & williams (2012), generally accepted accounting principles – us gapp. the association of accountants and auditors of serbia was among the first to recognize the necessity for standardization and harmonization in accounting in the republic of serbia; as ifac full member, it reached the decision and declared the direct implementation of the international accounting standards at the end of december 1998, along with the expected legislative support. in may 2002, the iasb published the final preface to the international financial reporting standards, with the following basic goals (stefanović, 2003): 130 economic analysis (2019, vol. 52, no. 1, 128‐137)  to develop a set of high‐quality, comprehensible and applicable global accounting standards with the high‐quality, transparent and comparable information in financial reports as a result, to help the participants in world capital markets and other users in reaching economic decisions;  to promote the use and mandatory implementation of these standards;  to take an active part in finding a solution to the national accounting standards and the ifrs convergence along with the national standard‐makers. the decision reached by the iasb and the financial accounting standards board (fasb) in the united states of america is of particular importance in the context of the above stated goals, which establishes their mutual cooperation for a higher degree of conformity within the united states between generally accepted accounting principles (us gaap) and the international financial reporting standards (ifrs), formerly known as the international accounting standards (ias). the successful outcome of this harmonisation will significantly improve global capital market efficiency: the costs would be reduced, report comparability improved as well as corporate management (ivkov, 2014). new international financial reporting standards should offer a key contribution to more correct and accurate financial report compilation in the future, in order to create prerequisites for reaching more reliable financial and business decisions (dragojević, miljević & milojević, 2012). the international accounting standards can be applied in various ways. the in ias/ifrs application is as follows (klikovac, 2008):  ias/ifrs are used as the national standards in the countries where there are no national accounting standards, i. e., financial reporting standards, or in the countries that have ceased to implement them.  ias/ifrs are used as the international benchmark in many industrial countries and the growing market countries developing their standards.  ias/ifrs are accepted by numerous stock exchanges and regulators allowing foreign or domestic companies to submit financial statements compiled according to the ias/ifrs.  ias/ifrs have been recognized by the european commission and many other international bodies. when it comes to the national law on accounting that contributed to financial reporting harmonisation, apart from later adopted ias/ifrs, the law adopted in 1996 had particular importance (stevanović & ilić, 1996), because it was based on the european union directives and other international accounting standards. the aforementioned law represents a further step in creating assumptions for financial reporting quality improvement in relation to the previous laws from 1989 and 1990. according to the aforementioned law (1996), financial reporting harmonization should have left enough possibilities for national professional regulation. some provisions of the former law were completed starting from the provisions of the fourth and seventh directives as well as the international accounting standards. for example, it refers to the mandatory compilation of the cash flows statements in addition to the balance sheet and income statement, as well as the parent company liability to compile and present an additional report annexe, in addition to the consolidated balance sheet and income statement. the income is a form of the result and regular company financial reports, and the contents of the balance sheet, income statement and cash flows statements are completely adapted to the demands in form and content stated in the eu directives and the international accounting standards (škarić & dendić, 2005). according to the above‐mentioned authors, the adoption of the law on accounting and auditing (2002) was a condition for ias/ifrs acceptance in financial report position evaluation. several changes in this law influenced its more complete harmonisation with ias/ifrs. it is stated there that “legal entities and entrepreneurs are obliged danijela anđelković, danijela zubić 131 to manage bookkeeping, financial report compilation and presentation according to the accounting principles defined within the ias. the ias will be applied for financial report recognition, evaluation and presentation.” the adoption of law on accounting and auditing (2002) continued the efforts referring to the financial report harmonisation. however, a lot of issues regulated by the former law on accounting from 1996 were not regulated by the law on accounting and auditing valid at the time, or at least they were not regulated in the appropriate manner. in that context and according to the paper by vukelić (2010), we can state that the historical aspects of the regulations are important for the legal regulations in the area of financial reporting. škarić and dendić (2005) consider these as the most important weaknesses of the law from 2002:  the request that the ias has to be applied in all companies, regardless of size;  the division of the jurisdiction of the state and professional organisations that is not distinct;  the non‐existent specific mechanism for the provision of high‐quality translation for the ias as the normative foundation for financial report compilation;  the deadline provided for the ias application was not appropriate. the adoption of the law on accounting and auditing in 2006 as well as in 2009 continues the efforts to organise the accounting profession and the achievement of full harmonisation with the international accounting regulations. these laws enabled the establishment of institutions referring to the chamber of authorized auditors and national commission for accounting. the provisions of these laws related to the ias application should enable the compilation of the compatible financial statements. faced with the new financial reporting model based on the ias/ifrs, the attention of our companies, primarily their accountants, was mostly attracted by ifrs 1 (the international financial reporting standards, 2009). this is the consequence of the fact that the ifrs 1 establishes the procedures the companies must follow during the initial application of the ifrs as the foundation for the preparation of their financial statements. in the course of the practical application of these procedures, the subjects are faced with the challenge of retrospective application combination with certain exceptions, and it makes the initial ifrs application rather complex. from the point that financial report quality can be provided in accepting the ias as the national accounting standards, the aforementioned laws on accounting and auditing imposed their application as mandatory. the republic of serbia accepted the international financing reporting standards as the only framework for financial reporting in all companies. only small taxpayers are exempted from this obligation because they can decide not to apply the ifrs if their securities are not traded in the organised securities market. on the basis of the research conducted in the previous 18 years of the twenty‐first century, when a need for harmonization in accounting appeared as a result of the growing globalization in the world of business, the leading authors in the international accounting reached the results indicating the existence of a number of causes for the international differences in financial reporting. some of the most common in the references are (alexander, britton & jorissen, 2005): 1) legal system, 2) funding sources, 3) the relation between financial and tax reporting, 4) the influence of national accounting profession, 5) inflation levels, 6) microeconomic theory, 7) business development and 8) historical coincidence (accidence). the differences mentioned above question the possibility of financial reporting comparison between entities from various countries. compatibility problem is particularly manifested in foreign financial report analysis necessary for making investment and credit decisions. therefore, the users should carefully identify the causes of the differences in the analysis of these reports, i. e., they have to determine whether they come from the accounting measurement differences, basic environment factors (primarily social, political, legal, economic) or whether they are caused by the true differences of the attributes measured. based on this, we can state that our country unilaterally accepted the 132 economic analysis (2019, vol. 52, no. 1, 128‐137) international financial reporting standards as the only framework for financial reporting for all companies (small taxpayers exempted) when it adopted the new law on accounting (2013; 2018), disregarding the differences in the accounting measurements, basic environment factors as well as company size and structure. this kind of accounting system design in a country – national accounting system, had a negative effect on the financial information quality for their users (especially investors and creditors). based on these statements, we can say that financial reporting quality improvement perspectives also depend on the consideration of the basic factors influencing financial reporting in each country, especially if it aspires to a certain union of the countries, as is the case with our country. however, in this case, the differences influencing financial reporting cannot be minimised to such an extent that they result in “the unique set of the international financial reporting standards”. also, the differences in company size structure, the business they deal in, whether the company securities are rated on the stock exchange or not, as well as other specific points, should define a commitment to apply the ias/ifrs. the iasb project of the ifrs for small and medium‐sized enterprises the adoption of the new law on accounting (2018) continued the efforts towards the achievement of financial reporting total harmonisation. there is a special international financial reporting standard for small and medium‐sized entities ‐ ifrs for smes, approved by the international accounting standards board (iasb) for financial reporting position recognition, evaluation, presentation and disclosure. in doing so, there is still a possibility for small entities to decide in favour of ifrs application related to large entities. in relation to small and medium entities, the new law on accounting, unlike the previous law on accounting and auditing, specifies the special ifrs application for large entities that have an obligation to compile consolidated financial reports, as well as for public companies. regular annual financial report for entities applying the ifrs, i. e. ifrs for smes, includes, according to the law on accounting (2013; 2018): 1. balance sheet, representing an overview of assets, liabilities and capital of a legal entity on a given day; 2. income statement, representing an overview of revenues, expenditures and business results incurred in a given period; 3. the statement on the rest of the result, which consists of income and expense items (reclassifications due to correction included), not recognised in the balance sheet as required or allowed according to other ifrs. the components of this result consist of items recognized within capital according to certain ifrs requirements; 4. capital changes statement, providing information on the changes in legal entity capital during the reporting period; 5. cash flow statement, providing information on cash inflow and outflow as well as cash equivalents during the reporting period; 6. notes to the financial statements, containing descriptions or breakdowns of the items disclosed in the aforementioned reports, the accounting policies applied, as well as information on items that did not qualify for recognition in these reports, and they are significant for the assessment of the financial position and legal entity performance, as well as other information in accordance with ifrs requirements. according to the financial reporting committee decision, a draft of the croatian accounting standards was started for small and medium entities in the republic of croatia. the accounting standards were based on the ifrs, but they also accepted some specific points based on the small and medium‐sized enterprises needs in croatia. based on the financial reporting standards committee decision from 2006, balance sheet, as well as profit and loss account is danijela anđelković, danijela zubić 133 stipulated by law, in form and content compliant with the fourth eu directive, as well as the former law on accounting. the form and content of abbreviated balance sheet and profit and loss account is stipulated for the companies classified as small enterprises according to the aforementioned law on accounting. consequently, small enterprises are only required to compile an abridged balance sheet, profit and loss account, but not cash flow statement or capital change statement as previously stated in our professional regulations. “according to the law on accounting from january 2008, the implementation of the national croatian financial reporting standards (cfrs) was introduced. according to these standards, small and medium‐ sized enterprises are required to implement the ifrs only if their securities are quoted in the securities market or preparing to be introduced into the croatian market. otherwise, small and medium‐sized enterprises are not required to implement ifrs (klikovac, 2008). the stated approach is in accordance with the statements from the first part of this paper related to the financial reporting harmonization, the creation of our national professional accounting regulations, with considerations of the international differences present in financial reporting (legal system, funding sources, financial and tax reporting relations, the influence of the national accounting profession). in the absence of expert criticism and professional normative regulation ethics, it was the easiest to accept the ias/ifrs implementation automatically and completely for financial reporting purposes. also, we should take care of our close environment in relation to the european union, and consider the professional accounting regulation of its members as well as the relation to the ias/ifrs. if we consider the case of croatia in this context, the basic stabilization and association agreement between croatia and the european union anticipates croatia’s commitment to adjust its legislation to the eu regulations within the deadlines. likewise, the national program of croatia for eu accession from 2005 accepted the commitment to adopt the eu legislation in accounting. thereby, it was necessary to harmonize the law on accounting with the fourth and seventh directive, as well as the eu provisions regulating the accounting system in the european union. the new law on accounting was created according to the eu provisions, and therefore croatia, as well as most of the eu countries, does not require the mandatory implementation of ifrs for all companies, but only for those large listed companies or those preparing for listing. the rest of the companies in croatia are given the opportunity to choose whether to implement the ifrs or any other standards approved by the financial reporting standards committee. the fact remains that the national accounting standards differ in certain segments in some of the countries. in other words, not all companies have an obligation to implement international accounting regulations. thus, for example, only the companies with the securities quoted at the american stock exchange have to compile their financial statements according to the us gaap. on the other hand, mandatory implementation of the ias/ifrs is explained differently in the eu countries, while mandatory ias/ifrs implementation refers to all the companies in our country, although it is structured in a different way depending on the company size (dmitrović – šaponja, milutinović & šijan, 2010). mandatory implementation of the ias/ifrs is defined for large companies separately from the implementation for small and medium‐sized enterprises. in doing so, the burden of regulations and financial statement simplification for small and medium‐sized enterprises was not considered, especially when it comes to micro subjects and entrepreneurs. the experiences about financial statement quality improvement for small and medium‐sized enterprises have already existed when we speak about the european union. in fact, previous accounting directives: eec directive iv (1978), and eec directive vii (1983), for small and medium‐sized enterprises, and particularly for micro subjects, often represented great regulatory burdens. an appropriate audit of the accounting directives was carried out, and there were significant simplifications in financial statements structure for small and medium‐sized enterprises in new eu directive 34 (2013). the focus of special attention in terms of regulatory burden reduction was on micro subjects. harmonisation of legal regulations with professional regulations, i.e. eu directive 34 (2013) and the international financial reporting standards, is particularly emphasised on the path to financial reporting quality improvement. on that basis, national accounting regulations that strive and 134 economic analysis (2019, vol. 52, no. 1, 128‐137) participate in the standardisation process become an active participant in the modern, international financial reporting system. the key role in the financial reporting harmonisation process at the international level belongs to the european union, which has a significant impact on the international accounting standards board (iasb). it strives to adjust the ifrs to its interests and the interests of the eu member countries with its influence (anđelković, 2018). the first european attempt to harmonise financial reporting at the international level was, as mentioned, through the eec directive iv (1978) and eec directive vii (1983) introduction. in june 2013, a new eu directive 34 was adopted, on annual financial statements. this newly adopted eu directive 34 (2013) replaces the fourth and seventh directives through their integration, with certain changes and additions. a separate part of the eu directive 34 (2013) refers to large companies with the quotes at the stock exchange as well as the consolidated financial statements. ias/ifrs implementation is prescribed for the listed companies. most of the eu members allow (do not prescribe) ias/ifrs implementation in the course of the compilation of consolidated financial statements for the companies not quoted at the stock exchange. the directive requires consolidation for the group of companies over a certain size, and the audit based on this requirement. presented balance sheets in terms of form (in horizontal and vertical forms) and according to the assets and liabilities structure have been framed in order to fit all companies, regardless of their legal form and size. one of the balance sheet models can be used by large, medium‐sized and small enterprises. when it comes to small and medium‐sized enterprises, there are certain simplifications. small enterprises compile their balance sheets according to the same scheme, but they only show the positions marked by letters and roman numerals. further analysis, denoted in arabic numbers, does not refer to these companies. directive 34 pays special attention to the recognition rules in the context of financial reporting quality improvement. the main methodology of business events evidence and evaluation is based on the historical cost principle, i. e. price (production costs) or purchase value in order to provide information reliability in financial statements. however, the directive allows the national legal systems to use alternative evaluation methods, as in the case of a fair value method. the basic goal of eu directive 34 (2013) implementation is to increase financial information comparability and transparency on the basis of the aforementioned statements and other normative scopes; in order to achieve that, it is necessary for the eu member states to provide a common framework for balance position recognition, their measurements and financial statement presentation (andjelković, 2018). financial statements comparability as one of the means of communication among the member state companies is increasing, bearing in mind its significance for their users. these are only some of the examples, not the only ones, indicating the differences among the national regulations of certain countries. all that, along with the above‐mentioned issues, indicates that the process of financial reporting harmonisation at the global level is difficult to achieve, considering the companies not quoted at the market, especially when it comes to medium‐ sized and small enterprises. but surely, as ensues from the discussion on the eu directives, in some parts of the world “the language of accounting will be changed”. in this context, martić (2013) states that extensible business reporting language – xbrl appeared at the end of the 1990s, used for structural business information exchange via web, widely accepted in the international accounting community, promising a revolution in financial reporting and business information exchange. xbrl standard offers a wide range of advantages in business information collection, storage and processing, as well as financial statements compilation and disclosure. in one part of the paper on “harmonization of serbian accounting standards with the eu standards”, vukelić, đuričin & belopavlović (2011) state that “the development of the global economy imposes a need for the harmonisation of financial reporting. in order to make relevant decisions, capital investors demand a unique system of financial reporting at the global level and also expect that domestic competent institutions will create such a regulatory framework which will elevate the domestic financial reporting to a higher level. hence they have expectations in view of legal solutions, which would provide conditions for the standardisation and compliance danijela anđelković, danijela zubić 135 with the best solutions in the countries with developed market economies“. in connection to this, đuričin (2012) illustrates the same issue in a separate part of the paper, related to the national accounting standards harmonisation with the eu standards. in this context, the critical review of the national financial reporting is indicated as well as the recommendations for the national accounting regulations improvement. in the context of the public companies functioning and characteristics, bearing in mind the specific environment, milojević (2018) also raises the question of financial reporting quality improvement. finally, we can state that in addition to various solutions in terms of ias/ifrs implementation (from full acceptance of the ias/ifrs for all the companies to the exclusive implementation of their own standards), generally speaking, we can state that the ias/ifrs are accepted, as a rule, in the companies where securities are publicly traded with, while the others implement the national standards. according to this, the american securities and exchange commission (sec) requires foreign companies with the securities listed in the stock exchange to present their financial statements periodically. nevertheless, the reporting requirements for foreign companies are essentially the same as the ones set for national companies. the foreign companies may present secondary financial statements compiled based on the us gaap. thereby, the sec requires the canadian companies procuring capital in the us capital market to publish any deviation from “the generally accepted accounting principles” in the usa, and to present the financial effect of these deviations on the property, financial structure and success of the company. according to barth, landsman, lang, & williams (2012), the question of accounting standards comparability based on ifrs and us gaap arises in this context. the aforementioned discussion in this paper results in the statement that the process of global financial reporting harmonisation refers primarily to large companies that are listed on the stock exchange. conclusion the current tendencies of the national accounting regulations show that, in addition to the ias/ifrs, the us generally accepted accounting principles (gaaps) and the eu directive 34 (2013) represent the key segments of professional regulation. most countries that have their national accounting regulations align their accounting rules in the most important aspects of these regulations. hereby, not all enterprises have an obligation to implement international accounting regulations. the european union plays a key role in the process of harmonising financial reporting at the international level, and it also has a significant impact on the international accounting standards board (iasb). the newly adopted eu directive 34 relating to the annual financial statements particularly contributes to this. the republic of serbia should have its national accounting regulations, its own accounting rules which, as we strive to the european union accession, must be harmonised in the most important issues, in the first place with eu directive 34 (2013). the directive 34 (2013) sets out the form and content of the financial statements, the rules for the preparation of financial statements of large, and especially medium and small‐sized enterprises. it also regulates other issues that seek to adopt the ifrs to the interests of the european union and the national interests of its member states. the implementation of the ias/ifrs may be mandatory for large enterprises and listed enterprises. likewise, the implementation of the ias/ifrs for small and medium‐sized enterprises often represents a large regulatory burden. from this aspect, an appropriate review of the ias/ifrs should be carried out and a significant approximation of the regulatory framework to the interests of small and medium‐sized enterprises. in this case, the implementation of the ias/ifrs may be mandatory for medium‐sized enterprises whose securities are quoted on the stock exchange. for other enterprises, the implementation of the ifrs would be permitted, but not prescribed. this would leave the possibility to create special 136 economic analysis (2019, vol. 52, no. 1, 128‐137) national standards for small and medium‐sized enterprises. the process of global harmonisation of financial reporting when it comes to the unlisted enterprises and especially when it comes to small and medium‐sized enterprises can be relatively difficult to achieve. special attention, when it comes to professional accounting regulations, should be directed at micro entities, given their importance and contribution to the economic development of our country and the 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(2011). harmonization of serbian accounting standards with the eu standards, in the publication: serbia and the european union: economic, coimbra, portugal, the institute of economic sciences, belgrade baking academy – faculty of banking, insurance and finance, pp. 92‐104. article history: received: april 9, 2019 accepted: june 3, 2019 doi: 10.28934/ea.20.53.1.pp133-148 scientific review what drives private equity and venture capital in central and eastern europe countries: focus on serbia isidora ljumović1* | ivana lečovski milojkić2 | vladimir obradović3 1 institute of economic sciences, belgrade, serbia 2 university of belgrade, faculty of organizational sciences, serbia abstract the paper examines the main drivers of private equity (pe) and venture capital (vc) capital into the central and eastern european (cee) market with focus on serbia. also, this article analyses the current trends in the industry. although most of cee economies remain far behind eu-15 countries in the amounts invested trough pe and vc industry, the region is becoming increasingly attractive. poland, hungary, slovakia, romania, and the czech republic currently attract the majority of pe/vc investors. investment activities in cee observed by sector, show that the largest total investments are made in the sector of consumer goods and services, in the sector of information and communication technology and in life sciences. cee private equity market remained dominant in buyouts, where vc as a proportion of total investment activity remained relatively low. main drivers of the region are increased economic activity, favorable tax rates, tax incentives for investors and high quality of labour with low costs. according to swot analysis, serbia has many advantages in terms of attracting pe/vc investments, with the most important factors such as geographical position, well educated and qualified labor with relatively low cost of labour and advantages related to the tax treatment, free trade agreements, but also the efforts made in recent years such as reforms, improvement of fiscal discipline, and introduction of numerous incentives in order to attract investments. key words: private equity, venture capital, investments, central and eastern europe, serbia, country attractiveness jel classification: e50, g00 introduction the phenomenon of private equity, i.e., investing in order to buy a stake in a potentially successful business venture or company, is a concept as old as business itself. examples of entrepreneurs who are receiving money from private investors for their business ventures and in return giving a share of their business are part of everyday life, but also, they are a historical constant. private equity (pe), as defined by evca (european association of venture capital funds) is a form of equity investment into private companies not listed on the stock exchange; medium to long-term investment, characterised by active ownership which builds better business by strengthening management expertise, delivering operational improvements and helping companies to access new markets and outsize their returns. pe investors are not interested in regular dividends, but rather in an exit strategy from the investment in a period of * corresponding author, e-mail: isidora.ljumovic@ien.bg.ac.rs 134 economic analysis (2020, vol. 53, no. 1, 133-148) usually 3-6 years (ptacek, kaderabkova, 2014). on the other hand, venture capital (vc) is a subtype of private equity focused on start-up companies with innovative ideas for a product or service who need investment and expert help in achieving growth. rao&jain (2002) highlight that vc funds invest in start-ups and early-stage businesses, as well as businesses in ‘turn around’ situations. vc funds invest mainly in small and medium-sized enterprises, which are not listed on the stock exchange and have high growth potential (ramadani, 2014). thus, they are an important catalyst for nurturing start-up firms with high-growth potential to undertake innovative endeavours that contribute to national wealth (pradhan et al., 2017). it is considered that firms backed up by vc are more innovative (cao et al. 2015) so the industry has given rise to many successful enterprises, some of which have produced major innovations (tykvova, 2017). this paper aims to explore factors that determine pe/vc investments in cee, with the focus on the serbian market. sistematization of the countries included in cee region is taken from invest europe, since they have the most comprehensive data bases on pe and vc. for this purpose, we analysed available data on pe/vc investments in period 2007-2016. according to the analysis, the most attractive countries for pe and vc were poland, the czech republic, hungary and slovakia, and that countries received the largest amounts of investments. some of the factors that drove pe/vc in these countries are accelerated economic activity, favourable tax regime, and qualified working force. the most unattractive countries in the analysis include bosnia & herzegovina, north macedonia, moldova and montenegro who received sporadic investemnts of low amounts. these markets are still perceived as small and too risky. theoretical background literature review investment of pe or vc funds provides capital to a private company, getting a stake in the company in return, to sell the company when its value increases and therefore generate significant capital gains. the choice of investment is preceded by a detailed analysis of socioeconomic factors that have an impact on the performance of the investment itself. therefore, it is important to take into account a large number of socio-economic factors that will influence the outcome of a potential investment. according to global pe watch worldwide, total pe investments amounted us$391b in 2016, down 4% from 2015 or 50% from 2007, when pe investments reached us$740b. in cee, fundraising peaked in 2008, but under the delayed influence of financial crises, pe investments decreased by about 50% by 2010. the strong private equity market is a cornerstone for commercialization and innovation in a globalized world (groh, 2009). private equity industry has a significant role in the modern economy since it can contribute to the growth by nurturing new enterprises and reenergizing existing ones (european commission, 2011). vc helps the development of innovations, economic growth, and job creation and has a lasting positive effect on the economy because it mobilizes long-term investments (ljumovic et al. 2015). empirical studies confirm that private equitybacked firms are less likely to fail (goncalves-raposo&lehmann, 2019). pe investors allocate their funds to companies with high growth potential, from innovative start-ups needing capital to grow or mid-cap companies with the ambition to take the next level in their development, but also to large business, with the capacity to become the leader on the market. related to that, moritz et al. (2016) found that younger, more innovative and with higher growth expectations are more likely to access equity from vc or pe investors. suppliers of capital estimate the demand for pe and vc with one to two year horizon, make their allocations accordingly and judge the individual countries’ attractiveness, which is determined primarily by expectations about the ability of local pe and vc funds to perform a sufficient number of transactions with satisfactory risk and return ratios (groh, liechtenstein&lieser, 2008). pe and vc industry contributes to the value-creating process, meaning that they add value to companies to make them worth more. however, in evaluating the potential market, they take into account numerous factors. according to oberli (2014, p.47), these factors are: capital markets, macroeconomic, fiscal/legal environment, government intervention, culture-related issues; while variables include past returns to investors (in countries with enough information on track records), initial isidora ljumović, ivana lečovski milojkić, vladimir obradović 135 public offerings (ipos), recent investment activity, growth of gross domestic product, (short term) interest rates, gross domestic savings volume, capital gains taxation, the legal system, fairness, protection of property rights, liberal bankruptcy laws, investment regulations, labour market policies, the maturity of the private equity market and its size, technological opportunities, risk capital culture, and managerial talent. some of these factor will be analysed in this paper. costs of equity finance are depending on macroeconomic conditions and credit supply in the country. according to the masiak et al. (2017) most important macroeconomic determinants are the inflation rate, inflation volatility, unemployment rate, tax rates, gdp per capita and gdp growth rates. pe and vc investments in emerging economies are riskier than that of developed countries because of firm characteristics that are combined with high risk and volatile political environments (johan and zhang, 2016). however, high economic growth and lowering of state intervention in those markets are making them interesting for pe and vc industry on one side (leeds and sunderland, 2003), but challenging on the other since they are still relatively immature, under-developed, with substantial regulatory restrictions and corporate governance weaknesses (bruton and ahlstrom, 2003) and usually high level of corruption that has negative effect on the cost of doing business (fisman and miguel, 2007). however, hain et al. (2015) that market-driven corruption may actually have a positive impact on vc investments into a country, but generally corruption should have a negative impact. a research from cherif and gazdar (2011), shows that gdp growth is a significant indicator for venture capital investments, but also, research and development expenditures and lack of corruption have positive impact on vc investments. they have not found statistical significance for variables such as divestments by ipo, trade sale, or write-offs. institutional and cultural differences matter, nahata et al. (2014) found a positive influence on venture capital investment success when there is cultural distance between the country of the venture capitalist and the portfolio company. they also discovered positive relation between developed stock market and vc performance. in order to analyze the attractiveness of the national equity market, several methodologies and publications are used. however, they all use similar methodologies and input parameters to determine the attractiveness. venture capital and private equity country attractiveness index, which was initiated by iese business school barcelona is used most often by researchers and professionals. it measures the attractiveness of 125 countries for investors in the vc and pe asset classes, by monitoring national pe and vc markets, taking into account specific factors. they consider that “key drivers,” which potential investors focus on when making investment decisions, are economic activity; depth of capital market; taxation; investor protection and corporate governance; human and social environment and entrepreneurial culture and deal opportunities. overview of the industry since the whole investment process in the pe/vc industry is geographically biased, it is reasonable to expect that the largest, most prominent and most active institutional investors in the pe/vc asset class are located in the us, which contributes to the dominant role of the us vc and pe market (groh et al., 2010). according to the venture capital and private equity country attractiveness index, in 2018, top ten ranked countries are: the usa (score 100.00), the uk (94.40), canada (92.60), hong kong (91.20), japan (91.20), singapore (90.70), australia (90.20), germany (87.70), new zealand (87.20) and denmark (84.30). total pe investments in cee between 2007 and 2016 were around 16,7 billion eur, and the largest total investments were made in 2007 (3,01 billion eur), but they had a negative trend up to 2013. there has been a trend of growth until 2016, but the investments didn’t reach the maximum level achieved in 2013 (figure 1). 136 economic analysis (2020, vol. 53, no. 1, 133-148) figure 1. total investments in cee between 2007 and 2016 source: authors own calculation based on data from invest europe on the other hand, if we look only at the specific countries of the cee region, this index shows that the most attractive country in 2018 for pe/vc investors is poland, which took 26th place (globally), with 72.40 score. serbia is ranked 88th out of 125 countries (figure 2). most of cee countries remain far behind eu-15 in areas such as economic activity, entrepreneurial opportunities and depth of capital markets (stefanova, 2015, pp. 51-52), as a result of significant changes that took place in the 1990s – the collapse of the communist centrally-planned system in the cee countries or the self-management system in the former yugoslav countries and transformation to a market based economies. today, pe and vc are part of the common framework at eu level in the process of further integration of eu capital markets, but since its appearance, they have gone through several phases in the cee. the first phase occurred during the early and mid-1990s, where pe/vc investments played a significant role in the process of transition. in this period investments came mainly from global funds and also from specific country-focused funds (relatively small investments, up to 50 million eur). the second phase, which from the late 90s to the mid-2000s, was characterized by the emergence of regional funds with a portfolio of eur 200-250 million and by the first gains on initial pe investments occurred in the first phase. figure 2. cee countries scores for 2018 based on the vc and pe country attractiveness ranking source: the venture capital and private equity country attractiveness index 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 isidora ljumović, ivana lečovski milojkić, vladimir obradović 137 most private equity investments, around 85%, are into small and medium enterprises (smes), that have high potential to grow and develop. (oecd, 2017). smes are the dominant form of business organization in both developed and developing economies (harvie et al., 2013), but in eu smes are largely financed by bank loans (over 80% of attracted funds) and only 2% by venture funds, while in the us about 15% of investments in the sme sector are vc (oecd, 2017). according to stefanova (2015) the lack of sufficient investments in start-up phase of smes in eu is due to the comparatively low returns of these investments (the rate of return on 10-year investments from all forms of venture capital in eu amounts to about 6.3% while in the us, it is 26%, respectively). serbian economy is also dominated by smes (table 1), where almost 65% of the labour force is employed and smes are accounted for 56% of total gross value added and 44.8% of total exports in 2014 (oecd, 2017). table 1: distribution of firms in serbia, 2014, by firm size (enterpreneurs are included under micro enterprises) firm size (employees) no. firms percent no. employees percent all enterprises 324 766 100.0 1 174 947 100.0 smes (0-249) 324 272 99.8 761 539 64.8 micro (0-9) 312 943 96.4 355 389 30.2 small (10-49) 9 198 2.8 185 206 15.8 medium (50-249) 2 131 0.7 220944 18.8 large (250+) 494 0.2 413 408 35.2 source: oecd, 2017 investments by sector investment activities in cee observed by sector between 2007 and 2016 (table 1) shows that the largest total investments are made in the consumer goods and services, total eur3,81 billion; in the sector of information and communication technology eur3,41 billion and in life sciences eur2,04 billion. table 2. investments by sector in cee between 2007 and 2016 amounts in 000 € 2007 2008 2009 2010 2011 sector focus amount % amount % amount % amount % amount % agriculture 11251 0.4 4300 0.2 82 0.0 43794 3.4 6721 0.5 business products and services 356195 11.9 218963 9.0 67156 2.7 118778 9.2 149866 12.0 chemicals and materials 227637 7.6 53041 2.2 6882 0.3 21822 1.7 10688 0.9 ict (information and communication technology) 719842 24.0 495803 20.1 535664 21.9 164387 12.7 272364 21.8 computer and consumer electronics 163297 5.4 54218 2.2 173598 7.1 97448 7.5 61005 4.9 construction 65871 2.2 43883 1.8 16849 0.7 15211 1.2 25301 2.0 consumer goods and services 319871 10.6 362863 14.8 888890 36.3 418620 32.4 362054 29.1 energy and environment 127495 4.2 91106 3.7 248377 10.2 93962 7.3 50842 4.1 financial and insurance activities 318767 10.7 308356 12.5 249536 10.2 107487 8.3 97994 7.9 life sciences 300770 10.0 616522 25.1 210591 8.6 158838 12.3 12 9.5 real estate 91634 3.0 5068 0.2 45555 1.9 4258 0.3 0.0 138 economic analysis (2020, vol. 53, no. 1, 133-148) amounts in 000 € 2007 2008 2009 2010 2011 transportation 301621 10.0 184476 7.5 0.0 47351 3.7 91436 7.3 other 875 0.0 17011 0.7 3858 0.1 0.0 213 0.0 total 3005126 100 2455610 100 2447036 100 1291685 100 1246901 100 table 1 (continued). investments by sector in cee between 2007 and 2016 amounts in 000 € 2012 2013 2014 2015 2016 sector focus amount % amount % amount % amount % amount % agriculture 8638 0.9 20345 0.9 56269 4.3 37905 2.4 11548 0.7 business products and services 90375 9.0 95848 12.1 81051 6.2 113609 7.2 100113 6.3 chemicals and materials 8719 0.9 12564 1.6 973 0.1 1254 0.1 27486 1.7 ict (information and communication technology) 109075 10.8 133487 16.9 492213 37.5 136999 8.7 344680 21.6 computer and consumer electronics 67885 6.7 26008 3.3 245957 18.8 0 0.0 0 0 construction 11552 1.2 48299 6.1 687 0.1 688 0.0 46239 2.9 consumer goods and services 243311 24.2 141891 18.0 193620 14.7 511214 32.3 365674 22.9 energy and environment 86057 8.5 76627 9.7 119062 9.1 489414 30.9 192490 12.1 financial and insurance activities 115283 11.4 23657 3.0 16551 1.3 88538 5.6 149023 9.3 life sciences 259074 25.7 31999 4.1 85758 6.5 135399 8.6 240318 15.1 real estate 0.0 99413 12.6 1158 0.1 7389 0.5 113 0.0 transportation 7046 0.7 77333 9.8 17616 1.3 59257 3.7 101193 6.3 other 0.0 1230 0.2 0.0 0.0 16863 1.1 total 1007015 100 788702 100 1310914 100 1581664 100 1595740 100 source: authors own calculation based on data from invest europe pe investments by stage focus. in period 2007-2016, european private equity market remained dominant in buyouts, which accounted for 52.5-78.8% of total investments by value; cee market followed europe in terms of total investments by stage focus. however, in cee total buyouts were relatively higher, up to 40% of total value invested, which is consistent with the growth orientation of the cee economies. vc as a proportion of total investment activity in europe remained relatively low, 9.3% on average, and in cee it was even lower in this period (5.3% on average). even though the regulatory framework for vc is still not in place in the republic of serbia, there are some sporadic investments of vc and equity funds established abroad (oecd, 2017). in serbia, in 2007, only 0.6% of investments were vc, while buyouts dominated with almost 53%. isidora ljumović, ivana lečovski milojkić, vladimir obradović 139 table 3. type of investment in cee by stage focus 2007-2016 source: invest europe note: other consists of bosnia & herzegovina, north macedonia, moldova and montenegro. 140 economic analysis (2020, vol. 53, no. 1, 133-148) data analysis and results so far, we examined pe/vc investments in cee, in total amount, as well as a percentage of gdp. we compared the results with the european average in period 2007-2016 but also presented pe/vc investments in total value by stage focus. as investors in pe/vc funds have an objective to get access to activities with satisfying risk and return ratios, they are taking into account many factors to evaluate their investment opportunities. as already mentioned, venture capital and private equity country attractiveness index, which was initiated by iese business school barcelona is used most often by researchers and professionals to analyze the attractiveness of the national equity market. the most important factors according to iese are: economic activity (gdp, inflation, unemployment rate); size and liquidity of capital markets; taxation; investor protection and corporate governance; the human and social environment (human capital, labour market policies and crime); and entrepreneurial culture and opportunities (including innovation capacity, the ease of doing business and the development of high-tech industries)(groh et al, 2008). macroeconomic indicators economic size and growth, employment level and entrepreneurial activity are important criteria for pe/vc country attractiveness and their stable and predictable trend is desirable. investors follow indicators such as gdp, inflation and unemployment rate to evaluate their investment opportunities. table 2 presents total pe investments as a percentage of gdp (as a determinant of a country’s economic performance) in cee countries in period 2007-2016. the results show that in europe as in cee, the highest level of investments as a percentage of gdp was in 2007, but the european market has experienced a sharp decline in 2008. this fall came as a consequence of the global economic crisis. after this period pe investments remained relatively stable until 2016. in cee, there has been an increase in 2009, but the trend turned negative until 2014. majority of cee countries (except estonia, moldova, serbia, and slovakia) have reached their maximum of investments as a percentage of gdp between 2007 and 2009. significant investments in relation to gdp in serbia occurred in 2007 (0.548%) when it was above the cee average. however, the level of investment reached a maximum level of 0.7% of gdp in 2014. observed in relation to cee average investments, hungary was the most successful, by 6 out of 10 observed years with above-average investments. table 2 shows that unfortunately, we cannot determine a a stable trend on pe investments in any of the observed countires. rather, it seems that pe the investments in these markets happen ad hoc, as and individual initiatives when the investor sees a chance to buy a specific companies. table 4. pe investment as a percentage of gdp country 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 bosniaherzegovina 0.007 0.034 0.052 0.000 0.000 0.000 0.000 0.000 n/a n/a bulgaria 1.923 0.265 0.530 0.228 0.019 0.211 0.027 0.006 0.100 0.049 croatia 0.046 0.213 0.061 0.027 0.035 0.073 0.044 0.097 0.010 0.090 czech republic 0.133 0.297 1.010 0.133 0.092 0.069 0.085 0.193 0.020 0.096 estonia 0.332 0.088 0.033 0.176 0.041 0.109 0.147 0.204 0.090 0.361 hungary 0.487 0.423 0.223 0.068 0.194 0.103 0.056 0.164 0.150 0.078 latvia 0.793 0.274 0.005 0.029 0.100 0.017 0.066 0.141 0.150 0.103 lithuania 0.567 n/a 0.004 0.006 0.086 0.023 0.064 0.107 n/a n/a macedonia 0.177 n/a 0.217 0.000 0.000 0.000 0.094 0.000 n/a n/a isidora ljumović, ivana lečovski milojkić, vladimir obradović 141 country 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 moldova n/a n/a 0.000 0.000 0.019 0.000 0.035 0.000 n/a n/a montenegro n/a 0.582 0.000 0.000 0.000 0.000 0.000 0.000 n/a n/a poland 0.222 0.165 0.089 0.192 0.183 0.125 0.096 0.061 0.210 0.172 romania 0.392 0.198 0.187 0.101 0.049 0.020 0.049 0.052 0.090 0.087 serbia 0.548 0.025 0.000 0.104 0.000 0.014 0.047 0.986 0.700 0.142 slovakia 0.043 0.046 0.003 0.022 0.013 0.137 0.003 0.015 0.020 0.016 slovenia 0.139 0.010 0.224 0.019 0.039 0.010 0.012 0.037 0.030 0.183 ukraine / 0.247 0.045 0.085 0.053 0.033 0.015 0.004 0.020 0.013 total cee 0.325 0.209 0.241 0.119 0.104 0.082 0.062 0.104 0.130 0.120 total europe 0.570 0.404 0.186 0.314 0.328 0.260 0.249 0.277 0.300 0.329 source: authors own calculation based on data from the invest europe capital market the depth of capital market, its development, liquidity, capitalisation, number of listed companies and ipo activity, m&a market, presence of financial institutions such as investment banks are crucial for pe/vc activity. black&gilson (1998) state that well-developed stock markets, which allows general partners to exit investments via ipos, are crucial for the establishment of vibrant vc/pe markets. bank-centered capital markets are less able to produce an efficient infrastructure of institutions that support vc/pe. according to oberli (2014), exit opportunities and the amount of credit provided by the banking sector are strong determinants of new funds raised overall. annual fundraising volume is dependent on the previous year’s market liquidity (balboa&marti, 2003). cee companies face small capitalisation of local markets, limited liquidity and poor effectiveness of legal systems, all of which can have detrimental effects on stock pricing (korczak&bohl, 2005). serbian capital market is categorized into a group of frontier markets (very small and illiquid emerging stock markets), where privatization significantly influenced on the features and volatility. although the number of companies listed on the belgrade stock exchange is extremely high, this does not reflect the developed capital market, since the level of market capitalization is extremely low. a large number of companies listed on the belgrade stock exchange are a direct consequence of the selected model of privatization of the economy and forced involvement in the stock market (ljumović et al. 2015). secondary capital market is underdeveloped, and although formally there are conditions for initial and secondary public offer, in practice this is extremely rare. however, similar effects of privatization were noticed in other transition economies (minović&vuković, 2013). stock markets in cee countries significantly collapsed during the financial crisis of 2008 (kizys&pierdzioch, 2011). taxation tax system influences on the decision to invest, since the return from pe/vc investments is realised in the form of capital gain, dividends or interest income that are subjected to taxation. corporate income tax is one of the key elements that investors are considering when making decisions about investing in a particular country. other tax items also relevant for pe/vc, according to invest europe (2018) are vat on management fees charged to the fund; withholding taxes on dividends; tax exemptions available for dividend income and capital gains; the availability of special fund regimes; stamp duties or financial transaction taxes. cee countries have a lower corporate income tax rates compared to the developed countries, where the goal of maintaining such low tax rates is to create a favourable investment climate and thus economic growth in order to create new job opportunities. in the cee region, the highest 142 economic analysis (2020, vol. 53, no. 1, 133-148) corporate tax rate is in slovakia (21%), while montenegro and hungary have the lowest corporate tax rate at the level of 9%. bosnia-herzegovina, bulgaria, and macedonia have a 10% rate, and together with montenegro and hungary, according to this criterion, they are the most attractive for investing. serbia’s corporate tax rate of 15% is among the lowest in europe, and a special rate of 10% is applied for sole traders. non-residents are taxed only based on their income generated in serbia. serbian vat rates are also among the most competitive in cee – a standard rate of 20% for most taxable supplies and reduced rate of 10% for basic foodstuff, newspaper etc. (table 3). even though this looks good on the first glance, para-fiscal charges (such as social security contribution etc.) represent a heavy burden for the local economy in serbia. table 5. tax rates in cee relevant for pe/vc investing country corporate tax rate (%) withholding tax on dividends (%) vat (%) social security contribution (%) personal income tax (%) standard reduced employer employee bosniaherzegovina 10 5 17 10.50 31.00 10 bulgaria 10 0/5 20 9 18.9219.62 13.78 10 croatia 18 12 25 13 17.20 20.00 12-36 czech republic 19 15/35 21 15 34.00 11.00 15 estonia 20 0 20 9 33.80 1.60-3.60 20 hungary 9 0 27 5/18 19.50 18.50 15 latvia 20 0/20 21 5/12 24.09 11.00 23-31.4 lithuania 15 0/15 21 5 9 31.18 9.00 15 macedonia 10 10 18 5 10.00 27.00 10 moldova 12 6 20 8 27.50 10.50 7-18 montenegro 9 9 21 7 10.70 24.00 9 poland 15-19 19 23 5/8 21.00 22.71 18-32 romania 16 5 19 5/9 2.75 35.00 10 serbia 15 20/25 20 10 17.90 19.90 10 slovakia 21 0/35 20 10 35.20 13.40 19 25 slovenia 19 15 22 9.50 16.10 22.10 16-50 ukraine 18 15 20 7 22.00 18 source: deloitte (www2.deloitte.com) investor protection and corporate governance investor protection and corporate governance in terms of country’s legal environment is an important factor that investors consider when making pe/vc investing decisions, and it is concerned with the agency problem, as a result of the weaker legal protection of shareholders. a country’s institutional framework (both legal system and capital markets) is important for the success of privately held companies and, in turn, for promoting entrepreneurship and the vc industry (rajarishi et. al, 2014). to measure a level of shareholder protection against expropriation by corporate insiders, djankov et al. (2008) developed “anti-self-dealing index”, which is calculated for 72 countries based on legal rules in 2003. their results show that high shareholder protection is positively related to measures of stock market development, such as market cap to gdp, number of listed companies per million inhabitants and ipos. la porta et al. isidora ljumović, ivana lečovski milojkić, vladimir obradović 143 (2002) found that shareholder protection is empirically associated with the higher valuation of corporate assets. other important factors that determine the attractiveness of a particular market are accounting standards and property rights protection. pe financing improves corporate governance in companies by involvement of a pe fund manager in the early stages of company development or in existing companies, who sets a certain level of corporate discipline and improves shareholder protection because pe investors are actively involved in portfolio firms by monitoring and supporting managers with value-adding services (croce&marti, 2016). human and social environment human and social environment is very important for pe/vc activity because human capital is the key for company performance and success. vcs, expecting cultural differences, make a more careful job screening potential investments before investing in their portfolio companies (rajarishi et. al, 2014). family firms can suffer from nepotism, lack of professionalism, and rigidity in adapting to new challenges (poutziouris, 2001; croce&marti, 2016). at the other side, chakrabarti et al. (2009) and rajarishi et al. (2014) state that greater cultural distance between lead vc investor and portfolio company increases the likelihood of vc success, instead of reducing it. one of the most important business performance drivers in cee is high qualified labour force, which requires minimum training to adapt to the international business environment. this represents good value for money for investors because of relatively low labour costs and incentives for creating new job positions. pe/vc market in serbia during the process of transition, serbia started the transformation process into an open market economy with a goal of creating a favourable climate for foreign investments leaving the domination of social property as a basic ownership form. in recent years, the serbian government has made efforts to improve investment climate conducting macroeconomic reforms, greater political and financial stability and improved fiscal discipline. eu accession process that provides the impetus for legal changes that improve the abusiveness environment contributed to the process. one of priority of the serbian government is promotion on the world bank’s doing business list. currently, serbia is ranked 48th globally in terms of ease of doing business (april 2019). to analyze the factors that influenced and shaped the current pe/vc market in serbia, we conducted a swot analysis. taking into account all the factors that determine pe/vc investments, we summarize all strengths, weaknesses, opportunities, and threats of cee economies with swot analysis in table 4. the main barriers for the development of pe and vc operations, either foreign investments or local initiatives, are market size, since the market is too small and immature, lack of entrepreneurial culture and venture friendly environment, political and economic factors (low market competitiveness, corruption, lack of strategies and legal framework, bureaucratic delays and administrative burdens, etc.), and lack of access to finance. however, serbia’s main advantages are favourable geographical position, cheap and well-educated workforce, low corporate tax rate, free trade agreements. smes engaging in professional, scientific, technical and innovative activities represent 11.69% of all businesses in the serbian economy, and 11.71% of the entire sme sector (đuričin&beraha, 2016). 144 economic analysis (2020, vol. 53, no. 1, 133-148) table 6. swot analysis of serbia in terms of attracting pe/vc investments strengths weaknesses well educated and highly qualified labour relatively low labour costs (total costs about 50% of labour cost in eu countries from cee) competitive operating costs: corporate income tax rate (15%) vat standard 20%, reduced 10% tax on dividends 20% personal income tax 10% availability of tax incentives for foreign investments customs-free imports of raw materials and semifinished goods, machinery and equipment for foreign investors free zones (many municipalities offer the possibility to operate within industrial zones with favourable geographic location and infrastructure, and some of these zones are free from the vat, customs and clearance) consumer spending growth fast registration of companies with founding capital small market lack of entrepreneurial culture corruption practices and insufficiently developed anti/corruption strategies and legal framework bureaucratic delays, low efficiency of public administration smes reliance primarily on bank credits and loans from family and friends unresolved problems with state-owned enterprises serbian capital market is categorized into a group of frontier markets very small and illiquid emerging stock markets opportunities threats the possibility of developing certain business activities thanks to a favourable climate and natural resources strategic geographical position macroeconomic reforms, greater political and financial stability improve the business environment the ambition to access to eu forces countries to maintain fiscal discipline free trade arrangements with key markets (countries of south eastern europe and russia) mechansims for investor protection developing infrastructure demographic crisis and aging of population new technologies global economic crisis and slow down global competition growth source: authors own research regional vc and pe attractiveness landscape shows that eastern europe countries have taxation as the main drive to pe and vc investors and the weakness in the depth of capital market, and in investor protection and corporate governance; human and social environment and entrepreneurial culture and deal opportunities relative to other regions (groh et al. 2018). ten years ago, serbian economy was characterized by the low level of capital, old technology, lack of know-how management, but on the other hand, a country with a great opportunity for investing, taking into account the natural resources, qualified and cheap workforce and its central position in the balkan peninsula (makojević, 2009). during the 2009-2011 period when the serbian economy was hit severely by the world economic and financial crisis, private equity backed companies have increased their total assets from eur 814 million in 2009 to eur 882 million in 2011, which is an 8.25% increase (trbovich, et al., 2014). isidora ljumović, ivana lečovski milojkić, vladimir obradović 145 table 7. type of investment in serbia by stage focus 2008-2018 (amounts in 000 eur) year seed startup growth later-stage venture buyout total 2008 7102 1300 8402 2009 2010 13208 2011 2012 4350 4350 2013 16076 16076 2014 326100 326100 2015 425 228657 229082 2016 2050 2050 2017 300 1200 1500 2018 400 3465 3765 source: authors own research based on data from the invest europe according to the results published by the invest europe, the dominant type of pe investment in serbia between 2008 and 2010, was growth capital (which is usually a minority investment); between 2012 and 2015 the investment focus shifts to buyouts, although in 2015, for the first time startup investments are emerging, accounting for only 0.2% of total investments, while in 2017 startup investments dominated with 80%, as in 2018 with as much as 92%. serbia stands to benefit both from entrepreneurial private ventures, as well as important regional initiatives supported by european union such as the western balkan enterprise development and innovation facility (wb edif) and the new eu programme for the competitiveness of enterprises and smes (cosme), which will also stimulate the supply of venture capital, with a particular focus on the expansion and growth phase of smes (trbovich, et al., 2014). conclusion private equity and venture capital industry is not a solution for macro-economic underperformance and poor competitiveness, but it can make an important contribution to the revitalization of the economy. having in mind economic and historical heritage of the cee counties, especially in the collapse of communist/socialist central-planning systems and transition into open market economy, pe and vc can play an important role in developing and promoting high-growth innovative companies that can contribute to fast economic growth and development. although most of cee economies remain far behind eu-15, as a result of significant changes that took place in the 1990s, countries as poland, hungary, slovakia, romania, and the czech republic are growing fast now, and they are very attractive for investors in pe/vc funds. there are many factors that drive pe/vc in cee, like economic activity, because in core cee countries gdp is growing faster than gdp in developed countries; taxation and favorable tax rates which are relatively low, and what is more important – presence of numerous tax incentives for investors and high quality of labor with low costs. total cee investments were dominant in the form of buyouts in analyzed period, at their highest level in 2007, and after decline which lasts for six years, they started to recover from 2013. the private equity fund managers present in cee mostly operate on a regional basis, and although being ready and resourced to complete transactions, they commit their exposure only when the deals have foreseeable exit horizons. fund managers assess exit strategies rigorously before deciding on an investment. the goal is to ultimately exit investments before the pe partnership is terminated. exits through ipos may be 146 economic analysis (2020, vol. 53, no. 1, 133-148) problematic, even for successful investments. several reasons contribute to this outcome including small and illiquid local exchanges. according to swot analysis, serbia has many advantages in terms of attracting pe/vc investments, with the most important factors such as geographical position, well-educated and qualified labor with relatively low cost of labour and advantages related to the tax treatment, free trade agreements, but also the efforts made in recent years such as reforms, improvement of fiscal discipline, and introduction of numerous incentives in order to attract investments. however, financing through pe/vc is almost negligible. no equity or venture fund has been established in serbia yet, but this is not an obstacle for investing. a fund can be geographically located anywhere in the world and invest in serbia. the main reason for the low level of equity and venture capital investments is the poor socio-economic environment, immature and small market. also, the unwillingness of companies for equity investments is one of the reasons for the low level of investments. they have a climate of so called "hostility" towards investors in capital, because the owners are not ready to give up part of the ownership and interfering with the process of decision-making. however, serbia is putting a lot of efforts in to in attracting the investors. recently, the new law on alternative investment funds was introduced, that will start to apply in april 2020. acknowledgements this paper is a part of the results within research on project 179001 financed by the ministry of education and science of the republic of serbia references balboa, m., martí, j. 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(2011). “venture capital and private equity investing in western balkan region”. industrija. 4/2011. 71-87. article history: received: may 14, 2019 accepted: june 30, 2019 http://dx.doi.org/10.1787/fin_sme_ent-2017-en what drives private equity and venture capital in central and eastern europe countries: focus on serbia isidora ljumović125f* | ivana lečovski milojkić2 | vladimir obradović3 investments by sector pe investments by stage focus. data analysis and results macroeconomic indicators capital market taxation investor protection and corporate governance human and social environment pe/vc market in serbia conclusion acknowledgements references microsoft word 2007_01_02.doc   investing in human resources    jovan zubović, institute of economic sciences belgrade    key words: human resources, education system, long‐term strategies    udc: 005.96          jel: j24, e22 editorial    abstract – investing in human resources is a taboo in many countries worldwide. unlike in undevel‐ oped and transitional economies, in countries with developed economic system there is an open debate about  the need to analyse educational policies and investment policies with an aim to increase quality of human  resources. there are few blind spots which can substantially reduce long‐term value of human capital, and  diminish level of investments’ efficiency in educational systems.  introduction  as a reply to labor market demand where on one side real wages of highly educated and  qualified labour force have increase, and on the other side the wages of lower qualified and edu‐ cated labor have been reduced, there is a renewed interest for creation of policy which may enforce  social productive knowledge worldwide. politicians and sociologists often raise question about  consequences of economic inequality. it seems that it is close for a consensus to be reached, by  which an  improvement of qualification and education of nonqualified personnel would  lead to  their easier adoption by society and reduction of inequality in wages.   this  paper  reviews  the  current  policies  of  knowledge  creation.  as  a  result  of  years  long  school development policy there have been certain roles widely accepted. there is a need for an  education system of  the wider scope so as  to reach  the system  in which people  increase  their  knowledge and qualifications in such a way which is in accordance with modern economy needs.   contemporary world trends  current practice in education and qualification of people for job are based on wrong stan‐ dards of creation of socially required skills. creators of such standards have a sight only through a  prism of reached knowledge tested on iq tests regardless of social knowledge, self‐disciple and  several non‐cognitive skills which enable success in life. overweighting of cognitive and academic  “intellectuals” whose qualities are measured on tests which do not cover social adaptability and  motivation, raise doubt in valuation of investments made in development of human resources.   conventional wisdom represented by politicians, educated person and many academics –  especially professors  in education – place formal educational  institutions on  the central spot of  creation of required knowledge  in modern economies. such a practice denies  favorable role of  families  and  companies  in  knowledge  and  many  other  skills  improvement  needed  by  modern  economy.  popular  discussions  of  knowledge  creation  almost  always  focus  on  investments  in  schools  or  educational  reform,  disregarding  important  non‐institutional  sources  of  knowledge,  which by a great extent, maybe more than formal educational institutions help on creation of sev‐ eral skills needed in the world today.   investments in training and education  current situation in formal education, disregarding informal and non‐institutional sources of  knowledge is a result of three wrongly factors misunderstood by politicians and analysts.  2007 ‐ 2  •  economic analysis®  the first is in the very nature of human and comes as a result of not understanding the fact  that learning is life long process and that a lot of learning comes out of schools. learning begins in  the childhood, much before formal education begins and is continued through whole life. recent  research in psychology have shown the vital role of knowledge creation in preschool age, when  skills and motivation are created in families and non‐institutional environment. success or failure  in this phase leads to success or failure in school, and further on after school. early learning trig‐ gers later learning and early success feeds later successes, as well as failures bring more failures in  grown ages. formal or institutional education is important aspect of educational process, but ac‐ cording the recent research it is not always most important.   in the publication “colerman report” (1966) we have seen that family and environment, not  only school, according to test results have a key role in creation of motivation and education suc‐ cess. broken families create bad skills and lowly motivate students who fail in schools. favourable  family oriented policy may be more effective on improvement of success level in schools than di‐ rect investments on lecturers’ wages or computer equipment. it is more expensive to follow the  policy of covering the failures of early stages than too invest in a sophisticated education system,  and at the same time it does not recover lost potentials even if investments are very high. the later  in life we try to change mistakes from the childhood, more expensive it would be.  on the other hand, work experience and skills learned in jobs are skipped in modern debates  because they are hardly measured. after school education is a source of knowledge creation which  covers 1/3 to ½ of total knowledge in the modern economies (heckman, lochner i taber, 1998).  since a lot of such education is made in non‐formal environment, educational technocrats and poli‐ ticians deny it for the reason of equalising such knowledge with knowledge reached in schools.  once we understand the importance of non‐formal education and knowledge creation, then we  may begin with creation of knowledge improvement policy on the other way.  the second factor for many education planners and policy creators is overweighting of tests  results and measuring of cognitive skills as indicators of success in education. it is certainly correct  that cognitive skills are important in life and there are proofs of profitability of investing in them  (see cawley, heckman i vytlacil, 1999), but such a narrow focus on cognitive, diminish the full  scope  of  socially  and  economically  important  non‐cognitive  skills  and  motivation,  which  are  learned in schools, families and other environment. a special accent ought to be put on the way  how are evaluated investment programs results. on one hand the enriched investment programs  in early ages of life do not significantly change the iq level, but on the other hand they signifi‐ cantly influence non‐cognitive skills and people social status.  another mistake often made in analysis of human resources policy is the assumption that  development of skills is completed in early life age. static concept of skills is opposed to many re‐ searches made on children development. in early ages of life, core skills can be changed. education  creates knowledge, which as a result creates a need for education.  the third factor of misunderstanding in visions of most of the education planners and policy  creators is mistrust for parents’ ability to wisely choose their children education path if choice is  offered. there is disbelief to competition and system in which there is more than one choice for  improvement of success in education.   conclusion  all researches made in past give advantage to systems with high competition. monopoly in  any system of economic and social life prevent development of needs and preferences and ignore  well being of people, unlike systems with developed competition. in analysis of competition influ‐ volume 40 • spring 2007 • 3  ence in the education system it is important to separate systems where there is existent educational  policy from the others where there is no such policy. the question is not whether it is necessary to  invest in education, but rather what should be the level of these investments. increase to low level  of investments would bring significant results. increase of education quality is visible when there  is  low  level  of  investments.  if  investments  are  high  already,  increase  would  bring  no  visible  changes. for example in usa direct cost subventions for students in most state universities is 80%.  the ongoing debate is not about necessity of subventions but about possibility of increase to above  80%.  graph 1 – return of investments in hr in respect to age  there  is a fourth misunderstanding which  is not covered  in this paper and needs deeper  analysis. in many countries in the world large numbers of under qualified personnel are becoming  burden to companies and society as a result of increase in qualifications required. common mis‐ take made by policy makers is that retraining of these people would easily help them keep their  jobs. no one calculates the cost of such retraining, and in the age of strict budgets, it is obvious that  investments in retraining would bring no results except to politicians. the highest cost of these  investments is turning the emphasis of education of younger people who could learn faster (graph  1) with more effective and higher probability to have positive results in long term.  references  coleman j, campbell e, hubson c, mcpatland j, mood a, weinfeld f, york r: equality of educational opportunity, wash‐ ington d.c., u.s. government printing office, 1966  heckman j, lochner l, taber c.: explaining rising wage inequality, explorations with a dynamic general equilibrium model  of earnings with heterogeneous agents, review of economic dynamics, 1(1), 1998  cawley j, heckman j, vytlacil e.: a note on policies to reward the value added by educators, review of economics and  statistics, 1999  heckman j, law and employment: lessons from latin america and the caribbean, university of chicago press, for nber,  2004.  heckman j, borghans l., duckworth a. l., and ter weel b. the economics and psychology of personality traits,  journal of  human resources, 2008.    high capacity low capacity age r et ur n on in ve st m en ts in h r microsoft word 2008_01_02.doc volume 40 • spring 2008 • 73    original paper    application and diagnostic checking of univariate and     multivariate garch models in serbian financial market    jelena minović, belgrade banking academy    key words: multivariate garch models, ljung‐box statistics,     residual‐based diagnostics, lagrange multiplier test    udc: 519.868          jel: c30, g10    abstract  ‐ the goal of this article is to give theoretical and empirical review for diagnostic check‐ ing of multivariate volatility processes. in theoretical part we presented three categories diagnostics for con‐ ditional heteroscedasticity models: portmanteau tests of the ljung‐box type, residual‐based diagnostics (rb)  and lagrange multiplier (lm) tests. in our empirical analysis we used the ljung‐box statistics (q‐test) of  standardized residuals, those of its squared, as well as of the cross product of standardized residuals to check  the model adequacy. our results showed that the residual‐based diagnostics provide a useful check for model  adequacy. overall result is that models perform statistically well.   introduction  as empirical researchers are equipped with various conditional heteroscedasticity models,  checking the adequacy of a fitted model becomes an important issue for model selection. gener‐ ally, misspecification in the mean and variance results in inconsistency and loss of efficiency in the  estimated parameters (tse, 2002, 358). since estimating multivariate garch models (mgarch)  is time consuming, both in terms of computations and their programming (if needed), it is desir‐ able to check ex ante whether the data present evidence of multivariate arch effects. ex post, it is  also of crucial importance to check the adequacy of the mgarch specification (bauwens et. al.,  2006, 79). mgarch models specify equations for how the covariance move over time (rombouts  et. al., 2004). there are also tests specifically designed for multivariate models that are applied to  the vectors of residuals together. popular univariate procedures that are also relevant for multi‐ variate models include asymmetry tests and residual‐based conditional moment tests (mills et. al.,  2006). as mentioned by tse (2002), diagnostics for conditional heteroscedasticity models applied in  the literature can be divided into three categories: portmanteau tests of the box‐pierce‐ljung type,  residual‐based diagnostics (rb) and lagrange multiplier (lm) tests (bauwens et. al., 2006, 79). the  box–pierce–ljung portmanteau statistic  is perhaps  the most widely used diagnostic  (tse, 2002,  358).  we considered trivariate time series models for some selected securities listed at the belgrade  stock exchange (www.belex.co.yu). prior to that, we had to perform univariate garch analysis  for each of the analyzed return series. then, we checked the fitted models carefully: the ljung‐box  statistics of standardized residuals and its squared values showed that models are adequate for  describing the conditional heteroscedasticity of the data. multivariate (trivariate) garch models  which will be covered in this paper are restricted version of bekk (named after baba, engle, kraft  and  kroner,  1995),  model,  the  diagonal  vec  (dvec,  initially  due  to  bollerslev,  engle  and  wooldridge, 1988)  model and conditional correlation model (ccc, bollerslev, 1990)). for trivari‐ ate version of restricted bekk, dvec and ccc representations we estimated covariances among  daily log returns of belex15 index, hemofarm and energoprojekt stocks. for estimation of pa‐ rameters in the univaraite and trivariate garch models we used eviews program, version 4.1.  the methods for estimation parameters which we used are maximum log‐likehood and two‐step  2007 ‐ 74  •  economic analysis®  approach. particularly, we tested how the covariances between chosen securities move over time in  trivariate case. overall, our results show that the residual‐based diagnostics provide a useful check  for model adequacy.  the rest of the paper is organized as follows. in section 2, we present different diagnostics  for univariate garch models which are used in our analysis. then, we report results of diagnos‐ tic checking  for univariate garch models. in section 3 misspecification  tests  for multivariate  garch  models  are  described.  then,  we  report  results  of  diagnostic  checking  for  trivariate  garch models. finally, section 4 concludes.  univariate case  diagnostic checking of univariate garch models (theoretical part)  here we briefly reviewed of different test‐statistics and diagnostics for univariate garch  models which are used in this paper and in references (minović, 2007).  lagrange multiplier (lm) test: this test is used to investigate whether the standardized re‐ siduals exhibit arch behaviour. if the variance equation of arch model is correctly specified,  there should be no arch effect left in the standardized residuals (eviews 5 user’s guide). it is  calculated as lm = tr2, where r2 is defined above. reject h0 if lm > ( )2 mχ∗ , where m is order of  arch effect (greene, 2003).   q test (ljung and box, 1978): it is used to test for the presence of autocorrelation of order m  in residuals and it is calculated as  ( ) ( ) 2 1 ˆ 2 m l l q m t t t l ρ = = + − ∑ .                                                                                       (2.1)  the function  1ρ̂ ,  2ρ̂ , ... is called the sample autocorrelation function (sacf) of rt (tsay, 2005).   q test has a  2χ ‐distribution with m degrees of freedom under the null hypothesis (vogelvang,  2005). the ljung–box statistics of the residuals can be used to check the adequacy of a fitted model  (tsay, 2005).    q2 test: it is used to test for the presence of autocorrelation of order m in squared residuals.  then, it is used to test for remaining arch effect in the variance equation and to check the specifi‐ cation of the variance equation (eviews 5 user’s guide).  the f‐statistic reported in the regression output is used to test the null hypothesis that all of  the slope coefficients (excluding the constant, or intercept) in a regression are zero. for ordinary  least squares models, the f‐statistic is computed as:  ( ) ( ) ( ) 2 2 / 1 1 / r k f r t k − = − − .                                                                                               (2.2)  under  the  null  hypothesis  with  normally  distributed  errors,  this  statistic  has  an  f‐ distribution with (k ‐ 1) and (t ‐ k) degrees of freedom. the total number of regressors is termed as  k; number of restrictions is termed as k – 1; t is number of observations (brooks, 2002), (eviews 5  user’s guide). the p‐value given  just below the f‐statistic, denoted prob(f‐statistic), is the mar‐ ginal significance level of the f‐test (eviews 5 user’s guide).   diagnostic checking of univariate garch models (empirical part)  in this part we consider univariate case and we use data of daily log returns for belex15 index,  hemofarm stock and energoprojekt stock, respectively. our data cover the period from october 3,  volume 40 • spring 2008 • 75  2005 to october 6, 2006 (minović, 2007). we applied log‐difference transformation to convert data  into continuously compounded returns, because the price series (log values) of both stocks and  index is not stationary and are stationary when they are first differenced. let  1tr ,  2tr , and  3tr  be the  log return series (figure 1) corrected for autocorrelation in the mean of belex15 index, hemofarm  and  energoprojekt stocks, respectively [8].    figure 1: the graphs of daily log returns of belex15 index (r1), hemofarm (r2) and energoprojekt (r3)  stocks, respectively.  -.015 -.010 -.005 .000 .005 .010 .015 2005:10 2006:01 2006:04 2006:07 2006:10 r1 -.03 -.02 -.01 .00 .01 .02 .03 .04 2005:10 2006:01 2006:04 2006:07 2006:10 r2 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 2005:10 2006:01 2006:04 2006:07 2006:10 r3   we observe from figure 1 that the log returns of belex15 index, hemofarm and energopro‐ jekt stocks evidence the well known the volatility clustering effect. it is tendency for volatility in  financial markets to appear in bunches. thus large returns (of either sign) are expected to follow  large returns, and small returns (of either sign) to follow small returns (brooks, 2002), (minović,  2007).  we use four steps for building a volatility model for each of the log return series. the first  step is to specify a mean equation by testing for serial dependence in the data and building an  arma model for the log return series to remove any linear dependence. then, in the second step,  we use the residuals of the mean equation to test for arch effects. next, in the third step, we spec‐ ify a volatility model if arch effects are statistically significant and perform a joint estimation of  the mean and volatility equations. finally, in the fourth step we check the fitted model carefully  (tsay, 2005).  in univariate case, obviously, the residuals have to be tested for the presence of autocorrela‐ tion. in time‐series terminology this is called ‘diagnostic checking’. with the ljung‐box (q) test, we  tested whether the residuals behave like a white noise process (vogelvang, 2005). table 1 reports  the q(m) and q2(m) statistics for each series. we applied the lagrange multiplier (lm) test on our  series in order to investigate whether the standardized residuals exhibit arch behaviour (eviews  5 user’s guide), (bauwens et. al., 2006, 79), (minović, 2007).     table 1: the ljung‐box statistics of standardized residuals and squared standardized residuals in arma  models and test for arch effect.  the ljung‐box statistics  arch‐lm(5) test  series  q(2)  q(5)  q(9)  q(36)  q2(2)  q2(5)  q2(9)  q2(36)  f‐stat  obs*r^2  belex15  0.655  (0.721)  2.780  (0.734)  4.290  (0.891)  26.559  (0.874)  2.726  (0.256)  4.121  (0.532)  6.496  (0.689)  26.178  (0.885)  0.726  (0.604)  3.666  (0.598)  hemofarm  1.453  (0.484)  7.483  (0.187)  11.491  (0.244)  34.857  (0.523)  33.866  (0.000)  47.446  (0.000)  72.915  (0.000)  86.635  (0.000)  6.613  (0.000)  29.775  (0.000)  energoprojekt  1.848  (0.397)  2.209  (0.820)  3.406  (0.946)  26.659  (0.871)  10.437  (0.005)  13.065  (0.023)  13.852  (0.128)  26.716  (0.870)  3.138  (0.009)  15.099  (0.010)    2007 ‐ 76  •  economic analysis®  we see from table above that is the significant q‐statistics for squared residuals across all lag  lengths  for  hemofarm  stock  and  we  infer  the  presence  of  arch  effects.  the  q‐statistics  for  squared residuals across all lag lengths for belex15 index is not significant, it ignores the exis‐ tence of arch effects. but the heteroscedasticity in belex15 and hemofarm is also observed in  the plots of the actual values of residuals (see minović, 2007). from table 2.1 we see that is only  one significant autocorrelation on lag 2 in squared residuals in arma model for energoprojekt  stock. it is evident that exist arch effect for energoprojekt stock. on the other hand, the lagrange  multiplier (lm) test (table 2.1) shows strong arch effects for hemofarm stock with test statistic f  = 6.613, the p‐value of which is zero; and arch effect for energoprojekt stock with test statistic f =  3.138, the p‐value 0.009. then this test shows no arch effect for belex15 index with test statistic  f = 0.726 and the p‐value 0.604 (minović, 2007).  we  built  a  volatility  model  for  each  asset  returns  and  we  inferred  that  right  model  for  belex15  index  is  the  arma(1,1)‐garch(1,1),  then  for  hemofarm  stock  is  the  arma(2,2)‐ igarch(1,1) and for energoprojekt stock arma(0,0)‐garch(1,1) model (for detail see minović,  2007). however, hemofarm stock follows integreted garch model (igarch). in order to exam‐ ine igarch process, we applyed wald test. finally, we checked the fitted models carefully. the  ljung‐box statistics (table 2.2)   of standardized residuals and those of its squared showed that  models are adequate for describing the conditional heteroscedasticity of the data . we applyed the  arch test on the standardized residuals to see if there ware any arch effects left. both the f‐ statistic and the lm‐statistic are very insignificant, suggesting no arch effect up to order 5 or 10  for each series belex15 index, hemofarm and energoprojekt stocks (see table 2) (minović, 2007).    table 2: the ljung‐box statistics and arch‐lm test of order 5 and 10.    the ljung‐box statistics  arch‐lm(5) test  arch‐lm(10) test  series  q(36)  q2(36)  f‐stat  obs*r^2  f‐stat  obs*r^2  belex15  25.590  (0.901)  26.319  (0.881)  0.265  (0.932)  1.351  (0.930)  0.423  (0.934)  4.356  (0.930)  hemofarm  29.038  (0.788)  23.685  (0.943)  0.084  (0.995)  0.432  (0.994)  0.146  (0.999)  1.518  (0.999)  energoprojekt  26.447  (0.878)  22.156  (0.966)  0.799  (0.551)  4.028  (0.545)  0.606  (0.808)  6.183  (0.800)    on figure 2 we plot the garch variances for belex15 index, hemofarm and energopro‐ jekt stock. we see on this figure that all variances are unstable over time.     figure 2: the garch variance series for belex15 index, hemofarm and energoprojekt stocks.      we found that correlation coefficients between log returns of belex15 index and hemofarm  stock is 0.49; between log returns of belex15 index and energoprojekt stock is 0.40; and between  .000005 .000010 .000015 .000020 .000025 .000030 .000035 2005:10 2006:01 2006:04 2006:07 2006:10 variancebelex .0000 .0001 .0002 .0003 .0004 .0005 .0006 .0007 .0008 2005:10 2006:01 2006:04 2006:07 2006:10 variancehemofarm .0000 .0001 .0002 .0003 .0004 .0005 .0006 2005:10 2006:01 2006:04 2006:07 2006:10 varianceenergoprojekt volume 40 • spring 2008 • 77  log returns of hemofarm and energoprojekt stocks about 0.02 and we conclude that these two  stocks are practically noncorrelated (minović, 2007).  in addition to visual inspection figure 2.2 tell us that garch variance series exhibit signifi‐ cant changes over time for both stocks and index. therefore, these variances are very unstable over  time. a plot of garch variances of belex15 index, hemofarm and energoprojekt stocks reveals  that belex15 index has been more volatile than hemofarm and energoprojekt stocks. on graph  for variance of hemofarm stock, we observe the greatest peak  in period june‐july 2006,  it was  when company schtada was bought stocks of hemofarm and schtada was became of major. we  see significant autocorrelation on  this graph which occur because hemofarm  in univariate case  follow igarch process. on graph for variance of energoprojekt, we see that the first peak was in  february 2006, when energoprojekt company signed contract in nigeria valued 151 million euros  (minović, 2007).  multivariate case  theoretical review of misspecification tests for multivariate garch models  asymmetry tests  engle and ng (1993) have proposed a set of tests for asymmetry in volatility, known as sign  and size bias tests. the engle and ng tests should thus be used to determine whether an asymmet‐ ric model is required for a given series, or whether a symmetric garch model can be deemed  adequate. in practice the engle and ng tests are usually applied to the residuals of a univariate  garch fit to individual series. denote an individual series of disturbances as  tε , and define  1ts − −   as an indicator dummy that takes the value 1 if  ˆ 0tε <  and zero otherwise. then the test for sign  bias is based on the significance or otherwise of  1φ  in the regression  2 0 1 1t̂ t ts eε φ φ − −= + +                                                                                                     (3.1)  where  te  is an i.i.d. (independently and identically distributed) error term. if positive and  negative shocks to  1t̂ε −  impact differently upon the conditional variance, then  1φ  will be statisti‐ cally significant (mills et. al., 2006).  it could also be the case that the magnitude or size of the shock will affect whether the re‐ sponse of volatility to shocks is symmetric or not. in this case, a negative sign bias test would be  conducted, based on a regression in which  1ts − −  is now used as a slope dummy variable. negative  sign bias is argued to be present if  1φ  is statistically significant in the regression    2 0 1 1 1t̂ t t ts eε φ φ ε − − −= + + .                                                                                             (3.2)  finally, defining  1 11t ts s + − − −= − , so that  1ts + −  picks out the observations with positive innova‐ tions, engle and ng propose a joint test for sign and size bias based on the regression  2 0 1 1 2 1 1 3 1 1t̂ t t t t t ts s s eε φ φ φ ε φ ε − − + − − − − −= + + + + .                                                                 (3.3)  significance of  1φ   indicates the presence of sign bias, where positive and negative shocks  have differing impacts upon future volatility, compared with the symmetric response required by  the standard garch formulation. on the other hand, the significance of  2φ  or  3φ  would suggest  the presence of size bias, where not only the sign, but also the magnitude, of the shock is impor‐ tant. a joint test statistic is formulated in the standard fashion by calculating  2tr  from regression  2007 ‐ 78  •  economic analysis®  (3.3), which will asymptotically follows a  2χ  distribution with 3 degrees of freedom under the null  hypothesis of no asymmetric effects (mills et. al., 2006).  residual‐based conditional moment tests  if the model is correctly specified, and represents an adequate characterization of the data,  certain moment relationship should hold on an appropriately standardized measure of the residu‐ als. let θ  denote a  1k ×  parameter vector (containing all model parameters) and  ( )r θ  denote the  restrictions function required for the test. the null hypothesis is:   0 : ( ) 0h r θ = .                                                                                                            (3.4)  let  ˆvar( ( ))r θω = ,                                                                                                    (3.5)  where θ̂  is vector of estimated parameters.  then the wald test statistic is given by  1ˆ ˆ( ) ( )tw r rθ θ−= ω .                                                                                                   (3.6)  under the null,  2jw α χ: , and so the null hypothesis is rejected if  2,jw αχ> , where α  is the  size of the test and  j  is the number of restrictions. the variance‐covariance in (3.5),  ω̂ , may be  calculated from the residual sum of squares of the regression of  m̂  (the values of elements of the  moment restriction function by observation) on  1 2 ˆ ˆ ˆ, ,..., ,kd d d  the values of each of the derivatives  of the log‐likelihood, observation by observation. the residual sum of squares of this regression is  given by  ( ) 1ˆ ˆ ˆ ˆt t t tr m m m d d d d m−= − .                                                                                (3.7)  the required variance is then  2 ˆ r t ω =  (mills et. al., 2006).                                                                                    (3.8)  multivariate model diagnostics  among  the specific multivariate model diagnostics, bauwens  (2003) propose  the use of a  multivariate version of the ljung‐box test due to hosking (1980) (mills et. al., 2006). this test is the  most widely used diagnostics to detect arch effects (bauwens et. al., 2006, 79). let  1/ 2ˆ ˆˆt t tz h ε −=   denote the n‐vector of standardized residuals, the test statistic is given by  ( ) ( ) ( ) ( ) ( ) ( ){ }12 1 1 ' 1 0 0 t t t t m z z z z t hm m t t j tr c c j c c j − − − = = −∑ ,                                   (3.9)  where  ( )'ˆ ˆt t tz vech z z=  and  ( )tzc j  is the sample autocovariance matrix of order j given by:  ( ) ( )( )'1 1 , 0,..., 1, t n z t t j t j c j t z z z z j t− − = + = − − = −∑                                            (3.10)  with  ( )1 ... /tz z z t= + + . under the null hypothesis of no dependence in the standardized  residuals (i.e. no arch effects), the test statistic is asymptotically distributed as a  2χ  with  2n m   degrees of freedom (bauwens et. al., 2006, 79), (mills et. al., 2006).   the box‐pierce portmanteau statistics have been used as the benchmark for detecting model  inadequacy  in  multivariate  conditional  heteroscedasticity  models.  this  test  is  based  on  cross‐ products  of  the  standardized  residuals  often  provides  a  useful  diagnostic.  denoting   volume 40 • spring 2008 • 79  ( )'1ˆ ˆ ˆ,...,t t tkε ε ε=  and the elements of  ˆ tς  by  ,ˆij tσ , we define the i‐th standardized residuals at time t  as  ˆ ˆ/it it iitz ε σ= .                                                                                                        (3.11)  let  ,ˆij tρ  be the estimated conditional correlation coefficient defined by  , , , ,ˆ ˆ ˆ ˆ/ij t ij t ii t jj tρ σ σ σ= ;  we consider  ,ij tc  defined by  2 , , 1 ˆ it ij t it jt ij t z i j c z z i jρ ⎧ − =⎪ = ⎨ − ≠⎪⎩                                                                                         (3.12)  for  , 1,...,i j k= . when the constant‐correlation or the no‐correlation models are estimated,  ,ˆij tρ  is a constant with respect to t. under correct model specification,  ,ij tc  is asymptotically serially  uncorrelated and  ( ), 1| 0ij t te c −φ →  as  n → ∞ . thus, a diagnostic can be constructed based on the  box‐pierce statistic of the squared lag autocorrelation coefficient of  ,ij tc . specifically, we denote  hijr   as the lag‐h autocorrelation coefficient of  ,ij tc  and define  ( ) 2 1 , ; m hij h q i j m n r = = ∑ .                                                                                                (3.13)  if the multivariate conditional heteroscedasticity model fits the data,  ,ij tc  should be serially  uncorrelated for i and j. an excessive value of q would suggest model inadequacy. the test has  been widely used in the empirical literature for diagnosing both univariate and multivariate condi‐ tional heteroscedasticity models (tse et. al., 1999, 679).  ling and li (1997) develop another diagnostic test for unparametrized heteroskedasticity in  the standardized residuals (mills et. al., 2006). the ling‐li test represents a rigorous approach to  conducting tests for multivariate conditional heteroscedasticity, providing the justification for the  asymptotic null distribution (tse et. al., 1999, 679). their formulation resembles a multivariate ver‐ sion of the durbin‐watson test applied to the squares of the standardized residuals. it is defined  as:  ( ) ( )2 1 m h ll m t r h = = ∑ %                                                                                              (3.14)  which asymptotically follows a  ( )2 mχ  under the null of no conditional heteroscedasticity,  and where (bauwens et. al., 2006, 79), (mills et. al., 2006)  ( ) ( )( ) ( ) ' 1 ' 1 1 2' 1 1 ˆ ˆˆ ˆ ˆ ˆ ˆˆ ˆ t t t t t h t h t h t h t t t t t h n n r h n ε ε ε ε ε ε − − − − − = + − = + σ − σ − = σ − ∑ ∑ % .                                                          (3.15)  in particular, imposing the restriction that the variance matrix  tς  is diagonal, ling and li  reported that the ll(m) statistic has power against situations in which the orders of the condi‐ tional variance equations are misspecified (tse et. al., 1999, 679).  in the derivation of the asymptotic results, conditional normality of the innovation process is  not assumed. the statistic is thus robust with regard to the conditional distribution choice. tse and  tsui (1999) show that there is a loss of information in the transformation of the residuals  ' 1ˆˆ ˆt t tε ε −σ   and the test may suffer from a power reduction (bauwens et. al., 2006, 79). in other words, the  2007 ‐ 80  •  economic analysis®  ling‐li test may not have good power if the misspecification occurs only in the conditional covari‐ ance term (tse et. al., 1999, 679). furthermore, duchesne and lalancette (2003) argue that if an in‐ appropriate choice of m is selected, the resulting test statistic may be quite inefficient. for this rea‐ sons, these authors propose a more powerful version of the ll(m) test based on the spectral den‐ sity of the stochastic process { }' 1ˆˆ ˆ ,t t t t zε ε−σ ∈  which is i.i.d. under null of homoscedasticity. interest‐ ingly, since their test  is based on a spectral density estimator, a data‐dependent choice of m  is  available (bauwens et. al., 2006, 79). ling and li (1997) further developed this work and derived  the asymptotic distribution of the portmanteau statistic in the multivariate case. the ling–li statis‐ tic is based on the serial correlation coefficients of the transformed vector of residuals (tse, 2002,  358).  lagrange multiplier (lm) tests are also very widespread in the garch literature. gener‐ ally, they have an advantage over ljung‐box and ling and li tests due to their efficiency when the  alternative is correct (although they can be asymptotically equivalent in certain cases). bollerslev,  engle, and wooldridge (1998) and engle and kroner (1995), among others, have developed lm  tests for mgarch models (bauwens et. al., 2006, 79).   to reduce the number of parameters in the estimation of mgarch models, it is a common  practice to introduce restrictions. for instance, the ccc model of bollerslev (1990) assumes that the  conditional correlation matrix is constant over time. it is then desirable to test this assumption af‐ terwards. tse (2000) proposes a test for constant correlations. the null is  , , ,ij t ij ii t jj tσ ρ σ σ=  where  the conditional variances are garch(1,1), while the alternative is  , , , ,ij t ij t ii t jj tσ ρ σ σ= . the test  statistic is a lm statistic which under the null is asymptotically  ( )( )2 1 / 2n nχ −  (bauwens et. al.,  2006, 79).  engle and sheppard (2001) propose an alternative procedure to test the constant correlation  hypothesis, in the spirit if the dcc models (for detail about these models see minović, 2007). the  null  0 : 1,...,th t tρ ρ= ∀ =   is  tested  against  the  alternative  ( ) ( ) ( ) ( )* *1 1 1: ...t t p t ph vech vech vech vechρ ρ β ρ β ρ− −= + + + . the test is easy to implement  since  0h  implies the nullity of all coefficients in the regression  * * * * 0 1 1 ...t t p t p tx x x uβ β β− −= + + + + ,  where  ( )'ˆ ˆut t t nx vech z z i= − ,   uvech  is like the vech operator but it only selects the elements  under the main diagonal,  1/ 2 1ˆˆ ˆˆt t tz dρ ε − −=  is the  1n ×  vector of standardized residuals (under the  null), and  ( )11, ,,...,t t nn td diag σ σ=  (bauwens et. al., 2006, 79).  the residual‐based f test (rbf(i,j)) described by pagan and hall (1983) consists of running a  regression of the cross‐products of the standardized residuals on some ‘information variables’ and  examining the statistical significance of these variables. bollerslev (1990) incorporated the lagged  values of the cross‐products of the standardized residuals. the diagnostic is then based on the f  statistic for the joint significance of the two regressors (tse et. al., 1999, 679).  y. k. tse and albert k. c. tsui (1999) considered several tests for model misspecification after  a multivariate conditional heteroscedasticity model has been fitted. they examined the perform‐ ance of the recent test due to ling and li, the box‐pierce test, and the residual‐based f test using  monte carlo methods. they found that there were situations in which the ling‐li test had very  weak power. the residual‐based diagnostics demonstrated significant under‐rejection under the  null. in contrast, the box‐pierce test based on the cross‐products of the standardized residuals of‐ ten provided a useful diagnostic that has reliable empirical size as well as good power against the  alternatives considered (degroot et.al., 2003).  volume 40 • spring 2008 • 81    empirical analysis of trivariate garch models  for  estimation  of  parameters  in  the  univaraite  and  trivariate  garch  models  we  used  eviews program, version 4.1. we use program for modeling restricted version of trivariate bekk  model (named after baba, engle, kraft and kroner), and we extend this program on trivariate case  of  dvec  (diagonal  vector arch  model)  and  ccc  (constant  conditional  correlation  model)  models (minović, 2007). a first simple method to estimate the parameters of a trivariate garch  models is the berndt‐hall‐hall‐hausman (bhhh) algorithm. this algorithm uses the first deriva‐ tives of the quasi‐maximum likelihood (qml) with respect to the number of parameters that are  contained in multivariate garch models. this is an iterative procedure, the bhhh algorithm  needs suitable initial parameters (franke et.al., 2005). for all calculations in our programs number  of iteration is 100 and convergence criterion is  51 10−⋅  which suggests about high precision (mino‐ vić, 2007).   modeling of restricted bekk, dvec and ccc models in trivariate version  table 3 contains the coefficients, standard errors, z‐statistics, log‐likelihood and information  criteria for trivariate bekk, dvec and ccc model. the methods for estimation parameters which  we  use  are  maximum  log‐likehood  and  two‐step  approach.  although  maximum  log‐likehood  method can be used for all three models (bekk, dvec and ccc), for ccc representation we will  estimate parameters using the first step of two‐step approach. it is enough because ccc model  uses constant correlation coefficient, and second step should be used only when correlation coeffi‐ cient is time dependent (minović, 2007).     table 3: estimated parameters of trivariate bekk, dvec and ccc models  bekk  dvec  ccc       coeff.  s.e.  z‐stat  coeff.  s.e.  z‐stat  coeff.  s.e.  z‐stat  mu(1)  ‐0.0003  0.0002  ‐1.4536  ‐0.0001  0.0002  ‐0.3216  ‐0.0001  0.0002  ‐0.6120  mu(2)  ‐0.0006  0.0001  ‐8.1946  ‐0.0003  0.0002  ‐1.6585  ‐0.0006  0.0001  ‐8.4620  mu(3)  ‐0.0005  0.0007  ‐0.7305  ‐0.0003  0.0006  ‐0.5244  ‐0.0003  0.0006  ‐0.5453  omega(1)  0.0017  0.0004  4.8070  0.0000  0.0000  1.9624  0.0000  0.0000  1.3449  beta(1)  0.7826  0.0879  8.9069  0.5216  0.1549  3.3679  0.4973  0.3058  1.6260  alpha(1)  0.3495  0.0739  4.7325  0.2006  0.0709  2.8288  0.1479  0.0913  1.6192  omega(2)  0.0000  0.0000  0.0519  0.0000  0.0000  3.0426  0.0000  0.0000  ‐9.3533  beta(2)  0.8416  0.0058  144.5231  0.6827  0.0168  40.5688  0.7085  0.0010  70.8697  alpha(2)  0.7682  0.0373  20.6101  0.5952  0.0623  9.5593  0.5820  0.0534  10.8965  omega(3)  0.0016  0.0006  2.4940  0.0000  0.0000  2.6601  0.0000  0.0000  5.1316  beta(3)  0.6814  0.1607  4.2397  0.3052  0.2135  1.4291  0.2269  0.1382  1.6417  alpha(3)  0.4283  0.0975  4.3925  0.2479  0.1152  2.1518  0.2539  0.1057  2.4011  omega(4)  0.0001  0.0002  0.2752  0.0000  0.0000  5.6805  ‐  ‐  ‐  beta(4)  ‐  ‐  ‐  0.6431  0.0690  9.3175  ‐  ‐  ‐  alpha(4)  ‐  ‐  ‐  0.2545  0.0692  3.6794  ‐  ‐  ‐  omega(5)  ‐0.0055  0.0210  ‐0.2643  0.0000  0.0000  2.2551  ‐  ‐  ‐  beta(5)  ‐  ‐  ‐  0.3899  0.2062  1.8905  ‐  ‐  ‐  alpha(5)  ‐  ‐  ‐  0.1765  0.0716  2.4647  ‐  ‐  ‐  omega(6)  0.0003  0.3462  0.0010  0.0000  0.0000  ‐0.1434  ‐  ‐  ‐  beta(6)  ‐  ‐  ‐  0.4663  0.2539  1.8363  ‐  ‐  ‐  alpha(6)  ‐  ‐  ‐  0.3630  0.1137  3.1918  ‐  ‐  ‐  log likehood  2886.269  2697.955  3534.373  avg. log likelihood  11.8290  11.5792  14.4851  number of coeff.  15  21  12    2007 ‐ 82  •  economic analysis®  in figure 3 we plot conditional covariances for daily log returns of belex15 index ‐ hemo‐ farm stock (cov_r1r2); belex15 index ‐ energoprojekt stock (cov_r1r3); hemofarm ‐ energoprojekt  stocks (cov_r2r3), respectively in restricted bekk, dvec and ccc models.    figure 3: estimated conditional covariance for daily log returns of belex15 index and hemorfarm stock;  belex15 index and energoprojekt stock; hemofarm and energoprojekt stocks in the trivariate bekk,  dvec and ccc models, respectively.  -.00002 .00000 .00002 .00004 .00006 .00008 .00010 .00012 2006:01 2006:04 2006:07 cov_r1r2 -.00001 .00000 .00001 .00002 .00003 .00004 .00005 2006:01 2006:04 2006:07 cov_r1r3 -.00020 -.00015 -.00010 -.00005 .00000 .00005 .00010 2006:01 2006:04 2006:07 cov_r2r3 bekk model   -.00002 .00000 .00002 .00004 .00006 .00008 .00010 2006:01 2006:04 2006:07 cov_r1r2 -.00001 .00000 .00001 .00002 .00003 .00004 .00005 .00006 2006:01 2006:04 2006:07 cov_r1r3 -.00020 -.00015 -.00010 -.00005 .00000 .00005 .00010 2006:01 2006:04 2006:07 cov_r2r3 dvec .00000 .00001 .00002 .00003 .00004 .00005 .00006 .00007 .00008 2006:01 2006:04 2006:07 cov_r1r2 .000005 .000010 .000015 .000020 .000025 .000030 .000035 2006:01 2006:04 2006:07 cov_r1r3 .000000 .000001 .000002 .000003 .000004 .000005 .000006 .000007 .000008 .000009 2006:01 2006:04 2006:07 cov_r2r3 ccc   we observe from  these pictures on figure 3.1 that the restricted bekk and dvec results  have similar behaviour for all pair log returns of stocks and index, but very different behaviour in  ccc model where the covariance is positive and of not negligible magnitude especially in case  hemofarm  and  energoprojekt  stocks.  it  is  because  ccc  model  reduces  to  three  univariate  garch(1,1) models (covariance equations do not contain terms with cross‐product of residuals).  it is evidently that correlations between log returns of stocks and index are very unstable over  time. then, from figures 3.1 we observe that hemofram and energoprojekt stocks are noncorre‐ lated, this plots around zero on the graph (minović, 2007).  on all figures in cases of belex15 index and hemofarm stock as well as hemofarm and en‐ ergoprojekt stocks we see that relationship between these stocks changes dramatically in period  june‐july 2006 (it was when company schtada was bought stocks of hemofarm). since on all fig‐ volume 40 • spring 2008 • 83  ures in case belex15 index and energoprojekt stock we see that the greatest peak match with time  when energoprojekt company signed contract in nigeria, february 2006 (minović, 2007).  in figure 4 we plot conditional variances for daily log returns of belex15 index (var_r1),  hemofram (var_r2) and energoprojekt (var_r3) stocks, respectively in our three considering mod‐ els.  figure 4: estimated conditional variances of daily log returns on belex15 index, hemofarm stock and en‐ ergoprojekt stock, respectively in the trivariate bekk, dvec and ccc models.  .000004 .000008 .000012 .000016 .000020 .000024 .000028 .000032 2006:01 2006:04 2006:07 var_r1 .0000 .0001 .0002 .0003 .0004 .0005 .0006 .0007 .0008 .0009 2006:01 2006:04 2006:07 var_r2 .0000 .0001 .0002 .0003 .0004 .0005 2006:01 2006:04 2006:07 var_r3 bekk   .00000 .00001 .00002 .00003 .00004 .00005 2006:01 2006:04 2006:07 var_r1 .0000 .0001 .0002 .0003 .0004 .0005 .0006 .0007 .0008 2006:01 2006:04 2006:07 var_r2 .00000 .00005 .00010 .00015 .00020 .00025 .00030 2006:01 2006:04 2006:07 var_r3 dvec   .000008 .000012 .000016 .000020 .000024 .000028 .000032 .000036 2006:01 2006:04 2006:07 var_r1 .0000 .0001 .0002 .0003 .0004 .0005 .0006 .0007 .0008 .0009 2006:01 2006:04 2006:07 var_r2 .0000 .0001 .0002 .0003 .0004 .0005 .0006 2006:01 2006:04 2006:07 var_r3 ccc   we  observe  from  figure  above  that  the  restricted  bekk,  dvec  and  ccc  results  exhibit  rather similar behaviour for each considering stocks and index. figure 3.2 shows that belex15  index has always been more volatile than hemofarm and energoprojekt stock. on the second pic‐ ture in all three models we see that time of the greatest peak match with time when hemofarm  was sold. we observe  from  figures  that exist significant autocorrelations  in data of hemofarm  stock, it is because in univariate case hemofarm follow igarch process. on the third picture in  all three models we observe the first peak in february 2006, when energoprojekt company signed  contract in nigeria valued 151 million euros. the graphs of conditional variances for daily log re‐ turns of belex15 index, hemofram and energoprojekt stocks in our three considering models are  2007 ‐ 84  •  economic analysis®  very similar to graphs in univariate case. all variances in all three models are highly unstable (mi‐ nović, 2007).   however, in order to choose the best model, diagnostic tests should be calculated.    diagnostic checking  in the multivariate case we propose to examine the standardized residuals, squared stan‐ dardized residuals as well as the cross products of the standardized residuals. our results show  that the residual‐based diagnostics provide a useful check for model adequacy (for detail see refer‐ ence minović, 2007) (tse, 2002, 358).    figure 5: the standardized residuals of belex15 index (stres1), hemofarm (stres2) and energoprojekt  (stres3) stocks versus  its log returns in trivariate garch models.  0 1 2 3 4 5 2006:01 2006:04 2006:07 stres1 -.015 -.010 -.005 .000 .005 .010 .015 2006:01 2006:04 2006:07 r1 0 1 2 3 4 5 6 2006:01 2006:04 2006:07 stres2 -.02 -.01 .00 .01 .02 .03 .04 2006:01 2006:04 2006:07 r2 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2006:01 2006:04 2006:07 stres3 -.04 -.03 -.02 -.01 .00 .01 .02 .03 .04 .05 2006:01 2006:04 2006:07 r3   the standardized residuals for log return of belex15 index, log returns of hemofarm and  energoprojekt stocks are calculated as:  ( )ˆˆ /i i i iz r μ σ= − , where i = 1, 2, 3.                                                                      (3.16)  volume 40 • spring 2008 • 85  the cross product of residuals for log returns of belex15 index – hemofarm stock; log re‐ turns of belex15 index – energoprojekt stock; log returns of hemofarm – energoprojekt stocks  are calculated as:  ( )( )ˆ ˆˆ ˆ /i j i i j j ii jjz z r rμ μ σ σ= − − .                                                                            (3.17)  where i = 1, 2, 3,  j = 1, 2, 3 and in the equation  i j≠ . if the model is correctly specified, the  standardized residuals should be uncorrelated, and identically distributed random variables with  mean zero and variance one (eviews 5 user’s guide).  the goodness‐of‐fit of a multivariate garch model can also be assessed by calling the ge‐ neric plot function on a fitted “mgarch” object. there is significant deviation in the tails from the  normal qq‐line for both residuals, which shown earlier. thus it seems that the normality assump‐ tion for the residuals may not be appropriate (zivot et.al., 2006).    figure 6: the qq‐plot of standardized residuals of belex15 index (stres1), hemofarm (stres2) and en‐ ergoprojekt stocks (stres3) vs. normal distribution in trivariate garch models.  from figure 6 we see that all curves have concave shape indicating that the distributions of  standardized residuals are positively skewed with long right tail. thus, there is significant devia‐ tion in the tails from the normal qq‐line for all three standardized residuals and estimates are still  consistent under quasi‐maximum likelihood (qml) assumptions.  for diagnostic checking we used the ljung‐box statistics of standardized residuals and those  of its squared, and of cross product of standardized residuals (table 4 and 5). we observed that in  trivariate case we have arch effect in variance equation of hemofarm stock, except for dvec  model. the q‐statistics for checking whether there are any arch effects left in the residuals show  that autocorrelation is not significant in variance equations for log returns of belex15 index and  energoprojekt stock (minović, 2007).    table 4: the ljung‐box statistics of standardized residuals and those of its squared for log return of  belex15 index, log return of hemofarm and log return of energoprojekt stocks,   where the number in parentheses denotes p‐value.  q(36)  belex15  hemofarm  energoprojekt  bekk  25.628 (0.900)  44.451 (0.158)  31.161 (0.698)  dvec  23.205 (0.951)  43.256 (0.189)  34.341 (0.548)  ccc  22.976 (0.955)  40.311 (0.247)  26.675 (0.871)  q2(36)        bekk  29.221 (0.781)  58.530 (0.010)  38.323 (0.365)  dvec  24.128 (0.935)  47.444 (0.096)  40.719 (0.270)  ccc  26.468 (0.877)  83.197 (0.000)  34.328 (0.548)    -3 -2 -1 0 1 2 3 0 1 2 3 4 5 stres1 n or m al q ua nt ile -3 -2 -1 0 1 2 3 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 stres3 n or m al q ua nt ile -3 -2 -1 0 1 2 3 0 1 2 3 4 5 6 stres2 n or m al q ua nt ile 2007 ‐ 86  •  economic analysis®  table 5: the ljung‐box statistics of cross product of standardized residuals,   where the number in parentheses denotes p‐value.  q2(36)  belex15‐hemofarm  belex15‐energoprojekt hemofarm‐ energoprojekt bekk  30.429 (0.730)  32.122 (0.654)  34.498 (0.540)  dvec  31.550 (0.680)  27.746 (0.836)  32.244 (0.648)    from table 5 it is evident that there are no arch effect in covariance equations for bekk  and  dvec  models  for  pairs  belex15‐hemofarm;  belex15‐energoprojekt,  hemofarm‐ energoprojekt.  thus,  the  check  of  the  models  shows  that  the  models  are  appropriate  i.e.  q‐ statistics show that models are adequate for describing the conditional heteroscedasticity of the  data.  final conclusion: it is interesting to note that dvec model would be the most convinient  model, because only that one does not show arch effect for hemofarm stock. bekk and ccc  model  have  smaller  number  of  parameters  and  they  are  much  easier  to  estimate  than  dvec  model. thus, we found that the most ‘complicated’ model is the best model (minović, 2007).  conclusion  this article presents theoretical and empirical calculation for diagnostic checking of univari‐ ate and multivariate garch models. we  illustrated our empirical approach by applying  it  to  daily returns of the belex15 index, hemofarm and energoprojekt stocks. we presented different  diagnostics for univariate garch models which are used in our analysis (lagrange multiplier  test, ljung‐box test, f‐test) and we reported results of analysis. overall, our results showed that the  residual‐based diagnostics provide a useful check for model adequacy. in theoretical part for mul‐ tivariate case we presented three categories diagnostics for conditional heteroscedasticity models:  portmanteau  tests  of  the  box‐pierce‐ljung  type,  residual‐based  diagnostics  (rb)  and  lagrange  multiplier (lm) tests. the box–pierce–ljung portmanteau statistic is the most widely used diag‐ nostic. in empirical part, after a trivariate conditional heteroscedasticity model had been fitted, we  used the ljung‐box statistics (q‐test) of standardized residuals, those of its squared, as well as of  the cross product of standardized residuals to check the model adequacy. overall result  is that  models perform statistically well.  literature  bauwens, l., laurent s. and rombouts j. v. k. february 2006. “multivariate garch models: a survey”. journal of ap‐ plied econometrics: 79‐109  brooks, chris. 2002. introductory econometrics for finance. cambridge university press  degroot, morris h. and schervish mark j. 2002. probability and statistics.third edition. adddison‐wesley  franke, jürgen, härdle wolfgang, hafner christian. july 2005. introduction to statistics of financial markets.   http://www.quantlet.com/mdstat/scripts/sfe/html/sfeframe131.html  greene, william h. 2003. econometric analysis, fifth edition. prentice hall  mills, terence c., kerry patterson. 2006. handbook of econometrics, vol. 1, palgrave  minović, jelena z. (2007) “multivariate garch models: theoretical survey and model application”, master thesis.  minović, jelena. 2007. ’application of multivariate garch models in serbian financial market analysis’, international  scientific conference, economic faculty, belgrade, serbia  minović, jelena. 2007 ’univariate garch models: theoretical survey and application’, balcor 07, zlatibor, serbia  mladenović, zorica, pavle petrović. 2002. uvod u ekonometriju. ekonomski fakultet, beograd.  volume 40 • spring 2008 • 87  rombouts, jeroen v.k., verbeek marno. december 8, 2004. “evaluating portfolio value‐at‐risk using semi‐parametric  garch models”. http://ideas.repec.org/p/iea/carech/0414.html   tsay, ruey s. 2005. analysis of financial time series, wiley, new jersey.  tse, y. k. 2002. “residual‐based diagnostics for conditional heteroscedasticity models”. econometrics journal. vol. 5, pp.  358‐373.  tse, y. k., and tsui albert k. c. 1999. “a note on diagnosing multivariate conditional heteroscedasticity models”. journal  of time series analysis. vol. 20, no. 6: 679‐691  tse,  y. k.,  and  tsui albert  k.  c.  december  1998.  “a multivariate  garch model  with  time‐varying  correlations”.  http://www.econometricsociety.org/meetings/wc00/pdf/0250.pdf  vogelvang, ben. 2005. econometrics: theory and applications with eviews. prentice hall.  yang, w., david e. a., “multivariate garch hedge ratios and hedging effectiveness  in australian  futures market”,  accounting and financ, 45 (2004) 301‐321.  zivot, eric and jiahui wang. 2006. modelling financial time series with s‐plus. springer  quantitative micro software. eviews 5 user’s guide  microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp1‐22 original scientific paper business sector innovation and economic growth: a comparative analysis between eu countries cláudia caseiro1 | marta simões1* 1 ceber and faculty of economics, university of coimbra, portugal abstract this paper examines the relationship between innovation carried out by the business sector and economic growth in the 28 member states of the european union, divided into two groups (1 and 2) according to their innovation performance. we use fixed effects panel data methods to test the hypothesis that business sector innovation plays a relevant role in explaining the behaviour of real gdp per capita, estimating two growth regressions according to data availability (1990‐2015 and 2008‐2015; unrestricted/restricted sample). the results indicate that the role of business sector innovation in economic growth not only varies according to the sample of countries and the period under analysis but also the proxy for innovation used. in group 1 (above average innovation performance) the innovation indicators statistically significant in explaining growth also present a positive sign (with a few exceptions). in group 2 (below average innovation performance) on the other hand, the statistically significant business sector innovation indicators present a negative sign. one possible justification for these signs are differences in absorptive capacity so that the growth benefits of innovation activities depend on aspects such as human capital availability, accumulated knowledge, technological and financial support. since group 1 includes countries with higher absorptive capacity, business sector innovation is effectively translated into faster economic growth. in group 2, innovation activities do not translate into productivity increases due to a lack of absorptive capacity. additionally, resources used in innovation activities might compete with other activities more relevant in terms of the stage of the growth process these countries are in so that innovation saps growth key words: business sector innovation, economic growth, eu 28, fixed effects jel classification: c23, o30, o47, o52 introduction there seems to be a consensus in the literature that innovation drives economic growth, supported both by the neoclassical theory of exogenous growth, but especially by endogenous growth models, pointing to technological progress and thus innovation as drivers of economic growth, albeit from different perspectives ((solow, 1956); (lucas, 1988); (romer, 1990); (jones, 1995); (jones, 2005)). at the firm level, several studies examine the relationship between innovation carried out by firms with the respective productivity levels and growth ((oecd, 2009); (mohnen and hall, 2013)). eurostat data show that the intensity of r&d expenditures in the 28 eu member states (eu) increased between 2005 and 2014, with expenditure carried out by the business sector increasing from 1.10 % of gdp in 2005 to 1.30% in 2014. innovation * corresponding author, e‐mail: mcsimoes@fe.uc.pt 2 economic analysis (2019, vol. 52, no. 1, 1‐22) through r&d and investments in technology are considered essential to ensure competitiveness and increase productivity and in this way, sustain economic growth (pece, 2015). innovation is however difficult to measure since it encompasses technological aspects, such as new or significantly improved products/ services, but also includes non‐technological aspects, such as new organisational models, new marketing strategies, or new processes (mohnen and hall, 2013). the aim of this paper is to relate the different aspects of innovation by firms (technological and non‐technological) to a country's long‐term macroeconomic performance (economic growth), grouping the different countries under analysis according to different characteristics/indicators of their business sector innovation activity. in particular, we aim at better understanding the relationship between inputs and outputs of business innovation and the behaviour of output in different groups of countries. following the identification of country groups based on the performance of indicators of inputs and outputs of innovation activities relative to the eu28 average, we estimate two empirical models that correspond to growth regressions where the different innovation indicators are the main explanatory variables taken alongside other relevant growth determinants. depending on data availability, the period under analysis is 1990‐2015 or 2008‐2015, for unrestricted and restricted country samples. the remainder of the paper is organized as follows: after the introduction, the second section contains a brief review of the literature on the relationship between innovation and growth. in the third section, we analyse the average performance of firms’ innovation activity in terms of inputs and outputs, grouping the countries under analysis according to their position relative to the eu28 average. the next section contains the methodology and results. in the final section, we present the main conclusions. innovation and growth: theory and evidence in the 1930s, joseph schumpeter highlighted that economic growth is caused by innovation, in particular, creative destruction, with business innovation fundamental for this change. (solow, 1956) also stresses that technological progress is the driver of growth, but does not provide an explanation how the decisions by economic agents in terms of input allocation between final goods production and innovation activities can influence the pace of economic growth. in the mid‐1980s, endogenous growth theories assign knowledge a fundamental role in the explanation of technological progress. first‐generation endogenous growth models consider innovation as an unintentional by‐product of inputs accumulation, for instance through from learning by doing or learning by studying ((romer, 1986); (lucas, 1988)). second‐generation endogenous growth models, pose that decisions by firms concerning r&d activities increase the respective productivity levels and also generate positive externalities in terms of productivity improvements in other firms, and, consequently, faster growth ((romer, 1990); (jones, 1995)). there thus seems to be a consensus in the literature that technological progress and innovation are at the basis of economic growth, with many empirical studies presenting evidence on this link. for instance, (ulku, 2004), using panel data to study the relationship between economic growth, r&d expenditures and innovation in 20 oecd member states and 10 non‐member countries, concludes that innovations (measured by patents) have a positive growth impact, although only developed oecd countries seem to be able to increase the level of innovation through r&d expenditures. (pradhan et al., 2016) studied 18 eurozone countries over the period 1961‐2013, using time series data. the dependent variable considered was the growth rate of real gdp per capita and the independent variables correspond to five indicators of innovation (number of patents per resident per thousand inhabitants, number of patents per non‐residents per thousand inhabitants, number of patents per resident and non‐resident per thousand inhabitants, real r&d expenditures as a percentage of real gdp and researchers involved in r&d activities per million inhabitants) and eight indicators of financial development. the authors conclude that financial development and innovation are important in determining cláudia caseiro, marta simões 3 economic growth and that long‐term growth depends on countries' ability to innovate in order to remain competitive, which requires adequate (financial) resources devoted to r&d activities. in a recent study, (maradana et al., 2017) examined 19 eu member states and concluded that there is a long‐run equilibrium relationship between the innovation indicators used (resident patents, non‐resident patents, r&d expenditures, r&d researchers, high‐tech exports, and scientific and technical journal articles) and growth. however, despite the consensus on the importance of innovation for economic growth, many authors recognise that it is difficult to measure this concept, which hampers the results from empirical studies. measuring innovation in a precise and rigorous way is critical to correctly assess its effect on growth (hasan and tucci, 2010). often business innovation is not included in the analysis due to data availability and accessibility (microdata) issues (oecd, 2009). in addition, there is no unique and perfect measure of innovation. according to (hong et al., 2012), in practice, companies innovate in different ways: investing in r&d, actively patenting, cooperating with external partners, acquiring technology externally via licensing, through design, marketing and staff training. it is, therefore, crucial to choose the adequate innovation proxies, although previous studies do not all point in the same direction concerning this choice. several authors consider r&d expenditures as a proxy for innovation, e.g. (goel and ram, 1994) and, more recently, (freimane and bāliņa, 2016). but, according to (wang, 2013), since (schmookler, 1966) demonstrated the adequateness of patent data as an indicator of innovation, these have often been the preferred proxy for innovation. similar to other authors, (wang, 2013) considers that r&d expenditures are only inputs to innovation activities and do not measure innovation results/outputs. the literature also distinguishes between two types of measurement of innovation: indirect and direct (hong, oxley and mccann, 2012). according to the authors, r&d expenditures are indirect measures since they only measure inputs to innovation activities, while patents focus on the successful commercial application of innovations. however, (hong, oxley and mccann, 2012) consider that for econometric analysis the best option is to use direct measures, which may be objective (when it comes to the number of innovations or "count of innovations") or subjective. the oecd oslo manual (oecd, 2005) identifies the existence of four different types of innovation: product, process, marketing and organisational. product innovation refers to the "introduction of new or significantly improved goods or services concerning its intended characteristics or uses" ((oecd, 2005), p.57). process innovation refers to the "implementation of a new or significantly improved production or distribution method" ((oecd, 2005), p.58). marketing innovation refers to "implementing a new marketing method with significant changes in product design or packaging, product positioning, promotion or pricing" ((oecd, 2005), p.59). finally, organisational innovation concerns the "implementation of a new organisational method in the company's business practices, in the organisation of its workplace or in its external relations" ((oecd, 2005), p.61). at the firm level, several studies show a positive relationship between productivity and different types of innovation (moreno and surinach, 2014). based on the former oecd classification, (hall, 2011) concluded that there are significant impacts of product innovation on productivity, but, on the other hand, the impact of process innovations is more ambiguous and may even be negative. (tavassoli and karlsson, 2015) analysed the persistence of the innovation behaviour by firms and, similar to (hall, 2011), concluded that the degree of persistence is not the same for all types of innovations, being greater for product innovations: product, process, and organizational innovations have a "true" dependency, that is, the decision to innovate in the next period is influenced by the success of the innovation of the previous period, while marketing innovations have a "false" dependency because the persistence effect does not remain in marketing innovations. (mohnen and hall, 2013) updated the previous research analysing the existing evidence on the effects of technological and non‐technological innovations on the productivity of firms and the existence of potential complementarities between the different 4 economic analysis (2019, vol. 52, no. 1, 1‐22) types of innovation. the authors concluded that all types of innovations contribute to improved productivity performance. (moreno and surinach, 2014) also sought to empirically analyse the relationship between the business sector innovation and productivity growth in 25 eu member states, as well as in iceland, norway and turkey for the period 1998‐2000 and 2002‐2004, concluding that innovation has a positive impact on productivity growth, but this impact is more important in the case of process innovations than output innovations, which can be justified on the basis that by introducing a new production process firms become more efficient, reducing costs and, thus, increasing productivity. to sum up, it is consensual in the literature that innovation boosts economic growth and, from a business sector perspective, the introduction of innovations by firms, whether a product, process, organisational or marketing innovations, leads to an increase in the respective productivity, which should also lead to faster economic growth. the present studies contribute to the existing literature by carrying out a comprehensive analysis of the relationship between firms’ innovation activity and economic growth taking into account a wide array of indicators (technological and non‐technological) to measure business sector innovation (inputs and outputs). business sector innovation in the eu28: a comparative analysis in this section we differentiate the 28 eu member states in terms of the innovation activity carried out by the respective business sector (firms), grouping countries into different sets according to their average performance in terms of inputs and outputs, i.e. differences between innovation efforts/investments and the results of innovation activity for the countries under analysis, relative to the eu28 average. the business sector innovation indicators related to inputs considered in this study are r&d expenditures, innovation expenditures in the business sector, percentage of firms that promote the training of their employees, total staff in r&d activities and researchers in r&d activities. outputs are represented by the following indicators: number of patent applications by the business sector to the european patent office (epo), number of patents granted by the uspto to the business sector, number of registrations of trademark applications, percentage of small and medium enterprises (smes) that introduce product or process innovations, percentage of smes that introduce marketing or organizational innovations, percentage of smes that innovate internally, and percentage of innovative smes that cooperate with others. table a.1 in the appendix summarises the indicators used, as well containing a detailed description and classification of each indicator according to the european innovation scoreboard (eis) 2017. the countries under analysis were grouped based on their average performance in terms of inputs and outputs of business sector innovation relative to the eu28 average for the period 2008‐2015. we started by computing, for each country, the average indicator for the period 2008‐2015. next, we computed the ratios of each of these indicators relative to the eu28 average (eu28=100). finally, in order to analyse the overall performance in terms of either inputs or outputs, we computed the average of the ratios for each of these two categories, based on the relative performance of each indicator. four different groups were identified. the first group of countries (group 1) is made up of countries with average performances above that of the eu28 in terms of both inputs and outputs of business sector innovation. this group comprises ten countries: austria, belgium, denmark, finland, france, germany, ireland, luxembourg, the netherlands and sweden. in the eis classification for 2015, these countries are classified as innovation leaders (sweden, netherlands, luxembourg, finland, denmark, and germany) and strong innovators (ireland, france, belgium, and austria). figure 1 contains information on the relative performance of these member states in terms of inputs and outputs for the period 2008 to 2015 relative to the eu28 average. according to figure 1, all these member states have higher performances in inputs and outputs compared to cláudia caseiro, marta simões 5 the eu28 average, with finland, sweden, denmark, austria, germany and luxembourg recording the highest ratios. however, this aggregate information masks different performances in terms of the various indicators used to measure inputs and outputs. only germany and sweden perform above the eu28 in all indicators. the remaining member states have lower performances than the eu in some indicators. for instance, austria, belgium, denmark, finland, france, ireland, luxembourg and the netherlands show levels of expenditure on innovation by the business sector (excluding r&d) below the eu28 average. on the output side, austria, denmark and luxembourg have performances above the eu28 average in all indicators, especially for registration of trademark applications in luxembourg, an outlier. belgium, finland and france record lower than average trademark registrations applications, while in ireland epo performance is lower than average, as well as the trademark registrations applications1. figure 1. group 1: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. 1 the data for these more detailed indicators are available from the authors. 6 economic analysis (2019, vol. 52, no. 1, 1‐22) figure 2. group 2: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. the second group of countries (group 2) includes member states which, on average, perform worse than the eu28 in terms of both inputs and outputs of business sector innovation. this group includes fifteen countries: bulgaria, croatia, czech republic, estonia, greece, hungary, italy, latvia, lithuania, malta, poland, portugal, romania, slovakia and spain. in the eis typology for 2015, these member states are classified as modest innovators (romania and bulgaria), moderate innovators (croatia, czech republic, greece, hungary, italy, lithuania, latvia, malta, portugal, poland, slovakia and spain) and, in the case of estonia, a strong innovator. figure 2 contains information on the inputs and outputs of this group 2 for the period 2008‐2015 relative to the eu28 average. according to figure 2, overall these countries have a performance in terms of inputs and outputs of business sector innovation below the eu28 average, although romania, bulgaria and latvia stand out with levels of inputs and outputs which are more distant from the eu28 average than the other member states in this group. on the other hand, the czech republic, estonia and malta record levels close to the eu28 average. within this group, there are also substantial differences in the performance of certain indicators. for instance, the czech republic performs above the eu28 average in terms of r&d activities personnel; croatia, slovakia, estonia, greece, latvia, lithuania, malta, poland and the czech republic record higher than average expenditure on innovation in the business sector; and in croatia, slovakia, malta, portugal and the czech republic the percentage of companies promoting employee training is also above average. for output indicators: trademark applications are above the eu28 average in malta; the same applies to product and/or process cláudia caseiro, marta simões 7 innovations and the percentage of smes innovating internally in estonia, greece, italy, portugal and the czech republic and in marketing and/or organizational innovations in greece, italy, portugal and the czech republic2. figure 3. group 3: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. figure 4. group 4: inputs and outputs of business sector innovation relative to the eu28 average, 2008‐15 source: own elaboration. the third group (group 3) is characterised by higher than average inputs and at the same time lower than average outputs. this group consists only of slovenia, classified by the eis in 2015 as a strong innovator and its innovative activity is very close to the eu average. according to figure 3, the performance is higher than average for inputs (in three out of the five indicators and very close for the others), but below average for outputs. slovenia performs well in most input indicators but records patent levels and registrations of brand applications well below the eu28 average. finally, the fourth group (group 4) includes countries with inputs below the eu28 average and outputs higher than the eu28 average. two countries, cyprus and the united kingdom, are included in this group. according to the eis in 2015, cyprus is classified as a moderate innovator and the uk as a strong innovator. in figure 4, it is possible to see that in cyprus the performance for inputs is lower than average, while outputs are slightly above the eu28 average. cyprus records high innovation expenditures and percentage of firms that promote the training of officials and above the eu28 average, but low levels of patents (applications and concessions). in the united kingdom inputs are close to the eu28 average, although slightly below, but the uk records a higher than average performance in three out of the five indicators. outputs are below‐average due essentially to trademark applications, the introduction of the product and/or process innovations, and the percentage of smes innovating internally (three out of seven indicators). in the econometric analysis, since slovenia has a large number of output indicators (four in seven) which are close to the eu28 average, this country will be included in group 1. the united 2 the data for these more detailed indicators are available from the authors. 8 economic analysis (2019, vol. 52, no. 1, 1‐22) kingdom will also be considered in group 1 as inputs are close to the eu28 average, while cyprus will be included in group 2 since it performs poorly in inputs. these changes also make the groups more in line with the eis classification. empirical models, methodology and results in this section, we present the two empirical models estimated, the methodology used and the main results obtained for the total sample as well as for the two groups defined in the previous section. empirical models in order to study the relationship between business sector innovation and economic growth, we consider the global sample of 28 eu member states as well as the two country groups, 1 and 2, defined in the previous section. two periods were considered in the analysis due to data availability for some indicators of innovation activities: 1990‐2015 (model 1) and 2008‐2015 (model 2). the first empirical model (model 1) is similar to that of (moreno and surinach, 2014), corresponding to an ad hoc growth regression, with variables measured at 5‐year intervals, and is given by equation (1): , , , _ 1 1 2 (1) where: δ0 – constant; ui,t – error term.; i – countries (i = 1, 2, …, n). t – 5‐years sub periods (t = 5); t‐1 – initial year of each sub period. the dependent variable in the first model, equation (1), is the annual growth rate of real gdp per capita in ppps (purchasing power parity) (δlngdprpc) for 5‐years sub‐periods. the data for this variable are from the penn world table 9.0 (feenstra et al., 2015) and the world bank3. the main explanatory variable of the model is inov1 (proxy for the business sector innovation activity), and the proxies used, alternatively, are six indicators of business innovation (see table a.1 in the appendix) that constitute measures of both inputs and outputs, selected based on their importance in explaining the relationship between business sector innovation and growth, as reported in previous literature ((hasan and tucci, 2010); (hong, oxley and mccann, 2012); (wang, 2013)). we expect a positive sign for all the estimated coefficients, in line with the endogenous growth predictions of (romer, 1990) and (jones, 1995) and the results of studies such as (freimane and bāliņa, 2016), (hasan and tucci, 2010) and (wang, 2013). the control variables included were selected from the theoretical and empirical growth literature (e.g. (romer, 1986); (barro and sala‐i‐martin, 2004); (hasan and tucci, 2010)). initial real gdp per capita (lngdprpc) is expected to deliver a negative estimated coefficient based on the convergence predictions of (solow, 1956) and technology diffusion growth models (weil, 2013) with poorer countries recording higher real gdp per capita growth rates. a positive relationship is expected between investment in physical capital (gcf) and economic growth based on (solow, 1956) and also between investment in human capital (hc) and growth as this allows for higher production of new ideas/projects and the accumulation of knowledge, leading to higher productivity and (romer, 1990)). government consumption (gov_cons) is expected to present a negative sign, assuming that these are non‐productive expenditures: (mitchel, 2005) 3 the data up to 2014 is from pwt 9.0 (feenstra, inklaar and timmer, 2015), the values for 2015 were calculated based on per capita real gdp growth from the world bank. cláudia caseiro, marta simões 9 argues that each monetary unit that the government spends means less money in the productive sector of the economy, which reduces the rate of output growth. the expected relationship between globalisation (glob) and growth is ambiguous. according to (samimi and jenatabadi, 2014), globalisation allows countries to allocate resources more efficiently, as well as benefit from economies of scale and cost reductions, which leads to higher growth. on the other hand, globalisation has negative effects on growth in countries with weaker institutions and with political instability and also in countries specializing in activities that are not effective in the process of globalization. the second empirical model (model 2) is given by equation (2): , , , _ 1 1 2 (2) where: δ0 – constant; ui,t – error term.; i – countries (i = 1, 2, …, n). t – years (2008‐2015). in model 2 the dependent and control variables are the same as those in model 1, although the proxy for human capital now corresponds to the percentage of the population aged 15 to 64 years old with upper secondary, non‐tertiary post‐secondary and higher education (tertiary) due data availability. the frequency of the data used is yearly since the innovation proxies related to smes (inov2) are only available for a limited number of years, from 2008 until 2015. according to the studies reviewed, a positive relationship is expected between the various business sector innovation indicators and output growth ((oecd, 2009); (hall, 2011); (mohnen and hall, 2013), (moreno and surinach, 2014)). however, different types of innovations are expected to have different quantitative impacts. the indicators of the different types of innovation used aggregate product and process innovations into a single indicator and marketing and organisational innovations in another. we thus expect that the former will have a more significant impact than the latter, but may not contribute to the explanation of economic growth due to the inclusion of process innovations, in light of the conclusions of (hall, 2011) and (moreno and surinach, 2014). marketing and organisational innovations might even have a negative impact on growth, according to (tavassoli and karlsson, 2015). in both models 1 and 2 the variables d1 and d2 correspond to time dummies, included to consider the potential impact of the financial crisis on real gdp per capita growth. in model 1, d1 assumes the value 1 for the five‐year period 2005‐2010 and 0 otherwise; and variable d2 assumes the value 1 for the last five years (2010‐2015) and 0 otherwise. in model 2, d1 assumes the value 1 for 2009, 2010, 2011 and 2012, 0 otherwise; and variable d2 assumes the value 1 for 2013, 2014 and 2015 and 0 otherwise. methodology and results the empirical models were estimated using the econometric package gretl version 2017d. as a preliminary analysis to determine the appropriate estimation method in a static panel context, we applied the usual diagnostic tests to choose between pooled ols, fixed effects or random effects: the f‐test, the breusch‐pagan test (breusch and pagan, 1980) and the hausman test (hausman, 1978). the f‐test allows one to choose between the pooled ols and the fixed‐effects methods: the null hypothesis (h0) considers homogeneity in the constant, so the pooled ols method is the most adequate, against the alternative hypothesis (h1) that there is heterogeneity in the constant, so the most appropriate method, in this case, will be fixed effects. the breusch‐ pagan test, in turn, allows to decide between the pooled ols method and the random effects method: h0 considers the homogeneity in the constant, so the most appropriate method is pooled ols; h1 admits heterogeneity between countries (not constant over time), so the random effects method is the most appropriate. finally, the hausman test allows to decide 10 economic analysis (2019, vol. 52, no. 1, 1‐22) between fixed effects and random effects: h0 considers heterogeneity across countries (not constant over time), so the random effects method is the most appropriate; h1 also considers heterogeneity across countries, but constant over time, so that the fixed effects method is the most appropriate. we performed these tests for the baseline specifications given by equations (1) and (2) and the alternative innovation indicators considering the whole sample of 28 eu member states. according to the results for f‐test, the fixed‐effects method is preferable to the pooled ols method. according to the breusch‐pagan test, the random effects is the most appropriate. finally, from the results of the hausman test, we concluded that the fixed‐effects method is preferable to the random‐effects method. overall these diagnostic tests thus indicate that the most appropriate estimation method for models 1 and 2 considering the whole sample is the fixed effects method. we also carried out the diagnostic tests for the sub‐samples, groups 1 and 2, and both empirical models. for model 1, group 1, the most appropriate method is pooled ols for all innovation indicators, except for trademark_app (fixed effects); when group 2 is considered, in model 1 the most appropriate methods are: random effects for rdepc; pooled ols for rd_staff, res_rd and patent_app; and fixed effects for patent_g and trademark_app. for model 2, the fixed effects method is the most appropriate estimation method for groups 1 and 24. main results of the estimation of model 1 table 1 presents the results of the estimation of model 1 for the whole sample using fixed effects. in each column, a different indicator of business sector innovation is considered. table a.2 in the appendix contains the results of the estimation for group 1 and table a.3 contains the results for group 2. regarding the control variables, the results obtained for the whole sample for lngdprpci,t‐1 confirm the predictions, negative and statistically significant coefficients in all columns, and thus the convergence predictions of (solow, 1956) and technology diffusion models. these results also apply to groups 1 and 2. the estimated coefficients for the investment rate also confirm predictions when the eu28 or group 2 are considered, with a positive and statistically significant sign (except column v for eu28 and vi for group 1). the estimated coefficients for human capital for the eu28 are only statistically significant in columns ii and v. in group 1 the estimated coefficients confirm the predictions, positive and statistically significant, except when trademark applications are used. for group 2, we obtain a negative (although not statistically significant) relationship between human capital and economic growth in columns i and vi. in the remaining cases, we get positive coefficients but not statistically significant. as for public consumption, some of the results are not in line with the predictions: for the eu28 the estimated coefficient is negative, but not statistically significant in columns i, ii, iii and v, it is positive but not statistically significant in column iv and negative and significant in column vi. when the sample is restricted to group 1, the results show that an increase in public consumption has a negative and statistically significant impact on the growth rate of real gdp per capita. when the sample is restricted to group 2, the results indicate that the relationship between public expenditure and growth is negative for columns i, ii, iii, iv and vi but not statistically significant. the results found for the eu28 show that the globalisation index has a positive and statistically significant impact on growth, supporting the predictions of (samimi and jenatabadi, 2014). these results continue to apply for groups 1 and 2, with a few exceptions. overall, these results indicate that our growth regression is correctly specified since the majority of the results are in line with evidence from previous empirical growth studies. regarding the time dummy d1 (2005‐2010), for the eu28 and the subsamples the majority of results show a negative (and generally statistically significant impact) on growth. as for the results with the time dummy d2 (2010‐1015), for the eu28 and group 1, in general, the 4 these results are available from the authors. cláudia caseiro, marta simões 11 estimated coefficient is not statistically significant, while for group 2 the coefficient is positive and usually statistically significant. these results indicate that the sovereign debt crisis period did not affect all the eu countries in the same way. turning now to the results for our main explanatory variables, when inputs of business sector innovation are used (r&d expenditure, total r&d staff and r&d researchers), the results obtained with the eu28 (table 1, columns i, ii and iii) indicate that these inputs do not contribute to growth over the period 1990‐2015, since the respective estimated coefficients are not statistically significant. these results remain for group 1, as can be seen from table a.2, columns i, ii and iii. the results obtained for group 2 (table a.3) are different: an increase in total r&d personnel and r&d researchers has a negative and statistically significant effect, contrary to predictions. the lack of statistical significance for group 1 could be because these inputs, in reality, do not result in successful innovations, with economic value, and thus do not lead to productivity increases and faster growth. it could also be the case that there is a time lag between r&d activities and innovations becoming effective (wang, 2013). as for group 25, these countries might be devoting r&d expenditures to the imitation of innovations from developed countries that are not adequate to their reality and thus do not permit faster growth. according to (galor, 2005), the growth process is characterized by different stages in terms of the relative importance of physical, human capital and knowledge accumulation, so countries in group 2 might be deviating scarce resources from more important activities as far as their stage in the growth process is concerned, which results in less growth. when outputs of business sector innovation are introduced as the main explanatory variable (patent applications, patents granted and trademark applications registrations), the results for the eu28 (table 1, columns iv, v and vi) show that there is a positive impact on growth, however, only trademark applications produce statistically significant effects6. for instance, patents do not contribute to the explanation of growth, contrary to the conclusions of authors like (hasan and tucci, 2010). this result can be due to a number of reasons, including that many innovations do not result in patens, in order to effectively remain secret and not be copied, so that technical details are not revealed; and also because some firms use patents to prevent other firms from placing an invention in the market (hasan and tucci, 2010); and finally, because the costs of patenting are high, becoming unfeasible for small firms (wang, 2013). these results remain for group 1, according to table a.2, columns iv, v and vi. when the sample is restricted to group 2, the results obtained, as shown in table a.3, columns iv, v and vi, are in general statistically significant (except patents granted). in the case of patent applications, the coefficient obtained is in line with the findings of (hasan and tucci, 2010): an increase in the number of patent applications produces positive and significant effects on the real gdp per capita growth rate. on the other hand, contrary to predictions, registrations of trademark applications lead to a decrease in growth. trademark application records are not associated with technology and are relevant to the services sector, according to the eis (2017). in countries such as bulgaria, croatia, hungary, poland and romania (transition countries) this indicator does not become relevant and may indicate that trademark registrations do not lead to productivity increases, as evidenced by the results of the estimation of the model leaving out the outliers cyprus and malta. 5 consisting of some of countries considered by the imf as developing countries: bulgaria, croatia, hungary, poland and romania. 6 cyprus, malta and luxembourg represent outliers in the trademark_app indicator and were therefore withdrawn from the sample to check the impact on the results: trademark applications are no longer statistically significant in any of the samples under analysis, which may indicate that if the legal framework does not protect intellectual property, this indicator is not relevant for growth. these results are available from the authors. 12 economic analysis (2019, vol. 52, no. 1, 1‐22) looking at the aic, bic and hq information criteria for the eu28 models in table 1, we can conclude that the model that best explains growth is the model that considers patent applications since the criteria present the lowest value. the same applies for groups 1 and 2 (tables a.2 and a.3, respectively)7. table 1. results of the estimation of model 1 (fixed effects), 28 eu countries, 1990‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi constant 0.7386 *** 0.8976 *** 0.8894 *** 0.948 *** 1.1756 *** 1.1877 *** lngdprpci,t‐1 −0.0932 *** −0.1167 *** −0.1169 *** −0.1249 *** −0.1456 *** −0.1297 *** gcfi,t 0.1891 *** 0.216 *** 0.2292 *** 0.2677 *** 0.0475 0.2278 *** hci,t‐1 0.0042 0.00787 * 0.00755 0.0060 0.00885 * 0.000794 gov_consi,t −0.0744 −0.0552 −0.0434 0.0091 −0.0191 −0.3460 *** globi,t 0.0019 *** 0.0023 *** 0.0024 *** 0.0025 *** 0.0027 *** 0.0018 *** rdepci,t −1.0516e‐5 ‐ ‐ ‐ ‐ ‐ rd_staffi,t‐1 ‐ −3.1771e‐6 ‐ ‐ ‐ ‐ res_rdi,t‐1 ‐ ‐ −3.4140e‐8 ‐ ‐ ‐ patent_appi,t ‐ ‐ ‐ 0.000121 ‐ ‐ patent_gi,t ‐ ‐ ‐ ‐ 0.0001073 ‐ trademark_appi,t ‐ ‐ ‐ ‐ ‐ 4.6620e‐5 *** d1 −0.00995 −0.0111 −0.0120 −0.0146 * 0.000197 −0.00953 d2 0.0143 * 0.0148 0.0135 0.0152 * ‐ 0.0231 ** lsdv r2 0.6097 0.6361 0.6369 0.6649 0.7718 0.6644 r2 dentro 0.4591 0.5561 0.5429 0.6189 0.7437 0.5465 aic (akaike) −635.3512 −623.6562 −605.0257 −648.7218 −554.6305 −536.4121 bic (schwarz) −531.8441 −519.6036 −502.0724 −542.8226 −459.4830 −439.1948 hannan‐quinn −593.2916 −581.3732 −563.1937 −605.6875 −516.0262 −496.9802 notes: column i ‐ r&d expenditures; column ii ‐ total staff in r&d activities; column iii ‐ researchers in r&d activities; column iv ‐ patent applications; column v ‐ granted patents; column vi ‐ registration of trademark applications. ***, **, * indicate statistical significance at the 1, % and 10% levels, respectively. source: own elaboration. taking the results as a whole, we can conclude these differ according to the group of countries and time period under analysis. between 1990 and 2015, in the eu28 and group 1, inputs do not contribute to the explanation of aggregate output behaviour, while only r&d personnel and r&d 7 we also estimated model 1 with data for the period 2008‐2015. the results obtained with the inputs indicators show that r&d expenditures have a relevant role in explaining an increase in the growth rate of real gdp per capita, as predicted. the results with the outputs indicators are different depending on the sample under analysis. for the eu28, registrations of trademark applications are no longer statistically significant, with patents granted explaining economic growth. the coefficients obtained with outputs in group 1 show that patent applications and trademark application have significant negative and positive impacts, respectively. the results with outputs for group 2 show that patent applications in this period fails to explain the behavior of output. these results are available from the authors. cláudia caseiro, marta simões 13 researchers play a relevant role in explaining growth (but with a negative sign) in group 2. on the other hand, restricting the period to 2008‐2015, r&d expenditures present a positive and statistically significant role. as for outputs, between 1990 and 2015 trademark applications contribute to the explanation of growth due to the outliers cyprus, luxembourg and malta (and also patent applications in group 2). between 2008 and 2015, the results relative to the longer period change: for the eu28, patents granted have positive and relevant impacts on growth and brands lose their significance; for group 1, patent applications have negative and significant growth impacts; and for group 2 patent applications lose statistical significance. main results of the estimation of model 2 table 2 presents the results of the estimation of model 2 for the eu28 with fixed effects considering each indicator of business sector innovation alternatively. tables a.4 and a.5 in the appendix contain the results for groups 1 and 2, respectively. concerning the control variables, according to table 2 for the eu28 initial real gdp per capita presents a negative and statistically significant coefficient in all models (at the 1% level of significance), as expected, and the same applies for groups 1 and 2 (tables a.4 and a.5, respectively). the results obtained for the investment rate are also as expected: we obtain a positive relationship and statistically significant for the eu28 and group 2. the relationship between human capital and the real per capita gdp growth rate for the eu28 and both groups 1 and 2 is positive and statistically significant. the results obtained for public consumption are negative and statistically significant for the eu28 and group 2. however, when the sample is restricted to group 1, the results are not statistically significant (some exceptions apply). finally, as far as globalisation is concerned, the results are positive and statistically significant in the eu28 and group 2 as expected, but negative and not statistically significant in group 1. the time dummy d1 (2009‐2012) does not influence economic growth in the eu28 sample, so that the 2007‐08 financial crisis shows no negative growth effects. however, the latter occurs in group 1, while in group 2 (table a.5) the estimated coefficient is positive and statistically significant. the results for the time dummy d2 (2013‐15) for the eu28 (table 2) indicate that this was a post‐crisis recovery period, with a positive and in most cases, statistically significant coefficient for d2. the coefficients obtained for group 1 (table a.4) contrast with the previous ones since negative coefficients were obtained although without statistical significance. turning now to the results of the estimation of model 2 with inputs indicators (innovation expenditure and training of employees), the results obtained for the eu28 (table 2, columns iii and iv) show that only an increase in the percentage of firms that promote employee training contributes positively to growth. the results obtained for group 1 (table a.4, columns iii and iv) remain the same. when the sample is restricted to group 2, the results indicate that no input indicator contributes to the explanation of the growth rate of real gdp per capita, as can be seen in table a.5, columns iii and iv. the lack of statistical significance of innovation expenditure in group 1 can be justified by the relatively small investment in innovation in the form of dedicated machinery and equipment (within this group only germany and sweden have a ratio in this indicator that is higher than the eu average), which is not enough to spark innovation that promotes productivity improvements. for group 2, the lack of significance of innovation expenditure can be justified by the lack of absorptive capacity. this group includes transition countries with a low level of technological and scientific development, and thus, investments in innovation (equipment and machinery) do not translate into successful innovations. additionally, the lack of statistical significance for the percentage of firms that promote training to develop/upgrade the ict skills of employees for group 2 can be justified by the fact that this type of innovation input is more relevant in more advanced economies, according to the eis methodology report 2017, so it does not translate into productivity gains in this second group. 14 economic analysis (2019, vol. 52, no. 1, 1‐22) as for the results with indicators of outputs of business sector innovation (product/ process innovations, marketing/ organizational innovations, smes that innovate internally and smes that cooperate with others), the results reveal that for the eu28 all these indicators present negative coefficients, but only statistically significant for marketing and/or organizational innovations. the results for group 1 are not statistically significant. for group 2 (table a.5, columns v, vi, vii and viii), the results show that outputs have statistically significant negative effects on growth (except the percentage of smes that cooperate with others, without statistical significance). the lack of statistical significance of the outputs indicators for group 1, according to the eis methodology report of 2017 lies on the fact that adoption of product and process innovations is especially relevant to the manufacturing industry and since the present study studies business sector innovation (which encompasses all business sectors, not only manufacturing), it is not enough to explain growth in this group of countries, especially because this is not the most important sector of activity in advanced countries. another possible explanation, this time for the lack of significance of marketing/organisational innovations is that the adoption of new organisational methods requires a period of adaptation that often does not translate into success, because in many firms there is "resistance to change". third, the lack of significance of cooperation activities related to innovation among group 1 firms could be explained by the fact that this type of activity has not enough relevance in the overall activities of the firms. on the other hand, a possible justification for the lack of relevance of cooperation activities between group 2 firms may be due to the fact that many cooperation agreements require complex innovation levels, which in the case of countries such as bulgaria, croatia, hungary, poland and romania may not be successful as these countries lack human capital/more skilled workers. the negative impact of output indicators (product/ process innovations, marketing/ organizational innovations and smes that innovate internally) for group 2 may indicate that the resources devoted to innovation activities, such as skilled workers, may be necessary for other more fundamental activities in terms of the growth process of these countries, resulting in slower growth. we also considered as explanatory variables exports of medium and high‐tech products, exports of knowledge‐intensive services and sales of new‐to‐firm and new‐to‐market innovations. the results for the eu28 countries and both country groups are not statistically significant (tables 2, a.4 and a.5, columns i, ii and ix, respectively). one possible justification for this lack of significance is that exports of these types of products and services are just a small share of total exports, and the same applies to sales of innovations as a share of total sales. from the aic, bic and hq information criteria for the different models using the eu28 (table 4), we conclude that the best model corresponds to the one considering the percentage of firms that promote employees training as the innovation variable. the same is true for group 1 (table a.4). for group 2, the best model is the one using the percentage of smes that innovate internally (table a.5). taking the results as a whole, again, the role of business sector innovation for growth differs according to the group of countries and the innovation indicator considered. in most cases for the eu28 and group 1, the results with inputs show that only employee training has a relevant (and positive) role; while for group 2 inputs do not have a growth effect. in terms of outputs, for the eu28 only marketing/organisational innovations have a significant (although negative) effect; for group 1 outputs do not play a relevant role and for group 2 product/ process innovations, marketing/organisational innovations and internally innovating companies have negative and significant impacts on economic growth. cláudia caseiro, marta simões 15 table 2. results of the estimation of model 2 (fixed effects), 28 eu countries, 2008‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi vii viii ix constant 2.64*** 2.66*** 2.62*** 2.71*** 2.69*** 2.76*** 2.70*** 2.66*** 2.61*** lngdprpci.t‐1 −0.3653*** −0.3736 *** −0.369 *** −0.3839 *** −0.3737 *** −0.3868 *** −0.3753 *** −0.3714 *** −0.3711 *** gcfi.t 0.6476 *** 0.6504 *** 0.6708 *** 0.615 *** 0.6615 *** 0.7029 *** 0.6674 *** 0.6524 *** 0.6389 *** hci.t‐1 0.0094 *** 0.0097 *** 0.0095 *** 0.0096 *** 0.0097 *** 0.0102 *** 0.0099 *** 0.0097 *** 0.001 *** gov_consi.t −1.1774 *** −1.1703 *** −1.081*** −1.218*** −1.124*** −1.149*** −1.1*** −1.16*** −1.19*** globi.t 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007*** 0.007 *** export_hti.t −0.000518 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ export_servi.t ‐ 0.000674 ‐ ‐ ‐ ‐ ‐ ‐ ‐ inov_ei.t ‐ ‐ −0.0121 ‐ ‐ ‐ ‐ ‐ ‐ train_empi.t ‐ ‐ ‐ 0.0032 ** ‐ ‐ ‐ ‐ ‐ prodproc_inovi.t ‐ ‐ ‐ ‐ −0.000554 ‐ ‐ ‐ ‐ markorg_inovi.t ‐ ‐ ‐ ‐ ‐ −0.0011 * ‐ ‐ ‐ ino_sme.t ‐ ‐ ‐ ‐ ‐ ‐ −0.0012 ‐ ‐ coop_inovi.t ‐ ‐ ‐ ‐ ‐ ‐ ‐ −0.0002 ‐ sales_inovi.t ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.0008 d1 0.0106 0.0107 0.0085 0.0102 0.0105 0.0095 0.0095 0.0107 0.0103 d2 0.0279 * 0.0282 * 0.026 0.0267 * 0.0259 0.0251 0.024 0.0277 * 0.0284 * lsdv r2 0.6122 0.612 0.6155 0.6234 0.6127 0.6195 0.616 0.6118 0.6133 r2 within 0.5437 0.5434 0.5475 0.5568 0.5442 0.5522 0.548 0.5431 0.5449 aic (akaike) −765.103 −764.99 −766.73 −770.81 −765.33 −768.79 −766.99 −764.87 −765.64 bic (schwarz) −647.09 −646.98 −648.72 −652.80 −647.32 −650.78 −648.98 −646.85 −647.62 hannan‐quinn (hq) −717.33 −717.2 −718.95 −723.03 −717.56 −721.02 −719.21 −717.09 −717.86 notes: column i ‐ exports of medium and high‐tech products; column ii ‐ exports of knowledge‐intensive services; column iii ‐ innovation expenditures; column iv ‐ training of employees; column v ‐ product/ process innovations; column vi ‐ marketing/ organizational innovations; column vii ‐ % of smes that innovate internally; column viii –% of smes cooperating with others; column ix ‐ sales of innovations. ***, **, * indicates that the coefficients are significant at 1, 5 and 10% levels, respectively. source: own elaboration. conclusion this study investigates the relationship between business sector innovation and real gdp per capita growth in the 28 european union member states using static panel data methods for the estimation of two growth regressions, assessing how inputs and outputs of firms' innovation activities play a role in economic growth and distinguishing between two groups of countries identified according to their innovation performance (above or below) relative to the eu28 average in terms of selected business sector innovation indicators. the results obtained indicate that the role of business sector innovation in economic growth varies according to the sample of countries and the period under analysis, as well as according to the proxy used to measure business sector innovation activities. overall, the innovation indicators that play a relevant role in explaining economic growth for group 1, the group with the highest innovation performance in the eu, have a positive impact on the growth rate of real 16 economic analysis (2019, vol. 52, no. 1, 1‐22) gdp per capita, except patent applications (2008 ‐2015). on the other hand, group 2, characterized by below‐average performances in business sector innovation, mainly presents indicators that have negative growth impacts (r&d personnel, r&d researchers and trademark registrations, product/ process innovations, marketing/ organizational innovations, and smes that innovate internally between), with the exception of patent applications for the 1990‐2015 period and r & d expenditure between 2008 and 2015. one possible justification for this divergence lies in absorptive capacity, which is associated with the level of development of countries, as the success of the innovations in terms of increasing productivity and generating faster growth depends on different aspects, namely human capital availability, accumulated knowledge, adequate infrastructure, technological and financial support/development. group 1 includes the more developed member states (higher real gdp per capita) thus has in principle higher absorptive capacity, and so innovation in this group has more positive impacts, and higher business sector innovation indeed translates into faster growth. on the other hand, group 2 includes less developed/transition member, so that innovations do not translate into productivity increases because they lack the necessary absorptive capacity. the negative growth impacts obtained could also be the result of competition for scarce resources between different types of activities, with different weights in the process of growth of these countries, with business sector innovation activities using resources that would have higher growth returns in other sectors of activity. the findings also allowed us to conclude that not all inputs and outputs of business innovation are relevant to the explanation of the behaviour of output in the 28 eu member states, which again could be explained by the lack of certain types of absorptive capacity so that not all r&d activities carried out translate into successful innovations. in terms of policy implications, public policies can promote innovation through different instruments, e.g. either directly by providing funds, through human capital formation, enforcing patent protection laws, through tax benefits or indirectly through regulatory policies ((griffith, 2000); (oecd, 2007)). also, government policies can also provide incentives for firms to innovate. in light of the results obtained, the policy design should be different depending on the target group of countries. first, the results for the most recent period support policies that allow for an increase in r&d expenditures in the business sector. for group 1, the results suggest that policies that promote the acquisition of machinery and equipment for r&d activities are key to growth. for group 2, the results suggest that similar to (pradhan, arvin, hall and mahendhiran, 2016), policies must ensure an efficient allocation of resources, avoiding that innovation competes with other key sectors for resources. besides, investment in innovation infrastructure is still necessary for business sector innovation to translate into productivity gains and higher growth. future research should focus on a deeper understanding of the differences in results across samples and periods, as well as between inputs and outputs of business sector innovation. references barro, r. j. & sala‐i‐martin x. 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(2013). economic growth. boston: pearson/addison wesley. 18 economic analysis (2019, vol. 52, no. 1, 1‐22) appendix table a.1. variables in the empirical models: description and sources variables model description source dependent variable lngdprpci,t 1 e 2 average real gdp growth rate per capita at constant 2011 prices (usd) in ppps pwt control variables lngdprpci,t‐1 1 e 2 initial value of real gdp per capita at constant 2011 prices (usd) in ppps pwt gcfi,t 1 e 2 gross capital formation as % of gdp pwt hci,t‐1 1 e 2 average years of total schooling of the population aged 15 and over (barro and lee, 2013) gov_consi,t 1 e 2 public consumption as % of gdp pwt globi,t 1 e 2 globalization index kof investments/ inputs rdepci,t 1 r&d expenditures in the business sector per capita (euros) – source eurostat eurostat inov_ei,t 2 expenditure on innovation (excluding r&d) as % of turnover– source eis eis train_empi,t 2 firms that promote training to develop or upgrade the ict skills of employees, % of total firms– source eis eis rd_staffi,t‐1 1 total staff in r&d activities in the business sector per million inhabitants– source pordata pordata res_rdi,t‐1 1 researchers in r&d activities in the business sector per million inhabitants– source pordata pordata innovation activities/ outputs patent_appi,t 1 number of patent applications to the epo by the business sector per million inhabitants– source eurostat eurostat patent_gi,t 1 patents granted by the uspto to the business sector per million inhabitants– source eurostat eurostat trademark_appi,t 1 number of european union trademark applications (eutm) per million inhabitants– source eurostat eurostat prodproc_inovi,t 2 smes that introduce product or process innovations as % of the total number of smes– source eis eis markorg_inovi,t 2 smes that introduce marketing or organisational innovations as % of the total number of smes– source eis eis ino_smei,t 2 smes that innovate internally as % of the total number of smes– source eis eis coop_inovi,t 2 innovative smes that cooperate with others as % of total smes– source eis eis impacts export_hti,t 2 exports of medium and high‐tech products as % of total exports of products eis export_servi,t 2 exports of knowledge‐intensive services as % of total exports of services eis sales_inovi,t 2 sales of new‐to‐market and new‐to‐firm innovations as % of turnover eis temporal dummies d1 1 e 2 temporal dummy 1 (model 1: 1 for the period 2005‐2010, 0 otherwise; model 2: 1 for 2009, 2010, 2011 and 2012, 0 otherwise) ‐ d2 1 e 2 temporal dummy 2 (model 1: 1 for the period 2010‐2015, 0 otherwise; model 2: 1 for 2013, 2014 and 2015, 0 otherwise) ‐ source: own elaboration based on data from the penn world table 9.0 (pwt), barro‐lee dataset, kof, eurostat, european innovation scoreboard (eis) and pordata. cláudia caseiro, marta simões 19 table a.2. results of the estimation of model 1, eu12 (group 1), 1990‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi constant 0.1878 0.3344 0.2280 0.2510 0.5379*** 1.5891 *** lngdprpci,t‐1 −0.0280 −0.0429 * −0.0318 −0.0330 * −0.0558 *** −0.1572 *** gcfi,t 0.2180 *** 0.1989 ** 0.2118*** 0.2170 *** 0.0284 −0.1266 hci,t‐1 0.0071 ** 0.0076 ** 0.0073 * 0.0074 ** 0.0055 ** 0.0062 gov_consi,t −0.3376 ** −0.3975 *** −0.3541 ** −0.3982 *** −0.4278 *** −0.9902 *** globi,t 0.000759 0.000856 0.000730 0.0006584 0.000858 ** 0.0023 * rdepci,t −7.2578e‐6 ‐ ‐ ‐ ‐ ‐ rd_staffi,t‐1 ‐ 1.6809e‐6 ‐ ‐ ‐ ‐ res_rdi,t‐1 ‐ ‐ −1.2094e‐7 ‐ ‐ ‐ patent_appi,t ‐ ‐ ‐ 2.3588e‐5 ‐ ‐ patent_gi,t ‐ ‐ ‐ ‐ 7.2195e‐5 ‐ trademark_appi,t ‐ ‐ ‐ ‐ ‐ 9.4847e‐5 *** d1 −0.0238 ** −0.0231 ** −0.0238 ** −0.0251*** −0.00999 −0.0044 d2 0.0103 0.0122 0.0104 0.0115 ‐ 0.0406 *** r2 0.3685 0.3703 0.3620 0.3851 0.5481 ‐ adjusted r2 0.2654 0.2675 0.2534 0.2887 0.4690 ‐ lsdv r2 ‐ ‐ ‐ ‐ ‐ 0.8439 r2 within ‐ ‐ ‐ ‐ ‐ 0.8131 aic (akaike) −268.3492 −268.5145 −257.0800 −278.4762 −259.9794 −255.5067 bic (schwarz) −249.8052 −249.9705 −238.8518 −259.6271 −245.0097 −218.0827 hannan‐quinn −261.1260 −261.2912 −250.0129 −271.1033 −254.3223 −241.3641 notes: column i ‐ pooled ols for r&d expenses; column ii ‐ pooled ols for the total staff in r&d activities; column iii ‐ pooled ols for researchers in r&d activities; iv column ‐ pooled ols for patent applications; column v ‐ pooled ols for granted patents; column vi ‐ fixed effects for the registration of trademark applications. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. 20 economic analysis (2019, vol. 52, no. 1, 1‐22) table a.3. results of the estimation of model 1, eu16 (group 2), 1990‐2015 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi constant 0.7373 *** 0.766124 *** 0.7719 *** 0.8930 *** 1.2841 *** 1.0914 *** lngdprpci,t‐1 −0.0907 *** −0.0948377 *** −0.0953*** −0.1114 *** −0.1640 *** −0.1247 *** gcfi,t 0.2005 *** 0.179851 ** 0.1692 ** 0.2341 *** 0.1575 * 0.3654 *** hci,t‐1 −0.0013 0.000828091 0.000564 0.000264 0.0072 −0.0066 gov_consi,t −0.0507 −0.103619 −0.0979 −0.0774 0.1050 −0.0822 globi,t 0.0021 *** 0.00226445 *** 0.0023 *** 0.0024 *** 0.0027*** 0.0021 *** rdepci,t 1.0100e‐5 ‐ ‐ ‐ ‐ ‐ rd_staffi,t‐1 ‐ −8.6045e‐6 * ‐ ‐ ‐ ‐ res_rdi,t‐1 ‐ ‐ −1.7627e‐5 * ‐ ‐ ‐ patent_appi,t ‐ ‐ ‐ 0.000463 * ‐ ‐ patent_gi,t ‐ ‐ ‐ ‐ 0.000974 ‐ trademark_appi,t ‐ ‐ ‐ ‐ ‐ −0.000138 *** d1 −0.0078 −0.0076 −0.0053 −0.0116 0.000567 −0.0033 d2 0.0136 * 0.0151 * 0.0176 ** 0.0158 * ‐ 0.0440 *** r2 ‐ 0.5639 0.5829 0.6404 ‐ ‐ adjusted r2 ‐ 0.5111 0.5308 0.5999 ‐ ‐ lsdv r2 ‐ ‐ ‐ ‐ 0.8421 0.7133 r2 within ‐ ‐ ‐ ‐ 0.8256 0.5628 aic (akaike) −355.5393 −348.6601 −344.4415 −370.7207 −311.6848 −313.4456 bic (schwarz) −334.9252 −327.8027 −323.8274 −349.2825 −262.0305 −262.3944 hannan‐quinn −347.3242 −340.3319 −336.2264 −362.1255 −292.1235 −293.4016 notes: column i ‐ random effects for r&d expenditure; column ii ‐ pooled ols for the total staff in r&d activities; column iii ‐ pooled ols for researchers in r&d activities; iv column ‐ pooled ols for patent applications; column v ‐ fixed effects for granted patents; column vi ‐ fixed effects for the registration of trademark applications. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. cláudia caseiro, marta simões 21 table a.4. results of the estimation of model 2 with fixed effects, eu12 (group 1), 2008‐15 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi vii viii ix constant 6.3944*** 6.1876 *** 6.2550 *** 6.6236 *** 5.9766 *** 6.3595 *** 6.1626 *** 6.2453 *** 6.4380 *** lngdprpci,t‐1 −0.6641 *** −0.6421 *** −0.6468 *** −0.6782 *** −0.6270 *** −0.6540 *** −0.6371 *** −0.6451 *** −0.6698 *** gcfi,t 0.1869 0.1768 0.1598 0.1538 0.1521 0.1953 0.1735 0.1632 0.1516 hci,t‐1 0.0134 *** 0.0130 *** 0.0133 *** 0.0121 *** 0.0132 *** 0.0129 *** 0.0130*** 0.0131*** 0.0135*** gov_consi,t −0.7687 −0.8443 −0.8478 −0.8567 * −0.8805 * −0.8466 −0.8339 −0.8067 −0.7162 globi,t −0.0027 −0.0024 −0.00245 −0.0027 −0.0021 −0.0023 −0.0025 −0.0025 −0.0023 export_hti,t 0.000739 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ export_servi,t ‐ 0.000533 ‐ ‐ ‐ ‐ ‐ ‐ ‐ inov_ei,t ‐ ‐ 0.0068 ‐ ‐ ‐ ‐ ‐ ‐ train_empi,t ‐ ‐ ‐ 0.0029 *** ‐ ‐ ‐ ‐ ‐ prodproc_inovi,t ‐ ‐ ‐ ‐ 0.0013 ‐ ‐ ‐ ‐ markorg_inovi,t ‐ ‐ ‐ ‐ ‐ −0.000365 ‐ ‐ ‐ ino_smei,t ‐ ‐ ‐ ‐ ‐ ‐ 0.000327 ‐ ‐ coop_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.000559 ‐ sales_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.0016 d1 −0.0306 * −0.0291 * −0.0294 * −0.0262 * −0.0292 * −0.0287 * −0.0294 * −0.0309 * −0.0318 * d2 −0.0074 −0.0060 −0.0066 −0.0051 −0.0034 −0.0050 −0.0062 −0.0074 −0.0091 lsdv r2 0.6465 0.6457 0.6461 0.6848 0.6517 0.6465 0.6460 0.6466 0.6490 r2 within 0.6284 0.6275 0.6279 0.6686 0.6338 0.6284 0.6279 0.6285 0.6310 aic (akaike) −335.5293 −335.3313 −335.4253 −345.1485 −336.7694 −335.5249 −335.4088 −335.5508 −336.1278 bic (schwarz) −286.9129 −286.7150 −286.8090 −296.5322 −288.1531 −286.9085 −286.7925 −286.9345 −287.5115 hannan‐quinn −315.9859 −315.7879 −315.8820 −325.6051 −317.2261 −315.9815 −315.8654 −316.0074 −316.5844 notes: column i ‐ exports of medium and high‐tech products; column ii ‐ exports of knowledge‐intensive services; column iii ‐ innovation expenditures; column iv ‐ training of employees; column v ‐ product/ process innovations; column vi ‐ marketing/ organizational innovations; column vii –% of smes that innovate internally; column viii ‐ % of smes cooperating with others; column ix ‐ sales of innovations. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. 22 economic analysis (2019, vol. 52, no. 1, 1‐22) table a.5. results of the estimation of model 2 with fixed effects, eu16 (group 2), 2008‐15 explanatory variables dependent variable ‐ a growth rate of real gdp per capita i ii iii iv v vi vii viii ix constant 2.5022 *** 2.4888 *** 2.4548*** 2.5312 *** 2.6043*** 2.4820 *** 2.2812*** 2.5214 *** 2.4941 *** lngdprpci,t‐1 −0.3670 *** −0.3681 *** −0.3675 *** −0.3746 *** −0.3829** * −0.3840 *** −0.3538 *** −0.3716 *** −0.3704 *** gcfi,t 0.7714*** 0.7674 *** 0.7924 *** 0.7502 *** 0.8471 *** 0.8735*** 0.8341*** 0.7757 *** 0.7662 *** hci,t‐1 0.0088 *** 0.0089 *** 0.0089 *** 0.0087 *** 0.0094 *** 0.0109 *** 0.0103 *** 0.0088 *** 0.0090 *** gov_consi,t −1.2168 *** −1.2079 *** −1.1076 *** −1.2289 *** −0.9851 *** −1.1182 *** −0.8771 ** −1.2014 *** −1.2349 *** globi,t 0.0086*** 0.0087 *** 0.0088*** 0.0088 *** 0.0085 *** 0.0092 *** 0.0080 *** 0.0087 *** 0.0087 *** export_hti,t −0.00029 6 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ export_servi,t ‐ −0.00011 8 ‐ ‐ ‐ ‐ ‐ ‐ ‐ inov_ei,t ‐ ‐ −0.0108 ‐ ‐ ‐ ‐ ‐ ‐ train_empi,t ‐ ‐ ‐ 0.0017 ‐ ‐ ‐ ‐ ‐ prodproc_inovi, t ‐ ‐ ‐ ‐ −0.0024 ** ‐ ‐ ‐ ‐ markorg_inovi,t ‐ ‐ ‐ ‐ ‐ −0.0019 ** ‐ ‐ ‐ ino_smei,t ‐ ‐ ‐ ‐ ‐ ‐ −0.0030** ‐ ‐ coop_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ −0.00040 6 ‐ sales_inovi,t ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 0.000465 d1 0.0297** 0.0295 ** 0.0272 * 0.0292 ** 0.0316 ** 0.0256* 0.0233 0.0301 ** 0.0297 ** d2 0.0415 * 0.0408 * 0.0393 * 0.0417 * 0.0351 0.0312 0.0247 0.0416 * 0.0424* lsdv r2 0.6666 0.6665 0.6704 0.6696 0.6839 0.6845 0.6891 0.6665 0.6670 r2 within 0.5830 0.5828 0.5877 0.5867 0.6046 0.6054 0.6112 0.5829 0.5835 aic (akaike) −440.920 8 −440.866 5 −442.196 1 −441.925 8 −446.8741 −447.105 2 −448.748 6 −440.899 3 −441.063 7 bic (schwarz) −375.676 8 −375.622 5 −376.952 1 −376.681 9 −381.6301 −381.861 3 −383.504 6 −375.655 3 −375.819 8 hannan‐quinn −414.449 2 −414.395 0 −415.724 5 −415.454 3 −420.4026 −420.633 7 −422.277 0 −414.427 7 −414.592 2 notes: column i ‐ exports of medium and high‐tech products; column ii ‐ exports of knowledge‐intensive services; column iii ‐ innovation expenditures; column iv ‐ training of employees; column v ‐ product/ process innovations; column vi ‐ marketing/ organizational innovations; column vii –% of smes that innovate internally; column viii ‐ % of smes cooperating with others; column ix ‐ sales of innovations. ***, **, * indicate statistical significance at the 1, 5 and 10% levels, respectively. source: own elaboration. article history: received: november 8, 2018 accepted: may 30, 2019 doi: 10.28934/ea.19.52.12.pp23-35 original scientific paper comparative analysis of insurance premiums in serbia and bosnia and herzegovina ‐ multiple linear regression analysis model tijana kaličanin1* | sandra kamenković1 | ivana simeunović1 1 university union, belgrade banking academy ‐ faculty of banking, insurance and finance, belgrade, serbia abstract in the last few years, the global insurance market has shown a trend of concentration growth, which was conditioned by the processes of mergers and acquisitions in insurance. the aim of this paper is to make a comparative analysis of insurance premiums in serbia and bosnia and herzegovina. dynamic analysis of market concentration indicators calculated on the basis of absolute amounts of premiums indicates that the insurance market in bosnia and herzegovina is characterized by low concentrated supply, i.e. there is greater equality of market share in relation to high inequality and high concentration among market participants in the insurance sector of the republic of serbia. having applied the multi‐linear regression model in order to analyze the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐2017, it can be concluded that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had the average net salary, households and final consumption expenditure and gross domestic income. key words: insurance premiums, insurance sector, multiple linear regression analysis model jel classification: c30, g22, l19 introduction in the last two decades, countries of central and east europe have experienced tremendous changes in the political, cultural, social and economic environment. central and east european financial system has been rapidly developing during the last couple of years, contemporary regulations have been introduced and new financial institutions have been established contributing to the maintenance of macroeconomic stability in the region. nonetheless, the macroeconomic sector in the region, underdeveloped even before the recession took place, has been a highly risky place for investments and unstable in comparison with western europe (kaličanin & hanić 2016a). the insurance market in the western balkans is characterized by significant changes caused by different economic growth pace. countries preparing to become members of the european union are carrying out faster reforms, and there is also a significant inflow of foreign capital due to a reduction of financial and political risks (novović‐burić et al. 2017). in this paper, the insurance sectors were analyzed in the republic of serbia and bosnia and herzegovina. in addition to the transition process in both countries, these countries have * corresponding author, e‐mail: tijana.kalicanin@bba.edu.rs 24 economic analysis (2019, vol. 52, no. 1, 23‐35) undergone similar political and economic changes in the past decade. both insurance markets have passed through the process of integration and internationalisation. in addition to many similarities characteristic for these two markets, there are substantial differences that are reflected in the number of residents, the number of insurance companies, the market structure, the participation of the market leader, and the number of companies with foreign capital. the market of a country is as developed as its competition is able to function on it. competition has to be constantly stimulated and protected by mechanisms in line with the european integration processes and policy focused on market economy development. competition as such has been a particularly sensitive issue in transitional countries such as serbia and countries in the region. changing the number of insurance companies on the market influenced significantly the formation of a group of leaders in the insurance market as well as strengthening the position and increasing the individual market share of the leader (kaličanin & lazić, 2018). initial structural changes raised an issue and brought about the need for a higher competitiveness in serbia. every country aspiring to join the eu and integration processes ought to develop legal norms and apply the eu regulations (kaličanin & hanić 2016a). in recent years, the insurance sector has become a significant factor in the development of the overall financial and economic system. in the first part of the paper, insurance markets and level of competitiveness were analyzed. competitiveness in the market has led to changes in the balance sheet structure of the entire financial sector as well as the position of individual insurance companies in previous years. the insurance sector is extremely important for the economy of a country, not only from the point of view of security and protection from different types of risks but also from the point of view of the overall economic development and improvements in the functioning of the financial market. in the second part of the paper, the focus is on the analysis of insurance premiums and the impact of selected macroeconomic indicators on premiums using the multi‐linear regression model. literature review there are many analyses which deal with insurance premiums and economic growth. outreville (1990), zhi (1998), beck and webb (2003), webb et al. (2002) have shown a very strong interaction between insurance premiums and gdp despite different periods and country patterns. analyses mainly suggest that higher gdp growth rates have an impact on economic activity growth, which leads to assumptions about a positive correlation between gdp growth rate and demand for insurance. haiss and sumegi presented very extensive research in 2008, which led to the conclusion that there is a correlation between insurance and gdp growth in eu‐15 countries with developed financial markets as well as short‐term linkages between gdp and non‐life premiums on a sample of cee countries. serbia and bosnia and herzegovina are selected for this research because very few authors have analyzed this region from the insurance aspect. novovic‐buric et al. (2017) explored the influence of certain factors on the purchase of insurance products through a panel analysis. western balkan countries were analyzed in the period from 2005 to 2015, and the results show that most of the economic factors affect total life premiums. the demand for life insurance has a significant and positive impact on gdp and wages, while the influence of unemployment and interest rates is negative. dragos (2014) used the fixed and random effects model in the analysis, which entailed 17 countries in asia and central eastern europe. the aim was to compare emerging markets in europe characterised by market economies and emerging markets in asia, which are predominantly planned economies in terms of the impact of economic performance on life and non‐life insurance. it has been noted that the differences certainly exist. the results concerning the cee, taking into consideration the countries which are analyzed in this research have shown tijana kaličanin, sandra kamenković, ivana simeunović 25 that income and education have a positive impact on the insurance demand, while urbanisation has shown a significant impact on non‐life insurance. on the other hand, income distribution negatively influences the demand for insurance. kjosevski (2012) analysed the determinants of life insurance demand in central and southeastern europe by using fixed‐effect panel models in the period 1998‐2010. the results show that in terms of life insurance, the most significant predictors are the following: high gdp per capita, inflation, health expenditure, level of education and the rule of law. mitra (2017) analysed the impact of economic, demographic and cultural factors on life insurance consumption in 28 eu countries. the focus was on the emerging east european economies, given that in the analysed period 2009‐2014, there were significant reforms of the insurance sector in these countries. the results show that the higher gdp is an indicator of higher wages and higher levels of economic activity, the more positive impact on insurance demand. ward and zurbruegg (2002) analysed 37 countries in the period 1987 ‐ 1998 with the intention to point to the links between insurance premiums and various legal and political factors, as well as economic and social factors. the analysis has shown that the consumption of life insurance products is under stronger influence of gdp in asia than in oecd countries, which is an expected result given that in the oecd countries there is a considerably higher average income level and that ‘s curves’ suggest that at higher levels of income the demand for insurance is less susceptible to the revenue growth. bianchi et al. (2011) analysed the insurance market in central, eastern and southeastern europe and both countries which were analyzed in this research are contained in the sample. they used panel regression (a cross section with fixed effects) to examine the impact of gdp growth on insurance premium growth. the results suggest that economic development and catching‐up processes mainly condition premium growth, and that in unstable periods, it shows increased volatility. comparative analysis of the insurance market figure 1 shows the total number of insurance companies operating in the insurance market in serbia as well as in bosnia and herzegovina in the last ten years. the largest number of insurance companies in serbia was present in the period 2011‐2013 when there were 28 companies, followed by the decline in the number of insurance companies, ranging from 25 in 2014 to 21 at the end of 2017. figure 1. number of insurance companies, 2007‐2017 with the number of insurance companies in the market in bosnia and herzegovina, fewer oscillations can be noted in the observed period, ranging from 24 to 27. the largest number of 0 10 20 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 20 24 26 26 28 28 28 25 24 23 21 25 26 26 26 25 25 25 24 24 27 27 number of insurance companies ‐ serbia number of insurance companies ‐ bih 26 economic analysis (2019, vol. 52, no. 1, 23‐35) insurance companies at the b&h market operated in the last two years of the observed period, i.e. 2016‐2017 with a total of 27 companies. in addition to the banking sector with the largest share of the balance sheet total in the total financial sector ‐ about 90%, the balance sheets of the leasing companies, pension funds and insurance companies are included. figure 2 shows a fall in the share of the insurance sector's balance sheet total in the total financial sector, which is notable in both markets in the period 2005‐2008. after 2008, the share of the insurance sector balance sheet total in serbia rose from 4.2% in 2008 to 6.3% in 2017. the same trend is present in the insurance market of bosnia and herzegovina, where the growth of the balance sheet total in the total financial sector increased in the same period for the same percentage ‐ 2.1%, from 3.45% to 5.57% in 2017. figure 2. contribution of the balance sheet total of the insurance sector to the overall financial sector, 2005‐2017 figures 3 and 4 show the ratio of the total number of insurance companies and foreign companies in the period 2007‐2017. it can be concluded that the number of foreign insurance companies in serbia has changed proportionally with the total number of companies present in the market. the number of foreign companies in the insurance market of b&h did not change significantly in the observed period. there were 10 foreign insurance companies in the period 2008‐2014, after which this number increased to 11 and 12 in 2015, 2016 and 2017, respectively. figure 3. relationship between the total number of insurance companies and foreign companies, 2007‐2017, serbia 4,42 3,75 3,46 3,45 3,72 3,86 4,43 4,77 4,86 5,19 5,38 5,57 5,57 5,3 4,3 4,1 4,3 4,2 4,2 4,4 4,5 4,8 5,2 5,8 6,1 6,3 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih serbia 20 24 26 26 28 28 28 25 24 23 21 13 17 19 19 21 21 21 19 18 17 15 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign tijana kaličanin, sandra kamenković, ivana simeunović 27 figure 4. relationship between the total number of insurance companies and foreign companies, 2007‐2017, b&h given that the subject matter of the analysis is the amount of income earned by insurance companies, the companies’ market shares are calculated on the basis of the amount of total premiums at the end of the year taken from the balance sheet of insurance companies. figure 5 shows a comparative analysis of the concentration of the largest companies in b&h and serbia according to the criterion of the total balance sheet. dunav insurance company was the market leader in serbia according to the mentioned criterion and has absorbed about one‐quarter of the entire market in the observed period. by the end of 2015, sarajevo insurance was the market leader in b&h according to the criterion of the total premium. for the next two years of the observed period, uniqa insurance achieved the largest amount of total premiums. the concentration of leader ratio in b&h is much lower than in serbia, so the leader in this market has a share of about one‐tenth of the entire market. figure 5. cr1 according to the criterion of the total premium, 2007‐2017 the number of companies involved in the calculation of this indicator is determined by government agencies that are monitoring the degree of bid concentration in that particular country, provided that this coefficient is used as an official indicator (martin, 2002). cr 1, cr3 and cr5 are most frequently accrued in the reports of the responsible insurance institutions, according to the criterion of total premiums, total non‐life insurance premiums and total life 25 26 26 26 25 25 25 24 24 27 27 9 10 10 10 10 10 10 10 11 11 12 0 5 10 15 20 25 30 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 total foreign 013 012 012 012 013 013 012 011 010 009 008 031 025 028 026 027 029 027 025 027 026 027 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 28 economic analysis (2019, vol. 52, no. 1, 23‐35) assurance premiums. figure 6 shows the concentration ratio of the top five insurance companies with the highest total premium. although there is a mild tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. (as can be seen in lorenz curves 8 and 9). cr5 had fallen from 84.16% in 2007 to 77.19% in 2017. the mentioned concentration ratio in b&h dropped from 45.97% to 39.21%, from 2007 to 2017. figure 6. cr5 according to the criterion of the total premium, 2007‐2017 figure 7 shows the dynamic analysis of the herfindahl‐hirschman index in the period 2007‐ 2017 for both markets. the significance of the index is reflected in the fact that although it respects the individual market share of all companies in the branch it particularly responds to the presence of companies with large market participations, which significantly increase its value (lipczynski & wilson, 2001) given the above and taking into account the high cr5 concentration ratio on the insurance market of the republic of serbia, high values of the herfindahl‐hirschman index are not surprising. figure 7. herfindahl‐hirschman index according to the criterion of the total premium, 2007‐017 with the increase in the number of insurance companies in serbia, this index has declined, so the highly concentrated bid with the index of 2050 in 2007 reached the level of a medium concentrated bid (it is considered thin the market is medium concentrated if the hhi index value 046 045 045 046 046 045 046 045 042 041 039 084 082 079 077 077 077 076 077 076 075 077 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 bih srb 2050 1820 1654 1520 1551 1595 1495 1496 1558 1495 1543 655 623 622 643 636 640 636 610 585 555 534 0 500 1000 1500 2000 2500 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 serbia bih tijana kaličanin, sandra kamenković, ivana simeunović 29 ranges from 1000 to 1800). it can be concluded that from 2008 until today, the insurance market in serbia is medium concentrated. herfindahl‐hirschman index according to the criterion of the total premium differs significantly in the market of bosnia and herzegovina, where the permanent low‐concentration bid is present in the observed period. although the hhi index fell from 655 to 534, from 2007 to 2017, it can be concluded that the insurance market in b&h is inconsistent, i.e. that there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. figure 8 shows lorenz curves based on the amount of total premiums for the initial and the last year of the observed period, i.e. 2007 and 2017. first, insurance market leaders have reduced their market share, i.e. the top 20% of insurance companies in 2007 had a cumulative 80% of the total market share measured by the total premium, while the same percentage of leaders in 2017 had less than 60%. with the exception of market leaders (the first four companies) of 18 companies in 2007, 14 companies shared 18.85% of the total market, while in the year 2017 some 15 companies shared 18.69%, which suggests that the number of companies increased in the market with smaller market share, primarily due to the appearance of new companies in the market. this finding contributes to the value of the herfindahl‐hirschman index as well as the value of cr5. figure 8. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, serbia constructing lorenz's curve in terms of the degree of concentration of supply in the relevant market, the distribution of the entire market between business entities can be clearly seen. (kaličanin & hanić 2016b). lorenz curves for the insurance market of bosnia and herzegovina constructed based on the premiums shown in figure 9 differ considerably from those presented in figure 8. the distribution of the market share of insurance companies in the stipulated market is characterised by greater equality, which can be inferred from the lorenz curve distance from the equal’s curves (in case of equal distribution of market share among all participants in the market). fewer companies have been able to increase their market share over the observed period, while market leaders reduced their cumulative market share. 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz 30 economic analysis (2019, vol. 52, no. 1, 23‐35) figure 9. lorenz curve and herfindahl‐hirschman index according to the criterion of the total premium, 2007‐2017, b&h in 2017 in bosnia and herzegovina, there were 27 companies, i.e. 6 companies more than in the republic of serbia. in addition to the difference in the number of companies, there is greater inequality in the distribution of market shares in the serbian insurance market as well as greater concentration on the supply side compared to the low concentration of the insurance market of bosnia and herzegovina. methodology as emphasised before, the aim of this paper is to analyse the insurance market in serbia and bosnia and herzegovina with reference to certain macroeconomic indicators that play a key role in the development of insurance. in this respect, we investigated the mutual influence of individual variables on the movement of total premium income earned in these countries. in this analysis, a time series is used for the period 2000‐2017, i.e. for a period of 18 years. for the mentioned period, the following independent variables were analysed:  – average net salary (current, rsd/km)  – unemployment, total (% of tthe otal labor force)  – gross domestic income (constant lcu)  ‐ gdp per capita (current us$)  ‐ wage and salaried workers, total (% of total employment)  ‐ households and npishs final consumption expenditure (current us$) while the dependent variable was – total premium (current rsd/km). for this research, multiple regression analysis was carried out using the spss statistical software. the choice of independent variables is based on empirical fundaments that relate to the studied variable, as well as on the information contained in the relevant literature. six independent variables were included in the analysis to identify those that could explain the major part of the variability of the studied (dependent) variables. a model involving variables whose calculated regression coefficient is significant at 5% level is selected. empirical research and discussion usually, the first part of the study contains basic indicators of descriptive statistics. since all variables included in the analysis were measured on the ratio scale, the values of arithmetic mean and standard deviations are presented as indicators of a descriptive statistic (table 1 and table 2). 0 20 40 60 80 100 0 20 40 60 80 100 2007 equals lorenz 0 20 40 60 80 100 0 20 40 60 80 100 2017 equals lorenz tijana kaličanin, sandra kamenković, ivana simeunović 31 table 1: descriptive statistics for different variables – serbia mean std. deviation n total premium 49372718.5000 24831359.35237 18 average net salary 345729.3333 183811.84680 18 unemployment, total (% of total labor force) 17.6239 3.61340 18 gross domestic income (constant lcu) 2855342777777.7780 458570337497.97485 18 gdp per capita (current us$) 4614.9873 1798.25314 18 wage and salaried workers, total (% of total employment) 69.4582 1.98410 18 households and npishs final consumption expenditure (current us$) 25301236558.1667 9670960437.31504 18 source: authors using spss table 2: descriptive statistics for different variables – bih mean std. deviation n total premium 430206288.0000 141434498.99548 18 average net salary 1035.7778 262.30260 18 unemployment, total (% of total labor force) 27.3079 2.00943 18 gross domestic income (constant lcu) 24073220032.1667 3036558289.97812 18 gdp per capita (current us$) 3848.6667 1366.86275 18 wage and salaried workers, total (% of total employment) 66.5221 6.48730 18 households and npishs final consumption expenditure (current us$) 12811176132.8333 2684992943.38614 18 source: authors using spss below is an output that refers to the multiple regression model which was implemented on the data obtained for both countries involved in the analysis. table 3: model summary along with the values of r and r square – serbia model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .962a .925 .920 7023512.91992 .925 196.491 1 16 .000 2 .981b .962 .957 5152189.94256 .037 14.733 1 15 .002 3 .992c .983 .980 3548389.97989 .021 17.624 1 14 .001 4 .996d .993 .990 2444365.32992 .009 16.502 1 13 .001 a. predictors: (constant), average net salary b. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$) c. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu) d. predictors: (constant), average net salary, households and npishs final consumption expenditure (current us$), gross domestic income (constant lcu), unemployment, total (% of total labor force) source: authors using spss 32 economic analysis (2019, vol. 52, no. 1, 23‐35) in the case of variables describing the insurance market in the republic of serbia, four models were generated, where the last model was selected having the highest value of the coefficient . the value in this case shows that 99.3% variations in total premium can be explained by selected four variables and this model can be considered appropriate to develop the regression equation. the independent variables selected by the above mentioned model are as follows: average net salary, households and npishs final consumption expenditure, gross domestic income and unemployment, total (table 3). the following table shows the unstandardized and standardised regression coefficients for all models. in the last model, t‐values for all the two regression coefficients are significant as their significance values (p‐values) are less than 0.05. therefore, it can be concluded that the previously selected 4 independent variables significantly explain the variations in the total premium. table 4: regression coefficients of selected variables in different models along with their ‐ values and partial ccorrelations – serbia model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) 4460520.406 3606405.932 1.237 .234 average net salary 129.906 9.267 .962 14.018 .000 .962 .962 .962 2 (constant) 14150355.208 3656718.281 3.870 .002 average net salary 178.058 14.268 1.318 12.479 .000 .962 .955 .628 households and npishs final consumption expenditure ‐.001 .000 ‐.405 ‐3.838 .002 .753 ‐.704 ‐.193 3 (constant) ‐66019515.273 19262250.240 ‐3.427 .004 average net salary 102.779 20.448 .761 5.026 .000 .962 .802 .174 households and npishs final consumption expenditure ‐.002 .000 ‐.640 ‐6.977 .000 .753 ‐.881 ‐.242 gross domestic income 4.254e‐5 .000 .786 4.198 .001 .934 .747 .145 4 (constant) ‐49098413.472 13907538.352 ‐3.530 .004 average net salary 107.565 14.135 .796 7.610 .000 .962 .904 .182 households and npishs final consumption expenditure ‐.001 .000 ‐.550 ‐8.200 .000 .753 ‐.915 ‐.196 gross domestic income 3.880e‐5 .000 .717 5.512 .000 .934 .837 .132 unemployment, total (% of total labor force) ‐783350.327 192833.041 ‐.114 ‐4.062 .001 .250 ‐.748 ‐.097 a. dependent variable: total premium source: authors using spss using the values of the unstandardized regression coefficients of the last model presented in table 4, the following regression model can be shown: 49098413.472 107.565 0.001 0.0000388 783350.327 tijana kaličanin, sandra kamenković, ivana simeunović 33 concerning the same analysis carried out for the data from bosnia and herzegovina, two models were generated, where the second one was selected for which the value of 0.983 was assigned for the determination coefficient (table 5). in this way, a multiple hierarchy model was formulated which combines two independent variables as follows: gross domestic income and wage and salaried workers, total. since the f‐value for this model is highly significant, the model is reliable. also, the regression coefficients in the stipulated model are statistically significant, and it is considered that the selected variables have a great predictive significance in estimating the value of the total premium. table 5: model summary along with the values of r and r square ‐ bih model r r square adjusted r square std. error of the estimate change statistics r square change f change df1 df2 sig. f change 1 .975a .951 .948 32128444.21790 .951 313.443 1 16 .000 2 .992b .983 .981 19491967.96979 .032 28.470 1 15 .000 a. predictors: (constant), gross domestic income (constant lcu) b. predictors: (constant), gross domestic income (constant lcu), wage and salaried workers, total (% of total employment) source: authors using spss the last table contains the values of the regression coefficients for the previously selected model. table 6: regression coefficients of selected variables in different models along with their ‐ values and partial correlations ‐ bih model unstandardized coefficients standardised coefficients t sig. correlations b std. error beta zero‐ order partial part 1 (constant) ‐663490820.738 62238137.572 ‐10.661 .000 gross domestic income .045 .003 .975 17.704 .000 .975 .975 .975 2 (constant) ‐827546449.311 48694106.929 ‐16.995 .000 gross domestic income .035 .002 .759 14.452 .000 .975 .966 .483 wage and salaried workers, total (% of total employment) 6110923.803 1145287.155 .280 5.336 .000 .866 .809 .178 a. dependent variable: total premium source: authors using spss regression equation, which can explain the variability of the observed total premium variable analysing trends in selected independent variables goes as follows: 827546449.311 0.035 gross domestic income 6110923.803 wage and salaried workers 34 economic analysis (2019, vol. 52, no. 1, 23‐35) conclusion after 2008, the share of the insurance sector balance sheet total in serbia and bosnia and herzegovina increased in the same period for the same percentage – 2.1%. the number of insurance companies with foreign equity in serbia has changed proportionally with the total number of companies present in the market whereas the number of the foreign insurance companies in bosnia and herzegovina remained almost the same although the total number of the insurance companies increased. the concentration of leader ratio (cr1) in bosnia and herzegovina is much lower than in serbia, so the leader in this market has a share of about 10% of the entire market while in serbia it is about 27%. although there is a moderate tendency of market penetration at both markets, at the serbian insurance market, the first five insurance companies have a much larger share than it is the case in bosnia and herzegovina. it can be concluded that in the last decade the insurance market in serbia is medium concentrated according to herfindahl‐hirschman index calculated by total premium and it differs significantly in the market of bosnia and herzegovina, where permanent low‐concentration bid is present in the observed period ‐ there is greater equality of market share compared with the high inequality among market participants in the insurance sector of the republic of serbia. in this paper, the multi‐linear regression model was applied in order to analyse the impact of selected macroeconomic indicators on the amount of insurance premiums in the period 2000‐ 2017. we can conclude that the greatest impact on the amount of the premium in bosnia and herzegovina had gross domestic income and wage and salaries workers. in the republic of serbia, the greatest influence on the amount of premium in the observed period had average net salary, households and final consumption expenditure and gross domestic income. therefore, there is a positive correlation between household income (including salary and other income) and premiums. also, in the periods when household expenditure was higher, the amount of total insurance premium was also higher. both of the selected economies have undergone changes in the financial sector, particularly in terms of recent regulatory reforms. this paper provides information on the determinants of insurance demand in the republic of serbia and bosnia and herzegovina. this research is limited to a macro level analysis of the insurance demand. further, detailed analysis can be performed on individual life insurance products, 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"evaluating the level of market concentration in insurance sector: the case of serbia." in: western balkans economies in eu integration, past, present and future, ed. richet, xavier, dejan erić, srđan redžepagić, ivan stošić and duško bodroža, 202‐ 221. nice: cemafi international association. kjosevski, j. (2012). “the determinants of life insurance demand in central and southeastern europe”. international journal of economics and finance, 4(3): pp. 237–247, doi: 10.5539/ijef.v4n3p237. lipczynski, j. & john, w. (2001). industrial organization: an analysis of competitive markets. prentice‐hall, london. martin, s. (2002). advanced industrial economics. blackwell publishers ltd, oxford. mitra, a. (2017). “influencers of life insurance investments: empirical evidence from europe”. australasian accounting, business and finance journal, 11(3): 87–102. https://doi.org/10.14453/aabfj.v11i3.7. outreville, f. (1990). "the economic significance of insurance markets in developing countries." the journal of risk and insurance 57, no. 3: 487‐98. doi:10.2307/252844. ward, d. & zurbruegg, r. (2002). “law, politics and life insurance consumption in asia”, geneva papers on risk and insurance, 27(3): 395–412. doi:10.1111/1468‐0440.00181. webb, i., martin, g. & skipper, h. (2002). “the effect of banking and insurance on the growth of capital and output”. centre for risk management and insurance, working paper, no. 02‐1. robinson college of business, georgia state university, atlanta. zhi, z. (1998). die nachfrage nach lebensversicherungen: eine empirische analyse für china, mannheimer manuskripte zu risikotheorie, portfolio management und versicherungswirtschaft 112, universität mannheim. www.nbs.rs www.azobih.gov.ba www.data.worldbank.org article history: received: april 1, 2019 accepted: may 29, 2019 microsoft word 2007 3 4.doc 2007 ‐ 8  •  economic analysis®    abstract: the feldstein‐horioka thesis was considered one of the greatest puzzles in economics.  proposed to be a measure of international capital mobility, has known a process of immunisation to be con‐ formed to empirical evidence and respect econometric knowledge. we apply to the portuguese economy the  proposed tests not only to know the degree of capital mobility but also to know if this economy is external  sustainable. the original ideas in the paper are our interpretation of the theoretical evolution of the f‐h the‐ sis, the importance of analysing the random nature of the model of one equation and not only the retention  coefficient and the macro view given by an appropriate var model with investment and saving. we con‐ clude by the confirmation of important capital mobility in the portuguese economy and the external unsus‐ tainability of this economy.  introduction  feldstein and horioka (1980) (f‐h) proposed a very simple and imaginative measure of the  international capital mobility. the results obtained with  it originate one of  the most  important  «puzzles» in economics. they have caused innumerable debates, where corrections and extensions  were suggested, as well as positions which deny the interest of this thesis. in andrade (2007) we  presented the idea that the studies of this thesis are an example of a scientific practice like karl  popper  described  it.  in  reaction  to  the  problems  of  refutation,  attempts  of  immunization  were  built. we can also recognize  in this evolution a certain “methodological anarchism” à  la feyra‐ bend1.   accepting the positive effects of the mobility of capital for the development, a measurement  of this mobility is very important. the results of the tests to confirm the thesis were responsible by  its evolution, either at the level of the analysis, or at the level of the econometric techniques. a  theoretical  position  has  adapted  to  the  econometric  methods  and  allowed  an  interpretation  in  terms of external sustainability and capital mobility. we will apply these ideas to the portuguese  economy to the period 1910‐2004. finally we conclude.  f‐h and the international capital mobility  the mobility of capital is important, if not even essential, to allow an efficient allocation of  capital, from the point of view of the diversity of its industrial uses as well as geographical loca‐ tion. an economy is internationally integrated if its flows of capital can enter and leave the country  freely and if the national financial assets are good substitutes of the financial assets of other coun‐ tries.  the  real  and  financial  integration  of  less  developed  economies  has  the  consequence  of  worsen the negative external balances2. and a country whose growth is faster than that of the oth‐ ers will have, in theory, an imbalance of its external balance more important.   the development of financial practices of protection against the risk will also contribute to  1 feyerabend (1993).  2 or the avarage level of development. blanchard and giavazzi (2002).  mobility of capital and external sustainability  of the portuguese economy  joão sousa andrade, gemf – faculty of economics, university of coimbra key words : feldstein‐horioka, capital mobility, saving, investment, current account  jel : e21, e22, f21  original paper volume 40 • autumn 2007 • 9  the reduction of the national savings3 and consequently to worsen external imbalance. economic  integration can lead, in the case of certain countries to external unsustainability of the economy.  independently of this last result, economists believe in the growth of the economy4 as a result of  the mobility of capital. as a consequence we are interested in a simple measurement of this mobil‐ ity.   the idea, behind the thesis of feldstein and horioka (1980), (f‐h), is quite simple: if an econ‐ omy is well internationally integrated, then, its accumulation of capital should not be constrained  by national savings. that paper, later on, was refined by feldstein (1983) and feldstein and bac‐ chetta (1991). the equation which summarizes their work is the following:   i s y y α β= + ⋅   5    feldstein and horioka  (1980) concluded  that 85%  to 95% of  the national saving was  in‐ vested locally. vis‐a‐vis these results, of absence of international mobility of capital, for developed  economies, obstfeld and rogoff (2000) regarded this result as a enigma (a “puzzle”) and as one of  the six larger “puzzle” than one knows in international economy.  the empirical result is difficult to accept. how can one accept that contrary to our convic‐ tions, about freedom of capital movements, the national saving can continue to constraint national  investment?  the definition of f‐h of international capital mobility, that the variations of domestic saving  will not have effects on domestic investment, is the most demanding of the definitions6. taking  account of the existence of exchange rate risk and his cost (the cost of this risk) and also of real  losses anticipations of the currency value, there will be certainly considerable differences, between  countries, in the real interest rate. and consequently, one must expect that the coefficient of reten‐ tion of f‐h ( β ) can have values far away from the unit7.    from a more formal point of view lemmen and eijffinger (1998) showed that the condi‐ tions required by f‐h to evaluate a perfect integration are really leonine. it is consequently natural  that one can arrive at different ideas on actual integration when other methods are used8. method‐ ologically this thesis is extremely powerful, because it is exposed to its refutation. the problem,  moreover frequent in economy, it is that it’s possible refutation has resulted in the creation of aux‐ iliary conditions to protect it, to immunize it9.  the adaptation of f‐h thesis to the results  we can summarize in two tendencies the models which worked on the assumption of f‐h:  the conciliation of their results with the accepted fact of the mobility of capital and the proposal of  the new methods more appropriate to the problem in question10. in the first case the authors are  3 kimball (1990) and parker, jonathan and preston (2002).  4 see agenor (2003). for another point of view, edison, ricci and slok (2002).  5 they have studied the ocde countries for the period of 1960 to 1976, with cross‐section data, to eliminate cyclical and  endogenous problems. see also bayoumi (1990).  6 see frankel (1992).  7 for small economies the coefficient β must be zero. for big economies it must be equal to the contribution of the coun‐ try to the world stock of capital. a big economy will have a higher retention coefficient, cf. ho (2003). for murphy (1986),  a scale effect doesn’t allow the f‐h aproach to measure the capital mobility.  8 see bayoumi (1990), sachs (1981), obstfeld (1986), frankel (1991), levy (1995), frankel and macarthur (1988), popper  (1990), baxter and crucini (1993), bayoumi and macdonald (1995) and goldberg, james and okunev (2003).   9 in the sense of popper. popper (2002).  10 coakley, kulasi and smith (1998).  2007 ‐ 10  •  economic analysis®  led to confirm two ideas: the international mobility of the capital was very high for the period of  the  traditional gold standard;  it was considerable  less  for  the period of bretton‐woods agree‐ ments, with an increasing tendency after the abandonment of this regime11; at the same time, the  mobility of the capital for the less developed countries is always higher than that obtained for de‐ veloped countries12. obviously that there are results which contradict those13 and coakley, hasan  and r.smith (1999) support the assumption that a low value for the coefficient of retention can be,  simply, the result of not strong economic policies measures  in response to external  imbalances.  other authors as pomfret (1998) defend the idea according to which the test of f‐h is a reasonable  measurement of the immobility of capital, but not of the mobility of capital. the zero value of β, (β  = 0), is a sufficient condition but not a necessary one for perfect mobility of capital. and the value  of β equal  to 1, does not  imply necessarily  the  immobility of capital14. with regard  to  the new  econometric methods we must take  into account the difficulty  in comparing the former results,  because a good share of them were obtained with stationary methods15 applied to non‐stationary  data16. we must apply non‐stationary approaches, either with time series data, or panel data, for  the study of the «puzzle» of f‐h17. even if with these techniques of co‐integration (ci) the contents  of information of the thesis can almost be destroyed18.  mobility, external soutenabilité and co‐integration  coakley, kulasi and smith (1996), applying non‐stationary methods, support the thesis ac‐ cording to which f‐h does not measure capital mobility, but external sustainability. a coefficient  close to the unit is nothing more but the result of the intertemporal19 budgetary constraint. a very  simple development, starting from the accounting identity of the macro equality between global  supply and demand, makes  it possible  to expose  this argument. from  the macro definition of  product:  ( )y c i g x m= + + + − 20, we deduce:  ( ) x ms i y y −− = . the stationnarity of  ( )x m y − 21  is sufficient to prove external solvency22. this stationnarity means that the series  i y  and  s y  are  integrated of order 1 and co‐integrated with the vector of co‐integration (1, ‐1). in this case, we  cannot deduce anything with regard to the international capital mobility from the value of the long  term coefficient.  the econometrics of the non‐stationary variables involves with it new questions. how “to  deduce”  the  f‐h  thesis  from  the  obtained  coefficients?  corbin  (2004)  proposes  that  if  co‐ integration  is not rejected,  the adjustment coefficients  to correct de disequilibrium  in  the ecm  model represent the intensity of the capital mobility. but in this case we can also put the question  11 hogendorn (1998). aussi bayoumi (1990) and blanchard and giavazzi (2002).  12 coakley, hasan and r.smith (1999). see also mamingi (1997), chakrabarti (2006), payne and kumazawa (2006) and  payne and mohammadi (2006).  13 see lemmen and eijffinger (1998) and  rocha and zerbini (2000).  14 see also jansen and schulze (1996).  15 see ho (2002).  16 first difference estimates are not efficient  if  the variables are c‐i. as certain authors have done, feldstein  (1983),  feldstein and bacchetta (1991) and bayoumi (1990).  17 coakley, kulasi and smith (1998). coakley, fuertes and spagnolo (2004) and kim, oh and jeong (2005).  18 totally in the case of jansen (1997).  19 tesar (1991), husted (1992), jansen (1996), jansen and schulze (1996), moreno (1997) and corbin (2004).  20 where c, g, x and m represents private consumption, public consumption, exports and imports.    21 if wee want to me more precise we must add other variables to obtain de current account from the commercial ac‐ count.   22 obstfeld (1991), alyousha and tsoukis (2003) and coakley, kulasi and smith (1996).  volume 40 • autumn 2007 • 11  of the policy interventions, in short period, to push the economy towards its balance of long pe‐ riod. and so will the analysis be done compared to the capital mobility or to the effectiveness of  the interventions? one will be able to never answer this question in a simple way23. moreover, let  us not forget that, with the increase in the number of observations, the probability of the station‐ narity of the external balance increases24 25.    taylor  (1996)  and  banerjee  and  zanghieri  (2003)  propose  the  equation  ( )t t t ti s s iα β γδ = + ⋅δ + ⋅ − 26  to test the presence of co‐integration27. for these authors, γ  repre‐ sents the degree of capital mobility. jansen (2000) proposes  β  to measure short period mobility  and γ  the long period mobility. beyond of an abusive simplification, the interpretation of the coef‐ ficients is obviously not clear.  applied analysis to the portuguese economy (1910‐2004)  we will apply the above ideas to the portuguese economy for the period 1910 to 2004. after  presenting the sources of data (a), we look for this economy in the international context (b). the  evolution of investment and saving (c), as well as of the current account (d), will be analysed in  order to identify periods of rupture. after this previous analysis we will be in conditions to verify  the f‐h thesis with respect to capital mobility and external sustainability. we will study the tradi‐ tional model of a single equation (e), usually authors stop at the interpretation of regression coeffi‐ cients and the quality of fitting, we will go beyond this and we will insist on the stability of the  model. in order to apply non‐stationary methods we must be sure about the presence of unit roots  in the series (f). we will use traditional adf method, but also the kpss, the perron method for  structural rupture, the value of persistence in accordance with cochrane and a more recent version  of the  variance ratio of wright (2000). after this study we will be in conditions for the study of a  var model (g) and for the analysis of co‐integration between investment and saving (h). we think  that at the end of our analysis we are in conditions to have a supported opinion on the interna‐ tional mobility of capital and on the external sustainability of portugal.  a. statistical sources. from 1910 to 1953 we used indices of investment, saving and gross  domestic product published by batista, et al. (1997); with these indices we have calculated the val‐ ues of our variables taking in account the information about 1953 from banco~de~portugal (1998);  with this last source we construct our base from 1953 to 1959; and with commission (2005) we  widened the information from 1960 to 2004. for the international comparisons we used the values  of taylor (1996) updated with those from  commission (2005) and for the cases of greece and ire‐ land we used the data of heston, summers and aten (october 2002) for the initial period of 1910‐ 14.  b. international comparison. at the beginning of the 50ʹs and 60ʹs portugal invests a pro‐ portion of its product greater than that of greece and ireland, but lower, in general, to that of de‐ veloped economies (table 1). after the 70ʹs portugal invests more than the developed economies,  greece and ireland. at the beginning of the new millennium, the portuguese economy continues  to invest more than those economies.  the saving at the beginning of the century and at the beginning of the decades of 50 and 60  23 see also fattouh (2005).  24 taylor (2002) confirms the sustainability for 15 countries since 1870 to 1990.  25 the ruptures in the series raise also particular problems. see husted (1992), ozmen and parmaksiz (2003a), ozmen  and parmaksiz (2003b) and westerlund (2006).  26 that we adapted here to the time series data.  27 what poses interrogations concerning the remainder of the c-i model and constraints of nullity of the coefficients. 2007 ‐ 12  •  economic analysis®  was less than that of developed countries (table 2). the portuguese economic growth has contrib‐ uted to high levels of saving during the 70ʹs, 80ʹs and 90ʹs. but at the beginning of the millennium it  presents lower values than those of the other selected economies. in a process of sustainable eco‐ nomic growth we have an  increase  in savings to support  investment. its relative reduction can  mean the end, or an impediment, of this growth process, unless other sources of investments can  be obtained.    table 1 – i/y (%) in portugal and other countries    prt  grc  irl  dnk  fra  ita  swe  gbr  usa  1910‐14  3      21  14  14  13  10  22  1950‐54  17  16  11  26  25  20  21  14  16  1960‐64  24  22  18  25  24  29  25  18  19  1970‐74  32  28  24  25  27  27  23  20  20  1980‐84  34  25  25  17  21  24  18  16  20  1990‐94  27  21  17  17  20  19  17  16  16  2000‐04  25  24  24  20  20  20  17  17  19    table 2 – s/y (%) in portugal and other countries    prt  grc  irl  dnk  fra  ita  swe  gbr  usa  1910‐14  15      18  16  17  9  12  23  1950‐54  16  16  2  25  25  20  21  14  16  1960‐64  22  19  16  24  25  28  25  18  19  1970‐74  32  33  19  24  27  26  24  19  20  1980‐84  27  25  15  18  21  23  19  18  19  1990‐94  24  21  17  21  21  20  18  15  16  2000‐04  17  17  23  23  21  20  23  15  14      c. the evolution of investment and saving. in the analysis of investment and saving se‐ ries, i/y and s/y, we have applied the methodology of bai and perron (1998) and bai and perron  (2003)28 for the identification of points of rupture.  let us start with the analysis of investment. on table 3 we have the average and also the co‐ efficient of variation29. the values on this table illustrate a change of behaviour in 1983.  we can  identify a previous 1983 behaviour and another one that starts in 1984. the year of 1983 was a year  of strong instability that closed the political cycle after the democratic revolution of 1974. in 1983  the president of the republic decides to dismiss the government at the beginning of the year, in  23rd january, against the opinion of the state council. the legislative elections in 25th april will  lead to the formation of ixth constitutional government of the central block, with mário soares as  first‐minister and mota pinto as vice‐first‐minister. the portuguese currency keeps the system of  crawling pegg, at the rhythm of 1% the year, being devaluated in 21st june in 12%. the social con‐ flicts were present throughout the year, over all in the naval transports, shipyards, social commu‐ nication and still with the glass workers of marinha grande. more than 100000 workers30 had not  received their wages in due time. in this year the terrorist acts of the fp25 are initiated. the infla‐ tion rate reached the highest value after the beginning of xx century, 26.5% in terms of implicit  prices of gdp. this value was more than 8,2 points above the value of the previous year. the situa‐ tion of external disequilibrium was also serious. as a result of an agreement with the fmi, portu‐ 28 we have used as deterministic variables a constant and a trend.  29 the average divided by the standard deviation.  30 of a total of 2 979 900 workers in portugal (including madeira and açores).  volume 40 • autumn 2007 • 13  gal receives the first advance of 350 million usd of the total of 750 million. in the second half of the  year the monetary and the budgetary policies become strong restrictive31.  the behaviour of investment proves the importance that the restrictive policies had on the  permanent behaviour of this series. in case of unit root the shocks tend to be permanent and so  those politics had very high costs for the economy.    table 3 – investment  i/y  average  cv  1910‐1982  0,165  0,658  1984‐2004  0,267  0,101    figure 1 – investment evolution  1910-2004, break: 1983 1910 1918 1926 1934 1942 1950 1958 1966 1974 1982 1990 1998 0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 i_y       the evolution of savings presents different phases as if it can see in figure 2. applying the  methodology of bai‐perron we arrive at the identification of three ruptures, 1925, 1946 and 1973,  whose sub‐periods are characterized in table 4. this ruptures correspond to years of important  political events. the year of 1925 corresponds to the final period of political instability associated  with the first republic; in 1946 the portuguese economy, after the wwii32, had important financial  problems including problems associated with international reserves; in 1973 we have the end of  the dictatorship, the crises of payments with the colonies and the first oil shock; and finally in 1983  we had liquidity problems in international payments that resulted on a new agreement for stabili‐ zation with the imf.    we think that the facts most relevant with savings are its instability of the beginning of xxʹs  century until the wwii, the very low values in the period that follows the war (from 1947 to 1950),  the growth of savings up to 1973 and its subsequently decrease on the 90ʹs. the instability of the  values of saving is relatively low from 1974 to now. the negative evolution of savings since the  90ʹs has been responsible for an increasing necessity of external financing of the portuguese econ‐ omy, as we can see in table 533.   31 see banco~de~portugal (1984) and moreira and pedrosa (2004).  32 second world war.  33 data from banco~de~portugal (1997), banco~de~portugal (2004) and i.n.e. (2005).  2007 ‐ 14  •  economic analysis®    table 4 – savinsg  s/y  average  cv  1910‐1924  0,176  0,221  1926‐1945  0,116  0,407  1947‐1972  0,209  0,395  1974‐2004  0,243  0,201    table 5 – net liquid necessity of external financing    1995  1996  1997  1998  1999  2000  2001  2002  2003  nlfe  0  1,3  3,0  4,5  6,1  8,8  7,9  4,9  3,1  tx_c_pib  2,3  3,5  4  4,6  3,8  3,4  1,7  0,4  ‐1,1    figure 2 – saving evolution  1910-2004, breaks: 1925, 1946 & 1973 1910 1918 1926 1934 1942 1950 1958 1966 1974 1982 1990 1998 0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 s_y       the reduction of the external financial dependence in recent years was caused by the slow‐ down of economic growth of the economy. two dates were important in the evolution of saving:  1974 and 1991. the first one corresponds to the revolution (1974) and its implications on agents  behaviour, where we must include a radical change of customs and the changes in terms of institu‐ tions. the state started to call itself responsibilities that until then were of individual or family na‐ ture. we must remember at the  level of social security, the principle of universal pensions, the  health national service and the unemployment benefit. the second date corresponds to the practice  of financial liberalization34. from 1977 to 1990 the monetary policy was based on the direct control  of bank credit volume on a context of an inexistent market for funds out of banks. the financial  liberalization followed by innovation and increasing competition was a key factor in the reduction,  if not elimination, of liquidity constraints of families.    summarizing,  in  the evolution of  investment and saving we must distinguish  long and  short term behaviour. in the long term both variables are characterised by values above those of  similar economies. in the short term the evolution of investment and saving is a really problem.  the first one after 198335 and the second since 198936, doesn’t stop to fall.  34 see bação (1997).  35 in 1982 its value was 0.38.  volume 40 • autumn 2007 • 15  d. evolution of the current account. we will define current account on a simplified form,  as  ca s i y y y = − . the years of rupture, in accordance with the methodology of bai‐perron, are 1940  and 1949. in figure 3 we have its representation.     figure 3 – current account evolution  1910-2004, breaks: 1940 & 1949 1910 1918 1926 1934 1942 1950 1958 1966 1974 1982 1990 1998 -0.15 -0.10 -0.05 0.00 0.05 0.10 0.15 0.20 0.25 ca       as a general impression the values of this variable has been decreasing, but not on a regu‐ lar way. the average value becomes negative in the last decades and the instability is considerably  in the first period (table 6). for the total period the average is practically null (0,0057).    table 6 ‐ current account  ca/y  average  cv  1910‐1939  0,075  13,460  1950‐2004  ‐0,029,  ‐1,337    we also verify that for this variable we must distinguish a long period where the value is  null from a short term where after 1986 its value does not stop to fall.   e. traditional results of f‐h equation. in order to take in account the periods of rupture of  investment and saving we created the following dummy variables, which take the value 1 for the  indicated periods:  mi (1910‐1981)  ms_0 (1910‐1925)  ms_1 (1926‐1946)  ms_2 (1947‐1973)    to estimate the model  t t t t i s d y y α β γ ε⎛ ⎞ ⎛ ⎞= + ⋅ + ⋅ +⎜ ⎟ ⎜ ⎟ ⎝ ⎠ ⎝ ⎠  we looked for the elimination of auto‐ correlation problems, arch process and non normality of the errors. the symbol d represents a  vector of deterministic variables beyond the constant. the three better estimations that we got  with the values of the information criteria are reproduced in table 7. in any one of them we have  included one lag of the dependent variable (i/y) to reject the null hypothesis of the �coefficient.  36 with the value of 0.30 this year.  2007 ‐ 16  •  economic analysis®    table 7. values of the information criteria of the simple model  d  �  aic  hq  sc  mi, ms_0, ms_1 and ms_2  0,018  ‐7,912  ‐7,830  ‐7,709  mi, ms_0, ms_1 and t  0,018  ‐7,958  ‐7,888  ‐7,785  mi and t  0,018  ‐8,025  ‐7,967  ‐7,881  aic represents the criterion of akaike, hq of hannan‐quinn, sc of schwarz and � the stan‐ dard error of the estimate.    these criteria lead to the selection of the last model37. the null hypothesis of the coeffi‐ cient associated with saving, the retention coefficient, is rejected at the 10% level. its value is not  high, confirming the presence of capital mobility in the portuguese economy. the positive value  associated with the trend (t) translates the reduction of the retention phenomena of investment by  saving throughout time, what confirms the idea of mobility.    we think, however, that more than the rejection of the null hypothesis of the retention coef‐ ficient, the thesis of mobility must be confirmed by the stability of the model. in figure 4 we pre‐ sent three tests of chow38, standardized by the critical values, which clearly exclude the hy‐ pothesis of stability of our best model.    figure 4. chow tests to the model of one equation  1930 1940 1950 1960 1970 1980 1990 1 2 1up chows 1% 1930 1940 1950 1960 1970 1980 1990 1 2 3 ndn chows 1% 1930 1940 1950 1960 1970 1980 1990 1 2 nup chows 1%       in face of this result we can admit the inexistence of retention of investment by saving in  the portuguese economy, that is, we admit the perfect mobility of capitals in the sense of feldstein‐ horioka.  f. unit root analysis. as a result of the presence of ruptures in the series we applied the test  of perron (1997), beyond the dickey‐fuller39 and kpss40 tests. in the application of the perron test  we considered the cases of rupture with change of intercept (a), with change of intercept and incli‐ nation (b) and change in inclination without discontinuity in the evolution. in the case of invest‐ ment we only have a rupture and therefore we can apply the test of perron to the totality of the  available data. in the case of saving we have three ruptures and so we have divided the total sam‐ ple  in sub‐samples where the rupture points are  inside each sub‐sample. we have retained the  37 to see the coefficients and other data of the estimation see the annexe.  38 that is, “1‐step chow tests”, “break‐point chow tests” and “forecast chow tests”. see p. 254 of hendry (1996).  39 dickey and fuller (1979), phillips (1987) and phillips and perron (1988).  40 kwiatkowski, et al. (1992).  volume 40 • autumn 2007 • 17  estimations of models (a), (b) and (c) that reject the null hypothesis of relevant coefficients41. in ta‐ bles 8, 9 and 10 we present the results obtained for investment.    table 8 – perron test of structural rupture (i/y)42  model  lags  t�=1  (a)  1  ‐3,991  (c)  0  ‐4,579*    table 9 – adf test  (i/y)  var.  periods  lags  t  z  det.43  i/y  1910‐2004  0  ‐1,541  ‐2,727  c  i/y  1910‐1982  0  ‐3,788**  ‐24,168**  c, t  i/y  1984‐2004  0  ‐2,086  ‐6,878  c  �(i/y)  1910‐2004  0  ‐9,041***  ‐87,505***  ‐  �(i/y)  1911‐1982  0  ‐9,713***  ‐82,010***  c  �(i/y)  1984‐2004  0  ‐3,799***  ‐14,731***  ‐    table 10 – kpss44 test  (i/y)   var.  periods  lags  μη   τη   i/y  1910‐2004  0  8,325  1,347  i/y  1911‐1982  0  7,078  0,799  i/y  1984‐2004  0  0,782  0,123  �(i/y)  1910‐2004  0  0,218***  0,077***  �(i/y)  1911‐1982  0  0,088***  0,013***  �(i/y)  1984‐2004  0  0,078***  0,075***      let us analyse the results for (i/y) starting with the totality of the period. by the adf and  kpss tests this variable has a unit root. this variable is integrated of order 1, i (1). although the  perron test, for model (c), allows the rejection of a unit root along the trend, at the level of 10%. for  the period until 1983 we verify that the adf test reject the presence of a unit root at the 5% level  and the kpss test reject stationnarity at 1%. for the subsequent period, after 1983, all the tests al‐ low us to consider (i/y) as i(1). these confirm, however with some contradiction, the investment to  be (i/y), integrated of order 1, i (1).    the results obtained for saving are in tables 11, 12 and 13.     table 11 – perron test of structural rupture (s/y)  periods45  model  lags  t�=1  1910‐1945  (c)  0       ‐3,853  1926‐1972  (a)  0       ‐4,502  1947‐2004  (b)  2       ‐5,399**  1947‐2004  (c)  1       ‐4,609*  41 with the exception of the constant where sometimes the null hypothesis can’t be rejected.  42 “lags” means lags to correct for the auto‐correlation. use use 3 stars to represent rejection at least at the level of 1%, 2  for 5% and 1 for 10%.  43 c means constant and t trend.  44 the stars, 3, 2 and 1, mean no rejection at the 10%, 5% and 1% level, respectively.  45 these intervals allow us to retain maximum periods with an internal rupture.  2007 ‐ 18  •  economic analysis®    table 12 – adf test  (s/y)  var.  periods  lags  t  z  det  s/y  1910‐2004  0    ‐2,286  ‐10,236  c  � (s/y)  1910‐1982  0  ‐10,001***  ‐97,064***  ‐    table 13 – kpss test  (s/y)  var.  periods  lags  μη   τη   s/y  1910‐2004  0  4,091  0,756  �(s/y)  1910‐2004  0  0,0612***  0,054***      for this variable (s/y) we can reject the presence of a unit root along a trend for the period  from 1947 to 2004, at the 5% level, in the case of the model (b). for the remaining sub‐periods, as  well as for the totality of the data, we cannot reject the hypothesis of the presence of a unit root.    concluding, we will take the investment and saving as integrated of order 1, i (1). we will  now study the behaviour of the current account.    the perron test applied to the subdivisions suggested by the bai and perron results doesn’t  lead to any interesting result. so we have applied the test to the totality of the period. we arrive at  the result of table 14.    table 14 – perron test of structural rupture (ca/y)  period  model  lags  t�=1  1910‐2004  (c)  0       ‐4,503*    table 15 – adf test  (ca/y)  var.  periods  lags  t  z  det  ca/y  1910‐1939  0  ‐3,279*  ‐17,428*  c,t  ca/y  1950‐2004  0  ‐4,672***  ‐24.968**  c,t  ca/y  1910‐2004  0  ‐3,685**  ‐23,853**  c,t  � (ca/y)  1911‐1939  0  ‐6,926***  ‐36,198***  ‐  � (ca/y)  1951‐2004  0  ‐7,289***  ‐49,170***  ‐  � (ca/y)  1911‐2004  0  ‐9,836***  ‐95,432***  ‐    table 16 – kpss test  (ca/y)  var.  periods  lags  μη   τη   ca/y  1910‐1939  0  2,301  0,183*  ca/y  1950‐2004  0  1,130  0,154*  ca/y  1910‐2004  0  4,505  0,643  � (ca/y)  1911‐1939  0  0,039***  0,038***  � (ca/y)  1951‐2004  0  0,040***  0,025***  � (ca/y)  1910‐2004  0  0,031***  0,019***      we cannot reject the stationnarity along a trend, with a temporal rupture (table 14), at the  level of 10%. the adf test reject, in general at the level of 5%, the presence of a unit root for the  totality of the period and for its last part, 1950‐2004. for the period 1910‐1939, the presence of a  unit root is rejected at the level of 10%. the kpss test denies these results. this test only supports  volume 40 • autumn 2007 • 19  stationnarity of the sub‐periods along a trend, at a very weak level of not rejection. in what con‐ cerns the first difference of this variable all the results are conclusive about the stationnarity. con‐ cluding, we will take this variable as probably stationary along a trend since 1950.    in face of all these results for the three variables we have opted for studying two more  characteristics of the series: the persistence, measured by the a (1) factor of cochrane (1988)46, and  the ratio of variance in accordance with campbell, lo and mackinlay (1997)47 and wright (2000).    in table 17 we have the values of the first indicator, for different values of the lags.     table 17 – cochrane a(1) factor  k  s/y  i/y  ca/y  �(s/y)  �(i/y)  �(ca/y)  5  0,776  0,872  0,785  0,435  0,507  0,450  10  0,749  0,845  0,661  0,387  0,353  0,387  20  0,709  1,019  0,489  0,241  0,294  0,254      the persistence is clear in the case of saving and investment and less clear in the case of the  current account. in this case, 50% (0,489) of a shock will be present 20 years later. as is expected  the differentiation leads to a substantial reduction of the persistence.    in table 18 we have the values for different forms of the variance ratio for the study of iid  and mds48 processes. m1 and m2 correspond to the usual tests of the variance ratio; r1 and r2  correspond to those ranking the values of the variables; and s1 from the signal of the values of the  series. the second test (m2 and r2) corrects the presence of conditional heterocedasticity.    table 18 ‐ values of m, r and s  var  k  m1  m2  r1  r2  s1  i/y  20  22,88  20,02  22,79  20,35  29,18  s/y  20  21,82  19,47  22,48  21,16  29,18  ca/y  20  5,87  4,71  5,73  5,51  4,40  �(i/y)  20  ‐0,72  ‐0,64  ‐0,97  ‐0,90  ‐0,90  �(s/y)  20  ‐1,34  ‐1,23  ‐0,90  ‐1,11  ‐1,10  �(ca/y)  20  ‐1,63  ‐1,53  ‐1,43  ‐1,51  ‐1,40      all the variables in levels reject those processes. after differentiation they do not reject the  hypothesis of iid or mds processes, at least at the level of 5%49.   as  a  consequence  of  these  re‐ sults, we will take investment and saving as integrated variables of order 1, i (1). we think this  hypothesis is the most reasonable. the possible stationnarity of ca along a trend reduces the value  of information of tests in table 18 for this variable.  g. a var model. respecting the f‐h hypothesis we propose a var model between exclu‐ sively investment and saving, to evaluate the importance that assumes the saving for the invest‐ ment. in the case of a macro model a weak constraint of saving on investment can be the result of  important capital mobility or  the keynesian confirmation of  investment exogeneity and saving  endogeneity. in this case the investment will cause the saving. if the influence of investment on  saving is weak we can conclude for a neo‐classical regime.    to obtain the order of our model we start from a maximum of 4 lags. the only dummy  46 see also campbell and mankiw (1987).  47 see point 2.4.3, pp. 48‐56.  48 iid, identically independent distributed values and mds, martingale difference sequence.  49 see table 1 of wright (2000).  2007 ‐ 20  •  economic analysis®  variable that we can’t reject is ms_0. in tables 19 and 20 we present the values of different informa‐ tion indicators and the tests of restriction on the coefficients.    table 19 – information indicators  var(k)  sc  hq  aic  var(4)  ‐8,157  ‐8,486  ‐8,709  var(3)  ‐8,334  ‐8,597  ‐8,775  var(2)  ‐8,520  ‐8,718  ‐8,851  var(1)  ‐8,690  ‐8,821  ‐8,910    table 20 – restriction tests on coefficients  var(k+1) ‐> var(k)  df of f  f  sl  var(4) ‐> var(3)  4, 160  0,429  0,788  var(3) ‐> var(2)  4, 164  0,247  0,911  var(2) ‐> var(1)  4, 168  0,613  0,654      as we can verify by the information criteria and also by the restriction tests on the coeffi‐ cients, we must retain a model of order 1. this model rejects the nullity of endogenous variables as  well as the dummy variable (ms_0). in table 21 we summarize these results.    table 21 – restriction tests on var(1)  variables  f(2,89)  sl50    variables  f(2,89)  sl  (i/y)‐1  228,1  (0,0)    (s/y)‐1  40,0  (0,0)  constant  1,654  (0,197)    ms_0  4,959  (0,009)      only for the constant we can’t reject the null hypothesis. the eigen values of the accompa‐ nying matrix of the var have as modules 0,9589 and 0,6356. in table 22 we have the usual tests to  the errors of the model. either for first order auto‐correlation (ar (1)), or for the normality by the  jarque‐bera test (j‐b), or for the presence of first order arch process (arch (1)), the model pre‐ sents the desirable characteristics at the desirable level of 5%.    table 22 – analysis of the errors of the var (1)  equation  test  statistics and sl  i/y  ar(1)  f(1,89)  =  0.173    (0.68)  s/y  ar(1)  f(1,89)  =  1.034    (0.31)  i/y  j‐b  chi^2(2) = 3.569    (0.17)   s/y  j‐b  chi^2(2) = 4.837    (0.09)  i/y  arch(1)  f(1,88)  =  0.026    (0.87)  s/y  arch(1)  f(1,88)  =  0.261    (0.61)      the decomposition of the variance (table 23) confirms the importance of each variable in  the explanation of the other51. the contribution of investment in the explanation of the saving is  greater than the inverse (30.49>21.65) what is a suggestion of a keynesian behaviour.     50 sl: significance level.  51 we have tried to obtain a structural representation of this model but the overidentification l‐r test rejected this possi‐ bility at the 5% level.  volume 40 • autumn 2007 • 21  table 23 ‐ decomposition of the variance of i/y and s/y  t  i/y  s/y    t  i/y  s/y  1  100,0  0    1  3,06  96,94  2  98,15  1,85    2  5,42  94,58  ...  ...  ...    ...  ....  ...  20  78,35  21,65    20  30,49  69,51      figure 5 presents the evolution of the two variables and the 95% intervals, during 20 years,  after shocks of the magnitude of the standard error of each equation.     figure 5 ‐ effect of shocks  impulse responses r e s p o n s e s o f i_y s_y i_y i_y s_y s_y 0 5 10 15 0.0000 0.0025 0.0050 0.0075 0.0100 0.0125 0.0150 0.0175 0.0200 0.0225 0 5 10 15 0.0000 0.0025 0.0050 0.0075 0.0100 0.0125 0.0150 0.0175 0.0200 0.0225 0 5 10 15 0.000 0.005 0.010 0.015 0.020 0.025 0.030 0.035 0.040 0 5 10 15 0.000 0.005 0.010 0.015 0.020 0.025 0.030 0.035 0.040   the investment is the variable with the higher degree of inertia to its own shock. ten years  after a shock on this variable 58.13% of it will still be retained. the effects of this shock over the  saving are much more reduced but more persistent. in the 5th year the effect is 62% higher, and in  the 20th year is of equal value, than in the period of the shock in the investment.     the shocks on the saving have an impact on it that disappear quickly, in the 10th period  they are 18% of the initial shock. the effects over the investment are slightly more important, but  less than of the investment on the saving, and are relatively persistent, the value of the 10th period  being the same of that of the 7th period. a shock of 10% on savings produces an increase in the 7th  period of 2.3% on the investment and 1.9% on the saving. this difference of results will last for  long time.    we conclude therefore that the shocks on the saving are not important for the investment,  what confirms the international financial integration of the portuguese economy. this conclusion  2007 ‐ 22  •  economic analysis®  confirms thus the result obtained with the traditional model, to an equation, of the f‐h hypothesis.  h. co‐integration between the investment and the saving: the problem of external sus‐ tainability. as the var model was of order 1 we concentrate our attention in co‐integration rela‐ tions, between investment and saving, with 1 lag52. we have two possibilities for our dummy vari‐ ables: its inclusion in the vector of co‐integration or its exclusion of this vector, but being part of  the vecm53 model. in the first option we have considered the presence of ms_0. its exclusion of the  co‐integration space is rejected by a lr test,  21 9, 06 (0, 00)χ = 54. we identify this model as c‐i (a).  we arrive also to the conclusion that we can reject the nullity of the presence in the co‐integration  space for all the dummy variables. we have the following results for the lr tests when we include  all de dummies:   2 1 2 1 2 1 2 1 0 4, 690 (0, 03) _ 0 16, 287 (0, 00) _1 9, 660 (0, 00) _ 2 7,161 (0, 01) mi ms ms ms χ χ χ χ = = = = =   and for all the variables  24 18,80 (0, 00)χ = . this means that we must consider a model (c‐i  (b)) with the inclusion of all these variable. in the second possibility we have put all the dummies  out of the vector of c‐i, but they belong to the vecm (c‐i(c)). the tests for the rejection are the  following:   2,84 2,84 2,84 2,84 0 2, 699 (0, 07) _ 0 16, 291 (0, 00) _1 12,178 (0, 00) _ 2 6,139 (0, 00) mi f ms f ms f ms f = = = = =   all  these  results  reject  the  null  hypothesis  of  the  dummy  variables.  the  values  of  the  johansen test for each one of these models are on table 24.    table 24 ‐ johansen tests of co‐integration    lambda  h0: r<=  trace  sl  c‐i(a)            0,199  0  23,802  0,002    0,031  1  2,847  0,086  c‐i(b)            0,278  0  39,054  0,000    0,086  1  8,460  0,004  c‐i(c)            0,257  0  30,030  0,000    0,022  1  2,137  0,140      the joint hypothesis of stationnarity for investment and saving in the case of the first two  models is not rejected. this means that the correct representation will be by a var, like we have  done below. as for the last model we couldn’t reject the existence of a relation of co‐integration  between investment and saving. we have tried the hypothesis of a vector (1,‐1). the lr test give  52 the rule of k‐1 could not be applied because k=1. see lütkepohl (2004).  53 also known as var model accompanying the c‐i. vecm: vector error correction mechanism.  54 the sl (significance level) is on parenthesis.  volume 40 • autumn 2007 • 23  the result �21=4,167 (0,041), and so we must reject such restriction. the values of the equilibrium  relation are in table 25.    table 25 ‐ coefficients of the space of co‐integration  var.  �  �  ��  ��  i/y  1  ‐0,209  ‐‐‐  0,064  s/y  ‐0,677  0,434  0,094  0,119      the study of co‐integration between investment and saving leads to two alternative  ways: the analysis in terms of var or the acceptance of a co‐integration model, c‐i (c). we have  already considered the first way. the second produces a long run retention coefficient equal to 0.68  and the rejection of a unitary value for this coefficient. from this relation of long term we obtain  the value of ca/y as  0, 32t t tt t t t s i s ca y y ε − = = + ⋅ , where �t represents a stationary variable and,  remember, s/y is a variable with a unit root, i(1). the current balance presents a situation  of not sustainability in the portuguese economy.  conclusion  the original ideas in the paper are our interpretation of the theoretical evolution of the f‐h  thesis, the importance of analysing the random nature of the model of one equation and not only  the retention coefficient and the macro view given by an appropriate var model with investment  and saving. the f‐h thesis is presented as a simple measure of the international capital mobility.  we have presented its importance and the problems that were raised. the application of the thesis  was immunized to economists’ beliefs and its evolution reflects also the advances in econometric  practice. nowadays the thesis allows not only measuring the level of financial integration of the  economies but also to test its external sustainability. after a short theoretical presentation of the  thesis we applied it to the portuguese economy.  we begin the empirical part of this paper by the analysis of the evolution of investment and  saving in portugal. those values must be considered favourable to growth and give a better pic‐ ture than other developed economies. a deep regarding gives us a different picture for the short  term. since 1983 and 1989, investment and saving, respectively, have a decreasing behaviour and  since 1986 the disequilibrium between the two is worsening every year. the rupture years given  by bai and perron method coincide with abnormal years from the point of view of the economic  environment and political events for those variables in the portuguese economy.    with the study of the f‐h relation in its traditional form, of one equation, we have esti‐ mated a retention coefficient for the long term equal to 0.212. a value of this magnitude confirms a  situation of great capital mobility. we think, however, that more than analysing the average value  of a coefficient, it will be more interesting to study the random nature of the model if we want to  know the level of restriction on investment from saving. when following this strategy we discover  that the chosen model is not stable. and so we can conclude for the presence of international capi‐ tal mobility in the case of the portuguese economy.   in the study of the stationnarity characteristics we had in account the rupture periods previ‐ ously identified. the ordinary used tests don’t give a unanimous and clear answer. we have used  other tests and we think that we can conclude that investment and saving could be taken as inte‐ grated of order 1, i(1).  2007 ‐ 24  •  economic analysis®  we think that the level of integration of these variables is very interesting from the macro  point of view. a shock on investment or saving will produce very long term consequences. we  begin our macro interdependence research by the study of a var model of order 1 and we have  verified that the importance of the saving in the explanation of investment was inferior to the in‐ verse one. in terms of analyses of the shocks we conclude that the effect of a shock on saving were  not important on investment. we have obtained with the var information that confirms the idea  of the international capital mobility in the portuguese economy.  the  analysis  of  co‐integration  between  investment  and  saving  was  conducted  with  three  possible vecm models. by the multivariate test of johansen we can’t reject the joint stationnarity  of investment and saving in the case of the first two models. the johansen test confirms the pres‐ ence of 1 vector of co‐integration in the last model. the study of this model rejects the hypothesis  of a vector (1, ‐ 1), what means that the bc is not sustainable. in terms of short period we can con‐ firm the idea of capital mobility, the � is 0.21, and in terms of long period the retention coefficient  of 0.68 puts some doubts on the level of integration.   we can conclude by the idea of a high level of capital mobility and a strong propensity to ex‐ ternal unsustainability of the portuguese economy.      annexe: linear equation model, ols  eq(13) modelling i_y by ols, the estimation sample is: 1911 to 1994                       coefficient  std.error    t‐prob  i_y_1  0.701435  0.06922  0.000   s_y  0.0634468  0.03421  0.067   mi  0.0361159  0.007945  0.000   trend  0.00139731  0.0003385  0.000   constant  ‐0.0469948  0.01156  0.000   sigma  0.0175698   r^2  0.975116   arch 1‐1 test:  f(1,77)  = 0.086785 [0.7691]    normality test:  chi^2(2) =   3.3048 [0.1916]    reset test:  f(1,78)  =  0.58714 [0.4458]      solved static long‐run equation for i_y     coefficient  std.error    t‐prob  s_y            0.212506    0.1114     0.060  mi  0.120965      0.02712     0.000  trend  0.00468008    0.0004356     0.000  constant  ‐0.157402      0.03576     0.000  long‐run sigma = 0.0588473  wald test: chi^2(3) = 265.211 [0.0000] **    testing for error autocorrelation from lags 1 to 1   chi^2(1) =0.0087593 [0.9254]   and f‐form f(1,78)  =0.0081344 [0.9284]      testing for error arch from lags 1 to 1  arch 1‐1 test:    f(1,77)  = 0.086785 [0.7691]      normality test for residuals  normality test:   chi^2(2) =   3.3048 [0.1916] volume 40 • autumn 2007 • 25  literature  1. 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knowledge proved to be devastating in the number of economic episodes. key words: financial crisis, globalization, washington consensus, beijing consensus, brics, cis jel classification: g01, n71, o4 introduction the focus of this paper is on a few key developments that shaped the global economy in the 1987-2017 period. the reason for this 30-year timeframe lies in the significance of the journey started with the first profound market crash after the world war ii. several historical “first” has happened from 1987 till today. these developments are presented chronologically. this paper seeks to answer two research questions. the first research question is: what are the defining events of the world economy from 1987 until 2017? the second research question is: what are the lessons learned? therefore, the events that defined the last 30 years are critically identified: from stock market crash in 1987, thru the collapse of the soviet union and easter block, creation of euro, rise of washington consensus, emergence of beijing consensus, via the great recession and creation of cryptocurrency (bitcoin). globalization was viewed from the convergence and divergence perspectives. analysis of the key economic events leads to few lessons worth a critical and constructive debate. the end of history or the new beginning: 1987-1991 the stock market crash known as “black monday” happened in october of 1987. it is worth noticing that very few experts predicted it. fox (2013) pointed out that the term word “bubble” appeared in only 33 articles in the leading journal of finance (1946-1987). yet from november 2012 till november 2013 there were 36 articles addressing this topic. the market crash of 1987 emphasized “the unprecedented extent to which financial markets worldwide had become intertwined and technologically interconnected.” (federal reserve, 2013).the u.s. stock market * e-mail: pesakovic@msn.com 2 economic analysis (2017, vol. 50, no. 3-4, 1-8) lost 22.6 % in a day, while the market in new zealand collapsed by 60%. some of the reasons for a market crash were rise in foreign investment in the usa; trade in “portfolio insurance and involvement in extensive use of options and derivatives. this crises raised serious questions “about both the information content of prices and the stability of the risk measures used in finance” (fox, 2013) . federal reserves reacted immediately by actively stimulating banks to continue lending. the crisis was successfully and swiftly contained. though, this increased the probability for moral hazard behavior in the future that reoccurred time and again since 1987. the fall of berlin wall in 1989 and subsequent reunification of east and west germany in 1990, historically symbolize the end of one era and the beginning of another. looking back, two other defining moments for world history were also shaped by germany, the end of world war i and ii. the treaty of versailles (1919) defined the borders for a number of countries. this had implicitly influenced their destinies in years to come. in 1945, the yalta conference marked the new borders and spheres of influences for the usa, uk and france at the one side, and the soviet union on the other side. all three historical turning points called for new quest for identity for the major players as well as for other countries in the world. therefore, the last decade of the 20th century and the first decade of the 21st century were characterized by the new quests for identity: from united germany, to new russia, from the single superpower, usa, to the emerging superpower china, from the nelson mandela’s south africa to nuclear north korea. the disintegration of soviet union and demise of its economic, military and ideological structure (cmea and warsaw pact) triggered the conviction of “the end of history”. the last decade of the 20th century became a testament of the market power, benefits of integration processes and globalization. however, the serious challenges were present as well. the washington consensus became the economic and political symbol of this new area. formulated by john williamson in 1989 (focused on economic development in latin america) and was later expended by international financial institutions and the us treasury. moises naim (2000) describes it as “an ideology for a world that was pinning for something to replace the god of socialism that had just failed” (in williamson 2004, p. 16). the initial “ten commandments” comprised of: fiscal discipline; reorientation of public expenditures; tax reforms; financial liberalization; unified and competitive exchange rates; trade liberalization; openness to fdi; privatization, deregulation and secure property rights. the expended washington consensus version in addition to the later included: legal and political reform, regulatory institutions, anti-corruption, labor market flexibility,; wto agreements, financial codes and standards, “prudent” capital account opening, non-intermediate exchange rate regimes, social safety nets and poverty reduction (rodrik 2002). converging or diverging world: 1992-2004 bonciu (2017) debates if the countries were converging, diverging or staying apart during the period since the collapsed of the soviet union. convergence evolves at three levels: “a. developing countries will convergence with the developed ones; b. central and east european countries will convergence with west europe: c. different social, cultural and political systems will converge with the western style democracy and liberal market economy” (p. 52) . the following developments in the last decade of the 20th century, partially support convergence trends, while unveiling benefits and challenges of the new era. the first, creation of one of the largest economic integration block in the world, nafta, was based on the premise of free trade benefits that will “lift all boats up”. it was expected that elimination of trade barrier brings improvement in living standards and protection of intellectual property rights, will benefit all participants. still, the 1992 presidential candidate, ross perot warned on the “giant sucking sound” that will eliminate manufacturing jobs in the usa. a premise that has regained supporters particularly since the great recession. gordana pešaković 3 the second event happened in 1996 when south korea, the first country that made impossible possible, making the grand leap forward from developing to developed economy, became a member of oecd. this has been later identified as one of the possible contributors to the country’s financial collapse in 1997. south korea’s membership to the exclusive club of the most developed countries enabled significant foreign investment into the country which facilitated economic development, while making country more receptive to the global financial market’s swings. unfortunately, the financial crisis in thailand (that followed development prescription by washington consensus), triggered the global investors ‘concerns that all countries in the region were prone to the same destiny. thus the capital inflow, not only to thailand but to other countries in the region as well, including south korea, started to dry out and the reverse process, capital outflow followed (balino & ubide, 1999). the south east asian crisis created deep mistrust in international monetary fund and washington consensus doctrine. the third episode, the collapse of long term capital management (ltcm) in 1998, almost, brought global financial system to the brink of abyss. this crisis unveiled all the challenges of the unregulated hedge funds market alongside with moral hazard behavior and the notion of “too big to fail”. edwards (1999) provides detailed analysis of the hedging markets as well as the reasons and consequences of the collapse of the ltcm unfortunately, lessons learned from this story were short lived, as the developments in the next century will demonstrate. the fourth development, the launching of the single currency, euro in 1999 symbolized the ultimate triumph of the european integration. the convergence criteria was developed by the maastricht treaty in 1991 and was influenced by german hard monetary and fiscal policy. the criteria were based on: price stability, sound and sustainable public finances, exchange rate stability and long-term interest rates limits (http://www.consilium.europa.eu/en/policies/joining-euro-area/convergence-criteria/). the road toward single currency was long and painful. however, most countries switched to euro without fulfilling the convergence criteria. ozturk & sozdemin (2015) suggested that greece should have been left out the single currency system. instead it was accepted in 2001. the subsequent financial crisis in the country, which seriously challenged the european monetary union could have possibly been avoided. almost simultaneously with the disintegration of the soviet union, the fifth development, creation of the commonwealth of independent states – cis (1991), and the subsequent multilateral economic agreements (economic union 1993, eurasian economic community 2000, common economic space 2003) happened. all previous states of the soviet union with exception of baltic states who joined the european union, became members of the cis and some of the above economic integration groupings. the significance of the mutual trade flows between the member states of cis was limited (2000-2016, cis export was between 16-19% of the total export of member states, while import at the same time, was between 46% in 2000 and dropped to 22% in 2016 (http://www.cisstat.com/eng/cis.htm). however, a number of cis member countries depend on the remittances from migrant workers working in russia (table 1). in the case of tajikistan 51% of gdp, and in the case of kyrgyzstan, 31% of gdp comes from remittances from russia (ryazantsev, 2016). the russian political and military influence was and is likewise noticeable. 4 economic analysis (2017, vol. 50, no. 3-4, 1-8) table 1. personal remittances (2013) from russia to cis countries in millions of us $ uzbekistan 6.689 tajikistan 4.173 ukraine 3.424 kyrgyzstan 2.106 armenia 1.715 azerbaijan 1.340 moldova 1.279 kazakhstan 561 belarus 399 turkmenistan 40 cis countries total : 21.726 source: central bank of russia http://www.cbr.ru/eng/statistics/?prtid=svs&ch=tgo_fiz_post#checkeditem the fall of twin towers in new york on september 11, 2001 was another defining event of the 21st century. it was on this date that the new grouping, for the purpose of creating a new investment fund, was created by goldman sachs’ chief economist. o’neill explained, “what 9/11 told me was that there was no way that globalization was going to be americanization in the future – nor should it be. in order for globalization to advance, it had to be accepted by more people … but not by imposing the dominant american social and philosophical beliefs and structures.” (tett, 2010) bric countries (brazil, russia, india and china) officially met for the first time in 2008. although brics countries’ (south africa joined in 2010) collaboration is not significant for the time being, the creation of the new development bank (2014) indicates a deeper commitment. the power that 42% of global population and 30% of global output combined with the growing middle class (that can surpass the g7 by 2020) should not be underestimated. theoretical views the optimistic view of globalization emphasizing benefits of the pluralistic culture has faded since 2001. “the generalized trust” started to crumble (chan 2007). chan use “generalized trust” as the measure for the total effect of globalization on national values. he suggests positive impact on generalized trust, however, if globalization generates economic inequalities, its impact on national values is negative. although the global gdp was mostly moving upward, the closer analysis by countries and inside countries, gave a mixed picture. the gap between rich and poor was widening. this trend has been deepening over time without serious consideration inside and between countries. bonciu (2017) referencing findings of oxfarm international report for 2017, states “that number of people that own wealth equal to 50% of the world population” declined from 388 people in 2010 to only eight people in 2016! when a robust analysis that focused on the economic, demographic, knowledge, financial and political dimensions and global convergence from 1960-2009 was conducted it revealed illuminating results. instead of convergence, anticipated to occur with globalization, the divergent forces were more powerful (berry et allies 2013). although the literature suggests convergence among countries (dobbin et allies, 2007; polillo & guillen, 2005; fourcadegourinchas & babb 2002) thru: competition, coercion, emulation, mimicry and normative pressures the opposite has been recorded. berry et allies (2013) tested convergence and divergence forces in the global system and within global subcomponents. their results indicated that “since the mid-20th century, globalizing forces have encourage divergence across countries due to diversification, differentiation and specialization dynamics”, since all five test gordana pešaković 5 components (economic, demographic, knowledge, financial and political) are positive and statistically significant. when testing development within each sub-component of the global system (core, semi-peripheral and peripheral countries; trade blocks and its member states and among different trade blocks), similar results occurred. the convergence was recorded only in: 1. demographic component in the core countries, 2. economic volumes for the original 11 member countries of the eurozone and 3. financial components in nafta. the overall finings of this study were that “divergence in the world as a whole is driven by divergence between clusters, with little convergence within clusters” (p. 401). new consensus and the great recession – 2004-2017 while the pillars of the washington consensus were being tested and challenged globally, the new consensus was emerging: the beijing consensus. since economic reforms introduced by deng xiaoping, china achieved (1978-2012) an impressive real gdp average growth rate of 9.4%. the chinese economic development path and its rising role in the global economy became noticeable. ramo (2004) suggested that the beijing consensus emerged as an alternative global development model. it included components like, quality of life, politics and global balance of main pillars are: institutional innovation; equitable and sustainable development and selfdetermination. although focused on chinese development, many developing countries viewed it as an alternative to the washington approach. chinese position as a new emerging super power became evident in 2010, when china took over japan as the second largest economy in the world. the departure from the previous deng xiaong ping’s maxim “hide our capabilities and bide our time; never try to take the lead”, became evident with the creation of “one belt, one road” (2013) and asian infrastructure investment bank (2016). chinese economic, ideological and military influence and control are noticeable and significant. the president of china, xi jinping emphasized this in his address at the 19th communist party’s congress (2017) “it is time for us to take the central stage in the world.” the great recession as beijing consensus was evolving, the new global storm was set in motion. this one brought the global economy to the deepest downfall since the great depression. only a few years prior (2003) to the great recession, a nobel prize laureate for economics, lucas, suggested that the “problem of depression-prevention had been solved.” fox (2013) summed up this new approach: “a combination of steady, rule-based monetary policy and a few automatic fiscal stabilizers—such as increased unemployment insurance payments as people lose their jobs and lower tax receipts as incomes fall—were all it took to tame the business cycle.” instead, like the previous financial crises demonstrated, unpredictability of the predictability outlined the nature of financial markets the best. the previous experiences suggested the need for the swift and significant intervention by central banks. the bailout that followed was generous. the usa alone committed initially thru tarp $ 700 billion, the amount was later reduced to $475 billion. (u.s. department of the treasury, https://www.treasury.gov/initiatives/financial-stability/tarpprograms/pages/default.aspx). this time, the system survived almost unchanged. though, one can look at this as mixed blessing, since a need for reforms has been postponed or eliminated. the great recession exposed the limitations of the market economy while at the same time demonstrated a power of government intervention. 6 economic analysis (2017, vol. 50, no. 3-4, 1-8) creation of cryptocurrency one can argue that the great recession made possible an unprecedented birth (2009) of the cryptocurrency, bitcoin. the creation of the new currency by an unknown founder at an unknown location made everyone wondered. henry kissinger once expressed his doubts in euro, indicating the fragility of the currency lacking an army to defend it! this time, the new currency, bitcoin entered the global stage without a central bank nor military backing! is this the ultimate end of the nation state, central banks and need for national defense or the ultimate testament of the power of globalization? the unprecedented value rise of this currency is recorded in figure 1 its performance is suggesting next potential bubble to burst. figure 1. bitcoin value in us dollars (2013-2017) source:https://encrypted.google.com/finance/chart?rlz=1c1ggrv_enus751us751&q=currency:btcusd& tkr=1&p=5y&chst=vkc&chs=268x94&chsc=1.875&ei=ztlbwch1oouvmqh4qywgbw brexit and us elections in 2016, the eu exit vote in the uk, and the election of the republican presidential candidate in the usa, have common denominator: call for regaining national sovereignty after the deepest and longest economic downfall since the great depression. gross (2017) identified four reasons of uk discontent that solidified the no eu vote: “a divergence between the united kingdom and the continent about the meaning of the european project and the nature of sovereignty; a gradual estrangement of british political parties from the public; the aftermath of the 2008 financial crisis; and brussels’ lackluster management of the eu’s problems.” in the case of presidential victory of donald trump, the comprehensive analysis is yet to be presented. some of the reasons for his victory are linked to the economic and political divide between haves and have nots and negative outcomes of globalization, which significantly worsen since the great recession. the severity of these sentiments was either ignored or not adequately acknowledged by other candidates. the slogan “make america great again”, echoes the slogans from brexit campaign: “let’s take back control”. president’s trump inaugural address emphasized these sentiments: “washington flourished – but the people did not share in its wealth. politicians prospered – but the jobs left, and the factories closed. the establishment protected itself, but not the citizens of our country” (https://www.whitehouse.gov/inaugural-address). the lessons learned thirty years is a long period of time that allows for a process to be initiated and results to be harvested. in this paper critical defining episodes were addressed. there are few lessons that are derived from the 1987-2017 period. the first one can be expressed as unpredictability of the predictability. there were limited studies predicting the collapse of the soviet union and the big crash of 1987. both had happened. there was an idealistic prediction about “the end of history”. it did not happen. the market doctrine, expressed in washington consensus, was challenged by the holistic approach of beijing gordana pešaković 7 consensus. the notion that the currency needs to have an army to defend it has been challenged. the economic convergence, expected to happen with globalization, was modest and present only in a few cases. the second finding of this analysis is a need for the historical perspective. in a number of situations (e.g. financial crisis presented in this paper and others not covered here) the lessons from the past were almost completely ignored. although all economic crisis have some unique features, in general, "plus ça change, plus c'est la même chose," the same factors overheated economy (where all, or few factors occur: high inflation, high levels of credit, a low savings rate, low interest rates, an appreciating currency), and some form of economic bubble, were universally present. the third takeaway is recognition of the plurality of ideas, expressed with the “one size does not fit all” approach. therefore the qualification like “superior or inferior model” is misleading and should be avoided, particularly in the academic discourse. the evolution of economic theories, developed and suitable for different circumstances speaks in favor of this view. the washington consensus and the beijing consensus both have place in the economic development literature and applications in different countries at different times. the final lesson that this paper conveys is the need for revisiting socrates saying, “i know that i know nothing”. proclamations of “the end of history” or “problem of depression-prevention has been solved” are good illustrations of this. the arrogance of perceived, yet fragmented knowledge, proved to be devastating in a number of global crisis, and not only economic ones. acknowledgements i want to express my gratitude to dr. judy smith for editing this manuscript. references balino tomas j.t. and angel ubide. 1999. “the korean financial crisis of 1997 a strategy of financial sector reform,” international monetary fund working paper 99/28 https://www.imf.org/external/pubs/ft/wp/1999/wp9928.pdf berry heather, mauro guillen f. and arun hendi s. 2014. “is there convergence across countries? a spatial approach,” journal of international business studies, 45 pp. 387-404 bonciu florin. 2017. ”world economy between yesterday and tomorrow: the transition towards a new international economic order, “romanian economic and business review, vol 12. no. 1 pp. 50-58 chan s. kenneth. 2007. “trade, social values, and the generalized trust,” southern economic journal, 73(3), pp. 733-753 dobbin frank, beth simmons and geoffrey garrett. 2007. “the global diffusion of public policies: social construction, coercion, competition, or learning?” annual review of sociology, 33 pp. 449-472 dollar david. 2015, “china’s rise as a regional and global power,” horizons, issue 4, pp. 162172 edwards franklin 1999. “hedge funds and the collapse of long-term capital management” journal of economic perspectives vol. 13 (2) pp. 189-210 federal reserve. 2013. “stock market crash of 1987,” https://www.federalreservehistory.org/essays/stock_market_crash_of_1987 fourcade-gourinchas marion and sarah babb l. 2002. “the rebirth of the liberal creed, paths to neoliberalism in four countries,” american journal of sociology, 108(3) pp. 533-579 fox justin. 2013. “what we learned from the financial crisis,” harvard business review, november issue, https://hbr.org/2013/11/what-weve-learned-from-the-financial-crisis 8 economic analysis (2017, vol. 50, no. 3-4, 1-8) oztuk serder, and ali sozdemir. 2015. “effects of global financial crisis on greece economy,” procedia economics and finance 23, pp. 568-575 polillo simone and mauro guillen f. 2005. ”globalization pressures and the state: the global spread of central bank independence,” american journal of sociology, 110 (6), pp. 1764-1802 ramo joshua cooper. 2004. the beijing consensus, the foreign policy centre rodrik dani. 2002. “after neoliberalism, what”, remarks at the bndes seminar on “new paths of development,” rio de janiero, september 12-13 ryazantsev sergey. 2016. “labor migration from central asia to russia in the context of the economic crisis,” russia in global affairs, http://eng.globalaffairs.ru/valday/labourmigration-from-central-asia-to-russia-in-the-context-of-the-economic-crisis-18334 tett gillian. 2010. ”the story of brics,” financial times magazine, https://www.ft.com/content/112ca932-00ab-11df-ae8d-00144feabdc0 williamson john. 2004. “the washington consensus as policy prescription for development,” a lecture in the series "practitioners of development" delivered at the world bank on january 13, peterson institute for international economy, https://piie.com/publications/papers/williamson0204.pdf article history: received: october 5, 2017 accepted: october 23, 2017 udc: 336.744/.746 336.76(497-15) cobiss.sr-id 252604940 scientific review assessing a currency substitution persistency in the western balkan region mehmed ganić1* | alina dizdarević1 | agim mamuti2 1 faculty of business administration, international university of sarajevo, bosnia and herzegovina 2 american university in the emirates (aue) dubai, united arab emirates abstract the study aims to examine the euroization phenomenon in seven western balkan countries (albania, bosnia and herzegovina, bulgaria, croatia, romania, serbia and macedonia) between 2000 and 2015 and a number of –specific challenges faced by the region. more precisely, the paper analyzes the impact of the latest global financial crisis on the extent of currency substitution persistency by exploring the trends before, in wake of the financial crisis, and after the financial crisis. the study employed several indicators as a proxy variable for measuring of the overall level of currency substitution or euroization and cross country analysis in selected countries (liability euroization, credit euroization and deposit euroization and asset substitutionoverall euroization index). finally, the study found that deposit euroisation, credit euroization, and liabilities euroization in seven western balkan countries is still high with relatively high degree of heterogeneity. in some countries of the western balkan region the process of euroisation was further intensified in spite of the consequences of the latest global financial crises, while in the other ones the crisis years were marked by the trend of de-euroisation. in overall, this study does not find any significant evidence on significantly increases or decreases in currency substitution at the region sub-samples. finally, student t-test results indicate that there is no significant difference in means of before, in wake and after the financial crises at level of western balkan region. key words: credit euroization, deposit euroization, liability euroization, western balkan region jel classification: f41, g01, e52 introduction the question of euroisation has been on the forefront of the economic debate. it is very natural that this debate intensifies and leads the economic analysis process during and after crisis. the western balkan economies are known as the highly euroised countries. it seems impracticable to report all available leadership definitions within the scope of this paper. due to this, it will be contented with definitions which are distinguishable and relevant to approach in question. the terms euroisation and dollarization are used interchangeably to describe a situation when residents of a country hold foreign currency and when the assets and liabilities, including bank loans, deposits, as well as non-banking assets are denominated in foreign currency (izeand levi yeyati, 2003). euroisation is especially a widespread phenomenon in transitioning economies which needs to be carefully considered and comprehended. among the transitioning economies the western * e-mail: mganic@ius.edu.ba 44 economic analysis (2017, vol. 50, no. 3-4, 43-54) balkans is one of the most euroised regions in europe characterized by a history of political uncertainty, macroeconomic instability, conflicts as well as by the hyperinflation (bechmannand scheiber, 2012). the study explores the dynamics of euroization as a widespread phenomenon in the western balkans, by focusing on seven countries in the region (albania, bosnia and herzegovina, bulgaria, croatia, macedonia, romania and serbia). post-socialist development characterized by disparities in levels of economic development across the region is the main reason for selecting the western balkan region for this research. in order to define variables needed to conduct the analysis, a detail research on previous writings on this topic has to be made. the findings of number studies are shown in literature review section. this paper first of all aims to discuss the concept of euroisation and make a twofold contribution to the current debate. firstly, is to examine the impact of latest global financial crises on the trends of euroisation of deposits, loans, and liabilities in selected countries. secondly, it evaluate if there is consistency in the impact of euroisation over the years across countries. in this study, the main research question is to investigate whether the latest financial crisis caused any changes in euroization level in the western balkan region? there are no many researches on analysis trend of euroisation in post crises period in western balkan region. main reason may be found in the lack of data especially in long term. most of the researches were conducted in pre crises period. consequently, the significance of this paper is to provide more information about trends of euroization in selected transition countries in post crises period. this paper consist of the following sections: the second section of this paper contains literature review, and followed by methodology. the fourth section contains cross-country analysis, and paper ends with conclusion and recommendations. literature review in the literature on monetary theory and system, there exist many works on dollarization/euroization and its advantages and weaknesses, but very limited number of academic work has been carried out about trend of euroization in crises and post crises period. the term euroisation is described by winkler, et al. (2004) as a term which refers to the situation when a country uses the currency of another country. the term is used interchangeably with the term dollarization. however, the term dollarization is used more frequently than the term euroisation, and suggests the replacement of the national currency in general. a large number of indicators of euroisation can be found in research literature. the choice of a concrete indicator to analyze the quantitative data depends on the characteristics of the economy and its purpose to be used. traditional approaches to the measurement of euroisation are mainly based on foreign currency deposits. reinhart, et al. (2003) describes the dollarized economy as one in which economic entities hold a part of a foreign currency portfolio, and / or the one in which the private and public sector borrow in foreign currency. thus, financial euroisation implies the euroisation of deposits and / or loans. on the side of banking assets, the level of euroization is most often measured by the ratio of fx loans or fx indexed loans to total loans. financial euroisation is actually asset and liability euroisation, while the term real euroisation is used for the situation when the foreign currency is set for the local prices and wages (winkler et al., 2004). fischer (1982) suggests that the country which adopts foreign currency benefits from the elimination of costs related to the exchange of domestic currency for the foreign one. moreover, mehmed ganić, alina dizdarević, agim mamuti 45 dollarization can lead to improvement in a country's economic integration with the economy whose currency is adopted (dallas and tavlas, 2001; frankel and rose, 1998). as a result of higher integration, the gdp levels and business cycles may converge with the issuing country (dallas and tavlas, 2001). also, shocks between euroized and the foreign country become more symmetrical, business cycles become more synchronized, and the integration further improves (winkler et al., 2004). barro and gordon (1983) argue that the financial euroisation can benefit the country since it is fostering macroeconomic stability by solving the problem with credibility that arises when a domestic central bank is not able to pre-commit itself to a low rate of inflation. by adopting the monetary policy of the foreign country with a high degree of credibility, the level of inflation and interest rates in the domestic economy is expected to converge to the level in the foreign country (winkler et al., 2004). if the convergence works, the output costs associated with disinflation in the low environment should be avoided (országhová, 2015). ize and levi yeyati (2003) describe financial euroisation as the situation when assets and liabilities are held in foreign currency; while calvo and veigh (1992) discuss that the process of euroization begins with substitution function of money as a store of value, which is the most vulnerable function in the periods of inflation. within the balance sheets of households, asset euroisation is referred as the situation when households hold deposits in foreign currency, whereas the liability euroisation represents their obtained loans in foreign currency (calvo and veigh, 1992). when it comes to the banks' balance sheets, the asset euroisation refers to the situation when banks are lending in foreign currency, while raising deposits in foreign currency refers to liability euroisation (calvo and veigh, 1992). ivanov, et al. (2011) defines the deposit euroisation as the tendency of households, enterprises, and even governments, to hold deposits in foreign currency. the western balkans region is an area characterized by a long history of political uncertainty, macroeconomic instability, and distrust in the quality of institutions (bechmann & scheiber, 2012). the region as whole has a long history of hyperinflation, which is one of the driving forces for euroisation (bechmann & scheiber, 2012). however, the countries of western balkanswere characterized by the abundant supply of foreign capital inflows, which made foreign currency lending easily accessible at low interest rates. the easy access to foreign currency lending caused the liability side of banks’ balance sheets to become heavily dominated in foreign currency (országhová, 2015). also, the countries’ economic and financial links with the countries in eurozone as well as the overall eu integration process intensified the process of euroisation (fabris et al., 2004). luci et al., (2006) investigated the level of euroisation in albania, by taking into account foreign deposits and foreign currency in circulation. they found very high level of euroisationin albania (45%). merollari and mosko (2015) investigated the level of euroisation in albania between 2007 and 2014 and suggested that the level of euroisation is relatively high, even though the official euroisation did not take place yet. the results of the study indicate that the ratio of the foreign currency deposits to the total is over 30% and therefore the tendency towards euroisation is high. as it is argued by galac (2012), euroisation in croatia is a consequence of a set of historical events in both economic and financial spheres. besides the events, it is influenced also by the monetary and prudential measures of the croatian national bank and by the attempts by banks to minimize their financing costs (galac, 2012). madzova et al. (2014) discuss that the process of intense euroisation in macedonia started in 2002 when the euro was adopted as the exchange rate anchor. however, they found the extensive use of euro in the banking system of macedonia was followed by the process of deeuroisation, which implies the decrease in the level of liquid assets, deposits, and loans in foreign currency. 46 economic analysis (2017, vol. 50, no. 3-4, 43-54) euroisation in serbia was investigated by chailloux et al. (2010) who claim that the phenomenon is rooted in a history of instability in macroeconomic terms. chailloux et al. (2010) also argue that after the process of intense euroisation, the process of de-euroisation has started, so that the borrowers have become more interested in the local currency borrowing. methodology the paper examines the trend of currency substitution persistency seen through the case of the selected western balkan countries. it analyzes qualitatively pre-determinants of the latest financial crisis and statistically describes selected countries’ indicators sourced from the world bank data, national central banks annual reports and imf database. the study has divided the years into three different sub periods: 2000-2007 (pre-recession period), 2008-2009 (recession period) and 2010-2015 (post-recession). data for all variables used in the study are sourced an annual basis. the rationale behind this division is to compare the countries’ trend of currency substitutions before, during and after the crisis and to explore whether the trend of currency substitution is influenced by the global financial crises. the analysis involved the manipulation of data with an aim of getting the results which would answer the research question. due to data consistency problems, a relatively short time series of annual data was employed in order to measure changes in the level of currency substitution. in much of the existing professional literature, we encounter various variables for measuring the degree of dollarization / euroization. in order to examine how the latest financial crisis influences on the changes in the degree of currency substitutions of the western balkan countries, a set of certain variables need to be determined and tested. by examining of previous researches on measuring euroisation it is possible to note that some authors employed a whole range of variables to measure the level of euroisation of a particular national economy (ize and levi yeyati, 2003; calvo and veigh, 1992; ivanov, et al. 2011). accordingly, some variables as deposits, loans and liabilities, between 2000 and 2015, are employed to estimate the extent of currency substitution in the selected transition countries hit by latest financial crises. credit euroization is measured as the ratio of foreign currency denominated loans to total loans; liability euroization is measured as the ratio of foreign currency denominated liabilities to total liabilities; and deposit euroization is measured as ratio of foreign currency denominated deposits to total deposits. furthermore, euroization index (roeinhart, et al., 2003 and imf) as the ratio of foreign currency bank deposits to m3 (broad money) is used to measure the level of asset substitution and represents proxy variable for euroization. for the sake of our analysis , the study employs a descriptive statistical analysis (mean) to assess certainty level of currency substitutions across the western balkan region while for the purposes of estimating the significance of the difference in means between numerical variables, a parameter t-test: two-sample with unequal variances is used. the first indicator used in many studies is deposit dollarization (ize and levy yeyati, 2003). another important point that we can speak about is liability euroization. also as a measure of euroisation is increasingly used by indicator of liability euroization(barajas and morales, 2003). this indicator is calculated as the ratio of foreign currency denominated liabilities as percentage of total liabilities. the inclusion of this indicator is based on recent experiences from the recent financial crisis as the private and public sector liabilities in developing countries were largely denominated in foreign currency. based on an overview of research problem, and the aims of the study, this paper set out the main hypotheses as follows. h1: there is no significant difference in means of before, in wake and after the financial crises for our variables mehmed ganić, alina dizdarević, agim mamuti 47 h0: there is significant difference in means of before, in wake and after the financial crises for our variables. cross-country comparison analysis financial sector development the degree of financial intermediation, as measured by the ratio of banking sector assets' to gdp, is one of the most representative indicators of the maturity of the banking sector. as shown in figure 1, the western balkan region is characterized by a relatively high degree of heterogeneity. between 2000 and 2015, the average percentage of bank assets to gdp ranges between 55.69% (romania) and 111.6% (croatia). with the exception of croatia (121.6% of gdp) and bulgaria (106.2% of gdp) where the size of the banking system in relation to gdp is predominantly above 100% of gdp, the level of financial intermediation in other western balkan countries is predominantly below 90%. if we neglect the banking sector of romania, in other analyzed eu member states (i.e. bulgaria, and croatia), the banking sector made the progress in its development showing greater saturation in comparison to the other countries in the region. analyzed as a percentage of gdp, it was found that croatia has the most developed banking sector (121.6% of gdp) measured by total assets of banks while the least development was observed in romania (75% of gdp). figure 1. total assets of banks as % of gdp (2000-2015) source: the authors’ elaborations on global financial development database (gfdd), national cbs furthermore, the ratio of private sector credit to gdp provided by the banking sector to measure of financial development reveal significant differences between the western balkan countries (figure 2). in our case it varies widely across the countries. in the three new eu member states the ratio has grown slowly in the range between 45.00% (romania), 73.25% (croatia) and 75.50% (bulgaria). bulgaria’s standard deviation is high showing us that the country has experienced significant fluctuations in evolution of its banking sector. 0.00 50.00 100.00 150.00 average stdeviation min max 48 economic analysis (2017, vol. 50, no. 3-4, 43-54) figure 2. bank private credit to gdp (%), 2000-2015 source: the authors’ elaborations on global financial development database (gfdd), national cbs among the other countries of the western balkan region out of eu the highest ratio was found in b&h (56.37%) and it doubled several times between 2000 and 2015. the highest value in relative terms for this ratio was found in bulgaria, (75.50%), while the lowest one was recorded in albania (38.26%) and romania (45%). moreover, the highest share of deposits in gdp (figure 3) was recorded in albania (71.7%) and slovenia (69%), with the lowest in romania (34.4%) and serbia (47.15 %). the reason for lower ratio in romania and serbia may be found in excessive of hyperinflation in the middle of 1990s. figure 3. bank deposits to gdp (%) for selected western balkan countries (2000-2015) source: the authors’ elaborations on global financial development database (gfdd), national cbs our cross-country comparisons of average total deposits to gdp ratio indicates that serbia (47.15%) and romania (34.4%) with their ratio are lagging significantly behind other analyzed countries. the demand for loans has been steadily increasing over the period 2000-2015. the positive trends in terms of economic growth, privatization revenues, as well as restored confidence in the banking system have created a basis for the creation of deposits potential. (de) euroization in western balkan countries during the period of transition only few western balkan countries established financial system similar to the ones in advanced transition countries. the level of euroization significant varies among countries in the region. cross-country comparisons of euroization deposits as measured by fx deposits to total deposits show some differences in terms of euroization 0.00 20.00 40.00 60.00 80.00 albania b&h croatia macedonia serbia romania bulgaria average stdeviation min max 0.00 20.00 40.00 60.00 80.00 average stdeviation min max mehmed ganić, alina dizdarević, agim mamuti 49 deposits across region in the years before the crisis, in the wake of crisis and after the crisis (figure 4). as it can be seen from figure 4, the growth of euroization deposits is generally found in albania and serbia as a notable exception. more specifically, in pre-crisis period, fx deposits amounted to the 63.21% of the total deposits, which increased to 72.25% in the wake of crisis, and 75% in post-crisis period. as presents, croatia is among the countries with the highest extent of euroization deposits. in the pre-crisis period the ratio amounted to 68.23%, while the period of de-euroisation was experienced during the crisis as result deposit withdrawals. after the crisis, however, there was high degree of euroisation deposits when compared to the one in the pre-crisis period. on the other side, macedonia recorded fall of the deposit euroisation and the ratio had declined significantly compared to pre crises period. in the meantime, when pre crisis and crisis periods are compared, it can be seen that there was a slight decline in deposit euroisation during the crisis. figure 4. deposit euroization, between 2000 and 2015 source: imf country reports, different issues after the crisis, a trend of further deposit euroisation was found in albania, croatia serbia and bosnia and herzegovina. the data for macedonia, romania and bulgaria shows the decline in deposit euroisation. in case of romania, the crisis period was marked by the 7.54% decline in deposit euroisation, while in the post-crisis period there was only 1.92% decline. in bulgaria, the data indicates that the trend in de-euroisation deposit before, during, and after the crisis was similar. however, in the case of bosnia and herzegovina, the crisis period was marked by deposit de-euroisation, while in the post crisis-period the ratio of foreign-currency denominated deposits in total deposits increased to 44.47%, which is lower than 46.65% as experienced in pre-crises period. when the comparison is made across countries, it can be said that the tendency towards holding euroization deposits in albania and serbia increased during the financial crisis while in the case of romania, bulgaria, serbia, croatia, bosnia and herzegovina, and macedonia recorded de-euroisation of deposits in the wake of crises. moreover, in the post-crisis period, the data on albania, croatia, and serbia shows the trend of growth euroisation deposit. however, the data on macedonia, romania, and bulgaria show that deposit de-euroisation occurred in the years following the financial crisis. further, considering western balkan countries the differences in the extent of credit euroization in serbia, albania, croatia, macedonia, romania, bulgaria, and bosnia and herzegovina, in pre-crisis, in the wake of crises, and post-crisis period are given in figure 5. as it 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 albania croatia macedonia serbia romania bulgaria bosnia and herzegovina before in wake after 50 economic analysis (2017, vol. 50, no. 3-4, 43-54) can be seen from figure 5, the post-crisis period was affected by decline of credit euroization in albania and macedonia. on the other side, in the post-crisis period the credit euroisation has slightly risen in romania and bulgaria. however, croatia and bosnia and herzegovina experienced the opposite trends. additionally, in croatia the ratio decreased (68.85%) in the wake of crisis, and increase in postcrisis period (73.86%). interestingly, in case of bosnia and herzegovina there was recorded rise of credit euroization in the wake of crisis (73.6%) and decline in post crises period (64.61%). however, the trend of credit de-euroisation occurred in post-crisis years, with the number of fx loans being lower than the one in pre-crisis years. the similar trend was occurred in macedonia. specifically, credit euroization increased by 1.45% in the wake of crisis and a decline of 7.13% in post-crisis period. figure 5. credit euroization, between 2000 and 2015 source: imf country reports, different issues figure 6 shows some interesting differences in the percentage of liabilities euroization in selected countries in pre-crisis, crisis, and post-crisis period. serbia (77.5%) and croatia (77.5%) are considered countries with very high euroization ratios across the years, while the data on albania (41.4%) and romania (43.25%) shows the lowest values when compared to the other countries. figure 6. liabilities euroizations, between 2000 and 2015 source: imf country reports, different issues 0 10 20 30 40 50 60 70 80 pre crises in wake after crises 0 20 40 60 80 pre crises in wake after crises mehmed ganić, alina dizdarević, agim mamuti 51 the overall euroisation trend in serbia was high, with a sharper increase in post-crisis years in comparison with the pre-crisis period. the rise of euroisation liabilities was also experienced in the economy of albania, reaching 41.4% in pre-crisis period, 48.7% in the wake of crisis, and 52.13% in post crises period. in case of croatia, the increase in liabilities’ euroisation was recorded during the financial crisis (77.55%), to slightly decline in post-crisis period to the value lower than the one in pre-crisis years (72.58%). macedonia, bosnia and herzegovina, and bulgaria experienced the same trend in liabilities’ euroisation. thus, there was an increase in liabilities’ euroisation during the crises, with de-euroisation trend in post-crisis period. however, the number of foreign currency denominated liabilities remained higher than the one in pre-crisis period. in the case of romania there was a different trend when compared to other countries considered in the study. as figure 6 reveals, there was liabilities’ de-euroisation in romania in the wake of financial crisis (43.25%). after the crisis, the euroisation trend occurred again, but the value remained lower than the one before the crisis (44.13%). finally, we included an indicator euroization index (ei) used by roeinhart, rogoff and savastano, 2003 and imf in our study to measure overall level of euroization or asset substitution. figure 7 presents average ei across countries between 2000 and 2015. most countries of western balkans are high-euroization countries with notable exception of romania. a closer look at the data reveals that all countries of the western balkan (with exception of romania, macedonia and bosnia and herzegovina) increased its euroization ratio from pre crises to post crises period. figure 7. euroization index (ei), between 2000 and 2015 source: imf country reports, different issues although the phases of the euroization are similar by countries there are some striking differences among them. first, while the euroization ratio is increasing continuously as of pre crises period until post crises period (in albania, croatia, serbia and bulgaria), the decline of the extent of euroization (in romania, macedonia and bosnia and herzegovina) starts in post crises period. second, the euroization ratio has recovered significantly better in albania (9.29%) and croatia (6.9%) from the crisis than in serbia (3.72%) and bulgaria (1.72%). third, while the trend of euroization slowed during the global crisis, its level is still high in some countries as follows: croatia (60.67%), serbia (67.08%), bulgaria (42.57%) and macedonia (41.19%). student’s t-test is employed to explore the variations in the level of de euroization the countries of the western balkan region over the three sub periods. it examines statistically 0 10 20 30 40 50 60 70 albania croatia macedonia serbia romania bulgaria bosnia and herz. pre crises crises post crises 52 economic analysis (2017, vol. 50, no. 3-4, 43-54) different from one to another sub periods (before of the financial crisis, in wake of the financial crisis, and after the financial crisis).the means for the three sub periods are the same for selected variables is tested as the main hypothesis. the following hypothesis is tested: h0: μ1 =μ2= μ3 where μ1 is the mean for pre-crisis period (2000-2007), μ2 is the mean for post-crisis period (2008-2009) and μ3 is the mean for (2010-2015). it compares the average deposit euroization, credit euroization, liability euroization and euroization index calculated for pre-crisis period with the average the ratios calculated for crises and post crises period. a hypothesis test examines critical values associated the mean with test statistics. our basic assumption: if p-value is less than or equal to the significance level (p≤ α = 95% confidence interval for the mean of a group), the null hypothesis is rejected. and vice versa if p-value ≥ α, the null hypothesis is not rejected. table 1 below provides a summary of a student’s ttest results for the three sub periods under review. table 1. student’s ttest results pre-crisis (20002007) crisis (20082009) p-value* crisis (20082009) post crisis (20102015) p-value* pre-crisis (20002007) post crises (2010-2015) p-value deposit euroizatio n 50.86% 51.07% 0.95 51.07% 51.86% 0.84 50.86% 51.86% 0.71 credit euroizatio n 62.98% 66.08% 0.22 66.08% 63.73% 0.31 62.98% 63.73% 0.71 liability euroizatio n 57.39% 61.60% 0.27 61.60% 60.59% 0.79 57.39% 60.59% 0.20 euroizatio n index 41.51% 45.10% 0.30 45.1% 45.8% 0.84 45.51 45.8% 0.09 *α =95%,p=0.05 source: author`s elaborations on data from imf country reports, different issues analysis of the results by student's t-test for dependent samples has shown that there is no significant difference in means of before, in wake and after the financial crises for our variables. analyzing the average values for our variables, before, during the crisis and after the crisis, a statistically significant difference is not found (p> 0.05) and mean values has remained almost unchanged over time. accordingly, our main hypothesis is accepted. conclusion the study aimed at investigating the changes in the extent of deposit, credit, liability and asset substitution before, in the wake of crises, and after the latest financial crisis in seven western balkan countries. findings our study indicates that overall the deposit euroization in the postcrisis period are higher than their pre-crisis levels in three countries (albania, croatia and serbia). while this decrease is more pronounced from the crisis to post-crisis period for macedonia and romania, the deposit euroization for bosnia and herzegovina has increased from crisis to post crises period. the trend with deposit euroisation was quite different in croatia, where the increase in fx deposits occurred in the wake of the crisis, which was preceded by the sharp decrease in crises period. mehmed ganić, alina dizdarević, agim mamuti 53 also, overall credit euroization has increased in the post-crisis period in croatia, romania and bulgaria over crisis period levels. the study found that the credit euroisation of bosnia and herzegovina was affected by the financial crisis in the way that the number of fx denominated credits increased in the wake of crisis, while after the crisis there was a trend of decline of credits held in foreign currency. in macedonia, the crisis influenced on the fall of credits held in foreign currency in post crises period in comparison to crises period. when the liability euroisation is taken into consideration, macedonia and croatia had the situation of the sharp decrease of the fx liabilities in post-crisis period, while in albania the euroisation of liabilities sharply increased during and after the crises. the level of overall euroisation measured by euroization index in all four countries was high over the years and it is still sizeable in some of selected countries with exception of romania, macedonia and bosnia and herzegovina. furthermore, student t-test results indicate that there is no significant difference in means of before, in wake and after the financial crises at level of western balkan region. in overall, this study does not find any significant evidence on significantly increases or decreases in currency substitution for the region sub-samples. references barajas, a. and bueno, a. m. 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(2004). economic policy in dollarized economies with a special review of montenegro. central bank of montenegro, working paper no. 1. fischer, s. (1982). seigniorage and the case for a national money. journal of political economy, 90 (2), pp. 295-313. frankel, j. a., & rose, a. k. (1998). the endogeneity of the optimum currency area criteria. the economic journal, 108 (7), pp. 1009-1025. galac, t. (2012). global crisis and credit euroisation in croatia. croatian national bank, working papers no. 33. imf (2014) bosnia and herzegovina: sixth and seventh reviews under the stand-by arrangement and requests for augmentation of access and modification of performance criteria-staff report, imf country report. imf (2014) republic of croatia: 2014 article iv consultation-staff report, imf country report. imf (2014). republic of serbia: staff report for the 2014 article iv consultation and request for stand-by arrangement imf (2015) bosnia and herzegovina: 2015 article iv consultation-press release; staff report; and statement by the executive director for bosnia and herzegovina imf (2015) albania: second and third reviews under the extended arrangement and request for waiver for the nonobservance of performance criterion, waiver of applicability of 54 economic analysis (2017, vol. 50, no. 3-4, 43-54) performance criteria, and rephasing of future disbursements-staff report, imf country report. imf (2016). albania : staff report for the 2016 article iv consultation, seventh review under the extended arrangement, and request for waiver of applicability and modification of performance criteria-press release; staff report; and statement by the executive director for albania imf (2016). bulgaria: 2016 article iv consultation-press release; staff report; and statement by the executive director for bulgaria imf (2015). bulgaria: 2015 article iv consultation-staff report; press release; and statement by the executive director for bulgaria imf (2015) former yugoslav republic of macedonia: staff report for the fourth review under the post program monitoring discussions, imf country report. imf (2015) romania: 2015 article iv consultation-staff report, imf country report. imf (2017) republic of serbia : 2017 article iv consultation, seventh review under the standby arrangement and modification of performance criteria-press release; staff report; and statement by the executive director for the republic of serbia. ize, a., & levi yeyati, e. (2003). financial dollarization. journal of international economics, 59 (2), pp. 323-347. ivanov, m., tkalec, m., & vizek, m. (2011). the determinants of financial euroisation in a posttransition country: do threshold effect matter? czech journal of economics and finance, 61 (3). luci, e., muco, m., & sojli, e. (2006). euroisation in albania: from spontaneous to consensual. balkan observatory working paper 71. madzova, v., sajnoski, k., davcev, l., & delcev, g. (2014). the process of de-euroisation in the macedonian banking sector in the period of sovereign debt crisis. journal of social studies, 89, 116-121. merollari, k., mosko, a. (2015). the level of euroization of albanian economy.” academic journal of interdisciplinary studies, part i vol. 4. országhová, l. (2015). eu enlargement: euroisation in the western balkans. biatec, 23 (2), 26. reinhart, c. m., rogoff, k. s., savastano, m. a. (2003). debt intolerance. brookings papers on economic activity, vol 34. winkler, a., mazzaferro, f., nerlich, c., & thimann, c. (2004). official dollarisation/euroisation: motives, features and policy implications of current cases. frankfurt: european central bank. world bank (2017). global financial development database (gfdd), wahington d.c. article history: received: october 12, 2017 accepted: november 10, 2017 ea_2016_1-2 udc: 005.334:658.114.25(497.11) 658.14 jel: g10, g32, o52 cobiss.sr-id: 224799500 original scientific paper capital structure in emerging markets: the case of serbian joint-stock companies arsov sašo1, university sv. cyril and methodius, faculty of economics, skopje abstract – this paper is an attempt to extend the empirical research on the capital structure theory to a post-transition economy and to determine if there are any factors that could be linked to the behavior of the companies with respect to their selection of the sources of financing. the study is based on a sample of joint-stock companies, most frequently traded on the belgrade stock exchange, and using their financial data for a period of 6 years, it applies a panel regression model. the regression results show that the leverage of the analyzed companies is positively related to their size and inversely related to the tangibility of their assets, profitability and the effective corporate tax rate. surprisingly, no relation has been found between the level of fixed-asset investments and the use of debt. these results do not give sufficient support for any of the capital structure theories, but the closest match is some form of a modified pecking order key words: capital structure, leverage, financing, debt, equity, transition introduction the famous paper of modigliani and miller (1958) on the capital structure of the companies opened a new era in the science of corporate finance. the issue that has been overlooked in the decades before has grasped the attention of the researchers, with numerous papers written on the topic, but the outcome of this immense engagement of scholars’ resources is still disappointing. namely, even 60 years after the first scientific efforts in this field, the finance theorists are not yet able to answer the question on the optimal choice of sources for financing the operations of a company. several theories have emerged, all of them with the ambition to provide the best possible solution for the open issue, but the most they have achieved is to add a piece or two in the capital structure puzzle. the basic dilemma which occupies the attention of the scientists and practitioners in this field is the one regarding the optimal debt-equity mix the companies should use with the ultimate goal of maximization of shareholders’ wealth. after the first several decades in which the search for the optimal capital structure was in the focus of the research, during the last twenty years we could observe a change in the researchers’ attention which has shifted 1 full professor 2 economic analysis (2016, vol. 49, no. 1-2, 1-14) toward explaining the determinants that most likely influence the decisions the companies make in the selection of the sources of financing. this paper follows the latter trend. we have made a selection of 51 serbian joint-stock companies, for which we have manually compiled a 6-year data set containing the information from their annual financial statements. on the basis of these data, we have applied a panel regression analysis to determine if there are any factors that have a significant influence on their financing mix, and in addition, to determine if any of the capital structure theories could be found applicable in the case of the serbian economy. the constraints we have faced in the analysis are related to the availability of data, so that we had to limit our research to the companies which have disclosed their financial statements on the belgrade stock exchange. as a result, our sample misses some prominent serbian companies, especially those privately owned, but the capital structure theory anyway deals with the companies able to issue securities, which reinforces our confidence in the validity of the sample used. our basic hypothesis is that the companies in serbia apply some form of the pecking order theory, i.e. they do not set a specific target capital structure, but begin with reinvesting earnings, then reach for debt financing and issue securities only as a last resort. this hypothesis is based on our observation of similar research in the countries of central and eastern europe (bauer, 2004, avarmaa et al., 2011, etc.). the paper is structured as follows. first, we provide an overview of the existing research in the field of capital structure. in the second part, we develop our model by identifying the factors that have been most often used as probable determinants in similar papers. the third part presents the results of the calculation, while the fourth part contains the results of the robustness tests of the model. the paper ends with the conclusions and recommendations for future research. review of literature on capital structure the basis of the theory on capital structure was set in 1958, when modigliani and miller (mm) asked the question if there was any structure of financing that could be considered optimal, so that the companies could use it as a target debt to equity ratio. such a capital structure should correspond to the long-term goal of maximization of the value of the company. this further translates into a capital structure under which the weighted average cost of capital would be at the lowest level. mm have used a very restrictive set of assumptions and found out that the value of the firm is not dependent on the financing mix, i.e. the capital structure is irrelevant. in other words, regardless of the debt-equity mix applied, the value of the company would not be affected. in 1963, they relax the assumption on non-existence of corporate taxes, which results in the conclusion that 100% debt is the optimal level. therefore, the optimal financing choice for the company would include only debt and no equity financing. in 1977, miller revised their study again and included the personal income taxes for the first time. the conclusion of this revision is that the differential tax impact on debt and equity holders lowers the important of the interest tax shield. therefore, during a period of twenty years, the theory on capital structure has been enriched arsov, s., the case of serbian joint-stock companies, ea (2016, vol. 49, no. 1-2, 1-14) 3 with a number of contributions, but it has hardly made any advance from the beginning positions (myers, 1984). later, the trade-off theory makes an attempt to overcome one of the biggest weaknesses of the mm findings – ignoring of the costs of using too much debt. its proponents contend that the benefits of the debt tax shield can be felt only up to a certain point, when they become offset by the direct and indirect costs of borrowing such as rising interest rates, risks of bankruptcy, agency costs, etc. the conclusion of the trade-off theory is that there should be an optimal level of debt, but its actual estimation remains vague, especially when indirect costs are involved. the most influential research in this regard is the one by jensen and meckling (1976), while other contributions include baker and wurgler (2002), welch (2004), etc. during the 1980s another line of research is initiated, which does not accept the existence of a target capital structure as a predetermined ratio and asserts that the capital structure is a consequence of a sequence of decisions made by the company managers. the most notable consequence of these studies is the so-called pecking order theory. according to myers (1984) and myers and majluf (1984), the managers follow a sequence of steps trying to minimize the negative consequences of information asymmetries. baker and wurgler (2002) link the capital structure to the market timing theory and assert that the capital structure is mostly a result of the past decisions of the companies to issue equity in periods with the highest market valuations of their shares. the work of harris and raviv (1991), in which they link the empirical research with the existing theories on capital structure has probably initiated the latest wave of research in this field. in the last two decades, most of the studies have focused on investigating the significance of particular determinants of the capital structure. the basic problem with these studies is that most of them have been associated with the developed economies and they could not be easily transferred to the developing countries. therefore, they could not be used to explain the behavior of the managers in these countries, so that new efforts were needed to fill this gap. his became especially important during and after the transition of the former socialist economies in europe in the 1990s. as a result, in the last 20 years we could observe an increased interest among researchers to extend the findings of the capital structure theory to the developing countries and the emerging economies. examples of this trend include: demirgüç-kunt and maksimovic (1999), booth et al. (2001), gonenc (2003), benkato et al. (2005), teker et al. (2009), etc. the papers that we find most interesting are those related to the former transitional economies. these countries have begun to attract the scholars’ attention recently. most of these studies focus on exploring the determinants of capital structure in these countries in order to examine whether the existing capital structure theory could be applied in their context. nivorozhkin (2002) has studied the impact of various determinants on capital structure using a sample of companies from hungary, and found out that in the early years of the development of the national capital market, the companies from the manufacturing sector use more debt financing and also do the companies with large state ownership. wen et al. (2002) examine the impact of corporate governance on leverage in the case of the chinese 4 economic analysis (2016, vol. 49, no. 1-2, 1-14) listed companies and conclude that the use of debt as a source of financing is affected by the composition of the board of directors, but not its size. in a study of slovenian companies, berk (2007) concludes that the private and public firms use similar financing patterns, which he attributes to the relatively undeveloped primary capital market. bauer (2004) uses a sample of 74 czech listed companies. he finds that the leverage of these companies is positively related to the size of the companies, but negatively related to the tangibility of assets and their profitability. črnigoj and mramor (2009) explore the importance of the ownership structure using a large sample of slovenian public and private firms. they find that the domestic companies, which are mostly employee-governed, do not follow the objective of shareholder wealth maximization and that it affects their capital structure decisions. avarmaa et al. (2011) explore the companies in the three baltic states, and conclude that the use of debt is positively related to the size of the company, asset tangibility and profitability, but negatively related to the age of the companies, which is in line with the pecking order theory. basic features of the financial system of serbia in order to obtain a better understanding of the analyzed issue, we find it useful to present some background on the financial system of serbia. serbia emerged as an independent country in 2006, after the volatile breakup of former socialist federal republic of yugoslavia in 1990 and the subsequent war conflicts in the region in which serbia had been directly or indirectly involved. as a result of that, the process of its real transition to a market economy started somewhat later than in most of the other eastern european countries. the privatization in serbia was overburdened by the political turmoil that the country was going through in the nineties and the early years of the last decade. the international sanctions, the nato intervention and the assassination of the prime minister created a very unfavorable environment for economic reforms. after several waves of privatization, a large part of the economy is in private hands, although a number of companies could not survive the transition years and the role of the foreign investors in the privatization process was quite low. the privatization was done on a paid basis, through auctions and public tenders, resulting in a more concentrated ownership than a voucher scheme would have generated. however, the number of state-owned companies and companies in which the state owns considerable stakes is still significant and their privatization is seen as an opportunity to attract foreign investors and improve the fiscal position of the country. table 1 provides some basic information about the financial system of serbia. it is obvious that the system is dominantly bank-centered, with the foreign banks gaining larger share in the overall banking sector throughout the years. the bank assets mostly consist of loans, while deposits from the non-financial sector are the dominant source of external funding. the bank operations are conservative, with little exposure to risky activities. the main problem for the banks is the increase in the percentage of non-performing loans to total loans which has reached 21,5% in 2014, compared to 16,9% in 2010. t ab le 1 . b as ic i n fo rm at io n o n t h e fi n an ci al s y st em o f s er b ia e u r m il li o n 20 10 20 11 20 12 20 13 20 14 n o . a ss et s % n o . a ss et s % n o . a ss et s % n o . a ss et s % n o . a ss et s f in a n c ia l s e c t o r 84 26 .0 32 10 0, 0 87 27 .3 17 10 0, 0 85 27 .2 63 10 0, 0 80 26 .7 93 10 0, 0 78 26 .6 69 10 0, 0 (i n % o f g d p ) 9 0 ,0 % 8 4 ,2 % 8 6 ,7 % 7 9 ,5 % 8 3 ,2 % b an k in g s y st em 33 23 .9 01 91 ,8 33 25 .2 37 92 ,4 32 25 .2 59 92 ,6 30 24 .7 50 92 ,4 29 24 .5 36 92 ,0 st at eo w n ed b an k s 8 4. 28 1 16 ,4 8 4. 49 7 16 ,5 8 4. 57 6 16 ,8 6 4. 64 1 17 ,3 6 4. 71 7 17 ,7 l o ca l p ri v at e b an k s 4 2. 04 7 7, 9 4 2. 02 8 7, 4 3 1. 70 5 6, 3 3 1. 70 4 6, 4 2 1. 54 9 5, 8 f o re ig n -o w n ed b an k s 21 17 .5 72 67 ,5 21 18 .7 12 68 ,5 21 18 .9 77 69 ,6 21 18 .4 05 68 ,7 21 18 .2 71 68 ,5 n o n b an k i n st it u ti o n s 51 2. 13 0 8, 2 54 2. 08 0 7, 6 53 2. 00 4 7, 4 50 2. 04 4 7, 6 49 2. 13 3 8, 0 in su ra n ce c o m p an ie s 26 1. 10 5 4, 2 28 1. 19 7 4, 4 28 1. 23 2 4, 5 28 1. 28 6 4, 8 27 1. 39 7 5, 2 p en si o n f u n d s 8 93 0, 4 9 11 9 0, 4 9 14 0 0, 5 6 17 1 0, 6 6 19 5 0, 7 l ea si n g c o m p an ie s 17 93 2 3, 6 17 76 4 2, 8 16 63 1 2, 3 16 58 7 2, 2 16 54 1 2, 0 c a p it a l m a r k e t b ro k er ag e co m p an ie s 5 1 42 35 31 28 t o ta l t u rn o v er o n b el g ra d e st o ck e xc h an g e (b se ): s h ar es ( tu rn o v er ) r eg u la te d m ar k et 17 7, 0 23 9, 3 17 9, 9 25 2, 2 13 3, 2 o t c 25 ,3 89 ,4 64 ,7 42 ,5 78 ,6 c o rp o ra te b o n d s 1, 4 0, 2 l is te d c o m p an ie s o n b se 7 8 8 7 8 v al u e o f b e l e x s to ck in d ex e n d -o fy ea r 65 2 49 9 52 3 55 7 66 7 in v es tm en t fu n d s (n u m b er ) o p en -e n d 16 15 16 11 12 c lo se d -e n d 2 3 1 1 1 p ri v at e 3 2 3 2 2 t o ta l n a v o f o p en -e n d i f 10 ,2 15 ,4 20 ,4 46 ,1 75 ,7 s ou rc es : n at io n al b an k of s er b ia , b el g ra d e s to ck e x ch an g e, s ec u ri ti es a n d e x ch a n g e c om m is si on o f s er b ia 6 economic analysis (2016, vol. 49, no. 1-2, 1-14) the level of activity on the only stock exchange in the country has dropped significantly after the boom in 2007-2008. there have been no ipos in serbia so far, while the seasoned equity offerings are rare and mostly aimed at fulfilling certain capital adequacy requirements. corporate bonds are rare and mostly sold on a private basis. the participation of foreign portfolio investors on the stock market is insignificant. the only encouraging trend is the rise in the total value of the assets controlled by the investment funds, which have managed to attract the attention of the serbian investors, especially as the bank interest rates have dropped to multi-year lows and are expected to stay there for a considerable future period. development of the regression model in order to develop the model which will be used to examine the possible impact of various determinants on the capital structure, we have first explored the existing literature in this field. our intention was to find out which of these determinants are most often used in similar studies and structure our model accordingly. herewith we elaborate the most important findings we have reached. size. the larger companies are expected to use more debt simply because it is easier for them to borrow more. this is a result of their perceived stability in the long run and that they are usually more diversified which makes them better able to deal with crisis during the business cycles. larger companies are usually listed in the stock exchanges and thus more transparent, which provides them with bigger chances to issue bonds, for instance (jensen and meckling, 1976). however, this relationship is not so straightforward. namely, smaller companies are also induced to use more bank debt, because issuing equity is costly and complicated. tangibility of assets. tangible assets are those assets that are fixed and have a material form (as opposed from patents, receivables, etc.). the companies with more tangible assets are expected to have higher leverage because of the ability to use them as collateral when borrowing from banks. this is also related to the universal use of assets such as buildings, machinery, vehicles, compared to specific assets which are not appropriate for this purpose (titman and wessels, 1988). profitability. although it might seem logical that the more profitable companies should use less debt because they have sufficient funds, which is also an argument of the pecking order theory (donaldson, 1963; higgins, 1977), this relationship is not so clear. namely, the more profitable companies find it easier to borrow, as a result of the less uncertain cash flows. also, according to the static trade-off theory the more profitable companies have an incentive to borrow more, because the debt and non-debt tax shields are functional only when the company makes profits. growth and growth opportunities. the general expectation is that the companies that grow faster need to borrow more. this is also in line with the pecking order theory. on the other hand, according to the theory on asymmetric information, companies with significant growth opportunities use more equity financing to avoid transferring wealth from shareholders to debtholders. finally, the trade-off theory says that growing companies have higher risk of financial distress and the accompanying debt-related agency problems, so it arsov, s., the case of serbian joint-stock companies, ea (2016, vol. 49, no. 1-2, 1-14) 7 predicts a negative relation between growth and leverage (myers, 1977; rajan and zingales, 1995). tax shields. it was mentioned that in one of the versions of their study modigliani and miller (1963) introduced the impact of the tax shield caused by the interest paid on debt. it means that if the corporate tax rates are higher, the companies would be motivated to use more debt. later, the importance of this proposition has been reduced by the trade-off theory. on the other hand, the existence of the so-called non-debt tax shields (e.g. depreciation, loss carryforwards, etc.) reduces the attractiveness of borrowing (deangelo and masulis, 1980). also, the empirical studies in many cases far have failed to prove the utilization of tax shields by the companies in this respect (mackie-mason, 1990, p. 1471). risk. normally one would expect that when the borrower is a company that belongs to a higher risk category, the lenders would be resistant to provide them with loans. the riskiness is assessed by the credit rating of a company, but in underdeveloped capital markets we rely on the volatility of the profit and their debt history. other determinants. the list of potential factors is far from exhaustive and numerous authors have investigated the possibility that other variables could have a significant influence on the capital structure. frank and goyal (2009) investigate the impact of stock and debt market conditions, as well as macroeconomic settings on leverage; titman and wessels (1988) and bauer (2004) analyze the impact of the industry to which the company belongs, using a dummy variable; jiraporn and gleason (2007) analyze the impact of shareholder rights on leverage, etc. using the above experiences, we have decided to explore the following regression model: leveri,t = α + α1 tangi,t + α2 sizei,t + α3 profi,t + α4 growi,t + + α5 riski,t3y + α6 taxi,t2y + εi,t the meaning of the regressors is as follows: leveri,t – leverage of the ith company in period t tangi,t – tangibility of assets of the ith company in period t sizei,t – size of the ith company in period t profi,t – profitability of the ith company in period t grow i,t – growth potential of ith company riski,t3y – standard deviation of roa of company i for the past three-year period taxi,t2y – effective tax rate of company i for the past two years (average) − εi,t – error term for firm i in period t for the purposes of the regression, we had to select appropriate proxies for the variables included. size. the size of the company is usually represented by its total assets or the sales revenues. in regressions, they are usually represented by the natural log of these items and these values are usually highly correlated. we are using the log of sales in this paper and we expect a positive relationship of this variable with leverage. tangibility of assets. the most usual proxy for assets tangibility is the ratio of tangible fixed assets to total assets, while other possibilities involve the amount of r&d expenditures 8 economic analysis (2016, vol. 49, no. 1-2, 1-14) (more r&d indicating higher share of intangible assets, durnev and kim, 2005), while the uniqueness of assets is usually proxied by a dummy variable. we expect a positive sign. profitability. the profitability of the company is measured relatively by the ratio between the company earnings and its assets or equity. in this case we apply the ratio of operating income to total assets (roa). we expect an inverse relationship between profitability and leverage. the growth opportunities are usually proxied by the market-to-book ratios (m/b or p/b), on the basis of the widely accepted interpretation of a higher m/b ratio as a sign that the company with a growth potential is worth more than the book value of its assets. however, in the less developed capital markets where share valuations are doubtful, a more appropriate proxy would be the one representing the company’s total capital investments, such as capital expenditures to total assets or a change in the log of assets. we have decided to use the amount of fixed asset investments made in the last three years relative to the assets of the company and we expect that investments will be positively related to the amount of debt used. the most obvious candidate to proxy the importance of tax shields is the effective tax rate, which is usually calculated as a ratio of the difference between pre-tax and after-tax earnings and the pre-tax earnings. the non-debt tax shields are proxied by ratios between the respective expenditures items and the total assets of the company. we don’t have specific expectations about this variable. the operational risk of a company is a result of the volatility of its earnings. however, if we look at the company from an investor’s point of view, its riskiness would be expressed by the volatility of its stock price. this would increase the cost of equity and reduce the appeal of issuing shares. for the first type of volatility, the standard deviation of the return on assets (roa) based on the operating income is used. we expect that higher volatility will lead to lower leverage. regression results for the analysis, we have collected financial data about 51 companies. we have included all the listed companies on the belgrade stock exchange and additional 45 companies with the highest turnover on the stock exchange in 2014. the companies from the financial sector (banks and insurance companies) are normally excluded in analysis of this kind, because of their specific sources of financing. the data we have gathered are for the period 2008-2013 and are taken from the audited financial statements. this has enabled us to make a panel regression using fixed and random effects. the differentiation between fixed and random effects is made using the hausman test. in addition, as a dependent variable we have used the total leverage (ratio between the total liabilities and total assets), but also the total debt (only bank loans) and long-term debt. first, we present the correlation matrix to ensure that there is no multicollinearity problem. arsov, s., the case of serbian joint-stock companies, ea (2016, vol. 49, no. 1-2, 1-14) 9 table 2. correlation matrix tang. size roa invest. risk tax tangibility 1,000 size -0,273 1,000 profitability (roa) -0,203 0,148 1,000 investments -0,095 0,255 0,366 1,000 risk -0,285 0,017 0,102 0,043 1,000 tax 0,017 0,048 -0,146 0,061 0,045 1,000 we can see that there are no high correlations between any of the variables. the highest correlation is 0,366 between the investments and the profitability, which is not a high correlation, so we conclude that the multicollinearity problem does not exist in the sample. the regression results are given in table 3. table 3. regression results model 1 model 2 model 3 dependent variable total liabilities total debt long-term debt constant 0,229 -0,101 0,641 (0,187) (0,149) (0,241) *** tangibility -0,368 0,011 -0,073 (0,056)*** (0,048) (0,047) size 0,0412 0,029 -0.050 (0,017)** (0,013)** (0,022)** profitability -0,401 -0,148 0,060 (0,091)*** (0,079)* (0,070) investments 0,031 0,030 0,041 (0,066) (0,058) (0,052) risk -0,196 0,035 0,311 (0,193) (0,169) (0,149)** tax -0,154 -0,054 -0,076 (0,049)*** (0,023) (0,038)** no. of observations 273 273 273 adjusted r2 0,237 0,23 0,69 prob (f-statistics) 0,000 0,04 0,000 model used random effects random effects fixed effects hausman test for random effects (prob. chi-sq.) 0.41 0.353 0.048 standard errors in parenthesis. *-significant at 10%, **-significant at 5%, ***-significant at 1% 10 economic analysis (2016, vol. 49, no. 1-2, 1-14) the results show that the larger companies use more debt financing. this is an expected sign because the larger companies are usually older, well-known companies and they find it easier to borrow from the banks. in these markets, the informal relations between the companies and banks also play a significant role in the process of approving loans to the clients, so this could also be another reason for the positive sign. however, we see a negative sign of the size variable when long-term debt is used as a dependent variable. this leads us to a conclusion that the larger companies use more short-term financing or even accounts payable to cover their financing needs, which is a result of their better market position somewhat surprising is the sign of the tangibility variable. we expected a positive sign, but the inverse relationship between the tangibility of assets and the total liabilities can be explained on the grounds that the companies with more tangible assets have already established their capacities, so that they do not need extensive additional financing. this is also in line with the negative relationship between the size and long-term debt. other papers exploring the capital structure in developing countries have also found a negative relationship (booth et al., 2001; bauer, 2004; črnigoj and mramor, 2009). as expected, the more profitable companies do not need to borrow, which is in line with the pecking order theory. the tax rates are negatively related to leverage, which is contrary to the trade-off theory, which stipulates that the companies use more debt to take advantage of the tax shield. this is expected, because the tax rates prevailing in serbia today are considerably lower than in many other countries and also they are much lower than those that were in place when mm had worked out the tax shield proposition. interestingly, risk is not related to leverage, except in the long-term debt model, when we see an unexpected positive sign. we explain this by the fact that the companies with more volatile earnings had to borrow more on the long-term, to cover deficiencies of cash, while at the same time, the banks do not take past volatility into account when granting credits. it is also surprising that no significant relationship has been found between leverage and the amount of past investments. robustness check to ensure that the regression results are not biased due to the sample used, we have performed a robustness check applying three modifications of the model and the sample. first, having in mind that the data set is not complete for all the companies, we have created a subsample consisting only of the companies with complete data set. there are 34 such companies. second, researchers have also found differences in the capital structure among the companies, depending on the industrial sector (bauer, 2004). namely, it has been found that the manufacturing companies use less debt than those from trade and the services sectors. for that purpose, we have made a subsample consisting of manufacturing companies and reworked the regression on that subsample containing 41 companies. finally, we have separated the companies by their size, by simply cutting the whole sample by half using the log of assets criterion and applied the regression to these subsamples. the results from the robustness tests are given in table 4. arsov, s., the case of serbian joint-stock companies, ea (2016, vol. 49, no. 1-2, 1-14) 11 table 4. robustness check dependent variable manufacturing full data set large companies small companies constant 0,438** -0,031 -0,221 0,168 (0,214) (0,204) (0,426) (0,250) tangibility -0,490*** -0,366*** -0,506*** -0,218*** (0,064) (0,060) (0,091) (0,072) size 0,026 0,059*** 0,084** 0,043* (0,019) (0,018) (0,035) (0,026) profitability -0,443*** -0,322*** -0,559*** -0,347*** (0,090) (0,100) (0,136) (0,113) investments 0,123* 0,004 0,086 -0,065 (0,073) (0,071) (0,085) (0,102) risk -0,223 -0,158 0,204 -0,694*** (0,189) (0,206) (0,288) (0,247) tax -0,223*** -0,080*** -0,209*** -0,084 (0,190) (0,026) (0,064) (0,074) no. of observations 220 202 135 138 adjusted r2 0,304 0,283 0,350 0,199 prob (f-statistics) 0,000 0,00 0,000 0,000 model used random effects random effects random effects random effects hausman test (prob. chi-sq.) 0,113 0,34 0,404 0,062 standard errors in parenthesis. *-significant at 10%, **-significant at 5%, ***-significant at 1% the robustness tests results are more than satisfactory. the signs of the tangibility, size, profitability and tax variables are confirmed in almost all the model applications. it is especially important that the model applied to the subsample of companies with full data confirms the initial findings with extremely high significance levels. conclusions the paper tries to make a contribution toward explaining the behaviour of the managers and companies in the former socialist economies regarding their capital structure. having this in mind, we have analyzed the serbian economy, using a sample of 51 joint-stock companies and their financial data for a 6 year period. the panel regression model provided us with results that were to some extent unexpected. as expected, we have concluded that the larger companies are more leveraged, which is explained by their assumed longevity and stability and also the more profitable companies have less debt, which should be a result of the availability of internal funds. however, the companies with higher share of tangible assets seem to use less debt, which is 12 economic analysis (2016, vol. 49, no. 1-2, 1-14) an unexpected outcome, since most of the banks require high-value collateral to be pledged when extending loans. in addition, the insignificant sign of the amount of investments in the previous several years is a little surprising, but the only possible explanation for this is that the companies have been using debt for purposes other than fixed-asset investments and/or the investments have been financed mostly from internal funds. the insignificance of the risk variable can be understood as a lack of reliance on the past earnings that the banks exhibit in the lending procedures. the robustness check has to a great extent confirmed the regression results. all of this induces us to think that the serbian companies follow some kind of modified pecking order in the design of their capital structures, although the support from the regression results is not very strong. they first rely on their internal funds, borrow when needed and issue securities only as a last resort. additionally, the low corporate tax rates and the negative sign of this regressor, fail to support the trade-off theory. at the end, we must make some notes regarding the study. the sample is quite small and its size could have affected the results of the study. however, the sample consists of the 50 companies with the highest stock market turnover on the belgrade stock exchange for 2014. as such, they should be quite representative for the serbian economy, but we suggest an extension of the study with other companies, as soon as the data constraint is overcome. references avarmaa m.; a. hazak; and k. männasoo. 2011. “capital structure formation in multinational and local companies in the baltic states.” 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rezultati regresije pokazuju da je leveridž analiziranih kompanija pozitivno povezan sa njihovom veličinom, a negativno sa materijalnošću njihovih sredstava, profitablinošću i efektivne stope poreza na dobit. iznenađuje rezultat da nije otkrivena povezanost između iznosa investicija u prethodnim godinama i nivoa zaduženosti. ovi rezultati ne daju dovoljno potpore ni za jednu od teorija strukture kapitala, međutim, najbliži su nekom obliku teorije redosleda finansiranja. ključne reči: struktura kapitala, leveridž, finansiranje, vlastiti kapital, tranzicija article history: received: 21 january, 2016 accepted: 15 february, 2016 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp60-78 original scientific paper marketing of public services: the impact of service quality, reputation and consumer engagement on customer perceived value, satisfaction and loyalty sanjay k parahoo1* | heather lea harvey2 | madhavi ayyagari3 1 business school, hamdan bin mohammed smart university, dubai, united arab emirates 2 hashemite university, school of medicine, zarqa jordan 3 murdoch university, dubai, united arab emirates abstract public services are provided by government and have been traditionally supply-oriented. changing citizen expectations put pressure on government agencies and public sector organizations to be accountable for efficiency and effectiveness. further, the quest to enhance international competitiveness by ranking high in the echelons of world’s best governments, led to the adoption of proven marketing philosophy and methodologies in the domain of public service as well. the present study aims at examining the impact of service quality, reputation and consumer engagement on customer perceived value, satisfaction and loyalty for an important public service viz., dubai metro which operated in an intensely competitive market. the study developed and empirically tested a structural model of travel behavior which hypothesized that reputation, quality and customer engagement are major drivers of value and value in turn leads to satisfaction and loyalty. the findings supported the model with reputation having a stronger impact than quality. a positive association was found between value, satisfaction and loyalty. however, consumer engagement was not found to have a significant influence on customer perceived value. key words: marketing of public services, service quality, reputation and consumer engagement, customer perceived value, satisfaction and loyalty jel classification: d4, h0 introduction citizen expectations from public services have registered a significant shift during the recent decades resulting in growing demands for transparent, accessible, and responsive services from the public sector. traditionally, governments have functioned with a supply-orientation, focusing on their own requirements and processes instead of the needs of the people they serve (dudley et al., 2015). the disenchantment with government performance, characterized by the bureaucratic public administration approach, gave way to the new public management paradigm which embodies a result oriented, entrepreneurial and citizen-centric management style (gaebler and osborne 1993). public sector was encouraged to draw from the experience and lessons learnt by the private sector in ensuring effective service design and delivery. gash et al., (2013) exhort: “government must urgently professionalize its approach to commissioning and overseeing public service markets, embracing what we call a ‘market stewardship’ approach.” * e-mail: s.parahoo@gmail.com sanjay k parahoo, heather lea harvey, madhavi ayyagari 61 moreover, governments face competition from other countries for attracting foreign direct investment. countries are vying with each other to enhance their competitive advantage and are rated on a number of indices related to government excellence. these challenges made transformation imperative. some government agencies have successfully adapted themselves and implemented a customer-oriented approach to service design and delivery. they also regularly evaluate customer satisfaction levels and aim at effecting continuous improvements. if marketing of services is more complex than that of goods due to their intangibility (e.g., parasuraman et al., 1988; zeithaml et al., 1985), the challenge is even greater in the case of public services which are complex value propositions that serve multiple publics (osborne et al 2013). data driven insights about citizen satisfaction and its determinants helps public service providers address the key elements for improving service design and delivery. in this context, the present study aims at examining the impact of service quality, reputation and consumer engagement on customer perceived value, satisfaction and loyalty for an important public service viz., dubai metro. the service chosen is highly competitive since mass rapid transport (mrt) faces intense competition from other modes of transport including personal vehicles. the government is encouraging residents to move from personal transport to the use of public transport as part of its sustainability strategy (uae state of green economy 2014). therefore, the objective of this study was to develop and empirically test a structural model of travel behavior based on variables such as satisfaction, value, quality, reputation and engagement that have been found to drive loyalty in various industry settings. it would therefore be useful to determine the pertinence of these variables in motivating riders to select mrt as their mode of transport, particularly for local authorities engaged in promoting the use of their mrt services. an understanding of the drivers of satisfaction would also contribute to the government’s aim of delivering services that rival the best in the private sector (mckinsey 2016). further, the study contributes to the neglected public service context in the service management literature (hodgkinson 2017) and captures insights that help the shift to servicedominant thinking within the public sector. literature review and development of conceptual framework public services public services are the services provided by the government (or its agencies) to those residing within its jurisdiction. unlike their private sector counterparts, public service delivery carries the mandate of ensuring universal access often associated with the fundamental rights of citizens and hence the service context is significantly different (van de walle 2016). for example, provision of healthcare and education is the responsibility of the government towards its citizens. another unique characteristic is ensuring justice involving fair and equitable treatment of all sections of society. the private sector firms can choose which segments they want to target, but the public services often have little choice in targeting segments that are accessible and profitable. public services are targeted at all segments and have to offer value propositions to various stakeholders and not just the users, making it a complex service (osborne et al 2013). mrt services and dubai metro mass rapid transit systems (mrts) are collective urban or suburban passenger services operating at high levels of performance, particularly with regard to travel times and passenger carrying capacity (cdm, 2010). they are more efficient time-wise for consumers and have numerous environmental benefits as compared to private transportation, leading to many cities adopting strategies to encourage this shift in ridership (fouracre, 2003). dubai metro, launched in 2009 to cater to the transport needs of a modern city (pr 2.0, 2011), was chosen as the 62 economic analysis (2018, vol. 51, no. 1-2, 60-78) empirical context of this study. dubai metro is a fully automated system with a total length of 74.7 km, and the longest driverless metro network in the world. furthermore, summer weather conditions in dubai serve as a conduit to the posh air conditioned malls being a social space where residents and visitors spend considerable time. the linkage of the dubai metro to the city’s major shopping malls therefore helps in reducing traffic congestion since the malls generate 4 000 to 10 000 vehicles per hour (maitha, 2011), while the connection of the metro network to the international airport provides tourists with increased mobility. the monthly number of metro users has increased from 1.8 million passengers in october 2009 to 5.5 million passengers in october 2011, with the cumulative total number of passengers crossing 275 million in the first half of 2017 accounting for 36.4 percent of all public transport ridership (dubai metro, 2017). financially, the metro project cost the rta approximately us$ 7.6 billion, but authorities are expecting the metro to generate us$ 4.9 billion in income over the next 10 years (wikipedia, 2012). dubai shares a profile similar to other metropolitan hubs and expanding urban centers in the region, consequently making the findings generalizable to other regional cities that are launching mrt projects, including abu dhabi, riyadh and doha. even though there are considerable advantages to draw consumers to mrt usage, many mrt schemes have experienced severe financing and debt repayment problems due to poor financial returns, resulting in public authorities inevitably being involved in financially supporting the projects (fouracre, 2003). for this reason, it is crucial for management of mrt services to develop passenger loyalty to motivate maximum ridership so as to maximize revenue from the mrt operations to help recoup the large investments associated with launching and operating mrt projects. hence, loyalty is chosen as the output variable of the study model and its drivers and their relationships are next discussed through a review of the extant literature. dependent variables customer loyalty customer loyalty, or one’s intention or predisposition to purchase from the same firm again is a key construct within the service industry (edvardsson et al., 2000). the motivation for understanding and improving loyalty emerges from empirically validated studies linking customer loyalty and profitability (turel and serenko, 2006; and oliver, 1997). in practice in the mrt context, this translates into commuters in a city adopting the service on a regular basis ahead of other transportation alternatives. industry experience shows that has not always been easy to achieve with seoul mrt initially reporting half of the forecast occupancy (chang and lee, 2008), while for chennai’s mrt the corresponding occupancy was only 10 % (madhavan, 2010). loyal customers also act as prescribers, spreading positive word-of-mouth (reichheld and teal, 1996) which may increase the utilization of the service. since, the mrt is a perishable service, unoccupied capacity on a train journey cannot be inventoried and sold later, thereby representing lost revenue. further, while operating a train journey involves high fixed costs increasing the number of passengers transported represents only marginal cost increases. given the inherent flexibility in transportation capacity of mrt by accommodating standing passengers in a train compartment, it would be desirable from purely profitability considerations that mrt trains operate ideally near maximum capacity or in factoring in passenger comfort, near optimum capacity. customer satisfaction customer satisfaction has been identified as a key determinant of customer loyalty (e.g. deng et al., 2009; liang et al., 2009; ha and john, 2010), and as a key global construct for predicting consumer behavior (garbarino and johnson, 1999). it represents the core construct of sanjay k parahoo, heather lea harvey, madhavi ayyagari 63 marketing, and has been defined as “a judgment that a product or service feature, provides a pleasurable level of consumption-related fulfillment” (oliver, 1997). the pertinence of satisfaction as a driver of loyalty is well recognized in the mrt industry illustrated for example by melbourne mrt where performance figures have been linked to customer satisfaction ratings (metro, 2012). in dubai, serco, the dubai metro management company stated: “the dubai metro is similar to a railway system we run in the uk that has customer satisfaction levels of at least 90% and close to 100% availability for services such as ticket machines, escalators and information displays” (www.joindubaimetro.com/serco.asp). the preceding discussion leads to the following hypothesis: h1: passenger satisfaction with dubai metro is positively associated with customer loyalty. perceived value satisfaction is often conceptualized through its key antecedent perceived value (e.g. mc dougall and levesque, 2000; butcher et al, 2001; cronin et al., 2000), and has been defined as the consumer’s overall assessment of the utility of a product based on their perceptions of what is received and what is given (zeithaml, 1988), or a cognitive trade-off between quality and sacrifice (lee, 2010). value has been proposed to be the core purpose and central process of economic exchange (vargo and lusch, 2008), and as a stable construct to predict loyalty (nguyen, et al., 2018; trasoras et al., 2009; pura, 2005; and hellier et al., 2003). but while traditional models of value creation have focused on the firm's output and price (e.g. kleine et al., 2009), vargo and lusch (2008) have shown that value is fundamentally derived and determined by use rather than in exchange. this leads to the following two hyotheses: h2: value perceived by passengers of dubai metro is positively associated with their satisfaction. h3: value perceived by passengers of dubai metro is positively associated with their loyalty. independent variables service quality one’s cognitive evaluation of the service experience (ha and john, 2008) or “judgment about the superiority or excellence of a product” (parasuraman et al., 1988), is known as service quality. it may be influenced by consumer preferences such as utilitarian benefits (roy and ng, 2012). in the airline industry, service quality has long been considered as key to supporting a differentiation strategy (bamford and xystouri, 2005; rhoades and waguespack, 2008), between what might otherwise be considered as a homogeneous service. therefore, service quality has become an expectation of customers that businesses strive to meet or exceed, including the rta who as part of their mission seeks to provide ‘quality service’ of the highest standard to all dubai metro passengers (rta, 2011). value represents a cognitive trade-off between perceptions of quality and sacrifice (lee, 2010), with quality identified as what one gets, whereas sacrifice is seen as what one gives up (drew and bolton, 1987). under constant gives, when higher service quality is perceived by customers, this will lead to an increase in benefits derived from the product or service, indicating that value is also increased. this perceived service quality-perceived value relationship has been empirically demonstrated by many authors (e.g. butcher, et al, 2001; parahoo, 2012; lee, 2010;). therefore, the following hypothesis emerges: h4: service quality perceived by passengers of dubai metro is positively associated with the value perceived 64 economic analysis (2018, vol. 51, no. 1-2, 60-78) reputation reputation is important to a service organization as it represents a valuable intangible asset (vidaver-cohen, 2007). three related terms have been used interchangeably: in the reputation literature: organizational identity, organizational image, and corporate reputation (barnett et al, 2006). but in actuality, the three constructs may be differentiated in terms of whether they refer to internal or external stakeholders, or both. helgesen and nesset (2007) state that organizational identity refers solely to internal stakeholders, organizational image to only external stakeholders alone, while corporate reputation to refers to both internal and external stakeholders, particularly employees and customers. corporate reputation has therefore been defined as the collective judgments of a corporation based on assessments of the financial, social, and environmental impacts attributed to the corporation over time” (barnett et al, 2006, p 34). furthermore wang et al. (2004) acknowledged the critical role of reputation, where an organization’s reputation is based on its past actions (nguyen and leblanc, 2001). and as expected, developing a good reputation is crucial to a business as it leads to value creation (roberts and dowling, 2002). in the transportation industry, the influence of corporate reputation on consumer behavior is well documented, with airline passengers developing a reputation judgment of a service which then influences their consumer behavior in the service (graham and bansal, 2007; parahoo, harvey, and radi, 2014). in mrt industry, public authorities setting up mrt schemes have consequently focused on positioning their service to reflect a positive image and reputation illustrated by singapore’s mrt representing a symbol of “smart singapore” (richmond, 2008), by dubai metro with its aesthetically designed modern stations, and having the longest driverless metro system in the world (gulf news, 2012), and with chennai’s mrt having “15odd futuristically-designed stations” each having parking spaces (madhavan, 2010). the appeal of metro services, particularly for passengers who have an alternative choice for transportation, therefore depends on its reputation. branding and reputation development are prominent in the marketing strategies of firms, as customers prefer not to patronize a service that does not have a good reputation, as this affects their self-image (kwak, and kang, 2009). it has been argued that a good reputation is crucial as it leads to value creation (roberts and dowling, 2002). therefore it was important to effectively incorporate the effect of reputation of mrt services in the study model, particularly since consumer reputation studies in the field have been scarce (graham and bansal, 2007); mostly concentrating on theoretical reasoning, and lacking empirical research designs (jarvinen and suomi, 2011). the above discussion leads to the following hypothesis: h5: reputation of dubai metro is positively associated with perceived value. consumer engagement finally, traditional consumer behavior models have considered passengers of public transport passive consumers, while management created ‘value-in-exchange’ (lovelock et al., 1987) using methods such as improving efficiency and punctuality of traffic services, and enhancing travel comfort (knutsson, 2003). however, the emerging service-dominant logic literature has shifted to operant resources, which are considered as core competences or organizational processes, with customers acting as active participants in relational exchanges and as co-producers of the service. within the service-dominant logic paradigm, management involves social and economic processes largely based on operant resources with which the firm is striving to make better value propositions than its competitors. it is often debated as to whether an enterprise may create value independently, or may only do so collaboratively following acceptance of its value propositions by customers (vargo and lusch, 2008). in the present study, the construct of engagement adopted an ongoing emotional, cognitive and behavioral activation state in sanjay k parahoo, heather lea harvey, madhavi ayyagari 65 individuals (wefald and downey 2009), for the engagement of passengers in public-transport has been shown to be a major driving force behind consumer behavior and decision making (vargo and lusch, 2008), and to be proactively co-created as value-in-use by engaging customers in the service process (gebauer et al., 2010). therefore, it is proposed: h6: customer engagement in service co-creation is positively associated with perceived value these hypotheses are represented by the structural model below (see figure 1). figure 1. conceptual structural model source: developed based on literature review above the conceptual model incorporates the hypothesized drivers of loyalty and their interrelationships in an mrt setting. in the next section, an empirical study is designed to determine the influences, if any, of two specific constructs, reputation and engagement, which have rarely been investigated quantitatively in driving passenger loyalty in mrt service, thereby filling a gap in the literature. methodology to develop measures for the six study constructs, a pool of items was constituted by sourcing from literature validated measures that matched the conceptualization of each of the related constructs in the present study. to supplement and contextualize this pool of items, 20 openended interviews were conducted with passengers at 4 different metro stations, followed by indepth interviews with the managers at the stations. the resulting draft questionnaire (40 items) was discussed with industry experts, and pilot tested with seven passengers which led to some minor refinement of question wording. all items were measured on a seven point semantic differential scale from strongly disagree to strongly agree. an overall measure of each study construct was also included in the questionnaire to assist with item purification. the sampling frame was designed after consultation with industry experts to constitute a representative sample of passengers using the metro. it involved selection of seven stations (out of 28) on the red line and four stations (out of 18) on the green line. personal interviews were conducted as it enabled clarification of any queries, and the data collection was completed during a one week period at various times of day and on multiple days to capture different categories of passengers. a total of 520 passengers were interviewed by a trained interviewer with 511 represented usable responses, and the data analysis was derived using spss (questionnaire purification and descriptive analysis) and lisrel (modeling) software packages. purification of questionnaire the measures for the study constructs were purified using item-to-total correlations (churchill, 1979), as well as correlation with an overall measure of the related construct (e.g overall how would rate the service quality of the metro?). at this stage, items having loadings greater than 0.7 on their associated construct were retained (fornell et al, 1982). this process purified the 40-item pool to 18 items (see table 1). 66 economic analysis (2018, vol. 51, no. 1-2, 60-78) a necessary condition for assigning meaning to estimated constructs is that the measurement items postulated as alternate indicators of each construct must be unidimensional (gerbing and anderson, 1988). the retained 18 items were therefore subjected to a confirmatory factor analysis (cfa) to establish the unidimensionality of the measurement scales. while the p value associated with the chi-square statistic was significant, it is known to be sensitive to sample size. therefore, other fit indices were investigated which pointed to an good fit of the model according to prescribed criteria (e.g. hu and bentler, 1999): chi-squared to degrees/ degrees of freedom (322.68/120) =2.69; ifi=0.99; gfi=0.93; srmr=0.033; rmsea=0.056. the measurement models reflecting the study constructs were confirmed to be one-dimensional and each measurement item having a path loading exceeding 0.70 on its associated latent variable, with the loading being statistically significant at p<0.05. reliability of the model was determined using cronbach alpha with each of the 6 scales having alpha values generally > 0.70, indicating excellent reliabilities (see table 1 below). in addition to reliability, a measurement scale must demonstrate validity and hence several forms of validity were next measured. concurrent validity was measured by correlating the composite score of a construct scale with the overall measure of the same construct, and construct validity was captured by the correlation of the composite score of a construct scale with a related measure (their outcome variable as per figure 1). the high values of the pearson correlation coefficients and their statistical significance (p<0.01) for both concurrent and construct validity confirmed the validities of the six study constructs (see table 1). table 1. summary characteristics for scales of constructs construct initial no. of items final no. of items after purification cronbach alpha concurrent validity: correlation construct validity: correlation. quality 17 3 0.81 0.535 0.698 reputation 4 3 0.82 0.584 0.728 engagement 4 2 0.71 0.434 0.529 value 7 3 0.80 0.429 0.729 satisfaction 3 2 0.77 0.606 0.727 loyalty 5 5 0.91 0.626 0.727 (*all correlations are significant at 1 percent levels with p<0.001) source: constructed from data analysis statistics in spss one final measure was further undertaken to determine discriminant validity by constructing a 95% confidence interval (± two standard errors) around the correlation estimate (φij) among each of the exogenous latent variables (anderson and gerbing, 1988). none of the confidence intervals included unity, with values of 0.77-0.89 for quality-reputation, 0.49-0.65 for qualityengagement and 0.62-0.78 for reputation-engagement, thereby confirming discriminant validity among the constructs. having ascertained reliable and valid unidimensional measures for the study constructs, data analysis was undertaken followed by modeling to test the study hypotheses. data analysis and discussion descriptive analysis and discussion of findings it was observed that the metro passengers represented a mix of different age groups, however nearly 84% were 40 or younger (see table 2). in terms of gender, males (57.3%) slightly outnumbered female passengers, while there were approximately equal proportions of singles sanjay k parahoo, heather lea harvey, madhavi ayyagari 67 (49.7%) and married respondents. the respondents came from a wide range of occupational types, with well over 65% holding administrative positions and above (see table 3). table 2. age distribution source: primary data table 3. type of occupation source: primary date dubai’s cosmopolitan profile was reflected in the nationalities of the respondents as shown in table 4. arabs constituted the most common users of the metro (35.4%), followed by europeans (28.8%), and asians (25.8%) comprising indians, pakistanis and philipinos. in addition, nearly a third (33%) of the users identified themselves as tourists. table 4. nationality of respondents source: primary date among all dubai mrt riders, 28.1% reported owning a vehicle, moreover 32% of local residents were car owners. further analysis to make sure non-resident riders were not a 68 economic analysis (2018, vol. 51, no. 1-2, 60-78) confounding variable was analysed but not found to be significant. but frequency/usage status showed that among riders just over half were heavy users (50.8%, with a metro usage rate of 11-30 days per month), while 19.5 % used the metro more moderately (1-9 days/month), with the rest using the metro even less frequently. thus management needs to identify a means to motivate casual riders to use the metro more regularly. on a more positive outcome more than three-quarters (77%) of passengers reported having used metros in other countries, and 91% of these respondents rated dubai metro better than the metro they used elsewhere. but while the majority had a positive rating for the mrt, passengers had mixed feelings regarding accessibility of feedback mechanisms. there was considerable room to increase forums for interactions with customers. finally, the respondents’ ratings on the six study variables were generally quite high, (see table 5) with one exception, engagement. while this is a very positive signal for metro management and reflective of current success in their operations, it does not preclude continuous improvement efforts as customer needs are known to be dynamic. table 5. mean ratings on study constructs quality value reputation engagement satisfaction loyalty mean 6.2050 6.0049 6.2162 5.6833 6.0078 6.2537 std. deviation .98711 1.10001 1.02355 1.31868 1.15212 1.08217 source: constructed from data analysis in spss testing of hypotheses by structural equation modeling the conceptual model depicted in figure 1 along with the measurement models associated with each of the latent variables were tested using lisrel 8. an inspection of the measurements models confirmed that the measurement variables were good indicators of the constructs, with statistically significant loadings over 0.70 and much smaller corresponding error terms. further, an evaluation of the structural model confirmed that all model paths were statistically significant (p<0.05), except for the path from engagement to value (t = 1.47, and path loading= 0.08), indicating that the postulated relationship between engagement and value based on theoretical considerations was not empirically supported by the data. as a result the model was reformulated by deleting engagement as well as its two associated measures, and a path analysis was again run with the revised model. the new output files showed that all the paths in the measurement and structural models were now significant at p<0.05 (see figure 2). the chi-square statistic was non-significant (p<0.000) and too sensitive to sample size to be used in the present study having a large sample size. the path loadings in the structural model were as postulated by the six study hypotheses (see figure 3). therefore other fit indices were examined and they supported a good fit of the model to the data (chi-square/df = 258.45/98=2.64; gfi= 0.94; agfi=0.92; rmsea= 0.057; srmr=0.032; nnfi= 0.99; cfi=0.99). it may therefore be concluded that the study hypotheses (h1-h5) proposing quality and reputation as drivers of the hierarchical marketing chain represented by variables valuesatisfaction-loyalty could be accepted, while the relationship between engagement and value (hypothesis 6) was not supported. in this regard, it was noteworthy that reputation and quality exerted strong indirect effects of 0.67 (t=9.11) and 0.15 (t=2.24) respectively on loyalty, thereby emphasizing the major influence of reputation as the primary driver of loyalty. sanjay k parahoo, heather lea harvey, madhavi ayyagari 69 figure 2: t-values of paths in structural and measurement models source: lisrel output figure 3: paths in the structural and measurement models source: lisrel output discussion and implications theoretical as a result of the study analysis, the passenger behavior model in mrt services – which posited that reputation and quality are the major variables that drive the marketing chain valuesatisfaction-loyalty for passengers using dubai metro was empirically validated, with the 70 economic analysis (2018, vol. 51, no. 1-2, 60-78) exception of passenger engagement, which was not found to have a significant influence on value perceived by passengers. while the positive association between value, satisfaction and loyalty was expected having been determined in studies in other industry contexts (e.g. cronin et al., 2000; lee, 2010), the major contribution of this study was in identifying reputation and quality as drivers of loyalty for dubai metro passengers. the study model explained 85%, 76%, and 64% of the respective variance in the three dependent variables: value, satisfaction and loyalty, which was encouraging particularly in view of the model’s parsimony. the role of service quality in influencing consumer behavior in various services is well documented in literature (e.g. lee, 2010; parahoo, harvey, and tamim, 2013, ahrholdt, gudergan, and ringle, 2016). specifically, in the transport industry, various studies have identified service quality as a major determinant of airline positioning (rhoades and waguespack, 2008), and in influencing demand for public transport (paulley et al., 2006). therefore, the present study confirms the influence of service quality in driving passenger behavior in the context of dubai metro as well. what was more unforeseeable however was that reputation exerted a much stronger effect on the value-satisfaction-loyalty chain than quality, demonstrated by an indirect effect of 0.67 (t=9.11) for reputation on loyalty compared to quality on loyalty 0.17 (t=2.24). this overriding influence of reputation in influencing travel behavior in a mass public transport service is not common, with the influence of reputation being previously associated with more exclusive transport services such air travel. in fact, anecdotal evidence shows that in commuting between cities business executives generally opt for air rather than rail travel (a mass public transport) even if the journey time differential between the two travel modes is practically the same. the study findings that reputation is the key variable driving passenger loyalty in what could be considered as a less exclusive transport modemetro services -is therefore innovative, particularly that mass public transport is a visible service likely to affect its passengers’ selfimage. the reasons for this shift in consumer attitude and behavior therefore needs to be investigated further. at this stage, it may be proposed that a shift in traveler expectations towards a “smart way to travel” is illustrated by one indicator of the reputation construct (see annex). this seems to be supported by several mutually reinforcing underlying factors. first of all, in an era of growing environmental consciousness, using a cleaner and more efficient mode of transport becomes a lifestyle statement likely to boost a traveler’s self-image. further, dubai metro is based on stateof-the art infrastructure and facilities, with aesthetically designed stations, excellent functional passenger flow, and a good network of connecting allied transport services, which reinforces its image and reputation, making it desirable for various passenger segments. finally, the image of the metro with its futuristic design and image mirrors that of the emirate of dubai projecting global standards of modernity and excellence, thereby motivating its use. a parallel could be drawn here with the mrt service in singapore, a city state to which dubai is often compared, with singapore being described as having a “reputation as a well-oiled city-state, replete with a peerless transport system” (mahtani and wong, 2011). as a conclusion, enhancing the reputation of the metro is the factor that will motivate its enhanced patronage. the lack of empirical support for the influence of engagement on the value-satisfaction-loyalty chain warrants further discussion, for it contrasts the emerging literature on service-dominant logic, as well as recent studies (e.g. gebauer, 2010, edvardsson et al., 2011). it is recognized that consumers increasingly wish to act as active participants within relational exchanges with the service firms to cocreate value for themselves (vargo and lusch, 2008). instead of concluding that engagement of passengers is not a driver of their loyalty, it is proposed that the conceptualization of engagement measures in the study may be a cause for its weak non– significant effect in the study model. in hindsight, this lack of support for engagement as a driver for value may have been linked to the fact that engagement was measured in the present study sanjay k parahoo, heather lea harvey, madhavi ayyagari 71 on the ability (e.g. “i play an active role in my travel by using self-service equipment at dubai metro stations”) rather than the willingness of customers to co-create the service (see item details at annex). for 41.9 % of passengers reported they did not have easy access to a feedback system, thus their engagement was not readily facilitated by management, implying they could not effectively participate in value co-creation, reflected by engagement scoring the lowest average rating among study constructs (see table 5). to rectify a similar situation in future studies, it would be appropriate to measure customer engagement by customer willingness rather than their ability to co-create the service, for the ability to be engaged is moderated by the design of the service process by its provider. the empirically validated travel behavior model in public transport services in dubai, identified and highlighted the major role of reputation as a driver of passenger loyalty, contributes a new insight to the sparse literature of public transport usage which has so far emphasized mainly service quality and passenger satisfaction to drive usage. the multiethnic profile of residents and economic development stage of dubai make the study findings generalizable to public services being offered in highly competitive contexts. managerial the major decision problem that operators of an mrt system face is how to increase their ridership to maximize revenue generation in order to recoup their investments in infrastructure and operational costs, as well as to achieve environmental benefits associated with clean, safe and efficient travel. the present study has demonstrated that to achieve enhanced ridership on the metro, management must focus on developing its reputation and enhancing the service quality offered, for these two variables had significant effects on driving the value-satisfactionloyalty chain with path loadings (gamma) on value of 0.77 (t=9.01) for reputation and 0.17 (t=2.24) for quality. the validated measurement model for reputation (see wording of items at annex) also demonstrates that dubai metro management should focus on image or brand development as well as positioning the metro as a “smart way to travel” by highlighting its lower cost of travel, its associated environmental benefits, and its stress free travel experience (e.g. no traffic jam, comfortable journey). while, for service quality, metro management needs to maintain their emphasis on the quality of infrastructure, pleasant design and excellent passenger amenities at the stations, the quality of service at stations, enhance the passengers’ experiences through the ambience created through interior design, signage and a sound system that matches the positioning of the metro as representing global standards of modernity and excellence. in actual practice, dubai metro management has been successful in increasing its ridership and has opened up new lines and stations since 2009, by precisely focusing on image development and offering a quality service both through human intervention (ticket counters) as well as automated ticketing machines. this is confirmed by the overwhelming majority of passengers of various nationalities (see table 4) who have used metro services overseas, and who rate dubai metro as a better service. while this is an encouraging and motivating situation, in perspective of continuous improvement, efforts must be sustained to maintain the reputation of the metro. for example, the pr campaign of (free) public transport day on november 1, where national leaders, top executives, and private transport users are encouraged to swap their cars for the metro, is a good approach for building the metro’s reputation. targeted advertisement campaigns to car owners, emphasizing the environmental benefits of the metro, as well as its stress free riding experience, may encourage even more residents to swap their cars for the metro, for currently only 32% of the local transit riders reported owning a vehicle. in addition, there is an opportunity to engage the senior managers (among the 41.4 % of users in managers/directors category) in a long-term relationship by proposing monthly 72 economic analysis (2018, vol. 51, no. 1-2, 60-78) passes for first class travel. this service may be leveraged through value added services such as provision of reserved car parking spaces at the park and ride stations, and incorporating free wi-fi in the first class compartment. other services may be offered to these high-end passengers resulting in a win-win partnership, based on qualitative research, for with more executives being encouraged to use the service, the process would enhance the reputation of the metro, and, this could have a multiplier effect on other segments of passengers as well. in a perspective of continuous improvement, metro management should focus on continual feedback from their customers both through visible suggestions boxes at stations as well as electronic means in an attempt to track their expectations, which may then be considered for implementation which would enhance their satisfaction. for example in the present study, certain passengers willingly contributed numerous valuable suggestions: proposing that passengers should be educated to keep clear of the train entrance and to be prepared to exit before reaching their destination; requesting for seats on platforms; and better directional signs to dubai mall. such comments from passengers, if effectively implemented, could lead to higher value and satisfaction. limitations and future research although this research was carefully designed, there were inevitably some limitations: for safety reasons it was not possible to conduct the survey inside the trains, which may have provided a more relaxed atmosphere for the interviews. in addition, while the findings may be generalizable to other cities in the region that are launching metro services with which they share similarities including: customer demographics, economic development stage, and state of infrastructure, it may not be extended to metropolitan hubs in the west (european and us markets) where the higher gas prices may be a driving factor for use of mrt in the western cities. since very few academic studies have investigated passenger behavior in mrt services, there are various future research directions. confirmatory studies should be conducted in other metropolitan cities to determine generalizability of the study findings in other markets, and it would be pertinent to use in-depth studies to delve deeper into the reasons why reputation plays such a key role in influencing consumer behavior in dubai. in addition qualitative techniques may be used to determine how customer engagement may be further enhanced in metro services. such techniques may also shed light on the unexpected lower effect of quality on value, as compared to reputation. further research can also aim at understanding customer journey and customer experience as a source of innovation for enhancing customer delivered value in public service management. conclusion the present study has validated a model of travel behavior in dubai mrt industry demonstrating that a good reputation associated with the metro as well as delivering a quality service were the factors driving passenger loyalty, with the effect of reputation on value being over 4 times that of quality on value. the travelers considered a good reputation to be primarily associated with a positive image as well as the metro representing a smart way to travel. quality was associated with excellent stations, appealing physical infrastructure and a pleasant ambience. various suggestions have been made to support management to enhance metro ridership by focusing primarily on enhancing its reputation, which will help to increase revenue for the metro operator. furthermore from a perspective of social responsibility the city benefits due to reduced traffic congestion, decreased road accidents and reduced carbon emissions thereby improving quality of life, and reducing the negative carbon footprint. thus the study makes a contribution to enhance value not only for the specific user groups but to the larger goal of enhancing the effectiveness of sustainable public services. sanjay k parahoo, heather lea harvey, madhavi ayyagari 73 references khaleej times. 2017. 275m use dubai public transport in first half of 2017. august 5. retrieved from https://www.khaleejtimes.com/nation/dubai/275m-use-dubai-public-transport-infirst-half-of-2017. accessed on 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however, the relationship is rarely scrutinized. this manuscript attempts to contribute to the literature through investigating the role of corporate entrepreneurship on innovation performance of the firms. a quantitative research design is used to study the relationship between corporate entrepreneurship and innovation performance of the firms. to do so, 178 firms, in three main cities of iran, were studied through a survey. results show that corporate entrepreneurship affects the rates of process innovation and product innovation, as well as the technology indicators of the established firms. some contradictory evidence is also mentioned in the findings, which are elaborated future researchers. the originality of the manuscript goes back to studying the concept in an emerging market, i.e. iran. also, technology indicators are rarely discussed in the literature, which are studied in this research. it is advised, based on the findings, to improve process innovation as well as product innovation, along with technology indicators through improving corporate entrepreneurial activities. the main limitation of the research was to encourage managers to complete the questionnaire. to handle this limitation, the researcher held face to face meetings, in order to increase the response rate. key words: corporate entrepreneurship, innovation performance, established ventures, iran introduction entrepreneurship, at both individual and corporate levels, is becoming an integral part of any innovative atmosphere (bharadwaj and menon, 2000). today's companies vigorously striving to become more and more entrepreneurial (morris et al., 2010). since they understood that there are many benefits associated with corporate entrepreneurship (ce), in the last three decades a considerable wave is shaped (dunlap‐hinkler et al., 2010). moreover, as mentioned in this manuscript, to some scholars, innovation performance is highly dependent on entrepreneurial activities. however, this argument is not supported in the extant literature (otache and mahmood, 2015). there are several approaches in investigating ce which led to a variety of definitions. however, the present study is developed based on three main models of ce. the story is the 1 email: zahra.minafam@mail.com minafam, z., corporate entrepreneurship, ea (2017, vol. 50, no. 1-2, 62-76) 63 same for innovation performance. the relationship between these two is also controversial. to some scholars, corporate entrepreneurial activity is a function of different types of innovation performance in an entrepreneur firmin which corporate entrepreneurship is realized (chen et al., 2014). however, to others there are moderating variables which affect such relationships (sykes and block, 1989). innovation-based corporate entrepreneurship is a trend which focuses on this area of research to clarify the potential relationships and their specifications (dunlap‐hinkler et al., 2010; salamzadeh and kirby, 2017). this research also stands in the same stream, which tries to investigate such relationship in a less studied context, i.e. iran. moreover, most of the few research conducted in this context had dealt with individual level variables such as entrepreneurial orientation (e.g. madhoushi et al., 2011; khalili et al., 2013). thus, for ce, a questionnaire was designed based on morris and kuratko (2002), miller (1983), and ireland, kuratko and morris's (2006) questionnaires; and for ip, wong and chin's (2007) conceptualization of the phenomenon is used. in a nutshell, this manuscript attempts to contribute to the existing literature through investigating the role of corporate entrepreneurship on innovation performance of the firms. to do so, first the existing literature is studied. then, conceptual model and indicators are defined. findings are presented afterwards, and the paper concludes with some remarks and suggestions for future research. literature review corporate entrepreneurship (ce) over the past decade, ce has been extensively followed by senior managers and scholars as an effective means for stimulating firms and increasing their productivity (zahra and covin, 1995). it refers to cases where firms, rather than individuals or strategic business units, act in entrepreneurial ways (covin and miles, 1999). in fact, this could be of paramount importance for surviving and renovating the existing firms and making them more profitable (zahra, 1996; kuratko et al., 2014). ce, which entails a multifaceted process due to the challenges regarding the pre-existing structures and processes of the firms, is a behavioral phenomenon. thus, all firms are situated in a continuum that ranges from highly conservative firms to highly entrepreneurial firms (barringer and bluedorn, 1999; morris et al., 2010). this is the case, even, for those firms which rarely attempt to reveal an entrepreneurial image, but are innovative in nature (radovic markovic and salamzadeh, 2012). through its evolution, ce underwent many changes, both in its nature and definition. in a recent definition, ce is defined as a process through which employees of organizations undertake new activities, follow innovative patterns, or show interest in departing from routine processes in order to explore, create, or pursue profitable opportunities (garcíamorales et al., 2014). it is entrepreneurship which involves fostering entrepreneurial behaviors within an established organization (mason, 2011). however, according to some old definitions, ce is defined as the ability of a firm to explore and exploit opportunities without being inhibited by limitations of resources, rules and regulations, as well as managerial decisions (otache and mahmood, 2015). as verma (2013) argues, it encompasses three types 64 economic analysis (2017, vol. 50, no. 1-2, 62-76) of process, i.e. innovation process, venturing process, and strategic renewal process (salamzadeh et al., 2016). furthermore, some authors suggest that due to the existing interactions between different characteristics of individuals, organizations, and according to the contextual factors, the nature of corporate entrepreneurial activities might alter over the lifecycle of any typical firm (fini et al., 2012).s in sum, since the beginning of the 1980s, many academics and experts have shown interest in the corporate entrepreneurial activities owing to its valuable effect on the revival and productivity of firms (urbano and turró, 2013). however, some scholars contended that corporate entrepreneurial activities could not appear in large firms, still there are a growing number of advocates for corporate entrepreneurship. therefore, as we could see, in the last decade of the 20th century the “corporate entrepreneurship" was emerged as a scientific field of study (paunović, 2012). while western scholars' work provides a foundation for explaining and predicting how ce goes on in western countries, the author finds it necessary to pay attention to this concept in developing economies (e.g. see analoui et al., 2009; maatoofi and tajeddini, 2011). the present study is developed based on three main models of corporate entrepreneurship: (i) miller (1983): according to his view, the process through which firms renovate their entity as well as their markets by pioneering, innovation, and risk taking, shows the corporate entrepreneurial behavior of the firm; (ii) morris and kuratko (2002): in their book, they tried to explore the concept of ce in established firms. they highlighted different aspects of corporate entrepreneurial activities and corporate entrepreneur firms; and (iii) ireland et al. (2006): in this distinguished works, the authors described ce and its significance for corporate innovation activities. moreover, they identified the categories which must be considered while designing a ce strategy for a firm. finally, they enumerated the reasons behind ce and depicted a supportive environment (see table 1). innovation performance (ip) according to the literature, the consequences and effects of corporate entrepreneurship are mirrored in two types of activities, i.e. (i) strategic renewal of the firms, and (ii) the performance/new venture creation activities (gómez-haro et al., 2011). despite the fact that a firm's approach toward corporate entrepreneurial activities directly affects its performance, one could develop a more inclusive explanation, based on the fact that this approach might develop and extend the firm's status (simsek and heavey, 2011). scholars of ce research have conventionally put more stress on ways in which individuals could create constructive changes within their firms (dunlap‐hinkler et al., 2010). innovation performance is variously defined by several authors. for instance, it is defined as the degree to which new products goods and servicesmeet their expected goals in the market (wang and lin, 2012), or as the extent to which new products have attained their share in the market, promoted sales, and increased the rates of asset return, investment return, and respectively met profit goals (chen et al., 2014). in fact, innovation performance, the output of a firm's innovation efforts and innovative inputs, has been permanently a crucial concern for state-of-the-art firms (wang and lin, 2012). moreover, improving innovation performance is critical to an overall understanding of minafam, z., corporate entrepreneurship, ea (2017, vol. 50, no. 1-2, 62-76) 65 the concepts of learning, creativity, as well as innovation within firms (bharadwaj and menon, 2000). but, one should note that ip varies widely across industry segments and organizations (lee et al., 2015). hopefully, there are several measures to gauge ip and the economic consequences of innovative products/services (guan et al., 2009). in other words, in the extant literature, numerous managerial factors have been linked with the performance of innovation in innovative firms (wong and chin, 2007). in the present study, wong and chin's (2007) conceptualization of the phenomenon is used, which includes three main groups, i.e. (i) product innovation rate (including: number of changed product/total products, change in sales/total sales; and change in profit/total profit); (ii) process innovation rate (including: number of process changes/total processes; and change in overall productivity due to product change); (iii) technology indicators (including: percentage of expenditure on r&d/total sales; number of externally adopted technologies; and number of internally developed patents). corporate entrepreneurship and innovation performance in order to elaborate the relationship, according to the extant literature, the following hypotheses are proposed. indeed, product innovation is a crucial topic for any firm which tries to compete in this competitive world. as the pace of technologies and science becomes faster than before, product innovation turns to a more critical issue to be considered by firms that are striving to succeed (chen et al., 2015). moreover, today, within firms with corporate entrepreneurial approach, the extent to which new product development is considered vital and followed by its members is higher than others (kuratko et al., 2015). thus, it is important to measure the rate of product development in order to succeed in this rivalry. on the other hand, the existing literature suggests that it is a part of the most of corporate entrepreneurial movements (kuratko and audretsch, 2013). according to jennings and young (1990), there are distinctions between objective and subjective measures of the product innovation domain of ce. they even tried to highlight these measures. zahra (1996) elaborated this issue, but still there were some cases in which there was not a necessary relationship between ce and product innovation. more recently, some scholars confirmed this relationship in a series of cases (chen et al., 2014). however, the topic is not studied in developing/emerging economies (kuratko et al., 2015). thus, the first hypothesis is proposed as follows: h1. there is a significant relationship between corporate entrepreneurship and the rate of product innovation of the established firms. another factor to be studied is process innovation, which is extensively used among corporate entrepreneurial firms (kuratko et al., 2014). there are many benefits associated with process innovation. it is about making radical, substantial, or even gradual changes in the existing process in a way the process becomes more productive or beneficial (alegre and chiva, 2013). therefore, the process innovation is another issue to be taken into account while studying corporate entrepreneurial activities. in fact, innovation is generally measured by process innovation and product innovation (hsu et al., 2014). it is argued that the more innovative processes one firm has, the more it would be a candidate to become a corporate entrepreneur. despite this argument, one could not mention that any corporate 66 economic analysis (2017, vol. 50, no. 1-2, 62-76) entrepreneurial firm has process innovation (jayaram et al., 2014). then, the relationship remains controversial. therefore, the following hypothesis is proposed: h2. there is a significant relationship between corporate entrepreneurship and the rate of process innovation of the established firms. while, some scholars believe that innovation performance could be measured by process innovation and product innovation (hsu et al., 2014), others such as wong and chin (2007) and garcía-morales et al. (2014) add technology indicators for being more precise in this measurement. technology indicators include a wide range of factors, however, in order to be more specific, in this study, we bounded our definition to the mentioned above indicators (wong and chin, 2007). technology indicators are rarely investigated in the relevant literature (gonzález-benito et al., 2015). thus, the third hypothesis is proposed as follows: h3. there is a significant relationship between corporate entrepreneurship and the technology indicators of the established firms. methodology research design and hypotheses a quantitative research design is applied to conduct this research. thus, in order to scrutinize the relationship between ce and ip of the established firms, a survey was designed and employed by collecting data from the research population of 178 firms in three main cities of iran, i.e. tehran, isfahan, and shiraz. the conceptual model is developed based on four main models. for ce, a five-point likert scale of 15 items was adapted from morris and kuratko (2002), miller (1983), and ireland, kuratko and morris (2006); and for ip, wong and chin's (2007) conceptualization of the phenomenon is used through a five-point likert scale of 8 items. table 1 shows the indicators. spss 21.0 was used to analyze the data. table 1. indicators of ce and ip code indicators reference(s) corporate entrepreneurship ce1 high rate of new product/ service introduction, compared to competitors miller (1983); ireland et al. (2006) ce2 emphasis on continuous improvement in methods of production and/or service delivery morris and kuratko (2002); ireland et al. (2006) ce3 risk-taking by key executives in seizing and exploring growth opportunities miller (1983); morris and kuratko (2002); ireland et al. (2006) ce4 a very competitive ‘undo-the-competitor’ posture miller; ireland et al. (2006) ce5 seeking of unusual, novel solutions by senior executives to problems, via the use of ‘idea people’ morris and kuratko (2002); ireland et al. (2006) ce6 a strong emphasis on r&d, technological leadership, and innovation ireland et al. (2006) ce7 a bold, aggressive posture, in order to morris and kuratko minafam, z., corporate entrepreneurship, ea (2017, vol. 50, no. 1-2, 62-76) 67 code indicators reference(s) maximize the probability of exploiting potential when faced with uncertainty (2002); ireland et al. (2006) ce8 active search for big opportunities ireland et al. (2006) ce9 rapid growth as the dominant goal ireland et al. (2006) ce10 large, bold decisions, despite uncertainties of the outcome ireland et al. (2006) ce11 steady growth and stability as primary concerns morris and kuratko (2002) ce12 number of new products introduced during the past five years morris and kuratko (2002) ce13 number of product improvement or revisions introduced during the past five years morris and kuratko (2002) ce14 comparison of new product introductions with those of major competitors miller (1983); ireland et al. (2006) ce15 level of significance of new methods or operational processes implemented during the past five years ireland et al. (2006) innovation performance ip1 number of product changed to total product wong and chin (2007) ip2 change in sales (due to product change) to total sales ip3 change in profit (due to product change) to total profit ip4 number of process changes to total processes ip5 change in overall productivity due to product change ip6 percentage of expenditure on r&d to total sales ip7 number of technologies adopted externally ip8 number of patents developed internally source: morris and kuratko (2002), miller (1983), and ireland, kuratko and morris (2006), wong and chin (2007) harman’s one-factor test is used to test for the presence of common method variance bias (harman 1976; chang et al., 2010). all variables were entered into an exploratory factor analysis, and the results identified factors with eigen values of greater than one. no general factor accounted for the majority of the variance. therefore, common method bias did not have a substantial impact on the present study. sampling a random sampling technique was used to select the firms from 300 top firms in three main cities of iranbased on the listing of the presidential office. according to cochran's formula, at the confidence level of 95%, and accuracy of 5%, 169 questionnaires were required. thus, a total of 200 questionnaires were distributed, and 178 completely filled out questionnaires were returned (response rate: 89%). firms were the unit of analysis in this 68 economic analysis (2017, vol. 50, no. 1-2, 62-76) study. the questionnaires were answered by top managers or chief executives of the firms. questionnaires were printed and distributed by the researcher among the respondents. validity and reliability the research instrument applied in this research was adapted from morris and kuratko (2002), miller (1983), and ireland, kuratko and morris (2006), wong and chin's (2007). following a pilot testamong thirty five firms, the instrument was modified and refined by three experts2 before it was used. in order to examine the reliability of the instrument, cronbach's alpha coefficient was computed. reliability analysis showed the value of cronbach’s alpha of .723, which lies in an acceptable range. hence, the administered questionnaire had enough reliability to proceed for further analysis. variables in model (descriptive statistics, measurement model, reliability) are shown in the following tables table 2. specifications of the data variable code cronbach's alpha cronbach’s alpha mean no of items c o rp o ra te e n tr ep re n eu rs h ip corporate entrepreneurship ce1 .712 .746 3.47 15 ce2 .823 ce3 .679 ce4 .756 ce5 .749 ce6 .895 ce7 .698 ce8 .784 ce9 .781 ce10 .792 ce11 .834 ce12 .721 ce13 .657 ce14 .781 ce15 .721 in n o v at io n p er fo rm an ce product innovation ip1 .711 .743 3.78 3 ip2 .706 ip3 .803 process innovation ip4 .678 .698 3.52 3 ip5 .701 ip6 .708 technology indicators ip7 .659 .702 3.23 2 ip8 .721 2 expert validity/ face validity minafam, z., corporate entrepreneurship, ea (2017, vol. 50, no. 1-2, 62-76) 69 findings based on the statistics, most of the respondents were male (79.21%). moreover, about one third of the respondents had more than ten years of experience, and most of them had a bachelor's degree (64.61%). table 3 illustrates the information of the firms. as shown in the table, most of the firms had less than a hundred employees and might considered as small businesses. in terms of the experience of the firms, those that have 5-10 years of experience constitute the highest (42.13%). nearly half of the firms were in manufacturing field (52.25%), and the rest were service providers (47.75%). moreover, the firms were located in three main cities of iran, i.e. tehran, isfahan, and shiraz. most of the firms had less than ten new products/services (76.97%). table 3. demographic information of firms frequency percent industry type manufacturing 93 52.25 service provider 85 47.75 location tehran 88 49.44 isfahan 23 12.92 shiraz 67 37.64 establishment (years) less than 5 10 5.62 5-10 75 42.13 10-15 42 23.60 over 15 51 28.65 number of new services/ products less than 5 73 41.01 5-10 64 35.96 more than 10 41 23.03 number of employees less than 50 52 29.21 50-100 62 34.83 100-500 31 17.42 more than 500 33 18.54 table 4 shows the mean index of the phenomena in question, i.e. ce and ip. means of means shows that firms are somehow conservative and corporate entrepreneurship is moderately done in these companies. innovation performance index also shows a moderate level of innovation performance in the firms. table 4. mean index of ce and ip code frequency mean corporate entrepreneurship indicators ce1 178 3.48 ce2 178 2.78 ce3 178 3.14 ce4 178 3.59 ce5 178 2.98 ce6 178 4.01 ce7 178 3.48 70 economic analysis (2017, vol. 50, no. 1-2, 62-76) code frequency mean ce8 178 3.26 ce9 178 3.78 ce10 178 3.12 ce11 178 3.94 ce12 178 3.48 ce13 178 3.67 ce14 178 3.25 ce15 178 4.17 mean of means (ce) 3.47 innovation performance indicators ip1 178 4.12 ip2 178 3.58 ip3 178 3.64 ip4 178 3.45 ip5 178 3.86 ip6 178 3.25 ip7 178 3.19 ip8 178 3.28 mean of means (ip) 3.54 hypotheses are tested and the results are discussed below. regression analysis generated an equation to describe the statistical relationship between predictor variables and the response variable. after defining the regression model in spss, the fit was verified by checking the residual plots, and the results were interpreted. h1. there is a significant relationship between corporate entrepreneurship and the rate of product innovation of the established firms. a linear regression was performed. as can be seen, corporate entrepreneurship was a significant predictor of rate of product innovation. the regression equation was as follows: rate of product innovation = 60.654 + 0.057 * corporate entrepreneurship, r2 = .132, f (1, 177) = 7.770, p < .007. according to table 5, product innovation rate is significantly dependent on corporate entrepreneurship in the studied firms. thus, the more innovative products are produced by the firms, the more they would be considered corporate entrepreneurial firms (kuratko et al., 2015). as artz et al. (2010) previously, during their longitudinal study, mentioned, rate of product innovation could significantly affect corporate entrepreneurial performance of the firms, while sezen and çankaya (2013) or zhang (2011) believed that product innovation was not found to be significantly effective on corporate entrepreneurship performance. our finding is in line with the first group of scholars; however, one might propose different hypotheses to examine the probable differences in these findings. h2. there is a significant relationship between corporate entrepreneurship and the rate of process innovation of the established firms. a linear regression was performed. as can be seen, corporate entrepreneurship was a significant predictor of rate of process innovation. the regression equation was as follows: rate of process innovation = 61.235 + 0.051 * corporate entrepreneurship, r2 = .127, f (1, 177) = 6.432, p < .000. minafam, z., corporate entrepreneurship, ea (2017, vol. 50, no. 1-2, 62-76) 71 based on table 5, rat of process innovation is also significantly affected by corporate entrepreneurial activities. this finding is in line with some scholars such as kuratko et al. (2015), however, to some scholars, process innovation is not significantly affected by corporate entrepreneurial activities (e.g. see bigliardi et al., 2011). it might be due to the differences in range of studies, which is highly affected by firm size and industry type (damanpour, 2010). in this study, most of the firms had less than a hundred employees and might considered as small businesses. h3. there is a significant relationship between corporate entrepreneurship and the technology indicators of the established firms. table 5. model summary and parameter estimates dependent variable equation model summary parameter estimates r square f df1 df2 sig. constant b1 technology indicators linear .110 7.753 1 177 .001 60.125 .052 process innovation linear .127 6.432 1 177 .000 61.235 .051 product innovation linear .132 7.770 1 177 .007 60.654 .057 the independent variable is corporate entrepreneurship. a linear regression was performed. as can be seen, corporate entrepreneurship was a significant predictor of technology indicators. the regression equation was as follows: technology indicators = 60.125 + 0.052 * corporate entrepreneurship, r2 = .110, f (1, 177) = 7.753, p < .001. table 5 shows a significant relationship between technology indicators and corporate entrepreneurship. as it is shown in the table, technology indicators could be affected by corporate entrepreneurial firms. it means that if these firms become more entrepreneurial, technology indicators might change significantly (alarcón and sánchez, 2013). this element is rarely discussed in the literature, and the findings of this research approve such relationship. in sum, all the hypotheses were accepted according to the results. it shows that corporate entrepreneurship affects innovation performance of the firms. the interesting point is that, although a considerable number of the firms were risk averse in nature, still the relationship exists. conclusion in today's vuca world, corporate entrepreneurship is considered as an integral part of any innovative firm; since it affects the innovative nature and innovation performance of the firms (otache and mahmood, 2015). in this study, the relationship between corporate entrepreneurship and innovation performance in 178 firms is studied and the three hypotheses are accepted. that is to say that there is a significant relationship between corporate entrepreneurship and the rate of product innovation, rate of process innovation and the technology indicators of the established firms. these findings are in line with those 72 economic analysis (2017, vol. 50, no. 1-2, 62-76) of barringer and bluedorn (1999), bharadwaj and menon (2000), chen et al. (2014), garcíamorales et al. (2014), and in contrast to the findings of zhao (2005), goodale et al. (2011). thus, the issues and controversies regarding the role of corporate entrepreneurship in innovation performance are studied based on three main propositions. despite the present discussions regarding the propositions in the extant literature (kirca et al., 2005), most of the relations were not studied, in detail, in a developing country, such as iran (madhoushi et al., 2011). thus, the relationships between corporate entrepreneurship and the rate of product innovation, rate of process innovation and the technology indicators of the established firms are scrutinized in this research. however, khalili et al. (2013) highlighted the importance of this topic, only a single case study was conducted by them to investigate the influence of entrepreneurial orientation on innovative performance in a public company. there are other similar studies such as govender (2010), karimi et al. (2012), moshtaghi et al. (2012), and mohammadi (2012). another part of the body of the literature deals with the factors affecting innovation performance. for instance, maatoofi and tajeddini (2011) investigated the effect of market orientation and entrepreneurial orientation on innovation. this category fails to study the effect of product/process innovation on ce (e.g. see jalali et al., 2013; kakapour et al., 2016). this shows that previously authors did not study the relationship itself. then, the contribution of the paper is to scrutinize this relationship in quite a large number of companies. however, there are some points to be considered by future researchers. future researchers might focus on industry level innovation performance to see if regions with higher rate of corporate entrepreneurship enjoy higher innovation performance or not. moreover, contextual elements are not considered in this research, but as sakhdari et al. (2014) argue, taking institutional context might add some fruitful evidence in this regard. also, corporate entrepreneurship might be operationalized variously (e.g. see zahra, 1996; kuratko et al., 2014; garcía-morales et al., 2014). thus, it is suggested for future researchers to use other operational definitions as well. in addition to this, there is an emphasis on ce as a means of development and strategic replenishment for existing firms (lumpkin and dess, 1996). then, policy makers might improve corporate entrepreneurship atmosphere in order to enhance innovation performance of the firms. besides, it is assumed that considering entrepreneurial initiatives for firms might improve their level of innovativeness, and therefore, it could lead to higher performance and success of corporate entrepreneur firms (schuler, 1986). managers could also concentrate on corporate entrepreneurship to make their organization more innovative. this research could pave the way for researchers in 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innovation management, 14(1): 118-132. zhao, f. 2005. “exploring the synergy between entrepreneurship and innovation.” international journal of entrepreneurial behavior & research, 11(1): 25-41. article history: received: 15 january, 2017 accepted: 7 june, 2017 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp18-36 scientific paper a proposal of the model of international marketing research as information basis in game theory vedran stanetić1* 1 supreme office for the republic of srpska public sector auditing, financial auditing, banja luka, republic of srpska, bih abstract analyzing the theory of games it can be noticed that the moves and strategy of the players are not sufficiently based on the relevant information. most often, the only information that game strategy methodologists advocate is rationality, which certainly does not have to be the case in all games. in addition, the greater practical representation of game theory is avoided by the numerous assumptions and limitations set by the particular model of a particular game, and whose practical foundation does not always have to be realistic. an interdisciplinary combination of international marketing research and game theory would create a new quality for one and the other discipline. however, the biggest benefit would be for business or marketing decision makers, especially in industrial marketing. the aim of the paper is to present a new model that, in conditions of globalized business, will provide information support from the international market for business decision making using the theory of games. the proposed model is in the form of an information system for international marketing research in support of business decision-making. the first part of the paper is devoted to the analysis of game theory, in particular the analysis of assumptions and limitations for its greater practical application. a model that would partially overcome the described problems is proposed in the second part of the paper. the methodology used in the paper is also characteristic of marketing research and game theory. key words: information, international marketing research, rational behavior, game theory jel classification: c79, d83, m39 introduction the determination of the methodologists of the game theory for theoretical development or its application in laboratory conditions has resulted in not quite an enviable level of its practical usability when solving the problems that are faced by business or marketing decision makers. game theory deals exclusively with rational behavior of players and predictable decisions. if there are deviations from rational behavior, such deviations should be easily explained. that's why much of game theory appears sterile to the marketing scientist (chatterjee, lilien, 1986, p. 90). marketing exists to control consumer behaviour, which is usually irrational and affected by many different, often unidentifiable factors such as feelings and desires which can’t be predicted or quantified (chowdrey, 2014). the characteristic of modern business is a very dynamic and wide environment where the game theory models are usually not adapted for. some of the characteristics of the current * e-mail: staneticv@yahoo.com vedran stanetić 19 business are: large and sudden changes in the environment and working conditions; a large amount of diverse data; information and knowledge as the most valuable resource; unpredictable competitive influences from the farthest parts of the world, consumer penetration and the like. the world is rapidly globalizing and this is providing many opportunities and major challenges to the nations and people of the world (salvatore, 2013, p. 1). we are witnessing the phenomenon of close integration of countries and peoples of the world (peng, 2011, p. 16) which is shortly called globalization. the cultural characteristics of some nations, the psychological circumstances of the decisionmakers, the context in which the game is located, etc. can classically described behavior of homo oeconomicus in a game and conditions of globalized business make irrational and vice versa. some games in game theory are designed as individual, independent and isolated, and today's business, as briefly described, has exactly the opposite characteristics. when added to this, information based on information from the local environment, without considering problems in a global context and without an organized information flow from the international market, would not be sufficient to ensure full information coverage, gaining a sense of seriousness and the size of the problem. however, this should in no way mean the rejection of further attempts to apply the game theory as a valuable tool in business or marketing decision-making in the future. the reason why game theory has not so far been represented in marketing is not because it can not be applied, but only because it is very challenging (chowdrey, 2014). this paper will show how an interdisciplinary approach to the problem described can provide an appropriate solution to the problem. the proposal of the solution of the problem was given in the form of the model of international marketing research as information basis in game theory. as international marketing research is a discipline that is very broad and comprehensive, the model proposal is concretized in the form of an international marketing information system. the advantage of such an approach in marketing research is its analyticity and the convenience of programming – at least some parts of such a model. on the other hand, the lack is sometimes too formalized and slow conduction of research. this paper presents a combination of the most important principles and ideas on which international marketing and international marketing research, game theory and information systems are based and aimed at solving the problem described. in the available literature, which was available to the author, no papers were found suggesting a similar solution to the problem described. general theoretical assumptions of game theory strategic decision making using models of game theory the two basic assumptions in game theory are: 1. players participating in the game try to behave rationally, i.e. they strive to achieve maximum profit at a given moment (i.e., selfish players), and 2. players decide strategically, i.e. making decisions they take into account decisions of other players. game theory, by its definition, should focus on rational strategic decision-making. in order to behave rationally, players must have a predetermined payment function (material benefit) that they will behave and decide on. since these are strategic decisions, players do not know the final decision of other players before they make their own decision. based on the above, it can be concluded that the players can realize or do not realize material benefit solely based on the chosen own way of action, as well as the actions of other players. 20 economic analysis (2018, vol. 51, no. 1-2, 18-36) in theory, there are at least five possible concepts equilibrium in any game. these are the following concepts: 1. maxmin and minmax, 2. social welfare, 3. pareto optimal concept, 4. the concept of iterative domination and 5. nesh equilibrium. the goal of each of these concepts is the same: coming to equilibrium. however, the ways of achieving this goal are different. at the beginning it would be good to point out the definition of equilibrium because the notion of equilibrium in game theory is not identical to the notion of equilibrium in the economy generally. the equilibrium s* = (s1*... sn*) is a strategy profile consisting of a best strategy for each of the n players in the game (rasmusen, 2006, p. 18). in game theory equilibrium is a strategic profile, while in the economy equilibrium would be the outcome of this strategic profile. the maxmin concept is recognizable in that the player-striker strives to maximize his winnings, i.e. to choose the highest of all the minimum wins (the maximum minimum amount an attacker can achieve). on the other hand, the player-defence must sacrifice a certain amount. the player-defender will try to minimize his losses, or from the maximum payouts for each bet, he chooses the one for which the payoff is minimal. where the values of the maximum of all the minimum strikes of the striker and the minimum of all the maximum defenses of the defender are matched, there is a solution of the game (maxmin = minmax). realizing this concept for one of the players would not be a problem to predict the outcome of the game, provided that it anticipates the actions of another or other players. reasoning on the basis of the minmax of choice, in a way, really works conservatively. the more you suppose that your opponent knows your move in advance, and then devises his best reaction, the minmax becomes more attractive. if we imagine that some of them are the first to choose the row, then his opponent chooses the field in that row, the maxmin would have a perfect sense. on the other hand, if both players are uncertain of what will happen and can not determine the probability, they will surely choose other strategies. if both players gamble this way, we can not predict the outcome of the game (gaus, 2012, p. 116). the concept of social welfare represents forms of games in which society is mutually opposed to individuals in order to preserve or establish social values. individuals often pretend to some public good in order to achieve personal benefits. in situations where personal benefits for individuals mean the reduction of social well-being, and vice versa, a relevant concept is described as social welfare. examples are: construction of infrastructures, pollution, water resources, social organization, etc. as in such situations does not exist mechanism that would bring players into equal negotiating positions, this concept is not representative of the market conditions or business, so the analysis of information needs in those cases is not expressed. the concept of pareto efficiency implies that resources are fully utilized. this means that there is no possibility of improving the position of one of the players, except for the resources that someone else already uses. in the pareto optimal concept, some of the players can not improve their position, and as a consequence, do not harm another player. for the economy to be pareto efficient, it must meet the conditions of exchange efficiency, production efficiency, and product-mix efficiency (stiglitz and walsh, 2006, p. 222). the listed conditions can only be met in a competitive market. the concept of iterative domination is based on the principle of domination of some strategy for one of the players because this strategy brings more or equal benefit than any other strategy of other players. some strategies will simply never be used, because there are always others that vedran stanetić 21 are better for the player being watched. in the case of a strategy of iterative domination, information about planned player actions, similar to the maxmin concept, is very valuable. in the nash equilibrium concept, each player follows his strategy of maximizing possible winnings assuming that other players do the same. this strategy is best represented by theorem 1: (webb, 2007, p. 72) suppose there exists a pair of pure strategies ),( 21 ∗∗ ss such that ),(),( 211211 ∗∗∗ ≥ ssss ππ ∀ 11 ss ∈ and ),(),( 211212 ssss ∗∗∗ ≥ ππ ∀ 22 ss ∈ than (s1*, s2*) is a nash equilibrium. unlike the strategy of iterative domination, the nash equilibrium concept does not start from the probability of choosing each of options available to players, but the outcome of a game that provides the most favorable amount of payouts for each player is sought. the extent to which this strategy is significant in game theory is best confirmed by theorem 2 – nash's theorem of 1950: (gibbons, 1992, p. 45) in the n-player normal-form game { }nn uussg ,...,;,..., 11= , if n is finite and si is finite for every i then there exists at least one nash equilibrium, possibly involving mixed strategies. in some cases it is possible that in one game there are two or even more nash equilibrium. it is a question how will players then decide and how they will choose the right equilibrium. pareto optimum nash equilibrium at first glance should be preferred by every player. however, this does not always have to be the case. therefore, the theorist of game theory introduced in the analysis the concept of the improved nash equilibrium (gints, 1999, p. 103). different concepts of approach to equilibrium give different solutions (equilibriums). in addition, it is often not easy to determine which solution is the best, because the solution often depends on the type of game, how players interpret the winnings from the payment matrix, and so on. the situation is further complicated in the event of a greater number or lack of balance. clearly, this makes it difficult to apply game theory. the assumption that all players know their own utility function is important but also difficult to prove. it is true that players in one game have not only one but more of their utility functions. often, these utility functions are not clearly separated. in accordance with the development of the game, some utility functions become more dominant than others. due to the frequent interconnection of multiple players' games, their own utility functions are changing. the assumption that all players know the actual choice of action for each player in simple games is real. however, as games in practical conflicts of players are mostly complex, without an appropriate mechanism for collecting and processing data and reporting on observed actions of other players this assumption is not real. assumption that each player knows that each player knows etc. the utility function of each player, similar to the above, without the appropriate mechanism for collecting and processing data and reporting on the useful function in complex games is not realistic. the utility function of each player is not easily noticeable; they are not easily measurable and are not unchanged, even in simple games. assumption that every player i knows that his rival j has some belief about player i moves given with some probability p without a proper mechanism for collecting and processing data and reporting on rival beliefs remains a clear assumption – not about probabilities but about the assumption itself. how to believe in the assumption that a rival has a probability of a player's planned moves when there is no evidence that he has any knowledge about planned moves of any player. it should be kept in mind that during the theoretical setting and the elaboration of the previously presented concepts of approach to equilibrium in the game theory, it did not take into 22 economic analysis (2018, vol. 51, no. 1-2, 18-36) account their application solely in the economy. the game theory is most often seen as a field of mathematics. in game theory analysts almost always starts with assumption that the payment matrix is predetermined and equally known to each player – an assumption that is hardly realistic. also, relying on the principle of insufficient reason (gints, 1999, p. 103) and the like. as can be seen from the previous analysis, there is no concept in game theory which predict the possibility of acting solely after consideration of all available information and anticipate further steps on the basis of that information. even if information about the previous and immediate effects of other players in the model is considered, there is no guarantee that the information is the last, that they are fully accurate and timely, as there is no complete information about the most probable actions of competitors as response to the actions taken by the players (reactions of competitors). there is no any concept in game theory that involves the process of collecting and processing data and information, particularly not in an organized and arranged form. far from the fact that some of the concepts have a model of constant observation of an environment; environment in which the actions of other players are only some of many information (there is no evidence that action of some payer comes as a response solely to the actions of the other players). the previously discussed concepts do not have a built-in mechanism of flexibility so much needed in economic science. business decision-making without proper information base and without the possibility of flexible adaptation to changes in the environment could not be characterized as strategic and planned. the previously stated assumption that in the game theory players decide strategically could not satisfy the definition of strategic business or marketing decision-making. from the foregoing, one might conclude that the game theory in fact is not an appropriate tool in the hands of strategists. any methodologist of intellectual work and conclusions, as well as almost anyone who tried to make any contribution to scientific or professional thought in any field of science, can distinguish two opposing processes in intellectual work and conclusion: deductive and inductive. for a deductive way of thinking and concluding, it is characteristic that it starts from general principles and goes to individual, while inductive going to the opposite sequence – from individual to general. in the procedure of deductive thinking it is concluded on the basis of the whole, while in inductive thinking the knowledge of the general is based on one or few individual elements that make up whole picture. when it comes to the nature of the relationship between theory and research itself, then the following condition applies: whether theory guides research (known as deductive approach) or whether theory is an outcome of research (known as an inductive approach) (bryman and bell, 2003, p. 3). it is obvious that deductive conclusion is more perfect and scientifically acceptable. mathematics only recognizes deductive conclusions. however, in natural sciences it is impossible to think and conclude exclusively on the basis of a deductive approach without the application of induction to a certain extent. in mathematics, conclusions are derived from basic, sometimes unsaid, assumptions or conventions (axioms). the same principle applies to the whole deductive approach to conclusion. sometimes, some assumptions are not entirely scientifically grounded, but are only confirmed as generalizations of relevant experiences. such generalizations are derived from two basic forms of inductive elements: enumerations and analogies (stebbing, 1961, p. 249). the enumeration allows for the conclusion of the population based on the characteristics of the sample. analogy is the conclusion based on belonging to the same or similar class. observations should also be added to the inductive elements mentioned above. since observation is not a scientific method, generalizations based on such a method serve only to corroborate, but not to prove conclusions. however, as the conclusion is sometimes impossible to fully justify on axioms or on deductively proven assumptions, the described generalizations based on observation must enter the process at some point (rapoport, 1966, p. 147). at the vedran stanetić 23 same time induction, on the small door, entrances in the process of scientific conclusions and produces conclusions that bear wider knowledge than that given in axioms. studying the literature that deals with the field of game theory, the acquired impression is that the game theory is viewed almost exclusively as one of the fields of mathematics. a deductive way of thinking and concluding is the only one relevant to that science field, while for induction there is usually no place. on the other hand, the majority of the academic community, and especially practitioners of strategic thinking in the economy, are aware of the modest application and practical usefulness of game theory. however, as soon as game theory purports to be a prescriptive theory (purports to derive optimal course of action), the inductive component can no longer be dispensed with in application (rapoport, 1966, p. 147). the characteristic of strategic business or marketing decision-making and operation is the continuous collection and processing of information and adjustment of direction of movement according to changes in the environment. observation is an irreplaceable method in this process. the application of induction in game theory, especially for the purposes of strategic business, is a concept that should make a significant contribution to the development of both the scientific field. information base in formulating the most likely game the analysis below focuses on the information base on planned future actions of other players in the game, as well as to predict what other people guess you will do (miller, 2003, p. 56). based on this information a rational player sets the game to maximize its payment function. every participant can determine the variables which describe his own actions but not those for other. nevertheless those 'alien' variables cannot, from its point of view, be described by statistical assumptions. this is because the others are guided, just as he himself, by rational principles – whatever that may mean – and no modus procedendi can be correct which does not attempt to understand those principles and the interactions of conflicting interests of all participants (von neumann and morgenstern, 1953, p. 11). also, when two rational individuals have the same information, they must draw the same inferences and come, independently, to the same conclusion (hargreaves and varoufakis, 1995, p. 25). previous claims are known as harsanyi doctrine (by the theorist john harsanyi). in the game theory there is no assumption that one of the players is smarter than the other. the initial beliefs of each player are the same, and the only difference is in the type and amount of information among the players. the goal of the player is to anticipate the actions of other players and as a result the outcome of the game. in real business conditions, beside the knowledge about rationality of players, it is possible to notice a number of other signals or complete information about the intended actions of other players. such signals, data or information are often not easily available, nor are they systematized, formatted, or verified. there are three basic categories of the information structure of any game (geckil and anderson, 2010, p. 18) : 1. perfect vs. imperfect information, 2. complete vs. incomplete information, and 3. symmetric vs. asymmetric information. under perfect information it is understood that at every step of the game of a player who is on the move knows the whole history of the current course of the game. for these games, it is characteristic (but not necessarily) that the players drag the moves sequentially (consecutively). each player is familiar with the strategies and most likely the moves of any other player and accordingly he acts in the game. the greatest responsibility is on the player who first takes the move, because this move most often determines the further course of the whole game. that 24 economic analysis (2018, vol. 51, no. 1-2, 18-36) player has to consider how another player (s) will respond to each of the possible moves of the first player. in these games, some of the players are waiting for their opponent's moves and for each of his moves he has already elaborated an answer. these are games that are rarely met in real business conditions. this is not true for games with non-perfect information. for such games it is characteristic that players act simultaneously, as players do not have the ability to calculate for lack of information. for the games with complete information, unlike perfect, there is a certain degree of uncertainty in predicting the moves of players involved in the game, as well as the outcome of the game. this is a consequence of the likelihood with which some of the actions can be taken by some of the players. on the other hand, games with incomplete information are actually games with non-perfect information. in games with symmetrical information, players are informed in the same way. that is all that one player who has the most information as much as other players know. otherwise, this is a game with asymmetric information. the hierarchy in the information structure goes in the following order: perfect information aggregates complete and symmetrical information. reversed does not apply. perfect information is virtually unrealistic in the market. in a large number of cases this also applies to complete and symmetrical information. in real working conditions and business prevailing non-perfect, that is, games with incomplete, as well as games with asymmetric information. if games with nonperfect or incomplete or asymmetric information could be as much as possible translated into games with perfect, complete or symmetric information, they would create preconditions for achieving truly optimal solutions for each player. if this possibility was given to only one of the players, the outcome of market competition could easily be predicted. the usual ways of accessing information in game theory is the belief in rationality and usefulness for players in the game, which is in line with the concept of "banning exogenous information". there are few situations where players do not have any information about the preferences of the opponents – for example, in games against nature. it is clear that without the assumption of rationality and usefulness of players, in the conditions of the prohibition of exogenous information, it would be impossible to form any kind of getting information about the payment matrix, or the expected outcome of the game. however, how one sees such belief formation depends on how one sees decision nodes—with or without appreciation of their histories. the obvious requirement for the history-insensitive view is that players ought to believe that their opponents are rational at every possible decision node. there does not seem to be an obvious requirement for the history-sensitive conception (de bruin, 2010, p. 17). even in the conditions of a very strict ban of exogenous information, the appropriate information basis, on which the rational behavior of the participants in the game should be based, must be satisfied. as mentioned above, this information base should be minimally based on the collecting and processing information about behaviour of opponents in the past – at each decision-making node. this is called adaptive learning: follow the history of how other players have played in the past, and choose a strategy for the future that is a best response to the past play of others (gints, 1999, p. 256). this would create preconditions for establishing a completely rational information flow based on rational behavior learned from past in the form of dynamic recursiveness. collecting data and accessing information is much easier in games in an extensive form. on the other hand, the information need in games in extensive form is far less than games in normalized form. however, from the previous two passages it can be seen that even in the theoretical considerations games in a normalized form have a greater significance than games in extensive form. actually the normalized form is better suited for the derivation of general theorems, while the extensive form is preferable for the analysis of special cases (von neumann and morgenstern, 1953, p. 85). undoubtedly, in business and real working conditions games in normalized form are more represented. vedran stanetić 25 the conclusion of the previous analysis is that the behavior of participants in the game should be determined primarily by the information and knowledge relevant to the game in question. it was unrealistic in game theory to have designed games where players are assumed to have full knowledge of the rules and payoffs of the game. this is a serious idealization which only rarely is met in actual situations (geckil and anderson, 2010, p. 5). the assumption that the players in game theory are rational has to be satisfied. however, without sufficient knowledge about the previous and, more importantly, the intended behavior of the players, it is not possible to confirm whether it is really a rational behavior. also, information whether the threats or promises (rewards) that some players point to other players are realistic and well-founded largely determines the type of game and the behavior of the players in the game. in game theory rationality is almost exclusively viewed in the form of matrix of payments. the matrix is the only thing that calibrates a further analysis in a certain direction in accordance with the principle of rationality. a wrong set of matrix of payment can make the whole analysis nonsense. in conditions of insufficient information, relying on the principle of insufficient reason does not guarantee the successful implementation of any strategy. the equally plausible treatment of the emergence of each of the possible outcomes of the game is not an adequate substitute for an appropriate information base that can indicate the likely occurrence of an outcome. also, in the conditions of banned exogenous information, the principle of adaptive learning requires from players to monitor how other players played in games in past and on the basis of such information choose a strategy for the future, which is the best answer to the moves and strategies of other players in games in the past. information on past behavior of player is in this case only available and without their proper collection, sorting and processing the future strategy according to which the players act should not be considered rational. what is previously said also applies to games in extensive form. for games in normal form the information need is particularly pronounced. in the case of games without repetition, the realized profit, in accordance with the set matrix of payments, usually represents only one part of it (total profit), depending on the context in question. full information about players can relativize the matrix of payments itself. rationality does not necessarily imply ruthlessness and action that brings selfish, secure, and highest profit at a given moment – as it is the case in prisoner's dilemma model. for bayes games with non-perfect information, information about possible conditions and probabilities of their realization is crucial for the rational behavior of participants in the game. for games with a large or infinite number of repetitions information about discount rates almost completely determines the rational behaviour among players (rasmusen, 2006, p. 113). the possibility of achieving the current profit, while sacrificing the long-term profit gained as a sum of partial profit generated in each individual game (the solution given as the perfect equilibrium) in most cases is not rational. information about the possibilities, amount and the ways of realization potential long-term profit is often more valuable than the current profit received in the matrix of payments. the appropriate information base, sharing of information with other players, as well as giving and collecting signals that determine the future actions and strategies of the player in question can contribute to a long-term, truly optimal solution that is essentially only rational. proposal of the model the aim of the model, which will be proposed at this point, is to try to improve theoretical development and the possibility of practical application of the game theory by including the appropriate information base as support to the participants in the game. if prerequisites could 26 economic analysis (2018, vol. 51, no. 1-2, 18-36) be made that at least some forms of games bring as close as possible to games with perfect information, the goal of this model will also be fulfilled. the graphic form of the model of international marketing research as the information basis in the game theory is attached. the verbal form follows the graphic representation. the basis of the proposed model is the information system as support to business decisionmaking. as it is a model of international marketing research, the beginning is always on the international market, in other words the collection of data from the global environment. such an environment is very wide, diversified and usually contains the most relevant data for a particular research. certainly, research focus is on the collection and analysis of data related to, or could have anything to do with current or potential players and their choices in the analyzed game. marketing intelligence has the most important role in filtering and pointing to relevant data only. a marketing intelligence system is a set of procedures and sources that managers use to obtain everyday information about developments in the marketing environment (kotler and keller, 2012, p. 71). the development of global communication enables the creation of an information network at the level of a particular organizational unit (e.g., companies or other organizations) enables the creation of marketing intelligence as an information framework in strategic business decision-making. through intelligence analysis we take collection-produced data and turn it into information, knowledge, and understanding for leaders’ decision-making processes. but it is not through traditional intelligence analysis that we will come to know these things. it is through a different kind of intelligence analysis—advanced analysis—that we will come to know how to think about and subsequently use such knowledge to conduct intelligence operations to support decision-making in urban operational settings (hall and citrenbaum, 2010, р. 2). the practical application of marketing intelligence is not possible without the knowledge and application of tools that are inherent and consistent with the definition of intelligence. there are three categories of business intelligence tools: tools for aiding information and knowledge discovery, tools for analyzing data to improve decision making, and tools for visualizing complex data relationships (valacich and schneideр, 2016, р. 249). although each category of tools is important for marketing intelligence in the proposed model, the first category, or tools for information and knowledge discovery, is most significant. the remaining two categories of tools are fully included in the rest of the proposed model. there are several tools, techniques, or methods that help to uncover existing data, information and knowledge in order to analyze the problem and at the initial construction of the game. some of the most important are: method of content analysis, business negotiations, education and training, and the like. certainly, the stated methods of access to data and information are not the only ones. other categories could include information on websites of potential competitors or other players in game theory, purchasing data, also data obtained from: buyers, suppliers, government or supranational agencies, journalists, consultants, experts, etc. some internal data that may be useful in this business should also be forgotten, such as: financial statements (in particular notes to the financial statements), various documents, organizational charts, instructions, procedures, policies, management of the organization, other persons with an interest in the organization and similar. the data to be collected are determined by the research problem, that is, the relevant factors of success in a game. the information base in the game theory model is determined by the rules applicable to any game. these are the following rules: (geckil and anderson, 2010, р. 16) • players. how many players do we have in a game? are their interests matching or conflicting? vedran stanetić 27 • information. what information does each player possess? do they have complete, symmetric, or perfect information regarding each other’s actions and payoffs? what are the moving sequences of players? • actions or strategies. what actions or strategies are the players allowed to have? what are the specifics of interaction between players? are they allowed to communicate? • payoffs. what are the possible outcomes for each player? what is the utility or expected utility for each player at the end of the game for every action they are allowed to have? based on collected data and information it can be accessed to the initial construction of the game in a strategic or extensive form. it is an initial construction, because the data available at this moment is not complete, they are not final and have not been verified. this step is important for the theory of games, because based on the initial game analysis and data collection, information and knowledge are directed in a direction that can achieve the greatest research effects. it would be a good idea to make a plan about further activities and thus ensure the rational disposal of resources. the planning process begins by defining the problem and determining general information needs. by analyzing the problem needs for information are reduced from the general ones to concrete and at the end, they are detailed precisely taking into account the technical possibilities and real needs of the observed organization and the concrete situation. conducting general information needs to specific ones could be achieved by determining the most important input variables. although it could be concluded that it is easy to determine which basic input variables are for a particular game, this is not such case. previously conducted research through marketing intelligence, the initial construction of the game, as well as the expert knowledge of people working in the organization or external collaborators in the field of game theory, marketing research and information systems, should point out quite precise by which variables the research should continue. some of the variables that might be important for some games are: the determination of the players to start or continue the game (the importance of the results of the game for players), the existence of other strategic or operational alternatives or participation in other games whose results are more important for players (when conquering or maintaining a strategic position in a particular market or product), the time required to develop a strategic game (time, or faster and better preparation for participation in the game can be decisive), material and human resources, anticipated change in the strategic the position of competitors and the like. we should not lose sight of the cultural and ideological characteristics of players, sociological and psychological characteristics, economic, legal environment and practice and customs of other competitors and the like. these examples certainly do not exhaust the list of the most important input variables; their definition is again determined for each game and the specific situation in which each player is individually located. answers to the following questions could help determine the basic input variables: does everyone have the same objectives? would other players benefit from lying to me about their strategy? is the game fixed or variable sum? do i want my opponent to guess my future moves? am i better off being perceived as rational or crazy? (miller, 2003, р. 82). also, the continuation of the process of collecting, processing and analyzing data, information and knowledge is not performed only by selected variables that are estimated to be able to determine the final outcome of the game, but all other data and information assumed to have an impact on the analyzed game should be collected and processed. this ensures the necessary degree of caution, which is significant in a constantly changing environment. data, information and knowledge represent three basic inputs into the system. their processing and usage generate usable results that determine the strategic position in a game, and thus affect the outcome of the game. the structure of the three elements mentioned above is 28 economic analysis (2018, vol. 51, no. 1-2, 18-36) such that the data are represented the most, then information and, finally, the most scare resource, knowledge. data represent the basic and most common input element. these are facts that are known, partially known or completely unknown to the researcher, and whose processing and installation in a given context generates information. researchers are surrounded on a daily basis by a large amount of data, most of which are not helpful or even pointing to the wrong track. a questionnaire with the following content should help the organization in the process of collecting and processing data: what data is currently being collected; whether data on deviations, exceptions, etc. are collected; where and how these data are collected; where and in what form the data is stored; which application programs can be accessed by data; whether and how information is shared between applied computer programs; who and how is in charge of data reliability; who and how is in charge of data security and creation of their backups, and the like. data can be structured and unstructured. unstructured are those that are not complex, categorized or sorted. researchers estimate that 80% of all enterprise data consists of unstructured or semistructured data (valacich and schneideр, 2016, р. 252). in data handling, two processes need to be distinguished, their collection and processing. information is the second, much scarce, input element. information is interpretation of these data. an interpretation of data always has some goal and context (kavanagh, thite and johnson, 2015, р. 67). information represents a sufficient set of useful data with a specific tactical, operational or strategic meaning for the organization. the more strategic the information is, the more valuable they are. the harder it is to get information they are usually more valuable. it should be noted that important and valuable information is not always secret and hidden. in this context, it can be said about information transparency: information transparency is defined as the degree of visibility and accessibility of information. in this regard, information transparency becomes one of the key features that distinguish digital exchanges from traditional markets (zhu, 2005, p. 17). also, in the process of communicating messages – which are essentially information – they can move in a spectrum of secret, private or public, i.e.: message may be a “secret”(one agent receives it and the other does not know he receives it), “private” (one agent receives it, the other knows that he receives it without knowing its content and this is common knowledge) or “public” (each actor receives the message and this is common knowledge) (walliser, 2008, p. 41). previously said refers that information can and should, together with the data, appear as one of the components of the system's input. the path from data to information is usually not easy and it means processing the appropriate data. also, the information has its own "lifetime" and if it is not used within the deadline and for the needs for which they were created, they lose the category of information and switch to the lower category – the data category. perhaps the most fundamental propositions are that the greater the task uncertainty faced by an organisation, the greater the size, and the greater the interrelatedness of units, then the greater is the amount of information to be processed (piercy and evans, 1983, р. 188). because of this, information has a much higher value than the data. unlike information that are the goal to which researchers are striving, knowledge is a subject, that is, knowledge goes with a person, or another (artificial) intelligence, which understands the content and value of information. knowledge is information that has been given meaning (kavanagh, thite and johnson, 2015, р. 68). the meaning of the information can be given by a person, an expert in the area for which information is relevant. there are systems which are in the development process that would be able to possess and use knowledge similarly or better than the subject matter of a particular field. consequently, what constitutes knowledge assets are all the underlying skills, routines, practices, principles, formulas, methods, heuristics, and vedran stanetić 29 intuitions, whether explicit or tacit. explicit knowledge assets reflect knowledge that can be documented, archived, and codified, often with the help of information systems. in contrast, tacit knowledge assets reflect the processes and procedures that are located in a person’s mind on how to effectively perform a particular task (valacich and schneideр, 2016, р. 260). in the context of this work and the proposed model, knowledge is the ability to correctly interpret information in order to propose or make optimal decisions, or moves in game theory, either by persons – experts or artificial systems trained for such complex operations. knowledge is the ability to understand information, form opinions, and make decisions or predictions based on information (valacich and schneideр, 2016, р. 48). it has already been mentioned that knowledge can be explicit and implicit. explicit knowledge resembles sophisticated information, and is exchanged as such. implicit knowledge can only be dealt with by considering the entity in which it is incorporated. on the production side, it is obtained at a higher cost than information, since it is the result of hard reasoning or long experience. moreover, knowledge is generally more effective in producing other goods than simple information is. on the consumption side, knowledge is consumed more efficiently than information, as it generates increasing returns: prior knowledge helps to build further knowledge (walliser, 2008, p. 141). system enters, given as data, information and knowledge, are structured so that the data represent their largest part, while the information and knowledge are the least represented. this is understandable, because marketing methods and data collection techniques mostly come up to data, while information is only a small part of their product. knowledge is the most comfortable at this moment and is the result of knowledge that experts carry with them. the education and experience of experts from previous, similar situations certainly forms part of the knowledge that represents the entry into the system. the central and most important part of the proposed model are people, experts for international marketing research, game theory, information systems for decision support and other similar areas. experts dispose with collected data, information and knowledge and continue to process them in order to reach the same elements but structured otherwise. the goal is to get out of the system to make the most of knowledge and information, while the data should be at least represented. the questionnaire with the following content should help determine the current situation regarding the human resources of the organization, as well as to enable the identification of the needs for additional staff: how the personnel involved in data collection and processing activities are organized; the number of such employees; how to report to the superior; how the work of these people fits the organization's mission; how many of these staff have been trained and qualified; is the frequent fluctuation of such employees (especially to direct competitors); what is their opinion about existing applications, information infrastructure, proposed model, and the like. the work of the experts beside already mentioned is data collection and their processing, analysis, synthesis and interpretation. processing of data means basic processing, but also any advanced processing that at one moment goes into data analysis. basic data processing consists of: sorting, categorizing, tabulating, updating, etc. the goal of the data processing is to facilitate the management and records of what kind of data and in which quantity is available. it is a very important step in the research process because as advanced as technology has become, information technology still needs structured data such as a tabular format in spreadsheets or databases, to effectively process it. yet roughly 85 percent of an organization 's data do not exist in this format, rather the data are in the form of e-mails, powerpoint presentations, voice mails, and even meetings and conversations. most organizations are unable to use or often even locate these "unstructured" data, and thus the potential of an invaluable resource lays unrealized (devine, sirinivasan and zaman, 2004, p. 23). some methods of data analysis require that data should be displayed and sorted in tables; otherwise their application is not possible (for example 30 economic analysis (2018, vol. 51, no. 1-2, 18-36) goodnes of fit). the advanced processing of data includes the application of: statistical, marketing, mathematical, econometric, financial, graphic and similar methods and techniques. these methods and techniques are used for the purpose of more efficient analysis of the collected data. an analysis implies the interpretation of complex facts into the simple elements and the understanding the relationships that exist between such elements. this is a critical step in the whole process in the proposed model, because the omission of some of the elements or lack of proper connections between them most often results in wrong information. however, the important limitation of the analysis is that the analysis does not come to a natural end, nor does it encounter a cause, it is an element that determines more than other elements than it is defined by them (schumpeter, 2012, p. 16). the current knowledge of experts at this moment is very important and it often determines the success of a research. without proper data analysis it is not possible to successfully perform the second critical task of the experts, or the synthesis of the analyzed data. under the synthesis it is assumed reassembling data which are under the analysis disassembled with the same, changed or completely new relations between them. in this work, the existing knowledge of experts, as well as their experience, ideas, creativity and the like are also expressed. by connecting appropriate data among them leads to information, the value of which should be confirmed in the market. the more impact information generated on organization and environment, its value is greater. synthesis is closely related to the interpretation of data. interpretation is an assessment of the significance of the data. the corresponding estimated data take the appropriate place in the synthesis. interpretation is also related to the synthesis result, or to information. it checks whether the analysis and synthesis is carried out in an appropriate manner, or whether the information transmits the context of the analysis and synthesis. also, the aforementioned expert knowledge is also very evident in this case. the task of the experts is also to maintain the connection with other information systems in the organization, such as the information system for human resources, accounting, production, management and the like. this achieves cost-effectiveness, but also partially ensures that the highly professional tasks of the experts are carried out even more professionally. by sharing resources among the information systems in the organization, a reduction in the cost of their engagement by product unit is achieved (in this case, the product is information). increased resource utilization increases their productivity. the most suitable form of organization in this case is a network or project form. also, by sharing resources among different information systems, especially the best quality resources, better product quality is achieved. as the focus of the proposed model is on experts their value grows. investing in their additional training will increase the knowledge and experience they have at their disposal. also, experts should have high creativity, the ability to produce ideas and the skills to find new facts and knowledge. this is especially important when synthesizing and creating information. few of these key characteristics of the experts determine the success of the proposed model. in addition to the aforementioned, the application of the proposed model requires some other resources, namely: business networking, databases, appropriate computer programs (software), hardware, established procedures and the like. business networking is an unlimited possibility of accessing the internet at the appropriate data transfer speed, then the possibility of accessing intranet networks, as well as the possibility of accessing some local or regional networks (library, branch network, etc.). the ability to access databases is also a very important resource. databases are mainly in electronic form and are accessed via the internet or some local networks. when we talk about the classic concept of marketing research, we need to underline the fact that the internet and data bases available via the internet (but only as a source of secondary data) and various software applications for data processing are used for these vedran stanetić 31 marketing researches. however, that is a far lower level of application of information technology in marketing research in comparison with the online concept (hanić and čivić, 2017). there are also some older databases that are not in electronic, but in material form. access to such a database is important, but it is not critical. it would be good if there are established working procedures, exchanges, behaviors, etc. which can direct the work and behavior in the application of the proposed model, as well as to ensure the smooth functioning and flow of data and information. the questionnaire with the following content should help determine the current technical condition of the organization, as well as to enable identification of the need for additional technique: what hardware make the existing it infrastructure; what basic and applied computer programs are currently being used; whether the infrastructure has become obsolete; is there any overclocking of the system; which network infrastructure is currently being used; whether the it infrastructure is decentralized; whether some parts of the information infrastructure are leased; in which ownership is the it infrastructure and the like. analyzing the answers to the previous questions, information about existing and currently available resources should be provided, i.e. how well they serve the organization. also, the answers to the questions will also indicate the segments that should be changed and/or improved. the purpose of applying the proposed model is the exits from the system in the form of data, information and knowledge. the result of the described process of the proposed model should be the values in which the data are the least represented, while the most common are information and knowledge. it is certainly not possible to avoid data completely as a result of work; it's not even the goal. the data can help in decision making, however, their greatest value is in re-entering the system in the next iteration using dynamic recursiveness. information is the most important component that influences decision-making. they are dynamically focused, that is, their goal is the effect and to make some change. their quality influences the decision, and hence the future of the organization. information should be the most significant result of the proposed model. in addition to information, the knowledge that the experts acquire while working on the process in the proposed model are also the most important product of the model. the value of the mentioned knowledge could be read in the possibility of interpreting the aforementioned information, as well as the possibility of applying this knowledge in the next iteration in the proposed model. the result is continuous improvement and raising the quality of the proposed model. the problem with which each of the information systems or other forms of data collection and processing often meets is the exit from the system in the form of an excessive amount of data and information. knowledge is least represented in this case. an excessive amount of data and information suffers to the whole system and diminishes its effectiveness. information is often produced without an appropriate goal, or the goal is to create as much of the necessary and unnecessary data and information as possible. uncontrolled information generation is of no use to an organization (devine, sirinivasan and zaman, 2004, p. 28). this is called redundancy, capturing the same data more than once leads to data redundancy and inconsistency. information systems have limited collection, processing, and data storage capacity. data redundancy overloads facilities and reduces the overall efficiency of the system. inconsistency among redundant data elements can result in inappropriate actions and bad decisions (hall, 2011, p. 12). certainly the goal is to reduce or completely eliminate redundancy. although this is not an easy task, experts should, during the work on data collection, processing and accessing information and also by gaining knowledge and experience (they are not decision makers), recognize what information is relevant. by presenting only relevant information, redundancy 32 economic analysis (2018, vol. 51, no. 1-2, 18-36) will be reduced. the most relevant information, which arises in the process of work in the proposed model, should be archived in databases and preserved for eventual later application. based on the relevant information, as well as on the basis of the acquired knowledge and experience, in cooperation with decision makers, reconstruction of the game set at the beginning of the described process should be carried out. the new knowledge gained in the application process of the proposed model should, in most cases, provide a proper setting of the game in a strategic and / or extensive form. the difference with respect to the original construction of the game should reflect the value and quality of the entire process in the proposed model. greater security reflected in the realistic setting of the game and, based on that, making better decisions or strategic moves in the game, is a motive for the reconstruction of the game. although the responsibility at this point in the whole process may be the biggest one, it should be kept in mind that this is not the last phase before making the final decision. the reconstructed game should be tested before the final setting of the game and making a decision. it is possible to test different alternative scenarios, as well as the sensitivity of the system output and reconstructed games. result of system output is usually the large amount of data, information and knowledge, they can be contradictory to each other, which can sometimes result in different ways how to reconstruct the game. it would be good for each of the alternatives, in cooperation with the decision makers, to test separately. to test a game means to put it in the context of a real market situation, taking into account some less likely situations. by testing, some actions of the players in the game are developed to certain iteration in the future. the player's behavior is checked based on the information collected and conclusion drawn on that basis if the reconstructed game is valid. although it is not easy task to simulate the real situation of players' behavior in a game, this step is also important, because it can indicate the quality of the work done so far. based on the results of the performed game tests (or several alternative games), the final game setting is performed according to the most important elements, such as: payment matrix, information on the player's rational behavior, history of player's behavior and gameplay, probability of choice assigned to each of the possible strategic alternatives for each of the players in the game, to which iteration could repeat the game, and other elements that may be relevant in the context of each particular game. making a decision is one of the results of the work of the proposed model; the second one is, due to the constant change in the global environment, the restart of the process, this time anticipating the results of already made own decisions. in real life, most of the games are played more than once. play may unfold differently with a sequential game; that is where the players play the game more than once consecutively. we call this type of game dynamic. repeated games are dynamic. an example of a real life dynamic game would be one where firms set prices periodically (geckil and anderson, 2010, р. 30). the proposed model has the characteristics of a dynamic model, but its dynamism is not the result of a simple reboot, but rather a result of established dynamic recursiveness. conclusion greater practical application of game theory, not only in very specific conditions, or when dealing with isolated problems such as: nuclear wars, major political, economic or social conflicts, sanctions, and so on but its application in addressing problems that are more often encountered in everyday business, should be a significant preoccupation for those who intend to give their contribution to development and practical application of game theory. the greater representation and usability of game theory in business decision-making in conditions of globalized business can provide an adequately designed model of international marketing research in the form of an information decision support system for business. the model proposed in this paper could largely remove or reduce the deficiencies in game theory, vedran stanetić 33 and make the game theory one of the most important tools in the hands of the business or marketing decision maker. the development of the appropriate information-based decisionmaking in game theory is the greatest contribution of this paper. the information flow from the international market is the most important information basis in the conditions of globalized business. data and information that are not verified on the international market have a major disadvantage because they carry the risk of incomplete coverage, obscurity or inadequacy. only the global environment in present and future business represents a final information instance. international marketing research and game theory, two largely unconnected and mutually distant disciplines, are by the proposed model somewhat closer. linking of the two disciples makes reduction of entropy in business or marketing decision-making. proposed model is one of the ways of connecting the two disciplines and providing information support in game theory. with this work the mentioned possibilities are not exhausted. certainly the possibility of further improvement of the proposed model remains, prioritizing the establishment of a dynamic recursive linkage of the model output with the re-entry into the model, respecting the changes that the decisions made can have on the behavior of the other players. the most appropriate form of the proposed dynamic recursiveness could be a neural network. also, there is a possibility of mathematical programming of same parts in the proposed model, as well as the possibility of developing appropriate forms of testing reconstructed games based on available data, information and knowledge. 34 economic analysis (2018, vol. 51, no. 1-2, 18-36) vedran stanetić 35 references bryman, alan, and emma bell. 2003. business research methods. oxford: oxford university press. chatterjee, kalyan, and gary l. lilien. 1986. “game theory in marketing science, uses and limitations”, international journal of research in marketing, 3: 79-93. chowdrey, n. 2014. “playing 'game theory' as a marketing tool”, marketing, december 4. http://www.marketingmagazine.co.uk/article/1309753/playing-game-theory-marketingtool. de bruin, boudewijn. 2010. explaining games the epistemic 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jersey: princeton university press. walliser, bernard. 2008. cognitive economics. berlin heidelberg: springer-verlag. webb, james n. 2007. game theory decisions, interaction and evolution. london: springerverlag. šumpeter, jozef. 2012. teorija privrednog razvoja. beograd: jp službeni glasnik. article history: received: january 10, 2018 accepted: may 23, 2017 ea_2019_2_final doi: 10.28934/ea.19.52.2.pp64-70 scientific review market analysis on the presence of social responsibility in companies in bosnia and herzegovina mirjana štaka1* 1 university of e. sarajevo, faculty of economics, east sarajevo, bosnia and herzegovina abstract corporate social responsibility implies that all transactions in the company executed with respect to the economic legal and ethical principles. in bosnia and herzegovina, a relatively small number of companies expanding their economic objectives of socio economic and included in solving social problems. due to technical technological progress changes occur rapidly and result in a large number of social problems that can return a negative impact on business operations. there is a wide choice of alternatives by which companies can do business socially responsible, and each of these alternatives offers a number of benefits for all involved (company, non-profit organizations and consumers). the subject of this analysis involves, on the one point of view corporate social responsibility, and on the another the success of the company. corporate social responsibility will be examined through economic, social, environmental and ethical dimension. the aim of this thesis is to theoretically position management and social responsibility as part of the management functions in the work of the business entity. also, aim is to point out the many advantages resulting from the application of socially responsible business practices and point to the achievement of successful cooperation between of interest groups influential in the development of boards. this paper will explain the dimensions of corporate social responsibility, to point out the many benefits arising from the application of such business practices and potential problems that may occur. methodology is based on the analysis and synthesis of primary and secondary data. secondary, data were used in this study are available in the scientific and professional literature. in the development of work methods were used to analyze, synthesize, descriptions and comparisons. the research purpose and significance is to highlight the growing impact that society has on the company and / or organization and importance of corporate social responsibility as an important factor of achieving competitive advantages. the purpose of the study also explained that csr is the value and strategy, not just a means of making a profit company. key words: management, social responsibility, consumers, strategy, corporation, development jel classification: d47, m31 * e-mail: mirjana.staka@gmail.com mirjana štaka 65 introduction corporate social responsibility (csr hereafter) is defined as a concept in which companies knowingly and voluntarily increased activity arising from the primary functions of the company of increasing profits and affect their working, social and natural environment (mašić, 2010). corporate social responsibility is a new awareness of the location and meaning that companies have in the contemporary global society and the responsibilities arising from it. also, the practice of social responsibility includes the activities of companies such as: what products to buy and sell, whether they comply with legal regulations, relationship with employees, whether investing in the development of the local community and whether it contributes to the preservation of the environment. the idea of development, which affects the needs of future generations the sustainability of development. economically sustainable development is not a sufficient condition for the development of a society, a key factor for achieving sustainable development, and therefore its impact on the local community implies responsibility (milisavljević, 2007). harmonization of relations between the spheres of economy, as the pillar of development and the interests of society as a whole must not be individually monitored nor ignored. corporate responsibility in bosnia and herzegovina, also in the region poses a relatively new term applied to large companies and growing mid-sized and smaller companies. csr basically means that companies and other legal entities exercise activities mentioned above the primary function and achieving a positive impact on their working, social and natural environment. the concept of social responsibility and practices relating to the dimensions of the activities of a company or organization and all the relationships that it establishes with that. to contribute to the overall economic and social development but how to invest in the community and respect human and labor rights, to recruiting, training and influences the development of our employees and their target category, to affect the protection of the environment. according to drucker et al., (2004) corporate social responsibility means a commitment the company management to take actions that will improve the welfare of the entire society and the business system. it represents a global business imperative and the idea that it is impossible to ignore. one can say that it is a successful company that simultaniously takes account of its economic, social and environmental impact, and socially responsible business is the business model and management style in which profit is realized in a socially responsible manner (drucker et al., 2004). development of the concept emerges as a new way of doing business in global companies that are exposed to risks due to non implementation of environmental policy and employees. in future many of global companies that apply the concept of corporate social responsibility, because in it they can provide an effective means for gaining competitive advantage (muller, 2004). the concept of corporate social responsibility is not just a passing fad, but an imperative in the business world all the companies that will sooner or later have to accept if they are to keep their place in the business scene. this business concept brings multiple benefits, not only for companies, but also in world integrity. research methodology research hypothese given the proposed details in theoretical principles and the literature, the research hypotheses are formulated as follows: the general hypothesis h0: it starts with the assertion that the concept of social responsibility of business has a positive impact on the company creating significant prerequisite 66 economic analysis (2019, vol. 52, no. 2, 64-70) for the welfare of the community by making it more competitive in the market. for the purposes of the research performed and auxiliary hypotheses that help make it easier to draw conclusions that will be reached in the study. auxiliary hypothesis h1: there is insufficient appropriations from the budget of the company to finance socially responsible activities. auxiliary hypothesis h2: the ability and the integration of csr in the serb republic, bosnia and herzegovina is not pleasent position. there are significant activities in larger companies, while medium and small companies remain the primary function of the engaged business. research methods the paper is based on the collection and analysis of secondary data sources. secondary data used in this study are available in the scientific and professional literature of the problem of environmental protection in business, corporate social responsibility, also about business ethics. in the development work were used methods of analysis and synthesis, descriptions and comparisons. a method of analysis and synthesis is used in the theoretical part of the work for parsing (analysis) complex concepts and conclusions in a simpler and merging (synthesis) of simpler elements in more complex parts. the description is used to describe facts, objects and processes in nature and society without the scientific interpretation and explained, which is used in the work in theoretical and application part. in the applicative part of the work, the method of comparison, based on data from annual reports on sustainable development observed businesses available on the website, researches, comparing different events, objects on examples of companies in the same activities in order to compare their basic characteristics. reasearch findings there are many theoretical frameworks that attempt to explain why the company should strive to do business socially responsible. the following tables provides an overview of authors reaseaching of framework of corporate social responsibility since its inception until the nineties. csr activities include a strong fight against corruption and implementation of anti-corruption measures in all segments of society. in fact, in bosnia and herzegovina is particularly acute problem of corruption and useless fight against it. this, for example. as estimated by transparency international bosnia and herzegovina on the basis of the analysis of the monitoring only in 2007 more than half a billion km of budget funds was lost through corruption and illegal transactions in the process of privatization. the current status of the presence of social responsibility in companies in bosnia and herzegovina can be viewed through surveyed the marketplace. the survey included 30 questions that are sent to different mail addresses to companies selected randomly and who were willing to fill out the questionnaire and thus participate in the project. the first part of the questionnaire made by author survey, related to general information about the company, ownership structure, activities, number of employees and total revenue. the second part concerned the situation of csr in the company, the existance of csr strategy and who is responsible for its implementation.the next set of questions related to the degree of integration of iso standards and international treaties dedicated to corporate social responsibility. an important part of the questionnaire focused on the situation of employees and their rights within a company immediately thereafter, and the relationship to the community. philanthropic activities are explored through the next set of questions and in the end they sought answers to questions that deal with the relations between government and media relation activities in the field of corporate social responsibility. mirjana štaka 67 table 1. the research results are presented in the following table: activity frequency percent finance 5 14.30 industry 3 8.58 energetics 2 5.71 bussines 11 31.46 tourism 1 2.86 telecommunications 1 2.86 architecture 1 2.86 services 1 2.86 other (it and etc.) 10 28.6 total 35 100% source: author’s survey table 2. number of employees: number of employees frequency percent under 10 6 17,19 under 50 16 45,71 under 100 9 25,65 over 200 4 11,45 total 35 100% source: author’s survey table 3. availability strategies in public: availability frequency percent yes 34 97,14 no 1 2,86 total 35 100% source: author’s survey table 4. management activities of corporate social responsibility: presence frequency percent yes 19 54,34 no 16 45,66 total 35 100% source: author’s survey table 5. allocations of funds for csr activities: percent of budget frequency percent under 2% 21 60,06 from 2 to 5% 7 20,02 from 5 to 7% 5 14,30 over 7% 2 5,62 total 35 100% source: author’s survey 68 economic analysis (2019, vol. 52, no. 2, 64-70) table 6. employment of workers in accordance with international conventions and humans rights: presence frequency percent yes 35 100 no total 35 100% source: author’s survey table 7. security, safety of workers at the workplace (insurance and health care): presence frequency percent yes 35 100 no total 35 100% source: author’s survey table 8. experimental part are workers familiar with their work and how are they satisfied with their workplace and their superiors: presence frequency percent yes 21 59,85 no 14 40,15 total 35 100% source: author’s survey table 9. competence of workers to participate in social responsibility of community: presence frequency percent yes 35 100 no total 35 100% source: author’s survey table 10. are company is environmentally conscious and are they use biodegradable materials in the work/ing area: presence frequency percent yes 32 91,20 no 3 8,80 total 35 100% source: author’s survey table 11. does the company take part in humanitarian actions persence frequency percent yes 35 100 no total 35 100% source: author’s survey mirjana štaka 69 conclusion explained in a simple way, social responsibility is based on the integration of economic, social and environmental dimensions in the daily operations of the company, thus contributing to the advancement of society and the growth of the companies themselves (berčić, 2012). set the main hypothesis h0: it starts with the assertion that the concept of social responsibility of business has a positive impact on the company creating significant prerequisite for the welfare of the community by making it more competitive in the market. being socially responsible means not only to fulfill legal obligations, but to go beyond the established compliance with laws and regulations, but also to invest more in human capital, environment and relations with stakeholders. in this way, companies are investing in their future. take business by these ways, they will find that their voluntary engagement and commitment can help community development. the main hypothesis is demonstrated through the analysis of research that was used in the work. given that more than 96,90% of the companies surveyed responded that most are familiar with the impact of the concept of csr for the market and the community. auxiliary hypothesis h1 which said inadequate budget from the budget of the company to finance socially responsible activities was also confirmed as the results of the research showed that companies allocate less than 2% of the budget for the needs of socially responsible activities. bosnia and herzegovina is 103. of 137 countries in europe presenting a situation in which the country compared to other countries in the region and its modest opportunities can not do much to contribute to increasing corporate social responsibility through financing, subsidies and sponsorships and increase social responsibility in the community auxiliary hypothesis h2 which read ability and integration of csr in bosnia and herzegovina is not satisfactory position. there are significant activities in larger companies, while medium and small companies remain the engaged primary function operations, also confirmed the part of the previous hypothesis because it is causally associated with this research is proving to be big companies apply corporate social responsibility because of the complexity his business and as such have at least departments and special administration of philanthropy and help the local community. positive examples in serb republic are: m: tel, banja luka brewery business that its impact on humanitarian activities and environmental protection, approaching the trend of global business companies in place of their existing. references banja luka brewery company. 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(2019). award for contribution to the development of corporate social responsibility. www.vitinka.com (accessed on may 21, 2018). article history: received: june 25, 2019 accepted: october 3, 2019 ea_2018_3-4 olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža et al. 81 doi: 10.28934/ea.18.51.34.pp81-94 original scientific paper estimation of tobacco products price and income elasticity using aggregate data olivera jovanović1* | jovan zubović1 | marko vladisavljević1 | duško bodroža1 isidora ljumović1 | ivana domazet1 | mihajlo đukić1 1 institute of economic science, belgrade, serbia abstract the main aim of this paper is to estimate long run and short run price and income elasticity for cigarettes based on aggregate level data for period 2002-2016 using error correction model. in order to estimate elasticity of demand for tobacco products authors of this paper used aggregate level data. because the cigarettes make the largest share in overall consumption of tobacco products in serbia, conducted research is based on approach that 90% of total consumption of tobacco products are cigarettes. this research is unique in the see countries, while research conducted in other low and middle income countries in western balkan region showed similar results. price elasticity among the see countries is in range between -0.44 and -0.78 research among low and middle income countries over the world empirically showed that demand for tobacco products is usually inelastic. analysis conducted in the republic of serbia showed that price elasticity ranged between -0.76 and -0.62 while income elasticity ranged between 0.34 and 0.39. key words: tobacco products, consumption, elasticity, price jel classification: e20, h20, c13 introduction in order to empirically estimate the long-term and short-term effects of increasing cigarettes price on cigarettes consumption in serbia we have used the error correction model (ecm). this model is often used in research among countries with low and middle income to estimate price elasticity using macro aggregate data (ross and al-sadat, 2007). research nalysis aims to present price and income elasticity for tobacco products in serbia using official statistical data for the period 2002-2016. according to official institute for public health “batut” data more than one half of total population consumed tobacco products in a lifetime (health and statistical yearbook for serbia, 2018), while world bank data shows that in 2017 at least 33% population above age 15 in serbia smokes at least one cigarette per day, amounting to about 2,457,000 active smokers (tobacco control fact sheet, serbia). thus, tobacco products’ consumption in serbia should be of high concern to policymakers. results of empirical research shown in this paper can help policy makers (in the field of economics, finance and health) to understand the factors affecting the demand for cigarettes including their prices/taxes, others tobacco control policies, and income so that they can design policies to lower tobacco use in serbia. * corresponding author, e-mail: olivera.jovanovic@ien.bg.ac.rs 82 economic analysis (2018, vol. 51, no. 3-4, 81-94) the main obstacle in this analysis was the lack of data to construct a long time series. given that only a short time series is available, we have carefully defined variables to assure that they are compatible and found the best methodological approach to deal with data deficiency. we opted for a classic linear model of cigarette demand with consumption per adult as a depended variable, while real tobacco price and real income are the primary independent variables. the model tested for the impact of various tobacco policies as well as for a summary index of tested tobacco control policies. other relevant variables that could affect consumption such as tertiary education, life expectancy at birth for male and female, average employment and employment rates for male and female were also tested in the models but not included in the final specification and presentation of results due to concerns related to the degree of freedom. data cigarette demand price and income elasticities were estimated using annual data. we have constructed several linear models of cigarette demand with a maximum of three independent variables to preserve the degree of freedom. cigarettes consumption and cigarette price data in serbia are available only for the period after year 2002. several measures of cigarette consumption and cigarette price have been accounted for and tested their properties to assess their suitability for our models. the dependent variable is the annual cigarette consumption per capita of adult population1. this measure of aggregate cigarette consumption is calculated using retail sales volume as reported by the statistical office of the republic of serbia. since the volume is measured in the sticks, we divided it by 20 to get cigarette consumption in packs (figure 1). we have also considered an estimate of consumption based on the household budget survey data (hbs). however real consumption is underreporting in hbs data by a large amount and was therefore abandoned. another possible measure of consumption can be derived from cigarette production added to net import and export level. this measure resulted in unstable estimates, most probably due to time lags of recording foreign trade, so we excluded it from further analysis. figure 1. cigarettes in packs per adult, 2002-2016 source: statistical office of the republic of serbia 1 population of age 15 and older olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 83 the most important independent variable is the price. we first considered official data on weighted average cigarette price and the price of the most sold brand2, but their values do not exist for all years included in the model. therefore, we opted for real (or relative) tobacco price index3 (real tobacco cpi; figure 2) that we obtained by deflating (using general cpi) nominal tobacco cpi published annually since 2007 by the statistical office. methodology for creating tobacco cpi was implemented in 2007 by statistical office of the republic of serbia. so we extended time series data using official statistical office methodology for calculation and extrapolation of real tobacco cpi. real tobacco cpi in the period 2002-2016 is shown in figure 2. figure 2. tobacco price index (real tobacco cpi), 2002-2016 source: statistical office of the republic of serbia real income was measured by real gross domestic product (gdp) per capita obtained from the statistical office of the republic of serbia. 2 available in official gazette of republic of serbia 3 tobacco price index is official data available in statistical yearbook, published annually by statistical office of republic of serbia. it represents a retail price index of tobacco products, calculated by weights that present structure of household consumption of cigarette and other tobacco products. it is obtained from the data of hbs, national accounts, trade and catering trades statistics, particular ministries etc. note that in serbia, cigarettes are main consumed tobacco product. because this index is available as chained, we converted into base index and extended time series. 84 economic analysis (2018, vol. 51, no. 3-4, 81-94) figure 3. real gdp per capita, 2002-2016 source: statistical office of the republic of serbia tobacco control policies are an essential factor in the demand for cigarettes as well as for all other tobacco products consumption we have analyzed the impact of two policies in our models using dummy variables for the ban on smoking in all public indoor areas (value 0 before 2005, value 1 otherwise) and the ban on tobacco advertising (value 0 before 2010, value 1 otherwise). effects of implementing regulatory policies were measured separately, including one by one variable in the model. we created a tobacco policy index by adding up the two dummy variables which represent the summary measure for tobacco control policies. even though many factors influence the final price of cigarettes, the most essential policy-related determinants of cigarette prices are taxes (chaloupka et al., 2010). chronically poor competitiveness of serbian market during the global economic crisis has become a basic weakness of serbian economy. therefore, the negative effects of the crisis in serbia felt widely, exposing the deep structural problems of serbian economy (domazet, stošić, 2013). those are reasons why we decided to include in analysis several variables more. current socioeconomic environment indicate the importance of employment (male and female) into our study (đuričin, pantić, 2015). we have used other independent variables such as the number of graduates with tertiary education (to measure impact of education on cigarette demand), average level of employment (an alternative measure of income and stress level) life expectancy at birth for male and female (to assess the impact of the return to the investment in health). structural changes lead to changes in the level of employment, especially in the private sector (ognjanović, 2013). in recent decades, women have successfully fought for their equality in society and proved they are capable of great achievements, so we used average level of employment for women in our study (ljumović, pavlović, 2017). however, results of the models including these variables are available upon request. table 1 and table 2 summarized the data used in our analysis. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 85 table 1. data used in the macro model of cigarette demand, 2002-2016 year retail volume (consumption of cigarettes, packs per adult)* real tobacco consumer price index** real gdp per capita*** tobacco control policy index law1 law2 2002 157.11 97.10 2280 0 0 0 2003 187.08 95.45 2505 0 0 0 2004 195.17 97.11 2675 0 0 0 2005 204.24 91.53 2836 1 1 0 2006 193.77 100.00 3297 1 1 0 2007 190.29 118.60 3990 1 1 0 2008 189.42 117.54 4586 1 1 0 2009 201.12 133.44 4187 1 1 0 2010 180.89 141.50 4082 2 1 1 2011 152.96 150.68 4619 2 1 1 2012 133.96 162.75 4400 2 1 1 2013 112.35 195.81 4781 2 1 1 2014 119.55 220.32 4672 2 1 1 2015 116.08 212.42 4720 2 1 1 2016 111.12 230.61 4904 2 1 1 *source: statistical office of republic of serbia, 2017 **source: statistical office of republic of serbia, 2017 ***source: statistical office of republic of serbia, 2017 law 1 is the law on the protection of the population from exposure to tobacco (2004) law 2 is advertising law (2009) table 2. data used in the macro model of cigarette demand, control variables, 2002-2016 year education, graduated students life expectancy at birth, female (%) life expectancy at birth, male (%) life expectancy at birth, total (%) employment level, average employment rate, women employment rate, male employment rate, total 2002 18,709 75 69.7 72.3 2,207,903 40.3 57.5 48.6 2003 19,748 75.1 69.9 72.4 2,168,678 38.7 56.9 47.6 2004 22,047 75.5 70 72.7 2,166,949 36.3 54.9 45.2 2005 27,537 75.6 70.2 72.8 2,171,457 32.9 52.4 42.3 2006 29,406 76.1 70.8 73.4 2,115,135 32.0 49.3 40.4 2007 32,039 76.5 70.9 73.6 2,085,242 33.8 50.3 41.8 2008 34,671 76.6 71.3 73.9 2,081,676 36.5 53.2 44.4 2009 40,330 76.7 71.4 74.0 1,984,740 34.0 49.1 41.2 2010 43,545 77 71.8 74.3 1,901,198 31.1 45.3 37.9 2011 46,162 77.2 72 74.5 1,866,170 29.0 43.1 35.8 2012 47,523 77.5 72.3 74.8 1,865,614 28.7 42.8 35.5 2013 47,797 77.9 72.6 75.2 1,864,783 30.8 45.2 37.7 2014 58,728 78 72.8 75.3 1,845,494 33.0 46.9 39.7 2015 50,501 77.9 72.8 75.3 1,896,000 35 50 43 2016 50,326 77.8 72.8 75.2 1,921,000 38 53 45 source: statistical office of republic of serbia, 2017 86 economic analysis (2018, vol. 51, no. 3-4, 81-94) the model specification tests conventional model in linear form is used to estimate the price and income elasticity of cigarette demand. all variables are used in real values. (1) yt = α + β1 x1t + β2x2t + εt, where t=1, …,15 (1.1) where the following represent: ytcigarette consumption per adult (retail sales volume in packs, per adult) x1treal tobacco price index (real tobacco cpi) x2treal gross domestic product per capita (real gdp per capita) β1price coefficient β2income coefficient model (1) includes only price and income measures as independent variables. therefore, their coefficients represent the upper bound, since the impact of tobacco control variables is not taken into account. model (2) is similar to model (1), but includes tobacco control policy. in this case, we used variable tban (law2) to reflect the adoption of the advertising law (ban on advertising of tobacco products). β3 is a coefficient capturing the impact of advertising law on cigarette consumption. (2) yt = α + β1 x1t + β2x2t + β3x3t + εt, where t=1,…,15 (1.2) we estimated several versions of demand model with tobacco control policies/event to find an adequate specification, but because the analysis is limited with the degrees of freedom, all individual policies could not be included in just one model. besides variable tban which is used in the model (2), variable tlaw1 (law on the protection of the population from exposure to tobacco) is implemented in the model (3). tobacco control policy index (tpi) defined as the sum of the other two indicators is used in the model (4). apart from these variables, we took into consideration life expectancy at birth4 (total) in estimated model 55. because life expectancy at birth of a female is not integrated at the same order as dependent and independent variables, we did not use it in final estimation of cigarette demand. the diagnostics of variables listed in table 1 starts with stationarity unit root tests. the classic analysis of time series is based on the assumption that the data are stationary, which implies a constant mean and a constant variance over time. the time series is stationary if the following conditions are satisfied: 1) e(xt)= const, t=1,2,3… 2) v(xt)= const, t=1,2,3… 3) cov(xt, xt-k)= f(k). t=1,2,3…. k=1,2… in practice, many time series do not meet this requirement. for example, a random shock that would weaken its impact over time in case of a stationary series can have a permanent effect for an indefinite period if the time series is not stationary (or has a unit root). to test for stationarity, we used dickey-fuller (df) statistics for the presence of unit root (mladenović and nojković, 2007). we tested two main hypotheses in the first step: 4 life expectancy at birth is average number of years a newborn is expected to live if mortality patterns at the time of its birth remain constant in the future. 5 dickey-fuller test results are presented in table 2. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 87 h0: time series is not stationary, has a unit root h1: time series is stationary the result for a level order of integration shows that we cannot accept ho hypothesis that the variables are stationary because df statistic is above than all critical values. therefore, we proceeded with the second step and tested hypothesis. the test revealed that cigarette consumption, price and income are stationary in their first differences and are integrated at first order (i) (table 3). table 3. results of df unit root test dickey-fuller variables adf t-test statistic level/first dif. h0: variable has a unit root level z(t) first dif. z(t) decision main variable consumption -0.102 -3.029** i(1) real tobacco cpi 0.988 -3.278** i(1) gdp per capita -1.526 -3.492** i(1) control variable tobacco policy index -1.412 -3.986*** i(1) tlaw1 (regulator policy 1) -2.171 -3.606** i(1) tban (regulator policy 2) 0.857 -3.606** i(1) employment, average -1.411 -2.071 i(2) employment rate, total -1.755 -1.605 i(2) employment rate, male -1.829 -1.385 i(2) employment rate, female -1.650 -1.678 i(2) education-graduated students -1.236 -4.787*** i(1) life expectancy at birth, (male) -1.137 -3.739*** i(1) life expectancy at birth, (female) -1.688 -2.317 i(2) life expectancy at birth, (total) -1.398 -2.979* i(1) note: z(t) is compared with corresponding test critical values;*** indicates rejection of h0 at the 1% significance level, **5% significance level, and * 10% significance level. source: authors own calculation based on the results presented in table 2, we observe that measure of cigarette consumption in serbia is integrated at first order i(1), it is stationary at first differences since the reported value of z(t) test statistic was -3.029, on 5% significance level. real tobacco cpi and real gdp per capita are integrated at first order i(1) at 5% significance level, with reported z(t) test statistic values: 3.278 and -3.429, respectively. tobacco control policy index, and individual regulatory variables tlaw1 and tban are integrated at same order as main independent variables i(1), all significant at 1% and 5% level. different measures of employment in serbia cannot be included in the further analysis, because df test results show integration at second order i(ii). df test statistics for employment rate female is z(t)= -2.695, p=0.023, employment rate male is z(t)= -3.406, p=0.007 and for employment rate total is z(t)= -2.988, p=0.014.6 6 results of df test shows us that variables of employment are not integrated at first difference. 88 economic analysis (2018, vol. 51, no. 3-4, 81-94) to determine the existence of a long-term relationship between our variables of interest, we applied a test for cointegrationdickey-fuller residual tests (dfr). if the time series are cointegrated, then the residual series is stationary, while the non-stationarity of the residual means that the time series are not cointegrated. if a h0 hypothesis is accepted than the residuals are nonstationary and the time series are not co-integrated. the rejection of the zero hypotheses (h0) confirms the stationarity of the residual, and therefore the cointegration of given time series. using the dfr test, we found that the variables in models (1), model (2) and model (4) are cointegrated and thus, they have a long-run relationship. to confirm this result, we applied another test for cointegration, johansen cointegration test (johansen, 2005). table 4 present results of the johansen cointegration test for variables in authors preferred modelsmodel (1), model (2) and model (4). table 4, results of johansen co-integration tests. model 1 null hypotheses eigenvalue trace statistic 0.05 max-eigen 0.05 critical value critical value h0: (r=0)* 0.0000 23.2142 24.3100 14.4272 177.8900 h0: (r≤1) 0.6432 8.7869 12.5300 8.7478 11.4400 h0: (r≤2) 0.4647 0.0392 3.8400 0.0392 3.8400 model 2 h0: (r=0) 0.0000 45.5888 39.8900 25.2938 23.8000 h0: (r≤1)* 0.8358 20.2950 24.3100 13.4566 17.8900 h0: (r≤2) 0.3748 6.8385 12.5300 6.5662 11.4400 model 4 h0: (r=0) 0.0000 57.0688 39.8900 29.1951 23.8000 h0: (r≤1) 0.8757 27.8737 24.3100 17.1833 17.8900 h0: (r≤2)* 0.7069 10.6904 12.5300 10.4773 11.4400 note: johansen, s. 1995. likelihood-based inference in cointegrated vector autoregressive models. oxford: oxford university press. r is the number of the cointegrating equation. *indicates the rejection of the null hypothesis at the 5% level. source: authors own calculation results of max-eigen and trace statistics indicate that h0 of no cointegration vector can be rejected and that there exists one co-integration equation at the 5% significance level in model 1. after stationarity and cointegration tests, we proceed with estimating long-run and short-run relationships. engle-granger two step method is used to estimate long run and short run price and income elasticities. first, long-run relationships between cigarette consumption, price and income is estimated using the classic linear demand model (equations 1.1 and 1.2) because models are specified in linear form, price and income elasticity is calculated multiplying the estimated price and income coefficient β1 and β2 by price and income fitted values, divided by fitted value of cigarette consumption in packs. the use of fitted values instead of actual average values is required to obtain results based on the long run equilibrium (ross and al-sadat, 2007). since cointegration exists in observed models, we estimated the second step of the englegranger method the error correction model (ecm) – to estimate short-run price and income elasticities (ross and al-sadat, 2007). this model used the first difference of all variable and olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 89 lagged residual from the long-run model (mladenović and petrović, 2007). the short-run ecm model can be expressed as follows (mladenović and nojković, 2012): tktktktkt ktktktkttt zzii ppyyuy 141413131 2121111110 ........ ........ εγγγγ γγγγγ +∆++∆+∆++∆+ ∆++∆+∆+∆+=∆ −−−− −−−−− (1.3) where k represents the number of lags; δ is the difference operator; γ ’s are parameters to be estimated; t1ε is the error term; 1−tu is error correction term that represents residuals from the long-run equation, and 0γ measures the speed of adjustment toward equilibrium in long-run. in our specification of ecm model, we choose to use one lag to avoid losing too many degrees of freedom because our time series are short (a small number of observations). ∆ [! = (\'!"# + (#∆�!"# + (]∆ !̂"# + /#! (1.4) ∆ [! = (\'!"# + (#∆�!"# + (]∆ !̂"# + (_∆`ab�!"#c/#! (1.5) ecm model for cigarette demand which includes only measures of tobacco price and income is given with equation 1.4. the equation for cigarette demand model which includes tobacco control policy index or regulatory variables like tban or law1 is given in 1.5. since we are using lin-lin form, price and income elasticities are calculated using lin-lin form of the model: results table 5 presents results of the long-run cigarette demand for several different demand models. table 5. long-run cigarette demand function 1 (basic) 2 (tban) 3 (tlaw1) 4 (tpi) 5 (lifetotal) variables consumption consumption consumption consumption consumption rtobcpi -0.86335 -0.6995449 -0.7958605 -0.8467552 -0.7820187 gdppc 0.01406 0.0150893 0.0046155 0.0161606 0.019342 regulatory 1 (tban) -20.07846 regulatory 2 (tlaw1) 18.38403 regulatory (policy index) -3.70036 life expectancy at birth, total -7.962421 constant 232.7062 214.455 245.1503 226.8379 789.4529 observations 15 15 15 15 15 dickey-fuller test for unit root residuals test statistic test statistic test statistic test statistic test statistic 90 economic analysis (2018, vol. 51, no. 3-4, 81-94) 1 (basic) 2 (tban) 3 (tlaw1) 4 (tpi) 5 (lifetotal) variables consumption consumption consumption consumption consumption adj. r-squared z(t)= -3.323 z(t)=-3.671 z(t)= -3.247 z(t)= -3.419 z(t)= -3.465 dickey-fuller test for unit root residuals hausman test m-statistic ------- --------- m=0.04 m=0.64 m=0.04 note: t-statistics in brackets;*** p<0.01, ** p<0.05, * p<0.1; source: authors own calculation all variables in model 1 are statistically significant. this model is the basic model, because it includes only two independent variables, without any other controls. real tobacco price index has a negative sign, which is in line with the economic theory if the price of cigarettes increases, their consumption will go down. real income has a positive sign which is also in line with the economic theory of normal good – the higher the income, the higher the consumption. r2 value is 0.845, meaning that 84.5% variability in the model is explained with selected variables. real tobacco price index and real income in model 2 are statistically significant with sings similar to model 1. variable tban which represents one tobacco control policy (ban on tobacco advertising) is not statistically significant, but it’s inclusion leads to the improvement in r2 value. the statistical insignificance of the policy variable can be explained by the short length of the time series. in model 3, variable tlaw1 is not statistically significant (p=0.317), and it has the opposite sign. the tobacco policy index (tpi) in model 4 is also not statistically significant (p=0.760), but it has the expected sign. in model 5 we include life expectancy at birth (total), and results show that variable is not statistically significant (p=0.730), but has a negative coefficient sign. it is expected result even if we did not get significant in the model, one of reason can be a very short and limited time-series data. the values of long-run price elasticities for our favorite models are shown in table 6, including the results bootstrapping. table 6. long-term price and income elasticity for tobacco products long-run model 1 model 2 model 4 price elasticity -0.764408 -0.6193687 -0.749707 price elasticity bootstrapped (100 replication) -0.7808978 -0.5985788 -0.7562662 (0.1583772) (0.2150423) (0.1607641) income elasticity 0.3368191 0.3612285 0.3868732 income elasticity bootstrapped (100 replication) 0.3461998 0.3972342 0.4354273 (0.0085674) (0.0085617) (0.0139486) note: se in brackets source: authors own calculation the long-run price elasticity in model 1 is -0.764, which is in line with results obtained in other lowand middle-income countries. this implies that 1% increases in prices of cigarettes lead to a 0.76% decrease in cigarette demand. price elasticity is higher in model 1 than model 2, because this specification does not control the impact of tobacco control policies. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 91 the value of long-run income elasticity coefficient was 0.34 which implies that 1% increases in real gdp per capita lead to a 0.34% increase in cigarette demand. when variable tban is included in the model (model 2), the value of long-run price elasticity coefficient is 0.62 which implies that 1% increases in prices of cigarettes led to a 0.62% decrease in cigarette demand. the value of long-run income elasticity coefficient was 0.36 and implies that 1% increases in real gdp per capita led to a 0.36% increase in cigarette demand. however, this result is not statistically significant. when variable tpi is included in model 4, the value of price elasticity is -0.75 which is almost similar to basic model 1. value of income elasticity is 0.38 but this result also is not statistically significant. table 7. short run cigarette demand function model 1 model 2 model 4 variables d.consumption d.consumption d.consumption d.rtobcpi -0.8802679** -0.8574294*** -0.8563312** -2.67 -3.41 -2.63 d.gdppc -0.0049126 -0.0004975 -0.0012268 -0.45 -0.05 -0.1 d.regulatory (d.tban) -2.107591 -0.17 d.regulatory (d.tpi) 4.280726 0.37 l.residuals -0.7381731** -0.9576962*** -0.8358793** -2.68 -3.67 -2.68 constant 5.581537 4.85751 4.040065 1.13 1.19 0.71 observations 14 14 14 r-squared 0.517 0.7284 0.5679 adj. r-squared 0.3721 0.6077 0.3759 breusch-pagan/ cookweisberg test for heteroskedasticity chi2(1) =0.43 chi2(1) = 0.15 chi2(1) = 0.09 ho: constant variance prob > chi2 = 0.5140 prob > chi2 = 0.7023 prob > chi2 = 0.7612 durbin's alternative test for autocorrelation chi2(1) = 0.0023 chi2(1) = 0.168 chi2(1) = 5.568 h0: no serial correlation prob > chi2 = 9.290 prob > chi2 = 0.6815 prob > chi2 = 0.0174 lags 1 lags 1 lags1 breusch-godfrey lm test for autocorrelation chi2(1) = 0.0077 chi2(1)=0.289 chi2(1)=5.800 h0: no serial correlation prob > chi2 = 7.111 prob > chi2 = 0.5911 prob > chi2 = 0.0160 lags 1 lags 1 lags 1 92 economic analysis (2018, vol. 51, no. 3-4, 81-94) ramsey reset test f(3, 6) = 2.77 f(3, 6)=0.10 f(3,6)=1.43 ho: model has no omitted variables prob > f =0.1205 prob > f =0.9565 prob > f =0.3238 skewness/kurtosis tests for normality adj chi2(2)= 2.97 adj chi2(2)= 3.96 adj chi2(2)=0.87 ho: normality prob>chi2= 0.2264 prob>chi2= 0.1404 prob>chi2= 0.6484 jarque-bera normality test chi(2)=1.084 chi(2)= .6345 chi(2)= .6974 ho: normality prob>chi2= .5817 prob>chi2= 0.9099 prob>chi2= .7209 mean vif 1.19 1.37 1.4 note: t-statistics in brackets;*** p<0.01, ** p<0.05, * p<0.1; source: authors own calculation the results presented in table 7 shows a negative real tobacco cpi coefficient in all models. it means that an increase in cigarette price in the short run will have a negative effect on consumption. income coefficient in all models (models 1, 2 and 4) are negative, but not significant, so in a short-run increase of real gdp per capita leads to decrease in cigarette consumption. estimated parameters for price in all three models are statistically significant at 5% and 1% level, while estimated parameters for income in all three models are not statistically significant. coefficient for a regulatory variable tban has no statistically significant effect on the tobacco consumption, but has a negative sign. same sign has a tobacco control policy index in model 4. negative sign of tobacco control policy variables in models is in line with the assumption that tobacco control policies leads to decrease cigarette consumption in a short run. error correction parameters values are -0.738, -0.957, -0.836 for models 1, 2 and 4 respectively7. interpretation of these coefficients is that 73.8% to 95.7% deviation from long-run equilibrium will be corrected in the following year. the diagnostic test was applied in order to analyze the presence of heteroscedasticity, autocorrelation, multicollinearity and specification of functional form. also, the normality of residuals is checked with jarque-bera and skewness/kurtosis tests (mladenović and nojković, 2012). results of all specification tests are presented in table 7. the short-run elasticities of cigarette demand are presented in table 8. table 8 short run price and income elasticities short-run model 1 model 2 model 4 price elasticity -0.05 -0.05 -0.05 income elasticity -0.01 -0.001 -0.001 source: authors own calculation in the short-run model, real tobacco cpi is statistically significant, and it implies that changes in price have an impact on the demand for cigarettes even in the short run. short-run price elasticity is quite low, which is quite common for addictive products such as cigarettes (ross and al-sadat, 2007) since consumers may need some time to quit. on the other hand, real income does not have a significant impact on cigarettes consumption, so we can conclude that in short-period of time smokers in serbia will change their consumption of cigarettes. the impact of price and income changes in a short run is smaller compared to the long-run, as expected. we were not able 7 error correction parameters are statistically significant on 5% and 1% level, respectively. olivera jovanović, jovan zubović, marko vladisavljević, duško bodroža, et al. 93 to do bootstrap standard errors for the short-term price elasticities, because we have an insufficient number of observations. conclusion tobacco taxes are the most effective measure for preventing initiation and reducing tobacco consumption. studies about tobacco taxation topic provide evidence that higher tobacco prices lead to a significant reduction in tobacco products consumption. these studies estimate the price elasticity of consumption in the range from -0.25 to -0.50, but the estimates for lowand middleincome countries are higher (chaloupka et al., 2010). ross and al-sadat (2007) suggest that in lowand middle-income countries a 10% increase in cigarette prices can reduce cigarette consumption by 4%-8%. the results presented in this study represent the first estimates of the price and income elasticities of cigarette demand in the republic of serbia. we used official data from the statistical office of the republic of serbia for this analysis covering the period 2002-2016. we found that 10% increase in cigarette prices would reduce cigarette consumption by 6.2%-7.6% in the longrun, and by 0.5% in the short-run. this means that the total cigarette demand would decline by 6.7% to 8.1% in response to a 10% increase in price. based on empirical research, price elasticity for cigarettes in serbia is quite similar to other low and middle income countries who estimate price elasticity using the same methodology. even though research was conducted on a small number of observations (short time-series), our results correspond to the results obtained in other lowand middle-income countries. this confirms that higher tobacco taxes that lead to higher cigarette prices have the potential to reduce cigarette use in serbia substantially. this would be desirable given the large toll of tobacco use on both public health and the economy. acknowledgements this paper is a result of international research project "accelerating progress in taxation of tobacco and tobacco products in lowand middle-income countries". this research is funded by the university of illinois at chicago’s institute for health research and policy through its partnership with the bloomberg philanthropies. references chaloupka iv, f. j., peck, r., tauras, j. a., xu, x., & yurekli, a. (2010). cigarette excise taxation: the impact of tax structure on prices, revenues, and cigarette smoking (no. w16287). national bureau of economic research. domazet, i., stošić, i. (2013). “strengthening the competitiveness of serbian economy and the corporate market restructuring”, economic analysis, vol. 46, no ¾, pp. 108-124. đuričin s., pantić o. (2015). “the development of micro-crediting as a factor of promoting women entrepreneurship in serbia”, journal for women entrepreneurship and education (jwee), no1/2, pp. 50-66. hjalmarsson e., österholm p. (2007), testing for cointegration using the johansen methodology when variables are near-integrated, imf working paper, western hemisphere division. johansen, s. 1995. likelihood-based inference in cointegrated vector autoregressive models. oxford: oxford university press. ognjenović k. (2013) “how structural changes affect enterprises’ expectations about employment in serbia”, economic analysis, vol. 46, no ¾, pp. 141-152. mladenović z., nojković a. (2012), primenjena analiza vremenskih serija, centar za izdavačku delatnost ekonomskog fakulteta u beogradu 94 economic analysis (2018, vol. 51, no. 3-4, 81-94) mladenović z., petrović p. (2007), uvod u ekonometriju, centar za izdavačku delatnost, ekonomski fakultet univerziteta u beogradu pavlović d., ljumović i. (2016), “prospects and challenges for female leaders from the balkans”, journal for women entrepreneurship and education (jwee), no1/2, pp. 58-75. ross, h., & al-sadat, n. a. (2007). demand analysis of tobacco consumption in malaysia. nicotine & tobacco research, 9(11), 1163-1169. article history: received: november 20, 2018 accepted: december 13, 2018 microsoft word 2007 3 4.doc 2007 ‐ 68  •  economic analysis®    abstract: the mega program is funded by the united states agency for international develop‐ ment, and implemented by the urban institute from washington dc. its objective is, in short, to enable  local governments and local businesses in serbia to foster economic growth not only in the participating  municipalities but also, through the effect of keeping up with them, in all others. the eleven municipalities  that joined the program in its second stage, referred to as cohort 2, exhibited a weak economic performance  in 2006, as the baseline year. in comparison with serbia, the majority of these municipalities had a lower  share of women in employment (in total, and by enterprises and entrepreneurs), and a higher share of women  in unemployment. the unemployment rates in total and for women in particular, were high everywhere.  only for two municipalities were they lower than for serbia. at last but not the least, new enterprises and  new entrepreneurs were established, for the most part, in the wholesale and retail trade – which is not crucial  for the economic growth of impoverished areas.  introduction  the mega program is funded by the united states agency for international development,  and implemented by the urban institute from washington dc. its objective is, in short, to enable  local governments and local businesses in serbia to foster economic growth not only in the partici‐ pating municipalities but also, through the effect of keeping up with them, in all others. (mega is  the acronym from the municipal economic growth activity.)  the program has been fully operative since january 2006. it has two stages so far:  o in the first stage, ten municipalities were chosen to participate in the program: indjija,  kragujevac, krusevac, loznica, novi beograd, prokuplje, subotica, uzice, vranje and  zrenjanin. as a whole, they are referred to as cohort 1. changes in the economic per‐ formance of the municipalities within cohort 1 in the course of time have to be assessed  in relation to the baseline year 2005.  o in the second stage, additional eleven municipalities joined the program: arilje, cacak,  kraljevo, leskovac, pancevo, paracin, pecinci, prijepolje, sabac, smedervo and vrsac.  as a whole, they are regarded at as cohort 2. changes in the economic performance of  the municipalities within cohort 2 over time have to be evaluated with reference to the  baseline year 2006.  the economic position of the municipalities within cohort 1 in the baseline year 2005 and its  changes up to march 2007 have been already assessed.  this paper – which has been also supported by the ministry of science and the protection of  human environment of the government of the republic of serbia within its program for the pe‐ riod 2005–2007 – will deal with basic economic facts on the municipalities within cohort 2 in the  baseline year 2006.  as the dissemination of official data at lower levels of aggregation is aggravated in case of  serbia,  the aforementioned basic economic  facts  involve  four variables only:  the employed,  the  cohort 2 of the mega program:  basic economic facts, 2006 gordana vukotić‐cotić, institute of economic sciences, belgrade, serbia  key words: eu employment, unemployment, new job opportunities jel : r11 original paper volume 40 • autumn 2007 • 69  unemployed, new enterprises and new entrepreneurs. the data on the variables in question are  released by:  the statistical office,  the national employment service and  the business registers  agency of the republic of serbia.  employment and unemployment  employment, unemployment and the labor force, in total and for women, relating to serbia  and cohort 2  in 2006, are presented  in tables 1–3 as the simple arithmetic means of the corre‐ sponding values of 31 march and 30 september. employment includes persons who are employed  in enterprises, on the one hand; and entrepreneurs, with or without employees, on the other hand.  consequently, and unfortunately,  it excludes farmers. enterprises are taken  in a broader sense:  they cover small, medium and large firms – as well as cooperatives, institutions and organizations.  unemployment comprises persons who are registered as unemployed, although they might have  been occasionally or informally employed. this concept of unemployment differs, therefore, from  that adopted by the international labor organization. the labor force is defined as the sum of the  employed and the registered unemployed.    table 1. employment: 2006  total  enterprises  entrepreneurs    total  women  total  women  total  women     absolute values  serbia  2,025,627  872,907  1,471,750  636,244  553,877  236,664  cohort 2  236,289  97,247  164,461  68,824  71,828  28,423  arilje  6,487  2,327  3,389  1,516  3,099  811  cacak  28,741  13,433  22,460  10,155  6,281  3,278  kraljevo  33,906  13,857  20,907  8,267  12,999  5,591  leskovac  32,969  14,221  22,764  9,678  10,206  4,543  pancevo  37,700  15,788  27,550  11,052  10,151  4,736  paracin  12,021  4,706  8,360  3,473  3,661  1,233  pecinci  4,034  1,531  2,190  1,091  1,844  440  prijepolje  7,666  3,454  5,853  2,770  1,814  684  sabac  28,063  11,148  19,238  8,062  8,825  3,087  smederevo  29,357  9,831  20,623  7,782  8,734  2,050  vrsac  15,344  6,951  11,128  4,978  4,216  1,973     shares (%)  serbia  100.0  43.1  100.0  43.2  100.0  42.7  cohort 2  100.0  41.2  100.0  41.8  100.0  39.6  arilje  100.0  35.9  100.0  44.8  100.0  26.2  cacak  100.0  46.7  100.0  45.2  100.0  52.2  kraljevo  100.0  40.9  100.0  39.5  100.0  43.0  leskovac  100.0  43.1  100.0  42.5  100.0  44.5  pancevo  100.0  41.9  100.0  40.1  100.0  46.7  paracin  100.0  39.1  100.0  41.5  100.0  33.7  pecinci  100.0  38.0  100.0  49.8  100.0  23.8  prijepolje  100.0  45.1  100.0  47.3  100.0  37.7  sabac  100.0  39.7  100.0  41.9  100.0  35.0  smederevo  100.0  33.5  100.0  37.7  100.0  23.5  vrsac  100.0  45.3  100.0  44.7  100.0  46.8    source: statistical office of the republic of serbia  2007 ‐ 70  •  economic analysis®  table 2. unemployment: 2006  absolute values  shares (%)    total  women  total  women  serbia  917,298  495,667  100.0  54.0                cohort 2  133,788  73,963  100.0  55.3  arilje  2,037  1,047  100.0  51.4  cacak  17,238  9,120  100.0  52.9  kraljevo  15,964  9,242  100.0  57.9  leskovac  22,413  11,792  100.0  52.6  pancevo  15,246  8,741  100.0  57.3  paracin  8,659  4,721  100.0  54.5  pecinci  2,923  1,453  100.0  49.7  prijepolje  6,872  3,740  100.0  54.4  sabac  19,901  11,255  100.0  56.6  smederevo  14,973  8,770  100.0  58.6  vrsac  7,564  4,084  100.0  54.0      source: national employment service of the republic of serbia  table 3. labor force: 2006  absolute values  shares (%)     total  women  total  women  serbia  2,942,925  1,368,574  100.0  46.5               cohort 2  370,076  171,210  100.0  46.3  arilje  8,524  3,374  100.0  39.6  cacak  45,978  22,553  100.0  49.1  kraljevo  49,870  23,099  100.0  46.3  leskovac  55,382  26,013  100.0  47.0  pancevo  52,946  24,528  100.0  46.3  paracin  20,679  9,427  100.0  45.6  pecinci  6,957  2,983  100.0  42.9  prijepolje  14,538  7,194  100.0  49.5  sabac  47,964  22,403  100.0  46.7  smederevo  44,330  18,601  100.0  42.0  vrsac  22,907  11,035  100.0  48.2      sources: tables 1–2  the female participation in employment is displayed on charts 1–3. it was higher than the  male participation only in terms of entrepreneurs in cacak exclusively. six municipalities within  cohort 2 were ranked lower than serbia in respect of the portion of women employed with enter‐ prises and entrepreneurs taken separately. on the other hand, seven municipalities within cohort  2 were ranked lower than serbia in respect of the portion of women employed with enterprises  and entrepreneurs taken together. smederevo, with the leading role of the us steel in its economy,  was at the bottom of the list in each case.  volume 40 • autumn 2007 • 71  chart 1. female participation in the total employment (%): 2006  46.7 45.3 45.1 43.1 43.1 41.9 40.9 39.7 39.1 38.0 35.9 33.5 cacak vrsac prijepolje leskovac s e r b i a pancevo kraljevo sabac paracin pecinci arilje smederevo     source: table 1  chart 2. female participation in the employment with enterprises (%): 2006  49.8 47.3 45.2 44.8 44.7 43.2 42.5 41.9 41.5 40.1 39.5 37.7 pecinci prijepolje cacak arilje vrsac s e r b i a leskovac sabac paracin pancevo kraljevo smederevo     source: table 1  chart 3. female participation in the employment with entrepreneurs (%): 2006  52.2 46.8 46.7 44.5 43.0 42.7 37.7 35.0 33.7 26.2 23.8 23.5 cacak vrsac pancevo leskovac kraljevo s e r b i a prijepolje sabac paracin arilje pecinci smederevo     source: table 1  the female participation  in unemployment  is shown on chart 4. only  in pecinci was the  share of unemployed women lower than the share of unemployed men. six municipalities within  cohort 2 had a higher rank than serbia. among these municipalities, smederevo was at the top of  the list.  2007 ‐ 72  •  economic analysis®  chart 4. female participation in unemployment (%): 2006  58.6 57.9 57.3 56.6 54.5 54.4 54.0 54.0 52.9 52.6 51.4 49.7 smederevo kraljevo pancevo sabac paracin prijepolje s e r b i a vrsac cacak leskovac arilje pecinci     source: table 2  the female participation in the labor force is given on chart 5. it was lower than the male  participation both for serbia and all the municipalities within cohort 2. in comparison with serbia,  a lower share of women in the labor force was recorded for six municipalities within cohort 2.  chart 5. female participation in the labor force (%): 2006  49.5 49.1 48.2 47.0 46.7 46.5 46.3 46.3 45.6 42.9 42.0 39.6 prijepolje cacak vrsac leskovac sabac s e r b i a pancevo kraljevo paracin pecinci smederevo arilje     source: table 3  the rates of employment and unemployment, in total and for women, are presented in table  4. the rate of the total employment is calculated as a percentage ratio of all the employed to the  total labor force, while the rate of the female employment is computed as a percentage ratio of em‐ ployed women to the female labor force. consequently, the rates of the total and female unem‐ ployment are obtained by subtracting the rates of the total and female employment from one hun‐ dred (see also charts 6–7).  table 4. rates of employment and unemployment (%): 2006  employment  unemployment     total  women  total  women  serbia  68.8  63.8  31.2  36.2                 cohort 2  63.8  56.8  36.2  43.2  arilje  76.1  69.0  23.9  31.0  cacak  62.5  59.6  37.5  40.4  volume 40 • autumn 2007 • 73  kraljevo  68.0  60.0  32.0  40.0  leskovac  59.5  54.7  40.5  45.3  pancevo  71.2  64.4  28.8  35.6  paracin  58.1  49.9  41.9  50.1  pecinci  58.0  51.3  42.0  48.7  prijepolje  52.7  48.0  47.3  52.0  sabac  58.5  49.8  41.5  50.2  smederevo  66.2  52.9  33.8  47.1  vrsac  67.0  63.0  33.0  37.0      sources: tables 1–3  chart 6. unemployment rates both for men and women (%): 2006  47.3 42.0 41.9 41.5 40.5 37.5 33.8 33.0 32.0 31.2 28.8 23.9 prijepolje pecinci paracin sabac leskovac cacak smederevo vrsac kraljevo s e r b i a pancevo arilje     source: table 4  chart 7. unemployment rates for women (%): 2006  52.0 50.2 50.1 48.7 47.1 45.3 40.4 40.0 37.0 36.2 35.6 31.0 prijepolje sabac paracin pecinci smederevo leskovac cacak kraljevo vrsac s e r b i a pancevo arilje     source: table 4  the unemployment rates, in total and for women in particular, were high everywhere. only  for arilje and pancevo were they lower than for serbia.  new enterprises  new enterprises in 2006 accounted for 11,510 in serbia, and 953 in cohort 2 (see tables 5–6).  new enterprises emerged, for the most part, in the private sector, which thus appeared to be the  leading  sector  of  ownership.  the  private  sector  in  cohort  2  was  expanded  by 911  enterprises,  while all other sectors of ownership were enlarged by 42 enterprises only. newly opened private  2007 ‐ 74  •  economic analysis®  enterprises, distinguishable by  large numbers, were those  in: pancevo (217), sabac (145), cacak  (122), and kraljevo (106).  table 5. number of new enterprises by ownership: 2006     total  state  public  private cooperative mixed  serbia  11,510  250  4  10,927  196  133                      cohort 2  953  19    911  18  5  arilje  28  1     25  2     cacak  128  6     122        kraljevo  109  2     106  1     leskovac  78  6     72        pancevo  224  1     217  5  1  paracin  61       61        pecinci  12       10  2     prijepolje  22       22        sabac  154  3     145  3  3  smederevo  90       88  1  1  vrsac  47        43  4           source: business registers agency of the republic of serbia  the distribution of new enterprises by activities shows that the wholesale and retail trade  was the most attractive sector of activity in serbia, as well as in cohort 2 (except for arilje). the  greatest number of new enterprises in this sector within cohort 2 was notified for pancevo (114).    table 6. number of new enterprises by activities: 2006    serbia  co‐  hort 2  arilje cacak kra‐ ljevo les‐  kovac pan‐ cevo para‐ cin  pecin‐  ci  prije‐  polje  sabac    sme‐  derevo vrsac total  11,510  953  28  128  109  78  224 61  12  22  154  90  47  agriculture, forestry, water  resources management  355  30  2  2  2  1  8  1  1    5  2  6  fishing industry  9                          mining and quarrying  industry  40  5  1  1    1        1  1    manufacturing industry  1,872  197  11  29  27  19  31  10  3  5  42  15  5  electricity, gas, water sup‐ ply  28                          construction  765  59  3  7  7  7  15  3    1  9  4  3  wholesale and retail trade  4,363  453  10  55  45  31  114 41  4  11  77  45  20  hotels and restaurants  334  14      2  1  6        2  2  1  transportation, storage,  telecommunications  703  68  2  18  4  6  17  2  1  4  3  7  4  financial mediation  87  1                    1    real estate businesses  2,473  93    10  15  7  26  3  2  1  13  8  8  public administration,  compulsory social security  3                          education  104  10      2  2  2          4    health and social work  97  11    4  1  1  3    1      1    public utilities, personal  services  277  12    2  3  3  1  1      2      source: business registers agency of the republic of serbia  volume 40 • autumn 2007 • 75  new entrepreneurs  there were – as  it might have been expected, considering  the size of  initial  investment –  more new entrepreneurs than new enterprises in 2006. new entrepreneurs amounted to 45,867 in  serbia, and 6,549 in cohort 2 (see table 7). the largest number of new entrepreneurs within cohort  2 was recorded for pancevo (1,426).  the wholesale and retail trade was again a well‐favored activity by far, both in serbia and  cohort 2 (with the exception of arilje). it attracted 16,009 entrepreneurs in serbia, and 2,513 entre‐ preneurs in cohort 2. the greatest number of new wholesalers and retailers within cohort 2 was  reported for pancevo (685).    table 7. number of new entrepreneurs by activities: 2006     serbia  co‐ hort 2  arilje cacak kral‐ jevo lesko vac  panč evo  para‐ ćin  pećinci prije‐ polje  sabac  smeder evo  vrsac total  45,867 6,549  133  892  829 785  1,426 326 82  291  659  809  317  agriculture, forestry, water  resources management  518  60  1  4  9  7  8  9  1  3  5  3  10  fishing industry  4                                  mining and quarrying indus‐ try  23  2       2                       manufacturing industry  6,721  967  51  187  128 134  122 62  14  60  89  97  23  electricity, gas, water supply  6  1                            1  construction  4,598  563  8  80  93  90  102 26  8  19  45  71  21  wholesale and retail trade  16,009 2,513  30  264  278 320  685 124 35  84  245  307  141  hotels and restaurants  5,098  711  23  99  125 72  79  41  9  29  102  94  38  transportation, storage, tele‐ communications  4,238  773  5  112  64  66  264 21  9  57  32  121  22  financial mediation  333  60  1  3  10  10  2  2     5  13  13  1  real estate businesses  4,680  494  8  77  67  51  85  20  4  17  68  62  35  public administration, com‐ pulsory social security  3  1          1                     education  168  15     1  1  1  4  1        2  3  2  health and social work  767  92     16  17  9  19  3  1  5  8  6  8  public utilities, personal ser‐ vices  2,698  297  6  49  35  24  56  17  1  12  50  32  15  households  3                                      source: business registers agency of the republic of serbia  conclusion  the economic performance of the municipalities within cohort 2 was weak in 2006, as the  baseline year. in comparison with serbia, the majority of these municipalities had a lower share of  women  in employment  (in  total, and by enterprises and entrepreneurs), and a higher share of  women in unemployment. the unemployment rates, in total and for women in particular, were  high everywhere. only for two municipalities were they lower than for serbia. at last but not the  least, new enterprises and new entrepreneurs were established, for the most part, in the wholesale  and retail trade – which is not crucial for the economic growth of impoverished areas.  literature  1. vukotic‐cotic  g.  (2006),  relative  position  of  the  selected  municipalities  in  serbia,  2005,  pp.  1‐77,  2007 ‐ 76  •  economic analysis®  http://www.ien.bg.ac.yu/download/wp06‐9.pdf  2. vukotic‐cotic g. (2007), cohort 1 of the mega program: the economic performance from march 2005 to march 2007,  pp. 1‐22, http://www.ien.bg.ac.yu/download/cohort%201‐ies.pdf      ea_2018_1-2 notes from of new editor-in-chief as of september 2017 i am privileged and honored to take over the position of editor-in-chief of the economic analysis. on behalf of all the members of our new editorial board (ivana domazet, vladimir simović, jelena minović, sonja đuričin, duško bodroža), i would like to point out that we want that this change will mark the beginning of a new stage of journal development as we seek to position economic analysis among leading journals in the field economic analysis with special focus on emerging countries. as part of our future strategy the mission of the journal has been created: the economic analysis mission is to introduce the scientific and professional public with the original research results in the field of economic sciences, as well as with public policies proposals that are aimed at overcoming the identified challenges. the main thematic areas, which will be in the focus of the journal, are: sustainable economic development and resilience, business economy and management, labor economics and human capital and the international economy. accordingly, we invite academicians, professors, researchers, phd and master students which are connected to these topics to publish their work in our journal. the new editorial board decided that the quality of the editorial processes should be improved and that our publications should follow the international standards. therefore, starting from the end of 2017 open journal system (ojs) has been introduced to facilitate the development of entire editorial management workflow, including: article submission, multiple rounds of peer-review, and indexing. the new editorial board took the steps in indexing economic analysis in international databases such as central and eastern european online library (ceeol), central & eastern european academic source (ceeas), research papers in economics (repec), erih plus, doaj... last but not least, all the members of the international and local editorial board are entirely aware of upcoming challenges and high-level goals related to further improving the quality of the journal. however, over the next few years we shall work hard to build up a journal with a successful international reputation, publishing high quality research data, which will be abstracted and indexed in the main journal databases. in order to obtain this, i look forward to receiving your high quality submissions, general feedback and suggestions or criticisms for improving the journal. editor-in-chief ivan stošić, phd microsoft word 2007_01_02.doc results and problems of serbian real sector privatization  ivan stošić, institute of economic sciences, belgrade, serbia  key words: privatization, restructuring, real sector of serbian economy  udc: 332.025.28          jel : e65, o11  original paper  abstract ‐ the process of privatization of the real sector of serbian economy has not been com‐ pleted after 17 years of implementation. in spite of certain results, the privatization in serbia has been ac‐ companied with numerous problems and opposings. it is hard to believe that privatization could be success‐ fully finished in planed period. so, it is obvious that renewed institutional framework is necessary for con‐ cluding privatization in short time period.  1. introduction  while the majority of countries of central and eastern europe has already carried out struc‐ tural  changes,  improved  significantly  business  environment  and  quality  of  economic  activities  (and are joined to eu or are about to be joined to eu), serbia (together with the majority of other  countries of western balkan), is still in the process of transition. many changes, immanent to the  process of transition develop with slower than desired pace. among these changes is the process of  privatization and restructuring of enterprises that has key  importance for  improvement of perform‐ ances of economic activities and change in economic structure.   in serbia, not even after 17 years of implementing privatization, according to several differ‐ ent basic models and laws, this process has not been successfully completed. for this reason, sup‐ ports of international financial institutions of this process are not surprising. the focus of imf mis‐ sions, from reforms in monetary and fiscal sector, has been directed to implementation of struc‐ tural reforms, before all the process of privatization and restructuring of enterprises.   since a large number of non‐privatized socially owned enterprises has remained in serbia by  the  end  of  2006,  and  that  privatization  public  state  enterprises  (at  republican  and  local  level)  hasn’t in fact even begun, a question arises, what has brought to this situation in privatization field  and what are possibilities for this process in the real sector of the economy of serbia to be com‐ pleted finally in relatively short term?  2. the results of privatization of the real sector of the economy of serbia  • in serbia, with the outset of implementation of intensive transitional changes (in fact since  the beginning of 2001.) processes of privatization in the real sector of the economy were intensi‐ fied.  it is noticeable that prevailing share of up to now privatization revenues (around 81%) and  number of privatizations (around 76%) was realized in 2002 and 2003. namely, efforts in privatiza‐ tion were initially directed to the most attractive parts of the economy (industry of tobacco, ce‐ ment, beer, medicines, rubber, construction materials, then sugar refineries, chemical industry, oil  derivates distribution…) and successful enterprises. concerning the attractiveness of these enter‐ prises (large market and/or significant property), a greater number of investors were interested in  buying them, which influenced on the results in privatization to be initially very favorable. with  the privatization of only 14 most attractive enterprises,  the revenue of around €869 millions or  somewhat less than half of total realized privatization revenues. in the acquisition of enterprises in  serbia, a large number of reputable big world companies was included: “philip moris“, “bat“, “la  2007 ‐ 40  •  economic analysis®  farge“, “holcein“, uss, “lukoil“, “tarkett somer“, “titan“, “tondah“, “pharmaco“, some reputa‐ ble foreign investment funds ( e.g. “salford“) and many others.  • in 2004, a certain slowdown became evident in privatization in the real sector of the econ‐ omy of serbia. to a significant extent this was caused by the fact that the corpus of enterprises at‐ tractive for privatization was noticeable decreased, i.e. that some market attractive public enter‐ prises have not entered  the privatization process. at  the same  time,  for majority of remaining  ʺbusiness controversialʺ enterprises, in difficulties and problems there was no great interest from  potential investors. considering a immense number of these enterprises, a question was imposed  in which method to access to the privatization and transforming of enterprises, which can very  hardly find new owners due to their current performances  for those reasons, by the middle of 2005, do amendments of the law on privatization were  introduced, with which a new incentive was given to the process of privatization. by the amend‐ ments of the law on privatization, basically, the government (and public enterprises) has written  of  their debts  towards non‐privatized enterprises.  in  that way,  indebtedness has been reduced  considerably and remaining socially owned enterprises have been made more attractive to poten‐ tial investors. that has put revenues from the sale of enterprise and their support to the budget of  serbia into the second plan, and the priority was given to speeding up and finishing the process of  privatization.  besides,  the government has  taken over  to  itself  financing  the redundancy, with which a  great number of enterprises burdened by enormous of employees in relation to current production  and market possibilities, has been made more attractive for potential buyers.  • in 2005, 190 enterprises were sold by auction, with around 22 thousand employees, and  revenue of €173.1mn was realized. through tender privatization 15 enterprises were sold, with  around 8.8 thousand employees, and revenue of €96.6mn was realized. in 2005 activities in sale of  minority packages were intensified, and share fund of the republic of serbia realized the best re‐ sults in number of sold shares of the companies (more than 294) as well as in financial result (more  than €125,5mn). all that indicates to certain acceleration of the process of privatization compared  to previous year.  • in 2006, 206 enterprises were sold by auction, with around 22 thousand employees, and  revenue  of  €161mn  was  realized.  through  tender  privatization  25  enterprises  were  sold,  with  around 21.6 thousand employees, and revenue of €101.2mn was realized. in 2006. share fund of  the republic of serbia sold shares of the 306 companies for €70.1mn.   • in the field of privatization through restructuring, modest results were realized until 2005.  through processes of financial and organizational restructuring (mainly fragmentation of enter‐ prises), the government i.e. the privatization agency has been trying to prepare a certain number  of once large and/or significant enterprises for local self‐government for privatization and more  successful business operating in forthcoming period. unfortunately, in around 70 economic enti‐ ties that have initially been in the process of restructuring, until the alteration of the law on priva‐ tization  in  2005,  this  process  was  implemented  in  a  small  number  of  enterprises  (“livnica“  kikinda, “sever“ subotica, parts of other enterprises, like “zmaj“ zemun, etc.). therefore, visible  effects of implemented processes of restructuring to total business operating of domestic economy  were not noticeable. but the recovery of these enterprises is of key importance for adding dynam‐ ics of business activity in some cities, regions and on the level of the country as a whole.  after the amendment of the law on privatization (since 2005), visible moves in restructuring  field  were  realized,  and  some  big  enterprises  were  privatized,  like  “azotara“  pančevo,  “fvk“  kraljevo,  “hisar“  prokuplje,  “nitex“  niš,  “partizanski  put“  beograd,  “hipol“  odžaci,  etc.reducing  indebtedness and number of employees, as well as stabilization of  total economic  volume 40 • spring 2007 • 41  ambient are key reasons that influenced on adding dynamics to the process of privatization and  restructuring of the real sector of the economy of serbia since 2005.    table 1 ‐ results in the process of privatization real sector of serbia in 2002 –2006.    tenders  auctions  share  fund  total  number of enterprises sold  76  1343  433  1852  number of employees in enterprises  67776  127547  94710  290033  selling price (in mil €)  1004.63  691.75  398.26  2094.64  total investment (in mil €)  926.44  189.37  5.9  1121.72  redundancy programme (in mil €)  278.02  ‐  ‐  278.02  source: bulletin of public finances of the republic of serbia    the ebrd in transition report 2006 do not estimate the results of large‐scale privatization  and enterprise restructuring very highly in comparisons with other selected countries of former  yugoslavia. on the other hand the results of small‐scale privatization are estimated much better:    table 2 ‐ transition indicators in privatization  large scale privatization  2002  2003  2004  2005  2006  bosnia and herzegovina  2.33  2.33  2.33  2.67  2.67  croatia  3.00  3.33  3.33  3.33  3.33  fyr macedonia  3.0  3.0  3.33  3.33  3.33  montenegro  2.67  2.67  2.67  3.33  3.33  serbia  2.00  2.33  2.33  2.67  2.67  small scale privatization  2002  2003  2004  2005  2006  bosnia and herzegovina  3.00  3.00  3.00  3.00  3.00  croatia  4.33  4.33  4.33  4.33  4.33  fyr macedonia  4.00  4.00  4.00  4.00  4.00  montenegro  3.00  3.00  3.00  3.00  3.00  serbia  3.00  3.00  3.33  3.33  3.67  enterprise restructuring  2002  2003  2004  2005  2006  bosnia and herzegovina  1.67  2.00  2.00  2.00  2.00  croatia  2.67  2.67  3.00  3.00  3.00  fyr macedonia  2.33  2.33  2.33  2.33  2.67  montenegro  1.67  1.67  2.00  2.00  2.00  serbia  2.00  2.00  2.00  2.33  2.33  source: transition report ebrd 2006, ebrd. the measurement scale for the indicators ranges from one  to 4+, where one represents little or no change from a rigid centrally planned economy and 4+ represent the  standards of an industrialized market economy  3. problems and opposings to changes in privatization and restructuring process  • the process of privatization of the real sector of serbia has been followed by numerous  opposings and problems. the problem of opposing to changes often presents the main obstacle to  successful privatization and restructuring process, and the most often leads to significant dragging  out in implementation of necessary changes. opposing is present when a concept of implementing  changes is concerned, as well as proposed implementation method.  2007 ‐ 42  •  economic analysis®  namely, changes affect the management and employees, that is, their positions, responsibili‐ ties and existing forms of behavior. therefore the majority of employees, including there manages  too, not only are not interested in changes, but also with hostile attitude towards them. there is no  readiness in the management to enter into the privatization and restructuring, i.e. alter the gloomy  present of business operating “of their enterprises“ with uncertain, maybe even better future. in‐ stead of working on enabling their enterprise for business activities in completely different condi‐ tions of business operating, efforts of management are still directed to a great extent to keeping  obsolete methods of business operating (not rarely based on renting capacities to private entrepre‐ neurs) or to searching for different aspects support from the government. besides all that, it is not  rare a domination of temporary private interest of some managers over the interests of the whole  enterprise and the employed in them.  unfortunately, neither the employees are too much  interested  in the privatization and re‐ structuring, because they do not see direct  interest  in that. in addition, the majority of the em‐ ployed is very scared for their work posts and wages and opposes to strategic changes due to fear  from future, although they are unsatisfied with their current status as well.  • the processes of privatization, especially of big enterprises of the real sector of serbia are  burdened  by  objective  business  problems  with  which  these  economic  subjects  meet.  although  great differences exist from an enterprise to an enterprise, however numerous mutual problems  are characteristic for all these enterprises, which cannot be systematized to presented swot ma‐ trix.  table 3 ‐ swot matrix of large non‐privatized enterprises in difficulties  strengths  weaknesses  • long tradition and production experience • experienced and trained labor force • large surface of building facilities • significant production capacities • high indebtedness • obsolete production equipment and technology • obsolete production programme • narrowed market • a great number of employees, inadequate qualification and age structure of employees • high fixed costs and non-competitiveness • unsolved property-legal relations • numerous court disputes • chronic lack of own working capital opportunities  threats • written of debts through financial restructuring • implementation of redundancy programnmes • investments in state-of-the-art production technologies and development of products • possibilities for increase of sale on domestic and european market through privatization by strategic partners   • intensification of competition by smaller domestic and big foreign producers • liberalization of import regulations • non-understanding of a part of creditors for existing situation • inefficient system of solving litigations • political instability   presented matrix indicates to a conclusion that mainly enterprises are considered, in which  weaknesses and threats prevail over advantages and chances that exist. the privatization of these  enterprises, in particular without abundant processes of restructuring and implementation of ma‐ jor changes, is extremely difficult. one of the main reasons is the fact that there is no expressive  great interest of potential investors for their privatization, particularly not in present form, existing  level of competitiveness, business performances and market currently available to them.  • numerous controversies related to new owners and their behavior forms are present in  serbia. in a certain number of enterprises, the privatization was mainly motivated by speculative  reasons, in the first place by the acquisition of property that those socially owned enterprises pos‐ volume 40 • spring 2007 • 43  sessed. therefore, new owners and management are not interested in development of a business of  enterprise, but to buy the property. the new owners frequently create conditions, with different  measures, and before all low wages and introducing rigorous working discipline, for employees to  give notice and leave enterprises (in spite of social programme of adopted plan). in such manner  the existing property remains on disposal of new owners, which they will offer after the term an‐ ticipated by law (related to a ban of alienation of privatized enterprises’ property) for sale on the  market (probably at considerably higher prices in comparison to those at which they had bought  the capital of those enterprises).  a number of “annulated privatizations“ in which purchase contracts were cancelled due to  the method of business operating of new owners is relatively small and amounts around 9% (the  most famous is the case of “putnik“ beograd). nevertheless, a number of enterprises in which even  after implemented privatization there was no visible improvement of performances is considerably  higher,  which  emphasizes  opposition  of  the  management  and  employed  in  up  to  now  non‐ privatized enterprises.  • in serbia practically everybody speaks in favour of privatization, but new owners disturb  almost everybody. for many people, privatization by multinational foreign companies presents  sale of national property (so called “family silver“). even more undesirable are domestic private,  especially substantial entrepreneurs (delta m, mk commerce, east point...). though it is shown  that the privatization by multinational companies, and even large domestic entrepreneurs by rule,  in middle term, brings to an increase of efficiency of economic operating and raising the competi‐ tiveness and volume of operating (e.g. “uss serbia“, “vb“ sevojno, “juhor“ jagodina) almost all  serious strategic  investors are subject  to numerous criticisms and demands for revision of pur‐ chases done. a concept of workers’ shareholding, at one time applied, was abandoned in serbia  (which was incorporated in legal provisions until july, 2001) and it is obvious that overall consen‐ sus has not been realized in regard of existing concept of privatization, in particular when new  owners are considered. in addition, negative examples of behaviour of some new owners do not  contribute to overcoming the opposition to privatization and restructuring process.  • the privatization (and restructuring) of enterprises is not the aim by itself, but means for  improvement of performances of business operating of the real sector and entire economy. that  should result with an increase of production volume, export, then decrease of inflationary pres‐ sures, inflow of foreign investments, and increase in wages of the employed, etc. although rela‐ tively satisfactory results of key macro economic trends in serbia have been realized in previous  period, it could not be stated that all expected effects efficiently have been realized up to now. al‐ though the production, export, real wages, investment inflow has been increased... all initial expec‐ tations have not been fulfilled until now. serbia with gdp per capita of somewhat more than 3.5  thousand us$ falls into, even henceforth, the lowest in the region.  negative effect on employment presents key problem in the implementation of privatization  and the process of restructuring. unfortunately, the number of unemployed in serbia is still very  high and during the implementation of privatization and restructuring it has increased for around  200  thousands.  according  to  available  data  for  the  end  of  2006,  the  number  of  unemployed  amounted 1.081 million persons, and official unemployment rate has reached the level of around  27% (according to survey on labour around 20.8%), which presents one of the greatest economic  and social problems of serbia. namely, as a consequence of the process of privatization and re‐ structuring of public and other enterprises, it comes to increased lay off of workers, which at low  level of economic activity and still insufficiently broad fan of incentive measures for development  of small and middle enterprises influences on high unemployment rate in serbia.  2007 ‐ 44  •  economic analysis®  table 4 ‐ basic macroeconomic indicators for period 2002‐2006  period  gdp growth  in %    industrial  production  growth in %  inflation  growth in %    export in  mil. us$    import in  mil. us$    real wages   growth in %    2006  5.8  4.7  6.6  6428  13172  11.4  2005  6.5  1.3  16.5  4553  10570  5.7  2004  9.3  7.1  10.1  3701  11139  10.1  2003  2.4  ‐3.0  11.7  2755  7473  13.6  2002  4.5  1.8  19.5  2075  5614  29.9  source: republic bureau of statistics  4. outlook of the process of privatization  • by the law on privatization, it was determined that se by the end of march 2007 should be  finished the process of privatization of socially owned enterprises in serbia, which had begun even  in 1990. however, in the portfolio of agency of privatization in the march 2007 were more then  1200 non‐privatized firms. in addition to that there are a great number of stocks socially owned  enterprises within share fund.  majority of non‐privatized enterprises are small enterprises, which due to their business per‐ formances, small property and/or unsolved  legal problems were not attractive for privatization  and the interest for them has not been shown by potential buyers up to now. but there are more  then  300  large  firms  or  around  somewhat  less  than  1/3  of  all  large  enterprises  among  non‐ privatized enterprises. these enterprises employ many persons, possess immense property and are  of a great significance for the economy of state and local self‐government. nevertheless, as a rule  (with exemption of large public enterprises), these non‐privatized enterprises will objectively be  very  difficult  to  be  successfully  privatized,  even  with  a  precondition  decreasing  indebtedness  through writing off debts and a reduction of the number of employees through implementation of  social‐ redundancy programmes.  • therefore an issue imposes, in what way will finally be successfully completed the process  of privatization in serbia that had begun long ago, which in majority of other countries in transi‐ tion in central and eastern europe has practically been finished?  according  to current  legal provisions,  the possibility of  fast privatization of such a great  number of enterprises in anticipated term is practically unfeasible. namely, there are no capacities  to prepare in so short‐term corresponding sale documentation for such a great number of enter‐ prises, in particular concerning numerous legal problems (immanent to business operating of these  enterprises), as well as unwillingness  (or  incapability) of  the management  to work actively  on  preparation for privatization.  apart from that, it is hard to believe that effective domestic and foreign demand exists for so  great number of such enterprises. at last, an offer of a great number of enterprises for privatization  in short term will inevitably lead to inadequate privatization revenues and other negative effects.  special issue is the privatization of public state enterprises. after significant pressures by in‐ ternational financial institutions processes of restructuring of some big public enterprises and their  preparation for privatization have begun. it regards in the first place parts of gas and oil industry,  then railway, post, airways company, etc. nevertheless, processes of privatization and restructur‐ ing of these enterprises (which possess around 50% assets of the total economy) are in a very out‐ set and they have ahead of them approaching implementation of huge transitional changes. al‐ though due to its attractiveness buyers for this sector of the economy exist surely (before all nis ‐  volume 40 • spring 2007 • 45  gas and oil industry, eps ‐ electrical power complex), there are still numerous opposings in the  privatization of these enterprises, a threat of social tensions, as well as a lack of consensus (in po‐ litical and economic circles) about which of these enterprises and in what method should be pri‐ vatized.  6. instead of conclusion  although processes of privatization and restructuring had initially negative effect in other  countries in transition (so called transitional crisis), the data indicate that the countries character‐ ized by intensive restructuring processes come faster out of the crisis and realize faster economic  growth monitored in longer term period. namely, the sooner it comes to change in economic struc‐ ture and changes in a method of operating of the real economy sector, the faster assumptions are  realized  for  faster and more stable economic  growth,  improvement of competitiveness and  in‐ crease of export, living standard, and even growth of employment. all that indicates to necessity  of implementation intensive processes of privatization and restructuring, regarding the fact that  with obsolete economic structure and ancient history method of business operating more success‐ ful results of business operating in the real sector of the economy of serbia cannot be achieved.  privatization and recovering of non‐privatized, especially large enterprises (including there  also big public enterprises, as well as numerous public enterprises at local level), will present one  of the greatest challenges for economic policy in forthcoming period. nearly all business perform‐ ances of the economy of serbia will essentially depend on the success of solving this issue in forth‐ coming period.  the role of government, through (not so big) subsidies for employees’ wages and contribu‐ tions and/or providing short‐term credits for prolongation of existing, mainly unprofitable, pro‐ duction is not sustainable in the long term. it is effective solution. although the restructuring is  often ʺpainfulʺ process followed by a row of undesirable effects, which includes leaving certain  productions, “cutting” of the number of employees and closing numerous non‐propulsive enter‐ prises or their parts, the privatization and restructuring of the firms in real sector of the economy  of serbia is inevitable. the sooner it comes to change in economic structure and alterations in a  method of operating, the faster assumptions are realized for greater economic growth, improve‐ ment of competitiveness and increase in total effectiveness and efficiency of business operating.  therefore the process of privatization must be speed up and accomplished with firmer carrying  out the bankruptcy procedures that are the only feasible way for privatization of large number of  non‐attractive firms. only, by larger scale bankruptcy procedures then in previous period, the pri‐ vatization process could be implemented and finally to be ended.  udc: 336.71:28(497.11) cobiss.sr-id 252605964 scientific review process of internationalization in islamic banking: the case of serbia aida hanić1* 1 institute of economic sciences, belgrade, serbia abstract islamic banks are financial institutions operating in accordance with religious islamic law (sharia). although it is familiar as non interest banking, because the interest is forbidden, islamic banking represents a complete set of moral and ethical activities that must be taken into account when making investment decisions and financing business activities. share of islamic banking in islamic finance is around 80% with the value of approximately $ 1.57 trillion by the end of 2015 (ifsi stability report 2016). islamic banking in western balkan is present only in bosnia and herzegovina (b&h) that has one islamic bank, bosna bank international (bbi) established in 2000. serbia, as a country that has attracted many arab investors, doesn’t have any islamic bank operating in the country. the aim of this research is to explore is there a public interest in islamic banking, especially among the commercial banks in serbia and are there possibilities for development of islamic banking in this country. to explore these two main questions, author conducted a research by using a questionnaire among the chairmen and members of the administrative board of 12 commercial banks in serbia. the result of the research show that commercial banks in serbia are not interested in this type of a banking activity. on the other hand they are also not sufficiently familiar with the concept of islamic banking. the research showed that process of internationalization of islamic banking is not present in serbia. key words: islamic banking, internationalization, ethical identity, development, serbia jel classification: g21 introduction islamic banking is a financial activity done in accordance with islamic religious law (sharia), and it is based on principles that are different compared to conventional banking. first, money is seen only as a medium of exchange because sharia forbids payment or receipt of interest (riba), gambling (maysir) or excessive uncertainty (gharar). secondly, it promotes risk sharing where every economic activity must have a connection with the real economy and the parties are bound by agreement that includes the profit and loss sharing paradigm. human effort and activities that are included in some investment project are valued equally as the funds that are going to use to finance that same investment project. in that case, individual has the right and responsibility to the society ("therefore, as for the orphan protect him, as for the beggar, oppress him not, and as for thy lord's favor, declare it“; quran: 9:11) and must be oriented towards the creation of a moral and sustainable society which form the basis of islamic ideology. according to iqbal & mirakhor (2007), ideology is important because if the ideology is strong enough, the * e-mail: aida.hanic@ien.bg.ac.rs aida hanić 67 divergence between the choices individuals make and those expected of them are less. in other words it means that asymmetry and moral hazard are minimized since a large part of uncertainty is eliminated with rule compliance. islamic financial system began to develop when the process of decolonization started and the first islamic bank, mit ghamr savings, was founded in 1963 in egypt and followed the model of german savings bank. ever since, islamic financial institutions (ifi’s) started to grow at 10-12% annually. beside islamic insurance (takaful), islamic bonds (sukuk) and other sharia financial instruments, islamic banking with a percentage of 80% is dominant in islamic financial industry. current size of the islamic finance market range is estimated from $1.66 trillion to $2.1 trillion with expectations of market size to be $3.4 trillion by end of 2018.1 according to magazine “the banker”, in 2015 there were 360 registered islamic financial institutions and 111 conventional institutions with sharia windows. dubai center for islamic banking and finance reports that, currently, on the global level, there are around 150 islamic commercial banks that are fullyfledged2. iman & kpodar (2015) notes that countries where islamic banking is present has positive impact on growth and experience faster economic growth than others. but despite the growth and economic stability, especially during the crisis, islamic finance assets are still concentrated in the majority muslim countries. nevertheless, there are some exceptions like indonesia, the world's most populous muslim country, where according to world islamic banking competitiveness report (2016), islamic banking has only 3.8% of market share. in others gcc3 countries, islamic banking has different market share: saudi arabia (31.7%), malaysia (16.7%), uae (14.6%), kuwait (10.50%), qatar (7.7%), turkey (5.8%), bahrain (1.7%), pakistan (1.2%). this still represents a relatively small share of the economy. islamic banking in europe is present since 1978 when islamic banking system international holding was established in luxembourg. in 2002, the luxembourg stock exchange was the first to list a sukuk. today, london is considered to be europe’s capital of islamic banking. the first islamic financial institution in the country was founded in 1981, al-baraka international company, and in august 2004 the islamic bank of britain was established as the first islamic retail bank. for the purposes of this paper, analysis will be focused on serbia. in near b&h, there is only one islamic bank, bosna bank international (bbi), based in sarajevo and established on october 19, 2000 as the first bank in eastern europe to operate on the principles of islamic banking. the share capital of bbi amounted around eur 23 million, which at that time, was the largest paid in capital compared to other banks in the country. the bank founders are islamic development bank (the major shareholder of bbi with 45.5% share capital), dubai islamic bank (shareholder of bbi with 27.27% of the share capital) and abu dhabi islamic bank (shareholder of bbi with 27.3% share capital). in serbia there are no islamic banks but only one bank from uae, “mirabank” that is focused primarily on corporate financing. this paper aims to provide an answer to the research, which is, whether islamic banks have a perspective of development and further expansion in countries such as serbia. this paper is organized as follows. section literature review gives a brief overview of the process of internationalization, especially in banking industry. section theoretical framework examines islamic banking and islamic financial country index. in the third section, methodology, the process of data collection, regarding the presence of islamic banking is serbia, is explained. 1 https://www.islamicfinance.com/2015/05/size-islamic-finance-industry/(accessed on february 2017). 2 fully fledged islamic bank is a bank whose business is totally based and performs with islamic principles while islamic window is just a service provided by conventional banks but based on islamic principles. 3 the cooperation council for the arab states of the gulf known as the gulf cooperation council (gcc) is consisted of bahrain, kuwait, oman, qatar, saudi arabia, and the united arab emirates. 68 economic analysis (2017, vol. 50, no. 3-4, 67-74) results from questionnaire where given in the section results and discussion. the conclusion presents the outcome of the paper. literature review internationalization, in commerce, can be defined as a growing tendency of a company to take its business from local to international market. as a process, internationalization is unpredictable but from business perspective it can bring several advantages such as to increase the companies turnover, to be used to recover from the losses as the domestic sales is shedding, to help the company to be more competitive (burdus & alpopi) and from marketing perspective, it requires from companies to adopt it products and services to different cultures and languages. paliu–popa (2008) notes that process of internationalization is done in several stages and it is consisted of internationalization of trading goods, the internationalization of production and the internationalization of the firm. in study “banking across borders” done by slager (2004), there are seven major incentives why to internationalize: 1. follow your client, 2. increase earnings, 3. exploit financial and economic developments of the home country, 4. regulation, 5. market concentration, 6. herding, 7. efficiency, profitability. in the case of islamic banking, rapid growth increased the demand for islamic banking products contributing to its development. islamic banking in the society can bring changes because it promises to foster greater financial inclusion, it is based on assetbacked financing and risk-sharing what is a good support for sme and it poses less systemic risk than conventional banking (kammer, norat, piñón, prasad, & towe, 2015). islamic banking is based on ethical norms, derived from the islam, and according to garas & manama (2007) it enhances their corporate social responsibility (csr), what can bring them a favorable image from the stakeholders and enhanced their performance in their early stage. historically, during the first three decades of its development, islamic banking was focused on two core markets: bahrain in the middle east and malaysia in south-east asia (imam & kpodar, 2010). today islamic banking is being identified as a multi-dimensional market. in practice more international banks are turning to islamic banking in form of islamic windows or as a fullyfledged bank which resulted in the expansion into new markets (malik, 2010). in some countries, islamic banking became systemically important and, in many others, it is too big to be ignored (imf, 2010). muslims make 24% of world population and in europe there are around 20 million of muslims as potential customers where deloitte stands (2014) that saving rates of european muslims are higher than those of other european populations. eu governments are welcoming islamic banks and trying to make better conditions for their business. for example, luxembourg is recognized as a leading hub for islamic funds with 111 islamic funds doing business in this country while in ireland their number is 53 (deolitte, 2014). as a way of moving islamic banking to new markets, some islamic banks are rebranding their name and moving the word “islam” from the banks name. in january 2014, dubai-based noor islamic bank changed its name to noor bank. on the other hand in turkey, islamic banks are named as „participation banks” although they are operating in accordance with sharia rules. islamic banks are not planning to leave sharia rules but just to be more close to other customers that are not muslims especially in nonmuslim countries. as said before, islamic banking is present in the region, with only one islamic bank but the fact is that public is still not sufficiently enough familiar with the core of their business. goksu & becic (2012) conducted a survey whose main objective was to show customers’ attitudes, beliefs and perceptions about the services offered by islamic bank in b&h. survey had three parts: demographics, general experiences and perceptions about islamic banking in b&h. results of the research on 186 clients showed that around 60% of respondents didn’t gave the correct answer regarding understanding the principles of islamic banking. in serbia the awareness of aida hanić 69 the islamic banking is even lower not just among the customers but also among the participants of the financial sector, especially conventional banks. theoretical framework islamic banking, as a financial activity, has its own principles and every transaction includes the following: 1. there must be a mutual trust and transparency between the partners in every part of a transaction, 2. the use of profit and loss sharing paradigm, 3. ownership – you can sell the commodity or the subject of the contract only if you own it. because of the prohibition of interest, islamic banks have developed many products as an alternative to the conventional banking, with the aim to satisfy their clients financial needs but on a more ethical and moral way. there are two main types of product: a) profit and loss sharing instruments (pls) b) mark-up (cost plus) contracts. the further division would be the following: a) sales based (murabaha, istisn'a, ijarah, tawarruq), b) equity based (musharakah, mudarabah), c) fee based (wakalah, kafalah, rahn), d) islamic deposits (wadai'ah, qarḍ, tawarruq), e) investment accounts (mudarabah, musharakah) and f) investment accounts (wakalah). although the islamic banking is still a relatively new way of doing business, according to thomson reuters' islamic finance development indicator (ifdi 2016), by 2021 islamic banking assets will reach us$2.8 trillion as shown in chart below. chart 1. expected islamic assets globally source: thomson reuters' islamic finance development indicator in geographic terms, islamic banking is mostly concentrated in the middle east and asia. 0 0.5 1 1.5 2 2.5 3 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 global islamic banking assets growth (2012 2021, us$ trillion) 70 economic analysis (2017, vol. 50, no. 3-4, 67-74) chart 2. islamic banking assets source: ey world islamic banking competitiveness report 2014-15 when analyzing a countries profile, as a potential market for islamic banking, “islamic financial country index” (ifci) was launched in 2011 with total 45 countries involved. variables that are included in the index are presented in the next table. table 2. ifci variables and their weights variables description weights number of islamic banks full-fledged islamic banks in local and foreign origin 21.8% number of islamic banking financial institutions (bfis) all islamic banking and non-banking financial institutions including islamic windows provided by conventional banks 20.3% shari’a supervisory regime a central institution or body to look after the shari’acompliance process in all islamic banking financial institutions in certain country 19.7% islamic financial assets islamic financial assets under management of islamic and conventional institutions 13.9% muslim population number of muslims in absolute value 7.2% sukuk total sukuk outstanding in the country 6.6% education and culture level of educational and cultural environment in the area of islamic finance such as professional qualifications, degree courses, diplomas and other dedicated training programs 5.7% islamic regulation & law legal framework that regulates ibfis in the country such as islamic banking act or islamic capital markets act, etc. 4.9% source: global islamic finance report 2015 when all of the variables are analyzed, the results of a countries ranking is given in the next table. 2009 2010 2011 2012 2013 gcc 295 333 385 454 517 asean 71 93 117 140 160 turkey and row 41 50 53 69 78 south asia 11 14 17 20 23 295 333 385 454 517 71 93 117 140 160 41 50 53 69 78 11 14 17 20 23 islamic banking assets in usd billions gcc asean turkey and row south asia aida hanić 71 table 3. ifci ranking countries, top 10 and other countries in 2015 country rank in 2015 rank in 2014 score 2015 iran 1 1 85.6 malaysia 2 2 80.3 saudi arabia 3 3 73.6 united arab emirates 4 6 38.0 kuwait 5 5 36.7 bahrain 6 4 26.3 indonesia 7 7 24.7 qatar 8 10 20.9 sudan 9 8 15.7 pakistan 10 9 14.7 turkey 12 12 9.7 uk 14 13 6.7 switzerland 24 2.3 france 38 35 0.9 germany 40 36 0.6 china 42 39 0.6 source: global islamic finance report 2015 sharia in the fundamental basics of islamic banking and finance and in some countries like bahrain, iran, pakistan, saudi arabia and sudan it is the official law of a country while in countries like malaysia it is not a part of the legal framework (imf, 2014). one very successful example of how to introduce islamic banking into financial system is malaysia. this country has a dual banking system where conventional and islamic banking system operates in parallel. in 1983, malaysia introduced the islamic banking act that gave foundations for islamic banking. from the table above we can see that serbia and bosnia and herzegovina are not on this list. the reason is that both countries do not fulfill these variables contained the ifci. in the case of bosnia and herzegovina, bbi bank in 2012 was ranked in ninth place amongst the fastest growing banks in bosnia and herzegovina and in 2015 bbi had 5.6 millions of km (apx. 2.83 millions of eur) of revenue. sarajevo stock exchange (sase) and bbi signed a contract of implementation of islamic index, as the only islamic index in the region. according to the census in 2013, in b&h 50.7% population are muslims what is a good foundation for the development of islamic banking, but in practice conventional banking is more present among the customers in b&h, regardless of religion. although, bbi started the process of public education by publishing articles on islamic banking and finance where in association with sarajevo school of economics and business, university of sarajevo there are master programs for islamic banking, the awareness of islamic banking is still low. in serbia, banking system consists of the central bank (national bank of serbia) and commercial banks. at the end of march 2016, banking sector numbered 30 banks of which 17 banks operated with profit, while 13 banks reported a negative result. four banks which posted the highest net profit together made up more than half of the total sector’s profit, while one bank with the highest net losses accounted for one half of the total losses. “mirabank”, the only bank in serbia from arab area, which is not offering islamic banking, on 30.9.2016 reported losses in value of rsd 320 million (apx. 2.583.040 eur). one of the key elements regarding development of islamic banking in serbia is regulation. the “law on banks” doesn’t recognize islamic banking as a way of doing business but in the activities such as a) foreign exchange operations, foreign currency operations and exchange transactions; b) payment transactions; c) issuing payment cards; d) activities regarding securities (issuing securities, custody bank activities, etc.); e) brokerage-dealership activities; these operations are 72 economic analysis (2017, vol. 50, no. 3-4, 67-74) allowed. in that aspect if there is a demand for this types of services maybe in future the law can create conditions for the implementation of islamic banking. methodology this particular research was created to provide an insight into degree of familiarity of directors of commercial banks in serbia with the principles of islamic banking and the possibilities for the development of this financial activity and to provide an insight in further internationalization of islamic banking in serbia. the author created a short questionnaire containing only 7 questions. the questions were related to areas such as: a) the rate of growth of assets of islamic banks, b) the level of informed about the principles of islamic-banking, c) the degree of acceptance of the establishment of islamic banks by the public d) percentage of the rate of return risk of islamic banks compared to conventional banks, e) level of interest of conventional banks to provide islamic banking services through islamic windows, f) regulating the business of islamic banks and g) business ethics in islamic banking the questionnaire was delivered to banks in serbia via their e-mail addresses and 12 banks answered the questionnaire. the survey questionnaire contained questions that included single response, multiple response, ranking response, and five-point scale questions. the survey was conducted during the september of 2016. it is important to note the research result provides very limited insight into the state and prospects of development of islamic banking in serbia, because the period of survey was short and the pattern is small, but it still provides an insight into the degree of internationalization of islamic banking in serbia. results and discussion the research revealed that: 1) based on the distribution of responses, on the indicative level, only one third of the members of the board of directors of commercial banks in serbia know that the islamic banking sector in 2008 achieved a higher rate of growth of assets. 2) relating the level of informed about the principles of islamic-banking, 83% of respondents answered negatively which is consistent with the answer to the first question, leading to conclusion that directors of commercial banks in serbia are aware that public is not sufficiently informed about the principles of islamic banking. 3) in aspect of establishing islamic bank in serbia, 65% of directors of commercial banks believe that islamic bank would be well accepted by the public in serbia, 25% have the opposite opinion while the remaining 10% were not able to comment on the matter. 4) if a client is late with repayment of the loan, the islamic bank can’t charge interest, as in the case of conventional banks, that suggests that islamic banks, in most cases, are more exposed to return risk. the results of the research showed that 75% of directors of commercial banks in serbia are sure that islamic banks are not exposed more to the rate of return risk while 25% were not able to comment on the matter. this percentage is consist with the fact that public is not sufficiently informed about the principles of islamic banking. 5) from a total of 12 directors who participated in the survey, 90% answered that they do not intend to offer islamic banking through islamic windows in the next five years, while only 10% said probably not. aida hanić 73 6) regarding regulation of islamic banks, 58% of the respondents are aware that islamic banks face a problem with the regulation in the countries like serbia, 25% were not able to comment on the matter and 17% of the respondent participants answered that current regulation is not an obstacle to the development of islamic banking in serbia. 7) a) 50% of the of directors of commercial banks in serbia strongly disagree that islamic banking is applicable only in muslim countries which is consisted with the statement that islamic bank would be well accepted by the public in serbia, 20% of the respondents disagree partially while 30% can’t take a stand on this matter. b) regarding the statement that islamic banks are more profitable than commercial banks, 66% of directors of commercial banks in serbia couldn’t take a stand on this matter, 17% disagree partially with this statement and 17% partially agree. c) in the case of social responsibility, 67% of respondents takes a stand that islamic banks are not more social responsible than commercial banks, 17% couldn’t take a stand on this matter while the rest of 16% think islamic banks are more social responsible. d) regarding the question of ethics, 55% of directors of commercial banks in serbia couldn’t take a stand on this matter, 25% disagree with the statement and 20% think islamic banks is more ethical. conclusion islamic banking is a financial activity that operates under the different conditions than commercial banking. this type of financial activity is present worldwide and it continues to expand. this process of internationalization gained importance after the outbreak of the global economic crisis in 2007 when islamic banks, on average, showed stronger resilience than commercial banks. to examine the possibility of implementing the islamic banking in serbia, author did a research among the members of the board of directors of commercial banks in serbia regarding: the rate of growth of assets in islamic banks, the level of knowledge about islamic banking, would the public in serbia accept islamic banking, what is the rate of return risk in islamic banking compared to commercial banks, are commercial banks interested in providing islamic banking services through islamic windows, is the regulation of business of islamic banks supported by the regulator and the ethics among commercial banks compared to islamic. the results show that only one third of the members of the board of directors of commercial banks in serbia know that the islamic banking sector in 2008 achieved a higher rate of growth of assets and where 83% of respondents answered negatively regarding their knowledge about the principles of islamic banking which is consistent with the fact that public in serbia is not sufficiently informed about the principles of islamic banking. although 65% of directors of commercial banks in serbia believe that islamic banking would be well accepted by the public in serbia and where 50% of the of directors strongly disagree that islamic banking is applicable only in muslim countries, 90% of directors of commercial banks are not interested in offering islamic banking in serbia through islamic windows. in the case of social responsibility, 67% of respondents take a stand that islamic banks are not more social responsible than commercial banks while in the aspect of ethics, 55% of directors of commercial banks in serbia couldn’t take a stand on the matter are islamic banks more ethical than commercial. it is important to highlight that this research has a limit because the pattern is small and the period of research is short but also this is a good indicator is the serbian financial sector ready for islamic bank? the answer will depend on the demand of this type of financial product. on the other hand, process of internationalization of islamic banking in serbia might take a stand if future islamic banks do a rebranding of their name, not to leave shari'a rules, but to be more close to customers that are not muslims especially in nonmuslim countries 74 economic analysis (2017, vol. 50, no. 3-4, 67-74) acknowledgements this paper is a part of research projects number iii 47009 (european integrations and socioeconomic changes in the economy of serbia on the way to the eu) and oi 179015 (challenges and prospects of structural changes in serbia: strategic directions of economic development and harmonization with the eu requirements), financed by the ministry of education, science and technological development of the republic of serbia. references garas, s., & manama, b. (2007). internationalization of islamic financial institutions: challenges and paths to solution. thunderbird international business review, 49(2), 225–249. http://doi.org/10.1017/cbo9781107415324.004 goksu, a., & becic, a. (2012). awareness of islamic banking in bosnia and herzegovina. international research journal of finance and economics, 100(100), pp. 1–14. imam, p., & kpodar, k. (2010). islamic banking: how has it diffused? imf working paper, wp/10/195(september), 1–18. http://doi.org/10.2753/ree1540-496x490607 iqbal, z., & mirakhor, a. (2007). an introduction to islamic finance: theory and practice. singapore: john wiley & sons (asia). kammer, a., norat, m., piñón, m., prasad, a., & towe, c. (2015). islamic finance : opportunities , challenges , and policy options. islamic finance, pp. 1–38. paliu-popa, l. (2009). economy globalization and internationalization of business. analele universităţii “constantin brâncuşi” din târgujiu,seria economie, nr. 3/2009 slager, a.m.h. (2015). banking across borders. journal of international economics, 96(2), 244– 265. http://doi.org/10.1016/j.jinteco.2015.02.001 books h. van greuning., z. iqbal. (2008). risk analysis for islamic banks. washington dc reports deloitte (2014). “islamic finance in europe”. uk ernst & young (2016). “world islamic banking competitiveness report”. uk islamic financial services board (2014). “islamic financial services industry stability report”. kijang, bank negara malaysia monetary and capital markets department & middle east and central asia department (2010). “the effects of the global crisis on islamic and conventional banks: a comparative study.” imf working paper. monetary and capital markets department. (2014) “islamic banking regulation and supervision: survey results and challenges”. imf working paper. thomson reuters' islamic finance development indicator. (2016). https://www.salaamgateway.com/en/story/report_icdthomson_reuters_islamic_finance_dev elopment_report_2016-salaam06122016021157/ article history: received: october 13, 2017 accepted: november 13, 2017 ea_2018_3-4 115 economic analysis (2018, vol. 51, no. 3-4, 115-124) doi: 10.28934/ea.18.51.34.pp115-124 scientific paper satisfaction and loyalty of clients towards banking products and services milica raičević1* | dijana medenica mitrović2 1 mediterranean university, faculty of economics and business, podgorica, montenegro 2 faculty for business management, bar, montenegro abstract transformation of the banking sector has led to today's banks providing a complete service financial service both on the domestic and international level. the focus of their business is the client whose loyalty depends on the operations of the bank. the aim is to indicate that there is a direct link between the quality of the banking product and the service that affects the client's satisfaction and loyalty, which directly affects the bank's business and its competitive advantage in the financial market. the paper gives a theoretical and practical overview of the quality of service, satisfaction and loyalty of clients, and the performance of the bank, which depends on clients. in the theoretical part, the concept of a client, its significance and specifics related to its influence on the bank's business, through its satisfaction and loyalty to the bank, is defined. the empirical part deals with the analysis of customer satisfaction and loyalty towards banking products and services in montenegro and how much the quality of banking services has an impact on the satisfaction and loyalty of the customer. the analysis of the factual situation will be carried out, the conclusions will be presented and recommendations made for improvement of the quality of the service, which will contribute to the greater satisfaction of the clients, and therefore the loyalty to the particular bank. all of this is directly related to the possibility of achieving the competitive advantage of banks within the banking sector where a particular bank operates. key words: quality of service, satisfaction, loyalty, client, banking sector, strategic management jel classification: j5, e5 introduction in the business world, there is a "fight" around every potential but also a permanent client. services are a key segment in achieving these goals. if we have a good placement of products and services, and most importantly, if we take care of the client and his needs, we can gain his loyalty. this is precisely the key to the success of banks, because a loyal client is satisfied with the client, and therefore the bank has secured the advantage of the bank and a secure profit. banks through the perception of quality perception by clients can improve their business and offer a better and better service that is tailored to the needs of clients. what contributes to satisfaction is building full loyalty among bank clients because clients are hitting propaganda messages that try to influence their perception. thus, when creating a service, account must be taken of the heterogeneity of the market and service supply gaps, i.e. the difference between the expectations of consumers and their perception of the delivered service (hill, 2006) and must achieve superior value for the consumer (marinković, 2012). consequently, the quality system of services becomes a lever that prevents attempts to influence customer satisfaction and loyalty. in this way, the * corresponding author, e-mail: milica.raicevic@unimediteran.net 116 economic analysis (2018, vol. 51, no. 3-4, 115-124) quality and comprehensiveness of the service is the best tool for building a sense of loyalty with banking clients. the methodology of the work includes a theoretical and practical overview of the importance and role of the quality of services, satisfaction and loyalty of clients towards banking products and services, and hence the success of the bank itself. theoretical part defines the concept of the client, his / her significance and specific features related to his / her influence on the operations of the bank, through his / her satisfaction and loyalty to the bank. the empirical part deals with the analysis of client's satisfaction and loyalty for banking products and services in montenegro and how much quality of banking services affects the satisfaction and loyalty of the client. based on the collected data, will be carried out an analysis of the factual situation, the conclusions will be drawn and recommendations made to improve the quality of the service, which will contribute to the greater satisfaction of the clients, and therefore the loyalty towards the specific bank the initial hypotheses of the paper read: h0: the quality of banking operations has a crucial role in the process of building long-term relationships with consumers. only satisfied clients are loyal clients, who make it possible for the bank to achieve long-term business goals and make profit. h1: by improving the quality of products and services, the mutual relationship between the client and the bank is improved, as well as the business environment in which both parties take part. h2: by improving the quality of banking services, a competitive advantage is achieved and the position of banks in the financial market strengthens, especially considering that banks operating in an environment which is rapidly changing. the aim of the paper is to determine whether the clients are satisfied with the quality of banking products and services, as well as in which part of the relationship there is customer dissatisfaction and how banks should act to dissatisfy dissatisfaction. only a satisfied client is a loyal client. improving the quality of mutual relations, improving the business environment, and contributing to the creation of a competitive advantage of the bank in the financial market. theory aspects of the orientation on the loyalty of the client and the quality of services relationship between the client and the quality of banking products and services each market and thus the banking sector consists of two main players bank and client (raicevic, medenica-mitrovic, 2018). on this relationship between these two actors there is a service that provides a satisfied client on the one hand, and on the other, a satisfied bank. satisfied customer satisfaction with the product and service manifested by loyalty, and the company is even better service. on the path of defining the "complete service" of the questions to be answered, according to baker (vasiljev, 1999) that the client would be satisfied and, in the future, he was loyal to the services of the given company: which goods and services should be produced and in what quantities? how to produce (resources and technology)? for whom to produce? this third question, by market research, leads us to the client's profile who buys or will buy our products and services. the goal of clients is to fulfill their needs for a specific product and service with the easiest and fastest way, with the least cost. this leads us to questions about the cost of the cost, and why and on what basis the client for a product or service is prepared to pay more, what are the "value components" of the product or service, and what is the most important for the buyer in purchasing (maričić, 2005). what we need to keep in mind when creating products and services is the fact that the client and his satisfaction are the most important for the company because the company depends on the client, that the client is the purpose of the company's existence (kotler, milica raičević. dijana medenica mitrović 117 1999) and that, based on his wishes, we create products and services and marketing activities, i.e. product synthesis, pricing, access, distribution channels and at the end of the promotion, we want to satisfy the client who will come again. thus, a company creates a loyal customer on the one hand, and on the other provides him with a competitive advantage and a secure profit. a satisfied customer is not a sufficient guarantee of success at work. what distinguishes successful companies today from unsuccessful is the phenomenon of customer loyalty (zelenović, 2015). a prerequisite for the formation of consumer loyalty is satisfaction with the product or service. if consumers are not satisfied on any basis, loyalty cannot be achieved. the more loyal consumer is the one who is absolutely satisfied with the product and the service, and the company is more important than the one who is just satisfied. it is considered that a completely satisfied client is a precondition for forming loyalty and strengthening relations with the company in the long run. the customer's first impression is very important it is crucial to achieve customer satisfaction at the first meeting, in order to have the basis for the formation of loyalty. client demands, needs and expectations represent a basic basis that enables the establishment of appropriate relationships on a client-to-client relationship in order to create good conditions for creating satisfaction, which is the main means of creating long-term consumer loyalty (rajola, 2004). thus, according to veljković (2004), all clients could be divided into four categories: absolute loyalty, unstable loyalty, relative loyalty and disloyalty. each market consists of these four segments of consumers, according to the degree of loyalty. for each company, it is very important that as many consumers are in the category of absolutely loyal. only an absolutely loyal consumer is a security for the company, that is, only such consumers will, in the long terms, be faithful to company and its services. satisfaction and loyalty of clients towards banking products and services loyalty can be defined as an attitude towards a particular brand, which results in a constant purchase over time. the service that the company markets on the market depends on consumer loyalty, so it is very important that close and effective communication is achieved with existing and potential clients. implementation of the loyalty program has a positive trend in our country as well. they are increasingly applied, and more and more companies are introducing, innovating, expanding, creating new channels of communication with consumers, but also allowing buyers to influence the creation of a range of products and services with their advice, wishes and suggestions in order to achieve long-term satisfaction. depending on the frequency of repeated purchases and the intensity of attitudes towards a particular brand, it is possible to identify four types of loyalty, according to veljković, which are (veljković, 2009): false loyalty, latent loyalty, stable loyalty and no loyalty. establishing a quality and long-term relationship with the client is a concept that has turned into a special business philosophy in the banking sector in the last decade. this approach implies putting the client in the center of business processes and planning based on an analysis of his needs, which in practical terms means a good knowledge of clients, as well as providing a timely response to their demands (gaborović, 2009). banks are struggling to adapt their service to the aforementioned concept on multiple levels in order to achieve a high quality relationship with customers. first of all, a good relationship with the client begins with the first contact in the branch office, where during a well planned meeting, the bank officials try to determine the client's profile and, on the basis of the information obtained at that time, prepare the appropriate offer of products and services. the offer should be in line with the client's financial capabilities, needs and plans for the future. the highest level of quality relationship with clients, which gives full meaning to the principle of "putting the customer at the center of attention", is the customer relationship management, which, in addition to the above, implies a proactive relationship with the client and a response to his needs prepared on the basis of the acquired knowledge of the client, through profiling and 118 economic analysis (2018, vol. 51, no. 3-4, 115-124) analysis (hanić, domazet, 2012) (hanić, domazet, drašković, 2011). by applying this method, the bank approaches the client by offering him services and products that suit his profile style of life, occupation, and even habits and interests. in this way, a long-term relationship with clients is guaranteed that meets the interests of both sides. customer relationship management (crm) or customer relationship management is an approach to managing the company through interaction with current and future consumers (jovićević, žugić, 2018). the crm approach analyzes customer data and their history with the company, in order to improve business relationships with customers / customers, with an emphasis on their retention (jokić, 2016). the challenge is to combine the information coming from different sources and which are selected in the database in the function of selling products and services crm refers to the organization of data, that derives from business relationships on all bases between the bank and the client, and even beyond. building a database is a gradual process (rajević -grujević, radević, 2016). by placing the customer at the center, crm is based on integrated market management, sales and customer service, as the key functions of banks that face daily customers. crm is a strategic approach in building value for stakeholders, through the development of customer relationships (marinković 2015). the bank should aim at the spirit of building teamwork. in the future, it is necessary to provide a high standard of quality and professionalism with the client as a central point. the goal starts with every employee, so accordingly, individual performance should include qualitative goals such as: integrity, kindness, responsibility, professionalism, knowledge, training, consistency, discipline and most other positive qualities. analysis of customer satisfaction and loyalty towards banking products and services in montenegro research methodology the subject matter of the research of this paper is whether the customers are satisfied with the quality of banking services, and whether the satisfaction with quality affects customer loyalty towards the products and services of the banks whose services they use. the aim of the paper is to determine where the dissatisfaction of clients lies regarding the available banking products and services; how banks should act to eliminate dissatisfaction and ensure, through customer satisfaction, that the client is loyal to a specific bank, which improves the quality of mutual relationship, and, consequently, the business environment as one of the factors of competitiveness. the initial hypotheses of the paper read: h0: the quality of banking operations has a crucial role in the process of building long-term relationships with consumers. only satisfied clients are loyal clients, who make it possible for the bank to achieve long-term business goals and make profit. h1: by improving the quality of products and services, the mutual relationship between the client and the bank is improved, as well as the business environment in which both parties take part. h2: by improving the quality of banking services, a competitive advantage is achieved and the position of banks in the financial market strengthens, especially considering that banks operating in an environment which is rapidly changing. quantitative exploratory research was conducted on a sample of 300 respondents. for the needs of the research, a non-random convenience sample was used. the data were collected by the survey method, using a specially designed questionnaire. the survey was carried out on-site and on-line during the period august-september 2018 in the territory of montenegro. a total of 350 questionnaires were distributed, out of which 300 or 85.71% of questionnaires were valid for processing, which is a high response for the purposes of this pilot survey. the questionnaire milica raičević. dijana medenica mitrović 119 consisted of two parts: the first part concerned the collection of general data on respondents; while the second part covered a set of questions about the habits in the use of banking services, as well as about the satisfaction of users of banking services with both products and services, and the attitude of the staff of the bank who they come into contact with. based on the processing of the questions, the findings were made that might help the managers to recognize the weaknesses of the bank’s offer, and what customers need, how they are informed and where they see the deficiencies that can affect loyalty towards the products and services of the banking sector. research findings it was found out by the descriptive statistics that 53.33% of female respondents and 46.67% of male respondents participated in the survey. as for the age, respondents belong to one of the five categories offered, with an equal number of respondents (100 of them or 33.33 per cent) belonging to the 18-28 age group and 29-38 age group, followed by respondents aged 39-48 with 15% the respondents aged 49-58 accounted for 11.67%, while the smallest percentage was of respondents over 59 years of age who accounted for 6.67%. as regards educational qualification, the majority of respondents completed higher education, 45% of them, followed by respondents with completed secondary education who accounted for 31.67%; while 15.67% of respondents have a college or university degree; followed by respondents with completed postgraduate studies, 7.66% of them; while there were no respondents among the surveyed ones who completed only elementary school. the respondents also provided answers about their employment status, with 59.33% of respondents who are employed; 27.67% of respondents are unemployed; while pensioners account for 13% of the sample. out of a total of 300 respondents, 260 of them responded that they used only the services of one bank, while 40 respondents confirmed that they used the services of more than one bank. thus, we gained an insight that the use of the services of one bank is certainly an important and non-negligible piece of information that gives us a clear picture of the loyalty of users. although, we must emphasize that in our informal conversation, the answer was mostly that "they do not want to deal with more banks, and that it is an unnecessary cost; that one bank is quite enough; and that they choose the best/most favourable one" as the most important factor for the selection of the bank, respondents noted the amount of commission (25% of respondents or 75 respondents). the vicinity of the bank was crucial for 45 users (15%). 16% of the respondents mentioned the kindness of the staff as a crucial factor in using the services of the selected bank. the competence of the staff as a factor was indicated by 40 respondents (14.67%). the quality of products and services was suggested by 70 respondents (23.33%), while the speed of service provision, as the dominant factor in the decision regarding the selection of a bank, was indicated by 18 respondents (6%). it can be concluded that the amount of commission and the quality of service are the two factors that stand out in the selection of the bank, and that the kindness and the competence of the staff, as well as the vicinity of the bank are equally and not less important factors. the respondents provided answers about whether they were satisfied with the way of communication of the staff, and the findings showed that 40% of respondents were dissatisfied, the same percentage answered they were partially satisfied, while only 20% of respondents were completely satisfied with the way employees communicate with them. this piece of information is important for the management to bear in mind when training and appointing the front office clerks, because the significance of the front office staff is often overlooked when creating an impression about the service company itself. it is these 40% of partially satisfied ones that need to be won and turned into satisfied consumers, who will also turn into the category of loyal consumers. frequently, a well-designed service or product has less value for consumers themselves if we encounter impolite staff. 120 economic analysis (2018, vol. 51, no. 3-4, 115-124) when questioned whether the respondents experienced some inconvenience in their selected bank, the majority of them 217 (72.33%) gave a negative answer, while 83 (27.67%) respondents answered that they had suffered inconvenience in the bank. the reasons for the inconvenience were the following: a lack of interest and kindness of employees to obtain the right information; a poor explanation of technical terms; inadequate explanation about the user rights and benefits; new products; unkindness at the counter, etc. as the ways of informing about the services of the bank, the highest percentage of respondents answered that they got informed through friends (30.67% or 92 respondents), almost the same percentage was of those who got informed through advertisements -tv, newspapers, the web, the internet (25%) and flyers (24%). 12.67% (or 38 respondents) go directly to the bank to get information about the products and services, while 7.66% (or 23 respondents) use call centre services to get information about the products and services of the bank. as much as 66.67% of respondents said they would not change their bank, while 33% of respondents were not satisfied with the services they receive in the bank whose clients they are, thinking that the services are of poor quality, that employees are not accurate, interested, etc. even though a high percentage of respondents would not change their bank, respondents were given the opportunity to indicate which elements mostly affect the existence of dissatisfaction or what are the elements that customers themselves would recognize the banks could improve in order to increase customer satisfaction. as reasons for dissatisfaction, the users of banking services cited crowds at the counters (97 respondents), impolite staff (63 respondents), high commission (42 respondents), high default interest rates (44 respondents), short grace period (36 respondents) and too much paperwork (18 respondents). figure 1. the evaluation of certain aspects of the bank's services source: authors' analysis, september 2018. the respondents were asked to evaluate certain aspects of the bank's services with "excellent", "good" or "bad". the clients rated: • kindness of bank clerks (“excellent“ 67 respondents, “good” -160 respondents, “poor” 73 respondents) • interaction with clients through social networks (“excellent” -63 respondents, “good” -38 respondents, “poor” 199 respondents) milica raičević. dijana medenica mitrović 121 • quality and availability of information on the website (“excellent” – 45 respondents, “good” – 48 respondents, “poor” 207 respondents) • quality of e-banking services (“excellent” -154 respondents; “good” 44 respondents, while 102 respondents did not answer the question because they do not use e-banking services) • technological innovations in the function of providing better quality services (“excellent” – 94 respondents, “good” – 63 respondents, “poor” 143 respondents) we can conclude that the respondents are particularly satisfied with the quality of e-banking, that the average rating was given for the kindness of the front office staff, while more than 50% of respondents gave a poor rating for technological innovations in the function of providing better quality services, the quality of the information available on the website, and the interaction with clients through social networks. all of the above aspects have the potential for improvement so that the clients could be more satisfied and, therefore, more loyal. as for e-banking, 66% (or 198) of respondents are users of this service, and they cited the elimination of waiting in branches, time savings and access at any time as the advantages of ebanking. of the respondents who responded positively that they used e-banking services, 57.1 % (or 113) confirmed that they used the services on a daily basis. it can be concluded that the use of e-banking is increasingly represented in our country, and that it is becoming a commonplace phenomenon. most frequently, e-banking services are used for paying bills, online shopping, checking the account balance, money transfer. 34.6% of respondents do not use e-banking services, and as the main reason they cited insecurity, insufficient information and lack of interest in this type of services. in accordance with new trends in banking and bank networking, banking operations are performed faster, safer, in a better quality and uniform manner. in the banking sector, innovations have occurred and the ebanking and virtual banks are created. innovations in banking operations primarily relate to the technology of payment operations and the transfer of funds. in line with these modern trends, the respondents were supposed to rate on a scale of 1 to 5 which of the offered services they use most: telephone banking, home banking, online banking, internet banking, or mobile banking. before the respondents even circled and gave their ratings, it was necessary to give them brief and clear explanations of what is meant by these five terms. thus, it was established during the survey that respondents did not know the difference between the terms and often did not differentiate between them. after a brief introduction and provision of information, the respondents started to fill in the questionnaires. the average rating for telephone banking is 3.1; for home banking 3.8; online banking was given an average rating of 4.4; internet banking 4.8; mobile banking was rated with an average rating of 4. from the findings of the conducted research we can conclude that the respondents are loyal to the products and services of the selected bank, and that the amount of commission and the quality of the banking product and service are indicated as the main motive for selecting the bank. the competence and kindness of the staff, as well as the vicinity of the bank, are also important factors in selecting the bank. what the banks need to improve is the training of their front office staff. clients expect from employees to be polite and professional, and it is precisely the incompetence of the staff that the clients are most complaining about and which causes the most dissatisfaction in the client-bank relationship. kindness and professionalism of the staff must also be taken into account because the respondents answered that they most frequently got informed about the bank from the experience of acquaintances/friends, so the poor user experience or dissatisfaction can have a negative impact on attracting new clients. the research showed that clients were familiar with and were using innovations of contemporary trends in banking. citizens in montenegro, although still "shy", are increasingly using electronic and mobile banking services, 122 economic analysis (2018, vol. 51, no. 3-4, 115-124) which enable them to use the banking services in a convenient, fast, but, above all, in an efficient manner. it can be concluded that this research has confirmed the set hypotheses. high quality banking plays a crucial role in building long-term relationships with consumers, as well as in building customer loyalty, especially considering that banks operate in an environment that is rapidly changing, so the basis for survival and generation of profit and competitive advantage can be seen in the strengthening and improving mutual relations between the client and the bank. the contribution of the paper and the conducted research is reflected in the fact that the attention of marketing managers in banks is drawn to the fact that, in line with the modern concept, they must not rely on an independent and blanket assessment of customer satisfaction solely on the basis of sales results, but that the quantifying of the level of client satisfaction and placing it at the level of the business goal is as important as the financial result in the overall business success. customer loyalty has always been one of the basic parameters of business success, and the client's satisfaction with bank products and services is a guarantee of long-term cooperation. conclusion the sudden changes in the banking market and the volatility of the clients and the variety of choices influence the constant increase in the level of expectations in the next purchases or transactions. a successful bank brand is created in the way that users of banking products and services build long-term relationships with the bank based on trust, emotional experience and mutual understanding. in considering the relationship of satisfaction and customer loyalty, one should bear in mind that the information obtained in the satisfaction measurement process relates to a certain moment. on the other hand, the emotional response of the client after the purchased purchase changes over time under the influence of a number of factors. in cases of using banking services, the sense of satisfaction is variable and depends on the time cycle of using a particular service, such as, for example, the use of a long-term loan. fighting for clients with competition is never greater. so many banks and each of them offers the most favorable services to future clients, but also those who already is. the decision is on the clients; they choose the best services according to their personal preferences. it is up to the banks to keep the existing ones with good offers, to try to keep improving and technological advancement, because they will only be competitive, on that way, in a market that is "ruthlessly" for all participants on it. from the findings of the conducted research we can conclude that the respondents are loyal to the products and services of the selected bank, and that the amount of commission and the quality of the banking product and service are indicated as the main motive for selecting the bank. what the banks need to improve is the training of their front office staff. clients expect from employees to be polite and professional. impoliteness of staff has proven to be the factor which causes the most dissatisfaction in the client-bank relationship. the survey has showed that clients are familiar with and are using innovations of modern trends in banking. in modern conditions of banking operations, one of the most important tasks of management is customer satisfaction and their long-term retention. the priority of retaining the existing clients in relation to winning new ones is dependent, above all, on intense competitive pressures and high costs of winning new clients. the most effective way of retaining consumers is to build customer loyalty by continuously providing satisfaction and creating high costs of switching to other brands. trust and commitment are the most important determinants of loyalty of bank's clients. and while the absence of trust, most likely, will mean loss of partners, on the other hand, the positive milica raičević. dijana medenica mitrović 123 performances of the partner, especially the quality of the delivered value, contribute to the strengthening of trust. long-term trust between the bank and its clients creates commitment. commitment, in addition to trust, is a key factor in the establishment of a quality relationship. consumer commitment occurs as a result of the perceived difference between the costs and benefits (economic, social, status). references domazet, ivana and 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growth in transitional economies: evidences from countries from central and eastern europe and western balkans katerina kocevska shapkova1* | elena makrevska disoska2 1 faculty of law iustinianus primus, university ss. cyril and methodius skopje 2 faculty of economics, university ss. cyril and methodius skopje abstract the importance of institutions and free trade for economic growth is widely acknowledged in recent economic literature. in this paper we are focused on determining the fractional effects of changes of institutions and trade on economic growth as dependent variable. the analysis includes selected transitional economies from central and eastern europe and western balkans. in order to estimate the effect on the institutions and trade on growth rates we develop an ordinary least squares (ols) panel regression model. the model examines 16 cross section units (countries) in the period 20002016. the novelty of our work is that this is the first organized effort to inspect the importance of institutions and trade on economic prosperity in this specific geographic area. cross-country log-log regressions models demonstrate that both institutions and trade are statistically significant determinants the gross domestic product per capita in the selected economies. key words: trade, institutions, growth, central and eastern europe, western balkans jel classification: f10, f13, p20 introduction the main assumption on which this paper is based is that countries that have institutions that work efficiently and countries that participate in the international trade have higher rates of economic growth. another hypothesis is that countries that have “solid” institutions, realize higher trade flows. these connections have been recognized in many academic papers (dollar and kraay, 2003; groot, linders and rietveld, 2005, wei, s.-j., 2000). in this paper we investigate the partial effects that institutions and trade cause on growth in several economies of transition. transitional countries that are considered are from two geographical regions: central and eastern europe and western balkans. we chose the following group of countries since they passed through a transition process from socialist planning economies to market economies. the transition was initiated as a result of the new ideological perspective towards accession in the european union. in the last two decades and within a short time span, parallel to the process of transition from planned to market economy the countries had to adjust to the process of globalization. that meant reforms in the liberalization of the four freedoms (goods, services, capital and people) without permits and restrictions. in this group of * e-mail: k.shapkova@pf.ukim.edu.mk katerina kocevska shapkova, elena makrevska disoska 33 transitional economies from central and eastern europe, alphabetically ordered, we include: bulgaria, czech republic, estonia, latvia, lithuania, hungary, poland, romania, slovenia and slovakia. in our paper, we also include the western balkans countries: albania, bosnia and herzegovina, croatia, macedonia, montenegro and serbia, since countries that belong to this region followed the same trend of transformation to market economy and eu integration, but with slower pace compared to the cee countries. most of them are candidate countries of the eu and croatia already became a member in 2013. in the analysis are included representative countries from both group of countries, mainly countries that have data availability. the analysis goes back to 1995, since it is considered that most of the transition reforms were completed and countries stared to show positive rates of economic growth (fischer and sahay, 2004). figure 1, demonstrates the economic prosperity through the indicator: average gdp per capita from 1995 to 2016. it can be seen that there are significant differences between the selected countries. the highest values are evident for the czech republic, slovenia and slovakia, as well as poland. these countries suffered less from the current economic and financial crisis and therefore remain to sustain high levels of gpd per capita. in general the average value for all countries from the cee countries is higher than in western balkans, which might be result of the caching up process towards the eu. the only exceptions are bulgaria and romania which achieved modest gains since the entrance in the eu in 2007. in addition due to the economic crisis they undertook mostly austerity measured rather than structural reforms, which is not likely to stimulate economic growth. it seems that the baltic countries are having future growth prospects since they undertook many structural reforms in their domestic economy. according to the world bank regular economic report for the western balkans countries (2017), it seems that the countries are following two separate growth patterns. serbia and albania experienced fiscal consolidation and structural reforms that helped them to increase export and therefore economic growth. kosovo, macedonia, montenegro and bosnia and herzegovina are growing slowly due to political uncertainty and slow pace of structural reforms. figure 1. gdp per capita, ppp (constant 2011 international $), average value 1995-2016 source: authors` calculations. data from world bank development indicators. trade openness is strong determinant of the long term economic growth (grossman and helpman 1991, 1996; aghion and howitt 1992, feyrer, 2009). trade openness supported by the expansion of the multilateral trading system under the auspices of the world trade organization, had brought many advantages for the countries, such as higher productivity, increased competition, lower prices, technological spillovers and therefore higher economic growth and better living standards. however, to what extent the economy will prosper will depend on the characteristics and domestic policies, such as the nature of export specialization 0 5000 10000 15000 20000 25000 30000 alb bih bgr hrv cze est hun lva ltu mkd pol rom srb svk svn 34 economic analysis (2017, vol. 50, no. 3-4, 32-42) and degree of production diversification (henn et al., 2015), as well as from the quality of institutions. however, since the early 2000s, there is a significant slowdown in the trade reforms, rise of protectionism as a result of the economic downturn. figure 2. average trade openness (sum of export and import as percent of gdp), 1995-2016 source: authors` calculations. data from world bank development indicators. the degree of trade openness, calculated as the sum of total export and total import as percentage of the gross domestic product (gdp) of the country results in values over 100 percents in most of the observed countries. in poland, romania, serbia and albania the value of the indicator is below 80 and it appears to be stagnating in the last decade (figure 2). however, in 1995, the ratio of trade was less than 100 percent for more than 10 countries (out of 15 observed countries) in central and eastern europe and countries has been steadily increase their trade openness especially toward the countries in the eu. in the whole analyzed period from 1995 to 2016, the highest average trade openness has been notified in estonia, hungary and slovakia (by more than 20 percent). the level of openness is higher in the western balkans countries, which is understandable since these are small economies and export-dependent. countries from the western balkans are part of the central eastern free trade area – cefta 2006, have preferential treatment in the intra-trade and also almost half of the trade is with the eu countries. the growing uncertainty in external risks, might indicate reverse trend in the following years. those risks include: the rise of protectionism, slowdown of the economic growth in the eu economy, possible depreciation of the euro and variability in commodity prices as well as political tensions especially for the countries from the western balkan. finally, figure 3 sketches the median and average values of rule of law estimate published in the worldwide governance indicators. the estimates are presented on -2.5 to 2.5 scale, where higher values symbolize better rule of law. we consider this estimate to be precise variable representing the institutions in this research agenda (auer, 2013; easterly & levine, 2003; rodrik, subramanian & trebbi, 2004). from the graph we can conclude that there is difference in the rule of law between the countries from central europe and countries from western balkans. as it can be noticed, average and median values of rol estimate in central european countries are higher than 0 (zero), while the western balkans countries they receive negative values. the only exception the wb countries group is croatia. the average and median estimates are calculated for the period 2000-2016. 0 20 40 60 80 100 120 140 160 alb bih bgr hrv cze est hun lva ltu mkd pol rom srb svk svn katerina kocevska shapkova, elena makrevska disoska 35 figure 3. rule of law average and median estimate, 2000-2016 source: authors` calculations. data from world bank development indicators. literature review questions regarding influence of trade on the economic growth have been persistently present in the economic literature. openness generates predictable and positive consequences for growth (oecd 1998: 36). the design of the foreign trade policies, i.e. trade liberalization, trade agreements and the policy of foreign exchange rate are very important determinant of the economic growth for the countries in transition. this is empirically confirmed in the studies of krueger (1998: 1513), as well as stiglitz (1998, p. 36) and dollar (1992). trade integration and participation in the multilateral trading system can help countries to increase their economic growth (fischer, 2000). one of the first most comprehensive definitions of institutions is given by the pioneer of the new institutional economy, nobel prize laureate douglass north. by institutions north defines the humanly devised constrains that structure human behavior (1994: 360). more detailed approach in determination of this category understands institutions as legal, administrative or customary arrangements (pejovich, 2008). the purpose of the institutions is to enhance human interactions that are repeated, bit cannot be predicted. according to pejovich, “good” institutions are those that are credible and stable. on the subject of the importance of institutions on economic prosperity, acemoglu, johnson and robinson, (2005a) argue that institutions are the primary cause that explain the differences in economic development around the countries of the world. these authors recognize two separate types of institutions, economic and political institutions and they further continue with estimation of the effects of these institutions on different economic variables. glaeser at al. (2004), state that countries can assure higher rates of economic growth if they have stable political institutions and investments in human and physical capital. several authors have been interested in examining the links between the institutions and trade versus the economic growth (dollar and kraay, 2003; rodrik, 2008, 2003). moreover, fischer and sahay (2004) by “strong” institutions recognize independent central banking, development of credible tax systems and fully operating market economy. they find large variation in functioning of the institutions in different transition countries. there is some more recent literature that is attempting to explain the differences between development levels using institutions, trade and geography. for example, bhupatiraju and -1 -0.5 0 0.5 1 1.5 alb hrv est lva pol svk cze mne mkd average rol median rol 36 economic analysis (2017, vol. 50, no. 3-4, 32-42) verspagen (2013) conclude that the institutions are at same importance as geography and trade in determining the level of the gdp per capita in the long run. research on institutions in western europe as particular geographic region is included in the study of acemoglu et al, (2005b). these authors show that the rise of western europe after year 1500 is correlated with improved trade and the allied colonialism. consequently, increasing trade led to development of dynamic institutional environment. there are published studies that confirm the joint effect of trade and institutions on the economic growth for african countries (baliamoune-lutz and ndikumana, 2007). studies for the central eastern european countries and western balkans are rare and few. they are focused particularly on the relationship between either trade and growth or alternatively institutions and growth. moers (1999) suggests that improvement of institutions in the cee countries is necessary; in particular state institutions are crucial for delivering macroeconomic stabilization and economic growth. the author suggests that institutional development should be one of the key priorities in the transition countries. kucharčuková et al. (2010), referring to the countries from south eastern europe, explain that weak economic institutions lead to lower international trade. data and sources in order to examine the relationship between economic growth and, on the other hand, institutions and trade we use modification of the model of dollar and kraay (2003). this model captures the effects of trade by exploring the deeper trade factors, such as geographic determinants. according to these authors, both landlocked countries and countries that are distant from the main markets have tendency to trade less compared to the other countries. the depended variable in the model is titled gdp and it presents the logarithm of the gross domestic product (gdp) per capita, measured in ppp in constant terms for 2011. the data is obtained from the world bank national accounts database and national accounts database from oecd. in our paper we use several independent variables for the model constriction. first, the variable trade symbolizes the sum of exports and imports of goods and services in the selected economies. it is presented as a share of the gross domestic product of the country. trade is also collected from the world bank national accounts database and national accounts database from oecd. the variable population growth stands for annual population growth rate. it is the exponential rate of growth of midyear population from two subsequent years, expressed as a percentage. population is based on the de facto definition of population, which counts all residents regardless of legal status or citizenship. the data are derived from the world population prospects of the united nations population division and united nations statistical division. the values are based on the de facto definition of population, presented as midyear estimates. trade and population growth variables are treated as measurement of the market size. further, our model includes an institutional variable. for this purposes we use rule of law index as a variable that represents the institutional environment. this index is published in the worldwide governance indicators, a colossal research project by the world bank. this index captures “perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence” (kaufmann, kraay and mastruzzi, 2010). this aggregate indicator originally is published on a -2.5 to 2.5 scale. for the purposes of our research, we have rescaled the rule of law index on a 0-100 scale, where 0 (zero) stands for worst, while 100 (hundred) for best performance. we use the title rolnew for the rescaled variation of the rule of law index. katerina kocevska shapkova, elena makrevska disoska 37 in our model, we also introduce one geographical variable. lcr is the percentage of the land area within 100 km of ice-free coast in the selected countries (gallup, mehlinger, sachs: 2010). this variable is time invariant. other control variables for economic sectors other than external are included in the model. these variables are: inflation, measured as annual growth rate of the gdp deflator. this indicator show the rate of price change in the economy as a whole; gross capital formation as percentage of gdp and debt or central government debt as total expressed as percentage of gdp. the data are obtained from world bank national accounts database and national accounts database from oecd. because many of the counters that are included in the model received their independence in the late 20th century, we have decided to use the period from year 2000 to year 2016 for the analysis. descriptive statistics of the common sample are presented in table 1. table 1. descriptive statistics of the model variables gdp rule of law trade population growth lcr gross capital formation debt inflation mean 19984.09 60.043 114.793 -0.431 74.266 25.469 37.468 5.058 median 20299.20 62.087 116.65 -0.283 75 24.774 36.627 3.316 maximum 31137.78 77.292 184.551 0.904 98 41.538 98.083 48.126 minimum 4461.074 25.944 43.2202 -2.258 48. 12.371 0.26 -9.753 std. dev. 5967.023 9.621 33.4053 0.585 15.338 5.217 24.556 7.319 source: authors’ calculations. the model the purpose of the paper is to examine the relationship between formal institutions, trade and gdp per capita in selected countries from central and eastern europe and the countries from the western balkan region. the dependant variable in the models we have constructed is gdp per capita ppp, measured in constant 2011 international dollars which is a variable in real terms. the variable is not used in absolute terms, but as logarithm of the value same as in the study of dollar and kraay (2003) and frankel and romer (1999). different independent variables are employed to explain the variance of the dependent variable. as a measurement of institutional quality we use rule of law index published in the worldwide governance indicators dataset. the index is rescaled on 0-100 scale. trade represents the sum of exports and imports of goods and services in the selected economies given as a percentage of the gross domestic product of selected country. other than rule of law and trade, we introduce different economic variables in the model in order to strengthen its statistical power. all of the constructed models are panel regressions using the ols method. the depended variable and trade variable are transformed into logarithmic form, while, we use the linear form of the other independent variables. the approach that emphasize rule of law and trade has been presented by dollar and kraay (2003), but we have made substantial modifications in the other explanatory variables and alternative measurements of institutions. the results from the regressions are presented in the following tables. both models have high r squared which explains the variability of the dependent variables the most part of the variability’s of the independent variable. 38 economic analysis (2017, vol. 50, no. 3-4, 32-42) table 1. logarithm of gdp per capita models using institutions and trade dependant variable: log (gdp per capita) (1) (2) (3) (4) (5) (6) (8) (9) constant 7.99*** (126.75) 7.35*** (34.02) 7.41*** (34.09) 7.04*** (30.14) 7.08*** (29.5) 6.98*** (33.63) 7.26*** (33.3) 7.03*** (31.46) rule of law 0.03*** (27.35) 0.03*** (19.47) 0.03*** (19.53) 0.03*** (19.07) 0.03*** (19.04) 0.02*** (14.64) 0.02*** (14.6) 0.03*** (13.28) log (trade) 0.17*** (3.11) 0.16*** (2.93) 0.21*** (3.70) 0.21*** (3.72) 0.36*** (7.65) 0.32*** (6.65) 0.31*** (6.03) population growth 0.04* (1.94) 0.04 (1.63) 0.04* (1.66) 0.11*** (4.81) 0.11*** (5) 0.08*** (3.63) lcr 0.001 (1.31) 0.001 (1.29) -0.004*** (-3.97) -0.004*** (-4.4) gross capital formation -0.002 (-0.66) -0.001 (-0.005) 0.001 (0.38) 0.004 (1.48) debt 0.001 (1.18) 0.001 (1.02) 0.0002 (0.51) inflation -0.01*** (-3.32) -0.005*** (-2.73) adj. r2 0.75 0.75 0.76 0.76 0.76 0.81 0.82 0.81 # obs. 255 255 255 238 238 169 169 169 note: t-stats are given in parenthesis. *** significant at 99% level; ** significant at 95% level, * significant at 90% level. the first model, model (1), is a simple regression where rule of law is independent variable. the estimated value of the coefficient is 0.03, followed by high value of the tstat, 27.35. these results indicate that there is a strong positive relationship between institutions and economic prosperity. on average, if rule of law increases by 1 unit on a 0-100 scale, gdp per capita is expected to increase by 3 percentages. the second model, model (2), is augmented by the trade as a percentage of the gdp variable as a regressor. again, both of the estimates are significant at 99 percent level. all else held constant, one unit increase of the rescaled rule of law index increase gdp per capita by 3 percent on average, while one percentage change of trade variable increases gdp per capita by 0.17 percent, on average. the results are both statistically and economically significant. in addition we have introduced few other variables as possible explanatory variables of gdp per capita, according to the economic literature. we can conclude that adding new variables in the model slightly improves the explanatory power of the regressions, presented by higher values of adjusted coefficient of determination. also, the variable rule of law is permanently presents statistical and economical significance, with coefficient estimates between 0.02 and 0.03. trade, as well, is statistical and economical significant independent variable, with coefficients ranging from 0 .16 to 0.36. in order to overcome the limitations given that the cross-sections are not sampled randomly and when the research focuses on the behavior of the specific sample without drawing inferences about the whole population, we employ fixed-effects panel data model, which seems to be more appropriate when working with macro panels. in addition, the fixed-effects estimator is consistent even when individual effects are correlated with the regressors (baltagi, 2008). in these regards, the assumption that the regressors are not correlated with the disturbance term, which is critical for employing the random effects model, seems to be implausible (wooldridge, 2002) as many of the regressors included in the model may be correlated with the unobserved country-specific effects. formally, we base our choice of the fixed-effects vs. the random-effects model on the hausman-test. for example, when we conduct this test on regression model (7) from the previous table, it resulted with chi-sq. statistic of 27.06 with corresponding p-value of 0.0001. hausman test of regression model (8) from table 1, resulted with chi-sq. statistic of katerina kocevska shapkova, elena makrevska disoska 39 15.56 with corresponding p-value of 0.016. low p-values suggest that we should reject the null hypothesis that the regressors and the disturbances are not correlated. in addition, our preference for the fixed-effects model is supported by the results of the f-test for the joint significance of the fixed effects. in the following table 2, we present the results from the reestimated regression models with fixed effects. table 2. logarithm of gdp per capita models using institutions and trade; fixed effects on cross section dependant variable: log (gdp per capita) (1) (2) (3) (4) (5) (6) constant 7.64*** (54.6) 6.02 *** (27.44) 6.04*** (27.44) 11.8*** (4.56) 11.81*** (4.55) 4.71*** (21.99) rule of law 0.04*** (14.63) 0.03*** (9.99) 0.03*** (9.98) 0.03*** (11.55) 0.03*** (11.52) 0.03*** (11.29) log (trade) 0.48*** (8.84) 0.48*** (8.78) 0.59*** (10.61) 0.59 *** (10.59) 0.69*** (14.16) population growth 0.03 (1.18) 0.02 (0.8) 0.02 (0.80) 0.03 (1.11) lcr -0.09** (-2.54) -0.09** (-2.54) gross capital formation -0.0001 (-0.08) 0.01*** (4.3) debt 0.001 (1.07) adj. r2 0.86 0.89 0.89 0.91 0.91 0.93 # obs. 255 255 255 238 238 169 note: t-stats are given in parenthesis. *** significant at 99% level; ** significant at 95% level, * significant at 90% level. similar to the previous results, the regression models with fixed effects, also confirm the hypothesis that rule of law and trade have strong and positive correlation with gdp per capita in the countries from central and south europe, including the western balkan, ceteris paribus. all of the coefficient estimates of rule of law variable are statistically significant at 99% level. the range of the estimates is from 0.03 to 0.40, which we interpret that one unit increase in rule of law rescaled index, on average will increase gdp per capita for 3 to 4 percent, all else held constant. this conclusion is in line with the results from the regression models with no cross section effect, presented in table 1. the coefficient estimates of the logarithm transformation of the trade variable vary in the range from 0.48 to 0.69. in all of the above reported models, the estimates are significant at 99% level. compared to the previous models that did not include fixed effects, we can notice that the coefficients are slightly higher. on average, 1 percentage increase in trade measured as sum of total export and total import of goods and services in the sample countries, leads to 0.5 to 0.7 percentage change in gdp per capita, ceteris paribus. alternative measurements of institutions in this section we have examine the possibilities to use alternative measurements of institutions in order to check the robustness of the previous findings. for this purpose, we have introduced three alternative measurements of institutions as substitutes for the rule of law index: control of corruption, regulatory quality and voice and accountability. 40 economic analysis (2017, vol. 50, no. 3-4, 32-42) control of corruption captures perception of the extent to which public powers is exercised for private gain, including minor and grand forms of corruption (kaufmann, kraay and mastruzzi, 2010). regulatory quality captures perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development (kaufmann, kraay and mastruzzi, 2010). voice and accountability captures perceptions of the extent to which a country's citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and a free media (kaufmann, kraay and mastruzzi, 2010). all indexes are published in the worldwide governance indicators and are rescaled on a 0-100 scale. the results from the rerun regression models are presented in table 3. table 3 regression models using alternative measurements for institutions dependant variable: log (gdp per capita) (1) (2) (3) (4) constant 4.71*** (13.21) 4.59*** (8.29) 4.53*** (14.71) 4.14*** (9.31) trade 0.69 *** (9.51) 0.87*** (10.12) 0.73*** (10.04) 0.88*** (9.82) population 0.03 (2.14) 0.03 (1.05) 0.003 (0.13) 0.03 (0.73) gross capital formation 0.01*** (2.96) 0.01* (1.74) 0.01 (1.59) 0.01** (2.00) debt 0.001** (1.57) 0.001*** (3.22) 0.002** (2.19) 0.002*** (3.26) alternative measurements for institutions rule of law 0.03*** (7.53) control of corruption 0.017*** (5.04) regulatory quality 0.02*** (7.14) voice and accountability 0.02*** (4.04) adj. r 0.93 0.89 0.91 0.88 obs. 169 169 169 169 note: white cross-section standard errors & covariance (d.f. corrected) are used. fixed effects assigned on cross section. t-stats are given in parenthesis. *** significant at 99% level; ** significant at 95% level, * significant at 90% level. we find that in all of the above reported models, trade variable proves to be significant at 99% percent level. in majority of cases, the newly employed measurements of institutions appear to be both statistically and economically significant. conclusion the regression models capture the long-run effects of trade and institutions on economic growth in selected countries form central and eastern europe and western balkan. we conclude that the constructed ols panel regressions explaining changes of the logarithm of gdp per capita suggest statistical and economic significance of institutional variables and trade as independent variables. since, country openness and participation in international trade and better institutional quality can be traced back to common historical factors, we believe that the katerina kocevska shapkova, elena makrevska disoska 41 findings are applicable to all of the countries. therefore, join role of both trade and institutions on long run influence on the rates of economic growth. these findings indicate that countries should put a greater focus on the institutions quality that is likely to result in enhanced growth prospects. much attention was given to trade liberalization in the policy agenda compared to the institutional strengthening since these cee and western balkan countries lack resources to reform. we suggest reform oriented towards strengthening the rule of law and the legal environment, in general, in order to stimulate faster growth rates in the selected economies. references acemoglu, daron, simon johnson and james robinson. 2005b. “the rise of europe: atlantic trade, institutional change, and economic growth”. the american economic review, 95(3): pp. 546-579. acemoglu, daron, simon johnson, and james robinson. 2005a. “institutions as a fundamental cause of long-run growth”. handbook of economic growth, 1: pp. 385-472. aghion, philippe, and peter howitt. 1992. 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d.c. wooldridge, jeffrey m. 2002. econometric analysis of cross section and panel data. cambridge, ma: mit press. article history: received: march 31, 2017 accepted: october 1, 2017 ea_2019_2 doi: 10.28934/ea.19.52.2.pp1-11 original scientific paper a comparative study of minimum wage and employment in china and in the united states duanxiang fu1 | jianfeng yao2* 1 research center for energy economics, school of business administration, henan polytechnic university, jiaozuo 454000, china 2 college of business and economics north carolina agricultural and technical state university, 1601 east market street, greensboro nc 27411, usa abstract in this paper, we use regression models to analyze and compare the effect of a change in real minimum wage on employment rate both in china (the largest emerging market) and in the united states (the largest developed country). the longitudinal data we use is from 2000 to 2016 published by both countries. after controlling for unobserved heterogeneities by using the fixed effect estimations, the results show a significant and negative correlation between real minimum wage and employment rate in both countries, with a smaller and weaker effect of real minimum wage in china. it indicates that employment in china is less responsive to a change in minimum wage because of its unique economic system. in addition, we find that the effect of minimum wage on employment rate turns into insignificant in recent years in china since 2008, which is the opposite of and different from the situation in the u.s. key words: minimum wages, employment rate, comparative analysis jel classification: j31, d23 introduction motivation the minimum wage system is a basic wage and social security system that has been utilized by governments to directly intervene in the wages of labor market. in order to meet the demand of the developing market economy and to protect the basic living needs and lawful rights of working individuals and their families, former department of labor of china initiated in november 1993 “minimum wage regulations for enterprises” (labor department, 1993) and officially piloted the minimum wage system and the minimum wage standard in 1994.the minimum wage system has now been implemented in all provinces in china. the united states is one of the earliest countries to implement the minimum wage system. in 1938, the united states enacted the national minimum wage act – ‘fair labor standards act’ (united states congress, 1938) and set up the federal minimum wage standard in order to ensure the daily life of the poor. as such, the minimum wage system is carried out across the country and is widely used (jiao d. 2014). the vast majority of the american people who receive minimum wage are young people ranged from 16 to 24 years old. * corresponding author, e-mail: jyao@ncat.edu 2 economic analysis (2019, vol. 52, no. 2, 1-11) china’s minimum wage has risen sharply in the past decade amid an imperfect social security system and labor market. the us government is cautious about raising the minimum wage. with the rise in cpi and the advent of the information technology revolution, the adjustment of the us federal minimum wage is characterized by a small increment at slow pace. so, should the minimum wage continue to rise? what effect will a higher minimum wage have on employment rate? how do we achieve an effective combination of a rational level of minimum wage and the promotion of employment? the effect of minimum wage on employment has attracted extensive attention in academic circles, and its conclusions have always been controversial. the comparative analysis of the effect of the minimum wage on employment in both china and the us has produced few results. in this study, we use a relatively comprehensive panel data to conduct a comparative analysis over the impact of minimum wage on employment rate in both countries, and to seek the difference of the impact and the reasons behind the difference. this study is to perfect the minimum wage system, to improve the quality of employment and the effectiveness of the minimum wage, and to improve the coordination between minimum wage and employment rate. it is believed the study possesses both theoretical significance and practical values. historical background as economy develops and living expenses rises, minimum wage increases gradually. in china, minimum wage has entered a period of rapid and frequent increase since 2004. from 2000 to 2016, the average annual growth rate of the minimum wage in china was 11.3%, and the average wage increased by 13.2%. the minimum wage adjustment in the united states appears to be small and slow; however, the federal minimum wage has risen from $0.25 per hour in 1938 to the current $7.25 an hour. from 2001 to 2017, the average annual growth rate of the minimum wage in the us was 2.3%, and the average wage increased by 2.5%. research question what impact will the increase of minimum wage have on employment? what is the difference, between china and america, of the impact of minimum wage increase on employment? what are the reasons for their difference? the study of those questions is the main content of this paper. this paper is organized in six sections. section one is about the background and significance of the study. section two is a literature review which provides the research basis for our study. the third and fourth sections use the panel data from both china and the united states (2000-2016) to evaluate the employment effect of the minimum wage in china and in the united states by using a regression method. the fifth section is the comparative analysis that explains the research results and the reasons for any differences between the two countries. section six concludes and puts forward policy suggestions. literature review researchers have long put forward different opinions on the implementation of the minimum wage system and studied the adjustment and evaluation of minimum wage and its economic effects on employment. they proposed some relative theoretical models and used them to explain how the minimum wage affects employment. at the same time, different evaluation methods were used from a variety of perspectives to empirically test the effect of minimum wage on employment. in china, leping yuan and gongfei li (2007) used a model of labor supply and demand to study the increase in minimum wage and concluded that it not only increased the income of the workers, but also reduced the unemployment rate. guangxin wang and xianguo yao (2014) used the 2000-2010 panel data of 30 autonomous regions in china and took the contracted duanxiang fu, jianfeng yao 3 employees from various companies as their research object to study the impact of the minimum wage increase. they found a negative effect on the employment of those employees by using generalized least square method. you wu (2014) used a differential gmm (generalized method of moments) method to conduct an empirical study using panel data from 26 regions of china from 1998 to 2012. the results showed that the effect on national employment was negative, but the negative impact on employment could be offset by economic growth. the increase of minimum wage has a significantly inhibitory effect on employment in the north-eastern and eastern regions, while the employment impact in the central and western regions is not significant. abowd, francis & margolis (2000) found that the overall employment effect of the minimum wage is negative, but there are differences in the degree of employment impact on workers of different genders. every 1% increase in the minimum wage reduces the employment of american male and female workers by 0.4% and 1.6% respectively. sabia & joseph (2014) studied the employment effect of minimum wage on low-skilled workers in different economic cycles of a country, and the impact of national productivity and spatial heterogeneity on low-skilled sectors. it turns out that the increase in the minimum wage between 1989 and 2012 reduced employment for low-skilled workers more during the recession than that during economic expansion. the employment flexibility range of the national minimum wage is 0-0.2 in the economic expansion, but as high as -0.3 in the trough of the economic cycle. the study by neumark and wascher (1992) found that the minimum wage had a significant negative impact on employment, especially for low-income workers. the increase of the minimum wage by 10% increased the unemployment of american teenagers by 1%-2%, and increased the unemployment of young adults by 1.5%-2%, that is, the increase of the minimum wage reduced the employment of young people. kalenkoski and lacombe (2013) used spatial econometric techniques and the annual average data from 1990 to 2004 collected by the us bureau of labor statistics to check the youths’ employment effect of minimum wage. the results showed that youth employment has been affected. the minimum wage increased by 10% in real terms, the youth employment fell 2.1%. neglecting the spatial correlation will underestimate the impact of minimum wage on youth employment. slonimczyk and skot (2012) conducted a regression analysis on the relative impact of the minimum wage on employment and concluded that the reduction of the minimum wage in the united states may lead to the decrease of employment and the deterioration of the relative wage of low-skilled workers. it is evident that the research on minimum wage has achieved great outcomes in the past decades. different data and different methods have been used to study the employment effect of the minimum wage. there is a large amount of studies over the employment effect in china that is created by the minimum wage, but they are mainly on chinese migrant workers and employment in different regions. studies on the impact of minimum wage on american youth employment, different gender workers and employment in different states are relatively focused in america. but comparative analysis of the impact of the minimum wage on employment in different countries is rarely fruitful, which provides a research space for this study. this study uses relevant governments’ annual statistical data for the period of 2000 and 2016 and uses the regression analysis to analyze the employment effect of the minimum wage increase in both china and the united states. through comparison of the results we try to explore the differences between the two countries and the reasons for the differences. 4 economic analysis (2019, vol. 52, no. 2, 1-11) data data sources the chinese data adopted in this study comes from chinese official statistics including the national bureau of statistics of the people's republic of china, the ministry of human resources and social security and the national federation of trade unions and other departments, such as “the statistical yearbook of china (2004-2016)”, “the labor statistical yearbook of china (2004-2016)”, “the statistics bulletin of the national economy and social development of china (2003-2016)”, as well as the relative annual statistical yearbooks from different provinces, autonomous regions and municipalities directly under the central government and labor law and so on. the u.s. data are mainly from the statistical data and the investigation reports released on the website of the bureau of labor statistics by the department of labor. those data include the minimum wages and average wages, employment, gdp (gross national product), relevant data such as the consumer price index and foreign direct investment. the data are all collected from official agencies, with authenticity and reliability. variable selection there are many factors that can affect employment, such as the economic development speed, wage level, labor supply and demand, and changes in the international economic environment. this study mainly analyzes the effect of the increase of the minimum wage on employment. in the process of econometric analysis, the analysis variables mainly include employment-topopulation ratio as a measure of employment rate, minimum wage, average wage, and gdp per capita. the minimum wage, average wage and gdp are then converted into monthly minimum wage, monthly average salary and monthly gdp per capita. in china, minimum wage level is difference across different provinces, and we use the province level monthly minimum wage documented by the national bureau of statistics of china. the american state minimum wage standard form is usually an hourly minimum wage standard, so the hourly minimum wage standard is converted into monthly minimum wage (calculated by using 40 hours a week, 52 weeks in a year, or 12 months in a year) in the process of econometric analysis. in order to ensure the comparability of the panel data, the minimum wage, average wage, and gdp per capita and so on are converted into the real value by applying the consumer price index with the base year of 2009. in order to eliminate possible heteroscedasticity between variables, the annual time series such as the minimum wages and average wages and gdp per capita are transformed into the natural logarithm. summary statistics table 1 and table 2 show the descriptive statistics for both china and u.s. between 2008 and 2016.as we can see from table 1, the employment rate in china is slightly higher than the rate in the u.s.; monthly nominal minimum wage, average wage and gdp per capita are in u.s. dollar values and converted into real values by using the consumer price index with the base year 2009 equal to 100. the real values of wages and gdp per capita is substantially low for china compared to the ones for the u.s. table 2 allows us the observe the trend of growth of minimum wages, average wages and gdp per capita both in china and u.s.; column 2 and 3 in table 2 reports the statics of china before and after year 2008. column 4 and 5 include the information for the u.s.; with respect to the employment rate and minimum wages ( in terms nominal and real values), we observed a large increase in minimum wages in china, which is associated with slight increase of labor employment rate. yet in the u.s., the trend is the opposite, an increase in the minimum wages is accompanied by a decrease in the labor employment rate. these trends duanxiang fu, jianfeng yao 5 suggest that the effect of minimum wage on employment in china may not be as sensitive as the effect in the u.s. in an expected direction. as a result, this merits a more detailed regression and comparative analysis. other variables such as average wages, gdp per capita and consumer price index all keep increasing over time in both countries as we expected. econometric specification in this paper, our objective is to estimate the effect of minimum wage on employment indicated by the labor participation rate. in order to accurately measure such effects and given the longitudinal structure of our data, we use the fixed-effect estimation models to control for the unobserved time-invariant heterogeneities. the model specification is as follows: ln���� � = c + c� ln� ��� � + c� ln����� � + c� ln����� � + c�� + c� ln� ��� � ∗ ln����� � + �� + ��� where employment-to-population ratio or employment rate, ��� , is the dependent variable of the province i or state i in year t. we aim to estimate, c�, the captures the effect of minimum wage on employment. in the specification above, �� is a province-specific effect that stays constant across time and ��� is an idiosyncratic error term. �� may include factors such as working cultural or confidence in the economic and political system such as communism that does not vary much with time. fixed effect estimate models remove the effect of those unobserved time-invariant characteristics so we can assess the net and unbiased effect of the predictors on the outcome variable. ��� represents the monthly real minimum wage of the province or state i in year t. we assume that the time variant minimum wage in each province is exogenously determined by the local governments in both countries. we converted minimum wages to monthly values in both countries to for the purpose of consistency and performance of comparative analysis. ���� is the monthly real average wage of a province or state, and it is also time variant and reflects the degree of average income of workers in a certain area and time. it also captures individuals’ incentive to work and the average number of jobs employers are willing to offer. ���� is the explanatory variable that reflects the monthly real gdp of a province or state. the growth of the real gdp indicates the economic growth a country or region and the development of an industry that may eventually determine the employment or the labor participation. other control variables include the interaction term the between real minimum wage and real average wage and time trend. the effect of real minimum wage on employment varies with the real average wage. the time trend is used to illustrate growth in production or industry earnings which also influence the employment or the labor participation. results table 3 shows the fixed effect estimation results for china and u.s. between 2000 and 2016. as we may observe, minimum wage has significant negative effects on the employment rate or employment-to-population ratio for both countries. however, the effect is significantly smaller for china than it is for the u.s.; more specifically, from the estimate coefficients, we can say that the marginal effect of log real minimum wage is -1.249 in china, which is smaller than the marginal effect of log real minimum wage in the u.s., -3.524. as a result, china's labor force and employment is less sensitive to a change in the minimum wage. also, by comparing the coefficients of log real gdp per capita, we may conclude that china's employment is more sensitive to a change in gdp than it is for the u.s. table 4 describes the estimations result in different time periods for china and u.s. respectively. we use the estimations in different time periods to examine how the effect of minimum wage on employment changes over time. for china, an interesting observation is that the effect is significantly negative before 2008 and then turns into insignificant and weak after 6 economic analysis (2019, vol. 52, no. 2, 1-11) 2008. it indicates that the employment is not quite sensitive to an increase of minimum wage in china in recent years probably due to the change of exogenous policies or economic environments. however, in the u.s. we have a different situation, that is, the effect of minimum wage on the labor participation tends to be stronger and bigger in recent years. in table 5, we perform the estimations at a different range of minimum wage. the effects are estimated on the upper 50th percentile of the minimum wage. we do this in order to see if there is any change of the effect when minimum wage becomes relative higher. from the table, we find that, in china, at the upper range of the minimum wage, the effect of such wage on labor employment does not persists, which may indicate that as the minimum wage increases, the relationship between minimum and employment tends to become weak and insignificant. again, in the u.s., we have a more stable and consistent situation, the effect of minimum wage is still negatively significant at higher levels of such wage. table 6 shows the estimation results in different areas for china. we mainly look at the coastal areas and inner areas of china. coastal areas are in general more developed than inner area. by comparing the coefficients of the minimum wage, we observe that labor employment is more sensitive to the change of minimum wage in coastal areas where there are more private and foreign invested companies. labor market and market of goods and services are also relatively mature and open in coastal areas. the effects of other variables such as average wage, gdp per capital and time trend are also significantly bigger in coastal areas. table 7 captures the fact that the effect of minimum wage on employment also depends on foreign direct investment (fdi) in china. fdi is associated with the private industries and companies that are not owned and operated by the government. foreign invested companies in china are sensitive to the change of minimum wage because of the characteristics of cheap labor intensive industries in which most of these companies are involved. on the other hand, stateowned domestic industries are less responsive to the change of minimum wage because they are not sensitive to the cost variations thanks to the government subsidies. the evidence that stateowned industries and foreign invested companies behave differently and that fdi reinforces the negative effect of minimum wage can be found in the estimation results. as the table 7 shows, when the effect of minimum wage is significant between 2000 and 2016, especially before 2008, the interaction term minimum wage and fdi are also significantly negative, which demonstrates the fact that, as the minimum wage increases, its negative effect is further amplified the value of fdi and the number of foreign invested industries. conclusion this paper studies the effect of minimum wage on employment measure by the employmentto-population ratio. the analysis over the panel data from 2000 to 2016 shows that the minimum wage is significantly correlated to the employment rate both in china and in the united states. in capitalist economy, raising minimum wage may lead to a decline in employment rate due to the fact that employers are reluctant to hire or keep labor because of the increased cost of labor, which is consistent with the results of our data analysis. however, the magnitude of such effect is different between china and u.s. because their different economic and political systems. from our analysis, a dollar increase in minimum wage in china would reduce employment rate lower than it does in the u.s.; this indicates that the increase of minimum wage in china has a smaller impact on the decline of employment rate, which may be because china’s demographic structure, national system and enterprise structure are different from those in the united states. this shows that china’s employment may not be sensitive to raising the minimum wage. one explanation could be that china has a large number of stateowned enterprises or companies that are subsidized by the government, and when the cost of employing people increases, these companies are not quite responsive due to the government subsidies. when we divide china into inland and coastal regions, the significant negative duanxiang fu, jianfeng yao 7 correlation still exist between the minimum wage and employment rate in the both regions. however, coastal regions are more responsive to the change of minimum wage, which may indicate different portions of the state-owned companies in these areas. when we divide the time into two periods, before 2008 and after 2008, there is an interesting observation in china: before 2008, an increase of the minimum wage significantly reduces the employment rate, but after 2008, an increase in the minimum wage did not significantly lower the employment rate. this may indicated that, after 2008, due to policy uncertainties in china, there may be the withdrawal of foreign invested enterprises or the enterprises relying on cheap labor, or it may because of the upgrades of domestic industries. some domestic enterprises in china may no longer rely on the labor intensive operations that pay the minimum wage. for the united states, the economy is relatively more stable, and the increase of minimum wage before and after 2008 is always significantly associated with the decrease of employment rate. in addition, for china, after the minimum wage exceeds a certain level, such as 50th percentile, the increase of the minimum wage has no significant impact on the employment rate. it may be because that an increase in the minimum wage has led to an exodus of foreign firms or firms that heavily rely on cheap labor. the remaining firms are less sensitive to the minimum wage. after we introduce the interaction term between foreign direct investment and minimum wage, we also find the effect of raising minimum wage on the employment rate is dependent on and reinforced by the foreign direct investment (fdi) before 2008. however, raising the minimum wage after 2008 had no such significant effect on the employment rate. our estimation would be more accurate if the data for the employment rate of foreign enterprises or domestic enterprises are available. in the future, if we could get county level or individual level data, we would be able to perform more comprehensive analysis. research project key research projects of universities in henan province (no. 18a790019), science and technology project of henan province (no. 172102310710), soft science research project of henan province (no. 192400410200). table 1. summary statistics for china and u.s. 2008-2016 china 2008-2016 u.s. 2008-2016 employment rate 0.661 0.654 (0.361) (0.068) monthly nominal minimum wage 103.420 1176.854 (58.398) (242.712) monthly nominal average wage 375.572 3487.108 (241.017) (593.755) monthly nominal gdp per capita 346.868 3958.465 (272.323) (987.243) monthly real minimum wage 83.224 1183.582 (38.119) (170.007) monthly real average wage 300.829 3477.129 (166.198) (467.893) monthly real gdp per capita 279.592 3978.900 (203.341) (775.008) consumer price index (2009 dollar) 118.436 98.962 (16.076) (11.537) observations 510 504 8 economic analysis (2019, vol. 52, no. 2, 1-11) table 2. summary statistics for china and u.s. before and after 2008 china 2000-2007 china 2008-2016 u.s. 2000-2007 u.s. 2008-2016 employment rate 0.610 0.707 0.668 0.644 (0.389) (0.329) (0.064) (0.069) monthly nominal minimum wage 55.855 145.699 978.575 1335.478 (17.779) (48.573) (158.975) (170.846) monthly nominal average wage 183.188 546.580 3049.328 3793.554 (79.160) (204.877) (392.845) (513.289) monthly nominal gdp per capita 167.408 506.388 3408.004 4398.833 (126.938) (267.831) (776.037) (915.377) monthly real minimum wage 53.425 109.712 1110.457 1242.082 (15.762) (32.128) (171.528) (144.440) monthly real average wage 174.836 412.824 3398.805 3532.236 (71.901) (144.639) (462.507) (464.597) monthly real gdp per capita 160.127 385.784 3851.122 4081.121 (119.929) (203.487) (771.320) (764.038) consumer price index (2009 dollar) 103.933 131.327 88.215 107.560 (4.634) (10.745) (6.094) (6.583) observations 240 270 224 280 table 3. fixed effect estimation for china and u.s. 2000-2016 china u.s. employment log real minimum wage -1.249*** (0.190) -3.524*** (0.700) log real average wage -1.999*** (0.144) -3.234*** (0.625) log real gdp per capita 0.465*** (0.056) 0.229*** (0.023) time trend 0.054*** (0.012) -0.003*** (0.000) interaction between real minimum and average wage 0.249*** (0.032) 0.430*** (0.086) constant -102.671*** (23.596) 30.533*** (5.141) observations 510 476 standard errors in parentheses *p< 0.05, **p< 0.01, ***p< 0.001 duanxiang fu, jianfeng yao 9 table 4. fixed effect estimations for china and u.s. before and after 2008 china<2008 china>=2008 u.s.<2008 u.s.>=2008 employment log real minimum wage -1.514*** (0.508) -0.175 (0.390) -1.382* (0.795) -4.136*** (0.886) log real average wage -2.113*** (0.441) -0.557* (0.306) -1.361* (0.706) -3.839*** (0.788) log real gdp per capita 0.582*** (0.218) 0.252*** (0.051) 0.240*** (0.023) 0.235*** (0.038) time trend 0.002 (0.033) 0.023 (0.014) -0.005*** (0.000) 0.001** (0.000) interaction between real minimum and average wage 0.324*** (0.099) 0.069 (0.066) 0.166* (0.098) 0.508*** (0.109) constant 1.731 (64.704) -46.865* (27.885) 17.697*** (5.784) 26.228*** (6.602) observations 240 270 196 280 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 table 5. fixed effect estimation for china and u.s. china median u.s. median employment log real minimum wage 0.298 (0.435) -5.584*** (1.301) log real average wage -0.812** (0.357) -5.139*** (1.132) log real gdp per capita 0.299*** (0.052) 0.232*** (0.028) time trend 0.079*** (0.013) -0.002*** (0.000) interaction between real minimum and average wage -0.021 (0.071) 0.679*** (0.158) constant -159.426*** (26.219) 43.487*** (9.405) observations 258 347 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 10 economic analysis (2019, vol. 52, no. 2, 1-11) table 6. fixed effect estimation for coastal and inner provinces all areas coastal areas inner areas employment log real minimum wage -1.249*** (0.190) -1.177** (0.460) -1.011*** (0.215) log real average wage -1.999*** (0.144) -2.429*** (0.349) -1.586*** (0.165) log real gdp per capita 0.465*** (0.056) 0.607*** (0.156) 0.382*** (0.060) time trend 0.054*** (0.012) 0.098*** (0.026) 0.015 (0.014) interaction between real minimum and average wage 0.249*** (0.032) 0.236*** (0.080) 0.229*** (0.036) constant -102.671*** (23.596) -188.518*** (52.063) -26.656 (27.723) observations 510 102 408 standard errors in parentheses *p< 0.1, **p< 0.05, ***p< 0.01 table 7. fixed effect estimation after the control of foreign direct investment 2000-2016 2000-2007 2008-2016 employment log real minimum wage -1.443*** (0.193) -2.636*** (0.500) 0.688 (0.510) log real average wage -2.270*** (0.167) -3.736*** (0.521) 0.442 (0.489) log real gdp per capita 0.417*** (0.053) -0.031 (0.201) 0.234*** (0.051) log real fdi 0.301*** (0.068) 1.100*** (0.171) -0.334*** (0.123) time trend 0.048*** (0.011) 0.042 (0.029) 0.024* (0.014) interaction between real minimum and average wage 0.321*** (0.042) 0.780*** (0.127) -0.157 (0.108) interaction between real minimum wage and fdi -0.039** (0.016) -0.221*** (0.044) -0.078*** (0.029) constant -91.592*** (22.509) -74.800 (56.391) -54.198* (28.299) observations 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(2007). “the impact of minimum wage system on unemployment rate in china’s labor market.” journal of hunan financial and economic college, 23(109):126-128. article history: received: june 20, 2019 accepted: september 19, 2019 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp103-119 original scientific paper green economy and indicators of sustainable and ecological development zoran todorović1* 1 d.o.o. društvo za reviziju, procjenjivanje, vještačenje i usluge konsaltinga „auditing-mont“, podgorica abstract the need for global economic growth has raised the level of living standards around the world, and following this aspiration, all countries, both developed and developing countries, look at the growth rate of gross domestic product as a critical indicator of success and prosperity. the actions aimed at continuously increasing consumption have had a devastating impact on the global environment, exploiting natural resources without sufficiently considering the consequences that this exploitation leaves in the environment. the national level, as far as the most responsible for the implementation of the green agenda, will have to make appropriate changes in fiscal policy, through the reform and elimination of subsidies that can be considered less favorable from the environmental aspects. a major step in this direction may be the adoption of policies and procedures for green public procurement and green accounts. at the supranational level, further efforts must be made to improve the situation on world markets, to promote the rules of free trade and the flows of international development assistance, and to further encourage international cooperation. key words: green economy, sustainable development, green economy policy, traditional economy, sustainable development indicators jel classification: q57 introduction the need for global economic growth has raised the level of living standards around the world, and following this aspiration, all developing countries, as well as developing countries, see the gdp growth rate as a critical indicator of success and prosperity. at the same time, the pursuit of economic growth and actions aimed at constant increase in consumption had a devastating impact on the global environment, the exploitation of natural resources without taking into account the consequences that this exploitation leaves in the environment, as well as the valuation of short-term financial gains in relation to the long-term the benefit of preserving some of the most prestigious and valuable ecosystems. climate change, the economic and energy crisis, and all the aforementioned problems imposes the need for radical socio-economic changes in the cities of the 21st century, in the direction of encouraging the so-called "green economy." the concept of green economy implies a widespread use of renewable energy sources, places and investments in the so-called green industries the green economy is defined as the one that emits little carbon, uses natural resources efficiently, and is socially inclusive green economy creates great chances for sustainable development, * e-mail: zoran.todorovic@auditing-mont.me 104 economic analysis (2018, vol. 51, no. 1-2, 103-119) which means increasing income, reducing poverty and improving the quality of life green economy, especially renewable energy, is also crucial for reducing poverty, a particularly significant problem for developing countries. the business community of each state must create preconditions for a green economy as an integral part of a broader concept of sustainable development to become one of the challenges to the challenges facing modern mankind. the notion and definition of a green economy the green economy has been promoted in recent decades as a very important change in thinking. as we look at the concept of a neoliberal economic paradigm, it is quite clear that something new is needed, but it is not always easy to translate it into practice. neoliberal thinking has been transformed into the leading paradigm of development since the time of regulation and point of view through the reaffirmation of the washington consensus so that in one moment almost the power of a certain religion could be gained. this form of economic organization adopted, or even imposed on states around the world, was considered as one of the successful ways to achieve the human well-being within the framework of the concept of human rights and freedoms. the economic crisis, of which we are witnesses, has led to a deterioration in terms of economic development. there are many ways to stop the process of destroying ecosystems and restoring it. what they have in common is the understanding that our global ecosystem must be evaluated in a different way and that it should be invested in the environment and services it provides and on which all human and economic activities depend. finally, a "green economy" needs to be developed. the concept of green economy is not new. it is only more and more mentioned in the last decade, bearing in mind that global interest in environmental issues is growing and that climate change is slowly taking over the primacy of the world's leading theme. the un environment program (unep) defines a green economy as an economy that has, as a result, enhanced human well-being and social equity, and significantly reduces environmental and ecological disadvantages. a simplified, green economy can be considered an economic activity that is carried out with low carbon emissions, through which resources are spent efficiently and socially inclusive. in the green economy, growth in earnings and employment is achieved through public or private investment that reduces carbon emissions and other pollution, achieves energy efficiency and efficiency in resource use, or prevents loss of biodiversity and ecosystem services. these investments should be directed and supported by targeted public expenditures, political reforms and legislative changes. the development framework should preserve, enlarge and, where necessary, rebuild natural capital reserves as a source of public benefit, especially for poor people whose living conditions and safety depend on nature. theoretical framework nevertheless, the most significant step in the development of economic theory was the appearance of the book "the law of entropy and the economic process" by nicholas georgescuroegen (1971). this study is based, a new look, based on thermodynamic concepts, is being further developed in the works of mirowski (1989) and recently beard and lozada (1999). at the same time when georgescu-roegen's book appeared, the views of meadows and associates (1972), devoted to the exhaustion of resources and the possible limits of growth, draw attention to the far wider circle of the world, scientific and political public. thus, the concept of sustainable development is at the top of the priorities of international political action. in stockholm, in 1972, at the un environment conference, the establishment of the united nations environment program, unep, was initiated. this was followed by the establishment of zoran todorović 105 national environmental agencies in a number of countries. with the coordinated action of national and international bodies, in 1980, a program of global action to promote sustainability was proclaimed. the world conservation strategy, by the international union for the conservation of nature. accordingly, in 1983, by the un, the world environment and development commission was established, later called the brundtland commission, by the name of the chairperson. seizing the danger of potential climate change, the world meteorological organization, the wmo and the un environment program, unep, established the interstate panel on climate change in 1988, the ipcc, which, with its three working groups, aims to collect all relevant scientific, technical and socio-economic information related to anthropogenic climate change. numerous activities by state and non-governmental organizations around the world led in 1992 to the un conference on environment and development, unced in rio de janeiro. important conference papers were adopted at this conference: un framework convention on climate change and convention on biological diversity. the following was established in 1993 by the un commission for sustainable development (csd), with the primary objective of overseeing the implementation of the above mentioned documents and other acts. during the 1990s, the number of organizations aimed at fostering sustainable development was significantly expanded, among them the committee of international institutions for development and environment, cidie, and the world resources institute, wri. many of the existing international institutions, e.g. the organization for economic cooperation and development, the oecd and the world bank, wb, are beginning to intensively encourage sustainable development. the relationship of green economy and sustainable development the concept of green economy does not replace sustainable development, but today there is increasing evidence that the attainment of sustainable development goals depends to a large extent on developments in the economic sphere. decades in which new values and well-being are real on principles and with the use of traditional economic models have not managed to tackle social marginalization and excessive resource consumption, and today we are still far from reaching the millennium development goals. sustainability remains a first-class long-term goal, but additional efforts must be geared towards achieving the concept of a green economy if that goal is to be achieved. green economy in the context of sustainable development and environmental sustainability is a very important function in the development of society as well as the overall economic system of each state. the basic ideas, which represent the term of sustainable development, are aggregated (world bank, 2003; coper & vargas, 200; stead et al., 2004): • ecological and economic integration. ensure that economic development and environmental protection are integrated at the same time in planning and implementation. • environmental protection. dedication reduces pollution and degradation of the environment and more efficient use of resources. • justice. commitment meets at least the basic needs of the present poor generations (as well as equity between generations). • future events. explicit concern about the impact of current activities on future generations. • quality of life. realizing that human beings are concerned not only about income growth, but also about health and a sense of life satisfaction in their societies. 106 economic analysis (2018, vol. 51, no. 1-2, 103-119) • participation. the realization that sustainable development requires the participation of all interest groups of society. sustainable development is an umbrella concept and a magnificent paradigm that connects economy, society and environmental protection, within which green growth strategies can be considered as an appropriate framework of practical policies. bearing this in mind, it is clear that the green economy is something more concrete than sustainable development. the principles of sustainable development relate to long-term aspirations, while the green economy combines the aspirations for creating new opportunities that would lead to more robust economic recovery in the short run with the introduction of new, more environmentally efficient sources of economic growth in the long run. what is most important: green growth policies place emphasis on places where economic and environmental interests are touched or overlap and try to find the best development options in such a framework. thus, the green economic growth strategies contribute to sustainable development by creating a better political framework, necessary for achieving the concept of sustainable development. environmental performance indicators there is a growing demand for company reporting, which is clearly and focused on the key impacts of their business on the environment. this requires reporting on environmental performance, which will bring benefits in two ways: • provide information to management to utilize savings that a good environmental impact usually brings; • it will provide the opportunity to discover important components in the company's environmental protection (becker, 2008). environmental performance indicators are one of the tools for such measurements and information on how to understand and evaluate the environmental performance of companies. enterprises will carry out significant environmental conservation activities if they can determine the appropriate performance indicators. environmental indicators will facilitate communication with stakeholder ecological groups if they are involved in reporting. through the application of environmental indicators, assessment and measurement of environmental conditions, a set of data is provided for information and assistance to governments, development coordinators, planners and decision makers in monitoring their impact on environmental sustainability (bell & morse, 1999; bel & morse, 2003). environmental performance indicators (epis) have progressively developed over the past ten years and have been used by international organizations such as the united nations, the world bank, the world business council for sustainable development and the global reporting initiative (oecd, 1993; neimanis & kerr, 1996). environmental performance indicators stand out as an important tool for environmental protection and improvement of local life measurement and overall national development and sustainable development. indicators cover a wide spectrum and are applied at the local, national and regional levels. their users can easily access them, directly select them and immediately apply them to measure national ecological performance. in practice, indicators can help to make decisions on a global and national level. the ecological series of iso standards (international organization for standardization) is widely used in companies that implement environmental management, which outcomes have ecological performance reporting. this is especially true for the evaluation of environmental performance and the setting of a set of standards on a global level, which require constant commitment to improving environmental performance in order to meet environmental objectives and criteria. iso 14031 and iso 14032 are an extension of the iso 14000 series. iso zoran todorović 107 14031 provides guidelines for the selection and realistic organizations to illustrate the use of the guidelines in iso 14031 (evaluation of environmental performance guidelines: specification for the purpose of evaluating environmental performance, preparing the evaluation plan, collecting data, this is regulated as jis q 14031 on october 20, 2000). although the guideline defines the concept and procedure for selecting environmental performance indicators, it does not include the development of indicators themselves. implementation of individual esdp recommendations the esdp (european commision, 1999) is an "umbrella" document that regulates the spatial development of the territory of the european union, through a number of different topics and through concrete advice and recommendations, which are the most useful at the level of programming tasks. as a country that is seeking to join the european union, it is necessary for us to approach access to planning and spatial planning to better align with the principles that apply in the union. in that sense, it is necessary to innovate the approach to creating program tasks in accordance with sustainable development and esdp (european spatial development perspective). sustainable (green) economy according to the esdp, a sustainable (green) economy contributes to: • strengthening co-operation on specific topics in the field of spatial development through cross-border and transnational networks; • improving the economic base, ecological and service infrastructure of cities, especially in underdeveloped regions, in order to increase their attractiveness for investments; • promoting the strategy of expanding the economy in cities that depend only on one branch of the economy and supporting the economic development of cities in underdeveloped regions; • strengthening of small and medium-sized cities in rural areas as centers for regional development and promotion of their networking; • strengthening networks between businesses and rapidly expanding innovation, especially with the help of regional institutions that can promote innovation; • promoting cooperation and information exchange between rural areas. sustainable society according to the esdp, a sustainable society means: • promotion of integrated urban development strategies that take into account social and functional diversity. particular attention should be paid to combating social exclusion and recycling and / or restructuring of under-utilized or abandoned urban areas or areas; • assistance in finding effective methods for reducing uncontrolled urban expansion; reducing the excessive pressure of settlement, especially in coastal regions; • promotion of diverse development strategies, which take into account domestic potentials in rural areas and contribute to the achievement of domestic development (including promotion of multifunctionality of agriculture). helping rural areas through education, training and job creation outside agriculture; • providing access at the european level to the knowledge infrastructure, taking into account the socio-economic potential of modern small and medium-sized enterprises as a driver of sustainable economic development; 108 economic analysis (2018, vol. 51, no. 1-2, 103-119) • a comprehensive public support as a necessary prerequisite for effective implementation • access to spatial development policy; examples of principles and recommendations useful for creating program tasks 17 extensive integration of knowledge-related policies, such as promotion innovation, education, vocational training and education, development research and technology, into spatial development policies, especially in remote areas or densely populated areas. ecology according to the esdp, the ecology includes: • promotion of rational management of urban ecosystems (urban development leads to more productive agriculture, uncontrolled tourism especially in coastal areas in the summer months, harmful infrastructure projects, which leads to loss of habitat, destruction, modification and fragmentation of ecosystems); • careful use of natural resources and implementation of protection measures; • cooperation at the national, regional and global levels; • providing sustainable agriculture, applying ecological measures and enriching the use of agricultural land; • exploiting the potential for renewable energy in urban and rural areas, taking into account local and regional conditions, especially cultural and natural heritage. research framework the aim of this paper was to improve the preparation of program tasks for planning documents that are being made in montenegro. the idea was that the principles of sustainable development and environmental protection integrate, as much as possible, into the content of the planning documents, one segment of which makes the development of program tasks. the main purpose is to improve the spatial planning system in montenegro. the new system should provide sustainable development through the rehabilitation of the consequences of space devastation, the rational use of resources and the preservation of the environment. in such a way, with sustainable spatial development, we will create a better place for living in montenegro. the most common reasons that lead to failure when creating program tasks: • insufficient knowledge and understanding of the sustainable concept spatial planning, which leads to a lack of harmonization of the guidelines in the framework the same dueling task; • the lack of precisely defined measures of sustainable spatial planning as part of the program task, which leaves space for the future inadequate treatment, abuse and degradation of the space itself; • important absence of a reliable, thoughtful and generally accepted sequence guidelines and procedures that can provide quality planning; • the lack of quality, applicable municipal development strategies that would based on the principles of sustainable development, and which would facilitate the creation software tasks. research results analysis of the survey for municipalities and state institutions zoran todorović 109 the method of survey was used for the empirical part of the work, and data from municipalities and state authorities were collected through the questionnaire, which were analyzed further. 1.1. objective of the research: to determine the level of understanding of the modern european approach to the preservation of the environment and sustainable development of the representatives of municipalities and state authorities through issues focused on knowledge of the term sustainable development, its principles, degree of application of existing legislation and emphasizing the most frequent problems in the field of environment 0 in montenegro . period of realization; june-july 2011. number of respondents; 35 (municipalities 21, state bodies 14) report structure: the report is made up of two parts part i: analysis of the survey intended for the municipalities in which 21 surveys from 21 municipalities were processed. part ii: analysis of the poll intended for state bodies dealing with environmental issues. 14 surveys were obtained from the competent state institutions: the ministry of sustainable development and tourism, the environmental protection agency and the office for sustainable development. part i analysis of municipalities surveyed 1. the first question 1.1. the survey referred to the knowledge of the very term of sustainable development. employees in municipalities were able to respond affirmatively, withholding or not being sure. in chart 1, it can be seen that all surveyed / not familiar with the term sustainable development. yes no i am not sure chart 1: do you know the term sustainable development? 1.1. in the second part of the first question, municipal employees were asked to indicate priority areas for sustainable development. responses are offered: environmental protection, social development, economic development, all three areas. in addition, respondents / did not have the possibility to add other priority areas that are not mentioned in the issue itself. as can be seen in chart 2 (on the next page), the vast majority emphasized that the priority areas of sustainable development are: environmental protection, social development and economic development. 2. the second question also consists of two parts. in the first part of the question, the respondents answered / did the question whether participants / participants in some trainings / seminars / conferences in the area of sustainable development. it was found out that 14 of the total of 21 respondents had a certain type of training, which can be clearly seen in chart 3. 0 5 10 15 20 25 110 economic analysis (2018, vol. 51, no. 1-2, 103-119) all three areas environment economic development social development chart 2: list the basic principles of sustainable development? yes no chart 3: have you been a participant in some trainings / seminars / conferences in the futility of sustainable development? 1. what was also interested in was how many employees in municipalities were familiar with the adoption of the local environmental action plans, the local agenda 21, the local sustainable development strategy or some other local strategic framework that regulates the issue of sustainable development, and in what percentage, according to in their opinion, the beneficiaries of this program have been applied. the collected data show that the above documents were presented in most municipalities (chart 4), but also that in 8 municipalities they are applied in less than 50%. out of the total of 21 surveyed municipalities, 8 did not answer at all the part related to the implementation of local documents, which indicates that they either are not familiar with the situation in the municipality itself or are not interested in the application of the mentioned municipal documents. 0 5 10 15 20 25 0 5 10 15 20 25 zoran todorović 111 yes yes, more of them no i am not sure chart 4: has your municipality adopted the local environmental action plan (leap), the local agenda 21. the local sustainable development strategy or another local strategic framework that regulates the issue of sustainable development? one of the segments we wanted to process through this survey is certainly spatial planning and the problems that municipalities encounter on their way to achieving sustainable development through space planning. as can be seen in chart 5. the most frequent problems are: insufficient funds, incomprehension of the principles of sustainable development, lack of willingness to implement, as well as insufficient knowledge, capacities and mechanisms for their implementation. the above facts speak about the necessity of further improvement of the existing staff, monitoring of the realized activities and the need for providing additional financial resources. financing misunderstanding implementation knowledge, capacities principle mechanisms chart 5: problems faced by municipalities on the road towards achieving sustainable development? 5. in view of the growing problems in the field of environment, we wanted to find out which of the five environmental problems would be highlighted by the employees in the relevant municipal services as the most important ones in montenegro. almost all respondents pointed out the problem of waste disposal. an important place is the migration of people to cities, which creates additional pressure on the environment in certain areas. more pronounced problems are pollution of water and social and economic stratification of the population. the obtained results are presented in chart 6. 6. the last set of questions concerned software tasks, i.e. are municipalities managed by analyzes that bring about the real needs of the population and society as a whole and the use of space in the development of program tasks, and do they clearly define the valuable resources that will be preserved for future use? needs and spatial capacity analyzes, as well as socio0 5 10 15 20 25 0 10 20 30 112 economic analysis (2018, vol. 51, no. 1-2, 103-119) economic analyzes are done in 10 municipalities, while demographic analyzes work in 7 out of 21 municipalities surveyed. none of the above analyzes is performed in the two municipalities. additional analysis was not mentioned in the responses, although there was a possibility for that. waste migration use of energy water pollution social and economic stratification chart 6: five most common environmental problems in montenegro 7. when it comes to defining value resources through probation tasks, the answers are unequal. nine respondents point out that this issue is ignored in program tasks, while 6 consider this to be partial. the number of respondents who believe that this is not working or that they are not safe is the same (3 respondents). a graphic representation of the answer to this question is given in chart 7. yes no partially i am not sure chart 7: does your municipality clearly define the valuable resources that will be saved for future use in the development of program tasks? part ii analysis of the survey intended for state authorities 1. through the first set of questions, we wanted to determine how long the term of sustainable development is known to officials employed in state institutions, as well as a closer explanation of this term. of the 14 respondents, all recognized the term sustainable development, as can be seen in chart 1. 0 5 10 15 20 25 0 5 10 15 20 25 zoran todorović 113 yes no i am not sure chart 1: do you know the term sustainable development? most respondents gave a full and identical definition of sustainable development: "sustainable development is a concept that represents resource management in order to meet the needs of current generations in a way that does not endanger the ability of future generations to meet their needs." in one case, we also had more definitions, the one most commonly used, in the report "our common future" prepared by the world commission on environment and development in 1987, to the most comprehensive: "sustainable development is an integral economic, technological, social and cultural development, in line with the needs of protection and improvement of the environment, which enables present and future generations to satisfy their needs and improve the quality of life." on the basis of the collected explanations, it can be claimed whether it is a real knowledge and understanding of terms, given the fact that most of the answers received are identical. 2. the principles of ecological, social, cultural and economic sustainability are the most important for most respondents, which can be seen in the graphic representation (chart 2). ecological sustainability social and cultural economic sustainability chart 2: list the basic principles of sustainable development 3. a small number of respondents believe that an important role in sustainable development has: integrating environmental issues into development policies (3), the participation of all stakeholders in decision-making (3), and equality among generations and equality within the same generation and gender equality ( 3); 0 2 4 6 8 10 12 14 16 0 5 10 15 114 economic analysis (2018, vol. 51, no. 1-2, 103-119) the collected data indicate that the employees / do not know which are the most important principles of sustainable development. 3. a special part of the survey includes training related issues / training / seminars / conferences in the field of sustainable development. of the 14 respondents employed in state institutions, 9 attended trainings / seminars / conferences in the field of sustainable development, which indicates that a significant number of employees have undergone some training, which can be seen in chart 3. yes no chart 3: have you been a participant in some trainings / seminars / conferences in the field of sustainable development? of respondents who attended trainings / seminars / conferences in the field of sustainable development, they were asked to specify what training was: from 9, one person did not indicate which training / seminars / conferences it was. most of the employees attended round tables on the topic of architecture and sustainable building, then spatial planning, the environment and the green economy. the data collected show that training should be focused on other activities in the field of sustainable development and organized in the form of high-level workshops with clear instructions for employees in state institutions. 5. through the fourth issue, we wanted to find out what are the fundamental problems that montenegro faces in pursuing the principle of sustainable development. according to the opinion of the civil servants interviewed, these are: • harmonization of plans and programs in the field of environment, energy, transport and tourism with the principles of sustainable development, as well as their implementation; • social inequality, insufficient development of system institutions, poor implementation and monitored legislation and difficult access to financial resources; • ignorance and misunderstanding of sustainable development, lack of adequate staff; • improving the environmental performance of products and increasing demand for sustainable products and manufacturing technologies; • improve cooperation, coordination and consultation between the various sectors within the government, as well as between the government and the private sector, as well as the need to improve regional cooperation so as to contribute to the achievement of a sustainable development pipeline; • making decisions on the environmental impact of social peace and economic development; 0 5 10 15 zoran todorović 115 • low level of environmental awareness of citizens of montenegro and insufficient commitment of the education system to environmental issues and the importance of sustainable development; • the presence of private interest over the general, which leads to the short-term profit of an individual; • lack of systematic approach to planning and use of space; • the unsolved problem of corruption. the data collected indicate that government officials are aware of existing problems in order to achieve the principles of sustainable development, but also barriers to overcome in order to achieve the goals. graph 4 shows that the respondents consider that the disposal of waste and irrational use are the most frequent problems. also, significant migration of population to cities, as well as pollution of industrial gases and contaminated water were also highlighted as a major problem. waste energy migration ind. gases water pollution chart 4: five most common environmental problems in montenegro 1. when it comes to the need to adopt additional regulations in the field of environmental protection and sustainable development, half of the respondents are not sure whether the adoption of additional regulations is necessary, which indicates that the employees are not familiar enough with the existing regulations in montenegro and the degree their applications or do not want to answer this question. on the other hand, out of 14 respondents, 6 stated that changes to existing regulations were necessary, while one respondent considered it unnecessary. the graphic representation is given in chart 5. 0 2 4 6 8 10 12 14 16 116 economic analysis (2018, vol. 51, no. 1-2, 103-119) 50% yes 43% no 7% i am not sure graph 5: do you consider it necessary to adopt additional regulations in the field of environmental protection and sustainable development? as part of this question, we interrelated in which areas changes of regulations are necessary. the answers are different and range from new laws on chemicals, noise and ionizing radiation, water management, waste management, eco-fund law, spatial planning, changes to all laws related to the environment, and the adoption of acts that would serve for checking the sustainability of policies, laws and strategies. 1. we were interested in the issue related to the environmental penal policy, whether it was appropriate. in the graph no. 6 it can be seen that most respondents consider that there is no proper environmental policy. on the other hand, since it is about employees in state institutions, it is worrying that a large number of those who are not safe. 43% yes, 29% no, 28% not sure chart 6: is there a proper environmental policy in the field? in the explanations of the answer we reached the rating: • that there is an adequate criminal policy, but that the implementation of the law and implementation of the penal policy is lacking; • the necessity of educating citizens about the importance of preserving the living environment, as well as those employed in the competent state institutions and the judiciary, is emphasized; • one of the problems is highlighting the decentralization of the system, since the units of local self-government still lack sufficient capacity to implement regulations such as waste management, noise, environmental impact assessment; • poorly positioned responsibility of the institutions responsible for environmental issues and inadequate mechanisms for their resolution; • lack of environmental law practice. there is no locus stand (the right to initiate an action in a court hearing or address to a court) for interested individuals, organizations and the public in general with regard to the environment. 8. when asked whether they are satisfied with the current situation in the field of environmental protection and improvement of the environment, half of the total number of respondents answered that it is partially satisfied, 4 of 14 people are not satisfied with the smallest number of those who are satisfied with the current situation. zoran todorović 117 9. in addition, we were interested in priority fields of action in which post-environmental progress is necessary. participants of the survey had the opportunity to give seven responses. the most common answers were: waste disposal and waste and waste water management, water protection, biodiversity protection and climate change (chart 7). some of the respondents also stressed the importance of adopting appropriate legislation, its alignment with eu regulations, implementation, as well as strengthening institutional capacities and establishing an appropriate information system. we also had recommendations on the importance of socially responsible business and the development of the green economy and the prevention of migration to cities. waste and waste water protection biodiversity climate water changes chart 7. priority fields of action in which progress in the field of environment is necessary some respondents emphasized the need for action in the fields of transport, tourism, regional development and employment, energy, agriculture, rural development and industry (3 respondents). 10. when asked about the harmonization of domestic legislation in the field of environment in montenegro with the recommendations of the european union, two out of the total number of respondents consider that environmental laws are largely in line with the eu recommendations, while three believe that the laws are harmonized, but it is necessary to work on the implementation of adopted regulations. also, three respondents consider that the laws are sufficiently harmonized, but minor changes are minor. in addition, two respondents believe that the degree of harmonization depends on the area. three respondents consider that they are not completely harmonized. one respondent believes that it is working on full harmonization. conclusions the green economy has been promoted in recent decades as a very important change in thinking. from the united nations conference on environment and development in 1992, sustainability is becoming a widely accepted goal. although information can provide a better basis for decision making and measuring progress, accountability can only be achieved if goals and measures of progress are explicitly stated. properly formulated indicators can provide such measures, improving the diagnosis of the situation, both progress and regression. in both surveys, whether intended for municipalities or civil services, several areas are distinguished: • knowledge of the term sustainable development and its principles; • part that relates to capacity building of employees; 0 2 4 6 8 10 12 14 16 118 economic analysis (2018, vol. 51, no. 1-2, 103-119) • key problems in the field of environment in montenegro and priority fields of action; • legislation, both at national and local level; • the situation in the field of criminal policy. the vast majority of surveyed state and municipal officials recognize the term sustainable development and the basic principles of sustainable development. when it comes to the closer explanation of this term, we can not claim to fully understand its meaning, given the fact that we have received a large number of identical explanations. we found that employees attended trainings / seminars / conferences whose topic was only one of the segments of sustainable development, which indicates the need to further improve and strengthen the capacities of competent state and municipal services. through these tests, we obtained a confirmation that employees in state bodies and municipalities also share opinions with citizens that in montenegro the problem of waste disposal is currently the most serious and that it requires fast and efficient resolution. rational use of energy, expressed migration of population, problems of pollution of water and air are emphasized as priority problems. according to the answers received, the opinions of civil servants are divided when it comes to the changes in existing regulations in the field of environment in crna gora and range from those who are not sure that the changes are needed to those who deem it necessary. the minimum number of respondents considers that changes should not be made. opinions on compliance with eu regulations are divided. very few believe that domestic laws are not in line with the relevant obstacles of the eu. the majority of respondents think that the laws are harmonized or that minor changes are needed. the issue of implementation of existing laws was emphasized. it is also pointed out that there is no appropriate environmental penal policy. on the other hand, since it is about employees in state institutions, it is worrying that a large number of those who are not sure whether the existing criminal policy is appropriate. different types of analysis are carried out in the preparation of program tasks, with a very small number of municipalities doing all the above analyzes. integrating issues of valuable resources through program tasks is also done in a small number of municipalities, and often only partially done. environmental awareness, expressed the interest to rationalize the exploitation of natural resources, especially non-renewable, in caring for the conservation of wildlife diversity (biodiversity) on earth, in caring for the protection of the quality of the human environment including the socio-political and economic developments, not as decorative philosophical declaration, but as a permanent element in the practical design and implementation of business and other ventures. for the purpose of effective implementation of objective knowledge and theoretical concepts of modern science of nature, find the exact new measures and indicators. really, not a formal environmental assessment of development programs becomes a mandatory component of the economic planning. modern macroeconomics is faced with the task of promptly assimilated by ecological insights and predictions, both local and global, and to anticipate and provide their implications. references georgescu-roegen, n.r. 1971. the law of entropy and the economic process. m. and associates 1972. the limits to growth. new york: universe books. beard, r., & lozada, g. 2003. economics, entropy and the environment. journal of bioeconomics 5. bell, s., & morse, s. 1999. sustainability indicators: measuring the immeasurable? erthscan publications limited. zoran todorović 119 bossel, h. 2001. assesing viability and sustainability: a systems-based approach for deriving comprehensive indicator sets. european commision. 1999. european spatial development perspective, towards balanced and sustainable development of the territory. european commision (211). the european eco-management and audit scheme. international network for environmental compliance and enforcement . (2012). iucn – international union for conservation of nature. 1991. caring for the earth, a strategy for sustainable living. gland, switzerland. mirowski, p. 1989. more heat than light: economics as social physics, physics as nature's economics (historical perspectives on modern economics). cambridge university press. natasa, p., slovic, d., & cirovic, d. (n.d.). indikatori ekoloških performansi kao smjernice ka održivosti. fakultet organizacionih nauka. neimanis, v. a. 1996. developing national environmental indicators. . rotterdam: a.a. balkema. tickell, c. 1997. the human species: a suicidal success' in goudie. a. (ed.). the human impact reader: readings and case studies, pp. 450-460. unced. (n.d.). agenda 21: programme of action for sustainable development. rio declaration on environment and development. new york: united nations. unija poslodavaca crne gore. 2017. istraživanje o zelenoj ekonomiji i zelenim poslovima. world bank. 2003. sustainable development in a dynamic world: transforming institutions, growth, and quality of life. oxford university press. world commission on environment and development. 1987. our common future – the bruntdland report. article history: received: february 26, 2018 accepted: may 4, 2018 udc: 336.71(540) 339.13.024 cobiss.sr-id 252602892 scientifi review disruption in banking in emerging market economy: an empirical study of india reena agrawal1* 1 chairperson centre for entrepreneurship development (ced), jaipuria institute of management, lucknow, india abstract the present study was taken up to capture the ongoing disruptions in banking in the indian economy. the objective of this research was to: (1) study the initiatives taken by reserve bank of india to stimulate the payment market, (2) explore the disruptions in the indian payment space, (3) examine the digitization at banks in india and (4) identify the challenges faced by traditional indian banks and (5) propose measures to cope with threats posed by non-bank players. the study found that as technology companies and other non-bank players have successfully penetrated into large customer segments by offering basic banking services, to the customers at their doorsteps and at their convenience; it is obligatory for the traditional banks to expand market outreach and enrich service quality via digital podia, strategic alliances and disruptive innovations, in case they wish to avoid the risk of being relegated to back-office utilities. key words: disruption, fintech, payment space, digitization, uberisation jel classification: g21, g15 introduction digitization has transformed the financial services sector. it may be rightly said that no other service has been impacted as much by the phenomenon of digitization as payments, a traditional throttlehold of retail banks. by enabling the customer, digitization has allowed non-bank players to intimidate banks’ dominance in this area. as millennials appear to be leading adopters of smart phones and internet technology, banks have to be appropriately equipped to entice and hold this significant demographic. so the present study was taken up to capture the ongoing disruptions in the banking in the india economy. objective of the study the objective of this research was to: (1) study the initiatives taken by reserve bank of india to stimulate the payment market, (2) explore the disruptions in the indian payment space, (3) examine the digitization at banks in india and (4) identify the challenges faced by traditional indian banks and (5) propose measures to cope with the threats posed by non-bank players. * e-mail: reena.agarwal@jaipuria.ac.in reena agrawal 21 methodology this was an empirical research. the research was built on secondary information. the facts and figures were collected from large number of publically available sources such as research papers, periodicals, and government documents, reports prepared by private agencies, newspaper articles and websites. the data was collected from some of the recent reports prepared by government, semigovernment as well as private agencies such as internet and mobile association of india, payment council of india, price waterhouse cooper, confederation of indian industry, emarketer, gsma intelligence, kpmg, iamai, mxv consulting, assocham, rncos to name a few. information was also collected from the official website of several financial institutions such as indusind bank, icici bank to name a few. the information collected from these reports was then used, to demonstrate the varied dimensions of the digital transformation taking place in the banking sector in india. research implications the study provides valuable insights, to the traditional banks and micro finance institutions, to help them envisage strategies to benefit from the ongoing transformation in the indian economy and also advantage from globalization. the study will enthuse the policy-maker to bring about desirable reforms to stimulate financial outreach to all strata of society through digital podia without jeopardizing the public interest. the study gives food for thought to the academicians and researchers, who can conduct further researches, to explore the implication of digitization on the people living at grass root level and examine whether there is any correlation between digitization and poverty reduction and other such aspects. overview of the literature as the developed economies witnessed the transition of smart-phone users from the cash payment to digital payment, the emerging economies are also exploring ways to use their 3g and 4g mobile phones for delivering wide-ranging financial services to the end users (hughes & lonie, 2007; holmes, 2011; william & suri, 2010; bold & rotman, 2012; donovan, 2012, ehrbeck et al, 2012; the economist, 2012). newman (2012) stated that as people increasingly adopt smart phone and internet and readily switch to on-line purchasing; it seems that smart phone will soon substitute the paper currency and plastic currency. in developing countries, where there is dearth of formal financial institutions and basic banking as well as money transfer is still a challenging task (collins et al., 2009; de soto, 1989; noz et al., 2010), the growth of e-payment and e-banking is a laudable achievement (okereocha, 2010). the use of credit cards, debit cards, smart cards and online banking is widely prevalent and mobile payments, transfers and mobile money are rapidly becoming popular (oecd, 2006). according to desai (2012), the mobile money industry is expanding rapidly and the growth has been driven largely by mobile network operators (mnos). davidson and pénicaud (2012) in their survey (in june 2011), found that mobile money service providers processed 141.80 million transactions, out of which 29.80 million transaction were related to transfers, bill payments, and bulk payments while the rest were cash in, cash out, and airtime top-ups. the mobiles have made it possible for the unbanked to avail banking services, thus making it eligible to play the role of a “branchless bank” (william and suri, 2010; martinez and mc kay, 2011). mobile phones have the ability to transform the regions and grow economies (adb, 2003; butler, 2005; elijah & ogunlade, 2006; srivastava, 2008; business week, 2007; ssewanyana, 2007; the economist, 2012; etim, 2011, 2012). today it is essential that retail banks create partnership with mobile network operators (mnos) for the delivery of financial services to the world`s unbanked (ehrbeck, 2012; jenkins, 2008). 22 economic analysis (2017, vol. 50, no. 3-4, 20-31) findings disruption in payment space digital payments are a direct result of the digitization. they cover all payments and transfers made through electronic formats, including online payments, mobile payments and cryptocurrencies through instruments such as mobile wallets, digital wallets and contact-less cards. with the creation of national payments corporation of india (npci) as a nodal infrastructure agency for small payments and real time payments using immediate payment service (imps), there was a fillip to the system and growth of electronic payments started in right earnest. licenses were issued to forty prepaid payment instruments (ppis) and ten payment aggregators to operate in india (kpmg, 2016). ppis began with railway ticketing, bill payments, recharges and small remittances and gradually captured larger portions of the customer wallet by offering convenient and secure options for small payments and transfers and by creating touchpoints for cash loading and cash out, acting as banking correspondents, thus creating a new set of service providers to assist in this low-margin, high-volume business. as per pwc (2015) “in a span of less than eighteen months, ppis contributed to more than forty percent of all imps transactions between banks and non-banks connected to imps switch. despite the friction faced by lack of cash-out and interoperability, ppis deserve much credit for spurring an almost eight-fold increase in prepaid transactions” (annex 1). in the spree to further add momentum to the payment space, the reserve bank of india in august 2015 granted ‘in-principle’ licenses to eleven non-bank entities, to establish ‘payment bank’ in india. the payment licenses were granted to the telecom companies, security market entity, postal service provider, payment service provider, technology companies, and nonbanking finance companies. with the entry of these new payment banks the landscape is bound to change and the payment solutions are bound to become efficient and cost effective. given below is a brief overview about the new entrants in the payment space: i. aditya birla nuvo: it is an aditya birla group company that owns idea cellular. as of june 2015, idea cellular had a customer base of 162.08 million mobile phones and 37.16 million internet subscribers. idea cellular has partnered with axis bank to offer money transfer services through mobile. ii. airtel m commerce services: it started its operations three years ago. as on june 2015, airtel had a customer base of 234.11 million mobile and 82. 57 million internet subscribers. as on march 2014, airtel money had conducted 38 million transactions and had 1.70 million active customers. partnership with kotak mahindra bank. iii. cholamandalam distribution services: the company has a network of 534 branches and more than 7,000 dealers across india. it has a customer base of over 750,000 and seventy one percent of its branches are in rural areas. the end customers are majorly farmers. iv. department of posts: it has the largest postal network in the world. it has a network of 154,856 post offices in india with ninety percent post offices are in rural areas and 260,000 ‘dak sevakas’ (postmen). it offers saving schemes and accepts public deposits. v. fino pay tech: it acquired nokia money in 2012. it then launched alpha payment services in 2013. today the company has 450 fino money marts and 15,000 merchant distribution services. it has reached to 80 million individuals for their banking needs. it provides customer service points including business correspondents to nationalized banks like state bank of india. vi. national securities depository: it provides permanent account number (pan). it enrolls individuals for the implementation of the aadhaar project. it holds 14 million demat accounts and handles large volume of transaction as a depository. reena agrawal 23 vii. tech mahindra: it operates a pre-paid payment instrument (m-wallet) known as ‘mobo money’, which is near faced communication (nfc) based mobile wallet solution from group company canvasm. it has launched nfc based payments for icici bank. it has partnered with mahindra finance for operating the payment bank. it has a network of about 100,000 outlets under saral rozgar yojana. viii. reliance industries: the company has nationwide 4g telecom license. it provides telephony and broadband services in all states, ninety percent of urban india and over 215,000 villages in india. it has 2300 retail stores across 166 cities, connects to more than 1 million customers per day. it has entered into a joint venture with state bank of india for setting up payments banks. state bank of india operates 16,377 bank branches across the nation, has 59,516 customer services points including business correspondents. ix. dilip shantilal shanghvi: he is the founder of sun pharmaceuticals. he partnered with telenor group and idfc bank. telenor group is world’s leading providers of mobile financial services. x. vijay shekhar sharma: he is the founder of paytm. paytm is a mobile payments commerce business. paytm got prepaid wallets license from rbi in 2013. it has reached a customer base of 100 million wallet users and facilitates 75 million transactions per month through its platform. xi. vodafone m pesa: it is a two year old venture. it has 90,000 agents through which it facilitates money transfers. it has a customer base of 3.60 million. these entities who entered into the foray of payment banking certainly enjoy an edge over the existing traditional retail banks in terms of robust infrastructure, huge market outreach (including rural outreach), huge customer base, trained and experienced workforce, advanced technology, updated digital platform to engage the customer, capacity to handle huge volumes of transactions, economies of scale and first mover advantage. as these entities already have a huge existing customer base they can easily and immediately offer the basic banking services to their existing customer without much difficultly. figure 1. prominent fintech player operating in india payment space source: mxv (2015) wallets payment paytm, mobikwik,oxigen citrus, payumoney, freecharge, vodafone m pesa, airtel money, idea mycash instarem, eko, zero, vodafone m pesa, airtel money, idea mycash remittances credit cards & loan insurance consumer lending share trading asset management asset business lending bank bazar.com, paisa bazar, apna paisa policy bazar, insuring india.com, coverfox india lends, rang de, faircent.com, i-lend.in zerodha, finvasia aditya birla money, my universe, retirewe.in, fundsindia, scripbox lendingkart, capitalfloat, sme.corner.com crowd funding lets venture, wishberry, catapooolt 24 economic analysis (2017, vol. 50, no. 3-4, 20-31) the various technology companies also known as ‘fintech’ that have emerged as prominent players in the payment space in india include: aytm, mobikwik,oxigen, citrus, payumoney, freecharge, vodafone m pesa, airtel money, idea mycash, instarem, eko, zero, vodafone m pesa, airtel money, idea mycash, bank bazar.com, paisa bazar, apna paisa, india lends, rang de, faircent.com, i-lend.in, policy bazar, insuring india.com, coverfox, lets venture, wishberry, catapooolt. aditya birla money, my universe, fundsindia, scripbox, lendingkart, capitalfloat, sme.corner.com, zerodha and finvasia. while some areas are in early stages of adoption, the others have already gained wide acceptance. according to kpmg (2016) in india share trading via digital platform has already reached maturity; digital payments and remittances are enjoying rapid growth; credit cards, insurance, digital wallet, mobile wallet are being enthusiastically accepted by consumer; whereas lending and crowd funding thru digital route is still in an early stage (annexure 2). the emerging payments segment has enormous potential due to: (i) the speed with which it recognizes and captures the space of small transactions, primarily e-commerce, peer to peer and bill payments and (ii) their capability to arrange funding and make a mark, along with their ecommerce peers, who are fast disrupting the traditional retail space, and giving way to aggressive competition between themselves and their offline counterparts. with advanced technology mobile phones have become disruptive payment platform, attempting to replace cash and cheques. some of the products that have the potential to disrupt the payments industry include p2p payments, mobile wallets and pre-loaded cards among others. i. p2p payments: vodafone led m-pesa and airtel money provide successful mobile money system for the unbanked, which lets customers pay bills, transfer money without any bank involvement. ii. mobile wallets: a number of non-bank players like paytm, oxigen, mobikwik among others, have taken the lead in launching the mobile wallet. contactless payment technologies allow these players to launch digital wallets that can potentially replace physical wallets and also provide a number of add on services like ticketing, couponing, loyalty offers, payments and banking. according to rncos (2015), the current indian market size of mobile wallet market stands at inr 3,500 million and is estimated to rise at inr 12,100 million by 2019 and anticipated to grow at 225 percent cagr to become usd 5.12 billion in 2020. iii. pre-loaded cards: reloadable prepaid cards sold at retailers and banks function like debit cards without the checking account. they target people who are unbanked and those who would like to avoid high bank fees. these cards can be used for: cash withdrawal at atms, online purchase, purchases at supermarkets, reloading cash, with lower fees than that of bank accounts. at the heart of the digital revolution in payments sits the smartphone and the internet access. some of it is due to the increased ‘uberisation’ of user experience and involvement in both online and offline spaces, some of the services became the instrument of choice for small payments, even for customers of traditional banks. the quick footed non-bank players, undeterred by their heritage, have been fast to seize the business opportunity. to this end, banks need to adopt technologies and strategies that will allow them to sustain their relevance in the payments market. banks going digital given the level of customer-centricity in the financial service sector and the digital wave further empowering the customer, it is critical to explore the impact of digital on banking. this exploration should not be limited to customer contact points, but should also include banks internal processes and operations where digital will have impact. reena agrawal 25 i. using social media platforms: growing one’s customer base continues to be one of the top priorities for any banking institution. traditional customer acquisition strategies tend to have relatively low conversion and purchasing customer database is an expensive option. digital avenues provide alternatives to tackle both these issues. one of the most significant effects of the digital boom is the accessibility of data at fairly low cost. social media podia are fertile ground for understanding the customer perception, testing hypotheses and building brand equity. banks today are raiding this space to obtain huge data and use it in novel ways. the objective is not only to get connected to potential customers, but also to use powerful analytics tools and techniques to better understand their requirements. icici bank helps customers connect via twitter (“bank on twitter”), facebook (app by the name of ‘pockets’ on facebook) (icici, 2016) to get the related benefits. ii. making strategic alliances: data analytics can help in understanding the customer’s interests and needs based on their purchases, locations, frequency of transaction, seasonality, demographics, phase of life cycle, travel pattern, etc., create customized offers and make pointed suggestions. analytics can also help banks in partnering with vendors and e commerce companies. with phenomenal boom in the e-commerce space in india, banks use these channels to connect to new customers, especially in smaller cities and also use it for joint product offerings. bankbazaar.com, which is an aggregator for loans and credit cards among other financial products, recorded double the disbursements across all product categories, in 2013-14, the company disbursed inr 30 billion across all products on its platform (cii & pwc, 2015). hdfc bank and snapdeal (online marketplace company) have entered into a partnership to launch a co-branded credit card, which will target customers in smaller towns and cities. this will jointly provide a host of opportunities to both the companies: (i) for snapdeal, the tie-up will drive more purchases apart from potential sales increases with specific offers from using the card, the company expects to generate a significant portion of its annual gross merchandise sales, from tier iii and tier iv towns and cities; (ii) for hdfc, this move will help in customer acquisitions in smaller towns, apart from gains from increased card usage and transaction volumes (gooptu, 2015). iii. leveraging technological boom: mobile and smartphones continue to be a prime channel for reaching customers. with a burst of affordable smartphones being launched in the indian mobile market, the device penetration is estimated to experience substantial growth. with such fascinating trends, designing content tailored for smartphones, and leveraging the increased functionality of smartphones, including gps, camera and access to fast internet, will continue to be a key driver for the growth of the industry. developing innovative apps and tying with the smartphone’s gps to locate branch, atm etc. and also to provide with top retail offers and further bundling this with discounts when using the bank’s products has induced the customer to use bank’s products. messaging or calling through the app or geo-tagging the customer’s location is being used to set up a meeting with a bank sales representative. with the onset of ‘aadhar’, biometric technologies banks can now develop ‘doc-less’ application processes. by scanning one’s fingerprint and hitting the ‘aadhar’ and pan database, one’s kyc is automatically generated, eliminating the need for photo-identification or having to carry duplicates. various examples, such as icici’s tab banking, illustrate the leveraging of digital technologies to streamline processes and overcome the application drop-off hurdle. aditya birla’s myuniverse is an innovator in the personal finance space, it provides a completely digital customer experience. the registration process is simple. the platform helps to get the summary of one’s accounts, track expenses and manage one’s personal finances. the platform classifies the expenses, provide expenditure analytics and helps in carrying out financial transactions. it helps in analyzing the existing portfolio, provides advice for investment and direct to aditya birla’s investment 26 economic analysis (2017, vol. 50, no. 3-4, 20-31) platforms for the purchase stocks etc. a superior digital experience helps in building good relationships with the customers and steers them towards other premium offerings. (myuniverse, 2016). iv. engaging the customers: e zone concept may be used as alternate for contact centers and telephone banking. customers feel more associated and contented interacting with a bank assistant, rather than interacting with an individual over phone. skype and other video chat application must be integrated with bank mobile apps. the banking mobile app as a means of customer interaction, as opposed to one-way communication, is a fertile space, beginning to be explored by industry players. the sales force with the technology to carry out customer requirements such as payments, scanning and applying, go a long way in creating niches in one’s customer’s brand impression and improve the chances of recall, loyalty and referrals. equipping the bank staff with digital connectivity will help in reducing the transaction handling cost and time and will improve the service quality. connected conversations could enable deeper relationship with customers, assist in customer retention and better business and profitability for banks. fully engaged customers tend to spend a significant share of their wallet in investments, deposits, credit cards, loan, payment options etc. while using multiple platforms to communicate with one’s customer improves the reach, it may not be the most optimum strategy. using analytics to study channel consumption trends and applying predictive modelling to identify communication routes that provide greater success, are techniques that have become more common today. fully engaged customers bring as additional revenue per year to their primary bank compared to disengaged customers (hughes, jon and youra, betha, 2014). indusind bank has launched ‘video branch’, a service available through the bank’s website and via a mobile phone app. it allows customers to talk to bank representatives through a video call. the app leverages the ever increasing popularity of digital video calling made popular by services such as skype and facetime. positioned as an alternative option to phone banking, and especially attractive to its nri clients, the app is a smart move in establishing the bank’s digital brand. (indusind bank, 2016). v. digital payment solutions: with the evolution of a digitized economy, the multi-channel delivery has become vital. pay orders and demand drafts are on the verge of superannuation and might extinct like telegram. as we enter in an era of digital revolution, payments made through cash and card is paving the way for payments through digital channels. rtgs and neft facilitate maximum fund transfers while payment using imps, mobile payments and other payment platform are catching speed. this transformation is not only triggered by a revolution in mobile technology but also by the rising awareness about digital payments and an increase in the preference for hassle-free transactions. as per ken research, india’s payment market is expected to reach inr 8,172.70 billion by 2019. the payment industry in the country is composed of various segments, mobile wallet, mobile banking, mobile point of sale (mpos), bill payments and online payment gateway, with each segment comprising of a number of players. each of these segments is being dominated by different players, for example, mobile banking is dominated by banking institutions, mobile wallets by partnerships between financial institutes and mobile operators and mobile point of sale (mpos) by new players such as technology companies. icici bank provides ‘cardless cash withdrawals’ all that is needed is a mobile number and provides payments through banking app by the name of ‘pocket’ on facebook (icici, 2016). discussion the payments industry has become a center for innovation with new players wanting to upstage the traditional ones and dominate the market quickly. they come from varied industries reena agrawal 27 ranging from start-ups, telecommunication companies, card companies, supermarket chains, technology companies and de-nova banks, offering simpler functionality through an exciting digital experience that appeals to everyone including the millennials. a number of these players offer everything from debit cards, digital wallet, savings accounts, and money transfers to small business lending outside of traditional banking. the indian banking industry has also undergone several transformations from manual ledgers to computerization, core banking, atms, internet banking, kiosks, sms banking, telebanking and mobile banking (annex 3). some of these have lured customers away from the physical to the digital channels. emergence of smart phones and internet connectivity has given the consumers a power of connectivity at their doorstep and at their convenience. there were 453 million unique subscribers with sim connections in 2014 which is estimated to go up to 734 million in 2020. there were 149 million smartphones in 2014, 185 million in mid-2015 and it is anticipated to increase to 690 million by 2020. there were 85 million mobile internet connections in 2010 which is expected to reach to 592 million in 2020 (pwc & assocham, 2015; gsma intelligence, 2015, mxv, 2015) (annex 4&5). with india ranking 3rd in terms of smartphone users after us and china (iamai, 2015) and ranking 2nd in terms of internet users (in the second half of 2015) only after china (emarketer, 2014: annex 6), it is imminent that there will be further tectonic shifts in consumer migration to the digital channels. as diverse industry players are trying to influence the financial service marketplace in the backdrop of a rising customer preference for greater self-service, in an increasingly integrated digital and physical world. banks will have to rush to extensive digitization in case they wish to avoid the risk of being relegated to back-office utilities. banks will have to: (1) consolidate their existing strength and capabilities; (2) enhance rural and overseas outreach using digital media;(3) offer innovative prepositions through digital platforms; (4) digitize business processes; (5) help consumers to make optimum decisions; (6) enhance customer experience through dedicated innovation and strategic alliances; (7) facilitate mobile cheque deposit; (8) introduce digital currency and (9) redefine cross-border remittances through a sophisticated virtual engine. conclusion as sizeable number of people in india, rarely have access to banking services, despite their heavy dependence on remittances. there is a pressing need for the development of effective payment and remittance platforms. mobile networks operators and technology companies have taken a lead as major financial service providers, bypassing the sparse network of traditional retail banks. technological advancements have led to the emergence of innovative and disruptive payment models, which will shape the industry`s future. as consumers show their preference for hassle free and convenient transacting through mobile and internet, anywhere and anytime, it is for banks in india to rise up to the occasion and delight their customers in this new digital age. by taking up the digital routes banks would certainly be able to encompass the large number of financially excluded living within in the country and will also be able to connect with the diaspora living across the different nations. references asia development bank. 2003. “toward e-development in asia and the pacific”. asian development bank. 28 economic analysis (2017, vol. 50, no. 3-4, 20-31) bold, chris, porteous, david, and rotman, sarah. 2012. “social cash transfers and financial inclusion: evidence from four countries”. consultative group for assisting the poor (cgap), february 2012: pp. 1-20. business week. 2007. “upwardly mobile in africa”. http://www.bloomberg.com/news/articles/2007-09-23/upwardly-mobile-in-africa (retrieved on may 1, 2016). butler, rhett. 2005. “cell phones may help save africa”. https://news.mongabay.com/2005/07/cell-phones-may-help-save-africa/ (retrieved on may 2, 2016). cii & pwc. 2015. “banks taking a quantum leap through digital”. a report by cii & pwc, april 2015: pp. 1-20. collins, daryl, morduch, jonathan, rutherford, stuart, & ruthven, orlanda. 2009. “portfolios of the poor: how the world's poor live on $2 a day”. princeton university press. davidson, neil, and pénicaud, claire. 2012. “state of the industry: results from the 2011 global mobile money adoption survey”. gsma, london. desai seema. 2012. “mobile money for the unbanked”. gsm (annual report 2012) accessed from http://www.gsma.com/mobilefordevepment/wpcontent/upload s/2012/10/ 2012. donovan, kevin. 2012. “private sector development: what’s next for mobile money?” http://blogs.worldbank.org/psd/what-s-next-for-mobile-money-0. 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joseph kasumba. 2007. “ict access and poverty in uganda”. international journal of computing and ict research, 1(2): pp. 10-19. the economist. 2012. “mobile money in africa press 1 for modernity: one business where the poorest continent is miles ahead”. http://www.economist.com/node/21553510. retrieved on april 20, 2016). 30 economic analysis (2017, vol. 50, no. 3-4, 20-31) annex 1 source: pwc | iamai | pci (2015) annex 2 reena agrawal 31 annex 3 annex 4 annex 5 annex 6 article history: received: january 12, 2017 accepted: november 1, 2017 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp48‐55 original scientific paper assessing organisational maturity in predictive analytics of telecommunications companies in the republic of macedonia kalina trenevska blagoeva1 | marina mijoska1* 1 ss.cyril and methodius university, faculty of economics ‐ skopje, department for e‐business, republic of macedonia abstract data analytics and predictive analytics are among major trends companies are facing worldwide. in a highly digitalised environment, it is not only to question the usage of data analytics but how analytically mature organisations are. the goal of this paper is to assess organisational maturity in predictive analytics of telecommunications companies in the country. in order to assess the level of organisational maturity in predictive analytics, we use predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competence, deployment and governance). for each dimension, four maturity levels are defined: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony (capgemini, 2012). survey results confirmed that analysed companies fully understand the benefits of predictive analytics as a valuable source of gaining competitive advantage from data. the overall level of predictive analytics maturity is set between levels 2 or 3 for almost all dimensions. this research is the first attempt to analyse organisational maturity in predictive analytics in the country. its originality derives from the specific characteristics and development of the telecommunications sector. this sector is one of the most advanced service sectors in the country and hence represents a benchmark concerning digital transformation. results of this survey provide useful information needed to design a roadmap for migrating towards higher maturity levels key words: organisational maturity, predictive analytics, predictive analytics maturity framework, telecommunications sector, republic of macedonia jel classification: m19, l96 introduction companies in all industries worldwide are using and benefiting from data analytics. data analytics, especially big data analytics, advanced analytics, and predictive analytics, are among the major trends for 2017 companies worldwide are facing (gartner, 2017). but, in spite of how powerful data analytics is, almost every organisation of every size is currently struggling with the challenges associated with building a proper analytics team and becoming a data‐driven * corresponding author, e‐mail: mijoskam@yahoo.com kalina trenevska blagoeva, marina mijoska 49 organisation. in the literature, there are a variety of explanations about what a data‐driven company is and how an organisation can become one. an organisation where every individual can use data to improve decision‐making and has ubiquitous access to the needed data can be considered as a data‐driven company. there is no doubt that more companies will attempt to drive value and revenue from their data (forester, 2017). “predictive analytics is a branch of the advanced analytics which is used to make predictions about unknown future events and uses many techniques from data mining, statistics, modelling, machine learning, and artificial intelligence to analyse current data to make predictions about future” (www.predictiveanalyticstoday.com). predictive analytics provide analysing large amounts of data with different variables; it includes clustering, decision trees, market basket analysis, regression modelling, neural nets, genetic algorithms, text mining, hypothesis testing, and decision analytics (mishra and silakari, 2012). the goal is to go beyond knowing what has happened to providing a best assessment of what will happen in the future (https://www.forbes.com). data and analytics are also changing the nature of industry competition. the most significant changes are reported in high tech, media and telecom, and consumer and retail (mckinsey, 2016). the ability to derive new insights from data using analytics techniques can enhance the decision‐making process in companies. in today’s analytics economy, in which data science is increasingly adopted by companies across all industries, it is not only to question the usage of data analytics but how analytically mature organisations are since the higher levels of analytical maturity provides better perspectives. in this sense, analytical maturity refers to organisations being able to get their business to its optimal potential by using predictive analytics. using the maturity model can provide an understanding of the current state and help management form a strategy of what level of capability is desired in order to support the achievement of organisations objectives. the telecommunications sector has seen momentous growth over the past decades and continues to be a critical force for growth, innovation, and disruption across multiple industries/countries. as a whole, the telecommunications industry generates upwards of 1 trillion euro in service revenues each year (https://www.statista.com/). the 54 telecommunications companies on the 2018 forbes global 2000 list claim more than $3.4 trillion in assets and totalled nearly $1.5 trillion in revenue last year (www.forbs.com). while in the past revenue was essentially sourced from a traditional landline and wireless services, today the range of products and services available in this industry is persistently increasing, offering further opportunities for revenue creation. the telecommunications industry is competing on analytics and embracing the new science of winning by investing in data science capabilities within the enterprise. these companies use predictive analytics for analytical customer relationship management (acrm), fraud reduction, bad debt reduction, price optimisation, call center optimization, etc. in the study published by ernst & young “global telecommunications study: navigating the road to 2020“, participants scored “improving big data and analytics capabilities” as very important in order to boost their organisational agility, with nearly 40% of respondents selecting it as a priority. consumer behavior has changed significantly in the last five years. consumers are shifting to applications like whatsapp, facebook messenger, snapchat, and instagram rather than calling and texting. according to stephan gatien, general manager of telecommunications business, sap, the core services of telcos – text, voice, and data – are actually evaporating and the revenue associated with these services is evaporating as well. the big challenge in this industry is to determine how to offset the degradation of this revenue coming from text, voice, and data to a certain extent, by buying new services that will be relevant to subscribers. in the article. “turning data into insights: how digitization creates new opportunities for the telecommunications industry, julie stoughton, the head of telecommunications marketing and communications at sap, stated that telecommunications 50 economic analysis (2019, vol. 52, no. 1, 48‐55) companies are trying to reinvent themselves and stay relevant in the digital era. this has led to two major trends. first, companies are focused inward on their customer experience. they need to retain their most valuable customers and secondly, telcos are looking outward. they’re considering how they can monetize the enormous volume of iot data currently in their possession. there is no doubt that data analytics is not going to be neglected as a valuable tool for achieving that reinvention, not only for telecommunications companies but other service companies as well (stoughton, 2018) the telecommunications industry is area specific industry regarding predictive analytics use. this counts for the telecommunications sector in the republic of macedonia as well. this sector is one of the most advanced service sectors in the country and hence represent a benchmark concerning digital transformation. in line with global trends, the telecommunications market in the country is developing rapidly, particularly in the mobile segment. telecommunications in the republic of macedonia include radio, television, fixed and mobile telephones, and the internet. according to the latest report of agency of electronic communications of the republic of macedonia ‐aec, the telecommunications market in the country is fully dominated by two companies (makedonski telekom and one. vip) in all segments of the market (mobile, internet, fixed lines). according to the data of the same report, in 2017, the mobile operators' share in the mobile telephony market per number of active subscribers shows that makedonski telekom’s share was 47.97%, while one. vip operator’s share was 49.57%. the market share of mobile operators in the republic of macedonia by revenue generated from the provision of mobile communication services on the retail market is as follows: makedonski telekom has the largest market share at 52.56%, while one. vip operator has a market share of 47.21%, with a third operator having an insignificant share of 0.23%. the market shares were calculated for the total revenue, which represents the sum of revenues arising from call initiation service, monthly subscription, data transfer, terminal equipment, sms, mms, roaming (traffic, sms and data), and other revenues. the operators’ share in the total number of active subscribers to broadband and narrowband internet access via mobile network (2g/3g/4g) states that one.vip operator has a market share of 52.18%, makedonski telekom has a market share of 46.51%, while the third operator has an insignificant market share of 1.31% (www.aek.mk). methodology and results according to the latest data and analytics global executive study and research report (2018) prepared by mit sloan management review, organisations can outperform by making use of data from multiple sources. these organisations are considered innovative and analytically mature. data analytics in companies matures differently with regards to different aspects/dimensions and different parts of an organisation (departments). in practice, the maturity path of an analytical organisation is not linear in all dimensions and departments. it has a more complex trajectory which is not synchronised nor by dimension or sector/department. according to lismont (2017) “it is not unfamiliar that analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy”. (lismont, 2017). but, what analytically mature organisation means and how one organisation can become innovative and analytically mature. different authors and consulting groups propose different analytics maturity models/frameworks in order to reach a predefined analytical maturity level. in the literature, one of the latest research representing a summary of the existing analytics maturity models is one of chen and nath (2018). according to their research, numerous maturity models have emerged recently, following the proliferation of the predictive analytics tools development. chen and nath (2018) suggest that business analytics maturity models can kalina trenevska blagoeva, marina mijoska 51 be categorized by the following determinants: technology, organization, capability, and impact ‐ focused. one of the latest is the analytic processes maturity model (apmm) for evaluating the analytic maturity of an organisation (grossman, 2018). the apmm identifies analytic‐related processes in six key process areas, defined as: 1) building analytic models; 2) deploying analytic models; 3) managing and operating analytic infrastructure; 4) protecting analytic assets through appropriate policies and procedures; 5) operating an analytic governance structure; and 6) identifying analytic opportunities, making decisions, and allocating resources based upon an analytic strategy. based upon the maturity of these processes, the apmm framework of grossman (2018), organizations can differ i.e. reach five maturity levels defined as: level 1 ‐ organizations that can build reports level 2 ‐organizations that can build and deploy models; level 3 ‐ organizations that have repeatable processes for building and deploying analytics; level 4 ‐organizations that have consistent enterprise‐wide processes for analytics; and level 5 ‐ enterprises whose analytics is strategy driven. this model is based upon the capability maturity model ‐ cmm that is the basis for measuring the maturity of processes for developing software created by software engineering institute, carnegie mellon university. another approach which provides estimation of analytics maturity i.e. analytical maturity levels differs organizations in three major categories based on their relative level of sophistication in adopting analytics i.e. 1) the analytically challenged organizations display limited analytical capabilities; 2) analytical practitioners largely use analytics to track and support performance indicators; and 3) analytical innovators incorporate analytics into virtually every aspect of their strategic decision‐making, including gleaning data from a variety of sources such as direct measurement and sensors, industry data, and third parties (ransbotham and kiron, 2018, p.7). according to the defined methodology, in order to determine the relative analytics proficiency of an organization, it is suggested to calculate the analytics core index, based on the organization’s core analytics capabilities in three major areas like: (1) ingesting data (capturing, aggregating, and integrating data); (2) analyzing data (descriptive analytics, predictive analytics, and prescriptive analytics); and (3) applying insights (disseminating data insights and incorporating insights into automated processes). in detail. the analytics core index is calculated by assessing how effectively the organisation performs these seven analytics‐related tasks and activities defined like 1. capturing data, 2. aggregating/integrating data, 3. using descriptive analytics, 4. using predictive analytics, 5. using prescriptive analytics, 6. disseminating data insights and 7. incorporating analytics insights into automated processes (ransbotham and kiron, 2018, p.9). the measurement process is based on a five‐point scale ranging from very ineffective to very effective. the analytics core index score represents the sum of the responses to the seven questions, scaled to a range from 0 to 100. higher levels of analytical maturity are associated with higher levels of customer engagement, which in turn is associated with higher scores on the analytics core index, which in turn is associated with greater use of diverse data sources. this means that organizations that make effective use of a wide range of data sources — from different types of technologies and different types of entities, such as customers, vendors, competitors, and publicly available sources — are more likely to use analytics to generate higher levels of customer engagement and gain a competitive advantage than organisations that use fewer sources of data. (ransbotham and kiron, 2018, p.9). according to lismont et al., (2016), the application of analytics in organisations generally differs with regards to five different aspects like: data, enterprise or organisation, leadership, targets or techniques and applications, and the analysts who apply the techniques themselves. in their research, they found that the analytics organisation in companies matures with regards to these aspects. moreover, analytics is differently propagated throughout companies as they mature with a larger focus on department‐wide or organisation‐wide analytics and a more advanced data governance policy (lismont et al., 2016). 52 economic analysis (2019, vol. 52, no. 1, 48‐55) in our survey in order to assess the level of organisational maturity in predictive analytics, we use the predictive analytics maturity framework assessment (pamfa) (capgemini, 2012), since it best describes maturity levels in the telecommunications sector. the method of analysis is based on interviewing managers with a questionnaire that guides respondents through all dimensions and levels proposed by the framework. in different business units within the same organisation, there are different maturity levels. for that reason, managers from different organisational sectors were approached and interviewed. according to the pamfa five dimensions are analysed (vision and strategy, enablers, competency, deployment and governance). for each dimension, managers were asked to choose the appropriate level of usage out of four available maturity levels: level 1: impromptu, level 2: solo, level 3: ensemble and level 4: symphony. this framework can serve as a roadmap for moving the organisation towards achieving its predictive analytics goals. the suggested framework which defines analytics adoption level of an organisation and its environment is illustrated in figure 1. figure 1. the pamfa – dimensions and maturity levels source: capgemini. 2012. “measuring organisational maturity in predictive analytics: the first step to enabling the vision”, p.8. according to the defined methodology, the five different aspects/dimensions of predictive analytics maturity are assessed. the first dimension is vision and strategy. it is rare today for an organisation to develop software and information systems, without striving to use the data in best way. in this sense, having an analytics vision and strategy is very important, as the long term decisions an organisation makes about how it uses its data is needed. by defining maturity level of this dimension, the companies can write a broad “analytical map” in which the current level of the organisation will be stated, accompanied with the vision of the future wanted level. the roadmap can help in harmonising predictive analytics incentives with the organisation’s high‐level strategic goals. it demonstrates where legitimisation, or execution of extra activities, is required. pamfa looks at the current predictive analytics strategy, distinguishing any gaps and key enablers required for execution. having a vigorous methodology set up makes it conceivable to prioritise analytics initiatives based on enterprise level business imperatives, not departmental ones. the second measurement is called – enablers, and it alludes to discovering how prepared the company’s environment is to adopt or pursue predictive analytics. pamfa examines the data condition, legacy solutions, analytics process, and technology and support arrangements. it likewise survey the association's comprehension of predictive analytics and its impression of the advantages. among the empowering enablers considered in the framework are an information framework that suits predictive analytics needs and a justified portfolio of applications. kalina trenevska blagoeva, marina mijoska 53 the third dimension is competence. this implies that organisations ought to have a full understanding of all current predictive analytics projects, and of parts where analytics could be used further on. next is deployment. this measurement estimates the organisations capacity to convey predictive analytics and coordinate it into business processes which is a basic part of predictive analytics maturity. the central matter predictive analytics is to power is the decision making capability of the organisation. the last, fifth dimension in the pamfa is governance. governance is a regularly disregarded yet fundamental part of predictive analytics. therefore, it is essential to look at the organisation’s modelling lifecycle management and its administration of model precision and pertinence. for every one of these measurements, four maturity levels are characterized. level 1 is called impromptu. at this level, sporadic and secluded analytic capability results from impromptu undertakings done by a solitary administrator or speciality unit. the second dimension is named solo. level 2 is separated into two sub‐levels: amateur solo, implying that predictive analytics abilities and procedures exist for the most part at an individual dimension, and are not natural to the organisation, and professional solo which is a brilliance inside a silo. predictive analytics processes, capacities and environment meet up to address business issues adequately, yet just for individual tasks. level 3 is named ensemble. on this level, one can perceive predictive analytics activities crosswise over business functionalities, with certain procedures being made together. the last, most developed level is symphony level, where well‐organised, company’s wide activities apply analytics for achieving business advantage. this framework can fill in as a guide for moving the organisation towards accomplishing its predictive analytics objectives. pamfa is structured not exclusively to distinguish the present dimension of predictive analytics development, yet additionally to find the company's ideal analytics maturity level (iaml). the iaml is the dimension that would empower the firm both to capitalise on existing assets and furthermore to put ideally in extra assets, so as to accomplish key objectives and infer greatest business benefits. the results of the survey confirm that analysed companies fall somewhere around level 2 or 3 for almost all dimensions. more precise, results for each dimension are shown in the table below. table 1: survey results vision and strategy enablers competency deployment governance a b a b a b a b a b level 1 impromptu level 2 solo * * * * * level 3 ensemble * * * * * level 4 symphony regarding the first dimension, vision and strategy, analysed companies are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not formulated enterprise vision and strategy for using predictive analytics as a valuable asset for the company as a whole. although some employees in separate departments have an analytics vision, yet there is no single formulated analytics strategy, even for that department. the achieved level is relatively high and can be a boost for achieving higher level on other dimensions. the maturity of the analysed companies for the second dimension – enablers is on level 2 (solo). this implies that separate business departments may work together with innovation or business intelligence units, yet there is almost no data exchange. while discussing this 54 economic analysis (2019, vol. 52, no. 1, 48‐55) dimension with the managers‐respondents, it was obvious that they are not satisfied with the alignment of the processes. the third dimension is called competency. analysed companies in our research are on level 2 of maturity. this implies that some business units, individual competency may exist, but it is not used widely on a regular basis. the reported level is in correlation with the reported level of the dimension enablers, and the silo thinking is still an obstacle in this companies for performing predictive analytics and monetizing its results. for the fourth dimension ‐ deployment, the answers from the interview are more dispersed. this means that company a is on the second level of maturity and company b on the third. level 2 (solo) means that in company a integration with the business information systems is manual. for company b which is on level 3 (ensemble), this score shows that the analytics is integrated with decision‐making systems. for both companies, the predictive analytics model output is not yet integrated with business intelligence systems, decision‐making systems and business information systems. the last dimension (governance) for both companies shows level 3 of maturity. this level, ensemble, means that business unit level governance in both companies exist but, there is still a limited enterprise‐level governance. according to the results, the overall level of predictive analytics maturity is set between levels 2 and 3 for analysed companies. although both companies are doing well on maturity journey, there is an evident difference in the maturity of the fourth dimension – deployment. the pamfa can serve as a plan for guiding the organisation to achieving its predictive analytics objectives. this framework is designed not only to identify the current level of analytical maturity but also to discover the organisation’s ideal analytics maturity level (iaml) (capgemini, 2012). the limitation of the research methodology is the subjectivity that is expected in assigning the levels by the managers‐respondents. overestimating the levels of maturity is possible. however, this bias is present in every methodology of this type. with respect to initially measurement, vision and methodology, broke down organizations are on level 3 (ensemble). this score implies that they know about the capability of pa, yet they have not characterised and verbalised a venture vision and technique for utilizing it on a big business level. increasingly exact, an investigation people in some speciality units have an examination vision, yet there is no enunciated examination methodology, notwithstanding for a solitary speciality unit yet. vision is explained by individual speciality units, alongside the it, who need to help the vision. the accomplished dimension is moderately high and can be a lift for accomplishing a more elevated amount on different measurements. conclusion organisations nowadays are focused on predictive analytics as a valuable tool to use data for achieving competitive advantage. the telecommunications sector in the country is one of the most advanced service sectors and hence represent a benchmark concerning the digital transformation. the results of our survey confirmed that telecommunications companies in the country understand the benefits of predictive analytics as a valuable source to gain a competitive advantage from data. the interview results confirm that organisations fall somewhere around level 2 or 3 for almost all dimensions. this survey results provide useful information needed to design a plan for migrating towards the higher levels of maturity. the road to achieve higher levels across all dimensions is hard, and it will take full management commitment in order to maintain competitive. this research is the first attempt to analyse organisational maturity in using predictive analytics in the country. its originality derives from the specific characteristics and development of telecommunications sector in the country and its importance. knowing where an organization is on this journey will help managers/strategists to kalina trenevska blagoeva, marina mijoska 55 adopt ideal analytics maturity level, i.e. the highest level that would enable organisations to derive maximum business benefits and achieve its strategic objectives. further research can include companies from other industries in the country (finance, health) since the pamfa can be used to measure and describe their predictive analytics efforts. references agency for electronic communications of the republic of macedonia. 2018. “report on the development of the electronic communications market in the republic of macedonia for 2017.“ https://www.aek.mk capgemini. (2012). „measuring organizational maturity in predictive analytics: the first step to enabling the vision.“ https://www.capgemini.com ernst & young. (2015). “global telecommunications study: navigating the road to 2020.“ https://www.ey.com grossman, robert l. (2018). “a framework for evaluating the analytic maturity of an organization.“ international journal of information management, 38: 45–51 chen, l. & nath, r. (2018). "business analytics maturity of firms: an examination of the relationships between managerial perception of it, business analytics maturity and success", information systems management,. 35(1): 62–77 lismont, j., et al. (2017). “defining analytics maturity indicators: a survey approach.“ international journal of information management, 37 (3): 114‐124 mckinsey global institute. (2016). “the age of analytics: competing in a data‐driven world.“ https://www.mckinsey.com mishra, n. & silakari, s. (2012). “predictive analytics: a survey, trends, applications, opportunities & challenges.” international journal of computer science and information technologies, 3 (3): 4434‐ 4438 morabito, v. (2015). “big data and analytics: strategic and organizational impacts.“ springer ransbotham, s. & kiro, d. (2018). “using analytics to improve customer engagement, findings from the 2018 data & analytics global executive study and research report.” mit sloan management review, https://www.sloanrieview.mit.edu stoughton, j. (2018). “turning data into insights: how digitization creates new opportunities for the telecommunications industry.” https://www.digitalistmag.com trenevska blagoeva, k., josimovski, s., mijoska, m. & jovevski, d. (2018). “determinants of analytics usage to improve customer engagement in chosen macedonian companies.“ knowledge ‐ international journal, 22(1): 187‐192. valdez‐de‐leon, o. (2016). “a digital maturity model for telecommunications service providers“, technology innovation management review, 6 (8): 19‐32 https://www.digitalistmag.com. https://www.forbs.com https://www.gartner.com https://www.infoworld.com https://www.predictiveanalyticstoday.com https://www.statista.com article history: received: may 16, 2019 accepted: june 21, 2019 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp47-59 original scientific paper competitive relations in the aftersales market of major home appliances in serbia ivana domazet1* | ivan stošić1 | milena lazić2 1 institute of economic sciences, belgrade, serbia 2 belgrade banking academy, belgrade, serbia abstract the primary goal of this paper is to deepen the knowledge and provide analysis of the basic features of the major appliances aftersales market in the republic of serbia. this is relatively large, and for a huge number of consumers significant market, which, according to the available knowledge, was not the subject to more detailed research until now. therefore, through a combination of survey (desk) and secondary (field) research, a detailed overview of the scope and structure of the major appliances aftermarket was carried out. with the aim to identify potential issues and propose curative to overcome them, an analysis on the competitive relations between the main actors and the factors that predominantly affect the market relations in this segment of the aftersales market was conducted. bearing in mind the basic characteristics of the primary market in serbia, it can be concluded that interbrand competition on the major appliances aftermarket is intense, and that significant issues are noticed. a potential problem related to competitive relations in this market segment is reflected in the constraints of intrabrand competition (competition between distributors / servicers / spare parts resellers of the same brand). the manufacturer is in a position to impose restrictions on distributors in respect of the terms of their contracts with authorized services and spare parts dealers, obliging them to install / sell spare parts exclusively from its production. restrictions of this kind are justified only if they provide higher quality of the after-sales service. otherwise they represent a serious distortion of competitive market behavior, as this limits the entry of independent spare parts manufacturers and servicers, who can offer spare parts and technical and repairing services of the appropriate quality. key words: aftermarket, major home appliances, household appliances, competition, serbia jel classification: l10, l68 introduction aftermarkets or secondary markets can be defined as markets for complementary products (secondary products) which are usually purchased subsequent to the purchase of another, related product (primary product) (carlton, 2010, coppi, 2007). in other words, the term aftermarkets refers to markets for complementary goods and services such as maintenance, upgrades, and replacement parts used in conjunction with durable goods (carlton & waldman, 2006, p. 1). according to some authors (cohen, agrawal & agrawal, 2006) in industries such as automobiles, white goods, industrial machinery, and information technology, companies have sold so many units over the years that their aftermarkets have become four to five times larger than the original equipment businesses. * senior research associate, institute of economic sciences, belgrade, serbia, e-mail: ivana.domazet@ien.bg.ac.rs 48 economic analysis (2018, vol. 51, no. 1-2, 47-59) the aftermarket business, as a result of changed customers demand, increased competition and diminishing profit margins, has gained strategic importance for numerous industries over the past few decades. the reasons for this lay in the fact that aftermarket services stabilize company’s long-term revenues, enhance customer satisfaction and offer an essential strategic weapon in a competitive environment. therefore and due to increasing number of companies, aftermarkets are acknowledged as a rich source of revenue, profit and customer loyalty (domazet & stošić, 2017). the aftermarket business has certain characteristics: • the basic parameters in the aftersales (secondary) market are largely determined by changes in the volume and structure of sales revenues in the relevant primary market • the intensity of competitive relationships, as well as the sales margin on the aftermarket are largely determined by the position of the suppliers (sellers) in the primary market. • a large number of suppliers (sellers) opt to operate in both the primary and secondary markets of a particular product category, thus creating significant barriers to the entry of new competitors. when it comes to the situation in serbia, the major appliances aftermarket is also a significant subsystem of the entire market, as indicated by the following data: • according to the data of the republic institute for statistics, 98.3% of households in serbia (2,487,886) have a refrigerator, and 93.6% of households have a washing machine. in quantitative terms, this would mean that around 2.445 million refrigerators and 2.328 million washing machines is in use in serbia. table 1. comparative overview of the number of households in the period 1991-2011*, by region 1991 2002 2011 republic of serbia 2,418,156 2,521,190 2,487,886 serbia north 1,200,296 1,277,282 1,302,590 belgrade region 515,040 567,325 606,433 region of vojvodina 685,256 709,957 696,157 serbia south 1,217,860 1,243,908 1,185,296 region of šumadija and western serbia 657,792 678,934 662,769 region of south and east serbia 560,068 564,974 522,527 source: the institute for statistics of the republic of serbia; * censuses 1991-2011 do not contain data on households in autonomous province of kosovo and metohija. • according to the ministry of finance, the customs administration and the republic institute for statistics, it was estimated that 151,812 new refrigerators and 171,472 new washing machines were sold in serbia in 2017. table 2. insight on the use of refrigerators in serbia in 2017 total number of refrigerators number of refrigerators purchased in 2017 % of new refrigerators in the total number 2,527,590 151,812 6.01% source: ministry of finance, customs administration, the institute for statistics of the republic of serbia ivana domazet, ivan stošić, milena lazić 49 table 3. insight on the use of washing machines in serbia in 2017 total number of washing machines number of washing machines purchased in 2017 % of new washing machines in the total number 2,350,664 171,472 7.30% source: ministry of finance, customs administration, the institute for statistics of the republic of serbia regardless of the size and significance, the major appliances aftermarket in serbia was not the subject to more detailed analyzes and studies, which suggests that knowledge about the market in question is still very limited. from this point of view, the subject of this paper is the examination of the basic dimensions, structure, characteristics and current issues in the major appliances aftermarket in serbia. the main goal of the research is identification of specific market structure, the behavior of market players, and the types of relations between them as well as the analysis of the factors affecting the after sales service and customer satisfaction. the paper consists of four main chapters. after introductory considerations, the second chapter of the paper presents a review of the literature and the design of the research. the third chapter of the paper presents the results of the conducted research arranged into three parts basic characteristics of the major appliances aftermarket in serbia, different perspectives of chosen key stakeholders and basic characteristics of competitive relations in the major appliances aftermarket in serbia. the fourth chapter summarizes the results of the research and provides recommendations for further research work in the area. literature review and research design it is widely accepted that the after sales services may be defined as the various processes with the main purpose to make sure customers are satisfied with the products and services of the organization. in other words, after sales services are important part of total customer satisfaction. the companies may ensure product functionality and customer satisfaction by offering different aftermarket services. in fact, aftermarket services can create sustainable relationships with customers and contribute significantly to their satisfaction (kurata & nam, 2010), (ahn & sohn, 2009). according to certain authors (slater, 1996), (wilson, 1999) aftersales services represent a significant source of competitive advantage for the companies that operate in the same market. in support of the above, the authors seth, deshmukh and vrat (seth, deshmukh & vrat, 2005) in their study point out that the after-sales activities are recognized as a primary source of revenue, profit and competitive advantage for many industries. the focus of prior research has been also the critical factor of a firm’s success (hakansson & snehota, 2006) particularly on spare parts supply, optimal warranty periods, components which should be included or excluded from a warranty, approaches to better utilize the benefits of the spare parts business, analysis of supply strategies, optimal final order quantities, etc. numerous publications in the field of spare parts logistics and management focused their scope to one or a few of the constituent components of a spare parts logistics strategy (aronis, magou, dekker & tagarsa, 2004), (kumar, 2005). last, but not least, numerous researchers have concentrated on legal aspects of aftermarkets and their impact on competition restraint. in his paper bauer (bauer, 2007) defined the aftermarket restraints as the techniques by which a firm selling a product which is frequently referred to as the "primary product" is able to require its customers to purchase some other product or service—oftentimes referred to as the "secondary product"—from that firm. the 1992 “kodak decision” by the us supreme court raised several questions about aftermarkets, and especially about the circumstances under which behavior by oems can have anticompetitive effects (goldfine & vorrasi, 2004), (hovenkamp, 1993). in the report of the organization for economic co-operation and development (capobianco, ogawa & abate, 2017) it is stated that 50 economic analysis (2018, vol. 51, no. 1-2, 47-59) from a competition perspective, the manufacturer of the primary good is often a major supplier in the aftermarket and may enjoy market power in the secondary market, which raises questions as to whether antitrust intervention is warranted to protect consumer welfare on the primary and secondary markets. the report prepared for the needs of the european committee of domestic equipment manufacturers (the economic impact of the domestic appliances industry in europe: report for the european committee of domestic equipment manufacturers (ceced), 2015) presents the basic parameters of business operations in the major appliances sector of the eu member states. according to the report, in the period from 2008 to 2012, there was a decline in sales revenues from 52 billion euros to 44 billion euros, followed by a slight increase in 2013, when sales revenues amounted to 48 billion euros. in addition, it is estimated that the number of employees in this sector decreased by about 20,000 in the period 2009-2011. when it comes to regulation of business operations in this sector, there is a need to increase energy efficiency as soon as possible. according to the author, despite the negative indicators of business in the post-world economic crisis period, the major appliances sector remains an important segment of the eu economy however, there is a huge gap between the high importance of the aftermarket business for an increasing number of companies, and the scientific literature dealing with the aftermarkets and the strategic positioning of its players. the situation is similar when it comes to research in this area in serbia. nevertheless, in recent years, several studies have been conducted on this topic. the results of their research indicated that the proximity of technical and repair services for major appliances is, beside the price, one of the most important criteria for their choice (domazet & simeunović, 2015). in addition to the above mentioned, the study aftermarkets (comission for protection of competition, 2016) provides an analysis of the key dimensions and issues of the major appliances products and services aftermarket, primarily from the aspect of regulatory conventions in the competition protection segment. taking into account the object and purpose of the research, the research method used in this paper included the combination of desk, field and expert model. conducted desk research involved the collection and analysis of aggregate data relevant to the major appliances products and services aftermarket. the main sources of aggregate data and information used for this analysis are: data of the business registers agency on the number of participants in the market based on the registered main activity; data from the ministry of finance customs administration on import and export of relevant types of products (bestselling major appliances, spare parts); data from the ministry of trade of the republic of serbia on the sale of household appliances and consumer complaints; data from the republic institute for statistics on production of goods, import and export of white goods; data of serbian chamber of commerce, trade association, commission for protection of competition and publicly available data on the internet. field research was carried out using the survey method through semi-structured questionnaires (with additional personal interviews in situations where it was possible) in the period from february 1 to may 31, 2018. a sample of 84 respondents consisted of relevant market participants belonging to different segments of major appliances aftermarket in serbia. the basic criteria used to select the respondents for the sample were, first of all, the income, the number of employees, the significant representation in the import, wholesale and retail of spare parts of major appliances. in addition to the companies, business entities registered as entrepreneurial agencies engaged in servicing, and which are estimated to represent significant market participants, were included in the sample. after completion of all interviews, the analysis was conducted followed by a cross-case analysis. the results of the conducted research were presented in the next chapter of the paper. ivana domazet, ivan stošić, milena lazić 51 basic characteristic of the major home appliances aftermarket in serbia the characteristics of the key factors determining the size and structure of the major appliances aftersales market in the republic of serbia are the following: • there is around 30 brands present in the major appliances market in the republic of serbia, and interbrand competition in the market of major appliances (washing machines and refrigerators) is high. according to the conducted research, the leader in the sale of refrigerators and washing machines is the brand gorenje, with over 30% of the market share, which has 37 authorized services. the brand beko is following with approximately 13% of the market share and a network of 52 authorized services. the brand vox holds around 10% market share. candy and whirlpool brands have a market share of around 7-9%, while the other 26 brands together have a 35-40% stake in selling new refrigerators and washing machines. table 4. estimated market share of major appliances leading brands in the sale of refrigerators and washing machines in 2017. (sales volume) brand name market share in % gorenje over 30% beko 10-13% vox 8-10% candy 7-9% others 35-45% source: field research results, author's survey, publicly available websites of general representatives and major appliances central services • the herfindahl-hirschman index, the most important market concentration index used in competition law, calculated on the basis of physical sales volume of major appliances individual brands is 1.3641, which indicates that it is a market with moderate concentration. in the past period, in the washing machines and refrigerators market, only the brand gorenje had a market share of more than 30% (table 4.). • the main trend in the white goods market in the past five to seven years showed a decline in demand, which is a consequence of the downtrend in the real financial power of the population. at that, orientation towards cheaper brands is evident. the only way for traders with technical goods to survive on the market at a time of unfavorable economic situation, are numerous special offers and discounts, deferred payments, the possibility of obtaining interest-free loans at the point of sale and other purchase incentives. • the downward trend in business activity, impacts the major appliances aftersales services market, that is, the decrease in the number of employees and the realized business income of companies registered for performing activities under the code 9522 repair of household appliances and home and garden equipment in the territory of the republic of serbia. according to the business registers agency data, the total operating income of companies registered under the code 9522 in the period 2012-2014 decreased from 15.82 to 7.26 million euros, while the number of employees from 343 in 2012 decreased to 299 in 2017 • given that the average lifetime of the refrigerator and washing machine is estimated at 10-12 years, and that the defect rate in the warranty period is 1.5-2% (and after the 1 calculated based on the average of the estimated market share of brands 52 economic analysis (2018, vol. 51, no. 1-2, 47-59) warranty period increases incrementally every two years by about 2%), the major appliances aftermarket (washing machines and refrigerators) is estimated at around 1315 million euros, of which 4-5%, or 0.5-1 million euros appertains to the aftersales services market in the guarantee period. table 5. an assessment of the major appliances aftersales services market in 2017 market type in millions of euros new washing machines and refrigerators market 70-75 major appliances aftermarket total 13-15 major appliances aftermarket in the warranty period 0,5-1 source: author’s estimate based on the research by conducting field research, which included interviews with experts in the field of servicing and the length of the warranty period of major appliances, we conclude that the average number of defects on new refrigerators and washing machines at the annual level is around 1.5-2%. compared to the number of new refrigerators and washing machines sold, on the annual level, the average percentage of refrigerator defects is 1.77%, while washing machines partake 1.95%. the percentage of defects in relation to the quantity of washing machines and refrigerators sold in 2017 is 1.5-2% depending on the manufacturer, which is a relatively small percentage, but determines the aftersales services market in the warranty period. since the spare parts for the repair of washing machines and refrigerators during the warranty period are not charged, and the authorized servicers of the leading brand (gorenje) do not charge the service (replacing the part within the warranty period) either, major appliances aftermarket in the republic of serbia is estimated at 0.5-0.75 million euros. the total post-sales service market in the warranty period is estimated at 12-15 million euros. • authorized services of major appliances perform repairs both in and out the warranty period. the terms of the service vary, because the warranty period provides the buyer with a free replacement of the defective part with the original, and for certain brands, authorized services provide a complete repair (replacement of the spare part with the work of the service technician, as well as the potential transport of the product if the major repair is possible only in the service and not at the customer's location) in the warranty period for free. certain number of authorized services that charge a repair service within the warranty period (with all authorized services, spare parts are free of charge within the warranty period) have an official pricelist of small and large repair services and it is precisely defined in which category each service work belongs. table 6. number of authorized and independent major appliances services authorized major appliances services independent major appliances services total 540 810-1,000 1,350-1,500 source: author’s estimate based on the business registers agency data and publicly available data of the major appliances central authorized services different perspectives of chosen key stakeholders an analysis of the economic aspects of establishing a network of authorized services from the perspective of the manufacturer / importer or the angle of the consumer of major appliances can be summarized as follows: ivana domazet, ivan stošić, milena lazić 53 manufacturer / importer or representative perspective: • according to business registers agency data, as well as publicly available data from general distributors, authorized and independent services on the major appliances market, the relevant entities in the major appliances aftermarket are: 24 general agents / distributors of household appliances, 540 authorized services, and an estimated number from about 810-1,000 independent white ware repairers. in addition, the relevant entities in the aftersales services market are also spare parts dealers for white goods. in addition to the major appliances leading brands central authorized services (gorenje studio d.o.o, lth servis d.o.o, erg d.o.o, beotronik d.o.o. etc.), the most important traders dealing with spare parts sales in the major appliances market are: loren d.o.o, dekom d.o.o, eurofrigo d.o.o, elpok d.o.o, tecnoricambi d.o.o, aswo d.o.o. • manufacturers and importers (representatives and agents) of major appliances were faced with a sharp decline in white goods sales of around 35-40%, especially after the economic crisis in the period 2009-2010. in that period, some of the leading major appliances distributors (retailers such as tehnomarket, techno max, eltim) stopped working. this was followed by a large rearrangement of forces in the major appliances market, and today, by market share, leading market entities in the white ware trade are: roaming electronics d.o.o. (retail shops known as „tehnomanija“), moskomerc beograd (retail shops known as „svt“) and gorenje studio d.o.o. • aftersales services represent a legal obligation, so general representatives and distributors invest significant efforts to organize their own network of authorized services and spare parts dealers. • the dimensioning and territorial structuring of the network of the official major appliances services (usually dealers of original spare parts) is usually carried out by importers (general agents or distributors) in cooperation with manufacturers based on the territorial dispersion of defect reports through unified contact centers. • the duration of the warranty period and the geographical coverage of the service network, besides the price of the new product, represent the most important marketing mix instruments and dominantly temper the customers for the purchase of a particular major appliance brand. these factors also direct the creation of sales strategies for importers and dealers in terms of giving longer warranty periods (leading brands of household appliances gorenje, beko, vox, candy give five year warranties on refrigerators and washing machines) and the expansion of service networks of their brands. authorized service / official dealer perspective: • the status of an authorized service ensures greater security in the performance of activities and the purchase of spare parts under more favorable conditions (rebates and bonuses); • in order to provide the status of an authorized service / official spare parts dealer, a series of pre-conditions must be fulfilled: obligation to do business according to the manufacturer's standards (e.g. obligation in terms of size and arrangement of business premises, disposal of appropriate equipment, tools and diagnostic devices, obligation to hold spare parts stock, obligation to install "original spare parts"). these obligations result in a better service for consumers, but also, according to conducted surveys, higher prices of aftersales services. • in the major appliances aftermarket, there is moderate competition within the warranty period and very intensive price competition outside the warranty period between authorized and independent services. high price competition is a characteristic of the spare parts trade, especially in the segment of "non-original" replacement parts. 54 economic analysis (2018, vol. 51, no. 1-2, 47-59) • authorized services point out that the biggest problem in the business is the disloyal competition of independent services operating in the "gray" zone and offering cheap and low quality spare parts (which no one controls).2 consumer perspective: • major appliances consumers are interested in getting the best quality service at the lowest possible price. in this regard, apart from the price of a new product, the most important factor when purchasing a particular brand is the length of the warranty period and the proximity of the authorized service. • consumers do not recognize the issue of the major appliances price difference in and out the warranty period, nor complain about the differences in the quality of service of authorized and independent services. there was 755 customer complaints and claims in respect to major appliances in 2015, as registered by the ministry of trade of the republic of serbia. by product group, the highest number of complaints 40.7% was related to washing machines, and 24.6% to refrigerators. most complaints refer to the need for advice regarding a particular defect in the purchased product. • consumers do not notice a structural distortion of competition in this market segment, either within or beyond the warranty period, as the ministry of trade recorded less than 0.4% of complaints concerning customer reclamations related to the difference in the repair price within and outside the warranty period, as well as complaints in respect to different treatment of repairs in or out of the major appliances warranty period. basic characteristics of competitive relations in the major appliances aftermarket in serbia according to the conducted analysis of the aggregate data and the results of the field research, there are around 1500 major appliances services in serbia, of which 497 are authorized, and about 1000 are independent services. the dominant number of authorized white ware services are registered as entrepreneurs, while 88 of them are registered as legal entities for performing activities under the code 9522 repair of household appliances and home and garden equipment in the territory of the republic of serbia. certain number of independent services are registered as entrepreneurs, while the dominant part (about 80%) of major appliances independent services occasionally or temporarily perform this activity "in the black market". the network of the official major appliances services is created by general agent or distributor, and it is usually centralized, with one (main) authorized service. the dispersion of service network mainly depends on the estimated number of defect reports, and the optimal geographical coverage with authorized services. most manufacturers, or general distributors of the leading brands of household appliances in the territory of the republic of serbia, have a centralized network of services, where there is a central service that incorporates a contact center with operaters who handle inbound calls (complaints and defect reports) of product buyers, that are equipped with a module for analizing the number and type of defect, and geographical location of complaints and defect reports. this is the basic input for designing the dimensions and geographical distribution of the authorized services network. central authorized services, besides servicing activity, handle the sale of original spare parts and customer inquiries, and provide technical instructions related to a particular product model. central authorized services for major appliances, receive complaints and defect reports through contact centers and forward customer requests to one of their authorized services, according to the criterion of geographical proximity to the customer. apart from designing the size of a network of authorized services in the territory of the republic of serbia, the analysis of the 2 source: author’s survey ivana domazet, ivan stošić, milena lazić 55 customer call registered in the contact center also enables better coordination and more effective management of spare parts stock. namely, based on the call history data, the necessary spare parts for certain products can be predicted (for example, over 80% of the total call volume in the territory of the republic of serbia regarding the boiler defects, comes from the territory of the municipality of jagodina, due to the specific water structure), which helps servicers from that areas to always have the necessary spare parts available, and perform repairs in a relatively short period of time. there is no interbrand competition between authorized representatives within the warranty period, since they are obligated to use only original parts of their brands for spare parts replacement, when servicing and repairing of major appliances. intrabrand competition between authorized services within the warranty period is moderate, which means that they are prioritized when receiving service requests from the centralized contact center of the general agent, according to the proximity of the geographical location of the customer who reported the defect. the location, or proximity of the authorized service, is the first criterion according to which the call for major appliance repair is distributed from the contact center, while the second criterion is the number, i.e. availability of the authorized service technician at the moment of service request. as for independent white ware services (there is around 1000 of such companies in the territory of the republic of serbia), who perform their activities outside the warranty period, the competition is very intense and the market dictates service conditions and prices. the results of the conducted survey indicate the following: • the key problem encountered by household appliances servicers is unfair competition, or the presence of a large number of unregistered services that operate "in the black market". • 80% of respondents believe that there is moderate competition among major appliances servicers, while the remaining 20% consider the intensity of competition in the market at an extremely high level. • all surveyed service providers believe that the level of service prices on the market is low, while 80% believe that the main reason for this is the low purchasing power of end users, and unfair competition (60%). • in 2015, the revenue of authorized services on average accounted for about 55% of the total turnover in the white goods market in serbia, while it is estimated that the revenues of independent service providers accounted for about 45%. • in the structure of revenues of authorized services realized in 2015, the servicing of products in the warranty period takes about 63%, while the share of sales of white goods products outside the warranty period is slightly lower and on average it amounts for about 37%. • authorized services use only original spare parts during servicing, which greatly affects the level of operating costs and, consequently, on the margin decrease. • there are no barriers to the provision of technical information for the products considered as the major appliances. original spare parts can be obtained from general distributors (gorenje d.o.o, lth servis d.o.o, erg d.o.o, beotronik d.o.o. and others), authorized service or retailers dealing with the sale of spare parts for major appliances (loren d.o.o., dekom d.o.o, elpok d.o.o, tecnoricambi d.o.o. and others). the availability of non-original spare parts is high through numerous retailers that, among other things, are engaged in the trade of spare parts for white goods. • entry barriers related to the provision of technical information related to the purchase of original spare parts were not recorded in the conducted surveys. central authorized services even try to expand a network of retailers that will place genuine spare parts for 56 economic analysis (2018, vol. 51, no. 1-2, 47-59) home appliances because their standpoint is that this will lead to reducing the number of defect reports on major appliances of their brand. central authorized services are obliged to provide customers with appropriate technical and service documentation and spare parts catalogs • small individual services, in particular those who are not registered and who operate in „grey zone“ and „the black market", are not equipped with the appropriate technical equipment for using technical information or the purchase of original spare parts, and rely mainly on their experience and contacts with local stores of major appliances spare parts. • consumer protection act prescribes the right for major appliances customers for a warranty period of minimum 2 years. leading brands of household appliances (gorenje, beko, vox, candy) give five-year warranty on refrigerators and washing machines3. • the warranty includes the obligation of the guarantor or the authorized distributor or authorized retailer to eliminate all defects caused by the manufacturer's error without compensation. services, that is, works and consumables (spare parts) covered by the guarantee are not charged to the buyer. the warranty covers repair of identified defects or, replacement of defected part(s), according to the assessment of the authorized service. the obligation to replace the parts that can be repaired is excluded. the guarantee implies that repairs and parts replacement can only be carried out by authorized service personnel. the warranty is void if repairs are carried out by unauthorized service, regardless of the scope of the repairs performed or if it is outside the service network. the analysis of official price lists of white ware repairs used by authorized services that were submitted to the authors during the field survey, shows that the price of an authorized service technician's work hours is on average about 30% higher compared to the price of the work hours of independent servicers. servicers in the warranty period justify differences of labor prices in the need for significantly higher investments in standards required by manufacturers (facilities, tools, training, information systems), as well as the fact that many servicers who service the product after the expiration of the warranty period operate in "gray" or "black" zones (i.e., only partially or completely fail to record parts and employees, do not provide fiscal accounts and do not pay legally prescribed taxes and contributions). in addition, the analysis of responses from survey questionnaires and submitted price lists showed that prices of original spare parts are on average about 75% higher than the prices of replacement spare parts whose technical characteristics meet the quality but are not original spare parts. the stated price difference is the consequence of the poor quality of replacement parts, but also due to their shorter durability. conclusions on the basis of the conducted research and analysis, it can be concluded that the major appliances aftersales service market is in many ways different from the "classic" product or some other type of services market, for several reasons: 3 five-year warranties were recorded during the period of realization of this research, and they can be related to a certain period of time of promotional campaigns or the consequence of conforming with current trands in the industry. the length of the warranty period is variable and amounts to a minimum of 2 years, which is stipulated by the consumer protection act, and within the context of certain strategies and marketing campaigns, the warranty period can be extended. ivana domazet, ivan stošić, milena lazić 57 • the aftersales service market is largely defined by the primary market (e.g. the change in the volume and structure of sales of major appliances significantly defines trends in the relevant secondary, aftermarket for these products); • the position of the suppliers in the primary market greatly influences the intensity of competitive relations and, consequently, the level of product prices and other competition parameters on the market of aftersales services. nevertheless, there is a possibility that suppliers who do not have a dominant position in the primary market and operate at different levels of a production and sales chain, through some non-price or price factors, significantly affect the intensity of competition in the aftermarket, by applying different marketing strategies aimed at linking the primary product buyers to the aftersales services provided by the manufacturer of a particular brand, its distributors, or service providers; • many bidders operate simultaneously both in the primary and secondary markets, achieving a significantly higher level of profit in secondary market operations and creating barriers to entry of competitors or directing them exclusively to the primary or secondary market. the refrigerators and washing machines aftermarket, as the best-selling major appliances products, is characterized by an extremely large number of subjects on the demand side (final product buyers), but also a relatively large number on the supply side of major appliances repair services (about 1,510 service technicians). as a rule, the dimensioning and territorial structuring of the network of official major appliances services (usually dealers of genuine spare parts) is done by importers (general agents or distributors) in cooperation with manufacturers based on the territorial dispersion of defect reports through unified contact centers. the duration of the warranty period and the geographical coverage of the service network represent, besides the price of the new product, the most important marketing mix instruments and dominantly define the customers for the purchase of a particular major appliances brand. these factors also direct the creation of sales strategies of importers and agents in terms of providing longer warranty periods and expanding service networks of their brands. authorized services conduct repairs within and out of the warranty period, while independent major appliances servicers are dominantly performing repairs out of the warranty period. there is no interbrand competition between authorized repairers within the warranty period, as authorized services are under contractual obligation to use exclusively the original parts of the brand for the reported major appliances repairs. intrabrand competition between authorized services within the warranty period is moderate, which means that they are prioritized when receiving service requests from the centralized contact center of the general agent, according to the proximity of the geographical location of the customer who reported the defect. the location, or proximity of the authorized service, is the first criterion according to which the call for major appliance repair is distributed from the contact center, while the second criterion is the number, i.e. availability of the authorized service technician at the moment of service request. when speaking about independent major appliances services, there is around 1000 of such companies in the territory of the republic of serbia who perform their activities outside the warranty period. here, the competition is very intense and the market dictates service conditions and prices in the major appliances aftermarket, none of the 1,500 services has a market share of over 5%, and we can conclude that it is a competitive market, that is, a market with an extremely low concentration. 58 economic analysis (2018, vol. 51, no. 1-2, 47-59) problems in the field of competitive relations in the aftersales service market arise when interbrand competition (competition between manufacturers of different brands and their distributors) is not strong enough, or if the manufacturer of a particular brand has significant market share compared with the manufacturers of competing brands. in such a case, the manufacturer of certain brands and its distributors is not sufficiently stimulated to provide endcustomers with quality service for the repairing and installation of spare parts, despite the fact that they charge a high price for the basic product. bearing in mind the basic characteristics of the primary market in serbia, it can be noted that in the major appliances aftermarket, the interbrand competition is intense and that no significant problems are noticed. potential problems in the field of competitive relations in this market segment reflects in limitations of intrabrand competition (competition between distributors / services / spare parts resellers of the same brand). the manufacturer is in a position to impose restrictions on distributors in respect of the terms of their contracts with authorized services and spare parts dealers, obliging them to install / sell spare parts exclusively from its production. restrictions of this kind are justified only if they provide higher quality of the after-sales service. otherwise they represent a serious distortion of competitive market behavior, as this limits the entry of independent spare parts manufacturers and servicers, who can offer spare parts and technical and repairing services of the appropriate quality. acknowledgements this paper is a result of the research project under the code 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements), and project european integrations and social and economic changes in serbian economy on the way 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key words: keynesian cross diagram,  macroeconomic policy, pollution    udc: 502.2:330.101.541          jel: q58, q50, e12, e61    abstract ‐ the economy of the environment is traditionally the field of micro‐economy. yet pro‐ viding an analysis purely macro‐economic  is  from a theoretical and praxeological point of view   possible.  with this in mind, we change the model is‐lm so that it incorporates the pollution. this extension of the  model has allowed us to show the ecological and economic effects of different monetary or budgetary policies  depending on the type of small open economy considered (with or without different kind of control pollution  activities).  introduction  even if there is a debate about the exact meaning to be attached to the term sustainable de‐ velopment, it appears that whatever their opinions underlying theory, the authors involved in this  debate agree that the concept of sustainable development implies managing and maintaining an  inventory of resources with a view to equity between generations and between countries1. indeed  the economics of the environment is traditionally treated as a sub division of the micro‐economy. it  therefore appears to us, after authors like daly2, there is a place also for a macro‐economy of the   environment, where the macro‐economy would be regarded as a sub‐system open to the ecosys‐ tem and totally dependent on the latter, both for the source of inputs into low entropy of matter  and energy, and as a receptacle outputs for high entropy of matter and energy. the macroeconomy  of  environment should focus on the volume of trade that cross the boundaries between the system  and the subsystem. as daly points out if the optimal allocation of a given level of resource flows  within an economy is a micro‐economic problem, the optimal scale of the economy relative to the  ecosystem is an entirely different problem in fact a macroeconomic one.  moreover, to try to establish the foundations of a macro‐economy environment, and measure  their lessons, we will incorporate into the model is‐lm, but in its dynamic form, function pollution  in the form of stock.  a dynamic is‐lm model extended to the case of pollution  in its original version, the  is‐lm  model relies on comparative statics, but the principle of  correspondence of samuelson stipulates that the properties of comparative statics of a model relies  on its dynamic properties3. as we intend to modify the model by adding new variables in order to  introduce pollution, we therefore must study the dynamical properties of the corresponding model  before to make any comparative statics analysis.  1 pearce d, markandya a, barbier e.b  (1989), blueprint for a green economy, london, earthscan publications.  2 daly h. e.,“elements of environmental macroeconomics”, in costanza r , ecological economics, the science and manage‐ ment of sustainability, columbia university press, new york, pp 32‐45  3in fact, in its comparative statics form, the assumption of automatic balancing of the market for goods and services is  made. but in its dynamic form, one wonders about the existence of this equilibrium and the process of adjustment of the  economy toward it.  2007 ‐ 12  •  economic analysis®  in  the  dynamic  model  is‐lm  we  consider  an  economy  in  which  national  income  (y)  re‐ sponds to excess investment (i) on savings (s). thus, the first dynamic equation based on the is  curve is given by the following:   &y i s= −   in case you  introduce budgetary expenditure  (g),  the environmental budget  (ge),  taxation  (t),  productive investment (i) and pollution (ie) and exports (x) and imports (m), the previous dy‐ namic equation becomes:    &y i i g g s t x me e= + + + − − + −   the function of exports of the economy is ( )x x= ω  with the exchange rate ω  = $ / €.we suppose  that when the exchange rate increases ceteris paribus, imports rise, and when the level of house‐ hold  income  increases imports are also  increasing, hence the function of  imports  m my= ( )ω ,  where m is the propensity to import of the economy.   the investment in this economy is divided into a productive investment aimed at increasing  the production capacity of  the economy, i, and investment  in pollution control which does not  have this capacity, ie4. regarding the investment function,  arii −= , the level of productive in‐ vestment depend on the level of interest, r, where the parameter ʺaʺ reflects the incentive to invest  from rate interest and  i  an autonomous level. note that the firm’s calculation of profitability in‐ tegrates expected demand,  through  the assessment of the marginal efficiency of capital and  its  comparison to the rate of interest. this assessment process will take a special importance with the  function of investment in pollution control. in fact we suppose that interest rate  plays a lower role  in the pollution control investment function than in the function of investment in other sectors,  resulting in a coefficient ʺbʺ very low and less than ʺaʺ5. in this case, we write the investment func‐ tion in pollution control  i i bre e= − . thus a fundamental element in our model will be to know if  the expectations of the firms in the sector of the pollution would be resolutely optimistic about the  behaviour of the stateʹs environmental standard.   in this economy public expenditure, is assumed exogenous, with the request of the state in  consumer goods and services and property investment, g, and public investment in pollution con‐ trol, ge, respectively g g=  and g ge e= . with all these assumptions, is equation is rewritten :  (1)  & ( )y s t y ty ct c g g i ar i br x mye e= − − − − + + + + − + − + −1   in our model is‐lm dynamic interest rate (r) responds to excess demand for money (l) on  the money supply determined exogenously (m). but in open economy the money supply will vary  depending  on  changes  in  foreign  exchange  reserves  and  the  in  monetary  base,  h,  [ ] [ ]&r hy l lr h r= + − − + , where  r x m f r= − + ( ) . thus, a fixed exchange rate regime, the lm  curve dynamics is given by the relationship (2) where hy  is the demand for money for purposes of  transactions, and  l lr− is the demand money for purposes of speculation, and finally the mone‐ tary base exogenous:  4 from a strictly accounting on a perfectly entitled to present the overall investment in the form of two sectors since these  equations are equations balance ex‐post. and we know all prices in the economy, since this is the prerequisite for the  aggregation of goods produced for obtaining the equation of balance between accounting income and expenditure.  5 several reasons require that choice. first reason is that firms that invest in clean‐up will do so only if the state has en‐ couraged the market for mitigating pollution by enacting laws requiring in all other sectors the use of new products of  pollution control : the pollution sector can not declare unilaterally an increase of its production unless it has correctly  anticipated a strengthening of pollution standards. the second reason lies in subsidies granted by the government which  are merely transfers therefore making private investment in pollution less dependent on interest rates. finally, in this  case we must also consider the fact that environmental standards, in the first place, determine the use of cleaner prod‐ ucts. once internalized this information the rate of interest takes the second place.  volume 40 • spring 2008 • 13  (2)  [ ]& ( )r hy l lr h x my f r= + − − − − +   we will now introduce the environmental dimension in this model showing the evolution  equation stock pollution widely used in theoretical models of sustainability6. thus strom7 in his  article assumes that the stock waste is the appropriate measure of environmental  the rate of de‐ cline in the density of waste, reflecting the rateδquality. with  of increase in the assimilative capac‐ ity of the natural environment due to capital investment, and w the waste was then the following  equation:  & ~ z w h i zr= − − δ . in transposing this equation to adapt to the dynamic model is‐lm,  we can then write the equation dynamic equilibrium macro‐environment in the form of the equa‐ tion (3), namely:  (3),  & ( ) ( ) ( ) ( ) ( )e y g i br ee e= − − + −α β γ γ δ   where e is the stock of pollution or waste,  αy is the emission of pollution emitted by the  productive activities,  β ge the reduction of the stock of pollution caused by government spending  on pollution, and γ γ( ) ( )i bre −  the reduction of the stock of pollution due to the clean‐up activi‐ ties of the private sector, δ the rate of decline of natural waste stock e. therefore, the dynamic sys‐ tem can be written by the following matrix:  ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ −− −− −+++++ + ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ − +−+ +−−−−− = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ )()( 0)()( 0)()1( ee ee ig xhl tcxcgigi e r y b flmh bamtts e r y γβδγα& & &   in the mathematical appendix, we demonstrate the stability of this model. we can therefore study  its behaviour near of the equilibrium. doing so the previous equations become:     ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ + −− +−++++ = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ − +−− +++− )()( 0)()( 0)())1(( ee ee ig xhl xtccgigi e r y b lfhm bamtts γβδγα   this system is in fact the structural form of a small open economy subject to a pollution problem.  we examine this structural form deducting the reduced form in the next section.  dynamic behaviour analysis of the model   the behavioural analysis of the previous dynamic model is identical to study the behaviour  of the structural form of a keynesian model of a short‐term applied to the local pollution. we will  study the structural form by deducting the reduced form.   with activities for pollution reduction private non‐autonomous  i i bre e= − , and public ex‐ penditure shocks g ge e= , the is curve, in open economy, is given by the relationship (1), i.e.:  y t cy cty ct ty c g i g i ar br x mye e( )1− = − − − + + + + + − − + −   the lm curve is given by the relationship (2), namely:  h x my f r hy l lr+ − + = + −( )    the equation environmental equilibrium, taking into account the public and private spending on  pollution control is given by (3):  6 see for example gradus r., smulders s. (1993), the trade‐off between environmental care and long‐term growth, pollu‐ tion in three prototype growth models, journals of economics, 58(1), pp25‐51.  7 strom s, “economic growth and biological equilibrium”, swedish journal of economics, vol. 75, n°2, june 1973. strom  s, (june 1973)  economic growth and biological equilibrium, swedish journal of economics, 75(2).  2007 ‐ 14  •  economic analysis®  e y g i bre eδ α β γ γ= − − +( ) ( ) ( )    presented in matrix form the previous three equations give us the following system:  ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ + −− +−++++ = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ − +−− +++− )()( 0)( 0))1(( ee ee ig xhl xtccgigi e r y b lfhm bamtts γβδγα    with  the  determinant  ( )[ ]λ = − − + + + + + +δ s t t m f l a b h m( ) ( ) ( )( )1 ,  and  with  ⎟⎟ ⎟ ⎟ ⎠ ⎞ ⎜⎜ ⎜ ⎜ ⎝ ⎛ + −− +−++++ = )()( ee ee ig xhl xtccgigi m γβ .the structural system  is  written  in  its  reduced  form  in  the  following manner:  m bmttsbalfbhm mttsmh balf e r y ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ λ−++−−++−+− ++−−+− ++− ⎟ ⎠ ⎞ ⎜ ⎝ ⎛ λ = ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎝ ⎛ δγααγ δδ δδ /))1(()()()( 0))1(()( 0)()( 1   starting from this reduced form model we will deduct the behaviour of this model in the  several cases. to do this we will calculate the various multipliers corresponding to this model.  comparative statics in the simplified case without pollution control  in the simplest case we make the assumption that no expenditure pollution, neither public  nor private, shall be undertaken in the economy ( 0== ee gi  and b=0). in sum, it’s only the assimi‐ lative capacity of the environment  that converts waste produced by the economic process. the  equation of environmental equilibrium is given by:  e yδ α= .  multipliers  the multipliers are obtained by differentiating the reduced form model:   δ δ δ δ δ δ y c y i y g ky= = = >,1 0    and    δ δ y t cky= − >,1 0   δ δ y h ky= − >,2 0    δ δ y l ky= <,2 0   where  ( ) ( )( ) ( )[ ] k f l s t t m f l a m h y , ( ) 1 1 = + − + + + + + , and  ( )( ) ( )[ ] k a s t t m f l a m h y , ( ) 2 1 = − − + + + + +   the monetary and budgetary multipliers are:  δ δ δ δ δ δ r c r i r g k r= = = >,1 0    et    δ δ r t ck r= − >,1 0   δ δ r h k r= − <,2 0     δ δ r l k r= <,2 0   where  ( ) ( )( ) ( )[ ] k m h s t t m f l a m h r , ( ) 1 1 = + − + + + + +   volume 40 • spring 2008 • 15   and  ( ) ( )( ) ( )[ ] k s t t m s t t m f l a m h r , ( ) ( ) 2 1 1 = − + + − + + + + +   the equation of  ecological equilibrium allows us to calculate the environmental multipliers:   [ ] [ ]δ δ δ δ δ δ δe k c i g c t k l he e= + + − + −, ,1 2   δ δ δ δ δ δ e c e i e g k e= = = >,1 0    and    δ δ e t ck e= − >,1 0   δ δ e h k e= − >,2 0     δ δ e l k e= <,2 0  where ( ) ( )( ) ( )[ ] k f l s t t m f l a m h e , ( ) 1 1 = + − + + + + + α δ and   ( )( ) ( )[ ] k a s t t m f l a m h e , ( ) 2 1 = − − + + + + + α δ   the sign of ecological multipliers are the same as monetary and budgetary multipliers com‐ pared to y. this is perfectly normal. indeed in this model no place has been given to expenditure  on pollution control, so the emission level is equal to the difference between the level of gross pol‐ lution and assimilative capacity of the natural environment, assumed fixed. so in this case, emis‐ sions of pollution are only proportional to the volume of production and hence the national in‐ come of the economy and in a linear fashion. therefore, any economic stimulus of income through  budgetary and monetary policies corresponds to an increase in national income and thus and thus  to a proportional increase in the same sense of the level of waste emissions. the main reason is that  any distribution of income, wages, or simply any stimulation of demand creates ceteris paribus, a  stimulation in the same direction of pollution (more wages mean more consumption more invest‐ ment and so on. and therefore more consumption and thus more waste).  graphical representation   the graphic representation of the environmental equilibrium equation is exactly like that of  a balance of payments curve. indeed it is written (3)  0 = −α δy e , iey e= δ α . the status of this  curve is very particular. it brings together all the points which, for a given level of pollution, e, for  a given level of assimilation of natural waste,δ , and finally to an intensity of pollution in the pro‐ duction sector aα,  associates a level of income, y. it is not a worthy that for a given objective pollu‐ tion emitted, e, there is a single level of income, y. thus be is a line parallel to the axis. hence the  graphical representation of the environmental equation is the following:    be(e,α,δ) r y be'(e'>e,α,δ) y=eδ/α y'=e'δ/α   2007 ‐ 16  •  economic analysis®  figure 1. environmental equilibrium curves according to the emission level of pollution  thus you have a family of curves where the  closest to the origin correspond to low levels of  emissions and    the furthest a higher  level of pollution. in the case of this small open economy  where no environmental expenditure  is  implemented,  the environmental  impact of a policy of  budgetary or monetary can only be the same as that exercised by these policies on income level  since we  just verify that the respective multipliers are the same, as can be seen in the following  graphic:  is lm' be bp r y lm is' be' y y'     figure 2. effect of a budgetary stimulus in open economy on the level of income and of pollution.  thus, in open economy and in a fixed exchange rate regime any budgetary policy moves is   to the right, thereby increasing the rate of interest. in fixed exchange rate regime, and with com‐ plete freedom of capital movements, it increases the stock of gold and currency of the central bank,  and it has more than compensate for the fact that imports have increased. the balance of payments  is in surplus resulting in a exogenous creation of money (capital flows). so lm move to the right.  at the equilibrium the  three lines  intercept (isʹ lmʹ and bp, which  in fixed exchange does not  move); national  income has  increased, with yʹ> y. from an environmental perspective,  this  in‐ crease in overall income implies that the level of waste has been raised and therefore the curve be  move to the right in be ʹ. in the new ecological and economical equilibrium, the economy is at a  higher income level, which implies an emission level also higher.  thus, from a macroeconomic view, we get the same results as those of usual is‐lm model  with a fixed exchange rate regime. however all variations in the level of national income reflects a  change in the same sense of the level of emissions. therefore after adjustment we will always be in  equilibrium macroeconomicaly and ecologically speaking. note that in the latter case the notion of  equilibrium should be understood as  the  level of pollution consistent with the level of  income,  given the intensity in pollution of the national economy, and bearing in mind assimilative capacity  of the environmental represented by δ . it’s certainly not the level of emissions that would ensure  an hypothetical ecological ʺparadiseʺ. this is of great importance if one believes, like daly, in the  notion of size or scale of the sustainable economy. indeed, in this case, we can consider that this  ʺsustainable sizeʺ corresponds to a maximum amount of waste that can assimilate the ecosystem in  the short term and in the long term. this leads us therefore to set an upper limit to the evolution of  gnp. as stated daly, the limit depends on the country and a whole range of factors, geographical,  ecological and demographic8. in the next part of this article we introduce environmental public  and private spending allowing more flexibility to reconcile national income and environmental  constraints.   8 in our model, we could introduce it as a theoretical form of a line parallel to the y‐axis.  volume 40 • spring 2008 • 17  comparative statics in the general case   multipliers  using the equation representing the equilibrium on the market products ie is we get the fol‐ lowing multipliers:  δ δ δ δ δ δ δ δ δ δ y c y i y g y i y g k e e y= = = = = >,1 0 and  δ δ y t cky= − <,1 0   δ δ y h ky= − >,2 0    δ δ y l ky= <,2 0   with  ( ) ( )( ) ( )( )[ ] k f l s t t m f l a b m h y , ( ) 1 1 = + − + + + + + +   and  ( ) ( )( ) ( )( )[ ] k a b s t t m f l a b m h y , ( ) 2 1 = − + − + + + + + +   applying the same method to the equation on the money market, we have:   δ δ δ δ δ δ δ δ δ δ r c r i r g r i r g k e e r= = = = = >,1 0  and  δ δ r t ck r= − <,1 0   δ δ r h k r= − <,2 0     δ δ r l k r= >,2 0   where  ( ) ( )( ) ( )( )[ ] k m h s t t m f l a b m h r , ( ) 1 1 = + − + + + + + +    and  ( ) ( )( ) ( )( )[ ] k s t t m s t t m f l a b m h r , ( ) ( ) 2 1 1 = − + + − + + + + + +   regarding be we obtain:  [ ] [ ] [ ]δ δ δ δ δ δ δ δ δ δ δe k c i g g i c t k l h k g ie e e e e e e= + + + + − + − + +, , , ( ) ( )1 2 3 β γ   δ δ δ δ δ δ e c e i e g k e= = = >,1 0  and  δ δ e t ck e= − <,1 0   δ δ e i k k k e e e e= + = − >, , ,( / )1 3 1 0γ γ δ and   δ δ e g k k k e e e e= + = − >, , ,( / )1 3 1 0β β δ   δ δ e h k e= − ,2     δ δ e l k e= ,2    with the multipliers    ( ) ( ) ( )( ) ( )( )[ ] k f l m h b s t t m f l a b m h e , ( ) 1 1 = + + + − + + + + + + α γ δ ,  k e , /3 1= − δ , and   ( ) ( ) ( )( ) ( )( )[ ] k s t t m b a b s t t m f l a b m h e , ( ) ( ) 2 1 1 = − + + − + − + + + + + + γ α δ .  the important point about these multipliers is to note that, from a strictly economic point of  view, nothing changes compared to the usual is‐lm  model without pollution. nevertheless, from  an ecological point of view  the environmental public expenditure multiplier has the same eco‐ nomic  impact  that  another  government  expenditure  (dy/dg=dy/dge),  but  without  having  the  2007 ‐ 18  •  economic analysis®  same environmental consequences, since the multiplier of environmental pollution control public  expenditure is less than that of an usual public expenditure (de/dg>de/dge). thus, while increas‐ ing ge lead to an increase on income identical to that of the same increasing of g but with an emis‐ sion level of pollution corresponding much less important. however, it must be stressed that, for  ge, it has been implicitly supposed that environmental government spending have a real   envi‐ ronmental effect on pollution, symbolized by the coefficient β between zero and one. but one could  imagine the case of environmental public spending that would not impact assessments, adminis‐ trative activities, without significant effect (a part from the distribution of wages to employees of  the ministry of environment or writing reports with non‐recycled paper etc. ..), that is to say a co‐ efficient β equivalent to  zero or very close to zero.   regarding the monetary multiplier, they depend on the sign of  ( ) ( )s t t b a b( )1 − + − +γ α .  this term is only represents the slopes of is and be. we stressed in the previous section that the  coefficient “b” is smaller than ʺaʺ. this means that the normal case is a negative sign of the previ‐ ous term. in the unusual case where the term is positive, it means that the multiplier effect of pri‐ vate investment in pollution control is more important than for the usual investment. this could  happen only in an economy where the expectations of the decision makers in the field of pollution  would be resolutely optimistic on the behaviour of the stateʹs environmental standard. therefore,  any monetary policy has a double effect in lowering the rate of interest: it facilitates investment as  a whole, and hence pollution, but investment in pollution control is also encouraged. thus, an en‐ vironmental point of view, the net effect depends on expectations of the firms and hence rely on  the environmental policy imposed by the state, and, hence, by the respective sizes of the pollution  control sectors  compared to the usual investment sector.  graphical representation  the  graphic  representation  of  the  environmental  equation  is  given  by  (3)  e y g i bre eδ α β γ γ= − − +( ) ( ) ( ) . this equation may be written in the following form:  r b y e g i b e e= − + + +α γ δ β γ γ( ) ( ) ( ) ( )    the status of this curve is consistent with the previous case. indeed it gather all the points  which, for a level of public and private environmental expenditure and for an intensity of pollu‐ tion in the production sector, associates to a couple of income level and  interest rates  a specific   level of pollution e. the reverse of the slope of the curve be is then equal to −α γ ( )b , hence the  graphic representation of figure 3:  y=δe/α y'=y''=(δe'+βge+γie)/α r=δe/(bγ) r'=(δe'+βge+γie)/(bγ) y r be be' be'' r''=(δe'+βge+γie)/(b''γ)     figure 3. curves balances macro‐environment according to the emission level of environmental expenditure  volume 40 • spring 2008 • 19  and the sensitivity of private environmental investment at the rate of interest.  an examination of figure 3 shows us that, when comparing the curve be  and the curve be ʹ,  an increase in the level of environmental private or public expenditure lead to increased pollution  level, income level and interest rates. this is perfectly consistent. a comparison of curves be ʺand  be ʹshows that for identical level of environmental expenditure, for a ratio b different, we obtain  income and pollution levels which are  identical but different interest rates ( the more b decrease in  passing from b ʹ to b ʺ, the more interest rate increases). thus, we conclude that lower is b, i.e. less  private investment in pollution control is sensitive to interest rates, the stronger changes in r have  to be in order to obtain the same level of pollution. moreover this chart  is perfectly consistent with  the definition of be given in the previous section because, when the coefficient b tends towards  zero, ie when private investment becomes independent and indifferent to the rate of interest, then  be becomes vertical.  an important consequence of the shape of the curve be is that, according to the place of the  curve be compared to is, the effect of monetary policy on the emission level will not be the same  (as indicated by the sign of the corresponding multiplier which differs depending on whether one  is in the usual case or not). but this changes nothing with regard to the comparison between the  effect of an environmental public expenditure versus a usual public expenditure, as can be seen in  figure 4:  be(e) is lm bp is' lm' be'(e') e e* e** y y' y ''=y'y lm lm'' bp is is'' be(e ) be''(e'') e e* e** usual public expanditure dg>0, dy=(y'-y)>0, de=(e'-e)>0 environmental public expanditure dge>0, dge=dg , dy=(y''-y)=(y'-y )>0, de=(e''-e)<(e'-e)   figure 4. effects on the level of income and of pollution compared to those of a budgetary environment.  in this figure, we make the assumption that we are in the normal case, ie that the slope of is  is not greater than or equal to that of be (but change this assumption would not into question the  results). in the first case, a budgetary stimulus has the effect of  moving is to the right where it  crosses lm in e *. but this is not a point of equilibrium in open economy. the interest rate has in‐ creased resulting in an influx of foreign capital just inflating the stock of gold and foreign exchange  considering our implicit assumption of high mobility of capital (given the slope of the curve bp).  this largely offsets the decline in the stock of foreign exchange resulting from increased imports.  in total, there is therefore an exogenous creation of money that moves lm to the right where it  crosses is ʹ in e **. this is a point of economic equilibrium symbolized by the intersection of is ʹand  lm. from an environmental point of view, the shift from y to y ʹhas resulted in an increase in same  intensity in the level of emissions from e to eʹ. hence, from the environmental point of view, the  situation has worsened without ambiguity.  this figure, allows us to verify that for an increase in environmental public expenditure of  same  intensity as  the public expenditure of  the previous case,  income y  increases of  the same  amount as in the previous case, and passes from y to y ʺ, where y = y ʹ. the curves fit is and lm is  the same as in the first case. by contrast the level of emissions  even though it has increased com‐ 2007 ‐ 20  •  economic analysis®  pared to its initial level e is at a level eʺ which is less than eʹ. accordingly, a an environmental pub‐ lic expenditure, even if it leads to an increased pollution, is more efficient ecologically speaking  than a usual public expenditure, because it causes relatively less pollution that the latter, for the  same increase in national income.  by contrast, if we look to the environmental impact of a monetary economy open, there is no  such dichotomy ʺusual/ environmentalʺ, but a dichotomy between normal and abnormal as can be  seen on the figures 4 and 5:  is lm' be(e) bp r y lmbe'(e') y y' e e' r r'        figure 4. effect of an active monetary policy in open economies on the level of income and that of emissions  in the normal case.  in the normal case, the sign of the environmental monetary multiplier is positive. an initial  increase of money supply by lowering the level of interest rates going from r to r ʹ, stimulates the  economy whose income goes to yʹ. but, in open economy, e ʹ is a situation of unstable equilibrium  because situated below the curve of the balance of payments. indeed, with a perfect capital mobil‐ ity, the declining interest rate leads to a flight of capital which, coupled with rising imports leads  the stock of gold and currency of the central bank on the decline. so the money supply contracts.  therefore lm go back to its original position. the level of income returns to y, and hence the econ‐ omy returns to its stable equilibrium position, e. from an environmental view situation is identical.  at first, when the income from y to y ʹ, the level of emissions increases since the multiplier mone‐ tary environment is positive, and therefore the curve be moves on the right (where the level of  pollution emissions e ʹ is higher than e). then the lm’ , be’ is ʹcurves intercept in eʹ. this position  being unstable, when the level of income is declining to return to y, the level of emissions is declin‐ ing as well and hence the curve be shift back. indeed, the money supply experienced an exoge‐ nous destruction  of money, so the multiplier monetary environmental operated but with a decline  in money supply. hence the economy  has experienced a reduction in emissions in the normal case,  and therefore a return to the level of emissions at its initial level e after passing through the level e  ʹ: the economy has returned to its initial level of wealth and pollution.   if we turn now to the unusual case, illustrated figure 5, the results are greatly changed.  volume 40 • spring 2008 • 21  lm lm' bpis be(e) be'(e') e'<e e e' r r' y y' y r        figure 5. effect of an active monetary policy in open economies on the level of income and that of emissions  in the unusual case.  in  the unusual case,  the  sign of  the  monetary multiplier environmental  tells us  that  any  change in the money supply reflects a change in direction in the level of emissions, because the  declining interest rate stimulates heavily investing in pollution control that compensates well be‐ yond or even adverse effects on investment usual. as a result, an increase of the amount of cur‐ rency in the case abnormal, leads to lower emissions of pollution. therefore, active monetary pol‐ icy by lowering the level of interest rates going from r to r ʹ, stimulates the economy which income  rise from y to y ʹ. but in the open economy eʹ is a situation of unstable equilibrium because situ‐ ated below the curve of the balance of payments, which is in deficit. indeed with a perfect capital  mobility declining interest rates caused a flight of capital which therefore reduces the lm curve to  its original position. the level of income returns to y, and hence the economy returns to its stable  equilibrium position, e. from an environmental point of view, the situation is reversed. at first,  when the income rise from y to y ʹ, the level of emissions decrease, following the stimulation of  investment in pollution control, and therefore the curve be moves left to beʹ where e ʹ<e. but this  position is an unstable economic equilibrium. when the level of income return from y’ to y the  level of emissions increases in response to the declining investment in pollution control. so the  curve be ʹ leaves back and returned to his original position, be, where the level of emissions re‐ gains its initial level e. hence, after adjustments, the economy has returned to its initial level of  wealth and emission pollution.   note finally that in the unusual case we make the implicit assumption that the private sector  of investment in control of pollution is an extremely important sector of the economy with the con‐ comitant assumption that the firms, when they formulate their expectations, know that the gov‐ ernment is committed to not to relax the laws and standards, and therefore not depress demand  for goods of pollution‐control equipment, explaining the important weight of this sector. it is there‐ fore a very special case which to our knowledge doesn’t exist up to now in the reality  where the  private sector of investment in pollution control is less important than usual private sector:  that’s  why we consider it as an abnormal case.   conclusion   the introduction of pollution in the form of stock in a dynamic is‐lm model, has allowed us  to analyse the environmental consequences of macroeconomic policies. according to the model, an  environmental public expenditure, even if it leads to increased pollution  is preferable to a usual  2007 ‐ 22  •  economic analysis®  public expenditure, because it causes relatively fewer emissions of pollution that the latter, for an  identical increase in national income. the environmental effect of an expansionary monetary pol‐ icy depends on the type of economy involved in.  in the unusual case, where the bulk of invest‐ ment activities would be dedicated to clean‐up, any change in money supply leads to a variation in  the opposite sense in the level of pollution, for the reason that a lower interest rate stimulates in‐ vestment in pollution control that compensates the much more adverse effects of investment in  usual sector. in the normal case where the private sector pollution is smaller than the usual private  sector, any monetary policy induced by the decline of interest rates encourages more the usual  investment ( with environmental standards unchanged), thereby increasing pollution and the in‐ come levels. hence, one of the major lessons of this model is that what is important is the expecta‐ tions  in the sector of the pollution  control and the size of this sector relatively to the rest of the  economy. also, a government anxious to make a sustainable economic growth should give priority  to try to drive the expectations of these pollution control firms through environmental standards  increasingly severe as long as the economy did not have a private sector of pollution control at  least as important in its economic size as the usual private sector. in the meantime, environmental  public policies should be preferred, from an environmental point of view, to any monetary and  budgetary policy, provided that public environmental measures are concrete and truly effective  remediation. thus, our findings reinforce the arguments of post‐keynesians like peter bird9, who  recognized the importance of informational constraints in a state of uncertainty, and prefer main‐ taining standards seeking optimality.  moreover, if one takes as relevant the criterion proposed by daly of ʺcarrying capacityʺ, ie  the optimal scale of the economy compared to the ecosystem behind it, we can conclude that our  model, except in unusual circumstances, show that any monetary or budgetary policy increases the  pollution level and therefore drive the economy a little closer to the sustainable limit. if the econ‐ omy is in an unusual case, one moves more and more of this limit, then there is sustainable devel‐ opment in its fullest sense.  bibliography   bird p. w. n.(1982), neoclassical and environmental post‐keynesian economics, journal of post‐keynesian economics, 4(4),  pp586‐593.  daly h. e.,elements of environmental macroeconomics, in costanza r , ecological economics, the science and management  of sustainability, columbia university press, new york, pp 32‐45.  gradus r., smulders s. (1993), the trade‐off between environmental care and long‐term growth, pollution in three pro‐ totype growth models, journals of economics, 58(1), pp25‐51.  ouyahia e., macrodynamics and international pollution in open economies, thesis  presented nice january 15, 1999.  pearce d, markandya a, barbier e.b  (1989), blueprint for a green economy, london, earthscan publications.  strom s, (june 1973)  economic growth and biological equilibrium, swedish journal of economics, 75(2).  mathematical appendix  the resolution of the dynamic system passes through the calculation of values of the main matrix. the result is the char‐ acteristic polynomial following:  ( ) [ ] ( ) ( )[ ]p s t t l m f s t t m l f h m a bλ δ λ λ λ= − − + − + + + + + − + + + + + + =² ( ) ( ( ) )( ) ( )( )1 1 0     the resolution of this polynomial imposes using the determinant δ where :  9 bird p. w. n.(1982), neoclassical and environmental post‐keynesian economics, journal of post‐keynesian economics,  4(4), pp586‐593.  volume 40 • spring 2008 • 23  δ = − + + − − − + +( ( ) )² ( )( )s t t m l f h m a b1 4 .  if δ  is positive, then the three values, solutions of the previous polynomial equation are three real rootsl:  δλ −=3 and  [ ]λi s t t l m f= = − − − − − − ±1 2 12 1, ( ( ) ) δ .   if  δ  is  zero,  then  the  three  values  of  polynomial  previous  solutions  are:  δλ −=1   and  a  real  double  root  ( )[ ]fmltts −−−−−−= )1(21λ .   if  δ    is  negative,  then  the    three  values  of  polynomial  previous  solutions  are  λ δ3 = −   and  two  complex  roots  ( )[ ]δ±−−−−−−== ifmlttsi ))1((212,1λ    all the real values are strictly negative, the model is stable.    ea_2018_3-4 bogdan dima, ştefana maria dima 33 doi: 10.28934/ea.18.51.34.pp33-56 original scientific paper do business regulations promote growth in low-income countries? bogdan dima1 | ştefana maria dima2* 1 faculty of economics and business administration, west university of timisoara, timişoara, romania 2 east european center for research in economics and business (ecreb), faculty of economics and business administration, west university of timișoara, timişoara, romania abstract the present article addresses the complex web of interactions between the architecture and quality of the business regulatory setting and economic growth. thus, we aim to advance a two-fold contribution to the literature: we methodologically account for the uncertainty related to possible alternative explanations for growth processes, by means of ‘bayesian model averaging’; and we assess the impact of business environment on growth, involving the descriptors reflected by country policy and institutional assessment. these indicators benefit from a pronounced ‘in-field’ nature and reflect a large variety of possible public policies. the results suggest a statistically significant positive relationship between the overall quality of business regulatory environment and growth. this outcome is found to be robust to various choices of priors’ structures. moreover, the outcome’s estimated amplitude largely declines once the endogeneity is considered. key words: economic growth, business regulations, cpia, low-income countries, bayesian model averaging jel classification: c11, f43, k20 introduction the neo-institutionalism framework allows for the identification of a complex web of interactions between the architecture and quality of the regulatory set and economic growth. as dawson (2006: 490) argues: “it is reasonable to think that regulation may affect an economic agent’s ability to engage in voluntary exchange and the efficiency with which resources are used in an economy. thus, we might expect that the level of regulation in a country is related to indicators of long-run economic performance such as the level of investment or per capita income growth”. at least two types of transmission channels can be involved. first, the regulatory framework defines the ‘rules of the game’. if this framework is stable and predictable, the economic agents can set their decisions in a low-uncertainty environment and, hence, can engage themselves in long-run projects. second, if such framework incorporates various ‘positive externalities’, it can foster entrepreneurial initiative and support human resources’ mobility. thus, the quality of regulations can be directly linked to growth engines. meanwhile, regulations impact the standard determinants of growth, such as capital accumulation, research and development processes or labor market. in consequence, one can expect a synergic impact of regulations, by means of multiple key determinants of growth. * corresponding author, e-mail: stefana.dima@e-uvt.ro 34 economic analysis (2018, vol. 51, no. 3-4, 33-56) indeed, several empirical evidences in the literature suggest that regulations matter in explaining sustainable growth. for instance, beugelsdijk’s (2010) findings suggest that differences in economic growth in europe can be explained by differences in entrepreneurial culture, albeit, mostly in an indirect way. for a data sample of 172 countries, haidar (2012) finds that, on average, each business regulatory reform is associated with a 0.15percentage point increase in growth rate of gdp. similarly, djankov et al. (2006) finds that, for 135 countries, recovering from the worst quartile of business regulations to the best implies a 2.3 percentage point increase in annual growth. however, not all public policies with regulatory content have the same impact on growth. for instance, kolko et al. (2011) find that business climate indices, which focus on productivityrelated variables, have essentially no predictive power for economic growth. in contrast, business climate indices focusing on taxes and costs predict growth of employment, wages, and gross state product. furthermore, hanusch (2012) involves the doing business index components and finds evidences suggesting that the focus on indicators related to credit and the enforcement of contracts is the most important factor. indicators related to cost have the largest potential for fostering growth. messaoud and teheni (2014) find as well a robust link between regulation indices and economic growth, except for trading across borders and dealing with construction permits components of doing business index. however, they conclude that regulation indices and control variables do not matter in terms of growth induction in africa. dawson (2006) finds that credit market regulations affect growth, primarily through the investment channel, while business regulation has a significant effect on growth, via the total factor productivity channel. moreover, countries are far from adopting an uniform set of regulations and large differences between them are in place. just to provide an example, nicoletti and scarpetta (2003), by using a large new dataset on product market regulation, show that regulatory policies in oecd nations have become more dissimilar in relative terms over time. they explain this finding by different starting points and different reform speeds. their data also show that this divergence in the regulatory settings lines up with the divergent growth performance of oecd nations; in particular the poor performance of large continental economies relative to that of the united states. hence, if the nature of the regulatory framework is really relevant in explaining growth, one might expect large spectra of effects induced by changes in this framework on growth. thus, any model aiming to describe the impact of regulations should account for this potential heterogeneity of associated effects. supplementary, it can be argued that there might be a tradeoff between the number of regulations and, respectively, their quality. on one hand, regardless of the quality of regulations, too many regulations can be detrimental for growth. surely, this argument should be considered with caution (for instance: busse and groizard, 2008, show that excessive regulations restrict growth, through the channel of foreign direct investments, only in the most regulated economies; dawson, 2006, finds that an increased complexity of the regulatory framework is negatively related to private investment and positively related to government investment). however, at a general level of discussion, it can be considered that ‘excessive’ regulations burden the free economic initiative and so it might harm growth. on another hand, at a comparable level of regulatory pressure, the differences between countries in terms of growth can be, inter alia, explained by differences in the quality of regulations (as pointed out by findings, such as haltiwanger et al. (2014), suggesting that, even after controlling for industry and size effects, there remain significant differences in job flows across countries, which could reflect differences in labor market regulations). similarly, djankov et al.(2002) find (consistently with the public choice approach emphasizing rent extraction by politicians) that countries with less limited, less democratic, and more interventionist governments regulate entry of start-up companies more heavily, even controlling the level of economic development. as the authors explain “entry is regulated more heavily by less bogdan dima, ştefana maria dima 35 democratic governments, and such regulation does not yield visible social benefits” (djankov et al., 2002:35). finally, the regulations are not adopted in an empty societal space. rather, this space is populated by various formal and informal, macro and grassroots institutions. also, these institutions are the outcome of evolutionary historical processes. for instance, botero and al. (2004) find that the historical origin of a country’s laws shapes its regulation of labor and other markets and that the countries have pervasive regulatory styles inherited from the transplantation of legal systems. both ‘policies’ and ‘institutions’ influence growth and, so, any model of policies’ impact on growth cannot be ‘context-free’: it should account for the influence of the existing institutional surround. though, while policies can be adjusted on ‘short-run’, institutions usually evolve on ‘long-run’. during ‘institutional adjustment’ period, the social landscape can be substantially modified and several endogenous or exogenous shocks might occur. thus, there is no guarantee that the presence of a certain institution will always generate the same outcomes of social decisions. consequently, the impact of policies, as modulated by institutions, is not necessarily uniform. for instance, there is no warranty that a democratic arrangement of social institutions will always leads to public decisions that are socially optimal; while, correlatively, it is not clear, on an ex ante basis, that an authoritarian regime will always adopt ‘bad’ policies. but what really matters is the possibility to operate corrections to the negative consequences of ‘bad’ policies and, hence, the extent to which the institutional arrangements allow for feed-back corrective reactions from the private sector and civil society. following such arguments, one can expect a large variety of synergic effects between institutions and policies in growth processes. we aim to advance a two-fold contribution to this stream of literature. first, we methodologically account for the uncertainty related to possible alternative explanations for growth processes by involving a ‘bayesian model averaging’. second, we assess the impact of business environment on economic growth. even ifa large body of literature employs world bank’sdoing business index, we see this measure as not immune to various criticisms. hence, we involve other indicators for the quality of policies, namely the descriptors reflected by country policy and institutional assessment. these indicators benefits from a pronounced ‘in-field’ nature and reflects a large variety of possible public policies. methodology growth is a multi-dimensional process. it depends on resources and geography, technology and human capital. but it depends as well on institutions and politics, culture and social norms and behaviors. it is shaped by long-run historical forces and it is affected by short-run shocks. furthermore, growth influences almost any aspect of the societal life and feed-back and feedforward mechanisms link growth to any major economic and social variable. hence, the task of modeling growth faces a large degree of uncertainty in regard to the ‘true’ model that should be involved. still: “standard statistical practice ignores model uncertainty. data analysts typically select a model from some class of models and then proceed as if the selected model had generated the data. this approach ignores the uncertainty in model selection, leading to over-confident inferences and decisions that are more risky than one thinks they are” (hoeting et al., 1999:382). let consider the following standard model of economic growth: ( ) ( )γ γ γα β ε ε σ= + + � 2, 0, 1y x n i here, y stands for the dynamic of economic output, x is a matrix of economic growth determinants, αγ is a constant term, while ε is a shock to growth modeled as a normal i.i.d. error term with variance σ2. 36 economic analysis (2018, vol. 51, no. 3-4, 33-56) a major issue for the estimation of such model relates to the existence of a substantially large list of potential economic growth determinants. such list may include both ‘hard’ economic and social variables, but also ‘soft’ institutional, cultural and behavioral ones. this raises several subsequent questions, which are critical for the proper specification of growth models: which variable xr from the set {x} should be included in the ‘true’ model? how important is actually an individual variable in explaining the mechanisms of growth? the ‘bayesian model averaging’ (bma) provides a way for relevant variables identification and dealing with model uncertainty, by estimating models for all possible combinations of {x} and, further, by constructing a weighted average over all of them (see, as an example for the application of this methodology in the context of growth, horvath, 2013). hence, if the full set of possible explanatory contains k variables, there are l = 2k variable combinations and, thus, m1, …,ml models to be considered. the specific model weights derive from posterior model probabilities that stand up from bayes' theorem: ( ) ( ) ( )( ) ( ) ( ) ( ) ( ) ( ) 1 | , | | , | | , 2 | | , l s s p y m x p y m p y m x p y m p m y x p y x p y m x p m γ γ γ γ γ γ = = = ∑ since denotes the integrated likelihood, which is constant over all models, the posterior model probability (pmp) appears to be proportional to the marginal likelihood of the model multiplied with a prior model probability p(mγ) reflecting prior beliefs about how probable is model mγ before any data examination. from here, one can derive the pmps and, thus, the model weighted posterior distribution for any statistic θ (such, for instance, the one for parameters β): ( ) ( ) ( ) ( ) 1 | , | , , | , 3 l p y x p m y x p m x yγ γ γ θ θ = = ∑ in addition, the ‘unconditional coefficients’ are defined as: ( ) ( ) ( ) ( ) 1 | , | , , | , 4 l e y x p m y x p m x yγ γ γ γ β β = = ∑ these coefficients represent a weighted average over all models, including those where this particular coefficient was restricted to zero. by contrast, the ‘conditional coefficients’ are ‘conditional on inclusion’, i.e. they represent a weighted average only over those models, where its regressors were included. finally, the associated posterior variance is equal with: ( ) ( ) ( ) ( ) ( ) ( )( ) ( )2 1 1 | , | , | , , | , | , , | , 5 l l v y x p m y x v m y x p m y x e m y x e y xγ γ γ γ γ γ β β β β = = = + −∑ ∑ this posterior variance includes both the weighted average of the estimated variances of the individual models, as well as the weighted variance in estimates of coefficients across different models. hence, even if there is obtained precise estimates in all the models, one might end up with considerable uncertainty about the parameter, if those estimates are very different across specifications (moral-benito, 2015). it can be noticed that the choice of the prior model probability is critical in obtaining plausible estimates. several solutions are usually considered. one is the so-called ‘uniform prior probability’ designed to reflect the lack of prior knowledge ( ) 1p mγ ∝ . a second alternative, based on an ( )|p y x ( )| ,p m y xγ ( )| ,p y m xγ bogdan dima, ştefana maria dima 37 ‘inclusion and exclusion probabilities’ approach, corresponds to the ‘binomial model prior’. it places a common and fixed inclusion probability θ on each of the regressors. hence, the prior probability of a model of size k is ( ) ( )1 k kkp m γγγ θ θ −∝ − . subsequently, the expected model size is m kθ − = and the ‘fixed’ prior is ( ) 1 k k k m m p m k k γ γ γ −− −       ∝ −         . however, one can observe that the fixed common parameter in the binomial prior is centering the mass of its distribution quite close to the prior model size. a random approach grounded on beta-binomial model prior, in the case of which the inclusion probability is drawn from a beta distribution, provides a less ‘tight’ prior distribution. in correspondence to her / his prior beliefs on the appropriate model, one can choose among such options, in order to specify the prior model probability. still, obtaining posterior distributions also requires the specification for the priors on the model parameters. more exactly, it should be specified a prior belief about the normal distribution of the coefficients with a certain specified mean and variance. a ‘conservative’ set of the prior mean is equal to zero, while their variance structure can be defined according to zellner's g hyper-parameter. thus: ( ) 1 2 '1| 0, 6g n x x g γ γ γβ σ −         � the hyper-parameter encapsulates the uncertainty related to coefficients being close to zero, while posterior distribution of coefficients reflects this prior uncertainty: with a given g, this distribution might follow, for instance, a t-distribution with expected value ( ) ^ | , , , 1 g e y x g m g γγ γβ β= + (with ^ γβ being the standard ols estimator for model γ). hence, the expected value of coefficients might be seen, in this case, as a convex combination of ols estimator and prior mean (zero) and changes in g will lead to changes in this value. this framework allows the estimation of the marginal likelihood ( )| , ,p y m x gγ with a size penalty factor adjusting for model size kγ. of course, the critical issue here is the choice of g. one frequently used choice is the so-called 'unit information prior' (uip), which sets g = n as a common value for all models. other used settings are: g= max (n, k2) (“bric”) and g=log(n)3 (“hannan-quinn”). a particular method is represented by the selection of an “empirical bayes (local)”g. this implies a model-specific gγ estimated via maximum likelihood: ( ) ( )( ) 2 2 1 max 0, 1 , 1 r n k g f f r k γ γ γ γ γ γ γ − − = − = − (with rγ2 being the ols r-squared of model mγ). finally, there is also a “hyper-g prior” method related to a beta prior on the shrinkage factor with 1, 1 ,2 4 1 2 g a p b a g    = − < ≤  +    . a value of a=4 implies prior shrinkage to be uniformly distributed over [0, 1]; while a→2 implies a mass close to unity. here, there are two versions that guarantee asymptotic consistency. the first one sets the prior expected shrinkage factor equivalent to the ‘uip’ prior, while the second one sets it at ‘bric’. a key point in the selection of the priors relates to the fact that, in large growth models, there is a relatively high degree of uncertainty: while for standard determinants of growth is somehow easier to formulate ex ante evaluations, the impact of institutions, policies and culture on growth is less straightforward. eicher et al. (2011) find that the uip with uniform model prior generally 38 economic analysis (2018, vol. 51, no. 3-4, 33-56) outperform the other priors considered in their study. it also identified the largest set of growth determinants. hence, for our baseline results we involve this uip/uniform specification. we use the implementation of the bma from feldkircher and zeugner (2015). for the bayesian model sampling, we take 100000 burn-ins and 1000000 draws, yielding to a sufficiently high correlation between the analytical and posterior model probabilities. an mc3 ‘birth-dead’ sampler is considered: one of the k potential covariates is randomly chosen; if the chosen covariate forms already part of the current model mi, then the candidate model mj will have the same set of covariates as mi but for the chosen variable ('dropping' a variable). if the chosen covariate is not contained in mi, then the candidate model will contain all the variables from mi plus the chosen covariate ('adding' a variable) (for more details on the implementation, see zeugner, 2011 and feldkircher and zeugner, 2015). international data we aim to evaluate the potential impact exercised by the individual business regulatory framework in a growth context for a dataset of 65 low-income (and lower-middle income) countries (as classified, in 2015, according to world bank criteria) (see table a.1. from the appendix for the list of these countries). in assessing the relationships between the quality of business regulations and growth, our first task is to consider a proper measure of the business regulatory environment (and other growthoriented public policies). for this, we involve the components of world bank’s international development association (ida) resource allocation index, which is based on the results of the annual country policy and institutional assessment (cpia) exercise that covers the ida eligible countries. the cpia assesses the quality of a country’s current policy and institutional framework. in this context, “‘quality’ refers to how conducive that framework is to fostering poverty reduction, sustainable growth, and the effective use of development assistance” (world bank, 2014:1). since we are mainly interested in public policies aiming to support growth, we choose these indicators rather than alternative assessments (such as, for instance, the ease of doing business). the key argument is related to that: “the criteria focus on policies and institutional arrangements, the key elements that are within the country’s control, rather than on actual outcomes (for example, growth rates) that are influenced by elements outside the country’s control” (world bank, 2014:5). in other words, our goal is to appraise the impact exercised by the individual quality of public policies in sustaining growth in low-income countries and, hence, we choose to involve those explanatory variables able to describe the design of these policies, rather than their outcomes. also, we are aware of the existence of some important criticism in respect to doing business index (see, for instance, the arguments from arruñada, 2010 according to which this index methodology promotes biased measurements that impede proper consideration of the essential trade-offs in the design of formalization institutions; also, irwin, 2009, argues that doing business results are based entirely on rankings that imply an equal spread between consecutive ranks and effectively ignores shortcomings in the research methodology. hence, the derived rankings can mislead countries that have made an effort to reform). by contrast, the cpia business regulatory environment variable “assesses the extent to which the legal, regulatory, and policy environment helps or hinders private business in investing, creating jobs, and becoming more productive. the emphasis is on direct regulations of business activity and regulation of goods and factor markets. three sub-components are measured: (a) regulations affecting entry, exit, and competition; (b) regulations of ongoing business operations; and (c) regulations of factor markets (labor and land)” (world bank, 2014: 19). the cpia rates countries against a set of 16 criteria grouped in four clusters: (a) economic management; (b) structural policies; (c) policies for social inclusion and equity; and (d) public sector management and institutions. all criteria within each cluster receive equal weight, and each bogdan dima, ştefana maria dima 39 cluster has a 25 percent weight in the overall score, which is obtained by averaging the average scores of the four clusters. for each of the 16 criteria countries are rated on a scale of 1 (‘low’) to 6 (‘high’). the scores depend on the level of performance in a given year assessed against the criteria, rather than on changes in performance compared with the previous year. the ratings process involves two key phases. in the benchmarking phase a small, representative sample of countries drawn from all regions is rated; in the second phase, staff rate the remaining countries using benchmark countries’ scores as guideposts (see world bank, 2014, for more details). to these assessments of public policies, we add several other explanatory variables. first, we control for the level of initial development in order to check if there is a certain ‘path-dependence’ in growth processes. second, we consider the impact on growth exercised by growth domestic investments. we also account for the fact that, starting with 1970s, an abundant string of literature explores the significant (although still controversial) relationship between the natural resource abundance and economic growth (leite and weidmann, 2009; gylfason and zoega, 2006; bond and malik, 2009; asiedu and lien, 2011; murphy and hall, 2011). third, we take into account the role played by higher education in the formation of human capital, building technological capabilities and supporting the emergence of knowledge-based growth mechanisms (wolf, 2002; barro, 2001; lin, 2004; bloom et al., 2006; gyimah-brempong et al.,2006; kruss et al., 2015). fourth, we consider the possible existence of a ‘virtuous circle’, where growth and democratic capital reinforces each other as well as the various constraints induced by democratic institutions in the design of public policies (przeworski and limongi, 1993; alesina et al., 1996; feng, 1997; jong-a-pin, 2009; youniset al., 2008; persson and tabellini, 2009). finally, we refer to the role played by culture (as well as by the past colonial experience in sustaining a specific growth trajectory, as are these captured by the use of english language (price, 2003; austin, 2008; williamson and mathers, 2010). all the dependent and explanatory variables are averaged on a time span between 2005 and 2014, in order to eliminate the impact of short and medium business cycle, and a cross-section analysis is carried out. figure 1. business regulations and growth (cross-country evidences) bgd ben btn bol bfa bdi cpv khm cmr caf tcd com zar cog civ dji dma eth gmb gha grd gin gnb guy hti hnd ken kir kgz lao lso mdg mwi mdv mli mrt mda mng moz npl nic ner nga pak png rwa wsm stp sen sle slb lka lcavct sdn tjk tza tgo ton uga uzb vut vnm yem zmb -2 0 2 4 6 8 10 12 1 1,5 2 2,5 3 3,5 4 4,5 5 cpia business regulatory environment 40 economic analysis (2018, vol. 51, no. 3-4, 33-56) results and comments baseline results the baseline results are report in table 1. here we report the unconditional, conditional and standardized (i.e. coefficients that arise if both the response and the regressors are normalized to mean zero and variance one) coefficients. column 1 reflects the relative importance of the considered variables in explaining growth through the posterior inclusion probabilities (pips)-i.e. the sum of posterior model probabilities for all models where a covariate was included. column 2 displays the coefficients averaged over all models, while column 3 shows posterior standard deviations. table 1. growth and business regulatory environment (baseline results) unconditional coefficients conditional coefficients standardized coefficients variables posterior inclusion probabili ties post mean post sd posterior probability of a positive coefficient expected value conditional on inclusion post mean post sd post mean post sd (1) (2) (3) (4) (5) (6) (7) (8) cpia trade 0.859 -1.355 0.766 0.000 -1.578 0.576 -0.300 0.169 natural rents 0.589 0.026 0.027 1.000 0.044 0.020 0.163 0.169 cpia transparency, accountability, and corruption in the public sector environment 0.547 -0.639 0.714 0.000 -1.167 0.562 -0.189 0.212 cpia business regulatory environment 0.534 0.891 1.028 0.998 1.670 0.825 0.214 0.247 cpia equity of public resource use 0.524 0.856 1.000 1.000 1.634 0.798 0.208 0.243 cpia property rights and rule-based governance 0.512 -0.870 1.071 0.003 -1.701 0.910 -0.232 0.286 cpia debt policy rating 0.476 0.454 0.584 1.000 0.955 0.488 0.150 0.193 english language (as first or second language) 0.468 -0.537 0.702 0.000 -1.147 0.594 -0.104 0.136 gni per capita, ppp (constant 2011 international $) (loglevels for 2004) 0.465 -0.825 1.094 0.000 -1.773 0.945 -0.121 0.160 cpia building human resources rating 0.391 0.493 0.767 1.000 1.261 0.731 0.126 0.196 cpia social protection and labour 0.291 0.347 0.700 0.999 1.191 0.825 0.073 0.148 cpia quality of budgetary and financial management 0.259 0.284 0.639 0.998 1.100 0.828 0.065 0.147 cpia quality of public administration 0.217 0.232 0.640 0.964 1.068 0.996 0.048 0.133 bogdan dima, ştefana maria dima 41 gross capital formation (% of gdp) 0.212 0.007 0.017 1.000 0.031 0.026 0.029 0.077 gross enrolment ratio 0.209 0.005 0.016 0.943 0.026 0.026 0.028 0.083 political stability and absence of violence/terrorism 0.205 0.076 0.262 0.849 0.372 0.475 0.033 0.113 cpia gender equality 0.195 0.101 0.311 0.962 0.518 0.531 0.029 0.089 cpia financial sector 0.187 -0.141 0.463 0.062 -0.756 0.824 -0.029 0.096 cpia fiscal policy 0.144 0.048 0.275 0.831 0.336 0.656 0.012 0.070 cpia macroeconomic management 0.141 0.035 0.268 0.755 0.249 0.675 0.008 0.062 cpia efficiency of revenue mobilization 0.132 0.042 0.296 0.826 0.320 0.757 0.009 0.064 cpia policy and institutions for environmental sustainability 0.125 0.021 0.271 0.710 0.170 0.750 0.005 0.062 model space (2^k) 4194304 % top models 48% correlation between iteration counts and analytical pmps for the 10000 best models 0.997 the average number of included regressors 7.680 notes: parameter prior:” g”; parameter prior value: uic; model prior choice: ”uniform several conclusions can be draw based on such results. first, it appears clearly that the quality of business regulations positively supports economic growth in a robust manner, regardless of how the coefficients are specified: 53.4% of posterior model mass rests on models that include cpia business regulatory environment. the extent to which the legal, regulatory and policy environments help or hinder private businesses in investing, creating jobs, and becoming more productive acts like a strong pro-growth factor. a comparison between unconditional and, respectively, conditional estimates of the corresponding averaged coefficient (column 5) provides further details about the relatively importance of business regulatory environment comparing with other determinants of growth. since the computation of the unconditional coefficients often includes models where these coefficients are zero, the conditional level appears to be almost two times larger in the case of this explanatory variable. however, only in the case of standardized coefficients (column 7) the data displays the same order of magnitude, allowing for more direct comparisons. for such coefficients, the inference of the importance of the considered explanatory variables leads to the conclusion that the extent to which the policy framework fosters trade, natural resources rents, transparency, accountability, and control of corruption in the public sector environment, business regulatory environment, equity of public resource use and, respectively, property rights and rule-based governance with the largest levels and posterior inclusion probabilities superior to 0.5 exercises the most important influences on growth. from these variables, the cpia estimate of business regulations appears to exercise the third largest impact after trade policies and rule-based governance. nevertheless, it can be noticed that trade, accountability and property rights and rule-based governance variables display ambiguous negative signs (as column 4, reporting the posterior probability of a positive coefficient, shows it). several factors can explain such outcome: the existence of a ‘path-dependence’ in growth processes; the adoption by the considered countries of an ‘extensive’ model of growth with a lower weight of high-technology sectors (as, for instance, suggested by the importance of natural rents as a growth determinant); the dependence to international markets’ prices (such as the 42 economic analysis (2018, vol. 51, no. 3-4, 33-56) prices of ‘strategic’ raw materials) and, broadly, the countries’ vulnerability to exogenous shocks; the shock waves of the recent financial and real turmoil; the legacy of a history of poor institutional quality or the social, cultural and behavioral environment. supplementary, harstad and svensson (2011) provide an interesting argument in explaining the negative sign obtained for cpia transparency, accountability, and corruption in the public sector rating. according to their model, when the level of development is low, companies are more inclined to bend the rule through bribery. meanwhile, they tend to switch to lobbying when the level of development reaches a certain threshold. hence, the liberalization of the regulatory framework is more likely to generate positive effects over time and their results suggest that the penalty of corruption should be lower in poor countries. second, as displayed in figure 2, the prior model size distribution implies a symmetric distribution around k/ 2 =11. nevertheless, updating it with data, yield to a posterior that puts more importance on parsimonious models. more exactly, with 2k possible variable combinations, a uniform model prior means a common prior model probability and a prior expected model size of k/2. likewise, the uniform model prior puts more mass on intermediate model sizes e.g. expecting a model size of while the posterior expected model size (i.e. the average number of included regressors) is equal to 7.68. also, figure 2 presents the best 2,000 models encountered ordered by their analytical posterior model probabilities (pmps) (the red line), and plots their mcmc iteration counts (the blue line). at a level of 0.997, the correlation between iteration counts and analytical pmps indicates a high degree of convergence. figure 2. posterior model size distribution and probabilities (uic/uniform priors) third, figure 3 displays the marginal densities of posterior coefficient distribution for cpia business regulatory environment, which is a model-weighted mixture of posterior densities for each model. the coefficient appears to be neatly above zero, but somewhat skewed. 0 .0 0 0. 1 0 0 .2 0 posterior model size distribution mean: 7.6798 model size 0 1 2 3 4 5 6 7 8 9 11 13 15 17 19 21 posterior prior 0 2000 4000 6000 8000 10000 0 .0 0 0 0 0 .0 0 1 5 0 .0 0 3 0 posterior model probabilities (corr: 0.9974) index of models pmp (mcmc) pmp (exact) bogdan dima, ştefana maria dima 43 figure 3. marginal densities of posterior coefficient distribution for cpia business regulatory environment overall, it appears that the uniform model prior assumption provides some evidences for the positive impact of business regulatory environment quality on growth. however, eicher et al. (2011) show that the pips for some standard growth determinants may vary depending on the prior structure. for instance, when g takes the ’hyper-g’ prior distribution (as in liang et al., 2008), with the default hyper-parameter a set such that the prior expected shrinkage factor conforms to ’bric’, the overall picture changes as in table 2. table 2. growth and business regulatory environment (hyper bric parameter prior) posterior inclusion probabilities post mean post sd posterior probability of a positive coefficient expected value conditional on inclusion (1) (2) (3) (4) cpia trade 0.913 -1.217 0.632 0.000 cpia business regulatory environment 0.712 0.982 0.913 0.999 cpia property rights and rule-based governance 0.681 -0.982 0.997 0.001 natural rents 0.669 0.021 0.021 1.000 cpia transparency, accountability, and corruption in the public sector 0.660 -0.591 0.609 0.000 gni per capita, ppp (constant 2011 international $) (log-levels for 2004) 0.644 -0.898 0.965 0.000 english language (as first or second language) 0.624 -0.543 0.610 0.000 cpia debt policy rating 0.603 0.421 0.498 1.000 cpia equity of public resource use 0.564 0.591 0.783 0.998 cpia building human resources rating 0.490 0.393 0.635 1.000 political stability and absence of violence/terrorism 0.465 0.177 0.343 0.920 cpia social protection and labour 0.452 0.347 0.643 0.996 cpia quality of public administration 0.423 0.330 0.706 0.969 gross enrolment ratio 0.413 0.008 0.018 0.928 cpia quality of budgetary and financial management 0.404 0.244 0.567 0.985 44 economic analysis (2018, vol. 51, no. 3-4, 33-56) gross capital formation (% of gdp) 0.397 0.008 0.018 0.999 cpia financial sector 0.371 -0.153 0.487 0.117 cpia gender equality 0.368 0.099 0.344 0.878 cpia macroeconomic management 0.337 0.006 0.397 0.533 cpia fiscal policy 0.336 0.049 0.388 0.690 cpia efficiency of revenue mobilization 0.332 0.068 0.412 0.802 cpia policy and institutions for environmental sustainability 0.321 0.005 0.393 0.529 model space (2^k) 4194304 shrinkage-stats average 0.780 standard deviation 0.110 % top models 12.8% correlation between iteration counts and analytical pmps for the 10000 best models 0.963 notes: parameter prior:” hyper”; parameter prior value: bric; model prior choice: ”uniform here, the corresponding pip for cpia business regulatory environment variable substantially increases to 0.71, while the sign remains positive. for the other variables, gni per capita as a measure of the initial level of development, a cultural variable such as english language (as first or second language), cpia debt policy rating, and cpia equity of public resource use largely gains in explanatory power, while trade, accountability and property rights and rule-based governance variables continue to display the same ‘wrong’ impact. 0 .0 0 0 .1 0 0 .2 0 posterior model size distribution mean: 11.1787 model size 0 1 2 3 4 5 6 7 8 9 11 13 15 17 19 21 posterior prior 0 2000 4000 6000 8000 10000 0 e + 0 0 4 e -0 4 8 e -0 4 posterior model probabilities (corr: 0.9630) index of models pmp (mcmc) pmp (exact) bogdan dima, ştefana maria dima 45 figure 4. posterior model size distribution and probabilities (hyper-bric/uniform priors) the upper chart of figure 4 shows that posterior model size distribution remains very close to the model prior. meanwhile, the lower part of this figure 4 displays the discordance between iteration count frequencies and analytical pmps. the posterior expected shrinkage is 0.78, with rather tight standard deviation bounds. figure 5 confirms that posterior shrinkage is tightly concentrated above 0.70. figure 5. posterior density of the shrinkage factor (hyper-bric/uniform priors) we further investigate the sensitivity of our results to the selection of priors’ structures. table 3 reports the results of such analysis for other nine different settings. table 3. the impact of business regulatory environment on growth (various priors) posterior inclusion probability 0.534 0.712 0.723 0.724 0.519 0.517 0.710 0.733 0.721 0.699 0.711 posterior mean 0.891 0.982 1.011 1.013 0.864 0.863 0.979 1.065 1.046 1.015 0.980 posterior standard deviation 1.028 0.913 0.920 0.921 1.023 1.023 0.913 0.932 0.934 0.937 0.913 parameter prior g hyper g g g g hyper hyper hyper hyper hyper parameter prior value uip bric ebl ebl hq hq uip uip uip bric bric model prior choice uniform uniform fixed uniform uniform fixed fixed random uniform random fixed notes: the results for the other variables not reported here. different from baseline results, a reversiblejump sampler is involved (madigan and york, 1995).this sampler either draws a candidate by the birthdeath method with 50% probability. in the other case (chosen with 50% probability) a 'swap' is proposed, i.e. the candidate model mj randomly drops one covariate with respect to miand randomly adds one chosen at random from the potential covariates that were not included in model mi. with these settings, the corresponding pip for business regulations varies between 0.52 and 0.72, while posterior mean remains positive in a stable manner (around 99.8%-99.9% of the cases 0.4 0.5 0.6 0.7 0.8 0.9 1.0 0 1 2 3 4 5 posterior density of the shrinkage factor shrinkage factor d e n si ty ev 2x sd 46 economic analysis (2018, vol. 51, no. 3-4, 33-56) depending on the prior structure). the highest pips are obtained when the ’hyper-g’ prior distribution (as in liang et al., 2008) is involved jointly with ‘fixed’ or ‘random’ settings for model prior choice. lowest pips occur when the hyper-parameter on zellner’s g-prior for the regression coefficients mimics the hannan-quinn criterion (cf. fernandez et al., 2001: 395) with ‘uniform’ and ‘fixed’ model prior choice. for all estimates, the values of posterior means are greater than the uniform prior. endogeneity issues if the design of public institutions and the implementation of public policies are chosen in a completely exogenous manner by the members of political structures or, alternatively, if the institutions and policies are viewed as being ‘fixed’ (at least on ‘short-run’) then the potential causality flows from these institutions and policies to growth and no endogeneity issues should be expected. nonetheless, if rapid growth processes are susceptible to modify the institutional framework and to change the public authorities’ utility function, then reverse causality from growth to institutions and policies might occur. indeed, literature provides some evidences of such impact of growth. for instance, alonso and garcimartín (2013) find that development level determines institutional quality: higher the former, higher the latter. two main arguments might account for such positive impact of development, which emerges both through supply as well as demand side. first, a higher level of development generates more resources available for the construction of better institutions. second, there is an increased demand for a higher institutional quality with sustainable development evolutions. islam and montenegro (2002), glaeser et al. (2004), and rigobon and rodrik (2005) obtain similar results. in glaeser et al. (2004:287) words: “from the beginning, the growth and institutions research recognized that growth may itself lead to better institutions”. thus, we need to address this potential endogeneity within bma model. in order to perform this check, we follow the method proposed by karl and lenkoski (2012) and implemented in karl et al. (2015) to perform model averaging in two-stage linear regression systems subject to endogeneity. this method is built on a gibbs sampler for the instrumental variables framework, discussed in rossi et al. (2006) and it is based on the notion of a conditional bayes factor (cbf). it compares two models in a nested hierarchical system, conditional on parameters not influenced by the models under consideration. karl and lenkoski (2012) show that, by nesting model moves inside the gibbs sampler, model comparison can be performed, via conditional bayes factors, leading to straightforward calculations, without evidences of mixing difficulties. the considered ivbma models the entire system, jointly with important improvement in computational efficiency. table 4 reports the results. table 4. growth and business regulatory environment (ivbma results) variable posterior inclusion probabilities posterior mean lower median upper natural rents 0.784 0.041 0 0.046 0.085 cpia transparency, accountability, and corruption in the public sector 0.768 -0.718 -1.855 -0.752 0.009 cpia equity of public resource use 0.74 0.811 0 0.799 2.249 cpia trade 0.686 -0.679 -1.794 -0.748 0 cpia building human resources rating 0.674 0.591 -0.243 0.51 1.9 gni per capita, ppp (constant 2011 international $) (levels for 2004) 0.651 -0.329 -1.591 -0.02 0.684 cpia business regulatory environment 0.604 0.089 -1.375 0 1.574 bogdan dima, ştefana maria dima 47 cpia social protection and labour 0.53 0.376 -0.304 0 1.75 cpia property rights and rule-based governance 0.528 -0.285 -1.651 0 0.591 cpia quality of budgetary and financial management 0.504 0.286 -0.596 0 1.632 cpia debt policy rating 0.492 0.313 -0.052 0 1.35 cpia efficiency of revenue mobilization 0.461 0.051 -0.832 0 1.046 english language (as first or second language) 0.459 -0.33 -1.561 0 0.149 cpia fiscal policy 0.441 0.205 -0.355 0 1.319 cpia quality of public administration 0.439 0.288 -0.487 0 1.764 cpia macroeconomic management 0.404 0.079 -0.66 0 1.002 cpia policy and institutions for environmental sustainability 0.382 0.036 -0.792 0 0.953 cpia gender equality 0.348 0.158 -0.244 0 1.145 political stability and absence of violence/terrorism 0.283 -0.01 -0.45 0 0.375 cpia financial sector 0.248 -0.066 -1.026 0 0.492 gross enrolment ratio 0.084 0 -0.006 0 0.016 sargan test(probability) 0.760 notes: instruments for business regulatory environment: two regional dummies for africa and asia and foreign direct investments (net inflows; % gdp) we argue that there might be some regional trends in setting the regulatory architecture and, hence, we use, as instruments, two regional dummies for africa and asia. in addition, there is an extensive stream of literature dealing with the inter-connectivity between foreign direct investments and the quality of regulatory environment (alesina and dollar, 2000; globerman and shapiro, 2002; busse and groizard, 2008; morris and aziz, 2011; munemo, 2014; adams and opoku, 2015). the argument is a quite straightforward one: if the foreign companies are largely present in the host economy, these will be able to put pressure on the implementation process of pro-business policies and the implementation of a sound, transparent and stable business environment. with this procedure, the estimated influence of business regulatory environment variable on growth remains important and positive with a pip of 0.60 (although the level of the coefficient substantially declines around ten times, once endogeneity is accounted for). in respect to other variables, the picture remain largely unchanged with natural rents, cpia transparency, accountability and corruption in the public sector, cpia equity of public resource use, cpia trade and gni per capita among the most important explanatories. however, three other new variables become relevant: cpia building human resources rating, cpia social protection and labor and, respectively, cpia quality of budgetary and financial management, while, for english language, the corresponding pip becomes lower than 0.5. the instrumentalisation does not correct for the ambiguous impact of trade regulations, accountability and rule-based governance. additionally, it is worth to note that, in this framework, we also checked for a potential nonlinear transmission of the impact exercised by business regulations on growth. the results (not reported here, but available at request) do not indicate that a higher quality level of business supporting policies is detrimental to growth. we find virtually a zero pip for the squared level of the cpia variable, while the inclusion of the non-linear effect leads to a decrease in the corresponding pip for level to 0.41. 48 economic analysis (2018, vol. 51, no. 3-4, 33-56) sample issues several examples from literature suggest that the mechanisms of growth are far from homogenous, even for low-income countries. for instance, masanjala and papageorgiou (2008) argue that key engines of growth in africa are substantially different from those in the rest of the world (with mining, primary exports and initial primary education exerting a differential effect). thus, a deeper assessment of the results’ robustness requires a more detailed analysis of the considered sample. glaeser et al. (2004: 286) suggest an interesting split-of criterion by noticing that: “although nearly all poor countries in 1960 were dictatorships, some of them have managed to get out of poverty, while others stayed poor. this kind of evidence is at least suggestive that it is the choices made by the dictators, rather than the constraints on them, that have allowed some poor countries to emerge from poverty”. in accordance with this line of reasoning, ‘good’ policies can compensate (at least to a certain extent and up to a certain level of development) for ‘bad’ institutions. of course, this argument does not entail that ‘democracy does not matter for economic growth’. rather, it is related to the view that “countries that emerge from poverty accumulate human and physical capital under dictatorships, and then, once they become richer, are increasingly likely to improve their institutions” (glaeser et al., 2004: 298). hence, as we already mentioned, there might be a growth-policies-institutions nexus. accounting for this, and aiming to evaluate the importance of the potential substitution effects between policies and institutions, we consider a sub-sample of countries with lower levels of political and individual freedoms. with this purpose, we involve the world governance indicators (wgi) project measure of the democratic status -“voice and accountability” -, which seeks to capture perceptions of the extent to which a country's citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and a free media (kaufmann et al., 2011). we exclude, from our dataset, the countries with positive averages values of this indicator for the analyzed time span and we focus exclusively on the others in the ivbma framework. table 5 reports the results. table 5. growth and business regulatory environment (ivbma results)-reduced sample variable posterior inclusion probabilities posterior mean lower median upper cpia trade 1 -1.341 -2.163 -1.359 -0.461 cpia building human resources rating 0.877 0.894 -0.178 0.939 2.214 english language (as first or second language) 0.657 -0.341 -1.51 -0.086 0.501 cpia business regulatory environment 0.634 0.483 -0.552 0.141 2.124 cpia financial sector 0.626 -0.071 -1.263 0 0.96 cpia fiscal policy 0.593 0.453 -0.255 0.232 1.647 cpia equity of public resource use 0.553 0.413 -0.259 0 1.733 cpia transparency, accountability, and corruption in the public sector 0.542 -0.266 -1.329 0 0.398 cpia property rights and rule-based governance 0.508 0.122 -0.831 0 1.272 cpia macroeconomic management 0.474 0.204 -0.497 0 1.281 cpia quality of budgetary and financial management 0.469 0.225 -0.474 0 1.427 cpia social protection and labor 0.45 0.27 -0.505 0 1.723 bogdan dima, ştefana maria dima 49 cpia policy and institutions for environmental sustainability 0.378 0.012 -0.993 0 1 cpia quality of public administration 0.34 0.023 -1.005 0 1.057 gni per capita, ppp (constant 2011 international $) (levels for 2004) 0.326 0.074 -0.636 0 0.973 cpia debt policy rating 0.311 0.146 -0.145 0 1.116 cpia efficiency of revenue mobilization 0.261 -0.008 -0.703 0 0.73 cpia gender equality 0.216 0.005 -0.503 0 0.541 political stability and absence of violence/terrorism 0.171 0.034 -0.233 0 0.637 natural rents 0.128 0.005 0 0 0.052 gross enrolment ratio 0.061 0 -0.009 0 0.006 gross capital formation (% of gdp) 0 0 0 0 0 sargan test(probability) 0.436 notes: same instruments as in table 4. excluded countries (with positive average values for ‘voice and accountability’ variable) are: benin, cabo verde, dominica, ghana, grenada, guyana, kiribati, mali, mongolia, papua new guinea, samoa, sao tome and principe, solomon islands, st. lucia, st. vincent and the grenadines, tonga, and vanuatu. the relative importance of the business regulatory environment slightly increases in terms of pips, but is around six times larger in terms of posterior mean. for the other variables, the most striking increase in explanatory power is the one corresponding to the national policies and public and private sector service delivery that affects the access to and quality of health and education services [although a variable for higher education such ‘school enrolment, tertiary (% gross)’ does not appear to play any role in explaining growth]. since such policies affect directly and extensively the human capital, it appears that the public policies supporting business supports growth together with the enhancement of human and social capital, even in countries with lower institutional quality. interesting enough, in this sub-sample, the cpia variable reflecting private economic activity is facilitated by an effective legal system and rule-based governance structure, in which property and contract rights are reliably respected and enforced; and it appears with a pip greater than 0.5 and with a “right” positive sign of posterior mean. less democratic countries seem to be able to benefit from relatively high rates of growth, under the condition of promoting corresponding policies to support private sector and to enhance the business environment as well as to protect property rights (together with the development of financial sector and implementation of sound fiscal policies). still, one can note that the world governance indicators’ variable ‘political stability and absence of violence/terrorism’ which measures perceptions of the likelihood of political instability and/or politically motivated violence, including terrorism does not play virtually any role both in the full sample as well as in the sub-sample. one possible explanation relates to that, for this variable, a country that is a functioning democracy, but is wrecked by domestic politically motivated violence, may not score well on this indicator. nevertheless, at a more profound level, we see this as a supplementary evidence of an impending process, which takes place on ‘short-run’, between ‘policies’ (mainly economic-related ones) and ‘institutions’ in terms of growth-induced effects. however, it seems that this is not the case for other types of policies, such as those promoting gender equality or environmental sustainability: in low-income countries, these types of policies exercise little impact on growth regardless of their democratic status. nor does it exercise a significant impact a standard economic variable, such as the gross capital formation: if the overall economic environment does not provide enough opportunities, internal investments are less able to act as a growth engine. 50 economic analysis (2018, vol. 51, no. 3-4, 33-56) conclusions we use cross-country data for a sample of 65 low-income (and lower-middle income) countries in order to investigate the relationships between business regulatory environment and growth, in the framework accounting for model uncertainty, i.e. ‘bayesian model averaging’. the results suggest a statistically significant positive relationship between the overall quality of business regulatory environment, as captured by the corresponding cpia indicator, and growth: countries with a higher quality of their business supporting policies are more likely to enjoy higher growth, regardless of their initial level of development. this outcome is found to be robust to various choices of priors’ structures. we also contemplate the existence of some potential endogeneity issues that might emerge in the processes linking business regulations and growth, by involving an bma model with instrumental variables. while the direct impact of regulations on growth remains significant, its estimated amplitude largely declines once the endogeneity is considered. finally, we consider the possibility that ‘good’ policies might compensate (up to a certain degree) for ‘bad’ institutions. indeed, when a sub-sample of countries with lower levels of political participation and freedom of expression and association is considered, then the impact exercised by the quality of business regulations appears to be more pronounced. overall, we view such findings as providing an empirical support for the thesis that regulatory policies and their outcomes really matter in explaining growth. however, further research is required for a more detailed analysis of the multiple interactions between policies, institutions and growth. acknowledgement this work was supported by a grant from iceland, liechtenstein and norway through the project 15-see-pc-ro timisoa01 "opportunities and challenges for tertiary educational system in promoting evidence-informed good governance society activegovedu" co-funded from the the eea financial mechanism 2009-2014 inter-institutional cooperation projects, contract no. 2/24/07.2015. references adams, s., and opoku, e.e.o. 2015. 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" perspectives: policy and practice in higher education, 6(4): 115–118. doi:10.1080/ 136031002320635023 world bank. 2014. cpia 2014 criteria. washington, d.c.: world bank group. retrieved from http://documents.worldbank.org/curated/en/2015/06/24698216/cpia-2014-criteria world bank. 2015. world development indicators 2015. world bank. doi:10.1596/978-0-82137386-6 zeugner, s. 2011. bayesian model averaging with bms for bms version 0.3.0. retrieved from http://bms.zeugner.eu 54 economic analysis (2018, vol. 51, no. 3-4, 33-56) appendix table a.1. list of countries included in the dataset bangladesh ethiopia maldives sierra leone benin gambia, the mali solomon islands bhutan ghana mauritania sri lanka bolivia grenada moldova st. lucia burkina faso guinea mongolia st. vincent and the grenadines burundi guinea-bissau mozambique sudan cabo verde guyana nepal tajikistan cambodia haiti nicaragua tanzania cameroon honduras niger togo central african republic kenya nigeria tonga chad kiribati pakistan uganda comoros kyrgyz republic papua new guinea uzbekistan congo, dem. rep. lao pdr rwanda vanuatu congo, rep. lesotho samoa vietnam cote d'ivoire madagascar sao tome and principe yemen, rep. djibouti malawi senegal zambia dominica table a.2. list of variables variable content source of data dependent variable gdp growth (annual %) annual percentage growth rate of gdp at market prices based on constant local currency. aggregates are based on constant 2005 u.s. dollars. gdp is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. it is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources (2005-2014 averages) world bank group, world development indicators database (http://databank.wo rldbank.org/data/re ports.aspx?source= world-developmentindicators) cpia criteria cpia business regulatory environment rating the extent to which the legal, regulatory, and policy environments help or hinder private businesses in investing, creating jobs, and becoming more productive. world bank group, cpia database (http://databank.wo rldbank.org/data/re ports.aspx?source=c ountry-policy-andinstitutionalassessment) cpia building human resources rating national policies and public and private sector service delivery that affect the access to and quality of health and education services, including prevention and treatment of hiv/aids, tuberculosis, and malaria. cpia debt policy rating whether the debt management strategy is conducive to minimizing budgetary risks and ensuring long-term debt sustainability. cpia efficiency of revenue mobilization rating the overall pattern of revenue mobilization--not only the de facto tax structure, but also revenue from all sources as actually collected. cpia equity of public resource use rating the extent to which the pattern of public expenditures and revenue collection affects the poor and is consistent with national poverty reduction priorities. cpia financial sector rating the structure of the financial sector and the policies and regulations that affect it. cpia fiscal policy rating the shortand medium-term sustainability of fiscal policy (taking into account monetary and exchange rate policy and the sustainability of the public debt) and its impact on growth. bogdan dima, ştefana maria dima 55 cpia gender equality rating the extent to which the country has installed institutions and programs to enforce laws and policies that promote equal access for men and women in education, health, the economy, and protection under law. cpia macroeconomic management rating the monetary, exchange rate, and aggregate demand policy framework. cpia policy and institutions for environmental sustainability rating the extent to which environmental policies foster the protection and sustainable use of natural resources and the management of pollution. cpia property rights and rule-based governance rating the extent to which private economic activity is facilitated by an effective legal system and rule-based governance structure in which property and contract rights are reliably respected and enforced. cpia quality of budgetary and financial management rating the extent to which there is a comprehensive and credible budget linked to policy priorities, effective financial management systems, and timely and accurate accounting and fiscal reporting, including timely and audited public accounts. cpia quality of public administration rating the extent to which civilian central government staff is structured to design and implement government policy and deliver services effectively. cpia social protection and labour rating government policies in social protection and labour market regulations that reduce the risk of becoming poor, assist those who are poor to better manage further risks, and ensure a minimal level of welfare to all people. cpia trade rating how the policy framework fosters trade in goods. cpia transparency, accountability, and corruption in the public sector rating the extent to which the executive can be held accountable for its use of funds and for the results of its actions by the electorate and by the legislature and judiciary, and the extent to which public employees within the executive are required to account for administrative decisions, use of resources, and results obtained. the three main dimensions assessed here are the accountability of the executive to oversight institutions and of public employees for their performance, access of civil society to information on public affairs, and state capture by narrow vested interests. economic and social variables gni per capita, ppp (constant 2011 international $) gni per capita based on purchasing power parity (ppp). ppp gni is gross national income (gni) converted to international dollars using purchasing power parity rates. an international dollar has the same purchasing power over gni as a u.s. dollar has in the united states. gni is the sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output plus net receipts of primary income (compensation of employees and property income) from abroad. data are in constant 2011 international dollars. world bank group, world development indicators database (http://databank.wo rldbank.org/data/re ports.aspx?source= world-developmentindicators) gross capital formation (% of gdp) gross capital formation consists of outlays on additions to the fixed assets of the economy plus net changes in the level of inventories. fixed assets include land improvements; plant, machinery, and equipment purchases; and the construction of roads, railways, and the like, including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings. inventories are stocks of goods held by firms to meet temporary total natural resources rents (% of gdp) the sum of oil rents, natural gas rents, coal rents (hard and soft), mineral rents, and forest rents. foreign direct investment, net inflows (% of gdp) foreign direct investment are the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. it is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. this series shows net inflows (new investment 56 economic analysis (2018, vol. 51, no. 3-4, 33-56) inflows less disinvestment) in the reporting economy from foreign investors, and is divided by gdp. school enrolment, tertiary (% gross) gross enrolment ratio is the ratio of total enrolment, regardless of age, to the population of the age group that officially corresponds to the level of education shown. tertiary education, whether or not to an advanced research qualification, normally requires, as a minimum condition of admission, the successful completion of education at the secondary level. other policies and institutional variables political stability and absence of violence/terrorism measures perceptions of the likelihood of political instability and/or politically-motivated violence, including terrorism. estimate gives the country's score on the aggregate indicator, in units of a standard normal distribution, i.e. ranging from approximately -2.5 to 2.5. world bank group, worldwide governance indicators database (http://databank.wo rldbank.org/data/re ports.aspx?source= worldwidegovernanceindicators) voice and accountability captures perceptions of the extent to which a country's citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and a free media. estimate gives the country's score on the aggregate indicator, in units of a standard normal distribution, i.e. ranging from approximately -2.5 to 2.5. cultural variable english language (as first or second language) dummy for english language as a first (or second) spoken language in the country (“1”) central intelligence agency, the world fact book, (https://www.cia.go v/library/publicatio ns/the-worldfactbook/fields/209 8.html) article history: received: november 19, 2018 accepted: december 21, 2018 microsoft word 2007 3 4.doc 2007 ‐ 28  •  economic analysis®    abstract: renewed confidence in the positive benefits of fdi to the economic development of the  host country has led many countries to be more open towards fdi since the beginning of 1990s.1 as a result  of increased liberalisation and technological advances, fdi flows rapidly increased during last few decades.  fdi increased as a ration of domestic investment and gdp in many countries (unctad, 2005). however,  while some countries attracted large fdi flows, others were less successful, even though they had liberalised  fdi regimes. a huge number of different studies on the impact of fdi on economic growth and productivity  of domestic economy have been published.2 a general conclusion of these studies is that the benefits of the  foreign companies in terms of economic development, even though they possesses a bundle of desirable assets  (including a long‐term external financing, new technology, skills, management practice and market access),  and in general they are more productive, pay higher wages and are more export intensive than local firms,  are by no means automatic. in addition, researches showed that fdi can also lead to some less desirable or  undesirable outcomes such as rising inequality between individuals or groups of individuals in the society  and between the regions, direct or indirect crowding‐out of local capabilities or an erosion of the tax base or  labour and environmental standards. development of the local absorptive capacity (skills, r&d, infrastruc‐ ture and etc.), is of the key importance in shaping the ultimate effect of fdi, suggesting an important role of  complementary policy. different programmes of encouraging linkages between tncs and local firms, pro‐ grammes supporting clusterisation and upgrading fdi are also approved as  important. in this paper we  analyze appropriate role of fdi policy in raising national competitiveness. the first section discusses the role  of fdi in technology transfer, learning and competitiveness. here we analyze benefits and costs of internal‐ ized technology transfer through fdi flows and in general, this type of technology transfer is very efficient  mean of  transferring a package of capital, skills,  information, networks, and brand names  to developing  countries. for many technologies, internalised transfers are the only possible mode of transfer. also, inter‐ nalization may be the most efficient way of transferring the tacit knowledge involved and in the case of rapid  technology changes. however, internalized technology transfer may also have some expenses. in general, the  more standardized and diffused the technology and the more capable the buyer, the more economical will  externalized modes be. a more subtle reason in favour of externalization concerns the existence of learning  benefits, deepening and externalities. costs of internalized technology transfer are especially expressed on the  top level of technological capabilities where local innovative efforts become viable. at this stage, there is a  case for restricting reliance of internalized forms to promote local r&d capabilities based on externalized  forms, or for intervening in the fdi process to induce mncs to transfer more advanced technological func‐ tions. we discuss the rationale for fdi policy and preset the experience of ireland and singapore since these  two  countries  have  been  highlighted  for  using  the  best‐practice  policies  toward  attracting  fdi.  using  benchmarking method we analyze fdi policy in bosnia and herzegovina.  1 it is important to mention that more open approach toward fdi is became necessity having in mind wto rules and  importance of technology transfer because they have maid almost impossible for developing countries to build up an  industrial capacity behind closed doors.  2 these studies are focusing on different level of analyses (country, sector or company) and they are different by the  number of countries included in the analyses. for detailed review of the results of these researches see te velde (2003).  foreign direct investment and  national competitiveness – financial aspects  adnan rovčanin, university of sarajevo key words : fdi policy, competitiveness, bosnia and hertzegovina  jel : e21, e22, f21  original paper  volume 40 • autumn 2007 • 29  introduction    renewed confidence in the positive benefits of fdi to the economic development of the host  country has led many countries to be more open towards fdi since the beginning of 1990s.3 as a  result of increased liberalisation and technological advances, fdi flows rapidly increased during  last few decades. fdi increased as a ration of domestic investment and gdp in many countries  (unctad, 2006a). however, while some countries attracted large fdi flows, others were less suc‐ cessful, even though they had liberalised fdi regimes.  a huge number of different studies on the impact of fdi on economic growth and productiv‐ ity of domestic economy have been published.4 a general conclusion of these studies is that the  benefits of the foreign companies in terms of economic development, even though they possesses a  bundle of desirable assets (including a long‐term external financing, new technology, skills, man‐ agement practice and market access), and in general they are more productive, pay higher wages  and are more export intensive than local firms, are by no means automatic. in addition, researches  showed that fdi can also lead to some less desirable or undesirable outcomes such as rising ine‐ quality between individuals or groups of individuals in the society and between the regions, direct  or indirect crowding‐out of local capabilities or an erosion of the tax base or labour and environ‐ mental standards. development of the local absorptive capacity (skills, r&d, infrastructure and  etc.), according to those analyses, has a key importance in shaping the ultimate effect of fdi, sug‐ gesting an important role of complementary policy. different programmes of encouraging linkages  between tncs and local firms, programmes supporting clusterisation and upgrading fdi are also  approved as important.  this paper is organised as follows. the first section discusses the role of fdi in technology  transfer, learning and competitiveness. here we analyze benefits and costs of technology transfer  through fdi flows and tnc subsidiary characteristics which enable them to contribute more to  the national competitiveness of its host country. in the second section, we discuss the rationale for  fdi policy and preset the experience of ireland and singapore since these two countries have been  highlighted for using the best‐practice policies toward attracting fdi. in the third section of the  paper, using benchmarking methodology, we analyze fdi policy in bosnia and herzegovina by  comparing it with the experiences in the two countries. finally, in the forth section we draw con‐ clusions and give some policy recommendations.  the role of fid in raising national competitiveness  global fdi flows are dominated by the multinational corporations (mncs). mncs are also  the main source of innovation and innovation is often the main competitive factor that allows them  to become and remain multinational  (unctad, 1999). as  the major  innovators, mnc are  the  main source of international technology transfer. their role is naturally higher in high‐technology  activities where production and export grow much faster than the total world production and ex‐ port (lall, 2003).   in general, technology flows between the mnc affiliates (hereinafter: internalized technol‐ ogy flows) are very efficient means of transferring a package of capital, skills, information, and  brand names to developing countries. for many technologies, internalised transfers are the only  3 it is important to mention that more open approach toward fdi is became necessity having in mind wto rules and  importance of technology transfer because they have maid almost impossible for developing countries to build up an  industrial capacity behind closed doors.  4 these studies are focusing on different level of analyses (country, sector or company) and they are different by the  number of countries included in the analyses. for detailed review of the results of these researches see te velde (2003).  2007 ‐ 30  •  economic analysis®  possible mode of transfer, since innovators are unwilling to part with them to unrelated parties.   even where technologies are available at arm’s length, internalization may be the most efficient  way of transferring the tacit knowledge involved because of the commitment of transferor and its  capability to support learning. if the technology is changing rapidly, internalization provides the  most direct access to improvements. if the activity is export oriented, internalized transfers offer  the additional advantages of international marketing skills and networks, established brand names  or, of increasing relevance, access to integrated production structures spanning several countries.   however, internalized technology transfer may also have some expenses. profits are realized  by the mnc on the package as a whole rather than  just the  innovation component. if the host  country already possesses other elements of the package, it is cheaper to buy the technology sepa‐ rately. in general, the more standardized and diffused the technology and the more capable the  buyer, the more economical will externalized modes be. however, there is a more subtle reason:  the existence of learning benefits, deepening and externalities may tilt the choice in favour of ex‐ ternalization even for relative complex and difficult  technologies. in such activities, reliance on  foreign  investment can shorten  the  learning period but reduce  the other benefits of  technology  transfer and capability building.   costs of internalized technology transfer are especially expressed on the top level of techno‐ logical capabilities where local innovative efforts become viable. on this level there can be a con‐ flict of interest between the host country and foreign investor. there are god reasons for interna‐ tional  investors  to keep  innovative work centralized at home or  in a  few developed countries;  these  include ease of coordination, skill availability, proximity  to main markets, and more ad‐ vanced science and technology infrastructures. at the same time, it is important for countries at a  certain stage of industrial development do deepen their capabilities and move into the innovation  led competitiveness phase, according to porter’s classifications.5 there  is clear scope for a clash  between the social interests of the host economy and the private interests of mncs. at this stage,  there is a case for restricting reliance of internalized forms to promote local r&d capabilities based  on externalized forms, or for intervening in the fdi process to induce mncs to transfer more ad‐ vanced technological functions.   the above discussion also  implies that tnk subsidiaries with a certain characteristics are  able  to contribute more  to raising and sustaining national competitiveness of  the host country.  o′donnell and blumentritt (1999) point out the following: (1) the level in which the subsidiary has  an active role in creating and  implementing corporative strategy and the level in which it is a crea‐ tor and user of the knowledge within company; (2) the type of industry, i.e. the level of technology  which the subsidiary is using in its business processes; (3) the volume of the formal and informal  training of the subsidiary’s employees; (4) the degree to which the activities and outcomes of the  foreign subsidiary affect or are affected by the activities of headquarters or other foreign subsidiar‐ ies. the subsidiary characteristics stressed here  involve a high degree of knowledge and skills  transfer from the parent company to its foreign location. in that way they impact innovative capa‐ bility of the host county and its competitiveness. they also may have synergetic effect. a subsidi‐ ary that is both, high‐tech or knowledge intensive as well as having a global mandate role will de‐ velop to an even greater extent the firm‐level resources that contribute to national competitiveness.  foreign direct investment policy  as it was already mentioned, fdi flows continuously grow as well as their ratio in the total  investments. however, while some countries managed to attract large fdi flows, others were less  5 for the detailed insight in the national competitiveness development phases see porter (1990).  volume 40 • autumn 2007 • 31  successful; even they had liberalized their fdi regimes. the objectives of fdi attraction differ by  country (e.g. access to modern technology, market access, economic growth and poverty allevia‐ tion). also, while some countries pay more attention to the quantity of flows, others change their  policy focusing more  to  the quality of fdi. the  term quality usually refers  to fdi with a high  value‐added fdi and/or to fdi with positive linkages and spill‐over effects for the domestic econ‐ omy. countries that have had successful development based on fdi continued with their activities  on further fdi upgrading by encouraging the existing mnc affiliates to develop into strategic in‐ dependents, or by targeting higher value‐added fdi.  the key question economic policy makers in one country should discuss is how fdi can be  incorporated in the country’s development strategy. since the implementation of fdi policies re‐ quire financial resources (through up‐front grants, promotion activities and institutional reform or  through tax concessions) they should decide, if a such an option exist at all, if using fdi is more  efficient and effective way of realising the objectives set in the development strategy. finally, how  much the country will relay on fdi in realising its objectives, and also which type of fdi is neces‐ sary with this respect.   with respect to fdi, the host country in general has to recognise and remove two specific  market failures. the first one refers to the problem of missing information foreign investors are  facing, and the other is the divergence in interest between mobile foreign investors and the host  economy. regarding the degree of the country  intervention on removing these market failures,  lall (1995) identified four different approaches: (1) passive open‐door policy with limited policy  interventions and no industrial policy, (2) open door policy with selected to improve supply con‐ ditions, (3) strategic targeting of fdi, and (4) restrictive fdi policy. while options (1) and (4) are  not  sufficient  to  exploit  opportunities  for  technological  learning,  the  optimum  for  many  low‐ income countries will be near the second approach and only if local capabilities develop a more  strategic and targeted approach may produce better results.   selection of the certain fdi policies should be followed by adequate  implementation. the  most successful are the countries that can follow fdi policies consistently and respond in a flexible  manner to demands by potential investors. as a good and appropriate implementation of this pol‐ icy can be mentioned economic development board – edb – singapore or ireland development  agency – ida.  finally, it is important to point out that some world trade organisation agreements, such as  agreement on conditions for foreign investments, which unable the member countries to use so  called trade‐related investment measures ‐ trim, agreement on trade‐related aspects of intel‐ lectual  property  rights  –  trips,  and  agreement  on  subsidies  and  countervailing  measures  –  scm, limit the options for the domestic fdi policy. however, the general assessment is that there  is still some scope for creating the corresponding fdi policies and for their incorporating in devel‐ opment strategy of the country. it is more a question of whether a country desires or is able to  conduct a proactive fdi policy.  fdi policy in ireland and singapore  in this part of the paper we present fdi experience of ireland and singapore. both countries  have been stressed for using best‐practice policies towards attracting fdi. we first briefly present  some data which highlight importance of fdi in these two economies, than we analyze the role  played by policy in attracting and upgrading fdi and enhancing linkages between tncs and local  firms.   2007 ‐ 32  •  economic analysis®  ireland  economic analysts agree that fdi has played an important role in transformation a largely  agricultural irish society into one of the fastest growing economies in europe with one of the high‐ est per capita gdp. fdi has created jobs in new sectors, raised investment and enhanced overall  and local productivity. in 1995, foreign affiliates in irish manufacturing accounted for 47.1 per cent  of the total number of employees, 76.9 per cent of value added, 52.6 per cent of wages and salaries,  68.0 percent of r&d expenditure (in 1993), 82.3 per cent of exports and 77.8 per cent of imports  (oecd, 1999). value added per employee in foreign‐owned firms was over 60 per cent higher than  in domestic firms. barrel and te velde (1999) estimate the impact of fdi on overall technical pro‐ gress and find it to be significant and positive.   visible influence of fdi on irish economy has resulted in huge number of papers that stress  importance of different factors in attracting fdi, starting from industrial (ruane and gorg, 1999)  and macroeconomic policy (fitz gerald, 2000), but also some other factors (ruane and gorg, 1999)  such as its location. some papers also put attention to policies for upgrading fdi and to make link‐ ages between tncs and local firms (o′malley, 1998).   industrial policy towards fdi has been implemented by ida. initially a part of the depart‐ ment of industry and commerce with powers to issue grants that covered the costs of land and  buildings, ida was established as a separate state agency in 1969 with the responsibility for na‐ tional industrial development. ida expanded quickly in terms of staff (230 initially) and location  of operation with ida staff operating worldwide. ida targeted aggressively and firm‐specifically  involving telephone calls, presentations, provision of research, visits and other meetings. the ida  identified electronics and pharmaceuticals companies from the us as offering the best opportuni‐ ties for fdi led industrialisation.6   the ida was also able to award grants to firms covering part of their initial capital expendi‐ ture and these were later coupled to employment generation.7 ida expenditure per job decreased  from over ir 35,000 in the period 1981‐1987 to ir 10,000 over 1993‐1999. total expenditure of ida  ireland in 1999 amounted to ir 160 million, with ir 129 million paid in grants and ir 21 million  paid  towards promotion and administration, of which ir 5 million  towards marketing, consul‐ tancy, promotion and advertising (ida, 2000).   fiscal  incentives  have  been  perhaps  more  important  in  attracting  fdi  (ruane  and  gorg,  1999). there was a  fifteen‐year  (zero)  tax holiday on profits  from new export profits  from  the  1950s, which changed into a 10 per cent corporate tax to all new firms (compared to around a stan‐ dard 50 per cent corporate tax rate by that time) from 1982 to be consistent with eu rules. under  futher international pressure ireland is now committed to a 12.5 per cent corporation income tax  for all firms from 2003, with some concessions until 2010. thanks to these fiscal incentives and spe‐ cific targeting, the ida was in the position to develop key export‐intensive sectors (electronics and  pharmaceuticals) leading to band‐wagon and agglomeration effects.   while specific industrial policies have been very important in attracting fdi, there are also  macroeconomic policies and other important factors without which it would have been difficult to  attract fdi. the government has consistently followed a policy of skill‐upgrading by providing  education (fitz gerald, 2000). the availability of skills further improved recently through net im‐ migration of irish and other nationals. while  the physical  infrastructure was  initially neglected  6 these sectors now form the basis of industrial clusters. in 1999, 15 per cent of employment in foreign companies (ida  supported) was in pharmaceuticals/healthcare and 49 percent in electronics/engineering.   7 nowadays, these grants must be consistent with eu rules on state aid which means that they are still allowed only in  low‐income regions.  volume 40 • autumn 2007 • 33  until the late 1980s, eu structural funds (6 per cent of gdp in early 1990s) have helped to develop  the infrastructure since then. ida ireland also develops land and industrial parks for foreign in‐ vestors.   other important factors have been strong historical ties with the us, which helped to attract  us investment, the use of the english as the official language and more recently the boom in the  us and electronics sector.  last but certainly not least, the opening‐up of the irish market, first with signing anglo‐irish  free trade agreement in 1965 and than eu membership in 1973, combined with proximity to the  huge eu market has been of crucial importance for the development of ireland as an export plat‐ form to the eu. however, we must notice that portugal and greece are also close to the eu, but  have been less successful in attracting fdi. economic (as opposed to geographical) distance be‐ comes more important as transportation costs fall and the ´weightless´ economy gains in impor‐ tance.  up to early 1990s, ireland focused more on attracting quality fdi rather than on upgrading  existing fdi. firms in high‐value added sectors were targeted (e.g. through higher grants) more  because  they  added  new,  high‐value  exports,  rather  than  because  they  could  link  in  with  (non)existing local manufacturing capabilities. from the early 1990s there was also concern about  developing affiliates (as ´strategic independents´), focusing on raising the level of r&d in foreign  and also domestic firms. while business r&d as a percentage of gdp has been rising from 0.7 in  1981 to 1.4 per cent in 1997, it is rather low according to the international standards (oecd, 1999).   while attracting export‐intensive tncs ensures fewer fears of crowding‐out of domestic op‐ erations,  there was considerable concern  that  the economic distance between  local and  foreign  firms was too great to lead to significant spillovers and linkages. as a reaction to this national  linkage a programme has been launched. the aim of this programme was to improve organisa‐ tional and marketing skills as well as quality and productivity of local firms to bring it up to the  standard required by tncs. tncs helped to upgrade local suppliers by providing technical know‐ how. partly as a result of the nlp, but also because tncs were present in the market for a longer  time, irish raw material purchases rose between 1988 and 1998, from 15.4 per cent to 21 per cent in  non‐food manufacturing and from 13.2 to 22.8 per cent in electronics (ruane and gorg, 1998). a  key  strategy  for  developing  local  capabilities  was  to  develop  sub‐supply  industries  along  the  value‐added chain, not only for supply of tncs in ireland but also to be able to compete interna‐ tionally, thereby also reducing the dependence on tncs.   singapore  there are many stories about singaporeʹs remarkable development path and the role that  fdi has played8 singapore developed from a struggling low‐income colony in 1960s to a modern  and developed high‐tech country. gdp growth rates have continued to be 10 per cent on average  over the past fourth decades. at the same time, the accumulated stock of fdi as a percentage of  gdp has risen from 5.3 per cent in 1965 to 98.4 per cent in 1998 (yeung, 2001). in 1997/1998, foreign  firms employed 50.5 per cent of workers in manufacturing, 29.1 per cent in trade and 25.7 per cent  in finance.   singapore became independent after two‐year stint with malaysia failed in 1965. singapore,  though traditionally an important trading port, was now isolated from its hinter‐land, as indonesia  refused to import goods and malaysia wanted to cut out the middle‐man singapore in its trading  activities. singapore also lacked natural resources and entrepreneurial business elite. further, there  8 for the detailed insight in the fdi policy in singapore see lall (2000).  2007 ‐ 34  •  economic analysis®  was the impending withdrawal of the british armed forces, which contributed an estimated 20 per  cent to the economy. all these made an import‐substitution strategy virtually impossible. singa‐ pore had no policy option but to industrialise relying on tncs bringing their expertise and tech‐ nologies.   singaporeʹs industrial strategy was partly based on a 1960 undp study on the future of sin‐ gapore. this study recommended the establishment of economic development board (edb) to be  responsible for industrialisation of singapore. the edb was founded in 1961 as one‐stop agency  with a budget of around us$ 25 million (over 4 per cent of gdp). in the beginning of its work edb  was  focusing on ship repair, metal engineering, chemicals and electrical equipment and appli‐ ances.  the edb has acted proactively (developing sites, seeking promotion) and responded to mar‐ ket forces ever since it began operations. the edbʹs aim was to promote industries (mainly foreign  after 1965) in singapore and begun to build up offices abroad. it had four divisions: investment  promotion, finance, projects and technical consultant service and industrial facilities. it was set up  as an autonomous government agency, which could set ist own wages, had a board comprising  business and other agencies, and had an  international advisory board comprising executives of  major foreign companies located in singapore. while in the initial stages the notion of a one‐stop  centre was helpful to attract fdi, the operations became more complex over time and resulted in  the specialisation towards fdi promotion while other activities were  left to other agencies. the  edb has maintained close links with those new agencies ever since and still acts as a one‐stop ser‐ vice.   the edb decided to spend a significant share of allocated funds on the development of the  jurong industrial estate. an uncultivated piece of land was quickly transformed into an industrial  estate with adequate infrastructure and factories and a new port was built. however, the estate  was unsuccessful in the early years and with only twelve pioneering firms in 1961, it had slow start  (activity remained sluggish until 1965). the edb had invested vast sums in joint ventures, some of  which had failed. nevertheless, there have never been real doubts about the fdi‐led industrialisa‐ tion opposite to other developing countriesʹ view that tncs only exploit developing countries.   the industrial strategy proved to be successful by the late 1960s and early 1970s and was  able to reduce unemployment rate fairly quickly. whilst employment generation was a major fo‐ cus of policy in the 1960s and early 1970s, this shifted to capital‐intensive projects in the 1980s, and  knowledge‐intensive sectors in the 1990s. the incentive structure is complex and has developed  over time. a significant  incentive was the pioneer industries ordinance of 1959, with firms ex‐ empted (or significantly reduced) from the 40 per cent corporate tax for a fixed period of time pro‐ vided  that firms developed new products. as  the result  the share of manufacturing output for  firms with pioneer status increased from 7% in 1961 to 51.1% in 1971 and 69% in 1996. another  important tax incentive was the reduction the corporation tax for capital‐intensive industries that  suppose to replace labour‐intensive industries.  over time wages rose, especially in the period 1985‐1986, when the county faced first post‐ war recession. it was obvious that singapore could only cope with rising wages in local firms de‐ veloped capabilities (technical and human resources) and  if tncs continued to upgrade (using  r&d  incentives,  incentives  to set‐up high skilled head quarters and encouraging  joint research  institutes  through government  funding). special programme has been  launched  in 1986, under  which tncs were encouraged to enter into long‐term supply contracts with local firms, leading to  upgrading. the edb began to target knowledge‐intensive industries that could pay higher wages.   as part of a number of relevant skill‐upgrading schemes (lall, 1996), the psb is responsible  for the skill development fund. set up in 1979, it imposed levy on the payroll on employers for  volume 40 • autumn 2007 • 35  every worker earning less than a pre‐determined amount. it is an efficient way to enhance within‐ firm skill upgrading of unskilled workers because firms themselves do not have sufficient incen‐ tives to do so.   more recently, the edb has followed a cluster approach, targeting firms around the electron‐ ics/semi‐conductor, petrochemicals and engineering industries.9 the cluster approach also leads to  enhanced linkages and spillovers to the local economy. government further enhances the value of  the cluster through investment in r&d centres.  while the above indicates a strong role for industrial policy, macroeconomic policies have  also played a role. infrastructure has been built with regard to the needs of tncs. trade policies  have always been very liberal with very low tariff and thanks to an increase in iso certificates also  low non‐tariff  trade barriers. besides  training, general education has also been  important  (lall,  1996).   however, there are also some external factors, which have shaped policies towards fdi or  have been important in attracting fdi, and which may take the case of singapore less general in its  application to other countries. singapore is a city‐state with a relatively authoritarian state that can  formulate policies without much resistance from either other levels of government, or from civil  society. further, singapore never runs government deficits, which  is helpful  to  find capital  for  (profitable)  investment (in part financed out of a high statutory pension  levy). perhaps another  factor for attracting fdi is that the working language is english. further, the location in the time  zone enabled financial services to fill the gap between the us and europe during the 24‐hour day.   bosnia and herzegovina  since the declaration of independence from the former yugoslavia in the beginning of 1992,  bosnia and herzegovina suffered from a conflict for more than three years. according to dayton  peace agreement, which is signed in 1995, bosnia and herzegovina was to remain a single state  comprising two constituent entities – the federation of bosnia and herzegovina, and the repub‐ lika srpska. in the post‐war period economic reconstruction was at the centre stage of activities  and transition to a market economy was to be enhanced.   table 1: b&h main economic indicators indicators  2003  2004  2005          nominal gdp (million eur)  6,812  7,495  8,052  gdp per capita (eur)  1,778  1,950  2,095  real gdp growth rate (%)  3.0  6.0  5.5  annual inflation rate (%)  0.6  0.4  3.7  annual unemployment rate (%)  42.0  43.2  31.1*  trade balance (million eur)  ‐3.035  ‐3.227  ‐3.781  inward fdi (million eur)  *  534  421  * revised estimates based upon the annual labour force survey carried out for the first time in april 2006  source: statistical agency of b&h; central bank of b&h bosnia and herzegovina has relatively stable macroeconomic climate, characterised by sus‐ tained economic growth, stable currency and low inflation (see table 1). in 2005, nominal gdp  reached 8.05 billion eur. real growth was 5.5 per cent, continuing the underlying trend of growth  of around 5.5 – 6 per cent. the central bank of bosnia and herzegovina (cbbh) that started its  9 the edb began an s$ 1 billion cluster development program in 1994, and has recently tripled in size.  2007 ‐ 36  •  economic analysis®  operations in august 1997, pegged its currency (the convertible marka) first against the german  mark and later the euro through the currency board system.10 average inflation rate is the lowest  in see region. b&h has a liberal trade regime with average tariff rate of 6 percent, the lowest in  see after croatia. bh has also signed free trade agreements with all see countries.  the other side of the economic situation in b&h is as follows. the real gdp in 2005 was only  63 percent relative to one from 1989, which is much lower comparing to transition countries aver‐ age (ebrd, 2005). unemployment rate is incredible high. a liberal trade policy compound with the  lack of international competitiveness resulted in huge trade deficit. export to import coverage has  been slightly growing in last few years but still is less than 40 per cent. current account deficit in  2004 was about 17 percent relative to gdp (world bank, p. 24). b&h’s revealed comparative ad‐ vantage in eu markets is concentrated in products with low level of processing. in addition, bh  exports  to  the  eu  are  heavily  concentrated  in  natural  resources‐based  and  unskilled  labour‐ intensive products. resources‐based products the dominant category, accounting for 45 percent of  eu‐bound exports in 2002, while the unskilled labour‐intensive products accounts for the 42 per‐ cent. unlike experiences in other ceecs, bh witnessed limited restructuring in factor intensities of  its  exports.  combined  share  of  skilled  labour‐intensive  and  capital‐intensive  products  in  eu‐ destined sales remained virtually unchanged at about 13 percent over 1997‐2003 period (world  bank, 2005, p. 36‐37).  the enterprise sector of b&h is poorly integrated into international production and distribu‐ tion networks. firms in b&h are primarily inward‐oriented. for example, over 63 percent of the  surveyed firms  in beeps2 relied on foreign sources for their supplies of material  input. at the  same time, export receipts were 10.6 percent of sales revenue in 2002, a number lower than the  see8 regional average of 12.5 percent. only surveyed firms in serbia and montenegro reported  weaker export intensity among the eight see countries. surveyed firms in b&h also fared worse  than the average see firm regarding their activities in new international markets. every fifth sur‐ veyed see firm exported to new markets between 1998 and 2002, while only 6.6 percent of the  surveyed firms in bh had reached new foreign customers during the same period. the reaching of  new markets by bh companies between 1998 and 2002 is similar to the international expansion of  firms in albania and sam, but considerably lower than that of firms from romania and bulgaria  (broadman et. al., 2004).    fdi policy in bosnia and herzegovina  after the 1992‐1995 war, foreign nationals are encouraged to  invest  in the country and to  take part in the privatization process. foreign ownership is generally unrestricted, except in a few  sectors where it is limited to 49 per cent of the legal capital. under the 1998 law on foreign direct  investment policy, foreign investors are given national treatment, and enjoy the same rights (in‐ cluding property rights) and obligations as local investors. they are free to transfer profits abroad  and to repatriate funds related to their investments. no performance requirements are imposed as  a condition for establishing an investment. protection against expropriation is available. guarantee is  given to investors, in the event of a change in legislation, to choose to be subject to the law that is  favourable to them. moreover, in the event of civil unrest arising from political disturbance, pro‐ tection against loss incurred by foreign investors is offered by the investment guarantee agency, a  state body, and backed by the ing bank of netherlands.   the foreign investment promotion agency (fipa), a state body established in july 1999 by the council of ministers, is responsible for promoting and attracting foreign investment. with links at  various levels of government and industry, it provides information on legislation and investment  10 convertible mark is pegged to the euro at a fixed exchange rate of km1 = euro 0.51129.  volume 40 • autumn 2007 • 37  opportunities to potential investors, and assists them to establish joint ventures or greenfield op‐ erations.  bosnia and herzegovina enhances its attraction for fdi in authorizing duty‐free imports of  capital goods that contribute to the capital base of a foreign‐invested enterprise. as the country’s  taxation rate is under the jurisdiction of each entity, investment incentives offered may vary be‐ tween the federation of bosnia and herzegovina, and the republika srpska. the rate of corporate  income tax is 30 per cent in the federation of bosnia. the federation law on corporate income tax  provides that the corporate income tax is reduced for a period of 5 years equal to the percentage of  foreign capital invested in the assets of the company, provided that the foreign capital is greater  than 20 per cent of total capital. this incentive includes companies with 100 per cent foreign capital  investment. the rate of corporate  income tax  is  invariably 10 per cent  in the republika srpska.  bosnia and herzegovina introduced vat on the 1st january 2006 at a flat rate of 17 per cent on all  goods and services and it is collected on the state level.  access to any of the nine free trade zones (ftzs) is possible to both local and foreign inves‐ tors, where most activities may be performed. additional benefits are granted to firms operating  within a ftz boundary. goods manufactured or transformed in the zone may also be sold in the  local market, after payment of duties and taxes on imported items. no taxes and contributions are  levied, except on salaries paid. transactions within an ftz may be expressed in any foreign cur‐ rency and investors are permitted to open foreign‐exchange accounts in authorized banks.    table 2: inward fdi in see region  in million of dollars as % of gross capital formation   fdi flows  1990‐2000  (average)  2003  2004  2005  1990‐2000 (average)  2003  2004  2005  albania  63  178  332  260  21.1  13.5  18.5  13.8  b&h  78  381  606  298  7.8  26.4  34.1  16.0  bulgaria  301  2,097  3,443  2,223  18.1  54.3  68.1  35.1  croatia  544  2,133  1,262  1,695  13.1  25.2  12.5  15.4  fyr, macedonia  59  95  157  100  9.7  12.2  15.9  9.7  romania  656  2,213  6,517  6,388  9.4  17.4  39.9  28.1  serbia and  mont.  165  1360  966  1481  13.4  44.9  24.4  35.8  slovenia  139  333  827  496  3.6  5.1  10.6  5.9    source: unctad (2006b)  despite all the above efforts fdi inflows in b&h are among the lowest in see region (see  table  2).  what  is  maybe  more  important,  according  to  the  world  economic  forum  estimates  (2006), fdi contribution  to b&h  technological upgrading, export and competitiveness  is rather  low.     comparison of b&h with ireland and singapore  here we will make some interesting comparisons between fdi policy in b&h experiences in  ireland and singapore.   o as we saw in the second section of the paper both countries, ireland and singapore,  had an aggressive one‐stop agency with ample political power to swing policies to‐ wards foreign investment. foreign investment promotion agency in b&h has no po‐ litical power. it has around twenty employees. because of relatively low salaries fipa  2007 ‐ 38  •  economic analysis®  is facing problem of frequent fluctuations of its stuff. in last few years its budget has  not been changing and it around 1,5 million of km.   o ireland and singapore followed a pro‐fdi policy consistently and had a strong proac‐ tive  industrial  policy  approach  (perhaps  not  always  explicit  in  policy  documents)  with fiscal incentives and grants. fipa dos not have the strategy of fdi promotion.  every foreign  investor  is treated equally. it dos not matter from which  industry  it  comes, what kind of technology it bring, or is it export oriented or not. b&h has ap‐ plied passive open‐door policy with  limited policy  interventions and no  industrial  policy, according to the lall (1995) classification.   o both countries realised that local capabilities did not develop sufficiently, and put in  place linkage programmes between tncs and local firms. fipa nor any other politi‐ cal entity in b&h do not even analyze the issue of potential gaps between tncs and  the local economy. it is left to the market forces.  o both countries launched programmes of upgrading established foreign investors to  solve the problem of rising factor prices. in b&h there is no political entity which is is  authorised for following activities or  launching programs directed  toward existing  foreign investors.   o what is maybe the most important is that in the case of both countries fdi policy was  clearly fitted in with their development strategies. in this way they were able to de‐ velop  integrated fdi policies. they have used both macroeconomic and  industrial  policies and they have used them to attract fdi, upgrade existing fdi and to enhance  linkages and spillovers to domestic firms.11    conclusions and policy recommendations  based upon renewed confidence the positive effects associated with fdi many developing  countries are  increasingly  looking  for best‐practice policies  towards fdi. whilst fdi can bring  positive effects (technology, finance, market access or brand names), it can also bring negative ef‐ fects. moreover,  the positive effects are not automatic  for host countries and depend on many  other policies and external factors.   importance of different policies depends on the specific country characteristics, the objective  of the country and the derived fdi strategy. however, we can identify some common elements. in  each country fdi policy should fit in with a countryʹs development strategy. also, fdi policy are  likely to be some combination of different policies. macroeconomic polices, as we saw in the case  of ireland and singapore, are often combined with specific industrial policies. both of them are  used for affecting the location decision of foreign investors, affecting upgrading established for‐ eign investors and affecting linkages and spillovers to domestic firms. realising that fdi policy  should comprise policies in each of these categories is a positive step towards enhancing the bene‐ fits of fdi.   analyzing fdi policy in bosnia and herzegovina and comparing it with the experience some  other successful countries we can point out some broad policy recommendations:  o first of all, b&h has to fit in its fdi policy with its development strategy;  o it has to work more on building  local capabilities (r&d, education etc.) and  infra‐ structure to establish economic fundamentals to attract fdi and benefit from fdi;  11 both of these countries had favorable external factors, but according to here reviewed studies they were not decisive in  attracting fdi.  volume 40 • autumn 2007 • 39  o it is needed to start target specific firms that fit into development strategy which can  be coordinated by a true one‐stop investment promotion agency, with more political  power and resources (human and financial);  o fipa or some other political entity has to put in place linkage programmes between  tncs and local firms and programmes of upgrading established foreign investors to  solve the problem of rising factor prices.  literature  1. barrell, r. and te velde, d.w. (1999): ʹlabour productivity and convergence within europe: east german &  irish experienceʹ, niesr discussion paper 157  2. 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government and the banking regulator for successful transition to a financially inclusive economy: an empirical study of india reena agrawal1* 1 jaipuria institute of management, finance & accounting and entrepreneurship, vineet khand, gomti nagar, lucknow india abstract the current study was done to evaluate the measures used by the government of india and indian banking regulator ‐reserve bank of india to promote financial inclusion in india. the study aimed at reviewing the impact of the initiatives on financial inclusion. the paper also intended to explore the impact of increasing penetration of mobile phone and internet on financial inclusion. the study revealed that government initiatives like pradhan mantri jan dhan yojana (pmjdy), aadhar enabled payment systems (aeps) and direct benefits transfer; regulatory reforms by reserve bank of india such as immediate payment service (imps), prepaid payment instruments, differentiated banks; digital revolution and active participation of private technology companies, are facilitating in successful transition into a financially inclusive economy. key words: financial inclusion, mobile money, digital financial inclusion, branchless banks jel classification: e425, p34 introduction “financial inclusion is crucial in decreasing poverty and attaining inclusive economic growth. financial inclusion is not an end, but a means to an end […]. greater access to financial services may help decrease income inequality and accelerate economic growth”. (demirguc‐kunt et al., 2015). availability of funds, especially for the deprived and the underprivileged, is a powerful intervention for economic development. as leaders and policy‐makers search for feasible solutions for balanced and sustainable growth, equitable access the financial product and services, reduction in disparity and poverty come out to be inevitable desirables in the process. conducting financial literacy programs and intensifying the use of financial services, helps in consolidating domestic savings, boosts financial sector resilience, stimulates business, opens up a new horizon for deprived groups and fosters inclusive growth. an inclusive and efficient financial system also helps the government to proficiently implement societal strategies (gpfi, 2014a) and extend new economic opportunities to the people living at low strata of the society. financial inclusion is likely to unleash the immensely unexploited prospective at the grass root level of india`s economy. possibly, financial inclusiveness can result in a revolution of prosperity and growth. * e‐mail: reena.agarwal@jaipuria.ac.in 82 economic analysis (2019, vol. 52, no. 1, 81‐96) in india, for decades, banks were responsible for financial inclusion. but the fact of reality is that financial inclusion can be achieved only when there is strong political will, administrative backing and dogged persuasion by the financial regulator. dovetailing monetary policies with the ongoing structural reforms, with the government as a fulcrum, can lead to steady and sustainable financial inclusion. in the recent years both state and the reserve bank of india have numerous pioneering and devoted measures to push the agenda of financial inclusion. at present, the indian economy is moving through a phase of extreme transformation due to globalisation and technological advancement. the increasing penetration of mobile phone and internet, entry of technology companies in the financial arena and disruptive innovations along with policy and regulatory reforms have improved the financial outreach in the country. the current study was done to evaluate the measures taken by the state and the banking regulator to promote financial inclusion in india. the intention also was to study the impact of these measures in promoting financial inclusion in the country. the paper also intended to explore the impact of increasing penetration of mobile phone and internet on financial inclusion in the banking sector. the study sought answers for the following questions: 1. what role did banks and india post play to promote financial inclusion? 2. what are the steps taken by the state to support financial inclusion and what has been the impact? 3. what are the measures taken by the banking regulator to stimulate financial inclusion and what has been the impact? 4. what is the impact of increasing penetration of mobile phone and internet on financial inclusion? this was empirical research. the research was built on secondary sources of information. the facts and figures were collected and put together from large number of publically available sources such as periodicals, research papers, reports and bulletins by the indian banking regulator‐ reserve bank of india (rbi), world bank, government documents such as report on financial sector reform by planning commission, newspaper articles, research reports by private agencies such as kpmg , pwc, assocham etc. the study provides valuable insights to the traditional banks and microfinance institutions to help them to envision policies to profit from the ongoing changes in india`s economy and also advantage from globalisation. the research will stimulate the policy‐maker to bring further progressive reforms to stimulate financial outreach to the bottom of the pyramid through digital podia, without jeopardising their interest. the research would provide insights to the researchers and academicians, who can explore further, to examine the effects of digitisation on the persons at the grass root level and evaluate whether there is any correlation between digitisation and poverty reduction, financial inclusion and poverty reduction and other such aspects. overview of the literature financial inclusion financial inclusion is “widespread availability of a wide variety of financial services at a rational cost. these comprise banking, insurance and equity” (planning commission, 2009). goi (2008) defines financial inclusion as the procedure of ensuring access to financial services to susceptible groups at a reasonable cost. according to chakraborty (2011), financial inclusion is “ensuring access to suitable financial products and services needed by all present in society especially the deprived groups at a reasonable cost, in transparent manner financial institutions”. most definitions of financial inclusion talk about ―access to inancial services, thus referring to the supply side of financial services. this means that merely by giving the right to use financial services, the deprived groups will start using the services, regardless of whether reena agrawal 83 they are familiar with the services, they need it, or the services suitable to them. however, financial inclusion invariably includes both the demand and the supply side of financial services. roadblocks in financial inclusion gangopadhayay (2009) found that a large number of the low‐income adult population in india is financially excluded – they include not merely those who live in rural areas but also those reside in urban areas. according to ravichandran and alkhathlan (2009), on the demand side illiteracy, low income levels, lack of consciousness and knowledge of financial products and social exclusion are the key hurdles in financial inclusion in india. while on insufficient branches, arrogance of bank officials, lengthy paperwork, lack of customized products and linguistic barriers are the major obstacles on the supply side. das (2010) suggested that banks need to adopt new approaches, such as mobile‐banks, agency system instead of relying on self‐ help groups, to reach vast populations living in remote areas and emphasized on the need to scale up the technology to build a desirable inclusive financial ecosystem. chakraborty (2009) focused on the role of technology in financial inclusion, and said banks should use technology platform, however, the technology solution should be user‐friendly. role of technology in enhancing financial inclusion according to hishigsuren, (2006) technology can help banks to operate thru mobile, atms and point‐of‐sale (pos) grids etc., it thus helps in improved outreach, quicker processing, reduced operational costs and increased customer satisfaction. technology is a tactical instrument which facilitates operators to become effective and proficient. it serves the twin purpose ‐ outreach to deprived groups and sustainability (brynjolfsson and hitt, 2000). mfis in bolivia, peru used atms, smart cards and voice prompts, to enlarge microfinance nets in remote areas with a large number of illiterate people. these service reduced operating costs and benefits were passed to the users (hernandez and mugica, 2003; global envision, 2003). in uganda, mfis used mis, personal digital assistants (pdas), atms, mobiles and smart cards (ssewanyana, 2008). mis for microfinance services, efficiently process transactions, offer quality services to customers, and improves the reach (turaga, 2004). pdas are small palmtops that allows credit officers to get connected to their institution’s mis from the areas where they operate (turaga, 2004). mfis operating in african nations, also use technology for improved efficacy and quicker progress (kinyanjui, 2009). role of telecom companies in boosting financial inclusion in east africa, telecom companies render services like receipt and disbursement national and international payments. safaricom, one such telecom company, single‐handedly helps above seven million customers with an agent‐net which surpasses the entire bank branches in kenya. in kenya, the agent‐based m‐pesa provides mobile‐enabled, p2p money transfer system, it also allows users to store money in electronic account and withdraw and deposit money at m‐pesa’s agent locations (hughes and lonie, 2007; morawczynski and pickens 2009; morawczynski, 2008; morawczynski, 2009; mas and morawczynski, 2009). though m‐pesa wasn’t the first to operate, yet its rapid acceptance among the people is what discriminates it from g‐cash or smart money or in philippines (mendes and alampay, 2007; wishart, 2006). an m‐pesa‐linked bank account is popular among the public, as the clients can open bank accounts using their m‐pesa wallets, get loans without any paperwork and get interest income on savings. the same was imitated in tanzania, afghanistan, and pakistan cgap (2016). globe telecom, in the philippines, offer an e‐wallet facility to its clients, even non‐subscribers can use the services. in the philippines, above two million people use mobile wallets for receipts and disbursements. (wishart, 2006; mendes and alampay, 2007). in the philippines, smart offered bayaload, is used for state transfers, national health insurance program, national housing agency and social benefits schemes, (shrader, 2013). it allows users p2p transfers, paying utility bills, pay at retail stores (murphy, 2014). smartmoney in oona in zambia and tanzania enabled mobile disbursements between farmers and suppliers, 84 economic analysis (2019, vol. 52, no. 1, 81‐96) resulting in lowering operating costs and enhanced security (parada and bull, 2014). zoona, which works in malawi and zambia, provides farmers to generate electronic vouchers and use e‐ wallets (pénicaud and katakam, 2014). m‐kopa in kenya and mobisol in tanzania provide digital payment option (parada and bull, 2014). mobile point‐of‐sale (mpos) enables minor traders to use mobile as pos‐terminals as a substitute to cash transactions. the global mpos installed base is anticipated to increase from 13.3 million units today to 54.0 million units in 2019, with maximum growth in developing nations (rolfe, 2015). payment kiosks are particularly widespread in eastern europe, russia and central asia and, they are increasing in india, china, malaysia, brazil, jordan, argentina, peru, chile, colombia and panama. they are popular among migrant labourers for transnational transmittals (kravtsov, 2013; owens, 2015; ppi, 2014). digital payment services like m‐pesa, tigo pesa, airtel money, easypaisa, b – kash, help in promoting financial inclusion as they process repetitive, small‐value high volume transactions remotely and provide a variety of financial services, at near marginal cost. mobile banking has also facilitated government‐to‐person (g2p) payments. it brings the formerly un‐served, in the ambit of organized financial services, by channelising the steady flow of money into their accounts. in south africa over 80 per cent and in brazil 88 per cent of the payees get state remittance in their bank accounts. move to digital g2p payments has helped mexico to cut it`s expenditure on pensions, wages and other social benefits by 3 per cent per annum (demirguc‐kunt et al. 2015). thus digitizing g2p disbursements have momentous effects on the overall economy of the country in terms of efficacy, security and fair approach. findings banks around the world, the most usual mode of savings is thru bank account, india being no exception. yet, with above 1.3 billion population, only 52.8% of adults have bank accounts. india is home to 21% of the world’s unbanked adults (world bank, 2015). as india toils hard to promote financial inclusion, plotting various financial access points at different levels will help to shift more people from unbanked to banked. the level of financial inclusion in a country is usually measured on the basis of three tangible dimensions: i. branch penetration; ii. deposit penetration iii. credit penetration. according to the reserve bank of india`s report on financial inclusion progress: banks and rrbs during 2014‐15: i. branch penetration: there were 33,378 banking outlets in villages in 2010, which increased to 46,126 (2014) and 49,571 (2015). in 2010 there were 34,316 banking outlets in villages which were working on branchless mode, which increased to 337,678 (2014) and 504,142 (2015). in 2010 there were 67,694 total banking outlets in villages, while in 2014 they increased to 383,804 and 553,713 in 2015. the urban locations covered through bcs were 447 in 2010, 60730 in 2014 and 96,847 in 2015. reena agrawal 85 source: rbi, financial inclusion plan‐summary progress of all banks including rrbs 2014‐15 source: rbi, report of the committee on medium‐term path on financial inclusion 2015 the above graph clearly brings out that though there is substantial surge in the penetration of banks in the villages, yet the number in case of remote areas is 7.8 per 100,000 population, while in urban and metropolitan areas it is 18.7 per 100,000 population which continues to be substantially low when compared to other growing economies. ii. deposit penetration: the deposits in basic savings accounts thru branches amounted to inr 44.3 billion in 2010, inr 273.3 billion in 2014 and inr 365.0 billion in 2015. the deposits in basic savings accounts thru bcs amounted to inr 10.7 billion in 2010, inr 39.0 billion in 2014 and inr 74.6 billion in 2015. total deposits in basic savings bank deposit accounts amounted to inr 55.0 billion in 2010, inr 312.3 billion in 2014 and inr 439.5 in 2015. 86 economic analysis (2019, vol. 52, no. 1, 81‐96) source: rbi, financial inclusion plan‐summary progress of all banks including rrbs 2014‐15 iii. credit penetration: overdraft facility availed in basic savings accounts amounted to inr 0.1 billion in 2010, which increased to inr 16 billion in 2014 and to inr 19.9 billion in 2015. kisan credit card transactions amounted to inr 1,240.1 billion in 2010, which increased to inr 3,684.5 billion in 2014 and to inr 4,382.3 in 2015. general credit card transactions amounted to inr 35.1 billion in 2010; it increased to inr 1,096.9 billion in 2014 and to inr 1,301.6 in 2015. source: rbi, financial inclusion plan‐summary progress of all banks including rrbs 2014‐15 mentioned below are some of the select measure taken by some of the banks in india to boost financial inclusion in the country: i. axis bank: facilitates the opening of bank account using the e‐kyc route. ii. bank of baroda: established above 1,000 urban kiosks and provided banking services through mobile vans in six states. iii. canara bank: introduced micro pension and micro insurance schemes and conducts credit counselling. iv. dena bank: installed biometric atms for illiterate and semi‐literate clients. reena agrawal 87 v. hdfc bank: created a net of remote trade hubs to reach the financial excluded. vi. icici bank: started ‘branch on wheels’ to serve remote unbanked areas. tie‐up with mobile network operators to facilitates remittance to migrant workers. vii. uco bank: mobile vans with cbs connection are operated in unbanked areas. viii. yes bank: introduced yes money and micro atms for domestic transfers. source: annual reports 2013–14 of various banks.  india post india post, the state‐run postal system, has provided savings products for low‐income groups. in addition to financial products aimed at creating demand, india post is a biggest postal system in the world having above 154,822 post offices –of which 1, 39,182 (89.86%) are in remote areas (india post 2016). as a result, the postal network exceptionally has “last mile connectivity” to contribute to financial inclusion. india post has over 349 million accounts, serving nearly 42% of the country’s adult population thru its various savings products and also served as a channel for g2p transfers under programs such as nrega and mgnrega. the benefits got transferred to 63 million india post account under the above mentioned programs (india post, 2016). government initiatives financial inclusion was a top priority of the government. some major initiatives taken by the state to increase financial inclusion are: a) pradhan mantri jan dhan yojana (pmjdy): any citizen 10 years and above in age, living below the poverty line could open a bank account with zero balance. the services offered included deposit, transfer and credit. it provided free of cost insurance cover for an accident up to rupees one hundred thousand, life insurance cover of inr 30,000 and rupay debit card. the account holder could borrow loan up to inr5000. an enormous countrywide rollout of atms and micro atms in post offices was proposed for the next three years. till 2016, 132.7 million accounts in rural areas and 83.4 million accounts in urban areas were opened, and 126,000 ‘bank mitras’ were appointed (pmjdy, 2015). b) pradhan mantri jan suraksha bima yojana: it provides a death benefit of inr two hundred thousand for a premium of inr 12 annually. till 2016, 94.2 million suraksha bima policies have been issued (pmjdy, 2015). c) pradhan mantri jeevan jyoti bima yojana: it provides a renewable life insurance cover of inr two hundred thousand for a premium of inr 330 per annum. as on 20 april 2016, 29.6 million jeevan jyoti bima policies have been issued (pmjdy, 2015). d) pradhan mantri mudra yojana (pmmy): it was launched to offer loans to businesspersons at the foot of the pyramid. the target was to grant loans of inr 1.8 trillion during 2016‐ 17. it intended to ‘fund the unfunded’ by giving credit starting inr 50,000 to inr 1 million, with settlement time of 5‐7 years. financial organisations reported sanctioning inr 1 trillion to above 25 million people by early 2016. the scheme is expected to advantage above 58 million micro businesses. e) the technology‐leveraged ‘aadhar’ is anticipated to support widespread access and acceptance of financial products by un‐served groups. following initiatives are projected to push demand: i. aadhar enabled payment systems (aeps): it is aadhar‐enabled banking system that allows cash withdrawal; balance enquiry; cash deposit and funds transfer, thru pos, micro atm and kiosk. 88 economic analysis (2019, vol. 52, no. 1, 81‐96) ii. aadhar payments bridge system (apbs): it facilitates g2p remittances thru banks and post offices. over 880 million ‘aadhar’ cards were issued until 2015, but it aims to achieve 100 per cent coverage by 2016 (uidai, 2015). iii. direct benefits transfer (dbt): it enables the transfer of government benefits such as national rural employee guarantee act (nrega), handicapped old age pension scheme, social security pension scheme, lpg subsidy etc. iv. creation of a viable rural banking model: it is expected to create a cost‐effective model for dispensing last mile access by leveraging aeps. v. analytics: ‘aadhar’ data is expected to create enormous opportunity for leveraging analytics for customizing offerings. f) ‘digital india’ initiative, joined with a payments ecosystem, is laying the foundation for a digital economy. the impact of ‘digital india’ initiative by 2019, as envisioned by the government, would lead to (digital india, 2016): i. set up pan india fibre‐optic grid by 2016. ii. providing wi‐fi services in cities above 1 million people and key tourist spots. iii. providing internet access across 250,000 villages by 2019. iv. make available ‘digital lockers’ to every citizen. v. develop 100 smart cities. vi. universal phone connectivity. vii. set up 400,000 internet access points. measures taken by reserve bank of india (rbi) in a vision to encourage cashless society and ensure that the payment ecosystems are efficient, safe, accessible, inclusive and compliant with global standards reserve bank of india took following major initiatives (rbi, 2012): a) basic savings bank deposit accounts (bsbda) scheme: it allowed people to open a bank account with zero balance (rbi, 2013). in 2010 there were 60.2 million basic savings bank deposit account through branches, which increased to 126.0 million in 2014 and to 210.3 million in 2015. in 2010 there were 13.3 million basic savings bank deposit accounts through bcs, which increased to 116.9 million in 2014 and to 187.8 million in 2015. total basic savings bank deposit accounts were 73.5 million in 2010, which increased to 243.0 in 2014 and 398.1 million in 2015 (rbi,2015). source: rbi, report of the committee on medium‐term path on financial inclusion 2015 reena agrawal 89 b) electronically know your customer (e‐kyc): a paperless procedure for opening of accounts by customers having aadhar cards. c) mobile wallet: in 2012, the reserve bank of india sanctioned permission to telecommunication companies to offer mobile wallet facility to the people. as those telcos had a huge network of over 158,000 agents, of which 60 per cent were in remote areas, the mobile telephony and prepaid wallets were expected to encompass the unbanked people as well (rbi, 2013). d) immediate payment service (imps): launched by npci in 2010 it offers an immediate, round the clock, inter‐bank electronic fund transfer thru mobile phones, internet and atms. the client base who registered to mobile banking services was approximately 30 million by 2013. the number of mobile money identifiers (mmid) issued were 4.7 million in 2010 increased to 63.2 million in 2014, and the number of transactions grew from 2001 to 5 million(rbi, 2014b). e) micro‐atms: micro‐atms were installed at each ‘bank mitra’ location to facilitate immediate deposits and withdrawals. the micro‐atms offer an online inter‐operable and low‐cost payment platform. f) national unified ussd platform (nuup): the unstructured supplementary service data (ussd) code and gateway, is device and operator independent; a solution for people who have basic phones and worked on gsm network. it facilitated balance inquiry, inter‐bank fund transfer, mini statement besides others. g) rupay debit cards: rupay card payment scheme launched in 2012, intended ‘mass cardification’. it is offered a domestic, open‐loop, multilateral system which facilitated electronic payments. since its launch, the number of card‐issuing banks have risen from around 60 to 238. in 2013 rupay went online for e‐commerce purpose and eventually finally become a credit card. the aim was to cover all the banks and about 12,000 online traders (rbi, 2013). rupay cards were also issued to the188.6 million new bank accounts holder under pmjdy (mid‐october 2015) to encourage the usage of bank accounts (demirguc‐kunt et al., 2015; kumar and radcliffe, 2015; pmjdy, 2016). h) rupay kisan cards: nabard inspired co‐operative banks and rrbs to issue rupay kisan cards for facilitating withdrawal/distribution of loans through pos/atm/micro atms using cards. till 2013 close to 65,300 rupay kisan cards were issued. maharashtra and karnataka were among the first states to roll out the scheme. there were 40 million farm accounts kisan credit cards (kcc) in 2014. besides, with the addition of 3.8 million small non‐farm sector credits during 2013–14, there were 7.4 million non‐farm accounts general credit cards (gcc) in 2014. nearly 328 million transactions were carried out during 2013–14 as compared to 250 million during the preceding year (nabard, annual report nabard, 2013–14; rbi, 2014). i) white label atms (wla): in 2012 the rbi allowed nonbanking entities to set up white label atms (wla) with an aim to enhance the spread of atms in remote areas where bank‐owned atms were not working (rbi, 2014). the wlas operate 4,370 atms, 60 per cent of that owned by tata communications payment solutions private limited. j) prepaid payment instruments: licenses were issued to forty prepaid payment instruments (ppis) and ten payment aggregators. ppis began with bill payments, railway ticketing, recharges and small transfers and gradually seized larger proportions of the customer wallet thru convenient and safe options for small disbursements and by making touchpoints for cash loading and cash out, thru banking correspondents, thus generating new category of service providers to assist in low margin, high‐volume business (rbi, 2016; kpmg, 2016). in less than 18 months, ppis contributed to more than 40% of all imps transactions and stimulating an eight‐fold increase in prepaid transactions (pwc, 2015). retail electronic payments grew from 167 million to 2,268 90 economic analysis (2019, vol. 52, no. 1, 81‐96) million, while the volume of transaction grew about 100 times from about inr 500 billion to inr 50,000 billion (rbi, 2014). k) small banks: in‐principle approval was given to ten microlenders to set up small banks to give loans mainly to the unbanked, farmers, micro and small enterprises and unorganised sector which do not have access to funds. brief profile of the entities who were given license to create small banks are given below (rbi,2015b; indian express, 2015): i. au financiers (india) ltd: incorporated in 1996 as an nbfc, present across ten states in north india and provided vehicle loans and other loans to micro and small. ii. utkarsh microfinance: formed in 2009 and had a client base of 600,000 thru 271 branches, operated across eight states. 49 per cent rights held by norwegian microfinance initiative, cdc and lok capital. iii. rgvn (north east) microfinance: setup in 2008, had a network of 104 branches in 5 northeastern states‐ meghalaya, assam, sikkim, arunachal pradesh and nagaland had around 220,000 borrowers. iv. disha microfin: established in 2009, offered credit to women in under‐banked in remote areas in madhya pradesh, gujarat, rajasthan and karnataka. in 2015, it had 71 branches across 39 districts and covered over 8,600 villages and had a total of 335,426 members and around 176,000 borrowers. v. capital local area bank: it completed 15 years of operations in jalandhar, hoshiarpur in punjab ludhiana kapurthala and amritsar. it had 39 branches, 332,000 accounts and more than 80 per cent of its business is in remote areas. vi. equitas holdings: founded in 2007, operated 361 branches in 124 districts across seven states and had 2,292,000 customers. vii. esaf microfinance: largest mfi in kerala that served 500,000 customers through 175 branches in maharashtra, kerala, chhattisgarh and jharkhand. viii. janalakshmi financial: largest urban mfi with 233 branches and a customer base of 2,300,000 and present in 151 cities across 17 states. ix. suryoday microfinance: it operates in seven states, has 605,000 customers and a network of 164 branches and focusing only on female borrowers from deprived groups. x. ujjivan financial: it is the fourth largest mfi in india which began operations in 2005. the company is spread across 24 states and union territories and serves over 2 million clients through a network of 423 branches. l) payment banks: the reserve bank of india in august 2015 gave license to eleven non‐ bank entities to set‐up ‘payment banks’. the payment licenses have been granted to the security market entity, telecom companies, postal service provider, bottom of the pyramid players, payment service provider, technology companies, and nbfcs. brief profile of entities who got granted a license to create payment banks (rbi, 2015a): i. aditya birla nuvo: aditya birla group company that owns idea cellular. as of june 2015 idea cellular had 162.08 million mobile and 37.16 million internet subscribers. idea cellular has an agreement with axis bank to offer mobile money transfer. during f.y. 2014‐15 idea cellular generated substantial revenues from its financial services business. ii. airtel m commerce services: started 3 years ago. as in june 2015, airtel had 234.11 million mobile and 82. 57 million internet subscribers. as on march reena agrawal 91 2014, airtel money had 38 million transactions and 1.70 million active customers. partnership with kotak mahindra bank. iii. cholamandalam distribution services: company has a network of 534 branches and more than 7,000 dealers across india. has a customer base of over 750,000. 71 per cent of branches are in a remote region and end users are farmers. iv. department of posts: largest postal network in the world. has a network of 154,856 post offices in india. ninety per cent of post offices are in rural areas. 260,000 ‘dak sevakas’ (postmen) offers saving schemes and accepts public deposits. v. fino pay tech: acquired nokia money in 2012, launched alpha payment services in 2013. 450 fino money marts and 15,000 trader distribution services. had touched 80 million people for their banking needs. vi. national securities depository: handled a large volume of the transaction as a depository and held 14 million demat accounts. vii. tech mahindra: operated m‐wallet is known as ‘mobo money’. launched nfc based payments for icici bank. partnership with mahindra finance for the payment bank. had a grid of about 100,000 outlets. viii. reliance industries: provided telephone and broadband services across all states, 90 % of urban india and over 215,000 villages in india. had 2,300 retail stores across 166 cities, connected to above 1 million customers per day, signed a joint venture with sbi which will hold 30 % stake to set up payments banks. ix. dilip shantilal shanghvi: founder of sun pharmaceuticals, partnered with telenor group and idfc to provide banking services. telenor group had an experience of being the world’s leading mobile financial service provider. x. vijay shekhar sharma: founder of paytm, a mobile payment platform. got license for prepaid wallets in 2013. touched 100 million wallet users and 75 million transactions per month. xi. vodafone m pesa: a two‐year‐old venture of tele company with 90,000 agents and had a client base of 3.6 million. these entities who enjoyed an advantage over traditional banks in terms of robust infrastructure, enormous outreach, radical technology, and capacity to handle huge volumes of transactions, economies of scale and first mover advantage. discussion the study has shown that the government initiatives such as ‘pradhan mantri jan dhan yojana’(pmjdy), pradhan mantri jeevan jyoti bima yojana, ‘pradhan mantri bima yojana’ (pmby), ‘pradhan mantri’ micro units development and refinance agency ltd, i.e. mudra bank, aadhar enabled payment systems have created historic landmark. the government is also focusing on paying benefits of subsidies, pension scheme, remuneration under poverty alleviation programs and employment generation schemes such as mahatma gandhi national rural employment guarantee act (mnrega) and such other twenty‐five schemes directly into these accounts under direct benefits transfer. this was bound to ensure that numerous accounts opened under such programs, remain active and witness ‘movement’ thus integrating access with usage. in india, the government benefits transfer market is worth usd 55 billion (where cash is being transferred to unbanked beneficiaries). the government`s ‘digital india’ initiative which aims at pan india fibre‐optic network; provision of wi‐fi services in major tourist centres and cities with substantial population; provision of internet access to village 92 economic analysis (2019, vol. 52, no. 1, 81‐96) clusters; ‘digital lockers’; universal phone and internet connectivity, will lead to digital empowerment, enhance demand for services and improve the governance. the government also wants to connect all the 250,000 village panchayats to a national optic fiber network, through ‘bharatnet’ which would expand the market for financial services. branchless banking and mobile technology can make government‐to‐person (g2p) payments more accessible, efficient, safe and transparent as it will reduce leakage of funds, procedural delays and corruption and prove to be a great game changer. reserve bank of india`s initiatives such as mobile wallet, immediate payment service, micro‐ atms, national unified ussd platform, rupay debit cards, rupay kisan cards, kisan credit card, and white label atms, aimed at creation of an efficient ecosystem for electronic/digital payments and ensure that the payment systems are accessible to one and all and efficient and that it boosts financial inclusion in a big way. these initiatives have facilitated millions of low‐ value high volume transactions through these platforms. permission to forty prepaid payment instruments, ten aggregators, twelve small banks and eleven payment banks, resulted in a new revolution in the country’s financial services sector. these new entrants are targeting the potential customer base in tier 2 cities, tier 3 cities and in rural india. new age technology companies, i.e., the ‘fintech’ have come forward to offer a variety of financial services across all different customer bases through digital platforms. they have already helped millions of people outside the formal banking circumference in accessing banking facilities, yet there is infinite untapped potential. india has conventionally been cash‐dominated economy, with above 90 per cent of the volume of payments done in cash. however, with the introduction of the payments and settlement system, structural developments and regulatory reforms, trends hint at the ongoing transition towards the cashless financially inclusive economy, powered by the digital proposition. digital india holds the perspective to change the financial landscape; the way mobile transformed the face of connectivity. with its exceptional features such as ease of use, low cost, scalability and ubiquity, digital banking, when united with the innovative business model, an empowering ecosystem, can speed up the integration of the unbanked into the economic mainstream. the ongoing increased mobile penetration and use of mobile internet, clearly reflect at the potential of achieving total financial inclusion using digital platforms. the reports show that there were 453 million unique subscribers with sim connections in 2014, which is estimated to go up to 734 million in 2020 with a penetration rate of 54 per cent. the connections excluding m2m were 944 million in 2014 and is projected to go up to 1.3 billion in 2020 with a penetration rate of 94 per cent. the number of m2m connections are anticipated to reach 25 million by 2020. there were 85 million mobile internet connections in 2010, which is expected to reach 592 million in 2020 with a penetration of 44 per cent. the data traffic is estimated to grow by a compound annual growth rate (cagr) of 66 per cent over the period 2014‐2019. there were 149 million smartphones in 2014, 185 million in mid‐2015 and the anticipation is that this number will increase to 690 million by 2020. in 2010 the percentage of connections for a featured phone was 98 per cent, and this is expected to come down to 47 per cent in 2020, while the percentage of connections for smartphones which was 2 per cent in 2010 is projected to go up to 53 per cent in 2020. the access to the internet in rural areas is growing by 58 per cent annually. over the last three years, there were 11.2 billion electronic transactions done annually, 74 per cent of electronic transactions by debit and credit cards, prepaid instruments volume grew above 33 million, the shopping thru mobiles grew 800 per cent in 2013, and is expected to clock a cagr of 150 per cent by 2016. (pwc & assocham, 2015; gsma intelligence, 2015). looking at the ongoing trends and the future projections it seems necessary that financial intermediaries focus on “digital financial inclusion” which broadly means using digital technology to reach unbanked and under‐served people, with big basket of financial products and services, tailored to their needs, at an reasonable cost to the customer and is sustainable for the service‐providers ( gpfi white reena agrawal 93 paper, 2011; gpfi issues paper, 2014b; afi , 2013).the traditional commercial banks, microfinance institutions and business correspondents need to leverage the penetration of mobile phone, smartphone, internet and emerging disruptive technologies. new business models, integrated strategies and partnerships need to be forged between banks, mobile network operators, technology companies and e‐commerce companies for customer acquisition, customer retention, delivery of sustainable values to the new customer categories and for creating a remarkable customer experience by making available to them innovative customer service models. as user‐friendly technology is becoming popular among the low income and deprived groups, it opens up new horizons for the delivery of financial services at the doorstep of the customers. india post, which has a network of 154,856 post offices, with nearly 90 per cent post offices in remote regions (india post, 2016) needs to team up with mobile network operators and technology companies to deliver their services to the marginalised groups. the technology companies which offer innovative financial services such as mobile wallet and mobile money suffer from operating challenges and regulatory restrictions, which limit the volumes, so if such companies tie‐up with financial companies it would solve a lot of issues. in india, not only urban areas but also countryside areas, are experiencing huge digital transformation. the financial intermediaries can think of working out partnership with food corporation of india, which has 504,715 fair price shops all over the country (ministry of consumer affairs, food and public distribution, 2016), and technology companies to set up shared point‐of‐sale (pos) equipment/ kiosks in fair price outlets, for allowing people to do basic banking transactions, using biometric identification and smart cards. this will speed up the process of financial inclusion, and will also bring down the cost of service. the business correspondent outlets / customer service point (csp) could be set up in the village panchayat office, community health centres, ‘kirana’ shop, or any other public place. conclusion to conclude, in the digital world, traditional discrepancies such as rich‐poor, urban‐rural, old‐ young, educated‐uneducated, outdated‐modern are becoming blurred. today the issues that have become significant are seamless creation boundaries, user‐friendly technology, universal mobile and internet connectivity, hassle‐free transactions, increasing the use of regional linguistic in digital podia. as unbanked people increasingly gain access to mobile phone, smartphones and internets, it is essential that elementary financial services are offered at larger suitability and affordable cost using diversified digital platforms, to serve the poor customers better. the components of a financially inclusive ecosystem, i.e., reliable intermediaries, private players, innovative technology, payments infrastructure, banking, insurance, government and regulator, are already in place, yet better coordination is required at the market level, to enable a successful transition to a financially inclusive economy. references alliance for financial inclusion. 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(2015). financial inclusion data / global findex 2014, the world bank report 2015: http://datatopics.worldbank.org/financialinclusion/country/india, retrieved on april 29, 2016. article history: received: february 9, 2018 accepted: june 10, 2019 ea_2018_1-2 doi: 10.28934/ea.18.51.12.pp120-130 scientific review impact of exports on economic aggregates of pakistan hasnain naqvi1* | slobodan adžić2 | nebojša zakić3 | milijanka ratković4 | israr ahmad5 1 university of hafr al-batin, hafr-al batin, saudi arabia 2 arab open university, al-ardia, kuwait university union – nikola tesla, faculty of management fam, sremski karlovci, serbia 3 university union – nikola tesla, fmn fpb, belgrade, serbia 4 university union – nikola tesla, faculty for education of the executives, belgrade, serbia 5 islamic international university, islamabad, pakistan abstract the study employs cge model, on the data provided in sam 2007-08 for pakistan designed by dorosh et al. (2012), to investigate the impact of pakistan’s exports on the major aggregates of the economy. to this end, three experiments have been conducted, exports are increased by 5% in the first simulation (sim-i), in the second simulation (sim-ii) by 10% and in the third simulation (simiii) by 15%. the findings of the study reveal that increase in exports has favourable impact on the performance of macroeconomic variables of the economy i.e. gdp, public and private consumption, savings and investment. domestic output level of most of the commodities has risen except mine, food manufacturing and other manufacturing. incomes and expenditures of all the households have risen that results in rise of utility level of all the households. moreover, all the households have also recorded an increase in the values of compensating variation which implies higher level of welfare for households. however, the value of compensating variation for non-agriculture households has risen more than that of agriculture households indicating pro-urban effect. equality among the households has improved as the inequality indices have registered declining trend. the study suggests that export promotion measures should be incorporated in poverty alleviation, income equality and economic growth strategies. key words: economics, export, aggregates, cge model. economic growth, sustainable development, pakistan, poverty allevation jel classification: b22, d58, o4, q01, i30, i32 introduction trade openness plays an important role in the economic growth of a country and helps a country to achieve higher economic growth, (anderson and babula, 2008), through efficient utilization of resources and transmitting economic growth from one region of the world to another. in international trade much importance is assigned to exports because exports have a profound impact on the output of a country. the importance of exports goes back to the mercantilist time. in view of mercantilists international trade is a “single-pie” and they stressed on ‘more exports and less imports’. exports are a means of valuable foreign exchange earnings which enables us to import our indispensable inputs (technology and machinery). exports lead to employment generation, optimal utilization of resources and economic development of a country. that is why exports are considered to be an engine of economic growth. domestic monopolies are vanished and the availability of goods is made at lower prices on one hand and * e-mail: naqqvi23@hotmail.com hasnain naqvi, slobodan adžić, nebojša zakić, milijanka ratković, israr ahmad 121 incomes of the people are raised through employment generation on the other hand. these lower prices and higher incomes raise the consumption level (welfare) of people. exports have impacted the gdp of pakistan positively and there is a strong long-term relationship between exports and gdp of pakistan, (shirazi and manap, 2004). the literature on the history of export performance of pakistan shows bleak picture of the export performance of pakistan. during 1950s and 1960s, export performance of pakistan remained poor either because it did not receive serious attention or due to limited capacity. in general pakistan exports showed an increasing trend both in terms of value and quantity. the rate of growth of exports remained very slow till 1972 but after that it accelerated. on the other hand, imports have increased more than exports due to which pakistan has always confronted the problem in deficit in balance of trade (bot) with exceptions of a few years (1950-51, 195455 and 1972-73). the growth rate of the world output and trade witnessed deceleration in 2011 due to detrimental impact cast by the deteriorating global environment. growth rate of the world output declined from 5.3% in 2010 to 3.9% in 2011. in the same manner growth rate of the world trade decelerated from 13% in 2010 to 5.8% in 2011. but quite opposite to it, growth rate of pakistan’s exports accelerated from 9.06% in 2009-10 to 28.61% in 2010-11 and pakistan’s imports grew at the rate of -0.32 in 2009-10 to 16.43 in 2010-11. this indicates inflating volume of pakistan external trade. pakistan’s exports are characterized by high concentration in commodity and export markets. however, shift in the nature of pakistan’s exports has been seen from primary products to manufactured products. the share of primary products in pakistan’s total exports was 33% in 1971 which has declined to 18% in 2011. similarly, the share of semimanufactured goods in pakistan’s total export was 24% in 1971 which has now declined to 12% of total exports in 2011. on the other hand the share of manufactured goods has increased from 44% in 1971 to 70% in 2011 (pakistan’s economic survey, 2011-12). a large number of facilities/incentives have been given to the exporters to inflate the volume of exports from pakistan. these incentives are targeted to make exports zero-rated (exporters pay no tax on sales abroad). these facilities include export financing (in domestic and foreign currency), export credit guarantee, concessionary rate of income tax (under the income tax ordinance 1979), common bonded warehouse scheme, export marketing and product upgradation fund, duty drawback scheme, and export house scheme (haque and kemal, 2007). this shows that there have been no systematic trend in pakistan’s exports growth over the years that calls for its analysis as it can impact different economic aggregates in a significant way. this study aims to unfold the nexus between export and various economic aggregates in pakistan. review of literature economists have employed cge models for the analysis of economic policies and for the appraisal of costs and benefits accrued to nations through economic integration and trade liberalization, for example, oslington (2005), akerman (2005), bouet et al. (2004) and kurzweil (2002). to simulate the fiscal policy, bhattarai and trzeciakiewicz (2016) developed a computable general equilibrium model to analyze fiscal policy in united kingdom. they found that investment and public consumption causes high gdp multiplier in short run. in long run, whereas, private investment and capital income tax have high impact on gdp. moreover, this study also explored effectiveness of public outlays and consumption taxes. naqvi, et al. (2011) developed cge model of pakistab to analyze the impact of agricultural income tax on household welfare and inequality. the model analysed the economic implications of agricultural income tax and reduction in sales tax for production activities to adjust the budget surplus. the objective of this experiment was to determined the possibility of 122 economic analysis (2018, vol. 51, no. 1-2, 120-130) implementation of agricultural income tax in case of pakistan and to analyse its benefits at macro and household level. two variables were considered in this experiment i.e., imposition of agricultural income tax, and decrease in sales tax rates. the article concluded that the imposition of agricultural income tax is beneficial in terms of household and economy-wide welfare indicators. bouet et al. (2010) appraised the gains and losses accrued to members and non-members of south asia from south asian free trade agreement (safta) by using cge model. the study assessed the costs and benefits of both the cases: including the sensitive products envisaged in safta and excluding them from the process of trade liberalization. full trade liberalization (including sensitive products) had been considered to cause trade diverting effects in terms of income that was reduced due to tariff-cut. liberalization of sensitive products was thought to be non-beneficial for ldcs of the region. the pattern of distribution of gains among the factors of production promised higher incomes for unskilled labourers, hence, pro-poor. however, the consequences of safta were deemed to cause low tariff income for almost all of its members. ahmed and o’donoghue (2009) analyzed the impact of variations in external balance of pakistan developing country on the various economic entities of the economy by employing cge model. the study integrated the economy into 33 sectors and gauged the impacts of changes in import prices and external savings on these aggregates. simulation results of the study ascertained that increase (50%) in foreign savings led to expansion of imports and contraction of exports. the sectors expected to face reduction in their exports were cement, leather, textile and livestock. under these conditions the factors expected to receive increased incomes were non-agriculture unskilled wage labour and agriculture wage labour. a rise in import prices especially petroleum and industrial raw material led to decline in exports. the state of poverty and income inequality was aggravated. gilbert (2008) investigated the impact of integration of the south asian economies under safta on the welfare, poverty and income distribution of the concerned countries through cge model. the main contribution of this study in the existing literature was that it took into account the whole south asian region, not a single country for cge approach. the findings of the study revealed that almost all of the countries except bangladesh would gain from trade liberalization, though the gains would be modest because these countries had similar export structure. in case of bangladesh, unilateral reforms had been proposed to be the best option. the trade reforms stipulated to be brought about under the auspices of safta had been perceived to cast positive impact on overall welfare. thus, regional integration was deemed to be pro-poor especially in bangladesh and india. however, income inequality was liable to rise. panda and kumar (2008) explored the relationships among trade liberalization, economic growth, food security and poverty through cge model constructed for india. the study used the data provided in the sam for india for the year 2003-04. the simulation results of the study depicted that trade liberalization had a negligible impact on the growth of gdp. it was the only agriculture sector that benefited from both unilateral and multilateral trade liberalization in gdp while non-agriculture gdp remained invariant in face of unilateral liberalization and declined under multilateral liberalization. both wages and consumer prices rose but wages rose more than prices; hence, real incomes of all households soared. due to rise in real income, income poverty plummeted. consequently, lower income groups of both rural and urban sections witnessed a decline in food intake in terms of calories while others increased the intake of nutrients. siddiqui (2007) investigated and compared the effects of liberalization of agriculture trade in the domestic and the world economy on the economic growth of pakistan by employing both static as well as dynamic cge frameworks. the study used the data provided in pakistan social accounting matrix for the year 2002 (sam 2002). the simulation results of the study depicted that liberalization of agriculture trade whether at domestic level or international level had favourable impact on the economic growth of the country. however, the effects of liberalization hasnain naqvi, slobodan adžić, nebojša zakić, milijanka ratković, israr ahmad 123 of agriculture trade at international level were found to be stronger than those of liberalization at domestic level. complete liberalization of agriculture trade was expected to increase the incomes of both rural and urban households. however, long run consumption of rural households increased more than that of urban households. the distribution of income was, in the short run, improved while it was worsened in the long run. cockburn et al. (2006) investigated and compared the effects of trade liberalization on different economic aggregates of seven african and asian countries by using cge model. roles of relative factor endowment, initial tariff structure, trade pattern, production pattern and income and consumption patterns were given much consideration in explaining the results. the findings of the study demonstrated that trade liberalization had varying effects on different commodity sectors and household groups. manufacturing sector had gained while agriculture sector had lost under trade liberalization process. the urban households benefited while rural households lost in terms of welfare. nonetheless, overall trade liberalization raised the level of welfare and reduced poverty. wages of households increased more than the increase in domestic price of consumer goods. the pro-urban effect of trade liberalization was considered to be due to substantial fall in the returns to land. adam and o’connell (2000) employed cge model to investigate and compare the gains accrued from aid and trade preference to a recipient developing african country. the findings of the study substantiated that the gains from trade preference were dominant over the gains from aid. the study advocated for transfers (whether in the form of aid or trade) that promote capital accumulation in the receiving country. through capital accumulation, a developing country was thought to shift from raw exports to manufactured exports. this shift, in turn, was deemed to enhance welfare effects of donor assistance. transfer of resources via aid impacted the manufactured exports and total domestic output adversely. contrarily, trade preferences increased domestic output and consumption. fiscal distortions attached more importance to aid than trade because export subsidy given to promote exports would result in increased fiscal burden. methodology the study has employed computable general equilibrium (cge) model designed on the pattern of lofgren et al. (2002), on the data provided in sam 2007-08 for pakistan designed by dorosh et al. (2012), to investigate the impact of pakistan’s exports on its economic aggregates. the framework of mathematical equations is based on the neo-classical assumptions of optimizing behaviour of economic agents: maximization of utility and output, and minimization of costs1. trade elasticities for different commodities in pakistan have been borrowed from ahmed et al. (2008). three experiments have been conducted to gauge the impact of increase in pakistan’s exports on various economic aggregates of pakistan. in the first simulation (sim-i) pakistan’s exports have been increased by 5%, in the second simulation (sim-ii) by 10% and in the third simulation (sim-iii) by 15%. interpretation of results macro level the gdp (at fixed cost) of pakistan has registered growth of 1.474%, 2.911% and 4.314% in sim-i, sim-ii and sim-iii respectively (table 1). this rise in gdp can be attributed to increase in investment, higher level of activities, increase in household incomes and hence higher savings. investment has grown by 0.942%, 2.011% and 3.193% in the respective three experiments. this increase in investment is in line with theory as rise in institutional incomes and consequent rise 1 mathematical equations and economic aggregation can be provided on demand. 124 economic analysis (2018, vol. 51, no. 1-2, 120-130) in their savings have resulted in higher investment. government consumption has inflated by 0.702%, 1.418% and 2.141% while private consumption has risen by 0.936%, 1.859% and 2.769% due to rise in the incomes of institutions coupled with fall in the prices of various consumer goods and fall in the price of imports in terms of domestic currency due to appreciation of domestic currency. table 1. national income accounts (% variation) base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) gdp at factor prices 3377101.000 1.474 2.911 4.314 government consumption 408940.000 0.704 1.418 2.141 investment 534109.000 0.942 2.011 3.193 exports 677841.000 3.716 7.491 11.325 imports 1030150.000 1.181 2.517 3.993 net indirect taxes 251634.000 -0.163 -0.177 -0.059 private consumption 3037997.000 0.936 1.859 2.769 source: research by authors both exports and imports have grown but the growth rate of exports is higher than that of imports (table 2 and 3). exports have grown by 3.716%, 7.491% and 11.325%. this surge in exports is in conformity with economic literature as it is mainly due to rise in activity level, consequent increase in output and rise in gdp. moreover, increase in imported inputs has led to increase in domestic output which in turn has increased the quantity of commodities to be exported. imports have registered growth rate of 1.181%, 2.517% and 3.993%. this positive growth of imports is mainly the result of fall in the price of imports due to appreciation of domestic currency and increase in foreign exchange reserves due to more exports. table 2. quantity of exports for commodities (% variation) commodities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) agriculture 26415 2.924 6.085 9.478 mine 5292 6.755 13.305 19.635 food manufacturing 112975 1.890 3.868 5.928 cotton lint/yarn 60824 1.595 3.232 4.908 textiles 216278 1.734 3.452 5.157 leather 15385 2.903 5.790 8.667 other manufacturing 122350 6.667 13.247 19.725 services 118322 0.689 1.339 1.956 source: research by authors table 3. quantity of imports for commodities (% variation) commodities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) agriculture 36087 17.960 37.678 59.154 mine 95779 0.720 1.487 2.296 food manufacturing 57923 14.577 30.111 46.564 cotton lint/yarn 7297 14.472 29.952 46.421 textiles 18918 15.603 32.514 50.730 leather 1178 14.615 30.337 47.159 other manufacturing 807118 3.609 7.198 10.766 services 53953 13.118 27.215 42.307 source: research by authors hasnain naqvi, slobodan adžić, nebojša zakić, milijanka ratković, israr ahmad 125 domestic output output of most of the commodities has shown rising trend except mine (c-mine), food manufacturing (c-fman) and other manufacturing (c-manf) as shown in table 4. table 4. level of activities (% variation) activities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) agriculture 1364731 0.000 0.000 0.000 mine 28424 -1.665 -3.156 -4.496 food manufacturing 673967 -0.174 -0.342 -0.503 cotton lint/yarn 224415 0.289 0.561 0.820 textiles 545403 0.530 1.029 1.500 leather 35937 1.220 2.415 3.588 other manufacturing 646118 -0.724 -1.342 -1.866 energy 189246 0.060 0.117 0.170 services 3067054 0.059 0.106 0.142 source: research by authors the highest rise in the output of leather and textile is witnessed. the output of leather (cleat) has increased by 1.220%, 2.415% and 3.58% respectively in the sim-i, sim-ii and sim-iii. the output of those commodities has increased whose producer price and domestic price have risen and the commodities whose producer price has fallen their output has shrunk (table 5). however, the fall in the output of mine (c-mine) is at the highest rate, it has observed the fall of 1.665%, 3.256% and 4.496% in the respective three experiments. on the other hand the quantity of domestic output sold domestically has fallen (table 6). supply of composite commodities in domestic market has increased (table 7). table 5. producer price for commodities (% variation) commodities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) agriculture 1.000 0.393 0.744 1.056 mine 1.000 -1.612 -2.970 -4.107 food manufacturing 1.000 0.432 0.842 1.235 cotton lint/yarn 1.000 0.684 1.353 2.010 textiles 1.000 0.719 1.438 2.158 leather 1.000 0.565 1.143 1.734 other manufacturing 1.000 -1.272 -2.351 -3.260 energy 1.000 0.552 1.153 1.799 services 1.000 0.802 1.619 2.446 source: research by authors table 6. quantity sold domestically of domestic output (% variation) commodities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) agriculture 1338316 -0.058 -0.121 -0.189 mine 23132 -3.624 -7.051 -10.296 food manufacturing 560992 -0.591 -1.197 -1.815 cotton lint/yarn 163591 -0.198 -0.438 -0.714 textiles 329125 -0.263 -0.574 -0.927 leather 20552 -0.045 -0.137 -0.270 other manufacturing 523768 -2.477 -4.852 -7.134 126 economic analysis (2018, vol. 51, no. 1-2, 120-130) commodities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) energy 189246 0.060 0.117 0.170 services 2948732 0.034 0.057 0.069 source: research by authors table 7. quantity of composite goods supplied domestically (% variation) commodities base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) agriculture 1374403 0.406 0.832 1.277 mine 118911 -0.130 -0.193 -0.197 food manufacturing 618915 0.802 1.627 2.473 cotton lint/yarn 170888 0.416 0.808 1.179 textiles 348043 0.582 1.153 1.718 leather 21730 0.735 1.455 2.163 other manufacturing 1330886 1.200 2.402 3.604 energy 189246 0.060 0.117 0.170 services 3002685 0.264 0.523 0.778 source: research by authors incomes of households incomes of all households have shown soaring trend in all the three experiments but the rate of increase in incomes differ from household to household (table 9). the growth rate of incomes of households who are not concerned with agriculture sector is higher than the growth rate of incomes of those who are concerned with the agriculture sector (table 7). the income of urban poor households (h-urpr) has registered highest growth rate of 1.485%, 2.945% and 4.381% in the three experiments. the average prices (rewards) of all the factors have increased but the rate of increase in the prices of labour whether skilled or unskilled has remained higher than that of other factors (table 8). price of unskilled labour has registered the highest rate of growth. moreover, the output of leather and textile has witnessed substantial increase so the demand for skilled and unskilled labour has increased leading to increase in their rewards, hence, income of these households has increased. the increased outputs of domestic commodities and increased exports have indirectly increased labour demand. resultantly, jobless workers have got employment and a source of income. table 8. average price of factors (% variation) factors base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) own large farm 1.059 0.659 1.230 1.725 own medium farm 1.058 0.659 1.230 1.725 own small farm 1.056 0.659 1.230 1.725 agriculture wage 1.081 0.659 1.230 1.725 non-agriculture unskilled 1.058 1.878 3.740 5.485 skilled 1.037 1.803 3.574 5.316 large farm 1.054 0.659 1.230 1.725 irrigated medium farm 1.063 0.659 1.230 1.725 irrigated small farm 1.059 0.659 1.230 1.725 non-irrigated small farm 0.979 0.659 1.230 1.725 capital 1.067 source: research by authors hasnain naqvi, slobodan adžić, nebojša zakić, milijanka ratković, israr ahmad 127 table 9. income of households (% variation) households base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) large farm 93954 0.800 1.568 2.306 medium farm 226190 0.818 1.602 2.357 small farm 501515 0.937 1.847 2.735 landless farmers 104611 0.905 1.779 2.628 rural agriculture landless 98471 0.948 1.867 2.760 rural non-farm non-poor 400770 1.303 2.589 3.861 rural non-farm poor 134399 1.242 2.471 3.688 urban non-poor 1744122 0.775 1.549 2.321 urban poor 181413 1.485 2.945 4.381 source: research by authors welfare of households table 13 depicts that overall welfare of households has increased. incomes of households have risen as a result of rise in factor rewards and higher level of activities. higher incomes have lifted constraints to consume more (table 10) which in turn has guaranteed higher level of utility (table 12). moreover, the welfare effect can be assessed by comparing prices of the factors owned by households and consumer prices of commodities (cpi). table 8 represents average prices of factors while consumer price indices have been portrayed in table 11. by comparing the results of these tables it can be concluded that average factor prices have risen at higher rate than consumer prices of commodities. consequently real incomes of households have risen. the results about compensating variation (cv) of households reveal that the households would be better-off in the consequence of increased pakistan’s exports. all the households have positive cv. however, the highest cv is recorded by urban non-poor, non-farm non-poor, small farm and urban poor households (h-urnp, h-nfnp, h-sf and h-urpr) respectively. the highest value of cv for urban non-poor and non-farm non-poor (h-urnp and h-nfnp) is due to negative change in consumer price indexes (cpis) for these households and substantial increase in average price of factors – unskilled and skilled labour (la-sku and la-sk). the households who have witnessed negative change in their respective cpis are large farm, medium farm, nonfarm non-poor, urban non-poor households (h-lf, h-mf, h-nfnp and h-urnp). the low value of cv for large farm households (h-lf) is due to lower rewards of factors owned by h-lf, though it has witnessed negative change in its respective cpi. anyhow, the lowest values of cv are recorded by agriculture wage, non-farm and large farm households (h-agw, h-0f and hlf) respectively. it is evident that the households related to agriculture have received fewer gains than households related to non-agriculture. nevertheless, the incomes and expenditures of all the households have soared. consequently, an increase in utility is witnessed by all the households (table 12). however, the highest utility is recorded by non-farm non-poor, non-farm poor and urban poor households (h-nfnp, h-nfp and h-urpr). conversely, the lowest gains in terms of utility are stipulated for non-farm and agriculture wage households (h-0f and h-agw). such pattern of distribution of utility also confirms that more gains are promised for households engaged in non-agriculture (urban households). however, overall, economy-wide cv has risen (table 14). 128 economic analysis (2018, vol. 51, no. 1-2, 120-130) table 10. consumption expenditures of households (% variation) households base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) large farm 84554 0.800 1.568 2.306 medium farm 214882 0.818 1.602 2.357 small farm 476443 0.937 1.847 2.735 landless farmers 99374 0.905 1.779 2.628 rural agriculture landless 93542 0.948 1.867 2.760 rural non-farm non-poor 360694 1.303 2.589 3.861 rural non-farm poor 127680 1.242 2.471 3.688 urban non-poor 1408485 0.775 1.549 2.321 urban poor 172343 1.485 2.945 4.381 source: research by authors table 11. household consumer price index (% variation) households base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) large farm 1.023 -0.126 -0.244 -0.355 medium farm 1.023 -0.130 -0.252 -0.367 small farm 1.020 0.082 0.156 0.222 landless farmers 1.021 0.140 0.268 0.385 rural agriculture landless 1.020 0.204 0.392 0.563 rural non-farm non-poor 1.022 -0.007 -0.015 -0.023 rural non-farm poor 1.023 0.143 0.272 0.390 urban non-poor 1.021 -0.052 -0.098 -0.139 urban poor 1.022 0.136 0.261 0.377 source: research by authors table 12. utility of households (% variation) households base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) large farm 82670 0.927 1.816 2.670 medium farm 210039 0.949 1.859 2.734 small farm 467056 0.854 1.689 2.507 landless farmers 97329 0.763 1.507 2.234 rural agriculture landless 91732 0.742 1.470 2.184 rural non-farm non-poor 352910 1.310 2.604 3.885 rural non-farm poor 124810 1.098 2.192 3.285 urban non-poor 1379794 0.827 1.648 2.463 urban poor 168712 1.347 2.677 3.990 source: research by authors table 13. compensating variation of households households simulation-i (5%) simulation-ii (10%) simulation-iii (15%) large farm 783.018 1531.453 2249.628 medium farm 2036.844 39833.94 5852.417 small farm 4074.444 8060.780 11972.136 landless farmers 759.681 1501.683 2228.701 rural agriculture landless 695.911 1380.172 2054.809 rural non-farm non-poor 4724.538 9392.037 14010.118 rural non-farm poor 1403.589 2806.924 4210.789 hasnain naqvi, slobodan adžić, nebojša zakić, milijanka ratković, israr ahmad 129 households simulation-i (5%) simulation-ii (10%) simulation-iii (15%) urban non-poor 11648.041 23194.694 34648.929 urban poor 2322.181 4624.842 6901.769 source: research by authors table 14. economy wide compensating variation simulation-i (5%) simulation-ii (10%) simulation-iii (15%) total compensating variation 0.937 1.859 2.769 source: research by authors inequality inequality has been a question of debate. a great deal of economic literature has been devoted to answer whether inequality retards the process of economic growth or not? a number of different techniques and indicators are used by economists to measure inequality but the most popular and common in practice are hoover index and theil indices: theil-l, theil-t and theil-s. these indicators measure intra-group and inter group inequality. however, in this study inequality among groups has been measured. the results of these indices, as depicted in table 15, show that inequality among the household groups has decreased with the increase in pakistan’s exports as these indices have shown smaller values in sim-i than in sim-ii and so on. table 15. indices of inequality indices base simulation-i (5%) simulation-ii (10%) simulation-iii (15%) theil-t 0.318 0.317 0.316 0.315 theil-l 0.326 0.325 0.324 0.323 theil-s 0.322 0.321 0.320 0.319 hoover index 0.346 0.345 0.344 0.344 source: research by authors conclusion the study employs cge model, on the data provided in sam 2007-08 for pakistan designed by dorosh et al. (2012). trade elasticities for different commodities in pakistan have been borrowed from ahmed et al. (2008). three experiments are performed to gauge the impact of increase in pakistan’s exports on its various economic aggregates. pakistan’s exports have been increased by 5% in the first simulation (sim-i), in the second simulation (sim-ii) by 10% and in the third simulation (sim-iii) by 15%. the findings of the study reveal that increase in exports has favourable impact on the performance of macroeconomic variables of pakistan’s economy i.e. gdp, public and private consumption, savings and investment. domestic output level of most of the commodities has risen except mine, food manufacturing and other manufacturing. incomes and expenditures of all the households have risen. resultantly, utility level of all the households has risen. moreover, all the households have also recorded an increase in the values of compensating variation which implies higher level of welfare for households. however, the value of compensating variation for non-agriculture households has risen more than that of agriculture households indicating pro-urban effect. equality among the households has improved as the inequality indices have registered declining trend. all this suggests that export promotion measures should be incorporated in poverty alleviation, income equality and economic growth strategies. 130 economic analysis (2018, vol. 51, no. 1-2, 120-130) references adam, christopher s., and stephen a. o’connell. 2000. “aid versus trade revisited.” wps 2000-19. ahmed, vaghar, and cathal o’donoghue. 2009. “external shocks in a small open economy: a cge-microsimulation analysis.“ department of economics, national university of ireland, galway. working paper no. 0142. akerman, frank. 2005. “the shrinking gains from trade: a critical assessment of doha round projections.” gdae working paper no. 05-01. anderson, lili, and ronald babula. 2008. “the link between openness and long-run economic growth.” journal of international commerce and economics, united states international trade commission. bhattarai, keshab, and dawid trzeciakiewicz. 2017. "macroeconomic impacts of fiscal policy shocks in the uk: a dsge analysis," economic modelling, elsevier, vol. 61(c):, pages 321-338. bouët, antoine, jean-christophe bureau, yvan decreux, and sébastien jean. 2004. “multilateral agricultural trade liberalization: the contrasting fortunes of developing countries in the doha round.” cepii. bouët, antoine, simone mevel, and marcelle thomas. 2010. “is safta trade creating or trade diverting? a computable general equilibrium assessment with a focus on sri lanka.” ifpri discussion paper no. 00950. cockburn, john, bernard decaluwé, and véronique robichaud. 2006. “trade liberalization and poverty: lessons from asia and africa.” poverty and economic policy, micro impact of macro and adjust policies (mimap) project. dorosh, paul a., dario debowicz, sherman robinson, and syed hamza haider. 2012. "a 2007-08 social accounting matrix for pakistan:," pssp working papers 1, international food policy research institute (ifpri). gilbert, john. 2008. “trade policy, poverty and income distribution in computable general equilibrium models: an application to the south asian free trade agreement.” macao regional knowledge hub, working papers, no. 14. haque, nadeem, and m. ali kemal. 2007. “impact of export subsidies on pakistan’s exports.” pide working papers 2007: 26. kurzweil, marianne. 2002. “the need for a complete labour market in cge modeling.” landbauforschung volkenrode 52(2): 102-119. lofgren, hans, rebecca lee harris, sherman robinson, marcelle thomas, and moataz elsaid. 2002. “a standard computable equilibrium model in gams.” international food policy research institute, washington d. c. microcomputers in policy research 5. naqvi, hasnain a., muhammad mohsin hakeem, rashid a. naeem. 2011. “impact of agricultural income tax on household welfare and inequality: pakistan a case-in-point” international journal of business and social science 2 (6):, 103-118 oslington, paul. 2005. “unemployment and trade liberalization.” world economy 28(8): 11391155. panda, manoj, and a. ganesh-kumar. 2008. “trade liberalization, poverty and food security in india.” indira gandhi institute of development research, wp-2008-013. shirazi, nasim shah, and turkhan ali abdul manap. 2004. “exports and economic growth nexus: the case of pakistan.” the pdr, 43:4 part ii (winter 2004): 563-581. siddiqui, rizwana. 2007. “dynamic effects of agriculture trade in the context of domestic and global liberalization: a cge analysis for pakistan.” pide working papers, 2007:38. article history: received: march 26, 2018 accepted: june 20, 2018 microsoft word 2007 3 4.doc volume 40 • autumn 2007 • 77                  abstract: the formal precision of modern economics, with its theoretical abstraction, its mathematical  analytics and its reliance on disinterested scientific method in testing hypotheses about how economic system  behave, might suggest that economics as a discipline does not have a cultural context, that it operates within  a world that is not considered by, nor conditional upon, any cultural phenomena. but just as the radical  critique described of contemporary economics has argued that the sort of economics described above cannot be  value‐free, so also can it be suggested that economics as an intellectual cannot be culture‐free.  introduction      it is striking fact that one of the leading scholarly journals in economics with the economic  problems of developing countries bears the title economic development and cultural change. few of  the articles published in this journal deal directly with culture as such. yet the acknowledgement is  there in the title that in some fundamental sense culture, however it is to be interpreted, underlies  the development process and will have some important relationships with economic behaviour in  poor countries. the implication is that strategies to alleviate poverty in the third world and to  promote economic advancement will need  to have regard  for  the processes of cultural change  which may be critical in determining their success or failure.  in the analysis of economic progress in the industrialised world, however, a role for culture in  influencing  or  conditioning  economic  performance  is  scarcely  recognized.  economic  growth,  measured in terms of rising material standards of living per head of population, remains a central  economic policy objective in all developed countries. yet the growth process as constructed in con‐ temporary economic analysis has been interpreted solely in terms of economic variables.1   this may be due in part to the supposition that these variables can capture any cultural in‐ fluences of importance to economic growth, without need for further specific elaboration of what  those influences are. so, for example, it may be thought that the inclusion of human capital as an  explanatory  variable  in  economic  growth  models,  allowing  technological  change  to  be  endo‐ genised, may be sufficient to represent important cultural influences, because those influences will  be manifested as characteristics of the individuals making up the labour force.2   alternatively, the neglect of culture in explaining economic performance may simply reflect  the fact that, to economists, economic variables are all that matter, in other words that so compre‐ hensive a picture of both the causes and the outcomes of economic growth can be gained by con‐ sideration of phenomena such as productivity, technology, industrial transition, factor shares, lev‐ els of investment, capital flows, etc. that nothing more is required. indeed this econocentric posi‐ tion might be seen as a further example of the reification of the economy, where the economy is  seen as having a life of its own, determined only by, and responsive only to, economic forces.  this paper considers the role of culture in the process of economic development in both in‐ dustrialised and developing countries, using ʹcultureʹ here in the broad constituent sense of ways  of living rather than in the more specific sense of cultural activity. the influence of culture on eco‐ about culture in economics dragan milinkovic fimon, institute of economic sciences, belgrade, serbia key words: economic development, culture, sustainability, efficiency, equity  jel: a12, z1  original paper  2007 ‐ 78  •  economic analysis®  nomic performance  is considered first by reviewing the relatively small amount of work which  attempts to bring cultural factors into an explanation of the relative growth and decline of different  economies.   we then discuss recent efforts to think more fundamentally about what constitutes the idea  of human development, efforts which place the development process squarely into a cultural mi‐ lieu, and which have some implications for how economic policy might be reinterpreted in a de‐ velopment environment. finally this chapter looks again at the issue of sustainability, given that  sustainable development has become a key concept in the operational world of development assis‐ tance. how does culture fit into such a picture?  if we accept the broadly based definition that culture can be seen as a set of values, beliefs,  traditions, customs, etc. which serve to identify and bind a group together ‐ then it is not difficult  to propose that culture will affect the way individuals in the group think and act, and will also  have a significant effect on the way the group as a whole behaves. such a proposition can be put  forward for a small group such as a corporation, where the group identity is built around a corpo‐ rate spirit, or for a large group such as a nation, where shared values may include religious beliefs,  social customs, inherited traditions and so on. in either case, an economic version of this proposi‐ tion might be phrased in terms of the ways in which the groupʹs identity and values shape indi‐ vidualsʹ preference patterns, and hence their economic behaviour.  it  is then possible to suggest that culture may affect economic outcomes for the group  in  three broad directions. first, culture will perhaps affect economic efficiency, via the promotion of  shared values within the group which condition the ways in which the groupʹs members under‐ take the economic processes of production. for example, if these cultural values are conducive to  more effective decision‐making, to more rapid and varied innovation and to more adaptive behav‐ iour in dealing with change, the economic productivity and dynamism of the group will be likely  eventually to be reflected in better financial outcomes (in the case of the corporate enterprise) or in  higher growth rates (in the case of the economy).  secondly, culture may affect equity ‐ for example, by inculcating shared moral principles of  concern for others and hence encouraging the establishment of mechanisms by which that concern  can be expressed. in the case of society as a whole, one significant aspect of this might be seen in  intergenerational equity, if a moral obligation to provide for future generations is an accepted cul‐ tural value. in general, the effect of culture on equity will be seen in resource allocation decisions  of the group directed at achieving equitable outcomes for its members.  thirdly, culture may be seen as influencing or even as determining the economic and social  objectives that the group decides to pursue. at the small group level, say that of the individual firm,  the corporate culture may be one of concern and care for employees and their working conditions,  and  these values may mitigate  the  importance of profit‐seeking or other economic goals  in  the  firmʹs objectives. at the societal level, cultural values maybe entirely in tune with, say, the pursuit  of material progress, enabling criteria of macroeconomic achievement to be used to distinguish  ʹsuccessfulʹ from ʹunsuccessfulʹ societies.3   the culture of other societies, on the other hand, may be such as to temper the pursuit of ma‐ terial reward in favour of non‐material goals relating to various qualities of life, thus affecting the  pace and direction of economic growth; in such cases the criteria defining ʹsuccessfulʹ and ʹunsuc‐ cessfulʹ will be different from the former case.  by these three avenues, the effect of culture on individual behaviour will be reflected in col‐ lective outcomes. thus, for example, at an aggregate level, we might observe the influence of cul‐ ture on macroeconomic outcomes in terms of efficiency indicators such as the rate of growth of per  capita gdp, rates of technological change, employment  levels, rates and directions of structural  volume 40 • autumn 2007 • 79  change and so on, and in terms of equity indicators such as patterns of income distribution, social  welfare programmes (especially care for the aged and sick), the supply of community services and  (reflecting concern for intergenerational equity) the willingness to undertake long‐term public in‐ vestment programmes which may not be of much direct benefit to the present generation.  how far has economics come in viewing economic performance as being mediated by cul‐ tural influences along the lines sketched out above? mark casson has suggested that:  economics is making progress in coming to terms with culture. just a few years ago an economic theo‐ rist would typically claim that culture simply does not matter so far as economic performance is concerned;  everything that matters is explained by prices ‐ real prices in external markets and shadow prices in internal  ones. today the theorist is more likely to admit that culture matters, but to argue that it is something that  economics cannot, or should not, attempt to explain.4  casson  goes  on  to  argue  that  such  defeatism  is  unwarranted,  and  that  indeed  economic  analysis can make progress in identifying the influences that culture has on economic performance  and  in quantifying their effects. his own work attempts to specify cultural variables that affect  interfirm relations such as cooperation and competition, and intrafirm relations such as organisa‐ tional behaviour, and to postulate their effects on economic outcomes in different cultural settings.  nevertheless  scepticism  among  economists  still  persists,  especially  at  the  macroeconomic  level where there remains considerable speculation as to whether and to what extent cultural fac‐ tors have played a role in determining economic performance in different countries. for example,  the sources of post‐war growth in japan, and more recently in south korea, taiwan, hong kong  and singapore, have been widely contested. it is undeniable that economic factors in these coun‐ tries have contributed significantly to their rapid growth, including stable macroeconomic man‐ agement (getting the fundamentals right), promotion of competition, strong export orientation, pres‐ sure for ʹcatch‐upʹ technological change, investment in human capital and so on.   even so there is disagreement among economists as to how far targeted industrial policies  and strategic government  interventions, which have been markedly contrary  to  the precepts of  neoclassical orthodoxy, have been influential in promoting accelerated economic performance. yet  underlying all this, a more fundamental and pervasive role for culture can be proposed, in which  certain cultural principles, derived to a significant extent from confucianism, have helped to create  the conditions for economic success.   these factors include concern for the welfare and mutual esteem of the group, an achieve‐ ment‐oriented work ethic, regard for the importance of the family, a belief in the need for educa‐ tion, a respect for hierarchy and authority and so on.5 looking specifically at the japanese case, we  can observe that such factors as religion, family attitudes, patterns of cooperation within a cultur‐ ally homogeneous society and so on, have shaped the public and corporate institutions of japan  and the manner of their operation; in this way can the cultural foundations of japanese society be  seen to have permeated all aspects of japanese economic life.6  a difficulty besetting the resolution of various theoretical disputes about the effect of culture  on economic performance is the availability of appropriate data for the testing of competing theo‐ ries. nevertheless, some progress in assembling and interpreting empirical information on culture  and the economy is being made. for example, measurement of relevant cultural traits and their  inclusion in cross‐country models of economic growth is beginning to show more clearly the quan‐ titative importance of the cultural context in which economic activity takes place. ronald ingle‐ hart, for example, tabulates a wide range of individual attitudes towards religion, work, the family  and social issues across a broad sweep of countries and relates them to economic achievement.7     2007 ‐ 80  •  economic analysis®  in an alternative approach to empirical analysis, hsin‐huang michael hsiao argues that cul‐ tural factors should not be interpreted as individual social behaviour per se, but should rather be  viewed as a set of orderly, institutionalised cultural arrangements at the societal level.8 only at that  level, he suggests, can one relate cultural behaviour to economic activities. ultimately, however,  whether the approach is micro or macro, neoclassical or institutional, the significant cultural influ‐ ences do need to be carefully specified and measured if theories about their contribution to eco‐ nomic outcomes are to be properly tested.  culture in third world development  let us turn from the functional role of culture in affecting economic performance to more  fundamental issues of what economic development means and how culture, in its broad constitu‐ ent sense,  is  implicated  in  that process. the conceptualisation of economic development as  im‐ provement in the material circumstances of the population (ʹall the necessaries and conveniences  of lifeʹ, in adam smithʹs phrase) dates back to the nineteenth century political economists and be‐ yond. in the mid‐twentieth century the theory of economic development as understood by econo‐ mists still clearly equated growth with material progress. thus simon kuznets wrote in 1966 that  ʹwe identify the economic growth of nations as a sustained increase in per capita or per worker  productʹ.9   gradually, however, this restricted view of what comprises progress in the developing world  has been replaced with a concept of development reflecting a broader array of societyʹs needs and  its aspirations for improved standards of living. ʹdevelopmentʹ in this more general sense certainly  includes advancement in material wellbeing, measured as increases in per capita gdp or disposable  incomes, but it also includes changes in an array of social indicators such as nutritional levels of  the population, health status, literacy levels, educational participation, standards of public or wel‐ fare service provision and a number of non‐material characteristics that fall under the heading of  ʹquality of lifeʹ, including environmental indicators such as air and water quality.   furthermore, the fact that simple per capita measures taken across the whole population con‐ ceal inequities in the distribution of income and wealth has been widely recognised, and the im‐ portance of redistribution as an element in the development process acknowledged. by and large  the theory of development as it stands in economics today has taken these wider interpretations on  board.  nevertheless  the  focus  remains  clearly  on  material  progress,  especially  of  the  poorest  groups, as the principal indicator of advancement in the developing world.  such a view is readily rationalised by reference to the basic needs of human beings for food,  shelter and clothing, needs which it is said can be satisfied only by improvement in material cir‐ cumstances. further, it is argued that peoplesʹ desires for enhancement in the various aspects of  quality of  life,  including non‐material characteristics such as environmental amenity, can be se‐ cured only through economic advance measured in material terms. within this paradigm there is  little or no role for culture, either as a mediating influence on the achievement of material progress  or as an element in the structure of needs and wants felt by different societies.   as a result, as vernon ruttan has remarked, cultural considerations have been cast into the  ʹunderworldʹ of development thought and practice; writing in the late 1980s and early 1990s, he  suggested that no development economist would agree to the proposition that cultural variables  might be important in explaining political and economic development. 10 since then, little seems to  have changed. mainstream texts in economic development have no time for culture; taking three  such texts more or less at random,11 an inquisitive reader can find no reference to culture in the  subject indexes of any of them.    volume 40 • autumn 2007 • 81  despite this orthodoxy, however, there are clear signs of a shift underway in thinking about  development, associated with a refocusing on human beings themselves as both the object of de‐ velopment and as the agents by which development is brought about. thus a commodity‐centred  notion of economic development gives way to a people‐centred strategy of human development.  this shift in focus dates from the late 1980s when the united nations development strategy for the  1990s adopted human development as its key focus, and the united nations development pro‐ gram (undp) instituted its annual human development report, the first of which appeared in 1991.  the objective of human development is interpreted as being to expand the capabilities of people to  lead the sorts of lives they desire.   amartya sen has argued that, although increased output per head may enlarge such capa‐ bilities,  the ultimate concern of development should not be output as such.12 keith griffin has  summarised senʹs argument as suggesting that the focus should be on enhancing the ability of  people to lead a long life, to enjoy good health, to have access to the worldʹs stock of knowledge  and information, to participate in the cultural life of their community, to have sufficient income to  buy food, clothing and shelter, to participate  in the decisions that directly affect their  lives and  their community, and so on. these are the things that matter ‐ increasing the capabilities of people  ‐  and  the  enhancement  of  capabilities,  not  the  enlargement  of  domestic  (or  material)  product,  should be the objective of development policy.13  a reorientation of development thinking along these lines has obvious cultural implications.  people as the object and means of development do not exist in isolation. they interact in a variety  of ways, and the framework within which this  interaction occurs  is provided by their culture  ‐  their shared beliefs, values, languages, traditions and so on which contextualise their daily lives.  as  indicated  by  the  un  world  commission  on  culture  and  development  (1995),  re‐ conceptualising development in human terms brings culture in from the periphery of development  thinking and places it in centre stage. in these circumstances notions of economic development,  human development and cultural development might become absorbed into a more comprehen‐ sive theory of transformation in the developing world.14  the rigorous articulation of such a theory remains to be worked out, but it is possible to dis‐ cern several likely features of a new development paradigm emerging in contemporary thought.   first,  it  is unlikely that a new development model will  incorporate strictly uni‐directional  causalities. rather the interconnectedness of the elements of the model, with influences flowing in  many directions at once, is likely to be emphasised. so, for example, the effect of cultural character‐ istics  and  aspirations  of  a  given  society  on  traditional  economic  variables  such  as  output  per  worker is likely to be counter‐balanced by an account of the influence of labour productivity on  changing values.   secondly, and relatedly, it will be acknowledged that neither culture nor economy is a static  thing but that each is constantly changing, such that relationships between variables are dynamic  processes rather than fixed constants.   thirdly, no single model of development will be appropriate to all circumstances, but rather  the differences in development paths between countries which have brought about different eco‐ nomic, social, cultural and institutional conditions, will determine how development prescriptions  should be made in each particular case.15   fourthly, the new paradigm is likely to see pluralism, not uniformity, as an essential compo‐ nent,  in particular an acknowledgement that human development begins at a  local  level where  cultural diversity within and between communities is a vital manifestation of civilised human exis‐ tence.   2007 ‐ 82  •  economic analysis®    finally, a concomitant of pluralism is cultural freedom, both the collective freedom of socie‐ ties to choose what sort of development they want, and the individual rights which are central to  the idea of a free society. these freedoms presuppose an institutional structure, established by col‐ lective agreement and operating through the state and civil society, which provides the guarantee  that such freedoms will be upheld. thus attention to institutional arrangements is also likely to  figure prominently in this development model.16  within  such  a  broadly  based  development  framework  we  can  suggest,  as  before,  that  a  means of bringing economic and cultural concerns together is to return to the basic notion of value  creation, where the generation of both economic and cultural value can be discerned as outcomes  of  a  development  process  which  balances  the  desire  for  material  goods  and  services  with  the  deeper needs and aspirations of human beings for cultural recognition, expression and fulfilment.  culture, development and sustainability  an invocation of economic and cultural value as components of a development model, to‐ gether with an acknowledgement of the long‐term and evolutionary nature of both economic de‐ velopment  and  cultural  change,  render  the  idea  of  sustainability  a  natural  frame  of  reference  within which to integrate an analysis of economic and cultural development. furthermore, given  that one of the main connotations of sustainability has to do with the natural environment and its  relationship to economic processes, and given the similarities between the natural and the cultural  environment and between natural and cultural capital, it can be readily suggested that environ‐ mental interpretations of sustainability will have a counterpart in the cultural sphere.   we have noted this already in drawing attention to the parallels between the ways in which  the ecosystem supports the biosphere and the cultural infrastructure supports the social universe;  both in turn provide essential sustenance for the economic life carried on in their respective do‐ mains.  the principles of sustainability provide a basis on which to approach the broader issue of  culture in economic development. indeed it can be suggested that they might be capable of speci‐ fying a type or pattern of development that is ʹculturally sustainableʹ in the same way as a some‐ what similar set of criteria derived for the natural world provides a formula for defining ecologi‐ cally and environmentally sustainable development. thus we might accept the principles of mate‐ rial and non‐material advancement,  intergenerational and  intragenerational equity,  the mainte‐ nance of cultural diversity, the precautionary principle and the recognition of system interdepend‐ ence as benchmarks against which to assess a cultural development process, strategy or specific  project. in the overall scheme of things, a requirement that development be culturally sustainable  would extend and complement an expectation that it should be ecologically sustainable.17  these sorts of ideas are beginning to be reflected in approaches to development policy in the  international community. for example, at the intergovernmental conference on cultural policies  for development held in stockholm in april 1998, the first policy objective agreed to by the 150  governments represented was to make cultural policy one of the key components of development  strategy. it was proposed that governments should establish policies which recognise the perva‐ sive importance of culture in development ʹin such a way that they [the cultural policies] become  one of the key components of endogenous and sustainable developmentʹ.18  turning to the operational world of development assistance, we may note that the role of  culture in sustainable development now appears to occupy the foreground of development think‐ ing. in the world bank, for instance, which disburses many millions of dollars annually in devel‐ opment loans to poor countries, the notion of sustainable development was introduced about a  volume 40 • autumn 2007 • 83  decade ago, opening out the development paradigm to encompass environmental and social con‐ cerns. but the further extension to culture is much more recent, responding in part to the broadly  based transformation of thinking about economic development to which we referred in the previ‐ ous section.19 let us review how culture is now being seen in the international arena of bilateral  and multilateral development assistance. three aspects can be highlighted:  • if it is true that globalisation transmits materialist values and a standardised form of  mass popular culture, it can be seen as a potential threat to local cultural differentia‐ tion, leading perhaps to social alienation and dislocation. because of this, an increas‐ ingly important target of development assistance in any sector is the nurturing and  build‐up of local cultural values.  • in formulating specific programmes and projects, attention is now being paid to tai‐ loring such interventions to local traditions and institutions, making use of local ex‐ pertise  and  knowledge  and  emphasising  cultural  interactions  within  and  between  communities. in practical terms this is evidenced in a search for ʹbottom‐upʹ processes  of strategy formulation and implementation.   • programmes particularly directed towards the poor can recognise how important cul‐ tural legitimation can be in energising communities and improving their self‐esteem.  poverty reduction programmes may therefore be more effective  if directed specifi‐ cally towards cultural targets, promoting cultural expression and awareness as being  concomitant with improvement in material circumstances.  these sorts of considerations are beginning to have an influence on the way in which devel‐ opment assistance organisations, aid agencies, ngos and other players on the field perceive their  role and carry out their business. for example, the world bank has now spelled out the fact that  culture can contribute directly to its core development objectives. it sees culture in a development  context as helping to:  • provide new opportunities for poor communities to generate incomes from their own cul‐ tural knowledge and production and to grow out of poverty  • catalyze  local‐level  development  through  the  diverse  social,  cultural,  economic,  and  physical resources that communities have to work with  • conserve and generate revenues  from existing  (cultural) assets by reviving city centers,  conserving socially significant natural assets, and generating sustainable, significant  tourism revenues  • strengthen social capital ‐ in particular, to provide a basis on which poor, marginalized  groups  can  pursue  activities  that  enhance  their  self‐respect  and  efficacy  and  to  strengthen  respect  for  diversity  and  social  inclusion  so  that  they  can  share  in  the  benefits of economic development  • diversify strategies of human development and capacity‐building for knowledge‐based dy‐ namic societies ‐ for example, through support for local publishing, library services,  and  museum  services,  especially  those  that  serve  marginalized  communities  and  children.20  the bank is pursuing these lines of action in its operational work through efforts, first, to in‐ tegrate cultural considerations into its lending strategies in all sectors, especially education; sec‐ ondly, to promote culture in its grass‐roots community development work; and thirdly to engage  with specifically cultural projects in borrowing countries, such as heritage projects of various sorts.    2007 ‐ 84  •  economic analysis®  in the  last‐mentioned case, where free‐standing projects  involve the restoration of historic  property or some similar line of investment in borrowing countries, the immediate revenues that  the project can generate assume a particular importance, since the loan and its repayment have to  be substantiated in financial terms. a major revenue source in many heritage redevelopment pro‐ jects is likely to be tourism. the bank is careful in its propaganda to emphasise that tourism to cul‐ tural sites in developing countries must not degrade the very culture that attracts it and must be  developed in a manner respectful of local traditions and cultural sensitivities.   in short, it must be culturally and environmentally sustainable. nevertheless, an emphasis  on an economic justification for a cultural heritage project, no matter how well the economic ap‐ praisal might encompass non‐use values and other indicators of levels of cultural esteem, may ori‐ entate the project in directions inimical to the generation of cultural value. it is important that the  dual values, economic and cultural, be accounted for in decision‐making in such projects.   conclusions  this text has pointed to a paradigm shift in thinking about the nature of economic growth  and development. by no means all development economists, still less all growth theorists, would  see the shift as important, and a number would not acknowledge its existence at all. nevertheless a  move towards recognising a role for culture  in  influencing economic performance  in small and  large groups, and more particularly in underlying and conditioning processes of economic growth  and change in developing countries, is gradually becoming more apparent.   central to this movement has been a reorientation of development thinking from a uniform  commodity‐centred  model  of  development  towards  a  pluralistic  human‐centred  one.  oddly  enough, the shift in development thinking is more evident in the practical world of development  assistance than in the theoretical arenas where paradigm shifts usually originate. in this respect,  we have pointed in this chapter to the acceptance by the world bank and other development agen‐ cies of an explicit role for culture in development as some evidence of the paradigm shift that is  taking place.   we have suggested, as before, that a distinction between economic and cultural value can  help to clarify the nature of the different sorts of value created by the development process.  notes  1. see, for example, the pioneering work of simon kuznets (1966), who demonstrated uniformities in the patterns  of economic growth across a number of countries by reference to an extensive range of economic phenomena.  note that kuznets did refer briefly to cultural characteristics of different countries (racial and linguistic homo‐ geneity, literacy, adoption of western values) which he discussed as ʹother aspectsʹ of the non‐economic charac‐ teristics of underdeveloped countries (1966, pp. 454‐60). nevertheless these variables were considered of minor  significance and the overwhelming focus was on economic phenomena.  2. for  the development of such models, see lucas  (1988); becker et at.  (1990); romer  (1994); barro and sala‐i‐ martin (1995).  3. for example, in considering the historical development of the world over the broad sweep of the second mil‐ lennium, david landes (1998) characterises nations as successful or unsuccessful on the basis essentially of per  capita wealth and income. note, nevertheless, that within this world view landes recognises the importance of  culture in influencing economic performance: ʹif we learn anything from the history of economic development,  it is that culture makes all the differenceʹ (1998, p. 516).  4. casson(1993, p. 418).  5. the standard orthodox assessment of the ʹasian miracleʹ was undertaken under the auspices of the world bank  (1993);  for  consideration  specifically  of  interventionist  interpretations,  see  lall  (1996)  and  masuyama  et  al.  (1997).  insightful  accounts  of  the  cultural  context  of  asian  economic  performance  are  contained  in  berger  (1993); hsiao (1993); brook and luong (1997); sen (1998a); see also ozawa (1994) and gray (1996). for dissent‐ volume 40 • autumn 2007 • 85  ing views see krugman (1994); woo‐cumings (1997); arrow (1998).  6. see further in munakata (1993); di maggio (1994, pp. 33‐4); fukuyama (1995, pp. 161‐93); hayami (1998, pp. 14‐ 17).  7. see inglehart (1990).  8. hsiao (1993, p. 20).  9. kuznets(1966, p. 1).  10. ruttan(1988, 1991).  11. gillis et al. (1996); ray (1998); todaro (2000).  12. sen (1990).  13. griffin (1996, p. 233).  14. for a contemporary anthropologistʹs approach to formulating a more comprehensive  development theory and  practice, see escobar (1995).  15. for  further discussion of path‐dependent and path‐independent models of development, see  j. mohan rao  (1998).  16. for an analysis of the importance of institutional structures as they relate to cultural beliefs and the trajectories  of developing economies, see greif (1994).  17. a brief reference is made to culturally sustainable development in the world commission on culture and de‐ velopment report mentioned in the previous section (wccd, 1995, pp. 24‐5; see also pp. 206‐7). for a more  elaborate treatment see throsby (1995).  18. see unesco (1998b, p. 14).  19. 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wolfensohn, james d. et al., 2000. culture counts: financing, resources, and the economics of culture in sustainable development, wash‐ ington, dc: world . bank  world bank, 1993. the east asian miracle: economic growth and public policy, new york: oxford university press  world bank, 1999. culture and sustainable development: a framework for action, washington, dc: world bank  world commission on culture and development (wccd), 1995. our creative diversity, paris: unesco      microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp109‐127 scientific review a literature survey of the environmental kuznets curve petar mitić1* | milena kresoja1 | jelena minović1 1 institute of economic sciences, belgrade, serbia abstract since the 1970s, the issue of environmental degradation has received considerable attention. environmental kuznets curve is one of the most well‐known hypotheses that explains the relationship between economic growth and environmental pollution. it represents an important model that enables policymakers to deliver quality information‐based decisions. in this paper, we provide the theoretical framework of the environmental kuznets curve and examine existing literature on the ekc hypothesis. the systematic literary survey includes studies conducted for single countries as well as for groups of countries. most of the studies were empirically testing the existence of an inverted u‐shaped relationship between economic growth and carbon dioxide emissions. due to the different periods, sets of independent variables and methodological frameworks, the results are inconclusive, which is consistent with previous literature surveys on the same topic. key words: environmental kuznets curve, environmental degradation, income, economic growth, co2 emissions jel classification: q50, q56 introduction environmental degradation and lowering the quality of the environment has become a global problem attracting considerable attention. although it is not a generally accepted point, authors such as tietenberg & lewis (2016) state that in the field of environmental economics the natural environment is viewed as commodity or asset with many qualitative attributes. the natural environment can be used as a source of renewable resources, but also as aesthetic consumer goods. even today, there are ongoing discussions between economists and ecologists about a desirable or acceptable level of environmental pollution. the point that most economists and ecologists see as common is that zero pollution is neither desirable nor sustainable. ecologists emphasise that the environment has limited waste processing power and that environmental pollution occurs only when waste is deposited in the environment outside its assimilation capacity, i.e. beyond its ability to timely decompose waste. accordingly, the discharge and disposal of waste must not exceed the renewable assimilation capacity of the environment. economists often try to challenge, or better say, extend this view, stating that it is completely rational that society pollutes outside the assimilation capacity of the environment to the extent that it collectively benefits from increased pollution through the added value of goods and services produced (hussen, 2000). * corresponding author, e‐mail: petar.mitic@ien.bg.ac.rs 110 economic analysis (2019, vol. 52, no. 1, 109‐127) simon kuznets set up a model in 1955 that shows that relationship between income per capita and income inequality exhibits an inverted‐u shape curve. as the per capita income increases, inequality of income also increases initially and then begins to decline after a certain turning point. in other words, the income growth in the initial stages has unequal income distribution, and then, income distribution gains greater equality with economic growth (kuznets, 1955). this empirical phenomenon is known as the kuznets curve. from the 1990s, this curve gets a novel interpretation. empirical evidence that both the level of environmental degradation and income per capita follow the same inverted‐u shape has been found. therefore, the environmental kuznets curve (ekc) now becomes a means of describing the relationship between the level of environmental quality and income per capita (dinda, 2004). before creating the concept of ekc, the limited ability of the environment to absorb waste has been in the focus of scientific and professional discussions. after establishing the theoretical model of ekc, the focus shifted to the necessity of achieving and maintaining economic growth to overcome the problems of environmental pollution. high economic growth rates are the basis of all developing countries’ policies, resulting in extremely high environmental costs, primarily in terms of urban and industrial waste accumulation, deterioration of air, land and water quality, loss of biodiversity, climate change and global warming (gill, viswanathan, & hassan, 2017). thus, economic growth in developing countries will produce more pollution than economic growth in developed countries due to the level of technological progress and innovation. this systematic relationship between economic development and the environment is an assumption on which the ekc hypothesis has been developed. webber & allen (2010) have taken the view that ekc has important implications, primarily that developing countries should direct their policies to achieve rapid economic growth, rather than adopting and implementing environmental policies. they state that "economic growth ultimately leads to the achievement of both ecological and economic goals, while pro‐environmental policies only slow down economic growth" (webber & allen, 2010). the term “environmental kuznets curve” was coined by panayotou (1993). the first studies that empirically tested and demonstrated the existence of the inversed‐u shape of the ekc between income and environmental pollution were carried out by grossman & krueger (1991) and shafik & bandyopadhyay (1992). studying the interdependence between air quality and economic development, grossman & krueger (1991) found the inversed‐u shape curve between so2 and smoke and income per capita. this is the first formal confirmation of the ekc validity. these results indicated that the concentration of air pollutants increase with the income level at first, and then decrease at higher levels of income. the ekc was further popularised in the 1992 world bank development report, which states that as revenues increase, the demand for improving the quality of the environment will increase along with the resources available for investment (ibrd, 1992). this position is also supported by beckerman (1992), who states that although economic growth usually leads to environmental degradation in the early stages, it ultimately represents the best and possibly the only way to achieve an adequate quality of the environment in most countries. thus far, a vast number of papers have been published which empirically investigate and analyse the issues of interdependence between environmental quality and economic growth, using diversified tools of econometric analysis. it is important to point out that the hypothesis of environmental kuznets curve was, and still is today, particularly interesting in this type of research. according to mitić, munitlak ivanović, & zdravković (2017), empirical models that analyse the environmental kuznets curve most often observe the indicator of environmental degradation as a dependent variable in relation to the indicators of economic development and their squares as the independent variable. the remainder of this paper is organised as follows. in the next section, the theoretical framework of the ekc is presented. special emphases are given to the factors of influence on the shape of the ekc curve, and econometric specification of the model. rest of the paper provides petar mitić, milena kresoja, jelena minović 111 an overview of ekc research for both individual and groups of countries. last part of the paper gives several concluding remarks. theoretical framework of the environmental kuznets curve the intuition behind the ekc is intuitively attractive (dinda, 2004). "environmental kuznets curve represents a hypothetical link between different indicators of environmental degradation and income per capita" stern (2004). this curve postulates that in the early stages of economic development, industrialisation and urbanisation greatly exhaust natural resources and create industrial and urban waste. at this stage, economic growth and pollution are interconnected, in the sense that economic growth also increases environmental pollution (gill, viswanathan & hassan, 2018). dasgupta et al. (2002) confirm this view, stating that pollution is rising rapidly in the early stages of industrialisation, as the main goal is to increase material production, and people are more interested in business and earning revenues rather than having clean air and water. rapid achievement of economic growth implies increased use of natural resources and emissions of pollution, which creates greater pressure on the quality of the environment. people at these stages of economic growth are too poor to invest in improving the quality of the environment and most often neglect the consequences that growth makes to the environment. it is said that multi‐dimensional poverty is often high in the initial stages of economic development, and environmental conservation is often ignored (asumadu‐sarkodie & strezov, 2019a). therefore, at this stage, there is a positive linear link between economic growth and environmental pollution. reduction of pollution comes with the advancement of the process of industrialisation, technical and technological improvements and growth of the service sector (panayotou, 1993). in other words, pressure on the environment is growing faster than income in the early stages of development and slows down with gdp growth at higher levels of income. “green economy and especially renewable energy are crucial for reducing poverty, a particularly significant problem for developing countries” (todorović, 2018). only in the later phases of economic development, there is a significant increase in income levels which, in combination with an increase in institutional quality, awareness of environmental sustainability and high diffusion of technology and innovation, causes a decrease in environmental degradation (asumadu‐sarkodie & strezov, 2019a). therefore, it is evident that ekc represents a well‐established relationship between the level of economic activity and the pressure on the environment. “in brief, environmental kuznets curves are statistical artefacts that summarise a few important aspects of collective human behaviour in two‐ dimensional space.” dinda (2004). as it is stated above, at higher levels of income, people start to value the environment more. therefore, there are more requirements for environmental quality in the advanced stages of economic development. at higher levels of economic development, structural changes towards information‐intensive industries and services, together with increased environmental awareness, implementation of environmental protection regulations, better technology and higher environmental costs, result in a gradual reduction in environmental degradation. when income per capita crosses the turning point of ekc, it is assumed that improving the quality of the environment begins to grow. therefore, this could be an overview of the natural process of economic development from an agrarian and industrial economy to a clean economy based on information‐intensive activities and services sector (arrow et al., 1995). all this speaks in favour of the fact that the environmental indicator is a reversed function of income per capita. precisely this systematic relationship between income per capita and environmental quality is the core of ekc hypothesis. pollution increases with an increase in revenues in the early stages of economic development and is reduced with an increase in revenue in the later stages of economic development, as shown in figure 1. 112 economic analysis (2019, vol. 52, no. 1, 109‐127) figure 1. environmental kuznets curve source: authors the conceptual framework of ekc may imply that environmental problems that arise as a result of economic growth are automatically solved in later stages of economic development. in a dynamic economic environment, with technological advances and increase in population preferences toward a better environment, economic growth does not pose a threat to environmental quality, but rather a condition for raising its’ quality. under the assumption of the truthfulness of the ekc hypothesis, economic growth should not be viewed as a threat to the quality of the environment, but as a means for eventual improvement of the environment. this idea also underwent an administrative embodiment in the new idea of sustainable economic development in our common future report published by the world commission on environment and development in 1987 (stern, 2004). lapshina, bakaeva & sotnikova (2017) claimed that a transition to the sustainable development concept is a necessity, especially for the urban territories. ekc had a significant impact on the economic policies of both developing and developed countries alike. even the priorities of the international monetary fund and the world bank have been focused on supporting policies for growth. therefore, economic growth has become the primary goal of developing countries without proper consideration of environmental issues. according to van den bosch & telenius (2016), changes in the environment are evident all over the world and take place at a faster pace than previously thought. for this reason, it is imperative that governments now take steps to reverse and adapt to the damage already done. the empirical results of the ekc indicate that economic growth can support environmental improvements if appropriate policies are taken. however, the consensus is that effective environmental policy can only be achieved in terms of income growth. however, before adopting a policy, it is important to understand the nature and the causal link between economic growth and the quality of the environment (coondoo & dinda, 2002). therefore, dinda (2004) puts a relevant question here: can economic growth be part of the solution and not the cause of environmental problems? this was the basic motivation for empirical studies in the search for proofs of interdependence between income growth and environmental degradation. petar mitić, milena kresoja, jelena minović 113 factors affecting the inversed‐u shape of the environmental kuznets curve factors that influence the inverted‐u shape between environmental degradation and income levels are (asumadu‐sarkodie and strezov, 2019a): • income elasticity of environmental quality • scale, composition and technique effect • international trade “income elasticity of environmental quality demand is the proportional change in environmental quality demand per the proportional change in income level.” (asumadu‐ sarkodie & strezov, 2019a). they further state that demand for quantity instead of quality means an increase in exploitation of natural resources and manipulation of environmental regulations and industry standards to attract polluting industries from developed countries. only when the level of income and the living standard increase, people are ready to pay for a better environment. in other words, the most common explanation for the ekc form is the idea that people attach greater value to ecological aspects only when the country achieves a sufficiently high standard of living (edenhofer et al., 2011, girod et al., 2014). the interdependence between environmental degradation and economic development takes place through three effects: the effects of scale, composition and technique (grossman & krueger, 1991). these effects are presented in figure 1. economic development has a negative impact on the environment, while the scale effect is in place. higher production volumes require greater exploitation of natural resources, thus increasing environmental degradation. furthermore, economic development implies a high consumption of non‐renewable energy sources that is cheaper than renewable energy (asumadu‐sarkodie & strezov, 2019a). the use of non‐renewable energy for industrial processes can reduce production costs and provide a greater volume of manufactured goods and services, but it nevertheless encourages the increase of harmful emissions, primarily from industrial processes (owusu & asumadu, 2016). furthermore, the composition effect implies that economic development has a negative or positive impact on the environment, depending on structural changes in the economy (asumadu‐sarkodie & strezov, 2019b). as the level of income grows, the structure of the economy is changing and economic activities that produce less pollution gradually increase. environmental degradation is increasing as the structure of the economy is directed from agricultural to industrial activities, but also with a structural change from the energy‐intensive industry to services and knowledge‐based innovations and technologies. the technique effect implies that economic development has a positive impact on the environment. as countries with higher levels of income invest more in research and development (komen et al., 1997), this allows the replacement of old technologies that emit large quantities of pollution with new, cleaner and more sophisticated technologies. this combined with strict environmental regulations and industry standards, leads to an improvement in the quality of the environment. taking all three effects into account, ekc suggests that the negative impact of the scale effect on the environment tends to govern at the initial stages of growth. it will ultimately be overcome by the positive impact of the composition and technique effect that tends to reduce the level of harmful emissions (dinda, 2004; asumadu‐ sarkodie & strezov, 2018). certain economists, such as lee & roland‐holst (1997) and jones & manuelli (1995) argue that trade is not the main cause of environmental degradation. however, free trade has diversified and contradictory effects on the quality of the environment, as it also increases pollution and motivates their reduction (dinda, 2004). through the scale effect, the quality of the environment decreases because increasing the volume of trade, and above all exports, increases the size of economic activities, which increases pollution. on the other hand, trade improves the environment through composition and technique effects. openness and trade 114 economic analysis (2019, vol. 52, no. 1, 109‐127) liberalisation leads to the specialisation of countries in those sectors where they have a competitive advantage. however, if a competitive advantage arises from liberal environmental regulations, then trade openness will degrade the environment. trade liberalisation, through the composition effect, is also called the pollution haven hypothesis. if the environmental protection regulations are weak, they attract energy‐intensive industries that emit large quantities of pollution. it is most often the case that developed countries transfer their industrial capacities to developing countries with poor environmental legislation. poor environmental policies and regulations in developing countries are becoming a source of comparative advantage, and therefore, changes in the trade structure promote environmental degradation in these countries (sun, zhang & xu, 2017). in the same way, if innovation, research and development, as well as clean and modern technologies are transmitted through foreign direct investments from developed countries to developing countries, this can reduce the level of pollution. an econometric framework of the environmental kuznets curve the studies that investigated the ekc hypothesis have common characteristics of the used data and methodologies. in other words, regardless of the different methods and techniques used in the analysis of the ekc, almost all follow a similar model specification. most of the data used in this type of research are panel data. therefore, the basic specification of the ekc model is as follows: , , , , , , , , where y represents environmental indicators,  is the constant, x, x2 and x3 represent the income level, the squared income level and the cubical income level, k are the coefficients estimates of the regression, z represents other indicators of interest for the model, i is a spatial index (country), t is the time index (year), and  is white noise. based on the econometric specification of the model, the testing of the relationship between environmental pollution and income levels can provide several interpretations (asumadu‐ sarkodie & strezov, 2019a; dinda, 2004). we have divided these interpretations into three groups. the first group displays linear relationships, which are presented in figure 2. figure 2. a linear relationship between environmental pollution and income source: authors petar mitić, milena kresoja, jelena minović 115 the left‐hand plot of the figure 2 represents a case where a monotonically decreasing relationship between environmental degradation and income exists (1 < 0 and 2 = 3 = 0). middle plot of the figure 2 represents a situation where no relationship between environmental degradation and income is detected (1 = 2 = 3 = 0), while the right‐hand plot of the figure 2 illustrates a case where a monotonically increasing relationship between environmental degradation and income is present (1 > 0 and 2 = 3 = 0). the second group represents the u shaped relationships between environmental degradation and income levels. these relationships are graphically presented in figure 3. figure 3. inverted‐u and u shaped relationship between environmental pollution and income source: authors left‐hand side of the figure 3 shows a situation where an inverted‐u shaped relationship exists, i.e. which supports the ekc hypothesis (1 > 0, 2 < 0 and 3 = 0). on the other hand, right‐ hand side of figure 3 represents a situation where the relationship has the shape of u shaped curve (1 < 0, 2 > 0 and 3 = 0). third and final group represents the n shaped relationships between environmental degradation and income levels, which relationships are graphically shown in figure 4. figure 4. inverted‐n and n shaped relationship between environmental pollution and income source: authors 116 economic analysis (2019, vol. 52, no. 1, 109‐127) left‐hand side of the figure 4 visualises an inverted‐n shaped relationship (1 < 0, 2 > 0 and 3 < 0). right‐hand side of the figure 4 represents a situation where there is a n shaped curve (1 > 0, 2 < 0 и 3 > 0). based on all the above mentioned, the ekc hypothesis is valid only in the case when 1 > 0, 2 < 0 и 3 = 0, i.e. left‐hand side of the figure 3. the turning point of the curve is then obtained as a maximum of the quadratic function: ∗ 2 . a vast number of econometric studies have used the previous model to test the existence of an ekc for a wide range of environmental indicators. it is necessary to point out that the values of the indicators in this type of research are often used in their logarithmic form. selected literature review for single countries as mentioned above, there is an extensive number of studies which tested the environmental kuznets curve hypothesis for individual countries. some countries, such as china, turkey, malaysia and pakistan, etc. have been of great interest in the context of testing ekc hypothesis, but there is a certain number of countries that have not yet been examined in this context. for example, ahmad et al. (2017) examined the validity of ekc in croatia using autoregressive distributed lag (ardl) model and vector error correction model (vecm) on quarterly data for the period 1992q1‐2011q1. their results confirmed the validity of the ekc, i.e. there is an inverted u‐shape relation between co2 emissions and economic growth in the long run. similarly, kang et al. (2016), lacheheb et al. (2015), and saboori et al. (2012) tested the relationship between economic growth and co2 emissions in china (1997–2012), algeria (1971‐ 2009), and malaysia (1980‐2009), respectively. using a spatial panel data model, kang et al. (2016) showed the existence of inverted‐n ekc in china. oppositely, lacheheb et al. (2015) used ardl co‐integration framework and showed that ekc hypothesis does not exist in algeria, while results from saboori et al. (2012) indicated that there is support for the ekc hypothesis in malaysia, again using ardl methodology. another study that examined the validity of ekc hypothesis for the period 1960‐2007 in china was conducted by šimurina & dobrović (2011). the authors used regression analysis and the following variables: economic growth (per capita gdp) and carbon dioxide (co2) emissions per capita. results presented by kang et al. (2016), indicate that the ekc hypothesis is rejected for china, but here a linear relationship fits the data more properly. another study that does not support the ekc hypothesis was conducted by al‐ mulali et al. (2015). they were examining vietnam for the period 1981‐2011 and showed that the relationship between gdp and pollution is positive in both the short and long run, follow an inverted‐u shape. to the contrary, li et al. (2016) found that ekc hypothesis is supported in china. the selected methodology was a dynamic panel model with generalized method of moments (gmm) estimator and ardl model with alternative panel estimator, to test ekc hypothesis in the period 1996‐2012. on the other hand, in the case of spain, esteve & tamarit (2012) examine the long‐run relationship between per capita carbon dioxide and per capita income over the period 1857– 2007. they utilised threshold cointegration techniques, and their results suggest the existence of an inverted‐u shape between two selected variables, supporting ekc hypothesis. saboori & sulaiman (2013) employed ardl methodology, johansen–juselius maximum likelihood approach, and vecm to test the relationship between economic growth, carbon petar mitić, milena kresoja, jelena minović 117 dioxide emissions and energy consumptions. these authors test the ekc hypothesis in malaysia for the period 1980‐2009, by employing both the aggregated and disaggregated energy consumption data. their results did not support the ekc hypothesis when aggregated energy consumption data was used. however, when data were disaggregated based on different energy sources, their study does show evidence of the ekc hypothesis. for romania, shahbaz et al. (2013) used ardl cointegration tests to analyse the dynamic relationship between economic growth, energy consumption and carbon dioxide emissions for the period 1980‐2010. their empirical results suggest that the ekc is found both in long‐and‐ short runs. same results were obtained in the case of pakistan for the period 1971‐2008. here ahmed & long (2012) tested the existence of ekc using data for carbon dioxide emissions, economic growth, energy consumption, trade liberalisation and population density. these authors utilised the cointegration analysis using the ardl bounds testing the approach on yearly data. the same methodology – ardl has been used by al‐mulali et al. (2015) for vietnam, bölük & mert (2015) for turkey, jalil (2012) for china, and mrabet & alsamara (2017) for qatar. bölük & mert (2015) test the validity of the ekc hypothesis during 1961‐2010. their results show the existence of a u‐shaped relationship between per capita greenhouse gas emissions and income in turkey. jalil (2012) test the long‐run relationship between openness and income inequality in the period 1952‐2009. it was found that income inequality rises with the increase of openness and then starts to fall after a critical point, which is in line with the ekc hypothesis. mrabet & alsamara (2017) tested the ekc hypothesis using two different environment indicators: the carbon dioxide emissions and the ecological footprint in the period 1980–2011. the variables used in this study are the real gross domestic product, energy use, financial development, trade openness, carbon dioxide emissions and the ecological footprint. their results suggest that the ekc hypothesis is not valid in qatar when they use carbon dioxide emissions, whereas the ekc hypothesis is valid when using the ecological footprint. furthermore, al‐mulali et al. (2016) investigated the ekc hypothesis for kenya from 1980 to 2012 using the ardl approach again. their results showed that fossil fuel energy consumption, gdp, urbanisation, and trade openness increased air pollution mutually in the long run and short run. al‐mulali et al. (2016) showed that the ekc hypothesis does exist in kenya. zambrano‐ monserrate et al. (2018) and tiwari et al. (2013) used ardl and vecm methodology to test the ekc hypothesis for peru (1980‐2011) and india (1966‐2011), respectively. zambrano‐ monserrate et al. (2018) showed that ekc hypothesis does not exist in peru, while tiwari et al. (2013) results suggested the presence of ekc in the long run as well as in short run in india. for malaysia, ali et al. (2017) investigated ekc using the following variables: the impact of real gdp per capita, financial development, trade openness, foreign direct investments, and energy consumption on co2 emissions throughout 1971‐2012. the authors employed ardl bound test and the granger causality test to investigate the long‐run relationship between the selected variables. their results suggest that the ekc hypothesis exists in malaysia. using the same methodology, jalil & mahmud (2009) tested the ekc relationship between carbon dioxide emissions and per capita real gdp in the period 1975‐2005 in the case of china. these authors used the following variables: carbon emissions, energy consumption, income, and foreign trade. jalil & mahmud (2009) found a quadratic relationship between income and carbon dioxide emissions, supporting the ekc relationship. fodha & zaghdoud (2010) used cointegration analysis to show that the ekc hypothesis was valid in tunisia for the period 1961‐2004. similarly, lau et al. (2014) employing the bounds testing approach and granger causality methodology and got results that the ekc hypothesis does exist for malaysia in the period 1970‐2008. for saudi arabia, mahmood & alkhateeb (2017) employed ardl cointegration tests in order to test the impacts of trade and income level on carbon dioxide emissions in the period 1970‐2016. the authors’ results showed inveterate the ekc hypothesis. for cambodia, ozturk & al‐mulali (2015) used the generalized method of moments and the two‐stage least squares to investigate whether better governess and 118 economic analysis (2019, vol. 52, no. 1, 109‐127) corruption control help to form the inverted u‐shaped relationship between income and pollution for the period of 1996–2012. their results suggest that the ekc hypothesis was not confirmed in cambodia. nasir & rehman (2011) and shahbaz et al. (2012) investigated the ekc hypothesis in case of pakistan for the period 1972–2008, and 1971–2009, respectively. both nasir & rehman (2011) and shahbaz et al. (2012) confirmed the existence of the ekc for pakistan. table 1. summary of studies on individual countries author period country methodology variables ekc ahmad et al. (2017) 1992q1‐ 2011q1 croatia ardl & vecm granger causality co2, gdp yes ahmed & long (2012) 1971‐ 2008 pakistan ardl co2, gdp ec, to, pd yes ali et al. (2017) 1971‐ 2012 malaysia ardl & vecm granger causality co2, gdppc, fd, to, fdi, ec yes al‐mulali, saboori & ozturk (2015) 1981‐ 2011 vietnam ardl co2, gdppc, el (fossil fuels) el (renewables), ca, lf, ex, im no al‐mulali, solarin, & ozturk (2016) 1980‐ 2012 kenya ardl & vecm granger causality co2, gdppc, el (fossil fuels) el (renewables), fd, to, ur yes bölük & mert (2015) 1961‐ 2010 turkey ardl co2, gdppc, el (renewables) yes esteve & tamarit (2012) 1857‐ 2007 spain threshold cointegration techniques co2, gdppc yes fodha & zaghdoud (2010) 1961‐ 2004 tunisia panel cointegration and vecm granger causality co2, gdppc, so2 yes jalil & mahmud (2009) 1975‐ 2005 china ardl co2, gdppc, ec, to yes jalil (2012) 1952‐ 2009 china ardl open, gini, fd, inf, yes kang, zhao & yang (2016) 1997‐ 2012 china the spatial panel data model co2, gdppc, to, cc, ur, pd yes lacheheb rahim & sirag (2015) 1971‐ 2009 algeria ardl co2, gdppc, cf, to no lau, choong & eng (2014) 1970‐ 2008 malaysia bounds testing & vecm granger causality co2, gdppc, fdi, to yes li et al. (2016) 1996‐ 2012 china dynamic panel model, gmm, ardl co2, iww, iws, gdppc, ec, to, ur yes mahmood & alkhateeb (2017) 1970‐ 2016 saudi arabia ardl co2, gdp, tr yes mrabet & alsamara (2017) 1980‐ 2011 qatar ardl co2, ef, gdppc, ec, fd, to no (for co2) yes (for ef) nasir & rehman (2011) 1972‐ 2008 pakistan panel cointegration and vecm granger causality co2, gdppc, ec, to yes ozturk & al‐ mulali (2015) 1996‐ 2012 cambodia gmm & tsls co2, gdp, el, to, cor, gov no petar mitić, milena kresoja, jelena minović 119 author period country methodology variables ekc saboori & sulaiman (2013) 1980‐ 2009 malaysia ardl, johansen–juselius maximum likelihood approach, vecm granger causality co2, gdppc, ec no (when aggregated ec) yes (when disaggregated ec) saboori, sulaiman & mohd (2012) 1980‐ 2009 malaysia ardl & vecm granger causality co2, gdppc yes shahbaz et al. (2012) 1971‐ 2009 pakistan ardl & vecm granger causality co2, gdppc, ec, to yes shahbaz et al. (2013) 1980‐ 2010 romania ardl co2, gdppc, ec yes šimurina & dobrović (2011) 1960‐ 2007 china regression analysis co2, gdppc no tiwari, shahbaz & hye (2013) 1966‐ 2011 india ardl & vecm granger causality co2, cc, gdppc, to yes zambrano‐ monserrate et al. (2018) 1980‐ 2011 peru ardl & vecm granger causality co2, gdppc, el, dng, pc no source: authors note: variables: co2 – carbon dioxide emissions, gdp – gross domestic product, gdppc ‐ gross domestic product per capita, to – trade openness, cc – coal consumption, ur – urbanisation, pd – population density, cf – gross fixed capital formation, ec – energy consumption, el – electricity consumption, ca – capital, lf – labour force, ex – exports, im – imports, open ‐ openness (further divided in trade ratio, average tariff rates, effective tariff rates, economic globalization and overall globalization), fd – financial development, inf – inflation, ef ‐ ecological footprint, fdi – foreign direct investments, dng – dry natural gas, pc – petroleum consumption, so2 – sulfur dioxide emissions, tr – total trade, cor – corruption index, gov – government effectiveness index, iww – industrial waste water, iws – industrial waste solid emissions, methodology: gmm – generalized method of moments, tsls – two‐stage least squares, ardl – autoregressive distributed‐lagged model, vecm – vector error correction model. selected literature review for groups of countries the ekc analysis can be performed and extended by considering a region or a group of countries instead of a single country. there are many available studies exploring relationships described above within various regions and groups of countries. mena countries are particularly interesting for researchers. according to the analysis performed on single mena counties, the results are very heterogeneous. arouri et. al (2012) investigated the nature of the causality relationship between carbon dioxide emissions, energy consumption, and real gdp for 12 mena countries (algeria, bahrain, egypt, jordan, kuwait, lebanon, morocco, oman, qatar, saudi arabia, tunisia, and uae) covering the time period 1981‐ 2005. the authors utilised bootstrap panel unit root tests and cointegration techniques and estimated panel error correction models (ecm) to examine the interactions between short‐ and long‐run dynamics of environmental variables. ekc hypothesis is tested for the mena region for co2 and each country separately. at the region level findings support an inverted u‐shape pattern associated with the ekc hypothesis for the mena region. on the other hand, at the country‐level, there is poor evidence in support of the ekc hypothesis for the studied countries except for jordan. this result is confirmed by farhani et al. (2018). the authors analysed the following 10 mena countries over the period 1990–2010: algeria, bahrain, egypt, iran, jordan, morocco, oman, saudi arabia, syria, and tunisia. the authors tested the ekc hypothesis but also considered modified ekc to explore the relationship between sustainability and human development. in addition to the variables chosen by arouri et 120 economic analysis (2019, vol. 52, no. 1, 109‐127) al. (2012), these authors added trade openness, manufacture value‐added and modified hdi in the list of independent variables. data were analysed using panel data methods: panel long‐run estimates (fmols and dols) and panel vecm. panel data results offer support in favour of the ekc hypothesis, i.e., there is an inverted u‐shape relationship between environmental degradation and income. unlike two studies which applied parametric approaches on the panel of data sets from the mena region and whose findings supported the ekc hypothesis, research by fakih and marrouch (2019) led to opposite findings. these authors examined the ekc hypothesis for the selected ten countries in the mena region and covered the period from 1980 to 2010. the analytical framework included only two variables: carbon dioxide emissions and real gdp. the approach applied in this study was a non‐parametric regression model and technique in estimating the functional form of the curve is the deviance difference test. findings revealed that the ekc hypothesis is rejected, i.e., provide evidence against the postulated inverted‐u shaped relationship between pollution and the level of economic development. another interesting group of countries is the organisation for economic co‐operation and development (oecd). churchill et al. (2018) examined the ekc hypothesis for 20 oecd countries for the period between 1870 and 2014. in order to achieve this goal, the authors investigated cross‐sectional correlations. the specification of the model was the following. the dependent variable was carbon dioxide emissions, while the set of independent variables consisted of gdp, the square of gdp, the ratio of trade population, population, financial development. utilising recently developed panel data estimators that account for cross‐sectional dependence and parameter heterogeneity, the ekc hypothesis is verified for the panel with three of the four estimators (mg, amg, and pmg). the similar results were obtained by lau et al. (2018) who studied the ekc hypothesis in 18 oecd countries for the period 1995‐2015. however, the main aim of the study was to investigate the effects of electricity production from a nuclear source, electricity production from non‐renewables and trade openness on co2 emissions. these authors employed technique generalized methods of moments (gmm) and panel fully modified ordinary least squares (fmols). the results support the ekc hypothesis in oecd countries where nuclear energy plays a pivotal role in protecting the environment. another group of countries has been very popular among researcher, and that is the association of southeast asian nations (asean). budhi utomo & widodo (2019) tested the ekc hypothesis in 9 asean countries within the period from 2007 to 2014. utilising advanced econometric technique generalized methods of moments (gmm) estimator they determined how economic growth and energy use influence co2 emissions. one of the significant findings is that ekc is based on economic growth for asean countries, but that energy use has a positive and not significant effect. heidari et al. (2015) performed ekc analysis for 5 asean countries in the period from 1980 to 2008 using the panel smooth transition regression model. this flexible model has two regimes: levels of gdp per capita below 4686 usd (1st regime) and gdp per capita above 4686 usd (2nd regime). in the 1st regime, there is an increase in environmental degradation with economic growth while the 2nd regime showed a reversed trend. the authors have derived results which support the validity of the ekc hypothesis in these asean countries. however, zhu et al. (2016) state that there is only poor evidence for supporting the ekc hypothesis. these authors used panel quantile regression model to investigate the influence of foreign direct investment, economic growth and energy consumption on carbon emissions in five asean countries. the chosen period is from 1981 to 2011. ekc hypothesis was also tested in bric countries. pao & tsai (2010) investigated the impact of economic growth and energy consumption on in bric countries from 1971 to 2005. the methodology included panel cointegration techniques and granger causality. the overall results support the ekc hypothesis. lau at al. (2018) continued examining the ekc phenomenon. they focused on 100 developed and developing nations by considering the role of institutional quality. the countries were classified into three groups: low income (13 countries), lower‐middle income (28 countries), petar mitić, milena kresoja, jelena minović 121 upper‐middle income (25 countries) and high income (34 countries) and the analysis was conducted for each group as well as for all countries together. the selected period was from 2002 to 2014. independent variable was co2 emissions, while gdp, the square of gdp, ratio of trade population, institutional quality, fdi, trade openness ratio were chosen as independent variables. the methodological framework included the generalised method of moments estimators. independent variable was co2 emissions, while gdp, the square of gdp, ratio of trade population, institutional quality, fdi, trade openness ratio were chosen as independent variables. the results provide evidence in support of the ekc hypothesis and an inverted u‐ shaped relationship between economic growth and co2 emissions for the whole group of 100 countries. on the other hand, the analysis conducted on the income‐based groups shows a strong influence of economic development stage on the existence of inverted u‐shaped ekc. it is shown that the ekc hypothesis is verified only developed, i.e., in high‐income countries, but not in developing nations. testing the ekc hypothesis in countries classified by income was also performed by shahbaz et al. (2019). they tested the ekc hypothesis for 86 high‐income, middle‐ income, and low‐income countries over the period 1970–2015. for this goal, the cross‐ correlation was applied to understand the relationship between globalisation and energy consumption in terms of time lags and leads. their findings revealed that there is clear evidence in support of the ekc hypothesis in 64 out of the 86 countries. zhang & meng (2019) investigated the ekc hypothesis using data from 1996 to 2014 on co2 emissions from 115 countries with multiple levels of per capita gdp and internet penetration. the chosen countries were grouped by income into low‐income, lower‐middle income, upper‐middle‐income and high‐income countries. they estimated functional forms with quadratic transformations of regressors. empirical results verify the existence of the ekc and reveal that internet penetration does generally reduce the actual income level beyond which pollution begins to decrease. developed countries were in the focus of beşe & kalayci (2019). they tested the ekc hypothesis for denmark, the united kingdom, and spain for the period 1870‐2014. the authors have examined long‐term relationships between gdp, co2, energy consumption, and the square of gdp using johansen cointegration test. according to the results, the ekc hypothesis is rejected. usa countries were analysed by işık et al. (2019). the authors tested the ekc hypothesis for ten selected usa states in the period from 1980 to 2015. these chosen states have the highest levels of carbon dioxide emissions in the usa. the influence of the following independent variables on the co2 emissions was estimated: real gdp, population, renewable and fossil energy consumptions. the panel estimation method was applied with cross‐sectional dependence. the empirical results verify the ekc hypothesis and indicate inverted u‐shaped for only five out of ten states. table 2. summary of studies on groups of countries author period country methodology variables ekc arouri et al. (2012) 1981‐ 2005 12 mena countries bootstrap panel cointegration techniques, and ecm co2, ec, gdppc yes beşe & kalayci (2019) 1960‐ 2014 denmark, united kingdom, & spain ardl, toda and yamamoto granger non‐causality test, var granger causality co2, ec, gdppc no budhi utomo & widodo (2019) 2007‐ 2014 9 asean countries gmm co2, ec, gdppc yes churchill et al. (2018) 1870‐ 2014 20 oecd nations cross‐sectional dependence, panel cointegration, mg, amg, co2, gdppc, tr, pop, fd yes (3 of 4 estimators) 122 economic analysis (2019, vol. 52, no. 1, 109‐127) pmg, ccemg estimators fakih & marrouch (2019) 1980‐ 2010 10 mena countries non‐parametric regression co2, gdppc no farhani et al. (2018) 2002‐ 2014 10 mena countries dols, fmols & vecm granger causality co2, gdppc, to, mav, hd, rl yes heidari et al. (2015) 1980‐ 2008 5 asean countries panel smooth transition regression model co2, ec, gdppc yes işık et al. (2019) 1980‐ 2015 ten states in usa panel estimation method with cross‐sectional dependence co2, gdp, gdppc, ec (fossil fuels), ec (renewables), pop yes for five states lau et al. (2018) 1870‐ 2014 100 developed and developing nations gmm co2, gdppc, to, inq, fdi yes lau et al. (2018) 1995‐ 2015 18 oecd countries gmm & fmols co2, gdppc, to, el (nuclear), el (non‐ renewable) yes pao & tsai (2010) 1971‐ 2005 bric panel cointegration, vecm granger causality co2, ec, gdppc yes shahbaz et al. (2019) 1970‐ 2015 86 countries cross‐correlation glo, ec yes for 64 countries zhang & meng (2019) 1996– 2014 115 countries functional forms with quadratic transformations of regressors co2, gdppc, ini, int, el, tr, fdi, inf, urb, ind, ar, pd, popgr, prw, dem yes zhu et al. (2016) 1981‐ 2011 5 asean countries panel quantile regression model co2, ec, gdppc, pop, fdi, to, inds, fd no source: authors note: variables: co2 – carbon dioxide emissions, gdp – gross domestic product, gdppc ‐ gross domestic product per capita, to – trade openness, ec – energy consumption, glo – globalization, ini – investment intensity, int – internet, fdi – foreign direct investments, tr – total trade, inf – inflation, urb – urbanization, el – electricity consumption, ind – industrialization, ar – aging rate, pd – population density, popgr – population growth, prw – proportion of women in total labour force, dem – democracy, fd – financial development, inds – industrial structure, inq – institutional quality, pop – population, hd – human development, mav – manufacture value‐added, rl – rule of law. methodology: ecm – error correction model, ardl – autoregressive distributed‐lagged model, vecm – vector error correction model, var – vector autoregression, gmm – generalized method of moments, mg – mean group estimator, amg – augmented mean group estimator, pmg – pooled mean group estimator, ccemg – common correlated effects mean group estimator, dols – dynamic ordinary least squares, fmols – fully modified ordinary least squares. countries: mena – the middle east and north africa region, asean – association of southeast asian nations, oecd – the organisation for economic co‐operation and development, bric – brazil, russia, india and china. concluding remarks for a summary of the ekc research conducted for single countries, it can be concluded that studies have been carried out over different periods depending on available datasets. the majority of analyzed studies have used carbon dioxide (co2) or sulfur dioxide (so2) as a depended variable, while energy consumption, gdp, and square value of gdp were used as explanatory variables. some authors used the set of explanatory variables as follows: trade liberalization, population density, financial development, trade openness, foreign direct investments, labour force, export, import, urbanization, foreign trade, environmental productivity, energy use, ecological footprint, coal consumption, control of corruption and governess, etc. in most of the studies dealing with ekc for single countries, the ardl petar mitić, milena kresoja, jelena minović 123 methodology is used. additionally, in these studies, other panel techniques were utilized, such as granger causality approach, vecm method, and cointegration approach. similarly, as in the single country case, studies conducted for a group of countries have been carried out over different periods, with a different set of input variables and various methodology frameworks. almost all studies have used co2 emissions as the depended variable, while energy consumption, gdp and square value of gdp were used as explanatory variables in nearly all of the studies. throughout time, the set of explanatory variables has been expanded towards considering trade openness, globalization, investment intensity, internet, foreign direct investments, total trade, inflation, etc. if countries are considered and analyzed as a group, then researches applied a wide range of methodologies and advanced econometric models appropriate to considered panel dataset. in most cases, standard tests such as panel unit root tests, cointegration techniques and granger causality were utilized. given that variables are cointegrated, different estimators were used to estimating the relationship between variables. due to the panel type of data, researchers tried to address the slope heterogeneity and cross‐ section dependence by considering panel data estimators such as amg and ccemg, that have shown advantages over mg. the other group of researchers used parametric dols and non‐ parametric fmols estimator to deal with bias by taking the leads and lags of the first‐ differenced independent variables. in addition to these estimators, researches also used a more advanced panel dynamic gmm to address autocorrelation and country‐specific effects. an innovative approach in testing ekc includes panel smooth transition regression model as well as panel quantile regression model. according to asumadu‐sarkodie & strezov (2019a), lind & mehlum (2010) claim that “the criteria are weak when “the true relationship is convex but monotone over relevant data values”, as such, the quadratic specification produces erroneous turning point and u‐shaped relationship.” they further claim that to properly test the existence of a u‐shape, “there is a need to test the decreasing relationship at low values within the interval values and the increasing relationship at high values within the same interval. thus, when the relationship increases at the left‐hand side of the interval and decreases at the right‐hand side, the traditional method of u‐ shape estimation is not suitable.” (lind & mehlum, 2010). they created an algorithm used to test the presence of the u‐shaped, inverted u‐shaped or monotonic relationship of the interval. u‐ test algorithm can be applied to the data range as an interval unless otherwise indicated (asumadu‐sarkodie & strezov, 2019a). acknowledgements this paper is a result of research projects under the code 179015 (challenges and prospects of structural changes in serbia: strategic directions for economic development and harmonization with eu requirements) and 47009 (european integrations and social and economic changes in serbian economy on the way to the eu) financed by the ministry of science and technological development of the republic of serbia. references ahmad, n., du, l., lu, j., wang, j., li, h. z., and hashmi, m. z. 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(2016). “the effects of fdi, economic growth and energy consumption on carbon emissions in asean‐5: evidence from panel quantile regression.” economic modelling, 58: 237‐248. article history: received: may 5, 2019 accepted: june 7, 2019 microsoft word ea 2019 1-2 ver 4.docx doi: 10.28934/ea.19.52.12.pp69‐80 original scientific paper challenges and perspectives of development of private pension funds in serbia marija đekić1 | miloš nikolić1 | tamara vesić1* 1 faculty of business, economy and entrepreneurship, belgrade, serbia abstract following the successful implementation of the chilean reform, the world bank proposed a solution from three pillars of the pension system: compulsory state, compulsory private and voluntary private pension insurance. serbia, like many other developed and undeveloped countries, has only adopted the third pillar, in addition to the already existing state. the introduction of compulsory private insurance was also considered. however, there are no market conditions or financial possibilities for achieving this idea. voluntary pension funds in serbia were introduced by the 2005 laws. there are seven voluntary pension funds in serbia, managed by four management companies. so far, the funds have achieved positive yields, although due to limited investment opportunities, these rates were very modest. in addition to limited investment opportunities, one of the problems is the accumulation of funds. the problem of population savings has many sides, and it is certain that some of the causes can be sought in bad experiences from the past. the paper analyses the limitations and possibilities for further development of private pension funds. key words: voluntary pension insurance, private pension funds, savings, private pensions, security in old age jel classification: g23, j32 introduction the pension systems of most countries in the world are based on a system of ongoing financing, which is characterised by the fact that employees, through contributions, finance the pensions of those people who have completed their working life. however, this kind of intergenerational solidarity is not sustainable in the long run. the main reasons for this tendency are demographic and financial nature. for the sustainability of such a pension system, demographic factors are not favourable due to the ageing of the population and the increasing share of those over 65 in the total population, from one, and low fertility rates, on the other. the problem of financing pensions in serbia arose in the 1980s with the occurrence of deficit in the pension and disability insurance fund. it reached its peak in the 1990s in times of crisis, sanctions and economic decline. the decrease in the number of employees, avoidance to pay employee contributions and a widespread grey economy brought about a decline in the number of policyholders (pjanic & lucic, 2012). as a result, there is greater pressure on the financial side because currently employees are unable to fund pensions without increasing their contributions. * corresponding author, e‐mail: tamara.vesic@vspep.edu.rs 70 economic analysis (2019, vol. 52, no. 1, 69‐80) the increase in contributions in serbia is not an appropriate measure because it affects the increase in operating costs, which can further reflect the reduced competitiveness of the company and the economy, as well as the increase in tax evasion. in serbia, there are tougher measures regarding the non‐registration of workers, but this form of grey economy is still at a high level. in the case of a state pension system, workers often try to reduce the excessive burden of pure taxes by adjusting their working lives and work volumes, or by switching to an informal labour market, most commonly in developing countries, where there are ways to avoid pension and other taxes. companies respond to more labour costs by adopting less labour‐ intensive technology or by switching to informal markets (corsetti & schmidt ‐hebbel, 1995). so, the reform of the pay‐as‐you‐go system should not be directed just towards expenditures or to the reduction of insurance rights, but it should also include a better look at income: better control over the payment of contributions for compulsory pensions or disability insurance; an increase in the number of employees; and the reduction in the grey economy; etc. (kosanovic & paunovic, 2010). since 1981 close to forty countries have introduced systemic pension reforms that have replaced all or part of prior pay‐as‐you‐go (payg) schemes with privately managed systems. since the great recession, some european countries that had partly privatised their pension systems between the mid‐1990s and early 2000s increasingly scaled back their mandatory private retirement accounts and restored the role of public provision (wang, williamson & cansoy, 2016; naczyk & domonkos, 2016). in the period after the crisis, because of the increase in unemployment and the reduction of tax revenues, the redirection of contributions to private pension insurance has become too expensive, so some countries have permanently (hungary, bulgaria since 2015), and some temporary (estonia) suspended the second pillar of pension by reducing the contribution rate (poland, romania, latvia, lithuania, slovakia) (horstmann, 2012, p. 11) the process of globalisation, that is, the process of integration of the world economy has a great influence on the reforms of the pension system. this can be seen in eastern europe, where countries that are hoping to join the european union must reduce their fiscal deficits and limit the overall debt burden (schiffrin & bisat, 2004). these are requirements that involve a reduction in investment in pension insurance and must be undertaken prior to eu accession (domonkos & simonovits, 2016). with this in mind, it is clear that reforms of the pension system are necessary not only in countries in transition but also in all countries that are facing the problem of financing pensions (kastratovic, kalicanin, 2017). „serbia opted for a more traditional western european approach, combining payg cost‐containment parametric reforms with the introduction of tax‐preferred supplementary private pensions” (altiparmakov & matkovic, 2018). in this regard, the process of starting the reform of the pension system in serbia has led to the introduction of the third pillar of pension insurance, according to the world bank classification system. these three pillars the world bank proposed in its report “averting the old‐age crisis”, 1994, proposing the basic concepts and principles of model implementation. after that, her attention was focused on individual solutions adapted to the different conditions and needs of countries with different structure of the population (tolos, wang, zhang & shand, 2014). additionally, although the eu does not elaborate a unitary approach for all member states since about 2000, the commission has implemented the multi‐pillar approach of the world bank. the approaches of the eu are summarised and systematised in the 2012 white paper (windwehr, 2017). of course, in addition to the fact that the reform allowed the appearance of the first and third pillar of the pension system, periodic changes occurred in the functioning of the pension system, as well as the introduction of new and changing existing one's legal provisions. however, in this paper, the functioning of private pension funds in serbia is analysed and the obstacles faced by these institutional investors. marija đekić, miloš nikolić, tamara vasić 71 sector for voluntary pension funds in serbia the past few decades of old‐age pension policy have been characterized as an age of privatisation (ebbinghaus, 2015). in recent decades “pension privatisation,” has become one of the most widely implemented reforms (holzmann, hinz & dorfman, 2008). in the early to mid‐ 1990s, many european countries introduced voluntary pension funds. in the period from 1998 to 2006, some countries in europe introduced a three‐tier model of the pension system. pension reforms enacted since the 1980s can be grouped into three categories: parametric reform, supplemental systemic reform and extensive systemic reform (wang, williamson & cansoy, 2016). pension reform is not cheap, but a good fiscal discipline can make it feasible. the main problem of replacing the paygo system with the system of individual pension accounts is high transitional costs. if active contributors contribute to the new system, there remains a financial gap in the old one. the number of contributors then decreases, but the government must continue paying to current pension beneficiaries. these high fiscal costs were evident during the chilean reform. what's extraordinary in chile is that although total tax burdens have fallen by about 10% of gdp, fiscal accounts have remained in surplus for most of the time since the late 1980s. the long‐term effects of replacing the system are positive, as shown by all previous estimates, as well as projections of the world bank that the debt of the pension system without reform in 2050 would amount to 211% of gdp, and with the implemented reform, the debt should be zero (vial & melguizo, 2009). in chile, the idea of a private pension system has been developed, where each employee has his individual account in a private fund to which he pays contribution. the chilean private pension system model emerged as an alternative to the bismarck idea of the pension system. most countries in the world that have a pension system have entered the modified application of the idea that originated in chile (vukotic, 2004). several countries of the western balkans have introduced partially privatised three‐pillar pension systems in an environment of underdeveloped capital markets. it highlights the problems and risks facing the partially privatised pension schemes. the inadequate introduction of individual private‐sector pension accounts in many european developing countries stems from high operating costs and unhedged capital markets. these conclusions are based on empirical data for one decade in developing countries that have privatised retirement systems (altiparmakov, 2011). the western balkans' pension system analysis suggests that those countries that have not introduced a three‐pillar pension system do not have to do that yet, but focus on improving the efficiency of existing pay‐as‐you‐go systems (bartlett & xhumari, 2007). the second pillar in the developing countries is characterized by high administrative costs and very low contribution rate, which represent the main reasons for leaving this type of pension system (oecd, 2013, p. 10). since there is no evidence that the introduction of the second pillar into the domestic pension system creates conditions for a safer and sufficiently high pension, the reforms kept the parametric changes in the first pillar, and in 2006, the first voluntary pension funds emerged as a result of the introduction of the third pillar. however, voluntary pension insurance in serbia began to develop before the adoption of the law on voluntary pension funds and pension plans, in 2002, when certain forms of savings were similar to today's voluntary pension insurance (damnjanovic, 2017). the third pillar was designed as a voluntary private pension scheme. however, well known is that pensioners are vulnerable and disadvantaged groups, and in 2014 7.9% of the poor in the age group of 46‐64 years, and 7.4% of the poor in the group of 65 years and more, so it is necessary to take into new reforms to order to improve that facts (djukic, balaban & radisavljevic, 2017). many authors (bartlett & xhumari, 2007; altiparmakov, 2011; altiparmakov, 2013) agree that, as the reform continues, serbia should focus on parametric changes of the first pillar and the adequate integration of voluntary pension funds into the pension system of serbia. 72 economic analysis (2019, vol. 52, no. 1, 69‐80) the current state of the voluntary pension funds sector in serbia voluntary pension insurance, as a form of pension insurance, is in our country at the beginning of its development and represents an additional form of retirement benefit. at the end of 2017, voluntary pension funds in serbia operated four management companies that managed the assets of seven voluntary pension funds, one custodian bank and five intermediary banks. membership in the fund is divided into the accumulation phase ‐ the period when the funds are paid, and the withdrawal phase. in the period from 2008 to the end of 2017, the number of users increased by almost thirty thousand. of course, the number of contracts is higher, given that one user can conclude more contracts with voluntary pension funds. from year to year, the number of users and contracts increases, but so far positive movement of investment units, fondex and net assets of funds have been recorded. fund assets are the sum of the various investment instruments in which the asset is invested. the net asset value is equal to the difference between the fund assets value and the fund's liabilities on the same day, ie to the result of the multiplication of the number of investment units and the value of the investment unit. the net assets of pension funds at the end of the third quarter of 2017 amounted to 34.9 billion dinars. the change in the value of the assets is influenced by the net payments of funds into funds, payments of funds from funds and the profits made by the funds from the investment (national bank of serbia, 2017). the nominal net return on investments in pension funds in serbia for 2016 amounted to 7.4% and real 5.8%. in the period after the financial crisis, i.e. for the period from the end of 2011 to the end of 2016, serbia is among the countries that achieved the highest five‐year average real investment rates (without investment costs), that is, serbia is in second place with 7, 1%, and only the dominican republic with 8% in front of serbia. this oecd report covered 45 countries (oecd, 2017). table 1. net assets of voluntary pension funds by years. year 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 net assets (bill. din.) 3,1 4,6 7,2 9,9 12,5 16,0 19,7 23,6 28,9 32,8 34,9 source: national bank of serbia, 2017 in serbia, it is still difficult to determine the stable rate of return of pension funds due to the frequent fluctuation of the value of pension fund units. funding costs are high, which significantly reduces yields. structure of investment of voluntary pension funds in serbia pension funds in diverse financial markets primarily invest in long‐term securities with high yields. their investment strategies depend on several factors. due to legal constraints, public funds invest more in low‐risk securities, while private pension funds invest in shares, futures and other risk capital to achieve higher yields. voluntary pension insurance in serbia differs from the public in that the funds in the personal accounts of the insured are invested and the realised profit is credited quarterly to each account, thus increasing these funds. a favourable tax treatment, which implies the exemption from the tax on all profits, as long as funds held by the fund have resulted in funds being invested in securities for high tax burdens that yield and yield more. such a favourable tax treatment greatly influenced the growth of size and the importance of these institutional investors. the differences in the structure of the portfolio of pension funds depend on many factors in addition to the aforementioned tax restrictions, and above all the returns provided by various assets, the risks that carry those assets, but also many regulatory constraints. investments are marija đekić, miloš nikolić, tamara vasić 73 made to increase the total return but in accordance with the basic principles of investment activities related to portfolio security, portfolio diversification and portfolio liquidity. the pension funds' portfolio must contain liquid assets of a certain volume so that funds can at any time respond to the due liabilities. nevertheless, most of the assets of pension funds consist of long‐term financial investments in stocks and bonds. the safest and least risky instruments are long‐term government bonds, but many funds, for their greater return, nevertheless determine for holding shares in their portfolio. bonds in the past have taken a significant place in the structure of the portfolio of pension funds, as these institutional investors are cautious investors. in the us, japan and canada, during the 1980s, bonds accounted for 50% of the total assets, and in germany, 30%. however, in the united kingdom bonds accounted for around 20% of the total assets of the funds, while most of the portfolios constituted shares. today, corporative bonds and stocks prevail in the portfolio of pension funds in the world (labudovic, 2010). in the countries of central and eastern europe, the share of government bonds in the portfolio is even more pronounced. due to this structure of the portfolio, there is no significant difference between private pension funds and pension funds in the paygo system. in 2014, pension funds in the oecd countries invested on average 23.8% of portfolios in shares, 51.3% in bonds and bonds, and 9.6% of portfolios were in deposits and cash. private pension funds at the end of that year had $ 38 trillion worth of assets in oecd countries (oecd, 2015). unlike the developed financial markets, the serbian stock market, despite notable growth in the volume of transactions, is generally still very illiquid. the small number of companies whose shares are actively traded and an inadequate offer of shares are the main problems for the further development of the market. the liquidity coefficient, as a ratio of total turnover and total market capitalisation, is very low. the financial market of serbia imposes a large number of restrictions on institutional investors, and therefore on pension funds. one of these constraints relates to the inability of a good diversification of portfolios, i.e. pension funds are forced to invest in certain market segments. due to the low liquidity of the market, the prices of securities vary and move very quickly in very high ranges. also, a major constraint is the lack of low‐risk securities, such as corporate or municipal bonds. in 2007, before entering the financial crisis, there was a tendency to increase investment in shares, a slight decrease in the share of debt securities and an increase in the amount of transaction accounts, as a result of the underdevelopment of the capital market and the weak supply of financial instruments (matkovic, bajec, mijatovic, zivkovic & stanic, 2009). the largest part of the funds of pension funds in serbia was invested in bonds 83.7%, the next place in the structure of the assets of the funds was 7.5%, the shares were invested 7.1% of the assets, in the time deposits 1.1%, and the rest of the funds in the amount of 0.6%, was invested in other securities, real estate, investment units of open investment funds and other forms of receivables. compared to the previous year, the share of cash and the share of government bonds in the total portfolio structure of all funds decreased, while the share of time deposits and shares increased (national bank of serbia, 2017). perspectives for the development of the private pension fund sector in serbia the performance of the pension system and the development of the voluntary pension funds sector depend on the overall state of the economy of a country. obstacles for the development of the third pillar are numerous: low incomes, insufficient tax incentives, high rates for compulsory pension insurance, but also mistrust and lack of knowledge of potential beneficiaries (matkovic, 74 economic analysis (2019, vol. 52, no. 1, 69‐80) 2016). the perspectives of pension funds should be viewed in the context of the overall economic reforms, the economic environment and the institutional framework of the country. the european bank for reconstruction and development (ebrd) announces a set of indicators for the development of the countries in transition, on the basis of which it assesses the process of reforms of these countries from a planned to an open market economy. transition indicators range from 1 to 4+, where 1 represents little or no change compared to rigidly planned economies, and 4+ represents the standards of an industrialised market economy. table 2. transition indicators for the financial sector of the countries in the region for 2016‐ 2017 countries in the region financial sector banking insurance and fin. services private equity capital market bosnia and herzegovina 3‐ 2+ 2‐ 2 macedonia 3‐ 3‐ 1 2 montenegro 3‐ 2+ 1 2 serbia 3‐ 3 2 2 romania 3 3+ 3‐ 3‐ source: ebrd, 2016 the third pillar is a result of citizens’ voluntariness if strict legal regulations are created for its functioning with strict control by the state (birovljev, vojinovic & mirovic, 2015). for the voluntary pension funds to function in the right way, it is necessary to introduce several formal and material conditions, such as in the field of fiscal policy, which would improve tax incentives for contributions to voluntary pension funds. certain tax exemptions have been introduced in serbia since the creation of voluntary pension funds. in addition to being introduced, they have been increased several times. thus, in february 2009, by amending the law on personal income tax, the maximum non‐taxable payment into voluntary pension funds in serbia from 3,303 dinars was increased to 3 528 dinars (laketic, 2010). amendments to the law on personal income tax, which came into force on 1st of january 2016, this amount was increased to 5 501 dinars a month (law on income tax on income of citizens). this is not about large amounts, but it can be seen that there is the will and support of the state in the development of the third pillar of the pension system in serbia. employers were thus given the opportunity to increase the number of contributions they pay for their employees and that they were exempt from paying citizens' income tax and contributions for compulsory social security. table 3.total investments in pension funds in serbia in the period from 2010 to 2014. year investments in millions of dinars percent of gdp 2010 9912 0.3 2011 12493 0.4 2012 16366 0.5 2013 19747 0.5 2014 23654 0.6 2015 28954 0,7 2016 32860 0,8 source: oecd, 2017 the great potential for further growth in the number of pension funders is in companies with a large number of employees since the largest number of payments to pension funds is precisely the payment of employers' salaries. however, the slower development of private pension funds marija đekić, miloš nikolić, tamara vasić 75 in countries in the region than in developed countries has more causes. first of all, the limiting factor is a poorly developed capital market, which results in limited investment opportunities for these funds. secondly, the big problem is the poor experience of saving, fraud and fraud related to the financial institutions and the financial system of serbia. thirdly, on the eu level, a large number of regulations govern only indirectly operations of these investors. some of the relevant regulations are mifid, ucits, the directive on pension funds (pension funds directive) and directives, which are loosely linked to capital requirements (capital requirements directive). in serbia, there is still no clear regulations for these investors, although, for years, there are institutions that operate in this region (djekic, gavrilovic, roganovic i gojkovic, 2017). fourthly, there is a pronounced low level of cultural investment in serbia, that is, there is a lack of knowledge of the population and insufficient knowledge of the concept of private pension and the operation of private pension funds. therefore, in addition to the market, legal, political and institutional frameworks, there is a problem from the aspect of the population, which is very unfavourable for the accumulation of funds. according to (bilankov & aleksic, 2016) “an increased popularisation and education of the citizens would make these voluntary funds leading investors in the market.” empirical research ‐ methodological issues the aim of the paper is to examine the problems and the perspective of the development of voluntary pension insurance in serbia. since private insurance in serbia is characterized by the principle of voluntarism, since in serbia there are the first and third pillars of the pension system according to the world bank's categorization, it is concluded that the consciousness, opinion and opinion of citizens regarding private pension importance is of great importance for the further development of the pension system. in this regard, the following research questions were asked: how many respondents are familiar with the concept of voluntary pension insurance and private pension funds? how many respondents have confidence in financial institutions in serbia? how much does the impact on the decision on private pension insurance have a living standard? to obtain answers to the above research questions, empirical research was carried out using the survey method. the survey was conducted in the period from mid‐december 2017 to mid‐ january 2018, and the method of a random selection of respondents was applied. the sample of the respondents is a free random sample, consisting of 104 respondents. results analysis was performed using ibm spss statistics 21. depending on the characteristics of the variables and the relationships established between them, some results are shown by cross‐tabulation, while some variables show descriptive measures. also, a hi‐square analysis was performed, and data for variables were shown for which there is a proven linkage. results of empirical research in the conducted research, basic information about the respondents was obtained. the observed characteristics of the subjects can be summarised as follows: 1. in terms of gender, there is no significant difference between the groups, i.e. 51 (or 49%) of the male respondents, and the female 53 (or 51%); 2. regarding the educational structure, the highest number of respondents with the completed secondary school were 38 (or 36.5%) and completed basic higher education studies of 33 (or 31.7%); 3. regarding the age of the respondents, the majority of respondents belong to age groups of 25‐35 years (29 subjects or 27.9%) and 35‐45 years (28 subjects or 26.9%); 4. in terms of employment, most respondents are employed (89 respondents or 85.6%), while a small number of respondents are unemployed (15 respondents or 14.4%). 76 economic analysis (2019, vol. 52, no. 1, 69‐80) table 4. educational structure of respondents source: authors table 5. age structure of respondents up to 25 years 25‐35 years 35‐45 years 45‐55 years 55‐65 years 3,8% 27,9% 26,9% 20,2% 21,2% source: authors the largest number of respondents in this random sample is not a member of any private pension fund or even 92.3% of respondents. through cross tabulation, we can conclude that respondents, whether they are or not members of the private pension fund, state a low standard of living as the biggest obstacle for higher investment in private pensions. table 6. opinion of the respondents on the biggest obstacles to investing in private pensions in serbia funds are paid personally funds are paid by the employer they are not members in total low standard of living 3 2 62 67 % 2,9% 1,9% 59,6% 64,4% insufficient information on ppo 1 2 13 16 % 1,0% 1,9% 12,5% 15,4% poor trust of citizens in fin. institutions 0 0 12 12 % 0,0% 0,0% 11,5% 11,5% disinterested for security in the future 0 0 4 4 % 0,0% 0,0% 3,8% 3,8% i do not know 0 0 5 5 % 0,0% 0,0% 4,8% 4,8% in total 4 4 96 104 % 3,8% 3,8% 92,3% 100,0% source: authors the table below shows descriptive measures for the four questions asked by respondents. on all questions, the respondents gave answers on the lickert scale from one to five. however, on the first two questions, the answers are graded, so that the grades of 1‐absolutely agree, to 5‐ absolutely disagree; and on the other two issues i'm completely aware of the 1st, i'm not familiar with 5. based on the data, the following can be concluded: 1. respondents have different trusts in financial institutions, but the average attitude is neutral, that is, neither trust nor trust in financial institutions; 2. the respondents highly believe that a better standard is needed for citizens' interest, as is shown by the fact that no respondent replied that he disagrees with this claim, as well as the mean value and the standard deviation that indicates that there is no high deviation in answers); high school college/ university faculty‐basic studies college‐master studies phd studies 36,6% 13,5% 31,7% 16,3% 1,9% marija đekić, miloš nikolić, tamara vasić 77 3. the respondents are better acquainted with the presence and operation of private pension funds than with the concept of private pension insurance, but generally speaking, they are not familiar with each other or are partially acquainted. table 7. descriptive statistics for individual variables variables min max mean st. dev. 1. i have trust in financial institutions in the republic of serbia 1 5 3,06 1,022 2. is it necessary for a better standard of citizens' interest in investing in paid pensions 1 4 1,68 ,728 3. are you familiar with the concept of private pension insurance 1 5 2,78 1,024 4. are you familiar with the presence and business of private pension funds in serbia 1 5 2,91 1,098 source: authors also, it is important to note that 76.9% of respondents want additional income because they believe that state pensions are not enough for a secure age, and 4.8% of respondents consider that state pensions are not enough for security in old age, but that they do not want additional income. only 18.3% of respondents believe that state pensions are sufficient for a secure age, of which 15.4% still want additional income, while the other 2.9% do not want. the next graph shows the opinion of the respondents regarding the biggest advantages of investing in private pension funds. it can be concluded that as many as 39.4% of the respondents consider that the greatest advantage of investing in private pensions is that the amount of private pension does not depend on years of service, but on the total payments and how these funds are invested. table 8: the biggest advantages of investing in private pension funds according to respondents' opinion advantages percentage tax exemptions can be made to the contributions paid into the fund 4,8% private pension does not depend on the length of service, but from the total payments and income of the fund 39,4% they do not have to make regular payments but can be paused in monthly payments 16,3% they do not have to make regular payments but can be paused in monthly payments 11,5% they do not have to make regular payments but can be paused in monthly payments 11,5% none of the above 16,3% source: authors below are the data obtained by testing the variability of variables using the hi‐square test. only those links that we found statistically significant are shown in the body. based on the realized values of the hi‐square statistics, the significance level of the test (as. sig.) and the observation of the obtained coefficients (cramer's v and the contingency coefficient), we have come to the conclusion that there is dependence between the following variables: level of education and familiarity with the concept of private pension insurance; level of education and familiarity with the presence and operation of private pension funds in serbia; knowledge of the concept of private pension insurance and familiarity with the presence and operation of private pension funds in serbia. 78 economic analysis (2019, vol. 52, no. 1, 69‐80) table 9: results of the conducted empirical analysis using the hi‐square test variable pearson chi‐square df cramer’s v contingency coeff. first the other one val. as.sig. val. ap.sig. val. ap.sig. level of education familiarity with the concept of ppo 17,339 0,027 8 0,289 0,027 0,378 0,027 level of education awareness of the presence and business of ppf in serbia 15,607 0,048 8 0,274 0,048 0,361 0,048 familiarity with the concept of ppo awareness of the presence and business of ppf in serbia 91,041 0,000 4 0,662 0,000 0,683 0,000 source: authors  it can be concluded that respondents with a higher level of education are more familiar with the concept of private pension insurance and with the presence and operation of private pension funds in serbia. this relationship is statistically significant but not strong. we also conclude that those respondents who are familiar with the concept of private pension insurance are also familiar with the presence and operation of private pension funds in serbia. previous connections are logical, but the last connection is very strong and statistically significant. connections among other variables were also investigated, but no statistical data were obtained. conclusion the pension system in serbia, as well as the systems of a large number of countries in the world, faces the problem of functioning and the crisis in financing. in the last few years, pension spending in serbia is 13% of the gdp, which is 4.5% more than the average found in european countries in transition and it is a burden that serbian economy and taxpayers cannot bear in the long run (veselinovic, 2014). the most common reasons for the difficulty of financing state pension funds are demographic nature. due to the poor sustainability of state funds, many countries have gone through or are still going through the reform processes of the pension system. apart from the parametric reform of the state system of current financing, the reform of the pension system in serbia included the introduction of voluntary pension insurance. pension reforms in serbia have long since begun, but it cannot yet be considered that this process has been completed. during several reforms in serbia, the pension system has undergone certain changes that relate to parametric reforms in the first pillar of the pension system (according to the world bank classification system) and the introduction of the third pillar. the introduction of the second pillar is not a good solution, which is also supported by the experiences of other developing countries. further recommendations to ensure the better functioning of the pension system relate to the increase of the efficiency of the first pillar, but also the promotion of the development of voluntary pension funds in serbia. private pension funds (third pillar) exist in serbia for more than a decade, but their development is limited by market, legal, institutional and political factors. also, some of the restrictions also relate to the population of serbia, as can be seen from the conducted research. by analysing the answers to the set research questions, we conclude the following: 1. the knowledge of the respondents with the concept of voluntary pension insurance and private pension funds is not at a satisfactory level, and is related to the level of education of the respondents; 2. the level of confidence of respondents in financial institutions in serbia is not satisfactory, as on average respondents have a neutral attitude on this issue; marija đekić, miloš nikolić, tamara vasić 79 3. the largest number of respondents cite the standard of living as the biggest obstacle for higher private pension investments, and most agree that for citizens to invest in private pension funds, it is necessary to improve the standard of citizens in serbia. in future research, features and variables varied 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"europeanization in pension policy: the crisis as a game‐changer?" journal of contemporary european research 13 (3): 1301‐1318. law on income tax on income of citizens, "sluzbeni glasnik", br. 112/2015. article history: received: november 13, 2018 accepted: may 31, 2019 ea_2018_3-4 darko marjanović 95 doi: 10.28934/ea.18.51.34.pp95-104 scientific paper competitiveness of the serbian economy through the prism of tax incentives for foreign investors darko marjanović1* 1 instituite of economic sciences, belgrade, serbia abstract in order to make serbia the most attractive investment destination in relation to countries in the region, special attention should be paid to the current tax incentives granted to foreign investors. hence, the aim of this paper is to find the opinion and attitudes of foreign investors in the relevant research and analysis regarding the importance of tax relief for their investment in serbia. tax incentives are one of the most important tax instruments that can play a decisive role on foreign investors when choosing an investment location, and therefore to increase the competitiveness of the serbian economy. in this paper, special attention will be given to tax incentives in certain areas for the business of foreign investors, depending on the way foreign investors enter the serbian market. the methodology of empirical research in this paper is based on a quantitative approach to the collection of primary data through the survey of relevant subjects, the comparison of collected data, and the analysis of the causality of the investigated phenomena. on the basis of the obtained results it can be concluded that the greatest influence on the investor when making a decision on investing in serbia is tax incentives in corporate income tax. key words: tax incentives, competitiveness, fdi, investors jel classification: e62, h20 introduction fiscal policy is a very powerful instrument for attracting foreign investment. during the 1990s, central europe countries used "tax breaks" and other fiscal incentives for this purpose. as a result, there has been an increase in the volume and quantity of capital inflows, all of which has led to the growth of the economies of these countries, and thus to increasing their competitiveness. as it is known that taxpayers seek to lower their tax liability to the lowest possible level, they are interested in using the various tax incentives provided by the state in the process of tax competition. there is a conflict between the interests of the state, on the one hand, to attract as much investment (lower tax burden) and, on the other hand, to raise as much funds to finance public functions (higher tax burden). with the increasing increase in the free movement of capital in the world market, the states have come in a position to compete with one another for the affection of business entities, with the aim of attracting as much investment as possible on their territory. as one of the most important forms of international capital movements, fdi play an important role in any economic system (musabegović et al., 2015). a generally supported attitude is that fiscal policy is a very powerful instrument for attracting investment, that is, tax competition is one of the most important indicators of overall competitiveness. for this reason, it is very important for all * e-mail: darko.marjanovic@ien.bg.ac.rs 96 economic analysis (2018, vol. 51, no. 3-4, 95-104) countries to offer attractive conditions to investors, first of all through favorable tax treatment, and in this way try to secure as high a capital inflow. under special tax treatment, it is understood, above all, to expand the tax base and/or reduce the tax rate of the corporate income tax. in creating tax policy, it is attempting to reduce the tax burden, which should contribute to entering new investments, i.e. preventing their outflow. the result of all this should be an increase in the volume and quantity of capital inflows, the growth and development of the economy, and the increase in competitiveness. therefore, one state's goal is to provide a favorable ambience for investors, which are reflected in providing better conditions than competitive countries, and thus create an advantage that will lead to new investments. however, in this situation, usually it happens "race to the bottom", when individual countries, in order to be attractive to investors, compete in lowering tax rates by creating an attractive tax environment. one of the instruments for increasing investments also relates to a stimulating tax environment in which the largest impact on companies and potential investors has a tax on profits, or tax incentives in the corporate income tax system (domazet & marjanović, 2018). tax on profit is one of the most important tax instruments for stimulating economic activity in the domestic environment, but also for attracting the necessary foreign capital. different tax incentives in the profit tax system have become a key determinant of tax competition in attracting foreign capital. nowadays, the most successful ones are those countries that have undoubtedly realized a significant inflow of foreign capital precisely by providing investors with a preferential tax treatment with a series of reliefs, primarily in the corporate income tax system, but also providing the necessary economic and social conditions. one of the key factors in starting the process of improving the competitiveness of the serbian economy is, of course, also the fiscal system and fiscal policy. it is precisely for this reason that it is necessary to set the institutional foundations of the fiscal system, while simultaneously increasing the efficiency of the tax administration and creating a transparent control of public finances. in addition to institutional arrangements, for the competitiveness of the serbian economy it is certainly necessary to make changes within the fiscal system that should be one of the factors of economic development (domazet & marjanović, 2017). literature review competition is created in moments when individuals and companies get the choice. the greatest satisfaction of individuals and companies is the aspiration for a lesser degree of jurisdiction, i.e. the state in which individuals and companies conduct business (keen & konrad, 2012). the main reasons explaining the phenomenon of tax competition are increasing international trade flows and investments, increasing labor mobility between countries, and the ever-faster transfer of technology. in such an economic environment it is very difficult to maintain high tax rates. freedom of movement of capital creates a kind of pressure on the state to reduce the tax rate, above all the profit tax, in order to maintain its attractiveness (davies & voget, 2008). tax competition is fully in line with the fundamental tax reform. among other things, the tax reform objective is a system with low tax rates in response to productive behavior, as well as a system in which income is taxed only once. tax competition promotes tax reform by helping to reduce marginal tax rates as well as eliminating double taxation of revenues that has been saved and invested (paraušić et al., 2017). when tax rates are in question, the most obvious negative effect of tax competition is a sort of "race to the bottom", precisely because countries and/or regions compete in reducing tax rates to create equally attractive business environments that would be favorable for foreign investments. tax competition, by its impact on lowering tax rates, often involves lowering the tax base for tax collection, and hence the local government or government of the country has fewer resources to spend on public services, which should further be on a high level, i.e. in accordance with the preferences of its citizens (hansson & olofsdotter, 2003). if tax systems between countries differ significantly, companies and individuals will for the darko marjanović 97 place of capital investment and performing business activities choose the country where the total tax burden is lower. by shifting taxpayers to those countries where the tax burden is lower, automatically reduces tax revenues in countries that have a higher tax burden, causing difficult financing of public expenditures (domazet & marjanović, 2018). an economy is competitive if it does things that are likely to encourage economic growth (makrevska & nenovski, 2014). observing the conditions where there is no competition, there are market conditions where there are little or insufficient bidders on the supply side who have the ability to determine market conditions, define prices as well as other factors which are in their favor, and not for individuals or companies (marjanović et al., 2013; round, 2009). to the extent that economic integration between countries is gaining momentum, companies and individuals gain greater freedom to take advantage of the different economic opportunities offered to them, so their decision on capital investment, among others, is influenced by the tax factor. from the point of view of economic competition, the participants themselves take the initiative in seeking to realize their own interests and take a more favorable position in the global market, with the decisive role have market laws that determine the movement of supply and demand. in tax competition, however, the situation is different. she is caused by pressure from countries with low tax burdens, and other countries have to keep their tax pressures at a "reasonable" level, to discourage investors and workers from moving their business activities into such favorable tax environment (kalamov, 2013; siedschlag et al., 2013). modern technologies are the bearers of global development, but also a priority for each country whose goal is to attract as many foreign investments as possible. the motive for broad tax incentives granted to an investor who brings high technology to the country is that high technology is the highest level of production modernization. by improving the production processes using modern technologies, it contributes to the competitiveness on the world market and hence the dynamic struggle for achieving tax attractiveness for investors who are high technology carriers. (patterson & serrano, 1998) in the process of attracting foreign direct investment, it is necessary to take measures of tax policy ensuring that greater competition in the capital market. this is precisely the reason why the taxation systems introduced many changes, especially from the standpoint of tax incentives, exemptions and deductions (domazet & marjanović, 2018). the investment incentives are highly effective in attracting foreign investments. however it is necessary to note, that to give the investor tax holidays is nowadays not enough. the country has to have a well-developed system, which will help the investor to realise his project within the investment scheme fast and without additional administrative costs (porter, 2003). research methodology for the purposes of this empirical research, a quantitative approach has been used, which is based on the collection of numerical data, their mutual comparison, and the identification and analysis of the interrelationships between them. on the one hand, it was necessary for the sample to be representative, and on the other hand, through adequate approach and implementation of the research, qualitative and quantitative data were obtained on the basis of which it was possible to make certain conclusions. therefore, this survey covered the 300 largest foreign investors that have invested capital in serbia over the last 15 years. considering that 88 investors took part in the survey, the response rate of 29.33% is considered to be quite satisfactory for all the criteria for this kind of research. in order to determine the impact of tax incentives on foreign investors when choosing serbia as an investment destination, a quantitative approach was applied in the survey using the method of testing, or survey technique via e-mail. this technique has been selected from the perspective of the quality and quantity of data that can be obtained by eliminating every form of bias of the person performing the research, as well as the benefits of this type of survey research for testing the selected target group. therefore, the questions were of a closed type, since in this way it was 98 economic analysis (2018, vol. 51, no. 3-4, 95-104) possible to get more detailed and clearer answers, which can be coded and analyzed at a later stage. the research involved exclusively owners of companies, general directors or managers who are in charge of investments or operations in foreign markets. depending on the way of entry foreign investor to the market of serbia, this research shows the importance of tax incentives in certain areas for the business of foreign investors in serbia. basic characteristics of the company who participated in the research are shown using schedule frequencies and percentages. table 1. mode of entry foreign investors on the market of serbia direct investment indirect investment frequency percentage frequency percentage 47 53,4 41 46,6 source: authors` calculations the first segment of the research was related to graphic presentation of all dependent variables and descriptive statistics, given that they made it possible visual presentation of results and calculation of frequencies, percentages, average estimates, standard deviation and variance. in the second segment, attention is focused on the analysis of differences in dependent variables, based on the subgroup of independent variables. more precisely, it was necessary to link the dependent and independent variables, since in this way it was possible to determine whether there were statistically significant differences in the evaluation of the investigated issues among different groups of foreign investors (the difference between three and more groups of respondents). for that purpose a single-factor analysis of the variance of different groups was used. (1) η 2= ∑ i= 1 k n i(x i − x ) 2 ∑ i=1 k ∑ j= 1 n j (x ij − x ) 2 (1) ( )2n2n1t2 t22 −++ =η (2) in a situation where it is necessary to compare the differences between two groups of respondents, for calculate the value statistically significant differences it was used t-test of independent samples. (2) research results the results that have been achieved through the conducted empirical research, which were supposed to give an answer on the significance of tax incentives in certain areas for the business of foreign investors, first shown graphic, and after that through descriptive statistics and analyzes the differences between foreign investors depending on their individual characteristics in evaluation the significance of tax incentives in certain areas. in order to determine the competitiveness of serbian economy through the prism of tax incentives for foreign investors, the focus in empirical research was related to the establishment of the importance of tax incentives in certain areas for the business of foreign investors in serbia, and depending on the way foreign investors entered the serbian market. consequently, attention darko marjanović 99 is focused on tax incentives for investing in underdeveloped regions, tax incentives for investing in certain branches of industry, tax incentives for exporting companies, tax incentives for doing business in free zones, tax incentives for hiring new workers, tax incentives for the establishment of small and medium enterprises, tax incentives in corporate income tax and tax incentives for citizens' income tax. figure 1. the importance of tax incentives in business activities of foreign investors in serbia source: authors` calculations according to the conducted survey, the largest number of foreign investors marked tax incentives in corporate income tax (35.2%) as the most significant and determining factor for investment and business in serbia. after that, tax incentives for recruitment of new workers (26.1%), tax incentives for exporting enterprises (21.6%), tax incentives for investing in underdeveloped regions (18.2%), tax incentives for investing in certain (11.4%), tax incentives for the establishment of small and medium enterprises (9.1%), tax incentives for personal income tax (6.8%) and tax incentives for business in free zones (6.8% ). after the graphic presentation, the descriptive statistics (table 2) show the views of foreign investors, ie how the investors assessed the impact of tax incentives in certain areas on their business in serbia. 15,9 20,5 20,5 38,6 15,9 47,7 9,1 31,8 13,6 15,9 23,9 13,6 15,9 4,5 4,5 15,9 34,1 34,1 18,2 21,6 13,6 22,7 30,7 29,5 18,2 18,2 15,9 19,3 28,4 15,9 20,5 15,9 18,2 11,4 21,6 6,8 26,1 9,1 35,2 6,8 tax incentives for investment in underdeveloped regions tax incentives for investment in certain indus tries tax incentives for companies that export tax incentives for business in free zones tax incentives for hiring new workers tax incentives for the es tablis hment of s mall and medium-s ized enterpris es tax incentives for corporate income tax tax incentives for the pers onal income tax completely insignificantly mostly insignificantly neutrally mos tly significantly very significantly 100 economic analysis (2018, vol. 51, no. 3-4, 95-104) table 2. the importance of tax incentives in business activities of foreign investors in serbia degree of evaluation m sd v 1 2 3 4 5 f (%) f (%) f (%) f (%) f (%) tax incentives for investments in not sufficiently developed regions 14 (15,9) 12 (13,6) 30 (34,1) 16 (18,2) 16 (18,2) 3,0909 1,30107 1,693 tax incentives for investments in certain industry branches 18 (20,5) 14 (15,9) 30 (34,1) 16 (18,2) 10 (11,4) 2,8409 1,26751 1,607 tax incentives for exporting companies 18 (20,5) 21 (23,9) 16 (18,2) 14 (15,9) 19 (21,6) 2,9432 1,44920 2,100 tax incentives for doing business in free zones 34 (38,6) 12 (13,6) 19 (21,6) 17 (19,3) 6 (6,8) 2,4205 1,35377 1,833 tax incentives for the employment of new employees 14 (15,9) 14 (15,9) 12 (13,6) 25 (28,4) 23 (26,1) 3,3295 1,42814 2,040 tax incentives for setting up small and medium-sized enterprises 42 (47,7) 4 (4,5) 20 (22,7) 14 (15,9) 8 (9,1) 2,3409 1,43748 2,066 tax incentives in paying corporate income taxes 8 (9,1) 4 (4,5) 27 (30,7) 18 (20,5) 31 (35,2) 3,6818 1,25529 1,576 tax incentives in paying income tax by citizens 28 (31,8) 14 (15,9) 26 (29,5) 14 (15,9) 6 (6,8) 2,5000 1,27757 1,632 source: authors` calculations the existence of statistically significant differences between foreign investors in assessing the significance of tax incentives in certain areas for the business of foreign investors in serbia was investigated through the t-test of independent samples. the results of the t-test of independent samples on the existence of statistically significant differences between foreign investors entering the serbian market through direct investment and foreign investors entering the market of serbia through an indirect investment in assessing the significance of tax incentives in certain areas are shown in table 3. table 3. differences between foreign investors in evaluation the degree of significance of tax incentives in certain areas, and depending on the mode of entry to the market of serbia m (sd) md 95% cid t p* di, n = 47 ii, n = 41 lower upper tax incentives for investments in not sufficiently developed regions 3,5106 (1,17718) 2,6098 (1,28215) 0,90088 0,37958 1,42218 3,435 0,001 tax incentives for investments in certain industry branches 2,9362 (1,35782) 2,7317 (1,16242) 0,20446 -0,33534 0,74427 0,753 0,454 tax incentives for exporting companies 3,1064 (1,41781) 2,7561 (1,47954) 0,35029 -0,26436 0,96493 1,133 0,260 tax incentives for doing business in free zones 2,7021 (1,36597) 2,0976 (1,28072) 0,60457 0,04083 1,16830 2,132 0,036 tax incentives for the employment of new employees 3,4681 (1,41192) 3,1707 (1,44745) 0,29735 -0,30952 0,90423 0,974 0,333 tax incentives for setting up small and medium-sized enterprises 2,8298 (1,46435) 1,7805 (1,19399) 1,04930 0,47776 1,62084 3,650 0,000 tax incentives in paying corporate income taxes 3,5957 (1,32959) 3,7805 (1,17286) -0,18474 -0,71964 0,35015 -0,687 0,494 tax incentives in paying income tax by citizens 2,9149 (1,29933) 2,0244 (1,08369) 0,25726 0,37909 1,40192 3,461 0,001 * statistically significant difference occurs at the level p < 0,05 source: authors` calculations darko marjanović 101 the results of the t-test of independent samples showed that there are the following statistically significant differences between foreign investors: in assessing the impact of tax incentives for investing in underdeveloped regions, t (86) = 3,435, p = 0,001, md = 0,90088, 95% cid: from 0,37958 to 1,42218 between foreign investors who entered the serbian market with a direct investment (m = 3,5106, sd = 1,17718) and those who entered the serbian market with an indirect investment (m = 2,6098, sd = 1,28215). the size of the difference between these two groups of foreign investors expressed by the eta square is η2 = 0,120 and can be considered as a big difference. accordingly, foreign investors entering the serbian market through direct investment have given greater importance to the impact of tax incentives for investing in underdeveloped regions compared to those entering the serbian market through an indirect investment. in assessing the impact of tax incentives for business in free zones, t (86) = 2,132, p = 0,036, md = 0,60457, 95% cid: from 0,04083 to 1,16830 between foreign investors who entered the serbian market with a direct investment (m = 2,7021, sd = 1,36597) and those who entered the serbian market with an indirect investment (m = 2,0976, sd = 1,28072). the size of the difference between these two groups of foreign investors expressed by the eta square is η2 = 0,050 and can be considered a small difference. accordingly, foreign investors entering the serbian market through direct investment have given greater importance to the impact of tax incentives for business in free zones in relation to those who entered the serbian market through an indirect investment. in assessing the impact of tax incentives for the establishment of small and medium-sized enterprises, t (86) = 3,650, p = 0,000, md = 1,04930, 95% cid: from 0,47776 to 1,62084 between foreign investors who entered the serbian market with a direct investment (m = 2,8298, sd = 1,46435) and those who entered the serbian market with an indirect investment (m = 1,7805, sd = 1,19399). the size of the difference between these two groups of foreign investors expressed by the eta square is η2 = 0,134 and can be considered as a big difference. accordingly, foreign investors entering the serbian market through direct investment have given greater importance to the impact of tax incentives for the establishment of small and medium-sized enterprises in relation to those who entered the serbian market through an indirect investment. in assessing the impact of tax incentives on citizens' income tax, t (86) = 3,461, p = 0,001, md = 0,25726, 95% cid: from 0,37909 to 1,40192 between foreign investors who entered the serbian market with a direct investment (m = 2,9149, sd = 1,29933) and those who entered the serbian market with an indirect investment (m = 2,0244, sd = 1,08369). the size of the difference between these two groups of foreign investors expressed by the eta square is η2 = 0,122 and can be considered as a big difference. accordingly, foreign investors entering the serbian market through direct investment have given greater importance to the impact of tax incentives on citizens' income tax in relation to those who entered the serbian market through an indirect investment. conclusion the aim of this research is to identify potential problems that can negatively affect the decision of a foreign investor when investing capital in serbia. that is, which are tax incentives and to what extent is significant for foreign investors, which in the coming period can contribute to the improvement of the business environment in serbia. the results of the conducted research were clearly and unequivocally pointed out, that for foreign investors, tax incentives is very important, with special emphasis on tax incentives in corporate income tax. when it comes to these tax incentives, it is primarily thought to reduce tax rates, tax holidays or investment incentives. the very low rates of corporate income tax have a positive impact on investments, and therefore on the competitiveness of serbia internationally. multinational companies most closely match low tax rates, given that the main benefits relate to the simplicity and transparency of the cost of 102 economic analysis (2018, vol. 51, no. 3-4, 95-104) fulfilling the tax obligation, the generality, the horizontal character of the relief, and neutrality in relation to other tax incentives. given that foreign investors have certain expectations regarding the business environment in serbia, it is more important that the significance of tax incentives be adequately pointed out in the next period. therefore, it is extremely important that economic policy creators in serbia in an adequate way executed implementation those tax incentives which foreign investors expressed through this research. if one looks at the obtained results, it is clear that in the coming period there are good prospects for increasing the inflow of foreign capital. therefore, it is very important to investors to offer a broader spectrum of tax incentives, where special attention should be paid to those tax incentives which investors categorized as less important in this survey. of course, in no case should be neglected other indicators that have a certain impact on investors when choosing serbia as an investment destination. in this way it is possible to improve the business environment as a factor of competitiveness of the serbian economy. from all of the foregoing, it is clear that the results of this research are primarily intended for the creators of tax policy in serbia. it is very important to spot the weakness of the tax system in time, and then implement the implementation of all requirements that are expressed through this research. in this way, a clear signal will be sent to 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eric. 2015. “tax incentives: protecting the tax base”. paper for workshop on tax incentives and base protection, united nations, new york. article history: received: november 3, 2018 accepted: december 20, 2018 ea_2019_2 doi: 10.28934/ea.19.52.2.pp128-136 scientific review the modelling of tax influence on macroeconomic framework in spain vera mirović1* | branimir kalaš1 | jelena andrašić1 1 university of novi sad, faculty of economics, department for finance and accounting, subotica, serbia abstract the study provides an empirical analysis of tax impact on selected macroeconomic aggregates in spain from 1996 to 2016. the objective of this research is to determine how tax forms effect on macroeconomic framework of spanish economy. the analysis includes the impact of direct taxes such as personal income tax, corporate income tax and tax on property as well as social contributions. on the other hand, gross domestic product per capita, unemployment, inflation, investment and government expenditures are selected as the main macroeconomic determinants and present dependent variables in defined models. results of defined model show that tax revenue growth, personal income tax, tax on property and social security contributions significantly affects the gross domestic product per capita. further, personal income tax and corporate income tax have a significant impact on unemployment, investment and government expenditures. findings show that the intensity of personal income tax' effect is higher on investment and government expenditures compared to corporate income tax. in addition, present tax structure does not have a significant effect on inflation, which can be explained by fact that indirect taxes are more related to inflation than direct taxes. key words: direct taxes; structure; macroeconomic aggregates; ordinary least squares model jel classification: b40, h20, h21 introduction tax forms should take an important place in the economic policy of each country. the level and share of taxes in the economy must be adequately defined so that taxes would be in function of growth and enable optimum functioning of the economy. any increase in taxes can potentially have a negative influence on the main macroeconomic indicators. however, tax cuts can result in lower revenues, which mean lower public funds, or resources needed to meet public expenditures there are numerous tax forms that are related to income, profits, ownership and value of assets, turnover, consumption, as well as to imports and exports in the course of performing economic activities. what type of tax is present in a particular country depends on the level of its economic development. boadway and pestieau (2002) state that personal income tax and consumption tax are classified as key tax forms in taxation systems around the world. when tax forms are used as a proxy for fiscal policy, engen and skinner (1999) listed several mechanisms of tax influence on economic growth. namely, taxes can decline investments and slow down growth in labour supply by distorting labour-leisure choice in favour of leisure. in addition, it is necessary to mention that a higher level of tax burden can distort the effective use * corresponding author, e-mail: vera.mirovic@ef.uns.ac.rs vera mirović, branimir kalaš, jelena andrašić 129 of human capital (tosun and abizadeh, 2005). looking at the tax structure in spain in past twenty years, tax on goods and services, personal income tax and social security contributions are the most generous taxes in this economy. namely, these three taxes consists almost 30% gross domestic product at an average level and over 80% of tax revenues in spain. this is similarly trend compared to other countries, especially oecd countries and these taxes are the basis of tax structure in spain. the need for research is reflected in providing information support and giving guidance to economic policymakers in the observed country about the influence of direct taxes on macroeconomic aggregates such as gross domestic product per capita, unemployment, inflation, investments and government expenditures. in addition to determining the impact of tax forms on selected macroeconomic aggregates, as well as the nature of their relationship, there is a motive to show how the current tax structure influences on the macroeconomic framework in analyzed period. literature review there are many studies that have analyzed the impact of taxes on macroeconomic variables in order to dominant research is related to economic growth. when it comes to economic growth, myles (2000) defined as the fundament for increasing prosperity of the economy. petrov and trivić (2018) determined sustainable income as a measure of growth and a trajectory to a developed state that can sustain over a very long period. many papers are focused on relationship between tax forms and economic growth (abizadeh, (1979); helms, (1985); chelliah, (1989); barro, (1990); bleaney et al. (2001); lee and gordon, (2005); furceri and karras, (2007); arnold, (2008); arnold et al. (2011); ferede and dahlby, (2012); gale et al. 2015; li and lin, (2015); grdinić et al. 2017; andrašić et al. 2018; mcnabb, 2018). lee and gordon (2005) analyzed seventy countries for the period 1970-1997 and found that corporate income tax is related to lower economic growth. namely, their results showed that a cut in a corporate tax rate of 10% enhances annual gross domestic product growth per capita by 0.64%. similarly, furceri and karras (2007) found that an increase of tax share in gdp leads to a decline of gdp per capita in twenty-six oecd countries in the period 1965-2007. however, tax on property is an only tax, which has a significant influence on gross domestic product per capita although other tax forms such as personal income tax, corporate income tax, social security contributions, and tax on goods and services negatively affect the gross domestic product per capita. in addition, arnold (2008) confirmed the negative influence of taxes on economic growth in order to income taxes is generally related to lower economic growth than taxes on property and consumption. in an analysis of oecd countries, macek (2014) pointed out personal income tax, corporate income tax and social security contributions cause the highest damage to the economic growth in these countries. li and lin (2015) analyzed the effect of sales tax on economic growth in the united states from 1960-2013 and estimated the long-run and short-run elastic coefficients of sales tax on growth. their findings are that economic growth is negatively related to sales tax in the long-run, although this tax has positive effects in the short-run. in addition to relationship between taxes and economic growth, there are studies that examined their potential influence on unemployment, inflation, investments and government expenditures. the argument that higher labour taxes result in a higher unemployment rate is widely presented in public finances. daveri and tabellini (2000) researched the relationship between labour tax and unemployment in eu countries in the period 1965-1995. their findings confirmed that an increase in labour tax of 14% leads to an increase in unemployment of 4%. zimmermannova et al. (2016) found a negative correlation between personal income tax and unemployment in czech republic, which implies that higher revenues are related to the smaller level of unemployment. poterba and rotemberg (1990) researched tax rates and inflation rate in united states, united kingdom, france, germany and japan in the period 1981-1986. their findings confirmed a positive correlation in united states and japan, and negative correlation in the other three countries. value added tax is often related to inflation and price movements, 130 economic analysis (2019, vol. 52, no. 2, 128-136) where gabriel and reiff (2010), as well as benkovski and fadejeva (2014), confirmed the significant effect of this tax form on inflation rate. it is an essential relationship between taxes and government expenditures where taha and logahtnan (2008) confirmed that the decrease in tax rates could lead to a decline of government expenditures. similarly, zortuk and uzgoren (2008) found bidirectional causality between government expenditures and tax where 1% increases enhance tax by 0.8%. methods and materials for the purpose of this study, authors used secondary data of oecd revenue statistics for the period 1996-2016. in order to determine the impact of direct taxes on selected macroeconomic aggregates such as gross domestic product per capita, unemployment, inflation, investment and government expenditures. table 1. review of explanatory variables variable symbol calculation source tax revenue growth trgrowth annual growth rate oecd personal income tax pit % share of gdp oecd corporate income tax cit % share of gdp oecd tax on property top % share of gdp oecd social security contributions soc % share of gdp oecd gross domestic product per capita gdppc u.s. dollars oecd unemployment unm annual rate imf inflation inf consumer price index imf investment inv % share of gdp imf government expenditures ge % share of gdp imf source: authors' illustration models can be presented as: gdppct=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5unmt + β6inft + β7invt + β8get+ …et (1) unmt=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6inft + β7invt + β8get+ …et (2) inft=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6unmt + β7invt + β8get+ …et (3) invt=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6unmt + β7inft + β8get+ …et (4) get=β0+β1trgrowtht+β2pitt+β3citt+β4soct + β5gdppct + β6unmt + β7inft + β8invt+ …et (5) where are gdppc gross domestic product per capita, trgrowth tax revenue growth, pit personal income tax, cit corporate income tax, soc social security contributions, unm unemployment, inf inflation, inv investment, ge government expenditures, β0 the constant term, β the coefficient of the independent variables and e the error term of the equation. empirical results this section provides descriptive information for explanatory variables, as well as trends of macroeconomic aggregates and direct taxes. in addition, correlation matrix is presented in order to identify the nexus between tax structure and macroeconomic framework in spain. vera mirović, branimir kalaš, jelena andrašić 131 table 2. descriptive statistics variable mean std. dev. min max trgrowth 4.9619 5.9678 -10.4 11.3 pit 6.8857 0.4151 6.2 7.6 cit 2.7428 0.7788 1.8 4.7 top 2.2952 0.3968 1.7 3.2 soc 11.6476 0.2159 11.1 11.8 gdppc 4.3719 0.1370 4.17 4.55 unm 16.4714 5.8497 8.22 26.1 inf 2.3805 1.3441 -0.5 4.08 inv 24.7371 3.9217 19.14 31.33 ge 41.9833 3.2041 38.27 48.09 source: authors calculation figure 1. trends of macroeconomic aggregates in spain source: authors based on imf database the average gdp per capita is 24491 usd which is higher than eu average, but worrying is a decreased trend from 2008. firstly, gdp per capita was 35725 usd in 2008 and in the next eight years felt for 9409 usd. further, it can see that unemployment was growing trend from 2007 to 2016 where the highest rate of 26.1% was recorded in 2013. however, positive fact is unemployment is decreased in the last four years for more than 9% compared to 2013. also, inflation is relatively stable where the greatest price level was 2008, which is positively correlated with economic growth in spain (gdp growth rate was 1.12%). it is a recorded average inflation rate of 2.38% what is higher than most member countries in eu whose had null or zero price level. the average shares of investment and government expenditures are 24.74% and 41.98% of gross domestic product. it's indicative that when investment share increased the gdp growth rate was higher. on the other hand, when share of government expenditures exceeds 45% of gdp, economic growth was slower and smaller measured by annual gdp rate. 132 economic analysis (2019, vol. 52, no. 2, 128-136) figure 2. trends of direct taxes in spain source: authors based on oecd revenue statistics figure 2 shows the movement of direct taxes in spain in the observed period 1996-2016. tax revenue had the highest growth in 2005 where it increased by 11.3%. after that, tax revenue had declined trend, especially in 2008 year, where they fell by 10.4%. this negative trend is a consequence of the global economic crisis that slowed down economic activity in the world. in past five years, average growth of tax revenue was 2.7%. looking at the tax structure, personal income tax and social security contributions have the greatest share of gross domestic product in this country. the average share of personal income tax is 6.9% of gdp, while revenues collecting of social security contributions consists 11.7% of gdp. on the other hand, corporate income tax and tax on property have an average percentage share behind 3% of gdp in the analyzed period. table 3. correlation matrix variable trgrowth pit cit top soc gdppc unm inf inv ge trgrowth 1.00 pit -0.32 1.00 cit 0.45 -0.25 1.00 top 0.35 -0.05 0.79 1.00 soc -0.13 -0.29 0.45 0.49 1.00 gdppc -0.55 0.47 0.08 0.41 0.51 1.00 unm -0.36 0.59 -0.85 -0.60 -0.59 0.07 1.00 inf 0.31 -0.35 0.42 0.12 0.25 -0.23 -0.60 1.00 inv 0.52 -0.59 0.88 0.69 0.51 -0.11 -0.95 0.54 1.00 ge -0.60 0.62 -0.80 -0.57 -0.36 0.34 0.91 -0.57 -0.92 1.00 source: authors calculation based on correlation test, it can see a negative relationship between tax revenue growth and gross domestic product per capita, as well as personal income tax and social security contributions are positively correlated with gross domestic product per capita. results show that direct taxes are significantly correlated with unemployment, while on the other hand, these tax forms are not correlated with inflation at the significant level of 0.05. also, tax revenue growth, corporate income tax, tax on property and social security contributions are positively correlated with investment. finally, the nexus between taxes and government expenditures is significant, except social security contributions. vera mirović, branimir kalaš, jelena andrašić 133 table 4. model validation and specification tests model i model ii model iii model iv model v bp/cw test 0.7046 0.5222 0.0716 0.0669 0.2801 dw test 1.1644 1.8774 2.3257 1.9407 1.7755 rr test 0.2359 0.2280 0.0615 0.2256 0.1225 source: authors calculation based on results from table, it can notice that model is adequately defined in terms of econometric preconditions such as heteroscedasticity, autocorrelation and misspecification of the model. based on breusch-pagan/cock weinsburg test, models do not have a problem with heteroscedasticity (p-value > 0.05). also, dw test show there is no autocorrelation in residuals as well as rr test reflects the model correction. after we examined the fundamental assumptions of the appropriate determined model, the analysis includes the impact of direct taxes on macroeconomic aggregates in spain from 1996 to 2016. table 5. model estimation model i ii iii iv iv variable gdppc unm inf inv ge trgrowth -0.0112** (0.0028) -0.0471 (0.102) 0.0551 (0.0625) 0.0504 (0.0554) -0.102 (0.0726) pit 0.128** (0.0369) 4.957** (1.323) -0.134 (0.810) -3.692*** (0.718) 3.112** (0.942) cit -0.0470 (0.0294) -6.102*** (1.054) 1.235 (0.645) 3.135*** (0.572) -2.555** (0.750) top 0.219** (0.0585) 1.976 (2.098) -2.299 (1.284) 1.191 (1.138) 0.0219 (1.492) soc 0.234* (0.0819) -4.989 (2.938) 1.730 (1.798) 1.245 (1.594) 0.207 (2.090) c 0.444 (1.038) 52.42 (37.24) -15.23 (22.79) 24.07 (20.21) 25.60 (26.49) n 21 21 21 21 21 r-sq 0.876 0.913 0.381 0.943 0.853 adj r-sq 0.835 0.884 0.174 0.924 0.804 rmse 0.056 1.996 1.221 1.083 1.420 standard errors in parentheses * p<0.05, ** p<0.01, *** p<0.001 source: authors calculation as we can see, model i manifests significant impact of tax revenue growth, personal income tax, tax on property and social security contributions on gross domestic product per capita. also, tax revenue growth and corporate income tax have a negative influence on gross domestic product capita, while personal income tax, tax on property and social security contributions positively affect the gross domestic product per capita. results show that social security contributions and tax on property have the highest impact where their change of 1% raises gross domestic product per capita by 0.22% and 0.23%. model iii determines the impact of direct taxes on unemployment where personal income tax and corporate income tax have significant influence. looking at the character of their impact, tax revenue growth, corporate income tax and social security contributions negatively affect the unemployment, while personal income tax and tax on property have a positive influence. compared to the previous model, corporate income tax and social security contributions cause the highest change of the unemployment rate in these countries. an increase of 1% of these taxes declines unemployment 134 economic analysis (2019, vol. 52, no. 2, 128-136) by 6.1% and 4.99%. model iii reflects the influence of direct taxes on inflation where tax revenue growth, corporate income and social security contributions positively affect the price level. on the other hand, personal income tax and tax on property have negative influence on inflation. as we can see, there is no significance of direct taxes impact on price level. in model iv, personal income tax and corporate income tax have a significant impact on investment compared to other tax forms. simultaneously, these taxes cause the highest change of investment share in the gross domestic product, where a 1% increase of personal income tax declines investment by 3.69%. likewise, corporate income tax raises investment by 3.13% at the significant level of 0.05. finally, model v examines the impact of direct taxes on government expenditures and shows a significant influence of personal income tax and corporate income tax. tax on property and social security contributions positively affect the government expenditures, but there is no statistical significance. on the other hand, personal income tax positively affects the government expenditures where 1% increase of this tax raises government expenditures by 3.11%. corporate income tax has opposite influence where 1% increase declines government expenditures by 2.55%. reliability and validation of these results are confirmed by the adequate defined model as well as fact that the value of r-squared is above 80% expect model iii. conclusion the study has researched the impact of direct taxes on the macroeconomic framework in spain from 1996 to 2016. empirical analysis has included ols model which has estimated the influence of tax revenue growth, personal income tax, corporate income tax, tax on property and social security contributions on main macroeconomic aggregates such as gross domestic product per capita, unemployment, inflation, investment and government expenditures. based on results of the ols model, tax revenue growth, personal income tax, tax on property and social security contributions have a significant influence on gross domestic product per capita. in addition, personal income tax and corporate income tax have the greatest impact on unemployment, investment and government expenditures. for example, personal income tax has a higher impact on investment and government expenditures compared to corporate income tax. findings of these models show a significant influence of direct taxes on macroeconomic aggregates, except inflation where current tax structure does not have significant effect on inflation rate in this country. this is logical because indirect taxes are more related to inflation than direct taxes. the contribution of the study is reflected in the fact that we have ensured the quantitative measurement of tax forms and analysis has enabled informatical support for policy makers about which tax forms are important for macroeconomic framework in spain. also, the originality of paper is manifested in fact that there are no studies, which analyzes particular tax structure in spain in terms of macro influences of direct taxes. the study has provided a better understanding of the 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"the relationship between the taxation and government expenditure in turkey bounds test approach". banks and bank systems, 3(1): 57-62. article history: received: june 11, 2019 accepted: september 2, 2019 microsoft word 2008_01_02.doc     original paper    on balance of payments crisis in serbia:     if it ain’t broken, why fixing it might still be a good idea?    marko malović, belgrade banking academy    key words: balance of payments deficit, serbia, dinar depreciation,     sudden stop crisis, foreign debt, macroeconomic adjustment    udc: 332.053.2 (497.1)         jel: f32, f34    when you are in a hole, first thing you should do is to stop digging  ‐anglo‐american proverb‐    “yes there are two paths you can go by but in a long run,  there is still time to change the road you’re on”  ‐led zeppelin, stairway to heaven‐    abstract:  contrary to mainstream opinions, with external deficit of more than 16% of gdp and  foreign debt of 16 billion €, serbia is at the verge of balance of payments crisis. it is most likely going to un‐ ravel as a sudden stop phenomenon, after which considerable real depreciation of national currency will be  finally  forced by both domestic and  international portfolio adjustment. however,  if serbian monetary au‐ thorities manage to coordinate real exchange rate depreciation with urging reforms on a wider macroeco‐ nomic front, capital flow reversal does not necessarily have to bite into long‐run  economic growth and em‐ ployment. in fact, it might prove to be a starting ingredient of bottoming out. one thing is for sure: serbia  won’t be able to maintain the present level of spending for much longer.  hopefully sooner rather than later,  irrational or morally hazardous exuberance shall dissipate and leave room for inevitable rebalancing along  the national saving‐investment axis.  introduction  in spite of the fact that recent policy migration ‐from dirty float (which in fact was dirty peg)  to more flexible exchange rate regime‐ pretty much disabled the possibility of currency crises in  serbia, the country is still at the verge of severe and potentially rather painful balance of payments  crisis. worse still, professional community is largely either ignoring or dismissing the very exis‐ tence of the alarming external disequilibrium. at the other side of the argument, among the few  who are cautiously whispering about it, some analysts are at best underestimating the problem,  while others are blowing whistles of doom almost without policy prescriptions whatsoever. on a  top of  it,  there seems  to be a profound misunderstanding of  the balance of payments concept  among serbian decision‐makers and some of their influential local advisers.  the aim of the paper is to debunk expensive myths of the so‐called burns‐lawson‐robichek  doctrine, deeply rooted in serbia’s recent economic policy, as well as to consider the inevitability of  the balance of payments crisis in serbia, envisage possible future developments in that regard, re‐ view macroeconomic mix deployed thus far and suggest some conditions ‘n’ cures that might be  lurking ahead.  the rest of the paper is organised as follows: first section deals with some basic bop theory as  opposed to lawson’s doctrine itself, second part gives some stylized facts on serbia coupled with  more heterodox theoretical considerations which climax in several policy recommendations. the  volume 40 • spring 2008 • 25  third section summarizes the main findings and caveats in the serbian context, as well as earmarks  the allies for future research.  a pinch of theory: it ain’t broken…or is it?  after democratic revolution from october 2000, serbia made long strides in an attempt to  join ‐and take the most of‐ the european and world economy. reentering major international fi‐ nancial and political institutions, swift privatisation of socially owned enterprises, efficient (if not  entirely effective) reform of nearly collapsed banking sector, and imf‐guided macroeconomic re‐ forms ‐that improved tax collection and balanced the budget, brought down inflation, liberalised  trade and opened the country for foreign investors‐ were all worthy achievements even more so in  such a short period of time and following such a devastating decade (once again “lost for growth”)  of 1990s. according to the world bank and ebrd, serbia was the leader in economic reforms and  successful transition in the year 2005. sovereign debt paris club wrote off some $700 mill. of debt.  credit rating  improved, growth is steadily catching up by sustaining rates well above those in  oecd economies. in 2007, serbian economy achieved 7% real gdp growth. mounting foreign ex‐ change reserves, pouring fdi, introduction of fairly formal inflation targeting, steady development  of belgrade stock exchange as well as serbia’s  lately abstinence from formal stand‐by arrange‐ ments with imf, give overall impression that somehow serbia has been finally closing in towards  economic graduation and the league of wealthier nations. at last, but not the least, saa with the  eu seems to be just around the corner, where unresolved territorial issues over kosovo and meto‐ hija are more likely to speed up serbia’s eu accession rather than stall it for good.  however, is  there time and ground for celebration?  the aim of this paper is to draw attention to specific aspects of serbian bop dynamics and  macroeconomic health, in the context of it framework nowadays typical for increasing number of  emerging markets, whose key characteristics can be summarized in phrases like:   o lawson’s doctrine  o sky‐rocketing foreign debt   o imported  pecuniary  expansion  (through  the  combination  of  net  inflow  of  foreign  loans, exhausting remittances and current consumption of finite privatisation reve‐ nue),   o fear of floating, “original sin” and dollarisation (euroisation)  o razor‐sharp trade‐off between loss of competitiveness due to imminent currency ap‐ preciation (or evident overvaluation as it is) and edgy inflation expectations if capital  inflows were to be monetized,   o transition  fatigue, not enough employment, not enough export‐driven, sustainable  growth.   it is advisable and therefore customary in serbian public discourse, to make clear what one  claims not before taking the actual professional stand on the issue at hand. i find that approach  useful in the logical sequence of this paper too. the paper makes no attempt to suggest that small  open economies in transition should not run bop deficits, nor that running bop deficits (even for  number of years) is necessarily bad and undesirable phenomenon. in fact, intertemporal (and in‐ ternational) trade in financial assets that enables bop deficits is undoubtedly beneficial and indeed  often indispensable for small open economies in transition. yet what is the meaning and what are  the consequences of protracted bop deficits? what or who are bop deficits caused by? when are  they unsustainable after all? from a current account (or essentially merchandise trade balance)  2007 ‐ 26  •  economic analysis®  point of view, the sheer fact that serbia imports net of its’ exports understandably prompts many  to utter‐ so what? moreover, large and prolonged external deficits seem to be the macro light mo‐ tive in many rich countries as well during the last two decades or so [blanchard, 2007].1 therefore,  we shall reintroduce the financial (or more broadly capital account) view of the bop disequilibria,  since this financial perspective of bop deficits happen to be of crucial interest in the case of serbia.   balance of payments represents an interconnected set of accounts which summarizes all the  international transactions carried out by individuals, firms and government of one country with  their counterparts in the rest of the world [yarbrough‐yarbrough, 2000]. since international trans‐ actions give rise to two offsetting bop entries, according to the latest imf manual,2 from an ac‐ counting perspective its’ main three components automatically add up to zero [krugman‐obstfeld,  2006]:  b+ќ+φ=0                    (1)    without too much loss of generality of findings, we may often write this fundamental bop  equation simply as: b+k=0, where k binds the last two additive terms on left‐hand side of (1).3  from an economic perspective, however, balance of payments is almost never in equilibrium, the  trouble being that cumulative and more sizeable external disequilibria bear very real and unpleas‐ ant adjustment arithmetic, which so frequently catches up with great many of those who didn’t  exactly have a saying nor benefit in its accumulation.  mathematical definition of bop (dis)equilibrium from the current account perspective is by  now common knowledge in open‐economy macro:  y‐a=x‐m+ω=b                  (2)  here y stands for gdp, a for absorption (comprising the usual suspects final spending is  made of), x, m exports and imports of goods and services, respectively, while ω denotes net factor  proceeds and unilateral transfers. nevertheless, rather than mechanically repeating the fact that  bop deficit indicates that we imported more from overseas than we managed to export abroad, it is  worth noting that this equation painfully reminds us that literally the only way for a country to  run bop surplus is to produce (y)4  more than it spends (a). contrary to popular belief in serbia  and elsewhere,  this  identity continues  to hold even when many or majority of capital/financial  transactions are autonomous rather than counterbalancing!  in terms of keynesian static represen‐ tation, bop disequilibria are represented by gap between national output (y) and its’ total expendi‐ tures (e):    1 within the euroland, spain and portugal, for instance, run current account deficits of as much as 10% of their gdp  lately, while us in spite of depreciating dollar still has more than 5% deficit in bop [ibidem].  2 due to prominent rise of international portfolio investment flows and the intention to take back the transfers as essen‐ tially capital transactions from the current account, aggregate capital account has been broadened so as to comprise of  the financial account (which record international trade in financial assets) and the capital account (which tracks only  nonmarket activities in international asset movements) [krugman‐obstfeld, 2006]. thus, newly established capital ac‐ count contains unilateral transfers and automatic transactions caused by global migrations etc. in earlier imf manuals,  overall capital account was usually disaggregated into foreign reserves dynamics and the rest of international capital  transactions, so as to read: b+ķ+δr=0  3 quite generally speaking, k≠ќ+φ because the right hand side contains unilateral transfers from the current account as  well, but since many central banks still put them on the current account and since they are often relatively insignificant, i  shall stick to the approximation in the main text so as to keep things simple.   4 with sustained, if not improving, exportable quality  volume 40 • spring 2008 • 27  figure 1. national income, total expenditures and bop deficit    adapted from: yarbrough and yarbrough (2000)    clearly, excessive spending via rising expenditures (e=a+m‐x) pushes the output up in the  short run, but at the unavoidable expense of deteriorating current account. this is especially true  for small open countries in transition with limited (or indeed given) export/production potential  and considerable import dependence (or import‐biased, distorted preferences).  however, from a financial/capital account view point, there are also some important portfo‐ lio insights from defining bop (dis)equilibrium, although formula itself is well‐known too:  b=s‐i= (t‐g) +sp‐i                  (3)  here s stands for aggregate savings, g for government spending, t for fiscal revenue, spfor  private sector savings and i for investment in serbia. this capital account view reads that eventual  current account deficit has to be financed by surplus of aggregate investment in serbia over do‐ mestic accumulation,  i.e. that capital/financial account balance countervails so‐called “twin defi‐ cits” or the sum of net government and private savings. we shall pick up this latter point later on  in the paper.  for the time being, it is in order to dwell on some reoccurring anecdotal evidence here, so as  to draw a poster child of profound misunderstanding of bop phenomenon among certain serbian  economists and decision‐makers. classics first: one of the very top serbian officials gave several  statements in the past couple of years on how imperative it was for the country to reverse if not  eliminate such a huge bop deficit “(...) and the only way for us to do that is to attract as much for‐ eign direct investment as possible”. sorry mate, the open‐economy macro identity clearly shows  that one cannot do both things simultaneously, perhaps not even in the extended short run: so long  as we need net capital inflows from abroad we shall unavoidably accumulate bop deficits. more  disturbingly, one academic economist and respectful advisor in serbia  wrote in a conference paper  in late 2005 that “(…) since this year’s financial and capital inflows in serbia were even greater than  the current account deficit, the overall serbian bop was in fact positive”!!!  i beg your pardon sir,  but the sum of financial and capital account within the bop cannot possibly exceed the size of cur‐ rent account disequilibrium since they exactly cancel each other out (in accounting terms), nor it is  feasible for “the overall serbian bop” to be positive when it actually was in deep and worrisome  45° e y y x(y*, i) m(y ,i) b<0 y0 y1 e0 e1 x,m,b 2007 ‐ 28  •  economic analysis®  deficit in 2005 already!!! finally, analyses that mirror that of sanfey (2007), for example, asserting  that capital account surplus (ķ) in serbia is recently greater than current account deficit, hence offi‐ cial reserves must be piling up are correct in an accounting sense, yet de facto coming to terms with  such an imbalance financed by net capital inflows remains equally dubious in terms of its alleged  macroeconomic neutrality or indeed sometimes “favourable” outcome a propos bop sustainability  drawn from the constellation. we shall return to this seriously counterintuitive paradigm of side‐ by‐side growing reserves & bop deficit in the last section of the paper. certainly, this let it grow  phenomenon is scarcely distinguishable from the burns‐lawson doctrine itself; moreover, it dis‐ solves into economic cocktail as if made for fireworks. which prompts one to ask how much is too  much when it comes to bop deficit?  theory preaches that every current account deficit of 5% of gdp or bigger should be taken as  a red alert for macroeconomic watchdogs [frenkel‐razin, 1996], [aristovnik, 2006]. nonetheless,  more accurate estimate of potential  for and  long  term sustainability of current account deficits  could be grasped only via stressing the intertemporal nature of the bop concept. the intertemporal  approach  originally  relied  on  two  indisputable  facts:  a)  economic  well‐being  of  consumption  smoothing, i.e. ability to balance and coordinate country’s income stream/output dynamics with its  foreign debt repayment and b) that both saving and investment somewhat depend upon time pref‐ erence ‐ such as life cycle spending requirements or expected return on investment project. follow‐ ing obstfeld and rogoff (1998), for instance, it is possible to construct an intertemporal bop model  simply by sticking to country’s budget constraint and transversality condition5:  ‐bt =∑j=t,∞  β j‐t+1(yt‐at)                   (4)  if we recognize β as a discount factor or 1/(1+i), and the term in brackets on the right‐hand  side of (4) as net exports needed for current account reversal, formula is unambiguous. however,  different specifications of intratemporal6 as well as intertemporal7 preferences, imperfect interna‐ tional capital mobility as described by feldstein‐harrioka puzzle e.g., and not least fiscal shocks  gave poor empirical verification and accordingly bad name to intertemporal bop models. as a mat‐ ter of fact, not corrected for  the aforementioned deficiencies, these models imply that country’s  optimal response to negative exogenous shocks is to run very large bop deficits [edwards, 2001],  which  was  of  course  overwhelmingly  greeted  by  political  cycle  myopia  and  academics  who  claimed that current account did not really matter. little it meant that econometric research deci‐ sively rejected advice that in the face of financial reform and transition it was safe to run massive  bop deficits, for instance as high as 60% gdp [edwards, 2004]. alas, a rise and coexistence of so‐ called burns‐lawson doctrine and mounting bop deficits (which often heavily violate ricardian  equivalence)  is  to be  traced  in another, more blurred, side‐effect of  intertemporal bop concept.  namely, compared to traditional keynesian views, the  intertemporal approach to bop uninten‐ tionally reduces emphasis on the economy’s intratemporal competitiveness measured by the real  exchange rate [nason‐rogers, 2003].8    now, what kind of intellectual baggage bears the so‐called burns‐lawson doctrine?  for‐ mer chancellor of exchequer in uk nigel lawson was among the first to engage in outright de‐ 5 practical application of transversality condition, so often conveniently neglected by politicians, requires that in the  foreseeable time limit sum of all current account disequilibria must be nullified.  6 for example, justification for assuming non‐separable rather than additive preferences between leisure and consump‐ tion in a micro founded open‐economy model [nason‐rogers, 2003, pp.6‐7].   7 wild swings in world interest rates or for any other reason rising gap between home rate of preference and the refer‐ ence rate [blanchard, 2007]. after all, edwards (1990, p.20) recalls often abstracted fact that national rate of time prefer‐ ence is itself a variable influenced by accumulation rate, investment opportunities and foreign debt sustainability… in a  word, influenced by bop dynamics.    8 real exchange rate adjustment ‐absolutely essential for current account balancing‐ will be dealt with in the next section.  volume 40 • spring 2008 • 29  fense  of  benign  neglect  in  regard  to  rising  bop  deficits  that  stemmed  from  private  investors’  autonomous behaviour.9 this was followed by academic apologies of the lawson doctrine by at  least two famous international economists, jeff sachs and max corden, who both argued that so  long as government budget was roughly in balance and/or with declining proportion of gdp, bop  crisis is impossible: private sector’s borrowing and spending considerations and current account  deficits so  induced need not be of any public policy concern  [muellbauer‐murphy, 1990],  [ed‐ wards, 2004]. if we are to review the official heuristics of serbian ministry of finance with respect  to nature and causes of serbian bop dynamics, it used to almost completely mimic the lawson’s  own credo with respect to uk: “we are prisoners of the past, when uk current account deficits  were  almost  invariably  associated  with  large  budget  deficits, poor  economic  performance,  low  reserves and exiguous net overseas assets. the present position could not be more different. “10 in  other words, representatives of serbian ministry of finance, serbian chamber of commerce and  national bank of serbia (to a lesser extent) made clear in several instances in last couple of years  that they consider “trade deficit to be sustainable for as long as serbia manages to cover it through  remittances and fdi, moreover, for as long as serbia’s foreign exchange reserves are mounting”.  what is erroneous about these statements? clearly, serbia is not uk or us, to begin with. serbia  does not have london as the world’s most important financial market within its borders let alone  legal tender serving as a leading vehicle currency, hence every serious regional political instability  or global financial crisis could endanger the long‐term stability of foreign capital inflows, i.e. the  long‐term solvency of the country. moreover, private investors’/consumers’ behaviour  is not al‐ ways rational in the short to medium run, since lots of capital inflows in serbia are being simply  spent or at best invested in non‐exportable sectors, therefore some of the net fdi inflows might be  postponing necessary reforms and enlarging their eventual scale. milesi‐ferreti and razin (1996),  interestingly, characterise bop sustainability as an imbalance consistent with continuation of pre‐ sent economic policy, or in other words, no dramatic changes in exchange rate, monetary and fiscal  policy are deemed inevitable [hansen‐hansen, 2004]. after all, liquidity problems ‐detrimental for  stability of foreign capital inflow‐ often arise out of irrational savings‐investment and/or consump‐ tion smoothing patterns of domestic as well as foreign private agents, which in small open econo‐ mies in transition all too frequently ended in boom‐bust cycles and twin (bop and banking) crises  [tornell‐westerman, 2003]. finally, fdi inflows in the long run painfully remind the hosts on its  liability‐ rather than asset nature, whereas in the meanwhile even minor (from a global investor  view  point) portfolio  stock  adjustments  may  render  the  host country’s  life  “nasty,  brutish  and  short”, which are probably  the reasons why fernandez‐arias and hausmann  (2001) as well as  hansen and hansen (2004), among others, do not consider fdi as reliable source of finance for bop  deficits in the long run. moreover, the above mentioned intertemporal optimisation/consumption  smoothing considerations tackle only the ability, but not the willingness of future generations (or  of those very same private agents’ that lawson’s doctrine initially presupposes as fully rational) to  give  up  perhaps  too  large  a  fraction  of  its  gdp  in  order  to  meet  its  foreign  debt  repayment  tranches, as originally addressed by eaton, gersowitz and stiglitz (1986). all in all, it is nowadays  probably sufficient to say that lawson’s doctrine and intellectual spawns of that kind of reasoning  were plain‐and‐simple discredited by the bop and currency crises in southeast asia and even latin  9 almost identical line of reasoning could be found in the statements and papers of samuel brittan, and further traced to  sir terrence burns, chief economic advisor. h.m. treasury in the late 1980ʹs and early 1990ʹs. doctrine is sometimes  also associated with the name of walter robichek, director of western hemisphere operations of the imf [nachane,  2007]. however, in as much as the idea gained some popularity in academic circles too, it would be unfair to blame it  completely on either burns, robichek or lawson [muellbauer‐murphy, 1990].   10 lawson (1988), quote taken from muellbauer and murphy (1990, p.347, footnote 1).  2007 ‐ 30  •  economic analysis®  america in the late 1990s, where crashes erupted in spite of roughly balanced government budg‐ ets.11  therefore, in a number of papers economists attempted to develop methodology for sustain‐ ability tests of bop deficits. obstfeld and rogoff (1998), e.g., justifiably highlight the cases of aus‐ tralia and canada who continued to run fairly large bop deficits for more than 40 years even after  wwi, at which time they took off from theoretical transitional paradigm, without going broke or  even woke their investors’ doubts regarding economic reforms having been pushed through. if not  by strict victorian prudence, international financial rubicon appears to be defined by maintaining  at least a constant ratio of foreign debt to both output and/or wealth [krugman, 2007]. hence, pro‐ vided that output grows at strictly positive rate of g  while economy targets a fixed debt to output  ratio so as bj+1=(1+g)bj , steady‐state pattern of current account imbalance according to obstfeld and  rogoff (1998) must be:  bj+1‐bj=gbj=ibj+nxj                      (5)  here, nxj labels net exports, that is (yt‐at), or slightly rewritten,  nxj/yj= (g‐i)bj/yj                  (6)  however, if we assume the growth rate to be even higher than the discount rate (which is not  unreasonable in a fast growing emerging market world), the state‐space realm for intertemporal  consumption smoothing becomes  theoretically unbounded  [obstfeld‐rogoff, 1998]. this  is why  transversality condition in practice ought to be imposed at some proximate finite point in order for  bop deficit to be reversed so as to achieve significant reduction in foreign indebtedness. foreign  indebtedness, naturally, amounts to cumulative current account deficits aimed to be eliminated.      figure 2. serbian bop deficits as percentage of serbia’s gdp   0 5 10 15 20 2002 2003 2004 2005 2006 2007   source: national bank of serbia, * estimate made by quarterly monitor (2007)    now, even a casual glance at recent bop dynamics in serbia shows unambiguous signs of  concern.12 such a colossal external deficit pattern paired with excessively high wages ‐compared  11 for in depth analysis see for example reisen (1998).   volume 40 • spring 2008 • 31  not only with serbian productivity13 but also with real wage levels of the latest eu entrants‐ and  additionally complicated by unemployment of around 20%, place serbia in one of the less com‐ fortable corners of rudi dornbusch’s latin triangle [dornbusch, 2000].  what are statistical and  macroeconomic causes of economist’s discontent?  in the last couple of years serbian exports did grow slightly faster than serbian imports but  since imports were circa double the size of imports, trade deficit gained weight. proverbially inap‐ propriate structure of serbian exports of goods and their slower pace in 2007 coupled with recent  deterioration (trend?) in trade in services (namely, visible fall in unilateral transfers, especially re‐ mittances) further obscure the viability of serbian bop. comparative analysis with other transition  countries in the region indicates that serbia is falling behind in terms of international competitive‐ ness too: world economic forum made public in its 2007 international competitiveness report  that serbia dropped from 87th to 91st place. unprecedented global upward trend in crude oil prices  aggravated the terms of trade and bop problems further still. however, traditional current account  troubles are getting deeper in parallel with certain new developments regarding financial account  and international capital flows, as outlined in what follows. while in the first half of the decade  serbia’s capital account surplus stemmed primarily from privatisation revenues (clearly finite in  amount and duration) which were by and large currently spent rather than invested, in 2005 and  2006 subsidiaries of foreign banks operating in serbia were the ones who borrowed significant  funds abroad very cheaply (at 2‐4% p.a.) in order to profit from financing central bank’s admittedly  expensive sterilisation activity (20% p.a. on the average). as a consequence, serbia’s sovereign debt  in 2006 marked a 9% decrease in real terms, whereas foreign indebtedness of private sector ex‐ ploded 70% up! however, in 2007 owing to monetary policy switch and administrative obstacles  imposed by the national bank of serbia (hereafter nbs), this form of carry trade sui generis gave  room to considerable cross border lending of the corporate sector in serbia. that latest develop‐ ment  is very much encouraged by official claims of serbian monetary authorities in support of  long term “reality” and sustainability of current dinar exchange rate. as a corollary, back in 2006  only three european transition countries (bulgaria, latvia and montenegro) had deeper current  account deficits and estonia had deficit of approximately the same size measured in percentage of  their respective gdps [ebrd, 2007]. so one should not fool him‐ or herself with patronising com‐ ments of politically correct analyzers that serbia’s bop deficit and foreign debt are still not that  large in absolute terms. at the end of 2007, serbia’s current account deficit reaches disturbing 16%  of gdp14, while its foreign debt amounts to almost 60% of gdp.   in a nutshell, serbia is facing potentially exhausting and quite certainly unavoidable bop cri‐ sis, which once again neither generally condemns running bop deficits in its transition years nor it  has to end in complete macroeconomic doom. yet, it easily might…and probably will if serbian  authorities and its economic agents continue to ignore the crisis in the making. so to sharpen the  working light thrown on the bop challenge in serbia, this paper does not claim the inevitability of  murphy’s breed: “nothing works and whatever may go wrong, will”, but rather underlines inevi‐ 12 worsening of serbia’s bop would appear even clearer if 2004 and 2005 deficits were amended downward and upward,  respectively, due to vat introduction effect which increased imports in 2004 and curb them in early 2005 causing a priori  tax evasion. see e.g. petrović and vasiljević (2007).   13 strictly speaking, industrial wage growth has been more or less aligned with industrial productivity in serbia from  2005 until present. however, sharp real appreciation of dinar during 2006 and 2007 together with inherited excessive  employment in state owned and pumped‐up employment in government sector post‐october 2000 caused that overall  serbian productivity still lags behind the growth of salaries. already executed and announced wage and pension growth  substantiate fears of continued fiscal expansion through the first part of 2008 too.  for more information on interplay  between unit labour costs, wages and competitiveness in serbia see petrović and vasiljević (2007).   14 once properly expressed in constant prices, bop deficit may turn out to be even slightly larger.  2007 ‐ 32  •  economic analysis®  tability of macroeconomic identities and market forces: “what cannot go forever, will eventually  stop”.     so, where exactly do we stand, what is the likely crisis scenario, what must happen and what  could be done? in the next section, concerned with ongoing irrational exuberance of investors in  serbia and the so‐called sudden stop threat, i shall try to provide some of the answers to the first  three questions posed. the answer to the last piece of this research rhetoric remains to be met in  the fourth section of the paper.  sudden stop and irrational exuberance in serbia: economics of odds and ends  preliminary conclusion after the basic bop arithmetic and statistical facts on serbian external  economic position laid out above, coincides with recent imf warning that considerable capital in‐ flows  in serbia  (as  indeed  in so many other emerging markets  in  transition) raise  income and  spending, but simultaneously expose the country to striking external vulnerability, which if came  true, would require paramount macroeconomic adjustment [sorsa et alia, 2007]. in the previous  section i have already explained why endless financing of current account deficits is neither sus‐ tainable in the long run nor entirely reliable in the short to medium run. in addition, i shall briefly  reproduce hodrick‐prescott filtered, extrapolated trends of serbian exports and imports of goods  extracted by the serbian statistical office (sbs), to highlight the fact that unlike capital account  surpluses, current account deficits in serbia are apparently not showing signs of self rectification in  the foreseeable future, as much steeper import trend clearly cracks open the trade gap. obviously,  serbia’s external position cannot be further from sustainable and the longer this collective hypnosis  lasts and rapid indebtedness goes on, the harder our eventual landing is going to be.     figure 3. trend components of imports and exports in serbia        in what remains, i argue  that  the inevitable bop adjustment may  lead to either relatively  smooth and gradually relaxing steady‐state equilibrium or may take the bumpy road through very  costly recession, even a genuine economic plunge. at the moment, it is difficult to prophesy which  of the two adjustment paths will (have to) be travelled, since the outcome depends on plethora of  both exogenous and inherited factors. however, not least shall it pend on the readiness of eco‐ volume 40 • spring 2008 • 33  nomic authority to face the adversity already upon us, on determination and coordination in carry‐ ing a dozen of cumbersome reforms inclusive significant depreciation of national currency!  in order to produce a snapshot of the current serbian macroeconomic challenges and deci‐ sion makers’ reaction function at hand, we shall draw upon already mentioned “bermuda trian‐ gle” analysis in open‐economy macro and determine whereabouts and results of economic policy  mix deployed in serbia thus far.     figure 4. serbia ‘s whereabouts in a latin triangle    adapted from: dornbusch (2000)    according to dornbusch (2000), along the yy line there is a full employment, whereas any  level of output ahead of natural rate y* creates an excess demand in the labour market, loss of  competitiveness and possibly hyperinflation. external balance is represented by bb schedule so  that points to the right and above bb indicate deficits and vice versa. finally, ww line defines so‐ cially acceptable real wage cum benefits package of those employed. in absence of the first best  world, there is no common point of intersection between the three schedules. at the point a, policy  makers achieve maximum output potential, full employment and manage to keep the labour fi‐ nancially satisfied, but at the expense of bop deficit. at the point z social piece prevails and exter‐ nal balance is kept, but unemployment is high and output is depressed. at point v, however, au‐ thorities maintain both external balance and full employment, yet at the brink of social unrest: real  wages are dangerously low. now it is of interest to summarize within dornbusch (2000) latin tri‐ angle framework the macroeconomic evolution of serbia after being catapulted by positive politi‐ cal and economic shock of democratic revolution and transition from 2000 onwards. thanks to  injected  aid,  low  starting  point  and  post  revolutionary  euphoria/impatient  expectations,  target  wages quite expectedly rose! reforms were hasty in serbia (in part because enough time was lost  already) and the natural antagonism between aspirations and constraints has been reconciled in  exactly the same way as many times before in latin america: through borrowing [ibidem]. serbian  b b w w y y y* (at which u=0) 2007 ‐ 34  •  economic analysis®  authorities gave their best to push the country to the north east by maintaining high rates of out‐ put growth and increasing the real wage, while bop kept collecting the bill. however, external fi‐ nance disequilibrium (mirror image of current account deficit) can be postponed only up to the  stochastic point in time when international capital inflows run out. in my opinion, as indicated on  figure 4, serbia’s contemporary position is in the upper middle part of the latin triangle; its’ real  wage  is pretty close  to social welfare optimum, but misery of unemployment still cripples  the  overall living standard in the country, whereas bop deficit got clearly worse and needs urgent at‐ tention. policy maker’s reaction function that would move the country in direction of z, amounts  to trying to cut the absorption, contract gdp while still protecting real wages. nevertheless, mov‐ ing too far a left from point a bites into social piece since unemployment would be raging and re‐ cession guaranteed, and thus has to be dismissed.  the only reasonable reaction which stands the  chance to find the way out of crisis is restoring competitiveness and reverting the fundamental  macroeconomic disequilibrium, i.e. heading towards point v, while simultaneously reforming ser‐ bian economy in order to translate not only ww schedule southwards, but ‐in the medium to longer  run‐ also shift bb schedule to the north‐east!15 in the realm of sticky prices and downward‐resistant  wages, deflation or even administrative freezing of prices/wages probably wouldn’t prove terribly  effective. hence, dinar depreciation would have to be the key ingredient of decision maker’s reac‐ tion function. in fact, a traditionally built case for floating exchange rates is that they speed up and  partially substitute necessary macroeconomic adjustment in terms of bop scales, or to put it differ‐ ently,  that  appropriate  nominal  depreciation  makes  up  for  lack  of  downward  price  flexibility  [devereux‐engel, 2006].16 not withstanding the fact that a fall of wages in real terms will recover  serbian competitiveness, it is fair to say it will most likely reduce aggregate demand cum national  output in the short run. nonetheless, this negative income effect could be more than offset in the  medium run by the positive substitution effect that shifts demand onto domestic products [dorn‐ busch, 2000].    ongoing and by now immediately visible credit boom in serbia is threatening serbian exter‐ nal debt sustainability and invoking a bop crisis. it is well known that faced with debt crises, if not  ex ante then certainly ex post, international creditors and their state representatives are inclined to  demand from the debtor government to sovereignize external private obligations. therefore, nbs  is right in warning against such a steep credit growth in serbia (in parallel with early sovereign  debt repayments and falling indebtedness of banking sector due to injected recap, there is almost  20% credit growth in the first three quarters of 2007). despite of nbs efforts to mitigate such a  credit explosion via introducing vast reserve requirements (45%) for banks borrowing abroad, as  especially worrying emerges cross border lending, i.e. direct external indebtedness of private cor‐ porate  sector  in  serbia  which  amounts  to  more  than  9%  of  2007  gdp  [nbs,  2007],  [petrović‐ vasiljević, 2007].17 consumer credits have also exhibited considerable growth momentum at 4% p.a.  15 i’m well aware there are plenty of serbian economists who are going to shout “impossible!” at this instance. namely,  who are going to dwell on serbian traditional import‐dependence, dubious prospects of marshall‐lerner condition ever  been fulfilled in serbia etc. be that as it may, i would like to face those of my distinguished colleagues with an alterna‐ tive. first of all, history of economic thought keeps reminding us that successful growth strategies have always been  rooted in maximising the output made with disposable resources, never in winging about scarcity and limitations. at  last but not the least, if serbia continues to pile up foreign debt in trying to achieve y*, maintain uncompetitively high  ww and consciously sacrifice bop equilibrium, we may expect over time bb schedule to shift south‐east instead, which in  turn would require multiplied pain and belt‐tightening to eventually equilibrate its external position.    16 in the end of the day, dragutinović (2007, p.9) rightfully argues that if serbian monetary authorities restrain from any  activism and informed judgment in monetary policy making whatsoever, serbia would be better off in opting for out‐ right dollarisation.  17 in the quoted figures, petrović and vasiljević (2007) stress that extraordinary loan taken by serbian telecom in order to  execute acquisition of telecom of srpska (b&h) has been disregarded, or else cross border lending in serbia would have  reached over 11% of gdp!   volume 40 • spring 2008 • 35  and 5%p.a.  in 2006 and first  three quarters of 2007 respectively  [ibidem]. reported steepness of  credit boom in serbia comes at the moment when there is no more low credit base to calm us, since  serbian credit aggregate already amounts to  just over a third of serbian gdp. many economists  think this is still moderate as opposed to credit stocks of 40, 50 or even 60 something percentages  of gdp in neighbouring countries [petrović‐vasiljević, 2007], [sanfey, 2007]. however, compared  with production and export potential18, stability of business climate and the level of country risk,  serbia fares far worse than the rest of balkans and might be closer to imminent danger of credit  crunch and sudden stop crisis. lorenzoni (2007) accurately describes such a constellation (without  mentioning serbia) in a theoretical model of inefficient credit boom, where financial frictions result  in a priori overborrowing and a posteriori excessive volatility. the inefficiency of transitional boom‐ bust cycle is provoked by combination of two factors:   first of all, there are probably traces of moral hazard kind of behaviour on behalf of interna‐ tional investors, as suggested by krugman (2000) or roubini and setser (2004), among others.19  furthermore, there is imperfect or imprudent understanding20 ex ante [sorsa et alia, 2007] and lim‐ ited commitment ex post in de facto international financial contracts credit booms are made of [tor‐ nell‐westerman, 2003], [lorenzoni, 2007]. to the extent, correspondent overborrowing and lack of  financial commitment could be blamed on reassurance repeatedly being made by the nbs that  dinar exchange rate against the euro is not misaligned, is here to stay at the current level and, god  forbid, shall be defended by official reserves interventions. apart from moral hazard or sheer bad  judgment on either side, the second remaining determinant of transitional credit boom’s  ineffi‐ ciency is the fact that asset prices are being discovered almost exclusively in the spot market, an  externality not internalised in private contracts [lorenzoni, 2007]. even more so in emerging mar‐ kets where forward markets are pitifully underdeveloped or nowhere to be seen.   kiss, nagy and vonnak (2006) summarize a recent empirical research done by imf and find  that 70% of credit booms in emerging market world ended in simultaneous consumption and in‐ vestment boom, while the coincidence probability of credit boom and output boom appears to be  rather low. credit explosions in emerging markets are furthermore often accompanied by sharp  real  appreciation of national  currency  and overvalued  stock  markets,  followed  by ostentatious  drop in prices of these assets at the onset of credit growth adjustment [kiss‐nagy‐vonnak, 2006].  sounds familiar? serbian bop crisis is almost certainly going to take the guise of sudden stop phe‐ nomenon. sudden stop in dynamics and size of capital inflows, frequently reversed into net capital  outflows with mind‐blowing speed, may indeed be brought about or called upon by global ad‐ verse political or economic events, common  lender paradigm and alike exogenous parameters.  however, sudden stops are first and foremost national credit events, which expose certain weak‐ nesses after which ‐practically overnight‐ countries find themselves bereft from hard currency in‐ flows [calvo, 2006].  18 the volume of serbian exports currently stands at only 27%, one of the lowest in western balkans, while serbia’s seem‐ ingly high 8 % points increase of exports from 2002 till present, as a matter of fact, is still below average in emerging  europe [imf, 2008].  19 international lender’s moral hazard implies the risk of creditor’s willingness to extend credit/or otherwise exploit the  international interest differential, which rests on expectation that either political pressures or actual emergency lending  by imf/g7 will secure the full repayment in crisis times [roubini‐setser, 2004].  20 sorsa et alia (2007) argue that among foreign bank/company subsidiaries in host countries there may be hidden matur‐ ity mismatches since a loan from a parent bank or enterprise booked as a long term may in practice be called at will. on  the other hand, some ad hoc research prompted nbs top officials to repeatedly warn serbian citizens on exchange rate  clause in their credit contracts which effectively leaves them vulnerable to downside currency risk.  2007 ‐ 36  •  economic analysis®  at  the end of milosevic era, external sovereign debt of serbia  together with montenegro  (fry at the time) was some 12 billion us$.21 many serbian economists back then kept arguing that  such a high foreign debt was unsustainable. at the time of this writing, serbia alone accumulated  over 16 billion € of external debt, however, chorus of those very same serbian economists today  claims that this external debt and current account deficit could be sustained indefinitely.22 on the  other hand, not more than a dozen of academically trained serbian economists23 in the last 20 years  dared to utter that, when bop is in deep disequilibrium, theory of international finance suggests  that there must be something wrong with the exchange rate too. nevertheless, several of these dis‐ sonant views have been predicting not only that dinar ought to be devalued/was in for a fall, but  also a harsh macroeconomic price to be paid on a line of duty. contribution of this last two remain‐ ing sections, however, is in explaining 1) not whether, but whenabouts and why dinar must even‐ tually fall, 2) how this in fact may be the good news for serbia and 3) under which conditions mac‐ roeconomic doom won’t really materialize in spite of initial adjustment hardships. persistent ex‐ ternal deficits in serbia are being increasingly financed by recent rapid accumulation of private  foreign debt. a million dollar question in sudden stop models of bop crisis is whether investors  could be taken as forward‐looking? do they in fact take into account the size of foreign debt and  production potential of serbian economy while estimating the prospects for future dinar decline?   or are we, perhaps, witnessing some sort of investor myopia or simple we‐can‐get‐away‐with‐it   logic (either by capital flight or by international/domestic pressures for post festum bail‐out)? either  way, we’ve got an irrational exuberance equivalent to ignoring the “peso problem”24 and bop crisis  which should be amended or indeed resolved by nominal depreciation of dinar.25 opponents of  this policy are expressing fears  that an abrupt sudden stop crisis and subsequent hard landing  would cut off the supply of foreign savings on which serbian economy has become so heavily de‐ pendant.  by building on portfolio balance model of exchange rate, krugman (1989) explains on us  example why reducing harsh external imbalances requires real depreciation by deficit country.26  however, krugman (1989, 2007) argues that actually there is never an immediate capital flow re‐ versal! when irrational or imprudent foreign investors realize the unsustainability of host coun‐ try’s  bop  position,  its  foreign  debt  and  subsequently  currently  prevailing  exchange  rate,  they  would indeed try to simulate a sudden stop: everyone shall try to rebalance their portfolios and  come out of troubled country (positions). instead, however, when everybody is trying to sell in  capital markets, what usually happens is not a realization of massive selling (capital flow reversal),  21 after nine years of penalty interest rates, due to unilaterally broken payment ties by the international community and  hammering effect of economic and financial sanctions against yugoslavia.  22 for further discussion see for example kovačević (2006).  23 noticeable exceptions are oskar kovač and mladjen kovačević, to name the most prominent two.   24 if speculator’s perceptions about the future value of exchange rate prove to be seriously wrong, whereas spot rates  nonetheless immediately move in anticipation of fundamentals that fail to materialize, than the ex post realized bop  crisis and exchange rate misalignment represent a mirror image of a classical peso problem. or in krugman’s (2007) own  terminology, realization of antagonism between  ballooning  foreign debt and  overshooting real exchange rate brings  about the wile e. coyote effect. however, blanchard (1979) proposed an alternative explanation, other than irrational  exuberance, that he dubbed rational bubble. i call it imprudent exuberance or the moral hazard bubble. anyway, rational  bubble exists when speculators are more or less aware of the imminent overvaluation of dinar, but continue to hold it for  a while after while longer, enjoying and reinvigorating its appreciation. in other words, foreign investors believe they  will either be compensated for currency risk with more than sufficient capital gain or will be able to come out of their  dinar positions just before depreciation gains momentum.   25 it goes without saying that in a world of sticky prices nominal currency depreciation helps facilitate necessary real  exchange rate adjustment [krugman, 1987].  26 in an earlier paper, krugman (1987) dismisses ronald mckinnon’s myth (yet another ancestor of lawson’s doctrine)  that under perfect international capital mobility, little or no real exchange rate changes are needed to globally redistrib‐ ute savings and close saving‐investment gaps.   volume 40 • spring 2008 • 37  but rather a huge drop in price of the underlying asset (and its denomination vehicle), in this case  the real exchange rate [krugman, 1989].    with remarkably little amendments, serbian bop crisis and required real exchange rate ad‐ justment can be depicted under the framework laid out by krugman (2007) and corsseti (2007).  real exchange rate mechanics is given by following behavioural equation:  ε®=f(df , δe)                    (7)  (δe+, ε®‐), (df +, ε®±srlr)  real exchange rate ε® is a negative function of expected rate of dinar depreciation  δe, while  real exchange rate depreciation itself is defined as dε®/dt<0. because of portfolio balance effects,  dinar exchange rate is also a function of serbian international investment position – its’ net external  debt expressed in percentage of gdp. in the short run, net capital inflows and debt accumulation  may cause a surge in real exchange rate, but excessive foreign debt and bop deficits require a real  depreciation in the long run.27 sustainability criterion in krugman’s (2007) analysis is not simply  stabilizing current account deficit as a % of gdp, but rather external debt to gdp ratio. the differ‐ ence is in the fact that external disequilibrium measured by latter method takes into account both  gdp growth (denominator changes28) and capital gains or losses. tolerable bop deficit is repre‐ sented by bb schedule in figure 5, as geometric locus of points at which valuation‐corrected cumu‐ lative current account disequilibrium is a stationary variable, given zero expected change in the  exchange rate (df= const.) [krugman, 2007]. dfdf schedule shows foreign debt evolution provided  that δe=0, i.e. investors do not expect any future depreciation of dinar. however, under fully ra‐ tional expectations, macroeconomic adjustment would happen along the saddle path ςς in figure  5.     figure 5. real exchange rate, debt/gdp dynamics and bop adjustment       source: krugman (2007)  27 forward looking prudent agents understand this relationship and behave accordingly, which is why rational expecta‐ tions equilibrium tends to be saddle point stable.  28 if effectively deployed, increase of foreign debt should bring down external debt to gdp ratio, i.e. decrease the rate of  foreign indebtedness!  b b s.t. ddf/dt=0 ς ς df df s.t. e( dε®/dt)=0 ε® df 1 2 2007 ‐ 38  •  economic analysis®  the actual debt dynamics in corsseti‐krugman model is described by equation (8):  dfstac =df0+ k‐1 ddf0/dt                (8)  after log‐linearisation of the model, it is also possible to describe relationship between initial  (ε®0), current (ε®) and long run equilibrium value of real exchange rate (ε®stat), consistent with  steady state debt dfstat and sustainable current account dynamics:  ln ε®stat=(ektln ε®‐ln ε®0)/(ekt‐1)              (9)  krugman (2007) dubs parameter k the rate of convergence, i.e. speed and size of elasticity of  foreign (serbian) demand for serbian (foreign) assets,  but, following corsseti (2007),  it is perhaps  more convenient and closer in spirit to portfolio models of exchange rate, to think of it as being  degree of substitutability between domestic versus foreign bonds. i venture to guess that serbian  bop adjustment will be characterised by low substitutability, moderate real depreciation on impact,  yet fast and furious drop in real exchange rate along the saddle path of accommodation. to put it  differently, after some kind of economic shock or even political sunspot, investors shall wake up  and take a better  look at long run equilibrium exchange rate as well as dinar denominated ex‐ pected return: subsequently, economy would arguably  jump from point 1 on dfdf curve south‐ westwards to the point 2 on saddle path ςς [krugman, 2007]. in the case of serbia, likewise, this  crude awakening from irrational exuberance won’t cause a free falling of dinar, i.e. a drop directly  to the south (and consequent tightening of the debt noose), due to valuation effects of ongoing sig‐ nificant dollar depreciation, in as much as serbian net foreign debt is denominated in weaker us$  (see figure 5).  in addition, chari, kehoe and mcgrattan (2005),  in a standard equilibrium model within  which sudden stops are generated by tightening country’s collateral constraint on foreign borrow‐ ing, show that contrary to widespread opinion, sudden stops cause a surge rather than contraction  of gdp! they stop short of arguing that capital flow reversals cannot be linked with output drops,  but in order for output contraction to be generated by bop crisis, their model must include addi‐ tional economic frictions, with negative effects large enough to overturn the positive effect of sud‐ den stop alone. an obvious suspect in the case of serbia is conceivably a real estate bubble: i.e.  whether sudden stop phenomenon would cause its burst or not. as many other emerging markets,  serbia has also become a fertile ground for development of real estate bubbles. real estate bubbles  are initially beneficial since they temporarily provide local stores of value&sources of income and  increase investment in construction industry. however, caballero and krishnamurthy (2005) for‐ mally demonstrate how domestic financial underdevelopment not only facilitates the real estate  bubbles, but also induces agents to underestimate the aggregate risk embodied in the overall real  estate frenzy. to the extent that emerging market monetary policy cannot possibly be so counter‐ cyclical as it would be in the oecd countries, sudden stop in serbia might easily lead to one or  two year long recession.   algieri and bracke (2007), after applying multinomial logit model on 71 episodes of bop cri‐ sis, find that on average current account deficit correction has been accompanied by mild recession  and some real effective depreciation of national currencies. cluster analysis deployed to account  for wild heterogeneity within a sample led them to conclude that majority of incidents has never‐ theless been resolved by internal adjustment, where fiscal and monetary contraction were paired  with export reorientation.29 in half of remaining episodes, adjustment has been mainly external,  enabled and catalysed by real depreciation yet without economic slowdown [algieri‐bracke, 2007].  however, in about ¼ of cases external adjustment has been preceded by sluggish growth or even  outright recession, possibly reflecting competitiveness challenge of these countries [ibidem].  29 it is important to stress that this dominantly internal adjustment seems to be characteristic of fast‐growing economies.  volume 40 • spring 2008 • 39  what are the prospects for serbia in this respect? what should be done to avert the danger of  deepening the crisis? the answer to that is sketched along the last section of the paper, but it may  be summarized in: it all depends, and quite a bit. some things are for sure, however. first of all, i  have explained that if we set aside common investor problem, sudden stop will not lead to imme‐ diate nor durable negative financial spillover, but rather to a drop in the value of national currency.  i have also elaborated why foreign investors won’t be willing to cover the gap between serbian  accumulation and investment indefinitely, which makes real depreciation and perhaps some in‐ termittent capital flight look like arguably good news. hence, decision makers in serbia need not  fear that dinar decline would cut off the supply of foreign savings, because serbia’s chronic de‐ pendence on it does not represent sound  international finance at all and  is not sustainable any  more! on the other hand, serbian nationalists would be barking under the wrong tree if they ac‐ cuse exchange rate policy of fire sale of serbian assets that may ensue. it just might prove to be the  unavoidable part of portfolio accommodation process. as krugman (1989) once rightfully articu‐ lated, the only way to avoid a fire sale is not to need one, in other words, to decrease domestic (es‐ pecially import‐oriented) spending and thereby avoid over‐reliance on foreign capital inflows.    concluding remarks: underaged patients and chronic conditions call for heterodox  medicine  serbia has been squandering too much for too long, while it has one of the lowest propensi‐ ties to invest in today’s europe. to make bad situation worse, imminent bop crisis is amplified by  persistent overvaluation of dinar  (which  further discourages exports&domestic production and  encourages imports) as well as by 25% unemployment (at the end of december 2007). speculative  capital inflows succeeded by cross border lending are swelling serbian private foreign debt in re‐ cent years, while inflation is being controlled by allowing real appreciation of dinar and price con‐ trol in public sector. all of the above mentioned is extremely bad news and represents a textbook  example of erroneous macroeconomic policy. what could be done to tackle those problems more  appropriately on fiscal, monetary and official reserves policy fronts?  in terms of monetary and exchange rate policy, the sooner monetary authorities choose to al‐ low for real depreciation of dinar (of probably over 30% to be spread across the next say 6 years),  the smaller the damage is going to be. what should be the response of monetary policy in the im‐ mediate post‐depreciation time span? the chances are that severe monetary contraction followed  by a sharp interest rate cut should do the trick, as suggested by braggion, christiano and roldos  (2007). raising interest rates should help mitigate the fire sale effect and provide a cushion for  binding  collateral  constraint,  while  as  adjustment  difficulties  wear  off  interest  rates  might  be  gradually set to their tranquil or even lower level. however, serbian central bank chose bad mo‐ ment (and with no obvious urge) to oblige to bringing down core inflation forecast in 2008 as op‐ posed to core inflation target for 2007. inflation of agricultural product prices as well as ongoing oil  crisis would be conceived by many as hard enough already, while in addition to that, nbs appears  to be ignoring the need for real depreciation of dinar (and its price level consequences) by pro‐ claiming perhaps unrealistically low 3‐6% core inflation band for an official target just after serbian  headline inflation forecast of 2007 has been de facto overshot. if not carefully calculated, inflation  and  exchange  rate  targets  may  mess  with  each  other,  resulting  in  divergent shivers  down  the  monetary stability spine.30 luckily enough, exchange rate pass‐through in serbia is found to be  much less than unity [arsić et alia, 2005], which gives reasonable room for restoring competitive‐ 30 even more so since ‐in the event of sudden stop crisis‐ interest rate spreads on domestic bonds may tilt for more than a  notch, thereby making inflation targeting considerably more expensive yet again [calvo, 2006].  2007 ‐ 40  •  economic analysis®  ness and external balance without too high a price in terms of reflation havoc. that said, i must  warn against the odds that under domestic liability dollarisation of current serbian scale, smaller  pass‐through coefficients may actually increase the probability of financial distress, if marshall‐ lerner condition is satisfied too late! therefore, nbs should do all in its power to overwhelm “the  original sin” constraint, partially at least. on the other hand, it is hardly anything but futile for  governor of nbs to repeat that exchange rate is market‐determined (since serbian central bank  recently intervenes only infrequently) [jelašić, 2007], because that would be equivalent of central  bank setting the money supply and leaving the price of dinar entirely to fx market [calvo, 2006],  while in practice nbs sets the interest rate –rather than monetary aggregate‐ and justifiably ma‐ nipulates  both  inflation  and  exchange  rate.  finally, on  many occasions  market  determined  ex‐ change rates proved  to be capable of differing starkly from fundamental equilibrium exchange  rate: irrational exuberance and/or sheer moral hazard, in my opinion, can serve as quite plausible  explanation for local fx market failure.   when  it  comes  to  the  interplay  between  monetary  policy  and  asset  prices,  government  should do more in creating technical platform, legal environment and disseminating knowledge  that would boost financial instruments which provide residents with adequate store of value [ca‐ ballero‐krishnamurthy, 2005], [dragutinović, 2007]. if depreciation affects negatively the net worth  of domestic firms or badly hurts real estate by and large, the domestic interest rate may rise (due to  the risk premium effect), «(...) exerting an additional contractionary impact on output. if, on top of  that, the monetary authorities force a further increase of the interest rate in an effort to curb the  exchange rate, the contractionary effect will be emphasized» [delli gatti et alia, 2007, p.27]. less  often, however, research is focused on how if at all, asset price movements affect the conduct of  monetary policy [clarida‐waldman, 2007]. this reverse causality  is especially  important should  the event of double bubble occur, when simultanious downward revision of expectations about the  future value of dinar and expectations about future price of houses31 may push long‐term interest  rate either way [krugman, 2007]. however, demand for housing in fast growing poles of serbia is  such that potential piercing of the real estate bubble is hopefully unlikely to crumble into a genu‐ ine slump.   monetary policy has a difficult and unpopular job in contemporary serbia. true, there is no  help from fiscal policy yet,32 whereas inflation pressures are being generated outside central bank´s  reach so to speak: they are to be pinned to lack of competition in nontradable sector, jump of world  and government‐controlled prices and consumption biased preferences of  serbian population. if  inflation targeting in serbia is being implemented through some sort of taylor rule, than higher  expected inflation counterintuitively results in nominal appreciation of dinar on impact, as sug‐ gested by clarida and waldman (2007). this is another channel of perverse exchange rate move‐ ment recently witnessed in serbia, which only postpones eventual rectification of its fundamental  misalignment. if, however,  inflation  targeting  is being  implemented via some sort of monetary  conditions index, this short run collusion should be imediatelly recognised while inflation, output  gap‐33 and exchange rate targets better harnessed in a cointegrated manner, but monetary policy  31 you may also think of those as of suddenly depressed secondary market price of mortgages, due to massive payment  inability and defaults brought about by dinar depreciation and diminished real wages.  32 the thing is that lowering government expenditures ‐ the kind of help nbs is expecting from fiscal authorities is  probably not viable, since it would hurt population stratum with still the lowest (if partially non deserved) level of in‐ come. as contradictio in adiecto, public outcry for decreasing excise duties on petrol&oil derivatives (so that nbs could  ease a bit its unpopular monetary restriction) would boil down to fiscal expansion, hardly a helping hand in nbs’s bop  and monetary stability assignments.    33 it seems that lately, trade liberalisation and financial globalisation have been increasingly efficient in reducing output  gap fluctuations, hence to the extent emerging markets are really opened and accepted, small economies in transition  should in time put smaller and smaller weight on output gap in central bank’s utility‐based loss function, i.e. put greater  volume 40 • spring 2008 • 41  task still remains a tough one, since 70% of all deposits is in foreign currency and 70% of loans is  indexed to euro (or swiss franc).   if we turn back to equation (3), it is straight‐forward that fiscal policy must be more restric‐ tive, despite roughly balanced government budget.34 private sibling`s dissipation urges for equiva‐ lent budget surplus which should relatively swiftly suck out excessive liquidity out of corporate  sector and households. i would advise this fiscal restrictiveness to consist of progressive tax in‐ crease primarily and expenditure cuts only in terms of costly and ineffective subsidies as well as  hidden unemployment in the public sector.  the reader should bear in mind that inevitable dinar  depreciation by definition dwarfs the absolute (let alone real) value of fiscal revenue since vat is  charged on imports too, which means that during initial stages of bop crisis fiscal restriction must  be even more pronounced. needless to say, there is absolutely no room for further increases of the  aggregate wage fund of civil servants and government should not back down before the syndicates  in this regard. on average, individual nominal wages in government sector ought to stay where  they are, and for quite some time so.  however, i would dare to say that official foreign exchange reserves in serbia are by any  measure  counterproductively  high.  presumably,  nbs  is  guided  by  the  so‐called  greenspan‐ guidotti‐obstfeld criterion on size and use of reserves, according to which huge foreign exchange  reserves are encouraged in emerging market countries in order to stave off bad equilibria of specu‐ lative nature [calvo, 2006]. the optimal stock of official reserves is always a function of their po‐ tential decumulation. currency crises of the 1990s thought us that reserves are not intended only  to fill the financing gap in case of extraordinary/cyclical bop deficits or whether the problems with  favourable  roll‐over of  external  short‐term  debt.  speculative  attacks  on  currencies of countries  whose macroeconomic health was in «the grey zone», and intricate multiplicity of equlibria that  emerging  markets  may  encounter,  have  dramatically  catapulted  the  optimal  level  of  reserves.  obstfeld (1996), in his seminal contribution, showed very forcefully how the size of international  reserves could prove to be of utmost importance in this coordination game. if reserves are expected  to prop up the lender of last resort duty of central bank rather than a few months of imports, then  m2 or even broader money concept is more appropriate denominator as opposed to short‐term  foreign debt [calvo, 2006].   however, reserves are not the only macroeconomic fundamental of  concern: moreover, it  is rather dangerous to intellectually nurture a misconception of the kind.  within a stochastic dynamic equilibrium model calibrated to a sample of emerging markets, alfaro  and kanczuk (2007) demonstrate that huge reserves do not play a crucial role in successful reserve  management. in fact, they show that the optimal policy is not to amass reserves at all, and their  finding seems to be fairly resilient to introducing interest rate shocks, sudden stops, contingent  reserves etc. [alfaro‐kranczuk, 2007]. on the other hand, i disagree with some critics who argue  that these excess funds could get a much higher rate of return if invested by the state in alternative  uses. as a matter of fact, they perhaps would, but then they wouldn’t be reserves any more. never‐ theless, if those excessive reserves are accumulated by this or that type of borrowing,35 thatʹs quite  another matter, as one may legitimately ask how economical is this window‐dressing business and  what kind of insurance against sudden stop these reserves really represent?! calvo (2006) suspects  mercantilist objectives behind such a large accumulation of reserves, more concretely, a misleading  desire to generate an artificially high real exchange rate! sounds familiar? but even if one abstracts  emphasis on reducing inflation [loungani‐razin, 2005]. this implies that as serbia progresses in its european economic  and financial integration, the opportunity cost of giving up national currency is going to be gradually reduced.  34 i don’t expect budget deficit in 2008 to exceed 3.5 % of serbia’s gdp.  35 in serbian case world bank loans, reserve requirements etc. of course, there’s another associated issue of difference  between gross and net foreign exchange reserves in respect to off‐balance sheet liabilities, short to medium term sover‐ eign debt and alike.   2007 ‐ 42  •  economic analysis®  from the above written, in financially scorched and hence rather risk‐averse latin america, inter‐ national reserves went up to around 37% of m2 on the average in 2006, which is a stunning 10%  higher than in pre‐crisis 1994 [ibidem]. in serbia, this figure ranges from 270‐260% in the last two  years! enough said... now, for quite some time, iʹve been defending the idea that faced with net  capital inflows from outside world and inflation cum competitiveness concerns from the inside,  early repayment of external debt is superior policy response to costly and ineffective sterilisation.  it took two years before nbs came to the exact same conclusion. many economists presently argue  that this policy wisdom is pretty much exhausted, since acute portion of serbian foreign debt is of  private origin. however, fiscal restriction advised earlier could still serve as leverage for further  early debt repayment! this is reasonable enough (if confusing at first), having in mind numerous  examples of a posteriori forced sovereignisation following debt repudiation or default. in addition  to that, prasad and rajan (2005) laid out perhaps even more valuable mechanism  for optimal re‐ serve management  in small open economies experiencing  large capital  inflows. their proposal  essentially amounts to securitising a part of net capital inflow through (government‐controlled)  investment fund shares denominated in domestic currency, purchasing euros from central bank  out of investment proceeds and subsequently investing them abroad. this strategy would elimi‐ nate the fiscal costs of sterilisation, while simultaneously enabling private financial outlet for asset  bubbles and headline inflation, or to put it differently, it would stimulate both international portfo‐ lio diversification and development of domestic financial market. most importantly, prasad and  rajan (2005) insist upon the fact that this investment device would allow central bank to actively  manage the quantity as well as timing of capital outflows, a courtesy not to be extended in the  event of sudden stop crisis.  finally, it is important to point out that favourable bop adjustment would require not only an  inevitable real depreciation of dinar to disentangle massive misallocation of resources that went on  for years now, but would also demand determination and speed in fostering competition and dis‐ mantling (in)visible obstacles for domestic start‐ups (diaspora  included) as well as provision of  finance/subsidies for expanding production of exportables. in other words, current account im‐ provement would have to be brought about by dramatic change along serbian savings‐investment  axis, which cannot be accomplished solely via real depreciation of the national currency. many  supporting policies must preconceive and consolidate a fine‐tuned restructuring front in order for  bop deficit to melt smoothly: otherwise, upward trends in nominal exchange rate may, instead of a  helping tool, become part of the problem: both in terms of protracted j‐curve effects and possible  reflation spiral. as devereux and engel (2006) forcefully showed, in the short run, without thor‐ ough  macroeconomic  reform  and  institutional  strengthening  well  under  way,  expenditure‐ switching role of exchange rate movement is likely to be diminished because of low elasticity of  substitution between home and foreign tradables.36 one way or the other, relative size and exces‐ sive price level of nontradable sector would have to be compressed, since any increase in the size  and terms of trade of the nontradable sector requires formidably greater subsequent fall of dinar to  rectify  the  trade  imbalance  [corsseti,  2007],  [sbordone,  2007].  consequently,  if  serbian  society  wishes to stall and minimise the necessary real depreciation of national currency along the bop  adjustment path, then it should do all in its power and beyond, to push down outrageously high  prices of serbian nontradables and push up their quality. trade‐off between the size of nominal  depreciation and  the relative price of nontradables means that  instead of nominal depreciation  induced cost push, nontradable deflation and quality consolidation does similar magic on supply  36 on long run effects of net capital inflows in the external debt‐led growth regime, and a corresponding possibility of  multiple  equlibria  depending  on  speed  of  adjustment  in  the  production  structure,  i.e.  relative  size  of  the  tradable‐ nontradable sector, see kalantzis (2004).   volume 40 • spring 2008 • 43  side, aiming to redirect domestic demand from tradables to locally produced goods, expand the  overall competitiveness of the economy, and with god’s speed, the size of its tradable sector.  intricate, robust and far‐reaching as they appear, these are rather unorthodox pieces of medi‐ cine, it is fair to say. crucially relevant point reiterated in the paper is that even if serbia avoids the  hard‐landing due through inevitable bop adjustment, crisis management cannot rule out –quite on  the contrary‐ it is bound to prescribe a significant real depreciation of dinar. by how much, and  stretched along which period, alas, remain highly debatable issues. fitting the current macroeco‐ nomic and financial constellation of serbia into more formal, perhaps new keynesian real business  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